Mortgage & Lending Information
Mortgage & Lending Information
There's a lot of information out there to help home buyers and home owners refinancing get a better understanding of lending when buying or refinancing a home, most of the information you can find on the web is either far too extensive or confusing for most people and thus they won't bother to read it, or not nearly extensive enough and possibly riddled with more ads than valuable and relevant content. So we created this page on our website to highlight what every borrower should know in a straight to the point clear and easy to understand format linking to pages either on our site or on external sites that explain certain terms in more depth if want more information on a given subject. This information changes all the time so this is meant to be fairly generic and thus relevant over the years. We are Portland real estate agents, not lenders but we have had multiple lenders review this content for accuracy. For detailed information relevant to your situation please contact your lender or we would be happy to refer you to one we know and trust.
Credit score requirements vary greatly depending on the market conditions, banking conditions etc. During the boom of 2001-2006 a low and even "poor" credit score was in some circumstances acceptable to obtain a subprime loan if other conditions were met such as at least a few thousand dollars for a down payment, solid job history and income levels, good debt to income ratios etc. A poor credit score is typically below 579, under this score and you're going to have an extremely tough time getting financed especially in a more typical market. In a boom market for buyers such as we just had from 2001-2006 obtaining a loan in this range was doable, but not easily doable. Scores from 580-619 are better but still not great, in this range you can expect a bit lower down payment requirement, higher DTI acceptable and less job stability flexibility than the previous 579 and under range. Moving into the range of 620-679 are beginning to move into the good category, but depending on market conditions can still be looked upon by lenders as a low score. If all else is equal (DTI is ok, down payment is ok, job history and income level are good) than you shouldn't have a problem stepping out of a subprime loan and into a more traditional loan program with competitive rates and low to no mortgage points.
NEGATIVE ITEMS ON CREDIT REPORTS
To some extent this could be considered to be even more important than an overall credit score, in that even if you have a high credit score if there are derogatory items on your credit report most of the time you will need to get those cleaned up BEFORE going through the loan application process. The long and short of why? Well, if your credit report shows you have failed to pay someone you owed money to, that raises the risk to the lender of you not paying the loan back; at least that's how they see it. If you have no derogatory items on your credit reports from the three credit reporting agencies Experian, Transunion & Equifax, then chances are you have a fair to good credit score, but the opposite is not always true. For instance, a charge off, repossession etc will definitely lower your credit score, but if you have 20+ years of perfect credit history and a score of say 790 (really high), then a repossession is not going to bump your score down to 500, maybe somewhere more around 700, but it will cause an underwriter to question whether their institution should lend to you.
LOAN TO VALUE RATIO OR "LTV"
This is pretty simple and straight forward, so I'm not linking to it externally. This is the ratio of the loan amount compared to the homes appraised value. So, if you're buying a $300,000 home and you need to have an LTV of 80% then you need 20% down or $60,000 in the case of a $300,000 home. Typically 80% or lower is what a lender likes to see and traditionally it was almost a requirement, however in recent times we've seen 100%, even 110% and these loans, usually subprime loans, are largely what went wrong in the housing market leading to the bubble bursting in 2006. In the aftermath we're still commonly seeing 97% LTV's but only with FHA Loans, the rest are usually looking for at least 10% or more down so a 90% or lower LTV.
Mortgage points or "discount points" are a good and a bad thing. They can be good when used to buy down your interest rate but be sure this makes sense for your situation by discussing this option with your mortgage broker/lender. They are bad when your lender is charging points and you are not getting a discounted interest rate in return. Although this is extremely unethical, we see lenders attempt this with buyers every so often, charging "points" for no apparent reason other than to further line their own pockets at their clients expense. If a lender try's this with you, find another lender - PERIOD. If you can't trust them to not take you on points then you can't trust them.
DEBT TO INCOME RATIO OR "DTI"
Debt to Income Ratio is the ratio of debt to income that you currently incur. Typically this needs to be below 50%. So for example if you currently have a $1,500/month house payment, a $300/month car payment, revolving credit (credit cards) of $150/month minimum payments then you should be making at least $4,000/month to have a DTI of less than 50%. If however you are making $3,000/month your DTI is almost 75% and it would thus be difficult for you to be approved for a loan. Another commonly used DTI is in the format of say 31/43, what this means is you can have a DTI of 31% for housing, and/or a DTI of 43% for housing plus monthly debt. The debt considered here is not just housing, car loans and credit cards, taxes & insurance could also be factored in depending on the loan program being used.
LOAN TYPES: FHA, VA, USDA, CONVENTIONAL, ARM, INTEREST ONLY, HOME EQUITY & MORE
There are many, MANY types of loans, so we'll only go over the most common ones you are likely to run across. Right now the one we see the most is FHA as it's the only loan someone could use to buy a home with only 3% down (and as of January 1st 2009 it will be 3.5%). FHA, or Federal Housing Administration loans are U.S. Department of Housing and Urban Development (aka "HUD") federally insured loans and thus are less risky so to speak for lenders as Uncle Sam is backing these loans. These loans are a bit messier in terms of paperwork, requirements etc however in recent years they have loosened up a bit. A few years back a lot of sellers wouldn't even look at offers with FHA specified as the loan type due to the red tape, hoops and seller contributions that had to be made at the time. Now, they are more widely accepted and thus more widely used. If you're a first time home buyer with little money down an FHA insured loan is something your lender will likely talk to you about. For existing home owners and or 2nd, 3rd (etc) time home buyers talk to your lender as the requirements for this change often and may or may not currently qualify.
V.A. Loans are U.S. Department of Veterans Affairs loans specifically for military veterans and can often offer significant (and often not so significant) discounts for Veterans when purchasing a home depending on the programs they are offering at the time. Talk to your lender about these if your a veteran.
A USDA Loan has nothing to do with beef! A USDA loan is essentially a benefit laden government backed loan from the U.S. Department of Agriculture specifically for those buying, renovating, building, moving a home or preparing land for a home in rural areas. If you are looking/living in a rural area, be sure to ask your lender about this type of a loan.
Interest only loans are exactly what they sound like, you are paying interest only in your monthly loan payments and are thus not paying down the principle loan balance at all and in exchange for that your rate is typically going to be lower than the going traditional 30 year fixed rates and thus you end up with a lower payment. These loans are absolutely useful if you use them properly. For instance in a typical loan amortization schedule the first few years of payments are primarily paying down the interest and not the principle balance, so if you know you are only going to be in the home for 2-3 years this may be a good option for you as with a 30 year fixed loan you wouldn't be paying much principle at all anyway, so why not benefit from a lower payment? Or if you're planning on refinancing in 2-3 years the same could be true. Another situation is maybe you expect to be making significantly more money in a few years. The catches here are many, A) you really need to be sure of the situation you are in now and are likely to be in in a few years and B) often there is a balloon payment schedule for the balance after X number of years and/or a rate increase to begin paying principle in X number of years which could jump your rate up significantly. Be careful using this type of loan, in the right hands it's a valuable tool, in the wrong (careless) hands it could be devastating to get caught in the strings of this type of loan.
An ARM, or Adjustable Rate Mortgage is exactly that, "adjustable rate". What happens is this, lets say current interest rates are 5%, but a lender can get you a loan at 4% or maybe even 3% for 3 years but it will adjust annually to X amount of or at then current rates. This would be a 3/1 ARM. The amount it could adjust each year is usually no more than 1%, but can be more depending on the loan program. Like interest only loans these can be useful if you plan to refinance in a few years or sell the home in a few years (preferably before the rate jumps). But be aware this loan is the one primarily at fault for the market bust in 2006! Lots of people used these to buy homes at 100%+ LTV's, their home values dropped and their rates went up and they could no longer afford the often significantly higher payments resulting in short sales and foreclosures and an eventual market collapse. Use this option wisely!
Home equity loans. I'm not going to go into too much detail here, but suffice it to say there are a lot of different choices here. Loans that give you a lump sum up front and instant payment that remains steady, or loans that give you available credit and quite literally a check book to use to withdraw equity from your home, the more you pull out the higher your monthly payment goes. Typically these loans are "2nd's" on a home, that is used in conjunction with a primary more traditional mortgage and we're largely being used to do 80/20 loans where a borrower had no down payment and didn't want to pay mortgage insurance so they take out a loan as a "1st" or "primary position" loan at 80% LTV, then take out a home equity line of credit or "HELOC" or a home equity loan to cover the other 20% needed to buy a home. Additionally these are used for home owners when they want to renovate/remodel their home and pay for it using the existing equity they have in their home.
Last but not least we have the traditional loans. These are 15 year and 30 year fixed rate mortgages and the years can vary, 10 year or some loans even at 50 year (though at 50 years you're well into the "is this really a smart decision" area). These are by far the most common loans on the market. The rates are usually market, sometimes just below or above depending on factors such as points, LTV, DTI, Credit Scores etc. Generally you want to go with the shortest term you can here and the shorter the term usually the lower the interest rate.
Subprime loans are loans that borrowers with negative status in terms of credit, job history, income level etc may end up with when purchasing a home. Generally these loans have higher interest rates, pre-payment penalties, adjustable rates, high points and/or any combination of these undesirable traits loans can have. This does not mean a subprime loan is always a bad thing, if you can afford to buy a home and have a solid and stable job owning a home is definitely better than renting in almost every situation. Get into the home, get whatever challenges you have resolved that resulted in only qualifying for a subprime loan and then refinance it later.
Loan amortization is simply the schedule at which the principle balance of a loan is paid over the term of the loan at a increasing rate and the interest of the loan is paid at a decreasing rate. As a result in the beginning of the loan term the interest paid absolutely dwarfs the principle paid, then roughly little less than half way through a typical loan that reverses and the principle being paid is ever greater than the interest being paid until the loan gets to 0 balance at the end of the term. Bankrate.com has a good loan amortization schedule calculator here that shows this amortization schedule for a given loan that you want to see.
A prepayment penalty is something you absolutely have to know about with your loan. On some occasions there may be something in a particular loan program that makes a pre-payment penalty worth putting up with (like a lower interest rate) but in most cases only if you do not intend to pre-pay the loan. These penalties are often also associated with subprime loans. These penalties range in details from paying anything over your minimum payments each month, to a certain amount in a month or a year pre-paid that causes it to kick in, to complete payoffs of the loan that kicks them into gear, so know the details if your loan has one. If your loan has one and there is no benefit to you in exchange (again, lower interest rate?) try to get it removed from the loan or find another loan program as you generally should not be stuck with one.
MORTGAGE INSURANCE OR 80/20 LOANS
Mortgage Insurance, also known as PMI (Private Mortgage Insurance), is generally required by a lender when there is a really high LTV. It's an extra payment on top of your loan payment that goes to "insure" your loan against non-payment of the loan. When this is required often doing "80/20" loans or similar set of loans will drop the requirement for mortgage insurance. An 80/20 (and there are 85/15's, 90/10's, 70/30's etc with 80/20 being the most common) is a primary first loan and a secondary well, 2nd loan creating a 100% loan on the home through two different lenders one in first position and one in second position. First and second position just refers to the priority of the loan if/when there is a short sale, foreclosure, bankruptcy etc, the first position loan has priority to get paid over the second position and thus lenders prefer to be first position lenders and as a result "2nd's" at a higher risk also tend to be at a higher interest rate.
Really super straight forward; how much money can you put down on the home? Current requirements with an FHA loan are 3.5%, outside of FHA currently there are 10% plus loans available and traditionally you would want 20% minimum down payment and most money geeks will say you have to do at least 20% down to minimize your risk if the home drops in value as homes are doing as of this writing. Down payment assistance programs are few and far between but they do pop up from time to time so check with your lender to see if there is something available that could help.
LOCKING THE INTEREST RATE
This is something we find buyers are frequently not properly educated on but is fairly easy to understand so no links for terms used here. Interest rates change daily and even hourly, so "locking in the interest rate" can be crucial when buying a home. The escrow process of buying a home most commonly goes on for 30 days, sometimes as short as 1-2 weeks, sometimes as long as 90 days; it all depends on what the buyer and seller agreed to and what time frame the buyers lender can perform in to fund the purchase of the home. During this time interest rates can change drastically effecting a home payment by even hundreds of dollars a month in some instances so it's important when you have a good rate you with a payment you are comfortable with that you lock that rate. Problem is a rate cannot be locked without a property address so you need to have made an offer on a home and come to mutual agreement with the seller on a price and have entered escrow before your lender can lock the rate. Sometimes we see lenders forget to lock the rates so make sure to ask your lender to lock it when you have a property in mind and an interest rate you are comfortable with.
Underwriting is the process a financial institution uses to basically make sure you qualify for the home purchase and that the home itself qualifies. Underwriters check to make sure the information you provided your lender is accurate, check your previous accounts to make sure the credit reports are accurate, check job history, references and information on the property itself (for instance if the property needs a new sewer an underwriter will decline the loan on the property). Underwriters are largely pencil pushing accountants, but they are detail oriented and looking for a reason to not approve the loan, so be careful, don't give them a reason! In house underwriting is when a mortgage lender/broker has underwriters in house that they have access to. This is preferred for a few reasons. Often something will come up with underwriting in even the cleanest transactions. When this happens with underwriters that are not in house, you could be looking at delaying closing for a few days and might be risking going out of contract of the sale waiting for them to respond where as in house underwriters typically respond and resolve issues quickly.
MORTGAGE BROKER, MORTGAGE LENDER (AKA A "BANK") & CREDIT UNIONS
Whether to use a mortgage broker, a mortgage lender or a credit union is largely personal preference and what's good for one person may not work so well for another. Mortgage brokers have a huge array of "products" (loan programs) available to them often in house and always from outside sources and will thus often find a better deal for a client than a traditional brick and mortar bank can offer. On the flip side a mortgage lender (aka a bank) and credit unions may have a specific deal available to their own clients or members in the case of a credit union that mortgage brokers do not have access to. Check with both, it doesn't hurt to get multiple opinions on a mortgage from various sources. Be aware however if you are dealing with someone that is difficult to get a hold of we highly HIGHLY recommend finding another lender because if they are hard to get a hold of in the beginning then when/if there is a lending problem just days or even hours from closing and your stress level is about to pop. you will pop if your lender is unreachable. Do yourself a favor and work with a lender that answers their cell phone day or night and on the weekends as there are plenty of excellent lenders out there that work this way.
During the boom market from 2001 - 2006 appraisers worked closely with lenders, probably too close literally on occasion asking the lender what they need a home to appraise for and making sure the appraisal came in at the mark. Since the bubble has burst appraisers have become extremely tough and are no longer willing to work this way (a good thing for the most part). Appraisers are used on every loan and can make or break a home purchase. If you're using an FHA loan program to buy a home the appraisal is critical because if the home does not appraise for the sale price the lender will not be able to approve the loan. If however you have a significant down payment on the home then the appraisal is less critical to the loans success but you may be a bit irritated if you agreed to pay say $300,000 for a home that just appraised for $285,000.
YOUR REALTORS ROLE
Your Realtor (hopefully us!) should be a wealth of information for you on this and many other subjects when buying or selling real estate and should never "fudge" an answer to a question you have. If your Realtor doesn't know the answer to a question you've asked they should tell you they do not know, but they will find out and get back to you ASAP and follow through on that promise. Your Realtor also should work to coordinate the escrow process, they should be in regular contact with your lender or if you're a seller with the buyers lender. It's sad but often we find we are the only "professionals" in a given transaction that actually care about keeping in line with contracts, deadlines etc to close transactions in a professional & timely manner. If you end up stuck with someone in a transaction be it escrow, lending or otherwise that is not on the ball and doesn't seem to care at least make sure you've picked a Realtor that will keep them on track and on the ball whether they like it or not.