Financing
The Mortgage Process
A mortgage is the largest, longest-term, debt one will probably ever take out during their lifetime. It might seem daunting and complex. We are here to explain it all so you can handle it like a pro. The more you understand how a mortgage works, the better equipped you will be to shop and find the mortgage that’s right for you.
What is a mortgage
A mortgage is a loan you get from a lender to finance the purchase of a home purchase. When you take out a mortgage, you are promising to repay the money you’ve borrowed with periodic payments with an agreed-upon interest rate. The home is used as collateral. In some states, the bank holds the title of the home (title theory) like in Virginia, or has a lien on it (lien theory) like in Maryland and DC.
Title theory states are states where banks or mortgage lenders hold the title of a property until it is paid in full. They hold the title in the name of the borrower through a Deed of Trust. When the loan is paid in full, or the home is sold and they are paid, the lender gives up the title and records a Deed of Reconveyance either to the owner (when paid in full) or the buyer (if sold). The bank owns the home and if you can’t pay the mortgage then the bank has the right to foreclose on your property (sell your home). Your loan is a lien on the home, aka a right to keep possession of property belonging to another person until a debt owed by that person is paid.
Washington D.C. and Maryland are a little different. They are a lien theory state whereby banks or mortgage lenders only have a lien on the property and not the deed. The deed stays with the borrower, and the lender places a lien on the property using a mortgage. The lien ends when the loan is paid in full. This makes foreclosure more difficult for lenders as they have to go to the courts and pass more hurdles before foreclosing.
Mortgage Guide
How a mortgage works
Every month you make a payment, and each payment is split into at least four different sections that make up principal, interest, taxes, and insurance or PITI. The four sections are:
- Principal: This is the amount of your loan balance that is paid down with each payment.
- Interest: This is the interest charged each month on what is left of your loan (principal).
- Taxes: Yup you have to pay property taxes. Your yearly property tax assessment for the year (which can change every year) is divided into 12 payments.
- Insurance: Your lender will require homeowners insurance to cover your home against fire, theft, or accidents.
- PMI: If you didn’t have at least a 20% down payment then mortgage insurance based on your down payment or loan type will be required. Once you build up enough equity in the home then the PMI will stop.
In the early years of your mortgage, interest makes up a greater part of your overall payment, but as time goes by, you start paying more principal than interest until the loan is paid off.
Your lender will provide an amortization schedule (a table showing the breakdown of each payment). This schedule will show you how your loan balance drops over time, as well as how much principal you’re paying versus interest.
Different types of mortgages
Below is a list of the most common types of mortgages available.
Mortgage type | |
Fixed-rate mortgage |
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Adjustable-rate mortgage (ARM) |
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Long-term loans |
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Short-term loans |
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FHA loans |
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Conventional loans |
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VA loans |
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USDA loans |
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How DOES one qualifY for a mortgage
You’ll need to meet minimum requirements based on the type of loan and the down payment and credit score requirements of that loan. Lenders will consider the following when reviewing your mortgage application:
Getting Financing
Start a file and gather all of your important financial documents. Lenders will need information about finances so might as well do that first. Make copies of bank accounts, investments, recent credit cards statement, car and student loans, recent pay stubs, and 2 to 3 years’ worth of tax returns.
Check Your Credit Rating
Your credit score is of one the most important pieces of information that lenders will be looking at. Do pull your credit score and review the information for mistakes or issues you can clear up.
Below is the contact information for the 3 major credit reporting agencies:
Equifax | (800) 685-1111 |
Experian | (800) 392-1122 |
Trans Union | (800) 888-4213 |
Scores of “800” are considered “Very good to Excellent”.
680 + is considered “Premium”.
620-800 is considered “good”.
Is your credit not great? Well there are non profits and government agencies that help you fix your credit score and get you ready to apply for a mortgage.
The good news is that today you can do this from home online. Long and Foster works with a select few lenders that come recommended. If you need help with poor credit or down payment assistance your state housing department can help you with those.
How to choose the right lender?
Evaluate lender based on the following:
- How transparent they are about fees and rates?
- Are they offering competitive rates, costs, and fees?
- Do they have different programs or one size fits all
- Have experience in the type of home and location you are looking to buy?
- Do they have good reviews online?
First of all, you must understand which loan you are getting and what the rate is. Some lenders are going to say one rate but mean another. The one to pay attention to is APR, or annual percentage rate. The APR is the sum of the interest rate plus other loan costs. The APR is going to tell you the total annual cost that you’ll end up paying for borrowing money. Now what rate vs APR, what are the most common loans:
Fixed Loan: The monthly payments will stay the same over the life of the loan, which is typically between 15 and 30 years.
ARMS (Adjustable Rate Mortgage): ARM’s vary in rate over the lifetime of the loan. They start lower than a fixed-rate loan at first, saving you money initially, then vary based on an index based on market rates. Some lenders will tell you what that index and how it is legally fixed. If not they can do so at their discretion and at your cost. Some ARMS (Intermediate/Hybrid) can fix the interest rate for 3,5,7 or 10 years. ARM’s are better if you plan on not living in a home long-term or plan to refinancing in the future and want to take advantage of lower payments now.
Based on the type of loan and terms, the monthly payments can vary widely and how much your total payment (over the lifetime of the loan) is going to be. Best to compare them all and find out which trade-off you are willing to make. Payless per month but pay more long-term or pay more per month and pay less over time.
Other things to consider are:
Points: Your lender might offer you points (fee) to lower interest rates. They will charge you a one-time pre-paid interest payment calculated as a percentage of the loan ranging from 0.25% to 2% of the loan balance. Points are tax-deductible but best to consult with your tax advisor on how they will affect your taxes.
Origination fee: An origination fee is a payment associated with the creation of an account with a lender handling the processing associated with taking out a loan. An origination fee can vary from 1.0% to 5.0% of the loan amount so shop around and negotiate.
Miscellaneous Fees: Lenders will charge borrowers various fees including notary, courier, recording fees. Always best to ask for an explanation and if they are optional or can be waived. Why overpay.
credit score
Your credit score is one of the most important pieces of information that lenders will look at as it shows how you’ve managed debt in the past. The higher the score the better you managed your past debt and therefore the more likely you will be able to manage to pay a mortgage. The higher your credit score, the lower the risk the better the interest rate you will get, and therefore l result in a lower monthly mortgage payment (less interest). Most lenders will require a FICO score of:
- 620 for a 30-year or 15-year fixed rate mortgage or adjustable-rate conventional mortgage
- 580 for FHA government-backed loan
- 500 for FHA government-backed loan with a higher down payment (at least 10%)
debt-to-income ratio
DTI or debt-to-income ratio is the total amount of monthly debt payments divided by your gross monthly income. DTI tells lenders how much mortgage payments you can take on and not exceed your ability to pay all your debts. A DTI of 43% or lower is favorable to most lenders as it is the recommended DTI level by the Consumer Financial Protection Bureau (CFPB). Some lenders will work with borrowers upward of 50% or more but borrowers should be aware that this is a very high number and could impact their ability to manage not only their mortgage payment but their other debts such as college loan, car loans, and credit cards and leave little for incidentals.
income
Your lender will ask for proof of income such as W2, paystubs, several years of tax returns, and other sources of income (alimony, child support, retirement funds, social security or disability payments, dividends, interest earned). They want to see stable income coming in and make sure you can pay the mortgage in the future.
down payment
A down payment, or how much money you are putting into the home is also another factor. If you are putting down 20% that means the bank owns 80% of the house and if they foreclose they will be getting back their money and most expenses from the foreclosure are coming out of your 20% not their 80%. Not all loan programs require a down payment, but the more you put down, the lower the risk for the lender and the lower the rate they are willing to give you. Rates are linked to risk. The less risk for the bank, the lower the rate. Lenders will ask for two to three months of bank statements to show where your funds are coming from. You’ll need to document where the down payment funds came from such as savings, a gift (family or friends), 401(k) loan, or from a down payment assistance program.
Savings & Other assets
Lenders are also going to want that you have money left over after buying a home. You will be paying for points, inspections, closing costs, and fees and the lenders want to make sure you have savings and assets left over to make your mortgage payments in case of job loss or other issues. Lenders can use savings and assets you hold to meet a mortgage reserve requirement such as:
- Money in checking and savings accounts
- Investments in stocks, bonds, mutual funds, CDs, money market funds, and trust accounts
- Vested retirement account assets
- The cash value of life insurance policies
Pre-Qualified vs Pre-Approved
Pre-qualification is usually the first step in the mortgage process and pre-approval is the next step. Pre-qualification means that you supplied financial history and other documents to the lender which reviewed them to estimate how much mortgage you may qualify for. The lender did not do an extensive review and could potentially change the numbers after verifying the information.
Pre-approval is very similar, but it requires more extensive documentation and verification of your income, assets, debts, and a hard inquiry of your credit. A hard inquiry is a request for your full credit history. It stays on your credit report for 2 years and is a small hit to your credit score. Too many hard inquiries can dramatically reduce your credit score, so it’s never a good idea to do too many of those. Pre-approval will tell the lender how big or small a mortgage you can take on as they verified your information and the number they give you + your down payment will tell you how much home you can afford. For sellers, pre-approved is better, as it tells them that your offer is less likely to have issues with financing and more likely to close on time. If your offer comes with pre-qualification you will still need to be approved while pre-approval makes approval a near formality and done much quicker. Your offer with pre-approval will stand out versus the pre-qualified competition.
Credit Score, Cut Spending, Save, and Shop Around
Buying a home is one of the biggest financial decisions, one is likely to make in life. So before you go shopping for a home, you have to shop for a mortgage, and before you do that you start by doing the following:
Get a free credit score report and fix errors
Your credit score is important. It influences your chances of getting a mortgage and how much interest you’ll end up paying. You can check your credit score and improve it by:
- Requesting a free credit report from annualcreditreport.com
- Dispute errors
- Reduce your credit card balances. A debt to line ratio of 30% is a good number. If you have a $1,000 credit line, try to keep the used amount to $300 or pay it off
- Pay all bills on time
- Add bills not showing that you are paying on time like cell phone, utilities, Netflix. Nearly 30% of your score is influenced by on-time payments. The more on-time bills paid are shown the better.
Cut Spending
You will need some savings for your down payment, closing costs, mortgage reserves, furnishing, moving expenses, and other costs. The best way to get there is to save and cut down on unnecessary spending. Those savings could also be applied to reducing or paying off debt before you go mortgage shopping. Then your DTI score will improve making your application look much better to lenders.
Shop for Mortgages
There are multiple lenders, different loan programs, and types of loans out there. From government-backed, conventional loans, 30 year fixed, 15 year fix, or ARMS, and fees and rates will widely vary by loan type and by the lender. Best to shop around lenders and compare different packages to see which one is best for you.
Check with your State for Mortgage Assistance
Nearly every state has a program to assist homebuyers in obtaining a mortgage. To the right, you will find information on some programs in the District of Columbia, Maryland, and Virginia. They can offer everything from getting a loan to consolidating debt with your mortgage to reduce your monthly debt payment.
The Home Purchase Assistance program of the District of Columbia can help first-time homebuyers receive interest-free loans for closing costs. Typically the loan is based on income, family size, total assets, and other factors to determine eligibility.
The state of Maryland has several programs to help first-time homebuyers reach their dreams.
The programs can help with getting loans guaranteed by the Federal Housing Administration (FHA), the U.S. Department of Veterans Affairs (VA), or the U.S. Department of Agriculture/Rural Housing Service (USDA/RHS).
There is even a Down Payment Assistance Program to help pay not only the down payment but also for closing costs, and/or prepaid/escrow expenses.
The SmartBuy program can also help reduce or pay off student debt while purchasing a home.
Check with MMP for eligibility and requirements.
Virginia Housing offers a wide range of loans and assistance to homebuyers in Virginia.
From government-backed loans, down payments assistance or no down payment, credit score assistance, and helping to reduce federal taxes.
Loans are max out by income, purchase price limits, and differ based on location.
Resources on fixing your Credit Score
You don’t need a perfect credit score to get a mortgage but it helps if you want to have a lower mortgage payment. With government-backed loan programs like the FHA, you may be approved for a loan with a credit score as low as 500 with 10% down. But before you go off and apply try to work on fixing your credit score first. There are some credit repair services out there but you can also do it yourself or with the help of nonprofits and government agencies. The following is a list of non-profits and consumer advocacy groups that can guide you on how best to fix your credit score and get ready for buying a home:
American Consumer Credit Counseling Founded in 1991, American Consumer Credit Counseling (ACCC) is a nonprofit that provides confidential consumer credit counseling services, debt management, budget counseling, bankruptcy counseling, housing counseling, student loan counseling, and financial education to consumers nationwide. ACCC is a leader in the credit counseling industry and has national counseling experience. Phone: 800-769-3571 |
Community Credit Counselors, Inc. A non-profit that has been around since 1958 helping consumers take back their finances and manage their debt. Phone: 800-531-5124 |
Money Management International, Inc. This is one of the nation’s leading non-profits and they also operate in Maryland. They help with debt reduction, credit repairs, and applying for mortgage assistance. Phone:: 866-889-9347 |
Maryland Mortgage Program This is a state agency that helps first-time homebuyers navigate the process with support and education as well as helping with credit and getting FHA loans. |
U.S. Department of Housing and Urban Development (HUD) HUD is another great resource for you that will point you to local programs and Federal ones that can really help get you approved for a FHA mortgage even if conventional loans from banks are difficult to get. |