Planning to buy your first home is an exciting step toward a more independent financial future. While it’s easy to get wrapped up in the details of searching for the perfect new residence, it is important to take the time to prepare. If you’re not particularly familiar with the home-buying process, you might be wondering, “What exactly is there to prepare?” You likely understand that there’s the down payment, closing costs, and a mortgage involved, but there are many financial factors at play that require careful decision-making.
Before you purchase your home, you need to think about the long-term trajectory of your income and financial stability, what type of home loan is best suited for your circumstances, how high of mortgage payment you can afford, and more. This guide will provide a general outline of how you can financially prepare for your first home, so you can enter this next chapter in the best position possible.
Make a Financial Preparation Checklist
Before you make any plans, you need to have a checklist you’re going to follow so nothing gets left out. Here is a basic list that you can further break up based on your personal situation:
- Evaluate your current financial position (FICO score, credit history, etc.)
- Create a budget (figure out how much home you can afford with your current income and how much you need to set aside to have enough for a down payment)
- Start saving (put money aside for a down payment and emergency fund)
- Work on improving your credit (the better your credit, the better mortgage terms you will receive)
- Find a home loan (research loan types, lenders, and qualification requirements—for instance, VA home loans offer many advantages for service members and their families)
Step 1: Evaluate Your Current Financial Position
If you consider yourself especially financially literate, you might be able to skip this step. However, for the majority of first-time homebuyers, taking a hard look at finances is one of the most important aspects of this process. At the surface, you will need to look at:
- Your credit scores
- How often you make late payments
- How much outstanding debt you have
- How much discretionary income you have
- What your spending habits look like
- Do you have a healthy savings account established?
- How much money do you need to buy a home?
The goal of this is to determine whether you are financially stable and identify areas that require your attention to get to where you need to be.
Step 2: Create a Budget
Now that you’ve identified the strengths and weaknesses of your finances, you can create a budget to help you get on the right trajectory for purchasing a home—it is the biggest financial investment you’ve made so far, after all.
If you haven’t created a budget before, it doesn’t have to be an elaborate process, but it does require attention to detail. To create a working budget that gives you a clear view for planning, you want to first list all of your expenses and all sources of income. Then, subtract expenses from income, giving you your discretionary income.
What you have left over can be split between saving and recreational spending. When you are getting ready to buy a house, the first should be your number-one priority. Your budget should also give you a good idea of how much you could reasonably afford for your monthly mortgage payment (if you are currently paying rent, that would be included in that estimate), and where you can cut expenses (which will help you save more).
Step3: Start Saving
Even if you have an ample savings account as a starting point that can go toward your down payment, there are a lot of other costs that need to be accommodated for. For example, closing costs can be thousands of dollars, and once you move in, you will be responsible for maintenance of repairs which can’t always be planned for over time.
In addition to closely following your budget, there are tools that can help you start or increase your savings, like apps that invest your spare change.
Step 4: Work on Improving Your Credit Score
Your credit score plays an important role in qualifying for a home loan and determining your mortgage payment. Even if you have a good credit score, it can usually be higher. There are several things you can do to potentially improve your credit score:
- Continue making payments on-time
- Pay down credit card balances
- Double-check your credit report for errors
In the months leading up to applying for a mortgage, you should also avoid making large purchases if possible, such as buying a new car. If you have a fair (mid 600’s) or bad credit score (approximately 580 or lower), this step should be a priority for you.
Step 5: Find a Home Loan
The terms of your home loan can have a lasting impact on your financial situation. For example, if you only qualify for a high-interest loan, you’ll be spending much more over the life of your loan. It’s important to understand that there are many types of loans, even those that cater to individuals with less-than-stellar credit.
Before you commit to a home loan, make sure you do your research into how different types of loans work and your lender’s requirements. This information can help you make adjustments and prepare, so that you can get the best terms.
With these steps in mind, you can be better prepared when it comes time to put an offer down on the home of your dreams.