Hopeful homebuyers see their hopes turn to reality when they receive their first mortgage loan approval. Although it's often difficult for them not to grab the dangling carrot that's just within reach, borrowers stand to miss out on potential savings if they pounce too soon and accept their first offer without obtaining the best mortgage their money can buy. The "best mortgage" may mean the best mortgage product, the best mortgage rate, or both.
If you're a first-time homebuyer, shopping for a mortgage may feel like a daunting undertaking, but typically, it only involves the investment of your time to do a little research, gather some paperwork, and communicate with mortgage lenders. It's up to the mortgage lenders to provide the lending details. When you have these details, you'll only need to compare the different offers before making your final decision and choosing the best mortgage for you.
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Potential Savings When Shopping Mortgages
We're not talking pennies here. An April 2018 report by Freddie Mac noted that prospective homeowners saved an average of $1,500 in interest over the term of their mortgage loan simply by getting a quote from a second lender. The average interest savings doubled to $3,000 over the life of the loan when borrowers got five quotes. These dollar amounts represent only the potential savings from interest rates. Diligent comparison shoppers may also realize additional savings when they shop for the best mortgage terms and fees in addition to finding the best mortgage interest rate.
Closing costs, mortgage origination fees, and points (fees buyers pay to lower the interest of the mortgage) are only some of the fees that can increase a mortgage beyond its actual loan amount. Because these costs vary depending on factors such as mortgage products, mortgage lenders, and the financial health of buyers, comparison shopping can help you find the best mortgage with the lowest costs.
How the Mortgage Process Works
Even though each mortgage uniquely fits each borrower's needs, the basic process from loan application to loan closing follows a similar route:
- A borrower will have to complete a loan application, but a mortgage lender also asks for copies of documents, which may include verification of employment, verification of income, copies of W-2s (or 1099s if you're self-employed), and/or tax returns and recent bank statements. The lender will also pull a copy of the borrower's credit report.
- Based on the application and any required supporting documents, a mortgage lender may issue a preliminary approval (or preapproval) subject to underwriting guidelines and verification of the documents.
- The underwriter returns an approval, a denial, or a conditional approval. A conditional approval means that the borrower must meet certain qualifying conditions before the loan can be approved, such as clearing up a blemish on a credit report or providing more paperwork. You should note that even if one lender doesn't approve a mortgage, it doesn't mean that other lenders will follow suit.
Different Lenders in the Mortgage Industry
Before you begin shopping for a mortgage, it's helpful to identify potential lenders on the playing field. Although you may be more comfortable working with the loan officer at the bank that services your checking and/or savings accounts because of your existing relationship, this may not be the lender that can offer you the best mortgage. Without eliminating your bank or savings and loan as a prospect, cast a wider net by considering other options, such as credit unions, mortgage companies, online lenders, and mortgage brokers.
Mortgage brokers are not actually mortgage lenders, but they facilitate transactions between borrowers and lenders. A motivated mortgage broker, particularly if under contract with you, will do a lot of the legwork for you because brokers work with multiple lenders. The Federal Trade Commission (FTC) notes that you may not know if you're dealing with a lender or broker unless you ask because a financial institution may perform services as a lender and a broker. Don't hesitate to ask this question because you'll want to know how a broker is compensated, which may be separate from the lender's fees.
How to Start Mortgage Shopping
Once you've made a list of potential mortgage lenders, you can fine-tune your choices by asking for referrals. Although family and friends may have solid advice for you based on their own experiences, temper their recommendations by realizing that your circumstances are likely different from theirs. Your financial health may be on a different level — whether better or worse than theirs — and the mortgage product that was best suited to them, which may have been their lender's specialty, may not be the best for you.
Seasoned real estate agents often have the best referrals for mortgage lenders, so be sure to choose your agent wisely. Check out lending websites to research which mortgage products (different packages of loans, essentially) and rates each lender offers and use an online rate comparison tool to shop multiple lenders at once. Bankrate, for example, has an online tool that lists the current day's interest rates for specific mortgage products available from multiple lenders based on information you enter, including your zip code, credit score, and the type of mortgage you want.
Qualifying for a Home Loan
To qualify for a mortgage, you'll have to jump through considerably more hoops than if you're qualifying for other types of consumer loans, primarily because of the higher price tag of most houses compared to the dollar amount of other financed items. When you're shopping different mortgage lenders to find the best mortgage, you'll go through a similar process with each prospective lender. Each lender will pay particular attention to the items on your credit report, your credit score and your debt-to-income ratio (DTI).
Your DTI is important because it compares your outstanding debts against your income, which helps lenders determine how much mortgage you can afford. A benefit of shopping for a mortgage is that you'll find that each lender may calculate DTI a little differently, and each lender has different requirements for DTI limits for each mortgage product.
To get an idea of your DTI, use an online calculator, such as the one by Zillow. As a rule of thumb, most lenders look for a DTI that's 36 percent or lower. For some loans, however, borrowers with high credit scores and acceptable assets may be approved for a mortgage with a DTI of 50 percent.
Likewise, lenders have different acceptable thresholds for the credit score required for a mortgage, and each of their mortgage products may also have different credit score requirements, which is another reason to shop around. Credit scores are another indication of the financial health of a borrower. Most lenders regard credit scores from 620 to 640 as the minimum to qualify for a conventional mortgage. However, scores as low as 500 may allow some borrowers to qualify for a Federal Housing Administration, or FHA loan, and a minimum score of 580 may be accepted from qualified borrowers for VA loans.
Shopping Can Minimize Mortgage Costs
Although you'll certainly want to find the lowest interest rate possible for your mortgage loan amount, the principal and interest monthly payments you'll be making represent only part of the total costs of purchasing a home. The additional costs vary among lenders, so it pays to shop around and compare these costs to make an informed decision about the best mortgage for you.
Earnest money (or a small percentage you put down to show the seller that you're serious about buying) parameters vary in amount and refundable terms depending on your lender. Know each lender's requirements, particularly the terms under which your earnest money can be refunded. You may want to improve the interest rate by buying discount points — cash you pay up front to lower your interest rate. If you're planning to live in your new home for quite a while — about 10 years or more — you may want to buy discount points. If not, your cash may be better spent or saved elsewhere.
Origination fees, private mortgage insurance (PMI), and closing costs are some other expenses that can add thousands of dollars to your mortgage costs. When these costs and fees are rolled into your mortgage, this means that you'll also pay interest on them for the life of the loan.
Shopping Mortgage Interest Rates
After shopping for different mortgage lenders, taking a good look at your financial health and perhaps even consulting with your tax attorney or accountant, you'll decide whether a fixed-rate or adjustable-rate mortgage is best for you. One benefit of a fixed-rate mortgage is that your payments will remain the same for the life of the loan. With an adjustable-rate mortgage, your payments will periodically adjust because of changes in interest rates, but the benefit is that your initial monthly payments are generally lower (because of a lower interest rate) than future payments, which may carry a higher interest rate.
The annual percentage rate (APR) gives a more comprehensive picture of the cost of your mortgage. The APR represents the total annual mortgage cost including all the costs and fees, represented by a percentage of the total amount you borrow.
Even a fraction of a percentage difference in interest rates can significantly increase the total amount you repay for your mortgage. For example, if you borrow $200,000 with a 30-year fixed-rate mortgage at 4.25 percent interest, your interest charges over the life of the loan total $154,197. However, if you shop different lenders for the same mortgage product, you may be able to get an interest rate of 3.5 percent, which translates to $123,312 in total interest charges — a savings of $30,885.
Negotiating a Mortgage
When you shop around for potential mortgage lenders, you'll receive a loan estimate (LE), which is a document that each lender is legally obligated to give you if you submit an application. With these documents in hand, you'll be better equipped to make an informed decision about the best mortgage for you. You can also use your LEs as a negotiating tool with competing lenders. For example, Lender A may reduce certain fees or pare down the interest rate to court your business away from Lender B.
Once you've chosen the lender you want based on rate quotes and other loan details, get it in writing. You can request a lock in (also called a rate lock), which not only guarantees a certain interest rate but also guarantees the lock-in period. You may pay a fee for locking in the rate, but you may be able to negotiate to have the fee refunded at closing.