Even for home buyers going through the process for the second or third time, home buying can be ridden with a variety of emotions, including anxiety, stress, doubt, happiness and anticipation. Once you get beyond some basic decision-making, such as location, mortgage financing may remain high on your list of concerns.
Financing your home at the best possible terms requires proper preparations and due diligence. Here are some tips that should help you demystify the mortgage loan process and put you in a stronger position to negotiate the right mortgage for your first home.
Review Your Credit Report
Before you make an appointment with a real estate agent or mortgage lender, the first thing you should do is review your credit report at least six months before applying for a mortgage, according to the mortgage website HSH.com. If the report has some inaccuracies or errors, you’ll have time to make the necessary corrections. You can enhance your credit score by paying your bills on time and limiting your monthly debt obligations.
In addition, avoid financing large purchases before you secure a mortgage, which can lower your score. The higher your credit score, the better the mortgage interest rate for which you will qualify.
Carefully Consider the Upfront Costs
Obtaining the best deal doesn’t imply that you should seek the lowest mortgage rate, which may not be in your best interest. Before you make your first mortgage payment, you will incur some other expenses associated with obtaining a loan. These costs include:
Mortgage application fees – Sometimes called mortgage origination or service fees, this can be a flat fee like $450, or percentage (1% or 2%) of the total loan.
Earnest money deposit – You need to put some weight behind your intention by putting an initial “good faith deposit” with your offer to purchase, especially in a “seller’s market.” This will make the difference between the seller accepting your offer over the competition.
Down payment – This cost ranges from 0% to 20% of the total cost of the home. The size of your mortgage down payment has a direct bearing on the mortgage rate. Try to put down as much as possible — 15 to 20% is ideal.
Other fees– These fees can include appraisal, underwriting and credit reporting fees. They are all typically worked into the closing costs.
Closing costs– This line item ranges from 2% to 4% of the total mortgage amount. Some buyers pay the closing costs as they pay down the loan by rolling it into the final mortgage amount. Typical closing costs can include:
o Mortgage application fees
o Attorney’s fees
o Inspections and surveys
o Title insurance and title search
o Escrow deposit
o City recording fees
Your mortgage lender will provide you with an estimate of your closing costs.
Understand Mortgage Points
Many first-time home buyers may not be aware that many lenders offer home buyers the option of paying mortgage points on a fixed-rate mortgage. Mortgage points refer to a form of prepayment of interest. A single point equates to 1 percent of the total loan amount — for example, on a $250,000 loan, one point equals $2,500.
Sometimes called “buying down the mortgage,” you simply pay the additional interest, along with other closing costs, in exchange for the lender giving you a lower interest rate. This results in a lower monthly mortgage payment.
Carefully consider the ramification of paying mortgage points because you will only save money from the reduced interest rate if you intend to stay in the home long-term. You must calculate your “break-even point.” How long does it take to recover the cost of the mortgage points?
Ask yourself another question: Will the interest amount I save make up for the additional cash outlay? In some cases, it may work to your advantage to increase the amount of the down payment instead.
Choose Fixed-Rate Mortgage or Adjustable-Rate Mortgage
The mortgage lending marketplace offers homebuyers a variety of mortgage products, with fixed -rate mortgages and adjustable-rate mortgages (ARMs) being the two most popular loan options.
A fixed rate mortgage has a set rate of interest that remains constant throughout the life of the loan. This mortgage type protects borrowers from abrupt and hefty increases in their monthly mortgage payments if the interest rate increases. Although most home buyers choose the 30-year fixed-rate mortgage because of a lower monthly mortgage payment, many lenders also offer other terms, such as 10, 15 or 20 years.
If you can afford a higher monthly mortgage payment, you may want to consider a loan with a shorter term. It necessitates making a higher monthly payment, but you’ll pay down the principal amount sooner and pay less interest.
In contrast, an adjustable-rate mortgage (ARM) changes frequently over the life of the loan. The initial interest rate starts low and remains fixed for a predetermined period, from one month to years. ARM mortgage products have two things:
- A “cap” — the most the lender can increase the interest rate during the adjustment periods
- A “ceiling” — the maximum interest rate increase over the life of the mortgage.
ARMs entice home buyers because the initial low interest rate allows the borrower to qualify for a larger loan, which can equate to a bigger house. In theory, a home buyer can hold an ARM long enough for the interest rate to surpass the prevailing rate for fixed- rate mortgages.
During the last real estate crisis, many home buyers experienced the risk of selecting an adjustable-rate-mortgage. Many borrowers could not afford the increase in their monthly mortgage payment and lost their homes.
The key to choosing an ARM lies in accurately predicting the interest rate trend and if the trend will continue. Consider an ARM if you desire a lower short-term mortgage payment. You should have the resources to handle sudden increases in your mortgage payment. ARMs also provide a viable option for borrowers who do not intend to live in the home when interest rates begin to increase.
Finalizing Your Deal
To get the best deal on a mortgage, clarify your long-term objectives from a “big picture” perspective and your personal finances. Discuss the various mortgage types and terms with your mortgage originator, including government-insured loans programs like VA and FHA. Always ask the lender for clarification if you don’t understand something.
Once you submit a mortgage application, lock in the interest rate and get it in writing. This will provide protection in the event of a mortgage rate increase.