Shopping for a home loan is just as important as shopping for the home itself. Here’s what you should “know before you owe.”
From weeding through paperwork to searching for optimal loan terms, purchasing a home can be as mentally taxing as navigating a foreign country without knowing the language. Let’s face it: Channeling your energy toward finding the perfect home in Atlanta, GA, or Sacramento, CA, is a much more pleasurable experience than agonizing over potential lenders and loan applications.
Yet, the loan and lender you ultimately choose should be just as important as the neighborhood you explore or the home on which you put an offer; therefore, the amount of legwork for each chore should be comparable. In an effort to bolster consumer education, improve the loan-shopping process, and cut through the jargon on loan documents, the Consumer Financial Protection Bureau (CFPB) last year established the Know Before You Owe mortgage program. (Now there’s really no excuse for not doing your homework before buying a home.)
Here’s a quick rundown on what Know Before You Owe entails — and what mortgage questions you should ask along the way.
Prior to October 2015 and the start of Know Before You Owe, loan applicants would have received two forms upon applying for a loan: a Good Faith Estimate and a Truth-in-Lending disclosure. Created by two separate federal agencies and filled with overlapping information, the forms made it difficult for consumers to compare everything from loan amounts to interest rates.
With Know Before You Owe’s streamlined Loan Estimate, it’s easier to find pertinent loan information, which in turn can encourage comparison shopping instead of hindering the process. (You can explore a sample Loan Estimate on the CFPB website.)
1. Are points included in the quoted interest rate?
Points are upfront fees — equal to 1% of the loan amount for each point — paid to reduce the interest rate on the loan. It’s important to clarify whether the quoted interest rate includes points and, if so, how many.
2. What are the closing costs associated with this loan?
Closing costs typically fall between 2% and 5% of the total loan amount — a large enough range to make this question an important one.
3. What is the required down payment?
A variety of loan types are available, and not all of them require the same down payment. Make sure to ask how much you will be required to put down and, if it’s less than 20%, ask if tacking on Private Mortgage Insurance (PMI) will be an additional requirement.
4. Is it a fixed-rate or adjustable-rate mortgage?
A fixed-rate mortgage keeps your interest rate and mortgage payment locked for the entire duration of the loan (yep, all 15 to 30 years). An adjustable-rate mortgage (ARM) can adjust after a designated period depending on the market, potentially increasing your monthly mortgage payment substantially.
5. Can the interest rate be locked down? If so, for how long?
The interest rate offered by a potential lender isn’t a guarantee — unless the lender can lock it down for you. If you are offered a particularly low rate, make sure you know when you need to lock it down and how long it can be held.
6. Are there any prepayment penalties on this loan?
In exchange for a lower interest rate or lower out-of-pocket costs upfront, some lenders will charge a prepayment penalty. Depending on the terms, the prepayment penalty might have to be paid before refinancing or selling the home within a designated period. It’s important to know beforehand exactly what your loan requires.
According to a survey conducted by the CFPB, only 47% of consumers shop around for a home loan, and for those who do, rates can vary by as much as a half-percent from lender to lender — a substantial difference over the life of a loan. In addition, some banks or mortgage lenders might not have access to the type of mortgage that would be the best fit for your specific situation. But without a little extra searching and knowing to ask the right questions, you would never be the wiser.