WHAT IS AN ARM LOAN?
The interest rate on an ARM is generally lower during the fixed rate period. Some people choose an ARM because they expect to sell or refinance before the interest rate adjusts. Some people choose an ARM because they expect their income to increase in the future, when they well are better able to pay a higher rate during the adjustable period.
ARMs start an interest rate lower than a fixed-rate mortgage at the same time, but their rates can go up a lot even if general interest rates don’t rise, depending on how the adjustment clauses are written. It is always best to consider what may happen under the worst case scenario. Let’s say you reach the end of the fixed rate period and you lose your job. You can’t sell and move into another house because without a job you won’t qualify for a new loan. And you can’t qualify for a refinance on your current home without a job. Under this scenario you would be forced to make the higher payments. Before choosing an ARM loan it is important to look at the monthly payment if the rate goes up to the loan cap.
WHAT ARE POINTS?
Loan Origination Points: Lighthouse typically does not charge points on a loan, but since they are commonly charged by other lenders, we will discuss them here. A “point” means a percent of the loan amount. One point is one percent, two points is two percent and so on. A two-point charge on a $200,000 loan is $4,000. An origination point is charged by a mortgage broker as a fee for their services.
Loan Discount Points: Here again one point is one percent of the loan amount. Loan discount fees are used to buy down the interest rate of the loan. For example, if the going rate for a 30 year fixed mortgage is 6% without any points, and you wish to buy the rate down to say 5% you can pay “discount points”. The number of points you have to pay depends on the interest rates at the time. In turn for paying an upfront fee, you will get lower monthly payments because you have “bought” a lower interest rate. It may make sense to do this if you intend to stay in the property for a long time. To be certain that this makes sense for you it is best to do a breakeven analysis. At Lighthouse we are happy to do this for you to see if it is in your best interest.
Typical closing costs on a Lighthouse refinance is approximately $2,000.00 with NO points:
Appraisal $385 to $450 range (for a single family home, multi-unit properties are higher)
Underwriting fee: $699 to $800 range
By law you will receive a Good Faith Estimate that details closing costs for your loan within 3 days of applying for a loan.
In some cases (especially in a buyer’s market), a seller may agree to cover some of the closing costs in order to make the loan work.
Sometimes this is done by raising the selling price to compensate. Lenders typically allow 3% to 6% in seller contributions.
Appraisal: This is a written estimate of a property’s current value prepared by a licensed appraiser based on the recent selling prices of similar homes in the area. It tells the lender what the property is worth and assures the both the lender and the buyer that he/she is not over paying for the property.
Closing: The loan papers are signed and money changes hands at a meeting called a “closing”. It usually takes place in the office of the title company that issues the title policy. The title fee also covers the cost of using their office for the closing.
Credit report: This is the fee that covers the expense of pulling the credit report(s). Reports may be pulled several times during the loan process.
Flood certification fee: A fee paid to a Flood Certification company to determine if your property lies in a flood zone. If your property is in a flood zone you will be required to purchase flood insurance.
Recording fee: Whenever property transfers to a different owner (buyer to seller, or lender to lender as in the case of a refinance), the transaction must be recorded with the county in which the property resides. The county fee for recording documents varies from county to county.
Tax service fee: A fee paid to a third party to monitor/handle your tax payments while the mortgage is in effect. This helps to ensure that payments are made on a timely basis and that tax liens do not occur.
Title charges: A title policy is an insurance policy that protects you and the lender if someone comes along after the purchase and claims they had a right to some of the money from the sale. Let’s say you buy a property from someone that you believe is single. After you purchase the property his ex-spouse claims that the property should never have been sold because part of it belonged to her. The title policy will protect you up to the amount of the loan. This is one example of how a title policy protects you. There are many other examples, including tax liens, mechanics liens, property line disputes, etc. Whether you have a refinance or a purchase loan, all mortgage lenders require that you purchase a title policy to protect them. In the case of a purchase loan, the Seller of the property typically purchases and pays for a policy to protect you, the buyer.
Underwriting fee: The process of underwriting a loan application involves verifying that the information on the loan application is accurate, assessing the borrower’s creditworthiness, and determining that the borrower meets the lending criteria for loan approval. This fee covers these services and is paid only if the loan close
Purchase Loans Will Have Higher Closing Costs
No Closing Cost Loans
Capacity. The first C is your Capacity to make monthly mortgage payments, and the likelihood this income will continue. Things like wages, overtime pay, bonuses, commissions, alimony, child support, rental property income, social security, pensions, unemployment, interest and dividend income are considered. Any income that varies, such as overtime pay, is averaged over two years. A minimum two year history in your current job is preferred, but if you have a strong work history in a given profession, it is okay if you are new at a job. Another important factor in qualifying for a loan is “debt-to-income ratio” (DTI). This ratio is determined by adding all your recurring monthly expenses to the proposed new mortgage payment and then dividing it by your gross monthly income. For example if your recurring monthly expenses are $2,000 and your gross monthly income is $5,000 you have a DTI ratio of 40%. Different loan programs allow different DTI ratios, depending on the risk factors of the loan. Generally, allowable DTI ratios are between 36% and 43%.
Cash. The second C is capital or cash. Lenders look at the amount of cash that a borrower has to make sure that it will cover down payment, closing costs and tax/insurance escrow. Lenders also look for “reserves”. They want to know that if something happens to your income, you will have some reserve money available to continue to make your mortgage payments. Lenders typically look for reserves that equal 3 to 6 months of mortgage payments. Capital can be in any form, savings/checking accounts, IRAs, 401Ks, stocks, mutual funds, etc.
Credit. The third C is credit. Your credit report is reviewed to make this determination. Loan programs have minimum credit score requirements. Lenders look at late payments. All late payments will lower your credit score, but mortgage late payments are particularly bad as they may disqualify you from getting a loan even if your credit score is high enough. In addition lenders also look at collections, judgments, public records (e.g. tax liens) and bankruptcy history if applicable. If you don’t have an established credit history it could hinder you, although some lenders allow for alternative credit history, such as how you pay utility bills, auto insurance, cable television, etc.
Collateral. The fourth C is collateral – the property the Bank can take if you are in default on the loan. Appraisal, inspection, a survey, and title research are all used to determine if the property is good collateral for the loan. The lender wants to know if the property could be sold to satisfy the obligation if the borrower were to default.
WHAT AFFECTS THE MORTGAGE INTEREST RATE?
- The amount of equity in your home (e.g. the larger the down payment the less likely you will default)
Other factors may affect your mortgage interest rate, but in a lesser way, such as DTI ratio and whether or not you escrow reserves,
HOW DOES A RATE LOCK WORK?
WHAT COSTS ARE INCLUDED IN A MONTHLY LOAN PAYMENT?
A monthly loan payment is typically made up of four components: PITI, which stands for Principal, Interest, Taxes and Insurance.
1. Principal and Interest. This is the loan amount with interest, amortized over the number of years of the loan (typically thirty).
2. Taxes. These are the annual real estate taxes for the property divided by 12 months.
3. Insurance. This is the amount of the annual hazard insurance divided by 12 months.
If you have less than 20% equity in your property you will be required to pay some form of Private Mortgage Insurance (PMI). This is included in your monthly mortgage payment.
If your property is a condo or townhouse, you will also pay a monthly homeowners association (HOA) fee. You pay it directly to the association, not the lender. The association fee is set by the association and will increase as time go on.
The more down payment a buyer puts into a purchase, the less likely he is to default on the loan. To reduce the lender’s risk when the down payment is lower than 20%, the borrower usually compensates the lender for the added risk by buying a Private Mortgage Insurance (PMI) insurance policy.
There are several methods that can be used to reduce the lender’s risk when the down payment is less than 20%. The lender will decide which ones you are eligible for, depending on your credit worthiness:
1. Traditional PMI. An additional amount is added to your monthly payment for PMI.
2. Lender Paid PMI. In this type of loan the lender pays the PMI for you, and you are charged a higher interest rate.
3. Financed Single Premium PMI. You pay the lender for the PMI in one lump sum at closing. No PMI payments are added to your monthly payments. The single premium can be financed within the mortgage.
Each method has it advantages and disadvantages, depending on the amount of your down payment and the time you expect to own the house. We will explain the differences to you if you have less than a 20% down payment.