5 Tips for First-Time Homebuyers: How to Prepare Your Finances

Purchasing your first house can be an exciting and complex process, and many first-time homebuyers look for tips that can help make the process easier. Buying a home is about getting the details right, so preparing your finances ahead of time is a great way to set yourself up for success.

From figuring out if it’s the right time to buy to calculating how much house you can afford, the following tips and tricks can help you position your finances in a way that makes the homebuying process easier and more straightforward.

1. Figure out if you want to commit to buying a home

Before you set off on your homebuying journey, take a moment to think about whether you’re ready to commit to buying a home.

As a few quick numbers to keep in mind:

• The average term on a mortgage is between 15 and 30 years, with many first-time homebuyers choosing to go with 30-year fixed-rate mortgages.
• The average sale price of houses in the United States broke $500,000 in Q1 of 2022.
• The median price of a home in the Midwest currently sits at around $400,000 to $430,000.

While you certainly don’t have to stay in your home for the full duration of your mortgage, it’s important to remember that buying a home is a long-term commitment simply due to the large amount of money involved.

For this reason, you should run the numbers to see if it’s better for you to purchase a home or continue renting.

Experts generally state that buying is better than renting if you plan on staying in one location for more than three to seven years. Note, however, that several factors can contribute to where this date falls, so it’s smart to speak with a local banker who can help you decide which strategy works better for you.

Ask a few more qualifying homebuying questions

The question of whether it’s the right time to buy a home can be difficult. For this reason, it’s wise to ask yourself a few qualifying homebuying questions to determine if it’s the right time to buy your first home:

• Do you have an emergency fund that covers three to six months of your expenses?
• Are you making regular contributions to a retirement account such as an IRA or 401(k)?
• Do you expect to have a steady source of income for at least the next five years?
• Do you have any significant sources of debt that may affect your ability to get a good interest rate on your mortgage?
• Do you have 20% of your expected home’s purchase price saved up as a down payment so you can save on mortgage insurance? If not, do you have at least 5–10% saved up?

If you answered “no” to any of these questions, you may want to wait a little longer before purchasing your first home. At the bare minimum, you should speak with your local banker or real estate agent to find a homebuying strategy that works for you.

Buying your first home is a huge step forward in improving your financial situation, so making sure it’s the right time to buy for you is critical in ensuring your success.

Partnering with a trustworthy local bank is a great way to make this process as easy and straightforward as possible. Working with a bank rooted in your local community often helps give you a competitive advantage as you navigate your homebuying journey.

2. Prepare your finances before you look for a mortgage

One of the most important factors a bank will look at when you purchase your first home is the state of your financial health. For this reason, it’s critical you get your finances in order before you begin shopping around for a mortgage.

Start saving up early for your home purchase and associated costs

While many people focus only on the monthly cost of buying a home, it’s important to keep in mind that there are several other upfront expenses you’ll have to account for as well:

• Emergency Fund — First, save up an emergency fund that can cover around three to six months of your expenses.
• Down Payment — Then, aim to save up an amount equal to around 20% of your budgeted amount as a down payment on the home. This can help you avoid having to pay for private mortgage insurance (PMI).
• Closing Costs — Next, save up a separate amount to cover the upfront costs of purchasing the home, such as attorney fees, inspections and other closing costs. These closing costs are typically equal to around 3–5% of the loan amount.
• Move-in Expenses — Finally, budget for expenses that come after you purchase your home, such as moving expenses, home repairs and paying for new furnishings.

As you approach the date you’d like to purchase your new home, you should make sure to have money saved up to cover all these expenses.

It’s important for you to begin saving up early and regularly so you can reach your saving goals as quickly as possible.

Take a look at your credit and debts

The first things a bank will look at when determining the size and interest rate of a potential loan are your credit history and how much debt you have. Specifically, lenders look for consistent and reliable behavior patterns that indicate you’re a safe investment for their money.

Do you pay your bills on time? Did you recently take out a loan for a car or other large expense? When you look at your finances, take a moment to see it through the eyes of a banker. Then, plan for how you’ll improve your financial situation if needed.

For example, you could request a free copy of your credit report from the three credit bureaus—Experian, Equifax and TransUnion—and dispute or fix any marks you may have against your credit. Or, if you have any outstanding debts, consider planning to pay them off quickly as a way of improving your debt-to-income ratio over the coming months.

If you have any issues you can’t easily solve (such as large outstanding debts) consider a few strategies that might offset the negative aspects of these factors.

For example, you may want to save up a larger down payment if you have a lower credit score. Or, if you used credit for a large purchase in the past few months, you may want to wait a little longer for the recent credit pull to fall off your credit report.

Calculate your debt-to-income ratio

Your debt-to-income ratio is the percentage of your gross monthly income that goes to paying down any monthly debts. When you go to a bank to take out a loan (such as a mortgage), the bank will calculate your debt-to-income ratio to determine the effect that the monthly payments will have on your finances.

In most cases, lenders will look for debt-to-income ratios of no more than 36% when qualifying someone for a mortgage, with no more than 28% of that debt going toward payments for housing.

As an example, let’s assume you want to buy a home and you have a gross monthly income of $10,000. This is the number on your paycheck before any deductions such as taxes or Social Security.

If you break down your monthly debt payments and add in how much you might have to pay a month for your mortgage, you’d see something like this:

• Expected mortgage payment: $2,000
• Car loan: $500
• Credit card payment: $300
• Student loan payment: $200

If you add all these numbers up, you get a total of $3,000 in required monthly payments, $2,000 of which would go toward the expected mortgage payments. Using the ratios from earlier, this would lead a total debt-to-income ratio of 30% with housing costs sitting at 20% of your gross monthly income.

Since these numbers are lower than the 36%/28% numbers mentioned above, there’s an increased likelihood that you could get a preferred rate on a mortgage for your new home.

3. Figure out how much house you can afford

Determining how much house you can afford can be difficult. From monthly mortgage payments to taxes and more, it can sometimes be challenging to budget out how much you should expect to spend on your dream home.

As someone looking to buy your first home, there are two general strategies for figuring out your budget: mortgage prequalification and mortgage calculators.

Get prequalified with your mortgage lender

Prequalification is basically a rough estimate of how much money your lender is likely to give you to buy your new home. Most lenders offer basic prequalification services as a way of helping you estimate how much home you can afford.

Since prequalification is an informal process, the estimate will usually be based on basic numbers such as your income and basic information from your credit report.

Once you have your prequalification estimate in hand, you’ll have a basic idea of the absolute maximum of how much you should spend on buying your first home. This can help you set an upper bound on your budget as you begin to look at potential homes in your area.

Calculate your maximum budget

As mentioned above, your debt-to-income ratio will determine how much you can spend per month on your mortgage, and generally caps your payments at around 28% of your gross monthly income.

For example, if you have a gross monthly income of $10,000, you should spend no more than $2,800 per month on mortgage payments.

You can calculate these numbers using our financial calculators:

• How much home can I afford?
• How much can I borrow for my home loan?
• How much will my mortgage payments be?

Take a moment to play with the numbers in each calculator to find an amount that works for you.

Find a budget that’s realistic for your finances

Many first-time buyers make the mistake of borrowing the maximum amount a bank will loan them and become “house-poor” because their monthly mortgage payment takes up too much of their monthly budget. This can make it difficult to pay for other regular expenses such as food, gas, utilities and home repairs.

Remember, a lender offering you a certain amount of money doesn’t mean you need to borrow the full amount.

When determining your budget you should account for other housing costs—such as property taxes, homeowner’s insurance, maintenance costs and closing costs. Make sure to add up these expenses in addition to your monthly mortgage payment to figure out a more accurate number of how much house you can afford.

Not only will this make it easier for you to budget for home improvement projects and living expenses, but it will also give you some wiggle room if you want to put in a larger offer for your dream home.

4. Create a list of “must-haves” to narrow your homebuying search

Once you have a general budget in mind, it’s often smart to create a homebuying wish list that can help you narrow down your search to only a few potential options.

There are several homebuying wish lists available on the internet, but most focus on three categories:

1. Priorities — Priorities are the things you can’t do without, such as a house being in a safe neighborhood or having a backyard. Try to aim for only three to five priorities as your main way of excluding houses that don’t match your criteria.
2. Wants — Wants are things that factor into your decision-making process but may not rule a house out by themselves, such as having a modern kitchen or being near a specific location.
3. Wishes — Wishes are factors that can help you choose between otherwise identical options, such as the square footage of the master bedroom or the presence of hardwood floors.

Once you itemize the factors that are the most important to you, use the list to narrow down your search to only a few options in your desired area. Having a list of requirements in hand to compare against the local market can also give you perspective of how much you should expect to pay for your dream home at the start of your search.

For example, you may find that homes with an attached garage cost more than your budgeted amount, meaning you’ll have to either raise your budget or change your list of priorities to match the current state of the market.

5. Don’t try to time the market

The housing market constantly moves up and down based on hundreds if not thousands of factors happening all around the world. For this reason, no one can tell you with certainty what the market will do in the next year, or even in the next week.

The phrase “timing the market” refers to the process of trying to predict the best time to buy a new home and then waiting until that moment to pull the trigger. However, trying to time the market will usually only lead to frustration for the average homebuyer—especially a first-time homebuyer.

While the overall state of the market is certainly a factor you should consider, waiting to buy a home until some unpredictable perfect moment will likely only leave you frustrated and renting for the foreseeable future.

Start your homebuying journey today

Buying your first home is a practice in debt management and smart saving habits. To qualify for a mortgage, you’ll need to have your finances in order. This means making sure you have strong credit, a low debt-to-income ratio and a down payment of around 20% of your budgeted mortgage loan amount.

However, even if you don’t have these things right now you should know that home ownership is still an attainable goal. With a little financial planning and some saving goals in place, you can start down the path toward a first home of your own.

Reach out to your local Associated Bank if you have any questions about purchasing your first home—or if you’d like to prequalify for a mortgage. We understand that the homebuying process is unique for everyone, and we’ll partner with you to make the process as easy and straightforward as possible.