How to Prepare to Buy a Home
You’re ready to take the plunge and become a homeowner – congratulations! Before jumping in headfirst, you should take five simple steps to make sure you’re ready.
By following these five steps, you’ll be well on your way to affording to buy your dream home.
Improve your Credit
Before applying for a mortgage, make sure your credit score is as high as possible. Pull your free credit reports here and see what you can fix, such as:
Bring late payments current
Pay credit card balances down to 30% or less of the credit line
Take care of collections
Dispute any errors or mistakes on your credit report
2. Determine What Mortgage Payment you can Afford
Eventually, you’ll get pre-approved by a lender to see how much they’ll lend you, but lenders often pre-approve borrowers for more than they’re comfortable spending. Before you apply for a mortgage, have a number in mind.
Revisit your budget and see how much room you have for a housing payment. If you rent now, are you comfortable with that payment? What if it was higher? Figure out what payment you’re comfortable with, and keep it in mind as you work through the process.
3. Determine your Debt-to-Income Ratio
Your debt-to-income ratio compares your total monthly debts to your monthly income. Your DTI includes minimum credit card payments, installment loans, new mortgage payments, and student loans. Ideally, you shouldn’t spend more than 43% of your monthly income on your expenses.
To calculate your DTI, divide your total monthly bills by your gross monthly income, including the estimated mortgage payment you can afford. If it’s over 43% with an estimated mortgage payment included, pay some debts down or off to lower it.
4. Calculate your Down Payment
If you’ve already been saving for a home, determine how much money you have and how much you’ll use to invest in your home. The down payment is money you put toward the house, and you finance the rest. With the down payment, you’ll pay closing costs 2% - 5% of the loan amount, so figure it into your budget.
At the least, you’ll need 3.5% down on a home, but anything higher is always welcome as it lowers your monthly payment and reduces your risk of default.
5. Get Pre-Approved
Once you’ve set yourself up and know what you can (or want) to afford, get pre-approved, a pre-approval is the lender’s way of evaluating your qualifying factors to determine what you can afford.
The lender will look at your paystubs, W-2s, tax returns, and asset statements. They will compare your income, assets, and liabilities to each program’s requirements to determine how much you can afford.
Preparing to buy a home can happen months or even years before you actually do it. The more prepared you are with good credit, a sizeable down payment, and a low debt-to-income ratio, the easier it is to get approved for the home of your dreams.