The United States' mortgage debt totaled more than 15.5 trillion in the first quarter of 2019, making it the most substantial debt for American households. Conventional wisdom tells us mortgages are good debt because homes typically appreciate in value, but that doesn't mean you should get a mortgage without careful research. Here are things to know before buying a house.
1. Mortgage prequalification and mortgage preapproval aren't the same thing
Mortgage prequalification and mortgage preapproval are steps most people take before making an offer on a house. However, they aren't the same thing.
Being prequalified or conditionally approved for a mortgage is the best way to know how much you can borrow. A prequalification gives you an estimate of how much you can borrow based on your income, employment, credit and bank account information.
Preapproval comes from a lender who has analyzed your finances carefully. They'll tell you how much you may be able to borrow and what your interest might be. Mortgage preapproval is usually done after prequalification, but before you find a home. Preapproval doesn’t guarantee you'll get a mortgage, but if all key factors stay the same it's very likely.
2. You'll pay more without a minimum 20% down payment
Experts continue to encourage buyers to save a down payment of at least 20% before applying for a mortgage. It makes sense, as the larger your down payment, the smaller your mortgage and the less interest you'll pay over the life of your loan. However, with the rise of FHA loans, which require as little as 3.5% down, and VA loans, which may not need any down payment, many buyers wonder whether a 20% down payment is as important as it used to be.
Keep in mind that you must pay private mortgage insurance (PMI) if you put less than 20% down on a conventional loan. PMI covers the lender if you stop paying your mortgage and default on your loan. The yearly cost of PMI is about 1% of your outstanding loan balance and is added to your monthly mortgage payment. You can request to have PMI removed once your outstanding balance reaches 80% of the original loan amount. You also might not realize that applicants with smaller down payments usually have a higher interest rate. A small down payment might let you enter the homeowner market sooner, but it can cost you in the long run.
3. Mortgage fees should be factored in
Many buyers focus solely on saving for a down payment and don't stop to consider the other fees associated with mortgages. You can expect to pay for things like commissions to your real estate agent or broker, application fees, appraisal fees, title search and insurance fees, closing costs and more. Some lenders also charge fees if you pay off your loan early.
Some fees are unavoidable while others are negotiable. Speak with your lender about the fees you should expect so that you know how much you’ll need to pay.
4. The higher your credit score, the better
Lenders are cautious about lending money since the subprime mortgage crisis of 2007, so your credit score matters now more than ever. Buyers with lower credit scores have higher interest rates, so they pay more for their mortgage over time. And if your credit score is less than 620, you may not be able to get a loan.
The higher your credit score is, the better your chances of securing a low-interest mortgage. Get a copy of your credit report and make sure it’s error free. Clear up any issues you find before you apply for a mortgage.
You can boost your credit score by paying off outstanding debts, including credit card balances and personal loans, and by making your payments on time, every time. If you have collections on your credit report, it's worth asking the collection agency if they'll agree to a "Pay-for-Delete" arrangement. In these cases, they'll delete the collection from your record if you pay the outstanding balance in full.
Opening new accounts also lowers your credit score. Until you get your mortgage, hold off on getting new credit cards or personal loans or anything else that calls for a credit check, such as switching phone carriers.
5. Lenders value job stability
While your credit score and the size of your down payment matter, don't underestimate the value of stable employment. While a stint of unemployment will obviously stand out, sometimes even changing companies can make lenders nervous. If you're contemplating getting a mortgage, you should stay in your current job if possible. The same holds true for any co-signers. Once your mortgage is approved, you can start pursuing new career opportunities again.
6. Mortgage payments must fit your budget
We all have ideas of our dream home, whether it’s a swimming pool in the backyard or lots of space for relaxing and hosting family and friends. However, these homes may not be in your budget. Before you start looking at houses, you should know what you can realistically afford. As a rule, you shouldn't spend more than 43% of your income on your monthly debts. Run your numbers through a mortgage calculator before you start looking for a home so you can see what's in your budget.
7. There are many different mortgage options available
There are a variety of different mortgage options available to suit all lifestyles and budgets. A 30-year mortgage is the most popular, but your loan term could be as little as 10 years. Most mortgages have a fixed interest rate, which doesn't change over the life of the loan. However, if you're willing to accept a degree of risk, you might opt for a mortgage with an adjustable interest rate. These usually have much lower interest rates for a limited amount of time, but the interest rate could become much higher if interest rates rise.
Discuss your lifestyle and budget with your lender to determine which mortgage option works best for you.
8. Mortgages require paperwork
Mortgages require a lot of paperwork. Collecting your financial records before applying can speed things up.
Most lenders ask for a month of recent pay stubs, two years of tax filings including the most recent year and the last two or three months of bank account statements. You may also need some supporting documents to explain any large deposits or withdrawals made recently. Any co-signers will need to provide the same records.
9. Mortgage offers can help you save
There are several national and state programs that can help you save money on your mortgage. Spend time researching what you qualify for, as well as what restrictions apply, to see if you can get a better deal.
Many state and local governments offer first-time homebuyer programs which encourage residents to buy within their home state. The Energy Efficient Mortgage program is ideal for people looking at green homes, while FHA 203(k) loans might suit you if you want a fixer-upper. If you're buying in a rural area, see if a U.S. Department of Agriculture loan may be right for you. Veterans or active-duty servicemembers, or members of the Guard or Reserve, may be eligible for a VA loan which can help save them money with low or no down payment options and no mortgage insurance requirements.
10. You should avoid making financial changes until your mortgage is finalized
Every financial decision you make before you close. While it can be tempting to finance some furniture for your new home, resist the urge to splurge. And it's not just credit your lender has their eye on. Your bank account should stay stable, so don't withdraw or deposit large amounts of money. Once you close, you can spend what you want to make your new home yours. But not until the paperwork is signed and the keys are in your hand.
Becoming a homeowner is part of the great American dream. Understanding how mortgages work and how yours will affect your financial health can help you manage and make the most of your mortgage.