Most people will need a mortgage to buy a home. That means that not only do you need to shop for a home, you need to shop for a home loan. But a survey of 2013 borrowers by the U.S. Consumer Financial Protection Bureau found that almost half of borrowers didn’t shop around before settling on a mortgage.
They should. In fact, you may find more loans to choose from than you do houses.
“Definitely shop around,” says Valentin Saportas, CEO and co-founder of MortgageHippo, a Chicago-based online mortgage application service that links buyers with mortgage brokers. “Don’t just go with the first option that you get. Being able to save even a little bit of money in your monthly payment definitely adds up.”
You should start looking for a mortgage professional before searching for a house. You want to make sure your credit is in order because mistakes can take months to correct. You also want to know how much house you can afford. You can run calculations online, but a good mortgage professional will better help you determine which loan is the best fit for you.
Whether you’ll get the best deal from going directly to a bank, a mortgage lender or a mortgage broker often depends on your situation, the mortgage pro handling your case and what’s being offered at the time. That means talking to actual people on the phone or in person, not just filling out an online form.
“There’s way too many variables in mortgage lending today to automate or streamline,” says Casey Fleming, author of “The Loan Guide: How to Get the Best Possible Mortgage” and a mortgage broker in the San Francisco Bay Area. “The online piece is nothing but a lead generation tool, and they hand it off to a real mortgage lender. The money comes from the exact same place, and the same people are involved.”
You can buy a home with as little as 3 percent down – and nothing down if you’re a veteran. But if you put less than 20 percent down, you’ll need private mortgage insurance (or the Federal Housing Administration equivalent) in most cases, which can add roughly $100 to a monthly payment on a $100,000 home.
To find a mortgage professional, start by asking friends, colleagues, relatives and your real estate agent. You might also ask any finance professionals you work with, such as accountants or financial advisors. If you’re a member of a credit union, ask there. Some credit unions and local banks do their own mortgage lending and others contract with brokers. Call the banks where you have accounts.
In general, banks have the fewest options available because they offer only their own products, but they may be more flexible if they’re lending their own money – and they may make a deal if you have substantial assets. “You could get a really good offer, but you have to dangle the assets,” Fleming says.
Mortgage brokers offer the largest number of options, since they can shop your loan among many lenders. “If your loan can be done, a broker can find a place to do it,” Fleming says. “My opinion is to go to a really honest broker. Without doubt, they are going to have access to better pricing than anyone else.”
While the rates and fees offered by lenders are usually comparable, lenders that see a slowdown in business may offer better pricing, and a good broker will grab those deals.
How Big a Down Payment Do You Really Need?
Financial experts disagree over how much money you need for a down payment. While 20 percent is often considered a rule of thumb, you can buy a house with as little as 3.5 percent down with a Federal Housing Administration mortgage, 3 to 5 percent with a conventional mortgage or nothing down with a VA loan available to military veterans.
But the less you pay down, the bigger your monthly payment will be. Plus, if our down payment is less than 20 percent of the purchase price, you’ll have to pay private mortgage insurance or the FHA equivalent, known as mortgage insurance premium.
The PMI can add about $92 a month, for example, to $475 principal and interest payments on a $96,500 loan to buy a $100,000 house. With 20 percent down, the principal and interest payment on that house is only $373 a month, at 4.25 percent. FHA mortgages also require an upfront MIP payment equal to 1.75 percent of the purchase price.
You may also get a lower interest rate with a higher down payment. “The less you put down, the more expensive the mortgage insurance is and the higher the interest rate,” Fleming says.
What to Know Before You Get Your First Mortgage
Get a copy of your credit report. The free credit report you can get annually, while it helps you identify problems, won’t show you the same credit score your mortgage officer will see. “The score is invariably higher than what you get when someone in the mortgage company runs it,” Fleming said.
Meet with a mortgage officer before looking at homes. This will help you determine whether you have credit problems that need to be solved first. It will also let you know how much house you can afford before you begin your search.
Pay off as much debt as you can first. This will help keep what’s known as your debt-to-income ratio down. Lenders look at your income and all your debts – student loans, car payments, credit card debt – to determine how much you can afford to borrow. If your total debt, with the new house payment, would be more than 43 percent of your income, you’re unlikely to get the loan. Some lenders may want a lower ratio.
Develop good credit habits way before you plan to buy. Missing payments on student loans or habitually paying your bills late will lower your credit score and make borrowing for a home impossible or more expensive. Once a bill goes into collections, it can take months or years to recover from the damage.
Consider consolidating or refinancing student loans. If you can’t pay off student loans before you buy a home, investigate whether you can lower your payments. You’ll have to decide whether it makes sense to stretch student loan payments over more years to buy a home sooner.
Show a solid work history. If you’ve just finished graduate school in engineering and gotten your first engineering job, a lender may not care that you don’t have two years of work history. But if you’ve just left graduate school and gone to work at Starbucks, you’ll have a hard time getting a mortgage until you’ve had that job for two years. That goes for part-time jobs, too. However, taking a part-time job on the side and using the money to pay down debt or add to your cash reserves may be helpful even if the lender isn’t willing to consider that income.
Be prepared to document everything. You’ll need tax returns, bank statements, brokerage statements and documents to verify the source of any money you plan to use. The lender will also verify your employment and income, once at the beginning of the process and again a day or two before closing.
Don’t buy anything on credit or apply for any credit while your loan is pending. You may be tempted to buy new furniture for your new home and put it on a credit card. Or, perhaps you realize you’ll have enough cash left for a down payment on a new car. “Once we start this process, don’t spend a dime that you don’t have, don’t put anything on credit cards, don’t apply for any credit,” Fleming warns. Otherwise, you may jeopardize the deal.
Make sure you have enough cash to cover all your costs. In addition to closing costs charged by the lender and the closing agent, you’ll need to pay for a home inspection, an appraisal, a survey and city, county or state transfer taxes. Not only that, most lenders ask for at least a year’s worth of homeowners insurance and property taxes upfront.
If you’re self-employed, prepare to jump through more hoops. People who own small businesses often can’t qualify for a mortgage until they’ve been in business two years, though exceptions are likely for professionals, such as doctors, who leave a staff position and become self-employed in the same field. Most self-employed professionals write off enough expenses on their taxes to make their adjusted gross income much lower than their actual income. The lender will consider that lower number your income.
The house may also have to qualify. If you’re getting an FHA mortgage, the house has to meet certain standards. Lenders may also set standards for home conditions for conventional mortgages. Plus, the house has to be insurable.
How to Get the Best Deal on a Mortgage
Compare apples to apples. When you get quotes from companies, don’t look at just the interest rate. Look at the rate and all the fees, including points, origination fees and any other fees charged by the lender. A “no-fee” loan just means the fees are included in the rates.
Ask to see the Good Faith Estimate worksheet, not just the GFE. Many people consider the current Good Faith Estimate, required by law, to be confusing, and it is being replaced August 1 with what consumer advocates hope will be a more useful document. Until then, ask for the complete worksheet, and make sure it itemizes all the fees.
Interview the actual person who will handle your loan. That could be a mortgage broker, a bank employee or a loan officer. Ask about experience and qualifications. Is the person licensed (required for brokers but not bank employees)? Does he or she belong to the National Association of Mortgage Professionals or your state’s mortgage professional association? Ask for references and look at reviews online. “The company does not matter as much as the originator,” Fleming says. “Even good companies hire really bad people.”
Plan for costs that are not charged by the lender. Additional costs include title insurance, real estate transfer taxes and required escrows for property taxes and homeowner insurance. In some states, shopping for closing agents can save several thousand dollars, while escrow or closing costs are minimal in other states.
Make sure the lender offers the program that is best for you. Not all lenders offer FHA, VA or USDA Rural Development loans. Down payment requirements, loan-to-value ratios and credit requirements also vary by lender.
Get your free credit report before you start. This will not allow you to put your feet up on the desk and demand the best terms, as one commercial suggests, but it will let you know where you stand. “Just because you have a 700 credit score doesn’t put the ball in your court,” says Donald Frommeyer, chief executive officer of the National Association of Mortgage Professionals and a loan originator at American Midwest Bank in Indianapolis.
Give the loan officer all details about your situation when asking for quotes. People who are self-employed, have suffered a foreclosure or recently changed careers especially need a good loan officer. “One of the toughest things for me is to tell a customer, ‘Hey, I really can’t help you,’ but I always have a potential solution,” Frommeyer says. “I don’t like to pull credit on somebody until I talk to them about what I can do.”
Ask about what documents will be required. All mortgages require significantly more documentation these days. Find out what’s required, and be prepared to provide it.
Know who you’re dealing with when you fill out an online form asking for rates. Will you get phone calls from mortgage brokers trying to gain your business? Will you get quotes online or via email? Most online forms require you to provide significant personal information before giving you quotes (and no one can provide an accurate quote without knowing your credit store). Will the service pull your credit once you fill in the form or wait until after you have talked to someone? Several automated systems we tried rejected our freelance writer with good credit with no explanation, while a human broker would likely have suggested making a larger down payment or choosing a less expensive home.