If you have been shopping for a mortgage, chances are you have found the process to be overwhelming and confusing. Besides the hundreds of loan programs, it can still be quite confusing even if you are only looking for the plain vanilla 30-year fixed mortgage, due to the different ways in which the mortgage company quotes their rates and fees. Unfortunately, there is no “standard” way of quoting rates and fees when discussing them over the phone. Some mortgage companies include items such as the appraisal and credit report fees in their closing costs and some don’t. Read through the suggestions below to gain a better understanding of the entire mortgage interest rate shopping process.
Understand Annual Percentage Rate (APR)
One of the worst ways to compare loans is to shop the “APR” or Annual Percentage Rate. The APR is an expression of the effective interest rate that will be paid on a loan, taking into account certain one-time fees and standardizing the way the rate is expressed. While the formula can be complicated, it’s primarily based on the interest rate and any service-related fees being charged on a loan. Examples of service-related fees would be processing, underwriting, and closing fees. Items such as appraisal reports, credit reports, and title insurance are tangible reports and therefore costs associated with them are not considered finance fees and don’t go into the calculation of the APR.
The APR is intended to make it easier to compare lenders and loan options. One should be able to call and inquire as to what a lender’s APR is and go with the lowest one. Unfortunately, despite repeated attempts by regulators to establish usable and consistent standards, the APR does not represent the total cost of borrowing nor does it really create a comparable standard. Some lenders will manipulate the APR, either intentionally or unintentionally, by omitting certain fees from the APR, thus reducing the rate.
The best way to find the lowest rate and cheapest closing costs is by requesting a Good Faith Estimate. By asking a lender to break the closing costs separately, you can better analyze and size up their offer against others.
Ask for a Good Faith Estimate (GFE)
So what’s the best way to shop for a mortgage? Always request a Good Faith Estimate. If you’re not familiar with this important form, this is a standard form that mortgage companies use to disclose particulars about the loan such as the loan amount, rate, and most importantly, a breakdown of the various fees and other charges such as escrows for taxes and insurance. The GFE, as it is sometimes called, loosely mirrors HUD’s Settlement Statement, the final statement you receive at closing. It is set up this way so that you can easily compare the fees from the original estimate to easily identify any discrepancies.
As you talk to each potential lender for your home financing, be sure to ask them to e-mail you a GFE with a complete breakdown of the fees and loan costs. This should help you when you want to compare between various offers you receive from different lenders.
Higher Rate, Lower Fees or Lower Rate, Higher Fees?
Ever wonder why there is such a disparity from one lender to another when it comes to rates and fees? It really comes down to two things, marketing, and their compensation. You see, most lenders are compensated by the companies they sell the loans to and therefore the higher the rate, the more compensation they receive. That is why it is in the lender’s best interest (no pun intended) to get you into a higher rate loan. What may only amount to a $20-30 higher monthly payment for you can mean hundreds or even thousands more in compensation to the lender.
This is where the marketing aspect comes in. Some lenders will use this compensation to subsidize the fees they normally charge. That is why you can find lenders with lower rates and higher fees or higher rates and lower fees. One way or another, you end up paying for it. Essentially you’re just financing it into the rate, with less due out of pocket at closing. If you shop long and hard enough, you can find the best of both worlds: a lender with low fees and low rates.
To Lock or Not to Lock? The Interest Rate Lock Dilemma
Mortgage rates normally move a little up or down every day, though occasionally, they move dramatically and can affect, not only whether you’ll be able to qualify, but can cost you thousands over the course of your mortgage.
If rates are steadily falling over a period of time, many borrowers, with advice from their Loan Officer, may choose to “float” the mortgage rate until near closing date. Even during times of falling interest rates, fluctuations do happen on a day-to-day basis and trying to time the market can be a futile and costly effort. Basically, if you cannot stand to have the rate rise at all, lock it in right away.
The larger the loan amount you seek, the more expensive it will be, even if there is a small increase in the interest rate. For example, say you’re looking to borrow $417,000 (the conforming Fannie Mae limit) over 30 years. The Principal and Interest (P&I) payment at interest rate of 4% would be $1,990.83. If the rate was to rise to 4.25%, the P&I amount you pay monthly rises to $2,051.39. Say you are looking at a Jumbo mortgage of $750,000. The rate might start a little higher at 4.75% with monthly principal and interest payment of $3,912.36, but at an interest rate of 5% the payment increases to $4,026.17. Over the entire duration of the loan term, these slight increases in interest rates amount to an additional cost of $21,801.60 and $40,971.60 respectively.
Things to consider as you decide to lock or not to lock:
- Till when is the rate lock valid for, and can you close within that timeframe?
- What happens if the rate lock expires before you can actually close on your mortgage?
- Is there a float-down option for rate if rates decline and what is the cost?
Rates are usually locked for 30, 45, 60 or 90 days. With some exceptions, you must close prior to the lock expiration. If you pass through the lock expiration without closing, it may get expensive, but it usually won’t get you a lower rate if rates have declined. You can work closely with your loan officer to make sure the mortgage process goes smoothly by supplying all of the requested documentation in a timely manner. If you chose to lock, make sure you get a lock agreement in writing and that you understand all of the terms and conditions.
Don’t Try to Predict Interest Rates
One of the biggest questions for homeowners to consider when shopping for a home loan is what type of loan to get: a fixed-rate or adjustable-rate mortgage. Conventional wisdom says that if interest rates are about to go up, you want to get a fixed-rate mortgage and lock in your interest rate. However, if interest rates are stable or likely to drop, an ARM is the best choice, as it enables you to take advantage of dropping interest rates.
The truth is: it’s virtually impossible to predict where interest rates are going. Investment professionals have a difficult time predicting interest rates, so why the average homeowner should be expected to have magical knowledge about where interest rates are going?
Even if you can predict how interest rates are going to behave short-term, it’s impossible to plan for long-term economic changes or forecasting. Within the past decade, the housing market was in great shape and the economy was booming. On the other hand, the past few years have been tough, with a sudden, sharp decline in the housing market and an unpredictable economic downturn.
What does all this mean?
It simply means that you can’t predict what’s going to happen with the economy long-term. Realistically, if you keep a 30-year mortgage for the life of the mortgage, you’re going to go through both economic upturns and downturns. Interest rates will drop and rise. It’s impossible to gamble on whether rates are going to spend more time up or down, so don’t choose a mortgage product by gambling on rates.
Look at your short-term and long-term goals, and choose a mortgage product that fits those goals. Don’t try to predict interest rates; look at where you are today, and where you plan to be in 3 years, 5 years, 10 and 15 years. Use your existing financial circumstances, growth potential and future goals to select the right mortgage product. Leave the interest rate gambling to the investment professionals who aren’t betting with your home.