|
Points vs. No Points
Points are often a misunderstood concept for first time home buyers. Points are nothing other than interest paid up front (at the time of closing), to obtain a lower interest rate on a loan. One point is equivalent to 1% of the amount of money borrowed. If you are going to borrow $300,000 on your loan, one point would equal $3,000 up front. This generally generates 1/4 to 3/8 of a percent lower interest rate, depending upon the loan program.
When does it make sense to pay points? Paying points is a prudent financial move, if you are planning to be in the loan for a long period of time. Again, one of the most important questions to address when you borrow money is, “How long do you need to borrow this money?” This will answer the two all-prevailing questions you will have, which are 1) Should I pay points? And 2) What loan program is best for me? Notice that the question is not geared to, “How long do I plan to live in the home?” But more appropriately, “How long am I likely to be in this loan?” How long you will be in the loan is not only affected by the tenure that you own the home, but also the probability of seeking a refinance at some point in the future. As a general rule of thumb, you will need to be able recuperate the total cost of the points in a period of time that is less than the amount of time you will need to borrow the money for. Here’s an example. Let’s say you are going to borrow $300,000 for your mortgage, and choose to pay one point, which equals initial up front closing costs of $3,000. If paying one point up front saves you $100 a month, this means it will take you 30 months or 2.5 years, to recuperate the cost of the point that you paid. If you refinance the home anytime before that 30 month mark, or decide to sell the home, you will have effectively wasted money. However, if you stay in the home for longer than a 30-month period of time, it is a wise financial move. When deciding whether or not you should pay points, take into consideration where interest rates are at when you seek financing, and compare that to historical market trends. When interest rates are at historical lows, it makes much more sense to pay points, especially if you think you will live in the property for an extended period of time. Historically low rates, combined with the fact that you know you do not intend to move would indicate you will have longevity in the loan. It is unlikely rates will go down, giving you incentive to refinance.
Rates are cyclical. When interest rates are off of their historical lows, and higher than they generally are, we know that there is a strong likelihood rates will eventually come down. This is certainly no time to pay points. The chances of refinancing at some point in the future are extremely high, and therefore, you would not need to be in this loan for a long period of time. Credit Scoring
Your credit score is a factor that will be considered by the lender when they look at your loan application. They want to know what your credit history is, and whether you have the ability to pay back the loan you are asking for. In short, good credit translates into lower rates for the home buyer and represents less risk to the lender.
Credit scores can range between a low score of 300 and a high of 900. Most commonly, we deal with scores ranging from 400 to 800. The higher the client’s score is, the less likely they are to default on their loan. We will run a credit report and determine what your credit score is, and if necessary, we can point out some simple ways to help you improve your credit score without enlisting the help of a credit repair service. Once you fill out a loan application and enter into the loan process, you should not run up your charge cards! This would have an adverse effect on how the underwriter looks at your file. If you have a poor credit score, it doesn’t mean you can’t qualify at all for a loan. There are loan programs available even if you’ve had a recent bankruptcy. While you may not get the interest rate you had hoped for, it is an opportunity to start building up your credit again. Once you begin making mortgage payments on time and in full, your credit standing will improve and we can seek to refinance you at a lower rate as soon as the opportunity arises. Pre-payment Penalties Lenders attach pre-payment penalties to loans to ensure that the loan will be profitable for them. As a general rule of thumb, we do not suggest that you accept a pre-payment penalty as a part of your loan structure. One of the most important aspects of financial planning is to have options with your money. Restrictive clauses such as a pre-payment penalty can prohibit you from maneuvering when it is necessary and when other opportunities arise.
If you want to accept a pre-payment penalty clause in your loan, it is much more advisable to go with a “soft pre-pay.” This only penalizes you in the event of a refinance, but not if you decide to sell the home.
Interest rates have dropped significantly many times over the last 15 years. Many home owners have not been able to take advantage of lowered rates by refinancing, because their hands have been tied by a daunting pre-payment penalty. Pre-payment penalties will generally provide you with a slightly lower interest rate in exchange for the pre-payment penalty clause. Mortgage professionals will sometimes push the benefits of a pre-payment penalty so they can beef up their commission. Be very leery of this type of sales pitch! Negative Amortization Negative amortization loans are some of the most misunderstood loans available in the market place. The negative stigma (no pun intended) comes from a lack of education to the consumer by mortgage professionals. The only way you can get into trouble with a negatively amortized loan is if you truly don’t understand how it works, or if you lack the financial discipline to make sure you are not allowing yourself to fall into a compromising position. In a regularly amortized mortgage payment, part of the payment goes toward a portion of the principal and part goes toward interest payment. In a loan that involves the potential for negative amortization, you have several payment options each month. You can make a low introductory rate payment, an interest-only payment, or a fully amortized payment. This type of loan works very well for borrowers with a seasonal income, or income that fluctuates. Certified Public Accountants, investment advisors, and sales people who work on a commission basis often go with this type of a loan because it allows them to have greater control over their cash flow on a month-to-month basis. Once again, each and every month you must choose between three payment options. Let’s understand how a negatively amortized adjustable rate mortgage works. All adjustable rate mortgages require the lender to add a fixed component (which is known as the margin) to the varying portion of the adjustable known as is the index (T-Bill, Libor, 11th District Cost of Funds, etc.). In an adjustable rate mortgage, the margin + the index = your interest rate. If your fixed margin is 3 and at the time of an adjustment the varying index of a treasury bill is 4, then your interest rate is 7%. Negatively amortized loans typically adjust on a monthly basis, which means that every single month the lender takes the fixed margin and adds it to the varying index to derive your current interest rate. One of the protection vehicles of an adjustable rate mortgage is called CAPS. CAPS limit the amount that your payment can go up in any monthly period of time. In a negatively amortized adjustable it is common to have a 7.5% annual increase CAP. For example: If your mortgage payment in the calendar year of 2003 was $1,000 per month, the most that your mortgage could be in the calendar year of 2004 is $1,075 dollars per month. This is because the annual payment increase CAP of 7.5% would kick in and limit an obligated payment to the lender to a maximum of 7.5% increase over the previous year’s payment. However, during each of those months the lender would still add the fixed margin to the varying index to derive what the true interest rate is and calculate the mortgage payment associated with that true interest rate. If in fact the payment in this example came out to $1,100 a month, you would still only be obligated to pay $1,075. However the $25 difference would be tacked on to your principal balance that you owe, therefore accruing interest against your principal and increasing the balance that you owe on your loan to more than you originally borrowed. Hence the term “negative amortization” comes into play. Once again, a negative amortization loan doesn’t have to be a negative situation. It works well for people who understand how to use it to their benefit. Many consumers actually use this type of loan as an equity line of credit that is built in to their 1st Trust Deed indebtedness. Often when consumers want to invest money in the stock market or other types of investment vehicles, or simply want to control their cash flow and minimize their monthly payment, they will intentionally choose this “equity” that a negatively amortization loan permits. Just remember that most of these loans have a 125% CAP on the original amount borrowed. This means if you originally borrowed $100,000, once the loan amount rises to $125,000 the lender would not permit you to continue to use negative amortization. Junk Fees A junk fee is a derogatory term defining extra fees tacked on by the lender, which are charged as a dollar figure rather than a percentage. It is important to know that you can often negotiate these fees or have them removed if they have not been properly disclosed to you. The lender is required to provide you with a Good Faith Estimate disclosing their fees.
Other fees that are NOT considered junk fees are the appraisal fee, credit report fee, escrow or attorney fee, title insurance fee, recording fee, notary fee and transfer taxes. These are legitimate fees that are paid to third parties and are necessary to complete the transaction.
|