Topics: banking, lending, real estate
Now that we’ve covered finding the lender that’s right for you and the difference between pre-qualification and pre-approval, it’s only fair to give you a few warnings about the pre-approval process. While the end result is a loan for a handsome sum of money, there are a few potential bumps in the road you’ll definitely want to avoid.
Ding! The Effect of Mortgage Pre-Approvals on Your Credit
Just like when you’re out applying for a new credit card or a car loan, your application for a home mortgage loan will appear on your credit reports. And if you’ve ever seen the effects of applying for a new credit card or car loan on your credit score, then you know your score will get dinged a few points when you start seeking pre-approval. Fortunately the effects are minor, though the severity and duration of your score drop will depend on those magical formulae put together by the fine folks at TransUnion, Experian, Equifax, and Fair Isaac.
“But what if I apply for pre-approval at 20 different places? Will my score drop 20 times as much?”
Lucky for you, my bold-fonted friend, the credit reporting agencies will see all of your mortgage-related credit inquiries as a single inquiry–provided they all take places within 14 days of each other. (Some of the agencies will see all inquiries within up to 45 days as just one, but you should care equally about all three scores since that’s just what your lender will see.) So be sure to do your lender research ahead of time and group all of your pre-approval efforts into a two-week span.
Flavors of Pre-Approvals (Hint: Chocolate Ain’t One of Them)
There are three types of pre-approval letters you can receive from your mortgage lender. All three are equally powerful in that they specify that someone is willing to lend you money based on a full analysis of your financial status, but some may give you a competitive advantage when putting in an offer on a property.
Here are the three different flavors of pre-approval letter and the pros and cons of each.
- Full pre-approval amount. Most commonly, a lender will give you a single pre-approval letter specifying the maximum you can afford to borrow and pay for a property. I suggest only providing this letter with your offer if the price you’re offering is considerably lower than your pre-approval amount. Otherwise, the sellers may see that small difference between the offer and your maximum pre-approval amount as extra cash they can squeeze out of you.
- Offer amount. Another option is to obtain a pre-approval letter for the specific amount you wish to offer on a property. Of course, if you’re seeking pre-approval before you start looking, you’ll need to go back to your lender for this later. This type of letter can stop sellers from picking those extra pennies from your pockets, though it can also hurt you if the sellers receive a slightly better offer and reject yours because they don’t think you can beat it.
- Specific to a property. This pre-approval letter has no dollar amount on it–only a property address. Using this, you can keep your maximum affordability a secret while still proving you can pay what you’re offering and maybe go a little higher if necessary.
So Many Pre-Approvals–Which One’s the Best Deal?
All that hard work and form-completing paid off! You’ve received numerous pre-approvals from various lenders, and you’re ready to start shopping around for a home. But before you call up your real estate agent and start visiting properties, you’ll want to weed those offers down to a few or even just one. After all, you only need to show a seller one pre-approval letter, and that’s probably going to be the one for the lender from which you’ll ultimately obtain your loan.
To narrow down your big selection of loan offers, follow these simple steps in order.
- Ditch offers too good to be true. Start off by eliminating any loan offers which seem suspiciously superior to the others. Unless they’ve fully disclosured of all their fees, that delicious rate may be packing a ton of hidden charges. Also research your prospective lenders on the internet and discard offers from lenders with bad reputations or a history of poor customer service.
- For the remaining lenders, compare same rate, same day, same products. Mortgage rates change daily or even hourly, so you want all of your offers to be as recent as possible. It is also difficult to compare a 5-year adjustable rate mortgage to a 30-year fixed mortgage, so try to separate your offers by product type. It also helps to ask your potential lenders for all of their offers at the same rate. So if the average rate between lenders is about 7%, ask them to provide details for loans at that rate. Some lenders may need to include extra discount points (not necessarily a bad thing) to bring your offer to that rate, but it makes it much easier to compare products if they all have the same rate.
- Total and compare lender fees. Fees charged for originating or processing your loan will vary between lenders, so they are the main source of price differences between loans. Don’t bother to compare “third-party” fees like title insurance or appraisal fees since lenders do not set the prices of these. If all that matters to you is saving money, choose the loan with the lowest fees and you’re done.
- Consider other factors. Sometimes lowest closing costs don’t indicate the best loan for you. If you have little cash on hand, you should choose the cheapest loan that asks for little or no money down. If you’re planning to move to another home after a few years, you might want to choose an adjustable-rate loan product regardless of its closing costs because it’ll carry a lower initial rate. And one lender may simply give you a bigger loan than others; you may have no choice but to use that lender to afford the home you want. But if multiple loans meet all of your needs, and all else being equal, it makes sense to choose the one with the lowest lender fees.
You may end up keeping two or more loan offers in mind. For example, consider these loan offers for which all other factors are equal:
- Offer A. Maximum purchase price: $200,000. APR: 6.25%. Lender fees: $10,000.
- Offer B. Maximum purchase price: $225,000. APR: 6.5%. Lender fees: $15,000.
Offer A has a lower rate and fewer fees than Offer B. But if you’re looking to make a $215,000 purchase, you’ll have no choice but to go with Offer B. So hang on to both of them until you’ve finalized your offer price.
Locking Your Rate: A Hidden Feature Which Can Save You Thousands
Buried somewhere in your loan offer documentation should be some text regarding the rate lock period. This is the crucial but limited length of time during which your loan’s interest rate cannot change. How would you feel if you walked into a store, loaded a $20 item into your cart, and when you went to checkout the price had increased to $40? That’s what rate locks attempt to prevent. Since interest rates fluctuate daily, you want a promise from your lender that your rate will be the same on day one as it is on closing day. Aww, how nice of your lender.
Rate locks can vary in duration, though 30- and 60-day locks are most common. You might be able to obtain a longer lock for an extra fee, so keep that in mind if you anticipate a long period of time between loan application and loan funding since even a small rate jump can cost you tons. Different lenders may start your rate lock at different points in the loan process, too; some will begin it upon pre-approval while others wait until you’ve found a property and submitted the formal loan application.
Note that the rate lock also prevents your rate from dropping. If you suspect rates may come down before your closing date, you may wish to “float” your rate–allowing it to change in response to market conditions until the time of your choosing.
Our Progress So Far, And One Reason to Stay Away From Internet Lenders
With our closing just a week away, I can say that the most difficult part of the homebuying process has been seeking pre-approval. With so many lenders to choose from, just deciding whose long forms to fill out was a monumental choice. In the end, we applied for mortgage loans at a dozen places–mostly “internet” lenders with no local physical presence (or even no branch locations anywhere!). We did not use a mortgage broker because we are first-time homebuyers and most lenders do a pretty good job of advertising their best first-time buyer programs; a broker probably wouldn’t have found any other products we didn’t find ourselves.
We compared all of the offers we received and immediately discarded a few from internet lenders who couldn’t compete with the others. Our best internet offer came from Amerisave.com, a lender which featured great customer service initially but failed in the last mile thanks to our personal representative who couldn’t or didn’t answer some of my questions. For shame, Amerisave!
Our three best offers all came from the same lender–big ol’ Bank of America. Even though our primary checking account is with BoA, we only applied there because it was listed on the approved lender list for Maryland’s first-time homebuyer program. Our beautiful and talented Bank of America loan officer sat down with me and walked me through the application process. She immediately sensed I knew a thing or two about the mortgage process, so she only filled in the gaps as needed. The whole pre-approval process went smoothly, and she priced three product variations for us. All three were for 30-year fixed loans with rates that matched or even beat some of the 5- and 7-year ARMs we priced at other banks. Two of the loans were through Maryland’s first-timer program, but the product we ultimately chose was Bank of America’s own special first-time homebuyer program. How special are we talking? Very special…
For the amount we’re looking to spend, we have a maximum 5% down payment available. Since we’re not putting down the 20% banks would like to see from borrowers, we would either need to pay private mortgage insurance (PMI, a.k.a. wasted money) or slap on a second mortgage at a higher rate… unless we chose Bank of America’s awesome first-time homebuyer program. Through this program, Bank of America gave us a single mortgage loan for 100% of the purchase price at a below-market rate with no PMI.
Yes, that special.
The only requirement for this program was for me to attend about four hours of first-time homeownership classes. Bank of America pays for all of it, so the only expense I incurred was time. Even keeping in mind that my free time is worth $90 an hour to me, that $360 is nothing compared to $200+ we’d pay each month for mortgage insurance or a higher second mortgage interest rate.
Top all this off with the fact that Bank of America’s lender fees are pretty darn low–and they even gave me an additional discount because they have a partnership with my employer–and the smoke signals coming from this offer could be seen from space.
We also went with a 40-year payback period. The terms and rates were the same as the 30-year option, and we can still pay down principle as if it were a 30-year loan, but the required monthly payments are lower.
If you’re a first-time homebuyer in Maryland, definitely keep Bank of America in mind. You should still price other lenders, but I can’t believe anyone can beat or even match this offer. Montgomery County residents, feel free to contact me if you want my loan officer’s name; she’s an absolute delight to work with.
As episode #5 draws to a close, I’m sure you can’t help but notice that all we have to show for our work is a piece of paper. But don’t worry, episode #6 will net us a bigger prize–a real live human being they call a “real estate agent.” OoOOooOooh, mysterious!