Mortgage Basics

Not many people can buy a home without a mortgage. When it comes to financing your new home, there are a number of options available to fit a wide range of financial needs. Below you can read about some of the most popular today. You can also learn lots of other valuable facts about mortgages.

How Much Can You Afford?

You can save yourself a good bit of time by figuring out up front how much mortgage you can afford. As a general rule, a lender will want your monthly mortgage payment to total no more than 29% of your monthly gross income.

Your monthly mortgage payment includes the repayment of the loan (principle and interest), property taxes (state, county and city as applicable), homeowners insurance, association dues and mortgage insurance (as applicable).

Getting Prequalified or Preapproved

It's important to know how much home you can afford, especially for first-time home buyers. That means that prospective buyers should consider getting prequalified or preapproved before they begin house hunting. What's the difference between prequalification and preapproval?

Prequalification. The mortgage lender reviews your income, assets, and liabilities to determine an appropriate loan amount. With prequalification prior to beginning the home search, you'll narrow your search to those properties in your price range. This service is often provided free by mortgage lenders.

Preapproval. The mortgage lender reviews your credit and commits to a specific loan amount. Although you'll usually have to pay some basic fee for this service, the process will likely lead to increased buying power by making you ready to make an offer.

Types of Mortgages

Some of the most common mortgages available today include fixed rate, adjustable rate, and balloon.

Fixed-rate mortgage. One of the most common mortgages is the fixed rate. It lets a homeowner know exactly what the payments will be during the length of the loan, often 30 years, but sometimes 25, 20, or 15. The fixed-rate is a good choice when interest rates are low and if you expect to live in the house for at least several years. Because the interest rate never changes, the monthly principal and interest payment never changes either.

Adjustable-rate mortgage. The adjustable-rate mortgage (ARM) is geared to homeowners who want to start with relatively low monthly payments. ARMs come with interest rates that fluctuate over the life of the loan. They begin with a relatively low interest rate, then the interest rate is readjusted at agreed upon intervals, typically increasing no more than a maximum of 2% in any one year and 6% over the length of the loan.

Balloon mortgage. This type of mortgage may be a good choice for homebuyers who don't expect to own their home past the maturity date of the balloon note -- five or seven years. Monthly mortgage payments are based on a 30-year schedule, but the entire mortgage balance becomes due at the end of the five or seven year term. If you decide to stay, however, you may be able to reset your interest rate for the remainder of the mortgage period.

Source: Equifax

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Who's Handling Your Mortgage Payments

A home may be one of the most expensive purchases you will ever make. That’s why it’s important to know who is handling your payments and that your mortgage account is properly credited.

In today’s market, mortgage loans and the rights to service them often are bought and sold.

A mortgage servicer is responsible for collecting your monthly loan payments and crediting your account. A servicer also handles your escrow account, if you have one. An escrow account is a fund held by your servicer. You pay money into this fund to cover charges like property taxes and homeowners insurance. The escrow payments typically are included as part of your monthly mortgage payments.

The servicer pays your taxes and insurance as they become due during the year. If you do not have an escrow account, you are responsible for paying your taxes and insurance, and budgeting accordingly.

Within 45 days of establishing an escrow account, the servicer must give you a statement that clearly itemizes the estimated taxes, insurance, and other anticipated charges to be paid over the next 12 months, and the expected dates and totals of those payments.

The mortgage servicer also is required to give you a free annual statement that details the activity of your escrow account.

If your loan has been sold, the new servicer must notify you within 15 days after the transfer has occurred. The notice must include the name and address of the new servicer, and the date the new servicer will begin accepting your mortgage payments.

To help protect your investment, the FTC offers these tips:

• Keep records of what you’ve paid; include billing statements, canceled checks, and bank account statements.

• Review your billing statements. If you have a dispute, continue to make your mortgage payments, and challenge the servicing in writing.

• Read all notices from your mortgage servicer carefully. If the servicer asks for proof of homeowner’s insurance, send it in promptly, and keep a record that you sent it.

Source: Federal Trade Commission

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Mortgage Settlement Costs

Mortgage settlement--sometimes called mortgage closing--can be confusing. A settlement may involve several people and many documents and fees. This information will help you understand all that is involved. Although the focus of this guide is on settlements for home purchases, much of it will also be useful if you are refinancing a mortgage.

Settlement costs can be high, so it pays to shop around and negotiate with the seller, your lender, and your attorney or settlement agent. The less you have to pay in settlement costs, the more funds you will have for other things.

Different regions have different customs and practices regarding who pays for what at settlement. Buyers and sellers are free to negotiate certain fees. In slow-moving real estate markets, the seller may agree to pay points or fees for the buyer. In fast-moving markets, the buyer may have to agree to pay more costs to close the deal. Whatever you negotiate will become the sales contract. However, be careful; if some buyer's costs are shifted to the seller, it may increase the price you pay for the property.

You can reduce some settlement costs by shopping around for the services. The point is this: the more you know about the process, the better your chances are for saving money at settlement time.

Because practices vary significantly from area to area, it is difficult to provide estimates for settlement costs that fit everywhere. However, one rule of thumb for buyers is to figure that settlement costs will be about 3% of the price of your home. In some relatively high-tax areas of the country, 5% to 6% is more common

Some settlement costs, such as homeowner’s insurance, private mortgage insurance, or points, can be more expensive if your credit rating is low. Knowing your credit score can help you understand how lenders will evaluate your applications. Beginning December 2004 your lender is required to give you a copy of your credit score.

Mortgage- and Lender-Related Settlement Costs

Most people associate settlement costs with mortgage loan charges. These fees and charges vary, so it pays to shop around for the best combination of mortgage terms and settlement costs. Mortgage-related costs that may apply to your loan include the following items.

Application fee

Imposed by your lender or broker, this charge covers the initial costs of processing your loan request and checking your credit report.

Estimated cost: $75 to $300, including the cost of the credit report for each applicant

Loan origination fee

The origination fee (also called underwriting fee, administrative fee, or processing fee) is charged for the lender’s work in evaluating and preparing your mortgage loan. This fee can cover the lender’s attorney’s fees, document preparation costs, notary fees, and so forth.

Estimated cost: 1% to 1.5% of the loan amount

Points

Points are a one-time charge imposed by the lender, usually to reduce the interest rate of your loan. One point equals 1% of the loan amount. For example, 1 point on a $100,000 loan would be $1,000. In some cases--especially in refinancing--the points can be financed by adding them to the amount that you borrow. However, if you pay the points at settlement, they are deductible on your income taxes in the year they are paid (different deduction rules apply when you refinance or purchase a second home). In your purchase offer, you may want to negotiate with the seller to have the seller pay your points.

Estimated cost: 0% to 3% of the loan amount

Appraisal fee

Lenders want to be sure that the property is worth at least as much as the loan amount. This fee pays for an appraisal of the home you want to purchase or refinance. Some lenders and brokers include the appraisal fee as part of the application fee; you can ask the lender for a copy of your appraisal. If you are refinancing and you have had a recent appraisal, some lenders may waive the requirement for a new appraisal.

Estimated cost: $300 to $700

Lender-required home inspection fees

The lender may require a termite inspection and an analysis of the structural condition of the property by an engineer or consultant. In rural areas, lenders may require a septic system test and a water test to make sure the well and water system will maintain an adequate supply of water for the house (this is usually a test for quantity, not for water quality; your county health department may require a water quality test as well, but this test may be paid for outside of the settlement). Keep in mind that this inspection is for the benefit of the lender; you may want to request your own inspection to make sure the property is in good condition.

Estimated costs: $175 to $350

Prepaid interest

Your first regular mortgage payment is usually due about 6 to 8 weeks after you settle (for example, if you settle in August, your first regular payment will be due on October 1; the October payment covers the cost of borrowing the money for the month of September). Interest costs, however, start as soon as you settle. The lender will calculate how much interest you owe for the part of the month in which you settle (for example, if you settle on August 16, you would owe interest for 15 days--August 16 through 31).

Estimated cost: Depends on loan amount, interest rate, and the number of days for which interest must be paid (for example, a $120,000 loan at 6% for 15 days, about $300; a $142,500 loan at 6% for 15 days, about $356)

Private mortgage insurance (PMI)

If your down payment is less than 20% of the value of the house, the lender will usually require mortgage insurance. The insurance policy covers the lender’s risk in the event that you do not make the loan payments. Typically, you will pay a monthly premium along with each month’s mortgage payment. Your private MI can be canceled at your request, in writing, when you reach 20% equity in your home, based on your original purchase price, if your mortgage payments are current and you have a good payment history. By federal law your private MI payments will automatically stop when you acquire 22% equity in your home, based on the original appraised value of the house, as long as your mortgage payments are current.

Estimated cost: 0.5% to 1.5% of the loan amount to pre-pay for the first year

Some lenders will pay for private MI--called lender’s private mortgage insurance (LPMI)--and in turn will charge a higher interest rate. Unlike private MI that you pay, there is no automatic cancellation once you acquire 22% equity. To eliminate the LPMI, you must refinance the loan, which in turn means carefully considering market interest rates and settlement costs at the time to see if refinancing would be an advantage, rather than keeping your current mortgage.

FHA, VA, or RHS fees

The Federal Housing Administration (FHA) offers insured mortgages and the Veterans Administration (VA) and the Rural Housing Service (RHS) offer mortgage guarantees. If you are getting a mortgage insured by the FHA or guaranteed by the VA or the RHS, you will have to pay FHA mortgage insurance premiums or VA or RHS guarantee fees. As with Private MI, insurance premium payments will stop when you acquire 22% equity in your home. FHA fees are about 1.5% of the loan amount. VA guarantee fees range from 1.25% to 2% of the loan amount, depending on the size of your down payment (the higher your down payment, the lower the fee percentage). RHS fees are 1.75% of the loan amount.

Homeowner’s insurance

Your lender will require that you have a homeowner’s insurance policy (sometimes called hazard insurance) in effect at settlement. The policy protects against physical damage to the house by fire, wind, vandalism, and other causes. This insures that the lender’s investment will be secured even if the house is destroyed. If you are buying a condominium, the hazard insurance may be part of your monthly condominium fee; you may still want homeowner’s insurance for your furnishings and valuables.

Estimated cost: $300 to $1,000 (depending on the value of the home and the amount of coverage; you can estimate the cost to be about $3.50 per $1,000 of the purchase price of the home)

Flood determination fee

f your home is in a flood hazard area where federally subsidized flood insurance is available, lenders cannot make a mortgage loan for your home unless you buy flood insurance. Your lender may charge a fee to find out whether the home is in a flood hazard area.

Estimated cost: $15 to $50 (this is not the cost for the flood insurance; flood insurance, if required, would be in addition to your homeowner's insurance and may cost from $350 to $2,800 depending on location and property value)

Escrow (or reserve) funds

Some lenders require that you set aside money in an escrow (reserve) account to pay for property taxes, homeowner’s insurance, and flood insurance (if you need it). Lenders use escrow funds to ensure that these items are paid on time to protect their interest in your home. With an escrow account, money is held by the lender or the lender’s agent, who then pays the taxes and insurance bills when they are due. At settlement, you may need to provide some payment into this account, depending on when payments will be due. For example, if you are buying your home in August and property taxes are due the following January, you will need to deposit funds into your escrow account at settlement so that you have enough to pay the taxes when they become due in January. Survey costs Lenders require a survey to confirm the location of buildings and improvements on the land. Some lenders require a complete (and more costly) survey to ensure that the house and other structures are legally where you and the seller say they are.

Estimated cost: $150 to $400

Other miscellaneous settlement costs

Depending upon the location and type of property, and the extra services you or your lender request, you may also have to pay some of the following fees at settlement:

Assumption fee. If you are assuming (or taking over) an existing mortgage, the lender may charge a fee.

Estimated cost: Depends on the lender, but will range from several hundred dollars to 1% of the amount of the loan you are assuming

Expenses prorated between the seller and the buyer. In your purchase contract, you may agree to split some costs with the seller. In addition to prorated property taxes, some of these expenses may involve large amounts. For example, annual condominium fees, homeowners’ association fees, water bills, and other lump-sum service charges may be split between you and the seller to cover your respective periods of ownership for the calendar year or tax period.

Inspections. As a buyer, if you make your purchase offer contingent on the results of a home inspection--such as testing for structural damage, water quality, and radon gas emissions--you will have to pay for these inspections.

Escrow account funds. In the purchase contract, you can request that the seller set up an escrow account to cover any costs for repairs, radon mitigation, house painting, or other items. For example, if you have not had a chance to test all the appliances (for instance, if you buy in the summer, you may not test the furnace), you may request an escrow account to cover repairs if they are needed in the future. The seller may agree to split the costs with you, in which case you would need these funds at settlement.

Fees paid to find a lender. As a buyer, you may work with a mortgage broker or other third party to find a mortgage loan. For example, you may want to work with a broker to find a loan with nonstandard terms or conditions. Brokers arrange transactions rather than lending money directly; in other words, they find a lender for you. Brokers will generally contact several lenders regarding your application, but they are not obligated to find the best deal for you unless they have contracted with you to act as your agent.

Estimated cost: Depends on agreement with the broker; can range from no fee to a percentage of the loan amount.

Charges for Establishing and Transferring Ownership

Title search

The goal of a title search is to assure you and your lender that the seller is the legal owner of the property and that there are no outstanding claims or liens against the property that you are buying. The title search may be performed by a lawyer, an escrow or title company, or other specialist

Public real estate records can be spread among several local government offices, including surveyors, county courts, tax assessors, and recorders of deeds. Liens, records of deaths, divorces, court judgments, and contests over wills--all of which can affect ownership rights--must also be examined.

If real estate records are computerized, the title search can be completed fairly quickly. In some cases, however, the title search may involve visiting courthouses and examining other public records and files, which is more time-consuming.

Title insurance

Most lenders require a title insurance policy. This policy insures the lender against an error in the results of the title search. If a problem arises, the insurance covers the lender’s investment in your mortgage.

The cost of the policy (a one-time premium) is usually based on the loan amount and is often paid by the buyer. However, you may negotiate with the seller to pay all or part of the premium.

The title insurance required by the lender protects only the lender. To protect yourself against title problems, you may want to buy an “owner’s” title insurance policy. Normally the additional premium cost is based on the cost of the lender’s policy, but this premium can vary from area to area.

Some advice on keeping title insurance costs low: If the house you are buying was owned by the seller for only a few years, check with the seller’s title company. You may be able to get a “re-issue rate,” because the time between title searches was short. As well, if you are refinancing, you may be able to get a “re-issue rate” on your title insurance. The premium is likely to be lower than the regular rate for a new policy. If no claims have been made against the title since the previous title search was done, the insurer may consider the property to be a lower insurance risk.

Usually you will have to buy title insurance from a company acceptable to your lender. However, you can still shop around for the best premium rates (which can vary depending on how much competition there is in a market area). If you decide to buy an “owner’s title policy,” look for one with as few exclusions from coverage as possible. Exclusions are listed in each policy, and if a policy has many exclusions--that is, situations under which the insurer will not pay for your title problems--you may end up with little coverage. The estimated cost of title services and title insurance varies by state. For example, a lender’s policy on a $100,000 loan can range from $175 in one state to $900 in another. In some states, the price can even vary by county.

Settlement companies and others conducting the settlement

Settlements are conducted by title insurance companies, real estate brokers, lending institutions, escrow companies, or attorneys. In most cases, the settlement agent is providing a service to the lender, and you may be required to pay for these services. You can also hire your own attorney to represent you at all stages of the transaction, including settlement.

You may be involved in some of the closing activities and not in others, depending on local practices and on the professionals with whom you are working. In some regions, all the people involved in the sale--the buyer; the seller; the lender; the real estate agents; attorneys for the buyer, seller, and lender; and representatives from the title firm--may meet to sign forms and transfer funds. In other regions, settlement is handled by a title or escrow firm that collects all the funding, paperwork, and signatures and makes the necessary disbursements. The firm delivers the check to the seller and the house keys to you.

Costs for settlement services vary widely, depending on the professional services involved. Regardless of the way settlement is handled in your region, shop around and ask for information on all services provided and all fees charged.

“All-in-One” Pricing of Settlement Costs

Some lenders have bundled most of their settlement costs into a single price. Generally, they combine the following fees:

application
origination
underwriting and processing
points
pest inspection
appraisal
credit reports
lender’s attorney
flood certification
title search and title insurance
recording
and fees for other tax services

This all-in-one price, however, does not include all of the fees needed at settlement. You will also need funds for the following:

prepaid interest (based on the day of the month you settle)
mortgage and transfer taxes (determined by your state or local taxing agency)
private mortgage insurance (if needed)
homeowner's (hazard) insurance
flood insurance (if needed)
and reserve (or escrow) funds for property taxes and homeowner's insurance.

Source: The Federal Reserve Board

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Glossary of Mortgage Terms

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Reverse Morgages

Whether seeking money to finance a home improvement, pay off a current mortgage, supplement their retirement income, or pay for healthcare expenses, many older Americans are turning to “reverse” mortgages. They allow older homeowners to convert part of the equity in their homes into cash without having to sell their homes or take on additional monthly bills.

In a “regular” mortgage, you make monthly payments to the lender. But in a “reverse” mortgage, you receive money from the lender and generally don’t have to pay it back for as long as you live in your home. Instead, the loan must be repaid when you die, sell your home, or no longer live there as your principal residence. Reverse mortgages can help homeowners who are house-rich but cash-poor stay in their homes and still meet their financial obligations.

To qualify for most reverse mortgages, you must be at least 62 and live in your home. The proceeds of a reverse mortgage (without other features, like an annuity) are generally tax-free, and many reverse mortgages have no income restrictions.

Three Types of Reverse Mortgages

According to the Federal Trade Commission, there are three basic types of reverse mortgage are: single-purpose reverse mortgages, which are offered by some state and local government agencies and nonprofit organizations; federally-insured reverse mortgages, which are known as Home Equity Conversion Mortgages (HECMs), and are backed by the U. S. Department of Housing and Urban Development (HUD); and proprietary reverse mortgages, which are private loans that are backed by the companies that develop them.

Single-purpose reverse mortgages generally have very low costs. But they are not available everywhere, and they only can be used for one purpose specified by the government or nonprofit lender, for example, to pay for home repairs, improvements, or property taxes. In most cases, you can qualify for these loans only if your income is low or moderate.

HECMs and proprietary reverse mortgages tend to be more costly than other home loans. The up-front costs can be high, so they are generally most expensive if you stay in your home for just a short time. They are widely available, have no income or medical requirements, and can be used for any purpose.

Before applying for a HECM, you must meet with a counselor from an independent government-approved housing counseling agency. The counselor must explain the loan’s costs, financial implications, and alternatives. For example, counselors should tell you about government or nonprofit programs for which you may qualify, and any single-purpose or proprietary reverse mortgages available in your area.

The amount of money you can borrow with a HECM or proprietary reverse mortgage depends on several factors, including your age, the type of reverse mortgage you select, the appraised value of your home, current interest rates, and where you live. In general, the older you are, the more valuable your home, and the less you owe on it, the more money you can get.

The HECM gives you choices in how the loan is paid to you. You can select fixed monthly cash advances for a specific period or for as long as you live in your home. Or you can opt for a line of credit, which allows you to draw on the loan proceeds at any time in amounts that you choose.You also can get a combination of monthly payments plus a line of credit.

HECMs generally provide larger loan advances at a lower total cost compared with proprietary loans. But owners of higher-valued homes may get bigger loan advances from a proprietary reverse mortgage. That is, if you have a higher appraised value without a large mortgage, then you may likely qualify for greater funds. Location (for example, your neighborhood) is only one part of the determination of appraised value.

Loan Features

Reverse mortgage loan advances are not taxable, and generally do not affect Social Security or Medicare benefits. You retain the title to your home and do not have to make monthly repayments. The loan must be repaid when the last surviving borrower dies, sells the home, or no longer lives in the home as a principal residence. In the HECM program, a borrower can live in a nursing home or other medical facility for up to 12 months before the loan becomes due and payable.

Reverse Mortgage Safeguards

The federal Truth in Lending Act (TILA) is one of the best protections you have with a reverse mortgage. TILA requires lenders to disclose the costs and terms of reverse mortgages. This includes the Annual Percentage Rate (APR) and payment terms. If you choose a credit line as your loan advance, lenders also must tell you of charges related to opening and using your credit account.

Source: Federal Trade Commission

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Beware of Mortgage Scams

For most people, their home is their biggest purchase, and they’ll do practically anything to protect it. Unfortunately, that’s the reason why fraud artists target homeowners with high-cost and often illegal mortgage offers.

In one common example, con artists promise to erase a bad credit history or make easy loans to people with spotty credit histories. “Most of these offers involve exorbitant fees, come with hidden terms or never provide the promised money,” said Michael Benardo, manager of the FDIC’s Financial Crimes Section.

Mortgage foreclosure fraud is on the rise, with thieves posing as lenders or housing counselors offering to “help” people at risk of losing their homes to foreclosure. More than likely, the consumer pays high upfront fees for questionable services, and in the worst cases, thieves have tricked people into signing over ownership of their homes.

How can you avoid these types of fraud? “Try to deal only with businesses and other organizations you already know or that have been recommended,” said Benardo. He added that it’s safe to assume that any offer that sounds too good to be true, especially one from a stranger or an unfamiliar company, is probably fraudulent.

Source: FDIC

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Resource Center
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Avoiding Home Equity Scams
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Private Mortgage Insurance
Fed. Reserve Bank of San Francisco

Mortgage Servicing: Making Sure Your Payments Count
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Mortgage Discrimination
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Can’t Make Your Mortgage Payment. Ask Your Lender or Loan Servicer About Restructuring or Refinancing Your Mortgage as Soon as Possible.

Home Price Calculator
OFHEO

HUD Approved Counseling Agencies

Consumer's Guide to Mortgage Settlement Costs
Federal Reserve Board

Looking for a New Mortgage or Refinance? Improve Your Credit Score in the Months Before You Apply for a Mortgage.

Military personnel and their families can find out about special loan assistance programs by checking with:
Department of Veterans Affairs and their state government.

Home Mortgage Application Checklist