A Tale Of Wealth Building & Affordability
Money is always on the mind, but these last few years have been filled with rising inflation, a wavering stock market, and an economic recovery that has left us with stark divides and a financial pressure that is of a different caliber than before. When it comes to homeownership, this wealth disparity is staggering.
According to Federal Reserve data from 2019, homeowners had a median financial net worth of $255,000, while renters net worth was just $6,300.
That means that homeowners have nearly 40 times the net worth as renters.
Unfortunately, the number 40 also shows up in the percent increase of rents in some parts of the US this year according to the Washington Post, with the national average being 11.3 percent.
While the benefits of owning a home are clear, the path to homeownership has never felt so steep. If you’re struggling in this market, don’t give up hope. Here are some tactics you can use to find an affordable home in any market.
Figure Out What You Can Really Afford
The first step to responsible homeownership is knowing how much you can afford to spend on a monthly mortgage payment and a down payment—and not to push this limit. If you need a refresher on what goes into determining a mortgage payment, check out our previous newsletter Mortgage 101 here. One of the best ways to start figuring out what you are able to pay for your mortgage is to calculate your debt-to-income ratio.
Start by adding up all your monthly debts, such as your credit card bills, student loans, car payments, as well as any other debts you’re responsible for paying on each month. Now, divide it by your gross monthly income, which is how much you make before taxes. Multiply this number by one hundred to get your debt-to-income percentage.
Most mortgage companies want your debt-to-income ratio below 36 percent. The lower your debt-to-income ratio, the better your chances of qualifying for a mortgage. Also important, the lower your debt-to-income ratio is the better shape your wallet is in, since you won’t be putting every penny toward existing debt.
Deciding how much you can afford should also involve some thought about how your financial profile will change in the coming years. If you expect to incur a bunch of new costs—for example, if you plan to start a family—it might be smart to scale back. On the other hand, if you’re about to make your final car payment, you may be able to afford a little more. In the long run, your peace of mind and financial security is what matters most.
When it comes to your down payment, the first thing you should do is take a breath. Even though historically home buyers have been asked to put 20 percent of the cost of a home down, that is not always the case.
And, before you start beating yourself up for enjoying an occasional coffee or avocado toast, just know that according to the National Association of Realtors (NAR), 28 percent of first-time buyers reported using a gift or loan from friends or family for the down payment.
There are several programs and mortgage types designed specifically for first-time home buyers that allow borrowers to put down as little as 3 to 5 percent toward a new house (more on those in a bit).
If you are planning to put down less than 20 percent, you should be aware that your mortgage company will require you to pay private mortgage insurance (PMI) in your monthly payment until you reach 20 percent of equity. The cost of PMI depends on your credit score and down payment, but generally it ranges from 0.3 percent to 1.5 percent of the original loan amount each year.
Work On Your Credit
Establishing and maintaining your credit score is critical to your ability to qualify for the best mortgage interest rate. A fair bit can go into your credit score, from paying your rent on time to getting a new credit card. The main ingredients that make up your score are payment history, your amount of debt, amount of new credit, the length of your credit history, and your credit mix.
Depending on your credit scores, you can end up affording more than you realize. The credit scores used for mortgage lending aren’t generally the same ones used for your credit cards. Instead, lenders tend to rely on FICO 2, 4, and 5—those are mortgage-specific credit scores.
These scores tend to take a much larger picture of your overall credit health, considering things like your debt-to-income ratio. If you have good credit, you’ll get better interest rates on your loan. That could potentially mean buying a house for less money than you’d be paying in rent.
You can learn more about your credit score and how to improve it with these resources from the Consumer Financial Protection Bureau.
Learn About Different Types Of Mortgages
Although the most common type of mortgage is a 30-year loan with an initial down payment of 20 percent, there are alternatives. Some of these are:
- FHA loans are backed by the US Department of Housing and Urban Development and allow first-time buyers to pay a down payment as low as 3.5 percent of the purchase price.
- VA home loans are an option for servicemembers, veterans, and eligible surviving spouses who are looking to become homeowners. These loans have a long list of benefits: They require little to no down payment, have competitively low interest rates and limited closing costs, require no PMI, and can be used multiple times throughout one’s life.
- ARMs, or Adjustable-Rate Mortgages. These loans have interest rates that fluctuate—or adjust—over the life of the loan. Unlike their fixed-rate counterparts, whatever interest rate you secure at the time the loan starts is only temporary. Usually, the starting rate for an ARM is incredibly low. Then, slowly, depending on the rate index, your interest rate may increase, if rates are on the rise.
To understand the nuances of each loan listed—and to find out even more alternatives—speak with your agent and lender. You may determine that there’s a program out there for you and your budget.
Consider Nontraditional Homes To Start
When most people think of the “American dream” they picture a stand-alone house (and maybe a picket fence). However, the reality is there are tons of different options available—townhouses, duplexes, condos—and more. And all these options generally have a lower price point in addition to shared amenities and other perks.
Purchasing this type of property first can help you attain the dream of owning a single-family home easier than by simply saving. It’s true that there may be a higher initial cost to buying a property than renting. However, if you’re planning on staying in a location for a few years, each mortgage payment you make helps you build equity. And, if the property appreciates, you may find yourself in a better position to sell it and use the transaction to purchase that stand-alone home. According to NAR, over half of buyers—56 percent—reported that they financed their home purchase by using the proceeds of selling a primary residence.
As we say in Your First Home, the best way to get closer to buying your dream home is to buy your first home.
Explore New Places
How many times have you questioned the reason for a steep sale price or rental payment, and the answer turned out to be the old chorus of “location, location, location”? That’s real estate in a nutshell! If you’re able, looking a little farther afield may help you spot more friendly prices.
According to a survey conducted by Nerd Wallet and The Harris Poll, 44 percent of Americans have worked remotely at some point since March 1, 2020, and 25 percent of those who have worked from home or another remote location say they bought or plan to buy a home in a different location as a result of their ability to work remotely.
If your situation allows, you might find that looking outside of major metro areas will make your homeownership dreams more accessible.
Understand That Value Takes Time
Right about now you may be thinking that perhaps a home purchase is in the cards for you after all. You’ve done the math and are ready to earn equity for yourself instead of your landlord, but maybe the current market and all its craziness has you flustered. That’s understandable, but the truth is that no market is perfect. There are always market fluctuations and economic issues, so focusing only on the current market can be a bit short-sighted. As we share in Your First Home, there are two ways to make money in real estate: timing and time.
Either you purchase a home before its price appreciates, or you hold it for long enough so that the appreciation makes it a smart purchase. We hope you’ll do your due diligence and when you find a home that meets your personal and financial criteria, you’re able to enjoy the benefits of homeownership.
If you’re ready to start a lifelong journey toward homeownership, download the first chapter of Your First Home here:
With step-by-step advice on how to approach the home-buying process, this book is meant to help you find and finance your home. Go to YourFirstHomeBook.com for other downloadables and to pre-order your copy.
Do you have helpful advice for how to make a first-home purchase affordable and attainable? Share it with us on our KellerINK Facebook page. And subscribe to our newsletter for more articles and research.
Correction, June 6: The newsletter version of this blog post that came out on Monday incorrectly stated that there is a 40 percent difference between homeowners' and renters' net worths. The actual difference is that homeowners' net worths are 40 times the net worths of renters. This has been corrected.