What Have You Heard?

You can't turn on the TV or Radio today without hearing something about the housing market, home mortgages, rising rates, the bond market, interest only loans, adjustable rate mortgages (ARMs), Option ARMs, increases in the Prime Rate, Mr. Greenspan, the "Conundrum," rate inversions, etc., etc. ...

It's scary times for both the uninformed as well as the informed! "Interest Only loans are a recipe for disaster." "Always get a fixed rate mortgage!" "Stay away from ARMs! They're nothing but trouble." "Get a cheap rate!" "Never pay points!" "Finance those closing costs!" "Never finance closing costs." Everyone is an expert. I love the infamous: "They say..." Well, who the hell are "they!" We are all victims of the electronic age. Everyone is an expert. Everyone is correct. Everyone is wrong.

STOP! If you're going in for heart surgery, do you ask the kid at the car wash or your neighbor or your best friend for their advice? Not unless, they are a heart surgeon, or at least part of the medical industry. Financing your house can be just as complicated as open heart surgery and the results can be just as unpredictable if you are unprepared. Let's see if we can shed some light on the realities of mortgage financing.

What's Your Financial Mindset?

• Are you spontaneous? I LOVE that house! Let's get it.
• Are you hesitant? I LOVE that house, but can we really afford it?
• Are you analytical? I LOVE that house, but what are the comprable values for this area? Who offers the best financing?

In today's market. you MUST have a little of all of these mindsets. Don't rush into a contract simply because you'll do whatever it takes to acquire your potential new home. Do your homework! What are the area home values? What area services are important to you? How much will you need to put down? What can you really afford? You need a larger house, but do you need more income or a larger payment? There are so many financing programs, which is right for you? What should you do?

1. Before you even think of looking for a house, understand your current finances. Determine for yourself what your monthly debt to income (DTI) is. That should be easy to determine. What's your monthly income? What's your monthly cash out for debt (credit cards, auto loans, personal loans, mortgages, department stores, gas cards, etc.). Divide your cash out by your income. If the result is a ratio of higher than 55%, you have some challenges that you will need to address first! Your DTI ratio should be less than 45%; preferably below 40%. Do not include utilities, groceries, or day to day expenses. Concentrate on your debt only in this calculation.
2. Determine what your credit rating is. You can get this by going to www.myfico.com or to request a copy, contact the credit reporting agencies directly: (remember, you're looking for the mid score of the three agencies - that's the key number that most institutions use)
   
   - Equifax: (800) 685-1111, www.equifax.com  
   - Experian (formerly TRW): (888) 397-3742, www.experian.com  
   - TransUnion: (800) 888-4213, www.transunion.com 
3. What's your monthly budget look like? Are you paying rent? Do you currently own a home? Can your income accomodate a higher living expense? If you're renting or leasing, don't forget to include your new living costs: Property taxes, property insurance, utilities, services, etc. It isn't always as simple as trading one rent or mortgage for another. You must look at it realistically with your eyes wide open. How do you determine what these costs might be? Ask your realtor. Go on the internet and look at such sites as www.realtor.com - this is an excellent resource for finding out the cost of taxes, maintenance, insurance, etc. Ask your realtor for access to their site or for estimates of this type of expense.
4. Determine what is important to you as far as the amenities of the house, both inside and out. What services are important to you in the general area? What do comprable homes go for in this general area? It's one thing to listen to your "heart," but this is the largest type of transaction you will typically do in a lifetime. You need to look at it from a business or financial standpoint. If you do this, you will get what you want.

What are Those Hidden Costs?

If you are doing your homework, there should be no "hidden" casts. Take a look at the section on this web-site that discusses "Closing Costs!" Understand what they are and how they might apply to you. If you have a question at anytime, you must ask it! Don't for one minute think that "I'll figure it out." You will not. ASK THE QUESTION! Look at the section provided on this web-site that discusses "the Types of Loans." Understand how they work. I've sat through so many closings where not a single question was asked. People just signed on the dotted line. Let this be your mantra: "I will not be afraid. If I do not understand, I'll ask the question. I'll continue to ask questions, until it's straight in my mind." Ask for it in writing. Ask them to point out where in the contract this subject is discussed. Do this, and you will not be surprised! The best resource for getting the proper information is your Mortgage Loan Officer, if they don't have the answer off the top of their head, they sould be more than willing to get you the proper answer. At your closing, ask the lawyer who handles your paperwork. They are there to provide answers in layman terms. Use them. I'm sorry to belabor this issue, but so many people are just complacent enough to "let it go." Like lemmings, they simply run over the edge and into the abyss. Have the presence of mind to STOP, LOOK and LISTEN! Want to understand the various costs involved with mortgage financing? Give me a call - I'll give you the answers.

Let's discuss in general several types of loans and what to anticipate:

FRM: Fixed Rate Mortgages

This is the type of mortgage that your mom and dad always had. It has a fixed rate, a fixed term, a fixed monthly payment for the length of the term. Typically, the principal and total interest due for the length of the loan are calculated in advance of the closing. The total interest and principal are added together to give you the total cost of your loan. This one figure is then divided by 360 (or the number of months in your loan term), giving you your monthly payment. The interest amount is then front loaded. This means that you will pay much more interest on the front end of your loan than on the back end of the loan. Take a 30-year loan. How much principal do you think will be paid off after 15 years? You would like to think the number is 50%, but it is much closer to 25%. Hey, banks are in the business of making money.

The average life of a loan is 3-5 years depending upon who you talk to. At times, it appears to be much closer to 3 than 5. That means that a 30-year loan will never reach maturity. It will be either rewritten or paid off within 3-5 years. If everything was equal, the bank would lose a great deal of interest because the loan was paid off early. Therefore, the interest is front loaded so that the bank receives a larger portion of the interest before the loan is terminated.

The Neverending Search for New Products and Services

Over the past 20 years there have been incredible changes in the mortgage lending arena, and it continues to evolve. Right or wrong, the lending institutions often create a loan product designed specifically for a target consumer profile, whether it be for first time buyers, new home buyers, refinancers, renovators, builders, investors or whomever. Each product is designed and focused on a given group to offer them the most reasonable terms and conditions to meet their individual needs. Then, over time, aggressive loan marketeers figure out that if they tweaked this and changed that, they could offer the loan to a larger audience. This isn't just a lender trait, any company offering consumer products and services will over time add, change or delete features of their product to either meet new customer demands or widen the product appeal. Often the original target audience gets lost in the shuffle.

ARM: Adjustable Rate Mortgages

These loans were originally designed to offer an alternative to consumers seeking lower payments and interest rates. They offer lower starting rates and payments and then gradually increase both over the term of the loan. New home buyers, credit challenged owners, and investors loved these loans, because it gave them the chance to get lower payments, and grow into the higher payments over time. It's easy to forget that your monthly payments will grow larger in the very near future. If folks don't understand this upfront or fail to plan for the increases down the line, it can easily become a rude awakening. (PLEASE NOTE: ARM's can work for you or against you. If rates are rising, your payments will go up. If rates are falling, your payments will go down)

The interest rates on these mortgages change periodically resulting in fluxuating monthly payments. Typically, they have a short period where the rate is fixed (1 year, 3 years, 5 years, 7 years, and 10 years). During that period, your monthly payment will remain fixed. Once the period expires, the rate can be changed, either up or down, based upon some market index and a fixed margin. Will it be a lot? Could be, especially if you have a strained budget. Once the rate starts changing, it will continue to do so until the loan is paid off. This can happen monthly, quarterly, semi-annually, annually or periodically as defined by your original mortgage note.

These loans are cognizant of the potential for financial disaster and try to combat that risk with control limits for the amount of change in any given period. There are limits as to how much your rate can change in any given change period. There are limits as to how much your rate can go up or down over the life of the loan. These limits are product and lender specific. Understand them before signing your contract. Do not hesitate to ask the question!

Payment Option ARMs

These are varients of the adjustable rate mortgage. The underlying mortgage note rate continues to adjust the same as the ARM. The difference is that every month the owner is given several options on making a qualified monthly payment. Typical options are Interest Only, 30-year amortization and 15-year amortization. With these options, your interest obligation is paid in full for any given payment period. 30 and 15-year amortization, means that you will make a payment as if your loan term were 30 or 15 years. The smallest payment with respect to these options is the Interest Only. The 30 and 15-year amortizations will include both principal and interest. The 30-year payment will be less than the 15-year payment.

There is one more option available on these loans, and that is the MINIMUM Payment. This is the lowest possible amount necessary to qualify for a monthly payment. Unless you know exactly what you are doing, it is recommended that you not use this payment very often. The payment is calculated at a fixed 30-year rate that is typically very low. Today's rates vary from 1% to 1.75%. This is a special rate used to determine your MINIMUM payment only. It is NOT the rate at which your loan is accruing. The underlying loan rate follows the standard ARM calculations where the rate is determined from adding a fixed margin amount to an averaged index amount. It WILL normally be larger than the introduction rate used to calculate your MINIMUM payment. The difference between an Interest Only Payment (Based upon the Loan Rate) and the MINIMUM Payment (Based upon the introduction Payment Rate) is called Deferred Interest. Get out the garlic and the crosses, because the bloodsucker has arrived! Deferred Interest is also known as Negative Amortization. Each month if you use the minimum payment, you are creating deferred interest. This interest is added onto your principal creating a situation where your principal balance is growing rather than reducing. This is not unlike a credit card. For the average consumer this is NOT a very good deal. However, it's the middle of winter and your furnace decided to die. You've got to replace it immediately and you need to divert money from your monthly budget to cover the costs. Use the minimum payment to give you emergency relief, but make up the deferred interest later in the year.  Nice to have, clean and no real damage.

Are there any good times to use this minimum payment to your best advantage? Yes! Let's say you've been transferred to another psoition in another city. You need to sell and move. It would be helpful to have additional cash available to facilitate the move. Using the minimum payment allows you to have the extra cash. The deferred interest will be picked up by the bank at your future closing with the new owner. No real damage! You're laid off unexpectedly. You need to lower your monthly cash flow to accomodate an emergency situation - for a short period of time, there will be no damage.

Investors love this type of loan. Their focus is on reducing their costs so that the difference between costs and rental income, create a stronger cash flow. They really don't care whether the interest is deferred or not. If the investor is in the business of renovating and then, reselling - this is the perfect loan to minimize their costs during the renovation. Again, the deferred interest is captured at the closing with the new buyer. No real damage.

You want to renovate your home, add a room, refinish the cellar, convert the attic, use the minimum payment during the time of renovation. It will create deferred interest, but what you are doing to your house will far outweigh the interest by significantly increasing equity and value in your house.

There are many more instances that support the use of the minimum payment, but the message here is to simply use restraint and planning when applying the minimum payment. Make it work for you, not against you. Want to explore what's best for you, give me a call today.

The Interest Only Revolution

About one third of the mortgages written today are Interest Only loans. Like the payment option ARM, it was designed to provide lower payments to the buyer on the front end. Basically "buying" the consumer time until their income levels reach a higher level that allows them to support higher payments. Interest Only applies for a contracted amount of time (usually 1, 3, 5, 7 or 10 years). At the end of the interest only period the loan is recast to generate payments that will cover both interest and principal for the REMAINING period of the loan. If you were to acquire a 30-year note with the first 10 years as interest only, the beginning of the 11th year will increase your payments significantly. Your loan will payoff in 30 years, whether you like it or not. In the 11th year, your note is recast into a 20-year mortgage and you will begin making payments as if your original note was written for 20-years. Remember, your first 10 years included no principal payments - it will be time to begin paying against principal in that 11th year.

Interest Only loans are available for both fixed rate mortgages as well as adjustable rate mortgages. Is it right for you? Give me a call; we'll determine the options together.

Is it Trust or Risk Management?

It's the old round peg in a square hole dilemma. 20 years ago, if your financial profile didn't fit the rules and regulations for a defined mortgage loan product, you would be summarily declined credit. Decisions were made by loan committees, and unless you had someone to champion your cause, you would be declined. It was a judgement call. If you were close but not right on for their defined loan limits, forget it. It was strick interpretation of the rules and regulations.

Fast forward 20 years into the world of technology, computer driven decision processing and the emergence of the FICO score. Trust it ain't! Risk Management? You betcha! Statistical models rule the decision making process. But computers are literal, not figurative. How does one address a black and white situation with a gray prospect? Easy, lie!

Stated Income, Stated Assets, Low Documentation, No Docuementation, Verified Employment, Verified Assets, etc. Isn't that cheating or lying? No, it's a means to an end based upon risk management. The higher your FICO score, the lower the risk in doing business with you. If your FICO score is above 720 or 740, you're going to receive carte blanche treatment. Your application will fly through "the system," and you'll have your financing in the shortest amount of time. What if your financial profile doesn't fit the rules and regulations? How can you get past the "gate keepers?"

Your FICO score is key to the gray areas. As your FICO score climbs through the ranks, so does the "trust" level because you are tied to a risk factor. Maybe your debt-to-income ratio is too high for a given mortgage product, but it's close. If you could simply raise your income to support a lower ratio, you could get approved for that product. If your FICO score is above certain levels, you are indeed allowed to "state" your income. For example, if your income is $5200 a month, but to qualify for the loan you need an income level of $5800, based upon your qualifying FICO score you are allowed to "state" your income as $5800. Well, don't they check on that stuff? Yes and no. You must declare that you are "Stating" your income because youre FICO score allows you this luxury. By doing so, the lender will not verify your income, but they might verify your employment.

All of the various document types are based upon what the lender perceives as the risk in doing business with you. These types of luxuries are wonderful for people who are self employed, or have difficult income to verify, etc. It's a level of "trust" granted by the lender based upon your risk factor. These are not tricks, but acceptable business tactics.

To see if you qualify for these optional document types, give me a call.

So Many Choices; So Little Time

We live in a day where choices border on excessive. It's extremely difficult to figure out what loan product is best suited for your needs. Additionally, making the wrong choice can hurt you financially. Seek advice. Ask questions. Explore the Internet. Make informed decisions. Want some help? I'm more than willing to take the time to sort out the options for you. Please, give me a call. It doesn't matter whether you are a first time home buyer, need 100% financing, have credit blemishes, recently discharged bankruptcy, or whatever, I know we can find a program that will meet your needs and allow you to be in that new home as quickly as possible.

First Call Mortgage Co., Inc 18 Constitution Drive, Suite 8 | Bedford, NH 03110 Phone 603-622-4100 x19 Fax 603-666-3249

This web site may contain concepts that have legal, accounting and tax implications. It is not intended to provide legal, accounting or tax advice. You may wish to consult a competent attorney, tax advisor, or accountant. Privacy Statement