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Check Your Credit
The better your credit score, the better your interest rate will be (check out this cool calculator to see what a difference your credit score can make to your monthly payment).
If you’re not happy with your score, fixing your credit begins with knowing what’s wrong with it in the first place. Go to annualcreditreport.com and get a free credit report from each of the three major credit bureaus—Transunion, Experian, and Equifax.
If you see any mistakes on your report, get them fixed right away. When you fix a problem, the lender must report the correction to all three credit agencies, so you shouldn’t have to fix the same problem three times. Look for:
- Payments incorrectly posted as late
- Bills marked unpaid that you actually paid
- Loans or credit cards you didn’t sign up for
Get Financial Documents Ready
Your lender will need financial documents from you when you apply for a mortgage. Here’s a short list of things you’ll need.
- Pay stubs
- Personal tax returns (2 years)
- W-2s or 1099s (2 years)
- Bank statements (2 months)
- If you own a business, business tax returns (2 years)
- Proof of alimony or child support payments
You may need more documents as the loan process continues, but this is a good place to start.
Pay Down Debt
The lender will use a ratio called the debt-to-income ratio (DTI) that compares your monthly debt payments to your monthly income.
Basically, DTI is your monthly debt obligations (car payment, student loans, monthly minimum credit card payments) divided by your monthly gross income.
So if you have $1,500 in monthly debt payments and $5,000 in monthly income, your DTI is 30%.
This number is important because it helps the lender determine how much money to lend you. They don’t want your monthly debt obligations to be too high.
If you have debt that you don’t want to count in your DTI, pay it off right now, before you apply for a loan.
Stop Other Borrowing
If you’re applying for a mortgage soon, it’s a smart move to stop other kinds of borrowing. In other words, now is not the time to get your dream car and a house full of furniture. There will be plenty of time for those things after you’ve closed on your new home.
In fact, don’t even apply for any new types of credit during the loan process.
Decide on a Down Payment
You’ll need to put money down to buy a home. You may have heard that you need 20% of the home’s price, but that’s actually not true. You can buy a home with as little as 3% down. Just remember that the more you put down, the lower your monthly payment will be.
Now is a good time to sit down with your finances and decide what you feel comfortable putting down on your new home and how long it might take you to get there. It will be much easier (and quicker!) to get pre-approved for your new home if your finances are straightened out. After that work’s done, it’s time to move on to pre-approval!
Determine How Much You Can Afford
The lender will tell you how much you can afford during pre-approval (more on that in the next section), but this doesn’t necessarily mean you can actually afford a home that costs that much.
Take a hard look at your budget and make sure that you know exactly how much of a monthly payment you can really afford. You may need to look at homes that cost less than the number the bank pre-approves you for.