If you are thinking about buying a
house, especially your first one, you may have some basic questions about the
home-financing process. The following answers may help. You also may want to
obtain some of the free or low-cost information listed at the end of this
How large a mortgage will you be able to get?
A general rule is that you usually can qualify for a mortgage loan of two to
two and one-half times your household's income. For example, if your family has
an income of $30,000 a year, you can usually qualify for a mortgage of $60,000
Lenders use many other factors to determine how large a mortgage they will give
you. For example, lenders generally prefer that your housing expenses (including
mortgage payments, insurance, taxes, and special assessments) not exceed 25 to
28 percent of your gross monthly income. Other long-term debt (monthly payments
extending more than 10 months) added to your housing expenses should not exceed
33 to 36 percent of your gross monthly income. Federal Housing Administration
(FHA) and Department of Veteran Affairs (VA) mortgage loan percentages may vary.
In addition, lenders want to know about your employment and credit history. This
includes finding out about your job and income and how well you handled and
repaid loans in the past.
Legal safeguards exist to ensure this information is used fairly. For example,
the Fair Credit Reporting Act states that lenders must certify to the credit
bureau the purpose for which this information is sought and that it will be used
for no other purpose. The Equal Credit Opportunity Act prohibits discrimination
in lending based on sex, marital status, race, national origin, religion, age,
or because someone receives public assistance.
How much money will you need for a downpayment and closing costs?
Lenders usually expect you to be able to make a downpayment of between 10 and
20 percent of the house's price and to pay closing costs, often three to six
percent of the loan amount. If you make a downpayment of as little as five
percent but less than 20 percent, the lender will require you to pay for private
mortgage insurance. (Requirements for VA or FHA loans may differ.) Under the
federal Real Estate Settlement Procedures Act, the lender must provide you with
information on known and estimated closing costs.
How do you shop for mortgage loans?
Mortgage packages vary widely, and it is important to investigate several
options to find the one best for you. If, for example, you are using a real
estate agent or broker to shop for a home, you may want to consider their
suggestions about lenders and mortgage packages. Check real estate or business
newspaper sections, which may include brief tables on mortgage availability.
Look in the Yellow Pages under "Mortgages" for a list of mortgage
lenders in your area. Call several lenders for rates and terms on the type of
mortgage you want. In addition, consider trying a commercial "computerized
mortgage shopping service," although such a list may reflect only a
selection of lenders and you may be charged a fee.
Compare the mortgages offered by several lenders before you apply for a loan.
Most lenders require you to pay a fee when you file your loan application. The
amount of this fee varies, but it can be $100 to $300. Some lenders do not
refund this fee if you are not approved for the loan, or if you decide not to
accept the loan terms offered. Before you apply, ask the lender whether they
charge an application fee, how much it is, and under what circumstances and to
what extent it is refundable.
What kind of mortgage should you select?
There are two major types of mortgage loans -- those with fixed interest
rates and monthly payments and those with changing rates and payments. However,
there are many variations of these plans on the market, and you should shop
carefully for the mortgage that best suits your needs.
Common fixed-rate mortgages include 30-year, 15-year, and bi-weekly mortgages.
The 30-year mortgage usually offers the lowest monthly payments of fixed-rate
loans, with a fixed monthly payment schedule.
The 15-year fixed-rate mortgage enables you to own your home in half the time
and for less than half the total interest costs of a 30-year loan. These loans,
however, often require higher monthly payments.
The bi-weekly mortgage shortens the loan term from 30 years to 18 to 19 years by
requiring a payment for half the monthly amount every two weeks. While you pay
about 8 percent more a year towards the loan's principal than you would with the
30-year, one-payment-per-month loan, you pay substantially less interest over
the life of the loan. Keep in mind, however, that with shorter-term loans, you
trade lower total costs for smaller mortgage interest deductions on your income
Mortgages with changing interest rates and/or monthly payments exist in many
forms. The adjustable rate mortgage (ARM) is probably the most common, and there
are many types of ARM loans available. The ARM usually offers interest rates and
monthly payments that are initially lower than fixed-rate mortgages. But these
rates and payments can fluctuate, often annually, according to changes in a
pre-determined "index" -- commonly the rate of return on U.S.
Government Treasury bills.
Some adjustable loans, for a fee, contain a provision permitting you to convert
later to a fixed-rate loan. Another type of mortgage loan carries a
fixed-interest rate for a number of years, often seven, before adjusting to a
new interest rate for the remainder of the loan. A "buydown" or
"discounted mortgage" is another type of loan with an initially
reduced interest rate which increases to a higher fixed rate or to an adjustable
rate usually within one to three years. For example, in a "lender
buydown," the lender offers lower monthly payments during the first few
years of the loan.
What features should you compare with different mortgage loan
Probably the single most important factor to look for when shopping for a
home mortgage is the annual percentage rate, or the "APR." The APR
includes all the costs of credit, including such items as interest,
"points" (fees often charged when a mortgage is closed), and mortgage
insurance (when included in the loan). Lenders must disclose the APR under the
Truth in Lending Act. The lower the APR, generally the lower the cost of your
loan. Advertisements that state other rates such as "simple" interest
rates, do not include all the costs of the loan.
If you shop for a mortgage loan with interest rates or payments that change, be
sure to compare:
* initial interest rates;
* the "cap" -- or how much the interest rate can increase/decrease
over the life of the loan, and how much the rate can change at each adjustment;
* how often the interest rate can change;
* how much and how often the monthly payments and term of the loan can change;
* what index is used to determine the rate changes;
* what "margin" is used -- or how much additional a lender can add to
the adjusted interest rate;
* the limits, if any, on "negative amortization" -- the loss of equity
in your home when low monthly payments do not cover fully the interest rate
charges agreed upon in the mortgage contract; and
* any "balloon" payments -- a large payment at the end of your loan
term, often after a series of low monthly payments.