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Mortgage Blog

Oct 17

Why Will Some Lenders Reject Borrowers That Other Lenders Accept?

Some mortgage applicants will be accepted by every lender and others will be rejected by every lender. However, there is a group of marginal applicants who will be rejected by some lenders and accepted by others.

During the period 1920-34, before the development of secondary markets and mortgage insurance, the risk associated with every mortgage loan was entirely borne by the lender making the loan. The number of marginal applicants was sizeable in that period because each lender had its own underwriting requirements, which varied widely, depending on their business model. Those focusing on generating large loan volume would have more liberal requirements, but would also charge higher rates to cover the larger losses resulting from that policy. The rates charged by more selective lenders would tend to be lower.

The vendor-neutral mortgage professional of that era, if there had been one, would have advised borrowers who could meet the requirements of a selective lender to patronize such a lender. Borrowers with strong credentials who unwittingly placed themselves in the hands of a volume-oriented lender with liberal requirements, would usually overpay.

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Oct 11

The Take on Closing-Cost Rebates

The government shutdown and the debt limit have dominated the headlines, but a behind-the-scenes fight over federal mortgage policy has been brewing and it could affect your choices the next time you apply for a home loan.

The issue concerns differing rules for different types of mortgage sources. Some mortgage brokerage firms have begun advertising that they offer substantial credits to their customers -- often in the $2,000 to $5,000 range per loan but sometimes more than $10,000 -- that can be used to defray borrowers' closing costs. A survey of 164 member firms of the National Association of Mortgage Brokers found that these companies provided more than $69 million in closing-cost credits to clients last year, and are on track to pay out the same or more this year. The group estimates that brokers nationwide rebated upward of $2 billion in 2012.

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Sep 13

Smart Mortgage Shoppers Understand Mortgage Pricing

Mortgage pricing is a complicated process. The first step for any borrower looking to obtain the best possible price is to learn how the pricing process works.

Each Mortgage Type Is Priced Separately

A 30-year fixed-rate mortgage (FRM) carries a different price than a 15-year FRM, and the same is true of each type of adjustable rate mortgage (ARM). Loans carrying special options, such as prepayment penalty or interest-only, are also priced separately.

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Sep 6

Fix Up a Home Before Selling it, or Not?

Recently I put my home up for sale, and because it needed a new roof, deck, and septic system, came face to face with this question. This article is based heavily on that experience, in which I made a serious mistake that other sellers can avoid.

Attend to Cosmetics

It is easier to sell a house that is attractive to potential buyers, which means that you spend a little time and money on cosmetics. This is partly just a matter of making sure it is clean, the yard is neat, the driveway is swept, bushes pruned, and so on. Easily-fixed structural defects, like a loose shingle, should be fixed.

Houses almost always look better when furnished than when empty – they also look larger! If you are moving to another residence and plan to take your furnishings with you, if possible, arrange things so that you show the house before you move out of it.

However, if your house also has structural defects that are costly to fix, as mine did, the challenge is in deciding whether or not to fix them before sale.

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Jul 26

The Fully Amortizing Mortgage With Equal Monthly Payments: An Under-Appreciated (and Often Misunderstood) Blessing

The standard mortgage contract in the US today calls for full repayment of the balance over the term with equal monthly payments of principal and interest. For example, a $100,000 loan at 6% for 30 years has a monthly payment of $599.56. That payment, if made every month, will pay off the loan in 30 years. I will save space by calling a fully amortizing mortgage with equal monthly payments a FAM.

Under-Appreciation

The great virtue of the FAM is budgetary convenience for the borrower, plus the prospect of full payoff at the end of the term. It is underappreciated by those who have not considered the alternatives.

One alternative, which was very common during the 1920s, was for borrowers to pay interest only until the end of the term, at which point they had to pay the entire balance. If they could not refinance, which was frequently the case during the depression of the 1930s, the alternative was foreclosure -- until the creation of the Home Owners Loan Corporation (HOLC), which bailed out many distressed borrowers.

Another way to pay off the balance by the end of the term is to pay interest plus equal monthly principal payments. For a long time, this was the method used in New Zealand. In my example, this would require a principal payment of $100,000/360, or $277.78 a month. In the first month, interest would be $500, making the total payment $777.78, as compared to $599.56 on the FAM. While the payment using this approach would decline over time, the borrower's ability to afford a given-priced house would be reduced, which is why New Zealand ultimately replaced it with the FAM.

The FAM was developed and used by our early building societies, which were mutual institutions that later evolved into savings and loan associations. In 1934, the newly-created FHA declared that all FHA-insured mortgages had to be FAMs. Within a few years, the FAM had become the standard for the industry.

Misunderstandings: The Conspiracy Theorists

The feature of a FAM that generates misunderstanding is that the composition of the monthly payment between interest and principal changes over time. In the early years, the payment is mostly interest while in the later years it is mostly principal. This has given rise to the allegation that the way lenders charge interest is both unfair and self-serving – possibly even sinister. The following statement is typical.

"All mortgages are front end loaded, meaning you're paying off the interest first. So during all of those first years, you aren't paying down the principle. Instead, you're buying the banker a new Mercedes...Your 6% mortgage is really costing you upwards of 60% or more!"

This is nonsense, but it is widely believed nonsense. Interest payments in the early years are larger because the loan balances on which the interest is calculated are larger. On the 6% $100,000 loan, the interest payment in month 1 is $500 because the borrower owes $100,000, in month 253 the interest payment is $250 because at that point the borrower is owed only $50,000. The lender is earning the same annual rate of 6% in month 1 and month 253.

If large interest payments in the early years really generated additional profits for lenders, they would prefer 30-year to 15-year mortgages, because interest payments on the 30 are higher in the early years and don't decline as rapidly. They should therefore charge higher rates on 15s. In fact, they charge lower rates on 15s.

Mortgage lenders have enough to answer for without saddling them with a charge that is wholly bogus.

Misunderstandings: Borrowers With Multiple Mortgages

Borrowers with more than one mortgage who are deciding how they should allocate their extra payments, sometimes go astray for the same reason.

"I am coming into a large sum of money that I intend to use to pay down my mortgage balances. I have a first mortgage at 4.5% and a second mortgage at 6%, but the second is more recent and a smaller part of the payment goes to principal. Am I thinking correctly that I will save more interest by paying down the first mortgage?"

This is a perfect illustration of the old adage that a little bit of knowledge can be a dangerous thing. Borrowers who don't understand how FAMs work assume correctly that you pay down the highest rate loan first. It is only borrowers who are aware of how the mortgage payment is divided between interest and principal who mistakenly believe that they will do better directing their extra payment toward the mortgage on which the principal payment is the highest. The mistake is in not realizing that 100% of extra payments are always allocated to principal.

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