Frequently Asked Questions
- Looking for a home without being pre-approved. As
a potential buyer competing for a property, you'll have a
better chance of getting your offer accepted by being as prepared
as possible. Consider this hierarchy of preparedness:
- Neither pre-qualified nor pre-approved
The benefits available at each level can be easily understood
when viewed from the seller's perspective. Imagine you're
a seller in receipt of multiple offers to purchase your property.
A complete stranger (buyer) is asking you to take your property
off the market for at least the next two to three weeks while
they apply for a loan. As the seller, lets consider the type
of buyer you'd prefer to deal with.
- Neither pre-qualified nor pre-approved
- This buyer provides no evidence that they can afford
to purchase your property. You may wonder how serious
they are since they're not at least pre-qualified.
- This buyer has met with a mortgage broker (or lender)
and discussed their situation. The buyer has informed
the broker regarding their income, expenses, assets and
liabilities. The broker may also have seen their credit
report. The buyer provided you with a letter from the
broker stating an opinion of what the buyer can afford.
- This buyer has provided a broker written evidence of
income, expenses, assets, liabilities and credit. All
information has been verified by a lender. As a result,
much of the paperwork for this buyer's loan has been completed.
This buyer will probably be able to close quickly. They
provide you with a letter (pre-approval certificate) from
the lender. You're as certain as possible that this buyer
As a potential buyer, you can see that being pre-approved
will give you the best chance of getting your offer accepted.
This is critical in a competitive situation.
- Making verbal agreements. If you're asked to sign
a document containing instructions contrary to your verbal
agreements--don't! For example, the seller verbally agrees
to include the washing machine in the sale, but the written
purchase contract excludes it. The written contract will override
the verbal contract. More importantly, your state may require
that contracts for the sale of real property be in writing.
Do not expect oral agreements to be enforceable.
- Choosing a lender just because they have the lowest rate. While
the rate is important, consider the total cost of your loan
including the APR , loan fees, discount and origination points.
When receiving a quote from a lender or broker, insist that
the discount points (charged by the lender to reduce the interest
rate) be distinguished from origination points (charged for
services rendered in originating the loan).
The cost of the mortgage, however, shouldn't be your only
criterion. Have confidence that the company you select is
reputable and will deliver the loan with the terms and costs
they promised. If in the final hours of the transaction you
determine that the lender has suddenly increased their profit
margin at your expense, you won't have time to start again
with a different lender. Ask family and friends for referrals. Interview
prospective mortgage companies.
- Not receiving a Good Faith Estimate. Within three
business days after the broker or lender receives your loan
application, you must receive a written statement of fees
associated with the transaction. This is both the law and
the best way to determine what you'll pay for your loan. Bring
the Good Faith Estimate (GFE) with you when you sign loan
documents. You should not be expected to pay fees which are
substantially different from those contained in your GFE.
- Not getting a rate lock in writing. When a mortgage
company tells you they have locked your rate, get a written
statement detailing the interest rate, the length of the rate
lock, and program details.
- Using a dual agent--i.e., an agent who represents the
buyer and the seller in the same transaction. Buyers and
sellers have opposing interests. Sellers want to receive the
highest price, buyers want to pay the lowest price. In the
standard real estate transaction, the seller pays the real
estate commission. When an agent represents both buyer and
seller, the agent can tend to negotiate more vigorously on
behalf of the seller. As a buyer, you're better off having
an agent representing you exclusively. The only time you should
consider a dual agent is when you get a price break. In that
case, proceed cautiously and do your homework!
- Buying a home without professional inspections.
Unless you're buying a new home with warranties on most equipment,
it's highly recommended that you get property, roof and termite
inspections. This way you'll know what you are buying. Inspection
reports are great negotiating tools when asking the seller
to make needed repairs. When a professional inspector recommends
that certain repairs be done, the seller is more likely to
agree to do them.
If the seller agrees to make repairs, have your inspector
verify that they are done prior to close of escrow. Do not
assume that everything was done as promised.
- Not shopping for home insurance until you are ready to
close. Start shopping for insurance as soon as you have
an accepted offer. Many buyers wait until the last minute
to get insurance and do not have time to shop around.
- Signing documents without reading them. Whenever
possible, review in advance the documents you'll be signing.
(Even though some specifics of your transaction may not be
known early in the transaction, the documents you'll sign
are standard forms and are available for review.) It's unlikely
that you'll have sufficient time to read all the documents
during the closing appointment.
- Not allowing for delays in the transaction. In a
perfect world, all real estate transactions close on time.
In the world we live in, transactions are often delayed a
week or more. Suppose you asked your landlord to terminate
your lease the day your purchase transaction was scheduled
to close. A day or two before your scheduled closing date,
you discover your transaction is delayed a week. In a perfect
world, no one is inconvenienced and your landlord is willing
to work with you. More likely, however, your landlord is inconvenienced
and angry. Will you be thrown out? Will you have to find interim
housing for a week or more? The eviction process takes a little
time, so the Sheriff won't immediately remove you, but this
type of stress-producing episode can be avoided. How? Terminate
your lease one week after your real estate transaction is
scheduled to close. That way, if there is a delay in closing
your transaction, you have some leeway. This approach might
cost a little more, then again, it might not.
The most common reason for refinancing is to save money.
Saving money through refinancing can be achieved in two ways:
- By obtaining a lower interest rate that causes one's monthly
mortgage payment to be reduced.
- By reducing the term of the loan, thus saving money over the life
of the loan. For example, refinancing from a 30-year loan to a 15-year
loan might result in higher monthly payments, but the total of the
payments made during the life of the loan can be reduced
People also refinance to convert their adjustable loan to a fixed
loan. The main reason behind this type of refinance is to obtain the
stability and the security of a fixed loan. Fixed loans are very popular
when interest rates are low, whereas adjustable loans tend to be more
popular when rates are higher. When rates are low, homeowners refinance
to lock in low rates. When rates are high, homeowners prefer adjustable
loans to obtain lower payments.
A third reason why homeowners refinance is to consolidate debts and
replace high-interest loans with a low-rate mortgage. The loans being
consolidated may include second mortgages, credit lines, student loans,
credit cards, etc. In many cases, debt consolidation results in tax
savings, since consumers loans are not tax deductible, while a mortgage
loan is tax deductible.
The answer to the question "Should I refinance?" is a
complex one, since every situation is different and no two homeowners
are in the exact same situation. Even the conventional wisdom of
refinancing only when you can save 2% on your mortgage is not really
true. If you are refinancing to save money on your monthly payments, the
following calculation is more appropriate than the rule of 2%:
- Calculate the total cost of the refinance--example:
- Calculate the monthly savings--example: $100/month
- Divide the result in 1 by the result in 2--in this case
2000/100 = 20 months. This shows the break-even time. If you plan to
live in the house for longer than this period of time, it makes sense
Sometimes, you do not have a choice--you are forced to
refinance. This happens when you have a loan with a balloon provision,
but with no conversion option. In this case it is best to refinance a
few months before the balloon comes due.
Whatever you choose to do, consulting with a seasoned mortgage
professional can often save you time and money. Make a few phone calls,
check out a few web sites, crunch on a few calculators and spend some
time to understand the options available to you.
The best way to decide whether you should pay points or not is to
perform a break-even analysis. This is done as follows:
- Calculate the cost of the points. Example: 2 points on a $100,000
loan is $2,000.
- Calculate the monthly savings on the loan as a result of obtaining
a lower interest rate. Example: $50 per month
- Divide the cost of the points by the monthly savings to come up
with the number of months to break even. In the above example, this
number is 40 months. If you plan to keep the house for longer than the
break-even number of months, then it makes sense to pay points;
otherwise it does not.
- The above calculation does not take into account the tax advantages
of points. When you are buying a house the points you pay are
tax-deductible, so you realize some savings immediately. On the other
hand, when you get a lower payment, your tax deduction reduces! This
makes it a little difficult to calculate the break-even time taking
taxes into account. In the case of a purchase, taxes definitely reduce
the break-even time. However, in the case of a refinance, the points
are NOT tax-deductible, but have to be amortized over the life of the
loan. This results in few tax benefits or none at all, so there is
little or no effect on the time to break even.
If none of the above makes sense, use this simple rule of thumb: If
you plan to stay in the house for less than 3 years, do not pay points.
If you plan to stay in the house for more than 5 years, pay 1 to 2
points. If you plan to stay in the house for between 3 and 5 years, it
does not make a significant difference whether you pay points or not!
Whatever happened to the conventional wisdom of waiting for the rates
to drop 2% before refinancing?
You have a 30-year fixed loan at 8.5%. A loan officer calls you up and
says they can refinance you to a rate of 8.0% with no points and no fees
What a dream come true! No appraisal fees, no title fees and not even
any junk fees! Is this a deal too good to pass up? How can a bank and
broker do this? Doesn't someone have to pay? Whose money is being used
to pay these closing costs?
No--this is not a scam. Thousands of homeowners have
refinanced using a zero-point/zero-fee loan. Some refinanced multiple
times, riding rates all the way down the curve in 1992, 1993 and, more
recently, in 1996. Some homeowners used zero-point/zero-fee adjustable
loans to refinance and get a new teaser rate every year.
The way this works is based on rebate pricing, sometimes also known as
yield-spread pricing, and sometimes known as a service-release premium.
The basic idea is that you pay a higher rate in exchange for cash up
front, which is then used to pay the closing costs. You will pay a
higher monthly payment--so the money is really coming from
future payments that you will make.
You can also think of this as negative points! For example, a 30-year
fixed loan may be available at a retail price of :
8.0% with 2 points or
8.25% with 1 point or
8.5% with 0 points or
8.75% with -1 point or
9% with -2 points
On a $200,000 loan, the loan officer can offer you 8.75% with a cost
of -1 point, which is a $2,000 credit towards your closing costs. A
mortgage broker can use rebate pricing to pay for your closing costs and
keep the balance of the rebate as profit.
What are the benefits of a zero-point/zero-fee loan?
The main benefit is that you have no out-of-pocket costs. As a result,
if the rates drop in the future, you could refinance again even for a
small drop in rates. So if you refinanced on the zero-point/zero-fee
loan to get a rate of 8.75% and if the rates drop 1/2%, you can
refinance again to 8.25%. On the other hand, if you refinanced by paying
1 point and got a rate of 8.25%, it may not make sense to refinance
again. Now, if the rates drop another 1/2%, a zero-point/zero-fee loan
can drop your rate to 7.75%, whereas if you paid points, you may have to
do a break-even analysis to decide if refinancing will save you money.
The zero-point/zero-fee loan eliminates the need to do a break-even
analysis since there is no up-front expense that needs to be recovered.
It also is a great way to take advantage of falling rates.
Some consumers have used zero-point/zero-fee loans on adjustable loans
to refinance their adjustables every year and pay a very low teaser
What are the disadvantages of a zero-point/zero-fee loan?
The main disadvantage is that you are paying a higher rate than you
would be paying if you had paid points and closing costs. If you keep
the loan for long enough, you will pay more--since you have
higher mortgage payments. In the scenario where you plan to stay in the
house for more than 5 years, and if rates never drop for you to
refinance, you could wind up paying more money. If, on the other hand,
you plan to stay at a property for just 2-3 years, there really is no
disadvantage of a zero-point/zero-fee loan.
Whose money is it?
Since you are being paid "cash" up-front in exchange for a
higher rate, it really is your own money that will be paid in the future
through higher payments. Investors who fund these loans hope that you
will keep the loans for long enough to recoup their up-front investment.
If you refinance the loans early, both the servicer and the investor
could lose money.
To summarize, zero-point/zero-fee loans in many cases are good deals.
Make sure, however, that the lender pays for your closing costs from
rebate points and NOT by increasing your loan amount. So if your old
loan amount was $150,000, your new loan amount should also be $150,000.
You may have to come up with some money at closing for recurring costs
(taxes, insurance, and interest), but you would have to pay for these
whether you refinanced or not.
Zero-point/zero-fee loans are especially attractive when rates are
declining or when you plan to sell your house in less than 2-3 years.
Zero-point/zero-fee loans may not be around forever. Lenders have
discussed adding a pre-payment penalty to such loans, however few
lenders have taken steps to implement such a measure.
A FICO score is a credit score developed by Fair Isaac & Co.
Credit scoring is a method of determining the likelihood that credit
users will pay their bills. Fair, Isaac began its pioneering work with
credit scoring in the late 1950s and, since then, scoring has become
widely accepted by lenders as a reliable means of credit evaluation. A
credit score attempts to condense a borrowers credit history into a
single number. Fair, Isaac & Co. and the credit bureaus do not
reveal how these scores are computed. The Federal Trade Commission has
ruled this to be acceptable.
Credit scores are calculated by using scoring models and mathematical
tables that assign points for different pieces of information which best
predict future credit performance. Developing these models involves
studying how thousands, even millions, of people have used credit.
Score-model developers find predictive factors in the data that have
proven to indicate future credit performance. Models can be developed
from different sources of data. Credit-bureau models are developed from
information in consumer credit-bureau reports.
Credit scores analyze a borrower's credit history considering numerous
factors such as:
- Late payments
- The amount of time credit has been established
- The amount of credit used versus the amount of credit available
- Length of time at present residence
- Negative credit information such as bankruptcies, charge-offs,
There are really three FICO scores computed by data provided by each
of the three bureaus--Experian, Trans Union and Equifax. Some
lenders use one of these three scores, while other lenders may use the
Frequently Asked Questions (FAQs)
How can I increase my score? While it is difficult to increase
your score over the short run, here are some tips to increase your score
over a period of time.
- Pay your bills on time. Late payments and collections can have a
serious impact on your score.
- Do not apply for credit frequently. Having a large number of
inquiries on your credit report can worsen your score.
- Reduce your credit-card balances. If you are "maxed" out
on your credit cards, this will affect your credit score negatively.
- If you have limited credit, obtain additional credit. Not having
sufficient credit can negatively impact your score.
What if there is an error on my credit report? If you see an error
on your report, report it to the credit bureau. The three major
bureaus in the U.S., Equifax (1-800-685-1111), Trans Union (1-800-916-8800)
and Experian (1-888-397-3742) all have procedures for correcting
information promptly. Alternatively, your mortgage company may
help you correct this problem as well.
To understand why mortgage rates change we must first ask the
more general question, "Why do interest rates change?" It is
important to realize that there is not one interest rate, but many interest
- Prime rate: The rate offered to a bank's best
- Treasury bill rates: Treasury bills are short-term
debt instruments used by the U.S. Government to finance their debt. Commonly
called T-bills they come in denominations of 3 months, 6 months and 1 year.
Each treasury bill has a corresponding interest rate (i.e. 3-month T-bill rate,
1-year T-bill rate).
- Treasury Notes: Intermediate-term debt instruments
used by the U.S. Government to finance their debt. They come in denominations
of 2 years, 5 years and 10 years.
- Treasury Bonds: Long-debt instruments used by the
U.S. Government to finance its debt. Treasury bonds come in 30-year
- Federal Funds Rate: Rates banks charge each other
for overnight loans.
- Federal Discount Rate: Rate New York Fed charges to
- Libor: : London Interbank Offered Rates. Average
London Eurodollar rates.
- 6 month CD rate: The average rate that you get when
you invest in a 6-month CD.
- 11th District Cost of Funds: Rate determined by
averaging a composite of other rates.
- Fannie Mae-Backed Security rates: Fannie Mae pools
large quantities of mortgages, creates securities with them, and sells them as
Fannie Mae-backed securities. The rates on these securities influence mortgage
rates very strongly.
- Ginnie Mae-Backed Security rates: Ginnie Mae pools
large quantities of mortgages, secures them and sells them as Ginnie Mae-backed
securities. The rates on these securities influence mortgage rates on FHA and
Interest-rate movements are based on the simple concept of supply and
demand. If the demand for credit (loans) increases, so do interest rates. This
is because there are more buyers, so sellers can command a better price, i.e.
higher rates. If the demand for credit reduces, then so do interest rates. This
is because there are more sellers than buyers, so buyers can command a lower
better price, i.e. lower rates. When the economy is expanding there is a higher
demand for credit, so rates move higher, whereas when the economy is slowing
the demand for credit decreases and so do interest rates.
This leads to a fundamental concept:
- Bad news (i.e. a slowing economy) is good news for interest rates
(i.e. lower rates).
- Good news (i.e. a growing economy) is bad news for interest rates
(i.e. higher rates).
A major factor driving interest rates is inflation. Higher inflation is
associated with a growing economy. When the economy grows too strongly, the
Federal Reserve increases interest rates to slow the economy down and reduce
inflation. Inflation results from prices of goods and services increasing. When
the economy is strong, there is more demand for goods and services, so the
producers of those goods and services can increase prices. A strong economy
therefore results in higher real-estate prices, higher rents on apartments and
higher mortgage rates.
Mortgage rates tend to move in the same direction as interest rates.
However, actual mortgage rates are also based on supply and demand for
mortgages. The supply/demand equation for mortgage rates may be different from
the supply/demand equation for interest rates. This might sometimes result in
mortgage rates moving differently from other rates. For example, one lender may
be forced to close additional mortgages to meet a commitment they have made.
This results in them offering lower rates even though interest rates may have
There is an inverse relationship between bond prices and bond rates. This
can be confusing. When bond prices move up, interest rates move down and vice
versa. This is because bonds tend to have a fixed price at
maturitytypically $1000. If the price of the bond is currently at
$900 and there are 10 years left on the bond and if interest rates start moving
higher, the price of the bond starts dropping. The higher interest rates will
cause increased accumulation of interest over the next 5 years, such that a
lower price (e.g. $880) will result in the same maturity price, i.e. $1000.
Effect of economic data on rates
Number of arrows indicates potential effect on
interest rates. 1 arrow=least effect, 5 arrows=max. effect
|Economic Event ||Effect on |
|Significance of event
|Consumer Price Index (CPI) Rises
||Indicates rising inflation.
||Imports cost less; indicates falling inflation.
|Durable Goods Orders Increase
||Indicates expanding economy
|Gross National Product Increases
||Indicates strong economy
|Home Sales Increase
||Indicates strong economy
|Housing Starts Rise
||Indicates strong economy
|Industrial Production Rises
||Indicates strong economy
|Business Inventories Rise
||Indicates weak economy
|Leading Indicators (LEI) Increase
||Indicates strong economy
|Personal Income Rises
||Indicates rising inflation
|Personal Spending Rises
||Indicates rising inflation
|Producer Price Index Rises
||Indicates rising inflation
|Retail Sales Increase
||Indicates strong economy
|Treasury Auction Has High Demand
||High demand leads to lower rates
||Indicates weak economy
A pre-qualification is normally issued by a loan officer, who, after interviewing
you, determines the dollar value of a loan you can be approved
for. However, loan officers do not make the final approval,
so a pre-qualification is not a commitment to lend. After the
loan officer determines that you pre-qualify, he/she then issues
you a pre-qualification letter. This pre-qualification letter
is used when you are making an offer on a property. The pre-qualification
letter indicates to the seller that you are qualified to purchase
the house you are making an offer on.
Pre-approval is a step above pre-qualification. Pre-approval
involves verifying your credit, down payment, employment history,
etc. Your loan application is submitted to an underwriter and
a decision is made regarding your loan application. If your
loan is pre-approved, you are then issued a pre-approval certificate.
Getting your loan pre-approved allows you to close very quickly
when you do find a house. A pre-approval can help you negotiate
a better price with the seller, since being pre-approved is
very close to having cash in the bank to pay for the house!
You cannot close a mortgage loan without locking in an interest rate.
There are four components to a rate lock:
- Loan program.
- Interest rate.
- Length of the lock.
The longer the length of the lock, the higher the points or the
interest rate. This is because the longer the lock, the greater the risk
for the lender offering that lock.
Let's say you lock in a 30-year fixed loan at 8% for 2 points for 15
days on March 2. This lock will expire on March 17 (if March 17 is a
holiday then the lock is typically extended to the first working day
after the 17th). The lender must disburse funds by March 17th, otherwise
your rate lock expires, and your original rate-lock commitment is
The same lock might cost 2.25 points for a 30-day lock or 2.5 points
for a 60-day lock. If you need a longer lock and do not want to pay the
higher points, you may instead pay a higher rate.
After a lock expires, most lenders will let you re-lock at the higher of the
prevailing market rates/points, or the originally locked rates/points. In most
cases you will not get a lower rate if rates drop. In some cases, prior to the
rate lock expiration date, the lender may allow you to negotiate a rate lock
extension at the original rate/points. An additional fee may be charged for
Lenders can lose money if your lock expires. This is because they are
taking a risk by letting you lock in advance. If rates move higher, they
are forced to give you the original rate at which you locked. Lenders
often protect themselves against rate fluctuations by hedging.
Some lenders do offer free float-downsi.e. you may lock
the rate initially and if the rates drop while your loan is in process,
you will get the better rate. However, there is no free lunchthe
free float-down is costly for the lender and you pay for this option
indirectly, because the lender has to build the price of this option
into the rate.For example: the float-down rate may be 0.125% to 0.25% higher than the prevailing current market rate
What happens if rates drop after you lock?
Most lenders will not budge unless rates drop substantially (3/8% or more).
This is because it is expensive for them to lock in interest rates. If lenders
let borrowers improve their rate every time rates improved, they'd spend a lot
of time relocking interest rates, since rates fluctuate daily. Also, they would
have to factor this option into their rates, and borrowers would wind up paying
a higher rate.
If rates drop, one option is to go to a different lender. In this case, you
would be starting the loan process from the beginning. If you have your loan
with a mortgage broker, however, they'll probably be able to move your loan
package (including application) to a new lender offering lower rates.
Before applying with a different lender, inform your original lender that you
are aware that rates have dropped. You may be pleasantly surprised to find that
they will work with you rather than lose you to a competitor.
Most lenders will let you lock in an interest rate only on a specific property,
which means, if you are shopping for a home, you cannot lock in an interest
rate until after you sign a purchase contract for a specific property. If you
are shopping for a home, some lenders offer a lock-and-shop program that lets
you lock in a rate before you find the home. This program is very useful when
rates are rising. However, lock-and-shop rates are usually higher than the
prevailing market rate. Also, the lender may charge a non-refundable fee or
deposit towards closing costs.
New-construction rate locks.
Most lenders offer long-term locks for new construction. These locks
do cost more and may require an up-front deposit. For example, a lender
might offer a 180-day lock for 1 point over the cost of a 30-day lock,
with 0.5 points being paid up-front, as a non-refundable deposit. Most
long-term new-construction locks do offer a float-downi.e.
if rates drop prior to closing, you get the better rate.
Your loan can be sold at any time. There is a secondary mortgage
market in which lenders frequently buy and sell pools of mortgages.
This secondary mortgage market results in lower rates for consumers.
A lender buying your loan assumes all terms and conditions of
the original loan. As a result, the only thing that changes
when a loan is sold is to whom you mail your payment. If your
loan has been sold, your existing lender will notify you that
your loan has been sold, who your new lender is, and where you
should send your payments from now on.
If your lender goes out of business, you are still obligated
to make payments! Typically, loans owned by a lender going out
of business are sold to another lender. The lender purchasing
your loan is obligated to honor the terms and conditions of
the original loan. Therefore, if your lender goes out of business,
it makes little difference with regards to your loan payments.
In some cases, there may be a gap between the date of your lender's
going out of business and the date that a new lender purchases
your loan. In such a situation, continue making payments to
your old lender until you are asked to make payments to your
new lender. Speak with your Ascend representative to learn more.
PMI or Private Mortgage Insurance is normally required when
you buy a house with less than 20% down. Mortgage insurance
is a type of guarantee that helps protect lenders against the
costs of foreclosure. This insurance protection is provided
by private mortgage-insurance companies. It enables lenders
to accept lower down payments than they would normally accept.
In effect, mortgage insurance provides what the equity of a
higher down payment would provide to cover a lender's losses
in the unfortunate event of foreclosure. Therefore, without
mortgage insurance, you might not be able to buy a home without
a 20% down payment.
The cost of PMI increases as your down payment decreases. Example:
The cost of PMI on a 10% down payment is less than the cost
of PMI on a 5% down payment. Your PMI premium is normally added
to your monthly mortgage payment.
The decision on when to cancel the private insurance coverage
does not depend solely on the degree of your equity in the home.
The final say on terminating a private mortgage-insurance policy
is reserved jointly for the lender and any investor who may
have purchased an interest in the mortgage. However, in most
cases, the lender will allow cancellation of mortgage insurance
when the loan is paid down to 80% of the original property value.
Some lenders may require that you pay PMI for one or two years
before you may apply to remove it.
To cancel the PMI on your loan, contact your lender. In most
cases, an appraisal will be required to determine the value
of your property. You will probably also be required to pay
for the cost of this appraisal. Another way of cancelling the
PMI on your loan is to refinance and to get a new loan without
The annual percentage rate (APR) is an interest rate that is different
from the note rate. It is commonly used to compare loan programs from
different lenders. The Federal Truth in Lending law requires mortgage
companies to disclose the APR when they advertise a rate. Typically the
APR is found next to the rate.
The APR does NOT affect your monthly payments. Your monthly
payments are a function of the interest rate and the length of the loan.
The APR is a very confusing number! Even mortgage bankers and brokers
admit it is confusing. The APR is designed to measure the "true
cost of a loan." It creates a level playing field for lenders. It
prevents lenders from advertising a low rate and hiding fees.
If life were easy, all you would have to do is compare APRs from the
lenders/brokers you are working with, then pick the easiest one and you
would have the right loan. Right? Wrong!
Unfortunately, different lenders calculate APRs differently! So a loan
with a lower APR is not necessarily a better rate. The best way to
compare loans in the author's opinion is to ask lenders to provide you
with a good-faith estimate of their costs on the same type of program
(e.g. 30-year fixed) at the same interest rate. Then delete all fees
that are independent of the loan such as homeowners insurance, title
fees, escrow fees, attorney fees, etc. Now add up all the loan fees. The
lender that has lower loan fees has a cheaper loan than the lender with
higher loan fees.
The reason why APRs are confusing is because the rules to compute
APR are not clearly defined.
What fees are included in the APR?
The following fees ARE generally included in the APR:
- Points - both discount points and origination points
- Pre-paid interest. The interest paid from the date the loan closes
to the end of the month. Most mortgage companies assume 15 days of
interest in their calculations. However, companies may use any number
between 1 and 30!
- Loan-processing fee
- Underwriting fee
- Document-preparation fee
- Private mortgage-insurance
The following fees are SOMETIMES included in the APR:
- Loan-application fee
- Credit life insurance (insurance that pays off the mortgage in the
event of a borrowers death)
The following fees are normally NOT included in the APR:
- Title or abstract fee
- Escrow fee
- Attorney fee
- Notary fee
- Document preparation (charged by the closing agent)
- Home-inspection fees
- Recording fee
- Transfer taxes
- Credit report
- Appraisal fee
An APR does not tell you how long your rate is locked for. A lender
who offers you a 10-day rate lock may have a lower APR than a lender who
offers you a 60-day rate lock!
Calculating APRs on adjustable and balloon loans is even more complex
because future rates are unknown. The result is even more confusion
about how lenders calculate APRs.
Do not attempt to compare a 30-year loan with a 15-year loan using
their respective APRs. A 15-year loan may have a lower interest rate,
but could have a higher APR, since the loan fees are amortized over a
shorter period of time.
Finally, many lenders do not even know what they include in their APR
because they use software programs to compute their APRs. It is quite
possible that the same lender with the same fees using two different
software programs may arrive at two different APRs!
Use the APR as a starting point to compare loans. The APR is a result of
a complex calculation and not clearly defined. There is no substitute to
getting a good-faith estimate from each lender to compare costs.
Remember to exclude those costs that are independent of the loan.
Terms Used in These Articles:
Points (or Discount Points)
Points are an up-front fee paid to the mortgage lender at the time that you get your loan. Each point equals one percent of your total loan amount. Points and interest rates are inherently connected; in general, the more points you pay, the lower your interest rate.
Adjustable Rate Mortgage Loans (ARM)
Adjustable rate mortgages are loans with interest rates that adjust periodically based on changes in a pre-selected index. As a result, the interest rate on your mortgage and the monthly payment will rise and fall with increases and decreases in overall interest rates. These mortgage loans must specify how their interest rate changes, usually in terms of a relation to a national index such as (but not always) Treasury bill rates. If interest rates rise, your monthly mortgages payments will rise. An interest rate cap limits the amount by which the interest rate can change; look for this feature when you consider an adjustable rate mortgage.
Lock or Lock-In
Locking in your rate means a mortgage lender guarantees an interest rate for a set period of time, usually the time between loan application approval and loan closing. The lock-in protects you against mortgage rate increases during that time.
Also known as settlement costs, these costs are for services that must be performed to process and close your loan application. Examples include title fees, recording fees, appraisal fee, credit report fee, pest inspection, attorney fees, taxes and surveying fees.
Putting money in escrow means a third party acts as the agent for home seller and home buyer, or for borrower and mortgage lender, in handling legal documents and disbursement of funds.
A credit report is a report detailing the credit history of a prospective borrower that's used to help determine creditworthiness or credit risk.
A document that gives evidence of ownership of a property. It also indicates the rights of ownership and possession of the property. Individuals who have legal ownership in the property are considered "on title" and will sign the mortgage and other documentation.
Appraisal or Home Appraisal
An appraisal is a written analysis of the estimated value of your property. A qualified appraiser who has knowledge, experience and insight into the marketplace prepares the document. An appraisal demonstrates the approximate fair market value based on recent home sales in your neighborhood and is required to purchase or refinance your new home or property.
Also known as comparable properties. Comparables are properties like the
property under consideration; they have reasonably the same size, location,
and amenities and have recently been sold. Comparables help the appraiser
determine the approximate fair market value of the subject property.