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This post is part 3 in a series of posts entitled “How Can I Get a House” that outlines the basics of how to become a homeowner, including preparing your finances, your credit, the mortgage process, and working with real estate agents. If you’d like to start at the beginning of the “How Can I Get a House” series, click here.
Homeownership is a Big Financial Commitment
Homeownership is a great goal to have and rewarding once you achieve it, but it’s also a big financial commitment. When you’re a renter, you don’t need to worry about fixing the plumbing, replacing the boiler or AC unit, or replacing the garage door. However, when you graduate from renting to homeownership, these expenses become your responsibility – in addition to your mortgage payment and all the other unexpected expenses that life throws at you. This is why it’s important that you prepare financially for the new responsibility you’re about to take on.
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When you buy a house, mortgage lenders will want to see that you’re financially stable and have the capacity to repay a mortgage loan. Lenders know that a tight budget means you have less ability to cover unexpected expenses and keep up with your mortgage payments, which is why most mortgage lenders typically only allow a 45% to 50% debt-to-income ratio, depending on the loan program. In other words, to qualify for a mortgage, no more than 45% to 50% of your monthly qualifying income can go to debt payments such as car loans, leases, credit card minimum payments, personal loans, student loans, and expenses related to your home, such as property taxes, homeowners insurance, PMI, and HOA fees.
If you’re carrying a lot of debt, I highly recommend paying it down or eliminating it completely before you buy a home. Not only will homeownership be more enjoyable and less stressful, having little debt will make it far easier to meet mortgage debt-to-income guidelines.
Less Debt = Less Financial Stress
Think about how much more money you would have every month if you didn’t have to make payments for student loans, car loans, or credit cards? How much easier would it be to cover emergency expenses, save for retirement, or pay for your kids’ college or wedding expenses? Carrying a large amount of debt is stressful and greatly restricts your financial freedom. If you’re carrying a ton of bills and then add on a house payment, it’s a sure deal that financial stress will keep you up at night. Homeownership is far more enjoyable if you’re not stressing about keeping up with the payments.
How to Eliminate Debt Quickly
One tried-and-true method for eliminating debt quickly is the debt snowball, which is an integral part of Dave Ramsey’s Total Money Makeover plan. If you don’t have a copy of this book, I highly recommend grabbing a copy from Amazon.com or your favorite local bookstore. It offers a lot of great information about how to get out of debt as well as anecdotes about ordinary people who paid off extraordinary amounts of debt in a very short period of time.
The debt snowball is very effective and easy to implement, as follows:
- Create a list of all your debts, including credit cards, car loans, credit lines, student loans, etc.
- Order the debts from lowest to highest balance.
- Plan to pay just the minimum payment on each debt except for the smallest one. For that one, pour every last penny you can scrape up into paying it off.
- Once you get your first debt paid off, congratulate yourself on a job well done! Cross it off the list and move on to the next debt and begin pouring every last penny you can find into paying it off.
- Repeat until you have all your bills paid off.
I would encourage you to post the list of your debts in a conspicuous location so you can see your progress on a daily basis. Believe me, once you start seeing more and more debts crossed off the list and you feel your finances freeing up, you’ll find yourself even more motivated to get out of debt!
You might be wondering why I didn’t tell you to order your debts from highest to lowest interest rate. Yes, it certainly makes sense to eliminate the debts that cost you the most in interest charges first. However, Dave Ramsey suggests paying off your debts from smallest to largest regardless of the rate because you can eliminate the smaller debts more quickly, which is motivating and quickly frees up cash to roll into the larger debts. Even a small credit balance requires a $20 minimum payment, so eliminating the small balances quickly can generate a lot of extra cash flow you can use to pay down the bigger balances.
As you pay off accounts, like a snowball your available cash to pay off bills begins to grow. By the time you get to your largest debt, you have a lot more free cash and can get it paid down faster than if you had started paying off the largest debt first.
To free up additional cash that you can pour into debt payoff, you might also consider temporarily chopping out unnecessary expenses such as dining out, cable TV, etc. The sacrifice now will pay huge dividends later!
Consider Making Extra Income to Pay Off Your Debts
If you want to pay off your debts even faster, consider getting a side hustle such as an extra job or starting a side business. Side hustling isn’t so much about taking on an extra part-time job, it’s more about finding a way to leverage the skills you already have to make extra money. For instance, if you’re a network administrator, you could build computers or design websites for people on the side. Do you have a construction background? Maybe hire out your skills as a handyman on nights and weekends to bring in extra money. If you’re great with a camera, perhaps you could take photos for weddings or other special events.
If you’ve been in the work force for a good amount of time, chances are that you’ve accumulated a variety of useful skills that can be used to bring in extra cash. There’s also a variety of ways to make money on the side online through sites like Ebay, Craigslist, Elance, and Odesk. Get creative and really think about what skills you have to offer and figure out a way to leverage them for extra cash.
The goal of a side hustle isn’t necessarily to bring in a second full-time income, though that can happen, the goal is to make extra money that can be used to help you get out of debt faster and better position yourself to become a homeowner.
Be sure to check back next week for my next post in the “How Can I Get a House” series. I’ll be covering more about how to prepare your financial profile for homeownership.
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