How to Afford the Home You Want

When Jack Holden was asked, “How did your family get started buying real estate?” here’s how he answered. “We scraped, borrowed, and leveraged from every resource we had to muster the funds we needed… . For seed money we cashed in savings bonds and borrowed from our insurance policies and credit cards… . The entire family went on an austerity plan to cut back our food, travel, and entertainment expenses. Today we’re thankful we made those early sacrifices.” Thankful, yes, and also wealthy. Because of their disciplined spending, saving, and investing, the Holdens have built a real estate net worth of $3.5 million, which includes not only their home equity of $600,000, but also nine rental houses and apartment buildings.

As with most first-time homebuyers, the Holdens didn’t start out with money. As Jack says, his family scrimped, saved, leveraged, and bor­rowed every way they could. So what’s the mistake to avoid? If you want to own your own home, don’t wait until you get the money and then decide to buy. No! First, commit to own. Then figure out how to come up with the money. You can keep wishing and hoping to buy someday. Or you can decide to own now and immediately begin to shape up your finances and create a homebuying plan.

Affordability Depends on You

Each year millions of renters make the biggest mistake of all: They con­tinue to rent. These renters believe that they can’t afford to own, or in some cases, they believe they can’t afford to own the home they want. If you see yourself in either of these situations, you need this article.

To a much larger degree than most renters believe, affordability de­pends on you. Just like the Holdens, you may need to shape up your financial fitness and seek out (or create) a “tailor-made” home finance plan. But if you truly do want to own, you can do it. With home buying, “Where there’s a will, there is a way.”

To see how you stand financially, your Realtor or mortgage advisor will measure your fiscal fitness. As you have seen, two of these fitness tests are called qualifying ratios: (1) the housing cost ratio, and (2) the total debt ratio. Once the ratios are measured, an advisor can next es­timate your borrowing power. If it turns out that you’re not as strong as you would like, then you can rely on fiscal fitness and affordability strategies to dramatically boost your chances of owning the home you want.

Housing Cost (Front) Ratio

Many mortgage lenders will say that your total monthly house payments (principal, interest, property taxes, insurance) typically shouldn’t exceed, say, 28 to 33 percent of your gross monthly income. According to a lend­er’s reasoning, if you paid a higher percentage of your income toward housing costs, you might not have enough money left to pay for food, clothes, and other bills.

In today’s world of automated (computer-programmed) underwrit­ing, qualifying ratios are combined with a multitude of other financial characteristics. Nevertheless, this principle holds: The lower your qual­ifying ratios, the more likely your mortgage approval will sail through without a snag.

To further illustrate how lenders might apply the housing cost ratio we’ll go through an example. To keep it easy, we’ll ignore property taxes and insurance. Say your household brings in a gross income of $6,400 a month. If the lender applies a 28 percent housing cost (principal and interest, i.e., P + I) ratio, here’s how much you could pay each month for your mortgage:

.28 × $6,400 = 1,792 per month (P + I)

Next, you’ll want to see how much money you can borrow if you can afford to repay (according to the lender) $1,792 per month. If the lend­er’s interest rate is eight percent and you want a 30-year, fixed-rate loan, here’s how to calculate the amount you can borrow for your mortgage:

$1,792

= $244,142

$7.34

 

In the above calculation, the $7.34 figure represents the amount of monthly payment (P + I) necessary to pay off $1,000 of borrowed money at eight percent interest, amortized over 30 years. You can find this $7.34 figure in the mortgage repayment table (Table 11.1). Just look in the eight percent row, 30-year column.

To better get the hang of it, here’s another example: Say that instead of $6,400, your gross income totals $3,800 per month. If your lender qualifies you with a 28 percent housing cost ratio (principal and inter­est), you could qualify to pay $1,064 per month for your mortgage.

.28 × $3,800 = $1,064 per month

If you borrowed at eight percent interest with a 30-year payback, you could qualify for a mortgage of $144,959.

$1,064

= $144,959

$7.34

 

Based on today’s current mortgage interest rates (see www.hsh.com), take the appropriate payment factor from Table 11.1 and write out your borrowing power using a 28 percent housing cost ratio and your gross monthly income (GMI):

.28 × (your GMI) = $        (monthly payment)

$                           (P + I) = $      (mortgage amount)

$(mo. payment per $1,000)

Table 11.1 Monthly Mortgage Payment (P I) for Each $1,000 Borrowed at a Variety of Interest Rates and Terms

Qualifying Interest Rate

15-year

30-year

40-year

4.0 $7.40 $4.77 $4.17
4.5 7.65 5.07 4.50
5.0 7.91 5.37 4.82
5.5 8.17 5.67 5.16
6.0 8.44 6.00 5.50
6.5 8.71 6.32 5.85
7.0 8.99 6.65 6.21
7.5 9.27 6.99 6.58
8.0 9.56 7.34 6.95
8.5 9.85 7.69 7.33
9.0 10.16 8.05 7.71
9.5 10.45 8.41 8.10
10.0 10.75 8.78 8.50
10.5 11.06 9.15 8.89
11.0 11.37 9.53 9.28
11.5 11.69 9.91 9.68
12.0 12.01 10.29 10.08
12.5 12.33 10.68 10.49

If this mortgage amount is high enough to get you the home you want, great! If not, you have dozens of different ways to boost that fig­ure. Before we get into various fiscal fitness exercises and affordability strategies, here’s another type of ratio most lenders will use to help them qualify you for a mortgage. This fitness test is called the total debt (or back) ratio.

Total Debt (Back) Ratio

Whereas a typical housing cost ratio is say, .28, lenders typically might use a .36 total debt ratio. To illustrate: if your gross income is $2,400 a month, and applying a .36 total debt ratio, according to your lender, your total monthly bills could run up to $864 a month.

.36 × $2,400 = $864

In this context, the term “bills” doesn’t include all of your monthly living expenses. It just includes the payments on your long-term installment debt like car payments, credit cards, department store accounts, and your mortgage payments (to be).

Say your current monthly bills look like this:

Car payment                                     $142

Visa                                                     68

Sears                                                    45

Best Buy                                              58

Total                                                 $313

Since your lender says the monthly payments for all of your debts (including mortgage principal, interest, property taxes, and homeown­ers’ insurance, called PITI) can’t be more than $864 a month (.36 × your earnings of $2,400), you’re left with $551 a month to cover PITI. Assum­ing your costs for property taxes and homeowners’ insurance will run $75 a month, your mortgage payment (principal and interest) can top out at $476 a month. Here are the numbers:

Gross Monthly Income                     $2,400

Total debt ratio                                  × .36
Total allowable

Monthly debt payments                       864
less

Current installment debt                    − 313

Property taxes and insurance               − 75
leaves

Qualifying mortgage payment              $476 (P + I)

Look again at Table 11.1. You can pick out the monthly payment per $1,000 that corresponds to the interest rate and mortgage term lenders now offer—say, 7.5 percent for 30 years—for a figure of $6.99 a month for each $1,000 you borrow. Because you can pay $476 for your monthly principal and interest payment, the mortgage loan underwriters would figure they could loan you $68,097.

$476

= $68,097 (68.099 × 1,000)

$6.99 per $1,000

Gross monthly income                                    $_________

Total debt ratio                                                           × .36

Total allowable debt payments less

total monthly bills

Car payment no. 1

Car payment no. 2

Visa

Master Card

Discover

Department stores

Student loans

Other

Other

Property taxes and insurance

(estimate)

leaves

Qualifying mortgage payment (P + I)                $ _________

$                        (P +I) = $                  (mortgage payment)

$ payment per $1,000)

Figure 11.1 Your Financial Fitness.

Now, look at the financial fitness form (Figure 11.1). Fill in the blanks for your personal situation and current mortgage interest rates. How does your mortgage amount look? Can you qualify to borrow enough to own the home you want?

If you’re like many first-time homebuyers, your numbers won’t work out to give you the amount of mortgage you need. Your income may be too low, your debts too high, or perhaps mortgage interest rates are sit­ting out of sight. How can you overcome these problems?

For starters, look at how Tricia and Herb Renko were able to revamp their qualifying numbers to get approved for the loan they wanted. By following this example, you will see how shaping up your finances and selecting the right home finance plan can dramatically boost your home-buying power.

Tricia and Herb Renko Shape Up Their Financial Fitness

When Tricia and Herb Renko decided to buy a home, they called on loan advisor Steve Bailey. “Steve,” Tricia asked, “is there any way that we can buy a house? We’re so tired of wasting money on rent. Tell us, Steve, what do we have to do?”

Steve Runs the Numbers

“As a starting point,” Steve said, “let’s see where you now stand. Then, if necessary, we can work through some other possibilities.” Based on their situation at the time, here’s how the Renkos’ finances looked on paper:

Qualifying the Renkos

Herb’s monthly income                   $2,050

Tricia’s monthly income                    1,360

Total gross monthly income               3,410

Total debt ratio                                    × .36

Total allowable debt payments         $1,228

less total monthly bills

Car payment no. 1                                287

Car payment no. 2                                160

Discover card                                          85

Visa                                                      110

Student loan                                          138

Property taxes and homeowners’

Insurance (estimated)                        125

Total monthly bills                             $ 905

leaves

Qualifying mortgage payment           $ 323 (P + I)

At the then market interest rate of 9.5 percent for 30 years, $323 a month would pay off a mortgage loan of $38,407.

$323 (P + I)

= $38,407 (mortgage amount)

$8.41 (payment per $1,000)

Because Herb and Tricia were currently paying $850 a month in rent and hoped to buy a home in the $100,000 to $125,000 price range, they were quite disappointed when their loan advisor showed them how their current numbers worked out. They had no idea they were so fiscally out of shape. “But all is not lost,” Steve told the Renkos. “We’ve got lots of possibilities for getting you the home you want.

“Here are three things we can do,” Steve pointed out. “First, we’ll move you into a 5/25 adjustable-rate mortgage. That will bring down your interest rate. Second, I know of a first-time buyer program that permits a .41 total debt ratio. And third, we’ve got to figure out how you can get rid of some of your awful monthly bills.”

To shape up their finances, the Renkos sold their car. That not only eliminated a $287 per month car payment, it produced $1,200 in cash that the Renkos could use as part of their down payment. Herb and Tri­cia decided they could get by with just one car until they became ho­meowners. Next, the couple refinanced and consolidated their Visa, Discover, and student loan balances into one loan with a payment of $185 a month. Tricia also thought that because she had been winning praise in her job she might be in line for a raise. So she asked and re­ceived an extra $200 a month.

Here’s how the Renkos’ new shaped-up numbers worked out:

Total gross monthly income               $3,610

Total debt ratio                                      × .41

Total allowable debt payments           $1,480

less total monthly bills

Car payment                                            160

Consolidated loan                                   185

Property taxes and homeowners’

insurance (estimated)                          125

Total monthly bills                               $ 470

leaves

Qualifying mortgage payment            $1,010      (P + I)

Using an 8.5 percent 5/25 ARM, a payment of $1,010 a month will amortize a mortgage of $131,339.

 

$1,010

$131,339 (131.339 × 1,000)

$7.69

 

Back to the Housing Cost Ratio

The first-time buyer program that their loan advisor found for the Renkos applied a .29 housing cost ratio as a separate test of the Renkos’ financial fitness. Using this .29 housing cost ratio fitness test, the Renkos qualified for a mortgage payment (PITI) of around $1,047:

.29 (housing cost ratio) ×

$3,610 (their new monthly gross income) = $1,047 (PITI)

If we estimate $125 a month for property taxes and insurance, that leaves the Renkos $922 a month to cover principal and interest ($1,047 less $125):

$922 (P + I)

= $119.896 (mortgage amount)

$7.69 (payment per $1,000)

 

Considering both of these ratio tests, the Renkos’ income qualifies them for a mortgage of around $120,000 to $130,000—a figure large enough to get them the home they want.

Mortgage Approval Often Requires a Strategy to Qualify

“If you don’t qualify,” says mortgage broker Helen Crosby, “then I’m go­ing to see what I can do to make you qualify. I earn my living saying, ‘Yes, I think it’s doable,’ not by saying, ‘Oh, you don’t fall within Fan­nie Mae’s standard guideline ratios. I guess we’ll just have to turn you down.’ If I did that,” Helen adds, “I wouldn’t earn enough to make my own mortgage payments.”

As you try to figure out how much home you can afford, it’s important for you to work with a Realtor and a loan advisor who are committed to seeing you become a homeowner. You want someone like Steve Bailey and Helen Crosby, who are willing to work and rework your numbers. Never forget that borrowing power depends on how well you and your loan advisor explore possibilities. How much money you can borrow de­pends on a combination of many factors, such as the following:

  1. Your gross monthly income.
  2. Your long-term monthly installment debt payments. (Typically, if monthly payments on your car loan or other installment debt end within 6 to 10 months, your lender won’t include these payments in calculating your total debt ratio.)
  3. The qualifying ratios of a specific lender and loan program. (Re­member, different lenders and loan programs set different quali­fying ratios. A “not at this time” turndown by one lender may mean you should look for another lender or loan program whose qualifying guidelines better match your level of fiscal fitness. Or you might turn to seller financing.)
  4. The type of mortgage you select, its term, and the “qualifying” in­terest rate. (The qualifying interest rate may be higher or lower than the stated interest rate on your loan.)
  5. Other regular monthly costs of home financing or home owner­ship such as property taxes, homeowners’ insurance, and, typi­cally, homeowners’ association fees and mortgage insurance.

If you don’t currently qualify for the amount of mortgage you want, don’t accept no as a final answer. Figure out how you can increase your income, reduce your debt, find a more accommodating lender, or use a loan program that permits higher qualifying ratios. In fact, if you’re bor­derline even after you’ve completed your fiscal fitness exercises, you still may be able to get your loan approved by emphasizing your compensat­ing factors.

Qualifying Ratios and Compensating Factors

When Ursala Chang applied for her mortgage, she was turned down. Her lender’s guidelines called for a housing cost ratio of 28 percent. Ursala’s ratio was 33 percent. Nevertheless, Ursala didn’t give up. She wrote the vice president of mortgage loan operations and explained, “I’ve got a perfect credit record, no debts, and I can walk to work. So, I don’t pay any costs for commuting. Plus, I’m single. My living expenses are far less than they would be if I were supporting a family.” By empha­sizing these positive compensating factors, Ursala got her loan.

Compensating Factors Make a Difference

Gordon Steinback, an executive at the Mortgage Guarantee Insurance Corporation, says his firm “routinely approves borrowers who don’t meet standard underwriting criteria.” Yet, as Gordon points out, “regrettably, too many other renters never get beyond the application stage. This hap­pens because these renters don’t meet the so-called ‘standard’ qualifying ratios and are needlessly screened out prematurely by [those] real estate agents or loan officers at the local level [who too quickly try to pigeonhole borrowers as simply qualified or unqualified]. Experience shows, however, that a large percentage of renters fall into a gray area. These borrowers could get approved for a loan if only someone would show them how.”

Types of Compensating Factors

What types of compensating factors will lenders consider? Virtually anything positive that reasonably demonstrates you could make your monthly payments responsibly and control your finances. Here are ex­amples:

  1. You pay rent that equals or exceeds the after-tax cost of your pro­posed mortgage payments.
  2. You save regularly. You spend less than you earn and use credit sparingly.
  3. You are traveling on the fast track in your career or employment. You receive periodic promotions and raises.
  4. For your age and occupation, you own a high net worth—cash­value life insurance, 401(k) retirement funds, stocks, bonds, sav­ings account, or other real estate.
  5. You have saved more than adequate cash reserves to deal with un­expected financial setbacks.
  6. You or your spouse generates extra income through part-time work, a second job, tips, bonuses, or overtime.
  1. You owe little or no monthly installment debt. This can work well when your housing cost ratio exceeds its guideline, but your total debt ratio falls within its limits.
  2. You’ve completed a homebuying counseling program that helps homebuyers develop a realistic budget.
  3. You’re making a large down payment.
  4. Your employer provides excellent benefits: auto (a company car or credit for mileage), cash reimbursement for a home office, a superior health and dental insurance plan, or large contributions to your retirement account.
  5. You earn an above-average income. People whose earnings ex­ceed, say, $6,000 a month often enjoy the budget flexibility to de­vote more money to housing than qualifying ratios indicate.
  6. Your nonhousing living expenses are lower than average. You would explain that you can afford a higher mortgage because (1) the home is energy efficient; (2) you can walk to work or drive a short com­mute; (3) you partake of no costly vices (e.g., smoking, drinking); (4) you spend conservatively, backpack for vacations, drive a cream puff 2001 Taurus, and buy clothes at the Goodwill store; (5) you’re handy with tools so you can perform your own household mainte­nance; or (6) your food costs are low because your parents supply you with fresh and home-canned vegetables from their garden.

Put Your Compensating Factors (Letters of Explanation) in Writing

After you’ve developed a list of reasons why you are willing and able to pay back the mortgage you want, don’t just tell the loan representa­tive. Put your explanations in writing. Get supporting letters from your employer, minister, landlord, clients, customers, or anyone else who can vouch for your good character, credit-worthiness, job performance, or personal responsibility. Sometimes, too, it’s a good idea to write out a family budget. Show the lender that your monthly income exceeds your monthly spending. Then back up your budget with proof: financial re­cords, cancelled checks, letters, and other compensating factors. With convincing written evidence, you’ll be able to break through qualifying guidelines that deter or delay other would-be borrowers.

Credit Record

To qualify for most loan programs—although exceptions exist—mort­gage lenders put your credit history under a microscope. If they discover a record of prompt payments, many lenders will stretch their qualifying ratios. In contrast, few lenders will offset a poor current credit record with reduced qualifying ratios. To get a new mortgage, in most cases you’ll need good credit. But what is good credit?

Maybe not as good as you think. “There are perceptions out there [about credit standards],” says John Hemschoot of Fannie Mae, “that simply have no basis in fact.” As Mr. Hemschoot explains, “Generally a credit history that consists of a minor, isolated instance of poor credit or late payments is acceptable—as long as the lapse is satisfactorily ex­plained in writing and the borrower has other credit accounts that have excellent payment records.” Rent, though, excepts the rule. A history of late rent payments usually kills mortgage applications.

Whether it’s Visa, MasterCard, student loans, car payments, or rent, never carelessly let your payments fall behind. Any payments 30 days late will cause a lender to examine your application more closely. Late payments, when combined with any other problems (e.g., high ratios, low property appraisal, short job history, low down payment), may defer the approval of a new loan until you strengthen your fiscal fitness.

What about Major Setbacks?

If you’ve suffered major setbacks like foreclosure, eviction, bankruptcy, or multiple and continuous late payments, most lenders will want to see two years of near perfect credit history before they’ll consider you for a mortgage. However, recall that these are guidelines. Both FHA and VA have considered former bankrupts after just 12 months. An underwrit­ing guide of Freddie Mac states, “Adverse credit information in and of itself does not mean the borrower is not creditworthy… . Freddie Mac does not specify a minimum time period for re-establishing credit after the occurrence of adverse events.”

Freddie (and Fannie) Encourage Lender Flexibility

In its publication Discover Gold Through Expanding Markets, Freddie Mac tells mortgage lenders, “Our guidelines do not provide [rigid] rules for creditworthiness. When you evaluate a borrower we want you to weigh the credit record, including any past difficulties, along with other information on the borrower’s financial situation to arrive at a well- reasoned conclusion that supports your expectation that the borrower will repay the mortgage… .”

Freddie Mac published Discover Gold Through Expanding Markets as part of its outreach effort to educate its lenders. “This booklet” says Freddie Mac, “is to ensure that the flexibility you can use when applying our guidelines is widely known. … We provide guidelines for your deci­sion-making that let you assess each borrower.

“Our guidelines,” Freddie Mac continues, “provide the flexibility you need to participate in community revitalization … handle diverse cul­tural needs such as pooling of funds, financial support from extended families… . We allow gifts or grants … nontraditional sources of equity such as rent credits and sweat equity… .

Are You a Manageable Credit Risk?

Most important, lenders decide whether you’re a manageable credit risk. In its booklet A Plain & Simple Guide for First-Time Home Buyers, the Mortgage Bankers Association explains it this way: “If you’ve had credit problems, prepare to discuss them honestly with your mortgage lend­ers—and come to your application meeting with a written explanation. Responsible mortgage lenders know there can be legitimate reasons for credit problems … or other financial difficulties. If you’ve had a prob­lem that’s been corrected, and your payments have been on time for a year or more, your credit will probably be considered satisfactory.”

What are some “legitimate” reasons? These include major illness, uninsured medical bills, loss of job, business failure, divorce, or anything that doesn’t look like financial irresponsibility.

Write Clear Letters of Explanation

Whether you explain compensating factors or adverse credit history, write clearly and persuasively. State the facts. But also explain those facts in a way that’s favorable to your case. Freddie Mac even tells its lenders that in addition to securing explanations, “It is equally important to en­sure that a borrower is not disadvantaged by a poorly written or incom­plete explanation. We encourage you,” says Freddie, “to ensure that the borrower is provided whatever assistance is needed to provide you with complete, accurate information… .”

Your Realtor and your loan representative want to get your loan approved. If you could use some help in wording your letters of explana­tion, ask for it. Sometimes loan reps will draft explanatory notes and sim­ply ask you to sign them. A well-written letter can make the difference between a “not-at-this-time” turndown and a “thumbs up” approval.

Get Copies of Your Credit Reports

Within the United States are hundreds of local credit bureaus and credit agencies. But the great majority of these firms are affiliated with one or more of the three largest credit repositories: (1) equifax.com, (2) transunion.com, and (3) experian.com. Federal law entitles you to a free report each year.

These credit repositories are like large warehouses connected to the information highway. Through the credit data they collect on nearly ev­ery adult in the United States, they prepare credit reports by pulling up data from their computer files. Although these three firms are working to merge their data files, at present each company may show a some­what different credit picture for you. Therefore, before you begin to shop for a home, ask each of these companies to send you a copy of your credit record. Or, more easily, obtain your credit reports and Fico scores at myfico.com.

Once you’ve received your reports, check them closely for errors. “What’s so disturbing,” says Allan Fell, director of the Maryland Con­sumer Credit Commission, “is that we have documented beyond any doubt that the [credit repositories] aren’t doing what they say—they’re not cleaning up erroneous files when they’re asked to by the consumers directly affected by the errors.”

Because of this potential for mistake and delays, identify errors as early as possible. When you wait to correct your file until after you’ve applied for a mortgage, the credit bureau’s (or your creditor’s) reporting mistakes could put your loan on hold for months. By that time, the house you want may have sold to someone else. Just as important, first impressions count. When a lender pulls your credit report, you want it to look as good as possible. As the saying goes, “You never get a second chance to make a good first impression.”

Automated Underwriting and Credit Scoring

Everything this article tells you about preparing to qualify stands true. However, two other critical elements of mortgage qualifying enter the picture. They’re called automated underwriting and credit scoring.

Objective or Irrational?

Lenders and credit bureaus believe that automated underwriting and credit scoring force greater objectivity. Computer programs treat every­one the same without regard to race, sex, age, ethnicity, or other irrel­evant factors. Automated systems eliminate human bias. Nevertheless, critics say that until credit scorers release the exact nature of their meth­odology, consumers can’t learn precisely how to improve their finances and lift their credit scores.

Even worse, some people with excellent credit records score low, and others whose qualifying ratios dramatically exceed 28/36 are approved. At times, automated underwriting seems more irrational than objective. So, what’s up?

The lending and credit folks say they can’t tell you. If they released this information, they say, borrowers would rig their finances to achieve higher scores. Besides, over a period of years they’ve spent millions of dollars to finance the development of these statistical programs. Just think how much money they would lose if they opened their black box for everyone to see. Plus, think how much money they’re going to make by forcing 100 to 200 million Americans to buy their credit scores every year.

Nevertheless, even though secrecy rules, under pressure, Fair Isaacs now posts credit scoring tips on its website (myfico.com). These tips do not reveal everything you would like to know. But they’re a start.

Borrower Gains and Losses

In the overall picture, automated underwriting and credit scoring have helped more consumers than they have harmed. Automation lowers costs, speeds up the approval process, and, as practiced, has actually in­creased the number of borrowers who qualify for a mortgage and buy a home. Nevertheless, the critics make good points.

As a result, some members of Congress and state legislators are calling for more disclosures. In addition, the powerful lobbying arm of NAR (the National Association of Realtors) has sided with the critics and is also pushing for more disclosure. To follow the latest develop­ments, check out the following web sites: www.myfico.com, www.credit scoring.com, and www.creditaccuracy.com. Plus, you can visit www.ftc. gov, which is the agency responsible for enforcing the Fair Credit Re­porting Act and other consumer protection laws.

You Can Raise the Necessary Cash

Q: Would you like to own your own home?

A: Sure, wouldn’t everybody?

Q: Then why are you still renting?

A: We don’t have enough for a down payment.

Every year the National Association of Realtors, Fannie Mae, Freddie Mac, and other national organizations survey renters about home own­ership. And every year a majority of renters answer the same way: “Sure, we’d like to buy a home someday, but we don’t have enough money for a down payment.” Although it’s true that when you buy a home, you will probably need some cash for a down payment, closing costs, and maybe reserves, it’s also true that most renters overestimate the actual amount of cash required.

You can buy a $100,000 home with less than $5,000 in cash. You can buy a $250,000 home with no more than $10,000 to $15,000 in cash, sometimes less.

Even more important, it’s not a question of whether you have enough cash right now. Instead, the right questions are (1) What’s the least amount of cash you need? and (2) How can you raise it? As long as you tell yourself you don’t have enough money, you’ll never prepare a plan to raise whatever amount you do need. When you plan to qualify, you will be able to raise a down payment for some type of loan program within a period of 3 to 12 months.

Fiscal Fitness Exercises

If qualifying looks iffy, and you need to come up with more cash or qual­ifying income, here are several fiscal fitness exercises that will help you shape up your finances.

  1. Save more by cutting your expenses.
  2. Save more by increasing your income.
  3. Seek a gift, grant, or loan for your down payment.

Save More by Cutting Your Expenses

“We have been wanting to buy our own home for several years,” says Paul Silver, “but like a lot of other couples, we didn’t have money for a down payment. Yet, we did notice that our friends who bought didn’t earn any more than we did. They found the necessary cash; why couldn’t we?

“Then it dawned on us,” Paul continues. “We were trying to save by default. After we paid our bills each month and covered our living expenses, we said we’d put aside the money left over. Well, guess how much actually went into savings? Seldom anything. In fact, as often as not, by the end of the month, we had added several hundred dollars to our credit card balances. Obviously, after we thought it over we knew that unless we changed our spending habits, we’d still be paying rent with our social security checks.

“So,” Paul continues, “here’s how we changed our spendthrift ways. To start, I recalled something my grandmother told my parents. ‘Pay yourself first,’ she always said. ‘Write down how much money you want to accumulate by a specific date. Then every week put aside whatever amount is required to reach your goal.’

“So that was our starting point,” says Paul. “Rose and I decided we would save $10,000 during the next 10 months. To reach this goal, we adopted one simple rule: Don’t spend money for anything (other than bare necessities) that we wanted less than a house. By setting priorities, we found it much easier to pay ourselves first. Every time we consid­ered splurging at an expensive restaurant, taking a weekend trip, or buy­ing some new clothes, we asked ourselves, ‘Is this more important than owning our own home?”

“We ruled out the answer, ‘just this time won’t hurt.’ While my mother was on a diet, she gained 25 pounds repeating that excuse. ‘Just this time’ always leads to trouble. Once we committed to home owner­ship, we didn’t punish ourselves by longing for things we didn’t need. We just kept our goal in sight.

“And I mean literally in sight,” Paul continued, “We took photographs of homes we liked and stuck them up all over our apartment. With these ever-present reminders of our soon-to-be achieved reward, even the ma­jor slashes we made to our spending didn’t feel like sacrifices. Anyway, this approach worked for us. Eleven and a half months after we made up our minds to own, we closed on our first home.”

Do you find yourself short of cash? Then take the Silvers’ approach. Pay yourself first. Then, to maximize savings, itemize and list your cur­rent spending. Give yourself a Draconian line-item veto. Slash out all but necessities. Prioritize. Eliminate all purchases that you value less than home ownership. For spending that remains, shift to lower cost stores, products, and services.

Try the following suggestions:

  1. 1.      Never say budget. No one likes to budget. It sounds like work. Instead, think priorities. Think reward. The quality of your life improves as you allocate your money according to your highest values. If you truly want to own your own home, put your money where your heart is.
  2. 2.      Stop paying rent. For most people who don’t own their own homes, rent is the biggest money waster. Can you figure out how to eliminate or reduce your rent payments? Can you switch to a lower cost apartment? Can you houseshare? Can you find a hous­esitting job for the next 3 to 12 months? Can you move in with your parents or stay rent-free with relatives or friends? Bank your rent money for 6 to 12 months and you’ll never pay rent again.
  3. 3.      Cut your food bills in half. Eliminate eating out. Brown bag your lunches. Buy unbranded foods in bulk. Prepare your food in large quantities and freeze portions in meal-sized servings. Forget those $3 microwave lunches and dinners. Locate a discount grocery like Aldi’s Canned Foods, Big Lots, or Drug Emporium. Shop at the new food warehouses that have opened in many cities. Food prices in discount stores run 20 to 50 percent less than big name supermarkets. Collect and use as many coupons as you can find. When you see bargain-priced items that you use regularly, buy them in quantity.

4. Cut up your credit cards. Credit cards make spending too easy. Put yourself on a cash diet. Nothing curbs spending more than having to count out real cash. Besides, credit card bills zap strength from your borrowing power. Even worse, by the time you pay off your credit card balances at 18 percent interest, you will have paid back two dollars for every dollar you originally charged—and that’s in after-tax take-home dollars. Once you con­sider that you take home only 60 to 80 percent of what you earn, you have to earn more than two dollars to pay back every dollar you charge to your credit cards.

5. Dont put the car before the house. If you own a car that’s worth nearly as much as a down payment on a house, sell it. Get rid of those cash-draining car payments. If your car is mostly paid for, there’s a good part of the money you need to move up to home ownership. If you think about buying a more expensive car, don’t! Until you can afford your own home, drive the least expensive, dependable car you can find. For too many renters, a car is the enemy of their house.

6. Eliminate costly vices. How much do you spend each year on cig­arettes, beer, liquor, and drinks at restaurants, clubs, or bars? Add them up. These costly vices range upwards of $2,000 to $5,000 per year or more. Eliminate these wasteful habits. You magnify your power to save money.

7. Buy clothes from thrift shops. Even if you’re an up-and-com­ing investment banker on Wall Street, don’t spend your hard-earned after-tax dollars on new, expensive clothing. How about an $1,800 Armani suit for $695, or an Armani silk tie priced at $40? Both of these (and many comparable bargains) were avail­able at GENTLY Owned in Atlanta. These fashion items were new, bought at close out. For recycled clothing, savings can be much higher. In her newspaper column “Dress for Less,” Candy Barrie writes, “I’m a big fan of these [consignment and thrift] shops for the fashion bargains you can find there… . Get on down and you’ll discover we’re not just talking about 20, 30, or 40 percent discounts. Sometimes you can get your clothes for 90 to 95 percent off retail. Some wealthy people don’t give their expensive clothes away, so they place them in consignment and thrift shops.”

Want to save money? Follow Candy’s advice: Locate all the re­cycled and closeout clothing stores in your area or a nearby big city. Whatever your tastes and price range, you’ll find that you can slash your clothing expenses by 50 percent or more.

8. Wait to buy new furniture and appliances. As with cars and cloth­ing, most renters spend too much too soon for furniture and ap­pliances. Even worse, instead of paying cash, they charge it. They chain themselves to several years of payments at high interest rates. (Or, increasingly, they are hooked into those “no payments, no interest for six months” promotions that make credit purchases tough to pass up.) Do yourself a favor: resist this temptation. Like cars and clothing, furniture and appliances depreciate in price faster than they depreciate in condition. As a result, you can find second-hand bargains. I have bought many beautiful older pieces of high-quality furniture for less than the cheap particleboard stuff that most lower-priced furniture stores sell. Although used appli­ances can pose some risk, you can reduce this risk when you buy appliances with transferable extended warranties (or buy a home warranty plan that covers appliances).

Whether you buy clothing, cars, furniture, or appliances, let someone else suffer the depreciation. Pay only for the use of a product. The less money you waste on depreciating assets, the faster you can build wealth through home ownership.

Save More, Increase Your Income

Increasing your income not only improves your qualifying ratios, it helps you accumulate savings. Use the following techniques to bring in more income:

  1. Ask for a raise, promotion, or transfer to a higher-paying depart­ment. Most employers want their employees to own their own homes. Let your manager know how he or she can help.
  2. Work overtime or take on a second job.
  3. Find a higher paying job in your own field. Although lenders pre­fer to see two years of job stability, if you accept a new job where you have proven skills, an upward career move is usually consid­ered a plus. On the other hand, if you’ve been selling shoes for six years, no lender would look favorably on your quitting your job to start selling cars—even if you earn more money. In that case, most mortgage lenders would want to see one or more years of steady earnings in auto sales before they would approve you for a new mortgage.
  4. Put your spouse or kids to work. Today it often takes two incomes to afford a home. If they’re working already, make saving for a down payment a family affair. Even income from a part-time job helps.
  5. Not married? Buy with a friend. Nationwide, more than 250,000 homes a year are bought by alternative types of households. (This figure doesn’t include singles who buy alone or POSSLQs—a census term meaning persons of the opposite sex in shared living quarters.) See The New York Times (June 20, 2005) “Shared Own­ership Grows to Combat High Housing Prices.”
  6. Take in housemates, create an accessory apartment, or buy a du­plex, triplex, or other multiple-unit building. Part of the rent you collect counts toward your qualifying income.
  7. Earn more or cut spending through barter. Do you have skills or knowledge that you can swap for other goods or services?
  8. If you work in commissioned or incentive employment (tips, bo­nuses, piecework), think of ways you can work smarter and more effectively.

In the long-standing best seller, The Magic of Getting What You Want, Dr. David Schwartz points out that the other side of spending is earning. Although reduced spending keeps more money in your pocket, you gain even more when you figure out ways to increase your income. What are you going to do to earn more?

Caveat: You or your spouse generally can’t boost your qualifying in­come by starting to work overtime or taking on a second job just several months before you apply for a mortgage. Lenders usually like to see an earnings history of one or two years. They want you to show that your income has proven steady and foreseeable.

Even when lenders won’t include extra or indefinite income directly in your qualifying ratios, all is not lost. In those instances, lenders may count your extra income as a compensating factor. Treated in this man­ner, the income permits a lender to qualify you using ratios that exceed its typical guidelines. Either way, the extra income boosts your borrow­ing power.

Seek a Gift, Grant, or Loan for Your Down Payment

Would your parents, other relatives, or employer give or loan you some or all of the cash you need for a down payment and closing costs? At least 20 percent of all first-time homebuyers use this technique to raise money. When Joan and Theo Clapp got married, they told their friends and relatives, “Please, no china sets, Crockpots, or espresso machines.” But if their friends and relatives wanted to help, a cash gift to the Clapps’ “house account” was truly appreciated.

Besides the help of family or friends, some first-time homebuyers obtain down payment grants from government agencies or not-for-profit housing groups. This trend is growing. In addition to assistance from grants, some cities and states will loan homebuyers all or part of the money they need for a down payment or closing costs. “Public notice,” says the ad in the Los Angeles Times, “the city of Los Angeles will loan you up to $50,000 toward the purchase of your new home. No monthly payments required. Loan may never have to be repaid.” Other sources of loans (or gifts) for down payments include OWC (owner will carry) sell­ers, shared equity investors, homebuilders, and mortgage companies.

Frank Gehr

Wish your home was something you could feel comfortable with, proud of, and eager to invite people into your home?Frank Gehr