Buying a home can be an exciting and a stressful time. If this is your first time buying a home, be prepared for a deluge of information, advice and opinions. And don’t let your real estate agent or your banker make the most important decision of them all – your mortgage. You know your financial situation better than anyone else and you are best equipped to make an informed decision.
But understanding a mortgage loan isn’t as simple as say, an auto loan. There are multiple variables to consider and the language used to pitch the loan is quite different. Educating yourself is a good start! Getting familiar with the entire mortgage process at a high level is extremely important.
Rather than throw around definitions, I’m going to try a different approach.
The following snippets are taken from actual loan ads by mortgage lenders
This will give you an idea as to what to look for when shopping for a mortgage. With the knowledge gleaned here, you should be able to decipher any loan application!
Fixed Rate Mortgages
Fixed Rate Mortgages are very popular since this offers the least amount of surprises when it comes to making monthly payments! Here’s how Fixed Rate Mortgages work.
There are two important variables to consider when it comes to choosing a Fixed Rate Mortgage: The rate and the duration of the loan.
The rate is the interest at which the lender lends you the money and the duration is the term of the loan. You will not get the advertised rate unless your credit score is excellent. Rates vary from lender to lender, so shop around!
Typical durations for Fixed Rate Mortgages are 15, 20 and 30 years. The shorter the duration, the lower your interest rate will be but higher your monthly payments. The trade-off is between how much can you afford as monthly payments versus how much you will be paying overall to own the house.
Rate Buy Down
Also referred to as buying discount points, is an option to lower your rate by prepaying the interest at the time of borrowing. For example, if the lender offers a loan at 4.75% and you wish to lower it to 4.00%, most lenders will agree to lower the rate by offering discount points. 1 point is 1% or your loan amount.
Escrow Waiver Fee
An Escrow is an account setup by your mortgage company on your behalf to pay for property taxes and home owners insurance. The mortgage company collects this money at the beginning of each year and makes the payments on your behalf when taxes or insurance premiums are due.
If you wish to do this yourself and keep the interest which you would otherwise lose out if put in escrow, some lenders will charge a fee for it. This is the Escrow Waiver Free. In the ad above, the lender Alliant Credit Union is highlighting the fact that they do not charge this fee.
This is the fee charged by your lender for processing your loan. Origination fee can be a fixed charge or a percentage of your loan amount. For example, PenFed mortgages have a 1% origination charge whereas Alliant Credit Union charges a flat $1,350 origination fee on a 30 year fixed mortgage. So if your loan amount is for $200,000, a PenFed loan will cost your $2,000 as opposed to $1,350 with Alliant.
Loan rates change frequently and are determined by the current market conditions. Loan rates are set by a number of factors, most importantly the Prime Rate set by the Feds.
Lenders offer the option of ‘locking-in’ a rate for a certain number of days. Usually, 45, 60 or 90 days. If the deal closes within the lock-in period, you are guaranteed the lock-in rate. If, at the time of closing, the rate is lower than your lock-in rate, you are still bound by the lock-in rate.
If you choose to float your rate, your rate will be determined by the rate at the time of closing.
The more time a lender offers as a lock-in period, the better.
Adjustable Rate Mortgages (ARM)
As the name indicates, with an ARM, the rate fluctuates after an initial teaser rate.
From the above, 5/1 ARM indicates a fixed rate for the first five years and a varying rate every year after that. ARMs are a good choice if you plan on owning the house for a short period of time.
Conforming or conventional loan means that the loan is eligible for purchase by federal housing agencies, Fannie Mae and Freddie Mac and that the loan value is within the set limits. Conforming loans cannot be more than $417,000 for a single unit home.
See discount points above.
Rate & APR
If you look at the example above, you’ll find two values for the interest rate and that the APR is slightly higher than the rate. What is the difference between these two? Which value should a home buyer be looking at?
Say you locked in a rate of 4% but had to pay $2,000 as origination fee, purchased points, prepaid interest and other fees. What is your actual rate in this case?
The actual rate would be much higher than what you thought you were getting. Thankfully, the Truth in Lending act mandates lenders must disclose the rate as APR which takes into account all such fees. Good example of regulation done right no matter what the loonies say.
Jumbo loans, also called non-conforming loans are loans which cannot be repurchased by Freddie Mac and Fannie Mae in full. This makes it harder to sell the mortgage by the lender, hence, the rates will be higher considering the higher risk.
With a few exceptions depending upon the state, if the loan amount is over $417,000, it is considered a Jumbo loan.
If you are an existing home owner paying high premiums due to your loan lock-in rate, there are options to reduce your interest rate. Especially now, when the interest rates are at a record low.
When you refinance a mortgage, you essentially sell the mortgage to the new lender and start paying premiums at the new rate going forward. The catch is, you have to go through another closing and the costs associated with it. And closing costs are quite significant.
No Cost Refinancing
Some lenders offer what’s called a low or no cost refinance option. Cost here refers to Closing costs.
With a no cost loan, you don’t pay for closing costs at the time of refinancing your mortgage. But instead, this is rolled into your loan as a part of the principal. Or the lender might charge a higher interest rate to cover this cost.
Always be sure to ask what is covered if you decide to choose this option.
The American dream isn’t complete till you own a home! No one likes a depressed economy, but with it comes low interest rates. This is as good a time as any to buy or refinance a home. Just don’t go overboard! Evaluate your financial situation, cover the basics, educate yourself and make a decision.