If you want to buy a home in the next year, now is the time to start prepping your finances. Why so soon? Because becoming a homeowner is a process—and the more prepared you are financially, the smoother that process will be. Plus, you’re much better off discovering today that your budget can’t comfortably handle the expense, or that your credit score needs improvement, than after you’ve found your dream home. Here’s how to get started.
Having a lot of debt can negatively affect two of the most important factors mortgage lenders consider: your credit score and your debt-to-income ratio (DTI), or the percentage of your monthly pre-tax income that goes toward paying debts.
If you suspect your debt load could come between you and the perfect house, start aggressively paying it down. Paying off debt can improve your DTI as well as your credit score as it lowers your debt-utilization ratio, or the amount you owe compared to the amount of credit you have, which counts for 30 percent of your credit score. While you’re at it, look for other quick credit-boosting wins, like disputing any errors on your credit report, setting up automatic bill payments to ensure you never miss one and refraining from closing old accounts in good standing.
The payoff? Lowering your debt-to-income ratio will allow you to qualify for ‘more house,’ and raising your credit score helps you qualify for a lower interest rate, explains Nate Gafken, a senior loan officer with The Gafken Group at Hanover Mortgage.
New home expenses add up fast. In addition to a 20 percent down payment (which helps you avoid private mortgage insurance), you’ll also need cash to cover “extras” like property taxes, insurance and homeowners association fees. So make sure you factor those into your calculations.
And don’t forget closing costs, which can be tough to estimate, says David Davidson, a specialized buyer’s agent in Greenville, S.C. Research if sellers in the neighborhoods you like are willing to pay the closing costs for buyers, a possibility in a buyers’ market. If not, prepare for the reality that those costs could be your responsibility.
With all these costs in mind, you may want to amp up your savings efforts and aim for the higher end of what you might pay. Before I bought my house in 2013, I saved thousands by setting up automatic savings transfers and picking up a side gig as a freelance writer. But there are plenty of other smart strategies, from negotiating your cable, phone and auto insurance bills to taking advantage of cash bonuses (sometimes up to $300) offered by banks in exchange for opening a checking account.
An awesome real estate agent can make a world of difference in your home buying experience. “It’s important to trust your agent,” Davidson says. “Keep in mind they don’t just find a house. An agent also negotiates on your behalf, provides real estate advice on how to win a home and can guide you through every part of inspections, appraisals and repair requests.”
It’s also helpful to have a good relationship with your mortgage broker, as he or she will work with you to assemble important financial documents and answer questions about special assistance or programs. So vet carefully.
It’s also never too early to look up potential lenders and get a feel for interest rates. Many first-time buyers start by requesting a quote from their primary bank (I did), and then shop around using comparison tools like LendingTree and Bankrate and asking family and friends for referrals. Davidson says that while some of his clients have found great rates at banks, others have scored deals with credit unions—so diversify your search.
And pay careful attention to exact numbers. Rate differences may seem insignificant—sometimes just .25 percent or so—but calculated over the life of a 30-year loan, the lower option can save you thousands.
Remember those costs, like homeowners’ dues, utilities, taxes and insurance, you added up earlier? After you’ve paid off some debt and gotten a feel for interest rates, challenge yourself to a budget trial run to see how you’ll really deal with the added financial responsibility of owning a home.
Simply add up your estimated monthly costs (using a home mortgage calculator if needed), subtract your current housing expenses and then transfer the remainder to savings. Try this for a few months in a row.
If you realize this exercise leaves you feeling more financially stretched than you thought, think about putting your home-buying plans on pause for a while longer. Despite what you may have heard about capitalizing on low interest rates before they increase, know this: The best time to buy a home is when you’re financially, emotionally and mentally prepared.