Mortgage Buydowns
A buydown is a mortgage loan with a below market mortgage rate for a period of time that usually lasts one to three years. The buydown is a temporary reduction in the mortgage interest rate on the home loan that is paid for by paying additional points at the time of the mortgage loan closing. The buydown mortgage loan is created by having the homebuyer or another third party, often the seller or a home builder, making a subsidizing payment to the mortgage lender so that the buyer’s mortgage rate and, therefore, monthly mortgage payment are lowered. The buyer may incur the costs of the additional points or subsidy or the seller may foot the bill for the additional points or the mortgage lender can structure the buy down and fund its with a higher mortgage rate immediately preceding the buy down period over the life of the loan.
A mortgage buy down is a more popular home loan product used by builders in large subdivisions and by sellers in a slow sales market. A borrower may want to buy down mortgage rates because they have cash on hand, expect their earnings to go up, but need a lower monthly mortgage payment in the present. The monthly mortgage payment during the buydown is a fully amortizing principal and interest mortgage payment.
In a mortgage buydown, buyers are essentially paying cash up-front for points, and receiving a reduced mortgage interest rate in return. However, the buy down is only a temporary reduction in the mortgage rate. Typically, mortgage buydowns last from one to three years after the home loan is closed. Each year the mortgage rate will rise by a predetermined amount and the mortgage rate increases will only occur for the two or three years, depending on the type of mortgage buy down.
Each point equals one percent of your total loan amount. For example, 2 points on a $ 100,000 loan will cost $ 2,000, or 2% of the loan amount. The more mortgage points paid for the subsidy, the lower the interest rate will be. If these points can be paid for by the seller as an inducement for the seller to close the transaction, this can be a valuable tool. The mortgage lender may fund or structure the buydown by charging a higher interest rate over the life is loan, this is not very common as the mortgage lender has to protect against early payoff since their compensation for the lower initial mortgage rate is a higher than market rate in the later years of the mortgage loan.
For some borrowers a mortgage rate buydown is more advantageous than choosing an adjustable loan with a payment option that allows for negative amortization like an Option ARM. That’s because with mortgage buydown programs your mortgage payment always includes principal and interest. This means every time you make a payment your mortgage balance grows smaller instead of bigger. The prospect of experiencing negative amortization is always a must to avoid. In addition, the mortgage rate increases for a buy down are predetermined and not market influenced once the mortgage loan is signed.
A typical mortgage rate buydown looks like this:
Payments are reduced and figured on a mortgage rate over a specific term of a few years. The difference between the real interest rate and the lowered interest rate is paid in cash by the seller or sometimes the buyer. It’s like putting $1200 in the bank and withdrawing $100 every month for 12 months to help make your mortgage payment.
One popular buydown is called the 2-1 mortgage buydown. This is a 30-year fully amortized mortgage where the interest rate increases 1% every year for the first two years, at which point the interest rate is fixed for the remaining home loan term.
As an example, consider that your mortgage amount is $350,000 and the interest rate is fixed at 6.75% for 30 years. The buyer or seller will buy down the mortgage interest rate by paying a lump sum.
Here is how the mortgage interest rate would work out over the term of the loan.
First year mortgage interest rate is 4.75%
Second year mortgage interest rate is 5.75%
Years three through 30, the mortgage interest rate is 6.75%
It keeps payments low for 36 months for borrowers whose income is expected to later increase or intend to change the home loan or ownership in the future. The borrower qualifies for this home loan at the 4.75% interest rate and payment amount.
The 3-2-1 buydown mortgage is another version of a 30 year mortgage rate buydown. The interest rate increases 1% every year for the first three years, and then the interest rate is fixed for the remaining term.
These home loans are most advantageous when the seller pays for the buy down. The most common transactions where the buy down is used are on new homes or new construction. In these cases, the builder is willing to pay points to induce the buyer with lower monthly mortgage payments and a lower mortgage rate. Home builders generally prefer to provide incentives to prospective borrowers rather than make absolute reductions in the price of the home.
The bottom line on these mortgage products is that with the buy down you are able to drop the mortgage rate and monthly mortgage payment on your home loan without incurring the risks associated with of an adjustable rate mortgage or interest only home loan.
Locking in a Mortgage Rate
When a consumer contacts a mortgage lender to compare mortgage rates and mortgage products, in most cases, the terms that the consumer is quoted represents the mortgage terms for that immediate time period. The mortgage rate and costs that are given will almost always be those mortgage terms that are available to borrowers settling on their home loan agreement at the time of the quote. These quoted mortgage rates and mortgage terms may not be the terms available at the mortgage loan settlement that will take place a few weeks to several weeks later.
A mortgage loan lock or mortgage rate lock is a lender’s commitment to offer a certain interest rate with any related origination or discount points for the borrower for a specified period of time. This assures that the mortgage rate will remain available while the home loan application is processed and underwritten and cover that time period from mortgage loan application to mortgage loan closing.
Sometimes you have no choice as to when you settle on a mortgage interest rate. You have your eye on a house or condominium, and you are ready to go with a quick closing time frame, so you accept the current mortgage rate or apply for an adjustable rate mortgage that usually does not have a rate lock.
But what if you can wait, and believe that mortgage rates are falling and may continue to fall, you may want to take a shot at predicting the low point of the market and get the lowest possible mortgage rate. Wall Street is thrilled when interest rates fall a quarter of one percent, so why shouldn’t you be thrilled too?
Some of the time you will be fortunate and hit at just the right moment, and other times you will miss. It’s a bit of a gamble. You may look at today’s mortgage rate, use a mortgage calculator to calculate the monthly mortgage payment and be satisfied with where your mortgage payment is now based on the current mortgage rates.
Mortgage lenders tie mortgage rates to the interest rates on mortgage backed securities. It is possible to go online and find the current prices and interest rates for mortgage backed securities however, the rates on mortgage backed securities closely follow the interest rates on ten year Treasury bonds. This is not a direct relationship but the correlation with these rates is very high. As ten year Treasury rates moves down, mortgage rates generally will too. It’s fairly easy to follow the financial markets in the newspaper, online, or on television, and you may feel comfortable watching how the Treasury markets, bond prices and interest rates work.
Changes in interest rates on mortgage bonds will usually cause quick changes in consumer mortgage rates. Home loan rates may change dramatically due to the changes in mortgage bond rates from the day a prospective home owner fills out an application for a mortgage loan to the time they take possession of the home or close on the transaction. Watching the bond market action gives you a leg up on the near future direction of mortgage rates.
So, you get approved by a lender and you believe you have their best offer. At this point you need to decide whether to lock in the interest rate or not. What risk are you taking if the rate isn’t locked. If mortgage rates rise a great deal during the mortgage application process, it could bring about a significant change in the monthly mortgage payment. If your mortgage interest rate and points are locked in, you should be protected against mortgage rate increases while your home loan application is processed.
To avoid a mortgage rate change from having an adverse impact that may increase the new payment based on this rate change to a point that a borrower may no longer qualify for the home loan program, the mortgage rate lock is a great tool. To protect against this uncertainty, mortgage lenders allow the borrower to lock-in the mortgage loan’s interest rate, guaranteeing the borrower the prevailing loan rate for a specified period of time, often 30-60 days.
This protection will generally affect the mortgage one way or another. A locked-in mortgage rate will usually prevent the home loan applicant from taking advantage of mortgage rate decreases, unless the mortgage lender is willing to lock in a lower rate that becomes available during this period. The mortgage rate lock therefore prevents mortgage rate changes that are higher and can drastically impact the cost of the home loan but also prevent the borrower from obtaining a lower mortgage rate should interest rates decrease before the mortgage loan closes. How do you decide to lock in the interest rate?
It turns out that you will probably pay more money to lock in the rate even if locking in the rate turns out to be the right thing to do. That’s because a mortgage lender will usually charge you in some way to lock in the mortgage rate. You may pay higher points, or what is called the loan origination fee, in order to lock in the low rate. Sometimes the mortgage rate is even raised a tiny bit so that you can lock it in. You pay a bit more because the mortgage lender is taking on the risk that rates could go up while the transaction is processed, so the lender could end up losing money if the loan is funded at a lower-than-market interest rate.
A thirty day interest rate lock might cost a borrower one-half of a point at closing, and a sixty day lock might cost a full point. These fees are paid at closing. If a borrower doesn’t want to pay for a lock through points, the fee can be added into the interest rate.
Most borrowers are willing to pay a small and reasonable price for the peace of mind associated with knowing what their interest rate will be at closing. However, interest rates may continue down, in which case you’ve paid a fee for no good reason.
Or have you? As the borrower you are free to go elsewhere for a loan if you don’t like the interest rate before the closing. Your mortgage lender won’t tell you, and it’s a pain to go through the entire process again, but in the long run it may be worth it. Moreover, if you decide to pull out of the arrangement, the lender may be willing to renegotiate the mortgage rate. Especially in a market where there is competition for borrowers, a lender won’t let you walk away easily. It never hurts to ask for a lower mortgage loan rate.
Once you are satisfied with the terms of a home loan you have shopped around for, you may want to obtain a lock-in agreement from the mortgage lender or broker. The lock-in should include the mortgage rate that you have agreed upon, the period the lock-in lasts, and the number of points to be paid. A fee may be charged for locking in the mortgage loan rate at this time or added on to the cost of the loan. This fee may be refundable at the home loan closing.
Not-So-Glorious Home Ownership
According to any number of experts in the media, political arena and at backyard barbecues, we should all own our own homes. Home ownership has always been a goal in the United States as it makes a statement about the stability of your income and makes you a better citizen, among other things. Homeowners have long been extolled as being pillars of the moral society, being more involved in the community, and having more educated children. But how much of that is fact, and how much is mere propaganda?
Recent numbers have certainly shown that far too many Americans own homes that they can not afford. Mortgage delinquency is rising as more mortgage payments are slipping seriously past due. These homeowners fell victim to irrational pressures that push home ownership on the American people. People that are now trying to recover from financial loss associated with an unsustainable mortgage loan, credit problems and personal problems stemming from the desire to follow the propaganda pushing the American dream.
Is Home Ownership for Everyone?
If propaganda is to be believed, we should all own our own homes. Unfortunately, many people buy into this belief but fail to consider if, in fact, owning and maintaining their own home is really the right personal decision. There is no doubt society is telling you to buy a home. But it may very well be that your bank account, your lifestyle and your career are sending a very different message entirely.
There are many home loan programs available from the government and banks that have helped low income families become proud home owners with reduced mortgage down payment programs. Unfortunately, many of those homeowners are now staring at rising mortgage payments and imminent foreclosure. Many of these families and individuals took advantage of the sub prime lending craze that swept the nation in recent years thanks to overall low interest rates, low mortgage rates and in some cases additional government assistance.
Now, with mortgage rates creeping back up, mortgage loan payments are coming up too and money is getting tight. When these sub prime buyers are unable to pay their mortgage, they face eviction and foreclosure. Mortgage refinancing, which seemed like a viable option for mortgage payment relief, became more difficult and often involved an even higher mortgage rates. Not only have they lost any investment up to this point, they have also lost their credit rating and their pride. It’s hard to feel good about yourself after being kicked out of the home you were so proud to own a few short years ago as well as losing the mortgage down payment funds and any other money that may have allocated to make previous mortgage payments and housing maintenance.
Don’t Buy a Home
Home ownership isn’t for everyone. When you own a home you must have time and money to spend maintaining that property. You must learn how to cut and edge the lawn and how time consuming driving from the suburbs to the city can be. Many city dwellers who buy a home in the suburbs chafe at the sudden isolation and removal from community activities.
Others find their free time now consumed by drives to and from work every day. Still others realize that paying homeowner association dues and property taxes isn’t as much fun as they were anticipating.
Many homeowners are not only overwhelmed by the new mortgage payment, referred to as payment shock in the mortgage industry, especially when the home loan is based on an adjustable rate mortgage but are also unpleasantly surprised over the cost of maintenance. Maintenance does not just mean maintaining the yard and cleaning but unlike a rental unit in which the structure is maintained by the landlord, your home physical structure including plumbing, electrical and physical wear and tear is maintained by the home owner.
Buying a home isn’t the right choice for many people. If you are in a career that relocates you often, you may be frustrated trying to sell home after home and losing money in mortgage closing costs and commissions. You may also not be an ideal candidate for home ownership if you are at retirement age. Many retirees would do well to sell their homes (along with the maintenance they represent) and find a high-quality, well maintained rental instead.
But Is It Better To Own a Home?
There is some truth to studies that children are more successful academically in families that own homes. There is no difference between those children and children of long-term renters, however. It seems the mobility of families, not the home location is a factor in educational success. Your children will do just as well in a rental as a home, so long as you live there for a long period of time.
Home owners are not necessarily more involved in the community or better citizens, either. Again, the longer you are in a community, the more involved you are likely to become.
As evidence, you can look too many of the cities in Europe. In the United States, 70% of citizens own their own homes. In the well-educated, successful country of Switzerland, only 34% of residents own their own homes. In Berlin, a mere 11% are homeowners.
Perhaps your desire to own a house springs more from the pressure around you than your actual desire to plant a garden or build a porch. Consider strongly your motivation before following the rest of the country into the home buying craze. Study your own personal choices regarding time and your budget for both the mortgage loan down payment and the monthly mortgage payments. Investigate the mortgage programs available and mortgage rates and do not fall into a false sense of security believing that you can always refinance a high mortgage rate into another home loan. The mortgage calculators may be especially helpful in determining mortgage options and mortgage payments. But, the mortgage calculator and mortgage rates can not determine if the work, time and investment in home ownership matches your individual goals and needs.
Top Five Mistakes When Refinancing
There are many reasons borrowers make mistakes when they refinance their homes. Poor decisions in a refinance can be a costly error, it can mean paying fees, incurring unwanted debt and excessive interest when a less expensive home loan alternative was available. In light of how much information is available on mortgage programs, the availability of mortgage calculators for payment assistance and self help resources it’s startling the number of unfortunate judgments that are executed regarding someone’s home and mortgage loan. The wrong mortgage rate is not the number one mistake in home loan refinancing.
1.) The number one mistake is not understanding all of the terms of the new mortgage loan. Most consumers stuck with adjustable rate loans with high interest rates rushed into the home loan and failed to understand the mortgage terms. Make sure you fully understand the cost, mortgage rate, length of the loan and any penalties for early payment. Understand the terms of the new home loan and do the math on what the new payments will be, the loan amount and how long it will be to pay it off.
2.) The second most common error is to choose a refinance for the wrong reasons. If you are getting a refinance for cash back understand why you are taking out the cash. If you extract equity in your home for normal consumption perhaps the problem is your own personal budget. A refinance generally involves a longer term or greater loan amount then you presently have. If the funds of this refinance are not used prudently you are only going further into debt without much benefit. Perhaps it is possible to repair your credit situation and budget without the mortgage refinance.
3.) Not shopping smart is the number three problem. If a potential mortgage loan applicant obtains the bulk of their information in writing, this problem can often be ameliorated. Comparing the good faith estimates of the mortgage lender is a good starting point. Compare truth in lending notices. Talk to more than one source for your home loan request. Though this mistake sounds repetitive, the issue here is, a borrower taking a refinance that may very well be a good mortgage loan product but the borrower is saddled with a higher than market mortgage rate and high costs by not thoroughly shopping.
4.) Not considering the other options available. The most frequent problem here is getting cash back for short term needs. Though this may be a necessity consider other options such as budgeting, personal loans, or a home equity loan.
5.) Lastly, getting a refinance to solve a budget problem not a mortgage problem. Seeking a reduced mortgage loan payment without understanding you may be taking a negative amortization adjustable rate mortgage is simply postponing some financial housekeeping. Mortgage debt is harder to repay, don’t solve lifestyle problem by placing more debt on your home.
Always, research the terms, benefits, and costs of any mortgage transaction. Never rush into a home loan. If you are not completely happy with your choices or the information you are getting; breathe, wait and start the research process all over again. A mortgage company is in the service business. Make them serve you. Shop smart and revive the best mortgage rates and terms to fit your needs.
What Is a Mortgage Refinance
Refinancing is defined as taking one mortgage loan and replacing it with another. A refinance is useful for homeowners who want to lower their mortgage payments, change the length of their existing mortgage, or taking cash out for any worthwhile purpose.
Historically, refinance transactions were used mainly when interest rates and mortgage rates were falling. Homeowners would seek to refinance at interest rate that would be below what they had on their home loan when their first bought the property.
Reducing the existing rate on a mortgage or altering the existing length of your loan is referred to as a rate and term refinance. A rate and term refinance isn’t always used by someone to lower his or her payment or change the term of the home loan. In today’s chaotic interest rate environment numerous homeowners are refinancing into fixed rate loans from adjustable rate loans regardless of what the difference in mortgage rates may be. Some homeowners make use of a rate and term refinance to avoid the rate changes coming due on an adjustable rate mortgage and merely refinance into yet another adjustable rate loan with a lower start rate.
Refinancing for additional cash to pay for bills, other loans, home improvements or any other purpose is categorized as a cash out refinance. Paying off any other debts or using the funds from the proceeds of a new refinance for any thing other than paying off the existing mortgage and the costs associated with that mortgage loan, is considered a cash out refinance. A cash out refinance requires that there be sufficient equity in the property to cover the amount of cash requested. If a homeowner has paid down their mortgage for a long period of time or if property values have risen since the time the property was purchased, the homeowner has probably built up some equity in the home that can be accessed with a cash out mortgage refinance.
Refinancing an existing mortgage loan and taking out a new home loan can yield substantial monthly savings by reducing the mortgage rate, shortening a mortgage term to build home equity faster, changing the mortgage product from an adjustable rate mortgage to a fixed rates loan or a fixed rate mortgage into a an adjustable rate mortgage or taking cash out. However, mortgage refinancing comes with a cost to obtain the new home loan. It is essential that home owners who are considering a mortgage refinance transaction evaluate both the costs and benefits before filling out a mortgage application.
No matter which refinancing option you choose be sure to research it carefully. Your refinancing decision depends on current interest rates and mortgage rates as well as your own financial needs. Compare the available mortgage loan programs, gather information, and check out online mortgage calculators to see what type of mortgage refinancing will work best for you. Take your time to decide if refinancing is right for you before starting this new home loan transaction.
Risky Home Mortgages
Mortgages with risky terms or ones based on dicey credit standards are mortgages that can cause you problems. High risks mortgages may have an appropriate use in the mortgage marketplace for those borrowers who do not meet conforming guidelines. Borrowers who exhibit the needs of a high risk loan commonly needed a mortgage loan due to slow credit, extremely high loan amounts relative the homes value, or loans to speculate on real estate. In an earlier period, high risk loans were introduced to serve just this market segment. High risk loans were designed to relax the requirements for credit standards, little to no down payments and excessive debt ratios. Sub prime loans are the typical loan type we think of regarding high risk lending. As of recent, these loans have morphed and have now been used for a variety of purposes and sold to borrowers who don’t fall into a category of needing a home loan used for high risk transactions.
A mortgage is a loan that provides you with the resources to buy a home. If you aren’t educated about the types of loans that are available, some lenders may attempt to sell you a mortgage with lots of features and variations that don’t apply to your particular needs. There are many different products out there and some of them are dangerous. Make sure you know about high risk mortgages that can potentially get you in trouble. With slightly higher rates or conditions that are pushed onto the borrower, many lenders find offering these products more attractive for their overall rate of return.
Option ARM (adjustable rate mortgage) loans are probably the most dangerous type of mortgage. These loans give you a lot of flexibility when your monthly payment is due: pay a little or pay a lot. However, you can get in trouble very easily. Option ARM loans are mortgages that give a borrower a choice on how much a given payment is. This seems like a valuable feature inasmuch as you have the flexibility to respond to month to month circumstances. You can make a minimum payment, a full payment, or an interest only payment. These loans are filled with pitfalls.
First, you don’t build equity unless you make the full payments that you would make with a conventional mortgage. Given a choice between a large payment and a small payment, which one will you choose? With the smaller payments, you’ll actually owe more on your house at the end of the month than you did at the beginning, a situation of negative amortization.
Another peril of an Option ARM is that small payments will not last forever. Sooner or later the bank will want to put you back on schedule to pay the loan off, and will “recast” your loan at given intervals, or when you owe too much on the home (110% or 120%, for example) due to negative amortization. When they recast, they set the loan on track to fully amortize over its remaining life, and your minimum payment can increase sharply. If your budget can’t afford this increase, you’re in trouble.
An option ARM is almost always a bad idea. The mortgage rates on option ARM’s are initially a very low teaser mortgage rate. As soon as the introductory rate period or teaser rate is over the fully adjusted rate on this loan is as high as a 30 year fixed rate loan. Sometimes, the fully adjusted rate is distinctly higher than a 30 year fixed rate. If the introductory rate lasted a reasonable length of time, the low initial rate may have some value. The problem with the option ARM is that this teaser rate expires anywhere from one month to six months. The option ARM is clearly one of the worst loan products that were sold on a wide scale and in the category of Arms has the least favorable terms.
Interest only loans give you the ability to pay less each month because you’re not repaying principal. You can set up your own amortization schedule, that is, a schedule for paying back principal. However, you can also end up without any equity in your home – and possibly have to write a check if your home loses value and you want to sell it. Interest only loans should be used by the most disciplined of borrowers. The interest only option allows for a lower payment but, the principal has to be paid back at sometime. Delaying the repayment based on estimates of future home appreciation or the ability to refinance at a later date under more favorable terms may be a gamble that can cost you your home.
The home loan programs that have yielded some of the biggest problems this year are the no income verification loans and the various permutations of them. Alt-A, no income, no doc, and stated income are all terms to describe similar loan programs. These loan types don’t require the borrower to document their income. For the self-employed borrower who would employ aggressive techniques for write offs against their revenue stream or income, these loans filled a need. Recently, the use of low document income loans or no document income loans were used for wage earners and borrowers who had income that would have been easily verified. These mortgage loans may allow a borrower to qualify for a loan that under normal underwriting guidelines would have been impossible. The risk and cost for the borrower is now trying to figure out how to make the monthly payment on a loan based on income that they did not actually earn. Foreclosure figures on this loan type are certainly proving that not verifying income is not a free ride to homeownership.
Many of these loans have in fact opened the door for increased number of borrowers to become homeowners. Some of these home loan products may be appropriate for you. If you’re thinking of using one of these loans make sure you understand the risks. Don’t be tempted by the reassurances of a mortgage lender that profits at your risk. It may make more sense to buy a less expensive house with a fixed rate mortgage or repair your damaged credit first. Do your research and comparison shop before making the leap.
Balloon Mortgages
Balloon loans have many of the same features of a fixed rate mortgage with one major exception; at the end of a predetermined amount of time the remaining balance of the loan is due in full. These home loans offer a level payment feature during the term of the loan, but as opposed to the 30 year fixed rate mortgage, balloon loans do not fully amortize over the original term. In a balloon mortgage loan contract, the borrower agrees to make a lump sum payment of the loan balance at the end of a certain period, typically two to ten years. At the end of the original term the home loan borrower must pay off or refinance that remaining mortgage balance. That is, the payment is calculated over 30 years but the balance must be repaid sooner.
Balloon loans can have many different maturities or terms, but most balloons that are first mortgages have a term of 5 to 7 years. Though the term of the home loan is 5 or 7 years, the payment calculation is based on a longer term, generally 30 years but can also be for 15 or 20 years. Sometimes theses home loans are often viewed as close substitutes for an adjustable rate mortgage. They have an initial fixed interest rate period of five or seven years which shortens the interest rate risk for the mortgage company and thus the mortgage rate to the borrower the result is that these home loans generally have a lower mortgage rate than that of a fully amortizing 30 year fixed rate home loan.
Balloon loans can keep the monthly payment lower than standard 30 year fixed rate mortgages but these home loans also have risks. The balloon loan will come due and if you don’t have sufficient funds to pay off the balance or a substitute loan in place this can spell trouble since the borrower will now be in default on the mortgage loan. The general rationale for incurring the added risk of the balloon feature is that since the vast majority of mortgages will never be paid in full because very few people remain in a home for the full length of their mortgage.
When choosing a balloon loan be sure you fully understand the time frames involved and the terms and conditions of repayment or conversion. This loan is generally used by borrowers who are fairly certain they will be moving from the house that they have the balloon loan on.