Financing Questions

Applying for a home loan or mortgage has become a daunting process and a bit unnerving especially if you’re a first-time home buyer.  There are also many different types of products available and it is not always clear what the loan terms mean.  Before shopping for your next loan, it is recommended you prepare yourself for the mortgage journey by educating yourself. This information will allow you to better negotiate with mortgage lenders and select the company that will best benefit you in the long run. So you will be better prepared, we have assembled some commonly frequently asked questions.

Q: What is a lock in?
A: A lock in guarantees a certain interest rate for a certain period of time.

Q: What is underwriting?
A: Underwriting is the process of evaluating a loan to determine whether the loan is a good risk.

Q: What is PITI and what does it stand for?
A: PITI is the total monthly payment you make on a house-Principal, Interest, Taxes, and Insurance.

Q: What is a gift letter?
A: A gift letter is when an individual gives you money for a down payment as a gift, that person must write you a gift letter so that it can be included in your loan documentation.

Q: What is a debt-to-income ratio?

A: A debt-to-income ratio is the percentage of a person’s monthly earnings used to pay off all debt obligations.

Q: What does Prepaid Interest mean?

A: Prepaid interest is typically paid at loan closing. It is the interest paid on a new loan from the day of closing through the end of the month. All future interest on a mortgage loan is then paid in arrears. For example, if your new loan closes on February 19th, prepaid interest would be paid at closing from February 19th through the end of the month of February. Interest would then be paid monthly with your first payment beginning April 1st which would pay March interest. Your payment on May 1st would pay April interest, etc.

Q: What does the origination fee cover?
A: The origination fee is the fee some lenders charge to cover some of the costs of making the loan and is calculated by multiplying the total mortgage loan amount by the percentage shown. This fee is typically 1% or lower, but may also be influenced by market conditions or the type of loan being sought.

Q: Why is the Annual Percentage Rate (APR) on the Truth in Lending Disclosure higher than the rate shown on my note, which is the rate I thought I chose?
A: All lenders are required by the Real Estate Settlement and Procedures Act (RESPA) to show the rate which will be charged on the note signed at closing, including the total cost to obtain the loan. This includes, but is not limited to, the total interest paid over the life of the loan, assuming the full term is carried out at the note rate, plus certain closing costs. Closing costs could include prepaid interest, Private Mortgage Insurance/FHA Mortgage Insurance Premium/ or VA Funding fee, whichever may be applicable, and various miscellaneous costs including, but not limited to, underwriting fee and tax service fee, may be charged. All of these “Finance Charges” are taken into consideration when calculating the APR to give a more accurate picture of the total cost of the loan.

Q: Should discount points be paid to lower (buy down) an interest rate?
A: This question is best answered after careful consideration of your own personal financial goals. Buying down the interest rate (paying points on the mortgage – one point is one percent of your mortgage amount) may not be in your best interest. Here are some reasons why:

Mortgage interest paid is tax deductible in most cases (seek the advice of an accountant or the IRS).

The funds are no longer available to invest, save or use (ie. purchase an IRA, pay off credit card debt at a higher rate, etc.)

Falling interest rates can be taken advantage of sooner if discount points are not paid to buy down the interest rate (the original interest rate was higher).

In the past, if a consumer bought down the interest rate and then refinanced (buying down the rate again), it is possible not enough time will have elapsed to recover the “buy down” amount through the reduced monthly payment. This also occurs if the consumer sells the home before recovering the “buy down” amount.

Not only does the amount paid in discount fees (buy down amount) need to be recovered, the “time value” of the money spent or its “present value” also needs to be recovered. Present value is the income you could have earned or the satisfaction you could have received through alternative use of your money. Remember to consider the tax consequences of your ultimate decision.

Individuals should do what best fits their own personal situation and goals.

Q: How long does the loan process take?
A: The number of days from application to closing can vary from just a few days to 45 or more days, depending on a number of factors. Some of the factors include: loan type, whether an appraisal is needed, and title clearance. Time delays also occur if outside sources or the borrowers do not promptly provide documents to the lender.

Q: What is an escrow account?
A: When borrowers make their monthly mortgage payments, they generally also pay one-twelfth of the anticipated annual amount needed to pay taxes and insurance premiums. These additional funds are deposited into an escrow account until the lender pays the taxes and insurance premiums as they come due. The borrower benefits for budgeting reasons because costs are spread through the year rather than as a lump sum. This method allows the lender greater control in avoiding tax delinquencies or lapses of hazard insurance coverage on the property. Mortgage documents often stipulate lenders that establish an escrow account.

Q: Are lenders limited in the amount of escrow funds they can collect from borrowers?
A: The Real Estate Settlement Procedures Act (RESPA) sets standards for the calculation of the amount mortgage lenders require borrowers to deposit into the escrow account. RESPA limits the initial deposit into an escrow account to an amount equal to the sum sufficient to pay taxes, insurance premiums, and other charges on the mortgaged property for the first payment period, plus a cushion.

An escrow cushion is an amount of money held in the escrow account to prevent the account from being overdrawn when increases in disbursements occur.

On a monthly basis, mortgage lenders may not require borrowers to pay more than one-twelfth of the total amount of the estimated annual taxes, insurance premiums, and other charges, plus an amount necessary to maintain the allowable cushion.

Q: Can I pay my own taxes and insurance?
A: When a loan is originated, the mortgage documents specify the escrow conditions. This has become a standard practice for all mortgages, including FHA, VA and conventional mortgages. Occasionally on conventional loans, FRFCU waives the collection of escrow requirement at closing if the member has a minimum 20% equity position in the property.

Q: What do I do if I receive a tax statement?
A: Many tax authorities will mail an informational copy of the real estate tax statement to the homeowner in addition to the Credit Union. However, there are some statements tax authorities do not forward to the credit union, and in special cases we will need your assistance in obtaining the bill. If you receive a statement for any of the following, please forward it to our office by mail or fax.

* delinquent real estate taxes
* supplemental or additional real estate taxes
* special assessments
* if the tax authority will not honor a bill request from another party.

Q: Why did my mortgage payment amount change?
A: There may be several reasons. Some mortgages, such as ARM loans, provide for periodic adjustments to your principal and interest payment amount. A second reason for a change may be due to an annual analysis of your escrow account. In compliance with the Real Estate Settlement Procedures Act (RESPA), you will receive an Annual Escrow Disclosure Statement, which shows the adjustment to your escrow payment based on current tax and insurance amounts.

Q: What is an ARM loan?
A: An ARM loan is an Adjustable Rate Mortgage. The interest rate on an ARM loan is adjusted periodically based on the terms of the mortgage documents. The interest rate is typically based on a common index published periodically, adjusted by a margin. The margin is an amount charged in addition to the index and typically does not change over the life of the loan.

Q: What benefits do I receive from private mortgage insurance?
A: Prior to the existence of private mortgage insurance, individuals typically could not purchase a home unless they had a downpayment of at least 20% of the purchase price. Private mortgage insurance benefits the mortgage lender directly by reducing the costs associated with borrower default. It also benefits consumers by lowering downpayments, thereby allowing more people to achieve home ownership.

Q: How is interest calculated on a mortgage loan?
A: Most mortgages originated today calculate interest in arrears, unlike consumer loans which calculate interest to the date of payment receipt. As an example, when borrowers pay their February mortgage payments, they are paying the January interest. This method of calculating interest is based on a 360 day year in which each month has 30 days.

Q: Why does the title have to be cleared before I can get a mortgage?
A: When a lender makes a mortgage loan (other than a home equity loan), the lender typically requires a first lien position. This means there can be no other outstanding liens against the property that are superior to the new mortgage. Liens can result from a variety of sources, such as home equity loans or lines of credit, child support judgments, divorce settlements, delinquent taxes, and special assessments. Most realtors, mortgage companies, title companies, and escrow companies will assist the seller and/or borrower in clearing title. The ultimate responsibility, however, lies with the sellers of the property who are warranting clear title to the buyers. It is important the buyers receive clear title from the sellers so there are no future claims against their property ownership rights.

Q: How much time will it take to close my loan (sign the loan documents)?
A: Generally, the process takes as long or short as the borrower wishes. Explaining and signing the documents takes approximately 30 to 45 minutes. However, the borrower may choose to sign the documents and be on his/her way or ask a number of questions and spend more time. Closings may also vary from closing agent to closing agent.

Q: What are the benefits of doing a first and second lien combination?
A: By doing a first and second lien you will avoid private mortgage insurance, get a larger tax deduction, have a better equity position, and you will also be able to waive escrows if desired.

Q: What is preapproval or prequalification?
A: These are similar terms thrown loosely around by many loan officers. They essentially mean that a mortgage professional has reviewed your qualification ability from a credit, income, debt obligations, and assets available for the purpose of getting a home mortgage.

Q: How can I avoid private mortgage insurance?
A: The easiest way to avoid PMI is by putting 20% down payment; however, PMI can also be avoided if you only have 5% or 10% for the down payment. The way to accomplish this is via a first and second mortgage combination commonly referred to as 80/10/10′s or 80/15/5′s.

These two methods combine a first mortgage lien for 80% of the home price with a second mortgage lien for either 10% or 15% of the home price leaving the remaining 5% or 10% as the down payment. Because the first lien is at the magical 80% loan=to-value, there is no PMI required, even though a second mortgage is being “piggybacked” onto the financing thus allowing for the lessor down payment.

While the second lien terms are not as attractive as first lien rates, the second mortgage is still home mortgage interest and thus deductible as such on your federal tax return where PMI is insurance and offers no deduction.

Q: What is my credit score and how is it calculated?
A: Your credit score is a one look number at your overall credit rating. The calculation formula for this score is somewhat of a mystery and a secret held by the credit reporting bureaus. We do know that the major variables to derive this score are: public records, late payments, how recent and the number of late payments, amount of credit open, balances on credit open compared to available credit, and inquiries into your credit history. Each of the three major credit bureaus (Experian, TransUnion, and Equifax) offer a credit score for each borrower. So for a married couple there are six credit scores.

Q: Is there a minimum credit score?
A: This answer depends largely upon the type of mortgage you are trying to obtain. The most attractive and most common type of mortgage financing is FNMA & FHLMC also known as agency paper. To get an agency approval, the rumored acceptable credit score is 620. This can vary widely depending on other factors when underwriting the buyer (down payment, income, liquid assets…). To offer a range, consider the following: below 620 is poor, 620-650 marginal, 650-680 nothing special, 680-700 fairly good, 700-720 good, 720-750 very good, above 750 is excellent. Many loans are closed every day with credit scores less than 620. More than likely they are not on agency paper. Alternatives to agency paper are government loans (FHA & VA) and sub-prime money.

Q: Must I use the mortgage company that my builder directs me to?
A: No. It is your mortgage and you may decide upon the lender. However, most volume builders are effectively “forcing” their buyers to use their in-house mortgage company by refusing to pay certain fees or even altering upgrade packages based upon them getting or loosing the mortgage. This “forced-use” game most often spells higher interest rates for the buyer compared to what is available in the open marketplace.