I know… my title is not sexy or attention catching, but it is IMPORTANT!
A few weeks ago a past client reached out to me about doing a seminar on homeownership. We took it a step further (because we are both overachievers) and decided to do a 4-week live Facebook series. Our first one was about budgeting to purchase a home (watch it here), and it was chocked-full of great info. I decided that I would share the info in written format for anyone that wants to have a “checklist!” (Or am I the only one who geeks-out on checklists?!?!)
Purchasing a home is scary! It is a huge and responsibility, but if you are paying rent anyway, you really should consider putting that monthly rent toward your own mortgage to help build your future wealth! If you’re like many of my past buyers you are already on a budget and trying to make the most out of every paycheck… so, what do you need to know about budgeting for a home purchase? Here are five points to keep in mind.
1. Be aware of your current credit score/rating, and know how to build and/or maintain it.
Building credit is important. Sometimes no credit is just as bad as ‘bad’ credit. You don’t start life with a credit rating – you must work hard for it. But, how? When you need credit to be able to borrow money, but you can’t borrow because you have no credit… seems like a vicious cycle. You can build credit by obtaining a credit card, using it, and paying it off monthly. You can build credit by obtaining a secured credit card from your bank, if they offer it. A secured credit card is tied to an account you have at the bank, and they won’t allow you to spend more than what is in that account. You can build credit by obtaining a small loan, such as a car loan, which you may have to have a co-signor for. So, even though grand-pappy may advise to keep all your cash hidden under your mattress and to pay everything in cash, just know that is not going to help you build credit, and you will need a credit score to borrow money for a house.
Once you have built credit, it is imperative that you maintain it. The best way to maintain your credit is to pay your bills on time and keep balances on credit cards low or paid-off monthly.
2. Save Money
This may sound like a given… “duh, I know I need to save!” But many people just don’t know how to save or what to do with the money that they do save. A bonus is that lenders like to see that you are able to save! And, I suggest that you have at least one savings account (more if you like to create ‘buckets’ of savings: for example, a vacation bucket, a house purchase bucket, an education for the kids bucket, or a in-case-of-emergency bucket… the possibilities are endless!) Here are a few practical things that you can do to save.
“Practice” paying your mortgage. Wha? Yes. Figure out how much your monthly mortgage payment will be when you purchase (more on how to find this out a little further down the page!) Once you know how much it is, put the difference between what you are paying now (likely in rent) and place it in a special savings account. I suggest an account that you plan to use to accrue a down payment or funds you will need for closing costs or home repairs! For example, your rent payment is $800/month and your mortgage payment is going to be $1,200/month. This gives you $400/month to save. This will help two-fold in that you will know that you can maintain a higher payment than you are used to as well as build up a savings! Win-win! Look at you adulting like a real adult!!
Another pretty basic way of savings is just having a specific amount or percentage of every paycheck go directly into your savings account. You may be able to work this out with your employer if they do direct deposit, or you may have to manually do it yourself. Either way, it is an easy way to begin saving.
This one’s gonna sting, so hold on tight… cut something out of your current budget that isn’t a necessity. (Clarification: This does not include your electric bill, credit card payment, or student loans!) I’m talking about cutting something like your daily Starbucks coffee… you know the $5 specialty drink with “macchiato” in the title and whip on top!! Just as an example, say you stop purchasing a $5 beverage every weekday for one whole year… you will have saved up to $1,300 per year… that’s HUGE! You can start finding ways to cut other things, too… dinner at home vs. eating out, refilling a water bottle instead of buying a new bottle of water every time you want a drink, packing your lunch, skipping the dollar section at Target (I didn’t say it would be easy… but you won’t regret it.) There are a ton of small ways that add up to BIG savings!
3. Reduce Current Debt
There is a term that lenders use called “Debt-to-Income Ratio” which is important when getting a mortgage. The lender is going to make sure that your debt is not so significant that you won’t be able to take on more debt by way of a mortgage payment. So, it may be important to pay off some of your current debt such as a your car loan, credit cards, etc. Talk to your lender to make sure that your debt load isn’t too high for your income level, and see what debts should be paid off first.
4. Educate Yourself
This is my favorite, because when you educate yourself on purchasing a home (or anything for that matter), you become empowered, and you can make good purchasing decisions. Discuss with your lender how much your qualify for (this means the total purchase price that they will lend you), and then start breaking it down to monthly payments. In many cases, I have had buyers that qualify for much more than what they actually feel comfortable affording from a monthly payment standpoint. If you know that your current lifestyle will only allow you to purchase a home for $1,200/month, don’t purchase a home with payments at $2,000/month just because the lender will approve you for that much. (A note from the author: Please use your noggin… I don’t want to see your home on the foreclosure list because you weren’t smart about your personal finances from the beginning.)
5. Know the Costs of Purchasing a Home
There are some typical costs to consider before purchasing a home… here is a breakdown of those costs in our local (Harrisonburg, VA) market.
Earnest Money Deposit: $500+ (your agent will help you decide what is a practical amount, and should be enough for the seller to take you seriously.)
Inspection(s): $250+ (this one can be tricky because it depends on what type of inspections you want, or need, to obtain before purchasing. It includes as a minimum a home purchaser’s inspection, but can include other inspections too, such as radon testing, chimney/flue inspection, Engineer’s structural report, special water tests, special septic inspections, survey, etc.)
Appraisal: $400+ (required by the lender)
Down Payment: 0% – 3.5% of the purchase price (or more, depending on your loan type.)
Closing Costs: Typically 3% of the purchase price.
Moving Costs – Variable
Home Upgrades (painting, new flooring, etc.) – Variable
Moral of this story is that you should know how to budget, save, and ask questions about what to expect when you purchase a home. There are many knowledgeable professionals to reach out to. Ask questions, and if you still don’t understand ask for clarification. Your money & the money you are spending on a home is important, and you should feel confident in the decisions you are making. Home ownership is a life-changing pursuit that can be incredibly rewarding!