How to Budget for Purchasing Your First Home
So, you’ve finally made the decision. It’s time to stop throwing away money at rent every month and purchase your first home. But how do you get from paying a landlord to being an independent homeowner?
If you’re like most first-time homeowners, you’re overwhelmed and stressed at the idea of purchasing a house. There are many unknowns in the process — so it’s important to start saving up in advance and buy something well within your price range. It’s easy to go overboard and try to get a house that meets all your wants, but ends up being over your budget.
Your first guide will be what your mortgage lender approves you for, but there are other expenses to take into account. Here’s how to get started on budgeting for your first home.
How Much House Can You Afford
Before you begin, is this really the right time to purchase a home? It generally takes at least five years for a home to make sense financially (for you to build equity). If you plan on moving soon, renting may make more sense.
If you are ready, the common knowledge is to keep your total monthly housing payment, including mortgage, property taxes, insurance, and other fees under 30% of your gross monthly income. However, this increasingly isn’t such a simple rule, as it doesn’t take into account your personal situation. While spending under 30% is definitely a good goal, it can be too much for some and not enough for other earners.
When you apply for a mortgage with a lender, they’ll take all your financials into account, including your credit score, debt-to-income ratio, and other factors. Your lender may approve you for a mortgage much larger than you feel comfortable taking out — don’t worry. Stick to a number that feels comfortable for you. You don’t want to become house poor, where you have a lovely home but no money to save or even cover your expenses, and end up regretting your home purchase.
Get Your Finances In Order
Before you apply for a mortgage and get started in the house hunting process, you want to ensure you’re financially qualified. In general, you’ll need a good credit score, an income the lender can verify, and enough money on-hand for closing.
Improve Your Credit Score
You’ll get the best mortgage interest rates the better your credit score. In order to qualify for an FHA loan, you need at least a 580, but with better scores come more opportunities.
You can improve your score a few points by paying down credit card balances or even stopping using them for a month or two before applying for a mortgage. This will lower your credit utilization, raising your credit score.
Avoid opening new credit cards or applying for new loans during the year before you apply for a mortgage. Wait until after you’ve closed on the home.
If you’re applying for a mortgage with a spouse or significant other, both buyers’ credit scores will come into play. While you’ll have the advantage of two incomes potentially, there may also be additional debt and a lower credit score for one of you.
Start Saving Now for a Down Payment
The minimum down payment on most homes is 3.5% with FHA loans. While there are 0% down payment loans, it can be difficult to qualify for these programs. Assume you’ll need to save for a down payment.
If your mortgage is $200,000 and your down payment is 10%, you’ll need $10,000 plus $4,000-$6,000 in closing costs. For most Americans, this is a large sum of money they don’t have sitting in their checking account.
You can start by taking a portion of every paycheck and putting it into a savings account earning 2% APY or more. You might want to invest in something with a higher return, but you want your money readily accessible when you need it.
Getting the Money Together
So, how do you save this seemingly giant sum of money? It’s time to work backward. How much money do you make after taxes every month? Which expenses are fixed and which are unnecessary and be trimmed down? Once you’ve squared away your essentials like rent, utilities, and basic groceries, start cutting away the excess. Maybe it’s your expensive cable plan or switching from getting coffee on the way to work to drinking the office brew.
Take all those extraneous expenses and funnel them into your new home buying savings account. Depending on how much you’re saving, it could take just a few months or a few years to get the money ready for your first house.
Find a Mortgage
It’s probably not at the forefront of most first-time home buyer’s minds, but you mortgage rate is one of the single most important items in the home buying process. The APR over 15 or 30 years is one of the largest determinants for your monthly mortgage payment. If you’ve worked on your credit, shopping around for a great mortgage can save you thousands over the life of the loan.
Utilize online resources to find the best rates from online mortgage lenders, traditional banks, and even your local credit union. There’s no hard and fast rule for how many hard credit pulls you can do, but it seems you can apply for multiple loans in a 14- to 45-day period with FICO only counting one hit.
Once you’ve found the best rate, make sure to compare fees and terms to ensure it truly offers the lowest cost for you.
You’re Now Ready for Your First Home
After figuring out how much house you can afford, raising your credit score, saving up for a down payment, and finding the best mortgage rate, you’re ready to purchase your first home.
A great real estate agent will help you find a home you love at a price point that works for you. Now that you’ve got your finances in order, you’re ready to make the jump away from renting and into being a property owner.