With the shaky economy and the housing market in shambles, many would-be first time home buyers feel it’s better to wait out the bear market before purchasing a house. Although a sound strategy for some, it doesn’t apply across the board. If your credit score is 700+, your employment status secure and you earn (at least) a middle-class salary, there are great housing options available. In fact, these options continued to improve as recently as last week. On December 18, the average interest rate on a 30-year fixed mortgage dipped to 5.19 percent, the lowest rate ever reported by Freddie Mac in its 37-year history of surveying mortgage rates. This newest average is also significantly lower than the 6.00+ percent rates present throughout much of 2008.
It’s not just rates that are lower than usual. Because of the economic fallout, home prices are also being sold for reduced amounts. For example, a 2008 National Association of Realtors (NAR) survey found that a full 60 percent of home sellers cut their asking price at least once prior to selling their house. The survey also revealed that 17 percent of home sellers cut their asking price by more than ten percent. Further fueling of lower price points was caused by a steady stream of foreclosures throughout the country, backed up by the 2008 NAR survey finding that between 35 and 40 percent of houses sold in September 2008 were distressed properties, meaning they were in some phase of foreclosure at the time. According to Realty Trac, which monitors foreclosed properties trends, properties that are dealing with some stage of the foreclosure process are purchased at an average savings of 30 percent compared to the rest of the market.
In addition to historically low mortgage rates and reduced home prices, homeownership offers the biggest tax break opportunity possible. If you’re one of the lucky consumers who’s been able to avoid the many pitfalls plaguing our current economy, there’s no better time than now to take advantage of the market as a first time home buyer. It’s true that the mortgage process can be tricky, but the more you learn the sooner you’ll master it. Use the tips below to get started on your journey to homeownership.
Prepare for a Mortgage Loan: Check Credit Reports and Pay Down Other Debts
Do some prep work before you apply for a mortgage loan. Look over your credit reports from the major credit bureaus to make sure you’re in good standing; have any errors fixed immediately. Don’t apply for new credit cards or other types of loans if you plan on applying for a mortgage within a few months, because doing so will negatively affect your credit score. Also, pay off as much outstanding debt as you can before applying for the loan. There are two reasons you should do this. First, it’s a smart way to handle your finances – it doesn’t make sense to save up for a down payment but not pay off existing debt. It’s also wise to do because lenders won’t loan you money if your monthly debt service (the overall amount of your combined debts, including credit card balances, student loan payments, auto loans, mortgages, etc.) exceeds 40 percent of your gross income.
Determine a Down Payment Amount
The days of no money down mortgages are over and not a moment too soon. Not only has this policy done its part to fuel the foreclosure epidemic, it also makes the total mortgage amount much higher over the life of the loan. Nowadays, borrowers across the board are required to make a minimum down payment, which will vary by lender. Rather than stick to the minimum down payment amount, make the highest down payment you can reasonably afford. Doing so will reduce the total amount of your loan by thousands of dollars, as well as increase how much house you’ll be able to buy.
In addition to paying less interest on your mortgage over time, putting more money down can sometimes get you an upfront lower interest rate of approximately half a percentage point. Also, a down payment of 20+ percent will allow you to avoid the cost of private mortgage insurance, or PMI. Lenders require borrowers who make low down payments to have PMI in order to offset their lending risk, with premiums that average 0.5 percent of the loan amount. By making a down payment of at least 20 percent, you’re automatically opted-out of the PMI requirement.
Weigh the Pros and Cons Before Prepaying Interest Rate Points
There are two types of points – origination points and discount points. Regardless of type, each point represents one percent of your loan amount. (For example, one point on a $100,000 mortgage equals $1,000.) Origination points are the fees a lender and/or mortgage broker will charge you to start (originate) the loan process. You’re stuck paying origination points no matter what.
Discount points, on the other hand, are upfront payments expressed as interest rate percentages on a loan. When mortgage rates are high, some lenders may require you to pay these so-called discount points in order to qualify as a borrower. Now that rates are low, paying discount points is hardly a necessity, but it can be beneficial depending on your loan circumstances. According to Mortgage Professor, paying points won’t do much good if you pay off or refinance a loan within five years. On the other hand, it can save you a pretty penny if you stick with the same loan for ten years or more. Loans kept for longer than five years but less than ten may see some savings from paying points, but it won’t be much of a windfall. The bottom line? If certain you’ll have the same loan for at least a decade, consider paying points. If not, don’t bother.
A Final Word of Advice
Before you sign on the dotted line of a mortgage loan, keep in mind that your closing costs and fees can equal somewhere between three and six percent of your home’s total worth, so make sure you figure these costs into your calculations. Also, make sure that the yearly cost of property taxes, homeowner’s insurance payments and mortgage payments does not exceed 28 percent of your gross annual income. This will help protect against future foreclosure in case your finances unexpectedly take a turn for the worse.