Following the financial crash of 2008 and the subsequent collapse of the housing bubble, many (but not all) real estate markets eventually recovered. Entered into in a prudent way, home ownership remains something you should consider in your long-term financial planning. Understanding how mortgages and their interest rates work is the best way to ensure that you're building that asset in the most financially beneficial way.
Yes, the word “homework” makes us shudder too, but this time the reward is much bigger than memorizing geometry theorems or the periodic table. You’re finding a home but you’re also making a financial commitment you’ll have to live with for years: get the best deal you can. Research loans, rates and brokers exhaustively before you sign or commit to anything. Doing the hard work now will pay off down the road with a better rate and terms.
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Your debt to income, or DTI. Is the amount of monthly debt payments you have compared to your monthly income. Most mortgages will allow a maximum DTI of 41%, ideally you will want a DTI ratio of no higher that 36%. See how much house you can afford using our calculator. Try not to stretch yourself too thin, if you have a high DTI you will be more likely to miss mortgage payments if an emergency comes up.
In the simplest terms, a mortgage is a loan from a bank or other financial institution that enables you to cover the cost of your home. It's a legal agreement with the bank saying you will pay the loan back (plus interest) over the course of years—decades, usually. Unless you have the money to pay cash for your property, you’re going to need a mortgage.
Many mortgage programs will require a 620 or higher credit score in order to qualify for a loan. Although, FHA loans are available to people with credit scores as low as 580. However, just because you have a 580 credit score doesn’t mean you will automatically qualify. Lenders look at a lot more than just your credit score. You should have a relatively clean credit history over the past 12 months, with no late payments or collections.
Example – A $200,000 five-to-one-year adjustable-rate mortgage for 30 years (360 monthly payments) starts with an annual interest rate of 4% for five years, and then the rate is allowed to change by .25% every year. This ARM has an interest cap of 12%. Payment amount for months one through 60 is $955 each. Payment for 61 through 72 is $980. Payment for 73 through 84 is $1,005. (Taxes, insurance and escrow are additional and not included in these figures.) You can calculate your costs online for an ARM.
If you and your loan servicer cannot agree on a repayment plan or other remedy, you may want to investigate filing Chapter 13 bankruptcy. If you have a regular income, Chapter 13 may allow you to keep property, like a mortgaged house or car, that you might otherwise lose. In Chapter 13, the court approves a repayment plan that allows you to use your future income toward payment of your debts during a three-to-five-year period, rather than surrender the property. After you have made all the payments under the plan, you receive a discharge of certain debts.
Because the interest rate is not locked in, the monthly payment for this type of loan will change over the life of the loan. Most ARMs have a limit or cap on how much the interest rate may fluctuate, as well as how often it can be changed. When the rate goes up or down, the lender recalculates your monthly payment so that you’ll make equal payments until the next rate adjustment occurs.
Loan modification: You and your loan servicer agree to permanently change one or more of the terms of the mortgage contract to make your payments more manageable for you. Modifications may include reducing the interest rate, extending the term of the loan, or adding missed payments to the loan balance. A modification also may involve reducing the amount of money you owe on your primary residence by forgiving, or cancelling, a portion of the mortgage debt. Under the Mortgage Forgiveness Debt Relief Act of 2007, the forgiven debt may be excluded from income when calculating the federal taxes you owe, but it still must be reported on your federal tax return. For more information, see www.irs.gov. A loan modification may be necessary if you are facing a long-term reduction in your income or increased payments on an ARM.
If you are thinking about buying a home in the near future, before you start house hunting or get pre-approved for a loan, it’s a good idea to check your credit report and find out what your credit score is. You are entitled to a free credit report once a year from each of the three credit bureaus – Equifax, TransUnion, and Experian, which you can access at www.annualcreditreport.com.
The key takeaway: ask specific questions. See how each lender goes about the process of closing a loan and find out what additional fees you will have to pay. Asking questions is also a great way to gain insight into the lender’s level of professionalism and communication skills. Remember, you’ll be sharing a lot of personal information and placing a lot of trust in this person. Do your due diligence and you're certain to find the best mortgage lender.
If you have a credit card with a $20,000 limit, that doesn't necessarily mean that you should spend $20,000 on purchases with the card. The same logic is true when it comes to mortgages -- just because you can qualify for a certain mortgage amount doesn't mean that you have to max out your budget. Be sure that your new mortgage payment not only fits your bank's standards but your budget as well.
The United Way's 2-1-1 hotline connects people with local assistance programs. By dialing 2-1-1, you can receive referrals to organizations that help with food, housing, employment, health care, prescriptions and more. If you are a struggling homeowner, the United Way can help you find a foreclosure prevention counselor and refer you to available mortgage assistance programs. Trained specialists take calls day or night. The United Way may also provide emergency financial assistance to households in danger of losing their homes. Programs vary among locations.
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The Salvation Army provides financial assistance to help with basic needs. If funding permits, the charity offers a rent and mortgage assistance program. To qualify for mortgage assistance, a foreclosure notice from the mortgage company is required. Applicants are screened to determine eligibility. You must have an income sufficient to resume making the payments. Prepare to provide proof of all bills, such as credit cards and utilities. If approved, a check for the month's mortgage is mailed directly to the lender.
If you have a hybrid ARM or an ARM and the payments will increase – and you have trouble making the increased payments – find out if you can refinance to a fixed-rate loan. Review your contract first, checking for prepayment penalties. Many ARMs carry prepayment penalties that force borrowers to come up with thousands of dollars if they decide to refinance within the first few years of the loan. If you’re planning to sell soon after your adjustment, refinancing may not be worth the cost. But if you’re planning to stay in your home for a while, a fixed-rate mortgage might be the way to go. Online calculators can help you determine your costs and payments.
Conventional loans require a home buyer to make a 20 percent down payment and many home buyers don’t have enough cash on hand to make that down payment therefore they are required to pay for mortgage insurance as part of their monthly payment. This insurance protects lenders if a borrower should default on the loan. Until late 2014, Fannie Mae and Freddie Mac required down payments of at least 10 percent. This requirement pushed many home buyers into Federal Housing Administration loans or FHA loans, which have a 3.5 percent minimum down payment. The problem is that FHA premiums are costlier than private mortgage insurance. But in 2015, qualified buyers will be able to get Fannie and Freddie backed mortgages with down payments as little as 3 percent. These premiums will be dependent on credit scores and the size of the down payment. Private mortgage insurance premiums are generally more affordable than FHA premiums.
Mortgage loan repayment works through a process called amortization. When you take out a mortgage loan, you agree to pay back the principal amount (actual loan money) in addition to interest over a specified period of time. Because the interest can add up to more than the principal amount, an amortization schedule (provided by your lender) balances out the interest and principal cost over the course of the loan repayment. A borrower pays off more interest to start, and the ratio gradually reverses to where the borrower pays off more of the principal as the loan nears its end. This way, the payment amount is able to remain stable over the course of the loan. If you're considering refinancing your mortgage, an amortization schedule is an essential tool in learning how much money you can save.
Maybe your parents had a 30-year fixed-rate loan. Maybe your best friend has an adjustable-rate loan. That doesn’t mean that either of those loans are the right loan for you. Some people might like the predictability of a fixed-rate loan, while others might prefer the lower initial payments of an adjustable-rate loan. Every home buyer has their own unique financial situation and it’s important to understand which type of loan best suits your needs.
During dynamic economic periods, interest rate volatility can increase and move mortgage rates quickly. As a mortgage shopper or holder, these periods offer both risks and rewards. For example, you wouldn’t want to lock yourself into an interest rate that drops before the home closing, but you’d welcome a rate lock if rates were on the rise. Some mortgage lenders address this problem by offering rate locks that protect you from rising rates but allow you take advantage of a rate drop before closing.
Perhaps the most intimidating part of buying a home is applying for a mortgage. You may know exactly what “APR,” “points” and “fixed-rate” mean — but if this is your first home, or you just need a refresher, there are a lot of great resources to get you up to speed so you can be a well-prepared mortgage shopper. And because this is such a crucial part of owning a home, we’re going to break it all down.
DO THIS: GET IN CONTACT WITH YOUR LENDER TO DISCUSS THE REMAINING BALANCE ON YOUR MORTGAGE — AND WHEN YOUR PMI, IF YOU HAVE IT, CAN BE DROPPED. IF YOU’RE BUYING, CHAT WITH YOUR LOAN OFFICER ABOUT FINANCING YOUR UPFRONT MORTGAGE INSURANCE INTO A LOW-DOWN-PAYMENT LOAN, LIKE AN FHA, OR SEE IF YOU’RE ELIGIBLE FOR LOANS WITHOUT MORTGAGE INSURANCE, LIKE A VA LOAN.
John and Anne are a retired couple, aged 72 and 68, who want to stay in their home, but need to boost their monthly income to pay living expenses. They would like to remodel their kitchen. They have heard about reverse mortgage loans, but didn’t know the details. They decide to contact a reverse mortgage loan advisor to discuss their current needs and future goals.
If you are thinking about buying a home in the near future, it’s a good idea to check your credit report and find out what your credit score is early on. You are entitled to a free credit report once a year from each of the three credit bureaus – Equifax, TransUnion, and Experian, which you can access at www.annualcreditreport.com. Check for mistakes on your credit report. A mistake on your credit report can cost you when trying to secure a home loan. Mistakes do happen, so review your credit report closely to ensure everything is correct and dispute any errors you might find with the appropriate credit bureau.
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A lender offers you a mortgage interest rate based upon a number of factors, but by far the most important is the secondary market for mortgages. Banks typically sell their mortgages to aggregators like Fannie Mae and Freddie Mac, which are government-sponsored enterprises that buy and repackage mortgages. Aggregators issue mortgage-backed bonds to investors in the secondary market. The daily fluctuations of supply and demand affect the interest rates investors require to buy these bonds. As the economy strengthens, investors require a higher interest rate on bonds because of growing competition for their investment dollars. Banks peg their mortgage interest rates to the daily interest rate on mortgage-backed bonds in the secondary market.
Homeowners can lower their monthly mortgage payments and get into more stable loans at today's low rates. And for those homeowners for whom homeownership is no longer affordable or desirable, the program can provide a way out which avoids foreclosure. Additionally, in an effort to be responsive to the needs of today's homeowners, there are also options for unemployed homeowners and homeowners who owe more than their homes are worth. Please read the following program summaries to determine which program options may be best suited for your particular circumstances.
Once you research the types of financing available, determine which is best for your financial situation when buying a home: 15-year mortgage or 30, adjustable or fixed. If you are looking for security and a guarantee that payments won’t increase, a fixed rate mortgage might be the way to go. If you believe mortgage rates could still fluctuate and you want more flexibility, consider an adjustable rate mortgage.
The prices for mortgage-backed bonds, and by extension, the mortgage rate a lender offers, are constantly responding to economic factors. In a strong economy, the rise in inflation (i.e., the general price level of goods and services) speeds up as greater demand increases competition for financing, goods, services and labor. This drives mortgage rates higher. A slow-down or recession causes mortgage rates to fall. The U.S. stock market is considered a leading indicator of economic activity. If it tanks, demand for investment shrinks and mortgage rates drop. Conversely, rates rise when the stock market is strong. When there is high unemployment, the economy is relatively weak and mortgage rates tend to fall. If jobs are easy to find, the economy is strong, and rates rise. Like the stock market, rising foreign markets indicate a strengthening world economy and higher rates. When foreign markets tumble, it puts downward pressure on interest rates.
This is the distinguishing characteristic of a fixed mortgage. The interest rate you start off with stays with you for as long as you keep the loan, even if you keep it for the full 30-year term. The rate assigned to an adjustable mortgage, on the other hand, can change over time. These are very important differences, from a home buyer’s perspective.
For decades, the only type of mortgage available was a fixed-interest loan repaid over 30 years. It offers the stability of regular -- and relatively low -- monthly payments. In the 1980s came adjustable rate mortgages (ARMs), loans with an even lower initial interest rate that adjusts or “resets” every year for the life of the mortgage. At the peak of the recent housing boom, when lenders were trying to squeeze even unqualified borrowers into a mortgage, they began offering “creative” ARMs with shorter reset periods, tantalizingly low “teaser” rates and no limits on rate increases.
After you have applied for a home loan, it is important to respond promptly to any requests for additional information from your lender and to return your paperwork as quickly as possible. Waiting too long to respond could cause a delay in closing your loan, which could create a problem with the home you want to buy. Don’t put yourself in a position where you could end up losing your dream home, as well as any deposit you may have put down.
Interest – This is what you are paying to borrow the money for your home. It is calculated based on the interest rate, how much principal is outstanding and the time period during which you are paying it back. At the beginning of the loan repayment period, most of your payment actually is going toward interest, with a small portion going against paying down the principal. Over time this will reverse and more of your payment will go toward reducing the loan balance.
Everyone should make sure their credit score is as high as it possibly can be. If you high credit card balances, pay them below 15% of the credit limit. Dispute negative account information with the credit bureaus. Contact your creditors and negotiate a pay for delete. If you have a friend or family member with a credit card in good standing have them add you as an authorized user.
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Buying a home with a mortgage is probably the largest financial transaction you will enter into. Typically, a bank or mortgage lender will finance 80% of the price of the home, and you agree to pay it back – with interest – over a specific period. As you are comparing lenders, mortgage rates and options, it’s helpful to understand how interest accrues each month and is paid.
Union Plus Mortgage Assistance provides interest-free loans and grants to help make mortgage payments when you're disabled, unemployed, furloughed, locked out or on strike. If you qualify for the Mortgage Assistance loan benefit, you’ll also receive a one-time grant of $1,000 paid directly to you (Note: if you are applying due to a furlough the one-time grant is $300). The program has provided over $11.2 million in assistance to union members.
Typically offered by lenders, loan modification programs are designed to make your mortgage fit within your budget. If your income has decreased due to layoff, reduction in hours, reduction in hourly pay, or emergency expenses, you can go to your lender and explain why you can't pay the mortgage. If they offer loan modification programs, they can reduce their interest rates, keep your payment within a certain percentage of your income, increase or decrease the length of the loan, or negate certain penalty fees. Loan modifications are rarely sweeping, one-size-fits-all type deals. They take time to set up, and only provide indirect assistance by modifying your debt. They don't put cash directly into your pocket. For this reason, they're not useful as emergency mortgage assistance, but they can help if you're struggling just a little bit.
Many Community Action Agencies have programs and resources that homeowners can take advantage of. While they primarily focus on providing counseling, some of the community action agencies can provide cash grants, mediation services, and other tools to help a homeowner prevent or stop a foreclosure filing. Even if they don’t offer direct financial aid or can’t meet your specific need, almost all agencies can provide referrals and guidance. Find how to apply for free foreclosure counseling from community action agencies.