When I bought a house for the first time 15 years ago, the best mortgage rate I could get on my $130,000 fixer-upper (with a $10,000 down payment) was 6.8% fixed. That didn’t sound so bad at the time – mostly because that was the lowest rate available.
I soon realized that if I used the full 30 years to pay it off, with compounding interest, I would have ended up paying over $302,500! That is well over double the amount of the original price of my house. Fortunately I was able to refinance over the years and I was able to shave off tens of thousands of dollars.
If I was starting over today with a 3.75% fixed interest rate for 30 years (which is the rate that many banks are offering), things would be drastically different: on a 130,000 home I would have ended up paying a total of $197,800 (versus $302,500). That is over a $100,000 difference between a 6.8% and a 3.5%!! Do you see how much of a difference just a few percentage points on a fixed home loan make?
Are interest rates going to go lower?
Almost no one can predict if the interest rate on home loans will go lower, but personally I cannot imagine that they can go lower than 3.25% on a 30-year loan. Now add in the price of homes which are still low due to the recent real estate crisis. So if you have not purchased a house before, or you are in the market again, now may be a good time to buy.
One important thing to keep at the back of your mind
Keep in mind that the real estate market burst because many people were given home loans that they could not afford, which resulted in banks foreclosing on them when they fell behind on their payments. Many other people are still in homes in which they are “underwater” meaning that they owe more to the bank on the house than the house is worth.
So what can I afford?
What you can afford depends on a lot of things: your interest rate, your down payment, and your credit rating are just a few things. However you must also take into account how disciplined you are, your current bills, car payment and other expenses. If you have a lot of debt or expenses, making the house payment may be hard to do every month.
Remember to save as much money for a down payment as you can. Make sure that this is actual money from savings from investments such as high yield savings accounts and not money from a credit card or loan. Otherwise you are creating more debt than you can probably handle.
What is the rule?
I know that you want a beautiful home in a great neighborhood. However, you may not be able to afford all of that now.
Some experts say that you should not spend more than 35% total of what you take home on housing. So if you take home $65,000 a year, you should not be spending more than $22,750 a year (or $1900 per month).
Other experts say that you should not spend much more than three times your salary on a house. So if you make $100,000 a year, you should not buy a house that costs more than $300,000. Although this is not an exact science, these are good measurements.
If you focus on what you can afford, and you find a good place, the equity can soon build in your home. Start small. As you start to pay off the home, make improvements to the home, and the value of the house goes up, you will have a nice little nest egg. Your credit goes up and your net worth goes up. You can continue to live in a moderately-priced home, or upgrade if you wish.
Watch out for the hidden expenses
Remember that problems often come up in a house – especially if it is an older house. The furnace may go k-put or the hole in the fence needs fixing so that Sparky doesn’t get through and beat up the neighbor’s dog (believe me I lived through both of these aggravations!).
Remember also that with a house comes insurance and property taxes. These are often tied with the loan but they make for a higher payment than just the house itself. It is another expense that you may not have planned. As a general rule, I suggest to save 3-5% for any of these surprises.
Make sure that you save your emergency funds and housing savings in FDIC insured banks.
Should I go for a 30 or a 15-year home loan?
I know that you are excited to own your home outright and a 15-year loan not only has a better interest rate, it sounds very impressive to your friends. However, for a new home owner I suggest that you get the 30-year and just make one-two extra payments per year. This way the time line will be much shorter and the minimum payment due will be smaller than a 15 year mortgage.
Home ownership is one of the most important decisions that you will ever make. This is the place where you will watch sunsets, make gourmet meals, have barbeques with friends and play croquet with the kids. This place will grow old with you and if you play it smart, this house won’t break you financially. Get what you can afford and in the long run, you and your house will be the best of friends.
How to Shop for the Best Home Loan
The most important number to focus on when looking for the best mortgage loan is the APR. The APR is the total annual percentage rate that you will pay for your loan after factoring in all costs including points, closing costs, and other amounts that get added to the loan. If you are planning to keep your house for the long term, you should compare APRs from as many banks and credit unions as possible and choose the lowest. If you are planning on only keeping the house for a few years, you will want to consider a mortgage that will result in smaller monthly payments and/or lower closing costs so that you end up paying the least total amount possible for the short duration you plan on owning the home.