How to choose the best mortgage

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How to choose the best mortgage

By JOHN KUO

Getting a mortgage is like buying a pair of pants: One size does not fit all. And you should shop around to find the perfect fit for the right price.

But how do you find the best mortgage for you? The homebuying process can seem overwhelming. For most people, it's the biggest financial purchase of their lives -- and after diligently searching for the right house, mortgages can often be an afterthought. However, getting the right loan can save you thousands of dollars.

When it comes to choosing a mortgage, you'll need to consider your financial situation and your available options. Once you have a sense of the type of loan you want, you can compare lenders and offers. By understanding your needs and some basic loan terminology, you'll be able to make a better-educated decision about your loan offers.

Assess your situation.

Before considering your loan options, assess your situation and your needs. This can help you pick a loan that fits your unique circumstances. Here are some of the most important factors that will likely impact your financing options:

Potential home cost

Your mortgage payments will largely depend on your home's cost, which can vary depending on where you're looking to buy and what kind of place you're looking for. Check out this calculator to find out how much home you may be able to afford.

Financial well-being

Your credit history and the amount of money you have for your down payment can affect your loan options. People with high credit scores are generally able to get mortgages with lower interest rates. Similarly, a larger down payment can help you pay less in interest overall.

Life plans

The average American is expected to move approximately 11.4 times in his or her life. Depending on your career or life events, you might move shortly after buying a home or you might stay for decades. This may affect the mortgage option you should choose. For example, the longer you plan on staying in your home, the riskier an adjustable-rate mortgage (ARM) may be.

Consider loan options.

Now that you've evaluated your personal situation, you're ready to look at different loans. There are three main factors to consider when comparing loan options: the term, the interest rate type and the loan type.

Loan term

Typically, homebuyers get a 15-year or 30-year mortgage, though other terms may be available. The term length indicates how long you have to pay off the loan. On a 30-year mortgage, you'll generally have a lower monthly payment compared to a 15-year mortgage, but you'll pay more in interest over the life of the loan.

Interest rate type

There are two basic types of mortgage interest rates: fixed and adjustable. Adjustable rates generally come with higher risk: They're low initially and can change over the course of a loan, so your mortgage payments may fluctuate. On the other hand, fixed rates will stay the same and the mortgage payments won't change over the life of the loan. Historically, about 70-75 percent of homebuyers have opted for fixed-rate mortgages.

Loan type

You can choose from three main types of loans: conventional, FHA and special program loans. Conventional loans typically come from a bank or credit union and aren't part of a specific government program. FHA loans are insured by the Federal Housing Administration, allow for smaller down payments and are available to people with lower credit scores. The government also runs special programs for various groups, such as VA loans for veterans or U.S. Department of Agriculture loans for people living in rural areas.

Compare lenders and estimates.

Once you've assessed your mortgage needs and have a sense of the type of loan you're looking for, start shopping lenders. You may want to ask your friends and family for recommendations, then take a look at online marketplaces that'll help you compare interest rates and lenders.

Getting multiple offers may give you negotiating power and help you understand your options. Krystal Covington, who recently bought a home in Colorado, decided to pit the two lenders recommended to her by her developer against each other and was pleased with the results.

"We initially chose the one that responded first, but then the other lender presented a lower price, so we told them we would consider switching during the process to save thousands in interest," she says.

"In the end we chose the first lender because they seemed to be the most motivated and we wanted to close as quickly as possible. They were the best choice [in our opinion] because they were massively passionate and helped us get things done."

Kevin Quinn, senior vice president of retail lending at First Internet Bank, says there's no magic number for how many lenders to consider.

"Potential homebuyers should focus on researching and identifying the top lenders they want to consider and narrowing down those options until their 'short list' has been established," he says. "Key considerations for any prospective homebuyer may include expertise, reliability and, most importantly, available financing options to fit their specific situation."

Quinn notes that highly trained and experienced lenders should be able to help borrowers select appropriate financing options and find the best rates. Getting a mortgage is a big decision, so you should always feel comfortable asking your lender about interest rates, loan options and closing fees.

Understand loan costs and fees.

When comparing loans, your monthly payment amount can depend on the interest rate and point mix.

Points are fees you can pay upfront to decrease your interest payments over the course of the loan. Generally, homebuyers who plan to stay in their home for a long time may want to consider buying points upfront because they will have lower overall payments over the course of the loan.

For example, if you took out a 30-year mortgage for $100,000 at 5 percent interest with no points, your mortgage payment would be $537 each month. Paying for points might allow you to lower that 5 percent interest rate.

Hypothetically, let's say you paid $2,000 for two points and decreased your interest rate from 5 percent to 4.5 percent (actual decrease can vary). With a 4.5 percent interest rate, your monthly mortgage payments would decrease to $507. It would take you 67 months to make up the $2,000 difference, so you would have to stay in your home for nearly six years to make it worth your while.

Check whether buying points makes sense for your situation. USAA has a calculator that can help you make an informed decision, but you may also want to talk to your mortgage lender or broker to help you determine your exact point and interest rate mix.

Your mortgage lender is required to provide a Loan Estimate within three business days of receiving your application. This form goes over important details about the mortgage, usually including your estimated interest rate, monthly payment and total closing costs for the loan. Lenders are required to use the same form, which can make it easier for you to compare loans.

Taking time to understand all your financing options can help you choose the right mortgage. You'll be able to better negotiate with lenders and know what to look for in a mortgage that fits your needs.

Bottom line

Choosing a mortgage is a complicated decision. Although your interest rate is important, you should take other factors into account, such as how long you plan on staying in your house and what kind of loan you want. Also, it's best to shop around for mortgages to find the best rate and a lender that you trust.

About the Author: John Kuo is a personal finance writer living in Northern California. He writes about mortgages, small businesses and taxes. His work has been featured in numerous outlets such as The Washington Post and The Wall Street Journal. In his free time, he likes to play bocce ball and paint.

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One quick question: Isn’t a credit union a better option for fixed mortgage loans as they have low interest rates?

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