Things to Consider When Buying or Refinancing
If you are preparing to purchase a home, or are thinking about taking out a new mortgage, you should consider the different types of loans offered, whether refinancing makes sense, whether you should pay any "Points", and when you should lock in your interest rates.
We've tried to answer many of the most commonly asked questions here, but if you have a question you don't see answered, give us a call. We'll be happy to help.
1. What are the different type of mortgages?
Fixed Rate Mortgages
- Rates are fixed for the life of the loan and are available for various amortization periods: 10 years; 15 years; 20 years; 25 years; 30 years. Custom amortizations can be arranged, for example: 8 years.
Adjustable Rate Mortgages
- 1 month ARM: rate adjusts monthly after a 3-month intro period
- 6 month ARM: rate adjusts each six months
- 1 year ARM: rate adjusts each year
- 3/1 ARM: rate fixed for 3 years, then adjusts annually
- 5/1 ARM: rate fixed for 5 years, then adjusts annually
- 7/1 ARM: rate fixed for 7 years, then adjusts annually
- 5/25: Rates adjust once at end of first 5 years then remains fixed for 25 years
- 7/23: Rates adjust once at end of first 7 years then remains fixed for 23 years
- 5/25 or 7/23; Rate is fixed for first 5 years or 7 years. There is a conditional refinance (approximate cost $275) at the end of the initial 5 or 7 year period.
Variations on these loans
- Rates can be bought up or down. Buying the rate down can be permanent or temporary.
- A permanent buy-down for a fixed rate mortgage usually costs about 0.5 discount points for each 0.125% decrease in rate.
- A temporary buy-down usually means a 2-1 buy-down for a fixed rate mortgage. Temporary buy-downs are not available for ARMs. The rate for the first year is 2% lower, and 1% lower for the second year. For example, if the interest rate on a 30-yr. fixed rate is 8% and 0.0 discount points, then a 2-1 buy-down could give the following:
Year 1 - 5% Year 2 - 6 % Years 3-30 - 7% cost 2.75 discount points (approximately).
- Buying the rate up will reduce the closing costs. The formulas are not linear. For each 0.125% increase in rate, about 0.375% in discount points can be contributed to the borrower in order to lower the closing costs. If the rate is pushed high enough, this can result in a loan with no closing costs.
Please ask your MORTGAGE COUNSELOR for details on any of these programs.
2. Do I have to pay discount points?
A discount point is equivalent to one percent of the loan amount. It is commonly used to lower the interest rate and is usually optional. Unless an employer is paying discount points to lower the interest rate, we usually suggest that the borrower not spend more than 0.5 discount point. An exception is when using discount points to achieve a temporary buy-down of the rate. This is useful when helping a borrower qualify for a higher loan amount.
3. When should I lock in? Should I lock in?
This is a very difficult decision. Some luck and some guidance is needed. A similar question is when should you buy a specific stock.
4. How do I reduce the amount of cash required at closing?
There are loans for 100% of the purchase price, 97% LTV, and 95% LTV. In each case the contract price can be negotiated (up) so as to finance much of the non-reoccurring costs of closing the transaction. This is done by classifying these expenses as a "seller contribution". When including such aspects into a real estate sales contract, keep in mind that the seller's net proceeds could be affected.
5. What is PMI?
PMI is insurance for the benefit of the lender. You pay, they benefit. If the property is abandoned or goes into foreclosure, this policy protects some of the value of the home. This policy is usually required if the LTV is greater than 80.00%. There are many exceptions. There are loans for 100% of the purchase price that do not require PMI, and some loans at 75% LTV that do require PMI.
6. Can my loan be sold?
Yes, and the customer has no control - nor should the customer be concerned.
8. When should I refinance?
When the cost of refinancing (whether cash or equity) can be recovered prior to selling the home OR if the rates are sufficiently low so that the cost of refinancing can be covered in an interest rate that is lower than the rate you now have but higher than today's best rate.
9. When is a second mortgage a good idea?
- To avoid PMI (example: first mortgage of 75%, and a second of 15%).
- To diversify risk and get a low(er) LTV first mortgage. This is especially valuable when credit or income histories may not meet the rigorous demands of FNMA or FHLMC requirements.
- When the borrower wants a fixed rate mortgage, but plans to pay off a significant portion of the loan within a specific time period. This allows the prepayment and a corresponding decrease in monthly payment. ARMs allow this prepayment with a corresponding drop in monthly payments, but fixed rate mortgages do not allow this advantage.
10. Why do I have to establish an escrow account?
You don't. Although many lenders require an escrow account for real estate taxes and insurance, there are also exceptions.
An escrow account can be avoided (waived) if the loan amount is not more than 80% of the value of your home. If you bought the home within the last year, then use the sales price or the appraised value -- whichever is lower.
There is usually a fee of about 0.125% to 0.375% of the loan amount which is charged by the lender if escrows are waived.
Even if your loan amount is greater than 80% of the value of your home, escrows (and PMI) can be avoided. You can elect to get two mortgages at the same time: a first mortgage for about 75% of the value of the home, and a second mortgage for about 15%. You then have a combined LTV of 90% and the ability to waive escrows and PMI.