Think you’re ready to buy a home? Get your house in order before you start shopping. Here’s what you need to do, and when.
Buying a home is a complicated process, and it can be particularly daunting for the first-timer.
The following timeline starts one year before you hope to start seriously shopping for a home. This is an ideal; you can arrange your finances and buy a home in less time, if necessary, but you’d be smart to walk through all of the steps in order. The more time you give yourself for this process, the better.
A year out (or as soon as possible)
Get your credit reports. Errors on your reports can force you to pay a higher interest rate on your mortgage or even torpedo your chances of getting a loan. You can get free copies of your reports from the three major credit bureaus — Equifax, Experian and TransUnion — at AnnualCreditReport.com. Look for accounts that aren’t yours, collection accounts for debts you don’t owe and negative marks (other than bankruptcy) that are older than seven years.
You should be able to dispute errors with the bureaus and get them removed, but if the bureaus or the creditors balk, you may need to hire an attorney. (The National Association of Consumer Advocates can refer you to lawyers with knowledge of the credit-reporting and debt-collecting laws.) Don’t leave yourself in the position of having to pay a bogus collection account to get the loan you want or paying unnecessary interest because of credit-report errors.
Get — and improve — your FICO credit scores. Your credit scores, which are three-digit numbers used to gauge your creditworthiness, help determine the rates and terms you can get for a loan. There are hundreds of different credit-scoring formulas, but the one used by the vast majority of mortgage lenders is the FICO.
The only place you can buy your FICO scores for all three credit bureaus is MyFico.com. A package of three scores and three credit reports costs about $50. You can learn more about credit scores, how they work and how to improve them at MSN Money’s Your Credit Rating Decision Center, and you can get a copy of my best-selling book, “Your Credit Score: How To Fix, Improve, and Protect the 3-Digit Number That Shapes Your Financial Future,” which was published in a second edition in February 2007 (end of shameless plug). Three keys to better credit: Pay all your bills on time, pay down your credit cards and other revolving debt, and don’t open (or close) any accounts while you’re in the market for a mortgage.
Consider a credit-monitoring service. Normally, I think these are a waste of money for folks who aren’t at high risk of identity theft. But given how important your credit and credit scores will be in buying a home, you might appreciate the early warning if a collector tries to post a bogus debt.
Deal with your debt. Most people needn’t pay off their student loans, auto loans or other generally low-rate debt before getting a mortgage. What you want to eradicate is “toxic” debt: credit card balances and payday loans. These are signs you’re living beyond your means. If you don’t get your overspending problem fixed before you buy a home, your problems will likely just get worse because homeownership typically involves plenty of big costs (property taxes, insurance, maintenance, repairs, improvements, decorating). Get your act together before you house shop.
Save, save, save. Stop eating out. Drop your cable-TV subscription. Do everything you can think of to put as much money aside as possible, using your desire to be a homeowner as a motivator. (Read “Could you stop spending for a month?” for inspiration.) In today’s market, it’s best to have at least a 5% down payment; boost that to 10% and you’ll have even more financing options. Ideally, you’ll also have enough left over after you get your mortgage to cover the payments for two or three months.
Put your bills on automatic. A single 30-day late payment can knock 100 points off your score, and it can take many, many months to recover. Make sure every bill gets paid on time. If you don’t have a reliable bill-paying system, consider using automatic debits, so payments come directly from your checking account, or an online bill-payment system’s recurring-payment feature.
6 months out
Sort through your mortgage options. A lot of people are losing their homes today because they didn’t understand what kind of mortgage they had or they accepted bad advice. The low teaser payments that allowed them to buy a more expensive house have jumped skyward, leaving them unable to pay. It’s up to you to understand the risks of the different types of mortgages and to select the right one for your family. My 2 cents: Stick with traditional, fixed-rate mortgages. If you can’t commit to a 30-year version, at least use a hybrid loan with a rate that’s fixed for as long as you plan to own the home.
Start calculating how much house you can afford. Once you’ve settled on a type of mortgage and have a rough idea of your down payment, you can start using online calculators like this one at LendingTree.com to see how much house you can buy. Consider buying less home than the absolute maximum you can afford; if you keep your housing expenses (mortgage, taxes and insurance) to 25% of your gross income, you’ll be able to live more comfortably and have money left over for things like retirement savings, vacations and the kids’ college educations.
Research all the costs of owning a home. Your mortgage will be just the start. You’ll have to pay property taxes and insurance on the home. There may be homeowners- or condo-association fees as well. You may face higher utility bills, and you’ll take on maintenance and repair costs as well. Decorating your new house can cost a pile of money as well — have you shopped for window coverings lately? Your home-owning friends and a friendly real estate agent or two can help fill you in so you know what to expect.
Adjust your savings strategies. What you’ve learned so far may inspire you to boost your savings. A bigger down payment, for example, can result in a larger home or a lower mortgage payment. Or you may simply want to build up your emergency fund so unexpected home expenses don’t knock your finances off the rails.
3 months out
Reduce your credit utilization. The FICO scoring formula is sensitive to how much of your available limits you’re using on your credit cards and other revolving lines of credit. The less, the better. It doesn’t matter if you pay your balances in full every month; the figure the scoring formula typically uses is the balance that shows on your most recent statement. Try to keep that balance below 30%, or even lower. If you can’t — because you charge a lot for work-related travel, for example — make a payment before the statement’s closing date to reduce the balance reported to the bureaus. Just be sure to make a second payment after the closing date, so you don’t get reported as late.
Don’t open or close any accounts. Until the mortgage process is completed and you’ve moved into your new home, continue to avoid actions that could potentially harm your credit, such as opening credit accounts or closing old ones.