Frequently Asked Questions

FREQUENTLY ASKED QUESTIONS (FAQ)

What are the most commonly made mistakes in buying or refinancing a house?
Should I refinance?
Should I pay points?
What is a credit score?
What is the difference between pre-qualifying and pre-approval?
What is a rate lock?
Can my loan be sold? What happens if my lender goes out of business?
What is PMI? Can I get rid of the PMI on my loan?
What is an APR?

Common Mistakes

If you're like most people, purchasing a home is the biggest investment you'll ever make. Because of the numerous factors to consider when purchasing a home, it's important to prepare as best you can.

Buying a home

Looking for a home without being pre-approved. As a potential buyer competing for a property, you'll have a better chance of getting your offer accepted by being as prepared as possible. Consider this hierarchy of preparedness:
- Neither pre-qualified nor pre-approved
- Pre-qualified
- Pre-approved
The benefits available at each level can be easily understood when viewed from the seller's perspective.

Neither pre-qualified nor pre-approved
This buyer provides no evidence that they can afford to purchase your property. You may wonder how serious they are since they're not at least pre-qualified.
Pre-qualified
This buyer has met with a lender and discussed their situation. The buyer has informed the broker regarding their income, expenses, assets and liabilities. The lender may also have seen their credit report. The buyer provided you with a letter from the lender stating an opinion of what the buyer can afford.
Pre-approved
This buyer has provided a lender written evidence of income, expenses, assets, liabilities and credit. All information has been verified by a lender. As a result, much of the paperwork for this buyer's loan has been completed. This buyer will probably be able to close quickly. They provide you with a pre-approval letter from the lender.

As a potential buyer, you can see that being pre-approved will give you the best chance of getting your offer accepted. This is critical in a competitive situation.
Choosing a lender just because they have the lowest rate. While the rate is important, consider the total cost of your loan including the APR, loan fees, discount and origination points.
The cost of the mortgage, however, shouldn't be your only criterion. Have confidence that the company you select is reputable and will deliver the loan with the terms and costs they promised.
Not receiving a Good Faith Estimate. Within three business days after the broker or lender receives your loan application, you must receive a written statement of fees associated with the transaction. This is the best way to determine what you'll pay for your loan.
Not getting a rate lock in writing. When a mortgage company tells you they have locked your rate, get a written statement detailing the interest rate, the length of the rate lock, and program details.

Refinancing your home

Refinancing with your existing lender without shopping around. Your existing lender may not have the best rates and programs. There is a general misconception that it is easier to work with your current lender. In most cases, your current lender will require the same documentation as other companies. Even if you have made all your mortgage payments on time, your existing lender will still have to verify assets, liabilities, employment, etc. all over again.
Not doing a break-even analysis. Determine the total cost of the transaction, then calculate how much you will save every month. Divide the total cost by the monthly savings to find the number of months you will have to stay in the property to break even. Example: if your transaction costs $2000 and you save $50/month, you break even in 2000/50 = 40 months. In this case you'd refinance if you planned to stay in your home for at least 40 months.
Using the county tax-assessor's value as the market value of your home. Mortgage companies do not use the county tax-assessor's value to determine whether they will make the loan. They use a market-value appraisal which may be very different from the assessed value.
Not getting a rate lock in writing. When a mortgage company tells you they have locked your rate, get a written statement which includes the interest rate, the length of the rate lock and details about the program.
Pulling cash out of your credit line before you refinance your first mortgage. Many lenders have cash-out seasoning requirements. This means that if you pull cash out of your credit line for anything other than home improvements, they will consider the refinance to be a cash-out transaction. This usually results in stricter requirements and possibly a higher rate.
Getting a second mortgage before you refinance your first mortgage. Many mortgage companies look at the combined loan amounts (i.e., the first loan plus the second) when refinancing the first mortgage. If you plan on refinancing your first loan, check with your mortgage company to find out if getting a second will cause your refinance transaction to be turned down.

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 one's monthly mortgage payment to be reduced.
By reducing the term of the loan, thus saving money over 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.

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.

If you are refinancing to save money on your monthly payments, the following calculation can be used:

Calculate the total cost of the refinance--example: $2,000
Calculate the monthly savings--example: $100/month
Divide the result in 1 by the result in 2--in this case 2000/100 = 20 months. This shows the break-even time. If you plan to live in the house for longer than this period of time, it makes sense to refinance.

Should I pay points?

The best way to decide whether you should 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.

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!

What is a credit score?

A credit score is a method of determining the likelihood that credit users will pay their bills. Scoring has become widely accepted by lenders as a reliable means of credit evaluation. A credit score attempts to condense a borrowers credit history into a single number.

Credit scores analyze a borrower's credit history considering numerous 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
Negative credit information such as bankruptcies, charge-offs, 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.

Frequently Asked Questions (FAQs)

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.

What if there is an error on my credit report? If you see an error on your report, report it to 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, your mortgage company may help you correct this problem as well.

What is the difference between pre-qualifying and pre-approval?

A pre-qualification is normally issued by a loan officer, who, after interviewing you, determines the dollar value of a loan you can be approved for. However, loan officers do not make the final approval, so a pre-qualification is not a commitment to lend. After the loan officer determines that you pre-qualify, he/she then issues you a pre-qualification letter. This pre-qualification letter is used when you are making an offer on a property. The pre-qualification letter indicates to the seller that you are qualified to purchase the house you are making an offer on.

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, you are then issued a pre-approval certificate. 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!

What is a rate lock?

You cannot close a mortgage loan without locking in an interest rate. There are four components to a rate lock:

Loan program.
Interest rate.
Points.
Length of the lock.

The longer the length of the lock, the higher the points or the interest rate. This is because the longer the lock, the greater the risk for the lender offering that lock.

Let's say you lock in a 30-year fixed loan at 8% for 2 points for 15 days on March 2. This lock will expire on March 17 (if March 17 is a holiday then the lock is typically extended to the first working day after the 17th). The lender must disburse funds by March 17th, otherwise your rate lock expires, and your original rate-lock commitment is invalid.

The same lock might cost 2.25 points for a 30-day lock or 2.5 points for a 60-day lock. If you need a longer lock and do not want to pay the higher points, you may instead pay a higher rate.

After a lock expires, most lenders will let you re-lock at the higher of the prevailing market rates/points, or the originally locked rates/points. In most cases you will not get a lower rate if rates drop. In some cases, prior to the rate lock expiration date, the lender may allow you to negotiate a rate lock extension at the original rate/points. An additional fee may be charged for this extension.

New-construction rate locks.

Most lenders offer long-term locks for new construction. These locks do cost more and may require an up-front deposit. For example, a lender might offer a 180-day lock for 1 point over the cost of a 30-day lock, with 0.5 points being paid up-front, as a non-refundable deposit.

Can my loan be sold? What happens if 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.

What is PMI? Can I get rid of the PMI on my loan?

PMI or private mortgage insurance is normally required when you buy a house with less than 20% down. Mortgage insurance is a type of guarantee that helps protect lenders against borrower defaults and the costs of foreclosure. This insurance protection is provided by private mortgage-insurance companies. It enables lenders to accept lower down payments than they would normally accept. In effect, mortgage insurance provides what the equity of a higher down payment would provide to cover a lender's losses in the unfortunate event of foreclosure. Therefore, without mortgage insurance, you might not be able to buy a home without a 20% down payment.

The cost of PMI increases as your down payment decreases. Example: The cost of PMI on a 10% down payment is less than the cost of PMI on a 5% down payment. Your PMI premium is normally added to your monthly mortgage payment.

The decision on when to cancel the private insurance coverage does not depend solely on the degree of your equity in the home. Federal law requires the mortgage insurance on conventional loans to automatically terminate when the loan-to-value based on the current principal balance (current balance divided by the original value) reaches 78%. However, in most cases, the lender will allow cancellation of mortgage insurance when the loan is paid down to 80% of the original property value.

To cancel the PMI on your loan, contact your lender. In most cases, an appraisal will be required to determine the value of your property. You will probably also be required to pay for the cost of this appraisal

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.

Example:

30-year fixed

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 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.

The best way to compare loans in the author's opinion is to ask lenders to provide you with a good-faith estimate of their costs on the same type of program (e.g. 30-year fixed) at the same interest rate. Then delete all fees that are independent of the loan such as homeowners insurance, title fees, escrow fees, attorney fees, etc. Now add up all the loan fees. The lender that has lower loan fees has a cheaper loan than the lender with higher loan fees.

The following fees ARE generally included in the APR:

Points - both discount points and origination points
Pre-paid interest. The interest paid from the date the loan closes to the end of the month. Most mortgage companies assume 15 days of interest in their calculations. However, companies may use any number between 1 and 30!
Loan application fee
Attorney/settlement agent fee
Loan-processing fee
Underwriting fee
Document-preparation fee
Private mortgage-insurance

The following fees are NOT included in the APR:

Title or abstract fee
Escrow fee
Home-inspection fees
Recording fee
Transfer taxes
Credit report
Appraisal fee

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