When To Buy Real Estate

A lot of people ask me when they find out what I do for a living, "when is it the right time time buy real estate?" The question is innocent but often times coupled with the wrong motive - greed - which inevitably leads them down a path that has more inherent risk than a chummed shark tank.

There is one correct answer to this question. The answer is, "when you can afford it." I know, it really does not seem that helpful, and usually I'll get some crooked looks... but this answer inevitably triggers a much more important question which is not always vocal but always apparent in the questioner's eyes, "well how do I know that?"

This is real question you need to answer before you decide whether or not buying a home is the right decision for you. Living house poor, that is spending all your income on home expenses is the sad reality for many people. This is not only mentally straining, it prevents you from being able to save and invest in other opportunities while leaving you vulnerable to unexpected events. Avoiding this is imperative, and something many people really don't take into consideration when getting preapproved. Instead their focus is on how large of a home loan they qualify for which in turn tells them their ceiling purchase price. From here they run out with their agent and begin searching for homes at this ceiling threshold. This action is justified by their understanding that real estate is an investment, a relatively safe investment that over time should appreciate. This vague understanding along with the dozen reverse mortgage commercials has impressed upon them the idea that if you hold onto your home for a long enough period of time, eventually your home will appreciate to a point where it can support your retirement. Let me be clear - this is a fantasy.

Although real estate is a wonderful investment, unless you already own the home you live in, thinking about real estate as an investment as opposed to shelter is the wrong mindset. Real estate first and foremost is shelter, and as long as you pay your taxes (and mortgage if you have one, and insurance to protect it for disasters) your home will remain your property forever, providing you a place of to raise your family that no one can take away from you (excluding eminent domain which you are justly compensated for). Understanding that your home is shelter first, and an investment second is an important mindset because it takes the profit variable out of the equation. Unless you are an experienced investor, the main objective should not be making a profit. Why? Becuase this will help you from falling into bubble buying... because you are not buying for profit you are buying for function the question is not what to buy now, but if you should buy now, and if you don't need it because it serves no function, then you will not buy. Moreover because you are buying for function not profit, to remain functionable the cost must remain inside your budget which will keep you from spending more than you can really afford.

So how do you calculate your budget? Lenders use what is called your debt to income ratio or DTI to determine whether or not a borrower is qualified for a loan. Essentially your DTI takes gross monthly income and divides it by monthly debt obligations (credits cards, car payments, your mortgage, insurance, and taxes, etc...) If the resulting ratio is under 45% they consider you a qualified borrower. Now you could use this formula to determine what you can afford, but realistically the goal is to ensure you remain in a strong financial position and the new home does not absorb every last nickel, so I recommend keeping your personal debt to income ratio under 38% to ensure you are prepared for life's unplanned expenses. What if you debt to income ratio is over 38%? What can you do to reduce it? There are a number of solutions - earn more income, reduce your monthly obligations, borrow less money, and or borrow at a lower rate of interest.

So you have the income, and your debt to income ratio is below 38%, what about assets? Coming in with 20% down is always a good idea if only to avoid having to pay mortgage insurance. How you get this down payment is not the issue (unless it is borrowed, than it is borrowed and not really money down), savings, gift funds, gift of equity, whatever... what you need to focus on is what you will have left over after you own the home and have paid all closing costs.

For conforming loans, most lenders look for two months principle interest taxes and insurance for establishing reserves after closing. For jumbo conforming products this two month requirement becomes six months. For your own planning purposes, you should look to have a minimum of 6 months PITI. If you can, try and have 6 months of expenses (mortgage, credit card, car, food, gas, etc) as your reserves. This emergency fund is not for spending or even investing. It is for security and should be classified as such. Keep it in a liquid interest bearing account that you have access to at any point in time without penalty.

So you have the income and assets, now what does your credit look like? People that have taken the time to evaluate their income and assets as I have broken down above rarely have credit problems, however if you do now would be the time to focus your attention on fixing your credit. Generally speaking you want your credit scores to be in the mid 700s if you hope to obtain the best financing terms. If your credit is a problem fixing it is not a lifelong journey and can be accomplished in a reasonable amount of time. The most important aspects of credit are balances and payment history. Make all your payments on time and keep your balance low. High balance can have an adverse affect on your score even if you pay your bills on time.

With income, assets, and strong credit you are ready to buy a home. Do not fall victim to market games, timing rates, or waiting until the winter. If you find yourself in the market respect the fact that a home is a long term investment that you should not be looking to profit from. Hold this mindset, and profits will follow.