Before Buying a Home in MN
Numbers to Know Before Buying a Home MN
Recently a friend told me she was never good with finances and never really cared until the day she wanted to buy a home and discovered she didn’t qualify for a mortgage. For her, it was a great wake-up call, and she got up to speed pretty quickly. About a year later, she moved into her condo. Today, she not only knows all her financial statistics, but she tracks them regularly.
So just what are these numbers we should know, and why are they important? As you plan for your future, these vital financial statistics will show you where your finances are healthy and the areas where your finances need improvement. If your life plan includes buying a home, putting your kids through college, or retiring early, these numbers will be the guideposts along your path.
Before you Buy a Home, Know Your Credit Score
What exactly is a credit score? It is a snapshot of an individual’s entire credit history translated into a numeric value. Lenders use this number to help them determine if you are creditworthy. The score is calculated by FICO (Fair Isacc Corporation) using data provided by the three credit reporting bureaus, Experian, Transunion, and Equifax. In addition to your FICO Score, another commonly used is a Vantage Score.
Why is this score important? Like your shadow, it follows you everywhere. It is not only a major determining factor in getting a mortgage approved but also getting a car loan, a credit card, cell phone service, internet, cable, and utilities. Landlords use it to decide if they want to rent to you and how large a security deposit they will require you to pay. When you insure your car, the insurance company will use it to calculate your premium. Some employers use it to help them make hiring decisions.
Your credit score will also determine your interest rate and other loan agreement terms: the higher your score, the better rates and words you can expect. When you apply for a mortgage, this is a huge deal. Even a half a point lower can save thousands over the life of a mortgage.
If you don’t know your credit score, there are many places you can find it for free. If you have a credit card, the bank may provide your score as a benefit. This practice is becoming quite popular. There are also several online financial trackers, such as Credit Karma, Credit, and FreeCreditScore, where you can find your credit score for free.
Before buying a home, know your net worth
What is net worth? It is a measure of your wealth. The number results from adding up the value of all that you own, your assets, minus all that you owe, your liabilities. Your assets include all money in your bank accounts, retirement vehicles, and investment portfolios, the market value of your home, your car, boat, vacation home, and your bottle cap collection. I'm kidding about the bottle caps. Your liabilities are your mortgage balance, credit card debt, student loans, car loans, or other loan obligations.
Why is this number significant? Tracking your net worth yearly provides you with an overall view of the health of your finances. It can point out areas where you may be too heavily invested. It can be a warning that you are carrying too much debt or let you know if you are not saving enough. By comparing your net worth from year to year, you will see if you are building wealth for the future. It will help you determine what adjustments you need to make to achieve your financial goals.
Debt to Income Ratio
The debt to income ratio is a numerical tool that tells you if you borrow money wisely. The calculation is simple. First, get your monthly debt and divide that number by your gross monthly income. (before taxes).
For example, assume your mortgage payment is $950 per month, car loan $250, minimum credit card debt $100, student loan payment $300. The total is $1600 per month. Your monthly salary is $5000 per month, so when we do the calculation (1600/5000=32%), we find the debt to income ratio is 32%. Since we want this number to be under 43%, this is good and indicates you are using debt responsibly. Yeah, you!
Why is this important? When applying for a mortgage, lenders use 43% as a general guideline. If a debt to income ratio goes over that number, it indicates that the prospective mortgagee may be maxed out on financial obligations and in a weak position to take on more.
Please don’t jump to the assumption that you should keep accruing debt until you hit that 43% mark. Whenever you use credit, you pay interest. This interest adds to your purchase price, and when you combine that figure to the price, you arrive at the actual cost. Additionally, the more your income that goes to paying debt means you will have less available to save for the future, which brings us to the last number you need to know.
Percentage of Income Saved
My dad used to tell me to save a little, spend a little. When I was a kid, we made it an event when I threw some coins into my piggy bank. As an adult, it’s a bit more complicated. A popular general rule about saving is 10% towards retirement and 10% to other protection such as an emergency fund. I call super savers who dislike using credit to buy anything other than a home. They save up and pay cash for cars, vacations, and major appliances.
Why is saving important? Saving money is important because life is going to have rough patches. Cars will break down, unexpected illness or an accident can prevent you from working, plumbing may fail, jobs can be lost. Without savings, these events can turn into catastrophes. Then there is retirement and how you plan to finance and enjoy that part of your life. Savings give you choices.
I will end this topic the way I began it with another quote from dad. He used to say there was nothing worse than putting your hand in your pocket and finding out you didn’t have enough money there to buy a cup of coffee.
Research has pointed to a connection between financial difficulties and stress-related illnesses. Who needs that? This fact alone should inspire us not to leave our financial wellness to chance any more than we would our health. Let’s strive to bring order to our financial numbers to help us manage our money as we journey through each phase of our adult life.