The Easiest Way To Lower Your Rate On a Sub-Prime Mortgage Loan
So you’ve found a lender to approve your loan, can afford the monthly payments and may even have a settlement date set. But there’s one thing in the back of your mind… could you have gotten a better rate? “Buyer’s remorse” is very common, and “refinancing remorse” is no less common among borrowers. Before you get commit to the terms of a loan and sign paperwork, there are a few things you should ask yourself to make sure you’re getting the lowest rate possible.
1). Should I afford to pay points down?
If you are purchasing a home and are stretching to come up with the money for the required down payment and closing costs, you will probably want to take out a mortgage with the least amount of points possible. If your main concern is to lower your closing costs, you will probably be paying the fees associated with originating your loan within your interest rate. A broker or lender can be paid in several ways, primarily up-front in the form of points paid at closing or with a yield spread premium, which means the lender will offer your broker a “wholesale” rate and then offer to pay them by increasing your rate. Sometimes the best option paying for your loan one way or the other, but in many cases, your best bet may be a combination of the two. For example, you may be only able to afford a monthly payment with a certain rate and then need to pay a small amount in cash to make up the difference.
2). Take the pre-pay!
Almost every sub-prime lender will give each borrower the option to lower their rate by agreeing not to pay off their loan in the first two or three years. The reason for this is that as you pay off your mortgage, you pay off more interest in the beginning and more principal towards the end of the loan.
Even if you have a fixed rate mortgage, your monthly payment is being amortized. That means the amount of your monthly payment going towards principal and the amount going towards interest will change over the life of the loan. Because most of your monthly mortgage payment is going towards interest in the early years of your loan, the lender is making more money at that time and they don’t want you to refinance or sell your home at the most lucrative time of your loan. Also, the longer the pre-payment term, the lower the rate.
Be cautious of loans where the pre-payment term is longer than the fixed rate term, however. For instance, if you have a 2/28 ARM with a three year pre-payment term and interest rates skyrocket when the rate is set to adjust, you may still have a year where you are forced to make a much higher monthly payment. If you decide to re-finance or sell your home before the pre-payment term is up, you risk having to pay a large fine to do so. For this reason, many state laws are in place to protect borrowers. In Pennsylvania, for example, pre-payment penalties are not allowed on loans under $50,000 and many states have outlawed five year pre-payment penalties.
3). Go with a two or three year adjustable rate mortgage
It’s no surprise that the majority of sub-prime mortgages have been adjustable rate loans. Sub-prime loans are generally geared towards borrowers with blemished credit or other issues that keep them from qualifying for mainstream lending.
The 2/28 ARM has been by far the most popular product in the sub-prime market. In a 2/28 ARM, the interest rate is fixed for the first two years only, then adjusts for the remaining term of the loan (28) years. The 3/27 ARM and 5/25 ARM are based on the same principle as the 2/28 ARM, except their fixed interest rate terms are three and five years, respectively. The lender is assuming less of a risk in offering you an adjustable rate loan, because your payment is directly tied to market conditions over time. If you can see those two or three years as time to rebuild your credit, an ARM is often a sound choice.
30 year fixed rate loans on sub-prime mortgages are currently running about 0.5% to 1.0% above an otherwise identical 2/28 ARM. Also, 30 year fixed rate mortgages often carry three year pre-payment penalties whereas most 2/28 ARMs usually start with a two year pre-payment penalty.
Other factors that may affect your rate
Documentation Level:
Try to provide as much documentation as possible to your loan officer. Ideally, lenders two years’ W-2’s and two or three of your most recent pay stubs. Proof of two months’ worth of housing payments in reserves (savings, retirement fund, etc), and proof of employment will generally qualify you as a “full doc” borrower” and give you the best rates. However, many lenders will accept consecutive bank statements as proof of continuous income. 24 months’ banks statements is usually treated the same as two years’ W-2’s, 12 months’ bank statements can be considered limited or “lite” doc and some lenders may even accept 6 months’ bank statements. The more documentation you can provide, the lower the risk for the lender which usually translates into a lower rate.
Loan Amount
Lenders seem to like their loan amounts to fall between $150,000 and about $400,000. These numbers are very general however, as every lender is different. Those loan amounts are usually easier to sell to other investors. For that reason, you may be eligible for a rate cut if you have a traditional loan amount. Don’t be surprised if you have to pay a higher rate for a $50,000 mortgage and are similarly penalized for a $750,000 mortgage.
