Mortgage Loan Options

Unless you have enough money to pay for a house yourself, you'll need a mortgage loan. A mortgage is a loan you take out to finance the purchase of your home. It is also a legal contract stating that you promise to make a monthly payment until your loan is paid off.

Today, there are hundreds of different programs to choose from, but don't let that overwhelm you. Most of the home loans are variations of a fixed-rate mortgage and adjustable-rate mortgage. Knowledge of how these mortgage programs work will help you to understand the majority of available loan options. You may qualify for a new loan without even selling your current home.

Fixed-Rate Mortgages

A fixed-rate mortgage keeps the same interest rate for the life of the loan. For most people, especially first time homebuyers, this is the best option because you pay the same monthly principal and interest rate.

A fixed-rate mortgage means the interest rate and the payments remain the same for the entire life of the loan (taxes, of course, may change.) Advantages include consistent principal and interest payments, making this loan stable. In other words, your rate won't change, so you don't need to worry about market fluctuations.

Disadvantages include a possibly higher cost. These loans are usually priced higher than an adjustable-rate mortgage. Keep in mind that, on average, most people move or refinance within seven years. If rates in the current market are high, you're likely to get a better price with an adjustable-rate loan.

  • 30 Year Fixed-Rate Mortgages offer consistent monthly payments for the entire 30 years you have the mortgage. So if the market is good, you can benefit from locking in a lower rate for the full term of the loan.
  • 20 Year Fixed-Rate Mortgages allow you to make a consistent monthly payment throughout the 20 years you have the mortgage. The shorter term means you pay the loan off more quickly, and therefore pay less interest. And you'll build equity faster than you would with a 30-year loan. (But remember the shorter term means higher payments, when compared to the 30 year fixed-rate mortgage.)
  • 15 Year Fixed-Rate Mortgages provide consistent monthly payments for the 15 years you have the mortgage. By building equity even more quickly than with a 30 year or 20 year loan, and paying less interest, you'll save money in the long run. It's an ideal option if you can handle the higher payments and if you'd like to have the loan paid off in a shorter period of time - for instance, if you plan to retire.

Adjustable-Rate Mortgages

An adjustable-rate mortgage (ARM) is one that the interest rate changes over the life of the loan - according to the terms specified in advance. The interest rate fluctuates based on several money market indexes, which cause the cost of funds for lenders to vary. All ARMs are amortized (paid down) over 30 years.

With ARMs:

  • The initial interest rate is usually lower than with a fixed-rate mortgage.
  • The monthly repayment would also be lower.
  • The interest rate may be adjusted (up or down) at predetermined times.
  • The monthly payment will then increase or decrease.

ARMs are usually priced lower than fixed-rate mortgages so you can increase your buying power and lower your initial monthly payments. If interest rates go down, you'll enjoy lower payments. Usually an ARM is the best choice for homeowners who plan to relocate (for example, with their company or the military), or for those who are purchasing their first home and plan to be in the property only for three to five years. Remember that, on average, most people move or refinance within seven years.

Conversely, monthly payments could increase if monthly payments if interest rates go up. Keep in mind that ARMs are best for homeowners who aren't planning on staying with a property for a long period. If you're on a fixed income, an ARM (especially a short-term ARM) may not be your best choice.

10/1 Adjustable-Rate Mortgages provide a fixed initial rate of the loan for the first ten years of repayment. After 10 years, the rate adjusts every year thereafter for the remaining life of the loan. The loan is amortized over 30 years.

7/1 Adjustable-Rate Mortgages offer an initial rate that is fixed for the first seven years of repayment, then the rate adjusts every year thereafter for the remaining life of the loan.

5/1 Adjustable-Rate Mortgages mean the initial rate remains fixed for the first five years of repayment, and then adjusts every year thereafter.

3/1 Adjustable-Rate Mortgages provide three years at the initial fixed-rate, then the rate adjusts every year for the remaining life of the loan. A good choice if you expect to move or refinance in a relatively short period of time. But a much shorter fixed-rate period means your interest rate (and therefore monthly payments) may begin to fluctuate after three years.

New Construction Loan

If you are working with a builder in a sub-division or development you may be able to obtain a standard mortgage loan. But if you're hiring contractors, electricians, plumbers, and painters, you will probably need a construction loan, which provides funds to pay subcontractors as work progresses.

Assumable Loans

Assumable loans permit one borrower to take over a loan from another borrower without any change in the loan terms. Such loans still exist but they aren't very common or popular (for buyers) in a low-interest-rate environment. Plus, today new assumable loans are almost always adjustable rate mortgages. To find out if a loan is assumable, look to the loan agreement to determine if it is assumable by someone else, then talk to the lender about specific requirements based on the value of the home.

Getting a Mortgage

It is very important to research your mortgage company before dealing with them. Don’t be afraid to ask any questions you feel necessary and if anything strikes you as odd make sure you comment on it. Make sure you ask for references from satisfied customers.

There are several ways to secure a mortgage. You can get one directly by working with a mortgage banker or you can go to a bank, credit union or savings and loan. A CENTURY 21® real estate agent can help connect you with a reputable mortgage lender.

Many home buyers choose to arrange financing before shopping for a home and most lenders will "pre-qualify" them for a certain amount. Pre-qualification helps buyers to focus on homes that fit your plans and budget. Nothing is more disheartening for buyers or sellers than a deal that falls through due to a lack of financing.

Mortgage Interest Rates

Some lenders are willing to negotiate on both the loan interest rate and the number of points. Most established lenders set their rates like large corporations set the prices on their goods. However, it pays to shop around for loan rates and know the market before you talk to a lender. You should always look at the combination of interest rate and points and get the best deal possible. The interest rate is much more open to negotiation on purchases that involve seller financing. These loans involving seller financing usually are based on market rates but some flexibility exists when negotiating such a deal. When shopping for rates, look for published rates in local newspapers or check the growing number of Internet sites that publish such information.

Locking in a mortgage rate with a lender is one way to ensure that same rate will be available when you need it. Lock-ins make sense when borrowers expect rates to rise during the next 30 to 60 days, which is the usual length of time lock-ins are available. A lock-in given at the time of application is useful because it may take the lender several weeks or longer to prepare a loan application (though automated loan practices are cutting this time dramatically). However, some lenders require borrowers to pay lock-in fees to assure particular rates and terms. Be sure to check that the rates and points are guaranteed and that your lock-in period is long enough. If your lock-in expires, most lenders will offer the loan based on the prevailing interest rate and points. Lenders may have preprinted forms that set out the exact terms of the lock-in agreement. Others may only make an oral lock-in promise on the telephone or at the time of application.

Price discounts and interest rate buy downs are common incentives offered by new-home builders trying to overcome slow sales. Buy downs are a financing technique used to reduce the monthly payment for the borrower during the initial years of the loan. Under some buy down plans, a residential developer, builder or the seller will make subsidy payments (in the form of points) to the lender that "buy down," or lower, the effective interest rate paid by the home buyer. State agencies often offer lower rate loans. But to qualify, borrowers usually must be a first-time home buyer and meet income limits based on the median income level of their county.

APR: Annual Percentage Rate

The Annual Percentage Rate (APR) is the relative cost of credit as determined in accordance with Regulation Z of the Board of Governors of the Federal Reserve System for implementing the federal Truth-in-Lending Act*. The APR is the actual yearly interest rate paid by the borrower, figuring in the points charged to initiate the loan and other costs. The APR discloses the real cost of borrowing by adding on the points and by factoring in the assumption that the points will be paid off incrementally over the term of the loan. The APR is usually about 0.5 percent higher than the note rate.

Points

A point is calculated as one percent of the loan amount. Points that you get charged are additional to the interest rate that is charged on the loan and the point charges varies from lender to lender. A lender often makes his fees by charging points or by negotiating a lower interest rate.

Your Credit Report History

A credit report is used by lenders as one measure of the risk and a borrower’s likelihood to repay. There are numerous types of credit report issues that would cause a lender to reject your application for a loan, including: missed credit card payment(s), default on a prior loan, bankruptcy in the past seven years, or non payment of taxes. Other black marks on a credit report include any judgment (perhaps for non-payment of spousal or child support) or any collection activity.

If you feel that your credit report is wrong, experts say it's best to take it up with the organization or company claiming you owe them money. But if you've been late paying your bills, regroup by paying in full and on time for six months to a year to prove to the lender that the late payments were an aberration.

You can order a copy of your own credit report by calling the three major credit reporting agencies: Experian at (800) 311-4769, Equifax at (800) 685-1111 and Trans Union at (312) 408-1050. Please note that every time your credit report is ordered, there are points deducted which could lower your overall score.

Negative Credit Rating

There is no fast and easy way to repair damaged credit that took months or years to occur. The law allows negative information to appear on an individual's credit record from seven to 10 years. Credit problems are the main reason would-be home buyers are denied a loan. The first step to clearing up your credit is to get a copy of your credit report to make sure that the negative credit information is indeed accurate. Some states now have mandatory timelines to respond to your inquiry or remove the blemish.

For a copy of your report, contact one of the three major credit reporting agencies: Experian at (800) 311-4769, Equifax at (800) 685-1111 and Trans Union at (312) 408-1050. The bureaus should provide instructions on how to read the report and how to dispute any inaccuracies it contains. Please note that every time your credit report is ordered, there are points deducted which could lower your overall score.

If your credit report is correct, take care of any outstanding delinquent obligations first. Lenders usually won't consider any borrower who has had a delinquent payment in the past year.

Private Mortgage Insurance (PMI)

Private mortgage insurance, or PMI, insures the lender against a default. It is required when the borrower is making a cash down payment of less than 20 percent of the purchase price.

PMI costs vary from one mortgage insurance firm to another, but premiums usually run about 0.50 percent of the loan amount for the first year of the loan. Most PMI premiums are a bit lower for subsequent years. The first year's mortgage insurance premium is usually paid in advance at the close of escrow, and there is usually a separate PMI approval process.

Lenders generally turn to a list of companies with whom they regularly work when lining up private mortgage insurance. In most cases, PMI can be dropped after the loan to value ratio drops below 80 percent. The Homeowners Protection Act requires PMI to be dropped when the loan-to-value ratio reaches 78 percent of the home's original value AND the loan closed after July 29, 1999. For other loans, find out from your lender what procedure to follow to have PMI removed when your equity reaches 20 percent. For homeowners who have improved their properties and believe that their equity has increased as a result of these improvements, refinancing the property at a loan-to-value ratio of 80 percent or less is another possible way of eliminating PMI payments.

A growing number of private lenders are loosening up their requirements for low-down-payment loans. But private mortgage insurance, or PMI, usually is required on loans with less than a 20 percent down payment.

How to Apply for a Mortgage Loan

Your chances of obtaining a mortgage really depend on all the information that will be contained in the credit report. So, it’s a good idea to get your credit report, before you apply for a mortgage, and correct errors. If there are any inaccuracies you don’t know about, this could cost you thousands of dollars in extra interest or even cause a denial of credit.

When you apply for a mortgage, the lender will want a lot of information about you (and, at some point, about the house you'll buy) to determine your loan eligibility. Here's what you'll need to provide:

  • The name and address of your bank, your account numbers, and statements for the past three months
  • Investment statements for the past three months
  • Pay stubs, W-2 withholding forms, or other proof of employment and income
  • Balance sheets and tax returns, if you're self-employed
  • Information on consumer debt (account numbers and amounts due)
  • You'll sign authorizations that allow the lender to verify your income and bank accounts, and to obtain a copy of your credit report. If you've already made an offer on a house or condo, you'll need to give the lender a purchase contract and a receipt for any good-faith deposit that you might have given the seller.

Once you apply, your lender will verify all the information you’ve provided. This is a loan approval process and it can take one to eight weeks, depending on the type of mortgage you choose and other factors that will affect your approval such as fulfillment of contract contingencies.

As your mortgage application is processed and finalized, your lender is required by law to give you several documents. Within three business days of applying for the loan, the lender must inform you of the mortgage's effective rate of interest, or annual percentage rate (APR). If relevant, the lender must also give you consumer information on adjustable rate mortgages. In addition, the lender is required to give you an itemized good-faith estimate of your closing costs and a government publication that explains those costs.

Since the home that you're purchasing will serve as collateral for the loan, the lender will order a market value appraisal of the property. The lender will not lend you more than a certain percentage of the value of the property. If your down payment will be less than 20 percent of the value of the property, your loan will require private mortgage insurance, and the lender will obtain insurer approval. If the lender has not already done so as part of a pre-approval process, it will verify your employment and bank accounts as well as obtain and evaluate your credit report.

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