Whether you're buying a home or refinancing your existing mortgage, shopping for a mortgage can be overwhelming. Many people are uncomfortable with the process and don't understand the industry jargon that many banks and lenders use. However, finding the right mortgage is one of the most important financial decisions that you'll make on one of the most valuable assets that you own. In this article, we'll show you how to shop for a mortgage by helping you pick out a loan type, share how to get ready to apply, and offer dos and don'ts when picking a lender.
Consider Mortgage Types
There are two basic types of mortgages to choose from – conventional or government-backed. Conventional loans are for borrowers with strong finances and larger down payments, while government-backed loans make it easier for borrowers to qualify for a mortgage.
A conventional loan is a traditional loan that most people think of when buying a home or refinancing. These mortgages typically require at least a 20% down payment (or equity when refinancing) and offer some of the best interest rates. With such a large equity cushion, these loans are not subject to private mortgage insurance premiums.
Additionally, conventional loans are reserved for borrowers with the best credit. In general, a borrower should have at least a 720 FICO score. And some of the most attractive mortgage rates and terms may require even higher scores of 740 or 760 to qualify.
Borrowers who have smaller down payments, lower credit scores, or other financial hiccups often turn to government-backed lending programs to qualify for their mortgage. These programs are sponsored by the government and provide a backstop for lenders in case the borrower defaults on the loan.
Some of the most common government-backed mortgage programs include:
- Federal Housing Administration (FHA) Loans. These loans offer low down payments, low closing costs, and reduced credit requirements. FHA loans are typically available for any local market within the U.S. However, individual homes are subject to higher standards than a conventional loan, so some homes may not qualify. The FHA offers loans with down payments as low as 3.5% for eligible borrowers.
- Veterans Administration (VA) Loans. Loans designed for active-duty military and honorably discharged veterans. Many eligible borrowers qualify for a loan with a 0% down payment.
- US Department of Agriculture (USDA) Loans. Low-interest mortgages for low-to-moderate-income suburban and rural homeowners and homebuyers with less-than-ideal credit. Homes must be located within specific local markets to qualify. Borrowers may qualify for $0 down payment eligibility.
Understand Financing Options
In addition to picking a loan type, you'll need to decide what type of interest rate that you want to have for your mortgage. Fixed-rate mortgages have the same interest rate throughout the term of their loan, while adjustable-rate mortgages may increase or decrease periodically.
Many consumers choose a fixed-rate mortgage because the rate (and, therefore, their payment) cannot change throughout the life of their mortgage. Because of this guarantee, fixed-rate mortgages tend to be higher than adjustable-rate mortgages. A higher rate means that their principal and interest payment is higher as well.
With interest rates near all-time lows, many borrowers have locked in a low interest rate with a fixed-rate mortgage. As long as they do not sell or refinance their home, they'll keep that rate until the home is paid off.
Adjustable-rate mortgages (ARMs) are appealing for some borrowers because they offer initial interest rates lower than a fixed-rate mortgage. These lower payments provide borrowers with an easier path to approval and extra money each month. That extra money can be used to accelerate their mortgage payoff or to reduce higher interest rate debts, like credit cards, student loans, and auto loans.
As the name implies, the interest rate on adjustable-rate mortgages may change periodically. Generally, ARMs offer a fixed rate for an initial period of time, then adjust each year after that based on current interest rates. Even if interest rates jump considerably during your initial term, most ARMs place limits on the amount rates can rise each year and over the term of the loan. These limits minimize the impact of higher rates to keep loans affordable and give borrowers an opportunity to sell or refinance their homes if the new payment is stressful to their budget.
Figure out what you can afford
Although we'd all love to live in the fanciest house imaginable, the reality is that our paychecks won't allow that. Take a serious look at your finances and think about how much you can realistically afford. You don't want to end up being "house poor," where you have a nice house, but cannot afford to do anything else.
With the latest changes to tax laws, the mortgage interest deduction is less valuable than ever for the average home. For most people, the standard deduction is higher than your mortgage interest payments, so don't stretch your budget thinking that you'll receive a tax break because of your mortgage payment.
Check your credit reports and scores
Most mortgage lenders will check all three credit scores and choose the middle score to determine your rate and which programs you qualify for. Request a copy of your credit report from all three credit bureaus to review for accuracy. Federal law requires that each credit bureau provide one free copy to every consumer each year. Go to AnnualCreditReport.com to request your credit reports.
If you find any inaccurate information, dispute it immediately. You can dispute them online or by mail, but the online process is quicker and you can track progress more easily. This process can take up to 60 days to reflect on your credit report, so start this process as soon as possible.
Free credit reports do not provide your credit score, however, many banks provide it for free. Some banks require you to be a customer, while others offer it free to anyone. Discover is one of the banks that offer free credit scores to everyone, even if you're not a customer.
Get your documents together
Your lender will ask for numerous documents to underwrite and approve your mortgage. To keep the process moving smoothly and quickly, it helps to compile as many of the documents as possible ahead of time. Some of the most common documents requested are:
- Paystubs for the last two months
- Tax returns for the last two years, including W-2s
- Bank statements for the last two months
- Investment and retirement account statement (most recent)
- Gift letter (if using funds from someone else)
- Property taxes (usually found online, especially for new home buyers)
- Insurance policy (or quote if buying a home)
- HOA information (if applicable)
- Signed copy of the purchase agreement (if buying a new home)
- Copy of your Driver's License or other valid identification
If you are applying for your mortgage with a spouse or partner, they'll need to provide this information as well.
Having a pre-approval from a lender makes your offer stand out from everyone else. A pre-approval signifies to the buyer that a lender has approved your credit and financials while waiting for you to find a home to purchase. Pre-approvals are stronger than a pre-qualification letter.
A pre-qualification letter means that your credit score is acceptable and the lender might approve you based on the income and assets that you said you have. With a pre-qualification letter, the lender has not verified any of your financial information, nor have they started the underwriting process.
Compare rates from several mortgage lenders
The mortgage industry is very competitive and interest rate pricing changes several times throughout the day. Whether you go through a single site that compares multiple lenders at once or you speak with individual lenders personally, it pays to get several quotes.
Depending on your loan amount, credit score, and mortgage term, different lenders may be better than others. Some specialize in conventional loans, while others specialize in VA, FHA, or loans for self-employed applicants. And while one lender may have been perfect for your friend, relative, or co-worker, your finances are different and therefore need a lender that works best for your situation.
Dos and Don'ts: Tips to get the best mortgage
To get the best mortgage for your home purchase or refinance, follow these dos and don'ts to save money, avoid scams, and get the best rates and terms.
Don’t use advertised rates to choose a lender
Advertised rates are generic offers that are usually only available to a select few customers. Speak with a loan officer from the company to get a quote that is customized to your credit score, financial situation, loan type, amount and term, and the home you're looking to buy or refinance. When comparing lenders, always look at the APR to get a better understanding of what fees and costs they charge.
Do ask questions and read the fine print
Never assume something that isn't in writing. And if you don't understand a term or charge on your mortgage quote, ask for an explanation. With a mortgage, the devil is in the details. You should review all documents thoroughly and highlight each area that you have a question about. If the loan officer cannot provide an adequate explanation, then you may need to work with a different lender.
Don’t accept the first offer you get
It is ok to receive multiple offers from different lenders until you can find the best deal. Rarely is the first offer you get the best office. If you like a particular lender better than the others, use the other offers to negotiate with your preferred lender. Even if they don't provide the absolute lowest price, using those other offers can help you reduce their charges to make them more competitive.
Do consider paying points to lower your rate
For people who plan on being in their home for the long term, consider buying down your rate. For every "point" (aka 1%) that you pay, you should be able to reduce your interest rate by approximately 0.25%. It may take 6 to 7 years to break even on the points that you pay, but every year after that is extra savings in your pocket.
Don’t be afraid to negotiate
The interest rate is only one of the many ways that you can save on your mortgage. Many of the fees and charges on your mortgage documents can also be negotiated. For example, title insurance can be shopped around to find a better deal. And some mortgage lenders will waive or reduce origination fees and other costs, like credit reports, if you negotiate with them.
Do hold off on applying for any new credit
Your credit score and debt-to-income ratio are two of the most important factors in qualifying you for different loan programs. If you apply for new credit, this can affect both of these items. First, applying for new credit can drop your credit score by 3 to 5 points, which may be enough to disqualify you for that loan program.
Getting a new car, credit card, or another loan may impact your debt-to-income ratio. If it gets too high, you may no longer qualify for your mortgage payment. Today, lenders check your credit report one final time right before closing to ensure that there have been no changes to your credit.
Don't accept last-minute changes in wiring instructions
A common exploitation by scammers is to send last-minute changes to wire instructions to borrowers. These requests often come from a hacked email account within the lender or escrow company, or an email address that sounds official. If you wire money for your down payment to a scammer, it may be lost forever.
Before wiring any money, call your lender or escrow company to verify the information. Although they may think that you're being too cautious, this step will protect your hard-earned money from being stolen.
Do compare a 15-year loan term vs. a 30-year mortgage
Many people automatically default to a 30-year term when shopping for a new mortgage. While a longer term provides for a smaller monthly payment, a 15-year term accelerates your ability to be mortgage-free. A 15-year mortgage generally has an interest rate that is about 0.50% lower than a 30-year mortgage.
Depending on your loan amount and interest rate, the difference between the two loans may only be a few hundred dollars. For people who want to reach financial independence quickly, the small sacrifice of a larger payment is worth shaving 15 years off your mortgage.
When should you start shopping for a mortgage?
You should start shopping for a mortgage before you begin your new home search. Getting a pre-approval from a mortgage lender allows you to know how much home you can afford and makes your offer a stronger one. The pre-approval also provides for a quicker close to get you in your new home sooner.
How many mortgage quotes should I get?
You should get at least three mortgage quotes before choosing your lender. This allows you to compare the rates, terms, fees, and other costs among a variety of lenders. The first lender you speak with may not specialize in the type of loan you're looking for or borrowers with your finances or credit score. Getting additional quotes will either confirm the first lender's pricing or enable you to find a better deal.
What’s a good mortgage rate?
A good mortgage rate varies depending on a number of factors. These factors include the type of loan you want, its term, the amount borrowed vs. home value, your credit score, and the number of points that you're paying. The current market conditions when you're applying may also impact what a good mortgage rate is. On the date this article was written, a good rate for a 15-year purchase loan on a $500,000 home with a 20% down payment and no points is 2.25%.
How many days do you have to shop around for a mortgage?
It is wise to limit your credit inquiries under normal circumstances. However, credit bureaus understand that you may speak to multiple lenders when shopping for a mortgage. You have 45 days to shop around for the best mortgage deal without it affecting your credit.
Does it hurt your credit to shop for a mortgage?
No, it does not hurt to shop for a mortgage. In fact, credit bureaus encourage you to shop around for the best deal. All mortgage inquiries during a 45-day window will count as only one inquiry on your credit score. Each inquiry will show on your credit report, but only one inquiry is part of the calculation of your score.
How many preapprovals should I get?
You only need one pre-approval when shopping for a new home. Before you provide all of the documentation necessary to get a pre-approval, you should decide which lender you want to work with. Only after you've picked a lender should you go through the effort of sharing all of the financial documents necessary to get a pre-approval.
Is it better to go directly to a bank for a mortgage?
While many banks have appealing mortgage products, their employees can only offer products from their own bank. For this reason, many borrowers work with a mortgage broker to find the best rates, terms, and products from a variety of banks. Because you can shop for a mortgage without affecting your credit, you can speak with your bank and a mortgage broker to see who can offer the best deal. In some cases, your bank may offer the best pricing when they factor in relationship discounts or pricing for valued clients.