12 things help to get a better mortgage
Quite often we hear borrowers said they wish they could have gotten a better loan program, lower interest rate, or closing costs. Others also have said they should have known more about how mortgages work, especially how to read the closing statements. These 12 items below will help you to get better loan programs on your next mortgage.
1. Pre-approval Letter
Before going to look for your dream home or even signing a purchase agreement, you should obtain an explicit pre-approval letter from a mortgage lender. A pre-qualification letter is not highly recommended. Even both terms quite often have been used interchangeably; however, a pre-qualification is a less detailed process, while a pre-approval is more comprehensive, which requires thorough investigation of the borrower’s credit history and financial information. A pre-approval letter will not secure you a loan from the lender yet, but it may help to prove to a seller that you are a serious buyer who is able to receive financing for your purchase. It also helps you to determine whether all stipulations for your loan can be quickly satisfied or if you need more work. The main point is to avoid any delays closing your purchase on time that could potentially cost you more money or even losing your earnest money deposit at the end.
2. Loan-to-Value (LTV)
Loan-to-Value (LTV) ratio is metric lenders use to determine the risk of lending money to you, and if you need to pay mortgage insurance. LTV is the inverse of a borrower’s down payment. It plays a significant role in the interest rate adjustment. Lenders have been using 80% LTV as the benchmark. The higher LTV the higher the interest rate will be. In addition, for conventional loans with LTV over 80%, you may need to purchase mortgage insurance. So, if you have the ability to provide more on the down payment, such as an additional 5%, it might have a substantial reduction on the interest rates. The best suggestion is to discover your options wisely.
3. Debt-to-Income (DTI) ratio
Debt-to-income (DTI) ratio is all monthly debt payments divided by the gross monthly income. This ratio helps lenders to assess a borrower’s ability to manage the monthly payments. A high DTI not only signifies the borrower has too much debt for the income earned each month, it also could increase the interest rates. Ideally, this needs to be reviewed and approved by a lender during the pre-approval process, otherwise, it could affect the interest rate or even the loan approval if it goes over the threshold, and definitely you do not want to have this issue after you have signed a purchase agreement. Different loan products will have different DTI limits.
4. Loan Estimate (LE)
A Loan Estimate (LE) is a three-page form that is provided to you within three business days of receiving your mortgage loan application. When you receive this form, the lender has not yet made a decision for your loan. Basically, it provides you with important information, such as the estimated interest rate, loan term, monthly payment, and details of closing costs for the loan. It also indicates if the loan has special features that you should be aware of, such as prepayment penalty, balloon payment (known as negative amortization). You should review this form carefully, and ask the lender to explain on any items or fees that you are not clear. When you shop for a mortgage loan, preferably with three different lenders, you will receive an LE from each lender that you can compare their rates and the closing costs.
5. Closing Disclosure (CD)
A Closing Disclosure (CD) is similar to a Loan Estimate (LE), but it is provided to you once your loan is approved and ready for funding. It provides the final details of the closing costs and terms of the loan you’re about to commit to. The lender is required to provide this form to you at least three business days prior to funding your loan. You need to compare it with the most recent Loan Estimate for any changes that occurred but you are not aware of. If you find an error, you need to contact the lender or settlement agent immediately to have it corrected. Each change made on the CD could potentially delay the closing, so it is very critical to review this form as soon as you receive it.
6. Private Mortgage Insurance (PMI)
Private Mortgage Insurance or PMI is a policy that protects the lender against any losses if you stop making payments or fail to repay you loan. PMI is required when you have a conventional loan with a down payment of less than 20% of the home’s purchase price. This also applies to conventional refinance loans with less than 20% of the home equity. There are several different ways to pay for PMI with either a monthly premium, a one-time up-front premium paid at closing which is non-refundable if you decide to sell your property or to refinance, or split-premium that you pay a larger upfront fee that covers part of the cost to then shrink your monthly payment obligations. There are also several ways to remove PMI from a mortgage, such as pay down your principal balance, or gain enough equity through market increases or home improvements. By law, lenders must terminate PMI on the date your mortgage loan balance reduces to 78% of the home’s original value or purchase price. You should discuss with your lenders whether having a PMI or getting a piggyback HELOC loan for 20% of the down payment will save your monthly payment and/or closing costs.
7. Mortgage Insurance Premium (MIP)
Mortgage Insurance Premium (MIP) is an insurance policy that is required on all FHA loans regardless the size of your down payment. MIP is quite similar with the Private Mortgage Insurance (PMI) that both provide protection for the lenders, except MIP requires both an upfront premium that is paid at closing, and an annual premium that is divided by 12 months and paid along with the monthly mortgage payment. Also, MIP cannot be cancelled unless you made a large down payment such as 10% or more, and you will have to pay the annual MIP for 11 years; otherwise, you will have to pay off the FHA loan mostly through a refinance to a non-FHA loan.
8. Annual Percentage Rate (APR)
Annual Percentage Rate or APR represents the actual yearly cost of funds over the term of a loan. APR includes the interest rate plus any upfront costs, such as loan origination charges, mortgage insurance, and discount points. APR is also driven by your credit score, which means if your credit score is low, there will be an additional closing cost. The higher APR, the more you will pay in interest each month and the longer it will take to pay off your principal balance. Knowing APR up front can help you to compare among lenders to see who is offering the best interest rate and lowest fees. You can find APR on your Loan Estimate, and Closing Disclosure.
9. Escrow account
Escrow account or also called impound account. There are essentially two types of escrow accounts. One is used throughout the purchasing or refinancing process until your loan is funded. The other referred to as an impound account is used by a lender to manage property tax, homeowner insurance, and mortgage insurance (if applicable). You make monthly payments into the impound account that amount to 1/12 of each item’s annual total cost. Your lender will use the funds to pay those bills to the county/city, and the insurance providers on your behalf. An impound account can be voluntary or mandated by a lender depending on the loan scenario, for example, the loan amount is more than 80% Loan-to-Value (LTV), or required by law if you have an FHA loan. The VA does not require lenders to maintain impound accounts. If you waive an impound account, some lenders may charge you a fee or increase the interest rate. If your loan does not have it, you will have to pay these bills on time by yourself to avoid fines, penalties, and even facing foreclosure since the property tax will take priority lien on your home. The amount due each month into the impound account may vary depending on your annual property tax and insurance obligations. If the amount changes, your lender will notify you 30 days before your next payment. Also, if there are insufficient funds in your impound account to cover the property tax and insurances, your monthly mortgage payment may increase. You should always discuss this loan feature with the lenders to make a right decision for your loan.
10. Transfer tax
A transfer tax is a charge levied on the exchange of home ownership. This is also known as deed stamp tax, real estate conveyance tax or documentary stamp tax. A transfer tax is commonly imposed by state, county, and municipality; however, some states do not impose it at all, such as Alaska, Arizona, Idaho, Indiana, Louisiana, Mississippi, Missouri, Montana, New Mexico, North Dakota, Oregon, Texas, Utah, and Wyoming. Generally, the seller is liable for the real estate transfer tax, but not uncommonly the buyer will pay for this transfer tax if it is on the purchase agreement signed by both seller and buyer. There are some exceptions where transfer tax does come with a requirement for whose responsible to pay it. A transfer tax can be from 0.01% to 4.0% of the sale price. It is not tax-deductible; however, when you sell your home, you might be able to deduct this transfer tax from the capital gains if you paid it when buying your home. Unfortunately, you won’t be able to take advantage of this if you are selling your primary residence, and your capital gain is less than $250,000.00 if you are single, or $500,000.00 if you’re married.
11. Prepayment penalty
A prepayment penalty is a fee imposed by the lender if you pay off or part of your mortgage early. Most lenders allow borrowers to pay off up to 20% of the loan balance each year. The main reason of having prepayment penalty on a mortgage is because you haven’t put down a significant amount of money on the first few years of your loan term, so there is still a high risk to the lender. Therefore, lenders charge you interest to protect them from a financial loss. If you pay the loan off too early, they lose out on all those interest fees as their incentive when they gave you a loan. Prepayment penalty fees vary from a fixed amount, a number of months’ interest, to a certain percentage of remaining loan balance. If a loan you are considering has a prepayment penalty, you should read the fine print carefully to understand exactly the circumstances under which you will have to pay, and how much. By law, lenders are required to disclose prepayment penalties along with monthly fees and other loan details. You also should ask your lender for a quote for a similar loan without a prepayment penalty so you can compare and make an informed decision. After all, you should consider to get a loan without a prepayment penalty to avoid any anxiety and paying a significant fee because unexpected incidents can happen in our life.
12. Assumable loan
An assumable loan is a type of mortgage whereby an outstanding mortgage and its terms are transferred from a seller to a buyer. Not all loans are assumable, typically just some FHA, VA, and USDA loans are assumable. Buyers who wish to assume a mortgage from the seller must meet specific requirements and receive approval from the agency sponsoring the mortgage. There are several advantages for a buyer when having an assumable mortgage such as taking over the seller’s interest rate that is lower than the rate the buyer might be able to get based on credit history, and having fewer closing costs involved. On the other hand, there are also disadvantages that the buyer may need substantial down payments or take out a second mortgage if the value of the home is great than the remaining mortgage balance. Lenders may not cooperate when a second mortgage is needed.