Mortgages

The modern mortgage market offers a variety of mortgage loans catering to the needs of home buyers. The titles and details of these plans can become confusing, especially as new types are introduced continuously. You can make sense of these loan types, however, if you understand the basic principles that govern all mortgage loans. You can look to your real estate professional for assistance with understanding how the mortgage you obtain affects your purchase process.

Basic Principles of all Mortgage Loans

  • The home is used to secure the loan. A lender can force the sale of the home if the borrower defaults by failing to make scheduled payments. This is considered a short sale or foreclosure depending upon where the home is in the process when it sells.
  • The larger the loan compared to the value of the home, the more risk for the lender. An example of this would be a 'zero down' 100% financing home or a USDA loan. The lenders view is that they are 'taking all the risk' as the buyer has not invested any of their own money in the property. Past history has shown that buyers who have not invested their own money in the property are more likely to walk away from the property if they get into financial difficulty. In the recent downturn these loans were not available. With the return of the market these loan products are back again and available for qualified buyers. These loans often come with higher closing costs to the buyer to secure the loan. These loans will require the added cost of mortgage insurance on top of the payment on the loan.
  • Interest earned by the lender always is equal to the periodic interest rate times the outstanding principle balance of the loan. The periodic interest rate is the annual interest rate divided by the number of payments in the year (usually one per month).
  • The required payment usually is a bit larger than the interest due so that some of the loan principal is repaid with each payment. This process is called Amortization and is why most mortgage loans can be retired when all the monthly payments have been made.

Mortgage Insurance - What is PMI and how does it work?

Depending up your financial position you may be required to carry private mortgage insurance (PMI) on you loan. Below is an explanation of mortgage insurance as discussed on the Zillow website:

Mortgage lenders make many borrowers purchase mortgage insurance to protect the lender if the borrower is unable to pay the mortgage. In other words, mortgage insurance guarantees your lender will get paid if you default. For the borrower, it has a benefit, too: Getting mortgage insurance allows you to purchase a home before you have the full 20 percent down payment saved up. It will add an additional cost to your monthly payment.

If you are using a mortgage calculator to see what price you qualify for, be sure you consider this additional cost if you do not have a down payment of 20% or more. Here is a calculator you can use to help you calculate different mortgage options http://money.cnn.com/calculator/real_estate/mortgage-payment

What are the different types of mortgage insurance?

In general, there are two types of mortgage insurance: mortgage insurance bought from the government, designed for those with FHA or VA loans, or mortgage insurance for conventional loans which is bought from the private sector (this is called private mortgage insurance or PMI), Basically, the type of mortgage insurance required will depend on the type of mortgage loan you get. Your lender will be able to tell you which one you will need based on the loan that they feel is best for you.

Who is required to have mortgage insurance?

Typically on a conventional loan, if your down payment is less than 20 percent of the value of the home, lenders will require you to carry mortgage insurance. Usually, you pay those mortgage insurance premiums until your loan-to-value ratio (LTV) (this is simply the amount of money you borrowed divided by the value of the property you bought) reaches 80 percent. For example, let's say you bought a $100,000 home and put down 10 percent, or $10,000, and got a $90,000 loan to pay the rest. Your LTV in this case would be $90,000 divided by $100,000, or 90 percent. The longer you pay down your mortgage, the lower your LTV will become. On government loans (FHA, VA, USDA), mortgage insurance is normally required regardless of the LTV.

What does mortgage insurance cost?

Conventional Mortgage insurance rates may vary. The lower your down payment and/or the lower your credit score, the higher the premiums -- but typically the premiums can range from $30-70 per month for every $100,000 borrowed. So, if you bought a $300,000 home, you might pay about $150 per month for mortgage insurance. On FHA loans, there is an up-front MIP (mortgage insurance premium) and annual premium which is collected monthly. VA loans have an up-front fee (funding fee) and no annual or monthly premiums. Contact your lender for specific details.

What does mortgage insurance cost?

Typically, you'll pay your mortgage insurance premiums monthly right along with your mortgage payment (you can just send one payment to the lender). Lenders may also allow you to pay your PMI on a lump sum basis either in cash at closing. Otherwise it will be financed in the premium in your loan amount.

Why do I need mortgage insurance?

Your lender requires you to have mortgage insurance so that if you can no longer make payments on your home, the lender will still get paid (through the insurance policy). Mortgage insurance basically safeguards the lender in the event of borrower default. With the recent history of large amounts of foreclosures in the market mortgage insurance takes on an even greater importance.

How can I avoid paying mortgage insurance premiums?

If you put down 20 percent or more when you buy a home you can typically avoid paying mortgage insurance on a conventional loan. And once you've built up a certain amount of equity in your home, you can request to cancel it (see below).

When does mortgage insurance “fall off” the loan?

Once the borrower has built up a certain amount of equity in the house, typically 20 percent, the mortgage insurance policy usually may be canceled. The lender usually won't automatically cancel PMI until you've reached 22 percent equity based on the original appraised value of the home. You can request cancellation at 20 percent of the current market value. So if you own a home worth $100,000 and have paid down $20,000 in principal, you can request to cancel your PMI.

  • Interest earned by the lender always is equal to the periodic interest rate times the outstanding principle balance of the loan. The periodic interest rate is the annual interest rate divided by the number of payments in the year; usually one per month.
  • The required payment usually is a bit larger than the interest due so that some of the loan principal is repaid with each payment. This process is called Amortization and is why most mortgage loans can be retired when all the monthly payments have been made.

All mortgage loans have one of the following features:

  • Fixed payment and fixed interest rate - fixed rate mortgages
  • Fixed rate but variable payment - graduated payment mortgages
  • Variable rate and variable payment - adjustable rate mortgages

As you learn more about the types of financing available, you will notice that some loans appear to have more favorable terms. That may indicate that those loans are, indeed, bargains (and it does pay to shop around), but usually it means that those loans could have some feature that is less appealing to borrowers. For example, shorter-term loans often have slightly lower interest rates compared to longer-term loans. However, the monthly payment for the same amount of principal may be higher because of the shorter term. Variable rate loans usually have much lower interest rates to compensate for the risk the borrower accepts that interest rates will rise in the future.