Despite the government’s best efforts, borrowers still are occasionally puzzled by mortgage rates and pricing. They are not as simple as comparing the price of a gallon of regular unleaded gas. (But when gas companies advertise their additives for higher grades, things become more complicated.) But is there an easy way to discuss rates?
When a borrower shops for a home loan, they want to know about mortgage rates and should look at the “APR” or annual percentage rate. The APR includes both the annual interest rate as well as some — but maybe not all — non-interest charges paid at closing. The APR will be higher than the nominal interest rate because it includes additional costs. Most loan quotes include both the interest rate and discount points (the cost of doing the loan, often considered the up-front compensation to the lender). Points are paid up-front, in cash (or a higher loan amount) at closing. If the borrower expects to be a short-term owner then maybe the loan with a higher rate and fewer points is better; if the borrower expects to be a long-term owner then paying points and having a lower fixed-rate can be very attractive.
Experts and those in the industry usually prefer “par pricing” – par is a price of 100.00 (nothing paid, and nothing to be paid). In this situation all loan quotes show the interest rate with zero points. Now it’s very easy to compare rates. An FHA mortgage at 4.4 percent and an FHA mortgage at 4.6 percent are the same financial product with different costs. Why would you pay more?
So borrowers should ask lenders for a mortgage quote at par; that is, an interest rate with no points. Par pricing remains the easiest way to compare similar loan products, say a conventional loan from ABC Mortgage versus a conventional loan from XYZ Mortgage. The loans are the same, so the only issue is which lender can offer a better price.
With home buying comes a series of decisions, including where to buy, what kind of house, whether to obtain a loan and what are its terms, and so on. One issue that is often overlooked until the end of the transaction is, “Why do I need title insurance?”
Every buyer and seller in a real estate transaction sees charges for a title insurance policy, but few know what the purpose of the policy is, other than something gets insured. Title policies insure that things are what they are supposed to be: in a purchase the title policy is insuring that you are the rightful owner, that no one can come along later and claim ownership of your property. For lenders the title policy insures that their lien has a certain priority on title and that the only liens against title are documented and disclosed. Title insurance covers any title issues that occur up to the date deeds are recorded when the policy is in effect, it does not cover any issues that occur after the transaction.
Title insurance is not cheap, and claims are rare. But when title insurance companies do pay claims, they are usually very hefty, think tens or hundreds of thousands of dollars. Because of this most of the revenue title insurance companies collect do not go to paying claims, in fact the industry average is that only about 5% of premium revenue goes to claims compared with approximately 70% for auto insurance. Title insurance companies spend the bulk of their premium revenue on loss prevention (research).
Claims might be paid if the owner of your current home purchased the property eight years ago from a seller who had a lien against the property that was recorded improperly in the county records and that lender stepped forward to collect on your home and possibly force the sale. Forgeries on deeds, unpaid liens, easements improperly recorded or illegal confiscations of title on the property are problems; bank foreclosures and short-sales can complicate things, as can divorce settlements with a recalcitrant spouse, estate issues, easements, or a private party second from a prior seller.
Title policy premiums pay for all the work done by the title company prior to closing so they can insure the buyer/person refinancing obtains clear title. And if the owner discovers later that they do not have clear title, it is the title insurance company’s obligation to pay to correct any claims that may arise.
In underwriting a home loan, generally the income from a borrower who is an employee (that is paid regularly and who receives a W-2 at the end of each year), is whatever monthly income the employee is making at the time of the loan – including recent raises. Borrowers who are self-employed, however, often feel as though they are being discriminated against when it comes to qualifying for a mortgage. And rightfully so: income used to qualify for a mortgage for a self-employed borrower must be averaged over a 12 – 24 month period.
For sole proprietors, the income that is used to qualify the borrower must come from the bottom line on Schedule C of the federal tax returns. It is called “Net Profit” and is divided by 12 to come up with the monthly qualifying income. The net profit is what is left after the taxpayer deducts all of his expenses from his or her gross income. The more deductions the taxpayer claims, the lower the net profit and the lower the income tax liability; however, it also reduces the purchasing power of the borrower. Underwriters will often say, “A borrower can’t have one set of books for a loan and another set for taxes.”
Since many lenders want to average the self-employed borrower’s income over the last two years of federal tax returns, any increase in profits realized by the borrower from one year to the next is diluted when the sum of two years of net profits must be divided by 24. To top it off, when a self-employed borrower’s income drops significantly from one year to the next, it is the income on the most recent tax returns that is used to qualify the borrower and an explanation as to why their income is dropping is required.
Cash that sits in a business account of a self-employed borrower will generally not be accepted as cash that can be used to cover the down payment or closing costs for a home purchase. Generally borrowers who own 25 percent or more of a partnership, LLC, or corporation must also provide the partnership returns and/or corporate returns for two years – like a self-employed borrower.
There are, however, some programs that are better for self-employed borrowers, and that can be explained by a trained loan officer. Check with your lender!
Any lender knows that credit, collateral, and character are of the utmost importance in the lending decision. Unfortunately for many people of sterling character, in this day of automation and decision making, credit and collateral have more focus on them, and have become purely a numbers game. In fact one of the biggest issues facing homebuyers today is problems with their credit scores. Available loan products and interest rates will vary significantly with a person's credit score, and loan officers spend a fair amount of time working with borrowers to make sure that their credit score are as high as it can be.
Borrowers are told to make their mortgage payment on time and in no event later than the 30th day of the month. Even one 30 day late mortgage in a year can drop a credit score by 40-50 points and make one ineligible for certain mortgage products. Borrowers should not allow their credit card balances to go above 50% of their maximum credit limits, ideally (for credit score purposes) keeping the balances at 25% of the credit limits.
All minor medical bills should be paid once the insurance company has finalized the person’s share of the bill. Disputed charges are often less than $200, but a Collection Account on a credit report can reduce a credit score by 20-100 points.
A borrower, whether it is a purchase or a refinance, should not take out new debt during the mortgage process without speaking with their lender. This includes car loans, credit cards, etc., and also includes co-signing a loan for a friend or relative. (Co-signing, from a legal perspective, is the same as signing.) Nor should they have too many institutions run their credit report as each credit pull will reduce a credit score by about 5 points.
Many people are involved in the home loan process and lending decision, and it is in everyone’s best interest to keep credit scores as high as possible.
It goes without saying that the reason for applying for a home loan is to have it approved by the lender. But for some borrowers that is the most difficult step. Most “in the biz” agree that the lack of preparation through the pre-qualification process is the primary cause of most delays, or problems, in the loan approval process. When being pre-qualified or pre-approved, there are some common areas of questioning that borrowers should be prepared for, regardless of whether or not it is a QM or a non-QM loan: income, assets, and credit.
The first area of questions involves a borrower’s income. Is there overtime pay, commissions, self-employment income, and if so, for how many years? The basic rule on counting overtime and other income for qualifying is that it must be of a constant and continuing nature and applicant must have received for the past two years.
The second area is regarding assets: does the borrower have enough money for a down payment, closing costs, and reserves? Asset documentation, actually deposit of funds documentation is the number one stumbling block to final loan approval and closing. Generally, any deposit that is not part of employment income will need to be documented. Gift funds, sale of a car, lottery winnings, whatever - any deposit in two months of a borrower’s bank statements prior to application will need explanation and documentation.
The third area is credit. Any issues with credit are usually discovered early in the loan process when the credit report is run, at which point, if there are problems, the lender may help the borrower resolve or rehabilitate their credit.
Every loan is different because every borrower is different and brings their own set of issues to the process. The three main components of mortgage approval for an applicant are income, credit and cash, one of the three is usually the limiting aspect of how much a borrower can qualify to purchase. Knowing what the potential problems and weaknesses are in qualifying are key to a successful and smooth loan process.
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