Few people would search for a new car by visiting a single automobile dealer. The same should hold true for mortgage financing. To get the best deal, one must shop around. This is an enormously useful activity because the mere process of speaking to mortgage loan officers, real estate brokers and others is educational and potentially profitable.
To market their product--the rental of money--lenders disseminate vast amounts of information through advertising, direct public contacts, advisories to the real estate community and the news media. While the availability of information should certainly be regarded as beneficial to the public, the sheer volume of data is often makes it difficult to absorb or analyze. Not only is there a lot of information, but it is forever in flux--today's interest rates and terms at 50 different community lenders could easily change by tomorrow.
The information problem is compounded by imprecise definitions. What, for example, is an adjustable-rate mortgage? Basically, an ARM is a BUYING and SELLING mortgage in which the lender has the right to change the interest rate in accordance with a specific index. But the number of ARM formats, each with its own distinctions, is virtually endless.
Fannie Mae (the Federal National Mortgage Association) has defined eight standard ARM formats, but it has also purchased at least 125 non-standard mortgage products. In addition, there must be other ARM formats developed by local lenders which are not for sale or which are not acceptable to Fannie Mae.
Not all loans, even those with identical labels, are created equal. And the differences may be financially significant to individual borrowers.
There are many questions that should be asked to get a solid grasp of mortgage trends. For example:
* What is the current principal balance of the existing loan?
* What is the remaining term of the mortgage?
* If the loan is a fixed-rate instrument, what is its rate of interest?
* If the loan is an adjustable-rate mortgage, what is its current rate of interest? How often may the lender change the rate? When was the last rate change? Is there a cap on individual rate changes Is there an absolute cap on the loan rate, say no more than 15 percent interest regardless of any index changes? Is there a minimum level of interest? If the index used by the lender dropped sharply would it be possible to have a 6 percent mortgage? What index is used to determine rate adjustments? (Different lenders use different indexes such as the sale of certain Treasury notes or the prime rate of a particular bank. It can be argued that long-term indexes, say three to five years or more, favor the borrower since they are less prone to sudden changes than are short-term measures.)
* If the existing financing is a graduated--payment loan, what is its schedule, if any, of monthly payment increases?
* Is there a prepayment penalty? (Prepayment costs are limited in some states.)
* If the loan is assumable, does the lender have the right to raise its interest rate when the borrower changes?
* With an existing assumable loan, does the lender reserve the right to approve the new borrower. (In some cases a new borrower may only be "approved" if the lender can get a better rate of interest.)
* If the loan is assumable and has a low interest rate, the type of financing most lenders are eager to purge from their portfolios, will repayment at a discount be permitted? For instance, if a homeowner owes $20,000 at 6 percent interest, would the lender accept, $15,000 in full settlement of the note? If so, be certain to investigate the tax consequences.
To find information on new financing, call loan officers at savings and loan associations, commercial banks, mortgage bankers, credit unions and other lenders. Local real estate brokers are also an excellent source of real estate market information. Question to ask about new financing include:
* Are you making mortgage loans? If not, who is?
* What is your current rate of interest for conventional financing, that is, a loan for 80 percent of the purchase price of the property.
* In general terms, given an annual income of so many dollars, how much mortgage can I afford? The answer will usually be a formula, such as 1.6 times annual income, two times annual income or 25 to 28 percent of gross monthly income. Do not expect precise answers, or a loan commitment, over the phone.
* Is the rate quoted the nominal level of interest or the annual percent rate (APR)? Use the APR, a figure which tends to be higher because of compounding, as a standard when comparing rates.
* Does the APR figure include the value of points? (Note that in those cases where the points are divided between buyers and sellers, the effective loan cost to purchasers will decline.)
* Does the lender offer FHA or VA financing? Graduated payment loans? Adjustable-rate mortgages? Other formats?
* As a matter of policy, does the lender reserve the right to change the rate of interest between the time the loan application is made and the date of settlement? Some lenders closely follow the market while others guarantee that the rate quoted at the time of application will be in effect at settlement.
* On an adjustable-rate mortgages, how frequently may the lender change the rate of interest? Is there an overall interest cap?
* Is there a penalty if the loan is repaid early?
* Is the loan assumable? (FHA and VA loans have traditionally been assumable while other loans, particularly those issued after 1978, generally are not or are assumable only in those cases where the lender has the right to change the rate of interest or approve a new borrower.)
* Does the lender offer private mortgage insurance? This is a form of insurance where a third party guarantees partial repayment of the loan to the lender. This guarantee reduces the lender's risk. For this reason a smaller down payment, say 5 to 15 percent, will be acceptable to the lender. For its part in the transaction, the private mortgage insurer gets a fee, often 0.25 percent of the outstanding monthly mortgage balance.
* Will the lender escrow money to assure payments for property taxes, PMI fees or other liabilities? Escrow funds must be paid at settlement and are an additional cash expense to borrowers. Lenders commonly hold money in trust to assure the payment of property taxes, a claim which takes precedence over mortgage obligations.
* What rate of interest is paid on funds held in escrow?
* What fees does the lender require? For example, what is the cost of a mortgage loan application. Is all or part of that money returned if the application is rejected? In addition to an appraisal, which is required for virtually all mortgage loans, will the lender need a survey or photo of the property? If buying a condo or co-op, will the lender require a legal review? If so, at what cost?
Next week: Modern mortgage issues.