Buying a home is a milestone and an achievement, but if you plan to apply for a mortgage, you need to get your finances ready in advance. Getting a mortgage can be hard if you’re not ready, and successfully paying it off can be even harder. You’ll have better luck with lenders and handle the monthly payments better if you’re sure you’re ready before you apply for a mortgage.
You need to make sure your credit is as good as you can make it in order to qualify for lower interest rates on your loan. You need to pay off as much of your debt as you can so that lenders will be comfortable giving you a monthly mortgage payment to take on. And you’ll need to save lots of money – not just for a down payment, but also for closing costs, inspection fees, and emergency repairs that your new home might need after you move into it.
Check Your Credit
The very first thing you should do to get ready for a mortgage is check your credit. If you want to get a conventional loan, most lenders are going to want to see a credit score of at least 620. A higher credit score will also mean lower interest rates, which can save you tens of thousands of dollars over the life of the loan. There are online calculators available to help you figure out what your interest rate will be and how much money you could save, based on your credit score.
If your credit isn’t great, that doesn’t necessarily mean you can’t buy a house. You can get an FHA home loan with a credit score as low as 500 if you’re willing to put 10 percent down. If your credit score is at least 580, you can get an FHA home loan with as little as 3.5 percent down. Some government-backed loans, like the U.S. Department of Agriculture (USDA) loans or the Veterans Benefits Administration (VA) loans, don’t even have minimum credit score requirements.
However, you’ll still get better interest rates if you can improve your credit. Dispute any inaccuracies in your credit report. If you have unpaid items in collections, try to pay them off or at least settle the debts. Make your debt payments on time. Have a mix of different credit accounts in your name – for example, installment loans like car loans or student loans, as well as revolving credit like credit cards. Hold off on opening any new credit accounts right before you apply for a mortgage, as these will generate hard inquiries that will lower your credit score somewhat.
Pay Off Debt
Paying off debt, especially credit card debt, can boost your credit score by improving your credit utilization ratio, or the amount of your total available credit you’re actually using. It’s also important to pay off as much of your debt as possible before you apply for a mortgage. It’s not that you can’t have other debt payments, but lenders will look at your debt-to-income ratio (DTI) to figure out how much of your monthly income goes to paying debt. They use this information to help them see how a mortgage payment would fit into your debt picture, and to determine how likely you are to be able to make the monthly payments. You need a DTI of less than 43 percent, but the lower your DTI, the less of a risk you’ll seem to lenders.
Save Plenty of Money
You should save up as much as you can for a down payment, because if you make a down payment of less than 20 percent, you’re going to have to pay for private mortgage insurance (PMI), and that will increase your monthly payment. A larger down payment will also mean having more equity in the home right away. But buying a house costs a lot more than the down payment.
You’ll also need to cover closing costs, which can be three to six percent of the purchase price of the house. You’ll need to cover inspection fees, which can be more than a thousand dollars. Once you have the house, you’ll need money in savings to handle any emergency repairs that crop up – and Murphy’s Law says that there’s going to be one immediately after closing.
If you know you’re going to want to apply for a mortgage eventually, start preparing your finances now. You can’t take too much time to pay off debt, save money, and raise your credit score. In the end, it could mean the difference between getting your dream house or not.
