Instead of happily accepting whatever interest rate your bank is offering you when you need a mortgage loan, it is advisable to take control over the situation and do what you can to ensure that the rate you agree to is really the best one possible in your situation.
Since mortgage loans tend to be long-term loans involving huge amounts of money, even a small difference in interest rate, such as half a percent point, can translate into thousands of dollars lost – or saved. Putting some time and energy into obtaining the best possible mortgage loan interest rate is definitely worth it.
Getting a good interest rate has both long-term and short-term consequences. The size of your monthly payments to the lender will be impacted by the interest rate. With a lower rate, you can make a smaller payment each month or use the extra money to pay down the principal quicker. By paying down the principal, you create home equity and there will also be less to charge you interest on.
Creating home equity essentially means that if you ever need money, e.g. to renovate the house or to help pay for a child’s college tuition, you can take out a favorable home equity loan instead of having to utilize more expensive credit options.
1.) Start by assessing your creditworthiness
The first step is to find out how you look in the eyes of potential lenders. Most industrialized countries have some type of credit report registry. If you live in the United States, you should check your credit score and preferably also the credit report information that the score is based on.
If you notice anything that is incorrect in your credit report, take steps to have it corrected. Even small and seemingly insignificant things can impact a lenders assessment of you, which means that even small things can impact what interest rate you will be offered when you apply for a mortgage loan.
If your credit report looks bad or if you have a low credit score, you might want to consider not applying for a mortgage loan right now and devote some time to improving your creditworthiness instead. It’s not fun to have to wait when you want to become a home owner, but being patient can save you a lot of money, and you might even be approved for a mortgage loan that allows you to purchase a much better home than what would be available to you when you creditworthiness was lower.
If you live in the United States, the three main credit bureaus are Experian, Equifax and TransUnion. The famous FICO score is based on information from them. Your credit file isn’t necessarily identical with the three different bureaus, which means that your FICO score can vary depending on which bureau that provides the information to FICO to generate the score. You are entitled to see your own Experian, Equifax and TransUnion credit reports (not credit score) for free every 12-month period, and this is a right you should definitely make use of. There is no need to pay some third party to see your credit reports when the credit bureaus will give the reports to you for free.
If you have a credit card, check with the issuer or credit card company what kind of service you have access to as a client. Many credit card issuers or credit card companies give their clients free access to their own credit score and will also offer free advise on how to improve your score.
2.) Learn about mortgage loan types
Not all mortgage loans were created equally. By learning about the various mortgage loan types available, it will be easier for you to determine which type you would prefer.
Do not rely solely on a lender or broker to guide you to the mortgage loan type that is best for you. There are many examples of professionals within the industry that have been pushing the type of mortgage loan that is best for them rather than recommended the solution that would be best for the client. They may for instance get a higher commission for a certain type of loan or be absolved from dealing with a lot of paperwork if they steer you in a certain direction. There is also the risk that the professional simply isn’t knowledgeable enough – even if he wants to help you he doesn’t know the full picture. At the very least, he will be limited to recommending loans offered by his employer (anything else would be strange) which means that you may never find out about other mortgage loan types that could be available to you.
If you know the basics about various mortgage loan types before you contact any lenders, it will be easier for you to remain in control and find your way to the best mortgage loan for you.
Here are a few examples of things that you should check out before you start contacting lenders:
- What’s the difference between fixed-rate mortgage loan and adjustable-rate mortgage loan?
- What’s a non-amortizing mortgage loan and what are the pro’s and con’s?
- What’s a no capital – no interest loan?
- What’s a wraparound mortgage loan?
- What’s an investment-backed mortgage loan?
- What’s the difference between non-recourse loans and other loans?
- What are loan origination and loan origination fee?
- What are underwriting and underwriting fee?
- What are appraisal and appraisal fee?
- What’s closing costs?
- What are discount points and origination points?
While you are at this step, you should also check if you may qualify for any special type of mortgage loan, e.g. a VA loan (for U.S. veterans), an FHA loan (U.S. Federal Housing Administration) or an RHS loan (U.S. Department of Agriculture’s Rural Housing Service).
3.) Check the impact of down-payment size
Assess your ability to make a down-payment and how this will impact which mortgage loans that are available to you. Sometimes, saving a bit longer in order to make a larger down-payment means that you can negotiate a more beneficial mortgage loan. This is because the money you pay cash when you purchase your home creates equity and decreases the loan-to-value ratio.
- You purchase the house for $1 million. You pay $100,000 cash and obtain a $900,000 mortgage loan. Your home equity is $100,000. The loan-to-value ratio is 900,000 / 1 million = 0.9.
- You purchase the house for $1 million. You pay $250,000 cash and obtain a $750,000 mortgage loan. Your home equity is $250,000. The loan-to-value ratio is 750,000 / 1 million = 0.75.
A loan-to-value ratio that is very close to 1 means that the amount owed to the mortgage lender is very close to the market value of the collateral. Just a small dip in market price is necessary to create a situation where the collateral is worth less than the amount owed. Of course, this is not a desirable situation for the lender. That is why many lenders will quote you a high interest rate if you apply for a mortgage loan that is equal or almost equal in size to the market value of the house. You may also receive an offer of getting two mortgage loans instead of one; one long-term mortgage loan where the interest rate is fairly low and then another down-payment loan where the interest rate is considerably higher and the repayment term is shorter.
Example: The purchase price is $1 million, but you only have $25,000 in cash. You need to borrow $975,000. The loan-to-value ratio would be 0,975. The bank gives you an offer consisting of a $900,000 low-interest mortgage loan with a 30 year repayments term and a $75,000 medium-interest mortgage loan with a 5 year repayment term.
In some countries, laws limit how close to 1 the loan-to-value ratio is allowed to be for a licensed mortgage lender to approve an application. (These laws are typically only applicable for loans to people, not loans to businesses and similar entities.) This often means that applicants without sufficient cash reserves obtain a high-interest unsecured loan to cover the down-payment.
4.) It’s now time to contact the potential lenders
Instead of just going with the bank where you’re already a client, broaden your search to include several different suitable mortgage loan providers. Depending on where in the world you live, there may be several different banks to contact, plus credit unions, specialized mortgage companies, and community-focused thrift institutions.
As mentioned above, always check if there is some type of special home mortgage loan that you may qualify for, e.g. a beneficial loan offered by or backed by the government to help individuals like you.
The credit report
The lenders you contact will most likely order your credit report from a credit bureau in order to have something to base their evaluation of your creditworthiness on.
In some countries, requests by creditors to see your credit report is noted in the credit report and can have a negative impact on your creditworthiness. Because of this, it is usually best to contact all lenders at the same time to keep the requests within a focused period of time. For anyone taking a closer look at your report, it will be obvious that you are shopping around and comparing options rather than being someone who applies for a multitude of loans and credits.
In the United States, the FICO Score disregards multiple requests if they happen within a 45-day period. Several other agencies also employ some variant of this method, although with varying length of the window.
There are mortgage brokers that will contact multiple lenders on your behalf and obtain quotes for you. Unless the broker is under contract to act as your agent, the brokers is not legally required to act in your best interest. Also, even a broker that is impartial will still only work with a limited number of lenders.
Still, using mortgage brokers can be convenient since it makes it easier to obtain many quotes with a minimum amount of work. You can enlist the aid of several mortgage brokers to cover a larger section of the lending market, and then manually contact those few remaining lenders that doesn’t work with any of the brokers.
As mentioned above, having many requests from lenders to see your credit report can look bad on your credit report. To prevent this, some mortgage brokers will obtain your credit report themselves and then share it with the lenders. That way, only one request is made.
5.) Calculate the total costs
Now that you have the quotes from the lenders, make sure that you are comparing apples to apples and not apples to tennis balls. While many lenders love to smack a low interest rate in big bald print at the top of their quote, you need to take all the costs into consideration to make a fair comparison. Some lenders can keep a low interest rate since they rely on a plethora of fees to bring them money. Also be vigilant when it comes to various introductory offers, teaser rates, and so on. You want to know how good a mortgage loan is long-term, not just for the first six months.
Don’t forget to check out discount points and origination points. It is often a good idea to translate the points into dollar amounts to give yourself a better idea of what they actually entail.
It is often possible to negotiate with potential lenders to obtain better terms and conditions. This is especially true if your creditworthiness is high, since each lender then knows that there are many other lenders that would want you as a client.
Tips for the negotiation:
- You are negotiating the terms of a mortgage loan that you may or may not elect to accept. You are not begging, pleading or praying for a loan, and you aren’t a school-yard bully either. Be nice, polite and to the point.
- Be knowledgeable, both about your own financial situation, about mortgage loans and about the property or type of property that you wish to buy.
- The bank wants good collateral, preferably collateral that is worth much more than its liens. If you know something that gives you reason to believe that the property will increase in value more than the house market in general, let the lender know. Some lenders do not have much local knowledge and might need to be informed about why the house you’re buying is such a great deal.
- If there is anything that speaks in your favor but isn’t included in your credit report, make sure the lender knows about it.
- Do not automatically assume that negotiations done in person yield a better result for you than those conducted over the phone or through email. Each method of communication has its strengths and weaknesses. Being willing to drag yourself around from one bank office to another and meet the representatives at their turf can actually make you seem more desperate for a loan, especially at the early stage of negotiations. Also, while we all like to think of ourself as confident, convincing and devastatingly charming in person, capable of swaying even the toughest professional negotiator, this might not be entirely in line with reality.
- Some banks will give you a better deal if you become a full-client with them, e.g. set up a bank account, apply for a credit card, and so on. Sometimes this is a good route to go, sometimes not. Check the details and don’t make any rash decisions.
- When the lender gouges your ability to make monthly payments, your income may be compared to a standard for how much an individual reasonable similar to you would spend per month. If you know that your spending habits are significantly different, it can be useful to bring this up. “I know most people in this neighborhood owns a car, but I’m an avid biker and have no plans to get a car, because I can bike to my office at 4812 Main Street in 20 minutes if I take this route through the park.” You probably need to be pretty specific here. Simply claiming that you can afford a big monthly bill because your oh-so frugal wont be very convincing.
- If a representative seems unwilling to even entertain the idea of negotiating, don’t spend to much time trying to make them come around. It is usually easier to contact another person at the same company and see if you get a different response.
- If you have friends that are similar to you when it comes to creditworthiness but already have a mortgage loan, try to find a polite way of asking them about the terms and conditions of their loan. Knowing what other people got can help you with you negotiations. Lenders like for us to remain in the dark about the deals they strike with our peers, because knowledge is power. Of course, you shouldn’t cry Not fair! You have to give me the same low interest that you gave Sarah! but you can bring up Sarah’s rate and ask the lender what it would take for you to be given a similar offer.
- If a lender can’t budge much on the interest rate, see if there is anything else that can be changed to make the offer more appealing to you. Maybe there are certain fees that can be waived or at least reduced? Maybe another branch of the company can throw in a perk, such as a year of free home insurance? Of course, don’t allow yourself to be razzle-dazzled by insignificant favors. In most cases, it is better to pick the lender with the low interest rate than the lender that give clients free monogrammed slippers.
- Do not let a lender rush you into making a decision. No, not even when you are offered that super duper mega special deal that is only available right NOW NOW NOW and then never again in the history of mankind.
- After a successful negotiation, make sure you get a written lock-in that includes pertinent information about the offer and also clearly states for how long the lock-in lasts. It is also very important that the lock-in includes information about how long the terms and conditions will last if you accept the mortgage loan offer. Realizing that you have negotiated down your interest rate for just two months isn’t very fun.