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Archive for the ‘Interest Rates’ Category

I just wrote a big ole fat check to pay my second installment of Cook County property taxes so I thought it would be an opportune time to shed some light on property taxes.  Property taxes are just a fact of life when it comes to owning a home.  As such, lenders consider the annual cost of property taxes when approving you for a mortgage.

Here in Chicago, property taxes tend to run about 1.25-1.5% of the value of the home.  However, they can be as high as two percent in some of the suburban communities.  For example, a $400,000 condo in Chicago will typically have annual property taxes of about $5000.  Property taxes is primarily how schools are funded.

Escrowing

In most cases, homeowners escrow their property taxes.  This means the lender collects 1/12th of the annual tax bill along with your mortgage payment and pays the taxes when they are due.  In Chicago, taxes are due in September and March.  However, the September bill is almost always late which is why it was not due until November 3rd this year.  Twice per year, the lender will disburse the money that has been collected in your escrow account and pay the bill on your behalf.  Lenders prefer that borrowers escrow property taxes because it lowers the risk that you will not pay the bill.  As such, unless you are putting 20% down, the vast majority of lenders will force you to escrow your property taxes.

Prepaid Taxes

When you are escrowing taxes, lenders will collect anywhere from 3 to 8 months of property taxes from you at closing.   This money is used to fund the escrow account to ensure you have enough money available to pay the first tax bill after you move in.   The amount collected depends upon when taxes are due relative to your closing date.  The following shows how many months of taxes are collected as part of closing costs when escrowing taxes for purchases and refinances in Cook County

Closing Month/# of Months Taxes Collected

January / 8

February / 3

March / 4

April / 5

May / 6

June / 7

July / 8

August / 3

September / 4

October / 5

November / 6

December / 7

Waiving Escrows

When you put 20% down on a home purchase or take out a purchase money second mortgage (80/10/10) you will have the option of waiving escrows.  Basically, the lender lets you pay your taxes on your own.  This means the bank will not collect tax payments with each mortgage payment and nothing will be collected at closing to fund an escrow account.

Many borrowers prefer not to escrow because banks do not pay interest on the money held in escrow.  In addition, it is one less thing the big banks can screw up!

Be aware though that choosing to waive escrows is not free in most cases.  Most banks charge a risk premium of about .25%  to waive the escrow account which ultimatley gets reflected in your interest rate (will usually result in final interest rate of .125% higher).   When comparing two mortgage loans, it is good to know if one is requiring escrows and the other is not to ensure it is an apples to apples comparison.

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One of the most confusing aspects of mortgages is the rate lock.   In its simplest form, a rate lock essentially means the lender is setting money aside to lend to you at a specific interest rate.  Basically, a rate lock is a guarantee of the interest rate assuming you are approved for the mortgage.  It is very important that consumers understand how rate locks work.

Mortgage Rates Change Everyday:

Mortgage rates are a function of the pricing of mortgage backed securities.  As a result, the pricing lenders offer change EVERY SINGLE DAY.  If you are shopping mortgage lenders, you cannot call one lender on Monday and another on Tuesday to get an apples to apples comparison.  You have to call every lender on the same day.  This is especially important now because the market is so volatile that mortgage rates actually may change multiple times PER DAY, not just daily.  In order to have an accurate rate quote, the quote must be a quote that can actually be locked that day.

Time Frame:

The vast majority of lenders will only lock interest rates in 15 day increments up to 60 days.  Most home purchase take about 45 days to close from the date of contract to closing.  See the connection?  Rates are locked for 15, 30, 45, and 60 days in most cases.  The longer you need to lock the rate, the more expensive the mortgage will be.  There can be up to a .375% difference in rate between a 15 day lock and a 60 day lock.   It cost more to lock a loan for longer time period because it increases the chances that the lender will not actually close on the transaction.  Lenders track how many loans they have locked and if the loan will actually be delivered in order to hedge their capital.  The cost of that hedging goes up the longer the locks have to be in place.

Property Address:

Lenders will not lock interest rates without a physical property address.  In other words, no lender will guarantee an interest rate during the pre-approval stage if you are not under contract to buy a home.  There are a few banks who have “Lock & Shop” programs, but in most cases, the rates are not competitive to the current market.

Floatdowns:

Consumers often want to know what happens if they lock and interest rates go down.  Most lenders have in place “floatdown” policies.  This means the loan officer may be able to negotiate a better rate.  However, floatdowns are not free in most cases.  Consumers need to understand that a rate lock is a rate lock.  In other words, you can’t have your cake and eat it too.  The bank is not going to call you and raise the rate if the market worsen’s after you lock, so they aren’t necessarily going to lower your rate either if the market improves.  Often times many unscrupulous loan officers will use this as a sales tactic by insisting they will lower rates after a rate lock.  It is possible, but it isn’t as easy as it sounds and is dishonest to say it will automatically be done.

A Rate Quote is NOT a Rate Lock:

 A rate lock is when the broker selects the wholesale mortgage provider and takes the formal step of actually “locking” with that lender at a set interest rate within the constraints above.  Consumers should ALWAYS ask for some type of written confirmation that the rate is locked.  Simply calling around getting rate quotes is not the same thing as when a lender formally guarantees the rate. 

If you are transaction does not fall within the guidelines above it is POINTLESS to get rate quotes.  In fact, you should run, not walk, from any lender who willingly gives out rate quotes without you actually having identified a property and being within 60 days of needing to close.  The quote is worthless and most professionals won’t waste their time lying to you.

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USAToday has a front page article today discussing how the increase in interest rates over the past week are threatening the turn around of the housing market.   I take issue with the article because it oversimplifies some of the issues the market is facing right now and also shows how disconnected people who don’t write mortgages for a living are.

The issues facing the housing market HAVE NOTHING TO DO WITH INTEREST RATES.  Mortgage rates are still near historic lows so lowering them further won’t help anything.  You can get a 30 year fixed rate mortgage in the low to mid sixes this morning.  Sure, it ain’t a 5.5% 30 year fixed, however, if you can’t afford a home at 6.5% with a 30 year, the odds are you can’t afford it at 5.5% either!  While there is certainly a correlation between housing prices and interest rates, this isn’t the primary reason the market is not improving.

The housing market is in shambles due to stricter underwriting guidelines.  In other words, lenders have made it damn near impossible for many qualified borrowers to get mortgages.  I am not talking about restricting credit to deadbeat subprime borrowers flipping houses who can’t verify their income and two days out of a bankruptcy.  I mean people who by most measures should be relatively low credit risks can’t get mortgages due to an over tightening of credit standards.  Banks went from the absurdity of lending to anyone with a pulse to the absurdity of turning away good credit risks.  They have thrown the baby out with the bath water.

Here in Chicago, a large number of home buyers, in particular first timers, are being locked out of the housing market due to changes in private mortgage insurance, FHA restrictions on condos,  a lack of solid non-conforming (jumbo mortgages) products, and a non-existant second mortgage market.  In short, except in a few cases, you pretty much have to have a 10% down payment buy a condo in Chicago.  Not many first time home buyers have that much cash laying around when a starter two bed/two bath condo can run upwards of $400k here.  It doesn’t take a genius to figure out that prices are probably going to stagnate and homes are just going to sit on the market when you effectively eliminate a large portion of the buying audience.

What needs to happen is we need some serious financing alternatives for QUALIFIED and common sense underwriting to help buyers get into mortgages at decent interest rates with reasonable down payments.

There are plenty of people who want to buy and there are plenty of people who are trying to sell.  There are also plenty of people who would love to refinance.  However, the mortgage market has added a lot of friction to the process with the stricter guidelines that in my opinion are causing the problem to get worse.  It is almost like the mortgage industry caught on fire and decides to shoot themselves in the head to stop the pain. 

 

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Show Me The MoneyLoan Originator compensation is one of the world’s last big mysteries.  Fortunately for you, I am here to provide the answers.   When I say Loan Originator, I am referring to mortgage brokers and loan officers at banks.  The term is being used generically.

For the most part, all Loan Originators work on 100% commission basis and wouldn’t have it any other way.   Salaries are a for wimps.  They are only paid when your loan actually closes.   The LOs compensation is derived from the fees paid on a loan and can be structured in any number of ways.  Regardless if you see it or not, LOs are going to get paid as no LO is going to do a deal for free on purpose.

LO compensation can range from as little as .5% to 4% on a deal with typical fees ranging from 1 to 2% of the final loan amount.  So if a LO is making 1.5% on $400,000 transaction, the compensation amounts to $6,000.   While this is a lot of money, keep in mind that it is also usually split with the LO’s employer.  For simplicity, let’s assume 50/50.  So the LO gets $3,000 for the transaction and their employer keeps $3,000.  While that seems like a lot of money for one transaction, most LOs don’t do a substantial amount of business so that might be their only closing that month.  In addition, LOs spend an inordinate amount of time working on deals that die on the vine so they are not compensated adequately.  Obviously, if the LO is a top producer closing dozens of transactions each month, you can see that the sky is the limit in regards to income which is why the field is so popular.

LO Compensation is paid in one of three ways: 1) Buyer 2) Lender 3) Combination of Buyer & Lender

Buyer Pays: When the buyer is paying the LO, it is usually in the form of points or an origination fee.  The loan officer tacks on his 1.5% or the agreed upon amount as part of the closing costs.  Typically, this will allow the borrower to get a lower interest rate.    Even though you may get a lower rate, this may not be the best approach unless you plan on staying in your home for a long time.  It may takes three or four years to breakeven from paying points.

Lender Pays: When the lender pays, it is known as Yield Spread Premium (YSP) in the case of brokers or Service Release Premium for mortgage bankers.  Instead of offering you 6% with 1.5% in points, the LO may offer 6.5% with no points.  The 1.5% that the LO desires for compensation is instead paid by the lender for giving you the 6.5% rate instead of 6% rate.  By doing it this way, you don’t have to come up with thousands of dollars in additional closing costs.    The higher the rate, the larger the YSP/SRP paid to the LO.

It is important to note that if a loan has no points/origination fee then there is ALWAYS a YSP/SRP being paid to the LO.   By law, mortgage brokers must disclose the YSP they plan to earn on the Good Faith Estimate and any YSP will always be shown on the final settlement statement.  Mortgage banks are not required to disclose their SRP. 

Specifically, YSP has come under fire because many consumer groups believe that since the final rate increases as YSP increases that the LO has an incentive to upsell rates as much as possible.  While this is true to some degree as it is with any business that wants to make a profit, it is impossible for a LO to gouge a consumer who is proactively shopping for a mortgage.   If you have a standard mortgage and an LO is trying to make 3% on it when most LOs would probably do it for 1-1.5%, a few phone calls will quickly result in the gouging LO to be undercut by the competition as their final rate will be significantly higher than everyone else.

With few exceptions, most lenders offer rates within a very narrow range.  As such, most good LOs know when a borrower is being bait and switched because the YSP will not be available to realistically offer the rate to the borrower profitably.

Buyer & Lender Pays:  Sometimes the LO may structure the deal so some portion of the compensation comes from the borrower and some from the lender.  For instance, say the LO needs to make a total of 2% on the deal to feel adequately compensated.  The LO may charge 1% origination and receive 1% YSP/SRP from the lender.

Alternative Approach – Upfront Mortgage Brokers/Lenders

In order to prevent any inpropriety on the part of the LO, many have been operating in an upfront manner by agreeing to a set fee upfront with the borrower.  For example, a borrower agrees to hire an LO as an agent and pay the LO 1.5% (or whatever is negotiated) of the final loan amount for securing their financing.  In turn, the LO agrees to share their wholesale interest rates from their approved lenders with the borrower.  With this approach, the goal is transparency from both parties.  The LO can focus on the consumers needs knowing ahead of time that the borrower is not rate shopping them and the consumer can trust that the LO is working on their behalf in a transparent manner.

Many LOs have been doing this for years, myself included, but the practice was branded by Wharton Business School Professor, Jack Guttentag aka The Mortgage Professor.  He calls this approach Upfront Mortgage Brokers/Bankers or UMB.

While the transparency of UMB has some advantages, it really only works when you are dealing with mature consumers who understand money, service, and value.  Most consumers prefer to just call around and see who gives them the lowest rate quote ignoring all the risk inherent with that approach. 

It is important to note that dealing with a UMB DOES NOT assure you get the lowest rates.  It only guarantees the loan officer’s compensation and that they will be working on your behalf.  While there is a linkage between LO compensation and rates, it is not linear and varies greatly depending on what lenders a loan officer has access to in regards to rates and programs.  In other words, it is entirely possible for an UMB who agrees to 1% compensation to offer higher rates than a broker who is making 2% in compensation.  However, it should not be the rate or the LO’s compensation that is driving the consumer to the UMB, but being able to work with someone who is transparent, trustworthy, and who will not surprise you at the closing table.

The bottom line for consumers is that you should never be afraid to ask how the person representing you in your largest financial transaction is compensated.

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It is no secret that anyone getting a mortgage above the conforming limit of $417,000 is in for some sticker shock as the rates on non-conforming mortgage loans have gone through the roof.  For instance, a typical 30 year fixed rate mortgage is about 6.375% (no points) right now versus about 7.5% (no points) for a jumbo mortgage.  Huge difference.

Typically, the maximum purchase price to avoid a jumbo mortgage is $521,250.  If you put 20% down or go with a piggyback mortgage, your first mortgage amount would be $417,000.  $521,250 x 80% = $417,000.

Suppose you wanted to buy a place for $650,000 and put 20% down.  This means most loan officers would give you a mortgage of $520,000.  This loan amount is clearly in Jumbo territory and subject to the much higher non-conforming mortgage rates.  At a rate of about 7.5% this equates to a monthly payment of $3635.   However, is there a better way to structure the deal?  Of course.

Creative financing means running the numbers and thinking out of the box.

What loan officers should recommend is holding your first mortgage to $417,000 at 6.375% and putting the balance of $103,000 on a fixed rate second mortgage or home equity line of credit.  This gives you the total needed mortgage of $520,000 ($417,000 + $103,000).  I have 30 year fixed rate seconds in this scenario at 7.115% (no points).  The total combined payment between the two loans is $3294.  By structuring the loan this way, you save approximately $341 per month or $4092 per year!   The weighted average or “blended rate” of the two loans is just 6.522% or slightly higher than the conforming mortgage rates.

Take a closer look:

$520,000 @ 7.5% = $3635

vs

$417,000 @ 6.375 = $2601

+

$103,000@ 7.115 = $693

Total Payment: $3294

This is the difference between dealing with established mortgage professionals who know how to properly structure mortgage loans versus call center order takers.  In addition, this is also why it is important that you work with a mortgage broker who has access to multiple lenders so you can have more choices that will save you money.

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bernanke1.jpgSo Ben Bernanke got all Freddy Kruger and slashed the Fed Funds rate by .5% yesterday.  As expected, I have received a number of inquires from clients as to how this might affect their interest rates.  The short answer is that it will have very little to no impact on prevailing mortgage rates.  

A common misperception is that the Federal Reserve controls mortgage rates.  Mortgage rates are actually determined by the price of mortgage backed securities which are traded on Wall Street.  Wall Street expected a rate cut, albeit not this large, so the rate cut was already “priced in” the prevailing market mortgage rates. 

The purpose of the rate cut was to spur liquidity by making the cost of capital cheaper so banks will be encouraged to make investments and lend.  In addition, there appears to be concern that the housing slow down could cause a recession. 

What this rate cut does affect are short term loans such credit cards and home equity lines.  In fact, any loan that has an interest rate that is tied to the Prime Rate will see their rate fall by .5%.  All the home owners who were saw their HELOCs sky rocket over the past four years will finally get a little relief.

The larger issue with the mortgage market is that Wall Street has no confidence in mortgages that do not conform to Fannie Mae or Freddie Mac guidelines (sub-prime, alt-a, and jumbo mortgages, etc) which is what caused the tightening of credit and mortgage companies going out of business.  While the rate cut will not lower mortgage rates, it may give investors confidence to get back into the market which may ease pressure.

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When I was completing my MBA in marketing at Northwestern University (Kellogg), I recall a very well regarded marketing professor telling the class that when we are designing marketing campaigns at large corporations that it is important to remember that the general populace is pretty stupid.  Well, he didn’t say it that directly, but we all knew what he meant.  I didn’t really agree with his position at the time, but the longer I have been in the mortgage business the more I fear he may have been right.

The FTC is cracking down on unscrupulous brokers and lenders who use misleading advertising to lure borrowers.  You know, everything from the simply renaming negative amortization loans to something more friendly like Secure Advantage or Choice Pay to just outright lying about interest rates and fees like many of the companies who advertise on Bankrate.   While I applaud the FTC, the unfortunate reality is that this type of marketing works and these companies are simply giving consumers what they want.   The reality is that the general public really is pretty stupid and mortgage advertising that works best is usually dumbed down to the lowest common denominator.  If it didn’t work, mortgage companies wouldn’t do it.

The Atlanta Journal recently ran an article on Lenox Financial.  This company grew from a handful of loan officers in 2003 to originating more than $4 billion in mortgages today.  How did they do it?  By running the most irritating and misleading radio advertisements in the business touting that they don’t charge closing costs.  The President, John Shibley, actually compares his competition to child molestors for charging consumers closing costs (listen to the “blow torch” ad).   There is plenty of information available as to why this is misleading and how no closing costs loans simply mean you are getting much higher interest rates than you qualify for, so I will leave it at that. 

The point is no matter how much the professionals in this business hate Mr. Shibley’s advertisements, we have to admit – they work.  Mr. Shibley knows what my marketing professor taught – the general public is in fact stupid.   Why else would they respond so favorably to this type of advertising?   Seriously, who in their right mind would call these companies to borrow hundreds of thousands of dollars?  Unfortunately, plenty of people.

So should mortgage advertising of interest rates be illegal? 

I specifically say interest rates because we all know that it is impossible to actually quote interest rates without taking a full mortgage application.   In some ways, I say yes.  Buying a home is the largest and most complex financial transaction most people will ever undertake.  First, consumers have shown that they are not capable of critically evaluating their financial options.  Second, too many mortgage companies have shown that they cannot be trusted to actually develop ethical advertising.  If mortgage advertising were illegal, consumers would then be forced to seek out lenders the way they should – by asking for referrals from trusted sources whether it be a Realtor, neighbor, co-worker, or family member.  Additionally, mortgage companies would also be forced into looking at the long term and doing right by their clients because they would know that their business growth depends on gaining referrals from satisfied clients.

On the other hand, the heartless, greedy capitalist pig in me says caveat emptor.  Mortgage companies should be able to do what they want as long as it is legal and consumers need to stop being so gullible.  Any thoughts?

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