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Home Loans - Everything You Need to Know
Are you thinking of buying a home or contemplating remodeling your home? If so, you may need to get a home loan. Being knowledgeable about home loans and how they work can be beneficial to you now and in the future. Below is an overview of everything you need to know about home loans, including types of home loans, determining mortgage payments, finding lenders and basic tips on getting the best home loan possible.
Home Loan Terminology
Getting a home loan, referred to as a mortgage, can seem like a confusing and almost daunting process, particularly if you’re getting a home loan for the first time. Being familiar with home loan terminology may simplify the process a little. For the purpose of you better understanding this article, I am providing a list of common home loan terms. You’ll probably hear these terms at some point during your home loan transaction.
Adjustable rate mortgage – Also known as ARM, adjustable rate mortgages do not have the same interest rates throughout the loan. They start at one rate, but the interest rate adjusts based on the current market.
Annual percentage rate – Also known as APR, this refers to the rate of interest the homeowner pays annually to the lender.
Amortization – This is a schedule of how the home loan is going to be paid. It shows your balance and monthly payments as well as how much of the payment goes to interest and how much goes to the principal.
Closing – This is the day that the final loan documents are paid and you get the proceeds of your home mortgage loan.
Closing costs – These are the costs that you will pay when you get a home loan. They are either paid at the closing or added to the loan amount.
Debt-to-income ratio – This is a ratio lenders use to determine if you’re a good financial risk. It shows your monthly debts, including the new loan payment, in comparison to your monthly income.
Down payment – This is the amount of money the bank will expect you to put down when you get a home loan. Lenders often like borrowers to have a down payment of about 20 percent.
Equity – This is the difference between the value of your home and the amount you owe on the home loan. If your home is valued at $100,000 and you owe $75,000, your equity is $25,000. Equity may be used in lieu of a down payment.
Escrow – This is money set aside to pay the property taxes and/or the homeowner’s insurance. Since the lender makes these payments for you, the escrow money is included in your monthly payment. However, you do not pay interest on escrow accounts.
Fixed rate mortgage – This is a type of home mortgage loan where the interest rate stays the same throughout the term of the loan.
Good faith estimate – This form gives you an approximate amount of what your closing costs will be. This amount may change at the final closing.
Homeowner’s insurance – This is an insurance policy that protects your home against damages and loss such as lightning, storms, vandalism, etc. The lender’s name is listed as the payee on the insurance policy. Homeowner’s insurance has to be in force at the time of the closing.
Loan term – This describes how long you’ll be paying on your loan. Home mortgage loans are generally for 15, 20, 25 or 30 years.
Loan-to-value-ratio – Also known as LTV, this is an amount determined by dividing the loan amount by your home’s value. Lenders generally like to see an LTV of at least 80 percent.
Mortgage – This term refers to the loan and all the supporting documents. This is not to be confused with the deed, which is actually the title to your home.
Origination fee – This fee is often required by lenders at the time you apply for the loan, and it may include appraisal fees, application fees and any additional fees that go with the loan.
Principal – This is the original amount you borrow from the lender. It does not include the interest you are charged.
Private mortgage insurance – This is an insurance policy that may be required if the LTV is higher than 80 percent. It guarantees that the mortgage payments will be made. The borrower pays this either at the closing or as part of the mortgage payments.
Settlement costs – Unlike the good faith estimate, this form shows you the exact amount you’re expected to pay at the closing of the loan.
Title insurance – This is an insurance policy you’re required to buy at the beginning of the loan process. You're paying a title company to do a search of the property to make sure it is free of any other liens.
Truth in lending – Mandated by law, this form is required of lenders. It shows you the exact amount of fees they can charge and what lending policies they must follow. It’s also called a Loan Estimate.
Basics of Home Loans
Home mortgage loans are typically used for the following reasons.
Purchase a home – Consumers use the proceeds of a home loan to purchase a home.
Refinance a home loan – Homeowners may refinance their current home loan to lower monthly payments, get lower interest rates or change the loan term.
Get extra cash – Homeowners take out a second mortgage or increase the amount of the first mortgage based on the home’s equity.
Regardless of the reason for getting a home loan, the basics of home loans are all the same in one aspect. The homeowner borrows money from a lender and makes monthly payments, which include principal and interest, until the loan is paid. The length of time it takes to pay the loan back is determined at the time of the loan signing.
Types of Home Loans
Although lenders offer many types of loans, a loan is only called a home loan if a home is involved and used as collateral. Home loans are often given titles or descriptions based on the type of interest rate they offer or what type of lender or originator is involved. Here are some common types of mortgages.
Fixed Rate – This is a mortgage with a fixed interest rate.
Adjustable rate – This is a mortgage with an adjustable interest rate.
Balloon loan – This is like a fixed rate loan but only goes for a few years but uses interest rates as though it were a regular loan. You make monthly payments for the period, usually three to five years, and pay the balance at the end of the period or start another balloon loan.
Conventional loans – These are home loans you get at banks, credit unions or other lending institutions.
Government-insured mortgage loans – These are home loans that your get through a government agency. Examples are FHA, USDA, GI or VA loans.
Although the list above describes the type of mortgage loans you can get, home loans can also be broken down even further based on the need for the home loan.
Uses for Home Loans
As stated above, home loans are generally used to purchase a home. You find a home you want to buy so you visit a lender, take out a home mortgage loan and purchase the home. You pay the loan off by making monthly payments for a fixed amount of time. The monthly payments are the combination of the principal and interest. However, lenders also offer a couple of other types of home loans.
Home equity line of credit – This is a home loan homeowners get when they want cash for whatever reason. It’s only available when the value of the home exceeds the amount owed on the mortgage. For example, your home is valued at $200,000 and you owe $150,000 on the mortgage. You have $50,000 in equity.
Since lenders generally don’t like to borrow more than 80 percent of the equity, you could get a home equity loan for up to $40,000 . This may be added to your regular home loan or financed separately as a second mortgage. Home equity loans are popular because the interest on home loans is usually substantially lower than on regular installment loans or credit cards. Because it’s a mortgage, the interest may also be tax deductible.
Home equity line of credit – Also known as HELOC, this home loan is typically used if you were building a home. The advantage of a HELOC is that you take or draw out the money as you need it and only make payments on what you’ve drawn so far. You’re able to draw out money for a certain amount of time. Some go up to ten years.
For example, you’re building a home that’s expected to be valued at $150,000 and the bank has approved you for $120,000. Because it takes a while to build a home, you’re not going to need the entire $150,000 all at once. So, why pay interest on money you don’t even have yet? The bank advances the money to you as needed, and you only make payments based on the amount you took and the interest you’re charged on that amount.
There are also interest-only HELOCS, which allow you to only pay interest on the amount you’ve drawn so far. According to Bankrate, interest-only HELOCS are the most common. Once your home is finished, the HELOC is converted to a traditional home mortgage loan.
How Mortgage Payments Are Determined
Many potential home buyers estimate what their payments will be by taking the total balance needed and dividing it by the number of payments they intend to make. A mistake often made is forgetting the interest they'll pay on the loan. The monthly payment is determined by adding the total of the loan plus the interest you’re charged and dividing it by the amount of monthly payments you’ll make.
Your payments are affected by the term of the loan. Obviously, a 30-year home loan will have smaller payments than a 20-year loan, but you’ll also be paying more interest over the life of the loan. If you know how much you want to borrow, the interest rate you’ll pay and the term of your loan, you can figure out your payment using this online calculator. The calculator is also very handy in offering you different payment scenarios. Keep in mind that your loan payments will be higher if escrow or mortgage insurance is added to the loan.
Where Should I Get a Mortgage?
Getting a mortgage is a big step, particularly if it’s your first mortgage. It’s probably the largest investment you’ll make in your lifetime, so you want to make sure it's the best possible investment. There are several places where you can get financing for your home loan.
If you have good credit and are in a good place financially, you’ll have lenders very interested in getting your business. You can be selective until you find the best lender for your situation. Keep in mind that the lender your sibling or friend used may have been right for them but may not be right for you.
Since the housing market has started to pick up, banks and lenders are more competitive and willing to borrow money. In addition to credit unions, banks, mortgage companies and mortgage brokers, there is a large emporium of mortgage lenders online. Here are five steps to help you get the best lender.
1. Get a copy of your credit report. You can one free copy of your credit report annually. Even if you think you have good credit, get a hard copy so you can see what’s on the report and what your credit scores look like. Lenders and creditors usually report to one of these three major credit reporting agencies: TransUnion, Equifax or Experian. Even though lenders may see a different score than you see, the scores will be very similar.
Many creditors were surprised to see an unpaid debt that they thought was paid. There may be an error on your report. Once you have the credit report, you’ll be able to clear up any debts or have any errors corrected. Changes on your report take time showing up, so getting your credit report should be the first thing you do. Once you know your credit report indicates good credit, you’ll have more bargaining power.
2. Learn about the mortgage lending world and what’s all out there. If you are a member of a credit union or local bank, you may want to check there first. Lenders often look favorably on loyal customers, particularly those with good credit. Make a list of all the lenders including those online that may be of interest to you.
3. Compare interest rates. Once you have your list of possible lenders, compare interest rates. You can find the current and best interest rates here. You may not think there is a big difference between four percent and five percent, but it adds up to thousands of dollars over a 20- or 30-year loan. Check out this chart.
4. Ask the lender questions. A bank that charges fees but charges lower interest may be a better option than one with low fees and high-interest rates. However, if they seem to charge fees for every little thing, you may want to reconsider. What are their requirements? Do they have online access and good customer service? Get to know as much as possible about the lender's you’re considering. You'll be doing business with them for a long time, so you want to be satisfied.
5. Read the fine print. This can’t be emphasized enough. In addition to asking questions, make sure you read the fine print of everything the lender gives you. You don’t want any costly surprises later.
When to Apply For a Mortgage
If you’ve been thinking about buying a home for a while now, you’re probably also thinking about the prospect of getting a mortgage. Can you afford a mortgage payment? How will it affect your lifestyle? You are probably filled with concerns about if it’s the right time to get a mortgage. Here are some tips to help you decide.
Ownership vs. renting – This is probably the biggest reason why people purchase homes today. They would rather put their money towards owning their own homes and have equity than putting rent money in someone else’s pocket. Unless your rent is extremely low, getting a mortgage is a positive investment.
Your financial situation – If you’ve managed to pay off all or most of your debts, it’s probably the perfect time to get a mortgage. If your credit is good, that will help you get the best loan terms as well. If most of your other debts have been paid off for a while, your credit probably will be good.
Can you afford the payments? – Although making mortgage payments sounds better than making rent payments, make sure you’re not going to be paying more than you can afford. Make a list of the additional amounts you may be paying, such as mortgage payments, property taxes and homeowners insurance, etc. Will you have to buy new furniture or appliances? Was all your savings be used up on the down payment? If, after considering all these things, you can easily afford all these additional expenditures, now is a good time for a mortgage.
Time of month – The time of month may make a difference in getting a home loan, according to a credit and loan management company. If you’re a good credit risk, lenders are going to want your business any time of the month or year. However, banks generally are more eager to do new business at the beginning of the month as opposed to the end of the month when they’re trying to tie things up before “month's end”.
How Much Will You Be Able to Borrow?
Once you’ve decided you’re going to take the plunge and get a home mortgage loan, the first question you’ll have is how much money you’ll able to borrow. Many factors go into determining how much you can borrow. Two people can decide how much you can borrow: you and your lender. Unfortunately, you may not come to the same conclusion as the lender. Let’s start with you.
One thing to consider is that when you get your mortgage loan, that’s not the end of your spending. You may have paid for closing costs, insurance, down payments and possibly even moving costs, but it may just be beginning. While it’s true that your mortgage payment may be replacing your rent payment, you’ll now have homeowners insurance, property taxes, repair expenses and regular maintenance.
Remember all those times when something broke and all you had to do was call the landlord? Those times will be gone because, as a homeowner, those expenses will be your responsibility. Unless you have a nice savings account, you may want to set some money aside each month for these unexpected expenses.
Make a list of all these additional expenses that you will and could incur each month and add them to your potential mortgage payment. Using these figures and the online mortgage calculator, you can determine what type of payments you could be making each month. Comparing these with your income can help you see how much money you’ll have each month.
Now for your lender. You’ve based how much you can borrow based on what you think you can and will spend. Your lender will make the determination based on the facts he or she has from the documentation given by you. Lenders use a debt-to-income ratio to see what you can afford to spend. Debts such as loans, credit cards and car payments are added together, along with your new mortgage payment to make up what they consider as total debts.
Although they do make exceptions, lenders typically do not like the mortgage payment to be more than 28 percent of your total gross income or your total debts to be more than 36 percent of your total gross income. Keep in mind that they do not include monthly expenses like utilities, cell phone bills, fuel expenses, etc. when they figure the debt-to-income ratio. Lenders will determine how much you can borrow after they compiled all these figures.
Once they’ve given you a figure, it’s good time to ask to be pre-approved for your loan. Pre Approval gives you an exact figure of how much you can expect to receive and makes house shopping more fun and much easier. It also shows real estate lenders what you can afford and that you’re a serious shopper.
Steps for Getting a Mortgage
Now that you’re familiar with mortgage terminology, debt-to-income ratios, types of mortgages and all that good stuff, you’re ready to seriously consider getting a mortgage loan. Getting a mortgage can actually be an exciting time in your life if you do things in the right way. Below is a summary of the necessary steps for getting a mortgage loan.
Get Your Down Payment – You’ll be hard-pressed to find a lender that will not require a down payment. If you’re lucky, you may already have a nice nest egg saved for a down payment. If you don’t have a down payment, start saving. This is also a good way to determine if your financial situation is stable enough to buy a home. If you’re having difficulty saving for the down payment, you may not be ready to get a mortgage.
Get Your Credit in Order – As mentioned above, you can get a free copy of your credit report so you know what the lender will soon know. Any debts you can pay off should be paid off now. The fewer debts you have on your credit report, the higher your scores are going to be. Fixing any possible errors can also affect your scores.
Because getting the changes to show up on the report can be time-consuming, you’ll want to get your credit report as soon as possible. Hopefully, you’re not going to wake up one morning and decide to buy a house next week. Your home should be a lifetime investment, so don’t be afraid to do due diligence and do it correctly.
Get Your Financial Papers in Order – When you visit a lender, the first thing the lender will do is run a credit report. You will then be asked questions about your financial situation and be asked to fill out a loan application. At this point, the lender will ask for any financial documentation such as financial statements, proof of income, proof of employment, balance sheets and insurance policies. Have the paperwork ready and with you when you see the lender. It will save a lot of time and speed up the process should you decide to go with this lender.
Take advantage of mortgage calculators – Although not an exact science, mortgage calculators can give you a good idea of what type of mortgage payment you can expect. They also give you an idea of how much you can afford to spend.
Shop around for lenders and compare – All mortgages are not created equal, and the same can be said for lenders. Research what banks and lenders are offering for interest rates and shop around for lenders willing to match those terms. Ask questions about loan terms, requirements and fees. Fees can really add up quickly with the wrong lender.
Find out the total of your mortgage and what fees brought it to that point. Don’t be afraid to tell the lender that you are shopping around for the best deal. Ask questions, particularly if you don’t understand something in the terminology. If the lender isn’t willing to explain things to you in terms you understand, he or she is probably not the right lender for you.
Research interest rates – Interest rates play a huge part of what your home is going to cost you over the life of the loan. A few points can make a difference of thousands of dollars. Follow the market rates and watch the trends so you know when you’re in the good position to get the best deal.
Get pre-approved – There are a few advantages to being pre-approved. Real estate agents will know you’re a serious shopper that can afford to buy a home. Real estate agents work on commission and probably don’t enjoy wasting time showing homes to clients that can’t afford the home.
Getting pre-approved gives you and the real estate agent an idea of how much you can afford to spend. Make sure you ask the lender to pre-approve you. If the lender tells you that you are pre-qualified, state that you want to be pre-approved because, according to Consumer Reports, there is an important difference between the two.
Pre-qualification takes place at the beginning of the process. It’s based only on what you’ve told the lender as far as income and debt information. It’s also only an estimate of what they think you can borrow. Pre-approval takes place after the lender has run a credit report and has had the opportunity to go through and verify all your financial documentation. When you visit a real estate agent or seller, you want to show them you’re pre-approved.
Decide on loan type – Because there are several different types of loans, you’re going to want to learn as much as possible about each type. You may think you want a 15-year ARM, while your lender may think a 30-year fixed rate will work better. Have the lender give you a detailed explanation of each loan type available. Don’t be afraid to do some research on your own and ask questions if there is something you don't understand. It can be costly to change or redo a mortgage after it’s already in effect.
Avoid making financial transactions during the loan process. It can take months to get a mortgage and things may change in a person’s financial situation. For this reason, lenders often get a second credit report towards the signing of the loan. You want to make sure your credit report stays the same or it could affect your loan terms.
Be available for the lender. Just because you’ve provided the lender with tons of paperwork doesn’t me you won’t still get a phone call, text or email asking for additional information. Few things can slow a loan down then a lender and customer playing phone tag or the lender waiting on a reply. Get back to your as soon as possible. The sooner get the loan, the sooner you’ll be in your new home!
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