Unless you are planning to pay cash for your home, you will need to do some research to find a great lender and get a mortgage that fits your needs.
There are many types of lending institutions, offering a wide variety of loans and special programs. Invest some time to research your options and shop around for the best mortgage available to you.
The most common loan types are Fixed Rate Mortgages and Adjustable Rate Mortgages (or ARMs).
- Fixed Rate Mortgages – interest rate is fixed for the life of the loan. The advantage of a fixed-rate the mortgage is that they protect you against risk of rising interest rates and the payment stability can make it easier to plan and budget expenses.
- Adjustable Rate Mortgages – interest rate on the loan periodically adjusts based on an index which reflects the cost to the lender of borrowing on the credit markets. The interest rate may be fixed for a set time period (commonly initial 3-5 years). The advantage of Adjustable rate mortgage is typically the interest rate will be lower during the introductory fixed period of the loan.
Mortgage length or term is typically 15 to 30 years. 15 year mortgages typically have lower interest rates but the payments are higher than on a 30 year mortgage.
According to Tom Gilmour, CFP at LearnVest Planning Services:
- Choose a fixed rate mortgage unless you plan to live in your home no longer than the original fixed period of the ARM. Otherwise, if the interest rate rises, your mortgage payment could be higher than you can afford. (Source: www.lifehacker.com)
- As for the loan length, Gilmour favors a 30 year term over 15. “It may be a good idea to take out a 30 year mortgage but accelerate your monthly payments as if you had a 15 year mortgage. If you ever need to lower your payment in the future, you’ll still have that option.”
Down payment options: There are loan programs available that require as little down as 0% (VA, Navy Federal or USDA), 3% (with PMI) or 3.5% down (FHA). Note: unless you put 20% down the lender may require the mortgage to be guaranteed by a third party such as Veterans Administration (VA), the Federal Housing Administration (FHA) or a private mortgage insurer (PMI).
Lenders will qualify you for the maximum loan amount that they are willing to lend to you – which may be more than you can comfortably afford. You should make a list of your monthly expenses, and try to project what your significant expenses will be over the life of the loan. This will help you to determine how much you can really afford.
Consider a Mortgage Payment Trial Run
If you are concerned with your ability to afford a higher mortgage payment, try it out before you buy.
- Estimate your new mortgage payment including property taxes, insurance, HOA fees (if applicable), and home maintenance costs. This doesn’t have to be exact – you just want to see if you can afford the ballpark amount.
- If your new estimated monthly home expenses & payment are greater than you are currently paying, then subtract your current housing expense from the total of your new estimated monthly expenses and payment. Consider transferring the difference to your savings account for a few months. This will give you feel of what your finances will be like when paying your new payment.
- If this Trial Run was comfortable for you, then you can probably handle the typical monthly expenses associated with your new home. But if it was difficult, consider lowering your home price until the estimated mortgage payment is comfortable given your current income.
The loan you qualify for will depend on a variety of factors including: your credit rating, pattern of paying your bills on time, and debt- to-income ratio. Your debt-to-income ratio is your gross monthly income compared to the minimum payments on all your recurring debts. According to www.lifehacker.com, you need a debt-to-income ratio of 43% or less. The best rates and terms are typically available only to those with good credit so if you can, pay off your credit cards and make all other bill payments in full and on time.
- Check your credit report and make sure that any outdated derogatory or incorrect entries are deleted from your file. In general, negative credit information is not supposed to be reported on your report after 7 years with the exception of bankruptcy which can be reported for up to 10 years. You can obtain a free copy of your credit report at www.creditkarma.com.
- Officially cancel inactive credit cards. An inactive credit card, even with a $0 balance, can be viewed as a potential future debt by some mortgage lenders. Too many inactive credit cards with significant credit limits could keep you from obtaining a mortgage loan. Don’t just cut up your extra cards, officially cancel them, and do it now so there will be time for the status to be reported to the credit bureaus.
- Hold off on making any major credit card or car purchase until after you close on the new home. The monthly payments you will be obligated to pay will be counted against you, and reduce the amount of mortgage loan you’ll be offered. Even if you have been pre-approved for a mortgage, that approval is subject to a last-minute evaluation of your financial situation. A spending spree on appliances, furniture or other housewares intended for your new home may wreck your chances for buying it.