What’s in the Fine Print of a Mortgage?

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Taking out a mortgage is a laborious task. It takes hours of preparation and volumes of paper. It’s easy to be overwhelmed when it comes time to sign. But your signature is a declaration that you have read and understood the loan. It says you consent to all the fine print in the contract.

But what is this fine print, and how will it ultimately affect you? Terms in a loan aren’t always explicit. It takes time to read and understand. There are several loan terms you should know.

Types of Mortgages

Most people understand they need a down payment and that there are closing costs when buying a house.

Repayment terms or amortization are how payments are spread out throughout the loan. When a payment is made, a portion goes toward the interest and the rest goes toward the principal. Initially, the principal is high, and most of your payment goes toward the interest. It will take years before you start paying down the principal.

All loans charge an annual percentage rate (APR) for the use of the money. When shopping for a loan, you may see two interest rates listed. The larger number is your APR because it includes the additional lender fees.

There are several types of home loans, including:

• conventional
• jumbo
• government-backed
• fixed-rate
• adjustable-rate

All five loans have unique qualities and meet different individual needs. But although they are somewhat different, most have similar fine print.

Interest Rate Compounding

Compound interest is when the interest is calculated based on the principal amount plus any already accumulated interest. This means if a borrower makes a late payment, they will have to pay interest on the interest as well.

Most mortgages are compounded semiannually, but some variable-rate mortgages are compounded monthly. This rate of change affects how much interest you'll pay over time. Some banks have made compounding monthly a standard practice. So be sure to ask.

Loan Prepayment Penalties

A 2010 consumer Mortgage Survey showed that 13 percent of borrowers took advantage of prepayments. But if you want to prepay or even pay off your mortgage early, there could be penalties.

For prepayment, some lenders allow up to 25 percent of your original mortgage at any point in a 12-month period, while others only allow 10 percent on your mortgage’s anniversary date.

There is a penalty if you want to break your mortgage contract and pay it off early. The penalty is usually three months of interest. Not all lenders, however, penalize the borrower this way. Some use the interest-rate differential (IRD).

The IRD is calculated by subtracting the current market rate from your original mortgage rate to find the interest-rate differential. It then takes that figure and multiplies it by your mortgage principal. Finally, the number is multiplied by the months remaining in your mortgage term.

Read the fine print of your mortgage before you sign. If your lender uses the IRD method for an early pay-off penalty, it could cost you more than the three months of interest penalty.

Know the Closing Costs

There are closing costs. Borrowers should expect to pay between 2–5 percent of the purchase price of their home in closing costs.

One to two percent of the loan amount will go toward origination fees. Also, expect to pay a minimum of $1,000 for loan underwriting fees. If you choose to lower your interest by prepaying interest, that will cost you upfront but save you in the long run.

A Federal Housing Administration loan or other government-issued loan requires mortgage insurance. Plan on paying up to 2 percent of the loan for the premium.

The seller pays some closing costs, but verify with your lender what costs will be your responsibility.

Signed Closing Disclosure

The closing disclosure (CD) is one of the most important forms you’ll sign. Your lender must have the CD to you three days before the scheduled closing date. When you receive these documents, there are several items you must check.

Check that the loan amount, term, purpose, product, and type match your most recent loan estimate. Ensure that the CD has the same interest rate you agreed to.

Know and understand the prepayment penalty or if there is a balloon payment. Is the monthly payment correct?

Also, check that closing costs match the most recent loan estimate. Does your cash to close also match your most recent loan estimate? Check if you have items in estimated taxes, insurance, or assessments not in escrow.

It’s imperative to read and understand the CD.

Crucial Closing Mortgage Paperwork

There is paperwork at the closing beyond the CD. These may include:

• promissory note
• deed of trust
• initial escrow disclosure
• right of recission

The promissory note is an agreement to pay your mortgage. It will show the total amount being borrowed, the interest rate, and the consequences of late payments. If you have an adjustable rate, it will explain how the rate will change.

The deed of trust repeats some of the information from the promissory note. It defines your rights and gives your lender the right to claim the house via foreclosure if you fail to meet the mortgage terms. If you sell the property, you must repay the home.

A deed of trust also states that you are prohibited from storing hazardous materials in your home.

An initial escrow disclosure shows the charges you’ll pay into your escrow account. It will break down the principal and interest payments and show the amounts for insurance and taxes.

The initial escrow disclosure also shows you how the funds are spent.

If you are refinancing a house, you have a right of recission. This entitles you to cancel the loan within three business days. If this is a new home purchase, you don’t have the right to cancel after closing.

Final Miscellaneous Loan Documents Needed

You must sign a borrower certification form. It certifies that the information you gave during the loan process was accurate.

There’s also the servicing disclosure statement. It will indicate whether or not your loan servicing can be assigned, sold or transferred to another party. The lender will also have you sign the errors and omissions agreement. This will allow the lender to correct any mistakes in the loan package. This includes omitted signatures or missing documents.

Local and state governments will also have documents. These are primarily used to collect information and protect your rights.

Always Read the Mortgage Fine Print

Look over the documents ahead of time.

Ensure all the documents show the same loan amount and interest rate. The promissory note also needs to match. Nothing should look different.

The closing disclosure will have the amount of money you'll need at closing. It’s called the cash to close portion. Ensure that you have that amount.

This is a significant financial commitment. It’s wise to have an attorney read the documents before you sign.

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