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It’s no secret that securing a mortgage today is a difficult task. Unless you pay with cash, you’re going to need a mortgage if you want to buy a house. The unlikelihood of a cash purchase leaves house shoppers scrambling to find a lender.
There are a number of people you can hire that will attempt to find you a mortgage. Mortgage brokers make up the majority of lenders, more than half, in fact. A mortgage broker acts as an agent between a lender and borrower. Different brokers have different lending contacts, so be sure to do your homework on who you’re hiring. Mortgage bankers, on the other hand, work for a bank and offer bank loans.
JPMorgan Chase and Wells Fargo are well-known examples of commercial banks. Mortgage lending is not their main business yet they often provide competitive rates and sometimes even discounts to members. Credit unions offer mortgages as well and most do not sell theirs on a secondary market. We will follow up with more on credit unions later in this series.
If it becomes clear that you’re not going to be granted a mortgage any time soon there’s always old Great Uncle Whatshisname. A personal loan is worth just as much as a bank loan after all. Of course, convincing Old Penny Pincher to allow you access to his mattress full of cash might prove more difficult than getting a loan from a bank.
Pre-Qualified vs. Pre-Approved
Chances are you don’t have the means to grab your large, large bags of cash, dump them on someone’s porch, and say, “Mine” every time you see a house you want. You’re going to need a mortgage.
If you are applying for a mortgage, there are two terms you’re going to have to get familiar with: Pre-Qualification and Pre-Approval.
Technically, a pre-qualification means nothing. No real estate agent is going to look at your pre-qualification letter and give you the keys to the house. A pre-qualification is simply the process of estimating your mortgage payment. It’s a valuable tool for finding out how much you can afford without committing to a credit check. It’s a way for finding out where you stand.
You can pretty much find a mortgage calculator anywhere (Here! Here! Here!).
A pre-approval, on the other hand, well, that’s a big deal. A pre-approval shows that you’re in it to win it. You want that house and your credit’s been checked and your worth has been verified. It is a formal commitment from a lender that shows the real estate agent and seller that you have the money to make a deal. It’s no bag of cash, but it’s the next best thing.
One of the most important tools for a lender in determining your mortgage is the debt-to-income ratio. The ratio breaks down how much of your income goes toward paying debts. It looks like this: X/Y.
The X number, often referred to as your front-end ratio, represents your monthly gross income that goes toward mortgage and housing costs.
The Y number, cleverly referred to as your back-end ratio, represents X plus all monthly debt requirements, including such debts as credit cards, car payments, and student loans.
Say your lender requires a debt-to-income ratio of 25/40. This means that 25 percent of your income will go towards mortgage and housing costs. All other debts are then added to demonstrate that 40 percent of your monthly income can cover all debts.
Types of Mortgages
Brandon Cornett at the Home Buying Institute breaks down mortgages into two seemingly simple questions: do you want a fixed or adjustable rate, and conventional or government-backed loan? Here’s the rundown on each, plus some of the other varieties that are out there.
ADJUSTABLE RATE (ARM)
The interest rate in these loans is prone to change, usually in the “up” direction, resulting in the inevitability of higher monthly payments. While this sounds like something no one would want, it is an especially attractive option for those who don’t see themselves living in the home for a long time. This is because the initial interest rate you’ll receive with an ARM is usually lower than that of a fixed rate loan. The interest rate’s fluctuation is tied to some kind of index, such as LIBOR, or the bond market.
The interest rate is fixed for the life of an FRM loan (almost always 15 or 30 years), ensuring a reliable monthly payment. The price of this predictability is missing out on the initial savings of an ARM, but it might be worth it if you plan on settling down for the foreseeable future, especially with today's very low interest.
This type of mortgage begins with a fixed rate for the first few years (from one to seven, but typically five) after which an adjustable rate sets in.
Conventional mortgages are not by the VA, FHA, or the Rural Housing Service and are usually offered by banks, credit unions, and savings and loans institutions. Conventionals are categorized as conforming or non-confirming, the prior being acceptable to government-sponsored enterprises such as Fannie Mae and Freddie Mac. These kinds of loan usually require at least 5% down payment; a down payment of less than 20% requires Private Mortgage Insurance (PMI). PMI translates to a percentage of your loan amount that gets added to your monthly payment
Government backed mortgages are insured by some federal agency. The loan can be made by the private sector, but still receives the insurance of the federal government.
The biggies are
-FHA Loans - insured by the Federal Housing Administration, and the most popular type of government loan. You’re required to pay less of a down payment than with a conventional loan, and there’s more leeway if you have qualification roadbumps, but you are going to pay a premium for government mortgage insurance.
-VA Loans - a program managed by the Department of Veterans Affairs, these loans are available to military servicemembers and their families. VA loans can be used to finance 100% of the home purchase
With the country's real estate crisis came a series of mortgage reforms including the way "jumbo loans" are defined and dealt with. Because so much of San Francisco real estate is usually so expensive, you should be aware of current government regulation on loan amounts for conforming and non-conforming loans.
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