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Mortgage lenders, like companies that make car and credit card loans, take a risk that the person borrowing their money will be unable to repay it.

While mortgage companies use criteria such as credit scores and down payments to determine the likelihood that the borrower will repay the loan, they also use mortgage insurance (MI) to help offset their risk.

Mortgage insurance is required on conventional (Fannie Mae) loans when the down payment is less than 20%. The premium, which is included in your mortgage payment, is based on your down payment. The larger the down payment, the lower the premium because the risk that you may default is lower for the lender. As you approach the minimum down payment of 3%, premiums will increase, as well as credit score requirements.

There will be MI on most FHA loans, regardless of your down payment. On FHA, there are actually two types of MI: One is called the “upfront premium,” which can either be paid out of pocket or financed. The other type of MI is included in your monthly mortgage payment.

The biggest difference in MI between conventional and FHA programs is the way mortgage insurance is removed. On conventional mortgages, if certain criteria are met, MI can be stopped. With many FHA mortgages, the MI will remain on the loan until it is paid off.

While FHA mortgages can be more costly to obtain, and the monthly payment (which includes MI) will be higher, they are often easier to qualify for than conventional loans.

You’ve provided lots of documentation, including pay stubs, bank statements, and tax returns, to your lender as part of your home search. You’ve found your dream home and signed the contract. So what’s next?

Much documentation was required to prequalify you before you could even start looking for your new home, but don’t consider that chapter closed just yet.

Attorney review

Your first step after signing the contract is asking your attorney to review it. His or her job is to catch things on the contract that may have been missed. These may be items that favor the seller, not the buyer, so this is a step that absolutely should not be skipped.

Home inspection

The second step is a home inspection, which, unlike the appraisal required by your lender, isn’t mandatory. However, it is a good idea and may save you money in future. You have a small window to decide whether to order an inspection, which may be done simultaneously with the appraisal.

Underwriting

Providing all goes well with your attorney, the inspection, and the appraisal, your file moves into underwriting, where your loan is put under great scrutiny for several reasons.

The most important reason is to ensure that the lender has a complete file. Many loans are sold off by the lender shortly after; you may need to provide updated or additional documentation to satisfy the buyer of the loan. You may also need to clarify, in letters of explanation, anything the underwriting process has uncovered that seems unclear. This is typical. The file is also checked for compliance, verifying that you were provided with the correct disclosures in the correct time frame.

Closing, finally

Once the underwriting process is complete, you are ready to go to closing. This is where you and the seller settle the transaction, and the house becomes yours. So congratulations are in order. Finally!

What is a home inspection, and how is it different from an appraisal? A home inspection is a detailed review of all the major systems of a home, including the plumbing, electrical, and heating/cooling, as well as the structure and the roof.

The home inspector’s job is to inform you – the client – of any current or potential issues with the property. What he or she isn’t concerned with is the value of the property. An appraiser, on the other hand, does a less detailed review of the property and is primarily focused on the value of the property in the local market.

While lenders do require appraisals to protect their own interests, they don’t require home inspections. So should you still get a home inspection? The answer is probably yes. A home inspection will directly benefit you by helping you avoid expensive problems down the road – something that will also indirectly benefit your lender.

Any standard real estate contract gives you the right to obtain an inspection of the property; but some buyers in a sellers’ market will waive the home inspection condition in order to compete.

In deciding whether to call in a home inspector, you need to ask yourself how likely you think it is that there will be serious issues with the property.

Also, home inspections aren’t inexpensive, often starting in the $200 to $300 range and going up from there. But they may be cheap at twice the price if they uncover a serious problem with the property – items an inspector may find could cost thousands of dollars to correct.

You may not want to raise all the minor issues, but an inspection will give you leverage on your contract to address the major ones.

Also remember that if the inspection turns up significant issues, and you can’t negotiate a resolution, you can always walk away from the sale – with your deposit.

All of the costs incurred in the course of purchasing or refinancing a home are called “closing costs.” They include fees that you pay the lender, most importantly the origination fees, but other fees as well, such as appraisal, title, and recording fees.

Closing costs are usually paid from the borrower’s funds, but often you can lower them with seller credits. As well, your lender may agree to waive some of your closing costs. Sellers are often willing to cover some of your closing costs in exchange for a slightly higher purchase price, and lenders may waive some closing costs and charge a slightly higher interest rate.

Seller credits and trade-offs

These may sound great, but note that a higher home price and a higher mortgage rate will cost you more in the long run. When you begin the prequalification process, consider these “benefits” but ensure you know the downsides. Your real estate agent can help you decide the true worth of a sellers’ credit, while your lender can explain all the mortgage options available to you, including trading a higher rate for reduced closing costs. The decision, however, is yours.

Your down payment is also required at closing, and it’s the one cost that absolutely can’t be reduced by seller or lender trade-offs. Fortunately, you can use monetary gifts from close relatives to partially or completely reduce the down payment amount that comes out of your own funds, and you’re also able to use approved government or other nonprofit down payment assistance programs.

When you decide on your mortgage and lender, you may want to consider an escrow account.

This holds money to pay for your mortgage-related bills, such as property taxes and property insurance. And, while escrow accounts aren’t mandatory, they do help you stay on top of your important bills.

Escrow accounts are usually held by your lender and can be set up when you take out a mortgage. To fund the account, you make an initial deposit. At that point, the lender calculates an amount to be added to your monthly mortgage payment. This may include insurance premiums and property taxes.

For example, if you purchase a home with property insurance totaling $100 a month, prior to closing you must pay the insurer $1,200 for the first year’s coverage.

This $100 per month will then be added to your mortgage payment and held in the escrow account until it’s needed to pay next year’s insurance premium.

In the same way, the property tax amount will be added to your mortgage payments and held in escrow to pay your property tax bill.

These bills will be paid on your behalf from your escrow account, thanks to mortgage servicing (the handling of the daily functions of a mortgage.)

The responsibility for mortgage servicing can rest with your lender or a separate mortgage servicing company; both follow defined procedures and are regulated by the federal government.

The servicer will make adjustments to the escrow account annually, as property taxes and insurance premiums do change. If one expense is underestimated, you’ll need to top up your monthly mortgage payment, or write a check for it. Overages will be refunded.

You may waive the escrow account, but your lender can require a higher down payment and/or credit score, and charge a premium on the rate, to compensate for assuming the added risk, if you don’t pay your bills.

Prepayment penalties are imposed by some lenders on borrowers who either pay off, or pay down, their mortgage loan ahead of schedule. But take note, some states don’t allow these prepayment agreements and others have restrictions on them. Check your state regulations before you start your home search.

Prepayment penalty agreements usually last for three years. But even during these three years, borrowers will be able to pay off up to 20% of the principal per year without incurring the penalty. After that period, penalties won’t apply, even if you totally pay off your mortgage.

Penalties can be substantial

Penalties vary by lender, and can amount to the better part of six-month’s interest. For example, on a 30-year, $150,000 mortgage at 4%, six months of interest totals $2,989.15 – not a negligible amount.

To compensate for offering a lower interest rate, some lenders will include a prepayment agreement on a mortgage. This means the lender, and the investors who purchase their loans, will make something on the loan if you refinance, want to take advantage of lower interest rates or sell earlier than you anticipated.

If you are considering a loan that has a prepayment penalty, ensure you fully understand the terms. And know your options: If, for example, you expect to relocate during the penalty period, you may want to look for loans without prepayment penalties. If you plan to stay in your home, but would like the choice to refinance during the penalty period if interest rates decline, you’ll also want to consider your options.

An appraisal is a valuation that your lender orders before giving you a mortgage to purchase a property.

It provides an independent assessment of what the property is really worth.

In the event you are unable to make your mortgage payments, and your lender has to sell the property, the appraisal represents the true value of the home and will inform the sales price.

The lending company also requires someone to physically see the property and establish if there are structural problems or flooding risks that may impact its current or future value.

You pay for the appraisal

In the case of a purchase transaction, the appraisal is ordered and completed after you and the seller have signed a sales contract. The buyer will pay for the appraisal in advance.

Regardless of the outcome of the appraisal, this fee is nonrefundable. The lender will hire a third-party appraisal management firm to ensure the appraisal is independent, with little likelihood of bias in the report.

The property is inspected (with somewhat different criteria than a home inspection). The findings are then compared with similar properties in the same area.

After adjustments are made for differences such as the number of bedrooms and bathrooms and lot size, the appraiser comes up with a value.

Your real estate agent is also able to estimate the value of your property. He or she will have access to the same information that appraisers do, and an agent with experience should be able to come very close to the value submitted by the appraiser.

The lender, however, relies on the appraisal report, and that affects you: if the property is priced higher than its appraisal value, your lender is very unlikely to loan you the money to purchase it.

Of course, that also protects you, as you likely won’t want to pay more than the property is worth.

Assets are funds that are used in the course of either purchasing or refinancing a property, and are put toward items such as down payments, closing costs, and, depending on the mortgage program, some type of financial reserve.

Assets can come from a variety of sources: your checking and savings accounts, IRAs, and company retirement plans are the most frequently used sources of funds.

However, what many buyers don’t realize is that there are a number of things that one may think of as assets that can’t be used in the mortgage process.

These include valuable items such as cars, boats, jewelry, and art collections. They could be turned into cash, if necessary, to make a mortgage payment, but they and other valuables are excluded from a lender’s definition of an asset.

Other sources of assets you can tap into include gifts from donors, which include close relatives (by marriage or blood).

You can use a gift as an asset if the donor first signs a lender-provided gift letter, indicating that there is no expectation of repayment of the funds being used in the transaction.

Then the funds must be sourced: the donor is required to prove that he or she has the ability to donate the money. Usually this entails showing the lender a bank statement or other correspondence from the bank that indicates what the average balance in the account has been over a period of time. This will confirm that the gift amount wasn’t deposited just prior to the gift being made.

If you are a seller with an assumable mortgage, the buyer of your home can assume the payments on the loan balance you have remaining at that time. But is this a good idea?

Some loans are set up to be assumable; mortgages such as FHA loans, for example, come with an assumption clause, meaning that a buyer can take over your monthly mortgage payments. On the other hand, conventional mortgages – those created under Fannie Mae or Freddie Mac guidelines – will come with what is called a “due-on-sale” clause. This means that when you sell the property, if there is still a balance on the mortgage, the mortgage must be paid off at that time.

Why would you want your buyer to assume payments? It’s usually about the interest rate on your mortgage. If, for example, your FHA mortgage interest rate is in the 3% range, and the current market is offering rates above that, you can make your property more attractive relative to your competition by showing buyers that there is a financial incentive to purchasing your home; the buyer can assume your mortgage at that lower interest rate…providing your lender allows it.

In fact, to assume your mortgage, the buyer would still have to go through a qualification process with the lender, and your sale would be contingent on a successful outcome of this process.

An assumable mortgage does have its benefits, but it may not be right for you. Discuss the pros and cons with your mortgage advisor.

There are a variety of fees you may incur in your mortgage transaction.

One is an origination fee, which is paid directly to your lender for the work involved in reviewing and approving your loan.

Origination fees are expressed in points or as a percentage of the loan amount. A 1.25% (1.25 point) origination fee on a $100,000 loan will cost you $1,250.

Lenders need to make money in the mortgage process, either through the fees they charge directly to the borrower (such as the origination fee) or through the rate they charge.

For example, lender A is offering a 0 point (no origination fee) conventional mortgage for 4%.

That means that lending company A will make most of its money when your loan is sold to Fannie Mae or Freddie Mac on the secondary market.

But this is also good for you: if you’re tight on cash, you don’t have to come up with the origination fee, saving you thousands of dollars at closing.

Again, the lender will make most of its money when the loan is sold.

Mortgage lender B also offers you a conventional mortgage, but lender B is offering a rate of 3.75%, with a 1 point origination fee, which you’ll pay directly to B at closing.

This means lending company B accepts that it will make little or no money when the mortgage is sold.

This is OK, though, because company B has already made its money from the origination fee.

This may also work in your favor, providing you have sufficient funds at closing to pay the origination fee.
You’ll get an interest rate that is lower than you would get from lender A, and a lower monthly payment.

If you plan on remaining in the property for many years, it may be in your financial interest to pay an origination fee at closing.