How Mortgage Rates are Determined
There are many variables that will determine current mortgage rates. When assessing the direction of mortgage rates and the underlying factors that determine mortgage rates, there are two main forces that help shape the interest rates. The first factor involves macroeconomic forces that impact mortgage rates and interest rates and the second is the factors that are impacting a specific mortgage loan request.
Macro economic factors that affect mortgage rates include the inflation rate, economic activity and actions by the Federal Reserve. The rate of inflation is generally one the biggest components of the overall level of interest rates. A modest rate or low level of inflation will almost always lead to low interest rates, while concerns about rising inflation normally cause interest rates and consequently mortgage rates to increase.
Economic activity contributes to the direction of interest rates with brisk activity tending to drive interest rates higher while lower economic production tends to pull rates down. The affect of economic activity is a result of the demand for loans. As loan demand increases with increased economic activity, the interest rates on loans including mortgage loans increases.
The Federal Reserve’s actions have a significant impact on short term bank rates which in turn applies pressure to all rates including longer term rates and mortgage rates over time. The Federal Reserve, implements policies and generally announces its policies which are designed to keep inflation and interest rates relatively low and stable but a number of market forces can force the Federal Reserve to raise short term rates and thus push long term rates higher as well.
Loan specific factors that influence mortgage rates include: the type of home loan, the borrower’s qualifications, the property, the fees and points paid and the mortgage rate lock period.
The type of home loan impacts the mortgage rate because some types of properties have different mortgage rates than others primarily because of historical risk analysis. Condominiums have historically had higher default rates than single family homes especially during market slowdowns and therefore are frequently priced slightly higher than single family detached homes. Multi unit properties may have higher mortgage rates for similar reasons over the risk of default and non owner occupied properties will almost always have a higher mortgage rate due to the increased risk seen by the mortgage lender.
The borrower’s profile affects the mortgage rate based on their inherent risk factors regarding their credit history and financial position. The risk factors are determined by the mortgage lenders and are generally based on quantitative figures such as the credit profile or credit score of the borrower, the down payment amount and the debt ratios of the borrower.
Clearly, a borrower with a poor credit score will have a higher mortgage rate than one with an excellent credit score due to the higher risk of default on the loan.
Similarly, a mortgage loan that was obtained with a larger down payment than one with the minimum down payment will have a lower default risk and generally receives a slightly lower mortgage rate. This is why borrowers will often seen an advertised mortgage rate and then when they apply for the loan find the rate higher if they are placing the minimum down payment to obtain the mortgage loan. Lower down payments are the equivalent to higher loan to values and higher loan to values are seen as a greater risk and will have a higher mortgage rate.
The following items will reduce risk or perceived risk to the mortgage lender and generally lead to a lower mortgage rate: higher credit score, greater equity in the house or a larger down payment, a low debt to income ratio or a better ability to pay with a low debt to income ratio.
Increased points and fees generally lead to a lower mortgage rate while lower points and fees lead to a higher mortgage rate. Mortgage rates and points or total closing costs are often a trade off. A point is equal to 1% of the loan amount. A mortgage loan for $150,000 with a rate of 5.50% and 1 point will have a minimum cost of $1,500.00 or 1% of $150,000.00, in addition to the other closing costs charged by the mortgage lender. In a case such as this, the potential borrower may have the option to pay more points, perhaps 2 points instead of 1, and have the mortgage rate reduced for the additional charge.
There may also be the option to obtain the mortgage loan without points with a slightly higher interest rate. The trade off comes down to the cost of points which are paid at the time of the loan closing versus the mortgage rate which impacts the monthly mortgage payment for the life of the loan.
The mortgage rate lock period or time frame will also impact the mortgage rate. This is the smallest of the factors that will impact the rate but it is important to understand the concept and mechanism of rate locks. The rate lock period is the length of time that the mortgage rate offered by the mortgage lender is good for. Home loan borrowers can choose to lock in a mortgage rate for a period of time that generally runs between 30 days to 90 days but can also be obtained for as long as 180 days.
Without a mortgage rate lock, the mortgage rate is floating or will change as the market changes. When a potential borrower calls a mortgage lender for a rate quote, some mortgage lenders quote short term rate locks since they offer the best rate. A short term rate lock is of little use if the mortgage loan is not going to close or fund within the rate lock time period.
If a mortgage loan request does not close and fund before the lock expires, then the borrower will end up with a mortgage rate that will be at the mercy of whatever changes may have taken place in the market. The longer the lock in period, the more expensive it is to lock. Borrowers can also choose to float their rate initially, and lock in for a shorter period of time once they are near closing date. Floating the rate may save a little money, but it is also has the risk of being stick in a rising rate environment.
In a volatile market, a mortgage shopper may call about mortgage rates at one time during the day only to find out the rate has changed later in the day when they decide on the best mortgage lender to work with. Without the mortgage loan application and the rate lock agreement, the mortgage shopper will end up with the prevailing mortgage rate at the time the application and/or rate lock agreement is executed.
Mortgage rates change by small amounts between 30 and 60 day locks, the 90 day locks and 180 day lock periods will often bring about a measurable higher rate and may even entail and upfront fee for the rate lock. Most long term locks are used for new construction where the time from loan application to loan closing may run for several months.
Home Mortgages and the 4 C’s of Lending
All you need to do to make sure you have a better success rate in getting your home loan application approved at the terms you want is education and preparation regarding the process the lenders go through to approve your request. When evaluating your request for a mortgage loan, a mortgage lender will assess the application you have filled out with the supporting documents you have submitted. This process is referred to as underwriting the home loan. During this stage, the mortgage lender investigates the integrity of the data and evaluates the risks in order to qualify the applicant.
The home loan application is a summary of your assets, credit and income position at this particular point in time. It does not measure your character nor does it measure potential future changes such as potential employment changes or debts that maybe incurred or satisfied.
In order to evaluate your present position the mortgage lender will review your financial position, take inventory of your assets, income and credit profile. This procedure is accomplished by verifying your employment, verifying the funds you have on deposit with financial institutions, verifying the equity in the home by appraising the property, reviewing your debts outstanding and analyzing your credit history. This process has become highly automated with computer modeling and approvals but the underlying process is basically the same.
These criteria that are evaluated were once referred to as being the four C’s of lending or collateral, capacity, credit, and character.
Collateral - Collateral is a measure of the value, condition and marketability of the property. The mortgage lender will order an appraisal to determine the market value of your home. From here the loan to value or equity position in the property is determined. Loan to value is the ratio of loan amount to the appraised value. If the borrower is agreeing to down payment of $10,000.00 on a $200,000.00 home, the loan to value will 95%. This formula works on the refinance as well. If a borrower wishes to refinance an amount of $100,000.00 on a $200,000.00 home, the loan to value will be 50%. Loan to value (LTV) and the appraisal are the biggest factors in measuring collateral. Lower loan to values leave more equity in the property and is inherently less risky for the mortgage lender since it not only cushions the mortgage lenders risk but leaves more at stake for the borrower.
Capacity - Capacity is short for capacity to pay. In regards to mortgage qualifications the capacity to pay is measured by housing and debt ratios. The mortgage lender will ascertain the borrower’s gross monthly income first. The new housing payment on the mortgage requested is calculated as well as a summary of all contractual debt payments. Capacity is then measure by dividing the monthly mortgage payment by the gross monthly income to obtain the housing ratio and then dividing all contractual debt payments by the gross monthly income to get the total debt ratio. For example, if the total obligations of the borrower were $1,400 ($1,000 for housing expenses and $400 for other credit obligations), the housing ratio would be 25% ($1,000/$4,000 = 25%) and the debt ratio would be 35% ($1,400/$4,000 = 35%). Lower housing and debts imply greater capacity to pay a home loan back and hence lower risk.
Credit - Credit is evaluated by reviewing the credit report and the credit score. With the use of credit scoring, credit evaluation has become one of the simplest attributes of a loan request to measure. The credit is broken into three primary categories. Mortgage lenders will use credit scores, known as FICO scores, to determine the overall credit risk of the home loan borrower. From here a review of the public records such as, tax liens, bankruptcy filings, and judgments will be assessed. Finally, the individual accounts or trade lines in the credit report will be reviewed for delinquency, credit amounts, depth and length of time on accounts. Generally speaking, the higher the credit score the better the credit risk.
Character - Character is a qualitative measure of a borrower’s stability, integrity and honesty. Measuring character was mostly a measure of a borrower’s commitment to their credit and the new debt they intend to take on. Character may be classified as a measure of responsibilities with the loan commitment. Since mortgage lending and underwriting is almost entirely based on quantitative analysis, character is predominantly ignored. Since it is difficult to evaluate the risk and to even measure a borrowers character, in residential mortgage lending this gauge is rarely used.
Qualification for most mortgage loans and the mortgage rate a lender will charge depends on these three main factors. Understanding the basic guidelines and having knowledge of what a mortgage lender looks for in analyzing your loan request will make your mortgage application and homeownership experience and far smoother and less nerve racking experience.
Understanding the Mortgage Loan Application Process
Once you are satisfied with the mortgage lender you have chosen to handle your home loan, the next step is to begin the application process. During the mortgage loan application process be prepared to hear various unfamiliar terms that are often only used in to the mortgage loan process. Terms you may encounter include; 1003, credit score, Fannie Mae, preapproval, prequalification, subprime, FICO score, Tri-merge, compensating factors and a host of others.
Don’t be intimidated, do your research and remember this is your home loan request; you can control many aspects of the process. Use this site to review the mortgage loan terms and loan types before you apply.
Mortgage loan applications are completed primarily in four different ways; over the phone, by mail, via the Internet or in person. Either method ends in the same result, with the submission of a completed mortgage loan application regarding the type of home loan which is a summary of the borrower’s qualifications for that home loan.
The choice of how to complete your home loan application for a mortgage is based on your preference. Almost all mortgage applications, with the exception of home equity loans, use the uniform residential loan application referred to the industry by its code number, 1003 ( pronounced: 10, 0h, 3 ).
Before you complete the mortgage loan application make sure you have studied the various home loan programs available and go one step to further and review the general underwriting conditions needed to qualify for that type of loan. Shopping and comparing home loan programs and mortgage rates should be completed well before the loan application is submitted.
The application that will need to be completed details, among other things, a borrowers income, assets, liabilities and a description of the property for the home loan. The home loan application is summary of the borrower’s asset, credit and income position at a particular point in time. It does not measure your character nor does it measure potential future changes, such as potential employment changes or debts that maybe incurred or satisfied at a later date.
After the mortgage loan application is completed, the underwriter and processor will check the borrower’s credit. Credit checks will serve the purposes of investigating the credit worthiness of the borrower as well as verifying the debts outstanding. The processors and underwriting department will also proceed to verify the borrower’s assets and employment to establish adequate funds to close on the house as well as sufficient debt ratios to qualify.
Be prepared to discuss any unusual circumstances that may put a hick up in the process, such as frequent job changes, erratic income, big deposit and withdrawals in your bank accounts or delinquent credit. Generally speaking, the more information you provide the faster and easier the home loan process will be. And once you know what the mortgage lender is looking for with the mortgage loan application, it is a good decision to get a leg up on the process.
In order to be a step ahead on the home loan application process, a prospective borrower should view their credit report in advance so they know what accounts are in the report, see any delinquent accounts that will need to be explained, the account balances reflected in the credit report as well as any accounts that do not show in the credit report. In addition, take the time to review your income and assets and utilize online mortgage calculators to help determine your debt ratios and loan to value. Try to be precise with regards to calculating gross monthly income and use current mortgage rates to avoid conflicts in the future. A good source for mortgage calculators is www.selectcalculators.com.
Along with filling out the home loan application, a number of supporting documents will be needed so the mortgage lender can process the loan request. The following is a list of commonly required documents and information needed at the time of the home loan application.
Borrowers names, addresses and social security number ( a drivers license and social security is the standard supporting document).
Description of the property to be purchased or refinanced.
Names and addresses of employers for the past two years.
One month worth of paycheck stubs.
Last two years w-2’s.
Last two months financial statements ( bank, investment account, 401k, etc..)
List of all financial accounts.
List of debts, names and account numbers.
Q. What happens when you change the mortgage loan amount after the loan application is with the mortgage lender?
A. Generally this is not a big problem when the loan amount is altered by small amounts, but it will depend on a number of variables of which one may be significant. Mortgage loans are almost entirely approved or denied based on automated underwriting systems or programs or AUS. The two biggest are FNMA’s Desk Top Underwriter and FHLMC’s Loan Prospector program.
Once a home loan application is preliminarily approved that is an indication it has been submitted through one of these programs. The loan approval takes only minutes but the data entry and processing leading up to the approval may take an hour or more. Once the home loan is submitted the automated system will generate an approval with conditions or findings that need to be satisfied for final loan approval. The conditions usually involve items and procedures such as employment and income verification and supporting documents such as current paystubs or asset documentation. The key is that the mortgage loan request is approved based on several numerical factors such as the applicants credit score, debt ratios, income and assets not subjective judgments performed by an individual.
Altering the loan amount after the initial input in these automated underwriting systems is relatively easy. Once a mortgage loan request is entered into one of the automated underwriting programs the loan request can be altered multiple times without recourse. Each alteration does not change the credit profile or cause another inquiry into the applicant’s credit report. The credit score doesn’t change due to a higher loan amount nor does the applicants job or income. If an increased loan amount is not accepted it does not invalidate the prior approval amount and conditions.
Raising the home loan amount is most often a minor change that impacts the debt ratio slightly as well as the LTV or loan to value. It would also be easy to see that a loan increase of $3,000.00 on a $200,000.00 loan request is not going to raise the mortgage payment very much and therefore will have very little impact on the debt ratios. This can be verified by running your own mortgage payment calculations on a mortgage calculator. Therefore, unless the debt ratios are very tight the most significant factor in determining the outcome of increasing the loan amount is the loan to value.
This leads to the conclusion that for home loans that are already approved, raising the loan amount slightly should be relatively easy. It requires some simple data entry changes into the original approval request with the automated underwriting system and viola, a new loan approval.
However, if the loan request is for a home purchase, the loan amount change may very well be changing the down payment and the loan to value significantly. A home loan for 180,000.00 on a $200,000.00 purchase that changes to a $182,500.00 loan amount involves a fairly measurable change to the LTV. The original home loan request calls for a down payment of $20,000.00 or 10% of the purchase price which is equivalent to a 90% loan to value home loan. By raising the loan amount by only $2,500.00 the loan to value is now over 90% (91% or $182,500.00 / $200,000.00). Home loan requests that may alter the LTV above the minimum accepted level are likely not to be approved.
The first step to solving the question of whether your mortgage loan request can be increased is to run the loan figures on a mortgage calculator so you know how the loan amount changes are impacting the mortgage payment and debt ratio. Next, speak to the loan officer or mortgage lender and ask for their input. For a refinance it is fairly common for the loan amount to be changed. Underwriting considerations may prevent the mortgage lender from raising the loan amount but there is no downside to asking. If the credit, income and collateral allow room to change the mortgage loan amount, it should a fairly simple process.
Mortgage Refinance Numbers and Costs
Mortgage refinancing is a home loan process in which one or more existing mortgage loans are paid off and replaced with a new home loan. Shopping around for the right home loan has never been more important to assure a mortgage refinance candidate will get the best financing deal.
The requirements for a refinance have become much more restrictive in 2009. A homeowner’s eligibility for refinancing will still be similar to the mortgage loan underwriting and approval process that an applicant went through when they first obtained the mortgage they are now trying to refinance. A mortgage lender will review and evaluate the borrower’s income and assets, their credit history and credit score, outstanding debts, the appraised value of the property, and the mortgage loan amount requested. Unfortunately, the guidelines to approve these home loans are more stringent regarding the parameters such as credit scores, income, assets and property value. In addition, mortgage costs are running higher.
This makes comparing mortgage loan products, mortgage rates and mortgage loan costs that much more important. Shopping, comparing, and negotiating may save you thousands of dollars. The first step is to begin by getting copy of your credit reports to make sure the information in the report is accurate. Credit report errors or discrepancies are a sure fire way to put a real wrench in the mortgage refinance process. Make sure to correct any mistakes and evaluate how good your current credit profile is.
In order to help evaluate whether a home loan is a good deal or not is worthwhile to have an idea on what to expect for closing costs and refinancing costs. Refinancing fees will vary from mortgage lender to mortgage lender and there will be different costs in different states.
Mortgage lenders are required by federal law to provide a good faith estimate of closing costs within three business days of receiving a mortgage loan application whether it is for a home purchase or refinance. The good faith estimate will provide a detailed approximation of all costs involved in the home loan closing. This document can be very helpful when used to compare costs with different mortgage lenders. Once a mortgage loan is approved and a settlement or closing date is set, the borrower should make sure to get copy of the HUD-1 settlement cost form before the home loan closing takes place.
Here is a list of some of the usual costs and fees that charged on the average mortgage refinance:
Application Fee
Some mortgage lenders and banks charge an application fee at the time of the home loan application. This fee can range from $200.00 to $500.00 and covers the initial costs of processing your home loan request and checking your credit report. If the home loan is denied, you will most likely not be refunded the cost for the mortgage loan application fee. Some mortgage lenders will credit the cost to the closing once the mortgage loan is signed.
Points and Loan Origination Fees
A point is equal to 1 percent of the amount of your mortgage loan. There are two kinds of points you a home loan borrower may pay for the home loan. The first is the mortgage loan discount points, a one-time charge paid to reduce the interest rate of the mortgage loan. The second type of mortgage points are charged by some mortgage lenders as origination fees to earn money on the home loan. The number of mortgage points will vary from mortgage lender to mortgage lender. It is important to review the mortgage points and the mortgage rate between mortgage lenders because the number will often not be directly comparable. As an example one mortgage lender may charge one point for a rate of 5.375% while another mortgage lender will charge 1.5 points for a mortgage rate of 5.25%. The general rule is that mortgage points are fees paid to the mortgage lender or broker for the home loan and are often linked to the interest rate; usually the more points you pay, the lower the rate but this is not always the case. Compare rates and points carefully.
Appraisal Fees
The appraisal fee pays for an appraisal of the home to be performed by an independent licensed appraiser. The appraisal is used to determine the market value of the property, its condition and the overall property market. Some mortgage lenders include the appraisal fee as part of the application fee but many do not. Once the appraisal is completed, you may request a copy of the appraisal and you are legally entitled to that copy even if the home loan is denied. Customary appraisal fees range from $300.00 to $600.00.
Title Search and Title Insurance
A title search and title insurance is used to check and insure the ownership of the property and the existing liens such as other mortgages or judgments on that property. The search fee covers the process of checking these documents and the insurance is to protect the mortgage lender in the event of an error or unknown recorded claim against the property that may very well impact the mortgage lenders security interest or the mortgage loan. If a problem arises, the insurance covers the mortgage lender’s investment in your mortgage. Search fees and insurance vary significantly by state since some state regulates the cost on the title insurance, ranges run from $600.00 to $900.00
Attorney Fees and Closing Fees
The mortgage lender will usually collect the fees paid to the lawyer or title company that conducts the closing for the mortgage lender. Attorney fees on a purchase transaction are a different fee, the attorney fee in a refinance transaction is generally charged in states that require attorneys consummate the home loan transaction otherwise; the title company or other representative handles the mortgage loan closing paperwork. The cost range for these fees is approximately $200.00 to $1,000.00.
Real Estate Taxes and Homeowner’s Insurance Escrow
The mortgage lender will require that the real estate taxes and homeowner’s insurance policy (sometimes referred to as hazard insurance) are paid up to the time of the home loan settlement and that a new escrow is established to disburse future taxes and insurance premiums. The homeowner’s insurance policy protects against physical damage to the house by fire, wind, vandalism, and other causes covered by the policy. The policy insures that the mortgage lender’s investment is still sound even if the home incurs some devastating calamity. The real estate tax escrow insures that the taxes are paid and the property does not become delinquent and subsequently sold for unpaid property or real estate taxes. These charges are technically not closing costs, since they are not charged by the mortgage lender, only collected by the mortgage lender to disburse to the appropriate collecting body. It is difficult to provide a range of costs for the tax and insurance escrow costs since property taxes may range from $1000.00 to $30,000.00.
Private Mortgage Insurance or Mortgage Insurance
These fees may be required on home loans that have less than 20% down payment or over 80% loan to value on a refinance transaction or are insured by federal government housing programs, such as loans insured by the Federal Housing Administration (FHA) or the Rural Development Services (RDS) and loans guaranteed by the Department of Veterans Affairs (VA). If there is not at least 20% equity in the property, mortgage lenders usually require the home owner to have private mortgage insurance to protect the mortgage lender. Insured home loans with private mortgage insurance cover the mortgage lender’s risk that the home owner will not make all the home loan payments. Costs for mortgage insurance have a wide range from 1.75% for FHA loans and 1.25% for VA home loans to .50% on for conventional mortgage loans.
Once you know what each mortgage lender has to offer run the figures the mortgage calculators to see which mortgage loan program and mortgage rates best suits your needs. And don’t forget to negotiate for the best deal that you can. Armed with the right information and a sufficient amount of mortgage comparison shopping, a consumer should be assured they will receive the right home loan with best mortgage rate and lowest costs.