Mortgages explained
First of all….what is a Mortgage?
A mortgage is an agreement between you and your lender that you will repay the money they loaned you to purchase the property. The loan will be paid over a set number of years (amortization schedule) at a certain interest rate. You are using the home as collateral for the loan and the lender places a lien on the property until the loan is paid off or you sell the home.
Definition of a mortgage
Many of the mortgages of just very recently are no longer with us. And that is probably a good thing! Gone are the NINJA’s (No Income No Job and no Assets) or “liar loans” where the borrower just stated their income without providing any supporting documentation. The summers of lending love have passed and with it reality and sanity have returned (and moderate lender paranoia). Lending requirements are a lot stricter these days but if you do qualify for a mortgage today, then you are probably less likely to get into financial problems since the lender will have screened your financial health to the max.
The most important elements of a mortgage
Yes, mortgages can be a little complicated, but it is important that you become familiar with some of the basic concepts so you can protect yourself and get the best deal when shopping around for quotes.
The annual percentage rate (APR): This is what is what you will obsess over the most while shopping for a mortgage. APR is the interest rate you pay on the money you have borrow. The rate can either be fixed for the entire life of the loan (30 year fixed is the most common) or vary based on a pre-agreed schedule (adjustable rate mortgage or ARM). However, just because you got the lowest APR possible does not mean that you got the best overall deal. You need to look at all the fees and conditions associated with the rate you are offered. Keep reading……
Down payment: For first time buyers this can be the hardest part of the home buying process; scraping enough money together to make the down payment. FHA loans can be an excellent fit since they only require a 3.5% down-payment. In addition, all of the down-payment can be a gift from someone else, such as a family member. For the majority of mortgages you will have to come up with a larger down-payment. Lenders who were mauled by the sub-prime crisis (self-inflicted greed wounds!) are now adverse to risk and looking for well-qualified buyers. Since lending requirements are constantly changing the best course of action is talk with a mortgage broker for the most up to date information.
Origination fees, points and closing costs. An origination fee is a charge that the mortgage broker may or may not charge you for putting together your mortgage and acting as an intermediary with those who hold the purse strings (actual lenders). A 1% origination fee is common however you can find plenty of mortgages with no origination fee but you may pay a slightly higher fee.
What are Points? Points are additional fees that you have the option of paying upfront to reduce your interest rate and hence monthly payments. One point is equivalent to 0.125% of the loan amount. For example, for a $250,000 home, 1 point would be $2500. Points might be a good idea if you intend staying in your new home for a long time. However, if you intend selling your new home in less than 5 years or you intend to refinance at some stage, paying points is not a good idea. Personally, I am not a big fan of paying points. If you sell the home before you reap the benefits of the lowered interest rate you have essentially given the lender money for nothing. First time buyers should keep the $2500 and use it for something like paying off higher interest rate loans such as credit card debt.
The length of the loan: The most common types of loans are 30 year fixed which means that you have agreed to pay off the loan over the course of 30 years. Some borrowers who can afford higher monthly payments may opt for a 15 year mortgage. Both the 30 and 15 year loans have a fixed interest rate for the duration of the loan. Riskier adjustable rate mortgages (ARMs) are available but you need to study these very carefully before signing up. For these loans, you have a lower fixed rated initially. The rate then jumps up to the existing prime mortgage rate plus say 2%. A lot of the current foreclosure mess is due to the higher rates kicking in as the APR adjusts. Buyer Beware!
Pre-payment penalties: This clause is included in some mortgages and means that if you pay off the loan, refinance or sell earlier than a set amount of time, you will have to pay a penalty fee to the borrower. Mortgages with this clause will usually have a slightly lower rate. Beware of this when shopping for a mortgage and always ask if it is included. The penalty can be substantial and may restrict your options down the road. My advice, get a mortgage without pre-payment penalties.
Mortgage insurance: If you have a loan for greater than 80% of the value of the home ( > 80% loan-to-value, LTV) then you will have to pay private mortgage insurance (PMI). This is because the lender considers you to be a higher risk and it covers them against you defaulting on the loan. Once you own at least 20% equity in your home, either through paying down the principle on the mortgage or the real estate market going up, you are no longer required to pay mortgage insurance.
PITI stands for Principal, Interest, Tax and Insurance. Each monthly mortgage payment covers a payment on the principal of the loan and also an interest payment. At the start, you will pay more interest than principal as the lender wants their pound of flesh in a hurry! Alas the tax man always commeth and all homeowners are required to pay property taxes to pay for local schools and upgrades to Pike Place Market. Finally, if you have less than 20% equity, you will have to pay mortgage insurance (see above). PITI me indeed!
Closing costs: There are a number of costs associated with buying a home such as title insurance, escrow fees, the appraisal and origination fees for the loan. The cost of these non-recurring fees is collectively referred to as closing costs. At closing you will have to bring a banker’s check to cover your closing costs. Many times your Realtor can negotiate with the seller to have them pay some or all of your closing costs.
