Why Get Pre-Qualified?

1. Pre-qualification acts as a dry run of the loan application process. The mortgage lender will use details you provide about your credit, income, assets and debts to arrive at an estimate of how much mortgage you can afford. The whole process may take only minutes or a few hours at most, and is free.

2. While a "pre-qual" is non-binding to the lender (because the information you provide has not been verified), it does serve as a good indication to potential sellers of your general creditworthiness.

3. These days most sellers will NOT accept an offer without at least a pre-approval letter, so if you are serious about buying this is the first step towards getting you in your new home.

Interest Rate Buydowns

An interest-rate buydown is a tool to help you qualify for a larger loan and purchase a higher-priced house than you could under normal circumstances.  A buydown allows you to pay extra (tax-deductible) points up front in return for a lower interest rate for the first few years.  Often, people relocating for employment obtain buydowns because employers sometimes pay the extra points as part of a relocation package.

While the most common way of obtaining a buydown is by paying extra points up front, many mortgage companies now increase the note rate to cover the cost in later years.

The most common is the 2-1 buydown, which can cost 3 additional points above current market points.  During the first year of the mortgage, the interest rate is reduced by 2 percent and 1  percent the second year.  So if you get a 7 percent interest rate on a 30-year fixed mortgage, you'd pay 5 percent the first year, 6 percent the second year, and 7  percent for the remaining life of the loan.

Another option is the 3-2-1 buydown.  This reduces the mortgage rate 3 percent the first year, 2 percent the second and 1 percent the third.  Thereafter you pay the full rate.

Some programs are "flex-fixed" buydowns that increase interest interest at six-month intervals instead of annually.

Debt-to-Income Ratios

The debt-to-income ration is the way mortgage lenders decide how much money you can afford to borrow.  It is the percentage of your monthly gross income used to pay your monthly debts (not monthly living expenses).  Two calculations are involved, a front ratio and a back ratio, written in the ratio form, i.e., 33/38.

The first number indicates the percentage of your monthly gross income used to pay housing costs, such as principal, interest, taxes, insurance, mortgage insurance and homeowners' association dues.  The second number indicates your monthly consumer debt, such as car payments, credit card debt, installment loans, etc.

So a debt-to-income ratio of 33/38 means that 33 percent of your monthly gross income is used to pay your monthly housing costs, and 5 percent of your monthly gross income is used to pay your consumer debt - so your housing costs plus your consumer debt equals 38 percent.

33/38 is a common guideline for debt-to-income ratios.  Depending on your down payment and credit score, the guidelines can be looser or tighter, and guidelines also vary according to program.  The FHA, for instance, requires no better than a 29/41 qualifying ratio, while the VA guidelines require no front ratio but a back ratio of 41.

Build Home Equity Faster

Home equity is the part of your property you actually own.  For instance, if your property's worth $250,000, and you have a mortgage with a remaining loan balance of $100,000, your equity in the property is $150,000.

Naturally, building home equity comes at a price, usually in the form of larger payments.  If building home equity means incurring debt to make ends meet, then you've defeated the purpose of building equity in the first place.

The first option in home equity building is to make additional principal payments.  One way to do this is to sign up for a bi-weekly mortgage, in which you make two payments per month (which added together equal one monthly payment).  You will make the equivalent of 13 monthly payments per year instead of 12, which may seem insignificant.  But a 30-year loan with a bi-weekly payment plan is usually paid off in about 20 years.

The other way to build equity faster is to refinance.  If you had a $200,000 30-year ARM at 8.13 percent and replaced it with a 15-year fixed rate loan at 6.75 percent, your monthly payment would go from $1,485.69 to $1,769.82.  You would save $200,000 in interest and build the same amount of equity in half the time.

Loan Apps: What You Need

-3 month's bank statements on all accounts, including 401k

- Copy of HUD 1 Settlement Statement on recent sales of homes

- Gift letter (for funds from family members); donor's bank statement; copy of gift check; copy of deposit receipt.

- Landlord's name, address, and phone number.

- Explanations for late payments; credit inquiries in the last 90 days; charge-offs; collections; judgments; liens.

- Copy of bankruptcy papers filed within the last seven years.

- Copy of Social Security Card and driver's license.

- Last two years' W2 forms.

- Most recent pay stubs covering a 30 day period.

- Federal tax returns (1040's) for the last two years, if:

you are self-employed; earn regular income from capital gains; earn sizable interest income; earn more than 25% of your income from commissions or bonuses; own rental property; or you take non-reimbursed business expenses.

- Year-to-Date Profit and Loss Statement (for self employed)

- Corporate or Partnership tax returns (if you own more than 25% of a business)

- Copy of purchase agreement (if you have already made an offer)

- Receipt for child support payments

- Copy of Divorce Settlement

Should You Get An Arm

One of the most popular ways to finance a home these days is the Adjustable Rate Mortgage (ARM) because the initial interest rates and closing costs are typically low than fixed-rate loans.  The lender assumes the greater risk with a fixed rate mortgage because no matter how high interest rates go, the borrower's interest is locked in for 30 years.  That's why fixed interest rate loans have higher interest rates.

ARM qualifying rates are less than fixed-rate loans, so lenders also offer ARM borrowers more liberal qualification ratios.  The ARM interest rate is determined by an "index" that fluctuates with economic conditions and a "margin."  A typical rate cap on an annual basis is 2 percent, or 2 percent above or below the previous year's rate.

Any ARM is a good idea if -

- ARM interest levels are significantly below fixed-rate interest charges

- You won't by staying in the house for more than five years (especially if you have a locked-in rate for the first three, five or seven years)

- You anticipate a higher income in the future (such as a young professional just starting out)

- ARMs are not a good idea if -

- initial rates are comparable to fixed-rate loan rates

- high closing costs offset the low interest rate

The HUD-1 Explained

Law requires that the buyer and seller receives a copy of the HUD-1 (closing paperwork) at least one day before closing, ostensibly so they can check it over for errors.  Even if changes are made at the last minute, it is crucial to take the time to read over the form to make sure that no errors have been made.  What follows is an explanation of each Sec. of the HUD-!:

Sec. A-1: Lender info, settlement agent info, loan type, settlement date and property address.

Sec. L: Settlement Charges

Sec. 700: Agency Commissions

Sec. 900: Items Required by lender to be Paid in Advance

Sec. 1000: Reserves Deposited with Lender

Sec. 1100: Title Charges

Sec. 1200: Government Recording and Transfer Charges

Sec. 1300 & 1400: Additional Settlement Charges and Totals

Sec. J: Summary of Borrower's Transaction

Sec. 100: Gross Amount Due from Borrower

Sec. 200: Amounts Paid By or In Behalf of Borrower

Sec. K: Summary of Seller's Transaction

Sec. 400: Gross Amount Due to Seller

Sec. 500: Reductions in Amount due to Seller

Sec. 600: Cash at Settlement To/From Seller

What Are Points, Anyway?

There are two types of points.  Discount points are prepaid interest on your mortgage loan - you're basically paying finance charges in advance.  Discount Points are used to "buy" your interest rate lower.  This is known as a rate "buydown."  A general rule of thumb is that one full Discount Point will lower your fixed interest rate .250 percent or your adjustable rate .375 percent.

Lenders regard this type of points as covering their cost for offering a lower interest rate over the length of the loan.  The more points you pay, the lower the interest rate on the loan, and the fewer you pay, the higher the interest rate.  Paying discount points is a good idea if you plan to live in the house for a long time.

Origination points are charged by the lender to offset the costs of making the loan or to boost profits.  Most loan officers' compensation is based on origination points, but they still may be negotiable in whole or in part.  Some lenders add origination points into their quoted points while other lenders add an origination point in addition to their quoted points.  Where discount points serve the borrower by lowering the interest rate, origination points are gross profit for the lender.  They are not tax-deductible.

Your Mortgage has Been Sold: Now What?

In 1990, Congress moved to regulate the assignment, transfer or sale of mortgage loans.  As part of the National Affordable Housing Act, certain provisions were added to the Real Estate Settlement Procedures Act (RESPA):

1.  The lender must disclose to the borrower its policy on assigning or selling loans at the time a borrower applies for a mortgage loan.  HUD has written a model disclosure statement that all federally related mortgage lenders must use.

2.  If a lender assigns, sells or transfers your loan, both your current lender and the mortgage buyer must make certain disclosures, including the name, address and telephone number of the transferee, as well as the effective date of the transfer.

3.  Each disclosure statement must declare that the transfer does not affect any term of the mortgage other than who's servicing the loan (receiving the payments).

4.  A 60-day grace period ensures that borrowers can't be penalized if they mistakenly send payments to the old lender.

Organizations such as the Fanniemae and FreddieMac purchase large packages of loans from lenders at a discount, providing the individual lender more cash available to generate new mortgage loans. Lenders depend on available cash to do business.

Conforming vs. Non-Conforming Loans

Who decides what's conforming and what's non-conforming?  Fannie Mae and Freddie Mac, the two stockholder-owned corporations that purchase mortgage loans from lending institutions.  By doing so,a continuous flow of affordable funds for home financing results in the availability of mortgage credit for Americans.

Non-conforming loans, also known as jumbos, are for borrowers whose situations do not "conform" to strict Fannie Mae/Freddie Mac underwriting guidelines.

Non-conforming loans are much easier to qualify for than conforming loans.  They also close faster, have reduced or no reserve requirements, allow expanded use of loan proceeds and provide higher levels of cash out for debt consolidation.

Circumstances that might prevent conforming financing include: self-employment; complicated tax returns; if you don't wish to disclose your income; high debt ratios; current or previous credit difficulties; if you want to repay federal tax liens; and if you want to recoup equity from your homestead.

The most important difference between conforming and non-conforming loans, however, is loan limits, which change each year.  Ask your loan officer about these limits.

Know Your FICO Score

FICO measures credit-worthiness.  Underwriters have determined that people with low FICO scores default on loans with far greater frequency than do their higher scoring peers, so they use three credit bureaus - Equifax, Experian, and Trans union - to determine your score in several ways:

1.  Delinquencies: A 30-day late payment is less risky than a 90-day late payment.

2.  New credit: Your score drops when you open several credit accounts in a short period, as you may be unable to meet new credit obligations.

3.  A long credit history is better than a newly established one.

4.  A consumer with "maxed out" cards may have trouble with payments.

5.  Public records: Tax liens and bankruptcies jeopardize a healthy FICO score.

6.  The use of consumer credit counseling agencies may lower scores.

7.  Small balances, no late payments show responsibility.

8.  Too few revolving accounts: If you fail to use credit, there is no way to evaluate your ability to mange it.

9.  Too many revolving accounts may mean overextension.

10. Credit scores affect interest rates.  Some lenders establish lower interest for high FICO scores and vice versa.

Lock In Your Loan

A lock-in is a lender's promise to hold an interest rate and points for a specified period of time.  Depending on the lender, you will lock in the interest rate and number of points you agree to pay either at time of application, during processing of the loan, at time of loan approval, or later.

A lock-in at application may be useful when interest rates are on the rise.  By locking in your interest rate and points, you protect against rate increases.  On the other hand, if interest rates are falling, it might be best to wait until after application approval to lock in.

Some lenders have pre-printed forms that state the agreement in exact terms.  Others lock in by telephone at the time of application.

Lock-ins aren't always free.  Some lenders charge up-front fees, which may or may not be refunded upon application withdrawal or denial, or if the loan fails to close for some other reason.  Other lenders charge the fee at settlement.  The fee may be a flat fee, a percentage of the mortgage amount, or a fraction of a percentage point added to the lock-in rate.

Lock-ins of 30-60 days are common.  

Pre-Qualification vs. Pre-Approval

One sure way to reduce stress during the process of home buying is to seek pre-approval.  Buyers who are pre-approved are taken more seriously than their pre-qualified counterparts.

Pre-qualification is not a loan commitment from a lending institution: it is only a loan agent's opinion that you will be able to obtain financing.  Virtually anyone can achieve pre-qualification status.  Pre-approval, on the other hand, signifies that the application has been taken through a rigorous procedure.  Pre-approved buyers enjoy these benefits -

1.  If you make an offer on a home and then apply for a loan, you are at the lender's mercy.  He sets the interest rate and points, aware that you do not have time to shop around.

2.  Pre-approval saves time spent looking at houses you can't afford.

3.  If you rely on your lender to tell you what you can afford, you may end up with a high mortgage payment.  Most people can qualify for more than they feel comfortable paying.

4.  Having a pre-approval letter from a lender gives you an edge when multiple offers have been made on a house.

5.  Pre-approved buyers can generally close escrow more quickly.  Once you submit your credit package, most of the legwork has already been done. 

Time to Refinance?

Like anything else, refinancing has its good points and bad.  The most common reasons to refinance include: lowering interest rate or reducing length of mortgage, making home improvements, locking in interest rates if you have an ARM or converting to an ARM if rates rise, escaping a mortgage with a balloon provision and no conversion option, and/or consolidating debt.

Calculating your savings ...

Figure the following to help decide if a refinance is a good idea for you: current monthly payment, original cost of the home, itemized refinancing costs, monthly payment after the refinance, how long you plan to live in the house after the refinance, amount owed on the house, and the break-even point (total cost of the refinance divided by monthly savings on payments).

Many online "calculators" also provide refinancing data, including http://www.reficenter.com and http://smartmoney.com.

Plan carefully when you refinance:

Close your credit card accounts after consolidating debt.  Make home improvements right away.  Leave some equity in place for security. 

Mortgage Brokers vs. Mortgage Bankers

What is the difference between a mortgage banker and a mortgage broker?  Simply, a mortgage banker is the lender; a mortgage broker represents several lending institutions and serves as a liaison between the lender and borrower.

Which is better?  Here are the benefits of each.

Brokers: 1) Brokers work individually with borrowers to process the loan application. 2) The broker is independent and searches for a loan based on his customer's needs, not his employer's needs. 3) The broker matches his client with a lender, then walks the paperwork through final approval and funding. 4) Brokers' fees are paid by the lending institution, so are of no consequence to the buyer.

Bankers: 1) Mortgage bankers are direct lenders.  Working with them eliminates the middleman.  2) Mortgage bankers themselves approve or reject loans and may use automated underwriting systems, so working with a banker may prove more expeditious.  3) Mortgage bankers must have substantial net worth if they are to survive.  Brokers, on the other hand, need only a store front and telephone in order to set up shop.  4) Because they are competing with both other bankers and brokers, mortgage bankers have no choice but to maintain competitive rates.

Energy Efficient Mortgages

EEM Eligibility Requirements

1.  The borrower is eligible for maximum FHA financing, using standard underwriting procedures.  The borrower must make a 3-percent cash investment in the property based on the sales price.  Closing costs are not included in the 3-percent calculation but may be used to satisfy the requirement.  Any upfront mortgage insurance premium can be financed as part of the mortgage.

2.  Eligible properties are one-to-four-unit existing and new construction.

3.  The cost of the energy-efficient improvements that may be eligible for financing into the mortgage is the greater of 5 percent of the property's value (not to exceed $8,000), or $4,000.

4.  To be eligible for inclusion in this mortgage, the energy-efficient improvements must be cost effective, meaning that the total cost of the improvements is less than the total present value of the energy saved over the useful life of the energy improvement.

5.  The maximum mortgage amount for a single-family unit depends on its location and it is adjusted annually.  The cost of the eligible energy-efficient improvements is added to the mortgage amount.  The final loan amount can exceed the maximum mortgage limit by the amount of the energy-efficient improvements.