How to Get Your Finances in Shape to Buy a Home

You may be dreaming of buying a home, but are you financially ready? Keep reading to discover the essential steps to prepare for this major investment.

By getting your finances in order, you’ll not only increase your chances of securing a mortgage but also ensure a smooth, less stressful transition into homeownership.

Homeownership represents stability, a place to put down roots, and the freedom to personalize your space. It’s also a significant financial commitment. By getting your finances in order, you’ll not only increase your chances of securing a mortgage but also ensure a smooth, less stressful transition into homeownership.

Here’s a breakdown of key steps to get your finances ready for buying a home.

Important: The following are general guidelines and are not based on specific lending requirements.

Review Western State Bank’s mortgage checklist and start preparing for your home-buying journey!

Check and Improve Your Credit Score

Your credit score directly impacts the interest rates you qualify for. A FICO® Score of at least 620 is typically necessary to qualify for most home loans. Aim for a score of 780 or higher to unlock the best rates. Improving credit scores takes time, and starting early is crucial. Here are a few ways to boost your score:

Obtain your free credit reports. You’re entitled to a free annual credit report from each of the three major credit bureaus (Equifax, Experian, TransUnion) at AnnualCreditReport.com. Review the report carefully to identify any errors or discrepancies. If you find any inaccuracies, take steps to dispute and correct them promptly by contacting the credit reporting agency.
Commit to paying all your bills on time, every time. Late payments can affect your credit score. Setting up automatic payments helps ensure you never miss a deadline.
Manage your credit utilization ratio. This ratio measures how much credit you use compared to your total credit limit. Try to keep your balances below 30% of your available credit limits. Consider paying down existing debt to lower this ratio and improve your credit score.

Build an Emergency Fund

Life is full of surprises, and unexpected expenses can derail your homeownership dreams. To be prepared, it’s wise to have an emergency fund that covers three to six months of living expenses. Here’s how to start building yours:

Estimate your monthly living expenses and multiply by the number of months you want to cover (typically three to six).
Set aside a fixed percentage of your monthly income until you reach your emergency fund goal.
Keep your emergency fund separate from your other accounts to avoid temptation. Consider these options, which are all insured by the government up to $250,000 per depositor and offer easy access to your funds:

Savings Account
High-Yield Savings Account
Money Market Account

Having an emergency fund protects you from financial emergencies both before and after you become a homeowner.

Start Saving for a Down Payment

A traditional 20% down payment allows you to avoid private mortgage insurance (PMI) – which protects the lender in case of default – and it also significantly reduces the loan amount, and the total interest paid over the life of the mortgage. Consequently, a larger down payment can mean substantially lower monthly payments and long-term savings.

For many first-time homebuyers, saving a 20% down payment can seem daunting. Luckily, FHA loans and other government-backed programs can help you achieve homeownership with a smaller down payment.

FHA loans, insured by the Federal Housing Administration, are a popular option for first-time homebuyers. They require a minimum down payment of only 3.5%, making them easier to qualify for than conventional loans that typically require 20% down.

Many states offer down payment assistance programs specifically for first-time homebuyers. These programs can provide grants or low-interest second mortgages to help you bridge the gap between your savings and the down payment requirement. Find your mortgage loan officer at Western State Bank to hear about our FHA and first-time homebuyer offerings.

Here are ways to accelerate your down payment savings:

Explore high-yield savings accounts. These accounts offer a higher interest rate than traditional savings accounts, allowing your down payment to grow faster.
Consider low-risk investments with a short time horizon to potentially increase your down payment funds. Speak to a financial advisor to explore options suitable for your goals and risk tolerance.

Reduce Debt and Unnecessary Spending

Your debt-to-income (DTI) ratio is a metric that lenders use to gauge your ability to manage debt. Ideally, you want your DTI to be 36% or lower.

Calculate your DTI by dividing your total monthly debt payments (including your estimated future mortgage payment) by your gross monthly income.

To keep your DTI low, you may need to cut discretionary spending. Examine your budget and identify areas where you can cut back. Every dollar saved can be channeled toward your down payment. Consider reducing dining out, entertainment subscriptions, or expensive clothing purchases.

Develop a debt repayment plan to pay down existing debt. To maximize your savings, consider focusing on high-interest debts first.

Avoid Large Purchases

When you’re in the process of obtaining a home loan, it’s important to maintain your financial stability. Here are some activities to steer clear of during this sensitive period:

Postpone any significant expenses that aren’t necessary. Large transactions can increase your debt and alter your DTI, which lenders scrutinize closely.
Do not take out new loans. Applying for new credit, whether a car loan or a credit card, can lead to hard inquiries on your credit report and increase your overall debt burden.
Don’t cosign a loan. Cosigning for someone else’s loan can be risky during this time, as it could be counted against your DTI if that person fails to make payments.
Hold off on major financial moves. Any substantial financial changes can raise red flags for lenders, who prefer a stable and predictable financial history.

Calculate How Much Home You Can Afford

Don’t get carried away by the allure of impressing friends and family with a large home and high-end finishes. A crucial aspect of responsible homeownership is ensuring that your monthly housing costs, including mortgage payment, property taxes, homeowners insurance, and homeowner association (HOA) fees (if applicable) stay within your budget. Ideally, these combined housing costs shouldn’t exceed 28% of your gross monthly income.

While online mortgage calculators can provide a general estimate, it is highly recommended that you consult a mortgage professional for a tailored assessment. They can consider your financial situation and may be able to pre-qualify you for a loan amount that aligns with your budget and long-term financial goals. Remember, affordability is key – you want a home you can comfortably afford without sacrificing your overall financial well-being. Take a look at our Rent Vs. Own Calculator to see if buying makes sense for your situation.

Get Pre-Qualified for a Mortgage

Pre-qualification offers an estimate of how much you can borrow based on basic financial information. To get pre-qualified for a mortgage, you will answer some questions about your finances. Based on the information you provide, the lender will tell you approximately how much you can afford to borrow to buy a home. This will help you focus your house hunting on affordable homes and strengthen your position as a serious buyer in a competitive market.

Gain advantage over other buyers and apply to get prequalified with Western State Bank.

Practice Your Homeownership Budget

With the information you receive from the pre-qualification process, you can do a practice run for your future monthly budget. Here’s how to get yourself in the “homeowner mindset”:

Calculate your anticipated mortgage payment, including principal, interest, property taxes, and homeowners insurance. Deduct your current housing costs, such as rent, from this amount. Adjust your spending habits to ensure you are saving an amount equal to or greater than the difference between your current housing costs and your estimated future housing costs. Allocate these savings for your down payment. This will not only boost your savings but also help you adapt to the financial realities of homeownership.

Keeping an eye on your spending allows you to identify areas for improvement. Use budgeting apps or a simple spreadsheet to track your income and expenses. Analyze your data and identify opportunities to cut back on unnecessary spending.

Embrace a “needs vs. wants” mentality. Distinguish between needs, like groceries and utilities, and wants, like daily lattes or weekend getaways. Prioritize needs and allocate remaining funds toward your down payment or future homeownership expenses.

Taking the Next Step

The journey toward homeownership requires planning, commitment, and focusing on your financial well-being. By following these steps, you’ll be well on your way to achieving your dream. Remember, a strong credit score, an adequate emergency fund, a manageable debt load, and smart savings habits are the cornerstones of a successful home purchase.

If you have questions or concerns about preparing your finances to buy a home, reach out to our mortgage experts at Western State Bank.