Finding the right house to buy can take months—years, in some cases. Finding the right mortgage should be easier. With a few quick tips and some careful calculating on your part, we can help you make sure you get a mortgage that fits your budget and your financial goals.
1. Adjustable vs. Fixed Rate
One of the first things you need to look at when comparing mortgages is whether you want an adjustable or a fixed rate mortgage. Comparing the two can be difficult, as they play out in very different ways over the long term. Right now, with interest rates still at historically low levels, a fixed rate mortgage will be best for most borrowers - adjustable rates have nowhere to go but up.
2. Interest Rate and Points
Looking at the interest rates being offered by various lenders is key in effectively comparing mortgages. For virtually all mortgages, the interest rate or APR (annual percentage rate) is what determines how much the loan is going to cost you. Most lenders will offer several interest rates with various "points," and this can complicate matters slightly.
"[Points] are actually prepaid interest on the mortgage loan," explain the mortgage experts at Bankrate.com. "The more points you pay, the lower the interest rate on the loan and vice versa. Borrowers typically can pay anywhere from zero to three or four points, depending on how much they want to lower their rates. This kind of point is tax-deductible."
Points are tax deductible because they are mortgage interest, plain and simple. You’re simply paying the interest in an upfront lump sum rather than spreading it out over your monthly mortgage payments. If you have enough cash on hand and plan to stay in your home and with your mortgage for awhile, points can be a good idea; if you don't mind slightly higher monthly payments with less cash out of your pocket at closing, stick with a no-points deal. When comparing interest rates, look at the par rate — the rate without paying any points — on each loan.
3. Monthly Payments, Closing Costs and Overall Cost
The interest rate of your loan will determine how much your loan costs, but it's important to look at how the cost of the mortgage will be spread out. Shorter-term loans tend to have lower interest rates but higher monthly payments; you want to find the right balance of a low interest rate with monthly payments that comfortably fit into your budget.
Closing costs can also vary considerably from lender to lender, and should be an important part of your mortgage comparison.
"Get Good Faith Estimates (GFE) and Truth In Lending Act (TILA) statements from each lender you have chosen and look at the out-of-pocket closing costs for each loan," says personal finance writer Laura Bramble. "These legally required documents specify the individual closing costs for the loan. One lender may have a lower interest rate but charges higher closing costs."
With closing costs, monthly payments and the overall cost of the loan all laid out, you should be able to select the mortgage that’s best for your budget and your long-term plans. Remember: the less cash you have to come up with at closing, the more expensive the loan tends to be over the long haul. The key is finding the balance between what you can afford now and what you can afford in your monthly payments.