Common Mortgage Questions - Part 2

This is about a week later than I wanted, but I was able to implore the help of one of our newest colleagues- Sarah Stedman.  She is an up and coming LO and so her insight into questions from potential clients was greatly appreciated.  So without further ado - Part 2:

1. What is the difference between an ARM and a Fixed Rate?

• ARM (Adjustable Rate Mortgage) is a mortgage product that typically involves an introductory interest rate that in the future will adjust based on a variety of factors.  The most common ARM loans are 3/1, 5/1, 7/1, 10/1.  The first number means the introductory rate is fixed for the first 3, 5, 7, or 10 years respectively.  The second number following the "/" mean that every year after the introductory fixed period the rate could adjust based on the current market.  For example:  On a 3/1 ARM the introductory rate of 3.00% is fixed for the first three years and then every year after that for the next 27 years the rate could adjust.  Within the ARM program there are varying items that will affect the adjustment.  These include the Margin, Floor, Caps, Max Rate and whether it is based on the CMT or LIBOR.  We will explore these items in depth at a later time.

• Fixed Rate is a mortgage product where the rate is fixed for the entire term of the loan.  The most common fixed rate options are the 30 YR Fixed Rate and the 15 YR Fixed Rate option (though you can choose varying terms, i.e. 20 YR, 25 YR etc.)  For example: On a Purchase or Refinance you lock the rate at 3.75%, it will never change or adjust until the full 30 years is up.  This means that the only items that will change on your payment could be a change to your homeowners insurance premium and/or if the county property tax rate changes for the property you own.  Your principal and interest payment will always be the same.

     2.  Is there a situation where an ARM loan a better option than a fixed rate loan?

• That's a difficult question to answer.  Mostly because each borrower, situation and set of circumstances surrounding the purchase or refinance on a property are always different.  There is no "one size fits all" category to mortgage loans.  However, the duty of the Loan Originator is to provide the best options for the clients for their particular set of needs.  With that in mind, let's look at some key pros and cons to the differnt programs.
• ARM Loans
• PRO - Typically a Lower Interest Rate with the shorter term ARMS is evident.  A lower interest rate does lessen the interest cost that is paid to the bank during the introductory period and this reduces the principal balance faster.  Remember - less interest to the bank means more that can be applied to your principal balance.
• CON - Rate may adjust higher in the future which means more money to the banks and less towards principal.
• PRO - Borrower plans on selling within the timeframe on the loan.
• CON - Life, circumstances and markets can change so they may not sell.
• PRO - Lower payment could mean that a borrower could afford the payment
• CON - Any changes in the market could render the home no longer affordable which could leave the borrower in a bad situation.
• Fixed Loans
• PRO - Certainty of the same payment every month.
• CON - Rates are typically higher than the shorter ARMS so more interest is being paid to the banks and less towards your principal balance.
• PRO - Most common Programs - allows the borrower to set a budget for home affordability
• CON - Could limit your buying power because of the higher rates
• PRO - Simple and Effective
• CON - Most buyers don't keep their loans for 15 or 30 years.  The average homeowner refinance or moves every 5-7 years.  This means that more interest was paid out and less towards principal in the early stages of the loan.

Overall, the 15 and 30 YR Fixed rate options are the most common programs used today.  They allow certainty which, in this market, is great.  The rates are historically low so affordability shouldn't be a hinderance.  Plus, one should never switch to an ARM program to try and squeeze into the box so they can qualify.  This will inevitably lead to a bad situation. 

The best answer must come from each borrower individually.  Experts can predict the future, we can plan the future, but nobody really knows the future.  If you understand the loan program (whether it is Fixed or ARM) and you are comfortable with what the potential future holds with the loan you choose, then either option is valid.  I don't believe there is a specific situation where an ARM loan is "better" than a Fixed Rate loan.  I think they are different options to choose from and education is the key to making the best decision.

Changing Mortgage Perceptions

Everyone asks, when is it going to be easier to get financing?  Why do we have to jump through so many hoops to get a loan done?  Keep asking those questions and you may never like the answers.  Start asking questions like: How CAN we get financing on this new home purchase?  What ARE the options for my particular situation?  We have to continue to frame things properly.  The market isn’t bad – it’s actually much improved.  Financing isn’t difficult – it’s just work.  The place from which we question the system and view the world greatly impacts our reality.  The saying is that if we change our perception we can change the reality.  Our perception must be an understanding of all that it takes to work in this industry and then embrace that…don’t leave yourself at the mercy of your bad perceptions.

 

For example, our company alone has more loan products and programs to help people in all various stages of financing than even you can imagine.  Let’s see:

 

·         Clean Slate Program (for borrowers with short sale or foreclosure under 2 years)

·         Jumbo Loan Portfolio Option (quick closes for those quick deals)

·         Home in 5 FHA Grant Program (First time home buyer who needs a grant for down payment)

·         Canadian Financing (Looking for a 2^nd home – no problem)

·         95% LTV to $625,500 Loan Amount (Move up Buyer with a growing family)

·         90% LTV to $729,000 Loan Amount (Move up Buyer wants to keep some cash available)

·         80% LTV up to $2MM Loan Amount (Saavy individual who understands the time value of money and wants to leverage with current rates)

·         Brokered Options for your Underwater clients (Fannie and Freddie HARP deals) – Still stuck – we can help with that too!

·         Standard 30/15 YR Fixed Loans – (For the everyman/woman)

·         FHA between 580-620 (For those who hit a rough patch due to unusual circumstance)

 

And on and on the list goes.  ARM Programs, Construction Loans, Lot Loans, and more.  You see, it’s not that there isn’t financing available as some may say.  In fact there are many financing options available…it’s more about finding the right fit for the buyer than anything else.  You don’t have to go elsewhere to have the financing needs of your clients met…trust me, we run the gamut from top to bottom.  The only thing your clients need to know…is it will be work.  But hey, since when should asking for hundreds of thousands of dollars be easy.  Think about it, would you lend your $200K to the guy next door with 540 credit, who doesn’t pay his debt and can’t provide any documentation as to why that happened.  I venture to say no.  So, let’s call it like it is – work.  Are we really that afraid of a little work? 

Common Mortgage Questions

Mortgages are complicated - Truth.  Buying Real Estate is complicated - Truth. 

But just because something is complicated, doesn't mean it can't be understood.  My suggestion on the Real Estate side of things - find a competent and well versed Realtor in your target market area that works hard for you. 

As far as mortgages go - here are a few of the common mortgage questions:

1. How does my credit score affect the mortgage?

• Your credit score affects the ability to get a mortgage in different ways.  For example, with a score between 580 - 620, this typically means there was some type of derogatory credit (i.e. Bankruptcy, Short Sale, Foreclosure, Collection, Late Payments).  This derogatory credit influences the Underwriters (UW) decision to approval the loan.  In some instances, scores between 580 -620 are eligible, but they will require significant areas of strength in the file to overcome the credit hurdel, as well as a solid explanation for why the score is where it is.  Important Note: Financial mismanagement or choosing to not pay on an existing credit obligation is not a solid explanation.

• Your credit score will also affect the Interest Rate that you may receive on a loan.  Most lenders have "pricing hits" based on the credit score.  They typically go in increments of 20 or 40, depending on the lender.  For example, 620- 640 might have an interest rate at 4.00%, while a score above 740+ might garner a rate of 3.75% or lower.  With a lower score there is more potential risk so the lender will want to mitigate that risk with pricing differences. 

      2.  What's the difference between Origination Fee and Discount Points?

• The Origination Fee encompasses all the costs associated/charged by the lender for their services.  For example, the processing fee, underwriting fee, document preparation fee, etc. all comprise to give a final origination fee.  In some cases, the lender may even charge 1% of the loan amount just as a cost of doing business.

• The Discount Point is the charge the borrower (you) choose to pay for a specific rate.  Not all rates are created equal.  To keep it simple, I begin all rate quotes from the "Par" pricing.  This means the borrower pays the customary fees (i.e. uw fee, processing fee, etc.) but they aren't paying anything extra to secure a lower rate.  However, the choice is the borrowers.  They can offer to take a higher interest rate or a lower rate.  The higher rate will include a credit that will offset the customary fees or they can pay more above the customary fees to secure a lower rate.  There are pros and cons to both but we can save that for a later post.

      3.  Can I finance the closing costs in the loan amount when I am buying or refinancing?

• Another common question with a simple answer when you are buying a new home.  No.  In the "old mortgage world", lenders would allow borrowers to increase their loan amount to cover the costs on a purchase, however, that brings increased risk as the loan amount vs. the value of the home ratio will be higher than a lenders risk tolerance.  You can, however, take a higher rate to offset the costs (see #2 above) or include a seller credit to offset the costs.

• For refinancing - the answer is yes, in some cases.  If there is enough equity in the property, the lender may allow you to roll the costs into the new loan.  The most basic equity ratio is anything less than 80% will allow the borrower to roll the costs into the new loan.  However, if there isn't enough equity in the property, the answer is then no.

While these are a few of the common questions, there are many more that are asked.  What is the Seller's Owners Title Policy?  Does paying a discount point make sense?  Can I buy a new home if I currently own a home? What is a pre-payment penalty?  What is the escrow for taxes and insurance? What is the least amount of down payment one can contribute to a new purchase?  As the month of April continues I will work to answer a few questions each week in an attempt to let the mortgage process be better understood.