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Why Pay Points on a Mortgage: Are Points a Benefit or Not?

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Mortgage PointsWhy pay points on a mortgage, and how do they benefit you? Points are a typically American arrangement, and refer to payments made in order to receive a lower interest rate. They have certain advantages, although these are not universal. Here are some details on mortgage points, and how they can be used to your advantage.

Some people get confused between their deposit and the subsequent points payment. The fundamental difference between the two is that the deposit is typically mandatory, while points are not, and tend to rise in 1% increments. Once you have agreed the loan details and paid the deposit, you might then be offered the opportunity to reduce the agreed interest rate by paying points on the mortgage.

For example, once your loan has been complete: you have paid the deposit and have agreed to a specific interest rate, whether fixed or variable, you may then be offered points. For each 1% of your mortgage loan you pay in cash, you will be offered a corresponding reduction in your interest rate.

What Do Points Cost?

In many cases, mortgage rates are quoted including points, the base rate not being quoted unless you refuse points. For example, if you are offered a mortgage of $200,000 at 7.5% and 2 points, you may have to pay 8% interest if you refuse to buy the points. If you pay extra points over and above what is offered, your interest rate will reduce accordingly. For example, if you borrowed $200,000, two points would be 2% of that, or a cash payment of $4,000 to get the 7.5% rate.

You have no obligation to pay points, and there are certain circumstances in which it would be wrong to do so. Keep in mind that your points agreement only last as long as the mortgage does, so if you change homes fairly quickly, or decide to refinance, your points agreement is terminated.

Should I Buy Points or Not?

You should pay points on a mortgage if you have a relatively low income, but a good lump sum to use to pay for the points. If you can afford more than a 20% deposit, you should use the extra to purchase points rather than reduce you principal sum borrowed.

Using the example above, on a $200,000 loan you will pay simple interest of $16,000 in a year at an 8% interest rate. You would pay $15,000 at 7.5% interest, saving $1,000 each year. Yes, interest reduces as your principal reduces, but not by much over the first few years.

By paying for 2 points at a total of $4,000, you would make that sum up after approximately 4 years and benefit thereafter, this is known as your break even point. If you paid that $4,000 as payment off the principal, you would save around 8% of that each year, or $320 – losing $680 every year in relation to points.

If you intend selling your house or moving on within 4 years, it does not make sense to buy points because you would spend more than you gained. Otherwise it does – in this example.

So Why Pay Points on a Mortgage?

The simple answer is to save money over the longer term. The longer the term of your mortgage, the more you gain by buying points. If you are short of cash when you purchase your home, but expect to earn more later, then points don’t make sense. But if you are cash-rich for a short while (an inheritance or medium lottery win), points can help you pay less for your home, or purchase a better home for what you can afford with your current income.

Pay the minimum of a deposit and the maximum points you can afford or are offered if you are keeping your home for a long time.

Still Have Questions About Points?

We can help. For a FREE consultation about point or any mortgage questions you might have, feel free to call us directly. We can help educate you on what loan programs are available and get you an up to the minute mortgage rate quote.

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Refinance Basics: Should You Refinance Your Home?

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Home Refinance BasicsShould you refinance your home? Since we can only speak in regards to refinancing on a general basis, before you make a decision to refinance your home you should be sure to speak with a mortgage professional. Everyone’s circumstances are different, and what applies to one person might not apply to you.

Before making a decision to refinance you home, or any other property you own, you must first be fully familiar with the three fundamental aspects of acquiring a new loan to replace your existing loan with your home as security, which is what refinancing is, by definition.

The three major factors that determine the feasibility of refinancing a mortgage are:

The Interest Rate

You should not refinance your home to save money if the interest rate offered is greater than that you are currently paying with your existing mortgage. If you simply want some cash to pay for home improvements, then shop around for the best interest rates you can get, because there is a fine line between refinancing and a secured loan.

Another aspect of interest rates to consider is that if you have your mortgage for a long time, the bulk of your current payments will be used in reducing the capital. Initially, you are paying a lot more in interest than in capital, but as your capital sum reduces, so does the interest. If you refinance, you will likely be back to paying more on interest than repaying the actual loan.

Against that, of course, is the fact that your equity would reduce the sum borrowed, unless you want to include the ability for home improvements such as a new kitchen or a room addition.

The Term of the Loan

The term, or length of the loan period, will impact upon both your payments and how able you are to maintain them. You can refinance over whatever period your lender is willing to offer you up to 30 years, depending on your age, ability to pay and the equity on our home.

Fees

You will be informed of the fees in advance, but the cost of fees involved may play a role in  the decision making process and whether or not your new rate is low enough to justify refinancing.

Divide the fees by your monthly saving to find your break even point, and find out how long it will take before you are actually begin saving money. Let’s say you refinance your home and save $88/month over your existing payments. If the fees, including the closing costs of your existing mortgage, totaled $3,000 it would take 34 months before you are actually saving money. If the closing costs were $6,000 (which is not unreasonable), you would have to repay for 68 months before you would be saving money over your existing payments.

Refinancing: The Big Picture

Take the fees, including the closing costs of your existing mortgage, interest rate and repayment period into consideration, and figure out how much you will be repaying in terms of the finance provided. Perhaps an extended term would enable you to afford a sum you could not repay over a shorter period. Before you refinance your home, be sure to view your Good Faith Estimate  to insure your fees are in line.

There are a variety of factors (as mentioned above) that come into play when deciding if refinancing your existing home loan makes the most sense for you. Still have questions? We can help. For a FREE consultation, please call us at the number at the top of the page. We can help you understand if refinancing makes sense for you and help educate you on which programs makes the most sense for your needs if refinancing fits your current situation.

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Mortgage Lock Basics: Should You Lock-In Your Mortgage Rate?

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A mortgage lock can work for you or against you depending upon the terms of the mortgage rate lock in period and upon the current behavior of the economy as seen in the equities and bond markets (stock markets). Because these are common variables, it is not always easy to provide a definitive answer as to whether or not a rate lock makes sense. However, the following discussion should give you a better understanding of the components involved in trying determine whether or not locking in your mortgage rate is the best move for your specific circumstances.

First, it is important that you understand what it means when discussing a mortgage lock, and what benefits you can expect by locking in to a certain mortgage interest rate.

What is a Mortgage Lock?

In simple terms, you lock in your mortgage agreement to a specific agreed interest rate for an agreed period of time while your mortgage application is being processed. It is fundamentally an assurance that once you have agreed an interest rate with your mortgage lender, that rate will neither increase nor decrease until your mortgage papers have been signed.

You can also include the points when you lock in your mortgage, although this is not mandatory. The ‘points’ refer to lump sum charges you can pay to reduce you interest rate, and one point is generally equivalent to 1% of the sum being loaned – i.e. 1% of your mortgage. So if you borrowed $200,000 to purchase your home, one point would equal $2,000.

Should You Lock Your Rate or Not?

Given that your mortgage can take a few weeks or more to complete once you have made your offer backed up by a mortgage from your bank or building society, you will usually not lose with a mortgage lock, although much depends on the financial situation at the time.

In a highly inflationary period, when interest rates are generally rising, it makes sense to lock-in your mortgage to an agreed rate. However, if you are buying your new home in a recession, and prices are generally stable, interest rates tend to drop, and it might be to your benefit to hold out for a lower interest offer.

You are not restricted to what you accept, and you can usually ask for a mortgage lock at any time during the process. In a recession it is likely best to keep your options open and not lock in your interest rate until you see a trend – either up or down regarding interest rates. However, your lender will be doing the same thing, and is unlikely to agree to lock into an interest rate that is liable to increase over the short term.

To take full advantage of a mortgage lock, you are best advised to work with a mortgage professional that has a day in and day out working knowledge of the markets and latest mortgage rate activity, and accept a lock in mortgage rate if you believe that existing conditions appear to indicate a future rate increase.

How Long Does a Mortgage Lock Last?

Mortgage rate locks can typically last around 1 to 2 months. This depends on the lender, and some might hold the interest rate for only 7 days after approval of the loan. Others might go longer – to 120 days or more. Establish the period when you arrange it and make sure that you understand and agree to the terms of the rate lock.

Your lender might charge a fee for a mortgage lock, in which case this sum will likely increase with an increasing amount time for which the rate is held. The period should last until settlement, so before agreeing on a time period find out how long it generally takes for purchases to be settled in your area.

Should You Include Points?

The term ‘points’ refers to a means of reducing your monthly payments by paying a lump sum. Each point has a capital cost, and reduces your interest rate by a certain amount. You can also lock-in the value of each point to a fixed sum so that your lender cannot make up for any loss in interest payments by increasing the points charge.

You can lock-in your points and interest rate or just take a mortgage lock with floating points. Before making this type of important decision, you should first seek the advice of an independent financial advisor who is on you side, and not working for your lender.

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Private Mortgage Insurance Basics: The Fundamentals of PMI

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Private Mortgage Insurance BasicsPrivate mortgage insurance (PMI) is a form of protection for mortgage lenders in the event of borrowers defaulting on their payments. If a borrow takes a mortgage that is more than 80% of the purchase price of their home, then they must also purchase mortgage insurance to protect the lender. In other words, you need PMI if your down payment is less than 20% of the selling price.

In some cases, the value of your home may be appraised if the lender feels that the price you paid is not representative of its true value. Because its purpose is to protect the lender, the insurance premium is based upon the amount borrowed, and generally set at 0.5% of the total mortgage loan for year one, and then decreases each year as more of the principal is paid.

Benefits of Private Mortgage Insurance

Here are some of the benefits of PMI:

  • The lender is paid if the borrower defaults on the loan.
  • Those with lower income or less of a deposit available can become involved in home ownership.
  • People with little savings can purchase their dream home with a low deposit.
  • Once you owe less than 80% of the total purchase price you can elect to cancel the PMI assuming that you are paying the premiums and not the lender (more on this below).

PMI Payment Options

  • Your monthly private mortgage insurance payment can be integrated into your mortgage repayment, so you make the one monthly payment to your lender that includes an additional sum for the PMI.
  • You can make an annual lump sum payment, or even pay a single lump sum to purchase the insurance policy for the life of its term.
  • The lender can pay the PMI for you, and then claw the money back by means of an increased interest rate.

Whichever of these options suits you best will be determined by your personal financial circumstances. If you have the lump sum to spare, then the one-off payment might be worthwhile. However, you have to balance that with the benefits of using the lump sum as part of your deposit which might avoid you having to pay PMI at all.

If you have less spare cash, but can afford an annual payment, then that might be your best option. Many decide not to do that if they need the ready cash to furnish and decorate their new home. The lender-paid option might be attractive if you earn a good monthly income with prospects of advancement but have no spare cash.

As your salary increases, the extra interest you are paying becomes less significant to your overall income. In fact, the interest you pay on lender-paid private mortgage insurance is tax deductible, providing another reason for taking this option.

PMI Policy Cancellation

It is possible to cancel the policy once the amount you owe on the principal of your mortgage loan has reduced to below 80%. Even if the value of home has appreciated due to improvements this 80% refers only to the original loan. However, keep in mind that the vast majority of your initial mortgage repayments will be paying the interest charges, with very little being deducted from the sum you borrowed.

This is the case with any repayment mortgage, and it could be many years before your principal reduces to below 80%: 10-15 years is not unusual for a 30 year mortgage.

Summary

Private mortgage insurance is mandatory if your deposit is less than 20% of the purchase price. You may be offered options on how this is paid, and the most tax-friendly way is for the lender to include the PMI payment in your monthly repayment, when it will be tax deductible. Regulations can change during the lifetime of the average mortgage, and it makes sense to seek the advice of an independent financial advisor before signing any PMI agreement.

Have PMI Questions?

Still have questions about how PMI works? We can help, simply call us at the number above for free mortgage and PMI advice!

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Buy Vs Rent Basics: Should You Buy or Rent A Home

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Rent vs Buy BasicsThe question of whether to rent or buy is no longer a clear cut economic one. Many people who can afford to buy their home are choosing to rent instead because they no longer have confidence in home ownership. If you can’t afford your rent you move on, but if you cannot pay your mortgage you lose everything.

Many renters have no plans to own their own homes, preferring to rent and invest their money in anything but real estate. While home prices are still dropping, foreclosures remain rising, and many are discouraged from purchasing their home. However, many analysts believe that house prices have bottomed and the time is right for buying. Those with the cash available for a good deposit are liable to benefit from purchasing homes while prices are low.

Benefits of Buying a Home

Buying a home has been risky in years past since many home owners have lost money in their investments as home prices have fallen. That being said, real estate is an excellent long-term investment, and if you are seeking a home, then by purchasing when prices are low you will be both investing and buying yourself a permanent place to live.

You can improve your home to suit yourself, while many rental properties cannot be changed in any way. However, by adding a new kitchen or bathroom, you will be adding to the value of your investment. You cannot do this with a rental, and every cent spent is basically wasted money that you will never get back.

With a mortgage, you can usually expect to get every penny back due to appreciation of the value of your property. You also get mortgage tax benefit, and owning your own home is good for your credit rating.

A major disadvantage is maintenance costs. If your roof starts leaking or your air conditioning stops working, you have to pay for the repair or replacement. However, with a rental, your landlord might go for the cheapest option while you can fit your own home with a more energy efficient system to save you money on power costs.

Buy Vs. Rent: Advantages of Renting Your Home

When you rent a home you having nothing to pay but the rent and consumables such as power. In fact, so many people are renting these days that landlords are offering incentives, such as flat screen TVs, free parking and reductions in the deposit. Many renters cannot afford high deposits, and this is a definite advantage to them.

Depending on the city you live in, it could be cheaper to rent than to buy. However, the buy vs. rent debate is not all about economics, and many people simply like the freedom to move around the country as they please, renting as they go. It usually costs a lot less initially to rent than to buy a home, and purchasing a home is long-term commitment that many are not prepared to make.

However, once your mortgage is paid your housing is free and you will likely own an investment that has appreciated! Or you can buy another property to live in and rent out your house. You have these options, while renting brings you no such investment benefits.

Calculators are often used to establish the benefits of buy vs. rent, but the results can be misleading. Maintenance costs are often not included, and appreciation is always approximate at best and a guess at worst. Quite frankly, if you are confused and unsure of the best way for you to pay for your housing, then we can can give you specific advice based on your specific needs and circumstances.

 

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The Mortgage Application Process: First Steps in Buying a Home

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The Mortgage Application ProcessThe mortgage application process is the first step required if you need a loan to purchase residential real estate. The correct name for this is the Uniform Residential Loan Application, and takes the form of a substantial application form in which you must provide all the personal information needed for a lender to make a decision.

It is important that you have your mortgage application approved by your lender or builder before you make an offer. The information you provide must be backed up with proof in the form of documentation.

Information Required for Mortgage Application

Identification: Your name and residential addresses over the past two years, date of birth and Social Security number. Details of landlords are required if you have been renting.

Employment: Names and addresses of your employers over the last two years.

Income: Employment income share interest, average bonuses and any other type of income backed up by pay stubs (30 last days) and a W-2 form (last 2 years).

Debt: Credit and store cards, car loans, student loans, current mortgage if any and any other forms of debt. You should provide details of any new debts that are not listed on your current credit report. You should provide details of the amount owed, the creditors’ names and contact details, account numbers and agreed monthly payments.

Bank and Other Statements: Original copies of the last two monthly statements for your savings and checking accounts. If you intend using securities for your down payment, you should provide details of these such as statements of IRAs, Certificates of Deposit, stocks and any other relevant securities.

Self-Employed: If you are self-employed you should provide your tax returns for the past year. You will also be required to provide a balance sheet and profit-and-loss report for the last financial year.

Real Estate Details: You will also be asked for details of the house you want to purchase, and how much of a loan/mortgage you are asking for. In addition, you will have to provide details of any real estate you currently own, including its address and current value. If you have an existing mortgage, you must provide your lender’s details and your mortgage account details.

This list is not comprehensive, but the above is the main information asked for. It is very important that you are completely truthful with this information, particularly your current debts, because if you are found not to be then your application will likely be refused. Some get the help of their solicitor at this early stage.

Once your building society or lender has received and processed your application form, they will continue with the next part of the mortgage application process. Although different lenders, banks and building societies will have their own procedures, this past of the process will generally involve:

Credit Reports and FICO Score

You will be asked on the form for permission for the lender to check your credit reports and credit score: normally they will simple check your FICO credit score and make a decision based on that. However, they may also check individual credit reports provided by the three major credit bureaus, Equifax, Experian and TransUnion. They will use this information along with the information you have provided to determine your ability to make repayments and to check on your record of paying previous bills, loans and debt.

This part of the mortgage application process is designed to establish your identity, your disposable income, details of the house you want to purchase and how much you want to borrow. Your FICO score will give the lender an indication of your credit-worthiness, and whether or not you have a good record of paying past debts

Collateral and Real Estate Value

A mortgage is a secured loan, meaning that you agree that your property can be sold to recover the outstanding sum in the event of you being unable to pay. The lender will therefore also check on the worth of the home you are purchasing plus that of any other real estate you own that can be possessed and sold to pay your outstanding mortgage debt.

Lenders and banks must protect their investment in this way, particularly in view of the collapse of certain sub-prime mortgage over the past decade. It is not as easy to get a mortgage today as it was at the beginning of this millennium.

Debt to Income Ratio

The lender will likely also use a ‘Debt to Income’ ratio to establish your ability to pay. Let’s say this is 28/36, a common DTI ratio. This means that 28% of your pre-tax gross income may be spent on paying for your home (mortgage, taxes & insurance), and no more than 36% should be spent on repaying your total debts. Find out what DTI ratio your lender uses, and you can work out yourself the monthly payment you will be allowed.

Once satisfied with your ability to pay, the lender will inform you how much they are prepared to lend you, the interest rate, the monthly repayments and the term over which the loan is to be repaid. You can now make an offer on your home. Most lenders will offer pre-approval, based on the factors already discussed, so that you can look for a new home knowing the amount you can afford to offer.

Finally Steps in the Application Process

Once you have found real estate you want to purchase, the lender will have it appraised to make sure that it is worth your offer price (this is the collateral for your mortgage loan), and will then issue you with a “Commitment Letter” that provides full details of the approval of the loan. This is the final confirmation that you require to complete the purchase.

This completes the mortgage application process, which is followed by the payment of the deposit, the ownership search and the conveyancing, followed by completion or closure. Then will you be given keys to your new home!

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FICO Credit Score Basics

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FICO credit scores are use by lenders to assess how likely you are to be able to repay a loan. If you intend applying for a mortgage, knowing how FICO credit scores work could be of advantage to you. Understanding them might enable you to improve your credit score before you make your application.

First, however, it is important to understand credit reports, and the part they play in the calculation of your credit score. The three main credit bureaus, Experian, Equifax and TransUnion, each compile their own credit reports using a variety of data relating to your creditworthiness. Included is these data are your credit and repayment history, and the way you use credit, such as whether you are always around your credit limit or if you tend to keep it low.

The Function of Credit Reports in FICO Scores

FICO is short for the Fair Isaac Corporation, and is the most widely used credit score in the USA. FICO takes data from all three of your credit reports and generates a credit score by applying a weighting to each datum item. Without the initial credit reports, then, there could be no credit score.

Fundamentally, FICO scores are a shortcut to lenders, enabling them to check one single numerical figure rather than trawl through the alpha-numeric data offered by three different credit bureaus. They offer a rapid means of making a lending decision, not just ‘yes’ or ‘no,’ but also how much the lender can risk lending and at what interest rate.

How FICO Scores are Calculated

The three credit reports are scanned using an algorithm in roughly the same way as search engine scan web pages. Each factor use in your credit report is given a weighting, and the algorithm calculates your credit score thus:

Payment History: 35%

You must show that you are paying your bills and repaying loans you already have or have had in the past. Late payments, defaults and court judgments all count to reduce your score, and the more recent your problems the more significant they will be.

Outstanding Debt: 30%

The more you owe now, the less your borrowing power. Included are your credit card debts, overdraft and any other form of finance you are currently repaying. The computation also takes into account the state of your store and credit cards: try to maintain your cards within 25% of their limits.

Length of Credit: 15%

The longer you have had your credit cards and loans the better your score. This is because the lenders have a better idea of how you have been repaying, so stick with the same cards as long as you can. Many people switch regularly for better deals and interest-free terms, but come mortgage application time this might cost them dearly – in high interest rates, or even a refusal depending on the rest of the data.

New Credit Accounts: 10%

New credit will be punished by a reduced score until you have established a repayment history. Also penalized will be hard credit inquiries, where you have ticked a box agreeing that your credit records can be checked when you apply for new credit (e.g. mail order catalogs involving credit, new cards, secured or unsecured loans). Personal searches do not count.

Type of Current Credit: 10%

The final 10% of your FICO score is based upon the form taken by the credit you have. For example, it is best to have several different types of credit than several different credit cards. Examples are car loans, forms of revolving credit (store cards, store accounts), and personal loans.

No Credit?

If you have not yet taken out credit of any type, you will not have a credit score. The minimum criterion to get a FICO score is that you must have at least one credit account that has been updated over the past 6 months. So if you have never had credit, or closed your last credit account over 6 months ago you will have no FICO score!

Effect of FICO Credit Scores on Mortgages

FICO scores range from 300 to 850. There is currently no accepted definition of the various terms used, such as prime and sub-prime mortgages. However, a common definition is that any score above 710 is prime, with sub-prime being below 640.

If your FICO credit score is between around 510 and 640, you may be considered sub-prime and be offered a limited mortgage at a higher interest rate than normal. However, since the sub-prime collapse, many lenders are wary of such low scores. Below around 510 nobody will offer you a mortgage.

A credit score of 760 and above will likely result in you being offered a good mortgage with lower interest rates. You will also be offered a greater variety of mortgage options, such as fixed or adjustable mortgages. For example, with score of below 700, your interest rate might be set at 6.3%, with over 760 at 5.8% and below 600 at from 8.6 – 9.5%. These figures are for comparison only and not actual rates being currently offered.

That is fundamentally how FICO scores work, and by working on the various factors discussed you should be able to improve your score. FICO credit scores are important factors in the interest rate and type of mortgage you are offered – or even if you are offered a mortgage at all.

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Fixed Mortgage Basics: Fundamentals of Fixed Interest Rates

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Fixed Rate Mortgage BasicsA fixed mortgage is one whose interest rate remains the same over the full term of the mortgage loan. This contrasts with an adjustable rate mortgage, where the interest rate can fluctuate with market conditions after a specified period of time. A fixed interest rate is easier to understand, and many prefer the predictability of repayments, and the way they have more disposable income as their income increases but mortgage repayments do not.

Benefits of a Fixed Mortgage

If you are seeking stability, and the safety of knowing exactly what you will be paying every month, then this is for you. This type of mortgage enables you plan ahead with confidence, without the possibility of facing a sudden hike in your monthly repayments because interest rates suddenly increase.

When you decide on a fixed mortgage, your choice of lender or building society will make little difference to your monthly payments because all offer very similar fixed interest rates. However, where interest rates do vary between lenders, you have the advantage of knowing that when you select the lowest rate, it will not change over the period of the mortgage.

While the rate for a fixed mortgage will be higher than the initial rate for an adjustable rate mortgage, if you take your mortgage on at a period when interest rates in general are low, then you could get a good deal for the entire life of the mortgage.

Disadvantages of Fixed Interest Mortgages

One of the disadvantages of fixed interest loans in general is that you are limited in how much you can borrow. This is particularly true when interest rates are generally high: the amount of your mortgage depends on your ability to repay, and you are liable to be restricted in the size of home you can purchase, even with a 30-year loan.

Also, if interest rates fall back to lower levels, your mortgage rate will not fall with them. You are locked into a fixed interest mortgage, and might face penalty charges if you attempt to repay it early (prepayment penalty). This is a something you should establish prior to signing for the mortgage loan.

The term of the loan could make a difference, and here are the pros and cons of 15-year and 30-year mortgages with fixed interest rates.

15 Year Fixed Rate Mortgages

Benefits:

  • Because the amortization is over a shorter period, you can increase equity over a shorter period of time. This enables you to purchase upwards at a faster rate than if you were paying a 30 year mortgage, or to repay your mortgage sooner.
  • The interest rate will be lower than that for a corresponding 30 year fixed rate mortgage.
  • The total amount you pay the lender in interest will be lower and so more of your cash will be going to repay the capital.

Disadvantages:

  • The monthly payments will be significantly greater for a 15-year fixed rate mortgage than if you repaid the loan over 30 years. That is because you are repaying more of the capital sum, which has to be paid up in half the time.
  • Because your monthly repayments are higher, you might not be able to afford as large a house as you could purchase with a 30-year fixed interest mortgage.

30 Year Fixed Mortgage

Benefits:

  • You can take a mortgage over the longer term, knowing that your repayments will remain the same over 30 years, irrespective of the financial situation.
  • Interest is amortized over double the time period than a 15 year loan, so the monthly repayments will be smaller.
  • You will be paying more in interest overall with a 30-year fixed rate mortgage, so can claim more on your federal income tax returns.

Disadvantages:

  • The fixed interest rate will be set at a higher level than that for a 15 year mortgage.
  • Equity will build up very slowly in comparison to that of a 15 year fixed rate mortgage.
  • You will end up paying more in interest to the lender.

Even if they can easily afford a 15 year mortgage, many people choose to pay over 30 years, and invest what they save in monthly payments. This can give them a yield greater than the difference in the monthly payments. This will be particularly true for those that take the mortgage at a fixed rate when rates are generally low.

If it is necessary to take a mortgage at a time when rates are particularly high, many will choose the 15-year fixed mortgage or choose an adjustable rate mortgage instead. If you had arranged an adjustable rate mortgage when rates were high, you may consider trading it for a fixed-rate loan when mortgage interest rates have dropped. You will then benefit from the lower rate for the remainder of the mortgage term.

In general, then, a fixed mortgage offers the advantage of knowing exactly what your payments will be, irrespective of interest rate fluctuations. The major disadvantages are being unable to take advantage of interest rate drops, and a limitation in the mortgage amount, particularly when rates are high. If you have questions about fixed rate loans, we can help, simply contact us directly or request a rate request using the FREE rate request form above!

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Mortgage Prepayment Penalty Basics: Early Settlement Costs

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Prepayment Penalty BasicsFundamentally, a mortgage prepayment penalty is applied by lenders to recover some of the profit they would have made were the loan to have run its full term. Interest rates and other aspects of loans, including mortgages, are set on the basis of loans running for the agreed period, and should a borrower repay the loan sooner than that agreed period lenders will lose the interest they would have earned on the period still to run.

From the borrower’s perspective, it is best to repay the loan as soon as possible and so save on interest. However, were all borrowers to do this, lenders might lose much of the money they would have earned for the work they had carried out to arrange the loan. Income that would normally have been paid by the interest accrued over a period of time.

If not lose exactly, they would not make the expected income, and hence their own livelihood could be compromised. Lenders need some form of protection against early repayment if their income is dependent on interest payments. The alternative would be higher interest rates.

It should be made clear that such penalties are not allowed with Federal Housing Administration (FHA) loans, Rural Development (USDA) Loans and VA (Veteran Affairs) loans.

Variation Between States and Lenders

Mortgage prepayment penalties vary between states and lenders. There is no agreed national policy, although some states have laws in place whereby a prepayment penalty can only be applied to second mortgages on residential properties and on liens on properties purchased for investment.

They cannot be applied to early settlement of first mortgages on the primary home of the borrower. You should check up on what the law is in your state regarding early or prepayment penalties.

In simple terms, where this rule is applied, you can make early settlement of a mortgage used to purchase the home you live in without penalty, but, if you have borrowed money with your home as security, early payment penalties can be applied. The same is true if you have put property up as security (i.e. a lien) for a loan – if you pay the loan early you can face a penalty.

Some penalties relate to prepayment within a specific time frame, most commonly years, while others relate to specific circumstances. For example, some contracts absolve the need to pay a penalty if you sell your home and then pay off the mortgage with a cash sum from the proceeds. However, if you negotiate a mortgage with another lender at a lower interest rate, for example, you may have to pay a prepayment penalty.

Benefits of Prepayment Penalties

In many cases you might find that your mortgage is offered with the option of a lower interest rate with a prepayment penalty clause, or at a higher rate without such a clause. In effect, what the situation is likely to be is that you are paying more interest than normal if you refuse the clause, but you nevertheless have the option. You might also be offered lower closing costs in addition to or in place of the lower interest rate.

If you intend to live in your house for at least the term of the mortgage, you could gain by agreeing to the prepayment penalty clause. However, if you purchase your home with a view to upsizing within a few years, and selling to pay off your mortgage and negotiate a new home loan, then check out the fine print in your mortgage loan contract.

Check the Fine Print

If you check the Truth in Lending (TIL) statement that you are provided with when you are closing on your mortgage, you will find reference to payment penalties towards the end. If it states that your mortgage “may” be subject to a prepayment penalty, then you can be assured that means that it “will” be!

How Much is the Penalty?

The penalty for early mortgage settlement varies between lenders, and this policy should also be stated in your mortgage agreement. A common method of calculating this is to use a proportion of the total mortgage still due at the time of settlement. For example, if you paid off your mortgage when you still had $80,000 principal to pay, a 2% penalty would cost you $1,600.

Alternatively, the lender might apply a sliding scale based upon how much interest they would lose between the date of settlement and the original term date. A common calculation is to base the prepayment penalty on a proportion of the interest lost to the lender over a specific period of time such as six months.

When you arrange your mortgage, make sure you fully understand the terms of any mortgage prepayment penalty. If you already have a mortgage, check the fine print for details of any such penalty. Keep in mind that prepayment penalties are not necessarily to your disadvantage because you might be offered a lower interest rate in exchange for such penalties. You want to pay less, and the lender wants to protect their income. There are ways to achieve both.

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Adjustable Rate vs Fixed Rate Mortgage Basics

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Adjustable vs Fixed Rate MortgagesAdjustable Rate Mortgage Basics: ARM or Fixed Rate?

With an adjustable rate mortgage (ARM) you pay a fixed rate of interest on your mortgage for a specified period, after which the rate adjusts until the term of the loan is complete. The initial monthly payments will generally be lower than those with a fixed interest rate, but this type of mortgage is not suitable for everybody.

The initial rate period can be anything from one month to 10 years, although the general standard today is regarded as 5 years.  Other common arrangements are over 3, 7 and 10 years. Initially, the rate will be set at a level below than that of a fixed rate mortgage. At the end of the agreed term, the interest rate will be adjusted annually according to an index stated in the closing documents of the mortgage arrangement.

Fixed Rate Calculation

The fixed rate of an adjustable rate mortgage, known as the ‘Start Rate,’ is the minimum interest rate that applies to the sum borrowed. This ‘floor rate’ as it is known will not be reduced, even if general lending rates drop below this figure at a later date.

At the end of the ARM fixed rate period, the lender will check the ‘index rate’ and apply an interest rate to the balance of your mortgage that slightly exceeds this.  Your monthly repayments will then be increased accordingly. This is repeated each time an adjustment is required – usually annually, but this will be detailed in your initial AMR mortgage agreement.

Benefits of an Adjustable Rate Mortgage

There are several reasons for you deciding to take an ARM. They are not suitable for everybody, but if you prefer the security of knowing exactly how much your monthly repayments will be until your mortgage is paid off, then go for a fixed rate mortgage.

Some benefits of an ARM are:

a)   You may be purchasing your home with a view to selling it within the fixed rate period. For example, if you have reached the first rung of the housing ladder, you might intend to sell your home after 3-4 years for a better one. Your repayments will be less with an adjustable rate mortgage than with a fixed rate.

b)   You intend purchasing a new home within a few years of buying your first home.  Just like a) above, but perhaps you have purchased a small apartment or condo after marrying, and intend to upsize once a family comes along and you need more bedrooms.

c)    If you intend making extra payments, over and above your regular payment, then an adjustable rate mortgage will be ideal for you. Even by paying the same as you would had you taken a fixed rate mortgage, the extra payment will go towards reducing the principal rather than interest. Check on penalties for early repayment!

d)   You might intend to refinance sometime over the next 5 years or so. In this case, you enjoy the lower interest rate until you take that step. Some people do this when their credit is not as good as it might be. After two years or so your credit score might have improved enough through you maintaining your repayments on time to enable you to get a longer term fixed rate mortgage. Your home is your security for the initial fixed rate period.

Disadvantages of an ARM (Adjustable Rate Mortgage)

Obviously, lenders do not give money away, and would not offer an agreement enabling you to pay them less without them ultimately benefiting. Here are some of the aspects of this type of mortgage you should consider:  what happens after the honeymoon and your interest rate is ‘reviewed?’  Here are three problems you might have to face:

1)   During your fixed rate period the interest applied to your balance cannot drop below the agreed initial figure – even if general interest rates drop. You are tied into that fixed rate just like those that took a fixed rate mortgage (though your fixed rate will be lower than theirs).

2)   Also, once the agreed fixed period is over, that rate will be lowest and will not drop below it. If you take a mortgage during highly inflationary periods, where interest rates can be as high as 15% or more, you might be offered a fixed rate of 9% with your ARM. You are stuck with this, even if times improve and new borrowers are being offered 4%-5%.

3)   At the end of the fixed rate period, your repayments could increase significantly, putting you in financial distress.

Is An Adjustable Rate Mortgage or Fixed Rate Mortgage Right For Me?

If you are prepared to meet the significantly higher repayments you might face once the fixed rate period is over, want to repay your mortgage quickly or intend selling your home within a few years of buying it, then an AMR is likely your best choice.

However, an adjustable rate mortgage can come with complex terms and conditions, and it is critical that you fully understand what you are agreeing to.  We can help answer any questions you might have about fixed rate or adjustable rate mortgages. We can also give you an up to the minute mortgage rate quote if you call us directly or use the fast rate quote form above.

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Mortgage Rates