Acquiring Your Loan
Types of Loans
Loans can have a fixed interest rate or a variable interest rate. Fixed rate loans have the same principal and interest payments during the loan term. Variable rate loans can have any one of a number of “indexes” and “margins” which determine how and when the rate and payment amount change. If you apply for a variable rate loan, also known as an adjustable rate mortgage (“ARM”), a disclosure and booklet required by the Truth in Lending Act will further describe the ARM.
Most loans can be repaid over a term of 30 years or less. Most loans have equal monthly payments. The amounts can change from time to time on an ARM, depending on changes in the interest rate. Some loans have short terms and a large final payment called a “balloon.” You should shop for the type of home mortgage loan terms that best suit your needs.
Interest Rate, “Points” & Other Fees
Often the price of a home mortgage loan is stated in terms of an interest rate, points, and other fees. A “point” is a fee that equals 1 percent of the loan amount. Points are usually paid to the lender, mortgage broker, or both, at the settlement or upon the completion of the escrow. Often, you can pay fewer points in exchange for a higher interest rate, or more points for a lower rate. Ask your lender or mortgage broker about points and other fees.
A document called the Truth in Lending Disclosure Statement will show you the “Annual Percentage Rate” (“APR”) and other payment information for the loan you have applied for. The APR takes into account not only the interest rate, but also the points, mortgage broker fees and certain other fees that you have to pay. Ask for the APR before you apply to help you shop for the loan that is best for you. Also ask if your loan will have a charge or a fee for paying all or part of the loan before payment is due (“prepayment penalty”). You may be able to negotiate the terms of the prepayment penalty.
Conventional, fixed-rate mortgages
This traditional, “tried and true,” mortgage option is a loan with a constant interest rate and level, and equal payments over a set period of time-most commonly, 30 years. The biggest advantage of fixed-rate loans is predictability; they are particularly suited to people with steady incomes.
At some point, you may want to refinance your loan, or pay it off early to eliminate thousands of dollars in interest. If lower rates dictate that the time is right to refinance, it’s a good idea to compare savings on lower rates to the costs of incurring a new mortgage-such as prepayment penalties and loan origination costs and points.
Adjustable-rate mortgages (ARMs)
As the name implies, the interest rate on an adjustable-rate mortgage changes throughout the term to reflect current interest rates. ARMs are most popular when rates are relatively high and appear to be dropping, and when the difference between the ARM and the fixed-rate is greater than 2 to 3 percent. Different lenders offer variations in the front end of their ARM plans, such as points, or discounted initial rates.
To make a useful comparison of an ARM rate, consider the index upon which the rate is based, the margin or spread between that index and the rate paid, and the intervals at which the rate and payments are adjusted.
Tip: Always look at the index plus the margin when comparing ARMs. The larger the margin, the less likely the rate will go down, even if the interest rates drop.
Federal government programs
Federal Housing Administration (FHA) insured loans: Lenders offer FHA mortgages on new or existing single-family homes for as little as 3% down. FHA mortgages are also assumable. Sometimes a premium is required when the mortgage is assumed, then refunded when the note is paid off. Down payments are usually low.
Veterans Administration (VA) guaranteed loans
The Veterans Administration guarantees lenders against loss if a property is foreclosed due to default. These assumable loans are available to eligible veterans, and may be used to buy, refinance, construct or repair a house. If the VA property appraisal is less than the sale price, the borrower pays the difference as a down payment.
Farmers Home Administration (FmHA) loans
The government makes these loans available to persons of moderate to very low income in rural or non-metropolitan areas.
Comparing Loan Costs
Comparing APRs may be an effective way to shop for a loan. However, you must compare similar loan products for the same loan amount. For example, compare two 30-year fixed rate loans for $100,000. Loan A with an APR of 8.35% is less costly than Loan B with an APR of 8.65% over the loan term. However, before you decide on a loan, you should consider the up-front cash you will be required to pay for each of the two loans, as well.
Another effective shopping technique is to compare identical loans with different up-front points and other fees. For example, if you are offered two 30-year fixed rate loans for $100,000 and at 8%, the monthly payments are the same, but the up-front costs are different:
Loan A – 2 points ($2,000) and lender required costs of $1800 = $3800 in costs.
Loan B – 2 1/4 points ($2250) and lender required costs of $1200 = $3450 in costs.
A comparison of the up-front costs shows Loan B requires $350 less in up-front cash than Loan A. However, your individual situation (how long you plan to stay in your house) and your tax situation (points can usually be deducted for the tax year that you purchase a house) may effect your choice of loans.
Lender-Required Settlement Costs
Your lender may require you to obtain certain settlement services, such as a new survey, mortgage insurance or title insurance. It may also order and charge you for other settlement-related services, such as the appraisal or credit report. A lender may also charge other fees, such as fees for loan processing, document preparation, underwriting, flood certification or an application fee. You may wish to ask for an estimate of fees and settlement costs before choosing a lender. Some lenders offer “no cost” or “no point” loans but normally cover these fees or costs by charging a higher interest rate.
“Locking in” your rate or points at the time of application or during the processing of your loan will keep the rate and/or points from changing until settlement or closing of the escrow process. Ask your lender if there is a fee to lock-in the rate, and whether the fee reduces the amount you have to pay for points. Find out how long the lock-in is good, what happens if it expires, and whether the lock-in fee is refundable if your application is rejected.
Tax and Insurance Payments
Your monthly mortgage payment will be used to repay the money you borrowed, plus interest. Part of your monthly payment may be deposited into an “escrow account” (also known as a “reserve” or “impound” account) so your lender or servicer can pay your real estate taxes, property insurance, mortgage insurance and/or flood insurance. Ask your lender or mortgage broker if you will be required to set up an escrow or impound account for taxes and insurance payments.
Transfer of Your Loan
While you may start the loan process with a lender or mortgage broker, you could find that after settlement another company is collecting the payments on your loan. Collecting loan payments is often known as “servicing” the loan. Your lender or broker will disclose whether it expects to service your loan or to transfer the servicing to someone else.
Private mortgage insurance and government mortgage insurance protect the lender against default, and enable the lender to make a loan which the lender considers a higher risk. Lenders often require mortgage insurance for loans where the down payment is less than 20% of the sales price. You may be billed monthly, annually, by an initial lump sum, or some combination of all of these for your mortgage insurance premium. Ask your lender if mortgage insurance is required, and, if so, how much it will cost. Mortgage insurance should not be confused with mortgage life, credit life, or disability insurance, which are designed to pay off a mortgage in the event of the borrower’s death or disability.
You may also be offered “lender paid” mortgage insurance (“LPMI”). Under LPMI plans, the lender purchases the mortgage insurance and pays the premiums to the insurer. The lender will increase your interest rate to pay for the premiums — but LPMI may reduce your settlement costs. You cannot cancel LPMI or government mortgage insurance during the life of your loan. However, it may be possible to cancel private mortgage insurance at some point, such as when your loan balance is reduced to a certain amount. Before you commit to paying for mortgage insurance, ask abouts the specific requirements for cancellation.
Flood Hazard Areas
Most lenders will not lend you money to buy a home in a flood hazard area unless you pay for flood insurance. Some government loan programs will not allow you to purchase a home that is located in a flood hazard area. Your lender may charge you a fee to check for flood hazards. You should be notified if flood insurance is required. If a change in flood insurance maps brings your home within a flood hazard area after your loan is made, your lender or servicer may require you to buy flood insurance at that time.