Federal Reserve Chair Janet Yellen recently hinted that an interest-rate hike might be coming soon -- and many expect the rate to be increased repeatedly in coming years. Even with an increase or two, rates will still be quite low, historically speaking. That makes this a great time to buy a house should you want to.
Spending a little time learning about mortgages can really pay off when you start the homebuying process. The following three mortgage truth bombs are good examples -- two might save you thousands of dollars, if not tens of thousands, and one might save your skin.
Your credit score matters -- a lot
First up is your credit score. You probably know that lenders will check your creditworthiness before deciding what interest rates to offer you. But you might not fully appreciate just how much a low credit score can keep you from being offered great interest rates. Check out the table below, which reflects recent rates for someone borrowing $200,000 via a 30-year fixed-rate mortgage:
Total Interest Paid
Source: MyFICO.com, as of early March 2017.
Whether your credit score is 650 or 700 can lead to a difference of about $100 per month, and $35,000 over the life of the loan. The takeaway here is that it can be well worth it to spend a little time beefing up your score before shopping for a home -- though you may be racing against rising interest rates at the same time.
Some ways to improve your credit score include paying bills on time and paying off a lot of debt in order to lower your debt-to-available-credit ratio. Lenders like to see you owing only about 10% to 30% of the sum of all your credit limits because it suggests that you have your debt under control and can afford to take on more debt via the mortgage you're seeking. You can get free copies of your credit reports once a year from each of the main credit reporting agencies -- do so and correct any errors on them. Simply correcting errors can easily increase your score.
Enjoy massive savings by paying a little extra
Next, aim to pay more than the minimum amount on your mortgage payments. You might do this by sending in an extra $100 or $200 with each payment in order to reduce your principal, or by sending in a few thousand dollars every few months, if you can. Here's an example of just how much one might save, using an online calculator from The Mortgage Professor's website. It assumes a $200,000 loan at 4.5%. The regular monthly payment would be $1,013.38.
Pay Off Loan in...
Total Interest Paid
Total Interest Saved
$100 extra monthly
$200 extra monthly
21 years and 6 months
$500 extra monthly
15 years and 3 months
$1,000 extra monthly
10 years and 5 months
Source: Author calculations at mtgprofessor.com.
It's kind of mind-boggling, no? It can be a powerful move to get a 15-year mortgage instead of a more conventional 30-year one, but that will lock in higher minimum payments. If you can muster the discipline for it, it's safer to opt for a longer loan, but then pay more than you have to each month. Even just paying $100 more each month -- only $25 per week -- can lop five full years off your loan's life and save you more than $30,000!
When you're getting pre-approved for your mortgage and as you finalize your loan's details, make sure that it doesn't include a prepayment penalty.
You can pay very little down, but you may not want to
Finally, homes can be bought with much less of a down payment than you might think. Jonathan Smoke, chief economist at Realtor.com, summarized recent survey findings by the National Association of Realtors, noting that "39% of non-owners believe they need more than 20% for a down payment on a home," with non-owners, on average, expecting to have to pay 16% down. The reality is that the conventional arrangement is to pay 20% of the home's value down, borrowing 80% of its value through a mortgage.
It might surprise you to know that you can buy a home while putting down much less. Per Smoke, the average down payment on purchase mortgages in 2016 was 11% -- and for those under 35 -- who are typically first-time homebuyers -- it was 8%.
If you're getting a conventional mortgage backed by Fannie Mae or Freddie Mac, you may be able to pay as little as 3% down. Federal Housing Administration (FHA) loans are available with only 3.5% down. If you qualify for a VA loan or a USDA Rural Development loan (which applies to lots of not-so-rural areas near cities), you may get a mortgage with a $0 down payment!
Paying little or nothing down is not all good, though. Sometimes, a low down payment will lead to a higher interest rate from the lender, as you're seen with less skin in the game. Paying little down starts you off with little home equity -- and should home values fall, your loan might end up "underwater," where you owe more than the home is worth. That can make it hard to sell the home, should you need or want to.
Still, being able to pay little down can mean the difference between buying a home and not being able to. Just aim not to buy more house than you can afford, as that can get you in hot water should your financial fortunes change.