What is a mortgage?
A Mortgage (also called a home loan) is a legal
contract made between a lender and a borrower that uses
property as collateral to secure the loan. The lender
can take possession of the property if the borrower
fails to pay the prearranged home loan payments.
What is a second mortgage?
A second mortgage is a type of mortgage refinancing that
allows you to acquire a second loan on your home in addition
to your first home loan.
What is a reverse mortgage?
Reverse mortgages are loans that allow homeowners to
transfer some of their home equity into cash. In contrast to
traditional home loan mortgages, reverse mortgages do not
require borrowers to repay their home loan until the
homeowner no longer lives primarily at that residence,
although he or she stills owns the residence.
What is a mortgage refinance?
Occurs when borrower uses the money from a refinanced
loan to pay off an existing home loan. Borrowers typically
do this to extend their home loan period, apply for a lower
interest rate, or to use some money out of their equity.
What is a home equity loan?
A home equity loan is a type of loan that allows a
homeowner to obtain cash loans based on the present value of
their property minus the mortgage amount still left to be
paid off. Homeowners often apply for home equity loans to
pay for expenses such as home remodeling, debt
consolidation, college education, and other long-term
investments.
What's the difference between a
fixed and adjustable rate mortgage?
With a fixed rate mortgage, the interest rate and the amount
you pay each month remain the same over the entire mortgage
term, traditionally 15 or 30 years. A number of variations
are available, including five- and seven-year fixed rate
loans with balloon payments at the end.
With an adjustable rate mortgage (ARM), the interest rate
fluctuates according to the interest rates in the economy.
Initial interest rates of ARMs are typically offered at a
discounted ("teaser") interest rate that is lower than the
rate for fixed rate mortgages. Over time, when initial
discounts are filtered out, ARM rates will fluctuate as
general interest rates go up and down. Different ARMs are
tied to different financial indexes, some of which fluctuate
up or down more quickly than others. To avoid constant and
drastic changes, ARMs typically regulate (cap) how much and
how often the interest rate and/or payments can change in a
year and over the life of the loan. A number of variations
are available for adjustable rate mortgages, including
hybrids that change from a fixed to an adjustable rate after
a period of years, or "option ARMs" that allow you to
choose, on a monthly basis, whether to pay a minimum amount,
an interest-only amount, an ordinary principal plus interest
amount, or an accelerated payment amount.
Which is better -- a fixed or
adjustable rate mortgage?
It depends. Because interest rates and mortgage options
change often, your choice of a fixed or adjustable rate
mortgage should depend on:
the interest rates and mortgage options available when
you're buying a house
your view of the future (generally, high inflation will mean
ARM rates will go up and lower inflation means that they
will fall)
your personal financial and investment goals, and
how willing you are to take a risk.
When mortgage rates are low, a fixed rate mortgage is the
best bet for many buyers. Over the next five, ten, or thirty
years, interest rates are more apt to go up than further
down. Even if rates could go a little lower in the short
run, an ARMs teaser rate will adjust up soon and you won't
gain much if you plan to stay in the house more than a few
years (the broker can tell you your break-even point). In
the long run, ARMs are likely to go up, meaning many buyers
will be best off locking in a favorable fixed rate now and
not taking the risk of much higher rates later.
Keep in mind that lenders not only lend money to purchase
homes; they also lend money to refinance homes. For example,
if you take out a fixed rate loan now, and several years
from now interest rates have dropped, refinancing will
probably be an option.
How do I find the least costly
mortgage? Does it make sense to pay more points for a lower
interest rate?
You can save real money if you carefully shop for a
mortgage. Everything else being equal, even a one-quarter
percentage point difference in interest rates can mean
savings of thousands of dollars over the life of a mortgage.
A popular option recently has been "interest-only" loans,
which allow you to pay only the interest amount each month
-- not any principal -- for the first ten years of the loan.
This can lower your initial monthly payments significantly,
allowing you to afford more house. Most interest-only loans
are adjustable, but it's possible to find fixed rate
interest-only loans too.
In addition to comparing interest rates, there are many
types of fees -- and fee amounts -- associated with getting
a mortgage, including loan application fees, credit check
fees, private mortgage insurance (if you're making a low
down payment), and points.
Points comprise the largest part of lender fees, so it's
important to understand how they work: One point is 1% of
the loan principal. Thus, your fee for borrowing $250,000 at
two points is $5,000. There is normally a direct
relationship between the number of points lenders charge and
the interest rates they quote for the same type of mortgage,
such as a fixed rate. The more points you pay, the lower
your rate of interest, and vice versa.
What kinds of government loans
are available to homebuyers?
Several federal, state, and local government financing
programs are available to homebuyers. The two main federal
programs are:
VA loans. U.S. Department of Veterans Affairs (VA) loans are
available to men and women who are now in the military and
to veterans with honorable discharges who meet specific
eligibility rules, most of which relate to length of
service. The VA doesn't make mortgage loans, but guarantees
part of the house loan you get from a bank, savings and
loan, or other private lender. If you default, the VA pays
the lender the amount guaranteed and you in turn will owe
the VA. This guarantee makes it easier for veterans to get
favorable loan terms with a low down payment. For more
information, check the VA's Website at www.va.gov or contact
a regional VA office for advice.
FHA loans. The Federal Housing Administration (FHA), an
agency of the Department of Housing and Urban Development
(HUD), insures loans made to all U.S. citizens, permanent
residents, and noncitizens with work permits who meet
financial qualification rules. Under its most popular
program, if the buyer defaults and the lender forecloses,
the FHA pays 100% of the amount insured. This loan insurance
lets qualified people buy affordable houses. The major
attraction of an FHA-insured loan is that it requires a low
down payment, usually about 3% to 5%. For more information
on FHA loan programs, contact a regional office of HUD or
check the FHA website at www.hud.gov.
Types of Loans
Thirty-Year Fixed Rate Mortgage
The traditional 30-year fixed-rate mortgage has a constant
interest rate and monthly payments that never change. This
may be a good choice if you plan to stay in your home for
seven years or longer. If you plan to move within seven
years, then adjustable-rate loans are usually cheaper. As a
rule of thumb, it may be harder to qualify for fixed-rate
loans than for adjustable rate loans. When interest rates
are low, fixed-rate loans are generally not that much more
expensive than adjustable-rate mortgages and may be a better
deal in the long run, because you can lock in the rate for
the life of your loan.
Fifteen-Year Fixed Rate Mortgage
This loan is fully amortized over a 15-year period and
features constant monthly payments. It offers all the
advantages of the 30-year loan, plus a lower interest
rate—and you'll own your home twice as fast. The
disadvantage is that, with a 15-year loan, you commit to a
higher monthly payment. Many borrowers opt for a 30-year
fixed-rate loan and voluntarily make larger payments that
will pay off their loan in 15 years. This approach is often
safer than committing to a higher monthly payment, since the
difference in interest rates isn't that great.
Hybrid ARM (3/1 ARM, 5/1 ARM, 7/1 ARM)
These increasingly popular ARMS—also called 3/1, 5/1 or
7/1—can offer the best of both worlds: lower interest rates
(like ARMs) and a fixed payment for a longer period of time
than most adjustable rate loans. For example, a "5/1 loan"
has a fixed monthly payment and interest for the first five
years and then turns into a traditional adjustable-rate
loan, based on then-current rates for the remaining 25
years. It's a good choice for people who expect to move (or
refinance) before or shortly after the adjustment occurs.
Adjustable Rate Mortgages (ARM)
When it comes to ARMs there's a basic rule to remember...the
longer you ask the lender to charge you a specific rate, the
more expensive the loan.
2/1 Buy Down Mortgage
The 2/1 Buy-Down Mortgage allows the borrower to qualify at
below market rates so they can borrow more. The initial
starting interest rate increases by 1% at the end of the
first year and adjusts again by another 1% at the end of the
second year. It then remains at a fixed interest rate for
the remainder of the loan term. Borrowers often refinance at
the end of the second year to obtain the best long-term
rates. However, keeping the loan in place even for three
full years or more will keep their average interest rate in
line with the original market conditions.
Annual ARM
This loan has a rate that is recalculated once a year.
Monthly ARM
With this loan, the interest rate is recalculated every
month. Compared to other options, the rate is usually lower
on this ARM because the lender is only committing to a rate
for a month at a time, so his vulnerability is significantly
reduced.
Negative Amortization (Neg. Am) Loan
This is a deferred-interest loan which is very powerful --
and the most misunderstood mortgage program because of its
many options. Basically, the lender allows the borrower to
make monthly payments that are less than the accruing
interest. Therefore, if the borrower chooses to make the
minimum monthly payment, the loan balance will increase by
the amount of interest not paid on the loan. The power of
this loan lies in the borrower's ability to choose between
making the full loan payment, or the minimum payment, or any
amount in between. If a borrower's income varies throughout
the year (due to commissions, bonuses, etc.), the borrower
can make a lower payment during the "lean times", and then
make higher payments when funds are readily available.
What is the difference between
conforming and large nonconforming loans?
The term "conforming," as opposed to "nonconforming," is
sometimes used to explain loans that offer terms and
conditions that follow the guidelines set forth by Fannie
Mae and Freddie Mac. These are the two private,
congressionally chartered companies that buy mortgage loans
from lenders, thereby ensuring that mortgage funds are
available at all times in all locations around the country.
The most important difference between a loan that conforms
to Fannie Mae/Freddie Mac guidelines and one that doesn't
fit its loan limit. Fannie Mae and Freddie Mac will purchase
loans only up to a certain loan limit (currently it is
$417,000).
If your loan amount will be for more than the conforming
loan limit, the interest rate on your mortgage may be higher
or you may have slightly different underwriting
requirements, particularly in regard to your required down
payment amount. Check with your lender about this if you are
taking out a large loan payment.
TIP: Nonconforming loans are sometimes called "jumbo loans."
How much do I need for a down
payment?
Most lenders offer financing programs that allow the
borrower to finance up to 100% of the sales price of a new
home. However, if no down payment is made, the borrower will
be required to pay for private mortgage insurance (PMI), see
question ten, below, for further information on PMI. If you
can afford to put more money toward a down payment, it will
reduce the amount of your monthly mortgage payments. Some
loans programs offer 3% down payments if you meet certain
income standards. The Veterans Administration (VA) and the
Rural Housing Service (RHS) also offer no-down-payment
loans.
The lender will want to know how much money you plan to put
down and the source of those funds. Sources you may draw
upon include savings, stocks and bonds, pension funds, real
estate holdings, life insurance policies, mutual funds, and
employee savings plans.
You may also use a gift of money from a family member that
need not be repaid. If you do this, you will need to present
a letter to your lender that states the amount of the gift,
is signed by the giver, and is notarized by a third party. A
gift letter "form" may be obtained from your lender.
You are also now allowed to withdraw up to $10,000 from both
traditional and Roth Individual Retirement Accounts (IRAs)
with no early withdrawal penalty, if used towards buying
your first home.
Under some mortgage programs, such as Fannie Mae's Community
Home Buyer's ProgramSM with the 3/2 Option, part of your
down payment may come from a grant from a nonprofit housing
provider in your community.
What is APR (Annual Percentage
Rate)?
Annual Percentage Rate (APR) factors interest plus
certain closing costs, any points and other finance charges
over the term of a loan. The APR must be disclosed to you
according to federal Truth-in-Lending laws within three
business days of when you apply for a loan, or prior to or
at closing for a refinance.
How do you calculate LTV or
loan-to-value ratio?
The loan-to-value (LTV) ratio of your home is calculated
by dividing the fair market value of your home by the amount
of your home loan.
What are points?
In the special vocabulary of mortgage lending, "points"
are a type of fee that lenders charge (the full term to
describe this fee is "discount points"). Simply put, a point
is a unit of measure that means 1% of the loan payment. So,
if you take out a $100,000 loan, one point equals $1,000.
Discount points represent additional money you can pay at
closing to the lender to get a lower interest rate on your
loan. Usually, for each point on a 30-year loan, your
interest rate is reduced by about 1/8th (or .125) of a
percentage point.
Tip: Usually, the longer you plan to stay in your home, the
more sense it makes to pay discount points.
What are closing costs?
On the day you actually buy your new home, in addition
to your down payment, the prepaid property tax and
homeowners insurance premiums, you'll need cash for various
fees associated with the purchase. These expenses are known
as closing costs and are paid by both buyers and sellers.
Some closing costs you pay up-front when you apply for a
mortgage loan. Those include money for a credit check on all
applicants and an appraisal on the property. Keep in mind
that even if you don't eventually receive the loan, that
money is not refundable.
Other closing costs are possible and should be considered
when evaluating your financial situation. These may include,
but are not limited to:
- Title insurance fee
- Survey charge
- Loan origination fee
- professional fees or escrow fees
- Document preparation fee
Points-up-front, (interest paid in return for a lower interest rate). Each point is one percent of the loan amount. Sometimes you can contract for the seller to pay your points.
How is pre-qualification
different from pre-approval?
Any reputable Mortgage Banker will "pre-qualify" you for
a mortgage before you start house hunting. This process
includes analyzing your income, assets, and present debt to
estimate what you may be able to afford on a house purchase.
Real estate brokers can also calculate the same sort of
informal estimate for you.
Obtaining mortgage "pre-approval" is another thing entirely.
It means that you have in hand a lender's written commitment
to put together a loan for you (subject to verification of
income and employment).
Pre-approval makes you a strong buyer, welcomed by sellers.
With most other purchases, sellers must tie the house up on
a contract while waiting to see if the would-be buyer can
really obtain financing.
Why do I need to check my
credit prior to purchasing a house?
Even if you're sure you have excellent credit, it's wise
to double-check at the outset. Straightening out any errors
or disputed items now will avoid troublesome holdups down
the road when you're waiting for mortgage approval.
You may see disputed items, in addition to errors caused by
a faulty Social Security number, a name similar to yours, or
a court ordered judgment you paid off that hasn't been
cleared from the public records. If such items appear, write
a letter to the appropriate credit bureau. Credit bureaus
are required to help you straighten things out in a
reasonable time (usually 30 days).
What is the Truth in Lending
Act?
The Truth in Lending Act is a federal law that was
enacted as part of the Consumer Protection Act. This law
requires lenders to reveal all information to the borrower
and detail all costs associated with the transaction.