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• What are the most commonly made mistakes in buying a house?
• What are the most commonly made mistakes in refinancing your home?
• What are the most commonly made mistakes in getting a home-equity loan / line?
• Should I refinance?
• Should I pay points? Does a 0 point / 0 fee loan really exist?
• What is a FICO score?
• Why do mortgage rates change?
• What is the difference between pre-qualifying and pre-approval?
• What is a rate lock?
• Can my loan be sold? What happens if my lender goes out of business?
• What is PMI? Can I get rid of the PMI on my loan?
• What is an APR?
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 principals 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.
- Looking for a home without being pre-approved.
As a potential buyer competing for a property, you’ll have a better chance of getting your offer accepted by being as prepared as possible. Consider this hierarchy of preparedness:
• Neither pre-qualified nor pre-approved
• Pre-qualified
• Pre-approved
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, 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 provided a broker written evidence of income, expenses, assets, liabilities and credit. A lender has verified all information. As a result, much of the paperwork for this buyer’s loan has been completed. This buyer will probably be able to close quickly. They provide you with a letter (pre-approval certificate) from the lender. You’re as certain as possible that this buyer can close.
As a potential buyer, you can see that being pre-approved will give you the best chance of getting your offer accepted. This is critical in a competitive situation.
- Making verbal agreements.
If you’re asked to sign a document containing instructions contrary to your verbal agreements – don’t! For example, the seller verbally agrees to include the washing machine in the sale, but the written purchase contract excludes it. The written contract will override the verbal contract. More importantly, your state may require that contracts for the sale of real property be in writing. Do not expect oral agreements to be enforceable.
- Choosing a lender just because they have the lowest rate.
While the rate is important, consider the total cost of your loan including the APR, loan fees, discount and origination points. When receiving a quote from a lender or broker, insist that the discount points (charged by the lender to reduce the interest rate) be distinguished from origination points (charged for services rendered in originating the loan).
The cost of the mortgage, however, shouldn’t be your only criterion. Have confidence that the company you select is reputable and will deliver the loan with the terms and costs they promised. If in the final hours of the transaction you determine that the lender has suddenly increased their profit margin at your expense, you won’t have time to start again with a different lender. Ask family and friends for referrals. Interview prospective mortgage companies.
- Not receiving a Good Faith Estimate.
Within three business days after the broker or lender receives your loan application, you must receive a written statement of fees associated with the transaction. This is both the law and the best way to determine what you’ll pay for your loan. Bring the Good Faith Estimate (GFE) with you when you sign loan documents. You should not be expected to pay fees that are substantially different from those contained in your GFE.
- Not getting a rate lock in writing.
When a mortgage company tells you they have locked your rate, get a written statement detailing the interest rate, the length of the rate lock and program details.
- Using a dual agent – i.e., an agent who represents the buyer and the seller in the same transaction.
Buyers and sellers have opposing interests. Sellers want to receive the highest price; buyers want to pay the lowest price. In the standard real estate transaction, the seller pays the real estate commission. When an agent represents both buyer and seller, the agent can tend to negotiate more vigorously on behalf of the seller. As a buyer, you’re better off having an agent representing you exclusively. The only time you should consider a dual agent is when you get a price break. In that case, proceed cautiously and do your homework!
- Buying a home without professional inspections.
Unless you’re buying a new home with warranties on most equipment, it’s highly recommended that you get property, roof and termite inspections. This way you’ll know what you are buying. Inspection reports are great negotiating tools when asking the seller to make needed repairs. When a professional inspector recommends that certain repairs be done, the seller is more likely to agree to do them.
If the seller agrees to make repairs, have your inspector verify that they are done prior to close of escrow. Do not assume that everything was done as promised.
- Not shopping for home insurance until you are ready to close.
Start shopping for insurance as soon as you have an accepted offer. Many buyers wait until the last minute to get insurance and do not have time to shop around.
- Signing documents without reading them.
Whenever possible, review in advance the documents you’ll be signing. (Even though some specifics of your transaction may not be known early in the transaction, the documents you’ll sign are standard forms and are available for review.) It’s unlikely that you’ll have sufficient time to read all the documents during the closing appointment.
- Not allowing for delays in the transaction.
In a perfect world, all real estate transactions close on time. In the world we live in, transactions are often delayed a week or more. Suppose you asked your landlord to terminate your lease the day your purchase transaction was scheduled to close. A day or two before your scheduled closing date, you discover your transaction is delayed a week. In a perfect world, no one is inconvenienced and your landlord is willing to work with you. More likely, however, your landlord is inconvenienced and angry. Will you be thrown out? Will you have to find interim housing for a week or more? The eviction process takes a little time, so the Sheriff won’t immediately remove you, but this type of stress-producing episode can be avoided. How? Terminate your lease one week after your real estate transaction is scheduled to close. That way, if there is a delay in closing your transaction, you have some leeway. This approach might cost a little more, then again, it might not.
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- 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 and 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.
- Not getting a written good-faith estimate of closing costs.
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 that are substantially different from those contained in your GFE.
- 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.
- 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.
- Signing your loan documents without reviewing 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 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 costly delays.
- Not getting a rate lock in writing.
When a mortgage company tells you they have locked your rate, get a written statement that 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 can, in some cases, 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.
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- 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.
- 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., children’s college tuition in the future.
- Not checking the lifecap on your equity line.
Many credit lines have lifecaps 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. By all means, consider your bank, but shop around before making a commitment.
- Not getting a good-faith estimate of closing costs.
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 that are substantially different from those contained in your GFE.
- 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 effective rate 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 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.
- 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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The most common reason for refinancing is to save money. Saving money through refinancing can be achieved in two ways:
- By obtaining a lower interest rate that causes one’s monthly mortgage payment to be reduced.
- By reducing the term of the loan, thus saving money over the life of the loan. For example, refinancing from a 30-year loan to a 15-year loan might result in higher monthly payments, but the total of the payments made during the life of the loan can be reduced significantly.
People also refinance to convert their adjustable loan to a fixed loan. The main reason behind this type of refinance is to obtain the stability and the security of a fixed loan. Fixed loans are very popular when interest rates are low, whereas adjustable loans tend to be more popular when rates are higher. When rates are low, homeowners refinance to lock in low rates. When rates are high, homeowners prefer adjustable loans to obtain lower payments.
A third reason why homeowners refinance is to consolidate debts and replace high-interest loans with a low-rate mortgage. The loans being consolidated may include second mortgages, credit lines, student loans, credit cards, etc. In many cases, debt consolidation results in tax savings, since consumer’s 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%:
- 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. 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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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 house 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 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
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