Getting approved for a mortgage is probably the most important part of buying your new home. Most deals fall through because the buyer is not able to attain financing. The following is a list of essential things every homeowner should know before applying for a mortgage.
Retail banks = Higher rates, more fees.
One of the most common mistakes that homeowners make is applying for a mortgage with their local bank. Or worse, they call one of the “Big Banks”. If you do this, be prepared to pay at least .25% higher on your rate and 1% higher in closing costs. This might not sound like a lot, but on a $200,000 loan it is $2,000 more costs at closing and $10,000 more over the term of the loan!
So, how do you find the best deal? The lowest priced loans are available through wholesale mortgage lenders. These lenders have lower rates because they do not have the tremendous overhead of the large retail banks. You probably do not know their names since these lenders only work through brokers, but these companies offer the exact same loan products as the banks – Fannie Mae conventional & FHA mortgages. With wholesale lenders, you will receive the same type of loan but without the markup from retail banks.
Work with a professional from the start.
The most common complaint in the mortgage industry is regarding the amount of time it takes to close your loan and all of the annoying and cumbersome paperwork needed. The good news is most delays can be avoided by working with the right professional from the beginning. A good mortgage broker will review and underwrite your application before submitting anything to the lender. This way, any issues can be cleared up well before the closing.
The right broker will also be able to close your loan in 21 days or less by putting in the work with you upfront. Be prepared to provide a lot of documents in the first few days of your application, but getting it done right the first time will prevent any delays down the road.
Should you pay closing costs?
Mortgages with no closing costs have higher interest rates. This could be the best option if you only plan on owning the property for a short amount of time. But, more often than not it makes the most sense to get the lowest rate possible without paying points. This means that there will be several third party costs – title services, recording fees and appraisal fees are the most common.
Title fees will vary depending upon what state you live in and what your loan amount is. For a quick quote on the costs associated with title insurance, click here.
The recording fee is the charge paid to your local township/county to record the new deed and mortgage. It generally is $200-$400.
Appraisals usually cost about $450 which includes a local, independent appraisal company inspecting your home, reviewing recent comps and preparing a full report.
The only other cost associated with the loan is typically an origination fee due at closing. Most lenders will charge $750-$900.
What is the minimum down payment?
For conventional loans, the minimum down payment is 5.00 percent of the purchase price. For FHA loans, it is only 3.50 percent. Keep in mind, that if you are putting down less than 20 percent you will either have to pay private mortgage insurance (PMI) or you will need to work with a lender that offers lender paid mortgage insurance (LPMI). Mortgages with LPMI always have higher interest rates, so it is necessary to compare both options and figure out what makes the most sense.
The amount of PMI depends upon a number of different factors including your credit score, loan-to-value ratio and loan amount. The average monthly amount is $100-$200.
A down payment of 25 percent or more will attract the best interest rates and will have no PMI. For large loan amounts (over $417,000 in most areas) a 20 percent down payment is the minimum.
Should you lock in a 30 year fixed or shorter term?
Loans with longer terms (20-30 years) will have higher interest rates compared to shorter term loans (10-15 years). Although you are saving money on interest expense, your monthly payment will be higher with a shorter term loan since you are paying more towards principal every month.
For example, the principal and interest payment on a $200,000 loan will be about $1,000 per month with a 30 year fixed or about $1,400 with a 15 year loan.
You should also consider setting up bi-weekly payments which means paying half your mortgage every two weeks instead of one monthly payment. This results in more of your money going towards principal and less to interest since you will be paying a little extra each year.
What else should I watch out for?
- Prepayment penalties. In most circumstances, your loan should have no penalty for paying off early.
- Upfront/application fee. You should avoid paying a non-refundable upfront cost or application fee.
- Variable rates. With interest rates as low as they are today, it rarely makes sense to lock in anything other than a fixed rate. If you are 100 percent sure you will be selling the property in less than 5-7 years, a variable rate loan with a fixed upfront term might be a good option.
- Paying points. A lender fee higher than $1,000 usually means that points are included. This should be avoided unless you will be living in the home for a long period of time.
- APR. Always check the APR which is your interest rate plus lender fees and points. If the APR is much higher than the interest rate, the deal probably includes points or a large amount of fees that should be avoided.
- Interest only loans. These mortgages should only be used if the property is being sold or refinanced within a short period of time.