So, it’s time to buy a home. Many of you likely are ready to do so for very different reasons. For one, you might be starting a family and need more space. Two, you might be only months from retirement and long have been ogling a move to the beach. Three, you might want to live closer to aging family members. Four, you might be facing a big career transfer.
Or, maybe it’s simply time to become a homeowner. You’re done with renting. Weary of stuffing a landlord’s wallet each month rather than building equity in your own place (What’s equity? We’ll explain later).
Whatever your motivation, the path to homeownership is primarily a financial one. Where you want to buy and why you want to buy are up to you. How to buy a home requires careful consideration and self-honesty. Cruise with us as we walk you through a financial roadmap to a new home.
Check your credit
It all starts here. You won’t get anywhere with bad credit, except back in the rent cycle. Mortgage lenders check your credit history first because they want to know your track record with making monthly payments. If it’s not solid, you won’t get a home loan. Simple as that.
Based on your current financial status, spending habits and account balances, you probably have a decent guesstimate of what your credit rating could be. But, let’s find out for sure.
Your first step is obtaining a free annual credit report from each of the three reporting agencies — Equifax, Experian and TransUnion. They all employ similar-yet-different formulas to calculate your credit rating, and they all use your financial habits as fuel — how many times you’ve paid credit bills late, how many lines of credit you have open, how much you use those accounts and how often.
Examples of lines of credit (or credit accounts) include the usual credit cards, retailer (like department stores) credit cards, automobile loans, student loans, home loans, home-equity loans and the no-interest-for-12-months installment loan that helped you buy your new mattress.
Sometimes, your three credit reports aren’t pretty. Other times, they’re a pleasant surprise. Regardless, they all contain a three-digit score that will be similar to each other, and range somewhere between 300 (lousy) and 850 (awesome). A credit score of 700 is considered good.
Make a plan
You can’t plan for a new home until you know your credit scores. Good, bad or ugly, they’re a huge barometer of your overall financial health and a good guide for what you should do next.
Let’s assume your three credit scores are okay, but not super-fantastic. You can fix them. Just realize it’s not a quick fix. You’ll need at least a year of on-time, credit-account payments to establish a healthier credit history. Doing that requires planning.
Start with a little homework — jot down all your monthly income. Track how much goes to bill-paying and how much to necessary expenses such as groceries and gas. Next, track how you spend the rest of that monthly income — on clothes, restaurants, movie tickets and so on.
Then, what can you cut? Don’t say “nothing.” Small actions such as brewing your own coffee at home rather than patronizing a coffee shop every day add up big over time. If you’re eating out every other night, dial it back. Pack a lunch to take to work.
Trek through a couple months’ spending records and you’ll soon know where you can cut the financial fat. For now, plan to stockpile all the extras in a savings account.
‘Budget’ isn’t a dirty word
Once you’ve examined your income streams, expenses and spending habits, it’s time to align all that homework. Your next stop on the financial roadmap to a new home is sketching out a weekly or monthly budget.
Chart your bill payments and necessary expenses. Those are the items you must pay. If you need to knock out credit-account debt (especially credit cards), pick the account with the highest balance and nastiest interest rate, and begin doubling-down on monthly payments.
Calculate the maximum you can afford to pay on that account each month, then how many months it’ll take to pay it off. Do this with all of your credit-account debt, and your roadmap to financial health becomes less confusing and congested.
Do your best to resist spending unnecessary money. It requires discipline and thinking ahead — don’t go to the one-day sale if you don’t legitimately need anything. And politely tell the Girl Scouts that you’re not buying cookies this year.
The good news is that living on a monthly budget and sticking to it allows you to track your progress even if it’s via hand-written columns in a notebook. Every month you tally as having met your budget goals and made your on-time bill payments, is one month closer to healthier credit — and being able to buy a new home.
‘Save’ isn’t a dirty word either
If you can live on a budget, you can save money. One discipline feeds the other. Why do you need to save money if you want to buy a home? We know it sounds overly simplistic, since you know you should be saving for several important reasons anyway.
But here’s why, in the home-buying context. If you’re a first-time buyer, you’ll need to make a down payment when you close on your home. It’s the first payment you’ll make on your mortgage and it’s predetermined by the amount of your loan. Industry standard is 20 percent.
So yes, you probably should start saving now as an important step in your financial roadmap to a new home. Not to mention for kids’ college tuition, the motorhome you want to travel North America in once you retire, and replacement costs for new household appliances.
Pay everything on time
Repeat after us — pay all bills on time. We mentioned above that you’ll likely need at least a full year of on-time, credit-account payments to polish your credit history. Apply that same discipline to every other monthly expense and you’ll give your financial health a big booster shot.
How? Schedule automated online payments. Pay everything at the first of the month if your income streams allow it. Doing the latter (if possible) gives you a clearer view of remaining income for that month’s expenses. It means you might be able to tuck away even more in savings if your expenses are a bit lighter — for example, no youth-league fees due for the kids that month, or no quarterly insurance-policy payment.
But, imagine you do have those payments. Pay yourself and sock those amounts in savings!
Monitor your lines of credit
Many of us have some debt, so don’t feel alone in this arena. It seems like we’re always paying something off, even if it is only that new mattress, interest-free in 12 months.
Here’s the deal: successfully paying off that mattress within the promotional period boosts your credit. That’s an important marker on the financial roadmap to a new home. It’s okay to have lines of credit! Demonstrating a good history of paying off balances, avoiding late charges or worse, missing payments, tells creditors and the three credit reporting agencies — our friends Equifax, Experian and TransUnion — that you’re a smart credit user.
And it all works together. The credit reporting agencies reward you with good credit scores, and mortgage lenders are more likely to offer you a home loan.
A few tips: if your credit status needs work, don’t panic and close all your open lines of credit. Again, you need to demonstrate you can tame those balances and manage them smartly.
The reverse also is true: unless it’s a complete emergency (even then, consider it carefully and seek advice from a certified financial counselor), don’t open several new lines of credit while you’re improving your financial health. Discretionary purchases can wait until your household has a new home to put them in.
The last word: equity is what you want
Buying a new home = building equity in it. What’s equity? Think of it as financial insulation.
For the first few years of your mortgage, you’ll be paying off the interest on that loan (why you want a smart interest rate). But eventually, your payments go straight to principal. Once that happens, you’ve built “stock” in your home. That “stock” can be tapped for a home-equity loan, if you like (to buy that motorhome for retirement).
However, you’ll likely buy another home at some point. When you do, you’ll roll over the equity of your current home into a future home instead of making a down payment. Buy a less expensive home = making a profit.
Can’t do that when you rent!
Ready to buy a home now? ICI Homes is Florida’s Custom Builder. opens in a new windowGive us a shout here.