How to Shop for a Mortgage

Understand How Mortgages Work

A mortgage allows you to borrow the funds needed to purchase a new home. Most mortgages require you to make a down payment, usually at a minimum of 3% to 5% of the sale price, depending on the type of mortgage loan. Many buyers aim for a 20% down payment, but the amount you put down will depend on your unique financial situation. The amount of your mortgage is determined by the difference between your down payment and the purchase price of the home. You will also be responsible for paying closing costs and fees that typically range between 2% and 5% of the purchase price.

Mortgage terms can vary, but are commonly either 10, 15, 20 or 30 years. During that time you will make monthly payments to the lender to cover the following:

• Principal: This is the loan amount not including interest or what's already been paid off.
• Interest: The finance charge on the loan, interest is based on the annual percentage rate (APR) charged by the lender.
• Escrow: The escrow account holds a pool of money that is used to cover homeowners insurance, property taxes and other costs when they are due. You may also need to pay for mortgage insurance if your lender requires it.

During the repayment period, the deed to the home remains in the lender's possession. When you pay the mortgage in full, the lender will transfer the deed to you. If you fall behind on your payments and eventually default on the loan, the lender has a right to foreclose and take possession of the home.

Here's a breakdown of the different types of mortgages and how they work.

• Conventional loans: These mortgages are offered by banks, credit unions and other mortgage lenders. Conventional loans are not backed or insured by government agencies. They may be sold to a different lender within a few months of closing.
• Government-insured loans: Backed by government agencies, these loans are originated by private lenders but offer solutions for would-be homebuyers who might not otherwise be able to be approved for a loan. They include FHA loans, VA loans and USDA loans.
• FHA loans: These loans are insured by the Federal Housing Administration (FHA) and allow a down payment as small as 3.5%. You may be able to qualify for an FHA loan if you have a low income or less-than-perfect credit. Qualification criteria for these loans are less stringent than what you'd find with conventional loans.
• VA loans: Loans through the U.S. Department of Veterans Affairs cater to members of the armed forces and their families. If you qualify, you could get approved for a mortgage without a down payment.
• USDA loans: This loan is designed for low-income borrowers who plan to purchase a home in a rural area. No down payment is required.

No matter what type of mortgage you get, the interest rate will be a major deciding factor. However, it's important to understand that mortgages will fall into one of two broad categories that determine whether or not the loan's interest rate can change:

• Fixed-rate mortgage: Your loan's interest rate will remain the same over the entire loan term. These mortgages provide more predictability for your monthly payments, but they might result in higher rates compared with the alternative.
• Adjustable-rate mortgage (ARM): These mortgages come with an interest rate that can fluctuate. Generally, your interest rate will be fixed at the beginning of the loan term and then change annually with market rates. The frequency with which the loan rate can change is expressed with a fraction such as 5/1 or 7/1. With a 7/1 ARM loan, you will have a fixed rate for the first seven years, after which the rate can change annually. Some buyers prefer these loans since they can provide a lower interest rate during the initial fixed period compared with fixed-rate loans—but they are riskier because you don't have a guaranteed rate locked in for the life of the loan.

Check Your Credit Score and Report

When you apply for a mortgage, lenders review your FICO^® Scores^☉ and the information in your credit reports, often from all three of the national credit bureaus: Experian, TransUnion and Equifax. For single borrowers, the lender typically orders scores from lowest to highest and uses the middle score to assess eligibility for a mortgage loan. To illustrate, if you have scores of 620, 650 and 690, the lender will typically use 650 to make a lending decision. When two people are getting a mortgage together, the lender looks at the lower middle score of the two.

Here are the general credit score guidelines by loan type:

• Conventional loans: FICO^® Score of 620 or higher
• FHA loans: FICO^® Score of at least 580 (or 10% down payment for a FICO^® Score as low as 500)
• VA loans: FICO^® Score of 620 or higher
• USDA loans: FICO^® Score of 640 or higher

Knowing where your credit stands before you move forward can help you set realistic expectations. If you find your credit scores aren't as high enough to qualify you for a mortgage, you might take the time to improve your score to give yourself the best chance of getting approved.

You can get your credit ready for a mortgage by continuing to pay your bills on time, paying down your credit card balances and avoiding new credit applications.

Get Preapproved for a Mortgage

Once you feel your credit score is mortgage-ready, you can explore loan offers. You can do this by getting prequalified or preapproved. Although the terms are often used interchangeably, they have different meanings.

• Prequalification includes a quick review of your finances and credit history that helps estimate how much you could possibly qualify for. It only takes a few minutes to get prequalified, and you can call in or visit the lender's website to answer a few questions about your income, assets and debts.
• Preapproval is a more in-depth process that paints a more accurate picture of your eligibility for a mortgage. You have to formally apply for a mortgage loan and submit supporting documentation for the lender to review. Expect to provide personal details, consent to a credit check, and offer income documentation and a list of assets and debts. Some lenders also collect an application fee to get the ball rolling.

If everything checks out, you will get a preapproval letter that includes loan terms and your interest rate. Most preapproval letters are valid for up to 90 days and can be used to make an offer on a home.

Shop Around for the Best Rates

It's always ideal to shop around with mortgage lenders or brokers to get the best rates. This will require multiple lenders to access your credit report, which results in many credit pulls. However, most credit scoring models will group all the hard inquiries related to mortgages into one if you shop within a period of a couple of weeks.

If you're still not getting the rates you want, consider using a mortgage broker. They will shop your information around to a network of lenders who may be able to offer you more favorable loan terms. You may also secure a more competitive interest rate by providing a larger down payment.