Arms, Not a Good Idea

With mortgage rates as low as they are at the moment, you may be looking beyond fixed-rate options if you’re in the market to purchase a home or refinance your existing loan.
After all, while 30-year fixed mortgage rates are hovering around 4%, some 5/1 adjustable-rate mortgages are in the 2% range. This can certainly push your monthly mortgage payment lower.
And the interest rate on a 5/1 ARM is fixed for the first five years before becoming annually adjustable, so there’s relative safety there if you don’t plan on sticking around for long.
Let’s look at a quick example to illustrate:
30-year fixed @ 4%: $1432.25
5/1 ARM @ 2.75%: $1224.72
On a $300,000 loan amount, the difference in monthly mortgage payment is roughly $200 a month. Over five years, that’s $12,000.
Not an incidental amount by any stretch, but there has to be a catch, right?

Well, we’re in a unique spot at the moment. Mortgage rates are pretty much in unprecedented territory.
They’re not rock-bottom, as they’ve risen in the past few weeks, but they’re still at lows not seen pretty much ever in our lifetimes.
Mortgage Rates Have Nowhere To Go But Up
Unfortunately, the general consensus is that mortgage rates have nowhere to go but up. That’s pretty much not debatable, but the big question is when?
They could rise quite quickly if the economy gets back on track, which is a must eventually, right?
So if you reside in a home that you plan on living in for the foreseeable future, gambling on an ARM right now may burn you in the future.
Sure, you may save money over the next 5+ years, but after that, you may find that mortgage rates have surged.
At that point, when your ARM is set for its first adjustment, it will adjust higher. And potentially a lot higher.
Don’t Choose an ARM If You Can’t Handle the Higher Payment
If you can’t handle that interest rate uncertainty, and don’t know if you’ll be selling before the adjustable period ends, an ARM isn’t a good choice right now.
Once interest rates rise, you’ll be stuck with a larger payment, or forced to refinance to stop the bleeding.
And even refinancing may be out of the question if you’ve got income restraints (debt-to-income ratio).
Think of it this way. At the moment, affordability is a lot higher because interest rates are really low and home prices have fallen from their highs.
In the future, assuming both home prices and interest rates rise, you may not qualify for a new mortgage. So you’ll be stuck with what you’ve got.
Would you rather be stuck in an ARM that’s constantly rising, or a fixed mortgage in the low 4% range?

What is a Lender credit?

Mortgage Q&A: “What is a lender credit?”
Back before the mortgage crisis reared its ugly head, it was quite common for loan officers and mortgage brokers to get paid twice for originating a single loan.
They could charge the borrower directly, via mortgage points, while also receiving compensation from the issuing mortgage lender, via yield spread premium.
Clearly this didn’t sit well with regulators, so in light of this perceived injustice to borrowers, changes were made that essentially limited a loan originator to getting just one form of compensation.
Borrower or Lender Compensation?
Now loan originators must choose between borrower or lender compensation, with many opting for lender compensation as a means to keep a borrower’s out-of-pocket costs low.
With lender paid compensation, a lender essentially provides a loan originator with “X” percent of the loan amount as commission.
So a mortgage broker may receive 2% of the loan amount from the lender for funding the loan. However, in doing so, they are sticking the borrower with a higher mortgage rate. This is the tradeoff.
In other words, a mortgage with lender-paid compensation will come with a higher-than-market interest rate, all other things being equal.
Quick example of a lender credit:
Loan type: 30-year fixed
Par rate: 3.5%
Offered rate: 4%
As you can see, in this scenario the borrower actually qualifies for a par mortgage rate of 3.5%. However, they are offered a rate of 4%, which allows the loan originator to get paid for handling the loan.
The loan originator’s lender-paid compensation may have pushed the interest rate to 3.75%, but there are still closing costs to consider. They may bump the interest rate up to 4%, using a “lender credit,” to cover those costs so the borrower can refinance for “free.” This is known as a no closing cost loan.
In other words, the loan originator increases the interest rate twice. Once for their commission, and a second time to cover closing costs.
On the Good Faith Estimate, you should see a line detailing the lender credit that says, “this credit reduces your settlement charges.” It’s a shame it doesn’t also say that it “increases your rate.” But what can you do…
The obvious benefit is avoiding out-of-pocket expenses, which is important if a borrower doesn’t have a lot of extra cash on hand, or simply doesn’t want to spend it on refinancing their mortgage.
It also makes sense if the interest rate is pretty similar to one where the borrower must pay both the closing costs and commission.
For instance, there may be a situation where the mortgage rate is 3.5% with the borrower paying all the closing costs and commission, as opposed to 3.75% with all fees paid and the borrower receiving a lender credit.
That’s a relatively small difference in rate, and the upfront closing costs for taking on the slightly lower rate wouldn’t be recouped for years.
In the case of borrower paid compensation, the borrower pays all closing costs as well as the loan originator’s commission.
The benefit here is that the borrower can secure the lowest possible interest rate, but it means they must pay out-of-pocket to obtain it.
They can still offset some of the out-of-pocket expense with a lender credit, but that will come with a higher interest rate, so it’s somewhat counter-intuitive. And the credit can’t be used to cover loan originator compensation. But do the math to see if it’ll save you some money over lender-paid compensation.
Which is the Better Deal?
Generally, if you plan to stay in the home (and with the mortgage) for a long period of time, it’s okay to pay for a lower rate. You could save a ton in interest long-term.
But if you plan to move or refinance in a relatively short period of time, a loan with a lender credit may be the best deal.
You won’t have to pay much (if anything) for taking out the loan, and you’ll only be stuck with a slightly higher mortgage payment.
As always, be sure to compare both options to determine which is the best deal (yes, you need a calculator).
There will be cases when a loan with the lender credit is the better deal, and vice versa. So shop around! You should be able to find a competitive rate with a lender credit.

FHA vs Conventional

Our latest mortgage match-up pits FHA loans against conventional loans, both of which are popular options for homeowners these days.
In recent years, FHA loans have surged in popularity, largely because subprime lending (and Alt-A) was all but extinguished as a result of the ongoing mortgage crisis.
Some even claim FHA loans are the “new subprime,” mainly because of the low down payment and credit score requirements, despite originally being designed for low and moderate-income borrowers.
But you don’t have to be a subprime borrower to take advantage of an FHA loan.
FHA Loans Are a Great Low Down Payment Option
As noted, these government-backed home loans have become insanely popular. The main selling point of an FHA loan is the 3.5% minimum down payment requirement.
However, in order to qualify for the flagship low down payment option, you need a minimum credit score of 580.
And 580 is just the FHA’s guideline – individual banks and mortgage lenders still need to agree to offer such loans.
So there’s a decent chance you’ll need an even higher credit score. Of course, a 580 credit score is pretty dismal…
[How to get a mortgage with a low credit score.]
FHA Loans Good for Those with Poor Credit
The other major selling point to an FHA loan is that the minimum credit score is 500. Again, this is subject to lenders actually offering programs for scores this low. And scores between 500 and 579 require a minimum down payment of 10%.
But FHA loans can be a good option for those with poor credit who are determined to get a mortgage.
Another benefit to going with an FHA loan is the higher loan limit, which is as high as $729,750. This can be a real lifesaver for those living in high-cost regions of the country.
Meanwhile, conventional conforming loans backed by Fannie Mae and Freddie Mac are capped at $625,500. Anything above that is considered a jumbo loan, and will come with a higher mortgage rate.
FHA Loans Subject to Mortgage Insurance
We’ve talked about some benefits of FHA loans, but there are drawbacks as well.
The major one is the mortgage insurance requirement. Those who opt for FHA loans are subject to both upfront and annual mortgage insurance premiums.
The upfront mortgage insurance requirement is unavoidable, and the annual premium can only be avoided if you have 22 percent or more home equity and a loan term of 15 years or less.
All other borrowers must pay the annual mortgage insurance premium for a minimum of five years, which will clearly increase the cost of the mortgage.
[Note that FHA insurance premiums are also slated to increase!]
Keep in mind that FHA loan offerings are pretty basic. They offer both purchase money mortgages and refinance loans, but the choices are slim.

Should you Refi?

If you don’t mind, let me beat a dead horse.
Mortgage rates are at or near record lows and you could save a ton of money by refinancing.
There. I won’t say it again because I know how cliché and annoying it is to talk about how much money you can save by doing “X.”
The funny thing is I tell my family the same exact thing, though they don’t bother looking into refinancing either.
They bring it up to me here and there, but don’t do much beyond that.
And you can only tell someone something so many times before you give up.
Perhaps this explains why there are millions of homeowners out there with mortgage rates well above current rates that are indeed “refinance able.”
Don’t Have the Time to Refinance?
But for some reason, they haven’t bothered looking into a refinance. Maybe they don’t have any spare time to do so? Or it could be that the task is seemingly so daunting that they avoid it altogether.
Or maybe they don’t want to deal with a shady mortgage lender or a crusty mortgage broker?
The reasons are probably endless, but it still blows my mind that more homeowners don’t take action, considering “how much money you can save!”
It could just be that it sounds so darn “sleazy” to refinance, given all the negative attention the mortgage industry has received over the past five years.
So, how many homeowners are actually missing out?
Well, a couple months back a company named Core Logic noted that twenty million borrowers with positive equity, or 53 percent of all “above-water borrowers,” had above market mortgage rates.
They defined an above market mortgage rate as 5.1 percent (or higher), which is more than a percentage point above current rates for the popular 30-year fixed-rate mortgage.
Pretty surprising, no? I thought the number was high, considering all the news about the “record low rates” that seems to permeate the airways.
But no, many of us still don’t bother, and instead continue making inflated monthly mortgage payments.
All that said, it doesn’t make sense for everyone to refinance all the time. Like anything else in the world, it can be good or bad, depending on your unique financial situation and future plans.

Low like the Lowest ever Low

The ratio of mortgage payment to median family income is the lowest on record, according to a new report from Fiserv.

The company noted that purchase mortgage payments now account for just 13 percent of monthly median family income nationwide, which is the lowest figure since 1971, when data first started being collected.

In Las Vegas, the ratio has fallen to 11 percent from 32 percent!

Back in the first quarter of 2006, when mortgage lending moved at a frenzied pace and home prices only moved in one direction, the national number was 23 percent.

In areas where home prices exploded upwards, the number was probably beyond 50 percent, forcing many borrowers to go with teaser rates tied to option arms while simultaneously stating their income.

That explains why just a year or so later we experienced the worst housing bust ever.
Families Spending Less on the Mortgage

Nowadays, families are throwing a lot less of their income towards their housing payment each month, thanks to the near-record low mortgage rates and the reduced home prices.

Still, there are few buyers out there, evidenced by the continued weakness in purchase-money mortgage applications and faltering home prices.

The big issue continues to be consumer confidence, which has risen and fallen as new economic dramas unfold on a seemingly daily basis.

Until that business is resolved and the job market improves, it is expected that home sales (and prices) will remain flat.

Meanwhile, mortgage underwriting standards are a lot tougher than they had been during the boom, making it difficult for many to take advantage.

Then there are the millions stuck in their current properties thanks to issues like negative equity.
First-Time Homebuyers Rejoice

Unfortunately, this means many people aren’t able to benefit from this somewhat unprecedented situation, namely those with underwater mortgages.

But first-time homebuyers have the opportunity to get in on the cheap and position themselves much better than existing homeowners.

After all, if you buy now for say $200,000 and your neighbor (who isn’t going to walk away) owes $400,000 for a similar property, you’re looking pretty good.

That’s right. The current homeowner is banking on you, the new buyer, to buoy the housing market and get them back in the black. Assuming that happens you’ll experience some kick-butt appreciation.

Just be patient; it may take a while. Fiserv expects home prices to decline 3.6 percent into mid-2012 before rising 2.4 percent in the second half of 2012 through the first half of 2013.

Cash Out?

The number of homeowners who refinanced with "cash out" continued to decline in the third quarter according to information released on Monday by Freddie Mac. Eighty-two percent of borrowers who refinanced their mortgages during the period either maintained about the same loan amount or lowered their mortgage balance by bringing money to the table. During the second quarter 77 percent of refinances fell into this category.

Of those who refinanced, 44 percent maintained approximately the same loan amount and 37 percent reduced the principal balance. Eighteen percent of refinancing homeowners increased their loan by more than 5 percent, Freddie Mac's definition of cash out. Over the period from 1985 to 2010 the average percentage of cash out refinances was 46 percent.

Homeowners took an estimated $5.3 billion in equity out of their homes. This was the lowest amount of equity removed from the system since the third quarter of 1995 and was substantially below the $6.3 billion cashed out in the second quarter. In the peak year for cash out refinancing volume (Q2 2006) there was $83.7 billion refinanced out of home mortgages.

Homeowners had a median rate reduction through refinancing a 30-year fixed-rate mortgage of about 1.2 percentage points or a 22 percent improvement in their rate, saving them about $2,500 over the first five years of a new $200,000 loan. The median rate reduction in the second quarter was 1 percent.

Freddie Mac's figures indicate that the borrowers who refinanced in the third quarter owned homes that had lost a median of 7 percent in value over the median of 5 years that the old mortgage had been in place. As Freddie Mac's House Price Index shows about a 25 percent decline in its U.S. series between September 2006 and September 2001, appraisals that these homes had either held their value better than the average home or had benefitted from value-enhancing improvements

7 ways to hear Not right now

With mortgage rates so low, just about everyone and their mother has at least inquired about refinancing.
Unfortunately, a lot of current homeowners are finding that they don’t qualify for one reason or another.
That said, let’s explore some common reasons why you may be denied that precious refinance. And don’t fret, I’ll also offer solutions.
Lack of Equity/ LTV Restraints
Perhaps the most common reason for denial nowadays is a lack home equity, which translates to a loan-to-value ratio well above what’s acceptable.
For example, a great number of homeowners took out interest-only home loans and option-arms during the housing boom because home prices were only going in one direction. Up.
But once things took a turn for the worse, many of those homeowners had little, no, or even negative equity as a result.
Even those who opted for traditional fixed-rate mortgages may have sapped their home equity by cash-out refinancing repeatedly. Regardless, many of these homeowners will find that they don’t qualify for a traditional refinance thanks to their inflated LTV.
Solution: There are a few government-backed programs, as well as lender-based programs out there at the moment that deal with high LTVs. The most popular is HARP, and soon HARP 2.0 will be released, which has no LTV ceiling. Inquire with your loan servicer or any other lender/broker for details.
Loan Amount Too Big
What if your loan amount falls into the jumbo realm, and you don’t have the special qualities, such as an excellent credit score and a low LTV to qualify? This could make it difficult to get that low rate, let alone a refinance to begin with.
Jumbo loans are a lot more restrictive and come with higher interest rates than their conforming loan brethren. So expect more scrutiny if your loan amount is bigger than most.
Solution: Make it a cash-in refinance by bringing money in at closing to get the loan amount down below the conforming limit. This could also lower your LTV and land you with a lower interest rate! Just make sure you actually want to stay in the house for the long-haul.
Credit Score Too Low
Another common refinance roadblock is a less-than-perfect credit score. And by less-than-perfect, I mean crappy. If your credit score isn’t where it should be, there’s a good chance you won’t get approved for your refinance.
Credit scores below 620 are typically considered “subprime,” and will make qualification difficult, especially at high LTVs. Basically the combination of a low credit score and high LTV is a huge risk for a mortgage lender to take, especially in today’s market.
Solution: There are still options for those with low credit scores, such as FHA loans. You just need to shop around more to find them or enlist a mortgage broker to do the legwork for you. Either way, understand that the mortgage rate you see advertised on TV won’t be the one you receive. So you may want to work on ways to actually improve your credit score before you apply.
Insufficient Income
Another refinance killer is insufficient income. If your income isn’t as high as you said it was when you first got your mortgage during the boom (stated income loan), you may be in for a surprise this time around.
And supplying your actual income to the mortgage underwriter could be a rude awakening, even with the low mortgage rates on offer. If you aren’t able to squeeze below the maximum debt-to-income ratio limit, you’ll be denied.
Solution: While making more money is likely out of the question, adding a co-borrower could help you qualify. Or paying off existing debt. You can also shop around to find a lender with more forgiving limits.
Spotty Job History
This is a biggie, considering how bad the unemployment picture has become in recent years.
If you can’t prove that you’ve been steadily employed, typically for the past two years in a row, the underwriter may deny your refinance application, even if you make plenty and have loads of assets in the bank.
Solution: If you lost your job and resumed working, an underwriter may consider your application if you can document that your income is stable, predictable, and likely to continue. You can also consider a co-borrower for help qualifying.
Absence of Assets
Another toughie is asset documentation, especially with that nagging unemployment situation mentioned above.
If you don’t have sufficient, seasoned asset reserves to show the underwriter you’ll actually be able to make your monthly mortgage payments, you may be denied that refinance.
So it’s very important to put money away early and often into a verifiable account. Your mattress isn’t verifiable…checking and savings accounts, stocks, bonds, retirement accounts, etc. are.
Solution: Even if you don’t have the necessary assets, asking a friend or family member for a short-term loan could work. Just move the money into your own account several months before applying for the refinance to avoid getting the third degree from your lender.
You Listed Your Home
If you happened to list your home for sale, then quickly realized no one was interested, you may now be pondering a refinance. Unfortunately, your prospective lender probably won’t be too thrilled about it, considering the fact that you may sell again if given the chance and prepay your new loan. You may also run into problems when it comes time to appraise the property if it wasn’t selling at your asking price.
Solution: Call around and see which bank or lender doesn’t mind that the home is/was listed. Then remove the listing before you apply to ensure there aren’t any complications. And be prepared to write a letter or explanation regarding the “change of heart.”
In closing, these are just a few of the many, many ways you may be denied a refinance. This isn’t 2006. It’s 2011. And times have changed considerably.
Believe it or not, you actually need to qualify for mortgages these days. So do your homework and tie up any loose ends early on to avoid problems during the loan process.