I want to buy my first house, but I live in an expensive area and I don’t want to end up house poor. What can I do to lower my monthly mortgage payments?—Frank
The leap into homeownership is a big change, especially on your finances.
Buying a home is likely the biggest purchase you’ll ever make, so it’s important to keep your payments in line with what you can afford.
When your mortgage eats up too much of your budget, it can affect your long-term financial security by limiting your ability to save for retirement, pay down debt or follow other dreams like traveling or starting a business.
The general rule of thumb is to aim to have your monthly housing costs add up to less than 30% of your monthly before-tax income.
No doubt that in the country’s more expensive housing markets that’s hard to do, but buyers can take steps to help reduce their housing payments.
Improve your credit score
Your credit score plays a major role with lenders in deciding the terms of your home loan (or whether they’ll give you one at all).
The better your score, the more likely you are to get a lower interest rate, which means you will be paying less over the life of your loan.
A credit score of 750 and up is generally considered excellent and will make you the most attractive borrower.
Home buyers with credit scores below 620 tend to have very high interest rates and risky features on their home loans, according to the Consumer Financial Protection Bureau.
But a good credit score doesn’t happen overnight.
“It means that for a couple years before you really want to purchase a house, you start working to get your score as high as possible, said Nicole Theisen Strbich, a certified financial planner and director of financial planning with Buckingham Financial Group. “It’s not a switch you can flip.”
Start by reviewing your credit report to identify outstanding debt and create a game plan on how to reduce it as quickly as possible. Be sure to also look for any errors on your report since they can take time to fix.
Shop around … a lot
When it comes to getting a mortgage, it pays to shop around.
The interest rate for similar loans can vary by more than half of one percentage point from one lender to another, according to the Consumer Financial Protection Bureau. And while that number might sound small, it can save you thousands of dollars over the life of your mortgage.
The difference between the average person’s mortgage rate and the lowest rate available to them came to an extra $ 300 a year, a CFPB report found. That means paying an extra $ 9,000 over a 30-year mortgage.
Get quotes from a variety of lenders, traditional banks, online-only banks and community banks to find the best rate, the experts advised.
Don’t worry about hurting your credit score: Multiple credit checks from mortgage lenders within a 45-day window are recorded on your credit report as a single inquiry.
Related: 4 things first-time homebuyers need to know
Put down a large down payment
The larger your down payment, the less you need to borrow and the smaller your monthly mortgage payments will be.
It also means paying less in total interest.
If you can put down at least 20% of the home price, you can also avoid paying private mortgage insurance — which protects the lender in case you default — saving thousands of dollars a year.
If you put more money down, you can also avoid paying points and other loan fees.
While you’re saving to hit that 20% mark, be sure to keep those funds safe.
“If you are planning on purchasing in the next five years, save it in a place not subject to stock market volatility,” recommended Strbich. “Find the highest interest-bearing account with FDIC insurance. Online banks are a great option for that.”
The 30-year fixed rate mortgage is the most common home loan, but there are other options available.
“I try to steer young people away from 30-year mortgages,” said John Cooper, certified financial planner in South Carolina. “The extended maturity on the loan gives buyers a lower monthly payment, but it may in reality cause them to buy more of a home than they can afford.”
A 15-year mortgage comes with higher monthly payments, but also has a lower interest rate, which can bring significant savings.
Shorter loans also mean more of your payments are going toward the principal of your loan and less toward interest compared to a 30-year loan, so you’ll build equity faster.
For some buyers, an adjustable-rate mortgage could also make sense.
ARMs offer a fixed, lower interest rate for a set period of time. But after that introductory period expires, the rate can rise (or drop) to current rates. So it’s important to evaluate the risks and make sure your income will be able to cover a higher interest rate.
Cooper said an ARM could work for buyers who know they won’t be living in the home long term, or are in occupations where they aren’t making a lot of money at the start, but will see a significant increase in a few years.