Today's homebuyer has more financing options than have ever been available before. From traditional mortgages to adjustable-rate and hybrid loans, there are financing packages designed to meet the needs of virtually anyone.
While the different choices may seem overwhelming at first, the overall goal is really quite simple: you want to find a loan that fits both your current financial situation and your future plans. Though this article discusses some of the more common loan types, you should spend time talking with different lenders before deciding on the right loan for your situation.
General categories of loans
Most loans fall into three major categories: fixed-rate, adjustable-rate, and hybrid loans that combine features of both.
Other hybrid loans may start with a fixed interest rate for several years, and then later change to another (usually higher) fixed interest rate for the remainder of the loan term. Lenders frequently charge a lower introductory interest rate for hybrid loans vs. a traditional fixed-rate mortgage, which makes hybrid loans attractive to homeowners who desire the stability of a fixed-rate, but only plan to stay in their properties for a short time.
Balloon payments
A balloon payment refers to a loan that has a large, final payment due
at the end of the loan. For example, there are currently fixed-rate
loans which allow homeowners to make payments based on a 30-year loan,
even though the entire balance of the loan may be due (the balloon
payment) after 7 years. As with some hybrid loans, balloon loans may be
attractive to homeowners who do not plan to stay in their house more
than a short period of time.
Time as a factor in your loan choice
As has been discussed, the length of time you plan to own a property
may have a strong influence on the type of loan you choose. For
example, if you plan to stay in a home for 10 years or longer, a
traditional fixed-rate mortgage may be your best bet. But if you plan
on owning a home for a very short period (5 years or less), then the
low introductory rate of an adjustable-rate mortgage may make the most
financial sense. In general, ARMs have the lowest introductory interest
rates, followed by hybrid loans, and then traditional fixed-rate
mortgages.
FHA and VA loans
U.S. government loan programs such as those of the Federal Housing
Authority (FHA) and Department of Veterans Affairs (VA) are designed to
promote home ownership for people who might not otherwise be able to
qualify for a conventional loan. Both FHA and VA loans have lower
qualifying ratios than conventional loans, and often require smaller or
no down payments.
Bear in mind, however, that FHA and VA loans are not issued by the government; rather, the loans are made by private lenders. FHA loans are insured to the actual lender and VA loans are guaranteed in case the borrower defaults. Remember too, that while any U.S. citizen may apply for a FHA loan, VA loans are only available to veterans or their spouses and certain government employees.
Conventional loansRefinancing your home can be an excellent way to bring down your monthly mortgage payment, raise cash, or consolidate debts with high interest rates. However, you need to do your homework before deciding to refinance. One important factor is the difference between current interest rates and the rate of your original loan. You also need to take into account the amount of time it will take to recoup the costs of refinancing.
When should you refinance?
Some common reasons homeowners refinance include:
The old rule of thumb is that you should refinance your home if interest rates fall more than 2 points below your existing mortgage rate. That's because refinancing usually involves most of the same closing costs (loan origination fee, prepaid interest, etc.) as the original loan. For anything less than 2 percent, the savings on your monthly mortgage payment might not be significant enough to be worth your while.
Savings vs. time
For some homeowners, though, the 2 percent rule is not as important as
the time needed to break even on the refinancing. For instance, if it
costs $3,000 to refinance a house, and the monthly mortgage payment is
lowered by $90, it would take almost 3 years for the savings to cover
the costs of refinancing.
If all the information (survey, title search, etc.) for your old loan is still current, however, the lender may be willing to waive many of the fees. In addition, you may be able to roll the closing costs of a refinance loan into the new note. In other words, you don't avoid the closing costs, but instead pay them back over time along with the rest of the loan. If you consider this option, be sure to calculate the potential savings vs. the expense of paying off a higher principal balance.
Keep in mind that refinancing usually lengthens the time it takes to pay off your house. If you are 3 years into a 30-year mortgage and then refinance with a new 30-year loan, you'll end up making payments on the house for 33 years. Nevertheless, if the monthly savings are substantial enough, you still could end up paying much less over the long haul with the new loan.
Adjustable Rate Mortgages (ARMs)
Timing can also be a factor in switching from an ARM to a fixed-rate
loan. For example, rising interest rates might influence you to covert
your ARM into a fixed-rate loan if you plan to stay in your house for
several more years.
Conversely, you may plan to move in a year or two, and find a lender who is willing to offer you dramatic interest rate savings with an ARM. In this case (and as long as the closing costs are minimal), it might make sense to switch from a fixed-rate loan to an ARM.
Equity
Refinancing with a new loan doesn't mean you have to give up all the
money you've paid towards your old mortgage. With each payment, you
build up a certain amount of equity in a property--which is the amount
you've paid on the principal balance of the loan.
For example, if you have a $100,000 loan at 8 percent, you would build about $2,800 worth of equity in the first 3 years. Thus, if you refinanced, the new loan would only amount to $97,200.
Raising cash with home equity loans... use caution
If you've built enough equity, you can refinance in order to take cash
out of the property. Perhaps you need money to pay off your credit
cards, add a new bathroom, or cover the costs of braces for a child.
Regardless, lenders will typically allow you to borrow against the
equity you've built in your house, plus appreciation (often up to 75
percent of the current appraised value). These types of loans are also
called home equity loans.
Be cautious, however, of lenders offering 100 percent or 125 percent home equity loans--their rates are often markedly higher than traditional lenders. In addition, any amount you borrow that is above the market value of the house is NOT tax deductible. Check with your tax professional.
Talk to your lenderOne of the greatest financial aspects of buying a home is the ability to leverage your money. Simply put, leverage allows you to use a small down payment and financing to purchase a larger investment. For example, if you bought a $125,000 home with 10 percent down, you leveraged the $12,500 down payment to purchase an asset worth 10 times that amount!
Appreciation
The benefits of leverage really become apparent with appreciation, or
the rise in value of a property. Using the above example, say you were
to live in the house for 5 years, and during that time property values
in your area were to rise an average of 2.5 percent a year. Your home
would then be worth over $141,000. By putting only 10 percent down, you
get to enjoy the appreciation for the full amount!
Paying yourself
In addition to the 10 percent down, you'll also have to make mortgage
payments. But with each payment, a certain amount of money is being
used to pay down the principal balance that you owe. This is called
building equity. So in the event you sell your house, not only can you
realize a profit from your leveraged money, you also have a chance to
pay yourself back for the money you've put in over the years. No wonder
so many people consider a home an excellent investment!
The bundle of fees associated with the buying or selling of a home are called closing costs. Certain fees are automatically assigned to either the buyer or the seller; other costs are either negotiable or dictated by local custom.
Buyer closing costs
When a buyer applies for a loan, lenders are required to provide them
with a good-faith estimate of their closing costs. The fees vary
according to several factors, including the type of loan they applied
for and the terms of the purchase agreement. Likewise, some of the
closing costs, especially those associated with the loan application,
are actually paid in advance. Some typical buyer closing costs include:
Seller closing costs
If the seller has not yet paid for the house in full, the seller's most
important closing cost is satisfying the remaining balance of their
loan. Before the date of closing, the escrow officer will contact the
seller's lender to verify the amount needed to close out the loan.
Then, along with any other fees, the original loan will be paid for at
the closing before the seller receives any proceeds from the sale.
Other seller closing costs can include:
Negotiating Closing Costs
In addition to the sales price, buyers and sellers frequently include
closing costs in their negotiations. This can be for both major and
minor fees. For example, if a buyer is particularly nervous about the
condition of the plumbing, the seller may agree to pay for the house
inspection.
Likewise, a buyer may want to save on up-front expenditures, and so agree to pay the seller's full asking price in return for the seller paying all the allowable closing costs. There's no right or wrong way to negotiate closing costs; just be sure all the terms are written down on the purchase agreement.
Prorations
At the closing, certain costs are often prorated (or distributed)
between buyer and seller. The most common prorations are for property
taxes. This is because property taxes are typically paid at the end of
the year for which they were assessed.
Thus, if a house is sold in June, the sellers will have lived in the house for half the year, but the bill for the taxes won't come due until the following year! To make this situation more equitable, the taxes are prorated. In this example, the sellers will credit the buyers for half the taxes at closing.
A crucial step in starting your search for a new home is having a clear idea of your financial situation. By getting a handle on your income, expenses and debts, you'll have a much better idea of what you can afford and how much you'll need to borrow.
For lenders to verify this information, though, they're going to need to look at your financial records. It is also important to remember that you should include records for each person who will be an owner of the house. So before you even visit the bank, make sure you'll be able to provide copies of these important documents:
earnest money deposit
A deposit made by the potential home buyer to show that he or she is serious
about buying the house.
easement
A right of way giving persons other than the owner access to or over a property.
effective age
An appraiser's estimate of the physical condition of a building. The actual
age of a building may be shorter or longer than its effective age.
effective gross income
Normal annual income including overtime that is regular or guaranteed. The
income may be from more than one source. Salary is generally the principal
source, but other income may qualify if it is significant and stable.
encumbrance
Anything that affects or limits the fee simple title to a property, such
as mortgages, leases, easements, or restrictions.
endorser
A person who signs ownership interest over to another party. Contrast with
co-maker.
Equal Credit Opportunity Act (ECOA)
A federal law that requires lenders and other creditors to make credit equally
available without discrimination based on race, color, religion, national
origin, age, sex, marital status, or receipt of income from public assistance
programs.
equity
A homeowner's financial interest in a property. Equity is the difference
between the fair market value of the property and the amount still owed
on its mortgage.
escrow
An item of value, money, or documents deposited with a third party to be
delivered upon the fulfillment of a condition. For example, the deposit
by a borrower with the lender of funds to pay taxes and insurance premiums
when they become due, or the deposit of funds or documents with an attorney
or escrow agent to be disbursed upon the closing of a sale of real estate.
escrow account
The account in which a mortgage servicer holds the borrower's escrow payments
prior to paying property expenses.
escrow analysis
The periodic examination of escrow accounts to determine if current monthly
deposits will provide sufficient funds to pay taxes, insurance, and other
bills when due.
escrow collections
Funds collected by the servicer and set aside in an escrow account to pay
the borrower's property taxes, mortgage insurance, and hazard insurance.
escrow disbursements
The use of escrow funds to pay real estate taxes, hazard insurance, mortgage
insurance, and other property expenses as they become due.
escrow payment
The portion of a mortgagor's monthly payment that is held by the servicer
to pay for taxes, hazard insurance, mortgage insurance, lease payments,
and other items as they become due. Known as "impounds" or "reserves"
in some states.
estate
The ownership interest of an individual in real property. The sum total
of all the real property and personal property owned by an individual at
time of death.
eviction
The lawful expulsion of an occupant from real property.
examination of title
The report on the title of a property from the public records or an abstract
of the title.
Fair Credit Reporting Act
A consumer protection law that regulates the disclosure of consumer credit
reports by consumer/credit reporting agencies and establishes procedures
for correcting mistakes on one's credit record.
fair market value
The highest price that a buyer, willing but not compelled to buy, would
pay, and the lowest a seller, willing but not compelled to sell, would accept.
Fannie Mae
A congressionally chartered, shareholder-owned company that is the nation's
largest supplier of home mortgage funds.
Fannie Mae's Community Home Buyer's Program
An income-based community lending model, under which mortgage insurers and
Fannie Mae offer flexible underwriting guidelines to increase a low- or
moderate-income family's buying power and to decrease the total amount of
cash needed to purchase a home. Borrowers who participate in this model
are required to attend pre-purchase home-buyer education sessions.
Federal Housing Administration (FHA)
An agency of the U.S. Department of Housing and Urban Development (HUD).
Its main activity is the insuring of residential mortgage loans made by
private lenders. The FHA sets standards for construction and underwriting
but does not lend money or plan or construct housing.
fee simple
The greatest possible interest a person can have in real estate.
FHA mortgage
A mortgage that is insured by the Federal Housing Administration (FHA).
Also known as a government mortgage.
finder's fee
A fee or commission paid to a mortgage broker for finding a mortgage loan
for a prospective borrower.
first mortgage
A mortgage that is the primary lien against a property.
fixed-rate mortgage (FRM)
A mortgage in which the interest rate does not change during the entire
term of the loan.
flood insurance
Insurance that compensates for physical property damage resulting from flooding.
It is required for properties located in federally designated flood areas.
foreclosure
The legal process by which a borrower in default under a mortgage is deprived
of his or her interest in the mortgaged property. This usually involves
a forced sale of the property at public auction with the proceeds of the
sale being applied to the mrotgage debt.
fully amortized ARM
An adjustable-rate mortgage (ARM) with a monthly payment that is sufficient
to amortize the remaining balance, at the interest accrual rate, over the
amortization term.
good faith estimate
An estimate
of charges which a borrower is likely to incur in connection with a settlement.
hazard insurance
Insurance protecting against loss to real estate caused
by fire, some natural causes, vandalism, etc., depending upon the terms
of the policy.
housing ratio
The ratio of the monthly housing
payment in total (PITI - Principal, Interest, Taxes, and Insurance) divided
by the gross monthly income. This ratio is sometimes referred to as the
top ratio or front end ratio.
HUD
The U.S. Department of Housing
and Urban Development.
index
A published interest rate to which the interest rate on
an Adjustable Rate Mortgage (ARM) is tied. Some commonly used indeces include
the 1 Year Treasury Bill, 6 Month LIBOR, and the 11th District Cost of Funds
(COFI).
lien
An encumbrance against property for money due, either voluntary
or involuntary.
lifetime cap
A provision of an ARM that limits
the highest rate that can occur over the life of the loan.
loan to value ratio (LTV)
The ratio of the amount
of your loan to the appraised value of the home. The LTV will affect programs
available to the borrower and generally, the lower the LTV the more favorable
the terms of the programs offered by lenders.
lock-in
A written agreement guaranteeing
the home buyer a specified interest rate provided the loan is closed within
a set period of time. The lock-in also usually specifies the number of points
to be paid at closing.
margin
The number of percentage points a lender adds to the index
value to calculate the ARM interest rate at each adjustment period. A representative
margin would be 2.75%.
mortgage
A legal document that pledges a property
to the lender as security for payment of a debt
mortgage disability insurance
A disability insurance
policy which will pay the monthly mortgage payment in the event of a covered
disability of an insured borrower for a specified period of time.
mortgage insurance (MI)
Insurance written by an
independent mortgage insurance company protecting the mortgage lender against
loss incurred by a mortgage default. Usually required for loans with an
LTV of 80.01% or higher.
mortgagee
The person or company who receives the
mortgage as a pledge for repayment of the loan. The mortgage lender.
mortgagor
The mortgage borrower
who gives the mortgage as a pledge to repay.
non-conforming loan
Also called a jumbo loan. Conventional home mortgages not
eligible for sale and delivery to either Fannie Mae (FNMA) or Freddie Mac
(FHLMC) because of various reasons, including loan amount, loan characteristics
or underwriting guidelines. Non-conforming loans usually incur a rate and
origination fee premium.The current non-conforming loan limit is ,601
and above.
note
A written agreement containing
a promise of the signer to pay to a named person, or order, or bearer, a
definite sum of money at a specified date or on demand.
origination fee
A fee imposed by a lender to cover
certain processing expenses in connection with making a real estate loan.
Usually a percentage of the amount loaned, such as one percent.
owner financing
A property purchase transaction
in which the property seller provides all or part of the financing.
Planned Unit Developments (PUD)
A subdivision of
five or more individually owned lots with one or more other parcels owned
in common or with reciprocal rights in one or more other parcels.
PITI
Principal, interest, taxes and insurance--the
components of a monthly mortgage payment.
points
Charges levied by the mortgage lender and
usually payable at closing. One point represents 1% of the face value of
the mortgage loan.
prepaids
Those expenses of property which are paid
in advance of their due date and will usually be prorated upon sale, such
as taxes, insurance, rent, etc.
prepayment penalty
A charge imposed by a mortgage
lender on a borrower who wants to pay off part or all of a mortgage loan
in advance of schedule.
principal
Amount of debt, not including interest.
The face value of a note or mortgage.
private mortgage insurance (PMI)
Insurance
provided by nongovernment insurers that protects lenders against loss if
a borrower defaults. Fannie Mae generally requires private mortgage insurance
for loans with loan-to-value (LTV) percentages greater than 80%.
qualifying ratios
The ratio of
your fixed monthly expenses to your gross monthly income, used to determine
how much you can afford to borrow. The fixed monthly expenses would include
PITI along with other obligations such as student loans, car loans, or credit
card payments.
rate cap
A limit on how much the interest rate
can change, either at each adjustment period or over the life of the loan.
rate lock-in
A written agreement in which the lender guarantees the borrower
a specified interest rate, provided the loan closes within a set period
of time.
rebate
Compensation received from a wholesale
lender which can be used to cover closing costs or as a refund to the
borrower. Loans with rebates often carry higher interest rates than
loans with "points" (see above).
refinancing
The process of paying off one loan
with the proceeds from a new loan using the same property as security.
residential mortgage credit report (RMCR)
A report requested by your lender that utilizes information
from at least two of the three national credit bureaus and information provided
on your loan application.
seller carry back
An agreement in which the owner of a property provides financing,
often in combination with an assumed mortgage.
survey
A print showing the measurements
of the boundaries of a parcel of land, together with the location of all
improvements on the land and sometimes its area and topography.
tenants-in-common
An undivided interest in property taken by two or more persons.
The interest need not be equal. Upon death of one or more persons, there
is no right of survivorship.
title
The evidence one has of right to possession
of land.
title insurance
Insurance against loss resulting
from defects of title to a specifically described parcel of real property.
title search
An investigation into the history
of ownership of a property to check for liens, unpaid claims, restrictions
or problems, to prove that the seller can transfer free and clear ownership.
total debt ratio
Monthly debt and housing payments
divided by gross monthly income. Also known as Obligations-to-Income Ratio
or Back-End Ratio.
Truth-in-Lending Act
A federal law requiring a disclosure
of credit terms using a standard format. This is intended to facilitate
comparisons between the lending terms of different financial institutions.
Veterans Administration (VA)
A government agency
guaranteeing mortgage loans with no down payment to qualified veterans.
