Q: How is my interest rate determined?
A: Two challenging questions that surround every loan are – How does a lender determine my interest rate? What can I do to ensure I get the best possible rate? To answer these questions, we must consider three criteria on which a lender bases their decision.
Credit Rating – The credit score is the most important point in mortgage lending. The credit score is not the only aspect considered in lending, however in most cases it is the most crucial. Lenders will also look for multiple late payment occurrences over the last two years.
Ratios – Secondly, the borrower’s monthly obligations (this does not include utilities, phone, or items generally not reported on a credit report) are calculated and reviewed by lenders. Two ratios are determined, front-end and back-end. For most lenders, a “grade A” conventional loan is one in which a borrower has a front-end ratio less than 28% and a back-end ratio less than 36%. For example, a borrower has a gross monthly income of $4,000, a car payment of $350, a credit card payment of $55, and a new house payment of $1,000. The calculations are as follows:
- $4,000/1,000 = 25% Front-end Ratio
- $4,000/1,405 = 35% Back-end Ratio
Down Payment – Thirdly, the lender factors in the amount of a borrower’s initial down payment. The less money spent on the down payment means a higher interest rate charged by the lender. Simply stated, more risk for the lender equals a higher rate for the borrower. Even if a borrower has perfect credit and wants to put 0% down, their rate will generally be about ½% higher than a person who puts 10% down.
After a lender has considered the three points described above, the borrower’s application must pass the specifications set by an underwriting department for the loan to be approved.
Q: What are discount points?
A: Lenders generally charge discount points for the following purposes. 1 discount point equals 1 percent of the loan amount. Discount points are used to lower the interest rate. The discount fee is normally charged as a line item on your HUD or settlement statement at the time of closing. Please note that as of August 1st, 2015 HUD-1 will become the “Closing Disclosure”.
Q: How much should my closing costs be?
A: Your closing costs depend on the type of loan you decide is best for you. Depending on your home state, you normally pay the following amounts.
- Origination Fee: 1% of the loan amount – cost of establishing a loan
- Discount Points: Used to lower the interest rate (refer to Discount Points section above)
- Appraisal Fee: Dependent on the house size
- Credit Report Fee: Charge for pulling your credit report from the credit bureaus (Refer to Credit Report question in this FAQS section)
- Underwriting Fee: Payment to the end investor for services provided
- Processing Fee: Payment to the lender for services provided
- Flood Certification Fee: Certification that your property is not in the 100 yr. flood zone
- Title Charge: Payment to the title company for closing your loan
- Title Policy: 1% of purchase price depending on the state (the seller normally pays)
- Recording Fee: Payment for filing fees depending on the state
Many of these costs are third party charges and cannot be negotiated by you or the lender.
Q: What is the purpose of a credit report?
A: An important key point a loan officer considers when helping you decide which lender/program is best for you is to view your credit. The purpose of this report is to pull your credit history from each of the three major credit-reporting agencies: Equifax, Experian, and Trans Union. Your lender is required to use outside companies to acquire your credit report, as they are impartial to the findings on your credit report. Your account balances and account history on your report are verified. You will be provided with a “credit score”.
Q: What is the difference between Conventional and FHA loans?
A: There are many differences between conventional and FHA loans. In this portion we will outline some of the major differences for you.
On FHA loans, the minimum down payment is 3.5%. On a conventional loan, the down payment can be as low as 3% depending on a consumers credit scores. Additionally, the money on a conventional loan must be “seasoned” (60 days in the bank) prior to purchasing the home or be proceeds from the sale of your existing home.
A FHA loan requires an upfront Mortgage Insurance payment; a Conventional loan does not. Both do require monthly Mortgage Insurance premiums based on the LTV.
The taxes will be the same on either type of loan. A common mistake is that people believe is their taxes will vary depending on the loan they choose. The title company that closes the loan submits the taxes directly to the lender. If you reside in an attorney state, your representation is the one who orders the tax certificate from the appraisal district. Taxes reported to the lender will be included in your monthly loan payment. There is no mark-up or service charge over and above the actual tax amount.
Homeowner’s insurance works the same as taxes. You pay the lender for your policy amount on a monthly basis. The lender will escrow this amount and send it to your insurance company at the end of the year when renewal is due.
Interest rate differences will vary depending on the lender you choose. Most importantly, ALWAYS ask for the lowest rate for the type of loan you are obtaining.
The principal and interest portion of the payment is calculated by configuring the loan amount (MIP rolled into the balance on FHA) and term into an amortization schedule to calculate the payment amount. Ask your Supreme Lending representative for additional information on conventional and FHA loans.