Mortgages, credit scores and down payments: 5 things to know before buying a home

Thinking of becoming a homeowner but don't know where to start? Here's how to get your money in order before you buy a home.

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When I wanted to buy a home, the only thing that I had going for me was wanting to buy a home. I had a ton of debt , a few dollars to my name and no idea where to start.

That was seven years ago. Last month, I did buy a home after I finally got a handle on what I needed to do before taking the plunge. Here's what worked for me plus some other things that will get you into the right home.

1. Boost your credit score

If you plan to take out a mortgage (that's most people), your credit score is the most important factor in buying a home. Lenders look at your credit score and history to see if you (and, if applicable, a co-borrower) are a responsible credit borrower. The higher your credit score, the more likely you are to score a home loan at the lowest available rate.

That also means the lower your credit score, the higher your interest rate will be -- if you qualify at all. You can boost your score by:

  • Making timely payments: On-time payment history is the biggest factor in calculating your credit score. If your payment history is a little spotty, start making on-time payments right away. Sign up for autopay whenever you can to make sure your payments are never late.
  • Lowering your credit usage: If you're carrying a balance month-to-month on your credit cards, lenders might think you don't have enough cash on hand to make mortgage payments. Lower your credit usage by paying off your credit cards in full at the end of the billing cycle. If your credit score is pretty good, ask your credit card issuer for a balance increase. This will also lower your credit utilization, or the ratio of your credit card usage to available credit.
  • Removing bad marks: Check your credit score for free at You can pull your credit report from all three major credit bureaus: Experian, Equifax and Transunion. From there, you'll be able to see if there are any errors. If you have mistakes, contract the bureau to report it. Also contact the creditor that reported the error to see if you need to do anything to fix it.

Read more: Everything you need to know about credit scores

2. Start -- and contribute -- to a down payment fund

If you don't have any cash on hand, now is the time to start saving for a down payment based on the home price you're targeting. Saving for a down payment might delay your homebuying timeline, but it makes a big difference in what you can buy. 

Even though you don't need the standard 20% down payment, it's still recommended. You can qualify for a mortgage -- an FHA or conventional -- without one, but you'll need to pay private mortgage insurance on top of your monthly payments. PMI payments do not go toward your principal or interest balances; it goes toward your mortgage lender as a layer of protection in case you can't pay back your loan. With a 20% down payment, you'll avoid PMI payments and score a lower interest rate (without paying for points). 

Where you keep your down payment fund depends on when you plan to buy your home. If it's within the next year or so, you may want to stick with a high-yield savings account, like Marcus or Ally. The returns aren't as high as they would be if you invested in the stock market, but you won't be losing money, and you'll earn much more than what standard checking and savings accounts offer, usually around 0.09%.

If you have a little bit more time until you plan to buy, consider investing your money in the stock market. You can go with a traditional brokerage or a robo-advisor, like Betterment or Wealthfront. Robo-advisors automatically manage your assets by investing in low-cost exchange-traded funds. These advisors evaluate your risk with a survey asking about the type of investor you are and when you plan to cash out on your investments. This way, you can still invest in the stock market without hand-picking individual stocks or worrying about the technical aspects of trading.

To make the most of investing toward your down payment, find a way to make contributions often. See if you can set up monthly or biweekly autocontributions. Think of it like a bill you pay every month to avoid paying yourself last. 

Avoid borrowing money, whether through a personal loan or your future self with a 401(k) loan. A 401(k) loan lets you take money from your retirement fund to cover homebuying costs, like your down payment or closing costs. Even though you can use the funds, try to avoid it. Even when you repay that money, you'll lose out on any potential funds that would've grown through investing it. 

Read more: The best robo-advisors in 2020

3. Get preapproved

Before you start browsing dream homes, find out how much home you can buy. Lenders base their approval on your credit score, debt-to-income ratio, income, employment history and if you have any assets. 

A preapproval helps you shop for homes that are within your budget. It also shows sellers you're serious about buying a home and putting in an offer. To get a preapproval, you can apply through your bank, a broker or online lenders. Since preapprovals are loan applications that trigger a hard credit pull, see if you prequalify first. A prequalification is when you answer a few questions based on your credit history and income to see if you'd qualify for a loan. A preapproval is when a potential lender checks your background to make sure you'd qualify for a loan. While a prequalification is based on your answers, a preapproval is based on what's available through credit bureaus, your bank accounts and other financial information. 

4. Find a real estate agent

Navigating the world of homebuying isn't easy. There are ever-changing rules, which means having an expert around can make a complicated process much more manageable. Real estate agents are helpful in walking you through what you need as well as finding the right people to tackle those needs. For instance, they can identify neighborhoods with the best schools and negotiate costs with the sellers when it comes time to make your offer. They can also explain contract information when things get confusing, like seller disclosures and how much money to put in escrow. 

The best way to find an agent is to ask around to see who friends and family recommend. You may also want to find an agent that's familiar with the neighborhoods you're exploring.

5. Set your housing budget

When a bank or broker preapproves your loan, they'll provide a preapproved loan amount. But even though you were preapproved for that amount, it's not necessarily the right amount to spend on a home. 

What is the absolute most amount of money you can spend on a home every month? Determining your ideal monthly payment will help shape the best target price of a home. Your monthly payment is determined by your principal payment, interest rate, taxes, home insurance and whether or not you'll pay PMI.

To do this, review your budget and include what a potential new home payment looks like. Don't forget to add in your property taxes, utilities and any maintenance that comes with your new home (like pool upkeep, for example). This will give you an idea of how your finances will be affected when you buy a new home.

Browse homes (finally!)

While looking at potential homes is one of the last things you'll do, it's because it doesn't make sense to do it any sooner. Without having an idea of how much home you can afford and a preapproval letter, you'd only be hurting yourself by looking at homes you may never be able to buy.

Use your agent to find homes in your budget in neighborhoods you like. If those neighborhoods are out of your budget, ask your agent to see if there are similar ones around. Your agent will know the market better than most people you know -- use them.

Whether you attend open houses or you make appointments to view homes on your own, see as many as you need to. Buying a home will likely be the most expensive purchase you make. Don't settle for anything less than what's best for you.

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