Find out if you are financially fit to buy a home

Tumbling prices raise concerns about getting into the real estate market now. Here's how to judge if you are ready to buy.

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"Price discounts of 10 to 25 percent!"

"Low-interest financing available!"

"Large inventory, great selection, and terrific values in every neighborhood!"

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Is it just advertising hype to lure buyers into plummeting housing markets – or a sign of great buying opportunities?

As real estate's busiest months begin, potential buyers are challenged to understand both the opportunities and risks of home purchases in markets that have yet to stabilize. March home sales fell 19.3 percent from last year, dropping inventory to a 9.9 month supply, and housing prices fell 7.7 percent year over year.

Record foreclosures, forecasts of housing price declines of 10 to 25 percent from their 2005 peak, and massive sell-offs by desperate home builders have fueled buyers' fear that housing prices have not hit bottom.

Many prospective buyers are not persuaded that lower housing prices represent long-term values.

Yet, price reductions are a powerful lure for some buyers, says Kyle Richards, a real estate broker for Coldwell Banker in suburban Maryland. "Steep price cuts and quality inventory create attractive opportunities for the qualified buyer. Buyers can get homes in expensive neighborhoods that they didn't dream they could buy just a year ago."

In today's housing market, a successful buyer must be able to respond to market opportunities, have stellar credit, keen market intelligence, and a hefty down payment. To judge your fitness to buy, answer the following six questions:

1. Is your debt-to-income ratio less than 30 percent?

Divide monthly mortgage payments by monthly income. Lenders prefer a ratio less than 30 percent. Lower your mortgage payments by increasing your down payment. Settlement fees increase when a down payment is less than 30 percent. Visit bankrate.com to calculate your ratio.

2. Is your credit score higher than 680?

Poor credit results in higher loan fees. Credit scores of less than 620 pay a full 2 percent fee at Freddie Mac and Fannie Mae. Fees slide to zero with a score of 680. You can obtain a complimentary free credit score at annualcreditreport.com.

3. Is the local market price/rent ratio in balance?

Divide prices of homes by neighborhood rents and compare it with the historic average. Higher price/rent ratios signal renting rather than buying, as owners spend more in monthly costs, including mortgages, taxes, and insurance. The price/rent ratio at the end of 2007 remains 20 percent higher than the 15-year average, falling from a peak of 24 percent in 2005. Buyers should be interested when the current ratio moves back to within 10 percent of the average – a level not seen since 2002. Check realtor.org for individual city prices and bls.gov for the homeowner's rental index. Local prices and rents vary greatly by location. Check with a local broker to obtain that information.

4. Has the neighborhood generated a positive return on investment?

Housing appreciated 7 percent annually between 2002 and 2007. At the height of the housing bubble in 2005, a housing investment appreciated at 14 percent, annualized over five years.

The Case-Shiller index at standardandpoors.com represents home values for 20 major cities and the Office of Federal Housing Enterprise Oversight home price calculator at ofheo.gov tracks current housing price changes for 363 metropolitan areas. The Case-Shiller data is utilized as a price-trend, not a neighborhood-specific index. The OFHEO index is limited to mortgages of less than $417,000.

5. Are home inventories in the neighborhood low?

Abnormal vacancy rates, unsold inventory, and foreclosures portend continued price declines. Check with the US Census Bureau, census.gov, for vacancy rates in current markets and housingtracker.net for city inventory information. Vacancy rates during the first quarter of 2008 were 2.9 percent, significantly higher than the 1.7 percent rate in 2002.

6. Is it cheaper to buy than rent?

Many sites offer buy-versus-rent analysis to determine the investment horizon required to generate a positive return, including ginniemae.gov. Plan to occupy your home at least five to seven years, the length of today's housing cycle.

If you answered "yes" to five or more questions, you should become an enthusiastic buyer. Answering yes to four questions merits looking, but be cautious. Scores of three or less are an indication to wait out the present market, improve your credit scores, and increase savings.

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