6. Finding the Right Mortgage

Nutshell

And Lender...

What kind of mortgage is right for you? What size mortgage will best fit your needs and budget? Smart mortgage shoppers will determine a preliminary answer to these questions before they start shopping for a mortgage lender.

Would this fact surprise you? No house is bought with a mortgage. Every house sold is bought with cash. Your mortgage loan—whatever its amount or lender—buys you a specific sum of cash. Among the different types of mortgages, all the variables (such as fixed or adjustable interest rates, loan length, points, fees, etc.) can be boiled down to answer two questions: 1) What will that lump sum of cash cost you? and 2) How will you pay it back?

Before you begin to shop for the right lender, you should make a preliminary evaluation of what you need and can afford, as we indicated earlier in Chapter 3. If you did not do so then, now's the time to work through the steps and use the mortgage calculators in How Much Home Can You Afford? from our Military Consumer Justice Project Home Buying Guide.

Too rushed to take the time—and our advice? You can get a rough idea of the size mortgage for which you may qualify using the following rules of thumb. But remember, any figure you come up with is just a rough estimate. 

  • Most lenders will qualify individuals with steady employment and a good credit history for a mortgage that's 2 to 2.5 times the household's annual gross income. Household income typically means your income if you are single and your and your spouse's combined income if you are married. For example, if you and your spouse have a combined annual gross income of $65,000 then you might be able to qualify for a mortgage in the range of $130,000 to $170,000.
  • Federal Housing Authority (FHA) guidelines recommend that individuals/families spend no more than 29% of their gross monthly income (GMI) on a mortgage payment; other guidelines suggest between 28% and 36% GMI. Remember that your mortgage payment beyond the loan itself typically includes escrow payments for property insurance, property taxes, and (with a down payment of less than 20%) private mortgage insurance. You can use your GMI and estimates of other figures in the mortgage calculator in How Much Home Can You Afford? to determine an estimate of what you can afford monthly then use that figure in a "How Much Home Can You Afford Calculator". In our example, if you and your spouse have a gross monthly income of $5416 (1/12 of $65,0000, then using one calculator the monthly PITI mortgage payment might range roughly $1350-1500. On a 30-year fixed rate mortgage at 5.5% APR and 5% down, you could borrow about $180,000.

Fixed Rate or Adjustable Rate? 

Before you begin to compare mortgages and lenders, refreshing your understanding of the advantages and disadvantages of both fixed rate and adjustable rate mortgages is a good idea. When it's time to start shopping seriously, most people should compare both fixed-rate and adjustable-rate mortgage opportunities in order to select the best loan for their circumstances.

What About a Down Payment?

In many areas of the county where hot housing markets have pushed property prices higher and higher, the mortgage marketplace is full of "no down payment" or "100% financing" offers. Historically, a down payment of 20% of the home's value was standard. Today, down payments of 5% are common. Down payments typically offer the advantage of lower interest rates and a smaller loan. If you pay more than 20% down, you also avoid a lender's requirement of private mortgage insurance (PMI).

If you currently own a home in which you have equity and are seeking a mortgage to buy a new larger home, then that equity may provide an adequate down payment for the new home. But first-time homebuyers often have a hard time saving up even a modest down payment. Even a 5% down payment on a $150,000 home equals $7,500. With average housing prices much greater than our example in many areas, many first time buyers are looking at even larger figures for a modest down payment. This situation tends to increase homebuyers' attraction to the many creative financing options that lenders have devised, such as various "100% financing" plans.

Unfortunately for the borrower, such no-down-payment loans are more expensive than conventional and conforming loans: both interest rates and payments are typically higher. In addition, you start with no equity in your home and you won't build any quickly. Should home values decline in your area or should the value of your home decline for some specific reason (perhaps the woods behind your house becomes a shopping center), then you could owe more than the home is worth.

For all these reasons, carefully consider all aspects of down payment vs. low or no down payment as you evaluate mortgage options.

Finding a Mortgage Lender

When you've reached a preliminary idea of the types and size of mortgages that you wish to consider, you're ready to begin evaluating potential lenders.

What Types of Lenders Offer Mortgages?

Financial institutions offering individual residential mortgages include savings banks and savings and loans (often called thrifts), commercial banks (retail banks), credit unions, and mortgage banks or companies. Most of these institutions offer "retail" mortgage departments where you can inquire about the products the institution offers and apply directly for a mortgage. For that reason, they are often called "direct lenders" to distinguish them from "mortgage brokers," who can provide access to the mortgage products of multiple lenders.

What About Using a Mortgage Broker?

A mortgage broker is an independent agent who arranges mortgages for homebuyers from among the different lenders to which they have access. Mortgage brokers arrange more than 50% of mortgages annually in the U.S. Many borrowers choose to work with brokers because they can provide a wider selection of lenders, loan products and terms and, ideally, can potentially help a borrower find the best product to fit their specific needs.

Brokers usually receive a fee for their services that is often separate from the lender's origination fee and other fees. The broker's fee, for example, may be listed as a separate cost or may be paid by the lender and incorporated into the loan—but it still exists and has a cost to you the borrower. Therefore, if you are considering using a broker, always ask specifically about what their fees are and how they are paid. The FTC also reminds consumers that "brokers are not obligated to find the best deal for you unless they have contracted with you to act as your agent."* If using a mortgage broker appeals, check out several brokers just as you would lending institutions.

What About Online Mortgage Sites?

From website ads to online pop-up ads to television commercials, Internet mortgage businesses urge you to skip the hassle of comparing loans from multiple lenders and use their services for one-stop shopping. The Internet can certainly make gathering basic information on lenders and their mortgage products and rates easier. But before you click and go to any site, here are a few basic facts about different types of sites:

  • Rate information sites: these sites only provide timely information about rates offered by a variety of lenders. They may provide links to various lenders or have ads from lenders on their sites but don't make referrals to lenders. Bankrate.com is one example of a national rate information site; many daily newspapers also post local rates in their real estate pages.
  • Websites of individual mortgage lenders: almost all financial institutions who make mortgage loans provide information about their mortgage products and current rates on their company websites. Many also provide a way to request information, contact a loan officer, or make an application online.
  • Mortgage aggregators: these typically are the sites that claim that they will provide loan offers or comparisons from several lenders. Although they may claim to search a vast number of potential lenders, in actuality they work only with lenders who have signed up with their service and agreed to pay referral fees. Some mortgage aggregators are simply referral services who put mortgage shoppers in touch with specific lenders, who then process your loan application if you choose to apply. Other mortgage aggregators also function as mortgage loan processors, much like mortgage brokers.

    Many aggregators promise that they will provide you information at no obligation, but remember that to receive more specific information most sites require that you provide personal information including your Social Security Number and aspects of your employment and financial circumstances. Never provide such information without thoroughly checking out the business, including reading their privacy policy, company history, and any complaints with the Better Business Bureau.
  • E-lenders—online mortgage companies: a number of Internet mortgage companies do business only online—they have no brick-and-mortar offices. Give these lenders the same scrutiny you give any lender, and that includes checking out that they are properly registered with the appropriate state or federal regulatory agency, their privacy policy and company history, and their complaint history with the Better Business Bureau.

What is a Mortgage Servicer?

Most lenders who originate mortgages these days do not hold the loan among their assets (their portfolio) and service it until the loan is paid off. Instead, most lenders sell their mortgages on the "secondary mortgage market." The company that buys the loan then becomes the "servicer" to whom you make your monthly payments and who holds the escrow accounts from which your annual insurance and property tax payments are made. Mortgages may be sold several times during the life of the loan. Mortgage Servicing: Making Sure Your Payments Count, a consumer factsheet from the Federal Trade Commission, explains the legal obligations of a mortgage servicer, your rights, and how to do your part to ensure that all goes smoothly.

Identifying a List of Potential Lenders

You can identify potential mortgage lenders in several ways:

  • Many financial planning experts recommend starting a list of potential lenders or brokers by asking for recommendations from family, friends, and co-workers. It's a good idea not only to get the name of the lender, but to ask what type of loan they had, and what they found most helpful about working with the lender. You'd also like to know about any lender with whom they've had an unsatisfactory experience and why.
  • You may wish to check out mortgage opportunities offered by financial institutions with whom you already do business. Even if your credit union doesn't offer mortgages, they may have recommendations of lenders.
  • Real estate agents can be another useful source of recommendations. Your agent may have access to a database of lender options or be affiliated with particular lenders. When getting a recommendation, it's a good idea to ask if the agent has an affiliation with the lender—politely, of course.
  • Check your local newspaper, in print or online, for local lenders and their current rates.
  • Include any lenders online that you like.

Comparing and Evaluating Mortgage Lenders and Their Loans

From among your recommendations, identify three or four promising options to check out further. Because it's possible to preview many lenders' mortgage products and terms online, you may be able to look quickly at an even larger pool of candidates to narrow your list to a manageable few.

You may also wish to check that financial institutions and mortgage brokers are properly registered to do business. Most state banking divisions provide online databases where you can check state-regulated entities such as state-chartered banks, credit unions and mortgage companies as well as mortgage brokers. Many states also provide information about any complaints lodged against any of the companies. You can access your state's Banking Division through the links provided by the Conference of State Bank Supervisors; this site also provides links to the regulatory agencies that register federally chartered institutions: national banks, federal savings and loans, and federal credit unions.

The best way to compare mortgage options and terms is to use a checklist and call or visit your potential lenders. Because rates and terms change daily, it's a good idea to do this as quickly as possible. The Federal Trade Commission in cooperation with a number of other agencies has developed an excellent and very thorough Mortgage Shopping Checklist that we recommend.

Consider Getting a Mortgage Pre-Approval

If, as a smart homebuyer, you are shopping for your financing before beginning to shop for a specific home, then you should consider applying for a pre-approval for the mortgage option you've identified as best from your first choice lender. A pre-approval lets a seller know you are a serious buyer who can qualify for a mortgage. To apply for a pre-approval you will need to complete a loan application which involves providing various personal data and documents (as detailed in the next section, with the exception of information about a property). The lender will then check out your credit history, employment and financial assets and liabilities and give you an approval or denial for a certain mortgage amount. There is typically a fee for pre-approval.

Applying for a Mortgage

When the time comes to apply for a mortgage, get ready for paperwork. Here are the typical things you will need to provide.

  • Complete the lender's mortgage application form. It's important to fill this out completely and truthfully. Don't exaggerate your employment history, income, or assets. Detail your debts and credit history in full. Don't "doctor" your income tax returns. Doing these things is fraud and may carry criminal penalties. Also walk away if anyone associated with a lender suggests you do any of these things or that you sign blank forms. Report them to your state banking division or appropriate federal regulatory agency.
  • Pay stubs from your pay check for several months.
  • W-2 forms for the past two years and proof of any additional income.
  • Tax returns for the past two years.
  • Sales contract for the property you wish to buy (not when applying for a pre-approval).
  • Legal description of the property you wish to buy (not when applying for a pre-approval).
  • Anything else the lender requires, such as a statement of Personal Financial Statement detailing your assets and liabilities.

In addition, the lender will obtain and review a copy of your credit report and an appraisal of the property you wish to buy. During processing, the lender may ask for more information. As noted earlier, most lenders charge an application fee.

Within three days of your application, the lender is also required to provide a "Good Faith Estimate" of everything you must pay for the loan, including fees, closing costs, escrow costs, and any other costs associated with the loan.

The time lenders take to give you a decision can vary from several days to several weeks.

Don't Forget to Negotiate for the Best Terms

Even on the same day, mortgage lenders may offer different customers different rates for the same mortgage loan terms. So don't hesitate to negotiate. Not only can you negotiate interest rates, particularly if you have a strong credit history and financial picture, but many fees can be negotiated. Just remember, while you are negotiating a better rate to make sure that the amount you've "saved" has not in actuality been shifted to a different place in the contract such as added points or fees.

When You've Been Approved, Should You Iock-in Your Rate?

The right answer to this question depends very much on your specific situation and what's going on in the economy and the mortgage market. When you "lock-in" a rate, the borrower and the lender each make a legal commitment: the lender promises to loan the money at a specified rate for a specified period, the borrower may agree to pay certain points and fees. The rate lock usually lasts for a specific time period, typically 30, 45, or 60 days. If closing does not take place within that time frame, the contract expires. Many lenders will lock in a rate for 30 days or less for no fee but charge a fee for a longer lock period. If interest rates are generally rising, locking in a rate can ensure that you get the rate you've planned on. The lock protects the lender because in essence you've agreed to pay the agreed rate even if rates fall.

Letting the rate "float" is the opposite of locking-in. Whether to lock-in a rate or let it float is very much a judgment call. If you do choose to lock-in a rate, be sure that the commitment is in writing and, if you're using a broker you get a copy of the "loan commitment letter" from the lender making the loan.

Poor Credit? What are Your Options?

Actually, your options are the same as borrowers with a perfect credit history. Many people who've had credit problems assume that they will only qualify for a high interest rate, high fee loan. Such assumptions are a predatory lender's dream come true. Always shop your loan, compare terms, and negotiate.

If your past credit problems stemmed from a one-time problem such as a major illness or losing your job through "downsizing," but your recent handling of your finances and use of credit is sound, you may find more opportunities for a loan with good terms than you imagined. Even if your credit problems stemmed from personal bad choices or mismanagement, if you have taken control of your finances, you may find a receptive ear among reputable lenders.

No matter the reasons for your previous problems with credit, if you have a poor credit history (short of recent bankruptcy), you can take steps to improve your credit before you apply for a mortgage. Our Military Consumer Justice Project Report on Building and Maintaining Your Credit provides some pointers.

Whatever you do, don't fall for predatory lending tactics. It's better to keep working toward your dream of a home, than to sign up for a bad loan that not only costs you thousands but could also cause you to lose your home.

Recognizing Predatory Lending Practices

All borrowers, not just those with credit problems, should always stay alert for predatory lending signs and tactics such as these:

  • Saying or implying that they are your only chance of getting a loan and pressuring you to sign up right away.
  • Pressuring you to borrow more than you can comfortably afford.
  • Urging you to accept higher-risk loans such as interest-only mortgages or balloon mortgages (often to allow you to borrow more than you can afford).
  • Asking you to falsify information on your loan application or sign blank application documents.
  • Urging you to consolidate your other debt into your mortgage loan or to refinance in order to do that and "solve your money problem" (doing so often just puts your house at risk).
  • Writing high pre-payment penalties into the mortgage contract. These make it hard to refinance when your credit improves.
  • Pressuring you to accept their credit insurance products on the mortgage; having very expensive credit insurance products.
  • Charging excessive fees and points. According to the Center for Responsible Lending, the fees for most competitive loans total less than 1% of the total mortgage; in predatory mortgage loans those fees may exceed 5% of the amount borrowed.
  • Tell you that FHA insurance protects homebuyers against property defects or lending fraud. It does not.
  • At closing presents different (usually much higher) loan terms, rates and/or fees than you agreed to.

Never say yes to these tactics—you could lose your money and your home.