How to Get Your Finances in Order Before Buying a New Home
As exciting as buying a new home can be, it’s a process that also requires significant planning and preparation. In addition to choosing a neighborhood and finding a reputable realtor to work with, sorting your finances is another critical step when starting your hunt for a new home.
Organizing your finances ahead of time will give you peace of mind and can even help expedite the home buying experience. If you’re considering buying a new home, here are five factors to consider before taking on this new financial commitment:
- Determine How Much You Can Afford
As you prepare for homeownership, your first priority should be determining how much you can spend on a home. Overestimating your budget could jeopardize your financial health. However, by determining how much you can afford in monthly mortgage payments, you’ll be able to filter out any homes that are not within your spending limits.
As a general rule, it’s better to stay conservative with your estimates. Stretching your funds too thin might make it more difficult for you to save money or even cover your existing expenses. To avoid this, try to keep your mortgage payments below 30% of your net income as this will ensure you save for other life expenses, such as retirement or your children’s education.
- Save for a Down Payment
Once you’ve decided that you want to buy a home, it’s important to jumpstart your savings as soon as possible. A larger down payment means you’ll own more of your home right off the bat and can also help you get rid of private mortgage insurance faster.
How much you’ll need to save will largely depend on the type of mortgage you choose. For instance, if you’re a first-time home buyer or have less-than-perfect credit, you may want to opt for an FHA loan. Whereas conventional mortgages require a higher credit score and a down payment of up to 20%, the requirements for FHA loans are more lax and require less money down. Depending on the type of loan you choose, you can adjust your saving goals accordingly.
- Factor in Closing Costs
As you prepare your budget, you should also factor in unexpected closing costs, which are the expenses related to finalizing your mortgage. When overlooked, these expenses can be a sticker shock to homebuyers as they can tack on anywhere between 2% to 5% of your home’s purchase price (between $3,000 and $7,5000 extra on a $150,000 home).
Closing costs may include lender fees, home appraisal and inspection, title fees, property taxes, escrow fees, and interest. While you may be able to fold them into your monthly mortgage payments with interest, paying out-of-pocket is the most cost-effective way to cover these costs. That said, they should be factored into your savings goals, as well.
- Raise Your Credit Score
When applying for a mortgage, lenders look at your credit history to determine your credit-worthiness. Prior to applying, check your credit score and verify that all of the records are accurate. If you spot any errors on your report, be sure to dispute any false claims immediately as mistakes could hurt your chances of loan approval.
While there is no secret formula to raising your credit score, in general, you’ll see improvements to your score if you focus on limiting your credit usage, refraining from opening new lines of credit, and paying all of your monthly bills on time. Boosting your credit score can have a big impact on the type of financing you qualify for and can save you a significant amount of money over the life of your loan.
- Pay Down Outstanding Debt
In addition to checking your credit score, lenders will assess your history of paying your debts and look at how much outstanding debt you currently have. Some debt won’t necessarily hurt your chances of mortgage approval, but lenders will want to see that you’re responsible with managing your debt.
One of the most important metrics used to assess your creditworthiness is your debt-to-income ratio (DTI), which is a comparison of your current debts and your income. You can calculate your debt-to-income ratio by dividing your monthly debt payments by your gross monthly income. Unsurprisingly, the lower your DTI, the more favorable your loan terms will be, so it’s best to pay down your debts when possible or explore additional streams of income.
Buying a home is a significant financial undertaking that can be equal parts exciting and stressful. With proper financial preplanning, you can ensure a smooth home buying experience.