How to buy a home in a cooling market, according to top-ranked advisors

Becoming a homeowner can be challenging enough under good circumstances.

Add in higher mortgage rates, elevated home prices and unrelenting high inflation — i.e., the current home-buying environment — and it may feel decidedly unattainable.

The average rate on a 30-year fixed-rate mortgage has been trending above 7% for most of October, more than double the 3.3% heading into 2022, according to Mortgage News Daily. Meanwhile, the median list price for a home in the U.S. was $427,000 last month, 13.9% more than a year ago, Realtor.com’s latest monthly report shows.

However, conditions generally appear to be shifting in buyers’ favor as demand continues to fall. In the face of higher interest rates — which makes payments less affordable and reduces the pool of potential buyers — median home prices have been sliding on a monthly basis since hitting an all-time high of $449,000 in June, according to Realtor.com. 

While it’s impossible to know with certainty where home prices or mortgage rates will be in the coming months and years, there are ways to make sure you’re in the best financial position possible to enter the market as a buyer, whether soon or down the road.

Here are some tips that may help you get ready.

The first thing to do is figure out how much home you can truly afford, experts say. This means having a good handle on your current financial situation.

“Understand your current budget … what are your expenses, how’s your spending, would you need to make changes,” said certified financial planner Sandy Higgins, senior wealth advisor with Capstone Financial Advisors. The firm, based in Downers Grove, Illinois, ranked No. 77 on the 2022 CNBC Financial Advisor 100 list.

While the purchase of a house is a single transaction, affordability is largely about monthly mortgage payments. 

“Think about spending no more than 25% to 28% of your gross monthly income on your payment, including taxes and insurance,” said CFP Dean Karrash, principal at BLB & B Advisors in Montgomeryville, Pennsylvania. The firm ranked No. 87 on CNBC’s FA 100 list.

The home-buying transaction itself also generally comes with expenses, such as mortgage fees and other closing costs, such as transfer taxes or the price of a title search. Those one-time costs can total thousands of dollars.

You also should consider ongoing costs that come with homeownership like maintenance and repairs. 

“Try not to be house rich and cash poor,” Karrash said. “You’ll find there are a lot of things you can’t do, like afford a replacement vehicle or go on vacation.”

As you may know, the higher your credit score, the lower the interest rate you can qualify for on a variety of loans, including mortgages. Home buyers with lower credit scores may pay almost $104,000 more over the life of a 30-year fixed-rate mortgage than someone with an excellent score (based on a home price of about $354,200), according to a Zillow analysis.

“Look at your current credit score and see if you need to make improvements,” Higgins said.

Generally speaking, a score of 740 or higher yields the best mortgage rates. However, be aware that the scores you see for free online — so-called educational scores such as VantageScore — are typically not what lenders use in the approval process.

While mortgage lenders pull your score from the three big credit-reporting firms — Equifax, Experian and TransUnion — it is a specific FICO score that is used and can be different from an educational score.

Regardless, financial habits like paying your bills on time and getting rid of high credit card debt can help your score head higher.

Another part of the calculation of how much house you can afford is the down payment, which helps determine how big of a loan you need to take on. The less you need to borrow, the less you’ll pay in interest overall and the smaller your monthly mortgage payments. A bigger down payment can sometimes help you get a better mortgage rate, too.

“We usually advise people to put at least 20% down to avoid private mortgage insurance,” Karrash said.

That type of insurance is for the protection of the lender if you default on your loan and usually is applied to mortgages that are for more than 80% of the home’s value at the time of purchase. It can cost anywhere from 0.58% to 1.86% of the loan’s value.

If a 20% down payment seems out of reach, be aware that many home purchases involve a much smaller amount: First-time homebuyers put an average of 7% down, according to the National Association of Realtors. For repeat buyers, the average down payment is 17%.

Beyond things like real estate taxes and homeowners insurance, there are other costs that come with owning a house such as footing the bill for maintenance and repairs. Those expenses can easily set you back thousands of dollars all at once.

Before buying a house, make sure you’d still have money in savings to cover those surprise costs or any other unexpected hit to your income or budget, Higgins said.

“You should maintain an emergency stash,” she said. “As you own a house, more of those unplanned situations happen.”

Financial advisors recommend having at least three to six months’ worth of income in a savings account that you can tap in case of unanticipated expenses.