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Intro
While the "residential mortgage" product is mentioned in US history since 1781, it really didn't gain popularity until the 20th century. In 1949, mortgage debt was equal to 20% of total household income; by 1979, it had risen to 46% of income; by 2001, 73% of income.
Throughout the 20th and 21st centuries, many distressful events changed the mortgage instrument to what it is today. The most recent housing crisis of 2008 completely overhauled the way these loans are issued.
Loan Types
Today these loans are either guaranteed by the government (FHA, VA, USDA loans), by government sponsored enterprises (GSEs) such as Fannie Mae & Freddie Mac (conventional loans) or given out by private equity firms or investors (portfolio loans & hard-money loans).
Loan Term
The loan term is the number of payments the loan has to be paid for. It's usually expressed in months and years. For Example 360 months or 30 years.
Common options are: 10, 15, 20, 25, 30 years
Interest rate
Mortgage loans' interest rates are either fixed over the loan term (FRM) or adjustable rate mortgage (ARM). the ARM can be fixed initially for a few years (3/5/7) and then is adjustable after that. ARM are adjustable based on an Index + Margin and has a lifetime cap on rate.
The mortgage interest rate varies daily (sometimes multiple time a day) depending on many market factors.
the interest rate can be "bought down" to a rate lower than current market by paying a fee. This fee is called buydown point(s) and is expressed as a percentage of the loan amount. for example a 0.5% interest rate buydown costs 1.5 points (or percent). if the loan amount is $400,000, that cost is 400K X 1.5% = $6,000 to lower the rate by 0.5%.
Underwriting
Even though these different type of loans vary in risk and requirements, they use the same underwriting principles.
Underwriting is the process of verification a lender uses to assess the risk of the borrower / collateral and be able to issue or not issue a loan or based on the level of risk.
The loan is approved based on the characteristics of 2 main players: the borrower & the collateral (property).
Common requirements from borrower:
Income: 2 years history, stable and enough to cover minimum 2X all liabilities (new housing and current credit report liabilities). This is one part of the Debt-To-Income (DTI) ratio.
Credit: the better the history the better the credit score, the better the rate. Liabilities from credit report are factored into the Debt-To-Income (DTI) ratio.
Assets: Must be seasoned assets for at least 2 months. Need to source large deposits. Cash is NOT allowed. Gift for down payment is allowed for primary and 2nd homes.
Common requirements for property:
Clean title: the current owner is the actual owner, no one else has rights to the property. No open liens, permits or judgements.
Insurable: Can get homeowner insurance for the property. All properties with mortgage need to have homeowner insurance
HOA Approval if Townhouse or Condo: The Homeowner Association has to be approved by lender. Different loan types have different requirements but most require good HOA financials, adequate Master Insurance and no major litigation against HOA.
Appraisal ($ Value): A certified appraiser has to go view the property, take pictures, point out any dysfunctionalities, do a market analysis and give their honest opinion about the value of the property. The value could be higher or lower than the purchase price. the lender will lend based on the lower of the 2 values.
If appraisal value is lower than purchase price, the buyer's agent could negotiate a lower purchase price. The seller could lower purchase price to appraisal value, split the difference, lower the purchase price of any value, or not lower the purchase price at all. In this case, the buyer would have to pay the difference on top of the down payment.
If appraisal value comes in higher, the buyer is not required to notify the seller, unless otherwise specified in the contract. In this case, the buyer will buy the property for purchase price.
Closing Cost
Closing cost is the fees associated with issuing the loan. We will go over them in details in another blog post. but they are usually split into 2 categories: closing cost (fees paid one time), and pre-paid items (taxes, insurance and escrows prepaid as condition of the loan).
If the borrower and the collateral meet the loan's underwriting requirements, then the lender will issue a Note specifying the loan amount, terms and payment for the borrower, and the borrower will take ownership of the property.
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