Now may be an excellent time to start checking out your local housing markets thanks to interest rates that continue to hover around their lowest point ever. While Baby Boomers and older members of Gen X may remember taking out a mortgage with a 10% (or higher) interest rate, Millennials who are ready to buy can apply for and receive home loans with 30-year interest rates as low as 3.5%.
A better job market and lower unemployment rates leave many members of Gen Y in a better financial state than they were a year or so ago. A recent survey from American Express showed that 25% of Millennials plan to save up for buying a home in 2015.
If you’re part of the growing segment thinking about making their first dive into home ownership, understand these 4 ways to get the best deal on your mortgage.
Look at Your Finances Before Looking at Houses
Before you start house-hunting or approaching lenders for pre-qualification, you want to take a look at your own finances. Even with stricter regulations around mortgage lending, most banks will allow you to borrow more than may be financially wise to accept.
You need to decide for yourself how much house you can really afford. Don’t rely on online calculators to tell you. Look at your current budget, expenses, and financial obligations. Then research to determine a realistic total for your living expenses if you become a home owner.
Remember, a mortgage will cost you the principal and interest on the loan — but you also need to pay homeowner’s insurance and property taxes. Don’t forget to account for increased expenses associated with repairs, regular maintenance, and upkeep.
Looking at your finances will tell you a number of things. You’ll know how much you can truly afford, and from there you’ll know how much you need to save for a down payment. You should also pull up your credit report and get an estimate of your credit score (which you can get for free from CreditKarma.com or Credit.com).
Save for a Down Payment
Ideally you should save up 20% of the home’s purchase price to use as your down payment. It’s a big number, but putting down this much in cash means you only finance 80% of the purchase. That means you won’t have to deal with private mortgage insurance (or PMI) and your monthly payments will be much more affordable.
Coming to the table with more cash also makes you a more appealing borrower for lenders. You’ll likely secure a better interest rate if you reach the 20% down payment threshold.
You’ll also have more flexibility in choosing a mortgage loan type; you won’t be limited to choosing something because you only have a few thousand dollars or require adjustable rates to lower your loan payments in the first few years of ownership.
Again, this down payment may work out to be a large number for you. But you’ll need to do the saving yourself from money you earned. Most lenders do not like to see (and may not accept) borrowed money as a down payment — even if it was an informal loan from a family member or friend.
Work to Improve Your Credit Score
Only credit scores in the “good” or “excellent” range will receive the best interest rates available from lenders. The financial institution underwriting the home loan sees you as more of a risk if your credit score is below 720, and they’ll assign a higher interest rate as a result.
Whether or not the system is fair or favors you, you can take action to improve your credit score if it’s less than good or excellent before you apply for a mortgage. This will help you secure a better interest rate — and that will give you a lower monthly payment and save you money over the lifetime of your loan.
Here’s what you can do to improve your credit score before you go house-hunting:
- Ensure you pay off all your credit card balances on time and in full.
- Don’t run up your credit card balances to their limits. This affects your debt-to-credit-limit ratio and that negatively impacts your score. (Yes, even if you pay those balances off on time and in full.)
Remember, improving your credit score can take some time. Be consistent in your actions and be patient. You’ll see results if you stick with these good credit use habits.
You’ll also want to avoid applying for new lines of credit or taking out loans in the months before you apply for a mortgage. Don’t allow anyone to run a hard inquiry on your credit, either.
This won’t automatically disqualify you from approval of a new home loan, but taking out other loans will increase your debt-to-income ratio. That may make it harder to qualify. And you’ll need to explain any recent inquiries that appear on your credit report, which can be a hassle when going through the mortgage process because of the documentation you must provide.
Do Your Research When Choosing a Lender
There are countless mortgage lenders out there — and not all of them are big national banks. You can receive a mortgage with a bank like Wells Fargo or Chase, but you can also go to credit unions and other institutions whose sole purpose is to underwrite home loans. A mortgage broker is another great resource to tap.
Keep in mind that this is a business transaction for any institution. Lenders make money off mortgages via the interest payments, and they may court you for your business. Don’t feel obligated to go with one over another for any reason. You don’t have to choose the same bank where your checking account is, and you don’t have to go with a lender your Realtor says you should choose.
Do your own research, ask questions, and explore all your options. Here’s what to think about when choosing a lender so you can get the best deal on a mortgage:
- Get quotes on interest rates from the lenders you’re interested in working with. I recommend checking with at least 5 different lenders. Be sure to ask for quotes from all of them (and go through any pre-approval processes) within a 14-day time span. All inquiries made in that time period will appear on your credit report as one, which shouldn’t impact your credit score.
- Ask about fees and closing costs and get a good faith estimate to compare overall expenses for originating your loan. Getting an estimated interest rate is important, but it’s not the only cost to consider.
- Make sure potential lenders answer all your questions and are transparent with their mortgage loan application and underwriting process. If someone refuses to answer your question, cross that lender off your list of prospects.
- Think about more than just money. If two lenders provide you very similar information on the financial side of things, consider their customer service and accessibility. The mortgage process is a long and tedious one, and you’ll invest a considerable amount of time verifying information, sending in documentation, and working with your loan processor. Choosing a lender with good customer service is no small consideration.
Applying for and receiving a home loan is a big decision, and you should be prepared before you start this process. Understand what to expect and don’t shy away from asking questions and doing as much research as you can.
If you don’t know or understand something, ask a financial professional or a trusted expert. A CFP, CPA, or attorney may be able to help, as can financial resources and websites online.
By working down this list, you should be able to get the best deal on a mortgage when you’re ready to apply.