Master Your Mortgage
Updated: Jun 1, 2021
(originally published September 2, 2019)
The first part of a new home purchase should be figuring out your mortgage, unless you happen to have cash enough to handle it. Most of us don't, so I've put together a list of questions to get you started. You'll want to ask some of these questions of your lender to see if you are a good match before you make a final decision.
1. What is a mortgage lender? Basically, it's a financial institution that can loan money specifically for the purpose of purchasing a home. They'll advertise that they offer mortgages, so they're not all that hard to find. This can be a bank, a credit union, or a lender. I recommend smaller ones with a local flavor vs. a large firm, but once you ask the questions we're about to go through, you'll be in good shape to make a decision.
1a. Why do I need to talk with a lender early in the process? The first need you'll have from your lender is a pre-approval letter which will be required to put in an offer on a home. But first, this pre-approval letter and preliminary review of your financial records will be your guide of the amount of home you can afford. Talk to a lender first, get a pre-approval letter, and then, when you find that home you love, you're ready to go. When the market is moving fast, this is especially important.
2. What kinds of loans are available and what are the qualifications of each type? There are a lot of different mortgage types available, and it's best to talk through your particular situation with your potential lender to see what fits best for you and your financial goals. Some loans have dollar limits, some have status requirements (like military service), some have fixed rates, but there are also those with adjustable rates, some are government backed. You get the idea. Though your Realtor can educate you on the big picture, once you're ready to get serious, talking to a lender is best. Don't be afraid to ask them the pros and cons of each plans, and don't forget it's your decision. 3. What is the interest rate and Annual Percentage Rate (APR)? The first thing to point out here is that Interest Rate and APR are actually two different numbers. Interest Rate is determined by prevailing rates and the borrower's credit score, and is the determiner for your monthly payment. The APR includes fees for the loan, and is determined by the lender. In short, think of the interest rate as a way to gauge your monthly costs whereas the APR gives you a big-picture estimate of the cost of the overall loan. Since APR includes fees, and fees will differ from lender to lender, you'll need to make sure you're comparing apples to apples when you are shopping for the best rate. Ask for a detail of the fees included in that lender's APR, as well as a Good Faith Estimate for your particular loan.
Also, if your loan is adjustable (like an ARM, or Adjustable Rate Mortgage), you'll want to find out how long the interest rate remains fixed, and the max annual adjustment. You don't want any surprises down the road, so ask to make sure there are no changes that will significantly change your payment each month.
4. What will my monthly payment be? Think of your mortgage the same as any other new expense you're anticipating. Develop your budget, being sure to include taxes and insurance, and leave yourself room for savings and unexpected expenses. You should share your monthly payment goals with your lender so they can make sure your final monthly payment is a comfortable amount for you each month. 5. How much of a deposit will I need? First, let's start with what kind of money you'll need to put down when you want to make an offer on a house. Once you've decided that you've found the one, you'll need to pay Earnest Money, which is typically 1% of the offer price, and an Option Fee, which is nominal, usually somewhere in the $150 to $200 range. These two amounts are paid as soon as your offer is accepted. We can discuss the purpose of these two amounts at a later time, but these are part of the purchase transaction, and though are considered in the accounting of your transaction, this isn't the actual deposit, which is discussed in the next paragraph. A deposit, more often called a down payment, is the percentage of the loan you'll need to put down at closing. For a conventional loan, i.e. a non-government backed loan, you'll usually need a 20% down payment, but the lenders will waive the requirement for PMI, which stands for Private Mortgage Insurance. This can provide a hefty savings for your monthly mortgage amount. For other loan types, you can often go with a smaller down payment percentage. An FHA loan, for example, will allow for a 3.5% down payment but will require insurance for the life of the loan. This translates to less down up front, but more cost over the life of the loan. As a side note, a conventional loan won't always require a 20% down percentage, but if it's less, the interest rate will likely be higher. However, once you've reached a point where your equity reaches 20%, you can negotiate with your lender to waive the PMI amount each month. 6. Is there a Prepayment Penalty? Say you're planning on putting extra each month toward the principal of your loan which allows you to pay off your loan early. Or, you may be planning to refinance your loan down the road, which from the lender's perspective, is paying off your loan early and getting a new loan. You need to make sure there is no penalty in doing so to avoid unexpected additional fees. 7. Will you be able to close on time? Closing on time is important because you've agreed to a date to close on your contract with the seller. The wording says the date will be on this date or before, so closing early isn't typically an issue but closing late is. Also, even if a change in date doesn't bother you, it could have really big consequences for the seller who may need proceeds from the sale to be able to purchase their next home, which many times is happening at about the same time. I'll also tie this question into a whole other topic which is how easily you'll be able to work with your mortgage company. Your Realtor should be involved in this part of the process, so don't be concerned if they ask (and they should!) who your loan is with and that person's contact info. The most typical closing delays result from two things: the applicant not providing the necessary paperwork in a timely manner and lack of communication from the mortgage company. This second reason is why I recommend a smaller mortgage company. So that you know what to expect, a good lender will typically quote a 30-45 day process from start to closing. If that time period has to push out, the other party, the Seller, will need to be notified which could cause problems. Also, if you had a certain interest rate quoted, if that time period lengthens, you could be at risk to lose that great rate. 8. What are closing costs and how much should I expect mine to be? Some of the largest expenses involved in the purchase of a home are closing costs. Closing costs are fees that are paid at the end of the transaction, once the home is ready to be transferred from one owner to another. These costs can be paid by the seller, the buyer, or shared by both, depending on what was negotiated in the contract. Closing costs can vary from 2 to 5% of the home’s purchase price, so it's important to ask for an estimate of closing costs up front, since many of the fees associated with closing the transaction can be negotiated or vary from lender to lender. For more details and a list of what type of fees are including in closing costs, I recommend this article: https://www.investopedia.com/terms/c/closingcosts.asp 9. Are you going to sell my loan? Let's go ahead and assume that yes, they will. Most do. This is actually pretty common and is the way the secondary money market operates because lenders need to gain capital to make new loans. However, the Real Estate Settlement Procedures Act, or RESPA, requires lenders to inform you of their intent within three days of your application, in a document called a Servicing Disclosure Statement. This statement should clearly explain if the lender will keep the loan, sell the loan prior to the first payment, or sell the loan in the future. What's important for you to know is that the terms of your loan cannot change and you must be informed in advance of a transfer. 10. What are points and how do they affect my loan? One way to get a lower interest rate, and subsequently a lower monthly payment, is through points. Paying points is often referred to as "paying down the rate". There are two types of points, discount or origination. The first reduces the interest rate on your loan, the second reduces the fees for the loan. Using this system, buying one point costs 1% of your mortgage amount (or $1,000 for every $100,000). If you plan to own your home for the long term, it’s worth asking your lender whether this is a good option for you. If it is, make sure it’s cost-effective by comparing how much you’d be saving each month against how much it costs to buy points. Also, points can be tax deductible for your primary residence or a residence you rent out, but check with a tax advisor for more details. 11. What is escrow? I'm so glad you asked! The word is used in a couple of ways during the transaction so best you go ahead and understand that now. First, the term refers to the period between the time the buyer agrees to buy a property and the closing of the transaction. At the beginning of the escrow process, you will be asked to deposit money into an escrow account. This initial deposit is known as good-faith earnest money, the same Earnest Money I mentioned above in Question #5. Both the down payment and closing fees must be in escrow before the property can be transferred. However, there’s another escrow account to consider. Homeowners who purchase their property with less than a 20% down payment are often required to pay into an escrow impound account every month. The lender will charge this amount monthly along with the mortgage payment, and will use the money to pay property taxes and specific types of insurance directly instead of leaving it up to the homeowner. Be sure to review with your lender what they will be paying from Escrow to one, make sure you're not planning to pay for something that has already been accounted for, but also to make sure everything does get handled. With this knowledge under your belt, you should be in good shape to make a decision about the best lender for you. If you have any other questions, feel free to drop me a line! NB: The information provided above is accurate as of the writing of this article. Laws have a funny way of changing from time to time, and I have not mastered the art of predicting the future. Consulting with a Realtor, such as myself, in real time, is always your best bet. Rebecca Robertson is a Realtor who loves numbers. And helping people. And Houston. And real estate. Goodness, she sounds like the ideal person to help you with selling or buying your next home! You should probably go ahead and give her a call or drop her a line. That's firstname.lastname@example.org, just in case you need it.