For many Canadians, buying a home will be the largest financial commitment of their lifetime. But with so much at stake, how do you know when you’re truly ready to buy a home?
For me, that was the $270,000 question.
I recently purchased a home, but before taking the plunge and signing my financial future away, I struggled with whether or not I was ready. I had doubts and I didn’t know if I was “adult enough” to be a homeowner.
To better prepare myself, I talked with industry experts and came up with a list of key indicators to determine if I was ready to buy my first place. Here’s how I decided I was prepared to become a homeowner:
Have steady employment
The first key indicator of whether you are ready for homeownership is your employment status. You can’t pay your mortgage without an income so being employed in a secure position is important. If you’re an entrepreneur, you should have several years of decent income under your belt.
In my case, I’ve been at my job for several years and my husband has been at his for 18 months. Both employers are financially secure.
I also have a second job as a freelance writer, which means I have a steady stream of side income in the event of job loss.
To determine if I was ready for homeownership, I ran the numbers on what exactly would happen to our finances if one of us were to lose our job after buying a home. Based on my model budgets, I knew we’d still be able to meet our financial commitments to our home.
Keep housing costs low
Many personal finance experts recommend that your housing costs never exceed 35% of your net income. The 35% rule ensures you have enough room in your budget to save for retirement and pay down your debt.
Keeping your housing costs to 35% of your net income keeps your budget balanced so that you don’t become house poor. You can use this rule to determine if you’re ready to buy a home by running the numbers for your desired purchase price. If the total monthly housing costs are equal to or less than 35% of your net household income, you’re ready.
With this rule in mind, I used a mortgage payment calculator to estimate my mortgage payment, property taxes, utilities, and insurance costs for my $270,000 home. Based on my estimation, I could purchase this home without committing more than 35% of my net household income to housing costs.
An emergency fund
Buying a home means that, unlike with renting, you’re on the hook for your home’s repairs and updates. Because of this, you’re not ready to buy a home until you have an emergency fund in place. This emergency fund should be equal to at least 3% of your home’s purchase price. Ideally, it should ideally be larger to cover other unexpected life events like job loss.
In my case, I bought a house for $270,000, which means I needed $8,100 saved to pay for maintenance and repairs. Fortunately, I already had $10,000 in an emergency fund.
Now that I’m a homeowner, I’m working to increase my $10,000 emergency fund to $15,000, which will guard against both unexpected repairs to my home and unexpected life events.
Enough equity to withstand a downturn
When you take the leap into homeownership, you want to have enough equity in your home in the event that housing prices in your local market drops and you don’t end up with an underwater mortgage (the value of your home is less than what you owe your lender). Your home equity is calculated as the home’s value minus your mortgage.
In my case, I wanted to have at least 5% equity in my home. In my home city of Halifax, the market is not as competitive as Toronto or Vancouver. Here, a market downturn is already in effect and properties in some neighbourhoods are losing about 1% in value per year.
If I had to sell my home unexpectedly, 5% equity would be enough to guard against being underwater in my home, even if the markets dropped a little. Based on the size of my down payment, I knew I’d meet this requirement.
A 10% down payment
The size of your down payment will be different for every usituation. It should depend on many factors, including how much equity you want in your home, what you can afford to pay monthly, and how comfortable you’re paying for mortgage default insurance.
In my case, while I only needed 5% equity in my home, I wanted at least a 10% down payment. I chose a 10% down payment because that was the amount I needed to make the 35% rule work and I wanted to minimize the amount of mortgage default insurance tacked onto my mortgage.
That means I needed $27,000 for the down payment and around $6,000 for closing costs, for a total of $33,000. Saving this much money took me about 18 months. Once I reached that target amount, I knew I was ready for homeownership.