For many folks, a home mortgage represents the largest long-term debt obligation of their lives. For this reason, securing the most favorable possible mortgage rate is essential to minimizing the overall costs of home ownership. A mere 0.5% interest rate differential can either save or cost a homeowner tens of thousands of dollars over the lifespan of a loan. Locking in the best possible interest rate may involve some time and research, but it will pay off for the homeowner in the long run.
Get Your Credit Score
Credit scores help lenders determine who qualifies for loans, and the interest rates they’ll pay. Generally speaking, the higher the credit score, the better the terms. For this reason, borrowers should take the initiative to scrutinize their credit reports at least six months prior to applying for a mortgage, to give them enough time to correct any visible errors.
Some people worry that each time a lender makes a credit score inquiry it depresses a borrower’s credit rating. But credit agencies can tell when a homeowner is simply making the rounds, and they recognize that mortgage-related queries usually result in a single loan. Consequently, agencies cut house-hunters some slack, and don’t allow the multiple queries to negatively impact credit scores, provided that the loan-hunting occurs within a narrow time period. For example, FICO scores disregard multiple inquiries when they happen within a 45-day window.
- Borrowers looking for loans should know their credit scores, in order to correct mistakes, before approaching lenders.
- Borrowers should know whether a fixed-rate mortgage or an adjustable-rate mortgage best suits their needs.
- Borrowers should cultivate a helpful point of contact with a lending institution, to facilitate a smooth transaction.
Consider Mortgage Types
When shopping for loans, it’s critically important to determine which of the two following loan types best suits your needs.
- Conventional Loans. Representing approximately 65% of all mortgages issued, these loans are offered by private lenders like commercial banks, mortgage companies, and credit unions. They may also be guaranteed by the federally sponsored agencies Fannie Mae and Freddie Mac.
- Government-Backed Loans. Likewise obtained through private lenders, these loans differ in that they’re partially or totally insured by the U.S. government. Such loans tend to have less-rigid borrowing requirements, smaller down payments, low credit expectations, and more-flexible income requirements. However, buyers must use the purchased properties as owner-occupied primary residences, and not an investment or rental properties. Government-Backed loans are backed by the Federal Housing Administration and are most popular with first-time buyers and low-income individuals.
Review Financing Options
Loan shoppers must also choose between the following two financing categories:
- Fixed-Rate Mortgage. A fixed-rate (aka “plain vanilla”) mortgage is a loan with a set rate that cannot ever fluctuate throughout the term of the loan. This financing model is ideal for buyers who take comfort in knowing they’ll be making predictable monthly payments for extended time periods.
- Adjustable-Rate Mortgage (ARM). Also called “variable-rate” or “floating-rate,” an adjustable-rate mortgage refers to a loan whose interest rate periodically changes, usually in relation to an index. While the introductory rate is generally lower than that of fixed-rate mortgages, this rate may change at specified times after the introductory period ends, which can dramatically increase a borrower’s monthly mortgage payment. These loans are favored by buyers who anticipate declining interest rates, who plan to pay off the loan before interest-rate adjustments occur.
Contact Several Lenders
Loan officers aren’t all-knowing. Therefore, shrewd borrowers do their homework to truly understand the pros and cons of the different mortgage products available in the marketplace. Borrowers can get an assist in this department by paying fees to mortgage brokers, who can source suitable lenders and help facilitate the transactions. But such brokers also take fees from lenders, in exchange for sending business their way, so it’s important for borrowers to look at recommendations with a critical eye, rather than blindly taking a broker’s advice.
Add in the Additional Costs
Low advertised interest rates distract borrowers from the many fees that can significantly drive up the overall cost of a mortgage. Therefore, borrowers should strive to become fully aware of any added costs, such as application, appraisal, loan-origination, underwriting, and broker fees, as well as any settlement costs.
Points are fees paid to lenders or brokers, that are typically linked to interest rates. The more points paid, the lower the interest rate becomes. For instance, a single point costs 1% of the loan amount and reduces the interest rate by about 0.25%. To understand how much they will actually end up paying, borrowers should request that points be quoted in dollar amounts.
In general, people who plan to live in a home for 10 or more years should consider paying points, to keep their mortgage interest rates lower for the life of the loan. Contrarily, paying a large sum of money up front for points may not be fiscally sensible for borrowers who intend to move after a short period of time.
Lenders are legally obligated to provide a three-page loan estimate (LE) of the cost details associated with a mortgage, within three business days of receiving an application. This includes information about monthly expenses, estimated interest rates, and total closing costs. Although a loan estimate is not a loan offer, it does obligate lenders to accept the terms listed, if the borrower has the available funds and achieves the required credit approval.
Once lenders provide estimates, borrowers are entitled to negotiate for better terms, especially if they can make an above-average down payment or if they boast excellent credit histories. This may include asking lenders to shave interest rates or reduce certain fees.
Borrowers should be sure to discuss if they already do business with a financial institution, in order to secure a better mortgage rate deal. For example, Bank of America Corporation offers reduced fees based on the amount of cash a customer keeps in a Bank of America banking account or a Merrill Lynch investment account.
Lastly, a borrower can create a bidding war, by disclosing the better rates offered by competitors, especially in down markets.
Get It in Writing
Borrowers that are happy with the proposed terms should request written lock-ins or “rate locks” on the LE, that includes the agreed upon rate, the time period of the loan, and the number of points (if any) to be paid. Most lenders charge a nonrefundable fee for locking in these terms, but given the speed bumps that can occur on the road to approval, it’s often well worth it.
After settling on a particular lender, a borrower then obtains a pre-approval letter, which is a legally binding agreement to lend money, that lenders grant borrowers, after all, income verification, credit checks, and funding are secured.
Picking the Best Rate
Borrowers can cultivate an idea of what lenders are generally offering by conducting digital searches and using mortgage rate calculators. However, it’s important to note that interest rates fluctuate and that different lenders may offer promotions for certain loan products.
Picking the Best Lender
When choosing a lender, customer service is key. After all, applying for a loan requires substantial paperwork and information collection. Having a reliable point of contact to answer questions goes a long way toward easing this onerous experience. This will also ensure approval schedules stay on track, and that all final documentation is signed and executed by all relevant parties in a timely and efficient manner.
The Online Option
Although human interaction is generally preferable, borrowers can save money by opting to deal strictly with online lenders, who theoretically have lower overhead and can offer consumers lower rates and fees. But borrowers who prefer hand-holding might do better with traditional lenders.
The Bottom Line
Shopping for the best mortgage rate requires discipline and focus. Borrowers must thoroughly understand the terminology, choose the kind of mortgage that best suits them, and factor all costs and fees into their decisions. A mortgage is something borrowers will live with for years to come, therefore it’s crucial to choose wisely.