Smortgagesbord – Back to Basics at the Mortgage Buffet

Recent posts on Sweet Digs Seattle:

• Columbia City Redux
• Holiday Happenings in Bellevue and Eastside Price Reductions
• A New York Story (to Make Northwesterners Smile)
• Bainbridge Island: Janelle Property Sold–Blogger Heartbreak on BI
• Bainbridge Island: Festive Holiday Shopping on the Island 

The veritable smorgasbord of mortgages and things to consider when financing a house can make your head spin. Here are some basics in plain English that every future home buyer should know:

Credit score, credit score, credit score!
Your credit score tells lenders how likely you are to pay your bills on time. The credit score is about the future, not the past (this sounds backwards but it’s true). The credit score is used to determine the amount of risk you pose to a lender. One late car payment can drop your score. Be careful of how many times your credit score is pulled, this can also lower your credit score because it is interpreted as increasing risk because it looks like you’re trying to acquire lots of new debt.

The better your credit score, the lower the interest rate you qualify for, which means your monthly payments are lower, which means you’ll qualify for more house. Conventional lending wisdom limits housing costs to 28% of gross income and total debt payments to 36% of gross income.

Getting financing is a snap when (even now after the subprime debacle):

• You’re credit score is high (in the ballpark of 780 is super)
• You have little or no debt
• You have some down payment (10% or more is good)
• You have been in your job for a few years (at least more than 2 years)

You don’t have to pay PMI even if you don’t have 20% down:
Lenders will require that you to have Private Mortgage Insurance(PMI) if you borrow more than 80% of the appraised value of a home. PMI is an additional monthly cost that can be avoided. If you don’t have 20% down payment you can get an 80/20 loan where a primary loan finances 80% of the value and a second loan (line of credit) finances the rest. Usually the second loan will be at a higher interest rate but it’s on a smaller balance and you’ll want to focus on paying that down first.

Save money on Escrow:
Often if your Escrow and Lender are the same company, the escrow fee will be waved. For a $600k house this can be about $800 savings.

ARMs are risky:
Adjustable Rate Mortgages (ARMs) are marketed to people who “plan to sell within a few years”. If you’re planning to flip the house and want a low interest rate then an ARM might be a good way to go. If you’re buying a house to live in for a couple years and then plan to move, an ARM will force you to sell or refinance at the end of the 3, 5, or 7 year term. If you can’t sell without losing your shirt in the process because housing prices tank, lenders won’t loan you more than what the house is worth so you can’t refi either. Welcome to Foreclosureville. In the current real estate climate, I consider ARMs very risky and not a good idea.

Always pay extra toward the principal of the loan:
Just one additional monthly payment per year will reduce a normal 30-year loan to 22 years. In particular if you get an interest only loan make sure you pay toward the principal even though you don’t have to. Interest only loans have a bad rap because people have used them to get into homes they really shouldn’t be able to afford. Interest only loans enable you to have a lower monthly payment to help you qualify for more house but still being within the debt ratio rules the lenders have.  But if your income is not a consistent montly salary but is seasonal for example, interest only can enable you to have low monthly required payments and then pay more when you have more. You have to be disciplined to make this work.

Anything I missed?
Any one else have mortgage tips and tricks they want to share? Please leave a comment!