The Financial Steps to Take Before Applying for a Mortgage

Tom Gilmour is a senior director of Planning Experience Integration for Northwestern Mutual.

Dreaming about owning a house or condo is exciting, but the process can get daunting once you get serious. Since most people don’t pay in cash, securing a mortgage is a major step. Here, we’ll guide you through the key financial steps to take before applying for a mortgage so that you’re set up for success.

1. Review your cash flow

Keep track of what’s coming in each month and where your money goes. Create a budget and figure out how much you can afford each month for your future home. This figure should ensure that you’re still able to pay your bills, cover your lifestyle and keep working toward other financial goals. You don’t want to take on such a huge loan that it leaves you unable to enjoy life or keep up your emergency fund.

2. Check your credit report

Mortgage lenders will look at your credit score (most likely a particular version called your FICO^® score) to gauge your level of financial responsibility. A better score typically means you’ll pay less in interest, which can save you thousands of dollars over the life of your loan.

While a perfect FICO score is 850, scores of 800 and above are considered exceptional, according to Experian, one of the credit reporting agencies. A very good score is 740 to 799, a good credit score is 670 to 739, a fair score is 580 to 669, and a poor score is 300 to 579.

A FICO score is based on information like:

1. Payment history: Record of on-time payments on credit accounts.
2. Amounts owed: Total amount of debt and the ratio of credit used to total credit available.
3. Length of credit history: Time span of credit accounts.
4. New credit: The number of recently opened accounts and credit inquiries.
5. Credit mix: Variety of credit accounts (e.g., credit cards, mortgage, installment loans).

To see the details behind your score, you can get a free copy of your credit report from each of the three major credit bureaus (Equifax, Experian and TransUnion). Go to AnnualCreditReport.com. This website is authorized by the federal government.

The credit report doesn’t include your actual score—for that, you’ll have to pay a small fee—but it does show your credit history, including any blemishes like missed credit card payments. (Some credit card companies or other financial institutions will show your credit score for free on your monthly statements or on request.)

It’s worth checking your credit report before applying for a home loan because there might be errors that are damaging your score. A 2024 Consumer Reports investigation with the nonprofit WorkMoney found that 44 percent of their 4,300 volunteer participants spotted at least one error on their report. And many errors were serious. In fact, 27 percent of the errors could have affected their creditworthiness in terms of the ability to get a loan or credit card, rent an apartment or pay lower rates for auto insurance.

If you find an error on your credit report, report it. Here are the steps:

Dispute the error with the credit bureau. You can reach out online, in writing or by phone. You should provide a clear explanation of why you believe the information is inaccurate plus any supporting documentation.

Also, dispute the error with the company that furnished the information to the credit bureau. Again, provide them with any supporting documentation you have. Request that they correct their records and update the credit bureaus.

Monitor the investigation. It typically takes 30 to 45 days for the credit bureau to investigate your dispute.

If the credit bureau does not correct the error to your satisfaction, you can file a complaint with the Consumer Financial Protection Bureau.

If your credit is in bad shape because of late or missed payments or something else you did, then it could take several months to boost your score. So you may want to wait until your score goes up before applying for a mortgage.

Credit score requirements depend on what type of loan you’re getting. For most conventional loans, you need a FICO score of at least 620. Some alternative loans will accept a lower score.

3. Calculate your debt-to-income ratio

While your credit score is an important number that potential lenders will use to evaluate your mortgage application, it’s not the only number that you need to keep an eye on. Mortgage lenders will also consider your debt-to-income ratio.

This ratio quickly shows how much debt you have compared to your income. Lenders use it along with other numbers to predict how likely you are to repay the loan.

With this number, lower is better. A low debt-to-income ratio means you’ll be viewed as a less risky borrower. This can improve your chances of having your mortgage application approved, and it can even increase the amount that you’re approved to borrow. To improve your ratio, you’ll need to reduce your debt.

4. Gather documents

To apply for a home loan, you’ll actually start by seeking preapproval. That way, you’ll find out how much a particular bank may be willing to lend you so you know what your price range is.

Preapproval involves a thorough review of the borrower's credit report, income, assets and debts. The lender then provides a written commitment for a loan amount, subject to final approval (and other conditions).

To get preapproval, you’ll provide the mortgage lender with a number of documents. For the typical home buyer, this includes the following:

• Pay stubs from the past 30 days showing your year-to-date income
• Two years of federal tax returns
• Two years of W-2 forms
• 60 days or a quarterly statement of all your accounts, including your checking, savings and any investment accounts
• Residential history for the past two years, including landlord contact information if you rented
• Proof of funds for the down payment, such as a bank statement. If the cash is from a gift, you may also need to provide a gift letter to prove the money isn’t a loan.

You might hear about the 2-2-2 rule at this point. It’s a shorthand way to refer to the lender’s assessment of your ability to repay the mortgage. You provide documents showing that you have a stable employment history and consistent income. This reduces the lender's risk and increases the likelihood that your loan application will be approved. The numbers in the 2-2-2 rule refer to groups of documents:

• Two years of employment history–Demonstrates job stability
• Two years of tax returns–Provides a comprehensive view of income, especially for self-employed people
• Two most recent pay stubs–Confirms current employment and income

5. Determine your down payment amount

For a conventional loan, there are a couple of main benefits to making the widely recommended 20 percent down payment. The obvious one is that a larger down payment means a smaller monthly mortgage payment—and less money you’ll pay in interest over the life of the loan.

The other perk of putting 20 percent down is that you avoid paying private mortgage insurance (PMI). That money protects the mortgage lender in case you can’t pay the loan back. PMI ranges from about 0.5 to 2 percent of your home loan and is usually paid in monthly installments or as an upfront premium. Once you have around 20 percent equity in your home, you can usually get rid of PMI.

If you don’t have a conventional loan but have a Federal Housing Administration (FHA) loan, you’ll typically have to pay an upfront and monthly insurance premium (MIP). That’s true even if you have a large down payment. The timing for when or if the MIP is canceled depends on your loan terms.

6. Budget for closing costs

In addition to the cash that you’ll need for the down payment, you’ll also have to cover your share of the closing costs. These are one-time fees but can be surprisingly high.

Closing costs typically run from 2 to 5 percent of the home’s purchase price. For example, on a $300,000 home, your closing costs might be between $6,000 and $15,000. While that’s a wide range, your mortgage lender will provide you with a Loan Estimate, a document that spells out the terms of the mortgage, including the loan amount, interest rate and predicted closing costs.

At least three business days before closing, your lender must also provide a Closing Disclosure, which gives a final accounting of your loan terms and all closing costs. This waiting period ensures you have time to review and understand the final terms before proceeding with the transaction.

If significant changes to the loan terms occur—such as an increase in annual percentage rate, known as APR, beyond certain thresholds—the lender must provide a revised Closing Disclosure. A new three-business-day waiting period will apply.

Keep in mind that the entire mortgage approval process typically takes between 30 to 45 days from application to closing.

7. Talk with your financial advisor

As you begin to budget for a home, it’s important to know what you’re getting into and how much you can realistically spend. This can be a good time to check in with your Northwestern Mutual financial advisor. They can help by looking at your broader financial picture. They’ll look at a variety of financial tools, including insurance and investments, to see how you can meet your goals.

Together you can build a plan that’ll map out ways to grow and protect your money, including flexible financial tools like whole life insurance.

Your plan is personalized to you and will help you meet goals like buying your home—while keeping your other goals on track. Over time, your advisor can continue to point out opportunities and blind spots that can help you live the life you want, now and in the future.

Certified Financial Planner Board of Standards Center for Financial Planning, Inc. owns and licenses the certification marks CFP^®, CERTIFIED FINANCIAL PLANNER^®, and CFP^® (with plaque design) in the United States to Certified Financial Planner Board of Standards, Inc., which authorizes individuals who successfully complete the organization’s initial and ongoing certification requirements to use the certification marks.