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Choosing The Right Mortgage
It’s time. You’ve decided to bid farewell to renting and embrace the many benefits of homeownership.
Shopping for a home loan often begins by reviewing mortgage rates. If you’re considering a 30-year fixed rate mortgage and Lender A offers a rate of 4.250% while Lender B advertises a rate of 4.125%, the decision is an easy one, right? Move forward and sign the paperwork? Not so fast!
There are many additional factors to consider before making an informed decision, something that could save you thousands of dollars. Here are a few ways you can approach buying a home or refinancing as an educated consumer.
Rely on the APR.
Finding a low interest rate, deciding whether you want a fixed or adjustable mortgage and determining the loan term are essential first steps. Next, shift your focus to the loan’s annual percentage rate (APR), a strong indicator for making “apples-to-apples” comparisons between lenders. That’s because the APR factors in the interest rate plus other fees and costs (or credits) associated with borrowing.
One way to visualize this concept is to imagine a balloon. Squeezing one end will make it smaller while the other end will expand. In the same way, reducing the rate means increasing the costs at closing and vice versa. When all else is equal, comparing one APR to another should tell you which is the better deal. If there are differences, you may need to dig a little deeper.
Factor in points.
When a lender arrives at a lower rate than a competitor, try to understand how they did it. It may involve points, which are fees borrowers may pay to the lender. One point is equal to one percent of the principle amount of a home loan. Therefore, if a mortgage is $300,000, one point, which would be paid at closing, equals $3,000. The more points you pay, the lower the rate. For example, a lender may offer a rate of 3.875% but charge two points to get there. Another lender may offer a zero-point option with a higher rate. In that scenario, the former’s APR would be higher. When looking at a rate and APR and factoring in the impact of points, lower closing fees are a result of a higher rate, while higher closing costs come with a lower rate.
There are scenarios in which points can benefit a borrower, particularly if rates increase over the early life of the loan. For example, a 30-year fixed rate mortgage with no points may come with a rate of 4.000%. A loan that features a 3.750% rate might cost one point to buy down. That quarter-point difference, divided into one point, would take about four years to recoup. If a rising rate environment exists and the buyer does not have an opportunity to refinance in those four years, paying for points would make sense and it could be a way to save money beyond the fourth year.
Transparency is key.
Googling “mortgage rates” produces roughly 146,000,000 results in 0.65 seconds. Yes, really. While you could come across a less well-known lender offering rates substantially lower than those of its more reputable competitors, well, you know what they say about things that are too good to be true.
When securing a mortgage, transparency is a vital part of the process. As a borrower, you should have a crystal-clear understanding of not only the rate, loan structure and term, but the fees and other costs involved. You want to avoid surprises when it’s time to close. Familiarize yourself in advance with terminology used throughout the process and know up front the amount of the lending fee and appraisal fee, as well as costs for title services or lenders title insurance. In addition, be sure to thoroughly read your loan estimate before signing on the dotted line.
Shop, compare and decide.
Whether you’re a first-time homebuyer or someone who has purchased several properties, take the time to get quotes from more than one lender. Consider all the costs involved—the Federal Trade Commission’s Mortgage Shopping Worksheet is a helpful resource—then make an educated decision based on what is best for you and your unique set of circumstances. And don’t underestimate the value of a trusted, reputable lender that delivers unmatched customer service.
Remember, selecting a loan based solely on the interest rate could be a mistake. Focus on the APR when comparing lenders and loans, understand your options when it comes to points, and know what fees and costs to expect. If you do, you’ll be well on your way to securing the right mortgage for your situation.