by Matt Frankel, CFP | Dec. 7, 2020
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Your mortgage application will be much smoother if you follow these tips.
If you're in the market for your first home, the process may seem pretty daunting. Here are 15 things you should know that could save you thousands of dollars and minimize home buying regrets.
Let's say you're hoping to score a 30-year mortgage for a $200,000 house. You have a FICO® score of 650. With that credit score, you can expect to pay around $120,385 in interest (as of this writing) over the life of the loan. So you're basically paying $320,385 for a $200,000 house.
But let's say you raise your credit score to 680. Now, your interest costs will be significantly lower. You'll only pay about $95,194 in interest -- you've saved yourself $25,192.
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Having a higher credit score is like having an automatic mortgage discount. Before you start the home buying process, it can be a good idea to check your credit score. Then, take steps to boost your credit score.
Lenders generally use two different debt ratios to determine how much you can borrow.
First, your monthly housing payment (including taxes and insurance) should be no more than 28% of your pre-tax income. Use our mortgage payment calculator to estimate monthly payments for mortgages of different sizes.
Second, your total debt (including your mortgage payment) should be no more than 36% of your pre-tax income.
The ratio that produces the lower payment is what the lender will use. Many lenders have more generous qualification ratios, but these are traditionally the most common.
If you have a credit card with a $20,000 limit, that doesn't necessarily mean that you should spend $20,000 on purchases with the card. The same logic is true when it comes to mortgages -- just because you can qualify for a certain mortgage amount doesn't mean that you have to max out your budget.
Be sure that your new mortgage payment not only fits your bank's standards but your budget as well.
When you apply for a mortgage, you'll need to document your income, employment situation, identity, and more. It can be a good idea to start gathering the necessary documentation before you walk into a lender's office.
To start, locate these documents:
To be clear, you don't need a pre-approval to start looking at houses. But a pre-approval can be an extremely valuable shopping tool.
If you submit a pre-approval letter along with your offer on a home, the seller knows you're serious. The pre-approval letter shows you're not likely to run into trouble when obtaining financing.
The mortgage industry standard is a 20% down payment. However, you may be able to get a conventional mortgage with significantly less money up front -- as low as 3% of the purchase price in many cases.
Specialized loan types, such as VA and USDA mortgages require no down payments at all for those who qualify.
A higher down payment will lower your monthly housing costs. However, you can buy a home with a small down payment if necessary.
Generally speaking, you can expect closing costs to be in the neighborhood of 2%-3% of your mortgage principal amount. So, on a $200,000 mortgage, you can expect a bill of up to $6,000 that must be paid when you get the keys.
However, it's perfectly acceptable to work seller-paid closing costs into your offer in order to reduce your out-of-pocket expense. In other words, if you want to offer $195,000 on a home, you can offer $200,000 and ask the seller to pay up to $5,000 in closing costs for you.
This can be an excellent strategy for first-time buyers with limited savings to improve their ability to get a mortgage.
Typically, you'll need a minimum of a 620 FICO score to qualify for a conventional mortgage. But it can be difficult to qualify with a low credit score if your other qualifications aren't stellar.
An alternative to conventional mortgages is the FHA mortgage. This is designed for borrowers with qualifications that don't meet the standards of conventional lenders.
The downside is that FHA loans can be significantly more expensive each month. Nevertheless, they can be great resources for people who otherwise wouldn't be able to qualify for a mortgage.
If you put less than 20% down on your mortgage, you'll probably have to pay private mortgage insurance, or PMI. Make sure you budget for this while mortgage-shopping.
Mortgage insurance rates can vary significantly. Rates depend on your credit, the length of your mortgage, size of your down payment, and other factors.
One common mistake among first-timers and repeat buyers alike is accepting the first mortgage that's offered.
A seemingly small difference in mortgage rates can save you thousands of dollars over the course of a 30-year mortgage. As long as all of your mortgage applications take place within a short time period, mortgage shopping won't hurt your credit. Check out our guide to shopping mortgage lenders for tips on how to get started.
When you're shopping around, don't just check the big national mortgage lenders. Some regional or local banks may offer unique lending programs, especially for first-time homebuyers. For example, the young couple who bought a house from me a few years ago used a 100% financing program from Regions Financial that required no mortgage insurance for first-time buyers with outstanding credit.
If you can afford high mortgage payments, or you're willing to buy a less expensive home, consider a 15-year mortgage. This type of mortgage can save you thousands of dollars in interest and can allow you to own your home quickly. Fifteen-year interest rates are about one percentage point lower than 30-year rates. You might be surprised how much the combination of a lower rate and shorter amortization period can save you.
For the majority of homebuyers, a fixed-rate loan is the best choice. However, if you don't plan on being in the home you buy for more than a few years, an adjustable-rate mortgage could save you thousands of dollars in interest.
For example, if you're buying a home to live in during four years of graduate school, an adjustable-rate mortgage with a five-year initial rate period could be a smart idea.
In a perfect world, you could apply for a mortgage, have the home inspected, and show up at the closing table a month later to wrap things up. Sometimes that happens, but it's rarely that easy. More often than not, there are some hassles along the way.
When I was buying my first home, my lender called me three days before closing. My credit score had fallen to one point below the threshold for my interest rate. I was told I would either have to take an action that would improve my credit score immediately or accept a significantly higher interest rate. The solution required me to pay off one of my credit cards and fax proof of it to the lender -- not an impossible situation, but certainly a hassle.
Continuing on my last point, it's a good practice not to use your credit for anything out of the ordinary between the time you're approved for your mortgage and when you actually close on the home.
Lenders will generally pull your credit at least twice -- when you originally apply and shortly before closing (as happened in my situation). If there are any significant differences between the two, such as a new account or a significantly higher debt balance, it could lead to delays and could even disqualify you for the mortgage. Just leave your credit alone until you've signed your closing documents.
Chances are, interest rates won't stay put at multi-decade lows for much longer. That's why taking action today is crucial, whether you're wanting to refinance and cut your mortgage payment or you're ready to pull the trigger on a new home purchase.
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