Shopping for a mortgage is confusing for first timers, but a little knowledge can save you money.
So, here’s some knowledge. We’ll go step by step through the process of landing a good loan.
The first step is to check your credit report, says Suzanne Gellman, consumer economics specialist at the University of Missouri. The stuff on your report dictates your credit score, and your score goes a long way to determining the deal you’re offered.
You can get a free report once a year from all three reporting agencies at annualcreditreport.com, or by calling 877-322-8228.
Check for nasty goofs, such as false late-payment reports, debts that aren’t yours, or debts you paid off years ago. Challenge any mistakes with the credit agencies. About one out of five people finds a mistake that could lower a credit score, according to a recent Federal Trade Commission study.
Try to fix legitimate problems, says Al Fuss, vice president at Gershman Mortgage. That might include your dispute over an unfair medical bill that ended up with a collection agency. “Go back to the creditor and see if you can resolve it,” he says.
That can take time, so it’s best to start about six months before you buy a home, Gellman says.
Next, think about the kind of mortgage you want. The vast majority of people should want a fixed-rate loan — the kind where the interest rate holds steady for 15 or 30 years.
Adjustable rate mortgages, or ARMs, start off cheap for the first few years. Then the rate adjusts according to a published index, such as Libor, or the rate on Treasury bills.
Rates are near record lows today, and chances are they’ll be higher a few years from now when the adjustment happens. So, ARMs are good only for people who expect to sell in a few years.
Rates on 15-year loans are a little lower than on 30-year mortgages —2.9 percent versus roughly 3.7 percent in late May. But monthly payments are higher with a 15-year loan, since you’re paying down the balance more quickly. At recent rates, the difference in monthly payments is about $339 per month on a $150,000 loan.
A 15-year loan will save you lots of money over time, but the higher monthly payment could multiply your problems if you lose a job. So, a 15-year loan is smart for people feeling secure.
Now it’s time to learn about conventional and government-backed mortgages.
The cheapest loans go to good savers with good credit. If you have a 20 percent down payment, you’ll waltz into a conventional mortgage. Without 20 percent down, you’ll have to pay for mortgage insurance. That’s expensive. On a $175,000 loan, it might run $64 per month, according to an illustration from Bankrate.com.
The borrower gets nothing for that. The insurance protects the lender in case of default.
You can get a conventional loan with as little as 3 percent down if you have very good credit and cough up for the insurance. But you may pay a higher interest rate.
People with tiny down payments should consider going FHA. The Federal Housing Administration backs mortgages with down payments as small as 3.5 percent. The FHA is also more forgiving of credit blemishes — they’ll take credit sinners that conventional lenders won’t.
You’ll pay for that backing. There’s an upfront fee, which is rolled into the mortgage amount, plus a monthly charge. On a $150,000 mortgage, it might add $62 to the monthly payment.
Again, the fee protects the FHA when homeowners default. It doesn’t protect you. Recent changes in FHA insurance reduced the advantage of going FHA over paying private mortgage insurance, notes Al Will, president of Gershman Mortgage.
There are programs around the region to help low-and moderate-income people afford a down payment, along with free seminars for first-time buyers. Aid ranges up to $15,000 for people buying certain houses in the Normandy School District. More information at www.beyondhousing.org.
Now, it’s time to shop for a mortgage. Call at least three lenders, says Gellman. She recommends contacting local banks, credit unions and mortgage brokers. Brokers are independent operators who can place your loan with one of several lenders.
The mortgage rates you see advertised are for the best customers; those with big down payments and credit scores of 720 or better, good income and lots of equity. Many people will pay higher rates.
Mortgage shopping involves comparing two moving parts — the interest rate and closing costs. As you gather offers, you may notice that one lender offers lower closing costs but a higher interest rate, while another does the reverse. Lenders can make a profit on both, and both are negotiable.
Some closing costs are unavoidable; an appraisal will run about $400, title coverage will be roughly $700 to $750 on a typical house, there are small fees for a flood letter and a credit check.
Then we get into the negotiable stuff, such as an “underwriting” fee, often around $500, an “origination” fee or a “quality control” charge. These are largely profit for the lender, and you can bargain over them.
When you apply for a loan, or within three days, you should receive a “Good Faith Estimate” of closing costs. Study it closely. Tell the lender you’d like a final settlement statement a day before closing. Compare the cost numbers; they should be pretty close. Some of the costs are required to be within 10 percent of the estimate. You’ll find good information and videos at www.fha.gov. Click on “buy a home.”
There is no such thing as a true no-closing-cost mortgage. If you’re offered one, know that the lender is charging you a little higher interest rate in order to cover the closing costs.
Speaking of the interest rate, you can buy it down by paying “points.” A point is 1 percent of the loan amount paid at closing. A point will generally get you an eighth to a quarter point off the interest rate. On a $100,000 loan, a quarter point rate cut would save you about $14 a month. It would take about six years to recover the point you paid.
For the past seven years, paying points has been a bad idea. Falling rates let people refinance at a lower interest, and much of the money they paid for points wasted. But with rates now at historic lows, the chances of them going much lower are reduced.
Consider getting pre-approved or pre-qualified for a loan, Will says. To become pre-qualified you simply tell a lender your income, debts and some other information, and the lender can tell you how much you’d be able to borrow. That number will help in deciding on a house.
For pre-approval, the lender verifies your information and approves you to borrow a certain amount. That can be a plus for a home seller in deciding whether to accept your offer.