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Shop Around for Rates

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Posted On: 07/27/2016

QUESTION:

We are first-time buyers looking for a mortgage. We are very lucky and have no debts, good jobs, considerable savings and excellent credit. We spoke with one lender who said that 30-year conventional financing was available at 3.25 percent – but only with 30 percent down. With 5 percent down the rate was 4.125 percent. How do we get a better rate?

ANSWER:

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According to the National Association of Realtors, the typical existing home sold for $232,500 in April. Thirty percent of that amount is $69,750. If you don’t have such cash plus closing costs and reserves, then you’ll need to consider alternatives options.

The good news is that the marketplace is awash with lenders who would like to loan you money, including local lenders, national lenders, online lenders and the new players in the field, nonbanks.

Your situation raises two issues that are important for every borrower: First, was the offer you received competitive? Second, are lenders justified in asking for more down in exchange for a lower rate?

As to the amount down, the usual idea in lending is that more down means less lender risk. Less lender risk should mean a lower interest rate.

However there is considerable evidence that such long-held logic is questionable — and maybe wrong. For instance, VA loans are available with zero down and VA loans have a lower foreclosure rate than FHA and conventional mortgages, both forms of financing that require more down.

One reason the VA is so successful is that it has a unique way to underwrite loans. Instead of relying on credit reports and massive down payments, the VA checks the borrower’s residual income. Under this system, the VA looks at the borrower’s monthly obligations and then how much is left over. The VA also considers household size and where the property is located. If the borrower has enough left over after basic expenses, then the loan is approved. (Lenders who originate VA loans may elect to use credit reports when qualifying a borrower, however the VA does not actually have a minimum credit score requirement.)

Even among non-VA loan programs there is little evidence that big down payments result in less lender risk. According to a 2014 report from the Urban Institute, “of loans that originated in 2011 with a down payment between 3-5 percent, only 0.4 percent of borrowers have defaulted. For loans with slightly larger down payments — between 5-10 percent — the default rate was exactly the same.”

Meanwhile, your job is to shop, shop and shop until you find a lender that comes up with the right combination of programs, rates and terms that work best for your situation.

Peter G. Miller is author of "The Common-Sense Mortgage," (Kindle 2016). Have a question? Please write to peter@ctwfeatures.com.

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