- Before you start the homebuying process, make sure your credit and finances are ready for homeownership.
- This means taking the time to improve your credit if needed and paying down debt, which can help you get a lower mortgage rate.
- You should also aim to spend less than 28% of your monthly income on a mortgage payment.
For most people, buying a home takes some planning well in advance. Between all the money saving, credit improving, and decision-making that comes with purchasing property, it can take anywhere from a few months to many years for an individual to be ready to make the leap.
If you’re thinking about becoming a homeowner, there are some key steps to take before even starting the process. Here’s a step-by-step guide on where to start.
Step 1: Make sure you’re ready for homeownership
Before you embark on your journey to homeownership, you should make sure it’s the right move for you.
Determine whether it’s better for you to buy or rent
Whether it makes more sense to buy or rent will depend on your lifestyle and how rent costs in your area compare to mortgage costs. If you’re not sure which one is right for you, here are some questions to ask yourself:
- How long do I want to stay in my next home?
- Is rent rising in my area? If I continue renting, how much could my rent go up over the next few years?
- How does homeownership fit in with my other financial goals?
- Am I willing and able to save enough to cover a down payment and closing costs?
If you’re concerned about rising rent costs and you plan on staying in place for the next few years, buying a house might make more sense than renting. But if you think you might move somewhere else in a couple years, you’d likely be better off renting. Owning tends to be a better investment for those who plan to remain in the home for at least five years.
Understand the costs and responsibilities that come with owning a home
As a homeowner, when a pipe bursts, the heat stops working in the middle of the night, or the basement starts to smell suspiciously of mildew, you won’t have a landlord to call.
Taking care of a house can be expensive and time-consuming. You’ll need to do regular maintenance, such as changing the air filters, cleaning the gutters, and mowing the lawn, to make sure your home stays in good shape. And when things go wrong, you’ll need to make sure you can afford to get them fixed.
According to the Bureau of Labor Statistics, homeowners spent an average of $3,267 in 2020 on maintenance, repairs, insurance, and other expenses. How much you’ll spend will depend on a lot of different factors, including the age and size of your home. Be prepared to set aside between 1% and 4% of your home’s purchase price each year for repairs and maintenance.
Step 2: Get your finances ready for mortgage approval
If you plan on using a mortgage to purchase your home, you’ll need to make sure you meet the requirements for mortgage approval.
want to make sure you have the ability to repay the mortgage, so they’ll look at these key factors: your debt-to-income ratio, work history,
, down payment, and savings or other assets.
Start saving early
Even with a mortgage, you’ll still need a decent amount of cash to buy a home. Here are some of the main costs you’ll be saving up for:
- Down payment: Some mortgages and lenders allow down payments as low as 3% of the purchase price, while others will require larger amounts.
- Closing costs: There are a lot of different fees, taxes, and insurance costs that come with getting a mortgage and buying a home. These are known as closing costs, and they typically run between 3% to 6% of the purchase price, though average costs can vary quite a bit by state.
- Move-in expenses: It’s a good idea to set aside some cash for costs that pop up after you purchase the home and are preparing to move in, such as repairs, upgrades, or furnishings.
- Reserves: In some cases, your lender may require you to have a certain amount of reserves or savings that can be used to cover your monthly mortgage payment for a few months in the event that you lose your source of income.
On a $200,000 home, you’d need to save $6,000 for a 3% down payment, and between $6,000 and $12,000 for
. Saving that much is no small feat for most people, which is why it’s important to start early.
Look over your budget and determine how much you can afford to put toward your homebuying goal each month. Talk to others and see what strategies they used to save for a home. And if you have family or friends who want to help you out, sit down with them and find out how much they’d like to contribute. It might feel awkward, but you want to have a clear picture of how much you’ll need to save.
“Start having a conversation with everyone that would possibly be involved and understand where your funds will come from to avoid surprises,” says Lei Deng, CFA, CFP® professional, and financial planner with Core Planning.
Make sure your credit is in good shape
If you don’t tend to keep a close eye on your credit score, now is the time to start. You can use services like Credit Karma or Mint to view your score for free, with no impact to your credit.
To get a conforming mortgage, you’ll typically need a credit score of at least 620. FHA mortgages require scores of at least 580, though you can potentially go lower if you have a higher
You can improve your score by making on-time payments and keeping your credit utilization low.
“Consciously build up your credit line over time to lower credit utilization,” says Deng. “You can either get new cards or ask for higher credit limits from current credit card companies”
Pay down debt
Typically, you’ll need a debt-to-income ratio (DTI) that’s less than 43% to get a conforming mortgage, though in some cases you may be able to go up to 50%. To calculate your DTI, add up all your monthly debt payments and divide that number by your gross monthly income. Move the decimal point two places to the right to get your DTI percentage.
Paying down debt will help you lower your DTI. Deng recommends focusing on paying off your highest-interest debt first.
Step 3: Figure out how much house you can afford
The price range you can afford might be different than what your lender will approve you for. Don’t overspend just because you qualify for more money.
Try using the 28/36 rule
The 28/36 rule is a rule of thumb that says you should spend no more than 28% of your gross monthly income on housing expenses, and no more than 36% of your gross monthly income on all monthly debts you owe.
For example, if you make $5,000 a month, you shouldn’t spend more than $1,400 each month on a mortgage payment, or $1,800 on all your debts.
However, the 28/36 rule isn’t perfect for everyone. Find a ratio that works for you and doesn’t leave your budget stretched too tight.
“If you know your needs, you can potentially avoid comparing with others and/or buying houses that are too expensive for you,” Deng says.
Use a mortgage calculator
Once you have an idea of how much your budget can handle each month, play around with our free mortgage calculator to see what your mortgage payment might look like at different price points and down payment amounts.
Your estimated monthly payment
- Paying a 25% higher down payment would save you $8,916.08 on interest charges
- Lowering the interest rate by 1% would save you $51,562.03
- Paying an additional $500 each month would reduce the loan length by 146 months
If you see a house you like on Zillow or another home search site, plug the list price into the calculator to see what you might pay each month if you were to buy it.
Step 4: Familiarize yourself with your mortgage options
Learning about your mortgage options will give you a clearer picture of what you should be doing now to prepare for mortgage preapproval.
Learn about the main types of mortgages
The most common types of mortgages are:
- Conforming loan: What you might think of as a “standard” or “traditional” mortgage. This type of mortgage meets the requirements to be purchased by Fannie Mae or Freddie Mac.
- FHA loan: A mortgage backed by the Federal Housing Administration. These mortgages tend to be good for first-time or lower-income homebuyers, who often have lower credit scores or less money for a down payment.
- VA loan: A mortgage backed by the Department of Veterans Affairs. You can only get this type of mortgage if you’re a current or former member of the military who meets minimum service requirements, or if you’re a qualifying surviving spouse. These mortgages allow 0% down payments.
- USDA loan: Another 0% down payment mortgage. These mortgages are backed by the Department of Agriculture and are only available to lower-income borrowers in rural or suburban areas.
- Jumbo loan: A mortgage that exceeds the borrowing limit for conforming mortgages set by the Federal Housing Finance Agency. To qualify for one of these mortgages, you’ll need a good credit score and a sizable down payment.
The type of mortgage that’s best for you will depend on your credit score, your DTI, and how much you can put down.
Weigh ARM vs. fixed
You’ll also want to determine whether you prefer an adjustable-rate mortgage (ARM) or a fixed-rate mortgage.
Most ARMs have a fixed period, after which your rate will adjust periodically. For example, if you get a 7/1 ARM, your rate won’t change during the first seven years you have the mortgage. After that, it will adjust each year.
ARMs often have lower starter rates, but they’re riskier because you could end up with a larger monthly payment than what you started with once your rate adjusts.
Fixed-rate mortgages provide more stability. With a fixed rate, your interest rate will never change while you’re paying off your mortgage. The trade-off is that fixed rates are typically higher than adjustable rates.
Think about what term length is right for you
The most common mortgage term is 30 years. With a 30-year mortgage, it would take 30 years for you to pay off the mortgage in full. Though most people end up paying off their mortgage early when they sell or refinance, having their payments spread out over such a long period allows them to have lower monthly payments.
Shorter terms, like 15-year mortgages, have higher monthly payments, but lower rates and less paid in interest over the life of the loan.
The right term length for you will depend on your goals and what your budget can handle. If saving money in the long run, is important to you, a shorter-term loan will likely be preferable. But if you need to keep your monthly payment as low as possible, a longer term is going to be a better fit.