When purchasing a home, there are definite signs that you're about to get in over your head financially, such as borrowing from your retirement funds, or failing to account for the long-term impact of homeownership. Having more home than you can afford will have long-lasting effects that you may later come to regret.
While banking requirements to get a mortgage today are tighter than they were before the 2007 housing crisis, homebuyers can still easily find themselves biting off more than they can chew—and may not realize it until after the purchase is complete. Here are five signs that you might be buying a home you cannot afford.
- Getting pressured to take out a mortgage that you're not fully comfortable with or don't understand is a bad sign about the financing terms.
- When deciding whether you can afford a home, make sure to factor in all the extra costs that come with owning a home—not just the mortgage.
- Think twice before relying on assistance programs or pulling funds from your retirement account to afford a down payment, as these are last resorts.
- Your intuition can be a valuable source of guidance when deciding whether you can afford a home.
Creative Mortgage Terms
If the conditions of your financing look like a trail mix of mortgages (e.g., first mortgage, second mortgage, interest-only, adjustable-rate, extended term, and a balloon payment—although these payments are more common to commercial real estate), that is a significant indicator that you cannot afford the home you are looking to buy.
Likewise, if your broker encourages you to accept mortgage terms that are less than ideal with a plan to refinance somewhere down the road, that's a definite red flag. There is no guarantee that you will be able to refinance into better terms. If the financing feels forced in any way, you are taking on more than you can handle, which can spell trouble later.
Down Payment Assistance Programs
Many programs are designed to help homebuyers with their down payments and closing costs. While these programs are intended to remove the barriers to homeownership as well as stimulate the housing economy, they don't always work out that way.
If you are not prepared for the financial aspects of purchasing and owning a home—that is, getting into one before you are ready, or getting into one you could not afford without the assistance—that will inevitably result in more harm than good.
You Have Just Enough to Cover the Payment
You’ve done your due diligence by looking at your finances in full, crunching the numbers, and you've figured out that you can fit the new payment into your budget. There’s no wiggle room, but you feel you can “make it work.”
You can use an online mortgage payment calculator to figure out how much your monthly payments might be at different home price points. Make sure there's room in your budget, and think about how it might affect your lifestyle in the long term.
Keep in mind that the cost of homeownership goes way beyond your mortgage. In addition to your monthly payment, you'll need to cover the costs of maintaining and upgrading your home and property. And you'll need to be able to handle the unexpected: a broken appliance, a leaky roof, or the many additional expenses that come with owning a home.
Borrowing From a Retirement Account
Many homebuyers borrow from their retirement accounts to help cover their down payment. While you can withdraw funds penalty-free from a Roth IRA to buy your first home, remember that you are tapping into funds that were intended for the future. Remember the reason you chose to save for retirement in the first place. If dipping into your retirement savings is your only option for purchasing a home, consider that a warning sign.
You Have a Sinking Feeling
If something doesn't feel right, pay attention to those signs. Buying a home may be your biggest purchase ever in the course of your life. So if you don't have a good feeling, then this intuition can be the greatest indicator that you are walking down a path you should turn back from.
It’s not easy to admit, but you will know deep down if the home you’re buying is too much. If you have doubts or misgivings, you’ll be doing yourself a favor by paying attention to them, even if it means passing on the home you had your heart set on.
If you're feeling overwhelmed or uncertain about home affordability, seek out expert advice from a neutral professional. A financial advisor can help you see the big picture, and they have a fiduciary duty to act in your best interest.
Avoid Making a Decision You’ll Later Regret
Because purchasing a home is such a significant decision, make sure you are approaching it with a clear head. Don't get so get caught up in the emotion of owning a home that you are blind to the reality of the situation you are entering.
Ideally, your team of professionals will guide you to the best decision. But your mortgage broker and real estate agent might have their own mortgages to pay and may steer you in a direction that benefits them. You need to be the one to realistically review your options and choose what is best for you.