Too many of us leave many critical financial matters to chance. We save for retirement without a plan, and hope that we'll have enough. We assume the deal we struck at the first car dealership we visited was a good one.
And when we want to buy a home, we don't take the time to learn how to get the best loan we can. These three key tips for mortgage shopping can help you be a smart homebuyer -- and possibly save thousands of dollars, too.
Selena Maranjian: One key factor in how good of a mortgage you can get is your credit score. The higher your score, the lower the interest rates lenders will offer you. According to the folks at MyFICO.com, here's the kind of difference your credit score makes in the interest rates you're offered.
MyFICO recently showed that if you were borrowing $200,000 via a 30-year fixed-rate mortgage, and you had a top FICO score in the 760 to 850 range, then you might get an interest rate of 3.335%, which translates to a monthly payment of $880 and total interest paid of $116,717. If your score was 630, though, then your rate would be 4.924%, with a monthly payment of $1,064 and total interest of $183,174. That's $184 more per month -- and a whopping $66,457 more in interest.
If you ignore your credit score and just shop for the lowest interest rate you can find, then you might save a few tenths of a percentage point. But if you increase your score, you might save an entire percentage point, or close to it. Achieving an excellent credit score can take a long time -- even several years if you have a rock-bottom credit score, loads of unpaid debt, or a recent bankruptcy on your credit report -- but it can still be well worth it.
Some ways to improve your credit score include checking your credit report for errors and having them fixed, and paying your bills on time. You might also benefit by paying off a lot of debt in order to lower your debt-to-available-credit ratio. Lenders like to see you owing only about 10% to 30% of the sum of all your credit limits, because it suggests that you have your debt under control, and can afford to take on some more debt with the mortgage you're seeking.
Matt Frankel: One thing that far too many people do is accept the first mortgage quote they receive. At minimum, you should apply for a mortgage with two or three different lenders to compare the rates and fees.
To illustrate why, let's say that you're shopping for a home, and apply for a $200,000 30-year mortgage with two lenders. Both loans have equal fees, but one has an interest rate of 3.95%, while the other has a 3.90% rate. These may sound too similar to make any substantial difference, but in reality, the higher rate will cost you an additional $2,160 over the life of the loan. I'd say that would be worth the hassle of filling out a few extra applications.
And you don't have to worry about this harming your credit. It's true that too many credit inquiries can have an adverse effect on your credit score, but there's a special provision in the FICO formula designed to encourage rate shopping. Any mortgage inquiries within a normal shopping period – which can be from two weeks to 45 days, depending on the version of the FICO score – will count as a single inquiry for scoring purposes, no matter how many applications you complete.
In a nutshell, applying for your mortgage with a few lenders could save you thousands of dollars, and there's no credit-related reason not to do it.
Jason Hall: One of the most-important things you need to understand is how much you'll actually pay over the term of the loan. There are a lot of different kinds of mortgages, including fixed- or adjustable-rate (ARM), interest-only, balloon mortgages, and special programs sponsored by the Federal Housing Administration and Veteran's Administration. Depending on the loan, what you pay today could change very much in future years.
Mortgages are largely broken down into a few categories. These include whether the interest rate is fixed or adjustable, and whether or not the principal is amortized over the term of the loan, or if you'll have a big balance due (balloon and interest-only ARMs) at the end of the loan term.
For the vast majority of buyers, the best choice is the cheapest fixed-rate mortgage for which you qualify, and the shortest term you can afford. This is because interest rates are at historic lows, and are most likely going to increase in the coming years. At best, they will stay at current levels -- but that's less likely than rate increases. In other words, today's cheap ARM could end up costing you more than a fixed-rate mortgage in a few years.
If you're a U.S. military veteran, you could qualify for a VA loan, which doesn't require a down payment. There's also the FHA loan program, which can assist people who can't afford a big down payment, such as first-time homebuyers. However, depending on your financial situation, these may or may not be the best option for you, so you should still shop around.
Bottom line: Make sure you know how much interest you'll pay over the life of the mortgage, plus lending fees, like points, and other costs, like mortgage insurance. Only by looking at the total costs -- not just the monthly payment -- will you know what your best option really is.
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