RESIDENTIAL HOME FINANCING

With a fixed rate mortgage (FRM), your monthly payments will be steady. In contrast, with an adjustable rate mortgage (ARM), your payments will vary over time. Adjustable rate mortgages typically have an initial fixed rate lower than the rate of a comparable fixed rate mortgage. The initial fixed rate period is followed by adjustment intervals. For example, a “3/1 ARM” is fixed at an initial low rate for the first 3 years, and then adjusts every year based on an index. Common ARMs are: 1/1, 3/1, 5/1, 7/1, and 10/1.  To figure out your monthly mortgage payments, use this mortgage calculator.

Qualifying for a Home Loan:

Mortgage lenders are chiefly concerned with your ability to repay your mortgage. To determine if you qualify for a loan, they will consider your credit history, your monthly gross income and how much cash you’ll be able to accumulate for a down payment, which generally runs anywhere from 5 percent to 20 percent of the purchase price of the home. The lenders generally evaluate your credit worthiness by obtaining a FICO score from one or more credit rating agencies.

So how much house can you afford? You can easily calculate the answer using two standard debt-to-income ratios:

1)The housing expense, or front-end ratio, shows how much of your gross (pretax) monthly income would go toward the mortgage payment. As a general guideline, your monthly mortgage payment, including principal, interest, real estate taxes and homeowners insurance, should not exceed 28 percent of your gross monthly income. To calculate your maximum housing expense, multiply your annual salary by 0.28, then divide by 12 (months).  

2) The total debt-to-income, or back-end ratio, shows how much of your gross income would go toward all of your debt obligations, including mortgage, property taxes, home insurance, car loans, child support and alimony, credit card bills, student loans and condominium fees. In general, your total monthly debt obligation should not exceed 36 percent of your gross income.

There are  calculators that are useful in determining how much home you can afford,  which tells you the approx. amount that your monthly income needs to be to afford the house (when using this calculator, the amount given as “maximum debt service permitted” means other debt service, such as car payments, credit card payments, and other consumer installment payments; click on the “full details” box to get mortgage payments, monthly taxes, etc.), or whether to buy now or continue to rent and save for a larger down payment

Loan Terms:

Interest only loans have become very popular due to the fact that the monthly payment requires only payment of interest, and does not require a principal amortization payment. Because of this, borrowers may be able to qualify for a larger loan, and therefore be able to purchase a more expensive home, than they would otherwise be able to. The problem with these loans, however, is that the interest-only feature only lasts for a limited time, usually 5 years. At the beginning of the 6th year, however, the lender will require a significantly larger monthly payment which will include principal amortization, with this monthly payment being even higher that that of a 30 year amortized mortgage, because it is being amortized over a shorter period, which is the 25 years remaining on the mortgage. The borrower, of course, may refinance the loan at the end of 5 years, however if interest rates have increased significantly, the borrower may not have many alternatives.

Adjustable rate mortgages had generally been the mortgage type of choice in the recent past due to the previous large spread or difference between short term interest rates and long term interest rates. This had enabled borrowers to qualify for a larger mortgage than for a 30 year fixed mortgage due to the lower interest rate and the resultant lower monthly mortgage payment. The interest rate can be locked in for varying periods, ranging usually from 3 to 5 years, with the interest being readjusted yearly thereafter. The borrower is exposed, however to interest rate risk due to the potential for rapidly increasing interest rates which could significantly increase the borrowers monthly mortgage payment.

The attractiveness of the ARM over the 30 year fixed rate mortgage, however, had greatly  diminished from 2005 to 2009 due to the decreasing spread or difference between short term and long term rates. ARM’s were very attractive when there was a large difference between short-term ARM mortgage rates and 30 year fixed rates, and the spread between short and long term rates has decreased significantly. This led many borrowers to reconsider a 30 year fixed rate mortgage, in order to protect themselves from the possibility of rapidly increasing interest rates. In August 2007, however, turmoil in the sub-prime mortgage markets spilled over to the other sectors of the mortgage market, and significantly affected long term mortgage rates for non-conforming jumbo mortgages. These loans are dependent on lenders pooling these mortgages and reselling them as mortgage backed securities in the secondary markets, however investor interest in these mortgage backed securities decreased significantly, therefore raising the required interest rates on these mortgages to make them attractive to buyers, therefore leading to significant increases in jumbo mortgage rates. Rates on fixed rate long term mortgages for conforming loans, however, have not been significantly affected. See my new web blog for the latest in news about the trends in interest rates.

Prior to the sub-prime mortgage meltdown in 2007-2008, ARM lenders had offered multiple options as to the amount of the monthly payment. These options included interest only, a fixed payment regardless of the interest amount (which may result in “negative amortization”, or an increase in the loan balance, if the loan payment is less than the interest that accrued during the month), or a full amortization payment, which includes both interest as well as the principal payment required to fully pay off the loan over the loan period. Recently, however, many of these options have disappeared as lenders have raised their underwriting standards.

Locking in an Interest Rate when Applying for a Home Loan:

When applying for a loan, the borrower should obtain a “lock-in” of the quoted interest rate for a period adequate to close escrow. Lock durations can vary for mortgage financing, but most lenders lock in the interest rate for 60 days from the date the loan application is submitted. As long as the loan is closed within that lock-in period, the lender honors the agreed upon interest rate.

Some consumers are misled by advertising that quotes unrealistically low rates based on 15- or 30-day lock durations. This is called ‘short-pricing.’ The lender basically knows the borrower doesn’t have time to meet their conditions and have all the necessary paperwork in order within that brief time period. As a result, the lender is not obligated to honor the low rate that was listed in their advertising.

For simple refinance transactions, a 45-day lock-in period is more realistic. For purchase transactions, which are typically much more complex, you’re much safer going with a 60-day lock, even though the interest rate might be a little higher than the rate you see quoted on billboards and the Internet.

Borrowers should make sure they have a written rate lock agreement, and allow themselves a reasonable amount of time to close their loan.

Lender’s Required Loan Estimate Form:  Before October 3, 2015 lenders were required to provide potential borrowers with a Good Faith Estimate within three days of their application, and most experts recommended against committing to a loan before seeing it. In many cases, the GFE has been replaced by the Loan Estimate.

Conforming Loans, FHA insured loans, and Non-Conforming Loans:

Loans are generally categorized by either being “conforming” loans, or “jumbo” loans. Conforming loans are those loans that conform to the requirements of such secondary loan agencies as Fannie Mae (Federal National Mortgage Association) or Freddie Mac (Federal Home Loan Mortgage Corporation ) . These Federal Agencies buy these loans from loan originators. These organizations were originally chartered by Congress to facilitate selling mortgages in “pools” of funds to secondary investors, and reinvesting the proceeds in new mortgages. Both of these organizations had been privately owned by shareholders and chartered by Congress, however are now owned by the Federal Government due to large losses incurred in the housing downturn in 2008. Since the cost of funds for Fannie Mae and Freddie Mac are lower than other lending sources, the interest rate of conforming loans are significantly lower than loans exceeding the conforming loan limits.

Conforming loans generally require a minimum down payment of at least 20%. The Federal Housing Administration (FHA) provides a program of insuring qualifying loans that may have a down payment of as low as 3.5% for borrowers with a FICO score of at least 580. Loans with 10% down payments require a minimum FICO credit score of 500.. These loans are not purchased by the government, but are simply insured for loss by the Federal government, therefore the interest rates on these loans are among the lowest available. Loans that are FHA insured requires Private Mortgage Insurance if the down payment is less than 20%. There is an up front mortgage insurance premium equal to 1.75% of the loan amount that is paid at settlement. In most cases, this mortgage insurance premium is included in your loan amount, so you are really paying it over the life of the loan. In addition, on loans with a term of greater than 15 years and a loan-to-value ratio of 90% or greater (meaning you are borrowing more than 90% of the value of the home), you will pay an annual mortgage insurance premium in monthly installments.  The monthly mortgage insurance premium is dependent on the down payment percentage and the loan amount.

The loan limit effective 1/1/19 for a conforming loan is $484,350 (previously $453,100). For certain high cost areas such as Los Angeles there is a higher limit for so-called “Jumbo conforming loans”  between $484,350 and $726,525 (previously $679,650 ). Jumbo loans in excess of $726,525 also require a much higher down payment of 25 to 30%. In high-cost areas including Los Angeles county, the new FHA loan limit ceiling as of 1/1/2019 increased to $726,525, up from $679,650 in 2018. The FHA also increased its floor to $314,827, up from 2018’s $294,515..

 

The Veterans Administration (“VA”) Loan

The VA mortgage program is one of the few home loans that hope to make owning a home in America easy for service members. Although the application process has become stricter with time due to the recent wave of foreclosures, it still is a lot faster and less stressful than conventional programs.  

The U.S. Department of Veteran Affairs insures the home loan up to 25% and sometimes more in expensive locales.  Lenders will offer great rates because of this. In addition, closings costs, origination and appraisal fees tend to be low.  VA loan limit for Los Angeles County is $716,525 for 2018.

VA  loans also require no down payment. Conventional loans generally require no less than 20% down. The veteran must pay the closing costs, but the seller is allowed to pay these if negotiated. A funding fee is required (2.5% as of 1/1/18 for a 3% down). However, with a down payment over 3.5%t, the fee can be lowered.  

The monthly mortgage payment in itself can also be reduced with a sizeable down payment. The VA does allow the use of borrowed funds from relatives and other sources for the down payment.

Other ways the monthly payment is substantially lower than a conventional mortgage is that the VA does not require Private Mortgage Insurance (“PMI”). That means a veteran homeowner saves $100 to $200 more than conventional borrowers.  Other advantages to the VA loan is that VA Loans are assumable, provided the borrower assuming the mortgage is qualified, Veterans’s closing costs are limited by the VA, Additional assistance is offered by the VA should veterans have problems making their home loan payments in the future, and  Prepayment of the loan without a penalty is required.

Applying for a VA Loan

Veterans, active duty service members, reservists and members of the Public Health Service who are honorably discharged can take advantage of the VA loan. Eligibility is determined based on the following factors:

·     Served in the military for 90 days during wartime.

·     Served 181 days during a time of peace.

·     Honorably discharged.

Additional information on VA loans can be obtained at  http://www.benefits.va.gov/homeloans , and a web blog written by James Kelley ( who wrote the above VA loan summary) at http://vabenefitblog.com/

“Making Home Affordable” Loan Refinancing and Modification Program

Current Federal government programs the new Fannie Mae and Freddie Mac Flex Modification program established October 1, 2017 to replace the Home Affordable Modification Program (“HAMP”) which expired September 30, 2017 and the Homes Affordable Refinance Program (“HARP”) for Freddie Mac and Fannie Mae loans which expired at the end of 2018 .

The program, called Flex Modification, went into effect Oct. 1, 2017.

For information on the tax impact of refinancing, short sales or foreclosures see my web pages income tax issues or foreclosure properties.

  • Effect of Federal Reserve Funds Rate or Discount Rate on Long Term Mortgage Rates
  • Many borrowers are confused as to what the impact on mortgage rates is when  the Federal Reserve (the “Fed”) chooses to raise or lower short term interest rates. The Fed does this by  changing the “Discount Rate”, which is the rate at which member banks may borrow short term funds directly from a Federal Reserve Bank. This rate is set directly by the Federal Reserve. The Federal Reserve can also indirectly impact short term interest rates by open-market transactions (buying and selling government securities), which will impact the “Federal Funds” rate. The federal funds rate is the interest rate that banks charge each other to lend excess funds that they have on a daily basis, and is also referred to as an “over-night” rate. The discount rate and the federal funds rate is an important factor in determining other short-term interest rates that banks charge, such as the Prime Rate, which banks use as a factor in computing the interest rate on short term loans.  Since the actions of the Federal Reserve only directly affect short-term interest rates, the effect that they have on longer term mortgage interest rates is really an indirect one, and can often lead to a short term effect on long term mortgage rates that is the opposite of the move in short term interest rates.
  • The short term effect that the Federal Reserve’s actions have on mortgage interest rates is based on the interaction of the stock and bond markets (primarily longer term bonds and mortgage-backed securities), and will often lead to a short term effect on long term mortgage rates opposite that on short term rates. For instance, when the Federal Reserve increases the discount rate or federal funds rate, the stock market generally will react by selling off stocks due to the anticipated reduction in corporate profits due to the higher interest rate that companies will be paying on their short term borrowings. Investors will generally reinvest the proceeds from these stock sales in bonds, thus increasing the demand for long term bond investments, and an increase in the price of bonds. This increase in pricing of bonds effectively leads to a decrease in these bond’s interest rate yield to an investor, thus leading to a drop in the market long term interest rates.
  • On the other hand, when the stock and bond markets long-term inflationary expectations are similar to that of the Federal Reserve Board which sets the federal funds rate, the impact on long term mortgage rates may move in the same direction over the long term as the direction in short term interest rates set by the Federal Reserve. This is due to the fact that if the bond markets believe that inflation, over the  long term, is going to be increasing, then the interest rate yields that they demand to buy bonds, which are a fixed rate investment, will increase, at the same time that the Federal Reserve is increasing short term interest rates in an attempt to slow the economy down by making the cost of borrowing funds by companies more expensive.
  • This is why it is so important for your financial advisor and mortgage broker to understand these market forces which affect mortgage rates, both for short term rates as well as long term rates, and to be able to advise you as to whether it makes more sense for you to choose a mortgage instrument tied to short term rates, or to  fix your mortgage interest rate for a longer term. Understanding the market cycles of both short term and long term interest rates, and where we are in each cycle is critical in helping you make a choice as to whether to lock-in current long term interest rates, or to use a shorter term adjustable rate mortgage.
  • The spread, or difference, between short term interest rates and long term mortgage rates will also have an important effect on this decision. For instance, when the stock and bond markets believe that inflation, over the long term is generally under control, thus leading to relatively low long term interest rates, the Federal Reserve may be raising short term interest rates because they believe that the economy is growing too fast which may lead to future inflation. In this case, the difference between short and long term interest rates decreases, thus leading to a very flat interest rate yield curve (this is a term referring to a graph of interest rates, with shorter terms on the left of the graph and longer terms moving to the right, and plotting the related interest rate for each period of time). In this example, the advantage of selecting an ARM is not large enough to offset the risk of increasing interest rates, therefore a long term mortgage may be desirable. In the case where the spread in interest rates between short term and long term interest rates is large, it may be advantageous to select the ARM mortgage, particularly if the borrower expects to only live in the home for a relatively short period of time.

Reverse Mortgages:

For seniors, there is a relatively new mortgage available called a reverse mortgage. This type of mortgage is useful for people who have a large equity in their home, but who live on a fixed budget and find it difficult to live on their current income. Many seniors in this situation are forced to sell their homes. Instead of selling your home, a reverse mortgage pays the home owner a fixed amount each month while they own the home, with the mortgage amount thus increasing each month for the amount of the payment, plus interest. There are several types of reverse mortgage products, one of which, the Home Equity Conversion Mortgage which is used by 90% of reverse mortgage borrowers, is federally insured. All reverse mortgages are due and payable when the last surviving borrower dies, sells the home, or permanently moves out of the home. (Typically, a “permanent move” means that neither you nor any other co-borrower has lived in your home for one continuous year.)  For those homeowners who are sophisticated, they can effectively accomplish the same thing by obtaining a home equity line of credit, which is relatively inexpensive to obtain, and designing their own monthly draw program on their loan by utilizing a payment calculator using various assumptions about their age, home value etc.

An excellent web site for borrowers is one run by Jack M. Guttentag, Professor of Finance Emeritus at the Wharton School of the University of Pennsylvania, which is called Mortgage Professors’ Web Site. This site contains many excellent articles and advice on obtaining a mortgage and also includes many very useful calculators.

Sources of Funds for a down payment:

Sources of funds to make a down payment on a home can come from one of several sources:

1) Savings

2) Home equity line of credit on your existing home

3) Borrow money from your 401(K):  You may borrow money from your 401(K) for a down payment on a home purchase, if the plan allows for it without a penalty. You may not borrow money from your IRA for a down payment, however 1st time buyers, may withdraw funds one time with out paying a penalty, up to $10,000, however you would have to pay income taxes on the withdrawal.

4) Equity from the sale of your existing home or investment

For some excellent articles and discussions about financing your home, click on one or more of the following website links:

Bankrate.com

Quicken Loans

Bank of America Financing Advice and Articles

E-Loans

For some information on the level of recent interest rates, Click Here

I recommend the following mortgage brokers for assistance in arranging your financing: