Choosing the Right Loan and Right Down Payment

At first glance, it may seem as though large down payments and short loan terms are the key to saving money on a mortgage, but each of these decisions has its own benefits and shortfalls. We can help you put them in perspective so you can make the best choice with respect to your circumstances.

Deciding on a loan and down payment amount for your upcoming home purchase isn’t always easy. Several factors can impact which loan program you can, or should, use. Understanding options early on is a great way to save time and be sure you start the loan process in the right direction.

Finances And Credit

With so many types of loans and down payments available, how do you know which one is right for you? Start by being honest with yourself about your finances.

How much money do you have saved to put toward the down payment and closing costs? Keep in mind that you need to save about 3% of the cost of the house for closing expenses. While you won’t need a down payment for VA and USDA loans, you will typically need a 3.5% down payment plus closing costs for FHA loans, and 5 to 20% down plus closing costs for conventional loans.

Have you taken care of your credit? If your credit score is less than 620, you will not qualify for a conventional loan. If it is less than 740, your conventional loan interest rate will be higher than it could otherwise be.

FHA requirements allow someone with a lower credit scores to purchase a home, as do other government-backed loans. Regardless of the loan program, a higher credit score is always better – so do what you can now to ensure you have the highest score possible when it comes time to obtain your mortgage loan.

Timing

Government-backed loans may require more paperwork or inspections than conventional loans. Because of this, they could take slightly longer to process. If you need to move in a hurry, Government-backed loans may present unwanted challenges. Remember that missing or out-dated paperwork is one of the top reasons for loan delays – so stay on top of your documentation with the assistance of your loan officer to ensure a smooth closing.

Savings and Opportunity Costs

You may have a 20% down payment saved along with closing costs, but do you really want to spend it now? For conventional loans, you can put 20% down and avoid private mortgage insurance (PMI), or you can put as little as 5% down with PMI. Let’s look at an example to understand the costs and benefits of these two programs in more detail. For this example, we’ll consider these two options when purchasing a $250,000 home using a 30-year fixed rate loan at 3.5%.

Option 1: A 20% down payment ($50,000) results in a $898 monthly mortgage payment which includes principal and interest.  No mortgage insurance is required because the down payment is equal or greater than 20%.

Option 2: A 5% down payment ($12,500) results in a $1,167 monthly mortgage payment which includes principal, interest and mortgage insurance (which is $101 monthly).

Most people look at the monthly payments and say that obviously, they would want to pay less per month, so they would choose the first option. However, let’s look a little closer. In order to save $269 a month, you would have to reduce your savings by $37,500. At $269 a month savings, it will take you 139 months—almost 12 years—to recoup this money. That’s a lot of time to live without a substantial nest egg.

Then you have to look at opportunity costs. What else might you want to do with this money if it weren’t tied up in your house? Perhaps you’ll be asked to be a bridesmaid in a wedding and won’t want to have to refuse because you can’t afford the dress. Perhaps someone will have a destination wedding in Puerto Rico, and you won’t want to have to decline because airfare is not in the budget.

Maybe you’ll have the opportunity to buy the sailboat you’ve always wanted at a steal, and having that money in the bank will allow you to bring your dream to fruition. Maybe the money would be better off earning interest or making a great return on investment in the stock market. No matter what, that $269 a month savings has an opportunity cost, and you need to consider that when making a decision.

Length of the Loan

Should you apply for a 15-year or a 30-year mortgage? After looking at the numbers, most people agree the substantial savings in interest that comes with a 15-year mortgage makes it an attractive option. In reality, affording a 15-year mortgage is more difficult and may result in being house poor, meaning that you can afford your house but nothing else.

Think of the opportunity costs associated with selecting a shorter term loan with a higher payment: A higher monthly housing payment results in less funds for investments, smaller retirement accounts and less resources to support a growing family.

Also consider how long you intend to stay in the home. If you feel confident that you will remain in the home for years to come, then a shorter loan might be worth the interest savings. On the other hand, if you plan to move on quickly, it might be better to use the monthly savings that comes with a longer term loan towards other things, even if it means simply saving the money for your next move.

If you aren’t sure, you can always go with a 30-year mortgage and make the larger payments of the 15-year schedule by paying extra payments to your principal. In this way, you can have the benefits of a shorter loan but still be able to go back to a 30-year schedule if funds get tight or your financial situation changes. Remember that in these cases, once you pay money into your mortgage you need to “ask” for it back by applying for a new loan or second mortgage to access the equity.

With so many options available, it is important to compare rates and programs to determine which combination works best for you. At today’s low rates, you are sure to find many good choices so it is hard to go wrong!

Reverse Mortgages: What You Need to Know

How do reverse mortgages work, and when should someone look to obtain one? We’ve got answers to help you decide whether this commonly misunderstood product could be the best solution for you.

Reverse mortgages have been around for quite some time in various shapes and forms. Today’s reverse mortgage is very different from those of the past thanks to more safeguards, in the form of limitations, in place. Due to recent changes, reverse mortgages are making their way back into the mainstream of mortgage products nationwide. Sometimes referred to as a HECM (“heck-um”), the home equity conversion mortgage is a loan insured through the Federal Housing Administration (FHA).

At first, it’s difficult to get one’s head around a reverse mortgage because intuitively consumers are familiar only with traditional mortgages. With a traditional mortgage, money is borrowed and paid back in the future at regular intervals.

Reverse mortgages are set up in just about the same fashion with two main differences. First, they are far more flexible than traditional loans in that they can be customized to suit individual needs. Second, the timing associated with when the funds and interest must be paid back is quite different. Let’s take a closer look to gain a better understanding.

Reverse Mortgage Mechanics

A reverse mortgage is a loan where homeowners can access the equity in their home similar to a traditional mortgage or HELOC. Unlike a traditional loan, a reverse mortgage doesn’t require interest payments on a monthly basis. Rather, the interest accumulates and is simply paid at the time of a maturity event.

A maturity event is typically associated with selling the home or the borrower, or borrowers, passing. At the time of a maturity event, the FHA insurance on the loan ensures that any amount due does not exceed the value of the home at the time of sale. This feature is called “non-recourse” and is one of the main protections accompanying a reverse mortgage transaction.

As with traditional mortgages, those who take out a reverse mortgage may choose either a fixed or an adjustable rate loan. With adjustable rate programs, there are different types of disbursements that can be made. Homeowners can choose equal installments to be paid for as long as at least one of the borrowers continues to live in the property, or they can choose to receive reverse mortgage loan proceeds in equal monthly payments for a preselected period of time. They can also open a line of credit, much like a HELOC. Finally, borrowers can choose to receive a lump sum payment combined with monthly installments for as long as they occupy the property, or a combination of monthly installments and a line of credit.

With the fixed rate option, there are no installment payments or lines of credit available. Rather, a single lump sum is paid at closing.

Interest rates have historically been quite competitive on reverse mortgage loans. In most cases, both fixed rate and variable rate loan options are within 1% of the best rates on the market.

One other important note: As mentioned above, interest accrues on a reverse mortgage just like any other mortgage loan. As we will see below, qualifying for a reverse mortgage is much easier than a traditional loan – particularly in today’s tough lending environment.

It is important to point out that reverse mortgage borrowers can make payments on their reverse mortgage at any time – effectively turning them into the traditional loans we find more familiar. This means, for those who qualify, there may be an easy alternative to that traditional loan qualification process – so keep an open mind!

Who Qualifies?

Anyone who is at least 62 years of age, is currently a homeowner, and has sufficient equity in order to make the reverse mortgage loan work is a candidate for this product. It used to be that reverse mortgage loans were notoriously easy to qualify for. All one needed to have was sufficient equity in the home. Credit scores were not checked, and no employment or income was required.

Today, however, borrowers must be able to show they have the resources necessary to pay for annual property taxes, insurance premiums and maintenance of the home. This change was implemented after many reverse mortgage borrowers fell behind on their property taxes and local counties began foreclosure proceedings. As an additional safeguard, reverse borrowers also complete a reverse mortgage loan counseling session, which can typically be done over the phone or in person with a non-profit counseling agency.

As long as the borrowers have sufficient equity and can demonstrate they’re able to maintain the home and to take care of housing expenses such as taxes and insurance, a reverse mortgage is an easy loan to obtain.

How Much?

The amount one can be approved for is based on a set of actuary tables and takes into consideration the age of the youngest borrower on the loan application, current interest rates and the current value of the property. Loan sizes are larger for older borrowers with shorter life expectancies, when lower interest rates are available, and when the home value is higher.

If there is an existing mortgage on the property in the form of either a first or second lien, the proceeds from the reverse mortgage must go toward paying off those liens, leaving the reverse mortgage as the sole lien on the property. If the reverse mortgage is not sufficient to pay off the existing mortgage, the loan approval can be issued, but the borrowers must bring the extra money to closing to cover the difference.

When an existing mortgage is paid off, that frees the homeowners from making mortgage payments ever again as long as they own and occupy the property. For those who are “house rich” and would like to get rid of their current mortgage payment, a reverse mortgage is an ideal option.

Reverse Myths

Will the lender take my home? Do I lose ownership?

No. The homeowner does not lose ownership of the property. Similar to any other mortgage, the reverse mortgage lender simply has a lien on the property signifying there is an amount which must be paid off prior to a sale or another refinance.

What about my heirs?

Once the home is sold or no longer considered the borrower’s primary residence, the accrued interest and other finance charges must be settled. After the reverse has been paid off completely, any remaining equity will go to the homeowner’s heirs. In the event that the amount owed exceeds what the home value is at the time of sale, the non-recourse features ensures that the sale of the home fully covers any debt owed (Even if FHA must take a loss!).

Aren’t reverse mortgages expensive?

Not really. They do have origination fees like other loans, and there is a mortgage insurance premium that must be paid, but today’s reverse fees are much lower than they used to be, especially in comparison to the costs of selling. There are also options for nearly zero mortgage insurance paid up front. Similar to any other mortgage loan, there is not “one rate” and “one set of costs”. Shop around by using MortgageCS to compare – you’ll see quite a difference between lenders.

Don’t I have to pay income taxes when I take out a reverse mortgage?

Reverse mortgage proceeds are not considered income as you are simply trading one asset for another: Equity in the home for cash in hand. Generally speaking, cash received from a reverse mortgage is treated just like cash out from a traditional refinance. Due to this, it is not counted as income. To be sure, it always makes sense to contact your tax professional, as every homeowner’s situation is unique.

What if the home is sold and there isn’t enough money to pay for everything? Won’t my heirs be held responsible for my debt?

No. If the home is sold for at least the lower of the reverse mortgage balance or 95% of the current appraised value, the reverse mortgage insurance premium taken out on the loan will cover the loss. No debt is passed on to your heirs, and they are not responsible for paying any balance due.

Second Mortgages: What You Need to Know

What is a second mortgage? Isn’t just one mortgage enough? A second mortgage can allow you to access home equity for future purchases and great flexibility. Read on for more about the types available and what each will mean for you.

When most homeowners speak about second mortgages, they’re not talking about an additional mortgage used to buy a home as part of a combo loan, or refinancing an existing loan. They’re referring to a brand-new mortgage that sits in a second lien position behind an existing first mortgage. Second mortgages come in a few different shapes and sizes – and each can address a specific need.

The Home Improvement Loan

A second mortgage can be one loan paid out over time, used to either pull a sum of cash from the equity in your home or perhaps to undertake a home improvement project. For example, a couple who owns a home currently valued at $500,000 has an existing first mortgage balance of $250,000. Their family has begun to grow, and they will soon need another bedroom. They’ve looked into selling their three bedroom home and buying a home with four bedrooms, but that would mean borrowing more and having a larger mortgage than they currently have.

Instead, they decide to add onto their existing home. They work with an architect and a contractor and determine that the addition will cost another $50,000. They add on another $5,000 for “just in case” scenarios, and apply for a second mortgage in the amount of $55,000. The mortgage application is approved, and the lender deposits $55,000 into their bank account. The lender’s guidelines for the second lien required the combined loan to value—the combination of the first and second lien to be placed—was no greater than 80 percent of the current value of the home. This is referred to as the CLTV. The loan this couple received is a fixed-rate second lien with monthly payments stretched out over 15 years, but other terms are available.

Okay, now what if the 80 percent CLTV had posed a problem? What if the property had been worth $400,000 now, rather than $500,000? When improvements are made to a property, the lender can consider the future value of the property when reviewing the appraisal. Let’s say for a moment that adding the fourth bedroom increased the value of the property from $400,000 to $450,000. At the end of construction, the lender would have sent out an inspector who makes sure that that the construction had been completed and that the home’s value had risen to $450,000. In this example, the CLTV would now be 68, well below the 80 percent requirement. This type of arrangement, where a lump sum of cash is provided with a predetermined payment schedule, is referred to as a “closed end” second.

The HELOC Option

A more common type of second lien is a home equity line of credit, or HELOC. A HELOC works much like an everyday credit card, yet the loan is secured by the property. HELOCs also have CLTV requirements that must be met, and they most often use the current market value of the property.

Let’s again assume the CLTV guideline is 80 percent, and consider a home currently appraised at $500,000 with an existing first lien mortgage balance $350,000. Since 80 percent of $500,000 is $400,000, and an existing lien of $350,000 is already in place, a HELOC for $50,000 can be obtained on this property.

Let’s say the couple decides to accept the $50,000 offer. They will now have $50,000 accessible to them just as they would with a credit card, but the interest rates will be substantially lower. Most HELOCS require a minimum amount to be withdrawn, but once repayment is made that balance is immediately reduced.

HELOCS have a draw period, typically the first 10 years, followed by a repayment period that lasts for the remaining term of the loan. Most HELOCs are set for 25 or 30-year terms and have adjustable rates that can fluctuate as rates rise and fall throughout the repayment period.

Subordination

A second lien is more than just another lien placed on a property subsequent and subservient to the first. The second mortgage does not have the same types of legal protection that the first mortgage has, and should the borrowers ever go into default, it’s possible the second lien lender will be left out in the cold, having to deal with the collection process well beyond the foreclosure date.

When a lender is forced to foreclose on a property, the “superior” liens are paid off before any others. A first mortgage used to buy and finance a property is such a lien. Other superior liens are those filed for delinquent property or income taxes. Support payments to an ex-spouse, and child support are superior to a second lien as well. So are mechanic’s liens filed when a contractor builds or makes improvements on a home.

Once all those liens are satisfied after a foreclosure auction, it’s possible there isn’t enough money left to pay off the second lien holder. This is one of the reasons why second lien interest rates will always be higher than what is available for a first lien mortgage used to purchase a home. Simply put, there is greater risk associated with these loans.

There are also times when homeowners fail to pay the second mortgage but are still paying the first mortgage to the satisfaction of the first lien holder. The second lien lender then has the right to foreclose on the property but again, any and all superior liens will be paid off first.

The two types of second liens: closed-end seconds and a HELOCs, are excellent ways to access home equity without having to refinance your entire mortgage to pull out cash, a practice referred to as a “cash-out” refinance. If you plan to use the funds for a specific purpose without the need for future funds, a closed-end second might be the better choice. If you want access to the equity over time with a revolving line of credit, then a HELOC is the best fit for you.

Student Loans and Mortgages: A Financial Balancing Act

You’ve done your time in academia and have come out of college or grad school with a solid job, a good-looking spouse, and, if you’re like most college graduates these days, a fair amount of student debt. After renting for most of your adult life, you might feel ready to purchase your own home and have a space that is truly yours.

It’s certainly possible to qualify for a mortgage while you’re paying student loans, and in many cases it’s even financially advantageous. But before you stay up all night trolling online sites to find your dream home, there are a few factors you should consider to make sure you’re ready to handle both your student loan payments and a new mortgage. Prepare your finances first — then start packing.

Determine When and Where to Buy

Buying a house is a huge investment of both time and money. Before you dive into your search headfirst, take time to reflect on your short-term and long-term goals. Start by asking yourself a few questions:

  • Do you expect to stay at your job, or in your city for the next few years?
  • Do you plan on expanding your family?
  • Is the rent in your city exceptionally high?

Figure out how long you expect to stay in a new home, and whether renting or buying is the better value in your city. Once you decide that buying is the right choice for you, you can then determine how your student loans might affect your ability to qualify for a mortgage.

Make Sure You Can Afford Your Monthly Payments

It’s no secret that finances are an important factor when deciding on your price point. You might be able to handle your monthly principal mortgage payment, but there are many other fees to consider. Here are the most common ones:

  • Interest
  • County or city real estate taxes
  • Homeowners insurance
  • Mortgage insurance (if you have less than a 20% down payment)

These annual fees are broken down and incorporated into your mortgage payment each month. You also need to factor in the cost of home repairs. For relatively new houses, be prepared to set aside at least 1% of the home’s value each year for upkeep. All of these extra expenses might start to feel like a burden if you’re already paying off a sizable student loan balance.

Look at your Finances from a Lender’s Point of View

One of the biggest ways your student loans can affect your ability to qualify for a mortgage is through your debt-to-income ratio, or DTI. This number helps both you and your lender determine what mortgage amount you can realistically afford to repay. For most loan programs, you’ll need a DTI of 41% or lower. Here’s how to calculate yours:

Start by adding up all of your recurring monthly debts, like your credit card minimums, car loans and student loans. Don’t include bills like your cell phone, car insurance or utilities. Then divide that number by how much money you make each month (before taxes are taken out). Multiply your answer by 100 and you’re left with your DTI percentage. Let’s take a look at an example.

Claudia earns $4,000 each month before taxes and health insurance are deducted. She doesn’t have credit card debt, but her monthly student loan payment is $500, and her car payment is $400. So in total, her recurring debt payments come to $900.

$900 / $4,000 = 0.225

That means Claudia’s debt to income ratio is 22.5% — she’s a great candidate for a mortgage!

Consider the Pros and Cons of Refinancing Your Student Loans

You could always increase your down payment amount to lower your home loan starting balance and the associated DTI, but if you don’t have the cash or simply don’t want to deplete your savings, refinancing your student loans may help you qualify for a mortgage. Start by looking for a lower interest rate from private lenders.

Federal Student Loans

Federal loans are already consolidated, and cannot be refinanced, so you’re unlikely to save any money on interest with regard to them. What you can do, however, is lengthen your loan term on a federal loan. On the plus side, you’ll enjoy lower monthly payments, which can help get your DTI under 41% for buying a house. The downside is that you’ll pay substantially more interest in the long run.

Private Student Loans

Shop around with several different lenders to find the best rates on private loans. As with federal loans, you can extend the payment term to lower your monthly payments, or you can check into alternative lenders who use more diverse underwriting standards compared with traditional financial institutions. Refinancing your student loans is a big decision, so make sure to do your research and review multiple lenders before making a commitment.

“My Loan Was Sold!” (Video)

If you know your loan is going to be sold, or if you just found out it was sold, you may be wondering how it could impact your situation.

Watch this short video and find out what you really need to know:

Transcript of Video:

If you know your loan is going to be sold, or if you just found out it was sold, there is no need to panic. Lenders sell all types of loans to other banks on a regular basis. It’s part of their daily business and it’s how they ensure they can continue to make more loans in the future.

In all likelihood, your mortgage will probably change hands several times as banks buy and sell on the secondary market.

So what is this secondary market all about? And how does it impact the terms of your mortgage?

Let’s start with the impact on your loan. There’s no real impact. You have a contract that guarantees the terms of your mortgage, even after it’s sold to another lender. You may have to change the auto-payment settings on your checking account and call a different customer service number, but there won’t be any changes to any of the terms of your agreement.

Now why would a lender sell your loan in the first place? And what’s the secondary market? To answer this question you just need to remember that banks are always working to maximize their profits. And sometimes it’s better for them to sell a loan today, instead of waiting 15 or 30 years to collect small chunks in monthly payments.

Some lenders will sell a mortgage immediately after it closes, often lining up buyers while the loan is still being processed. Other lenders wait until they have a batch of loans. Then they sell them together in a single package, which bankers refer to as a “bulk” sale.

Keep in mind that the secondary mortgage market increases competition, which improves mortgage pricing and terms for you as the borrower. So the fact that your loan can be sold is a very good thing and it shouldn’t be perceived any other way.

Ace the Mortgage Process with these 7 tips

Buying a home is considered one of the most stressful events in the average person’s life, but it doesn’t have to be that way. Read on for simple steps you can take to avoid unnecessary frustration and delays.

Be Responsive

After you complete your loan application and submit your documentation, the loan officer needs time to review what you have submitted and make sure nothing is missing. He or she might have questions about your paperwork.

For example, your application might state that you make $6,000 per month while your year-to-date pay stub doesn’t match up exactly. Your loan officer or loan processor would then call or email you asking about the discrepancy. The lender can work on other parts of your loan application while awaiting your response, but when there is a question about income, the lender can only go so far. The longer you delay your response, the longer it will take the lender to process your application. You might even miss your settlement date!

When asked to clarify something about your application, respond quickly and clearly. If you have documentation to support your claim, always send it to your loan officer.

Review Your Credit In Advance

It’s easier than ever these days to get a free copy of your credit report. You really should review it annually, looking for any errors. Many credit card companies today offer a free credit score service, and the three main credit repositories: Equifax, Experian and TransUnion have also created a portal at annualcreditreport.com, where you can view and print your credit report for free.

When reviewing these reports, don’t focus exclusively on the score as it won’t be the very same one the mortgage company receives (but it should be close). What you’re looking for are mistakes because unfortunately, credit reports can often contain errors. Someone else’s bad credit might pop up on your report, or a creditor could mistakenly report a late payment. Don’t be caught off guard when your loan officer calls and tells you something on your credit report is causing problems – be proactive to preserve your credit profile.

Gather Your Financials

When you submit a completed loan application, you’ll also be asked to provide some documentation that will verify certain aspects of your loan. Prepare these in advance so you won’t have to worry about scrambling for paperwork while the clock is ticking on a 30-day closing. Gather your:

  • Most recent pay stubs covering the last 30 days
  • Two most recent W2 forms from your employer(s)
  • Most recent bank statements (all pages) covering the past 60 days
  • Homeowners insurance information
  • Two most recent annual federal income tax returns
  • A year-to-date profit and loss statement as well as business bank statements if self-employed

Note: When using a digital mortgage platform, you’ll still need information contained on these documents – or should review them to eliminate any surprises.

Lookout For New Info

Just before your settlement date and the signing of your loan papers, the lender will make a final pass over your application to be sure the documentation in the file is current.  This includes a review of recent pay stubs, retirement account documents, bank statements and other items. At this time, if there is a more recent document available, the lender will ask for it – and it will feel like a bit of an emergency.

To avoid this issue, always provide updated documents to your lender right when you receive them. You should also save a copy of all messages sent – so you can easily resend if needed.

Don’t Make Changes

This is one of the most common requests/gripes from loan officers when accepting a loan application because the consequences can be catastrophic.

Here are the “Don’ts” to follow when your loan is in process:

  • Don’t take out another credit account.
  • Don’t get a new phone
  • Don’t miss a payment on anything
  • Don’t ask a credit card company for a credit line increase
  • Don’t accept a new credit card offer
  • Don’t co-sign on a loan
  • Don’t buy or lease a car
  • Don’t change jobs
  • Don’t deposit cash into your savings or checking account
  • Don’t withdraw cash from your savings or checking account
  • Don’t change at all from what appears on your mortgage loan application.

Here is the list of “To Do” to follow when your loan is in process:

  • Follow the list above

Ask Questions

One of the main responsibilities of your loan officer is to ensure you have a clear understanding of the process, especially as it relates to closing costs and your interest rate. When you receive your initial offers or cost estimate, review the prospective charges with your loan officer line item by line item and get a clear picture of not just the charge, but why it’s being ordered.

For example, all transactions require a certified Flood Certificate stating whether or not the property is located in a flood zone. Even if your property is nowhere near water or flooding, you’ll still need this in your file. It’s best to ask questions long before you get to the closing table.

Follow Your Lender’s Lead

If you could to look inside your mortgage company while your loan application is being documented and verified, it would probably look like people were spinning plates.

Mortgage lenders must document every aspect of your application and work with multiple other professionals to complete the documentation process in order to get your loan to the underwriting department, which then approves loan. We touched on this earlier, but it can’t be stressed enough: follow the advice of your loan officer, and work with your loan processor to provide requested information as soon as possible.

Mortgage companies do one thing and one thing only: they process mortgage loans. They know exactly what documentation is required and when, so follow the mortgage company’s lead.

If you follow these simple steps, you will be your loan officer’s favorite borrower but more importantly, your loan approval will be easy and stress-free. It all boils down to communication. Talk, ask questions and work hand-in-hand and with your mortgage company to ensure a smooth and simple transition into home ownership.

Mortgage Closing Costs: 3 keys to successful shopping

Getting a mortgage is a complex transaction. Behind the scenes, the process of completing a mortgage requires services from a range of different providers.  Mortgage lending guidelines state that any company providing a service on your loan (and charging for it) must be accounted for and documented within your loan file.

Where can you find your closing costs?

Your mortgage company will typically collect the necessary documents pertaining to these charges and deliver a Loan Estimate.  By law, a Loan Estimate is provided to you within three days of your loan application.  This will be your first opportunity to see a detailed breakdown of the closing costs you can expect for your purchase or refinance. While some charges shown can change by up to 10 percent or more, other charges must be exact and cannot change between the time you make your application and your closing date.

When you first view the Loan Estimate, it may seem a bit confusing as you’ll find charges from numerous third parties – and you may not recognize the names or services they offer.

Fortunately, taking a short amount of time to understand the different categories of closing costs, fees and points will vastly improve your chances of getting a great deal because you will be an informed consumer. So read on!

1. Recurring vs. Non-Recurring Costs

When it comes to the costs of your mortgage loan, certain costs will occur again (recurring), while others are associated with the transaction only and are simply one-time charges (non-recurring).

Why is this important? It is important to differentiate these costs, as recurring costs will typically be associated with owning the actual property (regardless of which mortgage company closes your loan) and should be factored into your ongoing budget. Non-recurring costs are associated purely with the transaction and will not come up again.

Recurring Costs

Recurring costs include prepaid interest charges which are, in reality, your very first mortgage payment! (Wasn’t that exciting!) Normally, mortgage payments are made in arrears, which means that on the first day of every month, you are paying for the previous month’s interest accumulation and a bit of the principal balance.

When it comes time for your closing, you’ll see an amount listed as prepaid interest.  Prepaid interest is a “per diem” (per day) charge of interest between the day your loan closes up to the first day of the following month. This is the one and only time you will pay for interest ahead of time when it comes to your mortgage loan.

Example: Suppose your settlement date is on the 20th of a given month. Your settlement agent will collect ten days of interest (assuming 30 days in the month) at the time of closing. Again, this is your very first mortgage payment, and it is collected in advance just this one time.

Another form of recurring costs involves your property taxes and homeowners insurance. A full year of homeowners insurance premium is typically collected and paid to your insurance company at the time of closing.  Also, you’ll need to pay some amount of property taxes that may be due in the coming year. Property tax collection times and frequency will vary by state or county and include funds paid to the local school district, county and city.

Property taxes and homeowners insurance are recurring costs because you must continue to pay them as long as you are in your home – even if you pay off your mortgage balance completely!

If you decide (or are required to) escrow for these two items, your first regularly scheduled mortgage payment after closing (and all others) will include one-twelfth (1/12th) of your yearly tax and homeowners insurance amount.  These incremental payments will be accumulated by the mortgage company and paid when due.  If you receive a tax bill or insurance bill when you are escrowing these items it is always a good idea to forward to your mortgage company immediately.

Non-Recurring Costs

Non-Recurring costs are those costs associated with the closing of your mortgage loan which will not occur again.  Typically, these are referred to as transaction costs. Examples include a lender/broker fee (could be called “Origination Fee”), an appraisal fee, and document preparation fees.

In some states, you may also be required to pay a state-mandated transaction fee at closing. In the state of Pennsylvania, for example, a two percent (2%) transfer tax is charged by the State for each home purchase. This amount is typically split between the buyer and seller and is not a lender charge.

2. Lender Fees vs. Non-Lender Fees

When it comes to shopping for the best mortgage deal between lenders, you’ll want to pay attention to fees payable to the lender versus fees payable to third parties. Why? Lender fees and interest rates are the true “apples to apples” numbers you can compare when shopping for your mortgage provider. Accordingly, lender fees should be considered separately from third party fees which are payable to different companies and cannot be “padded” by the lender.

Note: You can always shop for third party services such as appraisal services, title companies and home inspectors, after you select a mortgage lender. 

Lender Fees

A lender or broker fee will appear in black and white when you are comparing offers or when you are viewing a Loan Estimate. This may also appear as a percentage of your loan amount.  In either case, this amount will be paid directly to the lender or broker in exchange for providing their services.

When two separate lenders provide the same interest rate, the offer that includes lower lender fees is the lower cost option of the two. 

Providing an interest rate above a “par rate” to earn yield spread (YSP) is another way money is generated for mortgage lenders or brokers.  Similar to a retail store owner sourcing and purchasing clothing at wholesale prices and then selling at a retail markup price, the mortgage lender or broker sources your loan on the wholesale market and charges a retail markup interest rate.

Non-lender Fees

Non-lender fees include charges for services such as title insurance, an appraisal or abstract. On your Loan Estimate, as well as on your Closing Disclosure, the lender charges will be located at the top of the document and all non-lender fees will be detailed below. Remember that you can shop for these third party services – just as you would a mortgage lender.

3. What are Points?

A point (discount point) is a percentage of the loan amount you can pay upfront to reduce, or discount, the interest rate on your loan.

Example: A loan officer might quote to you a 30-year fixed rate at 4.75% with no points, but if you want to get a lower rate, say 4.50%, you’ll be asked to pay one point, or one percent of the amount to be borrowed, at closing.

Points are a form of prepaid interest to the lender, and different from an origination fee or other fee, the lender is indifferent if you select to pay them. This is because the lender earns the same amount of interest either way. Either you pay a slightly higher interest rate over time, or you pay the interest upfront via a discount point and pay less interest over the life of the loan.

Lenders can provide an array of interest rate options based upon the number of points purchased. They can offer a particular interest rate for 0 points, another interest rate for 1 point, and so on. To determine whether or not paying points makes sense in your situation, it is a good idea to compare the total funds required at closing and the difference in monthly payments at various rate and point combinations. You may also want to think about how long you intend to be in the home and if paying interest ahead of schedule makes good financial sense.

Tip: Your lender can usually offer a lender credit toward closing costs if you elect to pay a higher interest rate over time. The higher rate generates extra revenue for the lender and they use these funds to pay some or all of your fees. When you hear about lenders advertising a “no closing cost loan,” this is how they do it.

Now that you know a bit more about the types of mortgage closing costs – be sure to compare them along with the interest rate when mortgage shopping. Your choice of a mortgage lender and loan program will have a lasting impact on your budget – so shop for a great loan and set yourself up for financial success by getting the best deal possible.

Tip: Compare mortgage lenders safely and easily at MortgageCS.com.  Once your account is set up – you can anonymously obtain detailed quotes for your exact situation.

VA and USDA Loans: 0% Down Loans For Those Who Qualify

FHA loans may be the most common government-backed loan when it comes to buying a home, but there are two others that may provide an even better fit for the right candidates: VA Loans, and USDA Loans.

VA Loans

The VA loan was created in 1944 to guarantee loans issued to veterans and their families. Many military families find it difficult to qualify for conventional loans due to tough credit standards and down payment requirements, but with a VA loan, home ownership is within their reach.

Here are some points about VA loans that may be of interest to you:

  • There is no down payment required, however, there is a funding fee of 2.15% of the purchase price (3.3% if you’ve used a VA loan before)
  • There is no private mortgage insurance (PMI) required
  • Interest rates can be better than conventional loans by up to 1 percent
  • Qualifying for a loan is easier
  • Your Basic Allowance for Housing (BAH) is counted as income
  • Closing costs can be lower

With such wonderful benefits, why isn’t everyone going for this loan? Not everyone qualifies. Let’s take a look at qualifications for the loan.

The VA Loan is designed for those who have served our country in the military.

To be considered, you must:

  • Have served 90 consecutive days of active service during wartime, OR
  • Have served 181 days of active service during peacetime, OR
  • Have more than 6 years of service in the National Guard or Reserves, OR
  • Be the spouse of a service member who has died either in the line of duty or as a result of a service-related disability

If you meet the military qualifications, you will also have some income qualifications to meet. Unlike most loans, the VA Loan doesn’t set a specific income level requirement. However, you will need to have stable, reliable income that can cover your monthly expenses including the new mortgage payment.

Instead of front-end and back-end debt to income ratios, VA loan requirements look at residual income. Residual income, also known as discretionary income, is the money that is left over after you have made all your monthly payments, including your mortgage and escrows, student loans, car loans, credit card bills, child support, spousal support, day care, and other obligations. Expenses such as food, entertainment, and utilities are not considered when determining your residual income.

USDA Loans

The USDA’s Rural Housing Service offers a program known as the Section 502 Direct Loan Program. This program provides either a direct loan or a loan guarantee to low and moderate-income borrowers wishing to buy in a rural area.

To qualify for this USDA loan, you must:

  • Have an adjusted income that is at or below the low-income limit for the area in which you are buying a home
  • Currently be without good housing
  • Be unable to get a loan from other sources
  • Plan on living in the home as your primary residence
  • Be a citizen of the United States

In addition to the borrower’s qualifications, the home itself must also qualify. It must:

  • Be less than 1,800 square feet
  • Have a market value that is less than the area’s loan limit
  • Have no swimming pool
  • Not be an income generating property
  • Be in an eligible area, which is a rural area with a population of fewer than 35,000 people

These loans have fixed interest rates based on current market rates. However, since the rates are modified by payment assistance, your rate could be as low as 1%. Additionally, most loans are for 33 years instead of the traditional 30. For those with very low income, this can be stretched to 38 years. Finally, you will not need a down payment unless your assets are higher than the predetermined limits. If they are, you may be required to use some of your assets as a down payment.

Unlike other government-backed programs, the USDA program will require that you repay all or a portion of the payment subsidy when you no longer live in the home.

When to Refinance, and When NOT To

Interest rates have been in their narrow range for some time now, after hitting record lows in late 2012. The average 30 year fixed rate hit 3.31% that year according to Freddie Mac’s weekly mortgage rate survey.

You may not be able to find a 3.31% rate today (at least without paying additional fees), but you can still get very close considering the recent few decades of interest rates. Many homeowners have taken advantage of lower rates and refinanced their mortgages to enjoy lower monthly payments, but there are still more who, for whatever reason, haven’t decided whether or not a refinance makes sense.

There are ways to know whether a refinance is a good idea, and it’s not always about the interest rate. Here are some basics to keep in mind when considering a new mortgage:

Interest Rate & Payment

This is the most common reason people refinance. When mortgage rates fall, homeowners soon see solicitations from mortgage lenders announcing the new opportunity to lower their monthly payments. While that certainly makes sense in many cases, it’s not the right solution for everyone, every time. You may have heard it’s a good idea to refinance if rates are say, 1.00% below what you currently have, but the rate is only part of the equation. If you have a 30-year fixed rate of 5.00% and rates fall to 4.00%, then that so-called “rule of thumb” would kick in. But that’s not the only consideration when evaluating a possible refinance.

Instead, you must first weigh the difference in monthly payments compared against the fees associated with getting the new mortgage, then determine how long it would take to recover those closing costs. Let’s look at a basic example. Let us suppose that you have a mortgage balance of $200,000 and a 30-year fixed rate at 4.00%. That puts your current monthly principal and interest payment at $954 per month.

Now imagine interest rates have fallen to 3.25%. The new monthly payment would fall to $870, for a monthly savings of $84 each month. That’s an attractive number, but how much will it cost to get that lower rate? Let’s say that lender fees are $1,000, and other third party charges add up to $3,000 for a $4,000 total. If you divide the monthly savings into the closing costs you get 47.62, or almost 48 months to recover those fees with the lower payment. Is that too long?

Possibly. Some think a recovery term of two to three years makes the most sense, and if you’re going to own the property for at least that long, then a refinance might be a good idea. When refinancing a mortgage because rates are lower, you must also consider the costs involved.

Note: It is also important to consider the costs of re-amortizing (or starting over) on your loan term. These details are not covered in this particular article –however here is a brief: If you are two years into a 30-year loan and refinance into another 30-year loan, you are resetting the 30-year period, meaning you have 30 more years to pay your new amount compared to just 28 years of paying the older mortgage payment.

To reduce costs, it is a popular option to obtain a lender credit at the time of closing. Mortgage companies are typically willing to increase your interest rate in exchange for lower closing costs. Using the example from above, if you increased the new rate from 3.25% to 3.50%, the monthly payment would still be $56 lower. At the same time, the lender would provide you with a credit of $2,000, or 1% of the loan amount. In this instance, the time it would take to recover your closing costs will be under three years, or 35 months- certainly a more attractive option.

If you are wondering how this works, you are not alone. In the same fashion that you can lower a 30-year fixed rate by paying discount points, you can also select to increase your interest rate and have the lender pay some of your costs in the form of a lender credit. Mortgage lenders have no preference on which option you take – so explore your options before making a final decision.

Changing Loan Terms

Another popular reason to refinance is to shorten the term of an existing loan. Reducing the term of a mortgage loan saves a considerable amount of interest, yet it also typically increases the monthly payment. Most borrowers opt for a 30-year fixed mortgage due to the lower monthly payments, even though it will take twice as long to completely pay off the balance.

Continuing our example from above, a $200,000 mortgage with a 30-year fixed rate of 3.50% will require a payment of $898 while a 15-year loan at 3.25% will require a payment of $1,405 per month. While the difference in monthly payment may be significant, so is the impact on how quickly the loan is paid down. Just five years into these loans, the principal balance remaining on the 15-year loan is nearly $36,000 lower, when compared to the 30-year loan option ($179,394 on the 30-year loan compared to $143,814 on the-15 year).

Sometimes the jump in payment between a 30-year fixed rate to a 15-year is too great, so much so that a borrower may not qualify for the shorter-term loan. Fortunately, there are other options that many may not know about. Mortgage lenders typically also offer fixed-rate terms of 10, 20 and 25 years. Compare these options if you want to shorten the term without dramatically increasing your monthly payment.

ARM to Fixed

Adjustable rate mortgages, or ARMs, offer lower introductory rates and can be attractive for buyers who don’t expect to finance a property for the long haul. Most ARM loans begin with fixed rates, which are in place for a period of time ranging between three to 10 years. After this fixed period, the interest rate can vary on an annual or semi-annual basis.

Refinancing an ARM or a hybrid takes the uncertainty out of future mortgage payments. ARMs can offer lower, “teaser” rates compared to fixed-rate products, but because they can and will change at some point, if fixed rates are low and the home owner intends to own the property for the foreseeable future, it is likely a wise decision to refinance.

When NOT to Refinance

Cashing Out

One of the worst reasons to refinance a mortgage is to pull out cash. Refinancing an existing mortgage requires closing costs, but borrowers typically pay for these with the equity in their home, while simultaneously putting some extra cash in the bank or using it for other purposes.

Refinancing for the sole reason of pulling out cash is a bad, expensive idea. If you are in need of extra cash, a home equity line of credit or second mortgage may be a better option as they are much less expensive overall.

Wasted Interest

Let’s review the $200,000 30-year loan at 3.50% from above. After five years, the amount of interest paid is $33,279. At first glance it seems like a good idea to refinance and lower the monthly payments if possible. By refinancing into another 30-year loan, you’ve lost that $33,279 and extended your loan back to its original loan term, effectively changing your original 30-year loan into a 35-year mortgage!

Important Note: In some instances, particularly those that involve low mortgage interest rates and a long-term outlook, a refinance into a longer-term loan could be an advanced and strategic financial planning decision. This is not intended to be financial advice – however, each situation is unique and you should discuss this option with your advisor in detail.

While the majority of homeowners will consider interest rate as the guiding light towards the appropriateness of a refinance, there are many other considerations worth evaluating. Take your time and consider both the short term and longer-term impacts of your refinance decision.

Purchase Mortgages Part 3: What goes into a mortgage payment?

When it comes to buying a home, it isn’t just the loan amount and interest rate that will impact your monthly payment. Additional items such as property insurance and taxes can increase a required monthly payment by as much as 35%.  If you are planning to put down less than 20%, you’ll also want to factor in paying for mortgage insurance each month.

What goes into a mortgage payment?

The good news is that virtually every mortgage payment is made up of the same key ingredients. They are principal, interest, taxes and insurance. These four items are typically referred to as PITI – which, when spoken, sounds like “pity”.

The bad news is that certain factors of your monthly payment will not be within your control.  Namely, the property taxes and property insurance. These factors can change (likely increase) over time and will usually be paid each month along with the principal and interest on your loan.

When you are shopping for a home, keep your eye on the amount of property tax required each year.  Property tax amounts can vary between properties and across state, town or county lines.

Now that you are armed with a better understanding of PITI, be sure to understand the basics of a mortgage and learn about debt ratios.  Once you have a handle on these three topics, you’ll be well on your way to becoming a savvy mortgage shopper and homeowner.

Looking to get your mortgage shopping started (or double check your rate and program)?  Ask your Realtor for access to MortgageCS so you can shop your mortgage terms without the requirement of giving up your personal contact information (and save 90% of the time it takes to shop elsewhere!).

Related Posts in this Series

Part 1: What is a mortgage?

Part 2: What is a debt ratio?