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Now you know how much you can
borrow! You should already have a rough
idea of how much you can borrow based on the
How much home can you
afford? page, but now you get to find out
exactly how much the bank is willing to lend
you. Once the bank has processed your application
and run your credit report they know how much
they're willing to loan you. Sit down with them and
go over the results.
 Or
more specifically, they know how much they think
you can afford in the way of a monthly payment.
Let's say they figure you're good for $1000 a
month. For that $1000 a month you'll get a much
bigger loan on a 30-year term than you will on a
15-year term. The lender will tell you how much
they'll loan on each term, depending on how big
your down payment is.
Get the
Pre-Qual Letter
A lender who has qualified you for a loan can
give you a "Pre-Qual Letter" which says that very
thing. (That they've qualified you for a loan.)
Having such a letter helps show realtors and
sellers that you're serious about wanting to buy a
house and that you're not just a window-shopper.
Get a Pre-Qual Letter from each bank that qualifies
you for a loan.
Evaluating
Different Options
The bank will probably give you at least a
couple of different, confusing options for your
mortgage. They do this to make more money,
because if you pick the wrong option you'll wind up
paying more. Let's see how to evaluate the
different options.
Fixed Rate vs.
Adjustable Rate Mortgages
(FRM vs.
ARM)
On a normal mortgage the interest rate stays
the same over the life of the mortgage. This is
called a fixed-rate mortgage, or FRM. If interest
rates are low then your lender will try to sell you
on an adjustable rate mortgage, or ARM, where the
interest rate varies over the life of the loan. If
interest rates are low they don't want to get
locked in to getting a low rate from you for 30
years, so they'll hope you take an ARM so they can
raise the rates later. Why on earth would you agree
to this? Well, for starters, they make it look
really attractive: They'll generally start out your
first year or two at a rate below the
current FRM rate. Then they'll tell you that
they'll limit the increases to a certain amount so
you won't have to worry about ridiculously high
interest rates.
So should you take the ARM or not? The general
rule of thumb is, take the FRM unless the rate
is above 10%, in which case take the ARM (after
scrutinizing it closely). Always make sure you read
the fine print on an ARM offer, but unfortunately
the details in ARM offers are varied and hard to
analyze. . It's worth paying an independent
financial advisor $50 to evaluate the offer for you
if you don't understand it, or if you're not sure
it's as good a deal as the bank says. Don't get
this one wrong: the foreclosure crisis of 2006-07
was due in large part to buyers who took an
expensive ARM and couldn't make the payments when
the rates went up. They should have taken the FRM
-- and if they'd followed my advice above about
taking the FRM unless the interest rate is above
10%, they wouldn't have lost their homes.
Mortgage
Points (Origination Points, Discount
Points)
Origination Points
Most banks charge you a fee to give you
a loan, on which you'll be paying them interest.
Basically, they're charging you money for the
right to charge you more money. Their fee for
doing so is called the Origination Fee.
The fee is a certain number of points. A
point is 1% of the purchase price of the home.
So if you're buying a $100,000 home, and the
lender charges two points, you'll pay a fee of
$2000 for the privilege of getting the loan.
This is part of the closing costs, usually the
biggest part, in fact. You can usually have this
amount added to your loan amount so you don't
have to pay it in cash at closing.
Different banks charge different amounts of
origination points, and some banks don't charge
origination points at all. This is something to
consider when you're shopping around for a
loan.
Discount Points
As you know, the lower the interest
rate, the better. So many banks will offer you a
deal: they'll offer you a certain interest rate,
but they'll let you buy the right to an
even lower interest if you pay them some points.
For example, they might offer you a rate of 7%,
but tell you that you can have a rate of 6.5 %
instead if you pay 4 points (4% of the purchase
price of the house. As we saw earlier, points
are part of the closing costs and can usually be
rolled into the mortgage.)
Okay, so in our example the bank is telling
you that you can have 7% straight up on a
30-year mortgage, or 6.5% if you pay 4 points.
How the hell are you supposed to know which is
the better deal? Well, you couldn't know, unless
you had these handy tables that show the
effective interest rate based on the number of
points.
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Effective
interest rate based on the number of
points
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30-year
mortgage
|
|
Points
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6%
|
6.5%
|
7%
|
7.5%
|
8%
|
8.5%
|
9%
|
9.5%
|
10%
|
10.5%
|
11%
|
|
1
|
6.09
|
6.60
|
7.10
|
7.60
|
8.10
|
8.61
|
9.11
|
9.62
|
10.12
|
10.62
|
11.13
|
|
2
|
6.19
|
6.69
|
7.20
|
7.70
|
8.21
|
8.72
|
9.22
|
9.73
|
10.24
|
10.74
|
11.25
|
|
3
|
6.28
|
6.79
|
7.30
|
7.80
|
8.31
|
8.82
|
9.33
|
9.84
|
10.35
|
10.87
|
11.38
|
|
4
|
6.38
|
6.88
|
7.39
|
7.91
|
8.42
|
8.93
|
9.44
|
9.96
|
10.47
|
10.99
|
11.50
|
|
5
|
6.46
|
6.98
|
7.49
|
8.01
|
8.52
|
9.04
|
9.55
|
10.07
|
10.59
|
11.11
|
11.63
|
|
6
|
6.55
|
7.07
|
7.59
|
8.11
|
8.62
|
9.14
|
9.66
|
10.19
|
10.71
|
11.23
|
11.75
|
|
7
|
6.64
|
7.16
|
7.68
|
8.21
|
8.73
|
9.25
|
9.77
|
10.30
|
10.82
|
11.35
|
11.87
|
|
8
|
6.73
|
7.26
|
7.78
|
8.31
|
8.83
|
9.36
|
9.88
|
10.41
|
10.94
|
11.47
|
12.00
|
|
15-year
mortgage
|
|
Points
|
6%
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6.5%
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7%
|
7.5%
|
8%
|
8.5%
|
9%
|
9.5%
|
10%
|
10.5%
|
11%
|
|
1
|
6.16
|
6.66
|
7.16
|
7.66
|
8.17
|
8.67
|
9.17
|
9.67
|
10.18
|
10.68
|
11.18
|
|
2
|
6.31
|
6.82
|
7.32
|
7.82
|
8.33
|
8.83
|
9.34
|
9.84
|
10.35
|
10.87
|
11.36
|
|
3
|
6.46
|
6.97
|
7.48
|
7.99
|
8.49
|
9.0
|
9.51
|
10.02
|
10.52
|
11.03
|
11.54
|
|
4
|
6.62
|
7.13
|
7.64
|
8.15
|
8.66
|
9.17
|
9.68
|
10.19
|
10.70
|
11.21
|
11.72
|
|
5
|
6.77
|
7.28
|
7.79
|
8.31
|
8.82
|
9.33
|
9.84
|
10.36
|
10.87
|
11.38
|
11.90
|
|
6
|
6.92
|
7.44
|
7.95
|
8.46
|
8.98
|
9.49
|
10.01
|
10.52
|
11.05
|
11.56
|
12.07
|
|
7
|
7.07
|
7.59
|
8.11
|
8.62
|
9.14
|
9.66
|
10.17
|
10.69
|
11.21
|
11.73
|
12.25
|
|
8
|
7.22
|
7.74
|
8.26
|
8.78
|
9.30
|
9.82
|
10.34
|
10.86
|
11.39
|
11.90
|
12.42
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In the table we see that a rate of 6.5%
with 4 points is just like a rate of 6.88% with
no points. And 6.88% is better than 7%, so in
this case we'd tell the banker, "Hell yeah, I
want those points. Put 'em on the table."
But what if they offered you 6.6% with no
points, or 6.5% with 2 points? In that case we
see from the table that a 6.5% with 2 points is
really 6.69% -- which is higher than the
original offer of 6.6%. In this case we'd slap
the banker upside the head and yell, "Why are
you trying to scam me by selling me points that
will only raise my effective interest
rate?"*
* Please don't
actually hit or yell at the banker.
Get another
offer
Don't forget our advice from our find
a lender page: Shop around by getting a
second offer from another bank or broker.
You don't have to make your decision about which
bank or broker to go with right now -- you can save
that for when you know exactly which house you want
to buy.
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