Refinancing Options Regardless of Mortgage Rates
Since the media has over zealously expounded on the issue of tighter bank lending standards, a number of homeowners that could refinance their existing mortgages are overlooking this option due to the concern over being denied for a new home loan.
While, it is difficult to refute the argument that bank mortgage lenders are more conservative in their home loan underwriting practices since the credit crisis began, this by no concludes that mortgage loans for refinance transactions are any more difficult to obtain than one for a purchase. In fact, quite the opposite is true. In general, mortgage loan approvals for a refinance transaction are easier to obtain than a purchase transaction.
A key difference between a mortgage refinance a mortgage for a purchase transaction from the mortgage lenders point of view is the equity in the home or down payment. A standard mortgage is evaluated based only a few factors, the most significant being the credit of the borrower, the income relative to the debt payments and the equity in the home.
The equity is measured by the loan to value. On a purchase, the loan to value is a reflection of the down payment amount where a 10% down payment would lead to a 90% loan to value. With a refinance the loan to value is the loan amount divided by the property value for example; a $100,000 loan request for a property worth $125,000 would have a loan to value of 80%.
Even with the recent reduction of property values over the past years, most homeowners find that their home is their most valuable financial asset and the mortgage they have is their largest debt. Consequently, reviewing the existing mortgage interest rate, monthly payment, mortgage balance and potential mortgage options is a prudent financial decision.
As part of the mortgage review, in order to assess the benefits and costs of a mortgage refinance, a variety of factors should be considered, including: mortgage interest rate, type of mortgage, expected holding period for the mortgage or home and tax consequences.
With mortgage rates at or near record low levels, homeowners that have not refinanced yet or purchased their home during the last period of low rates, should compare their mortgage rate with the current mortgage rates and measure this against the other loan factors such as the length of time to hold the loan and tax savings.
When evaluating the mortgage interest rates, note that mortgage interest rates charged on a home loan will vary greatly depending on the type of mortgage. Fixed rate mortgages offer the benefit of locking in a rate and knowing exactly what the monthly mortgage payments will be for the term of the mortgage. Generally the longer the mortgage term, the higher the mortgage rate. A 15 year term mortgage not only pays the home loan off in shorter time period but generally has a slightly lower interest rate as well.
When reviewing your mortgage options, be sure to factor in how long you intend to keep your home as well as your ability to handle potentially higher rates in the future with ARMs. If you plan to downsize and move to a smaller home in a few years, a 5 year ARM would provide a much lower interest rate than a traditional 15 or 30 year fixed rate mortgage.
For homeowners that itemize your tax deductions, the interest that is paid on a mortgage loan may be deductible. Refinancing a mortgage and taking cash out may provide the money to pay off higher rate loans, such as credit cards or auto loans, and provide a tax deduction as well.
It is possible that a refinance to maximize savings and improve finances can be accomplished in several ways, including:
Lowering the monthly mortgage payments.
Obtaining cash back by accessing the home equity.
Eliminating private mortgage insurance
Using equity to pay off high interest debts such as credit cards or loans.
Changing mortgage terms to pay off the home loan faster.
Switching loans to a fixed rate mortgage from an ARM or adjustable rate mortgage.
Inaccurate Mortgage Payment Estimates with Taxes and Insurance
A standard mortgage payment is often quoted by a mortgage lenders with either just the principal or interest portion of the monthly payment or the principal and interest as well as the monthly allotment for taxes and insurance. The terms used by the mortgage industry for these monthly mortgage payments are referred to by a couple of acronyms. PI is used to refer to the principle and interest payment and PITI is used to refer to the full payment of principal, interest, taxes and insurance.
When the mortgage lender is quoting a payment that includes the TI or taxes and insurance portion of a monthly mortgage payment, this number is frequently just and estimate and is often inaccurate.
Miscalculating the monthly amount of property taxes or insurance is generally not intentional. When a potential home loan borrower first calls a mortgage lender for a mortgage rate quote, a common question is what the monthly payment will be. It is fairly easy to provide a mortgage payment amount based on the loan amount, the mortgage rate offered by the mortgage lender and the term of the loan. In fact, with these figures, an exact mortgage payment can be calculated that includes principal and interest. Now when it comes time to quote the payment with taxes and insurance, the mortgage lender has to rely on an estimate of these figures based on the property value and location or use figures that are provide by the borrower.
In either case, the PITI monthly payment that is initially quoted is generally going to be an estimate that has quite a bit of room for error. This error amount is magnified in the current low mortgage rate and high property tax period.
As an example, a home in Naperville Illinois worth $500,000.00 will have a property tax bill of $12,500.00 ( approximately ), with a 20% down payment the loan amount would be $400,000, with mortgage rate of 4.50% the monthly mortgage payment would be $2,026.74. This is the principal and interest portion of the monthly mortgage payment. By dividing the annual taxes of $12,500.00, the tax portion of the monthly mortgage payment is $1,041.67. If the annual home owner’s insurance bill is $775.00, the insurance portion of the monthly bill would be $64.58. This puts the total PITI payment at $3,132.99. Of the total PITI monthly mortgage payment, almost 35% of the payment is for taxes and insurance.
Exact property taxes are typically available only through public records or through tax data published in a local multiple listing services. Once the mortgage loan request is being processed, the mortgage lender will have a more exact figure on the real estate taxes based on information retrieved form the county tax offices.
The same issue of inexact figures applies to hazard insurance or home owners insurance. The exact number for the insurance costs will come from the insurance company not the loan officer or the borrower. In the meantime, the figures that used in the initial calculations are just estimates.
Escrow accounts, sometimes called impound accounts are deposit accounts established by the mortgage lender to pay annual property tax bills and insurance premiums. The escrow amount is initially set up with approximately 1/6 of the annual real estate tax bill and 1/16 of the annual insurance bill. The cost or amount of money needed to fund the escrow account will impact the amount of funds need at the loan closing.
If the insurance policy and / or the property taxes are misquoted, it can be quite a shock when the mortgage borrower arrives to the loan closing and has to come up with more funds to cover changes in the escrow account and more importantly, discover for the first time the actual monthly mortgage payment including PITI is significantly higher than thought based on that first mortgage payment quote they received.
To avoid these surprises, pay attention to the numbers. When a mortgage lender quotes a payment, understand what is covered in that mortgage payment. Is it the mortgage payment PITI or just the PI and further recognize how these numbers were calculated. Check the results with a mortgage calculator for the term and mortgage rate and go the extra step to verify the tax payment amount and insurance costs.
What Type of Mortgage is Best for You?
When buying or refinancing a home, choosing the right mortgage is essential. The type of mortgage that is chosen can help a home owner towards greater financial stability, provide flexibility for life’s unforeseen circumstances, or help to build net worth at a faster rate. The right mortgage can make owning a home much easier, as well as help improve a home owner’s financial situation, but don’t wait until the time of the loan application to decide which mortgage loan is best suited for your needs.
The number of mortgage loan products available has dwindled in recent years as many of the esoteric loan products, such as sub prime loans and stated income – state assets loans are no longer being marketed. There are, however, many mortgage choices available and choosing the right one can be overwhelming. Prospective home loan borrowers should assess their financial situation and the attributes found in each loan type before choosing a type of mortgage, to help determine which mortgage is right based for their financial position.
Mortgages currently available usually fall into just a few main categories. The main mortgage loan categories are either fixed rate mortgages, adjustable rate mortgages, or a balloon mortgage. There are also FHA mortgages and jumbo mortgages, but these are categories of mortgages which in turn will have fixed rate terms, adjustable rate terms and balloon terms.
Each of these mortgage loans have different features and benefits, making them work well for different financial situations. There are also many types of individual mortgages within these categories that may involve how the rate changes on an adjustable rate mortgage or the term of the mortgage whether it is fixed, adjustable or a balloon loan.
Fixed rate mortgages are the most common home loan products and become an even larger share of mortgage originations when mortgage rates are low. A fixed rate mortgage may be right for you if you are on a fixed salary and have a regular budget. A fixed rate mortgage allows the borrower the security of knowing what their monthly payment will be each month, and this payment does not change. Fixed rate mortgages can be obtained with a variety of different terms with the 15 year terms and 30 year term being the most common.
The 30 year fixed rate home loan is by far the most common loan among all mortgage loans. Borrowers that choose shorter terms on fixed rate loan will build equity faster in their home and generally get a slightly lower mortgage rate. While it is certainly nice to build equity faster, standard 30 year loans do not have prepayment penalties and the borrower can prepay their loan at anytime either with a little extra every month, with an extra payment annually or a lump sum payment as they see fit and build equity quickly at their own pace.
Adjustable rate mortgages have the disadvantage of having a mortgage rate that may change over time and the advantage of a lower initial mortgage rate. In a low rate environment many borrowers become concerned that interest rates over the long term have only one direction in which they may go, which is up. The prospect of higher mortgage rates drives more borrowers to fixed rate loans even if the initial rate is modestly higher on the fixed rate loan. Of course, should mortgage rates decline, an adjustable rate mortgage may also experience a reduction in rate while fixed rate loans will not.
Another consideration, often overlooked in comparing an adjustable rate mortgage and a fixed rate mortgage in low interest rate environments, is that the difference between a fixed rate home loan and adjustable rate loan is often quite small. If interest rates rise it is always advantageous to borrow money at a low fixed interest rate that is subsequently paid back with a monthly payment that has been eroded in value by an increasing rate of inflation. And when mortgage rates are already relatively low, there is little room for an adjustable rate mortgage to come down any further.
An adjustable rate mortgage may very well still be a choice for those just starting out, who may not be able to afford a big mortgage payment or for those borrowers who know they will be in the home for only a short period of time. An adjustable rate mortgage allows the borrower to lock in a lower interest rate and low monthly mortgage payment amount for the first year or even few years of the loan. When the initial low rate expires, the monthly payments and mortgage rate may go up. Theoretically, by that point the borrower will be able to afford the higher payments, if they are just starting in their careers or will have moved on if they intended to reside in the home for only a short period of time.
Balloon mortgages generally have level payments for a certain number of years and then the remaining balance on the loan is due before the scheduled payments pay the loan off in full. The initial payment period is based on a longer period of time than the time at which the full balance is due. For example, balloon mortgage payments are frequently based on a 30 year term even though the full balance will due at the end of shorter term such as 5 years. Once the level payment period ends and the balloon balance is due, the borrower can refinance, sell the property or otherwise pay off the loan. The benefit of the balloon loan is a lower mortgage rate. The difference in rate when mortgage rates are high may be substantial but the difference is often quite modest when rates are low.
Before committing to any type of mortgage, research your options carefully. The key to making a sound financial decision regarding the choice of a mortgage is to both identify and measure the risks associated with that mortgage and to then determine if the risks worth the reward and even if any risks associated with a bad outcome be tolerated. But, the borrower would fully understand the risks, rewards and the costs of the home loan before filing out a mortgage loan application.
How Mortgage Rates are Determined
There are many variables that will determine current mortgage rates. When assessing the direction of mortgage rates and the underlying factors that determine mortgage rates, there are two main forces that help shape the interest rates. The first factor involves macroeconomic forces that impact mortgage rates and interest rates and the second is the factors that are impacting a specific mortgage loan request.
Macro economic factors that affect mortgage rates include the inflation rate, economic activity and actions by the Federal Reserve. The rate of inflation is generally one the biggest components of the overall level of interest rates. A modest rate or low level of inflation will almost always lead to low interest rates, while concerns about rising inflation normally cause interest rates and consequently mortgage rates to increase.
Economic activity contributes to the direction of interest rates with brisk activity tending to drive interest rates higher while lower economic production tends to pull rates down. The affect of economic activity is a result of the demand for loans. As loan demand increases with increased economic activity, the interest rates on loans including mortgage loans increases.
The Federal Reserve’s actions have a significant impact on short term bank rates which in turn applies pressure to all rates including longer term rates and mortgage rates over time. The Federal Reserve, implements policies and generally announces its policies which are designed to keep inflation and interest rates relatively low and stable but a number of market forces can force the Federal Reserve to raise short term rates and thus push long term rates higher as well.
Loan specific factors that influence mortgage rates include: the type of home loan, the borrower’s qualifications, the property, the fees and points paid and the mortgage rate lock period.
The type of home loan impacts the mortgage rate because some types of properties have different mortgage rates than others primarily because of historical risk analysis. Condominiums have historically had higher default rates than single family homes especially during market slowdowns and therefore are frequently priced slightly higher than single family detached homes. Multi unit properties may have higher mortgage rates for similar reasons over the risk of default and non owner occupied properties will almost always have a higher mortgage rate due to the increased risk seen by the mortgage lender.
The borrower’s profile affects the mortgage rate based on their inherent risk factors regarding their credit history and financial position. The risk factors are determined by the mortgage lenders and are generally based on quantitative figures such as the credit profile or credit score of the borrower, the down payment amount and the debt ratios of the borrower.
Clearly, a borrower with a poor credit score will have a higher mortgage rate than one with an excellent credit score due to the higher risk of default on the loan.
Similarly, a mortgage loan that was obtained with a larger down payment than one with the minimum down payment will have a lower default risk and generally receives a slightly lower mortgage rate. This is why borrowers will often seen an advertised mortgage rate and then when they apply for the loan find the rate higher if they are placing the minimum down payment to obtain the mortgage loan. Lower down payments are the equivalent to higher loan to values and higher loan to values are seen as a greater risk and will have a higher mortgage rate.
The following items will reduce risk or perceived risk to the mortgage lender and generally lead to a lower mortgage rate: higher credit score, greater equity in the house or a larger down payment, a low debt to income ratio or a better ability to pay with a low debt to income ratio.
Increased points and fees generally lead to a lower mortgage rate while lower points and fees lead to a higher mortgage rate. Mortgage rates and points or total closing costs are often a trade off. A point is equal to 1% of the loan amount. A mortgage loan for $150,000 with a rate of 5.50% and 1 point will have a minimum cost of $1,500.00 or 1% of $150,000.00, in addition to the other closing costs charged by the mortgage lender. In a case such as this, the potential borrower may have the option to pay more points, perhaps 2 points instead of 1, and have the mortgage rate reduced for the additional charge.
There may also be the option to obtain the mortgage loan without points with a slightly higher interest rate. The trade off comes down to the cost of points which are paid at the time of the loan closing versus the mortgage rate which impacts the monthly mortgage payment for the life of the loan.
The mortgage rate lock period or time frame will also impact the mortgage rate. This is the smallest of the factors that will impact the rate but it is important to understand the concept and mechanism of rate locks. The rate lock period is the length of time that the mortgage rate offered by the mortgage lender is good for. Home loan borrowers can choose to lock in a mortgage rate for a period of time that generally runs between 30 days to 90 days but can also be obtained for as long as 180 days.
Without a mortgage rate lock, the mortgage rate is floating or will change as the market changes. When a potential borrower calls a mortgage lender for a rate quote, some mortgage lenders quote short term rate locks since they offer the best rate. A short term rate lock is of little use if the mortgage loan is not going to close or fund within the rate lock time period.
If a mortgage loan request does not close and fund before the lock expires, then the borrower will end up with a mortgage rate that will be at the mercy of whatever changes may have taken place in the market. The longer the lock in period, the more expensive it is to lock. Borrowers can also choose to float their rate initially, and lock in for a shorter period of time once they are near closing date. Floating the rate may save a little money, but it is also has the risk of being stick in a rising rate environment.
In a volatile market, a mortgage shopper may call about mortgage rates at one time during the day only to find out the rate has changed later in the day when they decide on the best mortgage lender to work with. Without the mortgage loan application and the rate lock agreement, the mortgage shopper will end up with the prevailing mortgage rate at the time the application and/or rate lock agreement is executed.
Mortgage rates change by small amounts between 30 and 60 day locks, the 90 day locks and 180 day lock periods will often bring about a measurable higher rate and may even entail and upfront fee for the rate lock. Most long term locks are used for new construction where the time from loan application to loan closing may run for several months.
Mortgage Rates and Mortgage Brokers
To understand the function of a mortgage broker, a key component of understanding how they operate is to understand how the mortgage broker sets their mortgage rates.
A mortgage broker is predominantly a credit facilitator. Their job is to obtain the customer, which is the home loan borrower, process the loan request which entails verifying the borrowers employment as well as their assets and credit, submit the loan to a wholesale lender and upon loan approval, coordinate the loan closing.
Mortgage brokers may offer the lowest mortgage rates in the local market or they be the highest or just somewhere in between. Since mortgage broker is technically a facilitator of credit, the mortgage loan is funded by a wholesale mortgage lender or bank. Mortgage wholesale lenders fund the loans for the broker and provide the price at which they will fund the loans.
During the peak boom in mortgage originations, most all of the major banks in the U.S. engaged in wholesale mortgage lending or obtaining mortgage loans from brokers. Citibank, Wells Fargo, Bank of America, US Bank, National City Bank, Chase Bank and HSBC all had wholesale lending divisions which acquired home loans from brokers.
The mortgage rate and any discount points determine the price the wholesale lender will pay for the loan. The mortgage broker makes their money on any extra fees and the increase in rate or points over that paid by the wholesale lender. As an example, if the wholesale lender offers to pay the mortgage broker a mortgage rate of 5.25% and 1 point for a standard $200,000.00 mortgage loan and the broker in turn offers the customer a mortgage rate of 5.25% and 2 points, the mortgage broker makes the 1 point. 1 point represents 1% of the loan amount. The broker could offer the customer 5.75% and 1 point and make their income based on the difference between the 5.25% and 5.75%, as well.
When the amount of money the mortgage broker makes is based upon the difference between the wholesale mortgage rate and the rate to the borrower, this difference is referred to as a yield spread premium.
The mortgage rates established by the mortgage lender will be influenced by the type of loan, the size of the loan and how long the loan is locked for. Different loan types such as adjustable rate mortgages or FHA mortgages have different rates. Since most of the income derived form mortgage originating is based on a percentage of the loan amount, it is not uncommon to see minor difference sin rates base on loan size. And finally, longer loan lock costs more money since the mortgage lender has to honor that rate regardless of what happens to interest rates and mortgage rates in the market during the time of the loan lock and loan closing.
As a real life example of how this functions, the following is a rate from a wholesale mortgage lender in the U.S that funds loans for mortgage brokers and also engages in retail mortgages or loan that are direct to the consumer. The mortgage lender’s name will not be mentioned.
For a 30 year loan, this mortgage lender offers brokers a mortgage rate of 5.00% on a 30 day loan lock at a price of 101.509. This price means the mortgage broker that delivers to the lender on that 30 day lock at 5.00% will be paid 1.509% of the loan amount as a fee or yield spread premium.
That same wholesale lender offers a mortgage rate of 4.625% on 30 day lock at price of 99.253. This means the mortgage lender needs to be paid .747 points to obtain that rate. This can be accomplished if the mortgage broker closed the loan with the borrower at a rate of 4.625% and 2 points. 0.747 points would go the wholesale lender and 1.253 points would be kept by the mortgage broker. This kind of pricing is similar to bond pricing, in which 100 represents the par rate, over 100 is a premium and under 100 is a discount where each point represents 1% of the loan amount.
The longer the loan lock the higher the cost of the home loans. In this example, that same mortgage lender offers the 5.00% rate at 101.022 for a 6o day lock. Since it costs more for a longer lock, the broker makes 1.509% on the 30 day lock and only 1.022% on the 60 day lock. It is a fair assumption that shorter lock makes more money. In this case, the mortgage lender in fact offers a price of 101.696 on a 15 day lock, which is a slightly higher fee for the mortgage broker than the 30 day lock.
Here is what the rate sheet would like to the mortgage broker with the mortgage rate, lock period and price paid:
Rate 15 Day Lock 30 Day Lock 45 Day Lock 60 Day Lock
4.625 99.455 99.253 99.005 98.765
4.750 100.450 100.253 100.000 99.764
4.875 101.188 100.997 100.738 100.509
4.990 101.530 101.343 101.080 100.856
5.000 101.696 101.509 101.246 101.022
5.125 102.122 101.940 101.672 101.453
5.250 103.119 102.943 102.669 102.456
5.375 103.798 103.628 103.348 103.141
Now, to make this fun. Since this example involves a mortgage lender that offers retail services, we can compare the current mortgage rate offered on their website to any old home borrower to those rates they offer mortgage brokers. ( the wholesale rate sheet is not available to consumers and therefore this comparison is available for those in the mortgage business that have access to wholesale mortgage lender rate sheets )
On the mortgage lenders website, this bank is currently offering a 30 year fixed rate loan on a 30 day lock with a mortgage rate of 4.875% and 0.488 points. The same loan can be had at a rate of 4.750% and 1.323 points or 4.990% and 0.142 points per the website on a home loan in Illinois for $200,000.00.
It has been some months since we have reviewed the mortgage broker / retail lender pricing and I must say that the rates to the mortgage brokers look fairly aggressive. If I apply for a mortgage loan with this lender, the 4.99% rate will cost me 0.142 points and whatever other closing costs they have at closing, the mortgage broker can offer a 4.99% rate to me as well and get paid 1.343 points from the lender and make another 0.142 points if they charged the same points that the retail division of that lender charges. That is a total of 1.485 points on the home loan. If the loan amount is $200,000.00 that equates to a payment to the mortgage broker of $2,970.00. Not bad income for originating one loan. Of course, the mortgage broker will have cost for processing the borrowers loan request as well as fixed costs and marketing costs to finds the customers.
Freddie Mac Finally Stops Buying Interest Only Mortgages
Freddie Mac announced, with little fanfare, that it will stop buying and securing mortgage loans that are based on interest only payments. Freddie Mac is the second largest purchaser of home mortgages in the U.S. behind only Fannie Mae. The press release provide by Freddie Mac announced that on or about September 1, 2010, the company will cease purchasing and securitizing interest only mortgages, including Freddie Mac Initial Interest fixed-rate and adjustable-rate mortgages.
Interest only mortgages became popular near the top of the housing boom, allowing buyers to purchase a larger home based on a lower mortgage payment provided by the interest only loan feature. Interest only mortgage loans offered the borrowers the ability to make monthly payments that were only the interest portion of the debt and paid off none of the principal balance.
The interest only option would be for a specified period after which time the loan would require interest and principal payments to retire the debt in full. The interest only period frequently ran from five to ten years and then principal and interest payments would be scheduled on a fully amortizing basis for the remainder of the mortgage term.
Interest only options were available on both fixed rate mortgages and adjustable rate mortgages. These loans allowed homeowners to make purchases during the period when homes were becoming less affordable. The rational for these home loans is certainly suspect, the borrower is eventually going to be confronted with a larger more mortgage payment once the interest only period expires and for both the mortgage lender and home owner, there is no increase in equity during the interest only period unless housing prices continue to ratchet up. The end result, these types of mortgage loans ended up performing worse than conventional, fully amortizing fixed rate loans.
Fewer of these home loan have been produced in the past months since underwriting standards have become stricter. Borrowers need to qualify for the loan based on a fully amortizing payment instead of just the interest only payment and they often require a larger down payment.
These changes may not put an end to these type of home loans forever but there are certainly fewer banks that make loans that do meet the qualifications established by Fannie Mae and Freddie Mac. It is not likely that very many banks will be willing to take the risk of originating these loans without the security of Freddie Mac purchasing or securitizing the loans and leaving the possibly the bank will get stuck with a greater number of non-performing loans.
Mortgage Loans and Earnest Money Deposits
Once an interested home buyer wants to make an offer on a property, along with a contract to make the offer, the buyer will make an earnest money deposit to go with the offer.
The earnest money deposit is a good faith deposit to indicate that the buyer is serious about the offer and their intentions to consummate a transaction. The earnest money deposit is not to be confused with a down payment. The mortgage loan approval is not dependent or related to the earnest money deposit.
This deposit money is given to the real estate agent, attorney or seller at the time of the offer and if the seller accepts the offer, the earnest money is held in escrow until closing. If the earnest money is documented properly, it will generally be applied to the down payment or the buyer’s portion of the closing costs when the purchase goes forward.
If the purchase offer for the home is rejected, the earnest money is usually returned, since there is no legal contract between the buyer and seller. If the buyer withdraws the offer or does not fulfill the contract terms after the contract is properly executed by buyer and seller, the earnest money may be forfeited.
The amount of the earnest money deposit varies significantly depending on factors such as local practices in the specific market area, the price of the home, and the supply and demand for homes at that time of contract negotiations.
It is, of course, generally in the seller’s best interest to see a large earnest money deposit. With the larger deposit, the seller is in general more convinced to accept the purchase offer. This is a strategy that is more likely to be utilized in high demand markets where homes are selling at a brisk pace. In other markets, earnest money deposits of $500.00 or $1,000.00 are quite acceptable.
Understanding the market is the principal guideline for determining the amount of the deposit. Real estate professionals will all have opinions on what is a satisfactory amount, but unless the housing market has a strong demand and low supply, a lower earnest money deposit is not likely to dissuade a seller.
The buyer should have a contingency to inspect the property and withdraw the offer within a certain time frame written into the contract, with this in mind; it is in the buyer’s interest to make the smallest amount of earnest money possible. If the buyer cannot obtain a mortgage within a certain time frame, for example, the earnest money will be returned in full if the offer stated such a contingency.
To avoid any complications with a mortgage lender about the earnest money deposit and subsequent credit at the time of the mortgage loan closing, copy the check before submitting it with the contract and then copy the front and back once it clears the bank. The mortgage lender will then have ample proof that the funds deposited were the buyers and have already cleared the bank and the buyer will get a full credit for those funds as they may be applied to the down payment or mortgage closing costs at the time of settlement.
Mortgage Clauses and Covenants
When a home loan borrower closes on a new mortgage loan, included in the documents that have to be executed is the mortgage document. The mortgage is the security instrument that pledges the property as collateral for the loan. The mortgage secures your promise that the money borrowed will be repaid.
The terms mortgage and loan are often used interchangeably. But, to be precise the mortgage is actually a lien on the property which secures the loan. The terms of the loan such as the mortgage rate, term and monthly payment are set out on the note not the mortgage. Conditions of default and the terms regarding the security of the property are established in the mortgage document.
The mortgage will include various clauses and terms that protect the mortgage lender as well as the home loan borrower. Examples of the various clauses and covenants that may be included in a mortgage or deed of trust may include:
The mortgage is dated and contains the names of mortgagor and mortgagee. If the deed of trust from is used, the borrowers name appears, identified as trustor, grantor, or mortgagor. The name of the trustee or grantee and the name of the mortgage lender, who is both the trust beneficiary and the note holder also appear.
The note executed by the borrower is reproduced in the mortgage or deed of trust. The note includes an acceleration clause allowing the mortgage lender to declare the entire home loan balance remaining immediately due and payable if the borrower is in default.
The note may provide that the borrower is permitted to pay off the loan any time prior expiration of the full mortgage term without incurring a financial penalty for the early payoff, or it may provide for a penalty to be imposed on the borrower (prepayment penalty) if the debt is satisfied prior to expiration of the full term. FHA, VA and conforming fixed rate loans do not have a prepayment penalties.
The mortgage requires the borrower to pay all real property taxes and assessments on a timely basis, keep the building in a proper state of repair and preservation, and protect the building against loss by fire or other casualty by an insurance policy written in an amount at least 80 percent of the value of the structures. Many mortgage lenders may also require insurance for 100 percent of the loan value minus the lot value.
The mortgage contains a defeasance clause giving the borrower the right to defeat and remove the lien by paying the loan indebtedness in full.
The mortgage provides the right of foreclosure to the mortgage lender if the borrower fails to make payments as scheduled or fails to fulfill other obligations as set forth in the mortgage.
In the deed of trust form, a clause gives the mortgage lender irrevocable power to appoint a substitute trustee or trustees without notice and without specifying any reason, by recording and instrument of appointment on the public record where the deed of trust is recorded.
In both the mortgage form and the deed of trust form, a covenant always specifies that the mortgagor has a good and marketable title to the property pledged to secure payment of the note.
The mortgage or deed of trust may contain an alienation or due on sale clause entitling the lender to declare the principal balance immediately due and payable if the borrower sells the property during the mortgage term and making the mortgage unassumable without the mortgage lenders permission. Permission to assume the mortgage at a mortgage rate prevailing at the time of assumption can be given at the mortgage lenders discretion. The alienation clause may provide for release of the original borrowers from liability if an assumption is permitted. This release is sometimes referred to as a novation.
The mortgage or deed of trust always provides for execution by the borrower. The mortgage or deed of trust provides for acknowledgment by the borrower to make the document eligible for recording on the public record for the mortgage lenders protection.
Mortgage Loans and the Mortgage Note
In making a mortgage loan, the mortgage lender requires the borrower to sign a promissory note. The mortgage note or loan note, which must be in writing, provides evidence that a valid debt exists. The note covers the terms of repayment for the home loan. The note contains a promise that the borrower will be personally liable for paying the amount of money set forth in the note and specifies the manner in which the debt is to be paid. Payment is typically in monthly installments of a stated amount, starting on a specific date. The note also states the annual rate of interest or mortgage rate to be charged on the outstanding principal balance of the home loan.
The mortgage note is a negotiable instrument. It is an unconditional promise or order to pay a specified sum of money on demand at a definite time or, in the case of home loans, at definite time intervals. The note is made “to the order of “or “to bearer”. The negotiability of an instrument allows it to function the same as currency. Promissory notes, stocks, bonds, and checks are examples of negotiable instruments. The person responsible for the notes payment may be called the payor, promisor, or obligor. The person who is to receive the money may be called a payee, promise, or oblige. In real estate, mortgage lenders will require the buyer to sign a security instrument such as a mortgage or trust deed, which are not negotiable instruments. The mortgage is the security instrument that pledges the property as collateral for the loan.
Understanding the terms, interest rate and principal is essential to understanding notes, mortgages, deeds of trust, and all real estate financing methods. Interest is the money paid for using someone else’s money the interest rate is the rate at which the interest is calculated. The principal is the amount of money on which interest is either paid or received. In the case of an interest bearing note, principal is the amount of money the lender has lent the borrower and on which the borrower will pay interest to the mortgage lender.
The note can be an interest only note on which interest is paid periodically until the note matures and the entire principal balance is paid at maturity. Construction loans or notes are usually of this type. Or the note can be a single payment loan that requires no monthly mortgage payments on either principal or interest until the note matures, and the entire principal and interest is paid at maturity. This is seen more frequently in short term notes. The note also can be an amortizing note in which periodic monthly payments are made on both principal and interest until such time as the principal is completely paid. Most mortgage loans are of this type.
The original principal is the total amount of the note or the home loan. This amount remains the same in an interest only or a one payment loan until the entire principal is paid. In a amortizing mortgage loan, periodic monthly mortgage payments are applied first toward the interest and amount of principal gradually decreases. As each successive payment is made, the interest is applied to the declining principal balance; therefore with each successive payment, the interest portion of the payment decreases and the principal portion increases. The first payment is applied mostly toward interest, and the last payment is applied mostly toward principal. The payments can be set at a fixed rate for the life of the home loan, or they can fluctuate as adjustable rate mortgages do based on a specified index, or they can change at set intervals according to a set formula.
Simple interest is usually used to calculate mortgage loan interest. This means the annual rate of interest is used to calculate payments even though payments normally are made monthly. Payments sometimes are set up to be paid quarterly or annually. A payment plan in which payments are made every two weeks or biweekly mortgages have become popular because it reduces the term of the loan and saves a significant amount of interest over the life of the loan. A current home loan can sometimes be converted into a biweekly payment plan.
Mortgage loan interest almost always is calculated in arrears, although it sometimes is calculated in advance. If interest is calculated in arrears, a monthly payment due on the first of the month includes interest for using the money during the previous month. If interest is calculated in advance, a monthly payment due on the first of the month includes interest for the month in which the payment is due. When paying off or assuming a mortgage loan, one must know if the interest is paid in advance or in arrears to determine the amount of interest owed or to be prorated at the home loan closing. Interest must be paid in arrears on all loans sold in the secondary mortgage market.
Mortgage Closings and Per Diem Interest
Many home loan borrowers are confused about a charge on their mortgage loan closing statement referred to as per diem interest. Part of the confusion stems from the fact that this charge is referred to as a closing cost on the good faith estimate provided to the borrower.
Per diem interest means the amount of daily interest payable under a home loan. The mortgage lender needs to calculate per diem interest in order to determine the amount of interest payable by a borrower at the loan closing.
At the loan closing, this will the daily cost of interest form the time the funds are disbursed to either purchase the home or after the three day right of rescission on a mortgage refinance to the time period when the mortgage interest starts to accrue for the first payment.
Most all home mortgages have loans monthly payments that cover a 30 day period of time due on the first of the month. A borrower’s first monthly payment is typically due the first day of the second month after closing. For example, if a loan closes on January 15, then the first monthly payment will be due on March 1 not February 1.
Interest paid on home loans is payable in arrears, using the above payment date example, the March 1 monthly payment will cover interest which accrued during the month of February. Normally, rent payments are calculated another way and are forward payments, the March 1 payment covers the rent for the month of March not February.
Following this same example, the borrower that would close on the home loan on January 15 has their first monthly mortgage payment due on March 1, whether the loan was a refinance or for a purchase. The borrower has a payment due on March 1st that covers all of February’s interest charges and any principal due, but the borrower had access to the funds from the time it disbursed in mid January. To cover the interest charges from January 15 to the February 1st, at the closing the borrower will have to pay interest covering that period from January 15 through January 31 since this interest will not be included in the March 1 monthly payment.
Per diem interest is determined by first multiplying the principal amount of the loan by the interest rate to determine the annual amount of interest payable under the loan. Next, the annual amount is divided by 360 days to determine the per diem interest amount (note mortgage lenders typically calculate per diem interest based on a 360 day year; when calculating per diem interest it always divided by 360 days unless the mortgage lender specifically instructs otherwise). Finally, the per diem interest amount is multiplied by the number of days remaining in the month of closing, including the date of closing.
For example assume that a loan with an original principal amount equal to $100,000 and an annual mortgage interest rate of 7.00% is funded on January 15. To determine all charges at the closing, the mortgage lender must determine the amount of per diem interest which will be payable by the borrower at closing.
The total annual interest is equal to $7,000 or 100,000 x 7%. This is interest for the year and therefore has to be divided by 360 to obtain the daily interest of $19.44. This figure is now multiplied by the 15 days remaining in the month to come up with a total interest charge of $291.60.
This charge will be depicted as a closing cost on the settlement statement but this would seem like a misnomer. The interest charge is simply the cost of having access to that money before the first mortgage payment, referring to interest charges as a closing cost in the same general category as origination fees can appear confusing.