The complete guide to comparing mortgages

The buying process doesn’t stop once you’ve found your dream home or investment property. Finding the right loan key.

If you’re a homeowners, chances are that your mortgage is the largest sums of money you’ll ever borrow. On the plus side, your mortgage will eventually give you full ownership of a home and all the benefits that come with it.

Taking out a mortgage isn’t something you should rush into. Take the time to find out about how they work, the types of loans that are offered, the rates available to you and how to run an effective comparison. Taking out the right loan will save you thousands in the long run.

What is a mortgage?

When you want to buy a home or investment property, you take out a loan called a mortgage. You borrow money from a lender who charges a fee — known as interest — which is rolled into your monthly payments.

The lender considers your property collateral — or security for the loan. This means if you can’t make your payments, the lender can repossess your property and sell it to recoup the loss.

How does a mortgage work?

If you’ve never purchased a house and gone through the complicated mortgage lending process, the terms and process of applying can be daunting. Here’s a basic explanation of how a mortgage works.

Retail and wholesale lenders

Mortgages are offered by either retail or wholesale lenders

• Retail lenders are banks such as Citi, JPMorgan Chase, Bank of America, Wells Fargo, and U.S. Bank. You can apply directly with these banks for a mortgage.

• Wholesale lenders allow their loans to be offered through third-party lenders such as mutual or building societies and credit unions.

• Sometimes the lender funds loans with their own money and are known as portfolio loans. Lenders set their own requirements and loan terms.
• Most of the time mortgages are funded by borrowed money known as mortgage bankers. This means the loan is funded by borrowed money, and then sold to investors on the secondary mortgage market.
• When you apply for a loan, lenders assess your risk by considering your credit score, down payment, assets, debt and income. Your risk will determine if you get the loan and what your interest rates will be.
• The amount you actually owe is the principal. In exchange for lending you this money, your bank will charge interest.
• The interest rate given to you is applied to your principal each month, so it’s usually divided by 12 and then applied to what you owe each month.

Mortgage payment breakdown

A 4% mortgage rate on a principal amount of $500,000 would require a monthly repayment of $2,387.

This is made up of:

• An interest charge of $1,666.67 (4% divided by 12 = 0.33%. Divide $500,000 by 0.33% = $1,666.67)
• You’ll pay $720.41 of your principal each month.

What about interest-only loans?

In cases where you only wanted to pay the principal of a loan — usually if you’re only keeping a property for a short amount of time — you can choose an interest-only loan. Once the principal is eliminated from your monthly payment, you’ll pay less monthly, but it won’t reduce your loan about at all. Interest-only loans aren’t generally bought by Fannie Mae or Freddie Mac on the secondary market and usually require a good credit score.

What types of mortgage rates should I consider?

There are many types of interest rates, from fixed for a range of time to rates that can vary each year, also called adjustable rate mortgages.

Fixed rate mortgages

Most people opt for a fixed-rate mortgages. This allows you to lock in a rate for 10, 15, 20, 25 or 30 years. During this time, your rate and payments won’t change, giving you the security of mortgage payments that won’t fluctuate.

Who is best suited to this type of loan?

• Those with a solid budget. Your payments won’t change for the life of the loan, meaning you can rest easy knowing exactly how much you’ll pay each month.

Read more about fixed rate mortgages

Adjustable rate mortgages (ARM)

An ARM is a mortgage with an interest rate that can fluctuate periodically (once a year, for example), meaning your payments may rise or fall over the course of your loan.

Today, the hybrid-ARM is most common, having an initial fixed period (usually five, seven or 10 years), during which your rate and payments won’t change. Once this fixed period ends, the rate is adjusted to match market conditions which could raise or lower your monthly payments.

You are offered some security though. Usually lenders will cap the amount the rate can go up or down at each adjustment period and over the life of the loan. But be aware that your rate could jump significantly during adjustment periods, so be 100% certain that you can afford the worst-case scenario.

If you have a shorter fixed period, rates are generally lower. Adjustable rate mortgages are usually advertised with the initial fixed period first followed by how often the rate will be adjusted, so a 5/1 ARM will have an initial five-year fixed rate, with the rate adjusted once a year after.

Who is best suited to this type of loan?

• Those who are planning on selling their home before the fixed period ends. This means you’ll be able to enjoy a lower rate for the initial fixed rate years and then sell after.
• Those who can afford the worst-case scenario. If you choose to keep the loan once the initial fixed rate period ends, there’s always the possibility that rates can drop lower during the adjustable period, depending on market conditions. There’s also the possibility they can be raised higher than you can afford. Be sure you can afford your repayments at the highest interest rate.

Read more about ARMs

What types of mortgages may be available to me?

Conventional loans

These are regular mortgage loans that are not part of any government loan programs like a Department of Veterans Affairs (VA) loans or Federal Housing Administration (FHA) loans. Conventional loans can be both conforming or non-conforming.

Conforming. These loans meet the qualification standards imposed by Freddie Mac and Fannie Mae, such as maximum loan size, credit scores, the size of your down payment in relation to your total mortgage and your total debt. If your mortgage fits within their specific criteria, it will be bought by Freddie Mac or Fannie Mae. Some counties may have higher maximum loan sizes that Freddie Mac or Fannie Mae will still buy. These loans are known as conforming jumbo loans.

Non-conforming. A non-conforming loan doesn’t meet the criteria of a conforming loan and therefore isn’t usually bought by Fannie Mae or Freddie Mac in the secondary market.

• Jumbo loans. One of the more common types of non-conforming loan is the jumbo loan, which refers to a loan that’s larger than the maximum loan size set by Freddie Mac and Fannie Mae. This limit is usually $417,000, but can be as high as $625,000 in Alaska and Hawaii. The maximum amount you can borrow with a jumbo loan depends on your county.
• High LTV loans. LTV stands for loan-to-value ratio and refers to your down payment as a percentage of the property purchase price. For example, on a property worth $300,000, if you had a down payment of $30,000, your LTV would be 90% ($30,000 is 10% of $300,000). LTVs above 80% require private mortgage insurance (PMI) and may also be classified as non-conforming depending on the lender.
• Loans with lower documentation requirements. These loans are for those with complicated finances, such as the self-employed.
• Loans for non-standard properties. Non-standard properties that are difficult to appraise, like commercial farms or properties with large amounts of land, may require a non-conforming loan.
• Loans for credit-impaired borrowers. To qualify for a conventional mortgage, you’ll usually need a minimum credit score of between 580 and 640 depending on the lender. If you have recently declared bankruptcy you may find it difficult to get a conforming loan.
• Loans for those with high total debt. Those with a high debt to income ratio may not qualify for a conforming loan.

FHA loans

This type of loan is insured by the Federal Housing Administration (FHA), and allows borrowers to purchase a property with a lower down payment and with less-than-stellar credit scores.

The basics:

• You can borrow with a down payment of as little as 3.5% with a minimum credit score of 580.
• You can borrow with a down payment of as little as 10% with a minimum credit score of 500.
• Requires two forms of mortgage insurance, both which are paid monthly.
• Is assumable, which means that if you sell your property the buyer can take up your loan, making it more appealing.
• Must be used for a primary residence.

FHA loans have a number of other eligibility requirements, particularly around your employment history and debt ratio, so be sure to do your research before applying for one.

Find out more about FHA loans

VA loans

If you’re eligible, a Veterans Affairs (VA) mortgage can be a great way to buy a home with no down payment or mortgage insurance.

The basics:

• No down payment depending on the borrower.
• Competitive interest rates, usually 0.5–1% lower than conventional rates.
• No mortgage insurance premium is payable.
• Is assumable if the buyer is also eligible.
• Allows you to prepay your mortgage with no penalty fees.
• Must be used for a primary residence.
• Backed by the Department of Veteran Affairs, but funded by private lenders.

As with the FHA loan, a VA loan comes with a range of eligibility requirements. You will be required to fulfil one of the following conditions:

• During wartime: 90 days of active service.
• During peacetime: 181 days of active service.
• Over six years of service in the reserves or national guard.
• Spouses of those who have fallen in the line of duty.

You’ll also need to supply your lender with a certificate of eligibility, and you’ll need a stable income to pay your mortgage off, among other eligibility requirements.

Find out more about VA mortgages

USDA loan

A loan from the US Department of Agriculture is aimed at low to medium income borrowers who want to buy in a rural area. USDA loans offer benefits similar to a VA loan, including no down payment, but still requires private mortgage insurance (PMI).

The basics:

• No down payment required.
• Loans are either guaranteed by the USDA and issued by private lenders, are direct loans from the USDA, or are smaller loans and grants for home improvement.
• The loans must be used for primary residences.
• Applicants must have 24 months of stable income and an acceptable credit history.
• Debt ratio and credit score requirements also apply.

State and local programs

In addition to conventional loans and special program loans like those from the FHA, VA or USDA, there are a range of state and local programs to help Americans buy a home. These include programs targeted at those with low or moderate incomes and other groups, so be sure to speak to a housing counselor in your local area to see what’s available.

How can I compare mortgages?

1. Decide on a loan type. First, decide if a fixed or adjustable rate mortgage is best for your plans and budget. This is also a good time to find out your credit score and what loans are available to you.
2. Shop for different loans. Compare different banks and lenders based on your loan type and down payment.
   • Use the APR. The annual percentage rate (APR) is an interest rate that includes some of the fees and charges of your loan. This can be a more accurate way to compare loans, but this is only an indication of the cost of your loan over the full term. Getting out of your mortgage early will make the effective APR much higher.
   • Be wary of advertisements including points. When comparing loan rates, some lenders might advertise rates inclusive of discount points — fees paid directly to the lender at closing in exchange for a reduced interest rate. This isn’t necessarily bad, but when comparing loans you’ll want to exclude discount points on all loans to make your comparison fair.
   • Find out about rate locks. Find out if you’re able to lock in a rate so it doesn’t go up during the application process. This feature usually comes with fees.
   • Be mindful of prepayment penalties. Check potential loans to ensure there are no prepayment penalties, as you’ll more than likely want to change homes in the future.
3. Ask for a loan estimate. By law, lenders must give you a loan estimate. This three-page document shows you the interest rates, repayments, closing costs and even a section on the last page that gives you the key figures to use when comparing.
4. Repeat until you find a loan you want. It’s normal to ask for loan estimates from more than one lender until you find a loan you’re happy with.Back to top

How can I get the best rate on my mortgage?

• Compare multiple lenders. Always get more than one quote when looking for a mortgage. This way you’ll get a good mix of options from different types of lenders.
• Get your credit score in order. A credit score above 740 can open the door to more competitive interest rates, lower down payments and other loans — even special government program loans such as FHA and VA loans.
• Consider paying for points. Discount points are upfront charges you can pay to reduce the interest rates on your loan. You should work out if paying for points will be beneficial to your total cost in the long run, especially if you don’t plan on keeping your home for a long time.
• See if you qualify for special programs. There are a variety of government, state and local programs that may offer competitive rates and terms.
• Save a larger down payment. The bigger your down payment, the lower your interest rates will be because you present less of a risk to the lender.
• Lower your debt-to-income ratio (DTI). Your total debt load will affect which loans you qualify for. It’s a good idea to pay off and close any credit cards or loans you don’t currently need when you’re shopping for the best rate.

From start to finish what fees will I pay on a mortgage?

On average, you’ll pay 2% to 5% of the purchase price of a property in closing costs.

Once you pick your lender and type of mortgage, be sure to ask for a loan estimate (previously known as a good faith estimate or GFE). This includes a full list of all the closing costs you’ll be expected to pay.

Right before settlement, you will receive a closing disclosure (previously known as a HUD-1), which is a final listing of your costs and is more accurate than the loan estimate.

• Credit report fee. Your lender will want to know your financial history to get an idea of your risk.
• Appraisal fee. You’ll pay for an appraisal that proves that your property is worth the sale price. This protects the lender if it needs to sell your property and recoup the costs.
• Origination fee. This fee is for processing your loan application and is generally a percentage of your loan amount.
• Title insurance fee. At the time of closing, you’ll pay for title insurance that comes in two forms — the lender’s and owners. The lenders title protects the lender while the owners title protects you.
• Title search fee. This fee is charged to determine whether or not a seller has the right to sell a property to a buyer.
• Survey fee. In some states, a survey of the property is required to ensure property lines and boundaries are correct.
• Closing fee. You’ll pay this fee to the attorney or company handling your closing.
• Private mortgage insurance (PMI). If you have a down payment of less than 20% of the purchase price, you’re required to pay PMI each month. PMI doesn’t cover you but rather your lender if the bank has to repossess your home and sell it to recoup the costs. If the bank doesn’t recoup the costs, it will activate the PMI and you’ll deal with the PMI provider.
• Inspection fees. Home and pest inspections will uncover any nasty hidden surprises within your new home.
• Homeowners insurance. Your lender will usually require that you take out homeowners and possibly flood insurance to be paid monthly.
• Points. Paying for discount points can reduce your interest rate, saving you money on your monthly payments. This is an optional cost and one you should consider the merits of before paying.

Other fees you might have to pay include postal fees to send your applications and documents to your lender and attorney fees.

How to apply for a mortgage

1. Decide on a lender and loan you’re comfortable with.
2. Ask to start the application process. You’ll fill out a uniform residential loan application, which includes information about the type of mortgage you’re applying for, information about the property and your assets and liabilities. Be prepared to submit the required documents.
3. Your application is reviewed by a loan officer before you sign it. You may pay an application or processing fee, depending on the lender.
4. During this time, the appraisal will occur, your credit report will be examined and other processes like the pest inspection will happen. Your application will also be examined and reviewed by the underwriter. You should also receive your loan estimate document. (Prior to October 3, 2015, you would have received a GFE and truth-in-lending disclosure statement. On the other hand, if you’re applying for a reverse mortgage, you’ll still receive these two documents rather than a loan estimate).
5. You’ll receive your closing disclosure (formerly known as the HUD-1 settlement statement). This shows the exact closing costs you’ll pay.
6. Attend your closing meeting. Here you’ll sign all the remaining documents and get the keys to your new home.

Who’s involved in the purchase of your home?

When applying for a loan:

• Loan officer. Your loan officer will be your first point of contact and the person to help you find a loan when you approach a lender. Your loan officer will also help you complete your application and should keep you updated of its progress along the way.
• Loan processor. Once you’re ready to apply, the loan processor will collect the required documents from you to support your application and will check the necessary calculations for your loan.
• Mortgage underwriter. The final say on whether or not you’ll be approved for a loan rests with the underwriter, who will evaluate your application and either approve or reject it.
• Closing representative. This person will oversee and conduct the closing meeting and the transferring of funds between parties.

When buying a property:

• Real estate agent. A good real estate agent will be your point of contact to find a home and help you negotiate with the seller to get the best price.
• Real estate appraiser. Your lender will require an appraisal of the property you’re purchasing to calculate its value.
• Home inspector. A home inspector isn’t always mandatory, but can be well worth it if they find something wrong with your potential home. They are trained to look at the property checking for structural surprises or safety issues. They’ll be able to tell the overall condition of the property you’re buying.
• Pest inspector. This professional will evaluate your property for pests like termites, which can destroy wood over time.

What is a loan estimate?

A loan estimate is a document that lenders and brokers are required to give you by law. It gives you an estimate of the costs required when closing a particular mortgage.

The loan estimate will display information such as:

• The interest rate of the loan.
• A breakdown of the closing costs of a loan.
• An estimation of the tax and insurance costs of a loan.
• An estimate of your monthly payments.

By receiving a loan estimate, you’re not obligated to proceed with a specific lender. It’s just a good method of comparing loans accurately from more than one lender.

You should receive your loan estimate within three days of receiving your loan application.

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What’s a closing disclosure?

You’ll receive a closing disclosure at least three business days before closing. It lists all the important information about your mortgage, including:

• Your loan terms, such as how long you’ve fixed your loan for.
• What your monthly payments will be.
• The closing costs of your mortgage.

If you’re applying for a reverse mortgage, you’ll receive a HUD-1 and a truth-in-lending disclosure instead of a closing disclosure.

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Where to from here?

Now that you know about the basics of a mortgage and how they work, you might want to start asking yourself what type of mortgage will suit you. Do you want the stability and security of a 30-year fixed rate, or are you more likely to sell your property in the medium-term and therefore like the sound of a hybrid-ARM? Think about what features you want out of your mortgage and what may suit you before you start your comparison.

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