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Different Types of Mortgage -
Fixed -ARM
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Mortgage Time Period 15-Year, 30-Year,
or a Biweekly Mortgage?
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Mortgage and Closing Cost
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Mortgage Pre-Qualification - How
Much Can You Afford?
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Mortgage Down Payment - Saving for
the Down Payment
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Mortgage and Credit History -
Your Credit History
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Mortgage Preparation - Getting Your
Finances in Order
General categories of loans
Most loans fall into three major categories: fixed-rate, adjustable-rate,
and hybrid loans that combine features of both.
- Fixed-rate mortgages
As the name implies, a fixed-rate mortgage carries the same interest
rate for the life of the loan. Traditionally, fixed-rate mortgages
have been the most popular choice among homeowners, because the fixed
monthly payment is easy to plan and budget for, and can help protect
against inflation. Fixed-rate mortgages are most common in 30-year and
15-year terms, but recently more lenders have begun offering 20-year
and 40-year loans.
- Adjustable-rate mortgages
(ARM)
Adjustable-rate mortgages differ from fixed-rate mortgages in that the
interest rate and monthly payment can change over the life of the
loan. This is because the interest rate for an ARM is tied to an index
(such as Treasury Securities) that may rise or fall over time. In
order to protect against dramatic increases in the rate, ARM loans
usually have caps that limit the rate from rising above a certain
amount between adjustments (i.e. no more than 2 percent a year), as
well as a ceiling on how much the rate can go up during the life of
the loan (i.e. no more than 6 percent). With these protections and low
introductory rates, ARM loans have become the most widely accepted
alternative to fixed-rate mortgages.
- Hybrid loans
Hybrid loans combine features of both fixed-rate and adjustable-rate
mortgages. Typically, a hybrid loan may start with a fixed-rate for a
certain length of time, and then later convert to an adjustable-rate
mortgage. However, be sure to check with your lender and find out how
much the rate may increase after the conversion, as some hybrid loans
do not have interest rate caps for the first adjustment period.
Other hybrid loans may start
with a fixed interest rate for several years, and then later change to
another (usually higher) fixed interest rate for the remainder of the
loan term. Lenders frequently charge a lower introductory interest rate
for hybrid loans vs. a traditional fixed-rate mortgage, which makes
hybrid loans attractive to homeowners who desire the stability of a
fixed-rate, but only plan to stay in their properties for a short time.
Balloon payments
A balloon payment refers to a loan that has a large, final payment due at
the end of the loan. For example, there are currently fixed-rate loans
which allow homeowners to make payments based on a 30-year loan, even
thought the entire balance of the loan may be due (the balloon payment)
after 7 years. As with some hybrid loans, balloon loans may be attractive
to homeowners who do not plan to stay in their house more than a short
period of time.
Time as a factor in your loan
choice
As has been discussed, the length of time you plan to own a property may
have a strong influence on the type of loan you choose. For example, if
you plan to stay in a home for 10 years or longer, a traditional
fixed-rate mortgage may be your best bet. But if you plan on owning a home
for a very short period (5 years or less), then the low introductory rate
of an adjustable-rate mortgage may make the most financial sense. In
general, ARMs have the lowest introductory interest rates, followed by
hybrid loans, and then traditional fixed-rate mortgages.
FHA and VA loans
U.S. government loan programs such as those of the Federal Housing
Authority (FHA) and Department of Veterans Affairs (VA) are designed to
promote home ownership for people who might not otherwise be able to
qualify for a conventional loan. Both FHA and VA loans have lower
qualifying ratios than conventional loans, and often require smaller or no
down payments.
Bear in mind, however, that FHA
and VA loans are not issued by the government; rather, the loans are made
by private lenders but insured by the U.S. government in case the borrower
defaults. Remember too, that while any U.S. citizen may apply for a FHA
loan, VA loans are only available to veterans or their spouses and certain
government employees.
Conventional loans
A conventional loan is simply a loan offered by a traditional private
lender. They may be fixed-rate, adjustable, hybrid or other types. While
conventional loans may be harder to qualify for than government-backed
loans, they often require less paperwork and typically do not have a
maximum allowable amount.
In the past, the
30-year, fixed-rate mortgage was the standard choice for most homebuyers.
Today, however, lenders offer a wide array of loan types in varying
lengths--including 15, 20, 30 and even 40-year mortgages.
Deciding what
length is best for you should be based on several factors including: your
purchasing power, your anticipated future income and how disciplined you
want to be about paying off the mortgage.
What are the
benefits of a shorter loan term?
Some homeowners choose fixed-rate loans that are less than 30 years in
order to save money by paying less interest over the life of the loan. For
example, a $100,000 loan at 8 percent interest comes with a monthly
payment of around $734 (excluding taxes and homeowner's insurance). Over
30 years, this adds up to $264,240. In other words, over the life of the
loan you would pay a whopping $164,240 just in interest.
With a 15-year
loan, however, the monthly payments on the same loan would be
approximately $956--for a total of $172,080. The monthly payments are more
than $200 more than they would be for a 30-year mortgage, but over the
life of the loan you would save more than $92,000.
What are the
advantages to a 30-year loan?
Despite the interest savings of a 15-year loan, they're not for everyone.
For one thing, the higher monthly payment might not allow some homeowners
to qualify for a house they could otherwise afford with the lower payments
of a 30-year mortgage. The lower monthly payment can also provide a
greater sense of security in the event your future earning power might
decrease.
Furthermore, with
a little bit of financial discipline, there are a variety of methods that
can help you pay off a 30-year loan faster with only a moderately higher
monthly payment. One such choice is the biweekly mortgage payment plan,
which is now offered by many lenders for both new and existing loans.
Biweekly
mortgages
As the name implies, biweekly mortgage payments are made every two weeks
instead of once a month--which over a year works out to the equivalent of
making one extra monthly payment (compared to a traditional payment plan).
One extra payment a year may not sound like much, but it can really add up
over time. In fact, switching from a traditional payment plan to a
biweekly mortgage can actually shorten the term of a 30-year loan by
several years and save you thousands in interest.
If you're
interested in a biweekly payment plan, make sure to check with your
lender. In many cases, lenders also offer direct payment services that
automatically withdraw funds from your bank account, saving you the
trouble of having to write and mail a check every two weeks.
Making extra
payments yourself--do it early!
Another way to pay off your loan more quickly is to simply include extra
funds with your monthly payment. Most lenders will allow you to make extra
payments towards the principal balance of your loan without penalty. This
is especially attractive to homebuyers who are concerned about their
future earning power, but still want to be aggressive about paying off
their loan.
For example, if
you had a 30-year loan, you might decide to send the equivalent of one or
two extra payments a year (which could shorten the overall length of the
loan by many years). But if your financial situation suddenly took a turn
for the worse, you could always fall back on the regular monthly payment.
One important
note, though, is that if you do decide to send extra funds, make sure to
do it EARLY in the life of the loan. This is because most home loans are
calculated in such a way that the first few years of payments are almost
entirely interest, while the last few years are mostly applied towards the
principal balance. Thus, you can get the most bang for your buck by making
the extra payments early in the life of the loan.
The fees associated with the
buying or selling of a home are called closing costs. Certain fees are
automatically assigned to either the buyer or the seller; other costs are
either negotiable or dictated by local custom.
Buyer closing costs
When a buyer applies for a loan, lenders are required to provide them with
a good-faith estimate of their closing costs. The fees vary according to
several factors, including the type of loan they applied for and the terms
of the purchase agreement. Likewise, some of the closing costs, especially
those associated with the loan application, are actually paid in advance.
Some typical buyer closing costs include:
- The down payment
- Loan fees (points, application
fee, credit report)
- Prepaid interest
- Inspection fees
- Appraisal
- Mortgage insurance
- Hazard insurance
- Title insurance
- Documentary stamps on the note
Seller closing costs
If the seller has not yet paid for the house in full, the seller's most
important closing cost is satisfying the remaining balance of their loan.
Before the date of closing, the escrow officer will contact the seller's
lender to verify the amount needed to close out the loan. Then, along with
any other fees, the original loan will be paid for at the closing before
the seller receives any proceeds from the sale. Other seller closing costs
can include:
- Transfer taxes
- Documentary Stamps on the Deed
- Title insurance
- Property taxes (prorated)
- Broker's fees
Negotiating Closing Costs
In addition to the sales price, buyers and sellers frequently include
closing costs in their negotiations. This can be for both major and minor
fees. For example, if a buyer is particularly nervous about the condition
of the plumbing, the seller may agree to pay for the house inspection.
Likewise, a buyer may want to
save on up-front expenditures, and so agree to pay the seller's full
asking price in return for the seller paying all the allowable closing
costs. There's no right or wrong way to negotiate closing costs; just be
sure all the terms are written down on the purchase agreement.
Prorations
At the closing, certain costs are often prorated (or distributed) between
buyer and seller. The most common prorations are for property taxes. This
is because property taxes are typically paid at the end of the year for
which they were assessed.
Thus, if a house is sold in June,
the sellers will have lived in the house for half the year, but the bill
for the taxes won't come due until the following year! To make this
situation more equitable, the taxes are prorated. In this example, the
sellers will credit the buyers for half the taxes at closing.
Understanding how much you can
afford is one of the most important rules of home buying. Depending on
your individual situation, your budget can affect everything from the
neighborhoods where you look, to the size of the house, and even what type
of financing you choose.
Bear in mind, however, that
lenders will look at more than just your income to determine the size of
the loan. Likewise, you may find that there are some creative financing
options that can help boost your purchasing power.
Loan prequalification vs.
preapproval
One of the best ways to determine your budget is to have your real estate
agent or lender prequalify you for a loan. Prequalification is different
from preapproval, because it is only an estimate of what you'll be
able to afford. On the other hand, preapproval is a more formal process
where a lender examines your finances and agrees in advance to loan you
money up to a specified amount.
What factors are important to
lenders?
Banks and lending institutions will use several criteria to determine how
much money they'll agree to lend. These include:
- Your gross monthly income
- Your credit history
- The amount of your outstanding
debts
- Your savings--or the amount of
money you have available for a down payment and closing costs
- Your choice of mortgage (i.e.
30-year, FHA, etc.)
- Current interest rates
Two important ratios
Lenders also use your financial information to figure out two, very
important ratios: the debt-to-income ratio and the housing expense ratio.
- Debt-to-income ratio
Many lenders use a rule of thumb that the amount of debt you are
paying on each month (car payment, student loan, credit card, etc,)
shouldn't exceed more than 36 percent of your gross monthly income.
FHA loans are slightly more lenient.
- Housing expense ratio
It is generally difficult to obtain a loan if the mortgage payment
will be more than 28 to 33 percent of your gross monthly income.
Down payments make a
difference
If you can make a large down payment, lenders may be more lenient with
their qualifying ratios. For example, a person with a 20 percent down
payment may be qualified with the 33 percent housing expense ratio, while
someone with a 5 percent down payment is held to the stricter 28 percent
ratio.
Other ways to improve your
purchasing power
- Gifts
If you're having trouble saving money, many lenders will allow you to
use gift funds for the down payment and closing costs. However, most
lenders require a "gift letter" stating the gift doesn't
have to be repaid, and will also require you to pay at least a portion
of the down payment with your own cash.
- Negotiating Closing Costs
Through negotiation, some sellers may agree to pay all or most of your
closing costs (for example, if you agree to meet their full asking
price). If you choose to try this, make sure to ask your real estate
agent for advice.
- Loan Programs
Many local governments have special loan programs designed to help
first-time homebuyers. Loans may be available at reduced interest
rates, or with little or no down payments. Check with your local
housing authority for more information.
- Loan Types
Some homebuyers choose Adjustable Rate Mortgages (ARMs) because of low
initial interest rates. Others opt for 30-year loans because they have
lower monthly payments than 15-year loans. There are significant
differences between different loans, so make sure to discuss the pros
and cons of different loans with your agent or lender before making a
decision
Saving funds for a down payment
should be part of an overall program to get your finances in order prior
to shopping for a home. This includes rounding up financial records,
examining your spending habits, and setting a budget you can live with.
Remember, too, that the down payment is not the only up-front expense. An
allowance for closing costs should also be included in your savings
budget.
How much is required?
The down payment is usually expressed as a percentage of the overall
purchase price of the home, and varies depending on the lender, the type
of financing and amount of money being lent. In the past, the typical down
payment was 20%, but in recent years lenders have been willing to offer
conventional financing with as little as 3% down. U.S. Government
financing programs, such as those offered by the Dept. of Veterans Affairs
(VA) or the Federal Housing Administration (FHA), also require minimal
down payments.
Private mortgage insurance
Typically, if your down payment is less than 20% of the purchase price,
lenders will require you to carry PMI, or private mortgage insurance. This
insurance protects the lender in case of loan default, and usually
involves an up-front payment at closing, as well as a monthly premium.
However, once you have paid off 20% of the loan, you can request the
policy be canceled. Some lenders cancel the premium automatically, while
others require you to make a request in writing.
Gifts
If you are having trouble saving enough money, many lenders will allow you
to use gift funds for the down payment--as well as for related closing
costs. The gift may come from family, friends or other sources, but
remember that lenders usually require a "gift letter" stating
the gift doesn't have to be repaid. In addition, some lenders will also
require you to pay at least a portion of the down payment with your own
cash. Thus, if you plan to use gift money to purchase your house, ask your
lender about their policies regarding gifts.
Earnest money
Buyers are usually required to deposit earnest money with the seller when
they make an offer. If the offer is accepted, the earnest money is then
credited towards the down payment. The amount varies widely depending on
the seller and local custom, but be prepared from the outset to have funds
earmarked for this purpose.
Don't forget closing costs
In addition to the down payment, you will also need to save for additional
fees associated with the loan. Known as closing costs, these charges cover
items such as title insurance, documentary stamps, loan origination fees,
the survey, attorney's fees, etc. When you submit your loan application,
lenders are required to supply you with a good faith estimate of your
closing costs.
Some buyers are surprised by the
amount of the closing costs, which can easily run into the thousands of
dollars. Remember, though, that closing costs can be negotiated with the
seller. For example, you may agree to pay the full asking price in
exchange for the seller paying all the allowable closing cost.
As part of the loan application
process, virtually all lenders will want to see a copy of your credit
report. The report will list all your long-term debts (credit cards,
mortgage payments, automobile and student loans, etc), as well as your
payment history. If you don't have a copy of your credit report, most
lenders will generally require you to pay for a copy when they process
your loan application.
However, most real estate experts
agree that it is a good idea to obtain a copy of your credit report
several months before you apply for a loan. This is so you have a chance
to resolve any problems with your credit before your bank sees it. U.S.
Federal law ensures that you have access to your credit report, which may
be obtained from your local credit bureau or any of several national firms
that specialize in credit reports.
Late payments
For most people, problems with their credit report are likely related to
late payments on a debt. If you were late one month in paying off your
credit card, but otherwise have a good payment history, chances are most
lenders won't be too concerned. But if you have a history of late payments
you'll need to document the reasons why. A slow payment history won't
necessarily get you turned down for a loan, but you may have to pay a
higher rate of interest or otherwise prove to the lender that you can
repay your loan in a timely fashion.
Errors on your credit report
Many people are surprised to learn that credit reports can often contains
errors or inaccurate information. If this is the case with your credit
report, you'll need to contact the reporting agency or creditor to have
the problem resolved. This can sometimes be a slow process, so make sure
to give yourself time to clear up the mistake.
Bankruptcies and foreclosures
There's no getting around it, a bankruptcy on your credit report is not a
good thing. But that doesn't mean you still can't obtain a loan. Even
though a bankruptcy may stay on your credit report for seven to ten years,
lenders will often consider the circumstances surrounding a bankruptcy
(family illness, injury, etc.). Moreover, if you have reestablished good
credit since the bankruptcy, a lender will be more inclined to approve
your application.
The crucial step in starting your
search for a new home is having a clear idea of your financial situation.
By getting a handle on your income, expenses and debts, you'll have a much
better idea of what you can afford and how much you'll need to borrow.
For lenders to verify this
information, though, they're going to need to look at your financial
records. It is also important to remember that you should include records
for each person who will be an owner of the house. So before you even
visit the bank, make sure you'll be able to provide copies of these
important documents:
- Paycheck Stubs
Remember that lenders are most interested in your average income. Not
only will they want to see this month's paycheck, but also how much
you've been making for the past two years. Steady employment is also
more attractive to lenders, so if you've been hopping from job to job,
be prepared to discuss the reasons why.
- Bank Statements
In order to qualify you for a loan, most lenders will also ask you for
copies of your bank statements. Ideally, they'd like to see a steady
history of savings--or at the very least, that you're not bouncing
checks every month.
- Tax Records
It's always a good idea to save copies of your tax returns, especially
if you're self-employed. If you own your own business, it's important
to note that lenders generally consider your income as the amount you
paid taxes on--not the gross income of the business.
- Dividends
& Investments
Lenders will usually consider long-term investment dividends, as well
as your investment portfolio, when evaluating your income.
- Alimony/Child Support
If you receive steady payments as part of a divorce settlement or for
child support, you can also include this as part of your gross income.
Just remember that lenders will want to see a copy of your
divorce/court settlement verifying the amount of the payments.
- Credit Report
Virtually every lender will want to see a copy of your credit report
as part of the loan application process. The report lists all of your
long-term debts, as well as your payment history. In general, they
will require you to pay for the credit report (approximately $50), but
if you have a recent copy, they may accept that instead.
Copyright © 2002-2005
OscNews.com All rights reserved. Revised:
July 30, 2006
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