Mortgage Sanity

Get your estimate in writing early in the loan process
When you submit your loan application to your lender, he has by law three days to provide you with a Good Faith Estimate. Make sure your lender doesn’t drag you along for a ride. Get the estimate in writing early on in the process, so you can read and thoroughly compare.

Are you getting a loan for the right reasons?
If you’re going to go through the expense of refinancing your home mortgage, you want to make sure you’re doing it for something that is positive and not going to hurt you. If you’re doing it to consolidate debt, that’s one thing. If you’re doing it to take that trip to Paris you’ve always wanted, it’s not so wise. It costs you money every time you refinance your loan.

How your PMI is affected by your loan?
If your second mortgage means that the total value of your combined home loans totals more than 80 percent of the complete value of your home, you will be responsible for paying a monthly PMI charge. PMI is private mortgage insurance that lenders get to protect them against the possibility of you defaulting on your loan.

Will I get a lower interest rate if I apply for my second mortgage during a certain time of year?
Yes, strangely enough. Most people apply for second mortgages during the spring and summer months, so lenders tend to raise their fees and interest rates during these months. But if you apply for a second mortgage during the fall or winter seasons, you may be able to get better rates and lower fees.

Beware of becoming upside down on your loan
This is a major warning. Do not allow your home’s value to become less than the value of the loan. Know the real estate market that your home is in. If your home’s value is deteriorating and your loan value is increasing, you can be in trouble. If your home home’s value becomes greater than the amount your loan is worth, you are then responsible for paying for the difference to your lender.

What if I might refinance my mortgage over the next year?
If you have been thinking about refinancing your mortgage over the next year, you probably want to stay away from a second mortgage today. If you have two mortgages on your home—especially if one is a recent mortgage—you can be more easily turned down for a mortgage refinance. Or worse, your lenders can and will charge a higher interest rate because of your recent second mortgage.

Watch out for the fees
When you look for a second mortgage, get several lenders to compete for your business. Compare those offers side by side. Keep in mind that while the terms of the loans and interest rates might be comparable, their fees might not be. Some mortgage companies will have hidden fees. Watch out for high fees that mean nothing.

What to know about using a mortgage broker
If you go with a mortgage broker to find you a loan, you expect good service. Make sure your broker is definitely working hard to find you the best-possible loan and not just one that helps them out the best. Talk with your broker about getting a loan with the best-possible terms for your loan.

Watch out for add-on products
Read the terms of your loan carefully along with the list of your fees. Many lenders will try to tack on products and services on to the loan and tell you’re they’re mandatory or make you feel as though you don’t have a choice. When this happens, most of the time these products and services are not mandatory and are up to you whether you make the purchase.

Read all the documents
Do not let anyone pressure you into signing any documents, before you thoroughly read them. If the person reading you your mortgage contracts whips through them quickly and acts as though there isn’t much time and that you need to sign now, calmly tell the person that you need to take your time and read the documents thoroughly—and perhaps even take them home for a few hours or overnight—before you can completely understand what you’re signing.

The lowest interest rate isn’t always the best loan
Low interest rates are important and often essential when selecting the loan that’s right for you. But the lowest interest rate is not always attached to the best loan for you. Compare several loans side by side and compare all aspects of the loan from the interest rates to the loan terms to the fees involved. Often the companies with the lowest interest rates produce loans with the highest fees.

What if you don’t make payments on time?
Keep in mind that your second mortgage is a loan against your home. Just like with your first mortgage, if you don’t pay your second mortgage payments on time you can lose your home. Also, many second-mortgage loan terms include a clause that makes you responsible for paying the entire balance of your loan, if you are late on a couple payments.

Is a free loan really free?
Many lenders offer free home equity loans. This means that they are waiving closing costs in order to get your business. Regardless, no money is truly free. It is still money that must be repaid. Analyze the amount of your new loan versus how much you can afford to pay each month to decide whether the loan is right for you.

What if the value of the loan is higher than my property value?
If the combined value of your mortgages is greater than the value of your property, you will be responsible for paying the difference. Be alert to possible declining property values in your neighborhood before you sign up for a second mortgage, so you can know what to expect.

What if you change your mind?
If you’ve already signed on the dotted line and everything appears to be final, it’s not. Because your house is used as collateral on second mortgages or home equity lines of credit, federal rules allow you to cancel the contract for any reason up to three days after you signed. Make sure you cancel in writing.

How do I know if the loan will save me money?
Take a good look at the numbers your lender presents you. Find out what the cost of interest and payments will be for the rest of the term of your mortgage and what your break-even point will be for a refinance. Figure out whether there are worthwhile savings.

Watch out for Negative Amortization loans
Negative Amortization loans never work. Many lenders will propose you get an interest-only variable rate mortgage and pay only the interest each month. The rest of your monthly payment would go into an interest-bearing account. The loan payment you make with Negative Amortization doesn’t even have to be high enough to cover all the interest expenses. Instead, the balance of your interest each month simply is tacked on to the principal balance of your loan. Some lenders want you to believe that the interest in your savings account outweighs the costs of your added principal. But you always end up owing more interest on the total loan amount than what you borrowed to begin with.

Be cautious about what you use the loan money for
Don’t use the money in a second mortgage or line of credit loan for something that has no value. Don’t use it on a vacation or a party or to pay your monthly bills. Especially do not use it to pay for a new car that depreciates in value the instant you drive it off the lot! Use a second mortgage to improve your financial situation and your ability to pay your bills.

Know what the tax implications are of your loan
You won’t owe any income taxes for borrowing money against your home. But you will owe income taxes on money you gain from investments you buy with your equity money. If you invest your money in an interest-bearing or a brokerage account, you will be responsible for capital-gains taxes.

Can I get a home equity loan that’s greater than the value of my property?
If you have good, solid credit, it may be possible for you to qualify for a loan than is greater than the value of your property. Many lenders offer loans up to 125 percent of the value of your home. Keep in mind that the addition 25 percent of your loan is unsecured and is often treated like a typical credit card payment.

Know what types of loans are available to you
This is especially true if you use a mortgage broker. You might be presented with a number of different types of loans for you to consider. Every loan has its good points and its bad ones. Make sure you thoroughly understand the varying terms of different loans, so you can make educated decisions about which one is right for you.

Get several loan quotes
This is imperative. Don’t fall for one lender wanting your business and sending you what appears to be a great deal. Get an estimate from that lender along with an estimate from two or three others before you decide which one gets your business.

How do I know which loan is best for me?
Sit down with your estimates and look at interest rates, loan terms, and fees. Then compare them with what truly fits with your needs. Does one or more of the loans become more appealing because it fits with what you are hoping to accomplish?

How your credit is affected by a second mortgage?
Your credit score is affected by your ability to pay your loans on time and by how many inquiries are made into your credit score. As long as you pay your second mortgage loan on time, you’ll be fine. But if your spending habits show that you’ve had a number of credit inquiries within a short period of time, your credit score will be adversely affected.

Don’t hide your financial past
This can hurt you. It’s very tempting to hide negative aspects of your credit history. But if your lender finds it out from someone other than you, they will give you an even higher interest rate than they otherwise would to someone who was upfront with them.

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First time homebuyers often wonder what a lender is going to look for when determining whether or not you qualify for a mortgage and how much you qualify for. Lenders have many different ways of classifying your loan scenario according to risk. You could be considered “Full Doc”. “Limited Doc”, “Lite Doc”, “Stated Self-Employed”, “Stated Wage-Earner” or “No Doc”. There are also variations on these documentation levels based upon what assets you can verify for reserves (generally two months of mortgage payments are required; six months if the property is an investment property).

Basics of Income Documentation
Whether you have bad credit, poor credit or other factors that will put you in the “subprime” category, the following basics about income documentation will help you know what your risks are when applying for a mortgage loan.  Let’s unravel some of this jargon:

Full Doc - Full Documentation
If you can provide your lender with two years of W-2’s and two or three of your most recent pay stubs if you are a wage-earner, you will be eligible for “full doc” status, which carries the best interest rates and highest loan amounts, along with the most lenient credit requirements. If you are self-employed, your lender may ask for your past two years’ tax returns. Many sub-prime lenders will also accept bank statements to determine your income. They will want to see anywhere from twelve to twenty-four months of consecutive bank statements and will average the deposits to determine your income. If these bank statements are from a personal account, the lender will usually accept 100% of the deposits in calculating your income, and if they are from a business account, it they will typically count 50% - 75% of the gross deposits.

Limited Doc
This type of documentation is similar to Full Doc, except that your lender will probably on ask for your most recent W-2 or twelve months of bank deposits and a current pay stub. If you are self-employed, the lender will probably ask for your most recent tax return or twelve months of personal or business bank statements.

Lite Doc
Again, this is similar to Full Doc and Limited Doc, except that the lender will probably only ask for your past six months’ bank statements or a current pay stub covering at least six months of income history with year-to-date calculation.

Stated Income
With a Stated Doc loan, you are not required to provide the lender with any W-2’s, pay stubs or tax returns. Instead, you simply state your income on your loan application (called a 1003). If you are self-employed, the lender will probably ask for proof that your business exists, which can usually be verified by providing a tax ID number. If you have an employer and are considered to be a wage earner rather than self-employed, your lender will need to verify that you are in fact an employee of the company you state on your application, but will not ask about or verify your income. While your income will not be verified as a stated wage earner, if you list your occupation as a cashier at a fast food restaurant and are claiming to be earning $100,000 a year, you probably won‘t get a loan. Lenders have a variety of complicated software programs that calculate income based on where you live and that is consistent with your profession and level of experience.

Stated Documentation
Stated Doc loans are generally divided into these two categories–Stated Self-Employed and Stated Wage-Earner. Stated Self-Employed loans generally have better rates than Stated Wage-Earner loans because a lender questions why you are not able to provide W-2’s or pay stubs to support what you say you are making. Depending on the profession you are in, this may be your best or only option. Stated Income loans are common for borrowers in the food service industry for example, where a large portion of their income is in the form of cash or tips.

No Doc - No Documentation
No Doc loans are a mortgage broker’s dream. All a broker needs to do is fill out the basic parts of your mortgage application (name, address, social security number, etc.) and have the lender or broker pull your credit report. Do not list income, assets, or even employment on a true no-doc loan. You will need very good to excellent credit in order to qualify for one of these loans, as they are the most risky from a lender’s perspective. Also, don’t expect to obtain 100% financing with No Docs–they will typically require a down payment. There are a few lenders willing to do 100% No Doc financing, but your FICO score will probably have to be at least 720 and lenders’ guidelines have been tightening recently.

More Documentation Equals Better Interest Rates 
Mortgage lending is all about risk. Especially if you have credit problems, the more documentation you can provide, the better your interest rate will be. Also, you will probably won‘t have to shell out as much cash for a down payment and your lender will be more lenient about your credit score if you are full doc versus stated doc. Talk to your broker or lender about what you can and can’t provide in terms of documentation. They should be able to steer you towards the best program available to you.

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If you are shopping around for a mortgage, you will invariably run into “interest-only” loans. These loans have a set term (e.g., 30 years) just like regular mortgages and can have adjustable or fixed rates. The difference is that in the first years of the loan, you are only required to pay interest on the amount of money borrowed. These interest-only period can vary widely from two to five years typically in the sub-prime market or ten to fifteen years in the prime market with Fannie Mae products such as InterestFirst.

Lower Payments

Interest-only mortgages are popular because of the lower payments at the beginning of the loan. This may mean you can qualify for a more expensive home, as some of the sub-prime lenders will calculate your debt ratios based on the initial interest-only payments. These types of loans are especially useful in pricier housing markets and areas where property values are increasing. If your property value increases, you are inadvertently building equity in your property without paying down the principal. Be cautious though if you are really stretching just to make that interest-only payment because it won’t last!

Payment Increase

After the interest-only period is over, your monthly payment will become fully amortizing. That means that you will now be required to pay both the principal and the interest on the loan. If you have been making the minimum monthly interest-only payments during the early years of your loan, your loan balance will be the same as it was the day you began making payments. When considering an interest-only loan, make sure you can afford the higher payments that will come after the interest-only period is over.

Fixed Rate Vs. Adjustable

Interest-only mortgages are safer with a fixed interest rate rather than with an adjustable rate. Your initial interest rate on an adjustable mortgage is completely in dependent of any interest-only feature. For example, you may be enticed to take out an interest-only mortgage on a 2/28 ARM. Not only will your rate adjust after two years, but it will become fully amortizing at that adjustable rate in five years. This could lead to a significant increase in your monthly mortgage payment. Sub-prime lenders typically have a minimum credit score requirement on their interest-only loans because of the increased risk of default.

When is a Sub-prime Interest Only Mortgage a Good Idea?

So when is a sub-prime mortgage a good idea? If you are in an area where property values are increasing, you could offset some of that lost equity from not paying down the principal. Also, your entire interest-only mortgage payment is tax deductible. If you are saving $250 a month with an interest-only payment and can invest that $250 in a high-growth mutual fund or in stocks, you will certainly come out on top. Earning 12% interest on a $250 a month investment over five years is certainly better than borrowing that money at any interest rate.

Be Realistic About What You Can Afford

The bottom line is to be realistic as to what you can afford. You know your spending habits better than your mortgage broker, so don’t look for a house in a certain price range just because that’s the amount you are told you’re allowed to borrow. 100% interest-only financing can be particularly dangerous if home values plummet and you want to relocate. You may find yourself unable to sell your home for what you paid for it, in addition to any realtors’ commissions or other closing costs. But if you are careful about your spending habits, comfortable with your monthly payment and can afford the maximum possible payment when the loan becomes fully amortizing, an interest-only mortgage may be a wise choice.

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When you are in the process of looking for a mortgage, whether to purchase a home or re-finance an existing mortgage, you will most likely be working with either a mortgage broker or a loan officer working for a lender. So, what is the difference?

Loan Officer Vs. Mortgage Broker 

Loan officers working directly for lenders sell only their lenders’ loan programs. They are usually very well-informed about the programs their company has to offer, as those are the only programs they really need to know about. Mortgage brokers on the other hand, work with multiple lenders and need to know the general guidelines about their lenders’ programs. They will take your application, pull your credit report and forward that information to the lenders that they believe can offer you the best terms.

Advantages and Disadvantages of a Mortgage Broker 

The advantage of working with a mortgage broker is that they have access to a huge number of programs and can negotiate with the account executives from multiple lenders to see who can get them the best rate. The downside of that is the fact that the brokers make their living from the commission on your loan, paid either in the form of points or from the lender in exchange for a higher interest rate.

Advantages and Disadvantages of a Lender 

The advantage of working with a lender directly is you are effectively eliminating the middle man. For example, if you have accounts with a local bank and can obtain a mortgage from them directly, you could save a lot of money by working directly with the bank. However, your local bank will not have the number of programs available to you that you would have access to if you were working with a broker.

Unconventional Loans 

It’s always a good idea to work with a mortgage broker if you have any adverse credit history, gaps in employment, difficulty verifying your income, purchasing a non-traditional property (e.g., log home, modular or manufactured homes) or for any other number of reasons that would place out of the category of traditional, conventional financing. Any broker who has been in the industry for a few years undoubtedly has experience closing some very unusual loan scenarios.

Research and Compare 

Should you get your mortgage through a mortgage broker or from the lender directly? There is no definitive answer to that question. Remember that the main difference between lenders and mortgage brokers is that brokers don’t lend money–their job is to find the best lender for you. It may be a good idea to pursue both avenues, but beware–try to avoid having your credit report pulled multiple times in a short period of time. That can actually lower your FICO score and minimize the programs available to you.

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You may have noticed recently that more and more lenders are advertising loans with terms of 40 or even 50 years. The reason for the longer term is simply to stretch out the payments, and thus lower your monthly payment. You will certainly be paying more in interest, but that really only applies if you plan on keeping your mortgage for a long time. The average borrower holds their mortgage for five to seven years. Most sub-prime borrowers re-finance their loan if even less time.

Sub-prime Market

Although 40 year terms are available to prime “A-paper” borrowers as conforming loans, the majority of 40 and 50-year mortgages are in the sub-prime market. While extending the term of your mortgage will lower your monthly payment, you will be paying much less of the principal down.

Let’s use the following examples:

Example 1

Assume you take out a $200,000 loan at a fixed rate of 7.5% for 30 years. Your total monthly payment would be $1,398.43. In the first month, $148.43 of that payment would go towards your principal and $1,250 would go towards interest. Your total interest paid over 30 years would be $303,434.45, with an average monthly interest payment of $842.87. It would take just over 21 years to reduce your principal to below $100,000.

Example 2

Next, we can look at a $200,000 loan at a fixed rate of 7.5% for 40 years. Your total monthly payment would be $1,316.14. In the first month, $66.14 of that payment would towards your principal and $1,250 would go towards interest. Your total interest paid over 40 years would be $431,747.90, with an average monthly interest payment of $899.47. It would take about 30 years to reduce your principal to under $100,000.

Example 3

Finally, we’ll take the same scenario, a $200,000 loan at a fixed rate of 7.5%, but with a 50 year term. Your total monthly payment would be $1,280.47. In the first month, only $30.47 of that payment would go towards paying down your principal and $1,250 would go towards interest. Your total interest over 50 years would be $568,280.32, with an average monthly interest payment of $947.13. It would take 40 years to pay down your $200,000 loan to below $100,000!

More Interest Paid

Obviously, it does not make much financial sense to keep these 40 and 50 year mortgages for their full term. The difference in total interest paid between a 30, 40 and 50-year term mortgages are astounding! These longer term mortgages are not designed to be held for their full term; rather, they are a way to save money on a monthly basis. They can be very useful however in the short term under certain conditions. If you’re purchasing a home in an area where property values are increasing rapidly, the increased appreciation of your home can make up for the fact that you are not paying down the principal as quickly.

Great “Starter” Loan to Minimize Payment 

These longer term mortgages make sense if you are looking for a “starter” loan where you can minimize your monthly payments and build up a good credit history. Then, when you’ve got a higher credit score, you can qualify for the best fixed interest rates as a “prime” borrower.

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