The first step in simplifying your home purchase process is finding out how much house you can, and want to, afford. This involves knowing your financial situation, determining what type of loan is the best fit, and finding your ideal lender
First Step: What Type of Loan is the Best Fit?
There are numerous loan types available. A lender will be able to discuss with you what loan instruments they have available and which one might best fit your specific need. Be aware that every lender does not have every loan instrument available to him/her and so it is best to do some comparison shopping. A brief description of the most common loan types follows:
Conventional Fixed Rate is the most popular loan type. These loans are particularly attractive for those who plan to stay in their new home for several years and have a down payment of at least 3-10%. As the name implies these loans provide the borrower the most stability with no rate changes and constant payment amount over the life of the loan. A conventional loan is typically offered with 15-year or 30-year term and is a good hedge against increasing interest rates since these loans will be unaffected. Conventional fixed rate loans are also typically “conforming” loans meaning that they meet the criteria necessary for them to be sold by your initial lender to other lenders for “servicing”, or collecting your payments. If it is important to you that your future payments and servicing are handled by the initial lender, you should ask whether they plan to service the loan themselves or may sell the loan to another servicer.
Conventional Adjustable Rate Mortgage (ARM) offer lower initial interest rates and, therefore, lower initial payments. Typically, an ARM loan will be adjustable every year or every three years and the adjustment is controlled by a predetermined “index” that will be spelled out in the loan. The index is typically the Prime Interest Rate published by the Wall Street Journal or LIBOR. You need not be concerned about how either of these is determined but, rest assured that they represent the cost of borrowing money in the overall US economy.
ARM loans also typically have adjustment “caps” meaning that the increase in the interest rate can be no more than say 2% at each adjustment. The choice of a three-year ARM over a one year dramatically reduces the potential volatility of the interest rate and, the difference in the initial interest rates rarely justifies the additional risk of frequent rate increases (one must make that determination for themselves).
ARM loans are often popular with borrowers who expect to move within 3-5 years, expect their personal earning to increase substantially in a few years, or plan to refinance in the near future. These loans are usually popular when interest rates are relatively high and the borrower expects them to decrease in the next several years or, if interest rates are expected to increase, when the borrower will be selling the home before the loan gets old enough to be adjusted upward several times.
Federal Housing Administration (FHA) loans are popular with first time home buyers in some instances. FHA loans are insured by the Federal Housing Administration which is a division of HUD (the Federal government’s department of Housing and Urban Development). Because these loans are insured by the federal government it allows lenders to offer lower down payment options, lower closing costs and easier qualifying terms. As of December, 2018, in St. Clair County these loans can be up to $294,000 with a 3.5% down payment and lowered closing costs. FHA loans are somewhat more difficult to obtain than a traditional mortgage because of increased requirements in the application process and, these loans have the potential to negatively affect the attractiveness of your offer to a seller.
Veterans’ Administration (VA) loans are guaranteed by the Department of Veteran’s Affairs and are available only to eligible military veterans. VA loans are attractive to borrowers because the require no down payment, and also lower the borrower’s closing costs. However, similar to FHA loans, these may make your offer to purchase a home less attractive to sellers.
What is the interest rate and the APR (Annual Percentage Rate)? Of course, the interest rate is amount you will be charged for the privilege of using someone else’s money over the life of the loan or, in the case of an ARM, over the term of each adjustment period. This will vary based on the current economy and loan type you choose.
APR is a method to recognize that loan fees and other costs also impact the overall interest rate and so is the interest rate plus all the fees a particular lender will charge divided by the average loan balance over the life of the loan.
Shopping interest rates is important but shopping APR allows you to compare lender to lender on a more equal numbers-based level.
What are mortgage or discount points? One way to get a lower interest rate is through mortgage or discount points. These are fees the borrower can pay the lender in exchange for a reduced interest rate and, consequently, lower monthly mortgage payments. Using this system, buying one point costs 1% of your mortgage amount (or $1,000 for every $100,000 borrowed). If you plan to own your home for the long term, it’s worth asking your lender whether this is an option for you. If it is, make sure it’s cost-effective by comparing how much you’d be saving each month against how much it costs to buy points.
These loans are sometimes popular with lenders when they anticipate that the borrower will sell or refinance the home before the mortgage is completely paid off. Once the borrower pays one or more points, the lender is entitled to keep those points whether the loan is held until it is paid in full in 30 years or it is refinanced in a couple of years.
Do you offer loan rate locks? Loan rates potentially change every day and sometimes hourly. If loan rates are on the rise many lenders may offer the opportunity for you to lock a rate for a short period of time while your home purchase proceeds to close. This interest rate lock may be complimentary or there may be a fee required to lock the rate. Ask your lender how long their loan processing typically takes and ask them to lock the loan until they are able to close the loan on a complimentary basis. These “lock” periods are typically 60 days or less so you will want to have a property under contract and have moved through the initial phases of the home purchase process before you consider paying a fee for a short-term lock.
Finding Your Ideal Lender - What works for each person and circumstance will vary. Specific details will need to be determined between you and your lender. Watch for our article next month on Finding Your Ideal Lender!
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