Are you thinking about getting involved in the real estate market? Buying a home or an apartment is possibly the most significant purchase any American makes in their lifetime. While a new car could cost you $30,000 or $40,000, and a new home is going to be in the price range of $250,000 to $350,00 for most entry-level deals.
It would make sense that you try and get the best deal possible when working with this amount of money. However, many Americans ‘don’t understand the nuances of buying real estate, and they get overwhelmed by the complexity of the transaction.
When you go out into the market and find the home you want, ‘you’re so smitten by the thought of moving into your first home, that you may tend to lay down and let the banks and realtor walk all over you, and then thank them for the experience at the close of the deal.
It pays to prepare for the experience of buying a home. When you understand how the transaction works, and what the lenders and realtors are looking for, then it gives you leverage in the deal. This strategy allows you to get a better interest rate, negotiate on the sales price, and even the closing costs involved with buying your home.
We put together five ways to help you save money on your home purchase. Review them and think about how you can apply them to your transaction – you might be surprised with the results.
1. Improve Your Credit Score
When assessing you for a mortgage, a lender will review your credit report. The three big credit bureaus in the United States, Equifax, TransUnion, and Experian, receive data from credit agencies every month. The bureaus compile this information to create your credit report, which helps lenders assess your risk profile when lending you money.
Research shows that the average FICO credit score in the U.S is 695. This score is above the 680 thresholds for the banks to consider you as average risk for a home loan. Typically, lenders want to see a credit score above 700 if you’re going to get a good deal on your mortgage rate.
If you have a credit score in the 800s, then you have far more leverage in the deal, and the banks are likely to offer you closer to the prime interest rate on your mortgage. With an 800 credit score, you can visit multiple lenders and play them off against one another to secure the best rates.
So, how do the credit bureaus calculate your credit score, and what can you do to improve it to obtain a better rate. If you have a score in the 800s, then you ‘don’t need to worry about this exercise, but if you are below the 680-mark, or in subprime territory under 580, then you might want to look at ways and means to improve your credit score.
The bureaus look at five weighted factors when compiling your credit score.
- The amount of credit you have.
- Your payments history.
- Credit mix.
- Your utilization ration
- Length of credit history.
All five of these factors have individual requirements, and ‘it’s best if you understand how they affect your total score.
The amount of credit you have is relatively self-explanatory, and your credit mix describes how many different accounts or credit facilities you own. Your utilization ratio accounts for how much of your credit facilities you use, and lenders like to see this under the 30-percent mark.
In other words, if you have a credit card facility for $5,000, you ‘shouldn’t spend more than $1,500 of the facility, or it could adversely affect your score. The length of credit history refers to how long ‘you’ve had the accounts for, the longer, the better in this case.
Download your credit report from the bureaus and check your score. Think about ways in which you can reduce your credit utilization ratio and your payment history, as these are the two factors that tend to trip people up.
2. Negotiate Your Interest Rate
The Federal Reserve ended the last easing cycle in December of 2015. They then proceeded to enter a period of tightening, where they started to increase the Federal funds rate from zero to 2.5-percent over the following 5-years.
As of August 2019, the Federal Reserve changed direction on monetary policy and started the new easing cycle to stimulate the economy. They began with a 25-basis point cut to bring the Federal funds rate from 2.5-percent to 2.25-percent, and analysts expect them to steadily continue to cut rates over the rest of 2019 and into 2020.
However, when you buy a home and acquire a mortgage, banks, and lenders ‘don’t give you the Federal funds rate, they reserve that rate for inter-bank lending only. You get the prime rate, which is typically 3-percent above the Federal funds rate. Lenders reserve the prime rate for their best clients – those people with 800+ credit scores.
People with an average credit score between 695 and 780 are likely to receive an offering of prime plus one or two points. Those people with subprime credit scores below 580, may struggle to get a mortgage at all. If they do, the lenders are likely to run over them with a facility of prime plus 5-points or more.
If you take proactive steps to improve your credit score, then you have more room for negotiating your interest rate with the lender. Many Americans think that the price the lender offers is their final offering, and they have to accept this deal. However, in most cases, you have room for negotiation on the rate, even if you are only in the average range with your credit score.
When applying, ask the banker to “sharpen their pencil” when they offer you the interest rate. This strategy is an excellent statement to ask the lender to reduce your interest rate politely. If they refuse, go and try your hand at another lender. In most cases, the bank or lender will shave at least a quarter or half a point off of their initial offering, saving you thousands of dollars on interest fees over the lifetime of your mortgage.
3. Think About Taking an Adjustable-Rate Mortgage Facility
A fixed-rate mortgage is the most popular choice for Americans. With this mortgage facility, the lender fixes your interest rate for the lifetime of the loan. In exchange for fixing your interest rate at an agreed price, your lender typically charges you a point more than other forms of mortgage facilities.
The benefits of a fixed-rate mortgage are that you safeguard yourself from volatility in the interest market. With a fixed mortgage, you lock in your monthly payment, and you ‘don’t ever have to worry about it increasing if interest rates start to rise.
This strategy makes it easier for you to budget your monthly mortgage payment, and allocate your income to the facility, without worrying if you will have to cut back on other lifestyle expenses to pay the mortgage, thereby reducing your quality of life.
However, in ‘today’s interest rate environment, a fixed mortgage facility may not be the best choice. As we mentioned, the Federal Reserve started the next phase of interest rate easing after the conclusion of the FOMC meeting in early August.
Many Wall Street analysts and economists predict the Fed to enter into another easing phase where they continually cut the Fed funds rate over the next four to five years. Some experts even state that the Fed may return to zero-interest-rate policy, and even into a negative interest rate policy.
You can take advantage of this easing cycle in interest rates by applying for a variable or adjustable-rate mortgage. With these facilities, you benefit from the decline in interest over the coming years. As the prime rate follows the Fed funds rate in lockstep toward the zero rate mark, so does the interest on your mortgage facility.
Unlike a fixed-rate mortgage, a variable-rate or adjustable-rate mortgage tracks the current rates set by lenders. As a result of the drop in interest rates, you end up with a mortgage payment that steadily decreases over the years. This strategy allows you to save thousands of dollars over the lifetime of your home loan.
However, there is some downside to risk to this model as well. Should the Federal Reserve concede that they made a policy mistake, they may decide to reverse their decision to cut and continue to hike interest again. If this scenario should occur, then your mortgage rates would continue to increase as well, meaning that you would see your monthly payment grow.
4. Lower Your Mortgage Term
Another strategy to help you save tens of thousands of dollars on your mortgage is to reduce your mortgage term. When you apply for a mortgage, the lender offers you the chance to select a 10, 15, 20, or 30-year term on your mortgage.
As mentioned, you pay interest on the money you borrow from the lender to facilitate a mortgage. The longer the term, the more interest you pay. At a prime plus 2-points rate, you could end up paying almost half of the cost of your home in interest fees. In other words, you purchase a house for $250,000 and end up paying nearly $400,000 after 30-years when you take into account the interest.
By reducing your mortgage term to 15-years, you nearly double your monthly payment, but you could save up to $75,000 in interest fees when compared to the 30-year facility. While the monthly payment is high, you pay your mortgage off faster and save tens of thousands of dollars in interest fees.
However, not everyone can afford to take a lower term on their mortgage, as they rely on the lowest monthly payment possible to maintain their cash flow. However, if you are currently using savings and investment vehicles that pay less than a 10-percent annual return, you should consider putting your investments on pause and funneling that cash into your mortgage instead.
Paying off your mortgage faster means that you have the opportunity to achieve financial freedom sooner than you expected. After paying off your mortgage, ‘you’ll have a debt-free asset that you can use as leverage on other investment deals.
5. Increase Your Down Payment
Homeowners that provide lenders with less than a 20-percent down payment on their mortgage facility are subject to paying Purchase Money Insurance, (PMI). The lender requires you to pay this insurance in case you default on your monthly payments. While you may never intend to default on your mortgage, the lender is typically inflexible on their decision to charge you this monthly fee.
PMI can add thousands of dollars to your home loan, especially if you are taking a 30-year facility with the lender. In most cases, the bank or lender will only stop charging you this fee when you finish paying off 80-percent of the loan, which could take many decades if you take a 30-year mortgage. By placing a 20-percent down payment on your home, you can ask the lender to waive this charge, and most of them will comply with your request.
To find more money for your down payment, cash in your investments that ‘don’t have any penalty fees. Save and cut back on your expenses for as long as possible until you achieve the target figure needed for a 20-percent down payment. It may mean that you have to reduce your monthly expenses significantly for a few months, but the amount of money that ‘you’ll save over the duration of your home loan is well worth the effort.
Wrapping Up – Key Takeaways
Download your credit report, and assess how you can bring up your score if ‘it’s below the 780 range. This strategy gives you leverage in the interest rate negotiations with your lender.
‘Don’t take the first interest offering from your lender. Shop around and ask the financier to reduce your rate.
Consider taking advantage of an adjustable-rate mortgage, especially if you intend on selling your home within a 10-year timeframe.
Reduce your mortgage term if possible – the lower the timeframe, the more you save on interest costs.
Boost your down payment to 20-percent or more and avoid unnecessary interest charges.