- Should I refinance?
- Should I rent or buy?
- Should I buy a short sale or foreclosure?
- What is the difference between being prequalified and preapproved?
- What are points? Should I pay points?
- Why are there two rates quoted? What is an APR?
- What is a rate lock?
- Why do interest rates change?
- How will my monthly payments be calculated?
- What is a FICO score?
- How can I increase my credit score?
- What if there is an error on my credit report?
- Can my loan be sold?
Refinancing at a lower interest rate will lower your monthly payment and drop your total interest paid over the life of the loan. But it may also mean closing costs, and in some cases, points. Even "no closing cost" programs require some out of pocket costs, such as prepaid interest and funds to initiate an escrow account. You would have to fund a new escrow account with enough money to pay your taxes and/or insurances by the time they are due. (See How will my monthly mortgage payments be calculated for more information.) Also, no-cost programs can carry restrictions like very short repayment terms or minimum loan amounts, and many carry prepayment penalties. Be sure to ask if there are restrictions on the product you are interested in before making your decision to apply.
A refinance extends the length and increases the balance of the loan, so any long-term savings may be offset. If long-term interest savings is your goal, finance your loan for a similar term and balance and pay your costs out of pocket instead of including them in the loan.
Many homeowners refinance just to reduce their monthly payment and are fine with extending the term of the loan. If you plan to stay in your home for a long time this is a good option for you because eventually the costs are offset by the lower interest.
If you are thinking of refinancing and paying closing costs, you need to find out how long it will take to break even. For example: If your new monthly payment saves you $75 per month and it costs you $2,200 to refinance the loan, it will take you 30 months to recoup the fees. So if you don't plan on staying in your home over 30 months, it's not cost-effective.
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There are many things to consider before purchasing a home.
First, lenders will not finance 100% of the purchase price of your home. Lenders require a down payment, usually around 5%. Then you have to factor in closing costs, points, appraisal, title insurance and escrow, credit report, flood search, notarization, transfer taxes, pest inspections, prepaid interest and other miscellaneous inspections and verification fees. So, to purchase a home for $100,000 you will need $5,000 down, and as a rough estimate, approximately $2,000 - $3,500 for closing costs. To qualify for financing you need to show you have that amount in liquid assets.
In addition, some loan programs require you to have the equivalent of two to six months of mortgage payments ahead of time, called reserves. The number of months depends on the lender, the loan program, your FICO score and loan-to-value ratio. (For more information on FICO scores see What is a FICO score and What is a rate lock.)
Homeownership also means ongoing maintenance and upkeep that you would not be responsible for as a renter. In addition to your mortgage payment, you will have recurring annual expenses for property taxes, homeowners insurance and possible flood insurance. Plus, if you borrow more than 80% of the value of the home, you'll have to pay Private Mortgage Insurance, or PMI. These annual bills are averaged over 12 monthly payments and collected along with the principal and interest. This is called Impounding and it creates an escrow account that pays the annual tax and insurance bills. That's why a mortgage payment is also sometimes referred to as PITI, which stands for Principal, Interest, Taxes and Insurance.
Another major factor: What happens if your situation changes and you have to move? Historically, homeowners built equity and came away with a profit when they sold their homes. Recently, this has not been the case and many homeowners have taken a loss because the value of the home was less than what was owed against it. This is a potentially credit-damaging risk homeowners take that renters do not. (Read Should I buy a short-sale or a foreclosure to learn more about this.)
Renters benefit from minimal maintenance costs and responsibilities. They usually only have to give their landlord a 30-60 day notice when they want to move. Moving in typically requires your first and last month's rent and a refundable cleaning deposit, items that will either be refunded or used to cover your last month's expenses in the rental. You also won't have to pay annual taxes or insurance payments.
However, it's not all fees and headaches. Home ownership provides stability and a sense of security. It gives you the opportunity to become a part of a community. You can paint your rooms whatever color you want and take on all kinds of home improvement projects without having to get a landlord's approval. And because the interest you pay on your mortgage may be tax deductable, most homeowners get a sweet tax refund after the purchase of a home. (All situations are different; contact your tax advisor for specifics on your personal situation.)
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Underwater homes and REOs (or foreclosures) are common in the market. Your real estate agent will consider these as potential candidates for you. Keep in mind there are inherent and potentially restrictive conditions involved with these properties you need to know about before making an offer.
When a home is worth less than what the homeowner owes, the home is considered to be underwater and is listed as a short sale. If you make an offer and it's accepted by the seller, the lender holding the mortgage still has the option to approve or decline. If the lender determines it will receive the same (or more) money from the short sale as it would by foreclosing on the property and reselling it, the short sale is generally approved. However, some lenders will not even consider a short sale unless the sellers have a documentable financial hardship or can document that they don't have the assets to satisfy the shortage. Lenders can take months to complete this analysis so be prepared to wait a while. Plus, your lender probably won't allow you to lock your rate until the mortgage holder has approved the short sale, which means interest rates could be higher when you are finally in a position to lock your rate.
When a homeowner stops making their mortgage payments after a specific period of time, the lender forecloses and takes over ownership of the property. The property is then referred to as an REO (Real Estate Owned). If you're thinking about purchasing a foreclosed property, understand that the homeowner isn't the seller, the bank is. Banks generally won't pay costs associated with repairs or inspections required by the new lender, and that can add to your closing costs. Banks also won't allow you to do any repairs to the property before you own it, essentially rendering the property ineligible. Foreclosures may look like great deals, but remember the house may have been abandoned for months prior to the bank taking over, and if the homeowner was having financial problems the home may not have received proper maintenance.
Lenders won't fund a loan on a property unless it is free from health and safety issues and is "move-in ready," so if you move forward on a property and the appraiser says it doesn't meet minimum requirements, you will have paid for an appraisal on a home that cannot be financed. There are lenders who will provide financing for repairs along with the purchase, but they are specialized loans, generally more expensive and less attractive than conventional mortgages.
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A prequalification is performed during your initial loan interview with a loan counselor. During the interview your counselor will use your income and expenses to determine your debt-to-income (DTI) ratio. Using this ratio the counselor will determine the potential loan amount for which you may qualify. The counselor does not issue a loan approval and a prequalification is not a commitment to lend. A prequalification is simply a calculation used to determine the amount of money you qualify to borrow.
Preapprovals are very simply mortgages without property. If you go this route your credit will be checked, your assets will be verified and your employer and landlord will be contacted. Your loan application is formally underwritten to current guidelines and, if your application is approved, you will receive formal commitment in the form of an approval letter along with a preapproval certificate.
Having a preapproval gives you the peace of mind knowing that you are already qualified if you find the house of your dreams in your price range. A preapproval also tells the real estate agent and potential sellers that you are a serious shopper and often gives you an edge over buyers that still need to go through the qualification process. Your loan will generally close more quickly since you have already provided the documentation requested by your lender.
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A point is one percent of the loan amount. If you are applying for a $100,000 loan one point would cost you $1,000. Lenders can adjust the interest rate you pay by charging points. That's why you will often see rates offered two ways: one if you do pay points, one if you don't.
Additionally, lenders charge points to offset risk factors. If you're financing an investment property (a rental) the risk is higher than that of primary residences so add-on points are charged. Other risk factors include (but are not limited to) borrowing at higher loan-to-value ratios, having a FICO score below a certain cut-off, borrowing against a condo, townhouse or duplex and refinancing to borrow more than you currently owe.
Points are considered part of your closing costs and add to the amount of money you will need to bring when you sign your final documents on a purchase. If there is enough room in your loan-to-value ratio, points can be included in your refinance if you prefer to not pay them out of pocket. Paying points to reduce your interest rate is your option; paying the risk based add-on points is not.
Some lenders let you buy down points by increasing the rate or buy down the rate by increasing the points. Some borrowers are more sensitive to rates; others are more sensitive to fees. The best way to decide whether you should pay points to lower your interest rate is to perform a break-even analysis:
- Calculate the cost of the points. Example: 1 point on a $100,000 loan is $1,000.
- Calculate the monthly savings on the loan as a result of obtaining a lower interest rate. Same example: Say refinancing to a lower rate will save you $50 a 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 it is 20 months. If you plan on living in the home for longer than 20 months, it makes sense to pay points. If you don't, don't pay the points.
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The first is the "note rate," the rate from which your monthly payments are calculated. The second is APR, which stands for annual percentage rate. APR is an artificial number calculated according to a formula determined by the government, intended to provide you with a method to compare one mortgage offer against another, even when the rates, points and costs differ. The APR was created to help you determine the "true cost" of borrowing.
Certain costs associated with the loan and rate are totaled and then subtracted from the loan amount. A payment is then calculated on this lower amount causing the resulting APR to be higher than the note rate. The exception to this is when the lender pays all of your costs in a "no cost" loan. There are still costs but the lender is paying them so they are not calculated into your APR.
A loan with a lower note rate and higher points could easily have a higher APR than a loan quoted at a higher note rate and lower costs. Your "true cost" of borrowing may depend more on how long you keep the loan than anything else. Paying more in points to get a lower note rate may save you more money if you intend to remain in the property for a long time — even though it has a higher APR. Refer to the calculation at the end of question 5 for more information.
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A rate lock is the lender's commitment that your loan will fund at a certain rate with a certain number of points, even if rates go up while your loan is processing. A rate lock has a specific expiration date; if you go beyond it the lender is no longer required to honor the rate or points, regardless of the cause for delay. Conversely, if rates decrease during processing, the lock prohibits the lender from extending you the lower rate. There are five components of a rate lock:
- Loan program - Lenders have flexibility in pricing unless the loan is being sold to an investor. If it's sold, the investor dictates the guidelines as well as the pricing for rates.
- Loan-to-value (LTV) ratio - This calculation takes the loan amount and divides it by the value of the property and expresses it as a percentage. If you owe $140,000 against your home that appraises for $175,000, your LTV is 80%. The lower the LTV, the lower the risk to the lender, the better rates and fees to the borrower.
- Interest rate or note rate - This is the rate on which your payment is calculated. It can fluctuate according to the market. (See Why do interest rates change for more information.)
- Points - One point is equal to 1% of the loan amount. Points are charged to lower your interest rate or to offset risks associated with financing your home. (See What are points - should I pay points for more information.)
- Length of the lock period - Generally, the longer the lock period, the higher your points or rate. A longer lock period represents a greater risk to the lender's or investor's potential interest income so higher rates or fees are charged to offset the risk.
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Interest rates fluctuate on the simple principal of supply and demand. If there is high demand for credit, rates typically rise; if there is less demand for credit, lenders are forced to be more competitive and rates typically drop. Major investors like Fannie Mae (FNMA) and Freddie Mac (FHLMC) will also affect rates to adjust volumes. In times of high volume they will increase rates to provide relief to saturated pipelines. In times of low volume they will decrease rates to stimulate interest.
Rates can also be affected by inflation (including the impact of oil prices), short term interest rates (these can be determined by the "Fed" as well as other factors) and bond prices and rates.
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Monthly payments are based on four factors: Principal, interest, taxes and insurance, commonly referred to as PITI.
- Principal - This is the amount originally borrowed to buy or refinance the home. A portion of each monthly payment goes toward repaying the principal. You won't be able to divide the loan amount by your term to get the amount that goes toward the principal each month because in the beginning, the principal is only a small fraction of the monthly payment. This is because interest is charged on the outstanding balance each month, which is called amortizing. The portion of your payment going towards interest will decrease slightly each month. Over the years, this will reverse and the principal will increase, diminishing the remaining principal balance against which the interest is charged.
- Interest - To take on the risk of lending money, a lender charges interest. This is known as the interest rate or the note rate, and it has a very direct impact on your monthly payment. The higher the interest rate, the higher your monthly payment.
- Taxes - Real estate taxes are due twice a year in two equal installments. Many lenders collect 1/12th of the expected total tax bill along with the principal and interest every month. This amount is placed in an escrow account until the tax bill is due. Homeowners who finance over 80% of the home's value are required to have their taxes and insurances impounded monthly. Homeowners who finance less than 80% have the option of not doing so. Not having them impounded reduces your monthly payments, but the responsibility of paying these taxes falls to the homeowner.
- Insurance - Homeowners (or Hazard) insurance covers theft and damage to the home or property and is required on every loan. If your home is located in a federally zoned potential flood hazard area, flood insurance is also required. (You may purchase flood insurance if your property is not located in a flood zone, but it is not required by the lender.) New government regulations require flood insurance to be impounded if it is required. Additionally, if you finance over 80% of the value of your home, Private Mortgage Insurance (PMI) is required, the lender will require your taxes and all insurance to be impounded and you will no longer have the option not to include them in your monthly payment. Traditionally lenders required a 20% down payment on all purchases. As housing prices increased and saving 20% became impractical, PMI was offered as a way for lenders to offer financing at higher loan to values (LTVs). PMI is also available for refinances on programs that allow you to refinance more than 80% of your home’s value.
PMI insures the gap between the actual down payment and the traditionally required 20%. Purchasing PMI to make up this difference reduces the amount of money you must save for a down payment, but provides lenders with the same risk as if they were only financing 80% LTV. Reducing this risk also reduces associated add-on fees charged by investors, resulting in savings to the borrower. If you borrow over 80% LTV you are required to purchase PMI.
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A FICO score is a credit score developed by Fair Isaac Corporation. Credit scoring is widely accepted by lenders as a reliable means of credit evaluation, which means mortgage lenders base rates and fees on your FICO score. If your credit is even slightly weak it could add significantly to the cost of your loan and increase your interest rate. It's a good idea to check your credit so you can clear up any errors or inconsistencies prior to applying. FICO credit scores range from 300 - 850, with 850 being the best. Credit scores analyze a borrower's credit history considering numerous factors:
- If payments were made on time
- The length of time credit has been established
- Amount of credit used versus amount of credit available
- Length of time at present residence
- Negative credit information such as foreclosures, short sales, bankruptcies, charge-offs, collections, etc.
To obtain a copy of your credit report, contact any of the following credit-reporting agencies:
A credit score reflects a history of your credit usage and any credit for which you have been approved — open or closed — remains on your report indefinitely. Past derogatory credit issues like collections and slow payments will eventually be purged, but they stay on your report and affect your credit score for up to ten years. While a positive change in your credit habits will not immediately improve your score, the following tips will ensure that as poor credit habits are purged from your report, positive credit habits will take their place and improve your FICO score over time:
- Pay your bills on time. Late payments and collections have a serious impact on your score.
- Do not apply for credit frequently. Having a large number of inquiries on your credit report can impact your score.
- Reduce your credit card balances. "Maxing out" negatively affects your score.
- Do not close unused credit cards just to qualify. Closing unused credit cards will not affect your FICO score positively; it could affect it negatively, especially if you close cards that have available limits and only leave open cards that are maxed out. Closing unused cards to keep you from maxing out more lines of credit is fine, but closing cards with the intention of improving your FICO score is not the solution.
- If you have limited credit, obtain additional credit. Not having sufficient credit can negatively affect your score.
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To correct any errors on your credit report you must contact the creditor (the company reporting the incorrect data), not just the credit bureau. If the creditor concurs that an error has occurred, the company must correct the error and report the correction to the credit bureau within a specific period of time. Be sure to request that the company report the correction to all three of the major credit bureaus.
If the creditor does not concur they will either tell you how to resolve the issue, or, if they determine that the information being reported is correct (they cannot falsify the record by reversing or removing correctly reported information), they may advise you to place an explanation on the report called a "statement of dispute" which will become a part of your credit report. While this will not improve your credit score, it will eliminate the need to explain the issue to new creditors.
For more information on fixing an error on your credit report, visit www.myfico.com.
Most lenders reserve the right to sell your loan at any time. When the loan is sold it is generally to an investor and not another lender. The investor who purchases the loans is generally the same investor with whom the rate was locked. Because of the large volume of loans purchased by investors like Fannie Mae (FNMA) and Freddie Mac (FHLMC), lower rates can be offered. The investor buying your loan assumes all terms and conditions of the original loan note so you can be assured that no terms of your loan will change.
Generally, when the loan is purchased by the investor the only thing that changes is where you mail your payment. You will receive a notification, generally from both buyer and seller, that your loan was purchased, who your new servicer is and where to mail your payment.
When Schools Financial Credit Union sells a loan it is sold as "servicing retained." This means that although Fannie Mae has purchased the loan from us, we still collect the monthly payments to remit to them. You will continue to pay your monthly payment to the Credit Union, and we remain your direct contact for questions and servicing requests.
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