Some of our most asked questions center around home buying and the involved processes. When we think about it that makes perfect sense. The item in your budget where you’re likely to spend the most is your primary residence. Buying a house is a huge undertaking. If you think you’re ready to take the plunge there are lots of things to know.
You need to know how much house to buy, how you’re going to finance the purchase, who’s going to help you look, and on and on and on. That’s why we decided to launch this mini series. We do have other resources available which discuss home buying. However, our goal with this series is to discuss the home buying steps in depth, one at a time. The process can be overwhelming so our goal is to break down the process into more bite-sized steps.
Step 1: Get your financial house in order.
Oh, the joy of strolling through model homes and watching HGTV! It’s so beguiling and you know you want to stop renting, or upgrade, or just move into something new. It’s hard to withstand the temptation of buying a home. But, and this is a big but, don’t do anything until your finances are in order.
What exactly does it mean to have your finances in order?
In a nutshell, it means no debt, excellent credit, emergency savings funded, and savings for a down payment (and earnest money) in place.
Buying a house is most likely the single largest investment you’ll make during your lifetime, so for us to say “proceed with caution” is quite an understatement. There are too many people who jump into buying a home without being prepared and then find themselves in a dicey predicament down the road. We want to help you avoid that situation.
The work outlined in this step will take time but doing the right things here will make all the difference down the road.
Get Your Credit in Excellent Shape
Your credit reputation, known more commonly as your credit score and report, will affect your interest rate so it’s critically important to have the best credit possible. A good or excellent credit score is beneficial in getting the best rate possible. There can be a difference of up to ½ percent between an excellent score and a fair score (630-689) which can mean a difference of thousands of dollars over the life of the loans and hundreds in your monthly payment.
Here’s a comparison between terms for a $300,000, 30 year loan with credit scores in the fair versus excellent range.
Step 5 of this series, Get Pre-Approved, will cover mortgage shopping in detail.
When the thought of buying a home is just a twinkle in your eye, start by getting your credit in order. This means correcting any erroneous data in your credit report, paying bills on time and reducing your debt. You can get a free credit report at www.AnnualCreditReport.com. If you need some guidance on how to improve your credit score, check out our blog post on this topic here. Improving your credit score takes time but each month you’ll see an increase if you’re paying down debt, paying all your bills on time, and not opening new credit.
Pay Off All Debt
Debt is not only a drag on your budget, it’s a drag on your emotional and physical well being so getting rid of it is great advice all the time. For the purposes of buying a home, it’s especially important to rid yourself of other debt as you take on housing debt.
Institute a plan to aggressively pay off all debt: credit card debt, personal loans and car loans. Let’s pause for a minute to talk about student loans. I want to tell you to pay them off before you buy a house, I really do, but I also know there are many of you who are acutely in tune with your finances and can manage your student loans and a mortgage. So how do you know if it’s ok to pursue homeownership while paying off your student loans? If your payments are reasonable for your income (you could easily make double payments), you’re able to save 10% for a down payment, and you’re on track to pay your loans off by age 32 (average age for college graduate plus 10 years for standard repayment), then you can probably handle a mortgage while still paying student loans.
Once your debt is gone, you’ll be able to better manage a house payment and all the expenses that go along with home ownership.
Utilize the Momentum Method to efficiently pay down your debt. If you want to speed up your debt reduction, look for margin in your budget. Reduce spending in other areas to free up cash that can be applied to debt.
Save, Save, Save, and Save Some More.
The last part of Step 1 is to save a lot of money. Your emergency savings must be fully funded and you have to have a down payment. How do you do this? Paying off debt will free up a lot of money every month that can be redirected to savings. Additionally, you can challenge yourself to find even more margin in your budget for savings.
You’ve heard it before but it’s important: You need emergency savings to prevent financial disasters when emergencies occur. Three months of your current expenses at a minimum and as you get closer to buying a home, adjust this amount to be three months of projected expenses as a homeowner.
Once your emergency savings is fully funded, it’s time to save for a down payment. Ideally, you’ll save 20% of what you think you’ll spend to avoid mortgage insurance (PMI). A minimum of 10% should be the goal.
Both of these savings funds should be held in a safe and liquid account. An interest bearing checking or savings account would be a good place to keep this money. This isn’t money to be invested or put at risk.
Step 1 may take quite some time but it will be worth it in the long run. As you’re paying down debt, your credit will improve and once all your debt is paid off, you’ll be able to save at a much faster rate.
Once you’ve completed the work in Step 1, you’re ready to move on to Step 2: How Much House Can You Afford? Keep your budget handy, you’ll need it!On to STEP 2
Gayle Evezich, AFC® is a Senior Financial Concierge at Your Money Line and personal finance author. Gayle’s greatest joy is to help others find comfort with their money through financial empowerment. When not working or donating her services, you can find Gayle hiking, cooking creative vegan food, traveling or reading scandalous murder mysteries!