Financial Preparations for Homeownership

Home buying can be a long and stressful process, but it doesn't have to be. If you prepare yourself in advance and get organized, the entire process can become much more straightforward, quicker, and more enjoyable. To help you through this process, let's look at the financial preparations you need to make before buying your first home. Keep reading to discover excellent ways to get yourself financially prepared for homeownership.

Tips to Prepare Yourself Financially for Homeownership

If you're ready to take the next step toward homeownership, it's essential to have all of your financial ducks in a row before signing on the dotted line. So let's take a look at the financial preparations you need to make before starting your journey to homeownership.

Build a Budget

Before you start looking for the home of your dream, figure out your budget. Building a budget is essential to purchasing your home as it'll help you decide what you can afford and set up parameters to keep you from overspending. Ensure you include fixed expenses, like car payments, as well as flexible ones that can go up or down, like food and entertainment costs. You should also factor in money for household maintenance and upgrades—like new windows or appliances—as well as unexpected expenses like property taxes.

To ensure your funds are in order, you must know precisely how much money is coming in and out of your household each month. It may be a good idea to create a spreadsheet or schedule on Google Calendar to help you keep track of everything. We suggest recording all of your expenses in categories and listing them with their corresponding dollar amount. Examples of these categories include:

• Housing
• Utilities
• Transportation
• Credit cards
• Infrequent and unexpected expenses (vacations, medical bills, etc.)
• Installment loans (car payments, students loans, etc.)

Get Your Debt Under Control

It’s not just about how much you owe. It’s also important to consider your debt-to-income ratio, or DTI, which measures your ability to pay back debt in relation to your income. Lenders typically will want a DTI below 43 percent, but that number is negotiable depending on where you live and your credit score.

Take it from us—homeownership is so much easier when you aren’t bogged down by high-interest debt payments every month. Below are a few simple ways to best pay your debt:

• Determine the credit card debt with the highest interest rate and pay it first before handling the next debt.

• Transfer your high-interest credits to your low-rate credit account.

• Clear more than the minimum on your credit accounts.

• Stop adding more debts and stick to your regular budget.

• Avoid short-term money lending options.

• Declutter and sell the unused items. Use the cash to settle some of your debts.

Practice How to Pay Your Mortgage

When you're ready to buy a home, you'll need to be able to afford a mortgage payment. This isn't something that you can do in one day. If you start now to practice making monthly mortgage payments, it'll be more accessible when your mortgage payment becomes a reality.

For instance, if you're currently paying $800 monthly rent and the home you intend to buy will probably have a mortgage of about $1000. That'll be a difference of $200. So in the next few months, you can practice paying your monthly rent, then take the additional $200 and keep it in a separate savings account. Or use it to clear your debts. If you can manage to live without the $200, then you're ready to handle your mortgage payments.

Build Reserves

Saving money is a must before you commit to homeownership. Before buying a home, make sure you have savings in place to cover both your down payment, closing costs, among other upfront costs. You'll also want to have an emergency fund set up and fully funded—ideally with at least 3-6 months of living expenses socked away. This will help eliminate any unforeseen costs or obstacles when it comes time to own your own home. This emergency housing fund is referred to as "reserves."

Credit Score and Your Home Purchase

Checking your credit score and history is essential in preparing to purchase a home. It gives you an idea of how you currently use credit—and whether or not you need to make any changes before getting approved for a mortgage. The Mortgage Credit Qualification system (MCQ) evaluates potential buyers based on three factors: the ability to pay, financial responsibility, and personal characteristics that may result in a default on loan.

The higher your credit score, typically, the lower your interest rate will be. If you're considering securing a loan to make a down payment on a house purchase, don't forget to think about your credit scores. There are simple steps you can take to help improve your credit scores, and in turn, improve your chances of obtaining an affordable mortgage or other loans.

Bottom Line

Homeownership can be daunting if you're on the fence about making the leap from renter to homeowner. Fortunately, as discussed in this article, you can do several financial preparations beforehand to help you get prepared and make your transition as smooth as possible.