From how to budget for a house to tips for paying less in interest, these six strategies for financial planning to buy a house are intended to set you up for homebuying success—they may also have a positive long-term impact on your finances.
If you're planning on buying a home, it's never too early—or too late—to get your finances in order. That's because the better your credit history and the bigger your down payment, the better your mortgage terms may be. This is particularly true for first-time homebuyers, who often require careful financial planning to buy a house.
While a slightly bigger down payment or the difference of a fraction of a percentage point may seem negligible on paper, these seemingly small numbers may sometimes have a significant impact over the life of your loan. For example, let's say you'll need to finance $300,000 over a 30-year period to purchase a home. If you were able to lock in a mortgage rate at 7% instead of 7.5%, you'd pay $36,625 less in interest over the life of your loan.
Simply put, taking time to prepare your finances before buying a house may do more than expand your borrowing options—it may also have a positive long-term impact on your personal finances.
When it comes to financial planning to buy a house, there are several steps you should take. With enough time and planning, these tactics may help you improve your financial picture before you start shopping for a home. Even if your credit is excellent, the following six steps may help ensure that you're on solid financial footing before you apply for a mortgage.
As you review these steps, you may find our glossary of common mortgage terms helpful.
Two key factors that lenders look at to determine whether they'll offer you a mortgage—and on what terms—are your credit score and your credit report.
Your credit score—which may range from 300 to 850—serves as a snapshot of your credit history and potential ability to repay debt. While criteria varies between mortgage lenders and may change based on the type of mortgage you're applying for, borrowers typically need a score above 620 to qualify for a conventional mortgage and a score above 700 to receive a more competitive interest rate.
Many prospective homebuyers wonder if it's possible to get a mortgage with a lower credit score. While every lender has their own underwriting criteria, know that there are borrowing options for individuals with lower credit scores. For example, government home loans—including FHA and VA loans—typically have more flexible criteria and more attractive terms for borrowers who don't meet the requirements for conventional mortgages.
Learn more about the difference between FHA and conventional loans.
Mortgage lenders may review your credit report to get a more comprehensive view of your credit history. They'll evaluate your current financial obligations—including account balances and payment history—to assess how well you've managed debt over time. They may also look for any negative marks, including a history of making late payments, any collections activity or a recent bankruptcy.
By federal law, you're entitled to receive one free report each year from the three largest credit bureaus—Equifax, Experian and TransUnion. You may request these reports at AnnualCreditReport.com. Review each report carefully, checking for blemishes or errors such as incorrect personal information, accounts that don't belong to you and inaccurate payment history.
If you find an error on one of your credit reports, you'll need to contact that credit bureau directly. You can file a dispute online or download a form to submit by mail. The bureau will investigate and report on its findings, typically within 30 to 45 days. You can learn more in the Federal Trade Commission's guide to disputing errors.
One of the most important things you can do to maintain a good credit score is to consistently pay your bills on time. However, if you've made mistakes in the past, there are other tactics you may implement to improve your credit score. For example, paying down credit card debt to reduce your credit utilization ratio may have a positive impact, particularly if you're currently utilizing more than 30% of your available credit. Likewise, you'll want to maintain a good credit mix and hold off on opening new accounts or closing existing ones.
It might take time for changes to be reflected on your report, so the sooner you start working on your credit the better.
See our guide to credit scores for more tips on improving your credit score.
Another factor that lenders consider is your debt-to-income ratio, or DTI , which is how much debt you have in relation to your income. You may calculate your debt-to-income ratio by totaling all your monthly debt payments and then dividing that number by your monthly pre-tax income.
Lenders may require that your total debt—including your housing costs—does not exceed 36% of your gross monthly income. While lenders will occasionally accept borrowers with a higher DTI —particularly if they have an excellent credit score or a large down payment, or if they're applying for an FHA loan—improving your debt-to-income ratio will increase your approval odds.
Some ways to reduce your DTI include reducing your debt, increasing your income or some combination of the two.
Given the combination of low housing inventory and high prices, it would be easy to spend more than you might be able to afford in today's housing market. That's why budgeting for buying a house—and sticking to that budget—is an essential part of financial planning to buy a house, particularly for first-time homebuyers.
To calculate how much house you may afford, you should have a clear understanding of your total debt and your estimated monthly mortgage. But how might you know how much a mortgage payment will be for a home you haven't purchased yet?
The truth is you won't know the precise amount until you begin actively shopping for a house and a mortgage. You may, however, make a reasonable estimate using a few different data sources.
Make a list of all your current debt, including student loans, car payments, credit card debt and calculate how much you spend each month on these obligations.
Visit popular real estate sites and review listings in your desired location for the type and size of home you may be interested in purchasing. Jot down any information regarding the cost of property taxes, homeowner association fees and the cost of home insurance, and use these to determine your potential monthly expenses for a home.
Research the current typical mortgage rate. While the actual rate you qualify for may differ slightly depending on your financial picture as well as local market and future fluctuations, these national average mortgage rates may be a useful reference point.
Use our home affordability calculator to calculate how much home you may afford based on the above estimates. The calculator shows your target purchase price and may give you a general idea of the monthly mortgage payment you may be able to afford.
While a smaller down payment shouldn't prevent you from achieving your goal of buying a home, know that when it comes to down payments, bigger is better. The reason is simple—the less you finance, the less you'll likely pay in interest over the life of your loan.
If you're unable to save up enough cash to pay for 20% of the price of a home, know that you’re not alone—and there are options available, which we've outlined in our guide to down payments.
However, it's important to note that if your down payment is less than 20% of the home's purchase price, you may be required to pay for private mortgage insurance, also known as PMI , which will increase your monthly payments.
Remember a down payment isn't the only savings you'll need to put aside. Closing costs—which often run between 3% and 6% of the amount of your loan—may add to the price of your home. If you're buying a fixer-upper, you'll want to save for renovation costs as well.
During the months leading up to buying a house, it's a good idea to avoid significant life changes. This includes changing jobs, starting a new business, making large purchases or opening new lines of credit. This is important because lenders look at the stability of your income to assess the risk of potential default. Taking on new debt or opening new lines of credit—and even closing credit cards that you don't use anymore—may all lower your credit score or impact your debt-to-income ratio.
Some changes to your financial situation may be unavoidable, but demonstrating relative stability in the months before applying for a mortgage is recommended.
Many first-time homebuyers don't think of contacting a mortgage banker until they're ready to apply for a home loan. In reality, the best time to reach out is when you first begin building your financial plan.
A mortgage banker may help you make informed choices about the type of loan that may meet your needs and educate you on what it takes to qualify for a mortgage. They may also provide insight into any first-time homebuyer programs or down payment assistance programs you may be eligible for.
Building a relationship with a mortgage banker early on may be one of the most helpful steps you take on the path toward homeownership. The first step is to find an experienced, helpful mortgage banker near you.
