Archives for July 2008

Being a first time home buyer is an emotional decision. You plan on being in this home for the rest of your life (everybody says that) and starting a family or maybe your single and just want your own place.

You have researched homes and found one in your budget that suits your needs. Now you need to set up your financing.

It does not matter how much you have for a down payment but let’s assume you did yourself a solid and saved up enough to put a 20% down payment to avoid private mortgage insurance (PMI). Congrats.

And lets assume you already called a mortgage company and went through the pre-approval process where they verified your W2’s and bank statements.

Your realtor submits an offer which gets accepted. Its time to set up a closing. But right before you choose a closing date your mortgage banker tells you the 15 year mortgage interest rate is 1% lower than the 30 year you were approved on.

And since we are all conditioned to want the lowest rate you strongly consider it. I’ll do myself to explain why you, the first time home buyer, should stick with the 30 year fixed rate mortgage.

As an example:

$150k Loan

30 Year Payment at 5% = $805

15 Year Payment at 4% = $1109

$1109 – $805 = $304 less a month with the 30 year.

Retirement Accounts – Are you fully funding your 401k, IRA, and Roth IRA? No. Than you definitely have to get the 30 year fixed rate mortgage. Put the extra $304 a month into those accounts and let the compound interest work for you.

If you can fully fund your retirement accounts it’s still a no because…

Home Improvements – Unless you are buying a new construction home you will be updating the house. It’s not a matter of if, it’s a matter of when. It would be best to pay for those in cash instead of going into debt. Home improvements cost way more than $304 but every little bit helps. A new kitchen is $15k to $30k. Bathrooms are $10k to $30k.

Repairs – These are different from home improvements. And if you bought an older home you will have to fix something. Its inevitable. Roofs on a 1500 sq ft home cost $10k. That $304 would look nice now.

Because Houses – You do not understand how much money goes into a house until you buy your first one. You are familiar with paying utility bills in an apartment but your house is twice as large which means double the cost to heat and cool it.

And with a house double the size it means you have to buy double the amount of furniture. You can’t leave rooms empty. All of these add up quickly.

Babies – If you are a first time home buyer than there is a strong chance you are in your twenties or thirties and probably don’t have kids yet. Maybe your first child is on the way and it’s why your buying the house. You do not understand how expensive babies are until you have one.

You’ve heard parents talk about the costs of diapers, formula, clothes, and the biggest one – daycare. The stories are true. Daycare for one kid costs around $1000 a month. Would the extra $304 you’re not paying towards the house help you towards paying for daycare now?

I don’t care if you are single and buying your first house. We all know how fast our lives can change. Maybe you’ll meet someone in the next year, they move in, and then you’re planning your futures together. You have the 30 year fixed rate mortgage with a low payment allowing you some control over where you want the additional money to go.

New Job – With you being young there is a chance a better job comes up forcing you to move. What if you can’t sell the home? You could always rent it. And with the lower payment you might be able to cover the mortgage payment, property taxes, and home owners insurance.

Lost Your Job – Maybe your employer goes out of business nine months after you bought the house. Since you put all of your savings into the downpayment there isn’t much left over to get you through the job search. Wouldn’t it be nice to have the $805 payment versus the $1109?

And Stay In It

Keep the 30 year mortgage for as long as you own the house. The only reason you should want to refinance out of that loan is if interest rates on 30 year loans are now lower that the one you have.

If you have been maxing out your retirement accounts, there are no more home improvements, and there are no babies in the future or you have adjusted to your kids new costs than go ahead and bring some money to closing to pay down the balance.

But take another 30 year mortgage. Why? Because you never know.

Summary

You do not understand how expensive homes really are until you own one. If you are buying your first home you should heavily consider getting a 30 year fixed rate mortgage. Consider the 20% down payment in this scenario your “win”.

But as soon as you get into the home you will see the value in having those couple extra hundred dollars in your hands.

Mortgage companies love it when you tell them you want to escrow your property taxes and homeowners insurance with your mortgage payment. It reassures them that you are paying your property taxes and homeowners insurance every month.

As long as you make your monthly mortgage payment there is nothing for them to worry about. The additional money you pay every month is collected by the mortgage company and put in a escrow account. When your property taxes and homeowners insurance are due, the mortgage company sends a check to your city/county tax office and your insurance company.

Many homeowners find comfort in knowing this is going to be paid on time and its one less thing for them to worry about. The majority of homeowners elect for the escrow account thinking that they are coming out ahead. But are they?

Not really. Think about it this way. You are paying your property taxes and homeowners insurance 6 or 12 months in advance to a company to hold it in their escrow account. What do you think this extra money you pay on top of your mortgage payment is doing? How about earning the mortgage company interest on your money. This is a cash cow for the mortgage company servicing your home loan.

Not only will they know you are up to date with your property taxes and homeowners insurance but their bank accounts are getting fatter with interest you could have been earning. All because you want them to pay your bills.

Most mortgage companies charge .25% ($200,000 loan as example x .25% = $500) for an escrow waiver which is a cost to do business. Sometimes you can negotiate that off. Sometimes not. Its sold to you as being risky for them since they do not know whats going on with your property taxes and homeowners insurance. You should look at it as a way for them to make more money. Wouldn’t they rather you have that $500 in the example above to have to make your tax and insurance payment? No.

You Can Do It

I have made the comment to some to grow up already. If you can write a check to pay your mortgage on time than why can’t you write a check to your county tax office or homeowners insurance company on time.

I know it’s depressing to write a check for a couple thousand dollars to pay your property taxes and homeowners insurance (and it always seems they are due in the middle of summer and around Christmas) but think about how much you are giving up. I’m sure you didn’t buy the home in the first place thinking you could not pay your mortgage. So why go against your thinking to help out the mortgage company more.

Let’s say your yearly property taxes and homeowners insurance are $4,000. This would make your monthly escrow payment $333. If you had a 30 year fixed rate mortgage of $125k at 6% your principal and interest payment would be $750 a month + $333 (escrow)= $1,083.

Now, let’s put that $333 in a savings account or even a S&P 500 Index Fund. If you put the $333 away each month your $4k would earn $120 at 3% in interest. This is for doing nothing but just putting it aside each month. The $120 is almost half of a month of escrow payments which might not sound like a lot but its better than giving the mortgage company the money.

Most S&P 500 Index Funds earn around 7% a year. The $4k at 7% = $280 a year in returns.

If you let the mortgage company escrow your money and they put it in a savings account earning them 3% its like you are paying them 9% interest on your money. The 6% from your 30 year fixed rate mortgage and the 3% they are earning on your money in interest from your escrow. Sucks seeing that. Take your money back and earn some your self.

Puts You In Control

Cash Back – There is a good possibility your homeowners insurance is with the same company you buy car insurance from. And most insurance companies allow you to pay those bills with credit cards. Can it be assumed you have some sort of cash back or airlines credit card? If you escrow, you’re losing out on the cash back or airline miles you could be earning if you paid it on your own.

Most mortgage companies do not let you make mortgage payments with credit cards because they have to pay the fees. They allow you to write checks or do bank withdrawals. Neither which earns credit card rewards.

Discounts – Some county tax offices and homeowners insurance companies offer discounts if you pay ahead of time. If the discount is more than what you could earn in interest in your savings account then the opportunity cost to do so out weighs not doing it. If you asked your mortgage company to do this for you they will not do it and why would they. They will not earn interest on your money and they do not care about paying less taxes with your money. All they need to do is have your check post dated one day before its due. This way they can earn the maximum amount of interest off of your money.

No More Screwing Up Your Escrow – This does not happen a whole lot but occasionally a mortgage company will screw up the escrow account. And if you plan on refinancing your mortgage with a different company than the new one will have to set up a new escrow account.

Whatever money you had in your previous escrow account will be sent to you in a check within 10 days of closing but now the new escrow account needs to collect two months of reserves up front. You will need to come up with this money somehow. If you paid your property taxes and homeowners on your own this would never be an issue.

Dispute Rising Property Taxes & Costs – If your county tax office or homeowners insurance company decide to raise taxes or costs they will send the bill to the mortgage company. In turn, they will adjust your payment (up) accordingly. If you did not escrow you could at least be in a position to dispute those with the tax office or insurance company. Not so with the mortgage company. If you do not pay them they will ding your credit report with a mortgage late.

Summary

If you can set aside money every month to pay your property taxes and homeowners insurance than do so. You will earn interest on your money and have better control of what your money is doing.

You will not have to worry about your mortgage company sending your bill to the wrong office or getting notices that you do not have enough in your escrow account to make the tax bill (it does happen sometimes). Don’t give the mortgage company any more money than you need to.

Never escrow might be a little strong. For a lot of people it comes down to piece of mind. And not getting shocked when the huge summer property tax bill comes in.

At a minimum, you should know what you’re giving up if you choose to escrow your property taxes and homeowners insurance.

If you have bad credit and are trying to get approved on a mortgage to buy a house or to refinance your current mortgage than you may run into a few roadblocks.

You probably understand that already but fear not. There is still a chance you can get approved. I’ll do my best to explain how it can be done.

Mortgage companies have two kinds of loans. A desktop underwritten loan and a manually underwritten loan. Both are similar in their guidelines but one has more restrictions than the other.

Desktop Underwritten (DU) – A system connected to Fannie Mae that would approve or deny your application based on your mortgage application factors such as income, assets, loan to value, and credit score. Each of those factors had a strength value that would be put into consideration when doing your loan.

Your application is sent and returned through the system and an approval or denial is determined in less than a minute. If there was a denial it would say why. In turn it would tell the mortgage banker what they need to tell the client to do for an approval.

Your best hope on getting approved with bad credit scores lies with a desktop underwritten loan. And the best qualifying factor you can have is equity in the home.

Many people think having great credit is the most important factor in getting approved on a mortgage and they are wrong. Its important but not as important as equity (low Loan To Value).

I have seen people with a 585 credit score, collections, credit card debts, and a late mortgage payment get approved on a refinance. Reason being is even after paying the collections and credit cards off they still had 35% equity in the home.

The system determined they were worth lending to even with bad credit scores because if things got tight for the borrowers they would probably sell the house as they had equity or if it went into foreclosure there was enough equity to cover the mortgage.

Same thing with buying a home. If you can put down a lot of money (10% to 20%) then you’ll have a better chance of getting approved if you have bad credit.

Manually Underwritten – This is a loan not backed by Fannie Mae but by investors such as hedge funds and pensions. These loans are tailored for each investor. For a loan to get an approval it has to meet all guidelines, not just a couple. Basically, the mortgage company or bank makes up their own rules without the insurance backing of Fannie Mae.

As an example.

You had to have 720 credit scores, no cash-out, rate/term refinance, no mortgage lates in a year, debt to income ratio below 45%, 6 months worth of assets in accounts, been working for two years straight in the same profession, etc. If the borrower met all these guidelines than they would get approved.

Unfortunately for people with bad credit scores there was little chance of an approval. The lowest credit score I saw available was 620 with a lot of equity in the house.

Many of the manually underwritten loans went away after the housing collapse as there was too much risk. All that really remains for manually underwritten loans is Jumbo Loans (very high loan amounts).

Summary

It is possible to get approved on a mortgage with bad credit scores. Assuming you make enough money to cover the mortgage payment the number one factor in getting approved is if you have equity in the home.

I saw it quite a bit when I was a mortgage banker especially when people were trying to refinance. Things happened after they bought the house which ruined their credit scores. What I saw in those situations was their credit scores went down because of collections, credit card debts, liens, judgements, etc., and after we consolidated those into the new mortgage their credit scores jumped up 100 points four months later. Again, because they had equity in the house.

Buying a home with bad credit was few and far between. Rarely did anyone with under 680 credit scores try to buy a house with 10% or more down. They were all trying to buy with nothing down. And as I stated above, the system does not like that. In most situations it would make sense for them to clean up their credit scores first.

You have figured out by now that getting approved for a refinance with bad credit scores and some equity in the house is going to be easier than buying a house. And it’s because the mortgage company knows that at some point you probably did have good enough credit to get into the house.

If you do not have equity and have bad credit scores than it is going to be tough.

Refinancing your mortgage isn’t something that is hard to do. And why people refinance really comes down to “why” they want to. That’s it.

I’ll do my best to explain the reasons why people refinance their mortgage and some stories I heard from when I was a mortgage banker.

Why?

Lower Interest Rate – This ones easy. Of course you should refinance your mortgage if you can save some money on your payment. In most cases if you can save .5% or more than it makes sense to do so as long as you are comparing the same mortgage (30 year to 30 year).

Lower Payment – Some people may have been in a 15 year mortgage and can no longer make the payments. What they need is to free up cash flow. So they refinance into a 30 year mortgage and see their payment drop in half even with a higher interest rate.

Out Of An ARM To A Fixed – There is something about knowing your monthly payment will never change. Some people liked the thought of having an adjustable rate mortgage in the beginning but like the security of a fixed rate mortgage.

Take Cash Out – Consolidating credit card debt. Home improvements. Dream vacations. College education. Collections. Liens. Property taxes. Income taxes. Buying a rental property. Investments. And anything else somebody would rather finance than pay cash for. They use the equity in their home to consolidate all of these into one payment.

Some may even look to skip refinancing their mortgage and take out a home equity line of credit instead as the closing costs to get one are about $300 compared to the $3k with a 30 year fixed mortgage. Plus, you only pay interest on what you borrow.

Get Someone Off Title – Divorces and separations are another reason. There is only one way to get an ex off title of the home and that is to refinance the entire loan into one persons name. Some people find out they cannot get approved on a new mortgage without their ex’s income. This can be quite the dilemma because one person usually wants to keep the house.

If there is a lot of equity in the home than the spouse that is no longer living there needs to get paid from whatever equity that has been earned. It can be quite messy and some couples are finding out that they still have to live together until the house can be sold.

Clean Up Your Credit – Sometimes people have to refinance their homes to clean up their credit report for a job. Many employers do credit checks on possible candidates. If they see a bunch of collections, judgments, liens, child support payments, foreclosures, and late payments on bills they may not hire you.

A quick fix to this is to refinance your mortgage (if you can) and roll all of those into one payment. Your credit report will still show whatever you had on your report for 10 years but at least now all of it will show as being paid and your credit scores should start climbing up.

And if the mortgage company cannot refinance your mortgage they will at least be able to tell you whats on the credit report for free. The mortgage banker might even send you over a copy of the report. So instead of you paying $25 for a credit report, they pay to have it pulled. Kind of a sneaky way to get your credit report for free.

Legal Issues – It should be noted that if there are collections, liens, judgements, back property taxes, and back income taxes showing up on the credit report that those must be paid before a refinance can close.

In most cases those are all held against your property and if you were ever to sell or refinance again those must be taken care of first. Its a combination of guidelines written by the mortgage companies and the law. The mortgage company wants to be in first lien position on your property and those can be seen as first lien if registered before the new loan.

Summary

Did you know that refinancing a mortgage is relatively new. No one refinanced mortgages from the 1950s to the 1990s. Everybody that bought a home would put a 20%+ down payment on the home. This was a common practice for all banks in that time period because many did not want to have to deal with a home going into foreclosure.

Foreclosing on a home was a term hardly used in those years. People who bought homes had so much money invested in their down payment that they did not want to lose their home. They also had enough money saved up and had money to make the payments.

And interest rates stayed over 10% during those decades giving little benefit to do so. This is double or triple what today’s mortgage rates are at so people had to be able to afford the payment.

Refinancing is here to stay. And whatever your reason is, just make sure it hits all your goals and puts you in a good financial situation.