One of the most important things to do before applying for a mortgage is to research the different types of mortgages and mortgage lenders. The reason this research is so important is because there are many lenders who simply don't care how much money goes out of the borrowers pocket and into the lenders pocket.
Mortgages are more often than not about bottom lines and profit for mortgage lenders, and to a lesser extent economic development. There are three considerations that can be considered when determining which type of mortgage to apply for. Those considerations are provided below as an informational source to aid the mortgage application decision.
Types of mortgages
• Interest Only Mortgages
Interest only mortgages pay nothing on the base loan of a mortgage making most if not all of a monthly mortgage payment apply to that interest as determined by the amortization schedule. The advantage of this type of mortgage is the monthly payment can be smaller, but the disadvantage is that it will be more difficult to build equity in the home. The reason for this is equity is built from home appreciation in addition to capital investment i.e. buying the value of the home by paying off the mortgage.
• Adjustable Rate Mortgages (ARM):
Adjustable rate mortgages have a lot to do with the housing crisis of the mid to late 2000's. Many of these mortgages were written for home buyers who did not completely understand the implications of the mortgage terms or who were overly optimistic about their ability to pay their mortgages at a later point in time.
The reasons adjustable interest rate mortgages are able to cause so much default and foreclosure is because when interest rates rise, so do the mortgage amounts. For example, a $100, 000.00 ARM with an initial interest rate of 5% would cost $416.00 without insurance, property tax and capital payments built in.
If an ARM was not an interest only mortgage, the actual mortgage amount would be somewhere between $500-$600/month with capital investment and other costs. For each 1% rise in interest rates that mortgage goes up by $100.00 per month. Depending on the size of the mortgage a 1% increase may or may not lead to a dramatic increase in payment, however for increases more than 1% on smaller mortgages and larger mortgages with increases of 1%, the annual increase can end up being in the thousands of dollars.
• Fixed Rate Mortgage
Fixed rate mortgages are as the name implies, mortgages with interest rates that do not change for the life of the loan. Whether it be a 15, 20 or 30 year mortgage, the interest rate will be steady for this kind of loan. An advantage of fixed rate mortgages is the borrower does not have to fear a dramatic rise monthly payments when interest rates change. However, if interest rates drop, the fixed rate mortgage holder is left with a monthly payment that could have been lower with an adjustable rate interest only mortgage.
• Prime, Alt-A, and Sub-Prime Mortgages
A few other categories of loans are the credit ratings and income reporting requirements of the borrowers. Generally, borrowers who have very good credit ratings and solid earnings statements and asset capital are considered to be prime mortgage borrowers. Borrowers who have good credit ratings but do not fully document income when applying for mortgages are classified as Alt-A mortgages. The last and riskiest category known as Sub-prime, are for those lenders with poor credit ratings and/or limited income and asset leverage.
Types of lenders
Lenders are very important in the mortgage process as they determine whether or not funds will be available in time to make a successful bid on a home. Many factors go into the lending process which can take as long as 2 months in some cases. Those factors include loan officer know how and experience, research of lenders, financial soundness of the lender, lender requirements and bureaucracy, and overall process functionality and integration as loans may start off with a loan officer but end up with an accountant for approval. Making sure the application gets from start to finish can sometimes take a little prodding.
• Online Banks
When applying for a mortgage online, banks will offer what they call a "pre-qualification". A pre-qualification is essentially a statement of willingness to consider financing based on a credit check. Pre-qualifications are not the same as pre-approvals which are bank guarantee funds will be supplied to the lender in the form of a loan.
There is a little harm in obtaining one or two pre-qualifications, but too many may negatively affect one's credit score so it is wise to only request pre-qualification from banks one is seriously considering borrowing from. The more creditable and financially sound the online bank, the wiser the choice may be. Incentives for using online banks may include but not be limited to lower interest rates and settlement costs.
• Federally backed banks
Banks such as Fannie Mae and Freddie Mac are not managed by the Government but are linked to the Government through loan subsidization programs. These programs have strict lending requirements but are fairly secure and cost effective if a mortgage borrower qualifies for such financing. Often, these types of loans are reserved for first time home buyers and/or home buyers with income levels below a certain dollar denomination.
• Private and national banks
Other brick and mortar lenders include private and public national banks. Some of these banks have stellar reputations and financial security and offer competitive rates and a variety of mortgage loan products. An advantage with such banks is the fact one can access a loan officer who will be quite important in determining how the loan gets processed and answering any questions regarding the application procedure.
It is important to research the differing incentives, interest rates and benefits of private and public lenders because they can vary considerably. Also, since the value of mortgages can become quite large, being frugal with percentage points and percentage point reduction programs can end up costing thousands of dollars in the long run.
Paperwork requirements
Paper work requirements vary with the standards and requirements of the mortgage lender. Paperwork may include tax returns from the last 5 years, complete documentation of assets and liabilities, pay stubs, credit reports from all borrowers, loan education and testing materials, application forms, disclosures, and any other relevant paperwork such as proof of marriage, prior bankruptcy rulings if any, and all debts owed. Generally speaking, all lenders will require some income, credit, and asset reporting with the application.
Determining which type of mortgage to apply for can take and should take a little time in order to research the right lender, type of mortgage, convenience, cost effectiveness, accessibility of loan officers and accountants, practicality etc. Feeling completely confident with a mortgage is important in the home buying process because there are so many variables involved of which the mortgage is one significantly important part. The information provided above can be used as a supplemental reference and/or starting point when searching for a mortgage.
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