Odds are, you likely learned how to balance a checkbook at some point in your education. You may have even learned about supply and demand, simple interest, and everyone’s favorite topic: taxes.
What many people leave school without learning, however, is real-life, modern-day financial planning. We’re talking about how to prepare your tax returns, improve your credit, create investment strategies, and one of the key components of the “American Dream”, what goes into buying a home.
If you’ve ever felt ill-equipped to handle that dream, don’t worry—you’re not alone. That’s why we’ve assembled this list of financial planning tips for home buyers, to help you better understand the process and set yourself up for a successful purchase.
Four Financial Planning Tips For Home Buyers
When it comes to planning for your purchase, there are four key things to consider: Interest rates, credit scores, debt-to-income ratios, and closing costs. Here’s what you need to know about each of them:
- Interest Rates
Over the life of your loan, you’ll likely end up paying tens of thousands of dollars in interest, which is why it’s super important to find a rate that’s in your best interests. Don’t be afraid to shop around and compare rates from different lenders. Most importantly, don’t underestimate the impact of just 1%. The difference between a rate of 2.75% and 3.75% may seem like just 1%, but for a $350,000 mortgage, that 1% translates to almost $70,000 over the life of a 30-year loan.
- Credit Scores
Don’t go into buying blind. Take some time to review your credit report and your scores before you apply for loans. Most applications you submit will hit your credit report and bring your score down. If your score isn’t where you’d like it to be, there may still be options available to you. On the other hand, if you want to take some time to pay off your debts and establish a record of on-time payments, that’s beneficial as well. Lenders want to see that you’re a responsible borrower, which means they want to see that you qualify for loans and that you pay them back in a timely manner. Above all else, remember that building credit is a marathon—not a sprint. We understand that not everyone is able to pay off debts quickly, and many people have to delegate their funds to more important things. That’s okay. Remember: Slow progress is still progress.
Your debt-to-income (DTI) ratio is the total amount of your monthly debts divided by your gross monthly income. Lenders use this ratio to see how much money you’ll have available to pay your mortgage payment. A high DTI ratio may show that you have less money available to spend on a mortgage, while a lower DTI ratio would show the opposite. Paying off revolving debt, like credit cards, can not only help your credit score, but lower your DTI as well. If you made $6,000 per month and your monthly debts amounted to $2,000, your DTI ratio would be 33%. Many lenders like their borrowers to have a DTI ratio of no more than 43%.
- Closing Costs
If you’re not paying for a home with a gigantic pile of cash, you’re going to be subject to a handful of other costs called “closing costs.” These are paid throughout your home buying journey, but most are often paid near the end. You’ll be looking at appraisal fees, escrow fees, title fees, prepaid taxes and insurance costs, not to mention your down payment—which isn’t a closing cost itself. You’ll commonly hear that closing costs come out to 2–5% of your home’s purchase price, but many of those figures are negotiable.
Questions To Consider
Before embarking on your next big step, we recommend sitting down and asking yourself a few questions. Answer these honestly, because they’ll help establish a bigger picture for you to focus on as you move forward.
- Why do you want to buy?
Seems obvious, right? Some folks are simply tired of renting, others might just want more space. Whatever the reason is, it’s important to know that answer, since it’ll be your North Star in this exciting journey.
Buying a home isn’t a simple numbers game. There are emotions involved. Sometimes your dream home slips into another buyer’s hands. Sometimes you won’t qualify for as much as you hoped for. No matter what, don’t lose sight of your “why.” It may take weeks, it may take months, but you’ll find your home eventually.
- How does buying compare to renting?
There are a lot of valid reasons to rent. Short term living solutions, the freedom to move around as you’d like, and covered maintenance are a few of those reasons. Still, long-term renting can be even more costly than buying.
When you buy a home, you’re able to build equity—meaning almost every dollar you put into your home, mortgage payments included, adds value to your property. Beyond that, renters have to deal with rent hikes every year. Homeowners benefit from a consistent mortgage payment every month for years. Certainly makes budgeting a bit easier, right?
- How does location factor in?
Location is tricky, because it’s as much a numbers topic as it is an emotional one. You may want to live closer to your friends and family, but maybe home prices in that area are higher than what you can afford at the moment. It doesn’t stop at value, though.
Different zip codes may come with different property tax rates as well. Those tax rates contribute to your overall mortgage payment, and insurance companies may charge more for coverage in some areas compared to others.
- How big should the down payment be?
We’ll be straight with you—the more you put down, the less you’ll pay in the long run. That doesn’t necessarily mean you have to put down 20%, it just means you should explore loan options that fit your financial lifestyle.
Some options, like VA loans and USDA loans, may call for 0% down. Conventional and FHA loans require more. Work with your lender to find out what’s required, and if you need to, bring in a financial advisor to help you see what you can afford.
Plan For Success
The more you know, the better off you’ll be. Now that you’ve read up on our financial planning tips for home buyers, we’re here to help make home happen for you and thousands of other prospective buyers across the country.
When it comes to planning for your purchase, there are four key things to consider: Interest rates, credit scores, debt-to-income ratios, and closing costs.