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It is an important decision to make for you and your family. Whether you are buying a new home or refinancing an existing mortgage, taking out a home loan is never a small decision.
But, getting a home loan doesn’t have to be intimidating - especially when you understand the basics like options, features and costs of a home loan. Of course, your mortgage banker is available anytime to answer your questions and make the process a lot easier.
Here are some tips that could save you a lot of time, money and trouble.
Plan ahead. Establish good credit and save as much as you can for the down payment and closing costs.
Get pre-approved online before you start looking. Not only do real estate agents prefer working with pre-qualified buyers; you will have more negotiating power and an edge over homebuyers who are not pre-approved.
Set a budget and stick to it. Use an Online Calculator to help you determine a comfortable price range.
Know what you really want in a home. How long will you live there? Is your family growing? What are the schools like? How long is your commute? Consider every angle before diving in.
Make a reasonable offer. To determine a fair value on the home, ask your real estate agent for a comparative market analysis listing all the sales prices of other houses in the neighborhood.
Choose your loan (and your lender) carefully. For some tips, see the question in this section about comparing loans.
Consult with your lender before paying off debts. You may qualify even with your existing debt, especially if it frees up more cash for a down payment.
Keep your day job. If there is a career move in your future, make the move after your loan is approved. Lenders tend to favor a stable employment history.
Do not shift money around. A lender needs to verify all sources of funds. By leaving everything where it is, the process is a lot easier on everyone involved.
Do not add to your debt. If you increase your debt by financing a new car, boat, furniture or other large purchase, it could prevent you from qualifying.
Timing is everything. If you already own a home, you may need to sell your current home to qualify for a new one. If you are renting, simply time the move to the end of the lease. back to top
How much house you can afford depends on how much cash you can put down and how much a creditor will lend you. There are two rules of thumb:
The downpayment and closing costs - how much cash will you need? Generally speaking, the more money you put down, the lower your mortgage. You can put as little as 3% down, depending on the loan, but you'll have a higher interest rate. Furthermore, anything less than 20% down will require you to pay Private Mortgage Insurance (PMI) which protects the lender if you can't make the payments. Also, expect to pay 3% to 6% of the loan amount in closing costs. These are fees required to close the loan including points, insurance, inspections and title fees. To save on closing costs you may ask the seller to pay some of them, in which case the lender simply adds that amount to the price of the house and you finance them with the mortgage. A lender may also ask you to have two months' mortgage payments in savings when applying for a loan. The mortgage - how much can you borrow? A lender will look at your income and your existing debt when evaluating your loan application. They use two ratios as guidelines:
Lenders aren't inflexible, however. These are just guidelines. If you can make a large downpayment or if you've been paying rent that's close to the same amount as your proposed mortgage, the lender may bend a little. Use a mortgage calculator to see how you fit into these guidelines and to find out how much home you can afford. back to top
If you have a low, 30-year fixed interest rate you're in good shape. But if any of these Five Reasons applies to your situation, you may want to look into refinancing.
1. Decrease monthly payments.
If you can get a fixed rate that's lower than the one you currently have, you can lower your monthly payments.
2. Get cash out of your equity.
If you have enough equity you can get cash out by refinancing. Just decide how much you want to take out and increase the new loan by that amount. It's one way to release money for major expenditures like home improvements and college tuition.
3. Switch from an adjustable to a fixed rate.
If interest rates are increasing and you want the security of a fixed rate, or, if interest rates have fallen below your current rate you can refinance your adjustable loan to get the fixed rate you're looking for.
4. Consolidate debt.
You can refinance your mortgage to pay off debt, too. Simply increase the new loan amount by the amount you need and the lender will give you that cash to pay off creditors. You'll still owe the lender but at a much lower interest rate - and that interest is tax-deductible.
5. Pay off your mortgage sooner.
If you switch to a shorter term or a bi-weekly payment plan, you can pay off your home earlier and save in interest. And if your current interest rate is higher than the new rate, the difference in monthly payments may not be as big as you'd expect.
Is refinancing worth it?
Refinancing costs money. Like buying a new home, there are points and fees to consider. Usually it takes at least three years to recoup the costs of refinancing your loan, so if you don't plan to stay that long it isn't worth the money. But if your interest rate is high it may be smart to refinance to a lower interest rate, even if it is for the short term. If your mortgage has a prepayment penalty, this is another cost you will incur if you refinance.
Use the reasons above as a guideline and determine whether or not refinancing is the right thing to do. You can a refinance analysis calculator to help you decide. back to top
Here's what you can expect to pay when you refinance:
The 3-6 Percent Rule
Plan to pay between 3% and 6% of the amount of the new loan amount (if want cash-out, the loan amount will be larger). Yet some lenders offer no-cost refinancing in exchange for a higher rate.
Getting to the Points
Points play a big part in how much it'll cost to refinance - the more points you pay, the lower your interest rate. Points are a good idea if you're planning to stay in your home for a while, but if you'll be moving soon you should try to avoid paying points altogether.
Negotiate the Fees
Be aggressive and investigate the fees your lender is asking you to pay. You may not need an appraisal, or your loan-to-value may be such that you no longer need Private Mortgage Insurance. Sometimes if you refinance with your current lender they won't need a credit report. With a little research it's amazing how much you can save.
Here, we've explained the different loan refinancing fees.
Application Fee: This covers the initial costs of processing your loan application and checking your credit.
Appraisal Fee: An appraisal provides an estimate or opinion of your property's value.
Title Search and Title Insurance: A Title Search examines the public record to discover if any other party claims ownership of the property. Title Insurance covers you if any discrepancies arise in ownership. (A reissue of the title can save 70% over the cost of a new policy.)
Lender's Attorney's Review Fees: In any financial transaction of this scope, a lawyer's participation ensures that the lender isn't legally vulnerable. This fee is passed on to you.
Loan Origination Fees: This is the cost of evaluating and preparing a mortgage loan.
Points: These are basically finance charges you pay the lender. One point equals 1% of the loan amount (for example, one point on a $75,000 loan is $750). The total number of points a lender charges depends on market conditions and the loan's interest rate.
Prepayment Penalty: Some mortgages require the borrower to pay a penalty if the mortgage is paid off before a certain time. FHA and VA loans, issued by the government, are forbidden to charge prepayment penalties.
Miscellaneous: Other fees may include costs for a VA loan guarantee, FHA mortgage insurance, private mortgage insurance, credit checks, inspections and other fees and taxes.
How to Save Money Refinancing:
How do you decide which loan is best? These questions may help.
Discuss these with your lender so they can help you decide which loan would best suit you. back to top
This is the most common loan arrangement in the U.S. With a fixed-rate mortgage the loan's principal and interest are amortized, or spread out evenly, over the life of the loan, giving you a predictable monthly payment.
The upside is, if rates are low, you can lock in for as long as 30 years and protect yourself against rising rates. However, if rates fall you can't change your rate without refinancing the loan, and that could cost money.
The 30-year Fixed-Rate Mortgage, the most popular and easiest to qualify for, will give you the lowest payment. But you can also get a 20-, 15- and even a 10-year fixed-rate mortgage if you wish to save interest and pay your home off sooner. back to top
With Adjustable-Rate Mortgages (ARMs) interest rates are tied directly to the economy so your monthly payment could rise or fall. Because you're essentially sharing the market risks with the lender, you are compensated with an introductory rate that is lower than the going fixed rate.
How often does the interest rate change?
That depends on the loan. Changes can occur every six months, annually, once every three years or whenever the mortgage dictates.
How much can my rate change?
Your ARM will stipulate a percentage cap for each adjustment period, which means your interest may not increase beyond that percentage point. If the market holds steady, there may be no increase at all. You may even see your payment decrease if interest rates fall.
How are the changes determined?
Every ARM loan is tied to a financial market index, such as CDs, T-Bills or LIBOR rates. Your rate is determined by adding an additional percentage (known as a margin) to that index's rate. When the index rises or falls, your rate rises or falls with it.
Is there a limit to how much interest I'll be charged?
Yes. It's called a ceiling, or lifetime cap. This is a guarantee that your interest rate will never exceed a designated percentage. For instance, if your introductory rate was 5% and you have a lifetime rate cap of 6% (meaning that your interest rate can never increase more than 6% during the life of the loan) then your ceiling would be 11%.
What are the benefits of an ARM?
A few words of caution:
Negative Amortization -This happens when a lender allows you to make a payment that doesn't cover the cost of principal and interest. Watch for this. It may be used as a lure to get you into a home with the promise of low initial payments. Or, a lender may give you a payment cap instead of a rate cap. In this mortgage arrangement, if interest rates increase, your monthly payments could stay the same - but the higher interest will still be charged to your loan, adding to it instead of reducing it. Either way, if you find yourself with a negative amortization ARM, you'll be adding to your debt.
Discounted interest rates - Sometimes a lender will advertise an unusually low initial rate. This is a discounted rate, and it's essentially a marketing tool. If your ARM offers a discounted interest rate you are certain to see an increase at your next adjustment period, even if interest rates don't change. back to top
Administered by the Department of Veterans Affairs, these special loans make housing affordable for U.S. veterans. To qualify you must be a veteran, reservist, on active duty, or a surviving spouse of a veteran with 100% entitlement.
A VA loan is simply a fixed-rate mortgage with a very competitive interest rate. Qualified buyers can also use a VA loan to purchase a home with no money down, no cash reserves, no application fee and reduced closing costs. Some states allow a VA loan for refinancing as well.
Many lenders are approved to handle VA loans. Your VA regional office can tell you if you're qualified. back to top
FHA loans are designed to make housing more affordable for first-time homebuyers and those with low to moderate income.
Both fixed- and adjustable-rate FHA loans are available, and in most states, an FHA loan can be used for refinancing. The difference is, they're insured by the U.S. Department of Housing and Urban Development (HUD). With FHA Insurance, eligible buyers can put down as little as 3% of the FHA appraisal value or the purchase price, whichever is lower. Qualifying standards are not as strict and the rates are slightly better than with conventional loans.
Some adjustable-rate mortgages allow you to convert to a fixed rate at certain specified times. This mitigates some of the risk of fluctuating interest rates, but there will be a substantial fee to do it. And your new fixed rate may be higher than the going fixed rate.
This is an ARM that only adjusts once at five or seven years, then remains fixed for the duration of the loan. Not only will you benefit from a lower rate for the first few years, but the new fixed rate cannot increase by more than 6%. It may even be lower, depending on market conditions. Then again, you also run the risk of adjusting to a much higher rate.
Another ARM choice, the convertible loan offers a fixed rate for the first three, five or seven years, then switches to a traditional ARM that fluctuates with the market. If you strongly believe that interest rates will fall a convertible loan might be a smart move.
These short-term loans begin with low, fixed payments. Then, in five, seven or ten years a single large payment (balloon) for all remaining principal is due. While this saves money up front, coming up with a large payment at the end of the loan may be difficult. Some lenders will allow you to refinance that payment, but some won't, so be sure you know what you're getting into.
Graduated Payment Mortgage (GPM)
With a GPM you pay smaller payments that gradually increase and level off after about five years. Lower payments can make it possible for you to afford a bigger home, but they'll be interest-only payments, adding nothing to the principal. This could put you in a negative amortization situation. back to top
Short Term Mortgages
You don't have to finance your home for 30 years. Granted, the payments will be lower, but you'll be paying them longer. You could, instead, opt for a period of 20, 15 or even 10 years, pay your home off sooner and save in interest.
Furthermore, lenders offer much more attractive interest rates with short-term loans, so your payments may not be as much as you'd think.
The table below shows you the interest savings on a $100,000 loan at 5.375% interest:
|Term||Monthly Payment||Total Interest Accrued|
By paying $250.47 more a month on a 15-year mortgage, you'd save $55,770.54 in interest over a 30-year loan - and own the house in half the time. back to top
There are five factors that determine the ultimate cost of a mortgage.
The principal, or amount of the loan, is the total amount you borrow (the purchase price minus your down-payment).
The interest rate adds significantly to the cost of your mortgage. Fixed or adjustable, the interest paid at the end of the loan can exceed the original cost of the home itself. For instance, a $100,000 loan balance at 8.5% for 30 years will cost you $201,701.86 by the time the loan is retired.
The term of the loan is the length of time until the loan is paid off. A longer term means more interest and higher cost.
Points are interest paid on the loan and they're purely optional. You pay points at closing if you want to reduce the interest rate and make your monthly payments smaller. One point equals one percent of the loan amount.
Fees are paid to the lender at closing to cover the costs of preparing the mortgage. They can vary according to where you live and what type of loan you're securing.
While points and fees are not financed, they still contribute to the cost of the mortgage. back to top
What is Private Mortgage Insurance?
Private Mortgage Insurance, or PMI, is insurance purchased by the buyer to protect the lender in case the buyer defaults on the loan. PMI is generally applied when you put down less than 20% of the home's purchase price.
The reason is this:
With 20% down, you are considered a low risk. Even if you default the lender will probably come out ahead because they've only loaned 80% of the home's value and they can probably recoup at least that amount when they sell the foreclosed property.
But with 5% or 10% down, the lender has a lot more invested in the loan and if you default, they will almost surely lose money. This is why lenders require buyers to purchase PMI if they put down less than 20%. It's insurance that, no matter what happens, the lender will recoup its investment.
How does PMI increase your buying power?
In simplest terms, PMI allows you to put less money down, and the benefits are as follows:
What does PMI cost?
A Good Faith Estimate will be provided to you within a few days after we received your loan application. This disclosure will provide you with an estimate of your monthly PMI premium as well as the initial premium you'll need to pay at closing. Additionally, we will be providing you a disclosure on your rights (if applicable) to cancel the PMI. back to top
What type of loan is best for me?
If you've done some groundwork you should have a pretty good idea of what type of loan you need. But your lender may offer options you hadn't considered or even something you haven't yet heard about.
What will my closing costs be?
At closing, you'll be required to pay a number of fees such as transfer of title, origination and appraisal, attorney services, credit report, title insurance and inspections. Your lender is required to provide an estimate of these costs within a few days after your application is received, but you can always ask for an estimate sooner.
Will I be charged points?
Sometimes you'll have to pay points (one point = 1% of the loan amount) in order to get the interest rate the lender has quoted you. Before proceeding with your loan application find out if there are any points attached to your loan.
What items must be prepaid?
Some expenses, such as first year's property taxes and insurance, must be paid at closing. Your lender will let you know what's required.
How long will I be guaranteed the quoted interest rate?
This is called "locking in" a rate and most lenders provide this service. When you apply for your loan, the lender will lock in the agreed interest rate for an agreed period of time. But there may be a fee for this, so ask.
How long will it take to get approval?
It varies, so make sure you get an estimate of how long approval will take, especially if you have a deadline for closing on a new home.
Does the loan have a pre-payment penalty?
If you even think there's a possibility you may pay off your loan early (this includes refinancing) find out if there's a penalty for doing so.
Is there a call option attached?
A call option allows the lender to require you to pay off your loan balance before it's due. You don't want this, so make sure it's not in the contract. back to top
When preparing a loan, the lender will ask for substantial documentation. Here's a list of what is usually required.
If you receive rental income you'll need:
Debt Disclosure - Credit Cards, Loans and/or Current Mortgages
Loan Application for Home Purchase
Evidence of Funds for Downpayment
Preparing for Closing
Many things must be taken care of before you come to the closing meeting. Ask your lender for a list of your responsibilities so you can arrive fully prepared.
Set a Closing Date
When choosing a closing date give yourself time to gather all your information and free up any necessary funds. The lender will need time to prepare and deliver loan documents (usually 3-5 days), home inspections must be scheduled and if any repairs are needed allow enough time for them to be completed. Also, if your rate is locked in, make sure you close before the deadline so you'll be guaranteed the quoted interest rate.
Other Required Items
Your lender will provide you with a commitment letter that lists all the other documentation that's required at closing. The following are common examples.
A day or two before closing it's a good idea to take one last look at the home to make sure repairs have been made, there's no new damage, and anything meant to be sold with the property is still there. You can do this on your own or with your real estate agent.
One business day before closing your lender must allow you to review your
This is the final exact amount you'll owe at closing and it must be brought in the form of a certified or cashier's check. (A Closing Costs Checklist can help you keep track of these expenses.)
The Closing Meeting
The legal sale and purchase of your home happens at the closing meeting which is attended by the buyer (you), the loan officer, the seller and any real estate agents or attorneys involved. (In some areas, closing is done by an agent without a meeting.)
Examination and Signing of Documents
At the closing meeting, the closing agent will review the settlement sheet with you and the seller and ask you both to sign it. This is also when you'll present evidence of insurance and inspections and sign all other loan documents.
Payment of Closing Costs
Once all papers are signed and in order you'll hand over the check for closing costs (the downpayment is included in check) and the lender provides the remaining funds to purchase the house.
Transfer of Property
Congratulations! You now own your new home. After the meeting, the closing agent will record the mortgage and deed in your name with local government records and all funds will be disbursed.
During closing you'll sign stacks of important paperwork, including the following:
Closing costs vary according to lender, location and even from sale to sale. Some costs can be negotiated, reduced or even waived and some may be paid by the seller.
When you're doing your research, use this checklist to get a rough idea of what you'll pay at closing. The lender or closing agent will provide you with an exact total a day or two before closing.
Closing Costs Checklist
$______Loan origination fee
$______Survey of property
$______Prorated property taxes
$______Escrow account for and insurance
$______Other costs specified in purchase agreement
The Four "Cs" of Loan Approval
A lender will weigh your housing expenses and total debt against your monthly income to determine your ability to repay a loan.
Monthly Income - Your net monthly income. If you're self-employed or receive commissions or bonuses, the lender averages your monthly income over the last two years.
Housing Expenses - This is the monthly payment you'll have with the new loan, along with the monthly cost of insurance, property taxes and any homeowner's fees or other costs.
Total debt - Add up any current mortgages, credit card balances, child support or alimony payments, tuition, car loans or other installment loans that will take longer than 10 months to pay off and this is your total debt. If your monthly mortgage payment is less than 28% of your net monthly income, a lender will typically consider you qualified to repay the loan. That figure can even go as high as 36% depending on the buyer. For instance, many lenders will allow a first-time buyer's housing expenses to take up more of their income.
To find out what kind of credit risk you represent, your lender will investigate your:
A few late payments on a credit card may not hurt you all that much. But collections, repossessions, foreclosures and bankruptcies can be serious problems. If you have a good explanation you may still be able to repair your credit rating and get approval.
When you ask for a home loan, you're putting the home itself up as collateral. Naturally, the lender will want to know that the home is worth at least as much as the loan amount, which is why an inspection is required.
But they'll also want proof that you have the cash necessary for the downpayment and closing costs. They'll seek verification of funds from sources including bank accounts, stocks, bonds, mutual funds, the sale of an existing property or any gifts from family members that will not have to be repaid.
The way you conduct your financial transactions tells a lender a great deal about your fiscal character. If you take responsibility for your debts by paying your bills regularly and on-time, you will appear to have the integrity they're looking for in a borrower.
Other Compensating Factors
Many factors can sway a lender in your favor. The bottom line is that the lender wants to feel secure in loaning you money. Even if there are a few dings in your credit, if you appear to be a safe credit risk overall you should be confident your loan will be approved. back to top
There are three major decisions that a credit lender is empowered to make.
1. Loan Approval
Approval is often given with conditions, such as the sale of current property, that require documentation for final approval.
2. Loan Suspension
A loan is suspended when information is incomplete or questions remain unanswered in the loan application. The buyer must supply the needed information before a final decision can be made.
3. Loan Denial
There are a number of reasons why your loan may be denied, and you're entitled to know those reasons. If denial is based on your credit you're entitled to a free copy of that report. back to top
A Home Equity Loan works like a fixed-rate first mortgage in which all the funds are disbursed at closing and the loan is paid off in monthly installments.
Interest on both Home Equity Loans and Home Equity Lines of Credit may be tax-deductible. Consult with your tax advisor to see if you qualify. back to top