Buying or Refinancing
What are the most commonly made mistakes in buying or refinancing a house?
Should I refinance?
When is the best time to refinance?
Can I refinance a home loan more than once?
Can an older homeowner who is cash poor but house rich use their home
to tap into the equity?
Should I pay points? Does a 0 point/0 fee loan really exist?
What is a FICO score?
Why do interest rates change?
What is the difference between pre-qualifying and pre-approval?
What is a rate lock?
Can my loan be sold? What happens if my lender goes out of business?
What is PMI? Can I get rid of the PMI on my loan?
What is an APR?
What are the most commonly made mistakes in buying or refinancing a house?
Looking for a home without being pre-approved.
As a potential buyer competing for a property, you'll have a better chance of
getting your offer accepted by being as prepared as possible. Consider this
hierarchy of preparedness:
-
Neither pre-qualified nor pre-approved
-
Pre-qualified
-
Pre-approved
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 provided a broker 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. More importantly, your state
may require that contracts for the sale of real property be in writing. Do not
expect oral agreements to be enforceable.
Choosing a lender just 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).
The cost of the mortgage, however, shouldn't be your only criterion. Have
confidence that the company you select is reputable and will deliver the loan
with the terms and costs they promised. If in the final hours of the transaction
you determine 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. Interview prospective mortgage companies.
Not receiving a Good Faith Estimate.
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 Good Faith Estimate (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, it's highly
recommended that you get property, roof and termite 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.
In a perfect world, all real estate transactions close on time. In the world we
live in, 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 discover your
transaction is delayed a week.
In a perfect world, no one is inconvenienced and your landlord is willing to
work with you. More likely, however, your landlord is inconvenienced and angry.
Will you be thrown out? Will you have to find interim housing for a week or
more? 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. This approach might cost a little more, then again, it might not.
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 of the payments made during the life of
the loan can be reduced significantly.
People also refinance to convert their adjustable loan to a fixed loan. The main
reason behind this type of refinance 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-interest 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 consumers loans are
not tax deductible, while a mortgage loan is 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.
Even the conventional wisdom of refinancing only when you can save 2% on your
mortgage is not really true. If you are refinancing to save money on your
monthly payments, the following calculation is more appropriate than the rule of
2%:
1.
Calculate the total cost of the refinance - example: $2,000
2.
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. If you plan to live in the house for longer than
this period of time, it 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 provision, but with no conversion option. In
this case it is best to refinance a few months before the balloon comes due.
Whatever you choose to do, 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 the options
available to you.
When is the best time to refinance?
Many people flock to refinance while mortgage interest rates are low,
particularly when rates are two percentage points below their existing home
loans.
Other factors, like when to finance, will depend on how long you plan to hold on
to your home and whether you have to pay considerable fees to refinance. It also
will depend on how far along you are in paying off your current mortgage.
If you expect to sell your home shortly, you are not likely to recoup the costs
you incurred to refinance. And if you are more than halfway through paying your
current mortgage, you probably will gain little by refinancing. However, if you
are going to own your home for at least another five years, that is probably
long enough to recoup any refinancing costs and realize real savings as a result
of lowering your monthly payment.
In fact, if it costs you nothing to refinance, you can gain even more. Many
lenders will let you roll the costs of the refinancing into the new note and
still reduce the amount of the monthly payment. Plus, there are no-cost
refinancing deals available. Contact your lender, and its competitors, before
you refinance.
Can I refinance a home loan more than once?
You most certainly can. During the most recent refinancing boom, for
example, many homeowners refinanced their home loans two or three times within
relatively short periods of time because interest rates kept treading downward,
making it extremely attractive to trade in one loan for another. Just remember
that refinancing is basically like applying for a mortgage all over again. Each
time you refinance, you will still have to go through the application process,
get a home appraisal, and likely incur closing costs. Also, if you have a
pre-payment penalty clause in your present mortgage, you will have to pay that
penalty if you refinance. So be certain that it is actually worth it for you to
refinance.
Can an older homeowner who is cash poor but house rich use their home
to tap into the equity?
Yes, but not so much by refinancing. A reverse mortgage is a better, and
increasingly popular, option for older Americans to convert home equity into
cash. Money can then be used to cover home repairs, everyday living expenses,
and medical bills.
Instead of making monthly payments to a lender, the lender makes payments to the
homeowner, who continues to own the home and hold title to it.
According to the National Reverse Mortgage Lenders Association, the money given
by the lender is tax-free and does not affect Social Security or Medicare
benefits, although it may affect the homeowners' eligibility for certain kinds
of government assistance, including Medicaid. Homeowners must be at least 62 and
own their own homes to get a reverse mortgage. No income or medical requirements
are necessary to qualify, and they may be eligible even if they still owe money
on a first or second mortgage. In fact, many seniors get reverse mortgages to
pay off the original loan.
Repaying a reverse mortgage is not necessary until the property is sold or the
owner moves. Should the owner die before the property is sold, the estate repays
the loan, plus any interest that has accrued.
Should I pay points? Does a zero-point/zero-fee loan 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. Calculate the cost of the points.
Example: 2 points on a $100,000 loan is
$2,000.
2. Calculate the monthly savings on the loan as a result of obtaining a lower
interest rate.
Example: $50 per month
3. Divide the cost of the points by the monthly savings to come up with the
number of months to break even.
In the above example, this number is 40 months. If you plan to keep the house
for longer than the break-even number of months, then it makes sense to pay
points; otherwise it does not.
4. The above calculation does not take into account the tax advantages of
points.
When you are buying a house 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, use this simple rule of thumb: If you plan to
stay in the house for less than 3 years, do not pay points. If you plan to stay
in the house for more than 5 years, pay 1 to 2 points. If you plan to stay in
the house 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%
before refinancing?
You have a 30-year fixed loan at 8.5%. A loan officer calls you up and says they
can refinance you to a rate of 8.0% with no points and no fees whatsoever.
What a dream come true! No appraisal fees, no title fees and not even any junk
fees! Is this a deal too good to pass up? How can a bank and broker do this?
Doesn't someone have to pay? Whose money is being used to pay these closing
costs?
No, this is not a scam. Thousands of homeowners have refinanced using a
zero-point/zero-fee loan. Some refinanced multiple times, riding rates all the
way down the curve in 1992, 1993 and, more recently, in 1996. Some homeowners
used zero-point/zero-fee adjustable loans to refinance and get a new teaser rate
every year.
The way this works is based on rebate pricing, sometimes also known as
yield-spread pricing, and sometimes known as a service-release premium. The
basic idea is that you pay a higher rate in exchange for cash up front, which is
then used to pay the closing costs. You will pay a higher monthly payment, so
the money is really coming from future payments that you will make.
You can also think of this as negative points! For example, a 30-year fixed loan
may be available at a retail price of:
8.0% with 2 points or
8.25% with 1 point or
8.5% with 0 points or
8.75% with -1 point or
9% with -2 points
On a $200,000 loan, the loan officer can offer you 8.75% with a cost of -1
point, 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.
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 rate of
8.75% and if the rates drop 1/2%, you can refinance again to 8.25%. On the other
hand, if you refinanced by paying 1 point and got a rate of 8.25%, it may not
make sense to refinance again. Now, if the rates drop another 1/2%, a
zero-point/zero-fee loan can drop your rate to 7.75%, whereas if you paid
points, you may have to do a break-even analysis to decide if refinancing will
save you money.
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.
Some consumers have used zero-point/zero-fee loans on adjustable loans to
refinance their adjustable every year and pay a very low teaser rate.
What are the disadvantages of a zero-point/zero-fee loan?
The main disadvantage is that you are paying a higher rate than you would be
paying if you had paid points and closing costs. If you keep the loan for long
enough, you will pay more, since you have higher mortgage payments. In the
scenario where you plan to stay in the house for more than 5 years, and if rates
never drop for you to refinance, you could wind up paying more money. If, on the
other hand, you plan to stay at a property for just 2-3 years, there really is
no disadvantage of a zero-point/zero-fee loan.
Whose money is it?
Since you are being paid "cash" up-front in exchange for a higher rate, it
really is your own money that will be paid in the future through higher
payments. 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 servicer 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 house 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.
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 FICO 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.
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)
Experian (1-888-397-3742)
They 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. hey 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 pre-qualifying and pre-approval?
A pre-qualification is normally issued by a loan officer, who, after
interviewing you, determines the dollar value of a loan you can be approved for. However, loan officers do not make the final approval, so a pre-qualification is
not a commitment to lend. After the loan officer determines that you
pre-qualify, he/she then issues you a pre-qualification letter. This
pre-qualification letter is used when you are making an offer on a property. The
pre-qualification letter indicates to the seller that you are qualified to
purchase the house you are making an offer on.
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 an underwriter and a decision is made regarding your loan
application. If your loan is pre-approved, you are then issued a pre-approval
certificate. Getting your loan pre-approved allows you to close very quickly
when you do find a house. A pre-approval can help you negotiate a better price
with the seller, since being pre-approved is very close to having cash in the
bank to pay for the house!
What is 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.
Let's say you lock in a 30-year fixed loan at 8% for 2 points for 15 days on
March 2. This 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 price and the originally locked price. 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, there is no free lunch; the free float-down is costly for the lender
and you pay for this option indirectly, because the lender has to 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% or more). This is because it is expensive for them to lock in interest rates. If lenders
let the borrowers improve their rate every time the rates improved, they spend a
lot of time relocking interest rates, since rates fluctuate daily. 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 house, some lenders offer a lock-and-shop program that
lets you lock in a rate before you find the house. 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. If your loan has
been sold, your existing lender will notify you that your loan has been sold,
who your new lender is, and where you should send your payments from now on.
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 PMI? Can I get rid of the PMI on my loan?
PMI or Private Mortgage Insurance is normally required when you buy a house with
less than 20% 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. It enables lenders to accept lower down
payments than they would normally accept. In effect, mortgage insurance provides
what the equity of a higher down payment would provide to cover a lender's
losses in the unfortunate event of foreclosure. Therefore, without mortgage
insurance, you might not be able to buy a home without a 20% down payment.
The cost of PMI increases as your down payment decreases. Example: The cost of
PMI on a 10% down payment is less than the cost of PMI on a 5% down payment.
Your PMI premium is normally added to your monthly mortgage payment.
The decision on when to cancel the private insurance coverage does not depend
solely on the degree of your equity in the home. The final say on terminating a
private mortgage-insurance policy is reserved jointly for the lender and any
investor who may have purchased an interest in the mortgage. However, in most
cases, the lender will allow cancellation of mortgage insurance when the loan is
paid down to 80% of the original property value. Some lenders may require that
you pay PMI for one or two years before you may apply to remove it.
To cancel the PMI on your loan, contact your lender. In most cases, an appraisal
will be required to determine the value of your property. You will probably also
be required to pay for the cost of this appraisal. Another way of cancelling the
PMI on your loan is to refinance and to get a new loan without PMI.
What is 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% 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.
If life were easy, all you would have to do is compare APRs from the
lenders/brokers you are working with, then pick the easiest one and you would
have the right loan. Right? Wrong!
Unfortunately, different lenders calculate APRs differently! So a loan with a
lower APR is not necessarily a better rate. The best way to compare loans in
our opinion is to ask lenders to provide you with a good-faith estimate of
their costs on the same type of program (e.g. 30-year fixed) at the same
interest rate. Then delete all fees that are independent of the loan such as
homeowners insurance, title fees, escrow fees, attorney fees, etc. Now add up
all the loan fees. The lender that has lower loan fees has a cheaper loan than
the lender with higher loan fees.
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
An APR does not tell you how long your rate is locked for. A lender who offers
you a 10-day rate lock may have a lower APR than a lender who offers you a
60-day rate lock!
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.
