Buying a home is generally one of the best investments you make in your life. It provides you with an investment that supplies collateral for many other investments you may wish to make in the future. In essence, it provides one big item that you can borrow against for all other sorts of items you wish to purchase in the future. It can also provide security for your children, as a valuable possession to pass on to younger generations.
A home is also likely going to be the single largest investment you make in your life, and you should be sure when you enter into the market that you are able to maintain a mortgage and your home without it bankrupting the other parts of your life.
Initial Considerations
Unless you are in the position of being able to pay for a house outright (in which case you won’t need the majority of advice in this article), you are going to have weigh your current financial position, and that of the reasonably foreseeable future, to find out if you are in a position to start looking for a home. Before you start looking at financial considerations, consider the following questions carefully:
- Are your current job and income reliable?
- Do you know how to budget?
- Are you prepared to live in one place for a minimum of 3-5 years?
- After you buy the house, will you have enough money left over for current debts, house upkeep and repair?
- Do you have life or disability insurance to cover the cost of the home if you (or your partner if you have one) is unable to work or dies?
- Are you prepared to put the work in to maintain the house and yard so that the property value does not decrease because of neglect?
In order to survey your current situation, start with your credit rating. While at one time, a poor credit rating meant that your chances of getting a mortgage are slim, this is no longer the case. The worse your credit rating, however, the higher the interest rates your lending institution will charge.
In order to check the current status of your credit rating, contact a credit bureau. Most will provide you with your report free of charge, or for a small fee. This report will reflect how you have used credit in your financial history, and your record for paying it back. Take a look at your credit report, make sure that it is an accurate account of your credit history and ask the credit bureau to clarify and rectify any errors.
The two years before you apply for a mortgage will be the most important, so if you have a poor credit rating, start to rectify it immediately. Make an appointment with your banker to see how you can improve your score to reflect a responsible borrower.
The other thing to consider is your debt-to-income ratio. Even if you have a great credit rating, a large debt-to-income ratio can signal that you are not financially ready to buy a home. Typically, at any time, your debt should not be larger than 30-40% of your gross monthly income. Remember that debt includes credit cards, existing loans (including education loans, car loans, etc), alimony, child support and housing expenses. There are several online calculators that can help you calculate your current debt-to-income ratio.
A further calculation that is good to make is your net worth, which tells you if your assets exceed your liabilities. There are also many online calculators to be found to help you figure this out.
The next financial skill you require is a basic knowledge of budgeting. A budget gives you a picture of how much of your money every month is already accounted for, and how much you are able to spend monthly on your house (for mortgage payments as well as upkeep and repairs). It is best to start with a budget for how you currently live and then estimate what your likely “homeowner” budget would be.
To enable you to estimate a few of the figures you will need, if your debt-to-income ratio is low, multiply your gross annual salary by 2.5 to see what price-range you would be looking at in a home. For example, if you (or your household) make $50,000 per year (gross), then you would be looking for a home in the $150,000 range. Make an appointment with your banker or mortgage broker to see what kind of mortgage would be pre-approved in your current financial situation.
Unexpected Costs
When you are preparing your budget for possible homeownership, there are a few issues to keep in mind. The first is the down payment. There are many different types of mortgages out there. The hotter the real estate market, the more diverse the deals. Mortgages are great investments for banks because they are long term and they have something very valuable to take away in case you default on the loan. To that end, there will be many people competing to take your buck, and many will be offering deals.
A couple of decades ago, you required a down payment of 20% in order to qualify for a mortgage. These days, there are some institutions who are offering mortgages for zero down payment, especially to first-time homeowners. The more you can put down on your home, however, the better a mortgage you will get. Plan on putting at least 3-5% down. There are other costs attached to buying a home, however, that must be taken into account. One of these is the home inspection. No home should be bought without an inspection.
The most unexpected are closing costs. Closing costs will be paid when you get your mortgage loan and include such expenses as taxes, title insurance, financing costs, items that must be prepaid and other hidden closing costs. These costs will vary, so budget at least 3-6% for them as well. Make sure that your lender gives you an estimate of closing costs when you apply for your mortgage.
Finally, once you are a homeowner, budget at least 1% of the total cost of the home per year for upkeep, repairs, appliance replacement, and improvements. This home is an investment in your future, and the future of your family. Whatever improvements you make in it will increase its value, and will increase your comfort and happiness living there.
