Get Your Finances in Order

If you have made the decision to purchase a home, Congratulations! You have taken a big step. Now it’s time to get your finances in order! Your financial profile is so important that – if you’re one of the many people who have to borrow money to purchase a home – you will want to start working on it well in advance before you’re ready to apply for your mortgage loan. This way, if you need to address any issues with your finances or repair your credit, you’ll have some time in which to do this.

Here’s what you need to know about getting your finances in order so that you can buy a home.

What lenders look at when assessing your finances

When you apply for a home loan, lenders want to assess whether you will be able to pay them back and not default on your loan.


Lenders will check to see:

  • If you have a stable employment and income
  • How much cash you have available to cover your down payment, closing costs, taxes and other expenses.
  • Your recent banking activity
  • Investments and other aspects of your finances
If you’re Veteran, you can qualify for a No down payment mortgage and you will need your Certificate of Eligibility.

Lenders will also check your credit to assess your history of paying your debts and look at how much outstanding debt you have. When reviewing a loan application and your finances, most lenders will usually look at the same criteria. The goal is to assess and determine what risk level buyer you are and calculate what your interest rate will be based on various factors.

Here’s a list of what most lenders are likely to consider in their assessment:
  • FICO® credit scores and credit history
  • Down payment amount
  • List of assets (stocks, real estate, etc.)
  • Income and employment history
  • Tax returns
  • Banks statements (for two to three months)
  • Desired loan amount compared to value of home; aka: Loan-to-value (LTV)
  • Total debt compared to income — your debt-to-income ratio (DTI)
  • Rental history (if you’re currently renting or have rented in the past)
  • New mortgage payment shock (how much you are currently paying in rent vs. your new mortgage payment)
In order to improve your chances of obtaining a home mortgage with the best possible terms:
  • Save as much as you can for your down payment
  • Get your debt-to-income (DTI) ratio to no more than 43%
  • Do all you can to improve your credit scores

A higher credit score can help you get a better mortgage

Being that everyone’s personal credit situation is different, it’s hard to predict how to raise you r credit FICO score. However, if you start implementing the following suggestions within 6 -12 months prior to applying for your home mortgage, they will make a difference in increasing your credit score and therefore helping you in obtaining a better interest rate.

For a better credit score – Follow these Tips:
  • Pay your bills on time: Your credit scores will decrease if you’ve missed payments on a credit card or another debt.
  • Use less of your available credit: Your credit utilization ratio, which measures how much debt you’ve taken on compared to what’s available to you, is an important factor in your scores. Using less than 30% of your available credit may increase your scores. Paying down your debts may also lower your debt-to-income ratio, another measure that doesn’t impact your credit scores but is used by lenders to assess your creditworthiness. 
  • Don’t open new credit accounts: When you apply for credit, a lender will initiate a hard credit inquiry, which will have a temporary negative effect on your scores.
  • Maintain a mix of credit accounts: Your credit scores are affected by the types of credit accounts you have, how old they are, and how many of them you have. If you’re managing a mix of different types of credit without trouble, you’ll look less risky to lenders.
Note: You should NOT open new accounts just for the sake of creating this mix.
  • Do NOT do any credit card balance transfers as these will most certainly decrease your credit score by quiet a few points. When you do a transfer to a new credit card, the creditor of the new card will usually give you a starting line of credit equal to the amount that you are transferring (sometimes it could be just slightly higher). So now you have a brand-new credit card with no credit history that is already maxed out! You can surely see how bad this could be!

It really doesn’t take much to have higher FICO scores. If you have poor credit and stick with these suggestions over a period of months, your credit scores can’t do anything else but to go up. If your scores are higher, lenders may see you as a better risk and will be able to offer you a more favorable interest rate.

  • The down payment – The Bigger the Better

    The down payment – The Bigger the Better

    It’s advisable t o save as much as you can for a down payment. A bigger down payment means you will own more of your new home from the start (equity). This makes you a lower-risk borrower in the eyes of lenders and usually translates into a lower interest rate on your home loan, therefore, a lower monthly mortgage payment. 


    Another reason a larger down payment is to avoid having to pay monthly Private Mortgage Insurance (PMI).


    Most lenders will require you to have PMI, which protects the lender in case you should default on your loan (if your down payment is less than 20% of the purchase price of your home).


    The cost of PMI depends on the type of mortgage you obtain, how much you put down and some other factors, but usually costs between 0.5% and 2.33% of the loan amount each year, depending on your credit FICO score and Loan-to-value (LTV) and this can add up to thousands of dollars per year.

Down Payment Requirements:
How much cash you will need to purchase a home is dependent on the loan program, purchase price range and certainly your market area.
  • Conventional financing – Needs a minimum down payment of 5% (varies on maximum loan size according to the area)
  • FHA financing – Needs a minimum down payment of 3.5%
  • USDA financing – Does NOT need a down payment
  • VA financing (for Veterans) – Does NOT need a down payment
  • HomeReady Financing (by Fannie Mae) – Needs 3% down payment
  • HomePossible Financing (by Freddie Mac) – Needs 3% down payment

  • The Debt-to-income ratio (DTI)

    The Debt-to-income ratio (DTI)

    Your DTI, which measures your outstanding debt as a percentage of your income before taxes, is used by lenders as another way to evaluate your ability to repay your mortgage (ATR – Ability to Repay rule).


    Your DTI ratio is calculated by adding up all of your current recurring monthly debt payments such as: credit cards, personal loans, student loans, etc. and your proposed mortgage principal, interest, taxes and insurance (PITI) payments, and then dividing that number by your gross monthly income (your income before taxes and other deductions).


    For a Qualified Mortgage (QM) – a home loan that meets certain Federal regulatory requirements that was implemented back in 2014 to protect lenders and borrowers – you will need to have a DTI ratio of 43% or less.


    Lenders can extend loans to borrowers who have a DTI ratio higher than 43%, however, you generally need compensating factors (one of which is high cash reserves), and even then it’s rare. 


    Lenders consider a higher DTI risky for both you and the lender, as it suggests to them that you may struggle to pay your mortgage and keep up with all your other debts.


    If your DTI ratio is too high for lenders’ comfort, you’ll need to lower your debt or increase your income, or both. Since changing jobs or demanding a raise mid-mortgage application may not be practical, you may want to focus on paying down debt well in advance of applying for your loan.

There are differing opinions about the best way to pay down your debt such as:
  • Paying off your smallest debt first
  • Paying off your highest interest loans
  • Paying down your debt with the biggest monthly payment

Whichever way you decide to go, keep in mind that the goal is to lower the amount of debt you have as a percentage of your income, so choose a method that you can commit to and that effectively moves you in that direction.

Working towards your home purchase goal

Step 1

Order your credit report

About 6 – 12 months prior to starting to look for homes, you should consider ordering your free credit report(s) from the three major credit bureaus at www.annualcreditreport.com


Carefully review the reports and check for any errors. If there are errors, contact the companies right away to have the errors corrected and request that they send you confirmation letters on what will be corrected.


Being that interest rates are based partly on credit scores; you may also want to consider paying to get your credit score to see if it needs increasing. You can get your scores at: www.myfico.com


You will need a score of at least 620 to get a mortgage and the best interest rates will require a score of 740+

Step 2

Prepare a budget

Prepare a Budget worksheet so that you can see what your current monthly income and expenses are and to compare to what your projected total housing payment will be for your home purchase. For income qualification purposes, the lender will use your Gross Income.


Your total monthly recurring debt PLUS your total housing payment PITIA (Principal, Interest, Taxes, Insurance and HOA) Debt-to-income (DTI) ratio should not be more than 43%. However, depending on the loan program, credit FICO scores and other compensating factors, it could go as high as 50%. To be on the conservative side, it’s recommended to keep it at 43%.

Important Tip

Be sure to always consult with your lender or mortgage broker prior making any decision concerning your credit. Sometimes even the seemingly most harmless activity can cause considerable delays or, even worse – Your mortgage loan to be declined.

Download our Monthly Budget Worksheet:

Budget worksheet

Get in touch with a Lender or Mortgage Broker Aiello & Associates Mortgage to discuss your loan options and see what loan program and loan terms best fits your needs.


The bottom-line

It may take months or longer for you to save for a down payment, lower your DTI ratio or improve your credit scores. However, if you work hard and stick with it over time, you may begin to see your efforts rewarded with an easier loan approval and more advantageous loan terms.