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After You Buy
Getting a Mortgage
Mortgage 101, Fixed or Adjustable, Fixed Rate, Adjustable Rate (ARM), 15 or 30 Yr, Points, Fees, Locating a Lender, Good Lenders, Prequalify/Preapproval
What is a mortgage? A mortgage is a loan that you obtain to close the gap between the cash you have for a down payment and the purchase price of the home that you're buying.
Mortgages typically require monthly payments to repay. The mortgage payments are comprised of interest, which is what the lender charges for use of the money you borrowed, and principal, which is repayment of the original amount borrowed.
A Loan Officer will help you select a mortgage to meet your needs and will help you shop around for a mortgage.
Suppose that you borrow $144,000 (and contribute $36,000 from your savings as the down payment) for the purchase of your $180,000 home. If you borrow $144,000 with a 30-year fixed-rate mortgage at 7 percent, you pay $200,892 in interest charges over the life of your loan. $200,892 is a great deal of interest and more than the purchase price of the home or the loan amount originally borrowed!
So that you spend wisely on your mortgage, and get the mortgage that best meets your needs, it's important to understand the mortgage options out there.
Fixed or Adjustable?
Like some other financial and investment products, many different mortgage options are available for you to choose from. Two fundamentally different types of mortgages exist, and they differ in terms of how their interest rate is determined: fixed-rate mortgages and adjustable-rate mortgages.
Distinguishing fixed from adjustables
Before adjustable-rate mortgages came into being, only fixed-rate mortgages existed. Usually issued for 15 or 30-year periods, fixed-rate mortgages have interest rates that are fixed during the entire life of the loan.
- With a fixed-rate mortgage, your monthly mortgage payment amount does not change.
- Adjustable-rate mortgages (ARMs for short) have an interest rate that varies. The interest rate on an ARM typically adjusts every six to twelve months, but it may change as frequently as every month.
- The interest rate on an ARM is primarily determined by what's happening overall to interest rates. When interest rates are generally on the rise, odds are that your ARM will experience increasing rates, thus increasing the size of your mortgage payment. Conversely, when interest rates fall, ARM interest rates and payments generally fall.
Talk with a Response Loan Officer for more advice on your financing options.
Fixed Rate Mortgages
Because the interest rate does not vary with a fixed-rate mortgage, the advantage of a fixed-rate mortgage is that you always know what your monthly payment is going to be. Thus, budgeting and planning the rest of your personal finances are easier.
Adjustable Rate Mortgages (ARMs)
Adjustable rate mortgages (ARMs) fluctuate with the market level of interest rates and so does your monthly payment.
- Some first-time buyers or those trading up to a more expensive home may accept adjustable-rate mortgages. Because an ARM starts out at a lower interest rate, such a mortgage enables you to qualify to borrow more.
- Some homebuyers who can qualify for either an adjustable-rate or a fixed-rate mortgage of the same size have a choice and choose the fluctuating adjustable-rate mortgage. Why? Because they may very well save themselves money, in the form of smaller total interest charges, with an adjustable-rate loan rather than a fixed-rate loan.
- Because you accept the risk of a possible increase in interest rates, mortgage lenders cut you a little slack. The initial interest rate on an adjustable should be less than the initial interest rate on a comparable fixed-rate loan. In fact, an ARM's interest rate for the first year or two of the loan is generally lower than a fixed-rate mortgage.
- Another advantage of an ARM is that, if you purchase your home during a time of high interest rates, you can start paying your mortgage with the artificially depressed initial interest rate. Should interest rates subsequently decline, you can enjoy the benefits of lower rates without refinancing.
- Another situation when adjustable-rate loans have an advantage over their fixed-rate brethren is when interest rates decline and you don't qualify to refinance your mortgage to reap the advantage of lower rates. The good news for homeowners who are unable to refinance and who have an ARM is that they probably already capture many of the benefits of the lower rates. With a fixed-rate loan, you must refinance in order to realize the benefits of a decline in interest rates.
- The downside to an adjustable-rate loan is that, if interest rates in general rise, your loan's interest and monthly payment will likely rise, too. During most time periods, if rates rise more than 1 or 2 percent and stay elevated, the adjustable-rate loan is likely to cost you more than a fixed-rate loan.
Before you make the final decision between a fixed-rate mortgage versus an adjustable-rate mortgage, you should speak with your Loan Officer.
15 or 30 Year Terms
After you've decided which type of mortgage -- fixed or adjustable -- you also need to make another important choice -- typically between a 15-year and a 30-year mortgage.
- The main advantage that a 30-year mortgage has over its 15-year peer is that it has lower monthly payments that free up more of your monthly income for other purposes. A 30-year mortgage has lower monthly payments because you have a longer time period to repay it (which translates into more payments). A fixed-rate 30-year mortgage with an interest rate of 7 percent, for example, has payments that are approximately 25 percent lower than those on a comparable 15-year mortgage.
- What if you can afford the higher payments that a 15-year mortgage requires? Should you take it? Not necessarily. What if, instead of making large payments on the 15-year mortgage, you make smaller payments on a 30-year mortgage and put that extra money to productive use?
- A terrific potential use for that extra money is to contribute it to a tax-deductible retirement account you have accessible to you. Contributions that you add to employer-based 401(k) not only give you an immediate reduction in taxes but also enable your investment to compound, tax-deferred, over the years ahead.
- If you have exhausted your options for contributing to all the retirement accounts that you can, and if you find it challenging to save money anyway, the 15-year mortgage may offer you a good forced-savings program.
- When you elect to take a 30-year mortgage, you retain the flexibility to pay it off faster if you so choose. Just be sure to avoid those mortgages that have a prepayment penalty. Constraining yourself with the 15-year mortgage's higher monthly payments does carry a risk. Should you fall on tough financial times, you may not be able to meet the required mortgage payments.
Not all mortgages come in just 15 and 30-year varieties. You may run across some 20 and 40-year versions, but that won't change the issues.
Talk with a loan officer for more advice on your financing options.
Lenders quote points as a percentage of the mortgage amount and require you to pay them at the time that you close on your home purchase and begin the process of repaying your loan. One point is equal to 1 percent of the amount that you're borrowing. For example, if a lender says that the loan being proposed to you has two points that simply means that you must pay 2 percent of the loan amount as points. On a $120,000 loan, for example, two points cost you $2,400.
The interest rate on a fixed-rate loan has an inverse relationship to that loan's points. When you are able to pay more points on a mortgage, the lender may reduce the ongoing interest rate. This reduction may be beneficial to you if you have the cash to pay more points and want to lower the interest rate that you'll pay year after year. If you expect to hold onto the home and mortgage for many years, the lower the interest rate, the better.
Take a look at a couple specific mortgage options to understand the points/interest-rate trade-off:
- Suppose, for example, that you want to borrow $150,000. One lender quotes you 7.25 percent on a 30-year fixed-rate loan and charges one point (1 percent). Another lender quotes 7.75 percent and doesn't charge any points. Which offer is better? The answer depends mostly on how long you plan to keep the loan. The 7.25 percent loan costs $1,024 per month compared to $1,075 per month for the 7.75 percent mortgage. You can save $51 per month with the 7.25 percent loan, but you'd have to pay $1,500 in points to get it.
- To find out which loan is better for you, divide the cost of the points by the monthly savings ($1,500 divided by $51 equals 29.4). This gives you the number of months (in this case, 29.4) it will take you to recover the cost of the points. The 7.25 percent loan costs 0.5 percent less in interest annually than the 7.75 percent loan. Year after year, the 7.25 percent loan saves you 0.5 percent. But, because you have to pay one point up front on the 7.25 percent mortgage, it will take you about 30 months to earn back the savings to cover the cost of that point. So, if you expect to keep the loan more than 30 months, go with the 7.25 percent, one-point option. If you don't plan to keep the loan for 30 months, choose the no-points loan.
When you buy a home, the points are tax-deductible -- you get to claim them as an itemized expense on Schedule A of your IRS Form 1040. When you refinance, in contrast, the points must be spread out for tax purposes and deducted over the life of the new loan.
Other Lenders Fees
Application and processing
Lenders generally charge $200 to $300 up front as an application or processing fee. This charge is mainly to ensure that you're serious about wanting a loan from them and to compensate them in the event that your loan is rejected. Lenders want to cover their costs to keep from losing money on loan applications that don't materialize into actual loans. A few lenders don't charge this fee; or if they do, they return it if you take their loan.
Your credit report tells a lender how responsibly you've dealt with prior loans. Did you pay all of your previous loans back (and on time)? Credit reports don't cost a great deal, and you can expect to pay from $30 to $50 for the lender to obtain a current copy of yours.
If you know that you have blemishes on your credit report, address those problems before you apply for your mortgage. Otherwise, you'll be wasting your time and money applying for a loan for which you'll be denied.
Mortgage lenders want an independent assessment to ensure that the property that you're buying is worth approximately what you agreed to pay -- that's the job of an appraiser. Why would the lender care? Simple -- because the lender is likely loaning you a large portion of the purchase price of the property.
The cost of an appraisal varies with the size, complexity, and value of property. Expect to pay a few hundred dollars for an appraisal of most modestly priced, average-type properties.
Locating a Lender
If you've done a good job selecting a real estate broker or agent to help you with your home purchase, the broker or agent should refer you to good lenders and mortgage brokers in the area.
Traits of Good Lenders
Real estate brokers, agents and others in the real estate trade, as well as other borrowers that you know, can serve as useful references for steering you toward the top-notch lenders. As you solicit input from others and begin to interview lenders, seek to find lenders with the following traits:
- Straightforward: Good loan agents explain their various loan programs in plain English without using double-talk or jargon. They help you compare their loans to their competitors' loans.
- Approve locally: Good lenders approve your loan locally. They don't send your loan application to an out-of-town loan committee, where you're transformed from a living, breathing human being into an inanimate loan number. Good lenders use appraisers who are familiar with the local real estate market and have experience appraising the types of properties that are commonly sold locally. Good lenders actively work with you and your agent to get loan approval.
- Market savvy: Good lenders understand the type of property that you want to buy.
- Competitive: Good lenders are competitive. Don't be afraid to ask the lender that you like best to match the interest rate of the lowest-priced lender you find. At worst, the lender will turn your rate request down. At best, you'll get the lender you want and the loan terms you want. Loan rates and charges are negotiable.
- Detail-oriented: Good lenders meet contract deadlines. They approve and fund loans on time. Your agent knows which lenders deliver on their promises and which don't.
Loan Prequalification and Preapproval
When you're under contract to buy a property, it's important to have your mortgage application accepted. Some house sellers may not be able to wait for the approval process because they need to sell quickly. If the sellers have other buyers waiting in the wings, you run a risk of losing the property.
You should go through mortgage prequalification or preapproval.
- Prequalification is an informal discussion between borrower and lender. The lender provides an opinion of the loan amount that you can borrow based solely on what you, the borrower, tell the lender. The lender doesn't verify anything and is not bound to make the loan when you're ready to buy.
- Preapproval is a much more rigorous process, which is why we prefer it if you have any reason to believe that you'll have difficulty qualifying for the loan you desire. Loan preapproval is based on documented and verified information regarding your likelihood of continued employment, your income, your liabilities, and the cash you have available to close on a home purchase.
- Going through the preapproval process is a sign of your seriousness to house sellers -- it places a sort of a Good Borrowing Seal of Approval on you. A lender's preapproval letter is considerably stronger than a prequalification letter. In a multiple-offer situation where more than one prospective buyer bids on a home at the same time, buyers who have been preapproved for a loan have an advantage over buyers who haven't been proven creditworthy.
- Lenders don't charge for prequalification. Given the extra work involved, some lenders do charge for preapproval. Other lenders, however, offer free preapprovals to gain borrower loyalty.