Mortgages and Refinancing & Consumers' Legal Options
Most people have to obtain a mortgage loan in order to purchase a home . A mortgage is different than other types of loans in that the borrower typically signs both a promissory note and a mortgage or trust deed. A promissory note makes the borrower personally liable so that if payments are missed, the lender can, for example, pursue wage garnishment. The mortgage places a lien on the property so that the lender can cause a foreclosure sale of the property if payments are delinquent.
Before You Apply
You may have heard that you can buy a house that costs about 2.5 times your salary, and if you earn $40,000 per year you could buy a $100,000 house. It is more complicated than that. Lenders also consider your overall debt ratio, including car loans, student loans, and credit card debt. Consider paying off some of those debts before applying for a mortgage in order to qualify for a larger loan.
Obtain your free annual credit report and “clean up” your credit rating before applying. Consider delaying your purchase long enough to save a 20 percent down payment. It is possible to obtain a mortgage with a lower down payment, but that usually means higher monthly payments. The lender may require private mortgage insurance (PMI) in such situations.
In determining how much you can afford, be aware that most lenders require monthly escrow payments to cover real estate taxes and homeowners’ insurance. Also consider homeowners’ association dues.
Lenders charge different interest rates on different loans. To make good comparisons, decide in advance which type of mortgage is best for you.
With a fixed rate mortgage, the interest rate remains the same throughout the life of the loan, which can be 30, 15, or 10 years. The 30-year option is the most popular. Shorter terms require higher payments but build equity faster. A fixed rate provides security when mortgage rates rise, and the owner may refinance if the rates go down.
Be wary of “interest only” or “negative amortization” loans.
Mortgages are typically amortized, meaning that the borrower pays interest and principal each month. As the principal is paid off, the amount of interest due is lower and more of the payment is attributed to principal, building equity in the property. Borrowers should be very cautious about “interest only” loans and especially about “negative amortization” loans in which the monthly payment does not cover all of the interest so that the debt increases to account for unpaid interest. In these situations the borrower can end up owing more money than the property is worth
Balloon mortgages last for a short term. The monthly payments are fixed and low because it is primarily interest: a large balloon payment at the end of the loan. If the borrower cannot afford the balloon payment, the loan must be refinanced or the property sold.
An adjustable rate mortgage loan (ARM) is riskier because the payment can change, but an ARM with a low starter rate can allow the borrower to qualify for a higher loan amount. The borrower needs to know how soon and how often the rate can change, whether there are caps on increases, and how the rate of increase is determined. Some ARMS have “teaser” rates for the initial period and automatically change after that, regardless of whether market rates have changed. Some have “steps” with different rates for different periods of the loan. The terms may be expressed as, for example, a 10/1 ARM with an interest rate that is fixed for the first 10 years and then can change every year. With a 5/5 ARM, the payment does not change for five years, but it changes every five years beginning at the sixth year.
Adjustable Rate Mortgage Considerations
How soon can the rate change?
How often can the rate change?
Are there caps on increases?
How is the rate of increase determined?
Consider the highest possible increase. For example, with a 30-year, $200,000 ARM, an increase in the interest rate from six to eight percent increases the monthly payment by about $262 per month. You may not have received corresponding pay increases, and home values may not have gone up.
Lenders sometimes offer options, such as paying twice monthly. Since principal is paid more frequently, the borrower may build equity faster. Such programs usually require direct debit from the borrower’s bank account.
Borrowers may secure lower monthly payments by paying discount points up front. Points, essentially prepaid interest, express a percentage. A $100,000 loan with two points requires initial payment of $2,000.
Compare closing costs and fees between lenders and negotiate if possible.
Other closing costs and fees differ among lenders. It may be possible to get the seller to pay some costs, which may include fees for your credit report, loan origination or document preparation, inspections and surveys required by the lender, attorney review, appraisal, title search and title insurance, recording the deed, underwriting, and an initial deposit into the escrow for property tax and insurance.
Closing costs can be negotiable. Lenders are required by law to give you a good faith estimate of closing costs within three days of when you apply for a loan. At closing, you will receive a HUD-1 settlement statement, which details closing costs.
When you are ready to apply, be prepared to provide detailed documentation of your income, debts, and assets. The lender may want proof of how you acquired your down payment. If you did not save it from your income or acquire it from the sale of other property, the lender may want proof that it is not an outside loan. While some lenders offer “low-doc” or “no-doc” loans that avoid some of the paperwork, these typically come with a higher monthly payment.
Paying It Off
If interest rates go down, you may want to refinance. Use an online calculator to determine whether it is worth the effort, considering the closing costs described above. Approach your current lender about refinancing with fewer closing costs, based on your history of timely payments.
When you actually pay off the mortgage, be sure to obtain a release deed from the lender. Take the deed to the county recorder of deeds. Then celebrate!