Shopping for a home is always fun and exciting, but actually buying and financing one can be stressful. A push for more space during the lockdown, plus low interest rates, has turned the real estate market into a feeding frenzy. Surging demand has driven up home prices and sparked bidding wars among would-be buyers. And financing your home through a mortgage application process can be intimidating for first-time buyers.
If you do need to finance your home, it’s a good idea to educate yourself beforehand. Knowing what to expect won’t just make the process easier; it will also save you money in the long run.
What You Need To Know Before Financing Your Home
Here are five things you should know before you head to the bank:
1. The True Cost of Your Dream Home
When most people start shopping for and thinking about financing a home, they use a mortgage calculator to determine how much house they can afford. But online mortgage calculators are rudimentary at best. You simply input the home price, your down payment, interest rate, and the mortgage period. Most of them don’t take into account the cost of property taxes, homeowners insurance, or other costs of homeownership.
Depending on your situation, your lender may want to collect money up front to pay your property taxes and homeowners insurance. Some banks will actually build these costs into your monthly mortgage payment and pay them on your behalf. This is why it’s important to get an estimate on these costs beforehand.
Another expense few home buyers consider is the normal wear and tear on appliances and systems throughout the home. When you’re house-hunting, it’s important to consider the age of the home and everything in it. You can ask your realtor when appliances such as the furnace, sump pump, and hot-water heater were last replaced.
The cost of these appliances can give you sticker shock — especially if you’ve just invested your life savings. This is why some homeowners purchase a home warranty policy. While homeowners insurance protects you from the unexpected, home warranties protect you from predictable wear and tear. The best home warranties run between $30 and $60 per month. You will also have to pay a flat service-call fee for a technician to diagnose the problem. In the event that your AC goes out, the home warranty company will pay to repair or replace it.
2. Credit Score
Your credit score is one of the most important numbers banks will consider when evaluating your loan application for financing your home. Credit scores can range from 300 to 850, and anything above 740 is considered very good. Most banks require a score of 620 or above for a conventional mortgage. Individuals with lower scores may qualify for an FHA loan.
Ultimately, your credit score will affect your interest rate — and the cost of your mortgage. Tools like Credit Karma can paint a picture of your creditworthiness, but the scores on these platforms are notoriously unreliable. This is because most banks look at your FICO score — not your VantageScore, which is what Credit Karma uses. All three credit bureaus also have different information available, which can lead to variation in your scores.
That doesn’t mean these consumer-finance tools can’t still be useful. These services can alert you to changes in your credit and give you the opportunity to catch reporting errors. They can also give you real-time feedback on how your credit usage impacts your creditworthiness without a hard inquiry.
If you know you’re going to be financing a home, you can take steps to improve your score. It’s important that you pay your credit card on time every month — ideally paying off the entire amount. If you do maintain a balance on your cards, the ratio of available credit you’re using matters. This is called your credit utilization rate or CUR. If your credit cards have a combined limit of $10,000 and you owe $2,000, your CUR is 20 percent.
Ideally, you would keep your CUR below 10 percent, though experts say it’s important to keep using your cards. (To do this, you can simply use a credit card for a specific bill and pay it off each month.) At a minimum, aim to pay your balance down to 30 percent or less of your credit limit. Don’t open new lines of credit while you’re hoping to finance a home, and don’t close old ones.
3. How Much You Need for a Down Payment
If you’re shopping for a new home, chances are you’ve been saving money for it. But first-time homebuyers often underestimate how much they really need to put down in order to finance that HGTV-worthy home. Down-payment requirements will depend on several factors, including your income, the size of your loan, and your credit score.
If you put less than 20 percent down, most lenders will require you to carry mortgage insurance. Of course, there are exceptions to this rule. If you are military or shopping in a rural area, you might qualify for a VA or USDA loan. These loans are backed by the federal government, so you don’t need a down payment.
4. Your Debt-to-Income Ratio
Anytime you apply for a loan, the lender will evaluate your debt-to-income ratio. This is the percentage of your gross monthly income that is put toward paying your loans. This will include your mortgage, car payments, credit cards, student-loan debt, and even child support.
Acceptable debt-to-income ratios vary by lender and can range from 28 to 50 percent. To calculate yours, add up all the monthly payments you make toward debt and divide by your pre-tax monthly earnings.
5. The Best Interest Rates Available
Financing a home is a big commitment. The most common home loan is a 30-year fixed-rate mortgage, though some people choose a 15-year mortgage. The interest rate you get will determine what you will pay over the life of your loan.
While mortgage rates have been on the rise since last summer, rates remain relatively low. So far the Federal Reserve has telegraphed its intent to keep interest rates low until 2023. (The Fed doesn’t control mortgage rates directly, but its decisions do have an impact.) If you’re planning to buy a home in the near future, now might be a good time.
Keep in mind that the interest rates you see online won’t necessarily reflect the rate you’re offered. The good news is that you don’t have to take the first-rate the bank gives you. You can (and should) shop around.
Credit-reporting systems give you a shopping window ranging from 14 to 45 days. This gives you the chance to check with multiple lenders and have checks treated as a single inquiry. To be on the safe side, try to do all your comparison shopping within the same 14-day span.
Financing a home can seem like a complicated process, but it doesn’t have to be overwhelming. When applying for a mortgage, knowledge is power. You need to know your numbers so you can get your credit score and savings where they need to be. The more information you have, the smoother the process will be, and the more you’ll save in the end.