How to Prepare for a Home Purchase
Buying a home will give you a place of your own, and it will also help you to build wealth as your equity in your home grows. If you are planning on buying a home, you need to learn how to prepare for a home purchase so that your finances will be in order when you find a home that you are interested in. There are three main financial objectives you need to accomplish to prepare for a home purchase: (1) maintain or improve your credit score; (2) reduce your debt-to-income ratio; and (3) save money for the down payment, closing costs, and other home-buying expenses.
#1 – Credit Score
Importance of a Good Credit Score
The critical thing to remember when buying a home is that your credit score is going to play a huge role in your ability to purchase a house. The current minimum FICO score to qualify for a mortgage is 620. Without a good credit score, you won’t even be able to qualify for a mortgage, which means that your dreams of owning will remain just that, dreams.
Having a credit score that is good enough to be eligible for a mortgage should be your starting point, but what you should be aiming for is attaining an excellent credit score because that will give you a better interest rate. The lower the interest rate that you get on your mortgage, the lower your payment will be. Lower interest rates will give you a lower monthly mortgage payment, and who doesn’t want a lower mortgage payment?
To check your credit score, see How to Check Your Credit Scores and Reports.
What Makes Your Credit Score So Important to Lenders?
Your credit score is important because it shows a lender what your financial history is like, and how responsible you are with your money. In the eyes of the mortgage companies, a higher credit score means your risk of defaulting on your mortgage is lower. This means that since you are a lower risk, lenders will compete for the right to be your mortgage provider, which means that you’ll get lower interest rates that someone with average credit. Now for the critical question, how do you improve your credit score?
How to Improve Your Credit Score
There are several things that you must do to help boost your credit score.
Make Sure Your Credit Information is Accurate
The first thing to do is to get a free copy of your credit report from all three credit bureaus. Check your credit reports for errors, late payments, and accounts in collection. These derogatory items are awful for your credit, and it may take a while to fix. However, you should start the credit repair process right away by doing the following:
- Dispute any inaccuracies you find on your reports.
- Catch up on all of your late payments. If you have a hard time making the payments, call your creditors to work out a payment plan that you can follow for each account.
- If you have accounts in collection, work with your creditors to resolve these collections and close out the accounts.
Pay Your Bills On Time
Make sure that you always pay your bills on time. Late payments and missed payments are reported to the credit bureaus, and this is a major red flag that will cause your credit score to drop. Paying your bills on time is important, and that’s why you should live on a budget to ensure that you always have the money you need to pay your bills on time.
Establish Your Credit History
If you don’t have much credit history, you’ll need to start working on it before you will be able to buy a home. Lenders are going to want to see a history of you borrowing money responsibly and paying it back on time. This doesn’t mean you should go crazy and start getting a bunch of credit cards. What it does mean is that you should get a credit card or two, make a few purchases with the cards, and pay your bill on time.
Lower Your Credit Utilization
The balance you owe compared to the credit limit you have is called credit utilization. For example, if your credit limit is $10,000 and your balance is $8,000, your credit utilization is 80%, and that is way too high! — not to mention $8,000 is a lot of money to owe. To improve your credit, you need to keep your credit utilization low by doing these two things:
- Pay down your debts and keep your balances low.
- Ask for higher credit limits on your existing lines of credit (this has a similar effect as paying down your debt)
Besides the main actionable ideas above, here are some additional things you can do to improve your credit score:
- Keep your credit lines open, especially older accounts. Do not close your unused credit card accounts.
- Do not open a new line of credit, unless you don’t have any credit history and need to establish one. In general, it is better to keep your credit accounts steady when you are about to buy a house.
- Report on-time payments for your rent, cell phone bills, and utility bills (some services let you do this if you need to boost your credit)
#2 – Debt-to-Income Ratio (DTI)
The second important factor that influences your ability to purchase a home is the amount of debt that you have. Your lender will analyze the amount of money you need to pay your debt each month and compare that to the income that you get — this is called the debt-to-income ratio, or DTI.
If you have a lot of debt, it shows that your spending habits are not as disciplined as they should be. Lenders want to see that a good portion of your income is not tied up in your bills. When they are deciding on your mortgage, they’ll want to make sure that you can afford the payments, and if you’re making a lot of monthly payments to creditors, it’s going to be harder for you to make those payments. So, if you want to buy a home, and you have a lot of debt, start working on paying down your debt as soon as you can. It might require some sacrifices, but in the end, it will be worth it.
The second half of the equation is your income. You can also reduce your DTI by increasing your income. To do this, you might try several things:
- Apply for a promotion at your current job.
- Work more overtime hours.
- Look for a higher paying job.
- Start a side job, e.g., driving Uber, work a part-time job, etc.
- Try other income ideas.
The maximum DTI ratio varies by the mortgage lender, loan program, and investor’s requirements, but the number generally ranges between 40-50%. If your DTI ratio is too high, it could disqualify you from accessing some of the more favorable loan programs.
#3 – Save Money for the Down Payment
One of the most important pieces of advice you will ever get is that you should start saving up money for a down payment on a home as soon as you can. Although there are plenty of loan programs that let you put less than 20% down, you should strive to save that 20% down payment along with about another 3% to pay for your closing costs and other expenses. To learn more, see How Much Money Do You Need to Buy a House?
For the average person, coming up with $60,000 to put down on a house isn’t something that they can do at the drop of a hat. This kind of money takes time to save up, so you need to start saving years before you plan on buying your home. Remember, the more money you put down, the lower your monthly mortgage payment is going to be, and putting down 20% or more has the added benefit of eliminating the private mortgage insurance payment.
The key to saving up a large down payment is starting early, and living on a strict budget where saving money is a priority. If that means skipping doing some of the things you might want to do, then that’s what you’ll have to do. It’s a sacrifice, but it’s a sacrifice that will be worth it in the long run. Additionally, you can also try to boost your savings by finding ways to make money on the side.
Here are some articles to help you save money for a down payment:
- 40+ Ways to Save Money, Lower Your Bills, and Cut Expenses
- 40+ Extra Income Ideas and Ways to Make Money
Start Talking with a Mortgage Company
Once you’re getting closer to buying a house, it’s a good idea to start looking at banks and other lenders. The sooner you start talking with lenders, the earlier you’ll have an idea of what kind of house you can afford.
A bank or mortgage company can run your credit and tell you if you qualify for a mortgage, how much of a mortgage you are eligible for, what your interest rate is, and how much money you will need to put down as a down payment. This is all useful information, and it’s information that you’ll need before you start looking at houses. The last thing you want is to find the home of your dreams, only to find out that it’s out of your price range. Here are some articles that further explain why it is essential to talk to a lender:
It’s also crucial that you shop around and at what different lenders are offering. A difference of only a fraction of a percent may not seem like much, but it can end up being a difference of thousands of dollars over the length of a mortgage. Once you find a reputable mortgage company that you can trust, they can help you to decide when the best time is to apply and get a mortgage rate locked in. Mortgage rates fluctuate, so if the rates drop and are expected to go back up soon, it’s a good idea to try to get your mortgage rate locked in before they go back up.
Find a Realtor that You Can Trust
The chances are that you have at least some idea of what you’re looking for in a home. You know the areas you’re interested in, what kinds of features are important to you, and what your price range is. While a general idea is a good starting point, it’s just that, a starting point. Your best bet is to work with a reputable realtor to start narrowing down your options and start looking at actual homes.
Realtors are professionals that excel at finding people houses that match up with their needs and budget. You could spend countless hours online looking for different houses, but that’s a tremendous waste of time. A much better option is to work with a realtor that can help you by providing different homes that you might be interested in. When working with a realtor, always remember that the final decision is yours. A good realtor should be supportive and offer advice; they should never try to push you into anything.
It’s easy to become discouraged when you start looking at all of the things that you’ll have to get taken care of if you want to own a home. You have to budget so you can pay down debt and save money for a down payment. You have to make sure that you aren’t late on any payments, and you have to maintain low balances on your credit cards. In other words, you have to behave financially responsibly, and that often means sacrificing the things you want to do today so that you can have a brighter future.
Owning a home is the American dream, and it means far more than just having a place for you and your family to live. A house will also act as a vehicle to help drive your wealth. Real estate has historically been one of the safest things to invest in, and as long as you take care of it, a house should appreciate in value over time.
If you can be patient, and follow all of the steps necessary to prepare for a home purchase, then one day, you can enjoy the benefits of homeownership.