When someone is thinking up buying a house, they rarely, if ever, wake up one day with the dream of getting a mortgage.  The dream is to own a home. So people start looking for a home first, and that is where the problems usually begin

Here are the top 5 reasons to get your mortgage first: (plus a bonus reason)

1. You won’t spend too much. It’s easy to see that if you fall in love with a house first, then talk to a mortgage lender about the down payment and monthly payment, you could end up buying more house than you shouldafford.  By getting your mortgage first, you will know exactly what your closing costs, down payment and monthly payment will look like, so you won’t over extend yourself.  Too many people, after falling in love with a house, justify to themselves that they can afford the higher than expected costs. After a while, they regret the decision as they have trouble making ends meet.
2. You won’t spend too little!  This sounds crazy, when you just read reason #1, but think about it – if you spend too little and settle for a house that is too small, or in an inconvenient location(too far from work), or is missing a feature that you really need(2 car garage or bonus room), you will be looking to move and upgrade your house in just a few years.  So, if you buy a house that is too small, you will waste all that money on closing costs on the first house, and then spend even more money selling the house in just a few years and having to buy a new house with the right features. If you get the mortgage first, you will know what the right price range is and you can buy the right house for you the first time.
3. You won’t get surprised.   Many mortgage companies offer a full pre-approval.  Don’t confuse this with a fake pre-approval.  With a full pre-approval, your mortgage professional will collect pay stubs, bank statements, photo id, W2′s and possibly tax returns and have you sign all the application paperwork and disclosures.  If your ‘pre-approval’ consists of a phone call with a loan officer, it’s a ‘fake’ pre-approval and really just a pre-qualification.  A pre-qualification simply says, ‘Based on what you have verbally told me, we should be able to get your loan approved”.   A fake pre-approval or a pre-qualification gives you an indication of loan approval, but it’s not the same thing.  You still need to complete the paperwork and have an actual underwriter review your file.  Some mortgage companies won’t do this, but a good one should offer to get you you fully ‘credit approved’ prior to finding your house.  This leaves only the appraisal and sales contract to be reviewed by the underwriter, which leads to reason #4.
4. You can eliminate most of the stress of buying a house.  Most of the stress people experience when buying a house is totally preventable and mortgage related.  If you have your mortgage approved before you find the house, there isn’t really much left to do – pack a few boxes, clean up your old residence, and off you go.  Actually, there is a ton of stuff left to do.  Unfortunately, you can’t do any of it until you find the house and agree on the sales contract.  Except, of course, take care of the mortgage. So, rather than thinking about getting the mortgage approved, changing you address, packing, cleaning, registering kids in school, figuring out new routes to work, calming family members’ nerves about the move, changing your driver’s license and voter registration and 100 other things, you can focus on the 99 little things that still need to get done.  The mortgage application process is the only thing you can do prior to finding your new house, so don’t procrastinate and get one of the biggest items crossed off your to do list.
5. Your confidence will go sky high.  When your financing is taken care of, you will have a great deal of confidence that you are buying the right priced house and you will have no worries while waiting for the lender to call you back with news.  Eliminating uncertainty will increase your confidence about the whole process.
6. Bonus:  You will be able to negotiate a better deal.  If you are competing with another buyer, or if you are the only buyer, by being able to guarantee that you can buy the house, the seller will be much more comfortable accepting your offer, even if it’s not the highest one they receive, or not as high as they hoped for.  In today’s market, a fully approved buyer eliminates all the stress and surprise from the seller, too.  If you reduce their stress and uncertainty, you will be able to negotiate a better deal.

So, on that day when you wake up and decide it’s time to buy a house, stop, reconsider, and go buy your mortgage first – they really are two separate things.

I read an article in the paper this week from a home finance ‘expert’.  She closed with the comment, “be sure your refinancing costs can be covered in about six months”.  Great, meaningless, advice. 

Where does the ‘six months’ rule of thumb come from? (Hint: thin air.)  If you are going to move in six months, that is great advice.  If, however, you plan on staying in your home for more than a year or so, what difference does the time to recoup closing costs make?  If you spend less money on interest over time, does it really matter if it takes you six months, or six years to recoup your refinancing costs?

The real number you need to know

What will be your total cost of financing over the period of time you expect to have your mortgage?  A good loan agent should be able to calculate this for you.  It’s a pretty simple calculation, but, unfortunately the vast majority of loan agents are never taught how to do this.  Their training is ‘sales based’ training.  That is, they are trained to prospect, present, close, answer objections, and close again.  That is why so many loan agents came from other industries, and so many more are now leaving the mortgage business to go back to other sales jobs. 

The Total Cost of financing your house is the sum of the closing costs plus the interest you will pay on the mortgage.  By knowing the Total Cost, you can make an informed loan decision.  As an example, consider the case of Fred and Nicole.  They are going to live in their house for at least ten more years.  If they can refinance their current two year old mortgage from a current rate of 6.875% to 5.875%, they will save $274 per month.  However, with the lender fees, appraisal, and legal fees, they need to spend almost $6,000 to do so.  Our newspaper reporter mentioned above would simply divide the $6,000 by 274 and say, “That’s 22 months to recoup your costs, so that’s too long a time period. Don’t refinance and continue paying the bank an extra $274 each month”. 

However, using some good mortgage software, or by looking at the amortization schedule, we showed Fred & Nicole that over the next 10 years, a refinance would have them spending $32,850 less on interest.  Add back the $6,000 in closing costs, and refinancing now would save Fred and Nicole $26,850 in 10 years.

What to do with the savings

Using the priorities I spell out at StartwiththeHouse.com, the real benefit may not be the $274 per month or $26,850 in 10 years. More important that the Total Cost, may be “What will you do with the savings?”  For Fred and Nicole, they had an adequate emergency fund (Step One), carried no credit card or “bad” debt (Step Two), had adequate protection for their house (Step Three), so they were in a position to choose what the best way to deploy the monthly savings was. (Step Four).  Fred and Nicole decided, with advice from their Financial Planner, that the best use of that money for them was to continue making the same mortgage payment as before, but now more of their payment would go towards principal and less towards interest.  In 10 years, they would have $41,500 more equity in their house by refinancing with a plan.

What this means for you:

1. Forget outdated rules of thumb, like the one that prompted this article.  If Fred & Nicole needed to recoup their closing costs in an artificially low time frame, they never would have refinanced, and would have a much larger mortgage balance at the end of their 10 year time frame.
2. Make sure your loan agent can show you the real numbers.  Remember, his training may only be in how to close the sale, so if he/she can’t answer your questions, find a mortgage professional who can.  www.CMPSInstitute.org is a great place to find a local mortgage planner.
3. Know the Total Cost of home ownership.  Your refinance decision is not about interest rates or closing costs.  It’s about the amount of money you will spend to finance your house.  Closing costs are irrelevant if you save more money over time with a lower rate.  Conversely, the lowest rate with very high closing costs will be very expensive if you need to sell your house in 1-2 years.
4. (Commercial)  If you can’t find someone who can show you the true “Total Cost’ of home ownership, give me a call - that’s what I do.