Tips for Choosing the Ideal Mortgage

admin | March 17, 2013

Before we talk about the ideal mortgage, we need to find the ideal lender, not always an easy task.

Ideal Lender

If you are buying a bank-owned property (that’s PC speak for foreclosed home), the ideal lender is the selling bank. They will be more likely to forgive any shortcomings that might show up in your credit profile because they are motivated to sell the property.

You may also be in a stronger position to negotiate rates, points and other fees. If you’re not buying a foreclosed home, the best place to begin is a bank with which you have an established relationship.

This relationship could be in the form of an auto loan, checking or savings account, safe deposit box or certificate of deposit. Of course, your Realtor will have options as well, but be cautious.

These are frequently “I’ll scratch your back if you scratch mine” relationships and not necessarily your best option. This is a major transaction, so shop around.

What to Expect

In the current economic climate, mortgage lenders of all stripes have significantly tightened lending policy. Conservative lending is the norm these days.

If your credit record, employment history, income, references and down payment are not up to par, it is very probable that your loan will not be approved.

Alternatively, you may receive an approval, but at a higher interest rate. Remember, rates are a function of risk. If the information in your credit profile suggests a higher than average risk, you can expect to pay a higher than average interest rate.

If you find you fall into this high risk group, you may be better off deferring your home purchase until you can raise your credit score and bring other aspects of your credit profile to a higher level. Allow me to explain.

Cost of Borrowing

In this example, the calculations are accurate, and meant to illustrate the impact of paying a 1% per annum higher rate of interest. In our example, you will be financing a modest $75,000 dollars over a twenty-year term, which are 240 payments.

If this loan is approved at 4.5%, you will pay $474.49 per month. However, if the loan is approved at 5.5%, your payment rises to $515.92 per month, a difference of $41.43 per month. This may not seem like much, but multiply that by 240 payments and you are looking at an increased cost of $9,943.20 over the life of the loan!

It is important to recognize, the larger the loan, the greater the difference. You can readily see how interest rates affect your cost of borrowing.

Mortgage Types

Another factor that you must consider is what type of mortgage is best suited to your current needs and future goals. There are several types of mortgages available such as fixed-rate mortgage loans, adjustable-rate mortgage loans (“ARMs”) or hybrid ARMs.

Hybrid ARMs are mortgage loans that have interest rates that are fixed for an initial period (typically three, five, seven or 10 years) and, thereafter, reset at regular intervals subject to interest rate caps.

I believe that regardless of your current needs and goals, the fixed rate mortgage is the absolute best choice now. Here is why. Mortgage loan rates are at the lowest levels since 1971. In short, the only direction they are likely to move from here is up!

A 30 year fixed rate mortgage loan is available at less than 4%. Shorter-term loans have even lower rates. As a result, there is no reasonable argument for any of the more exotic mortgage loans available. They only allow your rate to increase as the cost of money increases. Why would you want to do that?

Choosing the Appropriate Term

The final point I would like to discuss is term, which is nothing more than the length or duration of the loan. Fixed rate mortgages tend to have 30, 25, 20, or 15 year terms.

I recommend that your mortgage payment should not exceed 25% of your income. On that basis, choose a term that meets this objective. Your lender can calculate payments for various terms or go on the Internet and find a mortgage calculator that allows you to do this for yourself.

A Word of Caution

In closing, I offer a few words of caution. Your home is an investment. For many, it is the bulk of their wealth and something to rely for emergencies.

You can sell the house or take out a second mortgage to access your equity and pay for something that is more important to you. However, the investment has another nuance to it; is it a good investment in the sense that it will provide you financial returns? This is no longer something we can take for granted. It may be years before housing recovers.

There is no guarantee that housing will ever recover fully. In short, be realistic with your expectations. At best, you may see your home appreciate as the years go by, creating a nest egg for retirement, your children’s education or other goals you may have.

At worst, you will live in a place of your own and not spend your money making a landlord wealthy. At either extreme, you could do a lot worse than investing money in a home of your own.