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Buying a home is likely the biggest investment most people will ever make. It’s exciting but also a huge financial commitment not to be taken lightly. Getting a mortgage is critical to affording that dream home, but there are many options and details to consider.
This article covers the key questions prospective homebuyers should ask themselves and their lender before signing on the dotted line for a mortgage.
A little preparation goes a long way towards securing the best mortgage terms and avoiding unpleasant surprises down the road.
What’s Your Credit Score?
First things first – get clued in on your current credit score from the three major credit bureaus.
Lenders live and breathe by credit scores when approving mortgages and setting interest rates. Those three little numbers tell lenders how risky or safe it is to lend to someone.
And the benefit for you is a lower interest rate and in turn a lower monthly mortgage payment.
Generally, scores above 760 net the lowest interest rates as lenders see minimal risk in extending credit.
Scores between 680-760 are considered good, but could mean paying moderately higher interest.
Below 620 may require some credit repair before approval or saddle borrowers with sky-high rates, if approved at all.
Get a free credit report and see for yourself what your score is as well as any issues you may need to take care of before looking for a mortgage.
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How Much Home Can You Afford?
Careful budgeting is crucial before shopping for homes and mortgages at lenders like Moreira Team. It is one of the first steps to buying a home.
Overextending on a monthly payment is a recipe for years of financial stress and struggle. As a broad guideline, experts suggest keeping overall cost under 30% of monthly gross income.
So, for someone earning USD$5,000 per month before taxes, the maximum affordable mortgage payment would be around USD$1,500. That includes principal, interest, property taxes, homeowners insurance, and any other recurring ownership costs.
It’s smart to leave ample breathing room in the budget as well. Build in a cash cushion for maintenance, emergencies, entertainment, and other inevitable expenses that come with homeownership.
Once you choose a mortgage lender they can help with this as they will give you a pre-approval for the amount of house you can afford.
How Large of a Down Payment Can You Make?
The longstanding mortgage product of a 20% down payment is still common but certainly not a must these days. Conventional loans allow as little as 5% down, while Federal Housing Administration (FHA) loans require only 3.5% down for first time home buyers.
However, putting down less than 20% means having to pay private mortgage insurance – an extra monthly fee that protects the lender should the borrower default. PMI can add USD$100+ to already pricey mortgage payments. Weigh the pros and cons carefully.
Bigger down payments accomplish two big goals. They reduce the total borrowed and interest paid over the loan’s lifetime. Plus, they provide an instant layer of home equity from day one – a nice safety net.
Check out these home buying tips for first time homebuyers.
What Loan Term Best Fits Your Plans?
Mortgages are built around two main loan terms – 30-year or 15-year. Each has its advantages and drawbacks to weigh.
The 30-year mortgage option is most popular as it provides the lowest possible monthly payment for a set loan amount.
While enticing for near-term affordability, 30-year loans mean paying a lot more total interest over time versus a 15-year mortgage. So essentially you pay more for the house you are buying.
But 15-year mortgages command higher monthly repayments to compensate for the accelerated payoff schedule.
They are best reserved for disciplined borrowers able to swing the higher but temporary monthly hit.
Think carefully about the anticipated time in that home when deciding between the two. If you are planning to move in five to seven years, then 30 years likely makes more sense than committing to a more aggressive, tighter payment for just a short stay.
Should You Pick Fixed or Adjustable Interest Rates?
Choosing between fixed or adjustable interest rates is another key decision point. Each has its pros and cons to evaluate.
Fixed-rate mortgages lock in an unchanging interest rate for the full mortgage term – either 15 or 30 years. These provide stability and predictable payments, but may start out a bit higher than the initial rate on adjustables.
Adjustable-rate mortgages (ARMs) have low introductory ‘teaser’ rates that are fixed for an initial period, commonly 5-10 years.
After that, rates adjust periodically based on market conditions – up or down. ARMs can save money in the near-term but carry more risk if rates rise substantially down the road.
ARMs make more sense for those planning to sell or refinance before the fixed period ends. Fixed-rates better serve borrowers determined to stay for decades.
What Other Costs Should You Budget For When Buying a House?
While a mortgage covers the bulk costs of buying a home, there are still several other significant expenses that must be financially prepared for:
Down Payment
As mentioned, the larger the down payment, the better in terms of interest saved and instant equity built.
Aim for 20% of the purchase price, but lenders allow much less if you just don’t have the funds for that. Here are some tips on saving up for a downpayment.
Closing Costs
These fees paid to third parties like the lender, title company, appraiser, and more can add up quickly. Budget 2-5% of the purchase price to cover them. In some cases however, you can negotiate part or all of the closing costs to be paid by the seller.
Cash Reserves
Most lenders require borrowers to have two to six months’ worth of mortgage payments in reserves just in case. Use the higher-end allowance if job security is a concern.
Moving Costs
From hiring professionals to renting a truck and purchasing supplies, moving across town or cross-country adds up quickly. Factor those temporary but real costs in too.
Prorating Costs
Expenses like property taxes and homeowners insurance are typically prorated between buyer and seller. Have funds ready to pay those partial costs.
Home Repairs/Renovations
Older homes in need of updates should prompt setting aside cash for repairs and desired renovations post-closing. Make sure you budget for unexpected expenses along the way.
Do You Want Any Special Mortgage Features?
The right mortgage helps accomplish both short and long-term homeownership goals. Think about whether any of these specialized mortgage features could be advantageous:
Interest-Only Option
These allow paying only interest for an initial period (typically 5-10 years) before principal payments kick in. Interest-only boosts near-term cash flow for other uses.
Biweekly Payments
Rather than monthly, half the payment is automatically drafted every two weeks. The result is one extra monthly payment applied yearly, which drastically reduces the total interest paid. This is a strategy for paying your mortgage off more quickly.
Prepayment Allowances
Many mortgages allow supplemental monthly payments to be made directly to the principal whenever desired. Find out if there are any caps or penalties for this.
Mortgage Insurance Options
When putting less than 20% down, lenders require private mortgage insurance (PMI) to safeguard their investment until sufficient equity is built.
But there are options like lender-paid, split-premium and single-premium PMI plans that can provide alternatives to ongoing PMI payments.
Renovation Loans
Special renovation loans allow money for home improvements to be rolled into one loan. This avoids paying double mortgages and can reduce costs versus separate construction loans.
Plus, you can take advantage of buying a fixer upper for a lower cost and more instant equity once renovations are made.
Shop and Compare Multiple Lender Rates/Fees
With the basic mortgage homework done upfront, the final important step is to shop multiple lenders and compare their rates, fees, and overall costs for financing.
Scoring a low mortgage interest rate is hugely impactful on housing costs. Just a fraction of a percentage difference can mean thousands more or less in interest paid over the full mortgage term.
Likewise, lender fees for originating, underwriting, and delivering the mortgage can vary greatly.
Every penny counts towards the overall financing costs. Comparison shop rates and fees simultaneously to land the most affordable loan package.
Ask About Special Program Eligibility Too
While most lenders offer conventional and FHA loan programs, it’s smart to ask about any specialized mortgage programs as well.
Certain professional careers, military experience, or economic backgrounds may qualify borrowers for unique low or no down payment programs.
Community assistance programs are also offered in some areas to incentivize homeownership and neighborhood revitalization.
The requirements and benefits differ by specific program and location. The lender can outline any local programs for which the borrower appears eligible.
Related reading:
- How to Save $5,000 with the Nickel Challenge
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- Needs and Wants in a Budget
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Keep Shopping If Unsatisfied
If, after shopping around, the lender quotes don’t align with expectations or comfort levels, keep looking elsewhere. It may take contacting 5-10 different banks, credit unions, and mortgage companies before finding the best overall fit.
Getting preapproved from multiple lenders and thoroughly analyzing their offers takes work but pays off. Having full transparency into interest rates, points, fees, and long-term costs helps with identifying the wisest mortgage choice.
There’s no rush or obligation until the final papers get signed. Take time to make sure you are happy with the specific loan terms and lender before pulling the trigger.
The Bottom Line
Finding the right mortgage is just as critical as securing the perfect home. It takes diligent upfront preparation, careful shopping, and detailed comparisons.
But that effort positions home buyers to land mortgage terms they can affordably manage for the long haul.
So, approach the process patiently and methodically. Do the credit score, budget, and down payment homework first.
Weigh the tradeoffs between 15 vs 30-year terms and fixed vs adjustable rates. Explore any special mortgage options or assistance programs that could benefit your situation.
Then, shop rates, fees, and lender reputations widely – getting quotes from multiple banks, credit unions, and mortgage companies. Don’t rush into signing until you fully understand and feel comfortable with the mortgage terms and costs.
This likely will be one of the largest financial commitments you ever make. Extra diligence in the beginning will help you get an affordable, sustainable mortgage.
With the right mortgage in place, you can just focus on enjoying your new home for decades to come!
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