How to get your finances in order before applying for a mortgage

While purchasing a home is a huge financial achievement, it can feel like there's a lot you need to learn to navigate the process, especially when it comes to preparing your finances.

Below, Select breaks down a few steps you can take to make sure you're as prepared for the homebuying process as possible.

Your credit score is one of the most important factors that's related to your financial health since lenders use this — as well as your credit report — to determine the interest rates you'll qualify for when applying for any line of credit or loan.

Interest rates can make borrowing money even more expensive. The higher the rate, the more costly it will be to take on that loan or line of credit. The same idea rings true for mortgages as well.

Keep in mind that some mortgage lenders do cater to borrowers with lower credit scores. When applying for a new line of credit or a loan with a lower credit score, you'll likely end up receiving a higher interest rate since the lender will view you as more of a risk.

Conversely, having a higher credit score typically results in getting a lower interest rate, making it more affordable to borrow money, so it's in your best interest to work on improving your credit score before submitting any mortgage applications. Continuing to pay your bills on time is the most important thing you can do to help raise your credit score.

As for your credit report, double check it for any inaccuracies that may be bringing down your credit score and increasing your debt-to-income ratio and make sure everything looks right. Lenders will want to make sure your total debt isn't significantly more than you can afford to manage before giving you a mortgage. Credit monitoring products like Experian (free) and IdentityForce® (paid) can help you monitor your credit report for any inaccuracies, potential fraud and identity theft.

Your debt-to-income ratio will definitely be scrutinized when you apply for a home loan, as lenders use this to determine whether or not you can actually afford to purchase a home. A general rule of thumb is your debt-to-income ratio cannot be more than 43% to qualify for a home purchase — and the lower this ratio is, the better.

One key way to lower your debt-to-income ratio is to pay down any existing debt, including any student loan debt, credit card debt, personal loans or other lines of credit you may have taken out.

The debt snowball method is one popular strategy for paying down debt faster, and involves eliminating the smallest debt balance first while paying just the minimum on all your other debts. Seeing smaller balances disappear first helps to keep you motivated, allowing you to work your way up to the largest amounts until you're completely debt free.

Another strategy, the debt avalanche method, involves eliminating your highest interest debt first while making minimum payments on the others and working your way down to the debt with the lowest interest rate. This method will actually help you save the most money on interest charges.

Unexpected expenses are bound to pop up as soon as you close on your home — the boiler needs replacing, the roof suddenly springs a leak or the floorboards start to look like they've seen better days.

That's why simply saving enough money to cover your down payment and closing costs just doesn't cut it when you're buying a home. It's important to be prepared to cover any unforeseen expenses as soon as possible. Having an emergency fund — a supply of cash you can access in the event of a dire situation — can help offset these surprise costs. 

Emergency savings can also help you continue to pay your mortgage payments in the event you are laid off after buying your home.

It's a good idea to keep your emergency fund in a relatively accessible account, such as a Marcus by Goldman Sachs High Yield Online Savings account or in an Ally Online Savings Account. With these high-yield savings accounts, you'll be paid interest on a monthly basis just for keeping a balance, helping to grow your emergency fund just a little quicker.

Experts typically recommend that you have an emergency fund made up of roughly three to six months worth of living expenses, though the amount you should save really depends on your individual situation and how much your monthly expenses usually end up being.

It's important to know how much you can actually afford to spend on a new home. Getting pre-approved for a mortgage can help you get a more accurate idea of how much of a loan you'll qualify for and what your monthly payments could look like.

That said, keep in mind that this estimate doesn't take into account other financial obligations you're on the hook for, such as assisting your family financially or other monthly payments that don't show up on your credit report.

For that reason, you should consider how much of a monthly mortgage payment you can comfortably afford. This can also be a good time to re-evaluate your monthly expenses and figure out which ones no longer serve you and which ones you can afford to scale back a little bit.

To estimate how much you can afford to spend on a new home, work with a financial planner or a real estate agent to do a deeper dive and see what a realistic budget would look like.

The down payment, a portion of the home's value, is one of the biggest upfront cost you'll have when purchasing a home. It can be as low as 0% if you qualify for a VA loan or 3.5% if you're applying for an FHA loan. Keep in mind that most conventional loans require a down payment of 5% to 20% of the home's value.

That said, some lenders do offer special loan options, such as the DreaMaker loan from Chase Bank, which requires a down payment of just 3%.

Closing costs are yet another set of expenses you'll need to be prepared to pay when buying your home, and can add up to around 2% to 5% of the loan amount to your final price. They also encompass appraisal fees, underwriting fees, home inspection fees, credit check fees and title insurance and title search fees, among other fees.

Fees are inevitable when purchasing a home, but it can help to apply for a mortgage through a lender that reduces or waives them. Ally Bank, for example, won't charge an application fee, origination fee, processing fee or underwriting fee.

Otherwise, be prepared to cover these fees so you aren't left scrambling at the last minute to scrape together extra savings.

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