Prequalification Status

This classification refers to the estimated amount of a mortgage a lender would offer after performing a preliminary investigation regarding a borrower’s current credit status, as well as the overall asset and liability figures presented for evaluation. This information is unverified at this stage, and yields only an estimate of the funding available until further inquiries can be performed. This preliminary status does not indicate a predetermined or ‘approved’ line of credit has been offered by the lender. Prequalification is a term used to describe what a potential lender might approve for the mortgage loan, and is only based on the validity of the unverified information provided by the borrower. It is a basis for the borrower to begin shopping for a home in the general framework of affordability.

Preapproval Status

This classification describes an evaluation that is further along in the loan acquisition process, though it doesn’t represent the lender’s complete and documented commitment toward a borrower’s final approval for the loan. Once a full credit evaluation is completed after acquiring the necessary reports from the credit bureaus will the lender finally commit to providing a mortgage estimate in writing. In recent years, there has been far more scrutiny directed toward complete verification of the stated asset and income figures a borrower provides before a ‘preapproval’ status will have much credibility. Therefore, until a complete application process has been initiated, a lender is not genuinely bound by the preapproval notification to actually honor any real terms in the preliminary agreement. Not until an application is officially filed will a prospective lender get serious about investigating a borrower’s true financial integrity.

After pouring over the mortgage rates posted all over the internet, after shopping around to the local banks and mortgage brokers, after watching the economy plunge the housing market into free fall, any potential home-buyer must wonder who or what determines how the interest rates are set. The effect a credit score has on a loan approval almost seems secondary compared to understanding how the big ‘interest’ game is played, and how it ‘trickles down’ to the everyday consumer’s ability to find a decent place to live, and the means to afford it.

It turns out, the lender or broker has little to do with how the mortgage interest rates are determined. They simply control who finally gets a favorable nod, and on what terms. Mortgage interest rates are played out on a much bigger game board, and are primarily manipulated on what is known as the secondary market, where mortgages are bought and sold, much like a game of Monopoly.

Fannie, Freddie, and the Wizards of Wall Street

A few decades ago, the federal government sought to stabilize the mortgage lending process, and created two enormous mortgage investment entities called Fannie Mae and Freddie Mac. These monoliths, along with other mortgage investors, purchase the loans that the local lenders and brokers arrange, gather them into portfolios or wrap them up with other loans into things called mortgage backed securities. From there, these bundles are sold to Wall Street, mutual fund managers and other financial powerhouses, to be traded just like Treasury bonds, securities and other financial instruments. This process is what actually determines the interest rate a potential homeowner will pay to put a roof over their heads.

From that point, and just like the stock market, these securities are tied to the higher yields the investors demand when the economy is good, which pushes the local lenders to raise the ‘local’ interest rates. When the markets take a dive, so do the interest rates, due to the higher demand from the investor side of the equation. And so it goes.

Generally, lenders require a range between 5, 10, or 20% of the purchase price, with a few 0%-down loan programs available. If a borrower can offer funds in the 25 – 30% range, then lower credit scores can be less of a factor, along with income verification. If a borrower falls below these thresholds, the lender will more than likely request private mortgage insurance, or PMI, to cover the risk. The bottom line strategy is – the more money down, the lower the monthly payment, or, the more ‘house’ a borrower can consider buying.

In simple terms, and following the required 28% monthly payment-to-income ratio, and the 36% debt-to-income ratio, a benchmark monthly mortgage payment of $933 can be used as an example. With an interest rate of 7.5% applied to a 30 year fixed-rate loan, the total principle would be $133,435.45. By offering 10% down on the loan, the mortgage payment would cover a home costing $148,262.00. Offering 20% as a down payment would boost the ‘available’ home purchase price to $166,794.

With this in mind, it is also best if the borrower has the necessary down payment funds secured at least 60 days prior to beginning the application process. In addition, it is wise to forgo or postpone other cash outlays or credit applications, as well as making sure sufficient funds for the closing costs are on hand, and the credit scores have been reviewed and mistakes rectified for the best chances for lender approval.

Just as a potential home buyer hopes to find a well-suited living space and neighborhood environment that best satisfies their needs and lifestyle, their search for the funding source will be equally matched by a lender’s evaluation of their ability to repay the mortgage. While there are numerous qualifications and requirements to be met during the somewhat lengthy and often nerve-bending process, the lending institution is certainly going to focus their attention on some primary factors, such as credit history, a borrower’s gross monthly income, and the available cash resources accumulated for the down payment. These criteria all translate into what kind of house a borrower is able to ultimately afford, and the viability of a qualification begins by what is referred to as a ‘debt-to-income ratio’.

The Front-End Ratio

This formula is based on standard calculation which encompasses the housing expense, or front-end ratio, combined with the total debt-to-income, or back-end ratio. The front-end, or housing expense portion, is determined by how much of a borrower’s gross monthly pre-tax income can be applied to the monthly mortgage payment. As a rule, the monthly payment, which includes the principle amount of the loan, the mortgage interest rate, the real estate taxes, and homeowners insurance, must meet a ceiling of 28% of the gross monthly income figure. This can be self-determined by multiplying a borrower’s yearly salary by .28, and dividing that result by 12 ( months ). This figure equals the maximum housing expense ratio portion of the formula. As an example, if a prospective home buyer has a yearly salary of $40,000, the equation would be represented as follows: $40,000 x .028 = $11,200, and, $11,200 divided by 12 months = $933.33, the maximum mortgage-related payment per month.

The Back-End Ratio

The back-end ratio, or debt-to-income portion of the formula, is determined by compiling all of the debt obligations of the borrower, including the mortgage itself, any car loans, child support, credit accounts, and even student loans. When totaled, this figure represents a number that cannot exceed 36% of a borrower’s gross yearly pre-tax income. Again, the formula would be stated as: gross yearly income x 0.36 / 12 months = the maximum allowable debt-to-income ratio. Therefore, the lender is basing an evaluation on a figure that would look something like this: $40,000 ( annual income ) times 0.36 = $14,400, and $14400 divided by 12 months is $1200 – the total amount of debt repayment obligations per month. With these figures in hand, a prospective borrower can certainly get a sense of where the numbers fall in the lending qualification formula, and more effectively determine exactly how much house is financially feasible to purchase.

Many consumers are exploring the numerous options in the lending market to access this yet untapped asset. The more conventional methods are home equity lines or refinancing their existing mortgages, to name a few. However, should monthly payment obligations or low income resources be a factor, these options could be difficult for an older borrower to qualify for. For those in the population pool that are moving toward the golden years of life, and would like to seek out another very popular concept making its way into the realm of financial possibilities, the answer might be the reverse mortgage.

What is a Reverse Mortgage?

In this broad summary, the loan option referred to as a reverse mortgage takes it’s definition and characteristics from its very name – in simple terms, it is the exact reverse process of a standard mortgage loan. It is a lending mechanism that permits a homeowner from the age of 62 years or older to tap into the equity of their home. It becomes the means to provide the homeowner with access to either a large ‘lump sum’ source of cash, or, a way to create a comfortable source of tax-free monthly income.

With a standard type of mortgage program, the typical borrower is obligated to maintain a monthly repayment schedule back to their lending source in order to repay the funds that were originally provided by the lender to either buy or refinance the home. Naturally, these repayment amounts include the interest applied to the loan in the approval and closing process. The loan procedure making up the reverse mortgage process is just the reverse. In this case, the lender provides the monthly payments to the homeowner. In addition, the home is used as security or collateral for the loan amount by the lender in a ‘reversed’ mortgage, just as it would be in a standard type of mortgage.

Reverse Mortgage Funding Options

There are certainly some key aspects in the reverse mortgage program that determine exactly what amount and what type of funding is available from a loan of this kind. Primary factors such as the value of the existing home are most important. The higher the market value, the higher the loan amount. Another factor is the borrower’s current age, along with a co-borrower’s age if applicable, and generally, the older a borrower is, the more funds will be available. The mortgage interest rates will be a factor as well, and will play the usual role in the funding decision as they do in a standard mortgage – the lower the rates, the more loan a borrower has access to. Geographical area also plays a role in the lending equation, and state and federal guidelines will determine if there are specific lending limits required.

There are three types of reverse mortgage funding guidelines a homeowner can decide upon based on their specific income needs. As mentioned, the first is the lump sum arrangement to allow the most access to the most cash all at once. The next option is the setting up of a monthly payment income stream. This option has two variables. One is to schedule the payments for a fixed time period, called a term type, or, until such time that the borrower (or borrowers) no longer resides in the home, called a tenure type. The third option is when borrowers can choose to set up a line of credit to draw from, accessing the funds as they need them. Almost two thirds of the borrowers who utilize the reverse mortgage concept choose the most popular line of credit option.

The Fine Print on a Reverse Mortgage

Based on the loan proceeds, there are indeed interest charges that will be accumulating on the funds that are withdrawn. However, there will be no monthly payments to be made on the loan. Also, the balance on the loan must be paid off at such times as the borrower either moves or sells the residence, or passes away, or if the ownership of the residence transfers to another individual. In addition, should the sale price of the home exceed the mortgage balance, the difference stays in the hands of the owner or is transferred to the heirs of the estate.

An additional stipulation is that at such time as the present mortgage is completely paid, this being a mandatory requirement, the funding issued with the reverse mortgage can be utilized for any purpose the borrow may need, whether for home improvements, medical expenses, or other debt consolidation. Reverse mortgages are an option for generally all types of property, though there are state-sanctioned guidelines with respect to co-ops. These reverse mortgage programs are federally insured private loans, and are provided through the U.S. Department of Housing and Urban Development (HUD), and handled through the auspices of the Federal Housing Agency (FHA).

The guidelines require that every potential borrower must receive assistance or counseling from a HUD approved agency before proceeding with the loan application. The counseling is necessary to ensure the terms and risk factors of the program are completely clear. Counselors are mandated to review all of the implications of the reverse mortgage program and each of its potential options. For every home-owning member of the senior demographic considering the advantages of living the stress-free retirement way of life, then the reverse mortgage can be a very rewarding and financially sound means to achieving that goal.

Check the Local Network
Whether the borrower is considering the services of a mortgage broker or banking institution, it is always a good practice to begin the search close to home. A great amount of useful information can be acquired in a local environment, such as banks or credit unions where a borrower has an established relationship. Friends and family members can also offer referral advice regarding loan officers or mortgage brokers who provided the best and most professional services, along with the most competitive offers. By virtue of the type of financial expense buying a home represents, a potential borrower deserves the very best attention when taking on such an important and long-term obligation like a mortgage loan. In fact, talking to the real estate agent they are considering working with is often a great place to start for their lender recommendations.

Evaluate the Performance and Service
When pursuing the mortgage options, a potential borrower will either resolve the decision on where to seek loan financing on their own, or acquire the services of a mortgage broker. One of the advantages of a mortgage broker is the ability to shop the loan funding among various lenders for the best offers available. While the broker may have the widest range of options to present, it is important to know that they do not necessarily have any special privileges or access to offers unavailable elsewhere, nor are they obligated to actually provide the best deal in the borrower’s interest, or at the lowest cost, because of their profit motivations. Certainly the best tactic is to speak with that particular broker’s most recent clients, to determine if they received the deal or loan specifications that where promised, did the costs or closing fees meet up with expectations, were the interest rates locked-in and did the closing process proceed according to the time-frame specified, and so on. Whether it is a banker or broker, the best mortgage deal will be evaluated based on how well the research has been done, and how carefully the potential borrower has studied all the options.

Lender Category Fees
The lender’s fees, also called ‘loan origination’ costs, cover any discounts, credit searches, assumption, broker fees, tax-related services, application, commitment, rate locks, wire transfers, as well as all processing and underwriting costs. Some of these can be negotiated for pricing modification, and if any charges appear vague or questionable, it is best to request verification.

Third-Party Category Fees
These expenses cover services the lender has set up via affiliate arrangement, and are not supposed to be value-added in terms of mark-up. These include settlement costs, closing or service charges, property appraisals, surveys, title insurance, searches and examination fees, city or county doc stamps, and all document preparation and recording via notaries and attorneys. They may also include interest pre-payment, mortgage or hazard insurance, and property taxes as well. In general, there is not a significant amount negotiating flexibility with these costs, but by examining each one through a competing proposal, a borrower can request a better detailed explanation.

The GFE is the most financially beneficial tool to utilize when a borrower is reviewing the best and most affordable mortgage options, and allows the best opportunity for cost reductions and savings options during the closing process before putting their signature on the dotted line.

• The current or existing interest rate and APR applied on the mortgage
• The type and term of the existing mortgage ( 30-year fixed, 5/1 ARM, etc. )
• The current mortgage having a pre-payment penalty charge
• The length of time, in number of years, planned on residing in the home
• The current home market value in comparison to the outstanding mortgage balance
• The interest rate available on a new mortgage based on current credit ratings
• The expenses associated with refinancing a new mortgage

Locating Your Key Mortgage Information

Most, if not all of the criteria listed above can be determined either by examining the relevant mortgage documents on file, or by checking with the lending institution or mortgage company that handled the transaction or loan process, including the mortgage balance remaining on the loan. On matters regarding the current home value, either seek the services of a private appraisal service, or wait until an appraisal is done during the loan application process. Another option is to review what comparable and recent home sales have been in the neighborhood, or request a market survey from a local realtor.

Probably the single most influential factor in determining both the chances of a loan refinancing approval, and the affordability of the loan, will be the credit scores and the subsequent current mortgage interest rate offered. Some internet research will reveal the current interest rates within the national and local markets, whether they be banks, credit unions or mortgage companies. These published rates will most certainly be the best rates, and not necessarily those a borrower will eventually qualify for.

Evaluating the Costs and Tallying the Numbers

Depending on the lending source and requirements, a borrower will obviously seek the most favorable terms and the lowest closing costs. The associated closing fees will be quite extensive, and will include those for the application process, appraisal, tax services, flood certification, credit reports, doc stamps, title and transfer fees, points, surveys, attorneys, recording fees, and much more. Many of these items, including the interest rate offered, can be detailed on a Good-Faith Estimate (GFE) provided by a lender of choice, and are not binding until the application process moves forward. Any pre-payment penalties need to be factored into the overall cost breakdown as well.

With these numbers well in hand, the next step is to determine if what is owed on the existing home is less than what it is currently worth. If a borrower is ‘underwater’, or owing more than the value of the home, then qualifying for refinancing will be slim without putting substantial funds on the bargaining table, which may negate the whole process. In addition, an interest rate comparison is needed to assess further progress advantages. It is generally felt that unless the rate offered is at least 1% lower than the existing APR, then the ‘cost’ of refinancing is less than worthwhile.

Short-Term Savings versus Long-Term Benefits

Another factor is the length of time a borrower decides to stay in the home – too short, and the costs of the refinancing expense will not be recovered. Conversely, if the current mortgage rate is adjustable on the existing loan, say at presently 4%, it could conceivably rise to a level during the remaining term of the mortgage, to say 9%, which makes refinancing with a fixed-rate loan that much more affordable, even with the identical interest rate applied. Another option is to investigate shorter loan terms, alternate loan types, or base the refinancing decision on monthly payment affordability.

One final note on the monthly payment side of things; if the goal is to merely lower the monthly payments, then refinancing with a lower interest rate will certainly accomplish that. However, if a borrower is ten years into a thirty year mortgage, and decides to refinance into a new thirty year commitment, even with a lower interest rate, the downside is the interest paid out over the additional ten years. In the end, the quickest and most informative method to determine if “should I ?” is the right course, is to grab hold of a mortgage calculator, create a few ‘scenarios’, crunch the numbers, and see how the refinancing pros and cons play out before coming to a conclusion. It is certainly a far better method than simply rolling the dice, or flipping a coin.

Discount Points versus Origination Fees
While most lenders assess a loan with one or two points or more, and some with none at all, they can certainly add to the cost of acquiring a loan if applied. Each point represents 1% of the total loan amount, so a single point added to a $200,000 mortgage would yield an additional $2,000 to the cost. The points are structured in one of two ways – discount points or origination fees. The discount type are tax-deductible points applied based on the interest rate, and paid upon loan approval, and will increase if interest rates decline. Origination points, on the other hand, are charged during the loan closing process, or in advance, are not tax-deductible, and are fees applied to the loan as a lender-charged expense for the loan approval. Your loan term has no bearing on the amount of points charged. So a 30 year mortgage could have the same amount of points as a 15 year mortgage.

Front End or Back End Benefits
The points determine how a particular mortgage loan is structured. The differences come into play when a borrower has little money available toward closing costs, and would opt for a higher interest rate, versus a borrower who is better able to absorb the upfront expense of the discount points. Conversely, if a borrower must maintain a certain monthly payment amount, they can opt for more points in exchange for a lower interest rate to lower the monthly payment. In essence, paying the upfront points fee at closing would reduce the overall pay-out over the life of the loan.

The best strategy for any home buyer is to access their credit scores long before they begin their search for lending options, or even looking for the prospective home itself. This is for two primary reasons. The first being just how long it takes to actually acquire the credit reports from each of the credit reporting bureaus ( Equifax, TransUnion and Experian ), and determining whether or not any changes, corrections or improvements need to be made, and this takes a bit of patience, and time. Getting reports from all three agencies is important because mortgage lenders will typically evaluate a potential borrower’s creditworthiness by merging those scores into one basic number, or ‘mid-score’.

Naturally, the better that number is, the better chances for loan approval, and with an affordable interest rate. In general, any potential home buyer needs to have a credit rating of at least 720 to keep from having any negative pricing adjustments factored into their mortgage. This will certainly reflect on the monthly payment structure, the amount of interest applied to the loan, and even how much funding the bank or lending institution will consider for approval. The better the credit score, the more affordable the offer will be, with the best possible terms.