Erik Carter Contributor
Along with paying down debt, building an emergency fund, and planning for retirement, buying a home is one of the most popular financial planning goals. With interest rates on the rise, you may be wondering how to buy a home as soon as possible. Here are some steps to take:
1) Get your credit in as good shape as possible. Your credit score can make a big difference in your mortgage interest rate. You can use sites like creditkarma.com (which uses TransUnion and Equifax) and freecreditscore.com (which uses Experian) to get free credit scores from all three credit bureaus, free credit monitoring to alert you of any changes to your credit, and advice on how to improve your credit scores. The key things are to make sure you make your debt payments on time, pay off as much of your debt as possible (except perhaps car and student loans, which tend to have relatively low interest rates), and be careful of closing credit card accounts. If you have a credit card that is charging you an annual fee, see if you can convert the card into a no-fee card rather than close it.
You can also order a free copy of your credit reports from each of the credit bureaus at annualcreditreport.com as long as you haven't done so in the last 12 months. One study showed that about 70% of credit reports have errors in them so check to see if there are any in yours that could be hurting your credit score and if so, be sure to have them corrected. It’s bad enough to suffer from your own mistakes. You don’t want to suffer from someone else’s too. Finally, you may want to put a security freeze on your credit reports to protect you from identity theft.
2) Figure out how much home you can afford. Remember, just because the mortgage company will loan you the money doesn't mean you should take it. There are rules of thumb like not spending more than 28% of your income on mortgage payments, but every person's situation is different. Two people may have the same income, but one may need to save more for retirement or choose to make large private school tuition payments for their kids. Take a look at your current saving and spending needs to see how much you can realistically afford to pay each month and don't forget to leave some room for the potential "hidden expenses" of home ownership like utility bills, HOA fees if applicable, repairs and maintenance.
3) Save for upfront costs. Ideally, you would be able to put down 20% of your home's purchase price to avoid having to pay PMI (private mortgage insurance). If you can't put down 20%, mortgage companies will usually offer you a smaller "piggy back loan" to help bridge the gap but those loans have higher interest rates. You may also need between 2% to 5% of the purchase price for closing costs plus whatever you want to spend on moving, furnishings and renovations.
Don't dip too far into your savings though. Try to keep at least 3-6 months of expenses set aside for emergencies. After all, you will be responsible for maintenance and repairs now. If you don't have enough money available in your regular accounts, you can access up to $10,000 without penalties from IRAs for a first-time home purchase and your employer's retirement plan may allow you to borrow from your retirement account with a longer time period to pay off home loans. There's always the "family and friends" route too.
4) Choose the right loan term for your needs. A 30-year loan has lower monthly payments and can be advantageous if you'll make good use of the savings by investing them or paying down high interest debt. You can always make extra payments if you want to pay the loan off sooner. But if you're honestly more likely to splurge the money you save each month with a 30-year loan, the 15-year loan could be better since it will cost you less in interest and you'll pay it off sooner.
In any case, consider picking a mortgage with a fixed rate for the longest time that you think you'll be keeping the home. That's because you could see your monthly payments jump up on a variable rate mortgage if interest rates keep climbing. On the other hand, fixed rate mortgages start with higher interest rates so it may not make sense to pay more to lock in a fixed rate for longer than you need it.
5) Shop around for a mortgage. Even a slightly higher rate can mean paying significantly more interest payments over the life of the loan so don't just talk to your existing bank. Consider non-profit credit unions, web sites like bankrate.com and eloan.com, and independent mortgage brokers who can shop around from multiple mortgage companies to find the one that can offer you the best deal. Just try to do all of your mortgage shopping within a 30 day period so it doesn’t affect your credit too much. You can then use this calculator to compare the loans.
6) Start house hunting. Once you've gotten pre-approved on a mortgage, find a buyer’s agent experienced in the neighborhoods you're interested in and only look at homes that are within your affordable price range. Otherwise, you may fall in love with a place outside your price range and talk yourself into buying it.
7) Get an independent inspection. Your real estate agent may recommend a home inspector, but they may be biased towards making the deal go through to continue being referred by the agent. Instead, consider an independent home inspector who only works for you.
Erik Carter, JD, CFP® is a senior resident financial planner at Financial Finesse.