Premier Realty & Financial Services

GENERAL MORTGAGE INFORMATION

Types of Mortgages

There are many types of mortgages you can choose from. Which type you choose usually depends on the length of time you think you'll be in your home or the other financial obligations you have. If you think you'll be there for the long haul, then you may want a fixed rate mortgage with the lowest interest rate you can get.

There may be other considerations, however. What if you have kids who are going to be entering college in 10 years? In that case, you might consider getting an adjustable rate mortgage or a mortgage with a balloon payment so you can keep your payments low for the first few years in order to save for college. Once the kids are out of college, you can refinance at the current rate. If you don't think you'll be in your home for that long, then you may also want to look at other options.

In the next few sections, we'll discuss some of the mortgage choices you'll find.

Fixed-rate Mortgages

This mortgage offers an interest rate that will never change over the entire life of the loan. If you lock in a rate of 7 percent that calculates a payment of $1,247 per month, then you know that in 20 years you'll still be paying $1,247 per month. The only things that will change will be the property tax and any insurance payments that are included in your monthly payment.

The length (known as the term) of your fixed rate mortgage can be 15, 20 or 30 years. These terms have an affect on the various benefits you'll get from your mortgage.

30-year fixed-rate - The 30-year term gives you the maximum tax advantage by having the greatest interest deduction. While the fact that you're paying more interest may not seem like a benefit, you make lower payments with the longer term fixed-rate loan and you get a bigger tax deduction. If you will be staying in your home for many years (especially if you think your income may not increase tremendously), this may be the best option. This type of loan is also the easiest to qualify for.
20-year fixed-rate - You can shorten your mortgage by 10 years and usually get a lower interest rate with the 20-year mortgage. These aren't offered through as many banks and lenders, however, so you may have to shop around to get one. The advantage with the shorter term, besides paying your loan off sooner, is that you'll also have more equity in your home sooner than you will with a 30-year loan. Your payments will be higher, however.
15-year fixed-rate - This loan term has the same benefits as the 20-year term (i.e., quicker pay-off, higher equity, lower interest rate), but you will also have a higher monthly payment.

Adjustable-rate and Balloon Mortgage

An adjustable-rate mortgage (ARM) has an interest rate that changes based on changing market rates and economic trends. They usually offer an initial interest rate that is two to three percentage points lower than fixed-rate mortgages, but they don't offer the stability or assurance of a known mortgage payment in the years to come. If you don't expect to be in your home for many years, however, an ARM may be just what you need.

How often your interest rate adjusts is determined by the terms of the loan. You may choose a six-month ARM, a one-year ARM, a two-year ARM, or some other term. There is usually an initial period of time during which the rate won't change. This might be anywhere from six months to several years. For example, a 5/1 year ARM would mean the initial interest rate would stay the same for the first five years and then would adjust each year beginning with the sixth year. A 3/3 year ARM would mean the initial interest rate would stay the same for the first three years and then would adjust every three years beginning with the fourth year.
There will also be caps, or limits to how high your interest rate can go over the life of the loan and how much it may change with each adjustment. Interim or periodic caps dictate how much the interest rate may rise with each adjustment. For example, the terms of the loan may be that the rate can go up as high as one percentage point each year depending on the market. Lifetime caps specify how high the rate can go over the life of the loan. For example, the terms of the loan might specify that the rate cannot go up by more than a total of six percentage points.
The interest rates for ARMs can be tied to any one index. There are many possible ARM indexes. Each one has distinct market characteristics and fluctuates differently. The most common indexes are:

- Constant Maturity Treasury (CMT or TCM)

- Treasury Bill (T-Bill)

- 12-Month Treasury Average (MTA or MAT)

- Certificate of Deposit Index (CODI)

- 11th District Cost of Funds Index (COFI)

- Cost of Savings Index (COSI)

- London Inter Bank Offering Rates (LIBOR)

- Certificates of Deposit (CD) Indexes

- Bank Prime Loan (Prime Rate)

CMT, COFI, and LIBOR indexes are the most frequently used. Approximately 80 percent of all the ARMs today are based on one of these indexes. When mortgage lenders come up with their rates for ARMs, they look at the index and add a margin of two to four percentage points. Being "tied" to these index rates means that when those rates go up, your interest goes up with it. The flip side is that if they go down, your rate also goes down. Try this ARM calculator to see how your payments might change with an adjustable rate mortgage.

Balloon Mortgage

A balloon mortgage offers an initial interest rate that is lower than fixed-rate mortgages. It keeps this low fixed rate for five to seven years and then requires a "balloon" payment. The balloon payment is the final payment of the loan and pays off the entire balance.

Monthly payments are low because the payments for those first five to seven years are amortized at a low interest rate over the total length of the loan. If you plan on either selling your home, paying it off, or refinancing it before the balloon payment is due, then this type of mortgage is good deal.

Government Loans

Government housing loans help lower the costs of mortgages so that more people can afford to own their own home. There are three government agencies that insure mortgages. The Federal Housing Administration (FHA), which is part of the U.S. Department of Housing and Urban Development, the Veterans Administration (VA), and the Rural Housing Service (RHS), which is a branch of the U.S. Department of Agriculture. Only approved lenders can offer these loans, and there will be required standards that the property has to meet in order to qualify.

Federal Housing Administration Loans

The FHA offers a mortgage financing program that insures home loans. The FHA doesn't make the loans itself; rather, it serves as an insurance policy for lenders. Because the financial requirements for FHA loans are relaxed compared to traditional commercial loans, more people are able to afford to buy homes.

FHA insurance makes lenders more willing to work with someone who might not completely fit their usual loan qualification requirements. FHA requirements reduce the debt-to-income ratio from 28/36, which is the traditional loan requirement, to 29/41 for FHA loans (we'll discuss how this ratio works a bit later). FHA loans also require a low down payment of 5 percent or less, and allow 100 percent of the money used for the down payment and closing costs to come from a family member. Traditional loans won't allow you to borrow the money used for those payments.

There are maximum loan limits with FHA loans. These limits vary by state or region. Visit the FHA Web page to find the limit for your area.

Veterans Administration Loans

VA loans are designed for qualified veterans and offer more relaxed standards for qualification than either FHA loans or traditional loans. As of 2002, loans can be for amounts up to $417,000 and require no down payment.

Like FHA loans, these loans are not made by the Veterans Administration, but are simply guaranteed by the Administration.

Rural Housing Service Loans

If you live in a rural area or small town, you may qualify for a low-interest loan through the Rural Housing Service. RHS offers both guaranteed loans through approved lenders and direct loans that are government funded. These loans enable low-income families to get loans for homes.

Other Types of Loans

Reverse Mortgages

Reverse mortgages pay you money as long as you live in your home. These loans are designed for people age 62 and older who own their homes and need an inflow of cash.

The loan is against the equity and isn't paid off until you sell or move out of your home. Until then, you receive regular payments in the amount set up in the terms of the loan.

Reverse mortgages are offered by state and local governments as well as banks and mortgage lenders. Shop carefully for these loans because interest rates and fees tend to be higher than in traditional mortgages. The AARP Web site offers additional information about reverse mortgages.

Conventional vs. Jumbo Loans

A conventional loan is one that falls under the loan limit set by Fannie Mae or Freddie Mac. These limits change annually based on the single-family home price survey done by the Federal Housing Finance Board each October. As of 2006, a conventional loan can be up to $417,000.

Loans that are above that limit are called jumbo loans. Because jumbo loans don't offer the same Fannie Mae- and Freddie Mac-backed safety to investors as conventional loans, their interest rates tend to be higher by about 0.25 percent to 0.50 percent. When the conventional loan limit changes, the FHA loan limit usually changes along with it.

The APR

Probably one of the most confusing things about mortgages and other loans is the calculation of interest. With variations in compounding, terms, and other factors, it's hard to compare apples to apples when comparing mortgages. Sometimes it seems like we're comparing apples to grapefruits. For example, what if you want to compare a 30-year fixed-rate mortgage at 7 percent with one point to a 15-year fixed-rate mortgage at 6 percent with one-and-a-half points. First, you have to remember to also consider the fees and other costs associated with each loan. How can you accurately compare the two? Luckily, there is a way to do that. Lenders are required by the Federal Truth in Lending Act to disclose the effective percentage rate as well as the total finance charge in dollars.

The annual percentage rate (APR) that you hear so much about allows you to make true comparisons of the actual costs of loans. The APR is the average annual finance charge (which includes fees and other loan costs) divided by the amount borrowed. It is expressed as an annual percentage rate -- hence, its name. The APR will be slightly higher than the interest rate the lender is charging because it includes all (or most) of the other fees that the loan carries with it, such as the origination fee, points, PMI premiums, etc.

Example of How the APR Works

Here is one example of how the APR works:

Suppose you are shopping for a mortgage and see an advertisement for a lender that is offering a 30-year fixed-rate mortgage at 7.0 percent with one point. You also see an advertisement for another lender that is offering a 30-year fixed-rate mortgage at 7.0 percent with no points. That would appear to be an easy comparison, right? Actually, it isn't. You have to dig deeper than that. Fortunately, the APR eliminates the need for you to do any digging at all.

Let's look at how the APR is calculated:

Say you're financing $100,000. With either lender, that means that your monthly payment is $665.30. If the point is 1 percent of $100,000 ($1,000), the application fee is $25, the processing fee is $250, and the other closing fees total $750, then the total of those fees ($2,025) is deducted from the actual loan amount of $100,000 ($100,000 - $2,025 = $97,975). This means that $97,975 is the new loan amount used to figure the true cost of the loan. To find the APR, you determine the interest rate that would equate to a monthly payment of $665.30 for a loan of $97,975. In this case, that is 7.2 percent.

If Lender 2 charges an application fee of $45, an origination fee of 3 percent (because it's cash you pay at closing, it's the same as points if it's expressed as a percentage of the total loan, but it's not always advertised that way), and other fees that total $775 at closing, then the total of those fees ($3,820) is deducted from the actual loan amount of $100,000 ($100,000 - $3,820 = $96,180). To find the APR, you determine the interest rate that would equate to $664.30 for a loan amount of $96,180, which in this case is 7.39 percent.

So there you have it! Although Lender 2 advertised no points, because it charged an origination fee it didn't really offer the best deal. Ask for the APR and compare with other lenders. Also, make sure you know which fees are being included in the APR calculation. Typically, these include: origination fees, points, buydown fees, prepaid mortgage interest, mortgage insurance premiums, application fees, underwriting, etc. -- any fees that are coming directly from the lender, but not fees that you would have to pay using any lender, such as title insurance, appraisals, etc.

Remember those algebra classes back in high school? Well, luckily you don't have to! You won't have to calculate the APR on your own -- the lender will give it to you when it gives you the Federal Truth in Lending Disclosure; you just have to understand its importance.

Other Things to Consider

Here are some other things to take into account when you look at the APR.

The more you are financing, the less impact all of those fees will have on the APR, simply because the APR is calculated based on the total loan amount.
The length of time you are actually in the home before you sell or refinance has a direct influence on the effective interest rate you ultimately get. For example, if you move or refinance after three years instead of 30, after having paid two points at the loan closing, your effective interest rate for the loan is much higher than if you stay for the full loan term.

Qualifying for a Loan: Debt-to-Income Ratio

In order to qualify for a mortgage, most lenders require that you have a debt-to-income ratio of 28/36 (this can vary depending on the down payment and the type of loan you're getting, however). This means that no more than 28 percent of your total monthly income (from all sources and before taxes) can go toward housing, and no more than 36 percent of your monthly income can go toward your total monthly debt (this includes your mortgage payment). The debt they look at includes any longer term loans like car loans, student loans, credit cards, or any other loans that will take a while to pay off.

Here's an example of how the debt-to-income ratio works: Suppose you earn $35,000 per year and are looking at a house that would require a mortgage of $800 per month. According to the 28 percent limit for your housing, you could afford a payment of $816 per month, so the $800 per month this house will cost is fine (27 percent of your gross income). Suppose, however, you also have a $200 monthly car payment and a $115 monthly student loan payment. You have to add those to the $800 mortgage to find out your total debt. These total $1,115, which is roughly 38 percent of your gross income. That makes your housing-to-debt ratio 27/38. Lenders typically use the lesser of the two numbers, in this case the 28 percent $816 limit, but you may have to come up with more down payment or negotiate with the lender.

You also have to think about what you can afford. The lender will tell you what you can afford based on the lower number in the debt-to-income ratio, but that's not taking any of your regular expenses (like food) into account. What if you have an expensive hobby or have plans for something that will require a lot of money in five years? Your lender doesn't know about that, so the $1,400 mortgage it says you qualify for today may not fit your actual budget in five years -- particularly if you don't see your income increasing too much over that time span.

Pre-qualification vs. Pre-approval

What's the difference? Getting pre-qualified just means that you have told a lender your income level and your debt and credit information, and the lender has estimated what you can afford.

Pre-approval, however, puts you much closer to the actual loan and means that the lender has done the leg work of pulling your credit report, checking your debt-to-income ratio, and has done a more in-depth analysis of your situation.

In most cases, you're much better off getting pre-approved so you don't have any surprises when a lender checks your credit report -- particularly if you haven't checked the report yourself first.

What do Lenders Look At?

A lender will look at your employment and your credit history as indicators of how likely you are to pay back your loan. Lenders want to see stability, which means they will look closely any late payments during the last two years of your credit history. They will pay particular attention to any rent or mortgage payments that were over 30 days past due. They'll look at late payments for credit cards during the last six months.

Your employment for the last two years is also important. Lenders look for steady employment with a single employer for the past two years (or at least employment in the same field). Other income -- such as income earned from part-time, overtime, bonuses, or self-employment -- is also acceptable if it has a two-year history.

Don't be afraid that just because you don't have two years with the same employer behind you won't be able to get a mortgage; you may just have to talk to more lenders and look at different types of loans.

Documents Needed

Here is a typical list of the documents you need when applying for a mortgage:

Money for the closing costs
Completed sales contract signed by buyers and sellers
Social Security numbers of all applicants
Complete address for the past two years (including complete name and address of landlords for past 24 months)
Name, address, and all income earned from all employers for past 24 months
Previous two years' W-2 forms
Most recent pay stub showing year-to-date earnings
Name, address, account number, monthly payment and current balance for all loans and charge accounts
Name, address, account number, and balance of all deposit accounts, such as checking accounts, savings accounts, stocks, bonds, etc.
Three months most recent statements for deposit accounts, stocks, bonds, etc.
If you choose to include income from child support and/or alimony, bring copies of court records of cancelled checks showing receipt of payment.

Closing Costs

Getting a mortgage for a home will cost more than just your monthly payments. Once a sales contract is signed, a series of events will pull together a group of people that will be involved in the closing process. "Closing costs" are the fees associated with the work these folks do, as well as taxes and insurance that must be paid when the loan is closed.

The amount of money you'll have to pay in closing costs varies a lot by region. If you live in a high tax area, for example, your closing costs will be higher. Also, realtors, lenders and attorneys have differing fee scales depending on the markets they are in. Typically, you will pay anywhere from 3 to 6 percent of your total loan amount in closing costs -- that means $3,000 to $6,000 if you get a $100,000 loan.

Of course, you can and should shop around and negotiate the fees. The Real Estate Settlement Procedures Act requires lenders to provide you with a good faith estimate of closing costs within three days of receiving your application. As you can see from the list below, there are a lot of fees that you might be able to convince the lender to lower or drop. You may also be able to negotiate for the seller to pay some of the closing costs.

The fees for services involved in closing a mortgage fall into three categories -- the actual cost of getting the loan, the fees involved in transferring ownership of the property, and the taxes paid to state and local governments. In the next section we will discuss these categories.

Loan Costs

Here is a breakdown of loan costs:

Processing fee - This is the fee the lender charges to cover initial costs for processing the loan. This includes the application fee and fees for accessing your credit report. These fees are usually around $400 to $550. Something to watch for when comparing lenders: Sometimes the credit report fee will be listed separately from the processing fee.
Appraisal fee - Because the lender wants to make sure the property is worth what you are paying for it, it requires an appraisal. An appraisal compares the value of the property to similar properties in the same neighborhood. These services are performed by independent appraisers and usually cost around $250 or more depending on the price of the property.
Origination fee - In addition to the application or processing fee, the lender may also charge an origination fee. This covers the additional work it has to do when preparing your mortgage. The fee may be a flat fee or a percentage of the mortgage. If the fee is a percentage of the loan, then it is typically considered a "discount point" in disguise. This changes the tax implications and your costs, so be sure to ask the lender about this fee.
Discount points - Buying discount points means that you are buying "down" the interest rate you will be paying. One discount point is equal to 1 percent of the loan amount. These points are paid either when the loan is approved or at closing. Buying points can save a lot of money in interest payments over the life of the loan, so investigate it when you're shopping around. Some lenders will let you add the cost of the points to your mortgage, or you may have the option of paying for them up front. You can also deduct those points from your federal income tax.
Document preparation fee - This fee may be included in the application or attorney's fee. It pays for the preparation of the mound of documents that have to be prepared and is usually a flat rate, but can also be charged as a percentage of the loan amount -- usually less than 1 percent.
Attorney fees - Both you and your lender will have attorney fees that you will typically have to pay. This fee covers costs for the attorney to draw up the documents and assure that everything is set up as it should be. Your own closing attorney will represent your interests and may be present at, or may facilitate, the closing itself. The closing attorney collects all fees, transfers the deed to the buyer, pays outstanding taxes and utility bills, pays himself and all other closing fees, and gives all remaining money to the seller. The attorney fees may range from $500 to $1,000 or more, depending on the purchase price of the property and the complexity of the sale.
Home and pest inspections - Your lender will probably require that the home be inspected to make sure it is both structurally sound and not being invaded by termites or other destroying insects. You may also have to have the water tested if the property has a well rather than city water. In some areas, the water test means checking only the quantity of water available to the house, rather than the quality. If this is the case, you may want to have your own water quality test done.
Homeowner's and hazard insurance - You will have to have these policies in place (and the first year's premium prepaid) at the time of the closing -- at least in most states. This insurance protects your (and the lender's) investment if the house is destroyed.
Private mortgage insurance (PMI) - If your down payment is less than 20 percent of the value of the house, you may be required to purchase mortgage insurance. This protects the lender in case you fail to make your mortgage payments. Premiums will usually be a part of your monthly mortgage payment and will be transferred into the same escrow account your taxes and homeowner's insurance fees are paid into. You have to pay these PMI premiums until you reach the 20 or 25 percent requirement -- or, they can go on for the life of the loan. (See the next section for more details on PMI.)
Surveys - Many lenders will require that the land be surveyed by an independent surveying company. This is just to ensure that there haven't been any changes, like new structures or encroachments on the property, since the last survey. These usually run $250 to $500.

Prepaid interest - Although your first payment won't be due for six to eight weeks, the interest will begin to accrue the day of the closing. The lender calculates the interest due for that fraction of a month prior to your first official mortgage payment. This means you will probably have to pay that interest upfront as part of the closing costs. For this reason, it is a good strategy to plan your closing for the end of the month to reduce the amount of interest you

Fees Involved with Transferring Ownership

Deed recording fees - These fees pay for the county clerk to record the deed and mortgage and change the billing information for property taxes. These fees are usually around $50, but they do vary by area.
Title search fees - A title search ensures that the person saying they own the property is the legitimate owner. A title company extensively examines public records such as deeds, records of death, court judgments, liens, contests over wills, and other documents that could affect ownership rights. This is an important step in closing your loan because it assures that there are no outside claims against the property. The fees charged for title searches are usually based on a percentage of the property cost. They typically range from $300 to $600 or more, depending on the area.
Title insurance - Just in the event that the title company made an error when they did the title search, or there was information that was not available in the public records, there is title insurance. It will prevent you having to pay mortgage on property you no longer legally own. Lenders will require title insurance to protect their investment, but you may also want to get your own policy. Title insurance has only a one-time fee that covers your property for the entire length of time you or your heirs own it (usually 0.2 to 0.5 percent of the loan amount for lender's title insurance, and 0.3 to 0.6 percent for owner's title insurance). It is also one of the least expensive types of insurance. If the previous owner of the property owned it for only a few years, you may be able to get title insurance at a "re-issue" rate, which is usually lower than the regular rate.

Closing Taxes

You will have to pay anywhere from three to eight (or more) months' taxes at the closing, or place the money in an escrow account for later payments throughout the year. These will include prorated school taxes, municipal taxes, and any other required taxes. In some cases, you may be able to split these taxes with the seller based on when they are due. For example, you would only pay taxes for the months following the closing date up until the date the taxes had to be paid. The seller would have to pay for the months up until the closing date.

Private Mortgage Insurance

Private mortgage insurance (PMI) can help you get into the home you want by enabling you to pay less than the typical 20 percent down payment. This is particularly helpful for younger buyers who haven't had the years to save but want to enjoy the tax benefits and investment aspects of home ownership. PMI is insurance that pays the mortgage in the event that you can't -- or that you default on the loan. It is protection for the lender who is taking a greater risk with a borrower who has less equity. Lenders have discovered through experience and research that there is a definite correlation between the amount of money a borrower has put into the home and the rate of default on loans. The more equity, the lower the rate of default.

Here is an example of how it works: If a couple has $10,000 in the bank, then they can buy a $50,000 home if they have to pay a 20 percent down payment. If they don't have to pay 20 percent, then that same $10,000 can be a 10 percent down payment on a $100,000 house or a 5 percent down payment on a $200,000 house. If they opt for the more expensive house, however, they have to pay for PMI. The costs for PMI are based on the loan amount. For a $100,000 loan with a 10 percent down payment, the average cost of PMI might be $40 per month.

In 1998, the Homeowners Protection Act established rules for mortgages signed on or after July 29, 1999, that require the automatic termination of PMI after you have reached 22 percent equity in the home, based on the original property value. You can also request that the PMI be dropped when you reach 20 percent if your mortgage was signed after that date. If your mortgage was signed prior to that date, you can request the cancellation of PMI once you've reached the magic 20 percent mark, but your lender isn't required by law to cancel it.

There are certain conditions that may make your loan an exception to this rule -- for example, if you haven't kept your payments current, if your loan is considered a "high risk" loan, or if you have other liens on the property.

Fannie Mae and Freddie Mac

Mortgages made by banks and other lenders are typically sold on the secondary market in order to produce cash so the lenders can make more mortgages. The more mortgages a lender makes, the more money it makes because most of its income comes from fees, points and other charges associated with the loan.

The largest purchasers of mortgages on the secondary market are the government-sponsored enterprises (GSEs): the Federal National Mortgage Association (Fannie Mae), and the Federal Home Loan Mortgage Corporation (Freddie Mac). These large enterprises were created by congressional charters in order to make mortgages available to more people with low and moderate incomes. They are now private companies. Both Freddie Mac and Fannie Mae have specific requirements for loan products that banks and lenders have to comply with if they want to sell the loan on the secondary market.

They purchase mortgages from lenders and then sell them as securities in the bond market. This provides lenders with the money to make more mortgages. These mortgage-backed securities (MBS) offer investors a good return.

In 2006, the loan limit for both Freddie Mac and Fannie Mae loans is $417,000 for single-family homes in the United States. This is what defines the "conventional" loan you hear about. Loans higher than that amount are called jumbo loans and usually have higher interest rates. These limits change annually based on the single-family home price survey done by the Federal Housing Finance Board in October.

What is Foreclosure?

Missing mortgage payments may mean you lose your property; in a word, it means foreclosure is likely. Foreclosure means that the lender takes possession of your home and sells it in order to get its money back. Technically, foreclosure is the legal process that takes place when this happens.

You do have options, however. According to the U.S. Department of Housing and Urban Development (HUD), working with your lender and possibly a housing counseling agency is the thing to do.

You may be able to get:

Special forbearance - This means you may be able to set up another repayment plan with your lender that will fit your financial situation. Sometimes, if you've recently lost your job or another source of income, you may find that your lender is willing to temporarily reduce or suspend your payments.
Mortgage modification - If you are recovering from some financial problem and now have an income level lower than it was before, you may be able to either refinance what you owe or extend the term of the loan.
Partial claim - You may be able to get an interest-free loan from HUD in order to get your mortgage current. This option has special qualification criteria.
Pre-foreclosure sale - If the appraised value of your property is at least 70 percent of the amount you owe, then you may be able to sell the property in order to pay off the mortgage. The sale price has to be at least 95 percent of the appraised value, and there are other requirements in order to qualify.
Deed-in-lieu of foreclosure - Because foreclosure damages your credit, you may be able to "give" your property to your lender in order to avoid the credit problems associated with regular foreclosure. Again, there are requirements you must meet in order to qualify for this option.

The thing to remember is to talk with a HUD-approved housing counseling agency, and watch out for the scams that take advantage of your bad situation.