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The internet is a wonderful tool but it can be a source of problems to mortgage shoppers if they don’t really understand the process and the program(s) being offered. The following is the second example of potential pitfalls of internet mortgage shopping.

Payment Versus Program Focus
Often when I talk to potential borrowers they are more focused on the monthly payment than on the terms of the loan. In some instances, this can create unexpected problems, especially if the borrower(s) doesn’t understand the loan program(s) s/he is reviewing online.

A current refinance client couple have come to me after discovering the refinance they completed last year was at a interest rate of 8.2% during a period when rates were averaging around 5.6%. They were not actually shopping for a refinance but for a line of credit. The company offered unsecured lines of credit, much like a credit card as well as equity lines and home mortgages.

After contacting the company to obtain an unsecured line of credit, the lender agreed to provide my clients a credit line of $20,000 but wanted to “refinance” their house too. My clients told the lender they were not interested in an equity line and they were assured that the line of credit would not be secured by their home but, as part of the deal, the company would refinance their current mortgage. My clients were interested in reducing their mortgage payment but did not understand that just having the payment lowered didn’t necessarily mean they were getting a good deal. Also, their goal was to get a line of credit, not refinance, so they weren’t focused on a mortgage loan. The loan program they were given was at a much higher rate of interest and didn’t include their monthly escrows which they then had to begin paying out of pocket. The effect appeared to be reducing their monthly payment, but in reality, it increased.

Another issue was the new mortgage cost them 5 points in origination in addition to the other closing fees which totaled over $11,000 for a loan amount below $180,000. The new mortgage included a 3-year pre-payment penalty of 2 points. The unsecured line of credit was at a 22% rate of interest.

In my opinion, this situation would fall under the definition of “predatory” lending practices. However, my clients readily admit, since they were in a hurry to close, get the line of credit and they were focused only on what the monthly payment looked like, they failed to fully read the terms of the loan and the line of credit or the settlement statement of closing costs.

When focusing on other issues instead of the terms of your mortgage, it is easy to overlook important details. Don’t do your mortgage in a rush. Make sure you understand exactly what the terms of the loan will be and what that will mean to you over the life of the loan. Have your loan office explain every aspect of the loan program and ask questions about anything you don’t understand.

A mortgage is a long-term financial committment. Make sure it’s one you can live with!

The internet is a wonderful tool but it can be a source of problems to mortgage shoppers if they don’t really understand the process and the program(s) being offered. The following are two examples of potential pitfalls of internet mortgage shopping.

Pay Option ARM Amortization
A client has come to me to refinance his 3/6 Pay Option ARM. He found the program after shopping on the internet for a low rate two years ago. Pay option ARMs offer a payment selection each month: minimum payment, interest-only payment, full principal and interest payment, or 15-year payment. What most borrowers don’t understand is how these payment choices really work and what their impact is on the principal balance over the life of the loan.

If you make the full principal and interest payment or the 15-year payment, you are maximizing the full benefits of the lower interest rate you get with these type ARMs. However, if you make the minimum payment or the interest-only payment, there is potential risk. With the interest-only payment, you are not reducing the principal loan balance so at the end of the fixed-rate period (in this case, 3 years), you still owe the same amount as you did when you first closed on the loan. With the minimum payment, you’re probably not even covering the full interest amount each month, which is then tacked onto the principal balance. In effect, you are then paying interest on interest.

Essentially, it works like this. If you have a $250,000 principal balance and the minimum payment is $1100 but the full interest-only is $1295, the $195 difference is tacked on to your $250,000 each month you make the minimum payment.

For my client, the result is that after making minimum payments for the last two years, his original loan balance has increased by over $10,000.

This can create serious problems if you are in a position where you need to sell your property and appreciation hasn’t off-set this principal balance increase. Not to mention, you are now paying interest on interest charges.

Pay Option ARMs are great loans when the borrower fully understands how they work and maximizes their advantages while avoiding their disadvantages.

Next, Part II…..Payment Versus Program Focus.

No matter what type of transaction you may be planning, it is necessary to read the fine print. As frustrating as it is, with the “us versus them” mentality of today’s world, it’s imperative that you read every line of a contract, agreement, lease, lien, etc. Businesses, in all forms, have contracts for just about everything. Even the most simple exchanges.

When conducting business of any kind, the “bigger” the company, the “longer” the contract and the “finer” the print. Even when consumer protection is mandated by laws and regulations, many business use finely-printed caveats or loopholes to “stack the deck in their favor”.

Federal regulations require that the terms and conditions when you are borrowing money for a home be written out as part of the settlement paperwork. Those terms and conditions are there, but they may be buried in small type and legal jargon. I’ve seen settlement paperwork that even the closing attorney found cumbersome and confusing.

Once you have decided to purchase a home or refinance one and complete the loan process, you are scheduled for closing with a settlement agent, usually a real estate attorney or title company. With the real estate boom of the last several years, the number of closings an agent has to complete in one day can be huge. Agents rarely schedule more than an hour for any particular closing.

What you should do? Arrange to get there early. Ask to have the closing paperwork ready and take the time to read every word. When you don’t understand something, make a note and then ask your settlement agent to explain it. If the settlement agent is unable to answer your questions, call your loan officer.

Don’t sign the paperwork without having your questions addressed to your satisfaction.

Created by Congress in 1938, Fannie Mae is the nation’s largest source of financing for home mortgages. A private, shareholder-owned company that works to make sure mortgage money is available for people to purchase homes. Fannie Mae describes it’s goal as “helping more families achieve the American dream of homeownership.”

Fannie Mae, as the largest underwriter and purchaser of mortgage loans, has set the standards within the mortgage industry for conventional lending. If you are purchasing a new house, no matter what lender you get financing through, the criteria you must meet in order to qualify for the loan has been established by Fannie Mae. Exceptions are niche market loans that are not eligible for re-sale to Fannie Mae.

Lenders and brokers access Fannie Mae’s underwriting guidelines via their web-based “Desktop Originator”. With the ability to submit a loan application directly into Fannie Mae’s automated underwriting, the time in which it takes a loan to be processed and closed has shorten considerably. Getting a mortgage used to take months, now it can be done in just a few weeks.

We [Fannie Mae] are in the American Dream business. Our mission is to tear down barriers, lower costs, and increase the opportunities for homeownership and affordable rental housing for all Americans. Because having a safe place to call home strengthens families, communities, and our nation as a whole.

Since 1938, we have helped put more than 66 million families into homes of their own, and as long as more Americans continue to dream of a safe place to call home, we’ll keep working with our partners to make it a reality.

More Americans own homes today than at any other time in history. Fannie Mae is working to expand homeownership opportunities by joining with lenders and community partners to create products and technologies to reach underserved communities, so that more people can own their own homes.

In a real estate transaction, earnest money or deposit on the contract for sale is made to a home seller or their representative, usually a real estate agent, to secure an offer to buy the property. It is required for the contract to be valid or ratified. The amount of the deposit is up to the buyer, although in some areas or situations, there are expected standards for the amount.

The earnest money is held in escrow by either the seller or the seller’s representative until closing. At the close of the sale, the money is transferred to the closing agent and deducted from the total amount the buyer must have available to complete the sale.

It is recorded on the settlement statement (HUD-1) under Amounts Paid By or In Behalf of the Borrower and subtracted from the Gross Amount Due from Borrower. Therefore, the borrower is credited with having paid that amount toward the purchase in advance of closing.

Should the terms of the contract for sale not be met by the seller, the earnest money deposit is returned to the buyer. If the terms of the contract for sale are not met by the buyer or he decides to withdraw his offer, the earnest deposit is subject to forfeit.

A point is one percent (1%) of the mortgage loan amount. The first point that you pay for a mortgage is usually called an origination point. It is sometimes called a brokerage fee or a bank fee. Additional points charged are often to cover costs associated with a particular loan program. Lenders charge different amounts in points for different programs. In general, the more risky the loan is to the lender, the more they charge in points and/or fees.

The points are tax deductible because they are considered interest paid in advance. Any points you pay at closing on a new purchase are tax deductible in the year your purchase the new home. Points paid in a refinance must be deducted over time. For more detailed information on how points are deducted from your taxes, you should consult a tax professional.

Believe it or not there are times the interest rate is unimportant when you are getting a loan. Right now everyone is caught up in trying to explain what Greenspan calls the “conundrum”. The National Association of Realtors’ chief economist, David Lereah, is reported as saying,

Not only have mortgage interest rates declined, but an expected rise in the second half the year will be slower than in earlier projections.

With the rate on 30 year fixed mortgages dropping below 5.5%, almost a full percentage point less than this time last year, when would someone purchasing a new home not want to worry about the interest rate?

If you are a first time homebuyer and have been paying premium rental fees, you will save money by purchasing a home no matter if the interest rate is 5.5 or 6.5. Depending on your income and tax bracket, the interest rate would have to hit double digits for you to question whether or not you would experience savings. It is almost always cheaper to own home than to rent, especially if you earn over $40,000 a year and have no dependents.

If you have specific circumstances which make your loan program a niche item, your rate won’t be as low as current market but if it allows you to meet your overall financial goals, then you want to do the loan despite a higher rate.

I tell my clients routinely that they have to look at the big picture of what they are trying to accomplish. If the higher rate program helps them better meet their financial needs, then the rate doesn’t matter.

Private Mortgage Insurance, also known as PMI, is a supplemental insurance policy you may be required to obtain in order to get a mortgage loan. PMI is provided by private (non-government) companies and is usually required when your loan-to-value ratio — the amount of your mortgage loan divided by the value of your home — is greater than 80 percent. It is important to note that PMI is an insurance policy for the lender to ensure that they will be paid back the amount of the mortgage in the event you default on your loan. The premium for this insurance is broken into monthly payments and added to your monthly mortgage payment.

PMI isn’t always a bad thing — it can allow you to make a lower down payment and still qualify for a mortgage loan. In past years, without PMI, many of us would not have been able to purchase our first home. Now with a number of lenders, if you have good credit, you can get a loan with a higher than 80% LTV and still not have to pay PMI insurance.

One thing about PMI insurance that has always bothered me is that you, the borrower, are paying for an insurance for the lender guaranteeing that the lender will be paid in full if you default, yet, the lender still gets to foreclose on the property as well. They get paid by the insurance and get the property too! Seems like a double dip to me.

Your PMI premium is fixed based on plan type (loan-to-value ratio, loan type, loan term, etc.) and is also related to your particular credit history or other individual characteristics. PMI typically amounts to about one-half of one percent of your mortgage amount annually, according to the Mortgage Bankers Association. On a $200,000 mortgage, you may be paying $1,000 per year for PMI. Nonetheless, I have seen PMI insurance premiums that were considerably more than .5% of the loan amount.

Your best bet to avoid this expense is to either put down the required 20%, ask your loan officer if you qualify for a program that does not have PMI even with higher LTVs, or do a combination loan.

A combination loan means that your loan is broken up into two parts. You have a first mortgage up to 80% LTV and at the same time a second mortgage for the balance up to 100% LTV. This type loan can allow you to make a lower down payment and still avoid PMI.

In some cases a subprime loan is a good way to avoid PMI. If the combine interest rates and payments on a combo are going to be uncomfortably high and you have good credit, you could ask your mortgage broker to look at subprime lenders. Subprime lenders do not charge PMI insurance no matter what the LTV is. Also, to borrowers with high credit scores, subprime lenders offer rates that are competitive to conventional lenders.

Subprime lending is often a two to three year proposition as the loans are usually 2 or 3 year ARMS and after the initial 2 to 3 years the rate adjustments could be too high for comfort. However, some subprime lenders offer excellent fixed rates to borrowers with superior credit and the savings of PMI insurance and/or combined costs of a combo loan can make this a more attractive loan option for those borrowers.

As a full-service mortgage broker, I deal with a broader range of consumers than other loan officers. It is because I am able to offer such a wide variety of programs from multiple lenders versus loan officers that work for just one lender and offer only that lender’s programs.

I also offer my clients as much information and/or assistance I can when helping them choose a specific type of mortgage since I believe this will significantly impact their overall financial picture. I do not attempt to act as a financial advisor. I do try to make sure that whatever type loan they are interested in will support whatever financial goals they tell me they have.

An informed, educated borrower is empowered to make better financial decisions for themselves and their family. Therefore, I work hard to make sure my clients are well-informed of the loan choices and/or options.

I’ve had two recent experiences that have led me to write this article. Both times my clients came to me with very specific ideas about what type of mortgage they wanted. After reviewing their credit and financial picture, I had to recommend against the loan programs they believed they wanted.

Why would I do this………………..especially since both times resulted in my losing the opportunity to make money on the loan?

The answer is simple. It was a bad financial decision for my client. In each case the loan was obtainable for them, the downside in both instances would have resulted in such a financial strain that my clients would have been risking their overall fiscal health.

While it’s not my job to manage my client’s finances, I do believe that I have a responsibility to point out potential pitfalls. If they are considering mortgage options that would leave them extremely vulnerable financially should they have an unexpected loss of income or health, I feel honor-bound to tell them the risks and recommend another course of action.

There are also a lot a loan programs that look good from some particular aspect but overall, if you read the fine print, are very risky to the borrower. I don’t recommend these products to my clients. When they come in to meet with me and ask for them, I recommend against them.

I base my recommendations to my clients on my heartfelt belief that if I wouldn’t buy it, I shouldn’t sell it to you.

Remember, when shopping for anything, the person representing the product is usually very knowledgeable, not only of their product, but of the competition’s products as well. If you’re dealing with an honest professional and you ask the question “would you do this” and their answer is “no”, you probably don’t want to do it either.

If you want the advantage of bi-weekly payments and are setting it up yourself, you may want to refer to the following checklist:

1. Figure out your draft amount for each pay period.
Take your total monthly payment, multiply by 12, then divide by the number of times you’re paid each year.

2. Go to your bank in person or online and find out what they need for you to set up your automatic draft payment schedule.

3. Make sure you are ahead on your payments when starting your automatic drafts to cover any unexpected payment delays and ensure there are no late payments.

4. Send your lender a letter telling them you are going pay by automatic draft, when drafts will begin, and how often they will be made. Please note that it is possible that there may still be some companies out there that don’t accept automatic drafts from a bank. If so, you can still pay on a bi-weekly schedule, you will just have to do it manually with a check. Make sure you send a copy of the payment coupon or statement with each check and put the last 4 digits of your loan number on your check for reference.

5. For the first few months, check your payment history and balance information every month with your lender. This ensures payments have been made and applied timely.

6. If you receive notice that your loan servicing has changed to another company, take steps immediately to have your drafts sent to the new company. Then follow step 5 again for the first few months.

Additional notes: Lenders sell their loans off to other lenders or servicing companies on a routine basis. A lot of my clients worry this will negatively impact their loan. This does not affect your loan in any way, it merely changes the location the payments are made to. It is helpful to know that for the first 90 days after a loan is transferred from one company to another, neither company can report any derogatory payment history to your credit report. So just make sure you have your payments sent on time to the correct place within those first 90 days.