How to Shop for Mortgages: Key Terms and Differences
If you're not paying cash for your home—and most of us aren't—you'll need to find a mortgage loan and submit an application for approval. Banks and lenders offer many different types of mortgage programs to finance a home purchase.
Before speaking with a lender, take the time to learn how to shop for mortgages by comparing terms, rates and other key factors that can affect how much you'll pay for your home.
Basic mortgage loan vocabulary
A basic understanding of how mortgages work can help you formulate the right questions to ask a mortgage banker. Banks and lenders may use different names for their mortgage programs, but the underlying components should be comparable. You'll need to understand the basic components of a loan, including the term, the interest rate and any additional fees the lender charges.
The loan term is how many years you're given to pay it off. One common mortgage term is 30 years, with 360 payments, or one each month for the life of the loan. Mortgage loans are also available with shorter terms, such as 10 or 15 years. A shorter term will help you pay off your home faster. Alternatively, a longer term will give you a lower monthly payment, but you'll typically pay more interest over the life of the loan.
Like all other loans, mortgages charge an interest rate. These rates can move up and down according to changes in the underlying benchmark rates. Interest rates are often controlled by economic factors that are out of your control. When it comes to interest rate, what you can control is making sure you're in a position to qualify for the lowest rate possible. The best rates, or prime rates, are often offered to those with higher credit scores. Paying down other debt prior to purchasing a home may also help you nab a better mortgage rate.
Many traditional mortgage programs require the buyer to pay for 20% of the property in the form of a down payment. Some mortgage programs allow for lower down payments, but the buyer may be subjected to a higher interest rate or may be required to purchase private mortgage insurance, known as PMI.
Prepaying interest in the form of points will lower your interest rate. A point is equal to a percentage of your mortgage loan, so for a $100,000 loan, one point is $1,000. Each point you pay upfront can lower your rate by a set amount. You can measure how much the lower rate would change your monthly payment by using a mortgage calculator.
When learning how to shop for mortgages, it's helpful to know some of the common benchmarks that can be used to compare loans. If you understand what's considered to be a baseline mortgage, you'll be in a better position to find a loan that works best for your homebuying situation.
- Conventional mortgages: A conventional mortgage is a loan that's made through a lender and isn't part of any specialized government programs. Conventional mortgages are approved through a well-established mortgage application process. Buyers must generally supply a 20% down payment to qualify for a conventional loan. If you're approved for a conventional mortgage, you should be able to compare similar loans from different lenders to determine which works best for you in terms of rates and fees.
- Interest rates: The prime rate is one benchmark that you can use to evaluate a loan. This prime rate is often the one the bank offers to the most credit-worthy customers. If you're offered a rate above prime, you may want to ask if there's anything you can do to qualify for a lower rate.
Know the different types of mortgages
Before you apply for a loan, you should talk to your lender about the different types of mortgages. Every homebuyer has a unique financial and personal situation. The mortgage you choose should be a good fit for your budget and help you meet your long-term financial goals. Once you select a mortgage type, compare what different lenders are offering.
A fixed-rate mortgage keeps the same interest rate over the life of the loan. This means the monthly payment will stay the same. Homebuyers like fixed mortgages for their stable payments, simplicity and ease of fitting into a budget. During periods of low interest rates, a fixed mortgage protects against rising rates in the future.
Adjustable-rate mortgages typically offer a lower rate for an introductory period, then reset according to an underlying base rate. Buyers who are planning to resell their homes in the near future may want to consider an adjustable-rate mortgage to take advantage of the lower introductory rate.
A conforming mortgage is a conventional loan that banks can sell to government-sponsored enterprises such as Fannie Mae. The buyer must meet certain minimum credit requirements, and the loan amount must be under the annual conforming amount. Non-conforming loans will be handled differently, and rates or fees may change. A jumbo mortgage is an example of a non-conforming mortgage because the loan amount is greater than what Fannie Mae will purchase for a single loan.
Ask about special mortgage programs
Some mortgage programs are offered to help homebuyers in specific situations. Buyers without a 20% down payment may still qualify for certain mortgage loans. Other mortgages may be designed to cater to certain demographics or buyers in specific geographic communities.
- First-time buyer: First-time buyers' programs are available through individual banks or government agencies. The loans may offer lower down payment options, but buyers will need to purchase mortgage insurance. Buyers may also be asked to attend a homebuying workshop.
- VA loans: Veterans Affairs, or VA, loans allow veterans to purchase a home with little or no money down. This loan doesn't carry a mortgage insurance requirement, and closing costs are generally lower.
- FHA loans: Federal Housing Administration, or FHA, loans can help buyers with lower credit scores and lower down payments purchase a home. Borrowers must purchase the FHA's mortgage insurance, known as a mortgage insurance premium, or MIP.
Choose a mortgage that works best for you
When shopping for a mortgage, you may be tempted to choose the loan with the lowest rates or fees. But it's also important to compare other characteristics including monthly payments, fixed versus adjustable rates and the term.
Your current lifestyle and household budget should also be a factor in your mortgage loan decision. You may want to structure a loan with a lower payment and use the extra cash in your pocket to cover other household expenses. Or you may want to increase your monthly housing payment to pay off your mortgage faster. An experienced mortgage banker can help you evaluate your options and find a loan that fits your unique situation.
A few financial insights for your life
This information is provided for educational purposes only and should not be relied on or interpreted as accounting, financial planning, investment, legal or tax advice. First Citizens Bank (or its affiliates) neither endorses nor guarantees this information, and encourages you to consult a professional for advice applicable to your specific situation.