Mortgage Information: Mortgage Basics
Adjustable Vs. Fixed Mortgages
When trying to decide between a fixed rate and an adjustable rate mortgage, here are some important questions to consider:
How long do you plan on staying in the home?
If you do not plan on keeping your home for more than a few years, it would make more sense to go with the lower rate ARM. This allows you to take advantage of the lower initial interest rate, and if the ARM is assumable, you can transfer your ARM to another buyer if you sell your home.
How often does the ARM interest rate adjust?
After the initial fixed rate period of 3, 5, 7 or 10 years, some Arms may adjust as frequently as every month. Most adjust every six to twelve months to reflect any changes in the index since the last adjustment. The less often your loan adjusts the less financial risk you are taking and this can translate into higher interest rate and/or a higher margin on the loan.
What could your maximum monthly payment be if interest rates rise?
With a fixed rate mortgage, interest rates are fixed at the time the loan is obtained and remain the same for the life of the loan. However, the interest rate for an ARM is tied to an index, and may rise or fall accordingly based on this index. If rates rise more than 1 or 2 percent and remain elevated, the adjustable rate loan will likely cost you more than a fixed rate loan. This is where the life cap for an ARM becomes important, because it will limit the highest rate allowed over the life of your loan. When considering an ARM, be sure you can afford to make payments if this limit should be reached.
Things to Consider
Because a home mortgage will probably be one of the biggest investments you will ever make, it is a good idea to figure out just how much you can realistically afford. Mortgage lenders use a variety of standards when evaluating your creditworthiness. Some of the things they will look at are:
--- Your credit history - if you have too many delinquencies and defaults on your credit report, lenders will see it as a sign that you are a potentially higher risk and less likely to default on your monthly mortgage payments. If you have any credit blemishes on your record, provide an immediate, detailed disclosure, and try to pay off as much debt as you can before applying for a mortgage loan.
--- Your monthly gross income and job security - One of the main reasons for foreclosures is borrowers trying to do too much. A loan processor will want to verify your employment information, your income, how long you've had your present job, and your likelihood of continued employment.
--- The amount of your down payment - The more cash you can put down, the lower the odds that you'll default on your loan because you have more invested in your property.
When you apply for a mortgage loan, a lender will generally require that your monthly housing expenses, which include the principle and interest of your mortgage payment, real estate tax and homeowner's insurance, not exceed 28 percent of your gross monthly income. In addition, lenders typically require that your total debt obligations not exceed 36 percent of your gross monthly income. Total debt obligation includes any other monthly expenses that you may have, such as student loans, auto loans, and credit card bills.
If you are a homeowner, you will have to pay property taxes to your local government. Therefore, it is important that you get an estimate of the property tax in the area where you want to look for a home, and also ask what additional fees and assessments may apply.
You will also be required to have adequate homeowner's insurance as a condition of your mortgage loan. The cost of your insurance policy will in large part be determined by the costs of rebuilding your home should it be destroyed. To be safe, buy the most comprehensive insurance plan that you can and take a high deductible to help minimize costs. In addition, inquire about special requirements for hazard insurance, such as mandatory coverage for floods, earthquakes, or hurricanes in high risk areas. If you put down less than 20 percent of the purchase price, you will also be required to pay private mortgage insurance (PMI).
Don't Forget Closings Costs
In addition to the down payment, monthly payment, real estate tax, home owners insurance, and possible PMI, there are also one-time closing costs that can add up to a considerable amount by the time you finish negotiating your mortgage deal. That translates to between $3,000 and $6,000 on a $100,000 home. Sometimes you can get these costs waived or reduced, but expect to pay a higher interest rate for a mortgage with little or no closing costs. Be sure to have enough to cover these additional costs, which typically amount to between 2 and 5 percent of the home's purchase price.
Good Faith Estimate
The closing costs are outlined in a good faith estimate. By law, lenders are required to give you an estimate of these costs within three business days of your application. It will list expenses related to inspections, taxes, title insurance and a host of other charges (outlined below). In addition, you should also receive an information booklet, "Settlement Costs - a HUD Guide". Obtain a good faith estimate from each lender to save time and to use as a comparison when shopping between different lenders.
Here is a list of some major closing costs
-- Loan-application fees and credit report
Title insurance protects you and the lender against the risk that the house you are purchasing is not legally owned by the seller. It checks for any defects, liens or encumbrances in the property title that may affect the rights of ownership, possession or use of the property. Separate title insurances must be issued for both the lender and yourself. Owner's title insurance is optional, but lender title insurance is included in the closing costs. Depending on your home's purchase price, this insurance can cost between several hundred and several thousand dollars.
These costs cover the additional costs associated with buying a home, such as private mortgage insurance (PMI), homeowner's insurance and property taxes. This insures that taxes and insurance fees are paid on time. Escrow fees can range from several hundred to several thousand dollars depending on the purchase price of the home. Some lenders may be willing to waive escrow fees in exchange for charging you a higher interest rate or more points. Beware of additional charges that may not seem familiar.
Cost saving tips
Negotiate with the seller of the property to help pay for some of the closing costs or other fees.
-- A real estate attorney is required to represent you with the seller. An attorney is also required to close the mortgage when dealing with the lender. By choosing one attorney that can perform both duties, you may be able to save hundreds of dollars.
-- Additionally, you may also be able to save money if you try to close on or near the end of the month. Because all mortgage loans are due on the first of the month, you pay interest from the day you close until the end of the month. By closing at the end of the month, you can reduce the amount of interest you have to pay.
Pre-Qualification vs. Pre-Approval
Prior to looking at any property, it is a good idea to determine if lenders consider you a creditworthy borrower and approximately how much they will let you borrow. There are typically two ways to go about this:
Loan pre-qualification is nothing more than a cursory overview of your financial assets by a lender based on what you tell them. After taking into account your present gross income, your expenses, and your cash savings for a down payment, a lender will give you an estimate of the mortgage you are qualified for.
However, because it is only a cursory overview, pre-qualification can be a potential waste of time and money. If, for example, you decide to apply for a mortgage after looking at property only to discover that there were additional financial liabilities or credit blemishes that turned up under closer scrutiny of your records, you could find your borrowing power substantially diminished, or your application rejected outright.
Loan pre-approval is significantly more thorough than pre-qualification. During pre-approval, the borrowers/buyers have APPLIED with our firm for a mortgage loan to purchase a home and the loan application has been approved by an Automated Underwriting System issued or accepted by FNMA, FHLMC, HUD or Nationally recognized purchaser/pooler of mortgage loans and a conditional commitment has been issued. In the end, you will have proof that you are a qualified borrower worth consideration. This will give you more leverage in negotiations and can also be a real benefit if you find yourself in a situation competing with other buyers for the same property.
There are circumstances that may cause a lender to reject your loan. You may be placed into this category of "special-circumstances" for a variety of reasons, such as if you are purchasing a condominium, if you've held your job for less than a year, if you are self-employed, if you put less than 20 percent down, or if you have a few late payments on your credit card. Here is some advice with regards to some of these special mortgage loan situations.
Buying a condominium or town house
When you buy a condo or town house, you get a deed to the individual unit, but you share the common areas (walls, grounds, fences, facilities) with the other owners in your complex.
Some of the factors they take into consideration are how many percentage of units are owned versus those that are occupied by investors. An acceptable figure is typically 60 percent owner occupied or higher. Another important factor is whether the project is 90 percent complete. Your loan will most likely be approved if these two criteria are satisfactorily met. Other possible considerations that determine loan approval include insurance coverage, operating budget, the competency of the management, and the capital reserved for repairs.
No doc or low doc loans
Designed for the entrepreneur, the self-employed, recent immigrants with capital in foreign countries, or for clients who choose not to reveal their financial information, no-documentation or low-documentation loans require only down payments and closing costs. They require no documentation such as tax returns, W2 forms, paychecks, or bank statements. In order to qualify for these loans, you will need a substantial down payment, ranging from 20 percent to 35 percent, as well as an excellent credit history. They also typically have a higher interest rate, often one-half a percent higher than the norm.
A low-doc loan requires that you be self-employed for at least two years, and have sufficient assets as well as excellent credit. Those that choose to go with these options may switch to a lower-rate, full documentation loan later when they refinance and their financial status improves.
Sub-Prime B-C-D loans
Developed for people with past or current credit problems, these loans provide more lenient lending guidelines, but charge higher interest rates and fees. This allows people with spotty credit histories to own a home and at the same time improve their credit ratings. Often, once the borrower's credit and financial situations improve, they have the option of refinancing to take advantage of the best current market rates.