One of the first steps you should take on your home buying journey is to take the time to educate yourself about mortgages and what is needed to qualify for a home loan. This step applies to both experienced home owners and first time buyers. The mortgage industry is constantly evolving and new loan types and interest rates are changing sometimes on a daily basis. Speak with your Real Estate Broker for a referral if you do not already have a mortgage company you are comfortable working with. In an effort to get you started, here are some key facts you need to know about mortgages.
Loan Aps: What You Need
Applying for a home loan sometimes feels as long, complicated and arduous as astronaut training. While the process is difficult, it shouldn’t prevent you from following your dreams of home ownership. With some preparation, applying for a mortgage loan can even be fun! (Okay, that’s a lie, but at least being prepared will make the process less painful.)
Before we gather up the substantial amount of paper you’ll need, there are a few things you should find out. First of all, ask how long the loan approval process will take. These days the range is broad—anywhere from a day to three or four months. This is important, because if you have a mortgage contingency clause in your purchase contract, your lender needs to know it so they can help you meet your deadline.
Next, you need to be aware that you’ll have to disclose where you got the money for your down payment. If you borrow the money, that debt will be considered in the approval process (it could even increase your interest rate or prevent you from being approved at all.) If relatives are providing the money, you need proof that the down payment is a gift—in other words, that you won’t have to pay it back.
Find out if your state allows mortgage prepayment penalties. You need to be aware that if these are legal where you are, there will be a charge if you pay off your mortgage early through refinance or multiple principal payments. Avoid mortgages that require a prepayment penalty beyond the third year.
Now get ready—the following is what you’ll need when applying for that loan:
Asset items
l Bank statements for previous two months (sometimes three) on all accounts. All pages, even if you don't think them important l Statements for two months on all stocks, mutual funds, bonds, etc. l Copy of latest 401K statement (or other retirement assets because they can count as reserves) l Explanations for any large deposits and source of those funds l Copy of HUD1 Settlement Statement on recent sales of homes l Copy of Estimated HUD1 Settlement Statement if a previous home is for sale, but not yet closed l Gift letter (if some of the funds come as a gift from a family member - the lender will supply a blank form) l Gifts can also require: 1. Verification of donor’s ability to make the gift (bank statement) 2. Copy of the check used to make the gift 3. Copy of the deposit receipt showing the funds deposited into bank account or escrow
Note: many get their statements of various kinds over the internet and these are not always acceptable to lenders, especially when the printed version does not contain the borrower's name, account number, and the name of the institution.
Credit items
l Landlord’s name, address, and phone number (if you rent - for verification of rental) l Explanations for any of the following items which may appear on your credit report: Late payments; Credit inquiries in the last 90 days; Charge-offs; Collections; Judgments; Liens l Copy of bankruptcy papers if you have filed bankruptcy within the last seven years
FHA loans
l Copy of Social Security Card (or other documentation of social security number) l Copy of Driver’s license
Income items
l W2 forms for the last two years l Most recent pay stubs covering a 30 day period l Federal tax returns (1040’s) for the last two years, if: you are self-employed; earn regular income from capital gains; earn sizable interest income, etc.; earn more than 25% of your income from commissions or bonuses; own rental property; or are in a career where you are likely to take non-reimbursed business expenses). l Year-to-Date Profit and Loss Statement (for self employed) l Corporate or Partnership tax returns (if you own more than 25% of the business) l Pension Award letter (for retired individuals) l Social Security Award letters (for those on Social Security)
Miscellaneous items
l Copy of purchase agreement (if you have already made an offer) l To document receipt of child support (if you desire to show it as income) l Copy of Divorce Settlement (to show the amount) l Copies of twelve months canceled checks to document actual receipt of funds
Refinances
l Copy of your most recent monthly mortgage bill l Copy of Note on existing loan l Copy of HUD1 Settlement Statement on existing loan
VA loans
l Copy of DD214
Debt-to-income Ratios
When you’re ready to buy a house, a lot of jargon is thrown around. One term you’ll hear a lot is debt-to-income ratios. If you’re not a math wizard, such lingo can sound intimidating, but it doesn’t need to. Debt-to-income ratios are simple to figure and use to your advantage, even giving you the opportunity to figure out how much house you can afford before you even set out to look.
The debt-to-income ratio is, simply, the way that mortgage lenders decide how much money you can comfortably afford to borrow. It is the percentage of your monthly gross income (before taxes) that is used to pay your monthly debts (not your monthly living expenses). Two calculations are involved, a front ratio and a back ratio, written in ratio form, i.e., 33/38.
The first number indicates the percentage of your monthly gross income used to pay housing costs, such as principal, interest, taxes, insurance, mortgage insurance and homeowners’ association dues. The second number indicates your monthly consumer debt, such as car payments, credit card debt, installment loans, etc. Other living expenses are not considered debt.
So a debt-to-income ratio of 33/38 means that 33 percent of your monthly gross income is used to pay your monthly housing costs, and 5 percent of your monthly gross income is used to pay your consumer debt—so your housing costs plus your consumer debt equals 38 percent.
33/38 is a common guideline for debt-to-income ratios. Depending on your down payment and credit score, the guidelines can be looser or tighter, and guidelines also vary according to program. The FHA, for instance, requires no better than a 29/41 qualifying ratio, while the VA guidelines require no front ratio but a back ratio of 41.
What if you already have a house or don’t plan to buy a house for a good period of time? You still need to know and control your debt-to-income ratio so you can avoid creeping indebtedness, or the gradual rising of debt. Impulse buying and routine use of credit cards for small, daily purchases can easily lead to unmanageable debt.
Debt-to-income ratio not only affects your ability to buy a home, but other purchases as well. Debt-to-income ratios are powerful indicators of creditworthiness and financial health. Know your ratio and keep it low. Your consumer-debt number should never go higher than 20 percent regardless. If you let it rise above 20 percent, you may:
l jeopardize your ability to make major purchases—cars, homes, major appliances—when you need them.
l not get the lowest possible interest rates and best credit terms.
l have difficulty getting additional credit in emergencies.
If you keep a stranglehold on your spending habits and therefore your debt-to-income ratio, you can:
l make sound buying decisions, and refrain from frivolous credit purchases and loans.
l see the clear benefits of making more-than-minimum credit card payments.
l avoid major credit problems.
Calculate your debt-to-income ratio before you begin looking for a house. Get your credit in order so you can get the best credit terms, the lowest interest rate and the most house possible.
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What Are Points, Anyway?
A quick quiz: mortgage “points” are
a) certain charges paid to obtain a home mortgage
b) the gross profit for the originator of the loan
c) up-front mortgage interest fees to reduce the interest rate
d) each equal to 1 percent of the total loan amount
e) loan origination fees
f) charged by a lender to raise the yield on a loan when money is tight, interest rates are high, or there is a legal limit on the interest rate that can be charged on a mortgage
g) come in two varieties
h) all of the above
If you answered (h), you are correct. Points are all those things and more. Points charged are often used to cover a lender’s overhead—salaries, building leases, employee benefits, unexpected expenses. Generally, paying one point should lower the interest rate on a loan ¼ percent, two points ½ percent and so on. A rule of thumb: a no-point loan will always have a higher interest rate than a loan with points. In other words, paying points now means you’ll pay less interest later. Lowering the rate reduces your monthly principal and interest payment. In essence, points equal prepaid interest.
With conventional loans, either the borrower or the lender can pay the points or each can agree to pay half. On HUD and Veterans’ Administration-guaranteed loans, borrowers can’t legally pay points—the seller is required to pay.
There are two types of points. Discount points are prepaid interest on your mortgage loan—you’re basically paying finance charges in advance. Discount Points are used to "buy" your interest rate lower. This is known as a rate "buydown." A general rule of thumb is that one full Discount Point will lower your fixed interest rate .250 percent or your adjustable rate .375 percent. These points lower the interest rate for the entire term of the loan.
The way lenders look at this type of points is that it covers the cost of a lower interest rate over the length of the loan. The more points you pay, the lower the interest rate on the loan, and the fewer you pay, the higher the interest rate. Paying discount points is a good idea if you plan to live in the house for a long time.
You can deduct the points in full in the year they are paid, if all the following requirements are met:
l You are legally liable for the debt and the loan is secured by your main home.
l Paying points is an established business practice in your area.
l The points paid were not more than the amount generally charged in that area.
l You use the cash method of accounting. This means you report income in the year you receive it and deduct expenses in the year you pay the points.
l The points were not paid for items that usually are separately stated on the settlement sheet such as appraisal fees, inspection fees, title fees, attorney fees, and property taxes.
l You provided funds at or before closing, which were at least as much as the points charged, not counting points paid by the seller. You cannot have borrowed the funds from your lender or mortgage broker.
l You use your loan to buy or build your main home.
l The points were computed as a percentage of the principal amount of the mortgage, and
l The amount is clearly shown on your settlement statement.
Origination points are charged by the lender for evaluating, preparing, and submitting a proposed mortgage loan (the costs of making the loan) or to boost profits. Most loan officers’ compensation is based on origination points, but they still may be negotiable in whole or in part. Some lenders add origination points into their quoted points while other lenders add an origination point in addition to their quoted points. Where discount points serve the borrower by lowering the interest rate, origination points are gross profit for the lender. They are not tax-deductible.
As a general rule of thumb, it takes approximately five years on a 30-year loan to recoup the cost of the points paid provided each point lowers your rate ¼ percent as described above. If the drop in rate is not ¼ percent for each point paid, the amount of time it takes to recoup the points is longer.
To calculate the break even:
l Calculate the principal and interest payment on a zero point loan
l Calculate the principal and interest payment on the point loan
l Calculate the dollar value of the point(s)
l Calculate a - b = the savings in your monthly payment
l Calculate d / c / 12 = the number of years to recoup your points
Closing Costs
Non-Recurring Closing Costs Associated with the Lender
Appraisal fee: cost varies. The property being appraised is collateral for your mortgage so the lender will want to verify that the property’s value is comparable to similar property based on recent sales in your area.
Credit Report: $7-$60. The lender naturally wants to verify your good (or acceptable) credit rating.
Flood certification fee: cost varies. The certification verifies whether your property is in a federally designated flood zone.
Flood monitoring: cost varies. This service monitors your property if and when flood zones are remapped.
Lender’s Inspection fee: cost varies. Also know as a 442, this inspection is for newly constructed property to verify that construction is complete with carpeting and flooring installed.
Loan discount: cost varies. These are discount points, each equal to 1 percent of the loan amount, in addition to the loan origination fee.
Loan Origination Fee: cost varies. This is also called "points." Typically, the more you pay in points, the lower the interest rate.
Mortgage broker fee: They may also add in any broker processing fees in this area.
Tax service fee: $70-$80. This fee goes to an independent service that monitors your payment of property tax for the lender.
Other Lender Fees
Administration fee: cost varies. Either this or an underwriting fee will typically be charged.
Appraisal review fee: $75-$150. An appraisal review is usually done on higher-valued properties.
Document preparation: around $200. Even though lenders now can draw up their own documents without paying document preparation firms, you’ll still pay this.
Underwriting fee: $300-$350. This is the cost of putting the loan together.
Warehousing fee: cost varies. This fee isn’t seen much anymore, but you may end up paying it – it’s the cost of a “warehouse” line of credit.
Wire transfer fee: cost varies. This is the cost to transfer funds from one account to another.
Items required to be paid in advance
Homeowner’s insurance: cost varies. You are usually required to pay the entire first year’s insurance premiums at closing.
Mortgage insurance: cost varies. Some first-time homebuyer programs still require the first year mortgage insurance premium to be paid in advance.
Pre-paid interest: cost varies. This is the interest that will accumulate between the day of closing and the day the first payment is due, usually the first of the following month.
Up front mortgage insurance premium: cost varies. This is 2.25 percent of the loan balance, normally added to the balance of the loan. It is charged on FHA purchases of single family homes or planned unit developments.
VA funding fee: cost varies. This is paid to the Veterans Administration for guaranteeing your loan.
Reserves Deposited with Lender
Homeowners insurance impounds: cost varies. Lenders are allowed to keep two months’ worth of reserves in your impound account, so you will need to deposit two months’ worth of premiums to start it up.
Mortgage insurance impounds: cost varies. As noted above, most lenders allow mortgage insurance monthly, but you might have to put two months’ worth of premiums into an impound account for a reserve.
Property tax impounds: cost varies. Depending upon when taxes are due determines how much you will have to deposit towards taxes to start up your impound account.
Non-recurring closing costs
Closing/escrow/settlement fee: cost varies.
Courier fee: cost varies. This is the charge for sending documents back and forth between lender and borrower.
Home inspection: cost varies. This is an optional, but recommended, cost.
Home warranty: cost varies. Also optional, a home warranty usually covers such items as the major appliances, should they break down within a specific time. Often this is paid by the seller.
Homeowner’s association transfer fee: cost varies. This is the cost to transfer the membership from the seller to the buyer.
Loan tie-in fee: cost varies. Usually charged by the closing agent, this is for services they provide in dealing with the lender.
Notary fees: around $40. This is to make the document signatures legal.
Pest inspection: around $75. This inspection tests for pests and problems such as wood rot and water damage.
Recording fees: $40-$75. Charged to record documents with county government recorder.
Sub-escrow fee: cost varies. The title insurance company usually charges this for dealing with the closing agent.
Title insurance: cost varies. You pay this to make sure you have clear title to the property.