The Home Decision II: Answers to Student Questions

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The Home Decision IIAnswers to Student
Questions
Personal Finance Another Perspective
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Objectives

• A. How are mortgage brokers paid?
• B. How do I know when to refinance my home?
• C. What happens when good credit marries bad
  credit?
• D. What about prepayment penalties? What should
  I know?
• E. Whats the lowdown on buying down or paying
  discount points?
• F. How do I make sure that brokers give what
  they promise, i.e., no bait and switch?

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A. How to Mortgage Brokers get Paid?

• Principle Stewardship
• Logic If you understand how people are paid,
  you can use that knowledge to your advantage in
  getting a lower interest rate
• Mortgage brokers are out to provide a service and
  make money
• They generally work with similar lenders with
  similar rates
• They are done with you after your loanthere is
  no follow up
• Your goal is to minimize your interest rate
  received with the fewest discount points (if any)

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Mortgage Brokers (continued)

• Mortgage brokers make money three ways
• Origination fees These are the costs and
  profits on making the loan
• Discount Points These are payments to lower the
  Loan interest rate
• Backend bonus These are bonuses paid to the
  mortgage broker if they get a higher interest
  rate than the lender requires
• There is a relationship between discount points
  you pay and the brokers backend bonus
• You want to minimize the discount points you pay
  as well as the brokers backend bonus

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Mortgage Brokers (continued)

• How do you get the lowest interest rate?
• Talk with multiple mortgage brokers
• Compare the rates across different brokers from
  different companies
• Look at the minimum interest they will let you
  buy down to
• Perhaps that is close to the Lenders rate
• Find the best rate from the multiple mortgage
  brokers you checked on
• Then ask your favorite broker to beat the best
  offer by ¼ - ½ and you will go with him/her

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The Underwriting Process

• The Underwriting Process
• From http//upload.wikimedia.org/wikipedia/commons
  /0/08/Borrowing_Under_a_Securitization_Structure.g
  if on 7Oct08

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B. How do I know when to Refinance my home?

• Principle Stewardship
• Logic Determine the costs you would pay before
  refinancing and the costs you will pay during and
  after refinancing
• If you will save enough money to cover the months
  remaining in the home before you will likely
  move, refinance
• Remember that this calculation does not take into
  account other uses of your funds nor the time
  value of money. It is a straight break-even
  calculation

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Refinancing (continued)

• Calculate
• A. Current monthly principle and interest costs
• B. Refinance monthly principle and interest
  costs
• C. Monthly savings from the refinance
• D. New origination fees and discount points on
  the refinance. In addition, be sure to include
  all new costs that will be incurred in the taking
  out of the new loan
• Note that costs that are the same for both loans,
  i.e., escrow or reserve accounts, do not need to
  be included in these calculations

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Refinancing (continued)

• To determine if refinancing makes sense, look at
  two calculations. If both are reasonable, then
  do it. If only one calculation makes sense, I
  would likely not do it
• 1. Divide all new costs (D) incurred, including
  origination and discount point costs by monthly
  savings from the refinance (C).
• This will give you your breakeven point in months
• If your breakeven point is
• Less than three years, it may be a good idea
• Three to five years, it might be considered
• Greater than five years, be careful. You will
  likely move before the benefit will be realized

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Refinancing (continued)

• 2. Calculate your overall refinancing costs
• If you will be paying less overall after
  refinancing versus without the refinance, it may
  be a good idea
• Calculate (A) your current monthly principle and
  interest costs remaining without refinancing
• Calculate (B) your refinance monthly principle
  and interest costs, and (D) your total new costs
  and fees from the loan until it is paid off
• If B D is less than A, it may make sense.
• If B D equals A, it may not make sense
• If B D is greater than A, it does not make
  sense

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C. What Happens when Good Credit Marries Bad
Credit

• Principle Stewardship
• Logic Determine the cheapest way of getting the
  highest credit score so you can pay the lowest
  interest on your loan
• There are five main options
• 1. Buy the house as co-owners and co-borrowers
• 2. Have good-credit buy the house alone
• 3. Have good-credit buy the home using a
  no-income verification mortgage
• 4. Have a third party with good credit replace
  the bad-credit as the co-borrower
• 5. Improve bad-credits credit score

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Good Marries Bad Credit (continued)

• 1. Buy the house as co-owners and co-borrowers
• Bad credit will result in bad credit for the loan
  and a higher interest rate
• This is what you want to avoid
• 2. Have good-credit buy the house alone
• This is the preferred option
• However, this may limit the size of the loan to
  the income that good-credit can support
• Do not buy a house on two incomes when you know
  you will drop to one income in the futureit is a
  recipe for disaster

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Good Marries Bad Credit (continued)

• 3. Have good-credit buy the home using a
  no-income verification mortgage
• This would be OK, but these mortgages are much
  harder to get
• These mortgages also require higher down payments
  of 25-30 of the property value
• 4. Have a third party with good credit replace
  the bad-credit as the co-borrower
• Co-signers are hard to find
• Usually, only a parent would be willing to do this

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Good Marries Bad Credit (continued)

• 5. Improve bad-credits credit score
• Suggestions include
• Put bad-credit on joint accounts with
  good-credit spouse. This can improve history
  and score
• Call bank to increase the available credit limits
  on bad credit
• Pay bills twice a month to reduce amount used for
  bad credit to reduce percentage of credit
• Pay off debt as quickly as bad credit can

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D. What about Prepayment Penalties? What should
I know?

• Principle Stewardship
• Logic Understand what you are getting into
  before you sign the Loan papers
• Mortgage lenders usually do not require a
  prepayment penalty on a first mortgage (but they
  do on 2nd , 3rd, or subprime loan)
• If mortgage brokers get a prepayment penalty on a
  loan, they may make more money
• Make sure there is no prepayment penalty on your
  first mortgage

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Prepayment Penalties (continued)

• There are two main types of prepayment penalties
  soft and hard
• Both have
• 1. A stated period of time, i.e., 1, 2, or 3
  years the prepayment penalty is in effect
• 2. A maximum pay down percentage (MPP), i.e., 6
  of the principle, and
• 3. The prepayment penalty if you sell it before,
  i.e., 6 months interest

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Prepayment Penalties (continued)

• Soft Prepayment You cannot within the stated
  period of time without penalty
• Refinance at all
• Sell the loan to family members
• Pay down more than your MPP each year
• The only way to get out of a soft prepayment
  penalty is to sell the property to an unrelated
  party

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Prepayment Penalties (continued)

• Hard Prepayment You cannot within the stated
  period of time without penalty
• Refinance at all
• Sell the loan to anyone
• Pay down more than your MPP each year
• There is no way to get out of a hard prepayment
  penalty before the defined period without paying
  the penalty

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What is the low down on buying down?

• Principle Be a wise financial steward
• Logic You can reduce your loan interest rate by
  paying discount points (these points go to the
  mortgage brokernot the mortgage lender)
• The longer you actually stay in the home the more
  valuable the discount points as those costs are
  allocated over more years
• Since the average homeowner is in their homes
  only 5-7 years, the savings from the discount
  points should break even before that time is up

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Buying Down (continued)

• To calculate your breakeven point, calculate
• A. Your monthly payments
• 1. Without the discount points, and
• 2. With the discount points
• B. The savings between options 1 and 2
• C. The cost of the discount points
• To get your breakeven point in months, divide the
  cost of your discount points (C) by your savings
  (B)
• If your breakeven is less than 3 years, it may be
  a good idea, 3-5 years, be careful, and greater
  than 5 years, it is likely very questionable

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Buying Down (continued)

• Before you pay the points, ask yourself
• Will you be refinancing soon? If so
• There may be better uses for your money than to
  buy down a tax-deductible interest rate
• Paying down higher-rate debt
• Saving for retirement in tax-eliminated or
  deferred accounts
• Building your emergency fund

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F. How Do I Get the Best Deal with Mortgage
Brokers?

• Principle Accountability
• Logic You can reduce your overall costs by
  shopping around and holding mortgage brokers
  accountable for what they say.
• Following are a few ideas to help you in this
  process
• Hold them accountable for their closing and other
  costs
• Hold them accountable for the interest rate that
  they promise

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Dealing with Mortgage Brokers (continued)

• Work with a number of brokers, and find the the
  lowest interest rate and fees
• Research the reputation and background of
  potential lenders. Check with the BBB
• Beware of the bait and switch routine. They
  should follow through with what they promise.
• Require brokers to give you a detailed Good
  Faith Estimate, not just a summary sheet of
  estimated costs. No GFE is no deal
• Once they promise you an interest rate, ask to
  see the Rate Lock Commitment Sheet where they
  lock in the rate for your loan. No RLCS is no
  deal

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Dealing with Mortgage Brokers (continued)

• Beware of lenders who advertise no closing
  costs or no origination fee. Generally, they
  will either raise the interest rates, call it a
  processing fee, or add the costs to the principle
  of your loan. There are costs to processing the
  loan
• If your lender promises a short turn around or
  processing period for your loan (7-14 days), ask
  to confirm that their underwriter is in the same
  state (or in the same building). Sending data to
  underwriters out of state can result in loans
  that take much longer to process.

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Other Questions?

• These were the questions that were sent to me.
  Do you have any other questions?