In truth, landing a mortgage with the best interest rate isn’t all that tricky and shouldn’t be scary. But it is complicated, painstaking, serious business. After all, closing on a mortgage is the single largest financial transaction most of us will ever undertake so doing enough homework to find the best deal make sense.
Luckily, we are in a prolonged period of historically low mortgage interest rates, making home ownership astonishingly affordable. Throw in the other traditional advantages — building equity, deducting interest payments, having a place to call your own — and it almost makes going through the harrowing mortgage-application hassle a no-brainer.
Comparison Shop for Mortgages
Speaking of no-brainers, on the long road to the moment the closing agent hands you the keys, this one tops the list: Comparison shop for your mortgage. Comparison shop hard.
We do it for everything else we buy, right? From cars to sneakers to canned vegetables, we want to know, to the fraction of the penny, we’re getting the best deal. Now we’re about to borrow $200,000, and suddenly we get bashful?
No, really. The Consumer Financial Protection Bureau (CFPB), reported in January 2015 nearly half of all mortgage seekers seriously considered only one lender. And roughly 77% applied with only one lender.
Such tunnel vision is a bad, potentially costly, idea. The CFPB website advises: “Shopping is important not only to help borrowers understand the different product features available, such as adjustable-rate versus fixed-rate, but also the price at which those products are offered (including the prices of ancillary services, like settlement services or title insurance).”
So, shop. But how? Well, there are plenty of places to get started.
- Drop “mortgage rates” into your favorite search engine and watch the results pile up: Wade past the advertisements to find the sites that don’t ask for personal information but do provide an assortment of lenders operating in your area accompanied by rates and, in most cases, consumer reviews.
- Contact banks (national and local), credit unions and mortgage brokers. It isn’t necessary, but it can help to have accounts with the institutions you contact. In fact, some banks or credit unions will shave a fraction of a point off your loan if you maintain an account and sign up to have payments automatically deducted.
- Ask friends, neighbors and relatives for recommendations. If you’re working with a real estate agent, ask him or her. You want a minimum of three quotes, but the CFPB recommends five or more.
- Remember, always provide each prospective lender with exactly the same information: price of the house, down payment, length of term, type of mortgage(s) you are considering, and your credit score. Because rates shift frequently, try to do it all in one day. You want apples-to-apples comparisons.
- The interest rate is important, but it is not everything. Fees can pile up in a jiffy. Your informed comparison will include the lender’s Loan Estimate, which, by direction from the CFPB, replaced the Good Faith Estimate in October 2015. Study each of the estimates. Like nuclear weapons treaties and prenuptial agreements, the devil is in the details.
Loan Comparison Calculator
Consider Buying Mortgage Points
You might think lenders who advertise “no hidden fees and no points” are the way to go. And you might be right. However, if you have extra cash and you plan to keep your house for a long time, spending on mortgage points could make sense.
Mortgage points, also known as discount points, are fees paid directly to the lender at closing. In exchange, the lender drops the interest rate, a transaction called “buying down the rate.” Generally, this bought-down rate will result in lower monthly mortgage payments.
A point costs 1% of your mortgage amount. In our $200,000 example, one point would equal $2,000. A key consideration is the break-even point on a bought-down rate. The monthly savings tends to be tiny, roughly $25 in our $200,000 example. That means it will take 80 months — 6 1/2 years — to recoup $2,000 you spent buying down the rate.
And that’s even before you consider the opportunity cost of forking over $2,000. What would that cash do if it was invested in an index fund over nearly seven years? Or perhaps it would be better spent paying down credit card debt.
On the other hand, you can deduct discount points on Schedule A of your income taxes. So, depending on your tax bracket, the scales may tip in the other direction.
The short answer to whether you should buy down your mortgage actually is a question: Will you keep your mortgage long enough to recoup the upfront expense? This includes weighing the probability that you will sell and move before the break-even point, but also whether you are likely to refinance, either to grab a lower rate, change the length of the mortgage, or both.
The best argument for buying points is:
- You’re settled in your career
- You’re content with your house and your neighborhood
- You doubt the money can be put to better use
- You can’t imagine getting better mortgage terms or, waiting on better terms isn’t worth the bother
All of which leads to that moment in the future when you host a mortgage-burning party. That point or two you bought 15, 20, or 30 years earlier could have resulted in thousands saved over the life of your mortgage.
However, if any one of the above conditions do not apply, — you’re younger; your career path demands relocating; you aspire to something different in a house or neighborhood; you’re always looking for a better financial deal; you think that cash would do better invested elsewhere — don’t buy points.
Go with a 15-Year Mortgage instead of a 30-Year
This is not your granddad’s mortgage environment. The 30-year fixed-rate mortgage with 20% down, once the gold standard for homebuyers everywhere, is being crowded by consumers seeking a custom-made loan.
Lenders are happy to oblige with shorter-term fixed-rate loans, as well as mortgages with variable rates. Which one works for you depends, again, on your circumstances and what you hope to achieve.
For instance, the 15-year fixed-rate mortgage can be attractive under the right conditions. In the fall of 2017, 15-year mortgages run more than a half-point lower than 30-year loans.
The upsides include building equity faster (which accrues to your benefit whether or not you go the distance), finishing pay off years earlier, and paying tens of thousands less over the duration of the loan. The downside: Your monthly payment will be substantially higher than with a 30-year loan.
Then there’s the variable interest-rate loan, which gets borrowers into a mortgage at an enticingly low interest rate, oftentimes more than a point lower than a 30-year fixed-rate loan. Variable rate — sometimes called “adjustable rate” — loans can be amortized over a 30-year period, so the loan begins with a payment that is substantially lower than any fixed-rate vehicle.
The catch — of course there’s a catch — is after a period of years the rate adjusts to reflect the current interest rate environment. Depending on the loan, that could happen at the five, seven or 10-year mark of the loan.
Variable-rate mortgages are attractive to homebuyers who are certain they’ll be moving on before long, and/or who are confident their household income will increase to cover any bump in monthly payments.
Scrutinize Fees and Other Costs
The best mortgage isn’t necessarily all about the annual percentage rate — APR — says Richard Staley, a Senior Licensed Mortgage Advisor at Atlanta-based Angel Oak Home Loans.
“Typically, comparing APR by lender is not a true reflection of all costs,” he says. “Consumers should ask for a detailed cost sheet breaking down the fees.”
This would be the Loan Estimate, mentioned above. Lenders are legally bound to provide one before you decide to give them your business. Put it to work.
Plenty of what you’ll see you can’t do much about. Escrow payments if you’re rolling taxes and insurance into your monthly payments, for instance. Prepaid interest, depending on your closing date. And certain fees if you’re taking out a loan backed by the federal government.
But be on the alert of excessive charges or processing fees in these categories:
- Application fee
- Underwriting fee
- Mortgage rate-lock fee
- Loan processing fee
- Broker rebate
This is where your apples-to-apples comparison is crucial. There are charts online that break down typical closing costs by state. Use them as a reference guide.
Also, don’t be shy about asking questions. Just questioning a fee can result in it being lowered or eliminated. Silence has consequences.
Improve Your Financial Health for the Best Rates
The federal government changed the landscape for lenders in the wake of the Great Recession, putting a premium on well-qualified buyers. The trick is to make yourself as well-qualified as possible.
In this, your credit score is crucial. Lenders reward borrowers who are proven excellent risks — 740 or higher FICO scores — with lower interest rates. As credit scores drop, interest rates inch up, along with monthly payments. The difference between a top score and one in the 620s can approach three percentage points.
Ways to improve your score include:
- Paying down debt
- Contacting creditors to ask about removing bad marks on your score
- Prudently raising your credit limits. This may sound counter-intuitive, but mortgage lenders are wary of borrowers who have maxed out their Visa cards.
Down payments, especially for first-time homebuyers, are hard work. But the bigger the down payment, the lower the interest rate. That’s not only because the borrower who has substantial skin in the game is unlikely to hand back the keys if finances get tough, but also because a large down payment protects the lender against sinking real estate values. Lenders call it “risk-based pricing.”
Even if you find a lender who’s willing to offer a competitive interest rate despite a small down payment, loans that account for more than 80% of a house’s value generally require PMI, or private mortgage insurance. The premium is based on the loan balance — typically between 0.25% and 2% — and can add substantially to your monthly payment.
In our $200,000 mortgage example, at 0.5% — a low, but not unusual, annual premium of $1,000 — PMI adds $83.33 to the monthly payment.
There are ways around the low-down-payment problem, none of them without pain.
- Wait until you have saved enough
- Find a lower-cost house so the money you have will cover a bigger portion of the sales price
- Ask for a money gift from a relative. Seriously. I bought my first house with an advance on my inheritance from a dear, childless aunt and uncle. Years later, my wife and I paid that favor forward when her goddaughter needed help with a down payment.
Above all, lenders want to know they’re going to be paid back. Part of the application process involves determining your debt-to-income ratio, or DTI. The calculation involves adding all your monthly debt payments — revolving charges, car payments, student loan payments, other consumer loans, prospective mortgage payment — and dividing that total by your gross monthly income (your income before it is reduced by taxes and other deductions).
The lower the ratio, the better lenders like it. But the key number is 43% because, in most cases, that is the cutoff to get a “qualified mortgage” — that is, a mortgage without certain risky features, such as balloon payments, interest-only periods, or negative amortization (the loan principle increases over time).
What should you do? Again, patiently pay down debt, for openers. A quicker solution might be to swap in a car for one with a more modest monthly payment. Or you could sell your boat … unless you don’t have one.
In that case, consider ways of increasing your income. Are you overdue for a raise? Make your case to the boss. Or consider taking on a part-time job.
Buy a Single Family Home for the Lowest Rate
Finally, there’s this: For assorted reasons, mortgage lenders prefer single-family houses over any other residential loan. Single-family houses are less likely to be affected by irresponsible behavior elsewhere in the neighborhood. Immediate post-bubble history notwithstanding, they tend to increase in value, and at a higher rate than attached housing or condominiums. So that’s it, then. You’re ready to make that dream come true.
Now get out there and comparison shop, comparison shop, comparison shop!