Facts about Buying a Home

Feb 26, 2002 4:11 PM

Q: What is my interest rate going to be?

A: It depends. All lenders have many rates, depending on the type of product you choose and the type of loan you qualify for. Most lenders have websites with their daily rates quoted. Check it first before you make any calls. If a loan officer quotes you a different rate than that which is listed, ask why. Remember, they are making a profit on loans and they could be negotiable.

Q: Don't rates change frequently?

A: Yes. Make sure to find out how long your rate will remain valid. A lender may quote you a low rate that is valid only for a 10 day "lock," meaning you have to close your loan within 10 days to get that rate. The rate "lock" period varies with each lender, but most lenders offer more practical 60-day rate "locks."

Q: What are Points?

A: Points are fees paid to lenders as closing costs. They are like prepaid interest. Generally, if you pay points you get a lower rate. For instance, your lender might offer you a loan of 6% with no points, or 5-3/4% if you pay one point.

Points are considered interest and are generally tax deductible on a home purchase loan, but not on a refinance.

Q: Should I pay the points? Paying 1% up front for 1/4% off over the life of the loan sounds like a good deal.

A: It might be. If you only stay in the house a few years you might not save enough on your monthly payments to recover the cost of the point. Paying points lowers your monthly cost and could qualify you for a larger loan. Of course, you need money to pay for the points at closing.

Q: What other factors affect mortgage payments?

A: The amount of the down payment, the size of the mortgage loan, the repayment term and the payment schedule all affect the size of your mortgage payment.

Q: I've heard the term "closing costs." What do they entail?

A: These are the fees that lenders, municipalities and attorneys charge when you buy or sell a home. Before you choose a lender, you should be sure to obtain —in writing — a "good faith estimate" (GFE) of closing costs.. Closing costs vary in different localities, but they usually include the following items:

• Attorney's or escrow fees (your and your lender's, if applicable).
• Property taxes, if applicable, to cover the tax period to date.
• Interim interest (paid from date of closing to 30 days before first monthly payment).
• Loan origination fee (covers lender's administrative costs).
• Recording fees.
• Survey fee.
• First premium of mortgage insurance (if applicable).
• Title insurance (yours and your lender's).
• Loan discount points (fees paid to induce lenders to make a mortgage loan. One point equals 1 percent.)
• First payment to escrow account for taxes and insurance. (Most lenders require a payment equal to two monthly mortgage payments.)
• Paid receipt for homeowner's insurance policy (and flood insurance, if applicable).
• Any documentation preparation fees.
• Mortgage broker's commission (if applicable).

When comparing lenders pay special attention to the costs set by the lender such as title insurance, lender attorney, points, application fees, commitment fees, etc. Other closing costs such as escrow for your property tax, insurance and the first month's interest are generally based more on when during the month your loan closes and don't vary much from lender to lender.

Q: What is the "loan-to-value" (LTV) ratio, and how does it determine the loan size?

A: The LTV ratio is the amount of money you borrow compared to the price or appraised value of the home you are purchasing — in other words, the amount of equity borrowers have in their homes. Each loan has a specific LTV limit. For example, with a 90 percent LTV loan on a home priced or appraised at $100,000, you could borrow up to $90,000 (90 percent of $100,000) and would have to pay $10,000 as the down payment. With LTVs of 80 percent or more, buyers are usually required to obtain mortgage insurance (explained below) to protect lenders against potential losses in cases of default.

Q: Are there different types of loans, and what are the advantages of each?

• Fixed Rate Mortgages: Payments and interest rates remain the same for the life of the loan — usually either 15 or 30 years. The advantage is its predictability: your housing costs will not be affected by interest rate changes and inflation. In fact, if inflation and other costs of living rise, your mortgage payments will become a smaller part of your overall expenses.
• Adjustable Rate Mortgages (ARM): Payments increase or decrease on a regular schedule with changes in interest rates. ARMs generally offer low initial interest rates, making lower monthly payments that may allow borrowers to qualify for larger loan amounts. The predictability in ARMS is limited to the term or time period it is designated as a fixed interest rate. ARMs are amortized on a thirty (30) year term. The rate is fixed in the beginning and fluctuates every year thereafter. For example, the 3/1ARM interest rate is fixed for the first three (3) years and adjusts every year thereafter for the remaining term of the loan. Adjustments are based on market interest rate fluctuations. There are usually annual and lifetime caps, which are only applicable to the term/period when the rate is adjusted.

Remember, in addition to the down payment you will need cash at closing for your closing costs.

Q: How much of a down payment will I need?

A: With a conventional loan, the maximum financing allowed is 80 percent of the purchase price or value of the property, whichever is lower. This means that the borrower will be required to provide a down payment of at least 20 percent of the purchase price. If a borrower wishes to borrow more than 80 percent of the purchase price, private mortgage insurance (PMI) will be required for the loan. The entire down payment must be the borrower's own monies and cannot be in the form of a loan or gift.

Q: Why is PMI needed if I need to borrow more than 80 percent of the purchase price?

A: Most lenders sell their loans to the secondary market (investors) who only purchase loans whose LTVs do not exceed 80 percent. Investors will also purchase loans if the LTV exceeds 80 percent, but the exceeded amount must be insured.Therefore, lenders require that borrowers requesting an LTV greater than 80 percent pay for PMI, so that the lender will be insured against the borrower's default.

Q: What are the payment options for private mortgage insurance?

A: PMI companies have different payment options, but generally they require payment on an annual, lump-sum or monthly premium plan. Premiums are based on the loan amount, term of mortgage, LTV, quality of loan and amount of coverage required by the lender.

• Annual plans require borrowers to pay an initial premium when they close on the loan, and then make monthly payments along with their mortgage payments.
• Lump-sum plans require borrowers to pay a premium covering several years in one lump sum at closing.
• Monthly plans allow borrowers to pay an amount equal to one or two months of the premium at closing and then a monthly premium thereafter.

Q: Is there another way to put down less than 20 percent on a house?

A: Yes. The Federal Housing Administration (FHA) provides insurance of up to 97 percent of the purchase price, meaning that a borrower can put down as little as 3 percent. Moreover, the entire 3 percent can come in the form of a nonrepayment gift from family members. The interest rate for FHA loans is usually higher than that of a conventional loan.

Discuss down payments with lenders you are considering.

Q: Do I automatically qualify for an FHA mortgage?

A: No. There are limits on the amount you can borrow. The approved FHA lender will have all the information.

Q: Are there other ways to put down less than 20 percent?

A: If the down payment is less than 20 percent and you neither wish to pay for PMI or have an FHA loan, you can take out a second mortgage along with your first mortgage. The second mortgage is usually in the form of a Home Equity Loan (HEL) or Home Equity Line of Credit (HELC).

• The HEL usually has a fixed rate for the full term of the loan and the payments are very similar to the first mortgage monthly payments.
• The HELC generally has an adjustable interest rate where the interest will fluctuate and the amount you pay is the amount you have used. HELC payments are similar to credit card payments.
• The differences between HELC and credit card payments are the starting dates of interest accrual and payment terms. For the HELC, interest accrual commences the same day you use your credit. A credit card typically allows a grace period before interest is accrued.
• A HELC has an access period and a repayment period. Depending on the duration of each period, you can use the available credit in your HELC during the access period and any credit used in the access period must be paid in the repayment period. You usually have the option to repay during the access period.
• Keep in mind that the longer you take to repay what you owe, the more you have to pay in interest because interest accrues from the day you use the funds. HELCs are preferred for their flexibility in fund availability and the frequency of taking out the amount of funds you need.

Q: Does the FHA have any requirements when it insures a mortgage?

A: Yes. It requires government-administered "mortgage insurance payments" (MIPs) on all of its loans. All borrowers have to pay a 1.5 percent insurance premium at closing and 0.5 percent a month thereafter, similar to the PMI annual payment plan.

Q: What are the differences between the FHA's "mortgage insurance payments" (MIP) and the "private mortgage insurance" (PMI) you mentioned earlier?

A: There are two:

• PMI insures the portion of a private lender's mortgage in excess of an 80 percent LTV. The borrower can generally cancel PMI when he or she has paid the loan down to 80 percent of the home's original value.
• In contrast, MIP insures the entire mortgage amount and can be cancelled when the loan is paid down to 78 percent of the original value or purchase price, but the insurance will remain effective for the life of the loan. The insurance remains because you are not canceling insurance — just not paying it. Loans insured with MIP have lower maximum regional loan limits than those insured with PMI. PMI's guidelines are generally more stringent than MIP. MIP is a good choice for borrowers who do not have their own funds for the down payment or who have credit history problems.

Q: What factors does a lender evaluate in qualifying a loan?

A: A lender reviews your income, credit and assets to determine whether you qualify for a loan. Lenders will require that you have stable income, a good credit history, and sufficient liquid funds (cash and assets easily converted to cash) to close the loan.

• Housing expense and total debt ratios are used to determine the loan amount that the borrower (you) can afford. The housing expense includes the PITI (principal, interest, taxes, insurance) or all expenses related to the home and the total debt consists of the PITI and all recurring debts such as credit card payments and other loans paid in installments. The housing expense and total debt amount is compared with your income to derive at the ratios. The ratios determine the expense percentage you will be carrying when compared with your income.
• Each lender has different qualifying ratios, but typical conventional loans are based on the 28/36 ratio. This means that in order for you to qualify for a loan, your housing expense cannot exceed 28 percent of your income, and your income should carry at least 36 percent of your total debts.
• The lender will evaluate what types of assets you have to determine how much cash you have. Funds used for the down payment and closing costs are considered readily available or easy to liquidate.
• Credit reports are reviewed by lenders to evaluate a borrower's credit history. Lenders determine if you will be able and willing to pay back the mortgage by examining your record of timely or late payments, and by determining the number of outstanding long-term debts you have.

Q: What happens after I have applied for a loan?

A: The turnaround time to complete the evaluation of your application varies from lender to lender. However, it usually takes a lender between one to six weeks. It is not unusual for the lender to request more information once the application has been submitted. The sooner you can provide the information, the faster your application will be processed. Once the lender reviews and verifies all your information, it will issue a written commitment letter or a denial. If the loan is approved, a closing date can be set and the lender will review the closing process with you. After the closing, you will be able to move into your new home!

Q: What are my biggest responsibilities during the lending process?

A: Two overall points are worth keeping in mind:

• Be honest. The home you are going to purchase is your investment, but it is also the lender's investment &madsh; in the property and also in your ability to pay the mortgage. That's why the lender conducts "due diligence" (verifying the information you provide). Do not overstate anything to qualify for the loan amount you need, be truthful about your credit problems and do not provide false supporting documents. Honesty will create a smoother and quicker lending process.
• Be thorough. To avoid falling victim to loan fraud, be sure to read and understand everything before you sign a document. And never sign a blank document.

Q: What happens at closing?

A: See timeline.