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Mortgage FAQ

1. What are the most commonly made mistakes in buying or refinancing a home?

Buying a home

1. Looking for a home without being pre-approved. As a potential buyer you are often competing for a property. You have a better chance of getting your offer accepted if you are prepared. Consider this hierarchy of preparedness:
   • Pre-approved
   • Pre-qualified
   • Neither pre-qualified nor pre-approved
   
   The benefits of each level can be easily understood when viewed from the seller's perspective. Imagine you are a seller in receipt of multiple offers for your property. A complete stranger (a potential buyer) is asking you to take your property off the market for at least the next two to three weeks while they apply for a loan. As the seller, think about the type of buyer you would prefer to deal with.
   
   Neither pre-qualified nor pre-approved
   The buyer provides no evidence that they can afford to purchase your property. You may wonder how serious they are since they are not at least pre-qualified.
   
   Pre-qualified
   The buyer has met with a mortgage broker (or lender) and discussed their situation. The buyer has informed the broker of their income, expenses, assets and liabilities. The broker may also have seen their credit report. The buyer has a letter from the broker stating an opinion of what the buyer can afford.
   
   Pre-approved
   The buyer has provided a broker with written evidence of income, expenses, assets, liabilities and credit-and the information has been verified by a lender. As a result, much of the paperwork for the loan has been completed. The buyer should be able to close quickly. They have a letter (pre-approval certificate) from the lender. You, the seller, are as certain as you can be that this buyer can close.
   
   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.
2. Making verbal agreements. Do not sign a document containing instructions that go against your verbal agreement. For example, the seller verbally agrees to include the washing machine in the sale, but the written contract excludes it. The written contract is binding and will override the verbal contract. More importantly, your state may require that contracts for the sale of property be in writing. Verbal agreements are rarely enforceable.
3. Choosing a lender just because they have the lowest rate. Getting a low rate is important, but you need to consider the total cost of your loan including the APR , loan fees, discount and origination points. When receiving a quote from a lender or broker, always insist that the discount points (charged by the lender to reduce the interest rate) be distinguished from origination points (charged for services rendered in originating the loan). The cost of the mortgage, however, should not be your only criterion. Have confidence in the company you select-make sure they are reputable and will deliver the loan with the terms and costs they promised. If in the final hours of the transaction you find that the lender has suddenly increased their profit margin at your expense, you will not have time to start again with a different lender. Ask family and friends for referrals, and interview prospective mortgage companies.
4. Not receiving a Good Faith Estimate. Within the 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 law, but it is also the best way to determine what you will pay for your loan. Bring the Good Faith Estimate (GFE) with you whenever you sign loan documents. You should not be expected to pay fees that are substantially different from those quoted in your GFE.
5. Not getting a rate lock in writing. Once a mortgage company tells you they have locked in your rate, get a written statement detailing the interest rate, length of the rate lock, and program details.
6. Using a dual agent--i.e., an agent who represents the buyer and the seller in the same transaction. Buyers and sellers have opposing interests. A seller wants to receive the highest price, while a buyer wants to pay the lowest price. In standard real estate transactions, the seller pays the real estate agent a commission. When an agent is representing both the buyer and the seller, the agent may try to negotiate more vigorously on behalf of the seller, in order to secure a higher commission. As a buyer, you should have an agent represent you exclusively. The only time you might want to consider a dual agent is if you are guaranteed a price break. Even then, proceed cautiously and do your homework!
7. Buying a home without professional inspections. Unless you are buying a new home, complete with warranties on most equipment, you should get property, roof and termite inspections. This ensures that you know exactly what you are buying. Inspection reports can be great negotiating tools when you are asking the seller to make necessary repairs. If a professional inspector is recommending certain repairs, the seller is more likely to agree to do them. If the seller has agreed to do repairs, before the close of escrow you should have your inspector verify that they were completed. Do not assume that everything was done as promised.
8. Not shopping for home insurance until you are ready to close. Start shopping for home insurance as soon as the seller accepts your offer. Waiting until the last minute means you will not have time to shop around and may end up paying more than you need to.
9. Signing documents without reading them. Review in advance the documents you will be signing whenever you can. (You may not know all the specifics of your transaction early on, but the documents you will need to sign are standard forms that are available for review.) Usually you will not have sufficient time to read all the documents in their entirety during the closing appointment, so come prepared.
10. Not allowing for delays in the transaction. Ideally, all real estate transactions close on schedule. In reality, transactions are often delayed a week or more. Suppose you had asked your landlord to terminate your lease on the exact day your purchase transaction was scheduled to close. Then, a few days before the scheduled closing date, you find out that your transaction is delayed a week. Hopefully, no one is inconvenienced and your landlord is willing to accommodate you. However, it is much more likely that your landlord is inconvenienced and angry. Could you be thrown out? Will you be able to find interim housing? The eviction process takes time, so you will not be forcibly removed right away. This whole stress-producing scenario can be avoided by terminating your lease one week after your real estate transaction is scheduled to close. If there is an unforeseen problem or delay in closing your transaction, you have some leeway. This approach may or may not cost a little more, but the security and peace of mind is worth it.

Refinancing your home

1. Refinancing with your existing lender without shopping around. Your current mortgage lender may not have the best rates and programs for refinancing. Many people mistakenly believe that it is easier to work with your current lender, but this is not always true. Most of the time, your current lender will require the same documentation as any other company. Because most loans are sold on the secondary market, they have to be approved independently. This means that even if you have made all your mortgage payments on time, your current lender will still have to verify assets, liabilities, employment, etc. all over again.
2. Not doing a break-even analysis. First, determine the total cost of the transaction, and then calculate how much you will save every month. By dividing the total cost of the transaction by how much you will save each month, you get the number of months you will have to reside in the home to break even. Example: if your transaction costs $2000 and you save $50/month, you divide 2000 by 50. 2000/50 = 40. So, in 40 months, or 3 years and 4 months, you would break even. In this case you should refinance if you plan to stay in your home for at least 40 months.
   
   Note: This is a simplified break-even analysis. If you are refinancing and considering switching from an adjustable to a fixed loan, or from a 30-year loan to a 15-year loan, the analysis becomes much more complex.
3. Not getting a written good-faith estimate of closing costs. See item number four above.
4. Paying for an appraisal when you think your home value may be too low. Appraisal companies will usually prepare a desk review appraisal at no charge. The desk review shows you with a range of possible appraisal values. Your mortgage company's appraiser might do this for you as well. Do not waste your money on a full appraisal if you are unsure of the value of your home.
5. 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 decide whether or not they will approve a loan. They use a market-value appraisal, which can vary drastically from the assessed value.
6. Signing your loan documents without reviewing them. See item number nine above.
7. Not providing documents to your mortgage company in a timely manner. Your mortgage company may require documentation beyond what you have already given them. Provide any additional documents as soon as you can get them together. They are necessary to get your loan approved and closed. Delays in providing documents can result in a costly hold-up in the loan process.
8. Not getting a rate lock in writing. When a mortgage company tells you they have locked your rate, get a written statement. This statement should specify the interest rate and the length of the rate lock, and also provide details about the program.
9. Pulling cash out of your credit line before you refinance your first mortgage. Many lenders have cash-out seasoning requirements. These requirements stipulate that if you pull cash out of your credit line for anything other than home improvements, the mortgage lender can consider the refinance to be a cash-out transaction. This usually results in stricter requirements and can even break the deal.
10. Getting a second mortgage before you refinance your first mortgage. When you are trying to refinance a mortgage, many mortgage companies will look at both the first and second loans, or what is called the combined loan amount. If you plan on refinancing your first loan, check with your mortgage company to find out if getting a second loan could jeopardize your chances for refinancing your first loan.

Getting a home-equity loan/line

1. Not knowing if your loan has a pre-payment penalty clause. Hefty pre-payment penalties are included in most "NO FEE" home-equity loans. You should avoid loan with these penalties if you are planning to sell or refinance in the next three to five years.
2. Getting too large a credit line. If you get a credit line that is too large, you could be turned down for other loans. Some lenders calculate your payments based upon the available credit, not the used credit, so even when your equity line has a zero balance, your large equity line indicates a large potential payment. This has the potential to make it difficult to qualify for other loans.
3. Not understanding the difference between an equity loan and an equity line. An equity loan is closed--i.e., you get all of the loan money up front and make fixed payments until it is paid if full. An equity line is open--i.e., you can get any number of advances for various amounts as you need or want them. Most equity lines are accessed through a checkbook or a credit card. You will only be charged interest on the outstanding principal balance, whether you have an equity loan or an equity line. An equity loan is ideal for home improvements, debt consolidation or anything else where you will need all the money up front. An equity line is better for future events or periodic expenses, such as a child's college tuition.
4. Not checking the lifecap on your equity line. Many credit lines have an 18 percent lifecap. Be prepared to make payments at the highest potential rate.
5. Getting a home-equity loan from your local bank without shopping around. Many consumers get their equity line from the bank with which they have their checking account because it is a convenient and trusted source. Your bank may be your best option, but shop around before making a commitment.
6. Not getting a good-faith estimate of closing costs. See item number four above.
7. Assuming that your home-equity loan is fully tax-deductible. Your home-equity loan is NOT always tax deductible. Do not depend on your mortgage company for information regarding tax deductions-check with an accountant or CPA.
8. Assuming that a home-equity loan is always cheaper than a car loan or a credit card. Compare the effective rate of your home-equity line with the rate on your credit card or auto loan to find out which is ultimately the cheapest. Even after deducting interest for income tax purposes, a credit card can be cheaper than a credit line. Effective rate = rate * (1 - tax bracket) Example: The rate of the home-equity line is 12 percent, your tax bracket is 30 percent, your effective rate is: .12 * (1 - .3) = .12 * .7 = .084 = 8.4 percent. If your credit card is higher than 8.4 percent, the equity loan is cheaper.
9. Getting a home-equity line of credit when you plan to refinance your first mortgage in the near future. Many mortgage companies look at both the first and the second loan, or what they call the combined loan amounts, 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 could cause your refinance to be turned down.
10. Getting a home-equity line to pay off your credit cards when your spending is out of control! If you open an equity line to pay off your credit cards, do not continue to abuse your credit cards. If you cannot manage your finances using credit cards, get rid of all except one for emergencies.

2. Should I refinance?

The most common reason for refinancing is to save money. You can do this two ways through refinancing:

1. By obtaining a lower interest rate that, causing your monthly mortgage payment to be reduced.
2. By reducing the term of the loan, thereby saving money over the life of the loan. Refinancing from a 30-year loan to a 15-year loan might result in higher monthly payments now, but the total of the payments made during the life of the loan can be reduced significantly, saving money in the long run.

People also refinance to convert an adjustable loan to a fixed loan. This type of refinance provides the borrower with the stability and security of a fixed loan. Because adjustable loans tend to be more popular when rates are high, refinancing to a fixed loan is a popular move when interest rates go down. When mortgage rates are low, homeowners refinance to lock in low rates. When mortgage rates are high, homeowners prefer an adjustable loan to lower their payments.

Consolidating debts and replacing high-interest loans with a low-rate mortgage is another reason homeowners may opt for refinancing. Consumer loans, such as second mortgages, credit lines, student loans, credit cards, etc., can be consolidated for tax savings. Since consumer loans are not tax deductible, but a mortgage loan is tax deductible, consolidating consumer debt and refinancing saves money with the lower interest rate and tax deduction.

The question "Should I refinance?" is a complex one, since every situation is different and no two homeowners are in the exact same position. The conventional wisdom of refinancing only when you can save 2% on your mortgage does not always apply. If you are refinancing to save money by lowering your monthly payments, the following calculation is more appropriate than the rule of 2%:

1. Calculate the total cost of the refinance--example: $2,000
2. Calculate the monthly savings--example: $100/month
3. 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.

Sometimes, you are forced to refinance. This can happen if you have a loan with a balloon provision, but no conversion option. In this case, you should refinance a few months before the balloon comes due.

When determining whether or not to refinance, consult with an experienced mortgage professional. This simple consultation will almost always save you time and money. Do your own research as well and make a few phone calls, check out web sites, and crunch some numbers. Spend some time to understand the options available to you, and find the option that will save you the most money.

3. Should I pay points? Does a 0 point/0 fee loan really exist?

If you are trying to decide whether or not you should pay points, the best way thing to do is compare costs with a break-even analysis. This is done as follows:

1. Calculate the cost of the points. Example: 2 points on a $100,000 loan is $2,000.
2. Calculate the monthly savings on the loan as a result of obtaining a lower interest rate. Example: $50 per month
3. Divide the cost of the points by the monthly savings. This will give you the number of months it will take to break even. In the above example, this number is 40 months. If you plan to keep the house for more than the number of months it will take to break even, it makes sense to pay points; otherwise, it does not.
4. Keep in mind that the calculation above does not take into account the tax advantages of points. The points you pay are tax-deductible, so when you are buying the house you will save some money immediately. On the other hand, when you get a lower payment, your tax deduction will decrease. Calculating the break-even time is a little more difficult because you must take taxes into account. In a purchase, taxes definitely reduce the break-even time. However, in a refinance, the points are NOT tax-deductible, but have to be amortized over the life of the loan. This means 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 live in your home for less than 3 years, you should not pay points. If you plan to live in your home for more than 5 years, you should pay 1 to 2 points. If you plan to live in your home for between 3 and 5 years, paying points or not will not make a significant difference.

Zero-Point/Zero-Fee Loans

Whatever happened to the conventional wisdom of waiting for the rates to drop 2% before refinancing?

Imagine you have a 30-year fixed loan at 8.5%, and a loan officer calls you up and says that they can refinance you to a rate of 8.0%--no points and no fees whatsoever.

Sound perfect, right? No appraisal fees, no title fees, no hidden fees. Is this a deal too good to pass up, or too good to be true? How can a bank and broker do this? Someone has to pay, right? Whose money is being used to pay these closing costs?

No--this is not a scam. Thousands of homeowners have refinanced using a zero-point/zero-fee loan. Some may have refinanced multiple times as rates went down in 1992, 1993 and 1996. Some homeowners might have used zero-point/zero-fee adjustable loans to refinance, getting a new "teaser" rate every year.

This works through rebate pricing, also known as yield-spread pricing, or a service-release premium. Basically, you pay a higher rate in exchange for cash up front, which is then used to pay the closing costs. You end up paying a higher monthly payment--so the money is really coming from future payments that you will make.

You could also think of this as a negative points system. For example, a 30-year fixed loan might be available for 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 could offer you a rate of 8.75% with a cost of -1 point, leaving a $2,000 credit towards your closing costs. A mortgage broker could use rebate pricing to pay for your closing costs, while keeping the balance of the rebate as profit.

What are the benefits of a zero-point/zero-fee loan?

The main benefit to you is no out-of-pocket costs. This means that if the rates drop in the future, even a small amount, you could refinance again. If you refinanced on the zero-point/zero-fee loan to get a rate of 8.75%, and the rates drop 1/2%, you could refinance again to 8.25%. However, if you refinanced by paying 1 point and got a rate of 8.25%, it might not make sense to refinance again. But, if the rates drop another 1/2%, a zero-point/zero-fee loan could drop your rate to 7.75%. But keep in mind that if you paid points, you may have to do a break-even analysis to decide if refinancing again will still save you money.

The zero-point/zero-fee loan eliminates the need to do a break-even analysis since there is no up-front expense that needs to be recovered. This makes it a great way to take advantage of falling interest rates.

Some consumers use zero-point/zero-fee loans on adjustable loans to refinance their adjustables every year, paying a very low "teaser" rate each time.

What are the disadvantages of a zero-point/zero-fee loan?

The major disadvantage is that you will be paying a higher rate than you would be paying if you paid the points and closing costs. If you keep the loan for long enough, you will end up paying more, because your mortgage payments are higher. If you plan to live in the house for more than 5 years, provided rates never drop enough for you to refinance, you could actually end up paying more money. However, if you plan to live in the house for just 2-3 years, there really are not any disadvantages to a zero-point/zero-fee loan.

Whose money is it?

Since you are getting "cash" up-front in exchange for a higher rate, it actually is your own money that you end up paying in the future through higher payments. Investors fund these loans in the hopes that you will keep the loans long enough for them to recoup their up-front investment. If you refinance the loans early, both the servicer and the investor stand to lose money.

To summarize, a zero-point/zero-fee loan can provide a good, money-saving deal. However, in order to truly save money, you need to make sure that the lender is paying for your closing costs from rebate points and NOT by increasing your loan amount. If your old loan amount was $150,000, your new loan amount should still be $150,000. You may have to come up with some money at closing for recurring costs that are not covered (taxes, insurance, and interest), but you would have to pay for these whether or not you were refinancing.

Zero-point/zero-fee loans are especially attractive when interest rates are declining or when you plan to sell your house in less than 3 years.

The future of zero-point/zero-fee loans is unsure. Lenders have discussed adding a pre-payment penalty to such loans, but as of yet, very few lenders have actually implemented additional fees or penalties.

4. What is a FICO score?

A FICO score is a credit score named after its developers, Fair, Isaac & Co. Credit scoring is a method of determining the likelihood that credit users will pay their bills. Fair, Isaac pioneered credit scoring in the late 1950s. Since then, scoring has become widely accepted as a reliable means of credit evaluation for lenders to utilize. A credit score condenses a borrowers credit history into a single number in an attempt at creating an "at a glance" summary of their borrowing profile. It is not know exactly how these scores are computed, but the Federal Trade Commission has ruled it acceptable for the credit bureaus to keep their computation methods confidential.

What is know about credit score calculation is that scoring models and mathematical tables assign points for different pieces of financial information in order to predict future credit performance. The development of these models required studying how thousands, possibly millions, of people use credit. Score-model developers found predictive factors in the data that have proven to be fairly reliable indicators of future credit performance. Models can be developed from different sources of data; for instance, credit-bureau models are developed from information in consumer credit-bureau reports.

A credit score analyzes a borrower's credit history by considering 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-offs, collections, etc.

A FICO credit score is actually a combination score computed from data provided by each of the three bureaus--Experian, Trans Union and Equifax. Some lenders use only one of the three scores, while other lenders use the middle score.

Frequently Asked Questions About Credit Scores

Can I increase my score?

While it is difficult to increase your score over the short run, there are things you can do to increase your score in the long run.

• Pay bills on time. Late payments and collections can have a negative 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 credit-card balances. "Maxed" out credit cards affect credit scores negatively.
• If credit is limited, obtain additional credit. Insufficient credit can negatively impact scores.

What if there is an error on my credit report?

If you suspect an error on your report, report it to the credit bureau. The three major bureaus in the U.S. are: Equifax (1-800-685-1111); Trans Union (1-800-916-8800); and Experian (1-888-397-3742). All three have procedures for correcting information promptly. In some cases, your mortgage company may be able to help you correct this problem as well.

5. Why do mortgage rates change?

To understand why mortgage rates always seem to be changing, you must first understand why interest rates change in general. It is important to remember that there are many interest rates.

• Prime rate: The rate offered to a bank's best customers.
• Treasury bill rates: Short-term debt instruments used by the U.S. Government to finance its debt. They are more commonly called T-bills and come in denominations of 3, 6, and 12 months. Each T-bill has its own interest rate (i.e. 3-month T-bill rate, 1-year T-bill rate).
• Treasury Notes: Intermediate-term debt instruments used by the U.S. Government to finance its debt. Treasury notes come in denominations of 2, 5, and 10 years.
• Treasury Bonds: Long-term debt instruments used by the U.S. Government to finance its debt. Treasury bonds come in 30-year denominations.
• Federal Funds Rate: Rate banks charge each other for overnight loans.
• Federal Discount Rate: Rate New York Fed charges to member banks.
• Libor:London Interbank Offered Rates; the average London Eurodollar rates.
• 6 month CD rate: Average rate you get when you invest in a 6-month CD.
• 11th District Cost of Funds: Rate determined by averaging a composite of other rates.
• Fannie Mae-Backed Security rates: Fannie Mae pools large quantities of mortgages and creates securities with them. They are then sold as Fannie Mae-backed securities. The rates on these securities strongly influence mortgage rates.
• Ginnie Mae-Backed Security rates: Ginnie Mae also pools large quantities of mortgages to create securities with them. They are sold as Ginnie Mae-backed securities. The rates on these securities influence mortgage rates on FHA and VA loans.

Interest-rate movement is based on the simple concept of supply and demand. If the demand for credit (loans) increases, so do the interest rates. Because there are more buyers, sellers can command a better price, meaning higher rates. If the demand for credit decreases, so do the interest rates. Because there are now more sellers than buyers, buyers can command a better price, meaning lower rates. Interest rates move higher when the economy is expanding, because of the heightened demand for credit. Interest rates go down when the economy is slowing, because the demand for credit is also decreasing.

The basic concept of interest rates is:

• Bad news for the economy (i.e. slowing down) equals good news for interest rates (i.e. lower rates)
• Good news for the economy (i.e. growing) equals bad news for interest rates (i.e. higher rates)

The biggest factor driving interest rates is inflation. Higher inflation is associated with a growing economy. If the economy is growing too strongly, the Federal Reserve will increase interest rates in an attempt to slow the economy down, thereby reducing inflation. Inflation is the result of the 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 raise their prices. Therefore, a strong economy 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, but the supply/demand equation for mortgage rates can differ from the supply/demand equation for interest rates. As a result, mortgage rates may move differently from other rates. For example, one lender may be forced to close additional mortgages in order to meet a commitment they have made. This might force them to offer lower mortgage rates, even though interest rates have moved up and they should be following suit with their mortgage rates.

In addition, there is an inverse, and often confusing, relationship between bond prices and bond rates. When bond prices increase, interest rates decrease, and vice versa. This is due to the fact that 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, if interest rates start increasing, the price of the bond will start to decrease. The higher interest rates will cause increased accumulation of interest over the next 5 years, such that a lower price (e.g. $880) will result in the same maturity price, i.e. $1000.

Effect on Economic Data on Rates

Number of arrows indicates potential effect on interest rates.

1 arrow=least effect
5 arrows=max. effect

Economic Event	Effect on Interest Rates	Significance of Event
Consumer Price Index (CPI) Rises		Indicates rising inflation.
Dollar Rises		Imports cost less; indicates falling inflation.
Durable Goods Orders Increase		Indicates expanding economy
Gross National Product Increases		Indicates strong economy
Home Sales Increase		Indicates strong economy
Housing Starts Rise		Indicates strong economy
Industrial Production Rises		Indicates strong economy
Business Inventories Rise		Indicates weak economy
Leading Indicators (LEI) Increase		Indicates strong economy
Personal Income Rises		Indicates rising inflation.
Personal Spending Rises		Indicates rising inflation.
Producer Price Index Rises		Indicates rising inflation
Retail Sales Increase		Indicates strong economy
Treasury Auction Has High Demand		High demand leads to lower rates
Unemployment Rises		Indicates weak economy

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

Pre-qualification is normally done by a loan officer. Once the loan officer has interviewed you, he or she will determine the dollar value of a loan you could be approved for. However, since loan officers do not make the final loan approval, pre-qualifying a borrower is not a commitment to lend to them. Once the loan officer has determined that you pre-qualify, he or she will issue you a pre-qualification letter. This pre-qualification letter is useful when you are making an offer on a property, because it indicates to the seller that you are qualified to purchase the house you are making an offer on.

Pre-approval is a step above pre-qualification. Pre-approval requires verifying your credit, down payment, employment history, etc. An underwriter reviews your information and application and makes the decision regarding your loan. If you are pre-approved, you will be issued a pre-approval certificate. Getting your loan pre-approved allows you to close very quickly when you find the house you want to buy. A pre-approval is beneficial because it allows you to negotiate a better price with the seller, since being pre-approved is seen as the next best thing to having cash in the bank to pay for the house.

7. What is a rate lock?

You cannot close a mortgage loan without first locking in an interest rate. A rate lock has four components:

1. Loan program
2. Interest rate
3. Points
4. Length of the lock

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

Imagine that on March 2nd you locked in a 30-year fixed loan at 8% with 2 points for 15 days. This lock will expire on March 17th (if March 17th is a holiday then the lock would most likely be extended to the first working day after the 17th). The lender must disburse funds by March 17th, or your rate lock expires, and rendering your original rate-lock commitment 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 to extend to a longer lock but do not want to pay higher points, you could opt to pay a higher rate instead.

Once a lock expires, lenders will usually let you re-lock at the higher of the prevailing market rates/points, or sometimes the originally locked rates/points. In most cases you cannot get a lower rate if rates drop.

Prior to the rate lock expiration date, the lender may choose to allow you to negotiate a rate lock extension at the original rate/points. However, there may be an additional fee for this extension.

Lenders are taking a risk by letting you lock in advance, so they stand to lose money if your lock expires. If rates go up, they are forced to give you the original, lower, rate at which you locked. Lenders will often try to protect themselves against rate fluctuations by hedging.

Some lenders do offer free float-downs, letting you lock the rate initially and giving you the better rate if rates drop while your loan is in process. However, the free float-down is costly for the lender and you end up paying for this option indirectly, in your rate. The lender has to build the price of the float-down option into the rate, so the float-down rate may be 0.125% to 0.25% higher than the prevailing current market rate.

What happens if rates drop after you lock?

Because it is expensive for lender to lock in interest rates, most will not budge unless rates drop substantially (3/8% or more). If lenders let borrowers improve their rate every time rates improved, they would spend a lot of time relocking interest rates, since rates fluctuate daily. Also, this option would have to be factored into their rates, and borrowers would wind up paying a higher rate anyway. If rates drop, you could switch to a different lender. If you choose this option, know that you will have to start the loan process over from the beginning. However, if you used a mortgage broker to get your loan, they will probably be able to move your loan package, including your application, to the new lender offering lower rates. Inform your original lender that you are aware that rates have dropped, and you may find that your lender would rather work with you than lose you to a competitor. It is worth trying before you start the application process with a different lender.

Lock-and-shop programs

Usually lenders will only allow you to lock in an interest rate on one specific property. This means if you are shopping for a home you cannot lock in an interest rate until you have signed a purchase contract for that specific property. Some lenders may offer a lock-and-shop program. A lock-and-shop lets you lock in a rate before you find the home, an attractive feature when rates are rising. This can be very useful for securing a lower rate; however, lock-and-shop rates are usually higher than the prevailing market rate. Also, there may be a non-refundable fee or deposit towards closing costs.

New-construction rate locks

Most lenders will offer long-term locks for new construction. Long-term locks come at a price; they tend to cost more and often require an up-front deposit. For example, a lender may offer a 180-day lock for 1 point over the cost of a 30-day lock and require that 0.5 points being paid up-front, as a non-refundable deposit. A benefit of long-term new-construction locks is that most offer a float-down, so if rates drop prior to closing, you can get the better rate.

8. Can my loan be sold? What happens if my lender goes out of business?

Loans can be sold at any time. Lenders frequently buy and sell pools of mortgages in a secondary mortgage market, resulting in lower rates for consumers. If a lender buys your loan, he or she assumes all terms and conditions of the original loan. For you, the only thing that changes when a loan is sold is to whom you mail your payment. If your loan is sold, your existing lender will notify you that your loan has been sold, who your new lender will be, and where you should send your payments from now on.

You are still obligated to make payments, even if your lender goes out of business. Loans owned by a lender going out of business are generally sold to another lender. The lender who purchases your loan is then obligated to honor all terms and conditions of the original loan. Therefore, with regards to your loan payments, it makes little difference if your lender goes out of business. Sometimes there will be a gap between the date of your lender going out of business and the date that a new lender purchases your loan. If this happens, continue making payments to your old lender until you are asked to start making payments to your new lender.

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

PMI, or Private Mortgage Insurance, is almost always required when you are buying a house with less than 20% down. This insurance protection is provided by private mortgage-insurance companies to help protect lenders against the costs of foreclosure. With mortgage insurance, lenders are able to accept lower down payments than they normally could. 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. This means that without mortgage insurance, your chances of buying a home without a 20% down payment are much smaller.

PMI's cost 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. Normally, your PMI premium is added to your monthly mortgage payment.

When the private insurance coverage is cancelled does not depend solely on the degree of your equity in the home. The lender, along with any investor who may have purchased an interest in the mortgage, has the final say on when to terminate a private mortgage-insurance policy. Usually, the lender will allow the mortgage insurance to be cancelled when the loan is paid down to 80% of the original property value. Some lenders may require that you pay PMI for one or two years before you can apply to cancel it.

Contact your lender to cancel the PMI on your loan. An appraisal will usually be required to determine the value of your property. The cost of this appraisal will most likely be your responsibility. You can also cancel the PMI on your loan by refinancing and opening a new loan without PMI.

10. What is an APR?

Annual Percentage Rate (APR) is an interest rate that is different from the note rate and is commonly used to compare loan programs from different lenders. Mortgage companies are required by The Federal Truth in Lending Law to disclose the APR when they are advertising a rate. The APR is usually found next to the rate.

Example:
30-year fixed	8%	1 point	8.107% APR

The APR has no effect on your monthly payments, which are a function of the interest rate and the length of the loan.

The APR is a confusing number, even to mortgage bankers and brokers. The APR is designed to measure the "true cost of a loan." It creates a level playing field for lenders by preventing other lenders from advertising a low rate while hiding fees.

If things were simple, all you would have to do is compare APRs from the lenders/brokers you are working with and pick the easiest one to find the right loan. Unfortunately, this is not the case.

Different lenders calculate APRs differently, so a loan with a lower APR is not necessarily a better rate. In this author's opinion, the best way to compare loans is to ask each lender 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. Take each estimate and ignore all of the fees that are independent of the loan such as homeowners insurance, title fees, escrow fees, attorney fees, etc. Now add up all the remaining loan fees. The lender with lower loan fees has a cheaper loan than the lender with higher loan fees.

The reason why APRs are confusing is because the rules to compute APR are not clearly defined.

What fees are included in the APR?

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, but companies may use any number between 1 and 30, so pay attention to this number.
• Loan-processing fee
• Underwriting fee
• Document-preparation fee
• Private mortgage-insurance

The following fees are SOMETIMES included in the APR:

• Loan-application fee
• Credit life insurance (insurance that will pay off the mortgage in the event of a borrowers death)

The following fees are normally NOT included in the APR:

• Title or abstract fee
• Escrow fee
• Attorney fee
• Notary fee
• Document preparation (charged by the closing agent)
• Home-inspection fees
• Recording fee
• Transfer taxes
• Credit report
• Appraisal fee

An APR does not tell you how long your rate is locked for. A lender who offers you a 10-day rate lock could have a lower APR than a lender who offers you a 60-day rate lock.

Because future rates are unknown, calculating APRs on adjustable and balloon loans is even more complex. This results in even more confusion over how lenders calculate APRs.

APRs for different types of loans cannot be compared. A 15-year loan might have a lower interest rate than a 30-year loan, but it could also have a higher APR, since the loan fees are amortized over a shorter period of time.

Some lenders do not even know what they themselves include in their APR because they use software programs to compute their APRs. This makes it possible that the same lender, with the same fees, using two different software programs could arrive at two different APRs.

Conclusion:
The APR is a result of a complex calculation and not clearly defined, so only use it as a starting point to compare loans. 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 when comparing loans.