A mortgage is a type of loan facility that the borrower can use to purchase real estate property. At the same time, this property becomes the borrower’s collateral for the loan. A mortgage is also known as property loan or a home loan. A person who wants to avail of a mortgage loan must apply for it. He fills up a mortgage application form and submits it to the lender. If approved, the lender will immediately notify the borrower.
Types of Mortgage Loans
A home loan has different types. It can be used to buy a real property, reduce the interest rate on a present mortgage loan, or use the equity on an existing property that a person owns.
- Home purchase loan
- Conventional mortgage loan
- Federal Housing Administration loan
- Veteran Affairs loan
- US Department of Agriculture loan
- Home refinance loan
- Home equity loan
- Reverse mortgage
- Home construction loan
- Commercial mortgage loan
The most prevalent types of mortgage loans are the Federal Housing Administration loan, home refinance loan, traditional home loan, and Veteran Affairs loan.
A traditional mortgage loan usually offers a low interest rate if the down payment is substantial. A Federal Housing Administration mortgage is supported by the US government and requires that the property be insured. A Veteran Affairs home loan, on the other hand, is extended to veterans, service personnel, and their spouses. It also comes with a host of other benefits.
A home refinance loan is slightly different from the conventional home loan, the Veteran Affairs loan, and the Federal Housing Administration home loan. It has a reduced interest rate for current mortgages. The borrower has to take a new home loan, which may be greater or equal to the existing property loan. When approved, the current mortgage is paid off using the proceeds of the home refinancing loan. The borrower then pays a lower monthly amortization on the new home loan because it has a lower interest rate.
Home refinancing allows a borrower to pay lower amortization monthly at either a shorter or longer repayment term. It also enables the debtor to convert the equity built up on the home into cash. However, before availing of this kind of loan, the borrower must first talk to his lender about his personal goals upon submission of the application form.
Home Loan Modification
Technically, a home loan modification isn’t really a loan. It is a collection of programs and services that aim to help a borrower who struggles to meet his real property financing obligations. It can be availed of by anyone, who’s really “upside-down” on his mortgage. An “underwater” or “upside-down” situation occurs when the debtor owes more money than the total worth of his property. For example, the borrower owes US$300,000 on a property, which is worth only $200,000. Even if he sells his real estate at $200,000, he still has to pay for the mortgage balance of $100,000. A home loan modification is often offered by the government to help borrowers who are in sticky “upside-down” situations.
The Mortgage Loan Cost
A borrower must be prepared to pay the following typical costs associated with a mortgage loan approval:
- Down payment
- Property mortgage insurance
- Closing costs
Down Payment – The down payment is an extra security on the mortgage. A borrower expresses his serious intent to borrow and repay a mortgage by making a down payment. Usually, a lender offers a reduced interest rate when a borrower pays more money as down payment to the real property because it means that the latter has a vested interest in his loan repayments.
Different types of mortgage loans have varying down payment requirements. These include:
- Conventional mortgages
- Federal Housing Administration mortgages
- Veterans Administration home loans
A conventional or traditional mortgage usually requires at least 20% down payment while a Federal Housing Administration mortgage only requires 3.5% down payment. On the other hand, the Veteran Affairs home loan requires no down payment. A borrower who can’t afford the 20% down payment on a traditional mortgage can still avail of a property loan. He will just have to ensure that he pays for the Private Mortgage Insurance if he gets approved for the mortgage.
Private Mortgage Insurance – The private mortgage insurance is used to protect the lender against any loss, which he may incur in case the borrower defaults on his loan. The insurance company guarantees that the loan will be paid to the lender even if the borrower doesn’t pay because it will shoulder the remaining balance. This type of insurance usually charges up to 1% of the total value of the property as yearly premium. For example, the property is worth $200,000, the borrower needs to pay the insurance company as much as $2,000 every year. The lender will usually require the borrower to have private mortgage insurance if the latter can’t afford to pay at least 20% down payment. As such, anyone, who wants to avail of a mortgage but doesn’t want to incur additional costs for private mortgage insurance, must make sure to put up a significant down payment on the real estate property.
Interest – Interest payments are often collected monthly during the term of the loan. Therefore, it is important for the would-be borrower to consider also the type of interest rate – which can either be fixed or adjustable – applicable to the loan.
- Fixed Interest Rate – A fixed interest rate means that the borrower has to pay a fixed amount of interest during the loan’s term. For example, if the lender offers a 4% fixed interest rate, it means that the borrower is assured that his interest payments won’t change throughout the loan period. The debtor won’t be surprised about unexpected increases in his interest payments. Therefore, he can easily set aside money for his monthly interest payments, especially if he’s earning a fixed income.
- Adjustable Interest Rate – An adjustable interest rate, on the other hand, may fluctuate throughout the term of the loan. It is usually based on an index. In the US, the adjustable interest rate is often tied up with Treasury Notes. Usually, a mortgage loan can offer a fixed interest rate for a fixed period only. Afterwards, the interest rate will be adjusted based on the prevailing interest rate of an index. It is very common for a borrower to be offered a mortgage with a fixed interest rate for 5 years and an adjustable interest rate for the remaining term of the property loan. There are also lenders who offer 7 years fixed interest and 3 years fixed interest.
How Interest Rate Is Computed
Aside from the adjustable and fixed interest rate on mortgages, a borrower must also consider the prevailing interest rate in the market. He can check out the national and state averages so that he’ll have a general idea of how much interest a lender may offer on a home mortgage loan. The applied interest rate is usually affected by the following factors:
- Borrower’s location
- Debt-to-income ratio C
- Credit score
Borrower’s Location – Interest rates can vary depending on the state. In the US, there are some states with higher interest rates than the others. The borrower can check out various websites that offer information on the prevailing interest rates by state to have an idea about the rate his lender may offer.
Debt-to-Income Ratio – The debt-to-income ratio is the present ratio of a borrower’s monthly income to his outstanding debts. It is computed by dividing his monthly debt payments by his gross monthly income and multiplying the quotient by 100. For example, the borrower only has an outstanding debt of $300 for his monthly car loan payments. If his monthly salary is $4,000, his debt-to-income ratio is computed to be 7.5%.
This debt-to-income ratio can either be back-end or front-end. A front-end debt-to-income ratio only includes payments to housing costs, like mortgage payments, property taxes, mortgage insurance, rental payments, homeowner’s association fees, and/or renter’s insurance. On the other hand, a back-end debt-to-income ratio includes all recurring and outstanding debts.
Usually, a home loan lender requires both the front-end and back-end ratios. For example, a 28/36 debt-to-income ratio requirement means that that borrower’s front-end debt-to-income ratio must be at most 28% while his back-end debt-to-income ratio must be at most 36%. For conventional home mortgages, the debt-to-income ratio requirement is 28/36. For Federal Housing Administration mortgages, the requirement is 31/43 debt-to-income ratio. For Veteran Affairs home loans, it is 41/41 while for US Department of Agriculture the debt-to-income ratio requirement is 29/41. In general, the lower the debt-to-income ratio, the higher is the probability that the lender will offer a reduced interest rate for the home mortgage.
Credit Score – The credit score and credit history of the borrower are also very important considerations in determining the mortgage’s interest rate. If the debtor’s credit score is excellent, the lender will offer him the lowest interest rate. However, if the borrower’s credit score is poor, he can expect to pay a higher interest rate than usual.
Searching for the Best Interest Rate
The borrower has to search for the most favorable interest rate if he wants to avail of a mortgage loan. Before applying for the loan, he must first know his debt-to-income ratio and how much monthly amortization he can afford to pay. There are various websites that offer online tools to help borrowers compute their debt-to-income ratio. Next, he can shop around for the best lender, who can offer him the best interest rate.
It isn’t advisable to apply to one lender only because the borrower will just be at this lender’s mercy. What a prospective homeowner can do is to get multiple offers from different lenders so that he can choose the best offer. It is important that he exercises utmost diligence in choosing the best mortgage for him. The borrower need not visit the offices of these lenders. There are websites that provide the capability to show various interest rates from different lenders on a single webpage.
Closing Costs – Closing costs are other costs, which don’t involve interest payments and the loan balance. These costs may vary, depending on the lender. The borrower can expect to pay from 3% to 5% of the whole mortgage amount as closing costs, which can include the following:
- Title insurance fees – The title insurance fee protects both the lender and borrower against any legal problems, which may be related to the property’s title. This is often shouldered by the borrower and required by the lender. The title insurance is of two types: lender’s title insurance and buyer’s title insurance.
The lender’s title insurance is required by every mortgage lender while the buyer’s title insurance is optional. The former protects the entity, which finances the real estate property loan while the latter protects the homeowner or borrower. In general, the title insurance premium is based on the amount of the mortgage loan. For lender’s title insurance, the borrower can expect to pay about $2.50 per $1,000. For borrower’s title insurance, the costs can be $3.50 per $1,000. For example, if the real estate loan is $200,000, the borrower has to pay about $500 for the lender’s title insurance and $700 for the borrower’s policy.
- Origination fees – The origination fee is paid by the borrower when he avails of a mortgage loan. It is a fee charged by the lender for the handling and processing of the mortgage. The creditor can charge between 0.5% to 2% origination fee based on the total amount of the mortgage. For example, the origination fee for a $200,000 mortgage can range from $1,000 to $4,000. Because this fee is an industry standard, the borrower has to pay it whenever he avails of a home loan.
- Appraisal fees – An appraisal of the property is now required by state and federal laws to prevent the housing collapse from happening again. It is required to ensure that the lender is only lending money that is at most equal to the appraised value of the real estate. Thus, the borrower has to pay for the appraisal fee before the lender approves the loan. Usually, the appraisal fee can cost anywhere from $250 to $400.
- Credit report fees – In some cases, a lender may not shoulder the credit report fee. The credit report is important to the creditor so that he can determine if the borrower is qualified for the mortgage loan or not. It also serves as one of the basis in the interest rate computation. A credit report can’t cost more than $11.50. So, if the lender won’t shoulder the credit report fee, the borrower can expect to pay at most $11.50 for his credit report.
How to Qualify for a Mortgage Loan
Anyone interested in availing a real estate loan must first ensure that he qualifies for it. He may be worried that he won’t be able to obtain a mortgage loan because of his bad credit score. If he’s young, he may fear that his loan application may be rejected because of his age. If he has an outstanding student loan, he may be afraid that this loan may be a stumbling block in his mortgage loan approval. He may even wonder if he can apply for a mortgage loan, without his spouse’s credit history being scrutinized. Furthermore, he may not have enough money for down payment so he’s afraid that he’s loan application may be rejected.
Most information about mortgage loans is actually available online. A borrower needs to search for answers to his questions and fears online. There are websites with frequently asked questions about credit history and credit score. There are mortgage loans available for people with bad credit. However, lenders approve a mortgage on a case-by-case basis. There are also lenders who accept loan applications from all types of borrowers. Furthermore, there are also websites which try to match up a borrower with a lender based on the borrower’s qualifications.
Basically, a mortgage loan requires a borrower to meet the following:
- At least 18 years old
- With a regular source of income
- Can afford to pay the monthly amortization on top of his outstanding debt payment requirements
How to Apply for a Real Estate Mortgage Loan
It is easy to apply for a property loan because the internet has provided a safe and secure method to obtain sensitive financial information. A borrower needs to fill out an online application form. Usually, the lender will respond immediately if the borrower has furnished complete personal data including the folloing:
- Bank account records
- Employment records
- Contact information
- The type of real estate that he intends to buy
A representative of the lender will get in touch with the borrower. He will discuss the loan terms with the loan applicant. If the borrower agrees with the terms, the application will move to the next phase. Usually, the lender will require the borrower to submit documents like proof of income, bank account statements, titles to other real properties which the borrower owns, and other more detailed information. The loan is approved once the borrower has satisfied the requirements of the lender.
A contract is signed between the borrower and lender to seal their agreement and the money is released by the lender so that the borrower can already purchase the real estate property that he wants.