Housing
Unfortunately, many creative professionals have internalized the starving artist myth, thinking that artists are destined to a life of destitution. Consequentially, many artists think they will never be able to buy their own house or studio. In the meantime, these same artists live in fear of rent increases, deal with greedy landlords, or get priced out of apartments and lofts after they have invested their own time and money on renovations. They constantly move from one neighborhood to another, trying to escape the next gentrification wave. If you feel powerless in a rental situation, you might want to consider saving to purchase your own home, condo, or studio. Owning a home means you have equity, which helps with getting loans and building wealth in the future. When you rent, your money is just going to a landlord, but when you own your house any investments you make to improve it increase your overall worth.
Buying one’s own place to live is tantamount to taking a stand against developers. Finding an under utilized building, or house in need of repairs, rather than purchasing something newly build or remodeled, is also an eco-conscious way to deal with housing.
If the idea of home ownership is overwhelming, consider consulting with a loan broker who can help you strategize for the future. The following are preliminary considerations:
Start a savings plan. Update it frequently.
Create a reasonable monthly budget and stick to it.
Determine what you can afford (or want to work toward) in terms of a down payment, mortgage, etc.
Consider asking a willing family member for assistance.
Talk with a lender about mortgage options.
If possible, get a pre-approval. Home sellers usually don’t want to even talk to you unless you are pre-approved. The pre-approval means that you are serious to buy and you are actively taking the proper steps to do so.
Actively look for homes, especially ones that need work—they tend to be less expensive. The old adage is to buy the worst house in the best neighborhood on the best block. You can always make changes and repairs to a house but you can’t change its location.
About Loans
Most people—and most artists—do not have a lot of disposable income. Ninety-nine percent of home buyers borrow money to purchase their homes. The important question to answer is how much money can you afford to borrow?
To determine this, a lender/bank will take a couple of things into consideration. First, a lender will take a very close look at your financial situation, which basically means the money you earn versus the money you owe. Second, a lender will look at your credit rating, or FICO score (FICO is short for “Fair, Isaac and Company,” which developed the mathematical formula used to calculate these scores). FICO scores range from 300 to 850 (higher than 660 is generally considered good). Your score will show a lender how much of a risk you carry as a borrower.
For instance, repeatedly paying credit card bills late, defaulting on prior loans or filing for bankruptcy, will lower your credit rating, and make you a greater risk as a borrower. By measuring your finances and credit rating, a lender will comfortably be able to provide you with an estimate of the home loan for which you are eligible. Generally speaking, if you have steady income and good credit, the amount is approximately 2-2.5 times your annual gross income.
Types of Loans
There are many options for the types of loans available to purchase a home. Financial structures and loan options seem to be changing rapidly, so do your homework and find out what resources are available.
Figuring Out Your Monthly Income
To figure out your monthly gross income (i.e., your monthly income before taxes), begin by listing your total annual income from work, sales or commissions, interest and investments, child support, Social Security, and any other income source you have. Income from your artwork should be included. In order to claim money as income, you must first have declared it to the IRS and paid taxes on it. You cannot include any money under the table. If you plan on buying the house with a spouse or partner, include her/his income as well.
Figuring Out Your Monthly Expenses
You also need to figure out your monthly expenses. List all of your total monthly expenses, including your car, student and other loans, credit card debts, alimony or child support, storage, rent and utilities, etc. If you are buying the house with a spouse or partner, make sure you include her/his expenses as well. Here is an additional tip: if you have fewer than ten monthly payments left on any loan, you do not need to include it in your monthly expenses. (You may also want to choose to prepay a loan to get it below ten monthly payments so that you will not have to count it.)
Debt-to-Income Ratios
Before giving you a loan, a lender will compare your monthly gross income and monthly expenses to a ratio called the Debt-to-Income Ratio. The most common Debt-to-Income Ratio is 28/36. The first number (28) is called the housing expense ratio. It is the maximum percentage (28%) of your monthly income that you can spend on your monthly mortgage payment. The second number (36) is called the overall debt ratio. It is the maximum percentage (36%) of your monthly income that you can spend on all of your combined monthly debts, including your monthly mortgage payment. Please keep in mind that the larger your down payment on a home, the less important the ratios are to lenders.
Affordability
Between the housing expense ratio and overall debt ratio, the lender will look at whichever is lower when pre-qualifying you for a loan. Please keep in mind that the two ratios only project what you can afford for a mortgage payment, but not what is referred to as PITI—a combination of principal, interest, taxes, and insurance expenses. The principal and interest (your monthly mortgage payment) will depend on the amount of money you borrow, the type of loan you select, and the interest rate. In addition to principal and interest, you will also be responsible for paying real estate tax and homeowner’s insurance. The amount of real estate tax will depend on where you live; the cost of homeowner’s insurance will be determined by the policy you choose. If you purchase a co-op apartment or condo, taxes, insurance, and, possibly, a Home Owners Association (HOA) fee (the fee for upkeep of common areas) will be covered by a monthly maintenance fee, which you pay in addition to your monthly mortgage payment. Be sure to include these fees in your overall budget.
Getting Pre-Approval
Once you have completed the above calculations, you should feel pretty comfortable with your financial situation. You now need to take the process to the next level: getting a pre-approval from a lender for a loan. To be pre-approved, you will need to present the following information to a lender:
Social security number
Home address for the past three years
Employment history
Salary/income
Current monthly expenses
Bank account balances
Current pay stubs (number various upon lenders)
During the pre-approval process, the lender will verify your information and check your credit. Banks also prefer a recent history of full-time employment, as this indicates a reliable source of income. This is part of what makes purchasing a home difficult for artists, since they sometimes work part-time, freelance, or cobble together different forms of employment in order to have the free time necessary to create art. Nevertheless, if all goes well, the lender will give you a letter stating that you have been pre-approved for a loan to be applied to the purchase of a home. The letter is usually good for a period of 60 days to a year. The pre-approval process is free, and having a pre-approval will make your bid much more appealing to a seller.
Down Payments and Closing Costs
There are two major expenses involved in closing on a home: the down payment and the closing costs. Lenders generally expect you to pay at least 20% of the sales price, up front, as a down payment. However, depending on a variety of factors, the amount of up front money can be as little as 3%-10%. Please keep in mind that if you pay anything less than 20% up front, a lender may require you to pay what is called Private Mortgage Insurance (PMI), which protects the lender in the event that you default on the loan. PMI can add anywhere from .25%-.75% to your monthly interest rate payments, but sometimes this is the only way to get a place of your own. Another way to avoid paying PMI is to ask your family for help with the down payment. If you choose this route, the money they give you must be a cash gift (not to be repaid—otherwise, it is another financial obligation that a bank would want to take into account), which they should commit to in writing. You should also plan on having additional money set aside for the closing costs, which generally amounts to 3%-6% of the sales price. Closing costs include things like appraisal fees, inspection fees, credit reports, insurance, PMI, taxes, attorney fees, accountant fees, escrow fees, title policy, bank processing, recording fees, etc.
In Summary
You must plan and do research in order to make your dream of owning a home a reality. Ask homeowners about their experience buying a home, taking out loans, etc. Consider working with an arts accountant to guide you through the process of saving for a down payment, or getting a pre-approval.
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