How to Shop for a Mortgage
If you plan to purchase a house soon, shopping for a mortgage will help you determine your affordability and the expected monthly mortgage payments. It will also help you decide which home loans are suitable and whether you need to increase your credit score to obtain a lower interest rate.
At the time of this publication, the 30-year mortgage interest rate hovered around 3% (the 15-year fixed loan was slightly less than 2.5%). However, securing these low mortgage rates requires preparation to find lenders with the most competitive mortgage products.
It’s crucial to understand how these mortgages work and check your creditworthiness while shopping for the best home loans. Shopping around for the best mortgage rates can save you hundreds and thousands of dollars on your home loan, which means more cash in your pocket every month. Read on to learn more about each step in this process.
Understand how mortgages work
A mortgage enables you to borrow the money you need to purchase a new house. Most mortgages require a down payment, usually between 3% and 5% of the purchase price, depending on the mortgage. Many buyers expect to pay a 20% deposit, but the amount you spend depends on your specific financial situation. The amount of your mortgage is the difference between the down payment and the home purchase price. You are also responsible for paying transaction costs and fees, typically between 2% and 5% of the purchase price.
Mortgage terms may vary, but it’s either 10, 15, 20, or 30 years. During this period, you will make monthly repayments to the lender to cover:
- Principal: This is the loan amount that does not include interest or the amount that has been paid already.
- Interest: The financing cost of the loan and is based on the annual percentage rate (APR) charged by lending companies.
- Escrow: The escrow account covers a pool of funds used to repay family insurance, property taxes, and other expenses in line with schedules. You may also be required to pay for mortgage insurance when your lender demands it.
During the payment period, the title deed remains in the lenders’ possession. The creditor will give you documents when you make total mortgage payments. If you violate the agreement and fail to pay the loan, the credit agency has the right to seize and take ownership of the house.
The following is a breakdown of the different types of mortgages and how they work.
1) Traditional loans:
These mortgage loans are provided by banks, credit unions, and other lending institutions. Conventional loans are not guaranteed or insured by government agencies. Furthermore, it may be offered to a different lender within a few months of closing.
2) Government-insured loans:
These government-insured loans are provided by private lenders and give solutions to potential homebuyers who may not receive approval for loans. These include FHA loans, VA loans, and USDA loans.
FHA home mortgages are backed by the Federal Housing Administration (FHA) that offer low down payment options (minimum 3.5%) and minimum credit requirements (500, only if a 10% down payment is possible). You may be eligible for an FHA mortgage loan if you have a low income and poor credit score. The eligibility criteria for these loans are not as stringent as traditional loans.
VA loans, approved by the U.S. Department of Veterans Affairs, are designed specifically for active military members, veterans, and surviving spouses. Once you qualify for a loan, you do not need to make an initial down payment to get approval for a mortgage.
This mortgage loan is provided by the United States Department of Agriculture (USDA). These mortgages are available to low- and middle-income borrowers in rural areas with no demand for a down payment.
The interest rate will be the most important deciding factor, no matter what type of mortgage you get. However, it is essential to understand that mortgages fall into one of the two main categories determining whether or not mortgage rates will change.
3) Fixed-rate mortgage (FRM)
With a fixed-rate mortgage, your loan interest rate will remain the same throughout the loan term. These home mortgages provide more predictability for your monthly payments but may result in higher interest rates compared to other alternatives.
4) Adjustable-rate mortgages (ARM)
The interest rates on these mortgages may fluctuate. Typically, your interest rate is fixed at the beginning of the loan term and then changes every year under standard market conditions. The rate of change in loan interest rate is represented as a fraction, such as 5/1 or 7/1. With a 7/1 ARM loan, the interest rate is fixed for the first seven years, and then the mortgage rate will change annually. Unlike fixed-rate loans, they offer lower interest rates during the initial fixed term, but they are riskier as they do not have a guaranteed fixed interest rate over the entire loan term.
Check your score and credit report
When applying for a mortgage, the financier will look at your FICO score and credit report information, usually from all three national credit reporting agencies: Experian, TransUnion, and Equifax. For individual borrowers, lenders typically rank the scores from low to high and use the average score to assess eligibility for housing loans. For example, when you have 620, 650, and 690 points, the lender typically uses 650 to make a lending decision.
Below are the basic credit rating guidelines by loan type:
- Traditional loan: FICO score of 620 or higher
- FHA loan: FICO score of at least 580 (or 10% down payment for FICO rating below 500)
- VA loan: FICO rating of 620 or higher
- USDA loan: FICO rating of 640 or higher
Analyzing your credibility before proceeding can help you set realistic expectations. If you find that your credit is insufficient to qualify for a mortgage, take the time to increase your score and get the best chance of receiving approval.
Get Preapproved for a Mortgage
Once you know that your credit history is mortgage-ready, you can search for various loan quotes. You can do this through prequalification or securing preapproval. Although these terms are often used interchangeably, they have different meanings.
Prequalification consists of a brief overview of your budget and credit history that helps the lender estimate how much loan you could afford. The prequalification only takes a few minutes, and you can contact or visit the lender’s website to answer some questions about your income. , assets, and liabilities.
Preapproval is a more detailed process that paints a more realistic picture of your eligibility for a home mortgage. You need to formally apply for a housing loan and provide the lender with appropriate documents. Be prepared to provide personal information, consent to a credit check, proof of income, and a list of assets and debts. In addition, some lenders charge a registration fee for the application process.
If everything checks out, you will receive a preapproval letter containing loan terms and interest rates. Most preapproval applications are valid for up to 90 days and can be used to make a deal on housing.
Shop around for the Best Mortgage Rates
It is always ideal for comparing interest rates with lenders or mortgage brokers to get the best interest rate. This requires multiple lenders to access your credit report, which creates many credit problems. Nonetheless, most credit scoring models will integrate all your mortgage queries into one group when you complete the purchase within a few weeks.
If you still don’t get the interest you want, consider using a home mortgage broker. They will connect your information with a network of lenders that can provide better loan terms. Besides, you might secure an affordable interest rate by providing a larger deposit.
The Bottom Line
How to Shop for a Mortgage? Shopping for a home loan doesn’t have to be stressful. By understanding how your mortgage works, knowing where your loan stands, and getting preapproval for a mortgage, you can no longer rely on guesswork when purchasing your ideal home. More so, shop with different lenders to find the best interest rate for your loan.