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

While financing the purchase of a home is a huge achievement, there's a lot you need to navigate to make it a reality.

That's especially true when it comes to your finances.

From having a good credit score and low debt-to-income ratio to being able to demonstrate adequate cash reserves, the state of your overall financial health is critical to mortgage lenders.

CNBC Select explains what lenders are looking for when considering approving borrowers for a home loan.

Your credit score is one of the most important factors related to your financial health since lenders use it (and your credit report) to determine approval and the interest rates you'll qualify for.

A higher credit score typically results in a lower mortgage rate, so it's in your best interest to improve 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.

Some mortgage lenders cater to borrowers with lower credit scores, but you'll probably end up receiving a higher interest rate.

Double-check your credit report for any inaccuracies or signs of fraud. 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 IdentityForce® can alert you to any issues.

Your debt-to-income ratio will be scrutinized when you apply for a home loan. A general rule of thumb is your DTI ratio shouldn't be more than 43%, and even lower is better.

To lower your debt-to-income ratio, 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. It 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.

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 warp.

That's why saving just enough money for a down payment and closing costs doesn't cut it: It's important to be prepared to cover unforeseen expenses with an emergency fund you can easily access in a dire situation.

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 situation and how much your monthly expenses usually end up being.

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 an Ally Online Savings Account. Both have generous returns, helping to grow your emergency fund that much quicker.

It's important to know how much you can afford to spend on a new house. Getting preapproved for a mortgage can give you an accurate idea of how much of a loan you 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 mau have. So, 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 costs 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.

Besides having the money for a down payment, closing costs, mortgage insurance and other up-front costs, lenders want to see you have a healthy amount of savings that can be used to make mortgage payments.

Many lenders require three to six months of mortgage payments in reserves, but you may need more, depending on the size of the loan and your overall financial picture.

While these reserves can be in checking or savings accounts, investment accounts and even retirement funds, money given as a gift by a loved one is often discounted because it doesn't demonstrate sustained income.

At CNBC Select, our mission is to provide our readers with high-quality service journalism and comprehensive consumer advice so they can make informed decisions with their money. Every tax article is based on rigorous reporting by our team of expert writers and editors with extensive knowledge of tax products. To research the best insurance companies, we compiled over 100 data points on more than a dozen insurance companies. While CNBC Select earns a commission from affiliate partners on many offers and links, we create all our content without input from our commercial team or any outside third parties, and we pride ourselves on our journalistic standards and ethics.

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