What does my mortgage payment include?
For most homeowners, the monthly mortgage payments include three separate parts:
Principal: Repayment on the amount borrowed
Interest: Payment to the lender for the amount borrowed
Taxes & Insurance: Monthly payments are normally made into a special escrow account for items like hazard insurance and property taxes. This feature is sometimes optional, in which case the fees will be paid by you directly to the County Tax Assessor and property insurance company.
How much money will I need to purchase a home?
The amount of funds that is necessary depends on a number of items. Generally speaking, though, you will need to supply:
Earnest Money: The deposit that is supplied when you make an offer on the house
Down Payment: A percentage of the cost of the home that is due at settlement
Closing Costs: Costs associated with processing paperwork to purchase or refinance a house
How do I know how much house I can afford?
Generally speaking, you can purchase a home with a value of two or three times your annual household income. However, the amount that you can borrow will also depend upon your employment history, credit history, current savings and debts, and the amount of down payment you are willing to make. You may also be able to take advantage of special loan programs for first time buyers to purchase a home with a higher value. Give us a call, and we can help you determine exactly how much you can afford.
Mortgage Types and Information
- FHA Loans
This program allows a first time home buyer who might otherwise not qualify for a home loan to obtain one because the risk is removed from the lender by FHA who insures the loan for the lender.
The most popular FHA home loan program for a first time home buyer is the 203(b). This is the standard fixed rate loan for 1-4 family owner occupied houses and only requires a minimum of 3.5% down payment from the borrower. This loan also permits 100% of their money needed to close to be a gift from a relative, non-profit organization, or government agency.
The main advantage of an FHA home loan is that the credit criteria for a first time borrower are not as strict as Conventional Loans sold to Fannie Mae (FNMA) or Freddie Mac (FHLMC). Someone who may have had a few credit problems or no traditional credit should not have a problem obtaining FHA financing. Also, FHA home loans are assumable, allowing a person to take over the mortgage without the additional cost of obtaining a new loan. In addition, the seller or lender must pay for part of the “traditional” closing costs (called non-allowable costs) while a borrower’s allowable costs can partially be wrapped into the loan. The monthly mortgage insurance premium is cheaper for an FHA loan verses a conventional loan with 3% down. Finally, FHA loans may require less income to qualify as they can exceed the Conventional debt ratios of 28/36% as their standard is 29/41%. To learn more about debt ratios, please see the income section.
2) VA Loans
Congress created the VA Loan Guaranty Program in 1944 to help returning service members achieve the dream of homeownership. Since then, the Department of Veterans Affairs has helped more than 18 million military members purchase homes.
What is a VA Loan?
A VA loan is perhaps the most powerful and flexible lending option on the market today. Rather than issue loans, the VA pledges to repay about a quarter of every loan it guarantees in the unlikely event the borrower defaults. That guarantee gives VA-approved lenders greater protection when lending to military borrowers and often leads to highly competitive rates and terms for qualified veterans.
What are the Key Benefits of a VA Loan?
By far the most significant benefit of a VA loan is the borrower’s ability to purchase with no money down. Apart from the government’s USDA Rural Development Home Lloan and Fannie Mae’s Home Path, it is almost impossible to find a lending option today that provides borrowers with 100 percent financing.
VA loans also come with less stringent underwriting standards and requirements than conventional loans. In fact, about 80 percent of VA borrowers could not have qualified for a conventional loan. These loans also come with no private mortgage insurance (PMI), a monthly expense that conventional borrowers are required to pay unless they put down at least 20 percent of the loan amount.
3) USDA Loans
USDA guaranteed home loans can assist most individuals and families in rural areas become homeowners. The primary purpose of the USDA Guaranteed Rural Housing Program is to help moderate and low income borrowers qualify for a mortgage loan, even if they cannot afford to make a down payment.
Guidelines for Qualifying for a Guaranteed Rural Home loan:
1) Have dependable and adequate family income. (Family income is defined as the combined gross income of the applicant, the co-applicant, and any other adult living in the household.)
2) Meet moderate income limits for your specific area.
3) Have a credit history which indicates a reasonable ability to pay obligations as they come due.
4) Be a citizen of United States, a qualified alien, or legally admitted into the U.S. as a permanent resident.
Before being approved for a Rural Housing loan some predetermined ratios are taken into account to determine repayment capabilities. Total debt must not exceed 41% of the gross income. The ratio is calculated by dividing the homeowner’s monthly debt payments by his gross income. These debts include, but are not limited to, new mortgage payment (principal, interest, taxes, and insurance), car payment, loan payment, credit card payments, child support, alimony and any other payment that will take longer than six months to fulfill.
4) Conventional Loans
How they work: “The dominant number of loans made in the conventional market use Fannie Mae and Freddie Mac guidelines for conforming loans,” says John Councilman, federal housing chairman for The National Association of Mortgage Brokers in McLean, Va.
Conventional loans are “conforming” if they are generally $726,200 or less for a single-family home. Conforming loan limits can be higher in pricier regions of the country. For example, in such states as Alaska and Hawaii, it’s $1,089,300. There are also established guidelines for borrower credit scores, income requirements and minimum down payments. For example, most conventional loans require somewhere between 5 percent and 20 percent down. “Right now those guidelines are changing frequently but they should have at least a 620 credit score,” Councilman says. “Anything below a 740 credit score and they (lenders) are going to start adding fees which can be quite sizable, in the several-percent range, as borrowers’ credit scores drop compared to loan-to-value (LTV).”
Conventional loans can be conforming or nonconforming. Loans above the lending limits set by Fannie Mae and Freddie Mac are called nonconforming or jumbo loans.
Most conventional mortgages have either fixed or adjustable interest rates. Typical fixed interest rate loans have a term of 15 or 30 years. A shorter-term loan usually results in a lower interest rate. Adjustable-rate mortgages, or ARMs, fluctuate in relation to the rate of a standard financial index, such as the LIBOR. Monthly payments can go up or down accordingly.
Cost: Origination fees, down payments, mortgage insurance, points and appraisal fees can mean the borrower has to show up at closing with a sizable sum of money out-of-pocket, or be prepared to roll over some of these costs into their mortgage amount, which may result in a higher loan rate.
Pros: Conventional mortgages generally pose fewer bureaucratic hurdles than FHA or VA mortgages, which may take longer to process because of the red tape. And because these mortgages generally require higher down payments than the others, home equity can build up faster.
To read about the pros and cons of fixed-rate versus adjustable-rate mortgages, see Bankrate’s story on “Loan products for big-ticket items.”
Cons: You’ll need excellent credit to qualify for the best interest rates. Also, many lenders require higher down payments than for government-backed loans. In declining markets such as this one, borrowers may only qualify for 90 percent loan-to-value and have to come up with the rest out of pocket. Some lenders may require as much as 20 percent down, particularly for condominiums in markets where it’s difficult to get mortgage insurance. Conventional loans are ideal for borrowers with excellent credit who can afford a down payment of 5 percent or more.
What is the difference between a fixed-rate loan and an adjustable-rate loan?
With a fixed-rate mortgage, the interest rate stays the same during the life of the loan. With an adjustable-rate mortgage (ARM), the interest changes periodically, typically in relation to an index. While the monthly payments that you make with a fixed-rate mortgage are relatively stable, payments on an ARM loan will likely change. There are advantages and disadvantages to each type of mortgage, and the best way to select a loan product is by talking to us.
Adjustable Rate Mortgages
Top Three Types of Adjustable Rate Mortgage Loan Products:
5/1 ARM loans
Payments are fixed for five years and adjust for remaining 25 years.
3/1 ARM loans
Payments are fixed for three years and adjust for remaining 27 years.
2/1 ARM loans
Payments are fixed for two years and adjust for remaining 28 years.
How is an index and margin used in an ARM?
An index is an economic indicator that lenders use to set the interest rate for an ARM. Generally the interest rate that you pay is a combination of the index rate and a pre-specified margin. Three commonly used indices are the One-Year Treasury Bill, the Cost of Funds of the 11th District Federal Home Loan Bank (COFI), and the London InterBank Offering Rate (LIBOR).
Refinance to a Fixed-Rate Mortgage
This option is feasible if you have enough equity and can afford higher payments.
If homes prices fall and appreciation declines, you might not have any equity.
Beware of prepayment penalties; some equal six-months of unearned interest.
Adding refinance costs and points to the loan further reduces equity because your loan balance increases.
Talk to a Reputable Credit Counselor
Arrange to make lower payments, deferring unpaid interest, which will increase your loan balance.
Work out lower payments on other debt obligations to allow for higher mortgage payments, called debt reorganization under bankruptcy laws.
Persuade the lender to come to an agreement on forbearance or postponing your payment increases based on ability to pay at a future date.
Sell Your House
List your house for sale with a real estate agent, providing you have enough equity to pay commissions and costs of sale, typically 7 to 10 percent of sales price.
Sell your house without representation, providing you can afford advertising and marketing expenses, including the advice of a real estate lawyer.
Deed your house to the lender under a deed-in-lieu-of-foreclosure arrangement, accepting that you will receive no money for your equity and a ding on your credit.
Foreclosure, of course, is always an option, but it is not the most desirable, especially when there are better alternatives available. The worst thing a home owner can do is nothing.
Fixed Rate Mortgages
Fixed-rate mortgages have been the mainstay of the home loan industry for decades. Over the years, loan-to-value ratios have fluctuated and interest rates have moved up and down, but the security a fixed-rate mortgage offers has never lost its appeal.
What is a Fixed-Rate Mortgage?
Fixed-rate mortgages allow for repayment of a debt in equal monthly mortgage payments over a specified period of time, from 10 to 50 years. A 30-year amortization period is most common.
Payments are credited first to interest, then to principal. During the early years of the loan, much of the monthly payment goes toward interest. Toward the end of the loan period, much of the monthly payment goes toward principal. Please realize however that a $200,000 amortized loan at 6% for 30 years means you will pay $231,676 in interest over the life of the loan.
Fixed-Rate Mortgage Benefits
Borrowers gravitate toward fixed-rate mortgages in-lieu-of adjustable-rate mortgages because they like the security of knowing exactly how much they will pay per month for principal and interest.
The interest rate is fixed, so if overall interest rates increase, it does not affect the fixed-rate borrower. Likewise, if overall interest rates decrease, the borrower’s payment still remains the same unless the borrower chooses to refinance the mortgage into a lower rate. A borrower can choose to make a larger monthly payment and direct the additional portion of the payment to be paid toward principal, thereby decreasing the principal balance of the loan faster. Paying half your monthly mortgage every two weeks pays off your mortgage in about 22 years. One extra payment per year reduces the amortization period to about 26 years. But additional principal payments are not required.
Should You Pay Points?
You can buy down your mortgage for the first few years by paying a lump sum to the lender. But unless the seller or somebody else is paying this fee for you, it doesn’t make much sense to buy down your own mortgage. You can put away the money in your own savings account and use that money every month, on which you earn interest, to help pay your own mortgage payment.
Points will decrease your interest rate. Each point is equal to 1% of your loan. To recover the cost of those points, figure out the monthly savings with the lower interest rate versus the rate without points. Then divide that number into your points to arrive at the number of months it will take you to break even. Everything after that is gravy.
For example, say you are paying 2 points on a $200,000 loan to get an interest rate of 5% with a payment of $1,074. Or you could get that $200,000 loan at an interest rate of 6% without points and pay $1,200 per month. The difference between the two payments is $126.
Two points will cost $4,000. To recoup that investment, $4,000 divided by 126 equals almost 32 months. By your 33rd month, after almost three years of payments, you will begin to profit from paying those points.
Collection for Taxes and Insurance
If you are considering a loan that is higher than 80% of the purchase price of your new home, you will likely be asked to pay monthly property taxes and homeowners insurance to your lender. Your lender, in turn, will pay the tax assessor and your insurance company. In this case, your monthly PITI will change from year to year as annual taxes and insurance go up or down. Lenders will also collect a reserve, from 2 to 8 months of taxes and insurance, in advance from you. This impound account reserve (sometimes referred to as an escrow account) will increase your closing costs.
The reserve amount collected depends on the time of year and when your annual tax bill is due.
Even if you are putting down 20% or more of the purchase price, often lenders will charge “1/4 point to rate,” meaning you will pay .25% more in interest NOT to set up an impound account. Personally, I prefer to be responsible for paying my own taxes and insurance.
As a hedge against interest rates falling, lenders who make fixed-rate mortgages will sometimes demand a loan feature known as a prepayment penalty. This means if you pay off the loan within a certain number of years, typically one to five years, you will also pay the lender an additional six months of interest, or more.
How do I know which type of mortgage is best for me?
There is no simple formula to determine the type of mortgage that is best for you. This choice depends on a number of factors, including your current financial picture and how long you intend to keep your house. Southern Mortgage Group can help you evaluate your choices and help you make the most appropriate decision.
Current Mortgage Rates
|30 Yr Fixed Conv.||7.125%||7.274%|
|30 Yr Fixed Gov.*||6.500%||6.843%|
|15 Yr Fixed Conv.||6.750%||6.988%|
|15 Yr Fixed Gov. **||6.250%||7.190%|
*Government loans include FHA, VA and USDA loans.
**We do not offer a 15 year USDA loan.