Evaluating the bank's offer

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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 and Discount Points)

Origination Points

Most banks charge you a fee to give you a loan. 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 loan amount. So if you're borrowing $200,000, and the lender charges one point, 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. And some banks that normally charge points will reduce or eliminate the origination fee if you ask -- and if they think you're going to take your business to another bank.

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 3 points (3% of the loan amount).

Is this a good deal or not? There's no way to know unless you run the numbers through a calculator. So... presenting the Discount Points Calculator! Here's how it works: Buying points lowers your monthly payment. So we're going to figure how long it takes for the savings from your lower payment to overcome the cost of buying the points.

Discount Points Calculator

The Loan

Interest rate w/o points

%

Interest rate with points

%

Loan amount

$

Number of points

Length of mortgage

years

Results

Monthly payment w/o points

$

Monthly payment w/points

$

Monthly savings from buying points

$

Upfront cost of points

$

Buying points becomes a good deal after...

years

This means that if you're going to stay in your house for more than years, then it's better to buy the points. However, it might not be better to buy a home in the first place (vs. continuing to rent). To see whether it's better to buy or to rent, see the rent vs. buy calculator.

Note that while most closing costs can be rolled into the mortgage, discount points cannot. The whole point of points (from the bank's perspective) is to get some money from you up front. 

 

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.


Amount spent so far.   Red items apply towards the purchase. Amounts are typical, not exact.

$40

Credit Check

To the Lender

$40

Total


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