Before you Buy that Home: Shop for the Best Loan

Before even starting to search for a home, the first thing you need to do is get pre-qualified for a home mortgage.  It only takes a brief phone conversation with a lender, either at a bank or with a mortgage broker to do this.  The reason this is necessary is to make sure that you really do qualify for a loan, and to know how much loan you can get and what type of loan will best suit your situation.

But the loan process can be scary for some folks.  Here’s some information to help you shop for the best loan.  I am often asked the following questions by prospective buyers when it comes to the loan process:

What type of loan should I get?

Let’s do a quick review of loan types.  The best is usually a conventional loan, but not everyone qualifies and you will probably need at least a 5% down payment.  FHA loans are for persons with lower credit scores and/or less money to put down.  The down payment on an FHA loan is 3.5% of the sales price.

If you or your spouse is a veteran of the armed forces or National Guard, you may qualify for a VA loan.  This is a zero down loan, but it carries a funding fee that is either paid at closing or you can have it added onto the loan amount.  The funding fee is usually about 2%, but can vary from year to year.

Another zero down mortgage is the USDA loan, which is available through the U.S. Department of Agriculture (USDA), and it too has a similar funding fee.  But USDA loans are only for areas of small populations, most often in rural areas. 

You can check this map to see if the area you want to buy a home in will qualify for a USDA loan.  Click the link that says “Single Housing” or” Multi family Housing” on the left side, accept the disclaimer and then insert an address at the top of the page.

Not everyone will have a choice of what type of loan to take.  A credit score of 700 or better is excellent, and may provide you with a choice of loans, but if your credit is only so-so (580-650), you probably will only qualify for one or two types of loans.

Should I use the bank where I have my checking or savings accounts?

Many people with whom I speak think that since they have been with XYZ bank for several years that somehow they will get a better deal or be more likely to qualify by obtaining their mortgage through them.  Of course that would be nice, but unfortunately it makes very little difference. 

Most pre-qualifications today are done through an automated underwriting system, in which the applicant’s information is entered and a computerized approval or denial is then generated.  Even if your great granddaddy went fishing with the great granddaddy of the bank President, it will make no difference if your credit score is too low to qualify for a loan.

Does the interest rate matter?

Yes it does!

If you buy a home for $200,000 with an FHA loan at 4%, your loan amount is $193,000 and your monthly payment of principal and interest will be $921.  The same loan amount at 4.25% will be $949 per month.  Believe it or not, over 30 years that’s a $10,000 difference.

What are “points” on a loan?

Points are fees that lenders charge to lower the interest rate on a loan.  There are two types.  The first is a loan origination fee, and the second is a discount point.  Charging a point reduces your interest rate by about 0.25%, but one point will also cost you 1% of the loan amount.  On that $193,000 loan, one point would equal $1,930.  So you can see that the number of points charged will significantly impact your out of pocket expenses on the day you close on your home. 

Therefore, don’t just shop around for the best interest rate without also considering the number of points being charged by each lender.  If you only plan on living in the home for a few years, you are far better off taking a higher interest rate with fewer points because it takes many years for the interest rate reduction you get to equal the amount of cash spent on those points.

Can I shop around for a mortgage without hurting my credit score?

Yes, you can!

FICO credit scores range from 300 to 850.  About 65% of your credit score is based upon your payment history and use of credit.  Paying creditors on time is the best way to raise your credit score.  Keep in mind that recent credit history is weighted more than your history from several years ago.  Even people with bankruptcies, foreclosures, and auto repossessions can still get a mortgage if enough time has gone by to reduce the effect of those credit “dings” on their score.

It used to be that shopping different lenders and having your credit report pulled several times would significantly drop your credit score.  But a few years ago, Fair Isaac & Co (FICO) changed their system so as not to penalize you too much for loan shopping. 

Under the current system, you can have multiple credit pulls for a mortgage without penalty, but only if you have them within a 45 day period.  At most each pull will lower your score by only 5 points.  So mark your calendar with the date of the first pull so you can stay within that time frame.

So happy shopping and good luck in finding the best loan for you before you buy that home!