Five Steps to Prepare Your Finances for Buying a Home
Buying a home is one of the most complex and expensive transactions you’ll ever make. If you’re planning to take that leap in the next year or two, preparing your finances now can save you money and help you avoid unpleasant surprises. “Time is a gift,” says Avi Adler, a Realtor at Long & Foster Real Estate. Here are five steps to get you started. 
1. Do a Financial Checkup
Before you start hunting for your dream home, take a comprehensive look at your financial situation. Assess your income, savings, expenses, and debt. Calculate the percentage of your gross income you save each month, how much goes to housing, your debt payments (credit cards, car loans, student loans, etc.), and your discretionary spending (like travel, entertainment, dining out, and streaming services).
Mortgage lenders consider various metrics when assessing your creditworthiness, but a key factor is your debt-to-income (DTI) ratio. Ideally, you should spend no more than 43% of your gross income on housing and other debt, with 35% being preferable. Optimally, your housing payments alone shouldn’t exceed 28% of your income.
If your DTI is high, consider adjusting your budget. “Look at your budget and figure out what your priority is. Are there expenses you can cut because buying a house is a bigger goal for you now?” suggests certified financial planner Sara Zuckerman, founder of Reset Financial Planning.
2. Check Your Credit Reports and Credit Scores
Lenders also consider your credit history and credit score. Start by checking your credit reports from each of the three major credit bureaus (Equifax, Experian, and TransUnion) through annualcreditreport.com. This allows you to understand your current credit health and check for any potential fraud or inaccuracies. If you find errors, dispute them immediately, as the investigation can take up to 30 days.
Next, order your credit score, particularly your FICO score, which is most commonly used by mortgage lenders. You can get a free FICO score based on your Equifax report, or for $29.95, get scores based on each credit bureau’s reports, including those specific for mortgage lending.
Typically, a FICO score of 720 or higher gets you the best mortgage rates, while a score below 620 makes securing a loan more difficult. If you’re buying with someone else, the lender may consider the lowest score between you.
Your credit score can change with your credit behavior. Improving your score can significantly lower your mortgage payments, saving you hundreds of dollars a month.
3. Reduce Credit Card Debt
A key way to improve your credit score is to reduce your credit card debt. Pay off any balances you’re carrying and ensure future charges are paid off in full and on time each month. Avoid making large purchases or using a significant portion of your credit limit before seeking a mortgage. Even if you pay your credit card bill monthly, it may not be reflected in the score lenders pull up.
Use your credit card sparingly in the months leading up to applying for a mortgage. “Because there are many variables that affect an individual consumer’s credit score, we can’t say a specific number of months,” says FICO’s Joe Zeibert. “The advice we can give is to do your best to get your utilization as low as possible leading up to the purchase of your home.”
Additionally, avoid opening new lines of credit, like store cards, for at least a year before seeking a mortgage, as new credit lines can suggest financial stress.
4. Budget for a Down Payment, Closing Costs, and Post-Purchase Expenses
To reduce your monthly mortgage payment, aim to make as large a down payment as possible. Keep your down payment funds in a high-yield savings account or a very short-term CD to earn a reasonable return before you start home shopping.
While 20% of a home’s purchase price is the traditional down payment standard, if your savings fall short, explore other funding sources like gifts from family or state-based home-buying assistance programs.
Also, budget for closing costs, which might range between 2% to 4% of the purchase price. Paying these out of pocket is less expensive than rolling them into the mortgage. Some homebuyer assistance programs may cover a significant portion of these costs.
Lastly, plan for post-purchase living expenses. “Think through not just the mortgage but the costs after,” says Zuckerman. This includes all your bills, home maintenance, and utilities.
5. Get a Lender’s Perspective
Since lenders determine how much home you can buy and your monthly payments, get preliminary assessments from a few lenders. Eventually, you’ll need a mortgage pre-approval letter, but wait until you’re ready to shop in earnest, as pre-approvals are typically valid for only 60 to 90 days.
Bottom Line
Taking time to prepare your finances now can make your home-buying experience smoother and more affordable. Start with a financial checkup, monitor and improve your credit, reduce debt, budget for upfront and ongoing costs, and seek advice from lenders. These steps will help you make informed decisions and set you on the path to homeownership.
