Things to Avoid When Looking for a Mortgage: Don’t Get Too Much
A Loan You Can’t Afford Is One of the Most Important Things to Avoid When Looking for a Mortgage. But Some Simple Concepts, Planning, and Math Can Help You Stay Safe.
Things to Avoid When Looking for a Mortgage
One of the most important things to avoid when looking for a mortgage is taking out too much money. It’s easy to put yourself in a position where the house you love requires financing that comes with mortgage payments you can’t afford to make. And even if you get pre-approved, if you have an expected decrease in earnings or know to expect some other costs in the future such as from an aging parent, you might get approved for more than you can afford and end up with a house that you will lose to foreclosure. The best way to avoid this is to figure out what kind of payments you can afford ahead of time, then shop around with banks to find someone who will offer you pre-approval you can afford, and then start house hunting when you have all your financial information.
The basic way to calculate how much you can afford is to look at your monthly after-tax income, subtract all necessary expenses like student loans, any other debt, food and utilities, then factor in a buffer for life, savings, and unexpected expenses. Whatever is left is how much you can afford to spend on a housing payment. Realistically, if you don’t own, you already pay rent, so you should think of that rent as the base around which you can plan your spending to service a mortgage payment.
That’s the simple calculation. You can actually get into a lot more detail. First off, there are a number of reasons you will need money up front when you get a mortgage, and understanding these fees is also important as far as things to avoid when looking for a mortgage. First, you have to have some kind of down payment. Making the right sized down payment is an art by itself, because it influences so many different aspects of your finances. On the one hand, you need to maintain appropriate savings in case of emergencies. On the other, the more you put down the better a rate the bank will give you. Larger down payments also encourage banks to offer loans to people with worse credit. So paying more cash out of pocket now will result in lower monthly payments in the future. However, you also have to think about how much you can be making by investing that cash instead of putting it towards a down payment. For example, the most paltry interest on savings CDs is around one percent, so you should deduct that from what you’d save on payments each month by putting more down.
Next, you have to evaluate all the other fees various banks charge to originate or refinance a loan. You can get a sense of what is basically standard by shopping around, and there are fees and levels of fees that are too high. Generally, unless you have really bad credit and some other issues on your financial record, you should never pay more than two points, meaning fees that add up to more than two percent of the total loan value. The more discount points you’re willing to give the better a rate you can get, and this is separate from the down payment, so it’s another way to think about fees and factor all this together. But the same considerations about up-front payments apply.
After you’ve looked at your savings and the cash you have available, you can think about what monthly payments you can afford in more detail. The primary consideration is how much you can afford to pay per month now compared to a few years in the future. This can help you choose between adjustable and fixed-rate mortgages, as well as between the range of adjustable-rate mortgage options, such as the 5/1 mortgage that gives you a fixed payment for the first period and then adjust the rate from there, changing it every year or however often is stipulated.
With these comparisons, it’s important to be wary of balloon-type payment plans that expect you to be earning significantly more in the future. With these plans it’s easy to find yourself with only a few months to prepare yourself to pay significantly more per month, so unless you’re very sure that future earnings will increase, more moderate changes are better. Whereas some types of investing emphasize a bit of aggressiveness because of the higher potential payoff, this gambling isn’t advisable when you’ll lose your house is you don’t manage to achieve the kind of higher earnings necessary to keep up with payments when the rate spikes.
The last thing to do is comparison shop. Knowing how much you can afford to pay up front and every month is obviously essential, but the benefit of doing all these calculations is that it lets you succeed at one of the most important things to avoid when looking for a mortgage; accepting a mortgage contract that you can’t afford. Armed with knowledge about your budget you can answer banks’ questions easily and make them work to cater their product to your financial needs.