11 Steps to Afford Your First Home and Beyond! Series: Part 8 of 11
Overview and Tips on Getting Pre-approved for a Mortgage
My goal is to help you realize your dream of owning a home! This is a decision that requires a lot of research and insight, and I am here to provide you with the right tools to succeed.
This is Part 8 of an 11 part series that I will share with you weekly. If you want to read the previous step, please click here.
8. Make a plan, save, and pay down debt
As we discussed in our previous example, our buyer has three options to consider to make buying a home more achievable: increasing income; paying down debt; buying a cheaper starter home. Let’s look at these one at a time. First off, increasing your income might happen naturally as a part of your career path. If you’re just starting off in your career and expecting your income to go up in the next few years, increasing your income may just be a matter of progressing along your chosen career path and working your way up. However, it’s possible that your current income is capped, or you’re in a role that doesn’t bring in a lot of income. In this case, you might want to consider looking for a higher paying job that matches your current skills and experience. Of course, it may also be the case that you need to build on your existing skills in order to increase your earning power. In this case, it might actually be more worthwhile to hold off on buying a property so you can focus on investing in training or education that will help you increase your income. Alternatively, if you’re committed to your current job, it may be worthwhile picking up a second job or a side gig to increase your income. In this case, it’s good to keep in mind that any taxable income coming in from a proper job will count toward your gross annual income as soon as you’ve completed your probationary period. However, if you decide to bring in extra income through self-employment, most lenders will require a minimum of two years of taxable income before this income will be considered. This means, a job is a much faster way to increase your gross annual income in the eyes of most lenders than starting a business or working for yourself.
The second option to consider is paying down your debt (i.e. consumer debt, student loan, etc.). Now, in a lot of cases, increasing your income may be more effective than focusing on paying down debt, especially if your debt service cost is fairly manageable as with our student loan example. In some cases, your mortgage broker may advise you to keep making your regular monthly payments rather than trying to pay this off as fast as possible. This is because if increasing your current household income and saving up for a down payment to afford your home are not too far off, then paying off your student loan right now might not save you much in terms of interest, but will significantly delay your ability to save up a down payment and get into the market sooner. As this is different for everyone, you’ll want to consult with your mortgage broker for advice in this area.
Alternatively, if you have a lot of expensive consumer debt (i.e. credit card or car loan payments), you might actually be a lot better off focusing on paying this off first before you start saving up a down payment to buy a home. Here’s why; most credit cards charge 19.99% annual interest on any balances you’re carrying. So let’s say your current credit card balance is a measly $5000. If you’re making a minimum payment of $150 per month then after a year you’ll have paid $1950 into your credit card debt, but you’ll still owe $4089. Paying this down slowly could take years to accomplish and cost you thousands more. So, in short it’s generally a good idea to tackle consumer debt before saving up for a house. This will not only improve your credit worthiness in the eyes of the bank, but it will also help you save up faster, as each time you pay off a loan, that means there’s more money you can put into saving for a down payment.
Finally, if you’ve put together a plan to address these first two options, and the cost is still too high, you may want to consider looking for a starter home that is a bit cheaper. Going back to our earlier TDS example from part 7, we can reverse this formula to determine how much a gross annual income of $64,500 can get you. In this case, assuming an annual debt service of $12,000 per year, our buyer is at a 54% TDS (cost & debt to income) ratio. This well exceeds the maximum allowable cut off at 42% and bars our buyer from getting into the market. This is why paying off existing debt can really come in handy. Without carrying that $12,000 annual debt servicing expense your TDS with the same income would change dramatically from 54% to a comfortable 35%; well below our 42% limit. That also means that paying off other debt obligations will make your mortgage budget skyrocket back up to $400,000. Now, as mentioned before, everyone’s situation is different and interest rates and market regulations evolve and change on a regular basis. For this reason, it’s important to consult a mortgage broker to help you develop a solution tailored to your specific needs. With that being said, whether you’re simply saving up for a down payment or paying off debt first, you’ll want to find a realistic, but disciplined saving strategy. If, for example, you’re saving up a down payment of $20,000 starting from square one and you’re able to save $1000 per month, it will take you 20 months, or just under 2 years, to reach your goal. If you can save $2000 per month, this will get you to your goal in 10 months, or just under a year. If however, you can only save $500 per month it will take you 40 months, or just over 3 years to get there. With this in mind, not everyone has the ability to save a large portion of their income each month, especially if you have kids, debt, family obligations, etc. If that’s your current situation, just do what you can. However, if you are able to save a large portion of your income and owning a home is a priority for you, then planning your finances toward a goal may be a valuable next step. Without getting into this too much, I will suggest two practical tips. First, set a budget and stick to it. A simple rule is the 70-20-10 rule, which states that 70% should go toward living expenses, 20% toward saving, and 10% toward retirement. You can create your budget following this rule or tailoring your own, but the main thing is to determine how much you’re going to save each month and then stick to the plan. Some people will even save as much as 40-50% each month, but this is typically more common among high earners and dual income homes. Naturally, it’s easier to save if you make more, provided you keep your expenses low and live within your means.
Second, pay yourself first. Whether this is $200, $500, or $2000 each month, set an amount and make sure to put this money into your savings as soon as you get paid. This will ensure this money doesn’t get mindlessly spent on consumer goods, concerts, or last minute trips which aren’t in your planned budget. It’s one thing to have a plan and quite another to actually stick to it. As the old saying goes “Everyone has a plan until they get punched in the face”. In this case, don’t let your plan get bashed to the side by the haymaker of temptations life can throw your way. Once you have a plan, find a way to make sure you can stick to it. For my wife and I, we’ve actually flipped this approach on its head. Rather than paying ourselves an amount for savings each time we get paid, we put all of our income into savings the moment it comes in. Then we allocate a monthly budget we’re allowed to spend each month. If we accidentally go over one month, we can cut back our spending the next to compensate. If we come in under budget, we can top up the difference in our next month’s budget, so in that way the surplus goes into savings as well. Whatever approach you choose, planning your finances puts you in the driver’s seat. So make sure you develop a plan that works for you and stick to the plan.
Stay tuned for part 9!
I am a Victoria based local realtor with eXp Realty. My commitment to honesty, integrity, loyalty and hard work have been important pillars for me because they drive a high standard of excellent service for my clients. Helping you realize your dream is my goal!
I service Vancouver Island, but my focus is on: Victoria, Sooke, Saanich, Malahat, Shawnigan Lake, Cobble Hill, Duncan, and the rest of the Cowichan Valley.
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