FAQs
-- Mortgages
I’d
like to own my own home. What’s the first step?
Before you begin searching
for a home—and a mortgage—it’s important
to take a close look at the funds you have available to
make your purchase. You’ll want to consider:
- Your present income;
- Your expected income over
the next few years;
- Outstanding long-term debt;
and
- How long you expect to stay
in your home.
How
do I know how much I can afford?
Essentially, the amount of
money you can borrow will be determined by the size of the
monthly payment you can afford. As a general rule, lenders
do not allow the monthly payment to exceed 25% to 33% of
gross monthly income. Other lenders have more flexible debt-to-income
ratios.
Start by taking a careful look
at your current assets (including income, savings, investments,
IRAs, life insurance, pensions and corporate thrift plans,
and equity in other real estate, etc.) and liabilities (including
outstanding loans, credit card balances, etc.). Also, think
about how your income—or household income, if there
are two wage earners in the family—might change over
the next several years.
How
do I know which type of mortgage is best for me?
Since some mortgage options
are less conservative than others, it is important to determine
if you are a “risk-taker” or if you prefer more
stability in your financial dealings.
Do you invest in the stock
market? Or put money into Certificates of Deposit? These
are two different ways of handling money. Depending on your
answers to these questions, and others that may be asked
by your lender, you will be able to choose the mortgage
that is right for you.
What’s
the difference between conforming and non-conforming loans?
Most loan rates that you hear
quoted are for conforming loans. A conforming loan is one
with an original balance of $275,000 or less for a single-family
home. Any loan amount larger than that is called non-conforming.
Two major agencies—the
Federal National Mortgage Association (FNMA) or Fannie Mae
and the Federal Home Loan Mortgage Corporation (FHLMC) or
Freddie Mac—can purchase conforming loans. For lenders
who sell their loans after they are closed, there is an
extremely liquid market. But the availability of potential
buyers is reduced greatly when the loan amount goes above
the conforming limit. To attract enough buyers for these
loans, a lender often increases the rate on non-conforming
loans. The conforming loan limit is adjusted annually at
year-end by FNMA and FHLMC. Some lenders also have their
own guidelines for dollar differentiation between conforming
and non-conforming loans.
What
is the APR?
To protect the public, congress
decided that a more precise measure of the true cost of
a mortgage loan was needed. The concept of the annual percentage
rate (APR) was developed to more accurately reflect this
cost factor. The APR represents not only the rate of interest
charged on the loan but certain other pre-paid finance charges.
These costs are expressed in terms of percent and may include,
among other costs, the following: origination fees, loan
discount points, private mortgage insurance premiums, and
the estimated interest pro-rated from the closing date to
the end of the month.
Please note: What may appear
as a low interest rate may have a lot of optional loan discount
points added to increase the effective rate to the lender.
Reviewing the APR will help you to determine if this type
of situation exists. When shopping for mortgage rates, get
the APR from your lender to make sure you have an accurate
comparison to other available mortgage rates.
Why
is the Annual Percentage Rate (APR) on the Truth in Lending
Disclosure higher than the rate shown on my mortgage note?
The APR rate reflects the cost
of your mortgage loan as a yearly rate. This rate is generally
higher than the rate stated on your mortgage note because
the APR includes other costs, such as origination fee, loan
discount points, and pre-paid interest. The APR allows you
to compare, in addition to the interest rate, the total
cost of financing your loan, among various lenders.
Is
my interest rate guaranteed?
It is important to ask the
lender how long they guarantee the quoted interest rate.
Some lenders guarantee the rate for 20, 30, 45, 60 or 90
days. Other lenders may only agree to set a rate when the
loan is approved. On occasion, lenders will not set a rate
for the loan until just before closing. A longer guarantee
period allows you to protect the rate for a longer length
of time, which could be beneficial to you in a volatile
interest rate market. Also, be sure to inquire whether long
guarantee periods are available and what additional costs
may be involved.
What
is the difference between 'locking in' an interest rate
and 'floating'?
Mortgage rates can change from
day to day or even more often. If you are concerned that
interest rates may rise during the time your loan is being
processed, you can 'lock in' the current rate (and loan
fees) for a short time, usually 60 days. The benefit is
the security of knowing the interest rate is locked if interest
rates should increase. If you are locked in and rates decrease,
you may not necessarily get the benefit of the decrease
in interest rates.
If you choose not to 'lock
in' your interest rate during the processing of your loan,
you may 'float', or hold off locking in until you are comfortable
about the rate. The borrower takes the risk of interest
rates increasing during the time from application to the
time the rate is locked in. The downside is that the borrower
is subject to the higher interest rates. The benefit to
floating a rate is if interest rates were to decrease, you
would have the option of locking into a lower rate than
if you had already locked in the rate.
What
is Prepaid Interest?
This is interim interest that
accrues on the mortgage loan from the date of the settlement
to the beginning of the period covered by the first monthly
payment. Since interest is paid in arrears, a mortgage payment
made in June actually pays for interest accrued in the month
of May. Because of this, if your closing date is scheduled
for June 15, the first mortgage payment is due August 1.
The lender will calculate an interest amount per day that
is collected at the time of closing. This amount covers
the interest accrued from June 15 to July 1.
Are
there different types of mortgages?
Yes. The two basic types of
mortgages are fixed rate and adjustable rate.
Fixed
Rate Mortgages
If you’re looking for
a mortgage with payments that will remain essentially unchanged
over its term, or if you plan to stay in your new home for
a long period of time, a fixed rate mortgage is probably
right for you.
With a fixed rate mortgage
the interest rate you close with won’t change—and
your payments of principal and interest remain the same
each month—until the mortgage is paid off.
The fixed rate mortgage is
an extremely stable choice. You are protected from rising
interest rates and it makes budgeting for the future very
easy.
But in certain types of economies,
the interest rate for a fixed rate mortgage is considerably
higher than the initial interest rate of other mortgage
options. That is the one disadvantage of a fixed rate mortgage.
Once your rate is set, it does not change and falling interest
rates will not affect what you pay.
Fixed rate mortgages are available
with terms of 15 to 30 years with the 15-year term becoming
more and more popular. The advantage of a 15-year over a
30-year mortgage is that while your payments are higher,
your principal will be paid off sooner, saving you money
in interest payments. Also, the rates may be lower with
a 15-year loan.
Adjustable
Rate Mortgages (ARMs)
An adjustable rate mortgage
is considerably different from a fixed rate mortgage. ARMs
have only been around since the early 1980s. They were created
to provide affordable mortgage financing in a changing economic
environment.
An ARM is a mortgage where
the interest rate changes at preset intervals, according
to rising and falling interest rates and the economy in
general. In most cases, the initial interest rate of an
ARM is lower than a fixed rate mortgage. However, the interest
rate on an ARM is based on a specific index (such as U.S.
Treasury Securities). This index reflects the level of interest
rates and allows the lender to match the income from your
ARM payment against their costs. It is often selected because
it is a reliable, familiar financial indicator. Monthly
payments are adjusted up or down in relation to the index.
Most ARMs have caps—limits
the lender puts on the amount that the interest rate or
payment may change at each adjustment, as well as during
the life of the mortgage. With an ARM, you typically have
the benefit of lower initial rates for the first year of
the loan. Plus, if interest rates drop and you want to take
advantage of a lower rate, you may not have to refinance
as you would with a fixed rate mortgage. An ARM may be especially
advantageous if you plan to move after a short period of
time.
The convertible ARM is an option
that is currently very popular because it allows you to
convert to a fixed rate mortgage after a specified period
of time has elapsed. For instance, you could get a one-year
ARM with the option to convert to the prevailing fixed interest
rate at any time after the first through the fifth adjustment
period.
Convertible ARMs offer the
ability to take advantage of lower rates initially and have
possible savings, and the option to convert to a fixed rate
loan later on when you may be able to better afford it.
Depending on your financial needs, you might find this option
the best of both worlds.
As a relatively new phenomena,
the purpose of an ARM is often misunderstood. Ask your mortgage
lender to explain the details to you so you can determine
if this type of mortgage fits your specific financial situation.
What does the application consist
of?
The typical application is
basically an outline of who you are, the property you want
to buy or refinance, and your financial assets and liabilities.
What
happens after I apply?
The lender initiates a credit
check and arranges for an appraisal of the property you
plan to buy (or the current property you want to refinance).
The appraisal assures you and the lender that the property
has fair market value. The lender is investing in you and,
in the unlikely event of default on your loan, the property
must be worth enough to settle the debt.
Once your credit check, appraisals
and verifications are complete, this “credit package”
is reviewed by an underwriter who makes the loan decision.
If your loan is approved, your lender will issue you a loan
commitment (a binding agreement) to lend you the money.
The commitment spells out all the details of the loan including
all charges and fees, closing requirements, and any important
conditions including:
- A list of documents you
will need for closing;
- Information on when the
commitment expires; and
- Important information you
should know when closing on your home.
The loan commitment may also
may have certain conditions that you must meet before the
loan is granted—bills you must pay off, or special
requirements of the homeowners association, fox example.
In the case of new construction,
the lender will want the appraiser to inspect the home just
prior to closing. This is to ensure that it is in accordance
with the plans and specifications furnished by the builder
or contractor.
You and an attorney (if you
choose to have an attorney represent you) should review
the loan commitment carefully. Make sure the terms are acceptable
to you. Assuming you and the lender come to terms, your
agreement with the lender is now complete.
Do
I need title insurance?
The lender will check the title
to the property to make sure there are no outstanding liens
or title problems. The lender requires, and sometimes will
arrange for, title insurance to protect the property against
unforeseen problems. This is called a “lender’s”
title insurance policy. You may want to obtain title insurance
to protect your own interest in the property. This is called
an “owner’s” title insurance policy. These
policies ensure that your property is free and clear of
any title defects, claims or encumbrances.
How
much will I need for the down payment?
Generally, your down payment
can be anywhere from 5% to 20% of the home’s value.
Veterans, or those serving active military duty,
may obtain loans with no down payment at all.
When
do I need Private Mortgage Insurance (PMI)?
If the down payment on your
home is less than 20%, your lender will probably require
that you get private mortgage insurance. This insurance
insures the lender against possible default on the loan.
It is not to be confused with mortgage life insurance or
homeowners insurance.
The cost of PMI is divided
into two parts. The first part is a payment made at the
loan closing. The second part is an ongoing payment made
each month along with the principal and interest payment.
Normally, PMI may be removed
if you have reduced the principal amount of your loan to
80% or lower than the original purchase price. It also may
be removed if you have obtained an independent appraisal
stating that the outstanding principal amount of the loan
is 80% or lower than the appraised value.
Some lenders do not require
PMI. Instead, they may increase their origination fee and/or
the interest rate on the loan. This can represent a significant
advantage to the borrower since PMI premiums are not deductible
for tax purposes and mortgage interest is usually deductible.
What
are closing costs? What is an Escrow Account?
Closing costs and procedures
vary from state to state and from county to county. In some
jurisdictions, an attorney represents the lender. In others,
the title company represents the lender. There may be state
or county transfer taxes to be paid. There may also be fees
for recording certain documents. There are also standard
charges that are paid at all closings. Taxes, title insurance
premiums, and interest on the loan pro-rated from the closing
date to the end of the month.
Prior to closing, be sure to
inquire if the lender requires an escrow account set up
for the payment of the real estate taxes and homeowners
insurance. Some lenders will waive the escrow requirements
if the down payment is above a certain limit. Depending
on when you close and when real estate taxes are paid in
your jurisdiction, the cash required to set up the real
estate tax escrow could represent one-half to three-quarters
of the annual real estate tax bill.
It is important that you review
what the closing costs will be with your lender and attorney.
This should take place far enough in advance of the closing
to allow yourself time to obtain the necessary funds to
pay the closing costs.
What
is involved in the closing?
This is the day you’ve
been waiting for, the final step before you own your new
home or complete the refinancing of your current home. At
the closing you, the seller, the lender and the attorneys
for all involved validate, review and sign all documents
relating to the purchase or refinance. The lender provides
the check for the loan amount. You receive the title to
your property and the keys to your new home.
What
is a Home Equity Loan?
The dollar difference between
the market value of your home and your current mortgage
balance determines your home equity. In other words,
if you sold your home this would be the cash you would receive
after the sale. A home equity loan allows you to access
this cash without selling your home by using your home as
collateral. As you pay down your mortgage, and/or
your home's value increases, your available equity increases
accordingly.
Why
are Home Equity Loans and Lines of Credit so popular?
Because home equity loans and
lines of credit are secured by your home, there are three
distinct advantages over other types of loans: lower interest
rates, tax deductible interest (consult your tax advisor)
and large loan amounts. Based on your personal financial
situation, you may be able to borrow up to 100% of your
available home equity.
You can use a home equity loan
or line of credit for almost any expense -- to buy a car,
consolidate debt, build an addition, remodel your home,
or pay college tuition. Many people use home equity
loans to pay off higher interest debt such as credit cards,
auto loans, and personal loans.
What
is the difference between a Home Equity Loan and a Home
Equity Line of Credit?
A home equity loan
is advanced in one lump sum. You make fixed monthly
payments over a fixed term and are charged interest only
on the unpaid balance. A loan makes it easier to budget
since your monthly payments are fixed over the life of the
loan.
A home equity line of credit
is a set amount of money you are approved to use whenever
you like. You access your funds by writing checks.
As you repay the balance, you can reuse it up to your approved
credit limit. You are charged interest based on the
unpaid balance. A line of credit gives you the flexibility
to borrow funds when you need them. When the line
of credit expires, you need to renew or pay your outstanding
balance.
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