Mortgage refinancing explained
A mortgage is a specific type of loan using a home or living quarters as collateral. Mortgages became common among wealthy people in the United States during the early 1900s when a 50% down payment was customary. After the Great Depression, the Federal Housing Administration (FHA) took action to make mortgages widely accessible by insuring mortgage debts. Banks could then lend money to home buyers without the financial risks associated with default.
Mortgage loans are built of many different factors that are customized to your needs. However, your needs as a homeowner today, might not be your needs as a homeowner later on in life, good thing we have the ability to refinance our mortgage.
When refinancing your mortgage you can, at most times, change almost every aspect of the loan. From number of years to the nature of your interest rate, many service providers can make these changes and will support you in this process.
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What are the different types of mortgages?
A loan to purchase a home, a home equity loan, or a home refinance loan requires different types of mortgages. There are two main types of mortgages currently used to purchase a home: government insured loans and conventional loans. A government-insured loan provides a safety net for lenders in case of default. A conventional loan doesn’t provide this safety net, so interest rates, down payment requirements, and fees may be higher. Each type will have varying requirements and uses.
Financing for a borrower’s existing home
Home refinance
Home refinance is an option that allows a borrower to replace their current mortgage with a new one with new terms.
Home equity loan or second mortgage
A home equity loan uses the equity, or market value, of a property to secure a new loan. This type of mortgage is sometimes called a second mortgage. The best mortgage lenders for a home equity loan are easy to find online, as well. Online lenders can significantly shorten the process time of a home equity loan than a traditional lender.
Conforming mortgages
A conforming loan follows the rules set by Fannie Mae and Freddie Mac. These two government entities set guidelines about credit scores, DTI, mortgage amounts, and minimum down payment amounts. Banks offering conforming mortgages can sell these loans to mortgage servicers after closing, freeing up more capital to lend to other potential homeowners. Conforming loans typically have lower mortgage rates than government-backed loans. To ensure you get the best mortgage rate, be sure to compare your options.
Non-conforming mortgages
A non-conforming mortgage doesn’t follow Fannie Mae and Freddie Mac’s rules. The loans may be larger than conforming loans allow. Borrowers with credit that doesn’t meet most lenders’ requirements and home loans that exceed the standard loan-to-value ratios may require a non-conforming loan.
Even the best mortgage rates on non-conforming loans are typically higher than conforming loan mortgage rates.
Conventional mortgages
A conventional mortgage is any type of mortgage loan not guaranteed or secured by a government entity. To get a conventional mortgage, the applicant must have a FICO credit score of at least 620 and a down payment of at least 5% of the total loan amount. Making a down payment of at least 20% means the borrower won’t have to pay private mortgage insurance (PMI) premiums on the loan. PMI cancels automatically when the equity in the home reaches 22% of its value.
With a conventional mortgage, the borrower pays appraisal and origination fees.
The maximum DTI (debt to income ratio) for a conventional loan is 45% to 50%, which means that all monthly debt payments add up to less than 45% to 50% of total monthly gross income. Those with lower credit scores may have a DTI requirement of less than 45%.
Government-insured mortgages
Government-insured mortgages include FHA loans, VA loans, and USDA loans. Getting this type of mortgage involves meeting specific requirements set forth by the FHA. Credit and down payment requirements for government-insured mortgages are typically more relaxed.
VA loans
Military veterans and their families may be eligible for a VA mortgage. There’s no minimum down payment or credit score with this type of loan. VA loan applicants must prove their eligibility with a Certificate of Eligibility (COE).
FHA/HUD loans
With an FHA (Federal Housing Administration) or HUD (U.S. Department of Housing and Urban Development) loan, borrowers make a minimum down payment of 3.5% of the total loan amount. Credit requirements include a minimum FICO credit score of 580. Borrowers with a credit score between 500 and 580 may be approved for an FHA or HUD loan, but they must make a 20% down payment.
USDA loans
Loans guaranteed by the USDA are for homes in rural areas. Those with a low household income may be eligible to receive a USDA loan to build, buy, or improve a home located in some regions of the United States. This type of loan allows borrowers to roll closing costs and mortgage expenses into the total loan amount to help minimize their out-of-pocket costs. Credit requirements for a USDA loan vary according to the lender.
What is the process of getting a mortgage?
Get a pre-qualification letter
Although not technically required, a common first step is to get a pre-qualification letter by providing financial and personal data to a lender. This document provides an estimate based on consumer-submitted data of how much you will be able to borrow. In some situations, realtors may require a pre-qualification letter before they’ll allow their client to make a formal offer to purchase a property. This is a good time to shop around for the best rates. Companies like Credible, AmeriSave and LendingTree allow you to easily compare rates of several lenders at once, all in minutes and completely online.
Get a pre-approval letter
Pre-approval comes after a lender assesses verified data in order to determine what size mortgage a borrower qualifies for, the terms, and the rate. The lenders will look at your income and DTI, run a formal credit check and give you a written, conditional commitment for an exact loan amount. Unlike pre-qualification, pre-approval is necessary to receive a mortgage loan.
Gather required documents
After receiving an accepted offer on a specific property, you will need to gather the following documentation for your chosen lender:
- Two years’ worth of W-2 forms and several recent pay stubs
- Profit and loss statements and 1099s for those who own a business
- Complete list of all debts, including total balance owed and monthly payments
- Full list of assets, including retirement plans, savings, investments, and property the owned
- Federal tax returns going back at least two years
Lenders may require other documentation related to income, debt, and assets, as well.
Receive and evaluate the Good Faith Estimate & Truth in Lending disclosure
If approved, the lender provides a Good Faith Estimate (GFE), which includes an itemized list of costs associated with the mortgage. The Real Estate Settlement Procedures Act (RESPA) requires lenders to provide a complete GFE within three business days of approving a mortgage application.
The Truth in Lending disclosure includes the APR. This number represents the cost of accessing mortgage funds, including interest, loan origination fees, processing fees, and underwriting costs. Comparing this number to other mortgage companies is a reliable way to quickly evaluate lenders. Even if one lender’s interest rate is lower than another, the APR may be higher if they impose more fees.
How to choose an online mortgage lender
When evaluating online mortgage companies, it’s crucial to verify that they service the right types of loans. For example, not every online lender offers FHA, VA or USDA loans. The best mortgage lenders offer a wide variety of loans and have extensive experience underwriting each type of mortgage.
The mortgage lender walks the borrower through each step of the mortgage process, so it’s important to be comfortable with their level of customer service and their availability.
Most importantly, do some research. Learn a little bit about types of loans to understand your needs, and be sure to shop around for the best rates. Be sure to pay attention to any added fees.
Online mortgage lender vs. traditional lender
Many online mortgage companies allow potential borrowers to submit documentation electronically by enabling the company to access the applicant’s online accounts. This streamlines the mortgage application process and is an essential advantage of using an online mortgage lender.
Perhaps you still prefer one-on-one guidance through the process? Many reputable online mortgage providers offer professional loan officers who you can connect with throughout the process.
With a traditional lender, the process could take weeks longer than with an online mortgage lender due to the amount of paperwork involved. While traditional lenders could appeal to borrowers that prefer face-to-face interaction, they may not offer the best mortgage rates in the marketplace.
A traditional lender typically requires several face-to-face meetings to discuss loan requirements, verify paperwork, and evaluate the loan terms. Closing the loan happens in person, as well.
An online mortgage company does everything over the internet, which makes the process shorter for many home buyers. Because of their lower overhead, online lenders may be able to offer lower closing costs or lower mortgage rates than traditional local lenders. Be sure to compare multiple offers from the best mortgage lenders before getting a mortgage.
