Comparing Costs For Different Types of Home Loans
How to Compare Mortgage Programs
Looking to buy a house? Congratulations! Now comes the hard part: deciding what kind of mortgage is right for you. You want to find the best rate, of course, but you also want to make sure you aren’t being taken advantage of. Make the process less overwhelming by knowing what you’re in for.
Considering Different Kinds of Loans and Lending Sources
Look into a fixed-rate mortgage.With a fixed rate, your interest rate and monthly payments will stay the same for the duration of the loan. For many people, this consistency is appealing, and for this reason fixed-rate mortgages are the most popular kind.
- While the dollar amount of your monthly payments will not change over time, the way this money is allocated will.
- At the beginning, you will mostly be paying interest. Toward the end, you will be paying mostly principle.
- Calculate the costs of a fixed-rate mortgage here.
Consider an adjustable rate mortgage (ARM).Adjustable rates will often be lower at the beginning, but they—and your monthly payments—will change over the course of the loan. Because this kind of loan carries more risk, many people try to avoid it.
- You will have a fixed rate for the first three, five, seven, or ten years of what is usually a thirty-year loan.
- After that, monthly payments will go up when interest rates go up, but they will also go down when interest rates go down. The amount of increase for a single year will be capped.
- You might want to consider this kind of loan if the initial fixed rate term compensates for the risk of interest rates going up later, if you plan on selling the house before the fixed rate period ends, or if you are confident that interest rates are going to go down over the course of the next several decades. They are generally a better deal when interest rates are high.
- Calculate the costs of an ARM here.
Weigh the pros and cons of different mortgage lengths.The length of a mortgage can vary greatly, with terms lasting anywhere from 8-30 years. 30-year mortgages are the most popular, but consider other options as well.
Determine if a shorter-term mortgage is right for you.A shorter-term loan means that the lender will assume less risk and may be willing to offer you a lower interest rate.
- However, a shorter-term loan also means that your monthly expenses will be greater.
- Choose a shorter term if you can afford higher monthly payments and want to save money on interest.
Determine if a longer-term mortgage is right for you.A longer term means that you can afford a bigger mortgage (because your payments will be more spread out).
- However, you will be paying more interest with a longer-term loan. Equity in home grows slower as the term of the loan increases.
- Choose a longer term if you want to get the biggest mortgage you can without your monthly payments becoming prohibitive.
Research special mortgage programs.Based on income or occupational background, you may qualify for government sponsored and/or administered programs. These usually involve more favorable terms than you could secure through private mortgages, including low or no down payment and lower interest rates.
- The Federal Housing Administration (FHA) Mortgage Program allows low and moderate income homebuyers to buy a home with a down payment of 3.5%.
- The U.S. Department of Veterans Affairs (VA) lets both active and retired military service members get mortgages with low or no down payment and at a lower interest rate. (Remember the explosion of suburbs after World War Two?)
- If you’re interested in living in a rural area, you may qualify for a U.S. Department of Agriculture (USDA) home loan, which comes with no down payment and a lower interest rate.
- Other forms of government-backed assistance include tax credits for mortgage payments and help with down payments and closing costs.
- Private organizations like Fannie Mae also offer aid to low and moderate income homebuyers.
- Occasionally, mortgages will be advertised for people in a particular industry, but be wary of these offers. They may be preying on certain industries with less favorable rates and fees.
Look at different kinds of lending institutions.Banks might be the most obvious place to start when looking for a mortgage, but they are not your only option. Several different kinds of institutions offer mortgages. They include the following:
- Savings and loan associations
- Mortgage companies or brokers
- Direct lenders
- Credit unions
- Private investors (generally contracted by individuals with poor credit, private investors will usually charge the highest interest rates)
Consider a broker.Unlike lenders (banks and other institutions), brokers don’t finance mortgages directly. Rather, they act as middle people and do some of the legwork for you by taking your application to several different lenders. That way, you can compare programs from multiple institutions.Brokers may have access to a wider variety of products than non-brokers.
- To make sure you are getting the best rates possible, you should work with multiple brokers.
- You won’t always know if a broker is involved. Some financial institutions both provide loans and work as brokers to find lenders. Moreover, not all people who work as brokers will self-identify as such. You will need to be proactive and ask if your transaction involves a broker.
Asking the Right Questions
Take your time.You may have a sense of what kind of institution you want to secure a mortgage with or whether or not you want to work with a broker, but don’t commit until you have gathered all the necessary information to compare plans. Experts suggest that you research at least four different lenders. Ideally, at least some of these will be from different categories of lenders.
- Do not worry about shopping around affecting your credit rating. While it is true that making multiple credit inquiries in a short amount of time can lower your number, this does not apply to mortgages.
- Credit reporting agencies only count one inquiry every thirty days. Once you submit one inquiry, you have thirty days to submit as many you would like before another inquiry is reported.
Get the details about interest rates.Financial institutions do not offer the same interest rates to everyone. Instead, they do so based on your credit rating. While you are doing your research on various lenders, make sure you get a quote that is tailored to your credit profile, not just the rate offered to customers with the best credit score.
- Be sure to find out whether the rate you are offered is fixed or adjustable.
Find out the annual percentage rate (APR).Interest doesn’t tell the whole story. The APR includes the entire cost of the loan over a year, including the interest rate and any additional fees. If these fees are expressed as one lump sum, ask to see an itemized list, and seek clarification for any you do not understand. Fees could include any or all of the following:
- Loan origination or underwriting fees (amount charged by the institution to process the loan)
- Broker fees
- Transaction, settlement, or closing costs (including legal fees and fees to obtain necessary documents)
Consider how big of a down payment you can afford.Traditionally, you would have to pay 20% of the house's purchase price (if you are buying the house) or appraised value (if you are refinancing) as a down payment. Now, however, most financial institutions have lowered this amount, making it possible to get a loan with as little as 3 or 5% down.
- A small down payment has its drawbacks. You will be required to buy private mortgage insurance, which guarantees that the lender will be paid even if you default on your loan.
- If you find yourself in this situation, make sure you find out how much the additional insurance will cost, what your monthly payment will be with insurance included, and how long you have to pay the insurance.
- If you pay less than 20% down, you must get Private Mortgage Insurance (PMI). Beware of lenders offering lower down payments with no PMI; they will charge you higher rates to pay for Lender Paid Mortgage Insurance (LPMI). Once you pay more than 20% of your loan value, regular PMI will go away, but LPMI will stick with you for the rest of your loan.
Ask for a loan estimate and Lender Fees Worksheet from all potential lenders.You will almost certainly become overwhelmed by all of the information you’ll be receiving from different lenders if you try to keep track of it in your head. These key documents will make it much easier to compare programs.
- The loan estimate lays out the most important parts of the mortgage (interest rate, closing costs, APR, etc.). Lenders are legally required to provide you with one within three days of your full application, so it is a huge red flag if they don’t. This is a standard document, so all lenders will provide you with the same information in the same format, making it easier to compare.
- The Lender Fees Worksheet goes into more detail than the loan estimate, breaking down every cost associated with the mortgage. It is not legally required, but you can usually obtain one if you ask. Many lenders will provide one before they give you a binding loan estimate.
Get it in writing.Once you and your lender or broker have agreed on terms, ask for a lock-in agreement along with your loan estimate, which guarantees the terms you have negotiated as long as the loan closes within a certain amount of time. You might have to pay a fee for this agreement.
- Getting a lock-in is important because interest rates might go up while your loan is being processed. However, they may also go down, at which point you would be locked into a higher rate.
- A lock-in alone will only protect the interest rate. To make sure that other fees do not change, you need the loan estimate as well. A loan estimate will prevent the fees for brokers, lenders, and required services from rising. A loan estimate cannot lock in fees for third party services, however.
Focus on the most important items.Interest rate and closing costs will have the biggest effect on your finances, both now and for years to come. These should be the main factors that you consider when comparing offers from different lenders. Both of them can be found on the loan estimate or worksheet.
- Locate the interest rate in the top of page one of the loan estimate.
- Locate closing costs at the bottom of page one. These costs fall into a couple of different categories, so look for “Total Estimated Settlement Charges” to get a general sense.
Look at the APR.This will give you a good sense of how your money is being allocated in terms of interest rates vs. fees. Find it on the loan estimate.
- Some lenders will offer attractive interest rates but high fees, while others will do the opposite. The APR lets you compare these disparate offers quickly and easily.
- If you see that your APR is significantly higher than your interest rate, it’s a sign that the lender is including a lot of fees. Consider negotiating these additional costs.
- If two lenders offer the same interest rate but different APRs, you know that one of them is charging higher fees.
Exercise caution when comparing different kinds of mortgages.Remember, for instance, that fixed rate mortgages will often have a higher interest rate than ARMs do at the beginning. Don’t forget to think about short-term vs. long-term costs.
Avoiding Predatory Loans
Exercise the right amount of caution.Most brokers and lenders are professional, trustworthy, and honest; however, predatory individuals and practices do exist. Be prepared for any of the following, which could make you susceptible to losing your house down the road:
- False appraisals that inflate the value of a house
- Encouragement to lie on your application
- High rates based on your race or national origin
- Fees that don’t exist or that you don’t need (remember to ask about anything you don’t understand)
Arm yourself with information.The U.S. Department of Housing and Urban Development keeps a list of counseling agencies approved to give homeownership courses. Especially if you are new to the process, you might benefit from attending one of these.
Make sure there is nothing out of the ordinary about the terms you are being offered.Always compare your treatment to how other people are being treated. If you notice any red flags, contact your local housing agency.
- Consult with several different real estate agents to make sure that the price of the home you want to buy is not being inflated.
- Compare the price of the house you want to buy to other houses in the same neighborhood.
- You already know to compare offers from several different lenders. Neither brokers nor anyone else should be pressuring you to choose a particular one.
- Know that the Equal Credit Opportunity Act and the Fair Housing Act protect you from discrimination at any stage in the process. If you think you have been discriminated against, file a complaint with the Department of Housing and Urban Development.
- Get your credit report before you apply for a loan. If you don’t have the best credit but have legitimate reasons for this, you may be able to explain to your broker or loan officer.
Video: 3 tips to guarantee you get the best mortgage interest rate
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