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Frequently Asked Questions

What is a mortgage

What is a mortgage?

A mortgage is a loan you take out from a mortgage lender to pay for a property. If you don't pay back the loan, as per the agreement you make, then the mortgage lender can take possession of the property and sell it to repay the loan. The loan is divided into the capital (i.e. the amount of money you borrowed to buy your property) and the interest (i.e. the amount the mortgage lender charges for lending you the money).

 


How much can you borrow?

This depends on how much you earn and how much the property you want to buy is worth. Most lenders will loan up to 80% of the property's value and many will go to 90 or 95%. Some will even let you have up to 100% - but you may be forced to buy private mortgage insurance (PMI) or take out two separate loans (a first mortgage and a second mortgage).

 

***For more information see "The 4 C's of Lending" under the Useful Tools section.

 


What are low down payment options, for buyers who can't afford a 20% down payment?

Assuming you can afford (and qualify for) high monthly mortgage payments and have a high credit score, you should be able to find a low (5% to 15%) or even no down payment loan. However, you may have to pay a higher interest rate and loan fees (points) than someone making a larger down payment.

 


What is private mortgage insurance (PMI)?

Private mortgage insurance or "PMI" policies are designed to reimburse a mortgage lender up to a certain amount if you default on your loan and your house isn't worth enough to entirely repay the lender through a foreclosure sale. Most lenders require PMI on loans where the borrower makes a down payment of less than 20%. Premiums are usually paid monthly and typically cost around one-half of one percent of the mortgage loan. You can normally cancel the PMI once your equity in the house reaches 20-25%, so long as you've made timely mortgage payments.

 


Can I tap into my IRA or 401(k) plan for down payment money?

Let's start with the IRAs. Under the 1997 Taxpayer Relief Act, certain homeowners can withdraw up to $10,000 penalty free from an individual retirement account (IRA) for a down payment to purchase a principal residence (though you might have to pay income tax on the amount withdrawn). If you've got a Roth IRA, however, you must have had the account for five years to make tax-free withdrawals. This $10,000 is a lifetime limit -- and the money must be used within 120 days of the date you receive it. The law limits use of this benefit to so-called "first-time homeowners" -- but generously defines these as people who haven't owned a house for the past two years. If a couple is buying a home, both must be first-time homeowners. Ask your tax accountant for more information, or check IRS rules at www.irs.gov.

 

If you have a 401(k), you have two options. One is to do a so-called hardship withdrawal -- but, because this would subject you to taxes and a 10% penalty, we recommend you avoid this. You can also take an ordinary loan from your 401(k) plan without penalty, as long as meet certain conditions and you promise to pay it back. Ask your employer or plan administrator whether your plan allows loans. If it does, the maximum loan amount under the law is one-half of your vested balance in the plan, or $50,000, whichever is less. (If, however, you have less than $20,000 in your plan, your limit is the amount of your vested balance, but no more than $10,000.)

 


What kinds of government loans are available to homebuyers?

Several federal, state, and local government financing programs are available to homebuyers.

 

The two main federal programs are:

VA loans - U.S. Department of Veterans Affairs (VA) loans are available to men and women who are now in the military and to veterans with honorable discharges who meet specific eligibility rules, most of which relate to length of service. For more information, check the VA's Website at www.va.gov or contact a regional VA office for advice.

 

FHA loans - The Federal Housing Administration (FHA), an agency of the Department of Housing and Urban Development (HUD), insures loans made to all U.S. citizens, permanent residents, and non-citizens with work permits who meet financial qualification rules. For more information on FHA loan programs, contact a regional office of HUD or check the FHA website at www.hud.gov.

 


What's the difference between a fixed and adjustable rate mortgage?

With a fixed rate mortgage, the interest rate and the amount you pay each month remain the same over the entire mortgage term, traditionally 15 or 30 years. A number of variations are available, including five- and seven-year fixed rate loans with balloon payments at the end.

 

With an adjustable rate mortgage (ARM), the interest rate fluctuates according to the interest rates in the economy. Initial interest rates of ARMs are typically offered at a discounted ("teaser") interest rate that is lower than the rate for fixed rate mortgages. Over time, when initial discounts are filtered out, ARM rates will fluctuate as general interest rates go up and down. Different ARMs are tied to different financial indices, some of which fluctuate up or down more quickly than others. To avoid constant and drastic changes, ARMs typically regulate (cap) how much and how often the interest rate and/or payments can change in a year and over the life of the loan. A number of variations are available for adjustable rate mortgages, including hybrids that change from a fixed to an adjustable rate after a period of years, or "option ARMs" that allow you to choose, on a monthly basis, whether to pay a minimum amount, an interest-only amount, an ordinary principal plus interest amount, or an accelerated payment amount.


 

Which is better - a fixed or adjustable rate mortgage?

Since interest rates and mortgage options change often, your choice of a fixed or adjustable rate mortgage should depend on:

 


How do I find the least costly mortgage?

You can save real money if you carefully shop for a mortgage. Everything else being equal, even a one-quarter percentage point difference in interest rates can mean savings of thousands of dollars over the life of a mortgage. A popular option recently has been "interest-only" loans, which allow you to pay only the interest amount each month -- not any principal -- for the first ten years of the loan. This can lower your initial monthly payments significantly, allowing you to afford more house. Most interest-only loans are adjustable, but it's possible to find fixed rate interest-only loans too. In addition to comparing interest rates, there are many types of fees -- and fee amounts -- associated with getting a mortgage, including loan application fees, credit check fees, private mortgage insurance (if you're making a low down payment), and points.


 

What are discount points and when does it make sense to pay points for a lower interest rate?

A point equals one percent of the loan and is usually paid at closing. For example, if your loan amount is $100,000 … then one point would equal $1,000 OR one percent. Discount points are fees paid by the buyer to the lender to reduce the loan's interest rate. If you plan to keep your residence for five or more years, it may be worthwhile to pay discount points to reduce your monthly payment and achieve greater savings over the life of the mortgage. The number of discount points required to buy down your interest rate will vary based on the loan type. The more points you pay, the lower your rate of interest, and vice versa. Generally speaking, points are tax deductible when you are buying a primary residence. Consult your tax advisor for more information on tax deductibility.


 

What is the difference between pre-qualification and pre-approval?

Pre-qualification is a lender's opinion of your ability to purchase a home and is based on your verbal statement of income, employment history and available down payment.

 

Pre-approval is a lender's underwriting decision that you are conditionally qualified and is subject to the lender's review of your completed application, credit check, appraisal and home inspection.

 

When it comes to writing an offer for a home, a pre-approval letter contains stronger language to the seller and the listing agent than a pre-qualification. You, the buyer, have the increased negotiating leverage of cash buyer status because the mortgage is already in place. A pre-approval can often be a determining factor in winning the contract in a competitive bid situation. Ask you mortgage professional for a pre-approval letter before submitting your bid when purchasing a home.


 

What is the difference between APR and Interest Rate?

The APR, or Annual Percentage Rate, is often higher than the quoted interest rate, or note rate. This is because the APR includes, in addition to interest, some of the additional costs of obtaining your financing. Simply stated, if there were no costs in obtaining financing, your note rate and your APR would be the same. Your APR will be noted on your Truth-in-Lending disclosure that you receive after application.


 

What does the term “locking the interest rate” mean and when should you lock in a rate?

When a lender "locks" the interest rate, you are guaranteed a specific interest rate for a specific period of time. That period of time is called the lock period. The lock guarantees your rate as long as your loan closes and funds prior to the expiration date of your lock period. If your closing is delayed beyond your lock expiration date, you might have to pay higher market rates or pay to extend the rate lock. It is good advice to lock for a period longer than you need. In other words, lock for a period beyond your actual closing date. This will protect you against any unforeseen circumstances that could delay your closing.

 

Typical lock periods are 15, 30, 45 and 60 days. In a stable rate environment, shorter lock periods generally provide you a better interest rate. However, the market can be volatile and rates move with market activity, both up and down. If you believe rates may go up, especially by a significant amount, lock as soon as possible. If you believe rates will go down, you would definitely benefit by waiting to lock. If you believe rates will stay the same, you may also do better to wait. Of the three scenarios, you benefit from a longer lock only when rates go way up after you lock.



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