1. Should I pay
zero points, or one point, or two or more points? Which choice saves the
If you think zero points is always
best, you're probably unaware of a powerful way to reduce your financing
costs and get your monthly payments down at the same time. Keep in mind
that you pay a lender in two ways. First, there's upfront fees
--including points. Remember, a point is equal to one percent of the
loan amount. Second, you pay a monthly interest charge (based on a
mortgage interest rate) over the life of the loan.
Many consumers have the mistaken
idea that each lender has a single price quote for each type of loan.
For example, let's assume you're given a rate quote of 8.25% with one
point. Many consumers would stop here mistakenly thinking that 8.25% and
one point is their only choice. Actually, all lenders offer lower
interest rates for all type of loans --if you pay more points; and
higher interest rates --if you pay less points.
Lenders like to call it "buying
the rate down" when you increase the points you pay and "buying the rate
up" when paying less points. A rule of-thumb is that approximately 1/2
point equals a 1/8 percent in the rate. In other words, you can decrease
the rate by a 1/8 percent by paying an additional 1/2 point, or vice
versa. As you can see, there's lots of choices. The trick is in knowing
which combination of rate and points is the most profitable for you. So
where do you start?
obtain some quotes
by calling one or more lenders and ask them what the rate and monthly
payment would be if you paid each of the following: zero points, one
point, two points.
you should figure
what the long-term interest cost would be for each of the interest rates
the lenders quoted. To do this take the monthly payment and multiply it
times the number of months in the loan, and then subtract the amount you
borrowed. Your result is the amount of interest you'll pay if you keep
the loan to full term.
determine what the
interest cost would be for each interest rate if you stay in your home
for only seven years, for example. To calculate this figure you'll need
to obtain a sample payment schedule from a lender, or tackle the
calculation yourself on a computer. The important things to determine
are how much total interest and how much total principal will be paid in
seven years for each of the rates the lenders gave you. Now you're ready
to start comparing options.
On a piece of paper construct a
table with the following column headings:
1) loan period; 2)points; 3)interest
rate; 4) monthly payment; 5) points as dollars; 6) total interest paid;
7) dollar sum of points and interest; 8) total principal paid. Each of
these eight items you have already determined or can easily calculate.
To start, fill in the options for
keeping the loan to full term. For example let's use 30 years with zero
points as the first option, then 30 years with one point as the second
option, and finally 30 years with two points as the third. The next set
of options is for keeping the loan for seven years.
Once you've filled all column
headings for each option, you are ready to compare the benefits of
paying points. Remember there are three goals here. First you want to
pay less for the mortgage in terms of interest charges (including
points). Second, you want to pay off the principal as fast a possible.
Third, you'll want the lowest monthly payment possible while
accomplishing the first two goals.
Another important consideration
is the Federal income tax ramifications of each option. To incorporate
the tax implications just add another column on your table that shows
If you are refinancing, consider
the options of paying the points and fees upfront or finance them along
with the loan principal. Keep in mind that the more points you throw
into the principal, the bigger the difference in monthly payment between
options. In summary, consider that forking over cash to your lender in
the form of points is not always a bad thing. A general rule is to spend
more on points (and "buy the rate down") the longer you plan to keep the
property. Also keep in mind that the choice of "points" to pay is a
powerful tool to both reduce your monthly payments and to save on the
total interest expense.
Should I pay off my mortgage early?
Acquiring the right mortgage is only
the first step in making home ownership a financially worthwhile
undertaking. Sure, now you can deduct the mortgage interest on your tax
returns, and in the future, you could refinance, secure a lower rate and
reduce mortgage costs. If you stop there, however, you're missing the
"big enchilada" when it comes to playing the mortgage game wisely. What
I'm referring to is paying down the mortgage principal early and
shortening the loan finance period --which equates to owning your home
sooner, paying less mortgage interest, eliminating PMI sooner, and
freeing up extra cash for savings or investments.
Sounds difficult? Well, it may not be as painful as you'd think, even if
your finances are stretched thin now. You may even have received, and
are considering, an offer from your loan servicer to accelerate paying
off your mortgage without making extra principal payments. Of course,
they'll require an extra fee to do this --but actually, you probably can
do the same thing on your own for free. So where do you start?
First, check your mortgage agreement for any "prepayment penalties." A
prepayment penalty is an extra charge some lenders tack on when you pay
the mortgage principal more quickly than the agreement calls for.
Usually such restrictions limit how much principal you can pay in
advance each year. You may need to refinance in order to take full
advantage of prepaying your loan if these requirements are too severe.
The following are
examples of ways to pay off a 30-year fixed-rate mortgage of $150,000,
with an 8 percent rate, sooner than the scheduled loan term. Remember,
these ideas are probably not the full range of options available to you.
extra payment -if
you made one extra $500 principal payment during the first month of the
mortgage, you would save $4803 in interest over the life of the loan and
retire the loan one year sooner. Make a $5000 principal payment in the
first month and you'll save $42,386 in interest and pay off the loan 3
payment each month -pay
an extra $20 each month ($6720 over the life of the loan) and you will
save $20,330 in interest. If you were to contribute $100 extra each
month ($27,600 over the life of the loan), you will pay off the loan 7
years early and save $72,951 in interest.
monthly payment in two parts -
pay 1/2 of the regular monthly payment every two weeks and you'll save
$69,451 in interest and retire the loan in 23 years. What you're doing
in this example is making a full extra monthly payment each year (26
instead of 24 payments that are half the normal monthly payment).
The big question
when accelerating mortgage payments is whether your loan servicer will
cooperate. For example, if you decide to send one extra principal
payment each month, will your servicer apply it to the principal balance
right away, or delay posting it until the first of the month? Or worse
yet, will the servicer ignore advance principal payments by applying
them to the next scheduled monthly payment?
Usually there's no way to tell
what will happen until you give it a try. The worst thing you can do is
implement your strategy and not monitor what your loan servicer is doing
with each of the additional payments. It could turn into a nightmare for
you if you fail to keep track of what's going on and maintain good
records. As added insurance, you can prevent an honest misunderstanding
by helping your loan servicer understand what you are trying to do. For
example, make out a separate check for each extra principal payment and
identify it as such. The more guesswork you can eliminate on the part of
your servicer, the better off you'll be.
You may be in a "no-win"
situation if your loan servicer refuses to acknowledge your extra
payments. In this case, aside from some expensive legal action with
little promise of solving the problem, you may have no recourse but to
refinance and hope for a better opportunity with another servicer. This
can be expensive, but the amount of potential savings at stake is
significant. The biggest disadvantage of accelerating your mortgage
payments is that you have less access to these funds once they're
committed to your mortgage. Also, in some cases, an alternative
investment might bring a larger return.
Do Lenders Calculate Interest Charges?
An often overlooked detail in
mortgage agreements is the method of interest calculation. If your
lender receives monthly payments on the due date each month, there
should be no difference in interest charges no matter what method is
used. But most borrowers send the payment in the mail and this, along
with inconsistent payment habits, adds variability to when the lender
receives the check.
Many mortgage lenders ignore the
fact that a payment has arrived a few days early or late, as long as it
is received before a typical 10-day grace period ends. Lenders calculate
the interest on a monthly basis by dividing the yearly rate by 12 (the
number of months in a year) and multiplying the monthly rate times the
loan balance. This month-to-month method of interest calculation mostly
benefits borrowers who pay a few days late each month. Other lenders use
daily interest methods that usually benefit them. Three common ones are
the "365-day", the "360 day" and the "365/360-day" procedure.
In the first, the annual interest
rate is divided by 365 (the number of days in a year) which yields a
daily interest rate. The daily interest rate is then multiplied times
the number of days between payments and then the result is multiplied
times the unpaid principal balance during that period.
The second, or 360-day method, is
similar except each month is treated as 30 days even though some months
have more or fewer days. This method is simpler and in some ways better
The 365/360-day method is a
combination of the two previous approaches that mostly benefits the
lender. In this method the lender uses 360 days to calculate the daily
rate, which is higher than the 365-day rate. The lender then applies
this rate to a 365-day year. This approach allows the lender to collect
5 extra days of interest each year. Some states have outlawed this
practice, but it still exists and has been popular with the banking
industry for over two centuries.
A good place to learn
about how interest is calculated is in your mortgage agreement.
Somewhere in the loan papers is a precise description of how the lender
is supposed to figure interest charges, payment terms, the grace period
(if any) and any other requirements. Chances are you'll discover one of
the above four methods applies to you but you shouldn't stop there. As
many find out, what is supposed to be and what actually is can be
different. Over a long period of time, a lender mistake can add up to a
nasty surprise. Your only protection in the event of errors is to
understand how interest should be calculated and verify that the lender
is doing it correctly each month.
Start by selecting a previous
month and duplicate the interest calculation from a monthly statement by
using the method described in your loan agreement. If you are
successful, try a couple of other months just to make sure. Remember
that your results should equal, to the penny, what is included on your
statement. In some cases, you might have to round up to the nearest
If you cannot replicate your
lender's calculations there are two possible explanations. The first is
it's your mistake; the second is it's the lender's. Again, if you
experiment and are successful, remember to verify at least 3 to 4 months
of interest calculations. In an error situation, unfortunately the knife
cuts both ways. You may have to pay the interest owed even though the
error was not your fault. On the other hand, the error can be in your
favor. Still you will have to document this and convince the lender
Where's the best place to get a loan?
The mortgage market is full of
options including lots of loan products and places to get loans. One of
the first and critical choices is who to do business with. The list
includes direct lenders or brokers, banks, savings and loans, mortgage
companies, credit unions, subprime and hard-money lenders.
At first glance, more choice
seems good for consumers. And this is true when you consider that
increased competition fosters lower rates. But in a practical sense,
many borrowers are intimidated by so many options because they are
unable to sort out the good from the bad. No wonder consumers find
themselves in an underdog position in the mortgage market, when it's
essentially a crapshoot to find the right party to do business with.
One reason: there's no equivalent
"buyer's agent" to help borrowers find the right lender and loan. While
some financial planners are acquainted with mortgage lending, consumers
have been reluctant to pay for such services. This is surprising
considering the complexity of the financial decisions borrowers face and
the fact that a mortgage can cost more than the price of the home. In
the end, such advice would almost certainly pay for itself. But here're
some tips in case you're going it alone.
Mortgage companies are
usually smaller organizations licensed by each state, whereas banks,
savings and loans and credit unions are federally regulated. Knowing
this is important for two reasons.
some believe that
federally regulated banking institutions are motivated to establish a
long-term customer relationship in order to sell financial products
other than just mortgages. They have a higher public profile to maintain
and are more heavily audited than smaller mortgage companies. These
factors play big in the minds of consumers who look for long-term
relationships over a one-time transaction. Still this is not the only
valid viewpoint. Many consumers have developed reliable long-term
relationships with small mortgage companies that yield just as good or
better results. The bottom line is that it is not only the organization
but the individual loan agent that matters. So it pays to interview both
the organization and the loan agent you would be dealing with before
making a decision.
the source of an organization's license is important in case
you run into problems. To file a complaint, you would have to go through
the licensing authority. The best way to deal with mortgage problems,
however, is to head them off before they occur. Remember that licensing
authorities usually will only record a complaint --not resolve it. This
means going to court on your own for resolution.
Mortgage brokers tout
their rates as the lowest because they pick and choose from numerous
loan sources. Direct lenders say just the opposite -that consumers can
eliminate the middleman broker fee and save big money by going to a
direct lender. Both sound convincing, right?
Actually in today's mortgage
market, I believe both of these arguments are more come-on than reality.
The surest way to find the best rate is to bypass the hype and make them
all compete for your business on the basis of the lowest quote.
There is no useful
repository of information that will directly answer all you questions.
You'll have to work for it. A good starting point is the appropriate
federal or state licensing agency. Usually these authorities maintain
complaint records that are available, in some form, to the public. The
Attorney General's office and the Better Business Bureau are also good
sources to check. Remember that lack of a complaint record is no
guarantee of legitimacy.
In addition, you should contact
the company and ask for information. Find out how long they have been in
business, where they are located and how long they have been there. Ask
for references and contact the references about their experiences with
this lender or broker. Avoid companies that won't provide references or
that don't have written information about their business or products.
Most important, wait until you have checked out a company and feel you
can trust them before providing personal and financial information about
I have not run across a
service that evaluates lenders or brokers. Although it's an intriguing
idea, the reality of developing an objective rating system and keeping
it up-to-date would be difficult, if not impossible. Developing funding
for such a costly venture also would be prohibitive.
5. What Can I Do About Loan Servicer Problems?
It can happen any time after you
sign the mortgage papers. Even if you took great care in selecting the
best mortgage company, it's likely that some other organization will end
up servicing your loan. And it's not uncommon to have loan servicers
switched on you more than once.
The problem for some borrowers,
however, is that there's no choice in the matter. If you end up with a
black hat servicer, you must find a way to deal with them or refinance
and hope that a better servicer comes with your new loan. Keep in mind
that there are probably many more good servicers than there are bad
ones. Here's one example of things-gone wrong.
Angelica Smitham's of Streamwood,
Illinois says her problems started shortly after her loan was sold to
Mellon Mortgage Company. "We are living in a nightmare." Our 3-year ARM
monthly payment has increased from $1333 to $1618 in the first 30
months. Every time we write, fax or call Mellon, they give us different
reasons for the increases. On top of that, they waited 6 months to
notify us that we were late on a payment and now they're trying to
foreclose on our home. They continually harass us. They don't always
return phone calls or reply to faxes or letters. The return receipt for
certified mail sent to them comes back with squiggles instead of a
person's name. Our attorney is trying to find a way to work with them,
but it looks like we are stuck unless we can refinance with another
lender. The problem is they have played havoc with our credit history
and it's going to be difficult to qualify for another loan until this is
A loan servicer is the lender's representative while the mortgage is
being paid. They typically collect a fee of 0.25% to 0.5% of the unpaid
loan balance. Their primary job is to collect monthly payments, send the
principal and interest to the lender and keep track of the financial
status of each loan. They also keep tabs on impound accounts to make
sure property taxes and hazard insurance payments cover what's needed.
Each year the servicer sends out Form 1098 to notify borrowers of the
total interest paid in the previous year. But from a borrower's
perspective, what separates the good from the bad, however, is the
quality of customer service. A loan servicer should have a toll-free
number and provide a live representative to answer questions and help
solve problems. A helpful attitude makes all the difference.
The Bad Guys
No matter what problems
you are having, it is most important to keep making your full monthly
payment on time. This will help protect your credit record in case you
want to refinance. For example, beware if your servicer starts recording
your payments late even though you mail them with adequate time to
arrive by the due date. Avoid this problem by using a dependable two-day
delivery service such as Federal Express or UPS that will require the
servicer to sign and date the arriving payment. It's an extra expense,
but a real bargain when you consider what's at stake.
The best solution is to resolve
issues directly with the loan servicer. Start by contacting your
servicer and explain the problem. Before you call, organize pertinent
documents and have them in front of you. Keep track of who you talk to,
the date and always carefully record what was said. If the person you
talk to can't immediately solve the problem, ask for a follow-up action
within an agreed upon timeframe. After each call, send a letter to the
servicer that briefly outlines what was said or promised. Keeping good
records is essential to get the results you want.
You have three major options if
you're getting nowhere with your servicer. The first is to submit a
formal complaint to the authorities that license the servicer's
organization. State agencies often regulate loan servicers as well as
the Federal Trade Commission. Such contacts may yield results in some
cases. Information about your rights and how to a file a complaint is
contained in a free publication called Mortgage Servicing which
is available by writing the Federal Trade Commission, Public Reference
Branch, 6th Street and Pennsylvania Ave., N.W., Washington, D.C. 20580;
or by calling 202-326-2222 (and select option 6). Your second
option is to legally pursue your servicer. Your third choice, when all
else fails, is to refinance.
Are Qualifying Ratios And How Do I Overcome Limitations?
The good news is you've found that
perfect home to buy, plus your excellent credit rating qualifies you for
a mortgage. The bad news is the lender has restricted your loan amount
to below what's needed to purchase the home because your income is too
low or maybe your debts are too high.
In this situation you will likely
hear that you don't qualify because you don't meet the ratio
requirements. Although this may seem like the end of the road, it's not
-- you still have lots of alternatives in securing the loan you're
Most mortgage lenders
will refuse a loan because of a poor history of paying debts. Likewise,
they will frequently decline loans to borrowers who appear incapable (in
terms of financial capacity) of repaying loans above a certain size.
In the first case, lenders use a
borrower's credit record to measure creditworthiness. In the second, a
borrower's financial capacity is usually measured by using what's called
"front" and "back" ratios. Remember that a ratio is simply a comparison
of one thing with another.
The front ratio compares the
total monthly housing expense (principal, interest and mortgage
insurance) to the total gross monthly income. The standard front ratio
calls for total housing expense to be less than 28% of total gross
income (31% for FHA).
The back ratio compares total
monthly obligations (including housing) to total gross monthly income.
The standard back ratio limits monthly obligations to no more than 36%
of the total gross income (43% for FHA). After calculating these ratios,
a lender will usually take the most restrictive one (from the borrower's
perspective) and interpolate a maximum monthly payment and maximum loan
The important thing to know about
qualifying ratios is that they are not cast in stone. Every lender has
some flexibility in deciding who can qualify for a mortgage. So if
you're initially told that your ratios will keep you from getting a
loan, don't believe it.
You can solve these problems by
working around the ratios with your current lender, checking other loans
and lenders, proposing other options to the seller, or doing some
combination of the above. Here are a few ideas to help get you started:
-Start by testing your lender's
flexibility to qualify you by submitting a list of compensating factors.
Your loan agent may have already done this, but some factors may have
been overlooked. For example, try to itemize your best financial
strengths such as: long-term job stability; stellar credit especially
for rent payments; job promotion/income prospects; potential overtime or
other income. The object is to sell yourself and prove that you can meet
a mortgage obligation beyond what the lender's ratios show.
to pay down short-term debts (credit cards) by selling assets or getting
financial help from a relative, for example.
your down payment -
A larger down payment should soften
the underwriters' ratio requirements. Evaluate whether you can convert
some of your assets to cash in order to increase the down payment.
Consider offering the seller your assets in trade for a credit applied
to the down payment. Or do you have a service you can barter with the
seller to increase the down payment?
other lenders and rates
-Since all lenders have different ways of operating, it pays to shop
around. Also consider that some lenders may be more eager for your
business and that may translate into more flexibility. Remember that the
mortgage interest rate is a key determinant in your ability to qualify
for a mortgage: the lower the rate, the higher the qualifying maximum
other loans -
A different type of loan may make all the difference in solving a
qualifying problem due to ratios. Adjustable rate mortgages are
especially good in this situation because a low start rate is used as
the basis for determining the maximum qualifying loan amount. Be
careful, though, that you don't end up trading an increase in your
qualifying loan amount for an expensive mortgage that you will regret
seller financing -
You won't need to worry about ratios
if you can find seller financing. In fact, you'll have full flexibility
in the terms of the loan agreement based on what you're able to
negotiate with the seller. There are drawbacks to this arrangement,
however, and it's best to fully understand what you're getting into.
Do I Estimate Property Value?
Much of what happens in real estate
transactions starts and ends with what's known as "property value."
Lenders use this key piece of information to define terms of the loan
agreement -such as the monthly payment, the upfront fees and need for
mortgage insurance. To establish what the property is worth, lenders use
an appraisal method that meets underwriting standards. Yet, the results
of the lender's appraisal is really only one opinion of what the
property is worth. The buyer and seller may have different convictions.
So what is the true property value?
When property is sold the true
value is the price a willing buyer will pay a willing seller. The
National Association of Realtors defines fair market value as "the most
probable selling price in terms of money which a property will bring
when exposed for sale in an open and competitive market under all
conditions essential for a fair sale . . . assuming both buyer and
seller act cautiously and the price is not influenced by pressure."
This coming together on a price,
however, can produce variable results. Therefore lenders must look at
"property value" in a broader sense, with a viewpoint that covers the
overall market with a range of opinion. An appraisal accomplishes this
by evaluating the property both scientifically and also through the
educated opinion of a professional appraiser.
Still there are times when
homeowners want to estimate what their home is worth without selling it
or through a formal appraisal. Maybe you believe your home is
over-assessed in terms of property taxes, or you would like to remove
the requirement to pay private mortgage insurance, or you would like to
know your equity position in order to take out a second mortgage or
refinance a first mortgage. No matter what the reason, it's now possible
to easily gather lots of information about property value at a
reasonable cost. The trick is in knowing how to use it.
Data Come From?
There are a growing
number of data firms that specialize in collecting and analyzing
property data for consumers and the real estate industry. These firms
operate by regularly gathering information about property sales and from
assessor's records. This data is publicly available from county recorder
and property assessor offices and you can collect the raw information
yourself. But unless you are an expert in property value analysis, it
will be difficult to make sense out of it.
Once collected, the data firms
run computer models and attempt to interpret current property values.
Actually, the property value information is developed through the use of
statistics and the results reflect a range of value --not a single
value. The wider the value range, the less accurate the results.
According the John Karevoll of
Acxiom/DataQuick, the methods used by all data firms have limitations.
More meaningful results are possible for geographic areas that have lots
of sales and also when there is good neighborhood uniformity as far as
price range and type of housing. Data firms that provide a single
estimated value can have a large error factor. To avoid this problem,
Karevoll recommends using a comparable sales approach to estimating your
This approach is a simple
comparison of recent (less than one year) home sales of properties
similar to yours and located in the same area. A meaningful comparison
should include a review of square footage, number of bedrooms and
bathrooms, and lot size. You may have to drive by the comps you have
selected to make sure they compare in appearance and overall condition
for landscaping, paint, roofing and style.
If the prices are similar for the
home you are comparing, then you have a good basis to estimate what your
home is worth. If the prices are much different, then you should try to
determine why. One way to learn more is to call the Realtor who sold it.
Remember that the price is also affected by circumstances other than the
physical property size and condition. Another way to estimate value is
to compare the cost per square foot of homes that vary by size and then
average the results for all comps. Then compare the average for comps
with the cost per square foot for your home.
Analytics, Inc., 888-864-6339,
Tax Deductions Justify A Home Purchase?
The "rent or own" dilemma is tough
to solve, especially if you've never owned before. For many the easy
part is weighing the pros and cons of lifestyle changes. The hard part
is understanding the financial aspects because of the large number of
variables involved. There's new furniture and household items, different
maintenance costs, utility and insurance charges, and lots of other
expenses to compare. From a financial standpoint, the deeper you dig,
the more you'll understand and, in the end, the better your decision.
Many simply look at home
ownership as a way to capitalize on the fabled mortgage tax break. But
is it all it's cracked up to be? If you're thinking about buying for the
first time --estimating tax benefits is a good place to start. But don't
make the mistake of stopping there. It may surprise you when all the
calculations are done that renting makes more financial sense for your
situation. Although you may choose to buy a home anyway, at least you'll
know what you're getting into.
In general, there are
three basic federal tax deductions for homeowners: real estate taxes,
points and mortgage interest. Always check with an accountant for
details and restrictions.
State and local real estate taxes
are deductible. This applies to real estate taxes you paid at
settlement. It does not include taxes for water or trash service, or for
"local benefit" such as for construction of streets, sidewalks, or water
and sewer systems. An exception is a tax paid for maintenance, repair or
interest charges on local benefit items. You cannot deduct property
transfer taxes or homeowners association assessments. Remember, you can
only deduct the amount of property taxes actually paid --not the amount
that goes into the escrow impound account.
Loan fees, also called "points,"
are deductible in the year paid if certain tests are met. Remember,
points are defined as an upfront fee with one point equal to one percent
of the loan amount. First, the loan must be for buying or building your
main home. Second, paying points must be an established business
practice and in the range of what is generally charged in your area.
Third, the points must appear as such on the standard Form HUD-1 and not
apply to other fees such as appraisal, inspection title or attorney
costs. Other restrictions apply but these are the major ones. In
general, points paid to refinance are not deductible in full in the year
you pay them. In this case you would spread them over the life of the
The largest and most important
deduction is for mortgage interest. Each year lenders must send you a
Form 1098 that shows the total interest you paid for that year. Again
the deduction is valid if you paid the accrued interest for a loan on
your main or second residence. You cannot deduct interest payments made
for someone else. Likewise, interest charges for second mortgages, a
line-of-credit or a home equity loan up to $100,000 are also deductible.
There are restrictions as to when you acquired the debt, and the maximum
applicable loan cannot exceed the value of your home. Mortgage
prepayment penalties and late charges for mortgage payments are
deductible. Prepaid interest (except points) is deductible only in the
year that it applies to.
It is useful to remember
that one hundred dollars of property tax and interest deductions do not
equate to $100 in net savings. First, in order to benefit from this
deduction, it along with all other Schedule A deductions must total more
than the standard deduction. Assuming it does, then your net savings
will be based on your tax bracket. For example, if you paid $10,000 for
mortgage interest and property taxes and you are in the 28% tax bracket,
then your taxes will be reduced by $2,800 (0.28 x 10,000 = 2,800). In
other words, you spent $10,000 to save $2,800. That leaves a $7,200
(10,000 - 2,800 = 7,200) expense for interest and taxes paid during that
year to own a home. Remember this is just one expense of homeownership.
Of course each year as you pay off the principal, the interest cost will
decrease and so will the amount you can deduct. The question then
becomes --is this the best use for the $7,200 spent for interest and
taxes (in this example)? The only correct answer when comparing renting
versus owning is in the context of all the costs and all the benefits.
Should I Refinance Based On What The Ads Say?
You've seen the ads promising lower
monthly payments with no upfront fees. At face value, such claims seem
like a good deal, but are they? Something important from a consumer
standpoint usually is missing from these advertised offers, yet rarely
will a loan agent help you solve the true refi puzzle. What's missing is
an "overall" cost comparison.
A classic example of this problem
occurs with credit consolidation loans. Consumers carrying balances on
multiple credit cards, for example, are sold on the idea of lowering
their total monthly payment. What's not explained is the extra cost from
accompanying changes in the interest rate, loan period and loan
principal. All of these factors determine the "back-end" loan costs
which become more important the longer you keep a loan. If you don't
know the total cost, including both short- and long-term charges, you
are only guessing whether the refi is worth it.
One of the best
money-saving opportunities that many overlook when refinancing is
"buying down" the interest rate by paying more points. All lenders and
mortgage brokers will give you a better interest rate if you pay more
points. Remember that points are a one-time, upfront fee with one point
equal to one percent of the loan amount. What the lender is offering is
a tradeoff: by paying more upfront in the form of points, you can obtain
a lower rate and ultimately save on long-term interest charges. This
long-term interest outlay is your largest mortgage expense if you plan
to keep the property for five or more years. In other words, lowering
the interest rate is more critical for longer loan periods.
Related to this is another
tradeoff: should you finance the fees? For many this is the only choice
since they don't have cash available to pay the upfront financing costs.
But by financing these costs, including points, your tradeoff is a
higher long-term interest expense, if you keep the property long enough.
So how can you find the best approach for your situation?
Short-term loan costs
such as points and fees are easy to calculate --you just add them up.
Estimating long-term costs, on the other hand, can present a problem if
you don't have the right information. Keep in mind that the long-term
loan cost is the total interest charge. Each monthly payment has a
principal and interest component. Early in the loan period, most of the
monthly payment is interest and then as the principal is paid down, the
amount of interest is reduced until, at the end of the loan, the payment
is almost all principal. If you want to know the interest cost for a
particular interest rate over the first 7 years, for example, you will
find it's not a simple one-time calculation.
But most mortgage organizations
will provide you with a useful tool called a "loan payment schedule" or
"amortization chart" that will list every payment for a given interest
rate and break this down into interest and principal components. Or if
you have a computer, software is available that will do the same thing.
With this information, you can add up the interest charges for any part
of the loan period. If you plan to stay in your home five years, for
example, then the long-term loan cost would be the sum of the monthly
interest charges for payments 1 through 60. Remember, however, that you
will need a different amortization chart for each interest rate.
In a final comparison, you will
need to estimate the long-term interest charges for six alternatives,
for example. The first three would include paying different amounts of
points (zero, one and two) and the resulting long-term interest costs.
The second three would involve taking these same options, include the
upfront costs in the principal, and then calculating the long-term
interest cost of each. One of these six alternatives will save you the
most in terms of total overall cost. Then compare your current loan cost
to the best refi alternative.
What's The Best Way To Get Through The Loan Process?
Is the loan process unfair? Many
would argue it is simply because it's so complicated and few experience
it enough to fully understand how it works. No, lenders don't have an
easy time either. But the lending procedure is established by lenders to
get their job done and consumers must fend for themselves.
The process it is commonly viewed
as having five steps, all of which occur in a particular order. The
application is first and then comes loan underwriting, followed by
application approval or denial, settlement and last, servicing and
repayment of the debt. Although this sequence reflects lenders' needs,
it is not the best arrangement for borrowers in terms of what to think
about when. In fact, many consumer protection laws try to short-circuit
lender procedures by changing the sequence of when information is
provided to consumers. Still all of these laws only address a small
percentage of what could help borrowers the most.
Early preparation is critical.
The worst thing you can do is respond to an ad and fill out a loan
application without first doing your homework. Once the lending process
is set into motion your options are drastically reduced. Here's a few
Two big guns consumers
have in their arsenal are: 1) comparison shopping; and 2) negotiation.
Comparison shopping requires obtaining quotes from more than one lender
and then using this information to play one mortgage company off on
another. This method along with negotiating most fees will help reduce
the cost of a mortgage. Ignoring this will most certainly cause you to
pay more than you have to --a lot more.
Moreover, both of these tools are
most effective when employed before formally applying with any one
lender. Keep in mind that once you fill out the application and pay
fees, your choices will be influenced by the risk of losing the money
already paid to that lender.
Related to comparison
shopping and negotiation is understanding your needs so you can shop
effectively for the best loan price and loan product. One common
misunderstanding is that each lender has one rate for each loan type
(i.e. 30-year fixed rate). Actually, all lenders have a range of rates
available with each rate corresponding to an upfront fee call "points."
Points are really an interest charge but instead of being paid over
time, they must be paid in full when you sign the loan papers. One point
is equal to one percent of the loan amount.
The tradeoff that all lenders
offer is that if you pay more points, you will receive a lower rate and
save on long-term interest charges. The benefits to borrowers of this
tradeoff are immense --but only when used correctly. Once the best
rate-point combination and loan program are identified, you can call
lenders to comparison shop. Comparison shopping is practically useless
without knowing how many points to pay.
The only protection you
have from daily rate changes is to purchase a lock-in agreement from the
lender. A lock-in is not a part of the loan agreement, but is a separate
contract (in writing) where the lender agrees to hold a rate for a
specified period, usually 30 or 45 days while the loan is processed. The
cost to borrowers ranges from 1/4 point to one-eighth of a percent in
the rate. Your decision about whether to use a lock-in and when, will
affect how much you ultimately pay for the loan. Locking a rate at
application will protect you if rates go up, but it also means you're
stuck if rates fall.
In order to make the best
decision about a lock-in, you must know something about the recent
movement of interest rates. This means following available sources of
information on rates before you apply for a loan. It may even effect
your decision on when to apply. Remember, few loan agents are experts on
interest rates and relying completely on their advice may not be in your
Within three days of loan
application, lenders must provide an estimate of all settlement fees. If
you wait to learn about these costs until then, it may put you in an
inferior negotiating position. A better time to know about such fees is
before you apply so you can do something about it before committing any
money in application fees that could be lost.
Should I Apply For A Mortgage Online?
Online mortgage lending is making a
big splash. A combination of low interest rates, high refi demand,
flowering technology and rapid consumer acceptance of the world wide web
as a marketplace, has ushered in a new way to hook up with a lender.
Touted as convenient, quick and cheap --the electronic mortgage is
maturing into a unique experience.
Still mortgage shopping on the
net is not for everyone. For consumers, the big tradeoff is service.
Electronic forms and email have replaced face-to face communication.
Also traditional loan agents are usually absent from the picture and
this can put some consumers at a disadvantage. For example, those who
require expert guidance to decide which loan is best for their
circumstances or to help solve qualifying problems are pretty much on
their own. If you're a first-time homebuyer or inexperienced with
finance, you probably should avoid applying for a mortgage on the web.
Here are some tips.
There are two major types
of mortgage sites. The first are lender/broker sites where consumers
deal directly with the mortgage company. These sites make up the bulk of
what's on the web and today most every organization has a presence. A
second is called a multilender site where a third party helps borrowers
search through participating lender programs. The third party owns and
operates the site and in exchange for bringing in new business, collects
a fee from participating lenders. Examples include E-Loan (www.eloan.com),
QuickenMortgage (www.quickenmortgage.com) and Interloan (www.interloan.com).
Although seemingly different, the
process of getting a loan from single or multilender sites is pretty
much the same. Multilender sites claim to save you time by doing the
shopping for you. But the only way to be certain is to compare programs
from other mortgage sites. The good news is that comparison shopping on
the web can be easier than trying to pry information from lenders over
the phone in the traditional way. The trick is to match up data from
different sites so that what you're comparing is apples vs. apples. To
do this effectively you'll need to tie down important factors such as
--How many days lock-in is included? . . .Is the price different for
different loan amounts . . . Is there a prepayment penalty? . . . And
are the fees (other than points) in line with what other lenders charge?
Remember that with mortgages "there's nothing for free" --plus there's
usually a reason a particular rate is lower than the rest. The hard part
is that it's your job to find out why, and this may require a phone call
since most lender sites I've seen are short on explaining everything.
Mortgage calculators, a
common feature on many mortgage web sites, are attractive because
they're easy to use. Just enter a few pieces of information about
yourself and these calculators will estimate things like the maximum
loan you could qualify for, what your monthly payment will be and
whether it would be worthwhile to refinance. While in theory, computers
are ideal tools to measure such subjects, their overall usefulness still
comes down to how they are programmed.
In many cases, online web
calculators are too simplified to yield meaningful results. In the worst
case, trusting the output of a poorly designed calculator can lead you
into costly mistakes --if you don't understand the inherent limitations.
Keep in mind that the "real-world" of mortgages is fairly complex. There
are many variables to consider, such as the type of loan and the array
of unique qualifying requirements, all of which are impractical to plug
into a useful tool for everyday consumers.
In general, the worst designed
calculators try to estimate the value of refinancing. They claim to
answer the question "will I save money if I refinance." While this is a
simple question to ask, a meaningful answer is not so easy to obtain. I
have yet to see one calculator that adequately covers all the variables
involved and produces anything better than a wild guess.
Protecting yourself while
doing business online is critical in case something should go wrong.
This means researching the company and, at a minimum, determining if
they have the proper licenses for your locality. Security issues about
sending private information over web haven't proved to be as risky as
once thought. Still, caution is a good practice. Don't apply to more
than one lender at a time as this may negatively affect your credit
score. Also, remember that an online application requires you to check
your email regularly.
Should I Get A Lease Option?
A "lease-option agreement" is a
contract between a homeowner and a potential homebuyer in which the
decision to purchase the residence is postponed for a period of time (1
to 3 years, for example). During that period, the potential homebuyer
leases the property and lives there. Also during the lease-option
period, a pre-agreed portion of the rent accumulates as a potential down
payment. Then at the end of the lease period, the potential homebuyer
either exercises the option to buy, or moves from the property.
A "lease-purchase agreement," on the other hand, is just what it says -
you've committed to buy the home. The main difference between this
transaction and purchasing a home outright, is simply the lease period
prior to gaining ownership. The lease-purchase route is more complicated
than setting up a lease option agreement because typically the complete
terms of the purchase are spelled out and a closing date is set. A rent
credit towards the down payment is also possible, if negotiated, in a
Both types of agreements
require that the buyer put up what's called "option money." This usually
is a nonrefundable sum of cash (or other consideration) that's applied
to the purchase price when the sale goes through. At the end of the
lease period, if the buyer refuses to purchase the property, the seller
can keep the option money. Option money must cross hands to the
homeowner for the contract to be binding; otherwise, the owner wouldn't
be obligated to sell the property. How much are we talking about here?
It could be $500 or $5,000; it all depends on what's negotiated
beforehand. An obvious point is that the seller will attempt to get as
much option money as possible.
One of the hardest parts
of a lease-option or lease-purchase agreement is finding the right
residence. Although the opportunities for such agreements are fairly
common, the home itself, its lot or location may not measure up to what
you had hoped.
A homeowner who resorts to this
type of agreement may be having difficulty selling the property. Be
aware, though, that there can be other seller motivations --like a
homeowner who must relocate quickly and wants to sell, but doesn't have
sufficient time. A lease-option or purchase would be an ideal solution
in this example because the owner could receive income from leasing the
property while concurrently attempting to sell it.
Another potential pitfall is
establishing the purchase price. Since this is done when the agreement
is set up, and property values can change over a short period of a time,
a badly priced property can kill the deal. Your option money would then
be at risk.
As you've probably already
guessed --lawyers are a necessary part of getting the most from these
types of deals. Things can go wrong even with simple contracts, and most
lease option/purchase agreements are on the complex side. Even so,
overall, a lease option or lease purchase can make a big difference in
terms of opportunity. With some luck, homeownership may follow.
What's A VA Loan And Should I Get One?
If you're a veteran --you're in
luck. Our country honors you with the only loan on the market that
requires no down payment, plus you can finance all of the fees. Think of
it --you can move into a home without paying a cent upfront. And if
that's not enough, there's no mortgage insurance to pay on a VA loan and
the qualifying ratios are less restrictive than for conventional loans.
What's A VA
VA loans are mortgages made by direct lenders with a partial guarantee
from the Veterans Administration that the loan will be repaid. The VA
doesn't actually make loans. But it does control all aspects of the
lending process including qualifying the borrower and the property, and
setting guidelines for lenders' fees. Currently, the VA program sponsors
regular fixed-rate programs, adjustables, growing equity mortgages (GEMs),
and graduated payment mortgages (GPM).
How To Get
Proof that you're a
veteran is based on a "Certificate of Eligibility" that's issued from
any local VA Office (check your phone book or call 800-827 1000). This
is obtainable by completing a simple application (VA Form 26 1880) and
enclosing a copy of your discharge record (for example, a DD Form 214).
Contact two or three lenders
through referrals from friends and relatives or check a lender survey in
your local newspaper. VA loans are widely available through larger
direct lenders, as well as many mortgage brokers. It's best to "shop
till you drop.
What Does It
The VA charges a funding
fee based on the size of the down payment. The fee is 2 percent of the
loan amount with less than a 5 percent down payment. If you put 5 to 10
percent down, the fee falls to 1.5 percent of the loan amount, and with
greater than 10 percent down, it drops to 1.25 percent of the loan
Since VA loan rates float up and
down with changes in the financial markets, you'll find that VA rates
(and points) are competitive with similar conventional loans. As I
mentioned before, it does pay to shop around as rates and points will
vary among lenders.
In addition, there are normal
closing costs including: appraisal, credit report, recording fees, title
search and insurance, survey and transfer taxes. Lenders usually charge
a one-point origination fee on top of the discount points. Remember, one
point is equal to one percent of the loan amount. The origination fee
covers the lender's expenses such as office rent, telephone, advertising
(and others). Discount points are paid by borrowers who want to get a
lower rate by paying an additional upfront fee. The more discount points
you pay, the lower your interest rate will be.
Of course there are a
couple of restrictions. First, your loan amount is usually limited to
the property value established in the VA appraisal. If the appraisal
comes in lower than expected, then you can make up the difference, in
cash, between the sale price and what the appraiser thinks the home is
worth. Or, better yet, the seller can lower the price.
As you can see, the appraisal can
lead to unexpected results. Therefore, from a buyer's perspective, it's
a good idea to find out what the appraised value will be prior to final
price negotiations with the seller. Also consider that the VA doesn't
impose limitations on loan size, but most lenders cap the largest loan
they will do at about $203,000.
More Good News
VA loans have no
prepayment penalties. Additionally, VA loans made before March 1988 can
be fully assumed without the new borrower qualifying for the loan. For
loans made after this date, the person assuming the loan must qualify
with both the VA and the original lender.