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Mortgage Cheat Sheet

Mortgage Cheat Sheet

Harry Jensen, Trusted Mortgage Expert with 45+ Years of Experience
, Trusted Mortgage Expert with 45+ Years of Experience

    Our Mortgage Cheat Sheet focuses on the key questions that borrowers have when getting a mortgage for the first time. The cheat sheet offers insightful explanations, helpful mortgage process recommendations and links to relevant resources on FREEandCLEAR.  If you are a first-time home buyer or getting a mortgage for the first time, you have come to the right place as the information below takes you through the process from start to the closing table.  Our cheat sheet complements the FREEandCLEAR Mortgage Process Guide which offers a more comprehensive review of the mortgage process.

    1

    Can I Qualify for a Mortgage?

    There are multiple factors that determine your ability to qualify for a mortgage, including the following:

    • Debt-to-Income Ratio: lender guidelines typically allow a borrower to spend a maximum of 43% to 50% of their monthly gross income on their mortgage payment, other housing expenses such as property tax and insurance plus other monthly debt including credit card, auto and student loan payments.  Debt-to-income ratios vary by loan program and lender.
    • Credit Score: the higher your credit score, the easier it is to qualify for a mortgage and the better the loan terms you receive from the lender.  Most lenders require borrowers  to have a credit score of at least 680 to 700 to receive their lowest mortgage rate and fees but you can qualify for a mortgage with a credit score as low as 500 and with no credit score at all, depending on the mortgage program.
    • Employment History: lenders typically want to see that you have a two year continuous employment history before you apply for a mortgage. The good news is that military service and full-time school such as college counts as employment when you apply for a mortgage so if you recently graduated or served in the military you may be able to qualify.
    • Down Payment: some lenders require that borrowers make a down payment of 20% in order for the borrower to receive their lowest interest rate although it is certainly possible to obtain a mortgage and buy a house with a down payment of less than 20%.  As we review below, there are many mortgage programs that enable you to qualify with little or even no down payment.
    • Lender Underwriting: the underwriting process involves a comprehensive review of your loan application including your financial and credit profiles.  Underwriting and borrower qualification guidelines vary across mortgage lenders -- one lender may decline your application while another lender may approve you.  You many need to contact multiple lenders to qualify for a mortgage.

    FREEandCLEAR Recommendation

    It is important to review your credit score and organize your personal financial documents at the beginning of the mortgage process.  Check out our Home Purchase Mortgage Checklist to get prepared before you apply for your loan.  We recommend that you speak to multiple lenders to understand your ability to qualify for a mortgage as qualification guidelines vary.  Contacting multiple lenders also  enables you to compare loan terms to find the lowest mortgage rate and fees.

    2

    What Size Mortgage Can I Afford?

    How much mortgage you can afford depends on several inputs.  According to debt-to-income ratio guidelines, borrowers are typically permitted to spend a maximum of 43% to 50% of their monthly gross income on total housing expense plus other monthly debt payments (such as credit card, auto and student loans).  So the less monthly debt you have, the more you can spend on your mortgage payment and the larger the mortgage you can afford.  Certain mortgage programs use lower or higher debt-to-income ratios so you should work with your lender up-front to understand what debt-to-income ratio the lender uses as well as the inputs that go into calculating the ratio.

    Regardless of industry guidelines, you should feel comfortable that you can afford your monthly mortgage payment and total housing expense -- you do not want to get in over your head when you get a mortgage.  Once you have decided how much you are comfortable spending on your monthly mortgage payment, you can determine what size mortgage you can afford based on your interest rate and loan length.

    You need to make sure you are comfortable with your monthly mortgage payment and total monthly housing expense regardless of what size mortgage a lender says you can afford. Remember, with programs such as an adjustable rate mortgage or interest only loan, your monthly payment can increase so although you may be able to afford your mortgage today, you may not be able to afford it in the future.

    FREEandCLEAR Recommendation

    Use our MORTGAGE QUALIFICATION CALCULATOR to determine what size mortgage you can afford based on your monthly gross income and debt payments

    3

    What Size Down Payment Do I Need to Buy a House?

    Lenders typically offer their lowest interest rate if you make a down payment of at least 10% to 20% of the purchase price of the home.  If you make a down payment of less than 20%, you may pay a higher mortgage rate or be required to pay mortgage insurance, which can increases your closing costs and monthly payment, depending on the loan program.  So while it is definitely possible to buy a home with a down payment of less than 20%, or no down payment at all, your mortgage may cost you more.  If you decide to make a lower down payment it is important to understand if your interest rate increases or if you are required to pay additional upfront and ongoing mortgage insurance fees.

    FREEandCLEAR Recommendation

    Use our DOWN PAYMENT CALCULATOR to calculate the down payment and total funds required to buy a home

    4

    How Do I Find the Best Mortgage Rate?

    Shopping for your mortgage is the best way to make sure that you are getting the lowest interest rate and closing costs.  Please note that lenders that offer lower mortgage rates may charge higher fees so there may be a trade-off between the rate and costs.  Interest rates also vary by mortgage program.  For example, the initial rate for an adjustable rate mortgage is typically lower than the rate for a fixed rate mortgage, so make sure you are comparing loan terms for the same type of mortgage.

    FREEandCLEAR Recommendation

    We recommend that you compare proposals from at least five lenders to find the best mortgage rate. Contact multiple lenders in the table below to find the best loan terms.

  • %
    Current Mortgage Rates as of January 23, 2019
    • Lender
    • APR
    • Loan Type
    • Rate
    • Payment
    • Fees
    • Contact
    View All Lenders

    %

    Data provided by Informa Research Services. Payments do not include amounts for taxes and insurance premiums. Click here for more information on rates and product details.
  • 5

    How Much are Closing Costs?

    When you evaluate closing costs, it is important to understand that there are non-recurring and recurring costs

    • Non-recurring closing costs: These are one-time, up-front costs that the borrower pays to various third parties to process and close the mortgage. Examples include lender, appraisal, title company, escrow and attorney (if applicable) fees
    • Recurring closing costs: These are costs that the borrower will continue to pay after the mortgage closes. Typically the borrower is required to pay a portion of these ongoing costs which are calculated based on at what day of month and time of year the mortgage closes. Examples include interest (from the day of closing until the end of the month in which your mortgage closes), pro-rated property taxes as well as other potentially applicable charges such as homeowners association fees, private mortgage insurance (PMI) and mortgage insurance premium (MIP)

    Closing costs vary depending on the lender, mortgage amount (larger loans having higher costs), loan type, geography and service provider.  There is no set rule for determining closing costs but non-recurring costs generally range from 0.5% to 2.0% of your property value (you can also check out our mortgage closing cost example).  Higher costs should raise a red flag and we always recommend that you compare multiple lenders to find the best loan terms including the lowest closing costs.

    FREEandCLEAR Recommendation

    Use our CLOSING COST CALCULATOR to estimate closing costs for a mortgage

    6

    What Mortgage Program is Right for Me?

    There are three primary types of mortgage programs: fixed rate, adjustable rate and interest only. We describe each program and outline their pros and cons below.  Most first-time homebuyers select a fixed rate mortgage because it involves the least amount of risk.  

  • Program 1Fixed Rate Mortgage 2Adjustable Rate Mortgage
    (ARM)
    3Interest Only Mortgage
    (IO ARM)
    Summary
    • Interest rate and payment do not change
    • Fixed interest rate and payment for first 3, 5, 5 or 10 years (fixed rate period)
    • Then rate and payment can change for the remainder of the loan (adjustable rate period)
    • Pay only interest at a fixed interest rate for first 3, 5, 7 or 10 years (interest only period)
    • Then pay both principal and interest for the remainder of the loan (adjustable rate period)
    • Rate and payment can change during the adjustable rate period
    Pros
    • Fixed mortgage payment over the life of the loan
    • Lower rate and payment during fixed rate period
    • Lower payment if rates go down
    • Lower initial payment than ARM or fixed rate mortgage
    • Qualify for a larger mortgage
    Cons
    • Higher payment than ARM or interest only mortgage
    • Locked into rate if you cannot refinance
    • Uncertainty
    • Potential increase in rate payment
    • Uncertainty
    • Payment increases when you start paying principal
    • Potential increase in rate
    Risk Level Lowest Higher Highest
  • Because of its certainty and peace of mind, a fixed rate mortgage makes financial sense for most borrowers although if you know you are going to sell your home or refinance your mortgage before the adjustable rate period for an ARM or an interest only loan, they could be the right program for you.  That way you benefit from the lower monthly mortgage payment during the initial period of the mortgage but you are not exposed to a potential increase in interest rate and monthly payment during the adjustable rate period, because you refinanced or sold the property.

    FREEandCLEAR Recommendation

    Review What Mortgage Program is Right for Me?

    7

    Are There Mortgage Programs for First-Time Home Buyers?

    There are multiple conventional and government-backed mortgage programs that enable you to buy a home with little or no down payment.  Many of these programs also use more flexible qualification guidelines which means more applicants can qualify.  We provide a comprehensive list of no and low down payment programs and a comparison of these programs so you can learn more about their program terms and eligibility requirements.  We also highlight some of the more popular programs for first-time home buyers below:

    • HomeReady Program: enables you to buy a home with a down payment as low as 3.0% and use non-traditional income sources to qualify
    • Home Possible Program: enables you to buy a home with a 3% down payment and use rental income or a non-occupant co-borrower to qualify for the mortgage
    • FHA Mortgage Program: allows you to buy a home with a down payment as low as 3.5%.  Applicants can qualify with a credit score as low as 580 if you make a down payment between 3.5% and 10% or a score of 500 if you make down payment of at least 10%
    • VA Home Loan Program: enables eligible active and retired military personnel to buy a home with no down payment
    • USDA Home Loan Program: allows individuals with low-to-moderate incomes to buy homes located in designated rural areas or small communities with no down payment

    FREEandCLEAR Recommendation

    Use the FREEandCLEAR Lender Directory to search for lenders by mortgage program including multiple no or low down payment programs.

  • MORTGAGE LENDER DIRECTORY
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  • 8

    What Length of Mortgage Should I Choose?

    Lenders typically offer mortgages with 10, 15, 20, 25 and 30 year terms, with the 30 year term being the most popular  The shorter the mortgage term, the higher the monthly mortgage payment but the lower the interest rate and less interest you will pay over the life of the mortgage.  The chart below compares a mortgage with a 15 year term to a mortgage with a 30 year term for a $300,000 mortgage:

  •   15 Year
    Mortgage
    30 Year
    Mortgage
    Difference
    Interest Rate 3.250% 4.125%  
    Monthly Payment $2,108 $1,454
    ($654)
    Total Interest Expense Over Mortgage $79,442 $223,422 $143,980
  • In the example above, although the 15 year mortgage has a higher monthly payment, you save approximately $144,000 in interest expense over the loan term as compared to a 30 year mortgage.  This shows both the advantages (lower mortgage rate and total interest expense) and disadvantages (higher monthly payment) of a loan with a shorter term.

    One approach to consider is to get a 30 year mortgage but make the higher payment that you would with a shorter term loan, such as a 15 year mortgage.  That way you maintain the flexibility of having a lower required monthly mortgage payment that goes along with a longer mortgage term, but you pay off your mortgage in approximately 15 years and save thousands of dollars in interest expense.  If you experience financial challenges over the course of your mortgage, this approach allows you to make a lower monthly payment without having to refinance your loan.

    FREEandCLEAR Recommendation

    Review What Length Mortgage Should I Choose? and use our MORTGAGE CALCULATOR to understand how your monthly payment and total interest expense change based on loan length  

    9

    How Long Does It Take To Process and Close a Mortgage?

    Many different factors such as real estate market conditions, your loan application, the lender review process, mortgage amount and program, property type and the availability of third party service providers such appraisers can influence how long it takes to process and close your mortgage.  Some borrowers may be able to obtain a mortgage in less than a month although it typically takes six-to-ten weeks.  Being organized before you apply for your mortgage can make the process go more smoothly but you should always be prepared for delays due to unexpected issues.

    FREEandCLEAR Recommendation

    Review our Mortgage Process Timeline and Day-By-Day Mortgage Schedule to review the key steps to processing, funding and closing your loan

    10

    What Types of Mortgage Lenders are There?

    It is important to remember that you have options when you select a lender for your mortgage.  The table below outlines the pros and cons of the four main types of traditional mortgage lender: banks, mortgage banks, credit union and mortgage brokers.

  •   1Bank 2Mortgage Banker 3Credit Union 4Mortgage Broker
    Overview
    • Takes deposits and makes loans
    • Does not take deposits
    • Offers mortgages to borrowers
    • Takes deposits and makes loans
    • Not-for-profit
    • Requires membership
    • Works with multiple lenders
    • Personal mortgage shopper
    Pros
    • Direct Lender
    • Potentially lower interest rate
    • Direct Lender
    • 100% focused on mortgages
    • Potentially lower interest rate and fees
    • Compare multiple mortgage offers
    • Select the best one
    Cons
    • Stricter qualification guidelines
    • Limited resources compared to some banks
    • May not offer better terms
    • Membership eligibility requirement
    • Not a direct lender
    • May not offer the best terms
    Examples
    • Wells Fargo, Bank of America, Chase
    • Quicken Loans
    • Navy Federal Credit Union
    • Small, local companies
  • FREEandCLEAR Recommendation

    As outlined by the table above, lenders have different positives and negatives so we always recommend that you contact multiple types of lenders when you shop for a mortgage.   Use our personalized mortgage quote form to compare no obligation quotes from lending lenders.  Our quote form is free, easy-to-use and does not affect your credit.

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  • 11

    Should I Pay Discount Points to Lower My Interest Rate?

    Lenders typically offer the borrower the option to pay discount points to obtain a lower mortgage rate.  A discount point is an up-front fee equal to 1.0% of the loan amount.  For example, the cost for a discount point on a $300,000 loan is $3,000 ($300,000 * 1.0% = $3,000).  Paying discount points is optional for the borrower as compared to paying an origination point, which is a mandatory fee charged by some lenders to process your mortgage.

    If you decide to pay discount points then your interest rate should be lower than if you do not pay points. As a general rule, a half of a point is equivalent to .125% (1/8th of 1%) in interest rate, so a full point is equivalent to .250% (1/4 of 1%) in interest rate. For example, a mortgage proposal with a 4.250% interest rate and zero discount points is equivalent to a 4.000% rate plus one discount point. In short, the borrower incurs a one-time, up-front cost to benefit from a lower interest rate and monthly mortgage payment over the life of the loan.

    Because it takes approximately five-to-six years to recover the cost of a discount point, if you are planning on owning your property for more than five years and your mortgage rate when you pay the point is at least .250% lower than if you do not pay the point, then paying discount points usually makes financial sense. To understand how long it takes to recover the cost of the discount point, divide the point cost by your monthly payment savings. The shorter the amount of time it takes to recover the cost, the more you benefit from paying discount points.

    FREEandCLEAR Recommendation

    Use our Discount Point Calculator to determine if you should pay points to lower your rate

    12

    How Much Money Should I Keep in Reserve After My Mortgage Closes?

    The reserve requirements for a mortgage vary depending on lender and loan program.  While many programs do not require reserves, some mortgage programs require that you hold one-to-six months of total monthly housing expense (your mortgage payment plus property tax and insurance) as savings in reserve at the time your loan closes.  For example, many low down payment mortgage programs require that you hold reserves.

    The reserve requirement is an extra financial obligation that many home buyers may not have the funds for after paying their down payment and closing costs. For example, if you have a three month reserve requirement and your total monthly housing expense is $2,500, you would be required to have $7,500 ($2,500 * 3 = $7,500) in your bank account when your mortgage closes. In many cases borrowers are unaware of the reserve requirement and may not have enough money to meet it. This is why it is important to understand if you are required to hold savings in reserve before you apply for a mortgage.

    FREEandCLEAR Recommendation

    If possible, we recommend that you keep enough savings in reserve to cover three-to-six months of total monthly housing expense. Maintaining sufficient reserves enables you to absorb financial challenges in the future.

Sources

What Mortgage Can I Afford?: https://www.consumerfinance.gov/ask-cfpb/how-can-i-figure-out-if-i-can-afford-to-buy-a-home-and-take-out-a-mortgage-en-118/

About the author

Harry Jensen, Mortgage Expert

Harry is the co-founder of FREEandCLEAR. He is a mortgage expert with over 45 years of industry experience. Over his career, Harry has closed thousands of loans for satisfied borrowers and now offers his advice and insights on FREEandCLEAR. More about Harry

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