Lesson 3: Mortgage Tactics

Mortgage Tactics

A Mortgage. What’s the “Point”?
Homebuyers must often choose between a higher mortgage rate with no points or a lower mortgage rate with one, two, or more points. To determine which is more cost-effective for you, calculate how much additional interest must be paid over the life of the loan in order to pay less money up front. A general rule is to equate each point with one-quarter percent interest rate. Thus, a 4.75 percent loan with two points costs approximately the same as a 5 percent loan with one point. However, the rule is only accurate for the first several years of the loan. The longer you plan to keep your home, the less effect points will have on the annual mortgage rate. Taxes must also be considered in any borrowing situation. While points for home purchase mortgages are typically fully deductible for the year in which they are paid, points on refinanced mortgages must be prorated over the life of the loan.

Adjustable Rate Mortgages vs. Fixed Rate Mortgages

If you are planning to purchase your first home, it will be helpful to understand two common home financing options: fixed rate mortgages and adjustable rate mortgages (ARMs). A fixed rate mortgage offers a borrower a set interest rate that will not vary for the life of the loan. In contrast, an adjustable rate mortgage, also called a variable rate mortgage, is a loan in which the interest rate is adjusted periodically, based on a measure or an index, such as the rate on U.S. Treasury bills or the average national mortgage rate. In exchange for assuming some of the risk of an increase in interest rates, a borrower often receives a lower initial rate with an ARM than with a fixed rate mortgage. Deciding which option is right for you depends on a number of factors, including current interest rates, the length of time you expect to own your home, and tax considerations from the home mortgage interest deduction.

Tactics for Home Financing in the New Mortgage Market

Given the fluctuations of Wall Street and the tight job market, today’s economy is characterized by a degree of uncertainty. So how can prospective homeowners navigate the changing climate of buying and selling a house? It helps to understand the events of the recent past and the lingering effects on real estate values.

While multiple factors led to the economic downturn, the housing market continues to play an important role in our economy’s health. A number of years back, some large lenders began to bundle mortgage debt into asset-backed securities, which were then sold as investment vehicles to Wall Street brokers. These were advantageous to both the mortgage lender, which made a profit from selling the bundled loans, and the investment firm, which received a portion of the fees.

As long as homeowners/borrowers were able to make payments on their mortgages, the securities made money. However, when consumer debt began to rise and borrowers failed to make payments, or defaulted on their home loans, these securities lost value. When a large number of mortgage-backed securities began to lose money, many investors sold to cut their losses, and the investment market as a whole suffered.

With increasing numbers of foreclosures and many adjustable-rate mortgages scheduled to adjust to higher payments, the mortgage-backed security is now seen as a high-risk investment. Large lenders no longer have a market for these securities, and they don’t have the assets to keep and service the loans themselves.

As a result, smaller banks and lenders don’t have large credit lines to fund mortgages and other loans, and lenders have been reverting to more conservative standards for extending credit. Without low teaser rates, no-money-down offers, and loose credit checks, potential homebuyers are now required to prove that they can truly afford their loan amount.

For those looking to buy a home, here are some tips to help facilitate the financing aspect of the sale:
1. Conduct an informal analysis of your finances before approaching your lender. You may
avoid surprises by taking the time to assess your current financial situation. Be sure to collect
full documentation about your income, debt, and credit report for scrutiny by your lender.

2. Get prequalified. Prequalification from an experienced lender is essential in the current real estate market: it demonstrates your seriousness. Consider seeking FHA-approved lending institutions.

3. Do your homework if you’re seeking a high-cost loan. Jumbo loans require extensive
documentation and generally carry a higher interest rate than conventional loans. Knowing the FHA loan limit in your locale can help you prescreen potential properties. 

4. Be prepared to move quickly after making an offer. Gather documentation and complete the loan application as soon as possible after an offer is accepted, to lock in the loan and rate. Loan prequalification letters may be dated for a short time period, so act quickly.

5. Factor in potential time delays. The traditional timeline for underwriting and the response time from lenders has increased with tighter lending standards. It may take up to three weeks to finalize a loan application.

6. Don’t forget about private mortgage insurance (PMI). Many lenders require borrowers to obtain PMI if the down payment on a house is less than 20% of the overall cost of the loan. Be sure to factor in the cost of PMI into your budget.

Although the real estate market may be uncertain, understanding the state of financing can help you better manage the purchase of your next home.

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