Guide to Financing Terms
Adjustable Rate Mortgage (ARM).
A mortgage in which the interest changes periodically, according to a term set forth in the note. Interest rate changes will be based upon changes in the appropriate index. All ARMs are tied to indexes.
All Adjustable Rate Mortgages will have (a) an Index (b) Margin (c) Anniversary Date. Some Adjustable Rate Mortgages may also offer features such as (a) Annual Cap (b) Life Time Cap (c) Payment Caps. An ARM loan can be a very confusing instrument to understand. We highly suggest you seek complete understanding. At TCB, we will allow you to speak with our broker, Gary Hart, who has over 40 years experience in the mortgage industry, for a better understanding of Adjustable Rate Mortgages.
ARM (adjustable-rate mortgage) index is the benchmark interest rate to which an adjustable rate mortgage is tied. An adjustable-rate mortgage’s interest rate consists of an index value plus a margin. Some indexes used by Lenders include: Fed Funds Index, Libor Index, Prime Rate, and 10-year Treasury. The Lender will select the index.
ARM Margin.
This is the agreed upon number which will be added to the index which will result in the new interest rate for an adjustable rate mortgage. This is the one feature of an ARM that the borrower can and should shop Lenders for. The higher the margin, the higher your interest rate will be with an ARM. If the index rate is 3 percent and the margin is 2.5 percent, then your fully indexed interest rate would be 5.5 percent. Whereas if your margin is 1.75 percent, the fully indexed rate would be 4.75%. In some shops, loan officers may receive a bonus for selling a higher margin to the borrower. So beware.
5-1 ARM.
An Adjustable Rate Mortgage where the initial interest rate is fixed for the first five years. After 60 payments, the loan becomes a one-year ARM with interest rate adjustments annually. Other examples of this loan type are: 3-1 ARM, 7-1 ARM and 10-1 ARM.
Amortization.
A payment method that first allocates money to the interest due and then, to the principal balance. Based upon the monthly payments required, the loan will be liquidated (amortized) in the specified time.
Annual percentage rate (APR).
This is not the note rate on your loan. It is a value created according to a government formula intended to reflect the true annual cost of borrowing, expressed as a percentage. It works sort of like this, but not exactly, so only use this as a guideline: deduct the closing costs from your loan amount, then using your actual loan payment, calculate what the interest rate would be on this amount instead of your actual loan amount. You will come up with a number close to the APR. Because you are using the same payment on a smaller amount, the APR is always higher than the actual note rate on your loan.
Appraisal.
A written opinion of value performed by an individual licensed as a real estate appraiser. For residential evaluations, the emphasis is based upon analysis of comparable sales of similar homes nearby.
Appraised value.
An opinion of a property’s fair market value, based on an appraiser’s knowledge, experience, and analysis of the property.
Appraiser.
An individual licensed to do appraisal work. Even though some Lenders have in-house appraisers, most appraisers are randomly assigned properties to appraise.
Assumable mortgage.
A mortgage that can be assumed by the buyer, from the seller, when a home is sold. Usually, the borrower must “qualify” in order to assume the loan. VA and FHA are examples of assumable mortgages. Conventional loans are not assumable.
Balloon Mortgage.
A mortgage loan that requires the remaining principal balance be paid at a specific point in time. For example, monthly payments are based upon a 30-year amortization, but require the entire principal balance to be paid after 10 years.
Balloon Payment.
A lump sum payment due at the termination of a balloon mortgage.
Bi Weekly Mortgage.
A program that allows you to save interest over the life of your loan. A popular version of making additional principal payments is a Biweekly mortgage, meaning you will make additional principal payments on your mortgage every two weeks. You can pay off a 30-year mortgage in approximately 21 years by making 13 payments every year – in other words every six (6) months you pay half your mortgage payment as additional principal. You can engage the services or a company to manage your additional principal payments or you can do it yourself. Should you do it yourself, you should send a separate check (for additional principal payment) and clearly indicate the extra money is to be applied to principal reduction and not placed into your escrow account.
Blanket mortgage.
A mortgage, or Deed of Trust, that covers more than one parcel of real estate. It may or may not provide for each parcel’s partial release from the mortgage lien on repayment of a definite portion of the debt.
Bridge Loan.
A temporary or gap loan used when a seller has not closed on their home but needs an advance of the equity from their home to close on the home they are purchasing.
Budget Loan.
A loan which the monthly mortgage payments include principal and interest payment and 1⁄12 of such expenses as taxes, insurance assessments, private mortgage insurance premiums, and similar charges. The additional payments are placed into an escrow for future payments.
Buydown.
A temporary payment subsidy. A typical buydown would be a 3-2-1, which means the borrower’s monthly payment will be subsided 3% for the first year, 2% for the second year and 1% for the third year. Buydowns are popular in times of higher mortgage rates. After the expiration of the “buydown period” borrower’s payment is calculated at the note rate. To facilitate the payment subsidy, a lump sum is escrowed and the portion of payment subsidy is withdrawn monthly. Buydown funds can be paid for by the seller, buyer, or lender. When mortgage rates are higher than normal, a buydown program can make it easier for you to qualify. It can be utilized for Adjustable Rate or Fixed Loans but more popular for Fixed Rate Loans.
Certificate of Eligibility.
A document issued by the Veterans Administration that certifies a veteran’s eligibility for a VA loan.
Certificate of Reasonable Value (CRV).
Certificate of Reasonable value is the appraised value when a VA guaranteed loan is used by Veteran borrower.
Closing Costs.
Closing cost are those fees paid by the buyer and seller at time of closing.
Buyer’s closing cost include items such as: Transfer and Recordation Tax, Title Fees, Title Insurance Fees, Inspection Cost, Home Owners Insurance Premium, Monies collected for Lender Escrow account, Termite Inspection, Prorated Property Taxes due to seller etc.
Sellers Closing Cost includes: Real Estate Commissions, Transfer and Recordation Fees.
Closing Disclosure Statement (replaced the HUD1).
The first page of the Closing Disclosure is almost identical to Page 1 of the Loan estimate, which was provided to the borrower at time of mortgage application. It describes the Loan terms, Loan amount, Interest rate, Monthly P&I and any prepayment penalty or Balloon payment. This page also provides the projected payments over the life of the loan. The document also discloses to the borrower what amounts will be deposited into their impound or escrow account and provides the total estimated closing costs and cash to close.
The second page is similar to Page 2 of the HUD-1 Settlement Statement. It provides a breakdown of all the closing cost details and lists all loan costs and other costs paid by borrower, seller, and other parties.
Co-borrower.
An individual who is obligated on the loan and is also a co-owner of the property. This is juxtaposed to a Loan Guarantor, who signs the note securing personal obligation to repay the debt, but is not an owner and thus does not sign the Mortgage or Deed of Trust.
Conforming Mortgages.
Securitized mortgages sold on the secondary market that meet certain requirements established by Fannie Mae and Freddie Mac. These loan types will have same maximum loan amounts and underwriting guidelines. See Non-Conforming or Jumbo Mortgages.
Construction Loan.
A short-term, interim loan used for financing the cost of construction. The lender makes payments, based upon a draw schedule, to the builder at periodic intervals as the work progresses.
Conventional Mortgage.
A home loan that is not guaranteed or insured by a government agency such as VA, FHA, and USDA. These loans are available thru a variety of institutions such as Lenders, Mortgage Bankers, or local Banks and are often referred to as a Fannie Mae or Freddie Mac loan.
Convertible ARM.
An Adjustable Rate Mortgage that may convert to a Fixed Rate mortgage.
Credit Score.
Your credit score is important in the mortgage approval process. Your credit score will be evaluated in conjunction with your down payment. A larger down payment lowers the Lender risk that may allow for loan approval with a lower credit score. Below are acceptable ranges for different mortgage loans:
- Conventional Loan – 620+ credit score
- FHA Loan – 580+ credit score (500-579 score is possible but unlikely)
- FHA 203K Loan – 620+ credit score
- VA Loan – 620+ credit score (some lenders require 580)
- USDA Loan – 620+ credit score
Deed of Trust.
Some states use Deed of Trust in lieu of Mortgage Instruments. Under the terms of a Deed of Trust, the borrower conveys title to a trustee, who holds it as security for the benefit of the Lender. Deeds of Trust are commonly used in Maryland as the instrument to secure real property for repayment of a loan. In these definitions, we use the term “mortgage” to include Deeds of Trust.
Deficiency Judgment.
A personal judgment levied against the mortgagor when a foreclosure sale does not produce sufficient funds to satisfy the mortgage debt in full.
Delinquency.
Occurs when the borrower fails to make mortgage payments when mortgage payments are due. For most mortgages, payments are due on the first day of the month and considered delinquent after a 15-day grace period. Failure to pay within 30 days could result in the loan being in default.
Discount Points.
A fee charged by a lender, to make the yield on a lower-than-market-value loan competitive with higher-interest loans. Each discount point equals one percent of the loan amount and is estimated to equal approximately 1/8 percent of interest on a 30-year loan. It is not unusual for a lender to charge a loan origination fee, which is industry jargon for a loan discount fee. Example, a 6.875% loan with one discount point is equal to a 7% loan without the point.
Down Payment.
The part of the purchase price that the buyer pays in cash and does not finance with a mortgage. A VA loan does not require a down payment, thus a veteran can borrow 100% of the purchase price. A FHA loan requires a 3.5% down payment and a Conventional loan requires a minimum of 3% down payment.
Escrow Account.
An account with your Lender, used to pay future obligations such as property taxes and hazard insurance. The account will be initially funded at time of closing. See also Budget Mortgage.
Fixed Rate Mortgage.
A home loan in which the interest rate is fixed for the duration of the loan term. This is contrasted with an Adjustable Rate Mortgage, which allows the interest rate to change during the loan term.
Fair Housing Administration (FHA).
An agency of the U.S. Department of Housing and Urban Development (HUD). Its main activity is the insuring of residential mortgage loans made by private lenders. The FHA sets standards for construction and underwriting but does not lend money.
FHA Mortgage.
A loan that is insured by the Federal Housing Administration (FHA). Along with VA loans, an FHA loan will often be referred to as a government loan.
FHA loans can be either Fixed or an Adjustable Rate Mortgage. Terms for these loans can be between 15 and 30 years.
The FHA 203(b) loan insurance program is the most popular FHA loan program. A 203-B loan requires a minimum down payment of 3.5% of the purchase price. A seller may pay up to 6% of the sales price toward buyers’ closing cost. FHA mortgage insurance is required. The FHA 203(b) “may be used to purchase or refinance a new or existing one-to-four family home in both urban and rural areas including manufactured homes on permanent foundations”. FHA does not lend the money but rather insures loss to the FHA approved Lender.
The 203-K is an “open end” FHA loan, which means additional monies will be available to the borrower after closing. The 203k loan helps the borrower open up one loan to pay for the purchase price of the home, plus the cost of repairs.
FHA loans require mortgage insurance where the down payment is less than 20%. Of course, a borrower with a 20% down payment will apply for a convention loan not FHA. The insurance on an FHA loan has to parts – an upfront fee (UFMIP) and a monthly fee (MMI). The UFMIP is 1.75% of the loan amount which is payable to FHA at time of closing – to offset cash required by the borrower the Lender will pay the premium to FHA – adding the premium amount to the loan. Additionally, the borrower will be required to pay an annual insurance premium to HUD (FHA) based upon .0045 to .0095 of the loan amount – the annual premium divided by 12 equals required monthly insurance payment. The annual premium is based upon the LTV, loan amount and loan term – thus the range of approximately ½ percent to 1% annually.
Flood Certification.
A fee, typically less than $15, charged to obtain the government-required document used to determine whether the subject property is located in a flood plain. Federal Emergency Management Agency (FEMA) flood maps are examined using the address or geographic coordinates of the property. If the property is located in a flood plain, then the Lender will require a Flood Insurance policy which is payable annually and will be escrowed by the Lender for payment.
Foreclosure.
The legal process by which a borrower in default under a mortgage is deprived of his or her interest in the mortgaged property. This usually involves a forced sale of the property at public auction with the proceeds of the sale being applied to the mortgage debt.
Funding fee.
A fee required by the Department of Veterans Affairs for guaranteeing a VA loan. The funding fee can be added to loan amount (financed) or paid cash. This fee is payable to the Veterans Administration.
Gift Letter.
A monetary gift, typically from a parent, that is used as down payment or closing cost. The gift letter must clearly show the funds are a gift and NOT a loan. The gift letter should include:
- The donor’s name, current address and home phone number
- The donor’s relationship to the client (e.g. card is signed, “Love, Mom & Dad”)
- The exact dollar amount enclosed
- The date of the fund transfer (in legible format MM-DD-YYYY)
- A clear statement from the donor expressing that no repayment is expected
- The donor’s clear signature
- The address of the property to be purchased
Some Lenders will also verify the donor’s capacity to give. In words, they will verify the donor’s bank statements.
Graduated Payment Mortgage.
A mortgage loan, for which the initial payments are low, but increase over the life of the loan. These types of mortgage plans are most popular when interest rates are high. During the early 80’s, FHA had several Graduated Mortgage Plans – known as FHA 245 loans.
Home Equity Conversion Mortgage (HECM).
Usually referred to as a reverse annuity mortgage, these loans are available to persons 62 and older and, as the name implies, the premise of the program is to allow senior citizens to borrow from the equity in their home. There are some Conventional Reverse mortgages, by far the most popular reverse is insured by FHA and referred to as a HECM loan – Home Equity Conversion Loan. There are no income qualifications and there are no monthly payments. You can borrow a percentage of the equity in your home based upon your age – the older the higher percentage of equity you can borrow. There are three options: (a) receive the proceeds as cash, (b) receive the proceeds as a monthly check sent to you, or (c) place the proceeds into an equity line which you can withdraw from in the future. The loan is a non-recourse loan, which means you have no personal liability to repay the loan other than the lien on your home. The borrower is responsible to maintain property insurance and pay the property taxes. The loan is repayable when the borrower no longer lives on the property. Each borrower must receive HECM counseling before proceeding with the loan application.
Home Equity Line of Credit.
A mortgage loan, usually in second position, that allows the borrower to obtain cash drawn against the equity of their home. Loan amounts are based on borrower’s equity in the property and other factors such as credit, income etc.
Installment Sale.
A contract (normally recorded in the land records) where the purchase price is paid over in a series of installment payments. Legal Title remains in the seller’s name and purchaser has equity. If the sale meets certain requirements, a taxpayer can spread recognition of the reportable gain over more than one year, which may result in tax savings. Also known as a Contract for Deed or Land Installment Contract.
Interest Rate Cap.
The instrument (number) used to control interest rate changes with Adjustable Rate Mortgages (ARM). Interest rate caps are generally expressed as an Annual Cap or Life Cap. Annual caps are most often expressed as the maximum change that occur within a period of time – example maximum 1% change per year, Life Caps set the max interest rate over the life of the loan. ARMS are very sophisticated loans and the borrower should fully understand concepts such as: Is there a carryover provision on annual caps? What is the index? What is the Margin? –the higher the Margin the more likely your interest rate will increase.
Insured Conventional.
A conventional loan, with less than 20% down payment or a loan to value ratio (LTV) exceeding 80%. This loan type requires private mortgage insurance, which protects the Lender from potential loss.
Lender Credits.
Lenders may offer to pay certain of the buyers’ closing cost subject to same limitations as “Seller Credits”. Generally, lender credits means the loan has an interest rate higher than market rate.
Loan Origination.
A fee charged by the Lender for processing a mortgage loan. Another term for this is a discount fee.
Loan-to-Value (LTV).
The percentage relationship between the amount of the loan and value of the property. A 90% LTV means the borrower had a 10% down payment and borrowed 90% of the purchase price. Different loan types allow for higher LTV ratios. VA loans cover 100% of the LTV (no down payment required). FHA loans cover 96.5% or 3.5% down payment. Some conventional loans allow up to 97% LTV or as little as a 3% down payment.
Lock-in.
An agreement where the Lender guarantees an interest rate and cost for a period of time. Lock-in periods are generally 30-60 days and will differ between Lenders. The opposite of a lock-in is a “float” where the interest rate will not be locked in until some future event such as loan approval or within days of closing.
Mortgage Application.
The form used to apply for a mortgage loan, containing information about a borrower’s income, savings, assets, debts, and more. Also known as the 1003.
Mortgage Approval.
There are two components to a Lender issuing a “Mortgage Approval Letter”. The first component is the property, which would act as security for repayment of the loan. The 2nd component is the borrower. To insure the property is sufficient security, the Lender will order an appraisal of the property.
The Lender will review several aspects of the borrower to establish their ability to make the required monthly payments. The Lender will review: (a) Borrowers’ credit history (b) Borrowers’ credit score (c) Employment history (d) Employment stability (e) Past and current earnings (f) Qualifying ratios. Each of these items will need to be verified to the satisfaction of the Lender.
Mortgage Banker.
A mortgage banker originates and funds their own loans, which are then sold either to an investor (another Lender) or on the secondary market such as Fannie Mae, Freddie Mac, or Ginnie Mae. However, firms rather loosely apply this term to themselves, whether they are true mortgage bankers or simply mortgage brokers.
Mortgage Broker.
A mortgage company that originates loan applications, then places those loans with a lending institution with whom they have pre-established relationships. Brokers are paid a fee (commission) by the Lender, at time of closing which is fully disclosed to the borrower.
Mortgage Deduction.
Annual mortgage interest paid and property taxes are deductible from Federal and State income taxes. By deducting mortgage interest and taxes from your gross income, your taxable income is reduced. For example:
$400000 Mortgage at 4%.
Monthly PI = $1908
Monthly Property Taxes: $333
Property Insurance =$100.
Total Monthly PITI = $2341
Gross taxable income of $100000
Mortgage Interest $17000
Property Taxes $4000
Federal Tax Bracket 22%
State Income Tax Bracket 5%
Taxes Due before Deduction: Federal – $22000 (.22*100000).
State Taxes Due – $5000
Tax Due After Deduction:
Federal $17380(($100000 minus $21000)*.22)
State Taxes Due $3950
Tax Saving Federal $4620
State Income Tax Savings $1050
Total Tax Savings: $5670
Short Cut Calculation: Federal $21000 (deduction) * .27 (Tax Bracket Federal & State) = $5670 Tax Savings
Net effective payment after tax savings:
Total PITI (Principal & Interest. Property Taxes and Insurance) = $2341 minus $472.50 (Monthly Tax Savings) = $1869 (Net Effective Payment).
The above example demonstrates that a mortgage payment of $2341 is comparable to paying rent of approximately $1900 per month.
Mortgage insurance (MI or PMI) is not deductible.
This is a general overview and you should check with your tax professional for further understanding.
Mortgage insurance (MI).
Insurance that covers the lender against loss due to loan default. The higher the LTV (loan to value ratio) the greater the risk to the lender. Thus, loans with an LTV greater than 80% (20% down payment) require insurance to the Lender to offset the additional risk. For conventional loans, the insurance is often referred to as PMI (Private Mortgage Insurance), even though PMI is actually the name of an insurance company for conventional loans. For conventional loans, the insurance premium can be paid one of several ways: (1) One time premium paid at closing (2) monthly premiums paid with the mortgage payment (3) Lender funded – usually based upon a higher interest rate on the mortgage. Annual PMI payments range from about .005 (1/2 of 1 percent) to .01 (1%) annually.
Mortgage insurance premium (MIP).
FHA loans require mortgage insurance where the down payment is than 20%. Of course, a borrower with a 20% down payment will apply for a convention loan not FHA. The insurance on a FHA loan has to parts – an upfront fee (UFMIP) and a monthly fee (MMI). The UFMIP is 1.75% of the loan amount which is payable to FHA at time of closing – to offset cash required by the borrower the Lender will pay the premium to FHA – adding the premium amount to the loan. Additionally, the borrower will be required to pay an annual insurance premium to HUD (FHA) based upon .0045 to .0095 of the loan amount – the annual premium divided by 12, equals the required monthly insurance payment. The annual premium is based upon the LTV, loan amount and loan term – thus the range of approximately ½ percent to 1% annually.
Mortgage life insurance.
A type of term life insurance available to borrowers. The term of the policy will be based upon the term of the mortgage. The face amount of the policy will be the declining amount of the mortgage balance. The premise or rationale for purchasing the insurance is simply that the mortgage will be paid off upon the death of the borrower – typically a younger couple that has ability the pay the mortgage payments are based upon both borrower’s income.
Mortgage Term.
The duration of the loan to amortize (payoff) the original principal amount plus interest. Typically, younger home buyers opt for a 30-year loan term whereas old borrowers may choose a 15-year loan term. The longer the term the more interest a borrower will pay over the life of the loan.
A $100,000 loan at 4% for 30 years will require a monthly payment of $477. The first payment will be allocated as 75% interest and 25% as principal reduction. Over the 30-year period, you will make total payments of $171,720 of which $71800 will be interest (42% of payments).
A $100,000 loan at 4% for 15 years will require a monthly payment of $740. The first payment will be allocated as 43% interest and 57% as principal reduction. Over the 15-year period, you will make total payments of $133,144 of which $33144 will be interest (25% of payments).
As you can see from the two examples, you can save thousands of dollars in interest by shortening the mortgage term. Of course, your monthly payments will be higher.
Negative amortization.
Negative amortization occurs when the required monthly PI (principal and interest) is insufficient to cover the interest payment due. Example, $100,000 loan at 6% with a monthly payment capped at $450 would have negative amortization of $50 per month – (interest due would be $500 per month). This is unusual and can only occur with a FHA 245 loan or an ARM (adjustable rate) where there is an artificial payment cap that does not reflect the current interest rate on the loan.
No cash-out refinance.
This refinance transaction is not intended to put cash in the hand of the borrower. Instead, the new balance is calculated to cover the balance due on the current loan and any costs associated with obtaining the new mortgage. Often referred to as a “rate and term refinance.”
No-cost loan.
Many lenders offer loans that you can obtain at “no cost.” You should inquire whether this means there are no “lender” costs associated with the loan, or if it also covers the other costs you would normally have in a purchase or refinance transactions, such as title insurance, escrow fees, settlement fees, appraisal, recording fees, notary fees, and others. These are fees and costs, which may be associated with buying a home or obtaining a loan, but not charged directly by the lender. Keep in mind that, like a “no-point” loan, the interest rate will be higher than if you obtain a loan that has costs associated with it.
Open-end mortgage.
A mortgage loan that provides the borrower with additional money after closing. Construction loans or FHA 203-K loans are examples of “open end mortgages”. In a 203K loan, purchase money funds are available at closing (to purchase the house) and additional funds are available to make upgrades to the property.
Origination fee.
Origination fees are discount points charged to the borrower. A discount point is equal to 1% of the loan amount and be charged in increments – 1/2 point etc. On Government loans there is a cap of 1 origination point that may be charged to the borrower. See also discount points.
Payment Cap.
An artificial payment cap may be a provision of an Adjustable Rate Mortgage. The “Cap” would limit the amount of payment increase due an interest rate increase.
PITI.
Which stands for Principal and Interest plus Taxes plus Insurance. Principal & Interest is the minimum monthly payment required on a mortgage. Taxes refer to 1/12 of the annual property taxes. Insurance equates to 1/12 of the annual property insurance. These funds are placed in an escrow and disbursed to pay annual property taxes and insurance.
Example: $400000 mortgage at 4% with a 30-year term. Property taxes are $4000. Property Insurance is $1200. The monthly PITI is:
$1908 – principal and interest payment
$333 – property taxes
$100 – property insurance
$2341 – total payment or PITI
Pre-approval.
The process of a borrower obtaining mortgage approval, prior to entering into a purchase contract. A loosely used term, which is generally taken to mean that a borrower has completed a loan application and provided debt, income, and savings documentation which an underwriter has reviewed and approved for a certain loan amount. There are degrees of a “pre-approval”. A pre-approval letter may or may not indicate whether the Lender has analyzed the borrowers’ credit. Generally, the potential borrower has provided information regarding, income, debt savings etc. to the Lender, however, the Lender has not verified the information. Thus, the “pre-approval” is conditioned upon the Lender verifying the information as provided, by the borrower, as part of the normal loan approval process. Pre-qualification means a loan officer has done some calculations that would indicate a borrower would qualify for a loan amount based upon information provided. Quite often, the “pre-approval” letter is nothing more than a pre-qualification, which is based upon unverified information.
Ratios.
Qualifying ratios are used in the mortgage approval process in an attempt to assure borrowers can afford the monthly mortgage payment. The ratios are guidelines which are based upon a percentage of gross monthly income that should be allocated to mortgage payment and other re-occurring monthly debts. The ratios vary slightly between mortgage types – historically conventional loans have had ratios of 28 and 36. Fannie Mae has recently indicated that, in some cases, back ratios may be in the 45-50% range.
Underwriting guidelines will vary depending upon the mortgage type. Conventional ratios will vary depending upon the amount of down payment. FHA underwriting guidelines are different than conventional, or VA.
Qualifying ratios are one part of the underwriting approval process. These will be evaluated in conjunction with other aspects of the borrower profile such as past payment history, past mortgage payments, income stability, down payment, amount of cash reserves after closing, and overall credit score.
The mortgage approval process is more an art than a science thus Lenders may differ in their approach to underwriting of mortgage applications.
Example of conventional ratios:
$100,500 combined household income or $8375 monthly
Re-occurring monthly debts $800
Front Ratio: $8375 * .28 = $2345 = Allowable monthly PITI
Back Ratio: $8375 *.36 = $3015 = Allowable PITI plus other debts
Proposed $400000 mortgage at 4% for 30 years = $1908 Principal and Interest monthly
Taxes are $4000 annually and Insurance is $1200 annually
Proposed PITI = $2341 is within allowable payment as per the “front ratio”
Proposed total Monthly obligation: $3141, which is slightly higher than allowed for in the “back ratio” of $3015. The borrower exceeds the guidelines by $126 monthly. In this scenario, the “front ratio” is fine but the “back ratio” would be 37.5% or 1.5% above the guidelines.
Possible solutions:
- Based upon the proposed loan to value (LTV), the higher “back ratio” may not present a problem. If the LTV is 80% or less (20% or more down payment) and other factors such as strong credit score then the underwriter may accept approve the loan with the higher back ratio.
- The underwriter may accept offsetting factors such as very good credit scores, large savings accounts or other lifestyle factors which may allow for the higher than normal ratio.
- Lower mortgage amount by $26000
- Lower monthly debts by $126. This may be accomplished by paying down the principal balance so that the debt will be paid off in 10-12 months.
Real Estate Leverage.
Leverage is the 2nd greater advantage in purchasing real estate after income tax deductions. Even though the concept is most appropriate to investing in real estate it can also be applied home ownership. What is leverage? Simply, leverage is utilizing borrowed money to maximize your return on an investment. Below two examples will illustrate the concept.
Example One. Cash Transaction. A $400000 property is purchased with cash. The property increases at an annual rate of 3%. The annual rate of return on cash investment is $12000 (.03*400000).
Example Two. A leveraged purchase. A $400000 property is purchased with a $360000 mortgage (90% LTV). The purchaser has invested $40000 cash. The property increases in value at an annual rate of 3% or $12000. The rate of return on cash investment is 30% (12000/40000). The rate of return, on cash, is 10 times the rate compared to the cash transaction. In this example, the purchaser is gaining wealth by using borrowed funds.
Of course, in the above example, assume real estate is appreciating.
Refinance Cash Out.
A loan that allows the borrower to obtain cash after paying off mortgage balance and closing cost. Funds are given to the borrower as cash, which they may use to pay off consumer debt (credit cards) and spend as they wish. Also known as a debt consolidation loan.
Refinance Streamline.
Amount of new loan will payoff existing loan balance plus closing cost. With a streamline refinance: (a) borrower may not need to qualify (b) no property appraisal is required (c) no cash is allowed to borrower. Existing VA and FHA loans may be eligible for a streamline refinance.
Renegotiable Rate Mortgage.
A mortgage loan that allows for a fixed rate for a given period of time and thereafter must be renegotiated thereafter for similar periods of time. A variation of an Adjustable Rate Mortgage (ARM).
Reverse Annuity Mortgage.
See definition for HECM loan.
Seller Credits.
Seller agrees to pay all or a portion of the buyers’ closing cost. For most loan programs there are limitations.
Conventional Loans: 9% seller concessions for loans with a loan-to-value (LTV) of 75% or less; 6% seller concessions for loans with LTVs between 75 and 90%; and, 3% seller concessions for loans with an LTV over 90%.
FHA Loans: the seller and other interested parties can contribute up to 6% of the sales price or toward closing costs, prepaid expenses, discount points, and other financing concessions.
VA Loans: The VA permits seller concessions, but requires that seller concessions do not exceed 4% of the loan amount. … Paying the buyer’s VA funding fee, Paying off judgements or credit balances on the buyer’s behalf.
USDA seller concession limits are limited to 6% of the loan amount.
Subordination agreement.
An agreement that changes the order of priority of liens between two creditors. When refinancing, an existing 2nd mortgage may need to be subordinated to allow refinance of a new 1st mortgage.
USDA Mortgage.
USDA loans are zero-down-payment mortgages for rural and suburban homebuyers. USDA loans are issued through the USDA loan program, also known as the USDA Rural Development Guaranteed Housing Loan Program, by the United States Department of Agriculture. USDA home loans are issued through private lenders and are guaranteed by the United States Department of Agriculture (USDA). The USDA loan’s purpose is to provide affordable homeownership opportunities to low-to-moderate income households to stimulate economic growth in rural and suburban communities throughout the United States.
Because USDA loans are meant to assist low-to-moderate income homebuyers, the USDA sets income limits based on the property’s location and household size. USDA eligibility for a 1-4-member household requires annual household income to not exceed $86,850 in most areas of the country, but up to $212,550 for certain high-cost areas, and annual household income for a 5-8-member household to not exceed $114,650 for most areas, but up to $280,550 in expensive locales.
USDA counts the total annual income of every adult member in a household towards the USDA income limit, regardless if they are a part of the loan.
USDA loans are only available to home buyers wishing to purchase in what the USDA considers a rural areas, although some suburban areas may be eligible as well. The USDA defines a qualified “rural” area as any area with a population under 35,000, is rural in character, and has a serious lack of mortgage credit for low- and moderate-income families. Additionally, USDA loans are only available to home buyers wishing to purchase a single-family home that will be their primary residence. Homes with acreage may be eligible, if the site size is typical for the area and not used principally for income-producing purposes. Income-producing property and vacation homes do not qualify. Boundary lines for USDA property eligibility can change every year.
The USDA offers two different loan options to help rural families achieve the dream of home ownership: the USDA Guaranteed Loan and the USDA Direct Loan. The primary difference in the two programs is who funds the loan. With the guaranteed loan, a USDA-approved lender issues the loan. However, with the direct loan, the USDA issues the loan and provides payment assistance in the form of a subsidy. While the purpose of both loan programs is to boost home ownership in rural areas, the two programs have significant differences and are meant for two very different financial situations.
For example, with the USDA direct loan, the home buyer must:
- Not have access to safe or sanitary housing
- Have an income classification as low or very low
- Be unable to obtain financing anywhere else
- Not be suspended or banned from participating in federal programs
Maryland Counties Eligible for USDA loans:
Allegany – Partially Eligible.
Anne Arundel – Partially Eligible
Baltimore – Partially Eligible.
Calvert – 100% Eligible.
Caroline – 100% Eligible.
Carroll – Partially Eligible.
Cecil – Partially Eligible.
Charles – Partially Eligible.
Dorchester – 100% Eligible.
Frederick – Partially Eligible.
Garrett – 100% Eligible.
Harford – Partially Eligible.
Howard – Partially Eligible.
Kent – 100% Eligible.
Montgomery – Partially Eligible.
Prince Georges – Partially Eligible.
Queen Anne’s – 100% Eligible.
Somerset – 100% Eligible.
St Mary’s – Partially Eligible.
Talbot – 100% Eligible.
Washington – Partially Eligible.
Wicomico – Partially Eligible.
Worcester – Partially Eligible
VA Mortgage.
A mortgage that is guaranteed by the Department of Veterans Affairs (VA). Normally, VA is the not the Lender but rather guarantees potential loss to the Lender. A Veteran may borrower 100% of the purchase price (zero down payment). A seller may pay all or any part of the VA buyers’ closing cost. A Lender may pay the closing cost (Lender credit). VA restricts certain closing costs that the veteran may not pay.
There is a requirement for a VA Funding Fee at time of closing. The funding fee can be added to loan amount (financed) or paid cash. This fee is payable to the Veterans Administration. For regular military borrowers with no down payment, the funding fee is 2.15%. The fee increases to 3.3% for borrowers with previous VA loans. For those with a down payment of 5% to 9%, the funding fee is 1.5%. Any loans with a down payment of 10% or higher will include a funding fee of 1.25%. Disable Veterans can be exempt from the funding fee.
The VA loan guarantee is based upon a Veteran or a Veteran and their spouse obtaining a VA loan. If a Veteran is buying with a co-borrower that is not a spouse or an eligible veteran then the VA loan guarantee will be based upon 50% of the purchase price. This scenario would require a down payment of approximately 25% of the purchase price.