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Making Sure You Rate in the Mortgage Market

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It took months of searching online, dozens of phone calls, and umpteen house tours, but you’ve  finally found a place you’d love to call home. It has a fabulous kitchen and circular floor plan for  entertaining, enough bedrooms for the kids you have, and even one for the kid you might want  to have later. All in all, that was pretty fun, wasn’t it? But most real estate experts recommend  starting the not-so-fun part— learning about and shopping for your mortgage—before you start  house hunting. 

Getting the best mortgage rate, and in turn, the lowest homeownership cost overall, takes some  knowledge and effort. From loan type to lender category to negotiating the final terms of your  loan, the path to securing a mortgage is complicated, particularly for first-time home buyers.  Let’s see if we can unpack the process a little bit. 

How are mortgage rates determined? 

Lenders set mortgage rates using the bond market—specifically mortgage bonds or mortgage backed securities—as a benchmark. As the mortgage bond market fluctuates, so do mortgage  rates. Mortgage rates are also loosely tied to the interbank interest rate set by the Federal  Reserve. That’s the rate banks and other financial institutions pay when they borrow money  from each other in the short term, usually to meet federally-mandated reserve limits. When the  interbank rate goes up, these costs are passed on to home buyers in the form of higher  mortgage interest rates. Mortgage rates also tend to reflect general economic indicators.  Downturns in the economy, including lower consumer spending and higher unemployment  rates, often trigger declining mortgage rates. Mortgage rates tend to go up when the economy  is booming. 

What other factors influence mortgage rates?  

While you can’t direct the larger economic forces involved in determining mortgage rates, some  factors are within your control. The single most effective way to secure a low mortgage rate is to  improve your credit score. To do so, you have to know what you are working with, so start by  ordering your own credit report. You are entitled to check your own credit for free with each of  the three credit bureaus that issue credit scores once a year; you’ll also find resources online  that can streamline the process for you and report changes to your credit score as they occur. It  does not affect your score when you check your own credit.  

You may find mistakes on your report including closed accounts that are listed as open, accounts  you don’t recognize (which can be a signal of identity theft), outdated credit limits, and more.  Resolving these issues before mortgage lenders start investigating your credit is paramount  when shopping for a great rate. Paying down high-interest credit cards will also improve your  credit score; in the context of the mortgage process, it’s a short-term investment with long-term  benefits.

Getting pre-approved
for a mortgage is another effective way to secure both a better mortgage  rate and a lower price for your home. Realtors recommend getting pre-approved by several  mortgage lenders before making an offer to buy a home. Remember that selling mortgages is  how mortgage lenders make money; they want your business. Getting several pre-approvals will  put you in a stronger negotiating position when locking in a mortgage rate. Some sellers will  only entertain offers from buyers who have been pre-approved because they don’t want to  waste time working with buyers who may not be able to secure a mortgage. In any case, pre approved buyers are in a better negotiating position because they are seen as a safer bet. While  getting pre-approved is time-consuming—you will need to provide such financial documents as  tax returns, bank statements, and pay stubs—you only need to gather that information once.  And you’ll have to do it eventually to secure a mortgage, so why not get it out of the way? Pre approval also effectively gives you parameters to live within when shopping for a home, so you  are less likely to fall in love with a home you can’t afford. 

Increasing your loan-to-value ratio by making a higher down payment will also typically result in  your being offered a lower mortgage rate, simply because your loan will be viewed as less risky.  You might also consider buying points at the outset of your loan. When you buy points, you are  effectively paying some of your interest upfront. This will increase your costs at closing, but the  expense may be offset over time by the lower interest rate your lender offers you. Be sure to  compare the rewards of buying points versus making a higher down payment to be sure which  is the right strategy for you. 

Like you, mortgage lenders have to manage cash flow. To incentivize customers to make their  mortgage payments on time, some lenders offer a lower rate to home buyers who are willing to  set up an automatic payment plan. Find out if yours is one of them. 

Finally, decreasing your mortgage term can also earn you a better mortgage rate. If you can  swing the higher monthly payment, consider taking a 15- or 20-year mortgage instead of the  standard 30-year variety to lower your mortgage rate and in turn, your total cost of  homeownership over time. 

What are the different types of mortgage loans? 

conventional mortgage is defined simply as any mortgage not backed by the federal  government. They are considered higher-risk loans than government-backed loans like VA and  USDA loans. You may need to meet more stringent credit guidelines and make a larger down  payment on your home than you would with a government-backed loan to qualify for a  conventional mortgage. Unless you are putting down 20% or more of the purchase price of your  home, you will be required to carry private mortgage insurance (PMI) until your home equity  reaches 78% of the loan amount. Conventional loans may be secured as fixed-rate or adjustable rate mortgages. Fixed-rate loans offer the benefit of consistency: over the life of the loan, your  principal and interest payments will remain steady. Adjustable-rate loans may be written for a low rate initially, but you run the risk of having your payment increase should mortgage rates  rise.  

FHA loans
were created in the wake of the Great Depression as a means of stimulating the  construction industry, lowering unemployment and providing a pathway to homeownership.  Today they are a staple product of many kinds of lending institutions. FHA loans have more  lenient requirements than conventional loans. In Pennsylvania, for instance, you can purchase a home with as little as 3.5% down, even without a stellar credit history. However, this leniency in FHA loan requirements in PA comes at a cost, as you are typically required to pay mortgage insurance premiums (MIP) for the life of your loan. 

Reserved for veterans and eligible active duty servicemen and women, VA loans are a great deal if you  qualify for one. In some cases, VA loans do not require a down payment. With a VA loan, you are not  required to carry Private Mortgage Insurance, even if your down payment is less than 20% of the  purchase price of your home. VA loan interest rates are also typically lower than conventional mortgage  rates because they are backed by the federal government and are therefore considered less risky by  mortgage lenders. Bear in mind, of course, the less money you put down at closing, the higher your  monthly payment will be. 

USDA loans
are similar to VA loans in that they also offer a no-down-payment option and lower  interest rates. They are offered to people who meet certain income criteria and are purchasing  homes in qualifying rural and suburban areas. While VA loans cap the amount of money you can  borrow, there is no such cap with a USDA loan. With a USDA loan, you can also funnel any  closing costs (lender’s fees and points, for example) into the amount you borrow and pay them  off along with your principal and interest. 

Balloon and other interest-only loans
allow you to delay paying against your loan principal for a  pre-determined amount of time, thereby lowering your monthly payment at the start of the  loan. You are then required to pay a lump sum payment equal to the balance of your loan when  the interest-only term expires. These loans are typically available only to buyers with stellar  credit histories and high net worth. They only make sense under limited circumstances. If you  have a lucrative career and expect to receive a year-end bonus, if you intend to “flip” your home  for a profit, or you’re trying to conserve cash to make a very sure investment, a balloon loan  might be the solution you’re looking for.  

What are the different types of mortgage lenders?  

Your local, garden variety bank
—the place where you keep your checking account—is very  likely to offer mortgages. It’s not a bad idea to make your bank your first stop along the journey  to finding a mortgage, if only because you already have a relationship in place there. Your bank  has access to some of the paperwork required to apply for a mortgage and can make the 

application process a little bit simpler. If you belong to a credit union, by all means, check out  what they can do for you on a mortgage. Credit unions are non-profit institutions focused on  giving their members the best possible service, not on meeting shareholder expectations.  

Mortgage banks
are institutions that do one thing only: originate loans secured by real estate.  The word “originate” is key here because once a mortgage bank issues you a mortgage, they will  typically sell it to another institution for ongoing service. Your mortgage may be sold many  times before you pay it off, creating administrative hassles for you. On the other hand, mortgage  banks are often able to process your loan more quickly than your bank can. 

Mortgage brokers
are not actually lenders themselves. They act as intermediaries between  home buyers and lending institutions. Because they have relationships with a wide range of  lenders and access to a broad range of loan programs, mortgage brokers can often find you a  mortgage even if you have imperfect credit. Mortgage brokers can also help you secure a loan  when the property you’re considering is itself considered risky. These may include  condominiums that haven’t yet been built, homes in historic neighborhoods, and even homes in  rural towns where the housing market is deemed too small for easy resale of the property. 

How can you be sure you’re getting the best mortgage for your needs? 

When it comes to securing a mortgage, you can never have too much information. Start with  your realtor, who is likely to have a great understanding of lending in general, and local lenders  in particular. Look for home loan comparison websites that offer apples-to-apples comparisons of the larger lending institutions and read each lender’s customer reviews carefully.

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