You hate sending that rent check to your landlord every month. The neighbors living above you have a newborn baby that cries all night long. And you dream of planting your own vegetable garden.
In short, you’re tired of renting and you want to buy your first home. But wanting to buy a home and being ready to do so are two different things. Are you financially ready for the burden of a monthly mortgage payment?
Here are five signs that you’re not ready to buy a house just yet. But don’t fret; even if you are struggling with these financial issues, you can still become a homeowner. You’ll just need a bit of patience and improved financial skills.
Sign 1: You Have No Savings
Buying a home is expensive. You’ll need money for a down payment. For most mortgage loans, you’ll need at least 5% of the home’s purchase price. For a home costing $200,000, that comes out to $10,000. If you are buying a home insured by the Federal Housing Administration, better known as an FHA loan, you’ll need a down payment of 3.5% of your home’s final purchase price, depending on your credit score. For a $200,000 home, that still comes out to a down payment of $7,000.
Then there are closing costs, the fees that mortgage lenders, title insurers, and others charge you to originate your mortgage loan. Real estate website Zillow says that these costs can run from 2% to 5% of your total mortgage loan. If you are borrowing $180,000, then your closing costs can run from $3,600 to $9,000.
It’s true that you can get help with some of these costs. You can use gift money from relatives, for example, to pay for all or part of your down payment. You might be able to convince a home’s seller to pay for all or part of the closing costs. But if you don’t have any savings built up, lenders might hesitate to lend you mortgage money. They want to make sure that you have reserve funds on hand to cover your mortgage payment for at least two to three months if you should suddenly run into a financial crisis such as a job loss.
What to Do
It’s best to start searching for a home only after you’ve saved enough money to cover a down payment and your estimated closing costs. Most lenders will also want to see enough money in your savings after you’ve paid closing costs and your down payment to cover at least two months of mortgage payments.
Sign 2: Your Credit Score Is Bad
Your credit score is a key number when you’re applying for a mortgage. Lenders pass out their lowest interest rates to borrowers who have FICO credit scores of 740 or higher. But the lower your score, the higher your interest rate — and your monthly mortgage payment — will be. If your score is too low, say under 640, you’ll struggle to qualify for a loan at all.
What to Do
First, order at least one of your three credit reports from AnnualCreditReport.com. You are entitled to one free copy of each of your three credit reports — maintained by the national credit bureaus of Experian, Equifax, and TransUnion — once every year. Once you get your report, read it carefully. It will list how much you owe on your credit cards and how much you owe on student loans and car loans. It will also list whether you have any late or missed payments during the last seven years. Those late or missed payments will send your credit score tumbling.
Next, order your FICO credit score. You can do this from the credit bureaus, too, but you’ll have to pay about $15 to do so. If your score is low, and there are negative marks on your credit report, it’s time to start a new history of paying all your bills on time. You also need to pay down as much of your credit card debt as possible. Both of these actions will steadily increase your credit score, though it could take months or even more than a year before your score recovers enough to make you a good candidate for a mortgage loan.
Be patient and wait to apply for that mortgage until your FICO score is over 700.
Sign 3: You Have a Mountain of Credit Card Debt
Your debt-to-income ratio is another key number when it comes to buying a home. Lenders want your total monthly debts, including your estimated new mortgage payment, to equal no more than 43% of your gross monthly income. If your debt-to-income ratio is too high, you’ll struggle to earn approval for a mortgage. (See also: 5 Day Debt Reduction Plan)
For many potential homebuyers, large amounts of credit card debt are what shoot that debt-to-income levels past 43%.
What to Do
Pay off that credit card debt. Always make more than your minimum monthly required payment. And wait until you’ve substantially reduced that debt before you add a monthly mortgage payment to your financial responsibilities.
Sign 4: You Routinely Miss Your Monthly Payments
Maybe you have more than enough money each month to pay all your bills on time — you just routinely forget to pay them. Making late payments, or missing payments completely, is a sure sign that you’re not ready for the financial responsibility of owning a home.
If you miss a mortgage payment by more than 30 days, your credit score will fall by 100 points or more. If you miss enough, you could lose your home to foreclosure.
What to Do
Learn better financial habits before you apply for a mortgage. Set up reminders on your phone or computer alerting you when bills are due. Or pay those bills as soon as they arrive to make sure you don’t forget them. It might makes sense to set up automatic payments through your bank. But don’t apply for a mortgage until you’ve broken the habit of regularly missing your monthly payment due dates.
Sign 5: You Don’t Have a Stable Job
You’ll need a steady, reliable stream of income if you use a mortgage to finance the purchase of a home. If you’re worried that you’ll lose your job, or if your income is sky-high one month thanks to overtime and then low the next, you might not be ready to buy a home.
Your monthly mortgage payment will become the biggest financial responsibility you have. What happens if you lose your job? What happens if your company goes through a dry spell in which they reduce your income for several months? Would you still be able to afford that monthly payment?
What to Do
Find a job that is reliable and that pays you a stable income each month. Don’t take the risk that everything will work out. You don’t want missed mortgage payments on your credit reports. And if your job is unstable? You’ll greatly increase the risk of these black marks.