How to get the best Mortgage
Buying your first home could very well be one of the biggest financial decisions that you have to make as a young adult. It’s the “American Dream” and for most people it will be the largest debt that they hold throughout their lives. Due to this fact, we want to ensure that we get the best mortgage loan that fits our situation and perhaps more importantly, ONE THAT WE CAN AFFORD! This blog covers the basics of mortgages and will guide you through best practices to put you in the best position for your next mortgage.
So before we dive into types of mortgages, rates, fixed .vs variable, lets discuss how we can put ourselves in the best position before applying for a mortgage:
Know your FICO credit score and keep it up!
Your credit score is one of the most important considerations when applying for a mortgage. The general rule of thumb is to have a 620 and to qualify for a good mortgage rate, but a 750+ will get you the best mortgage rates out.
You have 3 types of FICO credit scores (Equifax, Experian, Transunion) most mortgage lenders will take the middle score. If you are applying with a spouse they will to the lower of both middle scores.
Keep your Debt to Income Ratio low
Front End – what your mortgage payments are (taxes, interest, principle, and insurance) and divide that into your gross monthly income. General rule of thumb is max of 28%. (Ex. If you make $5,000 monthly your mortgage payments should cost you no more than $1400 a month.)
Back End – Pull in all of your monthly payments on debt (school loans, car, credit cards) 43% usually is max that want to see.
Have a Down-Payment Ready
The rule of thumb for a down-payment is 20%, this is mostly so that you avoid Private Mortgage insurance (PMI)
However some loans let you put down as little as 3.5% (FHA Loans)
Higher down payment = Lower loan amount = Lower interest rate
Now that we have reviewed habits in which we can use to put ourselves in the best position for a mortgage, how do we select the mortgage that is best for us? Great question, and as you may personal finance is exactly that “Personal”. So the best loan for you will depend on your exact situation but let me give you tools that will allow you to make the best decision for yourself.
Fixed vs. Variable Mortgage
A fixed mortgage is a mortgage that has a fixed interest rate and fixed monthly payment throughout the term of the loan. A variable mortgage will have a fluctuating interest rate throughout the loan. Simple enough right! But which is better you ask? In my opinion, fixed mortgage are the best types of mortgages for many reasons. First, the thought of a fixed interest rate and fixed payment throughout the lifetime of the loan provides me with peace of mind. Second, as we discussed earlier mortgage are most people biggest debt. Do you really want to play the guessing game with interest on the largest loan you have? Not a game I want to play. Variable mortgage rates are usually determined by the Federal Treasury Rates, so if rates rise…. so will your mortgage payments. Let’s take this example: If you bought a home for $300,000 with a variable rate mortgage of 3.5% your monthly payments would be $1,347 and the home would cost you $484,968 over 30 years. Now let’s imagine your variable rate jumped to 5%, your new monthly payments would be $1,610 and the home would cost you $579,767!! That is over $250 increase in monthly cost and over $100,000 in total cost!!
30-year vs 15-year Mortgage
The term for your mortgage has a direct correlation with how much your mortgage payments will be, the longer the term the lower the payments. What I love about 15-year mortgages is that you pay less interest over time and perhaps most importantly, it forces people to purchase a home within their means. On the contrary, 30-year mortgages give you more flexibility you’re your money. You can pay it off early and turn into a 15-year mortgage or you can pay the minimum and use the extra money to catch up on retirement savings. So which is better? I like to advise taking a hybrid approach here, buy a home in which you could afford the payments of a 15-year mortgage but get a 30-year instead. This will provide you with extreme flexibility and keep you living within your means!
In Conclusion, finding a mortgage that best suits you may take some time so please allocate enough time for this process. Take the necessary steps in advance to put yourself in the best position for a favorable mortgage loan. In addition, do your research on what rates are typical for someone in your situation (credit score, loan amount) so that during the application process you will know what type of rate to expect. If you take these the steps not only will you get the mortgage you want, you might even have some fun with the process!