Mortgage Basics

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	Mortgage Shopping Personal Finance Advisor by Deloitte & Touche OnLine July 15, 1996

A few mortgage basics can help you get the right deal.

Buying a home? A critical factor in the home-buying process is whether financing is available on acceptable terms. Here are some of the more important considerations in shopping for a conventional mortgage loan, that is, one not guaranteed or insured by the Federal government.

Mortgage Lenders

Financing for most single-family homes is provided by thrift institutions (including savings banks and savings and loan associations), mortgage companies, credit unions, and commercial banks. Although not a source of funds, mortgage brokers often can assist home buyers in finding a lender. Using a mortgage broker should not create additional costs to the home buyer because the lender typically gives the broker a discount on the loan.

Shopping for a lender may be as important as shopping for a home. Here are a few tips:

Seek referrals from attorneys, real estate brokers, and friends who have recently financed or refinanced a home (especially if there is no referral fee).
Check out the history and reputation of the lender with The Better Business Bureau or state and Federal regulatory authorities.
Ask the lender whether it has local underwriting capabilities. If not, the loan application and approval process might be delayed.
Also ask if the lender services the mortgage, that is, it accepts, processes and records mortgage payments. It generally is desirable for the lender to service the loan it originates unless the servicing company has a comparable reputation.

If lenders offer mortgage loan terms which are comparable, the level of service provided can be the determining factor.

Requirements of Lenders and Borrowers

The lender is required to disclose (and the borrower should insist on) these facts:

A good faith estimate of the borrower's settlement costs.
The annual percentage rate (APR) of the loan (the cost of the credit expressed as a yearly rate).
The lender's intent regarding the servicing of the loan after closing and what percentage of loans have been transferred for servicing in the past.
A "worst case" scenario of how monthly payments could be affected over the term of the loan if the interest rate is adjustable.

In most cases, the lender will require the borrower to:

Establish creditworthiness based on a credit bureau's report.
Submit a personal financial statement and supporting documentation (e.g., income tax returns and bank statements).
Meet such standard lending ratios as mortgage loan principal and interest payments not to exceed 28% of gross income, and mortgage and other debt payments, combined, not to exceed 36% of gross income.

Mortgage Terms

A familiarity with mortgage terms will make you a more informed borrower and might prove helpful in negotiating a more favorable mortgage loan.

Interest Rate: In addition to market factors, the interest rate will depend on such matters as the loan's maturity date, whether the rate is fixed, adjustable, or delayed-adjustable (a hybrid with fixed and adjustable features), and points paid. Be aware that rates on certain adjustable rate mortgages can rise as much as 2 percentage points per year and 6 percentage points over the life of a loan. A currently attractive adjustable rate mortgage may prove unsustainable in periods of rapidly rising interest rates.

Points: A point is a percentage of the face value of the loan. Because lenders frequently require the borrower to pay points to increase their return, they should be carefully evaluated in negotiating a loan.

Maturity: The advantages of both 15- and 30-year fixed-rate mortgages should be considered. Although monthly payments will be higher with a 15-year loan, it may well be worth it in terms of long-term interest savings; furthermore, it is a much quicker way to build equity (another way to build equity quicker is to increase the frequency of the payments).

Down Payment: A down payment of up to 20% of the purchase price will generally be required, depending upon the borrower's available resources and the lender's requirements. The down payment may affect the interest rate, standard lending ratios and, when the amount paid is less than 20%, whether the borrower must purchase private mortgage insurance (PMI). In some cases, a borrower can negotiate an 80% mortgage loan and a home equity loan that will avoid PMI.

Fees: Fees will vary depending on the lender and the locality, and should be carefully considered as to their cumulative impact on the cost of the loan. Examples include loan origination fees, application fees, appraisal fees, and miscellaneous charges (e.g., documentation preparation, credit check, verification of tax returns, and courier charges).

Prequalification and Preapproval: Prequalification simply means that the borrower has satisfied the standard lending ratios. Preapproval of a loan, however, may not only lock in a preferred interest rate but, more important, may also permit a home buyer to move quickly and decisively on an attractive opportunity while competing buyers search for financing.

Other Terms: Other important terms which the borrower should address include whether the loan can be prepaid without penalty and whether it can be assumed by a third party.

These are just some thoughts to consider. Your financial advisor can provide you with additional information and should be consulted before any action is taken.