Improving Your Personal Finances Before You Buy a Home

Buying your first home is a thrilling experience. However, too often people make the mistake of buying a home before they’re financially ready, or even worse, they buy a home with no idea of how it will actually affect their finances. More often than not, these scenarios take away much of the joy of owning your own home because you have to struggle every month to keep it. In order to make sure that you dream of home ownership doesn’t become a nightmare, it’s essential to whip your finances into shape before you buy and take a look at the big picture so that you don’t get in over your head financially.  

FICO and You

Depending on how close you are to an underwriter’s criteria, even just a few points on your credit scores can make a huge difference in the interest rate percentage you qualify for when you take out a mortgage. Anything and everything you can do to boost your credit scores as high as possible will help you get better mortgage terms. Here are some tried and true ways to raise your scores with the three major credit bureaus, Equifax, Experian and TransUnion.

• Pull all three credit reports and dispute any errors you find. Nearly 20% of all credit reports have misinformation of some kind.
• Old debts do have a removal date, so check for any old unpaid debts and if they are past the removal date, have them taken off your reports.
• If you have unpaid collection items that you can afford to pay off, then do pay them off so they don’t count as negative items.
• Improve your balance to credit limit ratios by paying down, or paying off, your credit card balances.
• Make sure that you pay all your credit card and loan bills on time. Late payments drastically lower your credit scores.
• If your consumer debt is more than you can manage on your own, consider getting professional credit counseling to learn how to get it under control.
• Do not close your accounts. Lenders like to see that you have available credit, but that you don’t use it all, so keep your paid off accounts open, but unused.

While there are other factors that go into preparing yourself financially before you buy a home, cleaning up your credit is one of the most important. If you have poor credit, you may still get approved for a mortgage, but you’ll be stuck with a high interest rate for the life of your mortgage. Even worse, if you’re already “maxed out” financially, then you will find it nearly impossible to deal with increase in costs between renting and owning a home. If you have a habit of overspending or living beyond your means, you need to break those habits for good before you buy a home.

Tighten That Budget

Prospective mortgage lenders will almost certain want a list of your income versus your expenses, but you should have your own budget prepared long before that. If you have to, track your spending for a month to see where your money is going. Look for ways that you can cut back some of your expenses such as eating out less, cutting your cable bill, not making “want” purchases for a while, etc. If you want to be able to buy your home with some sense of security that you’re not getting in over your head, you need to start off on solid financial ground.

Try to free up as much of your income as you can to apply that money towards improving your debt-to-income ratio, increasing your down payment on your home, or starting a savings account for home expenses. If possible, try to apply some money to all three. The two most important things are to be confident that you are spending less than you earn and getting by comfortably so that you will be able to afford your mortgage, home insurance, possible repairs and all the other costs that come with becoming a homeowner.

Total Cost of Ownership

Remember, owning a home means more than just paying the mortgage. If you figure that you can afford for your housing costs to jump from $900 for rent to $1300 a month for your mortgage, because you have a budget surplus of $400 every month, you’re set, right? Wrong. There is a lot more involved than just the monthly difference between renting and having a mortgage. First of all, the FHA recently changed their rules regarding mortgage insurance, which means you that many FHA borrowers will have to keep costly mortgage insurance longer than before. In addition to insurance, there are property taxes, school taxes and likely sewer taxes to consider as well.

You can’t plan for every expense, but when you’re figuring out how much house you can afford, you have to factor in all the known expenses at least. Also keep in mind that as a home owner, you are responsible if appliance breaks, repairs need to be done, and for damages not covered by your home owner’s insurance. With that in mind, you need to not only be able to afford the house itself, but have enough extra money saved so that you have a cushion for the inevitable unplanned expenses that will come up.  

It may seem a bit overwhelming at first, but remember that you are working towards owning a huge asset. The planning, budgeting, scrimping and saving you have to do beforehand really will make your life easier. Rather than buy a home and find yourself in over your head, know what you’re getting into and prepare yourself financially as much as you can. Just because a lender pre-approves you for a certain amount, that doesn’t mean you should spend every penny they’re offering. Thoroughly assess your personal finances beforehand and look at all the details of what you are getting into before you decide which home you buy.

About the Author: Tony Standin is a personal finance specialist. His goal is to help those who are struggling financially learn to repair their credit, make efficient budgets, and live strong, financially healthy lives.