What are points?
Should I pay points to lower my interest rate?
What is an APR?
What can I do to improve my score?
What is an Appraisal?
What is 80-10-10 financing?
How do I calculate my loan-to-value ratio (LTV)?
What happens at closing?
What is equity?
How do I know how much equity I have in my property?
What is amortization?
What is a credit score?
What is a FICO score?
It is often said that you should refinance when mortgage rates are 2% lower than the rate you currently have on your loan. Refinancing may be a viable option even if the interest rate difference is less than 2%. A modest reduction in the loan rate can still trim your monthly payment. For example, the monthly payment (excluding taxes & insurance) would be about $770 on a $100,000 loan at 8.5%. If the rate were lowered to 7.5%, the monthly payment would be about $700, a savings of $70. The significance of such savings in any scenario will depend on your income, budget, loan amount and the change in interest rate. Your trusted lender can help calculate the different scenarios.
Points are costs that need to be paid to a lender in order to receive mortgage financing under specified terms. A point is a percentage of the loan amount (one point = one percent of the loan). One point on a $100,000 loan would be $1,000. Discount points are fees that are used to lower the interest rate on a mortgage loan (you are discounting the interest rate by paying some of this interest up-front). Lenders may express other loan-related fees in terms of points. Some lenders may express their costs in terms of basis points (hundredths of a percent). 100 basis points = 1 point (or 1 percent of the loan amount).
If you plan on staying in the property for at least a few years, paying discount points to lower the loan’s interest rate can be a good way to lower your required monthly loan payment (and possibly increase the loan amount that you can afford to borrow). If you only plan to stay in the property for a year or two, your monthly savings may not be enough to recoup the cost of the discount points that you paid up-front. Ask your lender how long it would take for your monthly savings to recoup the costs of the discount points.
The annual percentage rate (APR) is an interest rate reflecting the cost of a mortgage as a yearly rate. This rate is likely to be higher than the stated note rate or advertised rate on the mortgage, because it takes into account points and other credit costs. The APR allows homebuyers to compare different types of mortgages based on the annual cost for each loan. The APR is designed to measure the “true cost of a loan.” It creates a level playing field for lenders. It prevents lenders from advertising a low rate and hiding fees.
The APR does not affect your monthly payments. Your monthly payments are strictly a function of the interest rate and the length of the loan.
Because different lenders calculate APRs differently, a loan with a lower APR is not necessarily a better rate. The best way to compare loans is to ask lenders to provide you with a good-faith estimate of their costs on the same type of program (e.g. 30-year fixed) at the same interest rate. You can then delete the fees that are independent of the loan such as homeowners insurance, title fees, escrow fees, attorney fees, etc. Now add up all the loan fees. The lender that has lower loan fees has a cheaper loan than the lender with higher loan fees.
The following fees are generally included in the APR:
- Points – both discount points and origination points
- Pre-paid interest. The interest paid from the date the loan closes to the end of the month.
- Loan-processing fee
- Underwriting fee
- Document-preparation fee
- Private mortgage-insurance
The following fees are sometimes included in the APR:
- Loan-application fee
- Credit life insurance (insurance that pays off the mortgage in the event of a borrowers death)
The following fees are normally not included in the APR:
- Title or abstract fee
- Escrow fee
- Attorney fee
- Notary fee
- Document preparation (charged by the closing agent)
- Home-inspection fees
- Recording fee
- Transfer taxes
- Credit report
- Appraisal fee
Credit scoring models are complex and often vary among creditors and for different types of credit. If one factor changes, your score may change — but improvement generally depends on how that factor relates to other factors considered by the model. Only the creditor can explain what might improve your score under the particular model used to evaluate your credit application.
Nevertheless, scoring models generally evaluate the following types of information in your credit report:
- Have you paid your bills on time? Payment history typically is a significant factor. It is likely that your score will be affected negatively if you have paid bills late, had an account referred to collections, or declared bankruptcy, if that history is reflected on your credit report.
- What is your outstanding debt? Many scoring models evaluate the amount of debt you have compared to your credit limits. If the amount you owe is close to your credit limit, that is likely to have a negative effect on your score.
- How long is your credit history? Generally, models consider the length of your credit track record. An insufficient credit history may have an effect on your score, but that can be offset by other factors, such as timely payments and low balances.
- Have you applied for new credit recently? Many scoring models consider whether you have applied for credit recently by looking at “inquiries” on your credit report when you apply for credit. If you have applied for too many new accounts recently that may negatively affect your score. However, not all inquiries are counted. Inquiries by creditors who are monitoring your account or looking at credit reports to make “prescreened” credit offers are not counted.
- How many and what types of credit accounts do you have? Although it is generally good to have established credit accounts, too many credit card accounts may have a negative effect on your score. In addition, many models consider the type of credit accounts you have. For example, under some scoring models, loans from finance companies may negatively affect your credit score.
Scoring models may be based on more than just information in your credit report. For example, the model may consider information from your credit application as well: your job or occupation, length of employment, or whether you own a home.
To improve your credit score under most models, concentrate on paying your bills on time, paying down outstanding balances, and not taking on new debt. It’s likely to take some time to improve your score significantly.
Appraisal is a document that gives an estimate of a property’s fair market value. An appraisal is generally required by a lender before loan approval to ensure that the mortgage loan amount is not more than the value of the property. The appraisal is performed by an “appraiser” who is typically a state-licensed individual trained to render expert opinions concerning property values. In an appraisal, consideration is given to the property, its location, amenities as well as its physical conditions.
Surprising as it may seem, some folks with hefty incomes find that it’s mighty tough for them to save enough money to make a 20% cash down payment on their dream homes. Using conventional financing, such buyers must purchase Private Mortgage Insurance (PMI) which increases the cost of home ownership and, ironically, makes it even more difficult to qualify for the mortgage. However, if you’re a dues-paying member of the cash-challenged class, don’t despair. Given that your income is sufficiently high, it’s eminently possible to avoid getting stuck with PMI. That is why 80-10-10 financing was invented. It is called 80-10-10 because a savings and loan association, bank, or other institutional lender provides a traditional 80% first mortgage, you get a 10% second mortgage, and make a cash down payment equal to 10% of the home’s purchase price. By using this method, you are no longer obligated to take out PMI on your property.
The same principle applies if you can only afford to make a 5% down, 80-15-5 financing is also available. However, because a smaller cash down payment increases the lender’s risk of default, do not be surprised when you are asked to pay higher loan fees and a higher mortgage interest rate for 80-15-5 than you pay for 80-10-10.
The loan-to-value ratio (or LTV) is one of the most important factors in your loan process. It is used to determine the limits within which your housing and debt ratios must fall for you to be approved. It can also determine which fees you will be charged for your loan and the amount of these fees. It will also determine whether you must pay Private Mortgage Insurance (PMI) and use an impound/escrow account.
Your loan-to-value ratio (LTV) is simply the amount you are borrowing divided by the value of the subject property you are purchasing or refinancing. This gives you a simple ratio. For example, a house valued at $100,000 which you intend to purchase with an $80,000 loan (and a $20,000 down payment of your own cash) is said to have an LTV of 80 percent – that is, the loan represents 80 percent of the value of the house.
The value of your property is its appraised value OR the amount you pay for the property (the market value), whichever is lower. In the initial stages of qualification and approval, your property’s value is understood to be an estimate. It will be confirmed, if necessary for your particular loan, by a professional appraiser hired by ditech.com.
At the closing, ownership of the newly purchased home is officially transferred from the seller to you. It may involve you, the seller, the real estate agent, your attorney, the lender’s attorney, representatives from the title or escrow firm, and a variety of clerks, secretaries, and other staff. It is possible to have an attorney act on your behalf if you cannot attend the meeting (for example, if the house is in another state). Closing can take as little time as an hour to sign all the forms and transfer ownership or it can take several hours, depending on the contingency clauses in the purchase offer (and any escrow accounts that may need to be set up).
Much of the paperwork involved in closing (or settlement) is done by attorneys and real estate professionals. You may be involved in some of the closing activities and not in others, depending on local customs and on the professionals with whom you are working.
Before you close on the house, you should have a final inspection, or walk-through, to make sure any repairs you requested have been made and that items which were to remain with the house (drapes, light fixtures) are still there.
In most states, settlement is done by a title or escrow firm to which you forward all the materials and information along with the appropriate cashiers’ checks and the firm will make the necessary disbursements. The real estate agent or another representative of the title company will deliver the check to the seller and the house keys to you.
Equity is a crucial aspect of home loans. Equity is simply the value of a homeowner’s unencumbered interest on real estate. Equity is computed by subtracting the total of the unpaid mortgage balance and any outstanding liens or other debts against the property from the property’s fair market value. A homeowner’s equity increases as he or she pays off his or her mortgage or as the property appreciates in value. When a mortgage and all other debts against the property are paid in full, the homeowner has 100 percent equity in his or her property.
Equity exists in conjunction with your loan-to-value ratio (or LTV). Your LTV is a ratio expressing the value of your property to the amount of your loan. You determine your LTV by dividing your loan amount by your property’s value or selling/purchase price, whichever is lower.
For example, you buy a $100,000 home with a $20,000 down payment of your own money, and cover the remaining $80,000 with a mortgage – 80,000 divided by 100,000 gives you a loan-to-value ratio of 80 percent and equity of 20 percent.
Equity and LTVs are important because lenders prefer a borrower to have as much equity as possible. Traditional wisdom holds that the higher the LTV on a loan, the higher the risk of default; alternatively, the higher the equity, the lower the risk – and therefore the lower the interest rate, cost, and fees associated with doing the loan. Equity also determines how much a lender will allow you to refinance your property for and how much they will lend you for a second mortgage.
Another way to think of equity is as the amount that you’ll receive when you sell the property and pay back the remaining loan balance. Again, for a $100,000 house bought with an $80,000 loan and sold for $100,000, you would get $20,000 in cash back – or 20 percent of the home’s value.
Equity is the value of a homeowner’s interest in real estate. Equity is computed by subtracting the total of the unpaid mortgage balance and any outstanding liens or other debts against the property from the property’s fair market value. A homeowner’s equity increases as he or she pays off his or her mortgage or as the property appreciates in value. When a mortgage and all other debts against the property are paid in full, the homeowner has 100 percent equity in his or her property.
Amortization means paying down your principal. You repay your loan in monthly installments. If you have a fixed mortgage (that is, an interest rate that remains fixed for the entire term of the loan), your payments will always be the same amount. Part of the payment goes toward the payment of the interest, and part toward the repayment of the money you’ve borrowed (the principal).
The balance of the principal (what you still owe at any given time) is reduced with each payment. As a result, your monthly payment will pay the principal in increasing amounts over time. With a fixed-interest rate, the amount of interest you owe will decrease as your principal balance decreases.
You can create an amortization schedule for fixed loans when they are originated. This schedule will show how much of each payment will go toward interest and how much will go toward principal over the life of the loan.
As your principal decreases, your equity in the mortgaged property increases. Equity is a very important factor in mortgage financing.
When lenders evaluate your loan application, a process called underwriting, they try to evaluate your ability and willingness to repay your loan. They judge your ability to repay by looking at your income and how stable your past earnings have been. This helps them to determine if you can afford the loan payments. They judge your willingness to repay by looking at your past credit history. Generally speaking, someone who has made payments on time in the past will probably do so in the future.
Lenders want their evaluation to be as accurate, objective and consistent as possible. To help achieve these goals, home mortgage lenders recently began using credit scores to help in the underwriting process. Credit scores are numerical values that rank individuals according to their credit history at a given point in time. Your score is based on your past payment history, the amount of credit you have outstanding, the amount of credit you have available, and other factors. According to Fannie Mae and Freddie Mac, two large investors in mortgage loans, credit scores have proven to be very good predictors of whether a borrower will repay his or her loan.
Credit scores are used to help lenders evaluate your home loan application. However, a credit score is just one of many factors lenders consider. Lenders look at the whole person. Even when a credit score is low, lenders try to find other factors that could overcome the negative credit issues and satisfy the underwriting criteria. Most lenders would not deny a loan application simply based on a credit score. The decision to approve or deny a loan application will be made based on sound, flexible underwriting guidelines.
"FICO" scores are a type of credit score developed by Fair Isaac & Company. FICO scores use credit bureau information to obtain a score which indicates how likely someone is to make their loan payments on time. Millions of consumers’ credit bureau records were used to develop score cards, and all of the consumer data – not just negative information – was included to develop the system. FICO scores range from approximately 350 to 900. The higher the score, the lower the probability of default on the loan.