Dear New Frugal You,
I want to buy a home. I currently have several personal loans. I want to get a new personal loan that would combine the current loans and pay just one bank. The interest rate would be 7 percent. That's about 2 percentage points higher than the loans I currently have. I have good credit and in the past year I was prequalified to purchase a home. Does it make sense to combine these loans to free up income to purchase a home? -- Laurie
Good question. Getting your financial affairs in order before you begin to seriously shop for a mortgage is a good idea. Not only is it wise to know your credit score, but also to understand what you can afford in mortgage payments and other home upkeep expenses. Let's look at both.
First, let's consider your current loans and their effect on your credit score. Consolidating your personal loans into a new loan will not help your score. How many loans you have isn't important. How much you owe and whether you're consistently on-time with your payments is.
Since you have a good credit score, I'll assume you're good about making your payments. Your best strategy is to continue that and, if possible, boost payments to reduce the amount outstanding. You'd be surprised how quickly you can reduce the loan amount by adding to your monthly payment, even if it's only for a few months.
Next, would combining the loans make it easier to handle mortgage payments? Mostly likely, no, it wouldn't.
You've said that the interest rate will actually increase by about 2 percent, so your payments won't go down -- unless you're switching from a fully amortized loan to one of its exotic cousins in which you pay no principal until the end of the loan. Such interest-only or balloon payment personal loans rarely make sense and have significant downsides, so if you're considering one, you need to get professional, individualized advice I can't give here.
Finally, you should consider how much home can you afford. You're about to make a major commitment. As of July 2014, there are more than 1 million properties in the foreclosure process, according to RealtyTrac. That means that over 1 million people thought that they could handle mortgage payments and found out that they were wrong. You don't want to join them!
Part of the reason that many people fall behind is that they fail to realize that they're responsible for more than just the mortgage payment. They also have to find the money for property taxes, insurance, repairs and upkeep on their home.
You should be able to get estimates for property taxes and insurance from the real estate agent or a little research. Some mortgages will require that you pay a portion each month with your mortgage payment.
It will be harder to estimate repairs and upkeep. Depending on the age and condition of your home it could range between 1 and 5 percent per year.
Most families find that they can afford to spend up to 35 percent of their after-tax take-home pay on all housing related expenses including the mortgage. Anything over that will strain your overall budget.
It sounds as if you're doing the proper things prior to beginning a house hunt. Hope that the one you find is your dream home!
See related: Home-sale mistakes
- Personal loan consolidation won't help win a mortgage
- Should I close card accounts to get a mortgage?
- Debt settlement vs. credit counseling: similar aims, different means
- Interest Rates
- personal loan
- credit score