How Mortgages Work

Typically, a mortgage loan is a long term commitment. However, it is important to find a mortgage to fit your needs. The most popular term is 30 years. Understanding the process can make you more comfortable and confident in your negotiations. A mortgage requires you to pledge your home as the lender's security for repayment of your loan. Generally for a purchase transaction:

Down payment + Amount of mortgage loan = Purchase price

When you sign a mortgage agreement, you are agreeing to repay the principal plus interest. During the first few years, most of your payments will be applied toward the interest you owe. This is because the interest each month is calculated on the outstanding balance. As the balance is reduced, so is the monthly interest. During the final years of your loan, your payment amounts will be applied primarily to the remaining principal.

You can choose a mortgage with an interest rate that is fixed for the entire term of the loan. A fixed-rate mortgage gives you the security of knowing that your interest rate will never change during the entire term of the loan. An adjustable-rate mortgage (called an ARM) has an interest rate that will vary during the life of the loan, with the possibility of both increases and decreases to the interest rate.

As the buyer, you pay in cash a down payment, that is a percentage of the purchase price of the home. The down payment represents your equity in the house. Lenders often view mortgages with larger down payments as more secure because you have more of your own money invested in the property.

A lender may charge a loan origination fee or discount points. Simply put, a point is a unit of measure that means 1 percent of the loan amount. The more points you pay, the lower the interest rate. Usually, for each point you pay for a 30-year loan. Your interest rate is reduced by about 1/4 (.25) of a percentage point. Paying points can be good if you plan on keeping the mortgage loan for more than three years.

The closing (or, in some parts of the country, settlement) is the final step. At the closing, your mortgage is activated, and you are given the keys to your new home. Closing costs are a mystery to most first-time buyers. One reason is that they are not standard and vary from state to state. Items may include transfer taxes and recording taxes, title insurance, survey, attorney fees, discount points, appraisal, and document preparation fees.

Check out the Lender Comparison Chart. The Chart can be used to get the information you need to make an informed decision on which mortgage lender offers the best deal for you.

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House Buying Tips

Mortgage, down payments, up-front cost. These words and the fact that buying a home is one of the largest purchases most of us ever make can drive someone to renting an apartment. Do not let these words scare you out of buying your first home. Many of us seek help from our friends and family but sometimes that is not always the best solution. Here are some common questions asked by first time home buyers:

How much can we afford?
The rule of thumb says you can afford twice your family's gross annual income. But the final answer depends on the nature of your income, the amount of debt you are currently carrying, the size of your down payments and the type and term of the loan. Generally, housing expenses for your mortgage, insurance, taxes and special assessments should not exceed 25 to 28 percent of your gross monthly income.

What is the minimum down payment required?
First a down payment is the initial payment you make when you purchase a home. This varies depending on the price of the home. Typically, you will need a down payment of 5 percent of the price of the home, though Federal Housing Association (FHA) and Veterans Association (VA) loans require smaller down payments between 0 and 3 percent.

What other up-front-cost are there?
Up-front-cost are all the cost you may have to pay in order to purchase your home. A down-payment is just one of the up-front-cost. Up-front-cost may also include a real estate appraisal, credit report, documentation, lock-in fees, etc. Together these cost can amount to 2.5 to 3 percent of the loan. There are also prepaid expenses for interest charges during the period between closing and the first payment, real estate taxes, etc. Finally, there are attorneys' fees, accessed by the title company who will handle the actual closing and other incidental cost.

Are the cost negotiable?
Sometime you can, sometime you can't. It just depends on the deal. You may be able to negotiate on fees by offering to pay a higher interest rate. Typically you would pay .25 percent higher interest for every point you save.

What types of mortgages are available?
A mortgage is a loan on a house; that is all it is. There are three types of mortgages available: a conventional mortgage, a FHA-insured mortgage and a VA mortgage. You have a choice of a fixed rate, adjustable rate mortgage (ARM), a 30-year term, 20-year term or a 15-year term; and monthly, bimonthly, biweekly or weekly payment schedules.

Is a 15-year term or a 30-year term best?
With a 15-year mortgage, you own the homes in half the time you typically pay .5 to 1 percent less annual finance charges, and your total interest charges are even lower because you pay off the debt sooner. But your monthly mortgage payment is higher than with a 30-year mortgage, so you may not qualify for as large of a home as you wish to buy. A suggestion would be to take the 30-year loan so you can afford the house you want. Then as your income increases, make additional payments sufficient to make the loan pay off in less time.

Why do lenders require Private Mortgage Insurance?
Private Mortgage Insurance (PMI), protects the mortgage lender against loss should you default on your mortgage. This is required unless you make a minimum of 20 percent down payment.

What is a discount point?
A point is prepaid interest. It is another factor in the purchase of your home. If you want to have lower long-term payments you would have points added to you loan. If you want to pay less at the time of purchase then you would try and lower the points but as a result the loan rate would be higher. A discount point is an amount equal to 1 percent of the loan amount. Generally, the lower the rate you receive the higher the points. When comparing rate, always ask for the rate and corresponding points. However, the market rate would be a zero discount points.

What will our monthly payment be?
Your monthly payment consist of principal and interest and possibly an escrow amount to cover real estate taxes and mortgage life insurance. The actual amount will depend on the size of the loan, the interest rate and the term and whether it is a fixed rate or adjustable rate.

Can we get pre-qualified for a mortgage loan?
Yes. Typically it is as simple as a phone call to your credit union. A pre-qualification is based on information provided by you and is subject to written verification. Therefore, this is not a guarantee you will be approved for a loan, but it will give you an idea of what price range you should look at, how much money you will need and what type of monthly payment you will incur.

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Loans Available

A wide selection of mortgages is currently available. The challenge is to select the loan terms that are most favorable to your situation.

Fixed Rate
Traditionally the most popular type of mortgage, borrowers enjoy the comfort and security of a fixed rate and payment. Longer term fixed rate mortgage loans, like the traditional 30-year fixed rate loan, offer the most affordable fixed rate option. This mortgage loan may be ideal if you plan to remain in your home for years. Shorter terms, like the 15-year fixed rate loan allow you to build equity in the home faster and save interest expense.

With an adjustable-rate mortgage (ARM), the interest rate you pay is adjusted periodically to keep it in line with the changing market rates. This means when interest rates go up, your monthly mortgage payments may go up as well. On the other hand, when interest rates go down, your monthly mortgage payments may also go down. ARMs are attractive because they may initially offer a lower interest rate than fixed rate mortgages. The chief drawback is that your monthly payments may increase when interest rates rise.

You may want to consider an ARM if: your income will rise enough in the coming years to comfortably handle any increase in payments, you plan to move in a few years and therefore are not concerned about possible interest rate increases, or you need a lower initial rate to afford the home you want. A typical ARM will adjust annually, have a yearly cap on interest rate increases of 2%, and a lifetime rate cap of 6%. The interest rate changes on an ARM are always tied to a financial index, such as the average interest rate on Treasury bills.

Initial Fixed Rate
You may want to consider a special type of ARM that does not adjust your interest rate until several years after you take out the loan. You can get a three, five, seven, or ten-year fixed period ARM. This means your interest rate would be the same the first three, five, seven or ten years and then, at the end of your chosen fixed rate period, the interest rate would adjust every year. This type of mortgage generally starts with a rate lower than standard fixed rate loans, and protects you against rapid interest rate increases in the early years of the loan.

Government Loans
The Federal Housing Administration (FHA) and the U.S. Department of Veterans Affairs (VA) are agencies that offer government-insured loans. To obtain these loans you apply through a lender that is approved to handle them. With FHA loans, you can purchase a home with a very low down payment. FH mortgages have a maximum loan limit that varies depending on the average cost of housing in a given region. The VA guarantee allows qualified veterans to buy a house costing up to $203,000 with no down payment. Also, the qualification guidelines for VA loans are more flexible than those for either a FHA or conventional loans.

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