For most would-be homebuyers, making a run at homeownership is going to mean getting approved for a home loan.
It's a process that, at best, can be stressful and confusing. Borrowers can be better prepared by taking steps to study their options and learn what to expect from a lender.
"It's surprising to me that people tend to spend more time in pre-purchase research for a car than they do for a home mortgage," says Chris George, president of home mortgage lender CMG Financial.
Keeping up to date on changes in the mortgage market is necessary, because the government, which essentially backs 90 percent of new home mortgages, keeps tweaking the guidelines for the loans it will guarantee.
Just this week, the Federal Housing Administration put into effect several new mortgage rules, including one that raises the cost of mortgage insurance for borrowers who take on FHA-backed loans, among other changes.
Here are six tips for improving the chances that the mortgage math will add up in your favor:
1. Build a strong credit score
One of the main factors that lenders look at to determine a borrower's creditworthiness is, aptly, their credit score.
Bad borrower behavior like late credit card or other loan payments, having a foreclosure or bankruptcy in one's credit report and carrying high balances will weigh down your credit score.
Most banks sell the home loans that they make to government-owned mortgage companies such as Fannie Mae and Freddie Mac. To do that, those lenders must adhere to certain lending criteria.
Loans backed by the Federal Housing Administration will accept FICO scores below 600, but expect to pay a significantly higher interest rate the lower your score. A stellar score ranges from 760 to 850 and can give you greater negotiating power over the terms of the mortgage and ultimately, the total cost of the loan.
One way to mitigate the impact of a low score: Make a higher down payment, George says.
If your credit is less-than-stellar shape, make sure you give yourself time to rack up good credit history well before you attempt to apply for a home loan. This starts by checking your credit.
Consumers are entitled to a free credit report every 12 months from each of the credit bureaus: Experian, TransUnion and Equifax. You can get copies at www.annualcreditreport.com.
2. Know your loan options
Apart from increasing the chances of qualifying for a loan, making a down payment of at least 20 percent of the sales price or appraised value of the home will spare you from having to pay private mortgage insurance.
If you can't afford that, you might qualify for financing on an FHA-backed loan. Those loans allow borrowers to make a down payment of as little as 3.5 percent of the purchase price. That's great if you're a first-time buyer and haven't saved up for a bigger down payment. But to protect itself from potential loan defaults, the FHA requires lenders to charge extra fees to cover monthly mortgage insurance payments.
Until this week, the FHA had dropped the mortgage insurance requirement for homeowners with 30-year loans who made payments for five years and managed to bring their loan-to-value ratio to 78 percent. Now, borrowers with a loan-to-value ratio between 78 and 90 percent will be able to stop making mortgage insurance payments after 11 years. But those borrowers who still have a loan-to-value ratio greater than 90 percent will be required to pay mortgage insurance for the life of the loan.
"No matter how much of your loan you pay down, you'll always have to pay that insurance premium, and that's pretty significant change," says Rick Sharga, senior vice president at mortgage lender and servicer Carrington Mortgage Holdings.
Another change that went into effect: The FHA is requiring that borrowers put down at least 5 percent on home loans of $625,000 or more. That's up from 3.5 percent, but actually less than the 10 percent down that most lenders require.
3. Consider making a larger down payment
Given the prospect of not being able to get out of paying private mortgage insurance, some experts say borrowers who can afford to put down more than 3.5 percent on a home should consider getting a loan that's not backed by the FHA, sometimes known as a conforming loan.
Such a loan typically only requires that the borrower make a 5 percent down payment. Although that means you still would have to pay private mortgage insurance, at least you're not locked in, notes Jack Guttentag, Wharton School professor of finance emeritus and founder of www.mtgprofessor.com, which offers advice and online calculators for weighing different mortgage scenarios.
That mortgage insurance can be canceled automatically when the loan-to-value hits 78 percent. "You're generally better off getting a conforming loan," Guttentag says.
4. Keep an eye on fees
In addition to a down payment, you'll also have to set money aside for closing costs, which can run into the hundreds or sometimes thousands of dollars.
Lenders charge all manner of fees, some of which are negotiable, while others are not. They are required to itemize all fees required to close the deal, so review them carefully.
Your bank could charge you to cover items such as credit reports, appraisals, documentation and administrative costs. The total expense will vary depending on where you live and your particular situation.
Also, if you end up with mortgage insurance, that could cost $100 or more a month, depending on the type of loan.
5. Wait for a good deal
Rising home prices and warnings, usually trumpeted by lenders, that interest rates will soon rise can create a sense of urgency to purchase a home. But if your finances and credit score are not solid enough to enable you to qualify for a loan at an affordable rate, it's best to not rush into buying.
To boost your chances of getting a good deal on a home loan, Guttentag recommends having a credit score of 740 or better, making a down payment of 20 percent.
6. Comparison shop
It's prudent to get a feel for what different mortgage lenders will offer. After all, getting a home loan is not unlike getting financing for a car. There is some room for negotiation, says George.
He suggests borrowers approach lenders and state what kind of loan term and interest rate they want, and how much of a down payment they're willing to make. Borrowers also should ask what can be done to accomplish this with the least amount of points, or fees that can be charged based on a percent of the loan amount.
As leverage, it's best to have quotes from competing lenders, which can be obtained on several websites. They may be enough to sway the lender to match more favorable terms offered by the competition.
In addition to Guttentag's site, you can find mortgage calculators and pricing quotes at www.bankrate.com and www.zillow.com/mortgage-rates.