517-LIVE-HERE
Livingston Realtor Referral Network
Toll Free: 866-700-3437
email: info@517livehere.com
When it comes to comparing interest rates for a mortgage loan, homebuyers often have the option of choosing a loan with a lower interest rate by paying points. Simply put, a point is equal to 1 percent of the loan amount. For example, with a $100,000 loan, one point equals $1,000. Points are usually paid out-of-pocket by the buyer at closing.
Paying points may seem attractive, because a lower interest rate means smaller monthly payments. But is paying points always a good idea? The answer generally depends on how long you plan to stay in the house. Let's look at an example:
Bob and Betty Smith are shopping for loan rates on a $150,000 home. Their bank has offered them a 30 year loan at 7.5 percent with no points. This works out to a monthly payment of $1,049.
However, their bank has also offered them a loan at 7 percent if they agree to pay 2 points (or $3,000). At this lower rate, their monthly payment drops to $998, or a savings of $51 per month.
By dividing the amount they paid for the points ($3,000) by the monthly savings ($51), we see that they will have to own the house for 59 months (or just under 5 years) before they will start to see savings as a result of paying points. If Bob and Betty plan to stay in the house for many years, then paying points could make good sense. But if they see themselves moving to another house in the near future, they'd be better off paying the higher interest and no points. (Note: for simplicity, the above example does not take into account the time value of money, which would slightly lengthen the break-even time.)
Can you deduct points on your income taxes?
In the United States, one side benefit of paying points on a mortgage loan is that they are fully tax deductible for the same tax year as your closing. However, this does not apply to points paid for a refinance loan. For refinances, the IRS requires you to spread out the deduction over the life of the loan. For example, if you paid $5,000 in points for a 30-year refinance loan, you can only deduct 1/30 of the $5,000 each year for 30 years. If you pay off the loan early, though, you can deduct the remaining amount that tax year.
Adjustable-rate mortgages (ARMs) differ from fixed-rate mortgages in that the interest rate and monthly payment can change over the life of the loan. ARMs also generally have lower introductory interest rates vs. fixed-rate mortgages. Before deciding on an ARM, key factors to consider include how long you plan to own the property, and how frequently your monthly payment may change.
Why choose an adjustable-rate mortgage?
The low initial interest rates offered by ARMs make them attractive during periods when interest rates are high, or when homeowners only plan to stay in their home for a relatively short period. Similarly, homebuyers may find it easier to qualify for an ARM than a traditional loan. However, ARMs are not for everyone. If you plan to stay in your home long-term or are hesitant about having loan payments that shift from year-to-year, then you may prefer the stability of a fixed-rate mortagage.
Components of adjustable-rate mortgages
Adjustable-rate mortgages have three primary components: an index, margin, and calculated interest rate.
Adjustment periods and teaser rates
Because the interest rate for an ARM may change due to economic conditions, a key feature to ask your lender about is the adjustment period--or how often your interest rate may change. Many ARMS have one-year adjustment periods, which means the interest rate and monthly payment is recalculated (based on the index) every year. Depending on the lender, longer adjustment periods are also available.
An ARM can also have an initial adjustment period based on a "teaser rate," which is an artificially low introductory interest rate offered by a lender to attract homebuyers. Usually, teaser rates are good for 6 months or a year, at which point the loan reverts back to the calculated interest rate. Remember, too, that most lender will not use the teaser rate to qualify you for the loan, but instead use a 7.5% interest rate (or calculated interest rate if it is lower).
Rate caps
To protect homebuyers from dramatic rises in the interest rate, most ARMs have "caps" that govern how much the interest rate may rise between adjustment periods, as well as how much the rate may rise (or fall) over the life of the loan. For example, an ARM may be said to have a 2% periodic cap, and a 6% lifetime cap. This means that the rate can rise no more than 2% during an adjustment period, and no more than 6% over the life of the loan. The lifetime cap almost always applies to the calculated interest rate and not the introductory teaser rate.
Payment caps and negative amortization
Some ARMs also have payment caps. These differ from rate caps by placing a ceiling on how much your payment may rise during an adjustment period. While this may sound like a good thing, it can sometimes lead to real trouble.
For example, if the interest rate rises during an adjustment period, the additional interest due on the loan payment may exceed the amount allowed by the payment cap--leading to negative amortization. This means the balance due on the loan is actually growing, even though the homeowner is still making the minimum monthly payment. Many lenders limit the amount of negative amortization that may occur before the loan must be restructured, but it's always wise to speak with your lender about payment caps and how negative amortization will be handled.
Understanding how much you can afford is one of the most important rules of home buying. Depending on your individual situation, your budget can affect everything from the neighborhoods where you look, to the size of the house, and even what type of financing you choose.
Bear in mind, however, that lenders will look at more than just your income to determine the size of the loan. Likewise, you may find that there are some creative financing options that can help boost your purchasing power.
Loan prequalification vs. preapproval
One of the best ways to determine your budget is to have your real estate agent or lender prequalify you for a loan. Prequalification is different from preapproval, because it is only an estimate of what you'll be able to afford. On the other hand, preapproval is a more formal process where a lender examines your finances and agrees in advance to loan you money up to a specified amount.
What factors are important to lenders?
Banks and lending institutions will use several criteria to determine how much money they'll agree to lend. These include:
Two important ratios
Lenders also use your financial information to figure out two, very important ratios: the debt-to-income ratio and the housing expense ratio.
Down payments make a difference
If you can make a large down payment, lenders may be more lenient with their qualifying ratios. For example, a person with a 20 percent down payment may be qualified with the 33 percent housing expense ratio, while someone with a 5 percent down payment is held to the stricter 28 percent ratio.
Other ways to improve your purchasing power
A crucial step in starting your search for a new home is having a clear idea of your financial situation. By getting a handle on your income, expenses and debts, you'll have a much better idea of what you can afford and how much you'll need to borrow.
For lenders to verify this information, though, they're going to need to look at your financial records. It is also important to remember that you should include records for each person who will be an owner of the house. So before you even visit the bank, make sure you'll be able to provide copies of these important documents:
As part of the loan application process, virtually all lenders will want to see a copy of your credit report. The report will list all your long-term debts (credit cards, mortgage payments, automobile and student loans, etc), as well as your payment history. If you don't have a copy of your credit report, most lenders will generally require you to pay for a copy when they process your loan application.
However, most real estate experts agree that it is a good idea to obtain a copy of your credit report several months before you apply for a loan. This is so you have a chance to resolve any problems with your credit before your bank sees it. U.S. Federal law ensures that you have access to your credit report, which may be obtained from your local credit bureau or any of several national firms that specialize in credit reports.
Late payments
For most people, problems with their credit report are likely related to late payments on a debt. If you were late one month in paying off your credit card, but otherwise have a good payment history, chances are most lenders won't be too concerned. But if you have a history of late payments you'll need to document the reasons why. A slow payment history won't necessarily get you turned down for a loan, but you may have to pay a higher rate of interest or otherwise prove to the lender that you can repay your loan in a timely fashion.
Errors on your credit report
Many people are surprised to learn that credit reports can often contains errors or inaccurate information. If this is the case with your credit report, you'll need to contact the reporting agency or creditor to have the problem resolved. This can sometimes be a slow process, so make sure to give yourself time to clear up the mistake.
Bankruptcies and foreclosures
There's no getting around it, a bankruptcy on your credit report is not a good thing. But that doesn't mean you still can't obtain a loan. Even though a bankruptcy may stay on your credit report for seven to ten years, lenders will often consider the circumstances surrounding a bankruptcy (family illness, injury, etc.). Moreover, if you have reestablished good credit since the bankruptcy, a lender will be more inclined to approve your application.
As part of the loan application process, virtually all lenders will want to see a copy of your credit report. The report will list all your long-term debts (credit cards, mortgage payments, automobile and student loans, etc), as well as your payment history. If you don't have a copy of your credit report, most lenders will generally require you to pay for a copy when they process your loan application.
However, most real estate experts agree that it is a good idea to obtain a copy of your credit report several months before you apply for a loan. This is so you have a chance to resolve any problems with your credit before your bank sees it. U.S. Federal law ensures that you have access to your credit report, which may be obtained from your local credit bureau or any of several national firms that specialize in credit reports.
Late payments
For most people, problems with their credit report are likely related to late payments on a debt. If you were late one month in paying off your credit card, but otherwise have a good payment history, chances are most lenders won't be too concerned. But if you have a history of late payments you'll need to document the reasons why. A slow payment history won't necessarily get you turned down for a loan, but you may have to pay a higher rate of interest or otherwise prove to the lender that you can repay your loan in a timely fashion.
Errors on your credit report
Many people are surprised to learn that credit reports can often contains errors or inaccurate information. If this is the case with your credit report, you'll need to contact the reporting agency or creditor to have the problem resolved. This can sometimes be a slow process, so make sure to give yourself time to clear up the mistake.
Bankruptcies and foreclosures
There's no getting around it, a bankruptcy on your credit report is not a good thing. But that doesn't mean you still can't obtain a loan. Even though a bankruptcy may stay on your credit report for seven to ten years, lenders will often consider the circumstances surrounding a bankruptcy (family illness, injury, etc.). Moreover, if you have reestablished good credit since the bankruptcy, a lender will be more inclined to approve your application.