The Good, The Bad, and the Truth about Adjustable Rate Mortgages (“ARMs”)

When Borrowers decide to lock in their fixed-rate mortgage, they are guaranteed that rate whether the Lender's interest rates increase or decrease.  I discussed how rates are determined in an earlier blog, Current Interest Rates Mean More House for Buyers  Rates will fluctuate based on the market and Borrowers need to decide when they want to lock in or set their rate.

One of the most common questions I get from Borrowers is "Should I lock in now or float?"   There is no crystal ball to let Lenders or Borrowers know if locking in early is a good decision.  I cannot give a definite answer because a rate can rise or decrease (multiple times!)  from when a Borrower applies for a mortgage until the time they are at the settlement table.  Unless you are in the mortgage industry, you might not realize that rates actually change a few times a day.  It’s similar to the stock market, you can follow the analysts, but no one can predict with 100% accuracy. 

So, what are your options? Outside the US, variable-rates mortgages are the norm, especially in countries such as the UK, Ireland, Canada, and Australia.  The majority of mortgages in the US are fixed rate, however ARMs should be considered by some borrowers

The Good:  Most ARMs provide a cap, so this safeguards or limits the risk to the borrower.  In the end, Lenders want Borrowers to pay back their loan, so there is a limit to how much risk they want the borrower to absorb. Current caps are still much lower than normal fixed mortgage rates were 10 years ago.  Moreover, Borrower’s initial payments will be lower, giving them more buying power and the ability to afford “more house”. 

The Bad: Adjustable rate mortgages or ARMs transfer the interest rate risk from the Lender to the Borrower. The Borrower will benefit if the interest rate falls, but could lose if the interest rates increase.  Borrowers should avoid ARMs if they play on staying in their home 11 years or more or if there is little chance rates will ever drop.  

The Truth:  The risk might be worth it! Overall adjustable rate mortgages are typically less expensive than fixed-rate mortgages. ARMs are a great way to get the house you want now before you can afford higher payments.  Consider this scenario:  You are working at a company what will increase your pay as soon you receive your Master’s Degrees.   You are less than a year ago from getting your degree and need to move for your spouse’s new job.   Instead of getting a small house and then looking for another house after your pay raise, it is more cost-effective to move once and get an ARM.  You know your pay will increase within the next year or so, meaning you can support an increase payments IF rates change in five years. Most ARMs have an initial fixed-rate period during which the borrower’s rate doesn’t change, followed by a period during which the rate changes at present intervals.  Compare the two choices below for a house worth $288,000:

Option 1: 30 year fixed rate Mortgage at 3.625%. Principal and Interest payment $1,313.43

Option 2: 5/1 ARM at 2.625%. Principal and Interest payment $1,156.75

Balance remaining in 5 years:

30 Yr fixed:  $259,408.54

5/1 ARM: $254,865.49

Winner: Principal balance on the 5/1 ARM is $4,543.05 lower

Best part is your monthly payments will have totaled $9,400.80 less for a Net savings of $13,943.85!

I would recommend ARMs for buyers when their income is expected to increase, they are likely moving in 10 years or less, or plan on retiring and paying off home within 10 years.   In reality, ARMs benefits a large segment of the population if you consider the fact that 91% of the mortgages are in place 9 years or less.  Read all the fine print closely to make sure your ARM does not have pre-pay penalties, provides caps on the rate, and the interval rate changes are when you can afford the possibility of a higher payment.  It comes down to being an informed consumer and knowing what your plan is for the next five years.  If you know that, you have the potential to save a lot of interest on your mortgage.   ARMs may seem risky at first glance, but they really can benefit certain Borrowers.   When in doubt, have your Mortgage Broker compare fixed and adjustable rate options so you can see the full picture.  

Overcoming Mortgage Hurdles for the Self-Employed

You might be one of the 9 million people who have decided to become self-employed.  Being self-employed probably introduced taxes and health care coverage challenges.  You have finally settled into your new lifestyle and decided to apply for a mortgage.   Perhaps you cannot provide W2 or traditional predictions of incomes.  There are still a few ways to prepare for a smoother process when you apply for a mortgage.

Self-employed borrowers have a higher hurdle to overcome after stricter mortgage requirements went into effect in 2014.  These borrowers must now provide two years’ worth of tax returns.  The most common complaint from borrowers is that these returns are an unreliable record of their take-home pay.   There are many tax advantages of taking as many deductions as possible, but that does not necessary translate into an advantage when applying for a mortgage.

How can a self-employed borrower overcome this extra challenge?  Organize and prepare BEFORE you apply for a mortgage.  Buying a home is a big decision and it helps to have your taxes aligned with your home buying goals.  Looking ahead means self-employed borrowers should plan on taking fewer deductions the two years before buying a home to boost their overall income.  Yes, it might translate into increased taxes for a short time, but being able to qualify for a mortgage and a better interest rate will be worth the extra time strategizing with your accountant. Moreover, make sure you are showing an increase from year to year.  Lenders might ignore seasonal increases and decreases (landscapers for example) but they do not want to see a constant decline.  Borrowers should focus on their business appearing consistent and not volatile.

For those of you on a time constraint, you might have to consider alternative options. Do you have a spouse or family member whose income is documented by W2s willing to co-sign on the mortgage? You might not be able to qualify for a larger home based on only one income, but applying for a conventional loan would be easier. 

If you are saver, you also have an option of an unconventional loan.  For example, unconventional loans allow qualified borrowers to apply using the deposits recorded in their bank statements.  Just because a loan is unconventional does not mean you are necessarily paying more in interest.  There are numerous options for the self-employed borrower.   A mortgage broker can look at your personal situation and suggest the best option for a loan.  Look for the most up to date rates on www.lordmortgage.com

“Know Before You Owe” Mortgage Rules Coming Soon....

“TRID”  is the less intimidating name for TILA-RESPA Integrated Disclosure Rule which will go into effect October 1, 2015.   This change in the regulations means new forms for mortgage professionals, real estate agents and consumers.   “TILA” or Truth in Lending Act and “RESPA” or Real Estate Settlement Procedure Act of 1974 are the two forms lenders must share with the borrower shortly before or at the time of closing the loan.   The intention of the original Act was to make the process less confusing, but the need enact a new law (TRID) would indicate that wasn’t always the case for consumers  TRID is a chance to correct past mistakes.

Everyone is aware that there are more stringent lending standards in place since 2008 to help consumers not get in over their head when applying for a mortgage.  My first impression of TRID is that it is meant to S-L-O-W down the process.   Certain construction loans, raw land, and “bridge” loans will be subject to TRID, but were previously exempt from required waiting periods from RESPA.  (Bridge loans are used to finance the purchase of a new home using funds from an existing home sale) Expect a longer mortgage cycle for these types of loan after August 1st. 

What exactly is slowing down the loan process? At the start of the mortgage application, there are new forms, such as the Loan Estimate form which will be provided to borrowers no later than three business days after they submit a loan application.   Clearer language and design will make it easier for the borrower to read and truly understand all the costs of the loan. In theory, this requirement will give borrowers more time to examine the costs of the transaction and confirm they truly want to move ahead with the transaction.  In addition to paperwork, the last update to the law (RESPA and TILA) required lenders to also provide applicants with a list of certified homeownership counselors if they are proceeding with a high-cost mortgage.  Realtors will need to wait a longer time period to hear back if a loan was approved for their buyers because of this new waiting period.

Also under the new rules, the borrower must receive the Closing Disclosure no later than three days prior to the date the note is signed aka “closing”.  In the past, the borrower might receive this paperwork the day prior or even the morning of settlement.  TRID will in essence, push the rush for documents from the day prior to closing to three days prior. The rush will be on the folks involved with the closing, not the borrower.   Realtors will have to be familiar with these forms which are replacing HUD-1 and Truth in Lending Disclosures. Working closely with a Mortgage Broker you trust will make sure your closing go smoothly and all required paperwork is sent at the required time interval.  

Writing the Perfect Letter of Explanation

You just received an email from your Loan Officer asking for a Letter of Explanation.   Many borrowers have no idea what should be contained in that letter or even more importantly, why it is required.

Lenders scrutinize every aspect of your financial life when you apply for a loan.  You probably already sent in copies of all your bank documents, taxes, W2s, etc.   Why would they be asking for more information? Underwriters are the people that “approve” the loan for the bank.  They compare their guidelines and your documents to determine if you fit the criteria to borrow the amount you requested.  If something cannot be explained in the loan file, then they will ask for information to fill the gap and complete the loan file.  That information can come in a form of a Letter of Explanation. These letters are then retained in case the Government or another Underwriter has to review the file.  Missing or incomplete files can mean penalties for the banks. 

For example, you provided bank statements for the last year. The Underwriter noticed a large deposit in your saving account in June 2014.   On the bank statement, it is simply listed as a deposit and is not categorized as a normal direct deposit from your company.  When asked, you immediately recognize the large deposit was the money from the personal sale of your boat.  The Loan Officer will then have to confirm it was money from the sale and not money someone had loaned you to help pay for the house.  You need to create a simple “Letter of Explanation” stating this was from the sale of your boat and you no longer have the receipt of sale available. You only need a few sentences to explain this and then most importantly, your signature.

These letters are almost like sworn testimony.  Perhaps you lost the receipt of sale or it got destroyed.  It is hard to replace that receipt, but the bank is willing to “take your word” in the form of a Letter of Explanation.   They can be used not only for deposits, but to describe conflicting addresses, names or employers that appear on your credit report. Letters can also be used to explain the circumstances surrounding late payments or bankruptcies.  What information should be provided? Start with a date and greeting and and introduce the specific issue or incident with as much detailed information as possible.   

April 22, 2015

To Whom It May Concern:

I am writing to explain the deposit of $6,700 in my Hometown Bank Account on 6/3/2014.  I deposited the funds received for the sale of my 2013 Nitro Z Boat to Tom Smith on June 2, 2014. I no longer have a receipt for the sale and the company that transferred the title is no longer in business.   

Sincerely,
Eager Borrower (and spouse name if joint application)  

Be as specific as you can and use actual dates and dollar amounts.  If the letter is describing a late payment or financial issue, describe the steps you have implemented so it won’t happen again.  For instance, you can describe the late payment of medical bills and then follow up by saying this debt has been entirely repaid and you have kept up with all new credit obligations since that illness. 

Understand, Letters of Explanation only help Lenders make decisions for marginal applicants; they are not going to be a replacement for Borrowers with insufficient credit or income to qualify for a loan. In essence, they provide the Lender with a more complete picture.  If you have any concerns about writing these letters, always ask your Loan Officer for guidance.

Looking for an extra 27k? Start by Maximizing this year’s Tax Return!

It’s that time of year again.  We all need to calculate how much we will be getting back from Uncle Sam.  Have you planned what to do with your tax refund?  Are you interested in getting more out of this year’s refund?  If so, be prepared for some shocking numbers. 

Borrowers often overlook the value of extra mortgage payments.  There are a few things you can do to shorten the time until you are debt-free.  Yes, it is possible to own your home sooner by following a basic piece of advice.  Consider putting a portion your tax refund to good use this year by making an extra principal payment on your mortgage.

So, how much can you really save if you pay one extra mortgage payment each year?  Does $27,000 and 4 less years of mortgage payments sound like a good return?   Yes, that would be the savings if you have a home worth $250,000 with monthly payments of $1,190.  (If your house is worth more, you will save even more!) Taking a portion of your tax return each year equal to just one month’s payment would produce a quite a savings for borrowers, even if they are only paying 4% interest on their mortgage.   It might be a small sacrifice each year, but imagine how memorable those last 4 years will be with no mortgage payment in addition to a tax refund! Call today and learn how much you can save by making one extra payment with your income tax return.

APR vs Interest Rates: Which one is more important when shopping for a mortgage?

Everyone has received various credit card offers in the mail that state 0% APR for the first 6 months.  Consumers are conditioned to glance past the disclosure part of the offer in fine print explaining how the APR is calculated and simply recognize that it is a good deal…..at least for the first 6 months.  You might already know "APR" is an abbreviation for annual percentage rate and it indicates how much is being charged to borrow money. However, you might not be 100% sure how the credit card company is calculating each month.  

The interest rate that you are quoted when you apply for the mortgage is the cost you will pay to borrow the money for the home loan.  The APR represents the entire cost of the mortgage, including closing costs, and any other charges to get the loan.   Therefore, the APR is usually higher than the interest rate.  It might be less than one percent higher, but by law, the lenders must have full disclosure to the borrower under the Federal Truth in Lending Act.  It is actually wise to look at the APR, not just the interest rate, when applying for a mortgage.

Why do our law makers want Lenders to disclose this particular number?  APR is the basis for comparing certain costs of loans.  Savvy borrowers should not only compare the interest rates quoted from the Lenders, but focus on the APRs to get a fair comparison of total cost.

The example below will demonstrate just how important the APR is:

Borrower is comparing rates between two Lenders. The current loan balance is $200,000 and the home is worth $250,000. Let’s see how the offers compare: One Lender is offering a rate of 3.625% and the other is 3.75%. He is about to lock with the first Lender when he sees the APR and is wondering why it is higher than the agreed upon interest rate.

Lender 1: 30 year fixed rate mortgage, 3.625% with 1.5 points and $3800 Closing Costs. APR is 3.9. To cover the Closing Costs the new loan amount is $206,500. Based on 3.625% the Principal and Interest payment will be $941.75.

Lender 2: 30 year fixed rate mortgage 3.75% with 0 points and $2400 Closing Costs. APR is 3.84 and the new loan amount is $202,400. Based on 3.75%, even though the rate is HIGHER than the first Lender the Principal and Interest payment will be $923.05. Option two will save the Borrower $6,732 over the term of the mortgage.

By requiring Lenders to disclosure the APR on a loan, Borrowers will get the full picture of costs when comparing the actual APRs.  Reviewing the Good Faith Estimate, a borrower can compare and determine how other loan costs such as points can increase the APR.  Even though the first loan at the lower interest rate seems like a better option at first glance, it will cost MORE over the life of the loan.   If this particular borrower wants to save money, he should go with the second option. Even though the interest rate is technically higher, it is costing him less money for the same loan amount. 

Current Interest Rate Means "More House" for Buyers

Why do Mortgage Brokers and Real Estate agents track mortgage interest rates daily? The difference in just a few percentage points means a family might be looking for their range of affordable houses in two completely different neighborhoods or even zip codes.

If the typical American family makes $60,000 a year and has basic living expenses and a normal amount of debt, they can afford approximately $1,850 a month for their housing payment. (The calculation is based on $2,250 in total expenses, including a car and house payments.)  What does that translate into as far as how much home this family can afford?  Well, the answer depends on the mortgage interest rate at the time of application.  This integral number factors into each monthly payment, which in turn factors into the overall amount of home loan they are allowed to borrow.

How are these rates determined? And how can they change daily?  It is a complex formula based on the secondary market where mortgages are bought and sold.  Mortgage rates most closely follow the 10 Year Treasury Bond, but fluctuates as bond prices changes. The economy is also a factor and if it is slower economy, rates drop which encourages homeowners to buy.   Both Freddie Mac and Fannie Mae are government agencies that try to keep this secondary market stable.

Comparing this same family’s buying power now and in 2000, they could afford much more home now because the rates are lower.  In July 2000, mortgage interest rates were 8.5%, which meant they qualified for a $250,000 home.   If they put 20% down at 8.5%, they would have a $200,000 loan amount.  After taxes and an insurance escrow at $315 month, the payment would be $1852.83 a month.

This same family can now afford a loan for a $400,000 home.  If they put 20% down at 3.75%, they would have a $320,000 loan amount.  After taxes and an insurance escrow at $370 month, the payment would be  $1851.97 a month because rates have dropped. This scenario assumes the same income and debt ratio as the previous example.  You can understand why anyone working in the real estate profession would be tracking these rates closely!  

Lord Mortgage provides daily, live rates so you can predict the best time to buy a home or even refinance your current home.  Add this site to your favorites, so you can also stay ahead of the curve http://www.lordmortgage.com/#!rates/c11su