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Most Frequently Asked Home Mortgage Questions
I’d
like to own my own home. What’s the first step?
Before
you begin searching for a home—and a mortgage—it’s important
to take a close look at the funds you have available to make your
purchase. You’ll want to consider:
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Your
present income;
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Your
expected income over the next few years;
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Outstanding
long-term debt; and
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How
long you expect to stay in your home.
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 the monthly payment to exceed 25% to 33% of gross
monthly income. Other lenders have more flexible debt-to-income
ratios.
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.
How
do I know which type of mortgage is best for me?
Since
some mortgage options are less conservative than others, it is
important to determine if you are a “risk-taker” or if you
prefer more stability in your financial dealings.
Do
you invest in the stock market? Or put money into Certificates of
Deposit? These are two different ways of handling money. Depending
on your answers to these questions, and others that may be asked
by your lender, you will be able to choose the mortgage that is
right for you.
What’s
the difference between conforming and non-conforming loans?
Most
loan rates that you hear quoted are for conforming loans. A
conforming loan is one with an original balance of $275,000 or
less for a single-family home. Any loan amount larger than that is
called non-conforming.
Two
major agencies—the Federal National Mortgage Association (FNMA)
or Fannie Mae and the Federal Home Loan Mortgage Corporation (FHLMC)
or Freddie Mac—can purchase conforming loans. For lenders who
sell their loans after they are closed, there is an extremely
liquid market. But the availability of potential buyers is reduced
greatly when the loan amount goes above the conforming limit. To
attract enough buyers for these loans, a lender often increases
the rate on non-conforming loans. The conforming loan limit is
adjusted annually at year-end by FNMA and FHLMC. Some lenders also
have their own guidelines for dollar differentiation between
conforming and non-conforming loans.
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, and pre-paid interest. The
APR allows you to compare, in addition to the interest rate, the
total cost of financing your loan, among various lenders.
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 long guarantee periods are available and
what additional costs may be involved.
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 (and loan
fees) for a short time, usually 60 days. The benefit is the
security of knowing the interest rate is locked if interest rates
should increase. 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 the rate.
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.
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
essentially unchanged over its term, or if you plan to stay in
your new 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. That is the one disadvantage of a fixed
rate mortgage. 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 15 to 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 will be paid off sooner, saving you money
in interest payments. Also, the rates may be 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. However, the interest
rate on an ARM is based on a specific index (such as U.S. Treasury
Securities). This index reflects the level of interest rates and
allows the lender to match the income from your ARM payment
against their costs. It is often selected because it is a
reliable, familiar financial indicator. Monthly payments are
adjusted up or down in relation to the index.
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 for the first year of the loan.
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.
The
convertible ARM is an option that is currently very popular
because it 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.
As
a relatively new phenomena, the purpose of an ARM is often
misunderstood. Ask your mortgage lender to explain the details to
you so you can determine if this type of mortgage fits your
specific financial situation.
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 after I apply?
The
lender initiates a credit check and arranges for an appraisal of
the property you plan to buy (or the current property you want to
refinance). The appraisal assures you and the lender that the
property has fair market value. The lender is investing in you
and, in the unlikely event of default on your loan, the property
must be worth enough to settle the debt.
Once
your credit check, appraisals and verifications are complete, this
“credit package” is reviewed by an underwriter who makes the
loan decision. If your loan is approved, your lender will issue
you a loan commitment (a binding agreement) to lend you the money.
The commitment spells out all the details of the loan including
all charges and fees, closing requirements, and any important
conditions including:
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A
list of documents you will need for closing;
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Information
on when the commitment expires; and
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Important
information you should know when closing on your home.
The
loan commitment may also may have certain conditions that you must
meet before the loan is granted—bills you must pay off, or
special requirements of the homeowners association, fox example.
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.
You
and an attorney (if you choose to have an attorney represent you)
should review the loan commitment carefully. Make sure the terms
are acceptable to you. Assuming you and the lender come to terms,
your agreement with the lender is now complete.
Do
I need title insurance?
The
lender will check the title to the property to make sure there are
no outstanding liens or title problems. The lender requires, and
sometimes will arrange for, 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.
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. 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 will
probably 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.
The
cost of PMI is divided into two parts. The first part is a payment
made at the loan closing. The second part is an ongoing payment
made each month along with the principal and interest payment.
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.
Some
lenders do not require PMI. Instead, they may increase their
origination fee and/or the interest rate on the loan. This can
represent a significant advantage to the borrower since PMI
premiums are not deductible for tax purposes and mortgage interest
is usually deductible.
What
are closing costs? What is an Escrow Account?
Closing
costs and procedures vary from state to state and from county to
county. In some jurisdictions, an attorney represents the lender.
In others, the title company represents the lender. There may be
state or county transfer taxes to be paid. There may also be fees
for recording certain documents. There are also standard charges
that are paid at all closings. Taxes, title insurance premiums,
and interest on the loan pro-rated from the closing date to the
end of the month.
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. Some lenders will waive the escrow
requirements if the down payment is above a certain limit.
Depending on when you close and when real estate taxes are paid in
your jurisdiction, the cash required to set up the real estate tax
escrow could represent one-half to three-quarters of the annual
real estate tax bill.
It
is important that you review what the closing costs will be with
your lender and attorney. This should take place far enough in
advance of the closing to allow yourself time to obtain the
necessary funds to pay the closing costs.
What
is involved in the closing?
This
is the day you’ve been waiting for, the final step before you
own your new home or complete the refinancing of your current
home. At the closing you, the seller, the lender and the attorneys
for all involved validate, review and sign all documents relating
to the purchase or refinance. The lender provides the check for
the loan amount. You receive the title to your property and the
keys to your new home.
What
is a Home Equity Loan?
The
dollar difference between the market value of your home and your
current mortgage balance determines your home equity. In
other words, if you sold your home this would be the cash you
would receive 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 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 reuse
it 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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