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Today, rates are still relatively low levels, but homebuyers could see rates rise 1% or more by year end.
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What is the difference between an ARM and a Fixed-rate mortgage?
A Fixed-rate mortgage is a mortgage where the interest rate remains fixed during the life of the loan. If you close on a mortgage loan with a 4.0% interest rate – and it’s a 30 (or 25, 20, 15, or 10) year fixed-rate mortgage…that means that your payment (principal and interest) will remain fixed over the life of the loan.
An ARM (or Adjustable-Rate Mortgage) is a mortgage that is fixed only for a short period of time at the beginning of the loan (1, 3, 5, 7, or 10 years), and after that period, the rate will adjust, generally once per year. The adjustment is tied to an index and a margin that sets what the new interest rate will be, and in turn, changes your payment.
Should I do 15 or 30 years?
A 15-year loan has the benefit of a lower overall interest rate – and forces you to pay off the loan in 15 years but has a higher payment as a result. A 30-year mortgage has a slightly higher interest rate, but in turn, will have a lower overall payment. Some people choose a 30-year loan so that they have the flexibility to pay it off sooner but aren’t stuck with a 15 year payment. Other people choose a 15-year loan because they want the lower interest rate and know they won’t have any problems paying the higher payment and want to force themselves to pay the loan off faster.
What is DTI? How is this calculated?
Debt-to-Income (ratio) or DTI ratio is calculated by taking the total of all monthly debt payments (house payment, car, credit cards, installment loans, student loans, child support, alimony) and dividing it by total monthly income.
There are two ratios used in mortgage lending: Front-end (or top) DTI Ratio, which takes the house payment for the new mortgage and divides that by total monthly income, and Back-end (or bottom) DTI ratio, which takes ALL debts – house, car, credit cards, etc) and divides that by the total monthly income.
Most loan programs have guidance on where they want to see the front-end DTI ratio and the back-end DTI ratio. Bottom line – the less debt you have, and the more income you make, the more you can qualify for.
What is MI? Why do I have to pay for this? When does it go away?
Private Mortgage Insurance (or PMI) is insurance that is paid for by the borrower to help offset potential costs of default that a lender can incur when a loan doesn’t perform as expected. As an average, a lender will incur 26% of the value of the home in foreclosure costs (resale costs, attorney and court costs, and rehab costs).
If a borrower puts 5% down, and the lender stands to lose on average 26% of the value of the home – you can see how the math doesn’t work in the favor of the lender. Any conventional loan with a down payment of less than 20% down is required by have mortgage insurance to help offset this risk of loss to the lender.
PMI will disappear on its own when the loan amortizes based off a normal payment stream to 78% of the original sales price or appraised value. However, you can get rid of it sooner than that when you can document at least a 20% equity position in the home if you follow certain rules that the loan servicer will provide.
Will my mortgage payment ever change? Why?
If the loan was originated as a Fixed-Rate Mortgage – no – the principal and interest portion of your payment will never change. It is fixed, contractually, by the terms of the Note.
However, homeowners’ insurance and property taxes, if collected as part of the payment, can change over time, reflecting normal property appreciation and inflation.
Why do I have to pay a full year of homeowner’s insurance at closing and still pay every month?
When you set up an escrow account at closing – you’re required to pay for the first year of homeowner’s insurance at closing. This covers you for the first year. Then, as you make your payment, a portion of your payment is set aside into the escrow account for insurance.
Over the course of the next 12 months – you get closer and closer to the end-date of the original policy period, but in turn, you’re filling up the escrow account with an additional month of insurance money. At the end of the 12 months – your original policy period is over, and you must pay the next year premium to cover yourself for the next year.
That money is pulled from the escrow account that you’ve been filling up for the previous 12 months, and the homeowner’s insurance is renewed for one more year, and the process starts all over again.
Am I contractually stuck to the loan when I sign the LE or ICD?
No – the Loan Estimate (LE) and Initial (or Final) Closing Disclosure (CD) that you sign is not a contract. The terms can freely change. You can decide to put more money down, less money down, buy down the rate, change terms to a shorter-term loan or change to an Adjustable-Rate Mortgage.
It is only intended to disclose certain things to you that were true at the time that the document was sent. Since the Consumer Financial Protection Bureau (CFPB) requires that lenders be able to document that the LE was given to you within 3 business days of formal application, and that the CD was given to you a minimum of 3 business days prior to closing.
There’s no better way to document that those documents were given to you than to have you sign the document acknowledging “Thank you – I have received this – you have done your job”. However, you’ll notice that on both documents, above the signature line, there’s a statement that says, “By signing this document, I am only acknowledging receipt of it”. In other words – you’re only stating, “I got this – thank you.”
But can you change anything? Absolutely. And, once that change is provided to you – you sign that modified LE or CD (known as a “Change of Circumstance LE or CD” with the same acknowledgement.
Can I reduce my interest rate if rates drop?
If your interest rate is locked? No. When you lock in an interest rate with a lender during the processing of the loan, the lender puts the loan into a pipeline hedge.
Without boring you to tears as to how a capital markets pipeline hedge works – in a nutshell, it’s a Wall Street financial vehicle that is used by all lenders nationwide to help manage the fact that once a rate is locked, regular interest rates are still shifting. Think of it as like buying a stock. When you buy a stock (Say, Google, at $2,700/share), and the very next day the share price drops to $2,000…do you call your financial planner and say, “Oh, never mind – I’d like you to buy my Google shares back at the original price, so that I can buy them again at the lower price”? Of course not.
Locking an interest rate functions the same way – when you lock – you’re protecting yourself against the rates going UP in the future. Much like the share of Google – when you buy it at $2,700, and it skyrockets the next day to $3,200…your financial planner won’t call you up and say, “I need that Google stock back”.
So, locking in an interest rate works the same way – you’re protecting yourself against the risk of the rates getting worse.