Investing Wisely To Achieve The Dream: Home Ownership In Five Years

Investing in a house is a big financial decision, so it's important to be proactive and prepare in advance. Here are some steps to help you get started on your home-buying journey in the next five years:

1. Evaluate your financial situation: Before taking any significant financial step, it's crucial to understand your current financial position. Assess your income, savings, and expenses to determine a reasonable purchase price for a home. A good rule of thumb is to aim for a monthly mortgage payment of no more than 28% of your gross monthly income.

2. Improve your credit score: A higher credit score increases your chances of getting approved for a mortgage and qualifying for lower interest rates. Focus on paying off existing debts, maintaining a good payment history, and addressing any negative items on your credit report.

3. Maximise your savings: Start saving for your future home as early as possible. Consider ways to increase your income or reduce expenses. Choose savings vehicles that offer both accessibility and growth, such as high-yield savings accounts or money market funds.

4. Consult a loan officer: Connect with a loan officer to gain a better understanding of the homebuying process and any potential considerations. They can guide you on improving your financial standing and inform you about different loan programs and lenders.

5. Keep your decision personal: Remember to consider your personal needs and preferences when entering the homebuying market. Think about factors such as location, the number of bedrooms, and your long-term plans.

Evaluate your financial situation

Evaluating your financial situation is a crucial step in the process of buying a house. Here are some key aspects to consider:

Income and Employment Status

It's important for lenders to see not only your income but also your work history, usually around two years, to ensure that your income source is stable and reliable. If you're on a payroll, you'll need to provide recent pay stubs and W-2s. If you're self-employed or have passive income, you'll need to submit tax returns and other relevant documents.

Debt-to-Income Ratio (DTI)

Your DTI is a critical factor that lenders assess when considering your loan application. It represents the percentage of your gross monthly income that goes towards debt payments, including credit card minimum payments, loan payments, etc. Lenders use this information to evaluate the amount of mortgage debt you can take on. A lower DTI improves your chances of getting a loan and securing better loan terms.

Credit Score

Your credit score plays a significant role in determining your eligibility for loans and the interest rates you qualify for. It gives lenders insight into your history of repaying debts. A higher credit score, typically above 620, improves your chances of securing a loan and getting lower interest rates. Taking steps to improve your credit score and reduce your debt can be beneficial.

Down Payment and Closing Costs

Most loan programs require a down payment, which is a large, one-time payment towards the purchase. The amount required varies depending on the loan type, but it's typically around 3% to 20% of the purchase price. Additionally, you'll need to pay closing costs, which are fees charged by the lender and other third parties involved in creating your loan. Closing costs can range from 3% to 6% of the loan amount, so it's essential to prepare for these expenses.

Emergency Fund and Other Financial Obligations

Before buying a house, it's crucial to have an emergency fund to cover unexpected expenses or loss of income. Aim to save at least three months' worth of expenses in a high-yield savings account. Additionally, consider any other financial obligations you may have, such as credit card debt, retirement contributions, or family support, and ensure that you can manage these alongside your mortgage payments.

Improve your credit score

Improving your credit score is one of the most important steps you can take when preparing to buy a house. Lenders will look at your credit score to determine how likely you are to pay back a loan, and a higher score will also help you qualify for lower interest rates on your mortgage. Here are some tips to help you improve your credit score:

Check your credit score and report

First, you need to know your credit score and what is on your credit report. You can access your credit score for free through credit card issuers or services like Experian. You are also entitled to one free credit report per year from each of the three major credit bureaus (TransUnion, Equifax, and Experian) through AnnualCreditReport.com. Reviewing your credit report will allow you to identify any errors or negative items that may be hurting your score.

Dispute any errors

Mistakes on your credit report can lower your score, so it's important to dispute any inaccuracies you find. Common mistakes include duplicate credit accounts and identity errors. Contact the relevant credit bureau in writing to dispute any errors and request that they investigate. You can also pay credit repair companies to file disputes for you, or you can use free dispute letter templates provided by the Consumer Financial Protection Bureau (CFPB).

Make timely payments

Your payment history is one of the most important factors in determining your credit score. Make sure to pay all your bills on time, including credit card payments, loans, and utilities. Setting up autopay or automatic payments can help ensure you never miss a payment. Late or missed payments can significantly damage your credit score.

Lower your credit utilization ratio

Your credit utilization ratio is the percentage of your total available credit that you're using. Lenders will look at this ratio to assess your creditworthiness. It is recommended to keep your credit utilization at 30% or lower. For example, if you have a credit line of $1,000, keep your credit utilization at $300 or less. Making extra payments during the billing cycle can help keep your balance low.

Become an authorized user

If you have a limited credit history, you can build your credit by becoming an authorized user on someone else's credit card. Ask a family member or friend with good credit to add you as an authorized user. Their good payment history will appear on your credit report, helping to raise your credit score. However, be aware that if their account has high balances or late payments, it could negatively impact your score.

Improve your debt-to-income ratio

Your debt-to-income ratio (DTI) is another important factor in qualifying for a mortgage. Lenders prefer a DTI of 43% or lower. You can improve your DTI by paying down debt and boosting your credit score.

Avoid closing open accounts

The average age of your credit accounts is also a factor in your credit score. Lenders want to see a long history of well-managed accounts. Avoid closing any credit accounts, especially older ones, before applying for a mortgage. Instead, use your credit cards occasionally to keep the account active.

Avoid opening new credit accounts

In the months leading up to your mortgage application, avoid opening any new credit accounts, such as credit cards or loans. Opening multiple new accounts can lower your credit score and increase your debt-to-income ratio, making it more difficult to qualify for a mortgage.

Maximise savings and keep funds in conservative accounts

Maximising your savings and keeping your funds in conservative accounts is a great strategy if you're looking to buy a house in 5 years. Here are some tips to help you achieve that goal:

• Assess your financial situation: Understand your income, savings, expenses and debt. This will help you determine how much you can afford to spend on a house and how much you need to save for a down payment.
• Set a clear savings goal: Determine how much you need to save for the down payment. The down payment is typically between 0% and 20% of the purchase price, but the median down payment in 2022 was 14%.
• Choose the right savings vehicle: Look for options that offer accessibility and growth, such as high-yield savings accounts, money market funds, CDs (certificates of deposit) or bonds. Avoid investing in the stock market for short-term goals as it's unpredictable over a relatively short time frame.
• Automate your savings: Consider having money automatically deducted from your paycheck and deposited into your savings account. This ensures that you save a certain amount every month without the temptation to spend it.
• Cut back on expenses: Reduce or eliminate unnecessary expenses such as dining out, entertainment, travel, subscriptions, and so on. This will help free up more money for your savings goal.
• Increase your income: Boosting your income will accelerate your savings progress. Consider taking on a side hustle, starting a small business, selling items, or adjusting your income tax withholding.
• Explore down payment assistance programs: Look into government and bank-sponsored assistance programs, as well as lender-specific programs, that can provide financial support for first-time homebuyers.
• Save windfalls and extra income: Commit to saving all or a portion of any unexpected income, such as a tax refund, bonus, legal settlement, or inheritance.
• Monitor and adjust your savings plan: Regularly review your spending and progress towards your goal. Stay motivated by visually tracking your savings progress and celebrating milestones.

Speak with a loan officer

Speaking with a loan officer is an important step in the process of buying a home. A loan officer can help you understand the homebuying process and any major considerations you need to make. They can also provide valuable insights into how you can improve your financial standing to qualify for better rates and mortgage terms.

When preparing to buy a home, it is recommended to connect with a loan officer as early as possible, even if you are a few years away from making a purchase. This will allow you to get guidance on what you need to do over the next few years to afford the kind of house you want. For example, you may need to get a higher-paying job, pay down debts, or address any negative trade lines on your credit report.

A loan officer will ask you about your savings, income, and other relevant financial information, and run a credit report. They will then be able to tell you how much you can afford to borrow and the types of loans you qualify for. This information will be crucial in determining your budget for buying a home.

It is worth noting that a loan officer typically works for the lending institution and may work on commission or a salary provided by their institution. They may also have specific loan programs and lenders that can suit certain needs. For example, some lenders offer specialized loan programs for medical professionals or first-time homebuyers.

When choosing a loan officer, it is recommended to start with trusted people and institutions. You can also look for a lender that provides resources to educate potential borrowers about the homebuying process. A quick search on a mortgage lender's website can help you find out what kinds of educational resources are offered.

Make a personal decision

When it comes to making a personal decision about investing to buy a house in five years, it's important to consider your individual needs and priorities. Here are some key points to keep in mind:

• Location preferences: Do you want to live in a specific neighbourhood or area? Are there particular cities or towns that align with your lifestyle and work requirements? Consider the proximity to your workplace, family, schools, and amenities that are important to you.
• Family dynamics: Think about your family's needs and future plans. How many bedrooms do you require? Are there any specific features or spaces that are essential, such as a home office or a backyard? Consider your long-term goals and whether you plan to expand your family or accommodate multi-generational living.
• Commute and transportation: Reflect on your tolerance for a daily commute. Are you comfortable with a longer commute to access more affordable housing options, or is a shorter commute a priority for your work-life balance? Consider the transportation options available in the areas you're considering and how they align with your preferences and budget.
• Personal comfort and lifestyle: Be mindful of your personal comfort and lifestyle choices. Do you prefer a quiet neighbourhood or a bustling city centre? Are there specific community features or amenities that are important to you, such as parks, gyms, or cultural offerings? Consider what truly matters to you in your daily life and how your home can support your overall well-being.
• Financial capabilities: Assess your financial situation and determine how much you can comfortably afford. Calculate your income, savings, and expected expenses. Be realistic about your budget and consider seeking advice from a financial planner to help you make an informed decision.
• Personal timeline: Evaluate your timeline and whether it aligns with your five-year goal. Are there any upcoming life changes or events that might impact your plans? Consider your short-term and long-term goals, and how purchasing a house fits into your overall personal journey.

Remember, buying a house is a significant decision that should be tailored to your unique circumstances. Take the time to reflect on what truly matters to you and your loved ones, and make a choice that supports your personal definition of success and happiness.

Frequently asked questions