If you've been thinking of buying a home, this might be a good year in which to do it. Interest rates have begun rising, and some experts are predicting that home prices will rise this year, too. Don't approach the home-buying process in a haphazard way, though. Be a savvy, informed buyer, and you may be able to save thousands of dollars -- and perhaps afford a better home, too.
Here are some critical mortgage tips you need to know as you start thinking about, and looking at, places that might become your next home.
A high credit score will get you low interest rates
Many people underestimate just how much influence their credit scores have on the interest rates that lenders offer them. If your credit score isn't as high as it could be, consider spending some time beefing it up before starting to buy a home. You might do so by fixing errors in your credit record, paying bills on time, and reducing your overall debt load.
To understand the kind of difference your credit score makes in the interest rates you're offered, consider sample rates listed at MyFICO.com. When I checked it recently, it showed that, if you were borrowing $200,000 via a 30-year fixed-rate mortgage and you had a top FICO score in the 760 to 850 range, you might get an interest rate of 3.9%, with a monthly payment of $941 and total interest paid over the 30 years of $138,735. If your score was 630, though, your rate would be 5.5%, with a monthly payment of $1,132 and total interest of $207,364. That's $191 more per month -- $2,292 per year -- and a whopping $68,629 more in interest.
Shopping around for a mortgage can yield a better deal
If you're offered a decent mortgage rate from a lender, don't stop there. Different lenders use different calculations when they assess you and quote interest rates. It's true that your own bank(s) may give you a bit of a discount because you're a customer. But check with other banks, too -- and with credit unions, which often sport lower interest rates.
You might also consult a mortgage broker, as a good one can access rates from a wide range of lenders and can be especially helpful if you have an underwhelming credit record. Visit Bankrate.com, too, where you can look up the best rates in your area and beyond.
Don't buy more home than you can afford
If you start looking at homes that cost around $300,000, it's not uncommon to find yourself suddenly considering ones that cost $325,000 or $350,000. It's tempting to look a bit beyond your price range, as you'll see homes that are bigger, or just better in some ways. Resist that temptation, though. If you spend more than what you can really afford, you'll be stretched thin financially.
Some suggest spending no more than 25% to 30% of your gross monthly income on housing (including property taxes and insurance), but instead of relying on that broad guideline, take the time to figure out just what you can afford. For many people, it's smarter and safer to spend no more than 20% on housing.
Take into consideration your regular household expenses, such as food, utilities, transportation, insurance, travel, entertainment, auto maintenance, debt payments, contributions to savings accounts, and so on -- and factor in other expenses, too, such as medical or automotive emergencies and the cost of prepping your old home for sale and setting up your new one. Buying less home than you can afford will give you a margin of safety and help you meet other financial goals, such as saving for retirement or college.
Aim to pay at least 20% down
One way to buy a bigger home than you can afford is by making a small down payment. It's generally not a good idea, though. Putting less than 20% down on a new home means you'll have to take on an extra loan in the form of private mortgage insurance (PMI), which will increase your monthly payment.
A low down payment might also result in a higher interest rate. It's particularly bad if home values drop during your ownership period, leaving you with an "underwater" mortgage, where you owe more than the home is worth. That can make it hard to sell the home if you need or want to.
Get pre-approved for a mortgage, once you're ready
Once you know what loan you want and from which lender, don't wait until you find the home of your dreams to start the paperwork. Get pre-approved for the loan before you go shopping. This has several advantages.
First, through the process of working with a loan officer, you can determine just how much home you can afford to buy. Second, it will make you a more credible buyer should you end up bidding against any other buyers for a home. Pre-approval means that the lender will have looked at your credit score, your employment, your financial health, and perhaps some tax returns -- and found you creditworthy.
Choose the kind of mortgage that will serve you best
Finally, remember that mortgages come in a variety of shapes and sizes. Don't assume that a standard 30-year fixed-rate mortgage will serve you best. It might, but consider alternatives.
For example, you need to decide between a 15-year or 30-year loan -- other time frames are also available -- and between a fixed-rate mortgage or adjustable-rate mortgage (ARM). Longer terms will give you lower payments, but you'll pay much more in interest over the life of the loan.
Consider this example from a Bankrate.com calculator. If you took out a $200,000 mortgage at the recent national average interest rates of 4.27% for a 30-year fixed-rate loan and 3.49% for a 15-year fixed-rate loan, you'd pay a total of $57,181 in interest over the life of the 15-year loan and $155,040 over the life of the 30-year loan. That's almost $100,000 more!
If you're not comfortable with a 15-year mortgage's steeper payments, consider getting a 30-year loan that permits prepayments -- then aim to pay significantly more than you need to each month in order to shorten the life of the loan. If you're not planning to be in the home long, an ARM could serve you better in today's low-interest rate environment, as it can lock in ultra-low rates for a few years. If you think you'll be in the home for decades, though, it can be better to lock in a low rate for the expected long life of the loan -- especially because interest rates have started inching up.
Keep these mortgage tips in mind as you prepare to hunt for and buy a new home. They may save you many thousands of dollars.