The next issues to explore before applying for a mortgage are the factors which will influence your upfront costs, and your monthly payments.
Your down payment will ultimately influence the interest rate offered by the lender, as well as your ongoing monthly payments.
In the past, the standard down payment was 20%. This in turn would mean the lender was providing 80% of the purchase price, a level most felt comfortable at. Most lenders reasoned at this level, if they were have to take the house back, they should be able to sell it for at least 80% of what the borrower purchase it at, and recoup their investment.
However, in recent years, the down payment level had come down. It was not unheard of in peak times (2006/7) that lenders would even go up to no-money-down mortgages. However, since the housing collapse and subprime crisis most are back to down payments in the 10-20% range.
An important point to keep in mind is that just because the lender only required 10%; it doesn’t automatically make that the best option for you. Often, a lender is willing to overlook a low credit score, or offer a more favorable rate the more the borrower is willing to put down. Even a small change in the rate offered can make huge impacts over the life of a mortgage, so it is important to pursue all options offered by the lender, and discuss the impacts of offering more upfront in the form of a down payment.
If you do decide to put less than a 20% down payment, the lender will require a guarantee that they can recoup their investment in event of a default. This guarantee will come in the form of mortgage insurance, often referred to as private mortgage insurance (PMI). With PMI, the borrower is required to pay a premium each month, to protect the lender against default. In the case where the borrower is unable to pay the mortgage, the PMI ensures that the lender will still be paid in full. Most often, this premium is included in the monthly payment the borrower makes, and is arranged by the lender.
An option often presented by lenders is the concept of ‘points’ and various arrangements of points and rates.
A point is a fee which equals 1% of the loan amount. For instance, on a $200,000 mortgage, 1 point would be equal to $2,000, and 2 points would be $4,000, etc.
Typically, the lender has two variations of ‘points’:
The first, ‘origination fee’, is a fee charged by the lender to cover costs of securing the loan. This fee is usually quoted in terms of points.
The second, ‘discount points’, is prepaid interest on the loan. The more points the borrower is willing to pay up front, the lower the rate of their mortgage will be over the life of the loan.
Although discount points add upfront costs to the mortgage, the reduction in rate over the course of the loan can often more than make up for this fee.
An important piece to keep in mind when debating points, is the positive impact of paying upfront points is realized over the course of the loan, and not quickly. For this reason, you must be fairly certain you’ll remain in that house for an extended period of time; otherwise points will not prove financially beneficial.