Lenders qualify buyers based on their incomes and debt-to-income ratios without considering how much the borrowers spend on items such as transportation, savings, food and other necessities.
“A lot of first-time buyers are optimistic about the future and excited about buying a home, so they borrow the absolute maximum they can afford instead of allowing themselves wiggle room for a partial loss of income or for future expenses such as children,” Harrison says.
Financial experts recommend that consumers decide how much they want to spend each month on housing before meeting with a lender.
“Every buyer should create their own budget and know their limits,” says Stephen Adamo, formerly president of Weichert Financial Services in Morris Plains, New Jersey.
Adamo says many homebuyers, especially first-timers, experience a sizable change in their housing payments. Some new owners may go from $500 per month in rent to a monthly mortgage payment of $2,000, he says.
“You need to deal with payment shock,” Adamo says.
Meeting with a lender for a buyer consultation and prequalification for a mortgage should be the first step toward homeownership. Yet many homebuyers wait until they are ready to start house-hunting before contacting a lender.
“It’s never too early to set up a free buyer consultation with a lender,” Adamo says. “Every buyer needs to get prequalified early enough in the process so that they can make some changes if they need to or correct errors on their credit report.”
Some buyers may need to spend up to a year saving more money, increasing their incomes or cleaning up their credit before making an offer on a home.
A buyer consultation should include creating long-term financial goals and strategies for buying property, Adamo says.
While most consumers know it’s important to have a high credit score, not everyone understands how costly a low score can be.
“All mortgage lending is done with a tier of interest rates and terms based on consumer credit scores,” Harrison says.
Borrowers with credit scores of 740 and above tend to get the lowest rates and fees, saving potentially thousands of dollars. Mortgage-related fees usually are a little higher for credit scores from 720 to 739, and they go up for every 20-point downward increment in credit scores. Interest rates can go up, too.
Consumers should learn about credit scores the minute they start working, Harrison says.
After a mortgage approval, consumers must avoid applying for new credit or taking on new debt, Adamo says, because another credit check is often required before settlement.
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Choosing the wrong mortgage type
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The 30-year, fixed-rate mortgage is the default home loan for most borrowers.
But Harrison says home loan alternatives to a 30-year fixed sometimes make more sense. For example, buyers who are certain their companies will relocate them within five years may find a 5/1 adjustable-rate mortgage “could be a much better mortgage,” he says.
“There’s no reason to pay a premium for a product you don’t need, like a 30-year loan,” Harrison says.
Homebuyers eager to build equity in their homes or who are older and want to live mortgage-free in retirement should consider a 15-year fixed-rate loan or, if they can afford it, even a 10-year mortgage to reach their goals.