All About Finance
Financing a home can be confusing and frustrating. Here are the most commonly asked questions and answers about home financing.

What is a mortgage, and what are the benefits of different kinds of mortgages?

Simply put, a mortgage is a loan that a home buyer obtains directly from a lender to purchase real estate. The mortgage is a lien on the property that secures a promissory note (promise to repay the debt) that states the terms of the loan, including the interest rate, and the number of payments.
The most popular mortgages available to home buyers today can be divided into two general categories: those which offer fixed interest rates and monthly payments, and those where one or both of those factors are adjustable.

Fixed rate/fixed payment loans are more traditional, and remain the most popular home financing method, currently accounting for about two-thirds of all residential mortgages. Their advantages are well-known: You always know what your monthly principal and interest payment will be, so your basic housing cost will remain unaffected by interest rate changes until the mortgage is paid off.

Mortgages that entail flexible rates and/or payments have grown in popularity in recent years, primarily during periods of high interest rates and/or rapidly rising home prices. Many, including the popular ARMs (Adjustable Rate Mortgages), offer lower-than-market initial interest rates that allow buyers a measure of affordability unavailable in fixed-rate loans. The tradeoff may be higher interest rates and higher monthly payments later on.

Are there any mortgages especially designed for first-time buyers?

Today, first-time buyers enjoy a number of mortgage options that make purchasing a home more affordable by minimizing down payments and keeping monthly payments as low as possible during the early years of the loan.
Most ARMs feature an interest rate that is below market for the first year, and may only rise gradually after that.

VA and FHA-insured loans call for extremely low down payments (0-5% of the purchase price), and often offer a below market interest rate. Similarly favorable terms can also be arranged with the help of private mortgage insurance.

Finally, first-timers who can find a cooperative seller or third-party investor can look into such non-traditional financing methods as a lease/buy arrangement.

Can I get an FHA or VA mortgage?

Just about anyone can apply for an FHA-insured mortgage through banks and other lending institutions. They are particularly well-suited for buyers of moderate income; the low down payments requirements (as low as 5% of the purchase price) are matched by a relatively low maximum mortgage amount.
Similarly, VA-guaranteed loans often require no down payment for up to four times the amount guaranteed by the VA. These loans are reserved for either active military personnel or veterans, or spouses of veterans who died of service-related injuries.

If there is a downside to these loans, it's the qualifying process. Though you apply for government-insured financing through a lending institution, the Federal Housing Administration or the Department of Veterans Affairs must insure or guarantee the loan and may require specific documentation or procedures not necessarily required for conventional financing. That may take more time than is generally required for conventional mortgage approval. Additionally, FHA-required insurance must be added to your payment.

How much of a down payment will I need to buy a home?

The amount of money that a buyer must put down at closing depends on the loan-to-value ratio -- the percentage of the property's appraised value or sales price (whichever is less) that a lender is willing to loan.
For example, if a property is appraised at $100,000 and the loan-to-value ratio is 90%, the lender would be willing to loan $90,000. The buyer's down payment is the remaining $10,000. Because the loan-to-value is a percentage, the higher the sales price of a house, the higher the down payment.

How does a lender determine the maximum mortgage I can afford?

The three primary areas lenders examine in determining the size of mortgage you can handle include your monthly income, non-housing expenses, and cash available for down payment, moving expenses and closing costs.
The most common way lenders interpret these variables to estimate your mortgage capacity is the Percentage Method. Most lenders feel a family should spend no more than 28% of its income on housing costs, including the mortgage, insurance, and real estate taxes. Also, these housing costs plus your long-term debts (car loans, child support, minimum credit card payments, student loans, etc.) shouldn't exceed 36% of your income. Some mortgage companies, including Cendant Mortgage, have relaxed ratios to help you purchase the home of your dreams.

Although this is not a true method, you can use the Multiplier Method formula as a general rule of thumb to determine how much home you can afford. Most lender's guidelines allow a family to carry a mortgage that is two to three times its gross annual income (income before taxes and expenses are taken out). The amount of down payment and the type of mortgage (fixed or variable rate) will determine the precise ratio used by the lender.

What are the steps involved in the loan process?

When you apply for a mortgage, you will need to furnish information regarding your income, expenses and obligations. It will be very helpful and a time-saver, if you have the following items available:
Most recent two pay stubs
W-2's for the last two years
Last two months' bank statements
Long-term debt information (credit cards, child support, auto loans, installment debt, etc.)
 

What are typical closing costs?

You can expect to pay the following closing costs at the time of settlement:
Appraisal fee - covers the cost of a professional written estimate of the property's value.
Attorney's or escrow fees - your own, and the lender's if they have one.
Credit report fee.
Points.
Documentation preparation - covers the cost of preparing the deed and other paperwork.
First-year's premium on fire and hazard insurance.
Impounds - sufficient to cover real estate taxes on the purchased property for the current tax period to date. The lender then pays these bills when they come due.
Interest - paid from the date of closing until 30 days before your first monthly payment.
Title insurance.
Mortgage insurance if required.
Origination fee - covers the lender's administrative costs.
Recording fees.
FHA mortgage insurance (FHA loans only).
VA guarantee fees (VA loans only).

What are points, and what's the point in paying them?

In real estate, the term "point" refers to 1% of the total mortgage loan amount. Buyers often pay lenders a supplemental fee, calculated in points, to get a better interest rate on a particular mortgage.
For instance, a lender may offer you a choice of two 30-year mortgages: the first at 8% with no points, and the second at 7-1/2% with an additional three points. If the loan is for $100,000, those three points will cost you an extra $3,000 up front - but you'll get a payback of significantly lower monthly payments for the lifetime of the loan.

Many lenders will advise you to pay the points for the better rate if you can afford it, especially if you plan on keeping the home for more than a few years. Like interest, the money you pay for points may be tax-deductible, and the investment may pay for itself through savings generated by lower monthly payments. We suggest you call your tax preparer.

Is the lending process regulated by the government?

Most definitely. There are many laws and government regulations that all lenders must follow to ensure that all applicants are given fair and equal treatment. For example, in 1968, Congress passed the Truth in Lending Law, which requires that lenders provide borrowers with information about a loan's true interest rate. By law, lenders must reveal a loan's annual percentage rate (APR).
The law also stipulates that for refinancing and second mortgage loans, the borrower has up to three days after closing to change his or her mind and call the deal off. The lender may not disburse money until after the three-day recession period has passed.

What is APR, and how is it calculated?

The annual percentage rate is a calculated rate of interest for a loan over its projected life. This rate includes the interest, all points (which are considered prepaid interest), mortgage insurance, and other charges associated with making the loan that the lender collects from the borrower.
The APR is calculated by a standard formula that all lenders use. This enables the borrower to comparison shop between lenders and/or loan products.

What is a good faith estimate?

Your lender or loan agent must provide you with a good-faith estimate within three days of your application. This is the information you need to make a fair and accurate judgment when shopping for a loan.
Your estimate is a written document that shows all the costs that can be estimated in advance by the lender. You need this information so there are no surprises on the day you close your sale on the property to be purchased. You will be expected to pay closing costs.

What does my monthly mortgage payment include?

The bulk of your monthly mortgage payment goes toward paying off the principal and interest of your loan. In addition, most lenders require that you pay a sufficient amount to cover your local real estate tax, plus your homeowner's or hazard insurance. This amount is placed in an escrow account, from which your lender then pays your tax and insurance bills as they come due.

Can I pay off my loan early?

If you can afford it, and are interested in the considerable advantages of having more equity and/or owning your home free and clear at the earliest possible date, the answer in most cases is yes. The FHA, VA, and even some states do not allow lenders to charge penalties for paying mortgages early or refinancing. In fact, many lenders now include space on monthly statements for borrowers to itemize an additional principal payment they wish to include with their regular payment.

If you're unsure about the rules governing pre-payment, review your loan agreement.

What are the respective advantages of 15-year and 30-year loans?

The 30-year fixed rate mortgage remains the standard mortgage, with an array of valuable benefits designed especially for buyers who expect to stay in their homes for a long time. Because the borrower pays more interest than principal for the first 23 years, the tax deduction is substantial. And as inflation causes income and living expenses to increase, your unchanging monthly mortgage payments account for a relatively smaller portion of income as the years go by.
As you'd expect, a 15-year monthly mortgage means higher monthly payments than an equivalent 30-year loan...but not as much higher as you may think. At the same rate of interest, payments on the 15-year mortgage are roughly 20-25% higher than a loan that takes twice as long to pay off. And one of the benefits of choosing a 15-year mortgage is that you can generally get a lower interest rate for an otherwise similar loan. Another advantage is faster equity build-up because a larger portion of your early payments are going to pay off principal. This makes the 15-year mortgage an ideal alternative for couples approaching retirement or anyone else interested in owning their home free and clear as quickly as possible. Visit our Cendant Mortgage area for more information.

Do adjustable rate mortgages offer any protection against rising rates?

Yes. ARMs and other variable rate of payment plans offer lower-than-market interest rates initially, but because they are tied to the interest rates of U.S. Treasury Bills or other indexes, interest rates later in the loan term may rise. However, many such loans offer built-in safeguards designed to minimize the effect of any rapid escalation in interest rates.
One such safeguard is the rate cap. Many ARMs include provisions for the maximum amount your rate can rise, both annually and over the life of the loan. For example, if your initial rate is 6.5%, the loan may include 1% annual and 5% lifetime caps...which means even if rates rise dramatically, you'll pay no more than 7.5% next year, 8.5% the following year and so on until a maximum rate of 11.5% is reached.

ARMs may also allow your rate to decrease when the index it is tied to goes down. As you might expect, decreases are usually capped as well.

A second protective device included in some ARMs is the payment cap. Under this provision, your monthly payments may rise by only a set dollar amount. The potential disadvantage of this type of cap is that it can slow or even reverse your equity build-up. If rates rise dramatically, you could actually wind up owing more principal at the end of the year than you did at the beginning.

Of course, ARM holders can also consider refinancing to a fixed rate loan after a few years. Some ARMs even include a provision for converting to a fixed rate after a set period of time.

What can I do if I have a fixed rate loan, and interest rates go down?

When interest rates drop significantly as they have in recent times, the homeowner should investigate the financial advantages of refinancing. Essentially, this means taking out a new loan to pay off your existing loan.
Refinancing may require paying many of the same fees paid at the original closing, plus origination fees. Most mortgage experts agree that if you can get a rate 2% less than your existing loan, and you plan on staying in your home for at least 18 months, refinancing is a good investment.

What is the difference between pre-qualifying and pre-approval?

A pre-qualification consists of a discussion between you and a loan officer. The loan officer will collect information regarding your income, monthly debts, credit history and assets, and based on this information calculates an estimated mortgage amount for which you qualify. The pre-qualification is not a mortgage approval, but more an estimate on what you can afford.
A pre-approval, on the other hand, is a more comprehensive approach giving an actual decision on a home loan.

What could be more comforting than the peace of mind that goes with knowing that your mortgage is fully approved?

You will have a greatly improved negotiating position when you are pre-approved for a mortgage. Sellers are more apt to negotiate with someone who already has a mortgage approval in hand. The pre-approval letter lets the seller know they are working with a serious cash buyer. A pre-approved buyer can also close on a property more quickly---another major consideration for a motivated seller. I strongly recommend it.

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