The mortgage may be defined as an ‘instrument of debt’ that is secured by a collateral and that the borrower is obliged to pay within a designated period of time with a predetermined set of payments.
Mortgages are used by businesses and individuals alike to purchase real estate without having to pay the amount at a time. Throughout a period spanning many years, the borrower pays a monthly amount that includes the interest and the principal until the property is cleared fully and the title of the property is then transferred to its rightful owner. The mortgage is an important part of anyone who is looking forward to buying a house. Mortgages are generally designed to last a number of years depending upon the rate and the amount taken.
In a residential mortgage, the buyer of the home pledges the house to the bank; the bank has the rightful claim to the house unless and until the borrower pays out the mortgage in which case the title of the owner shifts from the bank to the borrower.
The interest compounds monthly and initially the money paid is used to balance the interest, very less of the money paid actually covers the principal. As the time goes on, the payment reduces slowly and more amount gets diverted towards
Maximum amount borrowable-
The maximum amount that can be borrowed depends on a wide variety of factors. Most lenders will settle for around 10 to 20% of the price of the house as down payment. The rest 90 to 80% of the amount of the house will be financed by the mortgage. Many lenders do not want the borrower to pay the mortgage until retirement and therefore they calculate the approximate age the borrower will entire retirement and set the period of years accordingly.
Steps that need to be taken-
- Application– Fill out a 1003 Mortgage application. The loan officer looks at the character of the applicant, his willingness to pay the loan, his capacity and ability to do the same and lastly, the collateral for the loan is Collateral is the security against which the loan is provided to the individual.
- Credit Report-The loan officer runs the credit report with the three major credit bureaus- Equifax, Experian and Trans Union. The officer uses the middle score for deciding and discards the high and low scores.
- Loan Program– The loan officer helps the borrower decide the suitable loan program for him/her by going through all other loan programs and finding the best suitable one for the borrower. Some programs are- Federal Housing Administration, Conventional programs, Veterans Affairs, US Department of Agriculture, Jumbo Loans etc.
- Documentation- The borrower needs to provide identification, bank statements, W2s, Paychecks, Tax Returns and more depending upon the loan asked for.
- Processing- Processers will verify that the documents provided are authentic and ready to be sent to the next level.
- Underwriting- Underwriters verify if the loan meets all the loan program guidelines and might ask for additional documents if needed.
- Approval and setting of a closing date- All things checked, the loan is taken forward and processed accordingly. The borrower buys his/her dream house and the loan process starts.
- Closing day- The closing day is fixed at an attorney’s office or a title company. The borrower signs the closing documents that include the buyers promise to pay the loan back and the deed of trust which confirms that if by any chance the buyer does not pay back the loan, the lender can foreclose the agreement.
Difference between Fixed and Variable Rates during the loan period
A fixed rate mortgage as the name suggests charges a fixed rate of interest that does not change throughout the life period of the loan. In this case, although the principle and the interest may change from time to time, payment to payment but the total payment remains unchanged which helps the borrower budget his expenses accordingly.
The borrower remains protected from the sudden increase in spikes in rates thus increasing the amount payable. A fixed interest rate ensures that the borrower pays the fixed sum every month.
Before delving into variable mortgage rates, some knowledge of basic terminology is important.
- Adjustment Frequency– The amount of time between interest-rate adjustments.
- Adjustment Indexes– The interest rate in case of the variable rate of mortgages is tied to a benchmark. This may be the interest rate on a type of assets, such as certifications, treasury bills or deposits. It can also be the rate.
- Ceiling– The highest rate that the variable interest rate is permitted to touch during the total time period of the loan.
A variable rate mortgage is the type of mortgage that charges a variable interest throughout the course of the loan. The advantage of variable mortgage is that for the first three to seven years, the total amount payable is less compared to fixed mortgage rate. The variable mortgage seems attractive also because of the fact that their low initial payments enable the borrower to become qualified for a larger loan and coupled with the fewer interest rates at the beginning the amount does not pose any financial threat on the borrower immediately. However, the rate of interest varies largely throughout the course of the loan and for borrowers taking the large loan; the monthly payments may pose a threat later in the loan’s period.
The borrower must decide carefully what kind of mortgage rates he should opt for- the fixed or the variable.
Various types of loans
- Government Insured and Conventional Loans– A government insured home loan include loans such as FHA or VA which are guaranteed by the federal government.
- FHA (Federal Housing Administration) mortgage insurance program is managed by the Department of housing and development (HUD). It is a department of the federal government. FHA loans are available to everyone. Although the down payment gets reduced and the borrower has to pay as low as 3.5% but the borrower has to also pay the mortgage insurance which increases the overall size of monthly payments.
- VA Loans are the loans offered by the US Department of Veterans Affairs to military service personnel. These loans are also guaranteed by the US Federal Government. The VA reimburses the lender for loses resulting from the borrower’s fault. There is no down payment involved and the borrower can get 100% mortgage.
- USDA/RHS Loans are offered by the United States Department of Agriculture for borrowers who meet certain income requirements. The program is managed by the RHS (Rural Housing Service). This type of loan is offered only to rural residents having either low, medium or high income.
- Jumbo and Conforming loans– Based on the size of the loan asked by the borrower they can be classified into Jumbo and Conventional loans.
- A conforming loan is the type of loan that meets the underwriting guidelines of two government-controlled corporations, Fannie Mae and Freddie Mac. These corporations sell mortgage-based securities (MBS). It means that the loan from lenders who generate and sell the same to investors through Wall Street. This allows the lenders to help the next person in line without having to wait for 30 odd years to collect the loan amount and the principal.
- A jumbo loan represents a higher risk from the lender due to its sheer size. Jumbo loan borrowers need to have excellent credit scores and must be willing to pay larger monthly installments as well as down payments when compared to conforming loans. The interest rates associated with jumbo loans are higher too.
Mortgage broker and why they are important
A mortgage broker is a middleman who connects the borrower to the lender. Lenders can help get deals for the lender by approaching prospective borrowers for a mortgage. Mortgage brokers may not necessarily work for a bank; there are private lenders who perform the same function. In countries like the UK, USA, New Zealand, Australia the mortgage brokers are the biggest sellers of mortgage products on behalf of their respective lenders.
A mortgage broker has to be typically registered with the state where they work for their respective lenders.
Advantages of using a mortgage broker includes-
- The broker will work on behalf of the borrower to find the most suitable loan that suits the borrower with low mortgage rates
- The borrower saves his time and also money by the end of the term of mortgage
- The broker is not paid unless the loan is passed out and this encourages the broker to work on a personal level with the borrower and try to solve their problems out
- The borrower can compare various loan schemes with the broker and choose the best that best suits the borrower
Disadvantages of using a broker includes-
- The broker’s interest might not line up with the borrower’s interest all the time.
- The borrower may think that he/she is getting the best deal from the broker but in reality, it may not be the case.
- Some lenders may not work with mortgage brokers at all.
Brokers may help borrowers find the ideal mortgage but one should always evaluate the pros and cons of the situation before going ahead with it.
Differences between a loan officer and a mortgage broker
A mortgage broker is a bridge between the buyer (borrower) and the lender (various banks/individuals/other financial organizations) while on the other hand, a loan officer works directly for a particular lender. The loan officer is a salaried employee of that particular organization or company.
A mortgage broker is registered within the state where he can perform whereas a loan officer is an employee of the umbrella institution of that lending company.
Typically, a mortgage broker will make more money than a loan officer but the loan officer, on the other hand, can make use of referral network to accumulate more loans than the broker.
It is beneficial to use a mortgage calculator while choosing the type of mortgage that suits the borrower. Mortgage calculators are automated tools that enable the borrowers to determine the type of mortgage best suitable for them. It calculates the amount payable per month, the amount payable per year, number of years of the mortgage with the given interest rate, and a variety of other factors.
The variable used in the calculationinclude loan principal, balance, number of payments, periodic compound interest, regular payment amount and the total number of payments. There are various online mortgage calculators available today but it is best to use the lenders calculator if there is one, so that the calculation is accurate based on the type of organization/individual giving the loan.