This guest post was inspired by MLR’s recent update on his home purchase. As a guy in my early 20s, I’m getting ready to purchase a home myself, and the fact that I work for an internet mortgage information services company has given me some interesting firsthand experience with the lender side of the transaction.
I want to expand on what MLR introduced a month ago and offer a few home buying pointers that I’ve gleaned from my line of work. These points are intended to help you be intentional about leveraging your mortgage and your home for financial success.
But first, let’s talk about bread.
Everyone knows how to walk into a grocery store and buy bread. Centuries of marketplace development, mass consumer input, and a lifetime of incremental firsthand experience combines to make the bread purchasing process simpler for you than it’s ever been. But as much as your neighborhood market would like you to believe that their prices and their quality are the best in the world, the truth is that there’s still room to apply a bit of sweat equity to the transaction and get a better deal.
With some work, you can probably find better bread at lower prices elsewhere. And this is bread we’re talking about, not a sophisticated financial instrument like a mortgage. As much as it may seem that the mortgage application process is streamlined to assist consumers who have no clue what they’re getting themselves into, you’re setting yourself up for failure, or, at best, minimal success, if you don’t do it right.
Set Yourself Up For Success
You’re not buying a home. You’re buying an investment portfolio, and you’re funding the portfolio with a mortgage. What does this mean for you?
1. Know what you’re doing.
Don’t try to use debt to get ahead unless you know what you’re doing and you understand the costs involved. You don’t need to be an economist, but you need to have a strong sense of where you are and where you’re going, financially. Take the time to do some calculations. Make sure you’re ready to purchase a home.
Reread MLR’s Back from the Dead post, in which he spends a paragraph or two detailing the money he’s saving as a homeowner. You think this happened by accident? As with all things, calculate the costs involved before you move forward.
The best way to monitor your financial situation is through effective budgeting. Read the linked article. If you haven’t completed all of the steps outlined there, you’re probably not ready to buy a home. And that’s just a place to start. Talk to a trusted mentor or financial professional and discuss your options.
Don’t buy a home for social reasons. It might be nice to own a home, but unless you’ve got a family of five and you need the room to expand, your home is a financial product.
2. Every lender is different.
The first and most important part of taking on a mortgage is finding the lender or mortgage broker that offers the best rate on the investment. Most lenders offer similar rates. But similar does not mean identical, and closing fees and loan terms differ. The speed with which a given lender can close your loan makes a difference, too.
MLR’s Note: When I was going through my process to get pre-approved for a lender, I can tell you, I was quoted very similar rates, but my expected cost varied wildly. Between some charging points, lock in fees for the rate, appraisal fees, etc… some lenders with a slightly lower rate wound up being much more expensive.
Compare lenders and the mortgages they offer. You can check out current mortgage rates provided by multiple lenders at Lender411.com, Bankrate.com, LendingTree.com, or any other major internet mortgage site. For the sake of disclosure, be aware that I work for Lender411.com.
3. Get preapproved, not prequalified.
Prequalification is a meaningless thing. It’s an unofficial guess as to how much money you’ll be able to borrow. The guess is made by a lender who has received nothing more than a verbal statement from you regarding your own income and credit history. Prequalification won’t give you any financial backing to negotiate with.
Preapproval is different. It’s like applying for the loan in advance. Lenders will look at tax returns, pay stubs, bank statements, and your official credit report to determine what loan amount you’re qualified to receive. You’ll receive an official preapproval document that carries real financial weight. With this in hand, sellers will be willing to negotiate with you and you’ll close your loan much faster.
4. Avoid mortgage insurance.
Private mortgage insurance (PMI) is required for all conventional mortgages and Federal Housing Authority (FHA) mortgages in which the borrower purchases less than 20% of the equity of the home at closing. In other words, if you don’t make a 20% down payment, you’re going to have to pay for PMI. How much does PMI cost? It depends on the cost of your home, but you can expect to pay at least $50 or $60 per month, or $5,000 or more over the life of the loan.
The best way to avoid PMI is to make the 20% down payment. But many young home buyers can’t do this. The next best thing to do is to make at least one if not two additional mortgage payments each year toward the principal balance of your loan. This will build your equity faster than otherwise.
If your mortgage has a longer term length or you’re making minimum payments or, horror of horrors, missing payments now and then, it will take longer to gain the 20% equity required to eliminate the PMI. The best thing you can do is manage your mortgage well and make additional payments to bring down the principal.
5. Don’t take out an adjustable rate mortgage.
An adjustable rate mortgage gets you a low initial introductory rate for a brief fixed period. If you’re able to refinance into a low fixed rate before this period is over, it’s possible to use an ARM to your advantage. But most of the time, an ARM is a bad idea.
Please, just don’t get one. This may sound a bit dramatic, but unless you have a good idea of where the mortgage marketplace will be in seven years when your rate begins to adjust, you’re asking for uncertainty at best and financial terror at worst. Get a mortgage with a fixed rate.
6. You can negotiate closing costs.
Negotiation is a wonderful thing. Just about every closing expense you’ll have to pay, from the rate lock fee to the broker commission, is negotiable to some extent. Your success will vary depending on the lender you’re working with and your negotiating abilities. Here’s a list of a few fees you may be able to negotiate lower.
- Origination fee. This is simply the lender’s profit. Profit can always be negotiated, though you may not have much leverage to bargain with.
- Assumption fee. This one doesn’t apply in every case, but if you’re assuming a mortgage of a previous borrower, many lenders will charge you an assumption fee. Assumptions don’t cost lenders any additional money, which makes this fee unnecessary.
- Appraisal fee. This is the worst. Many lenders will charge you for the appraisal even after you’ve paid for it yourself. It’s just standard practice. Keep careful records and watch out for this.
- Mortgage insurance application fee. Exactly what it sounds like. Any private mortgage insurer worth working with will waive this fee. If your lender is charging it to you, dig deeper and find out why.
- Document preparation fee. Sometimes this fee is used to hire an attorney to review certain documents, but most of the time, it’s charged for no reason at all.
This list of closing costs and fees hosted on Zillow.com is pretty extensive and will give you an idea of the various costs you may have to cover at closing.
Oh, and MLR’s post reminded me of one more thing…
7. An emergency fund is a wonderful idea.
One missed payment on your mortgage will destroy your credit score, and there’s no better way to hinder your future financial success than a poor credit score. As in MLR’s case, it’s better to make a smaller down payment and retain an emergency fund than to pay everything you can up front.
MLR’s Note: I went back and forth with myself over this dilemma. In the end, having a year of living expenses in my bank account as a safety net is worth the bit in PMI I will pay for a few years. Because I have that safety net, I am paying additional on top of my mortgage to accelerate paying down the mortgage and get rid of PMI.
Be intentional about your mortgage.
This is really the point. Remember the bread story. Even with a product as simple as bread, you can save money if you take the time to research your options and do it right.
A mortgage is a tool you can employ to your advantage if you’re willing to be intentional about using it for financial success.