How to Shop for a Mortgage: A Step-by-Step Guide

Getting a mortgage loan to buy a house could be one of the best financial decisions you make. By owning a home, you can gain economic stability through the equity you build each month. 

But getting a mortgage is a major expense that will impact your monthly budget. Learn how to shop for a mortgage so you can compare lenders, understand rates, review loan terms, and ultimately find the best option for your budget and needs.

Why is it important to shop for a mortgage?

Not all mortgages are the same, and not all lenders offer the same rates and terms. Shopping for a mortgage helps ensure you get the best mortgage loan type for your needs from a lender that offers the most favorable terms. The first step is to choose the type of mortgage that best fits your criteria.

Types of mortgages

The three types of mortgages are conventional, government, and special programs:

• Conventional: Most mortgages are conventional loans, meaning they’re not backed by the government. Borrowers typically get the best deal with a conventional loan, but this type of mortgage can be more difficult to get, often requiring a higher credit score and a larger down payment.
• Government: These loans are backed by the government, making them less risky for lenders, which allows more people to qualify. The types are FHA, VA, and USDA. FHA loans offer low down payment options and lower credit score requirements. VA loans are for veterans, service members, and surviving spouses. They offer loans with no down payment and lower credit score requirements. USDA loans are for low- to middle-income borrowers who are buying a home in a rural area.
• Special programs: These are offered by state or local housing agencies and are generally for public service employees, first-time homebuyers, or low- to middle-income borrowers.

How to compare mortgage lenders

You can request loan estimates from multiple lenders and compare them. Research conducted by Freddie Mac found that consumers who do this can potentially save between $600 and $1,200 a year. The loan estimate helps you understand the terms of the loan. It tells you the estimated interest rate, monthly payment, and closing costs. It also tells you if there are special features, such as a prepayment penalty or a balloon payment. When you choose the loan you like best, you can move forward with the lender.

What factors should you consider when choosing a mortgage?

The Federal Trade Commission put together a worksheet to help consumers make an apples-to-apples comparison of mortgage lenders. Here are some of those factors to consider when choosing a mortgage:

• Minimum down payment required: If you don’t have a lot of cash saved for a down payment, you’ll want a loan with a low minimum down payment requirement. With a conventional loan, your down payment could be as low as 3%. FHA loans can be as low as 3.5%, and there is no down payment requirement with VA and USDA loans.
• Length of loan: Most mortgage loans are for 15, 20, or 30 years. Some lenders offer 40-year-loans as well.
• Interest rate: This is the amount you’ll pay each year to borrow money, expressed as a percentage. It does not factor in loan fees.
• Annual percentage rate: This reflects the total cost of borrowing money. It accounts for the interest rate plus any loan fees, points, and other charges.
• Points: Paying points is optional. Borrowers who choose to pay points do so to lower their monthly payments by lowering their interest rates. One point equals 1% of the loan amount. You’ll pay more upfront if you decide to pay points, but you’ll pay less interest.
• Monthly private mortgage insurance (PMI): Many lenders require mortgage insurance if you have less than 20% equity in the home. PMI generally costs between $30 and $70 per month for every $100,000 borrowed.
• Fees: Lenders charge a fee for lending money. These fees are expressed as origination fees, application fees, underwriting fees, processing fees, administrative fees, and more. Whatever the lender calls the fees, you should compare the total fee amount with what other lenders charge.
• Closing costs: These are fees you pay when you buy the home. Part of closing costs are lender fees.
• Other considerations: See if the mortgage contains any special stipulations, such as a prepayment penalty or a balloon payment.

Once you review all the factors, you can get an idea of which mortgage lender to choose.

Tips for getting the best mortgage rate

Before you apply for a mortgage, it’s a good idea to set yourself up as best as you can to get the lowest possible interest rate. Here’s how:

• Check your credit score: Your credit score largely determines your interest rate. You want your score to be as high as possible to get the best rate. FICO credit scores range from 300 to 850. You generally need a credit score of 620 to get a mortgage and a score of 760 and above to get the best rate.
• Have a steady job: Lenders like to see that you’ve been employed for two years or more in the same field.
• Lower your debt-to-income ratio (DTI): Lenders want to make sure you have room in your budget to afford the mortgage. They like to see a DTI of 36% or lower to offer the best rate. Let’s say you have a monthly income of $8,000. That figure multiplied by 0.36 equals $2,880, which would represent the highest mortgage payment for this income to get the best rate.
• Pay a larger down payment: A large down payment could result in a better rate. Make sure you can afford the down payment, as well as the closing costs and any repairs to your new home.
• Watch market rates over time: This will give you a sense of whether rates are rising or falling, but it’s wise not to base your decision solely on market rates. According to Gabrielle Mason, an Atlanta REALTOR® since 1998: “If you are ready to buy a home but trying to time the market, you might miss out on the property of your dreams. While it’s important to look at rate trends, you shouldn’t let that hold you back. If you need more space for your growing family or you’re looking to settle down somewhere closer to work, buying a home could still make sense for you, despite what the market is showing.”

Common mistakes to avoid when shopping for a mortgage

Buying a house is a huge financial undertaking, and getting the best mortgage product for your needs can save you a significant amount of money. Here are some common mistakes to avoid:

• Not checking your credit score: You might think you have a good credit score and then check it to find it’s lower than you thought. Whether it’s from an error on your credit report or for some other reason, it might be best to wait until your score improves before you apply for a loan.
• Spending the maximum you’re approved for: Lenders approve you for a certain dollar amount, but that doesn't mean you need to spend that much. You’re the best judge of how much you can afford to spend. Keep in mind that besides the monthly mortgage payment, which generally includes the principal, interest, property taxes, and homeowners insurance, you need to consider other costs, such as homeowners association dues and house repairs and maintenance. If you get in over your head and can no longer afford to make your mortgage payment, you could lose the home.
• Not comparing enough lenders: Unless you compare at least three different lenders, you probably won’t know whether you’re getting the best deal.