Homeownership: four financial areas to keep in mind as you work toward owning a home

Homeownership can be a way to build assets for yourself and your family. Read on for resources and suggestions on where to start!
What You Can Do: Here are four financial areas to keep in mind as you work towards homeownership:

1. Increase your income. Banks typically lend $4-$5 to every $1 of the buyer’s income. Gain an understanding of how much home you can afford with your present earnings and calculate your purchasing range. To find your purchasing range, multiply your annual income by $4; that's the low end of your range. Then, take your income and multiply it by $5; that is the high end of the range. For example, a person who makes $45,000 a year would have a purchasing range of $180,000 - $225,000.

After you have estimated your purchasing range, use a website like Redfin to look for home prices in your target cities. Can your income afford a home in your city of choice? If not, then explore other options, like researching home prices in other cities or increasing your income.

2. Save, save, save! Saving for a home goes beyond the down payment and closing costs. There are two savings categories that potential homebuyers should consider.

  • Down payment Savings: Strive to save at least 3-20% of the purchase price of your new home for down payment costs. Any down payment below 20% may require you to pay Private Mortgage Insurance (PMI). However, there may be special mortgage programs in your state that do not require PMI.
  • Emergency Savings: Strive to save 3 months of expenses in case of emergencies, such as necessary repairs to your home.

3. Target a credit score above 660. Many first-time homebuyer mortgage programs require a credit score of at least 660. And a credit score above 740 will qualify you for the lowest interest rate mortgages.

Understand how much you can save by improving your credit score. This calculator demonstrates how your credit score affects the monthly payment and interest rate on a mortgage: http://www.myfico.com/crediteducation/calculators/loanrates.aspx. To use this tool, enter the type of loan, state you live in, and a loan amount. The calculator will use the information you provide to estimate monthly mortgage payments based on different credit scores.

4. Reduce your debt-to-income ratio. Your debt-to-income ratio is the total of your monthly debt payments (student loans, auto loans, credit card minimums) divided by your pretax income. Studies prove that borrowers with higher debt-to-income ratios are more likely to fall behind on their monthly payments. Many mortgage lenders prefer a debt-to-income ration of 36% or less. Future homeowners should aim for the lowest debt-to-income ratio possible (Compass encourages less than 15%). Your coach can help you determine a plan for achieving this goal.