The purpose of this site is to provide clever ways of saving money for your home loan down payment. However, no site about saving money for a down payment would be complete without a discussion about mortgages. In saving up to own your own home, the down payment is the largest battle by far. Understanding the mortgage market and types of home loans offered is also critical so your down payment is put to good use and you get the right mortgage for you. Since this site is mostly written in first person and is all about my personal quest to save money for my first home, the following mortgage discussion is editorialized and biased towards my personal philosophy on home loans. For someone who is conservative and interested in long term financial freedom and sustainability of their finances, this guide will be right up your alley. If you are interested in getting a home sooner with a lower down payment and riskier mortgage, this guide will probably not be as useful (but hopefully I will convince you to take the conservative route).
Mortgage Rule Number One: Go With A Very Reputable Lender
We have all heard it. The news lately has been filled with mortgage disasters. Mortgage lenders have been going out of business almost every week. As a side note, an interesting site to follow the mortgage bubble is The Mortgage Implode-O-Meter. So that you can bypass the mortgage problems, the cardinal rule of getting your first home loan in this market is going with a very reputable name brand lender. You might not get the same deal as with a riskier lender but this is for good reason: the big lenders are not taking crazy risks. If something looks too good to be true, it usually is. I recommend checking out the large name brand banks that have been around forever and you are already doing business with. Losing out on a savings each month is worth it in my opinion if I can sleep at night knowing my business partner for the largest investment of my life is a very reputable lender.
Mortgage Rule Number Two: Go With A Fixed Rate Home Loan
There are two types of mortgage loans: fixed and variable. Fixed means you pay the same payment every month for the life of the loan because your interest rate is fixed. Fixed loans have been around the longest and are the most traditional and widespread home loan over the long term. Variable (also called an adjustable rate mortgage or "arm") means your payment may change every month with interest rates because the variable loan moves with interest rates. To lure consumers into variable loans, banks will often offer special incentives such as lower "teaser" interest rates in the first few years. A lot of borrowers are in big trouble these days because they have variable rate loans which start out at very low teaser rates and are now resetting to higher payments which they are not able to make. Out of these two options, my recommendation is fixed all the way. One of the greatest things in your financial life is predictability. Fixed rate mortgages offer predictability so you don't have to worry about your payments adjusting upward. You may sacrifice a few hundred dollars each month via higher payments but this extra money is totally worth the peace of mind. Moreover, interest rates right now are at historic lows so if you lock in a fixed rate mortgage, you will most likely end up spending less money over the long term on interest because variable mortgages will adjust upward as rates increase. Now is the time for fixed rate mortgages.
Mortgage Rule Number Three: Build Equity, Forget Interest Only
Real estate is a tremendous investment. I really like real estate for two main reasons: it is a hedge against inflation which is becoming a real problem in the US and also because it is an investment you get to enjoy. Building upon the fixed and variable example from the last paragraph, there are two subtypes of each of these loans: traditional and interest only. Traditional loans mean each month you pay money towards interest and also principal. The payments are amortized over the life of your loan so your payment amount is always the same but in the early days of the loan more goes toward interest and in the late days more goes toward building up equity and ownership in your home. Interest only means you only pay for the interest. You do not build up ownership in your home unless you pay more than your mortgage amount each month which requires huge dedication. With both loan types, you participate in appreciation of the home which is great.
I don't feel quite as strongly on this point as I do on fixed versus variable but still am a proponent of the traditional loan for two main reasons. First, at the end of my mortgage loan, I want to own my house completely. The traditional loan ensures my financial freedom in the form of home ownership at the end of my loan. Owning my home free and clear means I am very close to not needing to work anymore for a living which is also one of my greatest goals. Second, the traditional loan has higher payments each month. I like going with the loan with higher payments because I know I'm not getting in above my head. I am buying a home I can truly afford. A lot of borrowers have opted into interest only loans so they can spend above their means. This allows them to max out of the enjoyment of their home but at the end of the home loan lifecycle they have not built up the substantial equity allowed by the traditional loan (but they do participate in appreciation). Although I highly recommend the traditional loan, if you do go with interest only make sure there is no penalty for paying more than the amount due so you can build up equity by overpaying. Also, make sure to follow the money saving tips on this site so you can continue to save money and contribute your savings toward building up equity each month.
Mortgage Rule Number Four: Go With The 30 Year Mortgage
These days, there are several mortgage time periods which are popular with the 30 year mortgage winning the race. The reason I like the 30 year mortgage is it is the most widely spread mortgage and is a sweet spot where you get the best deals for your money. If you go with a shorter time period (such as a 20 year mortgage), you will pay far less interest however will be able to borrow much less as well. If you have a very substantial down payment saved up, this loan may make sense for you but definitely does not make sense for someone like me who is striving to save up a 20 percent down payment. If you go with a longer term loan (such as a 40 year mortgage), your interest rate goes up and negates most of the upside. Your monthly payment will go down and you will be able to borrow more however the higher interest rate does not make this the best loan. Looking at these two scenarios, I personally recommend the 30 year mortgage as the best option for the majority of borrowers.
Mortgage Rule Number Five: Look For Hidden Fees
While you are saving for your down payment, learn as much as you can about mortgages. Your home mortgage is likely the largest loan you will ever take out. Banks make a lot of money from mortgages and there are often hidden fees just like with checking and savings accounts. Often these fees are referred to as points. Make sure the loan you are getting has the most favorable fees and points as possible. A great place to learn more about the mechanics of mortgage loans is The Mortgage Professor.
Mortgage Rule Number Six: Let Banks Compete For Your Business
You have worked so hard to save up your home loan down payment. Don't let this money go to waste. Work equally hard in finding the best mortgage loan for your money. Taking all of the above advice into account, now it's time to shop around and find the high quality lender that's willing to give you the best deal. There are quote comparison services on the internet such as that allow you to get competing quotes from multiple lenders. Additionally, you can just go to your local Wells Fargo or other bank and ask for their offers. A great way to figure out exactly what each lender is willing to loan you is the mortgage pre-approval process. In this process, you fill out some paperwork and provide documentation on your savings and the bank then approves you for the amount they are willing to loan. Before placing an offer on a home, most real estate agents require a pre-approval letter. Pre-approval is good to see exactly where you stand and I recommend doing it when you first start saving up your down payment and also when you are getting very close to reaching your goal of actually buying a home.
Mortgage Rule Number Seven: The Down Payment Is Everything
This site is all about saving up your down payment for a reason. The down payment is everything. With a large down payment, you will get the best possible mortgage. You will start out owning equity in your home and will be set for the long term. Most people who get in trouble are those that don't save up a substantial down payment and then get in over their heads. If you follow the conservative route, you will be very happy in the long term and on the path to financial freedom and success.
Bonus Rule Number Eight: Leverage Down Payment Assistance
Check out our article introducing down payment assistance programs to learn how you can get "free" money towards your down payment. Doing research and due diligence on the programs available to you could save you thousands. Best of luck to you!
Interested in learning even more? You may wish to check out How Much Answers article about home loan mistakes to avoid.