Tips for Choosing a Mortgage
Provided by Robert Warther, Warther Private Wealth
If you are thinking about buying a home or refinancing your current mortgage, you are probably wondering how you can get the best loan. Read further for some helpful tips on shopping for and choosing a mortgage.
What lenders look for
Check your credit reports early
This is something that you should do long before you start shopping for a home or refinance. By looking at your credit early you will have time to improve it. At this time, you should look for any errors on your credit report so that you can dispute and fix them. It is also a good time to consider paying down debt and keeping credit card balances low. If you have some time before you need to buy or refinance, paying down debt will improve you credit score, it just takes time. The higher your credit score is, the lower your interest rate will be. Typically, the best mortgages rates are offered to those with credit scores higher than 760.
Employment and Income Stability
Lenders are going to prefer candidates who are able to prove a stable job history for the last two years. This also gives lenders a good idea on how stable your income is. If you are self-employed, you will be asked to prove your income with tax returns for the last two years. Sometimes the lender will require you to file an IRS Form 4506, which allows the lender to obtain a copy of your returns to verify them.
Debt to Income Ratio
There is currently two ways the DTI ratio is talked about. The back-end ratio represents all your monthly minimum debt payments, plus the new proposed mortgage payment, divided by your total monthly income. The front-end DTI ratio simply measures how much of your monthly income will be going towards your mortgage payment. Typically banks like to see a front-end ratio of 28% or less and a back-end ratio of 36% or less. Depending on the lender and the type of mortgage these ratios can vary.
Down Payment
Generally, it is a good idea to have a down payment of at least 20% of the homes value. The more money you can put towards your down payment the better your rate will be. The more money you are able to put down in the beginning, the less risky the lender will see the loan, and in turn offer a cheaper rate. Another reason you should aim to put 20% down is to avoid having to take out private mortgage insurance. Lenders will usually require this if the down payment is less than 20%. For a loan with a 5% down payment, mortgage insurance would add .62% to your payment. Assuming a credit score of 720 to 759, the insurance would increase your monthly payment by $103.33 on a $200,000 mortgage. Having a solid down payment is one of the best ways to ensure a low rate.
Cash Reserves
Lenders will typically view your cash reserves as how many months’ worth of mortgage payments you have saved. Your cash reserve is any money saved in a bank account, money market funds and certificates of deposits. They do not consider money in retirement plans as income because unless you are retired, because there will be heavy taxes and penalties for withdrawing early. Lenders usually require that you have at least 2 months of payments saved, depending on the riskiness of the mortgage, this requirement might be higher.
Picking a Mortgage
Choosing a mortgage can often seem overwhelming, which is why it is important to do a lot of research and shop around with multiple lenders. Now I will briefly explain some different types of mortgages, which all have different eligibility and down payment requirements.
Conventional Mortgages: A conventional mortgage is not guaranteed by the government, the requirements for these tend to be more stringent than government backed mortgages, but also tend to have more options in how you structure the loan, such as the length.
FHA Loans: The are loans that are backed by the Federal Housing Administration. These loans are good for borrowers who have a low credit score or a lack of savings. Down payments for these mortgages can be as little as 3.5% and they often have higher debt to income ratio limits.
USDA Loans: These loans are backed by the US Department of Agriculture and are available for rural homebuyers. These loans are available to eligible applicants and offer no down payment requirement and low interest rates.
VA Loans: These loans are for current and former members of the military and are backed by the Department of Veterans Affairs. Typically, they do not require a down payment and offer interest rates that are competitive with conventional and FHA loan rates.
Length of Loan
You will also need to determine what you want the length of the loan to be. Common term offerings for mortgages include 15, 20 and 30 years. A shorter-term loan will typically have a lower interest rate, but your total monthly payment will be higher than a longer-term loan. You should determine what the best term length will be for your income.
Fixed or Adjustable-Rate Mortgage?
Some types of mortgages offer either a fixed or adjustable interest rate. With a fixed rate mortgage, you will pay the same interest rate for the life of the loan. An adjustable-rate mortgage (ARM) will have an interest rate that occasionally changes. These mortgages typically have an introductory period where the rate is locked, but after this the rate can fluctuate, meaning your monthly payments may fluctuate as well. Interest rates on these loans tend to change once a year for the life of the loan. You should determine if you would be able to afford an increase in monthly payments and if you can’t or are not sure, you should choose a fixed rate. One benefit of an adjustable rate is that if interest rates go down, your monthly payment would reduce. You must determine if the risk of rising rates is worth the potential savings if rates were to go down. An individual who plans to move, refinance, or pay off the loan before the guaranteed rate expires could save money by choosing an ARM. However, if you plan on paying the loan off over a longer period, it might be smarter to choose a good, fixed rate now rather then hoping you can refinance to a lower rate later from an ARM.
Other Tips
Look for First Time Home buyer Assistance
Some states and cities aid first time home buyers such as low interest rate mortgages with down payment assistance or help with covering closing costs. Some first-time home buyer programs also offer tax credits, so if this will be your first home, be sure to thoroughly explore your options.
Get Pre-Approved
Once you have found some houses you are interested in, you should think about getting pre-approved for a mortgage. This is a process that lenders use to determine a borrower’s eligibility for a mortgage. To get pre-approved, the lender will complete a credit check, look at proof of income, tax returns and ask for your desired down payment and mortgage amount. If you do get pre-approved, the lender will send you an offer for your approved amount, which is good for 90 days. Applying for pre-approval through multiple lenders is a good idea and shouldn’t affect your credit score as long as you apply to them in a limited time frame. When you shop around for lenders, you can compare and negotiate rates more effectively so you should always reach out to multiple lenders. The main benefit of pre-approval is that it shows real estate agents and home sellers that you are serious and that your financials are in order, giving you a leg up on buyers who are not pre-approved.
Here are some resources you can use to shop for and compare mortgage lenders.
- Bankrate.com : This is one of the better sites for comparing the rates of different lenders. After entering some information, the website will provide you with a list of lenders and their rates for the type of loan you are looking for.
- Zillow.com : This is one of the most popular sites in the real estate industry, best known for its online home listings. However, the website will also provide you with information on mortgage lenders. After entering your basic information, lenders will reach out to you with quotes.
- Check with your Bank or Credit Union: It is also a good idea to check if your bank or credit union offers mortgages to its customers. Sometimes they offer preferred rates to customers, and because you are already a customer you might be more likely to get approved. Some banks might also other incentives such discounts for using auto pay.
Bottom Line
While applying for a mortgage can be overwhelming, making sure you are prepared and in the best financial situation can make the process much less stressful. Make the effort to prepare yourself by improving your credit and saving for a down payment. There is more to getting a good mortgage then shopping around and comparing rates, you should make sure your credit and financials are in the best shade they can be. The extra work in the beginning will pay off over the length of the loan!
Robert Warther may be reached (239) 276-7939, or bob@wartherprivatewealth.com.
Investing involves risks, and investment decisions should be based on your own goals, time horizon, and risk tolerance. The return and principal value of investments will fluctuate as market conditions change. When sold, investments may be worth more or less than their original cost.
Securities offered through Independence Capital Company, Member FINRA/SIPC, a registered broker-dealer. Investment Advisory services offered through Warther Private Wealth, LLC, a Registered Investment Advisor ("RIA"), registered in the State of Ohio. Independence Capital Company, Inc and Warther Private Wealth are not affiliated. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. The information contained herein is based on sources we believe reliable but is not considered all-inclusive. Past performance is no guarantee of future results. Please contact your Financial Advisor with information regarding specific investments. Opinions are our current opinions only and are subject to change without notice. Generally, investments are NOT FDIC INSURED, NOT BANK GUARANTEED, and MAY LOSE VALUE.
Sources:
- https://www.nerdwallet.com/article/mortgages/tips-for-first-time-home-buyers
- https://www.forbes.com/sites/robertberger/2015/05/07/6-tricks-to-getting- a-great-mortgage-rate/?sh=4314ddaa3f0f
- https://www.moneytalksnews.com/8-golden-rules-mortgage-shopping/
- https://www.nerdwallet.com/article/mortgages/how-to-choose-the-best-mortgage
- https://www.bankofamerica.com/mortgage/learn/mortgage-prequalification/