Mortgage Loans
If you are a first time home buyer or have purchased
many homes, the type of mortgage loan you select is
very important in Philadelphia. It is also very important
to prepare and know what is going to be expected when
applying for a mortgage. Below are tips on applying
for your home loan.
Applying for a home loan
Applying for a home mortgage loan may not be the most
exciting way to spend your time, but if you are like
many potential homeowners, it is probably a necessary
evil. If you have some knowledge of the process ahead
of time, however, it will go much more smoothly.
Home mortgage loan applications tend to be very long,
but if you are prepared ahead of time you can finish
the application procedure without breaking a sweat.
Before you begin filling out the form, make sure you
have available your Social Security number, information
pertaining to previous employers and residences, recent
pay stubs, copies of credit card and loan statements,
copies of bank statements and asset information such
as stocks, pension and retirement funds.
Information about interest rates
Where to find mortgage interest rates -
You can find information about mortgage interest rates
from lenders or brokers, in newspapers, or on the Internet.
You can search on the term “mortgage interest
rate” and find a variety of web sites that will
give you estimates of interest rates for various types
of mortgages. You can also search on some of the common
interest-rate indexes used for mortgages, such as constant-maturity
Treasury (CMT) securities, the Cost of Funds Index (COFI),
and the London Interbank Offered Rate (LIBOR).
ARM interest rates--the index and the margin
The interest rate on an ARM is made up of two parts:
the index and the margin. The index is a measure of
interest rates generally, and the margin is an extra
amount that the lender adds. If the index rate moves
up, so does your interest rate in most circumstances,
and you will probably have to make higher monthly payments.
On the other hand, if the index rate goes down, your
monthly payment could go down. Not all ARMs adjust downward,
however--be sure to read the information for the loan
you are considering.
Lenders base ARM rates on a variety of indexes. Among
the most common indexes are the rates on 1-year constant-maturity
Treasury (CMT) securities, the Cost of Funds Index (COFI),
and the London Interbank Offered Rate (LIBOR). A few
lenders use their own cost of funds as an index rather
than using other indexes. You should ask what index
will be used, how it has fluctuated in the past, and
where it is published--you can find a lot of this information
in major newspapers and on the Internet.
To determine the interest rate on an ARM, lenders add
a few percentage points to the index rate, called the
margin. The amount of the margin may differ from one
lender to another, but it is usually constant over the
life of the loan. The fully indexed rate is equal to
the margin plus the index. If the initial rate on the
loan is less than the fully indexed rate, it is called
a discounted index rate. Some lenders base the amount
of the margin on your credit record--the better your
credit, the lower the margin they add--and the lower
the interest you will have to pay on your mortgage.
In comparing ARMs, look at both the index and margin
for each program.
Interest rate caps - An interest-rate
cap places a limit on the amount your interest rate
can increase. Interest caps come in two versions:
- periodic adjustment caps, which limit the amount
the interest rate can adjust up or down from one adjustment
period to the next after the first adjustment,
- lifetime caps, which limit the interest-rate increase
over the life of the loan. By law, virtually all ARMs
must have a lifetime cap.
Payment cap
In addition to interest-rate caps, many ARMs--including
payment-option ARMs--limit, or cap, the amount your
monthly payment may increase at the time of each adjustment.
For example, if your loan has a payment cap of 7½%,
your monthly payment won't increase more than 7½%
over your previous payment, even if interest rates rise
more. So if your monthly payment in year 1 of your mortgage
was $1,000, the payment could only increase to $1,075
in year 2 (7½% of $1,000 is an additional $75).
Any interest you don't pay because of the payment cap
will be added to the balance of your loan. A payment
cap can limit the increase to your monthly payments
but also can add to the amount you owe on the loan.
Interest rate adjustment period
The initial rate and payment amount on an ARM will remain
in effect for a limited period of time--ranging from
just 1 month to 5 years or more. For some ARMs, the
initial rate and payment can vary greatly from the rates
and payments later in the loan term. Even if interest
rates are stable, your rates and payments could change
a lot. If lenders or brokers quote the initial rate
and payment on a loan, ask them for the annual percentage
rate (APR). If the APR is significantly higher than
the initial rate, then it is likely that your rate and
payments will be a lot higher when the loan adjusts,
even if general interest rates remain the same.
With most ARMs, the interest rate and monthly payment
change every month, quarter, year, 3 years, or 5 years.
The period between rate changes is called the adjustment
period. For example, a loan with an adjustment period
of 1 year is called a 1-year ARM, and the interest rate
and payment can change once every year; a loan with
a 3-year adjustment period is called a 3-year ARM.
ARMs often are advertised as 3/1 or 5/1 ARMs--you might
also see ads for 7/1 or 10/1 ARMs. These loans are a
mix--or a hybrid--of a fixed-rate period and an adjustable-rate
period. The interest rate is fixed for the first few
years of these loans--for example, for 5 years in a
5/1 ARM. After that, the rate may adjust annually (the
1 in the 5/1 example), until the loan is paid off. In
the case of 3/1 or 5/1 ARMs
- first number tells you how long the fixed interest-rate
period will be and
- second number tells you how often the rate will
adjust after the initial period.
You may also see ads for 2/28 or 3/27 ARMs--the first
number tells you how long the fixed interest-rate period
will be, and the second number tells you the number
of years the rates on the loan will be adjustable. Some
2/28 and 3/27 mortgages adjust every 6 months, not annually.
Graduated-payment or stepped-rate loans
Some fixed-rate loans start with one rate for one or
two years and then change to another rate for the remaining
term of the loan. While these are not ARMs, your payment
will go up according to the terms of your contract.
Talk with your lender or broker and read the information
provided to you to make sure you understand when and
by how much the payment will change.
15-year fixed rate
This is often called a traditional mortgage. The interest
rate is fixed across the 15-year term. For the comparison
calculator, use the contract interest rate for the mortgage,
not the annual percentage rate (APR). For example, if
the contract interest rate is 6.5% plus 1 point, enter
6.5.
30-year fixed rate
This is often called a standard or traditional mortgage.
The interest rate is fixed across the 30-year term.
For the comparison calculator, use the contract interest
rate for the mortgage, not the annual percentage rate
(APR). For example, if the contract interest rate is
6.5% plus 1 point, enter 6.5.
Adjustable-rate mortgage (ARM)
A mortgage that does not have a fixed interest rate.
The rate changes during the life of the loan based on
movements in an index rate, such as the rate for Treasury
securities or the Cost of Funds Index. ARMs usually
offer a lower initial interest rate than fixed-rate
loans. The interest rate fluctuates over the life of
the loan based on market conditions, but the loan agreement
generally sets maximum and minimum rates. When interest
rates increase, generally your loan payments increase;
and when interest rates decrease, your monthly payments
may decrease. For more information on ARMs, see the
Consumer Handbook on Adjustable Rate Mortgages.
Hybrid ARMs are a mix--or a hybrid--of a fixed-rate
period and an adjustable-rate period. The interest rate
is fixed for the first several years of the loan; after
that, the rate could adjust annually. For example, a
3/1 hybrid ARM has a fixed interest-rate period for
the first 3 years; then the rate adjusts every year
after the initial 3-year period. For ARMs not listed,
contact your lender or broker for details.
Interest-only ARMs allow you to pay only the interest
for a specified number of years, typically between 3
and 10 years. This allows you to have smaller monthly
payments for a period of time. After that, your monthly
payment will increase--even if interest rates stay the
same--because you must start paying back the principal
as well as the interest each month. For some I-O loans,
the interest rate adjusts during the I-O period as well.
For example, if you have a 30-year mortgage loan with
a 5-year I-O payment period, you can pay only interest
for 5 years and then you must pay both the principal
and interest over the next 25 years. Because you begin
to pay back the principal, your payments increase after
year 5, even if the rate stays the same. Keep in mind
that the longer the I-O period, the higher your monthly
payments will be after the I-O period ends.
Payment-option ARMs allow you to choose among several
payment options each month. The options typically include
the following:
- a traditional payment of principal and interest,
which reduces the amount you owe on your mortgage.
These payments are based on a set loan term, such
as a 15-, 30-, or 40-year payment schedule.
- an interest-only payment, which pays the interest
but does not reduce the amount you owe on your mortgage
as you make your payments.
- a minimum (or limited) payment that may be less
than the amount of interest due that month and may
not reduce the amount you owe on your mortgage. If
you choose this option, the amount of any interest
you do not pay will be added to the principal of the
loan, increasing the amount you owe and your future
monthly payments, and increasing the amount of interest
you will pay over the life of the loan. In addition,
if you pay only the minimum payment in the last few
years of the loan, you may owe a larger payment at
the end of the loan term, called a balloon payment.
The interest rate on a payment-option ARM is typically
very low for the first few months (for example, 2% for
the first 1 to 3 months). After that, the interest rate
usually rises to a rate closer to that of other mortgage
loans. Your payments during the first year are based
on the initial low rate, meaning that if you only make
the minimum payment each month, it will not reduce the
amount you owe and it may not cover the interest due.
The unpaid interest is added to the amount you owe on
the mortgage, and your loan balance increases. This
is called negative amortization. This means that even
after making many payments, you could owe more than
you did at the beginning of the loan. Also, as interest
rates go up, your payments are likely to go up.
Many payment-option ARMs limit, or cap, the amount
the monthly minimum payment may increase from year to
year. For example, if your loan has a payment cap of
7.5%, your monthly payment won't increase more than
7.5% from one year to the next (for example, from $1,000
to $1,075). Any interest you don't pay because of the
payment cap will be added to the balance of your loan.
Payment-option ARMs have a built-in recalculation period,
usually every 5 years. At this point, your payment will
be recalculated (lenders use the term recast) based
on the remaining term of the loan. If you have a 30-year
loan and you are at the end of year 5, your payment
will be recalculated for the remaining 25 years. If
your loan balance has increased because you have made
only minimum payments, or if interest rates have risen
faster than your payments, your payments will increase
each time your loan is recast. At each recast, your
new minimum payment will be a fully amortizing payment
and any payment cap will not apply. This means that
your monthly payment can increase a lot at each recast.
Amortizing loan
Monthly payments are large enough to pay interest and
reduce the principal on your mortgage.
Annual membership or maintenance fee
An annual charge for having the line of credit available.
Charged regardless of whether or not the line is used.
Annual percentage rate (APR)
A measure of the cost of credit, expressed as a yearly
rate. It includes interest as well as points, broker
fees, and certain other credit charges that the borrower
is required to pay. Because all lenders follow the same
rules when calculating the APR, it provides consumers
with a good basis for comparing the cost of loans, including
mortgages, over the term of the loan.
Application fee
Fees paid when an application is submitted. May include
charges for property appraisal and a credit report.
Balloon payment
A lump-sum payment that may be required when the mortgage
ends.
Buydown
When the seller pays an amount to the lender so that
the lender can give you a lower rate and lower payments,
usually for an initial period in an ARM. The seller
may increase the sales price to cover the cost of the
buydown. Buydowns can occur in all types of mortgages,
not just ARMs.
Closing or settlement costs
May include application fees; title examination, abstract
of title, title insurance, and property survey fees;
fees for preparing deeds, mortgages, and settlement
documents; attorneys’ fees; recording fees; and
notary, appraisal, and credit report fees. Under the
Real Estate Settlement Procedures Act, the borrower
receives a good faith estimate of closing costs within
three days of application. The good faith estimate lists
each expected cost either as an amount or a range.
Conventional loans
Mortgage loans other than those insured or guaranteed
by a government agency such as the FHA (Federal Housing
Administration), the VA (Veterans Administration), or
the Rural Development Services (formally known as Farmers
Home Administration, or FmHA).
Conversion clause
A provision in some ARMs that allows you to change the
ARM to a fixed-rate loan at some point during the term.
Conversion is usually allowed at the end of the first
adjustment period. At the time of the conversion, the
new fixed rate is generally set at one of the rates
then prevailing for fixed-rate mortgages. The conversion
feature may be available at extra cost.
Credit limit
The maximum amount that may be borrowed under the home
equity plan.
Discount
In an ARM with an initial rate discount, the lender
gives up a number of percentage points in interest to
give you a lower rate and lower payments for part of
the mortgage term (usually for one year or less). After
the discount period, the ARM rate will probably go up
depending on the index rate.
Equity
The difference between the fair market value of the
home and the outstanding mortgage balance.
Escrow
Holding of money or documents by a neutral or third
party before closing. It can also be an account held
by the lender (or servicer) into which a homeowner pays
money for taxes and insurance.
Expected interest rate change
The change--increase or decrease--you expect at the
first adjustment period. This amount is likely to be
between -3 and +3. If you think interest rates will
not change, enter 0 in this box. Some mortgages limit
this amount to 2 percentage points for each adjustment
period and to 6 to 8 percentage points over the life
of the loan (see Interest rate caps). For example, if
your initial rate is 6.5%, your mortgage may go up to
as much as 8.5% or down to 4.5% at the first adjustment
period.
Fixed-rate loans
These loans generally have repayment terms of 15, 20,
or 30 years; some lenders offer 40-year loans. Both
the interest rate and the monthly payments (for principal
and interest) stay the same during the life of the loan.
Fully-indexed rate
The interest rate that will apply after the introductory
period is over in a payment-option ARM; this is not
the Annual Percentage Rate (APR). This rate will be
higher than the introductory rate.
Good faith estimate
The Real Estate Settlement Procedures Act (RESPA) requires
your mortgage lender to give you a good faith estimate
of all your closing costs within 3 business days of
submitting your application for a loan, whether you
are purchasing or refinancing a home. The actual expenses
at closing may be somewhat different from the good faith
estimate.
Home value
Purchase price if you are buying the home or appraised
value if you are refinancing your mortgage.
Hybrid ARM
These ARMs are a mix--or a hybrid--of a fixed-rate period
and an adjustable-rate period. The interest rate is
fixed for the first several years of the loan; after
that, the rate will adjust annually. Hybrid ARMs are
usually advertised as 3/1 or 5/1--the first number tells
you how long the fixed interest rate period will be
and the second number tells you how often the rate will
adjust after the initial period. For example, a 3/1
loan has a fixed rate for the first 3 years and then
the rate adjusts once a year beginning in year 4.
Index
The published rate that serves as a base for the interest
rate charged by the lender. The lender uses the index
to make changes in the interest rate on an ARM over
time. No one can be sure when an index rate will go
up or down.
Initial interest rate for ARM
The initial contract interest rate of the mortgage;
this is not the annual percentage rate (APR). For example,
if you are considering a 5/1 ARM with an initial interest
rate of 6.5% for 5 years and 1 point, you should enter
6.5.
Interest-only ARM
Interest-only ARMs allow you to pay only the interest
for a specified number of years, typically between 3
and 10 years. This allows you to have smaller monthly
payments for a period of time. After that, your monthly
payment will increase--even if interest rates stay the
same--because you must start paying back the principal
as well as the interest each month. For some I-O loans,
the interest rate adjusts during the I-O period as well.
Enter the contract interest rate for the mortgage, not
the APR. For example, if the contract interest rate
is 5.5% for the first 3 years plus 1 point, you should
enter 5.5.
Interest-only fixed-rate mortgage
This is a traditional fixed-rate mortgage, but you only
pay interest for the first few years. Even though your
rate does not go up, your payments will go up after
the interest-only period because you must start paying
back the principle as well as the interest. Enter the
contract interest rate for the mortgage, not the APR.
For example, if the contract interest rate is 7% plus
1 point, you should enter 7.
Interest rate
The price paid for borrowing money, usually given in
percentages and as an annual rate.
Interest rate for interest-only fixed-rate
mortgage
The contract interest rate for the mortgage; this is
not the annual percentage rate (APR). For example, if
the contract interest rate is 7% plus 1 point, you should
enter 7.
Interest rate caps
A limit on the amount your interest rate can increase;
there are two types of interest caps:
periodic adjustment caps, which limit the interest-rate
increase from one adjustment period to the next, and
lifetime caps, which limit the interest-rate increase
over the life of the loan. By law, virtually all ARMs
must have a lifetime cap.
Introductory rate
The initial interest rate of the mortgage; this is not
the annual percentage rate (APR). This is usually a
fairly low number, generally between 1% and 3%. This
rate applies only during the introductory rate period,
which may only be a few months.
Introductory rate period
The number of months that the introductory rate applies.
This number is likely to be between 1 and 3 months,
although some mortgages may apply the introductory rate
for 6 months. When the introductory period is over,
the mortgage interest rate will change to the fully
indexed rate.
Loan origination fees
Fees charged by the lender for processing the loan and
are often expressed as a percentage of the loan amount.
Lock-in
Refers to a written agreement guaranteeing a home buyer
a specific interest rate on a home loan provided that
the loan is closed within a certain period of time,
such as 60 or 90 days. Often the agreement also specifies
the number of points to be paid at closing.
Margin
The number of percentage points the lender adds to the
index rate to calculate the ARM interest rate at each
adjustment.
Minimum payment
The minimum amount that you must pay (usually monthly)
on your account. Under some plans, the minimum payment
may cover interest only; under others, it may include
both principal and interest.
Mortgage
A contract signed by a borrower when a home is purchased
that gives the lender the right to take possession of
the property if the borrower fails to pay off the loan
as agreed in the contract.
Negative amortization
Occurs when the monthly payments do not cover all the
interest cost; instead of paying down the loan balance,
you are adding to the amount you owe. The interest that
is not paid in the monthly payment is added to the loan
balance. This means that even after making many payments,
you could owe more than you did at the beginning of
the loan. Negative amortization can also occur when
an ARM has a payment cap that results in monthly payments
that are not high enough to cover the interest due.
Overage
The difference between the lowest available price and
any higher price that the home buyer agrees to pay for
the loan. Loan officers and brokers are often allowed
to keep some or all of this difference as extra compensation.
Payment cap
A limit on how much the monthly payment may change,
either each time the payment changes or during the life
of the mortgage. Payment caps do not limit the amount
of interest the lender is earning, so they may lead
to negative amortization.
Payment-option ARM
An ARM that allows you to choose among several payment
options each month. The options typically include (1)
a traditional payment of principal and interest, (2)
an interest-only payment, or (3) a minimum (or limited)
payment that may be less than the amount of interest
due that month. If you choose the minimum-payment option,
the amount of any interest you do not pay will be added
to the principal of your loan. The interest rate on
a payment-option ARM is typically very low for the first
few months (for example, 2% for the first 1 to 3 months).
After that, the interest rate usually rises to a rate
closer to that of other mortgage loans--the “fully
indexed rate.” Your payments during the first
year are based on the initial low rate, meaning that
if you only make the minimum payment each month, it
will not reduce the amount you owe and it may not cover
the interest due. The unpaid interest is added to the
amount you owe on the mortgage, and your loan balance
increases. This is called negative amortization. This
means that even after making many payments, you could
owe more than you did at the beginning of the loan.
Also, as interest rates go up, your payments are likely
to go up.
Payment penalty
Extra fees that may be due if you pay off the loan early
by refinancing your loan, usually limited to the first
3 to 5 years of the loan’s term. These fees may
make it too expensive to get out of the loan. If your
loan includes a prepayment penalty, be aware of the
penalty you would have to pay. Compare the length of
the prepayment penalty period with the first adjustment
period of the ARM. Ask the lender if you can get a loan
without a prepayment penalty and what that loan would
cost.
Points
One point is equal to 1 percent of the amount borrowed.
For example, if the mortgage is $200,000, one point
equals $2,000. Lenders frequently charge points in both
fixed-rate and adjustable-rate mortgages to increase
the profit on the mortgage or the compensation to the
lender or broker, and to cover loan closing costs. These
points usually are collected at closing and may be paid
by the borrower or the home seller, or may be split
between them.
Primary mortgage amount
Amount of money you want to borrow; if you plan to have
2 mortgages, this is the amount of the major (or primary)
mortgage.
Principal
The amount of money borrowed or amount still owed on
a loan.
Private mortgage insurance (PMI)
Protects the lender against a loss if the borrower defaults
on the loan. It is usually required for loans in which
the down payment is less than 20 percent of the sales
price or, in a refinancing, when the amount financed
is greater than 80 percent of the appraised value. Once
you have 20 percent equity in your home, PMI is cancelled.
Depending on the size of your mortgage and down payment,
these premiums can add $100-$200 per month or more to
your payments.
Purchase price or home value
The amount listed in your purchase contract, the estimated
price of a home you are considering, or the appraised
value of the home you are financing.
Second mortgage
A second mortgage is a loan taken after the first (or
primary) mortgage, and it is secured by the same property
as the first. A property can have multiple loans against
it. The loan which is registered with the county or
city registry first is called the first, or primary,
mortgage. The loan registered second is called the second
mortgage. Second mortgages are called subordinate mortgages
because, if the loan goes into default, the first mortgage
gets paid off first before the second mortgage gets
any money. Thus, second mortgages are riskier for the
lender, and generally carry a higher interest rate.
You can use a second mortgage to make up the difference
between the down payment you can afford and 20 percent
of the home’s value. For example, your down payment
may be only 10 percent; your primary mortgage would
be 80 percent and your second mortgage would be the
remaining 10 percent. This allows you to avoid paying
PMI premiums.
Second mortgage amount
Amount of money you plan to borrow as a second mortgage.
A second mortgage is a loan taken after the first (or
primary) mortgage, and it is secured by the same property
as the first. The loan which is registered with the
county or city registry first is called the first, or
primary, mortgage. The loan registered second is called
the second mortgage. Second mortgages are called subordinate
mortgages because, if the loan goes into default, the
first mortgage gets paid off first before the second
mortgage gets any money. Thus, second mortgages are
riskier for the lender, and generally carry a higher
interest rate.
You can use a second mortgage to make up the difference
between the down payment you can afford and 20 percent
of the home’s value. For example, your down payment
may be only 10 percent; your primary mortgage would
be 80 percent and your second mortgage would be the
remaining 10 percent. This allows you to avoid paying
PMI premiums. A second mortgage is often a home equity
loan or line of credit.
Second mortgage rate
The contract interest rate for the second mortgage;
this is not the annual percentage rate (APR). The calculator
treats all second mortgages as fixed-rate loans for
the term you select. If you have a variable-rate loan
as your second mortgage, the amount shown in the “Second
mortgage” box on the Comparison page is the estimated
payment for the first month only.
Second mortgage term
Number of years you expect to have a second mortgage.
Most second mortgages are for 10 years or fewer.
Security interest
An interest that a lender takes in the borrower’s
property to ensure payment of a debt.
Settlement or closing costs
May include application fees; title examination, abstract
of title, title insurance, and property survey fees;
fees for preparing deeds, mortgages, and settlement
documents; attorneys’ fees; recording fees; and
notary, appraisal, and credit report fees. Under the
Real Estate Settlement Procedures Act, the borrower
receives a good faith estimate of closing costs within
three days of application. The good faith estimate lists
each expected cost either as an amount or a range.
Thrift institution
Is a general term for savings banks and savings and
loan associations.
Type of ARM
The initial rate period and the adjustment period for
the loans you are considering. The most common ARMs
are 2/1 (sometimes called 2/28), 3/1 (sometimes called
a 3/27), 5/1, 7/1, and 10/1. You will need to compare
at least one ARM and one fixed-rate mortgage.
Variable rate
An interest rate that changes periodically in relation
to an index. Payments may increase or decrease accordingly.
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