Investment-Property

When should you not buy a house?

Since the housing bubble burst and prices dropped, you hear a lot of people saying that it's a great time to buy a house. For some that may be true: Interest rates are low, and there are some great bargains on the market. Housing prices and interest rates aren't the only factors when you're considering homeownership, though, and there are times when renting is still the best option.

Even with lower home prices, there are a lot of responsibilities and additional expenses that go along with homeownership. From paying for maintenance to maintaining your ability to move, there's more to consider than just that mortgage payment.

Suitability for homeownership depends on many factors. How's your financial situation? Are you ready to settle down? Some red flags should prompt you to ask yourself if you want to buy a house right now. It might still make sense if just one of these situations applies, but more than one should definitely give you pause, and some carry more weight than others.

Owning a home has its advantages. You can build equity and capitalize on tax savings. You can furnish, decorate and enjoy a place of your own. And you'll likely have extra room to accommodate a growing family. With these perks in mind, why not buy a house?

The answer is simple: Not everyone is cut out to own a home. There are risks involved with this purchase. You could lose money. You'll be responsible for upkeep and repairs. And some people make better homeowner candidates than others.

Crunch the numbers and evaluate your circumstances carefully. Talk to experts like a real estate agent and mortgage lender, too. You may conclude that buying a property is in your best interests. Or you could determine that there are too many uncertainties involved.

Am I Ready to Buy a House?

The Current State of Your Finances

The current state of your finances is perhaps the single most important factor to consider when determining whether you are ready to delve into homeownership. When examining your current financial state, you must answer two questions:

Do I Have Cash Set Aside for a Down Payment? Ideally, you need to be able to put down at least 20% of the cost of the home to avoid having to pay private mortgage insurance (PMI). PMI is a huge waste of money since it essentially just protects the bank's investment in case you default on the loan. Buying a house without a down payment is risky for the bank and you, since you could end up owing more than the home is worth if property values fall. PMI protects the bank, but you won't have a safety net if you haven't put money down on the home.

Can I Afford the Cost of a Mortgage? This question seems obvious, but it is important to think about future mortgage payments, as well as current payments. If you take a fixed-rate mortgage, your payments will not change over the life of the loan, and it will be easier to predict whether you will be able to afford future payments. However, if you take an adjustable-rate mortgage, you may be able to afford the payments now, but not when they adjust upward in the future.

So, why have people taken adjustable-rate mortgages? Usually, it is because their initial interest rate was lower – making it seem like they could afford the mortgage when they really could not. Don't fall into this trap. If you need some type of creative financing to afford your house, then you simply can't afford it.

The Stability of Your Financial Future

This is another important factor when determining whether you should buy a house now or wait until the future. If you have recently changed jobs, if you are thinking about changing jobs, or if you are expecting any major changes to your income, it is not a good idea to buy a house until you are on more solid footing. Banks and mortgage lenders typically require you to have been with your employer for at least a year or two before they will consider you for a loan.

Furthermore, you need to have a plan to pay your mortgage if something does go wrong in the future, such as a layoff or a medical problem. Typically, this means you should have an emergency fund – at least a few months' worths of living expenses – set aside before you buy a home.

An emergency fund can also come in handy to help you to bear all of the unexpected costs that come along with being a homeowner. For instance, having cash set aside for repairs is essential, since you will not have a landlord to call when something goes wrong.

Your Credit Score

The state of your credit is just as important as the state of your finances when it comes to deciding whether you are ready to buy a home. Your credit score determines whether a mortgage lender will give you a loan at all, as well as the rate. A low credit score can result in a significantly higher interest rate, which means that you will pay thousands (or hundreds of thousands) more over the life of the loan.

Typically, you need a credit score above 720 to get the most advantageous rates. If your score is lower, consider waiting a while to buy a house as you try to improve it. You can do this by:

  • Paying down debt
  • Having inaccuracies removed from your credit report
  • Making payments on time every month
  • Avoiding opening new types of credit or applying for new loans

Over time, with responsible borrowing behaviour, old negatives on your report will have less of an impact, your score will go up, and you will be ready to purchase a home at a better rate.

Your Commitment to Staying in One Place

Buying a house entails a large initial expense. First, you must pay the closing costs associated with your mortgage, which can total several thousand dollars. Once you are in the home, most of the initial mortgage payments go toward paying interest on the loan, rather than paying down the loan balance. Keep in mind too that selling your home in the future may also be expensive, as you typically must pay commission to a real estate agent.

With all of these costs, it is very difficult – if not impossible – to make money on a home unless you plan to stay in it for a while. Until recently, many experts recommended that you plan to stay put for at least two years if you are going to buy a home. However, because of an uncertain real estate market and uncertain property values, this estimate has been revised to suggest that you refrain from buying unless you plan to stay put for at least three to five years. If you aren't committed to staying in one place for that duration, now is not the time to buy.

 

The Current Real Estate and Credit Market

While this factor may not be as crucial as the other considerations, you still need to consider it. Look at the current interest rates, and consider the experts' opinions as to whether property values are on the rise, or are likely to fall.

  • If interest rates are at record lows, it may be a good time to buy, as you will pay a reduced cost for the privilege of borrowing money.
  • If property values are on the decline, it may be a good time to wait as you could end up getting a better deal on the same type of home in just a few months' time.

It can be very hard to predict what interest rates or property values will do accurately, so these shouldn't be deciding factors – but they are worth considering.

Your Commitment to Home Ownership

Being a homeowner is different than being a renter. You need to take care of all of your own home repairs and maintenance, rather than counting on someone else to do it. You may have more yard work, as well as additional responsibilities (such as shovelling snow and cleaning out gutters) that renters don't have to worry about. While some people don't mind such chores, others don't want the hassle. Consider whether you are ready to take on these added responsibilities of homeownership before you make your decision.

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Understand Your Debt-to-Income Ratio First

The first, and most obvious, decision point involves money. If you have sufficient means to purchase a house for cash, then you certainly can afford to buy one now. Even if you didn't pay in cash, most experts would agree that you can afford the purchase if you can qualify for a mortgage on a new home. But what sort of mortgage can you afford?

The 43% debt-to-income (DTI) ratio standard is generally used by the Australian government as a guideline for approving mortgages. This ratio is used to determine if the borrower can make their payments each month. Some lenders may be more lenient or more rigid, depending on the real estate market and general economic conditions. A 43% DTI means all your regular debt payments, plus your housing-related expenses—mortgage, mortgage insurance, homeowner's association fees, property tax, homeowner's insurance, etc.—shouldn't equal more than 43% of your monthly gross income.1

For example, if your monthly gross income is $4,000, you multiply this number by 0.43—$1,720 is the total you should spend on debt payments. Now, let's say you already have these monthly obligations: minimum credit card payments of $120, a car loan payment of $240, and student loan payments of $120— a total of $480. That means theoretically you can afford up to $1,240 per month in additional debt for a mortgage, and still be within the maximum DTI. Of course, less debt is always better.

What Mortgage Lenders Want

You also need to consider the front-end debt-to-income ratio, which calculates your income vis-à-vis the monthly debt you would incur from housing expenses alone. Usually, lenders like that ratio to be no more than 28%. For example, if your gross income is $4,000 per month, you would have trouble getting approved for $1,720 in monthly housing expenses even if you have no other obligations. For a front-end DTI of 28%, your housing costs should be under $1,120. 2

Why wouldn't you be able to use your full debt-to-income ratio if you don't have other debt? Because lenders don't like you living on the edge. Financial misfortunes happen—you lose your job, your car gets totalled, a medical disability prevents you from working for a while. If your mortgage is 43% of your income, you'd have no wiggle room for when you want to or have to incur additional expenses.

Most mortgages are long-term commitments. Keep in mind that you may be making those payments every month for the next 30 years. Accordingly, you should evaluate the reliability of your primary source of income. You should also consider your prospects for the future and the likelihood that your expenses will rise over time.

Can You Afford The Down Payment?

It's best to put down 20% of your home price to avoid paying private mortgage insurance (PMI). Usually added into your mortgage payments, PMI can cost between 0.5% and 1% of the entire mortgage loan amount annually.3

Smaller down payment won't mean buying a home is impossible. You can buy a home with as little as 3.5% down with an FHA loan, for example, but there are bonuses to coming up with more. In addition to the avoidance as mentioned above of PMI, a larger down payment means:

  • Smaller mortgage payments: For a $200,000 mortgage with a 4% fixed interest rate for a 30-year term, you would pay $954. If your mortgage were $180,000 with a 4% interest rate for a 30-year term, you'd pay $859.
  • More lender choice: Some lenders won't finance you unless you put at least 5% to 10% down.

Being able to afford a new house today is not nearly as important as your ability to afford it over the long haul. Being able to afford a house and having a down payment doesn't answer the question of whether now is a good time for you to act on that option.

The Housing Market

Assuming you have your money situation under control, your next consideration is housing-market economics—either in your current locale or the one where you plan to move. A house is an expensive investment. Having the money to make the purchase is great, but it doesn't answer the question of whether or not the purchase makes sense from a financial perspective. One way to do this is to answer the question: Is it cheaper to rent than to buy? If buying works out to be less expensive than renting, that's a strong argument in favour of purchasing.

Similarly, it's worth thinking about the longer-term implications of a home purchase. For generations, buying a home was almost a guaranteed way to make money. Your grandparents could have bought a home 50 years ago for $20,000 and sold it for five or 10 times that amount 30 years later.

While real estate has traditionally been considered a safe long-term investment, recessions and other disasters (like the COVID-19 pandemic) can test that theory—and make would-be homeowners think twice.

 

During the Great Recession, many homeowners lost money when the real estate market crashed back in 2007, and ended up owning homes that were worth far less than the price at which they were purchased for many years after.

If you are buying the property on the belief that it will rise in value over time, be sure to factor the cost of interest payments on your mortgage, upgrades to the property and ongoing, routine maintenance into your calculations.4

The Economic Outlook

Along those same lines, there are years when real estate prices are depressed and years when they are abnormally high. If prices are so low that it is obvious you are getting a good deal, you can take that as a sign that it might be a good time to make your purchase. In a buyer's market, depressed prices increase the odds that time will work in your favour and cause your house to appreciate down the road.

It's too soon to tell what will happen to home prices in 2020. But if history repeats itself, we can expect a drop in home prices as a result of the COVID-19 pandemic and its dramatic impact on the economy.

All of these factors need to be weighed and considered when deciding if now is the right time to buy a home. Make sure everyone in your family is on board and that you think with your head, not your heart. If you don't carefully consider every aspect of this important financial decision, you could find yourself struggling to make mortgage payments you can barely afford – or worse, you could find yourself in foreclosure.

Are you ready to buy a house? In short, yes—if you can afford to do it. But "afford" isn't as simple as what's in your bank account right now. A host of other financial and lifestyle considerations should figure into your calculations.

When you factor in all these elements, "if you can afford to do it" starts looking more complicated than it first appears to be, but considering them now can prevent costly mistakes and financial problems later. Of course, there is one best time to pounce: When you find the perfect house in the perfect place for sale—at a perfect price.

 

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