How to Get Your Finances in Order Before Buying a Home
Buying a home is an exciting adventure. Things like floor plans, square footage, potential upgrades, and curb appeal often take center stage throughout the life-changing activity.
However, there’s one big, dull, and overwhelming aspect of the home buying process that shouldn’t be ignored: your finances. If your finances aren’t in good order, it can make it difficult to purchase a home. Even if you do so, poor financial preparation can leave you with tight finances and a lemon of a loan.
Here are a few considerations to help you prepare your finances before you head out house shopping.
Consider What You Can Afford
The first step is always to narrow down what you can afford. There is no official way to do this, but there are a couple of different ranges that many financial professionals recommend. On the more generous side, you can plan on a mortgage that is 35-45% of your pre-taxed income. More conservative estimates tend to recommend aiming for 25% of your after-tax income.
This can make a big difference in what you can afford. Crunch the numbers and consider your financial health, job stability, and what level of risk you’re willing to take on.
It’s also important to use a thorough budget calculator to understand how you’ll manage the cost of having a home. This shouldn’t just account for your mortgage payment. It should also include estimates for:
- Property taxes;
- Homeowners insurance;
- Utility bills;
- Home maintenance costs;
- Home improvement projects.
You should always go into the home buying experience with a clear idea of what you can afford.
Check Your Credit and Save a Down Payment
Next up, consider the condition of your finances. Get a copy of your free annual credit report and review it. Do you have a lot of debt or is there room to add a mortgage into the mix?
Also, check your credit score. You can technically buy a house with bad credit, but it is highly unadvisable. Instead, you want to have at least “Good” credit, and ideally even better. The higher your score is, the lower your interest rate will be.
Additionally, you want to start saving up for a downpayment. Some loan options require a downpayment of as little as two or three percent. However, it can make things less stressful if you can put down closer to 20% right from the get-go.
Get Comfortable with the Mortgage Process
It’s also a good idea to take some time to prepare for the mortgage process, as well. For instance, you can gather various forms of documentation that can help streamline the activity, such as:
- Proof of income;
- Credit history;
- Tax returns;
- Photo IDs;
- Bank statements and assets;
- Renting history.
It’s also a good idea to talk to a few different lenders about pre-approval. This gives you an initial idea of how much money a bank will approve you for. It also helps you decide if you want to get a fixed-rate or adjustable-rate mortgage as well as if you want the term of the loan to be 15, 20, 30 years, or more.
As a word of warning, don’t treat your pre-approval as a number that you should aim for. Instead, see how it fits within your previous calculations about what you can afford.
If you think you can afford a $100,000 home and the bank approves you for a $150,000 mortgage, don’t use that as license to go above your own budgeted calculations. You will always be more in tune with what you can afford than a banker anxious to rope you into a bigger mortgage.
Get Into a Long-Term Mindset
Finally, as you prepare, it’s also important to shift into a long-term mindset. Instant gratification and splurge spending have no place in the home buying process. Working on things like improving your credit score and getting savings pulled together can take months and even years.
That’s okay, though. Remember, you’re buying a home, not flipping one. Sure, if you do things right you’ll end up with some financial equity in your house, but you’re also looking for a place to live. In other words, this isn’t just a get-rich-quick scheme.
Even if you do everything right, common advice recommends that you plan on living in each home that you buy for at least five years to make it financially worth it. That said, make sure you’re in a long-term home buying mentality as you get things rolling.
Being Financially Prepared for Home Ownership
Remember that buying your own home is a huge life event. It provides a stable living environment for you and your loved ones. It can also have a tremendous positive impact on your finances — if you go about the process the right way.
So, before you start visiting local listings and making offers, make sure that your finances are in order. Consider what you can afford, check your credit, save for a downpayment, and get comfortable with the mortgage process.
Above all, make sure to shift into that long-term mindset. Make comprehensive plans and resist the urge to splurge. You’ll be thankful once you settle down into your new home for the long haul.
