1.What mistakes are commonly made when buying or refinancing a home?
2.Should I refinance?
3.Should I pay points? Does a zero point loan with no fees really exist?
4.What is a FICO score?
5.Why do interest rates change?
6.What is the difference between being pre-qualifed and pre-approved?
7.What is a rate lock?
8.Can my loan be sold? What happens if my lender goes out of business?
9.What is Private Mortgage Insurance (PMI)? Can I get rid of the PMI on my loan?
10.What is an Annual Percentage Rate (APR)?
What mistakes are commonly made when buying or refinancing a home?
If you’re like most people, purchasing a home is the biggest investment you’ll ever make. If you’re considering buying a home, you’re likely aware of the complexity of the endeavor. Because of the numerous factors to consider when purchasing a home, it’s important to prepare as best you can. Some common home-buying principles and caveats are presented here for your consideration. By keeping them in mind, you’ll help create a successful and more enjoyable experience. The information contained herein is presented as a primer. Since your home could cost you 25 to 40 percent of your gross income, it’s important to conduct research, ask questions and study the process carefully.
Buying a home
1. Looking for a home before being pre-approved. As a potential buyer competing for a home, you’ll have a better chance of getting your offer accepted by being as prepared as possible. Consider this hierarchy of buyer preparedness:
Offers are submitted and –
o The buyer is not pre-qualified or pre-approved
o Buyer is Pre-qualified
o Buyer is Pre-approved
The benefits available at each level can be easily understood when viewed from the seller’s perspective. Imagine you’re a seller in receipt of multiple purchase offers. A complete stranger (buyer) is asking you to take your property off the market for at least the next two to three weeks while they apply for a loan. As the seller, lets consider the type of buyer you’d prefer to deal with.
Neither pre-qualified nor pre-approved
This buyer provides no evidence that they can afford to purchase your property. You may wonder how serious they are since they’re not at least pre-qualified.
This buyer has met with a mortgage broker (or lender) and discussed their situation. The buyer has informed the broker regarding their income, expenses, assets and liabilities. The broker may also have seen their credit report. The buyer provided you with a letter from the broker stating an opinion of what the buyer can afford.
This buyer has completed a loan application, provided a broker or lender with written evidence of income, expenses, assets, liabilities and credit. All information has been verified by a lender. As a result, much of the paperwork for this buyer’s loan has been completed. This buyer will probably be able to close quickly. They provide you with a letter (pre-approval certificate) from the lender. You’re as certain as possible that this buyer can close.
As a potential buyer, you can see that being pre-approved will give you the best chance of getting your offer accepted. This is critical in a competitive situation.
2. Making verbal agreements. If you’re asked to sign a document containing instructions contrary to your verbal agreements–don’t! For example, the seller verbally agrees to include the washing machine in the sale, but the written purchase contract excludes it. The written contract will override the verbal contract. Do not expect oral agreements to be enforceable.
3. Choosing a lender because they have the lowest rate. While the rate is important, consider the total cost of your loan including the APR , loan fees, discount and origination points. When receiving a quote from a lender or broker, insist that the discount points (charged by the lender to reduce the interest rate) be distinguished from origination points (charged for services rendered in originating the loan). A below market or low interest rate quote may indicate some hidden loan requirements, like a prepayment penalty, requirement for escrow impounds, a short 15 day rate lock or requiring a bigger down payment. Make sure the rate quoted is for your specific loan request.
The cost of the mortgage, however, shouldn’t be your only criterion. Select a reputable company which will deliver the loan as promised. Insist on a written pre-approval from the lender. If in the final hours of the transaction you find that the lender has suddenly increased their profit margin at your expense, you won’t have time to start again with a different lender. Ask family and friends for referrals, and interview several prospective mortgage companies.
4. Not receiving a Good Faith Estimate (GFE). Within three business days after the broker or lender receives your loan application, you must receive a written statement of fees associated with the transaction. This is both the law and the best way to determine what you’ll pay for your loan. Bring the GFE with you when you sign loan documents. You should not be expected to pay fees which are substantially different from those contained in your GFE.
5. Not getting a rate lock in writing. When a mortgage company tells you they have locked your rate, get a written statement detailing the interest rate, the length of the rate lock, and program details.
6. Using a dual agent–i.e., an agent who represents the buyer and the seller in the same transaction.Buyers and sellers have opposing interests. Sellers want to receive the highest price, buyers want to pay the lowest price. In the standard real estate transaction, the seller pays the real estate commission. When an agent represents both buyer and seller, the agent can tend to negotiate more vigorously on behalf of the seller. As a buyer, you’re better off having an agent representing you exclusively. The only time you should consider a dual agent is when you get a price break. In that case, proceed cautiously and do your homework!
7. Buying a home without professional inspections.Unless you’re buying a new home with warranties on most equipment, consider obtaining property, roof, structural and pest control and other relevant inspections. This way you’ll know what you are buying. Inspection reports are great negotiating tools when asking the seller to make needed repairs. When a professional inspector recommends that certain repairs be done, the seller is more likely to agree to do them.
If the seller agrees to make repairs, have your inspector verify that they are done prior to close of escrow. Do not assume that everything was done as promised.
8. Not shopping for home insurance until you are ready to close. Start shopping for insurance as soon as you have an accepted offer. Many buyers wait until the last minute to get insurance and do not have time to shop around.
9. Signing documents without reading them.Whenever possible, review in advance the documents you’ll be signing. (Even though some specifics of your transaction may not be known early in the transaction, the documents you’ll sign are standard forms and are available for review.) It’s unlikely that you’ll have sufficient time to read all the documents during the closing appointment.
10. Not allowing for delays in the transaction. Ideally, all real estate transactions would close on time. In reality, transactions are often delayed a week or more. Suppose you asked your landlord to terminate your lease the day your purchase transaction was scheduled to close. A day or two before your scheduled closing date, you learn that your transaction is delayed a week. Very likely your landlord is inconvenienced and angry. The eviction process takes a little time, so the Sheriff won’t immediately remove you, but this type of stress-producing episode can be avoided. How? Terminate your lease one week after your real estate transaction is scheduled to close. That way, if there is a delay in closing your transaction, you have some leeway.
Refinancing your home
1. Refinancing with your existing lender without shopping around. Your existing lender may not have the best rates and programs. There is a general misconception that it is easier to work with your current lender. In most cases, your current lender will require the same documentation as other companies. This is because most loans are sold on the secondary market and have to be approved independently. Even if you have made all your mortgage payments on time, your existing lender will still have to verify assets, liabilities, employment, etc. all over again.
2. Not doing a break-even analysis. Determine the total cost of the transaction, then calculate how much you will save every month. Divide the total cost by the monthly savings to find the number of months you will have to stay in the property to break even. E.g., if your transaction costs $2000 and you save $50/month, you break even in 2000/50 = 40 months. In this case you’d refinance if you planned to stay in your home for at least 40 months.
Note: This is a simplified break-even analysis. If you are considering switching from an adjustable to a fixed loan, or from a 30-year loan to a 15-year loan, the analysis becomes more complex.
3. Not getting a written Good Faith Estimate of closing costs. See item number four above.
4. Paying for an appraisal when you think your home value may be too low. Have the appraisal company provide a list of comparable sales (typically at no charge) to provide you with a range of possible values. Your mortgage company’s appraiser or your Realtor may do this for you. Do not waste your money on a full appraisal if you are doubtful about the value of your home.
5. Using the county tax-assessor’s value as the market value of your home. Mortgage companies do not use the county tax-assessor’s value to determine whether they will make the loan. They use a market-value appraisal which may be very different from the assessed value.
6. Signing your loan documents without reviewing them. See item number nine above.
7. Not providing documents to your mortgage company in a timely manner. When your mortgage company asks you for additional documents, provide them immediately. They are doing what’s necessary to get your loan approved and closed. Delays in providing documents can be costly.
8. Not getting a rate lock in writing. When a mortgage company tells you they have locked your rate, get a written statement which includes the interest rate, the length of the rate lock and details about the program.
9. Pulling cash out of your credit line before you refinance your first mortgage. Many lenders have cash-out seasoning requirements. This means that if you pull cash out of your credit line for anything other than home improvements, they will consider the refinance to be a cash-out transaction. This usually results in stricter requirements and in some cases can break the deal!
10. Getting a second mortgage before you refinance your first mortgage. Many mortgage companies look at the combined loan amounts (i.e., the first loan plus the second) when refinancing the first mortgage. If you plan on refinancing your first loan, check with your mortgage company to find out if getting a second will cause your refinance transaction to be turned down. There are many programs where you can apply for both a first and second at the same time.
Getting a home equity loan/line
1. Not knowing if your loan has a prepayment penalty clause. If you are getting a “NO FEE” home equity loan, chances are there’s a hefty prepayment penalty included. You’ll want to avoid such a loan if you are planning to sell or refinance in the next three to five years.
2. Getting too large a credit line. When you get too large a credit line, you can be turned down for other loans because some lenders calculate your payments based upon the available credit–not the used credit. Even when your equity line has a zero balance, having a large equity line indicates a large potential payment, which can make it difficult to qualify for other loans.
3. Not understanding the difference between an equity loan and an equity line. An equity loan is closed–i.e., you get all your money up front and make fixed payments until it is paid if full. An equity line is open–i.e., you can get numerous advances for various amounts as you desire. Most equity lines are accessed through a checkbook or a credit card. For both equity loans and lines, you can only be charged interest on the outstanding principal balance.
Use an equity loan when you need all the money up front–e.g., for home improvements, debt consolidation, etc. Use an equity line when you have a periodic need for money, or need the money for a future event–e.g., childrens’ college tuition.
4. Not checking the life-cap on your equity line. Many credit lines have life-caps of 18 percent. Be prepared to make payments at the highest potential rate.
5. Getting a home equity loan from your local bank without shopping around. Many consumers get their equity line from the bank with which they have their checking account. Consider your bank, but shop around before making a commitment.
6. Not getting a Good Faith Estimate of closing costs.See item number four above.
7. Assuming that your home equity loan is fully tax-deductible. In some instances, your home equity loan is NOT tax deductible. Do not depend on your mortgage company for information regarding this matter–check with an accountant or CPA.
8. Assuming that a home equity loan is always cheaper than a car loan or a credit card. Even after deducting interest for income tax purposes, a credit card can be cheaper than a credit line. To find out, compare the effective rate of your home equity line with the rate on your credit card or auto loan.
Effective rate = rate * (1 – tax bracket)
Example: The rate of the home equity line is 12 percent, your tax bracket is 30 percent, your effectiverate is: .12 * (1 – .3) = .12 * .7 = .084 = 8.4 percent.
If your credit card is higher than 8.4 percent, the equity loan is cheaper.
9. Getting a home equity line when you plan to refinance your first mortgage in the near future.Many mortgage companies look at the combined loan amounts (i.e., the first loan plus the second) when refinancing the first mortgage. If you plan on refinancing your first, check with your mortgage company to find out if getting a second will cause your refinance to be turned down.
10. Getting a home equity line to pay off your credit cards when your spending is out of control! When you pay off your credit cards with an equity line, don’t continue to abuse your credit cards. If you can’t manage the plastic, cut them up!
1. By obtaining a lower interest rate that causes one’s monthly mortgage payment to be reduced.
2. By reducing the term of the loan, thus saving money over the life of the loan. For example, refinancing from a 30-year loan to a 15-year loan might result in higher monthly payments, but the total interest paid durring the life of the loan can be reduced significantly.
People also refinance to convert their adjustable loan to a fixed loan. The main reason for doing this is to obtain the stability and the security of a fixed loan. Fixed loans are very popular when interest rates are low, whereas adjustable loans tend to be more popular when rates are higher. When rates are low, homeowners refinance to lock in low rates. When rates are high, homeowners prefer adjustable loans to obtain lower payments.
A third reason why homeowners refinance is to consolidate debts and replace high-rate loans with a low-rate mortgage. The loans being consolidated may include second mortgages, credit lines, student loans, credit cards, etc. In many cases, debt consolidation results in tax savings, since consumer loans are not tax deductible, while a mortgage loan is usually tax deductible.
The answer to the question, “Should I refinance?” is a complex one, since every situation is different and no two homeowners are in the exact same situation. The conventional wisdom of refinancing only when you can save 2 percent on your rate is problematic. If you are refinancing to lower your monthly payments, the following calculation is more appropriate compared to the 2 percent rule:
1. Calculate the total cost of the refinance–example: $2,000
2. Calculate the monthly savings–example: $100/month
3. Divide the result in 1 by the result in 2–in this case 2000/100 = 20 months. This shows the break-even time period. If you plan to live in the home for longer than this period of time, it likely makes sense to refinance.
Sometimes, you do not have a choice–you are forced to refinance. This happens when you have a loan with a balloon payment and no conversion option. In this case it is best to refinance a few months before the balloon payment is due.
Whatever you’re considering, consulting with a seasoned mortgage professional can often save you time and money. Make a few phone calls, check out a few web sites, crunch on a few calculators and spend some time to understand your options.
1. Calculate the cost of the points. Example: 2 points on a $100,000 loan is $2,000.
2. Calculate the monthly savings on the loan as a result of obtaining a lower interest rate. Example: $50 per month
3. Divide the cost of the points by the monthly savings to come up with the number of months to break even. In the above example, this number is 40 months. If you plan to keep the home for longer than the break-even number of months, then it makes sense to pay points, otherwise it does not.
4. The above calculation does not take into account the tax advantages of points. When you are buying a home the points you pay are tax-deductible, so you realize some savings immediately. On the other hand, when you get a lower payment, your tax deduction reduces! This makes it a little difficult to calculate the break-even time taking taxes into account. In the case of a purchase, taxes definitely reduce the break-even time. However, in the case of a refinance, the points are NOT tax-deductible, but have to be amortized over the life of the loan. This results in few tax benefits or none at all, so there is little or no effect on the time to break even.
If none of the above makes sense, consider this simple rule of thumb: If you plan to stay in the home for less than 3 years, do not pay points. If you plan to stay in the home for more than 5 years, pay 1 to 2 points. If you plan to stay in the home for between 3 and 5 years, it does not make a significant difference whether you pay points or not!
Whatever happened to the conventional wisdom of waiting for the rates to drop 2 percent before refinancing?
You have a 30-year fixed rate loan. A loan officer calls you up and says you can refinance to a rate 0.5% lower than your current rate, and there will be no points, no appraisal fee, no title or escrow fees, etc. A No Cost loan, with a lower rate, lower payment and your loan balance stays the same.
Is this a deal too good to pass up? How can a bank and broker do this? Doesn’t someone have to pay? Who?
This is not a scam. Thousands of homeowners have refinanced using a zero-point/zero-fee loan. Some refinanced multiple times in a single year. Some homeowners used zero-point/zero-fee adjustable loans to refinance and get a new teaser rate every year.
This works due to rebate pricing, also known as yield-spread pricing or service-release premium pricing. You pay a higher rate in exchange for cash up front, which is then used to pay the closing costs. You are financing the closing costs by paying a higher rate. A zero point loan, with the borrower paying the closing costs would be 0.25 to 0.5% lower than the no cost loan.
On a $200,000 loan, the loan officer can offer you a rate with a cost of -1 point (rebate), which is a $2,000 credit towards your closing costs. A mortgage broker can use rebate pricing to pay for your closing costs and keep the balance of the rebate as profit. A no cost loan would need to have enough rebate points to cover all your closing costs, plus his profit margin.
What are the benefits of a zero-point/zero-fee loan?
The main benefit is that you have no out-of-pocket costs. As a result, if the rates drop in the future, you could refinance again even for a small drop in rates. So if you refinanced on the zero-point/zero-fee loan to get a lower rate and then the rates drop another 1/2 percent, you can refinance again.
The zero-point/zero-fee loan eliminates the need to do a break-even analysis, since there is no up-front expense that needs to be recovered. It also is a great way to take advantage of falling rates.
What are the disadvantages of a zero-point/zero-fee loan?
The main disadvantage is that you’ll pay a higher rate than you would, had you paid points and closing costs. If you keep the loan long enough, you’ll pay significantly more due to the higher rate. In a scenario where you plan to stay in the home for more than five years, and if rates never drop (no refinance opportunity), you could end up paying more money. If, on the other hand, you plan to stay in the home less than five years, there is likely no disadvantage with a zero-point/zero-fee loan.
Whose money is it?
The Lender advances the initial up front rebate points. Since you are receiving the cash in exchange for a higher rate, you will eventually pay back the rebate points. You’re essentially financing the closing costs. Investors who fund these loans hope that you will keep the loans long enough to recoup their up-front investment. If you refinance the loans early, both the lender and the investor could lose money.
To summarize, zero-point/zero-fee loans in many cases are good deals. Make sure, however, that the lender pays for your closing costs from rebate points and NOT by increasing your loan amount. So if your old loan amount was $150,000, your new loan amount should also be $150,000. You may have to come up with some money at closing for recurring costs (taxes, insurance, and interest), but you would have to pay for these whether you refinanced or not.
Zero-point/zero-fee loans are especially attractive when rates are declining or when you plan to sell your home in less than 2-3 years.
Zero-point/zero-fee loans may not be around forever. Lenders have discussed adding a pre-payment penalty to such loans, however few lenders have taken steps to implement such a measure. Read the Pre-Payment clause in your Note, before signing the final loan docs. As a counter measure, some lenders will prohibit your mortgage broker from refinancing your mortgage within the first 6-12 months.
What is a FICO score?
A FICO score is a credit score developed by Fair Isaac & Co. Credit scoring is a method of determining the likelihood that credit users will pay their bills. Fair, Isaac began its pioneering work with credit scoring in the late 1950s and, since then, scoring has become widely accepted by lenders as a reliable means of credit evaluation. A credit score attempts to condense a borrowers credit history into a single number. Fair, Isaac & Co. and the credit bureaus do not reveal how these scores are computed. The Federal Trade Commission has ruled this to be acceptable.
Credit scores are calculated by using scoring models and mathematical tables that assign points for different pieces of information which best predict future credit performance. Developing these models involves studying how thousands, even millions, of people have used credit. Score-model developers find predictive factors in the data that have proven to indicate future credit performance. Models can be developed from different sources of data. Credit-bureau models are developed from information in consumer credit bureau reports.
Credit scores analyze a borrower’s credit history considering numerous factors such as:
• Late payments
• The amount of time credit has been established
• The amount of credit used versus the amount of credit available
• Length of time at present residence
• Employment history
• Negative credit information such as bankruptcies, charge-offs, collections, etc.
There are really three credit scores computed by data provided by each of the three bureaus–Experian, Trans Union and Equifax. Some lenders use one of these three scores, while other lenders may use the middle score.
Frequently Asked Questions (FAQs)
How can I increase my score? While it is difficult to increase your score over the short run, here are some tips to increase your score over a period of time.
• Pay your bills on time. Late payments and collections can have a serious impact on your score.
• Do not apply for credit frequently. Having a large number of inquiries on your credit report can worsen your score.
• Reduce your credit-card balances. If you are “maxed” out on your credit cards, this will affect your credit score negatively.
• If you have limited credit, obtain additional credit. Not having sufficient credit can negatively impact your score.
What if there is an error on my credit report? If you see an error on your report, report it to the credit bureau. The three major bureaus in the U.S., Equifax (1-800-685-1111), Trans Union (1-800-916-8800) and Experian (1-888-397-3742) all have procedures for correcting information promptly. Alternatively, your mortgage company may help you correct this problem as well.
Why do interest rates change?
To understand why mortgage rates change we must first ask the more general question, “Why do interest rates change?” It is important to realize that there is not one interest rate, but many interest rates.
• Prime rate: The rate offered to a bank’s best customers.
• Treasury bill rates: Treasury bills are short-term debt instruments used by the U.S. Government to finance their debt. Commonly called T-bills they come in denominations of 3 months, 6 months and 1 year. Each treasury bill has a corresponding interest rate (i.e. 3-month T-bill rate, 1-year T-bill rate).
• Treasury Notes: Intermediate-term debt instruments used by the U.S. Government to finance their debt. They come in denominations of 2 years, 5 years and 10 years.
• Treasury Bonds: Long-debt instruments used by the U.S. Government to finance its debt. Treasury bonds come in 30-year denominations.
• Federal Funds Rate: Rates banks charge each other for overnight loans.
• Federal Discount Rate: Rate New York Fed charges to member banks.
• Libor: London Interbank Offered Rates. Average London Eurodollar rates.
• 6 month CD rate: The average rate that you get when you invest in a 6-month CD.
• 11th District Cost of Funds: Rate determined by averaging a composite of other rates.
• Fannie Mae-Backed Security rates: Fannie Mae pools large quantities of mortgages, creates securities with them, and sells them as Fannie Mae-backed securities. The rates on these securities influence mortgage rates very strongly.
• Ginnie Mae-Backed Security rates: Ginnie Mae pools large quantities of mortgages, secures them and sells them as Ginnie Mae-backed securities. The rates on these securities influence mortgage rates on FHA and VA loans.
Interest rate movements are based on the simple concept of supply and demand. If the demand for credit (loans) increases, so do interest rates. This is because there are more buyers, so sellers can command a better price, i.e. higher rates. If the demand for credit reduces, then so do interest rates. This is because there are more sellers than buyers, so buyers can command a lower better price, i.e. lower rates. When the economy is expanding there is a higher demand for credit, so rates move higher, whereas when the economy is slowing the demand for credit decreases and so do interest rates.
This leads to a fundamental concept:
• Bad news (i.e. a slowing economy) is good news for interest rates (i.e. lower rates).
• Good news (i.e. a growing economy) is bad news for interest rates (i.e. higher rates).
A major factor driving interest rates is inflation. Higher inflation is associated with a growing economy. When the economy grows too strongly, the Federal Reserve increases interest rates to slow the economy down and reduce inflation. Inflation results from prices of goods and services increasing. When the economy is strong, there is more demand for goods and services, so the producers of those goods and services can increase prices. A strong economy therefore results in higher real-estate prices, higher rents on apartments and higher mortgage rates.
Mortgage rates tend to move in the same direction as interest rates. However, actual mortgage rates are also based on supply and demand for mortgages. The supply/demand equation for mortgage rates may be different from the supply/demand equation for interest rates. This might sometimes result in mortgage rates moving differently from other rates. For example, one lender may be forced to close additional mortgages to meet a commitment they have made. This results in them offering lower rates even though interest rates may have moved up!
There is an inverse relationship between bond prices and bond rates. This can be confusing. When bond prices move up, interest rates move down and vice versa. This is because bonds tend to have a fixed price at maturity–typically $1000. If the price of the bond is currently at $900 and there are 10 years left on the bond and if interest rates start moving higher, the price of the bond starts dropping. The higher interest rates will cause increased accumulation of interest over the next 5 years, such that a lower price (e.g. $880) will result in the same maturity price, i.e. $1000.
Effect of economic data on rates
Number of arrows indicates potential effect on interest rates. 1 arrow=least effect, 5 arrows=max. effect
|Economic Event||Effect on
|Significance of event|
|Consumer Price Index (CPI) Rises||▲▲▲▲▲||Indicates rising inflation.|
|Dollar Rises||▼||Imports cost less; indicates falling inflation.|
|Durable Goods Orders Increase||▲▲▲||Indicates expanding economy|
|Gross National Product Increases||▲▲▲▲▲||Indicates strong economy|
|Home Sales Increase||▲▲▲||Indicates strong economy|
|Housing Starts Rise||▲▲▲||Indicates strong economy|
|Industrial Production Rises||▲▲▲||Indicates strong economy|
|Business Inventories Rise||▼▼▼||Indicates weak economy|
|Leading Indicators (LEI) Increase||▲▲▲||Indicates strong economy|
|Personal Income Rises||▲||Indicates rising inflation|
|Personal Spending Rises||▲||Indicates rising inflation|
|Producer Price Index Rises||▲▲▲▲▲||Indicates rising inflation|
|Retail Sales Increase||▲▲||Indicates strong economy|
|Treasury Auction Has High Demand||▼||High demand leads to lower rates|
|Unemployment Rises||▼▼▼▼▼||Indicates weak economy|
What is the difference between being pre-qualifed and pre-approved?
Pre-qualification is normally determined by a loan officer. After interviewing you, the loan officer determines the potential loan amount for which you may be approved. The loan officer does not issue loan approval, therefore, pre-qualification is not a commitment to lend. After the loan officer determines that you pre-qualify, he/she then issues a pre-qualification letter. The pre-qualification letter is used when you make an offer on a property. The pre-qualification letter informs the seller that your financial situation has been reviewed by a professional, and you will likely be approved for a loan to purchase the home.
Pre-approval is a step above pre-qualification. Pre-approval involves verifying your credit, down payment, employment history, etc. Your loan application is submitted to a lender’s underwriter, and a decision is made regarding your loan application. When your loan is pre-approved, you receive a pre-approval certificate. Getting your loan pre-approved allows you to close very quickly when you do find a home. Pre-approval can also help you negotiate a better price with the seller.
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What is a rate lock?
You cannot close a mortgage loan without locking in an interest rate. There are four components to a rate lock:
1. Loan program.
2. Interest rate.
4. Length of the lock.
The longer the length of the lock, the higher the points or the interest rate. This is because the longer the lock, the greater the risk for the lender offering that lock.
Suppose on March 2 you obtain a 15-day lock for a 30-year fixed loan at 8 percent, 2 points. The lock will expire on March 17 (if March 17 is a holiday then the lock is typically extended to the first working day after the 17th). The lender must disburse funds by March 17th, otherwise your rate lock expires, and your original rate-lock commitment is invalid.
The same lock might cost 2.25 points for a 30-day lock or 2.5 points for a 60-day lock. If you need a longer lock and do not want to pay the higher points, you may instead pay a higher rate.
After a lock expires, most lenders will let you re-lock at the higher of the original rate/points or current rate/points. In most cases you will not get a lower rate if rates drop.
Lenders can lose money if your lock expires. This is because they are taking a risk by letting you lock in advance. If rates move higher, they are forced to give you the original rate at which you locked. Lenders often protect themselves against rate fluctuations by hedging.
Some lenders do offer free float-downs–i.e., you may lock the rate initially and if the rates drop while your loan is in process, you will get the better rate. However, the free float-down is costly for the lender and you pay for this option indirectly, because the lender will build the price of this option into the rate.
What do you do if the rates drop after you lock?
Most lenders will not budge unless the rates drop substantially (3/8 percent or more), because it is expensive for them to lock in interest rates. If lenders let borrowers improve their rate every time the rates improved, they would spend a lots of time relocking interest rates. Also they would have to build this option into their rates and borrowers would wind up paying a higher rate.
Most lenders will let you lock in an interest rate only on a specific property. If you are shopping for a home, some lenders offer a lock-and-shop program that lets you lock in a rate before you find the home. This program is very useful when rates are rising.
New-construction rate locks.
Most lenders offer long-term locks for new construction. These locks do cost more and may require an up-front deposit. For example, a lender might offer a 180-day lock for 1 point over the cost of a 30-day lock, with 0.5 points being paid up-front, as a non-refundable deposit. Most long-term new-construction locks do offer a float-down–i.e., if rates drop prior to closing, you get the better rate.
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Can my loan be sold? What happens if my lender goes out of business?
Your loan can be sold at any time. There is a secondary mortgage market in which lenders frequently buy and sell pools of mortgages. This secondary mortgage market results in lower rates for consumers. A lender buying your loan assumes all terms and conditions of the original loan. As a result, the only thing that changes when a loan is sold is to whom you mail your payment. In the event your loan is sold you will be notified. You’ll be informed about your new lender, and where you should send your payments.
If your lender goes out of business, you are still obligated to make payments! Typically, loans owned by a lender going out of business are sold to another lender. The lender purchasing your loan is obligated to honor the terms and conditions of the original loan. Therefore, if your lender goes out of business, it makes little difference with regards to your loan payments. In some cases, there may be a gap between the date of your lender’s going out of business and the date that a new lender purchases your loan. In such a situation, continue making payments to your old lender until you are asked to make payments to your new lender.
What is Private Mortgage Insurance (PMI)? Can I get rid of the PMI on my loan?
PMI is normally required when you buy a home with less than 20 percent down. Mortgage insurance is a type of guarantee that helps protect lenders against the costs of foreclosure. This insurance protection is provided by private mortgage insurance companies to protect the lender. It enables lenders to offer loans with lower down payments. In effect, mortgage insurance pays the lender a certain percentage of your original purchase price to cover a lender’s losses in the unfortunate event of foreclosure. Therefore, without mortgage insurance, you would need to make a 20 percent down payment in order to buy a home.
The cost of PMI increases as your down payment decreases. Example: The cost of PMI on a 10 percent down payment is less than the cost of PMI on a 5 percent down payment. Your PMI premium is normally added to your monthly mortgage payment.
Cancelling your PMI:
Federal law requires PMI to be cancelled under certain circumstances, and Fannie Mae guidelines provide for cancellation of PMI in additional situations if the loan is owned by Fannie Mae. In general, PMI for a loan originated on or after July 29, 1999, which is secured by the borrower’s one-family principal residence or second home will be cancelled at the borrower’s request when the loan-to-value ratio (LTV) reaches 80 percent based on the value of the home at loan origination. In order to cancel PMI under the rules of July 29, 1999, the borrower must have a good payment history and the property value must not have declined.
PMI on mortgages owned by Fannie Mae can also be cancelled at the borrower’s request when the LTV reaches 75 percent based on the current value of the home as established by a new appraisal, provided that the borrower has a good payment history and that the loan is at least two years old.
If the borrower does not request PMI cancellation, the PMI servicer must automatically cancel PMI on these loans when the LTV is scheduled to reach 78 percent, based on the value of the home at loan origination, provided that the loan is current at that time. For loans originated before July 29, 1999, which are secured by the borrower’s principal residence or second home and that are owned by Fannie Mae, PMI will generally be cancelled at the midpoint of the loan term, provided that payments at that time are current.
What is an Annual Percentage Rate (APR)? The annual percentage rate (APR) is an interest rate that is different from the note rate. It is commonly used to compare loan programs from different lenders. The Federal Truth in Lending law requires mortgage companies to disclose the APR when they advertise a rate. Typically the APR is found next to the rate.
The APR does NOT affect your monthly payments. Your monthly payments are a function of the interest rate and the length of the loan.
The APR is a very confusing number! Even mortgage bankers and brokers admit it is confusing. The APR is designed to measure the “true cost of a loan.” It creates a level playing field for lenders. It prevents lenders from advertising a low rate and hiding fees.
Ideally, one should be able to compare APRs from various lenders, then select the loan with the lowest APR.
Unfortunately it’s not that simple. Various lenders calculate APRs differently! A loan with a lower APR may not be the best choice. A good way to compare different lenders is to ask them to provide a Good Faith Estimate of closing costs. Be sure you compare the same loan program (e.g., 30-year fixed), interest rate and rate lock period. You may ignore fees that are independent of the loan, such as homeowners insurance, title fees, escrow fees, attorney fees, etc. Pay particular attention to loan fees. The lender with the lowest loan fees will likely have the best deal.
The reason why APRs are confusing is because the rules to compute APR are not clearly defined.
What fees are included in the APR?
The following fees ARE generally included in the APR:
• Points – both discount points and origination points
• Pre-paid interest. The interest paid from the date the loan closes to the end of the month. Most mortgage companies assume 15 days of interest in their calculations. However, companies may use any number between 1 and 30!
• Loan-processing fee
• Underwriting fee
• Document-preparation fee
• Private mortgage-insurance
The following fees are SOMETIMES included in the APR:
• Loan-application fee
• Credit life insurance (insurance that pays off the mortgage in the event of a borrowers death)
The following fees are normally NOT included in the APR:
• Title or abstract fee
• Escrow fee
• Attorney fee
• Notary fee
• Document preparation (charged by the closing agent)
• Home-inspection fees
• Recording fee
• Transfer taxes
• Credit report
• Appraisal fee
Calculating APRs on adjustable and balloon loans is even more complex because future rates are unknown. The result is even more confusion about how lenders calculate APRs.
Do not attempt to compare a 30-year loan with a 15-year loan using their respective APRs. A 15-year loan may have a lower interest rate, but could have a higher APR, since the loan fees are amortized over a shorter period of time.
Finally, many lenders do not even know what they include in their APR because they use software programs to compute their APRs. It is quite possible that the same lender with the same fees using two different software programs may arrive at two different APRs!
Use the APR as a starting point to compare loans. The APR is a result of a complex calculation and not clearly defined. There is no substitute to getting a good-faith estimate from each lender to compare costs. Remember to exclude those costs that are independent of the loan.