by Carrie Schwab-Pomerantz, CFP®, President, Charles Schwab Foundation; Senior Vice President, Schwab Community Services, Charles Schwab & Co., Inc.
August 17,  2011

Dear Carrie,

I'm a single guy in my early 30s with a steady job. I'm renting right now but, having watched home prices decrease over the past couple of years, I'm tempted to buy. Should I jump in now before things turn around? And would an FHA loan be my best bet?

—A Reader

Dear Reader,

Before we get into any details, I want to stress that the decision to buy a house—surely one of the largest purchases most of us will ever make—should be based on wanting and being able to afford that home and lifestyle, not on hoping to make a good investment. You're absolutely correct that today's lower prices are attractive. But that doesn't automatically translate into financial gain.

That said, this is a great, timely question, and worthy of a close look. Starting with your overall financial situation, a steady job is important, but so is your annual salary, the amount you have saved for a down payment, how much other debt you already have and how much more you can responsibly handle. Last but not least is the housing market in your area and whether or not you can afford to buy no matter how far prices have come down.

But before you even get into the financial nuts and bolts of buying a first home, there are emotional and lifestyle issues I think you should address, especially at your stage in life. So let's deal with those first, then come back to whether buying makes economic sense.

Are you ready to commit?
Buying a home is a long-term commitment. While just a few years ago people had the idea of flipping a house to make a quick profit, we now know that that strategy is far from reliable. In fact, you're probably better off renting unless you plan to stay in a house for 5 or 6 years, or more. So you need to look closely at where you are now and where you expect to be in the next few years. For instance:

• Job status—Do you plan to stay at your current job? Is there a chance you might be relocated? Will you be looking for other career opportunities?
• Relationship status—Being single implies a certain freedom of movement. Are you really ready to settle down in one location? Also, would the house you buy now still work if a relationship and a family were part of your future?
• Ongoing responsibility—Buying a house means a commitment of time and energy in addition to money. Are you certain you want to take on this added responsibility at this time in your life?

Can you afford to?
If you honestly feel you're ready to be a homeowner, the next step is to crunch the numbers. While lower housing prices look tempting, you have to be realistic about how much it takes to get in the door. Then you have to factor in the ongoing costs.

First of all, do you have the down payment? While it's possible to put less than 20 percent down, if you do so you'll also have to pay private mortgage insurance (PMI) which will add to your monthly. This would be the case with an FHA loan. FHA loans are designed to make it easier for first time homebuyers—you can finance up to 97 percent of the cost—but PMI can be significant depending on the cost of the home. Insurance on FHA mortgages is 0.5 percent of the total amount of the loan annually. For conventional loans it can be as high as one percent. On a $240,000 loan, that could mean PMI of $2,400 a year—an additional $200 a month on your payment!

Initial costs also include things like transfer fees, appraisal fees and closing costs. Once you own your home, you'll have recurring expenses such as property taxes and homeowners insurance, ongoing maintenance, and perhaps home owners association fees. These costs can be somewhat balanced by the tax break you get on property taxes and mortgage interest. But tax deductibility won't help if you're having trouble making the monthlies.

How to decide
Take a look at your bigger financial picture. Before you buy a house make sure that you have an emergency fund of three to six months' living expenses tucked away just in case. Also make sure that you're contributing to your retirement fund every month. You should never let house payments stand in the way of your basic financial health.

If you're on track with savings, the general guideline is that your total housing costs shouldn't exceed 28 percent of your gross monthly income, and that all of your debt combined shouldn't exceed 36 percent of your gross monthly income. To find out what you would have to pay each month, I suggest running your numbers on an online mortgage calculator. You'll be able to create some scenarios that will give you a better idea of how much house you can afford. Then go talk to a lender. The more information you have, the better positioned you'll be to negotiate the right price on the right house for you—one that you'll be able to enjoy for many years to come. Good luck!

The information provided here is for general informational purposes only and is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, consult with a qualified tax advisor, CPA, financial planner or investment manager.

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