Deciding whether homeownership is right for you is one of the most important decisions you'll make. But how do you decide whether a house should be part of your financial plan? There's no crystal ball to tell you if a home is a good investment. However, some indicators can help guide you as you weigh your options. Ultimately, your decision should reflect your current budget and your unique financial goals.
How is a mortgage different from other loans?
A home mortgage is considered good debt. This is the key difference between a mortgage and many other loans such as personal loans, credit card debt and payday loans. Here are some reasons why a mortgage is viewed in a positive light compared to other types of debt:
- Homes often appreciate in value. This means there's a chance your home will be worth more money at the end of your loan.
- Monthly payments are designed to be affordable. This enables you to have money for living expenses, emergencies and investments.
- Interest rates are usually lower than other types of loans. You can also refinance to lower your interest rate to further reduce your monthly payments.
- You may be able to deduct the interest you pay from your taxes. Interest on most other loan types is not tax-deductible.
You can increase your net worth. Most other loans cost money but offer no possibility of improving your financial status. As you pay off your mortgage, you'll gain equity in your house.
How can you weigh the pros and cons of buying a home?
Understanding the benefits of buying a home is a great start. Once you understand the difference between good debt and bad debt, you need to decide whether homeownership is right for you. Making this decision is not always easy, especially for first-time homebuyers. Breaking the process down into simple steps is a good way to weigh the pros and cons of buying a home.
1. Outline your financial goals
If you're like many Americans, you have financial goals you'd like to achieve. Take a few minutes to define your financial goals and the risks you're comfortable taking. Write down your goals and keep them close as you go through the decision-making process. As you list your goals, keep the following points in mind:
- Include a timeline. Set specific dates to reach each goal. This helps keep you on track.
- Be as specific as possible. For instance, "Increase my net worth to $75,000 by 2022" is more specific than "Increase my net worth."
- Be realistic. Setting goals you don't think you'll be able to achieve could set you up for failure.
- Periodically review your goals. You may need to update them to reflect any changes in your financial situation.
Your financial goals help drive your investment decisions. Your goals also serve as motivation if you decide to move forward with buying a home.
2. Examine your current financial situation
This step gives you a good picture of your overall financial health. It also identifies whether you can afford a home. As you examine your financial situation, make a note of the following:
- Your monthly income. Investing in a home requires you to make monthly mortgage payments. You need a steady monthly income stream to do this.
- Look at your current debt-to-income ratio. You calculate this by dividing your monthly gross income by the total amount you pay toward debt.
- Consider any upcoming life changes. Examples include potential job change, plans to have a baby or a spouse's plans to work part-time instead of full-time.
- Your current net worth. This is calculated by subtracting your debts from your financial assets.
To qualify for a mortgage, you should generally have steady full-time employment or a steady income stream for at least two years and the ability to make a down payment. Additionally, your chances of being approved for a mortgage are best if your debt-to-income ratio is less than 43%.
3. Understand how much it costs to buy a home
Now that you have a good idea of your financial situation, you need to figure out how buying a home would impact your budget. In addition to your down payment and your monthly mortgage payments, you'll have to pay closing costs. These costs catch some buyers by surprise. Your lender will give you a Loan Estimate that includes the costs you're required to pay. Common closing costs, fees and other expenses include the following:
- Home inspection fees to pay a qualified inspector to evaluate your home's condition
- Loan origination fees to pay for the administrative processing of your loan application
- Title insurance costs to ensure there are no liens on your home
- Home appraisal fees show your home's fair market value
- Attorney fees to cover the cost of preparing and recording documents
- Underwriting fees to cover the cost of reviewing and evaluating your loan application
After closing on your home, there are costs you can expect to incur throughout homeownership. If you're used to renting an apartment or home, you may be surprised by some of the costs of buying a home. Here are some things you can expect to pay if you own a home:
- Your monthly mortgage payment
- Local property taxes
- Homeowners insurance premiums
- Lawn care and landscaping expenses
- Home maintenance costs
- Unexpected repairs
- Utility bills
- Homeowners association fees, if applicable
4. Explore the different types of mortgages available
The key to a good homeownership experience is to find the right mortgage for you. To do this, you should review the various mortgage options available. Mortgage options have different term lengths and interest rates. Here are some of the most common mortgage options:
- Conventional mortgage: This loan type is not backed by the government. Terms include 30-year and 15-year loans, and rates can be fixed or variable.
- FHA loans: FHA loans are insured by the government. You may be able to secure an FHA loan with a down payment of just 3.5%
- Veteran Affairs (VA) loans: VA loans are an attractive option for veterans or active duty members of the military, and they may offer a zero down payment option.
- Jumbo loans: A jumbo loan is a good choice if you're considering a more expensive home with a mortgage that exceeds conforming loan limits.
5. Know the limitations of homeownership as an investment
Owning a home is different from owning traditional investments such as stocks, bonds or mutual funds. For instance, you can buy and sell stocks in a matter of seconds with the click of a button. Buying and selling a home takes much longer. Here are some other potential limitations of owning a home:
- Your home's value may decrease. A housing crisis, changes in the neighborhood or the house being in disrepair can cause your home's value to depreciate.
- It takes time to generate equity. Some investments can yield a sizable profit in a short amount of time, but home equity can take years to produce.
- A home is not a liquid investment. Unlike stocks or bonds, you can't "cash in" a home the same day you decide you want to sell it.
Flexibility- Unlike renting, where you can move at the end of your lease term, you may not be able to move as quickly when you own a home. Finally, owning a home comes with responsibilities Homes require regular care and attention, or they deteriorate and lose value.
Is buying a home a good investment for me?
Deciding whether homeownership is the best option for you is not always easy. There are many variables to consider and no surefire method of predicting your financial future. For help deciding if a house is a good investment for you, talk to a Home Lending Advisor.
A Home Lending Advisor will help you review your specific circumstances and figure out if you can afford to buy a home. They'll also help you understand how much buying a home costs so you can make your decision with greater knowledge and confidence.