Halbergman | E+ | Getty Images
Are you ready to buy a home? Many renters have no idea.
Millions of renter households in 2022 could buy a home that year, according to a new analysis from Zillow, which is based on estimates from the US Census Bureau’s American Community Survey.
In 2022, 39 percent of the 134 million families living in the U.S. did not own the home they lived in, according to Census data. Among those who did not own their home, about 7.9 million families were considered “income mortgage ready,” meaning the share of their total income spent on a mortgage payment for the typical home in their area would be 30% or lower, Zillow were found.
Some people simply choose to rent rather than buy. But on the other hand, households may be unaware that they can afford a mortgage, said Orphe Divounguy, senior economist at Zillow.
More from Personal Finance:
What Project 2025 could mean for your wallet
“Renting” can be a path to owning a home
3 money moves to make before the Fed cuts rates
If you’re nearing the end of your current home lease, it might be smart to see if you’re in a position to buy, said Melissa Cohn, regional vice president of William Raveis Mortgage.
“If rental prices are going up, it might be a good time to think about it [buying instead],” he said.
Verbal default from a lender can help, Cohn said. “The first step is to try to figure out whether or not it’s worth gathering all the documents together,” he said.
But keep in mind that you should go into this important conversation with a working familiarity with critical facts like your annual income and debt balances.
Understanding your credit status and debt-to-income ratio is a good place to start.
1. There is “no harm” in checking your credit
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.
Some would-be homebuyers may have no idea what their credit status is or “be anxious to even check” out of a mistaken belief it will affect their credit, he said.
In fact, experts say it’s important to monitor your credit for months before buying a home so you have time to make improvements if needed.
“This has changed a lot in our industry, where we do soft credit checks upfront, where it’s not going to have any impact on someone’s credit score,” Nevins said. “It really doesn’t hurt to check.”
Your credit issues because it helps lenders determine whether to offer you a loan at all, and if so, depending on your ranking, at a higher or lower interest rate. And usually, the higher your credit score, the lower the interest rate offered.
That’s why being “credit invisible,” with little or no credit experience, can complicate your ability to buy a home. But as you build your credit, you need to strike a balance by keeping your debt-to-income ratio in line. Your outstanding debt, such as your student loan balance or credit card debt, can also complicate your ability to get approved for a mortgage.
2. Debt-to-income ratio
A debt-to-income ratio that’s too high is the “No. 1 reason” applicants are denied a mortgage, Divounguy said. Essentially, a lender believes that based on the ratio the applicant may struggle to add a mortgage payment on top of their existing debt obligations.
To calculate a realistic budget when shopping for a home, you need to know your debt-to-income ratio.
“The debt-to-income ratio is simply the amount of monthly debt you pay on your credit report,” Nevins said. “Think about your car payments, student loan payments, minimum credit card payments … any debt you’re paying and your estimated monthly mortgage payment.”
A rule of thumb to calculate your hypothetical budget is the so-called 28/36 rule. This rule says that you should spend no more than 28% of your gross monthly income on housing costs and no more than 36% of that total on all debts.
Sometimes, lenders can be more flexible, Nevins said, and will approve applicants who have a 45 percent or even higher debt-to-income ratio.
For example: If someone earns a gross monthly income of $6,000 and has $500 in monthly debt payments, they could afford a mortgage payment of $1,660 per month if they follow the 36% rule. If the lender accepts up to 50% DTI, the borrower may be able to take on 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 will also depend on factors such as the average home sale price in your area, how much money you can put toward a down payment, area property taxes, homeowner’s insurance, potential homeowner’s association fees, and more.
Talking to a mortgage professional can help you “map out” all the factors to consider, Cohn said: “They give people target positions, like what you need to get before you can buy.”