How to improve your finances before your first mortgage

Key takeaways 

• You increase your chances of receiving favorable terms on a mortgage by strengthening your financial situation before applying.

• Lenders consider several factors when determining your creditworthiness, including your credit score, income and other assets, debts, the ratio of your debt to income, and work history.

• Increasing your savings, lowering your debt, and raising your credit score are all ways to improve your financial profile.

As a first-time home buyer, you may need more money saved up or income. However, this does not imply that you will not be eligible for a mortgage. Before you apply for a home loan, consider these three ways to organize your finances.

Which financial factors are taken into account when applying for a mortgage?

When are you truly prepared to take out a mortgage? A recent Freddie Mac study found that some indications could indicate the yes answer. Among them are: 

• Your credit score: According to the study, a credit score of 661 or higher puts you in the creditworthy category, one of the major determining factors for mortgage approval. Your readiness for a mortgage may be approaching if your score falls between 600 and 660, but it may not be there yet. You must prepare to take on more debt if your credit score is 599 or less.

• Your debt-to-income ratio (DTI): DTI is measured in two ways and is also essential. The front-end ratio should be 25% or less. It is calculated by dividing your projected monthly mortgage obligation by your monthly income. Your total debt, including student and auto loans, makes up your back-end ratio. This can be higher, but most lenders prefer it to be at most 36 percent, with 43 percent being the maximum.

• No bankruptcies or foreclosures: Your credit profile should have been free of these blemishes for the previous seven years.

• On-time debt payments: Any payments that are 90 days or more past due should not appear on your credit report.

How to improve your finances before getting a mortgage 

When applying for a home loan, the mortgage lender evaluates every facet of your credit and financial history to determine your risk as a borrower. This covers your work history, income, debt, savings, other assets, credit history, and score.

When these factors are combined, the lender can better determine whether to approve or deny you for a loan and how much. Here are three strategies to increase your chances of being granted the desired amount. 

1. Check your credit 

Examine your credit reports and scores well before applying for a mortgage. The three credit bureaus, Equifax, Experian, and TransUnion, offer free weekly credit reports (excluding credit scores) via AnnualCreditReport.com. The credit bureaus can provide direct access to your credit scores; your bank may occasionally provide this information. 

Look for mistakes in your reports, such as misspelled contact details. If you find an error, contact the reporting bureau to start a dispute claim. Note any late payments listed as well; this will assist you in determining areas that require improvement. 

The lender may consider the middle score when evaluating your mortgage application, considering your scores from all three credit bureaus. Although some loans allow for as low as 500 or 580 if you have other "compensating factors," such as significant savings, most mortgages require a minimum score of 620. Outside of the conforming loan limits, a credit score of at least 700 is needed for a larger loan. 

That said, borrowers with scores of 740 or above receive the best terms and interest rates. Continue reading if your score still needs to arrive. 

2. Work on your debt 

Making your payments on time—which you should already be doing—will help you raise your credit score. Nothing lowers your score more than overdue payments. Make an effort to pay all your bills on time in the months before you buy a house. It's time to get in touch with creditors or service providers if you're having problems paying them back so that you can set up a payment plan or get other help. 

In addition to keeping a track record of timely payments, begin making small payments toward any outstanding balances. There are numerous strategies to deal with them, such as: 

Less debt lowers your DTI ratio—the percentage of your monthly debt payments, including your estimated mortgage payment—about your gross monthly income, positively affecting your credit score. This is something that lenders consider when deciding how much to approve you for.

Most lenders look for a DTI ratio of no more than 45 percent, though some are stricter and cap it at 36 percent. It all depends on the loan program. Some are more accommodating and permit up to fifty percent. This DTI ratio calculator can help you determine your situation.

Finally, refrain from taking out any new loans. This will increase your debt, raise your DTI ratio, and lower your credit score. This is particularly true if you cannot make the extra payments or your credit utilization is already high.

3. Get serious about savings 

You'll need to have a sizeable down payment and closing costs saved up, in addition to general reserves for expenses like furniture or home repairs, unless you qualify for a no-down payment mortgage, which is becoming harder to come by outside of some government-guaranteed loans. This is all on top of an emergency fund that typically covers three to six months' living expenses. 

According to data analysts for real estate and property at ATTOM Data Solutions, the typical down payment for a house in the third quarter of 2023 was $35,050. The good news is that a conventional mortgage can be obtained with as little as a 3 percent down payment. Closing costs typically range from two to five percent of the purchase price, depending on where you're buying. In the most recent year for which data were available, 2021, the average closing costs nationwide were $6,905.

Start saving immediately, even if you still determine how much you can afford to pay for a house. The following are some tactics: 

• Transfer funds designated for the purchase of a home into a high-yield savings account.

• Eat less or avoid going out to eat and spend more frivolously.

• Terminate any unused subscriptions, services, or memberships.

• Sell any furniture or clothes that you no longer need or desire.

What happens if my finances don't get better?

Your income may constrain your ability to save or pay off debt. That's okay; this could indicate that you should put off buying a house or take more time to establish yourself professionally and increase your income.

Do everything you can to keep your credit score intact in the interim. Even if you cannot qualify for or afford a mortgage, you will eventually be able to do so if you maintain sound financial practices. 

FAQs

How much money should you have before buying a house?

The money you should have before purchasing a home is determined by your desired home size, budget (income and other commitments), and the cash you can afford to pay in full. You must have sufficient funds for the down payment and closing costs when purchasing a home. Having enough savings to cover unforeseen expenses and pay for moving is also critical.

How much are closing costs?

Usually, closing costs represent two to five percent of the principal amount of the mortgage loan.

How much money do I need for moving expenses?

The cost will depend on the number of belongings you need to move and the distance. Angi estimates that you should budget between $883 and $2,552 on average.

Is $50,000 enough to buy a house?

Not entirely, of course, but sufficient to make a down payment. The National Association of Realtors reports that in November 2023, the median sale price of a home was $387,600, and the average down payment was approximately 13 percent. A 13 percent down payment for the median-priced home would cost $50,388. Moving and closing fees are not included in that amount.

When should I start saving for a house?

It is best to begin saving for a home as soon as possible. However, to improve your DTI ratio and be eligible for a better mortgage rate, paying off some of your debt might be wiser before saving for a home if you have a lot of it.