We’ve already explored some topics relating to mortgages, such as when to apply for a loan, credit scores, using gifts for a down payment, and interest rates. Here are four more frequently asked questions on mortgages that will help you gain clarity on this often confusing process.
How much money will I save by choosing a 15-year rather than a 30-year fixed rate loan?
A 15-year fixed rate mortgage gives you the ability to own your home free and clear in 15 years. And, while the monthly payments are somewhat higher than a 30-year loan, the interest rate on the 15-year mortgage is usually a little lower, and more importantly, you pay less than half the total interest cost of the traditional 30-year mortgage. However, if you can’t afford the higher monthly payment of a 15-year mortgage, don’t feel alone. Many borrowers find the higher payment out of reach and choose a 30-year mortgage. It still makes sense to use a 30-year mortgage for most people.
How do appraisals work?
After the appraiser inspects the property, s/he will compare the qualities of your home with other homes that have sold recently in the same neighborhood. These homes are called “comparables” and play a significant role in the appraisal process. Using industry guidelines, the appraiser will try to weigh the major components of these properties (i.e., design, square footage, number of rooms, lot size, age, etc.) to the components of your home to come up with an estimated value of your home. The appraiser adjusts the price of each comparable sale (up or down) depending on how it compares (better or worse) with your property.
As an additional check on the value of the property, the appraiser also estimates the replacement cost for the property. Replacement cost is determined by valuing an empty lot and estimating the cost to build a house of similar size and construction. Finally, the appraiser reduces this cost by an age factor to compensate for depreciation and deterioration. If your home is for investment purposes or is a multi-unit home, the appraiser will also consider the rental income that will be generated by the property to help determine the value.
Using these different methods, an appraiser will frequently come up with slightly different values for the property. The appraiser uses judgment and experience to reconcile these differences and then assigns a final appraised value. The comparable sales approach is the most important valuation method in the appraisal because a property is worth only what a buyer is willing to pay and a seller is willing to accept.
What is mortgage insurance and when is it required?
Mortgage insurance should not be confused with mortgage life insurance, which is designed to pay off a mortgage in the event of a borrower’s death. Mortgage insurance makes it possible for you to buy a home with less than a 20% down payment by protecting the lender against the additional risk associated with low down-payment lending. Low down-payment mortgages are becoming more and more popular, and by purchasing mortgage insurance, lenders are comfortable with down payments as low as three to five percent of the home’s value. It also provides you with the ability to buy a more expensive home than might be possible if a 20% down payment were required.
The mortgage insurance premium is based on loan to value ratio, credit score, type of loan, and amount of coverage required by the lender. Usually, the premium is included in your monthly payment and one to two months of the premium is collected as a required advance at closing.
It may be possible to cancel private mortgage insurance at some point, such as when your loan balance is reduced to a certain amount―below 75% to 80% of the property value. Recent federal legislation requires automatic termination of mortgage insurance for many borrowers when their loan balance has been amortized down to 78% of the original property value.
Do I need a home inspection AND an appraisal if I am purchasing a home?
Both a home inspection and an appraisal are designed to protect you against potential issues with your new home. Although they have totally different purposes, it makes the most sense to rely on each to help confirm that you have found the perfect home.
The appraiser will make note of obvious construction problems such as termite damage, dry rot or leaking roofs or basements. Other obvious interior or exterior damage that could affect the salability of the property will also be reported. However, appraisers are not construction experts and won’t find or report items that are not obvious. They won’t turn on every light switch, run every faucet or inspect the attic or mechanicals. That’s where the home inspector comes in. They generally perform a detailed inspection and can educate you about possible concerns or defects with the home.
It is highly recommended that you accompany the inspector during the home inspection. This is your opportunity to gain knowledge of major systems, appliances and fixtures, learn maintenance schedules and tips and to ask questions about the condition of the home.
Knowing the ABC’s of applying for a mortgage before you even begin the process of buying a home will definitely make for a smoother and easier mortgage application. Therefore, it pays to speak to an experienced mortgage broker before you call a real estate broker so you know if you can buy a house, and if you can, in what price range.
By Eli Garfinkel
