Guide to Finding and Getting a Mortgage
What is a Mortgage?
Whether you are buying your first home, trading up to a larger home, building your dream home, or even down-sizing once the kids are out on their own, a house is probably the single biggest investment you will ever make. When purchasing a real estate property, unless paying cash, consumers typically finance all or a portion of the purchase price. A mortgage in essence is the conditional pledge of the property to a creditor as security for performance of an obligation or repayment of a debt.
The document the buyers' sign promising to pay the money owed is the note. Both documents are filed for public record to protect all parties involved. The amount of the money borrowed, called the principal, plus interest, which is the cost of using the money, are paid back to the creditor in monthly installments. Some mortgages are available where the buyer pays interest only, monthly or quarterly. (Check with your lender for availability).
Home mortgages are available from several types of lenders: commercial banks, mortgage companies, and credit unions. Different mortgage lenders may quote you different prices, so you should contact several lenders to ensure you're getting the best possible price. You may also obtain a home loan through a mortgage broker. Brokers arrange financial transactions rather than lending money directly; in other words, they find a lender for you.
A broker's access to several lenders can mean a wider selection of loan products and terms from which you can choose. Brokers will generally contact several lenders regarding your application, but they are not obligated to find the best deal for you unless they are bound by contract to act as your agent. Consequently, you should consider contacting more than one broker, just as you should with any financial institutions.
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Qualifying for a Mortgage
Generally speaking, qualifying for a mortgage is based on the ratio of income and debt. It is determined by multiplying your gross monthly income (before any taxes are withheld) by a mortgage factor of 28 - 36%, and then subtracting all long-term monthly debts, i.e. car payment, credit cards, etc. The remaining amount is the mortgage payment you qualify for. (Please confirm your specific situation with an actual mortgage lender).
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Types of Mortgages
Fixed Rate Mortgage
With a fixed rate mortgage, payments remain the same for the life of the loan, which can be 15, 20, or 30 years, depending on your lender. Usually, the shorter the term, the lower the interest rate and the quicker equity is built in the property. During the beginning years of a 30-Year loan, more interest is paid than principal, meaning larger tax deductions. As inflation and costs of living increase, mortgage payments become a smaller part of overall expenses. With most fixed rate mortgages, your monthly principal and interest payment will not change for the term of the loan, regardless of whether interest rates rise or fall. In exchange for that stability, you may have a higher interest rate than you would with an adjustable rate mortgage.
Adjustable Rate Mortgage
With an adjustable rate mortgage, your payments will vary over time. This mortgage typically has an initial fixed rate lower than the rate of a comparable fixed rate mortgage. The initial fixed rate period is followed by adjustment intervals. For example, a "3/1 ARM" is fixed at an initial low rate for the first 3 years, and then adjusts every year based on an index. The adjustable rate mortgage is a good choice for buyers who will have a substantial increase in salary over the adjustment period and therefore, can absorb the additional payment if the payments increase during the adjustment. This mortgage type allows the borrower to qualify for a larger loan amount. Many adjustable rate mortgages also give the buyer the benefit of adjusting downward. The adjustment rate is determined by several indexes, so please consult with your lender to determine if this type of mortgage is right for you.
A balloon mortgage offers very low rates for an initial period of time (usually 5, 7, or 10 years); when time has elapsed, the balance is due or refinanced (though not automatically).
A two-step mortgage has an interest rate that adjusts only once and remains the same for the life of the loan.
The reverse mortgage is aptly named because the payment stream is reversed. Instead of the borrower making monthly payments to a lender, as with a regular mortgage, a lender makes payments to the borrower. This special mortgage is used to convert equity in a home into cash to provide seniors financial security in their retirement years. There are age restrictions with the reverse mortgage.
Become Mortgage-Free Faster
Monthly, Bi-Weekly, or Weekly Payments
Once your mortgage amount, rate and amortization period have been established, your monthly payment can be calculated. Now is the time to decide how often you want to make your payments, because by selecting the right payment frequency could literally mean thousands of dollars in savings. For example, on a $100,000 mortgage at 8% interest, amortized over 25 years, the monthly payments would be $763.21. However, by simply switching to bi-weekly payments (every two weeks) with payments of $381.61 (half of the monthly payment), there would be a saving of $30,484 in interest! Weekly payments of $190.80 will save $30,839 in interest, and you will be mortgage free in 19 years vs. the full 25 year period.
Prepayments - Extra Payments Against Principal
This is one of the most important features to look for when you are getting a mortgage. Having the prepayment privilege that works to your specific needs could mean a difference of thousands of dollars over the life of your mortgage. Although all financial institutions offer some form of prepayment privilege, the amount and how it can be applied varies from one to another. Some offer only up to 10%, once per year, and on the anniversary date. Then there are others that offer as high as 20% per year, and prepayments can be done throughout the whole year as long as the total does not exceed 20%. Ideally, you should work your prepayment privilege as often as possible throughout the year. Saving aside to make that big prepayment is not the best strategy. We have found that the small, regular prepayments will reduce your mortgage faster.
Increase Your Regular Payment
The secret to borrowing is borrow early in your life. The reason is that the future value of the dollar decreases. When you borrow early, your payments are set. As time elapses, our incomes tend to increase, but our mortgage payments stay the same, provided you locked-in to a long term, fixed mortgage. Therefore, in the future you may be in a position to increase your payment on the mortgage, regardless if you are paying weekly, bi-weekly, or monthly. Any increase in payment is directly going to pay down the mortgage, thus saving you thousands of dollars due to the effect of interest not compounding on that amount for the life of the mortgage.
Double-Up on Payments
A few lenders will allow you to double-up on your payments, and the extra payment goes directly in the principal. If you double-up once in the year, you have just achieved the benefits of the weekly or bi-weekly mortgage. This is a neat little feature for someone who prefers the monthly payments but wants the results of the weekly and bi-weekly payments.
Early Renewal Option
This is a great feature to have when interest rates are on the rise. If you are locked-in to a term and the mortgage will be maturing in months or years down the road, and the mortgage rates are on a rise, you can renew your mortgage before the maturity and lock-in the low rates for a new term. You may not even have to pay anything out of pocket and still save over the term, especially if rates move up considerably.
If you want to take your mortgage with you when you move, you can if your mortgage has a clause that allows you to do that. This option allows you to continue your savings on your lower rate if the going rates are higher, as well as avoid any penalties if you were to break that mortgage. If you need a larger mortgage for the new property, your existing mortgage amount can be increased. As for the associated costs, since a new mortgage document must be registered on title, legal fees and normal appraisal fees would be applicable.
If you are moving and don't want to take your mortgage with you, or you are selling and not buying, an assumable feature will allow the buyer(s) of your property to take over the mortgage, provided they meet the lender's qualifying criteria. By doing so, you will not pay any penalties as you are not breaking the mortgage contract. In fact, if your interest rate is lower than those available at the time, your assumable mortgage suddenly became a great selling feature for your property.
Remember: You must get a release from the Mortgage Company to ensure that you are no longer liable for the mortgage. Some mortgage companies automatically offer a release, but with others, you must make the request, and do it through your lawyer.
Mortgage Life Insurance (optional)
Since your home is likely your single largest investment, you may want to protect that investment. Many financial institutions offer mortgage life insurance at an affordable and competitive price, and the requirements for eligibility are usually quite simple to meet. If you or your co-borrower (if you choose joint coverage) becomes deceased, the insurance company will pay off your mortgage. Also, some institutions now offer job-loss and/or disability insurance to borrowers. The best thing to do in making a decision about how to insure your mortgage is to have an insurance agent work out the figures for a private term insurance and mortgage life insurance.
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Every lender or broker should be able to give you an estimate of their fees. Many of these fees are negotiable. Some fees are paid when you apply for a loan, and others are paid at closing. In some cases, you can borrow the money needed to pay these fees, but doing so will increase your loan amount and total costs. "No cost" loans are sometimes available, but they usually involve higher rates.
The costs banks and mortgage companies charge usually include the following:
Application fee - the money paid to the lender for processing the mortgage documents
Insurance - homeowner's coverage for fire and casualty to the home
Origination fee - A fee, often a percentage of the total principal of a loan, charged by a lender to a borrower on initiation of the loan
Closing costs - The numerous expenses (over and above the price of the property) that buyers and sellers normally incur to complete a real estate transaction
Interest - the cost of using the money, based on a percentage of the amount borrowed
The amount of money a buyer needs to pay down on a home is one of the most misunderstood concepts in home buying. Some people think they need to make a down payment of 50% of the home's price, but most loans are based on a 20% down payment. There are mortgage options now available that only require a down payment of 5% or less of the purchase price. If a 20% down payment is not made, lenders usually require the home buyer to purchase private mortgage insurance (PMI) to protect the lender in case the home buyer fails to pay. Ask about the lender's requirements for a down payment, including what you need to do to verify that funds for your down payment are available. Make sure to ask if PMI is required for your loan, and also find out what the total cost of the insurance will be.
Amortization is the paying off of the mortgage debt in regular installments over a period of time, i.e. 30 years. If you pay the same monthly amount according to the terms of your note, then your debt will be paid in the exact number of years outlined for you. You may, however, make additional monthly payments which are applied directly to the principal amount thus reducing your mortgage term substantially. Understand negative amortization. Some home loans offer attractive monthly mortgage payments but at times those low payments don't cover the interest portion of the loan. When that happens, part of the principal amount is deducted, resulting in what lenders call "negative amortization." Simply put, it means you are losing equity in your home.
The interest rate is the monthly effective rate paid on borrowed money, and is expressed as a percentage of the sum borrowed. A lower interest rate allows you to borrow more money than a high rate with the same monthly payment. Interest rates can fluctuate as you shop for a loan, so ask lenders if they offer a rate "lock-in" which guarantees a specific interest rate for a certain period of time. Remember that a lender must disclose the Annual Percentage Rate (APR) of a loan to you. The APR shows the cost of a mortgage loan by expressing it in terms of a yearly interest rate. It is generally higher than the interest rate because it also includes the cost of points, mortgage and other fees included in the loan. If interest rates drop significantly, you may want to investigate refinancing. Most experts agree that if you plan to be in your house for at least 18 months and you can get a rate 2% less than your current one, refinancing is smart. Refinancing may however, involve paying many of the same fees paid at the original closing, plus origination and application fees.
Discount points are prepaid interest and allow you to buy down your interest rate. One discount point equals 1% of the total loan amount. Generally, for each point paid on a 30-year mortgage, the interest rate is reduced by 1/8 (or.125) of a percentage point. When shopping for loans ask lenders for an interest rate with 0 points and then see how much the rate decreases with each point paid. Compare the monthly difference in payments with the total discount points you are willing to pay, and see how many months you need to stay in the home to recover your money. Points are tax deductible when you purchase a home and you may be able to negotiate for the seller to pay for some of them.
Established by your lender, an escrow account is set up to manage monthly contributions to cover annual charges for homeowner's insurance, mortgage insurance and property taxes. The borrower contributes 1/12 of the annual costs monthly, so that the lender will have sufficient money to pay for the taxes and insurances. Escrow accounts are a good idea because they assure money will always be available for these payments.
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The credit score is calculated by a statistical process and provides a guideline for lenders to extend credit (and if so, by how much) to a borrower. Mortgage companies, banks, and insurance companies determine the interest rate they will charge based on the borrowers credit score. The credit scoring process encompasses both your pay history and the amount of credit you currently have. The credit score is a substantial portion of the entire credit report.
Low Credit Scores will result in higher payments on loans, credit cards, and insurance. The credit score is sometimes called the FICO Score, which is an acronym for the creators of the FICO score (Fair Isaac Credit Organization). Below is a table showing different score ranges.
Score Range Rating:
780+ = Perfect
720 to 780 = Excellent
675 to 720 = Average
620 to 690 = Fair
Below 620 = Low
Don't assume that minor credit problems or difficulties stemming from unique circumstances, such as illness or temporary loss of income, will limit your loan choices to only high-cost lenders. If your credit report contains negative information that is accurate, but there are good reasons for trusting you to repay a loan, be sure to explain your situation to the lender or broker. If your credit problems cannot be explained, you will probably have to pay more than borrowers who have good credit histories. Ask how your credit history affects the price of your loan and what you would need to do to get a better price.
Lenders now offer several affordable mortgage options, which can help first-time homebuyers overcome obstacles that made purchasing a home difficult in the past. Lenders may now be able to help borrowers who don't have a lot of money saved for the down payment and closing costs, have no or a poor credit history, have quite a bit of long-term debt, or have experienced income irregularities. There are companies who specialize in consumer credit repair.
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