Recently, I had a Twitter interaction that has had me thinking of going back to the basics in an attempt to reach some readers who may be towards the beginning of their personal finance journey. Around the same time, I had a guest post hit my inbox covering a topic that I had long forgotten – buying my first home. Enjoy this post from Lazy Man and Money reader, Ivana.
If you’re anything like me, you consider the purchase of your first home a milestone in your adult life. After all, nothing quite says “I’ve made it” better than owning a home of your own, and it signals a kind of stability that wasn’t really there in your younger years.
Of course, to get that far, you’ve got to get approved for a mortgage (unless you’re independently wealthy, and if so, I congratulate you). When I first went through the process, I hadn’t the faintest clue what I was getting myself into – and that’s a scary thought because my mortgage represents the largest single debt on my personal ledger.
As it turned out, I learned a great deal from the process. I just wish someone had sat me down and given me the lowdown on what to expect before I jumped in head first. If you expect to be in a similar position soon, you’re in luck. Here are some of the important things you need to know about getting your first mortgage, but didn’t even know to ask.
Lay the Groundwork, or Suffer the Consequences
The first bit of wisdom that I’ll impart here may seem obvious to some, but it never occurred to me before I applied for my mortgage: check your credit reports (all three, I’ll explain why later). The reason I say this is that your credit report may be hiding some surprises that you’d rather not encounter while sitting in front of a loan officer. In my case, I found out from my mortgage specialist that Experian was under the impression that I owed Verizon Wireless about $550 from an account I had closed in 2001. Interestingly, Equifax and TransUnion had no record of the balance.
It turned out that Verizon had not closed my account when I requested it, and instead let the balance continue to build until they sent it off to a collections agency. That agency had never contacted me and only reported the “debt” to Experian. The good news is that I was able to get it worked out and it didn’t impact my ability to qualify for a mortgage, but the lesson is clear: don’t let the fact that you’ve never paid a bill late fool you into thinking your credit reports are accurate. Make sure everything’s right in advance, and also do everything you can to lower your debt-to-credit ratio. Be aware that lenders extend the best offers to applicants with FICO scores of 720 or higher, so that’s where you’ll want to be before applying.
Choose a Mortgage, Don’t Let One Choose You
Another thing that I hadn’t considered when looking for a mortgage was just how many options there are. Seriously, if you’ve never shopped for a mortgage, you’ll likely be astounded by how many lenders there are out there. What’s even more shocking is that you’ll feel like you need an advanced degree to tell the difference between all of the mortgage products you encounter.
So first things first – learn all of the lingo and as much as you can about the various available mortgage types before you try to tackle a mortgage comparison on your own. You’ll need to understand not only the way interest rates work, but also what kinds of fees may be part of the loan (origination, title search, insurance), and any other closing costs that might (or might not) get rolled into your loan. Be aware that it’s going to seem like lenders go out of their way to make it difficult to compare these products, with opaque documentation and the like. Don’t be afraid to admit that you’re in over your head. Use a mortgage broker if you must. Whatever you do, make sure you understand your mortgage before you sign it – you’re going to have to live with it for a while.
Look Out For Gotchas
The last major thing I wish I’d been counseled on before getting my mortgage was all of the various little considerations that go into the mortgage package you’re offered. I call them “gotchas”, only because if you don’t understand what they are before you take out your mortgage, you don’t get a do-over. First, you’re going to want to make sure that your lender has approved you for a mortgage you can actually afford. That means informing them about your real monthly expenses as opposed to just what’s on your credit report. For example, if you have financial obligations like supporting an ailing parent, child support, or any other ongoing monetary responsibility, speak up! Remember that it’s the lender’s job to look out for their own interests – not yours.
Second, scour the details of your mortgage offer to look for things that may come back to bite you later on. The biggest one I encountered is known as a prepayment penalty. This common little trap is the lender’s way of extracting their pound of flesh from the borrower, come what may. The idea is, you’re bound by contract to only pay back a certain amount of your mortgage within specific timeframes. It exists so you won’t be able to save on interest by paying down your principal when you’re flush with cash. The thing many don’t realize, of course, is that such an arrangement doesn’t only apply to unexpected financial windfalls.
It also means (depending on the language in your agreement) that you’ll get hit with the penalty if you sell your home (since you’d be paying down the mortgage with the proceeds). It could also mean you can’t refinance if interest rates improve without paying the penalty, too. And if you’re thinking it’s no big deal, consider that the typical prepayment penalty is equal to 80% of six months’ worth of interest, which can be a hefty sum. The good news (if there is any) is that prepayment penalties typically phase out after one to three years, but if you’re subject to one, it may mean you’re trapped in your mortgage for that amount of time even if you have an emergency and need to sell your home.
Welcome to Homeownership
If you’ve made it this far, that should mean you’re at least twice as prepared to go out and get a mortgage than I was the first time out. Don’t rest on your laurels, though. What I’ve covered here is by no means encyclopedic – far from it. On the contrary, getting a mortgage is one of the most complex and consequential financial decisions anyone can make, and they come in all shapes and sizes.
That’s why the best bit of advice I could ever give to anyone who’s about to look for their first mortgage is to take their time. Do as much research as you can beforehand because the more you understand in advance, the less daunting the process will be. The results will be better, too. After all, the last thing in the world that anyone should want is to have the home of their dreams come with the mortgage of their nightmares. With any luck, I’ve done a bit to spare you that fate – the rest is up to you.
My own experience was helped quite a bit by the support system I had. My mother was right there with me. My older brother was buying a house around the same time. One of my best friends, who I had lived with previously had recently bought his first house. My real estate agent was the spouse of a good friend. My closing agent was a groomsman at my wedding. It was almost impossible to imagine a better “Dream Team” of support.
Despite all that, I was still very nervous. So if you feel nervous, that’s to be expected. I hope you can surround yourself with at least a few people who have a lot of experience.
We bought our first home a couple of years ago and it was a very nerve racking time. In Australia, homes are almost always bought and sold at public auction. Everyone stands outside the front of the house while the auctioneer rattles off the numbers – so the whole street knows exactly who paid how much for the house. It’s almost embarrassing, but a very Australian past time. The price reached out limit and I said I was out, but my dream time (my father and mother in law), told me to go once more. So I bid an extra A$5,000. Luckily I did, cause we got the house and they pitched in the cash for the extra bit!
Then you have to go back to the back for final loan approvals – get your knee pads out.
Good information, but I would add a couple of things:
1) You need to know what you can afford. The nice real-estate agent and that nice person at the mortgage company do not work for you, and their job is to suck as much money out of you as possible. Qualification numbers are not budget numbers and assume you are willing to sit in your empty house and never go out. You need to have a real budget and a real understanding of your cash flow. We could have qualified for much, much(2 to 3 times generally) but that didn’t agree to what we knew of our budget.
1b) Know your numbers based on your future plans. When we bought our first house we knew we planned to have children and wanted my highly educated wife to stay home with them and we had to make housing choices to allow that to happen.
2) Understand your plans, but chose a house that can flex with your plans. We missed on this. First house was not one we could have easily grown with if we needed to, which meant we had somewhat unofficial planned obsolesce. So we moved up twice, now with the kids gone we’ve got too much house but the market would make it hard to logically downsize.
3) Have a firm plan to pay the thing off. With changes in the tax laws there’s a chance that the interest deduction is meaningless for many(as if that was a good reason to maintain debt). I know many financial experts say don’t pay off the house, save the money and invest. I disagree.
p.s. Enjoy low interest rates. I think we refinanced our first house to get the interest from 14% to 12%. Yikes.