After you've identified a potential mortgage lender and think you know which loan type may best meet your financial situation, the next step is to understand the specific terms of the mortgage. Some of these choices may be negotiable, and some of these choices may increase the monthly payment of your loan, or possibly the overall cost of the loan, or both.

Again, ask your loan officer or mortgage banker or broker questions to help clarify the information. Never sign any loan document unless you are sure you understand it.

Here's a list and explanation of these key mortgage components:

Prepayment penalties

Always ask the loan officer or mortgage broker if the mortgage carries a prepayment clause which requires you to pay a fee if you pay off your loan within a certain amount of time, often two or three years from the date you obtained the loan. You may have the option to obtain a loan with or without a prepayment penalty. Loans with a prepayment penalty generally have a lower interest rate and/or lower closing costs than loans without a prepayment penalty. However, if you want to pay off your loan during the period the penalty is in effect, the prepayment penalty may be high. This could make it harder for you to refinance or sell your property. You should carefully consider whether to obtain a loan that has a prepayment penalty.

No doc/low doc loans

You may have the option to obtain a loan without the lender verifying your income and other assets. However, you will likely be charged a higher interest rate or other fees than you would if you chose a "full documentation loan." Carefully consider whether to obtain a low documentation or no documentation loan. Not all borrowers are eligible to obtain a no or low documentation loan. The lender or broker you select will be able to advise you whether you are eligible for this type of loan.

Term of the Loan

Term refers to the period over which you pay back the loan (principal and interest). Usually, most loans are usually available in 15 or 30-year terms. A shorter term carries a lower rate and higher monthly payments, but more money is saved over the long run while you build equity at a faster pace. A loan with a longer term carries a higher interest rate and a lower monthly payment, so it makes a larger mortgage more affordable. However, you build equity at a slower rate. Other terms, such as 20 or 25 years may be available depending on the type of loan you select.

Closing Costs

Closing costs vary based on a number of factors - including the lender, mortgage type, purchase contract, and location - but they usually include the following:

Lender fees.   Your mortgage company may charge for expenses related to making the loan, including an appraisal fee, a credit report fee, origination points, and discount points.




Third-party fees.   Charges for services not provided by your lender often include the settlement fee, title insurance, and attorney's fees.




Prepaid items.   Certain mortgage costs must be paid to your lender in advance. The most common of these are prepaid interest, mortgage insurance premiums and hazard insurance premiums.




Reserves deposited with the lender.   If you are establishing an escrow account for payment of taxes and insurance, your mortgage company will require you to deposit an initial amount into the escrow account.




Private mortgage insurance.   Private mortgage insurance (PMI) provides your lender with a way to recoup its investment if you are unable to repay your loan. It is usually required for conventional mortgage loans when a borrower makes less than a 20 percent down payment during a home purchase. The coverage protects the lender against possible loss should the borrower default on their mortgage payments.




Obtaining PMI coverage may be a reasonable way to buy a home sooner because it allows a borrower to make a smaller down payment, but it could mean extra costs: an up-front fee at closing and an added fee to the mortgage payment each month, which can add up significantly. Previously, borrowers had no choice but to pay PMI when making a lower down payment.




Lender paid mortgage insurance (LPMI) offers an alternative to traditional PMI. The lender pays for the mortgage insurance in return for a slightly higher interest rate. The borrower may be able to get a higher tax deduction due to the higher rate if they itemize on their tax return, and, typically, the difference in rate payment is smaller than paying for PMI. (Please consult your tax advisor regarding the deductibility of interest.) LPMI also features no additional fees paid at closing, and no monthly mortgage premium.




Unlike PMI, however, the borrower cannot cancel LPMI, even when they reach a certain loan-to-value ratio. The only way to remove it is to refinance or satisfy the loan. Despite the no cancellation policy, however, first-time buyers who are planning to stay in the home for less than 10 years are among those who may benefit from LPMI.

Locking in a Rate

Locking your interest rate means your lender guarantees the rate on your loan even if market rates change before closing. Most lenders will allow you to lock your rate for 30 to 60 days, with the option to extend the rate-lock period for a fee. So how do you know whether to lock your interest rate? It depends on whether you expect rates to rise or fall before you close on your home. No one knows for sure which direction rates will go at a given time, so it's a difficult to make a reliable prediction. It helps to keep track of announcements from the Federal Reserve Board, whose monetary policies have an effect on mortgage rates, and to talk to you financial advisor about what may happen in the near term.

Making a Down Payment

There is generally no minimum down payment required for buying a home unless the lender requires a specific down payment as a condition of making a loan to you. Many first-time buyers believe they must be able to put down as much as 20 percent of a home's purchase price in cash. That may have been true in the past, but today, many lenders offer lending programs specifically geared to first-time homebuyers that may offer lower down payment requirements. A few years ago it was common for borrowers to obtain financing without making any down payment. However, as the real estate market and lending requirements have changed, fewer lenders are willing to make "zero down" loans.

Lower Interest Rate or Cash Back on Closing Costs

Many mortgage companies will offer you the option of paying either higher or lower closing costs in return for an adjusted interest rate. This decision is often based on whether or not you need more cash upfront or if you would prefer to enjoy savings over the long term.

Lowering Your Interest Rate by Paying Points

Discount points are a form of prepaid interest, which you can pay to your lender at closing in exchange for a lower interest rate on your mortgage. Points are an upfront cost designed to save you money over the future term of your loan by decreasing the amount you will pay in interest each month. Paying discount points, each of which is equal to 1 percent of the loan amount, is often called "buying down" your rate.

So does paying points make sense for you? The answer depends primarily on how long you plan to stay in your home. First, find out how much lower your monthly payments will be if you pay points. Then, calculate how long it will take for those monthly savings to add up to the cost of the points. If it would take five years to break even and you're planning to live in your home for 10 years, paying discount points may be a smart move.

Escrow or Impound Account

An escrow or impound account (the terms are interchangeable; each is used in different states) is the name of the account in which a lender collects payments you make toward your property taxes and hazard/fire insurance. If you have an escrow account, each of your monthly payments will contain a fraction of your annual property tax and insurance costs. Your lender keeps these funds in the escrow account and then pays your taxes and insurance directly when they become due.

An escrow account can be a convenient and trouble-free manner of ensuring that your insurance and tax payments are made on time.