For a lot of first-time homebuyers, getting a mortgage can turn into a baptism by fire. Often, you don’t know how complicated the process is until you’re in the thick of it. The truth is, financing your home doesn’t have to be a maddening experience. The better you understan how the industry works, the better the position you’ll be in to get a good deal and win bidding wars. Here’s what you need to know.
1. Preparation is Key
A strong credit score is one of the surest ways to make sure you get the best rate from a lender. That’s why homebuyers should ideally take a look at their credit report from the three major reporting bureaus – Experian, Equifax and TransUnion – well before they start house-hunting.
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“Most people will find small mistakes on there,” says Eric Tyson, co-author of the book Mortgage Management for Dummies. If you do see an error, you’ll want to file a dispute with the relevant credit bureau. It can take a month or more for them to complete the investigation, so get started early.
2. Pre-Approvals Create Stronger Offers
Before you start searching for a house or condo, Tyson recommends getting a pre-approval letter from a lender. The bank or mortgage company will evaluate your income, credit score and other factors to determine how much you can borrow.
Having the loan amount in hand prevents you from wasting your time looking at properties you can’t afford. And when you find a property you really love, a pre-approval letter can also make your offer more compelling to the seller. “It will absolutely put you in a better competitive position,” says Tyson.
3. It Pays to Shop Around
A home is likely the biggest purchase you’ve ever made, so even a small difference in interest rates can make a huge difference in the long run. Shopping around with several lenders is always a good idea, says Tyson.
A lot of people like to research using loan comparison websites, but Tyson says you shouldn’t get over-excited about low advertised rates that you see online. Instead, you should talk to an actual loan officer who gives you a rate based on your credit score, income and debt level. “It’s important you work with quotes that are specific to your situation,” he says.
The first step of home-shopping is finding out how much you can actually afford.
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4. Haggling is Allowed
After you apply for a mortgage, the lender has to send you a three-page document known as a Loan Estimate. It outlines your estimated interest rate and monthly payments, as well as the various closing costs associated with your loan.
Often, one of the biggest line items is the “loan origination fee,” which covers the commission that’s paid to the loan officer or broker selling you the mortgage. Some lenders are willing to negotiate on these, especially if you have a bigger loan amount, Tyson says. But you have to ask.
5. Rates Aren’t Everything
Who doesn’t like to brag when they get a killer interest rate on their loan? But sometimes it comes at the expense of higher closing costs, says Colin Robertson, who writes the blog The Truth About Mortgage.
Some lenders try to get you to prepay interest in the form of “points.” Each point is equal to 1% of the loan amount, so one point on a $400,000 loan would cost you $4,000.
While points lower you interest rate, they force you to dole out more money upfront. “You’ll need to keep the mortgage for a period long enough to break even, which is when the upfront cost is absorbed via lower monthly mortgage payments,” says Robertson.
6. Adjustable-Rate Mortgages Aren’t All Bad
Adjustable-rate mortgages (ARMs) got a bad rap after the housing market collapse, but Robertson thinks they’re still a compelling option if you don’t plan to own your home for very long. ARMs have a fixed rate for a certain period of time and then reset to a new rate. During that initial period, their rates are lower than comparable fixed-rate loans.
“You could be leaving money on the table, especially if you buy a starter home you plan to sell within five years or less,” says Robertson. If you plan to grow your family and upgrade in the near future, he says you might want to consider a 5/1 ARM – where the rate is flat for five years and then adjusts annually – and other hybrid loan programs.
7. Sometimes Less is More
A pre-approval shows how much credit the lender is willing to offer you. But that doesn’t mean it’s a good idea to spend that entire amount on your new mortgage.
“You may want to leave a larger cushion for expected (and unexpected) costs, especially with kids in the picture,” says Robertson. Over time, the cost of other things, like health insurance, food and tuition, is almost certain to rise. So having some additional money for savings and investments certainly won’t hurt.
8. Prepaying the Loan Can be a Mistake
Carrying a large amount of debt can be stressful. But paying down your mortgage early may not be the best solution.
“The value of money erodes over time, thanks to inflation,” says Robertson. “You could actually get a better return for your money elsewhere, especially if mortgage rates are low relative to other investments,” he says.
9. You Can Redo Your Loan
Perhaps you didn’t make the best mortgage decision the first time around. Don’t fret. As long as you maintain good credit, have steady employment and practice other healthy financial habits, Robertson says, you shouldn’t have trouble refinancing.
Just make sure you’ll be in your home long enough to justify the closing costs you’ll have to pay when you take out a new loan.
10. Banks Don’t Like to Foreclose
Life can sometimes bring unexpected financial strain, whether it’s a job loss or a sudden medical crisis. But don’t think you’ll necessarily lose your house if you’re unable to make your full mortgage payment.
Banks stand to lose a lot of money if they have to foreclose and resell the house, so they’re usually willing to work with you on a solution. According to Tyson, the best thing to do is be completely upfront about your situation with the lender and get the names of people you talk to along the way. “What you don’t want to do is duck the lender and not pick up your phone or open your mail,” he says.