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