Friday, April 11, 2008

The Power Of A Household Budget

I've become a Budget Geek.

Like so many people who grew up during the boom years after WWII, I never learned to do much financial planning. I managed to save for two years to purchase my first home at age 30, but beyond the down payment and closing costs, there never was a budget. If I had money in the bank, I spent it. If I didn't, I charged it or postponed vacations or purchases. It never occurred to me not to give myself everything I desired if I could swing it. Sound familiar?

In working with home buyers for the last twenty+ years, I've encountered the same attitude in first time home buyers as well as seasoned buyers. The lender tells us we can qualify for $XXX,XXX, and instills in us the confidence that the loan and monthly mortgage payment will be a piece of cake!

The lender really doesn't know (or care) anything about our real lives, our personal interests and obligations - not the kind that show up as debts on the credit report, but things like tithing to church, contributions to charity, children's extracurricular activities, hobbies, vacations, out of pocket health expenses, etc., etc.

Other things the lender doesn't consider are daily costs of living and maintaining a home. It's not just the rising cost of adjustable rate mortgages that have strapped homeowners, it's the rising cost of everything else, like utilities, food, insurance, and gasoline. The costs to maintain a home are unavoidable. When it's time to paint, or replace a water heater or roof, it must be done.

This is why it is important to create a realistic budget before planning your home purchase. That way, no matter what your lender tells you you can afford, you'll know what is realistic for you for a long term commitment to a home.

If you haven't already done so, take the time to track your expenses over the last 12 months. To come up with averages, add all the expenses for one category and divide by 12 for a monthly average. For annual, semi-annual, or quarterly expenses like car insurance or dues, take the 12 month total and divide by 12. That's the amount that you should budget every month so that the money will be available in reserve when the bill comes due. If you haven't kept a record of clothing purchases, "fun money" like movies, DVDs and eating out, you may need to estimate your monthly expenses just to get started.

Next, create a monthly budget using your real numbers from the last 12 months and your estimates of unrecorded purchases. Don't worry about any money that comes out of your check before you get it, like IRA contributions, health insurance, income tax. Just budget your "take home" money.

My strongest advice is BE HONEST. This is your budget, and it won't do you any good to lie to yourself. If you have a partner, you need to create this budget together. There are several great software programs that are an enormous help in planning and in tracking expenses. Just search Budget Software on the Internet. I use YNAB.

Your budget may include categories like Mortgage/Rent, Home Maintenance, Utilities, Phone and Internet, Cell Phones, Groceries, Pet Care, Cleaning and Paper Products, Health Care, Car Payment(s), Car Insurance, Car Maintenance, Gasoline and Car Washes, Car Tag, Credit Card Payments, Restaurants, Clothes, Cosmetics & Hair Care, Church, Charities, Vacation, Short Term Savings, Fun Money.

Don't ignore the "small change" items, because they add up. Most people are surprised at how much they spend on fast food and incidental items each month. That's money that can go toward paying off debts and into emergency savings.

Budgets always need tweaking after the first month or two, but you should have a realistic idea of how you've been spending your money. If you are buying your first home, or are moving up to a larger home, your budget will increase. Suze Orman recommends saving that estimated increase for six months before making a home purchase. In other words, if your new monthly payment will increase by about $300, and you'll need $200 more for utilities, and another $200 a month for maintenance, make sure these extra expenses will fit into your current budget. If not, is there something else that you are willing and able to give up?

I believe that home ownership can mean great personal satisfaction and the best investment you'll ever make. If you get started with a budget based on your real life and priorities, you'll be able to move forward with confidence in your decision to buy your first or your next home.


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