06/03/2015 05:15 pm ET Updated Dec 06, 2017

Buying a Home? Know Hard Costs Going In


Surveys of potential home buyers, particularly first time buyers, are telling us that many could use a little more knowledge about two of the largest costs of ownership. Everyone needs a mortgage and insurance is necessary as well. Your lender will require that insurance premiums be escrowed in advance to be certain that the money is there when they are due. Mortgage interest with a long term fixed rate is at least predictable and stable, but too many new buyers aren't aware of how their credit rating influences their mortgage rate.

The Mortgage and Credit Scores

Transunion, the credit rating agency, recently announced the results of a survey of potential buyers. The survey of those planning on or considering buying a home in the next 12 to 18 months, found that while nearly 74% believe it's important to check the accuracy of their credit report, only 45% or fewer correctly understand that their credit score measures:

• The amount of debt that they hold.
• The risk of them not paying back the loan.
• Their financial resources available to pay the mortgage payments.

Many believe that their payment history and on-time payments would be the only or the major factor in whether they get a mortgage or not. Also, too many fail to understand that the risk measurements influence the mortgage interest rate they'll be offered. Small increases in the rate result in mortgage payment increases that can result in being denied a loan on a home they believe is affordable for them. In fact, only around half could identify the aspects of the home buying process affected by credit scores: interest rate (52%), the amount they can borrow (53%) and their mortgage lending terms (50%).

When it comes to improving credit scores before applying for a mortgage, around a third of consumers surveyed thought that simply increasing their income would have a significant effect on their scores. And, 28% thought that closing old accounts would help a lot. Both of those things do have some influence on scores, but not nearly as much as many consumers believe.

Only around half of survey respondents understood that their credit score directly influenced the amount they can borrow, the interest rate they would be offered, and the terms of the mortgage. Only around a fifth of consumers correctly identified three months as the correct time before applying for a mortgage to check their credit score. Almost a third of respondents believed that one month before was sufficient time.

Insurance Premiums and Deductibles

The majority of consumers understand that raising the deductible on a homeowner insurance policy will reduce their monthly premium. However, far fewer of them understand that deductibles offered vary by state and even in how they're offered (flat dollar or percentage). Insurance is a must-have, and lenders will require advance payments into escrow to fund premium payments in the future. They will not allow a policy to lapse in order to protect their investment.

Why do deductibles vary by state? The first and most obvious reason is that the terms of insurance are controlled at the state level. They typically average somewhere between $250 and $5,000 per claim. One study found that raising the deductible from $500 to $2,000 could reduce policy premiums by as much as 16%. So, many home buyers understandably want to run their deductible up to reduce their monthly outlay.

However, that monthly savings varies a lot by state, with the 16% number being a national average estimate. In some states like Texas, it can result in a savings of only as much as 6%. In North Carolina that increase from $500 to $2,000 could drop premiums as much as 41%. When lenders are approving mortgages, the cost of insurance factors into the amount they'll loan on a home based on income and expenses of the borrower.

If you're about to gear up to buy a home, start planning early for credit evaluation and insurance cost estimates. You want to get prepared and have a firm understanding of what your lender is checking to determine what they will approve for your loan.