You’ve spent some time working on your new home’s wish list. Maybe it includes items like granite countertops, sleek stainless appliances, and a large walk-in closet.
What about your wish list for your mortgage?
It’s unlikely you’ve thought much about how to find the perfect mortgage. Yet, by not researching mortgages now, you could lose money on your loan. Data from Freddie Mac, the government-sponsored mortgage buying entity, reveals that homebuyers save an average of $1,500 over the life of their loans by contacting just one more lender.
We’re here to help you figure out how to shop for a loan and get the best deal. Follow our step-by-step guide to finding your dream mortgage.
Find the right loan type
You may not realize how many loan options are available to you. The type of loan you choose can make a big difference in the cost of your mortgage.
Think of choosing a loan like ordering a pizza. You can choose a 3-topping pizza and customize it to your liking in the same way that a conventional loan has a lot of flexibility of terms. Many places allow veterans a discount on their pizza order. Similarly, a VA loan lets veterans get a home loan with special discounts and terms just for veterans. A USDA loan, on the other hand, is only available in certain rural areas, just like a pizza made with a regional delicacy.
According to the US Consumer Financial Protection Bureau (CFPB), there are three general categories of mortgage:
- Conventional loans
- FHA loans
- Special programs (including VA and USDA loans)
A loan is considered “conventional” when it falls outside any specific government program, the CFPB notes. The most common loan type is the conventional “conforming” loan, meaning the loan follows the government’s maximum loan amounts ($484,350 in most counties) in addition to meeting other loan standards.
If you don’t have a 20% down payment for a conventional conforming loan, you’ll typically need to pay Private Mortgage Insurance (PMI) on your loan. PMI is a type of insurance that protects your lender if you default on your loan.
Most loans add the cost of PMI into your monthly mortgage payment. You can usually drop PMI coverage on a conventional loan once you meet certain requirements:
- Automatic termination when your loan balance is scheduled to reach 78% of the original value of the home.
- You can request to cancel PMI when you reach 20% equity in the home. This request must be approved by your lender.
- At the midpoint of your loan, such as year 15 of a 30-year mortgage.
The Federal Housing Administration (FHA) is a part of the US Department of Housing and Urban Development and backs a special FHA home loan program for buyers who may not qualify for conventional loans.
FHA loans aren’t issued directly by the FHA, but they are insured and regulated by the Administration. This helps lenders feel confident when lending to homebuyers who might be higher-risk. Buyers get the benefit of increased approval odds when applying for a mortgage.
Benefits of an FHA loan may include:
- Lower down-payment requirements
- Decreased closing costs
- Increased approval odds for buyers with lower credit scores
Although an FHA loan can help you get into a home with a lower down payment, it may not be the lowest cost over time. As NOLO, an online leader in legal advice, mentions, FHA loans have mortgage insurance. You’ll pay part of the MIP at closing, and then a monthly premium as well.
Unlike Private Mortgage Insurance (PMI), you cannot cancel MIP on an FHA loan if your down payment is less than 10%. (You could possibly do away with mortgage insurance payments down the road, though, if you refinanced with a non-FHA loan). If you put 10% or more down on an FHA loan, your MIP will terminate at year 11 of your mortgage.
Special loan programs
Several federal government agencies, as well as some state and local groups, offer special loan programs for certain groups. Most of these programs provide highly competitive loan terms, such as low or no down payment requirements. Not everyone qualifies for these loans, so be sure to check your eligibility.
The U.S. Department of Veterans Affairs offers a loan program for eligible service members, veterans, and certain surviving spouses. Much like an FHA loan, VA loans are offered through private lenders, but a portion is guaranteed by the VA.
According to the CFPB, VA loan benefits could include:
- Streamlined finance options with protections available if you can’t make payments later on
- Potentially no down payment requirement
- No mortgage insurance required thanks to the VA guarantee
USDA rural development loans
Looking for a home in a rural area? A USDA loan offers similar benefits to an FHA loan or VA loan for homebuyers with low to moderate income in rural locations. USDA loans often have little to no down payment requirements and may cost you less than an FHA loan.
Depending on your location, you may have local loan programs available to you through local organizations or your state. Be sure to ask local lenders if they have special loan programs in your area.
Local lenders can also potentially get you a better deal. Damian Gerard, a top performing real estate agent in Chesterfield, Missouri, points out that working with a lender that uses local underwriters is one of the best things you can do to get the best deal. Underwriters look at your financial situation and potential home purchase to see if you meet the lender’s loan criteria. An underwriter essentially decides whether you’re approved or not.
While you’ll never talk to the underwriter, Gerard stresses that a local underwriter knows the market in your area. Unlike a national underwriter (who might live in an area with higher median income or cost of living), local underwriters can look at your income and see it through the eyes of a neighbor, as opposed to an outsider.
Choose your loan term
Your loan term is the length of time you’ll pay your mortgage. Although loan terms can vary, they’re most commonly either 15 years or 30 years. Choosing between a shorter or longer term can affect the amount you’ll pay over the life of your loan.
As the CFPB points out:
- Shorter terms: You’ll have higher monthly payments, but you often get lower interest rates and may get lower overall cost.
- Longer terms: A longer term generally has a lower monthly payment, but you’ll probably receive a higher interest rate, meaning you will pay more overall.
Fixed-rate vs. adjustable-rate mortgages
Mortgages come with interest, but your mortgage interest rate could change depending on the type of rate you choose. You’ll have to decide between a fixed-rate or adjustable-rate mortgage when shopping for a loan.
Fixed-rate mortgage pros and cons
A fixed-rate mortgage provides a set interest rate for the duration of the loan.
- Your monthly principal and interest payments remain the same for the term of the loan.
- You don’t have to worry about maintaining a savings cushion to gamble on the decisions of the Fed and fluctuations of the economy.
- Fixed-rate loans usually have higher interest rates than the adjustable-rate offered for the initial period. If you plan to sell the home before the adjustable rate period begins, then an adjustable rate could be preferred.
- Your rate can’t increase, but it also won’t decrease if rates drop significantly.
Adjustable-rate mortgage pros and cons
Just like the name implies, adjustable-rate mortgages have interest rates that can fluctuate over time. Most adjustable-rate mortgages start with an initial fixed-rate term (usually the first 5, 7, or 10 years of the loan).
After the initial term is up, your mortgage interest rate can go up or down. The rate is usually tied to an index and will change according to current market rates.
- You’ll see low interest rates and payments during the initial fixed-rate period
- Your rate could decrease if market interest rates fall
- Your interest rate could increase if market rates rise
- You can’t always plan how long you’ll be in a house, so opting for an adjustable rate based on the initial fixed period could backfire
Gerard mentions that buyers should be aware of current rates when deciding between a fixed-rate or adjustable-rate mortgage. For most buyers, low, long-term rates are going to be a safe and economical option.
What you need to know about comparing rates
Each lender is going to offer you different rates. Even if the market rates are fairly similar, individual lenders can offer different rates at any time during different days or weeks. The Federal Trade Commission suggests asking potential lenders directly for a list of their current rates. After seeing rates, go ahead and ask the lender if those are the lowest rates for that day or week.
Why APR is different than interest rate
As you learn how to shop for a mortgage, you’ll start to notice two percentage rates when looking at loans. One is your interest rate. This is the percentage you’ll pay each year to borrow money. The other percentage is the APR, or Annual Percentage Rate.*
The CFPB explains that your APR includes not only interest costs, but also the cost of points, brokerage fees, and other fees required to get your loan. It’s often higher than your interest rate.*
Should you consider buying mortgage points?
Your mortgage lender or broker is likely to ask you if you’d like to purchase mortgage points. Discount Points, the most common type of mortgage points, work like prepaid interest for your mortgage, according to leading finance website The Motley Fool. A point equals 1% of your mortgage. For a $100,000 loan, one point would cost $1,000.
You can pay for points to help lower your interest rate. Each lender’s points have a different value to how much they’ll lower your rate.
Pros of buying mortgage points:
- You might be able to deduct the cost of points on your taxes
- You will reduce your interest rate
- You can potentially save money on the life of your loan
Cons of buying mortgage points:
- There is a high upfront cost
- Points could reduce the cash you have on hand for a down payment, paying off existing debt, or putting money into other investments
Bottom line on Discount Points: You’ll have to weigh the cost of paying more upfront versus your interest savings over time, which will be more advantageous if you plan to stay in the house for a longer period.
The importance of shopping around when choosing a mortgage
There’s a lot of stress involved when buying a home. Yet, you’re setting yourself up for financial stress for years to come if you don’t shop around for a mortgage.
To get the best rate, and save potentially thousands on your home purchase over the life of your loan, shop for a mortgage from different lenders. While it can be easy to choose a loan from your regular bank or at a friend’s suggestion, you’re probably leaving money on the table.
How to compare lenders
Before you commit to a lender, ask for a breakdown of their costs and fees. Decide what type of loan, loan term, and loan repayment you want. When you talk to lenders for a quote, Gerard suggests asking to see a quote comparing the exact thing as your other quotes. This eliminates one lender hiding fees and other costs while promoting a lower rate than other lenders.
One way to do this is to request a Loan Estimate from lenders. A Loan Estimate is a document from a lender that gives you an estimate on the cost of a loan for a particular property. If you have a house you want to buy, Loan Estimates are a great way to compare the potential costs of loans from multiple lenders.
Finding the right lender or broker
To find the perfect mortgage, you need to work with a lender you feel has your best interests in mind. Gerard often advises buyers to build a relationship with their mortgage loan officer. The more your officer knows you and your story, the more likely they are to pass your individual situation onto the underwriter. This can ultimately lead to more favorable terms, even if you’re not the ideal borrower.
*This information is for educational purposes only and not intended to illustrate available APRs or mortgage-related marketing under the Truth-in-Lending Act Section 1026.24.
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