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Home Financing Primer
Facts for Consumers from the Federal Trade Commission
Home Financing Primer -- December 1993
Prepared in cooperation with the Mortgage Bankers Association of
America
If you are thinking about buying a house, especially your first
one, you may have some basic questions about the home-financing
process. The following answers may help. You also may want to
obtain some of the free or low-cost information listed at the end
of this brochure.
How large a mortgage will you be able to get?
A general rule is that you usually can qualify for a mortgage
loan of two to two and one-half times your household's income.
For example, if your family has an income of $30,000 a year, you
can usually qualify for a mortgage of $60,000 to $75,000.
Lenders use many other factors to determine how large a mortgage
they will give you. For example, lenders generally prefer that
your housing expenses (including mortgage payments, insurance,
taxes, and special assessments) not exceed 25 to 28 percent of
your gross monthly income. Other long-term debt (monthly payments
extending more than 10 months) added to your housing expenses
should not exceed 33 to 36 percent of your gross monthly income.
Federal Housing Administration (FHA) and Department of Veteran
Affairs (VA) mortgage loan percentages may vary.
In addition, lenders want to know about your employment and
credit history. This includes finding out about your job and
income and how well you handled and repaid loans in the past.
Legal safeguards exist to ensure this information is used fairly.
For example, the Fair Credit Reporting Act states that lenders
must certify to the credit bureau the purpose for which this
information is sought and that it will be used for no other
purpose. The Equal Credit Opportunity Act prohibits
discrimination in lending based on sex, marital status, race,
national origin, religion, age, or because someone receives
public assistance.
How much money will you need for a downpayment and closing costs?
Lenders usually expect you to be able to make a downpayment of
between 10 and 20 percent of the house's price and to pay closing
costs, often three to six percent of the loan amount. If you make
a downpayment of as little as five percent but less than 20
percent, the lender will require you to pay for private mortgage
insurance. (Requirements for VA or FHA loans may differ.) Under
the federal Real Estate Settlement Procedures Act, the lender
must provide you with information on known and estimated closing
costs.
How do you shop for mortgage loans?
Mortgage packages vary widely, and it is important to investigate
several options to find the one best for you. If, for example,
you are using a real estate agent or broker to shop for a home,
you may want to consider their suggestions about lenders and
mortgage packages. Check real estate or business newspaper
sections, which may include brief tables on mortgage
availability. Look in the Yellow Pages under "Mortgages" for a
list of mortgage lenders in your area. Call several lenders for
rates and terms on the type of mortgage you want. In addition,
consider trying a commercial "computerized mortgage shopping
service," although such a list may reflect only a selection of
lenders and you may be charged a fee.
Compare the mortgages offered by several lenders before you apply
for a loan. Most lenders require you to pay a fee when you file
your loan application. The amount of this fee varies, but it can
be $100 to $300. Some lenders do not refund this fee if you are
not approved for the loan, or if you decide not to accept the
loan terms offered. Before you apply, ask the lender whether they
charge an application fee, how much it is, and under what
circumstances and to what extent it is refundable.
What kind of mortgage should you select?
There are two major types of mortgage loans _ those with fixed
interest rates and monthly payments and those with changing rates
and payments. However, there are many variations of these plans
on the market, and you should shop carefully for the mortgage
that best suits your needs.
Common fixed-rate mortgages include 30-year, 15-year, and
bi-weekly mortgages. The 30-year mortgage usually offers the
lowest monthly payments of fixed-rate loans, with a fixed monthly
payment schedule.
The 15-year fixed-rate mortgage enables you to own your home in
half the time and for less than half the total interest costs of
a 30-year loan. These loans, however, often require higher
monthly payments.
The bi-weekly mortgage shortens the loan term from 30 years to 18
to 19 years by requiring a payment for half the monthly amount
every two weeks. While you pay about 8 percent more a year
towards the loan's principal than you would with the 30-year,
one-payment-per-month loan, you pay substantially less interest
over the life of the loan. Keep in mind, however, that with
shorter-term loans, you trade lower total costs for smaller
mortgage interest deductions on your income tax.
Mortgages with changing interest rates and/or monthly payments
exist in many forms. The adjustable rate mortgage (ARM) is
probably the most common, and there are many types of ARM loans
available. The ARM usually offers interest rates and monthly
payments that are initially lower than fixed-rate mortgages. But
these rates and payments can fluctuate, often annually, according
to changes in a pre-determined "index" _ commonly the rate of
return on U.S. Government Treasury bills.
Some adjustable loans, for a fee, contain a provision permitting
you to convert later to a fixed-rate loan. Another type of
mortgage loan carries a fixed-interest rate for a number of
years, often seven, before adjusting to a new interest rate for
the remainder of the loan. A "buydown" or "discounted mortgage"
is another type of loan with an initially reduced interest rate
which increases to a higher fixed rate or to an adjustable rate
usually within one to three years. For example, in a "lender
buydown," the lender offers lower monthly payments during the
first few years of the loan.
What features should you compare with different mortgage loan
packages?
Probably the single most important factor to look for when
shopping for a home mortgage is the annual percentage rate, or
the "APR." The APR includes all the costs of credit, including
such items as interest, "points" (fees often charged when a
mortgage is closed), and mortgage insurance (when included in the
loan). Lenders must disclose the APR under the Truth in Lending
Act. The lower the APR, generally the lower the cost of your
loan. Advertisements that state other rates such as "simple"
interest rates, do not include all the costs of the loan.
If you shop for a mortgage loan with interest rates or payments
that change, be sure to compare:
l initial interest rates;
l the "cap" _ or how much the interest rate can
increase/decrease over the life of the loan, and how much the
rate can change at each adjustment;
l how often the interest rate can change;
l how much and how often the monthly payments and term of the
loan can change;
l what index is used to determine the rate changes;
l what "margin" is used _ or how much additional a lender can
add to the adjusted interest rate;
l the limits, if any, on "negative amortization" _ the loss of
equity in your home when low monthly payments do not cover fully
the interest rate charges agreed upon in the mortgage contract;
and
l any "balloon" payments _ a large payment at the end of your
loan term, often after a series of low monthly payments.
Where do you go for more information?
To find out more about mortgages and home financing, contact:
Public Reference, Federal Trade Commission, Washington, D.C.
20580; (202) 326-2222 for a free copy of Best Sellers. This
publication lists free and low-cost FTC brochures about homes,
credit, and other issues. In addition, you may want to write to:
Mortgage Bankers Association of America, 1125 15th Street, N.W.,
Washington, D.C. 20005 for other free information about mortgages
and home financing.
10/90
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