Here’s What Happens When You Take On a Smaller Mortgage Than You Qualified For

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Browsing million-dollar homes online is certainly fun. But when it comes to buying a home, learn how a more realistic approach can save you a lot of cash. 

House hunting can be an exciting prospect, despite all the stress involved. You get to imagine yourself in new places and picture how your life might be different in that perfect property. This house has a huge garden? You can finally give that green thumb a workout. That condo is in the hippest walkable neighborhood? Buh-bye car, you’re walking everywhere you need to go.

The only issue with the imaginary life you start building is it can lead to you getting carried away and stretching your budget for your dream home. I’ve gone through the home-buying process twice now, in two states, and my experience has taught me it’s much better to set a budget early and commit to staying below it.

Getting pre-approved for a mortgage

One of the first steps you should take when you begin looking for a home is to get a mortgage pre-approval. This is when a mortgage lender takes a look at your finances and approves you for a loan, laying out an upper limit it will lend you for a home purchase as well as the rate at which you’ll borrow. Getting pre-approved is an important step to take early in the process so you know what your price range will be.

However, many experts advise home buyers to avoid borrowing the entire amount they qualify for, and I couldn’t agree more. Doing so means you’re stretching your budget to the limit and can put your finances in danger in the future.

House hunting under budget

I feel lucky to say my husband and I have ended up in two homes we’ve been really happy with. However, I wouldn’t say either has been our dream home. The benefit of that, though, is both houses were priced well below our home-buying budget. The total purchase price of our current home was actually less than the amount we were approved to borrow from our mortgage lender. Once our down payment was accounted for, our mortgage loan fit extremely comfortably in our budget.

How a smaller mortgage saves money

The beauty of taking out a smaller mortgage than we qualified for is it saved us money in a number of areas. These include:

Closing costs: These are the fees associated with buying or selling a home. The average closing costs for buyers is between 2% and 5% of the home purchase price. By buying a more affordable home, you end up paying less at closing.Home insurance: This is another cost that is partially based on the value of your home. The more expensive your property is, the more expensive your home insurance will be.Property taxes: The amount you’ll owe in property taxes will vary based on your location, but it’s generally a percentage of your home’s value, so a pricier home will cost you more in taxes each year.Monthly payment: This one is pretty straightforward; a smaller mortgage means a smaller payment each month.Overall mortgage interest: It feels like people always talk about the purchase price of a home and forget to factor in the cost of borrowing. But the smaller loan amount you borrow, the less interest you’ll have to pay on that loan, no matter the term length.

Here’s an example: Let’s say you’re pre-approved for $350,000. According to the Federal Reserve Bank of St. Louis, the median home price is $436,800. If you put down 20% ($87,360) at today’s average rate of 7.19%, your 30-year loan would be $349,440, just at the top of your range, and your monthly payment would be $2,369. The total interest you’d pay would be $503,443.

If you chose to purchase a less-expensive house, say one costing $375,000, but still paid the same down payment ($87,360) since you already had it saved, your loan amount would be $287,640 and your monthly payment would be $1,950. The total interest you’d pay would be $414,407. That’s a savings of $419 each month and $150,836 over the life of the loan.

Here’s that info in table form for the more visually minded:

And that’s just the savings from the mortgage itself. You’d save even more on closing costs, home insurance, and property taxes by moving into the lower-priced home.

Avoid becoming house poor

My husband and I looked at a lot of homes during our two house hunts, and there were a few we seriously considered stretching for. But no matter how beautiful the house at the tippity-top of our budget seemed, we preferred to go for something more modest and apply that savings to other areas of our lives.

By not overburdening ourselves with a huge house payment, we’ve been comfortable spending more money on travel and vacations. It’s also allowed us to put more money into our emergency fund so that we’re prepared for any unexpected expenses that come up. (The costs of homeownership are no joke.) It’s also allowed us to place more cash in our retirement accounts and investments, which I’m sure our future selves will thank us for.

My advice is to go wild searching real estate listings for fun, but when the time comes to start seriously looking, don’t let a mortgage lender decide how much you can afford. Take a look at your finances, lifestyle, and goals, and make that decision for yourself.

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