MORTGAGE INFORMATION - What you should know about....

Mortgage Prequalification and Preapproval

Why get prequalified and then preapproved for a mortgage before you begin your search for a home? Because there are 3 people who will benefit from your preapproval: You, your Agent, and the seller from whom you eventually buy a home!

You: The most important beneficiary, of course, is you. One of the most common questions we get from users of this site goes something along the lines of "Please let us know how much house we can afford." We're stumped! Why? There are simply too many variables--credit history, income, debt, special mortgage programs and variations in qualifying guidelines between different mortgage types--to answer that question. The only sure way of getting the question answered is through prequalification. The mortgage prequalification step is a relatively simple one, but it is an important one. It begins the process of formally applying for a mortgage, and it gives everyone involved--especially you--a clear sense of the direction they should be headed.

Your Agent: By knowing what your financial parameters are, your Agent can spend more time looking for houses that "fit" and less time pursuing dead ends. No matter how much you might want a 4000 square foot home for $2,750,000, if your qualifications say $1,250,000, your qualifications say $1,250,000. When it comes to mortgages, "yes, but" doesn't carry much weight!

The Seller: Want to strengthen your bargaining position? Get prequalified. Want your offer to stand out in a case of multiple offers for the same house? Get prequalified. Look at it from the seller's perspective. If you had 2 offers on the table for your house, one from a fully prequalified buyer and the other from an "I'll get around to that soon" buyer--to which offer would you devote the most attention? Even if the prequalified buyer's offer was $1000 less, would you take the chance on the buyer that perhaps may not be qualified? When it comes to a seller evaluating offers, "a bird in the hand..." definitely applies.

It is important to remember that the amount of mortgage you will qualify for is the maximum . It is the amount that the lender feels you can afford , but it is not necessarily the amount that you want to pay . It sometimes is advantageous to be conservative here. For example, if you qualify for a $1,000,000 mortgage and you have $150,000 available in cash for downpayment and closing costs, you are qualified to buy homes with a maximum selling price of $1,150,000. So as to not push yourself to the limit, you may want to look at homes that sell in the $1,000,000 to $1,100,000 range. Too many buyers simply rush off to the $1,150,000 level and some find themselves strapped when it comes time to purchase necessary items (such as draperies, additional furniture and lawn and garden tools, for example) or when they forget to factor in increases in monthly expenses (for example utilities and maintenance and repair costs).

 

Choosing a Mortgage

Choosing among the many houses that may be available is hard enough--then you need to make a choice from the myriad of mortgages that are offered in today's market. So many decisions! Take heart, though, since although there are literally hundreds of different mortgages available, they all fall into only a few basic varieties. Some may fit perfectly into your situation, others may be unwise or unattainable. By narrowing your choices, the process of picking the right mortgage becomes much easier.

Fixed Rate or Adjustable

One of your first decisions should be between a fixed rate (the interest rate remains constant through the life of the mortgage) or an adjustable (the interest rate is adjusted--either up or down--at specified times during the mortgage term). Adjustable Rate Mortgages (ARMs) will have an initial interest rate lower than fixed rates but will adjust upward (unless rates really fall!) usually after the first year. They may be a good choice if you are sure that you will not be owning the home for an extended period (more than 5-7 years) of time.

You will probably want to shoot for the shortest term that is comfortable (and for which you will qualify). The interest savings are enormous as the term decreases. Always make a comparison between a 15 year term payment and a 30 year term payment. The difference is often surprisingly smaller than anticipated. The savings over the term of the loan, however, can be substantial. For example, comparing a 15 year term to a 30 year term, $1,000,000 mortgage at an 8 1/2% fixed rate yields the following results.

Common Loan Types: Conventional, FHA, VA and "No-Document"

Conventional: A "traditional" mortgage, not directly insured by the Federal Government. Most conventional loans under $417,000 are administered through Fannie Mae or Freddie Mac (private corporations but regulated by the government). Those loans over that amount are designated "jumbo loans" and are funded by the private investment market.

FHA: Insured by (but not funded by) the Federal Housing Administration (FHA) a division of the U.S. Department of Housing and Urban Development (HUD), and designed for, in general, low- and middle-income borrowers and many first-time buyers. There are, however, limits (which vary from county to county) to the maximum loan amount. On January 1, 2000 HUD began insuring home mortgage loans of up to $1,210,296 in communities where housing costs are relatively low, and loans ranging up to $2,190,849 in communities where housing costs are relatively high. FHA loans have somewhat more relaxed qualifying standards and ratios than conventional loans and have the availability of both 15 and 30 year fixed as well as 1 year adjustable mortgages.

VA: For those qualified by military service, the Veterans Administration (VA) insures (but does not fund) 15 and 30 year fixed as well as 1 year adjustable mortgages with lower down payment requirements (as low as 0 down) and somewhat more lenient qualifying ratios.

No-Document ("No-doc) Loans: No-doc mortgages are generally a wise choice for self-employed people, those who do not wish to verify their income, and those with a brief or blemished credit history, or no credit. The benefits of a no-doc mortgage include a shorter application process since you are not required to provide income, employment or asset documentation, as well as a streamlined approval process because there is little subsequent verification. However, no doc mortgages generally will be at slightly higher interest rates and are offered by fewer lenders.

Points or No Points

A large component of your mortgage decision has to do with one of the first charges associated with your loan--even before you make your first payment--the "points" attached to the mortgage. A point is 1% of the loan amount, paid to the lender or the mortgage broker at closing (in cash). For more information on paying (or not paying) points, see the article " Should I Pay Points? " written by Randy Johnson, author of the best-selling book on mortgages How to Save Thousands of Dollars on Your Home Mortgage.

Mortgage Comparisons

Once you have a general idea of the type of mortgage that best suits your situation, the next step is to begin to make comparisons among the lenders that are available. Weekend newspapers will often have the rates of individual local lenders posted in their Real Estate section. To get the specifics of each lender's rate and term, you can contact the bank or mortgage company directly. Another source is a mortgage broker in your area, who will often represent a number of sources of mortgage funds and can assist you in your choice.

 

Mortgage Hints

Don't build yourself a mortgage mountain. It's fine to want the best home you can afford, but be certain that it is comfortable affordability. Although you may find certain mortgage lenders who will stretch your qualification ratios (the ratio of your total mortgage payment to your total income), the traditional ratios--the mortgage payment as 28% of your income and the total of your mortgage payment plus your monthly debt payments as 36% of your income--are good basic guidelines.

Get your budget under control. Spending some time reviewing your budget (or developing one if you don't already have it) and sharpening your money saving skills can bring big rewards later. A coordinated budget allows you to get the most home for your money without strapping yourself while eliminating wasteful spending.

Prepare to pay off small debts. Having 3 credit card balances, for example, one with a $125 balance, a second with a $165 balance and a third with $275 balance will only cloud the picture. Even though the total is only $565, all 3 will have minimum payments, credit lines, etc. If possible, prepare to pay them down to $0 balances.

Begin to gather documentation. It is not necessary that you have all items on hand before you apply, but there are a number of documents you will need eventually and the approval process will go much smoother if you begin to gather them now. Examples: W-2's and income tax returns from the last few years (especially if you are self-employed), copies of pay stubs, a copy of your credit report (you can get a free copy of your credit report here ), records of any child support or alimony (either going out or coming in) and bank statements for all accounts (checking and saving) for the last several months.

Don't forget about closing costs. In addition to your downpayment, you will need to reserve funds for closing costs. Depending on the type of loan and your location, these costs can range from 2-5% of the mortgage amount, will be paid in cash at the closing and cannot be borrowed funds.

Compare. There are lots of sources for mortgage funds--be sure to make comparisons. Your local bank or credit union, mortgage brokers and Internet resources such as LendingTree --where you can get up to 4 offers from lenders competing for your business--are all available. Be certain to compare equal terms, downpayments and loan types.

Consider points when comparing . Your total mortgage cost will be determined by 3 factors: The interest rate, the term and the amount of points.

Get educated! Securing a mortgage is not all that complicated, but if you approach it blind, mistakes can be very expensive! Get as much information as you possibly can...whether from friends or relatives that have secured mortgages recently, from books and articles from authors such as Randy Johnson or from online resources MortgageLoanTips.com where you can get an hour and a half seminar, an accompanying manual plus 4 additional bonuses--all available immediately online.

Consider a 15 or 20 year term.

Many home buyers make the assumption that a shorter term will boost their payments out of reach. Unless you make the comparison, though, you may never know if a 15 or 20 year (if available) term could have been affordable. If you are concerned about committing to the higher payment of a shorter term, try this tactic: Mortgage the home with a 30 year loan but have the lender develop a 15 and a 30 year amortization sheet for you. Then, do your best to pay the mortgage at the shorter term payment. It will do wonders for your equity position!

Adjustable Rate Mortgages (ARMs). If you are certain that you are going to be in the house for a short time (less than 5 years for example) strongly consider an Adjustable Rate Mortgage (ARM). You will take full advantage of the lower intital rate and not be as concerned about rate increases since you will have moved when they begin to take effect. Tailor your ARM's first adjustment period to the time you will be in the house.

Major Mortgage Mistakes

Just as there is no neighborhood that is right for everyone and no single home that is perfect for every buyer, there is no one mortgage that will be the best for each and every home buyer. Each buyer's situation will be, to some degree, unique, and thus their mortgage needs will vary. This does not mean, though, that the mortgage selection process is an easy one. There are a number of situations where mistakes and errors can--and frequently do--occur. Mistakes made in the mortgage process can cause everything from minor annoyances up to, and including, financial disaster, so the potential for these mistakes should be taken very seriously.

To avoid mortgage mistakes, the very first thing that any home buyer must do is to clearly establish the attitude that they--and only they--will be responsible for the payment of the mortgage. Not the lender, not the Real Estate Agent, not friends or relatives. Therefore, any and all decisions should be first and foremost personal ones, and secondly, rooted in common sense.

Are many home buyers currently making major mortgage mistakes? We think the evidence is fairly clear, that many are, in fact, making mistakes as evidenced by the fact that last year saw the highest level of home foreclosures in history. (Higher than in much deeper and longer recessions, higher than in periods of much higher unemployment). We see this as absolute proof that many home buyers are making big errors as they examine and choose mortgages.

MISTAKE #1: Choosing the Wrong Mortgage

It is easy to make an error here, if only because there is such a vast selection of mortgage plans from which to choose. Common sense, though, should prevail here. For example, choosing a 30-year mortgage when you plan to retire (and move) in 10 years. Securing a fixed-rate mortgage with high closing costs when you are going to be transferred in 2 1/2 years is another example. Another mistake (potentially a budget-busting one) would be to select an adjustable-rate loan (especially in this historically low interest rate environment) when you don't expect your income to take a large jump in the future. Or,perhaps, the biggest "wrong mortgage" of all--getting a large mortgage when you know that 1 of the 2 incomes needed to support it will be going away in the future.

The key to selecting the right mortgage is to find the loan that fits your personal budget and situation, rather than trying--or worse, hoping--to have your budget and situation magically conform to the mortgage. The road to financial ruin is littered with examples of buyers who did not do the research necessary to ensure that they selected a mortgage that was a good fit. Take your time, analyze your situation, get several opinions and use your common sense.

MISTAKE # 2: Letting Qualifying Ratios Get Out of Hand

"The old rules don't apply anymore." We've heard these words so often that it is about to make us crazy. We heard them during the stock market run-up of the 1990s, when stock prices had no connection with reality. We heard the words in 1999 and 2000, when businesses that had no reason for existing drew accolades and admiration from the business press and the American public. Strange that it now looks as though the old rules--like proper valuation and smart business plans--DO apply.

Now we are hearing the same kind of nonsense when people speak about mortgage qualifying. "Oh, that's the way they USED to do it, but things are a lot different now. Mortgage lenders are much more flexible on how much you can afford."

True. But there are many homebuyers in very serious financial trouble now, so who was right? For years, you qualified for a mortgage based on some fairly well established ratios. Your total mortgage payment (including principal, interest,taxes and all insurances) should not total more than around 28% of your monthly gross income. Your total debt load, including the mortgage payment,as well as all other debts (car loans, personal loans, credit card payments and any other loans) should be no more than 36% of your total monthly gross income.

Many mortgage lenders have thrown those old ratios out the window, approving household debt ratios in excess of 50% of income. Let's be clear here: If over 50% of your income is going to debt service you will be forced to either live a very shallow life with little or no funds for saving, investment or enjoyment, or, worse, are headed for a financial disaster.

Want the financial aspect of your home owning experience to be as stress-free as possible?Do your best to adhere to the 28% and 36% ratios.

MISTAKE #3: Not Enough Downpayment

Want to really compound mistakes 1 and 2? Get the wrong mortgage (#1), have too heavy a debt load (#2) AND put little or nothing down. Not too long ago, a 20% downpayment was fairly normal when purchasing a home. In the last decade the average downpayment fell to 10% and recently, to even less. This has been a boon for home buyers, especially those purchasing their first home, but these lower (and, at times, nonexistent) downpayments carry with them some real potential downfalls.

As long as real estate values appreciate at the supercharged levels that have in the last couple of years (and virtually NO one thinks they will) there should be no problem for those buyers who have little or no downpayment should they want (or need) to sell.
Should housing values stagnate, though, or worse,go down, these buyers will not be able to sell their homes without paying for commissions, selling expenses and the like out of their own pocket. These expenses can total upwards of $50,000 on a $1,500,000 home for example. Still owe around $150,000? Those $10,000 in expenses will need to come out of your pocket.

 

Summing Up

How do you avoid these potential costly and/or disastrous mistakes? By preparing yourself as best you can for the mortgage lending process.

1) Carefully research the types of mortgages available in your area.
2) Spend the time necessary to take a clear look at your income, budget and future plans.
3) Tailor your mortgage decision to these factors, rather than just accepting a loan that the lender offers, even if it may not suit your situation.