Home Buying Advice
Should I rent or own my home?
Before you even begin the shopping process, the first question
you may ask yourself is, on the surface, quite basic: Does it
make sense for you to buy your home?
A place to
hang your hat...and own the hook it hangs from. Let's
start with the basics. Owning your own place gives you
peace of mind. If you are ready to settle down in your
community, you'll enjoy the established feeling of
Equity. When you own your home, each payment you make
establishes 'equity' in your house. This is an ownership
interest in the property that you can convert into cash
when you sell the house. These are also funds which you
can borrow against when you refinance or open a home
equity loan in the future. As a renter, you do not have
monthly payments. While your rent payment has a tendency
to climb each year, a mortgage payment usually stays the
same year after year, depending on your home loan.
Inflation, for the most part, does not affect your
mortgage payment. This assumes of course that your home
loan is a fixed rate - an Adjustable Rate Mortgage could
mean a fluctuating payment 3, 5 or 7 years down the
A home is
generally an appreciating asset. Houses typically
increase in value over time. A home you purchase for
$75,000 today could be worth a lot more in 10 years.
That extra money you realize through the sale of a house
benefits. The interest paid on a home loan is usually
tax-deductible. That's a significant savings,
particularly in the early years of ownership, when the
bulk of your payment is comprised of interest.
The increased costs of home ownership can take a big
bite out of your budget. While you may be surprised to
find out that your mortgage payment is actually less
than what you were paying in rent, you need to remember
the additional costs of property taxes, homeowner's
insurance, utilities, and general upkeep expenses. And
while your mortgage payment is primarily static (as
described above) these additional costs have a tendency
to go up over time.
mobility. As a renter, you are able to move on
relatively short notice. As a homeowner, it's your
responsibility to put your home on the market to sell
it. This process can take months, and sometimes years
depending on the market. If you anticipate a move in the
next couple years, buying a home may not be a wise
maintenance. No more calling the landlord when something
breaks. As a homeowner, it's your responsibility to fix
it. For many people, the thought of maintaining a home
and the yard that surrounds is not appealing. But don't
forget - condominiums are an option! Condos give you the
power of ownership, while leaving the maintenance to a
Getting Your Home Ready for the Market
Any marketing or sales professional will tell you that the
packaging is just as important as the product you are selling.
Any marketing or sales professional will tell you that the
packaging is just as important as the product you are selling.
As you get ready to put your home on the market, you may want to
spruce a few things up to attract potential buyers. Remember
that no touch is too little. After all, you may be selling the
steak, but you're also selling the sizzle.
A home that's visually appealing has a better chance of
attracting buyers. Now that you have the home listed in a few
newspapers and real estate publications, and the sign is in the
yard, you have to be ready for the buyers that drive by your
place for a look. Here are a few simple things that you can do
to cosmetically enhance your property:
lawn mowed, the trees clipped, and the shrubs
maintained. Pull the weeds and trim the hedges.
How do the
driveway, walkways, and foundation look? If there are
cracks, you may want to repair them. If the driveway is
in bad shape with cracks and deep oil stains,
resurfacing or sealing may be in order.
windows? Well, you may want to now. Wash the windows and
check the casings and shutters for a possible touch-up.
It's amazing what a quick paint job can do to your
yard clear of any tools, toys, or equipment. You never
know when the buyer will be driving by.
advantage of the spring or summer season by planting or
hanging a few flowers out front. It adds a little color
to the picture.
Now stand by the curb and take a look at all that you have done.
Try to look at your home through the eyes of the shopper. How
does it look? If you're happy with what you see, there is a good
chance the potential buyer will be enticed. ...And that means
you have to get the inside ready.
Now that you've successfully lured the buyer into your home,
you'll need to impress them with a clean and orderly house. You
don't need to spend a bundle of money, either. Doing a little
cleaning of the tiles, windows, floors, and bathroom will go a
long way. Make sure you have clean filters for your air
conditioner. Consider cleaning the carpets or perhaps doing a
little painting, especially if you're a smoker or have pets.
Removing some of the clutter inside is another consideration to
make. If you have a lot of furniture or personal items around,
you may want to consider putting a few things in storage for a
while. This will give the interior of the house a newer and more
Just before potential buyers arrive to look at your house,
consider these final touches for icing on the cake. Fresh
flowers and scented potpourri will appeal to their senses. Some
soft music is a good idea as well. There's also a lot of truth
to the old adage that baking bread or cinnamon rolls will give
the house a welcoming aroma.
You will find that a little elbow grease (and not necessarily a
lot of money) will go a long way in selling your home. After
all, a home is the biggest investment most people will ever
make. They'll want to be sure that the previous owners took care
of their investment.
It Pays to Ask Questions when Shopping for a Home
Home Buyers often look at dozens of homes before finding the one
that fits the bill. In order to avoid unpleasant surprises after
you've moved in, you'll need to get answers to some direct
How? The Financing Question
First and foremost is financing. It's always wise to have
already visited your credit union for pre-qualification on your
home loan. This way you will have a good idea of the costs
associated with buying a house, and you'll have a price range in
mind that will fit your budget. Call your credit union's loan
department and set up an interview. It is the logical first
Where? The Neighborhood Question
It's on to shopping. For each home you consider, you should take
a good look at the neighborhood. Think of your needs and whether
or not they will be easily met. Is the home convenient to
shopping, public transportation, schools, parks or recreational
facilities? Now look closer. Are many homes in the area for
sale? If so, why? Are there any rezoning plans in the near
future that may affect the value of the home? And don't overlook
the obvious resources - If you know someone that already lives
in the neighborhood, be sure to ask them what they like and
dislike about living there.
What? The Exterior and Interior Question
There are a lot of things to look at, and since you will be
visiting a lot of homes in the shopping phase, you may want to
take some notes. What is the size and age of the house? Consider
the size of the lot, the landscaping, and the structural
condition. Does the roof leak, or does the basement flood? On
the inside, you may want to make some crude sketches of the
floor plan. How many rooms, bathrooms, and bedrooms are there?
Is there adequate storage space? Is the kitchen functional? What
appliances are built in? Is the basement finished? Is there
central air conditioning? What is the quality level of the
building materials? You should also check insulation and whether
or not there are storm windows. Many sellers will have
information sheets on their house, but that shouldn't dissuade
you from asking these questions anyway.
What else? Some Remaining Questions
Not everything you'll want to know about a house will be in
plain view. How old is the home? How many previous owners have
there been? How long has the home been on the market? Are the
heating and cooling, electrical, and plumbing systems in
operating order? What is the fuel used to heat the house? What
are the average utility costs? Once you have the house
inspected, you will get many of these answered by a
professional. But it's always good to get these answers up-front
on homes that are serious contenders for your money.
Knowing Your Rights as a Borrower
Several federal laws provide you with protection during the
processing of your loan.
Several federal laws provide you with protection during the
processing of your loan. These laws prohibit discrimination and
provide you with rights to certain information. Here are some of
your basic rights.
The Equal Credit Opportunities Act (ECOA) prohibits lenders from
discriminating against credit applicants on the basis of race,
color, religion, national origin, sex, martial status, or age.
The Act also prevents discrimination resulting from the
applicants income source, if said income comes from any public
assistance program. Finally, ECOA prevents discrimination based
on the fact that the applicant has exercised any right under any
federal consumer protection law.
It's important however to note the following distinction - This
does not mean that the lender won't ask for certain information
such as race, sex, age, and marital status when taking your
application. In fact, they frequently must do so in order to
help government agencies monitor ECOA compliance.
Your local or state government will likely also have laws in
place prohibiting discrimination. While overall very similar,
these laws can and do vary from state to state.
Prompt Action/Notification of Action
Once you have submitted your completed application, your lender
or mortgage broker must act on it and inform you of the action
taken no later than 30 days after it is received. Note: your
application will not be considered "complete" until you have
submitted all of the material and information requested.
Statement of Reason for Denial
If your application is denied, the lender must give you a
statement of specific reasons why you were denied, or at the
very least tell you how you can acquire such a statement. If it
was due to information obtained on your credit report, the Fair
Credit Reporting Act (FCRA) requires the lender to give you
information on how you can obtain a free copy of your credit
report. You always have the right to dispute the accuracy or
completeness of any information found on your credit report, but
such disputes typically happen begin with you and the credit
reporting agency that provided the report. The agency will
provide you with the steps you'll need to take to clean up your
report. The three major credit reporting agencies are:
● Experian 1-800-682-7654
● Equifax 1-800-685-1111
● Trans Union 1-800-916-8800
Obtaining Your Appraisal
The lender needs to know the value of your home to determine if
it is enough to secure the loan. To do this, the lender
typically hires a professional appraiser to give their opinion
on the value of the home. ECOA requires the lender to tell you
that you have a right to get a copy of the appraisal report, as
well as how and when you can obtain it.
If you feel that you have been discriminated against by a lender
or anyone else in the home buying process, you may want to talk
to an attorney; or ask the federal agency that enforces ECOA
(the Board of Governors of the Federal Reserve System) or the
Fair Housing Act (HUD). For more information or to download a
complaint form, visit http://www.hud.gov/fhe/fheact.htm.
Shopping for a Mortgage: All loans are NOT created equal
Never before has there been such a wide range of sources for
home mortgages.Never before has there been such a wide range of
sources for home mortgages. Though many alternatives exist,
traditional lenders such as community banks, savings and loan
companies and credit unions may very well be your first and best
choice for a mortgage.
Where do I look?
You probably already have a relationship with your credit union
for your checking account. You might also have a savings account
or a credit card or a car loan. Odds are, you have chosen to do
business with your financial institution for a good reason -
competitive rates, superior service, convenience, etc.
Following that logic, it just makes sense that this should be
your first stop when shopping for a mortgage. You may be
surprised to discover your credit union has the best terms but
you don't know about it, simply because they don't cram your
mailbox full of solicitations and fill the airwaves with
What questions do I ask?
What a mortgage is going to cost will depend only in part on the
interest rate, so make sure your inquiry goes beyond just
"What's your rate?" Take notes when you visit with lenders about
terms. Try to build a basis of comparison of lenders by asking
for the same information from each. Here are the basics...
Do you do
originate first mortgages on homes? You can't use a
service if they don't offer it.
of mortgages do you offer? Fixed rates loans? Adjustable
rate Mortgages? Balloons? One size does not fit all.
What are the
current rates for each? Are rates lower with an up-front
fee? Depending how long you'll have the mortgage, buying
down the rate by paying a discount fee or "points" can
save you money in the long run.
How much are
closing costs? What other charges or prepaid items are
What are the
requirements for down payments? Will private mortgage
insurance be required?
your underwriting requirements for debt ratios, time on
job, and credit scores?
programs are offered for first time homebuyers?
Can I get
pre-approved ahead of finding a house?
will the process take? What can an applicant do to speed
How do I compare?
Look for terms you can live with. You have no use for a lender
with the lowest interest rate if the minimum down payment
exceeds the amount you'll have available. Look for the
combination of down payment, closing costs and prepaid expenses.
Combined, these make up your up-front costs. Next look at the
monthly payments for the total for principle and interest on
your loan and private mortgage insurance (if necessary).
Choosing a lender with a higher interest rate might be the best
move if the closing costs are hundreds of dollars less in a
situation where you are only going to be in the house a couple
years. Higher rate and higher closing costs might be the best
deal in a situation where the lender doesn't require the
borrower to pay private mortgage insurance premiums.
For the first time home buyer, this may seem overwhelming, and
it may be difficult to absorb every last detail. That's why you
need to work with a mortgage lender you can trust. After all,
you likely don't want to get bogged down in an exhaustive
analysis of your options. Check out the likely lenders, ask
questions, make a sensible choice and get on with the
The Application Process: What's the lender doing with all
Before you receive a loan, the lender will require that an
application be completed.Before you receive a loan, the lender
will require that an application be completed. Basically the
application is account of who you are, where you live, where you
work, what you earn, what you own and what you owe. A mortgage
is very likely the largest loan you may ever receive, and terms
will span decades. It shouldn't be a surprise that the mortgage
application process is far more in-depth.
What information does the lender need?
In addition to the basic loan application questions, the
mortgage lender will likely require additional documentation in
the form of payroll records and W-2 forms. Statements for
savings and checking accounts as well as investments and
retirement funds are used to document your ability to pay your
down payment and closing costs.
The lender will verify the information contained in the
application, check credit references and evaluate the property
that will collateralize the loan. They'll also determine if the
payments are within your means. It would be a disservice to a
borrower for a lender to grant a loan that the borrower cannot
afford. If everything checks out within the lender's
underwriting guidelines, the loan is approved. If not, the
lender may request additional information from the borrower,
offer alternate terms for the loan, or may deny the request.
Do I need perfect credit references?
Not necessarily, but the better your credit history is the more
likely that your loan will be approved. Most lenders will ask
for a written explanation of any derogatory items or recent
inquiries. Remember, to your lender, your credit history is a
pretty good indicator whether you'll make timely payments on
your mortgage loan. Some lenders will offer alternate terms for
borrowers with bad credit history. Such terms might require a
higher down payment, a higher interest rate or a cosigner to
guarantee the loan.
How is the property evaluated?
Most lenders will have the property appraised. An appraisal is
the determination of the market value of a property. The lender
wants to know what the property is worth and that it can be sold
if necessary in a foreclosure. Most lenders use independent
certified appraisers. You can reserve your right to see the
appraisal by signing a special section of the standard mortgage
How does the lender know what I can afford?
Most lenders will calculate the affordability of a house payment
in two ways. First, by finding the relationship between the
total house payment and your gross monthly income. Second, by
looking at the relationship between all your debts (including
the house payment) and your gross monthly income. The more
income that is committed to servicing debt, the harder it is for
borrowers to make payments.
How long does all this take?
The length of time involved from application to approval will
vary. You should expect any lender to be able to give you an
idea ahead of time how long the processing will take. The better
you understand what the lender's process involves, the better
position you are in to secure financing for your home loan.
How will I know if I'm approved?
The lender will provide an approval letter as written commitment
to fund your loan. It will state any conditions for the
approval. It is important that you meet all the conditions as
stated. Read all correspondence from your lender relating to
your loan. And if you have questions, ASK.
There's more than one type of Home Loan
Different borrowers have different needs. For that reason,
lenders offer an array of home loan products.ifferent borrowers
have different needs. For that reason, lenders offer an array of
home loan products. What are you looking for? Knowing the
benefits of each type may help you answer that all-important
Lenders generally offer three types of home loan products: Fixed
Rate Mortgages, Adjustable Rate Mortgages (ARMs) and Balloon
Mortgages. Which one will be right for you? Let's look at the
advantages of each.
Fixed Rate Home Loans
A fixed-rate mortgage has both a fixed rate and a fixed monthly
payment. Terms usually vary from 15 to 30 years. The shorter the
term, the lower your interest rate may be. With a shorter term
you can also count on building equity in your home at a much
faster pace. If you plan to live in the home for a long time, a
fixed rate home loan may be the route to take.
Advantages of a Fixed Rate Home Loan
The biggest advantage of a fixed rate home loan is that it is
predictable. While your property taxes and insurance may
increase, your loan payment will remain unaffected by interest
rate changes. So as costs of living and inflation increase,
mortgage payments become a smaller part of your overall
expenses. In addition, if you suspect interest rates will be
rising, it may be best to lock in to a fixed low rate.
With an ARM, monthly payments can increase or decrease on a
regular schedule depending on changes in interest rates. These
adjustment periods are usually 1, 3, 5 or 7 years. The interest
rate changes are usually in relation to an Index. Since ARM
loans offer a lower interest rate risk to lenders, they can
generally be offered at a lower initial rate than a long-term
fixed rate loan. This reduced rate can be an excellent choice of
financing under certain conditions; such as high interest rates,
rising income expectations, or short-term ownership.
Advantages of ARMs
ARM loans usually offer a lower interest rate than long term
fixed rate loans. This can translate to a lower monthly house
payment or can qualify you for a larger loan amount.
Balloon Mortgages are a bit of a hybrid of fixed and variable
rate loans. They are amortized for 25 or 30 years, but have a
fixed rate for a shorter period, usually 3, 5, 7 or 10 years. At
the end of that 3, 5 7, or 10-year term, the borrower either
pays the loan off or refinances the loan into a new balloon note
or a fixed rate loan at the then current interest rate. Since
this refinance is not automatic (as with an ARM), the borrower
may have to pay for closing costs if you choose to refinance the
balloon loan. Again, this is a popular choice for those who have
plans for short-term ownership.
Advantages of a Balloon Mortgage
As with an ARM, Balloon mortgages can save you interest expense
in the short run and qualify you for a bigger loan.
This is by no means a complete menu of loan options. Typically,
there are a host of products within each of these major
categories, with varying options to meet varying needs.
Understanding these categories is an important first-step in
determining which loan will ultimately work for you. You credit
union mortgage staff will become a valuable asset as you make
this decision, so be sure to use their knowledge and expertise
to the fullest!
Buying Down the Rate: Paying now or paying later
Many lenders will offer a lower interest rate for your loan when
the borrower pays a fee up front. Many lenders will offer a
lower interest rate for your loan when the borrower pays a fee
up front. The fee is normally paid at closing, but sometimes
collected at the time of application or when the rate is locked.
The fee is part of how the lender prices mortgage loans to
Is this what they call "points"?
Yes. Loan discount points are charged to adjust what the lender
earns on the loan. Points typically depend on the general
interest rate environment, as well as market conditions in the
geographic area in which the lender operates. The fee is based
on a percentage of the loan amount. This percentage can change
as often as interest rates change. One point equals one percent
of the loan amount.
Is paying the discount fee a good deal?
It depends on the amount of the fee in relationship to the how
much the rate is discounted. It also depends on how long you
plan on being in the house and having the loan. Plus, you've got
to be able to afford the fee and determine that it isn't better
spent on a larger down payment, or to pay off some other debt.
One might even prefer to save the money for a future purchase,
like furniture or improvements for your new house.
How are these things calculated?
Lets look at an example for a $100,000 30-year fixed rate
Lender A Note Rate Points Payment (P+I)
8.375 0.000 $760.07
8.250 0.125 $751.27
8.125 0.500 $742.50
8.000 1.500 $733.76
This lender has priced the first .125% rate reduction as only
.125% of the loan amount fee. The next reduction costs .375% and
jumping to the final reduction will cost an additional 1.00% of
the loan amount.
In the first reduction the borrower could save $8.80 a month on
a principal and interest payment by selecting the 8.250% rate
and paying .125% of the loan amount up front as the discount
fee. The fee is calculated by taking the loan amount ($100,000)
times the "point" (.125%) which equals $125. One can determine
how long it takes to recoup the fee by dividing the fee by the
monthly savings ($125.00 / $8.80 = 14.2). Thus it takes just
over fourteen months in lower payments to save back in lower
payments what was spent up-front in the discount fee. "Buying
down the rate" might make sense for the borrower who plans on
being in the house and having the loan for more than fourteen
Now look at the payment for the 8.000% loan. It's $26.31 per
month lower than the 8.375% payment. The discount fee is 1.500%
of the loan amount, which equals $1,500. Working the same
calculation as before, $1,500.00 / $26.31 = 57. In this case, a
borrower would want to be reasonably sure they will be staying
in the house for almost five years in order to recoup the points
they bought up-front.
How is the information obtained and when do I lock in a rate?
Though lenders are required to disclose rate and fee information
at the time of application, most lenders will answer a potential
borrower's questions about rates and discount points for lower
As far as locking in a rate, lenders vary on policy. Many
lenders do not require you to lock in a rate at the time of
application. However, know your risks when you do not lock in a
rate right away. Rates can go up as well as down. Many borrowers
save themselves days of anxiety by locking in early and focusing
on other details of their purchase.
Buying a Home: The Cast of Characters
Buying a home is an involved process, and you likely won't do it
alone.Buying a home is an involved process, and you likely won't
do it alone. While it's not quite a cast of thousands, the
purchase process will put you in contact with many professionals
along the way. Here are just a few of the people you might meet.
Generally, the first meeting on your list should be with the
mortgage representative at your credit union. After all, why go
shopping without knowing how much you can spend? Typically, a
brief visit with the friendly folk at your credit union can put
you on the road to mortgage pre-approval. At the very least,
you'll know what you can and cannot afford before looking at
Banks, Savings and Loans, and Mortgage Companies will, of
course, also lend money to homebuyers. As with any loan
decision, it's always wise to shop around for the best rates and
most favorable terms. But don't forget the value of good
old-fashioned service. After all, this is a loan you will be
likely making payments on for thirty years or more. Your
relationship with the lender is thus an important consideration.
Finally, keep in mind that many financial institutions sell
their home loans to mortgage investors, commonly referred to as
the Secondary Market. If your mortgage is sold, you could very
well have one, two, or more lenders over the life of your loan.
Real Estate Broker/Agent
While you can shop for a home without one, a real estate agent
can do much of the legwork for you - He or she will help find
homes available in your market, keeping your price range and
desired specifications in mind. The agent will often refer you
to many of the other characters in this cast, so it's naturally
a good idea to find a hardworking agent you can trust. Ask
friends or family who they might recommend. If this won't work,
interview several agents in order to find one that you feel
The Property/Mechanical Inspector thoroughly examines the home
you are going to buy. This means the plumbing, appliances,
electrical wiring, furnace and/or air conditioners, insulation,
and overall structure. The lender you choose may require an
inspector's services. Either way, it is a wise decision to have
this third party go over the house. They won't be swayed by
emotions, and will provide you with 'just the facts.' Their
inspection could save you thousands in future expenses and help
you negotiate a better price on the house.
While an inspector's job is to search for defects, an appraiser
determines the fair market value of the house. This is based on
a variety of factors including the home's condition and the
selling prices of comparable homes in the area.
An attorney is usually present at the closing of a home
purchase. They are responsible for ensuring that all documents
have been completed properly and signed. This agent will explain
each document and collect the transaction fees to be given to
the appropriate parties. Many credit unions will have an
attorney available for use at the closing.
The Mortgage Insurer comes into the picture if you plan to have
a small down payment on the home. A smaller down payment means a
greater risk for the lender, therefore they may require Private
Mortgage Insurance be purchased by the borrower. If for some
reason you cannot make the payments on the house, the mortgage
insurance helps cover the lender's losses.
I'll take it!
Now that you've done your homework, pre-approved your mortgage,
and zeroed in on the home you'd like to buy, it is time to make
The Realtor's Role
If you're using the professional services of a real estate
agent, it's a good idea to explain to them how you arrived at
the dollar amount in your offer. For example, if there are
certain flaws in the house that you feel should reduce the
purchase price. The real estate agent may also advise you on how
much you should offer. A good realtor should let you know if
your first offer is too low, or too high. While the realtor is
an expert, never forget that the ultimate decision is always
Contents of the Offer
Your offer is submitted to the present owners usually through
the real estate professional. This document is called a
"purchase and sale agreement". The agent is required by law to
deliver your offer to the sellers. Your offer should include:
description of the property
you are offering
money amount (see below)
The size of
your down payment and how the remainder of the amount
will be financed
personal property that the seller says will stay with
the house or that you wish to be included in the sale
time that the offer is valid (usually 3 to 5 days)
stipulation that your obligation to buy depends on the
negotiation of a satisfactory contract
What is earnest money?
This is a "good faith" payment held by the brokerage firm of the
real estate agent. This money shows the seller that you are a
serious buyer. It should be held in escrow and returned to you
if the seller does not accept your offer within a specified time
frame. You forfeit the money if the seller accepts your offer
and then you back out of the purchase. There is no set amount
and what is customary usually depends on where you live in the
United States. A real estate agent should be able to help you
determine what is fair.
Negotiating the final price
The real estate agent will usually present your offer to the
seller and relay the seller's response back to you. The response
can be acceptance, rejection, or a counteroffer. A counteroffer
usually indicates that you are close to an agreement. The seller
may have a few suggestions or alterations to make it work. A
rejection isn't necessarily the end. If you get this response,
and you have room to negotiate, you may want to draw up another
Once the seller has signed the dotted line, detailed
negotiations to write up a formal sales contract begin. Remember
that your offer to buy is reliant upon the negotiation of a
satisfactory contract. Along with the basic terms of the sale,
there may be contingencies that must be met in order for the
contract to take effect.
The Nuts and Bolts of Private Mortgage Insurance (PMI)
If you plan on having less than a 20% down payment on your home,
you may have to budget a little extra for Private Mortgage
Insurance (PMI). There's a lot you should know about this
coverage - though it is required for some, it is also quite
possible you're paying premiums that may no longer be necessary.
What PMI is...
Mortgage Insurance is a policy that protects lenders against
some or most of the losses that may result from a default on the
home loan. It is required of borrowers that plan to make a down
payment of less than 20%. These days, many first-time homebuyers
are putting far less than 20% down, making this coverage
increasingly popular. The lower your equity, the greater the LTV
(Loan-to-Value) ratio on the mortgage. And the greater the LTV,
the greater the risk of the loan to the lender. The goal of PMI,
therefore, is to reduce the default risk for the lender, which
in turn allows the borrower to use less money on a down payment.
What PMI is not...
PMI should not be confused with homeowners insurance. Homeowners
insurance protects your assets; including the home, the
property, and its contents (depending on your policy). PMI also
should not be confused with mortgage life, credit life or
disability insurance. These are designed to pay off a mortgage
loan in the event of the borrower's death or disability. The key
difference is that these coverages are designed to protect you
and your family. PMI is a tool designed to protect the lender.
How does it work?
Like other typical insurance policies, PMI requires payment of a
premium. You may be billed monthly, annually, or by an initial
lump sum for your premium. In many cases, the lender will
package this premium payment in with your other tax and
insurance escrow payments. Your premium is usually based on the
balance of your mortgage loan, so as the balance is paid down,
the premium may decrease. If the borrower can't repay the
insured loan, the lender may foreclose on the property and file
a claim with the mortgage insurer for any loss incurred by the
LPMI is Lender Paid Mortgage Insurance. As the name suggests,
this program has the lender purchase the mortgage insurance and
pay the premiums. The lender will increase your interest rates
to pay for the premium, but LPMI may reduce your settlement
Do I always pay PMI?
Private mortgage insurance was designed to protect the lender
from loss and allow the borrower to put less money down. As time
goes on, the loan gets paid down while the value of the property
may be increasing. That means the homeowners are building more
equity in the home. So what happens after the homeowners build
their equity up greater than 20% of the home's value? Depending
on when you purchased the home, PMI may be canceled by the
lender or applied for cancellation by the borrower. (LPMI or
government mortgage insurance can not be cancelled during the
life of the loan). Before you commit to paying mortgage
insurance, find out the requirements for cancellation.
Finally, it is important to note that PMI premiums may become
unnecessary sooner than you think. If property values are
increasingly rapidly in your neighborhood, you may achieve 20%
home equity faster than you initially predicted. If you feel the
value of your home has risen substantially, and that PMI is no
longer required, visit with your credit union's mortgage
department. It is possible that they'll recommend a re-appraisal
of your home.
Understanding Payments & Escrows
A mortgage payment is comprised of much more than a traditional
consumer loan.Principal, Interest, Insurance, and Taxes may all
be built into your payment. Eventually you're going to ask the
obvious question, "How is this all going to be paid, and what is
this going to cost?"
Payments on your mortgage will be divided into different
"parts". All lenders will collect for accrued interest on a
periodic basis and most will provide for principal reduction as
well. Some lenders will also collect for the escrow of property
taxes and hazard insurance premiums.
How much goes to principal and interest?
First of all, let's define some terms. Principal is the amount
you borrowed, or the balance remaining after payments begin.
Interest is the amount the lender charges you for loaning you
the money. Interest is accrued on the unpaid balance and is
collected by the lender before any remaining portion is applied
On a loan with a thirty-year repayment schedule, most of the
principal and interest payment goes to interest in the early
years. As an example, on a loan with a fixed rate of 8.250%,
monthly payments (the combination of principal and interest)
would be $702.04. Even after a year of payments, only $20.00 is
actually applied to principal. It takes over twenty-two years
before the monthly payment is evenly distributed between
principal and interest. Using a thirty-year term will thus keep
payments as low as possible, but total interest paid over the
life of the loan is high. Naturally, a shorter term loan would
mean less interest, but would also yield a higher monthly
Escrow... what's that?
An escrow account is balance held by the lender for payment of
property taxes, hazard insurance premiums and private mortgage
insurance premiums (if necessary). Most lenders will require
escrow accounts for borrowers with less than a twenty percent
down payment. There is greater risk to the lender when borrowers
make lower down payments. To make sure that taxes and insurance
premiums are being paid, the lender automatically makes those
payments for the borrower from this escrow account.
The account will start with a balance the borrower pays at
closing. Consider this your "head start" toward the funds that
will ultimately be needed when taxes and insurance premiums are
due. Additional funds are collected with monthly payments. The
monthly amount for escrows is usually one twelfth of the
estimated annual property taxes and annual insurance premiums.
The nice thing about escrowing for tax and insurance is that a
borrower doesn't have to worry about where the funds are going
to come from when the taxes and insurance premiums are due.
Further, most states require lenders to pay interest on escrow
If your lender doesn't require you to escrow for taxes and
insurance, you may want to do this on your own, by simply making
a monthly deposit in a savings account. Transfer from this
account to pay taxes and insurance premiums. Most financial
institutions can automate a monthly deposit to a special savings
account from your checking. Some institutions, particularly
credit unions, can set up such deposits through payroll
deduction with your employer.
Ways to save money on interest
Beyond shopping for a good rate, there are ways of saving on
mortgage interest. Providing there are no prepayment penalties,
borrowers can save on interest by applying additional funds to
principal. This might be done either by increasing your monthly
payment or by applying a lump sum to the loan. Policies
pertaining to accelerating payments vary from lender to lender.
Check with your lender how this might be handled in your case.
Note: As attractive as such savings may seem, don't apply
additional funds to your mortgage without considering a number
of factors - Do you have adequate savings or emergency reserves?
Are you saving enough for retirement or education expenses? Do
you have other outstanding loans at higher interest rates? Does
this make sense tax-wise?
Home Equity Loans
Understanding the Second Mortgage: Home Equity Loans
If you're a homeowner with equity in your residence, you may be
in for some good news. What is home equity?
Your home equity is your home's market value (what you can sell
it for) minus what you still owe on it. Perhaps you don't
realize what a large financial reserve this can be. One good
thing about inflation - it usually increases the value of your
home. For example, say you bought your home 10 years ago for
$100,000; its value today may exceed $150,000, increasing your
home's equity by $50,000. If your first mortgage has a $70,000
balance, the total equity in your home is $80,000.
What is a home equity loan?
A home equity loan allows you to take advantage of the increased
value of your home, without having to sell it. Why would you
want access to these funds? There are three primary reasons:
advantages - Most homeowners can deduct interest paid on
a home equity loan. This can result in considerable
savings over the long run. Consult your tax advisor to
see if you would qualify for such deductions.
Low rates -
Since your home is being used as collateral, the loan is
considered to have less risk to the lender. This means
that the interest rates charged on home equity loans are
usually quite low.
- The money you borrow does not necessarily have to be
used for the house itself. On the contrary - Equity
funds can be used for virtually any reason - to purchase
a car, pay tuition expenses, finance a vacation, to
purchase investments, or for any other reason you can
How much can I borrow?
Ask your credit union how much of the home's value you can
borrow against. Often lenders have different percentages that
they will loan up to. For example, lets say the lender will
provide home equity funds for up to 90% of the home's value. Now
lets assume that your home's market value is $100,000 and you
owe $60,000 on your first mortgage. 90% of $100,000 is $90,000,
minus the $60,000 you owe, leaves you with a $30,000 maximum
loan. As stated, some lenders will allow you to borrow higher or
lower than 90%, so it's a good idea to ask.
Popular Home Equity Products
There are three primary forms of home equity loans on the
Equity Loan - This product carries a fixed rate loan
for a fixed term. With this loan, you borrow a lump sum
and pay it back in equal installments.
Equity Line of Credit - As a line-of-credit, this
product allows for a bit more flexibility. Once the
credit line is established, you can advance yourself
funds as you need them. That means you can borrow more
money in the future without having to re-apply. Since
Home Equity Credit Lines are open-ended, they usually
carry a variable interest rate. Check with your lender.
Equity Credit Cards - A relatively new concept, this
combines the tax advantages of a home equity loan with
the convenience and worldwide acceptance of a credit