Understanding your escrow account
Your escrow account is an integral component of your mortgage. Learn more about your escrow account and how it should be managed.

As part of the home loan process, borrowers usually have to establish an escrow or impound account in which to deposit real estate taxes and insurance premiums. The purpose of such an account is to make sure that all real estate taxes and insurance costs will be paid in full and on time, protecting the lender from tax liens as well as uninsured losses.

Escrow accounts are confusing for many home buyers. Here are a few facts to help you better understand your escrow account:

What is an escrow account?
An escrow account is basically a savings account held by a neutral third party that is established when your mortgage is taken out. The money in the account covers estimated local and county real estate taxes, home insurance premiums and any special assessments.

How much money can my lender keep in my escrow account?
The Real Estate Settlement Procedures Act (RESPA) sets limits on the amount a lender can require you to put into your escrow account to that of one-sixth of the total amount of items paid from the account or approximately two months worth of payments. Any account assessments and adjustments are made on a yearly basis, with excess funds at the end of the year of $50 or more returned to the borrower.

How can I make sure my escrow account is operating properly?
The amount in your escrow account can vary throughout the year due to changes in your tax assessments and insurance premiums. If increases occur, the lender will typically cover any extra costs until it can adjust your monthly payment.

Once a year, you will get an escrow statement from your mortgage company for your home, showing how much money you paid that year in taxes and insurance premiums, as well as how much your new escrow payments are for the year ahead. It’s a good idea to review your escrow statement and try to figure out your charges is the smartest route. Mortgage companies have been known to mistakenly ask for too much money for an escrow account.

If you think you may be paying too much into your account, speak with your lender. If things don’t change, you can file a complaint with the U.S. Department of Housing and Urban Development (HUD). It’s important to continue to make your mortgage payment during this time. For more information, you may want to review the Department of Housing and Urban Development’s Web site at: http://www.hud.gov/offices/hsg/sfh/res/respafaq.cfm.

Keep in mind when reviewing your statement that mortgage lenders can forget to pay your taxes on time, which can result in the payment of penalties and interest, which the bank will often debit from your escrow account to cover any extra charges. These fees should be repaid to you, as your lender’s late payment is not your fault.

Can I avoid an escrow account?
It is a lender’s decision whether or not to require an escrow account and many lenders do require such accounts as part of their loan’s terms, particularly government-insured loans such as VA or FHA loans.

If you have a conventional loan and do not pay private mortgage insurance – meaning your loan-to-value ratio is less than 80 percent – a lender may allow you to pay your own property taxes and home insurance premiums, but some lenders may raise your interest rate to cover any added risks.

What is a Truth in Lending statement?
A Truth in Lending (TIL) statement can help you decide if a loan is right for you. But making sense of this document is not always easy.

A Truth in Lending disclosure statement is one of the more important documents in the mortgage process. It is designed to help borrowers understand their borrowing costs in their entirety. Federal law requires that lenders provide a Truth in Lending (TIL) document to all loan applicants within three business days of receiving a loan application, disclosing all costs associated with making and closing the loan.

Here is a breakdown of the some of the charges you may find on your Truth in Lending statement and what they mean:

Annual percentage rate:
The annual percentage rate (APR) is the “cost of credit” or the amount you will pay for the credit provided to you through the loan. APR is calculated at a yearly rate. It includes not only your contractual interest rate, but also any prepaid finance charges paid during or before the loan’s closing – such as origination points, service fees or credit fees, commitment or discount fees, buyer’s points, finder’s feels, etc. – as well as any private mortgage insurance (PMI). PMI is generally required if you put less than 20 percent down on a home. Note that the APR shown on the TIL disclosure statement always exceeds the quoted interest rate because of the additional items noted above. In essence the APR reflects the true cost of your loan.

Finance charge
The finance charge also calculates the cost of credit, however this figure is expressed in dollars rather than a percentage. Like the APR, the finance charge includes the total amount of interest incurred over the loan’s lifetime, plus any prepaid finance charges and mortgage insurance premiums.

Amount financed
The amount financed represents the loan amount minus any prepaid finance charges. The amount financed is important because it provides you with a clear, accurate assessment of the total amount of credit provided through the loan.

Total of payments
The total of payments indicates the total amount you will pay over the course of the loan if you make all required payments. This includes the principal, interest and private mortgage insurance (if required), but not your real estate tax premiums or monthly property insurance payments.

Payment schedule
The payment schedule includes the following information: number of payments, amount of payments, and when payments are due. Keep in mind that the amount of payments does not include payments for real estate taxes or property insurance premiums. If you have an Adjustable Rate Mortgage, the payment schedule will reflect the payments due based on any adjustments. If you have mortgage insurance, the payments may that reflected as well.

Other disclosures
Your Truth in Lending statement will contain a number of additional disclosures below the payment schedule information. Some of these may include whether or not your loan has a demand feature and / or a variable rate feature. A demand feature allows the lender to demand payment of the loan for any reason. A variable rate feature means that your interest rate is not fixed and may change. This essentially indicates that you have an adjustable rate mortgage. There is also a section on the Truth in Lending statement that details the late charge terms. This line will tell you when you will be charged a late fee and how much that fee will be.

Another important disclosure to look for is called prepayment. There are two lines under prepayment. The first tells you whether or not you have to pay a penalty if you pay your loan off early. (Remember this fee could apply if you chose to refinance your mortgage or sell your home before the end of your loan term.) The second line states that if you pay the loan off early, you are, unfortunately, not entitled to a refund of part of your finance charge. Basically, this means that you will pay interest for the period of time in which you use the loan and any previously paid finance charges are non-refundable.

Buying a home is a huge decision. If you have any questions about your Truth in Lending disclosure statement, be sure to ask our lender.

Understanding lender fees
Before you sign with a mortgage company, find out a little more about lender fees and what they all mean.

When buying a home, finding the right house and making an offer are just the beginning. Once your bid is accepted, the real fun begins – deciding on a mortgage provider. Finding the right lender can be a confusing process, especially if you don’t know the ropes. You not only have to consider your interest rate, but also lender fees, which can add up fast. Here is a list of possible fees to pay attention to when you are shopping for a mortgage provider:

Appraisal fee: Typically, the lender will require an appraisal to determine the value of a home and calculate the loan amount as a percentage of the property value or loan-to-value ratio – one of the factors used by lenders to approve your mortgage application.

Credit report fee: In order to obtain a loan, lenders want to know your credit record and history. As a result, a credit report is routinely pulled by the lender and paid for by the home buyer. The fee itself is paid to the credit reporting agency.

Flood certification fee: Lenders want to ensure that the property you are purchasing will not be threatened by natural hazards. This fee is used to determine if the home being purchased is located in a flood plain or not – if it is, expect to pay flood insurance as well.

Tax service fee: As part of their responsibility as lenders, mortgage providers hire a tax service agency to monitor the payment of your property taxes, for which they charge a service fee. The lender needs to know that the property taxes are being paid in full and on time to avoid a tax lien.

Underwriting fee: Underwriting fees are those associated with an underwriter reviewing your application and determining if the lender is willing to provide you with a loan and under what terms. The lender will review a number of factors including your assets and liabilities, income, credit history and property appraisal.

Origination fee: Some lenders charge an origination fee for the services they provide, particularly if the loan is one that may require more work such as a subprime mortgage. You may be able to dodge this fee; however, watch out that you don’t end up paying elsewhere, such as with a higher mortgage rate.

Processing fee: A processing fee is simply that – a fee to cover the cost of processing your mortgage application. This fee can sometimes be negotiated.

Commitment fee: A lender can charge a borrower a commitment fee to keep a line of credit open, or to guarantee a loan for a future date. Often, borrowers can avoid paying this fee.

Application fee: Application fees are often paid to cover other costs noted above such as appraisal, processing and underwriting fees. Some companies charge this fee to ensure that the borrower doesn’t go elsewhere. Of course, in a situation where these charges have already been paid, an application fee should be waved.

Discount points: A common way to reduce your interest rate is to pay discount points to your lender. Known as both origination and discount points, they are a one-time fee charged by the lender. Points are expressed as a percentage of the loan amount with one point equal to one percent, usually ranging in increments of .125 percent.

Loan lock fee: A loan lock fee is one charged to ensure that you get a certain rate and that it does not go up. Many brokers do not charge this fee, so shopping around to avoid it could save you some money.

Broker fee: A broker may charge you a fee for arranging your mortgage financing and any services provided, with the idea that as a broker they will find you the best rate possible. Generally if a lender charges a broker fee, they will not charge an origination fee.

Inspection fees: Many states require a home inspection and possibly a pest inspection of the property. Both inspections most be conducted by licensed professionals and serve not only as a safety measure for the lender, but also the borrower, in making sure that the home is structurally sound.

Lawyer fees: You may also have to pay an attorney to process and review your loan documentation.

Miscellaneous administrative fees: There are a variety of administrative fees charged by the lender to cover some of their expenses, such as courier costs for sending documents to various parties, wire transfer fees to wire funds dealing with your closings and document preparation fees for drafting and preparing your loan documents.

Finding the right mortgage lender takes time and energy, however, in the long run, a little extra work will probably pay off. Pay close attention to the different lender fees and be sure to ask for a good faith estimate of the approximate costs that you can expect at closing. You – and your wallet – will be happy you did.

Is your down payment too big?
Contrary to popular belief, it’s not always in your best interest to make the largest down payment you can when buying a home.

For many people, especially those buying their first home, it may seem as if the larger the down payment they can make, the better. But there’s a point where your deposit could be too large. Before emptying out too much of your savings account, ask yourself the following: Are you going to have enough left over to cover closing costs and moving expenses? Have you retained enough to serve as an emergency cushion in case something in your new home breaks down or your car quits? You may discover you’re better off to reduce the size of your deposit.

Start with the minimum
A 20 percent down payment has long been considered the standard when buying a home. Lenders do approve mortgages with smaller upfront payments — some even offer zero-down loans. But most experts agree that if you can put 20 percent down, you should.

Lenders offer more favorable interest rates to home buyers who make a down payment of at least this size. What’s more, you’re more likely to attract offers from several lenders and to find a mortgage with a good interest rate and the terms you want.

A 20 percent down payment also allows you to avoid added costs. When you borrow more than 80 percent of your home’s value, lenders require you to purchase private mortgage insurance (PMI), which typically costs about half a percent of the loan’s principal — about $83 per month on a $200,000 mortgage. You can avoid these premiums by putting 10 percent down and getting a second “piggyback” loan for the remainder, but this too comes at a price. A 20 percent down payment sidesteps both of these additional charges.

Determine the maximum
So, should you make a down payment larger than 20 percent? It’s true that every extra dollar you put down reduces your monthly payment and the amount of interest you’ll pay over the life of the loan. But you may be surprised at how the numbers break down.

1. Consider how much interest you will save

Assuming you’re buying a $200,000 home with a 6 percent mortgage amortized over 30 years:

As you can see, an extra $10,000 down saves you $60 a month, and an additional $20,000 will put $120 a month in your pocket. That sounds great until you consider that it will take almost 14 years for these savings to equal your initial outlay. And the overall interest savings, while significant, will be spread over three decades, amounting to just a few dollars a month.

2. Ask yourself the following questions:

Would you be better off using the money to cover other expenses?
Think about how $10,000 or $20,000 might be put to better use. Settling in to a new home is often more expensive than new owners bargain for. Don’t forget that reputable movers can easily charge over $1,000 — far more if you’re moving between cities. If you’re purchasing a larger home, you’ll likely need some new furniture. You may decide that the bathroom you thought you could live with needs to be gutted. Paying these costs with cash rather than your credit card can save you a bundle.

Should you keep the funds available in case of an emergency?
You might also want to stash that money in a high-yield savings account — a decision that might one day end up saving your home. If you, or your partner, ever lose your job, this emergency fund will allow you to make your mortgage payments until you’re back on your feet.

Have you retained enough to cover all of the required closing costs?
You will need to set aside a little extra to cover all of the closing costs associated with a mortgage. These will be listed in the Good Faith Estimate of costs that your lender is required to give you within three days of your application.

Will a larger down payment reduce the interest rate of your loan?
There are situations when a down payment larger than 20 percent may be a smart choice. If you have a blemish or two on your credit report, more money down may encourage a lender to give you a better rate.

What is your personal attitude towards debt?
If you’ll have more peace of mind with a smaller loan and more home equity, that’s a personal choice no one should dissuade you from.

Do the terms of your mortgage allow you to make prepayments?
Remember that a large down payment isn’t the only way to reduce your mortgage and increase your equity. Many lenders allow you to make prepayments (extra payments to help you pay your loan off faster) once a year. After you’ve been in your home for a while, if you decide you really do want to knock down your mortgage, this feature will allow you to still do so.

Can you afford to buy a home?
You’re ready for homeownership, but are your finances? Find out if your financial situation is stable enough to purchase a home.

Only fools rush in, and that’s certainly true when it comes to buying your first home. Take this quiz to help determine whether you’re in good enough financial shape to take on a mortgage.

After each question, we’ve provided an explanation that will help you understand why each factor is important to consider before you commit to buying a home.

1. How much of your target purchase price have you saved for a down payment?
a) Less than 5%
b) Between 10% and 20%
c) 20% or more

While it’s possible to finance up to 100 percent of a home’s value, a 20 percent down payment should enable you to get a better mortgage rate and terms, help you avoid having to pay for private mortgage insurance (PMI) and protect you against a drop in property values. On a $300,000 home, you’d need $60,000 to meet this goal. If you’re able to save $30,000 (10 percent of the house’s value) you can most likely still obtain a good mortgage, although you will likely have to pay for PMI. You will also need a little extra in your mortgage budget to cover all of the related closing costs. These will be listed in the Good Faith Estimate of costs that your lender is required to give you within three days of your application.

2. What percentage of your pre-tax income will you need to pay to cover mortgage, property taxes and homeowner’s insurance on a home in your target price range?
a) 35% or more
b) Between 28% and 35%
c) Less than 28%

When you apply for a mortgage, lenders will look at your debt-to-income ratio to ensure you won’t be stretching your paycheck too far. In general, no more than 28 percent of your pre-tax income should go toward your mortgage, property taxes and homeowner’s insurance. If you put 20 percent down on a $220,000 home, your mortgage will be $176,000, which would cost approximately $1,000 a month to carry. Add taxes and insurance and you’re looking at a payment of approximately $1,500 a month. An annual income of $65,000 would just allow you to cover that monthly payment within the 28 percent limit.

3. What is your employment status?
a) I recently started a new career
b) I am self-employed or work on commission
c) I’ve been on salary at the same company for several years

Lenders like to see at least two years of employment stability, so if you’ve just embarked on a new career, it may not be the best time to buy a first home. Those who are self-employed or work on commission can certainly obtain a good mortgage, although they may find it more difficult if they cannot document their income. For more information read our article Employment required for a mortgage.

4. What other debts do you have?
a) I have a substantial amount of debt (such as a car loan, student loan and large credit card balance
b) I have a small amount of debt (such as a small car loan and a credit card balance that I usually pay off every month)
c) I am virtually debt-free

Lenders may be reluctant to approve you for a mortgage if you’re already carrying a lot of debt. The rule of thumb is that no more than 36 percent of your pre-tax income should go to paying off debt, including the 28 percent maximum for mortgage, taxes and insurance. In other words, if your household income is $65,000 and your monthly housing expenses are $1,500, your other debt payments should not total more than $450 a month.

5. What is your credit score?
a) Below 620
b) Between 620 and 720
c) Over 720

The interest rate you obtain on your mortgage will be closely tied to your credit score. A score over 720 should get you a very favorable rate. Once you’re in the mid-600s, you’ll pay about one percent more. A score below 620 is considered “subprime” and you may pay as much as three percent more than someone with excellent credit.

Adding up your score:
Give yourself zero points for every question that you answered with an A, one point for every B and two points if you chose C.

8 to 10: Congratulations! You’re all set to become a homeowner. You’re in good financial shape and are well prepared to start shopping for a loan. Get no-obligation mortgage offers now through LendingTree.

6 to 7: You may be able to purchase a modest house, however, you may find it a struggle to meet your mortgage payments. It may be wise to save a little more for a down payment — within a year or two you should be well on your way to your first home.

5 or less: Your financial situation needs to improve before you buy a house. Spending the next few years improving your credit, paying off debt, building your savings and establishing a stable employment record will bring you much closer to achieving your dream of owning a home. Take the first step by obtaining your credit score through LendingTree.

To determine exactly what price home you can afford, use our Home affordability calculator. 

Credit score needed for a mortgage

Q: How high a credit score do you need to have in order for lenders to approve you for a mortgage?

A: Most lenders use a credit score designed by Fair Isaac Corporation (FICO) in order to make their assessments of your credit risk. On the basic FICO scale, a score below 620 is generally considered sub-prime, 620 to 650 is good (although you may still be viewed as a higher risk candidate) and above 720 is seen as excellent credit.

But there are no set numerical guarantees. The final decision on whether to give you a mortgage lies with the lender. And lenders consider other factors in addition to your credit score, such as your employment and salary, your savings and your debt-to-income ratio.

You may still get a mortgage with a score as low as 500. In fact, some lenders specialize in loans to borrowers with low scores. However, the lender will likely ask you to produce extra documents such as bank statements and W2s to support your application, and you may have to pay a higher interest rate. Also, Fannie Mae offers special Expanded Approval mortgages and Freddie Mac offers A-minus mortgages to those with lower credit scores.

While it’s wise to check your credit score regularly, it’s just as important to keep on top of your risk factors. These are the things that concern lenders — such as having a delinquent bill payment record. Working to improve these points can make it easier to get a mortgage at a favorable rate. When you request a credit report from a credit agency, make sure you ask for both a credit score and a credit report. Most lenders can also provide you with a risk factor statement if you ask for one.

You should also be aware that not all lenders use the most widely accepted FICO scores to make their lending decisions. Some use scores from other agencies such as Scorex, and others use FICO scales that are customized to fit their own method of risk assessment. So it’s possible that different lenders may quote different scores when processing your application, even though they indicate the same creditworthiness.

Request your free credit report and score from LendingTree.

Get a LendingTree Guide to Mortgages when you request a mortgage loan through LendingTree.

Home buyer’s checklist
This handy form can help you keep track of home-buying tasks.

Buying a home involves a myriad of tasks, especially when the purchase includes a new mortgage. While no two transactions are exactly alike, this checklist can help you organize what you’ll need to do after you’ve found a home you want to buy.

□ Negotiate and sign a purchase contract with the seller.

□ Complete and sign a formal loan application.

□ Review the lender’s disclosure documents, which should include a Good Faith Estimate, Truth-in-Lending Statement and other legally required disclosures, if applicable.

□ Submit your loan documents to the lender. Documents you may be asked to provide could include:

• Paycheck stubs
• W-2 forms
• Proof of additional income such as alimony, child support or rental income
• Two months of bank statements
• Two months of investment account statements
• Two years of federal and state income tax returns
• Two years of financial statements, if you’re self employed
• Proof of funds for your deposit, down payment and closing costs
• Explanation of any derogatory items on your credit report
• Divorce decree, if applicable
• Discharge of bankruptcy, if applicable
• Other documents requested by the lender

□ Review the seller’s property transfer disclosure statement, if legally required.

□ Review home inspector’s report, if obtained as provided for in your purchase contract.

□ Obtain a copy of the appraisal for your files.

□ Review the survey or title report as appropriate and customary.

□ Review homeowners’ association documents, if applicable.

□ Obtain approval of the homeowners’ association board, if applicable.

□ Purchase homeowner’s insurance.

□ Purchase any specialty property insurance (e.g., flood, earthquake) that may be required or that you want to buy.

□ Pack your belongings.

□ Hire a moving company or reserve a truck and recruit friends and family to help you move.

□ Notify your landlord to terminate your lease or rental agreement.

□ Notify the U.S. Postal Service of your new address.

□ Contact utility companies to transfer water, electric and gas services into your name.

□ Walk through the home before closing, if provided for in your purchase contract.

□ Obtain a cashier’s check for the balance remaining on your down payment and for any additional closing costs to be paid at closing.

□ Sign and obtain copies of your closing documents.

□ Pick up the keys to your new home!