Even if you’re still a few years away from your first home, the matter of finance might feel like it’s creeping up on you already. A home is no small investment; in fact, it’s one of the biggest ones a person can make, and it can be a lifelong – or at least long-term – investment with tangible benefits through both equity and your credit. That is, of course, if you plan well; it can also be a direct path to terrible credit and debt if you decide to tackle it on a whim.
Many a new homeowner has struggled with just beginning the process of getting their finances to prepare for taking out a mortgage. In order to make that step, at the very least, slightly less daunting, here are some plans we’d suggest for preparing to finance a home:
Decide what kind of mortgage you can afford
This is a good first step. Generally, you want to look for homes valued between two to three times your gross income. You can work with a financial advisor to help determine the size of loan for which you’ll qualify. Find out what kind of mortgage – 30- or 15-year? Fixed or adjustable – is best for you. And gather the documentation a lender will need to pre-approve you for a loan; this often includes W-2s, pay stubs, account numbers, and past bank statements.
Easier said than done, right? Even so, it’s important to be current on your debts – lenders generally don’t like to see a debt load of 35% or more of your income. That includes your mortgage, which typically ranges between 25 and 28%. So, you need to get monthly payments on the rest of your installment debt down to between 8 and 10% of your net monthly income to start out. To that end…
Create a budget
Use receipts and your transaction history to create a budget that reflects your actual habits over the last several months. This will better factor in the unexpected alongside more predictable costs like utility bills and groceries. You’ll quickly find ways to cut corners, whether it be skipping a Starbucks run or staying in one weekend night a week.
Establish a good credit history
Get a credit card and make all your bill payments on time. Pay off entire balances as soon as you can. Also, ensure that your current credit report is accurate, and correct any errors immediately. You might even look into a credit-building loan – a simple and relatively cheap loan wherein a sum is placed in a savings account that you cannot access until you’ve repaid the loan. If you pay as agreed, your financial institution will send a good report to the credit bureau. According to CitiBank’s Asset Funder’s Network, you could see an increase of about 35 points on average if you pay it all off on time.
Save for a down payment
Designate a certain amount of money to put in a saving’s account each month in order to put down the largest initial down payment that you possibly can. Although it’s possible to get a mortgage with less than 5% down, you’ll get a better rate the more you can put down. Aim for 20% of the total cost – you can do it!
Increase your income
Again, if only it were so easy. If your situation allows, now might be the time to ask for a raise. If that isn’t possible, consider taking up a second job to get your income at a high enough level to qualify for the mortgage you’d like. That said…
Keep your job
Having held your current job for under two years might mean you’ll have to pay a higher interest rate. If you can, stick with what you’ve got. At the very least, you’ll show your lender that you’re able to hold a secure position.
Even if you have enough money to qualify for a mortgage and cover your down payment, the fun’s not over yet. You’ll need to factor in closing costs – which can average from 2% to 7% or more of the home’s price – and incidentals like hiring a home inspector. Besides, you’ve got some nice momentum going here in terms of a savings plan. Keep up the good work!