Unless you're one of the few lucky home buyers larded with old money, an inheritance from Great Aunt Sue, or a Zuckerberg-style salary, you're going to need a mortgage. In the entire tortuous home buying process, it's perhaps the most intimidating and seemingly daunting step: convincing a bank to hand you hundreds of thousands of dollars. How do you pull it off? And what strings are attached?
Here are the questions to ask yourself—and the answers you need—to help you ace this all-important step.
Should you work with a bank or a broker?
The majority of home buyers get their mortgage directly from a bank—often the institution where they're stashing their primary savings. But that's hardly your only, or best, option. Shopping around with different lenders may land you a better deal (typically in the form of a lower interest rate).
Brokers work directly with lenders to negotiate terms and determine the best loans for you—not the generic “you," but you specifically, taking into account your needs, income, savings, and any special situations that might apply. For instance, first-time buyers might have just landed a better job or gotten a raise, giving you more buying power that isn't reflected in the last two years of your tax documents. The right broker will be able to find loans that take only the past year's returns into account.
The downside? Brokers do charge a fee, typically about 1% to 2% of the cost of your loan. While many receive this fee from the lender, they might also charge you, too. Still, if your financial situation is complex or you lack the time to do your own research, paying a broker could be money well spent.
How long will you live there?
For most people, the choice comes down to the two main types of loans: fixed-rate and adjustable rate mortgages, or ARMs. True to their name, fixed-rate mortgages offer home buyers an interest rate that remains the same for the life of the loan. ARMs have an interest rate that is fixed for an initial period (say, five years), then adjusts at regular intervals (typically one year) to reflect market indexes—which means that your payments will fluctuate, too.
If you prefer predictable payments and/or are planning to stay in your home for longer than a decade, a fixed-rate mortgage may be better, says Shikma Rubin, a mortgage consultant at Tidewater Home Funding in Chesapeake, VA. “This is especially true in today's market, when interest rates are low. Then, your interest rate remains stable, regardless of market conditions."
Yet there are times it makes more sense to get an ARM. For one, the starting interest rate for an ARM is often at least a percentage point lower than a fixed-rate mortgage, which can add up to substantial savings. And even though it may start vacillating at some point, that can be as far as 10 years down the line. Combine that with the fact that in a study from 2013, the typical buyer of a single-family home was predicted to stay in it for 13 years. So if you're expecting your residency to fall on the shorter end of the spectrum, an ARM might make total sense.
What monthly payments can you afford?
Most mortgages offer two loan periods: 15 and 30 years. A 15-year loan offers a lower interest rate but higher monthly payments, since you're paying it off in half the time. Conversely, a 30-year loan offers lower monthly payments, but you'll pay more interest over those 30 years.
So which one is right for you? That depends on what you can afford. According to realtor.com®'s mortgage calculator, if you get a 30-year fixed-rate loan on a $200,000 home, your monthly mortgage payments would amount to about $1,385 per month. A 15-year loan for that same house would cost you $1,909. This is higher, but you'll pay only $66,288 in interest, whereas over 30 years, you'll pay $143,739. So it's up to you: pay more now, or pay more later?
Do you expect your financial situation to change?
If you're expecting major upcoming changes in your financial situation—good orbad—make sure to consider them before deciding on a loan. For instance, a major increase in your income might mean an ARM is the best product for you, providing low payments for now and more rapid repayment after a promotion. Anticipating a lump sum payment soon? Same thing: An ARM lets you pay less now and aggressively attack your principal balance later. But conversely, if you're concerned about your job stability, “by all means, get a fixed rate," says Casey Fleming, author of “The Loan Guide: How to Get the Best Possible Mortgage." As always, discuss your plans with your financial adviser or mortgage broker.
Should you lock in your rate?
A lock allows you to lock in a specific rate for a specified length of time before closing. This protects you if market rates go higher.
A float-down is an extra feature that can be added to a lock. It allows you the flexibility to get an even lower rate if rates happen to retreat after a lock is set.
These features require a fee, but depending on the volatility of the market and how critical it is for you to keep down your monthly mortgage payment, that cash could be a worthwhile investment.
Can you negotiate anything?
You may not have much luck negotiating the interest rate or terms of the loan, but there are other areas where lenders might be willing to wiggle. “Ask for an itemized list of expenses, and see what's up for debate," says Anne Postic, the editor of Mortgages.com. Pay attention to the little charges. “Do you see a courier or mail fee, but you did everything electronically?" Postic says. “Those fees may be standard for your lender, and they can be waived." Lenders might also be willing to waive the application fee or pay some of your closing costs, decreasing your overall cost. Mortgage brokers can be extra-helpful here, so make sure to talk to them about lowering any added expenses and fees.