Closing on a mortgage is possibly the most significant financial transaction for any American. Before you sign the paperwork and move into your new home, stop to ask yourself if you’re getting the best deal on your mortgage.
When approaching a lender for a home loan, it’s vital that you do your due diligence on the lending facility before blindly signing the paperwork. Today, new homeowners have a variety of lenders to choose from when applying for a home loan.
While the United States monetary policy has undergone a tightening phase since 2015, the interest rate only reached upholstery 2.75-percent over the cycle. According to economists, they expect the Federal Reserve to end the current tightening cycle, and begin the next expansion phase to boost the economy.
This change in policy is great news for Americans looking to purchase a new home. You can expect interest rates to fall over the next couple of years, as the Federal Reserve cuts rates, reducing the costs of financing a mortgage. As a result, you get more home for your money, allowing you to move into the property of your dreams.
Searching the market for a lender with the best rates requires a bit of homework on the part of the new homeowner. However, with so many lenders willing to throw money at you for your new home, it’s a prudent strategy to search for the best deal that you can find.
Here’s a brief guide to everything you need to know for negotiating the best interest rate possible on your mortgage.
Shop Around for Your Mortgage
When we decide to purchase a new car, most of us spend a few days visiting dealers and test driving vehicles to find our new car. This bargaining may involve negotiating interest rates and down payments with the dealership, in the hope of getting the best deal possible. So, why should it be any different when applying for a mortgage?
First-time homeowners need to understand that shopping for the best interest rate on your new house, is no different to negotiating the terms on a new vehicle. Considering the amount of money that goes into paying off a mortgage, you would think that most Americans would want to get the best deal they could find.
It’s surprising that many Americans blindly accept the first mortgage offering they receive from the lender, believing that this is the best deal. However, like with any other financial transaction, there is always room for negotiation.
Financial institutions that provide home loans or just like any other business – they are there to make a profit. If you don’t challenge them on the terms and conditions of the deal, then they will run you over. This one-sided approach leaves you trapped in an expensive mortgage, that would have cost you significantly less with another lender.
According to data from the Consumer Financial Protection Bureau (CFPB), almost 50-percent of all Americans seeking a mortgage only seriously consider one lender. The research shows that more than 77-percent of Americans apply with one financial provider. Taking this tunnel vision approach could end up costing you thousands of dollars over the life of your mortgage.
- Shopping around for your mortgage is vital to help you understand the features of the financing available to you. Do you know the difference between fixed-rate and adjustable-rate mortgages? What about other services like title insurance? Shopping around helps you get an idea of what’s on offer from various lenders.
- Contact mortgage brokers, credit unions, and banks that you already have accounts with, and ask them for an interest rate on financing a mortgage. In many cases, these financial institutions will cut a fraction of a point off of the interest rate to retain your business. If you’re already a good client of these institutions, there’s no reason why you cannot negotiate a cheaper interest rate than with other lenders.
- Ask friends and relatives about their recommendations for lenders. You can try asking your real estate agent who they recommend. They may already have a lender that offers them discounted rates if they bring in new business.
When prospecting your lenders, always provide them the same information. This information includes the down payment, pricing, mortgage term, and the type of mortgage you are considering. Be upfront and tell them your credit score, and you should receive an accurate baseline of what you can expect from other lenders.
The Benefits of Buying Mortgage Points
If you have extra cash available when closing, many people make the mistake of adding to the down payment to minimize costs. While this may seem like a smart strategy, buying mortgage points instead of increasing your down payment will save you thousands of dollars over the lifetime of the loan.
Discount points, also known as mortgage points, are the fees paid to the lender upon closing. In exchange for the discount points, the lender drops your interest rate in a transaction called “buying down the rate.”
Typically, this discounted rate results in lower monthly loan payments, with a point costing around 1-percent of your total mortgage costs. Therefore, if you purchase a home for $200,000, one point would equate to $2,000.
While buying mortgage points sounds like a prudent financial strategy for reducing your monthly mortgage payment, it may not make the most financial sense. If you consider the above example of one-point costing $2,000 on a $200,000 home, this new rate means that it’ll take approximately 80-months to recover the $2,000 spent on mortgage points.
Instead of spending the money on discount points, you can invest this cash into an index fund that pays you income over eight years. This financial windfall from your investment could reduce your mortgage payment significantly if you reinvest it back into the home loan.
One of the benefits of buying mortgage points is the fact that you can deduct the points on your schedule A during income tax season.
When deciding whether to put the extra cash into your mortgage or another financial asset, you should take into account how long you intend to keep your home. You should weigh the probability of selling and moving before you reach the break-even point, as well as the likely possibility of refinancing to achieve a low-interest-rate or change the length of the mortgage.
The best reasons for buying mortgage points, are if you are already settled in your career, and do not intend on moving. Consider if the cash would better serve your financial interests if applied to other assets, such as the stock market, index funds, or your IRA.
However, if you intend for your home to be the last one you ever purchase, then mortgage points will serve you when you look back 10, 20, or 30-years from now. The amount you can save on the cost of the mortgage over the term of the loan could help you retire faster, and achieve your financial goals sooner.
If you are a young person and you have no intention on this being the first and last time you ever buy, then mortgage points may not be the best option for you.
Cut the Loan Term
For some reason, consumers think that the most critical part about purchasing a home is minimizing the monthly payment. It’s for this reason that many new homeowners decide to take out a 30-year loan on their property.
However, this strategy is a mistake. While taking a 30-year mortgage may significantly cut your monthly payment, it dramatically increases the total amount of capital you repay to the lender throughout the loan.
If you decide to take a shorter loan term, such as 15 years, then it may increase your monthly payment to the lender. However, you’ll pay significantly less on the total amount loaned. Most lenders are quite happy to oblige new homeowners with shorter-term fixed-rate loans with variable rates. Deciding on which option is the best for you depends on your financial situation, and what you want to achieve in your financial future.
15-year fixed rate mortgages can run as much as half a point lower than a 30-year loan. The upside of this strategy is that it helps you to build equity in your home faster. Therefore, it benefits your financial position, even if you intend to sell the house before the end of the mortgage period.
Variable-rate loans are another option worth considering, offering the new homeowner significantly low-interest rate. This facility is known as “adjustable-rate,” and it’s possible to amortize them over a 30-year term. This strategy allows you to benefit from a substantially lower payment than any other fixed-rate mortgage.
However, the downside of a variable-rate mortgage is that after a certain specified period, the rate increases to reflect the current interest rate set by the lender. While this may serve you well in the next expansionary phase of rate-cutting by the Federal Reserve, it may backfire on you should they decide to up rates again. It’s for this reason that variable-rate mortgages are more efficient for home buyers that do not intend to see out the duration of the loan and plan on selling at the 5, 7, or 10-year mark.
Negotiate Fees and Costs
While negotiating the best annual percentage rate is a great idea for new homeowners, it’s not the only determining factor when choosing your lender. Generally, when comparing APR between lenders, it’s not a true reflection of all the costs involved with the transaction.
Ask your lender for a detailed breakdown of the fees involved in the loan estimate. Lenders are obliged to provide you with an accurate estimate of all costs included, as per legislation.
You’ll also need to account for escrow payments if you’re rolling Insurance and taxes into your monthly installments. Prepaid interest is another vital factor that depends on the closing date and always ask about the fees involved with taking a federally-backed government loan.
Some of the more common areas where lenders may try to hide fees include the application, underwriting, mortgage rate lock, and loan processing fees. Also, watch out for any broker rebates mentioned in the mortgage agreements.
These costs can vary significantly from lender to lender so always ensure that you ask before you sign. Sometimes the act of asking about the fees can result in significant reductions in your closing costs; remaining silent will do you no favors.
Take Control of Your Finances for a Better Rate
Your credit score plays a significant role when applying for a mortgage. Most lenders will look at your FICO score before offering you an interest rate on your loan. After the 2008 financial crisis, lenders tighten their belts concerning the criteria needed tissue a mortgage. People with FICO scores under 580, may find it challenging to secure a loan from a traditional financial institution.
If you have a credit score above 640, then you shouldn’t have any issues with obtaining a mortgage. However, the higher your credit score – the more leverage you have with the lender to negotiate a better APR. If you have a credit score above 700, then there’s no reason why you shouldn’t be able to negotiate a rock-bottom interest rate from any lender.
There is a multitude of things you can do to improve your credit rating. Started paying down all unnecessary debt to sustainable levels and ensure that all your credit cards have balances that are well under the minimum monthly payments.
When assessing your ability to repay the loan, the lender will look at your income and discounted against outstanding credit facilities. If you have a monthly salary of $10,000 and no debt, then you have more leverage in negotiations than someone that has a monthly income of $50,000, but debt payments accounting for $40,000 per month. This factor is known as your income-to-debt ratio, and lenders like to see this ratio under 30-percent. In other words, if you earn $10,000 a month, your monthly debt payments, should not exceed $3,000 a month.
In Closing – Single Family Homes Offer the Best Deals on Interest Rates
When you’re out with your family shopping for a new home, it’s a great idea to take a look at single-family houses over condominiums and attached housing. Lenders view single-family homes as low-risk. Single-family homes tend to rise in value more than other types of property, and they make for excellent rental properties as well.