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Mortgage FAQ
Top Ten Questions
1. How much house can I afford?
2. Why do I need to check my credit prior to purchasing a
house?
3. How much do I need for a down payment?
4. How is pre-qualification different from pre-approval?
5. What is the difference between conforming and nonconforming
loans?
6. Should I choose fixed or adjustable interest rate mortgage?
7. What are points?
8. What is APR (Annual Percentage Rate)?
9. What are closing costs?
10. What is PMI (Private Mortgage Insurance)?
1. How much house can I afford?
The amount of loan for which you qualify is based on two different calculations.
Using what are known as qualification ratios, lenders evaluate your income
and long-term debts to determine a "safe" amount for your mortgage
payments. A fairly standard ratio is 28/33. Certain mortgage plans sometimes
use more liberal ratios - for example, the Fair Housing Authority currently
uses 29/41.
Here's how it works: With a 28/33 ratio, you are allowed to spend up
to 28% of your gross monthly income for mortgage payments.
The lender will then run a different calculation. This one is your loan
payment and debt payments combined, which may not exceed 33% of your gross
monthly income.
To calculate exactly how much you may borrow, you also need an estimate
of current interest rates. For example: Suppose you had $1,000 a month
for mortgage payment; at 7% that would let you borrow about $160,000 on
a 30-year loan. At 6% the loan amount would be nearly $175,000. If your
rate were 8%, the loan amount would be a bit less than $150,000.
As part of this calculation, you also need to estimate and include the
property taxes, homeowner's insurance, and homeowner association fees
(if applicable) you might need to pay, which are considered part of your
monthly expense.
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2. Why do I need to check my credit prior to purchasing
a house?
Even if you're sure you have excellent credit, it's wise to double-check
at the outset. Straightening out any errors or disputed items now will
avoid troublesome holdups down the road when you're waiting for mortgage
approval.
You may see disputed items, in addition to errors caused by a faulty
social security number, a name similar to yours, or a court ordered judgment
you paid off that hasn't been cleared from the public records. If such
items appear, write a letter to the appropriate credit bureau. Credit
bureaus are required to help you straighten things out in a reasonable
time (usually 30 days).
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3. How much do I need for a down payment?
Most lenders expect buyers to make a down payment of at least 5% of the
value of the home. If you can afford to put more money toward a down payment,
it will reduce the amount of your monthly mortgage payments. Some loan
programs offer 3% down payments if you meet certain income standards.
The Veterans Administration (VA) and the Rural Housing Service (RHS) offer
no-down-payment loans.
The lender will want to know how much money you plan to put down and
the source of those funds. Sources you may draw upon include savings,
stocks and bonds, pension funds, real estate holdings, life insurance
policies, mutual funds, and employee savings plans.
You may also use a gift of money from a family member that need not be
repaid. If you do this, you will need to present a letter to your lender
that states the amount of the gift, is signed by the giver, and is notarized
by a third party.
You are also now allowed to withdraw up to $10,000 from both traditional
and Roth Individual Retirement Accounts (IRAs) with no early withdrawal
penalty, if used toward buying your first home.
Under some mortgage programs, such as Fannie Mae's Community Home Buyer's
Program® with the 3/2 Option®, part of your down payment may come
from a grant from a nonprofit housing provider in your community.
Content Provider: Fannie Mae
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4. How is pre-qualification different from pre-approval?
Any reputable real estate broker will "pre-qualify" you for
a mortgage before you start house-hunting. This process includes analyzing
your income, assets and present debt to estimate what you may be able
to afford on a house purchase. Mortgage brokers, or a lender's own mortgage
counselor can also calculate the same sort of informal estimate for you.
Obtaining mortgage "pre-approval" is another thing entirely.
It means that you have in hand a lender's written commitment to put together
a loan for you (subject to verification of income and employment).
Pre-approval makes you a strong buyer, welcomed by sellers. With most
other purchasers, sellers must tie the house up on a contract while waiting
to see if the would-be buyer can really obtain financing.
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5. What is the difference between conforming and nonconforming
loans?
The term "conforming," as opposed to "nonconforming,"
is sometimes used to explain loans that offer terms and conditions that
follow the guidelines set forth by Fannie Mae and Freddie Mac. These are
the two private, congressionally chartered companies that buy mortgage
loans from lenders, thereby ensuring that mortgage funds are available
at all times in all locations around the country.
The most important difference between a loan that conforms to Fannie
Mae/Freddie Mac guidelines and one that doesn't is its loan limit. Fannie
Mae and Freddie Mac will purchase loans only up to a certain loan limit
(currently it is $240,000).
If your loan amount will be for more than the conforming loan limit,
the interest rate on your mortgage may be higher or you may have slightly
different underwriting requirements, particularly in regard to your required
down payment amount. Check with your lender about this if you are taking
out a large loan amount.
TIP: Nonconforming loans are sometimes called "jumbo loans."
Content Provider: Fannie Mae
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6. Should I choose fixed or adjustable-interest rate mortgage?
Interest rates are usually expressed as an annual percentage of the amount
borrowed. You can choose a mortgage with an interest rate that is fixed
for the entire term of the loan or one that changes throughout. A fixed-rate
loan gives you the security of knowing that your interest rate will never
change during the term of the loan. An adjustable-rate mortgage (called
an ARM) has an interest rate that will vary during the life of the loan,
with the possibility of both increases and decreases to the interest rate
and consequently to your mortgage payments.
Content Provider: Fannie Mae
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7. What are points?
In the special vocabulary of mortgage lending, "points" are
a type of fee that lenders charge (the full term to describe this fee
is "discount points".) Simply put, a point is a unit of measure
that means 1% of the loan amount. So, if you take out a $100,000 loan,
one point equals $1,000.
Discount points represent additional money you can pay at closing to
the lender to get a lower interest rate on your loan. Usually, for each
point on a 30-year loan, your interest rate is reduced by about 1/8th
(or .125) of a percentage point.
TIP: Usually, the longer you plan to stay in your home, the more sense
it makes to pay discount points.
Content Provider: Fannie Mae
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8. What is APR (Annual Percentage Rate)?
Annual Percentage Rate (APR) factors interest plus certain closing costs,
any points and other finance charges over the term of the loan. The APR
must be disclosed to you according to federal Truth-in-Lending laws within
three business days of when you apply for a loan, or prior to or at closing
for a refinance.
Content Provider: Fannie Mae
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9. What are closing costs?
On the day you actually buy your new home, in addition to your down payment,
the prepaid property tax and homeowners insurance premiums, you'll need
cash for various fees associated with the purchase. These expenses are
known as closing costs and are paid by both buyers and sellers.
Some closing costs you pay up-front when you apply for a mortgage loan.
Those include money for a credit check on all applicants and an appraisal
on the property. Keep in mind that even if you don't eventually receive
the loan, that money is not refundable.
Other closing costs are possible and should be considered when evaluating
your financial situation. These may include, but not limited to:
- Title insurance fee
- Survey charge
- Loan origination fee
- Attorney fees or escrow fees
- Document preparation fee
- Garbage or trash collection fees; and the big one
- Points - up-front interest paid in return for a lower interest rate.
Each point is one percent of the loan amount. Sometimes you can contract
for the seller to pay your points.
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10. What is PMI (Private Mortgage Insurance)?
If you put less than 20% down on most loans, you'll be asked to protect
the lender by carrying private mortgage insurance (PMI). Carrying PMI
ensures that the debt is repaid if you default on the loan. This charge
adds approximately an extra half a percent onto the loan.
FHA mortgages, in return for their low-down-payment requirements, also
charge for mortgage insurance premiums (MIP).
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