A: Prequalification is the process where the lender will look at a basic copy of your credit report and use the information you supply to determine how much mortgage you can afford based on your income. No accounts or employment information is verified. Pre-approval occurs when all credit and employment is verified and the mortgage is approved, subject to the appraisal of the property you have chosen to buy. Final loan approval occurs when the property has been appraised, all documentation is in the hands of the lender and all contingencies have been met. 

Q:  What are front and back ratios?  

A: Part of the mortgage application process will be the determination of how much house you can afford based on your income. The two ratios that will be computed are the front ratio and the back ratio.  

· Front Ratio: The total mortgage payment including principal, interest, taxes and insurance (PITI) as well as any condominium or homeowner association fees divided by your total GROSS income. Traditionally this ratio must be below 28% Example: With a gross income of $3700 per month, a total mortgage payment (PITI) of $973, the front ratio would be 26%.  

· Back Ratio: The total mortgage payment PLUS any car payments, credit card and any other loan payments divided by your total GROSS income. Traditionally must be below 36%. Example: With a gross income of $3700 per month, a total mortgage payment of $973, a car payment of $212, 1 credit card payment of $59 and 1 credit card payment of $43 for a total of $1287 with a back ratio of 35%.

Q: What options are there for buyers with no money down and no cash for closing costs?

A: Actually, very few. Since a mortgage payment will take a good percentage of your income, lenders will want you to be "involved" (meaning having your money involved) from the very beginning. There are options for low downpayment (5% or less) mortgages such as FHA mortgages and there is always the possibility that the seller could absorb some of your closing costs (which are usually 3-5% of the selling price) but to buy a home with no cash down is a rare occurance. If you have cash for closing costs, though, and excellent credit, there are new options in the conventional loan arena.

Q: What is PMI (Private Mortgage Insurance)?

A: One of the most frequently misunderstood aspects of mortgaging a home, especially for first-time buyers, is Private Mortgage Insurance (PMI). The most common misconception is that PMI is a mortgage life insurance policy whereby the mortgage would be paid off should the borrower die. It is not.

Instead, PMI is an insurance that most lenders require of all borrowers who put less than 20% down. It's purpose is to protect the lender against losses should the borrower default.

Virtually all conventional mortgages with less than a 20% down payment will dictate the inclusion of PMI. FHA mortgages, which are insured by the Federal Government, require a different type of insurance with different coverages. The cost of PMI will depend on a number of factors, including the insurance carrier and the size of the loan, but monthly payments for the insurance will generally fall into the $25 - $100 range for median priced homes. 

Common Loan Types: Conventional, FHA, VA and "No-Document"

Conventional: A "traditional" mortgage, not directly insured by the Federal Government. Most conventional loans under $322,700 are administered through Fannie Mae or Freddie Mac (private corporations but regulated by the government). Those loans over that amount are designated "jumbo loans" and are funded by the private investment market. 

FHA: Insured by (but not funded by) the Federal Housing Administration (FHA) a division of the U.S. Department of Housing and Urban Development (HUD), and designed for, in general, low- and middle-income borrowers and many first-time buyers. There are, however, limits (which vary from county to county) to the maximum loan amount. On January 1, 2000 HUD began insuring home mortgage loans of up to $121,296 in communities where housing costs are relatively low, and loans ranging up to $219,849 in communities where housing costs are relatively high. FHA loans have somewhat more relaxed qualifying standards and ratios than conventional loans and have the availability of both 15 and 30 year fixed as well as 1 year adjustable mortgages. 

VA: For those qualified by military service, the Veterans Administration (VA) insures (but does not fund) 15 and 30 year fixed as well as 1 year adjustable mortgages with lower down payment requirements (as low as 0 down) and somewhat more lenient qualifying ratios. 

No-Document ("No-doc) Loans: No-doc mortgages are generally a wise choice for self-employed people, those who do not wish to verify their income, and those with a brief or blemished credit history, or no credit. The benefits of a no-doc mortgage include a shorter application process since you are not required to provide income, employment or asset documentation, as well as a streamlined approval process because there is little subsequent verification. However, no doc mortgages generally will be at slightly higher interest rates and are offered by fewer lenders.

Q: What is APR?

A: APR or Annual Percentage Rate. The APR reflects the cost of your mortgage loan as a yearly rate. This rate may be higher than the rate stated in your mortgage or note because the APR includes, in addition to interest, loan discount or points, and other credit costs. Unfortunately, the interpretation of the Federal Truth in Lending Act is vague at best. The best way to shop and compare is to obtain a detailed Good Faith Estimate (GFE) in writing from your lender. If your actual interest rate does not change from the initial GFE (must be given within 3 days from time of loan application), then your final APR should not change by much.

Q: What determines how many months are set up for reserve in impound/escrow accounts for taxes and insurance?

A: When you choose or are required to have an impound account, the lender will set aside a certain amount to go into the impound account. Typically it goes like this. For home owners insurance, on a purchase you will pay 12 months in advance to the insurance company and another 2 months will go into the impound/escrow account. They will almost always have a 2 month slush in that account. If you are refinancing, they will usually require that there be at least 6 months remaining on your existing policy at the time of the first payment, and two months will go into the impound account. If you have less than 6 months remaining, they will require you pay a full 12 months plus 2 months to the impound account. For property taxes, depending on when you close will determine how much will have to be paid to the county tax collector and how much will go to the impound account. If the taxes are due to be paid within 6 months of closing escrow you could be required to put in 6-9 months of taxes to the reserve account. If taxes have been paid through the close of escrow, it could be as little at 1-3 months worth. Either way, your mortgage professional that you are working with should be able to provide this information when they prepare your Good Faith Estimate at the beginning of the loan process so you will no what to expect.

Q: When are they necessary?

A: If the loan is a regular conventional loan and below 80% LTV, then it is up to the borrower. If the loan is between 80% to 90% LTV it is still optional with most lenders but most would prefer there is an impound account set up. Over 90% it is mandatory. However, some lenders will offer better pricing incentives if there are impounds for taxes and escrow. VA and FHA loans are almost always mandatory for impounds.

Q: What is PITI?

A: PITI refers to Principal, Interest, Tax and Insurance. The term is often used in referring to the total loan payment and a lender will always use PITI to qualify a borrower for a loan.

Q: How do mortgage points figure and are there any limitations?

A: Points are how the lenders make their money. Mortgage companies collect a certain percentage of the loan amount as commission and is usually included in the points you are charged. Lenders charge points as a way of making their fee for lending the money and to off set the cost of doing business and re-coup their costs for obtaining funds to make loans. Points will vary with the interest rate. The lower the rate the higher the points. It is not always best to pay higher points for the lowest rate. Check with your mortgage consultant to see which is best for you.

Q: I know what lenders title insurance is and that is it necessary for the lender. What about Owners title insurance? And is it necessary?

A: Yes, owners title insurance is necessary. It insures the owner proper title to the property and guarantees no one else can come in an lay claim to the property. The lenders insurance guarantees them they are in first position as lien holder of record and that no other liens will be placed before theirs.

Q: I see advertisements for "no-cost" refinancing that sound too good to be true. Is it possible to reduce my rate without it costing me anything?

A: There are no-cost loans out there but you will pay a significantly higher rate than if you pay the costs yourself. If your existing mortgage rate is higher than the current rate on a no-cost mortgage, then "yes", you can reduce your rate without it costing you anything. But that doesn't mean you should.

It all depends on your time horizon. If you expect to be out of your house within 2 or 3 years, or you are not sure and want to hedge, the no-cost loan can be a good deal. If your time horizon is longer, the no-cost loan should be avoided. There is no reason to choose a no-cost loan because you are strapped for cash, since it is usually possible to include the costs of refinancing in the new loan.

If you shop for a no-cost loan, make sure that you and the lender agree on exactly what it means. It is not "zero points" which leaves you responsible for other types of lender fees as well as other payments to third parties. It is not "zero fees" which still leaves you responsible for payments to third parties. And it is not "no cash" because that could mean that you are paying the costs but the lender is increasing the loan by enough to cover them. On a true "no-cost" loan, the lender collects no fees and pays all other settlement costs on your behalf without increasing the loan amount. 

There are only two kinds of payments borrowers should expect to make on a true no-cost loan.  One is per diem interest, which is interest from the day of closing to the first day of the following month.  On a refinance, you will also pay interest from the first of the month to the closing day.  The other outlay you should expect to pay is escrow/impound account set-up fees.