Buying or Refinancing

What are the most commonly made mistakes in buying or refinancing a house?

Should I refinance?

When is the best time to refinance?

Can I refinance a home loan more than once?

Can an older homeowner who is cash poor but house rich use their home to tap into the equity?

Should I pay points?  Does a 0 point/0 fee loan really exist?

What is a FICO score?

Why do interest rates change?

What is the difference between pre-qualifying and pre-approval?

What is a rate lock?

Can my loan be sold?  What happens if my lender goes out of business?

What is PMI?  Can I get rid of the PMI on my loan?

What is an APR?

What are the most commonly made mistakes in buying or refinancing a house?

Looking for a home without being pre-approved.
As a potential buyer competing for a property, you'll have a better chance of getting your offer accepted by being as prepared as possible.  Consider this hierarchy of preparedness:

    - Neither pre-qualified nor pre-approved
    - Pre-qualified
    - Pre-approved

Neither pre-qualified nor pre-approved
This buyer provides no evidence that they can afford to purchase your property.  You may wonder how serious they are since they're not at least pre-qualified.

This buyer has met with a mortgage broker (or lender) and discussed their situation.  The buyer has informed the broker regarding their income, expenses, assets and liabilities.  The broker may also have seen their credit report.  The buyer provided you with a letter from the broker stating an opinion of what the buyer can afford.

This buyer has provided a broker written evidence of income, expenses, assets, liabilities and credit.  All information has been verified by a lender.  As a result, much of the paperwork for this buyer's loan has been completed.  This buyer will probably be able to close quickly.  They provide you with a letter (pre-approval certificate) from the lender.  You're as certain as possible that this buyer can close.

As a potential buyer, you can see that being pre-approved will give you the best chance of getting your offer accepted.  This is critical in a competitive situation.

Making verbal agreements.
If you're asked to sign a document containing instructions contrary to your verbal agreements--don't!  For example, the seller verbally agrees to include the washing machine in the sale, but the written purchase contract excludes it.  The written contract will override the verbal contract.  More importantly, your state may require that contracts for the sale of real property be in writing.  Do not expect oral agreements to be enforceable.

Choosing a lender just because they have the lowest rate.
While the rate is important, consider the total cost of your loan including the APR, loan fees, discount and origination points.  When receiving a quote from a lender or broker, insist that the discount points (charged by the lender to reduce the interest rate) be distinguished from origination points (charged for services rendered in originating the loan).

The cost of the mortgage, however, shouldn't be your only criterion.  Have confidence that the company you select is reputable and will deliver the loan with the terms and costs they promised.  If in the final hours of the transaction you determine that the lender has suddenly increased their profit margin at your expense, you won't have time to start again with a different lender.  Ask family and friends for referrals. Interview prospective mortgage companies.

Not receiving a Good Faith Estimate.
Within three business days after the broker or lender receives your loan application, you must receive a written statement of fees associated with the transaction.  This is both the law and the best way to determine what you'll pay for your loan.  Bring the Good Faith Estimate (GFE) with you when you sign loan documents.  You should not be expected to pay fees which are substantially different from those contained in your GFE.

Not getting a rate lock in writing.
When a mortgage company tells you they have locked your rate, get a written statement detailing the interest rate, the length of the rate lock, and program details.

Using a dual agent (i.e., an agent who represents the buyer and the seller in the same transaction).

Buyers and sellers have opposing interests.  Sellers want to receive the highest price, buyers want to pay the lowest price.  In the standard real estate transaction, the seller pays the real estate commission.  When an agent represents both buyer and seller, the agent can tend to negotiate more vigorously on behalf of the seller.

As a buyer, you're better off having an agent representing you exclusively.  The only time you should consider a dual agent is when you get a price break.  In that case, proceed cautiously and do your homework!

Buying a home without professional inspections.
Unless you're buying a new home with warranties on most equipment, it's highly recommended that you get property, roof and termite inspections.  This way you'll know what you are buying.  Inspection reports are great negotiating tools when asking the seller to make needed repairs.  When a professional inspector recommends that certain repairs be done, the seller is more likely to agree to do them.

If the seller agrees to make repairs, have your inspector verify that they are done prior to close of escrow.  Do not assume that everything was done as promised.

Not shopping for home insurance until you are ready to close.
Start shopping for insurance as soon as you have an accepted offer.  Many buyers wait until the last minute to get insurance and do not have time to shop around.

Signing documents without reading them.
Whenever possible, review in advance the documents you'll be signing.  Even though some specifics of your transaction may not be known early in the transaction, the documents you'll sign are standard forms and are available for review.  It's unlikely that you'll have sufficient time to read all the documents during the closing appointment.

Not allowing for delays in the transaction.
In a perfect world, all real estate transactions close on time.  In the world we live in, transactions are often delayed a week or more.  Suppose you asked your landlord to terminate your lease the day your purchase transaction was scheduled to close.  A day or two before your scheduled closing date, you discover your transaction is delayed a week.

In a perfect world, no one is inconvenienced and your landlord is willing to work with you.  More likely, however, your landlord is inconvenienced and angry.  Will you be thrown out?  Will you have to find interim housing for a week or more?  The eviction process takes a little time, so the Sheriff won't immediately remove you, but this type of stress-producing episode can be avoided.  How?  Terminate your lease one week after your real estate transaction is scheduled to close.  That way, if there is a delay in closing your transaction, you have some leeway.  This approach might cost a little more, then again, it might not.

Should I refinance?

The most common reason for refinancing is to save money.  Saving money through refinancing can be achieved in two ways:

By obtaining a lower interest rate that causes one's monthly mortgage payment to be reduced.
By reducing the term of the loan, thus saving money over the life of the loan.

For example, refinancing from a 30-year loan to a 15-year loan might result in higher monthly payments, but the total of the payments made during the life of the loan can be reduced significantly.

People also refinance to convert their adjustable loan to a fixed loan.  The main reason behind this type of refinance is to obtain the stability and the security of a fixed loan.  Fixed loans are very popular when interest rates are low, whereas adjustable loans tend to be more popular when rates are higher.  When rates are low, homeowners refinance to lock in low rates.  When rates are high, homeowners prefer adjustable loans to obtain lower payments.

A third reason why homeowners refinance is to consolidate debts and replace high-interest loans with a low-rate mortgage.  The loans being consolidated may include second mortgages, credit lines, student loans, credit cards, etc.  In many cases, debt consolidation results in tax savings, since consumers loans are not tax deductible, while a mortgage loan is tax deductible.

The answer to the question "Should I refinance?" is a complex one, since every situation is different and no two homeowners are in the exact same situation.  Even the conventional wisdom of refinancing only when you can save 2% on your mortgage is not really true.  If you are refinancing to save money on your monthly payments, the following calculation is more appropriate than the rule of 2%:

1. Calculate the total cost of the refinance - example: $2,000
2. Calculate the monthly savings - example: $100/month
Divide the result in 1 by the result in 2 - in this case 2000/100 = 20 months.  This shows the break-even time.  If you plan to live in the house for longer than this period of time, it makes sense to refinance.

Sometimes, you do not have a choice, you are forced to refinance.  This happens when you have a loan with a balloon provision, but with no conversion option.  In this case it is best to refinance a few months before the balloon comes due.

Whatever you choose to do, consulting with a seasoned mortgage professional can often save you time and money.  Make a few phone calls, check out a few web sites, crunch on a few calculators and spend some time to understand the options available to you.

When is the best time to refinance?

Many people flock to refinance while mortgage interest rates are low, particularly when rates are two percentage points below their existing home loans.  Other factors, like when to finance, will depend on how long you plan to hold on to your home and whether you have to pay considerable fees to refinance.  It also will depend on how far along you are in paying off your current mortgage.  If you expect to sell your home shortly, you are not likely to recoup the costs you incurred to refinance.  And if you are more than halfway through paying your current mortgage, you probably will gain little by refinancing.  However, if you are going to own your home for at least another five years, that is probably long enough to recoup any refinancing costs and realize real savings as a result of lowering your monthly payment.  In fact, if it costs you nothing to refinance, you can gain even more.  Many lenders will let you roll the costs of the refinancing into the new note and still reduce the amount of the monthly payment.  Plus, there are no-cost refinancing deals available.  Contact your lender, and its competitors, before you refinance.

Can I refinance a home loan more than once?

You most certainly can.  During the most recent refinancing boom, for example, many homeowners refinanced their home loans two or three times within relatively short periods of time because interest rates kept treading downward, making it extremely attractive to trade in one loan for another.  Just remember that refinancing is basically like applying for a mortgage all over again.  Each time you refinance, you will still have to go through the application process, get a home appraisal, and likely incur closing costs.  Also, if you have a pre-payment penalty clause in your present mortgage, you will have to pay that penalty if you refinance.  So be certain that it is actually worth it for you to refinance.

Can an older homeowner who is cash poor but house rich use their home to tap into the equity?

Yes, but not so much by refinancing.  A reverse mortgage is a better, and increasingly popular, option for older Americans to convert home equity into cash.  Money can then be used to cover home repairs, everyday living expenses, and medical bills.

Instead of making monthly payments to a lender, the lender makes payments to the homeowner, who continues to own the home and hold title to it.  According to the National Reverse Mortgage Lenders Association, the money given by the lender is tax-free and does not affect Social Security or Medicare benefits, although it may affect the homeowners' eligibility for certain kinds of government assistance, including Medicaid.  Homeowners must be at least 62 and own their own homes to get a reverse mortgage.  No income or medical requirements are necessary to qualify, and they may be eligible even if they still owe money on a first or second mortgage.  In fact, many seniors get reverse mortgages to pay off the original loan.
Repaying a reverse mortgage is not necessary until the property is sold or the owner moves.  Should the owner die before the property is sold, the estate repays the loan, plus any interest that has accrued.

Should I pay points?  Does a zero-point/zero-fee loan really exist?

The best way to decide whether you should pay points or not is to perform a break-even analysis.  This is done as follows:

1. Calculate the cost of the points.  Example: 2 points on a $100,000 loan is $2,000.

2. Calculate the monthly savings on the loan as a result of obtaining a lower interest rate.  Example: $50 per month

3. Divide the cost of the points by the monthly savings to come up with the number of months to break even.

In the above example, this number is 40 months.  If you plan to keep the house for longer than the break-even number of months, then it makes sense to pay points; otherwise it does not.

4. The above calculation does not take into account the tax advantages of points.
When you are buying a house the points you pay are tax-deductible, so you realize some savings immediately.  On the other hand, when you get a lower payment, your tax deduction reduces!  This makes it a little difficult to calculate the break-even time taking taxes into account.  In the case of a purchase, taxes definitely reduce the break-even time.  However, in the case of a refinance, the points are NOT tax-deductible, but have to be amortized over the life of the loan.  This results in few tax benefits or none at all, so there is little or no effect on the time to break even.

If none of the above makes sense, use this simple rule of thumb: If you plan to stay in the house for less than 3 years, do not pay points.  If you plan to stay in the house for more than 5 years, pay 1 to 2 points.  If you plan to stay in the house for between 3 and 5 years, it does not make a significant difference whether you pay points or not!

Zero-Point/Zero-Fee Loans
Whatever happened to the conventional wisdom of waiting for the rates to drop 2% before refinancing?

You have a 30-year fixed loan at 8.5%.  A residential mortgage loan originator calls you up and says they can refinance you to a rate of 8.0% with no points and no fees whatsoever.

What a dream come true!  No appraisal fees, no title fees and not even any junk fees!  Is this a deal too good to pass up?  How can a bank and broker do this?  Doesn't someone have to pay?  Whose money is being used to pay these closing costs?

No, this is not a scam.  Thousands of homeowners have refinanced using a zero-point/zero-fee loan.  Some refinanced multiple times, riding rates all the way down the curve in 1992, 1993 and, more recently, in 1996.  Some homeowners used zero-point/zero-fee adjustable loans to refinance and get a new teaser rate every year.

The way this works is based on rebate pricing, sometimes also known as yield-spread pricing, and sometimes known as a service-release premium.  The basic idea is that you pay a higher rate in exchange for cash up front, which is then used to pay the closing costs.  You will pay a higher monthly payment, so the money is really coming from future payments that you will make.

You can also think of this as negative points!  For example, a 30-year fixed loan may be available at a retail price of:

8.0% with 2 points or
8.25% with 1 point or
8.5% with 0 points or
8.75% with -1 point or
9% with -2 points

On a $200,000 loan, the residential mortgage loan originator can offer you 8.75% with a cost of -1 point, which is a $2,000 credit towards your closing costs.  A mortgage broker can use rebate pricing to pay for your closing costs and keep the balance of the rebate as profit.

What are the benefits of a zero-point/zero-fee loan?

The main benefit is that you have no out-of-pocket costs.  As a result, if the rates drop in the future, you could refinance again even for a small drop in rates.  So if you refinanced on the zero-point/zero-fee loan to get a rate of 8.75% and if the rates drop 1/2%, you can refinance again to 8.25%.  On the other hand, if you refinanced by paying 1 point and got a rate of 8.25%, it may not make sense to refinance again.  Now, if the rates drop another 1/2%, a zero-point/zero-fee loan can drop your rate to 7.75%, whereas if you paid points, you may have to do a break-even analysis to decide if refinancing will save you money.

The zero-point/zero-fee loan eliminates the need to do a break-even analysis since there is no up-front expense that needs to be recovered.  It also is a great way to take advantage of falling rates.

Some consumers have used zero-point/zero-fee loans on adjustable loans to refinance their adjustable every year and pay a very low teaser rate.

What are the disadvantages of a zero-point/zero-fee loan?

The main disadvantage is that you are paying a higher rate than you would be paying if you had paid points and closing costs.  If you keep the loan for long enough, you will pay more, since you have higher mortgage payments.  In the scenario where you plan to stay in the house for more than 5 years, and if rates never drop for you to refinance, you could wind up paying more money.  If, on the other hand, you plan to stay at a property for just 2-3 years, there really is no disadvantage of a zero-point/zero-fee loan.

Whose money is it?

Since you are being paid "cash" up-front in exchange for a higher rate, it really is your own money that will be paid in the future through higher payments.  Investors who fund these loans hope that you will keep the loans long enough to recoup their up-front investment.  If you refinance the loans early, both the servicer and the investor could lose money.

To summarize, zero-point/zero-fee loans in many cases are good deals.  Make sure, however, that the lender pays for your closing costs from rebate points and NOT by increasing your loan amount.  So if your old loan amount was $150,000, your new loan amount should also be $150,000.  You may have to come up with some money at closing for recurring costs (taxes, insurance, and interest), but you would have to pay for these whether you refinanced or not.

Zero-point/zero-fee loans are especially attractive when rates are declining or when you plan to sell your house in less than 2-3 years.

Zero-point/zero-fee loans may not be around forever.  Lenders have discussed adding a pre-payment penalty to such loans, however few lenders have taken steps to implement such a measure.

What is a FICO score?

A FICO score is a credit score developed by Fair, Isaac & Co.  Credit scoring is a method of determining the likelihood that credit users will pay their bills.  Fair, Isaac began its pioneering work with credit scoring in the late 1950s and, since then, scoring has become widely accepted by lenders as a reliable means of credit evaluation.  A credit score attempts to condense a borrowers credit history into a single number.  Fair, Isaac & Co. and the credit bureaus do not reveal how these scores are computed.  The Federal Trade Commission has ruled this to be acceptable.

Credit scores are calculated by using scoring models and mathematical tables that assign points for different pieces of information which best predict future credit performance.  Developing these models involves studying how thousands, even millions, of people have used credit.  Score-model developers find predictive factors in the data that have proven to indicate future credit performance.  Models can be developed from different sources of data.  Credit-bureau models are developed from information in consumer credit-bureau reports.

Credit scores analyze a borrower's credit history considering numerous factors such as:

Late payments
The amount of time credit has been established
The amount of credit used versus the amount of credit available
Length of time at present residence
Employment history
Negative credit information such as bankruptcies, charge-offs, collections, etc.

There are really three FICO scores computed by data provided by each of the three bureaus: Experian, Trans Union and Equifax.  Some lenders use one of these three scores, while other lenders may use the middle score.

How can I increase my score?  While it is difficult to increase your score over the short run, here are some tips to increase your score over a period of time.

Pay your bills on time.  Late payments and collections can have a serious impact on your score.
Do not apply for credit frequently.  Having a large number of inquiries on your credit report can worsen your score.
Reduce your credit-card balances.  If you are "maxed" out on your credit cards, this will affect your credit score negatively.
If you have limited credit, obtain additional credit.  Not having sufficient credit can negatively impact your score.

What if there is an error on my credit report?
If you see an error on your report, report it to the credit bureau.  The three major bureaus in the U.S.:

Equifax (1-800-685-1111)
Trans Union (1-800-916-8800)
Experian (1-888-397-3742)

They all have procedures for correcting information promptly.  Alternatively, your mortgage company may help you correct this problem as well.

Why do interest rates change?

To understand why mortgage rates change we must first ask the more general question, "Why do interest rates change?".   It is important to realize that there is not one interest rate, but many interest rates!

Prime rate: The rate offered to a bank's best customers.

Treasury bill rates: Treasury bills are short-term debt instruments used by the U.S. Government to finance their debt.  Commonly called T-bills they come in denominations of 3 months, 6 months and 1 year.  Each treasury bill has a corresponding interest rate (i.e. 3-month T-bill rate, 1-year T-bill rate).

Treasury Notes: Intermediate-term debt instruments used by the U.S. Government to finance their debt. hey come in denominations of 2 years, 5 years and 10 years.

Treasury Bonds: Long-debt instruments used by the U.S. Government to finance its debt.  Treasury bonds come in 30-year denominations.

Federal Funds Rate: Rates banks charge each other for overnight loans.

Federal Discount Rate: Rate New York Fed charges to member banks.

Libor: : London Interbank Offered Rates. Average London Eurodollar rates.

6 month CD rate: The average rate that you get when you invest in a 6-month CD.

11th District Cost of Funds: Rate determined by averaging a composite of other rates.

Fannie Mae-Backed Security rates: Fannie Mae pools large quantities of mortgages, creates securities with them, and sells them as Fannie Mae-backed securities.  The rates on these securities influence mortgage rates very strongly.

Ginnie Mae-Backed Security rates: Ginnie Mae pools large quantities of mortgages, secures them and sells them as Ginnie Mae-backed securities.  The rates on these securities influence mortgage rates on FHA and VA loans.

Interest-rate movements are based on the simple concept of supply and demand.  If the demand for credit (loans) increases, so do interest rates.  This is because there are more buyers, so sellers can command a better price, i.e. higher rates.  If the demand for credit reduces, then so do interest rates.  This is because there are more sellers than buyers, so buyers can command a lower better price, i.e. lower rates.  When the economy is expanding there is a higher demand for credit, so rates move higher, whereas when the economy is slowing the demand for credit decreases and so do interest rates.

This leads to a fundamental concept:

Bad news (i.e. a slowing economy) is good news for interest rates (i.e. lower rates).
Good news (i.e. a growing economy) is bad news for interest rates (i.e. higher rates).

A major factor driving interest rates is inflation.  Higher inflation is associated with a growing economy.  When the economy grows too strongly, the Federal Reserve increases interest rates to slow the economy down and reduce inflation.  Inflation results from prices of goods and services increasing.  When the economy is strong, there is more demand for goods and services, so the producers of those goods and services can increase prices.  A strong economy therefore results in higher real-estate prices, higher rents on apartments and higher mortgage rates.

Mortgage rates tend to move in the same direction as interest rates.  However, actual mortgage rates are also based on supply and demand for mortgages.  The supply/demand equation for mortgage rates may be different from the supply/demand equation for interest rates.  This might sometimes result in mortgage rates moving differently from other rates.  For example, one lender may be forced to close additional mortgages to meet a commitment they have made.  This results in them offering lower rates even though interest rates may have moved up!

There is an inverse relationship between bond prices and bond rates.  This can be confusing.  When bond prices move up, interest rates move down and vice versa.  This is because bonds tend to have a fixed price at maturity--typically $1000.  If the price of the bond is currently at $900 and there are 10 years left on the bond and if interest rates start moving higher, the price of the bond starts dropping.  The higher interest rates will cause increased accumulation of interest over the next 5 years, such that a lower price (e.g. $880) will result in the same maturity price, i.e. $1000.

What is the difference between pre-qualifying and pre-approval?

A pre-qualification is normally issued by a residential mortgage loan originator, who, after interviewing you, determines the dollar value of a loan you can be approved for.  However, residential mortgage loan originators do not make the final approval, so a pre-qualification is not a commitment to lend.  After the residential mortgage loan originator determines that you pre-qualify, he/she then issues you a pre-qualification letter.  This pre-qualification letter is used when you are making an offer on a property.  The pre-qualification letter indicates to the seller that you are qualified to purchase the house you are making an offer on.

Pre-approval is a step above pre-qualification.  Pre-approval involves verifying your credit, down payment, employment history, etc.  Your loan application is submitted to an underwriter and a decision is made regarding your loan application.  If your loan is pre-approved, you are then issued a pre-approval certificate.  Getting your loan pre-approved allows you to close very quickly when you do find a house.  A pre-approval can help you negotiate a better price with the seller, since being pre-approved is very close to having cash in the bank to pay for the house!

What is rate lock?

You cannot close a mortgage loan without locking in an interest rate.  There are four components to a rate lock:

1. Loan program.
2. Interest rate.
3. Points.
4. Length of the lock.

The longer the length of the lock, the higher the points or the interest rate.  This is because the longer the lock, the greater the risk for the lender offering that lock.

Let's say you lock in a 30-year fixed loan at 8% for 2 points for 15 days on March 2.  This lock will expire on March 17 (if March 17 is a holiday then the lock is typically extended to the first working day after the 17th).  The lender must disburse funds by March 17th, otherwise your rate lock expires, and your original rate-lock commitment is invalid.

The same lock might cost 2.25 points for a 30-day lock or 2.5 points for a 60-day lock.  If you need a longer lock and do not want to pay the higher points, you may instead pay a higher rate.

After a lock expires, most lenders will let you re-lock at the higher of the original price and the originally locked price.  In most cases you will not get a lower rate if rates drop.

Lenders can lose money if your lock expires.  This is because they are taking a risk by letting you lock in advance.  If rates move higher, they are forced to give you the original rate at which you locked.  Lenders often protect themselves against rate fluctuations by hedging.

Some lenders do offer free float-downs, i.e., you may lock the rate initially and if the rates drop while your loan is in process, you will get the better rate.  However, there is no free lunch; the free float-down is costly for the lender and you pay for this option indirectly, because the lender has to build the price of this option into the rate.

What do you do if the rates drop after you lock?

Most lenders will not budge unless the rates drop substantially (3/8% or more).  This is because it is expensive for them to lock in interest rates.  If lenders let the borrowers improve their rate every time the rates improved, they spend a lot of time relocking interest rates, since rates fluctuate daily.  Also they would have to build this option into their rates and borrowers would wind up paying a higher rate.

Lock-and-shop programs.

Most lenders will let you lock in an interest rate only on a specific property.  If you are shopping for a house, some lenders offer a lock-and-shop program that lets you lock in a rate before you find the house.  This program is very useful when rates are rising.

New-construction rate locks.

Most lenders offer long-term locks for new construction.  These locks do cost more and may require an up-front deposit.  For example, a lender might offer a 180-day lock for 1 point over the cost of a 30-day lock, with 0.5 points being paid up-front, as a non-refundable deposit.  Most long-term new-construction locks do offer a float-down, i.e., if rates drop prior to closing, you get the better rate.

Can my loan be sold? What happens if my lender goes out of business?

Your loan can be sold at any time.  There is a secondary mortgage market in which lenders frequently buy and sell pools of mortgages.  This secondary mortgage market results in lower rates for consumers.  A lender buying your loan assumes all terms and conditions of the original loan.  As a result, the only thing that changes when a loan is sold is to whom you mail your payment.  If your loan has been sold, your existing lender will notify you that your loan has been sold, who your new lender is, and where you should send your payments from now on.

If your lender goes out of business, you are still obligated to make payments!  Typically, loans owned by a lender going out of business are sold to another lender.  The lender purchasing your loan is obligated to honor the terms and conditions of the original loan.  Therefore, if your lender goes out of business, it makes little difference with regards to your loan payments.  In some cases, there may be a gap between the date of your lender's going out of business and the date that a new lender purchases your loan.  In such a situation, continue making payments to your old lender until you are asked to make payments to your new lender.

What is PMI? Can I get rid of the PMI on my loan?

PMI or Private Mortgage Insurance is normally required when you buy a house with less than 20% down.  Mortgage insurance is a type of guarantee that helps protect lenders against the costs of foreclosure.  This insurance protection is provided by private mortgage-insurance companies.  It enables lenders to accept lower down payments than they would normally accept.  In effect, mortgage insurance provides what the equity of a higher down payment would provide to cover a lender's losses in the unfortunate event of foreclosure.  Therefore, without mortgage insurance, you might not be able to buy a home without a 20% down payment.

The cost of PMI increases as your down payment decreases.  Example: The cost of PMI on a 10% down payment is less than the cost of PMI on a 5% down payment.  Your PMI premium is normally added to your monthly mortgage payment.

The decision on when to cancel the private insurance coverage does not depend solely on the degree of your equity in the home.  The final say on terminating a private mortgage-insurance policy is reserved jointly for the lender and any investor who may have purchased an interest in the mortgage.  However, in most cases, the lender will allow cancellation of mortgage insurance when the loan is paid down to 80% of the original property value.  Some lenders may require that you pay PMI for one or two years before you may apply to remove it.

To cancel the PMI on your loan, contact your lender.  In most cases, an appraisal will be required to determine the value of your property.  You will probably also be required to pay for the cost of this appraisal.  Another way of cancelling the PMI on your loan is to refinance and to get a new loan without PMI.

What is APR?

The annual percentage rate (APR) is an interest rate that is different from the note rate.  It is commonly used to compare loan programs from different lenders.  The Federal Truth in Lending law requires mortgage companies to disclose the APR when they advertise a rate.  Typically the APR is found next to the rate.

Example: 30-year fixed 8% 1 point 8.107% APR

The APR does NOT affect your monthly payments.  Your monthly payments are a function of the interest rate and the length of the loan.

The APR is a very confusing number!  Even mortgage bankers and brokers admit it is confusing.  The APR is designed to measure the "true cost of a loan".  It creates a level playing field for lenders.  It prevents lenders from advertising a low rate and hiding fees.

If life were easy, all you would have to do is compare APRs from the lenders/brokers you are working with, then pick the easiest one and you would have the right loan.  Right?  Wrong!

Unfortunately, different lenders calculate APRs differently!  So a loan with a lower APR is not necessarily a better rate.  The best way to compare loans in our opinion is to ask lenders to provide you with a good-faith estimate of their costs on the same type of program (e.g. 30-year fixed) at the same interest rate.  Then delete all fees that are independent of the loan such as homeowners insurance, title fees, escrow fees, attorney fees, etc.  Now add up all the loan fees.  The lender that has lower loan fees has a cheaper loan than the lender with higher loan fees.

The reason why APRs are confusing is because the rules to compute APR are not clearly defined.

What fees are included in the APR?

The following fees ARE generally included in the APR:

Points - both discount points and origination points
Pre-paid interest.  The interest paid from the date the loan closes to the end of the month.  Most mortgage companies assume 15 days of interest in their calculations.  However, companies may use any number between 1 and 30!
Loan-processing fee
Underwriting fee
Document-preparation fee
Private mortgage-insurance

The following fees are SOMETIMES included in the APR:

Loan-application fee
Credit life insurance (insurance that pays off the mortgage in the event of a borrowers death)

The following fees are normally NOT included in the APR:

Title or abstract fee
Escrow fee
Attorney fee
Notary fee
Document preparation (charged by the closing agent)
Home-inspection fees
Recording fee
Transfer taxes
Credit report
Appraisal fee

An APR does not tell you how long your rate is locked for.  A lender who offers you a 10-day rate lock may have a lower APR than a lender who offers you a 60-day rate lock!

Calculating APRs on adjustable and balloon loans is even more complex because future rates are unknown.  The result is even more confusion about how lenders calculate APRs.

Do not attempt to compare a 30-year loan with a 15-year loan using their respective APRs.  A 15-year loan may have a lower interest rate, but could have a higher APR, since the loan fees are amortized over a shorter period of time.

Finally, many lenders do not even know what they include in their APR because they use software programs to compute their APRs.  It is quite possible that the same lender with the same fees using two different software programs may arrive at two different APRs!


Use the APR as a starting point to compare loans. The APR is a result of a complex calculation and not clearly defined.  There is no substitute to getting a good-faith estimate from each lender to compare costs.  Remember to exclude those costs that are independent of the loan.

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