Things to consider in lining up a mortgage
Inflation fears have sent interest rates on home loans soaring and borrowers with adjustable-rate mortgages scurrying to refinance.
The challenge is finding an affordable loan.
Just as rates have risen, home prices have declined and credit standards have been tightened, making it difficult for anyone but borrowers with pristine credit histories to get a reasonable rate, experts say.
How should individuals seeking to buy a home -- or refinance one -- negotiate today’s mortgage market?
Here’s a step-by-step guide.
Step 1:
Check your credit
Although loan rates differ by lender, loan size, state and the borrower’s equity in the home, almost all lenders offer different rates for different risks. Even relatively small change in a credit score can make a considerable difference in the rate a borrower pays, said Jeff Lazerson, president of mortgage shopping website MortgageGrader.com.
On Tuesday, for instance, rates on 30-year fixed-rate mortgages ranged from 6.38% for a borrower with perfect credit to more than 7.25% for a borrower with substandard credit, Lazerson said.
A borrower with a pretty good but not great credit score could have gotten a loan with a rate of 6.5% to 6.75% that day. All the rates assumed that the borrower would pay one point -- 1% of the amount being borrowed -- as an upfront fee.
The differences in those rates can add up to thousands of dollars over the life of a loan. For example, a borrower who got the 6.5% rate would pay $14,873 less over 30 years than someone who got the 6.75% rate would pay.
It’s often easy to goose your credit score by a few dozen points, ensuring a better rate, Lazerson said. Sometimes all it takes is paying off a credit card balance or two, correcting errors in your credit report and ensuring that you have no outstanding late payments.
Lazerson suggests that borrowers get their scores and credit reports from their lenders or mortgage brokers. If your credit score is over 700, most lenders are likely to offer you their best rates, he said. But if you have a score in the mid-600 range, it might make sense to pay for credit advice, he said.
Mortgage Grader offers a “credit analyzer” service for about $20 that can tell borrowers how much their scores might change if they made a few adjustments.
Step 2:
Create a budget
With foreclosure rates rising, it’s increasingly clear that many borrowers failed to figure out how much in housing costs they could afford before signing on the dotted line.
It’s not just the mortgage payment -- and certainly not just the initial payment with an adjustable-rate mortgage. Home buyers also need to consider property taxes, insurance, home maintenance, repairs and utilities.
“The cost of home ownership goes far beyond the principal and interest mortgage payment every month,” said Greg McBride, a financial analyst with BankRate.com. “You have to account for a laundry list of expenses.”
Property taxes are likely to amount to between 1% and 1.5% of your home’s value each year. In other words, you’d need at least $2,500 for a $250,000 home.
Figure on adding $500 for property insurance, in this case, and another $500 for repairs. The bigger the yard, the more you should budget for water bills and a gardener. The list goes on.
If you are a first-time buyer, ask a homeowner -- preferably a close friend or family member -- if they would be willing to tell you the monthly cost of all these extras. Your costs will vary, of course, but at least this can give you a good idea of all the categories of expenses that you should consider.
Add those expenses to the monthly payment on the mortgage you’re looking at to see whether you can really afford it.
And if you’re considering an adjustable-rate mortgage, make sure you calculate what the payment is likely to be after the first adjustment and what it would be at the loan’s maximum interest rate.
Adjustable loans typically can boost their rates by as much as 2 percentage points per year -- more for some types of loans, such as so-called option ARMs. In fact, it is best to calculate, for each year over the loan’s term, the worst-case scenario -- the highest your monthly payment can go. If the resulting numbers make you queasy about your ability to make the payments, don’t get the loan.
Remember, if you can’t make the payments, you lose the roof over your head. That’s an asset that’s too important to gamble away.
Step 3:
Pick a loan type
There are dozens of different types of loans, from the safe and simple 30-year fixed-rate to the flexible but complex “option” adjustable-rate mortgage.
The best choice will depend on market conditions and your personal preferences.
Right now, many experts recommend sticking with fixed-rate loans. That’s because they’re safe and they’re currently not much more expensive than the riskier offerings.
For instance, at BankRate.com a 30-year fixed-rate mortgage was going for 6.84% on Thursday, while a so-called 5/1 adjustable --in which the interest rate is fixed for five years and then adjusts once a year after that -- was quoted at 6.67% -- just 0.17 of a percentage point less.
McBride says it’s hard to argue that the 0.17 percentage point break is worth losing the security of having your payment stay the same for an additional 25 years.
There are other options to consider, however. For instance, for an interest rate about a quarter-point higher than the rate you would get on a traditional fixed-rate loan, you can get a 30-year fixed-rate loan that offers the option of paying interest only in the first 10 years, saving you hundreds of dollars a month, McBride said.
But because you aren’t paying any principal during those first 10 years, your payments will be higher, possibly substantially, in the final 20 years of the loan. But the trade-off can be worth it for people who know that their income will increase substantially over that time -- or that they are unlikely to stay in the house for more than 10 years.
Step 4:
Compare offers
Spend whatever time is necessary to get offers from several lenders, then figure out all the costs of each mortgage you’re considering -- rates, points and fees, McBride said. Your lender or mortgage broker should be willing to help with the math.
“You can’t just use the payment as the deciding factor,” said Brian Wendt, vice president of marketing for First City Bancorp in Campbell, Calif.
“You shouldn’t have to scrutinize your loan documents, but you can definitely ask your loan agent to point out the key terms. Say, ‘Show me where it says there’s no prepayment penalty.’ ”
For each offer you get, look at:
* The interest rate.
* The annual percentage rate, which includes other financing fees, such as points.
* The frequency and maximum size of rate changes, if it’s an adjustable loan.
* Whether there is a prepayment penalty -- a fee you must pay if you want to pay off the loan early. If there is one, how much is the fee and how long does it last? (Typically, these fees apply only if the loan is repaid less than five years after it was taken out.)
* Whether the interest rate offered is “locked” and, if so, for how long. A rate lock gives you a guarantee that your interest rate is not going to rise while you wait for loan approval and funding.
Make sure that you get these details in writing. The lender should be willing to give the loan approval, the rate lock and a “good faith estimate” of your closing costs in writing. If not, keep looking. Unwillingness to provide that information can be a sign of a dishonest broker, Lazerson said.
“A real problem for consumers is that some mortgage brokers don’t honor what they quoted,” he said. “If you are being truthful and honest about it, you should not be concerned about putting it in writing. If they issue you a rate lock letter and a loan approval and a good faith estimate, they are not getting out of that deal.”
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The power of the credit score
Interest rates -- and resulting payments -- available last Tuesday on a $250,000, 30-year fixed-rate mortgage, based on the borrower’s credit score.
*--* Monthly Total payments Credit score Interest rate payment over 30 years 720 6.38% $1,560 $561,486 660 6.5 1,580 568,861 620 6.75 1,622 583,734 Below 620 7.25 and up* 1,705 613,959
*--*
*Prepayment penalty required.
Source: MortgageGrader.com
