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How to shop for home loans
For many years, a fundamental element of the American dream has been homeownership. For 63% of Americans, the dream of homeownership has come true. However, only 29% own their homes free and clear (source). The rest have home loans or mortgages. This guide provides a detailed discussion of everything you need to know about purchasing a home with a mortgage.
The vast majority of people who purchase a home cannot afford to pay the entire purchase price upfront. They have to take out a loan to help them pay for the home. This loan, which is secured by the property, is called a home loan, a mortgage loan, or a home purchase mortgage.
What types of home loans are available, and which is right for me?
Home buyers today have many types of home loans from which to choose. Let’s look at the types of home loans most widely known and commonly used today.
Fixed-rate home loans
With a fixed-rate loan your interest rate remains the same throughout your loan term. Your mortgage balance is split into equal payments made each month for a term of 10, 15, 20, or 30 years. Fixed-rate home loans that follows established guidelines for a given loan size and borrower type are called conventional (fixed-rate) mortgages.
Is a conventional (fixed-rate) mortgage right for me?
Do you have a credit score of 620 or higher, and a healthy savings that will allow you to afford a generous down payment? And is your debt-to-income ratio lower than 50%? If so, a conventional (fixed-rate) mortgage may be the right choice for you.
This type of mortgage is issued by a private lender and not insured by the federal government. Because it has a fixed interest rate, your monthly payments will remain the same throughout the lifespan of the loan.
This mortgage type is an especially good option if you are able to afford to make a 20% down payment. If you can’t, you’ll have to pay private mortgage insurance (PMI) every month, adding to the total cost of the loan.
Adjustable-rate home loans
With adjustable-rate home loans, your interest rate can change several times during the life of the loan. Under the broad heading of adjustable-rate home loans, you may find hybrid home loans, which begin with a fixed interest rate for a certain number of years, then change to an adjustable rate after that initial period is over. In such home loans, there is a cap on how much the interest rate can change from adjustment to adjustment and over the life of the loan.
For instance, suppose you have a 5-year adjustable rate mortgage (ARM) with an initial interest rate of 4.75%, a cap of 1% per year thereafter, and a cap of 5% over the life of the loan. That would mean that, for the first five years of your loan, your interest rate would be 4.75%. Then, each year after that, your rate could change by as much as 1%, but it could not increase past the upper limit of 9.75% (4.75% initial rate + 5% cap).
Interest rates on adjustable-rate home loans can adjust either up or down, often depending on the behavior of an independent financial index, such as the prime rate established by the Federal Reserve, or on some similar standard, such as one-, three-, or five-year Treasury securities.
Is an ARM right for me?
Are you looking to save more money overall, but you still have a healthy savings to fall back on if market rates surge upward? If so, this type of home loan could be right for you.
If you do pursue an ARM, look for one that has a cap on the interest rate. Otherwise, you may find yourself with a mortgage you can’t afford.
FHA home loans
FHA loans are home loans insured by the federal government through mortgage insurance paid for by the loan. They do not require as much down payment as some other types of home loans and are more lenient regarding credit scores. This makes them an attractive option for many home buyers.
Is an FHA mortgage loan right for me?
Are you unable to afford a large down payment, and do you have less-than-stellar credit? If so, an FHA loan may be for you.
If you have a credit score of 580 or higher, you can get an FHA loan with a down payment as low as 3.5%. But you can still qualify for a loan with a credit score of 500 or higher — you’ll just have to pay at least 10% down.
VA home loans
VA home loans are guaranteed by the Department of Veterans Affairs and are available to military veterans and their spouses. They do not require a down payment and are quite popular among military families.
Is a VA mortgage loan right for me?
If you are (or once were) a member of the U.S. military, you should definitely investigate VA loans. They are flexible, charge very low interest rates, require neither a down payment nor PMI, and often comp your closing costs.
USDA RHS home loans
Rural borrowers who meet certain program requirements are eligible for home loans provided through the U.S. Department of Agriculture (USDA) and managed by the Rural Housing Service (RHS).
Is a USDA mortgage loan right for me?
If you make a low-to-moderate salary and live in a rural area, a USDA RHS home loan may be right for you. These loans are fairly low-cost. And they often do not require any down payment at all. However, you must live in an eligible area to qualify.
How do you apply and get approved for a mortgage?
There are a number of things you need to do before filling out a mortgage application. A good first step is to get a copy of your credit report. You should check your credit report to ensure that everything on it is correct and that your credit score is acceptable.
The higher your credit score, the more likely it is that you will be able to get a mortgage loan with a favorable interest rate. This is important because you will be paying interest on a large sum of money over a long period. Just a small difference in your interest rate can amount to thousands of dollars over the course of a mortgage loan. If there are problems on your credit report, you should address them before you apply for a home purchase mortgage.
Once your credit score is in order, you will need to gather documentation for your lender, including items like W2s and recent check stubs to help verify your income. You will also need your social security card and your driver’s license or other photo identification. Some lenders may require additional documentation, such as utility bills, phone bills, and tax returns.
The mortgage application
The actual application for a mortgage loan is usually quite simple. Your lender will provide you with a standardized form to fill out. Once you’ve submitted the completed form and all required documentation, your lender will pull a credit report from one or more of the credit bureaus.
When everything on the application is verified and documented, the lender will send the application and documentation (the “loan package”) to an underwriter. Underwriters determine if you are an acceptable risk based on the loan amount you want to borrow and your current debt-to-income ratio. At this point, the underwriter decides what other documentation may be needed to continue the process.
How much can you afford?
Lenders decide how much you can afford to borrow based on how much you will able to repay each month. They determine how much you’ll be able to repay per month by reviewing your current income, current debt, available cash, and credit history. As a general rule, lenders prefer that borrowers keep the total of all their monthly payments below 28% to 44% of their income.
To get an idea of what you can realistically afford, you can look at your budget, figure out how much money is left over after your current bills are paid, and see what amount you have available for a house payment. Remember to figure in items like home maintenance, property taxes, and homeowner’s insurance. If you want to get a ballpark figure for how much you can afford, there are free online mortgage calculators that you can use, unless you prefer to calculate it yourself. Learn more about mortgages and mortgage rates by reading our mortgage guide.
How are mortgage rates calculated?
Several variables come into play for lenders as they calculate mortgage rates. First, lenders start with a base rate that is largely determined by market conditions. So you have no control over this base rate.
However, the other factors involved are somewhat under your control. Some of these factors are:
- The type of loan for which you apply (either fixed or adjustable rate).
- The type of home you choose (single or multi-family dwelling).
- The term of your loan (10, 15, 20, or 30 years).
- Credit score.
- Down payment amount.
- Your loan-to-value ratio, which is your loan amount divided by the value of your property.
Each of these variables plays a part in the final loan terms you are offered. For instance, if your credit score is excellent, you will likely get a lower interest rate. Similarly, the lower your loan-to-value ratio, the better your rate will be.
What will your monthly payments be?
Your monthly payments will consist of several different components. This is a brief review of the main elements of your monthly home loan payment.
Principal and interest on the loan
Your principal is the amount you borrowed from your lender. Each month, a portion of your payment will be applied to your principal balance. The interest is the money you have agreed to pay the lender for the loan. Each month, a portion of your payment will be applied to your interest amount.
When you own a home, you must pay the municipality where you live property taxes for that home. Your lender may require that a portion of your payment every month include a percentage of the annual property tax due. This money will be held in escrow by your lender. Then, when your property tax bill is due, the lender will pay the appropriate municipality the tax that is owed.
This insurance protects your home and belongings from damage or theft. The home insurance premium payment may be a part of your monthly home loan payment, although some lenders let you pay this yourself. You will need to check to see what your lender allows.
Private mortgage insurance
Private mortgage insurance (PMI) is required by some lenders when you have less than 20% equity in your home. The best way to avoid PMI is to have a down payment of 20% or greater on your home when you purchase it. If that is not doable, you will need to pay PMI until you own 20% of your house.
All of these items together will make up your monthly mortgage payment. Online mortgage calculators can give you a general idea of what your payment might be, but your lender can give you an exact figure once the terms of the loan have been set.
What do you need to know about mortgage rates?
Mortgage rates can vary a lot from lender to lender. They can also vary a lot with the same lender, based on factors like your credit score, the loan terms you are looking for, and the type of loan you choose.
Your mortgage rate matters because a 1% difference in mortgage rates translates into at least a 10% difference in the monthly mortgage payment, as industry experts have noted for some time.
If you’r surprised that such a tiny difference in interest rate produces such a large change in monthly payments, just keep in mind that compound interest always produces larger long-term effects than you might guess without doing some calculations. Compound mortgage interest is no exception, as one mortgage lender has explained.
You can readily confirm this rule by running some numbers in, for instance, an online mortgage calculator.
The bottom line on rates: it definitely pays to shop around for the best you can get.
How can you find the lowest home loans rates?
The single most important factor under your control when shopping for a good mortgage rate is maintaining a good credit score. If you have credit card debt, consider paying it down substantially before applying for a home loan.
If your credit is in tip-top shape, take the time to explore all your options to find the best mortgage rates.
Finding a mortgage lender you can work with early in the process will help you get a good mortgage rate. A knowledgeable lender can walk you through the process and provide education about options you may not have considered. It is a good idea to talk with several mortgage lenders to compare the options they present.
Family and friends may be able to steer you in the right direction with referrals to a good lender. Or you may choose to work with a mortgage broker. A broker will find a lender for you and help you navigate the process.
Can you get a mortgage if you have bad credit?
It is possible to get a mortgage loan even if you have bad credit. However, there are some factors to consider first. For instance, if you have reason to believe that your credit scores will improve in the next few months or years, you might want to consider waiting to purchase a home until the scores go up.
Remember that a poor credit score typically translates into higher interest rates on any loan you get. In the case of a mortgage loan, that higher interest rate will apply for the entire term of the loan, even if it is 30 years. When you consider it that way, you might decide it is best to work on improving your credit score before you apply for a home loan.
If you cannot wait, however, there are some things you can do to find a loan. First, you might consider working with a broker. Though there are fees involved, a mortgage broker may be able to find you a better deal than you can find on your own.
You can also increase the chances of getting a mortgage loan by providing a hefty down payment. The larger your down payment, the more likely it is that your lender will look favorably on your application.
If you are working directly with a lender, you might consider explaining why your credit score is low. Some lenders view events like the loss of a job or a divorce less harshly than they view irresponsible spending.
Additionally, if you can prove that you have paid your rent on time for 12 consecutive months, lenders may look more favorably on your loan application.
What is the difference between a mortgage lender and a mortgage broker?
Mortgage lenders are direct lenders. They sell their own financial products and have their staff review your mortgage application. Once you buy a loan, the institution will typically sell your loan on the secondary mortgage market. Direct lenders are regulated by state and federal agencies.
Here are the pros and cons of working directly with a mortgage lender.
- One-stop shopping experience. You get to deal directly with the lender.
- Cutting out the middleman can save you money.
- Direct lenders can process a loan faster than when two or more companies are involved.
- Limited choice of financial products
- You’re out of luck if you don’t meet their eligibility criteria
Mortgage brokers work with multiple mortgage lenders and usually offer a wide selection of mortgage products. They operate independently and must also be licensed. Mortgage brokers make money by charging a fee for their services, which is paid by either the mortgage lender or the borrower. The fee is usually 1% to 2% of the loan amount.
Here are the pros and cons of working with a mortgage broker.
- Wide selection of mortgage programs and lenders. A mortgage broker has more flexibility when looking for a mortgage product that is a good fit for you.
- Mortgage brokers can direct you to the lender that is most likely to approve your loan application.
- You spend less time shopping around for a loan.
- A broker may be able to find a loan with lower rates and more favorable terms.
- You have to pay the broker a 1% to 2% fee for processing your application.
- Some brokers add hidden costs to increase their profits.
- Mortgage brokers may lead you to the mortgage lender that pays the highest commission even if it’s not in your best interest.
Lender-vs.-broker bottom line
Mortgage brokers may save you time and money by helping you shop around for the best mortgage. However, you can save even more by dealing directly with the best lender for your circumstances. The catch is that shopping for a mortgage and comparing lenders can be complicated and time-consuming, particularly if it’s your first time buying a house.
Fortunately, there’s an alternative. SuperMoney makes it easy to compare the rates, terms, and customer reviews of dozens of mortgage lenders without charging you a dime and without the need for a broker. Cut out the middleman and check what mortgage rates you qualify for below.
What should you know before choosing a mortgage company?
The most important thing to know before choosing a mortgage company is that not all mortgage companies are created equal. It is wise to check out the credentials of your mortgage company before getting too far into the loan process. You can check with the Better Business Bureau and also check for online reviews to help you make your decision. Good questions to ask your mortgage company are:
- How long have you been in business?
- How many lenders do you deal with?
- What are your fees?
- Do you have any special areas of expertise?
Where can you find the best mortgage companies?
Getting a referral from family or friends who have used the services of a mortgage company can give you some peace of mind regarding your choice. Remember that it is wise to compare companies for yourself to find the one that will work best for your particular situation. A mortgage company should be willing to talk with you at length about the options you have and explain everything about the mortgage loan process to you in a transparent way.
How can you compare home purchase mortgages?
When comparing mortgages, consider the following factors:
What are the eligibility requirements for a home loan?
Are you eligible for a given mortgage loan? Is your credit score high enough? How about your debt-to-income ratio? Do you live in an area where that loan type is available? Can you afford to make a large enough down payment?
What are the interest rates?
Is the interest rate fixed or variable? Fixed rate mortgages protect buyers from sharp spikes in interest rates. On the other hand, adjustable rate mortgages can translate into significant savings when interest rates are falling.
If the interest rate is fixed, how high is it? Make sure that you’ll be able to afford it along with any additional costs every month for the next 20–30 years.
What are the loan terms offered?
How long is the loan term? In other words, how long will you be paying off the mortgage until your home is fully yours? A longer loan term means a lower monthly payment, but it also means losing more money overall.
With a shorter term, you’ll save more overall and will own your property sooner. But you’ll also have to make much higher monthly payments. And considering that even the shortest mortgage term spans several years, high monthly payments could hinder your quality of life for a long time.
What fees and costs will I be charged?
What is the origination fee of the loan? How about the closing costs? Will you have to pay PMI? Is there an application fee? Will you buy discount points to reduce the interest rate you’ll pay? How about a broker fee? How high is the origination fee?
These costs can add up to seriously raise the total price of the loan, so make sure to ask about all fees before you commit to any lender.
What is the minimum down payment to qualify for a home loan?
With a conventional loan, you’ll likely have to pay 20%. A federal loan may charge you only 3.5%. Can you afford to make a large down payment to lower your costs down the road? Or would you rather minimize upfront costs?
What is the lender’s customer service like?
You’ll probably be paying off your mortgage for the next few decades of your life. As such, you need to know that you can trust the lender you’ll be paying. If an error occurs and one of your monthly payments doesn’t go through, will they work with you to fix it? Or will they just charge you a late payment fee and report the missed payment to the credit bureaus? Flexibility and accessibility are both crucial in a mortgage lender.
What do borrowers say about the lender in consumer reviews?
The best way to find out what to expect from a lender is to read unbiased reviews from past customers. Click on any of the lenders below and scroll to the bottom of the page to read what other borrowers have to say about that lender.
FAQ on Home Loans
How can I qualify for a mortgage?
To qualify for a home loan, you will need a credit score of at least 580. Two years of consistent, verifiable income with W2s and tax returns. You will also need a down payment in most cases. There are, however, loans available requiring low or no down payment.
What is the most popular mortgage loan?
A mortgage in which the interest rate remains the same throughout the entire life of the loan is a fixed rate mortgage. These loans are the most popular, representing over 75% of all home loans. They usually come in terms of 30, 15, or 10 years, with the 30-year option being the most popular.
How much income do I need to qualify for a mortgage?
Most lenders require that you spend less than 28% of your pretax income on housing and less than 36% on total debt payments. If you spend 25% of your income on housing and 40% on total debt payments, they’ll focus on the higher number. As a result, the amount you can qualify for will be lower.
How long does it take to get mortgage approval?
You’ll need to provide documents for final review by a mortgage underwriter, but your lender will cast their eye over the application, just to be sure. This process will usually take one to two weeks, and after that, you’ll receive your “Approval in Principle” letter.
Can you be denied a mortgage after being pre-approved?
You can certainly be denied for a mortgage loan after being pre-approved for it. Pre-approval is not a guarantee you will get a loan. It is an indication that you appear to qualify based on responses to some basic questions. The actual approval process goes deeper. This is when the lender actually pulls your credit score, verifies your income, etc.
What is the difference between a home equity line of credit (HELOC) and a home equity loan (HEL)?
Have you already purchased property? And do you own equity in that property? If so, a HELOC or HEL might secure you a lower interest rate than you could find from a conventional or federal loan.
HELOCs and HELs are secured by the equity you have in your home. As a result, they offer very competitive interest rates. However, you can typically only borrow about 80% of the value of your property. So this option will be a good fit if your second property costs less than the one you presently own.
But choose this route with caution. If you fail to pay off your HEL or HELOC in time, you could lose your property.
How can I find the right mortgage lender?
One thing that can be useful when you are searching for a reputable mortgage company is online reviews. SuperMoney maintains a database of unbiased reviews you can check for free to see what consumers think of a lender before you commit. You can find the best mortgage companies and their reviews right here.
How can I get the best rates on my home purchase loan?
If you want low interest rates and attractive loan terms, the best thing you can do is shop around. Compare several different lenders against each other, and read reviews from their past customers. The more lenders you appraise, the likelier you are to find competitive rates and terms.