Mortgage 101

Since there are so many components to the mortgage process, we have taken special care to organize the most important elements of qualifying for a home loan. We’ve attempted to take the mystery out of what’s involved in the home buying and mortgage processes.

We hope that the information provided below gives you a baseline of how the home buying and mortgage process works. Please contact us at any time for a personal consultation where we can address your specific needs and questions.

1. Mortgage Basics

What is a mortgage, and who owns my home if I have secured financing to purchase it?

Whether you’re new to the home buying process, or a seasoned investor, I bet you didn’t realize that there are at least 20 top mortgage related terms that you may want to understand prior to speaking with a real estate agent or loan officer.

2.  Mortgage Approval Process:

Required down payment, income / employment information and credit standing are a few of the important factors lenders look at when considering a borrower for a mortgage loan approval.

There are several questions that a loan officer needs to ask before a simple pre-approval letter can be issued.

Whether you’re a  first time home buyer or seasoned investor, the mortgage approval process can be a slightly overwhelming adventure without a proper road map and good team, like the professionals at HomeQuest Mortgage in your corner.

Updated program guidelines, mortgage rate questions and down payment requirements are a few of the components you’ll need to be aware of when getting mortgage financing for a purchase or refinance.

Mortgage Approval Components:

Mortgage lenders approve borrowers for a loan, which is secured by real estate, based on a standard set of guidelines that are generally determined by the type of loan program.

The following bullets are the main components of a mortgage approval:

Debt-To-Income (DTI) Ratio -

A borrower’s DTI Ratio is a measurement of their income to monthly credit and housing liabilities.

The lower the DTI ratio a borrower has (more income in relation to monthly credit payments), the more confident the lender is about getting paid on time in the future based on the loan terms.

Loan-To-Value (LTV) -

Loan-to-Value, or LTV, is a term lenders use when comparing the difference between the outstanding loan amount and a property value.

Certain loan programs require a borrower to invest a larger down payment to avoid mortgage insurance, while some government loan programs were created to help buyers secure financing on a home with 96.5% to 100% LTV Ratios.

EX: A Conventional loan requires the borrower to purchase mortgage insurance when the LTV is greater than 80%.  To avoid having to pay mortgage insurance, the borrower would have to put 20% down on the purchase of a new property.  On a $100,000 purchase price, 20% down would equal $20,000.

Credit – 

Credit scores and history are used by lenders as a tool to determine the estimated risk associated with a borrower.

While lenders like to see multiple open lines of credit with a minimum of 24 months reporting history, some loan programs allow borrowers to use alternate forms of credit to qualify for a home loan. The basic rule-of-thumb for an acceptable credit history is a minimum of 4 trade lines documented on a credit report. For potential home buyers with little or no credit history, alternative sources of building credit include:

  • Rental History – Canceled checks and letter from property management company
  • Medical Bills – 12 months of statements from medical billing company showing paid as agreed
  • Utilities – power, gas, water, cable, cell phone
  • Auto Insurance
  • Health / Life Insurance – as long as it’s not auto-deducted from pay check

Property Types -

The type of property, and how you plan on occupying the residence, plays a major role in securing mortgage financing.

Due to some HOA restrictions, government lending mortgage insurance requirements and appraisal policies, it is important that your real estate agent understands the exact details and restrictions of your pre-approval letter before placing any offers on properties.

Mortgage Programs – 

Whether you’re looking for 100% financing, low down payment options or want to roll the costs of upgrades into a rehab loan, each mortgage program has its own qualifying guidelines.

There are government insured loan programs, such as FHA, USDA and VA home loans, as well as conventional and jumbo financing (jumbo loans are above the conforming loan limit in the county in which you live; in Orange County, the conforming loan limit is $636,150).

At HomeQuest Mortgage we will take into consideration your individual LTV, DTI, Credit and Property Type scenario to determine which loan program best fits your needs and goals.

3.  Understanding Your Credit:

Your credit picture plays a key role in the mortgage approval process, and it is essential to understand how scores are measured and calculated.

Should you close all cards or keep them open? What if you don’t have any credit history that shows up on a report, is there a way to use cell phone and utility bills?

Down payment requirements, loan programs,  flexibility on income and even interest rates can be impacted by a slight bump in a credit score.

According To Wikipedia:

A credit score in the United States is a number representing the creditworthiness of a person or the likelihood that person will pay his or her debts.

A credit score is primarily based on a statistical analysis of a person’s credit report information, typically from the three major American credit bureaus: Equifax, Experian, and TransUnion.

The Fair Isaac Corporation, known as FICO, created the first credit scoring system in 1958, for American Investments, and the first credit scoring system for a bank credit card in 1970, for American Bank and Trust.

The three credit reporting agencies in the United States of America, Equifax, Experian, and TransUnion, collect data about consumers used to compile credit reports. The credit agencies use FICO software to generate FICO scores, which are sold to lenders. Each individual actually has three credit scores at any given time for any given scoring model because the three credit agencies have their own databases, gather reports from different creditors, and receive information from creditors at different times.

In the United States, a resident is permitted by law to view their credit report once a year at no charge by visiting the website AnnualCreditReport.com. The individual’s “credit score” information is available for an additional fee from each of the three credit reporting agencies. In addition, the Fair Isaac Corporation sells FICO scores directly to consumers using data from Equifax and TransUnion.

A FICO score is between 300 and 850, exhibiting a left-skewed distribution with 60% of scores near the right between 650 and 850.

Once credit has been established and maintained, credit scores are based on five factors to varying degrees: payment history (35%), total amounts owed (30%), length of time (15%), type of credit (10%) and new credit (10%).

The largest impact on credit scores is payment history and amount owed, which is why it is important to pay bills on time.

Debt should be kept to a minimum and funds should be moved around as little as possible. It may be beneficial to leave all accounts open, even if they have a $0 balance.

Different types of credit (ie. mix of credit cards, installment loans and fixed payments) can also be beneficial to a credit score.

However, too many installment loans can negatively affect credit.

Although time is a necessary factor for improving credit scores, this can be controlled by keeping the accounts that are opened during the same time period to a minimum.

By following these guidelines over an extended period of time, credit scores can be maintained and improved in order to improve the borrower’s loan potential and interest rate.

Factors That DO NOT Impact Credit:

  • Age
  • Race
  • Sex
  • Employment History
  • Income
  • Marital Status
  • If you’ve been turned down for credit
  • Length of time at current address
  • Whether you own a home or rent
  • Information not contained in your credit report

Establishing Credit:

Several factors can be used to establish credit initially, including bank accounts, employment history, residence history and utility bills.

Although they are not reported directly to credit bureaus, bank account history is important to lenders for first time loans and should be kept in good standing.

While they are also not reported to credit bureaus, utility bills (such as electric, telephone, cable and water) can also show a lender the risk associated with a new borrower.

Credit may be initially established through a bank, in which a credit card is linked to a specific amount of money deposited in the bank.  If the credit card is not kept in good standing, the bank can then take the secured funds for payment.

Initial credit may also be established with a department store credit card (for example), but borrowers should beware of the high interest rates associated with these cards and pay off the balances in full.

4.  Mortgage Payments:

You’re probably curious why we’ve created an entire section about mortgage payments.

However, since a mortgage payment is one of the major side affects of purchasing real estate with a home loan financing program, we thought it would be important to highlight a couple topics and related articles about mortgage payments that may impact your monthly budget.

Mortgage Payment Basics:

Just in case your first mortgage payment comes due before you get your first payment coupon in the mail, there should actually be a temporary payment coupon included with your closing documents.

Your mortgage payment is generally due at the beginning of the month, and most lenders start assessing late fees on the 15th. It is extremely important to remain under 30 days late on a mortgage payment, especially within the first 8-12 months of closing on a new loan.

When you receive your first mortgage bill, there will be a few numbers that add up to your total payment:

Principal –

This is the portion that goes towards paying down your balance. An Amortization Schedule will break down the exact amount of each payment that is being applied to the principal and interest.

Interest -

The interest payment is essentially the amount you’re paying the bank over time to borrow the principal balance.

Depending on which loan program, interest rate and closing cost scenario you chose, the amount of interest due every month may vary.

Taxes -

Real Estate Taxes can either be included (Impounded) in your monthly payment (PITI), or paid by the homeowner separately.

Certain government loan programs or high Loan-to-Value (LTV) mortgages require that taxes and insurance be included with the total mortgage payment.

Either way, it’s important to make sure you ask your loan officer during the final loan docs signing to clearly explain what’s included in your monthly mortgage payment.

Insurance – 

This is your hazard insurance (Fire), which protects your home and belongings.  While there are many ways to save money on your property insurance, it’s important to know and trust your insurance agent so that you can be fully aware of what’s covered in your policy. Some homeowners shopping strictly on price may unknowingly leave valuable personal items without protection just to save an extra $15-$19 a month.

Mortgage Insurance -

This can come in a few different forms, depending on whether you have an an FHA loan, VA, Conventional, Jumbo….

Mortgage insurance is in addition to hazard insurance, and completely unrelated.  A lender will require a borrower to pay mortgage insurance on a property with a Loan-to-Value greater than 80%.  The main purpose of mortgage insurance is to protect from foreclosure losses if the borrower fails to meet the monthly payment obligations.

FHA has mandatory Mortgage Insurance, but in a different form. The FHA Mortgage Insurance Premium (MIP) is an important part of every FHA Loan.

There are actually two types of Mortgage Insurance Premiums associated with FHA loans:

1.  Up Front Mortgage Insurance Premium (UFMIP) – financed into the total loan amount at the initial time of funding

2.  Monthly Mortgage Insurance Premium – paid monthly along with Principal, Interest, Taxes and Insurance

Mortgage Insurance is a very important part of every FHA loan since a loan that only requires a 3.5% down payment is generally viewed by lenders as a risky proposition.

Without FHA around to insure the lender against a loss if a default occurs, high LTV loan programs such as FHA would not exist.

VA Loans have a separate fee instead on a monthly premium, called a Funding Fee. This fee protects the financial interests of the lender.

The VA Funding Fee is an essential component of the VA home loan program, and is a requirement of any Veteran taking advantage of this zero down payment government loan program.

This fee ranges from 1.25% to 3.3% of the loan amount, depending upon the circumstances.

On a $150,000 loan that’s an additional $1,875 to almost $5,000 in cost just for the benefit of using the VA home loan.

The good news is that the VA allows borrowers to finance this cost into the home loan without having to include it as part of the closing costs.

For buyers using their VA loan guarantee for the first time on a zero down loan, the Funding Fee would be 2.15%.

For example, on a $150,000 loan amount, the VA Funding Fee could total $3,225, which would increase the monthly mortgage payment by $18 if it were financed into the new loan.

So basically, the incremental increase to a monthly payment is not very much if you choose to finance the Funding Fee.

The Amount Of a VA Funding Fee A Borrower Pays Depends On:

  • The type of transaction (refinance versus purchase)
  • Amount of equity
  • Whether this is the first use or subsequent use of the borrower’s VA loan benefit
  • Whether you are/were regular military or Reserve or National Guard

*Disabled veterans are exempt from paying a Funding Fee

The table of Funding Fees can be accessed via VA’s website: http://benefits.va.gov/homeloans/

* Disclaimer – all information is accurate as of the time this article was written *

5.  Mortgage Rates:

Mortgage rates can fluctuate several times a day, and are influenced by many factors that are out of the loan officer’s control.

Determining if you’re getting the best deal at any given moment boils down to whether or not you trust that your preferred loan officer is truly looking out for your best interests. At HomeQuest Mortgage, we’re looking out for our clients by offering a much broader choice of loan programs than a retail bank. Check out this video which explains using a mortgage broker firm, such as HomeQuest Mortgage Corporation, versus a retail bank this video.

Fortunately, there are economic indicators that impact the typical movement of interest rate markets which you can be aware on a daily basis. When the media reports that the Fed is moving rates down, it always seems that home loan rates go up. What about the points vs no points, and APR?

6.   Mortgage Programs:

It’s amazing how many mortgage programs have been designed to help First-Time Borrowers get financing on new homes.

Before you start shopping for a listing that fits your living needs, it would be extremely beneficial to know what type of lending scenario best fits the type of property or neighborhood you’re looking to buy in.

With regards to a refinance, you may actually qualify for a new government sponsored program that has been designed with current market conditions in mind.

We covered the different loan options in another section http://www.draslerhomeloans.com/loan-options/.

7.  Home Buying Process:

What comes first – the approval or the purchase contract?

Once you have weighed the basic pros and cons of owning a home vs renting, tax benefits and timely market influences, assembling a winning team of real estate and mortgage professionals will help you cover all of your bases.

There are also some very important time lines that you’ll need to be aware of, such as appraisal, home inspection and loan approval dates.

Step 1 – Getting Pre-Approved Prior to Shopping for a Home

It’s obviously important to know how much home you can afford, what type of down payment to budget for, monthly mortgage payment as well as what type of loan program you’ll be using to finance the new property.

Certain mortgage loans have restrictions on property type, HOA solvency, appraisal or insurance restrictions that your real estate agent needs to be aware of prior to showing you listings.

At HomeQuest Mortgage, we partner with your realtor professional, and together conduct a personalized strategy session up front to address all of your initial loan approval questions, as well as uncover any potential challenges that can complicate the entire transaction.

Step 2 – Assembling Your Home Buying Team – Knowing The Players

Buying a new home is literally a team sport since there are so many tasks, important timelines, documents and responsibilities that all need special care and attention.

Besides working with a professional team that you trust, it’s important that the individual players have the ability to effectively communicate and execute on important decisions together as well.

Your agent, attorney, title company, insurance agent and lender all have important roles to play.

Real Estate Agent –

A Realtor® is a licensed agent that belongs to the National Association of Realtors®, which means they are pledged to a strict Code of Ethics and Standards of Practice.

If you don’t already have a realtor, I encourage you to interview and select a realtor professional from our list. Each agent has a particular community expertise http://www.draslerhomeloans.com/recommended-professionals/.  They are all experienced, knowledgeable, professional and successful agent who serve the communities of Aliso Viejo, Mission Viejo, Coto de Caza, Ladera Ranch, Santa Margarita, Lake Forest, Irvine, Laguna Hills, Laguna Niguel, Dana Point, San Juan Capistrano, San Clemente, Oceanside, San Diego, Brea, Diamond Bar and Inland Empire.

A few of the important roles your agent performs:

  • Determine your home buying needs
  • Define your property search criteria – neighborhoods, school districts, local amenities…
  • Provide insight on market trends and property values
  • Negotiate purchase contracts
  • Pay attention to due-diligence periods and other important timelines
  • Articulate inspection and appraisal reports
  • Professionally estimate fair market value on listings

A common misconception of many First Time Buyers is that hiring a real estate agent will end up costing more money.

However, the typical arrangement in a purchase transaction is for the seller to cover the buyer’s agent commission.  In some cases where a new home developer or For Sale By Owner is listing a property and offering a lower price to deal direct, it is still a good idea to have an agent in your corner to protect your financial and investment interests.

Considering that some buyers may see 5-7 real estate transactions in a lifetime, compared to an agent that closes the same amount in a month, it is obvious to see that there is a big advantage to having the ability to rely on that experience when your home and security is on the line.

Mortgage Professional – 

A mortgage professional (loan officer, mortgage planner, loan consultant, etc.) is the glue that holds the entire transaction together (biased comment).

In addition to establishing the purchase price and monthly payment a borrower can qualify for, the mortgage team will also need to communicate with all of the other players on the home buying team throughout the entire process.

To highlight a few details your mortgage team is paying attention to:

  • Initial pre-qualification to determine purchase price / loan amount
  • Explain all loan program options that may fit your investment goals
  • Collecting / organizing loan approval documents
  • Watching economic indicators that influence daily rate changes
  • Locking rates
  • Communicating with title / escrow officers
  • Submitting loan package to underwriting departments
  • Updating consumer protection and lender disclosures within proper time frames
  • Following funding through the final recording
  • Tracking inspections, insurance and other lending requirements 

Insurance Agent – 

The lender in any mortgage transaction will require a homeowner’s insurance policy (hazard insurance).

This policy protects the property in the case of fire, theft or other damage (except flood or earthquake, those are separate policies and may be optional).

If it is determined that the property that you want to purchase is in a flood zone, flood insurance is not optional, it is mandatory.

The flood zone determination will be done with a “flood certification” from a third-party provider.

Title and Escrow -

It is possible to have a title company and an escrow officer work for different companies.

Also, some states use closing attorneys and there are still a few states where they use abstract of title instead of title insurance.

In most purchase transactions, the seller has the option of choosing the title company.

The title and escrow officers are often thought of as the same role, but in reality are quite different positions.

The title officer takes care of all issues that have to do with the title (also referred to as the deed) of the property.

The lender may require a title insurance policy guaranteeing that the title is clear of all liens except those being filed by the lender.

Escrow takes care of receiving, signing, and notarizing the final loan documentation, as well as collecting the other paperwork associated with the home sale.

The escrow officer is a neutral third party that makes sure no money is transferred until all conditions for each side are met.

The money management of an escrow company include:

  • Real estate commissions
  • Funds to mortgage company
  • Homeownwer’s Insurance Premiums
  • Property Taxes
  • HOA dues and other third-party fees

Finally, the escrow officer will see that you are properly recorded as the new owner with the county.

Home Inspector – 

When you have found the home that you like, it is a wise idea to have a professional take a look at the home to see if there are any issues with the property that could be a problem in the future.

Even though some buyers have an “Uncle Joe” who has owed several homes and knows what to look for, a certified Home Inspector can be money well spent.

They will look at the functionality of the home to make sure the electrical, plumbing and physical aspects of the home are strong, which will help the buyer make an educated decision about following through with the purchase, or renegotiating certain aspects of the contract.

Keep in mind, the home inspector and appraiser have different jobs. An appraiser determines value, while the inspector looks for structural problems, defects or maintenance issues.

The inspector is doing this strictly for the buyer’s sake. The lender is not concerned if a faucet has a minor leak as long as the property is worth the sales price. Therefore, the lender generally does not require an inspection unless the purchase contract requires one.

So, an inspection is not required, but it is recommended. As a matter of fact, one of the forms in an FHA application package is one that says “For Your Protection: Get a Home Inspection.”

Appraiser – 

While the appraiser is typically never seen by the home buyer, an appraisal is obviously an important component of a home purchase transaction.

The appraiser will conduct an analysis of the property to determine the current market value. The bank will always require an appraisal, and in some cases need a second opinion of value if the loan program guidelines or loan amount require it.

Appraisers compare the sales prices of similar properties sold in the neighborhood and surrounding areas with the subject property.

This can be a very tricky process, especially if there are few properties to choose from, or if there is an overwhelming amount of foreclosures and short sale listings.

Now, since two homes are rarely identical, the appraiser has the difficult job of trying to compare apples to apples; sometimes red delicious to yellow delicious, or sometimes Fuji to Winesap.

When done, the estimate of value is given. If that value is below the purchase price, then negotiation may take place. If it is at or above the purchase price, we are ready to go forward

Step 3 – Purchase Offer Submitted

Assuming that you’ve already been given a mortgage approval and have a firm understanding of the type of property you are qualified to purchase, your agent will submit your purchase offer to a listing agent or seller.

Once you receive an accepted offer, the due-diligence period starts a series of timelines for final mortgage approval, appraisal, inspections and other requirements which would be spelled out in the terms of the contract.

Step 4 – Conditions and Paperwork

It comes in from all angles at this point, lenders, processors, insurance agents, sellers, real estate agents…. and the list can go on.

Step 5 – Closing

A successful closing requires all of the team players to come together at the same time, with the same agenda, on the same date…. with numbers and figures that match.

Don’t worry, at HomeQuest Mortgage we’ll make sure you are kept in the loop throughout the entire home buying process.

8.  Closing Process:

With the right home buying team on your side, the closing process should be a smooth transition from signed documents to closing.

The excitement has been building throughout the entire process from home shopping to mortgage approval; so it’s easy to overlook some important details at the end.

Understanding the industry lingo will certainly help you avoid feeling like you’re on a roller-coaster while all the team players come together at the end to perform doc signings, pre-closing conditions….

It also helps to know about all of the fees associated with a new home purchase or refinance. Understanding the difference between the fixed and variable fees will help you set a more accurate budget, which could impact whether or not you get your earnest money back at closing.