Where does mortgage money come from?
What factors will a loan officer consider when qualifying me for a mortgage?
What kinds of mortgage products are available?
What are the expenses involved in obtaining a mortgage?
Where can I go to get a pre-approval and a loan?
Where can I go to get additional information?
There are really two answers to this question. As a consumer looking to borrow money to buy a home, you might approach a bank, a mortgage broker, an online lending entity, or a community organization. You might think that mortgage money comes from banks, or brokers, or community organizations, but the large majority of mortgage money ultimately comes from Wall Street via two government-sponsored enterprises (GSEs) called Fannie Mae and Freddie Mac. As of September 2008, Fannie and Freddie have been in the conservatorship of the federal government.
The majority of conventional loans are bought (and securitized) by Fannie Mae and Freddie Mac. Fannie Mae (FNMA, Federal National Mortgage Corporation) was created in 1938 by Franklin D. Roosevelt to help lower the cost of buying a home. In 1968 it was re-chartered by Congress as a shareholder-owned company called a GSE (Government-Sponsored Enterprise). Freddie Mac (FHLMC, Federal Home Loan Mortgage Corporation) was chartered by Congress in 1970, and as far as I can tell it was created to make competition for Fannie Mae. If you’d like, you can ready more history on these entities here.
Loans that are bought by either of these entities are called conforming loans, in other words, they conform to Fannie Mae and Freddie Mac guidelines including loan limits and other lending criteria. (Incidentally, the loan limits for both of these entities are set by the OFHEO, the Office of Federal Housing Enterprise Oversight). Non-conforming conventional loans include jumbo loans (those that exceed the Fannie Mae limits) and a variety of other products. In the heyday of mortgage lending (now passed) there were a number of companies involved in securitizing mortgages and offering them as bonds called collateralized mortgage obligations. Since this source of funds has more or less dried up at the moment, and since it fueled much of the sub-prime lending spree, we won’t worry about it right now.
In additional to these conventional mortgages, government mortgages are available, specifically through the FHA (Federal Housing Administration, a Division of HUD, the Department of Housing and Urban Development) and the VA (U.S. Department of Veteran’s Affairs). These programs, incidentally use the same underwriting system as conforming loans (or a subset of it) and offer some special programs. You generally don’t have to go to a special source to get information on goverment-insured loans. Many mortgage brokers will have access to these programs. Here’s a link to a list of HUD-approved lenders. And here’s the link to the Massachusetts Regional Center for VA Loans.
Finally, there are times when a bank will fund and hold its own loan–this is called a “portfolio loan.” From what I can gather, portfolio loans represent about 1% of all mortgage loans.
A loan officer will typically look at four factors: credit, income, assets, and the property itself.
Credit. Higher credit scores generally correspond to lower rates. Low credit scores (especially these days) could mean not qualifying for a mortgage at all. FHA Loan Programs, and organizations like NACA seem to be a bit more flexible on the credit issue, so they’re worth checking out if you don’t have strong credit, and for other reasons as well.
Income. A lender will want to verify your income and will typically want to see two years of tax returns along with recent pay stubs. Ideally you’ll have been in the same job (or at least in the same line of work) for two years. To arrive at a maximum mortgage payment amount, they’ll take your gross income (your income before taxes) and apply a “front end” ratio (let’s say 29%, for this conservative example) to determine your total housing cost. Let’s say you make $70,000 per year. 29% of your gross income would be $20,300 or $1692/month. Subtract housing-related costs from this number (real estate taxes, condo fees, insurance) and you’ll come up with a mortgage number. Lenders will also look at a “back end” debt to income (DTI) ratio that includes other debt you may be carrying (car payments, student loan payments, minimum credit card payments, and any other debt payments). This ratio, in our example, should not exceed 36%. The lender will generally take the lower number to arrive at your mortgage amount. Please consult your loan officer for current ratios and specifics.
Assets. A lender will want to confirm the existence of funds for your down payment. Generally speaking, your down payment funds need to be funds that you’ve been holding in your accounts for at least 60 days. In addition, a lender will want to ascertain that you have adequate reserves, following the closing, to cover mortgage payments for a certain number of months (this varies by program, so again, ask your loan officer about your specific situation). FHA and NACA programs (see above) make some exceptions here as well. Down payment money can also come from a gift (in which case a “gift letter” will be required by the lender, to ensure that the gift is not actually a loan).
Property. Before issuing your loan commitment (the second-to-last step in your financing journey), the lender will order an appraisal of the property being financed. Generally, the appraisal needs to be at least the amount of your purchase price or you might be looking at a different type of loan. If your property is a condominium, the lender will also want to know about a bunch of things about it–the same types of things that you might want to know, and that are discussed in this section of the Home Buying FAQ.
As you can gather from the above, obtaining a mortgage loan can require a lot of documentation. Generally, the greater the level of documentation, the more favorable your loan terms. For this reason, try not to begrudge the paperwork–and if you loan officer isn’t asking you for information, make sure that s/he is getting you into the best program possible.
In the simplest terms, a mortgage is comprised of a term, a rate (which can be fixed or adjustable) and a loan-to-value ratio. A term can be 30 years (or even 40), 25, 20, 15, or even 5 years. A rate can be fixed (as in “30-year fixed”), variable (i.e. fluctuating based on a particular market index) or, more commonly, hybrid (having a period with a fixed rate followed by a variable rate). Loan-to-value ratio indicates the percentage of the home value that the mortgage represents, so an 80/20 refers to a purchase involving an 80% mortgage and a 20% down payment.
The simplest, most easy-to-understand mortgages are fixed rate mortgages, the most typical being the 30-year fixed. Let’s be absolutely clear about our definition. A 30-year fixed mortgage is a mortgage that gets paid (or amortized) over thirty years at a fixed rate of interest and with fixed monthly payments. As amortization schedules work, payments early on in your loan cycle consist primarily of interest, whereas payments toward the end consist primarily of principal. If you’d like more detail on this, calcamo.com, which appears to be a french company, has some handy calculators, graphs, and amortization charts.
In addition to 30-year fixed, there are loans that are fixed for 25, 20, 15, 10, 5 and even 40 years. As you can reasonably guess, the loans with shorter terms have higher monthly payments. They also carry slightly lower interest rates (because the lender is committing to the interest rate for a shorter period of time).
Then there are what are most correctly referred to as hybrid arms, which frequently have a 30-year amortization but are fixed for a certain period (often 5, 3, or 2 years) and vary after that based on a particular market index (like the U.S. Treasury Rate or the LIBOR). If you hear people talking about a 5/1 ARM, for example, they’re likely referring to a mortgage with a 30-year amortization that is fixed for five years and then adjusts once a year after that based on a index, as mentioned above.
Then there’s the question of loan to value. The most conventional mortgage will have a 20% (or greater) down payment. Mortgages with a greater loan to value ratio (a 90/10) will require the buyer to purchase Private Mortgage Insurance (PMI) to protect the lender against the possibility of default. One way to get around this has traditionally been to give the buyer two mortgages, for example, a mortgage for 80% of the home’s value, and a second mortgage (often a home equity line, at a higher, variable rate) for 10% of the value. This can be cheaper than paying PMI, and you can try to pay down the equity line to eliminate entirely and/or refinance into a new loan later to eliminate PMI. This is particularly possible if property values are rising and/or if you’ve added value to your property through improvements. In the same way, you could refinance out of a PMI loan. There are also special programs, like NACA’s, that don’t include PMI.
There are other kinds of loans out there as well (or there used to be!). These include negative amortization loans, “no doc” loans, balloon payments loans, and true adjustable rate mortgages. I’ll leave these to specific loan officers to explain, but I think we’ve covered the basic above.
The expenses involved in obtaining a mortgage are many. I’ve grouped them into categories below so that it’s easier to make sense of them.
- Fees for Doing the Loan:
- Origination Fee and/or Yield Point Spread: An origination fee can be a percentage of the loan or a flat fee. Some loans do not have origination fees. Instead, the fee shows up (on the closing statement, called the HUD) as a “yield point spread” (YPS) in a column marked “paid outside of closing” (p.o.c.). The Yield Point Spread is essentially a premium that a lender pays to a broker for obtaining an higher-than average interest rate. Is this method of paying for a loan by definition objectionable? Not in my opinion–it’s just another way of financing the cost of doing a loan.
- Processing or Administrative Fees.
- Third-Party fees incurred by the bank that you pay: can include appraisal fee and a survey of your property.
- Attorney’s Fees: both you and the bank will have fees to pay to attorneys. The bank will have their own attorney to perform the closing (at your expense) and your own attorney would normally attend the closing as well. Having the same person perform both of these functions can usually save you money. Ask your attorney if s/he can also do the bank work for you. The answer will usually depend on their relationship with your lender. You’ll also note that a large amount of the payment for the title insurance also goes to the bank attorney.
- Pre-paid Items: can include pre-paid interest, local taxes, condo fee, and private mortgage insurance (PMI), if applicable.
- Title Insurance: For some reason, this item rarely gets discussed with buyers until they’re sitting at the closing table. Your lender will require that you purchase title insurance to cover any defects in title for the amount of your mortgage. Attorneys always recommend that you also purchase title insurance for yourself. Massachusetts is one of the few states that does not regulate title insurance rates, so please be aware that this expense is coming, and shop for title insurance before your closing.
- Recording Fees: pay for the county clerk to record the deed and mortgage and change billing information for property taxes.
- Discount Points (optional): If you pay points to buy down your loan, this gets listed as an expense at the closing. FYI, discount points are tax-deductible in the year of closing. Closing costs in general are not tax-deductible but can be added to your tax basis when you sell.
- Other expenses (not necessarily on your closing sheet): home and pest inspections, homeowner’s and hazard insurance.
Here’s an example of a HUD statement where you can review some of these expenses.
How do you keep on top of these expenses, and how can you understand them? Within 3 days of your loan application, you should get a GFE, a good faith estimate of closing costs. Study this sheet, and use it (along with your loan terms) to compare loans. And make sure to bring it with you to the closing so that you can make sure that the expenses listed there are as stated. APR (annual percentage rate) is another good tool for comparing the costs of loans (as long as you’re comparing apples to apples). APR rolls the loan costs into the rate.
To obtain a loan (and a pre-approval for a loan, which you’ll need when you put in an offer on the property), you can speak with a mortgage broker, a mortgage banker, a credit union, a community organization, or an online lending entity. I’ve provided a bunch of information on all of the above here.
When seeking a mortgage broker or banker, as for a real estate agent, I’d recommend asking around. Ask friends and relatives for lenders that they’ve used and been happy with. As a first-time buyer (or as a more experienced buyer!) you’ll want someone you feel you can trust and who will be able to answer your questions for you. Here’s a list of loan officers that ePlace clients and agents have worked with.
A California-based company funded with Ford Foundation grant money that seeks to empower consumers by providing mortgage and cost information from a variety of different lenders. Mortgage Grader has been favorably reviewed in a number of major publications (Wall Street Journal, Time Magazine) and is certainly worth checking out.
Overall, two types of internet lenders exist: 1) those that lend money themselves and find their customers online (these include e-loan, e-trade, and ING Direct), and 2) internet-based lead-generators, companies that sell customer information to loan officers and/or real estate agents. This latter category includes lendingtree.com and housevalues.com. I had always been very suspicious of online lenders, but my sister did her last refinance (of a condo in Somerville) through ING and was very happy with experience, and the rate/expenses.
NACA (Neighborhood Assistance Corporation of America)
“The Best Mortgage in America.” NACA was formed out of a settlement with Fleet Bank around predatory lending practices. You can read more history here. There are no income limits to qualify for a NACA loan, but they do have purchase price limits. In addition, you must be in a NACA coverage area (Cambridge and Somerville are within the area) and you must not currently have ownership interest in a property. NACA indeed appears to have incredible mortgages and I’m not sure why they’re not more well known. My sister-in-law and her family in Buffalo, NY have a NACA mortgage which is indeed excellent, as did a friend of mine in California who had been a victim of predatory lending. They require membership and training to qualify, so getting a NACA mortgage is likely more work than getting some other types of mortgages, but seems worth checking out if you meet the criteria. There’s a good overview of NACA on the howstuffworks website.
Cambridge and Somerville Programs
Yes, both Cambridge and Somerville have special programs for residents, including affordable housing units and special mortgage programs.
City of Cambridge Affordable Homeownership Website. Cambridge offers affordable housing units for sale as well as mortgage programs geared to first-time buyers who meet certain income limits.
City of Somerville Housing Programs and Services. Somerville’s housing site is more a bit more difficult to navigate (check for lists of interesting links on the left side of their website, but mortgage assistance information can be found here. Affordable Homeownership Programs can be found here; and click on links at left for specific opportunities.
Bankrate is the leading online aggregator of mortgage rate information. They also provide rates for some credit unions. Be careful when you enter information on this site, as there are a number of prominent advertisements that look like editorial content.
“Beyond the Rate” Podcasts
In 2006, Patrick Schwerdtfeger, a California mortgage broker, created a series of podcasts (now available in .pdf format) on all aspects of the mortgage business. These rich, informative podcasts, though somewhat dated now, go into lots of detail and provide the best insider’s view of the business that I’ve seen. They’ve been an invaluable resource to me in understand mortgages and the mortgage market. Thank you Patrick! Patrick also has a publication available for download called How Mortgage Officers Get Paid which is very useful as well.