What is a mortgage?
A mortgage (or a mortgage loan) is a legal agreement where a lender or financial institution lends money to a borrower to purchase real estate. The lender earns interest on the money loaned for the duration of the mortgage. The loan is secured by the real estate so if the borrower fails to repay (defaults) the lender can foreclose on the property and sell it to recoup the original money lent to the borrower.
Choosing a mortgage to pay for your new home is just as important as choosing the home itself.
Purchasing a home could be one of the most exciting times of your life. Knowing where to start and what mortgage product to choose can be daunting at the best of times. There are so many various products, interest rates and terms to choose from. What documents and criteria are needed when applying for a mortgage? We will discuss each product below to help you make a knowledgeable and informed decision-
Conventional (Conforming) Mortgages:
A conforming loan is one that meets the standards of loan guidelines set by government-sponsored enterprises Freddie Mac and Fannie Mae which guarantee the loan up to a set amount. The criteria are:
- Credit score and usage - minimum - 620
- DTI (debt-to-income) -
- Historically is 28% for the proposed house payment and a ceiling of 36% with housing + all monthly debt
- Fannie Mae and Freddie Mac will allow 43% and up to 45 -50% with compensating factors
- LTV (loan to value) - less than 20% down payment requires mortgage insurance
- Guaranteed Loan Limit - $417,000 for a single family home. (see the HUD's website for your county's maximum loan limit)
- Jumbo Loan - Jumbo loans are Conforming loans whose amounts are higher than $424,100. These mortgages require larger down payments and applicants must have excellent credit, strong cash flow
Conventional (Non-Conforming) Mortgages:
Non-conforming loans are less standardized and do not need to fit the Freddie Mac or Fannie Mae requirements. Eligibility, pricing and features vary by lender. You will need to shop around as each bank will require different criteria.
An FHA loan is one that the Federal Housing Administration (FHA) guarantees. This allows the borrower to have a minimum down payment with a less than perfect credit score to qualify for a mortgage. The borrower in turn is required to pay mortgage insurance (MIP) monthly, approximately .85% of the loan amount annually. Should the borrower default on the FHA mortgage, it is foreclosed on and HUD (The U.S. Department of Housing and Urban Development) will pay the balance owing to the lender, take possession of the home and/or property. The home/property is then listed as a HUD home on the HUD Home Store website for resale. Approximately 40% of all home loans in the USA are FHA
FHA Requirements are:
- Credit Score:
- 580+ for a 3.5% Down Payment
- 500 - 579 for a 10% Down Payment
- Down Payment:
- 3.5% - 10% depending on credit
- can be a gift with a gift letter for proof
- DTI (Debt-to-Income)
- 31% for housing-related debt
- 43% for total debt
- MIP (Mortgage Insurance is required
- Steady employment with proof of income
- Two years of employment at the same company
- 18 years of age
- Home must be the primary residence
- Co-borrower does not need to live in residence
FHA loans also help provide refinancing loans. As well, FHA loans offer more choices of lending institutions so that you can find the best rates and terms for you.
VA Mortgage Loans
The United States of America believes in and supports their service members. The US Veterans Affairs (VA) helps Service members, Veterans and eligible surviving spouses become homeowners. Part of their mission is to provide a home loan guaranty benefit and other housing-related program to help you buy, build, repair, retain, or adapt a home for your personal occupancy. VA Home Loans are provided by private lenders, such as bank and mortgage companies. VA guarantees a portion of the loan, allowing the lender to offer you better terms and rates.
VA Purchase Loan
VA can help you purchase a home at a competitive interest rate especially if you have found it hard to find other financing.
VA Cash-Out Refinance Loan
This loan is for homeowners who want to take cash out of the equity in your home to pay off debt, make home improvements, school loans etc. The Cash-Out Refinance Loan can also be used to refinance a non-VA loan into a VA loan. VA will guaranty loans up to 100% of the value of your home.
VA Home Loan Guaranty - How does it work?
VA 'stands behind' the loan approval given by the private lending institution, by guaranteeing a portion of the loan. If something happens and you are unable to make payments anymore, the lending institution can ask VA to cover any losses they might incur. the VA loan guaranty is the 'insurance' that VA provides the private lender.
VA Home Loan Advantages
The VA guarantee allows lenders to provide servicemembers and veterans better terms including:
- no downpayment as long as the sales price does not exceed the appraised value
- no private mortgage insurance premium requirement
- VA rules limit the closing costs you can be charged
- the lender cannot charge early prepayment charges
- VA may be able to assist if you run into difficulty making payments
- You don't have to be a first-time home buyer
- the benefit is reusable
- VA-back loans are assumable as long as the 'buyer' assuming the loan qualifies
VA Home Loan Eligibility
- applicant must have satisfactory credit, sufficient income and a valid Certificate of Eligibility (COE)
- home must be for your personal use
- Service Requirements -
- service during wartime
- at least 90 days active duty - no dishonorable discharge
- less than 90 days active duty - if discharged for a service-connected disability
- can be used for a home, condo, building a home, home improvement, installment of energy-related features, manufactured home, refinance existing VA loan or private home loan
VA Loan Fee
All Veterans using the VA Home Loan Guaranty must pay a 'funding fee'. This reduces the loan's cost to taxpayers as a VA loan does not require a down payment or monthly mortgage insurance. It is a percentage of the loan amount which varies based on the type of loan and military category. The funding fee can be financed or paid in cash, but must be paid at closing. There are exceptions which are listed on the VA web-site.
The lending institution will also charge interest, closing fees and other additional charges. Closing costs, appraisals, credit report and taxes can be paid by the purchaser, the seller or shared.
No commissions, brokerage fees or 'buyer broker' fees may be charged to the Veteran buyer.
Note: Adding the VA Funding Fee and other loan costs to your loan may result in which you owe more than the fair market value of the house which could cause difficulty in refinancing or reselling the house.
Many people work their entire adult life working. They go to school, get married, raise children, pay bills, buy a house, go on vacation and at the end of their working years they hope they have enough to see them through their retirement and leave something for their children. Some people plan in detail for retirement - saving, investing, contributing to their 403(k) plan, and if they are fortunate to have a work related retirement plan accumulating on their behalf. There are those that no matter what they do, life happens and their well thought out retirement is not what they had planned or hoped. So many USA citizens live their retirement years in near poverty, living on a meagre monthly allowance hoping they do not get sick. Did you know that 41% of people aged 55 to 64 don't any any retirement savings?
If you own your home there are options available that will help you live comfortably throughout your retirement years and allow you to stay in your home. There are many reports and statistics show that seniors that can remain in their home as long as possible remain is much better for them overall. It is quite often more economical to have home care than then the expense of moving to a senior's care facility. How do you do that when you are already living on a very strict budget.
A reverse mortgage can add that extra income that you need to help with in-home care or for to take the pressure off of your finances. There are three types of reverse mortgages - traditional, jumbo and the government backed HECM mortgage.
The Home Equity Conversion Mortgage (HECM) and is backed by the US government. An HECM (reverse) mortgage is one of the most popular programs in the USA as they are backed by the HUD's Federal Housing Administration (FHA). An HECM allows seniors (62+ yrs) to convert their home's equity into cash. The equity payments include lump sums, lines of credit and monthly payouts. The borrowers must live in the home. They do not make monthly payments as it is paid out in full when the house is sold, they move to another property or pass away. There is no restriction on how the borrowers spend the money, but part of the application process is that they must be part of a reverse mortgage counselling course.
HUD offers three HECM options:
- Traditional: This is a mortgage based on the equity in the home and the borrower's age. The value of the HECM is capped at $636,150 and re-evaluated every year.
- Purchase: The HECM allows borrowers that are 62+ years to buy another house and get a reverse mortgage in the same transaction. This allows for down-sizing and keeps the HECM in place if required.
- HECM Refinance: If you already have a reverse mortgage, this refinance program allows you to modify your reverse mortgage for better interest rates, add your spouse or account for the increased value of the home.
- HECM Repayment: Interest accumulates monthly even though there aren't no payments. When the borrower moves to an assissted living or nursing home, they are allowed up to one year before the mortgage comes due.
- One borrower must be 62+ years of age
- Must have enough equity ($10,000 minimum mortgage) in their home
- Must maintain the home
- Must continue to pay property taxes and home-owners insurance
- Participate in Reverse Credit Counselling
- The balance of the mortgage cannot exceed the value of the home
HECM Borrowing Limit
Reverse mortgages increase over time. If you were able to borrow up to 100% of the equity in your home, your mortgage would eventually be more than the value of your home. The amount you can borrow is determined by a 'principal limit factor' (PLF). You take your property value (or the maximum limit of $625,000) and multiply it by your PLF. A common PLF factor is .50, depending on several factors.
- age of the youngest borrower. A non-borrowing spouse cannot be evicted from a home with HECM financing if the borrowing spouse dies or moves out.
- Current mortgage interest rates also determine the PLF - the lower the rate, the higher the PLF
- Amount of loan will determine the Mortgage Insurance Premium especially if the draw is 60% within the first year
- If HECM determines you do not manage debt well, they will withhold some of the proceeds and pay your bills for you. The HECM wants to help the borrower and prevent a foreclosure due to mismanagement of funds.
The borrower is responsible for the origination fees, closing costs (title insurance, inspection fees, appraisal), mortgage insurance and property taxes. The origination and closing fees can be built into the mortgage depending on the lender.
Traditional Reverse Mortgages
These are also known as Jumbo or proprietary reverse mortgages and are offered within the private sector. Each company sets it's own set of criteria and are usually more flexible than the government backed HECM's. Depending on the lender, the borrower may be able to borrow more than the guidelines set under the FHA program. These reverse mortgages are not as regulated as the HCEM reverse mortgages so it is important that the consumer does indepth lender comparisons.
Single Purpose Reverse Mortgages
These reverse mortgages are allowed to be used for only one purpose. Home repairs, proerty taxes, energy-efficient improvements are a few of these reasons. They are often offered with the backing of the local governments to help those who are low-income earners. Because these are offered to help low-income families the interest rates are very low. Again, it is prudent for the borrower to check each lenders eligibility guidelines to pick the loan amount, terms and conditions that best meets the needs of their requirements.
Mortgage Refinance is another loan secured by the equity in your home. You may have purchased your home at a time when the interest rates were fairly high. Rates have gone down and you would like to take advantage of the decline by lowering your monthly mortgage payment and ultimately the term. You may also want to switch to a fixed rate instead of a variable or vice versa. When you refinance your existing mortgage, the new mortgage pays the existing one out. Your payment is now on the new refinanced mortgage. You may also want to take advantage of the equity in your home and take out some cash for much needed renovations or purchases. You get the cash in one lump sum while taking advantage of the lower interest rate and term.
Steps to Refinancing your mortgage
- Decide why you want to refinance. If it is just to lower your payment by renewing with a longer term, use a mortgage calculator to see if it is advantageous in the long run. Smaller monthly payments with a longer term may actually cost you more money as you will end up paying more interest.
- Determine what your home is worth and how much equity you have available. The more equity you have in your home, the more options you will have. Depending on the reason for the refinance, you may want to grow the equity in your home to get better rates, amount and terms
- Confirm that your credentials for applying for a refinance are strong. A strong credit score, history and usage will insure better rates. Do you have a strong cashflow and good income.
- Be sure that you are property taxes and home insurance are current and in good standing.
- Check with each lender as to their fees and additional costs. Some lenders charge the same fees for a refinance as they do for an original mortgage. Other lenders only charge minimal fees if you are staying with their institution.
Fixed Rate Mortgage
A "fixed rate" mortgage is one that the interest rate won't change for the life of your mortgage home loan. Monthly principal and interest payments remain the same for the term. If you have chosen a 30 year fixed rate mortgage this means you know that for the next 30 years your payment will always be the same. By choosing this option it means you will pay more interest over the life of the loan than you would by choosing a shorter term mortgage.
By choosing a short loan term (10, 15 or 20 years) a fixed rate mortgage will help you pay off your home faster and build the equity in your home much more quickly. Your monthly payments will be higher than with a 30 year term, but often the benefit of paying less interest and building the equity offsets the difference in the payment.
What are the benefits of choosing a fixed-rate mortgage?
- No interest rate surprises. Should inflation cause interest rates to rise, your mortgage loan's interest will remain the same. It is a cushion for a fluctuating economy.
Adjustable Rate Mortgage
With an adjustable rate mortgage, the interest rates are not set and may go up or down. The reason for this is that the interest rate is tied to a broader measure of interest rates called an 'index'. Your payment goes up when this index of interest rates increases. When interest rates decline, your payment may go down. This is not true for all ARM's as some lenders have a cap as to how high or low your interest can go.
Things to know before taking out an ARM mortgage:
- how high the interest rate and monthly payments can go with each 'index' adjustment
- how frequently will your interest rate adjust
- after there is a rate adjustment how long before your payment goes up or down
- is there a cap on high or low the interest rate can go
- use a calculator to confirm if you can still afford the payment if the rates go up, but your income does not
- check to see if your lender would allow you to switch to a 'fixed-rate' mortgage if the rates went too high
What is a Balloon Payment
Some lenders will offer a mortgage with a balloon payment at the end. Although may sound good as your payments may be lower during the term of the mortgage, when the balloon payment comes due, you could owe a huge amount that you are unable to pay or secure a loan for. Usually, a balloon payment is more than two times the loan's average monthly payment but it can also be tens of thousands of dollars.
What Is a Qualified Mortgage
- A qualified mortgage is a category of loans that have more stable features that insure you will be able to afford your loan. A lender must determine that you have the ability to repay your mortgage before you take it out. The lender will confirm that the borrower's assets, income, employment, credit history and monthly expenses will enable them to make their mortgage payments even if the rates increase. A borrower must have a debt-to-income ratio of 43% or less (this includes the monthly mortgage payment and expenses)
- a qualified mortgage cannot have negative amortization or interest only payments
- A qualified mortgage has to have fees and points that are less than 3% of the total loan amount.
How To Qualify For A Mortgage
Lenders look at the following five items to confirm if you qualify:
- Credit Score - although there isn't a set minimum credit score required to obtain a mortgage, having a good or excellent score will insure that you get the best rates and terms.FHA loans will allow you to apply with a credit score of 500 with mortgage insurance.
- Credit History - lenders will want to insure that your credit usage is 'healthy'. This means that you pay your bills on time and do not have collections or a bankruptcy reported
- Income- this can be the household income (salaried, self-employment, benefits, other as long as it can be verified).
- Job History - lenders will look for how long you have been employed by the same lender. If you have switched jobs the lender will want to insure you have remained in the same industry.
- a letter of employment and/or a role change letter if you have a title change
- verification of income (most recent paystub)
- all jobs held in the previous 24 months must be listed, verified with proof.
- Commissions, overtime or bonuses must have a history if to to be included in 24 month average
- Debt-to-Income - Regardless of your income, lenders want to insure that you have the ability to repay the monthly payment. Lenders will usually not offer a loan to applicants with a DTI over 43%. Studies of mortgage loans have proven that those with a DTI over 43% are more likely to run into trouble making monthly payments.
- How to calculate your DTI - Add up all your monthly debt payments (including your new monthly mortgage payment, alimony or child support payments, student, auto and other monthly loan payments, credit card minimum monthly payment, and other debt. Divide this total by your gross (before taxes and deductions) monthly income. The result is your DTI. The lower your DTI, the less risky you are to lenders.
- Cash Reserves - lenders will ask about your assets and cash accounts. They will want to know what you have saved to come up with the down payment, closing costs, and reserves should you lose your job. Lenders typically ask for proof that the cash has been in your bank account for at least two months or more. If it just 'landed' in your bank account within a short period of time, they will need documentation as to where it came from.
- Down Payment Amount - Depending on the mortgage product you choose you will be required to show proof of down payment
- Conventional (Conforming) Mortgages - 5% - 20 %
- Conventional 97 Mortgage - 3 % (backed by Freddie Mac and Fannie Mae)
- FHA Loan - 3.5%
- VA Loan - No down payment is required
Closing Costs are fees charged by lenders for processing and issuing a loan. On average these costs can range from 2% - 5% of the purchase price. This is when the title of the property you are purchasing is transferred from the seller to the buyer.
Fees that are included in the closing cost
- Application Fee - This fee covers the cost the lender incurs while processing your application. This could include the cost of a credit check, an appraisal, and miscellaneous items. This can often be waived so talk to your lender
- Appraisal - If this is not included in the application fee, you will need to pay the appraisal company to confirm the fair market value of the home. This fee ranges from $300 - $400
- Home Inspection Fee - Most lenders require a home inspection to ensure that the home is structurally sound and in good shape. If the inspection shows that there are issues such as mold, electrical or structural damages you have the option to back out of the deal.
- Attorney Fee - this pays the attorney to review the closing documents on behalf of the buyer or lender. This is not required by all states. Depending on how much time the lawyer works on your behalf the fees will vary dramatically.
- Closing or Escrow Fee - this is paid to the title company, escrow company or attorney for conducting the closing. The title/escrow company oversees the closing as an independent party in your home purchase.
- Mortgage Broker Fee - If you have worked with a mortgage broker, they will usually charge a commission as a percentage of the loan amount (usually 1% - 2%) they can be paid by you or the lender
- Loan Origination Fee - (Underwriting Fee, administrative fee or processing fee). This is a charge by the lender for evaluating and preparing your mortgage loan. This can cover document preparation, notary fees, and the lender's attorney fees. Expect to pay about 1% of the amount you are borrowing.
- Prepaid Interest - lenders require buyers to pay the interest that accrues on the mortgage between the date of settlement and the first monthly payment due date
- Assumption fee - If you take over the remaining balance of the seller's mortgage, you may be charged a variable fee based on the outstanding balance
- Mortgage Insurance Fees - if you put less than 20% down, you may have to get private insurance (PMI insures the balance of the mortgage in case you default on payments. It is NOT home insurance)
- Home Insurance - some lenders expect borrowers to pay the first year's mortgage premium upfront. Others may ask for a lump-sum that covers the life of the loan. Expect to pay from .55% - 2.25% of the purchase price for mortgage insurance.
- FHA fees - you will have to pay mortgage insurance premiums
- VA fees - you will need to only pay guarantee fees which are about 1.75% of the loan
- Property Taxes - if you have purchased a condo, the homeowners association may ask for the payment in one lump sum. Usually, homeowners associations require a monthly payment that is automatically debited from your bank account.
- Title Insurance - most people question this, but it is a great insurance to protect yourself from title claims after closing
Prequalification and Pre-Approval
There are definitely benefits to getting prequalified for a mortgage and then by submitting a formal request for a pre-approval
You can easily use a prequalification debt-to-income ratio calculator to determine how much you can afford to borrow. The lender would assess your debt-to-income ratio to confirm that you fit the guidelines for applying for a mortgage. This information is valuable when you start the process of house hunting. You know how much you have for a down payment and how much you can afford to pay monthly. In turn, you can enter the real estate market with confidence knowing approximately how big of a house you can purchase. A prequalification does not take into account your other bills, buying furniture for your new home and the cost of living. This is something that you also need to take into account when starting the process of purchasing a home. A good rule to follow is 'make sure you own the house and the house does not own you!'
In order to speed up the process when you are serious about putting an offer on a house, it is advantageous to have a formal mortgage pre-approval from your lender. This process is a more formal process than the prequalification. The lender will ask for all supporting documentation that is needed for a mortgage contract. This will include a hard inquiry on your credit to confirm your score, credit history, and credit usage. The lender will ask for employment letters, proof of income, proof of down payment, bank statements etc. They will confirm how much they will lend you for a mortgage. It is not a legal documentation until you present a signed 'offer to purchase' on a home and the lender gives you a written contract for a mortgage with rates and terms. When you apply for a mortgage pre-approval from your lender be sure to confirm how long their rate terms hold for (90 - 120 days). Having a pre-approval in hand is a great tool for your real estate agent to show the prospective seller. They do not have to wait for you to complete this process with the lender (can take up to two weeks depending on the documentation they require) but can speed up the finalization of the sale. In today's market where homes are sold very quickly, have a mortgage pre-approval can give you the edge you need to close the deal quickly.
HARP is a government-backed program to help homeowners who without it might find that their refinance applications are declined. Those with a 'negative equity' (the market value of your home is less than the balance left on your mortgage) or if you have only a small positive equity benefit the most from HARP.
What is the HARP Program?
When you have little equity in your home or owe as much or more on your mortgage than your home is worth, it can be difficult to refinance your home. HARP was created for homeowners who have remained current on their mortgage and have loans owned by Fannie Mae or Freddie Mac.
Significant changes have been made to HARP since 2009 when it was first introduced. In 2011, the LTV ceilings were removed, property appraisals were waived in some circumstances, some risk fees were eliminated.
- your mortgage must be owned or guaranteed by Freddie Mac or Fannie Mae
- your mortgage must have been originated on or before May 31, 2009
- current LTV (loan-to-value) ratio must be greater than 80%
- you are current on your mortgage with no 30 day+ late payments in the last six months and no more than one late payment in the past 12 months
- your mortgage can be any depth underwater
- you don't need a certain credit score as long as your monthly payments won't increase by more than 20% after refinance
- income - you may not be required to prove your income if you are current in your monthly house payments
- if you owe more than your house is worth
- refinance under HARP with a fixed-rate there is no LTV ceiling
- refinance under HARP with a variable-rate LTV ceiling is 105%
- fixed-rate mortgages can be anywhere from 10 to 30 years
- HARP program allows primary residences, secondary home, investment properties, condos
Who does not qualify for HARP
- excludes homeowners who have lots of equity. HARP refinance is to help those with little or no equity in their home.
How much can a person really save with HARP?
How much a person saves with HARP, depends on the interest rates and type of refinancing that you choose. Some estimates are a savings of $60,000 or $70,000 over the life of a 30-year loan. How much you personally will save. Also depending on the term (shorter than 30 years) and interest rate (fixed vs. variable) will also affect your possible savings. Check our mortgage calculator to see how much you would save.