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Why
Buy Instead of Rent?
Decades after the phrase
"the American dream"
was first coined, home ownership is still a meaningful
goal for a large number of individuals and families.
Buying a home is considered by many to be a wise investment
because typically, houses increase in value over time.
And, as the years go by, you can build ownership interest
called equity, which you can borrow against. In contrast
to renters, most homeowners receive significant tax
breaks, because interest paid on a home mortgage is
almost always tax deductible. Finally, there's the
personal satisfaction of having a home you can call
your own to share and enjoy with friends and family.
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 your monthly payment to
exceed 25% to 33% of gross monthly income. However,
many of today's loan programs offer expanded guidelines
and more flexible qualifying ratios (29%/41% of your
gross monthly income) that allow you to devote more
of your gross monthly income to your combined monthly
debt. And with the increased use of FICO
credit scoring and automated underwriting, many home
loan applicants benefit from more flexible debt-to-income
guidelines that allow them to be approved for higher
loan amounts.
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.
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 Next?
You've applied for your mortgage. Now what? This simple,
four-step walk through to loan closing will help you
understand the procedure and give you an idea of what
to expect.
1. Processing
The lender collects the information needed to process
your loan and initiates a credit check. Documentation
requirements vary depending on the loan program you
apply for and your individual financial and credit
profile. If your property does not qualify for an
automated valuation or drive-by assessment, an appraisal
will be ordered to determine the fair market value
of the property you wish to purchase. You will have
the option to lock in your interest rate or float
your interest rate.
Depending upon the information from your credit report
and the type of property you want to finance, you
may need to provide additional documents or letters
that:
- Verify the income
you'll use for loan qualification
- Confirm your down
payment and closing expenses in your bank account
- Clarify any incorrect
items on your credit report
- Verify any debts
not listed on your credit report
The lender will also check
the title to the property to make sure there are no
outstanding liens or title problems. The lender requires
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.
2. Decisions
Many home mortgage applications receive approval decisions
swiftly and easily through an automated system. On occasion,
loan applications need to be reviewed by underwriting.
Underwriters are trained to evaluate your financing
requirements and will do everything possible to help
approve your application. In the case that your application
is not approved, your lender can help you determine
what actions need to take place in order for you to
obtain financing.
If your loan is approved, your lender will issue a loan
commitment (a binding agreement) to lend you the money.
The commitment includes conditions required prior to
or at closing, information on when the commitment expires;
and important information you should know when closing
on your home. You should review your loan commitment
thoroughly to make sure the terms are acceptable to
you.
3. Pre-Closing
Prior to closing, sometimes referred to as "loan settlement,"
your lender may ask you to provide certain insurance
and real-estate-related documents. When you are ready
to schedule your closing date, all involved parties
will be contacted to arrange for the closing to take
place at a convenient time and location for you. You
will be notified of the exact amount of money you may
need at the closing and any additional documents you
may need to bring with you.
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.
4. Closing
At your closing, ownership interest of the property
is transferred to you. A closing agent (an attorney
of your choice or a title agency representative, depending
on what is customary in your area) coordinates and distributes
all the paperwork and funds, according to the terms
agreed upon by you and the seller.
What's
the difference between conforming and non-conforming
loans?
A conforming loan is
one with an original balance of $333,700 (for 2004)
or less for a single-family home. The conforming loan
limit is adjusted annually at year-end by Fannie
Mae and Freddie Mac.
Conventional non-conforming or "Jumbo" loans have
original loan amounts greater than the conforming
loan amount. In most cases, jumbo loans have slightly
higher interest rates than conforming loans.
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 unchanged
over its term, or if you plan to stay in your 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. 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 10,
15, 20 and 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 balance will be paid off
sooner, saving you substantial money in interest payments
over the life your loan. Also, the rates are almost
always 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.
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. 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.
Another type of ARM is the convertible ARM which 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.
What
is an FHA or VA Loan?
The Federal Housing
Administration (FHA) insures a wide variety of first
mortgages, including fixed rate and ARM products.
Down payments are low and gift funds can be used for
all costs. Qualifying ratios are generally more liberal
than conventional loans. However, mortgage insurance
is required and the property being purchased must
be owner-occupied.
The Department of Veteran's Affairs (VA)
guarantees mortgage loans made to eligible veterans
or reservists who are first- or second-time home buyers.
In most cases, no down payment is required. For the
most part, VA-guaranteed loans are fixed rate products.
What
does my mortgage payment include?
Typically, your monthly
mortgage payment is made up of four parts: principal,
interest, taxes and insurance (PITI).
Principal is the amount of money you borrow. In the
early stages of your mortgage term, your monthly payment
includes only a small portion of your principal. As
you continue to make payments through the years, a
greater portion of your payment goes to reduce the
principal.
Interest is the cost of borrowing money. In the early
stages of your mortgage term, your monthly payment
is mostly interest. As you continue to make payments
through the years, a smaller portion of your payment
goes to interest.
Taxes are paid by homeowners to local governments,
and are usually charged as a percentage of the assessed
property value. Tax amounts vary depending on where
you live.
Homeowner's or Hazard Insurance is a policy that protects
you against financial losses on your property as a
result of fire, wind, natural disasters or other "hazards."
In addition, mortgage Insurance (MI) is required on
certain loans to protect the lender against financial
losses if the borrower fails to repay the loan. Usually,
whenever the down payment is less than 20% of the
home's purchase price, lenders require some type of
insurance. The name of the insurance varies based
on the product chosen. Private Mortgage Insurance
(PMI) is associated with conventional
loan products. Mortgage Insurance Premium (MIP) is
associated with FHA loans. Funding Fee is associated
with VA loans.
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. Some home buyers may be eligible for
a down payment assistance program if one is available
in the area in which you are thinking of buying a
home. Or, depending on the loan program you choose,
you may be able to buy a home with a very low down
payment (3% or less), or no down payment at all. 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 may 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. PMI is an ongoing
payment made each month along with the principal and
interest payment.
Some lenders do not require PMI. Instead, they may
increase the interest rate on the loan to cover the
PMI. This can represent a significant advantage to
the borrower since PMI premiums are not deductible
for tax purposes and mortgage interest is usually
tax deductible.
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.
What
is a discount point?
When inquiring about
rates, be sure to check if the quoted interest rate
reflects payment of points. Many loan programs allow
you to receive a discounted interest rate by paying
a fee in points and/or origination fees. One point
equals 1% of the loan amount, and the more points
you wish to pay, the more you can discount your rate.
Paying points is not a requirement; it's just an option
lenders offer to accommodate the immediate or long-term
monthly payment concerns of home mortgage customers.
What
is an origination fee?
Sometimes called a "point",
this fee cover's the lender's administrative costs
in processing the loan. Often expressed as a percentage
of the loan, the fee will vary among lenders. Be sure
to ask the lender if the rate quoted includes an origination
fee.
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
What
are closing costs?
Closing costs are fees
charged by the lender and closing agent to process
and record any new loan application and vary from
state to state and county to county. These costs may
include, but are not limited to, appraisal, credit
report, title, prepaid's, county and city transfer
taxes, recording fees and title insurance premiums.
Generally, closing costs amount to 3% - 7% of the
loan amount. The percentage depends on the region
of the country in which you buy/own, the loan amount
and the time of the month you close.
In some jurisdictions, an attorney represents the
lender and borrower and in others, a title company
represents the lender and borrower at the closing.
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.
It is important that you review what the closing costs
will be with your lender and closing agents. This
should take place far enough in advance of the closing
to allow you time to obtain the necessary funds to
pay the closing costs.
What
is an escrow account?
An escrow account is
established at the time you close your mortgage loan.
This account is held by the lender for future payments
as they become due of recurring items relating to
the mortgaged property such as real estate taxes and
insurance premiums. Lenders usually require you to
pay an initial amount for each of those items to start
the reserve account at the time of closing. Once your
mortgage is paid in full, you are still responsible
for paying taxes and hazard insurance.
What
are lender fees?
These are fees that
offset the cost of producing the loan. Different lenders
may refer to them by different names, such as, processing
fees, underwriting fees, or commitment fees.
What
are third party fees?
Third party fees are
fees that are passed on to a lender for services rendered
by a third party to facilitate the loan process which
are then passed on to the borrower. These fees may
include, but are not limited to, appraisal, credit
report, flood search, abstract or title search, title
insurance, recording fees and transfer taxes.
Will
the lender agree to include my closing costs in the
loan amount?
On a purchase transaction,
you cannot typically finance your closing costs into
the loan amount. Some lenders do, however, have special
programs under which you may be able to finance some,
or all, of the costs by agreeing to a slightly higher
interest rate. For refinance transactions, there is
the option to finance the closing costs into the loan
amount.
Can I close on
a home without having to be at the closing table?
Many lenders are willing to accommodate
what is termed a "mail away" closing. You may also
appoint someone to act for you by using a Power of
Attorney. In this scenario, you would actually assign
a spouse or an attorney to sign on your behalf. Check
with your closing agent for requirements specific
to your state. If you select a "mail away," the lender
will coordinate overnight delivery of the documents
to ensure a timely closing. Please note this process
may require some additional coordination time.
How much money
will be required at closing?
You should consult with your individual
lender and closing agent; however, the amount of money
needed for cash to close is comprised of your down
payment, closing costs, as well as the prepaid items
for your initial taxes and insurance escrow accounts.
A lender is usually required to provide you with a
good faith estimate of settlement costs at the time
of application. Also, typically within a couple days
prior to your closing, the closing agent will provide
you with the final sum of money required for the closing.
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, pre-paid interest
and mortgage insurance (if required). The APR allows
you to compare, in addition to the interest rate,
the total cost of financing your loan, among various
lenders.
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 for a short time, usually 60 days. The benefit
is the security of knowing the interest rate is locked
if interest rates should increase. However, 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 at the higher rate.
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 longer guarantee
periods are available and what additional costs may
be involved.
What is a Home
Equity Loan?
The dollar difference between the
market value of your home and your current mortgage
balance determines your home's equity. In other words,
if you sold your home this would be the cash that
would be available 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 personal 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 continue to access your credit line 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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