The Mortgage Process
Securing an affordable home loan with fair terms
requires understanding the types of loans available
and then selecting the option that fits your budget
and needs. It also requires determining how much
house you can afford and getting your finances in
order.
Often the cost of real estate financing is
greater than the original purchase price of a home
(after including interest and closing costs).
Because financing is so important, buyers should
have as much information as possible about mortgage
options and costs. Your Illinois REALTOR®
can provide you with mortgage information, discuss
financing options and recommend loan sources – and
may be able to help you find financing that suits
your needs.
Read on for five steps about the mortgage
process to get you started.
Five Steps to Financing Your New Home Purchase
-
Financing options
and types of loans
-
Applying for a mortgage
-
Annual Percentage Rates (APR)
-
Closing costs
-
Breakdown of a mortgage payment
A wide range of mortgage financing options can be
obtained from mortgage bankers, mortgage brokers,
mutual savings banks,
commercial banks, credit unions and insurance
companies. REALTORS can help you find responsible
lenders that make fair and affordable loans.
In general, the mortgage you choose will be
determined by:
Your down payment: Loans with low
money down are available from some lenders.
However, for down payments of less than 20%,
lenders require mortgage insurance.
Your credit: The best rates and terms
are available to those who have the best
credit/credit scores. To qualify for the best
loans, be sure to pay your credit cards,
installment payments, rent and mortgage bills in
full and on time.
“First-time” homebuyer status:
First-time Illinois homebuyers (or those who
have not owned a home in three years) may
qualify for low-cost loans through the
Partnership for HomeOwnership’s Rural
Initiative, Quincy Initiative and HomePower
Mortgage Assistance programs. Learn more about
these affordable mortgage programs from your
Illinois REALTOR®.
Types of loans include the following:
Conventional mortgages - A conventional loan is the most common type of
mortgage. For down payments of less than 20%, a
lender will require mortgage insurance on the loan.
Mortgage insurance helps the lender recover some of
the losses incurred in case you stop making payments
on the loan. Private mortgage insurance adds a small
cost to your financing, but it allows you to buy a
house with a lower down payment. The lower the down
payment is, the higher the mortgage insurance will
be.
Fixed-rate mortgages - A fixed-rate mortgage maintains the same interest
rate over the lifetime of the loan. Many consumers
prefer this mortgage option for its stability in
terms of budgeting and planning.
In addition to the typical 30 year mortgage, 25,
20 and 15 year mortgages also are available. The
short-term loans call for higher payments, but with
less interest than 30 year mortgages. Shorter loan
terms will build equity more quickly which can be
tapped for other financial needs. The 30 year
fixed-rate mortgage is easiest to qualify for
because the payments are lower. This should be
considered in financial planning.
Adjustable-rate mortgages (ARMs) - ARMs work well for buyers planning to live in the
home a short time, or whose income will continually
rise and the interest deduction then becomes more
important later. The ARM interest rate changes at
pre-determined times throughout the life of the
loan. As the interest rate changes, so does the
mortgage payment. The interest rate could adjust
every six months, once a year, or once every three,
five or 10 years.
ARMs usually have two caps which restrict how
much the interest rate index can fluctuate. One cap
will limit how much the interest rate can increase
from one adjustment period to the next, such as 2%.
The second cap will limit the interest rate
fluctuation for the duration of the loan. With a 6%
lifetime rate cap, the highest interest rate can be
no more than 6% above the original interest rate.
Note: The FHA ARM has a 1% annual and a 5% lifetime
cap, making it an attractive ARM.
Beware of ARM "payment caps" that limit how much
the principal and interest payment can increase.
Negative amortization can occur and the unpaid
interest will be added to the loan balance.
ARMs may initially provide lower interest rates,
therefore increasing the affordability of your
desired home. But, before embarking on such a loan
program, you must be certain you can manage sudden
payment increases. Here are some questions to ask:
- How long does the initial interest rate
apply?
- How frequently can the interest rate
change?
- How is the adjusted interest rate
determined? (Generally, a specified amount – known
as the “margin” – is added to a current published
rate – known as the “index.”)
- How high can the interest go? (Remember,
even small changes in your interest rate can affect
your monthly payment significantly.)
- Are there any limits on how much the
interest rate can change each year?
- Do the monthly payments still pay off the
loan even if the interest rates increase? (With some
loans, the amount you still owe – your “loan
balance” – can increase rather than decrease each
month. This is called negative amortization.)
Specialty mortgages - As conventional mortgage rates continue to
fluctuate, some homebuyers turn to specialty
mortgages to “stretch” their income in order to
qualify for a larger loan. Like ARMs, specialty
mortgages begin with a low introductory interest
rate – a “teaser” – but the monthly mortgage
payments are likely to increase a lot in the future.
Common specialty mortgages include: interest-only,
negative amortization, option payment ARM and 40-year mortgages.
It is in your best interest to learn the ins and
outs of specialty loans which can pose greater risks
to affording mortgage payments in the future. For
more information, download
Questions to Consider Before Choosing a Specialty
Mortgage – a free brochure from the National
Association of REALTORS.
Federally insured mortgages - In addition to conventional mortgages, one of the
safest and most affordable types of mortgages is the
Federal Housing Administration (FHA)-insured
mortgage. The
FHA mortgage insures homebuyers with
less-than-perfect credit and offers low down payment
options, a loan at reasonable cost and help with
mortgage payments if needed. The
USDA Rural Development and the
Veterans Administration (VA) also provide
insurance for home mortgage.
Read about
state and federal loan programs.
Seller financing - In some cases, a seller may provide financing.
The rate of interest may be lower than conventional
financing. Often, other contract terms are
beneficial to both the buyer and the seller. Seller
financing frequently occurs for speculative acreage
transactions and rural properties. If the seller has
a large equity position in the property, often he or
she is willing to accept a contract for deed, as the
IRS considers that transaction an installment loan,
and the profit can be spread over the term of the
contract. When mortgage money becomes tight,
interest rates rise or home values drop, homeowners
are more willing to accept a contract for deed to
complete a sale.
Reverse mortgages - A reverse mortgage is a type of home equity loan
that allows the owner to convert some of the equity
in their home into cash while retaining home
ownership. RMs work like traditional mortgages, only
in reverse. Rather than make a payment to the
lender, the lender pays the owner. Funds obtained
from an RM may be used for any purpose, including
expenses, such as taxes, insurance and maintenance.
To qualify, the borrower must own their home. The
amount available will depend on the borrower’s age,
the equity in the home and the interest rate the
lender charges. There are three RM plans available
today: FHA insured, lender-insured and uninsured.
To obtain a home mortgage, you must complete a
written loan application and provide supporting
documentation.
Acceptable income for a mortgage application is
considered to include:
- Full-time employment, two
years tenure
- Part-time employment if
steady for two years and expected to continue
- Overtime and bonus income
that has occurred for two years and which will
probably continue. (Lender will average.)
- Raises guaranteed to occur
within 60 days of loan closing.
Other possible income can include:
- Retirement income
- Military income
- Veteran's benefits
- Social Security
- Alimony/child support
- Notes receivable
- Interest and
dividend/trust income
- Unemployment benefits
- Rental income
- Auto allowance
Required documentation
During the
prequalification procedure, the loan officer will
describe the type of paperwork required. Specific
documents include recent pay stubs, rental checks
and tax returns for the past two or three years if
you are self-employed. Following is a checklist of
documents most lenders require in order to process
your mortgage application. Documents required may
vary by lender so be sure to follow your lender’s
instructions accurately. In addition, some fees
associated with appraisals, credit reports and
lenders may be required.
Buyers General Financial Information
W-2s, 1099s or 1040 tax returns for the
past three years and recent pay stubs
Profit and Loss Statements (when
self-employed) for current year and previous two
years.
List of savings bonds, stocks or
investments and their approximate market values.
List of inheritances and their cash values.
List of account numbers, addresses,
balances and past two months' statements of all open
bank accounts.
List of account numbers, addresses,
monthly payment and balances of all open and
liability accounts (credit cards, personal and
cosigned installment loans), and copies of the past
two month's statements.
Copy of lease agreement(s) on rental
property you own, mortgage held and notes due.
Verification of additional income
(veteran's benefits, pension, social security, trust
funds, disability, overtime bonus, commission,
interest income, etc.)
Copies of alimony, child support and
separate maintenance payments, with agreements,
decrees and canceled checks.
Other Buyer Documentation
Copy of military orders, if applicable
Copies of titles to any motor vehicles or
boats that are paid in full
Information about the Purchase
Signed copy of sales contract
Copy of canceled deposit check (earnest
money) on house
Copy of gift letter, copy of gift check
and copy of deposit slip for gift check (if money
for downpayment is a gift from a relative)
The Annual Percentage Rate (APR) is the ratio of
the total finance charge compared to the total
amount financed. For example, If your loan has a 10%
APR, you’ll pay $10 per $100 you borrow annually.
The finance charge can include interest and various
loan fees.
APR is one way to compare loans offered by
different lenders. Although APR comparison is not
completely accurate because lenders are not subject
to clearly defined rules for calculating this
number, it is a benchmark used by the U.S.
Department of Housing and Urban Development to
identify institutions that charge unreasonable fees.
APR calculations include a variety of fees,
including:
Points - these are
up-front fees where each point is equivalent to
1% of the loan amount.
Other fees – such as a
loan processing fee, document preparation fee,
pre-paid interest (paid from the closing date to
the end of the month), underwriting fee,
appraisal fee, credit report fee, attorney fees,
filing fees and private mortgage insurance.
Consumers should not use APRs to compare a 30
year loan to a 15 year loan. APR also should not be
used to indicate the true cost of an adjustable rate
loan as it does not indicate the interest rate
adjustments or the period of time the rate is
locked.
A good way to compare loans of the same type of
program is to request a good-faith estimate from
different lenders at the same interest rate. Then,
subtract all fees that are unrelated to the loan –
such as attorney fees – and add up all the loan
fees. The lower the loan fees, the cheaper the loan.
Closing, or settlement, is the formal process of
transferring the property title from the seller to
the buyer. When you apply for a loan, the lender
will give you an estimate of closing costs. Closing
costs will vary by lender and by area and may
include:
Application Fee: The fee
you paid at the time of the loan application to
cover your appraisal and credit report; will
appear on your closing statement as a pre-paid
fee.
Origination Fee: Your
lender may charge a fee to cover the
administrative cost of processing your loan.
This fee is usually a small percentage of the
loan amount.
Items Paid in Advance
(Prepaid Escrows): Most lenders require you to
pay in advance for some items that will be due
one year after closing. These pre-paid items
usually include first-year hazard insurance
premium and two months of mortgage insurance and
real estate taxes. However, you will get credit
for last year's taxes up to closing.
Title Insurance Charges:
Insurance policy that ensures against losses.
This also includes protection against unrecorded
easements or liens.
Recording and Transfer
Fee: A record of your home purchase will be on
file with your local government, and there will
be a fee to record the various forms.
Attorney's Fee: This fee
is to pay your attorney for preparing and
reviewing all of the documents needed to close
your loan.
Document Preparation Fee:
This fee covers the cost of the bank to prepare
and close your loan.
You can expect to pay closing costs from 3% to 4%
of the amount of your mortgage loan.
Most closing costs are either tax deductible or
should be capitalized and added to the purchase
price of your home when you are ready to sell.
Deductible costs for buyers include:
Points (interest collected in advance by
the lender)
Interest paid from the closing date to
the first payment
Property taxes
Deductible costs for sellers include:
Credits to the buyer for taxes already
paid
Mortgage interest for the selling year
Capitalized fees include:
Recording fees
Title fees
Attorney fees
Notary fees
Termite inspection fees
For more information, consult your tax advisor.
When you make a mortgage payment, exactly what
are you paying? You are probably familiar with
principal and interest, which are the major parts of
your mortgage payment. Here is a breakdown of all
the costs included in your mortgage payment.
Principal -
The amount of money you borrowed. Each month when
you make your mortgage payment, you are paying back
a small portion of principal. The longer you make
payments, the more of your payment goes to reduce
the principal you owe. Over time, interest will
become a smaller part of your monthly payment.
Interest -
The cost of borrowing money, usually expressed as an
annual percentage of the loan amount, for example
7.5%, 8%, etc. Your lender will give you an "end of
the year" summary showing the interest you paid.
That interest is a straight deduction from your
income prior to calculating the payment of your
Federal taxes.
Property Taxes -
Taxes paid to local governments, usually charged as
a percentage of the property value. Your lender
collects the taxes through your monthly payments.
The amount of tax will vary depending on where you
live. Your real estate taxes are deductible on your
Federal income tax return.
Hazard Insurance -
An insurance policy that protects you from any
financial losses on your property that might result
because of fire, flood or other "hazards." Before
you buy, compare companies and policies. Often, new
construction has lower premiums. Initially, "safety"
devices can also reduce the premium.
Mortgage Insurance -
An insurance policy that helps mortgage lenders
recover some of the losses incurred if a borrower
fails to fully repay a loan. Mortgage insurance
makes it possible to buy a home with a low down
payment. This amount is reduced with higher down
payment.
Lenders often refer to principal, interest, taxes
and insurance as the acronym PITI. Generally, the
PITI is the amount you will pay each month for your
mortgage.
|
