Ask a Mortgage Expert: Everything You Need to Know About Buying a Home
Buying a home is always a big decision, but it feels particularly fraught right now. Buyers are looking at a perfect storm of record-high prices, record-low inventory, and rising interest rates — all of which turns one of the biggest decisions of your life into a paralyzingly big decision.
To help us navigate this complicated process, we turned to Bankrate’s Senior Mortgage Reporter, Jeff Ostrowski, who’s been covering the housing market for more than two decades. He spoke to us over the phone about all things related to buying a home. Below is a lightly edited transcript of our conversation.
MYMOVE: When you’re ready to buy a house, should you talk to different lenders to see which one offers you the best rates or is it pretty much the same everywhere?
Jeff Ostrowski: That’s a good question. One of the big government-sponsored entities did a study a few years ago, and found that by comparing just three mortgage bids, consumers saved thousands of dollars over the life of the loan.
The mortgage is a pretty complicated financial instrument. There are a lot of moving parts — not just the rate, but then other terms like points and closing costs. So there are a lot of different things that go into the mortgage offer that you get from any lender, and you can get offers that are very different.
You can apply with three different lenders on the same day and get three different rates, three loans that are different in terms of the closing costs. So yes, definitely shop around. Sites like Bankrate will help you comparison shop, but the rule of thumb is to get at least three offers and possibly more.
It’s also a good idea to compare among different types of lenders. So maybe a brick and mortar bank and maybe a credit union. And right now, the mortgage industry is dominated by online players like Rocket Mortgage and some of the other big lenders that don’t actually have branches but still do a ton of mortgage business.
MYMOVE: Are they just able to offer lower rates and fees and things like that?
Ostrowski: Not necessarily. They’re certainly competitive, but you’re not necessarily going to get the best rates or best costs with Rocket or one of the other big players. It just really varies, so that’s why you should shop around.
MYMOVE: How much do you need to save to buy a home?
Jeff Ostrowski: That really depends. The conventional wisdom is 20% down payment, and for most borrowers that’s going to buy you the most flexibility in terms of rate. 20% might be the best number for most people but it’s certainly not the only number. With the median home price in the U.S. approaching $400,000 — 20% of that, obviously is $80,000 — and I don’t suppose a lot of first time homebuyers have saved up that much for a down payment.
But the good news is that you don’t need 20%. You can buy a house with much less than that if you’re eligible for a VA loan, a loan backed by the U.S. Department of Veterans Affairs. One of the benefits is that you can get a mortgage with zero down.
There’s another program called the FHA or the Federal Housing Administration loan program. That’s really geared towards first-time buyers and people with some credit issues. It only requires 3.5% down but there is a bit of a downside, and that’s its version of private mortgage insurance, which is insurance that the borrower pays to protect the lender from default. The FHA’s private mortgage insurance is pretty steep — that’s going to add hundreds or maybe even thousands a year to your mortgage payments. But if you want to get into a house and you’re not eligible for a VA loan, and you only have 3.5%, the FHA is a good option.
The conventional lenders, Fannie and Freddie, also have some programs that allow people to put down as little as 3% or 5%. The overall point is that there are options. So 20% is sort of the gold standard, and it’s great if you can do that, but if you can’t do that, it’s not the end of the world and you can still get into the homeownership game.
MYMOVE: Do you think it’s better to save up for more of a down payment or should you just try to begin building equity as soon as you can?
Ostrowski: It really depends. A couple of years ago, you definitely would have wanted to jump in because you would have gained the appreciation we’ve had over the past couple of years. But of course we didn’t know that at the time. That’s always the paradox of these decisions — you don’t necessarily know at the time that that’s going to be the case. But the size of your down payment is not the only thing that you should be thinking about.
The best rates go to borrowers with credit scores above 740, which is very good. If you have a credit score of 740 or higher, it means you haven’t had any major financial issues in the last five to seven years, and that you’ve had very few minor issues — you haven’t missed any credit card payments or other debt payments.
And then at some point lenders just won’t want to extend credit at all. So if your credit score is below 630, 640, then it becomes very difficult for a consumer to get a mortgage. The VA loans and FHA loans are popular because they have a lot more flexibility around credit scores. For both of those programs, you can have a credit score as low as 620 to 640 and still get a mortgage, but then you pay for it in terms of the higher fees and higher mortgage insurance.
For some borrowers who have credit scores below 700, it might make more sense to just throw that money into paying down the credit cards and trying to reduce your credit utilization rate. And that will save you money on your interest rate even though you might not have as much of a down payment when it comes time to close on the house.
MYMOVE: How are those mortgage rates determined?
Ostrowski: In general the overall overall mortgage rates are kind of at the mercy of a variety of factors. One is the yield on the 10-year Treasury note that’s sort of a benchmark that type of government debt is a benchmark for 30 year loans. And then what the Fed is doing has some effect when it comes to the individual borrower.
The most important thing that a lender is going to look at is the credit score. The lending industry has decided over the past few decades that the credit scores are accurate, they’re a credible indicator of how likely you are to repay your debt. That’s going to be the most important factor.
There might be some other factors that affect your rates, too. For instance, how much you’re putting down. If you’re putting down more than 20%, a lender is going to assume that you’re not much of a default risk even if you don’t have a great credit score. And then debt-to-income ratio is another thing that lenders might look at, but for the most part lenders use the credit score as a proxy for debt-to-income ratio.
So those are the three main factors, the biggest one being your individual credit score, and then also your debt-to-income ratio and the amount of money that you’re putting down on the house.
MYMOVE: What are just some common mistakes people make during the process?
Ostrowski: Not shopping around is one. Being confused about the amount of down payment you need and aiming for the wrong target on that front. Not paying enough attention to your credit score and doing the things in advance that will boost your credit score.
A lot of these things, it’s hard to really call mistakes just because it’s such a complicated process, and it’s such an individual process. The offer you get from lenders is going to be unique to your situation.
I can say that after writing about this stuff for many years and having a number of mortgages myself, I’m still confused when I get a sheet with closing costs on there. Even with some of the reforms after the financial crisis of 15 years ago, it’s still hard for consumers to make sense of the offers that they’re getting.
MYMOVE: Are there specific things borrowers should keep an eye out for in particular? What’s important amid all that complexity?
Ostrowski: It’s not necessarily bad, but you should keep an eye out for things like closing costs being rolled into the amount of your loan. Would you rather pay the closing costs upfront? Or would you rather have them rolled into the loan with the idea that you’re going to be paying those off over 30 years?
That’s one thing to look out for. But really, you’re taking a bit of a leap of faith. As a consumer, you want to work with someone who’s knowledgeable and trustworthy and just hope that that person can explain things to you. And I should say that there were a lot of abuses in the mortgage industry 15 years ago, where consumers with poor credit were being taken advantage of and being overcharged. That doesn’t seem to be commonplace in the industry now.
It certainly makes sense to shop around but I think you can, for the most part, feel confident that you’re not going to be gouged by your lender.
MYMOVE: Are there any rules that you believe in about how much your mortgage should be compared to your income?
Ostrowski: No, not really. With home prices going up so much and home prices outpacing wages by such a wide margin, a lot of those rules of thumb are kind of hard to stick to. It used to be that you didn’t want to spend more than a quarter of your income on your mortgage, or more than a third. But if you live in a place like Los Angeles or San Francisco or New York, it’s going to be really hard to stick to that.
It’s really more of a matter of taking into account how much you make and where you live. In some of the high-priced housing markets, you’re going to have to stretch. It’s going to cost you a lot of money to own a house. And then it’s a matter of just deciding what your risk tolerance is and where you think home prices are going to go in the future.
For the past 30 or 40 years, people who’ve bought homes in the most expensive markets have been rewarded because the home prices have continued to appreciate in those markets by a lot, whereas in some places, home prices have been fairly flat until the past couple of years
MYMOVE: It’s obviously a strange time to be buying a house in a lot of different ways. Do you have any advice for people who are entering the market for the first time?
Ostrowski: Yeah, it is a very intimidating housing market. A few years ago, first-time buyers were facing some affordability challenges depending on where they lived, or where they were looking. And now, home prices are up 30 and 40%.
Over the past few years, it’s just gotten really difficult for first-time buyers. Because you’ve got to come up with some amount for a down payment, and you have to qualify for a mortgage based on this. This very much expanded and inflated the amount that you’re paying for the house.
We recently surveyed American consumers at the beginning of the spring home-buying season to ask people what they were thinking about affordability. And a lot of respondents said they were willing to make some sort of concessions to be able to afford a home, and the share of consumers who said they were willing to make concessions really skewed towards younger Americans, which makes sense because Boomers and older Gen Xers have probably owned their homes for for a while and are sitting on top of some equity, which gives you a lot more flexibility.
But if you’re just coming into the market as a first-time buyer, it’s pretty tough. A lot of the respondents to that survey said they would be willing to go to a less desirable area — maybe farther out in the suburbs or even moving to a cheaper housing market. And we’ve seen a lot of that during the pandemic. We’ve seen a lot of people moving out of California and New York and going to Utah or Idaho or Florida or the housing markets that are comparatively cheaper.
Depending on how flexible you are geographically, there are still huge gaps in housing values. In Northern California, the median home price is a million and a half or more. That’s just the median. That’s not for a mansion. And then at the opposite end of the spectrum, in major metro areas like Pittsburgh, Cincinnati, Cleveland, St. Louis, and Indianapolis, you can get a home for $250,000 to $350,000. So there are very affordable housing markets if you’re willing to move.
We’ve seen a lot of white collar workers playing the housing arbitrage game where they’re keeping their big city paycheck and then going to a more affordable housing market. So if that’s possible for you and if that’s something that sounds attractive, that’s certainly one way to deal with the affordability challenge.
You might be able to save some money by buying a house that’s not in pristine, move-in ready condition. The downside is that you’re going to have to come up with money for renovations, and it might be six months or longer to finish construction. And then, of course, the construction schedules and budgets are never what you think they’re going to be going in, so it always takes longer and costs more.
We’re also seeing a lot of buyers going into bidding wars. If that’s the case for you, you want to make sure you go in with a number in mind. You don’t want in the heat of the moment to make an offer for the sake of winning the bidding war that you later come to regret.
The advice that a lot of buyer’s agents are giving to their clients is to have a number. Say the house is listed at $400,000 and you’re going to offer $410,000. If you don’t win, then what are you willing to go up to? $425? $450? It’s not that there’s any right or wrong answer in terms of the value of the home but you just want to set a ceiling so that in the emotions of a bidding war, you don’t wind up making a decision that you regret for years.
And then another thing that a lot of buyers have been doing is waiving inspection contingencies. This a way for the buyer to signal to the seller that, “Hey, I’m serious about this house. I’m not going to nickel and dime for scuff marks in the paint,” or something like that. The advice that buyer’s agents are giving their clients on that front is, it’s fine to waive the inspection contingency because you want to let the seller know that you’re serious and you’re not going to hold up the deal over $200 in repairs. But at the same time you do want to hire an inspector to come out and look at the house and just make sure that there are no major structural issues.
MYMOVE: Should buyers try to wait out a market like this? Or is that kind of a tricky game to play?
Ostrowski: Yeah, it’s a very tricky game. By all indications, this housing boom is finally starting to cool off a bit. The National Association of Realtors reported record low inventory in January. And then inventory levels have been ticking up a little bit each month. So they’re up in February and then in March and then again in April. It’s still definitely a seller’s market and a pretty strong seller’s market, but conditions aren’t quite as crazy as they were even back in January.
But it’s a tough call to make because even though the market is slowing, we’re seeing 15% annual appreciation instead of the 19% and 20% annual appreciation we were seeing earlier in this boom. So it’s not like there’s suddenly going to be a discount on homes next month or next year.
Then the other wild card is mortgage rates. We’ve seen a pretty sharp run-up in mortgage rates — almost 2.5% over the past six months. That’s another thing that’s really squeezing affordability and that’s part of the reason that the housing market is slowing as well.
I would say if you’re able to swing the transaction and you need to be in a house soon, then go ahead and do it. And if you’re not ready to buy financially, then maybe it’s time to sort things out — not so much because home prices are going to fall but just to get your financial situation in order before you make this commitment.
But the consensus seems to be that there’s still such a shortage of houses for sale and we’re not going to have a crash in prices. Prices might flatten, they might go up only a couple percent a year, but it seems unlikely that we’re going to have a real fire sale on houses in the near future.