Buying a home is likely to be the biggest financial transaction that you will ever make, so it is natural to feel overwhelmed. To help make the process a little bit easier for you, we asked a team of Fools to share their top tip to keep in mind when shopping for a mortgage. Read on to see what they had to say.
It pays to shop around
Matt Frankel: Far too few people shop around for a lender before getting a mortgage. Interest rates and origination costs can vary considerably between lenders, and you might be surprised at how big of a difference a seemingly small rate savings can make.
For example, let’s say that you’re buying a home for $300,000 and putting 20% down, which means that you’ll need a $240,000 mortgage. One lender offers you a rate of 4% while another offers you 3.9% with the same origination costs on a 30-year mortgage. Sounds pretty close, right? Well, the “barely” cheaper rate will save you over $5,000 in interest over the term of the loan. That’s why it’s important to shop around.
Applying to several mortgage lenders won’t ding your credit score, either. It’s true that credit applications can affect your score, but the FICO formula has a rate-shopping provision for just this purpose. Essentially, if you complete all of your mortgage or auto loan applications within a normal shopping period (14 or 45 days, depending on the exact version of the FICO formula), it will count as a single inquiry for scoring purposes. In other words, whether you apply for one mortgage or 20, it will have the exact same impact on your credit.
By doing a little rate-shopping, you have nothing to lose and thousands of dollars to potentially save.
Consider an adjustable-rate mortgage
Selena Maranjian: With interest rates having been near-historic lows for a long time now, opting for a fixed-rate mortgage has generally been a sensible move. There are times when an adjustable-rate loan will serve you better, though.
Remember that a fixed-rate mortgage features an interest rate that’s locked in. Lock in a 4.5% rate on a 30-year fixed-rate mortgage, for example, and no matter where interest rates go, you’ll get to enjoy that low rate for up to 30 years. (And with rates so low, it’s likely that they will go up in the coming years, at least to some degree.)
Meanwhile, an adjustable-rate loan typically features a starting interest rate that’s often lower than what you’d get with a fixed-rate loan. It’s typically locked in for a relatively short while, such as three or five or seven years. A 5/1 adjustable-rate mortgage, for example, will hold the rate steady for the first five years before starting to adjust it annually — upping it if prevailing rates rise or dropping it if prevailing rates fall. There’s often a cap limiting how much your interest rate can jump at one time, but if we head back into double-digit interest rates in the future, your adjustable-rate mortgage could feature double-digit rates at some point, too — and that can make your monthly payments much steeper.
That presents a scary scenario, but not if you’re only going to be in your home for a few years — or if you’re very sure that rates will fall or stay stable. As an example of how low adjustable-rate interest rates can go, note that the Bank of America website recently advertised a 30-year fixed-rate loan (with 0.813 points) for 3.625%, vs. a rate of 2.5% for a 5/1 adjustable loan (with 0.761 points).
Don’t forget about online lenders
Brian Feroldi: As Matt said above, it can really pay off to shop around. However, your natural inclination might be to only consider banks that have a branch in your local area. That could be a mistake as many online-only lenders can offer incredible deals, so do not forget to include them in your search.
I experienced this firsthand less than a month ago. I saw that mortgage rates had fallen, so I crunched the numbers and realized I could save a great deal of money by refinancing. I called a handful of local lenders to get quotes, but I also decided to fill out an application with Bank of Internet (NASDAQ:BOFI), too. To my surprise, Bank of Internet offered me the best deal by far, so I decided to move forward with them.
Fast-forward a few weeks and the closing was a success. When it was all said and done, I calculated that going with an online-only bank saved me more than $1,000 in closing costs over what my local lenders were offering.
If you are in the market for a mortgage, make sure you include a handful of online lenders in your search. You might just be surprised at how competitive their prices can be.