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Are you ready to buy a home? Many people who live in rented homes don’t know this.
A new analysis from Zillow based on estimates from the U.S. Census Bureau’s American Community Survey suggests that millions of renter households in 2022 could have purchased a home that year.
According to census data, 39% of the 134 million households living in the U.S. did not own their home in 2022. Of those who don’t own their home, roughly 7.9 million are considered “mortgage-affordable income,” meaning they can afford to dedicate 30% or less of their gross income to paying a mortgage on a typical home in their area, Zillow found.
Some people are choosing to rent rather than buy a home, but at the same time, households may not know if they can afford a mortgage, said Orphée Divongay, senior economist at Zillow.
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If your current lease on a home is coming to an end, it may be wise to consider whether you’re in a position to buy, said Melissa Cohn, regional vice president at William LaVais Mortgage.
“If rents are rising, it may be a good time to consider [buying instead],” she said.
Cohn said it helps to get a verbal pre-qualification from a lender. “The first step is to understand whether it’s worth it to get all the paperwork in place,” Cohn said.
But remember, when you go into that important conversation, you’ll want to be fully aware of key facts like your annual income and debt balance.
Understanding your credit situation and debt-to-income ratio is a good starting point.
1. There’s “no harm” in checking your credit report
Figuring out what your purchasing power is is important to know if you’re ready to buy a home, said Brian Nevins, sales manager at Bay Equity, a mortgage lender owned by Redfin.
Some potential homebuyers may have no idea what their credit situation is, or may be “nervous about even checking” due to a mistaken belief that it will affect their credit, he said.
In fact, experts say it’s important to start monitoring your credit report in the months before you buy a home so you have time to make improvements if necessary.
“Things have changed a lot in our industry. We now do soft credit checks up front, and they don’t impact anyone’s credit score,” Nevins says. “There’s absolutely no harm in checking.”
Your credit score is important because it helps a lender decide whether to give you a loan and, if so, whether you’ll be offered a higher or lower interest rate depending on its rank. Typically, the higher your credit score, the lower the interest rate you’ll be offered.
So having little or no credit history – “no credit” – can be a hindrance to buying a home. But as you build up your credit, you need to balance it with keeping your debt-to-income ratio consistent. Having outstanding debt, like student loan balances or credit card debt, can also make it harder to get approved for a mortgage.
2. Debt-to-income ratio
DiBongee said having a debt-to-income ratio that’s too high is the “number one reason” a mortgage application is rejected. Essentially, lenders use that ratio to determine that an applicant might struggle to make mortgage payments on top of their existing debts.
To create 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 have listed on your credit report,” says Nevins. “Think about your estimated monthly mortgage payment versus any debts you’re paying, like car loan payments, student loan payments, minimum payments on credit cards, etc.”
One rule of thumb for calculating a hypothetical budget is the so-called 28/36 rule, which states that you should not spend more than 28% of your gross monthly income on housing costs, and not more than 36% of that total on total debt obligations.
Nevins said lenders are becoming more flexible and may approve applicants with debt-to-income ratios of more than 45 percent.
For example, if your monthly gross income is $6,000 and your monthly debt payment is $500, following the 36% rule would mean your monthly mortgage payment would be just $1,660.If a lender is willing to accept a DTI up to 50%, a borrower could potentially get their monthly mortgage payment down to $2,500.
“That’s the maximum amount that will be approved for most loan programs,” Nevins said.
Your ability to afford and financially prepared to buy a home will also depend on factors such as the median home sales price in your area, how much you can afford as a down payment, local property taxes, homeowners insurance, and homeowners association fees.
Speaking with a mortgage professional can help you “map out” all the factors you need to consider, Kohn says: “They give people a goal of what they need to buy a home.”
