One of the biggest and costliest mistakes first-time home buyers can make is to get a mortgage or home they cannot afford. Lenders have guidelines about what size mortgage a borrower can qualify for so you may be wondering how it is possible to end up with a mortgage or home you cannot afford. First, just because a lender says you can qualify for a mortgage does not mean you will be comfortable making the mortgage payment. Always remember to select a mortgage amount and monthly payment that works for you, your budget and financial circumstances, despite what the lender says you can afford.
Second, it is important to understand that your mortgage payment is only one component of the cost of owning a home and you really should think about total monthly housing expense when you buy a home. Total monthly housing expense includes your monthly mortgage payment PLUS other housing related expenses such as property taxes and homeowners insurance as well as other potentially applicable costs such as homeowners association (HOA) fees, private mortgage insurance (PMI) or FHA mortgage insurance premium (MIP) -- so the all-in cost of owning a home. Additionally, you should factor in the cost for maintenance and upkeep of the property. Understanding what your total monthly housing expense will be when you buy a home will help you avoid getting in over your head.
Use our How Much Home Can I Afford Calculator to determine the home you can afford based on your down payment, income and debt expenses
Third, be aware of how your mortgage payment may change depending on the type of mortgage you select. If you select a fixed rate mortgage, you are set because your monthly payment will not change over the life of the mortgage. However, if you select an adjustable rate mortgage (ARM) or interest only mortgage, your monthly payment may increase in the future.
In many cases you may pay a lower initial interest rate or be able to qualify for a larger mortgage amount with an adjustable rate mortgage or interest only mortgage which can make these programs attractive to borrowers. If you select an adjustable rate mortgage or interest only mortgage be aware of what the downside risks are and how much your monthly mortgage payment can increase in the future. Although you may be to afford the monthly payment today, you may not be able to afford it in the future.
One of the most common mistakes first-time borrowers make is to not compare mortgage rates and fees from multiple lenders to select the loan with the best terms. In some cases the borrower’s real estate agent may recommend a lender or the borrower may have a friend who is a lender and the borrower decides to work with a lender without comparing proposals. Your friend or the referral may be perfectly good lenders but as a borrower it is important to understand that you have options when you get a mortgage.
There are different types of lenders such as banks, mortgage brokers, mortgage bankers and credit unions and each lender has pros and cons. You should treat the mortgage process like you would any other major purchase, such as buying a car -- shop around, compare mortgage proposals from multiple lenders and negotiate the best terms. We recommend that you compare quotes from at least five lenders, including one mortgage broker, to make sure that you find the loan with the lowest rate and fees. Comparing at least five proposals ensures that you have a range of mortgage options, which puts you in a stronger position when you negotiate your with lenders.
It takes extra time to compare lender proposals but spending an extra hour or two shopping your mortgage business can save you thousands of dollars. For example, on a $300,000 30 year fixed rate loan, reducing your interest rate by just .125% will save you almost $8,000. The table below shows mortgage rates and fees for leading lenders in your area. Contact multiple lenders to shop for your mortgage.
Mortgage rates are hard to predict and can change daily. In a rising interest rate environment borrowers should lock their rate at the beginning of the mortgage process to make sure that it does not increase from the time they apply for the loan until closing. An increase in interest rate can cost a borrower tens of thousands of dollars more in interest expense or potentially prevent the borrower from qualifying for the mortgage. In a steady or declining interest rate environment it may not make sense to lock your mortgage but if you do decide to lock your rate, make sure that the lock period is long enough to process and close your loan. In some cases, locking your loan can come at an extra cost to the borrower. The longer the lock period, the greater the cost; however, the insurance you receive against an increase in your mortgage rate can is usually worth the extra expense. Be sure to discuss the interest rate environment and pros and cons of locking your mortgage with your lender when you submit your loan application.
It is important that you maintain a consistent credit and financial profile during the application process. Your ability to qualify for a mortgage is dependent on your credit score and other personal financial factors including your monthly income as well as debt expenses such as credit cards, auto and student loans and spousal support (if applicable). If your credit score or financial profile changes significantly from the time you apply for your mortgage until closing, you may not receive final lender approval. For example, if you decide to close credit card accounts (even if they have a zero balance) or become delinquent on a monthly debt payment, this could cause your credit score to drop.
Understand the Credit Score Required for a Mortgage
Additionally, if you decide to change jobs or buy a new car, this could affect your monthly income or debt, which could prevent you from obtaining final lender underwriting approval. We recommend that you review your credit score six months to a year before you apply for a mortgage and address any potential issues you uncover. Make sure that you do not engage in any activities that could potentially lower your credit score over the course of the mortgage process. We also recommend that you avoid making any significant changes to your financial profile, such as a major purchase, until after your loan closes.
From paying for your down payment to closing costs, getting a mortgage and buying a house can be expensive and deplete your bank account. It is important that you keep enough savings in reserve to be in a position to absorb unexpected financial challenges after your loan closes. We recommend that you keep enough money in reserve to cover four-to-six months of total monthly housing expense, which includes your monthly mortgage payment plus other housing-related expenses such as property taxes and homeowners insurance.
Some lenders and loan programs require that borrowers hold a specific amount of funds in reserve to qualify for a mortgage. Whether the lender requires it or not, it is a good idea for borrowers to make sure that they have enough money in the bank to handle future financial adversity after they buy a home.
You have the option to pay discount point to lower your mortgage rate. One discount point equals 1% of your mortgage amount and usually reduces your rate by about .250%. You pay the points when your mortgage closes, which increases your closing costs
If you expect to own your home at least five and a half years then paying discount points may make financial sense because you own your home long enough to recover the upfront cost by paying a lower rate and monthly payment. If you expect to own your home for a shorter period of time; however, paying points may not make sense.
The most important point to remember is that it is 100% your choice to pay discount points. The lender cannot require you to pay points.
Additionally, when you compare mortgage proposals, be sure to review the quotes carefully to determine if the lender assumes you pay discount points. This may not be the right decision for you and can affect your mortgage rate. If two lenders are offering the same rate and one quote assumes you pay points, selecting the other lender can save you money.
Use ourDISCOUNT POINT CALCULATORto compare loans with different rates and points
Alexandrov, Alexei. Koulayev, Sergei. “No Shopping in the U.S. Mortgage Market: Direct and Strategic Effects of Providing Information.” Office of Research Working Paper No. 2017-01. Consumer Financial Protection Bureau, May 11 2018. Web.