A mortgage, basically speaking, is a loan. When you set out to purchase a home, no one expects you to have, say, $250,000 in cash. So that’s where a mortgage comes in: You borrow the extra money that you need to buy your chosen home, agreeing to pay it back in the coming years. A huge debt? Yes. But its appeal lies in the fact that the mortgage helps you to buy an asset with the expectation that its value will increase over time, which adds to your financial portfolio, gives you a big tax break and, you know, finances a place for you to live.
Along with being expensive, a mortgage can also be complicated, so we’re breaking down the basics for you.
FINDING THE RIGHT LENDER
The companies that supply you with the funds that you need are referred to as “lenders.” Lenders can be banks or mortgage brokers, who have access to both large banks and other loan lenders, like pension funds.
The first thing that potential borrowers should know is that mortgage lenders are in business to make loans. If the underwriter turns down all the applications that lender does not make any money and they are out of business. So the underwriter is not the bad guy in the loan process. Loan guidelines do need to be met and documentation is required and the underwriter’s job to see that those items are achieved for the loan approval.
That said, not all mortgage lenders are created equal. In 2012, the biggest lenders in the country included Wells Fargo, Chase and Bank of America. Those big banks have some great mortgage programs, but they aren’t the only option. You may decide to go local, which is great, but keep in mind that many community banks or credit unions will make a loan to you initially, and then sell it to one of these larger institutions. You want to make sure that you choose the mortgage program that’s right for you, and that whoever you work with directly has a reputation for being reliable and efficient.
STAN’S SLANT Consider finding your mortgage professional first, before hiring a real estate agent. Why? Before shopping for that new home, shouldn’t you know how much you can qualify for first? Why take your time and the real estate agent’s time looking at homes that are well above what you can qualify for?
SHOW ME THE MONEY
Cash may be king, but a high credit score is even better. Mortgage lenders don’t lend hundreds of thousands of dollars to just anyone, which is why it’s so important to maintain your credit score. That score is one of the primary ways that lenders evaluate you as a reliable borrower—that is, someone who’s likely to pay back the money in full. A score of 720 or higher generally indicates a positive financial history; a score below 660 could not only be detrimental, but lead to a higher interest rate. Even if you have a bank account that is overflowing with cash, but you have never made a payment on time in your life, expect to have a harder time in getting approved for that mortgage.
PRE-QUALIFIED VS. PRE-APPROVED
Before you start looking for a home, you will need to know how much you can afford, and the best way to do that is to get pre-qualified for your loan. Many real estate agents want you to be pre-qualified so they can show you homes in your price range.
To get pre-qualified, you just need to provide some financial information to your Discover mortgage banker, such as your income and the amount of savings and investments you have. Your mortgage banker will use this information to estimate how much Discover can lend you.
You can also get pre-approved for your mortgage, which may involve providing your financial documents (W-2 statements, paycheck stubs, bank account statements, etc.) so Discover can verify your financial status and credit. Pre-approval gives you “cash-buyer confidence” when you’re ready to make an offer, and it helps your seller take in your offer seriously because they know you can get the money you need to buy their home.
MORTGAGE STRUCTURE: IT’S A PITI With a mortgage, you’ll pay the principal, interest, taxes and insurance — commonly referred to as PITI. Principal: This is the original amount that you borrowed to pay your mortgage. Interest: This is essentially the cost of borrowing money. When you take out a mortgage, you agree to an interest rate, which will determine how much you pay a lender to keep lending. Since a higher interest rate means higher monthly mortgage payments, lower rates might mean that you can afford to borrow more money or pay the loan off faster.
Taxes: Property taxes go toward supporting city, school district, county and/or state infrastructure, and you can pay them along with your mortgage. They’re expressed as a percentage of your property value, so you can roughly estimate what you’ll pay by searching public records for the property taxes for nearby homes of similar value. If you’re a high-risk borrower, your lender might establish an escrow account to hold that money until it’s paid to the proper recipient–in this case, the government. Insurance: Any payments reserved for homeowner’s insurance to protect against fire, theft or other disasters are also held in an escrow account. If you’re a high-risk borrower — or if you lack the 20% down payment — you’re also required to have private mortgage insurance (PMI), which helps guarantee that the lender will get money back if you can’t pay it for any reason.
Mortgages are structured so that the proportion of your payment that goes toward your principal shifts as the years pass. At first, you’re paying mostly interest; eventually, you’ll pay mostly principal. Your actual payments will be the same, but they will be distinguished on the lender’s end in a process known as amortization.
FIXED OR ARM?
When it comes to getting a mortgage loan, homebuyers have two primary options: A fixed-rate loan maintains the same interest rate and monthly principle and interest payment for the entire term. Most borrowers choose either a 30-year or 15-year fixed-rate term, though other fixed terms may be available.
An adjustable rate mortgage (ARM) usually starts with a fixed term — often five or seven years — and then resets periodically, usually every six to twelve months, in line with current interest rates. This means the interest rate — and the monthly payment–can fluctuate over time, so you should carefully consider your ability to handle potential increases.
IT’S A LOCK: Interest rates can change in the time it takes to complete the home loan application process. To protect yourself against a potential rise in interest rates, you can ask your lender to lock in the rate you have been quoted for a specific period of time, usually 30-60 days (some lenders may charge a fee for locking in the rate). If you decide to lock in the rate, be sure to get the agreement in writing and make sure it covers the length of time needed to complete your home purchase or refinance your mortgage. Other borrowers prefer to take the chance that interest rates will decrease while the loan is processed and let the rate on their loan “float.” The rate can then be locked in at any time until the day before your loan closes.
CLOSING COSTS: The actual cost of obtaining a mortgage mainly depends on whether or not the borrower is paying “points” for a lower mortgage rate. These upfront fees (they typically work out to be about 1% of the loan amount) are usually a form of pre-paid interest. If you already have a good down payment, paying points may be a way to further reduce your interest rate on the loan, but they’re generally just a way for the lender to get more money upfront. Points are paid at closing, so if you’re trying to keep your upfront costs as low as possible, go for a zero-point option.
In some cases, there are also other loan processing and underwriting fees associated with the the work involved in the transaction. And, please keep in mind that there may be other closing costs not associated with a mortgage or real estate transaction to be aware of. Appraisal, pre-paid property taxes, insurance and interest, HOA dues and inspections are a few additional out-of-pocket expenses you should budget for.
Either way, a true mortgage professional has to be able to fully articulate the long and short-term financial benefits of choosing one loan scenario over another.
STAN’S SLANT: The final thing that you need to know is that the mortgage business is evolving daily. I have been in the real estate and mortgage world for 40-plus years and I am constantly learning new things and constantly seeing lender guidelines and requirements change. Which is exactly why you want to work with full-time professional lenders who take your business seriously.
