Understand your mortgage


One of the most important financial decisions in life is buying a home. Home ownership allows you to build up your home equity and deduct mortgage interest from your taxes. The value of a home could increase over time and there are intangible benefits, such as having greater control over renovations. When a person buys a home, monthly expenses tend to increase. However, owning your home can be rewarding if you make the right decisions from the beginning.

Key takeaways

  • Make sure your credit rating is the best it can be before you start shopping for a mortgage
  • Be on the lookout for the lender’s fees. Some are unavoidable and some are negotiable.
  • You may have to pay a PMI fee. If so, get rid of it as soon as possible.

Step one: polish your credit rating

Preparation is half the battle in obtaining a mortgage. The first step is to obtain your credit report and find out your FICO score, that is, if you will be considered creditworthy. Your score will be between 300 and 850.

Since 2010, the Federal Housing Administration (FHA) has required a credit score of 580 or higher to qualify for an FHA loan with a 3.5% down payment. Those with a credit score between 500 and 579 must deposit 10%, while borrowers with scores below 500 do not qualify. Other programs like Fannie Mae set a higher minimum of 620 to 640 for mortgage applicants.

What to do about it

If your score is low, strive to pay off any high-interest debt. Pay your bills on time. Do not apply for another credit card. However, do not close any credit cards that you have not used. Having credit available to you, but not using it, actually improves your credit score by increasing your credit utilization ratio. Also, check your credit report for errors or discrepancies and follow up to correct them.

Step two: find a lender

Once your credit score is where you need it, find a lender. Assuming you are a good prospect, let three or four lenders compete for your business. Don’t give every lender approval to access your credit report. Obtain a Loan estimate (formerly called the Good Faith Estimate) and review each charge. Only when you have selected a lender should you allow them to check your credit.

Mortgage points are an up-front interest charge. Avoid them if possible.

Lender fees to borrower can be very creative and negotiable. Fees like loan origination, processing fees, and underwriting fees can often be negotiated with at least 50% or can even be waived by the lender if they want your business.

Refuse to pay points

Avoid points if you can. When you pay points, you pay interest in a lump sum up front to get a lower rate on a fixed-rate mortgage. One point equals 1%. That basically increases the amount of your down payment. Points are unnecessary additional charges by the lender. Refuse to pay them or take your business elsewhere.

In some cases, it may be worth hiring a real estate attorney to identify unnecessary costs. An experienced real estate agent can tell you which costs are common and which could potentially be eliminated. For example, qualification Insurance costs in some Florida counties are the responsibility of the buyer (unless the seller agrees to bear the costs). If you’re shopping there, those costs should appear on your Loan Estimate. In either case, you don’t want big surprises when you receive the Closing Disclosure prior to closing.

Step 3: About the PMI

Most lenders charge private mortgage insurance (PMI) if you make a down payment of less than 20% on your home. This insurance protects the lender, not you, in the event of a loan default. PMI may be unavoidable if you cannot reach the 20% threshold. If you are applying for a $ 200,000 loan with a 10 percent down payment, you can expect to pay at least $ 100 per month for the PMI payment. It is not unusual to see PMI payments in the range of $ 150 to $ 200 per month.

Drop it

However, you should know that when you reach a certain percentage of equity in your home, usually 20%, you can cancel the PMI. And you will want to. Over 30 years, a monthly PMI payment of $ 150 can add up to more than $ 54,000. Lenders will not remind you that you can cancel the additional payment.

Avoiding the PMI

Let’s say you are looking for a $ 200,000 home and you have $ 10,000 for a down payment. Most lenders will require a PMI payment if you do not pay at least $ 40,000, excluding loan fees. For many first-time home buyers, a $ 40,000 down payment is out of the question.

However, you can try to “piggyback” your loans so that two lenders participate in the loan. This might look like an 80-15-5 plan: you finance 80% on a primary mortgage, 15% on a second mortgage or home equity loan, and 5% as a down payment. By using the home equity loan plus your down payment, you can leverage that amount against the purchase price of your home and cover the 20% down payment requirement, thus avoiding the PMI.

Your home equity or second loan will likely have a variable rate or a higher rate than your primary mortgage, so you’ll need to keep an eye on this loan and try to pay it off first. Interest on home equity loans is also federal tax deductible if the loan was used to purchase, build, or substantially improve a taxpayer’s home. However, a married couple is limited to deducting interest of up to $ 750,000 on total mortgage debt.

Loan types

The 30-year fixed rate loan is still the most common home loan. Most homeowners prefer this type of loan because their monthly payments will remain stable over the years.

A 15-year fixed loan is becoming more popular because it shortens the time horizon of the loan, which lowers the amount of interest paid over the life of the loan. These short-term loans tend to have a higher interest rate because the lender is giving up the opportunity to earn money, especially if the interest rate is increasing.

An adjustable rate mortgage (ARM) offers a low interest rate for a set period of time. The interest rate can then be adjusted annually or they can be listed as “3-1”, “5-1” or “7-1”. With a “7-1” adjustable rate loan, the loan amount will be fixed for the first seven years, then will adjust beginning in the eighth year based on current market conditions. They are generally based on the one-year Treasury index.

How ARMs Work

Initially, ARM interest rates can be one to three percentage points lower than a conventional fixed mortgage. Whether an ARM is right for you often depends on how long you plan to stay in the home. In the “7-1” case, if you only plan to stay in the house for seven years, this may be the perfect loan for you. However, if you plan to stay in the home longer and interest rates start to rise, your monthly costs can increase significantly.

It’s worth going the extra mile to review your Closing Disclosure and compare it to the Loan Estimate before your new home’s closing date.If the numbers are inflated or you see new charges, contact the lender and ask them to explain or correct the errors. Buying a home is a long-term commitment, so you want to fully understand all the terms of your loan and not overlook any hidden fees.

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Mark Holland

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