The first thing to know about acquiring your loan is that you don’t “get a loan”. You purchase a loan product.
Acquiring your loan: options and choices
Loans can have a fixed interest rate or a variable interest rate. Fixed rate loans have the same principal and interest payments during the loan term. Variable rate loans can have any one of a number of “indexes” and “margins” which determine how and when the rate and payment amount change. If you apply for a variable rate loan, also known as an adjustable rate mortgage (“ARM”), a disclosure and booklet required by the Truth in Lending Act will further describe the ARM.
Most loans can be repaid over a term of 30 years or less. Most loans have equal monthly payments (because they are fixed). The amounts can change from time to time on an ARM, depending on changes in the interest rate. Some loans have short terms and a large final payment called a “balloon.” You should shop for the type of home mortgage loan terms that best suit your needs.
This year, it’s expected that interest rates will rise. When acquiring you loan, do the math on what the rate could do to your payments if you get an adjustable rate.
Interest Rate, “Points” & Other Fees
Often the price of a home mortgage loan is stated in terms of an interest rate, points, and other fees. A “point” is a fee that equals 1 percent of the loan amount. Points are usually paid to the lender, mortgage broker, or both, at the settlement (we call it closing) or upon the completion of the escrow. Often, you can pay zero or fewer points in exchange for a higher interest rate, or more points for a lower rate.
Ask your lender or mortgage broker about points and other fees. Sometimes it makes sense to buy down the interest rate by purchasing points. Right now, in 2022, most buyers are getting zero point loans.
A document called the Truth in Lending Disclosure Statement will show you the “Annual Percentage Rate” (“APR”) and other payment information for the loan you have applied for. The APR takes into account not only the interest rate, but also the points, mortgage broker fees and certain other fees that you have to pay. Ask for the APR before you apply to help you shop for the loan that is best for you. Also ask if your loan will have a charge or a fee for paying all or part of the loan before payment is due (“prepayment penalty”). You may be able to negotiate the terms of the prepayment penalty.
Please note that the APR is NOT your interest rate. It’s a figure that tries to package the fees with the rate so that you can comparison shop for the best overall costs in acquiring your loan. (Sometimes the fees are different from one lender to the next, so having the APR helps you to compare more easily the total costs involved.)
Conventional, fixed-rate mortgages
This traditional mortgage option is a loan with a constant interest rate and level, and equal payments over a set period of time-most commonly, 30 years. The biggest advantage of fixed-rate loans is predictability and at times like today for locking in low interest rates over decades.
At some point, you may want to refinance your loan, or pay it off early to eliminate thousands of dollars in interest. If lower rates dictate that the time is right to refinance, it’s a good idea to compare savings on lower rates to the costs of incurring a new mortgage-such as prepayment penalties and loan origination costs and points. Usually it’s a math problem: how long do you have to keep the loan for it to break even on costs before it starts saving you money?
Adjustable-rate mortgages (ARMs)
As the name implies, the interest rate on an adjustable-rate mortgage changes throughout the term to reflect current interest rates. ARMs are most popular when rates are relatively high and appear to be dropping, and when the difference between the ARM and the fixed-rate is greater than 2 to 3 percent. Different lenders offer variations in the front end of their ARM plans, such as points, or discounted initial rates.
To make a useful comparison of an ARM rate, consider the index upon which the rate is based, the margin or spread between that index and the rate paid, and the intervals at which the rate and payments are adjusted.
Tip: Always look at the index plus the margin when comparing ARMs. The larger the margin, the less likely the rate will go down, even if the interest rates drop.
Acquiring your loan: federal government programs as an option
Federal Housing Administration (FHA) insured loans: Lenders offer FHA mortgages on new or existing single-family homes for as little as 3% down. FHA mortgages are also assumable. Sometimes a premium is required when the mortgage is assumed, then refunded when the note is paid off. Down payments are usually low.
These loans may not be as competitive as those with larger down payments, and it can be harder to get an offer accepted in multiple offer situations. Some do get through, however.
Veterans Administration (VA) guaranteed loans
The Veterans Administration guarantees lenders against loss if a property is foreclosed due to default. These assumable loans are available to eligible veterans, and may be used to buy, refinance, construct or repair a house. If the VA property appraisal is less than the sale price, the borrower pays the difference as a down payment.
As with FHA backed loans, these are not as favored in multiple offer situations, which are common in Silicon Valley. There are additional costs and burdens on sellers which make them less attractive.
The benefits are tremendous and this is a path worth exploring in the rare case where sellers may accept them.
Farmers Home Administration (FmHA) loans
The government makes these loans available to persons of moderate to very low income in rural or non-metropolitan areas. (Sharing this info, but I’ve never run into this with my real estate practice.)
Comparing Loan Costs
Comparing APRs may be an effective way to shop for a loan. However, you must compare similar loan products for the same loan amount. For example, compare two 30-year fixed rate loans for $1,000,000. Loan A with an APR of 4.35% is less costly than Loan B with an APR of 4.65% over the loan term. However, before you decide on a loan, you should consider the up-front cash you will be required to pay for each of the two loans, as well.
Another effective shopping technique is to compare identical loans with different up-front points and other fees. For example, if you are offered two 30-year fixed rate loans for $1,000,000 and at 4.125%, the monthly payments are the same, but the up-front costs are different:
Lender-Required Settlement Costs
Your lender may require you to obtain certain settlement services, such as mortgage insurance or a lenders policy of title insurance. It may also order and charge you for other settlement-related services, such as the appraisal or credit report. A lender may also charge other fees, such as fees for loan processing, document preparation, underwriting, flood certification or an application fee. You will want to ask for an estimate of fees and settlement costs before choosing a lender. Some lenders offer “no cost” or “no point” loans but normally cover these fees or costs by charging a higher interest rate.
“Locking in” your rate or points at the time of application or during the processing of your loan will keep the rate and/or points from changing until settlement or closing of the escrow process. Ask your lender if there is a fee to lock-in the rate and for how many days, and whether the fee reduces the amount you have to pay for points. Find out what happens if it expires, and whether the lock-in fee is refundable if your application is rejected.
Tax and Insurance Payments
Your monthly mortgage payment will be used to repay the money you borrowed, plus interest. Part of your monthly payment may be deposited into an “escrow account” (also known as a “reserve” or “impound” account) so your lender or servicer can pay your real estate taxes, property insurance, mortgage insurance and/or flood insurance. Ask your lender or mortgage broker if you will be required to set up an escrow or impound account for taxes and insurance payments.
Some of my clients prefer to have an impound account so they don’t have huge property tax bills twice a year. Others prefer to have direct control of their money and not have it tied up in the impound or reserve account.
Transfer of Your Loan
While you may be acquiring your loan with a particular lender or mortgage broker, you could find that after settlement another company is collecting the payments on your loan. Collecting loan payments is often known as “servicing” the loan. Your lender or broker will disclose whether it expects to service your loan or to transfer the servicing to someone else.
Private mortgage insurance (PMI) and government mortgage insurance (MI) protect the lender against default, and enable the lender to make a loan which the lender considers a higher risk. Lenders often require mortgage insurance for loans where the down payment is less than 20% of the sales price. You may be billed monthly, annually, by an initial lump sum, or some combination of all of these for your mortgage insurance premium. Ask your lender if mortgage insurance is required, and, if so, how much it will cost. Mortgage insurance should not be confused with mortgage life, credit life, or disability insurance, which are designed to pay off a mortgage in the event of the borrower’s death or disability.
You may also be offered “lender paid” mortgage insurance (“LPMI”). Under LPMI plans, the lender purchases the mortgage insurance and pays the premiums to the insurer. The lender will increase your interest rate to pay for the premiums — but LPMI may reduce your settlement costs. You cannot cancel LPMI or government mortgage insurance during the life of your loan. However, it may be possible to cancel private mortgage insurance at some point, such as when your loan balance is reduced to a certain amount. Before you commit to paying for mortgage insurance, ask about the specific requirements for cancellation.
Getting rid of MI or PMI may be a challenge at times. When acquiring your loan, you may want to consider instead getting a first and second loan. For instance, you could obtain an 80% first loan at a low rate and a slightly higher rate second mortgage (for whatever percentage you need). When you pay off the second, it’s over. You don’t have to pay for an appraisal to prove that you should no longer be charged mortgage insurance.
Flood Hazard Areas
Most lenders will not lend you money to buy a home in a flood hazard area (specifically, a 100 year flood plain) unless you pay for flood insurance. Some government loan programs will not allow you to purchase a home that is located in a flood plain. Your lender may charge you a fee to check for flood hazards. You should be notified if flood insurance is required. If a change in flood insurance maps brings your home within a flood hazard area after your loan is made, your lender or servicer may require you to buy flood insurance at that time.
Fire hazard Zones
Similarly, there are some areas with high fire risk. Your lender may not prevent your purchasing a home there, but your insurance company may charge a hefty sum for coverage. Be sure to clarify the price of hazard insurance if you purchase in a Very High Fire Hazard Severity Zone or other high risk area.
Acquiring your loan may be a bit of an ongoing process if you are buying a home. In escrow, the lender will ask for updated information, sometimes just days before the closing. (This happens with refinances, too.) Knowing it will happen ahead of time may stave off some frustration.
Finally, if you are purchasing a home, when acquiring your loan, DO ask your Realtor or real estate professional for recommendations on trusted lenders. Don’t just pick a rate (the loan officer may be terrible and not responsive) since time is of the essence and a bad person in the mix can cause headaches and financial harm. Be sure to go with a trusted, local resource.