For many people, the mortgage/financial transaction is the most difficult part of the process, whether they're buying, selling or both. If you're buying a home, you'll need to:
- Understand the different mortgage types and which one might be the best for you
- Understand your credit and try to clean up any blemishes on your credit report
- Have your financial information ready (recent pay stubs and tax returns for the last three years)
- Make a list of your monthly expenses, including everything from your current mortgage or rent payment to your utilities, credit card payment, insurance, student loans and transportation expenses. Your lender may want to know these as part of your loan application and it will help you determine an affordable mortgage payment.
Pre-approved vs. pre-qualified:
These terms have been often confused. It is critical that you understand the difference and your price range before you make an offer on a home.
Pre-approval means an underwriter has reviewed your credit, income and assets as required by the program for which you are being approved, and agreed to lend the money provided the property is approved as well.
Pre-qualify means some other entity, perhaps a loan originator, has discussed your information with you and has estimated an amount or range in which you should be able to borrow. You may have even provided information to a loan originator. Originators and underwriters are not the same people.
How much do you need? Down payments can vary based on loan type or whether or not you qualify for a specific loan program. Prior to 1934, borrowers were required to have 20% of the price of the home as their down payment. In 1934, the government created the Federal Housing Administration (FHA) to provide low down payment, government-insured loans. The federal government also created Fannie Mae (Federal National Mortgage Administration) and Freddie Mac to provide liquidity and allow the expansion of the mortgage market by selling mortgage-backed securities to investors on the open market.
So what does all this mean for you? Current standard down payments are 5% or more for conventional loans (loans made under Fannie Mae and Freddie Mac limits), 3% or more for FHA and zero down payment for Veterans Administration (VA) loans. There is also a rural housing program zero down payment that allows for up to 2% financed closing costs. VA loans are specifically for veterans. Down payment requirements and specific loan products change periodically. First time buyer? Veteran? Low income? A good, reputable lender should be able to identify a program that may be targeted to help you.
Loan to Value
Lenders look at the Loan to Value (LTV) when underwriting loans. Loan to value is the percentage of the price of the home which is the loan. Example: home sales price is $300,000.00, your down payment is 10% (or $30,000) and your loan amount is $270,000.00. The LTV = 90% The LTV can also affect the interest rate you receive. The greater your down payment, the better risk you are as a borrower. Lenders often charge a higher interest rate for lower down payments. This is called risk-based pricing.
Your credit is more critical today than ever in the wake of the mortgage market meltdown. Lenders are unwilling to grant credit if there's a very high risk of you defaulting on your mortgage. Credit scores are created by data repositories using risk-based data. Everything on your report can be calculated in risk. The available scores range from 350 to 850. The score tells the lender what the chances are of you defaulting on the loan. The higher the score-the lower the risk.
Currently lenders of conventional loans are seeking borrowers with 680 or better scores. FHA does not have a minimum credit score requirement, but most lenders will not consider a borrower with a credit score below 580. FHA does not make loans, they insure loans. Your score drives your choice of rates. Currently lenders charge more for lower credit scores, even starting with scores below 740.
The three major credit reporting agencies (Equifax, Experian and TransUnion) jointly sponsor a website (www.annualcreditreport.com) where you can request a free credit report. Request a credit report and review it for any inaccuracies. There's information on www.annualcreditreport.com on how to dispute and correct an item on the report. However, use this report as a guideline. Your lender will pull a credit report as well. What is on the report they pull (and not a report you give them) will determine your score.
How does a bank decide how much you can borrow? Your income and debt will be analyzed. Debt ratio is a calculation of how much gross income you receive per month and all your monthly debt including house payment. You may be asked to provide proof (such as a pay stub) of stable, long-term income. Monthly debt is only those items typically on your credit report. Items like insurance, gas, utilities, day care and food are not included except on some special government programs. These calculations are not exact in many cases and other factors determine loan approvals and exceptions.
Underwriting is the process of analyzing the collected data on both the borrower and property and deciding if a loan can be made. Underwriters work for banks and investors of loans and have special training and designations. You are not a number, but a person with special situations. Each borrower is looked upon as their own potential.
Loan Limits in Housing
Fannie Mae & Freddie Mac
In 1938, Congress created Fannie Mae. Prior to this, lenders were only able to loan locally and their terms were typically 5 year balloons (short term loans) with 20% or more down payments. When the bank reached a limit on available money for mortgages the community would have obvious challenges. Fannie Mae became the national resource in which local banks could sell their loans and have new money to loan.
Freddie Mac was created as a second resource for loan sales nationally. To sell a loan to these entities, the bank would need to meet Fannie Mae or Freddy Mac established guidelines, which include maximum loan limits. These maximum loan limits are reviewed annually and may change based on national home values. The loan limits for FHA, Fannie Mae and Freddie Mac have recently been changed.
Loans greater in size than saleable to Fannie Mae or Freddie Mac are considered non-conforming or Jumbo loans. Yes there are investors loaning in this pool, but it is much smaller a group of investors and the price of these loans is usually higher.
So this means with new, higher conventional loan limits under FHA, Fannie Mae and Freddie Mac you can borrow higher amounts at a cheaper rate.
Loan types have been changing rapidly in recent years. Since July 2007 many loan types have vanished. Those loan types have been deemed higher risk and subject to potential losses by banks. There are many remaining programs and new opportunities will evolve. Here are some examples of common loan programs:
Fixed rate loan - Loans where the rate does not change during the life of the loan. They are typically available in 15, 20, 25, 30, 40 year amortizations.
Balloon loan - These loans are usually 30 year loans which have a fixed interest rate for a set period. At the end of the period they must be paid off by cash, refinance or selling the home or they may have a built in one time reset for the remainder of the term. Example: 5 year Balloon, fixed for 5 years and reset for 25 remaining years. Your loan will have a disclosure detailing the exact terms.
Fixed-rate mortgages are mortgages in which the interest rate you pay is fixed for an amount of time. The most common are 30 and 15 year fixed-rate mortgages but there are 10, 20, even 40 or 50 year fixed-rate mortgages. These loans are structured so that by the end of the loan, the amortized principal is paid in full. The interest rate and the monthly payment do not change during the life of the loan. Fixed-rate loans give you the security of always knowing what your payments will be because they are set for the life of the loan. If you plan to keep your home for 15 or even 30 years, a fixed-rate mortgage is the conservative way to go. You are protected from fluctuating interest rates.
Adjustable-rate mortgages (ARMs) - These are loans that reset (i.e. the interest rate will change) at specific intervals. They may change monthly, every 6 months, 1 year, 2 years, 3 years, 5 years, 7 years or 10 years. Typically any loan will have a different reset after the initial change, such as 5 years at the same rate and then adjusting every 12 months thereafter. It is critical that you understand the loan you obtain before you go to closing and it is best to clearly understand it at or before application.
How do adjustable loans work and how would I know what to expect?
All adjustable loans have basic components: Index, Margin, Caps and changes. Index: this is the moving component that drives the direction of your interest rate.
Indexes: are published in the Wall Street Journal. You can also see historical data on the major indexes at www.moneycafe.com. If the index you choose is not at this site, ask for help in getting the data from your lender.
Margin: is the amount added to the index to determine your next rate adjustment. This calculation is typically done 45 days prior to your adjustment, giving you time to prepare. The margin will not change during the life of your loan.
Caps: the ceiling or maximum amount your rate can move up or down each adjustment.
Interest-only ARMs are loans where for a pre-determined period of time, you pay only interest and do not pay down the principal on your loan. If you are not planning to stay in the home for a long period of time, this type of mortgage allows you to buy something you ordinarily couldn't afford. In a "hot" market or a "hot" neighborhood, you'll have low payments while your house appreciates in value and you can always pay an additional amount to go toward paying down the principal. But watch out: the day will come when you will need to pay down the principal. If you can't make combined interest and principal payments, you could lose the house. If your plan is to sell your house and the market conditions change so that you can't sell it for what you owe, you'll be in trouble.
Veterans Administration guarantees loans to veterans (VA loans). VA loans do not have mortgage insurance but a VA funding fee that can be financed over the 100% of the loan if meeting the guideline loan limits. Current loan limit zero down payment is $417,000.00. Visit www.homeloans.va.gov for more information.
Federal Housing Administration (FHA) loans are government insured loans that anyone can apply to receive. It currently offers 3% down payment opportunities and that 3% can be from gift funds. On October 1, 2008 this will change to 3.5% down payment. FHA loans were crafted first to help people with less available down payment money and sometimes lower credit scores or no established credit. FHA currently does not have minimum credit score requirement. However the banks that loan under this program can and do set their own minimum credit score standards.
Reverse Mortgages are exclusively for seniors age 62 or older. These are no-monthly-payment loans that tap the equity in your home. They provide income resources for home improvement, medical, general income or help with lifestyle needs. It's not subject to credit or income requirements and can be used to purchase a home.
When considering any loan make sure you understand all the conditions of the loan and how those conditions could change over the life of the loan. For most people, a home is their biggest investment and the key to accumulating wealth.
What's the right mortgage for me?
Confused by all the mortgage options and not sure which one is best for you? The chart below will help you decide, based on your expectations and what's important to you.
Time to Refinance?
Since refinancing usually comes with closing costs, appraisals and other fees, refinancing may not make financial sense until your new rate is lower, perhaps two percentage points or more, than your existing rate. Please see our "Consumer's Guide to Mortgage Refinancings" publication in our Resource Download Center for more information.
Where should I get a mortgage?
The choices are many: banks, credit unions, mortgage bankers and mortgage brokers. Do not assume because they are a business with a business license or a large bank that they have all the expertise you need. Shop around, interview your prospective lender. Realize it is not always about the cheapest deal but the quality of service, integrity, knowledge, competency and most suitable program for you. Is your lender really looking at you as an individual?
To find the right program and product in a sea of choices, find a professional who is familiar with the many programs. Whenever possible get a personal referral.
Questions to ask when interviewing a lender and their representative, the loan originator:
- Are you licensed individually? (However, employees of federally-chartered lenders are not required to be licensed. See the "Licensing" section below.)
- What programs do you offer? Do you have government lending, FHA and VA loans? (The more programs they offer, the better you will be served with the best options for your specific needs.)
- When you quote an interest rate, can that rate be locked in and for what time frame (for example, 15 days, 30 days, etc.)? If a quoted rate is for 15 days and your loan cannot close for 30 days, the quote is of no value.
- When will you provide a good faith estimate of fees? Can you explain all the costs? Good faith estimates by law must be provided within 3 days of application. However, it is more important to get it immediately at application and prior to agreeing to work with a lender.
- Will my loan application be processed locally and if not what is the processing time? This can impact the time line it takes to complete your process. If you have time line requirements, this may be critical to your selection of a lender.
- How long is typical for your process?
- How did you arrive at the interest rate you quoted?
- What are interest rates based on? This answer should be the mortgage bond market. 30 year fixed is the 30 year bond. If the lender says other, they will not be watching the correct indicator.
- If an ARM, explain the details: index, margin, caps and worst case scenarios.
- Will there be mortgage insurance?
- Do you have references of satisfied clients?
If the loan originator cannot answer these questions, it might be a good idea to consider another lender.
A state law was passed in 2006 (and implemented in 2007) to license professional loan originators who worked at mortgage companies. This was a great event for consumers and professional mortgage brokers. You can check on-line at www.dfi.wa.gov to find out if your professional is so licensed. Licensed means the individuals background has been investigated for any illegal activity and the must pass a state test and have annual class hours. Certain entities under current law have not been included in this licensing. If your consultant works for a federally-chartered bank, they are exempt. If they work for under a consumer loan license they are exempt. You may want to ask more questions if they do not have a license