Back to the Basics: Mortgage Shopping 101 with Mortgage Country
This post was written in collaboration with our partner, Kristen Katz at Mortgage Country. Kristen is the mortgage expert I turn to when one of my clients is looking for a home purchase.
Imagine you finally find your dream home in the perfect location near great schools and amenities. You picture yourself doing yardwork, talking to friendly neighbors, and having family over for the holidays. Then you quickly realize this is a massive financial decision and could be the biggest purchase of your life, and all that dreaming can quickly turn to worrying.
The home buying process can feel overwhelming, even for seasoned industry experts. We hope you can use this as a guide to feel more comfortable while shopping for a mortgage to purchase your dream home.
Must-know terms to know when shopping for a mortgage:
Loan-to-value (LTV)
is a financial ratio that compares the amount of a loan to the appraised value or purchase price of the asset being financed. LTV is commonly used in mortgage lending to assess the risk of the loan and to determine the amount of equity the borrower has in the property.
LTV is calculated by dividing the loan amount by the appraised value or purchase price of the property (whichever is lower). For example, if you're buying a home for $300,000, making a down payment of $60,000 and taking out a mortgage loan of $240,000 the LTV ratio would be 80% ($240,000 divided by $300,000).
Typically loans with lower LTVs are deemed less risky and therefore have more favorable (lower) interest rates.
Closing costs
are the fees and expenses associated with buying or selling a home or property. These costs are paid at the time of closing and can include a variety of fees, such as loan origination charges, title insurance, appraisals, home inspections, attorney fees, recordings, escrow, property taxes and homeowners’ insurance prorations, transfer taxes, and others.
The total amount of closing costs can vary depending on the location of the property, the type of mortgage you're getting, and the purchase price of the property. In general, closing costs can range from 2% to 5% of the total purchase price of the property. It is important to carefully review and understand the closing costs associated with a real estate transaction before closing, as they can add a significant amount to the funds due at closing.
Origination fees
are intended to cover the cost of processing and underwriting a loan application, including the lender's time and resources, administrative costs, and other expenses associated with loan origination. These fees are usually paid upfront at closing, along with other closing costs.
Origination fees can be a significant cost for borrowers, particularly when taking out a large loan. However, some lenders may be willing to negotiate or waive origination fees, depending on the borrower's creditworthiness and other factors.
Origination fees can be a significant cost for borrowers, particularly when taking out a large loan. However, some lenders may be willing to negotiate or waive a portion of the origination fees, depending on the borrower's creditworthiness and other factors.
Discount points
are fees paid upfront to a lender at the time of closing in exchange for a lower interest rate on a mortgage loan. Each discount point typically costs 1% of the total loan amount and can lower the interest rate by a certain amount, usually 0.25% per point.
For example, if you're getting a $200,000 mortgage and decide to buy two discount points at a cost of $4,000, you would pay an additional $4,000 at closing, but your interest rate might be reduced from 4.5% to 4.0%, which could save you money on interest over the life of the loan.
Discount points can be a good option if you plan to keep your mortgage for a long time and want to save money on interest payments over the life of the loan. They can also be expensive upfront, however, and may not be worth it if you don't plan to stay in the home for very long.
Debt-to-income (DTI)
ratio is a financial measure that compares the amount of debt you have to your overall income. It's calculated by dividing your total monthly debt payments by your gross monthly income. Lenders use this ratio to assess your ability to manage additional debt and make loan payments on time.
For example, if your total monthly debt payments, including your mortgage or rent, car loan, credit card bills, and other debts, add up to $1,500, and your gross monthly income is $5,000, your DTI ratio would be 30% ($1,500 divided by $5,000).
50% is typically the maximum DTI threshold for conforming. government-backed loans, however the exact threshold can vary based on specific loan programs. If your DTI ratio is too high, it can indicate that you may have difficulty making loan payments on time, which could make you a riskier borrower.
Adjustable-rate mortgage (ARM)
is a type of mortgage loan in which the interest rate varies over time based on an index. The interest rate for an ARM is typically fixed for an initial period, such as 5, 7, or 10 years, after which it adjusts annually or monthly based on the index and predetermined margin.
ARMs are attractive to borrowers because they often offer lower initial interest rates than fixed-rate mortgages, which can result in lower monthly payments. However, the interest rate on an ARM can adjust upward or downward over time, which can result in higher or lower monthly payments. This makes ARMs more risky than fixed-rate mortgages, as borrowers may not be able to afford the higher payments if interest rates rise significantly. It's important for borrowers to carefully consider the risks and benefits of an ARM before deciding to take out this type of loan.
Amortization
is the process of paying off a debt over time through a series of regular payments. When you make an amortized payment, a portion of the payment goes toward the interest charged on the outstanding balance, while the remainder goes toward reducing the principal balance. As the principal balance is reduced, the amount of interest charged on the remaining balance decreases, resulting in a gradual decrease in the amount of each payment that goes toward interest and an increase in the amount that goes toward principal.
The amortization process helps borrowers pay off their debt over time and provides a predictable schedule of payments that can help with budgeting and financial planning. It also helps lenders manage risk by ensuring that the principal and interest are paid back over a set period of time.
APR
stands for Annual Percentage Rate, and it is a measure of the annual cost of borrowing money, including certain fees and interest charges associated with the loan. The APR includes not only the interest rate charged on the loan but also any additional fees and charges, such as origination fees, closing costs, and mortgage insurance premiums, over the life of the loan.
The APR provides a useful tool for comparing the cost of different loan offers, as it takes into account all of the fees and charges associated with the loan. However, it's important to note that the APR is not the same as the actual interest rate (note rate) charged on the loan, and the actual cost of borrowing may be higher or lower than the APR, depending on factors such as the term of the loan, the borrower's credit score, and other factors.
Private Mortgage Insurance(PMI)
is a type of insurance that borrowers are required to pay when they make a down payment of less than 20% on a conventional mortgage loan. PMI is designed to protect the lender in case the borrower defaults on the loan, and it provides a guarantee that the lender will be paid a certain amount in the event of a foreclosure.
PMI is typically required for the first several years of the loan, until the loan-to-value ratio reaches 80% or less. Once the loan-to-value ratio falls below 80%, the borrower may be able to request that the PMI be removed from their loan.
The cost of PMI varies depending on the size of the down payment, the loan amount, and the borrower's credit score. Typically, the cost of PMI is calculated as a percentage of the loan amount which is added to the monthly mortgage payment.
Mortgage underwriting
is the process by which a lender evaluates a borrower's creditworthiness and ability to repay a mortgage loan. The underwriter is responsible for assessing the borrower's credit history, income, assets, debts, and other factors to determine if they meet the lender's guidelines for approving a loan.
During the underwriting process, the lender may request documentation from the borrower, such as bank statements, pay stubs, tax returns, and other financial records. The underwriter may also order an appraisal of the property to ensure that the loan amount is appropriate for the value of the property.
The underwriter's job is to evaluate the borrower's financial situation and assess the risk associated with lending them money. The underwriter will consider factors such as the borrower's credit score, debt-to-income ratio, employment history, and assets when making a decision about whether to approve the loan. Ask your lender: What documents will I need to provide to apply for the mortgage?
Once the underwriter has completed their evaluation, they will make a recommendation to the lender about whether to approve the loan and under what terms.
How much house can I afford?
Determining how much you can spend on a house depends on several factors, including your income, expenses, credit score, and debt-to-income ratio. A general rule of thumb is that your total housing expenses (including mortgage principal and interest, property taxes, and insurance) should not exceed 28% of your gross monthly income. Additionally, your total debt-to-income ratio (including housing expenses, credit card payments, car payments, and other debt) should be no more than 36% of your gross monthly income.
However, it's important to note that these are just general guidelines, and your specific financial situation may allow you to spend more or less on a house. You should also consider other factors, such as your down payment amount, the interest rate on your mortgage, and any potential future expenses, such as home repairs or renovations.
What to consider when shopping for a mortgage.
When shopping for a mortgage, there are several important factors to consider. Here are a few key things to keep in mind:
Interest rates: The interest rate is one of the most important factors to consider when shopping for a mortgage. This is because it will affect your monthly mortgage payment, as well as the overall cost of the loan over time. Be sure to compare rates from trusted lenders to find the best deal.
Ask your lender: What are the current interest rates and terms available?
Loan terms: The term of the loan refers to the length of time you have to pay off the mortgage. Common mortgage terms are 15, 20, or 30 years. Be sure to consider the term of the loan when shopping for a mortgage, as it will affect your monthly payments and overall cost.
Down payment requirements: Different programs may require different down payment amounts. Be sure to compare programs and their down payment requirements to find a program that offers terms that work for you.
Ask your lender: What are the down payment requirements?
Fees: Mortgage lenders may charge various fees, including origination fees, appraisal fees, and closing costs. Be sure to compare fees from different lenders to get an accurate picture of the overall cost of the loan. Mortgage Country prides itself on having low fees. They offer mortgage lender services for a flat $495. This is a great way to save money during the overall process.
Ask your lender: What fees are associated with the mortgage?
Mortgage product: There are many different types of mortgages, including fixed-rate mortgages, adjustable-rate mortgages, FHA loans, Jumbo, and VA loans. Be sure to consider which type of mortgage is best for you based on your financial situation and goals.
Ask your lender: What type of mortgage is best for me based on my financial situation and goals?
Lender reputation: Finally, be sure to research the reputation of any lender you are considering. Look for reviews and ratings online and ask friends and family members for recommendations. A reputable lender will be transparent about their fees and terms, and will work with you to find the best mortgage for your needs.
Research your lender: Check your lender’s google review online.
Pro tips
Don’t let too many people run your credit. It could damage your credit score and hurt your ability borrow. Have one lender run your credit and ask other lenders to give you a rate quote based on your scenario; if you decide to move forward with them you can then authorize an additional credit pull.
When shopping for a loan, it's important to compare both the interest rate and the APR to determine the overall cost of borrowing.
Conclusion
Shopping for a mortgage can be exhausting if you aren’t prepared with the right knowledge or questions to ask. Consulting a financial professional or lender with a great reputation can make the difference between good and bad financial decisions. Do it right the first time so you can enjoy your dream home the way you had imagined.
Reach out to Kristen Katz if you want to learn more.
Fiduciary Mission
At Integritas Financial(IF), we are committed to providing fee-only, fiduciary financial planning services that are tailored to the unique needs of young professionals, particularly millennials. IF works with you to develop customized financial plans that address key areas such as estate planning, trusts and wills, retirement, workplace benefits, education funding, student debt, and buying a house.
IF believes in transparent, client-focused service that puts your financial goals at the center of everything we do. As a fiduciary firm, IF is dedicated to acting in your best interests, and we never sell products that charge commissions to clients.
IF’s goal is to help you achieve a stable and prosperous financial future by providing comprehensive financial planning services that are tailored to your individual needs. Whether you're just starting out in your career or you're already well-established, IF can help you navigate the complexities of financial planning and create a roadmap for success.