Don’t make this costly mortgage-shopping mistake

As with anything you buy, scoring the best deal on a mortgage or refinancing involves shopping around. Yet 77 percent of borrowers applied for a loan with a single lender instead of checking out several to compare costs, according to a recent study by the Consumer Financial Protection Bureau. “People may well put more time and effort into shopping for smaller products such as appliances and televisions than they do in shopping for the right mortgage,” the bureau’s director, Richard Cordray, said in a statement. But the potential savings from doing your homework are significant. If you get a $250,000 30-year fixed-rate mortgage at 4 percent interest from a lender instead of paying 4.5 to another, you’ll save $26,345 over the life of the loan.

We know it can be difficult to find the right mortgage; the process can be intimidating. Following these steps will help you get the best deal.

To get the most favorable rate on a loan, you have to have a credit score of at least 740, says Greg McBride, chief financial analyst at Bankrate.com. Recently, if your score was 740 and you applied for a $300,000 30-year fixed mortgage, you could qualify for a 3.75 percent interest rate. If your score was below 680, the best national rate we found on Bankrate.com was 4.25 percent for the same loan, which would cost you $31,130 more over the life of the loan.

Finding a free FICO score has become easier. About a dozen lenders now provide it to customers, although you may have to have a particular kind of account. If you don’t do business with a company that offers free scores, you can pay $20 for a FICO score and one credit report at myfico.com.

Get your score at least six months before you plan to shop for a mortgage. If your score is less than stellar, you’ll have time to try to boost it, says Kelly Long, a CPA in Chicago. (See the box below for more tips.)

Before you shop, determine how much you want to borrow, which type of mortgage you want, and how long a term you need so that you can compare lenders’ products.

Most borrowers go with a fixed-rate mortgage, usually for a 30-year term, to spread out the cost of a home purchase over time while making predictable payments each month, says David Reiss, a professor who teaches real-estate finance law at Brooklyn Law School. Those loans make sense especially when rates are low and for buyers who intend to own their house for a long time.

But also consider an adjustable-rate mortgage (ARM), also called a variable-rate or floating-rate mortgage), Reiss says. It has an interest rate that’s fixed for an introductory period of time, then changes periodically, usually in relation to an index. The introductory rate is often lower than the rate on fixed-rate mortgages. For example, the average 30-year fixed-rate mortgage recently had an annual percentage rate (APR) of 3.5 percent, according to Bankrate.com; the average 5/1 ARM (which adjusts annually after five years) was 2.67 percent.

When the rate adjusts, it can sometimes result in a sizable increase in monthly mortgage payments. “ARMs are appropriate for people who anticipate relocating or paying off the loan before it adjusts,” Reiss says, “or for empty nesters who don’t plan to stay in a home for many years.”

Many first-time homebuyers can qualify for Federal Housing Administration (FHA) loans. They usually have less rigid borrowing requirements, low down payments, and more flexible income requirements. For more information, go to fha.com/fha_loan_requirements.

After you decide on a type of loan, compare the deals you can get from a mix of large national banks, online banks, local regional banks, credit unions, mortgage brokers, and mortgage companies, Long says. Interest rates can fluctuate daily, so try to shop on the same day or within a few days, if possible.

Remember that lenders with the lowest interest rates may not necessarily be the best option because fees can significantly drive up the cost of a mortgage. In general, a mortgage with higher fees will have a lower interest rate, so it’s important to ask about loan origination or underwriting fees, broker fees, and closing costs. And ask lenders what each fee covers.

Points are fees paid to a lender or broker and are usually linked to the interest rate. The more points you pay, the lower your rate. One point costs 1 percent of the loan amount and reduces your interest rate by about 0.25 percent.

To find out how much you’ll actually end up paying, ask for points to be quoted as a dollar amount. In general, people who plan to live in a house for 10 years or more should consider points to keep interest rates lower for the life of the loan. Paying a lot of money up front for points may not be worth it if you plan to move in a shorter amount of time.

Calculators that compare mortgage deals, like the ones at Bankrate.com and HSH.com, can help you compare the cost of different mortgages over the life of a loan.

After you have found the best offer, try to negotiate even better terms. Ask the lender whether he will waive or reduce any of the fees he is charging or offer you an even lower interest rate (or fewer points). You are unlikely to get fees waived from third parties, like those for a title search, government processing fees, and appraiser fees, Reiss says. “But you may be able to cut the lender’s fees, like its underwriting, document processing, and document preparation costs,” he says.

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