Only fools rush in, and that’s certainly true when it comes to buying your first home. Take this quiz to help determine whether you’re in good enough financial shape to take on a mortgage.
After each question, we’ve provided an explanation that will help you understand why each factor is important to consider before you commit to buying a home.
1. How much of your target purchase price have you saved for a down payment?
a) Less than 5%
b) Between 10% and 20%
c) 20% or more
A 20 percent down payment can help you get a better mortgage rate and terms, avoid having to pay for private mortgage insurance (PMI) and protect you against a drop in property values. On a $300,000 home, you’d need $60,000 to meet this goal. If you’re able to save $30,000 (10 percent of the house’s value) you may still obtain a mortgage, although you will likely have to pay for PMI. You will also need a little extra in your mortgage budget to cover all of the related closing costs. These will be listed in the Good Faith Estimate of costs that your lender is required to give you within three days of your loan application.
2. What percentage of your pre-tax income will you need to pay to cover mortgage, property taxes and homeowner’s insurance on a home in your target price range?
a) 35% or more
b) Between 28% and 35%
c) Less than 28%
When you apply for a mortgage, lenders will look at your debt-to-income ratio to ensure you won’t be stretching your paycheck too far. In general, no more than 28 percent of your pre-tax income should go toward your mortgage, property taxes and homeowner’s insurance. If you put 20 percent down on a $220,000 home, your mortgage will be $176,000, which would cost approximately $1,000 a month to carry. Add taxes and insurance and you’re looking at a payment of approximately $1,500 a month. An annual income of $65,000 would just allow you to cover that monthly payment within the 28 percent limit.
3. What is your employment status?
a) I recently started a new career
b) I am self-employed or work on commission
c) I’ve been on salary at the same company for several years
Lenders like to see at least two years of employment stability, so if you’ve just embarked on a new career, it may not be the best time to buy a first home. Those who are self-employed or work on commission can obtain a mortgage, although they may find it more difficult if they cannot document their income. For more information read our article Employment required for a mortgage.
4. What other debts do you have?
a) I have a substantial amount of debt (such as a car loan, student loan and large credit card balance
b) I have a small amount of debt (such as a small car loan and a credit card balance that I usually pay off every month)
c) I am virtually debt-free
Lenders may be reluctant to approve you for a mortgage if you’re already carrying a lot of debt. The rule of thumb is that no more than 36 percent of your pre-tax income should go to paying off debt, including the 28 percent maximum for mortgage, taxes and insurance. In other words, if your household income is $65,000 and your monthly housing expenses are $1,500, your other debt payments should not total more than $450 a month.
5. What is your credit score?
a) Below 620
b) Between 620 and 720
c) Over 720
The interest rate you obtain on your mortgage will be closely tied to your credit score. And a low credit score may affect your ability to get a loan. A score over 720 should get you a favorable rate.
Adding up your score:
Give yourself zero points for every question that you answered with an A, one point for every B and two points if you chose C.
8 to 10: Congratulations! You’re well-positioned to become a homeowner. You’re in good financial shape and are well prepared to start shopping for a loan. Get no-obligation mortgage offers now through LendingTree.
6 to 7: You may be able to purchase a modest house, however, you may find it a struggle to meet your mortgage payments. It may be wise to save more for a down payment and / or raise your credit score. Within a year or two you should be well on your way to your first home.
5 or less: Your financial situation needs to improve before you buy a house. Spending the next few years improving your credit, paying off debt, building your savings and establishing a stable employment record will bring you much closer to achieving your dream of owning a home. Take the first step by obtaining your credit score through LendingTree.
To get an idea of what price home you can afford, use our Home Affordability Calculator.