A mortgage is a loan secured by a home as a collateral. When someone decides to buy a house, there are only two ways to achieve this: (1) pay cash, or (b) finance the loan. Unless a borrower has sufficient cash or savings to pay for the house in full, the other option is to finance the home for an extended period. The financing aspect is what most people opt for when buying a house. This is where a mortgage comes into the picture.
Taking on a mortgage is a massive undertaking for most people, the average person doesn’t want to bear an immense debt in their lifetime. On the other hand, we all want an asset that will appreciate over time. Something that when holding on to for an extended period can be passed down from one generation to another. This is the most significant appeal of a house or any real estate; the ability to appreciate and increase in value over time, thereby building equity.
A person buying a home (borrower) has to secure financing from a mortgage company (lender) to buy the house they want. Buying a home and getting the necessary financing for the home is a process. It starts with applying for a mortgage loan.
Applying for a Mortgage
A company that offers to finance a home is called a “Lender.” The lender has Loan Officers who are licensed to originate a mortgage loan. A borrower must apply for a mortgage with a Loan Officer to determine how much they qualify for, the requirements for such qualification and documentation needed to finalize the eligibility if they qualify at all. A borrower can apply for the loan in person, over the phone or online.
The Loan Officer will ask the borrower to provide specific documentation for their income and assets. Documentation includes, but not limited to, 30-day paycheck stubs, last two years W2s and previous two years tax returns. Asset documentation, such as two months worth of bank statements and most recent report of retirement accounts, must be provided.
After the Loan Officer reviews the borrower’s income and asset documentation, a credit report will be ordered and pulled for all three credit bureaus: Experian, Equifax, and TransUnion. As an industry standard, the middle score of the three credit reports will be used to qualify a borrower, hence, the term “middle FICO score.” The borrower’s middle FICO score determines what loan program they are eligible for, the down payment requirement for a loan, and the interest rate associated with the home loan.
There are three (3) things that borrowers must be aware of where the money will come out of their pocket when buying a house: (1) Down Payment, (2) Closing Costs, and (3) Prepaid Items. These three are all related to each other, but not the same thing.
– Down Payment – This is a percentage amount relative to the sales price. It could be anywhere from 3.5% for an FHA loan, 5% for a Conventional loan, all the way to 30% for non-conforming loans. It is pretty much self-explanatory, the down payment comes off the top of the sales price. The remaining amount is referred to as the “loan amount.”
– Closing Costs – It is the hard costs of doing business. The closing costs are charged by the lender, the title company, and other third parties such as an appraiser, surveyor, etc. The Lender closing cost and the title company closing costs are two separate entities. Most borrowers think that the lender is the one that charges all the closing costs. This is the common misconception in the mortgage industry. Each party (title company, lender, and third-party entities) have their own respective set of costs associated with the loan.
– Prepaid Items – These are daily interest, insurance, and taxes in reserve. A borrower must have 12 months of insurance paid at closing. The cost of 3 months of worth of insurance must be held in escrow reserve, as well as three months worth of property tax. A borrower is also responsible for the interest from the day they close on the loan, up to the first day of the following month. All these items constitute the “prepaid items.”
The combination of the down payment, closing costs, and prepaid items may seem like an enormous amount. At first glance, most borrowers at petrified by it. However, the closing costs and prepaid items can be negotiated to be paid by the seller as a “Seller’s Concession” or seller contribution to the borrower. Different loan programs have a different allowable percentage of seller’s contribution.
– Loan Terms – The term of the mortgage loan is anywhere from 10 – 30 years. The longer the term, the lower the monthly payment, thus, most borrowers goes for a 30-year term when they get a mortgage.
– Interest Rate – A common inquiry from a borrower is, “what interest rate are you charging?” The rate charged to a borrower is determined by several factors: middle FICO score, loan type, loan term, loan amount, down payment and loan to value (LTV), among other things. Rest assured, borrowers falling into the class and category, having the same criteria, will be offered the same rate. Since no two borrowers are precisely alike, thus, the difference in the interest rate offered to them.
Qualification and Approval Process
After the Loan Officer (or Originator) reviews the borrower’s documentation, pulls credit and determines the loan program that the borrower qualifies for, the file is submitted to an Automated Underwriting System (AUS) for a preliminary approval. When the file gets an approval from AUS, the Loan Officer can then issue a pre-qualification letter to the borrower. The pre-qualification letter will specify how much the borrower qualifies for, the loan type or program, loan term and interest rate, any other stipulation for such conditional approval.
With a pre-qualification letter in hand, the borrower is now ready to shop for a house. The borrower needs to share his pre-qualification letter with the Realtor they are working with to show that they have taken care of their financing before shopping for a home. The pre-qual letter is what the Realtor presents to the seller when making an offer on the house. This shows the seller that the borrower is all ready to go and serious about buying the home they are looking to buy.
For additional information about getting qualified or pre-approved for a loan, contact our Home Loan Specialists at 281-949-7218.