With mortgage interest rates at an all-time low, the temptation to buy is now higher than ever and may make sense for some. To put it in perspective, a 30-year $250K mortgage with a 5% interest rate would have once cost you $1,342; now, with a lower 3% rate, that same mortgage can cost you $1,054. At $288/month, the difference may seem negligible, but it adds up significantly over time — for someone making $3,000 per month, it represents almost 10% of their monthly income.
Although the math might be in your favor, there are several factors you should consider before pulling the trigger.
1. The amount and type of debt you have.
Lenders typically don't want you paying out more than 43% of your income on debt. They weigh your credit card minimums, auto/student loan payments and any other debts you might have against your gross income. If you’re struggling to keep up with your payments, you might want to delay committing to a 15- or 30-year mortgage.
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For a lot of us, that’s longer than anything we’ve committed to in the past. And unlike some types of debt, mortgages are typically recourse debts, meaning you’re personally liable for the loan. That loan may harm you if you foreclose and the lender decides to come after your other assets.
2. How much you have left to spend every month.
As a homeowner, you'll want to prepare for additional expenses. Whether it's an appliance that needs replacing, a plumbing emergency or a broken washer, you'll want to have the funds on hand to cover these emergencies. If you are used to running a tight budget, you may find yourself unintentionally taking on debt to cover these surprise expenses.
When budgeting, aim to keep all your bills to no more than 50% of your income, including the new mortgage. A healthy bill/income ratio ensures you have enough money left to spend and save every month.
3. Down payment funds.
Some lenders may lure you in with the promise of a small down payment. If you qualify, VA (Veterans Affairs) loans can even lend you money with a 0% down payment. However, expenses such as closing costs, escrow bills and legal fees can quickly add up, requiring you to have more than the required down payment for the house. You can also be at a disadvantage when negotiating without the necessary funds to buy down your interest rate or increase your down payment.
Keep in mind, any down payment lower than 20% may require you to purchase Private Mortgage Insurance (PMI). Depending on the size of the mortgage, this may cost you 0.5%-1% of your loan and adds to your monthly payment.
4. Your current credit score.
Similar to a low down payment, some lenders may make an exception for a low credit score. The catch is that lenders typically charge a higher interest rate to compensate for the risk of a lower down payment. Since mortgages charge interest differently, the tiniest difference in your interest rate can cost you thousands of dollars over the life of your mortgage.
Put into perspective, for a 30-year $250K mortgage, the difference between a 3% and 3.50% rate over the life of the mortgage is $24,697. Holding off for a few months and working on tackling your debt-to-income/credit score will improve your position in the long run.
5. A tight housing market.
Although it can be nerve-racking to watch a small number of houses fly off the market, the last thing you want is to rush into such a big decision and find yourself in the middle of a bidding war. Not only would purchasing a more expensive house lead to a higher payment, but you may risk having a loan worth more than your house in the event of a market downturn.
Overall, think of homeownership as an investment before anything else. Like any investment, ensure you're well off and able to handle the risks first. From there, your financial adviser can help you evaluate your options. You'll be surprised how often renting in a hot market and investing additional funds elsewhere may be the better option!
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