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Pete's Plain Talk About Mortgages

The Basics. So let’s start with the basic terms… 1st and 2nd Mortgages. Home loans are called mortgages. Unlike car or boat loans, it’s possible to have more than one loan which uses your home as collateral. Home loans are described as having 1st or 2nd priority on the title for a home in the event that the owner fails to make the payments. Consequently, they’re called 1st or 2nd Mortgages.

For simplification, I’ll limit our discussion to 1st mortgages. The amount owed on a home loan is called the principal. Normally, your home loan payments are structured to pay a combination of the principal and interest each month. Each payment covers the interest on the principal and the remainder is used to pay the principal off over time.

Early in a loan’s life, most of your payment goes toward interest. Then, as the principal is gradually paid down, less interest is owed each month… So a greater portion is available to pay down the principal. Home loans come in a variety of lengths like 10, 15, or 30 years. Normally, the shorter the loan period, the larger your monthly payment will be … And the greater the amount that goes toward paying down the principal each month.

Most lenders call your initial payment toward your home, a down payment. It’s normal to see terms such as 5%, 10%, or 20% down. Conversely, a loan might be called a 90% loan. Generally speaking, the higher your down payment %, the lower the risk that the mortgage company has to assume in the event of non-payment.

Fixed Mortgages & ARMs. If you’ve looked into home loans, you’ve probably seen the terms Fixed and Adjustable Rate Mortgages (ARMs). Virtually all mortgages require you to pay interest over the life of the loan. If the interest rate holds steady throughout the life of the loan, its called a Fixed Rate Mortgage (for example a 4.5% Fixed Mortgage). If the interest rate can change during the loan period, its called an Adjustable Rate Mortgage or ARM. ARMs tend to have lower interest rates in the 1st few years. You bear the risk that interest rates will adjust upward over a loan’s life. If you plan on owning your home for a short time, an ARM’s initial lower interest rate might make it desirable.

Many of the ARMs available today come with an initial 'fixed' period of say 1 to 7 years ... After the 'initial' period the interest rates will move consistent with a stated Index.  The interest rate movement may be limited to a stated rise or fall each you of say 1.5% in the direction of the Index's rate and the overall cumulative movement may be stipulated at a no higher than 'x' rate.

When looking into ARMs you'll notice that there a some typical Indexes which are advertised by lenders which will sound mysterious but need nor be. Here are a few commonly used indexes which you could follow or verify on your own:

Treasury Bills (T Bills) ... The prevailing rate paid by the US Gov't for it's notes.

Certificates of Deposit (CDs) ... Typically the average interest rates that banks are paying for 6 month CDs.

Cost of Funds Index (COFI) ... The monthly weighted average cost of savings, borrowings, and advances for member banks located in the 11th District (California, Arizona, and Nevada).

London Interbank Offered Rate (LIBOR) ... The average of the interest rates that major international banks charge each other to borrow U.S.Dollars in the London money market.

Gov’t Insured Mortgages. The Federal Government has a couple of programs which have made it possible for people to buy homes with low down payments. These programs are sponsored by the Federal Housing Administration (FHA) and the Veterans Administration (VA). FHA and VA sponsored loans provide guarantees to the lenders in the event that the borrower doesn’t pay the mortgage and it becomes necessary to foreclose.

In 2014, FHA mortgages are limited to $625,500 and down payment requirements as low as 3.5% of the purchase price.  VA mortgages can be zero down for loans of $625,500 or less. Loans above that amount require variable down payments. Both FHA and VA insured loans involve an up front fee hovering around 2% of the loam amount.  (VA loans top out in 2014 at $838,750.) While virtually all of us are eligible for an FHA loan, you (or your spouse) normally need to either be in the Military Service, or be a Veteran, to obtain a VA loan.

FHA and VA mortgages have another characteristic which might make them more favorable for you over the long term … Particularly if you think interest rates will go up in the future. Generally, these loans can be assumed by someone who is buying your home from you at a later date at your existing interest rate. Consequently, they're called Assumable Mortgages.

Conventional Mortgages. Non- FHA or VA loans are called a Conventional mortgages. They’re labeled as Conforming or Jumbo depending on whether they are above or below $625,500. There is an interest rate shift at the old conforming loan limit of $417,000.

Reverse Mortgages. While most mortgages require the borrowers to make monthly payments to their lender, a reverse mortgage (available to senior citizens) allows owners to borrow against their homes but not make any payments until they ultimately move from the home or die and it's sold. Loan proceeds can be pulled all at once or withdrawn bit by bit like a line of credit.  Interest is added to the loan principal and the owner retains title to their home. If you'd like to study up on the subject ... Take a peek at www.ReverseMortgageGuides.org 

Temporary Loans. If you would like to buy your next home and then sell your current home after you've moved out there may be a way to use your current home as collateral while obtaining a temporary loan to purchase your next home.  Then. once you've closed the sale of your old home, establish a new mortgage on your new home.  Ask your lender if they can handle a Cross Collateral Loan to temporarily finance your new home.

Mortgage Insurance.
If you obtain a non-VA loan with less than a 20% down payment, you may have to buy mortgage insurance. Mortgage insurance is intended to help the lender recoup losses associated with a foreclosure. FHA loans call this insurance cost a Mortgage Insurance Premium (MIP). Conventional loans generally use the term Private Mortgage Insurance (PMI). Both cost about ˝% of the loaned value per year and become part of your monthly mortgage payment. Some conventional loans are available with Lender Paid Mortgage Insurance (LPMI) internal to the loan's slightly higher interest rate.

What are Points? The home loan industry uses the term points to refer to a one-time charge at the start of a mortgage to obtain a slightly lower interest rate. It’s become common practice to advertise loans at low interest rates and state that the mortgage costs so many points, 2 points for example. One point is equal to 1% of the loan value. If you agree to a $200,000 loan for 1 point, you’d owe the lender $2,000 in Points when you use the loan at the closing.

Generally speaking, paying a point reduces the interest rate by about 1/4th of a % for the life of a mortgage. Conversely, if you didn’t want to pay points, you might be able to add 1/4th of a % to the advertised interest rate for each point you avoid. If you plan on keeping your new home for a long time, let’s say 5 or more years, it might be in worth your while to pay points to buy-down the interest rate. If you plan on a much shorter period… try to minimize the points you pay for a loan.

Loan Origination Fee. Most Mortgage Brokers charge a fee for helping you get a loan. This fee is called an Origination Fee. A typical Loan Origination Fee might cost 1 point (1% of the loan amount). While you might think of this as ‘points’ the broker might not. So, if you’re shopping for a home loan, be sure to clarify if the quoted points include or exclude the origination fee. The combination of Points and Loan Origination Fees normally represent a significant portion of what’s referred to as Closing Costs.

Escrow Accounts. Your lender may create escrow accounts in your name and may require that you pay a portion of your property taxes and homeowners or fire insurance into them as a part of your monthly mortgage payment. The lender assumes the responsibility for actually paying the property taxes and your fire insurance from these escrow accounts.

What’s PITI? Throughout our discussion I’ve used the term monthly payments. The correct term is actually monthly PITI payments or Principal, Interest, Taxes, and Insurance payments. The last I in PITI includes homeowner’s fire insurance as well as mortgage insurance MIP or PMI.

If I’ve done my job right in this discussion, you should now be able to understand the home mortgage charts which the Washington Post presents in its Real Estate Section every Saturday. Take a look at the Post next Saturday and see if it makes more sense to you now.

Can You Qualify for a Loan? Now that you’re familiar with home loans, why not see what it takes to qualify for a loan. There’s the three basic hurdles normally involved in financially qualifying for a loan … 1st you need to be able to demonstrate that you are creditworthy … 2nd you need to be able to show that you have an earnings stream sufficient to let you make the loan payments … And lastly, you need to be able to point to some resources which you can use if your purchase will require you to make a down payment or pay closing costs.

If you’re in good shape on these 3 things … You’re probably going to qualify for a loan.  Plus … There’s lots of exemptions to these rules. It’s easy to get a real answer … All you need to do is have a conversation with one of the loan officers my clients have had good experiences working with.

Are Loans for Condos Different? Obtaining a loan to purchase a condominium unit can be a bit more difficult than one for a single family Townhome or Detached home.  Most Lenders are concerned that the percentage of units which are owner occupied in the Condo Association be more than 50% or 70% as a general rule ... The FHA additionally has concerns as to whether the Condo Association was FHA Approved (when constructed) and what percentage of the existing 1st mortgages for the Condo Association's units are FHA (new rules limit new loans to those associations  with about 33% of the units owner occupied, as opposed to investor owned, to limit the FHA's exposure).  So yes ... Getting a loan to purchase a condo can be more difficult. To see if a Condo Association is on the approved list for FHA financing, Click and search here

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