Buying a mortgage is the most important purchase most people will make in their lifetimes. And it will also be one of the most expensive.
It is very important to make sure you are ready for a mortgage. The most important thing you need to do is get your credit rating as high as you can. Your credit rating will directly impact the interest rate you are offered. So make sure you start doing these things are early as possible:
- Pay all your bills on time
- Use as little of your available credit as possible
- Pay down your current debt as much as possible
- Don’t cancel any credit cards.
Over time, these actions will help raise your credit score. It’s also good to get a copy of your score so you can get a more accurate picture of your mortgage options. You may have to spend some money to get your score though. The cheapest way to do it is by getting it as an add-on when you get a free annual credit report from AnnualCreditReport.com.
Next you need to save for a down payment. In order to qualify for a conventional mortgage, you will have to put down a down payment of between 5% and 20% of the home. If you don’t have enough for a 5%, deposit you may still be able to qualify for a mortgage, but your options will be much more limited. And if you don’t want to pay mortgage insurance, you’ll have to put down more than 20%.
If you can’t manage a substantial down payment, you need to ask yourself if you are really ready to handle the burden of a mortgage. Saving for a down payment is excellent practice for the ability to manage a mortgage. And a big down payment will give you better rates, will pay down the principal you owe and lower the amount of interest you will have to pay. So if you can’t manage saving for a down payment, you may not be ready to handle a mortgage.
So what you should be looking for in a mortgage?
- The lowest interest rate you can get. Because a mortgage is the single most expensive purchase you will make, even a half point reduction in your interest rate can save you tens of thousands of dollars on your mortgage.
- The shortest term you can afford. The shorter the duration of the loan, the less total interest you will pay over the life of the mortgage. But the side effect of a short term is that you will have to pack the mortgage into fewer payments, thus raising the cost of each monthly payment. So try to get as short a term as you can, but one that is manageable.
Next, you’ll need to decide what kind of mortgage you want to get. You can get fixed rate and adjustable rate mortgages. Fixed rate mortgages are often preferred because they are predictable. You’ll know exactly what you’ll be paying until the day the mortgage is paid off. There will be no surprise changes to what you pay in the future.
Adjustable rate mortgages have interest rates that fluctuate. Usually they will have lower initial interest rates than the fixed rates mortgages on offer. But because the interest rate changes at fixed intervals in the future, the payments required to pay off the mortgage can change. Sometimes your payments will go down. But when interest rates are already low, they are more likely to go up. And when they go up, the added financial burden can be substantial.
There are also exotic adjustable rate mortgages with teaser rates that rise substantially later in the term of the mortgage. These mortgages are difficult to understand and even more difficult to manage. Avoid them if you can.
Now you have all the pieces of the puzzle. Armed with all of this information, use a mortgage calculator to figure out how much you can afford. There are great calculators at Bankrate.com, Zillow.com and Realtor.com. Look carefully at the monthly payment that the calculator generates. This is the cost you will have to shoulder month after month until your house is paid for. Make sure you can afford it!
Also compare your prospective payment to your income. This is called a debt to income ratio. The higher it is, the harder it will be to manage all of your debt. To find your debt to equity ratio, add up all you monthly debt payments (credit cards, car loans and the projected mortgage) and compare it to your monthly income (before taxes). If your debt ratio is 43% or above, your debt burden is very high, so high in fact that banks may not even lend to you. You should aim to have a ratio under 36% to make sure your mortgage isn’t too burdensome and that you have spare income to get through any financial bumps in the future.
Now that you know what kind of mortgage you want and how big a house you can afford, you can go look for a house!
You should have noticed that so far, you have not have gotten a quote for an actual mortgage yet. Which is good. When you start looking for mortgage quotes, the enquiries can actually ding your credit rating. The key is to get the quotes quickly (all within a month). So it makes sense to only shop for a mortgage when you are ready for one.
And make sure you get multiple quotes. Only around 50% of Americans get more than one mortgage quote! This is one of the most expensive decisions you will make in your life. It is essential that you get more than one quote.
So where do you look for a mortgage? Look to your own bank first. They know you and should give you a good rate. If you can’t get a good rate there, look to Credit Unions if you can. They can be more lenient with their requirements and can have competitive rates.
Mortgage brokers are the most flexible when it comes to different ways of financing a home. But be careful here. Being flexible can also mean being more costly.
If you have weak financials, a mortgage broker may offer you exotic adjustable rate mortgages that may look cheap today, but could hurt your wallet down the road.
Also look to sites like Lending Tree, which are loan marketplaces where lenders compete for your business. These sites are terrific ways of getting competitive quotes.
Once you get a quote, you will get a three-page form called a “loan estimate”. It will have all the information you need to gauge the full cost of your loan. Read it very carefully so that you understand what is ahead of you. The Consumer Financial Protection Bureau has a great list of questions you should ask yourself or the loan officer to make sure you’ve covered all issues with your loan.
Don’t ever feel pressured into signing the paperwork on a mortgage. You are under no obligation to sign if you are not completely comfortable with the loan. Your loan officer should answer every single one of the questions you have.
When you do sign, be ready for closing costs… But once everything is said and done, you will have an amazing place to call home, and an investment as well! Enjoy.