A Guide to Understanding Your Financial Health

Understanding financial health is a crucial step—some may argue the most critical step—in getting a mortgage. The thing to always remember with mortgage applications is: that the mortgage lender is a risk assessor. They will want to know whether lending a large sum of money to a potential borrower is a sensible decision. A home buyer’s primary way of proving that being given a mortgage won’t be too risky for the lender is by demonstrating that they have good financial health. 

But what is financial health? What are its essential components, and how can it be improved?

What is financial health?

Financial health is the current state of a person’s finances in relation to how it affects their day-to-day living. It includes every aspect of someone’s personal finances, from mortgage repayments to all other debt and income, to living expenses and savings. 

The term ‘financial health’ is used because it affects a person’s whole life, especially their physical and mental wellbeing. Poor financial health has been linked to poor physical and mental health. In contrast, good financial health (not necessarily vast amounts of wealth) has been linked to greater levels of happiness and physical health.

Although most people know whether they’re in good physical and mental health, it can be easy to forget how financial health will impact these essential life parameters. So, the key takeaway here is that it’s important to pay attention to financial health not for its own sake but for one’s overall wellbeing. 

How does financial health work?

Again, there is a simple answer: it’s being able to cover both expected and unexpected expenses. While most people are reasonably good at budgeting for everyday expenses, many are caught off-guard when unexpected expenses arise. An unexpected medical bill, legal fees, or even the cost of an unexpected move can plunge a person into debt if they’re not prepared. 

This is part of why savings are crucial to good financial health. However, it’s not all about being able to plan for negative experiences. A financially healthy person can enjoy a nicer vacation, a dream wedding, or whatever positive experiences require more financial investment than the more humble day-to-day pleasures like eating out. 

Financial health can improve a person’s resilience overall and will help them make better decisions in a time of crisis or during a significant life event. In other words, financial health protects one against the inevitable unknown stressors and challenges that are a normal part of life. Being financially healthy will make the psychological and physical stress of life’s challenges that little bit less impactful. 

However, being able to cover large or unexpected expenses is only part of what makes up financial health. Other things to consider are:

  • Whether one’s debt levels are manageable: for example, being able to repay a credit card in full each month. Struggling with living expenses after all monthly debt repayments indicates poor financial health.
  • Whether one is living within one’s means: that is, spending less than one earns each month.
  • Whether one qualifies for financial assistance if needed: Based on one’s current credit score, would they get a loan from a bank/mortgage lender at a reasonable rate? 
  • Does one have multiple loans they have trouble keeping track of: Does someone have many credit cards or just one or two loans they have no problem keeping track of?

These are all things to consider when working out financial health. If someone has never thought about their financial health, it may take time to form a habit of thinking about it and doing this regularly.

How to work out and improve financial health

There isn’t a precise method for working out financial health. There is no hard and fast formula for calculating financial health. If one’s finances are complex, it may be easier to hire an accountant or a financial advisor. For most of us, though, zooming in on these areas is always an excellent place to start:

  1. Monthly outgoings compared to monthly income. Knowing how much comes in and how much comes out is the first step to working out financial health. If one is spending so much that they aren’t able to save, they will need to find areas where they can reduce spending.
  2. What is their debt-to-income ratio? Someone’s DTI (debt-to-income ratio) is the percentage all of their monthly debt repayments take from their monthly income. The DTI is very important if someone is planning on getting a mortgage, as lenders use it to assess the risk levels of borrowers. However, the DTI is also helpful for working out one’s financial health. Deducting loan amounts from one’s monthly salary will determine how much is left for living expenses.
  3. Emergency savings: As previously discussed, unexpected expenses can suddenly plunge someone into debt. Committing to saving even a little each month can help build up a savings pot within as little as a year. Even if it’s small, it’s much better than nothing. 
  4. Credit score: Anyone planning on buying a home needs a good credit score. One’s credit score always affects the type of deal they’ll get on their mortgage – and a bad credit score can result in a rejected mortgage application. If a would-be homeowner is in trouble with their credit card balances, they can help their situation by transferring their credit card balances to a zero-percent credit card. This will reduce the amount of interest that needs to be repaid.
  5. Is there a retirement fund? This may be boring to think about for someone who is still young, but it’s never too early to plan for retirement. Paying attention to the retirement package that comes with one’s job is essential. It may be possible to get more out of it by agreeing to contribute more each month. Many employers will then match employee contributions, increasing the overall amount of retirement savings one has. Self-employed first-time homebuyers should look into private pension schemes and commit to monthly contributions they can afford based on their current income.

This simple five-point plan will allow one to work out and improve their financial health. Remember: financial health is never separate from the rest of one’s life. So looking after it in the same way one looks after their physical and mental health is crucial. Being in good financial health is also essential for a first-time homebuyer. Looking for a first home is often a stressful and time-consuming experience; the last thing someone worries about while house hunting is their financial health or whether they’ll be approved for a mortgage.

It’s also important to know that many real estate agents will want to see an agreement in principle from a mortgage lender before they even show someone a property. Getting such an agreement from a lender will put a homebuyer in a stronger position to negotiate a home purchase. It will also put them in the right frame of mind when looking for their dream home.

Does financial health affect the chances of getting a mortgage?

Yes. It’s the most critical factor lenders will consider when deciding whether to approve a mortgage application, how much to lend, and what deal they can offer. Working out what lender is best suited to a financial situation is not something a financial novice can do. It is strongly recommended to find an independent mortgage broker to help a homebuyer find a lender best suited to their level of financial health. An independent mortgage broker doesn’t work for any one lender but will be able to offer the best possible deals from all segments of the mortgage market. This is why many prefer consulting independent mortgage brokers rather than just asking for a mortgage from their bank.

An independent mortgage broker will review an applicant’s financial health and find their mortgage deals. It’s always best to ensure one is as financially healthy as possible before consulting a broker. Still, they may also be able to help one find a mortgage even if they have some financial problems. So long as the prospective homebuyer doesn’t have a poor credit score and can make improvements within several months, it’s still worth consulting a broker. A broker is not a lender, and speaking to them will not affect the chances of getting a mortgage.

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