The New York Times: Right at Home

ORGANIZE YOUR FINANCES

It’s time to assess your spending, clean up your credit and figure out what you can afford. Have you decided to buy? Before you jump into the world of open houses and real estate agents, take the time to get your finances in order. It will help you once it’s time to apply for a mortgage. It will also help you get some financial perspective before you fall in love with that perfect center-hall colonial or the studio with views of the park.

Check Your Credit Score

Lenders use credit scores, also known as FICO scores, to evaluate the potential risk of lending to you. The higher the number, which runs from 300 to 850, the better your score. The best mortgage rates go to borrowers with credit scores in the mid- to high 700s or above, according to the Consumer Financial Protection Bureau. Most lenders require you to have a score of at least 620 to qualify for a fixed-rate loan backed by the mortgage giant Fannie Mae.

Federal law allows you to get a free copy of your credit report every 12 months from each of the three major credit-reporting bureaus, Equifax, Experian and TransUnion, which generate their own FICO scores based on the data they collect. To find out where you stand, go to annualcreditreport.com, which offers a free report annually.

IS YOUR FICO SCORE LOW?

You can improve your score by paying down high credit card debt, and by cleaning up any financial mistakes, like errors resulting from identity theft or mixed-up files belonging to another person with the same or similar name. Be aware that it takes time for these changes to be reflected in your credit score, from months for an inaccurate bill to years if you’ve had tax liens or bankruptcies. Focusing on your credit may feel like a chore, but it’s a worthwhile one. With a higher credit score, you could get a lower mortgage interest rate, potentially saving you thousands of dollars in interest payments over the life of your loan.

HOW TO IMPROVE A LOW FICO SCORE

Pay your bills on time. The impact of late or missed payments on your FICO score fades over time as long as you establish good patterns over the long term. Make space between your bad credit history by creating a good track record moving forward. To avoid missing payments, sign up for automatic bill paying.

Keep any balances low. One of the factors that impacts your score is your debt-to-available-credit ratio. Getting close to maxing out your credit cards can have a negative impact on your score. Try to keep your credit utilization ratio below 30 percent to show you are managing your credit responsibly. That means if your total credit limit is $10,000, you should aim to keep your total revolving balance at $3,000 or less.

Don’t close credit cards. Even if you don’t use a credit card, keep it open because the line of credit benefits you. Closing it can negatively impact your debt-to-available-credit ratio, since you’re reducing your overall credit limit. If you are worried you will be tempted to use it, you can simply cut it up.

NO CREDIT HISTORY?

If you’re just setting out on your own, you may not have a credit history yet. Be patient. Building a strong credit history takes time. Getting a credit card and using it for small charges that you can easily pay off each month can be a good way to start proving your creditworthiness. You can also ask a family member if they would be willing to cosign for you or to add you to one of their credit card accounts as an authorized user. Just be sure that your folks, or whoever you are asking to add you as an authorized user, has good credit themselves or else you won’t be doing yourself any favors. Also, be aware that not all creditors report authorized user accounts to the credit reporting agencies. Staying on top of student loans can also have a positive impact on your credit history.

AVOID BIG PURCHASES

If you know you plan to buy a home in the next few months, or have an accepted offer, be careful about what else you buy. Sign a loan for a new car, and your debt-to-income ratio could change. Open a credit card to take advantage of a promotional interest rate, and your FICO score could take a hit. Open a new store credit card to buy furniture for the house that you made an offer on, and the bank may frown. If you must make a large purchase because, say, you’re moving to a new city and need that new car and have other large expenses, talk to your lender first.

Get a Mortgage Preapproval

A preapproval letter is a written estimate from a lender of how much you will likely be able to borrow from them. This letter will help you determine how much you can afford, and help demonstrate that you can secure a home loan when you are ready to make an offer on a house. Getting preapproved for a mortgage is different from getting prequalified for a loan, which is essentially a back-of-the-envelope calculation of how much of a loan you may qualify for based on unverified information. The preapproval application for a mortgage often requires submitting pay stubs, bank statements, tax returns and other financial documents.

TIP

Line Up Cash

The more cash you can pay up front toward your home, the less you will have to borrow. A bigger down payment means your monthly payments will be lower and you will pay less interest over the course of your mortgage. If you can afford to put down 20 percent or more of the total home price, you typically won’t have to pay for mortgage insurance, a premium that protects the lender in case you default on the loan.

CASH GIFTS

Saving up enough cash for a down payment is one of the biggest challenges first-time buyers face. A quarter of buyers age 36 or younger paid for their down payments with gifts from friends or relatives, according to a 2017 National Association of Realtors report.

Banks are wary of financial gifts, concerned that the money is another loan that must also be repaid. For conventional loans, banks will only accept gifts to be used toward your down payment from relatives, like your parents, grandparents, aunts and uncles. So you would not be able to use money from a friend or your second cousin’s sister. FHA loans are less restrictive, permitting gifts from sources like friends, employers and trade unions. Want to know more about different types of mortgages? Turn to here.

The money must have a paper trail, like via wire transfer, not cash in a shoebox. You and the gift giver should be prepared to show bank statements so the bank can trace the assets. Each of you will likely need to sign a letter affirming that the money is a gift and not a loan. There are also tax implications. The I.R.S. sets limits on how much money can be given as gifts in any given year without being subject to taxation. Check the I.R.S. website for the latest figures or consult with your tax preparer or financial advisor.

SAVING FOR THE UNEXPECTED

Don’t use all your money toward a hefty down payment. Lenders will want to see that you have some reserves in the bank. Closing costs typically add up to thousands of dollars. On average, closing costs for the buyer range between 2 and 4 percent of the price of a property, including government taxes and fees and prepaid items such as property insurance, according to Bankrate, which tracks financial rates and product information. You’ll also need cash on hand for moving, renovations and other incidentals.

Even if you’re not buying a fixer-upper, many houses and apartments need tinkering. The furniture from your rental may not fit. The living room might be avocado green. Set aside extra money for a fresh coat of paint, a new kitchen backsplash or a new sofa to make the place a little homier.