Guide to Mortgage Finance: Mortgage Rates, Types, Loans, and Equity
Generally speaking, a mortgage is a loan obtained to purchase real estate. The "mortgage" itself is a legal claim on the home or property that secures the promise to pay the debt. All mortgages have two features in common: principal and interest. The loan to value ratio (LTV) is the amount of money you borrow compared with the price or appraised value of the home you are purchasing. Each loan has a specific LTV limit. For example: with a 95% LTV loan on a home priced at $50,000, you could borrow up to $47,500 (95% of $50,000), and would have to pay $2,500 as a down payment. The LTV ratio reflects the amount of equity borrowers have in their homes. The higher the LTV ratio, the less cash homebuyers are required to pay out of their own funds. So, to protect lenders against potential loss in case of default, higher LTV loans (80% or more) usually require a mortgage insurance policy.
[ Top ]
Types of mortgages
Fixed rate, Flexible rate, Interest Only - all of the different types of home loans that are available these days can puzzle and confuse new homebuyers. But mortgage experts say that virtually every home loan is one of two general types: Repayment Mortgages and Interest Only Mortgages. Repayment Mortgage is the old fashioned, traditional type of mortgage and remains the only way the property is actually guaranteed to be yours at the end of the mortgage term - provided you have repaid the loan. Your mortgage debt is divided into principal repayments (repayment of the money you borrowed) and interest payments (repayment of the interest you're being charged for the loan). As you pay off your mortgage every month you're paying off a bit of principal and a bit of interest until the full debt is repaid. You usually pay off mostly interest in the early years and then gradually more of the capital debt. It may seem as if this is costing more but that's because unlike the other types of mortgages you're paying off the capital and not just the interest.
Interest Only Mortgage is an arrangement where you're only paying off the interest on the loan.
None of your capital debt is being repaid directly. This is supposed to have been repaid by the end of the mortgage term by your having made simultaneous monthly payments into an investment fund. The idea here is that this fund has hopefully grown enough to pay off the capital and leave you with a surplus. To do this your mortgage advisor may offer you an investment "side" or "by product", which they'll claim to be a suitable type of investment to pay off the capital part of the mortgage. You should be very clear that if the investment is not a success then you could lose your home - probably at the end of the mortgage term.
Home loans are further divided into a fixed rate loan and a flexible rate loan . Before you start looking for a home, make sure you understand the pros and cons of each type of loan. Here are the basics you need to know.
[ Top ]
Fixed Rate Mortgages:
Payments remain the same for the life of the loan, which is usually 15 or 30 years. 15-year loan is commonly made at a lower interest rate. Equity is built faster because early payments pay more principal. 30-Year loans guarantee that in the first 23 years of the loan, more interest is paid off than principal, meaning larger tax deductions. As inflation and costs of living increase, mortgage payments become a smaller part of overall expenses. With most fixed rate mortgages, your monthly principal and interest payment will not change for the term of the loan, regardless of whether interest rates rise or fall. In exchange for that stability, you may have a higher interest rate than you would with an adjustable rate loan. Fixed rate loans are available with different length terms and usually, the longer the term, the lower your monthly principal and interest payment will be.
[ Top ]
Offers very low rates for an initial period of time (usually 5, 7, or 10 years); when time has elapsed, the balance is due or refinanced (though not automatically)
[ Top ]
Interest rate adjusts only once and remains the same for the life of the loan.
[ Top ]
Flexible rate, also known as ARMS (Adjustable Rate Mortgages) are linked to a specific index. They generally offer lower initial interest rates as well as lower monthly payments. ARMS may allow borrower to qualify for a larger loan amount. An ARM may make sense if you are confident that your income will increase steadily over the years or if you anticipate a move in the near future and aren't concerned about potential increases in interest rates. Many people who choose adjustable rate mortgages also qualify for fixed rate loans. With most adjustable rate mortgages, your interest rate is fixed for a set period of time and then begins to adjust for the rest of the loan's term.
[ Top ]
A reverse mortgage is a home loan that you do not have to pay back for as long as you live in your home. It can be paid to you in one lump sum, as a regular monthly income, or at the times and in the amounts you want. The loan and interest are repaid only when you sell your home, permanently move away, or die. This option is geared towards older citizens, as you have to be at least 62 years old to be eligible for a Reverse Mortgage. One of the owners must live in the house most of the year. Reverse Mortgage is given for single family, one-unit dwellings or two-to-four unit, owner-occupied dwelling as well as some condominiums, planned unit developments or manufactured homes.
NOTE: Cooperatives and most mobile homes are not eligible. Most RM's require no repayment for as long as you live in your home. They are repaid in full when the last living borrower dies, sells the home, or permanently moves away. Because you make no monthly payments, the amount you owe grows larger over time. By law, you can never owe more than your home's value at the time the loan is repaid. You continue to own the home, so you must pay the property taxes, insurance, and repairs. If you fail to pay these, the lender can use the loan to make payments or require you to pay the loan in full. Reverse mortgages can be paid to in cash, all at once, or as a monthly income or credit line. The amount you get usually depends on your age, your home's value and location, and the cost of the loan. The greatest amounts typically go to the oldest owners living in the most expensive homes getting loans with the lowest costs.
Mortgage professionals suggest you keep a few key tips in mind when navigating the various mortgage product choices. People looking for a home tend to focus on finding it before they think about what kind of mortgage they'll get. That could be a mistake, as mortgage professional can tell homebuyers how much they can afford before they start shopping. That can save both time and heartache by making sure that homebuyers don't fall in love with a house they can't afford.
[ Top ]
The costs for loans from banks and mortgage companies usually include the following:
Monthly service fee
A home loan often involves many fees, such as loan origination or underwriting fees, broker fees, and transaction, settlement and closing costs. Every lender or broker should be able to give you an estimate of their fees. Many of these fees are negotiable. Some fees are paid when you apply for a loan, and others are paid at closing. In some cases, you can borrow the money needed to pay these fees, but doing so will increase your loan amount and total costs. "No cost" loans are sometimes available, but they usually involve higher rates. Ask what each fee includes. Several items may be lumped into one fee.
Ask each lender and broker for a list of its current mortgage interest rates and whether the rates being quoted are the lowest for that day or week. Ask whether the rate is fixed or adjustable. Keep in mind that when interest rates for adjustable-rate loans go up, generally so does the monthly payment. If the rate quoted is for an adjustable-rate loan, ask how your rate and loan payment will vary, including whether your loan payment will be reduced when rates go down.
Ask about the loan's annual percentage rate (APR). The APR takes into account not only the interest rate but also points, broker fees, and certain other credit charges that you may be required to pay, expressed as a yearly rate.
[ Top ]
The amount of money a buyer needs to put down on a home is one of the most misunderstood concepts in home buying. Some people think they need to make a down payment of 50 percent of the home's price, but most loans are based on a 20 percent down payment. There are mortgage options now available that only require a down payment of 5% or less of the purchase price. If a 20 percent down payment is not made, lenders usually require the home buyer to purchase private mortgage insurance (PMI) to protect the lender in case the home buyer fails to pay. Ask about the lender's requirements for a down payment, including what you need to do to verify that funds for your down payment are available. Make sure to ask if PMI is required for your loan, and also find out what the total cost of the insurance will be.
Ask how much your monthly payment will be when including the PMI premium. Ask how long you will be required to carry PMI. When considering the size of your down payment, consider that you'll also need money for closing costs, moving expenses, and possibly repairs and decorating. But also keep in mind that the larger the down payment, the less you have to borrow, and the more equity you'll have. The monthly mortgage payment mainly pays off principal and interest. But most lenders also include local real estate taxes, homeowner's insurance, and mortgage insurance. By sending extra money each month or making an extra payment at the end of the year, you can accelerate the process of paying off the loan. When you send extra money, be sure to indicate that the excess payment is to be applied to the principal. Most lenders allow loan prepayment, though you may have to pay a prepayment penalty to do so.
[ Top ]
When choosing a mortgage, always check the amortization schedule. How long will it take to own the home? Understand negative amortization. Some home loans offer attractive monthly mortgage payments but at times those low payments don't cover the interest portion of the loan. When that happens, part of the principal amount is deducted, resulting in what lenders call "negative amortization." Simply put, it means you are losing equity in your home.
Get expert help. With so many options, the lending process can mystify anyone. Lending professionals, such as qualified lenders or mortgage brokers can help you review your options so that you can select the right mortgage product based on your financial situation and long-term goals.
[ Top ]
A lower interest rate allows you to borrow more money than a high rate with the same monthly payment. Interest rates can fluctuate as you shop for a loan, so ask lenders if they offer a rate "lock-in" which guarantees a specific interest rate for a certain period of time. Remember that a lender must disclose the Annual Percentage Rate (APR) of a loan to you. The APR shows the cost of a mortgage loan by expressing it in terms of a yearly interest rate. It is generally higher than the interest rate because it also includes the cost of points, mortgage and other fees included in the loan. If interest rates drop significantly, you may want to investigate refinancing. Most experts agree that if you plan to be in your house for at least 18 months and you can get a rate 2% less than your current one, refinancing is smart. Refinancing may, however, involve paying many of the same fees paid at the original closing, plus origination and application fees.
[ Top ]
Discount points allow you to lower your interest rate. They are essentially prepaid interest, with each point equaling 1% of the total loan amount. Generally, for each point paid on a 30-year mortgage, the interest rate is reduced by 1/8 (or.125) of a percentage point. When shopping for loans, ask lenders for an interest rate with 0 points and then see how much the rate decreases with each point paid. Discount points are smart if you plan to stay in a home for some time since they can lower the monthly loan payment. Points are tax deductible when you purchase a home and you may be able to negotiate for the seller to pay for some of them.
Established by your lender, an escrow account is a place to set aside a portion of your monthly mortgage payment to cover annual charges for homeowner's insurance, mortgage insurance and property taxes. Escrow accounts are a good idea because they assure money will always be available for these payments. If you use an escrow account to pay property taxes or homeowner's insurance, make sure you are not penalized for late payments since it is the lender's responsibility to make those payments.
[ Top ]
Obtain Information from Several Lenders (Shop Around!)
Home loans are available from several types of lenders: commercial banks, mortgage companies, and credit unions. Different lenders may quote you different prices, so you should contact several lenders to make sure you're getting the best price. You can also get a home loan through a mortgage broker. Brokers arrange transactions rather than lending money directly; in other words, they find a lender for you. A broker's access to several lenders can mean a wider selection of loan products and terms from which you can choose. Brokers will generally contact several lenders regarding your application, but they are not obligated to find the best deal for you unless they are bound by contract to act as your agents. Consequently, you should consider contacting more than one broker, just as you should with banks or thrift institutions.
Whether you are dealing with a lender or a broker may not always be clear. Some financial institutions operate as both lenders and brokers. And most brokers' advertisements do not use the word "broker." Therefore, be sure to ask whether a broker is involved. This information is important because brokers are usually paid a fee for their services that may be separate from and in addition to the lender's origination or other fees. A broker's compensation may be in the form of "points" paid at closing or as an add-on to your interest rate, or both. You should ask each broker you work with how he or she will be compensated so that you can compare the different fees. Be prepared to negotiate with the brokers as well as the lenders. Be sure to get information about mortgages from several lenders or brokers. Know how much of a down payment you can afford, and find out all the costs involved in the loan. Knowing just the amount of the monthly payment or the interest rate is not enough. Ask for information about the same loan amount, loan term, and type of loan so that you can compare the information. Once you know what each lender has to offer, negotiate for the best deal that you can.
On any given day, lenders and brokers may offer different prices for the same loan terms to different consumers, even if those consumers have the same loan qualifications. The most likely reason for this difference in price is that loan officers and brokers are often allowed to keep some or all of this difference as extra compensation. Generally, the difference between the lowest available price for a loan product and any higher price that the borrower agrees to pay is an overage. When overages occur, they are built into the prices quoted to consumers. They can occur in both fixed and variable-rate loans and can be in the form of points, fees, or the interest rate. Whether quoted to you by a loan officer or a broker, the price of any loan may contain overages.
Have the lender or broker write down all the costs associated with the loan. Then ask if the lender or broker will waive or reduce one or more of its fees or agree to a lower rate or fewer points. You'll want to make sure that the lender or broker is not agreeing to lower one fee while raising another or to lower the rate while raising points. There's no harm in asking lenders or brokers if they can give better terms than the original ones they quoted or than those you have found elsewhere.
Once you are satisfied with the terms you have negotiated, you may want to obtain a written lock-in from the lender or broker. The lock-in should include the rate that you have agreed upon, the period the lock-in lasts, and the number of points to be paid. A fee may be charged for locking in the loan rate. This fee may be refundable at closing. Lock-ins can protect you from rate increases while your loan is being processed; if rates fall, however, you could end up with a less favorable rate. Should that happen, try to negotiate a compromise with the lender or broker.
[ Top ]
Don't assume that minor credit problems or difficulties stemming from unique circumstances, such as illness or temporary loss of income, will limit your loan choices to only high-cost lenders. If your credit report contains negative information that is accurate, but there are good reasons for trusting you to repay a loan, be sure to explain your situation to the lender or broker. If your credit problems cannot be explained, you will probably have to pay more than borrowers who have good credit histories. Ask how your credit history affects the price of your loan and what you would need to do to get a better price. Lenders now offer several affordable mortgage options, which can help first-time homebuyers, overcome obstacles that made purchasing a home difficult in the past. Lenders may now be able to help borrowers who don't have a lot of money saved for the down payment and closing costs, have no or a poor credit history, have quite a bit of long-term debt, or have experienced income irregularities.
[ Top ]
Fair Lending Is a Law
The law prohibits lenders from discriminating against credit applicants in any aspect of a credit transaction on the basis of race, color, religion, national origin, sex, marital status, age and etc.
Under these laws, a consumer cannot be refused a loan based on these characteristics nor be charged more for a loan or offered less favorable terms based on such characteristics.
[ Top ]
You are dealing with predatory lenders if they:
Sell properties for much more than they are worth using false appraisals.
Use high-pressure sales tactics to sell home improvements and then finance them at high interest rates.
Target vulnerable borrowers to cash-out refinances offers when they know borrowers are in need of cash due to medical, unemployment or debt problems.
Knowingly lend more money than a borrower can afford to repay.
Strip homeowners' equity from their homes by convincing them to refinance again and again when there is no benefit to the borrower.
Charge high interest rates to borrowers based on their race or national origin and not on their credit history.
Pressure borrowers to accept higher-risk loans such as balloon loans, interest only payments, and steep pre-payment penalties.
Encourage borrowers to lie about their income, expenses, or cash available for down payments in order to get a loan.
[ Top ]
Tactics they use:
You are told that you can only get a good deal on a home improvement if you finance it with a particular lender.
A lender or investor tells you that they are your only chance of getting a loan or owning a home.
You are asked to sign a sales contract or loan documents that are blank or that contain information that is not true.
The house you are buying costs a lot more than other homes in the neighborhood, but isn't any bigger or better.
You are told that the Federal Housing Administration insurance protects you against property defects or loan fraud - it does not.
The cost or loan terms at closing are not what you agreed to.
You are told that refinancing can solve your credit or money problems.
In general, if a deal to buy, repair or refinance a house sounds too good to be true, it usually is!
[ Top ]
Fraud and Security
Buying or refinancing your home may be one of the most important and complex financial decisions you'll ever make. Many lenders, appraisers, and real estate professionals stand ready to help you get a nice home and a great loan. However, you need to understand the home buying process to be a smart consumer. Every year, misinformed homebuyers, often first-time purchasers or seniors, become victims of predatory lending or loan fraud. Don't let this happen to you!
- Before you buy a home, attend a homeownership education course offered by non-profit counseling agencies.
- Interview several real estate agents, and ask for and check references before you select one to help you buy or sell a home.
- Get information about the prices of other homes in the neighborhood. Don't be fooled into paying too much.
- Hire a properly qualified and licensed home inspector to carefully inspect the property before you are obligated to buy. Determine whether you or the seller is going to be responsible for paying for the repairs. If you have to pay for the repairs, determine whether or not you can afford to make them.
- Shop for a lender and compare costs. Be suspicious if anyone tries to steer you to just one lender.
- Do not let anyone persuade you to make a false statement on your loan application, such as overstating your income, the source of your down payment, failing to disclose the nature and amount of your debts, or even how long you have been employed. When you apply for a mortgage loan, every piece of information that you submit must be accurate and complete. Lying on a mortgage application is fraud and may result in criminal penalties.
- Do not let anyone convince you to borrow more money than you know you can afford to repay. If you get behind on your payments, you risk losing your house and all of the money you put into your property.
- Never sign a blank document or a document containing blanks. If someone else inserts information after you have signed, you may still be bound to the terms of the contract. Insert "N/A" or cross through any blanks.
- Read everything carefully and ask questions. Do not sign anything that you don't understand. Before signing, have your contract and loan agreement reviewed by an attorney skilled in real estate law, consult with a trusted real estate professional or ask for help from a housing counselor. If you cannot afford an attorney, take your documents to counseling agency near you to find out if they will review the documents or can refer you to an attorney who will help you for free or at low cost.
- Be suspicious when the cost of a home improvement goes up if you don't accept the contractor's financing.
- Be honest about your intention to occupy the house. Stating that you plan to live in a house when, in fact, you are not (say because you intend to rent the house to someone else or fix it up and resell it) violates federal law and is a crime.
[ Top ]