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Remember that you'll get few chances in your life to have this kind of impact on your budget, so take the time to do things right. Four fundamental things reduce the cost of a mortgage:

Having a good credit score (see Chapter 8). In the fallout of the mortgage crisis, qualifying for a loan can be tough. Lenders have tightened their standards so that their best rates are only available if you have solid credit.

Buying a cheaper house. The lower the purchase price, the lower the mortgage. This is obvious but important (and a lot of people seem to forget it). It's the reason you need to set a budget before you start shopping for a house.

Making a bigger down payment. The less you finance, the less you pay each month. And if you don't put 20% down, you'll have to pay for private mortgage insurance, which can cost you hundreds of dollars a year (see Private Mortgage Insurance).

Finding a better interest rate. Interest rates have a huge impact on your monthly payments. As you can see in the following table, even one-half of a percent can make a difference of tens of thousands of dollars.

Table 10-1. Monthly mortgage payments on a $250,000 loan

Interest Rate

Length of Loan

10 years

15 years

20 years

25 years

30 years

5.00%

$2,653

$1,978

$1,650

$1,463

$1,343

5.50%

$2,715

$2,046

$1,720

$1,538

$1,420

6.00%

$2,778

$2,110

$1,793

$1,613

$1,500

6.50%

$2,840

$2,180

$1,865

$1,690

$1,583

7.00%

$2,905

$2,248

$1,940

$1,768

$1,665

7.50%

$2,968

$2,318

$2,015

$1,848

$1,750

8.00%

$3,035

$2,390

$2,093

$1,930

$1,835

8.50%

$3,100

$2,463

$2,170

$2,015

$1,923

The table shows roughly how much you'd pay every month on a $250,000 mortgage (including principal and interest). For example, if you took out a 30-year loan at 6% interest, your payment would be about $1,500. But if you shopped around and found a 5.5% rate, you'd pay $1,420, saving $80 every month for 30 years. A difference like that really adds up over time.

Tip

Vertex42.com offers a free Excel spreadsheet that lets you calculate approximate home-ownership expenses, including your mortgage, taxes, and insurance, but also maintenance and improvements. Download it here: http://tinyurl.com/home-calc.

The type of mortgage you take out will depend on your goals and your financial situation. Most people opt for a mortgage with a fixed 15- or 30-year term. Here's some info that can help you decide which is best for you:

Interest rates on 15-year mortgages are lower than those on 30-year loans, but because the loan is only half as long, your monthly payments are higher. (See the table above to compare monthly payments.) If you can keep saving for retirement and other goals despite the higher monthly payments, a 15-year-loan is a great option because it'll save you a bundle in interest. But if it's going to crimp your cash flow, go with a 30-year mortgage instead.

For most people, a 30-year, fixed-rate mortgage is the best choice. The monthly payments are lower than with a 15-year loan, and you have greater flexibility. If you want to pay more than the minimum amount every month, you can (see Should you prepay your mortgage?), but you don't have to. This gives you a kind of safety net: If you lose your job, say, it's easier to make the payments on a 30-year loan than a 15-year loan.

Note

Be wary of mortgage products like adjustable-rate and interest-only loans. These may seem attractive, but there are a lot of pitfalls involved. These types of loans are for "sophisticated" borrowers. (If you're not sure whether you're a sophisticated borrower, you're not.)

Closing the Deal

As you wait for the lender to approve your loan documents, there are a lot of other things to think about. Your top priority should be checking the background of the home you're about to buy. Your lender will require that the house be appraised, but you should go further. Once your offer is accepted: