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Frequently Asked Questions
- What mistakes are
commonly made when buying or refinancing a home?
- Should I refinance?
- Should I pay points?
Does a zero point loan with no fees really exist?
- What is a FICO score?
- Why do interest
rates change?
- What is the
difference between being pre-qualifed and pre-approved?
- What is a rate lock?
- Can my loan be sold?
What happens if my lender goes out of business?
- What is Private Mortgage
Insurance (PMI)?
- 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
- 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 -
- The buyer is not pre-qualified or
pre-approved
- Buyer is Pre-qualified
- 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.
- 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.
- Pre-approved
- 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.
- 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.
- 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.
- 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.
- 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.
- 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!
- 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.
- 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.
- 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.
- 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.
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Refinancing your home
- 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.
- 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.
- Not getting a written Good
Faith Estimate of closing costs. See item number four above.
- 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.
- 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.
- Signing your loan documents
without reviewing them. See item number nine above.
- 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.
- 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.
- 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!
- 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.
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Getting a home equity
loan/line
- 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.
- 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.
- 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.
- 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.
- 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.
- Not getting a Good Faith
Estimate of closing costs. See item number four above.
- 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.
- 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.
- 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.
- 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!
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Should I
refinance?
The most common reason for refinancing is
to save money. Saving money through refinancing can be achieved in two
ways:
- By obtaining a lower interest rate that
causes one's monthly mortgage payment to be reduced.
- 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:
- Calculate the total cost of the
refinance--example: $2,000
- Calculate the monthly savings--example:
$100/month
- 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.
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Should I pay points? Does a zero point loan
with no fees really exist?
The best way to decide whether you should
pay points or not is to perform a break-even analysis. This is done as
follows:
- Calculate the cost of the points.
Example: 2 points on a $100,000 loan is $2,000.
- Calculate the monthly savings on the
loan as a result of obtaining a lower interest rate. Example: $50 per month
- 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.
- 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!
Zero-Point/Zero-Fee Loans
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.
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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.
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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
| 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 |
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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:
- Loan program.
- Interest rate.
- Points.
- 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.
Lock-and-shop programs.
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.
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What is Private Mortgage Insurance (PMI)?
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.
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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.
Example:
| 30-year fixed |
8 percent |
1 point |
8.107% APR |
|
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!
Conclusion:
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.
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