Posted by: Kimberly Howard, CFP®, CRPC®, ADPA® | September 10, 2013

What You Need to Know When Choosing a Home Loan

HouseFor most people, buying a home is the biggest financial investment they will ever make. Because of the size of the commitment, most buyers need a home loan. That makes it extremely important to make the right choice when choosing a mortgage.

The first thing you need to consider when getting a mortgage is what shape your credit score is in. Your credit score plays a large role in whether you can get a mortgage and how low an interest rate you can get. The better your score, the lower rate you will get. Most lenders require a FICO credit score of at least 720 to get the lowest rate and some may require a score as high as 750.

Another consideration is what shape your finances are in. Lenders look at your debt-to-income ratio to determine how much you can borrow. Most won`t allow your mortgage debt to be more than 28 percent of your monthly income and your total debt, including your mortgage payment, to be more than 35 percent of your monthly income. If you have a lot of debt, you may want to consider paying some of it off before applying for a mortgage.

Keep in mind that any loan you get will have closing costs associated with it. Closing costs include things such as prepaid taxes and insurance, inspection costs and loan origination fees. Closing costs usually add about 1 to 2 percent of your loan amount, which is on top of your down payment, so keep that in mind as you determine your out-of-pocket costs to secure the loan.

Your down payment amount is important as well. If you are getting a conventional loan, meaning one that meets the standards demanded by Freddie Mac or Fannie Mae, you will have to have a 20 percent cash down payment. If you don`t, you will have to pay for private mortgage insurance. Some government programs, such as VA or FHA loans, require smaller down payments.

The term of your mortgage is also an important consideration. Most people get a 30-year mortgage, which means your monthly payments will be lower, but you will pay more for your house in the long run. Mortgages with 15-year terms have higher monthly payments but also mean you pay a lot less in interest over the term of the loan. Fifteen-year mortgages also come with slightly lower interest rates as well. Another option is an adjustable-rate mortgage, which starts out with a lower-than-market interest rate and then adjusts after an initial term is over. If you get such a loan, you have to keep in mind what interest rates are likely to do and what your payment could increase to once your initial term is up.

If your credit is not so great and you have a bankruptcy in your background, you may still be able to qualify for a mortgage, but be prepared to pay a higher interest rate. If you need information about bankruptcy, you can find it at Bankruptcy Advice Service.

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