Buying a home takes guts.
Renting an apartment might not build equity, but it is comfortably temporary. Squirrels in the ceiling, infectious tap water, a landlord who brings flowers to your girlfriend; there's a limit to how wrong things can go when you don't have to stay in those four walls longer than a year. (Yes, all of these things have happened to this writer.)
You can abandon a terrifying apartment, but a new house that goes wrong is a commitment of decades. If the neighbor starts rehearsing an all-terrier version of "Les Miserables" in his back yard, might as well learn to love his Yorkie's Jean Valjean.
This is a big decision, and one of the most important parts of buying a house is getting your mortgage right. Your relationship with the lender will last for decades. Here's how to approach picking the right one.
How to Choose a Mortgage Lender: 5 Tips
1. Tighten Your Personal Finances
Before you approach lenders, make sure that you're in the best possible position to apply for this loan and pay it off. Start in two places:
Check Your Credit Score
Your credit score will determine whether a lender approves your mortgage application as well as the terms on which they do so. So make sure it is strong before applying. Technically you will need a minimum credit score of 620 or higher to qualify for a decent Fannie Mae or FHA-backed mortgage, but realistically you should shoot for at least 700 if at all possible. It will reduce the down payment that the lender requires and will get you a significantly better interest rate.
It might mean waiting an extra year before you buy your dream house, but it will save you thousands of dollars in the long run.
Prepare for Increased Housing Costs
On a square footage basis you may get more for your money with a mortgage but you will also almost certainly pay more. Between your mortgage payment, insurance and associated costs, it costs 54% more on average to own than to rent.
Be ready for this.
If you haven't planned head, the increased costs of owning your home over renting might take you by surprise. Prepare your budget not only for the costs of your mortgage payments but also for costs unique to owning a home such as property taxes, interest, insurance, maintenance and upkeep, and appliances. The last thing you want is a neat, well-planned budget that blows up when you realize your new home doesn't come with a refrigerator.
2. Understand the Categories of Mortgages
First, you should know the major categories when it comes to getting a loan:
Conventional vs. Government Insured
A conventional loan is one that has been issued by a private lender, while a government insured loan is backed by one of the three major federal home loan programs. Almost all loans will be conventional mortgages, however if you feel that you qualify you should investigate the three major government home-loan programs:
The Department of Agriculture runs a program for rural housing. It is targeted at low-income individuals and only issues loans for houses outside of urban areas.
The Department of Veterans Affairs guarantees mortgages for military personnel and veterans. These are typically low-interest and come with zero down payment required.
The Federal Housing Administration runs a program that backs loans issued by private lenders. This can dramatically reduce your required down payment, although it also requires that you have mortgage insurance (which is distinct from property insurance). This is the most widely used government loan program.
Fixed Rate vs. Adjustable Rate
A fixed rate mortgage means that your interest rate never changes. This has the advantage of stability. Your mortgage payments will remain the same for the life of the loan.
An adjustable-rate mortgage means that your interest rate can change. Typically, this adjustment is made based on changes to the Federal Reserve interest rate along with other factors that reflect the current cost of credit.
As a general rule, an adjustable-rate mortgage starts with a lower interest rate than a fixed-rate mortgage. How the interest rate on the note changes over time can be unpredictable, though. An adjustable rate might be the cheaper option or it might push your payments higher over time.
You should make this choice based on how much flexibility you have in your budget. If you can afford higher payments in the event that your rates go up, an adjustable rate mortgage might be the right move. However, buyers who are close to their limit might be wise to take the certainty of a fixed-rate mortgage.
Jumbo vs. Conforming
Almost all mortgages are "conforming." This means that they meet the underwriting limits of Fannie Mae and Freddie Mac.
A jumbo mortgage is a mortgage which exceeds these underwriting limits, approximately $484,000 or $726,000 in high-cost areas such as New York City. A jumbo mortgage is used to buy particularly expensive houses and while it usually comes with competitive interest rates, the lender will also generally ask for a larger down payment. (That said, if the size of the down payment is a concern, you probably should not be taking out a jumbo mortgage.)
A balloon mortgage is generally a bad idea for the average home buyer. With a balloon mortgage you make low payments, typically either interest-only or even no payments at all, for a short period of time. At the end of the payment window you then pay the entire sum of the loan all at once.
These often look appealing because of their very low monthly payment schedule, but the balloon payment at the end can be ruinous, unless you only plan to stay in the home short-term.
3. Understand the Types of Mortgage Lenders
Next, familiarize yourself with the major types of lenders in the marketplace. Each makes a difference to your options when it comes time to choose a mortgage.
Not actually a lender, mortgage brokers help you to find a lender. They are paid on commission either by the borrower or the lending institution.
This is a depository institution that extends mortgage loans. Interest rates and mortgage terms here will typically be determined entirely by the state of the market.
You typically have to be a member to get a loan from a credit union, however if you qualify these tend to offer better rates than traditional banks. If you know that a mortgage is in your relatively near future it may be worth looking into membership at a local credit union.
These are dedicated mortgage firms. Unlike a depository institution they don't offer any other banking or lending services, just mortgages. They typically process an application more quickly than a retail bank would.
These come in several forms, such as correspondent lenders, retail lenders and hard-money lenders. All are a form of dedicated mortgage lending service.
Mutual Savings Banks and/or Savings and Loans
These tend to be small, locally-focused institutions. Don't count on them for jumbo loans, but their rates tend to be competitive since they can negotiate more directly with their customers.
4. Compare Interest Rates
Do not take the first mortgage you see.
You wouldn't buy the first car off the lot. Heck, you wouldn't even take the first piece of pizza someone showed you. Why accept the first 30-year, six-figure commitment someone offers?
Through the Nationwide Multistate Licensing System you can find a list of licensed mortgage lenders in your area. Shop around. Visit several different institutions and compare the offers that each one makes to you. It's important, and will give you some bargaining power as you decide on the terms of your agreement.
5. Get Competing Pre-approvals
At each institution you compare get your loan pre-approved. Through pre-approval an institution performs a credit check and runs your financial information then generates an actual potential offer. Pre-qualification or general research won't tell you the concrete terms on which the bank will lend you money. Pre-approval will.
The good news is that this will be relatively easy, if somewhat time consuming. The information you need to apply for this loan is consistent across lenders. It will typically include your and your spouse's:
• Social Security number;
• Bank account information (including savings, checking and investments);
• Current debts (including auto loans, student loans and credit cards);
• Two years of tax documents;
• Current salary and employer.
Gather that information and visit several different lenders. Start with your personal bank. This is a good place to begin and might well be the best place to get your loan, but don't end there.