What is a Mortgage?
The word “mortgage” is literally derived from the phrase “death pledge.” The mortgage itself represents a conveyance of an interest in property as security for the repayment of money borrowed, typically to purchase or refinance a home.
In simpler terms, when a borrower signs a promissory note, he is agreeing to pay the lender a specific amount of money according to certain conditions. The money owed may be set forth in the form of a mortgage or a deed of trust. Whichever document is used, the purpose of both types of documents is to secure the note and offer protection to the lender.
But what is the difference between a mortgage and a deed of trust? Depending on where the property is located, state law will determine which type of security instrument must be used.
The basic difference between the mortgage as a security instrument and a Deed of Trust is that in a DOT there are three parties involved, the borrower, the lender, and a trustee, whereas in a mortgage document there are only two parties involved, the borrower and the lender. In a Deed of Trust, the borrower conveys title to a trustee who will hold title to the property for the benefit of the lender. The title remains in trust until the loan is paid.
What is a Purchase vs. Refinance?
A “purchase” of a home, or real estate, is exactly that: the purchase of property. (This does not include inheriting a property.)
The vast majority of purchases in the United States involve the purchaser obtaining a loan from a mortgage company, such as American Mortgage. The terms of the loan used to buy the home or property will vary based on the current interest rate environment, underwriting criteria, etc. These terms will also vary based on the amount of money that the borrower “puts down,” or contributes toward the purchase.
A “refinance” occurs when the existing owner of the property obtains a new loan which either replaces the prior financing, or, if the property was owned “free and clear” with no debt, adds debt to the property. Typical reasons for a borrower to refinance their property may be to take advantage of better terms, to switch from an adjustable rate mortgage into a fixed-rate mortgage, etc.
Underwriting terms and loan pricing may vary based on whether the loan is used to purchase a property, or to refinance a property. Your American Mortgage loan originator can provide details.
What are mortgage rates?
A mortgage rate is the level of interest charged by mortgage companies, banks, and other lenders on a house purchase or refinance loans. Broadly speaking, an interest rate is the price of money, and a mortgage interest rate is the price of money loaned against the security of a specific property – often a residence. The interest rate is used to calculate the interest payment the borrower owes the lender.
The rates quoted (like 5%, or 7.125%) by lenders are annual rates. On most home mortgages, the interest payment is calculated monthly. Hence, the rate is divided by 12 before calculating the payment. As an example, a 6% rate on a $100,000 home loan. In decimals, 6% is .06, and when divided by 12 it is .005. Multiply .005 times $100,000 and you get $500 as the monthly interest payment.
Some home loans have fixed rates, whereas others adjust. These adjustable rate mortgages (“ARM”) may, and usually do, have interest rates that change over time. American Mortgage offers both types, and can cover the pros and cons of each type of mortgage based on the borrower’s individual situation.
Conventional vs. Government (FHA, VA, RHS)
There are many types of home loans. In the United States, two very broad types are “conventional” and “government.” Conventional loans are most closely associated with Fannie Mae and Freddie Mac, two government-sponsored agencies. The Federal Housing Administration (FHA) and Veteran’s Administration (VA) provide a loan guarantee program in lieu of private mortgage insurance so qualified borrowers can get a mortgage loan with a low down payment. Borrowers should know that these agencies don’t lend money, but they “guarantee” the loan so the lender doesn't take on a financial risk by extending you credit.
Underwriting guidelines for each change over time, but generally FHA lending guidelines are not as strict as the Fannie Mae or the Freddie Mac criteria. In addition, each agency’s programs have advantages and disadvantages. For example, many feel that the biggest disadvantage to FHA loans is the mortgage insurance premium. Borrowers are advised to speak with their American Mortgage representative in discussing the rates and terms for these programs: you need to shop rates when looking for a FHA mortgage just as you would with a conventional loan because the rates are established by the lender, not the government.
What is a down payment?
The down payment on a home loan (whether it is a mortgage or deed of trust) is the lower of sale price and appraised value, less the loan amount. Very generally speaking, if one purchases a property for $100,000, and obtains a loan for $80,000, the down payment is considered to be $20,000. Put another way, the borrower as a down payment of $20,000 in the form of cash, and therefore will need a loan for the remaining $80,000. In this example, the “loan to value” (LTV) would be 80%. The down payment is not the same as the borrower's cash outlay if some of that outlay is used for settlement costs.
The down payment is often smaller because of settlement costs. Also, the property value used in determining the down payment and the LTV is the sale price or appraised value, whichever is lower. The only exception to this is when the seller provides a gift of equity to the buyer, usually a family member. In this case, the lender recognizes that the house is being priced below market and will accept the appraisal as the value. Most lenders in such cases will require two appraisals, and they will take the lower of the two.
What is Private Mortgage Insurance?
Mortgage insurance protects the lender against loss in the event that the borrower defaults. The borrower pays the premium, but the lender receives the protection. PMI is extra insurance that lenders require from most homebuyers who obtain loans that are more than 80% LTV of their new home's value. In other words, buyers with less than a 20% down payment are normally required to pay for private mortgage insurance (PMI).
PMI, used in protecting a lender against loss if a borrower defaults on a loan, in effect helps borrowers by enabling those with less cash to have greater access to homeownership. With this type of insurance, it is possible for you to buy a home with as little as a 3 percent to 5 percent down payment. This means that you can buy a home sooner without waiting years to accumulate a large down payment.
Mortgage insurance has no connection to any kind of life insurance, and pays no benefits to borrowers. The sole benefit received by the borrower is that, with mortgage insurance, lenders are willing to make loans with down payments smaller than 20% of purchase price or appraised value.
Fixed rate vs. Adjustable rate
Borrowers who come to American Mortgage will decide between obtaining a “fixed rate” mortgage and an “adjustable rate” mortgage. As the name implies, the interest-rate of a fixed rate mortgage will remain the same throughout the life of the loan. If interest rates are low when you are buying or refinancing a home, an FRM is a good choice, because you can lock in that low interest rate. Adjustable rate mortgages (ARM’s), however, will fluctuate as interest rates rise and fall. Your 4% rate today could drop to 3% next year or end up at 6% if the market rate goes up.
Fixed rate mortgages are fairly straightforward, but ARM terms are more complicated. Exactly when the rate of your ARM loan will change depends upon the terms of your loan agreement, which could see rates change every three months, once a year, every three years, or not until five years. ARMs also generally come with a "cap," which limits the amount a lender can raise its rate. Whether or not the borrower obtains a fixed or adjustable rate mortgage will depend on risk tolerance, and also how long the borrower intends on staying in the property.
What are points?
Points are fees the borrower pays the lender at the time the loan is closed, expressed as a percent of the loan. On a $100,000 loan, 2 points means a payment of $2,000. Points are part of the cost of credit to the borrower, and part of the investment return to the lender. Virtually all lenders are willing to make no-point loans if you ask for them, but of course the rate will be higher to compensate for them. Therefore points, sometimes also called "discount points", are a form of pre-paid interest. By charging a borrower points, a lender effectively increases the yield on the loan above the amount of the stated interest rate.
Lenders will often have rate sheets with varying interest rates, and varying point costs. Points can also be a rebate, and are often used to cover closing costs, appraisal fees, etc. American Mortgage representatives see borrowers who have little or no leeway because they are "cash-short" or "income-short" and therefore seek to avoid paying points so that they will have enough cash to complete the deal.
For borrowers who expect to have the mortgage a long time, paying points to reduce the rate makes economic sense because you are going to enjoy the lower rate for a long time.
How much can I afford?
Your American Mortgage loan originator will work with you in answering this question. Your loan will be underwritten by a person trained and practiced in qualifying borrowers to see if they can make the required payments. Initially, however, qualification (or "pre-qualification" as it is often called) is simply an opinion by a lender (or someone else) that based on information you have provided covering your income, assets, and debts, and given current market interest rates, you qualify for a loan of some specified amount. If any of the information you provide turns out to be different, or if interest rates increase, the opinion is subject to revision. The opinion also assumes that your credit is satisfactory. If that turns out not to be the case, the qualification will be withdrawn.
In addition to the formal underwriting process, borrowers will need to make sure that they are comfortable with the home buying decision. No one should be put into a situation where they cannot make the payments, therefore ending up “under water”, and your American Mortgage loan originator will work with you to ensure that this does not happen.
What is APR? (Annual Percentage Rate)
Our clients will often see mortgage interest rates quoted as both a rate (5.125%) and as an “annual percentage rate”) such as 5.37%. The term refers to the interest rate for a whole year (annualized), rather than just a monthly fee/rate, as applied on a mortgage loan, or any loan. In other words, it is the cost of the loan, per year. The APR, often cited as “effective APR”, is the annual interest rate plus any fees that the borrower pays. When discount points are paid as first payment(s), the balance due might accrue more interest, as being delayed by the extra payment period(s).
On a mortgage, APR might include Private Mortgage Insurance, processing fees, and discount points. There are other fees and charges that may or may not be included in a given APR quote. These fees are added to the monthly payments, and given those payments, an adjusted rate is calculated. Therefore, you need to look closely at each and every APR, and your American Mortgage agent can help. By law, lenders, including credit card companies, must show customers the APR to facilitate a clear understanding of the actual rates applicable to their agreements.
What is a Reverse Mortgage?
A reverse mortgage enables older homeowners (over the age of 62 to convert part of the equity in their homes into tax-free cash without having to sell the home, give up title, or take on a new monthly mortgage payment. Equity is basically the difference between the value of the property and the total amount of outstanding debt. The reverse mortgage is aptly named because the payment stream is “reversed” so instead of making monthly payments to a lender, as with a regular mortgage, a lender makes payments to you.
The amount of funds you are eligible to receive depends on your age, the appraised home value, interest rates, and in the case of the government program, the lending limit in your area. In general, the older you are and the more valuable your home (and the less you owe on your home), the more money you can receive. Eligible property types vary by program, but can include single-family homes, 2-4 unit properties, newer manufactured homes, condominiums, and townhouses.
Borrowers can choose to receive the money from a reverse mortgage all at once as a lump sum, fixed monthly payments either for a set term or for as long as you live in the home, as a line of credit, or a combination of these.