What kind of mortgage?

Competition among lenders has given consumers a broad array of choices, but it hasn't made comparison-shopping easy. Mortgages now come in nearly every conceivable combination of interest rate, duration, and fee structure.

Which loan makes the most sense depends on how long you plan to remain in the home and the monthly payment you can afford. If you live in a city where co-operative apartments are common, you will probably have fewer options.

Lenders consider not just the credit-worthiness of the co-op buyer, but the underlying financial health of the corporation that issues the building's shares. The conventional 30-year fixed-rate mortgage has been the perennial favorite of borrowers, and it's more popular than ever as both buyers and refinancers scramble to lock in today's low rates. It offers homeowners the peace of mind of knowing that even if economic conditions cause interest rates to rise sharply, their payments will remain steady.

But in these footloose days, relatively few people remain rooted in a home for a lifetime. If you plan to relocate within a few years, you may find an adjustable-rate mortgage (ARM) less costly at least at first. The most common ARMs recalibrate interest once a year, based on an index of benchmark Government bond rates.

ARMs made sense for many borrowers in the early 1980s, when interest rates were high and volatile. Their lower initial rates were often the only way that many people could afford to buy a home. But lately the spread between conventional and ARM has narrowed to 2 points or less, too small to be worth the risk of paying more next year unless it's the only way your income qualifies you for a mortgage.

One breed of ARMs is worth considering. These maintain a fixed interest rate for a specified number of years typically 3, 5, 7, or 10 and then adjust annually for the balance of the loan. Multiyear ARMs may be well suited for consumers planning to relocate within or soon after the mortgage's initial period. In fact, the average mortgage is paid off in just seven years because the borrower moves to a different home or refinances the loan in that time.

Multiyear ARMs permit borrowers to lock in, at least for a few years, a lower initial interest rate than they could get for a fixed-rate mortgage. And, because the monthly payment on an ARM is lower, banks are able to qualify borrowers with a smaller income.

How to lower your costs

While the interest rate you get will be the biggest factor determining the ultimate cost of your mortgage, lenders have other ways of upping your costs. You can save thousands of dollars and much frustration by getting prequalified and preapproved for a mortgage and by minimizing transaction fees. Here's where to look for your best opportunities to save:

Prequalification.

Lenders expect borrowers to spend no more than 28 percent of their pretax income on total housing costs, including mortgage payments, insurance, and taxes. Housing costs plus all other long-term debt, such as car payments and student loans, should not exceed 36 percent of your gross income.

Ask your broker or a potential lender whether you would qualify for a loan before you begin shopping. It can save you time by focusing your attention on properties that realistically fit your budget.

Preapproval.

As you get closer to selecting the property you want, consider lining up a bank that will give you its provisional agreement to grant you a loan. Preapproval can boost your bargaining power with the seller, who knows that with financing in place you can close the deal quickly.

There are some pitfalls to beware of. While many lenders preapprove free, some charge a fee. At NationsBanc Mortgage in Roanoke, Va., for example, preapproved borrowers pay $50 for a credit check, but they won't get their money back if they decide to go with another lender.

Locking in the rate.

Before you pay to lock in a given interest rate for a specified time period, ask if the lender will be willing to lower it if interest rates decline. And get a commitment for at least 60 days. A 30-day lock-in won't be of much use if you're just beginning to shop for a home. (It can typically take 45 days to complete all the paperwork.)

Points and other closing costs.

Your lender may be willing to offer you a lower interest rate on a mortgage that includes points (each point equals a 1 percent fee paid at the closing on the total amount of the loan).

Your lender is required to give you a good-faith estimate of the charges you'll be expected to pay to finalize the loan for property appraisal, title insurance, credit reports, and the like. Carefully review every item on the list. Sometimes lenders will pad the bill with unnecessary charges, such as courier fees. Other items, like title insurance, you may be able to buy more cheaply on your own.

The mortgage-insurance ripoff.

Borrowers who put down less than 20 percent of the purchase price must have mortgage insurance to protect the lender in the event of default. But avoid "lender paid" insurance, a way some lenders like Countrywide and Chase Bank get you to make extra premium payments. It sounds good the premium is part of your tax-deductible monthly mortgage interest payment. But you go on paying even after your equity exceeds 20 percent of the home's value. You should pay the premiums separately in cash and drop the policy once your home equity crosses that 20 percent threshold.

Prepayment penalties.

Watch out for mortgages that impose a penalty if you decide to pay them off ahead of schedule. With more consumers trading in their old mortgages for lower-cost new ones, lenders want to write the penalties into more loan contracts something many states currently allow them to do.

Accelerated payment.

Another thing you shouldn't have to pay extra for: biweekly payments that help you pay off your loan faster. Lenders like Mellon Mortgage Co. in Denver, will charge you a fee of $400 or so to arrange it. If you make the extra payments yourself, however, you can avoid the fee and the obligation that comes with the lender's program. Borrowers who regularly make 13 monthly payments a year instead of 12 can pay off a 30-year mortgage in about 22 years and save some $52,000 over the life of a $100,000 loan.

Finding good advice

Lenders' advertisements in the local newspaper can give you a flavor of what's available, but don't buy on the strength of an ad alone. The most attractive advertised rates are often a tease to draw customers in; and, in any event, the rates in effect when the ad is published will likely be different when you are ready to deal.

One good source of up-to-date information is HSH Associates' "Homebuyer's Mortgage Kit," which you can receive by mail. For $20, you get a clearly written booklet on how to shop for a mortgage and detailed information on loan rates from 80 percent of the lenders in the market you select. (Call 800 873-2837 or check www.hsh.com.)

Where else can you turn?

A good real-estate agent should know which banks offer the best terms in the community where you are buying. And the National Association of Mortgage Brokers can help you locate a mortgage broker in your state who specializes in sifting through the competing offers of several banks.

(Write to the Association at 1735 N. Lynn St., Suite 950, Arlington, Va. 22209.) Be careful before you act on any expert's advice. A real-estate agent may refer you to a lender that is affiliated with his or her company. And mortgage brokers don't work for free: If you aren't paying their fee, the lender to whom they refer your business probably is. A good real-estate professional can help save you time, money, and anxiety, but you have too much at stake to trust an expert to do your homework for you.

Source: Consumers Reports Online
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