Adjustable Rate Mortgages
Adjustable Rate Mortgages (ARMs) as you may have guessed fluctuate the interest rate on your 30-year home loan. Most ARMs appeal to people who are planning on staying in a home for only a few years. For the first 1-3 years the interest rates are lower than the going rate. However, ARMs can be a bit risky and you may end up paying more interest than you would have with just your normal mortgage. Because the loan is variable the interest rate can go up and super exceed the going rate over time.
There is a maximum that the interest on the loan can increase in each variance. This is known as the rate cap. For example, if you have an ARM that changes interest rates every 12 months the cap might state that the interest rate cannot rise more than 2% each year. All ARMs have a lifetime rate cap that will not let the interest rate go above a certain point. This is for protection to the borrower.
The mortgage rate an ARM gets is determined by its index. Different indexes change at different rates. There is no good or bad index. They all have advantages and drawbacks and are used in different situations. You will want to find one that is more fit to your needs. ARM indexes generally relate interest rates to how the economy in doing. As the interest rates fluctuate up and down so do your payments. ARMs don't always adjust according to indexes, however, they can adjust to conditions also.
In the end if you play your cards right ARMs can save big bucks for the first three years. So, if you're planning on living in a home for less than 10 years an ARM may be the direction you want to go.
Here are some different types of ARMs:
1-Year ARM - An Adjustable Rate Mortgage in which the interest on your loan changes every 12 months from the anniversary mark of your 30 year loan. It is considered quite risky because your monthly payment will change each year and over time the interest rate will likely climb. This would suit somebody that is going to live in a house for a short period of time (3-5 years) while the rates are low, and who could afford a rate increase if the the rates did go up.
3-Year ARM - An Adjustable Rate Mortgage in which the interest on your loan changes every 3 years during the 30-year period of the loan. It's not as risky as the 1-year ARM because the interest rate doesn't fluctuate as much.
5-Year ARM - This Adjustable Rate Mortgage has an interest rate that changes every five years during the 30-year period of the loan. It is a safe median between a fixed rate mortgage and a 1-year ARM.
3/1 Adjustable Rate Mortgage - This is quite a different type of ARM. There is a fixed interest rate for the first three years of the 30-year loan. After that the it acts as a 1-year ARM with an interest rate that changes every year
5/1 Adjustable Rate Mortgage - Similar to the 3/1 ARM, the 5/1 has a fixed interest rate for five years then acts as a 1-year ARM for the remainder of the 30 years.
7/1 Adjustable Rate Mortgage - This ARM has a fixed interest rate for seven years. It will then act as a 1-year ARM and the interest rate will fluctuate every years.
10/1 Adjustable Rate Mortgage - Finally, this ARM allows for a fixed interest rate for 10 years. It will then act as a 1-year mortgage and the interest rate will change every year.
A Balloon Mortgage
is just like a 30 year fixed mortgage; however, after 5-7 years of monthly payments (depending on how long your balloon mortgage lasts) you must repay the entire loan back in full. If you are not able to pay the loan off you can refinance and get another loan, sell your house, or risk foreclosure. Home buyers generally don't pull out a balloon Mortgage unless they plan on selling their house before the loan matures. There are advantages and disadvantages to the balloon mortgage.
Easier To Qualify For: Since balloon mortgages are shorter term loans lenders take much less risk; therefore, it is much easier to qualify for such a loan.
Can Receive A Larger Loan: Because the lender is taking less risk by giving you a balloon loan you can get a larger loan. So, if you don't quite qualify for the loan to get your dream home this is an option for you.
Lower Interest Rate: With balloon mortgages you will get a lower interest rate than a thirty-year loan. The shorter balloon mortgages (5 year policies) get lower interest rates than the 7-year loans.
Once Policy Ends You Are Forced to Refinance, Sell, Pay off the mortgage, or Foreclose: The mortgage payments last 5-7 years, so if you don't have the money to repay the rest of the loan you will have to refinance, sell, pay off the loan, or foreclose.
Your Interest Rate May Rise: Once the term ends on your loan, if you have not paid it off, you may have to refinance. If interest rates have risen you will be looking at a higher interest rate for the next 5-7 years.
TWO TYPES OF BALLOON MORTGAGES:
5-Year: This loan is basically what is says. You have a fixed rate and monthly payment for 5 years and once the five years is up you must pay off the rest of the loan or get another one.
7-Year: Same thing again, but the interest rate and monthly payment lasts for 7 years. Once the loan is up you must pay it back or get another one.
What is a Buydown, 3-2-1 Buydown, 2-1 buydown and 1-0 buydown?
A buydown can be very beneficial to somebody looking for a big loan but won't have the money to make the monthly payments for a few years. It is fairly simple. Basically, it provides a way to lower the interest rate on your home loan temporarily. The way buydowns work is when somebody takes out a mortgage they can pay points to "buy down" the interest rate. One way to look at it is prepaying interest. Now, in order to buy down the interest, a lump sum is paid and set into an escrow account, which, in turn, is used to supplement the borrowers monthly payments. The seller of the house usually pays for this lump sum as a financial incentive for somebody to buy their property. Sometimes the lender will pay the lump sum; this is known as a "lender funded buydown." The reason a lender would provide the lump sum is usually because they make the note rate on the buydown higher than the market rate. So, once all the buydown adjustments are over with the lender will be making more money off of a higher interest rate.
For Example: If the going interest rate is 7%, the lender might make the note rate at 8%. If you were to get a 3-2-1 buydown, the interest in the first year would be 5%, the second year it would be at 6%, the third year it would be 7%, then every year after that the interest rate would be 8%.
This is beneficial to both the lender and the borrower. The lender will get all his/her money and most likely more back from the higher interest rate. The borrower, on the other hand, is able to qualify for the loan because of the initial lower interest rate. As stated earlier, it can really help somebody out if they are expecting a higher salary in the next couple of years. That way they can qualify for the bigger loan now and be able to afford it when time requires it.
Let's take a look at the different types of temporary buydowns:
3-2-1 Buydown - This buydown brings down the interest rate the most. Generally, you pay a total of 6 points to get a 3-2-1 buydown. For the first year the interest rate on your mortgage goes down 3% from the note rate. The second year it comes up to 2% below the note rate. Finally, the third year it comes to 1% below the note rate. After that the interest rate stays at the note rate for the remainder of the loan. A 3-2-1 buydown requires a larger lump sum than the other two to supplement your monthly payments over a longer period of time at a lower interest rate.
2-1 Buydown - This is similar to the 3-2-1 buydown except during the first year of the loan the interest rate goes down 2% from the note rate. It will then move to 1% below the note rate during the second year. From the third year on, the interest rate will equal note rate. This type of buydown will cost you 3 points. The lump sum required is not as great as for that of a 3-2-1 buydown but greater than that needed for a 1-0 buydown.
1-0 Buydown - This is the shortest Temporary Buydown and will bring your interest rate down 1% from the note rate for the first year. Every year afterwards will have an interest rate equal to the note rate. This buydown will cost you 1 point, and it will have the smallest lump sum in the escrow account.
Home Equity Line of Credit ( H.E.L.O.C.)
A Home Equity Line is a form of credit in which your home serves as the collateral for the loan. You will be approved for a certain credit limit, the maximum amount you can borrow at any time under the set plan. Many lenders set your credit limit by taking a percentage of the value of your home then subtracting the amount outstanding that you owe on the mortgage. For example we'll say your house is worth $200,000 and the lender sets the percentage for the credit limit at 75%, but you still owe $50,000 on the mortgage.
This is how it would look:
Appraised Value of Home $200,000
Percentage X 75 %
Percentage of Appraised Value = $150,000
Amount Owed on Mortgage - $50,000
Amount of Credit = $100,000
There are other factors the lender takes into account when calculating your credit limit such as your ability to repay. Lenders will look at your income, debts, credit history, and other financial obligations.
How Can I Draw from My Credit Line?
Once approved you will most likely be able to draw on your credit limit as much as you want. Typically, you will use special checks to draw from your account. Under some plans, however, the borrower can use a credit card or other means to draw from the line. Also, you may want to ask your lender if there is a minimum or maximum withdrawal requirements.
Are There Up front Expenses?
In taking out a Home Equity Line of Credit there are some initial closing costs. These include an application fee, title search, appraisal, attorney's fees, and points. You may want to negotiate with the lenders to see if they will pay for some of the costs.
What About Interest Rates?
Interest rates differ from lender to lender; so shopping around for a low interest rate can save you big bucks. You'll want to compare the annual percentage rates (APR). However, be aware that advertised APRs are based on interest alone. For a true comparison of what interest rate to grab, take a look at other charges. Low interest rates may be tacked with extra points, and the closing costs may be higher. The lowest APR may be more expensive than a slightly higher one. Make sure you check what type of interest rates the line has. Many home equity credit lines have variable interest rates, which start out low but may increase.
What Are Risks of Taking out a Line of Credit?
You will need to find out if there is a certain draw period. In paying off your Home Equity Line of Credit many lenders expect one large final (balloon) payment once the draw period has ended. Sense your home is used as collateral this can be risky, especially if you don't have the money to repay the lender at that time. You may have to get an additional loan to pay off the line of credit in order to save your house.
No Cost Loan - Who pays for it?
No-cost loans have become very popular with lenders. These loans, as the name implies, have no appraisal fees, document fees, or even points tacked onto them. You can just show up at the closing and sign the dotted line. No out of pocket expenses. As great as no-cost loans sound, there is one drawback. To get one you usually have to pay an interest rate that is 1/2 to 5/8 of a percentage higher than the "full cost" rate. So, which is the better deal, a no-cost loan, or a regular loan with a lower interest rate? The factors that really matters are how much you are looking at in expenses, and how long you plan on living in your home.
Example: A homeowner with a $200,000 home and $5,000 in closing costs would have to live in the home for just over 3 years to recover the up front costs of a regular loan at 7% interest, rather than getting a no-cost loan at 7.5%. So if the homeowner planned to be in the house still 4 or 5 years from now, he/she should look to getting a regular loan with a lower interest rate. If not, definitely go for the no-cost loan.
If you do decide to get a no-cost loan be sure to talk to the lender and clarify exactly what they define no-cost loans as. There are some lenders who have no closing fees associated with their loan, but they find other ways to get the money back whether it is fees to third parties, or raising the amount of loan to get the money back through interest. Just be careful to make sure you know how your plan works.
A true no-cost loan will have only two expenses.These are a slightly higher interest rate and escrow accounts.
A no-cost loan can be a useful stopgap in situations where you are not sure if you will be moving shortly. You can save some money while waiting for the situation to clarify, and if it turns out that you won't be moving you can refinance again later.
What is a Pledge Mortgage Account?
A Pledged Asset Mortgages, also referred to as Asset Backed Mortgage or Asset Integrated Mortgages are specially designed for those who have enough money to make monthly payments on a home, but have all their ready cash locked up into some sort of investments, such as stocks, bonds, or mutual funds. Depending on the lender you can use almost any type of investment. It's very helpful because the borrower can make the down payment without having to remove investment funds, allowing them to continue in growth... or decrease in value.
Here's how a Pledged Asset Mortgage works:
You buy a new home for $250,000. The down payment on the home is 20%, or $50,000. You don't have nearly that in cash on hand but you do have $100,000 in stocks and Certificates of Deposit. You can use these investments to cover as collateral for the down payment.
This sort of loan is excellent if the money you have invested is expecting a higher return than the interest rate of the loan, or when the assets you are backing could cause you capital gains income tax grief if you were to convert them to cash.
Benefits of Pledged Asset Mortgage:
Don't have to make big down payment
You continue to own the investments used as collateral and make any interest or profit that they generate.
In many cases the borrower can avoid having to take out mortgage insurance on the loan.
Disadvantages of Pledged Asset Mortgages:
If you default on the loan the lender gets both the assets you pledged and the house.
You must keep in mind that since you have not actually paid the down payment, but are rather holding collateral against it, it is still money you owe, and you will be charged interest on it.
Is this mortgage really worth it?
You should weigh the amount of interest you are making on your investments with the amount of interest you are paying towards the loan. If your investments bring in less than the interest it might be worth it to sell the investments and make the down payment.
How much can I pledge?
The amount a borrower can pledge towards the loan depends on the mix of investments he/she has in the portfolio. If the borrower has a conservative portfolio he/she could most likely pledge up to 50% of the portfolio's value. A borrower with a risky portfolio would have a lower pledge limit.
When is the best time to get a Pledge Account Mortgage?
The smartest time to get a Pledge Account Mortgage is when during a Bull Market, when stocks are rising, and during a time when real estate prices are relatively stable.
Home Equity Conversion Mortgage / Reversible Mortgage
First of all, what is a Reversible Mortgage? It's exactly what it says it is. Instead of you making a payment to your banker, your banker pays a monthly payment or lump sum to you. You may be thinking why would a lender even consider this. Well, given this loan is a Home Equity Conversion Mortgage (HECM) the money is backed by home equity. The Home Equity Conversion Mortgage, authorized in 1987 is the only reverse mortgage that is insured by the Federal Housing Administration, which is part of the U.S. Housing and Urban Development (HUD). It was the first widely available reverse mortgage in the United States.
To get this type of mortgage there are a couple pre-qualifiers you must pass. These include:
You must be at least 62 years old
You must be a home owner
This mortgage is a great way for seniors to free up the money locked in the value of their home to maintain or improve their standard of living. Some additional advantages of a Home Equity Conversion Mortgage are:
No income or credit information is required of persons over the age of 62
No monthly payments need to be made, in fact, no repayment is ever required as long as the home is the borrower's primary residence
There is no change in the title of property, which is passed to one's heirs
The HECM, specifically, provides a lot more cash than other programs, as well as gives you more options for receiving the money. You may receive cash, a line of credit, or a monthly check. Most people use the Home Equity Conversion Mortgage to receive a payment each month for the rest of their lives. The interest rate on a reverse mortgage is an adjustable rate that fluctuates monthly or yearly. The amount a senior homeowner can borrow through an HECM depends on the borrower's age, the current interest rates, and the value of the home.
It is important to remember that a reverse mortgage is different from a home equity loan or a line of credit. With a home equity loan or line of credit an applicant must meet certain income and credit requirements, begin monthly payments right away, and the home can have an existing first mortgage on it. Also, there is no age restriction such as there is with an HECM. Unlike a Home Equity Mortgage, a reverse mortgage doesn't require monthly payments from the borrower to the lender. A reverse mortgage is not repayable until the borrower no longer occupies the home as his/her primary residence. This may occur when the last remaining borrower dies or sells the home.
Appraisal Fee - What it covers and the typical cost
An appraisal fee is a fee sometimes charged during closing costs to have a qualified professional appraiser perform an appraisal or an estimation on the market value of a property.
The appraisal fee will vary depending on the specific characteristics of your home and the type of appraisal done. Appraisers may charge one fee for a single family home and a larger fee for duplex, fourplex, or a commercial building
How much is an appraisal fee?
The typical appraisal fee for a standard owner occupied single family tract home, condominium or town home is anywhere from $200 to $500.
Why is an appraisal needed?
Lenders use appraisals to confirm that the house you are buying is worth the price you have agreed to pay. The mortgage lender does not want to be stuck with a property less than what was loaned.
You can usually request a copy of the appraisal once your loan is complete.
What is Private Mortgage Insurance or (PMI)?
Private Mortgage Insurance is a way to enhance a borrower's ability to achieve a homeownership situation that is right for them. PMI helps borrowers obtain a low down payment loan. Lenders require PMI on most conventional mortgages because of the relationship between borrower equity and default. Time and past experience has shown that the less a borrower has invested in a home the greater chance of default. PMI provides a financial guarantee against loss on the lender's part in case the borrower defaults. This financial guarantee is what allows lenders to provide loans with a low down payment.
Private mortgage insurance can be paid on either an annual, monthly or single premium plan. Premiums are based on the amount and terms of the mortgage and will vary according to loan-to-value ratio, type of loan, and amount of coverage required by the mortgage company.
Under an annual plan, an initial one year premium is collected up front at closing, with monthly payments collected along with the mortgage payment each month thereafter. Monthly plans allow a borrower to pay only 1 or 2 months worth of premium at closing, and then on a monthly basis along with the regular mortgage payment. Under a single premium plan, the entire premium covering several years is paid in a lump sum at closing. Typically, homebuyers choose to add the amount of the mortgage insurance premium to the loan amount. By doing this, homebuyers can reduce their closing costs and increase their interest deduction.
While PMI is helpful to future homeowners, it can also be expensive. On a $100,000 loan with 10 percent down ($10,000), PMI might cost you $40 a month. You can check your annual escrow account or call your lender to find out how much your PMI is costing you each month. The range for a median priced home is $50 to $80 per month (In 2001 the national median price for a single family home was $147,500).
To help protect homeowners from pricey PMI's in 1998 legislation created the Homeowners Protection Act. The Homeowners Protection Act of 1998 - which became effective in 1999 - establishes rules for the automatic termination and borrower cancellation of PMI on home mortgages. These protections apply to certain home mortgages signed on or after July 29, 1999 for the purchase, initial construction, or refinance of a single-family home. In some states though there are laws that apply to early termination or deletion of PMI. These protections do not apply to government-insured FHA or VA loans or to loans with lender-paid PMI.
For home mortgages signed on or after July 29, 1999, your PMI must - with certain exceptions - be terminated automatically when you reach 22 percent equity in your home based on the original property value, if your mortgage payments are current. Your PMI also can be canceled, when you request - with certain exceptions - when you reach 20 percent equity in your home based on the original property value, if your mortgage payments are current. Another exception is if your loan is "high-risk."
The HPA (Homeowners Protection Act) has established three times when a lender must notify the borrower of his or her rights. Those times are at loan closing, each year during the loan, and upon cancellation or termination of PMI.
The content of these disclosures varies depending on whether: (1) PMI is "borrower-paid PMI" or "lender-paid PMI," (2) the loan is classified as a "fixed rate mortgage" or "adjustable rate mortgage," or (3) the loan is designated as "high risk" or not.
At loan closing, lenders are required to disclose all of the following to borrowers:
The right to request cancellation of PMI and the date on which this request may be made.
The requirement that PMI be automatically terminated and the date on which this will occur.
Any exemptions to the right to cancellation or automatic termination
A written initial amortization schedule (fixed-rate loans only).
Annually, your mortgage loan servicer must send borrowers a written statement that discloses:
When the PMI coverage is canceled or terminated, a notification must be sent to the consumer stating that:
PMI has been terminated, and the borrower no longer has PMI coverage.
No further PMI premiums are due.
The obligation for providing notice of cancellation or termination is with the servicer or lender of the mortgage.
What happens if your home value has increased?
Before cancellation of PMI can occur the lender requires that 20% of your home's equity has been paid off. If the home prices in your area are rising fast, your property value is probably rising also. Or, if you have done home improvements on your house, this can raise your property value. If this is the case you may be able to reach the 80% percent of the loan value a lot faster, allowing you to cancel your PMI in a shorter amount of time.
Is it possible to get PMI if you have a low income?
Yes. If you are a lower-income first-time buyer, you might be eligible for certain programs that make it possible for you to buy a home with 3% or less down. Their flexibility makes it possible for many lower-income buyers to achieve homeownership. The Programs are fitted to suit community needs and involve partnerships with local groups. They feature education programs that help you learn about the home buying process and counseling to help you keep your home if you run into financial trouble. They also offer a variety of options in such areas as down payment, PrivateMI premium and credit verification. Evidence of on-time rent and utility payments, for example can substitute for a more traditional credit history. Check with your lender to see if you're qualified for an affordable housing program.
Can I buy PrivateMI directly from an insurance company instead of through a lender?
No. The lender arranges for PMI coverage on your loan. A variety of PMI products with a different range of payment options is available to meet your specific needs. When you shop for a loan, ask lenders about your PMI options.
What's the difference between PMI and FHA(Federal Housing Administration) insurance?
PMI is from a private insurance while FHA is a government program backed by taxpayers. PMI usually costs less and it only covers the top 20 to 30 percent of a loan, while FHA insures 100 percent of the loan. PMI is also available on a wider variety of loan products, and there's no maximum loan amount. FHA loans are subject to maximum loan amounts, depending on the cost of housing in your area.
Ways to avoid PMI:
There are several ways to avoid paying the high cost of PMI. All are completely normal and are done many times each day.
The first way is to split your home loan into two loans. A regular loan at the 80% range which gets rid of the PMI and a second HELOC (home equity line of credit) for the remaining 15% of the loan. They call this a 80-15-5 - 80% first loan, 15% HELOC, 5% equity paid by the consumer. We typically don't recommend having less than 5% equity. If you can't cough up 5% equity to buy a home, you probably should look for a cheaper home.
The second way to avoid paying PMI is to go with a private lender. There are many "private" lenders who aren't required to tack on the PMI, and still have equally competitive interest rates.
The third and hardest way to avoid PMI is to pay down your loan to 80%. Then there is less risk on the lenders part and the lender is willing to take off the PMI safeguard.
What they are and how they work.
Origination points are commission points charged by the Lender or the Loan officer for their work in originating the loan. It is essentially prepaid interest. In other words, the Lender or Loan officer tacks on origination points as their fee for evaluating, preparing, and submitting and closing a proposed loan. Although this is not always the case, it is a very common practice. These points may also pay for some of the closing costs. You may be able to negotiate the origination points, but this may cause the interest rate to increase. This increase in the interest rate is often called the yield spread and the mortgage broker receives back end fees from the lender. The cost of these origination points should be negotiated before closing on the loan. There are some lenders that will not charge a higher interest rate or origination points. These are usually Credit Unions or specialty lenders, and may have more risky loan programs such as ARMs.
Origination points (or fees) are often expressed as percentages:
1 point = 1%
If the Proposed loan = $150,000 then 1 origination point = $1,500 ($150,000 * .01 = $1500)
Or If the Proposed loan = $125,000 then 2 origination points = $2,500 ($125,000 * .02 = $2500)
Since Origination points are considered prepaid interest, they are most often tax deductible. As always, though, you should seek tax counsel from your accountant, tax professional, or the IRS.
Knowing more about origination points and their purpose will help you in your search for the right loan. There are many competitive offers out there, and if you work the lenders against each other through careful negotiation you can easily lower the cost of your mortgage.