Link: FAQ’s
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.
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.
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The most common reason for refinancing is to save money. Saving money through refinancing can be achieved in two ways:
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:
Sometimes, you do not have a choice--you are forced to refinance. This happens when you have a loan with a balloon payment and no conversion option. In this case it is best to refinance a few months before the balloon payment is due.
Whatever you're considering, consulting with a seasoned mortgage professional can often save you time and money. Make a few phone calls, check out a few web sites, crunch on a few calculators and spend some time to understand your options.
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The best way to decide whether you should pay points or not is to perform a break-even analysis. This is done as follows:
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!
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.
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.
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.
The Lender advances the initial up front rebate points. Since you are receiving the cash in exchange for a higher rate, you will eventually pay back the rebate points. You're essentially financing the closing costs. Investors who fund these loans hope that you will keep the loans long enough to recoup their up-front investment. If you refinance the loans early, both the lender and the investor could lose money.
To summarize, zero-point/zero-fee loans in many cases are good deals. Make sure, however, that the lender pays for your closing costs from rebate points and NOT by increasing your loan amount. So if your old loan amount was $150,000, your new loan amount should also be $150,000. You may have to come up with some money at closing for recurring costs (taxes, insurance, and interest), but you would have to pay for these whether you refinanced or not.
Zero-point/zero-fee loans are especially attractive when rates are declining or when you plan to sell your home in less than 2-3 years.
Zero-point/zero-fee loans may not be around forever. Lenders have discussed adding a pre-payment penalty to such loans, however few lenders have taken steps to implement such a measure. Read the Pre-Payment clause in your Note, before signing the final loan docs. As a counter measure, some lenders will prohibit your mortgage broker from refinancing your mortgage within the first 6-12 months.
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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:
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.
What if there is an error on my credit report? If you see an error on your report, report it to the credit bureau. The three major bureaus in the U.S., Equifax (1-800-685-1111), Trans Union (1-800-916-8800) and Experian (1-888-397-3742) all have procedures for correcting information promptly. Alternatively, your mortgage company may help you correct this problem as well.
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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.
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:
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.
Number of arrows indicates potential effect on interest rates. 1 arrow=least effect, 5 arrows=max. effect
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Economic Event |
Effect on |
Significance of event |
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Consumer Price Index (CPI) Rises |
Indicates rising inflation. |
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Dollar Rises |
Imports cost less; indicates falling inflation. |
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Durable Goods Orders Increase |
Indicates expanding economy |
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Gross National Product Increases |
Indicates strong economy |
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Home Sales Increase |
Indicates strong economy |
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Housing Starts Rise |
Indicates strong economy |
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Industrial Production Rises |
Indicates strong economy |
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Business Inventories Rise |
Indicates weak economy |
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Leading Indicators (LEI) Increase |
Indicates strong economy |
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Personal Income Rises |
Indicates rising inflation |
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Personal Spending Rises |
Indicates rising inflation |
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Producer Price Index Rises |
Indicates rising inflation |
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Retail Sales Increase |
Indicates strong economy |
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Treasury Auction Has High Demand |
High demand leads to lower rates |
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Unemployment Rises |
Indicates weak economy |
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Economic Event |
Effect on |
Significance of event |
|
Consumer Price Index (CPI) Rises |
Indicates rising inflation. |
|
|
Dollar Rises |
Imports cost less; indicates falling inflation. |
|
|
Durable Goods Orders Increase |
Indicates expanding economy |
|
|
Gross National Product Increases |
Indicates strong economy |
|
|
Home Sales Increase |
Indicates strong economy |
|
|
Housing Starts Rise |
Indicates strong economy |
|
|
Industrial Production Rises |
Indicates strong economy |
|
|
Business Inventories Rise |
Indicates weak economy |
|
|
Leading Indicators (LEI) Increase |
Indicates strong economy |
|
|
Personal Income Rises |
Indicates rising inflation |
|
|
Personal Spending Rises |
Indicates rising inflation |
|
|
Producer Price Index Rises |
Indicates rising inflation |
|
|
Retail Sales Increase |
Indicates strong economy |
|
|
Treasury Auction Has High Demand |
High demand leads to lower rates |
|
|
Unemployment Rises |
Indicates weak economy |
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Pre-qualification is normally determined by a loan officer. After interviewing you, the loan officer determines the potential loan amount for which you may be approved. The loan officer does not issue loan approval, therefore, pre-qualification is not a commitment to lend. After the loan officer determines that you pre-qualify, he/she then issues a pre-qualification letter. The pre-qualification letter is used when you make an offer on a property. The pre-qualification letter informs the seller that your financial situation has been reviewed by a professional, and you will likely be approved for a loan to purchase the home.
Pre-approval is a step above pre-qualification. Pre-approval involves verifying your credit, down payment, employment history, etc. Your loan application is submitted to a lender's underwriter, and a decision is made regarding your loan application. When your loan is pre-approved, you receive a pre-approval certificate. Getting your loan pre-approved allows you to close very quickly when you do find a home. Pre-approval can also help you negotiate a better price with the seller.
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You cannot close a mortgage loan without locking in an interest rate. There are four components to a rate 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.
Most lenders will not budge unless the rates drop substantially (3/8 percent or more), because it is expensive for them to lock in interest rates. If lenders let borrowers improve their rate every time the rates improved, they would spend a lots of time relocking interest rates. Also they would have to build this option into their rates and borrowers would wind up paying a higher rate.
Most lenders will let you lock in an interest rate only on a specific property. If you are shopping for a home, some lenders offer a lock-and-shop program that lets you lock in a rate before you find the home. This program is very useful when rates are rising.
Most lenders offer long-term locks for new construction. These locks do cost more and may require an up-front deposit. For example, a lender might offer a 180-day lock for 1 point over the cost of a 30-day lock, with 0.5 points being paid up-front, as a non-refundable deposit. Most long-term new-construction locks do offer a float-down--i.e., if rates drop prior to closing, you get the better rate.
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Your loan can be sold at any time. There is a secondary mortgage market in which lenders frequently buy and sell pools of mortgages. This secondary mortgage market results in lower rates for consumers. A lender buying your loan assumes all terms and conditions of the original loan. As a result, the only thing that changes when a loan is sold is to whom you mail your payment. In the event your loan is sold you will be notified. You'll be informed about your new lender, and where you should send your payments.
If your lender goes out of business, you are still obligated to make payments! Typically, loans owned by a lender going out of business are sold to another lender. The lender purchasing your loan is obligated to honor the terms and conditions of the original loan. Therefore, if your lender goes out of business, it makes little difference with regards to your loan payments. In some cases, there may be a gap between the date of your lender's going out of business and the date that a new lender purchases your loan. In such a situation, continue making payments to your old lender until you are asked to make payments to your new lender.
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PMI is normally required when you buy a home with less than 20 percent down. Mortgage insurance is a type of guarantee that helps protect lenders against the costs of foreclosure. This insurance protection is provided by private mortgage insurance companies to protect the lender. It enables lenders to offer loans with lower down payments. In effect, mortgage insurance pays the lender a certain percentage of your original purchase price to cover a lender's losses in the unfortunate event of foreclosure. Therefore, without mortgage insurance, you would need to make a 20 percent down payment in order to buy a home.
The cost of PMI increases as your down payment decreases. Example: The cost of PMI on a 10 percent down payment is less than the cost of PMI on a 5 percent down payment. Your PMI premium is normally added to your monthly mortgage payment.
Cancelling your PMI:
Federal law requires PMI to be cancelled under certain circumstances, and Fannie Mae guidelines provide for cancellation of PMI in additional situations if the loan is owned by Fannie Mae. In general, PMI for a loan originated on or after July 29, 1999, which is secured by the borrower's one-family principal residence or second home will be cancelled at the borrower's request when the loan-to-value ratio (LTV) reaches 80 percent based on the value of the home at loan origination. In order to cancel PMI under the rules of July 29, 1999, the borrower must have a good payment history and the property value must not have declined.
PMI on mortgages owned by Fannie Mae can also be cancelled at the borrower's request when the LTV reaches 75 percent based on the current value of the home as established by a new appraisal, provided that the borrower has a good payment history and that the loan is at least two years old.
If the borrower does not request PMI cancellation, the PMI servicer must automatically cancel PMI on these loans when the LTV is scheduled to reach 78 percent, based on the value of the home at loan origination, provided that the loan is current at that time. For loans originated before July 29, 1999, which are secured by the borrower's principal residence or second home and that are owned by Fannie Mae, PMI will generally be cancelled at the midpoint of the loan term, provided that payments at that time are current.
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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:
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Example:
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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:
The following fees are SOMETIMES included in the APR:
The following fees are normally NOT included in the APR:
Calculating APRs on adjustable and balloon loans is even more complex because future rates are unknown. The result is even more confusion about how lenders calculate APRs.
Do not attempt to compare a 30-year loan with a 15-year loan using their respective APRs. A 15-year loan may have a lower interest rate, but could have a higher APR, since the loan fees are amortized over a shorter period of time.
Finally, many lenders do not even know what they include in their APR because they use software programs to compute their APRs. It is quite possible that the same lender with the same fees using two different software programs may arrive at two different APRs!
Conclusion:
Use the APR as a starting point to compare loans. The APR is a result of a complex calculation and not clearly defined. There is no substitute to getting a good-faith estimate from each lender to compare costs. Remember to exclude those costs that are independent of the loan.
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