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SOUTHLAND HOME FINANCE
SOUTHLAND HOME FINANCE
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Frequently Asked Questions
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)?
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.
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.
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!
Should I refinance?
The most common reason for refinancing is to save money. Saving money through
refinancing can be achieved in two ways:
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.
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:
1. 1. Calculate the cost of the points. Example: 2 points on a $100,000 loan is $2,000.
2. 2. Calculate the monthly savings on the loan as a result of obtaining a lower interest
rate. Example: $50 per month
3. 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. 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!
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.
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.
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.
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.
3. Points.
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.
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.
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)?
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. As
of January 1, 2007, a homeowner is now allowed to write off PMI payments on their annual tax
returns. Consult your CPA for advice on the benefits of this new tax deduction.
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.
Example:
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.
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)?
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.
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.
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!
Should I refinance?
The most common reason for refinancing is to save money. Saving money through
refinancing can be achieved in two ways:
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.
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:
1. 1. Calculate the cost of the points. Example: 2 points on a $100,000 loan is $2,000.
2. 2. Calculate the monthly savings on the loan as a result of obtaining a lower interest
rate. Example: $50 per month
3. 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. 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!
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.
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.
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.
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.
3. Points.
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.
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.
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)?
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. As
of January 1, 2007, a homeowner is now allowed to write off PMI payments on their annual tax
returns. Consult your CPA for advice on the benefits of this new tax deduction.
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.
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.