Like with all significant purchases, it makes sense to comparison shop when you get a mortgage although most borrowers typically do not take this potentially money-saving approach. In many cases a borrower may have a friend who is a lender or the borrower’s real estate agent may recommend a lender or the borrower uses the bank where he or she has a checking or savings account. When borrowers select lenders without comparing multiple mortgage proposals they could end up paying a higher mortgage rate or closing costs. Your friend, your real estate agent’s recommendation or your bank may be perfectly good lenders but it is important to understand that you have lender options when you get a mortgage. There are different types of lenders such as banks, mortgage brokers, mortgage bankers and credit unions and they are ALL competing for your mortgage business.
You should treat the mortgage process like you would any other major purchase, such as buying a car -- shop lenders, compare quotes and negotiate the best loan terms. We recommend that you compare proposals from at least five lenders, including one mortgage broker, to make sure that you are getting the loan with the lowest mortgage rate and closing costs. Reviewing at least five quotes ensures that you have a range of mortgage options and puts you in a stronger position when you negotiate terms. You can use lender competition to your advantage by negotiating a lower mortgage rate or reduced closing costs.
It takes extra time to compare lender proposals but spending an hour or two shopping for a mortgage can save you thousands of dollars over the life of your mortgage. For example, on a $300,000 30 year fixed rate mortgage, reducing your interest rate by just .125% saves you almost $8,000 in interest the course of the loan. You can use the lender table below to shop mortgage rates and fees for leading lenders in your area. Contact multiple lenders to find the best loan terms.
Your down payment also affects your mortgage rate. In order to receive the lowest rate for your mortgage, most lenders require you to make a minimum down payment of 20%. It is certainly possible to buy a home with a down payment of less than 20% but the lender will likely charge a higher interest rate or require you to pay private mortgage insurance (PMI), which is an additional monthly fee paid by the borrower. When you compare mortgage lenders ask them what minimum down payment is required to receive their lowest mortgage rate. If the answer is less than 20%, ask them what your rate would be if you made a down payment of 20% or more. Although it is not possible for all borrowers to make a down payment of 20%, you usually receive a lender’s lowest mortgage rate if you do.
If you are short of the 20% down payment requirement it may make sense to accept a gift from a relative so that you can put 20% down an benefit from the lower interest rate. It is important to highlight that any money that you receive for your down payment is truly a gift and not a loan. Additionally, lenders have very specific guidelines that you must follow when you use a gift to pay for part or all of your down payment so be sure to understand the exact steps your lender requires.
Another alternative for borrowers that lack the funds to make a 20% down payment is to take out a second mortgage, also known as a piggyback loan, to make up the difference. For example, if you are buying a home for $100,000 and only have $10,000 saved for a down payment you would get a first mortgage for $80,000 (80% loan-to-value (LTV) ratio) and a second mortgage for $10,000 as opposed to a single first mortgage for $90,000 (90% LTV).
Because the LTV of a single $90,000 first mortgage is 90%, the borrower is required to pay a higher interest rate or PMI. With a $80,000 first mortgage and $10,000 second mortgage, the LTV for the firs loan is 80% so the borrower pays a lower interest rate but is also required to make a monthly payment on the second loan. Depending on the interest rate on the second loan, getting two loans may enable the borrower to save money as compared paying a higher interest rate or PMI on a single first mortgage.
Having a high credit score enables you to receive the lowest mortgage rate from a lender. Lender credit score requirements vary but borrowers typically need to have a minimum score of 720 to receive a lender's lowest mortgage rate. We recommend that you review your credit report six months to a year before you start the mortgage process. This enables you to avoid negative surprises, potentially boost your score and receive the best interest rate when you apply for your mortgage
Understand The Credit Score Required for a Mortgage
Lenders offer borrowers the option to pay discount points to obtain a lower mortgage rate than they would otherwise receive. A discount point is an upfront fee that equals 1% of the loan amount. For example, for a $300,000 mortgage, one discount point costs the borrower $3,000. It is important to emphasize that paying discount points is completely optional for the borrower. In certain cases it may make sense to decide to pay discount points to lower your mortgage rate.
As a rule of thumb, paying one discount point should lower your mortgage rate by .250%. For example, if you receive a quote with a 4.000% mortgage rate plus one discount point, this equates to proposal with a 4.250% rate with no discount points. So if you decide to pay one discount point, you pay the lower mortgage rate of 4.000% as compared to 4.250% if you decide to pay no points.
You recover the cost of paying discount points over time through paying a lower monthly payment, because your mortgage rate is lower. Which highlights an important rule of thumb when you deciding if it you should pay discount points: paying points typically only makes financial sense if you intend to own the property you are financing for more than five years because that is a long enough period of time for you to be able to recover the up-front cost of paying the points. So if you plan to on own your home for more than five years, paying discount points is an effective way to reduce your mortgage rate.
Use ourDISCOUNT POINT MORTGAGE CALCULATORto compare loans with different points and interest rates
Your mortgage term, or the length of your loan in years, impacts your mortgage rate. The shorter the loan term, the lower your mortgage rate, and vice versa. So a 15 year loan has a lower interest rate than a 30 year loan. It is important to note that although you pay a lower mortgage rate with a shorter term you pay a higher monthly payment because you are paying off the loan over a shorter time period.
Additionally, paying a higher monthly payment means that you may qualify for a smaller loan amount than you would with a mortgage with a longer term. But if you are comfortable with a smaller loan amount and making a higher monthly payment, selecting a shorter loan term, such as 15 or 20 years, can lower your mortgage rate and reduce the total interest you pay over the life of the loan.
Although rates vary, you can reduce your mortgage rate by approximately a full percentage point if you select a 15 year mortgage as opposed to a 30 year mortgage. For example, if the mortgage rate on a 30 year loan is 4.000%, the rate on a 15 year loan would be approximately 3.0%. Using this example, with a $300,000 loan amount you save over $140,000 in interest expense over the life of the loan by lowering your mortgage rate and paying off the loan in 15 years instead of 30.
One creative way to approach mortgage length is to get a loan with a 30 year term but make the same payment that you would with a 15 year loan, so a higher payment than what is required. That way you maintain the flexibility of having a lower required payment that goes along with a longer mortgage term but you pay off the loan in 15 years and save thousands of dollars in interest expense.
The type of mortgage program you select also impacts your mortgage rate. Programs such as an adjustable rate mortgage (ARM) and interest only mortgage typically allow borrowers to pay a lower initial mortgage rate than they would pay on a fixed rate loan. A lower rate means a lower monthly payment, and in the case of an interest only mortgage, the monthly payment is also lower because the borrower pays only interest and not principal during the initial period of the loan.
Adjustable rate mortgages and interest only mortgages come with a catch though -- the borrower only pays the lower mortgage rate during the initial period of the loan, typically the first three, five, seven or ten years depending on what the borrower decides. Following this initial period, the rate is subject to change and potentially increase on an annual or semi-annual basis for the remainder of the loan (adjustable rate mortgages and interest only mortgages typically have 30 year terms). Depending on how interest rates change, borrowers may end up paying a higher interest rate over much of their loan with an ARM or interest only mortgage.
However, if you know you are going to sell your home or refinance your loan before the end of the adjustable rate period for an ARM or an interest only mortgage, they could be the right program for you. That way you benefit from the lower mortgage rate and monthly payment during the initial period of the loan but you are not exposed to a potential increase in rate and payment.
Determine What Mortgage Program Is Right for Me?
Some lenders may offer you a discounted mortgage rate if you have a bank or brokerage account with them. Large commercial banks such as Citibank, Wells Fargo and Chase or lenders with private banking operations are typically more likely to offer rate discounts to account holders. In some cases, to qualify for the discount you are required to have a minimum account balance when you apply for the mortgage. The minimum balance can be $5,000 or much greater depending on the lender. The amount of the rate discount can range from .125% to .500% or potentially higher and typically varies depending on your account balance. The more money you transfer to the lender or have in your account, the greater the discount.
When you contact lenders for mortgage quotes, be sure to ask them if they offer a mortgage rate discount if you open a bank or brokerage account or add funds to an existing account. It may make sense for you to open a new account or transfer money to an account with your existing bank to lower your rate. You can always close the account or withdraw your money in the future but you benefit from paying a reduced rate for the entirety of your loan. In almost all cases, you continue to receive the discounted rate even if you withdraw money from or close the account after your loan closes, although there may be a six month waiting period before you can close the account.
“Comparing loan offers.” CFPB. Consumer Financial Protection Bureau, 2017. Web.