How to Get Your Finances in Shape to Buy a Home
Homeownership represents stability, a place to put down roots, and the freedom to personalize your space. It’s also a significant financial commitment. By getting your finances in order, you’ll increase your chances of securing a mortgage and having a less stressful transition into homeownership.
Here’s a breakdown of key steps to get your finances ready for buying a home.
Important: The following are general guidelines and are not based on specific lending requirements.
Check and Improve Your Credit Score
Your credit score directly impacts the interest rates you qualify for. While not typically necessary to qualify for a mortgage, a score of 740 or higher can unlock the best rates. Improving credit scores takes time, so start early.
- Obtain your free credit reports. You’re entitled to free annual credit reports from AnnualCreditReport.com. Review your reports carefully and dispute any inaccuracies with the credit reporting agency.
- Commit to paying all your bills on time, every time. Late payments can affect your credit score.
- Manage your credit utilization ratio. Try to keep your balances below 30% of your available credit limits. Consider paying down existing debt to lower this ratio.
Start Saving for a Down Payment
A traditional 20% down payment allows you to avoid private mortgage insurance (PMI) and it also significantly reduces the loan amount, and the total interest paid over the life of the mortgage.
But for many, saving a 20% down payment can seem daunting. Luckily, there are programs that can help!
- FHA loans, insured by the Federal Housing Administration, are a popular option for first-time homebuyers. They require a minimum down payment of only 3.5%.
- Some states and localities also offer down payment assistance programs.
Reduce Debt and Unnecessary Spending
Lenders use your debt-to-income (DTI) ratio to gauge your ability to manage debt. Ideally, you want your DTI to be 36% or lower.
Calculate your DTI by dividing your total monthly debt payments (including your estimated future mortgage payment) by your gross monthly income.
To keep your DTI low, you may need to cut discretionary spending and focus on paying down existing debt.
Avoid Large Purchases
When you’re in the process of obtaining a home loan, it’s important to maintain your financial stability.
- Postpone any significant expenses that aren’t necessary.
- Do not take out new loans or open new credit cards.
- Don’t cosign a loan.
- Hold off on major financial moves.
Calculate How Much Home You Can Afford
A crucial aspect of responsible homeownership is ensuring that your monthly housing costs, including mortgage payment, property taxes, homeowners insurance, and homeowner association (HOA) fees (if applicable) stay within your budget. Ideally, these combined housing costs shouldn’t exceed 28% of your gross monthly income.
While online mortgage calculators can provide a general estimate, it is highly recommended that you consult a mortgage professional for a tailored assessment.
Get Prequalified for a Mortgage
Prequalification offers an estimate of how much you can borrow based on basic financial information. To get pre-qualified for a mortgage, you will answer some questions about your finances. Based on that information, the lender will tell you approximately how much you can afford to borrow for a home. This will help you focus your house hunting on affordable homes and strengthen your position as a serious buyer in a competitive market.
Practice Your Homeownership Budget
With the information you receive from the pre-qualification process, you can do a practice run for your future monthly budget.
Calculate your anticipated mortgage payment, including principal, interest, property taxes, and homeowners insurance. Deduct your current housing costs from this amount.
Adjust your spending habits to ensure you are saving an amount equal to or greater than the difference between your current housing costs and your estimated future housing costs. Allocate these savings for your down payment.
Taking the Next Step
The journey toward homeownership requires planning, commitment, and focusing on your financial well-being. By following these steps, you’ll be well on your way to achieving your dream.
If you have questions or concerns about preparing your finances to buy a home, please contact our mortgage lenders.