How to improve your finances before your first mortgage

As a first-time homebuyer, you might have little income or savings to work with. That doesn’t mean you won’t qualify for a mortgage, however. Here are three ways to prepare your finances before you apply for a home loan.

What financial elements are considered in the mortgage process?

How do you know you’re really ready for a mortgage? There are some signs that might point to yes, according to Freddie Mac. These include:

• Your credit score: One of the biggest determining factors for mortgage approval is credit score. A credit score of 661 or higher places you in the creditworthy category, according to Freddie Mac. If your score is between 600 and 660, you could be close to being ready for a mortgage but not quite there yet. If your score is 599 or lower, you’re likely not ready to take on the additional debt.
• Your debt-to-income (DTI) ratio: DTI is also significant, and there are two measures. The front-end ratio, which compares your projected monthly mortgage obligation to your monthly income, should be, ideally, 25 percent or less. The back-end ratio — your overall debt, including auto loans and student loans, can be higher, but most lenders like it to be no more than 36 percent, with 43 percent as the max.
• No bankruptcies/foreclosures: Your credit profile should be free of these blemishes for at least seven years.
• Timely debt payments: Your credit report should also be free of debt payments that are 90 days or more overdue.

How to improve your finances before getting a mortgage

When you apply for a home loan, the mortgage lender reviews all aspects of your credit and financial profile to assess your risk as a borrower. This includes your credit history and score, employment history, income, debt and savings or other assets.

The strength of these factors helps the lender decide whether to approve or deny you for a loan and for how much. Below are three tips to boost your chances of getting approved for the amount you want.

1. Check your credit

Well before you get a mortgage, take a look at your credit reports and scores. You can obtain your credit reports (which don’t include your scores) for free each week from each of the three credit bureaus (Equifax, Experian and TransUnion) through AnnualCreditReport.com. You can get your credit scores directly from the credit bureaus; sometimes, your bank also offers a way to get the info.

On your reports, keep an eye out for errors, such as incorrect contact information. If you spot a mistake, reach out to the reporting bureau to begin a dispute claim. Take note of any late payments listed, as well — that’ll help you identify areas that need improvement.

When you apply for a mortgage, the lender may look at your scores associated with each of the three credit bureaus and base its decision on the middle number. For most mortgages, you’ll need a minimum 620 score, although some loans allow for as low as 500 or 580 if you have other “compensating factors,” such as substantial savings. For a bigger loan, outside of the conforming loan limits, you’ll likely need a credit score of at least 700.

That said, the best interest rates and terms go to borrowers with scores of 740 or higher. If your score isn’t there yet, read on.

2. Work on your debt

To improve your credit score, strive to pay all your bills on time. Nothing dings your score like late payments. If you’re having trouble making payments, now’s the time to contact creditors or service providers to arrange a payment plan or other form of relief.

Along with maintaining a history of on-time payments, start chipping away at any outstanding balances. There are many ways to tackle them, including:

• Debt avalanche strategy
• Debt snowball strategy
• Debt consolidation options

Aside from the positive impact on your credit score, less debt lowers your DTI ratio. Lenders take this into account when determining how much to approve you for.

It depends on the loan program, but most lenders look for a DTI ratio of no more than 45 percent, although some are stricter and cap it at 36 percent. Others are more flexible, and will allow up to 50 percent. You can use this DTI ratio calculator to get a sense of where you stand.

Lastly, avoid taking on any new loans. This will add to your debt load, which increases your DTI ratio and can potentially dent your score. This is especially so if your credit utilization is already high or you can’t handle the additional payments.

3. Get serious about savings

Unless you qualify for a no-down payment mortgage, you’ll need to be ready with considerable upfront cash. Here are some things to save for:

• Savings for a down payment – As of July 2024, the median down payment on a home was $60,202, according to ATTOM Data Solutions, an analyst of property and real estate data. The good news is that you can get away with putting down as little as 3 percent for a conventional mortgage.
• Closing costs – The amount of closing costs depends on where you’re buying, but they generally range from two to five percent of the purchase price. Nationally, the average closing costs were $6,905 in 2021, the latest year for which figures were available.
• Moving costs – Be sure to budget for moving costs as well, especially if you plan to hire a moving company.  
• General reserves – It’s a good idea to set aside a portion of money to pay for costs like furniture or home repairs.
• An emergency fund – This should equal about three to six months of your living expenses. 

Even if you don’t know your homebuying budget or how much house you can afford yet, start saving now. Here are some strategies:

• Put funds earmarked toward the home purchase in a high-yield savings account.
• Avoid or cut back on eating out and other discretionary expenses.
• Cancel unnecessary memberships, services or subscriptions.
• Sell items you no longer need or want, such as clothing or furniture.

What if I can’t improve my finances?

Due to income, you might be limited in how much you can put toward debt or savings. That’s OK — this could simply mean you need to wait to become a homeowner or need more time to get established in a career and build your earnings.

In the meantime, do everything possible to maintain your credit score. If you can’t afford or don’t qualify for a mortgage now, with good financial habits, you’ll be able to in the future.

FAQs

• How much money should you have before buying a house?

  The amount of money you should have before buying a home depends on your budget (your income, your other obligations), how much home you’d like to buy and the amount of cash you can afford to pay upfront. When buying a home, you need to have enough money for a down payment and closing costs. It’s also important to have money for moving costs and enough savings as a cushion for emergencies.

• Is $50,000 enough to buy a house?

  Not outright, certainly, but it’s about enough to cover a down payment. The median sale price of a home in May 2024 was $419,300, according to the National Association of Realtors, and the average down payment is 15 percent as of 2024. A 15 percent down payment on the median-priced home would amount to $62,895. That figure does not include closing costs or moving expenses.

• When should I start saving for a house?

  The sooner you can start saving for a house, the better. But if you have a lot of debt, it may make more sense to pay down some of it before saving for a house to have a better DTI ratio and qualify for better mortgage rates.