Buying your first home is an incredibly exciting time, but it can also be a frightening one, especially when considering the cost associated with such a purchase. But before you apply for a mortgage, there are a few things you should know first. Understanding the process will help you make a more informed decision and get the most out of your mortgage.
Here are a few mortgage tips that all first-timers should know.
1. Don’t Take Out the Amount You’re Approved For
The amount that a lender agrees to loan you isn’t necessarily the amount you should agree to take out. Just because you’ve been granted approval for a certain amount of money doesn’t mean you should take it. In fact, you’d be wise not to. Instead, you might only want to take out a fraction of what you’ve been approved for.
If you spend the limit of what a lender is willing to loan out to you, it’s very possible that you may find yourself with a very tight budget to balance. And if you experience any negative financial circumstances in the near future, you could find yourself in a tough spot.
Lenders use your gross income and debts to assess how much you would be approved for, but they don’t factor in your lifestyle and spending habits. There are a ton of other expenses to cover that aren’t necessarily accounted for in the financial documents that you provide to your lender, such as travel, entertainment, daycare, extracurricular activities for the kids, and so forth. Your lender won’t take all of these extra costs into account when determining how much to lend you.
Stay well below your mortgage approval limit to give you a financial cushion to fall back on and to avoid maxing out on your ability to pay all of life’s expenses.
2. Save Up a 20% Down Payment to Avoid Extra Fees
Homes are incredibly expensive these days, so saving up for a down payment that’s 20% of the purchase price can be a tall order. But it’s not impossible, and the benefits of spending the time saving up for a hefty down payment are well worth it.
Putting down 20% means you’ll avoid having to pay private mortgage insurance (PMI). This policy is meant to protect your lender, not you, but you’ll still be paying the fee anyway. The lower the down payment amount, the higher the perceived risk to lenders. As such, an insured mortgage is meant to protect lenders in case borrowers default on their mortgages.
Unfortunately, you’re the one stuck with this fee until you’ve managed to pay down your mortgage balance to 80% of the property’s original appraised value. Until then, you’ll be paying anywhere between 0.5% to 1% of the loan amount on a yearly basis. On a $500,000 mortgage, for instance, you would be paying $5,000 per year based on a 1% PMI rate. That’s a lot of money that you could have otherwise sent elsewhere.
If possible, try your best to save up as much money as you can to be put towards a down payment. This will help you avoid throwing your money away on these extra insurance fees.
3. Take Measures to Boost Your Credit Score
Your credit score plays a key role in the interest rate that your lender is willing to offer you. The higher the rate, the more you’ll be paying. Even just a half of a percentage point on the interest rate can save you a ton of money.
For instance, a $100,000 fixed-rate mortgage on a 5-year term would cost you $53,405 in interest over the life of the loan base don a 3.7% rate. Slightly lowering the rate to 3.0% would cut down on interest to $42,250 over the life of the mortgage. That’s $11,155 in savings.
Besides paying less in interest, borrowers with a higher credit score have a better chance of getting approved for a mortgage. Generally speaking, lenders are seldom willing to approve borrowers who have a credit score of less than 620. If your score is currently less than that, now is the time to take steps to improve it.
Be sure to pay all of your creditors on time and in full, every month. Pay down as much of your credit card balance as you can instead of just making the minimum payments. And don’t take out any new debt, which will only increase your debt load and potentially have a negative effect on your score.
Making an effort to increase your credit score will help improve the odds of mortgage approval at a lower interest rate.
4. Budget For More Than Just Your Mortgage Payments
Your mortgage payments will probably be one of your biggest bills to pay every month, but they won’t be the only ones. Owning a home is an expensive endeavor that involves a lot more than just paying your mortgage. There are a few other costs associated with running a home that you should budget for.
Utility bills, new furniture, repairs, maintenance, and other costs will need to be covered. For this reason, it would be wise to come up with a workable budget that factors in all the fees associated with operating your home. Make sure you’re comfortably able to cover these extra costs in addition to making your mortgage payments every month.
5. Get a Mortgage Pre-Approval
Don’t start looking for a home until you’ve spoken with a mortgage broker and have been pre-approved for a mortgage. Doing so will help you identify how much you’ll be able to afford, which can help you narrow your focus on properties that fit your budget. Otherwise, you could be wasting your time looking at homes that are a lot more than you can realistically afford.
In addition, having a pre-approval letter in hand will show sellers that you’re a serious buyer and are financially capable of securing financing to make a home purchase. Sellers don’t want to take a chance on a buyer who may or may not be able to get a mortgage to close a deal. Those who are pre-approved stand a better chance of mortgage approval.
6. Shop Around
Consumers tend to look around and comparison shop before they make a purchase. After all, they want to make sure they’re not spending any more for a particular item than necessary. The same can be said for mortgages: by shopping around, you’ll be able to find the right lender who will offer you the right home loan package best suited for you.
Failure to shop around for a home loan can cost you. Without considering different interest rates, terms, and fee structures from different lenders, you could be missing out on significant savings. As mentioned earlier, a slightly lower rate can mean the difference of thousands of dollars over the life of the loan. That’s why it’s so important to scope out several lenders and see what they have to offer before settling on a deal.
The Bottom Line
As a first-time homebuyer, you’ll most likely need a mortgage to help you finance a home purchase. But you shouldn’t go into the process blindly. Instead, get acquainted with the mortgage process in order to take the right steps and make the best decision regarding your financing. Long before you start house hunting, speak with a mortgage specialist in depth to find out what you can do to put your best foot forward and set yourself up for success.