Preparing Your Finances

The Costs of Purchasing a Home

Funds for both upfront costs and ongoing costs are needed when purchasing a house. Both need to be taken into account in financial planning for home buying.

Upfront costs
Your upfront costs will include the down payment, various closing costs, and the costs of moving and settling into your new home.

Down payment
Virtually all home buyers rely on a loan (or mortgage) from a financial institution. However, no lender will give you a loan for the full purchase price of a house. Instead, a lender will insist you contribute some portion of your own funds (the down payment) as part of the deal. Lenders feel much more secure knowing you have some of your own money invested in the house because you are not likely to walk away from it if your finances take a turn for the worse. Traditionally, lenders expected buyers to make a down payment amounting to at least 20 percent of the purchase price of the house. This meant that buyers needed a down payment of $12,000 to buy a $60,000 house. Today, buyers can pay as little as 5 percent down provided they purchase private mortgage insurance (PMI), which protects the lender in case the borrower fails to repay the loan. This would reduce the down payment requirement on a $60,000 home to $3,000. You could buy the same house with a still lower down payment by taking out a government-insured (FHA or VA) mortgage.

Closing costs
Besides the down payment, home buyers must be prepared to pay a number of additional upfront costs incurred in buying a home. Collectively called "closing costs", these expenses generally come close to 6 percent of the amount of the mortgage. If you were to buy a $60,000 house with a 5 percent ($3,000) down payment, you could expect to pay around $3,000 in closing costs on your $57,000 mortgage. See a breakdown of these costs here.

Settling-in costs
You will also need to consider what it will cost to move and settle into a new home. If you buy a house that is in need of immediate repairs, you will need to have enough money left after buying the house to make those repairs. You may also need to purchase major appliances such as a stove and refrigerator. You really cannot spend all of your money on buying the house.

Ongoing costs

As a renter, your primary housing cost is the amount of your monthly rent payment. As a homeowner, your housing costs will include your monthly mortgage payment, property taxes, homeowner's insurance, mortgage insurance (if required by the lender), utilities, and maintenance.

Monthly mortgage payment
Since most home buyers are used to paying rent on a monthly basis, they are usually prepared to make monthly mortgage payments. Each mortgage payment includes both the repayment of a portion of the principal (the amount you actually borrowed) and the interest (a fee for using the lender's funds). The amount of your monthly payment depends on the amount you borrow, the interest rate, the repayment period (or "term"), and whether the mortgage is a fixed-rate or adjustable-rate mortgage.

Taxes and insurance
In many cases, a home buyer's monthly mortgage payments include not only the amount required to repay a portion of the principal and accrued interest, but also an added amount for property taxes, homeowners insurance and private mortgage insurance. The lender holds these additional amounts in a separate "escrow" account and then pays the tax and insurance bills when they come due. In this way, the lender ensures that these important annual expenses get paid on time. If taxes and insurance are not paid by the lender from an escrow account, the homeowner must be prepared to pay these bills when they come due each year. Because taxes and insurance are an essential part of a homeowner's housing costs, lenders often refer to the components of a mortgage payment as "PITI" (an abbreviation for principal, interest, taxes, and insurance).

Other costs of home ownership
Other ongoing costs of owning a home include utilities (oil, gas, electricity, and water) and maintenance costs. First-time home buyers often are surprised by how costly basic upkeep is, both in terms of time and money. The cost of utilities may vary greatly (increasing during the heating season, for example), while repairs often represent an unexpected expense. This makes it imperative that homeowners always have an available cash reserve on hand.

How much house can you afford?
You can go to a mortgage lender before you begin shopping for a house and ask them to pre-qualify you for a mortgage. They will collect income, asset and debt information from you and from this calculate about how much they would be willing to lend you and at what interest rate. This is basically just a rough estimate. Some lenders will also offer pre-approval. This involves a credit check and is a stronger statement for you to take to a seller that the lender thinks you are a good risk. Neither of these means you are guaranteed a mortgage loan.

Lenders use the following formula, in additions to your credit report, to assess your ability to pay back a loan:

• Your monthly housing costs (principal, interest, taxes and insurance) should total no more than 28% of your monthly pre-tax income.

AND

• Your monthly housing cost plus other long-term debts should total no more than 36% of your monthly pre-tax income.

Your monthly pre-tax income is at the bottom of your Income Worksheet. Multiply that number by .36. Then subtract the total from your Debt Worksheet. This is the amount the bank feels you can pay each month for housing.

Here's another way to look at the debt component of the formula:

Gross Annual Income	Allowable Debt Payments
$20,000  $30,000  $40,000  $50,000  $60,000  $70,000	$133  $200  $267  $333  $400  $467
For every $50 of debt above this number you can expect a   reduction of about $5,000 in the amount of mortgage you   qualify for.

Budgeting and Debt Reduction

What is a budget?
A budget is a written plan that shows your income and expenses as precisely as possible. A good budget will let you see exactly how much money you have to commit to savings and will show you how you might need to change your spending habits in order to save more. Making and following a budget will show you exactly where you stand financially.

How to budget

• Set realistic goals.  Objectives that are set too high may lead to frustrations that could cause you to abandon your plan.
• Be flexible. Your plan will require adjustments to keep up with your changing lifestyle and financial situation. Do not make a budget that is so rigid that each new development requires an entirely new plan.
• Be specific. State your objectives concisely. If goals are vague, objectives may never be met and you and other household members may have different ideas of what the end result should be.

A good budget helps you:

• Know how your money is being spent
• Increases savings
• Prevents or reduces impulse spending
• Protect against the financial effects of unemployment, accidents, sickness, aging and death

Preparing a budget takes planning. And following a budget takes determination.

To budget successfully:

• Talk with other members of your family. Consider each person's needs and wants so that all family members feel they are a part of the plan. When families don't talk about money matters, it is unlikely that they will budget successfully.
• Be prepared to compromise. If, for example, one person wants to pay cash for things and the other person prefers to buy on credit, they will need to discuss the pro's and con's of both methods and decide on a middle ground each can accept. A plan cannot succeed unless there is a financial partnership.
• Exercise willpower. Try not to indulge in unnecessary spending. Once your budget is made, opportunities to overspend will occur daily. Each member of the family needs to encourage the others to stick to the plan.
• Develop a good record-keeping system. You will need to keep a record of what you spend. This will show how well you are following the plan and will allow you to adjust your spending to meet your goals.

Debt Reduction
Reducing size and number of your debts can improve the financial picture that you present to lenders. Since this can help improve your credit rating, reducing your indebtedness before applying for a mortgage can get you a better deal on the money you borrow from the bank. This can mean you pay thousands of dollars LESS for your house over the life of the loan.

Steps you can take to reduce debt:

• Pay loans first. Pay for them before you spend money for entertainment and extras.
• Pay off credit cards every month - cut up or stop using the card until you can do this.
• Remind yourself that credit cards are loans - ask yourself when you pull out the card, "Would I really take out a loan to buy this?".
• Never pay only the minimum payment on a credit card - At 18% making minimum payments it will take you 7 1/2 years to pay off a $1000 purchase and you will end up paying back $1,800.

If you are having problems controlling spending and your use of credit, consider going to a non-profit credit-counseling organization. In Rochester, try calling:

Consumer Credit Counseling Service of Rochester, Inc. 585-546-3440

Stay away from "credit-repair" companies. Some charge you a fee to "fix" past credit problems. No one can erase bad credit information from your report if it is accurate. Any fixing on your credit report that is possible and legal you can do yourself. Why pay a company to do it for you? Continue our Steps to Home Ownership Tour to see how you may be able to correct and repair some items in your credit report.

Step 3 - Getting Credit