Financing: Basics of Home Mortages
Mortgage loans are utilized in most home buying transactions, when a buyer needs to acquire a loan for the difference between the purchase price and the amount of funds available. (For example, if a buyers was purchasing a $200,000 home, and had a 20% down payment of $40,000, a $160,000 mortgage would need to be secured to purchase the property.) For mortgage loans, a buyer, naturally, turns to a mortgage lender.
A few basics about working with mortgage lenders you should know:
- When you borrow money from a mortgage lender, you are charged a regular fee that is applied to your payments, also known as interest. The Interest is an annual percent of the loan, can vary dependent on current market conditions, your credit rating, and the type of mortgage you secure. The typical range is a low of 4% and a high of 12%
- Lenders and brokers may also charge other fees for the work involved in processing and managing a mortgage, like application fees, credit report fees, appraisal fees and points. These are sometimes lumped together as an origination fee and applied at the settlement.
- The overall annual percentage rate (APR) is a combination of the base interest rate with points and other fees to provide a total figure that allows you to compare various loans.
Fixed and Adjustable rates are the two different types of interest rates that you can elect to have for your mortgage loan. A Fixed rate mortgage is the most common, and is a rate that remains unchanged for the list of the loan, usually 10, 15, 20 or 30 years. An adjustable rate mortgage has lower initial payments that change over the course of the loan
Choosing the length of your mortgage: There are a few factors to consider when deciding the length of your mortgage. When it comes to interest, a 10 or 15 year loan is obviously less expensive and ensures you will pay off your loan at a much after rate, but be prepared for larger payments. Because most people move in 8 years or less, a 30 year mortgage, which has lower payments, might be a better choice, and an adjustable rate mortgage might be even cheaper. Consider how long you intend to keep your home, and use that as a factor in your decision making process.
Mortgage Interest Basics: Interest rates rise and fall regularly, like the stock market. A popular index for short term interest is the six-month certificate of deposit (CD) rate that banks offer. Mortgage lenders generally charge about 2.5% over the public CD rate, so if a six-month CD is being offers at 3%, a mortgage lender may offer you a loan with a 5.5% interest rate.
Short term rates, (for 10 year loans as opposed to 30 year loans), tend to be lower that longer loans because lenders consider it less of a risk to loan money for a shorter period of time. While a 15 year loan can have a rate that’s about .5% less than a 30 year loan, adjustable rate mortgages can be even lower than a standard 30 year loan. Bear in mind, however, that the Adjustable Rate offered only reflects the rate for the first period of the loan, anywhere from a few months to a few years.
Basically, while a 30 year mortgage may have a higher interest rate, it offers lower payments as well as stability, as the buyer knows what their principal and interest rates will be for the duration of the loan.
Mortgage Processing Fees: There are additional one time fees that mortgage lenders may charge for initiating and processing your loan. There is typically a $200-$400 mortgage application fee to cover the lender’s costs on applications that may or may not become loans. On occasion, these fees are refundable if the loan is approved.
You can also expect to pay a $25-$75 Credit Report fee, so the mortgage lender can access your credit scores. In the early stages of the home buying process, it’s a good idea to check and consider your credit, and take any actions needed to ensure you have the best possible credit score. Lenders will charge higher rates, or decline to offer you a loan, if your credit score is poor.
The Fair Credit Reporting Act (FCRA) requires each of the nationwide consumer reporting companies — Equifax, Experian, and TransUnion — to provide you with a free copy of your credit report, at your request, once every 12 months. For more information on obtaining your annual report, refer to the Federal Trade Commission (FTC).
Appraisal Fees: Your lender will also require you to obtain an appraisal to determine the market value of the property you wish to buy, and to ensure that the selling price reflects this value. (In other words, the mortgage lender wants to make sure you are not paying more than the home is worth.) These fees can range from $200 to $500, depending on the size of the property, and by the area. A professional appraiser will then inspect the property, and then look at similar properties that were recently sold, and / or are currently for sale.
Mortgage Points: Points are a form of the loan interest that must be paid upfront, (at closing.) A point is the equivalent of 1% of the total loan amount. The good news about point fees is that it makes the interest rate for the overall life of the loan lower. The majority of lenders give you the option to purchase more “points” and therefore lower your interest rate for the rest of the loan.
Annual Percentage Rate (APR): The annual percentage rate is a combination of all fees and interest associated with a loan, and allows you to compare different loan options. For example, a loan with 3 points and a 6.5% interest rate will have smaller monthly payment than a loan with 1 point and a 7% interest rate. The APR combines these base interest rates with the points and all other loan fees to produce a single interest rate, which is higher than the base rate for a loan sans fees and points, to compare the two mortgage loans.
Adjustable Rate Mortgage Loans (ARMs): While the initial rate of an ARM is typically lower than a fixed rate, it can raise periodically, depending on changes in short term interest rates (like CDs.) The limits of how high and how often the interest rate can rise is known as the “caps.” The annual cap is the limit of how high an interest rate can raise in a single year, and the life-time rate is the limit of how high the rate can raise during the entire length of the loan.
ARMs are an option for buyers who expect a higher income within the next couple of years, and / or who expect to refinance after a few years into the loan.