The smart way to get a mortgage in today’s market is by being prepared to show the lenders your ability to pay. The easier deals of the last few years have been cancelled because the standards were criticized as being too lenient, but the standards in effect now are still similar to what they were in the 1990s. Prepare yourself before you even start looking for a mortgage. The first thing you should do is stop building up debt and start saving up money. Most of what you save should be used as a down payment. Banks do not want to give 100% financing when housing prices are falling, so you will need a down payment even with good credit. You should also get a free credit report from TransUnion, Experian, or Equifax. One thing you won’t see on the free report is your FICO score. All three credit agencies charge you extra to tell you your FICO score, but you can estimate it at Money Central.
I got free report from Equifax. The report did tell me that canceling my oldest credit card was a mistake, and one I can’t fix now. The report also warned me not to shop for loans or apply for credit cards beforehand, because too many inquiries on your credit report are another thing that may alarm lenders. In my case all the companies that inquired were listed under “Inquiries that do not impact your credit rating” But if you do see some inaccurate information, the earlier it is cleared up, the better. If you get a report online, www.ftc.gov/freereports recommends you go through Annual Credit Report. You can determine your debt to income ratio by adding up your monthly payments and dividing by your total monthly income. Your monthly payments on all your debt should be less than 36% of your income. If your debt to income ratio is much above that, you should use some of your down payment money to pay off your debt instead to bring the ratio down.
Once you have cash on hand for to cover the down payment and application fees, and got your debt under control, it is time to start shopping for a mortgage. Mortgage rates have taken a drop since the Federal Reserve announced it would buy $600 billion in mortgage backed securities from Fannie Mae and Freddie Mac before Thanksgiving, so now is an excellent time to shop, especially for refinancing. You can get pre-qualified for a loan or pre-approved. You will have to consider the types of mortgage, the down payment vs. paying points, the lender, any special conditions, and the closing costs.
The difference between getting pre-qualified for a loan or pre-approved is how thuoghouly you are checked out. Getting pre-qualified is the easier of the two; you only have to provide your latest pay stub and monthly bills. The lender will usually just calculate your debt to income ratio from them. You should be honest, because the main point of prequalification is to give you an idea how much you can afford. Getting pre-approved means it is more certain you will get the loan. You should get a letter from the lender to show to sellers, and may get a chance to lock in your interest rate. You have to provide the same sort of information as you would when applying for a loan, and the lender will run a credit check on you. But an actual loan commitment can still depend on an appraisal of the house you make an offer on. Beware what different lenders call their programs, Quicken Loans offers a “Power Buyer” program which has the benefits usually associated with being “pre-approved”, and they refer to being “pre-approved” as if you were only pre-qualified.
Two standard types of mortgage are the 30-year fixed and the 5/1 Adjustable Rate Mortgage. The 30 year fixed rate has the lower interest rate right now, and interest rates are quite low by historic standards. Shorter fixed rate mortgages such as a 15 year fixed mortgage will let you pay off your loan sooner, and longer terms such as 40 years will let you have lower payments, but at the cost of paying higher interest over the length of the loan. The 5 in the 5/1 ARM refers to an initial period of 5 years when the rate is locked, other periods such as 3/1 are available. Adjustable rate mortgages were a good deal when the rates were historically high in the 1980s. ARMs are also good if the initial teaser rate is low and you are sure you won’t stay in the house longer than the initial fixed period, or you are sure your income will increase by the time the fixed rate expires. But right now interest on the 30 year fixed rate is lower, there is not much room for rates to drop. People are getting into trouble as their fixed period with a low teaser rate expires and they can’t sell or afford the new payments. So the fixed rates are looking like the best choice for now.
Should you invest money in a down payment or points? Paying a point is paying 1% of the mortgage amount to reduce the interest rate. Investing in the down payment reduces your need for PMI (private mortgage insurance). You can avoid PMI entirely by paying at least 20% down. Reducing PMI is more of an advantage to people who intent to stay a short time. You can cancel your PMI after you have gained enough equity, so after that you will wish you had the lower interest rate instead. Investing in points saves more money the longer you keep paying interest on the loan. So it makes sense if you will be staying a long time. There are many calculators online where you can try out different combinations.
Different lenders offer very different terms. Go to several lenders and see how they compare. Various lenders offer mortgages backed by the FHA. FHA home loans require the lowest down payments. Other requirements are 2 years of steady employment, less than 2 late payments in the last two years on your credit reports, any bankruptcies must be at least two years ago and any foreclosures must be at least 3 years ago. Credit Unions and large savings institutions are most likely to hold on to their own mortgages, which is helpful if you run into trouble and want to make a deal with them later. Find out if there are any prepayment penalties on their loans and if you can set up the loans to have biweekly payments instead of monthly payments. Compare the closing costs good faith estimates. Ask what is a fixed closing cost, what is an estimate, and what would the lender be willing to waive. The good faith estimates are sometimes wrong, but should at least give you a list of what the charges will be for. You can insist on receipt to justify the items that will be done by third parties, such as an appraisal fee, and ask if some items can be waived, especially if most lenders do not include them in the list. Bank of America is offering a “No Fee Mortgage Plus” program.