October 2, 2020
If you’ve decided to buy a home, congratulations! You have an exciting road ahead of you. It’s easy to get caught up in the anticipation and want to jump on things right away but try not to get ahead of yourself. It really does pay off if you make sure your finances are in order well before you apply. Things like getting your credit score up and your overall (debt to income ratio) DTI down can take a few months to a year, but could save you thousands of dollars on your ultimate monthly mortgage payment.
Actually applying for a mortgage isn’t a lengthy process in and of itself, but it does take some legwork on the frontend to make sure you’re prepared and well-positioned to get the best rate you can.
If you enter the application process without being fully prepared, it could slow you down, or affect the rate your lender is able to offer. Having a good financial profile could help your application and probably relieve some financial stress in your life, a great side effect.
Your budget is the road map for your money each month. A budget is just a plan, not necessarily a restriction on spending. It’s a plan for what’s coming in and what’s going out financially each month. Once you’ve outlined your total monthly income, subtract your fixed expenses (things they don’t change from month to month like rent, utilities, medical insurance, etc.), create a savings plan, and “budget” the rest - maybe you have $200 left over to spend each week. Creating a budget comes easier to some than others, but getting in the habit of making one is a smart money move. Like any lifestyle change, creating healthy habits requires dedication and intention!
Creating a budget for yourself can help if you have debt to manage, are trying to cut expenses, and can help you prepare for including a monthly mortgage payment into your monthly spending. Making a budget doesn’t need to be fancy or complicated - a simple spreadsheet will do, but there are plenty of apps and services out there to help you get organized. It comes down to knowing how and when to cut expenses, categorizing your spending by fixed and variable expenses and creating goals.
Having money in the bank is part of feeling financially secure. You never know when your car is going to break down or you might have to make a visit to the ER. A good rule of thumb when building an emergency fund is to have around 3-6 months of normal living expenses available.
When you’re applying for a mortgage, lenders like to see ready cash as part of your financial profile. Not living paycheck-to-paycheck, but having available cash lets lenders know that you’re responsible and will be able to pay your mortgage payments each month. You’ll be less of a risk for them as a borrower.
If you’re sticking to your budget and have an emergency fund, you should be more than able to pay all of your bills on time. Make a list of all of your monthly bills to include in your budget. Checking your active subscriptions (or reviewing your credit card activity) is also a good way to reveal those pesky trial versions you signed up for and forgot to cancel and now you’re unknowingly paying for each month
When budgeting, pay your bills first before moving onto variable expenses and “fun” purchases, or even paying off debt. If you have credit card debt, make sure you’re at least making the minimum monthly payment (more if it fits into your budget). Late or missed credit card payments can have negative effects on your credit score, ultimately impacting your mortgage application.
After you pay for all of the essentials each month, create a plan to pay off any debt you have. It’s OK to have some debt and there are even good kinds of debt. Lenders aren’t going to deny you a mortgage if you’re still paying off student loans or have some credit card debt. But you need to make sure you have a handle on your debt and you have a payment plan.
Analyze and prioritize your debt. What kind of debt do you have: consumer, auto, medical, student loans? Put them in order by overall amount and consider monthly minimum payments. One approach is to tackle the smallest one first so you can just eliminate it from the list. In preparation for a mortgage application, you want to lower your debt-to-income ratio (DTI) which can be found by dividing your monthly debt by your monthly income. You can lower this number by decreasing your debt and/or increasing your monthly income! Another approach is pay off highest interest rate debts first.
A full 45% of millennials have a retirement account and 33% are actively contributing to it, according to an Insider and Morning Consult survey. Saving for retirement is a practice that helps develop smart money habits all around. And the earlier you start saving, the more you’ll accumulate thanks to compound interest in the long run. Remember, it’s never too late to start! Many employers will offer 401(k) options and even match your contributions annually - a great perk to take advantage of if it’s available to you.
Because saving for retirement isn’t a bill we have to pay, it can sometimes get shifted to the backburner. But really, retirement savings should be a priority, not an afterthought. And while your retirement savings account won’t necessarily directly impact your mortgage rate or application, it shows lenders that you’re financially responsible, are thinking ahead, and have a diversified portfolio. Retirement savings accounts contribute to the liquidity of your financial profile, a plus for your application!
This is something you want to do early in your preparation for a mortgage application because it can let you know where you’re at and how much work you need to do before submitting an application. Ideally, you should check your credit score about 12 months before you plan on applying for a mortgage. There are a few different ways to check your credit score depending on what credit card you have or going through a service. If your credit score is lower than you’d like, you can make a plan to improve it before you talk to your lender.
You can improve your credit score by paying your bills on time, paying off your debt, keeping your credit card balances low, don’t close any credit cards, and limit the opening and application of new credit cards (it results in multiple inquiries which temporarily ding your score). There are no shortcuts to improving your credit score, but, depending on what delinquencies you have on your account, and if you start making positive changes right away, time will be on your side.
Remember, you’re entitled to one free credit report each year, and may receive other offers through different companies and apps. But checking your credit score too often can also result in a slight decrease in your score. Learn more about how credit is important in the mortgage application process here.
Being prepared is a good practice to get in the habit of whether you are considering purchasing a home. And once you become a homeowner, you’ll need homeowner’s insurance to protect from potential damages and losses. Most lenders actually require that you have homeowner’s insurance - learn more about that in our article.
Until then, make sure that you have things like car, health, and renter’s insurance to protect yourself from unexpected issues. Having something like life insurance can actually help your mortgage application because it’s considered a liquid asset, a plus for your financial profile.
Having good personal finance habits will carry over in how you manage your money as a homeowner. Some people developed good budgeting habits early, while others experience more of a learning curve. Don’t get down on yourself if you have a lot of work to do! Instead, make a plan and break it into manageable steps. It’s never too late to start saving money or creating a budget. Once you’ve cleaned up your financial profile, you’ll find the mortgage application process to be much quicker, easier, and hopefully stress free!