Home Finance Basics
|
|
|
|
 |
 |
Loan Programs |
 |
Finance Basics |
|
Home Loan FAQ |
|
Term Glossary |
|
Pre-Qualify Now |
|
Contact Us |
 |
Home Finance Basics will increase your understanding of lending terminology, the application process, and how to choose the right loan for you from the wide variety of programs available.
|
If you are considering buying your first home, the information immediately following will describe your loan choices, qualifying for the loan, and the application process. If you own your home and are thinking about refinancing, then link to that section and learn how to determine whether now is the time for you to refinance.
I. The Right Loan for You is a Matter of Choice
The 30-year fixed-rate mortgage was once the only choice you had for a home loan. Now you have a choice of a multitude of programs. There are 15- and 30-year Fixed Rate Mortgages (FRM’s), Adjustable Rate Mortgages (ARM’s) which are based on a number of indices and adjustment periods, and ‘variations on a theme’ in between.
The good news is that never before have you had the ability to pick just the right program for your circumstances and expectations. The bad news is that never before have you been faced with so many choices. Your Hallmark Mortgage Services, Inc. loan officer will guide you through what some describe as the ‘mortgage maze’ and lead you to the best loan for you.
FHA/ VA Programs
One way of dividing the world of mortgage programs is distinguishing between those loans insured by the Federal Government and those that are not. Those loans that are so insured are guaranteed by either the Federal Housing Agency (FHA) or the Veterans Administration (VA) and are known by those abbreviations. The idea behind these government programs is to promote the social goal of broad home ownership.
Their primary benefit is the borrower’s ability to buy a home with very little down payment. Coming up with down payment and closing costs is a major obstacle to home ownership for most first time home buyers. Statistically speaking, the smaller the down payment for a home, the higher is the chance the borrower may run into financial difficulty and be unable to make payments on the loan. FHA and VA insurance insures the lender against any loss which may arise if the borrower is unable to make payments on the loan.
Many states and municipalities also have special programs which promote home ownership for its citizens. Your loan officer can tell you what is available in your community.
Conventional Programs
Conventional mortgages are those which are not insured by the FHA/VA and thus not subject to their rules and regulations. These loans are offered by banks, savings and loans, credit unions, and mortgage bankers. Although these lenders also offer reduced down payment programs, the insurance for these loans is offered by private sector insurance companies, hence the name private mortgage insurance (PMI). PMI is usually required if the down payment on the home is less than 20%.
Another basic division is between fixed rate and adjustable-rate mortgages. A fixed rate mortgage is one in which the interest rate and payment remain constant throughout the term of the loan. Fixed rate loans are fully amortized meaning that the fixed monthly payments will completely pay off the debt (both principle and interest) over the term of the loan. Fixed rate mortgages are generally available with 30 year or 15 year terms.
Unlike fixed rate mortgages, Adjustable Rate Mortgages (ARM’s) can change at regular intervals (called "adjustment periods") according to changes in prevailing interest rates.
All ARM’s have the following characteristics: The "start rate" is the initial interest rate on the loan. A "life cap" is the maximum interest rate for the life of the loan and is often set at some number of percent over the start rate. During the life of the loan, the interest rate will be a combination of the particular index for that loan program which will change over the life of the loan and a constant margin which will remain the same over the life of the loan.
Popular indices used by lenders are the 11th District Cost of Funds, the 1 Year Treasury Index, and the New York CD rate, among others. The margin can be seen as the required yield to the lender for lending the money.
The interest rate on the ARM will adjust to changes in the index according to a schedule which is known as the adjustment period. The adjustment period could be as short as a month or as long as a year depending on the program and the index used. Each time the interest rate changes, the monthly payment is re-calculated so as to pay off the loan during the term remaining.
Variations on the Above Themes
You also can choose from variations on traditional FRM’s
and ARM’s. Balloon loans will offer you rates lower than
concurrently available 30 year FRM’s but could adjust after a period
of five or seven years. Fixed Adjustable Loans have an initial fixed
interest rate for a certain number of years (usually 3, 5, 7, or 10)
then their interest rate becomes adjustable for the remaining term. As
you can see, you have choices as never before.
The Right Loan for You
The "right loan" for you depends on a number of variables including your anticipated stay in the property, where you are in your career, and what you expect interest rates "to do" over the foreseeable future.
The right loan may be an ARM with a low start rate which allows you to buy more home now with increasing income covering higher possible payments later. It may be a 15 year fixed rate loan which would allow you to own your home free and clear by the time you plan to retire. A fixed adjustable loan with a three year fixed start rate may be just what you need to get you to the point when the children leave home and you plan to move to a smaller home.
Your Hallmark Mortgage Services, Inc. loan officer will help you decide which is the right loan for you.
II. Overview of the Loan Process
Where the Money Comes From
In the early days of home financing, banks would accept deposits from their customers and then use that money to lend out to borrowers who wanted to finance the purchase of a home. Banks were thus limited in how many loans they could make by the amount of money deposited with that bank. To eliminate that limitation and serve more borrowers, lending institutions learned to combine a lot of individual mortgages into "pools" and sell those pools to large investors such as pension funds, insurance companies, and investment firms who liked the idea of investing in debt secured by U.S. real estate but did not want to be in the banking business.
The federal government wanted to promote home ownership in America, and thus created the following financial cousins: The Government National Mortgage Association (GNMA) known as "Ginnie Mae", the Federal National Mortgage Association (FNMA) known as "Fannie Mae", and the Federal Home Loan Mortgage Corporation (FHLMC) known as "Freddie Mac".
Very simply, these agencies sell their bonds to Wall Street investors and in turn use the proceeds to invest in pools of mortgages originated by traditional lending institutions. In this way, there is always enough money for home loans.
The Golden Rule -- Underwriting Guidelines
The mortgage business variation of the Golden Rule is "They who have the gold make the rules." As the three financial cousins represent such a huge part of the home loan market, they collectively set the benchmark guidelines for the home lending industry.
By guidelines, we mean rules regarding what kinds of borrower income can be counted in qualifying for a loan, the quality of credit history demonstrated by the borrower, and the kinds of real estate property which can be used to secure the loan. These rules are based on a history of the millions of loans in which the three agencies have purchased over the years. Specifically, the agencies study what borrower income, credit, and property characteristics statistically contributed to a higher probability of default.
When we talk about "qualifying for a loan" in the paragraphs below, we refer to the rules under which Ginnie Mae, Fannie Mae, and Freddie Mac will invest in the loan.
Income and Debt Ratios
The very first consideration a lender reviews is the borrower’s ability to afford the payments on the proposed loan. This ability to afford the payments on the loan, other housing expenses, and personal debt is defined in percentages of the borrower’s monthly income, or ratios. You can calculate your own qualifying ratios on a payment calculator. The following is a description of how those ratios are defined and calculated.
Gross Monthly Income: For salaried employees, this is the gross amount the employee earns before deductions for taxes, insurance etc. Sometimes gross income is an average of such earnings over a period of time. For self-employed borrowers, gross income is the money earned by the borrower after all business expenses are paid. Self employed income is calculated using a two year average.
P+I: Monthly principle and interest. This is your monthly mortgage payment.
PITI: Monthly P+I, property taxes, property insurance, community home-owners fees (if applicable), private mortgage insurance, and any other expense directly related to the ownership of the home.
Revolving Debt: Usually this is credit card debt and typically calculated as three to five percent of the account balance.
Fixed Debt: As the name implies, a fixed monthly payment as you would make on a car loan, etc.
Using the above information, two ratios which compare monthly income and debt will be computed:
The Housing Expense Ratio - Calculated by dividing PITI by Gross Monthly Income.
Total Debt Ratio - Calculated by dividing the sum of PITI, monthly Revolving Debt, and monthly fixed debt by Gross Monthly Income.
Example:
- Gross Monthly Income $4,000
- PITI $1,000
- Monthly Revolving $200
- Monthly Fixed $200
- Housing Expense Ratio - 1,000 divided by 4,000 = 25%
- Total Debt Ratio - (1,000 + 200 + 200) divided by 4,000 = 35%
Most lending guidelines (remember the Golden Rule) call for a Housing Expense Ratio of 28% and a Total Debt Ratio of 38%. These ratios are not etched in stone. Lenders can show flexibility in these guidelines when there are other factors in the lending picture which lower the perceived risk of the loan.
For example, some of these compensating factors are a stable employment history, a down payment over 25%, and a high level of liquid assets remaining to the borrower after the transaction .
To get a ballpark idea of how large of a loan you could qualify for based on your ratios, see a payment calculator.
The Down Payment and LTV
Most home loans do not cover the full purchase price of the property. For example, if you pay 10% of the purchase price from your savings, you will need a loan for the remaining 90%. This 90% is known as LTV (Loan To Value).
As mentioned above, FHA and VA loan programs provide for very low down payments. Veterans eligible for VA loans can often qualify for a purchase loan with almost no down payment. Fannie Mae purchases loans with as little as 3% down payment or 97% LTV. However, in most transactions higher down payment and lower LTV’s are more common. Different loan programs allow for different LTV’s
Defaults and foreclosures statistically increase with down payments less than 20%. Conventional lenders normally require PMI (Private Mortgage Insurance) when the LTV is greater than 80%. Very similar to FHA and VA mortgage insurance, this insurance insures the lender against losses which would result from a borrower defaulting on the loan.
Down payment funds can be from a variety of sources. The two most common sources are the borrower’s own savings and/or gifts from relatives. As a general rule, the smaller the down payment the less flexibility the lender will have on other qualifying criteria such as income and expense ratios.
The Application
Once you and your loan officer determined the best loan program for you, the next step is to apply for the loan. This can be done in person at a Hallmark Mortgage Services, Inc. offices close to you or over the phone with The Mortgage Center. The loan officer will ask you for detailed information on your income, assets, and current debt obligations as well as information on the property* which will serve as security for the loan. Generally, your loan officer will ask you to pay an application fee to cover immediate expenses incurred by the lender for a credit report and property appraisal.
The smart way to shop for a new home is to qualify for the loan and receive a lending commitment before you decide on the home of your dreams. Hallmark Mortgage Services, Inc.’s "mortgage" program enables you to apply and qualify for a Hallmark Mortgage Services, Inc. lending commitment before you find your home. Having home financing "in place" allows for quicker, smoother closings and a tremendous advantage in purchase negotiations.
Processing the Application
After you and your loan officer complete the application you will be asked for evidence of your income and assets. This evidence usually is in the form of pay stubs and W-2’s as documentation of income and bank statements as documentation of funds for down payment and closing costs.
If you have identified a property you wish to purchase, and have reached a contractual agreement with the seller, the lender will also request copies of the purchase agreement, any property inspections ordered and title reports for the subject property. At that time an appraiser will be hired to appraise the property. In short, the lender creates a "picture" of the proposed transaction. Part of the picture will be drawn from borrower characteristics, and part from the property characteristics.
When the picture is complete, the application file goes to the Underwriter, who is the person responsible for making sure the picture presented conforms to the lending guidelines for the investor. If all of the borrower and property characteristics fit, then the loan is approved. Sometimes there remains a few missing pieces of the picture. If there are missing pieces, the underwriter conditions for those parts of the picture to be filled in prior to the closing of the transaction. At that point, the loan officer will communicate the approval, any conditions outstanding, and confirm the terms of the loan.
If there are characteristics of the loan which are outside of the investor’s guidelines, the underwriter will explain why the loan cannot be approved for that program. In that event the loan officer often can recommend an alternative loan program with guidelines which would allow for the borrowers particular picture.
Closing
The final completion of the purchase transaction is known as the closing. Loan documents are drawn by the lender and settlement statements prepared by the escrow agent. When the documents are signed and all conditions met, the lender sends money to escrow and the loan is recorded.
Why Refinance?
Lowering your monthly payment is only one reason for refinancing your existing home loan. Borrowers usually refinance their existing home loan because of the following reasons:
- Lower monthly payment
- Reduce the loan term (length)
- Consolidate other loans charging higher rates into one lower rate loan
- Take cash from the equity in the home for other purposes
- Replace a rising interest rate on an ARM loan
A refinance calculator lets you compare your current mortgage to a new one. You can adjust term, rate, loan size (cash-out), or interest rate to see how your payment and long term situation would change.
As is the case with purchase transactions, lenders will consider LTV, Housing Expense and Total Debt Ratios, and credit history in reviewing your application. The payment history on your current mortgage is particularly important as lenders consider it an important indicator of future performance on the proposed loan.
Costs of Refinancing
Once you know why you want to refinance, the next question becomes whether the new loan is worth the cost of getting it. The first factor to consider is what interest rates for the program you are considering are currently available.
For every loan made there is a return, or yield, the investor feels is fair for current market conditions. This yield is often called the "Par Rate". If you want to pay an interest rate lower than the Par Rate (Discount Rate), the investor will charge a corresponding fee called "discount points" to adjust the yield on the loan. A point is one percent (1%) of the loan amount.
The lower the rate you want to pay on the loan, the higher the points charged. If you choose a rate higher than the Par Rate (Premium Rate), the investor may be willing to pay you "premium points" which you can spend on the other closing costs of the loan. Using Premium Rate pricing allows lenders to offer "low" or "no-cost" loans.
Much like when you purchased your home, the following are some of the costs associated with placing a loan against your home:
- loan origination fees or "points"
- credit reports
- lender fees for processing, underwriting, and document preparation
- tax service fees
- appraisal costs
- title and escrow fees
- funds wire fee
- courier fees
- recording fees
There may be other costs related to the refinance transaction to be paid at the time you close your new loan. These costs may include:
- interest due on your current loan for the month in which you close your new loan
- property tax installment if due
- hazard insurance premiums if less that six months remain on current policy
- any prepayment penalty on your current mortgage
Refinance costs can range from nothing with a Premium Rate Loan to as much as 6% of the loan balance with a Discount Rate Loan. The two biggest components of the closing costs are the loan origination fee and the title and escrow fees. The combination of interest rate and fee you choose will determine your loan origination fee. Similarly, your choice of title and escrow services will determine those costs.
If your reason for refinancing is to reduce your monthly payments, you will want to look at your savings in comparison to the costs to make sure that the benefits are worth the costs. Dividing the anticipated costs by the monthly savings will tell you how long you need to keep the new loan before you "break-even."
As you can see there can be many reasons to refinance your existing home loan. At the same time, the loan you have may still be the best one for you. Your Hallmark Mortgage Services, Inc. loan officer can analyze your existing financing and guide you to the program that best meets your needs.
Return to Hallmark Mortgage Loans
| Questions, comments,
or suggestions? Please call 800-960-1150 Thank you for visiting! Return to Hallmark Mortgage Homepage |
|