Am I Ready to Buy a House?

Crunching the numbers on the American Dream.

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Mar 30 2018, 10:13pm

Illustration by Stella Murphy

It may seem like life is all laid out for you long before you even get a chance to vote: Finish high school, go to college, get a job, get hitched, then buy a house that you can fill up with mini mes. But like everything else the world says we should want or do, before you make a huge financial investment in anything—whether it's an expensive college or a place to call home—make sure it's something that will actually make your life better.

When it comes to buying a house or apartment, that means thinking about everything from whether you want to move to what will likely be a suburban neighborhood to figuring out if the mortgage payments and upkeep on your new digs will leave you with enough free time and money to do fun things like travel, pursue your hobbies and eat out. While there are undeniable pleasures that come with putting down roots, homeownership comes with a host of tradeoffs in terms of lifestyle, finances and how you spend your time.

I wanted to own a home because I didn’t like renting, and after dealing with a couple of bad landlords, I decided no one would ever tell me again whether I could hang a picture on the wall or have friends visit for a week. That was an emotional reason, which didn’t mean the numbers made sense from a financial standpoint. Maybe looking for a rental property straight away and keeping renting myself would have yielded better returns.

In general, if you moved to a city with a notoriously expensive housing market to get your first job, buying a home there rarely makes sense financially. For example, Trulia recently ranked San Francisco as the least affordable metropolitan area to buy a home. And with starter homes there selling for $820,000 (up 12% from 2017), it's no wonder. (To figure out if it is cheaper to rent or buy where you live, try this calculator.)

Of course, other cities and towns are much more affordable, and if you're itching to buy a house, there are plenty of places where you don't have to be rich to live the dream. With that in mind, here are five things to consider before you take the plunge:

Homeownership isn't a necessity—or even a great investment

You have probably been told that homeownership is the key to living the American Dream. And an overwhelming 85% of millennials expect to buy a house in the future. But what if it doesn’t fit your personality or lifestyle?

“What we need to consider first and foremost, is whether homeownership is in alignment with our values, goals and priorities,” millennial personal finance expert Stefanie O'Connell, author of The Broke and Beautiful Life, told me.

“If our goal is to get a job that will take us cross country or to move in with a partner in a couple of years, maybe putting the majority of our nest egg into a location that we don't plan to commit to long-term isn't the best move,” she said. “Between shifting work opportunities and shifting family structures, it makes sense that committing to one place through homeownership won't be the right choice for everyone.”

It's also not necessarily a great investment. As the Nobel Prize-winning economist Robert Shiller pointed out in the New York Times, "Despite solid price increases over the last few years, land and homes have actually been disappointing investments." In fact, home values increase at about the same rate as inflation over the long term—just a few percentage points per year at best.

“There are a lot of myths floating around out there like, 'renting is throwing away money,' that I think pressure young people into feeling like they have to buy a home.," O'Connell added. "These aren't necessarily true. While buying a home can be a way to build wealth, it's not a sure bet."

These tricks can lower your costs and help you afford a down payment

If you're set on owning a home, make sure your credit score is in top shape before getting preapproved for a mortgage. That's because a low credit score, say, below 600, can raise the interest rate on your loan, which in turn can make or break your ability to buy. Start by checking your credit score (many credit cards let you do it right on their site), then making sure to pay your bill in full each month. Aim for a score of 740 in order to get the lowest interest rates.

As for the down payment, you don't necessarily need the standard 20% anymore, as there are low or even no down payment loans available from the Federal Housing Authority, the Department of Veterans Affairs, and the USDA. However, you do need to prove that you will be able to pay the monthly bill to qualify for these. That means having a steady income well above the monthly payments. So if you've been traveling for the past year or cobbling together gig economy jobs, you could have problems qualifying even if you have a big chunk of change stashed away.

“Building up a strong credit history and savings for a down payment is always a good idea. Even if you ultimately decide you don't want to buy a home, having a large savings buffer and a good credit score can serve you in so many other ways," O'Connell said.

This is exactly how much money you'll need

A good rule of thumb is to avoid spending more than a third of your gross income on housing. If you make $45,000 a year, that means you can afford to spend $15,000.

Start with your mortgage costs. For example, a $180,000 mortgage at 4% interest over the next 30 years, will cost you $859 a month. (Here's a calculator you can use to plug in your own numbers.)

Next come repairs, which can cost between 1% and 4% of the purchase price per year. That's up to $8,000 a year for a $200,000 home, for example.

Other annual costs include property taxes (which average about 1% of your home price), insurance (about $1,083), utilities (another $2,060) and possibly even homeowners' association fees (roughly $2,400 to $3,600).

Lastly, don't forget those one-off expenses the first year, like new furniture, landscaping, deposits for utilities, cable, and internet setup fees, and so on.

Don't let this happen

You don’t want to start defaulting on your home payments because you couldn’t pay for the associated costs of homeownership. "It's really easy to jump into buying a home before you're ready," said Lindsay VanSomeren, a personal finance blogger at Notorious D.E.B.T..

That's what happened to her and her husband when they didn't budget for repairs and maintenance on their first home in Alaska. “We needed to replace the septic tank for $5,000,” VanSomeren told me. “We didn't have that cash, and so we had to go into debt for it.”

The couple ended up doing a deed-in-lieu of foreclosure on their home when they were unable to pay off $35,000 in debt for additional repairs and couldn't sell their home without going into more debt. Since they had bought it with a VA loan that required no down payment, they didn't have enough equity in the home to cover the cost of the repairs.

“Next time we buy a house, we'll be saving up at least ten percent extra from our monthly mortgage payment into a home repair fund so that we're covered no matter what—and don't have to go into debt anymore," she added. "We're done with debt!”

One last question to ask before pulling the trigger

I moved to a big city to pursue a career and earn more, so I could save money for a deposit. It took about two years of hard work and efforts to come up with a down payment. Six months later, I relocated 2,000 miles away. The numbers worked to keep the property as a rental, but leaving was the last thing going through my mind as I signed my mortgage with the bank. It could have been a huge loss had I had to sell in a hurry.

Nowadays, I still love real estate as a way to build wealth, but I always buy property with resale value in mind. Will a buyer like that property as much as I do, should I decide to sell it down the road? Is it attractive enough to at least recoup my costs? Those are the questions you should be asking yourself if you are unsure whether you will be living in your new home for the long-term.

Pauline Paquin is a personal finance writer who blogs about smart money choices and early retirement over at ReachFinancialIndependence.com .