How to Choose a Lender
A responsible lender can help you gain financial flexibility and achieve your goals. You’ll have to live up to the terms of the loan agreement you sign, so it’s critical that you understand exactly what you’re signing. Look for these characteristics when you look for a responsible lender:
- Established company
- Good reputation
- Answers your questions
- Provides everything in writing
- Gives you time to decide
Also, remember to ask sources you trust for referrals.
STEPS IN THE LENDING PROCESS
Here is the sequence of steps in the home loan process.
Note: Title insurance is a policy protecting a homebuyer and/or lender against loss due to an error or dispute related to the title, the document that proves property ownership.
TYPES OF MORTGAGES
The chart below provides an overview of the types of mortgage programs that are most widely available. (Keep in mind that these types can overlap. For example, a lender may provide an adjustable rate Federal Housing Administration [FHA] loan.) Check with mortgage financing experts for details about financing options. They can help you determine the loan to fit your needs.
|Mortgage Type||Key Features||Customer Benefits||Homebuyer’s Scenario|
|30-Year Fixed-Rate||Interest rate (and monthly principal and interest payments) remain the same (fixed) for the life of the loan.|
If payments are made as agreed, the loan balance will be $0 at the end of the term.
|Provides protection against rising interest rates.|
Predictable payments make budgeting for the future easier.
|Especially attractive in a low interest-rate environment. Ideal if you plan to stay in your new home for a long period of time, have a fixed or slowly increasing income, and have a lower tolerance for financial risk.|
|15-Year Fixed-Rate||Interest rate remains the same for the life of the loan; typically, slightly lower interest rates than 30-year fixed.||The loan is paid off sooner, saving substantial money in interest payments over the life of the loan.||Investment-minded homebuyers who can or wish to make higher mortgage payments can build equity faster.|
|Adjustable-Rate Mortgages (ARM)||Interest rate (and monthly principal and interest payments) adjusts periodically based on an index.|
The initial rate can be locked in for different periods. Some lenders offer introductory periods of one, three, five, seven, or ten years.
Typically the rate readjusts annually after the introductory period.
|The initial interest rate (and monthly payment) is usually lower than that of a fixed-rate mortgage, after which the rate adjusts periodically, based on a market index.|
Borrowers are typically protected from steep increases in rates through annual and lifetime adjustment caps.
|An ARM may be a good choice for borrowers who plan to live in their home a short period of time or can manage to make larger monthly payments after the rate adjusts.|
|Balloon Loan||Offers fixed payments for a period of time (usually 5 to 7 years), followed by one large payment, known as a balloon payment, of the remaining loan balance.|
The amount of the monthly payment is not sufficient to repay the balance during the scheduled term. For example, the payments are based on a 30-year term; however, the loan is due and payable in 5 years.
|Interest rate is typically lower than that of a 30-year fixed-rate loan.||A popular choice of homebuyers who are certain they will move or refinance in 5 to 7 years.|
|Renovation Loan||Finances the purchase of a home and provides the additional funds to improve or renovate it.||The amount of money that can be borrowed is based on the future value of the home after improvement.||Intended for a homebuyer looking to purchase a “fixer-upper” or a house that requires remodeling to accommodate family needs.|
|Construction Loan||Offers two types of programs: one that finances the purchase of a newly constructed home and one that finances the actual construction plus the purchase of the finished home.||Loans for new construction may offer options such as an extended rate lock or a bridge loan.||Intended for a homebuyer looking to build a new home – on a lot within a community or by buying land and separately having a builder construct the new home to accommodate family needs.|
|Federal Housing Administration (FHA) Loans||The FHA insures a wide variety of mortgages provided by many lenders.||Low down payment requirements.|
Loan limits based on geographic locations.
Generally more liberal qualifying guidelines.
Use of gift funds for down payment and/or closing costs.
|Homebuyers purchasing a home with little money down, who may be overcoming credit challenges including a limited or less-than-perfect credit history, and/or need the help of a family member or friend as a co-signer to qualify.|
|Veterans Affairs (VA) Loans||The Department of Veterans Affairs (VA) guarantees mortgages provided by many lenders.||Low or no down payment requirements.|
A wide range of rate, term, and cost options.
Flexible qualifying guidelines.
Use of gift funds for closing costs.
|Qualified veterans and active-duty military personnel and their spouses who are first- or second-time homebuyers.|
Tips for Loan Shopping
Ask about “points.” Points are fees charged to borrowers by lenders. One point is equal to 1% of the loan amount. Many loan programs allow you the option of receiving a discounted interest rate by paying points or other fees. Ask if the interest rate the lender quotes you reflects the payment of points.
Ask lenders for the Annual Percentage Rate (APR). When you want to determine which loan will likely cost you the most, the APR is a quick way to make a first comparison. The APR takes into account a loan’s interest rate, term, and fees to illustrate the total cost of credit expressed as a yearly rate. This will allow you to compare different loans.
Becoming preapproved allows you to house shop with confidence. Before you apply for a loan, a lender can “prequalify” you. This means they estimate how much financing you could receive.
After you’ve filled out a loan application and the lender has analyzed your credit more thoroughly, they can provide you with a “preapproval” — a written letter confirming the price of home you can purchase. Getting preapproved lets you and others see, in writing that you qualify for a specific home loan amount. With your preapproval in hand, you’re ready to look for your new home. The lender will consider final approval of the loan later on in the process, after you’ve found the home you want to buy.
- Helps you narrow your search to properties in your price range;
- Gives you confidence that you can secure a home loan for a specific amount;
- Reassures home sellers that your offer is serious because your financing is already in place; and
- Helps speed the process of getting a mortgage loan once you’ve found a home to purchase.
COMPLETE THE LOAN APPLICATION
This resource will help you understand the different parts of your loan application. It will clear up what lenders are looking for, and will give you some ideas of what to do if your loan is denied.
Loan applications use a lot of words you might not understand:
Note: In some cases, you may need to provide additional documents to verify your income and available cash, or request credit bureaus to correct items in your credit report that you believe are inaccurate.
HOW LENDERS DECIDE
How do lenders decide whether or not to loan you money? Many look at “The 5 Cs” of credit. Some lenders develop loan decision “scorecards” using the 5 C’s and other factors.
When lenders evaluate character, they look at stability — for example, how long you’ve lived at your current address, how long you’ve been in your current job, and whether you have a good record of paying your bills on time and in full.
Your other debts and expenses could impact your ability to repay the loan. Creditors therefore evaluate your debt-to-income ratio, that is, how much you owe compared to how much you earn. The lower your ratio, the more confident creditors will be in your capacity to repay the money you borrow.
Capital to your net worth — the value of your assets minus how much debt you have. In simple terms, how much you own (for example, car, real estate, cash, and investments) minus how much you owe.
This is any asset of a borrower (for example, a home) that a lender has a right to take ownership of and use to pay the debt if the borrower is unable to make the loan payments as agreed. Some lenders may require a guarantee in addition to collateral. A guarantee means that another person signs a document promising to repay the loan if you can’t.
Lenders might consider a number of outside circumstances that may affect the borrower’s financial situation and ability to repay, for example what’s happening in the local economy.
Reasons a loan may not be granted
It can be both confusing and frustrating when a lender denies your application. Here are some reasons why:
- Irregular employment
- Not enough income to repay the loan
- Poor credit history (slow repayment of other loans)
- Lack of credit history
- Too short a time at residence
- Insufficient down payment
Steps you can take to have the lender reconsider
If a lender turns you down, don’t take it personally. Read about the Equal Credit Opportunity Act (ECOA) and your rights as a borrower. You can also try these steps:
- No credit history? Find out if factors such as payment of rent or utility bills could be considered. Consider applying for a credit card with a low limit, make small purchases and pay on time to help build your credit up.
- Find out if all sources of income were considered in evaluating your application.
- Pay off some of your existing debt.
- Find a reliable co-signer who is acceptable to the lender.
- Offer to make a larger down payment if possible.
- Find out if there are errors in the information the credit bureau provided to the lender.
home loan vocabulary
Because homes have such a high price tag, almost everyone borrows some, it not most, of the money they need to buy one. To make sure you’re well prepared, you should be familiar with some basic vocabulary as well as different types of loans.
Mortgage lenders use a lot of words you might not understand. Here is a quick activity to teach you the basics. Click each word to view the definition.
A mortgage is a loan to help you purchase a home. In return for lending you the money to purchase the home, you promise the lender to pay back the funds over a certain time period at a certain cost.
Each mortgage payment you make includes principal and interest. Principal means the amount you borrow based on the sale price of the home. Interest is the cost of borrowing money — the amount the lender is charging you for the loan. Some mortgage payments also include property taxes and insurance. This is called escrow.
A mortgage loan is secured by the real estate being purchased. This means that the property backs up your promise to repay. If you stop repaying the loan, the lender has a right to take ownership of the property and use the proceeds from selling the property to pay the debt.
Many banks offer home loans, and some lenders specialize in mortgage lending.
Lenders must provide borrowers with a document that lists all the estimated costs associated with getting the mortgage loan. This is called the Loan Estimate and Closing Disclosure Form.
The rate a bank charges someone to borrow money. The bank will tell you the interest rate they are charging you but it can also be calculated by dividing by the principal amount (that is, the amount loaned) by the interest charged. For example, if you paid $5,000 in interest per year for a loan of $100,000, the interest rate is 5,000 divided by 100,000, or five percent (5%).
A fixed-rate mortgage is a loan with an interest rate that remains the same over the life of the loan.
An adjustable-rate mortgage (ARM) is a mortgage with an interest rate that may change based on an index, usually the Prime Rate, or changes at scheduled dates to reflect market conditions.
A period of time over which a loan is scheduled to be repaid. For example, a home mortgage may have a 30-year term, meaning it must be repaid within 30 years.
The amount of a loan in relation to the value of the property. For example: an $80,000 loan on a property worth $100,000 would be 80% LTV. If there is more than one loan, this is called the “combined” loan to value (CLTV).
A professional estimate of a property’s market value at a certain point in time. (The market value is the price a property will realistically sell for based on recent selling prices of similar properties in the same area.)
The day and time when all final mortgage documents are signed and all necessary payments are transferred to complete the purchase of a house.
The process by which a lender decides whether to lend money based on: the value of the property, the borrower’s creditworthiness and ability to repay, and the lender’s lending guidelines and practices.
BE CAREFUL OF PREDATORY LENDING PRACTICES
Watch out for any unethical practices during your loan process. Unfair, deceptive, or fraudulent practices might include:
Encouraging you to include false information
If a lender has changed any of your income or expense information or leaves your income blank, do not sign the loan application.
Asking you to sign incomplete loan documents
Never sign a loan document with missing information. Don’t work with a lender who asks you to sign a document that is not completely or accurately filled in.
“Bait and switch” sales tactics
A “bait and switch” occurs when a lender makes promises in order to make the sale, then backs out on the promises after the sale. To avoid this, it’s critical to carefully read and understand the agreement before you sign. Question anything in the document that is not consistent with what you were told. Don’t sign the agreement if anything in it is unclear, incomplete, or not as promised.
Charging for loan payments
Some lenders may charge you up to $1,000 for the “privilege” of paying your loan biweekly. Although this can decrease the total interest you pay over the life of the loan and the time it takes to pay in full, such accounts can often be set up for free or for a one-time fee of a few hundred dollars.
Advertising and promising “No Credit? No Problem!”
These are often warning signs of scams. Consumers responding to such ads are guided through a phony application process and may even receive fake loan approval documents. To receive the approved loan, they are told to pay money up-front for fees or services — and instead, end up losing their money — and in some cases, their homes.
Promises to refinance the loan to a better rate in the future
No one can make you that promise. Instead, ask the lender if there is anything you can do to get a better rate now.
Not explaining loan terms and features
Balloon payments are large, lump-sum payments due at the end of the term. Before you agree to a balloon loan, make sure you fully understand and are prepared to pay the loan balance when it’s due.