How to Financially Prepare to Buy Your First Home
Home-buying season is coming up. With the warmer weather approaching, home buyers are eagerly waiting to find their dream place.
Since buying a house is typically the biggest purchase you’ll make, preparing your finances can give you a significant win. For example, if your credit score is high enough, you can get more competitive rates with mortgage lenders.
Besides saving up for the down payment, there are other costs with the home buying process.
If you’re looking to become a homeowner soon, let me show you how to prepare your finances so that you can get a better deal on your house and still have money left over for other expenses!
Buying a House: More Than Just the Down Payment
While most attention is given to getting a good-sized down payment ready, there’s more involved than just your mortgage payments.
Lenders are looking at factors like income, debt to income ratio, but a huge factor is also your credit score. Your credit score is based on your credit reports. You have three credit reports and scores from each of the credit bureaus – Experian, Equifax, and TransUnion.
Want the Best Rate? Boost Your Credit Score
While the exact algorithm isn’t publicly disclosed, we do know the key factors that go into calculating your score.
- 35% Payment History
- 30% Amount Owed
- 15% Length of Credit History
- 10% New Credit
- 10% Types of Credit
Looking at how things are weighted, if you want to make the biggest impact on your credit score, you need to focus on your payment history and keeping your debts in check.
Let’s see how you can improve them which can help you boost your score before you start your home search.
The first thing you need to do is to get a copy of your credit report and make sure that it is accurate. Believe it or not, there is a chance that your report may have a mistake. In fact, it’s been estimated that more than 20% have an inaccuracy on their credit report. While it might be a minor detail like a misspelled name, if there’s any error with your payments or if it shows an open account that isn’t yours, that can really hurt you.
Because of the pandemic, you can now get your credit reports for free weekly over at AnnualCredit Report.com. If you do find a problem, you can then file a dispute with the credit bureau. In the meantime, keep your payment history in tiptop shape by automating them using your bank or credit union’s bill pay system.
You also want to keep in mind since lenders are assessing your finances to make sure you can handle a mortgage, you’ll want to make sure that your debt to income ratio is fairly low. Paying down your high-interest debts can be a huge win. If they are credit cards, after you pay them off, you may want to keep the accounts open at least until after you’ve bought your house. Lenders typically look favorably for those who have unused lines of credit. If you want to avoid the temptation of using it, you can tuck away your credit cards in an inconvenient, but safe place around your house.
Figuring Out How Much House You Can (Comfortably) Afford
Now that your credit report is accurate and your score has improved, it’s time for the next step in preparing your finances – finding out how much house you can afford. Besides having your mortgage lender calculate how much you can afford, it is also wise that you run the number yourselves. Chances are you have other goals than just buying a house.
When we were house hunting for our first place, we ran the numbers and then we checked them against what the lender had. With their calculations, we could ‘afford’ a significantly more expensive house. We looked at our number again and quickly realized if we went with their maximum budget, we’d be able to buy a house, but nothing else.
You may be thinking the same way. You’d love to buy a house, but you also want some money left over to enjoy it and other goals. You won’t be able to achieve them if your budget is maxed out on your house. You need to see for yourselves what you’re comfortable with so you can be a homeowner and still hit your goals. So how do you find out how much house you can afford?
The rule of thumb is that you should try to keep your mortgage no more than 2 ½ to 3 times your annual income. Let’s say that your family’s annual income is $65,000. Using that guideline, you’d be looking at homes around $163,000 – $195,000. If you’re a family making $120,000, then you can enjoy hunting houses between $300,000 – $360,000 and still have some money left over for other dreams.
Once you know how much you need to save you can use features like Mint’s Goals to keep track of your progress with the down payment. I’ve noticed that having a visual reminder has motivated many families towards their goals. As you hit certain milestones, have a small celebration.
Why Your Down Payment Matters
One of the biggest reasons why’d you like a larger down payment is to avoid paying private mortgage insurance (PMI). That gives lenders and extra assurance with the money they’re lending, but it can be an unnecessary weight on you.
Start automating transfers into savings with each payment, even if it’s a smaller amount than you hoped. You can then beef up your down payments by redirecting any windfall income (like a bonus, stimulus check or tax refund) into your savings. Having a bigger stash can be a huge help when you buy your home!
Closing Costs: What You Need to Know
You’ve saved your down payment, found an agent, and have found your dream house. Your offer was accepted. Before you celebrate, keep in mind there are some more expenses that come with the closing process.
I pulled out the paperwork from when we were buying a house a few ago and here’s what I found:
- Home Inspection
- Homeowners’ Insurance
- Transfer Taxes
- Underwriting Fee
- Loan Discount Points
- Pre-Paid Interest
- Property Tax
- Pest Inspection
It probably seems like too much and to a degree, I can understand. Some of these fees are non-negotiable and while others aren’t. However, you want to be careful with which expenses you try to save on. Skipping a home inspection is not a smart move, even with a new build. Believe me, we’ve been there.
When we bought our first house, it was a new build and so we thought it would be fine to skip the inspection and save some cash. However, new builds don’t guarantee good work. We had small mistakes become big headaches and by the time we sold our place about five years later, we had to have all but one of the windows replaced.
Would the inspection help us catch all of these things? No, but it would’ve given us a clearer idea of expenses to expect. With our second house, we did get an inspection and not only did it help us understand what future projects we’d need to tackle, but we were also able to use it as a negotiation tool.
I hope these tips give you a jumpstart towards your goal of becoming a homeowner. I want you to buy a home that you love, but allows you to pursue all of your financial and family goals!