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How to get the best mortgage

 

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Question:

How can I get the best mortgage to buy a house?

Answer:

You need to shop for the loan. And you need to do it the right way, or you are just going to hurt yourself. I will explain what to do, what not to do and why not.

Required:
  1. Know your credit score

    Know your credit score from at least 1 agency. You'll have to pay for this, about $10. The law gives you the right to one free credit report per year, but that will not include the score. There are different formulas to calculate the score and there is no point in buying all of those scores. Just know one of them and know which one it is. Personally, I know my Equifax score. You can go to Equifax' web site and buy one of their products there. I personally subscribe to their ScoreWatch product which sends me emails when something happens. I wrote a separate article about that here:
    How is my FICO credit score calculated?

    No, I do not earn referral fees or any other income from Equifax.

  2. Know what kind of loan you want

    What kind of loan? 30 year fixed or 15 year fixed and fully amortizing over this period? 5 yr fixed and then adjusting? Fully amortizing loans are a bit easier to compare, but maybe an adjustable one is better, if you get a lower APR that way. Do not look at how much your monthly payment is. It is important that you have enough money to cover the payment, but do not look at this number to compare 2 loans.
    If you are not familiar with the terms '30 year fixed', 'fully amortizing' etc, then it probably is a good idea to talk to an agent and let them advise you. For this kind of advice, they do NOT need to know your social security number. Do NOT GIVE THEM your social security number until you have decided that you will get the loan from them. Instead tell them "my Equifax score is 690 and my income is $75000, and my monthly payments on credit cards are $1200" (use your numbers of course).
    The reason why you should not give your social security number is that the agent will pull your credit. As you talk to 3 or more agents, each will pull your credit and hurt your score.

  3. Compare
    Once you know which mortgage product you want, it's time to compare. Call some banks, and some brokers and tell each of them:

    - type of mortgage (maybe 2 types) that you want
    - will you live there or rent it to someone? (owner occupied versus investment)
    - down payment
    - purchase price (new purchase) or value (refi)
    - income
    - debt service (average monthly payments on car loan, credit card etc)
    - credit score (agency name and the number, of course)

    Again. Do not give them your social security number.

    Then ask for this information:

    - loan interest rate e.g. 6.25%

    - if you wanted an adjustable loan, ask how soon it will adjust. How often (monthly, probably). What is the maximum it can go up in one year? What does it try to adjust to? One loan may adjust to PRIME + 4%, another one may adjust to PRIME + 3.5%

    The initial APR should be low, adjustments should happen not too often (annually is better than monthly) and the target should be low (PRIME + 3.5% is better than PRIME + 4.0%)

    You can see it is not trivial to decide between 2 adjustable loans. One loan may have the lower initial interest rate, but adjust to a higher target rate.

    One more reason why I personally don't like adjustable mortgages. Fully amortizing loans are easier to compare - simply compare the two interest rates. Well, there is a bit more to it. An agent can promise you gold but you don't know the most important part yet: what are their fees?

    - Get the GFE = Good Faith Estimate of closing cost. They are required by law to give you one after the application has started, within 3 days. Everyone I worked with had no problem emailing or faxing me a GFE prior to pulling my credit. Some agents will refer to the GFE as MLDS or Mortgage Loan Disclosure Statement. it's the same.

    If the person you are speaking with refuses to give you a GFE without having your credit pulled, hang up and call someone else.

  4. How to compare Good Faith Estimates
    Assuming that 2 loans have the same interest rate (and, if adjustable loans, comparable adjustment terms), compare the 2 Good Faith Estimate documents. You will find that they follow a certain standard structure. You only need to compare the section with items 800-899. This section has the lender's fees. The other sections include expenses that you will have to pay but they are out of control for the lender. For example they will put down 3 months of property tax, and 1 year of hazard insurance. They are usually too busy to get a real insurance quote, so they just put a rough estimate there. One lender may put $750 for insurance, another one may put $250, and in reality you can get the insurance for $350. (Don't let the lender pick your insurance company, by the way!)

    So, when comparing the Good Faith Estimate of closing cost, do not look at the total at the bottom. It has too many guesses such as the insurance one described above. One lender may have factored in pre-pay of 15 days of interest, the other lender - because you asked 5 days later - factored in only 10 days of interest prepaid.

    Instead, only focus on the 800 section. What do we see there?

    'Credit Check Fee' - I have seen numbers between $25 and $350 here.

    'Appraisal Fee' - this is really funny when you are buying from the builder and the builder's own financing company charges you for the appraisal? Can it be more obvious that they just try to make free money from you?
    An appraisal is a good idea when you buy a 'used' home, and the lender has every right to have it done. I think it is just funny when KB Home charges you $250 to tell you that this house that they built for you is indeed worth what they make you pay for it. Appraisals go for around $250 - $350.

    'Origination Fee' - this is simply money for the guy's willingness to talk to you, I guess. It can be 1% of the loan, or even more.

    'Underwriting Fee' - can be anything between $100 and more than 1% of the loan! Who knows, how high it can be. Fact is, I have seen an underwriting fee of 1%.

    'Points' - to buy down the interest of the loan. Usually 1 point = 1% of your loan amount reduces the interest by 0.25%
    So you pay a bit upfront to have lower monthly payments. I found that points make sense if you intend to keep the loan for longer than 5 years. Don't be fooled. 5 years is a long time. But right now, people expect rates to go up, so they may not refinance within the first 5 years. Points do make sense in this situation.

Let's look at an example.
You shop for a 30yr fixed mortgage. You need $140,000 to buy a house worth $180,000

One bank offers you 6.25% and the 800 section has only the credit report fee of $120.

The other bank offers you 6.125% (better) but the 800 section has an origination fee of $1400. The total 800 section comes to about $1900.

Which one is better? The first one is better. If you give the first bank $1400 your interest most likely will be bought down to 6.0% and you still pay less ($1400 + $120 is less than $1900) than at bank 2.

You can ask me questions in the comment section.


Notes:

  1. If you have very good credit (740 or higher), chances are that you can get all section 800 fees waived. Just ask 'Your offer is good, but can you waive that underwriting fee?'. Worst case, they will say 'No'.
  2. Another bargaining tool can be that you offer the lender to impound property tax and hazard insurance payment. Or if you know you will keep the loan, you could offer to accept a prepayment penalty.
    In return they may lower the interest rate or cut fees.


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