If buying a home might be the largest single investment you ever make, the mortgage you need to finance it will probably be the biggest debt you ever assume. A mortgage is a long-term financial obligation, and the mortgage rate you pay substantially affects the overall cost of your new residence. A 0.5% difference in interest rates (which determines the size of your monthly payments), for example, can save or cost you tens of thousands of dollars over the life of a loan. 

Needless to say, it makes financial sense to shop around for the lowest rate for which you can qualify. Here are the steps to take.

1. Get Your Credit Score

Lenders will use your credit score to help determine if you qualify for a loan and what rate you’ll be charged. In general, the higher your credit score, the better the terms you’ll be offered. It’s a good idea to get a copy of your credit report at least six months before you plan on obtaining a mortgage, so you have time to find and fix any errors (your own credit inquiry should not count against your credit score).

Once you start shopping, each lender you contact will want to pull your report. While you may have heard that it will lower your credit rating each time a lender makes an inquiry, credit agencies recognize that mortgage-related queries result in a single loan (and not multiple new lines of credit), so they’ll cut you some slack – provided you can do your loan-hunting within a focused period. The FICO score, for example, disregards multiple inquiries when they happen within a 45-day window; other agencies have a 14-day to 45-day window.

2. Consider Mortgage Types

Before you shop, determine how much you want to borrow, which type of mortgage you want and how long a term you need, so that you can fairly compare lenders. Mortgages fall into two basic types: government-backed and conventional.

  • Conventional Loans. These represent around 65% of all mortgages issued and are offered by private lenders (thrift institutions, commercial banks, mortgage companies and credit unions). Depending on their size and criteria, they may also be guaranteed by the federally sponsored agencies Fannie Mae and Freddie Mac.
  • Government-Backed Loans. Though also obtained through private lenders, they are insured, either completely or partially, by the U.S. government. These typically have less rigid borrowing requirements with low down payments, lower credit expectations and more-flexible income requirements. However, the property must be the borrower’s primary residence and owner-occupied (no investment or rental properties). Aimed at first-time or low-income buyers – though anyone can apply – the best known of these mortgages are FHA loans, backed by the Federal Housing Administration.

Also to consider: the nature of the financing you want. Again, these fall into two basic categories:

  • Fixed-Rate Mortgage. A fixed-rate (or “plain vanilla”) mortgage is a loan that has a set – that is, the same – rate of interest for the entire term, allowing you to spread out the costs of your home purchase over time while making predictable payments each month. Fixed-rate loans are ideal for buyers who have steady sources of predictable income and intend to own their homes for extended periods of time.
  • Adjustable-Rate Mortgage (ARM). An adjustable-rate mortgage (also called variable-rate or floating-rate) is a loan with an interest rate that changes periodically, usually in relation to an index. The introductory or teaser rate is often lower than the rate available on a fixed-rate mortgage, but the rate may change at specified times after the introductory period, resulting in sometimes sizable increases in your monthly mortgage payment. Adjustable-rate loans are typically the recommended option for buyers who anticipate declining interest rates (to avoid being locked into a higher rate), who plan on living in the home for a limited number of years or who expect to pay off the loan before the interest-rate adjustment period is reached.

    3. Contact Several Lenders

    Loan officers are not bad people, and most of them want your business. However, don’t assume they’ll be up on all the products out there. You should do a little work on your own to make sure you understand the full variety of available options in the marketplace and the pros and cons of each.

    You can also work with a mortgage broker, who, for a fee, finds a lender for you and arranges the transaction. (Note: Brokers will contact multiple lenders on your behalf, but they are not obligated to find the best deal for you unless they are under contract to act as your agent.) They are also paid a fee by the lender in exchange for bringing business to that lender. Some financial institutions act as both lenders and brokers, so it’s important to find out if the institution is getting a broker involved. If you’re unsure, ask.

    4. Add in the Additional Costs

    The lowest advertised interest rate you find may not necessarily be the best option. You have to look at fees, as they can significantly drive up the overall cost of a mortgage. In general, a mortgage with higher fees will have a lower interest rate, but it’s important to ask about loan-origination or underwriting fees, broker fees and settlement or closing costs.

    Some fees are paid when you apply for a loan, such as the application and appraisal fees, while others are settled at closing. Ask the lender which fees you will be charged and what each fee covers. Ask not just about immediate ones but potential ones down the road, such as prepayment penalties.

    Points are fees paid to the lender (or broker) and are typically linked to the interest rate: The more points you pay, the lower your interest rate. One point costs 1% of the loan amount and reduces your interest rate by about 0.25%. To find out how much you’ll actually end up paying, ask for points to be quoted as a dollar amount instead of just the number of points. (For more, see Mortgage Points: What's the Point?)

    In general, people who plan on living in a home for a long time (10 or more years) should consider points to keep interest rates lower for the life of the loan. Paying a lot of money up front for points may not be worth it if you plan on moving in a shorter amount of time.

    5. Negotiate

    By law, within three business days of receiving your application, lenders are obligated to provide a three-page loan estimate (LE) of the cost details associated with a mortgage. This will include information about monthly expenses (seeing the total out-of-pocket dollar amount per month can be highly useful), estimated interest rate and total closing costs. Some loan programs require mortgage insurance premiums for all applicants regardless of down payment amount, and this information is listed on the document for easy comparison.

    A loan estimate is not a loan offer, but it does obligate the lender to accept you under the terms listed if you have the available funds and credit approval required. Generally, part of the application information will be validated before the lender will offer an LE.

    Loan estimates provide a summary of the financial terms of a mortgage loan and a way to compare offers from multiple lenders and multiple loan programs. This document does not require you to accept the loan or obligate you to anything besides the provision of truthful information.

    Once a lender has given you an estimate, you may be able to bargain for better terms. Ask the lender to write down all the costs associated with the loan – interest rate, fees, points – and then find out if it will waive or reduce any of the fees or offer you a lower interest rate (or fewer points). The rate itself doesn’t have that much wiggle room in these low-interest times, but ask if the lender can shave off at least a little based on your strengths, such as having an excellent credit history or being able to make an above-average down payment.

    If you are already a client of the lender’s, definitely make that known – or ask if doing other business with the company would make a difference. Bank of America Corporation, for example, offers reduced fees based on the amount a customer keeps in a Bank of America banking or Merrill Lynch investment account.

    You can also get a little competitive spirit going, asking if the lender will match terms that you’ve found elsewhere. Mortgage companies are constantly battling one another for the finite business out there. Particularly during down markets, when fewer buyers are there for the taking, lenders frequently slash fees to get customers on board. A customer who shops around with multiple lenders and lets each know it is competing with several others stands a good chance of paying lower mortgage fees than a customer who does business with the first lender that calls.

    Although it may seem a little early in the game, ask about closing costs, too. The service, underwriting and document charges are all open to negotiation. The lender can usually waive the application and processing fees altogether, and even carrier charges should be challenged ($100 to send documents via FedEx – seriously?).

    6. Get It in Writing

    Once you are happy, ask for a written lock-in or “rate lock” on the LE that includes the rate you agreed upon, the number of points (if any) to be paid in the period and the period the lock-in lasts. Most lenders charge a nonrefundable fee for locking in the interest rate and points, but given the speed bumps that can occur on the road to approval, it may well be worth it.

    After you decide to go with a particular lender, finish the application and obtain a pre-approval letter. This is much more thorough than an LE – but more of a commitment as well. Pre-approval is only given after all income verifications, credit checks and funding are secured, and all necessary information has been validated and accepted by the lender.

    Pre-approval letters are formal offers to lend money and are legally binding upon the lender; they can be revoked or substantially changed only if the borrower does not meet the full terms of the agreement to loan. A potential buyer having a pre-approved mortgage provides the seller and other interested parties with official proof of the mortgage offer and intent of the lender to loan money. This document allows the purchase or refinance of property to move forward.

    7. Picking the Best Rate

    Even before you actually contact any lenders, you can get a sense of what they’re offering via a digital search and the use of a mortgage rate calculator. (For more, see Finding the Best Mortgage Rates.) Interest rates fluctuate, and different lenders may offer promotions for certain loan products. To keep the comparisons apples to apples, provide each lender with the same information and make sure you are asking about the same loan: for example, a $250,000 30-year fixed-rate mortgage with no points.

    Remember as well to compare the total dollar amounts of different-length terms. A 15-year mortgage may have a higher interest rate and monthly payments, but it may cost significantly less in the long run than a 30-year mortgage, because you’ve paid off the debt a decade and a half earlier.

    8. Picking the Best Lender

    On the service side, getting your questions answered in a timely and accurate way is an important element of the process. Applying for a loan requires quite a bit of paperwork, as well as the collection and dissemination of a significant amount of personal information. Having a single, reliable point of contact for your questions can make the difference between a smooth, easy process and a tough experience.

    Having the loan ready in time for your closing is another important consideration. Final documentation is often unavailable until days or even hours before the closing, and coordinating the schedules of the various parties involved in the transaction can be a challenge. A dependable lender will help to keep everything on track and on time and make a significant contribution to your personal peace of mind.

    Although dealing with someone in person is usually preferable, you might save money by using an online lender. In theory, because online lenders have lower overhead, they can pass on the savings to consumers in the form of lower interest rates and fees. Still, you need to comparison shop – don’t make the mistake that nearly half of regular mortgage borrowers make and only get a quote from a single lender. If you need a lot of hand-holding during the process, an online lender might not be right for you.

    The Bottom Line

    Getting the best mortgage rate for your new home requires discipline and focus. You need to thoroughly understand the terminology, decide on what kind of mortgage is right for you, make sure you are aware of all costs and fees, compare multiple possible lenders and not be afraid to negotiate, get loan estimates and pre-approvals in writing, and do your homework on your prospective lender’s history. A mortgage is something you are likely to be living with for a long time, so it’s important to do it right. Millions of people have, and so can you.

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