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 For most of us, buying a home is the single largest investment decision we will ever make. For many it involves a mortgage that is two or three times our annual gross income, which may take as many as 30 years to pay off. It also involves an asset that we live in nearly every day of the year. It's a decision that we might question every time we look at the house. Bottom line - buying a home is big.
So we probably all agree that buying a home is a really big decision that impacts our finances and lifestyle for years to come. In fact, that's why a lot of people experience anxiety over the decision, wondering if they make the right choice or got the best deal possible. It's also one of the reasons we have an entire section dedicated to the topic of buying a home.
Home Buying Terminology
Buying that first home is always the toughest step to take. That's because we hear all these terms that are really quite unique to this process. How many of us have heard the warning about closing costs and how much money to get together for an escrow account? You even need to work with a real estate agent and pre-qualify for a mortgage before you're even taken seriously.
To help demystify the terminology around home buying, we have a pretty extensive resource that includes many of the key terms you'll hear when you're talking to a relative or agent. So if you wondering what closing costs are all about or the difference between a fixed rate mortgage and a balloon mortgage are just take a look at our financial dictionary.
Financing a New Home
One of the biggest decisions you'll need to make deals with financing your new home. To be taken seriously as a bidder on a home, you may have to get pre-approved or pre-qualified for a mortgage. This is a relatively simple process that normally does not involve any commitment on your part or the lender's.
You'll need to supply some information such as your paycheck or other proof of income and answer some questions about outstanding debt or loans. The lender will evaluate your financial situation and provide an estimate on how large a mortgage you may qualify for.
We use the word "may" because until a thorough review is completed, you're not committed to the lender and the lender is not committed to lending you the money. The aim of this prequalification process is to make the homeowner selling the home feel a little more comfortable that you're serious about buying a home and that you can likely afford to buy their home.
When it gets down to the real financing choices, you'll need to wrestle with decision on the length or term of the loan and whether you want a variable rate loan such as an ARM or a conventional loan. Here are a couple of tips or simple "rules of thumb" to help you make an informed decision:
Term of Loans or Mortgages
The longer the term (time), the larger the mortgage you can afford. That's because you're paying off less principal each month. The downside is that the total interest you'll pay on the loan will be higher. Today, many people are trying to keep the term on their mortgage as short as possible - if they can afford it.
Variable versus Fixed Rate Mortgages
Depending on long term interest rates, an adjustable rate mortgage usually offers lower interest rates in the short term versus a conventional or fixed rate mortgage. That's because the lender is lowering their risk of interest rate movements and that means their risk premium is lower.
If interest rates start to creep up over the next five years, a five year ARM allows the lender to raise the interest rate on the loan. This feature allows them to insulate themselves from this type of risk. Essentially, this risk is no longer passed on to the consumer and they benefit from lower interest rates in the near term.
Mortgage Points
Mortgage points are simply a way you can lower the monthly payments on a loan by prepaying some of the interest on the loan. We'll talk about ways to compare mortgages using the annual percentage rate, but here is a tip concerning points.
Points are used to lower your monthly payment throughout the life or term of the mortgage. They are applied to the interest expense, not the principal of the loan. So an extreme example goes like this. If you were to buy a home and pay 2 points on a $200,000 mortgage, it's like prepaying $4,000 in interest (2% of $200,000).
If you turn around and sell that home in a month's time, then you've lost nearly the entire benefit of paying points. You've really paid the $4,000 and received no benefit other than the tax deduction. So the rule of thumb to remember goes something like this - you should avoid paying any points if you do not plan on staying in this new home for at least five to ten years.
Annual Percentage Rate
The annual percentage rate or APR quoted on a mortgage is probably the single most important number you can use to compare mortgages. That's because the APR "normalizes" each different type of mortgage for points, application fees and other types of loan origination fees.
If you could get a mortgage with no points and no fees, then the APR should be equal to the interest rate on the loan (which is used to calculate your monthly payment). In the same way, a loan with $500 in application fees will have a higher APR when compared to a loan at the same interest rate, but without any fees.
Home Buying Resources
Now that we've given you some tips on evaluating your financing options for your new home, we're going to finish up with a listing of some of the home buying resources we've assembled.
Amortization Schedules
In our article on amortization schedules, we have a total of seven different tables that you can use to calculate your monthly loan payment and how fast that loan vanishes over time. We've got schedules that range from 3 to 30 years and all of the common terms in-between.
First Time Home Buyers
We've also put together a four part series for first time home buyers that walk you through the process of figuring out how much you can afford to pay for a new home all the way through evaluating the home for structural or cosmetic problems. We'll help you figure out where you want to live and when to get involved with a real estate agent.
We've also put together a series of articles aimed at finding first time home buyers assistance in financing their home or finding specialized programs that make buying a home more affordable. For example, our article on First Time Home Buyer Grants talks about grants such as the American Dream program offered through HUD. In our article on First Time Home Buyer Loans, we'll help you figure out if, and where, you might be able to find affordable financing.
Mortgage Calculators
We've also a wide assortment of online mortgage calculators that you can use for free. At last count we had nearly twenty calculators that can help you compare mortgages, or figure out in impact of mortgage points, or the financial implications of taking out a balloon mortgage. We've even got a couple of calculators that can help you figure out how large of a mortgage you can afford.
The thing to keep in mind is that buying a home is something that happens all the time and there is a robust industry of attorneys, real estate agents and lenders that are there to help you. However, when you're buying that home you really want to lower the risk that you're making a bad decision, that's where we can try to help.
So here is our final words of advice - If you're thinking about buying a new home, then educate yourself best you can. Read what others have to say and figure out what is the best thing to do in your situation. Try best you can to make a decision that balances your heart and what's in your mind and you'll never look back with regrets.
About the Author - Buying a Home
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