I remember my first mortgage. Getting it seemed like a bureaucratic hurdle on the way toward buying a home, and I couldn't wait to get the paperwork done and out of the way. By the time we bought our second house, I was 10 years older and wiser. I played a much more active role in choosing a mortgage and negotiating terms that time, and saved us a fair amount of money as a result.
Assuming most people are about as naive as I was when they obtain their first mortgage, I want to offer some tips on how to be less passive so you can actively take control of your mortgage situation. My first time, I didn't think of it as a process that starts before you even apply for a mortgage, continues on as you choose a home loan, and even carries through once you are in your house and making payments on your loan — but it's very helpful if you do.
Before you shop for a mortgage
Let's say you're talking about buying a house but haven't even started shopping around. Is this too early to start thinking of a mortgage? Not at all. Here are some things to do early on that could save you some money once it comes time to get your home loan:
- Take time to save up for a larger down payment. There are a few benefits to boosting your savings account. Obviously, by allowing you to borrow less, this will both reduce the size of your monthly payment and the amount of interest you pay in the long run. It could also qualify you for a lower mortgage rate, and/or a loan with cheaper or no mortgage insurance necessary.
A larger down payment will also start you out with an equity cushion, which will give you more flexibility to refinance once you own a house.
Finally, going through the process of saving a regular amount every month will help you test the budget discipline you will need when you start making mortgage payments.
- Safeguard your credit rating. It's little use to start worrying about this once you are ready to apply for a loan. Building a good credit history needs to start long before then. Doing so could help you qualify for a lower interest rate, or even make the difference whether or not you are approved for a mortgage.
- Target a reasonable price range. Don't fall in love with a house and let it determine your budget. Before you start house hunting, use a mortgage calculator to figure out what you can afford. Allow some room for the unexpected expenses that are an inevitable part of home ownership, and also leave yourself some leeway to ride out a financial setback now and then. Limit your house search to the price range you figure out, and you will avoid being tempted into something you can't afford.
While you are looking for a mortgage
Okay, now that you're ready to buy a home, here are some things to remember as you look for a mortgage:
- Shop actively for a lender. Even small rate differences add up to big bucks when you apply them to the cost of a house and project them out over 30 years.
- Look at local real estate market dynamics. Even if you fall madly in love with the first house you see, check out other properties to see if the price of the one you picked is in line. Also look at local market dynamics like how many properties are for sale nearby and how long properties are staying on the market before they are sold. This will tell you whether it's a buyer's market where you can try to drive a hard bargain or a seller's market where you had better jump to meet the asking price as soon as possible.
- Consider alternatives to the standard 30-year, fixed-rate mortgage. This type of loan suits most first-time home buyers because it offers stable payments that are made more affordable by stretching them out over 30 years. However, make sure you understand the pros and cons of alternatives, and how they might apply to your situation.
For example, a 15-year mortgage is likely to offer a lower interest rate — as of the end of 2015, 15-year mortgage rates were 0.77 percent lower than 30-year rates. It will also cost you much less in the long run because you will be paying interest for half the number of years. The drawback is that 15-year loans have higher monthly payments, which you may not be able to afford.
As for adjustable-rate mortgages, these offer even lower initial rates, but carry the risk that your interest rate — and thus your monthly payment — can vary. However, buyers who are planning to move in a few years or otherwise expect to be able to pay the loan off early may be less exposed to this risk.
- Be aware of prepayment penalties. Many mortgages have these terms, so be aware that they could make it more expensive to refinance later on.
Once you have a mortgage
Now you have your mortgage, the only thing you need to do to control this debt is to make your monthly payments, right? Well, also consider the following:
- Be cautious about home equity loans. These can be a tempting source of cash, but eroding your equity can limit your ability to refinance. It could also leave you still paying off your mortgage into your retirement years.
- Be alert for opportunities to refinance. The best kind of opportunity is if interest rates fall, but you might also benefit from restructuring your mortgage. For example, if you can afford higher payments, shortening your mortgage term should reduce your long-term interest expense. Also, if you initially chose an adjustable-rate mortgage, you may decide it would be beneficial to stabilize your monthly payments by switching to a fixed-rate loan.
- Understand the cost of lengthening your remaining mortgage term. Refinancing to a fresh 30-year mortgage can be an easy way to make monthly payments more affordable, but it is likely to raise your interest expense over the life of the loan. Use a mortgage calculator to figure out the long-term cost of reducing your monthly payments this way.
People tend to feel that their debt controls them rather than the other way around. Probably the biggest difference between when we bought our first home and when we bought our second was learning to take more control of financial decisions rather than sort of being swept along by them. Taking control of your mortgage debt should not only help you build wealth, but also make you feel more secure in your home.
Have you taken measures to control how much mortgage debt you have? What steps did you take? What do you recommend?