What To Look For in a Home Loan

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Shopping for a mortgage probably doesn’t top your list of fun things to do this week, but it’s not something that should be rushed. Want to get a good deal on a home loan? Here are four important things you should be looking for during your comparison shopping.

The Interest Rate Isn’t Everything

If you only focus on the interest rate, you’re going to end up with a mortgage that costs you more than you want to pay. Why? Because home loans also come with fees or closing costs. That’s why interest rates are also advertised with the loan’s annual percentage rate (APR), which is the cost of the loan over one year including interest and fees. Unfortunately, there is no standard for which fees must be included in the APR so don’t assume that number paints the whole story.

Comparing loan offers can be tricky because one lender may have a lower rate but higher fees. Mortgage lendersĀ are required to disclose most loan costs on the Good Faith Estimate (GFE) which explains fees associated with the loan. The GFE can be used to effectively compare mortgage offers.

Adjustable Rate vs Fixed Rate

For most homeowners, a fixed rate mortgage makes the most sense. This means your interest rate will stay the same for the life of the loan and your monthly payments will be unchanged. With an adjustable rate loan, you may get a lower rate (and lower payments) initially, but mortgage rates are on the rise. When your loan resets, your interest rate can go up along with your payments. This can make your mortgage unaffordable.

There are some situations in which an adjustable rate mortgage (ARM) makes sense:
Know If You’re Paying Points

  • You are planning to sell your home before your rate resets.
  • You are expecting your income to rise significantly.
  • You are planning to refinance into a new loan in a few years. This may be the case if you have bad or fair credit when you get the mortgage but are taking steps to boost your credit score over time.

One point or discount point is equal to 1% of the principal amount of your loan. With a $200,000 loan, a discount point is $2,000. These points are a form of prepaid interest or fees that lower the interest rate on your mortgage. The more points you pay, the lower your interest rate — but it’s not always a great deal.

You can pay anywhere from 0 to 4 points on a home loan, but whether you should pay points depends on whether you have that much money to put down at closing and how long you’re going to live in the house. The longer you plan to stay in the home, the more you will save in the long-run by paying points. If you plan to sell in a few years or you want the lowest possible closing costs, look for a loan without discount points.

Are You Stuck with Private Mortgage Insurance (PMI)?

If your down payment is less than 20%, chances are you’re going to be paying for mortgage insurance. Mortgage insurance protects the lender if you default on the loan and it’s typically a payment you must pay in addition to your monthly mortgage payment until you reach 20% equity. As you can imagine, PMI isn’t cheap. Depending on your loan, you can expect the monthly PMI to be anywhere from $115 to $150 or more.

If you can’t put down 20% but you don’t want to pay PMI, there are alternatives:

  • Get a second mortgage or 80-20 mortgage. This means taking out a first home loan for 80% of the home’s value, avoiding the PMI, and taking out a second loan that brings you up to the sales price.
  • Lender programs without PMI. Some lenders advertise loans with no private mortgage insurance and low down payments. One example is Bank of America, which has partnered with Freddie Mac and Self-Help Ventures Fund.
  • USDA loans don’t have PMI, but there is an upfront insurance premium instead. The good news is this fee is much lower than PMI and it can be financed into your mortgage. You do need to buy a home that’s USDA-eligible.
  • VA loans don’t have PMI either. In fact, VA loans are almost always the best solution for eligible borrowers. VA loans do have a funding fee that depends on service credit, down payment, and whether it’s your first time using your VA loan entitlement, but the fee is still lower than PMI and can be rolled into your loan.