Mortgage Frequently Asked Question
What is the difference between pre-qualifying and pre-approval?
A pre-qualification for a specific loan dollar amount is based on a review of basic financial information you supply to us. No verification of this information is performed. The pre-qualification means that if the information you supplied to us is accurate, subject to verification of credit, appraisal of the property, and the lenders underwriting criteria for the loan amount, you should be able to receive a loan as described in the pre-qualification letter or document. This is not a final approval. A pre-qualification is not a commitment to lend. However, a pre-qualification letter indicates to you and the seller that in the opinion of the loan officer you are qualified to purchase the house you are making an offer on.
Pre-approval is a step above pre-qualification. Pre-approval involves verifying your credit, down payment, employment history, etc. Your loan application is submitted to an underwriter and a decision is made regarding your loan application. If your loan is pre-approved, the lender will loan you money on the basis that you requested subject to: a satisfactory appraisal (both as to value and type of product); your financial condition remains as stated on your application and satisfying any underwriting conditions from the lender.
Getting your loan pre-approved allows you to close very quickly when you do find a house. A pre-approval can help you negotiate a better price with the seller, since being pre-approved is very close to having cash in the bank to pay for the house!
Why are the advantages of a mortgage broker versus a thrift or a mortgage banker?
First we need to define the terms. A thrift is your typical neighborhood bank – mutual savings banks and savings-and-loan institutions offering savings accounts, mortgages and other financial products and services. Mortgage bankers work for a single lender and are in the sole business of lending money. Mortgage brokers, on the other hand, are middlemen who, by state law, work on behalf of borrowers. Brokers counsel borrowers on the loan options available from different wholesalers and then research a number of lending sources – commercial banks, thrifts and mortgage bankers – to find appropriate loans to meet the specific needs of borrowers they represent. Mortgage brokers do not add any net cost to the lending process because they perform functions that would otherwise have to be done by employees of the lender. When a broker processes the paperwork on a loan, it costs less for the lender to make the loan. Therefore, lenders often discount loans to brokers. The borrower pays no additional cost and benefits from the broker’s service. By state law, the broker’s fee and the discount the lender offers the broker must be disclosed to the borrower.
What are credit scores?
A credit score (such as FICO – developed by Fair Isaac & Co and used by Experian, or BECON – developed and used by Equifax or EMPIRICA – developed and used by Trans Union) or credit scoring is a method of determining the likelihood that a credit user (you) will pay their bills. Fair Isaac began its pioneering work with credit scoring in the late 1950’s. Since then scoring has become widely accepted by lenders as a reliable means of credit evaluation. A credit score attempts to condense a borrower’s credit history into a single number. Fair, Isaac & Co. and the credit bureaus do not reveal how these scores are computed. The Federal Trade Commission has ruled this practice to be acceptable.
Credit scores are calculated by using scoring models and mathematical tables that assign points for different pieces of information that best predict future credit performance. Developing these models involves studying how thousands, even millions, of people that have used credit. Score-model developers find predictive factors in the data that have proven to indicate future credit performance. Models can be developed from different sources of data. Credit-bureau models are developed from information in consumer credit-bureau reports.
Credit scores analyze a borrower’s credit history considering many factors such as:
- Late payments
- The amount of time credit has been established
- The amount of credit used versus the amount of credit available
- Length of time at present residence
- Employment history
- Negative credit information such as bankruptcies, charge-off’s, collections, etc.
There are really three credit scores computed by data provided by each of the three bureaus––Experian, Trans Union and Equifax. Some lenders use one of these three scores, while other lenders may use the middle score and still others may use all three.
How can I increase my score?
While it is difficult to increase your score over the short run, here are some tips to increase your score over a period of time.
- Pay your bills on time. Late payments and collections can have a serious impact on your score.
- Do not apply for credit frequently. Having a large number of inquiries on your credit report can worsen your score.
- Reduce your credit card balances. If you are “maxed” out on your credit cards, this will affect your credit score negatively.
- If you have limited credit, obtain additional credit. Not having sufficient credit can negatively impact your score. (Normally lenders like to see you have at least five (5) lines of credit not including utilities (such as telephone, gas and electric companies) and oil company credit cards.
What if there is an error on my credit report?
If you see an error on your report, to rectify it, you must contact the credit bureau. The three major bureaus in the U.S., Equifax (1-800-685-1111), Trans Union (1-800-916-8800) and Experian (1-888-397-3742) all have procedures for correcting information promptly. Alternatively, we as your mortgage company may help you correct this problem as well. Understand this process takes time, must be done in writing, and may require proof depending on the nature of the error.
Why are interest rates different from day to day and one source to another?
Interest rate movements are based on the simple concept of supply and demand. If the demand for credit (loans) increases, so do interest rates. This is because there are more buyers, so sellers (those who loan the money) can command a better price, i.e. higher rates. If the demand for credit reduces, then so do interest rates. This is because there are more sellers than buyers, so buyers can command a lower better price, i.e. lower rates. When the economy is expanding there is a higher demand for credit, so rates move higher, whereas when the economy is slowing the demand for credit decreases and so do interest rates.
This leads to a fundamental concept:
Bad news (i.e. a slowing economy) is good news for interest rates (i.e. lower rates).
Good news (i.e. a growing economy) is bad news for interest rates (i.e. higher rates).
A major factor driving interest rates is inflation. Higher inflation is associated with a growing economy. When the economy grows too strongly, the Federal Reserve increases interest rates to slow the economy down and reduce inflation. Inflation results from prices of goods and services increasing. When the economy is strong, there is more demand for goods and services, so the producers of those goods and services can increase prices. A strong economy therefore results in higher real estate prices, higher rents on apartments and higher mortgage rates.
Mortgage rates tend to move in the same direction as interest rates. However, actual mortgage rates are also based on supply and demand for mortgages. The supply/demand equation for mortgage rates may be different from the supply/demand equation for interest rates. This might sometimes result in mortgage rates moving differently from other rates. For example, one lender may be forced to close additional mortgages to meet a commitment they have made. This results in them offering lower rates even though interest rates may have moved up!
There is an inverse relationship between bond prices and bond rates. This can be confusing. When bond prices move up, interest rates move down and vice versa. This is because bonds tend to have a fixed price at maturity––typically $1000. If the price of the bond is currently at $900 and there are 10 years left on the bond and if interest rates start moving higher, the price of the bond starts dropping. The higher interest rates will cause increased accumulation of interest over the next 10 years, such that a lower price (e.g. $880) will result in the same maturity price, i.e. $1000.
Do I need flood insurance?
Most lenders will not lend you money to buy a home in a flood hazard area unless you pay for flood insurance. Some government loan programs will not allow you to purchase a home that is located in a flood hazard area. Your lender may charge you a fee to check for flood hazards. You will be notified if flood insurance is required. If a change in flood insurance maps brings your home within a flood hazard area after your loan is made, your lender or service may require you to buy flood insurance at that time.
What are your rates?
The first question customers usually ask when calling a mortgage company or lender is “What are your rates?” Because of the number of mortgage programs available and the various rate and point combinations, most mortgage companies have rate sheets that are 5-10 pages long.
Getting a rate quote is just a small part of shopping for a mortgage and usually not the best way to select a lender. Customer service, professional staff, convenience, and flexibility are some of the key attributes to selecting the best lender for your needs.
In helping you assess a rate, you will need to provide answers to a few basic questions like:
What is your purchase price?
What loan amount are you looking for or what loan amount do you want to finance?
Do you prefer a fixed rate or an adjustable rate mortgage?
How long do you plan to live in the house?
How many points are you willing to pay?
The purchase price or the value of your home affects the rate because it affects the size of the loan. For example, Jumbo Loans, currently over $322,700, have a higher rate. Similarly, smaller loans have a higher rate or cost more because it costs the same and takes the same effort to do $35,000 loan as it does a $200,000 loan. Lenders and brokers need to make or charge a certain minimum amount of money to cover overhead, per loan (transaction) cost and make a profit.
The type of loan (fixed or variable) affects the rate because it affects the lenders’ income and inflation risk. For example, with a fixed rate loan, if rates go up the lender could lend out money at a higher rate than they are currently loaning it to you, and therefore earn more money. With a variable rate loan since the rate the lender can charge you changes regularly their income remains consistent with their current income opportunities. Therefore with variable rate loans they give you a better rate since they know that if rates go up they can charge you more.
The length of time you will own a house affects both the type of loan you may want and the amount of points it may make sense to pay. For example, if you are going to keep a house for a short period of time (let’s say 3 years), you may be better off with a variable rate loan (e.g. a 3/1 ARM – fixed for 3 years and varies once a year every year there- after until the loan is paid off). Why? Because typically the 3/1 ARM has a lower rate associated with it than a 30 year fixed rate loan and since you will sell the house in 3 years you would not be affected by higher rates which may exist at that time. On the other hand, if you expect to live in the house for 30 years you might be willing to pay some points to receive a lower interest rate now. The lower interest rate would save you money every month over the life of the loan. The total savings in this situation should be greater than the cost of points, giving consideration to the amount that the point money could earn if invested (saved) after taxes.
What happens if my loan gets sold or my lender goes out of business?
Your loan can be sold at any time. There is a secondary mortgage market in which lenders frequently buy and sell pools of mortgages. This secondary mortgage market results in lower rates for consumers. A lender buying your loan assumes all terms and conditions of the original loan. As a result, the only thing that changes when a loan is sold is to whom you mail your payment. If your loan has been sold, your existing lender will notify you that your loan has been sold, who your new lender is, and where you should send your payments from now on.
If your lender goes out of business, you are still obligated to make payments! Typically, loans owned by a lender going out of business are sold to another lender. The lender purchasing your loan is obligated to honor the terms and conditions of the original loan. Therefore, if your lender goes out of business, it makes little difference with regards to your loan payments. In some cases, there may be a gap between the date of your lender’s going out of business and the date that a new lender purchases your loan. In such a situation, continue making payments to your old lender until you are asked to make payments to your new lender.
Does zero points really mean zero points?
Points are a cash payment as part of the charge for the loan, expressed as a percent of the loan amount; e.g., “2 points” means a charge equal to 2% of the loan balance. Points can be used to “buy down” the rate on a loan or to help fund closing costs. For example, a 30-year fixed loan may be available at a retail price of :
8.0% with 2 points or
8.25% with 1 point or
8.5% with 0 points or
8.75% with -1 point or
9% with -2 points
On a $200,000 loan, the loan officer can offer you 8.25% with 1 point ($2,000) cash at closing or a higher rate of 8.75% with a cost of -1 point, which is a $2,000 credit towards your closing costs. The basic idea of the zero-fee loan is that you pay a higher rate in exchange for cash up front, which is then used to pay the closing costs. You will pay a higher monthly payment––so the money is really coming from future payments that you will make.
The best way to decide whether you should “buy down” and pay points or not is to perform a break-even analysis. This is done as follows:
Calculate the cost of the points. Example: 2 points on a $100,000 loan is $2,000
Calculate the monthly savings on the loan as a result of obtaining a lower interest rate. Example: $50 per month
Divide the cost of the points by the monthly savings to come up with the number of months to break even. In the above example, this number is 40 months. If you plan to keep the house for longer than the break-even number of months, then it makes sense to pay points; otherwise it does not.
The above calculation does not take into account the tax advantages of points. When you are buying a house the points you pay are usually tax-deductible, so you may realize some savings immediately. On the other hand, when you get a lower payment, your tax deduction reduces! This makes it a little difficult to calculate the break-even time taking taxes into account. In the case of a purchase, taxes definitely reduce the break-even time. However, in the case of a refinance, the points are NOT tax-deductible, but have to be amortized over the life of the loan. This results in fewer tax benefits or none at all, so there is little or no effect on the time to break even.
If none of the above makes sense, use this simple rule of thumb: If you plan to stay in the house for less than 3 years, do not pay points. If you plan to stay in the house for more than 5 years, pay 1 to 2 points. If you plan to stay in the house for between 3 and 5 years, it does not make a significant difference whether you pay points or not.
Should I refinance?
The most common reason for refinancing is to save money. Saving money through refinancing can be achieved in two ways:
By obtaining a lower interest rate that causes the monthly mortgage payment to be reduced.
By reducing the term of the loan you actually save money over the life of the loan. For example, refinancing from a 30-year loan to a 15-year loan can significantly reduce the total of the payments made during the life of the loan.
People also refinance to convert their adjustable loan to a fixed loan. The main reason behind this type of refinance is to obtain the stability and the security of a fixed loan. Fixed loans are very popular when interest rates are low, whereas adjustable loans tend to be more popular when rates are higher. When rates are low, homeowners refinance to lock in low rates. When rates are high, homeowners prefer adjustable loans to obtain lower payments.
A third reason why homeowners refinance is to consolidate debts and replace high-interest loans with a low-rate mortgage. The loans being consolidated may include second mortgages, credit lines, student loans, credit cards, etc. In many cases, debt consolidation results in tax savings, since consumers loans are not tax deductible, while a mortgage loan is tax deductible.
The answer to the question “Should I refinance?” is a complex one, since every situation is different and no two homeowners are in the exact same situation. However, if you are looking to save money, try this calculation:
Calculate the total cost of the refinance (Example: $ 2,000)
Calculate the monthly savings (Example: $100 per month)
Divide the total cost of the refinance (#1) by the monthly savings (#2). This is the “break even” time. If you own the house longer than this, you will save money by refinancing. (Example: 2,000 / 100 = 20 months to break even)
Sometimes, you do not have a choice––you are forced to refinance. This happens when you have a loan with a balloon provision, but with no conversion option. In this case it is best to refinance a few months before the balloon comes due.
Whatever you choose to do, consulting with a seasoned mortgage professional can often save you time and money.
What is an Annual Percentage Rate (APR)?
The annual percentage rate (APR) is an interest rate that is different from the note rate. It is commonly used to compare loan programs from different lenders. The Federal Truth in Lending law requires mortgage companies to disclose the APR when they advertise a rate. Typically the APR is found next to the rate.
30-year fixed at 8% note rate and 1 point = 8.107% APR
The APR does NOT affect your monthly payments. Your monthly payments are a function of the interest rate and the length of the loan.
The APR is a very confusing number! Even mortgage bankers and brokers admit it is confusing. The APR is designed to measure the “true cost of a loan.” It creates a level playing field for lenders. It prevents lenders from advertising a low rate and hiding fees.
If life were easy, all you would have to do is compare APRs from the lenders/brokers you are working with, then pick the easiest one and you would have the right loan. Right? Wrong!
Unfortunately, different lenders calculate APRs differently! So a loan with a lower APR is not necessarily a better rate. An APR also does not tell you how long your rate is locked for. A lender who offers you a 10-day rate lock may have a lower APR than a lender who offers you a 60-day rate lock!
Calculating APRs on adjustable and balloon loans is even more complex because future rates are unknown. The result is even more confusion about how lenders calculate APRs.
Do not attempt to compare a 30-year loan with a 15-year loan using their respective APRs. A 15-year loan may have a lower interest rate, but could have a higher APR, since the loan fees are amortized over a shorter period of time.
Finally, many lenders do not even know what they include in their APR because they use software programs to compute their APRs. It is quite possible that the same lender with the same fees using two different software programs may arrive at two different APRs!
Use the APR as a starting point to compare loans. The APR is a result of a complex calculation and not clearly defined. There is no substitute to getting a good-faith estimate from each lender to compare costs. Remember to exclude those costs that are independent of the loan.