What can you afford?

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Working out a monthly household budget, one that includes any additional expenses that come with homeownership, can tell you what you should borrow. This approach helps you find an amount what comfortably fits your budget rather than stretching your budget to fit the loan.

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Once you've factored in all the costs and found the monthly payment that comfortably fits your budget, talk with your lender and have them help you translate that payment into a realistic mortgage, loan or line of credit amount. When comparing different loans or lines of credit make sure you clearly understand their terms and would feel comfortable with the monthly payments throughout the life of the loan.

If you’re getting a home loan, you may want to consider prequalification. While it doesn’t give you a loan commitment or guarantee, it’s a good first step to see the amount and type of loan a lender could offer you. Finally, keep in mind how much you can afford to borrow without putting the rest of your financial plans on hold.

Taking control of your credit score

Knowing how your financial decisions can impact your credit score can give you more control over your personal finances. This is critical if you're in the market for a mortgage, but it's always useful to know how to improve your score and make informed choices about your financial future.

No matter what your credit score is, you can look for opportunities to improve it. Your score is generally calculated using five key factors from your credit report:

Amount owed - This compares your total available credit to the amount you currently owe. Lenders generally like you to use no more than 20% of the credit available to you. But opening more cards just to increase your available credit limit may not be a good strategy. That could shorten your length of credit history, which can also affect your credit score.

Payment history - This part of the score measures how timely you've been about paying your debts. A history of paying off debts on time helps increase a lender’s confidence that you will pay your mortgage or other loan in the future. Always paying your mortgage and other bills on time is one of the best ways to maintain healthy credit.

Length of credit history - This takes into account the age of your oldest account, the average age of all your accounts, and the time since the last activity on each account. Opening a new credit card could shorten your average credit history while hanging on to an older credit card could show lenders a longer history of established credit.

New credit accounts and inquiries - Every time you open a new account or apply for a new account an inquiry is created, which may negatively affect your score. Limiting the number of times you apply for a new account helps reduce inquiries and can help prevent your score from decreasing.

Types of credit in use - On your credit report it will list your credit cards, installment loans like car payments, mortgages, and other accounts. If you are a co-signer on any accounts these accounts will also appear on your credit report. Check your credit report for accuracy and report any errors to the credit agency. Also, keep in mind that closing accounts or paying them off will not remove delinquencies from your credit report.

Monitoring your credit - Now that you know the general factors that influence your credit score you may want to monitor your credit report periodically.

You can contact any of the three major credit reporting agencies: Equifax, Experian and TransUnion to request your credit report and your score.

You can visit annualcreditreport.com to get a free copy of your credit report, which reflects your account and payment history; however, you may have to pay to obtain a current FICO® score.

Saving for a down payment

One of the main things you can do to prepare for homeownership is save money for a down payment. The more money you can contribute as a down payment, the more attractive you'll be to lenders. In addition, you'll borrow less, which means you’ll pay less in interest expenses over the life of your loan.

How much of a down payment will you need depends on the purchase price of the home you would like to buy and your loan program. The down payment is a percentage of the home's purchase price, and different loan programs require different minimum down payments. If you can put down at least 20% on a conventional loan you will not have to pay private mortgage insurance (PMI). If you can’t put at least 20% down you will typically be required to pay for PMI. Speaking with a mortgage professional about requirements to qualify for a home loan could help you figure out where you stand and set goals for your future.

There are several steps you can take to get your down payment savings started. Or if you've already been saving, there may be ways to help grow your down payment faster.

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Set up a down payment savings account - When you start saving for your down payment, it's a good idea to keep your down payment fund separate from the rest of your money.

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Continue adding to your savings - There are several ways you can add small amounts to your savings account on a regular basis so that saving is part of your routine:

  1. Enroll in an auto-savings program.
  2. Every time you get cash at an ATM, transfer a little to your down payment savings account.
  3. Have a predetermined amount automatically deposited every week or month from your checking account.
  4. Cut back on some luxuries and deposit what you would have spent into your savings account instead.
  5. Use a gift. A family member or other person may give you a monetary gift that can be used to cover a portion of your down payment; if you also have a signed letter explaining that the money is a gift and does not need to be repaid. There are limits to the amount that can be gifted.
  6. Investments. As your savings grow, you may opt to invest it in order to earn more interest. To help protect your savings from a loss in value, consider low-risk investments.

Budgeting for taxes and insurance

Your monthly home payment is made up of four parts: principal, interest, taxes, and insurance (known as PITI). The principal and interest is paid to your lender, while the property taxes and homeowners insurance are paid to third parties.

As part of the initial home loan requirements, you may choose to (or be required to) set up an escrow account with your lender and pay taxes and insurance monthly along with your mortgage payment. An escrow account works like this: Each month, you place your prorated property tax and homeowners insurance payments into an account managed by your lender. When these bills are due (usually once or twice a year), your lender makes the payments on your behalf by withdrawing the appropriate amounts from the escrow account and sending to the appropriate third party.

If you don't have an escrow account, it's a good idea to set up a savings account just for your taxes and insurance to ensure that you have the appropriate funds set aside when the bill comes.

Your insurance company may offer a discount if you pay the full annual premium in one lump sum payment as opposed to monthly. Likewise, you can pay your property tax once or twice a year, but this may also be a large bill to plan for, depending on where you live and the value of your home. To estimate your property tax before you buy, call your county assessor's office or visit their website. They should be able to tell you the property tax rates applicable in your area.

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