When it comes to mortgages, there’s no such thing as a “stupid question.” If you’re not familiar with the homebuying process, then the world of loans, interest rates, and real estate can be tricky.
(Psst! If this is you, make sure to check out our “ultimate homebuyers checklist.”)
To start, a mortgage is basically a loan that the bank or a lender gives you to help you purchase a home. You will have to pay some money upfront (called a down payment and closing costs), and that will help determine two things: how much money the bank will lend you (your loan amount)and then you will choose the particular loan program you feel is best for you and that will determine how much you’ll have to pay each month.
But mortgages can be confusing. There are so many programs, prices, and people to choose from!
Luckily, we were able to chat with one of the experts at Lafayette Federal Credit Union. Terry Rowland, an experienced mortgage loan originator, shed some light on the top questions people ask him.
1. How do I know how much I can afford? “The primary factors that determine how much you can afford are income, assets, and debts,” says Rowland. The key calculation is called Debt-to-Income or DTI. This is the ratio of your proposed housing expenses and all other monthly obligations. Generally, this ratio should not be more than 45 percent of your gross monthly income. As for having enough funds to close, lenders like to make sure the applicant has enough saved for a down payment, closing costs, and reserves.
“Programs such as LFCU’s First Time Homebuyer program, which requires little or no down payment, helps individuals own homes faster,” says Rowland. “And, in a market such as the DMV with rapidly escalating home prices, buying sooner rather than later can make a big difference in qualifying and faster growth of equity in the home.”
2. What’s the difference between pre-approved and pre-qualified? Real estate agents rely heavily on the pre-qualification or pre-approval letter when presenting and accepting real estate contract offers, says Rowland. The agents will often call the lender to determine the level of documentation provided and ask for an overall opinion of the qualifications of the consumer.
But keep in mind, the two are not the same thing.
Pre-qualification is based on consumer-provided data on a mortgage application and a credit report. The data is not necessarily verified by backup documentation like W-2s, pay stubs, and asset statements.
Pre-approval involves a complete mortgage application and tons of supporting documentation (the more complete the financial picture, the more relevant the pre-qualification letter). The file is submitted to an underwriter who makes a credit determination subject only to a satisfactory appraisal and updated documents when the consumer finds a property.
Usually, lenders only offer pre-qualifications. But a true pre-approval has benefits over a pre-qualification:
- When all of the documentation is complete, the pre-approved consumer can close on their house of choice faster—a competitive advantage when the seller is presented with multiple offers.
- The seller and the agent know they have a qualified and documented buyer, and it’s less likely that the buyer’s deal will fall apart before closing.
Lafayette FCU is one of the few lenders that offers a true pre-approval—a powerful factor to consider.
3. Should I get a fixed-rate mortgage or an adjustable rate? A fixed-rate mortgage is the most common type. This means the interest rate and the monthly payment remain the same throughout the loan period (usually 15, 20, 25, or 30 years).
An adjustable-rate mortgage (ARM) is either 15- or 30- year loans with monthly payments that change over the term of the loan due to increases or decreases in the interest rate. Many ARM programs offer a hybrid feature which locks in the initial interest rate is locked in for a number of years. For instance, a 5/5 ARM like one that we offer locks the rate in for five years, then can adjust and locks in for another five years. This continues throughout the life of the loan. There is a lot to know about adjustable rates. Call your loan officer and ask to receive a copy of the Consumer Handbook on Adjustable Rate Mortgags.
Rowland says you should consider several factors when choosing between the two:
- How low of a monthly payment do you want? If you want the lowest possible amount, an ARM is usually the best choice.
- How long do you plan on being in the home? If you don’t plan to be in the home long term, choosing an ARM that matches your expected timeframe may make the most sense. But, if you’re risk-adverse, you may want to pick the fixed rate. Even though the payments may be higher, you’ll have peace of mind for a long-term stay.
- Keep in mind that interest rates move in cycles. Most mortgages made for the purchase of a primary residence do not have pre-payment penalties, so you can keep checking the markets for refinancing opportunities.
4. What’s the difference between an interest rate and APR? The interest rate is called the “note rate.” It’s how your monthly payments are calculated.
The APR, or annual percentage rate, takes in to account other costs associated with obtaining a mortgage (use this to compare similar mortgages from other companies).
As an example, if you borrow $100,000 but the lender charges you $1,000, you have really only borrowed $99,000 but are repaying $100,000. The APR calculates an interest rate based on the payment of a $100,000 mortgage but uses the $99,000 as the indicative loan amount. In most cases, the APR will be higher than the note rate.
When you ask for a mortgage quote, also request the APR so you can compare it while shopping with other lenders.
5. How do I choose a mortgage lender? The most important thing is finding a lender that’s easy to work with and whom you can trust. Here are a few questions to ask when you’re researching:
For the mortgage company:
- Is all work done locally or done in a different city, state, or even country? You have more control when work is done locally.
- Does the company have a good reputation? Ask for references.
- Do fees and interest rates seem to be in line with the rest of the market?
For the loan officer:
- Is this someone you both like and trust?
- Is this person knowledgeable and experienced?
- Does this person propose solutions that actually work for you? Do you feel like this person has your best interests in mind?
- Will this person be responsive and get the job done?
- Get references from friends. Most loan officers build their business from referrals from prior customers.
Overall, make sure fees and rates are reasonable and then interview lenders for the factors that are most important to you.
Looking for an excellent mortgage loan to finance your next home? Through September 30, Lafayette Federal is offering an exclusive Equity Builder Mortgage that will allow you to borrow up to 97 percent loan-to-value with NO private mortgage insurance required!* Visit www.lfcu.org/ebm2018 to learn more.