Why on earth would you be willing to pay for the privilege of paying off your home loan? That is essentially what you will be agreeing to, if your finance company attempts to include a prepayment penalty in the terms of your loan. The simple advice is don’t walk away, run!
Good For Lenders Bad For Borrowers
Banks and other finance companies are in the business of making money. And thank goodness they are too! Because they provide an excellent service that has enabled consumers to reach high levels of prosperity, of which previous generations could not have dreamed.
Lenders like to be able to count on a monthly income and it annoys them when a borrower pays off a loan. That means the lender has to find another borrower to lend their funds to. From the time that you pay off your loan until the time they receive the first payment from the next borrower, they’re losing interest.
Prepayment Penalty Basics: The Short Answer Is No
Fortunately the lending market is big enough and competitive enough to keep this sort of thing in check. So, prepayment penalties are mainly for borrowers with poor credit histories and limited options, also known as the sub-prime lending market.
For the rest of us, penalties can be easily avoided by shopping around. One of your most important demands of a lender must be that they do not include any prepayment penalties.
The Long Answer Is Also No
When you are in the market for a home loan and you are choosing a lender, make sure that you establish that there are no clauses in their contract that amount to a prepayment penalty. If you have poor credit you may not be able to avoid penalties and they usually contain certain limits, such as the first five years.
A penalty may be triggered for even a partial repayment of principle within the penalty period. The particular terms of prepayment penalty clauses will vary according to the policies of each lender, again, shop around.
Since lenders are attempting to put cash into assets and earn some interest, the loss of interest is what prepayment penalties are meant to recover. That means they are generally expressed in terms of that lost income, say, six months of interest on 85% of your loan balance. That can be a pretty big chunk of change! Add on broker’s fees and transfer taxes and all the other costs of selling a home and you’re easily losing money, even in a rising market.
Avoid prepayment penalties if at all possible because they will do exactly what they are supposed to do: Tie you into a home loan with unfavorable terms. Most homebuyers should be able to avoid them with ease. It just requires that you pay close attention when you are reviewing the terms of the loans on offer and decline any that require you to pay for the privilege of paying off your home loan.
The Credit Data Big Three
Credit card basics form one of the key features of modern life. When you think about it, it’s pretty amazing that a person can borrow enough to buy a house, based entirely on electronic records. However, the most important thing to know about credit report basics is that lenders will want to understand who you are, as a financial entity. So, it is vitally important that you know too.
The records of almost anything that you have ever officially borrowed are stored in the databases of three very powerful multinational companies: Equifax, Experian and Trans Union. These three companies have made your financial existence their business. Any time a company has agreed to lending you money it is safe to assume that they reported it to at least one of these three agencies.
Financial companies sell your financial information to these services and buy it back, to judge your financial trustworthiness, in deciding whether or not to extend credit to you. This is related to your credit score but it goes into much more detail. Every time you apply for a loan, get credit and whether or not you make your payments is tracked by each of the credit agencies.
Credit Report Basics (As They Relate To Mortgages)
When you decide to purchase a home or refinance your current home, you are going to need approval from your lender before they agree to underwrite your loan. This requires that they get to know who you are. They want to make an accurate estimate of the risk that they will be taking by extending credit to you.
Your lender will request a copy of your records from each of the three agencies. The reports that they will receive will add up to something the size of a telephone directory when printed out, if you have had credit for an adequate length of time to qualify.
Your lender will be looking for records of what you have borrowed in the past, how punctual you were in making your payments and what your financial condition looks like at the time of application. They are trying to establish your behavior and your present net worth, as well as your net worth once they extend credit. Finally they will want to be assured that the monthly payment obligations will fit your budget. All of this information will be available from the records that they source from the three agencies.
Prepare To Be Judged
The laws that govern credit and lending as well as credit reporting state consumers must be able to review their credit files once a year, at no charge. The Federal government has a website that is the only place that is authorized to do this on the World Wide Web. By going to the approved site at www.annualcreditreport.com and requesting your reports.
Not all companies report to all three so you can expect there will be some minor variations on what is posted to your credit report. That is why lenders will be looking at all three reports, they want to make certain that they do not miss any important details. It is prudent to check your credit reports with all three agencies every year, as you are allowed by law. Another good reason is that, because there is the potential for variation in your three credit reports,there is also the potential for some error to crop up in one of them.
One word of caution when you are searching for your free credit report: The only site authorized for this purpose is www.annualcreditreport.com. There are credit-monitoring services and the reporting agencies themselves will offer to give you onetime access with strings attached. Be warned that they will attempt to tie you into a contract for expensive monthly services. While credit monitoring may or may not be something in which you are interested, that is not the objective here. You want to simply establish the credit report basics before you approach any lenders.
Requesting a copy of your three credit reports should be the first step when you are preparing to apply for a home loan. It will help you understand what lenders know about you and you can deal with any obstacles before they derail your application. It’s a matter of credit report basics.
The HARP Refinancing Lifeline In An Ocean Of Debt
The last few years have seen some turbulent times in the home lending market. One of the ways that the Federal government has been helping homeowners to recover is through the Home Affordable Refinancing Program or HARP. The conditions of the market in the mid-2000s were so buoyant that even the most levelheaded buyers became swept away in the currents of the bubble.
The HARP program is intended to help homeowners by giving them more affordable monthly payments and allowing some financial room to breathe. There are some conditions that apply and it will only be worth the effort if the lower payments balance against the cost of refinancing into a HARP mortgage.
When real estate markets are stable or rising, adjustable rate mortgages (ARMs) are a low-cost option for the home. The problem is that many were sold to homeowners with extremely low “teaser rates”. The selling point was that they could re-finance away the risk, when prices went up further. Instead, the bottom fell out of the market and it caused many personal financial disasters.
The Bottom Line For HARP
HARP is specifically designed to help with mortgage payments; there are no options to withdraw cash from the equity of your home. The program is available to struggling homeowners with Fannie Mae or Freddie Mac backed home loans that were funded before May 31, 2009. Your loan to value ratio must be higher than 80 percent.
It may not be immediately obvious whether your mortgage is actually held by one of these two agencies. Your loan may be serviced by other entities, such as Bank of America and still Fannie Mae or Freddie Mac might be holding it.
The HARP basics are pretty straightforward. The program allows struggling homeowners to refinance on favorable terms that include reduced interest rates. That in turn reduces the payments. If you currently have an adjustable rate mortgage that qualifies, you can use HARP to lock-in a fixed rate.
There are also options with shorter terms that might enable you to build equity more rapidly. Closing costs, which are added to the balance, are lower because in most cases you will not be required to get an appraisal or get loan qualification. Recent improvements to the program have reduced the paperwork, which has cut down the processing times.
This Too Shall Pass With Time And Assistance
The inflated appraisals of the last decade tempted far too many buyers into taking on more than they could ultimately handle or into withdrawing equity that vanished with the market collapse. HARP has been one of the solutions that homeowners trapped in negative equity and high payments can turn to for help. It may not be right for your particular circumstances but if you find your mortgage note is held by one of the two eligible agencies then it could potentially be a lifeline to personal recovery.
Mortgage pre-approval for real estate financing will put you in a much stronger position when you’re hunting for the home you want to live in. By having this important pile of paperwork out of the way you can be confident that sellers and realtors will take you seriously. They’ll see it as a signal that you’re prepared to negotiate in good faith. It’s a launch pad to owning your own home.
The Difference Between Qualified and Officially Qualified
When you’re shopping around for home financing you are likely to hear the terms pre-qualified and pre-approved. The first term gives you a point of reference on how much you can borrow. However, pre-approval says that you’re certified to actually borrow the stated amount from that lender, in writing. Usually, a mortgage pre-approval is good for ninety days. The only thing left is to find a property that you like, and have an appraisal of its value and condition, to receive the go-ahead to fund your new home.
Once you have a letter of approval from one lender it doesn’t mean that you’re bound by their offer. You might still find alternative financing on better terms. What it shows is that you’ve demonstrated you’re really in a position to commit to the home buying process. In the minds of real estate professionals, pre-approval separates the serious buyers from the window shoppers.
Mortgage Pre-Approval Is Two Of Three Keys To Home Ownership
Lenders will be asking two specific questions when you apply for mortgage pre-approval: Are you likely to behave responsibly and do you have the financial capacity to make the payments? You’ll be judged by your behavior, as recorded on your three credit reports. This gives them a pretty good indication of how you’re likely to act over the long term. They’ll pay close attention to your payment history and how you’ve used or abused your borrowing opportunities in the past.
Lenders will then look for evidence that you have the financial capacity to take on the responsibility of a mortgage. They do this by analyzing your income and assets. They’ll be looking to see that you have a stable source of income and that you can meet your monthly obligations.
The Market Starts To Care When You Get Two Thirds Of the Way There
Pre-approval unlocks home financing in principle. To get the loan in practice your lender will have to give an additional approval for the property you intend to purchase, as it’ll be used as collateral to secure the loan. This stage is not part of mortgage pre-approval but it will need to be addressed before they agree to finally lend to you. The most important thing to remember is that you won’t lose a mortgage because you couldn’t get the house but, if you’re not pre-approved, you’re very likely to lose that house that you just fell in love with. Mortgage pre-approval is two thirds of the battle.
Locking In Your Future Payments
When it comes to fixed mortgage basics, the greatest benefit for homebuyers is peace of mind. You get a little bit more of that when you do not have to worry about your payments escalating when interest rates rise. As long as interest rates remain low fixed rate mortgage financing is bound to be very popular. Of course, if and when interest rates rise, anyone who already has a fixed mortgage is going to be feeling pretty good but, as interest rates climb to the peak of the economic roller coaster, fear will drive new buyers out of the market.
The peace of mind you get from fixed mortgages comes from the certainty that the interest payments in your budget for the upcoming year are going to be predictable. Once the rate is locked-in you don’t have to worry that your payments are going to go up, unless you make the choice to pay off some extra principal and reduce the term of your loan.
The Two Terms Of Fixed Mortgages You Need To Know About
As a borrower intent on securing a fixed rate you have one major decision regarding your fixed rate home loan and that is the term of the loan. Fixed mortgages are usually either 15 or 30 years in length. The monthly payments on a thirty-year mortgage will be less expensive but not by as much as you might expect.
The shorter-term, fifteen-year loans have a lower interest rate and if you do choose the longer term it takes a considerable time to accrue any significant equity in your home. The first few years will be taken almost entirely by interest charges, with only a sliver contributing to principal.
Fifteen-year terms do build equity more quickly, however the larger payments they require are often beyond the reach of borrowers unless they are willing to compromise on the value of the home that they buy. Over the long term of monthly payments the thirty-year term is more expensive. The value in the thirty-year fixed rate mortgage is in the monthly affordability and the certainty of the cost, which makes them popular with borrowers. It is the most popular option for FHA insured home loans.
The View From The Other End
Lenders and institutions that invest in mortgages have a different view of fixed rates. The banks charge a little bit extra for the privilege of locking in your rate. From their perspective it is far more preferable to be able to adjust interest rates when interest rates climb higher. That is why fixed rate mortgages will carry slightly higher interest than the adjustable rate alternatives.
The turbulent recent history of the housing market shows clearly that the future is anything but certain. If you assume that tomorrow will be like yesterday and make your choices accordingly recent history has shown that you can end up in trouble. That has been the attitude of prudent borrowers for many years and very often the deciding factor in how they select their home loans.
How The FHA Built A Nation Of Homeowners
If it were not for the Federal Housing Administration (FHA) insured home loan, the United States would be a very different country in which to live. The FHA has been insuring home loans since 1934. Millions of homes have been bought by people who could only do so because this vital program was available. That doesn’t mean that you must be less affluent to take advantage of the program, the majority of American home purchases could potentially be funded with an FHA insured loan.
Is A Government Backed Home Loan The One For You?
Almost anyone who wishes to purchase a primary residence can apply, there is no restriction on income and you don’t need to be a first time buyer. An FHA home loan enables you to make a down payment as low as 3.5 percent, even if you don’t qualify for private mortgage insurance.
In return for this government backing, you pay a one percent up-front mortgage insurance premium, which is added to your loan balance and monthly premiums, which are added to your payments of principal and interest. This might seem to be a penalty but in reality it enables borrowers to finance home purchases when they cannot afford the twenty percent deposit required for a conventional loan.
The types of mortgages that are available with FHA backing are 30 year fixed, 15 year fixed or 5/1 ARM adjustable rates. The program allows you to purchase a single home, condominium or a building of up to four residential units. Condominiums must be FHA approved to qualify. As of 2014, the upper limit for single-family home FHA loans was at least $271,050 and in counties where housing is most expensive up to $729,750.
There are no prepayment penalties on FHA loans but you can’t assign your home loan to a buyer when you sell. In some circumstances you are also able to use funds from an FHA loan to fund home improvement. They also have features that let buyers and sellers negotiate on the choice of who shall pay the fees. Essentially when you qualify for an FHA loan the government is guaranteeing you as a buyer.
Something For Buyers Something For Bankers
The feature that has made them so popular with the industry, as well as the public, is that loans that conform to FHA standards can be transferred from the banks that originated them to institutions and agencies like Fannie Mae and Freddie Mac, which hold onto them as long-term investments. This secondary market provides the economic advantage that lenders can pass on their conforming loans for cash and reinvest in new lending.
This circle of lending helps more buyers to obtain home loans at reasonable rates. FHA backed mortgages have done much to enable homebuyers to qualify to purchase a home more easily. They allow for low down payments and have no pre-payment penalties. FHA insured mortgages have done much to support the culture of homeownership in the United States.
Is The Adjustable Rate Mortgage Just A Fair Weather Financial Friend?
Given the option, homeowners have always tended to prefer fixed interest rates on their home loans, as opposed to adjustable rates. When you’re paying monthly it’s nice to be able to count on the rate always staying the same. It gives you a sense of control. As you might expect, on the other side of the equation, lenders would prefer to have the control to adjust rates periodically, in response to increased interest rates in the market.
Less Now And More Later Maybe
Before you rush to judge adjustable rate mortgages (ARMs), let’s look at some of the features that they bring to the table. As it turns out, there may be times when having an adjustable rate mortgage works to your advantage. It depends on how the economy performs and how the indexes that define interest rates behave, over extended periods of time. Also, it depends on your attitude towards taking chances with your finances.
Ultimately, the Federal Reserve Board sets market interest rates in response to inflation. Lenders are willing to trade a rate that is closer to the current rate, in return for the chance to charge you a higher rate later, if market rates go up.
When you are deciding whether or not to take on an ARM, you need to consider how much of a discount the initial rate is, compared to the market rate for an equivalent fixed rate mortgage. It will tend to be less expensive and the savings from the first fixed period of your ARM must be weighed against the long-term cost that comes after it adjusts.
For example, a 5/1 ARM home loan means that the first adjustment occurs after five years (sixty months) and adjusts annually after that. That will give you five years at a reduced interest rate, so you can build up some equity. Unfortunately ARMs do have risks. If inflation is significantly higher than you expected, when it’s time to adjust, it will wipe out any savings you initially gain from an ARM very quickly.
Almost Limitless Adjustable Rate Combinations And Permutations
This is just one example of the kind of structures that you can have in an ARM. If you think it might be the right choice then be prepared to shop around before you commit yourself to one particular structure. Finally, you need to be very clear about you attitude toward risks. An ARM may look good on paper but ask yourself if the thought of a pending rate change will cause you to lose sleep at night.
The hope on the part of the lenders, and the fear on the part of the borrowers that rates will increase drastically may never come to pass. In which case, it will work out as a savings to the homeowner, who took a chance on an adjustable rate mortgage at the beginning of the term.
Cash-out refinance or a second mortgage can be used for debt consolidation if that becomes necessary. If the monthly payments for your various debts are getting too much for you, and you have equity on your home, it makes sense to use that to pay the debts off. The interest you are paying on loans and other debts is much greater than what you gain with tied up equity.
The question is whether it is better to use a second mortgage or cash-out refinance. The former is a loan taken out using your equity as collateral, while the second involves refinancing your mortgage for a higher amount. This should be sufficient to clear your current mortgage and also pay off your debts. Your monthly payment will increase, but should overall be much less than your old mortgage plus all your debt payments.
Which is Cheaper for Debt Consolidation?
You obviously want to make your choice based upon which debt consolidation option costs you the least. You will be comparing your current monthly payments with those of the refinanced mortgage and the second mortgage, assuming you release the same amount of equity with each. Here are some factors you should consider before making a decision.
Which is cheaper depends to a great extent on the current interest rate compared to the rate of interest when you arranged your first mortgage. If the new mortgage has a lower rate than the existing mortgage, then cash-out refinance will enable you to repay the new mortgage at a lower interest rate than the first. However, because your principal is higher, your overall monthly repayment will be larger.
However, there are factors other than just the interest rate to take into consideration.
Mortgage insurance: Will you have to pay mortgage insurance on the new mortgage? With a second mortgage, the home itself is the collateral so you may not need insurance. Whether or not you have to pay mortgage insurance on the refinanced mortgage will depend on the equity remaining. If you have a good equity, it is unlikely you will be paying insurance now. It will be an additional charge until your equity builds back up to 20% of the loan amount. Even then, you sometimes still have to keep paying it.
When You Sell: How long do you intend living in your home? The longer the better. If you intend moving shortly after consolidating your debts, then a second mortgage might be better for you. You can carry that on to your next home. It costs more upfront to rearrange a mortgage, so you should only do that if you have no plans to move.
Other Factors: The amount you need will be a factor, since the more you borrow the better a lower interest rate will favor you. Your tax situation is also relevant, as are the respective terms of your first and refinanced mortgages.
Benefits of Cash-Out Refinance Vs. Second Mortgage
The main benefits of cash-out refinance are that you have only the one monthly payment to make compared with two for the second mortgage. You will also likely have a lower interest rate, although there is a rate where the two options break even with each other. Generally, the higher your first mortgage rate, the more attractive refinancing becomes.
The main benefit of a second mortgage is that your first mortgage continues unaffected. It also has a fixed interest rate, so you know exactly what you are paying until it has been cleared. If you prefer, you can take your funds as a line of credit, where you pay interest only on what you draw.
If you are considering debt consolidation using your home equity, then these are your two main options. Choosing the better of cash-out refinance or a second mortgage for your situation can be difficult. It is usually a good idea to seek independent advice from a mortgage adviser.
Avoiding foreclosure is not easy, but an FHFA loan modification can help (FHFA is the Federal Housing Finance Agency.) When you are struggling to meet your mortgage repayments it can take a great deal of work to avoid foreclosure and that dreaded eviction day. A recently federal announcement in March regarding a new loan modification program has given many people hope in their attempts to save their home.
The Home Affordable Modification Program (HAMP) has been in existence for some time, and was theoretically able to help mortgagees facing hardship. However, the bureaucracy needed to initiate financial assistance was counter-productive. Those in trouble had to provide documentary evidence of their hardship, and also documentation revealing their income and expenditure and other financial details.
This level of bureaucracy resulted in significant delays, which reduced the appeal and effectiveness of the program to those using it. In many cases the foreclosure was proceeding at a rapid pace while the bureaucratic process was grinding slowly along.
The FHFA Loan Modification Process
The recently announced FHFA loan modification process is friendlier and makes avoiding foreclosure a quicker and less stressful process. There is no need to provide documentary evidence of income, hardship or inability to pay. If that sounds too good to be true, then read on, because it all makes good sense.
First, there are qualifications that limit those able to apply for help under the FHFA loan modification program:
- The mortgages must be backed by Fannie Mae or Freddie Mac.
- You must be at least 90 days but no more than 2 years behind on your mortgage repayments.
- The mortgage must be a first lien – it does not apply to loans backed by your equity.
- The mortgage loan must be at least a year old.
- The amount owed must be a minimum of 80% of the value of the home.
Avoiding Foreclosure Requires Commitment
If you are only a month or two behind with your payments you cannot apply – yet! You must also display an ability to make the revised payments by making three payments by the agreed dates. If you can manage that, then you should be able to meet all your payments in a similar way.
Avoiding foreclosure takes a commitment from you, and if you fail to meet that commitment, foreclosure will naturally follow. Hence the trial period, after which you are on the FHFA program.
The FHFA loan modification program designed to make avoiding foreclose possible to many people begins on 1st July, 2013. It is due to end on August, 2015 but who knows how it may be extended if it proves a success. Those offering mortgages must identify those that are maintaining their payments, and make them a loan modification offer by July 1st, 2013.
How the Loan Modification Works
- Mortgage owners will be offered an interest rate the same or less than their current rate.
- The term will be extended to 40 years. This will significantly reduce monthly repayments.
- Those with negative equity will have no interest applied on up to 30% of the unpaid balance.
- These factors are expected to reduce the average monthly payment by up to 30%.
Avoiding foreclosure is the prime objective, and reducing monthly payments is one way to achieve that. A reduction in the monthly commitment of those defaulting on their monthly repayments is probably one of the best ways to avoid further problems.
The FHFA Loan Modification program does not lower the principal owed, so is fair to lenders while making avoiding foreclosure easier for borrowers with financial difficulties.
Reverse mortgages are forms of equity release. In the USA, they are available to homeowners aged 62 or over who are living in the property concerned as their principal residence. They can borrow money using the equity on their home as collateral. There is generally no fixed period on the loan, which is repaid when they sell their home or pass away. In the latter case, the lender has first call on the value of the home irrespective of any will.
Although reverse mortgages appear to be a good way for elderly people to make use of the equity while they are still alive, there are some potential reverse mortgage problems. In many cases, the elderly are hitting problems, particularly when they use the equity release to pay off other debts. Here are some of these problems.
Some Common Reverse Mortgage Problems
Fixed-Rate Lump Sum Loans: When the equity is taken as a lump sum, the interest is included in the loan. The interest is therefore compounded over time, and you are paying interest on the interest! Not only that, but increasing numbers of people are taking loans based upon their total equity. Should they have a need for emergency cash at a later date, they cannot get it because they have used up all their collateral.
The Problem of Small Lenders: Because most of the large mortgage lenders have stopped offering reverse mortgages, those that are still doing so tend to be smaller firms that are not what are known as ‘depository institutions.’ This means that the borrowers are at a greater with these smaller companies. They do not have the financial strength of the larger lending banks such as Wells Fargo and the Bank of America.
Problems with Younger Borrowers: When borrowers aged 62 or just over use their equity in this way, they have little or no finance available to use during their later years of retirement. A reverse mortgage works best for over 70s who are able to use the cash tied up in their home in the latter years of their life. To use that prior to retirement is to use up all your insurance for a relatively wealthy retirement in your later years: your 80s and 90s!
Aggressive Marketing: Some companies use aggressive marketing tactics to persuade vulnerable elderly people that reverse mortgages are their best option. They stress the cash they will have to spend, but ignore the fact that they are using up all their equity. They will have nothing to leave their children, and no fall-back in the last years of their life. They fail to explain the effect of interest on their equity.
Are Reverse Mortgages Worthwhile?
Yes, reverse mortgages can be worthwhile if used correctly. You should be aware that they are loans and attract interest just like any other loan. This is often forgotten, since the interest is not paid as it accrues, but added to the reducing equity of the property.
You should first discuss a reverse mortgage with your family. If they finally agree that you should go ahead, the next step is to seek professional advice from a mortgage advisor. Your advisor will help you select the best company for the loan, and help you make sure you are leaving sufficient home equity for later use.
Keep in mind that you have other options to a straight home equity loan. An equity line of credit will charge you interest only on what you spend, not on the total amount of credit. There are also programs available for the elderly if you are having trouble paying for your medication or utility bills. A reverse mortgage should be your last resort – not the first.