Mortgage shopping can be a challenge. The details are fairly technical, there's a lot of money involved and it's not something that most people do very often. Mortgage questions about things like comparing loan offers, how to find the best mortgage lender and even "how much can I afford."
To help borrowers with the process, the Federal Reserve has five key recommendations for things consumers should address when they are shopping for a mortgage. These apply both to buying a new home or refinancing an existing mortgage; the basic rules are the same in both cases.
Some of these guidelines also overlap with the home buying process – particularly the first one about how much a mortgage will cost you – but apply primarily to mortgage questions borrowers may have.
1 – How much can I afford?
Before you start shopping for a home or planning to refinance a mortgage, you need to figure out what it's going to cost you. Don't just ask "How much can I qualify for" – ask how much you can afford. And by afford, focus on what you can comfortably handle within your budget.
Many people make the mistake of simply estimating what their monthly mortgage payment would be based merely on the price of the home. They overlook such costs as insurance and property taxes, which are typically bundled into the monthly mortgage payment, and ongoing expenses such as maintenance and utilities.
Beyond that, you also need to be prepared for irregular expenses, such as maintenance costs, both routine and unexpected. This can include pumping out the septic tank every few years, trimming or removing hazardous trees, fixing a leaky pipe or replacing a furnace or hot water heater that broke down. Anticipate long-term housing and personal costs as well - will you have to replace the roof in five years or need to buy a new in a couple years? What about repaving the driveway? Replacing siding or repainting?
Having a long-term budget and maintaining a contingency fund to meet unexpected expenses can make the difference between comfortably making your mortgage payments and falling into delinquency or even foreclosure, or seeing your home deteriorate due to neglected maintenance.
2 - Shopping around for a mortgage
When getting a mortgage, it's amazing how many people just automatically go to their usual bank or choosing the lender with the lowest advertised mortgage rate out of a handful of familiar names.
Maybe they just don't want to be bothered with sorting through the details of various mortgage offers and want to get it over with a minimum of hassles. Or perhaps they assume that since mortgage lending is a competitive business, all loan offers are going to be pretty much the same.
Such thinking can cost you money. Even with the same mortgage rate, loan offers from two different lenders can differ in cost by thousands of dollars over the life of the loan. The mortgage rate is important, but it's not the only factor that determines the cost of a loan – see "About pricing and fees" below.
You'll often find that you can get a better mortgage by comparing loan offers from at least 3-5 lenders, preferably more. Look at different types of mortgage lenders – large and small banks, credit unions, online lenders, local and national. You can also check with a mortgage broker, who represents a variety of mortgage lenders with different loan programs and helps match borrowers with the one that best suits their needs.
3 - Mortgage pricing and fees
Mortgage pricing is anything but simple. The interest rate is the biggest factor and it's the one most people focus on, but it's far from the only one that determines the cost of a home loan.
Mortgages come with a variety of fees and pricing options that can vary widely from lender to lender and have a big effect on the overall cost of the loan. The most important of these are discount points, often called points for short, which are a way of buying a lower interest rate. Each point you buy costs 1 percent of the loan amount (one point) and reduces the rate by a certain amount, often one-eighth to one-quarter of a percent. When you see an advertisement for an unusually low mortgage rate, it usually includes several point in the price.
Points may or may not save you money, depending on your situation. They usually work out best for borrowers who will stay in the home or have the loan for a long time. Compare the long-term costs of the loan both with and without points to find out which is the better mortgage option for you.
There's also a range of other fees and closing costs added into a mortgage. Some may be legitimate, such as the lender's origination fee for making the loan, others may be there only to pad the lender's bottom line. The names for these fees can vary from lender to lender and the way fees are structured vary widely from lender to lender, which makes them difficult to compare. So the best thing to do is simply compare lists of fees from different lenders to see how their costs stack up against each other and ask about any fees you don't understand.
4 - Understand the pros and cons of different mortgage types
Different mortgage types will offer certain advantages and disadvantages. An FHA loan may offer a small down payment, but require that you carry mortgage insurance for the life of the loan. A conventional Fannie Mae/Freddie Mac mortgage allows you to eventually cancel mortgage insurance but you'll pay a higher mortgage rate if you have imperfect credit.
An adjustable rate loan may give you a lower mortgage rate for the first few years but could go higher or lower after that. A fixed-rate mortgage can let you lock in a rate for 30 years but you may not need that if you expect to move in seven. And so on.
These days, borrowers don't need to be quite as wary of the "toxic" mortgage types that were common in the years leading up to the crash. Those loans – with features like teaser rates, interest only payments, negative equity amortization, balloon payments and the like – could easily get unwary borrowers into financial trouble. Mortgage lending today is far more conservative. But you still need to understand the trade-offs among your various mortgage options – and be on guard against more volatile mortgage types edging back into the market.
5 - Get advice from someone you trust
When shopping for a home loan, it helps to talk with someone who's been there before to get answers to your mortgage questions. Check with friends and family who've bought a house or refinanced and see what their experiences have been, and what sort of recommendations they have - ask what they might have done differently if they were to go through the process again.
You can also get low-cost professional assistance from a housing counselor endorsed by the U.S. Department of Housing and Urban Development (HUD) - search for "HUD housing counselors" in your community online.
Also, it's not a bad idea to hire an attorney to review the mortgage documents before you sign them - an attorney can also pick up on certain financial or legal consequences of the mortgage you may not have been aware of and which you might wish to renegotiate or try to eliminate entirely.
Working through the five steps above may not answer all your mortgage questions or address every issue you might encounter with a home loan, but they'll cover the major points and get you started on the right path.