A new home is the biggest purchase we will ever make. And any mistakes you make during this process will cost you dearly over the life of the loan.
Here are a number of things to remember before you take out a real estate mortgage.
The impact of your credit
A mortgage is a big loan. Lenders are taking a big risk when they loan you the money. The only reason the average loan has a low interest rate compared to credit cards is that it is secured by a valuable asset – the house itself. You should clean up your credit before you start shopping for a mortgage. Catch up on your bills, pay all your bills on time, clean up your credit report, and consider paying off small debts. Do not open up new credit accounts, even if you want to roll over debt to a new 0% credit card. Don’t start shopping for new furniture or buy a new car while you’re closing on a house, either.
The impact on your tax bills
The cost of home ownership is not just the monthly mortgage payment. You must also pay for homeowners’ insurance and property taxes. The property tax bill could range from half a percent to five percent of the property’s value, and that’s due every year. We often forget about this bill because the insurance and property taxes are collected in part each month along with the mortgage payment, and they pay the bill for you. However, if they make a mistake, you could face late fees. Or you’ll have to come up with several hundred dollars to pay the bill due at the start of the year.
Another factor to consider is how your mortgage payment relates to your income taxes. You can only deducted interest paid on a first and second mortgage up to a certain amount set by the IRS. Understand that you cannot deduct the principal paid. Note that you cannot deduct mortgage interest from your taxes if it is an investment property. And home equity debt such as a HELOC is no longer deductible. If you don’t keep up with tax laws, you could find yourself owing more in taxes than you expected. Then again, if you don’t pay your income taxes or real estate taxes, your home could be seized to pay for the debt. When facing the seizure of your assets, Chad Silver from Silver Tax Group says that a skilled tax lawyer will help you negotiate with the IRS.
Understand the tax rules that apply to you and factor them into your decision to buy a home, so you don’t end up with nothing left after paying your taxes and mortgage payment.
How the house affects your budget
We’ve already mentioned that you need to factor bills like homeowner’s insurance and property taxes into your budget. Then there’s the mortgage itself. However, these aren’t the only expenses you need to plan on. For example, as a homeowner, you’re now responsible for ongoing maintenance. Expect to set aside several hundred a month to pay for major repairs that come up like replacing a broken water heater or burned out AC unit. Save up to replace the roof in a few years so you don’t have to add to your debt load.
The types of loans and their associated costs
Another factor to consider is the loan terms. If you choose a 30 year mortgage, you’ll have a lower monthly payment, but you’ll pay tens to hundreds of thousands more over the life of the loan. Try to get a 15 year mortgage if you can, though you need to have enough wiggle room in your budget that you can make the mortgage payment even if a surprise bill like a big car repair hits. Saving longer so that you can put 20% down is worth it if you can achieve it. That would eliminate private mortgage insurance and yield a lower interest rate.
Avoid interest only loans, since they don’t make progress against the principal owed. Variable interest rates may save you money on loan payments when interest rates are low, but your house payment could spike if interest rates go up. Don’t take out a variable interest rate loan on the assumption you can refinance. Be sure you can afford your current mortgage before you take out the loan, because you cannot assume you can refinance the loan to a lower interest rate once your credit improves.
Do your homework so that you don’t have to pay more than necessary for your new home. With a little footwork now, you’ll enjoy your home instead of ending up house poor and turning your dream home into a nightmare.