My guests today are Diane Johnson with the First National Bank of Weatherford and Janis Spooner with the First National Bank of Weatherford Mortgage Company. Today’s topic is financing a home from start to finish and beyond. We will talk about interim financing, interest rates, credit scores and what it takes to qualify for a mortgage in today’s market.
What Is Fannie Mae?
The Federal National Mortgage Association, commonly known as Fannie Mae, trades under the New York Stock Exchange ticker symbol FNM. Fannie Mae was established in 1938 by the US Congress as a Government Sponsored Enterprise, or GSE. While Fannie Mae does not have an explicit guarantee of government backing, it is widely regarded being too important to fail.
Fannie Mae is responsible for maintaining a secondary market in home mortgages. By ensuring that mortgages meeting specific criteria can be readily traded among lending institutions and investment banks, Fannie Mae increases the ability of lenders to provide long term mortgages. A direct benefit to consumers is that mortgage interest rates are lower than they would otherwise be. For example, so-called Jumbo mortgages, which are loans larger than Fannie Mae will accept, generally carry an interest rate as much as one-half percent higher.
Fannie Mae's business consists of buying and pooling conforming loans. Conforming loans must meet criteria established by Fannie Mae, including restrictions on the size of the loan and qualifications of the borrower. When buying these loans, Fannie Mae assumes the risk of defaulting borrowers and changing interest rates.
To hedge the exposure to variable interest rates, Fannie Mae trades heavily in the market for financial derivatives know as interest rate swaps. Interest rate swaps allow Fannie Mae to sell a future series of unknown interest payments in exchange for a known series of payments over the near-term. Fannie Mae also buys and sells strips, mortgages in which the principal is traded separately, i.e. "stripped," from the stream of interest payments it is expected to generate. A large global market in these mortgage-backed securities has evolved, largely due to the existence of Fannie Mae.
What Is Freddie Mac?
A stockholder-owned government-sponsored enterprise (GSE) chartered by Congress in 1970 to keep money flowing to mortgage lenders in support of homeownership and rental housing for middle income Americans. The FHLMC purchases, guarantees and securitizes mortgages to form mortgage-backed securities. The mortgage-backed securities that it issues tend to be very liquid and carry a credit rating close to that of U.S. Treasuries.
Also known as "Freddie Mac".
Freddie Mac has come under criticism because its ties to the U.S. government allows it to borrow money at interest rates lower than those available to other financial institutions. With this funding advantage it issues large amounts of debt (known in the market place as agency debt or agencies), and in turn purchases and holds a huge portfolio of mortgages known as its retained portfolio. Many people believe that the size of the retained portfolio poses a great deal of systematic risk to the entire U.S.
HUD’s Energy Efficient Mortgages Program
Department of Housing and Urban Development
February 2005
As the single largest housing expense after a mortgage payment, your utility costs can have a direct impact on how large a mortgage you can afford. You can save money on the cost of utilities by purchasing new energy-efficient heating and cooling systems or by making home improvements, such as weatherizing and insulating older homes, and these investments can end up saving you money through lower utility bills. As a new homebuyer or current homeowner, you may be able to use an Energy Efficient Mortgage (EEM) to finance the cost of these improvements.
The U.S. Department of Housing and Urban Development’s (HUD) Energy Efficient Mortgages Program allows you to finance the purchase of a home—or refinance your current mortgage—and include the cost of the energy-saving, cost-efficient improvements through a single mortgage. EEM’s are mortgage loans that are insured by the Federal Housing Administration (FHA), which is a part of HUD.
FHA’s EEM program recognizes the monthly utility cost savings when homebuyers make energy-efficient improvements. Homebuyers, or homeowners when refinancing, may use the EEM program to finance the cost of energy efficient improvements into their new mortgages, without the need to qualify for additional financing, because cost effective energy improvements result in lower utility bills making more funds available for their mortgage payments.
How the Loan Works
You can take out an EEM loan as a 15- or 30-year fixed-rate mortgage or as an Adjustable Rate Mortgage (ARM) from an FHA-approved lender. FHA requires that you make at least a 3-percent down payment on the property, which is based on the sale price. Any upfront mortgage insurance premium may be financed as part of the mortgage.
The total amount of your mortgage is based on the value of your home plus the projected cost of energy-efficient improvements. When determining how large a mortgage you can afford, the lender can consider the estimated energy savings that are expected once you make energy efficient improvements to the home that meet energy-conserving standards. Because your home will be energy efficient, you will save on utility costs and, therefore, be able to devote more income to the monthly mortgage payment.
Your final loan amount can exceed the maximum FHA mortgage limit by the amount of the energy-efficient improvements. To find FHA mortgage limits in your area, visit the HUD website. A Home Energy Rating System provider or energy consultant determines the estimated cost of the energy improvements and estimated energy savings and provides a home energy rating report to you and your lender. You may finance up to $200 of the cost of the energy inspection report as part of the mortgage.
A portion of your loan is used to pay for the purchase of the home, or in the case of a refinance, to pay off any existing debt. The remainder is placed in an interest-bearing account on your behalf and released to you after an inspection verifies that the improvements are installed and the energy savings will be achieved. You can begin making energy improvements after the loan’s closing. You are responsible for hiring contractors and getting bids for the work to be done on your home. The work must be completed within 90 days after closing.
Eligibility
Almost anyone who has a satisfactory credit record, enough cash to close the loan, and sufficient steady income to make monthly mortgage payments can be approved for an FHA-insured EEM loan. There is no upper age limit and no certain income level required.
The following types of properties are eligible under the EEM program, including new construction or existing one- to four-unit single-family residences:
Detached houses
Townhouses
Condominiums (certain restrictions apply)
Cooperative units are not eligible.
The Cost and Types of Improvements
You may finance into your mortgage the cost of the energy-efficient improvements determined to be “cost effective,” which means that the total cost of the improvements, including any maintenance costs, is less than the total present value of the energy saved over the useful life of the energy improvement. The maximum cost of improvements that you can add to the mortgage is either 5 percent of the property’s value (not to exceed $8,000) or $4,000, whichever is greater based on the value of your property. For example, if your property’s value is $75,000, the maximum cost of improvements allowed is $4,000 because this is greater than 5 percent of the property value. If your property’s value is $100,000, the maximum amount of improvements allowed is $5,000 because this is 5 percent of the property’s value, greater than $4,000 but less than $8,000. Finally, if your property’s value is $160,000, the maximum cost of improvements allowed is $8,000, which is 5 percent of the property value and the maximum allowed overall.
Examples of improvements that are made under an EEM loan:
Replacing a heating or cooling system
Fixing or replacing a chimney
Insulating an attic, crawl space, walls and/or pipes and air ducts
Replacing doors or windows
Installing active and passive solar technologies
If you can demonstrate an ability to complete the work yourself in a satisfactory manner, you may complete the labor. Materials that you furnish may be applied to your down payment to the extent of the estimated cost of the materials.
Applying for an EEM
You may apply with any participating HUD-approved lender, such as a bank, credit union, or mortgage company. You can find a searchable list of HUD-approved lenders online at www.hud.gov.
Information Resources
Internet
http://www.hud.gov or http://espanol.hud.gov.
More details about the Energy Efficient Mortgages Program are on the HUD website, including a list of HUD-approved lenders.
HUD-Approved Housing Counseling Agency Locator
HUD supports a network of approved housing counseling agencies that provide counseling service’s across the nation. For a complete list of HUD-approved agencies in your area, call the HUD housing counseling referral line toll-free at 1-800-569-4287 or visit the HUD website at http://www.hud.gov.
Definition of An Interim Loan or Construction Loan
A construction loan or interim loan is a short-term loan for the building construction on real estate property. Construction loans are usually not standardized so the lender must know more information about the planned construction before they will lend you money. This is known as a story loan, since the lender must know the story behind the construction project. The payments during construction are interest only payments and the full amount is due after completion of the project. The interest is usually a variable rate for construction loans. Sometimes a borrower might be willing to pay a higher rate on the construction loan if the lender can transition them to a long term, more permanent form of financing after the project is completed. A higher rate paid on the construction loan generally translates into better mortgage terms and a better rate lock from the lender in the permanent financing.
Where to Shop for a Mortgage and What to Look For
Once you have found the home of your choice, you may think that your shopping days are over. Actually, only the first phase has been completed. Next comes finding a mortgage and payment terms that fit your budget. Where you shop and what you look for are important.
You might start by looking for a mortgage at the bank where you have your checking or savings account. But don’t limit yourself. A wide variety of institutions make home mortgage loans, including savings and loan associations, commercial banks, mutual savings banks, and mortgage companies. The mortgages these institutions offer will have varying features. One way to find the creditor with the most attractively priced loan is to look in your local newspaper; check to see if it publishes a shoppers guide to mortgage credit. These shoppers guides are available in many localities and can be used to identify the lenders with low rates. But, basically, the way to find the loan with the most attractive terms is to shop around.
You should have in mind some of the things to look for in a mortgage loan. For example, what types of loans are available from a given institution? Does the lender make privately or federally insured or guaranteed loans? Some lenders offer mortgage loans backed by a federal agency such as the Federal Housing Administration (FHA loans) or the Department of Veterans Affairs (VA loans). Loans that are not government-insured are called conventional mortgages. Insured mortgages may be more attractive than conventional mortgages in some ways--such as lower down payment requirements. But they may be more restrictive in other ways; for example, they may be available only for certain kinds of homes, or for properties whose value is below a specified price.
Other factors important to your mortgage decision are the length of the loan and the down payment required by the lender. The longer the term and the larger the down payment, the smaller your monthly payments will be. The interest rate is important too, and in some cases the amount of the down-payment will influence the interest rate that you pay (the larger the down payment, the lower the interest rate). In addition, mortgage loans may have interest rates that will stay fixed for the life of the loan (fixed-rate mortgages), that may change (adjustable-rate mortgages, or ARMs), or that represent a combination of fixed and variable rates (convertible mortgages). The initial rate of an ARM is generally lower than the rate available on a fixed-rate mortgage; but remember, the rate may change during the lifetime of the loan. Don’t hesitate to ask the lender how one loan differs from another, how the different features of the loan will affect the mortgage, or whether your chances to qualify would improve if you made a higher down payment.
When you're shopping around, you will find that some home mortgage lenders have special programs to assist veterans and low-income or first-time homebuyers. Ask the lender if such programs are available.
The Mortgage Application Process
The mortgage application process requires considerable paperwork. First there is the application form, which asks for detailed information about you, your employment record, the house you want to purchase, etc. The lender will need documentation pertaining to your personal finances--your earnings, your monthly expenses, and your debts--to help gauge your willingness and ability to repay the mortgage.
Lenders also will examine your file at the credit bureau to learn if you pay your bills on time. A lender may reject your application if the report shows that you have a poor credit history. Thus, you may want to make sure your credit file is accurate before you apply for your mortgage. You have a right to know what information is contained in your credit report and to have someone from the credit bureau help you understand what the report says. The names of credit bureaus can be found in the phone book.
You can prepare for questions about your financial condition by using the worksheets in this brochure. Worksheet 1 helps determine how much money you might have available for a monthly payment--just list all items of income and payments required on debts that won’t be paid off within ten months. There’s also a place for the estimated mortgage payment quoted by the lender.
To figure the mortgage payment, the lender will begin by asking how much you want to borrow. The maximum loan amount will be determined by the value of the property and your personal financial condition. To estimate the value of the property, the lender will ask a real estate appraiser to give an opinion about its value. The appraiser’s opinion can be an important factor in determining whether you qualify for the size of mortgage you want. Lenders usually will lend the borrower up to a certain percentage of the appraised value of the property, such as 80 or 90 percent, and will expect a down payment making up the difference. If the appraisal is below the asking price of the home, the down payment you planned to make and the amount the lender is willing to lend you may not be enough to cover the purchase price. In that case, the lender may suggest a larger down payment to make up the difference between the price of the house and its appraised value.
When looking at your projected mortgage payment and existing debt, some lenders might use ratios such as "28 and 36" to determine whether you qualify for the loan. These are commonly used ratios.
In the case of "28 and 36," the 28 refers to the percentage of your gross income (before taxes) that may be spent on housing expenses, including principal and interest on the mortgage, real estate taxes, and insurance. The 36 refers to the income that may be spent for payments on all your debts (including the mortgage): the monthly payments on your outstanding debts, when added to the monthly housing expenses, may not exceed 36 percent of your gross income. When you talk to a lender, find out what ratios will be used to evaluate your application. Then use Worksheet 2 to calculate whether you are within the lender's guidelines.
Be prepared to provide certain documentation about your income (W2s for prior years and year-to-date pay stubs), current debts (account number, outstanding balance, and creditor’s address for each), and the purchase contract for the home you want to buy. When you file your application, ask the lender how long the approval process will take. The time may vary depending on the complexity of your mortgage, current market conditions, and whether you have to provide additional information. It’s common for a decision to be made within 30 days after the lender receives all the necessary information. Applications for FHA or VA loans may take longer.
If your application is turned down, federal law requires the lender to tell you, in writing, the specific reasons for the denial. Make sure you understand the reasons given--you may be able to find answers or alternatives that will satisfy the institution’s lending standards. Even if that doesn’t happen, understanding fully why the loan was denied may improve your chances with the next lender you visit. Factors that may affect the loan decision include:
Down Payment; Is your proposed down payment sufficient? If not, perhaps the lender offers other types of mortgages with lower down-payment requirements.
Appraisal; Is the size of the mortgage you need too high, given the property’s appraised value? If similar houses in the neighborhood have sold at prices comparable to yours, maybe the appraiser undervalued the property. Suggest that the lender re-examine the appraisal. You also have the right to receive a copy of the appraisal if you have paid for it.
Credit history; Is the lender doubtful--because of your level of debt or credit history--about your ability to make the monthly payment? Ask how your debt ratios compare to the lender’s standards. If there were special circumstances surrounding old credit problems, ask for a chance to explain.
Worksheet 1
Monthly Income (before taxes)
Borrower Co-Borrower Total
Base employment
income $ _______ $ _______ $ _______
Overtime _______ _______ _______
Commissions _______ _______ _______
Interest/dividends _______ _______ _______
Other _______ _______ _______
Total monthly income $ _______
Monthly Payments on Existing Obligations
Automobile loan _______ _______ _______
Student loan _______ _______ _______
Credit cards _______ _______ _______
Alimony, etc. _______ _______ _______
Other _______ _______ _______
Total monthly payments $ _______
Monthly Housing Expense for New Loan (ask lender)
Mortgage payment (principal & interest) _______
Real estate taxes _______
Insurance premiums _______
Total monthly housing expense $ _______
Worksheet 2
Take the dollar amounts from Worksheet 1 and:
For the housing expense ratio,
Divide Total monthly housing expense by Total monthly income =
___________
For the all debt payments ration,
Divide (the sum of Total monthly payments and Total monthly housing expense) by Total monthly income = ___________
