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With the wealth of mortgage options available on the market, buying a new home or refinancing your mortgage can be a confusing, complicated process. The same can be said of getting pre-approved for a mortgage, a crucial step to take before scouring your local market for a new home.
With that in mind, Motley Fool analysts, Kristine Hartjes and Nathan Hamilton, discuss in the video below two ways that people can unknowingly sabotage their chances to secure a low mortgage rate during the preapproval process.
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KRISTINE HARJES:
So we're here, today, talking about mortgages and something that you hear about all the time, in the discussion about mortgages, is pre-approval. What is it? Why is it so important?
NATHAN HAMILTON:
It's a smart thing to do — put it that way — but here's some context to it. If you were in a market where it's a good seller's market and there are a lot of offers for a home, getting pre-approved shows the seller exactly how much you're qualified for. You're a serious buyer. Really, it just expedites that whole closing process.
Buying a house can be pretty emotional sometimes, and it helps you understand, "I can afford this much house. Maybe I can't go for that nice renovated kitchen. Maybe we need to stick with this kitchen. That's good enough." It just helps in the home-buying process altogether.
KRISTINE HARJES:
And something else that's worth keeping in mind when you're going through this process is that every little hair of a percentage point counts when you're looking at your interest rate. For example, if you have a $200,000 30-year mortgage, that will end up costing you $345,000 at the low rate of 4.04%, but it will cost you $388,000 if you're paying 5.04%. It's only a percentage point difference, but it ends up costing you $43,000 over the life of that mortgage. What do we do to avoid high interest rates?
NATHAN HAMILTON:
There are two things that you can do to improve your chances, but some new homeowners tend to make these mistakes not realizing that they're potentially losing that $43,000 down the road.
The first one is changing jobs just before or even during the pre-approval process. [If you think about it, a bank is lending you money]. They want to make sure that you're not a risky borrower. They want to get paid back and earn a return. And one factor that they use to determine [if] you are risky or not to lend to is what [your job history is]. Do you have stable income? It's really important in that process.
KRISTINE HARJES:
Right. And there is a little bit of wiggle room, there. You're allowed to change jobs to a similar job with a similar income; but if you're quitting your steady job to become an entrepreneur, that will be seen as a little bit riskier by a lender.
NATHAN HAMILTON:
Yes, if you have that dream of opening up that cafe or coffee shop and you're ditching your income to do it, it's probably not a good time to get pre-approved.
KRISTINE HARJES:
Exactly. And so another way that homebuyers are potentially sabotaging themselves and their savings is by ignoring their credit score during this process.
NATHAN HAMILTON:
I'd be willing to bet more people are doing it than not. I actually came across some research, recently, that says 60% of Americans (and this is astounding) don't know their credit score. That number is hugely impactful on your financial life. It determines what rate you can get and, as was showed in the example before, determines whether you're able to save $43,000. And that's just for a mortgage. You've got credit cards. Auto loans. [Maybe] you're renting an apartment. All of that is impacted by your credit score.
So make sure to take the time. Prepare beforehand. Look at your credit score a year before you even start to look at a house and verify if everything is set. Are there errors? Are there steps I can take now to improve it?
And the two biggest factors that are going to impact your credit score are two of the easiest ones to fix, and it's just pay your bills on time and don't borrow a lot of debt. So on credit cards if you have a utilization ratio (which is the amount of debt you're borrowing versus what you have available), if you're currently borrowing or overextending yourself on your credit card debt [then] 12 months before you get a home, just make sure to pay it down. Take those steps to get that utilization low. Below 30% you're going to get some improvement in your FICO score. Below 10% you're going to get some even better improvements, and 0% may even be an option, as well.
KRISTINE HARJES:
Right. These two things are so important, but there actually are also other steps that you can take to [00:03:57 lower] your credit score, and if you're looking for them, go to Fool.com/Mortgages where you can find a link to get this free report about how to increase your credit score over 800. Five tips for you.
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