Buying a home is one of the greatest achievements for many people and a source of joy and pride. At the same time the purchase of a home is the largest purchase most people will make in their lifetime. For that reason alone, it is very important to examine all of the possible options available before making such an important decision. This brief overview will help you understand the financing process and the industry language.

WHAT IS A MORTGAGE?

A mortgage is a loan to finance the purchase of a home. The entity that gives the money to purchase the home is a lender. To repay the debt, the borrower (that is, the person buying the house and borrowing the money) makes monthly payments. When a borrower obtains a mortgage on a property, the buyer will sign a “deed of trust” to the lender. This means that the property will be used as security for the loan. The borrower owns the property, but the lender has special rights that protect its ability to be repaid.

WHAT MAKES UP A MORTGAGE AND WHAT ARE THE ASSOCIATED COSTS?

All mortgages feature both principal and interest. Principal and interest comprise the bulk of the borrower’s monthly payments, which reduces the debt over a fixed period of time. Taxes and insurance costs are other costs that are usually added into monthly mortgage payments.

Principal -- The principal is the amount of money borrowed to buy a home. The borrower usually gives the seller a down payment and then borrows the principal to make up the difference between the down payment and the total purchase price.

Interest -- Interest is what the lender charges the borrower for the use of the money borrowed to purchase the house. The lender may also charge an additional sum known as “points.” A point is one percent of the amount borrowed.

Taxes -- Property taxes are taxes that a community levies annually, based on a percentage of the value of the home and land. The tax is generally used to help finance the cost of running the community by helping to build schools, roads, and other needs. Lenders often collect money from borrowers to pay these, so they can be certain the property does not become burdened with back taxes.

WHAT IS EQUITY?

Homebuyers who finance a purchase of a house with a conventional mortgage gradually build up an interest called “equity” in their homes. Equity is what a property is worth minus any unpaid mortgages or other liens. It represents the part of the house that the buyer owns “free and clear” at any point in time, and it gradually increases over the life of a loan.
Equity can also be used to obtain additional loans called equity loans. The equity in the home increases as a buyer pays down the principal balance on the mortgage, as improvements are made to the home, and as property values rise in the community. For example, where a buyer borrowed $100,000 to purchase a house and has paid enough in payments to reduce the principle amount borrowed by $25,000, if the house is worth $130,000, the buyer has built $55,000 of equity in the home ($130,000 – ($100,000 - $25,000) = $55,000).

WHAT IS A FORECLOSURE?

If a buyer does not pay the payments on a mortgage, the lender has the right to take back the house and sell it, because the house was used as security for the loan. The lender will use the money from the sale to pay back the loan. If the sale does not bring enough money to cover the loan, the buyer may be responsible to make up the difference. On the other hand, if any money from the sale is left over after the loan is paid back, the buyer will get what is left over. The amount left over from the sale after paying off the debt represents the buyer’s equity in the house. For example, if a house sold for $100,000 and the buyer still owed $75,000 to the lender, the buyer would receive $25,000 from the sale: the sale price minus the remaining debt of $75,000.

TYPES OF MORTGAGES

FIXED: A fixed term (for example, 15 or 30 years) as well as a fixed interest rate. The interest rate and term are fixed at the start of the mortgage. The monthly amount for the payment of principal and interest will not change during the term of the mortgage.

ADJUSTABLE: Often referred to as an ARM (Adjustable Rate Mortgage). The interest rate on your mortgage will be adjusted up or down according to current interest rate levels. The monthly amount for your principal and interest payment will go up or down with these rate changes.
Conventional, FHA (Federal Housing Authority) and VA (Veteran's Administration) loans are all available in both fixed and adjustable forms.

SELLER FINANCING: When selling your property, and depending on your equity position, it is possible that you may get an offer for your home with a seller financing contingency. This type of offer may or may not be to your advantage. Due to the many variances (and possible pitfalls) involved in such transactions, it is highly recommended that you review any contract with a seller financing contingency with your attorney and financial advisor.

ASSUMABLE LOANS: Although the vast majority of conventional loans have a "due on sale" clause (meaning the loan must be paid off if you sell your house), certain FHA and VA loans are assumable by the buyer. For example, FHA loans originated prior to December 14, 1989 and VA loans originated prior to March 1, 1988 are freely assumable, meaning that the buyer does not need to go through a qualification process. FHA and VA loans originated after those dates are assumable only to qualified buyers, with conditions. In any offer that contains a mortgage assumption clause, it is advisable to consult your attorney, since there are situations (e.g. on non-qualifying loans) where you as seller may still be held responsible for the timely repayment of the loan by your buyers.

OBTAINING FINANCING

If you need to obtain financing, it is important to make the purchase contingent upon receiving suitable financing. This insures return of the earnest money deposit to the buyer, in the event that the buyer cannot obtain financing in the time frame specified.
Included are some of the questions a borrower should ask when comparison shopping for a loan.
Get your credit score as high as possible, your interest rate and likelihood of being qualified increase significantly with a higher credit score. If possible, payoff as much debt as possible. Do this as early in the process as possible; it takes a while for these changes to your debt ratio to be reflected in your credit report.
Get preapproved by a lender or mortgage broker. This makes you essentially a cash buyer with a lender agreeing to approve you for a loan, barring any unexpected changes to your financial situation. It’s also a good way to find out how much you can afford before you waste time and energy looking at homes out of your price range. A good preapproval letter will contain the following information: amount of loan, interest rate, contact information for mortgage broker or loan officer, and date letter was issued (typically letters are deemed reliable for 30 days max).
Find a lender or mortgage broker. A good loan officer will provide all the information that you (the borrower) need to make an informed decision about which loan to choose. And will also assist you with doing everything in the power to troubleshoot potential obstacles that occur during the processing of the transaction. Also, many lenders offer information that helps buyers to compare loan types.

PRE-QUALIFIED, PRE-APPROVED, COMMITMENT. WHAT DOES IT ALL MEAN?

These are terms you will hear very frequently, so it is crucial that you understand the difference in what each of the different terms means.

Pre-qualified
The buyer has made application for pre-approval only. Income and debt figures have not been verified. A pre-qualification only says that a buyer can afford a specific payment (and therefore a mortgage amount) based on figures they have supplied. A credit check has been run on the buyers.

Pre-approved
The buyer has made a formal application for a loan. Income and debt figures have usually been verified. A complete credit check has been run on the buyers. A pre-approval will be subject to a satisfactory appraisal on the property in which the buyers are interested.

Commitment
There is final loan approval. All needed documents are usually in hand by the lender. An appraisal has been done on the property. All income, debt, and credit information has been completed to the satisfaction of the lender. Commitment is the last step before closing. It signals that the loan is complete.

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