While finding the lowest interest rates and closing costs is an important part of loan shopping, you can save thousands by selecting the right type of loan for your particular situation. Here are some options and situations you should be aware of before deciding on a loan.
Mortgage Loans with 5% Down or LessLoans with 5% down or less have become very common and some lenders even offer programs with no money down. These are intended for buyers who don’t have much down payment and usually carry higher interest rates. The higher interest rates are historically offset by appreciation of the property and tax benefits of ownership. The higher rate can be refinanced for a better rate later, when the borrower gains some equity and history of payment in the property, maturing the loan.
You should also be aware that when less than the traditional 20% is given as down payment, the lender will want the loan insured against default. Typical insurers are the Veterans Administration (VA), the Federal Housing Administration (FHA) and a private mortgage insurer. This is an additional monthly cost which arises from the low or no down payment. Basically, when the lender is faced with more risk, you wind up paying more. More on low/no down payment mortgages.
Avoid Paying PMI with an 80-10-10 LoanMany borrowers use an 80-10-10 type of loan to avoid paying private mortgage insurance. In this type mortgage, the borrower contributes 10 percent to the down payment, borrows 80 percent in the first mortgage, and obtains a second loan for the remaining 10 percent. The lender sees a 20% down payment and does not require the additional cost of private mortgage insurance.
Some borrowers use the 80-10-10 loan to save money on jumbo mortgages, which usually come with jumbo interest rates. The loans are used more often in high-priced housing markets to secure better prices from Fannie Mae and Freddie Mac and can be used in any combination, such as 70-20-10. The closing costs on a second mortgage are generally low, much lower than paying for PMI and higher rates.
The Fixed-Period Adjustable-Rate Mortgage (ARM)The fixed-period adjustable-rate mortgage is a savvy financial choice for first-time and move-up buyers who don't expect to remain in a home for the long term. These loans are set at a fixed interest rate, usually lower than that of conventional fixed mortgages, for a period of 3, 5, 7 or 10 years, after which they become subject to periodic increases or decreases based on the market. Since the typical mortgage of this kind only lasts 5 to 7 years, many homeowners will have moved on to another home and mortgage by the time the loan switches to an adjustable rate.
In addition to the lower initial interest rate, fixed-period ARMS also may allow some first-time buyers to qualify for a larger loan amount. They could be eligible for more money because the loan amount is usually based on current income and the ability to meet the first year's monthly mortgage payments, which will more often than not be lower because of the favorable interest rate. If the owner decides to keep the property after the initial fixed period, there are rate ceilings that keep the rate from going too high or the owner can refinance.
First Time Buyer Loan Programs"First time buyer" loan programs may be able to help you afford a home if you could not otherwise. First time buyers not only refer to someone buying a home for the first time, but under most state programs, it can mean that you have not owned property in the last three years. These programs can offer smaller down payments and lower interest rates. Program specifics may require that the property be held for a certain period of time or that certain education classes be taken. More on First Time Buyer Programs.
Solid Credit Gives You the Best RatesA better credit picture means a better loan package to the buyer. Your lender should be able to identify problems with your credit and find solutions to bring your credit score up. There is a good chance they will ask you to pay off some debt in order to bring your credit score up and therefore qualify for a more attractive loan or a higher loan amount. Typically lenders want to see a score of 660 or above for the better rates and 720 or above for the best rates.
Seller Assisted Down Payment ProgramsBecoming increasingly popular are seller assisted down payment programs. These work by having the seller pay a fee to have funds channeled through a non-profit organization to cover the buyers down payment, closing fees, or discount points. On a conventional loan this process is more direct and a buyer can ask the seller to credit them a percentage of the sales price to be paid for by the seller at closing. This is usually written into the offer to purchase and agreed to at the time the offer is accepted. Most lenders will allow the seller to pay 3-6% of the buyer’s closing costs, down payment, or a mixture of both.
Good Faith Estimates and Junk FeesEarly in the loan process the lender should provide a good faith estimate. The loan applicant should examine this document with a fine toothed comb and identify any charges that are vague or don’t make sense. Many lenders will add “junk fees” that are purely additional profit to them. Most lenders will agree to remove these fees when asked. At closing, be sure that the good faith estimate reflects your actual closing costs per the settlement sheet. More on Good Faith Estimates.
As with every other purchase made in life, a borrower must shop around to compare deals. A good mortgage broker or lender should be able to match you and your needs to the right loan package. With literally thousands of different lenders offering many different mortgage plans, their expertise is critical.
The buyer should compare 3-4 different lenders or brokers to find the best rates and total closing costs for the loan type they selected. Couple this with the loan strategies mentioned previously and nearly everyone should be able to purchase a home with a reasonable monthly payment. Enjoying the equity and tax benefits which stem from owning a home make real estate investment the most universal and common sense route to building wealth and financial freedom.