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You have undergone the pre-approval process earlier and determined how much of a loan you can receive. Now that you have found a home, it is time to finalize the specifics of the loan. Now is the time to determine what kind of loan you want, complete the process for applying for first-time homebuyer programs (if eligible) and finding a lender that is good for you. ConnectLA also wants to ensure that you have sufficient fair housing information to protect yourself from illegal practices, particularly predatory lending, by some unscrupulous lenders.

What kind of loan?

There are thousands of loans available out there from a variety of lenders, but in general, the mortgage you choose will likely be determined by at many of these key factors:

• How much down? Loans with 5 percent down or less are now less widely available.
• If you place less than 20 percent down, lenders will want the mortgage guaranteed by an outside third party such as the Veterans Administration (VA), the Federal Housing Administration (FHA) or a private mortgage insurers (as mentioned previously). PMI is required by lender to protect against any mortgage defaults. More than 2.5 million VA, FHA and PMI loans are generated each year.
• How’s our credit? The best rates and terms are only available to those with solid credit. To get the best loans make a point of paying credit cards, installment payments, rent and mortgage bills in full and on time.
• Are you a first-time buyer? There are some state and local programs for first-time homebuyers. Also, did you know that “first-time buyer” does not mean someone who has never owned property before, but under most state programs, the term refers to those who have not owned property within the past three years. State-supported first-time buyer programs often feature smaller down payments and below market interest rates. Click here for more details about local first-time buyer programs in Los Angeles.

What is a mortgage?

A mortgage is a loan to finance the purchase of your home and is likely the largest debt you’ll ever take on. Your home is collateral for the loan, which is also a legal contract you sign to promise that you’ll pay the debt, with interest and other costs, typically over 15 to 30 years. If you don’t pay the debt, the lender has the right to take back the property and sell it to cover the debt. To repay the debt, you make monthly installments or payment that typically include the principal, interest, taxes and insurance, together know as PITI.

Principal—The principal is simply the sum of money you borrowed to buy your home. Your down payment is used to reduce the amount that is financed.

Interest—Usually expressed as a percentage called the interest rate, interest is what the lender charges you to use the money you borrowed. As well as the given rate, the lender could also charge you points, and additional loan costs. Each point is one percent of the financed amount and is financed along with the principal.

Principal and interest comprise the bulk of your monthly payments in a process called amortization, which reduces your debt over a fixed period of time. With amortization, your monthly payments are largely interest during the early years and principal later. In addition to your principal and interest, your mortgage payment could include money this is deposited in an escrow or trust account to pay certain taxes and insurance. Generally, if your down payment is less than 20 percent, your lender considers your loan riskier than those with larger down payments. To offset that risk, the lender sets up the escrow account to collect those additional expenses, which are rolled into your monthly mortgage payment.

Taxes—The taxes are property taxes your community levies based on a percentage of the value of you home. The tax is generally used to help finance the cost of running your community, to build schools, roads, infrastructure and other needs. You must pay property taxes even if you don’t need an escrow account and even after your mortgage is paid off.

Insurance—Lenders won’t let you close the deal on your home purchase if you don’t have home insurance, which covers your home and personal property against losses from fire, theft, bad weather and other causes.
Another type of insurance that may be required is private mortgage insurance (PMI). If you put less than 20% down on your home purchase, most lenders will also charge you PMI premiums. The coverage does not protect you, it protects the lender from you defaulting on the mortgage. Without the coverage, many buyers could not otherwise afford to buy a home. Effective for loans written on or after July 29, 1999, lenders must automatically cancel PMI when your mortgage balance decreases to 78 percent of the home’s original purchase price.

Finding a Mortgage Provider

You can get a mortgage from many different sources, like mortgage banking companies, commercial banks, community banks, credit unions and other financial institutions. Mortgage brokers may be a source of information about different mortgage products available from a variety of sources.

How do you choose the right mortgage?

There is a wide selection of mortgages available in today’s market, and you should narrow the field by considering your particular situation. Your choice of mortgage will be influenced by questions such as:

• How many years do you expect to live in your new home?
• How important is it to be free of mortgage debt before facing other life obligations (i.e. children going to college, planning your own retirement, etc.)
• How comfortable are you with the certainty of a fixed mortgage payment versus a payment that can change over time?

ConnectLA recommend that you shop around for the best mortgage possible. Like shopping for a car, you should compare mortgages to make sure that you are getting the best deal available.
Click here to see a mortgage comparison worksheet.

But be aware! The lowest mortgage rate may not always be the best choice for you. Rates are important, but also consider the overall cost of the loan. Look at the costs such as loan and origination fees, and discount and origination points. Be sure to ask the lender exactly what he or she is quoting, to ensure that you are comparing “apples” to “apples”. Ask what the annual percentage rate (APR) of the loan is. The APR takes into account the interest rate and fees.

Ask for a “good-faith estimate” in writing from each lender that you work with so you understand all of the costs and you can compare lenders.

Type of mortgage

The type of mortgage is an important part of the decision. Some of the most common mortgages available today include:

• Fixed-rate mortgages
• Adjustable-rate mortgages
• Balloon mortgages
• Special Programs

Fixed-Rate Mortgages

If you expect to live in your home for many years, the interest rate on your loan may be your primary consideration. You may want a fixed-rate mortgage that will ensure that your interest rate will remain the same for as long as you have your loan. If you decide that you like the stable, predictable payments of a fixed-rate loan, then you must choose from a variety of repayment terms—15, 20, and 30 years are the most common. Here are some points to compare about various fixed-rate loans:

Longer Terms such as 20 to 30 years:

• Qualify for a larger loan amount, so you can buy more house.
• Have higher interest rates
• Pay more interest in total than shorter-term loans.
• Is a good choice if you don’t plan to move or refinance for at least 10 years or if interest rates were low when you locked in the rate.

Short terms such as 15 years:

• Have lower interest rates.
• Have a shorter period (term) to pay back the principal. Because of the shorter term the monthly payments are higher but more of the payment goes to principal and less to interest.
• Build equity faster
• Have higher monthly payments—because of which, you may qualify for a smaller loan amount.
• Is a good choice if you want to build equity quickly or you’d rather pay less interest than buy a more expensive home.

Low Down-Payment Options

Saving enough money for a down payment can be hard and meeting lender underwriting requirements can be challenging. Sometimes this prevents people from buying a home.

Some mortgage lenders offer low-down-payment fixed-rate mortgages and mortgages with more flexible underwriting. Below is an overview of low down-payment options available with some mortgages. Be sure to contact your lender for all the specifics related to loans with this type of option. Some mortgages need as little as 3% down payment. Others raise the maximum debt-to-income ratio, allowing you to qualify for a mortgage payment that is a larger percentage of your monthly income.

Ask you lender about fixed-rate mortgages with features such as:

• Small down payments (3% to 5%)
• Additional sources of money for down payment and closing costs. Sources like a federal, state or local government agency, nonprofit organization, private foundation, etc.
• Expanded debt-to-income ratios (sometimes, up to 33% of gross monthly income for housing expenses and 38% for total monthly debt expenses)
• Options for people with limited incomes in high-cost areas like Los Angeles
• Homebuyer education programs
• Lower mortgage insurance costs
• Seller contributions to your closing costs.

Adjustable-Rate Mortgages (ARM)

If you’re confident that your income will increase steadily over the years, or if you plan to move in a few years and aren’t concerned with potential rate increases, then you may want to consider an ARM. ARMs feature an interest rate that moves up and down as market conditions change. Although an ARM usually offers a lower initial interest rate, your mortgage payments change periodically (usually once or twice a year).

Because ARMs offer lower initial interest rates, initial monthly payments will be lower, so you may be able to qualify for a larger mortgage amount. However, you will likely be required to come up with more than a 5 percent down payment (usually at least 10 percent). Of course, if interest rates go down, your payment will decrease as well. Some ARMs offer you the chance to convert to a fixed-rate loan (for a fee) within a certain period of time.

All ARM interest rate adjustments are based on a published market index. Some frequently used indexes include Certificate of Deposit, U.S. Treasury Bill or Cost-of-Funds. ARMs have defined adjustment periods that determine how frequently the interest rate can change. The initial period before the first adjustment can be short (1 to 3 years) or quite long (7 to 10 years). After the initial period the interest rate on most ARMs adjusts every year. Once the initial period is up, the interest rate can increase or decrease based on an index plus a certain percentage, known as the margin. ARMs have rate caps, or ceilings and floors, on how much the interest rate can increase, and in some cases, decrease.

There are many different types of ARMs. Some of the most common are:

• 10/1 ARM
• 7/1 ARM
• 5/1 ARM
• 3/1 ARM
• 1/1 ARM

The first number is the length of the initial period—how long it is until the first interest rate adjustment. For example, the interest on a 10/1 ARM will not change for the first 10 years but can change in the 11th year. People often plan to sell or refinance their home before the end of the initial period.

Balloon/Reset Mortgages

Balloon loans offer lower interest rates for shorter term financing, usually five or seven years. At the end of this term, they require financing or paying off the outstanding balance with a lump-sum payment. Balloon mortgages may be suitable if you plan to sell or refinance your home within a few years and what a fixed, low monthly payment. Balloon/reset mortgages have monthly mortgage payments based on a 30-year amortization schedule but the entire mortgage balance becomes due at the end of the 5 to 7 year term.

However, under the reset option you may be able to “reset” your mortgage interest rate at the market rate at that time for the remainder of the amortization period if:

• you are still the owner and occupant of the home
• you have not been delinquent in your mortgage payments for a year before the maturity date of the balloon note
• you have no other liens against the property
• you have satisfied certain other conditions of the reset.

You may also qualify to refinance your balloon/reset mortgage. You might also consider a balloon/reset mortgage if you can’t afford the home you want because the monthly payment for an ARM or fixed-rat mortgage exceeds your Debt-to-Income Ratio. Balloon/reset mortgages typically come with a slightly lower initial rate than many other mortgage types.

Special Programs

Special Loan Programs. Special loan programs often exist to help first-time buyers. With some of these programs, you may be able to accept a gift from a relative or to borrow a portion of the money you will need for the down payment and the closing costs for a local nonprofit organization or government agency. With others, you may be able to get a grant or other funds that you will not have t repay and can use to cover some of these costs. If you don’t qualify for a mortgage based on some of the traditional underwriting factors described earlier, you may want to find lenders who offer special mortgage loans like these. These loans allow you to use a greater percentage of your income toward monthly housing expenses and will not require you to have two months of cash in reserve at closing. If you don’t have a traditional credit history, you can show you have a good credit history using your rent and utility receipts.

Government-Insured Loans. You may want to consider the mortgage plans offered by the Federal Housing Administration (FHA) and the Department of Veterans Affairs (VA). Properties purchased under these programs must meet certain minimum standards and possible loan limits. FHA-insured loans offer very low down payments (3 to 5 percent). VA-guaranteed mortgages with no down payment are available to qualified veterans. You must get a certificate of eligibility from the Department of Veterans Affairs for a VA loan.

Sources:
“Borrowing Basics: What You Don’t Know Can Hurt You”, FannieMae Foundation 2004
“Choosing the Mortgage That’s Right for You”, FannieMae Foundation 2003
“Knowing and Understanding Your Credit”, FannieMae Foundation 2002
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