Credit scores, mortgage payments, closing costs, household expenses…
If the details of buying a home make your head spin, you aren’t alone. One of the most common questions aspiring homebuyers ask is, ‘Can I afford to buy a home?’
The answer: It depends. There are various factors you should consider when you’re thinking about making your dream of home ownership a reality. Many are based on your personal situation—your household income, your current monthly expenses, how much money you have available in savings, and your credit score.
Let’s dive a little deeper into this question to help you decide if you’re financially ready to buy a home.
Home Affordability Calculators
If you do a quick Google search, you’ll find some great tools that will assess your current financial situation and how it might impact your ability to afford a home.
- Realtor.com Home Affordability Calculator
- Credit.com How Much House Can You Afford?
- NerdWallet Home Affordability Calculator
For example, Credit.com estimates the amount you can afford to invest in a home. These numbers are based on your annual income and monthly payments, as well as the down payment you intend to make. You can also adjust their monthly mortgage payment slider to determine how your ideal monthly payment affects how much home you can afford.
The Standard Rule
According to CreditDonkey, no more than 25% of your take-home pay should go toward housing. You’ve likely heard different numbers thrown around depending who you ask. A lender, for example, will use your gross monthly income (income before taxes) to figure your monthly income. However, it’s important to do your own calculations so you know exactly how much you’re getting from each paycheck.
Another good rule of thumb: save at least three months of housing payments, including your monthly expenses and utilities and a rainy day fund. This will give you a buffer in case unexpected expenses like household repairs arise, and it can be saved even before you become a homeowner.
Is There a Magic Credit Score?
Unfortunately, no. A ‘good’ credit score when you’re buying a home will depend on the type of mortgage you’re exploring. Plus, there’s more to the mortgage approval process than just your credit score.
First off, let’s review the five factors that go into determining your FICO credit score:
- Payment History: The most important factor that considers the ‘frequency, recency, and severity of reported missed payments’ and makes up 35% of your total credit score
- Credit Utilization: Percentage of available credit that’s been borrowed (30% of total credit score)
- Length of Credit History: Amount of time each account has been open and the amount of time since the account’s most recent activity (15% of total credit score)
- New Credit: Any new credit accounts you open (10% of total credit score)
- Credit Mix: Variety of debt that demonstrates to the lender that you can handle all types of credit (10% of total credit score
Credit Scores Required for Mortgage Loans
Different types of mortgages require different credit scores. That’s why there’s no single credit score number lenders are looking for. Generally, the better your credit score, the lower your interest rate will be.
So what types of mortgage loans are out there? Below we’ve listed some common mortgage types and the typical minimum FICO scores required in 2019, according to The Lenders Network.
- FHA Loan: 580+ credit score (500-579 score possible but unlikely)
- VA Loan: 620+ credit score (some lenders require 580)
- USDA Loan: 640+ credit score
- FHA 203K Loan: 620+ credit score
- Conventional Loan: 620+ credit score
Getting pre-approved for a mortgage is the first step in the homebuying process. Before you get serious about house hunting, it’s a good idea to get pre-approved for your loan so you can make a quick offer when you find the one.
Improve Your Credit Score
Under the FACT Act, you are entitled to a free credit report from each of the three credit bureaus once a year. Visit annualcreditreport.com, an authorized website where you can receive your free report.
If your credit score is lower than you expected, don’t panic. There are ways you can address a low credit score and position yourself for the best mortgage rate.
- Report Mistakes: 25 percent of people who get declined for a mortgage have errors in their credit report, according to Forbes. Report any errors you find in your credit report on the credit bureau website.
- Pay More Than the Minimum: It’s always a good idea to make more than the minimum payment on your debts. Not only will you avoid additional interest, but you’ll also tackle your balances faster.
- Maintain Low Balances: Keep your credit balances below 50 percent of your limit, and pay them off as soon as possible.
- Avoid Closing Accounts: Once a credit account is paid off, it may be tempting to close the account. However, according to CreditCards.com, if you close an account with a $0 balance, it can actually raise your utilization percentage—the amount of credit used compared to the amount available—and lower your credit score.
A Final Note
Crunching the budget numbers can tell you a lot about your current situation and how buying a home might hurt or improve your financial wellness. But it won’t give you the complete picture. You know your situation better than anyone. If your gut tells you buying a home isn’t in your financial best interests, you might be right.
A buyer’s agent can help you determine whether it’s the right time to buy and how much house you can afford. They can also help you find homes in your budget and prepare for any fees or expenses associated with buying a home.
Just reach out! Any of our REALTORS® would be happy to talk to you about your goals and how you can financially prepare to achieve them.