How to Prepare to Finance a Home

10 steps to take before applying for a mortgage loan.

1. Develop a budget.

Instead of guessing what you can afford to spend on a house, use bank statements and a spreadsheet to create a budget that reflects your actual spending pattern over the last several months to a year. This approach will help you factor in unexpected expenses alongside more predictable costs such as utility bills and groceries. You’ll probably spot some ways to save, whether it’s cutting out that morning doughnut run or canceling infrequently used streaming services.

2. Reduce debt.

Lenders will look at your debt load to determine how much they think you can afford to borrow. While only you can decide how much debt you're ready to take on, lenders have traditionally allowed a maximum debt-to-income ratio (DTI) of 36%. Some lenders or loan products allow a higher DTI, so be sure to shop around.

DTI is calculated by dividing your total recurring expenses for the month by your monthly gross household income (earnings before taxes and other deductions, such as funds allocated to retirement accounts). In adding up monthly expenses, don’t forget to factor in property taxes, insurance, maintenance, utilities, and association fees, if applicable. If your monthly income is variable, consider using a one-year average, or be conservative by calculating your DTI for your slowest-earning month.

A good ballpark for monthly housing costs is between 25% and 28% of your gross household income. So keep monthly payments on the rest of your  obligations (including installment debt—car loans, student loans, and revolving balances on credit cards) down to no more than 8% to 10% of your gross monthly income.

3. Keep your job.

While you don’t need to be in the same job forever to qualify for a home loan, having a job for less than two years may mean you have to pay a higher interest rate.

4. Ask for a raise.

If that’s not an option, some people consider taking on a second job in order to qualify for the home they want. Remember, though, that quality of life is important, too. It may be better to compromise on the size or location of your home so that you have time to enjoy it!

5. Establish a good credit history.

If you're just getting started, well before you think about applying for a home loan, get a credit card, make it a practice to charge no more than you can afford to pay off each month. Pay your credit card bill on time each month, and do the same for all your other bills.

6. Obtain a copy of your credit report.

A credit report provides a history of your credit, bad debts and late payments. Make sure yours is accurate, and correct any errors immediately. The Consumer Financial Protection Bureau offers clear directions on how to obtain a free credit report each year.

7. Save for a down payment.

Designate a certain amount of money each month to put into savings. While many people think a 20% down payment is essential, it's possible to get a loan for as little as 3% to 5% down. That can be a great option for first-time homebuyers who haven't yet built equity in an existing home. In 2023, the median down payment was 15% for all buyers, 8% for first-time buyers, and 19% for repeat buyers, according to the National Association of REALTORS® 2023 Profile of Home Buyers and Sellers. With a 20% down payment, you avoid the cost of mortgage insurance and can sometimes qualify for a better interest rate. Don’t forget to factor in closing costs, which can average between 2 and 7 percent of the home price.

8. Consider your mortgage options.

People generally look at homes valued at two to three times their gross income, but your level of recurring debt will be a factor in how much house you can afford (see #2 above). With the help of your real estate agent or mortgage lender, determine the best mortgage terms (30-year, 20-year, or 15-year? Fixed or adjustable rate? Conventional of FHA?) for your situation.

9. Gather documentation.

Lenders generally need a number of documents to preapprove you for a loan, such as W-2s, recent paystubs, and two to four months of recent bank statements.

10. Seek down payment help.

Talk with your agent, or check out state and local government websites, to find out whether you qualify for special mortgage or down payment assistance programs. If you have an IRA or Roth IRA account, you may qualify to withdrawal up to $10,000 for a home purchase before age 59-1/2 without incurring the normal 10% penalty for early withdrawal. Unless the account is a Roth IRA (composed of after-tax contributions), you'll owe taxes on the withdrawal amount. Some employers offer down payment assistance programs, too. And family members can be a source of down payment funds, provided they verify in writing that the assistance is a gift and not a loan.