I’ve owned five homes over the years and refinanced them over six times. I’ve taken on mortgages that looked like a good idea at the time, only to realize in hindsight that I wasted money. Should I refinance? What mortgage term is best for me? Should I avoid paying mortgage insurance? These are some of the questions I’ve learned the answers to in trying to determine what to avoid and what to look for in a good mortgage.
How Important Is My Credit Score?
My recent mortgage was for $360,000. One bank offered my husband and me a 4% APR on a 30-year fixed loan. But I knew that with a 3% APR on the same loan term, I could cut my mortgage by $200 a month. I then balance transferred some of my husband’s debt on to my credit cards. Then my husband applied for a mortgage with our credit union and was offered a 3% APR, because his credit score had risen above 740. At this point, he was in the highest bracket for the best loan rates. I recommend checking your credit score before you apply for a mortgage and raising your score if you can.
Why Is the Loan Term Important?
I had refinanced the mortgage in my old home from a 30-year fixed to a 40-year fixed. At the time, it seemed like a good idea, because it cut my mortgage payment by $400 a month. But I should have paid more attention to the fine print. Had I kept the loan for the full 40 years, I would have paid $475,000 in interest payments. Now that I had sold that house and was ready to finance a new one, I decided to apply not for the 30-year fixed loan I was initially thinking about, but for a 15-year fixed loan. With this shorter loan term (and an interest rate of 2.75% instead of 4%), I will pay $81,938 in interest payments over the life of the loan. That’s a $393,062 saving over my previous mortgage.
Tip: the trick is to be able to afford the payments on a 15-year fixed mortgage (rather than a 30-year fixed loan). I did this by buying a new home that was $211,500 cheaper than my older one. This permitted me to put 20% down on my new home, which meant that I would not have to pay PMI in addition to my mortgage payment, a $450 a month saving.
20% Down, PMI or a 2nd Mortgage?
In the past I could never afford to put down 20% on my property. I was then faced with having to pay mortgage insurance to the bank that financed my first mortgage. But mortgage insurance is assessed at 1.5% of the loan amount, that’s $4,500 a year on loan amount of $300,000 (or $375 a month). In some cases it is cheaper to apply for a second mortgage to cover the 20% down-payment. But this is not always the case. In fact, in my previous home my second mortgage payment was $530 a month on a $60,000 loan. It would have been cheaper to pay $375 a month for PMI. Most loan officers tend to recommend the second mortgage route, but I recommend you compare the cost of that over mortgage insurance.
Should I Buy Down My APR?
Banks never offered me the best APR upfront. Typically, they offered me the one that seemed most lucrative, because there was no fee associated or the rate was competitive with other banks. I recommend asking if you can buy-down your interest rate by paying points. Then compare the cost of the buy-down (I recently paid $6,000) with your monthly savings due to the lower interest. In my case, I would start benefiting from the buy-down within 3.4 years. Since I plan to keep the mortgage for the full 15 years, this made sense.
Closing Costs and Points?
Even when I applied to several institutions with the same credit score, I found that each bank would make me a different offer. Because loan amounts on homes are so high, even a quarter percent difference in APR can make a big difference. I recommend applying to three or five banks on the same day. Though this will hit your credit five times, because the nature of the inquiries is similar, they will only diminish your credit score by a few points (two to four points from my experience). Look at the APR, closing costs and points associated with the loan before choosing the best mortgage for your budget.
What Should I Know About Locking the Rate?
You used to be able to lock your APR when you applied. This is no longer the case. You can only lock the rate once you have a property address for your new home. If you are just starting to shop around and want to get a pre-approval letter (as I did), be aware that the rate you are quoted (which will determine your purchasing budget), may actually change. I find that it is best to provide a purchasing address to the bank as soon as possible so as to lock your loan rate for 90 days. It’s difficult otherwise to sign a contract on a home when your mortgage rate may be a full percent higher, resulting in an increase of your mortgage payment by $200 a month.
Tip: Keep in mind that your rate lock is attached to the property, not to your name. If you don’t win the bid on the home you wish to buy or if you change your mind, your rate lock will be lost. You’ll have to lock the rate again with a new property address. My bank advised me that they would charge me a $20 fee in that event.