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QUESTIONS TO ASK BEFORE GETTING A MORTGAGE
QUESTIONS FOR ALL TYPES OF MORTGAGES
- What is the simple interest rate and number of discount points?
- What other rate/point combinations are available?
- Discount points are a form of interest which is paid up front at closing.
Each point equals 1 percent of the loan amount.
- Most lenders offer a choice of interest rates and discount points the
lower the interest rate, the more points charged (one point equals
approximately 1/4 of 1 percent of the interest rate).
- As a general rule, the longer you plan to stay in your home, the greater
the advantage of paying more points to get a lower interest rate.
- An additional consideration is that (for new loans only, not refinancing)
points are fully tax deductible in the year paid (unless they are financed).
- What is the annual percentage rate (APR)?
The APR takes into account all costs of financing including the
interest, discount points, mortgage insurance, etc. and amortizes them
over the full term of the loan. This gives you an easy way to compare
mortgages, if you keep that loan until you pay it off. If you don't intend
to stay in the home that long, the APR becomes biased and is not the best
basis for comparison.
- Will you lock in the interest rate until closing?
The loan approval process typically takes from three to eight weeks
longer if applications have backed up. If not locked in, the mortgage
interest rate could change (upward or downward) before closing.
Some lenders will lock in rates at no charge for 45 to 60 days; others
charge a fee. Some allow you to lock in by telephone at any time during loan
processing. This is advantageous when market rates fall.
- What is the required down payment?
- What will mortgage insurance cost?
Most mortgages require a 20-percent down payment unless you pay for
mortgage insurance to protect the lender in case you default. Getting
mortgage insurance can reduce your down payment to as little as 5 percent of
the home's appraised value. However, many companies no longer insure low
down payment loans in Florida because of current economic conditions.
Private mortgage insurance usually requires you to pay a first-year
premium (up to 1 percent of the loan amount). After that, you pay a smaller
percentage each year until your loan balance is reduced to 80 percent of
your home's value. At that point your insurance payments and coverage should
stop.
For Federal Housing Administration (FHA) loans, you are charged a fixed
insurance premium (between 2 percent and 4 percent of the loan amount),
depending on the length of the mortgage term and whether the premium is paid
up front or financed.
- Is there an application fee?
- Is the application fee refundable?
Some lenders have no application fee. Others may charge as much as $250
and may or may not refund it if the loan is not approved or if you decide
not to take the loan.
- What are the closing costs?
The closing costs can total 2 to 4 percent of the loan amount. Most
lenders can give you a form which estimates closing costs for your potential
loan. This estimate may include the origination fees (for making the loan)
and title changes and items (such as insurance and taxes) which must be paid
at closing. There may be additional expenses that are not listed on the
form, and some of the fees may be paid by either the seller or buyer. Ask
the lender about any other possible closing costs, in addition to those on
the standard form.
In general, the actual closing and document preparations may be conducted
by an attorney or a title insurance company (usually at no additional charge
if title insurance is purchased).
- Are there any prepayment penalties?
Today, most mortgages do not charge penalties for prepayment of
principal. This is important if you later decide to sell your home or if you
want to make extra payments to shorten the loan term.
However, loans with prepayment penalties may have lower finance costs.
Such a loan may be a good choice if you do not intend to pre-pay or sell the
home within the penalty period.
- Is the loan assumable?
An assumable loan can be passed on to the buyer of your home if you sell.
It may or may not guarantee the same interest rate. Either way, the closing
costs on an assumed loan are less than for a new loan, so that
characteristic of a loan may help you sell your home in the future.
Today, fixed rate mortgages are rarely assumable. They have a due-on-sale
clause. However, most adjustable rate mortgages are assumable.
- Is there a late payment charge?
Most lenders charge a late payment fee, but they vary in how much is
charged and when the fee is imposed.
QUESTIONS FOR ADJUSTABLE RATE
MORTGAGES (ARMS)
- Is the initial interest rate discounted?
- When and how will the interest rate ever change?
Some lenders (and builders) may offer very low initial interest rates to
attract borrowers. At the end of a time span (usually one year) the interest
rate is raised to its normal level according to the loan agreement's
formula.
Unless you intend to have the mortgage for only a short time, it is
better to make comparisons based on the formula interest rate rather than
the initial rate. But, if you plan to sell soon, the savings from the
initial discounted interest rate can mean substantial savings for you.
- How often can the interest rate and payment amount change?
In general, the shorter the rate adjustment period, the lower the
interest rate and vice versa. Frequent adjustments are advantageous when
rates are falling but offer less protection when rates rise.
- What is an adjustment index and when is it used?
The interest rate of an adjustable rate mortgage follows a published
market index. Indexes based upon U.S. Treasury securities reflect true
economic conditions. Indexes based upon cost of funds to financial
institutions nationwide reflect what financial institutions must pay to
attract deposits.
In general, indexes tied to long-term indicators (such as three-year and
five-year securities) are less volatile than those tied to short-term
indicators (such as three-month Treasury bills). Long term is advantageous
when rates are rising; short term is better when rates are falling.
- What is the margin?
The margin or spread above the index determines what your mortgage
interest rate will be at each adjustment date. The smaller the margin, the
closer your interest rate is to the index rate and the less you pay.
Remember that the same margin over two different indexes may produce two
different interest rates if the indexes are different.
- Are there periodic and life-of-loan rate caps?
Rate caps limit how much the interest rate can rise or fall at the
adjustment dates and over the life of the loan. In general, the lower the
rate caps, the smaller the risk but the higher the starting interest
rate. Most ARMs today have 5-percent to 7-percent lifetime rate caps and
1-percent to 2-percent annual rate caps.
It is a good idea to figure out (or ask the lender to provide) what
happens to the monthly payment amount if: (a) rates rise to the upper limits
of the caps (the worstcase scenario) and (b) if rates drop 2 or 3
percent. This provides a clear picture of the risk and the realistic
opportunity for savings if rates fall.
- Are there payment caps?
- Is negative amortization possible?
If interest rates rise, payment caps (limits on your monthly payment) can
change when the interest rate changes, causing your debt to grow instead of
shrink. Loans which allow your debt to grow (negative amortization) are low
rate because of their high risk. However, loans with payment caps can be
structured with rate caps to avoid negative amortization.
Tables
Table 1.
PAYMENT TABLE
|
(Monthly payment for each 1,000
borrowed)
|
InterestRate
|
15 years
|
25 years
|
30 years
|
7.0%
|
$8.98
|
$7.07
|
$6.65
|
8.0
|
$9.56
|
$7.72
|
$7.34
|
9.0
|
$10.15
|
$8.39
|
$8.05
|
10.0
|
$10.75
|
$9.09
|
$8.78
|
|