Why Financial Literacy is Important in the Homebuying Process
An excellent first step when buying a home would be to understand your financial situation. You should know how long you plan on staying in the house, how much you expect to pay for it, and your credit scores.
After all, knowing your credit score will dictate how much you'll need for a down payment and what interest rate you can expect on a loan.
It also impacts other things that can affect the overall cost of living in a house: insurance, electricity, and homeowners' association fees, among others.
Making a Budget
If you are serious about achieving financial freedom, it's time to make a budget.
Don't worry—you don't need any fancy tools or software to get started. The best thing about creating a budget is that it can be as simple or complex as possible.
Begin by listing your monthly expenses, including rent or mortgage, utilities, car payments, insurance costs, and other fixed expenses.
Then add up your monthly income sources: your salary (or salaries) and any additional money that comes into the household during an average month.
Once you have added all of these numbers together (your total income minus your total expenses), use the following tips to ensure you're on track with savings goals:
Suppose you're breaking even - Congratulations! You are likely doing a great job covering all your expenses each month and may have some funds left over for saving and investing purposes. Be sure to check out our article on opening a Roth IRA so that you can begin saving toward retirement early in life!
- If you're spending more than you earn - It's time to cut back on eating out or shopping for unnecessary items. Look first at cutting back on nonessential services like cable television packages—you may find that online streaming options will cost less per month than cable does!
Qualifying for a Mortgage
When buying a home, it's essential to make sure you understand the fundamentals of financial literacy to make the right decisions for purchasing your home.
To qualify for a mortgage, you need to make sure that:
- You have enough money available for a down payment.
- You can afford the monthly payments.
- You can afford closing costs.
The loan amount you can afford depends on several factors, including how much money you make and how much debt you currently have.
The higher your income and lower your debt, the more considerable the loan amount you are likely to qualify for -- which means more houses!
Saving for a House
Good news! If you're planning to buy a house in the next few years, there are steps you can take now to prepare.
The first thing you'll want to do is create a savings plan by setting aside a fixed amount each month. If you're saving for your down payment, consider keeping your savings separate from your day-to-day funds so that it's easier to keep track of how much money you've saved.
If possible, consider investing some of your long-term savings in the stock market — this could help grow your savings faster. The sooner you start saving for a house, the better chance you hit your goal.
Planning for the Costs of Home Ownership
Owning a home is a significant investment and comes with many ongoing costs. For example, you will need to pay property taxes, insurance, and utilities.
It would help if you also planned for maintenance and repairs. In addition, it's a good idea to set aside funds for emergencies like unexpected roof problems or malfunctioning heating systems.
Depending on where you live, these costs can differ from one house to another. It's helpful to get an estimate of your monthly expenses to decide how much to budget for them each month.
If your mortgage payment is the same each month, but other costs vary, it may make sense to set up a separate emergency fund account or special savings account that you add money to throughout the year rather than just at tax time.
The Home-Buying Process
Home buying is a complicated process, and you're likely to encounter some terms and concepts that you haven't experienced before.
Some of them may seem familiar, but you may not know their specific definition or meaning within the context of this transaction.
A firm grasp of real estate terminology will help empower you to make informed decisions throughout the home buying journey.
You'll be less likely to feel intimidated by the process or overwhelmed by unfamiliar information when you understand key concepts and what they mean for your purchase.
Here's what usually happens:
Decide to buy a house - This is the first step in the homebuying process. You've decided that now is the right time to purchase a home - congratulations! Whether you've had this dream for a while or are just now starting, this is an exciting time that will lead you to your dream home!
Hire a real estate agent - Now that you're ready to start looking at homes, your next step should be to hire a real estate agent who knows your neighborhood and can help you find suitable properties. A good agent will also help make sure you don't pay too much and negotiate on your behalf when it comes time to make an offer.
- Get pre-approved for a mortgage - Before you even start looking at homes, you must speak with mortgage lenders so they can pull your credit history and determine whether or not they will approve you for financing - otherwise known as getting pre-approved for a mortgage loan. A pre-approval letter tells sellers that you're serious about buying their property and gives them confidence that if they accept your offer, it won't fall through because financing fell through later on down the road (which does happen!).
Hiring a real estate agent
Your real estate agent is your number one resource in the home buying process.
They are here to make it easier for you, help you find a home that fits your needs and wants, and negotiate on your behalf. Although their job is to assist you, there are some things that they can't do without your knowledge.
A great real estate agent will work hard to get you the best deal on the house. However, they can't estimate your closing costs or negotiate fees if they don't know what you can afford or your financial goals.
Financial literacy is essential when working with an agent; it shapes what kind of house they will show you and how much they can negotiate for when it comes time close.
Real estate agents get paid through commissions and fees – these vary based on location (urban vs. rural), cost of the home, etc.
Getting pre-approved for a mortgage
It is important to learn how to determine your credit score, debt-to-income ratio, and down payment, as they will determine what you can afford as a pre-approved loan amount.
Your credit score is determined by how you've handled your finances in the past. The higher your credit score means you have been more responsible with your finances.
A better credit score equals lower interest rates and a higher mortgage amount. Your debt-to-income ratio is calculated by taking your monthly income and dividing it by all of your debt.
That percentage will either qualify or disqualify you for a loan based on what lenders deem an acceptable ratio.
If there is too much debt, they won't want to add additional payments to the mix, which takes us back to the first point of financial literacy – pay down debts before attempting to purchase a new home!
Lastly, the down payment you provide when purchasing a home helps determine what kind of mortgage loan you qualify for.
Typically if your down payment is 20% or greater, then an FHA loan isn't necessary but preferred because some loans such as these require mortgage insurance on top of any other fees associated with buying a home and paying principal and interest each month towards homeownership.
Finding the right house
Are you ready to buy a house? Congratulations! That's exciting.
That also means you've done some significant financial planning for the future. You're in the right frame of mind, essential when making a substantial investment like buying a home.
However, don't forget that the hunt for your new home will be just as important as securing your mortgage. In addition to securing your financing and budgeting accordingly, these are the other steps to take:
Understand your budget - Once you know how much money your lender has approved for you, think about what kind of down payment can realistically come from savings and how much the house allows within your budgeted monthly expenses (mortgage payments, taxes, and homeowners insurance).
Get a real estate agent or broker - A trusted professional who knows the market is essential because they will have access to properties as soon as they hit the market and provide valuable advice along every step of this process—including contract negotiations and closing costs estimates.
- Look at many homes in different neighborhoods until one speaks to you - the layout is ideal; it's near great schools; it has room for expansion if needed; there are no HOA fees, etc. The search may take several months before finding something perfect, so don't go into any purchase before being entirely sure this is right for yourself or your family!
Making an offer on a home
At this stage, you'll be working with your real estate agent to make an offer on the home.
You are no longer just looking at homes and considering them in the abstract; now, you have a price tag attached to a property you might love. This is where it becomes clear why financial literacy is important.
To make a reasonable offer, you need to know the house's market value, how much money you can afford to put down on your mortgage, and what closing costs might look like.
You may want to make an offer below the asking price—you can often do this in a seller's market.
However, if there are multiple bidders for this home and you want it badly enough, you don't want to risk losing it by offering too low of a price, then making an offer above the asking price or at least at the asking price may be advisable as well.
During negotiations, other things might come up when making an offer on a home: how much money will go into repairs? Will the seller cover closing costs?
These decisions should all be made with your financial situation so that you don't overpay for the house or get saddled with too many monthly costs.
Closing on a home
Did you know that closing on a home is like going to the doctor?
There's paperwork and tests, lots of them. There are professional fees to be paid, many of which (you guessed it) have costs attached. And then there's the big day itself: the actual transaction at the bank.
That's where you'll get your keys and start to settle into your new place—and at which point you will most certainly probably feel stressed out.
But just like a visit to your doctor, it can all be managed with effort. It all starts with planning:
- What type of title is being held.
- What kind of deed is being held.
- Which type of mortgage will get you there.
Hiring home inspectors
Home inspectors have a crucial job that doesn't get enough attention in the home buying process. Make sure you know how to choose a good one, what to expect during your inspection, and what's important to know about the report you'll get.
You'll need to hire a few inspectors for your home search. Each one will specialize in something different. The most common type of inspector does general home inspections, which check most aspects of the house from top to bottom and give you an idea of its condition.
Then there are termite inspectors, who look for evidence of termite damage or infestation; radon gas inspectors, who test for dangerous levels of this odorless but deadly gas; lead-based paint inspectors, who look for lead in homes built before 1978; and septic system inspectors, who examine sewage systems not connected to public sewers (these are more common in rural areas).
To Know Your Money is to Know Yourself
Knowing your financial situation can help you make better decisions when buying a home. Here's how:
Avoid financial stress
Without proper knowledge of your finances, creating a homebuying budget that works for you and sticks with it can be difficult.
If you don't have an accurate picture of your finances, you could exceed your budget and fall deeper into debt.
Plan for the future
Taking the time to research your finances every year can help you plan for events like retirement or help determine if extra mortgage payments are worth it in the long run.
Knowing where all of your money goes throughout the year can also help you identify spending trends that could be causing problems down the road.
Save for a home
It's important to know if a new car payment or student loan will affect whether or not you can afford a home down the line.
Without proper planning, saving enough money for a large purchase, such as buying a home, can take longer than expected and create unnecessary difficulties.
Set realistic expectations
The home buying process is a long one. Most prospective buyers are not familiar with the process, and this lack of knowledge can lead to unrealistic expectations.
By becoming financially literate and learning about the purchase process, you'll have a better idea of what to expect throughout the entire process.
Set aside time to educate yourself on the various stages of becoming a homeowner to avoid unnecessary stress.
Avoid financial pitfalls
Buying a home is an exciting time for many first-time homebuyers, but it can also be stressful if you don't understand your finances or know what to expect from the lenders you meet with during your search for the perfect mortgage product.
Knowing what options are available to you and understanding how certain decisions affect your credit score or financial situation as a whole will help ensure that all goes smoothly during this important transaction.
Make an informed decision
When you understand the nuances of buying a home, you'll be able to decide what type of mortgage is best for you. You can decide if an adjustable or fixed-rate mortgage is best and how many points you want to pay on closing.
The best advice we can give to any homebuyer is to stay financially organized. Make sure you know what you want and how much you can handle. If you don't stay organized, you will bleed money.
With over 50 years of mortgage industry experience, we are here to help you achieve the American dream of owning a home. We strive to provide the best education before, during, and after you buy a home. Our advice is based on experience with Phil Ganz and Team closing over One billion dollars and helping countless families.
About Author - Phil Ganz
Phil Ganz has over 20+ years of experience in the residential financing space. With over a billion dollars of funded loans, Phil helps homebuyers configure the perfect mortgage plan. Whether it's your first home, a complex multiple-property purchase, or anything in between, Phil has the experience to help you achieve your goals.