Plan Your Purchase up Front
When you are getting ready to buy a home, everything seems to happen quickly. Surprises arise, and they can catch you off guard. The easiest way to take the sting out of the process is to plan ahead. There is a lot you can do before you cruise the real estate section of the newspaper or contact a mortgage lender for pre-approval.
Start by getting your documents in order; you are going to need them. You should dig out your tax returns for the past two years. If you do not have them, contact your tax preparer. Most will mail or fax you a copy right away, especially if you are not asking during tax season. Do you prepare your own taxes? Many people do. If you did not save a copy of your tax return, you can contact the IRS for copies. Keep in mind that it may take a few weeks for the IRS to get them to you. This is another good reason to plan ahead.
In addition to your tax returns, you will need your W-2 and pay statements for the past few months. Most employers do this electronically now, so you can go to the company intranet at any time and pull copies, print them and keep them for your records. If your company has not moved into the information age, start by talking to your Human Resources department. If they cannot help you out directly, they can still point you in the right direction.
For the self-employed, this step is a bit more complicated. You will need to collect your 1099 forms that have been issued to you by clients (if applicable), and you should prepare a profit and loss report. Make sure you have information, such as bank statements, to support your claims. The mortgage lender will not simply accept a report that you have prepared.
You should run your credit report before getting started as well. You are entitled to a free copy of your credit report every year from each of the three major credit reporting agencies: TransUnion, Equifax and Experian. This will give you an indication of your credit strength, and it will be an important factor in determining the mortgage interest rate you are given.
There can be other documents that you will need, too. Pull together your bank statements and balances from brokerage accounts. If you are divorced, you should have a copy of your divorce decree on hand. It’s better to have all your documents up front, especially if it could take you a few weeks to collect them. If you have everything you need when you start to look for a home, you won’t experience nearly as much stress down the road.
When Should You Refinance
Refinancing is strictly a game of measuring costs. A slight drop in rates may offer little reason to refinance your mortgage, especially if the trend is pointing downward. Instead of jumping for a lower interest rate, pull out the calculator and do a little homework. Measure the costs of a new mortgage against the savings it yields. This quick exercise could save you thousands of dollars, not to mention the headaches that come with the additional cost of buying your home.
A refinancing mortgage, like a first mortgage, has fees. The likelihood that you will have to pay closing costs is quite high. Before applying for a refinancing mortgage, take a look at the outcome. You should recapture more in savings than you pay in closing costs for the mortgage to work in your favor. Realistically, you should look at the savings against how long you plan to stay in your home rather than over the life of your mortgage. When you move, you’ll probably secure a new loan, making your current refinancing moot. Thus, the timeframe for recapturing the fees paid for your refinancing mortgage is shorter than you may think. Keep this in mind as you shop for a refinancing mortgage.
If the closing costs for you refinancing mortgage are $3,000 for example, and you play to stay in your home for another five years, you should save at least $3,000 over five years – at least. Otherwise, you are spending more than you would save. Including inflation, the calculation becomes a bit more complicated, but the outcome is that refinancing savings has to be higher for your new mortgage to work in your favor. Realistically, your mortgage savings should at least double your closing costs for the decision to pay off.
Be honest with yourself when doing the math. Sometimes, it’s too easy to be enchanted with what looks like a great deal. You may tell yourself that you can stay in your current home for a few extra years, even if it seems unimaginable. Don’t put this kind of unreasonable pressure on yourself. Your mortgage is a means to an end: home ownership for as low a cost as possible. When you put the mortgage before the home, you wind up paying more than you have to.
Refinancing is always worth considering, especially as your credit score improves (because you could be eligible for a lower interest rate). But, it pays to work the numbers first. You don’t want to pay the bank for nothing; you already pay them enough! Make sure your refinancing mortgage will save you money before you sign on the dotted line.
When Should I Consider an Adjustable Rate Mortgage?
Adjustable Rate Mortgages (ARMs) are not right for everybody. If you plan to stay in your home for a long time, have a rocky credit history or prefer that your payments be the same every month (i.e. predictable), you would be wise to get a 30-year fixed rate mortgage. But, buyers with strong credit ratings who plan to move after a few years can save a considerable amount of money with a 3-year or 5-year ARM.
Most lenders offer low interest rates on ARMs, making these loans quite attractive to prospective home buyers. For the first few years (three or five, depending on the particular mortgage you secure), the ARM has a low fixed rate. After this initial period, though, the rate becomes variable, changing monthly with the bank’s prime rate. In an economic climate with falling interest rates, an ARM can be advantageous; your monthly mortgage payment actually goes down every month. If rates are going up, on the other hand, your mortgage becomes more expensive. You are at the mercy of the interest rate market when your mortgage rate is adjustable. If there is a maximum monthly payment that you can afford, a fixed-rate mortgage would be safer.
For those who don’t plan to stay in the new home for a long time, though, an ARM can be an effective financing tool. If you plan to live in your new home for only a few years, you can use an ARM to get a low fixed interest rate. The fact that the rate will become variable in three-to-five years does not matter if you plan to sell your home by then. With an ARM, you get a lower interest rate for the short term – which is what you need. If you decide not to move, you can refinance into a fixed-rate mortgage later. Of course, if interest rates are going down, you may want to hold onto that ARM for a while! Keep it for as long as it makes sense, and then refinance when conditions change.
Since the interest rates for ARMs can be unpredictable, mortgage lenders apply stricter underwriting criteria. For the banks, these loans are riskier. If you do not have a high FICO score, you may not be eligible for an ARM. Before basing your house hunting plans on an ARM, talk to a few mortgage lenders first to see if you will qualify. When you have found a favorable mortgage lender, ask to be pre-approved or pre-qualified. Then, you will be more certain that an ARM is the right fit for you.
ARMs can be powerful tools for those who qualify. If you do not plan to spend more than a few years in your new home and you have a high FICO score, talk to a mortgage lender about an ARM. You will notice the savings every month.
Does It Make Sense to Skip the Down Payment?
Making a down payment can save you a lot of money through the life of your mortgage. But, the hardest part of buying a home is the money up front. With closing costs, inspections and appraisals, the price tag can get pretty steep, and none of this actually goes toward the home itself! You spend a fortune to be able to purchase a home, but it’s almost as though you don’t get credit for it. After preparing for thousands of dollars in closing costs, you are faced with the next hurdle: the down payment.
If it is at all possible, you want to make a down payment. Even if it is as little as 5% of the home, a down payment can save you hundreds of thousands of dollars over the life of your mortgage. Also, a small down payment means that your Private Mortgage Insurance (PMI) payments will end sooner, and you are likely to get a more favorable interest rate. By getting your down payment up to 20%, you can avoid PMI completely, putting hundreds of dollars back into your pocket every month.
Clearly, it makes sense to put money down. But, it’s not always that easy. Rising home prices are pulling down payment sizes upward as well. For most people, the issue is affordability. Most people do want to make a down payment, but they simply cannot afford to do so. “No money down” mortgages are available, but there are a few things you should consider before applying for one. Look at your estimated monthly payments. If you can afford one, a no money down mortgage will work. This is often the case in expensive rental markets (e.g. New York, Boston or San Francisco). High rents make it difficult to save enough for a down payment, but a mortgage may not cost much more than the rent.
Also, think about your credit. If you have a high FICO score, the interest rate on a no money down mortgage will be a bit lower. Start with the no money down mortgage, and refinance a few years later, after you have saved enough for a down payment. Remember; you aren’t stuck with your first mortgage for the rest of your life. You always can refinance later for more favorable terms, particularly a lower interest rate.
No money down mortgages may not be ideal, but they do serve an important purpose. If you can handle a high monthly payment but have trouble saving money for a down payment, skipping the down payment may be the right move. Revisit your mortgage in a few years, though, to refinance for a lower interest rate.
The First Question a Real Estate Agent Should Ask
“Have you been pre-approved for a mortgage?”
If this is not among the first questions that your real estate agent asks you, find a new one. Pre-approval (or at least pre-qualification) is an important part of the home buying process, and it normally is the first thing you should do after deciding to buy a house. If you start house hunting before being pre-approved or pre-qualified for a mortgage, then you really have no idea what you can afford. You could wind up spending all your time looking at homes that are out of your price range. An agent that does not insist that you be pre-qualified or pre-approved before beginning your search for a home is either inexperienced or ineffective, and your search will not yield satisfactory results.
Pre-approval and pre-qualification are often used interchangeably, though there are some important differences. Both are intended to help you figure out how large a mortgage you can afford. A mortgage lender will ask you a series of questions about your income, assets and debt in order to get a picture of your financial situation. Using your answers, as well as your credit score, the lender will tell you how much you can afford, your interest rate and what your monthly payment is likely to be. But, this is where the similarity between pre-approval and pre-qualification ends.
To be pre-qualified, the lender takes your answers at face value; he assumes that you have been honest. For a mortgage pre-approval, though, the mortgage lender will verify your claims. He will call the banks where you have accounts and verify your income with your employer. Either approach is acceptable, though, pre-approvals are preferred because they are more reliable, as all your claims will have been verified.
Pre-approvals and pre-qualifications are the only way that you can know how much house you can afford (unless you plan to pay cash for the whole house). Without this step, the real estate agent is forced to lead you blindly. When it is time for you to get approved for a mortgage, you may be surprised at the amount for which you are approved. In the extreme, you may have to start your search for a new home from scratch.
Use this as a way to screen potential real estate agents. If an agent does not ask in your first meeting if you have been pre-approved, keep looking. There are better agents out there!
