Few contracts you sign in your life are as important as a mortgage. Fully examining and comparing mortgages is incredibly important, so here are five basic questions you should discuss with your loan officer before you consider signing off on a home loan.
- What is the interest rate?
The interest rate on your loan has an influence on the size of your monthly payments and the total cost over the life of your loan.
It’s important to know what interest rate you’re getting and be sure you’re working with a lender who can offer a competitive rate.
- Is the interest rate adjustable?
In the right circumstances, an adjustable-rate mortgage can be a smart choice that provides you with significant savings on interest over a fixed-rate mortgage.
As their name implies, adjustable-rate mortgages have interest rates that can change. After an initial fixed-rate period – typically five, seven or ten years – an ARM’s rate will adjust periodically to a new rate based on the market rate at the time. Fixed-rate mortgages maintain the same interest rate over the life of the loan, though this rate is typically higher than the initial fixed rate on an ARM. Mortgage paperwork must disclose whether a loan has a fixed or adjustable rate.
You shouldn’t take on an ARM without a plan for how to continue making the monthly payments if the interest rate and monthly payment size increase. Your lender must provide the date for when your rate begins to adjust as well as the formula for calculating your new rates. The paperwork will also specify how frequently the rate can change and what its maximum cap is.
Planning to sell your home or refinance your ARM before the rate adjusts is a common strategy, but keep in mind that your plans may change, home values may decline or the ability to sell or refinance may not always be possible. If you can’t afford ARM payments should rates rise, a fixed-rate mortgage is almost always the better choice.
- Am I paying any points?
Some lenders offer the option to obtain lower interest rates by paying discount points, which are like pre-paid interest.
Points are paid upfront for savings on interest over the life of the loan. They cost 1 percent of the mortgage amount, so if you borrowed $200,000, you’d pay $2,000 to buy a point on the loan. Each point reduces your interest rate by approximately 0.25 percent. This benefit is biggest if you remain in your home for a long time.
- What are my closing costs?
Homebuyers typically pay between 3 and 7 percent of a home’s purchase price in closing costs. Review your mortgage paperwork carefully to learn what you will be charged for loan origination, appraisals, application fees, courier fees, private mortgage insurance, real estate transfer tax, underwriting fees and other fees.
Certain home loans, such as cash-out refinance loans, may incorporate closing costs into the loan. Alternatively, some lenders may provide the option of charging a higher interest rate but give you a credit on your costs so your upfront fees are reduced. Both strategies mean spreading the payment of your closing costs over the life of your loan. Make sure you compare the upfront and total costs of all options before selecting one.
- How long do I have to pay off the loan?
Mortgages typically give you 30 years to pay back what you owe, although other options exist such as 10-, 15- and 20-year mortgages. Shorter terms come with higher payments but will save on interest costs and require you to pay off your mortgage sooner.
Choosing the length of your loan means deciding between the interest savings and quicker equity building of a short-term loan versus the lower monthly payments and greater budget flexibility of a longer-term loan.
Understanding your mortgage requires careful reading of your loan documents and consultation with your loan officer. Once you can answer these five questions, you’ll be well on your way to a confident understanding of your mortgage.