As you start thinking about buying a house, one of your first considerations will likely be affordability – can you afford a house payment on top of whatever debt you already have? Or, should you pay off the debt you have prior to getting home financing? And, if you decide to pay it off, what’s the best way to get it done quickly? So much to think about! But, we’re here to help with a few answers and a few ideas.
Can You Afford It?
First, can you afford a house with your current expenses and current debt? There’s a lot of “rules of thumb” out there but the one we think makes the most sense is that your new mortgage related debt should be no more than 28 percent of your pretax monthly income. “Mortgage related debt” means the combined amount of your mortgage payment, property taxes and homeowner’s insurance. Keep in mind that homeownership also involves home repairs and upkeep – which can add up. So, if you can forgo using this amount to pay a mortgage and housing related expenses and not fall behind on your other debts, this is a good indication that you’re on the right track toward home ownership.
But What if Those Numbers Don’t Work for You?
But if setting aside 28 percent of pre-tax dollars for your home financing seems out of reach because of the debt you currently carry, does this mean all is lost? Not by a long shot! It just means you need to take time to pay down your current debt and save for a down payment. Yes, this might mean cutting back on expenses or getting a “side gig” but you’re working toward greater financial stability and that’s a good goal all around!
How Do I Cut My Debt?
When you’ve made the decision to cut your debt, what’s the best way to do it? These are four good ways we’ve seen:
While making minimum payments on everything else, pay down your smallest debt first. When that one is paid off, take the amount you paid to it and designate it to the next smallest debt. This gives you a couple of payoff wins quickly and builds your payoff momentum and confidence.
While making the minimum payments on everything else, pay off the debts that have the highest interest rates first, regardless of how much debt there is. With this method, you’re paying the debt down and avoiding the future interest you would have accumulated at the same time. As with the Snowball method, when you’ve paid off the high interest debt, take the money you were using to do that and commit it to the next highest rate debt.
Using this method, you roll multiple old debts into a single new, lower interest personal loan or credit card. The key to this type of payoff method is that you need to have the discipline to not use your paid off credit cards at the same time you’re paying off the new loan, thereby racking up even more debt.
There are non-profit credit counseling agencies that will help you take control of your debt by negotiating rate reductions with your credit card companies and putting you on a strict repayment plan. This type of debt repayment is generally only available for unsecured debt (credit card, student loans, medical bills). Some of the better rated Debt Management companies are Cambridge Credit Counseling, GreenPath Debt Solutions and InCharge Debt Solutions.
How Much Do I Have To Save?
How much do you have to cut back, pay off and/or save from a side gig? Enough to pay down your debt and enough to save for a down payment and closing costs.
When mortgage people look at your debt to income ratio (DTI) they generally want to make sure you’re not spending more than 43% of your gross (before taxes) monthly income on debt. Their calculation goes something like this:
(Current Monthly Debts + Potential Housing Payment) ÷ Monthly Pre-Tax Income = DTI
So to answer the "how much to save" question, you'll need enough so that your DTI falls (in a perfect world) below the 43%. Keep in mind that amount will change depending on the purchase price and the down payment you will be using.
So, you’ve got your debt paid down, your expenses under control and now you need to think about saving for your down payment. How much you’ll need depends on the price of the home you’re buying and the kind of financing you will be using to buy it. Conventional mortgages generally allow for 5%, 10% and 20% down payments while FHA mortgages require 3.5%. Your mortgage loan officer is a great asset for you and will be able to guide you through the financing process and point you in the right direction in regard to how much of a home you will be able to afford.
We're On Your Side!
As your real estate agent, we will work hand-in-hand with your loan officer to make sure that from the kernel of the idea to buy a home straight through to the presentation of keys, your home finding and financing process will go as smoothly as possible.