4. General Home Loan Financing Questions
Q: What is a mortgage?
Generally speaking, a mortgage is a home loan obtained to purchase real estate. The "mortgage" itself is a lien (a legal claim) on the home or property that secures the promise to pay the debt. All home loan mortgages have two features in common: principal (the amount you borrowed) and interest (the money the home mortgage lender earns for lending you the principal).
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Q: What is a loan to value (LTV) and how does it determine the size of my loan?
The loan to value ratio is the amount of money you borrow compared with the price or appraised value of the home you are purchasing. Each loan has a specific LTV limit. For example: With a 95% LTV loan on a home priced at $100,000, you could borrow up to $95,000 (95% of $100,000), and would have to pay $5,000 as a down payment. Today there are 100% loans available, and even loans that include 100% of the purchase price, plus closing costs.
The LTV ratio reflects the amount of equity borrowers have in their homes. The higher the LTV the less cash homebuyers are required to pay out of their own funds. So, to protect lenders against potential loss in case of default, higher LTV home loans (80% or more) often require a mortgage insurance policy.
Q: What types of home mortgage loans are available and what are the advantages of each?
Fixed Rate Mortgages: Payments remain the same for the life of the loan.
Types
- 15-year fixed
- 30-year fixed
- 40-year fixed
Advantages
- Predictable
- Housing cost remains unaffected by interest rate changes and inflation. (Keep in mind that insurance and taxes may increase, and may affect the monthly payment.)
Adjustable Rate Mortgages (ARMs): Payments increase or decrease on a regular schedule with changes in interest rates; increases subject to limits. With a 2 year ARM, for example, the interest rate and payment are fixed for two years and then change on a periodic basis. After the adjustment period, some ARMs can change as frequently as every month, but many change once a year. It's important to ask for details before choosing an ARM!
Types
- Balloon Mortgage- Offers very low rates for an initial period of time (usually 5, 7, or 10 years); when time has elapsed, the balance is due or refinanced (though not automatically)
- Two-Step Mortgage- Interest rate adjusts only once and otherwise remains the same for the life of the loan
- ARMs linked to a specific index or margin
Advantages
- Generally offer lower initial interest rates
- Monthly payments can be lower
- May allow borrower to qualify for a larger loan amount
Disadvantages
- Interest rate and payments may rise significantly after adjustment period.
- May be difficult to refinance if there is not enough equity, or if borrower's financial circumstances have changed.
Q: When do adjustable rate mortgages (ARMs) make sense?
An adjustable rate home mortgage loan may make sense if you are confident that your income will increase steadily over the years or if you anticipate a move in the near future and aren't concerned about potential increases in interest rates.
Q: What are the advantages of 15- and 30-year mortgage loan terms?
30-Year:
- In the first 23 years of the loan, more interest is paid than principal, meaning larger tax deductions.
- As inflation and costs of living increase, mortgage payments become a smaller part of overall expenses.
15-year:
- Loan is usually made at a lower interest rate.
- Equity is built faster because early payments pay more principal.
Q: Can I pay off my home loan ahead of schedule?
Yes. By sending in extra money each month or making an extra payment at the end of the year, you can accelerate the process of paying off the loan. When you send extra money, be sure to indicate that the excess payment is to be applied to the principal. Most home loan lenders allow loan prepayment, though you may have to pay a prepayment penalty to do so. Ask your lender for details.
Q: Are there special mortgages for first-time homebuyers?
Yes. Lenders now offer several affordable home mortgage loan options that can help first-time homebuyers overcome obstacles that made purchasing a home difficult in the past. Home loan lenders may now be able to help borrowers who don't have a lot of money saved for the down payment and closing costs, have no or a poor credit history, have quite a bit of long-term debt, or have experienced income irregularities.
Q: How large of a down payment do I need for my home loan?
There are mortgage loan options now available that only require a down payment of 5% or less of the purchase price. But the larger the down payment, the less you have to borrow, and the more equity you'll have. Mortgages with less than a 20% down payment often require a mortgage insurance policy to secure the loan. One option for avoiding this insurance is a piggyback loan, where you obtain a mortgage for 80% of the home's value, and a second loan (usually a line of credit) for the remaining 10 ? 20%. When considering the size of your down payment, consider that you'll also need money for closing costs, moving expenses, and quite possibly repairs and decorating.
Q: What is included in a monthly mortgage payment?
The monthly mortgage payment mainly pays off principal and interest. But most lenders also include local real estate taxes, homeowner's insurance, and mortgage insurance (if applicable).
Q: What factors affect mortgage payments?
The amount of the down payment, the size of the mortgage loan, the interest rate, the length of the repayment term and payment schedule will all affect the size of your mortgage payment.
Q: How does the interest rate factor in securing a mortgage loan?
A lower interest rate allows you to borrow more money than a high rate with the some monthly payment. Interest rates can fluctuate as you shop for a loan, so ask lenders if they offer a rate "lock-in" which guarantees a specific interest rate for a certain period of time. Remember that a lender must disclose the Annual Percentage Rate (APR) of a loan to you. The APR shows the cost of a mortgage loan by expressing it in terms of a yearly interest rate. It is generally higher than the interest rate because it also includes the cost of points, mortgage insurance, and other fees included in the loan. Use Lender Rate Match to find out what type of loan and payment you may qualify for.
Q: What happens if interest rates decrease and I have a fixed rate loan?
If interest rates drop significantly, you may want to investigate refinancing your mortgage. Refinancing may, however, involve paying many of the same fees paid at the original closing, plus origination and application fees.
Q: What are discount points?
Discount points allow you to lower your interest rate. They are essentially prepaid interest, with each point equaling 1% of the total loan amount. Generally, for each point paid on a 30-year mortgage, the interest rate is reduced by 1/8 (or.125) of a percentage point. When shopping for loans, ask lenders for an interest rate with 0 points and then see how much the rate decreases with each point paid. Discount points are smart if you plan to stay in a home for some time since they can lower the monthly loan payment. Points are tax deductible when you purchase a home and you may be able to negotiate for the seller to pay for some of them.
Q: What is an escrow account? Do I need one?
Established by your lender, an escrow account is a place to set aside a portion of your monthly mortgage payment to cover annual charges for homeowner's insurance, mortgage insurance (if applicable), and property taxes. Escrow accounts are often a good idea for new homeowners because they assure money will always be available for these payments. If you use an escrow account to pay property tax or homeowner's insurance, make sure you are not penalized for late payments since it is the lender's responsibility to make those payments.
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