|Financing a House or a Condominium:
Mortgages and other Property Loans
What they Cost and How to get One
The Personal Financial Management Page
House or a Condominium:
|The five Principal Ground Rules for Financing a House||1.1.The Documentation you need to obtain a Mortgage|
|Some Fundamentals about Financing your Dream||1.2.The
Total Costs of a Mortgage
1.2.1. The Costs of using someone else's Money
1.2.2. The Costs of getting a Mortgage: The Closing Costs
|Where to Find a Mortgage||Refinancing, Home Equity and other Property Related Loans|
For most people, taking out a mortgage, is the single most important financial decision they make in their life. As a consequence, it should be the most scrutinized and most carefully considered decision you make.
The combination of fast salesmen talk and a lack of awareness of how important such a decision is, has led to difficulties for many people, often ending in foreclosure and the loss of the house. Optimism about the future is one of the great American qualities. But, when optimism turns to recklessness, it becomes the cause of untold misery. The current worldwide financial crisis was principally caused by people here in the USA buying houses and spending on consumer goods that they could not afford. The "greedy Wall Street bankers" were not the cause, they just became the facilitators of the dreams that turned into nightmares.
You, as an individual, have the responsibility to prevent the nightmare. That is not a difficult task. There are a few ground rules one has to follow, when one embarks on the financial side of a house purchase. These can be summarized as follows:
|The total monthly mortgage related outgoings (meaning mortgage repayment and interest plus house insurance and property taxes) should never exceed 25% of your net, after tax, Income.|
|Base the 25% outgoings on your current income without any bonus payments and not on what you may, or may not, earn in the future!|
|In financing the house, do not take potential future capital gain on the house into account. Base any financing on the current house price, not a projection into the future.|
|Create a personal month to month budget covering the next five years, to decide what kind of house you can afford. Include sufficient contingencies to cover potentially unforseen events. (see How to create a personal budget when you buy a House)|
|If possible, take out a fixed rate, rather than variable rate mortgage. Don't let yourself be convinced by the "fast talking mortgage salesman" that:".... you could save so much money, if only........". Remember the person "selling you" the mortgage is probably on commission! A fixed rate mortgage has fixed outgoings, so you know what it costs every month!|
Here in the USA, mortgages can be obtained, amongst others, from banks, through mortgage brokers, from finance companies, from savings and loan associations or from sellers. In most cases the person you deal with, be it in a bank, finance company or a broker is paid by commission.
consequence, he (male or
female), is not your friend or impartial advisor: He
is primarily after his commission and therefore,
he is, to a greater or lesser degree, predatory
and you are the "victim". This is an
important factor to keep in mind. The
worse your credit rating, the riskier your job
situation, the more likely you will end
up with a "high risk financial
institution" (formerly known as sub-prime
lenders) as your mortgage holder.
The recent financial crisis has not stopped risky lending, it has only changed its character.
It is therefore very important that you remain in the "drivers seat" when you are in the market to obtain a mortgage: You evaluate and you decide, not the "friendly" mortgage advisor!
One of the key factors in the sub-prime crisis was that financial institutions and mortgage brokers would accept mortgage applications which had rather less than complete documentation from the applicant supporting them. We have prepared a page (Documents needed for a Mortgage and your Mortgage Choices) that shows you what you need and how the lack of documentation will affect your choice of mortgages. Click here to see it!
The costs for a mortgage can be divided into two groups and it is useful to recognize the two groups separately. The first group of costs are the rate of interest and therefore the actual loan costs and payments associated with late and default fees etc. These are the costs of using someone else's money.
|The Rate of Interest, or
the Periodic Rate or Corresponding
(Annual Percentage Rate) you pay for your money
is determined by
in the Rate of Interest. Mortgages come
in many different forms. Besides the life
time, or repayment period of the
mortgage, 10, 15, 20 years or more, the next
important aspects is whether you
negotiate a fixed or variable interest mortgage.
With a fixed interest rate mortgage, the rate of interest paid on the principal remains the same over the lifetime of the mortgage. That is advantageous, when overall interest rates are low as at present (2009) and are likely to stay the same or, are likely to go up in the future. But even on some fixed rate mortgages, the lender can increase the rate of interest, if your repayments are late. So beware of, and understand any rules within your mortgage agreement that say how often, when and under what circumstances the lender can change the rate of interest.
The alternative, to that is a variable interest rate mortgage. Here, the interest rate reflects the prevailing prime rate plus the margin the bank adds. If the prime (or base) rate goes up, your interest rate on the mortgage will go up, and vice versa if the prime rate goes down. Usually that is expressed in the mortgage agreement as "prime plus X%" where "X" might be 2.5, or 5 or even 10%. Whatever the lender thinks is enough to cover his risks and his profit motive.
It is vitally important to be fully aware how often, under what circumstances and how, the lender can change the rate of interest. Look through the agreement and see if the mortgage agreement states that
If this can be found in your agreement, there is really no problem, because the speed at which the bank can change your interest rate is predetermined and the maximum annual amount of increase (or decrease) is limited.
The borrowers maximum exposure is clearly limited within a timeframe where the borrower would have the possibility to get another mortgage from another lender. Under these circumstances, there might be a higher risk on a variation in your outgoings for the mortgage. But it is a predictable risk and one which is clearly limited. Most local banks, Credit Unions and Savings and Loan Associations, will offer loan agreements based on the above premises. If they do not, don't go to them!
However, one of the elements that contributed to the financial crisis we are in now, was the ability of many lenders to change the interest rates almost at will. These lenders intellectual argument was that they provided mortgages to high risk groups and therefore had to have a means to vary their "risk perception". It is an argument that allows "usury" (the charging of excessive rates of interest). Most countries have laws against that, but not the USA.
Beware of "Teaser Rates"
These lending practices also made the use of "teaser rates" common. A "teaser rate" is when the lender offers a borrower a low introductory rate of interest which at a later date (within 2, 4 or six months), will increase to a rate determined by the lender. The trigger that leads to an increase in the rate of interest the borrower pays for his mortgage, may not only be time but also late payments, changes in the borrowers credit report (credit scores) or similar occurrences. In the commercial credit world, these are known as "changes in the covenants".
The key to avoiding these potential problems is to read your loan agreement thoroughly and have a knowledgeable lawyer (not your friend who practices law and deals mainly with low level criminal cases, or works in some other unrelated field) explain to you passages that are not clear to you. The costs of doing that maybe worth it!
associated with late mortgage repayments.
Mortgage repayments are
due on the exact date specified, not some days
delays are no excuse! It is the borrowers
responsibility that payments are with the lender
on the specified payment day!
One would think, that this is clear to most people. Unfortunately, it is not! Late payments have become so widespread, that many lenders have introduced default, or late payment fees. This has become a substantial source of income, not only to credit cards, but also to mortgage lenders.
Repeated late payments may also change your rate of interest (in case of a variable interest rate mortgage) or can make the lender cancel your loan agreement. Some lenders, and not only small and marginal ones, may add fees to your principal, that exceed the amount of principal that you pay back with your monthly mortgage repayment.
|Payments associated with technical defaults on your mortgage agreement. Some banks have started to add charges for technical defaults to your mortgage agreement. A technical default may be a lowering of your credit score (and hence, an increase in the risk for your lender) or similar occurrences. This is not yet widespread, but we are aware of cases where this has taken place.|
When you read through the above items you might think you are safe if you use the local bank as your lender. You may or you may not be. Even large reputable banks have created finance offshoots that deal with more marginal customers. And in their hunger to expand their business and grow, they are not immune to some sharp practices. Therefore, read any mortgage agreement you intend to go into, thoroughly, and question any point you do not fully understand! Be aware that your mortgage officer, may have a direct interest in you getting the loan, since he is paid a commission!
If you really want to inform yourself about home buying and mortgages, there are some highly recommended books from amazon.com
|Some Books about Mortgages from Amazon|
The second group of costs are those associated with obtaining a mortgage or other third party financing for the purchase of a house. Here in the USA, these are generally known as the closing costs. As a borrower, you have to look closely at both of these groups.
A mortgage broker, mortgage company, or bank sells you a mortgage and puts all sorts of fees on top of the mortgage that you will see as the Closing Costs in a Statement known as the "HUD-1 Settlement Statement". Some of these costs vary from state to state and some are specific to certain states. Below is a list of the most common costs charged.
|Loan Origination Fee is really the loan officers commission. It is usually around 1% of the loan and can therefore be quite a hefty sum. The loan officer in a bank or mortgage company is paid a fixed salary and usually a variable bonus as an incentive to "sell" loans to clients. The variable bonus is paid from the Loan Origination Fee. The amount is a tax deductible expense of your costs of purchasing the home.|
obtain your mortgage through a broker, rather
than directly from a bank or a mortgage company,
you will have to pay a Fee to the
Mortgage Broker. It is a sort of finders
fee and is generally regulated by the
state governments. In most states
brokers are required to disclose their fees in
writing. The amount can be
substantial, usually 1 to 5%, but can be more,
depending on market conditions.
The brokers fee may depend on your credit rating and other risk factors. If you are a "prime-borrower" and have good credit and 100% income verification, you could pay 1 to 2%. If, on the other hand, you have poor credit, and/or some of your income cannot be verified, you become a "sub-prime borrower" and you pay a higher brokers fee. The rational being that the broker has to do more work for a "difficult client". The justification argument is largely humbug, since most brokers have lenders on their books that give mortgages for different qualities of clients. But it gives a justification for a whole industry.
or Loan Discount is an upfront
fee by the lender to reduce your interest rate. As a
rule, each "point" will cost about 1%
of the loan amount and will, if you have a fixed
rate mortgage, reduce the interest rate charged
by the bank by about 0.25%. Though this reduction
amount is variable. The Loan Discount is a sort
of prepayment of interest and, obviously, lowers
the risk the lender is taking with the borrower.
If you intend to keep the property and the financing of it for a long time and you have the cash, this might be worthwhile. There maybe some tax benefit for you in paying for points. If you are purchasing the property, the amount you pay for points is fully tax-deductible in the tax year you sign the mortgage. If you are refinancing the property, the amount you pay for points is deductible over the life of the loan. In other words if you refinance with a 10 year mortgage, then you can charge 10% of the amount you paid for points every year!
Agent and Attorney Settlement Fees
These three government fees sound like taxes on the same aspect of the transaction. But they are not. The Recording Fee is for recording the two transactions (change of ownership and change of lender); the Tax Stamp is a tax on the purchase of the property and the Transfer Tax is a tax on the transfer of the property!
The cost items shown above should cover all the costs of acquiring a property as well as an associated debt and the servicing of that debt. There are obviously other types of mortgages than the fixed and flexible interest rate mortgages mentioned above. But, they are far less common and not likely to be used by domestic house buyers purchasing a homestead dwelling.
|Information and Books about Mortgage Closing Costs from Amazon|
Because of the recent turmoil in the mortgage market, be sure that when you buy a second hand version of a book related to mortgages and closing costs, it has a relatively recent publishing date (e.g. 2007, or later). It should reflect all changes in legislation and current practice that have affected the mortgage market.
It is reported that more than half of all mortgages taken out in the USA are arranged by mortgage brokers. While each individual mortgage need, will depend on a variety of factors, a good place to start looking for a lender are your closest high street financial institutions. The best place to start are probably Savings & Loan Associations and Credit Unions, followed by the local bank, where you have your checking, or maybe even savings account.
& Loan Associations are regulated
through the The Office of Thrift
Supervision (OTS), a part of the US
Department of Treasury, set up in 1989. Their primary
sources of funding comes from Savings and Money
Market deposits on which they pay
interest to their clients.
business purpose of an S & L is
to accept deposits against interest and then, to
lend these funds as mortgages and construction
loans to the public. As a rule S&L's
will not make business or commercial loans, other
Some clients find dealing with S & L's easier than with commercial banks. S & L's will sell your mortgage on the secondary market (e.g. Freddie Mac and Fanny May)
|Credit Unions Commercial and Mortgage Banks do not like Credit Unions because, in their view, they have a commercial advantage. Because they are a kind of club, where members have, in some way to qualify, or share a common interest (for instance the same employer). Importantly, credit unions do not pay federal tax and have other tax advantages.||The
Primary Source of Business for Credit
Unions is to accept checking and savings
accounts from its members and then
to make consumer loans for the purchase of cars and
other consumer items, underwrite
mortgages and often, they also issue
They are very competitive as mortgage lenders, since they have generally a low cost base. However, in order to obtain a mortgage you have to qualify as a member.
Most Credit Unions will not sell your mortgage on the secondary market. You will therefore usually deal with the owner of your debt, rather than just the administrator.
|Commercial Banks in your high street offer many services. Although, making mortgage loans is not their main business, they often offer mortgages at competitive rates. If you are a checking/savings or investment account client, there may be special advantages and rates if you take out a mortgage at your bank.||The Primary
Business of most commercial banks is to act as
commercial lenders to businesses. They
accept checking and savings deposits from
businesses and individuals and lend, primarily to
businesses. They also issue credit cards and
personal loans, both of which are highly
profitable for them.
Recently, many large main street banks have created, as subsidiaries, special mortgage companies which cater to different risks that are inherent in mortgage lending. That way the main street banks could better package the mortgages as Collateralized Debt Obligations to Investors. The conditions under which mortgages were offered differed widely, and some of these subsidiaries of major banks were outright predatory. Therefore do not automatically assume, because you are dealing with a well know and recognized main street bank that all loan conditions are competitive and "have your well being in mind!"
Make sure that your lender is the main street bank and not some obscure company, associated with the bank. Main street banks will sell off your mortgage on the secondary market and will, in the end, only do the administration of the mortgage. Although, it is often said, that main street banks offer competitive rates, make sure that they are competitive and do not have any "specials", or little "nasties", such as "teaser rates", attached to the mortgage agreement.
But local high street banks have an advantage: They understand the local market and its peculiarities. Don't underrate that! It might even be worth a small increase in the interest rate offered!
Brokers. Most lenders, almost 50% of them, in
the USA, obtain their mortgage through a broker.
The reason for that is simple: Realtors often
have a broker attached to them so that they can
easily arrange financing for their sales.
Similarly, real estate developers associate
themselves with brokers, sometimes in informal
business arrangements, sometimes they become
co-owners of brokers, to makie sure that their
properties sell quickly in a competitive market.
Many of the mortgage companies that advertise, are in fact brokers and not mortgage companies at all. So, beware!
forget that the broker works for a fee to bring
lenders and borrowers together. The
broker, therefore only acts in your interest, as
long as his fee is not in jeopardy.
Theoretically, the broker tries to match a
borrower with his particular credit and income
history with a suitable lender.
Brokers are usually paid a fee by lenders and an origination fee by the borrower. The lenders fee could be a straight percentage of the amount of the loan or a Yield Spread Premium of up to 2 percent. In other words, the lender offers a 7% mortgage and then adds a 2% ISP for the broker. The ISP can obviously be less than 2%. But it has to be disclosed to the borrower and it is often negotiable.
Using a broker can become a necessity. Especially, when other lenders, such as S & L's, Credit Unions and high street banks refuse to finance a particular property.
You can have a broker working for you as the borrower, if you negotiate an up-front fee with him. Usually, the fee is a percentage of the amount you borrow.
|Mortgage Bankers are usually independent, often unlicensed, bankers that represent one or several banks and sell or arrange mortgages on their behalf. They are not employees of the bank and similar to mortgage brokers, they are paid by a commission from the bank.||The loans mortgage bankers arrange are straight forward bank mortgages. The fee , interest rate and maturity structure is thus limited by what the bank, or banks, with which the mortgage banker works offer. The advantage of going to a mortgage banker, rather than to your high street bank directly is that the mortgage banker has often nationwide contacts and can tap into funding from major internet or other banks, such as ING.|
|Private Individual Any private individual with the money can offer you a mortgage. The loan agreement with the individual has to conform to your states (or the state in which the property is located) as well as federal regulations and disclosure requirements.||Even
though, you may not be required by the private
lender to have an appraisal of the property made,
it is worthwhile to do it.
Similarly, the private lender might not require a title search or a title insurance, it is highly recommended to go ahead and complete these formalities. This applies especially in cases, where the private individual financing the property is also the original owner of the property!
|Stock Brokerages & Online Lenders - Since about the year 2000, some banks and stockbrokers have ventured into internet banking. Some of them offer mortgages to existing and new clients.||This is
an option for the more sophisticated
borrower with a high
FICO score (Credit Score) who
knows what he wants and knows the options
The major players in the Internet arena are:
If you want the personal touch these companies are not for you.
More operators enter this business. The key is that you contact only reputable and known firms, since the internet is an ideal platform for more shady operations.
You should be aware that almost every mortgage loan these days, contains an ALIENATION CLAUSE. It is a clause in your mortgage agreement that states, "if the owner sells the property or transfers the title, the outstanding amount of the mortgage plus any fees, will immediately become due for repayment to the lender".
You cannot transfer the title, and the remaining unpaid mortgage to a third party!
Getting a mortgage is, relatively speaking, a technical issue. The more you know about the key factors and the market place, the more likely you will make the right decisions. Therefore, it is probably useful to spend a little money for the purchase of books that will explain some of the points mentioned in this page in more depth! Some of the suggested reading material is shown below.
|More Books about Mortgages from Amazon|
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