The fun part of buying a home? Touring properties and picturing yourself taking a bath in updated master bathrooms, cooking a homemade meal with stainless-steel appliances and playing catch with your kids in sprawling backyards. However, what you may not realize is that the decision to buy a home should ideally be made at least five years in advance.
Buying a house requires plenty of planning. And none of it is much fun. But by creating a home-buying timeline before you start looking at homes, you’ll increase your odds of buying a place that truly fits your needs, wants, and financial situation.
If you’re thinking about buying, follow this five-step checklist to get ready for your big purchase.
5 Years Out: Build Your Credit Score
It might seem strange to start preparing for buying a home as early as five years before you’re ready to purchase, but it can take a long time to build a solid credit score. And when you’re applying for a mortgage loan, credit scores are key.
Your three-digit credit score tells lenders whether you have a history of paying bills late, missing payments or running up piles of credit card debt. If you do, your score will be low. If not, your credit score is probably relatively high.
Lenders reserve their lowest interest rates for those borrowers whose credit scores are 740 or higher on the FICO scale. But any score higher than 700 will usually qualify you for a good interest rate.
Long before you start touring homes, request a free copy of your credit report from AnnualCreditReport.com. You are allowed to pull copies of each of your three credit reports – maintained by the credit bureaus TransUnion, Equifax and Experian – once every 12 months. Once you have these reports, study them closely. They’ll list how much money you owe, on everything from car loans to student loans to credit cards. They’ll also list any late or missed payments you’ve made in the last seven years. If you’ve declared bankruptcy or suffered through a foreclosure within the last seven to 10 years, those will be listed, too. Report any errors to the credit bureau in question, something you can do today through e-mail.
You can also order your credit score from the three credit bureaus. You’ll generally have to pay about $15 to get a copy of your score from Experian, TransUnion or Equifax. Some credit card companies provide their customers with free credit scores and/or credit monitoring, but make sure your score is actually your FICO score, and not an alternative. Lenders care about FICO. They don’t care much about alternative scores such as the VantageScore.
If your score is low and your credit report is dotted with financial mistakes, it’s time to take corrective action. You can improve your score by starting a new history of paying your bills on time. You should also pay off as much credit card debt as possible. Just don’t close your credit card accounts once you completely pay them off; reducing the amount of credit available to you can actually hurt your credit score.
Fixing a broken credit score can take time – often two or three years. That’s why it’s important to start focusing on your credit score as much as five years before it’s time to buy a home.
3 Years Out: Start Saving
Lenders expect you to come up with at least some down payment to prove that you have what they call “skin in the game.” The theory goes like this: You’re less likely to stop paying on your mortgage loan when facing financial struggles if you’ve already invested thousands of your own dollars into your home before you’ve even gotten your first mortgage bill.
The amount you have to provide for a down payment varies. If you’re taking out a loan insured by the Federal Housing Administration – better known as an FHA loan – you’ll need a down payment of just 3.5 percent, as long as your FICO credit score is at least 580. For conventional home loans, you’ll usually need a down payment ranging from 5 percent to 20 percent of your home’s final purchase price. This can get expensive – a 5 percent down payment on a $200,000 home comes out to $10,000, so start saving early.
You’ll have to worry about closing costs, too. These are the fees that lenders and other third-party providers charge to close your loan. These fees vary, but Bankrate reported that the average closing costs on a $200,000 mortgage loan came in at $1,847 in 2015. This figure is only a basic starting point, though. Bankrate excluded costs like homeowner’s insurance, title insurance and taxes, costs that could add up to $3,000 more to your closing costs depending on your home state.
1 Year Out: Calculate How Much Home You Can Afford
Before you start looking at homes, you’ll want to know how much you can afford to spend on one. That’s where your debt-to-income ratio comes in.
Mortgage lenders recommend that your total monthly debts, including your estimated new monthly housing payment, equal no more than 43 percent of your gross monthly income, which is your income before taxes are taken out.
To calculate this ratio, list your regular income for the month and your recurring monthly expenses, everything from car payments and student loan debt to the minimum amount you must pay on your credit card debt. Be sure to include an estimated amount that you might pay for your mortgage each month (you can find that out with mortgage calculators on websites like Zillow and Realtor.com – Google even has its own). Don’t forget to estimate how much homeowners insurance and property taxes will cost you – those fees are usually added into your monthly mortgage payment.
Say your total monthly debts come out to $2,000, and your gross monthly income is $6,000. You’d divide $2,000 into $6,000 to come up with a debt-to-income ratio of 33 percent, well within that 43 percent safety zone.
1 Month Out: Get Pre-Approved for a Mortgage Loan
You don’t want to waste your time looking at $300,000 homes if mortgage lenders will only approve you for a loan of $200,000. That’s why getting pre-approved for a mortgage loan is such an important step.
During the pre-approval process, you’ll provide a lender with documents that prove your monthly income. This can include copies of your last two paycheck stubs, bank-account statements from the last two months, last two years of W2 forms and last two years of income-tax returns. Your lender will also run your credit to get your credit report and credit score. After studying this information, your lender will tell you exactly how much mortgage money it is willing to loan you. Your lender will also provide you with a pre-approval letter that lists this figure.
When you’re pre-approved, you immediately become a more attractive home buyer. Sellers know that you can qualify for a mortgage, and that a deal made with you is less likely to fall apart. Sellers will usually choose pre-approved buyers over others when two or more buyers are competing for the same home.
Don’t worry about costs, either. Lenders won’t charge you for a pre-approval. They hope that you’ll come back to them when it’s time to actually take out your mortgage loan. But you are under no obligation to work with a particular lender, even if you’ve received a pre-approval letter from them. You can still shop around for the lender that will provide you with the best interest rates and charge the lowest closing costs.
A Few Weeks Out: Interview Real Estate Agents
There’s no reason not work with a real estate agent if you are a buyer; you won’t pay a cent for your agent’s services. When you buy a home, your agent is paid by the sellers, who use the proceeds from their home’s sale to cover your agent’s fees. So you basically get your agent for free.
You still want to work with the right agent, though, so speak to several before signing a contract. Ask potential agents how long they’ve been in the business, how many buyers they’ve worked with in the last year, if they know the housing market in the neighborhoods you are targeting and whether they routinely negotiate down the final prices that their buyers pay for a new home.
Once you find an agent you like, sign that contract and get ready for the fun part: touring homes.