Here's another good reason to always have money on hand in the bank.
You'll often hear that having an emergency fund is crucial -- namely, because it can spare you from racking up debt when unplanned bills pop up. But not having an emergency fund could result in a scenario where you can't get a mortgage to buy a home. Here's why.
Too much debt could hurt your mortgage application
Mortgage lenders look at several factors when deciding whether or not to approve a home loan candidate. These include:
- Credit score
- Existing debt
- Funds for a down payment
- Income source and salary
Now, let's talk about existing debt. Lenders use a measure known as your debt-to-income ratio when figuring out if you qualify for a mortgage. That ratio compares your monthly debt payments (like your housing costs and credit card payments) to your monthly income. If that percentage is too high, you may be denied a home loan. After all, if you already have a lot of debt, a lender won't want to take the chance that you'll fall behind on mortgage payments because you have too many monthly obligations to manage.
So how does that tie in to having an emergency fund? It's simple: If you go without emergency savings, you may be forced to rack up debt when surprise expenses rear their ugly head. And that debt could take on different forms. It could mean having to put big charges on a credit card, or having to take out a personal loan and pay it off over time. Either way, it's debt that could serve as a red flag for lenders -- and cause you to lose out on the chance to buy a home.
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How to build your emergency fund
If you don't have an emergency fund yet, it's important to build one -- whether you're planning to buy a home or not. First, you'll need to figure out a target savings goal. As a general rule, it's a good idea to have three to six months of living expenses in a savings account set aside for emergencies.
Where will that money come from? You have options.
First of all, if homeownership is on your radar and you've already begun saving for a down payment, that money could become your emergency fund. That means you'll then need to save the equivalent amount to put down on a home. But having an emergency fund should trump all other financial goals you have. You may also have the option to make a smaller down payment than you may have planned on. For example, if you have $30,000 to put down on a home, you might take half of that for your emergency fund and see if a lender will accept a $15,000 down payment instead.
Otherwise, you can build an emergency fund by cutting back on spending and boosting your earnings. Shed nonessential expenses from your budget and put the difference in the bank. On top of that, see if there's work you can pick up on the side in addition to your main job. Freelancing as a web designer for a number of months or driving for a rideshare company could put a lot of extra money in your pocket.
Having emergency savings is crucial -- especially if you're planning to buy a home. When you own property, repairs can pop up at any time. Without money in the bank, they could easily become a source of debt. But also, an emergency fund could spare you from racking up debt that will hurt your chances of getting a mortgage in the future, and that alone should serve as motivation to save.
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March 28, 2021 at 06:32PM
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How Not Having an Emergency Fund Could Kill Your Homeownership Dreams - The Motley Fool
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