Do you have a mortgage on your home, or have you been thinking about getting one? Given how quickly many lenders dive straight into the weeds – interest rates, pre-approval processes, lending policies, etc. – it may feel as if something’s missing. Like, which, if any, is the best mortgage for your particular needs?

 

First Things First: Should You Have a Mortgage?

Have you got enough money to buy your home outright, but you’re holding a mortgage anyway? If so, I suggest you wander over to my colleague Ben Felix’s Common Sense Investing video, “Mortgage Debt and Asset Allocation.” Depending on how you go about it, paying off your mortgage may be a surprisingly prudent thing to do with your investment dollars.

Or maybe you’re just starting out, building your ideal career and paying off a hefty load of college debt. This may be tough love, but the truth is, you might be better off renting for now, if you’re still establishing your financial footing.

For the rest of us, there are mortgages. You’ve got some money saved. Not enough to purchase a home, but enough to cover some of the cost. Plus, you and/or your partner have a relatively dependable income stream. You long to ditch the landlord and decide for yourself what colors to paint your walls.

You could just keep saving until you’ve got enough to buy your dream home outright, but that could take a while. With a decent mortgage, you can start living in your home today, while paying off the balance as you’re able.

 

How Does a Mortgage Work?

It’s important to understand how mortgages work, so you can find the right one for you. A mortgage is a loan, like any other. The lender loans you a chunk of money – or principal – to pair with your own down payment to pay for your new home. You and the lender agree to various terms and a schedule for you to pay back the principal, along with interest.

Typically, your mortgage is set up with a fixed payment that is a combination of interest (a percentage of the principal you owe) and principal.  Often, to make the mortgage payments affordable, you keep them as low as possible. So, your initial payments on most mortgages usually represent almost entirely the interest you owe, and hardly any principal. When you’re close to paying off the mortgage, this relationship inverses, and you begin to pay off more principal than interest.

In the meantime, the lender registers your mortgage debt on your title. This means, if you sell the property, they will get paid out before you do. It is your home, and you’re entirely responsible for its upkeep (chartreuse walls and all). But if you go into default, they will have the right to sell the home, to seek repayment on the mortgage.

It’s worth remembering this reality, along with a related point: Just because a company pre-approves you for a homeowner loan, doesn’t mean you should go for it. Recalling a lender’s priorities, to ensure they make a profit on the lending arrangement,  a preapproved loan simply means they’re offering terms that seem like a good deal for them; it does NOT guarantee they’re a good deal for YOU.

 

Making the Loan a Good Deal – For You

Since your home is one of the biggest purchases you’ll make, my take is, you want to be the one calling the shots. Before you even talk to a lender or initiate an application, here are four important decisions to make first, so you can advocate for your best interests:

 

  1. What down payment will you make? A conventional loan requires you to cough up at least 20% of the purchase price to qualify for the loan. There are ways to get around this by turning to “high ratio” mortgages or other types of lenders. But the less skin you’ve got in the game, the more burdensome the terms will be. You’ll be required to purchase mortgage loan insurance if your down payment is under a 20% threshold – which, by the way, protects the lender’s assets, not yours.

 

If you’re catching my drift, you’re usually best off not becoming a homeowner until your cash flow can support a number of new expense items to your budget sheet – such as that mortgage payment itself, hydro bills, hot water, homeowner insurance, property taxes, and the inevitable emergency call to a plumber on Christmas Eve.

 

  1. Do you prefer an open or closed mortgage? The interest rates on a closed mortgage are usually lower – but for a reason. Closed mortgages limit your ability to make optional prepayments on the loan. With an open mortgage, you are free to pay off the principal as soon as you’re able, which can reduce the overall interest you end up paying. Thus, an open mortgage at a higher interest rate can still end up costing you less overall if you’re able to speed up your payments. You are exposed, however, to interest rate movements that could either work for or against you.

 

  1. How long will you borrow for? Along a similar theme, the longer you take to pay off your mortgage, the more interest you’ll end up paying. This makes sense, since you are using the lender’s money longer. If you can afford higher periodic payments, shorter terms will cost you less than longer ones.

 

  1. Will you pay a fixed or variable interest rate? Unfortunately, nobody can predict whether interest rates will rise, fall or remain stable during your loan period. If anyone claims otherwise, please ignore them! Your best choice comes down to whether you’re willing to pay a little extra to KNOW what your rate will be, or whether you’re okay accepting extra risk in exchange for POTENTIALLY lower payments … but possibly considerably higher ones.

 

There are plenty more points I could cover on being your own best lending advocate. If you review all options and none of them make sense at this stage in your life, don’t be afraid to remain a renter. And again, don’t be tempted to take a loan just because you qualify for it. That’s like writing a big check just because you have blank checks available to do so (never mind the dollars in the account).

What other questions can I help you “home” in on? Subscribe to my YouTube channel or connect with me on LinkedIn, and I’ll keep them coming your way.