Avoiding Payment Shock
When you are about to go from a lower payment or no payment on your housing to a higher payment, I recommend taking some steps to avoid running into problems with payment shock.
These steps can have 3 primary benefits:
Easing Your Transition
These steps can make the transition of lower/no payments to higher payments much easier, having a positive impact on your ability to not experience late payments/missed payments when you have a higher payment required.
Expediting Debt Pay Down & Savings Boost
These steps can expedite debt paydown and savings boosts so that when you are ready to buy, you'll be in a better place financially and possibly able to get a better property than you would have otherwise if paying down debt.
Boosting Your Lender's Perception
In some cases, these steps can help a lender know that you will be in a better position to transition to a new home. Manual underwriters may request this information & may deny your loan if they are too concerned about the risks, especially if they find that you are about to go from no payments to a high payment and haven't demonstrated the ability to either quickly pay down debt &/or rack up savings while you don't have a payment.
Here are the steps that I recommend:
Establish At Least 1 Free Savings Account At a Separate Institution
Ideally the new savings account would include the following elements:
Free to keep open with no minimum balance or a low minimum balance.
Free ACH transfers to your other accounts or another means of free transfers to other accounts.
High interest rates (i.e. >5%)
If you plan on funding an account with at least $1k and never going below $1k in the account, you might like https://www.cfg.bank/personal-banking/personal-deposit-rates/ with current APY on their money market account of 5.02%.
If you won't be funding the account with at least $1k, Synchrony Bank's 4% APY isn't bad:
https://www.synchronybank.com/banking/high-yield-savings/?UISCode=0000000
How Much to Fund Savings Account
For determining how much to fund your savings account, it's a good idea to treat things as though you were already paying everything that you would be in the new house. If you're already paying rent and utilities somewhere without receiving any food included, do the math on what your new utility expenses and mortgage might be and be sure that the amount that you fund the new account is the difference of the 2 payments, plus 10% of the new mortgage payment (to account for unforseen expense, maintenance, and repairs). If you're living with parents, not paying for anything, and receiving food from them, factor in food costs that you'll be incurring as well as the cost for the mortgage payment and utilities.
If you get paid twice a month, divide the funds you need after each paycheck in half to account for that.
How to Get Funds to Disburse Automatically to Your New Account with Your Paycheck
If you receive a regular paycheck, be sure to establish a means of the funds from your paycheck automatically being divided in some fashion so that funds automatically go to your new account. There are two primary options:
A. Ideally you have the money from your paycheck get split for direct deposit into your current account and your new account.
B. If you're unable to get a direct deposit to split, check with your current credit union/ bank account to see if it's possible to send money freely to other accounts that you own at separate institutions. If it's not free, consider workaround solutions or shutting down that account in favor of more flexible accounts.
If you don't receive a regular paycheck, establish thresholds in advance in terms of your income based on your average pay and any payment trajectory so that each time you receive a check, you know exactly how much you should be putting into your savings account based on where you are at in meeting these goals that you've established in advance. You want the funds to go from your paycheck 2 days after the date that you typically receive it but go through the calendar if necessary to make sure that won't ever disburse too early, and remember February is 28 days typically.
Separate Accounts for Other Recurring Expenses
It's a good budgeting idea to have separate accounts for different kinds of expenses. For instance, if you have a car payment or pay a tithe, you may want to establish accounts for those as well. If desired, these can all go to the same institution as you have your mortgage fund at or may go to a separate institution.
For instance, I have accounts at both Synchrony & CFG. At Synchrony, I have 9 separate checking or savings accounts. I use a separate account for my tithe & have free checks that automatically disburse by mail to my church for my tithe. If I used online bill pay, my church would be charged a few % for convenience. While it's very rare for me to have a car payment, I currently have one (<2% interest, vs my best bank account having >6% APY), and the funds for that and for my mortgage get parceled off right after I receive my regular paychecks, which helps for budgeting purposes and money management.