A home is typically the biggest investment any of us make, and this is why nearly all purchases involve a mortgage. Make a mistake, and you could pay thousands or tens of thousands of dollars more over the life of the loan than necessary. Here are three important things you should know before you get your first mortgage.
Knowing the Full Cost of the Home
You should not base the decision of whether or not to buy a home on whether or not the mortgage payment is equal to your rent. Home ownership adds on other costs that your landlord has paid that you don’t see. On top of the mortgage payment, you will have to pay the homeowner’s insurance and property taxes. Depending on where you live, homeowner association dues may be mandatory. You are also obligated to pay for all repairs yourself. When shopping for a home, a general rule of thumb is to add 40% to the mortgage amount to cover taxes, insurance and repairs. While this sounds high, setting aside the 20% you don’t spend this month in a savings account gives you the cash to pay for home improvements.
If you can only afford to buy a home equal to what you pay in rent, this means you’ll have to shop wisely and buy a home with a mortgage payment of around 70% what you’re paying in rent.
The Impact of Various Actions on Your Credit
Your credit score is, unfortunately, used as a measure of your ability to pay your bills and pay back loans. Your credit score will impact your mortgage rate in almost every situation. It will also affect the insurance premiums you’re charged for your first home. Many people know they need to “clean up their credit” before applying for a loan, though they don’t always know what this means.
Reviewing your credit report to have duplicate entries removed is one possible step. Paying off past due amounts is another. You should also build up a large emergency fund so that you don’t have to go further into debt if something like a car problem arises. One mistake many make is applying for the mortgage, and once pre-approved, going out to buy furniture or getting a credit card at the home improvement store. This is a major mistake, since the spike in activity and debt causes your credit score to go down while the bank is still assessing your risk.
Underwriting is where the lender determines the risk you as a borrower pose to them for late payments and defaults. Most lenders rely on the FICO score or your credit score as their measure of your risk. This is why so many people think you have to have a great FICO score to get a low interest rate on a loan. Banks like it because they can pull the FICO score and make a loan decision in seconds without even thinking about it.
Manual underwriting, reviewing your bank statements, income statements from a personal business, and other personal financial information by hand, takes more time. However, if you own a small business that generates most of your income or live by cash and thus don’t have much of a credit score, consulting a bank that does manual underwriting is crucial. They have to invest some time to determine your risk factor but may give you a mid-market rate versus the subprime loan a lender relying on your FICO score would. Working with a Minnesota mortgage lender who can find the best deals for you eliminates the need for you to shop for lenders who offer manual underwriting.
Getting a first mortgage is, for many people, the most important financial decision they’ll have to make for their whole lives. So, make sure that you take the process seriously and do your due diligence before you sign the dotted line.