Obtaining a mortgage in today’s ever-changing markets is often complicated. Numerous products serve varying needs depending on a homeowner’s future income and length of occupancy, and current real estate trends. Here PHH Mortgage Services answers some common questions.
Q. How do underwriting or qualifying ratios work?
A. Qualifying ratios are percentages of a homebuyer’s gross income that can prudently be allotted for debt. These calculations help the mortgage lender determine whether the borrower will be able to make monthly mortgage payments in a timely and consistent way. The most commonly used rule of thumb is 28%/36%, which limits the sum of monthly mortgage principle, interest, property taxes and insurance payments (PITI) to 28% of the homeowner’s monthly gross income, and further limits the total of PITI plus all other debt payments to 36%. Lenders may relax these limits to allow a financially stable borrower to qualify for a larger loan amount. Compensating factors that count include an excellent credit history, a consistent savings pattern, or a future increase in income. Moreover, borrowers who are being relocated by their employers are eligible for qualifying ratios of 33%/36% because as a group they show a track record of lower risk of default, and they move more frequently than other homeowners.
Q. What are points? When are discount points appropriate?
A. Points equal one percent of the loan amount and are usually paid at the closing. Origination points are what the lender charges for services rendered to originate, process and close the loan. Discount points are paid by the buyer to reduce the loan’s interest rate. Paying one discount point normally reduces the rate by 1/8 percent. To decide whether or how many discount points to pay, a consumer must evaluate the importance of paying upfront to reduce long term expenses. If money is available and the borrower expects an occupancy of about five years or more, then it’s worthwhile to pay as many discount prices as possible. The resulting reduced monthly payment will translate into greater savings over the life of the loan. If the borrower is financing most of the purchase price and closing costs, or if a shorter occupancy is anticipated, paying discount points makes less sense. Generally, taking a higher interest rate for a short time is preferable to spending a larger amount up front.
Q. What type of loan is best suited to the average buyer when interest rates are low?
A. In times of low interest rates, a fixed-rate loan offers the obvious advantage of assuring the monthly payment will remain the same, even in uncertain economic conditions. An adjustable rate mortgage (ARM) may appear riskier because the interest rate fluctuates with a predetermined index that is tied to market interest rates, such as the municipal bond market.
However, a low initial rate can be a critical advantage to an ARM, qualifying a borrower who anticipates an income increase for a larger loan amount initially. Employees who move, or are relocated every few years, can gain advantage from the low starting rate of an ARM.
Also popular is the balloon mortgage, a fixed-rate loan that amortizes over thirty years but requires full payment of principle at a specified time, usually five to seven years from the start of the mortgage. Interest rates for balloon mortgages are often a full percentage point below fixed-rate financing. Highly mobile individuals can take advantage of the lower rate. The only risk is allowing for refinancing or the purchase of another home when the balloon comes due.
The somewhat new fixed adjustable mortgage mixes the price appeal of an ARM with the stability of a fixed-rate loan, by increasing the interest rate in the first years at fixed intervals. This hybrid is available from some lenders.
Q. What advantages does pre-approval offer home buyers?
A. When a borrower applies for a mortgage before finding a house, and receives a written commitment from a lender to finance a suitable property when found, the buyer has several advantages.
- House hunting made easy.
Pre-approval lets the home-buyer know exactly how much home he or she can afford. Home finding is focused on a precise price range.
- Cash buyer status.
The buyer has the increased negotiating leverage of cash buyer status, because the mortgage is already in place.
- Accelerates the mortgage process.
Significant time is saved because a large part of the mortgage has already been processed.
Q. When is refinancing appropriate?
A. A homeowner refinances a mortgage either to reduce the interest rate and/or term of the loan or to take cash out of the equity in the home to pay off bills or make a major purchase. The first normally requires at least ten percent equity in the home. A cash- out refinancing requires at least 20 percent equity. Refinancing makes sense, as a rule, if the prevailing market rate is at least two percentage points below the existing market rate. Equally important is how much longer the home- owner plans to stay in the house. Three years is considered minimum by most experts. The box below shows why. By understanding the complex issues involved in obtaining residential financing, as well as their own needs and future plans, consumers will receive the most suitable mortgages for their individual needs.
When does it pay to refinance?
For example, on a $100,000 30-year mortgage: