Guide To Finding & Getting A Mortgage
- Qualifying for a Mortgage
- Types of Mortgages
- Mortgage Glossary
- Credit Scores
When purchasing a real estate property, unless paying cash, consumers typically finance all or a portion of the purchase price. The conditional pledge of the property to a creditor as security for performance of an obligation or repayment of a debt is called a mortgage. The document the buyers' sign promising to pay the money owed is the note. Both documents are filed for public record to protect all parties involved. The amount of the money borrowed, called the principal, plus interest, which is the cost of using the money, are paid back to the creditor in monthly installments. Some mortgages are available where the buyer pays interest only monthly or quarterly. (Check with your lender for availability).
Home mortgages are available from several types of lenders: commercial banks, mortgage companies, and credit unions. Different mortgage lenders may quote you different prices, so you should contact several lenders to make sure you're getting the best price. You may also get a home loan through a mortgage broker. Brokers arrange financial transactions rather than lending money directly; in other words, they find a lender for you. A broker's access to several lenders can mean a wider selection of loan products and terms from which you can choose. Brokers will generally contact several lenders regarding your application, but they are not obligated to find the best deal for you unless they are bound by contract to act as your agents. Consequently, you should consider contacting more than one broker, just as you should with any financial institutions.
Qualifying for a Mortgage
Generally speaking, qualifying for a mortgage is based on the ratio of income and debt. It is determined by multiplying your gross monthly income (before any taxes are withheld) by a mortgage factor of 28 - 36% and then subtracting all long-term monthly debts, i.e. car payment, credit cards, etc. The remaining amount is the mortgage payment you qualify for. (Please confirm your specific situation with an actual mortgage lender).
Types of Mortgages
1. Fixed Rate Mortgages
Payments remain the same for the life of the loan, which can be 15, 20, or 30 years, depending on your lender. Usually, the shorter the term, the lower the interest rate and the quicker equity is built in the property. During the beginning years of a 30-Year loan, more interest is paid than principal, meaning larger tax deductions. As inflation and costs of living increase, mortgage payments become a smaller part of overall expenses. With most fixed rate mortgages, your monthly principal and interest payment will not change for the term of the loan, regardless of whether interest rates rise or fall. In exchange for that stability, you may have a higher interest rate than you would with an adjustable rate loan.
2. Adjustable Rate Mortgages
With Adjustable Rate Mortgages, your payments will vary over time. Adjustable Rate Mortgages typically have an initial fixed rate lower than the rate of a comparable fixed rate mortgage. The initial fixed rate period is followed by adjustment intervals. For example, a "3/1 ARM" is fixed at an initial low rate for the first 3 years, and then adjusts every year based on an index. The Adjustable Rate Mortgage is a choice for buyer who will have a substantial increase in salary over the adjustment period and therefore, can absorb the additional payment if the payments increase during the adjustment. The Adjustable Rate Mortgage allows the borrower to qualify for a larger loan amount. Many Adjustable Rate Mortgages also give the buyer the benefit of adjusting downward. The adjustment rate is determined by several indexes, so please consult with your lender to determine if the Adjustable Rate Mortgage is right for you.
3. Balloon Mortgage
Offers very low rates for an initial period of time (usually 5, 7, or 10 years); when time has elapsed, the balance is due or refinanced (though not automatically)
4. Two-Step Mortgage
Interest rate adjusts only once and remains the same for the life of the loan.
5. Reverse Mortgages
The reverse mortgage is aptly named because the payment stream is reversed. Instead of the borrower making monthly payments to a lender, as with a regular mortgage, a lender makes payments to the borrower. This special mortgage is used to convert equity in a home into cash to provide seniors financial security in their retirement years. There are age restrictions with the Reverse Mortgage.
The costs banks and mortgage companies charge usually include the following:
- Application Fee - the money paid to the lender for processing the mortgage documents
- Insurance - homeowner's coverage for fire and casualty to the home
- Origination Fee - A fee, often a percentage of the total principal of a loan, charged by a lender to a borrower on initiation of the loan
- Closing Costs - The numerous expenses (over and above the price of the property) that buyers and sellers normally incur to complete a real estate transaction.
- Interest - the cost of using the money, based on a percentage of the amount borrowed.
Every lender or broker should be able to give you an estimate of their fees. Many of these fees are negotiable. Some fees are paid when you apply for a loan, and others are paid at closing. In some cases, you can borrow the money needed to pay these fees, but doing so will increase your loan amount and total costs. "No cost" loans are sometimes available, but they usually involve higher rates.
2. Down Payment
The amount of money a buyer needs to pay down on a home is one of the most misunderstood concepts in home buying. Some people think they need to make a down payment of 50 percent of the home's price, but most loans are based on a 20 percent down payment. There are mortgage options now available that only require a down payment of 5% or less of the purchase price. If a 20 percent down payment is not made, lenders usually require the home buyer to purchase private mortgage insurance (PMI) to protect the lender in case the home buyer fails to pay. Ask about the lender's requirements for a down payment, including what you need to do to verify that funds for your down payment are available. Make sure to ask if PMI is required for your loan, and also find out what the total cost of the insurance will be.
Amortization is the paying off of the mortgage debt in regular installments over a period of time, i.e. 30 years. If you pay the same monthly amount according to the terms of your note, then your debt will be paid in the exact number of years outlined for you. You may, however, make additional monthly payments which are applied directly to the principal amount thus reducing your mortgage term substantially. Understand negative amortization. Some home loans offer attractive monthly mortgage payments but at times those low payments don't cover the interest portion of the loan. When that happens, part of the principal amount is deducted, resulting in what lenders call "negative amortization." Simply put, it means you are losing equity in your home.
4. Interest Rate
The interest rate is the monthly effective rate paid on borrowed money, and is expressed as a percentage of the sum borrowed. A lower interest rate allows you to borrow more money than a high rate with the same monthly payment. Interest rates can fluctuate as you shop for a loan, so ask lenders if they offer a rate "lock-in" which guarantees a specific interest rate for a certain period of time. Remember that a lender must disclose the Annual Percentage Rate (APR) of a loan to you. The APR shows the cost of a mortgage loan by expressing it in terms of a yearly interest rate. It is generally higher than the interest rate because it also includes the cost of points, mortgage and other fees included in the loan. If interest rates drop significantly, you may want to investigate refinancing. Most experts agree that if you plan to be in your house for at least 18 months and you can get a rate 2% less than your current one, refinancing is smart. Refinancing may, however, involve paying many of the same fees paid at the original closing, plus origination and application fees.
5. Discount Points
Discount points are prepaid interest and allow you to buy down your interest rate. One discount point equals 1% of the total loan amount. Generally, for each point paid on a 30-year mortgage, the interest rate is reduced by 1/8 (or.125) of a percentage point. When shopping for loans ask lenders for an interest rate with 0 points and then see how much the rate decreases with each point paid. Compare the monthly difference in payments with the total discount points you are willing to pay, and see how many months you need to stay in the home to recoup your money. Points are tax deductible when you purchase a home and you may be able to negotiate for the seller to pay for some of them.
6. Escrow Account
Established by your lender, an escrow account is set up to manage monthly contributions to cover annual charges for homeowner's insurance, mortgage insurance and property taxes. The borrower contributes 1/12 of the annual costs monthly so that the lender will have sufficient money to pay for the taxes and insurances. Escrow accounts are a good idea because they assure money will always be available for these payments.
The credit score is calculated by a statistical process and provides a guideline for lenders to extend credit (and if so, how much) to a borrower. Mortgage companies, banks, and insurance companies determine the interest rate they will charge based on the borrowers credit score. The credit scoring process encompasses both your pay history and the amount of credit you currently have. The credit score is a substantial portion of the entire credit report.
Low Credit Scores will result in higher payments on loans, credit cards, and insurance.
The credit score is sometimes called the FICO Score, which is an acronym for the creators of the FICO score, Fair Isaac Credit Organization.
Below is a table showing different score ranges:
|720 - 780||Excellent|
|675 - 720||Average|
|620 - 690||Fair|
Don't assume that minor credit problems or difficulties stemming from unique circumstances, such as illness or temporary loss of income, will limit your loan choices to only high-cost lenders. If your credit report contains negative information that is accurate, but there are good reasons for trusting you to repay a loan, be sure to explain your situation to the lender or broker. If your credit problems cannot be explained, you will probably have to pay more than borrowers who have good credit histories. Ask how your credit history affects the price of your loan and what you would need to do to get a better price. Lenders now offer several affordable mortgage options, which can help first-time homebuyers, overcome obstacles that made purchasing a home difficult in the past. Lenders may now be able to help borrowers who don't have a lot of money saved for the down payment and closing costs, have no or a poor credit history, have quite a bit of long-term debt, or have experienced income irregularities. There are companies who specialize in consumer credit repair.