You have some extra cash sitting in the bank and are wondering what to do with it. You have heard about how home ownership is better than renting because you will accumulate equity as you pay off the mortgage. And so, you think, “I’ll make a down payment and buy my own house.” But, you could pay down your debts with that cash instead. So, what do you do? It’s never a simple answer.
Before you sign any papers, take a minute to consider the following:
Debt – Income ratio
When you are considering a mortgage, banks use the debt to income ratio to evaluate your borrowing ability. It is basically a calculation of what percentage of your monthly income is spent on repaying debt. As per industry standards, up to 28% of income spent on paying your mortgage and 36% of your income spent on paying all debt are the ideal numbers. If you are already creeping close to 30% of total income on your debt, then maybe you should first consider paying off your loans before making a home purchase.
20% Down payment
Most lenders require you to pay at least 20% down on the value of your home. If you do not have at least 20%, then private mortgage insurance (PMI) will likely be required – which will add 0.5% to 1.00% to your monthly mortgage cost. For first-time home buyers or veterans, there are often options with lower down payment requirements. Just remember that a lower down payment results in a higher mortgage balance.
Is it worth it to buy?
Yes, building equity through home ownership is worth considering. However, when you purchase a home, mortgage payments are not the only additional costs involved. Maintenance costs, repairs and property taxes also come along with home ownership.
What should I know about debt?
Types, terms and interest rates of loans can vary greatly. The most common loans in the Adventurer years are credit card debts and student loans. Financial advisors classify debt as “acceptable”, “unacceptable” or “in-between.”
Unacceptable debt is debt that has a high interest rate and does not give you any tax advantages, such as credit card debt. Acceptable debt is debt that has a low interest rate and allows you a tax deduction, such as student loans or home mortgages.
Thus, if you have credit card debt, you may want to consider paying it off before you buy your dream home. However, if you have student loans, you could consider buying the house while making student loan payments – as long as your debt to income ratios are good!
And finally, how do you envision your future?
Do you envision yourself staying in the same city for long? Don’t buy a house if you’re not expecting to remain in your city for at least a few years. The closing costs and commissions on the buy and later sale could eat up any potential appreciation – and might even leave you in the hole!
Deciding between repaying a loan or buying a house will never be a simple choice. It should be a well – thought out decision made after considering the many factors involved.