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Are you ready to buy a home? Many renters have no idea.
Millions of renter households in 2022 could have bought a home that year, according to a new analysis by Zillow, which is based on estimates from the U.S. Census Bureau’s American Community Survey.
In 2022, 39% of the 134 million households living in the United States didn’t own the home they lived in, according to census data. Of those who didn’t own their homes, nearly 7.9 million were considered “income-ready,” meaning the share of their total income they spent on a mortgage on a typical home in their area would have been 30% or less, Zillow found.
Some people simply choose to rent rather than buy. But on the other hand, families may not realize they can afford a mortgage, says Orv DeFungi, chief economist at Zillow.
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If you're nearing the end of your current home's lease, it might be smart to see if you're in a position to buy, says Melissa Cohn, regional vice president at William Ravis Mortgage.
“If rents go up, it might be a good time to consider buying instead,” she said.
Getting verbal pre-approval from the lender can help, Cohen said. “The first step is trying to figure out whether or not it’s worth putting all the paperwork together,” she said.
But keep in mind that you'll need to go into this important conversation with a working knowledge of crucial facts like your annual income and debt balances.
Understanding your credit status and your debt-to-income ratio is a good place to start.
1. There is no “harm” in checking your credit.
In order to know if you're ready to buy a home, it's important to understand what your purchasing power is, said Brian Nevins, director of sales at Bay Equity, a mortgage lender owned by Redfin.
He said some would-be home buyers may have no idea what their credit status is or are “afraid to even check” it because of a misconception that it will affect their credit.
In fact, experts say it's important to monitor your credit for several months before buying a home so you have time to make improvements if necessary.
“This has changed a lot in our industry where we now do a direct credit check, where it has no impact on anyone’s credit score,” Nevins said. “There’s no real harm in checking.”
Your credit is important because it helps lenders decide whether to offer you a loan at all, and if so, at a higher or lower interest rate depending on your rating. Typically, the higher your credit score, the lower the interest rate offered.
That’s why being “credit invisible,” with little or no credit history, can complicate your ability to buy a home. But as you build your credit, you need to find a balance by keeping your debt-to-income ratio in the right range. Also, your outstanding debt, such as your student loan balance or credit card debt, can complicate your ability to get approved for a mortgage.
2. Debt to income ratio
A very high debt-to-income ratio is the “number one reason” for mortgage denials, DeFungi said. Essentially, the lender believes that based on that ratio, the applicant may have difficulty adding a mortgage payment to their existing debt obligations.
In order to set a realistic budget when buying a home, you need to know your debt-to-income ratio.
“Your debt-to-income ratio is simply the amount of monthly debt you pay on your credit report,” says Nevins. “Think about car payments, student loan payments, minimum payments on credit cards…any debt you pay and your estimated monthly mortgage payment.”
There is a general rule for determining your default budget, which is called the 28/36 rule. This rule states that you should not spend more than 28% of your gross monthly income on housing expenses, and you should not spend more than 36% of that gross income on all debt.
Lenders can sometimes be more flexible, Nevins said, and will approve applicants with a debt-to-income ratio of 45% or higher.
For example: If someone has a monthly gross income of $6,000 and has $500 in monthly debt payments, they can afford a mortgage payment of $1,660 per month if they follow the 36% rule. If a lender accepts a debt-to-income ratio of 50%, the borrower might be able to afford a monthly mortgage payment of $2,500.
“That’s really the maximum for most loan programs that someone can get approved for,” Nevins said.
Affordability and financial readiness also depend on factors such as the average home selling price in your area, how much money you can put toward a down payment, property taxes in the area, homeowners insurance, potential homeowners association fees and more.
Talking to a mortgage professional can help you “map out” all the factors to consider, Cohen said: “They give people goals, like this is what you need to have in order to buy.”
