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Budgets 101
Money-the one thing that causes more disagreements and stress than just about
any other entity. Luckily, creating a budget for your home improvement project
does not need to be intimidating or cause World War III in your living room.
Just take this simple crash course in everything you need to know about
remodeling finance:
How Much Can You Afford?
This question alone is enough to strike fear into anyone's heart. The truth
is not many people enjoy establishing a remodeling budget-and many just don't.
Many homeowners prefer to call a remodeling contractor and expect him or her to
create the budget for them, which is not the best way to begin. How do you start
off right? You can begin by taking these four easy steps in the right direction:
Step One: Decide how long you plan on staying in your home. The length
of time you intend to stay in a home will affect how much money you should
invest in it. If you are going to stay in the home for more than ten years, you
should spend as much as you are able to create the home of your dreams. However,
if you are planning on moving in the near future, you should take care not to
over-build for your neighborhood. Look into the real estate comparisons for your
area and keep your investment in line with the average home sales price. You
don't want to invest thousands of dollars you won't be able to recoup at
closing.
Step Two: Make a list of all your debts. You should include any debts
you pay on a monthly basis, such as mortgages, car loans, credit cards, and any
other items with a fixed monthly payment. This list should not include payments
for groceries, utilities, telephone services, or other general expenses. Call
this list your monthly expenses.
Step Three: Determine your total gross monthly income. Include all
sources of income that you would list on a loan application.
Step Four: Complete the following worksheet to determine how much you
can afford to pay for your remodeling project on a monthly basis. These formulas
are used when the remodeling project is going to be financed. Warning: Cash is
not always the best option!
Calculations 101
STEP 1-DTI
Lenders use a simple Debt-to-Income (DTI) ratio to determine if a homeowner
can afford the additional debt of a remodeling project.
DTI
Enter Your Total Monthly Expenses $ __________________
Add the Estimated Monthly Payment for the Remodeling
Project + $ __________________
Total = $ __________________
Divide the Total by Your Gross Monthly Income … $ __________________
DTI % = __________________
Each lender will approve loans at a specific DTI percentage (most lenders
will tell you what their set DTI ratio is, if you ask). For example, if the
lender accepts DTI ratios of 45 percent and your DTI ratio is 30 percent, your
loan would be approved. However, if your DTI ratio is 55 percent, you would need
to find other financing options. Perhaps your lender offers debt consolidation
loans that could reduce your DTI ratio, which brings us to the next step:
STEP 2-The Maximum Payment
The next step is to determine the maximum monthly payment you can afford for
remodeling. Multiply your monthly gross income amount by the lender's maximum
DTI allowance, and subtract your current total monthly expenses, excluding the
estimated remodeling payment.
Gross Monthly Income $ ________________
Lender's DTI ratio x ________________
Subtotal = $ ________________
Total Monthly Expenses - $ ________________
Maximum Affordable Payment = $ ________________
If the last line is negative, you will not be able to borrow from that
lender. See step 3 for further options.
STEP 3-Consolidation
If your DTI ratio was above the lenders accepted percentage, or if your maximum
affordable payment was too low, you may want to consider a debt consolidation
loan. This would incorporate your current debts into the home improvement loan.
Not only does this allow you to roll your debts into what may be a tax
deductible loan, it also provides one easy payment for your debts and lowers
your DTI percentage. In addition, the interest rate on a debt consolidation loan
may be lower, which will save you additional money.
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