There is no set plan that is the perfect loan package for every person or situation. Many factors must be evaluated to determine what terms will offer the best available loan program. The interest rate , size of payment and down payment , schedule of payments, amount of loan, life of the loan, and any other requirements or conditions attached to the loan, all play into the evaluation of a loan plan.
The current market rates largely determine the range of interest rates that will be offered. But, many factors can make a difference to your ability to obtain a low interest rate. Some of the possibilities for decreasing your interest rate are:
Maintaining a good credit history , as documented in your credit report, generally obtained by the lender from one of the three main credit reporting agencies:
Having a high income level (however, if your debt-to-income ratio is too high, even a good credit report or high income level may not help obtain a lower interest rate)
Paying a large down payment (generally 3-20% is expected) –a larger down payment will typically qualify you to receive a lower interest rate
Paying discount points - an optional payment up front that lowers the interest rate (each point is 1% of the mortgage amount - $120,000 mortgage discount point would cost $1,200 and typically lower the interest rate by 0.125 percent)
Choosing the right type of loan :
An ARM (adjustable rate mortgage) can have a low interest rate when the market interest rate is low, but there is a risk as the rate fluctuates with the market a fixed rate mortgage stays the same for the life of the loan and depending on other factors you may be able to ”lock in” at a low rate
Asking for a shorter rate “lock-in” period – generally the lender will charge more, by way of fees and/or higher interest rate, the longer the commitment to hold to the lock-in rate.
Requesting a loan amount that is lower than the conforming loan limits set at the beginning of each year by Fannie Mae and Freddie Mac
Obtaining a loan with a shorter life (such as a 15 year mortgage rather than a 30 year mortgage) will cost you much less in interest even with comparable interest rates
Paying closing costs at the closing rather than financing them (including closing costs in your loan will typically increase your interest and possibly even the interest rate)
Use a comparable interest evaluation (often the stated interest rate is not the “true cost of the loan” which includes various fees). When trying to compare equivalent interest rates across different loan programs, the APR (annual percentage rate – a disclosure mandated by federal law) may be a good place to start, but even APRs are not totally accurate. Comparisons can be complicated because so many factors affect the outcome, such as which fees are included, the life of the loan (affecting the amortization of loan fees), or the length of the rate lock period. Another evaluation alternative would be to calculate the equivalent interest rates including only those fees that are direct loan fees (excluding items such as homeowners insurance, attorney fees, escrow fees, etc.)
Size of Payment
Every borrower must determine what size of payment will be feasible given the current monthly income available and other individual relevant factors. Lenders look at the debt-to-income ratio to help assess whether a particular loan payment is likely to be paid.
A borrower must also consider that the original loan payment may change over time. Depending on the type of loan , some payments may fluctuate each month if the interest is not fixed (as for an ARM). Some payment may adjust at certain points in the loan (some hybrid loans). Some loans have a balloon payment at future point in time. Although fixed higher payments generally mean less interest cost, a borrower must feel comfortable with the payment commitment. A borrower may want to set the payment high for several reasons:
To purchase a more expensive home
To build equity quicker
To pay less interest
To reduce debt load
To meet loan requirements
When you analyze what size of monthly payment is affordable, you will also want to take into consideration individual factors like your other monthly expenses, your lifestyle and up-coming events such as a new baby, college, retirement or employment advancements. This is an important decision as payments can last a long time.
Size of Down Payment
The amount of down payment you make on your loan will affect the size of your payments, the length of your loan life, the amount of interest you will pay, the type of loan you may obtain, conditions on the loan and other aspects of your life depending on how you obtain the down payment. Only certain types of money are acceptable for use as a down payment, and you will be required to prove your down payment source when the lender verifies your qualifications . However, there are many options for possible ways to come up with a down payment. These should be considered as you contemplate the affect the down payment has on the other loans terms. For instance:
Cash on hand or from savings
Accumulating cash for a down payment may take some sacrifices such as cutting expenses, reducing debt, forgoing vacations or getting a second job
Sale of other property or investments
Mutual funds, stocks, IRA, or 401K
A gift from a family member
A zero down mortgage (or other no-down or low-down mortgages)
When determining the size of your down payment keep in mind that, generally speaking, the higher your down payment amount the lower your payments, the shorter your loan life, the lower your interest, and the better your over-all loan terms.
Schedule of payments
Typically, loans are structured to require monthly payments. You should consider the impact of other possibilities before you commit to any particular payment schedule. For instance, a loan requiring a balloon payment may be difficult to meet or it may give the borrower sufficient time to refinance in a better position. Paying off a mortgage more quickly, such as a bi-weekly mortgage payment may reduce your interest but take needed cash from you budget. Annual payments may give short term relief but increase the financial stress in the long run; however, seasonal workers may need to take advantage of such a loan. Payment holidays (interest only or deferred payment) may provide needed relief but will be costly to the borrower.
Generally, any payment deferment will increase the cost of the loan. Sometimes the impact is hidden. It is important to understand what effect the payment schedule will have as you structure your loan plan.
Amount of loan
The amount a lender will loan on any given property is subject to factors such as the amount requested compared to the appraisal value of the home, the amount of the down payment, the qualifications of the buyer, and the profile of that lender's loans (for instance, conforming loans follow the guidelines set forth by Fannie Mae and Freddie Mac.) Some loans are backed by the government (FHA, VA and RHS) and offer specialized loan packages with more liberal terms, typically requiring less down. However, the VA and RHS loans are limited to specific eligible borrowers.
Generally, lenders will loan up to 80% of the appraisal value of a home. There are options available to increase that amount. Some lenders will loan more if the borrower gets private mortgage insurance (PMI). Other loan programs will require zero down or as low as 3% down. There are some plans that offer 100% financing but the risks are generally high. Before taking out a low-down mortgage you should review all the ramifications to determine if the costs outweigh the benefits.
Life of the loan
The life of the loan can be determined by a number of factors, such as the size of your payment (larger payment means shorter life), the amount of your loan (generally a larger loan will have a longer life), market standards (most mortgages tend to be 15 or 30 year loans), and the timeliness of payments (late payments increase the interest and extend the life of your loan).
Conditions of the loan
Certain conditions may be required by the lender such as maintaining specified insurance policies , an escrow account , current appraisals, etc. RHS loans are restricted to rural residents among other things. VA loans are only for eligible veterans. Some lenders may require conditions that create additional costs, such as having an attorney review the loan documents. Certain regulations place caps on loan amounts and interest amounts. Also, each lender will have a unique loaning profile, with its specific requirements and standards. As a borrower, make sure you know the conditions or restrictions placed on your loan before make the final commitment .