( FAQs are at bottom of page)
Understanding the Loan Process
The mortgage business used to be an incredibly complicated maze of paperwork and documentation. These days, with the advent of on-line application, automated underwriting and streamlined processing, the mortgage game has become simplified and easy to navigate. There are more products available and access to non-conforming loans has never been greater. The lending limits in the secondary market have kept pace with rising home prices and high loan-to-value mortgages are at an all time high. We'd like to give you some basic information regarding understanding the loan process along with some information on how mortgage lenders make their decisions on whether or not to lend.
Where to go for a Mortgage Loan?
It used to be that the local bank was the only place to get a mortgage. That's probably where our parents went for their mortgage financing. The banks would usually be "niche" lenders who would offer fast approvals on their mortgage products. Unfortunately, they would be fairly inflexible with their rates and had limited product lines. Now we have Mortgage Brokers & Mortgage Bankers who are actually representing many different lenders.
The Broker can offer on a wholesale basis the many different products available through their lender network. Brokers are currently originating nearly 60% of all home loans in America. The benefit to a borrower is that the Broker compensation can usually be paid by the lender who actually funds the loan. This compensation is invisible to the borrower and allows the Broker to be more competitive than local banks. Because of the Internet, marketing costs are lower and the pricing even better for the customer.
Brokers vs Bankers
If a company is a direct lender, it may become captive to its own products. This means that rather than search for the best rate or program, they may try to sell something which may not be in the best interests of the customer. A Broker, on the other hand, can sell a variety of products from any of its many sources, and can be more objective in their recommendations. This factor will usually get you the best loan for your circumstances.
How to Apply
Regardless of where you go for your mortgage loan, the bank, Mortgage Broker or Banker will each require the standard residential mortgage application form which is known as the "1003". This is the Fannie Mae designation for the application form.
In the application you will provide information regarding the type of mortgage you are looking for, employment information, asset information, and credit and debt information. The lender will require additional information regarding the property as well as verification of the information you have in the application.
They will pull credit reports and check over all the supporting documentation submitted with the loan package. They will also require an independent appraisal of the property. For some types of loans, they may require different inspections, such as a pest inspection for FHA loans.
The underwriting process is the review the lender does after all the documentation has been submitted. The underwriter will evaluate the credit history, assets, debts and income. The appraisal will be reviewed and checked for accuracy. In the end, the loan will either be approved, denied, or suspended. Usually, there will be underwriting conditions which simply are additional documents needed to make the underwriter more comfortable with the file. A suspension is usually an indication that the file is difficult and will need stronger supporting documentation for an approval.
Because conditions are requested at the end of the loan transaction, borrowers often are frustrated because they are being asked to come up with more information at such a late date. This is often due to the fact that the loan is being sold on the secondary market and the selling parameters can change from time to time. Also, the processing of the application and submission of the file is a monumental task. The system isn't perfect, but both the lender as well as your Broker want the loan to close just as much as you and would not ask for information if it wasn't needed.
After all the conditions are met, the loan documents will be drawn and forwarded to the settlement agent in preparation for closing. At a mutually agreed upon time, the closing will take place and many forms will be signed and the process will be completed.
To Lock or not to Lock
You have the option of Locking your interest rate for a specified period of time once your application has been received or you can Float the rate until just before closing. This option is available at most Mortgage Companies. It is designed to give you the flexibility to follow the market and lock-in your rate at your discretion. Keep in mind, however, that once a rate is locked, it cannot be changed regardless of market conditions. If you choose to float, it is necessary to check the rates daily with your Broker to protect your lock options.
As you shop for a mortgage loan, you will encounter advertisements for no-cost loans. This can be an excellent way to reduce your current interest rate without spending much money in closing costs. Brokers can offer several different combinations of interest rates and points to best suit your current situation. The determining factor is always the length of time that the mortgage is held.
For example, a purchase or refinance loan may be offered at 7% with 0 points. This loan would contain customary closing costs including broker fees, lender fees, and title charges. The same loan could be offered at 7.5% with no closing costs. The effective yield on the higher rate will allow the Broker to cover the costs as his premium will be increased when he sells the loan to the lender. If you, the borrower, plan to keep the mortgage from one to three years, this may be your best option. If you plan on keeping the loan four or more years, it would make sense to take the lower rate because the break-even point will occur during those years. After break-even, the lower rate will save you money each and every month.
Keep in mind that, generally, a no-cost loan will only cover the non-recurring costs. This does not include interest, property taxes and homeowners insurance. Also, make sure the no-cost loan will cover the lender fees as well as the broker fees.
Income Tax Issues
In a purchase transaction, all origination fees and/or points can be deducted in the year the loan closes. A refinance, however, is somewhat different. The points must be deducted over the life of the loan. For example, a 30 year loan with 1 point will allow you to deduct 1/30th of the point each year. If you refinance twice in the same year, you will be able to deduct the remainder of the unamortized points on your next tax filing. For more information, please consult your tax advisor.
To Refinance or not to Refinance
Many years ago, the rule was to refinance if you could drop your current interest rate by at least 2%. This would allow you to save enough in monthly payment to cover your costs of refinancing. Now the rules have changed. With the advent of low-cost and no-cost refinances, it can certainly be to your advantage to lower your rate by as little as 1/2%. Once again, the determining factor should be the length of time you plan on staying in the property. The longer the loan is maintained, the more savings realized through the refinance.
Some of the most commonly used reasons for refinance are:
Eliminate Mortgage Insurance
Change from an Adjustable Rate Mortgage to a Fixed Rate
Create a Lower Monthly Payment and Improve Cash Flow
Take Cash Out of Your Home
Purchase Power 3; Pre-Approvals
In today's mortgage market, those wishing to purchase property using a Realtor almost always need a pre-approval letter. Most Realtors don't want to work with a borrower unless they have been pre-approved by a lender. This seems contradictory because until you identify a property, you don't know the purchase price. We suggest that you do your homework and investigate prices of homes in the area that will best suit your needs. Once you settle on an approximate price, you can use that figure in your pre-qualification interview.
In this pre-qualification interview, the loan officer will gather information regarding your income, debts, credit, etc. and will be able to advise if you can qualify for the loan you are seeking. It is always better to pre-qualify for a higher loan amount and higher rate than you expect. It is much easier to lower the numbers than to raise them. You will then receive a pre-qualification letter which can be used to encourage sellers and create a comfort level with your Realtor. This is an invaluable tool in home shopping as you are now negotiating from a stronger position.
Once upon a time, in order to buy a home you would need a 20% Down Payment. These days, coming up with the necessary cash for the down payment may be difficult or even impossible. There are plenty of loans available with as little as 3% down payment. With these loans, however, it is usually necessary to obtain Mortgage Insurance (MI). This type of insurance guarantees your lender that should you fail to make your mortgage payments or default on your mortgage loan, the mortgage insurance company will cover the lenders exposure up to a certain percentage. In addition, mortgage insurance is expensive and non-tax deductible.
There are some options which can be used to avoid mortgage insurance. Some lenders offer 80/10/10 programs or 100% financing using an 80/20 formula. For example, in the 80/10/10 program, you, the borrower, will come up with a 10% down payment. The seller can carry-back a second mortgage or the lender can arrange a second mortgage for 10%. This will give you the 20% necessary to avoid MI.
The 100% financing option generally uses a "piggy-back" second mortgage of 20% with an 80% first mortgage. In either case, keep in mind that the interest rates on a second mortgage are significantly higher than a first but will eliminate the need for mortgage insurance.
What if you can't verify all of your income? How can you qualify for a loan? Usually, this type of loan is reserved for borrowers who are self-employed and are creative with their income tax returns regarding write-offs for tax purposes. This certainly can save money with Uncle Sam but is is a definite hindrance when it's time to apply for a loan. In all no-income verification loans or low-income verification loans, a higher down payment will be expected. The lender's exposure must be reduced in order to take a chance on the borrower who can't prove income.
There are several different categories of loans which carry lesser income qualifying procedures. There is the No-Income, No-Asset loan where income and assets are not used in qualification. Another type is the qualification with 6 or 12 months bank statements. In this loan, the lender will average deposits over a specified period and use that figure in determining income. Another possibility would be copies of invoices or checks received from customers.
Whichever program is used, it is important to remember that you will be paying a premium for a no-income verification loan of any type. These loans, regardless of the size of down payment, are higher risk and lenders will charge accordingly. You alone must weigh the differences in higher interest on the loan, or more money paid in taxes should you show more income.
Part of the American Dream is home ownership. Part of the American system is overabundant credit debt. Because credit is so easily obtained, it is often just as easy to over-extend. Those low monthly payments can quickly add up until all disposal income is expended in the servicing of the debt.
FREQUENTLY ASKED QUESTIONS (FAQs)
What Are Closing Costs?
There are several categories of closing costs. First, the mortgage company can charge various fees such as processing fees or administration fees. Next the actual lender or investor who gives you the money can charge fees such as underwriting, commitment, tax service, etc. Then, there are title fees. These can include the title search, commitment, endorsements, recording and courier fees. Usually, the mortgage company can negotiate their fees but rarely will a title company or investor lower their fees. Usually the total closing costs will range in the area of $1,000-$1,400.
What are Pre-Paids?
Pre-Paids are monies which you pay for in advance associated with your loan transaction. These will include interest from the date of closing to the end of the month. Also, any property tax or homeowners insurance which will be put into escrow and disbursed by your lender are considered pre-paids. Mortgage insurance is another pre-paid item.
Can I Roll In my closing costs and pre-paids? Pay Closing Costs With my loan proceeds?
If you are refinancing, provided there is sufficient equity in the property you will be able to Roll In your costs. If you are purchasing a property, closing costs are usually paid out of pocket. There are certain transactions where your seller or mortgage company can pay the closing costs for you.
What are Points or Origination Fees?
Points or origination fees are sometimes paid to buy down your interest rate. Typically, 1% of your loan amount will buy the interest rate down 1/4%. Therefore, a 7% rate with no points can be bought down to 6.75 % by paying 1 point. Generally, the determining factor in whether to pay points is dependent on how long the mortgage will be held. The lower rate will eventually save you money if you keep the mortgage a sufficient length of time.
What is a Credit Score?
Credit scoring is the method of rating, or scoring your credit history. These scores are now being used by credit grantors as a tool in determining risk factors in lending. The risk with mortgage loans is, of course, foreclosure. Although the lender has significant collateral with the lien placed on your property, they are not interested in owning that property. The credit scores give the lender a method of predicting the risk associated with your loan.
There are three major credit bureaus which have credit scoring models. FICO was created by Experian or TRW. Beacon scores are from CBI/Equifax and Empirica comes from Trans Union. These models differ somewhat but all can be used by a mortgage lender in determining risk. Derogatory credit information weighs most heavily on credit scores. Late payments, collection accounts, charge offs, judgements, bankruptcy and foreclosure will severely lower your credit scores. Other factors include numbers of open credit accounts, high balances compared to credit limits, recently opened accounts and recent inquiries into your credit history. Surprisingly, a borrower who has perfect credit history can have low scores because of too much credit.
What is PMI?
Private Mortgage Insurance. This type of insurance is required by lenders for loans with a low equity position. For example, if you purchase a property with less than 20% down payment, the lender will require you to have mortgage insurance. The insurance will cover a percentage of your mortgage should there be a default. Mortgage insurance must be paid each month and is included in your mortgage payment. You must maintain the insurance until you can prove that the equity in the property has reached 20%. In other words, the lender's exposure has been reduced to 80%. Mortgage insurance is expensive and if possible should be avoided.
What is AMORTIZATION?
This is how your payments break down during the life of the loan. It involves dividing the principal and total interest charges into equal payments and will completely pay off the debt at the end of the term.
What is an ARM mortgage?
An Adjustable Rate Mortgage. This is exactly as it sounds -- a mortgage that can adjust over periods of time. Typically, an ARM will have rate caps. This means that after a specified number of payments, the rate can only increase by a certain percentage, usually no more than 2%. There are also lifetime caps, usually 6%, which will indicate the highest possible rate for that particular mortgage. ARM mortgages are usually taken out by borrowers who plan to stay in the property a limited period of time, or by borrowers who need a lower rate to qualify for more mortgage money.
What is Locking-In?
Locking will guarantee your interest rate for a specified period of time regardless of market fluctuations.
What is Floating?
Floating means that there is no guarantee of what the interest rate will be on your loan. You are gambling that the market will improve so you can take advantage of a lower rate during the time your loan is being processed.
How does a BI-Weekly or Equity Acceleration Mortgage work?
The Bi-Weekly mortgage plan has been endorsed by financial analysts everywhere from the Wall Street Journal to Consumer Reports. This is a plan that breaks your monthly mortgage payment in half and is paid every two weeks. Since interest on a mortgage is calculated based on outstanding principal, you will drastically reduce the amount of interest you will pay over the life of the loan. The Bi-Weekly mortgage plan will build equity at over 2.5 times faster than a monthly mortgage.
What is an FHA mortgage?
The Federal Housing Authority is a government agency that insures lenders against default by borrowers. FHA loans require less money for down payment and somewhat more liberal credit guidelines. One must carry mortgage insurance for the life of the loan with FHA. This can add to the cost of credit but it will allow many more people the advantages of home ownership.
What is a VA mortgage?
These types of loans are available for US Military Veterans only. The advantages for Veterans are the more liberal credit guidelines and no down payment requirements. The Veteran must obtain a Certificate of Eligibility from the Veterans Administration in order to qualify.
What is Sub-Prime or Non-Conforming?
These are categories of mortgage loans for those with difficult credit, or borrowers who can not verify income. Non-conforming loans typically require a higher equity position as they are "higher risk" loans. The interest rates are higher but the credit and underwriting guidelines are more flexible