This is undoubtedly the year of the borrower. Interest rates are still at record lows across all types of loans in 2021 following the Federal Reserve’s emergency COVID-19 rate cuts last year. The mortgage lending market remains as competitive as ever, with more than 5,500 banks, credit unions, and other lenders fighting for borrowers’ attention.
In this climate, borrowers have the leverage to negotiate great deals on mortgages. Here are 10 factors to look for when searching for a mortgage lender to finance your home purchase.
A down payment is cash you pay upfront to buy a house and is expressed as a percentage of the total purchase price. The typical down payment for a conventional loan is 20%, although an increasing number of lenders now offer conventional loans with 3% down payment. The down payment for government-backed loans ranges from 3.5-10% for FHA loans (for borrowers with low credit) to zero down payment for VA loans (for qualifying service people and veterans) and USDA loans (for purchases in rural areas). Note that with conventional loans and FHA loans, most lenders will require you to pay monthly private mortgage insurance (PMI) until you reach 20% equity.
Personal credit score is the main factor lenders look at when assessing a person’s mortgage application. The standard minimum credit score for a conventional loan is 620 (considered fair), although credit ranging from 680-800 (good to excellent) is usually needed to get access to the best interest rates. Usually the only way to get a loan with less than 620 credit is with an FHA loan. Most lenders that deal with FHA loans have a 580 cut-off although a few lenders go as low as the federal government’s lowest legal minimum credit score of 500.
The other important factor lenders usually look at when deciding whether to prove mortgage applicants is debt-to-income ratio (DTI). Your debt-to-income ratio is all your monthly debt payments (your mortgage payment plus other loans) divided by your gross monthly income (the amount of money you earn before taxes and other deductions). For example, if you pay $1,500 per month for your mortgage, $200 for an auto loan, and $300 for other debts, your monthly debt payments are $2,000. If your gross monthly income is $5,000, then your DTI is 40% ($2,000 divided by $5,000). In most cases, the highest DTI offered by lenders is 43%, although it can vary.
Typical repayment terms range from 15 to 30 years, although some lenders offer terms as short as eight years. The repayment term is one of the two main factors that go into determining the size of your monthly payments, with the other factor being the interest rate. All other things being equal, shorter repayment terms equal higher monthly payments but less interest paid to the lender for the life of the loan. Longer repayment terms equal lower monthly payments but more interest paid to the lender for the life of the loan.
Interest rate refers to the annual cost of your mortgage and is expressed as a percentage. To understand how interest rates work, let’s take the average U.S. home value ($272,446 in Feb 2021, according to Zillow) and the average rate for a 30-year fixed-rate mortgage (3.12% in April 2021, according to Freddie Mac). A 30-year mortgage with these average rates and values and a 20% down payment would have a monthly payment of $933 in monthly payments and $117,952 in total interest payments for the loan duration. A quarter-point rise in interest rate to 3.37% would result in a $30 increase in monthly payment to $963 and $10,762 rise in total payments to $128,714.
Closing costs may include origination fees, property appraisal, title fees, taxes, and various other costs – some of which go directly to the lender and some which the lender collects on behalf of third parties. These costs usually range from 2-6% of the loan value and are payable at the beginning of the mortgage (with some exceptions – see below). Another way of understanding your closing costs is to look at the APR, the annual cost of the loan including interest rate and closing costs. While closing costs are charged upfront, the APR actually shows you the real cost of your loan in annual terms. This makes it easy to compare apples to apples instead of apples to oranges (i.e. one lender with a higher interest rate but lower closing costs to another lender with a lower interest rate but higher closing costs).
Mortgage points are sometimes referred to as “buying down the rate” because they give the borrower the option of paying an upfront fee to bring down the interest rate (and, in doing so, bring down their monthly payments). As the mortgage landscape has become more competitive, an increasing number of lenders have begun offering mortgage points as a way of attracting borrowers. The typical formula is one mortgage point equals 0.25%, so that purchasing one point on a 3% mortgage would reduce the interest rate to 2.75% for the life of the loan. Of course, the cost of a point varies between lenders, which is why it’s worth shopping around to see who has the cheapest mortgage points.
A prepayment penalty is a fee charged by some lenders for paying all or part of your mortgage earlier than set out in your monthly payment schedule. Lenders charge this fee to discourage borrowers from paying off their loan early, because early payments deprive the lender from collecting full interest on the loan. Most lenders give some leeway when it comes to prepayments, allowing borrowers to pay up to a certain percentage in prepayments before the penalty kicks in. In any case, if you think you might be in a position to pay off some or all of the loan early in future, it’s worth checking out the prepayment policies of the lenders you’re comparing.
In the digital age, the best lenders offer online or mobile platforms where you can upload all your documentation and even e-sign the final documents. The best online lenders are able to save time and money compared to traditional brick-and-mortar lenders, passing on the savings to borrowers in the form of lower closing costs and faster closing times.
If you’re buying in 2021, then you have the power to lock in a better deal on a mortgage than previous generations of buyers. With great power comes great responsibility – in this case, the responsibility to compare mortgage lenders on various factors like interest rates, repayment terms, and closing costs. Put time into a proper comparison shop now, and you’ll be rewarded with a better mortgage deal in the long term.