Things to consider beyond interest rates when buying a house
We walk you through several factors to consider other than interest rate when deciding if you’re ready to buy a house.
Buying a house can be one of the most rewarding decisions in your life. Beyond owning your own space and being your own landlord, building equity in a home can financially empower you in many different ways. You can use your home equity as a down payment for a future home, you can borrow against your home equity using a second mortgage, and you can take cash out of your home by refinancing if rates drop.
When deciding whether to purchase a home, many homebuyers consider interest rate to be the primary determinant, as fluctuations in interest rate can change your monthly payment dramatically. On a $300,000 mortgage, a one point swing in interest rate could increase your monthly payments by close to $200, and the cost of a 30-year mortgage by over $60,000. Thus, if interest rates appear to be on the rise, it may be best to buy sooner than later, and vice versa if rates are dropping.
That said, there are several factors beyond interest rate to consider when deciding whether or not to buy a home. We’ll place these into two categories: financial, i.e. whether or not you can afford it, and personal, i.e. whether or not homebuying is the right option for you right now.
Other than interest rate, the biggest factor in determining your monthly payment is the size of your down payment. It is best to put 20% or more down to avoid paying private mortgage insurance (a monthly fee paid by the borrower to protect the lender in case of default), but some lenders will allow you to put down as little as 3%. It’s important to know that smaller down payments will disproportionately raise the cost of the mortgage over its term.
Let’s take the $300,000 mortgage as an example. Assuming a 20% down payment ($75,000) was made on a $375,000 home, your monthly payment on a 30-year, fixed rate mortgage at 4.5% comes out to approximately $1,520. This equals to a total mortgage cost of about $547,000.
With a 10% down payment on the same home, your monthly payment jumps to approximately $1,710, with the full cost of the mortgage jumping to about $615,000. And at a 5% down payment, those numbers rise to approximately $1,805 and $650,000, respectively.
In our example, reducing down payment by $37,500 (10%) and $56,250 (5%) increases the price of the mortgage by $68,000 and $103,000, respectively. Putting a smaller down payment upfront is OK, but realize that you’ll pay more over the life of the loan.
Another thing to consider is DTI, or debt-to-income ratio. The Federal Housing Administration uses a DTI of 43% as a benchmark for approving mortgages, so typically you’ll need to be below this. To calculate DTI, take all of your monthly debt payments – student loans, credit cards, etc. – and divide the total by your gross monthly income. For example, if you make $4,000 a month, your maximum monthly debt payments should be ($4,000) x (43%) = $1,720. So if you pay $400 a month in debt payments, you can take on an additional $1,320 a month in mortgage payments.
Finally, consider if the house is in the shape you want it to be in, and how much investment it would require to get it there if not. Home repairs and renovations can be very expensive, so if you’ve found a home that needs some work, add those repair costs to the purchase price to calculate the final cost of the home.
Homeownership is becoming an attractive option for people of many different lifestyles. For example, the Joint Center for Housing Studies found a record number of single women are becoming first-time homebuyers, and single women make up more than one third of the growth in real estate ownership since 1994. Buying a home no longer necessarily means that you’re going to settle down and start a family.
While “being ready” to buy a home looks different now than in past generations, there are still several personal factors to reflect upon to ensure that you’re ready to take this next step in your life.
First, consider the location. Are you in love with it? Is it a place you’d like to live for the next five to ten years? If you have nagging hesitations towards the metro area – too noisy, too crowded, too boring, etc. – you probably don’t want to put your roots down just yet. Think of it as a relationship: if you still have reservations, it may not be the best idea to tie the knot.
Also consider how long you’re willing to stay put in the same property. It takes several years to break even on a house — typically four to seven years — so moving earlier could mean that renting is actually the cheaper option.
Lastly, think about your career trajectory. Do you feel secure in your current job? Do you foresee making any big changes, in terms of your company or your role? Most importantly, do you foresee having to relocate anytime in the near future? The best time to buy is when you feel secure in your career and – most importantly – your future income.
Buying a house is a huge responsibility, but if you’ve taken the time to assess your financial situation, lifestyle, and options and feel ready to become a homeowner, it’s one of the most rewarding experiences in life. If you are feeling like the time is right, click here to learn more about the journey of homeownership.
The content on this page is provided for informational purposes only and should not be considered investment, tax, or accounting advice. All calculations and information shown here are for illustrative purposes only.