Shopping For A Mortgage

Shopping For A Mortgage

Things to Know Up Front When Shopping for a Mortgage

There are many things that are helpful to know at the beginning of the process of shopping for a mortgage. Knowing this information will help to streamline the process, save time, and potentially put an individual in a better negotiating position. In fact, much of this information is critical to know prior to embarking on shopping for a home. It will make the entire home shopping and mortgage shopping experience easier because an individual will have the answers to basic questions.

Obtain Your Credit Report

When starting the process, it is important for individuals to understand their credit history. Because of the Fair Credit Reporting Act (FCRA), consumers can now order a free copy of their credit report from each of the three consumer credit reporting companies (Equifax, Experian, and TransUnion) each year. To order their credit report individuals may visit annualcreditreport.com or call 1-877-322-8228. This will allow individuals to check for errors or inaccuracies and have the problems fixed prior to shopping for a loan.

Understand What You Can Afford

When determining how much an individual can afford, it is important to look at three things:

    1. How much they can afford to pay for a mortgage on a monthly basis. There are several ways for individuals to determine how much they can afford:
  • They can use the rule of thumb that they should pay no more than 28% to 33% of their monthly income toward housing expenses (principal and interest payments, property taxes, home insurance, and potentially private mortgage insurance). They should also not pay more than 36% to 38% of their monthly income to cover all monthly debt payments (including housing).
  • They can ask a mortgage banker or broker to pre-qualify them for a mortgage letting them know what they can realistically afford.
  • The can use a home affordability calculator such as the one provided by Ginnie Mae (Ginnie Mae Home Affordability Calculator).
  1. How much can the individual afford for a down payment. Ideally, individuals should be able to put down 20% or more on their home. In doing so, they will likely obtain more favorable rates as well as avoid paying private mortgage insurance (PMI).
  2. How much do they have to cover closing costs. As a general rule of thumb, it can be assumed that points and closing costs will be about 4% of the value of the home. Of course, using money to pay the closing costs may reduce the amount an individual has to put down on a home.

Armed with this information, an individual should know how much they will be putting down on a home, how much they will have for closing costs, how much they can afford to pay on a mortgage on a monthly basis, how large a mortgage they can afford, and ultimately how much they can afford to spend on a home (down payment + mortgage amount).

Understand Your Own Income Potential

Individuals should also assess heir own income potential. Do they expect their income to remain fairly constant or do they expect it to increase significantly over time? Knowing this may give them some guidance in picking a type of mortgage. Individuals who expect their income to remain fairly constant should probably avoid mortgages whose payments will increase over time such as adjustable rate mortgages, graduated payment mortgages, or growing equity mortgages. Conversely, individuals who expect moderate to large increases in income may want to consider these other mortgage types rather than a fixed rate mortgage.

Other Things to Consider

Some other things for potential borrowers to consider include:

  • How long does an individual plan on staying in the home? If an individual knows that they will only be in the home for a short period of time (say three years or less) then they should probably consider loans that start with low initial payments that rise over time, such as an adjustable rate mortgage. They can do so comfortable in the knowledge that they will be out of the home prior to planned increases. Conversely, an individual who plans on being in a home for a long time may want to consider a more predictable mortgage such as a fixed rate mortgage.
  • Is paying the mortgage off early important? If an individual wishes to pay off their mortgage early then they may wish to take out a 15 year mortgage, or consider a graduated payment mortgage or growing equity mortgage, or simply making extra principal payments every month.

Decide on the Type of Mortgage

A potential borrower should now be ready to select the type of mortgage that best fits their needs. They should now know:

  • How much they are going to borrow
  • The types of mortgage they are willing to consider
  • The term of the loan (15 years, 30 years, or something else)

It is now time for the borrower to start shopping for the best loan deal that they can find. When shopping for a loan, a borrower needs to obtain a few pieces of information to be able to compare loan options. The information that they should obtain to be able to compare options includes:

    • The interest rate on the loan and the monthly payment that will result for the amount of money they wish to borrow. For individuals who are considering other than fixed rate mortgages, some additional information should be gathered:
  • For Adjustable rate mortgages (ARM) borrowers should understand what index will be used for interest rate adjustments, the adjustment period for the interest rate, the caps on interest rate adjustments for the first adjustment, subsequent adjustments, as well as the life time interest rate cap. They should also know if the ARM will allow negative amortization (which can occur with ARMs that have payment caps).
  • For graduated payment or growing equity mortgages, the borrower needs to understand when and how much payments will increase.
  • Any points that may need to be paid.
  • The closing costs for the loan (lenders should be able to provide a good faith estimate of a loan's costs).
  • The APR (annual percentage rate) of the loan which is an actual or realized interest rate being paid on the loan when the points and other closing costs are included. This can be used as a rough measure to compare loans. There are cases, however, where a consumer may wish to take a higher APR loan because in paying more points they obtain a lower interest rate and monthly payment.

Things to Watch Out For

Potential borrowers need to understand if a loan has any prepayment, or early payment, penalties. They should ask the lender as well as check their Truth in Lending (TIL) form. On that form there is a line that states "If you pay off your loan early, you [ ] may [ ] will not have to pay a penalty." A check mark in "may" means that there is a prepayment penalty. Prepayment penalties should be avoided if possible. If they cannot be avoided then the borrower needs to understand what the penalty is and for how much of the life of the loan is it in place.

Another thing for a borrower to watch out for are loans that can have negative amortization. Negative amortization means the the principal amount of the loan can actually increase (what the borrower owes goes up). This can happen in certain types of adjustable mortgages that have payment caps. If a capped payment is not enough to cover all of the interest payment, then the unpaid interest is added onto the principal amount of the loan. Negative amortization is also something that should be avoided if possible.

Where to Shop for a Mortgage

While there are thousands of lenders who may want an individual's mortgage business, there are really only a few places that a borrower needs to look to find a mortgage:

  • The potential borrower's bank is a good place to start looking for a loan. Their bank may provide preferred mortgage deals to existing customers, especially if they are large depositors. It is very common for banks to offer their large depositors's preferred rates on home equity loans or lines.
  • A mortgage broker is also another good place to look. A mortgage broker, because they represent many different lenders, can do some of the shopping for an individual
  • Online services exist that allow a potential borrower to put in their pertinent information and receive many different mortgage quotes from competing lenders

A borrower should expect to investigate at least a couple of these avenues when looking for a mortgage. This will enable them to better understand prevailing rates, terms, and conditions, and make a more educated decision on their ultimate mortgage.

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