What You Need to Know When Shopping For a Mortgage
If you're thinking of purchasing a home, you've probably started shopping for a mortgage. It's a daunting task to be sure, but it doesn't have to be. Before you dive into the sea of mortgage calculators and online applications, you'll need to know a few things about your financial picture before you apply: how much you earn; your credit score, your cash on hand; and your debt-to-income ratio. From bankers to real estate agents to mortgage brokers, we've assembled a panel of experts to weigh and help you understand how to hunt for that perfect deal.
There are multiple ways to obtain a mortgage. The most direct route is via a lending institution or a bank. This is called a direct lender. The bank uses its own funds, and sets its own rates. There are some benefits when dealing directly with a bank. Banks are regulated by state and federal agencies, which means they are typically reliable, and the bank is a one-stop shop. You don't have to deal with anyone else for your loan. However, when you work with a bank, you may have more-limited mortgage options. These types of lenders offer only their own loan packages. If you want to comparison shop, you will need to chat with a variety of lenders.
Known for their lower fees, credit unions are now active in making long-term first and second mortgage loans on residential properties. They offer special programs for first-time buyers and can even help those who are credit-impaired. That said, you have to be a member of a credit union to obtain its benefits. Many credit unions are local or regional, and some employers, such as Disney, sponsor their own credit unions. The website culookup.com can help you find credit unions in your area.
You can also check out some of the many lending agencies. These are companies like HomeBridge Financial Services or Skyline Home Loans. Lending agencies don't sell any products other than mortgages and typically offer a wide array of home loan options. But working with a direct lender isn't without disadvantages. Most have rigid loan programs and higher requirements.
A third option is to work with a mortgage broker. Brokers have access to a range of lenders and can guide you to a national or regional lender that would be more likely to accept your loan application based on your financial information. And because the mortgage broker deals with so many different lenders and companies, the broker is bound to get you a more favorable rate. Since better rates are key, we're going to focus on mortgage brokers, but before we go there, let's look at the different types of loans.
Conventional mortgages require an appraisal of the real property, and the property serves as security for the loan. Conventional mortgages are not guaranteed or insured by federal government. With a guaranteed loan, a third party (such as a government agency like the FHA or VA) guarantees the lender a repayment of a portion of the loan.
In an effort to ensure that quality housing was available for all U.S. citizens, the National Housing Act of 1934 created the FHA-insured mortgage loan. The Federal Housing Administration has limits on the amounts for which loans can be approved, but these amounts change. The FHA also sets standards for construction quality and credit requirements for borrowers. If you want an FHA loan, you must obtain financing through a lender, who agrees to make the loan. You cannot borrow directly from the FHA.
The Veterans Administration can guarantee loans for eligible servicemen and women. Like the FHA, the VA does not lend money but rather guarantees loans made by private lending institutions approved by the agency. Veterans seeking loans must apply for a certificate of eligibility. While there's no cap on the amount of loan a veteran can obtain, it does cap the amount guaranteed, which $453,100 for 2018.
If you are having credit issues, you may want to think about subprime lending options. However, subprime borrowers are not going to get the best interest rates. This option is designed for mortgage acceptance -- regardless of the rate given. Subprime borrowers pose a higher risk of defaulting on the loan. But hey, if your credit is 580 or less, and you want to buy, subprime lending may be a perfect option.
Fannie Mae and Freddie Mac are shorthand names for the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation, respectively. They are names homebuyers may hear a lot. These publicly owned corporations provide a secondary market for single-family and multi-family residential loans. They basically raise funds to purchase loans by selling government-guaranteed bonds at market interest rates and "create opportunities for people to buy, refinance or rent a home." They do not, however, issue mortgages directly to homebuyers.
There are several types of mortgages. A fixed-rate mortgage or FRM means the interest rate remains the same for the duration of the loan. An adjustable rate mortgage or ARM means the interest rate fluctuates with the volatility of the rates in the market. Translation: Some months your payment will be higher. A borrower can also make payments on a mortgage whose debt has not fully reduced or "amortized" by the time the final payment is due, making the last payment much larger. This is called a balloon mortgage.
If you're a renter, you're probably wondering if buying a home even makes sense. How will your current expenses play into the affordability of the house? How will your expenses change over the years? Will you still be able to save money for retirement with your new property taxes? How much should you have saved? These are great questions, and whomever decide to work with should help you navigate this new terrain.
If you're a young married couple and thinking of having children, your big questions about getting a mortgage may relate to whether one of you will be able to quit working and raise your children. How will your mortgage affect the long-range projections for growing your assets? If private schooling is on the table, how will you adjust your financial plan, or should you purchase a home in a better public school district? Also, whose name should appear on the title for the house? These are just some of the questions married couples should consider.
The lender is essentially worried about your ability to repay your loan. They want to know if your credit score is good and if you have a high-income to low-debt ratio. Is the loan an equity risk? Meaning, do you have enough for the down payment. Do you have enough assets in reserve? This is why it's sometimes a better option to work with a mortgage broker. The broker's concerns are generally the same as the borrower's.
Tony Sabella of Opes Advisors in Cupertino, California, has been in the mortgage business for 25 years and is approved to lend in all 50 states. He knows it's a competitive market and believes it's crucial to get pre-approved for a loan. "The preapproval process gives you a clear understanding of the funds you'll need to close on your home," says Sabella. Real estate agent Marc Hernandez with New York-based Douglas Elliman Real Estate concurs: "When ready to make an offer on a property, the key is stepping up to the negotiating table with verifiable funds. To do so, you need to obtain a preapproval letter, so finding a qualified and professional lender to work with is critical. It's definitely pay-to-play." So let's dive into the pre-approval process and find out exactly how it works.
"Interest rates advertised online are very general," says Marty Yeghishian, a mortgage broker with Option One Lending. It's only after assessing a credit checklist of items that includes bank statements, two years of tax statements, two years of W-2s or recent pay stubs, and filling out a loan application and authorization allowing a mortgage company to work on their client's behalf that a truly accurate determination of whether you have enough to even qualify for a mortgage comes into view.
Getting pre-approved gives you five advantages. The first, Sabella says, "Knowing your price range gives you a clear understanding of the funds you'll need to close on your home." Second, knowing your credit score and raising it before you buy a mortgage can save you money in the long term. Third, seller's like a sure thing. You'll have an advantage over buyers who aren't pre-qualified. Fourth, you will work more efficiently with your real estate agent. Fifth, you'll know your maximum monthly payment based on your personal budget.
Mortgage calculators, like this one, can be fun to experiment with, but beware. It's easy to fall into the trap of thinking you can run numbers online and get an accurate estimate of your future mortgage, but the bottom line is that there are a lot of factors that go into this calculation, including your tax returns, how much income you earn, and your credit score. It's often recommended that no more than 28 percent of one's gross income should go to the mortgage.
Your credit score affects your ability to get a larger loan. Remember those FHA loans? Even FHA loan applicants are now required to have a credit score of 580 or above. Having a higher credit score means lenders are more confident you're going to pay them back. If you have a credit score of 700 or above, chances are you're going to get a lower interest rate.
If you are buying a condo or a single-family home your interest rates will vary significantly. Yeghishian, the mortgage broker with Option One Lending, explains it this way, "Loans for condos carry higher interest rates because, historically if there is a distress in the market, condo prices drop faster, which means they are a riskier investment for lenders."
The type of occupancy of a property affects your interest rate, that is, whether it's owner-occupied or an investment. Owner occupancy will have a lower interest rate. Your loan amount and the size of your down payment can also change your rate. The larger the down payment, the lower the interest rate, generally. Especially large or small loans may also come with higher rates.
You may find that you don't have enough money for a substantial down payment. This is where dealing with a broker can work to your advantage. Yeghishian says, "Applying for a second mortgage in combination with the first, could be beneficial." Basically, if you don't have the full 20 percent for your down payment, you can apply for two loans at the same time. By splitting the loan into a first and a second mortgage you can avoid paying costly mortgage insurance to the lender.
If after determining your loan, calculating your payments and your interest rates, you find that your mortgage is still too high, you may be able to lower interest rates by buying points. A mortgage point is a fee equal to 1 percent of the loan amount. A 30-year, $300,000 mortgage might have a rate of 7 percent but come with a charge of one mortgage point, or $3,000. The more points you pay, the lower the interest rate. Borrowers typically pay up to three or four points, depending on how much they want to lower their rates.
Mortgage insurance protects the lender in the event that the owner defaults on payments. The main reason a lender may require mortgage insurance has to do with that 20 percent down payment. If you can't make that down payment, you may find yourself shelling out an "additional 0.3 to 1.5 percent of the original loan in a year" according to Bankrate, an independent financial comparison service. Mortgage insurance can be pricey, often costing hundreds of dollars a year.
Okay, so let's say you've been to your bank, or connected with a broker, and you've gone through the steps, and you're now pre-approved. Now you can start looking for homes. Yeghishian says, "The next step is that you will receive a letter specifying your approval, loan terms, and costs. Once that peace of mind is there, then you can start shopping for a home." At this point, the real estate agent works with the homebuyer, and the broker temporarily steps aside. When a property is found, and an offer is accepted, the escrow process begins and the terms of purchase are negotiated. This is when the broker, the escrow company, the title company, and the real estate agent work together to complete the sale.
The title process is one of the most important aspects of closing that mortgage. A title company makes sure that the title to a piece of real estate is legitimate and then issues title insurance for that property. The process protects the buyer against financial loss from any possible defects or encumbrances to the property. While auto or health insurance protects against events that may happen, title insurance protects the new homeowner from events that may have happened in the past. Issues with title can come in the form of liens, defects to the property, or easements. The main function of title insurance is to eliminate all such risks and prevent loss to the new owner.
Before title can be granted, the buyer may have contingencies written into the purchase and sale agreement that need to be addressed. There are many types of contingencies and there's no limit to the ways they may complicate a property transaction, but since we're discussing mortgage let's look at a typical mortgage contingency: the home appraisal. Mortgage lenders use home appraisals to make sure the property being purchased is worth the amount the buyer has agreed to pay and worth the amount they are agreeing to lend. A home appraisal gives the buyer the option of either negotiating the purchase price or backing out of the deal. It also gives the lender that option as well.
These are also called second mortgages. With a home equity line of credit, you can make necessary renovations, pay off bills, make tuition payments, or borrow cash for emergencies. Like other types of mortgages HELOC's may have fixed or variable rates, and HELOC's may also be tax deductible. To qualify for a HELOC, you must have available equity in your home.
Almost any lender that can complete a purchase transaction will have the ability to do a refinance as well. According to Mortgage Calculator, "Refinancing is typically used to obtain a new mortgage in an effort to reduce monthly payments." However that is not always the case. Some refinancing can actually raise your mortgage payments, but let's look at the top three reasons to refinance your home.
The most common reason homeowners refinance is to lower the interest rate in order to pay less on the mortgage. Let's say your current rate is 5 percent and the new rate is 3.5 percent. Refinancing the loan with different terms would make sense. Because of the costs of refinancing -- appraisals, loan application fees, and title searches -- the general rule of thumb is to make sure the new interest rate is at least 1 percent lower than your current rate.
According to Bank of America, this type of refinance pays off your existing first mortgage, and the remaining funds are yours to do with as you wish. Yeghishian explains it this way, "If your property is worth $100K, and your current loan is $60K, you have $40K in equity. You could pay off your existing $60K loan by rewriting a new mortgage for a loan of $70K. But there has to be a reason and benefit to take out the cash out because your mortgage will go up." Perhaps you're paying off a student loan, and you've figured out that spending an additional $350 per month will ultimately cost more than an increased mortgage payment. Whatever you decide, you have to run the numbers.
A third reason you may wish to change the terms of your loan is to pay off your mortgage sooner. Let's say you have a 30-year mortgage and you switch to a 15-year mortgage, your overall payments may go up, but you'd be paying more equity or principal, and less in interest on your loan. If you have an adjustable rate mortgage or ARM, this could be beneficial. ARMs have an initial fixed interest rate but after a period of time, that interest rate becomes adjustable and fluctuates with the market. Refinancing in this case may save you money.
These are government-backed loans that allow current homeowners to take advantage of their home's equity. It is sometimes an appropriate loan for seniors who don't care about selling their property or leaving it to someone else. These types of mortgages take quite a bit of planning, and to be eligible, the FHA requires that all homeowners be at least 62 years old.
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