Saying "I Do" to Homeownership:
How to Make
the Most of this Very Important Relationship
Buying a home is a major commitment. It's a bit like, well, getting married: you've got to be ready and you have to find the right "one." And, like a marriage, homeownership is a dynamic experience that requires a tremendous amount of care and attention.
If you are ready to shift from renter to buyer, you've got some legwork to do. Here's how to prepare:
Quite simply, the past can either haunt or help you. If your debt-to-income ratio is too high, financial institutions will likely be wary of extending you another loan. If you have had problems repaying past obligations, a lender will have trouble trusting that you will pay your mortgage on time.
You can increase your FICO score (a credit scoring model that helps lenders assess risk) by reducing debt, making timely payments, not shopping aggressively for credit, having a variety of credit instruments, and keeping at least one credit card for a long period of time. Significant improvements can be made in as few as six months.
Understand what you can afford
Most lenders require that total housing costs not exceed 28% of gross monthly income, and total debt payments per month (including the mortgage) not surpass 36%. In real terms, this means that if you owe no consumer debt and have a household income of $75,000, then $1,750 in housing costs is within your range.
If you don't have at least some cash in your coffer, start a savings plan now. How much you will need depends on many factors, including the home price and how much you will put as a down payment (zero-down loans are available, but because their interest rates are typically high, so too will your monthly mortgage payment). Closing costs, points, moving expenses, and a post-purchase reserve fund of two to three months worth of housing payments can add up to many thousands of dollars.
Once you own your own home, you may eventually want a bigger or better living space. Rather than purchase a new residence, first consider remodeling. You can add rooms and customize your home to meet your needs and desires without having to move. Yet while remodeling can be wise, it can also be stressful and expensive. Be careful when hiring someone to do the work for you. A contractor you hire should:
- Be licensed
- Carry general liability insurance
- Carry workers' compensation insurance
- Provide you with a written waiver at the end of the job
- Guarantee work for at least one year from date of completion
- Provide you with references
- Be financially sound, so won't declare bankruptcy in the middle of your project
- Can provide proof that he or she has completed similar projects
- Ensure that the price includes removal of all job debris and full clean up
So how are you going to pay for those fabulous improvements? There are three basic options: cash, refinancing, and using home equity.
- Cash: If the job is small or short term, paying with cash is often the best method. A nice advantage of using savings is that you wont have to repay a loan for the work that is done. When using cash, be sure to pay in agreed-upon increments.
- Refinancing: Swapping a higher interest mortgage for a lower interest one can free up money for the project. You can refinance your existing mortgage and take all or part of your current equity in cash. Keep in mind though, that it will only be cost effective if you plan on remaining in the home long enough to recoup the closing costs and other fees associated with refinancing.
- Home equity: Using home equity can be a great way to make major improvements - and get a tax benefit of interest deduction at the same time. To tap into your home's equity you can get a conventional second mortgage, a home equity loan, or a home equity line of credit. Second mortgages and home equity loans are best for large, long-term projects that require lump sum payments, while home equity lines are good for short-term projects or those requiring incremental payments.
Finally, remember that home is not only where the heart is - it is also where the money is. You can get the most from your relationship with real estate by giving it the time and attention it requires. Just like a marriage.