How to Shop for a Mortgage,For many of us, a home mortgage will be the biggest and longest financial obligation of our lives. So getting a good mortgage rate is essential. A mere 0.5% difference in interest rates can either save or cost you tens of thousands of dollars over the life of the loan.
How to Shop for a Mortgage
Check Your Credit Score
Credit scores help lenders determine who qualifies for mortgages and the interest rates they’ll pay. Generally speaking, the higher your credit score, the better the terms. For this reason, you should check your credit reports at the three major credit bureaus at least six months before applying for a mortgage and correct any errors that could be dragging down your credit score.
Starting early also gives you some extra time to demonstrate good credit habits, such as paying all your bills by their due date, if that has been a problem in the past. You can check your credit reports for free at least once a year at AnnualCreditReport.com, the official website for that purpose.
Note that mortgage shoppers generally aren’t penalized for too many credit inquiries from lenders, as they might be if they were applying for a lot of credit cards at one time. Credit bureaus can tell when a prospective homeowner is simply making the rounds of lenders, and they recognize that mortgage-related queries usually result in a single loan. Consequently, they cut house-hunters some slack and don’t allow the multiple queries to negatively affect their credit scores, provided that the loan-shopping occurs within a fairly narrow time period. For example, the FICO credit scoring model disregards multiple inquiries when they happen within a 30-day window.
Weigh the Different Types of Mortgages
There are two basic types of home mortgages, fixed and adjustable, and which one you choose can have a major effect on the rate you’ll pay.
A fixed-rate (or “traditional”) mortgage carries a set interest rate that won’t change during the term of the loan. That term might be, for example, 10, 15, 20, or 30 years, although loans with shorter or even longer terms may be available.4
The longer the term of your loan, the lower your monthly payments will be, but the more you’ll pay in total interest costs over the life of the loan.
Fixed-rate loans can be a good choice for homeowners who appreciate the predictability of knowing what their monthly mortgage payments will be for years into the future.
Adjustable-Rate Mortgage (ARM)
Also called variable-rate or floating-rate mortgage, an adjustable-rate mortgage is a loan with an interest rate that can change periodically, usually in relation to an index. While the initial rate is generally lower than the rate on a fixed-rate mortgage, the rate can rise after that, subject to the terms of the loan. Most ARMs have caps, or limits, on the size of each rate adjustment and how high the rate can go in total.
Shop Multiple Lenders
Mortgage rates can vary from lender to lender, even for the very same type of mortgage. So it pays to shop around, which you can easily do online, at least to get started.
Banks, savings and loan associations, and credit unions are the traditional sources for mortgages. In recent years, nonbank financial companies have also gained a major share of the mortgage market.
Any financial institution that you already have a relationship with could be a good place to start. In addition to knowing you, they may have special offers for established customers. At this writing, for example, Bank of America offers a fee reduction of $200 to $600 for mortgage applicants with a Bank of America bank account or a Merrill investment account.
Learn the True Cost of the Mortgage
Low advertised interest rates can distract borrowers from the actual cost of a mortgage. In comparing interest rates from different lenders, the figure to focus on is the annual percentage rate, or APR.
The APR, which will be higher than the basic interest rate, represents how much you’ll pay for the loan, including any additional fees charged by the lender. It is calculated on the assumption that you’ll keep the loan for the entire term, so costs are averaged over that period.
Another consideration is “points.” While this term sometimes refers to additional fees that are accounted for in the APR, it can also refer to what are known as discount points. Discount points are an optional upfront payment you can make in return for a lower interest rate. Each point is equal to 1% of your loan amount.
Ask for a Pre-Approval Letter
Once you have found one or more lenders that seem like good prospects, you should ask them for a pre-approval letter. A pre-approval letter isn’t a formal loan offer but indicates that the lender has performed a credit check or other investigation of your financial affairs and would be willing to lend you up to a certain amount of money.
Obtain Loan Estimates
If you have found a property you want to buy, you can obtain a Loan Estimate from the lenders that you are considering. This is a standard three-page document that details the type of loan, estimated interest rate, monthly payment, and total closing costs, along with estimated tax and insurance costs.
Formalize the Deal
Loan estimates are typically good for 10 business days, after which they expire. If you have decided on a particular lender you should notify them during that time frame and follow up with any additional information they request. You will also have to pay an application fee.
If you are happy with the proposed terms, you can request a written lock-in or rate lock. That will keep the loan’s interest rate from going up if market interest rates change before the deal is finalized.