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Mortgage and Refinancing 101 in the Age of Low Rates

Sep. 10, 2020   |   Updated 2:32 PM ET

Today’s mortgage interest rates hover at near historic lows. This trend represents a potential financial boon to all prospective and current homeowners in the Philadelphia region.  
 
Lower mortgage rates make owning a home a more realistic goal for first-time buyers. For those hoping to move out of a suburb and into an up-and-coming hot spot, that wish is more attainable than ever. Or maybe you love your current place, but your monthly payment stretches your budget too far. Refinancing in the current environment will create more room in your wallet.  
 
Applying for a new mortgage or a refinance makes good financial sense right now, but it’s still a big commitment. Don’t let the magnitude of the decision keep you from realizing your dreams—we’ve broken it all down for you so you can make the right call for your situation.   

 

Your Guide to Mortgages

To buy a home—or upgrade to a nicer one—the vast majority of us need to take out a mortgage. Understanding exactly how the home loan process works, from application to closing, makes you a more informed borrower.
 

Buying a Home

Once you start your real estate search, you can quickly fall in love with a home. Beautiful hardwood floors or quartz countertops in a recently toured 2,500-square-foot house or three-bedroom condo can make it hard to think about anything else. 
 
But before you jump in and make the seller an offer, step back a minute. It’s worth the time to ask yourself if you have the upfront funds needed to apply for and obtain a mortgage:
  • A down payment of up to 20% of the purchase price
  • Closing costs ranging from 2% to 5% of the loan amount
  • Home inspection fees of between $200 and $600
You can use Firstrust’s Home Savings Calculator to help you determine exactly how much money you need to set aside before you buy.
 
 
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Affording Your Loan

Besides the initial costs, you’ll have a monthly mortgage payment after your loan closes. Payments consist of two parts.
The principal and interest (P&I) portion pays down your original loan amount, also called the principal. Additionally, this portion includes the cost of borrowing, or the interest, you owe on that principal. In the beginning, a majority of your P&I goes toward interest. Eventually, the balance swings in favor of your principal. 
 
The escrow portion of your payment sets aside money to cover property taxes and homeowners insurance when they come due. Both of these items can fluctuate over time, causing a modest change in your total payment. In addition, based on the mortgage you choose and your down payment amount, you might also need to escrow for private mortgage insurance (PMI). 
 
Owning a home definitely fulfills the American dream, but it does come with a cost. Unlike when you rent, your property’s general maintenance and repairs fall on you. If you’re moving to a bigger space, your utilities might cost more. And, depending on where you live, you might owe homeowners association dues. 

Prepping for the Process

With the money matters resolved, you’re ready to move forward. To ensure the application and approval process goes as smoothly as possible and leads to the best deal, take these preliminary steps before you apply:
  • Check your credit report and clear up any inaccuracies. 
    • Here are some ways that you can check your credit report:
      • AnnualCreditReport.com
      • Call 877-322-8228 – You will go through a simple verification process over the phone.
  • Find out your credit score and do what you can to increase it, like paying your bills on time and reducing your credit card balances.
  • Prepare to provide proof of identity with your driver’s license or other government-issued ID and your Social Security number.
  • Gather all the necessary paperwork, which typically includes 30-days' worth of paystubs, two-years' worth of W-2 forms, and recent account statements for the source of your down payment.
 

Deciphering the Options

Borrowers have a range of home loans from which to choose. Be smart and educate yourself on the key differences between various mortgages before you start talking to lenders. 
 
First, there are several mortgage types at your disposal based on whether they are backed by a private lender or a government agency. 
  • Conventional loans: These are not insured by the federal government. As a result, the best rates go to those with higher credit scores because private lenders want borrowers with a history of paying their bills. Down payment requirements range from as little as 3% to up to 20%. But remember, you’ll have more initial equity in your house and reduce the chance that PMI is required by making a larger down payment. 
  • FHA loans: Because these are backed by the Federal Housing Association, you can put down as little as 3.5% if your credit score meets a certain threshold. However, you’ll be required to pay PMI, which in some cases lasts throughout the loan term. 
  • VA loans: Veterans, current service members, and surviving spouses are eligible for these zero-down-payment and no-PMI loans insured by the U.S. Department of Veterans Affairs. 
  • USDA loans: Low and middle-income borrowers located in rural areas can take advantage of loans through the U.S. Department of Agriculture. Some require upfront fees or PMI.
Second, mortgages can be tied to different interest rate types. The interest on a fixed-rate mortgage never changes over the life of the loan. This option provides certainty for borrowers who need a stable mortgage payment and plan to be in their homes for longer than a few years.
 
On the other hand, adjustable-rate mortgages (ARMs) start out with an initial low fixed rate. After three to five years, the interest starts to change to align with going market rates. This means your payment could go up or down. If you’re not planning to stay in your home for long, an ARM with a really good initial rate may make sense because you’ll likely never reach the adjustable stage.
 
Third, you can choose the length of your mortgage. The most common terms are 15 and 30 years. With a shorter duration, you’ll get a lower interest rate but typically a higher payment.

 

A Lesson in Refinancing

When refinancing your existing mortgage, the proceeds of your new loan pay off the old one. If your current rate is higher than today’s, this move can help you meet a few different financial goals, such as: 
  • A lower monthly bill because you’re spreading out repayment over a new term length
  • Less overall interest paid because of a lower rate 
  • A reduced repayment timeline and less interest paid due to a shorter term and possibly a higher monthly payment
  • Cash out to remodel your kitchen or upgrade other areas of your home
You typically incur closing costs to refinance. Plan on paying about 2% to 3% of the new loan amount. If you’re planning to move in the near future, that could negate the money you will save on interest.
 

Making a Lender List 

Whether you’re in the market for a new mortgage or a refinance, think of it like any other big purchase. It’s best to talk to more than one lender so you can compare offerings, customer service, and expertise in order to make a wise selection. 
 
Don’t forget to include your current bank in the competition. Because of your pre-existing association, it will already have some details on your financial situation. That can ease the process and often lead to a better offer because banks want to maintain and deepen their customer relationships.  
 
Sometimes home sellers want more than your word that you’ll be able to obtain a mortgage before they’ll accept a buyer’s offer from you. To be prepared for this scenario, reach out to one or more of your lending candidates before you start your home search. The loan officer will walk you through an initial screening process and provide you with either a prequalification or preapproval letter that you can share with sellers. 

 

Closing the Deal

When you’re ready to make it official, let the lenders on your list know. They’ll take your application and provide you with a loan estimate for your mortgage or refinance. This document indicates the estimated interest rate, monthly payment, and closing costs of your loan based on the information you provided. 
 
Carefully review each estimate you receive. After you accept the offer that best fits your budget and goals, it will take the lender a few weeks to complete the underwriting process. During that time, the property will be appraised to determine its current market value. You may also be asked to provide some additional information or documentation to help the underwriter make a decision.
 
Once your loan is approved, it's time for your loan closing. You’ll sign the final documents and either receive the keys to your new home or the benefits of refinancing your current one. 

 

Further Information

Want to learn more about the mortgage or refinancing process? The Consumer Financial Protection Bureau is a great resource for potential and current homeowners with questions about borrowing. This federal agency offers a wide range of educational tools to help you make smart financial decisions.
 
In addition, borrowers in the Philadelphia, South Jersey and Maryland regions can always speak with a Firstrust personal banker or mortgage loan officer to learn more about their mortgage options.



 

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