Six financial planning strategies to buy a house

From budgeting to paying less in interest, these six strategies for financial planning to buy a house are designed to set you up for homebuying success. They may also have a positive long-term impact on your finances.

Crunching the numbers

If you're planning on buying a home, it's never too early—or too late—to get your finances in order. The better your credit history and the bigger your down payment, the better your mortgage terms may be. This is particularly true for first-time homebuyers, who often require careful financial planning to buy a house.

While a slightly larger down payment or the difference of a fraction of a percentage point may seem negligible on paper, these seemingly small numbers can have a significant impact over the life of your loan. For example, let's say you'll need to finance $300,000 over a 30-year period to purchase a home. If you were able to lock in a mortgage rate at 7% instead of 7.5%, you'd pay $36,625 less in interest over the life of your loan.

Simply put, taking time to prepare your finances before buying a house may do more than expand your borrowing options—it may also have a positive long-term impact on your personal finances.

How to prepare to buy a house

When it comes to financial planning to buy a house, there are several steps you should take. With enough time and planning, these tactics may help you improve your financial picture before you start shopping for a home. Even if your credit is excellent, the following six steps may help ensure that you're on solid financial footing before applying for a mortgage.

1Check your credit score

Two key factors lenders look at to determine whether they'll offer you a mortgage—and on what terms—are your credit score and your credit report.

What credit score do you need to buy a house?

Your credit score—which can range from 300 to 850—serves as a snapshot of your credit history and potential ability to repay debt. While criteria vary between mortgage lenders and may change based on the type of mortgage you're applying for, you'll typically need a score above 620 to qualify for a conventional mortgage and above 700 to receive a more competitive interest rate.

Can you buy a home with poor credit?

While every lender has their own underwriting criteria, there are borrowing options for individuals with lower credit scores. For example, government home loans—including FHA and VA loans—typically have more flexible criteria and more attractive terms for borrowers who don't meet the requirements for conventional mortgages.

What do mortgage lenders look for on a credit report?

Mortgage lenders may review your credit report to get a more comprehensive view of your credit history. They'll evaluate your current financial obligations—including account balances and payment history—to assess how well you've managed debt over time. They may also look for any negative marks, including a history of making late payments, any collections activity or a recent bankruptcy.

How can you check your credit score?

By federal law, you're entitled to receive one free report each year from the three largest credit bureaus—Equifax, Experian and TransUnion. You can request these reports at AnnualCreditReport.com. Review each report carefully, checking for blemishes or errors such as incorrect personal information, accounts that don't belong to you or inaccurate payment history.

How do you fix a mistake on a credit report?

If you find an error on one of your credit reports, you'll need to contact that credit bureau directly. You can file a dispute online or download a form to submit by mail. The bureau will investigate and report on its findings, typically within 30 to 45 days. You can learn more in the Federal Trade Commission's guide to disputing errors.

What's the fastest way to improve your credit score?

One of the most important things you can do to maintain a good credit score is to consistently pay your bills on time. However, if you've made mistakes in the past, there are other tactics you can implement to improve your credit score. For example, paying down credit card debt to reduce your credit utilization ratio may have a positive impact, particularly if you're currently utilizing more than 30% of your available credit. Likewise, you'll want to maintain a good credit mix and hold off on opening new accounts or closing existing ones.

It might take time for changes to appear on your report, so the sooner you start working on your credit the better.

2Pay off debt

Another factor lenders consider is your debt-to-income ratio, or DTI, which is how much debt you have in relation to your income. You can calculate your debt-to-income ratio by totaling your monthly debt payments and dividing this number by your monthly pretax income.

What's a good DTI for a mortgage?

Lenders may require that your total debt—including your housing costs—not exceed 36% of your gross monthly income. While lenders will occasionally accept borrowers with a higher DTI—particularly if they have an excellent credit score or a large down payment, or if they're applying for an FHA loan—improving your DTI will increase your approval odds.

3Set a budget for buying a new house

Budgeting for buying a house—and sticking to your budget—is an essential part of financial planning to buy a house, particularly for first-time homebuyers.

How much house can you afford?

To calculate how much house you can afford, you should have a clear understanding of your total debt and estimated monthly mortgage. But how might you know how much a mortgage payment will be for a home you haven't purchased yet?

A good rule of thumb is to keep housing-related costs—including loan payments, insurance and taxes—between 25% and 30% of your take-home pay.

How to budget for a house

For a more exact calculation, take the following steps.

• Tally up your total debt. Make a list of all your current debt—including student loans, car payments and credit card debt—and calculate how much you spend each month on these obligations.
• Determine what your average monthly expenses might be. Visit popular real estate sites and review listings in your desired location for the type and size of home you're interested in purchasing. Jot down any information regarding the cost of property taxes, homeowners association fees and the cost of home insurance, and use these to determine your potential monthly expenses for a home.
• Look at current mortgage rates. Research the current typical mortgage rate. While the actual rate you qualify for may differ slightly depending on your financial picture as well as local market and future fluctuations, national average mortgage rates may be a useful reference point.
• Calculate how much you can afford to finance. Use a home affordability calculator to determine how much home you can afford based on the above estimates. It will show your target purchase price and a general idea of the monthly mortgage payment you may be able to afford.

Once you've calculated how much you can afford, remember that this amount is your maximum. It's worth aiming to purchase a home that costs less than your affordability maximum. Then, if you do have an unexpected life event such as a new baby or job transition, you have built-in flexibility.

4Determine the size of your down payment

While a smaller down payment shouldn't prevent you from achieving your goal of buying a home, when it comes to down payments, bigger can be better. The reason is simple—the less you finance, the less you'll likely pay in interest over the life of your loan.

Can you get a mortgage without putting 20% down?

If you can't save up enough cash to pay for 20% of the price of a home, you're not alone. Fortunately, there are options available, which are detailed in our guide to down payments.

However, if your down payment is less than 20% of the home's purchase price, you may be required to pay for private mortgage insurance, also known as PMI, which will increase your monthly payments.

A down payment isn't the only savings you'll need to put aside. Closing costs—which often run between 3% and 6% of the amount of your loan—may add to the price of your home. If you're buying a fixer-upper, you'll also want to save for renovation costs.

It's also a good practice to have enough savings left over after your down payment and cost of furnishings to cover emergencies because homeownership may involve unexpected maintenance and repair costs. In some cases, sellers may purchase a warranty to cover unexpected costs for a year after a sale, so you may have 12 months to build your emergency fund.

5Maintain your financial status quo

During the months leading up to buying a house, it's a good idea to avoid significant life changes. This includes changing jobs, starting a new business, making large purchases or opening new lines of credit. Lenders look at the stability of your income to assess the risk of potential default. Taking on new debt or opening new lines of credit—and even closing credit cards you don't use anymore—may all lower your credit score or impact your DTI.

Some changes to your financial situation may be unavoidable, but it's a good idea to demonstrate relative stability in the months before applying for a mortgage. And if you're self-employed or an independent contractor, keep a careful record of your income for at least 2 years before you buy. This will provide evidence of your creditworthiness to lenders.

6Talk to a mortgage banker

Many first-time homebuyers don't think of contacting a mortgage banker until they're ready to apply for a home loan. But the best time to reach out is when you first begin building your financial plan.

A mortgage banker can help you make informed choices about the type of loan that may meet your needs and educate you on what it takes to qualify for a mortgage. They can also provide insight into any first-time homebuyer programs or down payment assistance programs you may be eligible for.

Building a relationship with a mortgage banker early on may be one of the most helpful steps you take on the path toward homeownership. The first step is to find an experienced, helpful one near you.