Selecting a mortgage
Selecting a mortgage is one of the most important decisions a person makes during their lifetime. While I typically encourage people to never, ever take on debt, a mortgage is the only reasonable way the average individual can afford to own their own home. In addition, mortgage interest is federal tax deductible, adding considerable tax benefits that often offset the burden of such an enormous debt.
An increase in the number of defaults in sub-prime mortgages - the riskiest borrowers - has made borrowing for individuals with modest and poor credit backgrounds considerably more difficult. As such, the best thing you can do for your mortgage search is to ensure a strong credit score.
Types of mortgages
You want to know what kind of mortgage you need BEFORE meeting with a lender. While the lender will provide you with advice on the appropriate loan for you, the lender is acting in their own best interest, not yours. In general, you want the best loan you can afford, not necessarily the least expensive. If you have poor credit, you may want to reconsider purchasing a home until you can improve your existing finances. The following types of mortgages are available:
Fixed loan (15- or 30-year): Fixed loans are fantastic, they are the most stable type of loan, offer predictable fixed payments, and are a mature product. As your earnings (wages/salary/etc.) increase, your payments stay fixed, with the payments easier to make as time goes on. Fixed loans sometimes have higher rates than ARMs or alternative loans, but are the simplest type of loan with the least potential for something going wrong. Changes in market rates will have no impact on the loan. It's a regular, predictable payment. More than the phone or cable bill, because it will never change unless you refinance.
ARMs (Adjustable Rate Mortgages): Adjustable-rate mortgages offer a low interest rate for a span of 3, 5, or seven years after which the rate changes to reflect market rates. If rates are higher, you will have to pay more, although the opposite is also true. There are typically restrictions and/or penalties on refinancing these types of mortgages, so be careful. Typically, ARMs entice investors with lower rates before nailing them on the back end. Still, ARMs are appropriate for investors who want a house now and expect to be earning significantly more cash in a short span of years (such as a recent college graduate). In general, I do not like ARMs. There is a significant risk that once the loan reaches its "cliff", rates may be higher. Many individuals use ARMs because they are unable to afford fixed-rate loans or lack the credit, so a steep change in rates may force them from their homes. ARMs are also the primary loans responsible for a large volume of sub-prime defaults recently (March 2007).
Interest Only: Some investors cannot afford the payments of a fixed-rate, jumbo, or adjustable-rate mortgage. Those investors are typically forced to use interest-only loans or not buy a house. However, when you use an interest-only loan, you are not buying a house. You are basically renting the property from the bank, detracting from your net worth and lining the pockets of the lender. The house is no longer your asset, it is merely a place that you live while you make payments to the bank that will never stop. They may seduce buyers with an option down the road to pay down principal or talk about the tax benefits of interest-only loans, but in the meantime you are out a large volume of money in the form of that interest that you pay. Think credit card debt. Avoid interest-only loans at all costs. I cannot emphasize this enough.
How much should I put down as a downpayment?
As much as possible up to 20%; if you need to sell securities - retirement savings does not count, do not touch that - do so to pay up the 20%. You will get a much better rate and be that much closer to paying off the house. Otherwise you may get hit with PMI (a cost you do not want to pay).
Rate locks
Don't do it. The rate might be locked, but then so are you. Lock only when you are ready to buy, and you shouldn't have to pay for the lock.
Selecting a mortgage
If you selected a good real estate agent, they will likely know several lenders - the firms that offer the mortgage - you might want to consider. If you live in MA,VT, NH, ME, CT, RI, or Florida use Poli Mortgage Group (Peter Brock if you're within an hour of Boston). Poli was fantastic for us (I am in no way affiliated with Poli and received no compensation for this endorsement).
The large bank lenders such as Bank of America, Wells Fargo, and HSBC will leave the liability of up-front costs for closing such as legal fees and application fees on you, and they may charge you points. You don not want to pay points; you can Google it if you want, paying more up front is almost always to your detriment.
Mortgage brokers like Poli that specialize in matching lenders with buyers will typically cover the closing fees, legal fees, and every other fee except the down payment. In exchange, you may need to pay a higher APR. This is okay; the higher APR - for mortgages but not for many things - will generally cost less in today's dollars than total dollars. In other words, your money will be worth less in the future due to inflation, so that higher fixed payment (on a fixed mortgage, which I hope you select) will cost you less as time goes on because you have been investing the money you have saved - by not paying closing costs, etc. - and making money.
Maybe this sounds confusing, because it is. Investing in a home is very, very complicated and your lender should be patient and explain every line item to you (several times, if necessary, as it was with us). Select a lender you are comfortable with because when you sign your mortgage and hand over the down payment it makes you liable for a very large monetary stream for a long, long time.
More information
One of the best sites I found was from Fidelity, which in no way benefits from use of this particular tool . In addition to some solid professional commentary on the various types of mortgages, the site offers some strong opinions on good and bad mortgages.
Secondarily, lender Fannie Mae has a wealth of basic information on buying a home, having it inspected, getting a lender, legal pitfalls, legal rights, and more. You should not miss out on some of their best resources, like the Getting a Mortgage checklist and mortgage definitions .
Extra: Types of homes to consider
In the majority of situations, owning a home is more financially sound than renting a property. When purchasing a home, the first question you should ask is who else might want to buy it (if and) when you go to sell the property. Quirky homes, duplexes, condominiums, and any house that puts you at the mercy of your neighbors will have a more difficult time selling than a property that affords privacy. Houses with a bathroom upstairs and downstairs will sell better than homes with a single bathroom. Off-street parking or a garage is preferable to on-street parking to buyers.
Free-standing, single-family homes are always, always preferable to other property. Strongly consider a single-family home even if you are a single buyer. Get a good inspector. Get a third party to estimate repair costs if the inspector is concerned about any problems with the property. Get a good real estate agent that has seen a lot of houses. Get a good book to help you with selecting a home. Once the house is picked and you're happy, it's on to a mortgage.
Please note: I am not a mortgage expert. The aforementioned is what I have gleaned over the course of my own personal purchase of a home in the state of Massachusetts. Please notify me if you find errors in this document. Different situations and residential areas require different approaches when purchasing a home. As such, you should use a licensed real estate agent in good standing to advise you throughout the home purchasing process if you have not already been through it, or have some other competent individual to help guide you through the process. Also, pick up a good book on the topic. The mortgage is second in importance only to the home inspection.
Best of luck!