Arizona Mortgage Pro

First, let’s go over the basics of an Option ARM (adjustable rate mortgage). Option ARMs go by many different names depending on the lender offering them, but the general idea remains the same, flexibility and extremely low monthly payment options. You’ve probably seen TV commercials or gotten mailers offering too good to be true payments if you are a homeowner (even if you aren’t). These are almost exclusively Option ARM offers. They typically offer at least three payment options; fully amortizing (principal and interest), interest only (just interest), and lowest payment (less than just interest). Generally, people use Option ARMs to control their monthly cash flow because the loans have payment options that are lower than any other type of loan. In a moment I will cover a strategy to accomplish this without the negative aspects of an Option ARM.

Without getting into the technical business of caps/margins/indexes, Option ARMs are able to offer lower payments than other loans because the lowest payment option is negatively amortizing. In other words, you are using a little bit of your equity each month to subsidize your mortgage payment and keep it artificially low for cash flow reasons. If you are knowledgeable about financial matters and have no problem with a little risk, these loans can be a great tool. In my opinion, most people not heavily investing or not in a rapidly appreciating market should avoid them.

The drawbacks of Option ARMs are possible negative amortization, higher rates than comparable conventional mortgages, tougher guidelines for loan approval, and a higher likelihood of prepayment penalties. As I write this in June 2007, the actual rate that the best qualified borrower is paying on an Option ARM is somewhere between 7-8%. Even if the start rate or teaser rate is 1% (I’ve even seen 0.95%), the rate that the borrower is actually paying on their money is over 7%. The difference between the start rate, which determines the payment, and the actual rate, which determines how much interest you pay, over 7% comes out of the equity of the home each month.

So how do we get the benefits of an Option ARM without the drawbacks? The answer is a Mortgage Reserve Fund (MRF). An MRF is simply a checking or savings account that your mortgage payment is drawn from each month. I think savings accounts work better because of the limited accessibility to the money.

The MRF is established when a borrower deposits money from the equity in their home after a refinance. The borrower then automatically pays their mortgage with the MRF each month and deposits the amount they were going to pay to the lender into the MRF account. In other words, rather than having small amounts of equity taken off the top every month by the negatively amortizing loan, the borrower is managing these equity payments themselves. The amount to start the MRF with is determined by multiplying the number of months a borrower wishes to subsidize their mortgage payment by the amount they wish to subsidize every month. For instance, if you wanted to lower your monthly payments by $200 a month for 2 years (suppose you had a child with two years left of college), you would take out $200 x 24 months ($4,800) extra during the refinance process to start your MRF.

In our example, if a borrower was refinancing $100,000 and was considering an Option ARM because it had the option of payments that were $200 lower than a conventional loan, they would simply refinance $104,800 and start a reserve fund to accomplish the same goal, but with some added benefits.

One major benefit of an MRF is that it can be matched with any loan because it happens after the loan process. Another is that it acts as a sort of buffer for your mortgage payment. If you contribute to your MRF fund a little late, it’s ok because your mortgage payment is still automatically drawn from that account and it has extra room built in. Not to mention the fact that you have money handy in the case of an emergency. Lastly, and most importantly, you are able to qualify more easily for a mortgage with lower rates and less chance of a prepayment penalty. You would not be subject to the stricter guidelines and program limitations of Option ARMs because you can choose any program you wish and turn it into something that behaves in the same way as an Option ARM.

Many people would probably argue that it isn’t smart to take equity out of your house because you have to pay interest on money that you aren’t directly using. I believe the difference is negligible because you can use a high interest savings account as you MRF (they are available over 5% currently). On a small amount of money, this difference shouldn’t make a large difference and the benefits far outweigh this drawback. The idea of paying 1% or more less in interest on your entire mortgage balance should convince you that the small amount of negative interest you are paying on the money in your MRF is insignificant.

This concept is fairly advanced as far as mortgages go, so feel free to contact me if you have questions regarding this topic or any other mortgage related concern. If you live in Arizona, I would be happy to help you set up an Mortgage Reserve Fund with your refinance.

With the exception of a few types of mortgages, most lenders will require borrowers to show assets along with their income documentation. Assets as they pertain to a mortgage are sometimes referred to as “reserves.” Reserves are the number of months worth of mortgage payments you have available in assets. For a simplified example, if you are applying for a mortgage that has a total PITI* payment of $1,000 a month and you have $6,000 in your checking account, you have 6 months of reserves.

If you have a strong credit profile, very few, if any, reserves are necessary. If you have a little bit weaker profile (maybe a lower credit score or high loan-to-value ratio), reserves can help you qualify for a mortgage you may not have without them. The reasoning behind reserves is that if something were to happen to the borrower along the lines of a work layoff, serious illness, or accident, the mortgage would still be paid while the unexpected situation sorts itself out.

Assets are shown in a couple of different ways. The most common is to provide bank statements for asset accounts. These assets are usually 401k, checking, savings, IRA, mutual funds, stocks, etc. All pages of the statement must be shown and occasionally more than one month. Most underwriters will accept this method of documentation for assets.

The second way to document assets is called a verification of deposit (VOD). This requires the borrower to provide the mortgage broker or lender with their bank account info (bank and account number). The broker or lender then sends a standard form to the bank where the account is held. The bank generally verifies the amount in the account, average daily balance, and two months worth of balances.

“Seasoned assets” are those that have been in an account for two months or longer (some banks require three months). The reason most banks require seasoning is so that a borrower can’t just put assets (most likely not their own) into an account for the purpose of showing reserves and then remove them. Underwriters want a true picture of a person’s financial situation when approving them for a mortgage.

Certain assets are considered at face value and others are discounted. Liquid assets such as checking, savings, and mutual funds are generally considered at face value meaning if you have $3,000 in your checking account, they will give you $3,000 worth of consideration for those assets. Other assets such as 401ks, IRAs, stocks, bonds, etc. are usually taken at about 70% of face value. The reason for this is that most retirement accounts have penalties (taxes and early liquidation), so they are not worth face value in a crisis. Also, stocks may be worth one thing today and less tomorrow, so they are not usually taken for full value.

As I mentioned before and in other articles, some mortgages either don’t require assets, or they are not verified, meaning you simply how much you have in the bank and the lender takes your word for it. Obviously, this is more risky for the lender, so it can come with higher rates. With a strong credit profile, it may not cost you anything as far as rate or costs.

As always, if you have any questions regarding asset documentation or anything else, please do not hesitate to call or email me for a quick answer.

Arizona Mortgage Pro

I'll attempt to give a brief overview of the confusing world of loan closing costs. I'll go over the main three categories of closing costs and what are included in each. In my next post, I'll discuss the monies due at loan closing that are not considered closing costs and why. This post refers to a purchase or refinance loan transaction, not the sale of a home, which incurs different fees.

Closing costs are broken up into three main categories, appraisal fees, lender/broker fees, and title fees. Appraisal fees are the least complicated of the three categories. On the vast majority of loans, there is only one fee for the appraisal. This fee can range based on the size of the house and the type of appraisal ordered. The standard fee for a medium sized owner occupied house in Arizona is roughly $350 right now. Houses with larger square footages require more work and therefore, have higher appraisal costs. Also, investment properties generally have higher fees because lenders require two extra forms included with the appraisal, a rent survey and income statement. The appraisal fee or fees should be in section 800 of a properly filled out Good Faith Estimate. You may pay these fees directly to the lender, but they will eventually be paid to an appraiser for services rendered.

The second category of closing costs consists of lender/broker fees. These are also contained in section 800 of a properly filled out Good Faith Estimate. There are many different lender/broker fees that could be found in this section. If you are paying any points on a loan, they will be in this section. Also, broker fees, credit report fees, loan origination, escrow waiver fees, tax service fees, processing fees, underwriting fees, etc. The basic point of this section of the Good Faith Estimate is to encompass any fees being charged by the broker or lender in a loan transaction (with the exception of the appraisal fee, which also resides in section 800).

The third category of closing costs includes any fees associated with the title company. These fees are included in section 1100 & 1200 on a Good Faith Estimate. They are the fees required by the title insurance agency for the various jobs they perform in closing your loan. Usually, the largest sum of the title fees is for title insurance. The title company researches the history of the title on a property and insures that it provides accurate information to all parties. Another large chunk of the title fees is for the closing or escrow fee. This is the fee charged by a title company to prepare the closing documents for signing, go over the closing documents with the borrower, notarize them, and make sure they are accurate. There may also be other fees included in the title section for smaller items such as endorsements (don't ask), release and tracking fees, recording fees, notary fees, etc.

Those are the main closing costs associated with the vast majority of loans (I haven't seen any others, but that doesn't mean they don't exist). There are other items contained on a Good Faith Estimate, but they are not actually considered "closing costs." I will go over those items in my next post.

I am always available to answer questions on closing costs and/or other mortgage related items. If you have received a Good Faith Estimate from a lender and would like to make sure you are not being over-charged, I will be happy to look it over for you. You can contact me by following the links on the left side of this blog or email me at jmoran@azmortgagepro.com or call me at 602-476-7323.

The limits for loans that qualify as conforming have risen again on the heels of rising home prices. The new limit for a 1 unit property is $417,000, effective immediately.

Credit reports and agencies remain one of life's largest mysteries to most of the population. Hopefully, I can clear up a little bit of the fog that surrounds them here.

What is a credit report? Credit reports are generated by credit reporting agencies. These agencies collect information about a person regarding debts, public records, and credit inquiries. There are three main agencies (Transunion, Equifax, and Experian), which I will discuss at greater length in a minute.

Credit reports contain valuable information for anyone looking to determine how credit worthy or employable a person is. The basic personal information listed is as follows; name, social security number, most recent addresses, and birthdate. The debts are broken out into a separate section and contain the name of the creditor, the account number, the highest limit available, the current balance, the current monthly payment, the term, and most importantly, payment history. The "term" refers to the agreed upon length of time the debt is to be repaid. Credit card terms are referred to as revolving because they have no set timeframe for repayment. The public records section of a credit report lists things such as judgments, property liens, and bankruptcies. The final section of a credit report contains the recent inquiries received by the credit agencies.

What is a credit score? Credit scores are a basic measurement of a person's creditworthiness. They weren't always a part of credit reports. In the past, people were forced to read through an entire report and subjectively decide how credit worthy a person was. The change to the credit score system has made the process of obtaining financing and employment much more efficient (that is not to say it doesn't have it's own flaws).

Credit scores were developed by a company called Fair Isaac Company (FICO) and FICO scores remain the most common measure of a person's ability to repay debt. FICO scores range from 350-850, with the average score being somewhere in the 680 range. Credit scores under 620 are most likely relegated the "subprime" sector (see my June 13th post for more on that). Generally, if you have a score over 780, you are in the highest possible credit bracket as far as lenders are concerned. In the mortgage industry (possibly in others too, though I don't have the experience there), the middle credit score of the three major credit reporting agencies is considered the representative score. In other words, the high and low scores are thrown out and the middle is used to determine creditworthiness. This is to prevent a mistake or flaw in one agency's reporting to irreparably damage a person's ability to obtain credit.

"No Cost" credit reports You have seen them listed everywhere and it is one of the most prevalent types of email you don't want to receive. So what's the catch? If you order your credit report on any website that promises to pull your credit and give you a score and you don't have to pay for it, they will almost always sell your information to solicitors. Prepare yourself for the barrage. As far as I am aware (disclaimer), if you go directly to the three credit bureaus and pay them for your report, your info will not be sold to third parties.

Who are the three credit reporting agencies and how can I get in touch with them? As discussed above, the three major credit reporting agencies are Transunion, Equifax, and Experian. You will notice that there are links to each agency's website. If you would like to get a copy of your report to check for accuracy, these are the sources I would recommend. The $30 you spend to get the info straight from the source may save you hours of headaches from solicitors.

Those are the basics of credit reports. I will write another article in the future discussing late payments, inquiries, "good" debt, and other in depth issues concerning credit.

Recently, several lenders (though not all just yet) have increased their conforming loan limits to $400,000, up from $359,650. This change will likely spread to all lenders in the near future, but it is available now.

Conforming loan limit refers to the highest loan amount available without crossing into the "jumbo" loan category. Conforming rates are generally the lowest fixed rates available. This increase is probably a reaction to the rapidly rising cost of real estate.

Arizona Mortgage Pro

The Prime Rate (as published in the Wall Street Journal) is up another .25% to 6.25%. This marks the 10th straight quarter point increase since June '03.

I hear the following statement at least five times a day, "My neighbor's house is listed for X and mine's bigger, so my house must be worth Y." Replace X and Y with values that make sense in your neighborhood and you've probably heard it too. For this reason, I am going to go over the basics of how a residential appraiser finds value (FYI-this is not how income producing properties are appraised, but that's another subject for another blog).

Residential appraisals are based on three or more closely comparable sales. A common mistake borrowers make is comparing their home with a home that is listed for sale on the market. Just because someone lists a home for $1,000,000, doesn't mean that's what its worth or that someone would pay that amount for it. This is the first inconsistency with the statement above. Appraisers will check the recent sales in a neighborhood (usually they try to stay within one mile if possible). Pending sales may be an optional addition to an appraisal for a little extra support, but they cannot be used a true comp unless they are closed and ownership has changed hands.

Another common mistake people will make in trying to determine their own home value is ignoring comps that are lower. An appraiser can't simply ignore comparable sales that are lower than the target value, they have to take into account any home that is similar to the subject property. Its easy to search through recent sales and pick and choose a home here or there that would support a home's higher value, but the underwriters who approve loans have access to the same recent sales list. If you ignore comps, the underwriter will throw out or cut the value on an appraisal, making it virtually useless. Appraisers who do this repeatedly will get themselves blackballed from lenders and probably out of business shortly thereafter.

Now we know what appraisers use to determine value, how do they come up with the exact figure? An appraiser will line up the subject property and the three closest comparable sales and adjust them for positive and negative attributes. For instance, if the subject property has more square footage than one of the comps, that property will be adjusted downward. Other attributes that may cause increases and decreases in the home comparisons are # of bedrooms, # of bathrooms, lot location, views, lot size, garage size, upgrades to kitchen and baths, fireplaces, and on and on. Many of these items are quantifiable such as number of bedrooms and bathrooms. Others are more subjective like views and lot location. After putting all of these variables together for each comparable property versus the subject property, the appraiser comes up with adjusted values for the comps based on the sales price plus or minus the adjustments. It is then just a matter of averaging the values and coming up with a final value figure.

So you can see, the time the appraiser is actually inspecting the property is only a fraction of the time spent on each appraisal. Also, the value is not affected in any way by the listed sales price of homes in your neighborhood. The appraiser I use whenever possible in the Phoenix area is Appraisal-Tek (Trust-Experience-Knowledge). If you are in need of an appraisal, I highly recommend you look them up here:

www.appraisaltek.com

Please feel free to contact me with any questions or comments you may have on this post, blog, or real estate related issues:

Arizona Mortgage Pro

The term subprime refers to any loan which would not fall into the category of an A or A- ("prime" mortgages). A and A- (A- refers to just outside the scope of the best credit situation) loans are basically for those people who have good or excellent credit, no judgments or liens, and gainful employment for the past two years (not in all situations, but usually). The loans that are pruchased on the secondary market by mortgage giants Fannie Mae & Freddie Mac are generally referred to as A paper. These are usually the best rates available and most often the ones you will see advertised online, in print, and on tv.

However, not everyone fits into the neat little credit situation that A paper requires. These loan are referred to as subprime or B, C, & D paper. This is where people with bruised or bad credit will likely find themselves getting a loan. The terms are generally a little worse and many of the loans do contain prepayment penalties. That doesn't mean that these loans can't be beneficial. For someone who has had extenuating circumstances, a subprime loan can offer them a period of time to stay in their home and repair their credit. This is also the main reason most subprime loans contain short terms. Most subprime loans will be a 2 year ARM with the thinking that a borrower will use those two years to clean up the issues that forced them to obtain a subprime mortgage. Life can really throw some unfortunate situations at people, so sometimes these loans are really necessary after bankruptcy, job loss or medical problems. Certain banks specialize in this type of lending and most reputable brokers or bankers will have a wide range of programs to suit any credit situation and help any borrower that walks through the door. Click the links on the left to find one (shameless plug).

If you have less than 20% to put down or have less than 20% equity in your house, you have probably heard of the idea of two mortgages on your home. For those who have not, here's a simple explanation of why they are such popular options.

Let me begin by explaining the idea behind private mortgage insurance (PMI). Foreclosures may result in a bank selling a property for less than 100% of the value, sometimes as low as 80%. For this reason, if a bank has more than 80% of the value of a home borrowed on the property, it wants some sort of protection for the rest of the capital invested. That's where PMI comes in. It's insurance for the bank on the money they have invested above 80% loan-to-value (LTV). Therefore, the only benefit that a borrower receives from PMI is that they were able to get into a property for less than the formerly typical 20% down payment. One important note on PMI is that it is not tax deductible.

Some creative minds came up with the idea that borrowers could have one mortgage for 80% and take out a second mortgage for the rest of down payment they were unable to come up with. For example, if a borrower had 10% to put down, meaning they need 90% worth of mortgages, they could take out a first mortgage for 80% and a second mortgage for 10%. This would mean that the first mortgage could be at a low rate and avoid PMI (its still within the 80% threshold) and the second mortgage would be at a little higher rate, also without PMI. This mortgage situation is commonly referred to as an 80/10/10. A loan with zero down is generally called an 80/20 (80%LTV first mortgage and 20% LTV second mortgage). Another common option is an 80/15/5 (80% first mortgage, 15% second mortgage, and 5% down payment from the borrower). This type of loan situation, two mortgages for a purchase or refinance, is generally referred to as a piggyback loan because the second mortgage "piggybacks" the first mortgage.

Why can the bank offer the second mortgage without PMI? Because the second loan is at a higher rate, it is basically self-insuring, meaning that the bank is making enough extra money on these loans to cover the losses it may incur on an occasional foreclosure for less than the bank has invested.

The benefits of a piggyback mortgage are that the payment is usually lower than a loan with PMI and more of a borrower's monthly expenses are tax deductible because the interest on the second loan is usually tax deductible (check with your accountant to make sure this applies to your specific situation). Another benefit may be that a borrower who pays extra on their mortgage each month is able to pay down the principal on the second mortgage (because the rate is higher) faster and keep paying the minimum on the first mortgage with a lower rate.