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What are the commonly made mistakes in buying of refinancing a house? |
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Buying a home | Refinancing your home | Getting a home-equity loan |
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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. These Top Ten lists are by no means exhaustive. Since your home could cost you 25 to 40 percent of your gross income, it's important to conduct research, ask questions and study the process carefully.
Buying a home:
1.
Looking for a home 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:
o
Neither pre-qualified nor pre-approved
o
Pre-qualified
o
Pre-approved
The benefits available at each level can be easily understood
when viewed from the seller's perspective. Imagine you're a seller in
receipt of multiple offers to purchase your property. 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, let’s 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 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.
2.
Making verbal agreements. If you're asked to sign
a document containing instructions contrary to your
verbal agreements--don't! For example, the seller verbally agrees
to include the washing machine in the sale, but the written purchase
contract excludes it. The written contract will override the verbal
contract. 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.
3.
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.
4.
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.
5.
Not getting a rate lock in writing. When a
mortgage company tells you they have locked your rate, get a written
statement detailing the interest rate, the length of the rate
lock, and program details.
6.
Using a dual agent--i.e., an agent
who represents the buyer and the seller in the same transaction. Buyers
and sellers have opposing interests. Sellers want to receive the
highest price; buyers want to pay the lowest price. In the standard
real estate transaction, the seller pays the real estate commission.
When an agent represents both buyer and seller, the agent can tend to
negotiate more vigorously on behalf of the seller. As a buyer, you're
better off having an agent representing you exclusively. The only
time you should consider a dual agent is when you get a price break. In
that case, proceed cautiously and do your homework!
7.
Buying a home without professional
inspections. Unless you're buying a new home with warranties on most
equipment, 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.
8.
Not shopping for home insurance until
you are ready to close. Start shopping for insurance as soon as you
have an accepted offer. Many buyers wait until the last minute to get
insurance and do not have time to shop around.
9.
Signing documents without reading
them. Whenever
possible, review in advance the documents you'll be signing. (Even
though some specifics of your transaction may not be known early
in the transaction, the documents you'll sign are standard forms
and are available for review.) It's unlikely that you'll
have sufficient time to read all the documents during the closing
appointment.
10.
Not allowing for delays in the
transaction. 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.
Refinancing your home:
Refinancing with your existing
lender without shopping around. Your existing lender
may not have the best rates and programs. There is a general
misconception that it is easier to work with your current lender. In
most cases, your current lender will require the same
documentation as other companies. This is because most loans are sold
on the secondary market and have to be approved independently. Even if
you have made all your mortgage payments on time, your existing
lender will still have to verify assets, liabilities,
employment, etc. all over again.
1.
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. Example: 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 refinancing
considering switching from an adjustable to a fixed loan, or from
a 30-year loan to a 15-year loan, the analysis becomes much more
complex.
2.
Not getting a written good-faith
estimate of closing costs. See item number four above.
3.
Paying for an appraisal when you
think your home value may be too low. Have the
appraisal company prepare a desk review appraisal (typically at no
charge) to provide you with a range of possible values. Your mortgage
company's appraiser may do this for you. Do not waste your money on a
full appraisal if you are doubtful about the value of your home.
4.
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.
5.
Signing your loan documents without
reviewing them. See item number nine
above.
6.
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 result
in a costly delays.
7.
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.
8.
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 can, in
some cases, break the deal!
9.
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.
Getting a home-equity loan /line:
1.
Not knowing if your loan has a
pre-payment penalty clause. If you are getting a
"NO FEE" home-equity loan, chances are there's a hefty
pre-payment penalty included. You'll want to avoid such a loan if you
are planning to sell or refinance in the next three to five years.
2.
Getting too large a credit line. When you
get too large a credit line, you can be turned down for other loans
because some lenders calculate your payments based upon the available
credit--not the used credit. Even when your equity line has a zero
balance, having a large equity line indicates a large potential
payment, which can make it difficult to qualify for other loans.
3.
Not understanding the difference
between an equity loan and an equity line. An
equity loan is
closed--i.e., you get all your money up front and make fixed payments
until it is paid if full. An equity line is open--i.e., you can get numerous
advances for various amounts as you desire. Most equity lines are
accessed through a checkbook or a credit card. For both equity loans
and lines, you can only be charged interest on the outstanding
principal balance.
Use an equity loan when you need all the money up front--e.g., for home
improvements, debt consolidation, etc. Use an equity line when you have
a periodic need for money, or need the money for a future event--e.g., children’s'
college tuition in the future.
4.
Not checking the life cap on your
equity line. Many credit lines have life caps of 18 percent.
Be prepared to make payments at the highest potential rate.
5.
Getting a home-equity loan from your
local bank without shopping around. Many
consumers get their equity line from the bank with which they have
their checking account. By all means, consider your bank, but shop
around before making a commitment.
6.
Not getting a good-faith estimate of
closing costs. See item number four above.
7.
Assuming that your home-equity loan
is fully tax-deductible. In some instances, your
home-equity loan is NOT tax deductible. Do not depend on your mortgage
company for information regarding this matter--check with an accountant
or CPA.
8.
Assuming that a home-equity loan is
always cheaper than a car loan or a credit card. Even
after deducting interest for income tax purposes, a credit card can be
cheaper than a credit line. To find out, compare the effective rate of
your home-equity line with the rate on your credit card or auto
loan.
Effective rate = rate * (1 - tax bracket)
Example: The rate of the home-equity line is 12 percent, your tax
bracket is 30 percent, your effectiv
rateis: .12 * (1 - .3) = .12 * .7 = .084 = 8.4
percent.
If your credit card is higher than 8.4 percent, the equity loan is
cheaper.
9.
Getting a home-equity line of credit
when you plan to refinance your first mortgage in the near future. Many mortgage
companies look at the combined loan amounts (i.e., the first loan plus
the second) when refinancing the first mortgage. If you plan on
refinancing your first, check with your mortgage company to find out if
getting a second will cause your refinance to be turned down.
10.
Getting a home-equity line to pay off
your credit cards when your spending is out of control! When you pay
off your credit cards with an equity line, don't continue to
abuse your credit cards. If you can't manage the plastic, tear it
up!
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Should I Refinance? |
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The
most common reason for refinancing is to save money. Saving money
through refinancing can be achieved in two ways:
1.
By obtaining a lower interest rate
that causes one's monthly mortgage payment to be reduced.
2.
By reducing the term of the loan, thus
saving money over the life of the loan. For example, refinancing from
a 30-year loan to a 15-year loan might result in higher monthly
payments, but the total 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
3.
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. |
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Should I pay Points? Does a 0 point/ 0 fee loan really exit? |
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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:
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 for 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. |
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What is a FICO score? |
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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 borrower’s 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.
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) 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? |
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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!
- Prime rate: The rate offered to a
bank's best customers.
- Treasury bill rates: Treasury bills are
short-term debt instruments used by the U.S. Government to finance
their debt. Commonly called T-bills they come in denominations of
3 months, 6 months and 1 year. Each Treasury bill has a
corresponding interest rate (i.e. 3-month T-bill rate, 1-year
T-bill rate).
- Treasury Notes: Intermediate-term debt
instruments used by the U.S. Government to finance their debt.
They come in denominations of 2 years, 5 years and 10 years.
- Treasury Bonds: Long-debt instruments
used by the U.S. Government to finance its debt. Treasury bonds
come in 30-year denominations.
- Federal Funds Rate: Rates banks charge each
other for overnight loans.
- Federal Discount Rate: Rate New York Fed
charges to member banks.
- Libor: :
London
Interbank Offered Rates. Average London Eurodollar rates.
- 6 month CD rate: The average rate that
you get when you invest in a 6-month CD.
- 11th District Cost of Funds: Rate determined by
averaging a composite of other rates.
- Fannie Mae-Backed Security rates: Fannie Mae pools large
quantities of mortgages, creates securities with them, and sells
them as Fannie Mae-backed securities. The rates on these
securities influence mortgage rates very strongly.
- Ginnie Mae-Backed Security rates: Ginnie Mae pools large
quantities of mortgages, secures them and sells them as Ginnie
Mae-backed securities. The rates on these securities influence
mortgage rates on FHA and VA loans.
Interest-rate movements are based on the simple concept
of supply and demand. If the demand for credit (loans) increases, so do
interest rates. This is because there are more buyers, so sellers can
command a better price, i.e. higher rates. If the demand for credit
reduces, then so do interest rates. This is because there are more
sellers than buyers, so buyers can command a lower better price, i.e.
lower rates. When the economy is expanding there is a higher demand for
credit, so rates move higher, whereas when the economy is slowing the
demand for credit decreases and so do interest rates.
This leads to a
fundamental concept:
Bad news (i.e. a slowing
economy) is good news for interest rates (i.e. lower rates).
Good news (i.e. a growing
economy) is bad news for interest rates (i.e. higher rates).
A major factor driving interest rates is inflation.
Higher inflation is associated with a growing economy. When the economy
grows too strongly, the Federal Reserve increases interest rates to
slow the economy down and reduce inflation. Inflation results from
prices of goods and services increasing. When the economy is strong,
there is more demand for goods and services, so the producers of those
goods and services can increase prices. A strong economy therefore
results in higher real-estate prices, higher rents on apartments and
higher mortgage rates.
Mortgage rates tend to move in the same direction as
interest rates. However, actual mortgage rates are also based on supply
and demand for mortgages. The supply/demand equation for mortgage rates
may be different from the supply/demand equation for interest rates.
This might sometimes result in mortgage rates moving differently from
other rates. For example, one lender may be forced to close additional
mortgages to meet a commitment they have made. This results in them
offering lower rates even though interest rates may have moved up!
There is an inverse relationship between bond prices and
bond rates. This can be confusing. When bond prices move up, interest
rates move down and vice versa. This is because bonds tend to have a
fixed price at maturity typically $1000. If the price of the bond is
currently at $900 and there are 10 years left on the bond and if
interest rates start moving higher, the price of the bond starts
dropping. The higher interest rates will cause increased accumulation
of interest over the next 5 years, such that a lower price (e.g. $880)
will result in the same maturity price, i.e. $1000. |
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What is the difference between Pre-qualifying and Pre-approval? |
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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!
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What is rate lock? |
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You cannot close a mortgage loan without locking in an interest rate. There are four components to a rate lock:
- Loan program.
- Interest rate.
- Points.
- Length of the lock.
The longer the length of the lock, the higher the points
or the interest rate. This is because the longer the lock, the greater the
risk for the lender offering that lock.
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. |
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Can my loan be sold? What happens if my lender goes out of business? |
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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. 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. |
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What is PMI? Can I get rid of the PMI on my loan? |
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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 canceling the PMI on your
loan is to refinance and to get a new loan without PMI.
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What is an APR? |
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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:
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 the author's 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. |
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