What a mundane and seemingly obvious piece of advice! And yet, according to the results of a recent survey by LendingTree.com, 40 percent of mortgage shoppers obtained just a single quote before settling on a mortgage. Given that the same poll established that 96% of consumers will comparison shop for most items, this is nothing short of astounding.

There are a few probable causes for this phenomenon. First of all, there is a small contingent of borrowers that either doesn’t understand that mortgage rates vary among lenders and/or mistakenly believe that rates are determined by the Federal Reserve Bank and that such variations are therefore trivial. Second, there is a factor of laziness. How else can you explain the 10% of borrowers that  “admitted they had spent the same amount of time searching as it takes to brush their teeth.” There is also an aura of complexity surrounding mortgages, which spurs fatigued borrowers to simply choose any lender at arm’s reach. Finally, there is a misconception that lending standards have become so stringent that borrowers should immediately pounce on the first approval that they receive.

While mortgages have become a commodity product over the last decade, there is still a tremendous amount of variability between mortgage lenders, in terms of rates, points, fees, service, and lending standards. At the very least, it’s worth speaking to a few different lenders to make sure that you receive a good deal, fair terms, and good service.

The first step is to use the newspaper, internet, friend’s referrals, etc, to develop a preliminary list of 3-5 potential lenders. (You may also want to consider including a mortgage broker on the list. While this will add an extra layer of fees, a good broker will do your mortgage shopping for you and might even be able to help you save money overall). The next step is to contact each lender and ask them basic information about the types of mortgages that they offer and are potentially suitable for you. While you should focus on the financial (i.e. rates, points, fees) parameters, you should also inquire about other points of distinction. (The FTC has created an excellent table that you can use to comparison shop).

In order to give you an accurate quote, each lender will probably ask you for personal financial information. Bear in mind, however, that in order for them to offer you a precise estimate, they will need to separately pull your credit history, which could adversely affect your credit score. For that reason, it’s probably only worth obtaining a Good Faith Estimate only once you have settled on a property, and/or you know approximately how much you will need to borrow. If you elect to obtain pre-approval prior to shopping for a home, remember that you are not bound to that lender. You can always continue mortgage shopping or start afresh, after identifying the home that you wish to purchase.

Remember that different lenders have different lending standards. Don’t be discouraged if you are rejected by the first lender(s) that you contact. Conversely, don’t automatically accept the first offer that you receive. Even if you have a mediocre credit score, you might still be able to find a handful of lenders that are willing to give you a mortgage at an attractive rate.

Finally, there is something to be said for dealing with a broker/lender that you trust. As the LendingTree survey confirmed, shopping for a mortgage is a daunting process. It might ultimately be worth paying .05% more if you feel more comfortable with one lender than another.

The majority of home-buyers conduct their house-shopping before obtaining financing. After all, how can you obtain a loan for a property that you have not yet purchased?! What if I told you, however, that you could achieve a loan guarantee from a prospective lender at the beginning of the process, such that you could close on the purchase of a home immediately after selecting it?

Known as pre-approval, this guarantee represents a commitment by a specific lender to underwrite a mortgage for the potential purchase of a home. Based essentially on your credit score and a handful of other selected financial characteristics (pertaining to your assets and income), the lender will determine the maximum monthly payment you can afford to make. Prevailing interest rates are then applied to this figure in order to determine the maximum overall mortgage amount.

The advantages of pre-approval are two-fold. First of all, you can shop for a home with the confidence that you can obtain financing for it as long as it falls within the financial specifications laid out by the lender. Second, the pre-approval letter can be used as a bargaining chip in negotiations with the seller. For example, if two potential buyers make similar offers for the same property, the seller might be more willing to accept the offer from the pre-approved buyer, because it is more likely that the sale will close quickly. The advantage to the lender is that the borrower is more likely to return to it when he begins the actual process of obtaining a mortgage.

Unfortunately, it seems that lenders are now reluctant to grant pre-approvals, as part of a general trend towards stricter lending standards: “The rules from the Department of Housing and Urban Development require lenders to issue a binding good-faith estimate of total closing costs within three days of submission of a formal loan application.” In other words, it is not so much the pre-approval itself that frightens lenders, but rather locking in the closing costs.

Instead, lenders are turning to pre-qualification, which is “a less rigorous assessment of how much they can afford to borrow based on unverified financial data.” In such cases, a pre-approval might only be granted after the borrower’s loan application has been formally reviewed. While a pre-qualification is useful in that it gives the borrower a reasonable idea of the maximum loan they can hope to obtain, it is ultimately non-binding and thus, unreliable. Even if it is based on the same underwriting standards, the fact that it is only a pre-qualification means that a lender is not legally bound to it in the same way it would be to a pre-approval.

Borrowers should ultimately be aware of this distinction and push for a pre-approval. Most lenders should theoretically still be willing to issue them; it might just be a matter of persistence and understanding the process for applying for them.

Why do I feel a sense of Deja Vu every time I write a post on this topic? Maybe because mortgage rates have been in a state of free-fall for the last year, and every week seems to offer the same story of new record lows. This week was no exception, as Freddie Mac reported that the average 30-year fixed rate is now at 4.19% and the average 15-year fixed rate was 3.62%. Both rates have declined nearly 20 basis points over the last month.

Interestingly, points (which are paid upfront and used to buy down the mortgage rate) have been rising, from .6 earlier this year to .8 today. That implies that the actual decline in interest rates is less than Freddie Mac would have you believe. It’s interesting that while lenders are willing to pass along low rates to borrowers, they are taking a larger cut for themselves in the form of points. In practice, this means that your APR will be higher than the mortgage rate quoted to you be your lender.

Furthermore, the lowest rates are only available to the most creditworthy borrowers. Those with FICO credit scores of 720 or above can expect to pay around 4.3%, according to a Zillow survey of mortgage data. That’s great for the 47% of borrowers that fall into this category, but what about everyone else? As you would expect, (prime) borrowers with even slightly lower credit scores are offered interest rates that are more than .5% higher than their 720+ counterparts.  Unfortunately, those with scores below 620 probably won’t even receive an offer. Regardless of how you slice the data, however, rates are extremely low across the board.

One columnist recently wondered aloud whether they could fall even lower, perhaps all the way to 0%. It seems impossible, but then again no one thought that rates would be this low only a couple years after the housing bubble burst. She speculated that, “Rates at or near 0% could bring more first-time home buyers out of hiding to seek out extremely favorable financing for a house.” Even ignoring the fact that no sane lender would ever offer 0% mortgage financing, it seems unlikely that a significant number of potential borrowers are still biding their time in anticipation of still-lower rates, given that government home-buying incentives have expired and lending standards are being tightened. Already, 80% of mortgages are actually refinancings of existing mortgages. If rates decline further, it seems like it will only a trigger a new round of refinancing (as those who refinanced at 5% repeat the process).

At this point, I don’t really think it’s a meaningful exercise to ponder whether rates will fall farther. If you asked me for my honest opinion, I would say that an expansion of the Federal Reserve Bank’s Quantitative Easing program (in the form of additional purchases of Mortgage-Backed Securities) could drive rates even lower. Still, you have to wonder how much it would matter if rates fell to 3.5%, for example. For the purchase of a $200,000 home, this would lower one’s monthly mortgage payment by about $100. Don’t get me wrong- one would certainly be grateful for the savings, but for the majority of people, it wouldn’t be enough to make an otherwise unaffordable mortgage affordable.

As for how lower rates are affecting the housing market and housing prices, that’s the topic of my next post.

One of the aspects of mortgage lending that has changed the most in the wake of the housing bust is the down-payment. At the height of the boom, it looked like down-payments could soon become, well, if not extinct, than at least irrelevant. Nowadays, a sizable down-payment is not only essential to getting a loan with good terms, but also to getting approved for the loan in the first place.

The current benchmark for down-payment is 20% LTV. That means you are expected to pay 20% of the price of the property in cash, with the mortgage covering the remaining 80%. For those of you who can afford to make such a down-payment, statistics show that you will be comparatively likely to repay your mortgage. Thus, you can expect to receive extremely favorable terms on your mortgage.

The primary source of funds for this down-payment will probably be your own savings account. In some cases, you can also pledge securities (stocks, bonds, etc.) and the land that the property occupies assuming that you already own it. Lenders will also allow you to borrow against your retirement account (though in some cases this must first be approved by the administrator of your IRA) as well as to contribute gifted funds from family/friends, as long as the giver signs an affidavit pledging that the gift is not actually a loan.

If the target property was appraised for more than the purchase price, however, you cannot contribute the difference towards the down-payment, even though it is arguably equivalent to home equity. The only exception is if the seller is willing to raise the purchase price and contribute (most of) the difference to your down-payment for the loan. Such is perfectly legal and is known as a Seller-Assisted Down Payment. Bear in mind, however, that if the purchase price is raised to the point that it exceeds the appraised value of the property, this kind of arrangement will probably be rejected by your lender.

If you can afford to do so, you should consider making an even larger down-payment. Some lenders will compensate you by offering you an even more attractive mortgage rate. In addition, a larger down-payment combined with a shorter duration (i.e. 20 years instead of 30 years), would enable you to own your home in a shorter amount of time and save you money in the process (in the form of unpaid interest), all without affecting your monthly payment. If instead you were to continue to prefer a long-duration (30 years) mortgage, you can count on both a lower monthly payment and aggregate savings over the life of the mortgage.

For those borrowers that can’t afford – or simply don’t want – to make a 20% down-payment, you have a few options. First, you can apply to a Down Payment Assistance Program (DPAP); it’s advisable to ask your lender for advice, rather than solicit help on your own. If you’re eligible, you can consider a Veterans Administration (VA) loan, most of which don’t require down-payments. FHA Loans are also insured by (but not originated by) the government, and hence, require only 3.5% down-payments. This is offset by a more expensive loan, however, in the form a mortgage insurance premium, payable to the FHA to compensate for the increased likelihood of default.

For everyone else, you can expect to pay a hefty Private Mortgage Insurance (PMI) premium. Assuming your lender is still willing to underwrite your loan, despite a down payment that is below 20%, you will pay both an upfront PMI premium and an annual premium, until your home equity reaches 20% LTV. [Your home equity will gradually rise both as you repay the loan and if the value of the home appreciates].

Of course, the reality is slightly more nuanced. The actual importance of the down payment will depend on numerous other factors, including your credit score. In the end, you should first seek to understand the position of your lender before determining the size of the down-payment.

As the name of our website implies (and as the #1 Google ranking confirms), we are THE online source of mortgage calculators. Unfortunately, there isn’t enough space in this post to explore all 22 of our mortgage calculator tools, so I’ll focus on one in particular: Home Affordability Calculator.

The purpose of this calculator is to help you figure out the maximum that you can borrow, under a given set of loan parameters. Many borrowers begin the process by trying to find the home of their dreams, and then worrying about if/how they will afford to repay the mortgage associated with it. A better (or at least more conservative) approach, would be to begin by using the Home Affordability Calculator to determine a reasonable borrowing amount, and then go out and look for a home.

The first input in the calculator is your estimated down-payment. If you already have an idea as to a down-payment (which will come from your savings, and not from the loan), you can key it in here. For those of you just beginning the process, you probably won’t have a strong idea of what kind of down-payment will be expected of you. For a conventional mortgage, 20-25% is the standard, while FHA loans typically require only 3.5-5%.

Next, estimate your interest rate. Again, for those just starting out, this will probably be impossible, especially if you aren’t even aware of prevailing market rates. You can find information on regional interest rate levels from the weekly Freddie Mac Primary Mortgage Market Survey. Given that interest rates fluctuate over time and that you may have to pay a higher rate if your credit isn’t perfect, it’s a good idea to be conservative when estimating your rate, perhaps by adding .5% onto an “average” rate [Note: it is assumed that points, which are used to “buy down” the interest rate will come out of your pocket, and hence are not included in the calculation. The same is true for closing costs. Some loans allow you to finance your points, but that is beyond the scope of this calculator].

Length refers to the duration of your mortgage. 30 years is standard, although 15 years is also an option. Estimated front ratio refers to the percentage of your gross (after-tax) income that your PITI (mortgage principal, interest, taxes, and insurance) will represent. The estimated back ratio refers to the percentage of gross income that all of your debt (mortgage, auto loans, credit cards, etc.) represents. Unless you have reason to believe otherwise, you can assume a 28/36 (front/back) ratio, which means that your PITI cannot exceed 28% of your gross income, and all debt (including PITI) cannot exceed 36% of income.

The next step is to enter all of your gross (after-tax) income into the income fields. You should include the income for all parties who will be listed on the loan documentation. The same goes for the debt fields. [Note that you cannot exclude the debt of one of the parties without also excluding his/her income]. This data will be used in conjunction with the ratios to determine how much you are ultimately eligible to borrow, so it’s important to be accurate and truthful.

Then, enter in estimated property taxes (usually expressed as a percentage), as well as homeowner’s insurance, and private mortgage insurance (PMI) which is paid both upfront and annually by high risk-borrowers (i.e. those whose down-payments are less than 20%) to mitigate against the risk of default. If your projected down-payment exceeds 20%, you can leave this field blank.

Finally, click the calculate button, and you will be provided with the maximum that you will be allowed to borrow under the parameters you entered. You can play around with the loan parameters (i.e. increase the down-payment size, change the loan term) and watch the results change accordingly.

It is important to remember that this represents an estimate only. When it actually comes time to obtain your loan, most of the inputs will probably be different from what you originally assumed, so it’s important to be conservative. Last, this formula is designed to show how much you are eligible (the maximum that the bank will lend you) to borrow, and not necessarily what you can afford to borrow. If the housing bust has taught us anything, it is that the gap between these two figures is often larger than most borrowers initially estimated. Plan accordingly, and be conservative!

You’re mortgage is underwater. What do you do?

A few years ago, this would have been a fringe question for a fringe audience. Nowadays, though, 25% of all residential mortgages are underwater. In states like Nevada and Florida – two of the epicenters of the housing bubble and subsequent bust – more than half of borrowers owe more on their mortgages than their homes are worth. In other words, for a growing portion of homeowners, this question is of foremost importance.

For argument’s sake, let’s assume that you have already discussed a loan modification with your lender, and you have been either rejected or presented with an inadequate offer. As a result, you have made the decision to part with your home. [Admittedly, this is a weighty decision]. Should you sell your home at a loss, or simply walk away from your mortgage and allow your lender to deal with the fallout?

The first option is known as a “short-sale,” since the proceeds from the sale of your home wouldn’t be enough to cover the balance of your underwater mortgage. Accordingly, a short sale (or its first cousin, the deed in lieu of foreclosure) first requires the approval of the lender, because it is tantamount to writing off part of the mortgage as a loss. Still, many lenders are amenable to this possibility, because it is often less complicated – and hence, less expensive – than outright foreclosure. You will also need to confer with any junior-lien lenders as well as the mortgage insurance company, if applicable. After receiving an offer on your home, this must then be submitted to the lender (via its loss mitigation department) for final approval.

Here are a few additional things to keep in mind: Minimizing the transaction costs of the sale (by hiring an expensive real estate agent, for example) will go a long way towards convincing the lender that the deal is worthwhile. Next, while a short-sale is less painful than a foreclosure, there will still be some inevitable damage to your credit. In addition, you might be expected to pay taxes on the portion of your mortgage that was forgiven by the bank. Finally, be advised that short sales typically take longer to complete than normal sales, as lenders will often spend a long time deliberating over whether to approve the deal.

If your house has depreciated too much in value, and/or your lender is not willing to approve a short-sale, then a strategic default might be your last option. So-called as to distinguish it from a “conventional” foreclosure, a strategic default is a voluntary decision to stop making mortgage payments despite the capacity to do so. While choosing foreclosure might strike some as oxymoronic, it turns out that for many, it is actually a perfectly rational choice. Simply, the negative impact on one’s credit score and the possibility of a deficiency judgment, pales for some when weighed against the prospect of spending the rest of one’s lifetime paying off a mortgage that is well underwater.

That’s because while foreclosure technically remains on one’s credit report for 7-10 years, it can become functionally irrelevant in the eyes of lenders in half that time. In addition, deficiency judgments (in which the lender sues to collect the difference between the value of the property at the time of foreclosure and the amount owed under the mortgage) are illegal in many states, and rare in the rest. That being the case, the only remaining consideration is the moral one- deliberately breaking a contract that you have the ability to honor. While there are strong arguments to be made for both sides, I don’t think this is an appropriate forum to explore that dimension, however. Let your conscience be your guide.

If used properly, mortgage assumption can provide valuable benefits for both the buyer and the seller. If used improperly, however, they can be a bane for both parties, as well as illegal.

Let’s start with the basics: What is meant by the term “assumed mortgage?” In a nutshell, the assumption of a mortgage is just what it sounds like- the transfer of all liabilities associated with a mortgage from one party to another. There are several variations, but it basically refers to a situation in which the buyer of a home assumes the existing mortgage from the seller, in lieu of taking out a new mortgage.

The benefit of such an arrangement is cost savings. Especially if interest rates have risen in the interim (i.e. in the time that has elapsed since the mortgage was initially obtained), the savings can be significant. Even with significant changes in interest rates, there are savings associated with not having to pay closing costs associated with obtaining a new mortgage. A buyer whose credit is less than stellar meanwhile, can avoid negotiating with a bank, and instead negotiate directly with the seller. Typically, any savings are shared between the buyer in the seller, and are simply tacked on to the price of the home.

Historically, mortgage assumption was only ever popular during times of interest rate uncertainty, namely the 1980’s and early 1990’s. At that time, many mortgages were assumed privately. In other words, the transfer was negotiated directly between buyer and seller, without the knowledge of the lender. Such mortgages are often structured as wraparounds, whereby the original mortgage is maintained by the original borrower, who receives payment from a new homeowner at a spread to the original borrower. Nowadays, such assumptions have become the exception, since lenders have caught on and inserted due-on-sale clauses into mortgages, which essentially required them to be repaid in the event of a change of ownership on the underlying property. Failure to notify the lender of a mortgage assumption, in such a case, qualifies as mortgage fraud.

Some lenders have become more amenable to mortgage assumption, such that they are willing to honor a transfer to a new borrower without assessing fresh closing costs. The catch is that in the process, the interest rate is ratcheted up to conform with prevailing rates. [Otherwise, the lender would deprive itself of the income that it could earn from charging a higher rate]. It should be noted that FHA and VA loans are always assumable, although those originated after 1989 require the approval (and payment of certain fees) of the lender.

If private mortgage assumption strikes you as incredibly risky, that’s because it is! While a public (i.e. lender-approved) assumption relieves the original borrower of all liability, private mortgages are off-the-record (and often illegal) and hence must be resolves directly between the two parties involved. Failure by the new borrower to make timely payments would place the original mortgager in the awkward position of playing landlord, perhaps to the point of executing a form of foreclosure. Meanwhile, mortgages that are assumed multiple times still leave the borrower (and his credit rating) on the hook until for as long as the mortgage remains existence, as one borrower learned the hard way.

In today’s ultra-strict lending environment, chances are you won’t ever have to deal with mortgage assumption. Given that rates are projected to begin rising, however, it could conceivably experience a modest surge in popularity. Still, for the average borrower, it’s not something worth considering.

Determining the size of one’s down-payment is more complicated than it would seem. Historically, the prevailing wisdom regarding down-payments was the larger the better. During the inflating of the housing bubble, however, this logic was turned on its head, and it was even possible to take out a no-money down mortgage. As it turns out, there are advantages and disadvantages to both approaches.

Personal finance columnists usually advise a down-payment of 20% Loan-to-Value (LTV). In other words, take the size of your mortgage, multiple it by 20%, and VOILA, you have your down-payment. According to their reasoning, 20% is substantial enough both to demonstrate your creditworthiness to the lender and to cushion you from negative price swings in the value of your home.

Given the decline in housing prices, however, it’s perfectly conceivable that borrowers that made 20% down-payments are still underwater in their mortgages. After a foreclosure, then, such borrowers will be left with stains on their respective credit report, and gaping holes in their personal assets. From the lender’s perspective, meanwhile, such borrowers are actually considered less credit-worthy than those that make the minimum required down-payment. For those of you scratching your heads: It turns out that those who make down-payments between 20-25% are actually more likely to default. In addition, such borrowers aren’t required to purchase private mortgage insurance, further increasing the cost of default to the lender.

The cost of private insurance, then, can actually be recouped in the form of lower interest rates! In other words, there isn’t much of a financial penalty (sometimes even a reward!) for making a smaller down-payment. Some financial planners now encourage making the smallest allowable down-payment, based on the reasoning that borrowers can then set aside extra money in an emergency fund, making it less likely that they will become delinquent (miss payments) on their mortgage further down the road.

What is the minimum down-payment? Well, that depends on the loan, and the lender. A Federal Housing Administration (FHA) loan requires a 3.5% down-payment. [However, proposed legislation would increase this to 5%]. For veterans, or those that live in rural areas, there are VA home loans and Guaranteed Rural Development loans, respectively.

For those not eligible for the loans above, it might be worth looking into a down-payment assistance program. Some of these programs are also government sponsored, and/or provide low-interest loans to be used exclusively for making a down-payment. There are also several not-for-profit companies which offer down-payment assistance, typically by rolling the down-payment into the overall loan amount, but such organizations have come under scrutiny in the wake of the collapse of the housing market. For first time home-buyers, the $8,000 tax credit can now be “monetized” and applied towards the down-payment. [Under earlier rules, the credit was received in the form of a tax credit, and hence, could not used for a down-payment.]

For those still struggling to scrape together the cash, there are a few more options available to you. First, you can talk to your lender and try to pledge securities in lieu of making a down-payment, but be advised that such is tantamount to borrowing money to buy stock. Second, if you already own the land that your home is (being) built on, that may qualify as a down-payment. Third, you can appeal to family/friends for help, but be aware that the lender will demand proof that any such assistance is a gift, rather than a loan. Finally, you might try talking to the seller, and asking him to help you make your down payment (offset in the form of a higher sale price). This will only be possible, however, if the sale price initially exceeded the appraised value.

All else being equal, a larger down-payment should translate into smaller monthly payments, as a result of both lower principal and interest. It should also lower your mortgage insurance premiums. As I noted above, however, some lenders actually penalize those who make larger down-payments. Ultimately, every situation is different, and it probably makes sense to use calculators to crunch the numbers associated with a few different scenarios to see ultimately which one makes the most (financial) sense for you.