Home is a place where everyone loves to be. It’s the place where you are the happiest. This happiness also takes the form of an achievement for those who own their homes. So, having an own-house is one of the most common aims of life for many of us. Even from an investment point of view, buying a home is usually considered an ideal and safe deal. However, buying a house that caters to all your needs can be an expensive affair. Not many can afford to purchase a residential property outright. This is where home buyers need the mortgage services.
As every home-buyer needs a mortgage, it is clear that it is an important aspect of your home buying exercise. So it becomes quite necessary for you to know all the details about it before opting. Having a clear idea on how it works can be quite helpful. Also, there are different types of mortgages services, and choosing the right one that fits your need is crucial.
What’s a Mortgage?
It is a loan received by the home-buyer from a lender for purchasing a real-estate. The lender is usually a financial institution such as a bank or credit union. The lender offers the loan on the condition that the real-estate that is being bought is held by it as a security or collateral. In case, the borrower is unable to pay back the loan, the lending institution can exercise its right on the property and can sell it off to regain the amount. The lender charges an interest on the amount that has been lent, and also sets a duration in which it has to be repaid. The interest on the loan depends on various factors. One of the factors that plays a vital role in determining the rate of interest is the credit-score of the borrower. It basically means the credit-worthiness which is based on the income of the borrower, and the ability to pay-back the loan.
Another factor that is usually taken into consideration is the property that is being mortgaged. Also, the economic scenario can play a crucial role, as the interest rates also depend on demand and supply equilibrium. However, the rates are strongly controlled by the Federal Reserve. During recessions, for instance, the Federal Reserve would want to rates to be low, as this would encourage buying and borrowing, which in turn can revive the economy.
The mortgage is divided into 4 major components:
- Principal – It is the original amount lent to the borrower
- Interest Rate – It is the charge levied by the lender
- Taxes – These are assessed by the government and paid by the lender, but in some cases are passed onto the borrower.
- Insurance – The package policy covers both the damages caused to the house as well as the harm that could be done by the house or its members to a third person.
Acquiring a mortgage loan can be a tedious process as the lending institutions want to be totally secure before they are lending the money.
Therefore the process is usually divided into two steps. The initial step is where the loan applicants have to work out how much they would be able to afford. Based on this, they can set about finalizing the property for which they need the loan for. Also, they would be required to choose the type of mortgage that would fit their bill and needs. They can then go about looking for the bank or a mortgage company who could offer them the finance.
Once the customer sends out the application to a specific lender, the next step begins. Now the bank would take charge and go about performing a detailed affordability check of the applicant.
Banks and lending institutions usually hire the services of an underwriter, who is an expert in analyzing if the deal would be profitable for the lender. These experts could summon the applicant and ask them a series of questions. The answers would help them to determine the right type of mortgage for the customer. Also, they would be able to assess the financial condition of the applicant and then depending on the type of property and other factors, the lender would be given the indication on how much amount would be ideal to be be given as the loan. The lender would also assess how long it would take the borrower to repay and depending on it the exact duration of the loan and the interest rate would be fixed. All details about the range of products available with the lender apart from the additional service charges and fees for each of them would also be disclosed to the applicant. When both the parties are in agreement of all the things that have been discussed, the lender would then be able to begin a formal assessment of the customer’s affordability in detail.
The lending institution would check everything thing that could determine the eligibility of the borrower to pay back the loan. The borrowers have to produce their income proofs certificates, apart from various types of expenditure bills and their credit scores documents to be checked by the lender. Any other loan already secured by the borrower is also scrutinized. The lender may even ask documents related to personal expenses such as child maintenance and other household bills. Based on these documents, the eligibility of the home-buyer is thoroughly analyzed. They may also want to find out if the loan-seekers are able to keep up the repayments in case of a hike in interest rates. If all the criteria are not duly met by the loan applicants or if they think that the borrowers would not be able to afford the loan, the lending institutions may refuse it. Hence, having a thorough idea about the application procedure can be quite helpful for all the first time applicants.
Also, there are several banks, credit unions and finance institutions the loan seekers can choose from. So, in case the loan of refused by one lender, there is always a chance to get it from the other. Moreover, there are range of mortgage products available and in case if a loan seeker in ineligible for one, then he are she can always try for the others. In addition, the applicants can hire the services of a professional mortgage broker or an independent financial adviser (IFA). These professionals can help them compare the several types of loans available in the market and can also advice on going for the one that fits them best. They could also help them acquire the niche types of loans that are usually not offered to the new customers directly.
All most all the loan-seekers are required to go for a professional advise unless they are experts in finance, and specifically mortgages. While there are situations when customers can choose a mortgage without an advice, and such loans are called execution-only mortgages. However, these types of mortgages are available only to specific customers and under special circumstances. Thus, most customers are required to get an advice that will enable them to know all the details such as the exact type of property they are purchasing, the amount they would need to borrow, and the exact time period they would need to pay off the loan. They would also be advised on the type of interest rates, and the best rates they could borrow at. The lender will then confirm in writing that that the applicant has referred to a professional advisor and that all the details have been initiated upon the due consent of the loan-seeker. Otherwise, the lender will mention that the loan applicant hasn’t received has not taken the desired advice, and that the loan hasn’t been assessed to check if it’s suitable. So, the borrower would have to confirm in written that he or she is aware of the consequences, and is happy to go ahead. So, incase, for some reason the type of the loan turns out unsuitable for the borrower, then he or she are solely responsible for it and lender would not be held responsible.
Once the application has been accepted, the lender would then provide the customer with a ‘Binding offer’. This usually includes all the documents explaining the terms and conditions of the loan, apart from other series of documentation the borrower would have to sign and reproduce within a certain period. This is called the ‘reflection period’ and is usually about seven business days. In this period the customers will have the opportunity to compare the deal offered by the lender with other institutions and also asses the implications of the offer.
There are various types of mortgages available in the market and some of the most common ones are explained below
Options based on Rate
One of the primary type of choices a loan applicants has to make is to weather to go for a loan with fixed interest rate or one with adjustable rate. Most of the loans available today fit into either of this category. The remaining are usually the hybrid version of these two.
As the name suggests, these mortgages have the interest rate loans have the same interest rate fixed for the entire duration of the repayment term. This ensures that the amount you repay on a monthly basis remains the same. Even if the duration of the loan is as long as 30 years, the amount paid in the first payment at the beginning of the loan will be the same as the last one. The main advantage of this loan is that the borrowers are able to lock the amount they have to pay thereon. This means even if the interest rates sky-rocket after a decade or so, the borrowers would enjoy paying a fixed payment, which would be comparatively low. However, to enjoy this benefit, they would have to agree to pay a higher rate of interest.
This is a type of loan which allows the lender to change the interest rate and “adjust” it depending on the market scenario. This changes occur time to time and depends on the type of ARM the customer has opted for. Usually, the interest would change every year after an initial period, when it remains fixed and is therefore referred to as a “hybrid” product. For instance, in a 5/1 ARM, the rate remains fixed for initial 5 years, after which it would be adjusted every year. The advantage of this loan is that the customers have to pay a lesser interest as compared to the fixed rate loan. However, once the duration is over, there is always an uncertainty on the payment amounts as the rate could rise and may turn much higher depending on the future market scenario.
Options based on down-payment
These are the type of loans that are backed by the government and secure the lender in case of the borrower defaults. While there are benefits for lenders, they carry an extra cost of insurance that has to be paid by the borrower. However, the advantage of these loans is that the down payment required to be paid is quite low.
The government-backed loans include FHA, USDA and VA loans.
This loan is initiated by the Federal Housing Administration (FHA) mortgage insurance program and is supervised by the Department of Housing and Urban Development (HUD), under the federal government. These loans are available for all and accept a down payment as low as 3.5% of the property-price.
These loans are offered to the military service members and their families by the U.S. Department of Veterans Affairs (VA). Under this program, borrowers can receive 100% financing to buy their house, which means no down payment is required to be paid.
While these government-backed loans have undergone various changes over the several decades since they were started, they are now offered only to limited people.
A conventional mortgage loan is the one that is offered by a private mortgage insurance (PMI) firm and is not backed by the government. While the payment may not include the insurance cost from the government, the borrowers would have to pay a down payment to the lender, which could be a considerable amount.
Options based on size
Most loans that are lent conform to the underwriting guidelines prescribed by the government organizations known as Freddie Mac and Fannie Mae. These organizations are controlled by the government and their primary task is to purchase and sell mortgage-backed securities (MBS). They purchase these loans from the lending institutions generating them and then trade them off to the investors at Wall Street. When the amount falls within the maximum limit as mentioned by these organizations, they are termed as “conforming”.
If a loan exceeds the limits established by Freddie Mac and Fannie Mae, it is usually called a Jumbo loan. While they can be a risk to the lender, they are usually characterized by the high-interest rates and are available only to limit few with excellent credit scores. Also, the down payment in the case of the Jumbo loans is much higher.
While there are several other mortgages available with the lenders, the loan-seekers would benefit substantially by simplified particulars mentioned in this article. However, seeking the advice of a professional mortgage loan advisor is quite necessary, who could be able to explain many more things in further details.