This article was contributed by financial expert and blogger Mary Beth Storjohann, CFP, author, speaker, and founder of Workable Wealth. She provides financial coaching for individuals and couples in their 20s to 40s across the country, helping them make smart, educated choices with their money.
Thinking about buying a home? You’re not the only one. With interest rates at opportune levels, many people are anxious to get into the real estate market. However, even if you feel like you’re missing out on a hot opportunity, ensure you have the boxes checked in these five money areas first:
#1 Build a Home Emergency Fund (Before You Buy)
Are you sitting on $10,000 in cash and considering using that for your down payment? Congrats on the savings! Just consider whether you’ll have funds left if you use that for a down payment.
Having had countless conversations with consumers around the country, I can tell you that using all your saved cash cushion as a down-payment fund wipes out any money you might need in case of emergency home repairs or job loss. And that leaves you reliant on credit cards and debt.
Set aside a minimum of three months of expenses (ideally six) in addition to building your home down-payment fund.
#2 Keep Saving for Retirement
Home ownership is a key part of the American dream, but getting to your retirement years in a solvent position is also important.
If you’re looking to purchase a home, make sure the mortgage payment you’re taking on allows you to continue saving for retirement. As your income grows over time and your mortgage payment takes up a reduced percentage of your expenses, you’ll have room to increase your retirement funding.
#3 Build a “New Home” Budget
Budgeting may not be very sexy, but it’s smart. Knowing where your money is going before purchasing a home helps you to target areas for adjustment. In addition, knowing your monthly cash flow ins and outs allows you to consider how much home you can truly afford.
Remember, it’s not just about factoring in a mortgage payment. You should also consider:
- Property taxes
- Homeowners insurance
- Homeowners association (HOA) dues
- Increased utility costs
- Added cost-of-living increases, such as more expensive groceries or gas, depending on where you buy
- Commuting expenses
- General maintenance
A general rule of thumb is that your monthly housing payment (principal, interest, taxes, and insurance) shouldn’t take up more than 28% of your income before taxes. This debt-to-income ratio is called your “housing ratio.”
#4 Keep Your Debt Under Control
Before even considering purchasing a home, pull a free copy of your credit report from annualcreditreport.com and grab your free credit score (with account sign up) from Credit Karma. You’ll want a good credit score in order to get approved for a low interest rate on your mortgage (which translates into dollars back in your pocket).
Take stock of any outstanding debt you have from credit cards and car loans, etc. This will affect your debt-to-income ratio, which is the total of all your monthly debt obligations plus your housing expenses versus the amount you earn.
Ideally, you want this number to be as low as possible (with a target of 36% or below), although 43% is the highest ratio a borrower can have and still obtain a qualified mortgage. The lower your debt-to-income ratio, the more manageable your payments and the better off your financial picture is.
#5 Take Stock of Your Life Plans
If you’re one of the 35% of home buyers age 35 or under, you’re likely going through a significant amount of life change.
- Do you plan to start a family and need more space in the next few years?
- Is your job stable?
- Are you open and willing to move to a new area if given the opportunity?
- Are you thinking about getting married or starting a business?
Review your overarching goals and desires to ensure that the home you’re buying and its location align with your long-term objectives. For instance, is there a chance you may turn the home into a rental property? That’s a big case for keeping your mortgage payment low enough that a monthly rent payment could cover your costs.
Purchasing a home can be one of the most exciting times in your life. With a little advance planning, preparation, and thought, it’s an event you can enjoy instead of stress over.