Mortgage FAQs

About Mortgages

  • Question

    What is the difference between pre-qualifying and pre-approval for a mortgage?

    Answer

    A pre-qualification is normally issued by a loan officer, who, after interviewing you, determines the dollar value of a loan you may be approved for. However, loan officers do not make the final approval, so a pre-qualification is not a commitment to lend. After the loan officer 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 have the credit-worthiness qualified to purchase the house on which you are making an offer.

    Pre-approval is a step above pre-qualification. Pre-approval involves the verification of the information on your loan application, such as credit history, income, employment history, etc. by an underwriter. The underwriter then makes the decision to pre-approve your loan and issues a pre-approval certificate. Getting your loan pre-approved typically allows you to close very quickly when you do find a house. A pre-approval can also help you negotiate a better price with the seller, since being pre-approved is a step before full approval. It's almost like having cash in the bank to pay for the house!

  • Question

    What is an Annual Percentage Rate (APR)?

    Answer
    Example:      
    30-year fixed 8% 1 point 8.107% 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.

    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 designed to measure the “true cost of a loan.”

    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
       

    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.

    Use the APR as a starting point to compare loans.  There is no substitute to getting a Loan Estimate from each lender to compare costs. Remember to exclude those costs that are independent of the loan.

  • Question

    Why do mortgage interest rates change?

    Answer

    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: A rate that commercial banks charge credit worthy customers and is based on the Federal Reserve's federal funds overnight rate (typically about 3% above this rate).
    • 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. They 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.
    • SOFR: The Secured Overnight Financing Rate (SOFR) is a benchmark interest rate for dollar-denominated derivatives and loans that replaced the London Interbank Offered Rate (LIBOR).
    • 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.

  • Question

    What is the difference between pre-qualifying and pre-approval for a mortgage?

    Answer

    A pre-qualification is normally issued by a loan officer, who, after interviewing you, determines the dollar value of a loan you may be approved for. However, loan officers do not make the final approval, so a pre-qualification is not a commitment to lend. After the loan officer 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 have the credit-worthiness qualified to purchase the house on which you are making an offer.

    Pre-approval is a step above pre-qualification. Pre-approval involves the verification of the information on your loan application, such as credit history, income, employment history, etc. by an underwriter. The underwriter then makes the decision to pre-approve your loan and issues a pre-approval certificate. Getting your loan pre-approved typically allows you to close very quickly when you do find a house. A pre-approval can also help you negotiate a better price with the seller, since being pre-approved is a step before full approval. It's almost like having cash in the bank to pay for the house!

  • Question

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

    Answer

    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 potential tax advantages of points. When you are buying a house, the points you pay may be tax deductible, so you could 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 could 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. Please consult your tax advisor regarding the tax deductibility of points and mortgage interest paid.


    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. Along with staying in the house, if you believe you will refinance soon after purchase, or soon after a refinance (in a rate dropping  cycle), this could impact whether you should pay points. 

    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 loan officer 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 fees! Is this a deal too good to pass up? How can a bank 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 homeowners used zero-point/zero-fee adjustable loans to refinance and get a new 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 some or all of 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 loan officer can offer you 8.75% with a cost of -1 point, which is a $2,000 credit towards your closing costs. A mortgage loan officer 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 adjustables every year and pay a very low 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 for 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.

  • Question

    What is PMI?

    Answer

    PMI or Private Mortgage Insurance is normally required when you buy a house with less than 20% down conventional loan. 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.

  • Question

    Can I get rid of the PMI on my loan?

    Answer

    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.

  • Question

    Can my loan be sold?

    Answer

    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.

  • Question

    What is a rate lock?

    Answer

    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 prevailing market rates/points, or the originally locked rates/points. In most cases you will not get a lower rate if rates drop. In some cases, prior to the rate lock expiration date, the lender may allow you to negotiate a rate lock extension at the original rate/points. An additional fee may be charged for this extension.

  • Question

    What happens if my lender goes out of business?

    Answer

    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.

FICO Questions

  • Question

    How can I increase my score?

    Answer

    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.
  • Question

    What if there is an error on my credit report?

    Answer

    If you see an error on your report, report it to the credit bureau. The three major bureaus in the U.S., Equifax 888.378.4329, Trans Union 800.916.8800 and Experian 888.397.3742 all have procedures for correcting information promptly. You can visit annualcreditreport.com. Alternatively, your mortgage company may help you correct this problem as well.

Refinancing Questions

Rate Lock Questions

  • Question

    What happens if rates drop after you lock?

    Answer

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

  • Question

    Lock-and-shop programs.

    Answer

    Most lenders will let you lock in an interest rate only on a specific property, which means, if you are shopping for a home, you cannot lock in an interest rate until after you sign a purchase contract for a specific property. If you are shopping for a home, some lenders offer a lock-and-shop program that lets you lock in a rate before you find the home. This program is very useful when rates are rising. However, lock-and-shop rates are usually higher than the prevailing market rate. Also, the lender may charge a non-refundable fee or deposit towards closing costs.

  • Question

    New construction rate locks.

    Answer

    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 360-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.