Eliminate Debt before Buying Your Home
When buying a home, you want to have your finances in a strong position. This means demonstrating a capacity to save and to pay off debt. Your credit report shows both your current standing on the indebtedness scale, as well as your past history of debt repayment. Lenders consider the credit report their most important tool for evaluating your financial reliability. To unlock the secrets about you found in your credit report, see Decoding your Credit Report.
Eliminating debt will increase your credit score and qualify you for better interest rates when buying a home. Your debt will be eliminated when you: Focus your spending, assign a time frame, and envision the payback.
Focus your spending. We all have money; we are just too relaxed and unfocused about the way we spend it. Being decisive and even extreme in this area gets results fast. First, calculate your monthly income. Now list your required expenses:
REQUIRED EXPENSES: taxes, rent or house payment, food, gasoline, medical insurance, house insurance & taxes, phone, debt (minimum payments or typical payments), retirement savings, emergency savings.
You noticed some things are missing from the list, right? Now list your non-required expenses:
NON-REQUIRED EXPENSES: cable, internet, spa/gym membership, personal allowances, purchases other than food or gasoline, activities, restaurants; all those extras we once considered special that have now become a habit.
The area of non-required expenses is the leading edge of possibility when it comes to debt elimination. These are the things we can live without in the short term in order to reach our goal in the long term of being debt-free in order to buy a home, or to move up to a larger home.
Focus all spending on debt reduction, channeling all resources (other than required expenses) into paying off the smallest debt. When that is eliminated, eradicate the next smallest, then the next. With crystal-clear focus, you can tell your money where to go, rather than wondering where it went.
Assign a timeframe: To do an extreme financial makeover, eliminate all spending from the areas of non-required expenses for six months. The money made available will be used to reduce the credit card debt, pay off the cars, pay off all financing, and then, when all is paid down, get aggressive about saving for the down payment on your home. Don't use credit at all during this time; just focus on eliminating what you have already borrowed.
A serious six-month commitment to reducing debt as outlined above will take most prospective homebuyers to a qualifying level for a mortgage. For those who want Olympic Gold clout with the lender, plan a longer timeframe of one to two years. Longer lead time enables greater down payments and more sophisticated knowledge of the mortgage industry to avoid undesirable mortgages. Reserving the funds for a 20% or larger down payment will enable you to avoid mortgage insurance, a required add-on expense of about $100 per month for every $100,000 of mortgage loan.
Envision the results: Your focused spending toward debt reduction may cause short-term pain. Reducing our lifestyle for the life-altering purpose of home ownership is always a good thing; we just need ways to make it feel good in the short term.
Visit a few open house events held by Realtors in the area you want to live in as you begin your debt elimination focus. Get photos of the homes available, and place a few of these photos in strategic areas around the home; i.e. on the refrigerator, the TV, the bathroom mirror, the desk where you pay your bills. Store all credit cards in an envelope with one of these photos attached to remind you why you are focusing all spending toward debt elimination (and to avoid using the cards when you are out and about). Attach a favorite home photo to the file folder where you keep your bills, to inspire you as you pay those buggers off.
Speak with a lender about your income amount and your current credit score to get an indication of what size loan and interest rate you may qualify for. Then ask, "If I had no debt and my credit score was 100 points higher, what rate would I qualify for?" Use a mortgage calculation feature (MS Excel has one, or you can find one at http://www.homekey.org/ under Buyer Resources) to see the total amount of interest you will pay at the two interest rates. The difference will be in the tens of thousands.
Think twice, no, ten times about a no down payment loan. By putting 20% down you have a smaller loan to begin with, and you escape the Mortgage Insurance Premium, which can be several hundreds each month, depending on the size of the loan. Take a look at these figures on a 30 year fixed-rate mortgage at 6.50% interest for a $300,000 home:
NO Down payment 20% Down Payment
$300,000 home price $300,000 home price
0 down 60,000 down payment 20%
$300,000 loan $240,000 loan
1,896 monthly payment 1,516 monthly payment
300 mortgage insurance premium 0 no mortgage insurance
$ 2,196 monthly payment $ 1,516 monthly payment
Short-term ease = long-term struggle short-term struggle = long-term ease
That's a $680 per month difference! Just because of a 20% down payment.
Interest paid: $76,527 more is paid in the "no down payment" scenario compared to the "20% down" scenario over the 30 year life of the fixed-rate loan.
Taking six months to get in top financial condition for home buying will not only enable you to get a better mortgage rate due to debt elimination, you will also have time to become more financially savvy and run the numbers on a few mortgage possibilities before being asked to sign the stack of papers with mystifying mortgage terms.
Resolve to experience all benefits of knowledge plus action. Be a person of character who does what it takes in the short term to reach long-term success. Focus your spending, assign a timeframe, and envision the results. Bookmark this and email me to tell me about your success six months from now.
Call Marsha when you are ready to buy a home at (623) 337-8990. Search for available homes at http://www.homekey.org/. Choose your favorite and focus for success.