Here at CloseYour Mortgage, we get asked the same question all the time: “What are rates doing lately?” Maybe in days gone by that was a fairly straightforward question, but today there are a large number of factors that affect the interest rate that a borrower could qualify for. Here is a brief primer about what you should be looking for when you shop for a mortgage loan that fits your needs.
DO Understand that rates don’t move up or down, but rather pricing for rates moves
A mortgage interest rate represents the compensation a lender seeks in return for the risk of lending money. As economic situations change, so do lenders’ risk tolerances. One day a lender may seek a 4% return, another day the same lender may be willing to accept a 3.5% return. The way lenders express this risk is by establishing a price for each interest rate. The price for any rate can be as high as several percent of the loan amount or as low as a few percentage points of credit back to the borrower.
For example, if a lender seeks a 4% return on a loan, then the price for a 4% rate might be $0. If a borrower wanted to get a loan at a 3.5% rate, then the lender might charge a 1% or 2% upfront fee (or more) as prepaid risk compensation. Similarly, if a borrower accepts a 4.125% rate, then the lender may actually provide a credit to the borrower that can be used to cover closing costs.
DON’T forget about your primary financial goals
Since everyone’s life circumstances are different, everyone has different financial goals that they are trying to achieve. Are you looking for the lowest possible monthly payment so that you have cash left over to cover other expenses? Or maybe you are looking to pay off the loan as quickly as possible and are willing to accept a shorter term (with a higher monthly payment) in order to accelerate the loan payoff. Decide what is most important to you and discuss those goals with your mortgage broker.
DO understand everything that comes into play when getting a mortgage rate quote
As we learned above, a mortgage rate is really a function the lender’s acceptable risk, and is based upon a lot of factors. Some of these include:
1. Your FICO credit score - While there is a minimum score required to even qualify for a loan, those borrowers with the higher credit scores represent the lowest risk to borrowers and therefore qualify for additional lender pricing discounts.
2. The amount of the loan in relation to your home’s value – Lenders see borrowers that have a significant amount of equity in their homes as a lower risk. Lower risk = lower pricing.
3. Loan term - A typical mortgage is 30 years, but borrowers can realize huge price savings for loans of a 20 or even 15 years.
4. Type of home – Lending against your primary home represents the smallest risk for a lender, followed by a vacation home and then an investment property, which carry higher costs due to higher risk. A single-family detached dwelling is preferable to an attached/townhome dwelling.
5. Location of the property – As with all real estate, “location, location, location” comes into play. If a borrower defaults on a loan and the lender is forced to sell it to recoup its principal, selling a home in a better neighborhood is an easier proposition.
6. Loan purpose – in the case of a refinance, expect to pay more for a loan in which you receive a portion of your home’s equity in cash at closing.
DON’T focus on just the interest rate
While the interest rate is clearly the most important component of a mortgage loan and you want the rate to be as low as possible, especially when projected out over 30 years, don’t ignore the fact that, statistically, you most likely will hold that mortgage for a far shorter period. According to the National Association of Realtors, the average American lives in the same house for 13 years, and the average Utahn occupies the same home for even fewer years. Even if you do remain in your home for longer, there is a high probability that you will refinance your original loan multiple times to take advantage of lower rates or to leverage the equity in your home.
Therefore, make sure you consider how long you could hold that loan and make doubly sure that all closing costs and any additional points charged for a discounted rate netted against the interest savings can be easily recouped within the life of the loan.
DO look at the total cost of the loan, or APR
Of course, everyone wants to get a low with the lowest possible interest rate, but sometimes it doesn’t make sense to pay the incremental cost associated with a lower interest rate. The term for this is APR, or annual percentage rate, and represents the actual interest rate you are paying for the loan when rate and closing costs are factored in. A rate of 4% may carry an APR of 4.2% when closing costs are financed in.
It usually does not make sense to pay $3,000 up front for a lower interest rate on a loan, when that lower interest rate only saves $18 in monthly payments. It takes years to recoup those costs and often, as noted above, those costs are never recouped because the loan is paid off before any net savings can be realized.
At CloseYour Mortgage, we always aim to get our clients’ APR to be identical to their interest rate, which means you paid no closing costs. It is the sensible way to finance your home.
DON’T forget to do your part
Once you have found the right loan for your needs, there’s a lot of additional information that your loan officer will need to get your loan underwritten by the lender. Bank statements, pay stubs, tax returns and insurance information are just a few of the things that you will need to collect and submit to complete the loan process. Remember that time is of the essence and unforeseen issues can and do arise, so don’t delay in submitting everything requested as quickly as possible to avoid your rate lock expiring.
DO work with a licensed mortgage broker
A mortgage broker is an independent agent that has relationships with several lenders. This benefits you because your broker can save you time by shopping around for the best deal that meets your needs, rather than offer you deals from a single lender, like a credit union or a bank. A good mortgage broker, like the experts at CloseYour Mortgage, can serve as your single point of contact between all the various entities that are involved with your loan.
Bottom Line
A home is a huge investment, and there are several things you need to understand when considering the best way to finance your home so you can enjoy it to its fullest.