Your home could be the biggest single purchase you'll ever make, and shopping for a mortgage to finance that home or to borrow money by taking out a "reverse mortgage" on your house can be overwhelming.
There are many questions to ask, including: How do I get a good interest rate? What costs will I have to pay for a mortgage? Can I negotiate? If I want to buy a house, can I afford to buy the kind of house I'm interested in?
To help answer your questions, we recommend taking the following steps:
Get a copy of your credit reports at least six months before you plan to apply for a mortgage. Doing so will give you time to fix any errors and, in turn, possibly help you qualify for a better, cheaper mortgage. Lenders use your credit reports to help determine if you qualify for a loan and at what interest rate. The higher your credit score, the better the loan terms you may get. You are entitled to a free credit report once a year from each of the three nationwide credit bureaus. Go to AnnualCreditReport.com, the official site to help consumers obtain free credit reports, or call 1-877-322-8228. The Federal Trade Commission offers suggestions on how to fix errors on credit reports.
For advice on buying a home, consider talking to a housing counselor certified by the U.S. Department of Housing and Urban Development (HUD). To find a HUD-approved housing counseling agency near you, go to the HUD website or call 1-800-569-4287. These counseling agencies can offer independent advice, often at little or no cost to you.
Consider the best type of mortgage for you. There are basically two kinds of financing:
+ Fixed-rate mortgages feature a set interest rate for the entire loan term and predictable monthly payments. These are generally a good option for buyers who plan to stay in their home for a long time or just prefer the predictability of set monthly payments.
+ Adjustable-rate mortgages (ARMs) may start with a low introductory interest rate that changes periodically in relation to an index rate. Potential borrowers should be prepared for the likelihood that the initial low rate will go up, and that future rate increases sometimes can be sharp and dramatic, greatly increasing the monthly payment. During the term of the loan the interest rate can go as high as the lifetime cap. Many new ARM borrowers assume that their financial situations will improve before there are significant rate increases, but if not, the result can be financial strain. For these reasons, ARMs are typically best for buyers who plan to live in their home for a limited number of years or expect to pay the mortgage off early. For more information about ARMs, see the article in our Summer 2013 issue.
Contact several lenders. You can shop for a mortgage online, by phone or in person. Many websites have calculation tools that can help you answer questions on what kind of home you can afford and how much your monthly payment will be under different scenarios. HUD's maximum financing calculator is a good place to start.
You might also use a mortgage broker who will arrange for you to get a loan. However, keep in mind that lenders usually pay brokers a fee for their help bringing in new customers, and some lenders may pay brokers more for their services if a borrower agrees to pay a higher interest rate than what the lender itself may be charging for the same loan. When contacting mortgage brokers you should ask how they will be compensated and compare their fees.
Obtain all cost information. Knowing the monthly payment and the interest rate are not enough. You need to understand all of the mortgage costs. By law, lenders are obligated to provide you with a three-page “Loan Estimate” that provides a loan terms summary, estimated loan and closing costs, and additional application information. You can use the Loan Estimate to compare different loans and lenders.
“You should be able to depend on the cost disclosures in the Loan Estimate as the final amounts you’ll pay, because lenders face steep penalties if they charge you more at closing,” said Sandra Barker, an FDIC senior policy analyst. “And ask for an explanation of any fee you do not understand.”
Negotiate for the best possible deal. Once you know what each lender or broker has to offer, ask if they can give better terms than the original ones they quoted or than those you have found elsewhere. “Try to negotiate a waiver on charges such as application fees or a break on some of your closing costs,” Barker added.
Lock in a loan offer you like. If you are satisfied with the negotiated terms from a lender or mortgage broker, consider obtaining a written “lock-in.” It should include the rate agreed upon, the period the lock-in lasts, and the number of “points” (fees) to be paid to the lender or broker for the loan. (Usually, the more points you pay, the lower the interest rate.) A fee also may be charged for locking in the loan rate, but sometimes it may be refundable at closing.
If you're considering borrowing money via a reverse mortgage, take precautions before you agree to anything. Reverse mortgages allow homeowners over age 62 to borrow against their home’s “equity” (the current market value minus the outstanding mortgage balance) and don’t need to be repaid until the borrower dies, moves or no longer lives in the property. A reverse mortgage can be a good option for individuals near or in retirement because it typically offers monthly, lump-sum and other payout options. But, a reverse mortgage can be complicated and it might not be right for you. One big reason a reverse mortgage might not fit your needs is that the loan balance and the interest owed will increase over time, so you and your heirs might have to refinance or sell the house to have enough money to pay off the loan.
If you want to shop for a reverse mortgage, we suggest you consider the following:
+ Ask a reputable housing counselor for an unbiased opinion about your suitability for a reverse mortgage, including the financial and tax implications.
+ Consider a Home Equity Conversion Mortgage (HECM), which is generally a less expensive reverse mortgage, partly because the federal government insures it. In addition, HUD requires borrowers to receive counseling and undergo a financial review before getting a HECM. You also may find attractive reverse mortgage alternatives offered by state and local government agencies, nonprofit organizations and other lenders.
+ Take your time. A reverse mortgage isn’t something to rush into. You should stop and check with a counselor or someone else you trust before you sign anything, and if you don’t understand the cost or features of a reverse mortgage or you feel pressure or urgency to complete the deal, walk away.