Even with new programs geared at helping first-time and low-income borrowers get into a home; preparing your finances to qualify for a mortgage can seem like a daunting task for some. Despite needing to come up with as little as 3% down in some cases, on a $300,000 home (quite average by today’s standards) that’s still $9,000 cash. With the rising costs of rent and living, many people are living paycheck to paycheck already; so how do you get on the path to fulfilling the dream of home ownership? It’s not as hard as you may think. Here, we’ll explore some real-world options for getting a handle on your finances and discuss practical ways to start saving for your future.
1. Set Your Goals
Research the average cost of homes in the area you're hoping to buy. Look at properties that have similar square footage and number of bedrooms and bathrooms that fit your needs. It's always best to overestimate what you'll be paying to prepare for a 'worst case scenario.' After you've established the value of your desired property, decide how much of a down payment you'll want to make. In some government programs (like Fannie Mae's HomeReady™) it can be as little as 3%. To avoid paying MIP (mortgage insurance premiums) you'll want to come with 20% of the purchase price.
Down payments are allowed to come in the form of a gift, but it’s important to research and know the tax implications and program regulations before going this route. For those whom gifting is not an option, fear not. Though it may take some commitment and minor sacrifices, you can and will get your finances in order by following a few key steps.
2. Write It Down
First things first; it’s time to take a brutally honest look at your current financial profile: your debts, income, and spending habits. You can’t get to where you want to be without having a realistic view of your current situation. To start, pull your free annual credit report – it’s important to know everything showing up on there that your lender will also be looking at. If you notice anything that is incorrect, dispute it with the credit bureaus as soon as possible, as credit report corrections can take some time to reflect on your profile. The sooner you get that handled, the less likely it will become a hindrance in obtaining your home loan.
Start a spreadsheet to help organize your income vs. expenses. Note your dependable, verifiable income from all sources so you know exactly how much you have to work with each month. Make sure you’re using your post-tax - or net pay only, as this is your true monthly cash-flow. Don’t include income you can’t depend on fully – birthday gifts, tax refunds, and bonuses are never guaranteed (and your lender won’t count them either).
Next, make a list of your monthly financial obligations. Separate it into several categories: outstanding debt, expenses, and necessities. Your ‘outstanding debt’ will include anything that you pay down monthly: credit cards, home/auto/student/personal loans, and anything else with a balance. As you write these down, also note the interest rate you are paying. Depending on how much debt you have, you may want to consider some consolidation options to reduce your monthly burden. Move on to your expenses. List things like rent, utilities, internet, phone service, cable, and anything else that is typically a fixed amount. Finally, include your monthly necessities where the amount fluctuates; expenses such as gas, groceries, household items, and toiletries.
3. Cut Spending
Now it’s time to look at your actual spending habits. Take a peek at your bank statements from the past couple of months and itemize your spending by categories: coffee, take-out or restaurant food, clothing, subscriptions, entertainment, and anything else you regularly spend money on. Fair warning, you may be shocked at where your money goes each month… and this is the point. Once you see where – and just how much - you’re spending, you’ll be able to choose where you can cut back. Decide your priorities and determine where you can afford to make sacrifices. It might be time to invest in a great coffee maker at home, maybe you don’t really need the Netflix and Hulu subscriptions, or you could decide to make it a goal to do more grocery shopping and meal prepping than eating out.
4. Reduce Debt
Now that you’ve done all the hard work of itemizing your income and expenses, it’s time to get to refine and streamline your spending habits for maximum effectiveness and benefit. With your list of outstanding debt, organize it both from smallest debt to largest, and then highest interest rate to lowest. Depending on your situation decide which “snowball” method of pay-off is best for you. Some people choose to put extra money towards paying off the smallest debts first working their way up to the largest. However, it might make more sense to start by paying off the highest interest amount to the lowest. Either way… pick your method of choice, and start making extra monthly payments until your debt significantly reduces – or is eliminated. This will make a vital difference when lenders go to calculate your debt-to-income ratio and will significantly boost your FICO credit score.
It’s time to begin negotiations now. Call your service providers for insurance, cable, internet, cell phones, and any other expenses you can’t live without. Ask about other program options to help reduce your monthly obligations. If they seem hesitant, let them know you’re determined to get a better deal, and are shopping their competitors in order to do so. Mention you’d like to stay with them, but simply can’t if they don’t have any better options for you. Be prepared to follow up on that. Search online for the best deals and get quotes from other companies. Pick the plan that saves you the most money while still providing you the service you need.
Call your creditors and inquire about reduced interest and reduced minimum payment plans. Let them know that you’re facing financial difficulties and can’t afford to meet your minimums to see what they can do to assist you. Creditors are typically very open to this. Once you’ve secured a lower rate and/or minimum payment, you can apply additional payments that will pay down your principal balance faster (and save you money on interest). While you’re on the phone with them, make sure that your payment due-dates align with when you get your paychecks; then – set up auto payments as much as possible. This will avoid any possibility of incurring late fees, negative marks on your credit report, and give you greater peace of mind throughout the month. For those you can’t set up auto-pay for; take a little bit of time to set recurring calendar reminders in your phone so you’re sure to never miss a payment.
6. Start Savings Accounts
After deciding where and how much you are able to reduce spending, figure out your new “disposable” income. Take your entire monthly income and deduct ALL monthly expenses (include any extra amounts above the minimum payment you’re planning on making). This will be what you use to start your savings plan. Depending on how much you have left over, and how much you need, you can determine the best way to save. If your goal is to save $9,000; figure out how long it will take you to get there. If you want to make it in one year, you’ll need to save $750/month; 2 years will be $375/ month; and $250/ month will get you there in 3 years. To put it in perspective, your 2-year plan has a daily savings requirement of only about $13.40 (the price of a take-out meal). If you can manage to commit to making that small sacrifice for two short years, your dreams of home ownership will soon come to fruition.
Establish a savings account for your down-payment plan, and additional accounts as needed for separate goals. Not only will you earn some interest on what you’re saving, but you’ll also start building your assets; showing lenders that you are a financially responsible individual. Some banks have direct deposit functions where you can specifically designate an amount to automatically go into a separate account. If your bank and/or employer doesn’t have this feature, immediately deposit your committed amounts to the savings after each check. If you can’t trust yourself not to touch the money – consider opening up a CD with a term that fits your needs. Be sure you choose a term that you know will work for you as pulling out the money early will usually result in penalty fees.
7. Consider Cash Flow
Make sure your plan practically fits your income flow. Determine if you get paid bi-weekly (26 checks/year); semi-monthly (24 checks/year); or monthly. This will help you figure out how much of each check must be saved to accomplish your goals. It’s a much more practical method than estimating, trying to save in a jar daily, or any other time consuming or complicated system. Remember, if it doesn’t easily fit your lifestyle, you probably won’t stick with it.
8. Spend Cash Only
Try operating as much as you can from a “cash-only” mindset. Studies have shown that it doesn’t matter if the plastic is debit or credit; we tend to always spend more when it isn’t cash-in-hand. Only keep in your checking account the amount of money needed to cover your bills and automatic deductions, plus any required minimum amounts. Pull out the rest of your budget money (for groceries, gas, entertainment, etc…) in cash and separate it into envelopes. Once you do this, it’s simple. Use only the designated cash on hand and you won’t be tempted to self-sabotage your goals.
Finally, visualize. When it gets hard to stick with your plan, have a clear vision of your goals and why you’re doing this. Start a Pinterest board with images of beautiful homes, gardens, and interiors that inspire you. Picture yourself excitedly house-hunting, attending open houses, and putting in an offer on a home you love. See yourself there with your friends and family hanging out and spending holidays together. Imagine writing your last rent payment check, never having to live in an apartment again, and turning the key on your home. The overwhelming perks far outweigh any temporary discomfort that comes with adjusting to a new budget. Visualizing, daily, your dreams of home ownership coming true can make all the difference.
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Disclaimer: The Mortgage Radio Show is sponsored by Network Capital Funding Corporation, a direct lender, NMLS11712.