Mortgages Part 2

5 Things You Should Do When Getting A Mortgage

(If you haven’t read the previous post you may want to refer back to it for definitions of some of the terms you’ll find in this post.)

1. Buy What You Can Afford

Step one is to choose a home you can afford to buy. Invariably buying whatever home you choose will cost you more than you first thought in fees and charges you didn't know about or in maintenance, etc. that you can't avoid. If you stretch your budget to the brink to afford a specific house, you can't afford the house. Either choose another one or keep renting. Owning a home is great, but not worth bankrupting yourself or creating debt (beyond the mortgage) and stress in the process. If you're using a realtor to help you find a house, be very specific about your price range. They paycheck is dependent on the sale price of what you buy - so it is good for them if you buy more. Don't talk yourself into something you can't afford. It won't be worth it.

I'll stop short of telling you not to buy a house you can't put 20% down on, that simply isn't realistic for most first-time buyers unless they are getting some help doing it. Be aware that buying a house without putting down that percentage of the purchase price will result in additional costs (called PMI - Private Mortgage Insurance - which protects the lender in case you default on the loan). I will say this, many of the problems people are running into right now with foreclosures, etc. are stemming from the purchase of houses people couldn't afford and didn't put anything down on. Adding insult to injury are those who were sold Adjustable Rate Mortgages (ARMs) that are now adjusting to a much higher rate that pushes their payment beyond what they can afford. Please think twice before you decide to buy, there are pros, but there are also cons.

2. ARMs

Adjustable Rate Mortgages aren't all bad. The house we're selling was financed on a 5/1 ARM. That means that the rate is fixed for 5 years (which would expire in July 2009) and then can adjust each year. I knew going in we would sell this house within 5 years, so it made sense to take the lower rate offered on the ARM.

Some ARMs adjust after 1 or 3 years and you need to read the fine print to make sure you understand how, when, and how much the rate can and will change. In particular, you need to know what the adjustments are tied to - are they tied to the prime lending rate, which is generally higher than typical mortgage rates? What is the maximum it can adjust from one year to the next? What's the max it can adjust ever?

The ARM should have a lower interest rate (usually by .5%-1.0%). If it doesn't have a lower rate than a fixed rate loan, don't go with the ARM (that advice might change if we ever get to a point that rates are so high they can only go down - but even in that case I'd probably recommend going fixed and refinancing when the rates bottom out).

3. Use Someone You Trust

When it comes time to choose a lender and "lock-in" a rate go with someone you trust and who will get stuff done. Brokers will tell you that they can beat local banks by .25%-.5%. I inquired of several brokers, locals, even some on the internet. What I found was that Arvest Bank here in Joplin was very competitive (actually they had the best rate and closing cost combination throughout my search) and actively sought my business. Why they were able to match brokers and the internet I don't know, but by going with them we are able to deal directly with a person located here in Joplin who has repeatedly proven willing and capable of getting things done. Oh, and Arvest only sells the servicing on 2% of their loans. That means that while Fannie Mae will be the underwriter, Arvest will continue to service it - so if there is a problem or we need something we'll still be dealing with someone locally. May not seem like a big deal now, but in a pinch is a nice perk when you're getting as a good of a deal as anyone else had available anyway.

4. Shop Around

Shop around. Some lenders will compete, some can't, but don't be afraid to compare GFE's and show one lender what another is quoting. Be aware only GFE's from the same day are comparable.

Scrutinize the projected closing costs carefully and ask questions. Ask each prospective lender for a "GFE" (Good Faith Estimate). They will do a quick pre-approval and then can provide you with a written estimate of the costs associated with the loan you're interested in. Ask questions about what each fee is. Some are fixed amounts charged by third-parties (appraisals, closing fee, title search, etc.), but the variability is really seen in what the lender is really getting. It could be anywhere from $400 to $1000 (and generally isn’t labeled “lender’s profit margin”). Make sure that the GFE shows the right amount of "pre-paids". What that means is that you have to set aside amounts to cover certain insurance, interest, and taxes. The amounts vary by when during the month and the year you close. Some lenders will put a default amount in place for these - and it tends to be low. The net result is going to be that when you get to closing you're going to owe the actual amount which may be hundreds higher (or you’ll get an unexpected bill when your escrow is underfunded later in the year). This is one way a lender may try to make their costs look lower - don't fall for it. Make the lender explain the pre-paids to you (especially if they're setting up an escrow account for you, you want this done correctly because it'll cost you all at once when the error is discovered - either at closing or when the taxes/insurance come due).

A game that lenders like to play is the rate game. They like to advertise rates without telling you that to get that rate you have to buy it down ("buy points"). What that means is you pay an amount based on the loan amount to receive a lower interest rate over the life of the loan. If you plan to be in the home for a long time (10+ years) and the resulting rate you're going to get is low enough you won't be likely to have the chance to re-finance to a lower rate later this can be a smart move. For instance, a few years ago when 30-year fixed rates dipped near 5.0%, buying a point to get a .25% reduction in the rate for home you planned to live in forever might have been smart. But if you are financing at a time when rates are higher (say in the 8.0%+ range) I wouldn't do it. Why? Because there is a fair chance that in the next few years rates will go down enough to make it worthwhile to refinance to a much lower (like a full percent or 2 or 3) rate. Depending on the lender, the cost to refinance may actually be less than buying a point. By the way, a "Point" is equal to 1% of the loan amount. So for a $100,000 loan, one point would cost you $1000. In general, buying a full point (they can be bought in fractions as well) will reduce your rate by about .25% (though it can be a little more or less than this).

Rates change daily, sometimes more than once. Why, you ask? Well, to a large degree because the rates move as a complex function of things happening in the stock and bond markets as well as movements within large lending institutions and the federal reserve. Changes in the Federal Funds Rate (the rate that banks are charged for overnight lending and the rate that is most often affected when you hear that "The Fed" is going to raise or lower rates) is not tied directly to mortgages - and especially not fixed rate loans. The reason is that a mortgage isn't usually tied to the "Prime" lending rate and is over such a long horizon that the short term fed funds rate isn't a primary driver. That said, movements in that rate can have short-term effects on the rates you'll get quoted by your lender. For example, this week I picked up a 5/8% cheaper rate than they were last week just ahead of the drop in the Fed Funds Rate. Shortly after that rate change by The Fed, mortgage rates went up (though I don't know specifically how much, I made my lender promise not to tell me where rates were at from now until closing because I can't do anything about it at this point). My advice is not to get in a huge hurry to grab a rate unless there is a compelling reason to think they are getting ready to spike. Most days if they move it will only be .125 (or 1/8th of a percent) - though sometimes they'll move .25% from one day to the next. In real terms, on a $100,000 loan, each 1/8th they move will change your payment about $10 (or a little less) per month depending on what the rates are. Over time that $10 is worth something, but month to month that alone probably isn't going to bankrupt you (and if it is, you can't afford the home you're buying).

5. Know What You Need Before You Call

Lenders, like lots of businesses out there, are in the sales business. Yes, they are providing a service, but there are some services that are more profitable for the lender than others and they may try to sell yo u those. And while you’d like to think they have your best interests at heart, that’s not their job and if you assume they do you do so at your own risk. In some cases the things they offer might make sense for you, but you have to know your needs and limitations in order to make good decisions. Don't agree to a mortgage if you started the conversation with that lender not knowing what you really needed.

As I’ve mentioned, there are literally dozens of types of loans and options within those loans. We haven’t even talked about things like FHA loans – which is a government backed program. There are incentives in some cases for first-time buyers. Some loans will allow you to put nothing down or 3% or 5%.

Before getting serious about applying for a loan you need to know what your needs are and what you can afford. My suggestion would be to look first at a 30-year fixed rate loan. You may find that your income will support a 15 year loan – and if you’re comfortable with it, go for it. You’ll have to determine what you have available to put down, where cash for closing costs will come from, and make sure you’ve still got sufficient cash reserves to pay moving expenses and anything unexpected that may come up.

Ask the people around you who have bought a home who their lender is. See if you can find one you go to church with. While it is a little perilous to not do your homework before talking to lenders, they are the people who can generally best explain thing to you. If you can find a loan officer at a local bank who will work with you without being pushy let them explain your options to you. You may find that you want to use that lender, certainly their investment of time in educating you is worth something.

Once you feel confident you know what you need in a mortgage start making phone calls and finding out what is available.