Step 1: Staying in your budget

About 2 years ago, I was ready to purchase my first property. (There was a lot of prep work involved to get to this step that we can dive into in another post…)

There were a couple key things I was looking for :

  1. A property within my budget
  2. Flexible income opportunities
  3. Long term growth

Let’s focus on item 1 in this post.

Because I know it sounds simple. People typically go into the home buying process with a budget that fits their needs. The issue is that I have seen so many people get into the hustle of bidding on a house (especially in a competitive market like the one I live in) and immediately overshoot their budget.

Why do people often lose sight of their budget?

A few reasons.

  • They get emotional – you see the home of your dreams and either bid higher than asking because you don’t want to lose it, or get caught in a bidding war.
  • The realtor creates urgency and makes you feel like if you don’t bid now at a high price, you’ll lose it.

And this last reason is important:

  • Buying a house is typically the only time a person spends thousands of dollars in one go. With the amount of money people are dealing with, it feels like $5,000 or $10,000 more is no big deal. (There’s also an economic concept of perceived value happening here where the more you spend makes you feel like the product has more value.)

Overall, your budget is critical, and staying inside of it is important if you’re truly trying to make an income from your property.

But how do you find the ideal budget?

There’s a couple critical pieces here.

  1. The first piece is that your lender will try and convince you that you can borrow more than you need.

Why? Because that’s how lenders make money. And once you start putting less than 20% down, you start requiring PMI (private mortgage insurance) which makes banks even more money.

PMI is the main way to avoid putting 20% down. There are other options, but let’s leave it at PMI for now.

What else effects your budget?

2. How much income and savings you have.

This feels pretty basic, right? You have a certain amount saved up for the down payment and are expecting to make a certain amount of money each month from your other income streams (your 9-5 job or other regular income).

But think about it – when you apply for a loan, the lending bank is looking for proof that you can pay your mortgage each month.

This is important because the income you make from renting won’t be able to count towards your income towards your loan after purchasing the home right off the bat.

Why is that?

Banks want to be sure you are able to cover the debt you owe them.

If you can prove over a year that you are making reliable income from renting, by having your renters on a lease and claiming that income on your taxes, you can use it in the purchase of your next rental property (oh, yes you can own multiple rental properties)!

Even if you Airbnb your rental income, you will still need about a year to prove that the income from that rental is reliable enough to count as income in the same sense as your job.

And for your sake, you want to be risk averse on this one.

Let’s say it takes you 4 months to rent out this property. Let’s say there’s a major plumbing issue that takes 2 months to fix and no renter can live in the property for that time period. If you were relying on rental income only to pay the mortgage during this time period, you’d be in some trouble.

So be wise here. Rental income should feel like bonus income right now. Plan your rental property as if you may need to cover the mortgage yourself each month for the first year.

So what else effects your budget?

3. How much rental income you are expecting to make.

This is where PMI might make sense for you or why putting down 25% could also be wise.

Because the more you put down, typically the less your monthly mortgage payment is. That means less debt to the bank and more rental income each month. If you’re in the position of putting down more than 20%, and can expect a certain rental income in the neighborhood you are renting in, putting down more money early might be a better business decision here.

Same with PMI.

If you’re unable to get to a 20% down payment and PMI is the best option for you (and I would urge you to get as close to 20% as you can!), estimate about how much rental income you can expect.

If the neighborhood and quality of house you are renting (more on this in an upcoming blog post) allows you to capture enough rental income to cover your mortgage and then some, PMI might be a great option here. You can refinance and get out of PMI when you have more income (see above sections on declaring income from your rental property – but more to come on all this later).

It’s based on your unique situation, and you can work with your lender to get more options based on your needs (active duty military or veterans have incredible options here).

There’s more to explore about budget – and of course I am happy to answer questions.

More to come on the next two critical parts of looking for that first property.

 

 

 

 

 

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