Most important, know how much you’re prepared to spend on monthly mortgage payments including other home-related expenses such as property taxes, insurance, homeowners’ association dues, and private mortgage insurance (necessary on loans with less than a 20% down payment). Mortgage lenders can actually overestimate the affordability of mortgage payment because their pricing may not take into account additional expenses. Line items such as savings, investments, and school tuition are not considered when mortgage lenders calculate what you can afford.
To figure out what you can actually afford, tally all monthly expenses and compare the amount to your monthly income. The goal is for total expenses, including all costs of owning your new home, to be less than 40% to 45% of your gross monthly income, according to conventional lending guidelines.
Step 2: Understand the product. Since the collapse of the subprime mortgage market, there are fewer exotic home loan products available. But there are still important mortgage variables a borrower must understand.
Research the type of mortgage that suits you best. Determine whether you want an adjustable- or fixed-rate loan. Most buyers may want a 30-year fixed-rate mortgage—unless they plan to move from the home within a short period, in which case a five-year adjustable-rate mortgage might make sense. “We knew we wanted a 30-year fixed-rate and didn’t consider anything else,” Anjuan says. “We typically avoid risk and knew we’d prefer to be locked in at a fixed rate, and not take the risk of a variable rate swinging high and driving the payment up.”
Next, decide whether you want to pay an origination fee or discount points (prepaid interest borrowers can purchase that lowers the amount of interest they will have to pay on subsequent payments). Also choose the time frame for the loan product you prefer; 15-, 30- or even 40-year terms are available. The interest rate and total amount of interest a borrower will pay over time increase proportionally with the term of the loan.
Step 3: Decide how you’ll loan shop. Figure out whether you want to shop for a loan on your own by collecting rate quotes from different banks or work with a mortgage broker whose job is to help you identify loans from a host of lenders. Shopping on your own isn’t likely to save you much money. Many bank loan representatives are licensed brokers who get paid a commission. As with mortgage brokers, if you pay a bank loan representative’s origination fee up front, your interest rate will be lower. If you elect not to pay it up front, you will pay it over time by virtue of a higher interest rate.
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