Financially Preparing to be a Home Owner
You’re the only person who knows when you’re ready to own your own home. For most of us, our home is the most expensive thing we’ll ever buy, and we’ll only go through the process a few times, if that, in a lifetime.
Most people think that they are ready when they feel that they are prepared for the financial and emotional responsibilities of homeownership. You can’t always tell when that point is, particularly if you’re buying your first home. It’s absolutely vital that you examine your situation carefully and make sure that you are ready to take on the financial responsibility of owning a home.
Below are some of the essential things you should consider to ensure you’re as well prepared as possible.
Establish Your Budget
When you set up your budget, you’re creating a tool that will help you to achieve your financial aims and help you to verify if you can cope with a mortgage. You need to have a detailed understanding of your monthly incomings and outgoings. Examine your budget to ascertain if there are any changes you can make to boost your savings or disposable income. If you don’t have a clear understanding of your budget, it’s hard to verify the extent to which you can cope with mortgage payments.
There are many different ways and means of budgeting effectively. However, they all have the ultimate aim of helping you to calculate the best way of managing your finances so you can cover necessary expenditure and have a clear idea of what’s going on with your money.
Many people like to use spreadsheets for budgeting purposes because this allows them to keep track of their income and outgoings in a single file. Other people use apps or online services to monitor their budget and expenditure. Many different options are available online; Mint.com and You Need a Budget are two of the most widely used. You can enter your expenses into these online platforms to track your finances (bank accounts, savings accounts, credit cards, etc.) on a real-time basis so that you have a clear overview of your whole financial picture. Many prospective homeowners have found these types of products extremely useful.
However you keep track of your budget, it’s essential you know what you’re spending your money on. Start off by writing down all your outgoings for a month or longer, and make sure you don’t miss any sums that you might pay without thinking, such as ATM fees.
Start Out by Classifying All Your Expenses:
- Housing costs
- Installment loans (car finance, student loan, etc.)
- Credit cards
- Occasional expenses (vacations, car insurance, etc.)
- Emergency expenses (medical bills, accidents, etc.)
You could use different categories and/or give them different titles. Regardless, your budget should be an accurate reflection of your personal finances and what you want to save. This is the only way for you to identify where you can cut expenses and start creating savings.
Once you set out all your monthly outgoings, you can start formulating new plans for your spending. Imagine you want to cut your total spending by 10%, have a fund for emergencies, and begin saving for your first home. Take a look through your expenses and see where there are easy opportunities to reduce outgoings and turn them into savings.
Things To Cut Your Expenses
- Doing just one big weekly grocery shop, planning out your weekly meals, and reducing or eliminating the number of times you eat out.
- Searching for better value utility services like broadband and cable, developing more budget-conscious plans, or getting a library card so that you can reduce entertainment expenses.
- Reducing the amount you rely on your car. Can you find more cost-effective methods of travel, such as public transport or carpools?
- Evaluating the value you are getting from your subscriptions and memberships; be honest, how many times do you really go to the gym? Couldn’t you just work out at home?
- Buying your clothes from thrift shops, and learn to repair or even make clothing yourself.
Some people like to know which category every single dollar they receive goes into, be it the broadband bill, the grocery fund, or the saving account for the new house. Using bill pay and automatic withdrawals can help ensure every dollar goes just where you want it to. Other people like to use cash; they might put cash in different jars for different expenses. Discipline is key. Once the “groceries” jar is empty, you’ll just have to use what you’ve got in the cupboard until next payday.
However you decide to save, you must commit to your plans, be realistic about what you can achieve, and have some flexibility when necessary.
It can be very hard to save if you feel that the process is punishing you; make sure that you remember to put a few dollars toward actually having fun, alongside saving and paying “sensible” expenses. Looking after your budget should help you feel freer, not more restricted.
Proper budgeting is absolutely vital if you want to buy your own home.
Control Your Debts
If you want to get a home loan, you don’t have to have a completely clean slate as far as debt is concerned. However, lenders will look at your debts, including the payments you will have to make for a mortgage, and balance them against your gross monthly income in order to come up with a debt-to-income (DTI) ratio. If you have a gross monthly income of $4000 and your monthly outgoings for debt repayments are $1800, your DTI ratio will be 45% (1800÷4000 x 100).
In general, the VA is satisfied with DTI ratios of 41% or lower. You may still be able to obtain a loan if your DTA ratio is greater than this, but there may be extra financial conditions attached. All loan companies have their own permissible DTI ratios; however, generally speaking, the higher your ratio, the more difficult you will find it to obtain finance.
Not all types of debt are regarded in the same way: Loan companies may set a limit in terms of the amount of “derogatory credit” they will allow. “Derogatory credit” covers debts such as judgments, liens, charge-offs, and collections. Some lenders might cap derogatory credit at $5000, while some may allow up to $15,000. You may be asked to address certain types of derogatory credit; e.g., liens and judgments, prior to loan closure. Generally, this will require you to settle all the outstanding sums, or at least show that you have established a repayment schedule and are keeping up with the payments.
The essential thing to remember is that all significant monthly debts will heavily influence what loan companies believe you can afford to repay and, subsequently, the maximum purchase price they will allow.
Debt Repayment Stratagies That Work:
The same is the case when you set your budget. Many debt repayment strategies are available. These include the following:
- Pay off the debt that has the highest interest rates first (for many people this will be their credit cards). Get this paid off, and then start working on whichever remaining debt has the highest interest rate.
- See if you can take your high-interest debts and substitute them with lower interest debts. Remember you may have to pay to transfer your debts.
- Don’t just pay off the minimum repayments on your debts. If you can pay more than this, you will not only pay your debts off quicker, you will also pay less interest. If you only pay off the minimum each month, paying down your debt will take much longer.
- Target your smallest debts first as a way of working up to the larger ones. As you see how easy it is to pay off the smaller debts, you will get momentum and enthusiasm for paying off the larger ones.
- Don’t assume any new debts. Set your budget and don’t spend more than you have coming in. Create an emergency fund so that any essential expenditure that you haven’t budgeted for doesn’t mean reaching for the credit card.
- Have a look around the house and see if you’ve got anything you don’t need or use. Sell these items on eBay or through a garage sale and pay off some more of your debt with the proceeds.
- Don’t go for short-term opportunities such as payday loans. The high-interest rates associated with these loans can make your debt situation significantly worse. Don’t agree to be a co-signatory for anyone else’s loan.
Practice Repaying Your Mortgage
It’s a good idea to have a practice run for your mortgage to work out just what you can manage. The VA Home Loan Calculator will help you to work out how much you will be repaying.
Imagine that you are planning to take on a loan for a new home that will have mortgage payments of $1,200. At present, you’re paying $800 a month for rent. That equates to $400 more per month. For a few months, once you’ve paid your rent, take an extra $400 and put it away somewhere where you won’t touch it. This approach will help you to test whether or not you can manage without the extra $400. If you find living off $400 a month less manageable, that’s a big step toward taking on a mortgage. If you find you’re struggling without it, you might have to take another look at your budget or maybe lower your expectations in terms of the price you can afford to pay for your new home.
Some people might not be paying anything for housing at the moment. Maybe you are still living with mom and dad, or staying with a friend. In these cases, loan companies might have concerns regarding your ability to cope with the lifestyle change that paying a mortgage will bring about. If you haven’t been paying rent, mortgage lenders would like to see that you have been putting your money away in savings. If you haven’t, lenders may evaluate your financial stability with a jaundiced eye. If you’ve been spending your salary each month when you haven’t had to pay any rent, how will you manage when you’ve got a $1000 monthly mortgage repayment to make? If you can show a mortgage lender that you have been saving up the money you haven’t been spending on rent, that goes a long way towards demonstrating that you are financially responsible enough to take on a mortgage.
Build Up Your Reserves
So far, we have evaluated some of the upfront costs that you may have to face when taking out your home loan. Generally speaking, there is no definitive sum you need to have behind you before you start the process of purchasing a home, but lenders want to see that you can afford your loan and still meet your other outgoings.
Before you start the home buying process, work out what your living expenses will be for three months and try to save this amount separately. This way, you will have a reserve in case you lose your job, get sick, or suffer an injury. As well as giving you security, being able to show a lender that you have saved this amount will make them much more amenable to offering you a loan.
Some lenders will, in some cases, demand to see that you hold this type of reserve. If you’re planning to use rental income as part of your mortgage payments, or you’re asking for a larger loan than average, this is very likely.
If you plan your budget correctly, paying your mortgage will become a standard and manageable part of your monthly outgoings. You’ll have the know-how, commitment, and financial backing, and this will make meeting your debt obligations second nature.