Mortgage Sanity

In the U.S., all VA and FHA mortgages are insured by the federal government. Other types of mortgages, however, typically require some sort of mortgage insurance from a private mortgage insurer if the loan exceeds 80% of the value of the property. In any case, the borrower is responsible for paying for the insurance in one way or another. Private mortgage insurance essentially insures the top 20% of the loan (anything above 80%).

FHA and VA Mortgage Insurance 

That is not to say that FHA (Federal Housing Administration) loans are exempt from mortgage insurance premiums–quite the opposite. The typical upfront mortgage insurance premium on an FHA loan is 2.25% but can be reduced to 1.75% if the borrower completes a course on home ownership. With VA (Veteran Administration) loans, the VA assumes the risk of default on the loan and these loans are therefore exempt from Private Mortgage Insurance. With almost all other loans, however, the lender insists on being protected in the event that the borrower defaults on their mortgage.

20% Down Payment 

Loans where the borrower pay 20% or more of the sales price of a home as a down payment are considered very low risk. Anything above an 80% LTV (Loan-to-Value) ratio is considered to be a higher risk because 1) there is less equity in the home and 2) the borrower has less to lose if the house goes into foreclosure. Typical conforming loans will require only 5% as a down payment (which translates into a 95% LTV). However, the higher the LTV, the higher the private mortgage insurance rate. In other words, as the risk increases from the lender’s point of view, the more they require the borrower to pay to ensure the loan does not go into default. This is not to be confused with homeowner’s insurance, which is required with virtually every mortgage. Private mortgage insurance protects the lender, while homeowner’s insurance protects the borrower (and inadvertently, the lender if their collateral is destroyed).

Loan To Value Ratio Determines the Rate of Insurance

Monthly mortgage insurance can vary greatly, and is mainly dependent on the LTV. 80% requires no mortgage insurance, 85% requires a higher rate of insurance, etc. Programs that offer 100% financing in a single loan carry the highest insurance premiums, and FHA loans and Adjustable Rate Mortgages require higher rates of insurance than conventional, conforming, fixed-rate mortgages. Also, the more money you borrow, the higher the rate of your PMI, as the default on a large loan will affect your lender much more than a smaller loan would.

Watch Your Equity To Drop Your PMI

If your LTV is 90% (you put down 10%), your PMI will cost about $43 per month for every $100,000 you borrow. If the lender pays the PMI for you, that PMI is tax deductible. Also, keep an eye on the property values in your area and compare that to your loan balance. Once you have 20% equity in your home, you can drop the Private Mortgage Insurance. Not only that, as of 1999, lenders are legally required to eliminate your PMI once you have reached 22% equity.

Subprime Mortgage Loans and PMI 

You may be saying to yourself, “I have a mortgage with less than 20% equity and no one has mentioned anything to me about mortgage insurance”. If your loan was originated with a subprime lender, you are not required to pay private mortgage insurance; directly, that is. Subprime lenders have their own way of making up for not requiring you to pay PMI–they increase your interest rate. As your LTV rises above 80%, so does your interest rate.

“Piggyback Loans” 

An increasing popular way to avoid that pesky Private Mortgage Insurance is to structure your loan into a first and a second mortgage. This loans are called “piggyback loans”. Say you are only able to put 5% down and qualify for a conforming loan. If the sales price was $180,000 and your loan amount was $171,000, your monthly PMI payment would be $95.48. That’s almost $100! Your loan officer or lender would probably compare that total monthly payment with an “80 - 15” mortgage. That means you would take out two mortgages simultaneously; a first mortgage of $144,000 (80% of the sales price) and a second mortgage of $27,000, the combination totaling $171,000. The interest rate on your first mortgage would remain the same as it was with the 95% LTV loan of $171,000, but you wouldn’t have to pay the $95.48 in monthly PMI. The interest rate on the second mortgage would be higher, but it would be cheaper than paying the high PMI rate.

Lender Paid Mortgage Insurance 

Another way of sidestepping PMI is to have the lender pay for it. This is called LPMI (Lender Paid Mortgage Insurance). With LPMI, the lender will agree to pay the mortgage insurance that you would normally have to pay in exchange for a slightly higher rate. A typical charge would be an additional 0.5% to your interest rate for LTV’s between 80% and 90% and an additional 0.75% for an LTV above 90%. Many lenders will pitch the higher rate and they will remind you that the interest is tax deductible, while the PMI is not. However, you are stuck with the higher rate for the life of the loan, whereas the mortgage insurance can be terminated once you reach 20% equity.

PMI Options 

Ask your broker to compare the following scenarios regarding PMI: 1) paying one loan with monthly PMI that you pay separately; 2) having the lender pay the mortgage insurance (LPMI) in exchange for a higher interest rate; and 3) structuring the loan as a combo piggyback loan with a simultaneous first and second mortgage. The best deal could depend on your PMI rate, amount of money you’re putting out as a down payment, how long you plan on keeping your home or mortgage and even the rates your brokers’ lenders can offer. Not only will you be able to make a sound decision, but you’re much more likely to be taken seriously as a well-informed borrower and be given the best deal.

Bookmark to:

The billboard or TV commercial reads, “cut thousands of dollars off of your mortgage by converting to a bi-weekly payment plan!” Sounds too good to be true, doesn’t it? Well, it’s actually mostly true. A bi-weekly mortgage payment plan restructures your payment schedule. Instead of the traditional, one-payment-a-month mortgage payment, you make a half-payment every two weeks.

Bi-Weekly Payment Plans Mean More Money Paid to Your Principle Each Year 

Think about it this way: there are 12 months in a year and if you make two half payments every week, you would be making a total of 24 payments during the course of the year. There are also 52 weeks in a year, and if you made a “half-monthly” payment every two weeks, you would be making a total of 26 payments during that year. Assume your monthly principal and interest mortgage payment is $1,000 a month. Normally, you would pay $12,000 a year, right? In a bi-weekly payment plan, you are effectively making two extra “half-payments” a year (26 minus 24), which is equal to one full monthly payment per year and you would be paying a total of $13,000 instead of $12,000 over the course of the year. If you make sure that your extra payment is going towards paying down the principal on your mortgage, you will shorten a 30-year mortgage to about 5 to 8 years, depending on your interest rate.

Payments Can Be Automatic and Timed With Your Paycheck 

This idea appeals to many borrowers, especially because many people are paid every other week and the lender can set the payment up to automatically transfer your payment from your bank account. This also has a positive emotional impact on the borrower, as they feel that they are being responsible and proactive about paying off their mortgage early. Sounds great, right?

Costs to Set-up 

Yes, it sounds great, but as the old adage goes, if something sounds too good to be true, it probably is. Setting up a bi-weekly payment program can cost you $300 - $500 or more on both a new loan or if you wish to convert your current loan into a bi-weekly payment schedule. Also, your lender will most likely charge you $4 - $5 for each and every payment transferred from your bank account. Don’t get me wrong, I am all in favor of paying down your mortgage if you are able to accelerate your payments, but there is absolutely no reason to enter into a bi-weekly payment program. Here’s why:

Set Up Your Own Bi-weekly Payment Plan

You can easily set up your own bi-weekly payment plan. All you need to do is take your monthly mortgage payment ($1,000 for example) and divide it by 12. That comes to about $83. Send in an extra $83 every month ($1,083 total) and you’ve effectively reaped the benefits of a bi-weekly mortgage without the hefty conversion/start up fees or the transactions fees. Another way to shorten the term and reduce the total interest paid on your mortgage is to send in one full extra payment a year (13 total payments instead of 12). This may make sense if you receive annual bonuses or are paid in lump sums or commissions as opposed to hourly or salaried employees. On a $150,000 mortgage, bi-weekly payments will save you about $40,000 in interest over the life of the loan!

Requires Discipline 

These methods described require a certain degree of self-discipline. Also, if you don’t plan on staying in your home for the remainder of your mortgage term, you may lose some of the benefits of continuously paying down the principal over the period of 30 years. Just remember that the advantages of a bi-weekly mortgage can be yours without involving a third party or forking over large fees.

Bookmark to:

The word “escrow” has several different meanings, many of the pertaining to real estate and other financial transactions. In this instance, we will be discussing “escrow” as the process of allowing the lender or a third party keep part of your monthly payment in an account and then use the money accumulated in that account to pay your tax bills when they become due (school taxes, municipal taxes) and homeowner’s insurance. To determine what your monthly mortgage payment will be with an escrow account, simply add the total yearly property taxes, one year’s homeowner’s insurance premium and your monthly principal and interest together and divide by 12.

The Option of Escrowing Your Taxes and Insurance 

Most conforming lenders assume you will be escrowing your taxes and insurance to avoid a large tax bill and keep your monthly payments more uniform However, you are almost always given the option of waiving the escrow account and paying the taxes and insurance directly when they become due. Many savvy investors make it a rule not to escrow their taxes and insurance and instead invest that money in an account (stocks, bonds, mutual funds) that will earn interest for them. However, the majority of homeowners would rather not bother with that and instead prefer the convenience of a set, predictable payment every month. Also, escrow waivers typically carry a very small increase in the interest rate with conforming loans.

Subprime Lenders and Escrowing 

Subprime lenders, however, operate differently. Almost all subprime lenders do not charge extra if you decide not to escrow your taxes or insurance. Many people speculate that these lenders to that in order to give borrowers the impression of a lower monthly payment. BEWARE! Many subprime borrowers are shocked when they receive a tax bill for several thousand dollars. These borrowers probably assumed that their monthly mortgage payment included taxes and insurance. I recommend that almost all borrowers, especially those that have had financial difficulty in the past, to escrow their taxes and insurance so that their monthly payment is as steady as possible.

Escrowing Could Add to Your Closing Costs 

Make sure you tell your broker or lender that you would like to escrow your taxes and insurance before you are at the closing table! Most lenders require a few months’ “cushion” so that there is enough money in the account to pay the bills when they become due. Depending on what time of the year you close your loan, this could add thousands to your closing costs, but you will be glad you did it. If you are in the market for a subprime loan, the last thing you need is to receive a huge tax bill unexpectedly!

Bookmark to:

Chances are, you’ve seen headlines on the newspaper, stories on TV or video clips and articles on the internet recently about the subprime mortgage “meltdown”. What exactly happened? And more importantly, how is it going to affect you if you were in the subprime mortgage market?

Subprime Market Boom

There had been a few rumors here and there for a few weeks, even months, about lenders “pulling in the reins” in the subprime industry. For the past four or five years, the subprime lending industry has grown exponentially–truly at an astonishing rate. Several of the largest subprime lenders saw their loan volumes double for three consecutive years. We’re talking hundreds of billions of dollars in new loans. A lot of that had been following the refinance boom in late 2003 when interest rates hit rock bottom and then 2004, which saw housing prices skyrocket. The combination of low interest rates, more expensive homes and more homes being sold overall led to a what lenders saw as a huge opportunity. As more and more companies entered the market, competition reached a fever pitch. In order to stay competitive, some lenders began making loans to, as one account executive said to me, “anyone with a pulse and a pen“.

Incredible Loan Offers for Borrowers with Damaged Credit

As a broker, I would take a loan application, compile the information with a credit report and submit a short file to a handful of lenders whom I thought offered the best rates for that particular borrower and their situation. I had a borrower in mid-2004 whom had recently gone through a divorce and had to declare chapter 7 bankruptcy. The divorce totally wiped the borrower out, who was now moving on and buying another home. Obviously, he had no money for a down payment. A few years ago, this borrower would have had to rent for a while to rebuild his credit and save money for a down payment. However, many lenders’ guidelines had changed so much that I had seven different lenders competing for his loan, each offering 100% financing the day after the bankruptcy had discharged. Even more surprising, they were willing to do the loan for 6.25%, and make it interest-only for the first five years!

Housing Bubble Burst And Interest Rates Increased

This is just an example of how many different lenders had been competing so fiercely to reach out to new markets that they had made loans that were considered very risky. At the same time that the market became saturated with new lenders and even more loan products, the housing bubble burst, home values started to level off and the Federal Reserve continued to raise the Prime Rate. Through 2006, we saw housing prices continue to settle or even drop as the Prime Rate continued to rise from 4.0% in 2003 to its current 8.25%. During the period of 2003 to 2005, the majority of subprime mortgages originated were called 2/28 ARMs, where the interest rate was fixed for the first two years and then adjusted according to the market conditions. With interest rates on the rise, many people weren’t as prepared as they thought they were for the increased monthly payment. Late payments on mortgages skyrocketed and foreclosure rates peaked to their highest levels in years.

Lenders Unable To Sell Off Loans

Most lenders will originate a large number of loans and then sell them off in pools or large groups to investors on Wall Street. This is also where the lenders obtain the supply of money to fund the loans they are originating. As the investors began to see reports of the tremendous increase in monthly mortgage late payments and foreclosures, they began to worry and quickly stopped supplying the lenders with the money need to fund the loans being originated. As one account executive told me, “overnight, 32 of our primary sources of funding were completely shut off”. Panic ensued, and lenders’ stock prices plummeted forcing some to file for bankruptcy, others to limit the types loans they could offer and a handful to completely stop accepting any new loan applications.

Lenders Tightening Standards - The Worst is Over

It’s been a few weeks since the initial flurry of activity and it seems that the worst is over. Many guidelines have been tightened, so that 100% financing one day out of bankruptcy will probably not be available. Many lenders are capping their Loan-to-Value ratios (the percentage of the purchase price or value of a home to which they’ll lend) to a lower level. For example, if a lender would normally offer someone with a 580 FICO score 100% financing, they may now only be offering 90% or even 85%. It is important to note that with the rapid change in guidelines, lender offerings vary greatly, so check with your broker to see what is currently available.

The effects of this on the housing market may still be just beginning, but the tightening of lending standards has already been done.

Future Prospects of the Subprime Lending Market

That leads to the most important question: “Where does that leave me?” If you are a borrower with a blemished credit history, don’t count yourself out, even when it comes to 100% financing. While subprime lenders have been quickly tightening their guidelines, Fannie Mae and Freddie Mac seem to have been picking up the slack. In case you’re not familiar with Fannie Mae, it is a privately owned and operated corporation that is the largest purchaser and guarantor of home mortgages in the country. It was chartered in 1938 following the Great Depression and has been privately held since 1968. Freddie Mac was created in 1970 to help savings and loan associations (or thrift institutions, as they were known) distribute their loans in the secondary market.

Fannie Mae and Freddie Mac Conforming Loan Guidelines and Loan Limits

Fannie Mae and Freddie Mac purchase, repackage and sell these loans into the secondary market to help maintain fluidity in the housing industry. They have conforming guidelines and loan limits that are universal that are generally more strict than non-conforming loans, which include subprime loans. Because conforming loans have more streamlined and universal guidelines, they are easy to sell to investors, particularly investors on the more conservative side, where their yield may not be as high as that of subprime loans, but their risk is significantly lower. When interest rates started to adjust and borrowers became late on their payments, these investors started to panic.

“Perfect Storm” Theory of the Subprime Meltdown

Many economists agree on the “perfect storm” theory of the subprime meltdown. Three things happened simultaneously: 1) borrowers’ incomes dropped; 2) adjustable interest rates started to rise dramatically as their initial adjustment period began, and 3) housing prices fell across the country. A record number of subprime borrowers purchased their homes when prices were at an all time high and many put little if any money out as a down payment. Thus, when the housing prices fell, refinancing or even selling their home was often not an option because of the lack of equity (partly due to no property value appreciation). Many borrowers were and still are currently stuck with increasingly high monthly payments with no way out. That has caused foreclosure rates to reach 13% in 2006, compared to 2.6% for conforming loan borrowers. Many predict that as many as two million Americans are now facing foreclosure.

Suggestions for Borrowers With Damaged Credit

That leads borrowers to ask the question, “what do I do if I have tarnished credit (or a lack of credit history) and want purchase my first home?” Although there is no absolute answer to that question, here are a few suggestions:

1) Increase your down payment on purchase transactions.
This is the most immediately effective way to improve your chances of obtaining a loan, but for most people, it is also the most difficult option.

2) Ask a family member or close friend for a gift as a down payment.
Lenders will allow this, as long as the giver signs a paper stating the amount they wish to gift to the borrower and that the money is money is not a loan; hence, they do not expect to be paid back.

3) Find out whether or not the seller is willing to assist with financing in the form of a second mortgage.
If you (with your broker’s help) can convince the borrower that loaning you the difference between what the bank will lend you and the purchase price (or difference between the loan percentage and your down payment), many lenders will allow subprime loans with up to 5% down of the borrower’s own money. Negotiate with the seller a short-term loan with an attractive interest rate and it will probably be in everyone’s best interest. You an purchase your home, the deal closes, and your seller is earning monthly income from you.

4) Take some time to improve your credit score and cash reserves or save for a larger own payment.
Obtain a copy of your credit report and dispute any inaccurate information on it. Try to pay down collections to below $250. Many lenders will forgive medical related collections, so start with any tax liens or other judgments against you and then work on reducing your revolving debt (credit cards, etc).

5) See if you are eligible for certain first time home buyer programs.
There are a vast number of programs out there for first time home buyers (Flex loans, My Community, etc.). There are also special programs for teachers, police officers, firefighters, and health care professionals. If you served in the military, you can probably qualify for 100% financing with a VA loan. FHA loans require only 1% down and are geared towards borrowers with less than perfect credit and lower incomes. This is often an excellent option.

Many first time homebuyers reflexively gravitated towards 100% or 80%-20% subprime mortgages and they seem to be the group that has been hardest hit by the recent “subprime meltdown”. As you can see, however, there are a number of options available to those who still need a high percentage of financing but would not qualify for a “prime” mortgage. Speak with a knowledgeable mortgage specialist to see what options you may be able to pursue.

Bookmark to:

The Basics
If you accept your mortgage quote, it becomes the binding document that either means you keep your house or you lose it. If you break your mortgage and don’t pay your monthly payments, you will lose your home. But if you pay your mortgage on time or even ahead of schedule, it can be a great part of financial growth.

Lender Fees
Outside of your down payment, lender fees are some of the fees you’ll pay along with your mortgage or up front. Lender fees include but are not limited to: an appraisal fee by your lender, an application fee of about $250, and a $50 credit report fee.

Closing Fees
Closing fees are the fees you’ll need to pay in order to close on your mortgage. Closing fees include but are not limited to: legal fees if you hired an attorney, property taxes, title insurance of several hundred dollars, notary expenses, and homeowner’s insurance which is required by many lenders before you can purchase property.

Will You Get A Tax Break?
There’s no real “tax break” per se when you purchase property or acquire a mortgage loan. However, the interest you pay on your mortgage is deductible on your taxes. You should ask an accountant to help you with income tax deductions on your property.

What If I Change My Mind?
If you accept a mortgage quote, you do have a three day right of refusal. If you change your mind about a mortgage within three days after you sign it, write a letter to your lender to that regard and make sure they have it within those three days.

Fixed Rate Or Variable Rate Interest
Fixed-rate mortgages have interest rates that are exactly the same throughout the entire life of your mortgage. Variable-rate mortgages have interest rates that change based on what the current interest rate is. If you are acquiring your mortgage at a time when interest rates are exceptionally low, it is wise to acquire a fixed-rate mortgage. Then, your mortgage payment will be about the same each month. If interest rates are high and they’ll likely go down, you’ll want to acquire a variable-rate mortgage. In this case, your mortgage payment will fluctuate from time to time.

Is It The Best Deal?
When comparing various mortgage quotes, look at the terms of the loan along with the interest rate and monthly payments. Make sure you’re comparing apples to apples when you compare your quotes. Consult with your realtor, broker, or another expert to help you make sure you’re getting the best-possible deal.

Are You Being Overcharged?
Get a list of all the fees you’ll be charged for the loan at least a few days in advance of closing. Make sure you look closely at each charge and question why it’s there. Make sure the fees you’re charged don’t look like they’re higher than they should be or were promised that they would be.

The Bait-and-Switch
Many lenders will promise you an extraordinarily low interest rate or a low monthly payment in order to get you in the door. Then when you find out what your credit score is, all of a sudden you owe a lot more. Don’t stick with a lender or broker who makes all kinds of promises up front but can’t keep them. There are other lenders out there who are reputable—even for people with poor credit.

Don’t Be Pressured
Don’t let anyone pressure you into making a quick decision. Think things through, bring the document home to read and show to others you trust. Take your time. A good lender will work with you under your schedule to make sure you feel comfortable and are getting the best-possible deal.

Bookmark to:

Undoubtedly, you’ve seen advertisements for loans that will “utilize” or “tap into” your home equity. The majority of these loans are HELOCs. HELOC stands for Home Equity Line Of Credit and is often times a “junior mortgage” or second mortgage. That means that it stands behind your primary mortgage in lien position on the title of your property and is paid off only after your primary mortgage is paid off in the event of sale or the default of a loan. Since their inception, HELOCs have been very popular to homeowners because they allow a homeowner to borrow money against the equity they’ve built into their home.

Common Uses for a HELOC

HELOCs have a fixed limit that you can borrow up to (represented by what’s called the CLTV or Combined Loan-To-Value ratio). You can charge up a HELOC to it’s maximum allowance and you pay interest only in the early years of the loan. HELOCs are probably most commonly used for home improvements or as a means of consolidating other high interest rate charges (such as credit cards that charge 20%+.) Some people use them for college tuition, to fund business ventures or even to finance vacations.

Advantages of HELOCs 

The advantage of HELOCs is that you are paying interest only in the early years of the loan, so they act very much like high limit credit cards, but with one MAJOR difference. They are secured against your property as collateral, so if you default on a HELOC, the lender has legal right to your property.

Your Home Can Be At Risk

Although this is not a very common occurrence, the risk is still there and your should proceed with the process of selecting a lender and specific HELOC product with the same caution that you would a primary mortgage. In some cases where there is no primary mortgage, the HELOC assumes first lien position against your property.

Variable Interest Rates

HELOCs come in many different types, but the majority of them are variable interest rate loans tied to the “prime” rate. Currently, the U.S. prime rate is 8.25%. In late 2003, the prime rate was close to 4.0%, but subsequent adjustments made by Allan Greenspan and the “Fed” or Federal Reserve (the privately-owned governmental bank that determines interest rates) increased interest rates by 0.25% in successive sessions as an indication that the economy was improving. So, most HELOCs are within the range of 0.5% below prime (7.75%) to as much as 4.25% above prime (12.50%) and adjust whenever the Fed convenes and decides to adjust interest rates. Your specific FICO credit score will be a significant factor in the rate you are able to secure on your loan.

HELOC Terms

HELOC terms vary greatly, and there is usually a specifically designated “draw” period and a specific “repayment” period. Of course, these loans ca