Financial literacy is the cornerstone to financial success. The more you know about managing your money well, the better decisions you’ll make and the more benefits you’ll see — particularly when it comes to homeownership.
Buying a home can be one of the most strategic wealth-building steps you can take. But understanding financial basics and establishing smart money habits are key to using your home to build your financial legacy.
What's in this Article?
Financial literacy refers to having the skills and knowledge needed to make smart decisions about your money in all aspects of your life, including:
- Money management and budgeting
- Estate planning
The road to homeownership begins long before you start looking at houses, and even before you get preapproved for a mortgage. It starts with your financial habits. And what those habits look like depends on your level of financial literacy.
“There is never a downside to having a good financial knowledge foundation prior to or during the purchase of a home,” said Kevin Chancellor, a certified financial advisor based in Florida.
Financial literacy in the 21st century
Financial literacy is especially important in the era of social media, when snapshots of other people’s home purchases don’t tell the whole story of what it takes to buy a home.
“You have decided, ‘I want to buy a new home,’ you saw a home online and now you are ready to immediately get an approval for a mortgage, get a contract, and close in the next 30 days,” said Michael Bendebba, a branch manager with Fairway Independent Mortgage Corporation (Fairway owns Home.com). “It’s that simple, right? You saw a ‘quick and easy’ ad on TV or online and you’re ready to jump in with two feet. If a celebrity is getting approved from a bathtub, how difficult can it really be?”
The reality looks a bit different, especially if this is your first time really examining your finances. Even if you qualify for a loan, a real understanding of money management is key to buying a home you can afford and thriving in it.
“Homebuying is one the single largest financial commitments that people make,” Bendebba said. “Unfortunately, with down payment assistance and/or low down payment loans, the overall financial commitment can be overlooked. Understanding the commitment you’re making is extremely important.”
That’s not a criticism of low down payment loan programs. The option to put less money down can help you buy a home — and start building equity — sooner. But without some sense of your budget and overall financial obligations, you could feel overwhelmed by your payments.
The antidote to that, and to most obstacles to homeownership, is financial literacy.
Financial literacy as a homebuying tool
A 2019 poll from the National Foundation for Credit Counseling (NFCC) revealed the top barriers to homeownership:
- Rising home prices: 18%
- Lack of funding for the down payment or closing costs: 14%
- Existing debt: 13%
- Limited housing options within available budget: 13%
- Poor credit history or low credit score: 11%
There’s not much you can do about rising home prices. But the other four factors are elements you can control — and that’s good news.
People struggle with debt, savings, and credit for any number of reasons. So if you find yourself with a lower score than you expected or you haven’t saved as much as you’d like for a down payment, don’t beat yourself up. Anyone can learn the skills and steps needed to turn those factors around.
And you can start by learning why these factors affect your shot at qualifying for a mortgage.
One of the first things a lender will check when you apply for a home loan is your credit score.
Some loan programs have hard and fast credit score minimums, and the lender needs to ensure you meet those. Other loan options don’t have minimums, making them more accessible. But your lender may set their own minimums, and they also use your credit score to gauge whether you’re likely to be a reliable borrower.
Credit doesn’t tell your whole story, which is why lenders look at all facets of your financial life when you apply for a loan. But your credit score does indicate whether you pay your bills on time and whether you’re responsibly managed your debts in the past.
Your credit score also influences your interest rate. If you have good to excellent credit, you may qualify for your lender’s best rates. But if your credit score is on the low end, your lender may see you as a riskier borrower and therefore give you a higher rate.
If you have a low to fair score, though, don’t despair. Some lenders will work with you to increase your credit score, either via a rapid rescore (where you pay off debts and the lender requests a new score immediately) or a credit improvement plan.
Still, it helps to work on your credit score before you apply for a loan. Paying your bills on time and paying down credit card balances and other high interest debts can help boost your score and help you qualify for a better interest rate.
“Most people I talk to don’t understand the importance of tracking their credit score and keeping it healthy so that they don’t end up with a subprime loan even though they may qualify for better terms,” said Jenna Lofton, a Certified Financial Advisor with an MBA in finance.
Check your credit
All Americans are entitled to a free credit report from each of the three credit bureaus (Experian, Equifax, and TransUnion) each year, and you can order those through annualcreditreport.com. It’s a good idea to review your report and dispute any inaccurate information or report signs of fraud.
The reports also give you a snapshot of what lenders see when you apply for a loan, so look for accounts you can pay down and set goals for reducing your debts. Not only will that help your score, it will also improve your debt-to-income ratio (DTI).
Lenders have stringent standards on how much money they will lend you based on your debt obligations. That’s where the DTI comes in. Your DTI is your total monthly debt payments divided by your gross (before taxes) monthly income. DTI includes all your debts, such as car payments, student loans, and credit card bills.
If you’ve got too much debt, creditors see you as a high credit risk and may deny your loan application. Some loan programs also have limits on how high your DTI can be, so keeping this number low expands the number of loan products available to you.
For a conventional loan, you will typically need a DTI of 45% or less. VA and USDA guidelines suggest a DTI of 43% or lower, but these government agencies allow lenders discretion to approve borrowers with higher DTIs if they are otherwise strong loan candidates. Lenders may be able to approve borrowers for FHA loans with DTIs as high as 50% (higher in some cases).
Maintaining a low DTI doesn’t just help you qualify for a home loan, though. It can also help you keep the home. When you apply for preapproval, your lender will tell you the maximum amount you can borrow to buy a house.
But that doesn’t mean you need to use that full amount. In fact, buying a home for less can keep your payments manageable, even if you were temporarily out of work or had another financial emergency.
“Before buying a home, you have to consider your budget. How much do you feel comfortable spending monthly for your mortgage?” Bendebba said. “Don’t let an algorithm determine what you can or should spend monthly for your mortgage. You know what you can and can’t afford.”
Suppose your lender approves you for a mortgage with a $2,500 monthly payment. But you opt for a home with a payment of $1,750 instead. If you or a loved one got sick and your income dropped, it would be easier to continue making your payments. And even if you can afford the higher payment, you may be better off buying the less expensive home and putting the difference into a savings account for an emergency fund.
Then, when unexpected expenses crop up with the house (and they always do), you can pay for them in cash rather than taking on more debt. Having enough money to maintain, upgrade and update your home will add value while ensuring your dwelling is safe and comfortable.
There are a number of loan programs available to first-time and repeat homebuyers. Each has different eligibility criteria, one of them being down payment.
The good news for first-time homebuyers is that there are no and low down payment loan options out there. You may qualify for a conventional loan with as little as 3% down, and FHA loans have a 3.5% down payment option for homebuyers with credit scores of 580 and higher.
So if you don’t have a huge amount of savings, you’re still very much in the game.
But if you do have savings, or you don’t plan to buy a home for another few months, building up your down payment nest egg is smart. Your down payment affects your loan-to-value ratio (LTV), which refers to how much you’re borrowing versus the purchase price
If you put down 3%, you’ll be borrowing the remaining 97% to buy the home. Your LTV is 97%. Now, there’s nothing wrong with putting down 3%. But if you can put down more, your LTV decreases and therefore so does the risk to your lender (the more you need to borrow, the riskier it is for them). And they may reward you with a lower interest rate or cheaper mortgage insurance.
Borrowers who have limited down payment savings may also qualify for down payment assistance programs, which help eligible homebuyers through grants or forgivable second loans that can be used toward their upfront costs. These can be great resources for crossing the threshold to homeownership. But there are always trade-offs.
“You might not realize, but down payment assistance programs require higher interest rates,” Bendebba said. “Meaning that if you use your own money, you will save on your rate and monthly payment.”
If you’re ready to buy a home but need help with a down payment, an assistance program may provide the boost you need to make the purchase and start building equity. And you may be able to refinance to a better interest rate in the future.
But if you can make the down payment on your own, and you can put down more than the minimum required, you could potentially save money right from the outset.
All of these considerations — debt management strategies, budgeting, having an emergency — are key financial literacy skills with real-world implications.
Financial advisor Jamilah N. McCluney learned that firsthand when she bought her first home with an adjustable-rate mortgage (ARM).
“Right out of college, I purchased a home that was way more mortgage than I could comfortably afford,” she recalled. At 23 years old, she purchased a $500,000 home. Soon after, the 2008 housing crisis hit. When the ARM adjusted, her monthly mortgage payment doubled, and she could no longer afford her home.
“Had I been educated and understood how mortgages work, I would not have financed such a large amount, and I would have avoided the ARM product recommended by my lender,” McCluney said.
That experience inspired her to become a financial advisor.
“Without the proper guidance or financial knowledge, major decisions could be made in error,” she said. “Everything from choosing the correct down payment, the correct mortgage term, and even the right interest rate are affected by your financial literacy.”
Of course, interest rates and mortgage details can get complex, but you don’t need to become an expert. That’s what your loan officer is there for, and you can also work with a financial advisor to figure out what’s affordable based on your budget and goals.
But you can work on raising your credit score, paying down debt, and saving as much as possible to put yourself in the best possible position to buy a home.
Thankfully, there are more resources about financial literacy available than ever before. From YouTube videos to ebooks and ecourses to personal finance apps, you’ve got options when it comes to learning about money. No matter your learning style, you are bound to find plenty of information about money management and financial planning.
You can also work with a certified financial planner or wealth advisor to create a game plan for your money goals. And when it comes to homebuying, you can consult a nonprofit homebuying counselor in your area and work with your lender.
When you apply for a mortgage, your loan officer can explain the terms and conditions, as well as the pros and cons of different loan products. Some loan programs require you to complete a homebuyer or financial education course, which is a great way to sharpen your financial literacy skills before you close on the home.
Bendebba advised working with someone who can act as a loan adviser, not just someone who takes your application. Your loan officer can provide valuable insights and support throughout the application process, so be sure to ask about how readily they’ll be available to you before applying.
Financial literacy is an ongoing pursuit, as there is something new to learn at every stage of your life. That’s why it’s important to keep learning and honing your skills after you purchase a home.
Although you’re listed as the home’s owner, the bank has rights to it until the loan balance is paid in full. It’s crucial that you budget for your monthly mortgage payment and make sure it’s paid on time.
Falling behind on your mortgage can lead to default and, worst case scenario, to losing your home. There are steps you can take to avoid that, including requesting temporary relief or a modified payment arrangement with your loan servicer (the company managing your loan after you close).
But careful budgeting and saving can help you avoid that in the first place. Your budget is your spending plan, and it should guide your decisions on how money flows through your household. If you can maintain a budget, you are more likely to save for emergencies and future expenses and to avoid problems paying your home loan.
It’s not just your mortgage you need to budget for, either. You’ll also pay property taxes and homeowners insurance, which are part of your monthly payment. As the homeowner, you’re also responsible for maintaining the property, including repairs, upkeep, and lawncare.
The best thing you can do is be prepared for whatever comes by living below your means and cultivating a healthy savings habit.
Your home will likely be your greatest financial asset. And you can grow its value not just by maintaining it but upgrading it over time. Adding energy-efficient appliances, replacing an aging roof or HVAC system, and renovating the kitchen can be ways to increase the home’s value.
The higher the home’s value, the greater your opportunities for borrowing against the equity in the future or selling for a profit.
Financial literacy FAQs
You can learn financial literacy skills through books, online videos, courses, and ebooks, and through in-person trainings. Certified financial planners and wealth advisors can also help you create financial literacy plans, and your lender can be a great ally toward sustainable and lucrative homeownership.
Basic financial literacy begins with budgeting so you can live within your means, avoid debt, and save money toward your financial goals.
A financially literate person can create and maintain a budget and lives within their means (meaning they aren’t taking on new debt each month). They likely have minimal debts and weigh short-term financial decisions and opportunities against their long-term money goals. For instance, they are thoughtful about whether to spend money today on, say, clothing or entertainment when they could put those funds into their down payment savings.
Owning a home is rewarding, but it’s tough, too. It can be discouraging when things break down and your monthly budget always seems to be eaten up by repairs. But financial literacy helps keep those times at bay, because you’ll have an affordable mortgage payment and enough savings for all your housing-related expenses.
But as Bendebba said, “Homeownership is an amazing financial accomplishment when you take the time to truly understand your commitment.”
Ultimately, financial literacy leads to financial resilience. And having the ability to continue growing your wealth and investing in your greatest asset will help you make the most of your home.
Some references sourced within this article have not been prepared by Fairway and are distributed for educational purposes only. The information is not guaranteed to be accurate and may not entirely represent the opinions of Fairway.
Fairway is not affiliated with any government agencies. These materials are not from VA, HUD or FHA, and were not approved by VA, HUD or FHA, or any other government agency.
*A down payment is required if the borrower does not have full VA entitlement or when the loan amount exceeds the VA county limits. VA loans subject to individual VA Entitlement amounts and eligibility, qualifying factors such as income and credit guidelines, and property limits.
**Pre-approval is based on a preliminary review of credit information provided to Fairway Independent Mortgage Corporation, which has not been reviewed by underwriting. If you have submitted verifying documentation, you have done so voluntarily. Final loan approval is subject to a full underwriting review of support documentation including, but not limited to, applicants’ creditworthiness, assets, income information, and a satisfactory appraisal.