Mortgage Loan Refinance Break Even Analysis
Mortgage refinancing is a measurable sector of in mortgage lending. Mortgage refinancing is normally comprises at least 50% of all mortgage loan applications. When you refinance your existing home loan there are many factors to consider in choosing the optimal term, loan amount, and mortgage rate. The best way to measure the costs and benefits from refinancing is to compare all the costs of the existing mortgage and the new mortgage over a future period of time. The decision to refinance should only be made if the long term savings outweigh the initial expenses. One such tool to help make this cost and benefit decision for home loan refinance is a measurement called the break even period.
The break even period is the number of months it takes before the savings from the lower rate of a refinance covers the costs of the new mortgage refinance. In order to find your break even point, you will need to first determine the amount of time it would take for you to cover the amount of money you spend on closing costs. An example of this would be if you spent $2400.00 on closing costs for a new home loan to reduce the monthly mortgage payment by $115, it would take just under 21 months in order to cover the costs of the refinance or reach the break even point. As long you intend to hold the new home loan for a period beyond the break-even point, the new mortgage loan pays for itself.
There are several types of refinancing options available. If you already have an existing mortgage, simply replacing it with a new first mortgage at a lower mortgage rate may be an option for you but many borrowers are adding additional funds to the refinance or doing a cash out refinance to pay off other debt. Measuring the break even point is more difficult in these cases since the debt being paid off with the cash out transaction generally has much lower term left on it.
When existing homeowners are refinancing more debts into the refinance home loan transaction, extra care should be taken to make sure they are receiving a beneficial mortgage with the appropriate mortgage rate and term that matches the debt being paid off. In these situations it is wise to measure the cost of the home loan and review the savings on the debt you are paying off. The break even point on this debt should be measured over a similar time frame or term. Therefore, don’t just add $15,000.00 in credit card debt pay offs to your cash out refinance and calculate how much you are saving over a 30 year mortgage. The calculation on the savings should be performed as if you were to pay this portion off in a much shorter period that would be comparable to the amount of time it would take to pay off the debt the way it is structured now.
Before you make a commitment to refinance your mortgage, it’s important to do your homework and determine whether such a move is the right one for you. In order to get the best possible refinancing deal, you’ll need to shop around and conduct a detailed cost comparison to see which mortgage offers the greatest financial return.
But what really matters is how long it will take you to break-even on the transaction and whether you plan to stay in your home that long. In other words, make sure you understand, and are comfortable, with the amount of time it will take for your overall savings to compensate for the cost of the refinancing. Use the mortgage calculators to help with the evaluation on process on the home loan closing costs, mortgage payments as well as the break even time period.
Before you make a commitment to refinance your mortgage, it’s important to do your homework and determine whether such a move is the right one for you. And of course, it is always important to evaluate the mortgage rates and mortgage loan programs that are available. A mortgage refinance is all about the numbers, shop and compare to find the best mortgage that fits your needs.
Mortgage Loans and Loan to Value
LTV, or loan to value, is only one of the factors mortgage lenders use to evaluate or underwrite a home loan. LTV is expressed as a percentage or ratio. The ratio is calculated by dividing the mortgage loan amount by the value of the property. An example of this ratio is if someone was obtaining a $200,000 mortgage loan for a property that is valued at $400,000, the LTV of this transaction is 50%. Mortgage lenders use the loan to value ratio as a significant measure of risk in making a mortgage loan decisions.
The LTV is a very important consideration for the mortgage lender and the mortgage applicant for several different reasons and its risk measure will change with the home loan type and request. As a simple tool to measure risk, the higher the loan to value on a home loan, the riskier the home loan is perceived to be. Loan to value is essentially measuring the amount of equity in a property. This equity is a result of either the down payment amount, a larger down payment would equal more equity, or a reduced balance on a existing mortgage loan for a refinance request or an increase in property value.
Loan to values therefore measure the amount of equity in a property. The greater the equity, whether it be with a large down payment or appreciation when you already own the property, the more committed to the property a borrower generally will be and the larger the cushion there is to absorb losses by the mortgage lender should a borrower default on their home loan. Not only our borrowers more committed when there is more equity in the property, but the lenders loan balance has a greater level of protection should a borrower default. Certainly, 100% loan to value home loan transactions are defaulting at a higher rate than lower loan to value home loan transactions are.
If you are applying for a mortgage to purchase a home, the loan to value is measure of how much money has to be placed as a down payment to buy the property. In order for the mortgage lender to determine the value aspect of the loan to value ratio they will look at the lower of the purchase price, or appraised value of a home, when you are purchasing a new house. If the home appraises for an amount greater than the purchase price, this may make the transaction more desirable for you the borrower, but the mortgage lender will now use the lower sales price figure to determine the mortgage loan underwriting evaluation. Because of this, the mortgage lender will not have to worry about lending more money than the actual property is worth or lending more than you would be willing to purchase the property for or got caught in an over inflated purchase transaction.
The importance of the amount down payment for the borrower can’t be disregarded either. An important item to remember, when a property is purchased, the total down payment you make will have to come from your source of money, borrowed funds are unacceptable. If your down payment is less than 20%, you will need private mortgage insurance (PMI). This is insurance you pay to protect the mortgage lender if you don’t repay your home loan in full. With mortgage insurance coverage an extra premium or fee is included within your monthly mortgage payments. The type of home loan you receive, the insurance company as well as the home’s LTV determines the exact premium amount for the private mortgage insurance. Higher loan to value loans or home loans with smaller down payments will have a higher mortgage insurance payment, adjustable rate mortgages will also have a larger mortgage insurance cost.
When an existing home owner is refinancing their home, the appraised value is what will be used to find the value part of the loan to value equation. The biggest component in calculating your home’s appraisal value is by analyzing past sales of comparable homes that are within one mile of your property and were sold within the past year. Houses for sales or listings do not count towards this amount because they are not finalized sales and their prices can either rise or drop.
Mortgage refinances fall into two categories, cash out refinances and rate and term refinances. A cash out mortgage refinance is when you take out funds with the new home loan for anything other than paying off the existing mortgage and closing costs. A rate and term refinance is for paying off just the mortgages and closing costs. In these cases, the new home loan is changing either with a new mortgage rate or a new loan term. When you have to combine a first and second mortgages within a mortgage refinance transaction, you will want to remember than the second mortgage loan needs to have been open for at least twelve months. If your second loan is not “seasoned” long enough, the mortgage lender will consider the consolidation of the two mortgages as cash out refinance loan, thus you are subject to all LTV guidelines and their associated mortgage rate adjustments.
With all mortgage refinance transaction, you will find that the ratio used with the loan amount to appraised value is will be a big determinant of the home loan approval. This is especially true if the borrower wishes to cash out within the transaction. The typical rule for cash out transaction is a maximum amount of 90% of the appraised value for the entire loan amount, which also includes any cash out. And a 90% cash out refinance is the absolute high end of the approval range, meaning the mortgage lender considers this loan the riskiest loan is less likely to approve such a request.
When your LTV is over 75%, you will usually experience a minimum .125%, or 1/8th of a point, increase within the mortgage rate for every 5% in the LTV. An example of this would be when a person takes 85% cash out mortgage loan; their mortgage rate would generally be .25%, or 1/4th of a point, higher than with a 75% cash out mortgage with established mortgage rates. The main reason for the mortgage rate increase is the increased risk factor on the home loan, there is now less equity in the property.
If you require more than 90% cash out rate, there are lenders that will supply this to you. However, the mortgage rates are generally significantly higher than standard rates with the exception of FHA loans. FHA loans allow 85% cash out LTVs without a significant impact on the mortgage rate.
The lower the ratio between the loan amount to the appraised value, the loan to value, the more likely a mortgage lender will accept the risk of the home loan. The risk considerations will be different in owner occupant versus non-owner or rental situations. Loan to values will be more significant in cash out transactions versus rate and term refinance loan requests. As you compare mortgage lender costs and qualification requirements you will see how loan to value can play a key role in the final outcome.
Mortgage calculators are a great tool to evaluate the loan to value on a home loan. www.selectcalculators.com offers a wide assortment of mortgage calculators to help determine LTV and evaluate home loan products and mortgage rates.
Mortgage Refinance Numbers and Costs
Mortgage refinancing is a home loan process in which one or more existing mortgage loans are paid off and replaced with a new home loan. Shopping around for the right home loan has never been more important to assure a mortgage refinance candidate will get the best financing deal.
The requirements for a refinance have become much more restrictive in 2009. A homeowner’s eligibility for refinancing will still be similar to the mortgage loan underwriting and approval process that an applicant went through when they first obtained the mortgage they are now trying to refinance. A mortgage lender will review and evaluate the borrower’s income and assets, their credit history and credit score, outstanding debts, the appraised value of the property, and the mortgage loan amount requested. Unfortunately, the guidelines to approve these home loans are more stringent regarding the parameters such as credit scores, income, assets and property value. In addition, mortgage costs are running higher.
This makes comparing mortgage loan products, mortgage rates and mortgage loan costs that much more important. Shopping, comparing, and negotiating may save you thousands of dollars. The first step is to begin by getting copy of your credit reports to make sure the information in the report is accurate. Credit report errors or discrepancies are a sure fire way to put a real wrench in the mortgage refinance process. Make sure to correct any mistakes and evaluate how good your current credit profile is.
In order to help evaluate whether a home loan is a good deal or not is worthwhile to have an idea on what to expect for closing costs and refinancing costs. Refinancing fees will vary from mortgage lender to mortgage lender and there will be different costs in different states.
Mortgage lenders are required by federal law to provide a good faith estimate of closing costs within three business days of receiving a mortgage loan application whether it is for a home purchase or refinance. The good faith estimate will provide a detailed approximation of all costs involved in the home loan closing. This document can be very helpful when used to compare costs with different mortgage lenders. Once a mortgage loan is approved and a settlement or closing date is set, the borrower should make sure to get copy of the HUD-1 settlement cost form before the home loan closing takes place.
Here is a list of some of the usual costs and fees that charged on the average mortgage refinance:
Application Fee
Some mortgage lenders and banks charge an application fee at the time of the home loan application. This fee can range from $200.00 to $500.00 and covers the initial costs of processing your home loan request and checking your credit report. If the home loan is denied, you will most likely not be refunded the cost for the mortgage loan application fee. Some mortgage lenders will credit the cost to the closing once the mortgage loan is signed.
Points and Loan Origination Fees
A point is equal to 1 percent of the amount of your mortgage loan. There are two kinds of points you a home loan borrower may pay for the home loan. The first is the mortgage loan discount points, a one-time charge paid to reduce the interest rate of the mortgage loan. The second type of mortgage points are charged by some mortgage lenders as origination fees to earn money on the home loan. The number of mortgage points will vary from mortgage lender to mortgage lender. It is important to review the mortgage points and the mortgage rate between mortgage lenders because the number will often not be directly comparable. As an example one mortgage lender may charge one point for a rate of 5.375% while another mortgage lender will charge 1.5 points for a mortgage rate of 5.25%. The general rule is that mortgage points are fees paid to the mortgage lender or broker for the home loan and are often linked to the interest rate; usually the more points you pay, the lower the rate but this is not always the case. Compare rates and points carefully.
Appraisal Fees
The appraisal fee pays for an appraisal of the home to be performed by an independent licensed appraiser. The appraisal is used to determine the market value of the property, its condition and the overall property market. Some mortgage lenders include the appraisal fee as part of the application fee but many do not. Once the appraisal is completed, you may request a copy of the appraisal and you are legally entitled to that copy even if the home loan is denied. Customary appraisal fees range from $300.00 to $600.00.
Title Search and Title Insurance
A title search and title insurance is used to check and insure the ownership of the property and the existing liens such as other mortgages or judgments on that property. The search fee covers the process of checking these documents and the insurance is to protect the mortgage lender in the event of an error or unknown recorded claim against the property that may very well impact the mortgage lenders security interest or the mortgage loan. If a problem arises, the insurance covers the mortgage lender’s investment in your mortgage. Search fees and insurance vary significantly by state since some state regulates the cost on the title insurance, ranges run from $600.00 to $900.00
Attorney Fees and Closing Fees
The mortgage lender will usually collect the fees paid to the lawyer or title company that conducts the closing for the mortgage lender. Attorney fees on a purchase transaction are a different fee, the attorney fee in a refinance transaction is generally charged in states that require attorneys consummate the home loan transaction otherwise; the title company or other representative handles the mortgage loan closing paperwork. The cost range for these fees is approximately $200.00 to $1,000.00.
Real Estate Taxes and Homeowner’s Insurance Escrow
The mortgage lender will require that the real estate taxes and homeowner’s insurance policy (sometimes referred to as hazard insurance) are paid up to the time of the home loan settlement and that a new escrow is established to disburse future taxes and insurance premiums. The homeowner’s insurance policy protects against physical damage to the house by fire, wind, vandalism, and other causes covered by the policy. The policy insures that the mortgage lender’s investment is still sound even if the home incurs some devastating calamity. The real estate tax escrow insures that the taxes are paid and the property does not become delinquent and subsequently sold for unpaid property or real estate taxes. These charges are technically not closing costs, since they are not charged by the mortgage lender, only collected by the mortgage lender to disburse to the appropriate collecting body. It is difficult to provide a range of costs for the tax and insurance escrow costs since property taxes may range from $1000.00 to $30,000.00.
Private Mortgage Insurance or Mortgage Insurance
These fees may be required on home loans that have less than 20% down payment or over 80% loan to value on a refinance transaction or are insured by federal government housing programs, such as loans insured by the Federal Housing Administration (FHA) or the Rural Development Services (RDS) and loans guaranteed by the Department of Veterans Affairs (VA). If there is not at least 20% equity in the property, mortgage lenders usually require the home owner to have private mortgage insurance to protect the mortgage lender. Insured home loans with private mortgage insurance cover the mortgage lender’s risk that the home owner will not make all the home loan payments. Costs for mortgage insurance have a wide range from 1.75% for FHA loans and 1.25% for VA home loans to .50% on for conventional mortgage loans.
Once you know what each mortgage lender has to offer run the figures the mortgage calculators to see which mortgage loan program and mortgage rates best suits your needs. And don’t forget to negotiate for the best deal that you can. Armed with the right information and a sufficient amount of mortgage comparison shopping, a consumer should be assured they will receive the right home loan with best mortgage rate and lowest costs.
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.
No Doc, Stated, Alt Doc Home Loans Explained
Before reviewing the guidelines, the background and product description for alternative document home loans, it is important to be aware that most of these types of mortgage loans are no longer available. Limited variations are still available mostly by portfolio lenders but for the most part, the increased delinquencies and foreclosure rate on these loans has curtailed their use for home purchases as well as refinances.
Stated income loans, no document, no income no asset, SIVA, NINA and no ratio home loans are all variations of alternative documentation mortgage loans. Alternative documentation loans were intended to simplify and expedite the loan approval process. Mortgage lenders may offer a variety of documentation requirements from a full documentation loan to one of almost no documentation, aptly named a no doc loan.
The documentation requirements on a mortgage loan are intended to acquire information about the borrowers income, assets and employment. The varying types of alternative documentation mortgage loans lay the groundwork for how and whether this information will be used by the lender. In addition, the lenders documentation requirements will determine whether and how the mortgage lender will verify the information provided.
These mortgage loans were originally designed specifically for self-employed borrowers with high credit quality and significant amounts of equity or large down payments. Given that the risk to the lender rises as documentation requirements become less rigorous, the rate on these mortgages rise likewise.
A stated-income loan (SIL) or no income verification (NIV) loans were the simplest forms of alternative documentation loans. These home loans are designed to qualify a borrower using the income the borrower states, as opposed to the income the borrower can document. With an SIL or NIV, the lender agrees not to verify the income the borrower states on the application. While a mortgage lender does not verify income on an SIL or NIV, they do verify assets and the actual employment, not the income. From this point of documentation, a whole host of alternatives has crept up to establish the income and asset verification standards. On a no-ratio loan, income is not reported at all; on a stated-income/stated-assets loan, both income and assets are stated; on a no-income/no-assets loan, neither income nor assets are reported; and on a no-doc loan, nothing is reported, including employment.
The advent of these mortgage loans was to provide a means for some borrowers to purchase a home or do a cash out mortgage refinance with fewer documents and close the transaction faster. It afforded some borrowers the ability to maintain more financial privacy and confidentiality. These mortgage loan terms did in fact provide flexibility in mortgage financing for these borrowers. In its infancy, these loans were overlooking the verification of income or the borrower’s capacity to pay and compensating this decision with other factors. To account for this reduction in verification and increased risk, the lender would require greater equity in the property and a stronger credit profile combined with a higher interest rate. It was historically given that borrowers with high credit scores were much less likely to be unreasonable in their financial dealings and fail to make the mortgage payments.
Over time, the standards for credit and equity or down payments were reduced. These mortgage loans were now being offered to a much larger segment of borrowers than the programs were originally intended for. The misfortune on the expansion of alternative documentation loans is that some borrowers, without any practical basis for expecting a rise in income or additional resources of any kind, lied about their current income and took out home loans they could not afford. This irrational behavior of some of these borrowers was most likely encouraged by the behavior of greedy or even predatory loan officers who get paid only if a home loan closes.
With the increase in delinquencies on these mortgage loans, alternative documentation loans are regressing back to the original intention and original strict credit and equity guidelines. A borrower should not be steered to a low documentation or no documentation loan by a mortgage lender in order to speed up the loan application and approval process. Most borrowers should know that they would receive better pricing or a better mortgage rate the more documentation they provide. If an alternative documentation loan is needed, potential borrowers should be comfortable with their financial position regarding the affordability of the loan they may be accepting. As these home loans become more restrictive it is likely that potential borrowers will have to perform an amplified amount of shopping to find the best mortgage rate and terms.
Mortgage Closing Time and Tax Prorations
Prorations are items that are shared between the seller and the buyer at the time of a home loan closing. The largest prorations will be property taxes. Property taxes can be more complicated than other prorations because of the shear size of property taxes and the potential for increases in tax assessment that can occur either after the contract is signed and the closing on the property takes place or between the time of the last known tax bill and the time the property closing takes place. Tax proration is not a process involved in a mortgage refinance since there is no change in ownership on the property.
In many cases, the closing agent will use the property taxes from the previous year to determine the proration for the sale of the property. For example, let’s say that you close in August, but the new taxes aren’t available until November. Since you have only lived on the property for four months, if the taxes go up are you responsible for the taxes for the entire year? The converse can be true in some locations of the United States where county taxes are paying for services following the due date of the property tax bill. Fewer taxing authorities have you pay for future services and the problems lie with the property tax bill for past services.
In cases where a tax bill coming due is paying for prior months services the proration is a credit to the buyer which flows down to a credit for the funds needed to close on the home loan. At the time of the real estate closing the taxes payable have accrued on the property. As an example, if the property were located in a county that sends it tax bills out twice a year and the first bill is in July for the previous six months property taxes. If the purchase closes in March a proration credit is due the buyer. The buyer will be paying a bill in July that covers the months of March, April, May and June when he was in the property. But the bill also covers the months of January and February in which the seller still occupied the property. In this case, it would be customary for the seller to credit the buyer the amount of funds for those two months at the closing even though the tax bill for this time is not out yet.
The issue gets further complicated since the closing is taking place in March, the amount of the tax bill coming out in July is most likely unknown. It is certainly rare to see a county reduce the tax burden on real estate.
One way to solve this problem is for the buyer and the seller to sign a tax escalation or proration agreement into the purchase agreement. This means that the buyer and the seller have agreed to have an amount of the taxes credited to the borrower or seller greater than 100% of the most recent bill. 115% is a common figure used in the contract. The credit from the seller in the preceding example will now take the previous six month tax bill, divide that figure by the number of days the tax bill covers, this gives us the per day tax liability. This figure is multiplied by the amount of days the seller was in the property since the last tax bill up to the closing and then multiply that by 115% to get the credit for the buyer and the cost for the seller. If this escalation agreement is not part of the purchase contract, it is highly unlikely the seller will credit anything more other than what is mandatory.
It will be hard to get a complete grasp of the home loan closing process and funds needed to close on the mortgage loan without understanding the tax proration procedure. Tax proration will ultimately impact the amount of funds needed to bring to closing on a home loan. Most buyers and sellers don’t completely understand the prorations at the time of the mortgage or home loan closing; in fact many of the professionals at a real estate closing can’t explain the calculations on how all the funds disbursed. Make sure you fully understand any related prorations, consult the real estate agent, title company officer or your attorney regarding when property tax assessments are made, these figures will vary from state to state. Often the mortgage calculators available online can help to obtain estimates on the closing costs of a home loan including assisting with the tax proration.
Balloon Payment Mortgages
A balloon payment mortgage is home loan that does not fully amortize over the term of the loan. The payment on a balloon mortgage loan is calculated over a predetermined period, most commonly for 30 years, but the balance of the loan is due or payable after a specified period before the 30 years. An example of this is a five year balloon home loan. This home loan would have principal and interest payments based on a 30 year loan, but the outstanding balance has to be repaid in full before the end of the five year term. This payment is at the end of the term is how the balloon name was derived.
The most popular balloon mortgages have a fixed rate period of either five or seven years with a thirty-year amortization and generally they will not have a prepayment penalty. At the end of 7 or 5 years the borrower has usually two options to make the final balloon payment. The home can be sold to pay off the home loan or the borrower can refinance the home loan. Either option can be exercised up to the time the term of the home loan ends.
There is another type of balloon option to handle the remaining balance at the end of the term. This option is found in some balloon payment mortgages and has an option to extend the home loan for the remaining term at the prevailing market rates adjusted according to terms in the original mortgage note. The rate then remains fixed for the rest of the home loan term. This feature is referred to a convertible option, since you may convert the mortgage loan to a fixed rate at that time. The home loan may also be referred to as a two-step, the first step is the balloon term and the second step is the conversion. The general conditions to be able to convert include; the home is still your primary residence, you have a good payment history and your payment is current and there are no additional liens on the property.
The interest rates on balloon payment mortgages are generally lower than that of a 30 year fixed rate mortgage loans. The major advantages of the balloon payment mortgage are; lower interest rates, lower payments and the ability to qualify to buy a larger home. Generally these mortgage loans are considered when the borrower does not expect to be in the home at the end of the fixed mortgage loan term. Of course there are some disadvantages to the balloon mortgage, most notably, continually worrying about the end of the fixed rate period when the large balloon mortgage payment will be due.
The balloon payment mortgage is clearly not for everyone to consider. When interest rates and mortgage rates are low from the short term to the long term, the slight benefit of a balloon with a lower mortgage rate is eroded. Most home buyers however, do not have the same mortgage five or seven years later, they have since moved and paid off or did a mortgage refinance. Weighing the benefits and risks of the features on these mortgage loans against your needs will determine if the mortgage rate and costs of this product should be considered further.
Always investigate the differences in mortgage rates between the balloon mortgage loan and a standard fully amortizing home loan. These homes can be used for both a home purchase as well as a mortgage refinance. Use a mortgage calculator to help compare the mortgage rates, mortgage payments and the amortization schedule on the loan including the balloon payment can be very useful to determine if this type of home loan is right for you.
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
Before deciding which mortgage may be right for you, understand what it is you are trying to get a hold of. Gaining knowledge of what a mortgage is can be an important tool in searching for the right mortgage and help recognize the value of your rights and responsibilities while you have a mortgage.
Technically speaking, a mortgage is a written legal contract that establishes the rights and liabilities of both the creditor and debtor and creates a lien upon real estate. The mortgage is the pledge of the real estate as security for payment of a debt. The mortgage is actually the lien on the home and not the loan itself. The lender, mortgage company or any financial institution that holds the mortgage, has an interest in the property, they do not own the property. Often the term mortgage or loan or the combination mortgage loan and home loan are all used to mean the same thing.
The borrower or debtor is the party pledging the real estate as collateral for the mortgage loan and is therefore gives the mortgage. The mortgage lender or creditor is the party providing the loan or note that is secured by the property in the form of a mortgage on that property. The borrower is the mortgagor and the mortgage lender or mortgage company is the mortgagee.
Since the borrower pledges his or her property as security for repayment of a debt, the mortgage creates a lien against the borrower’s property. The lending institution, mortgagee, holds that lien. In return for holding the lien or mortgage on the property,the mortgage company is also agreeing to loan you money. The terms of how much money is loaned to you, at what interest rate or mortgage rate and for how long is established in the note or promise of repayment, but not on the mortgage itself. If you don’t keep your promise of repayment and default on the loan terms, the mortgage that pledges your property as security gives the lender the right to initiate foreclosure and sell the property to satisfy the debt if necessary.
The foreclosure action starts due to the failure to make the timely mortgage loan payments. Foreclosure allows the mortgagee to declare that the entire mortgage debt is due and must be paid immediately. This is accomplished through an acceleration clause in the mortgage. Failure to pay the mortgage debt once foreclosure of the property occurs, leads to seizure of the security interest, the home and land, and it’s sale to pay for any remaining mortgage debt. How the foreclosure process is carried out depends on state law and the terms of the mortgage.
There are several types of mortgage loans available with a variety of terms, mortgage rates and costs. Which home loan is best for any particular borrower depends on many factors about financial position and lifestyle choices. Using a mortgage calculator is a good start to compare different mortgage rates, terms and products. Research the terms and cost and comparison shop thoroughly to match the right mortgage loan to your needs whether its is to purchase a new home or an exiting mortgage refinance.
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.
What To Do Now That the Mortgage Rate Has Adjusted
When home prices appeared to be appreciated without an end in sight and interest rates seemed as though they were headed to zero, many homeowners jumped on adjustable rate mortgages. These mortgage loans offered low initial payments enabling borrowers to afford the ever rising home prices and were also used to help homeowners who had tight budgets on their existing house payments refinance into a more manageable payment structure. Some of these adjustable rate mortgages were sold to unsophisticated consumers with the assurance not to worry about future mortgage rates since you can just refinance. Well, for some borrowers, refinancing is not a possibility, particularly when many of these home loans had prepayment penalties. With housing now in a down cycle, expected appreciation has vaporized leaving little to no equity in the property, compounding the difficulty to refinance. Those that didn’t refinance are finding the new adjusted mortgage payment a difficult and often painful part of the household budget.
If the interest rate on your adjustable rate mortgage has not adjusted yet, study the paperwork from the mortgage loan closing to determine when and at approximately what mortgage rate it will adjust to. If it has not adjusted, the mortgage rate will be an approximation since you can not predict where the index your adjustable rate mortgage is based on will be in the future.
Keep in mind that the initial mortgage rate on an adjustable rate mortgage has little to do with the future rate changes; this rate was simply a start rate that was in fact a teaser rate. The adjustable rate mortgage interest rate is tied to an index plus a margin to get the interest rate the payment is based on. When you sign for the mortgage loan, you can calculate what this rate would be at that time. The introductory rate is almost always much lower than this mortgage interest rate. Therefore, when the first adjustment time comes, unless the index the loan is based on goes down, you are almost guaranteed the rate your loan is based on is going up. When your first adjustment rolls around, many loans allow a higher increase than for subsequent adjustments. Some adjustable rate mortgages loans can jump to the maximum cap rate, which could be as much as another 5 to 6 percent.
Let’s say you borrowed $300,000 at an initial rate of 4.75%, the current principal and interest payment would be $1,564.94 per month. If the home loan terms contained a cap of 2% per year and the new index plus margin hits the maximum change, the new rate will be 6.75%. At this mortgage rate, your payment would increase to $1,945.79 or about $381 more a month. If your rate adjusted the maximum amount at the following cycle or adjustment period the rate goes to 8.75%, and the payment would be $2,360.10, or a difference of an additional $415 a month. With property taxes increasing, utility bills swelling and the general cost of living going up, short of taking on a second or third job, not many borrowers can afford such extreme jumps in monthly payments.
Some of the options that are available include selling your home, talking to your mortgage lender to arrange payment relief, refinance into a fixed rate mortgage or refinance into another adjustable rate mortgage.
If you are planning on moving, refinancing is most likely not worth the time and costs. If you intend to sell, keep in mind some of the costs you may incur in selling the home. Listing your house for sale with a real estate agent, providing you have enough equity to pay commissions and costs of sale will typically absorb 5 to 10 percent of sales price. You can try and sell your house without representation, providing you can afford advertising and marketing expenses, including the advice of a real estate lawyer.
Refinancing to a fixed rate mortgage is a great option; you will of course have to qualify for the home loan. Mortgage refinance transactions are generally easier to qualify for than a purchase and the paperwork is slightly less rigorous. This option is feasible if you have enough equity and can afford higher monthly mortgage payments. Mortgage qualification will be based on the loan to value or amount of the mortgage loan divided into the property value, your credit history and your debt ratios. It is easier to qualify if you do the refinance as a rate and term refinance. A rate and term mortgage refinance is where there is no new funds are added on to the payoff of your existing mortgage loan other than closing costs, the opposite would be a cash out refinance. The mortgage calculator is a useful tool to measure the mortgage rates, costs and terms to see how your loan may qualify for the best mortgage loan available for refinancing.
If theses options are not practical, talk to your mortgage lender or bank. In most cases, your mortgage lender will be willing to cooperate with you and help you catch up if you have trouble making the payments after the home loan adjusts. Often, lenders are not interested in foreclosing your house except as a last resort because of the costs and time involved in the process. If you believe that you situation is untenable, speak to the lender to see if you can arrange to make lower payments, deferring unpaid interest and penalties even if it will increase your mortgage loan balance. You may also persuade the mortgage lender to come to an agreement on forbearance or postponing your mortgage payment increases based on ability to pay at a future date.
The worst thing a homeowner can do is ignore the coming mortgage rate changes and payment shock and do nothing.
Cash-Out Refinancing Basics
When you enter into cash out mortgage refinance you are making use of the equity that you enjoy in your home. The equity in your home is the part that you own outright. If you have a home that is worth $120,000 dollars, and you owe $90,000 dollars on your mortgage, then the amount of equity that belongs to you is $30,000 dollars. For most all mortgage refinances, you will not be able to borrow all of the available equity in the home.
When you refinance, any kind of refinancing, you are basically in some way trading your previous mortgage for a new mortgage. The new mortgage will likely have different options, a different mortgage rate, different term or length, and a different loan amount than your current mortgage loan. Using cash out mortgage refinancing, you enter into a mortgage for more than the mortgage you currently own, and the mortgage lender or bank gives you a lump sum check for the difference. When you refinance and you use the money for anything other than paying the existing mortgage and costs, you are doing a cash out refinance. Even if the money is used to consolidate your debt it is still considered a cash out refinance transaction.
Utilizing cash out refinancing allows an existing homeowner to access some of that equity to use for beneficial purposes. Borrowing against the equity in your home is almost always cheaper than other types of financing and the mortgage interest in most cases is tax deductible. In a favorable mortgage rate market, the cash out refinance may actually lower your monthly mortgage payment. If mortgage rates now are lower than when you first took out your mortgage, the payment may go down; in addition, since you are most likely extending the length of time for repayment, this may bring about a lower payment as well. Refinancing with new loan terms and possibly a lower mortgage rate can add value to an individual’s budget and personal balance sheet. Of course, even with a lower mortgage rate or monthly payment the full costs and benefits of cash out refinance should be reviewed. The process of comparing mortgage costs, mortgage rates, the loan amount and the costs and benefits of the mortgage refinance is easy to quantify with the use of a mortgage calculator.
After your previous mortgage is paid off with the cash out refinance home loan, the balance can be used for anything you choose to use it for. Debt payments, tuition, investing, home improvement, anything that you need a large sum of money for. If your interest rate on your cash out refinancing is lower than the original mortgage you had, the monthly rise in payments may be partly offset. If the interest rate is higher make sure you understand the implications on your financial position of extracting the cash out. Cash out refinance for conspicuous consumption can lead to budget problems down the road when refinancing no longer becomes an option.
Evaluating the costs and benefits of a refinance can include more than just how much money you save per month. Remember, if you pay off a four year auto loan with a 30 year mortgage, there better be a payment savings. In these cases you must factor in the total cost of interest and whether you will repay the mortgage faster with the additional cash flow. Evaluating inflation and the direction of interest rates should also be measured. Granted, this is almost impossible. But it hard to ignore the value of borrowing money at 5.75% fixed for 30 years in 2008 and discovering that inflation will be running over 5% in the ensuing years. Very little is paid to the terms of home equity lines of credit. These loans are almost always adjustable mortgage rates. The reason is that no financial institution provides a line of credit good for 15 or 20 years at a fixed rate giving the borrower to access the funds when market rates rise and the value of that line of credit at a low fixed rate skyrockets. Interest rates move based on various market forces. The most significant impact on rates is inflation.
There are clearly many factors to consider should you want a cash out refinance. The following considerations are the ones to address as you start to evaluate your individual needs.
Compare the mortgage rate and closing costs for the new home loan.
Compare those terms to your existing mortgage loan and its remaining term to avoid refinancing the existing balance at a higher overall cost.
The amount of cash you need including the amount to pay off the existing mortgage.
The purpose for the cash (This one has led many a borrower astray).
The amount of time you expect to be in the home or have this mortgage for.
Consider your tax bracket, other opportunities, and the overall direction of interest rates as well as your financial balance sheet.
In order to secure the loan request, cash out refinances are approved or rejected just like any other mortgage loan. Banks and mortgage lenders will sometimes allow you to finance up to one hundred percent of your homes value, provided that your credit is excellent. More often, the loan amount will have to be 95% or lower than properties appraised value. If income or credit situations tighten the restrictions you may be reduced even further on the amount of equity you can draw out. Depending on the amount of money that you owe on your first mortgage, the lender will often require private mortgage insurance in high loan to value requests. And as the amount financed becomes a higher percentage of your home’s value, the mortgage rate you are offered will increase as well.
Consider your needs, your existing financial health and what the future may hold. Research all loan types to see which best fits your needs. Be a proactive, be an educated mortgage shopper by reviewing all terms, the mortgage rates available and close on the new mortgage refinance that best fits your needs.
Can You Save Money by Closing a Home Loan at the End of the Month?
In order to understand if you will be able to save money from closing at the end of the month, you have to learn some background information on how the mortgage loan closing costs are determined. You will want to start by comparing renting or rental payments to a mortgage payment. When you pay rent, you normally have to pay the bill at the start of each month for the forthcoming month, which is basically paying in advance. However, with your mortgage payments, the monthly mortgage payment normally pay off the interest that was built up on the principle balance throughout the previous month. Mortgage payments pay the interest in arrears as opposed to how the rent payment is paying for future use.
When you want to close on your house, you are generally able to do so at any time during the month. As an example let’s say your closing date is on October 15, which would mean that your first mortgage payment is due on December 1st. In order to maintain a level of homogeneity in the mortgage securities market most all primary mortgage payments are due on the first of the month. This payment on December 1st would include the interest for November since monthly mortgage payments pay the interest in arrears. However, what about the 16 days of October that remains between the closing on October 15 when you receive the money or the keys to the new home and November 1? The amount of interest that would be due for the rest of that month is paid at closing, which is sometimes called pre-paid interest or interim interest. You will notice that the closer to the latter part of the month you close on your house, the smaller the interim interest payment will be since there are fewer days from the home loan closing to the beginning of the next month.
If you are currently renting, but intend on purchasing a home, you will probably want to settle for an end-of-the-month closing because you will be able to be moved out of your rental home and into their new house before the next month’s rent is due.
Because of this, many people decide to close at the end of the month. By closing at the end of the month you wont save money but since the purchase closing requires the down payment, closing costs and the interim interest, it does reduce the cash needed to close significantly. On a standard purchase transaction this is a real financial outlay, which many homebuyers could desperately do without. However, if you aren’t concerned with having to pay an interim interest payment, than you will not likely be concerned about which day you close on the new home loan.
The role of interim interest in a refinance may be very different. In many cases a homeowner will add the amount of money needed for their refinance based on their home mortgage balance including any type of closing costs and escrows and any interim interest that is involved. Therefore, many homeowners considering a mortgage refinance assume that if they close at the end of the month the closing costs are lower. However, the main calculation many borrowers forget is the build-up of interim interest within their old mortgage loan.
You will find that many borrowers will call their current mortgage lender at the very beginning of the month to find out how much their principle balance is so they can make a payoff. The borrowers intention is to make the last payment on the old mortgage and keep the interim interest down on the new one. Many borrowers will find that if they decide to close near the end of the month, their payoff is much higher than the original quote. This is because of the amount of interest that has accumulated throughout that month on this home loan.
These individuals who are considering a mortgage refinance will not pay that month’s mortgage payment. An example of this would be if the closing on your mortgage refinance wasn’t until October 15, many borrowers wouldn’t pay their October 1st payment. They can successfully do this because many mortgage lenders will not count a payment as late till the 15th of each month. While this is not suggested many individuals still continue to perform their home mortgage refinance in this manner. However, they will quickly find out that at closing they will have to pay interest not only for September (which was what the October 1st bill was covering) but also interest for half of October.
If you wait to close at the end of the month it may seem like you are saving money. Of course, you are doing a mortgage refinancing for a reason. If that reason is a lower mortgage interest rate or a consolidation to pay off debts at a higher rate, it never pays to wait. The longer you wait to close the more interest you are accruing on your existing mortgage, since its rate is higher than the new mortgage refinance, you are paying more money each day you wait to refinance. Better to pay interim interest on the lower mortgage rate of the new home loan than a higher mortgage rate on the home mortgage you are refinancing.
There are some mortgage lenders that will give you something called an “interest credit” when you close for the first five days of a month. This is a credit of interest during these five days, which will ultimately be included within the upcoming payment. When there is an interest credit, the first payment will be on the very next month. An example is if you close on the 2nd of January, instead of 28 days of interim interest and a first payment March 1st, you will get a two day interest credit and the first payment will be due February 1st.
FHA loans actually accumulate interest from the beginning of the month to the end of the month no matter when they were paid off. Because of this, when you’re paying off an FHA home loan, you will need to properly time the closing so you do not have to pay double interest. FHA does not calculate the interest daily on an existing mortgage loan.
The bottom line is that the closing date may save money for out of pocket costs versus costs added to the loan amount but the ultimate savings is really only an accounting issue. The interest for the mortgage loan has to be paid one way or another regardless of when the loan closes.