I recently purchased my first house and took out a 30 year fixed rate mortgage. It is a detached single family home that we built with a reputable builder in a new community. The process was intense, confusing, sometimes sleazy, effort intensive, and eye opening. I learned a lot about the process and wanted to share a few things to hopefully help you if you are taking out a mortgage. I am not a mortgage broker, officer, lender, etc so this is my personal experience and knowledge gained as an independent consumer. I am confident I received one of the best and overall packages possible, but I had to put in some work to achieve it. When you are paying this type of money over the long term, even the smallest tweaks to the rate and incentives have huge impacts. The point being is that the little extra effort pays off here. In this article I will share with you tips, how I got the best rate possible, and other information to inform you on making the best decision for yourself.
Types of Mortgages
There are many types of mortgages out there and many resources that will exhaustively explain them in detail so I am not going to focus on that here. Rather in this section I will explain some of the decision points that went in to choosing a mortgage that fit my needs. I chose a 30 yr fixed mortgage and came to that conclusion by applying the following:
- First I checked out whether I qualified for government loans or other special programs like FHA loans. These types of programs can offer better terms than regular bank loans. I also called on the banks for a conventional (mortgage) loan.
- Then I looked at whether I wanted a fixed rate or adjustable rate mortgage. Interest, especially during the first part of your loan repayment schedule, is the bulk of the payment so I want to make sure I chose the right rate type. Interest rates were pretty low at the time I got my mortgage so I chose to lock in that low rate (with a fixed rate mortgage) for the long term. Additionally, with a fixed rate I would have the most predictable payments making my family budgeting easier. I could have received lower rates (at least initially) with an Adjustable Rate Mortgage (ARM), which are loans whose interest rates change over time depending on different market variables. However, I did not want to guess my rate later (even if there is a cap on the rate) and deal with the risk of the maximum increases.
- Next, I thought about my timeline. My plan is to not sell my house in the short term so I did not go for a shorter term mortgage or one that is less than 30 yrs. A short term adjustable rate mortgage can be optimal in various situations such as if I know that I will sell my house soon after purchasing it or if I know I plan to pay off the mortgage quickly. Loans with shorter timelines should have lower rates so if it makes sense for you go for it. My suggestion is to think about where you think you will be in 5 yrs, 10 yrs, 15 yrs, 30 yrs. Performing this exercise helped me determine which type of mortgage fit me best. Also look at interest rates today and guess in which direction they will go under which timeframe. This also helped me decide on the type of mortgage to take out in terms of fixed vs adjustable.
- Another major factor to consider is the size of the loan (relatively smaller loans are called conforming loans and larger / higher risk loans are called non-conforming loans). Larger loans mean more risk for the lender which manifests itself in higher interest rates on the mortgage. What classifies as a non-conforming loan amount depends on factors such as location and property type. For example, a non-conforming loan is typically over the mid $400k range for a single family home.
- The amount I put down for the mortgage (aka downpayment or equity I put in to the home) also plays a role here - the more I put down the less risk for the bank relatively which should manifest itself in lower interest rates. Putting too little down ( < 20%) means I would have to pay mortgage insurance. For non-conventional jumbo (large loans) mortgages, 20% downpayment is required. Doing the math, I would need to make sure I can meet these amounts. The lender looks at it from the lens of the loan size using a ratio called LTV or Loan-to-Value. For example, $40k down on a house with a value of $100k has a LTV of ((100-40)/100) = 60%.
- I also needed to think about timing - doing all of this due diligence takes time. To complicate matters my builder gave me an approximate closing date 90 days in advance but they didn't guarantee it. 30 days in advance they made the closing date more official. If I was purchasing a resale there could be similar timing challenges of having enough time to perform my due diligence on loan packages and find the home/figuring when I would be closing on it. I needed to think of when I wanted to lock my rate. From what I found a 90 day lock costs more than a 60 day lock than a 30 day lock. This makes sense because I am paying the lender the option to have today's rate but applied in the future and the longer the lock period the more unknowns there are or risks for the lender. I took a more conservative approach and used a longer lock period because the rates were low and the math for the cost of the loan at that price made sense to me. If I was comfortable with more risk here I could have locked in 30 days prior, for example, and paid less.
- There are also factors that can impact loan choice--and in particular interest rates offered--such as credit score, income stability, how much income I have to how much debt I have, etc. If some of my personal factors here aren't great I would need to focus on specialized, high cost loans for high risk people.
Just a tip - finding the best loan is not as black and white as finding the loan with the lowest interest rate. For example, there can be other costs associated with a loan. There is a figure called the APR which takes the interest rate plus other loan costs in to consideration and is a good measure to use when comparing loan offers.
Even without doing much math I can compare mortgages out there to really narrow down what type is right for me.
Different Types of Consumers
Figuring out which type of consumer I am helped me determine what type of broker, lender, financial institution I wanted to work with. Here are a few questions that are worthwhile to think about:
- Is my sole mission to get the lowest rate and / or cost package?
- How important is a relationship with my lender to me?
- Am I a numbers person who will dive in to the details?
- Do I easily understand finances?
- Do I like to shop around?
- Do I like to become an expert on the process or do I like hand holding?
- Do I like all of my accounts and finances in one place such as a single financial institution?
- Am I willing to transfer funds around to reduce rates and costs?
- Do I have good credit and a solid financial foundation?
My mortgage matchmaking skills aren't at the level of Tinder's algorithms so unfortunately I don't have a formula for pairing you to specific lender types. However, by answering the above and talking to different lenders or brokers, I was able to quickly determine who I didn't want to work with. It is always easy to eliminate institutions, brokers, lending officers quickly this way which is really helpful when there are so many options out there. For me it was still worthwhile to get in touch with a lender even if I knew ahead of time that I might eliminate them because it is good to see what offers they may have, what their rates are, and I usually learned something new with each person I spoke with. When it came to choosing one out of several winners, I similarly refined my list via the above Q&A. The reason I am even writing about this is because a mortgage is one of the largest commitments you will make. Additionally, the mortgage process can be lengthy, test your wits and limits, and go in to some very personal information about your finances. With that said, it was important that I worked with someone I could trust and that I liked...in addition to getting a low rate. Armed with answers to the above questions, as you talk to different people I am confident you will start to see what I am getting at here.
Not all Lenders are The Same
I encountered different lender types out there and different personalities. Below are some of the different types that I came across and I am sure there are more out there. I soon realized that with this type of commitment, it was important to select a lender that I really wanted to do business with.
- My bank - I talked with my bank which I have been doing personal banking with for years. It was nice that they had some of my information already but I still needed to provide what I felt to be duplicative information that they already have on me. I know this is not an issue with my bank only. I like the idea of going with one's own bank because you can typically manage your loan from the same online account as your personal banking. Going in to the local branch, I knew the relationship would be good which is also a plus. However, in the end they just weren't competitive enough with the incentives and rates.
- The "I won't give you the lowest rate guy" - I encountered a few of these type of people that didn't even seem to want to work with me because I was comparison shopping and going after low rates. The good thing is that they were upfront on their strategy that they are all relationship based and probably won't get me the lowest rate. Supposedly they would take care of everything for you and provide a hassle-free experience. The lender I went through in the end provided that experience for me anyways along with real low rates. So not sure I understand this 'me or go somewhere else' attitude and I was really put off by this type of business person.
- Online lenders - After shopping around a bit I decided to go online and try SoFi. I personally did not like the experience. I performed all of the typical initial data collection stuff online as a first step. Then it got a little confusing on how to proceed. I did get an email stating that if I had questions to contact the loan officer they provided. I called but the person only worked California hours which is not my timezone and we had trouble connecting. Then when we did connect, after I chased her down, I felt that the engagement was lethargic and not personal. I also felt it would be in my best interest to have someone that I could meet in person if needed and have a relationship with. I do not shy away from technology but in this case the traditional old-school approach was better for me. This is such a large, complex, and detail oriented process that it was helpful to have someone close by.
- Quicken - I thought I would bring this one up since they are the nation's largest lender, are not a typical bank and, they don't have physical locations. Rocket Mortgage is their online platform. I called up Quicken because someone I knew used them and told me they provide the lowest rates. Well they don't and they weren't in tune with some local details that were relevant to my loan. However, the person I dealt with there was excellent and I felt I had a solid business relationship with her just as I would with a local person. Again, they just weren't the most competitive and didn't have that local touch.
- Builder - the builder of the community where I purchased my home also runs a financing company for loans. The builder offered extra incentives like credits if I used their financing and also made it appear like the process would be easier if I just used them since the home purchase and financing were tightly coordinated. I know people in the community who used them but I did not, even though they offered what appeared to be nice incentives and a user friendly experience. After due diligence I was able to get lower rates/costs from some banks directly and felt my experience was not more difficult because I went outside.
- Other local banks - When I say 'local' here I am referring to anything with a physical presence in the area, whether it is a small regional bank or big national bank. I called and visited a bunch of local banks. I also called the same banks through their corporate Websites and got to their national mortgage sales call centers. It wasn't bad but it was akin to working with Quicken. So the key difference here is that you can call a local branch and deal with someone local directly. I ultimately chose my loan through this route and my lender officer even came to my closing to make sure everything went smoothly. I found that my local bank understood the nuances of the local market/geography/construction best. Also with that personal connection they really spent time with me to help me get the best package possible.
One last tip is that dealing with someone local can really help. A local lender understood my needs, the local housing market, and special conditions related to the market better. For example, in some markets it is common to put flooring in post-close if you are building and a local lender would have no problem with this. A lender outside of the local market often would not approve of this or even understand why someone would do this. Or in some cases the non-local lender would allow it but require additional funds in escrow - why put more money in escrow?? Another example is flood zones. This could have insurance impacts that a local lender will have a better grip on. These are only a few examples but imagine all of the different nuances in each locale.
Different Types of Lender Offers
Lenders advertised different incentives to earn my business and these incentives can bring the total costs of my loan, including both initial and subsequent overall monthly costs, down. Again I didn't just look at the rate offered rather I looked at the overall package. I came across the following different types of offers in my search:
- Referal credit - if I am referred by someone else who got a loan by the lender, I would receive $750 off the closing costs.
- Auto-withdrawl credit - if I sign-up to have my mortgage payments be auto-withdrawn from my bank account then I would receive a $695 credit
- Existing customer credit - if I took a mortgage with my current bank, I would receive $600.
- Builder credit - if I used the financing company of the builder I would receive a $5,000 credit (but note that their interest rates were relatively high so this credit would help to purchase points to reduce the interest rate)
- Transfer money - This is probably where you see the biggest bang for your buck if you are in a position to do this. If I would transfer funds to the lender bank usually to either a brokerage account, if they offer one, or something like a checking/saving account then I would get significant discounts. Usually these discounts would come as point reductions that I could use to either reduce my interest rate or my closing costs. I saw that moving money to a brokerage account associated with the lender bank provided the best incentives. Typically, the more money that is moved the more the discount. It takes some effort to do this but even slight rate reductions have huge impacts over the long term.
I would look for the above types of incentives and I am confident that there are other offers out there too. This is why it was worthwhile for me to shop around and do my due diligence - I saved a ton of money this way. It can be a bit overwhelming though because one incentive might seem great but there are areas where the lender cost might be higher, like in the origination fee, to offset the discount. I had to evaluate the full picture not just the incentive itself.
The following details my experience which I like to refer to as the game. The lending officers, originators, or whoever was selling me the loan did not seem to like that I was shopping around. However, it is my right as a consumer in a free market to compare offers and choose the one that is best for me. This is also the advised strategy from the US Governments Consumer Financial Protection Bureau [CFPB] (which is a great resource for learning more about loans).
Here is how it is supposed to go...
- I contact a lender
- I provide some basic information (according to the CFPB I only need to provide 6 pieces of information (name, income, SS# for a credit check, new home address, home value, and loan amount) to receive a Loan Estimate (aka: LE, an official regulated document in a standardized format which I can use to compare loans from different lenders). And the lender is required to provide the LE within 3 business days.
- The lender provides me with a Loan Estimate
Here is how it really goes...
- I contact a lender
- Lender states a great rate and point package to get me hooked
- Lender collects the basic info
- Lender also collects more information than required for the Loan Estimate all in the name of: "that is the only way our system works," or "system limitations require collecting all of this info prior to sending the LE." I was even told once that I needed to give my credit card info in order to get a Loan Estimate (not ok) - and it wasn't to cover the expense for a credit check (however, it is ok if I am asked to pay for the credit check).
- The lender additionally puts pressure on me to provide supporting documents upfront -- such as bank statements and W2s -- to show that I am "serious." Sometimes going so far to say our email system is broken and the LE is in the mail, let's proceed in the mean time. I never received the LE in those cases.
- Lender provides a closing cost worksheet and says it is just like the LE. However, it is not the same document and I only want the LE which is the regulated, standardized document.
- Lender makes excuses to not provide the LE despite me having provided the minimum required information. Many only wanted to provide me the LE once they were convinced that I would use them for my loan. However, remember, the LE is a standardized document we use for comparing prior to committing.
- Either closing cost worksheet or LE do not have the rates promised by the lending officer.
- Lender says that s/he has the extra incentives in their "back pocket" and already approved by their manager. At the right time (at closing) it will be applied to the loan if I move forward. In these cases I just have promises, which aren't documented in a LE, and thus in my opinion do not hold value.
What is happening here is that the lender tries to hook me with amazing rates/promises and then tries to get me to sign on quickly (inducing fear that I will lose the opportunity) or get me sufficiently invested in their process so that I won't go anywhere else. It is true that the more information the lender receives, the easier it is for them to identify special situations and issues but it is just a plus rather than a requirement. If the LE does not include the exact loan package that was promised, then the lender's verbal offer doesn't mean much. I was given advice from someone in the industry that if a lender won't provide a LE or won't provide one with the amazing package that they verbally promised or even put in an email, then RUN! Also, after some time of getting these unofficial closing cost worksheets from the banks, I figured out that I would just need to fight to get the LE. The LE should be the same as the terms of the loan at closing if I move forward quickly enough to lock in the loan after I received the LE. Note though that the terms of the LE can change in certain circumstances if it specified that the rate is not locked or if the information I provided turns out to be different than what I stated to the lender.
While the whole bait and switch thing with these great promised rates is pure sleaze I do have some (but not much) empathy for the lenders. Most lenders would tell me, "give me the lowest LE you received from another lender and we will beat it." So the lenders will actually do what they can to not deliver a LE until they are more confident I will go with them - I can kind of understand why they take this approach. However my empathy stops there because I heard this offer match strategy from every lender so in the end I decided to use it -- a tactic that lenders both hate (I assume) and promote at the same time. I provided my final lender the LE of another bank to help reduce my final package costs.
The Loan Estimate
The Loan Estimate is a standardized document which means that its format is the same, no matter which lender produces it. As described in the game above, I highly recommend getting the Loan Estimate document from multiple lenders and not settle for anything less. When I got my Loan Estimate documents from different lenders, I needed to make sure that the terms were the same on the document in order to fairly compare offers.
The lender is required to send the LE--and it can be delivered via email--within 3 days of providing the minimum info mentioned above. Once I received the LE, I typically would have 10 days per the LE terms to accept the terms of the LE. To secure the terms I would tell the lender that I am officially moving forward with their offer. The next step would be to go down the path of their "official" application, which typically incurs an application fee and includes the terms agreed upon in the LE. In my case, the application fee was applied as a credit to the closing costs when I closed which was an added bonus! If I didn't accept the LE within 10 days, it would expire. In the LE I can lock my rate or leave it unlocked (aka floated). If I float the rate then I risk getting a higher rate at closing - at the time I was going through this process there was a lot of chatter about the fed raising rates so I chose to not float. I chose to lock in my rate and pay the extra costs which are delivered in the form of points or higher rates. Rates were very low when I locked it so I was comfortable with my choice and I had an extra piece of mind which is priceless.
When using the LE for offer matching between lenders, I needed to ensure that lender 'B' would turn around and match lender 'A's' offer quickly. To secure the match, the lending officer from lender 'B' may have to go to his manager and possibly to others, which could take time and put the LE I already have in hand from lender 'A' at risk of expiring. It is possible that lender 'B' may come back later claiming that things changed or that they couldn't match. This would leave me without the decent offer I had from lender 'A' and without a decent offer from lender 'B'. I needed to aggressively push the lenders here.
Here is a sample Loan Estimate from the CFPB*:
In terms of what to look for on the Loan Estimate...
The LE is 3 pages:
- Page 1 - The first page has a summary of loan terms, projected payments, and costs at closing. When comparing LEs the information on this page should be all the same unless you get different rates from the different lenders and then only some of the information will vary. Apart from the rate, the other items on this page that can affect the overall offer is (i) whether or not the rate is locked, which will usually have a cost in points if it is locked and (ii) whether or not items like property taxes and homeowners insurance are put in escrow. I saw that the lenders will give a discount on the points when I put these items in escrow. There is always a tradeoff: on one hand I would receive the discount because I reduce the lender's risk and on the other hand I would be tying my money up in escrow which has its own cost to me because I could theoretically garner returns if I were to invest that money in the interim. I chose rate lock and escrow.
- Page 2 - The second page of every LE is divided in to sections A through J and are clearly labeled for easy analysis. Ultimately I put the most focus on sections A and J when comparing lenders because that is what I could influence and everything else should be very similar, if not the same, across lenders.
- Section A is the origination fee and this total fee can vary by thousands from LE to LE so pay close attention here and negotiate these fees with your lender. It includes the cost of points or credits and various lender fees like application fees, rate lock fees, underwriting fees, and more.
- Section B contains services that I cannot shop for and are non-negotiable, however, each lender may have different totals here. The overall total in section B should be fairly consistent across lenders.
- Section C contains services that I can shop for and this is primarily shopping for a title company. I found most title company fees to be in the same ballpark (as most of their fees are rates set by the government) but can vary by several hundreds of dollars (via their own servicing charges or non-required fees that they insert) so I did extra due diligence to find the best priced title company that I felt comfortable doing business with.
- Section D just adds up A-C.
- Sections E through I lists costs that should be the same or estimated to be very similar on all LEs assuming the same loan and property value amount. I found this section less useful for comparing the offer and more useful for understanding what my overall costs would be on any loan. I just needed to verify that all the costs listed there were correct, like the property taxes.
- Section J contains closing costs which can include lender credits used to reduce closing costs. This can also be a large positive and tip the scale towards one lender or another. In general, it is good to compare the closing costs across LEs but may be hard to get an accurate number at this point. Just ensure that these credits don't come at the hidden expense of a cost somewhere else.
- Page 3 - this page contains a few basic aggregated costs which I used to compare to other LEs. I did not receive 2 LEs that were the same so these aggregated numbers help normalize that comparison by providing: my 5 yr costs, the APR (discussed at top), and how much interest I pay as % of the loan amount.
Before I go in to how to evaluate points to make the best decision, a quick heads-up... Many lenders threw around the different terms related to points as if I was in the industry myself. Not only do they throw around the many terms for the same thing but they will throw around numbers very quickly and for those that don't like fractions, brace yourself. I wouldn't let this scare me though and with a little understanding I was able to make informed decisions that gave me more flexibility and leverage with my money. Additionally, lenders can purposefully use this quick talking strategy with points to confuse consumers and hook them in to a package that is really not what was expected. They will make it seem like everyone should understand points quickly and be able to add fractions easily in addition to extrapolate point costs with ease. Don't worry you are not alone - points are confusing and make it that much more difficult to evaluate the full picture of what is being offered.
The basic idea is that points can be purchased at close to lower the interest rate on the mortgage term which in turn will lower monthly payments. On the flip side, I can actually take a higher rate and get credit back from the lender. I don't advise to just take the market rate (a rate with no points attached) without at least looking at what the points have to offer.
Below is an graphic I made illustrating key concepts of points:
I also drew up the below to help evaluate if it makes sense to purchase points.
Last, I created the below to help evaluate if it makes sense to take a credit from the lender via negative points.
On the first page of the Loan Estimate it indicates my yes/no option for putting homeowners insurance and property tax in escrow with the lender. I believe some lenders may require that escrow be used while others provide it as an option. The advantage of putting insurance and tax funds in to escrow is primarily conveniences because the lender will take care of the administration of payment of these bills. Putting funds in escrow make monthly budgeting a bit easier too. Lenders benefit from having this money in escrow because it reduces their risks and earns them interest off of my money. I was offered 1/8 of a point discount to use escrow and took advantage of it. For me the convenience factor + 1/8 point discount outweighed being able to invest this money elsewhere for a greater return. I am a new homeowner so with everything going on, I didn't want to deal with these payments separately. Like the points discussion above, using escrow depends on each own person's situation. I believe I can elect in the future to not use escrow without impacting the discount I already have received - a win win.
To include or not include...that is, closing costs in the loan?
I had the option to include my closing costs in the mortgage or pay cash for them at closing. If I rolled them in to the mortgage, I would be financing the closing costs over the term of the loan. This could also increase my loan-to-value ratio to the next risk tier for the lender, forcing him to bump my mortgage interest rate higher. The other downside is that I would be paying a significant amount in interest over the life of the loan on the closing costs. If I pay the closing costs at close I use up cash in hand but I wouldn't pay interest on them over the life of the loan. Again, this is a personal option that doesn't necessarily have a right or wrong answer. It goes back to the discussion of am I short of cash now and if not, can I invest this money elsewhere on my own and earn higher returns than the mortgage interest rates? I chose to finance the closing costs because I can put this money to work elsewhere, earning more. Plus if I end up selling my house for a profit and do it earlier than my anticipated long term horizon, I win out by having the closing costs covered in the profit and avoiding paying the closing costs upfront.
What I Can Quickly Impact
I found that I can quickly impact the following when looking for the best package.
- downpayment - the more skin I have in the game the less risk there is for the lender and this can be reflected in the interest rate
- the lock - the longer out the lock the more cost will be incurred.
- credit score - I didn't mention this above but if there are errors in my credit score that can be cleared quickly, it can result in a higher credit score which can positively impact the interest rate offered to me.
- the interest rate - probably hard to flat out negotiate this but I assume not impossible. Easier to negotiate through LE matching. I made sure to educate myself on the going rates for the specific loan for someone in my lender risk profile - this way I reduced the risk of overpaying when shopping around. A negotiated reduction in rate may come at the expense of points or other increased closing cost type fees.
- points - I can pay more upfront to reduce my interest rate. Or in some cases I can take a rate that offers negative points which manifests itself as a credit on the closing costs.
- escrow - it is less risky for lenders when I put insurance and real estate taxes in escrow so sometimes it is rewarded with discounts.
- origination fees - I believe this can be negotiated down. My guess is that the origination fee is one area a lender can also use to offset discounts provided elsewhere so be careful here.
- title company - I saved hundreds here by making a few calls and comparing prices. Many of the fees that a title company provides are published book rates based on the value of the property, meaning they will be the same across title companies, so it should be easy to compare. However, what I found though is that the unlike the Loan Estimate, there is no required standard format for comparing these costs so they will be presented in different ways which makes comparing confusing and harder. Often times one title company will provide a more comprehensive estimate than other title companies, including contract specific items like HOA fees. Other title companies may not go to that depth with their estimate and may look much cheaper - but don't get fooled. The title company estimate should have similar totals across quotes. Look for the closing service fee which is not a book rate and is service fee set by the title company - this fee can be discussed/negotiated.
- different types of lender offers mentioned above - this may be where the biggest bang for the buck is.
- closing costs - these costs can be rolled in to the loan and financed as part of the loan. I chose to role these costs in to the loan rather than pay at closing because I believe I can make more money over time with that cash in hand than the cost of financing it. This would seem to be a great approach too for shorter term loans, if offered.