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Should You Trade Discount Points For Your Down Payment?

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Should I Pay Mortgage PointsShould you divert funds from your down payment to get better terms on your monthly payments? Or should you go the opposite direction and add to your equity? How about getting cash back at closing? These are all things that you can do by adjusting the level of discount points that you agree to pay at the start of your new home loan.

Purchasing A Discount On Your Home Loan

The American system of mortgage lending and home lending is unique because of one valuable feature: The ability to pay points in advance, to control the repayment interest rate. By setting up a payment at the start of the loan period, lenders and borrowers have the flexibility to negotiate terms where they might otherwise not be able to come together in agreement on prices and other details.

The more you pre-pay as points, the lower the interest rate that your lender will allow. Conversely, if you are willing and able to withstand higher payments but you have little or no cash for your down payment, you can use negative points to supplement your deposit. Depending on what your lender offers, one point is equivalent to about a quarter percent in interest on your loan.

Your Discount Points Options

So, do you pay discount points? Or finance without points or do you go negative? A point is worth the equivalent of one percent of your loan and a discount for points will reduce your payments over the long term. Points are tax deductible and down payments are not.

If you put the funds into down payment instead of discount points, it could allow you to avoid buying private mortgage insurance. Depending on how close you are to gathering the cash for a substantial down payment, you may want to use negative points to get to twenty percent of the sale price. It will mean that you do not have to make monthly PMI payments, which will save you significantly on your monthly payment.

Going Negative On Points

Negative points might add a quarter of a percent to your rate for each negative point that you take, but it could give you the funds to increase your deposit or pay for closing costs. Negotiating the points you pay is one of the tried and true techniques that investors have been using for years, and it has the potential to secure investment properties or as your home.

However, it does hold moderate risk; if you intend to stay long-term, you will save money on monthly payments by refinancing as soon as you have the equity to do so. The experiences of the last dozen years in real estate show the extremes at both ends; we can see that the market can boom, or in the worst case, the market can collapse.

The uniquely American feature of discount points in real estate finance is an option that has more flexibility than most borrowers realize; you can negotiate the points you pay, not pay them at all, use them more creatively to secure the property that you want. Use home loan discount points to your advantage and you are one step closer to being the master of your real estate realm.

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Finding The Absolute Lowest Interest Rate

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Home Mortgage BasicsWhere Do You Find The Lowest Interest Rate On Offer Today?

Many factors play roles in determining home loan interest rates. Some of these things are structural and economic, and others are because of the terms that you accept when you take out a new home loan.

The Prime Interest Rate

The prime rate is the lowest rate offered by banks for commercial lending; the Wall Street Journal publishes a periodic survey of lenders about their current rates. Those current rates come from the Federal discount rate, set by the Federal Reserve; which the banks pay to borrow funds from the Fed and that they then offer to clients at anything from the prime rate upward. Only the most strongly favored customers can borrow at the prime rate, but it is a benchmark level of the markets for the rest of us.

Home Lending Market Supply And Demand

Banks earn their income by borrowing from the Federal Reserve’s discount window and taking in deposited funds and lending that capital to other customers as interest-bearing loans. The rates that they charge depend on what customers are willing to pay to get access to cash. The banks provide the supply and charge interest rates that will support the demand from borrowers.

In an open market that has competition between many lenders seeking to attract many borrowers, the rates of interest reflect these levels of supply and demand. Of course, it is never as simple as that; some borrowers are worthier of trust than others, as determined by the credit rating agencies, and they will receive preferred rates on their loans. Those customers that appear to be riskier will pay higher rates.

Prime rates and the economics of supply and demand set the background of the economy and the lending market. Now let’s look at the differences in the types of loans.

The Two Things That Define Low Rate Home Loans

Adjustable rates mean safer investments for banks – Lenders like to know that, if conditions change, they can update the interest that they charge occasionally. The adjustable rate home loan faces strict statutory limitations on how the rate can change but even so, lenders still have more flexibility than fixed rate loans. When banks can update at least once during the term, they offer slightly lower rates of interest in return.

Shorter terms mean better cash flow and less risk – When a loan has a shorter term it earns less interest than longer ones. But lenders can always replace a completed loan with new lending. The shorter term means that there is less time in which something can go wrong, and the higher repayments of principal mean more cash flow. Lenders will give lower rates in return for larger monthly payments.

So, in exchange for faster principal repayment and the right to adjust your interest rates banks and finance companies will give you the lowest rate on your home loan.

Choose Your Terms And Buy Your Home

From the principles discussed above, the lowest rates are for adjustable rate loans with a fifteen-year term. The conventional choices for term length are between thirty and fifteen years, without stretching too far into customized territory the best deal will be with a fifteen-year loan. It will be a better rate if you accept an adjustable rate loan. The question is whether you want to take the risk of there being unusual economic conditions at the time that the lender sets the new rate.

Whether you have excellent credit or not, some options for home loans will be less expensive than others. The structure of the lending market and the regulations around it mean that the best rate you are likely to receive for a home loan will be for a fifteen-year adjustable rate loan.

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Funding Home Upgrades By Cash Back At Closing

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Financing HomOptions For Financing Rehab And Home Repair

When you buy a home, whether to occupy or as an investment, no lender is going just to give you cash at closing and hope that you do the right thing; being smarter than that is how they stay in business. Fortunately, if you do need to find some cash to renovate or upgrade the property once you take ownership, there are a couple of options available to you.

If you hope to get cash at closing for home renovations, your best bets are either an FHA 203(k) program home loan or a Fannie Mae HomeStyle loan. Both of these programs provide practical solutions to funding your home upgrade and protect the interests of the lender at the same time.

The FHA 203(k) Home Improvement Loan

Section 203(k) Rehab Mortgage Insurance from HUD allows buyers to purchase or refinance, and rehab a property simultaneously. This policy insures up to the final, rehabilitated value so that borrowers can pay a discounted price and adds the value through repairs and refurbishment.

The cost of rehab must be at least $5,000, and the FHA mortgage limits still apply to the final value of the revitalized home. HUD provides a list of the permitted repairs, which range from the simple to the drastic. You can essentially rebuild a structure using this program. The Section 203(k) program is available through FHA-approved lenders.

There are some drawbacks to this program: Not all properties will qualify, there are funding limits, and the application process is complicated. Even so, they make repairs affordable, and the down payment requirements are low, in line with FHA lending.

The HomeStyle Loan From Fannie Mae

Fannie Mae offers something like a construction loan with the HomeStyle Renovation loan. This facility is available for purchasing or refinancing primary residences of up to four units and the minimum construction cost is, again, $5,000. Unlike the 203(k) program you can use it for some types of single-unit investment properties.

The deposit requirements depend on the kind of property; single unit owner-occupied have the lowest deposit requirements at five percent of the sale price if it is a fixed rate loan or ten percent for an ARM. The deposit requirements are higher for multi-unit properties, second homes, and investment purchases, or refinances. You should consider your options carefully and discuss them with an experienced lending professional before you commit to any of them.

The HomeStyle loan allows you to draw up to fifty percent of the appraised post-renovation value for costs of repair and construction. The improvements to the property must add value to it to qualify for inclusion in the loan.

The project must finish within six months, and you will have to make mortgage payments throughout the construction period. Like the 203(k) program the application process is extensive, you will need to hire a general contractor or other licensed professional to develop and submit your plans before you receive approval for the loan.

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Funding Home Improvement With Home Equity

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home-equity-loan-basicsHow To Withdraw Equity For Home Improvement

It may be that you are purchasing a property that needs renovation or perhaps you want to give your existing home a tune up. The cost of doing major renovations is likely to be too high for you to fund it out of pocket, so what do you do?

The obvious answer is to borrow the cash and let’s make the assumption here that you don’t have a family member who is willing to lend to you. The answer is to call on the financial services industry to give you what could amount to a sum that rises well into five figures.

Loan Or Line Of Credit

One of the priorities to consider will be the rate of interest at which you borrow so take advantage of secured lending because of the lower interest rate than that of credit cards or unsecured lines of credit. You will be applying to a bank or finance company for a second or junior loan secured against the property that you are renovating; these loans come in two main varieties: Home equity loans and lines of credit.

The home equity loan is a junior loan that dispenses a lump sum at the start of the term, which means of course that you will pay interest on the entire amount from beginning to end. The second option, the home equity loan (HELOC) allows you to draw funds against the line of credit as and when you need to use them to support the progress of your project.

A HELOC only requires that you pay interest on the portion of the line that you withdraw them, which saves cost for you on interest payments; it gives you the flexibility to use as much or little of the line of credit as you might choose. It is worth noting that this facility usually carries an adjustable rate of interest. However, you have the advantage of being able to draw the funds, repay the balance, and then advance cash again, as many times as you may require completing the project.

It Is All About The Numbers

Home equity loans command a higher rate of interest than HELOCs; you advance the full amount, and then you pay a fixed interest rate on the outstanding balance. If your renovation plan calls for an exceptionally high level of funding, other options such as cash-out refinancing or refinancing with an FHA 203(k) home loan might be preferable. These options are suitable for projects that require $100,000 or more.

Withdrawing the equity from your home or investment property is something to do only after careful consideration and only for purposes such as renovations that directly improve the value of the asset by at least the amount that you draw from it. Done correctly, borrowing against your property to improve it can be an excellent way to increase your equity, and therefore your wealth.

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What Do Mortgage Originators Do After Your FHA Home Loan Closes?

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FHA Mortgage BasicsMortgage Originators Initiate The Process

Your mortgage lender is part of an extensive and wealthy system of residential real estate finance. The person at the very knife-edge of the lending process is the loan originator, the loan officer or independent arranger who helps loan applicants fill out forms, gather documents and submit the loan application; they are there to help you. Applying for a home loan is uniquely stressful, and surprises can pop up, even after you begin making payments.

However, the mortgage originator is also responsible to the lender, and they have to balance the conflicting responsibilities of being the person in the middle. The range of organizations that offer residential mortgages to consumers is diverse; banks, credit unions, and finance companies to name just a few, but, the function of the loan officer who directly facilitates the process of setting up home loans is a constant.

Back Office Issues And Secondary Action

The first factor is that there are many regulations involved in mortgage lending, which includes requirements for loan originator licensing under the 2008 SAFE Act, a Federal statute that dictates that all originators must hold either Federal or state issued licenses. Also, the practices that work well in one instance tend to apply to the whole market; consumer behavior determines lending officer behavior to a large extent.

In all likelihood, the next thing that happens to your loan once you have begun the term, your lender will sell it on the secondary mortgage market. As a borrower in good standing, this means little to you directly. However, it sends the loan into a system that spreads the risk among many investors and gives liquidity back to the mortgage companies, so they can keep funding new loans.

Your loan officer or independent originator hands off the mortgage to the company that funds it, the funder may hold it and service it in-house or, when it is an FHA conforming loan, sell it to Fannie Mae or Freddie Mac to bundle into mortgage-backed securities (MBSs).

Mortgage companies routinely sell home loans on the secondary market for real estate loans. The transfer does not impact borrowers directly. However, the servicer will stake a fraction of a percent as a fee to send the payments to the MBS holders.

Sending Home Loans Down The Pipeline And Servicing Them

The organization that takes your payments and passes them to the MBSs is your mortgage servicer, which may be the same company that initially underwrote your loan, or it may not. Do not be surprised if, not long after you have bought a new home or refinanced, your lender sends you a formal letter of notification of a new servicer.

It is a common practice for lenders to sell to your loan on the secondary market. They may also introduce another financial company that will service your loan by taking your payments. As surprising as this is to unsuspecting consumers, you need not worry, it is all business as usual and part of the structure of the financial industry that forms the foundation of America’s dreams of homeownership.

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Use A Second Mortgage To Avoid The PMI Trap

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Private Mortgage Insurance BasicsWhen you finance the purchase of a home, in most cases, you will either have to make a sizable down payment or take out a private mortgage insurance policy (PMI). The choice is cut and dried for most borrowers.

But in some cases, if you want to have the most refined control over your costs, you may be able to find another alternative to PMI. If the numbers add up, you may be able to take out a piggyback loan to top up your deposit and save money over the life of the loan.

The Piggyback Loan

A second or junior loan is that because it takes a subordinate position in its claim on your assets, should you default on the payments. Your primary or first lender can claim your assets in foreclosure and sell them. Any amount that remains, after the recovered first loan, goes to repaying subordinated obligations, which means more risk and higher interest rates for junior loans.

In practice, a second often means a home equity line of credit (HELOC). PMI does not contribute to repayment, and you can potentially pay a second back more quickly, reducing the interest when otherwise you would still lack the equity to escape the need for a policy. A small second with a term of five years may be the right ticket. If your first loan is for thirty years, you may still have a high enough balance outstanding that you require PMI for more than five years.

Finding The Right Tools For Any Situation

Another instance that this strategy might be useful is when using a second mortgage will enable you to avoid a high-priced jumbo loan. If your loan would take you over the conforming limit, a jumbo loan will have a higher rate of interest and put additional requirements on your loan. One remedy would be to use a second loan to keep within conforming loan limits, saving money for you in the long-term.

The question is how to make up the equity in your home and having an adequate down payment rather than a loan that requires private mortgage insurance and the added cost. There are other options, for example, if you are a qualifying veteran, VA home loans have no requirements for insurance, regardless of the size of the deposit.

Weigh Your Options

Using second mortgages to save costs is just one of the many options you have in home finance. Connect with your lending professional to work out the numbers. Using a piggyback loan to circumvent the requirement for PMI is creative and proactive, it gives you an advantage as long as you first set it up in a viable plan and then you discipline yourself to stick to the plan.

Deciding to use a loan to avoid the obligation for PMI is a matter of determining the value of the trade-off regarding the risk. You might be able to reduce your payment obligation regarding the total payments. However, it is important to remember that you can always cancel your PMI but a second loan is an enduring commitment; you have to pay until the debt has been satisfied.

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Why Mortgage Back Securities Are A Good Thing For Home Buyers

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Mortgage Backed SecuritiesBonds are just loans that are so big that the institutions that create them divide them into standardized securities and slice them up into affordable units. That is what Fannie Mae and Freddie Mac do with residential mortgages; they bundle home loans together so that many small streams of income become giant securitized cash flows, this is the mortgage-backed securities (MBS) market.

For government debt and corporate bonds, the units usually are $1,000 each. For more technical bonds like MBSs, the units usually sell for $25,000 each initially. Once on the market, they can trade at a discount or premium to face value, depending on market sentiment.

The Market For Mortgage Backed Securities

Mortgage-backed securities give investors income from a small share in a wide range of borrowers. The MBS market helps you buy your home because they bring institutional money into the residential lending market and create a cycle of lending and investing that helps everyone. For most conforming loans, Fannie Mae and Freddie Mac do the work of putting MBSs together.

You take out a home loan, and the bank or mortgage company that sold it to you goes to the market and sells your loan for cash; the money they gave to you they recuperate from the MBS markets. The market makers then collect these loans and add them to new MBSs, which they sell to investors. The lender still services your loan, but they pass on most of your payment to the market, which distributes it to the investors who hold the bonds.

There has been a lot of talk in the financial press in the last decade about the MBS market; most of the chatter has put these bonds in a very negative light. However, there was a good philosophical concept behind MBSs, one that reflects the values of this country and its market-based culture of self-help. It is true that as the lending market overheated that financial markets made the situation worse and then suffered a collapse in 2008. Sub-prime loans were misidentified as triple-A rated debt and collapsed overnight, taking the markets down with them.

3 Reasons Mortgage Backed Securities Mean Easier Lending

They keep the funds liquid – Real estate is an investment that makes it difficult to withdraw funds; you cannot just cash out part of the value the way that you might sell off stocks or withdraw funds from a savings account. By taking loans and bundling them into securities the cash comes from the size of the market makes the best use of cash.

They replenish your local lender – More people can own homes because of the liquidity mentioned above. The cycles of cash that flow from institutional investors replace the funds for finance companies and banks, which can then create more loans.

They help to preserve standards in lending – As long as the agencies create the bonds correctly, and the ratings represent the actual quality of the underlying home loans, MBSs are stable assets that deliver income to investors. Although lenders do not have to follow the FHA rules for conforming loans, access to the secondary markets makes the terms appealing as part of successful lending business models, giving  lenders a stake in maintaining high standards.

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Ginnie Mae Fannie Mae And Freddie Mac – Is There A Difference?

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mortgage-loan-basicsWhat Are These Bonds And Why Should Home Buyers Care?

When you borrow from a bank or finance company to buy your home, the loan itself becomes a valuable asset for the holder. The value comes from your promise to pay the amount due each month, on time, every month. Given the time and effort that it took to approve you and the solid reputations of the institutions involved, it is very likely that your promise to repay your conforming loan will be a sound investment for the holders of such bonds.

Consumers want to purchase homes, but they seldom have the cash to do so without some assistance. Real estate ownership requires capital, which has to come from somewhere. It is also difficult to buy and sell homes, compared to other investments like stocks and bonds. These agency bonds make buying your home affordable by providing the liquidity that allows investors to inject capital into the market.

Liquidity For Mortgage Lending

If there were nothing like the real estate bond market investors would be in short supply, and lenders would charge much higher interest rates. Since it is the equity in the land and buildings that secure the lending, it is a relatively safe investment, and that was the attraction to pool loans together and sells them as agency bonds.

Bonds are high-value loans in which brokers sell shares. In return for holding a bond, you get a coupon, which is a periodic payment, usually semi-annually, and the repayment of the face value of the loan when it matures. However, no law says that this is the only structure; it is a matter of the market makers finding the bond structures that are most popular with investors and exploiting them for profit.

Agency Bonds From Fannie Mae Freddie Mac And Ginnie Mae

Entities such as FNMA (Fannie Mae), FHLMC (Freddie Mac), and GNMA (Ginnie Mae), are not part of the government, but they do receive sponsorship for the agency bonds they create. These instruments pool together home loans and sell the bonds to investors. These organizations were set up to purchase home loans and bundle them as investments, to sell to institutional investors such as investment banks, pension funds, insurance companies, sovereign wealth funds, and wealthy private investors.

Agency bonds generate the capital that funds your home loan. It is this form of institutional investing that enables you as a homeowner to purchase a home with financing at a low rate of interest and a low down payment. Ginnie only invests in loans that are backed by government guarantees. Fannie Mae and Freddie Mac will buy notes that conform to their standards but which do not have the same government backing. The government backing makes the Ginnie Mae bonds even safer investments than the others.

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When Should You Use Financing With A Balloon Payment?

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Balloon Mortgage BasicsBalance Due At Maturity

The conventional residential real estate mortgage has a structure, which includes monthly repayments of principal and interest, where the payments over the term of the loan pay off the principal entirely, and nothing is due at maturity. In other lending instruments, such as corporate bonds, the borrower has to make payments of interest, called coupons semi-annually, and the full balance becomes due when they reach maturity.

Balloon payment mortgages have features that make them intermediate between conventional amortizing home loans and bonds. The balloon is the balance that becomes due at maturity. The advantage that you get from this type of mortgage is that your payments will be lower, in the same way that an adjustable rate mortgage. The difference is the risk of not being able to make the balloon payment when it comes due.

Loans That Grow Up Too Soon

Lenders calculate the payments based on a long-term amortization, but the mortgage come due at a date considerably earlier than it would take to pay it off. That means that at the end of the term, you will have to pay the outstanding balance. The balloon is the large final repayment of principal.

If you have a seven-year term with a thirty-year amortization and a balloon payment it will be less expensive the same a loan with a seven-year amortization, but then so will an adjustable rate mortgage. ARMs tend to have much less painful adjustments than the balance due at the end of a balloon loan.

Emulating Commercial Real Estate Lending Practices

You make a few assumptions if you agree to a balloon payment. You assume that you will have the payment, one way or another. Perhaps you have the capital, but you don’t want to tie up in something as illiquid as real estate. Or you are very confident that you will be able to sell at a profit when the loan comes due.

This type of funding is more popular in commercial real estate; making a balloon payment is less of a concern if the property is merely one in a much larger portfolio of investments. As with most financial obligations, you will benefit most if you are in a position of strength; things cost less in the long run if you have the capital assets to back your choices.

Selling Balloon Property Tricks

Lenders also benefit from the balloon payment; they always prefer to receive payments sooner rather than later. The risk of investing extends along with the period of the loan so that on average, loans that pay back capital faster represent a smaller risk. To encourage consumers to take on balloon mortgages lenders will sometimes offer a version that gives the option of a reset at maturity.

Choosing a balloon mortgage is one option to finance your home. However, it is a less appealing option arguably than an ARM if you need the low payments. A 5/1 ARM will reset but rather than a struggle to cover a balance due at the risk of foreclosure; you might just have to scramble to find a larger but manageable monthly payment. If you can make larger payments and wish to pay less over the long-term, you will get greater benefit from a fifteen-year repayment loan.

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Assuming The Loan When You Purchase A Home

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Home Purchase ProcessAssuming a fixed rate mortgage loan is possible if you can meet some very stringent requirements. Loan assumption is a more compelling prospect if interest rates are rising and it would be harder to get equivalent terms any other way. An assumable mortgage just means that you can transfer the responsibility to repay the loan to a third party.

Any home loan is assumable in theory, but the lender will try every possible trick to resist it. Since the process of assumption is effectively a party process (buyer, seller, and lender) this can make it much more complicated. One of the central requirements to assume a home loan is that you meet all the lender’s requirements as the new borrower. However, the property most likely will not need to have a new appraisal.

The Due On Sale Clause

The way that lenders prevent you from assuming a loan is to include a due-on-sale clause in the terms of the loan; this means that if you sell the property, the loan becomes due at closing. Such clauses are valid for conventional loans, but FHA and USDA loans are assumable if they were created after March 1, 1988, and the buyer meets the acceptance of the lender.

VA loans were fully assumable if they closed before March 1, 1988, they did not require that the lender approved the transfer, since that date they have been assumable under the same terms as FHA and USDA.

Agreement Between Three Parties

It is rare that you will find a situation where you can take over a loan and not add cash at closing. In most cases, the property will have appreciated since the start of the loan, and you will have to bring cash to closing or take out a second loan to satisfy the seller.

An exception would be if the seller has negative equity, the reasons to not get involved with this are so numerous it would take several more posts to detail them all; that would be a bad investment even if the lender would agree to it.

Checking For Other Options

The note that describes the terms of the mortgage defines whether or not a loan is assumable, and lenders usually choose to include a due-on-sale clause. If there was seller financing involved in the property in question and it is not assumable, there might be another way. Instead of buying the property an alternative might be an option; the seller might consider giving you a lease option to buy.

Also, at the time of writing, interest rates on all home lending are low and new mortgages are likely to be relatively easy to obtain compared to gaining ascent from a lender to assume a loan. It might serve you well to investigate whether there are more appealing alternatives based on starting a new loan at closing.

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Mortgage Rates