How Do I Know if I'm Getting a Good Mortgage Loan?

Reader Question: "We have been talking to a lender about our mortgage options. As first time buyers, a lot of what he's telling us is confusing. We don't have anything to compare it to, so we don't know if we're getting the best deal. How do I know if I'm getting a good mortgage offer from the lender?"

I know how you feel. It can seem overwhelming to apply for a mortgage loan for the first time. A good broker or lender will explain your options thoroughly, to help you understand the pros and cons. Still, it's a lot of information at one time.

It's common for first-time buyers to feel like you do right now: How do you know if you're getting a good mortgage loan, if it's all so new to you?

Let's imagine that you and I are close friends. We're having lunch together, and you ask me this very question: Is this a good loan for me? Here are some things I would want to know about your situation...

Have you spoken to more than one lender?

How can you know if you're getting the best mortgage loan if you only deal with one lender? I saw a statistic recently that said nearly half of all home buyers end up choosing the first mortgage lender they talk to. This is a flawed strategy.

In the United States, we are not as negotiation-minded as people in other countries. We are used to walking into a store and paying a certain price for something without haggling. In most other countries, the price tag is merely a starting point. I believe this is partly why people choose the first mortgage lender they talk to. It's just easier than calling three or four different lenders.

But if you want to know if you're getting a good mortgage loan based on your qualifications, you have to get more than one offer. It's the only way to get a reference point for comparison. And remember, just because the lender presents you with an offer doesn't mean you're obligated to take it. Even if they give you a Good Faith Estimate and quote you an interest rate, you can still shop around.

It's a good idea to talk to different types of lenders too:

• If you've been presented with an offer from a local mortgage broker, you can request one through one of your state banks as well. Or try one of your local community banks.
• Do you have an existing relationship with a bank, perhaps for checking and savings? Ask them if they have mortgage lending options.
• What about credit unions? Are you a member of the credit union in your area? They might provide home loans as well.

It's all about comparison. When you look at a single mortgage offer in isolation, you have no idea if that's the best deal available. I recommend that you get offers from at least three different lending sources before making a final decision. This is the only way to know if you're getting a good mortgage loan from the lender.

Is Your Monthly Payment Affordable?

We can also define a "good mortgage loan" in terms of affordability. A good home loan is one that achieves your financing goals while being affordable at the same time. But here's something that most first-time buyers don't realize. Measuring affordability is your job, not the lenders.

The mortgage lender will tell you how much they're willing to lend you, and what kind of interest rate you can get. But their duties end there. So before you start shopping for the best mortgage loan, you need to know what your monthly budget is. Here's an article explains how to establish a housing budget.

Does the Mortgage Rate Match Your Qualifications?

What are your qualifications as a borrower? How does your credit score stack up against the national average? And what about your debt to income ratio? If you want to know if you're getting the best mortgage loan from a lender, you need to understand how strong you are as a borrower. You would then compare the interest rate you're being offered to the national average. This will help you understand if you're being offered a fair deal.

For example, let's say I check the average mortgage rates being reported by Freddie Mac. I find that the average rate is 5.1% with a half a point paid at closing. My credit score is excellent at nearly 800, my debt ratios are better than average, and I have a 20% down payment. My income is also more than sufficient for the amount of loan I seek.

Based on the above criteria, I meet every lender's definition of a "well-qualified borrower." But the lender I've been speaking to is offering me a rate of 5.3%. This doesn't add up. I'm better qualified than the average borrower, yet I'm being offered a higher rate.

Under these circumstances, I would not be getting a good mortgage loan from the lender. So I would do two things. I would let the lender know that I'm well aware of the average mortgage rates, and that I'm being offered a rate higher than the average. I would also remind them that I'm well-qualified borrower based on my credit score, my debt-to-income ratio, and other factors. I would also ask for an explanation as to why I'm not getting the best rate available. If they offer me a better rate, I might take it. If they tell me that's the best they can do, I would probably find another lender.

Of course, if your qualifications as a borrower aren't very strong, you won't have as much room to negotiate the mortgage rate. This is what I mean when I say your mortgage rate should match your qualifications as a borrower.

If your credit score is just barely high enough to qualify for a loan, you should not expect the lender's best rates. If you have higher debt ratios than the average borrower, you should not expect the best rates. The same goes for the size of your down payment. Generally, a larger down payment will help you secure a lower interest rate on the loan.

So you need to go into the process with reasonable expectations. You need to know (A) how you stack up against the average borrower, and (B) what the average rates are at the time you apply for the loan. This will help you spot a decent rate quote when it comes your way.

Is Your Interest Rate Fixed or Adjustable?

We've talked about the affordability of your loan, and how your interest rate should match your qualifications as a borrower. But what about the type of loan you are using? Getting a good mortgage loan also means choosing the right type of loan for your situation.

One of the biggest choices you will have to make is whether you want an adjustable or fixed-rate mortgage loan. The best way to make this decision is to think about your long-term plans. Are you going to be in this house for many years, or only 3 to 5 years?

• If you're planning for a longer stay, you are probably better off with a fixed-rate mortgage loan. It offers more stability and security over the long term.
• If you know for certain you're only going to be in the home for a few years, you might consider using an adjustable-rate mortgage (ARM). You can even use a hybrid ARM loan that offers a fixed rate for the first few years. The rate during this period would probably be lower than the rate for a traditional 30-year fixed mortgage.

There are certain risks to using and adjustable mortgage. If you are unable to sell or refinance before the initial fixed-rate period expires, you will see your interest rate change. They usually change by getting higher, rather than lower. So this would increase the size of your monthly payment. Could you handle that with your income?

Learn more about choosing between adjustable and fixed-rate mortgages.

Can You Afford Your Closing Costs?

The affordability of your closing costs is another important consideration. If you cannot afford these costs, you won't be able to close on the loan. This is another aspect of a good mortgage loan. It should be structured in such a way that you can afford the out-of-pocket costs that will be due at closing.

The lender will help you estimate these costs in advance, by giving you a document called the Good Faith Estimate. To be safe, though, you should expect your actual closing cost be slightly higher than those estimated in advance. This will give you an extra cushion for any unexpected costs.

Putting It All Together

Let's revisit the question at hand. How do I know if I'm getting a good mortgage loan from a lender?

The best loan is one that meets your financial needs while remaining affordable at the same time. The best loan will support your long-term plans, in terms of how the interest rate works. The best loan will have an interest rate that matches your qualifications as a borrower. Lastly, the upfront expenses (down payment and closing costs) should be affordable for you.

If you loan measures up in all of these categories, then you are probably getting a good mortgage situation.

If you would like to learn more about any of the topics discussed in this lesson, you can use the search tool located at the top this website. It will give you access to hundreds of tutorials and articles about the mortgage process. I hope this has answered your question, and I wish you all the best in your home buying process.