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Are you considering to buy your first home and wondering about the options?
Well, you're not alone. Many people exist in the same situation, and the dilemmas are more or less common to all of them. In this article, we will give my best to explain mortgages so that you can understand the way they work.
How Does a Mortgage Work?
There are two portions to your mortgage payment: principal and interest. The principal of a loan is the amount borrowed. Lenders charge interest for the privilege of borrowing money that you can pay back over time (measured as a proportion of the principal). For the duration of your mortgage, you pay monthly installments depending on an amortization schedule set by your lender.
Another factor to consider when pricing a mortgage is the annual percentage rate (APR), which calculates the total cost of the loan. The APR includes the interest rate as well as any additional loan costs. While it may seem like a basic loan payment, there are actually five basic components that make up a mortgage payment. These are:
- The principle: This is the loan amount that you will need to pay back over the lifetime of the mortgage.
- Interest: This is a percentage set in the mortgage terms and conditions.
- Taxes: This is for your property taxes
- Insurance: You may need to pay homeowner’s insurance and private mortgage insurance.
- Escrow: Many lenders combine the taxes and insurance into one lump sum for payment at the end of the year. This reconciliation is done via Escrow, so you can incur Escrow fees.
First time homebuyers account for 33% of all home sales. In this chart using 2020 NAR Trends data, you can see that the 22 to 29 year old age group is the most likely to buy a home for the first time, accounting for 88% of sales. This is followed by 52% of sales in the 30 to 39 year old age group. At the other end of the scale, only 6% of 65 to 73s and 5% of 74+ house sales were to first time buyers.
How Do You Get Ready For A Mortgage Application?
Before analyzing your lending options, consider your situation and needs. This might help you choose a loan that is tailored to your individual requirements. Here are some of the most important considerations that will almost surely affect your finance options:
- Affordability – the cost of your home will decide the majority of your mortgage payments, which may vary depending on where you want to buy and what type of property you desire. Use this calculator to figure out how much house you can afford.
- Future plans – depending on your employment or life circumstances, you may relocate soon after acquiring a home or stay for decades. This may have an impact on the type of mortgage you choose. For example, an adjustable-rate mortgage (ARM) grows riskier the longer you plan to stay in your home.
- Credit History – Your loan possibilities are determined by your credit history and the amount of money you have set up for a down payment. People with strong credit ratings are more likely to qualify for mortgages with reduced interest rates. In the long term, a larger down payment can help you pay less interest.
Anyone who has purchased a home will be aware that there are a number of steps in the buying process, but where do you start? In this chart, you can see 2020 NAR Trends data on the first steps taken during the home buying process. In 44% of cases, the process begins with online property searches. On the other hand, only 4% of respondents started by visiting open houses.
Types of Mortgages
There are various types of mortgage loans depending on different criteria. Nevertheless, the main classification we use is based on the type of interest rate and the type of lender. Here are the main types you should know:
1. Conventional Mortgages
If a loan is not secured by a government agency (for instance, FHA or VA), then we call this mortgage conventional. Because of the lack of government protection and guarantee, usually, banks impose stricter approval criteria. One of the things the lenders might want is a higher down payment – up to 25%.
In addition, if the borrower cannot afford this, the bank will require Private Mortgage Insurance. This is how the lender makes sure their money is protected in case of a default. The PMI can reach up to 20% of the property’s value, but you don’t have to pay it at once. The lender will include it as a part of your monthly payment.
- Fixed Rate Mortgages
These are mortgages whose interest rate remains the same during the whole term. If your rate is 7.5%, it will not change even if interest rates hike. This is a particularly good choice if at the moment of closing the rates are very low. So whatever happens tomorrow (most probably rates will go up again), these changes will not affect your mortgage payment. – Occasionally, the monthly payment might change in the future. Remember the escrow account? If you have to pay more taxes on your property, therefore the money in the escrow account will increase making the monthly payment slightly higher.
- Adjustable Rate Mortgages
Unlike fixed-rate loans, in adjustable-rate mortgages, the bank will change its rates during the term. These specific details will be part of the agreement so make sure you know all of them. For instance, usually, the rate is fixed for the first several years. Then, after this period, the lender changes it and recalculates your monthly payments. The lender will use an index to recalculate the old interest rate. Despite that, there will be limits on how much the rate can vary. Let’s look at an example illustrating this.
You have a mortgage at a 6% rate for the first three years and an annual cap of 2%. This means that the following year (after the first three), the rate cannot be more than 8%. There is also a percentage cap that shows how much the rate can increase during the whole term. If in the above-mentioned example this cap is 5%, it means that the highest rate you can ever have is 11%.
2. FHA Loans
An FHA mortgage is a loan which is insured by the Federal Housing Administration. These loans usually have more affordable terms. Bear in mind that the FHA does not lend you the money but rather ensure the property. Most private lenders offer this type of mortgage.
Borrowers can qualify even if their credit score is lower than 600 and make a very small down payment – below 5%. Although the requirements are less stringent, often the home buyer should pay a 3% cash contribution.
Check the FHA’s official website as well as your bank’s and make sure you know all the requirements and details.
3. VA Loans
Just like FHA loans and unlike conventional mortgages, this type is guaranteed by a government body – the Department of Veteran Affairs (aka VA). If you are a veteran, active-duty service personnel or even veteran spouses, you can qualify for a VA loan. What are the biggest perks of this type of mortgage?
No other loan on the market goes with 0% down payment. This is a huge advantage since many people have no cash whatsoever. In addition, overall the terms are much better than those of conventional loans.
4. USDA Loans
The Rural Housing Service (RHS), which is an agency part of the US Department of Agriculture (USDA), also offers affordable mortgages to people who live in rural areas. These loans have low-interest rates and people with relatively low income can benefit from them. The most common program is called Single Family Direct Home Loans or Section 502. Usually, local banks in association with the USDA offer these programs to borrowers.
In order for borrowers to qualify, they need to have low income. In addition, families should not have a house. Some of the benefits include an extended term up to 33 years and no down payment.
How Much You Can Afford?
The 36 percent rule is a great guideline to follow when deciding what home price you can afford. Your total monthly debt obligations (school loans, credit cards, auto payments, and so on), plus your expected mortgage, homeowners insurance, and property taxes, should never exceed 36% of your gross income (i.e. your pre-tax income).
While purchasing a new home is thrilling, it should also provide you a sense of security and stability. You don't want to be living month to month, just scraping by to fulfill all of your responsibilities: mortgage payments, electricity, groceries, loan payments, and so on.
You'll need to set out a housing budget that works for you in order to prevent buying a house you can't afford. If you spend 40% or more of your pre-tax income on pre-existing obligations, even a small change in your income or costs can have a major impact on your budget.
If you’re looking for a new home, you may wonder about the most common types of homes purchased today. In this chart using 2020 NAR Trends data, 83% of homes purchased are single family homes. This is significantly more than the second most popular homes, which is townhouses at 6%.
Banks are hesitant to lend to borrowers with a little margin of error. As a result, your previous debt will have an impact on the amount of property you qualify for when applying for a mortgage.
It's not just in your lender's best interests to remember this rule when looking for a home; it's also in yours. Because lenders offer higher loan rates to borrowers who exceed the 36 percent restriction, you'll almost certainly wind up paying more in interest if you choose a home that exceeds that limit. Furthermore, you may find it difficult to meet your other financial obligations, such as developing an emergency fund and preparing for retirement.
Mortgage Points & Rate Lock
A lock-in, also known as a rate-lock or rate commitment, is a lender's guarantee to hold a specific interest rate and number of points for you while your loan application is processed, usually for a set period of time. (Points are lender-imposed fees that are generally paid by the consumer at settlement but can sometimes be financed by adding them to the loan amount.) One percent of the loan amount is equal to one point.) You may be able to lock in the interest rate and number of points you'll be charged when you submit your application, during loan processing, when the loan is authorized, or later, depending on the lender.
Because your lender is likely to take several weeks or longer to prepare, document, and review your loan application, a lock-in offered when you apply for a loan may be beneficial. Mortgage rates may fluctuate at that time. However, if you've locked in your interest rate and points, you should be safe from hikes while your application is being reviewed. This insurance could impair your ability to repay the loan. However, unless your lender is prepared to lock in a cheaper rate that becomes available during this time, a locked-in rate may restrict you from taking advantage of price reductions.
Although some loan commitments may include a lock-in, it's crucial to remember that a lock-in is not the same as a loan commitment. A loan commitment is a pledge from the lender to provide you a loan in a certain amount at a later date. In most cases, you won't have a lender's commitment until your loan application has been granted. The loan terms that have been accepted (including the loan amount), the length of time the commitment is valid, and the lender's criteria for making the loan, such as receipt of a suitable title insurance policy protecting the lender, are frequently stated in this commitment.
Prepare Questions to Your Mortgage Lender
Here are some queries to ask to make sure you’re getting the best rate (and a pleasant deal).
- What type of mortgage should I consider?
- What is the interest rate and annual percentage rate (APR)?
- How do you handle rate locks?
- What is the minimum down payment required for this loan?
- Do you handle underwriting In-house?
- How much time do you need to fund?
- What are my closing costs & Other fees?
- Are you provide pre-approval or pre-qualification?
- Do I have to pay for mortgage insurance?
- Is there a prepayment penalty?
Shopping Around For The Right Lender
With so many possibilities available, it's critical to conduct extensive study and see what you can uncover. Don't apply for any loan that comes your way.
You need to understand your situation and what you have to give before beginning your investigation. When you do begin shopping, keep an eye on costs and terms, but don't be afraid to haggle. Finding the best mortgage lenders might be difficult with so many available on the internet. So, here are a few pointers to get you started.
- Assess Your Credit Score: When evaluating whether or not to approve your house loan, lenders will look at your credit score. Knowing your credit score might help you figure out which lenders are the greatest fit for you. You can, however, improve your score to get better rates and terms. The most obvious approach to achieve this is to keep your credit usage percentage below 15%.
- Compare Rates and Terms: Each online mortgage lender will offer a different rate and terms. As a result, getting quotations from three or four lenders and comparing them is a good idea. This will enable you to find the finest lender for your needs and obtain a competitive rate and suitable conditions.
- Check the Company's Reputation: We already mentioned the Better Business Bureau and Trustpilot, but it's worth repeating. It is critical that you select a trustworthy mortgage lender. There are a lot of scam companies out there, so make sure your finances and property purchase aren't in the hands of one of them. If you locate an online lender with favorable conditions, it's a good idea to see what the company's rating is and what customers have to say about it.
- Consider an Online Mortgage Marketplace: A simple internet search will likely yield hundreds of online lenders. Trying to reach all of them is nearly impossible. Even simply filling out a contact form on a company's website would take a long time. As a result, think about using an online mortgage marketplace. These platforms will connect you with lenders who are the ideal fit for your needs.
Mortgage Underwriting Process
Although it may appear complicated, underwriting simply means that your lender analyzes your income, assets, debt, and property information before finalizing your loan.
Although underwriting takes place behind the scenes, you will still be involved. Your lender may need more paperwork and information, such as where your bank deposits came from or verification of additional assets.
While your future house is being appraised, a financial specialist known as an underwriter examines your finances and determines how big of a risk a lender is willing to take on if you are approved for a loan.
The underwriter assists the lender in determining whether or not you will receive a loan approval and will work with you to ensure that all of your paperwork is submitted. Finally, the underwriter will make sure you don't end yourself with a loan you can't afford. If you don't meet the requirements, your loan may be denied by the underwriter.
Negotiate For Better Mortgage Conditions
Many consumers are unaware that their mortgage or refinance rate can be negotiated. It is, in fact, entirely plausible. But it isn't as simple as negotiating percentage points.
You'll need to demonstrate that you're a credit-worthy borrower in order to negotiate your mortgage rate. You'll also have a greater chance if you bring a reduced estimate from another lender to the table.
Lenders have some wiggle room when it comes to the rates they give you. If you have a preference for one lender — perhaps because you know the loan officer or have a branch nearby — don't be afraid to present them with a cheaper estimate and see if they can match it. Consider that a superior application will provide you far more negotiating power when it comes to your mortgage rate. Basically, the better your financials look, the more lenders are interested in working with you. And the more they're willing to bargain to get it, the better.
Your LTV & DTI
Before you begin shopping for a mortgage, you must first determine your debt-to-income (DTI) & loan to value ratio (LTV). This DTI is the difference between how much your debt costs you each month and how much money you have coming in. Someone who earns $4,000 per month and spends $1,000 per month on debt has a 25 percent debt-to-income ratio. In general, if your debt-to-income ratio (DTI) is greater than 43 percent, you are unlikely to be authorized for a loan. You should try to reduce your numbers as much as possible.
Now, you don't have to keep your DTI as low as possible, but you should keep it below 40% and aim to make it even lower. For the mortgage lender, this appears to be a better option.
The proportional difference between the loan amount and the current market value of a home is known as the loan-to-value (LTV) ratio, and it is used by lenders to assess risk before authorizing a mortgage. A mortgage application with a lower LTV appears to lenders as less risky. A low LTV may increase your chances of securing a better loan.
So, take a look at your bills and see what you can pay off, such as a car loan or credit cards. This will save you money while also lowering your debt-to-income ratio & loan-to-value (LTV) ratio, which will make your mortgage appear better.
A down payment is the amount of money a borrower should pay when closing their mortgage. Usually, banks require no less than 20% of the property’s value. Unfortunately, many people cannot afford this amount of money, therefore pay less. Your bank, consequently, will consider you a riskier borrower and will require additional protection. This will also mean worse terms on your mortgage.
If you pay less than 20% down payment, you will have to pay a Private Mortgage Insurance, which may be up to 20% of the home’s value. This money will be equally distributed each month and included in the monthly payment. There is good news. Once you pay off 78% of the property’s value, this insurance will drop off.
Depending on the city and state in which you buy the property, you will have to pay various statutory costs. Some of these expenses might include transfer taxes, pro-rate taxes, local mortgage fees and others.
Prepare yourself to pay also additional, which we call third-party, costs. If you work with an attorney, you have to pay attorney fees. Attorneys usually charge a small percentage of the property’s price. Other than that, if you have worked with a real estate agent, be ready to pay them a commission. Just like the attorney’s fees, it’s a percentage of the selling price. Some of the lenders can require you to pay the insurance premium for the first year in advance.
Mortgage Application Process
The specifics of acquiring a mortgage online differ between lenders. In general, the steps are as follows.
- Complete the online application: Once you've selected a lender's website that offers the best conditions for your situation, you'll need to click apply and fill out the online application form.
- Import Your Financial Information: Some lenders offer a function that allows you to link your payroll portal and bank account to import your financial information.
- Submit Your Documentation: The lender will give you with a list of extra documents you'll need to back up your application. It's possible that you'll be able to upload this to the lender's online application portal. If this isn't an option, you'll have to fax, mail, or bring the paperwork to a local branch.
- Organize inspections and appraisals: You'll require a home inspection, and your lender will need an appraisal, just like with a traditional lender. These are required to confirm the property's value and condition.
- Provide Proof of Insurance: You'll also need to get homeowner's insurance for the property and show your lender proof of coverage.
- Closing: Last but not least, you must attend a closing appointment. You may be able to do this online, or you may need to make an in-person appointment. You will also need to pay the closing charges and make your down payment at this time.
As you can see, some lenders have a completely digital process that includes document e-signing and video conversations with digital notaries, while others require in-person visits at a real estate office or local branch. If you wish to complete the entire process online, double-check the lender's terms to ensure that all of the necessary procedures are in place.
Even if a lender offers a dedicated application portal, there's no guarantee you won't have to go to an in-person meeting or fax any paperwork. Banks, payroll processors, and other financial organizations have direct links with the most advanced online lenders. This enables them to obtain financial information from your company and vendors directly.
This not only saves time and effort, but it also speeds up the process tremendously.
The Different Types of Mortgage Lenders
Here are the main types of mortgage lenders, each of them work in a bit different way and it's important to understand it, especially if you're not interested in conventional mortgage:
1. Direct Lenders and Correspondent Lenders
Correspondent lenders are those who provide funding for loans but not directly to the borrower. Instead, they sell the loan to a direct lender, who then distributes the money to the person who needs it. They're essentially a huge lender's extension, but they do have the capacity to sell loans through a secondary market. Under their own names, some mortgage lenders will resell products obtained from another company.
Where they tend to fall behind is that they don’t do as well with less common loans. Everything must be done in a precise way for these types of lenders, and if it isn't, it can be sent back all the way to the correspondent lender. It may be difficult for the borrower to get the loan processed as a result of this.
A direct lender, on the other hand, is not subject to any additional regulations. Instead, they can underwrite the loan and then service it completely independently. This makes it easier for them to get through the procedure because there are fewer steps to complete.
2. Mortgage Lenders and Mortgage Brokers
Mortgage lenders and brokers are another prominent area where you'll need to consider the distinctions. If you're like most people, you've probably seen these terms used interchangeably or perhaps used them yourself. However, the truth is that they are two distinct personalities.
The financial entity that makes the loan is known as a mortgage lender. They have criteria and rules that you must follow or fit into in order to demonstrate that you can repay the loan, and then they determine things like your repayment plan and interest rate.
However, when you talk about a mortgage broker, you're talking about someone who acts as a middleman between you and the mortgage lender.
3. Mortgage Bankers
A mortgage banker is a sort of mortgage lender who makes their own loans and can sell them to borrowers. They do, however, have the option of selling the mortgages to others, including investors. These could be huge corporations, such as Freddie Mac, or private investors.
These bankers can also finance loans using various forms of lines of credit, at least if they aren't a bank. The federal government holds banks to certain regulations and guidelines that they must obey.
Most mortgage lenders in the United States are actually referred to as mortgage bankers, however the term is not widely used. It implies that they are not lending money that they own. They are lending money that they have borrowed from a “warehouse lender.” They take out a mortgage, sell it, and then pay back the money they borrowed. The agencies are then able to resell the mortgage.
Another two common types are:
- Wholesale Lenders, Warehouse Lenders and Retail lenders – A wholesale lender is a bank or organization that makes loans to other businesses or individuals. These third parties include the credit unions and banks where you can receive a mortgage, as well as the mortgage brokers we mentioned before. They could be big banks that don't engage with clients or consumers directly.
- Portfolio Lenders – The portfolio lender, who offers their own money to the borrower, is the final sort of lender. Because they get to determine all of the rules and terms, they don't have to worry about other investors or what they want out of the mortgage.
Getting a Mortgage - FAQs
While some mortgage applicants prefer to keep their tax and insurance out of their monthly mortgage payment, even if you include them, there are still some things not included. This includes a number of home costs such as utilities. So, when you evaluate a mortgage deal, you will need to check what is and is not included in the payments, which will allow you to budget correctly.
Interest is calculated on your mortgage daily, but while most months will be a standard 30 day period, your first mortgage payment will typically be higher. The reason for this is that you will start to incur interest charges from when you close on your home. So, if you close on the 15th of March and your first payment is on the 1st May, you will be paying 45 days of interest rather than 30.
While your mortgage is calculated to pay off the principal with interest by the end of the loan term, it is possible to pay off your mortgage earlier. The fastest way is to make additional payments. This can be in the form of a lump sum once a year or by making additional payments throughout the year.
Many people find a lump sum an easy and quick way to pay off their mortgage. You can budget for an extra $50 or $100 a month and place this into a dedicated savings account. At the end of the year, you’ll have $600 or $1200 plus interest to put towards your mortgage.
Another way, which is not always possible with lenders, is to split your monthly mortgage payment and send in a payment every two weeks. So, if your monthly payment is $500, by sending $250 every two weeks, you’ll actually make an extra $500 monthly payment per year. This could save as much as four years off a 30 year loan, depending on your rate.
There are several steps to prepare for a mortgage loan application. You will need to be prepared for a lot of paperwork and financial questions. It is a good idea to check your credit report for any errors and ensure that you know your credit score. This will help you apply for appropriate loan deals.
You will also need to become very familiar with your finances. You will need to look at your current expenses, income and savings. You will need to think about your down payment and how much you can afford each month.
Finally, you will need to gather your paperwork that will be needed to support your application. Lenders typically require proof of income, proof of address and ID.
The “Fed” may raise rates, which means that it is increasing the base rate. This can impact mortgages particularly if you have a variable rate deal. Variable rates are calculated according to the current base rate, so if the “Fed” raises the rates, your monthly mortgage payment will also increase.
If you’re currently shopping for mortgages, you will find that when the “Fed” raises the rates, the advertised mortgage rates will be higher. You may find that even fixed rates are higher than they were the month before the rate increase was announced.
Again, it depends on the company. Credit card companies like Capital One do not perform hard credit checks. Instead, only soft credit checks are performed to see where you stand financially. As a result, your credit score remains untouched.
But many companies do perform hard checks, which do affect your credit score. Therefore, you should be certain that you want to request a credit limit increase before contacting your credit card company.