Get Your Money Right Before Buying a House
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Today's post is based on a response to a comment I made on another personal finance blog.
With The Debt Movement in full swing, I've been stopping by and checking out the site to get motivated and inspired by the debt reduction posts.
One post, called, Is Your Goal to Get Out of Debt or To Stay Out of Debt, grabbed me and I went ahead and read the whole piece.
As you know, we've paid off debts like credit cards and the car loan. We're now working on paying off the last student loan.
Our goal is to go ahead and get out of debt, which includes paying the mortgage off much earlier than the 30-year loan term.
Anyways, I decided to leave my comment about staying out of debt. I got a notification that someone replied. It was Jarim Person-Lynn, the author of the post.
What he asked me got me thinking:
Thanks so much! If I may ask, are you purchasing real estate in cash as well with you and your husband's awesome dual income?
To be honest I never really considered that option (I also never considered our dual income awesome, but now I do).
While I do think that buying a house with cash is a fantastic option to have, I don't think that getting a mortgage is in itself bad.
I do, however, believe that getting into heavy, unmanageable debt for a place is bad.
For those looking to buy a house with a mortgage, I wanted to share some advice based on our experience (the good and the bad).
Want to Buy a House? Think 15 Years or Less
If you want to buy a certain house and you can't afford a 15 year fixed rate mortgage on it, then you shouldn't buy it.
There I said it. Even if you plan on getting a 30-year mortgage on a plan, give yourself a buffer when you're house hunting.
I'm going to tell you something that most people may already know, but during the process of buying a house, they somehow forget – lenders are in it for the money.
When they give you numbers, they tend to give your higher estimates because that increases their cut.
However, at the end of the day, it's YOU that has to pay this mortgage every month. You have to look at the whole picture and plan accordingly.
We want to have this buffer because if you want a life outside of the mortgage you have got to include a safety margin into your calculations.
- Do you have enough to save for retirement?
- Can you stash money away for your child(ren)’s college fund?
- Can you go on the vacations you want to go on?
Check Your Numbers (Twice!)
Now it's time to pull up a spreadsheet or fire up an online calculator. We're going to look at your finances as if we were the lender and THEN we're going to look at them as the ones who actually foot the bill.
This is another way to make sure you have a good safety margin on your mortgage loan amount.
We'll look at the Debt to Income Ratio and the Loan to Value Ratio.
Debt to Income Ratio
Having a high amount of debt can ruin your chances of getting a loan.
Lenders want to know that you can make these payments for years down the line (so they get paid) and your debt to income ratio is one thing they analyze.
Your debt to income ratio is calculated by simply taking all your debt (student loans, credit cards, car loans, etc) and dividing that amount by your income.
Now conventional wisdom said that if your debt to income was 36% or less then you were good.
Let's be honest though – do you think that works in the REAL world, where bad stuff happens? Seriously, do you think that you could afford a bump in the road if your debt was that high? I don't.
I've seen, heard, and read about people who have lost their
homes houses because a financial setback that snowballed into a mess.
Please do yourself a big favor and look beyond 36%. Try to shoot for 25% or less with the ratio and make sure you've paid off high-interest debt like credit cards off before you buy a home.
Loan to Value Ratio
The loan-to-value (LTV) ratio is basically the mortgage loan amount you’re hoping to get divided by the appraised value of the property you’re considering to buy.
Don't buy more house that you can afford.
Try to see if you can get a mortgage that is at least 80% or less of the house's value.
Think Bigger on Your Down Payment
Aim big when you're figuring out a down payment for a house. The advantage of a bigger home down payment is that it will reduce your monthly mortgage payment.
If you put 20% or more, you can avoid paying private mortgage insurance. You can also get a better deal on your interest rate if your down payment is larger.
If you two are having a hard time getting a down payment ready while taking care of your other financial obligations, you may want to hold off on getting a home.
Buying a home can be a great experience, but it can also be a nightmare. If you’re not in a position to buy a home, don’t stress out.
Renting can be a wise choice for many people (either for the short term or the long term, depending on the city you live in).
Don’t be impatient; wait for the right time.
Your Thoughts on Buying a House
I'm calling all current and past home loaners to please help first-time buyers out.
What advice do you have about qualifying for a mortgage? Did you rely on the estimates from the lenders or did you run the numbers yourself?
Did you receive any pressure from your real estate agent to get a more expensive house? If so, how did you cope with it?
We’re currently saving up as much as we can so that we can put a large down payment down. Great tips!
Glad you guys have a plan; best wishes for when you do buy!
The best thing that we did (though it wasn’t really intentional at the time) was to use only one person’s (my!) income to qualify for a loan on our first house. The bank never even considered that there would be another income to augment the monthly expenses, so they weren’t approving us for some ungodly sum that we weren’t super comfortable with.
Even then our purchase was still well under what we were pre-approved for and our housing costs are so manageable today because of it.
I appreciate the tips. We did a similar thing with our house hunt and it has helped. Since my income varies it was easier for us to just include my husband’s paychecks as the budget.
A few thoughts:
1. Timing: home prices are cyclical – they go up and down. Be super-careful to not buy at the top of the market. Just ask anyone who bought in 2006. Much, much better to wait and buy when home prices are distressed. You have so much more choice and bargaining leverage.
2. Decide what you can afford. Then lower the price by 20%. Deliberately buy less than what you think you can afford. Then you can get more aggressive on the down payment and loan term.
3. Build a cushion. When we were still working, we always strove to have 6 months’ payments in the bank in case of a layoff. Some banks will allow you to make next month’s payment ahead of time. We once had a bank like that and worked our way up to having 9 months’ payment paid ahead of time. That shrinks your loan term but, most important, when your job hits a hiccup, you’re covered on that front. Of course, aiming lower when buying helps you get that cushion built.
4. Improve and upgrade. Should you ever need to sell, inexpensive upgrades will help you sell quickly and at a higher price.
Thanks William for all of the helpful advice!