A mortgage is likely to be the largest and longest loan of your life. As a first-time homebuyer, you’ll want to be in the best financial shape possible to qualify for a good rate and get the right loan for your needs. It can be hard to know where to get started, but we’ve got you covered.
Here are three ways to make sure you get the best possible mortgage:
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Clean up your credit
Your credit history and credit score are the biggest factors lenders use to determine whether you’re a risky borrower. As you get ready to apply for a mortgage, check your credit report, and if needed, file written disputes to eliminate errors.
If you have credit cards with high balances, try to pay them down to show that you’re not using all of your available credit, which sends up a red flag for most lenders. If possible, you should keep your balances at 30% of your total credit limit — or less.
It’s also best to avoid opening a lot of new accounts or making big purchases (like financing a new car) right before you apply for a mortgage.
Choose the best mortgage
Fixed rate or adjustable? 30 year or 15? The options can be dizzying.
A typical fixed-rate mortgage has a 30-year term and the interest rate doesn’t change during that time. This type of loan is a good idea if you think mortgage rates will rise over the next few years and you want to lock in current rates.
The other option is an adjustable-rate mortgage, or ARM. Typically, these come with an initial period of one, five or seven years at a set interest rate, which is usually lower than rates offered on fixed-rate loans. After the introductory period, however, the interest rate can rise or fall for the rest of the time you hold the mortgage. That means your monthly payment can also rise and fall. Typically, the adjustments are made on an annual basis and there’s a lifetime cap on how high the rate can go.
One way to be sure an ARM is for you is to carefully calculate how much your monthly payments could rise if rates go up and be sure you can afford the higher payment. An ARM also might be a good choice if you plan to sell your house or refinance before the initial fixed-rate period ends.
The length of the loan’s term (repayment period) is also an important decision. A 15-year mortgage may carry a lower interest rate, but the payments will be higher than if you were stretching payments over more years. A 30-year mortgage will come with a comparatively higher rate, but lower payments.
A shorter-term loan can be a good idea if you can afford the higher payments and want to pay off your home faster. However, you can usually whittle down the principal on a 30-year mortgage with extra payments to accomplish the same goal. Just make sure the loan doesn’t have prepayment penalties.
Consider a government-backed loan
Loans insured by the Federal Housing Administration, or FHA, can be helpful for first-time homebuyers because the minimum down payment can be as low as 3.5% for borrowers with good credit.
There is a catch, though. With an FHA loan, you’ll pay two forms of mortgage insurance. The first is an upfront premium of 1.75% of the loan. On most of these loans, you’ll also pay an annual amount of about 0.85% of the remaining principal balance, depending on how much you borrow.
Active military personnel and veterans may also qualify for loans backed by the Department of Veterans Affairs, and homes in qualifying rural areas can be financed by a U.S. Department of Agriculture loan. Your lender can help you evaluate these options.
Cleaning up your credit and doing careful research on your borrowing options takes time. But once you’re settled into your new home with a manageable mortgage payment, the hard work you’re putting in now will pay off.
VIRGINIA C. MCGUIRE