HOW LENDERS CHECKING YOUR CREDIT AFFECTS YOUR SCORE

Some borrowers worry about shopping around for the best loan because they are worried how it will affect their credit score. Lenders are interested in the number of inquiries to your credit report because multiple inquiries are an indication that you are requesting new credit. The credit scoring agencies have found that borrowers who request credit frequently tend to be higher-risk borrowers Thus, frequent inquiries on your credit report that result from frequent requests for new credit (credit cards, loans, etc.) can lower your credit score.

However, credit reporting agencies understand that borrowers need to shop around to find the best loan, which can create multiple inquiries over a short period of time. To address this, the scoring formula doesn’t penalize borrowers for shopping around. The score is set up to take into account that even though you are looking for only one loan, multiple lenders may request your credit report. Here’s what Fair Isaac, the company behind your FICO score, says about rate shopping

“The score ignores all mortgage and auto inquiries made in the 30 days prior to scoring. So if you find a loan within 30 days, the inquiries won’t affect your score while you’re rate shopping. In addition, the score looks on your credit report for auto or mortgage inquiries older than 30 days. If it finds some, it counts all those inquiries that fall in a typical shopping period as just one inquiry when determining your score. For FICO scores calculated from older versions of the scoring formula, this shopping period is any 14-day span. For FICO scores calculated from the newest versions of the scoring formula, this shopping period is any 45-day span. Each lender chooses which version of the FICO scoring formula it wants the credit reporting agency to use to calculate your FICO score.”

In any event, inquiries are likely to be an issue only if there is little other information in your file. If you have a long credit history and several current accounts, a single inquiry will not significantly affect your score. Since your credit score is so important, it’s wise to check your own file regularly to ensure that the information is accurate. You can do so for free using the Annual Credit Report Request Service: call 1-877-322-8228 or visit www.annualcreditreport.com.

You might consider staggering your annual requests. For example, you can request an annual copy of your Equifax report in January, your TransUnion report in May, and your Experian report in September. That way you’ll receive an up-to-date credit report every four months. Or you can request your: Free Credit Report and Score from www.lendingtree.com

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LOCK-INS

Once you’ve decided on a lender and a mortgage that suits your needs, you should request a lock-in, or rate commitment. This is a lender’s promise to hold a certain interest rate and number of points for a specified period, often 30 to 60 days. Sometimes you can lock in only the rate and let the points “float” or move up and down with the market. Depending upon the lender, you may be able to lock in when you apply for the mortgage, during processing, when it gets approved, or at some later date.

The benefit of a lock-in is that it protects you against rate increases while your application is being processed. Some lenders charge a fee for locking in (generally, the longer the guaranteed period, the higher the fee), but this may be refundable if you go ahead with the loan. Be sure to get the rate commitment in writing.

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COMPARING RATES, POINTS AND FEES

Choosing the best mortgage isn’t simply a matter of picking the one with the lowest

monthly payment, or even the best posted rate.

Suppose one lender offers a mortgage at 6 percent, plus two points, while another offers a similar product at 6.5 percent, but no points. Or perhaps one lender offers a

mortgage with a manageable monthly payment, but you discover later that you also have to pay private mortgage insurance that adds hundreds of dollars to the annual cost. In each case, it’s important to do the math to determine which is the better deal.

Mortgages may express their interest rates in various ways, and may carry hidden fees. Homeowners need to consider all of these as they shop around for the best loan.

Introductory rates

Many adjustable rate mortgages offer low introductory or “teaser” rates. It’s important to remember that these rates usually apply for only a few months, after which they go up significantly. If you take advantage of introductory rates, you will need to budget for the inevitable rise in your monthly payment. If you agree to a loan with an introductory rate, make sure you understand how long the rate will last. Some rates are good for only 30 days; make sure you read all disclosures so you’re not surprised when your mortgage bill arrives.

Discount points

Discount points are fees paid up front to obtain a lower interest rate. One point equals one percent of the loan amount and will typically lower the rate by 0.25 percent. Paying points may be worthwhile if you plan on keeping your mortgage for an extended period of time. If you intend to hold the mortgage for only a few years, however, the cost may exceed the benefit you’ll receive from a lower rate.

For example, if you are considering a $150,000 mortgage at 7 percent, you may be able to lower the rate to 6.5 percent by purchasing two points at a cost of $3,000 (two percent of $150,000). Next, find out how much you’ll save per month by paying points. In this example, if the loan is a 30-year fixed mortgage, the difference in monthly payments is $50 per month. Divide your cost by the monthly savings ($3,000 ÷ $50) to determine your break-even point (60 months, or 5 years). This means you will have to stay in your mortgage at least 5,recoup the cost of paying for points.

You can use the Discount Points calculator in the LendingTree.com Smart Borrower Center to help you do the math to decide whether paying points makes sense for you

Private mortgage insurance

If you are borrowing with a down payment of less than 20 percent, you may be required to have private mortgage insurance (PMI), which protects the lender if you are unable to pay back the loan. In this case, you may be required to pay annual or monthly premiums, or have a one-time fee added to your loan amount. Be sure to include this expense in your comparison. You should notify your lender to cancel the insurance once you have paid 20 percent of the principal on the loan.

Fees

Mortgage lenders may charge for a range of services, including fees for processing your application, conducting a title search, having your home appraised, obtaining your credit report, and other administrative or legal services. Borrowers may choose to pay these costs by adding the amount to their loan principal. In other cases, lenders may waive the fees in exchange for a higher interest rate.

Lenders may give different terms for these fees, or may combine several under a single name, making it difficult to know what you’re paying for. Your lender must provide you with a written good faith estimate (GFE) of these costs within three days of receiving your loan application. Your lender is also required to provide you with a Truth in Lending

(TIL) form. Read this closely; it will tell your annual percentage rate, if your loan is adjustable or not, and if there is a pre-payment penalty associated with your loan.

Annual percentage rate (APR)

To help homebuyers evaluate mortgages on a level field, the federal government requires lenders to publish the loan’s annual percentage rate (APR). This figure is designed to express the true cost of the loan by taking into account the base interest rate and several other fees charged by the lender. (Not all fees associated with a mortgage are included in the APR.)

Unfortunately, comparing mortgage costs over the medium and long term is not as simple as looking at the APR. You should not, for example, look only at the APR when comparing mortgages with different terms, such as a 15-year versus a 30-year mortgage. Nor is it possible to project future costs of an adjustable rate mortgage. Nevertheless, the APR is a

useful starting point for comparing the cost of loans.

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CREDIT SCORES AND MORTGAGES

When lenders review your application and set the interest rate for your mortgage, one of the most important factors they consider is your credit score.

The three major credit bureaus – Equifax, TransUnion and Experian – collect information on consumers from financial institutions and other sources. If you have a good credit history – you pay your accounts on time and don’t overextend your borrowing – that information is in their files. On the other hand, if you’ve missed payments on your car loan, maxed out your credit cards or had your credit accounts turned over to a collection agency, that will also be reflected in your credit file.

To generate your credit score, the bureaus take the information in your file and run it through a mathematical formula. Your score will fall somewhere between 300 to 850, although most are in the 600s and 700s. A high credit score means you will likely have no trouble being approved for a mortgage and securing a low interest rate. A lower score, however, makes it harder to find a lender, and your interest rate may be higher if you do qualify.

Let’s say you are looking for a $200,000 fixed-rate mortgage with a 30-year term. Here’s an illustration of how your credit score may affect your interest rate and payment:

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SPECIAL TYPES OF MORTGAGES

There are many different mortgage products available today, and choosing the best one can be almost as challenging as finding the right house. This guide explains common types of mortgages to help you decide which one will best meet your financial needs. Before you get a mortgage, consider:

• what you can afford to pay each month based on your current income. (see Worksheet 1: How Much House Can You Afford?)

• whether you expect your income to rise, fall or stay the same over time.

• whether you plan to stay in the house longterm or move in a few years.

• your tolerance for risk.

• whether you expect interest rates to rise, fall or stay about the same.

TYPES OF MORTGAGES

Understanding the pros and cons of different types of mortgages is the first step in finding the loan that’s right for you. Here’s a look at the options available.

Fixed rate mortgages

With a fixed rate mortgage, the interest rate and monthly payments stay the same for the life of the loan.

These mortgages are usually fully amortizing, meaning that your payments combine interest and principal in such a way that the loan will be fully paid off in a specified number of years. A 30-year term is the most common, although if you want to build equity more quickly, you might opt for a 15- or 20-year term, which usually carries a lower interest rate. For homebuyers seeking the lowest possible monthly payment, 40- and 50-year terms are available with a higher interest rate.

Consider a fixed rate mortgage if you:

• are planning to stay in your home for several years.

• want the security of regular payments and an

unchanging interest rate.

• believe interest rates are likely to rise.

Adjustable rate mortgages (ARMs)

With an adjustable rate mortgage (ARM), theinterest rate changes periodically, and payments may go up or down accordingly. Adjustment periods on an ARM can vary, but it’s usually one year. All ARMs are tied to an index, which is anindependently published rate (such as those set by the Federal Reserve) that changes regularly to reflecteconomic conditions. Common indexes you’ll encounter include COFI (11th District Cost of Funds Index), LIBOR (London Interbank Offered Rate), MTA (12-month Treasury Average, also called MAT) and CMT (Constant Maturity Treasury). At each adjustment period, the lender adds a specified number of percentage points, called a margin, to determine the new interest rate on your mortgage. For example, if the index is at 5 percent and your ARM has a margin of 2.5 percent, your “fully indexed” rate would be 7.5 percent.

While you don’t need to understand the economic theory behind your mortgage’s index, you should ask your lender for a chart or graph of its historical rates so you get an idea of how quickly it can change. Mortgages that are tied to fast-moving indexes tend to have smaller margins, but your rate may change more frequently or drastically.

ARMs usually have caps that prevent the rate or payment from rising beyond a certain level between adjustment periods, as well as over the life of the loan. Typical rate caps might be 2 percent in any year, and 6 percent overall.

Using the cap information above as an example, if your initial interest rate is 4.5 percent, even if yourindex rate rose 2.5 percent, the highest your rate would rise to would be 6.5 percent. However, you don’t escape the rest of the rate increase; your rate would likely rise the other half percent immediately in the second year, to 7 percent. Over the life of your loan, your rate would not be able to rise to more than 10.5 percent.

ARMs usually offer a lower initial rate than fixed rate mortgages, and if interest rates remain steady or decrease, they may be less expensive over time.

However, if interest rates increase, you’ll be faced with higher monthly payments in the future.

Consider a traditional adjustable rate mortgage if you:

• are planning to be in your home for less than three years.

• want the lowest interest rate possible and are willing to tolerate some risk to achieve it.

• believe interest rates are likely to go down.

Also called “flex ARMs,” these are adjustable rate mortgages with a twist. Each month, rather than paying a set amount, you’ll receive a statement with up to four payment options, ranging from a small minimum to a fully amortized payment. You select the amount you want to pay each month.

Option ARMs entice borrowers by offering initial low minimum payments, but after an introductory period, the required minimum can rise substantially. In addition, if you choose the minimum payment, you won’t cover all the interest you owe for a payment period. This unpaid interest is added to your loan amount, meaning that even if you’ve made a payment, you could owe more on your loan, not less, than when your loan began. This is called negative amortization, and is something you should avoid.

Consider an option ARM if you:

• want flexibility because you have a fluctuating income – for example, if you’re self-employed or work on commission.

• are financially disciplined and won’t be tempted to simply pay the minimum every month.

Hybrid mortgages

A hybrid mortgage combines the features of fixed rate and adjustable rate loans. It starts off with a stable interest rate for several years, after which it converts to an ARM, with the rate being adjusted every year for the remaining life of the loan.

Hybrid mortgages are often referred to as 3/1 or 5/1, and so on. The first number is the length of the fixed term – usually three, five, seven or ten years.

The second is the adjustment interval that applies when the fixed term is over. So with a 7/1 hybrid, you pay a fixed rate of interest for seven years; after that, the interest rate will change annually.

Consider a hybrid mortgage if you:

• would like the peace of mind that comes with a consistent monthly payment for three or more years, with an interest rate that’s only slightly higher than an annually adjusted ARM.

• are planning to sell your home or refinance shortly after the fixed term is over.

Interest-only and balloon mortgages

Unlike an amortized mortgage where you pay a combination of interest and principal each month, with an interest-only mortgage you pay only interest for a fixed period – usually from five to 10 years.

This means the principal never goes down, and after this period has elapsed you have to either pay the entire principal off or start paying down the principal, which results in much higher monthly payments.

Balloon mortgages also offer low regular payments for a number of years (often just slightly below what you’d pay for a 30-year fixed rate mortgage). After this fixed period, the principal must be repaid as a lump sum, which generally means refinancing. Because very little of the principal has been paid down, once again, your payments will increase.

These loans can be helpful temporarily, but they don’t allow you to build equity in your home, and they can cause serious financial strain when the principal comes due.

Consider an interest-only or balloon mortgage if you:

• are buying a home with the expectation of an improvement in your financial situation – for example, you have a large debt that will be paid off in a few years.

• want to stay in your current home but are experiencing a temporary financial squeeze – for

example, you are going back to school, or taking a few years off to stay home with your children.

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