Rate locks

"Locking in" an interest rate simply means a lender has committed to provide you a certain rates for a certain length of time. Beware - unless you have made arrangement with a lender to lock the rate, it is likely that any rate quote you have received is that day's rate, but it is not committed or locked. Be sure to ask your lender about rate locks and how they work for you. Locking a rate is a way of transferring the risk of market fluctuations from a borrower to the lender. Lenders typically expect you to complete the loan transaction within the lock period. While you are protected in the event market rates rise, you are likewise prevented from obtaining a lower rate if the market declines. A typical loan rate lock period is 30 days. Many lenders will lock rates for 45 to 60 days, but they typically quote a higher origination fee for this privilege. As a practical matter, locking a rate on a purchase transaction prior to execution of a purchase agreement is impractical. After entering into a purchase agreement it is a good idea to lock in your rate so that a wild swing in interest rates will not undermine your home purchase plans.

[top]

Pre-qualification vs. Pre-approval

Both these processes serve somewhat the same purpose. They are preliminary techniques to determine approvability of a loan application. Pre-qualification is simply the opinion of a loan officer/originator, often based on limited information, which has not been verified. The standard for pre-qualification varies from lender to lender, so its reliability will vary as well. There is a joke in the mortgage business that at some lenders, if you can breathe on a mirror and fog it up, you are pre-qualified. To be most meaningful, the person doing the pre-qualification should calculate debt to income ratios from information the applicant provides, verify this information in some fashion, and obtain a preliminary credit report.

Pre-approval, sometimes called a credit approval, on the other hand, represents an underwriter's (the decision maker) decision about the applicant's income and credit history, after submission of a formal loan application and appropriate supporting documents. All information except information about a property is reviewed. Typically pre-approval of an applicant is done before a property is identified, and the approval is subject to approval of property related information like an appraisal, a title report and other property related issues. Being pre-approved offers three main benefits, and in a competitive market it may be essential in order for a buyer to be competitive. By being pre-approved, the buyer says to the seller that, if the buyer's offer is accepted, it is likely the transaction will be completed. In other words, the seller does not have to wait and wonder if the buyer's loan will be approved. In addition, being pre-approved can relieve the buyer of the stress of the loan approval, especially if there are some question marks or uncertainty about the amount of the loan that can be obtained. Finally, getting the bulk of the loan application process taken care of leaves more time to focus on the property after a home has been found and a purchase agreement negotiated.

[top]

Why be pre-approved for a mortgage?

There are three good reasons to be pre-approved for a mortgage.

1. It eliminates any uncertainty about your ability to be approved, or approved for a known loan amount. For buyers striving for the maximum loan available, being pre-approved answers the question before shopping for a home. For those whose qualifications are uncertain, it eliminates the uncertainty.

2. Pre-approval makes you a more attractive buyer. When viewed by a seller considering your offer to buy, your offer becomes easier to accept. In a competitive market, it may be essential to be pre-approved so as not to be at a disadvantage vis a vis other buyers.

3. Getting the loan paperwork out of the way early will relieve pressure when it comes time to negotiate a purchase agreement.

[top]

What does it take to qualify for a mortgage?

When lenders examine a loan application they are looking for characteristics that will indicate the loan is likely to be repaid. Two key elements in this exercise include a measure of the applicant's ability to make the payments, and a look at the applicant's propensity to pay as indicated by the payment history on other accounts. Historically, top quality lenders would allow applicants to have monthly fixed payments, including the payments on the mortgage applied for, equal to 30% to 40% of the applicant's monthly gross income. In addition, they would expect a timely payment history on other accounts, with a focus on the recent (last 12 months) history and the pattern of payments on other mortgage obligations.

As lenders have worked to become more sophisticated in their loan decisions, some of the formerly rigid guidelines have become more flexible. The recent increased use of automated approval models has made previously unapprovable loans approvable, provided stronger aspects of the application are present to offset weaker aspects. For those applicants with erratic income steams or a less than perfect payment history, there are still many mortgage opportunities in what is generally referred to as a the "sub-prime" market. Sub-prime borrowers can expect slightly higher down-payment requirements and higher rates and fees to compensate for the higher risk of timely repayment.

[top]

What happens in the dark hole of loan approval?

To many the loan process is a mystery to be endured, usually with a sense of anxiety. A little basic understanding may make this aspect of buying or refinancing a home more comfortable. It all starts with the loan application. A complete and accurate application will make the process smoother, so invest additional moments at the beginning and save aggravation later. Next, The lender (or your mortgage broker) will verify all the key information on the application. The request you receive for pay stubs, W-2's, tax returns, bank statements and the like are to verify those amounts shown of the application.

Finally, the application, with the appropriate supporting documents, goes to an underwriter - that's the decision maker. The underwriter confirms that the application fits the parameters of the loan program applied for, and determines that the borrower's qualifications meet the standards for approval, then hopefully, approves the loan. It is common for underwriters to approve loan applications subject to satisfaction of certain conditions. At times these conditions are simply to complete the documentation of the file, but sometimes they are more substantive. This explains the common request for some additional paper work before the lender will prepare the final loan documents for signing by the borrowers.

[top]

What about credit scores?

A credit score is a three digit number generated from all the information that appears on your credit report. The purpose is to distill into one number a convenient measure f your creditworthiness. In recent years most mortgage lenders have come to rely on credit scores in their underwriting (approval) decisions. The exact algorithm that generates the score is a secret to prevent borrowers from attempting the beat the system. Still, certain behavior can be determined to lower the score, including a history of late payments, excessive use of credit, and a preponderance of newly established accounts.

The biggest frustration that comes from the use of credit scores occurs when there are factual errors on a credit report that are then factored into the score, making it lower than it should be. The process of correcting erroneous information and having it reflected on in the score is a slow process which can takes several months. If you are planning on applying for a mortgage and know there are errors on your credit report, it would be advisable to correct them well before the time you plan to submit your mortgage application.

[top]

What if my credit is not perfect?

It's not always well known by loan applicants, but there are lots of choices for those whose credit history is a little dinged up. There is an active and broad market for loans to people with damaged credit histories. This part of the mortgage market is often referred to as sub-prime or by letter grades like B or C that denote a credit quality below the top or A level. Lenders typically accommodate sub-prime loans by reducing the maximum amount of the loan they will make or requiring more equity of the part of the borrower. In addition, the terms will be somewhat less desirable, the degree being a function of damage the credit has sustained. In most cases the borrower would be wise to look at a sub-prime loan as a stepping stone to acquisition of a home now, with the expectation of refinancing a few years after rebuilding a timely payment history. Because many sub-prime loans are refinancing after only several years, most lenders impose pre-payment penalties on these loans to enhance their returns. Often the penalty can be bought out for a fee up front. In any event, be alert to this common feature.

[top]

How to get the best interest rate?

Wanting to get the best available rate on a mortgage is a normal and natural thing to want. The bad news is it is very difficult to make an accurate comparison among lending sources, what with the smoke and mirrors employed by many in the business to bring business in the front door. The good news, which few lenders will tell you, is that it may not really be necessary to make a research project out of comparing mortgage rates. Let me make a point by comparing the mortgage business to the consumer electronics retail business. A couple of years ago I tried to find the best deal on a new television by comparison shopping the three main consumer electronics dealers in the area. Starting out, I expected the task to be pretty easy. I would simply go from store to store, jotting down model numbers and prices to see who had the best price on the model I wanted.

The truth of the matter is the difference in rates and fees from one lending source to another is often so slight as to not be meaningful as a way of choosing a lender. Indeed, in seeking out that often elusive "best rate", home buyers may be exposed to false claims that cannot be honored in the end. Having said all this, there are times when different lending sources will be willing to provide credit at different pricing levels, and making a comparison is appropriate and necessary. The only accurate way to make such a comparison is to request what is known as a Good Faith Estimate from each source and to have them all prepared in the same time frame. The rate on most loan programs are based on many factors in the credit markets and they can move daily or even more frequently under circumstances. A rate quoted from Bank A on Monday should never be compared to the rate quote from another lender made on Tuesday. You can never tell any difference is a result of one source being cheaper or the market having changed.

There are a myriad of other factors that can make comparing rates difficult at best and potentially perilous for the amateur, including the period for which a rate is "locked in", and the nature of the loan program. To select a mortgage lender based on a rate quote for a program that the applicant cannot qualify is ridiculous, but it happens everyday when applicants listen only for what they want to hear - a low rate. It's not always a matter of the buyer not being qualified, sometimes a loan program may only be available for certain circumstances that the borrower does not fit. Why shop quotes without first identifying the circumstances of the transaction?

[top]

Five common mistakes to avoid when applying for a loan

1. Don't quit your job to start a new business. Lenders will want to see a two-year history of self employment, and will measure your income as reported on your tax returns.
2. Postpone any major credit purchases like buying a new car.
3. Avoid having a lot of credit reports prepared. Each inquiry about your credit can erode your credit score.
4. Do not choose this as a time to engage in a principled battle with some creditor that might cause them to report your account delinquent.
5. Don't commit your financial assets so they are unavailable for a home purchase.

[top]

Understanding closing costs

Closing costs are commonly all those items that must be paid at the time of closing, in addition to the down-payment, in order to close a purchase. Confusion sometimes arises because some terms are used imprecisely. Most items referred to as closing costs are one-time payments made at closing, but several are recurring expenses. The bulk of the one-time costs are related to the mortgage, with fees for the escrow agent and premiums for title insurance the next most significant in amount. Part of the confusion related to loan fees is the names for these fees that lenders use. All lenders charge fees and all call them something different. Direct comparison becomes more complicated because of this practice of using different names to label what are all "lender fees". Some of the common terms used include application fee, underwriting fee, document preparation fee, processing fee and the list goes on.

Common recurring costs that are paid at closing are the initial annual premium on fire insurance, and prorations of taxes and interest to account for the timing of the closing date. A typical $250,000 purchase could have closing costs equal to 2% to 4% of the purchase price. Ask your lender or agent to provide you a Good Faith Estimate of Settlement Costs which will itemize and estimate the amounts of all common closing costs.

[top]