Deposits for Prepaid Interest and Escrows

June 22nd, 2011

A mortgage loan transaction has a lot of moving parts, but none more confusing to the borrower than the deposit the borrower needs to bring to the closing table to cover prepaid interest and escrows for property taxes and homeowner’s insurance.  Often, this can amount to several thousand dollars, which can be a real shock, especially to a consumer on a refinance loan, who thinks they are rolling the closing costs into the loan amount and won’t have to bring any other cash to the table.  In fact, the consumer will recover most, if not all, of the closing deposit, within 30 days of closing, as prepaid interest and the escrow deposit are simply timing items.  This article will briefly explain the prepaid interest and escrow requirements so that borrowers will have a clear understanding of why they are bringing this money to the table, when they will get it back, and some strategies for reducing the required deposit if they don’t have the cash available.

Prepaid Interest

First, we will cover Prepaid Interest.  In the mortgage world, interest is calculated based on a 360-day year containing 12 30-day months, a calculation method known as 30/360.  And for the vast majority of loans, all monthly payments contain 30 days of interest (except for possibly the very last payment).  So, for example, when a borrower makes their July 1 mortgage payment, that payment contains the 30 days of interest that accrued from June 1 through June 30.  Similarly, when a borrower makes their August 1 payment, that payment contains the 30 days of interest that accrued in July, never minding the fact that the month of July has 31 days.  However, loans typically close in the middle of a month, which, in theory, would make it very difficult for the first payment to contain 30 days of interest.

How did the mortgage market solve this problem?  By having the borrower pay prepaid interest at closing to cover the interest that would accrue through the end of the month in which the loan closes, SKIPPING THE FIRST MONTH’S PAYMENT, and then accruing interest normally the following month so that the payment due on the 1st of the following month will contain the normal 30 days of interest.  As an example, if a loan closes and funds (interest accrual is actually based on the funding date) on June 16th, a borrower would bring 15 days of prepaid interest to the closing table to cover the last 15 days of June, SKIP THEIR JULY 1 MORTGAGE PAYMENT, and then make their first mortgage payment on August 1.

In terms of how much money a borrower needs to bring to closing, that calculation is different with a purchase loan than it is with a refinance loan.  With a purchase loan, the borrowers only have to concern themselves with the new loan they are taking out to buy the home.  There is no old loan for them to pay off.  So they will simply calculate the amount of interest they need to bring to closing based on the closing date to the end of the month.  With a refinance loan, on the other hand, the borrowers are paying off an existing loan, in addition to taking out a new loan.  So they have to make sure to account for all interest accrued from their last mortgage payment through the date the loan is paid off, PLUS, the prepaid interest on the new loan (from funding date through month-end as explained above).

At Anchor Street Mortgage, in order that the borrower is not shocked by the amount of Prepaid Interest required at closing, we assume 30 days of Prepaid Interest will be required at closing.  This number of days is designed to cover the payoff interest on the prior mortgage loan, and the prepaid interest for the new loan.  And most of the time, our estimate of prepaid interest is pretty darn close to the total of the payoff interest on the old loan and the prepaid interest on the new loan.

If you notice, I capitalized above, a couple of times, the point about the borrowers SKIPPING THEIR FIRST MONTH’S PAYMENT.  I wanted to emphasize this point because that’s the way that borrowers make up for bringing the prepaid interest to the closing table.  They get that money back right away by skipping the first month’s mortgage payment.  In truth, they aren’t really skipping a payment.  As we explained above, they are really making that payment at the closing table.  But the very important point that needs to be made is that PREPAID INTEREST IS SIMPLY A TIMING ITEM WHICH GETS MADE UP FOR RIGHT AWAY, and it is not a cost of the transaction.

Escrow Deposit for Property Taxes and Homeowner’s Insurance

Next, we will discuss escrow deposits.  Most borrowers prefer to escrow for property taxes and homeowner’s insurance.  There are a number of reasons for this, but the main one is so that they won’t need to remember to pay the quarterly property tax payments and the annual homeowner’s insurance premium.  Also, borrowers tend to like the fact that escrowing allows them to make regular monthly payments that cover all of their housing expenses, rather than having lumpy payments every quarter to cover taxes, and annually to cover insurance.  Banks typically require (and are allowed by law) a two month cushion of property taxes and insurance, so the highest number of months of taxes a bank could ever hold would be 5 months of property taxes, and 14 months of homeowner’s insurance (obviously, these are right before the bank would be required to make the quarterly property tax payment or the annual insurance payment).

 As with Prepaid Interest, escrow deposits are handled differently for a purchase loan than for a refinance loan.  With a purchase loan, the annual homeowner’s insurance premium has to be paid in full before closing, so the lender typically will only need to ask for a 3 month deposit (2 months for the cushion, and 1 month to cover the first skipped mortgage payment).  The property taxes can be a bit trickier.  As part of their home purchase, the buyer typically will reimburse the seller for the remaining property taxes for that quarter (which the seller has already paid).  Plus, the lender will require 2 months cushion, and then, depending on when the first mortgage payment will fall out, typically a deposit of 2 or 3 months of property taxes, to make sure that there are enough taxes on hand to make the quarterly property tax payment.

With a refinance loan, the escrow deposit for property taxes typically is 4 or 5 months, depending on when the first mortgage payment is due in relation to when the quarterly property taxes are due.  Remember, the monthly escrow payments are what the lender will use to make the property tax and homeowner’s insurance payments.  On February 1, May 1, August 1 and November 1 of each year, the lender needs to have 5 months of tax escrows in the escrow account – 2 months of cushion, plus 3 months, in order to make the required quarterly property tax payment.  However, for the first property tax payment due with a new loan, it is very unlikely that the borrower will have made 3 monthly payments by the time the property tax is due.  So, the lender needs to collect that money in advance at closing to make sure they will be able to make the next quarterly property tax payment that is due. 

At Anchor Street Mortgage, we generally assume the borrower will need to deposit 5 months of property taxes at closing.  It will occasionally come out to less, but we like to be conservative so that the borrower is properly prepared.  In terms of homeowner’s insurance, we see how many months remain until the annual insurance premium is due, and then add 2 months to cover the cushion.  Homeowner’s insurance isn’t very expensive in comparison to property taxes, so if we are off by a month or two in our homeowner’s insurance escrow calculation, it won’t have much of an effect on how much money the borrower needs to bring to closing.

On a refinance loan, similar to Prepaid Interest, THE ESCROW DEPOSIT IS A TIMING ITEM.   Most borrowers who are escrowing for taxes/insurance on their new loan also escrowed on their previous loan.  So the borrowers may have to bring an escrow deposit to the closing table to cover the escrows on their new loan, BUT THEY WILL GET THE ESCROW DEPOSIT ON THEIR PREVIOUS LOAN BACK WITHIN 30 DAYS OF CLOSING.  Once the borrower receives their escrow deposit back from the previous lender, the net effect in terms of cash out of the borrower’s pocket will be the same as if they never refinanced. 

Most lenders require borrowers to escrow for property taxes and some require escrowing for homeowner’s insurance as well.  If a borrower chooses not to escrow, it may sometimes have an effect on the interest rate for which they qualify, depending on how the loan is priced.  Specifically, if a borrower chooses not to escrow, their rate may go up by .125%.  Furthermore, there are certain loans for which escrowing is mandatory, specifically, any loan requiring mortgage insurance (either PMI or FHA), or any HARP loan (DU Refi Plus, Freddie Mac Open Access) where the loan-to-value ratio exceeds 80%.

Strategies to Reduce the Prepaid Interest and Escrow Deposit

If bringing money to the closing table for the prepaid interest and escrow deposit presents a major problem for a borrower, there are a number of strategies that may be used to mitigate this issue:

a)    The borrower can choose to go with a slightly higher loan size which will reduce the amount of cash needed at closing.  We discourage borrowers from doing this because it amounts to financing what are basically short-term timing items for the term of the loan (up to 30 years), but sometimes, a borrower simply will have no choice.

b)    If the option is available, the borrower can choose not to escrow, at least at closing.  Then, at a later date, the borrower can contact the servicing department and set up the escrow account.  This way, the borrower doesn’t have to bring the money to the closing table, and instead, can make the escrow deposit later when they are more able to do so.

c)    With the new compensation laws that went into effect in April 2011, the borrower often will receive a credit from the lender to be used against closing costs, and sometimes prepaid interest and escrows, depending on the size of the credit.  This typically happens when the borrower chooses the “no points” option, and the loan originator is being paid by the lender, not the borrower.  The credit can sometimes be substantial, depending on pricing.  If the borrower needs to reduce the cash to closing, they can choose a slightly higher interest rate which will increase the credit they are receiving from the lender at closing.  If the credit is high enough, it can cover most or all of the closing costs, and sometimes, some or all of the prepaid interest and escrow deposit, which will reduce the amount of cash the borrower needs to bring to closing.

Conclusion

At Anchor Street Mortgage, we understand how confusing some loan terms and requirements can be, and it is our job to make sure that our customers understand every aspect of the mortgage loan process.  The deposit for Prepaid Interest and escrows is one of the least understood elements of a mortgage loan transaction.  Hopefully, this article will help shed some light on this confusing topic.  If you have any questions about this article, or anything else mortgage-related, please email me at emitnick@anchorstreetmortgage.com, or call me at 973-808-3462.

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Letter to Federal Reserve Board

June 22nd, 2011

To Members of the Federal Reserve Board, Members of NAMB and NAIHP, Senior Managers in the Wholesale Lending Community, and other Industry Participants including Mortgage Brokers, Mortgage Bankers and Realtors: 

Yesterday evening, the United States Court of Appeals denied the request by industry professionals to delay the implementation of the Regulation Z Compensation Rule, and it went into full effect as of today.  Most of you likely are not fully aware of the many ramifications of this rule.  What I’d like to do is briefly call attention to the negative consequences of this rule for consumers, in the hope that some of its particularly damaging elements can be amended so consumers don’t have to suffer any further. 

The new rule does not allow loan originators (including mortgage brokers) to be paid based on the terms of a loan, other than loan size, and it also does not allow a loan originator to be paid by both the consumer and the lender in the same transaction.  We have to be paid by one party or the other – not both.  Also, when the lender is paying compensation to the loan originator (lender-paid compensation), such compensation has to be a fixed percentage of the loan amount. 

 The above would likely be acceptable under most circumstances. However, for lender-paid loans, the new rule goes further and prohibits the loan originator from using his/her compensation to pay for anything, including fees, on behalf of the consumer.  This is especially damaging to consumers, most of whom prefer “no points” loans.  I’ll give three examples in which the consumer is harmed by the implementation of this rule:

 1)    Often, we’ll quote a borrower a “no points” rate when in fact, we actually are using some of our compensation to buy down the rate from the lender so the borrower can take advantage of a lower rate.  For example, we may quote a borrower a rate of 4.75% at no points, and we would receive 0.75% from the lender instead of 1%.  Now, under the new rule, our compensation from the lender is fixed at 1%, so if the lender is offering the rate of 4.75% costing the borrower .25%, we are not allowed to give up .25% of our compensation in order to offer the borrower the lower rate at no points.  It bears repeating – even if we want to pay the .25% on behalf of the borrower, the new rule forbids us from doing so.

2)    If a transaction needs to be extended, even if it was the fault of the borrower or the lender, we generally pay for the extension out of our compensation so that the borrower can get the transaction they are expecting – same rate, same costs.  Now, under the new rule, if we are being paid by the lender, we are prohibited from paying the extension fee on behalf of the borrower, so in the event that a transaction needs to be extended, either the lender is going to have to waive its fee, or the borrower is going to have to pay it.

3)    There are times when the pricing of a transaction needs to change because certain facts change.  For example, an appraisal may come in lower than anticipated, and the lender may increase the borrower’s rate because the loan now has a higher loan-to-value ratio.  There are times when the mortgage broker will eat the difference out of their fee so the borrower can continue to enjoy the same rate as before.  Under the new rule, if we are being paid by the lender, we are not allowed to reduce our fee under these circumstances, and the consumer will have to accept a higher interest rate if they wish to continue with the transaction.

These are just a few examples.  The vast majority of our borrowers prefer loans with “no points,” meaning that the lender, not the borrower, is paying the loan originator.  With the lack of flexibility under the new rule, the Fed is threatening the ability of consumers to get “no points” loans at the lowest possible interest rates. 

I don’t think the Federal Reserve Board was intending to hurt consumers with the new rule.  Certain of its requirements, such as the anti-steering provisions, and getting paid a flat fee on loans, may prevent some of the excesses of the past from happening again.  And in fact, for mortgage brokerage shops such as ours, these rules mesh quite well with our existing business practices.  But the lack of flexibility for the consumer, particularly with the lender-paid option, is potentially very damaging to consumers, and, at a minimum, the rule should be amended to allow loan originators to use their compensation on the consumer’s behalf.

It’s quite possible that had the NAMB/NAIHP lawsuit focused exclusively on how parts of the new rule were damaging to consumers, rather than also focusing on how it would damage loan originators, it may have found a more receptive audience.  Going forward, we need to focus on the consumer, since that’s why we’re all here.  And until the rule is amended to allow us to use some of our compensation to help consumers, our lender partners also may want to consider ideas that will make things easier for the consumer. 

Please pass this along to anyone you feel may be in a position to affect change, either at the Federal Reserve, or within your respective organizations.  If you have any questions, please feel free to call me at 973-808-3462, or shoot me an email at emitnick@anchorstreetmortgage.com.

Thank you!

Sincerely,

Evan Mitnick

President

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Mortgage Insurance – FHA vs. PMI

January 27th, 2011

Given the historically low interest rates (even with the recent increases), we encounter a good deal of refinance inquiry on a daily basis. In the current economic environment, the main thing that limits folks from being able to refinance is their property value. In many cases, potential borrowers owe more on their house than it’s worth. Many of you probably read about this in the newspaper, or in trade papers, and I can assure you that it’s quite true. There are also a number of borrowers who took out conventional loans when they purchased their homes, but because of property value declines, their loan-to-value ratio (LTV) now exceeds 80%. If they are eligible for a HARP program (see earlier entry “The HARP Program That Should Have Been”), they can proceed with a refinance without mortgage insurance. But if they aren’t eligible for a HARP loan, a loan with mortgage insurance is their only option.

Many borrowers object to paying mortgage insurance. It’s funny – even if they’d be saving money on an overall basis with the mortgage insurance, they still prefer to avoid it. But mortgage insurance isn’t as evil as it’s cracked up to be, and it should definitely not be taken off the table in a refinance situation. Of course, borrowers have a different attitude when it comes to a purchase. There, we often have borrowers come to us asking for a loan with mortgage insurance, generally to accommodate the fact that they don’t have the money to cover the closing costs and a 20% down payment.

For both refinances and purchase loans, if a borrower has at least a 720 FICO score, and is putting down at least 10% as a down payment, we generally will recommend a loan with conventional mortgage insurance (widely known as Private Mortgage Insurance, or PMI) instead of the FHA program. However, if a borrower is looking to put down less than 10%, or just doesn’t have the high credit score, we typically will recommend an FHA loan. In order for a borrower to decide which of these options would be best, it is important to understand the features, and limitations, of each.

We’ll start with PMI. Typically, a borrower needs a 720 minimum FICO score, along with a debt-to-income ratio (DTI) of 43% or below, to qualify for PMI. PMI is paid monthly, along with the mortgage payment (and escrow payments). It is largely based on the LTV of the loan. For loans with LTVs of 85% and below, PMI is relatively inexpensive. It gets a bit more expensive for LTVs between 85% and 90%, and is expensive above 90%. PMI remains on the loan until the loan balance amortizes down to 78% of the purchase price, but a borrower can ask a lender to eliminate PMI once the loan is down to an 80% LTV (this can be helped by property appreciation). One thing to note – PMI gets less expensive if the loan term is shorter, so the monthly PMI for a 15-year loan is much cheaper than the monthly PMI on a 30-year loan.

The FHA program operates a bit differently. There are up-front and ongoing mortgage insurance premiums on an FHA loan. The up-front premium currently is 1% of the base loan amount (the loan amount before the premium is applied). This premium typically is rolled into the loan, so it gets added to the loan balance, not paid up-front in cash. The ongoing premium gets a bit more complicated. For loans with terms greater than 15 years, the ongoing monthly premium is .85% of the loan balance (calculated on an annual basis) for loans with LTVs of 95% and lower, and .90% of the loan balance for loans with LTVs greater than 95%. (The maximum LTV on a purchase loan is 96.5%, while the maximum LTV on a refinance loan is 97.75%.) For FHA loans with 15-year terms, the monthly premium is .25% of the loan balance, if the LTV is above 90%. For 15-year FHA loans with LTVs of 90% and below, there is no monthly mortgage insurance, just the up-front premium.

FHA doesn’t have a minimum FICO score, but most lenders require a minimum FICO score of 640 to qualify. Also, unlike PMI which can be removed as soon as the loan reaches 78% or 80% LTV, the monthly mortgage insurance on an FHA loan has to stay in place for a minimum of 5 years, after which, the 78% and 80% rules apply.

In many cases, the choice between FHA and PMI is obvious, either because of the amount of the down payment or the FICO score. Also, if the appraisal value is going to be iffy, FHA may be a safer bet because the insurance premium doesn’t change very much at the higher LTVs as it does for a conventional loan. Obviously on a refinance, monthly payment is going to be a key, so sometimes, even with the up-front mortgage insurance premium rolled in, the FHA loan may still make the most sense. Whereas on a purchase, the lower down payment requirements of an FHA loan often make it the obvious choice. Please remember that the FHA program was designed for low-to-middle income first-time homebuyers, so it’s no accident that people who fit that profile typically choose the FHA program. And, of course, if a borrower is interested in a 15-year loan term, the lack of monthly mortgage insurance on the FHA 15-year loan below 90% LTV makes that product particularly attractive.

Clearly, when mortgage insurance is required, the decision as to which type of mortgage insurance to choose needs to be determined on a case-by-case basis. Just remember, to paraphrase Billy Joel (from “The Stranger”), on a refinance loan, mortgage insurance “is not always evil, and it is not always wrong.” And for a home purchase, mortgage insurance makes it possible for a far greater number of people, especially first-time homebuyers, to qualify for the loans to purchase their homes. Given the current state of the housing market, the availability of mortgage insurance, especially through the FHA program, has never played a more important role in keeping the housing market afloat.

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Adjustable-Rate Loans (ARMs) – Sometimes the Right Choice

December 14th, 2010
For most of 2010, interest rates on fixed-rate mortgage loans of all maturities remained at historically low levels. However, over the past few weeks, we have seen a marked rise in interest rates on fixed-rate loans:
  • Fixed rates on loans with maturities of 20 years and longer have increased by .50% to .75%
  • Fixed rates on loans with maturities of 15 years or less have increased by .25% to .50%
  • These increases happened suddenly, and caught many people off guard
  • Rates on adjustable-rate loans have not increased by the same degree
  • A number of our clients have chosen adjustable-rate loans

There are many people who will only consider fixed-rate loans, and who just don’t want to deal with the perceived volatility of adjustable-rate loans. However, for certain borrowers, adjustable-rate loans may make sense. For example, a borrower who plans to move within a 5-7 year period may want to take advantage of a lower interest rate during that period. Or, if a borrower is going to be paying down a significant portion of their mortgage over the next few years, they may want a lower interest cost while their principal balance is still high. Also, there are a number of borrowers who refinance into adjustable-rate loans every 5 to 7 years, and are comfortable with the refinance risk.

In terms of how adjustable-rate loans work, the interest rate is fixed for an initial period (i.e. 5 years, 7 years), and then adjusts every year thereafter. Typically, the interest rate during the fixed period is lower than the rate that would have been available for a fixed-rate loan of comparable maturity. After the fixed period, the interest rate adjusts (generally) annually based on a specified margin over an index (i.e. one year LIBOR plus 1.75%).

To illustrate how an adjustable-rate loan would compare to a fixed-rate loan, let’s look at a loan with the following terms:

  • Loan size of $300,000
  • Property value of $400,000
  • Rate-term refinance loan (no cash out)
  • FICO score of 740
  • Acceptable debt-to-income ratio; escrow for taxes and insurance; property located in Essex County, NJ

For a loan of these characteristics, our quotes, as of 1PM on Tuesday, December 14, 2010 would be as follows:

a) On a 30-year fixed-rate loan, the rate would be 4.5% at one point, and 4.75% at no points

b) On a 5/1 adjustable-rate loan, the rate would be 2.75% at one point, and 3.5% at no points

Based on a $300,000 loan size, and assuming zero points, the monthly principal and interest payment on the fixed-rate loan would be $1,564.94, and the monthly principal and interest payment on the adjustable-rate loan would be $1,347.13. So, if the client chooses the adjustable-rate loan, they will be saving approximately $218 per month for the first 60 months of the loan.

If the borrower wants to put in a point to lower their rate, the difference is even more pronounced. Keeping the loan balance the same (assume the point is paid in cash), the monthly principal and interest payment on the fixed-rate loan would be $1,520.06, and the monthly principal and interest payment on the adjustable-rate loan would be $1,224.72. In this case, the difference is even greater – approximately $295.

Adjustable-rate loans are not for everyone. And if a borrower isn’t comfortable taking on the additional interest rate risk once the fixed period is over, then they shouldn’t pursue this option. However, there are borrowers for whom an adjustable-rate loan would be a great fit, and these borrowers should seriously consider this option, especially in light of today’s sharply rising interest rates on fixed-rate loans.

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Email vs. Telephone

December 14th, 2010
Everyone who knows me, either through work or socially, knows that I have a strong preference for communicating via email versus other forms of “instant” communication such as the telephone or texting or blackberry. In the mortgage business especially, I think that email is absolutely essential, and after one or two initial meetings or phone calls, should represent the primary form of substantive communication between the mortgage broker and the client. There are a variety of reasons for this:
1) Mortgage loan transactions are very complicated, with a lot of moving parts. The only way to keep track of everything is to have something in writing to constantly refer back to. Otherwise, things will get missed.

2) In terms of serving a client, communicating terms and conditions via email adds a great deal of transparency to the process. Customers have a written roadmap of everything they need, and of what is occurring in every step in the process.

3) Information communicated over the phone can be “misconstrued.” People tend to hear what they want, or expect, to hear, and a broker does not want to be in a position where the customer says “You never told me that” or “That’s not how you explained it to me.” Email provides clarity to the process, and also allows all parties a written record of all significant communications in case there is any confusion.

4) The mortgage profession, mortgage brokers in particular, have been under attack over the last few years. Specifically, our industry has been accused of abusive practices and fraud. Putting things in writing should prevent many of those accusations, at least among honest parties. It certainly helps protect those of us mortgage professionals who act with honesty and integrity. I’ll go as far as to say that, in any business, you should be careful dealing with someone who insists on talking on the phone most or all of the time, unless they are on a recorded line. If someone is honest and straightforward, they won’t mind communicating in writing, so there is a permanent record of their words that they can be held to.

5) I’m 45 years old. I can barely remember what I had for breakfast (Multigrain Cheerios in case anyone is curious). And my memory was never that great to begin with! There is simply no way I’m going to remember every detail of every conversation I have with a client. But with email, I magically have 100% perfect instant recall. And more importantly, so do our clients.

I know there are many of you who prefer to talk on the phone versus email. And in some businesses, that may be appropriate. But in a complex industry such as the mortgage business, where accuracy is essential, there is simply no substitute for email when it comes to communicating with a client to ensure a satisfying experience for all, with no surprises.

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APR – When It’s Useful and When It Isn’t

November 5th, 2010

As I was pulling into work this morning, I heard an ad on 1010 WINS from a large national mortgage lender.They were talking about “today’s low rates” and were advertising a 15-year fixed rate loan at 3.5%, and then quickly mentioned an APR of 3.9%. Quite frankly, that’s a huge difference. Basically, this lender was advertising a rate that was misleading, because he failed to mention that the advertised interest rate is only available if the borrower is paying points. As someone in the mortgage business, I understood that the borrower would need to pay points to get that rate because, by law, the lender had to mention the APR, but it is very unlikely that the average listener would have had a clue.

In fact, we at Anchor Street Mortgage could have delivered a 15-year fixed-rate of 3.5% at NO points, depending on the loan and the borrower. However, when we send disclosure documents to that borrower, they will see an APR higher than the interest rate. Even though there are no points in the loan, the APR will be higher than the interest rate, because of closing costs.

So, what is APR? APR stands for Annual Percentage Rate. It is not to be confused with Interest Rate. APR is a calculation which intends to express all of the costs of financing, including the interest rate, points and fees as a financing percentage rate. APR is a very useful calculation in credit card-land. Credit card companies don’t always calculate interest the same way. Some will assume 12 months of 30 days each (30/360), while others will use the actual number of days in a month assuming a 365-day year (Actual/365), or a 360-day year (Actual 360). APR is the great equalizer, so it can let people know that the credit card company that says it is charging them 10% interest is actually charging a higher rate if it charges 365 days of interest in a 360-day year. In the credit card world, customers can truly compare credit card offers based on APR.

However, in mortgage-land, APR is confusing. It ATTEMPTS to express all of the costs of the loan as an interest rate. But it is a calculation, and different lenders calculate it differently. Some lenders will include every possible cost in their APR calculation, while others try to include only those costs that are required to be included by statute. You could end up with a situation where a loan that has the same interest rate and the same fees will have two different APR calculations from two different lenders. Doesn’t sound like a very useful comparison now, does it?

Also, it’s the INTEREST RATE that is used to calculate the monthly payment on a loan, not the APR. In fact, with a mortgage, APR isn’t really used for anything. Which is interesting because when we send disclosure documents to a borrower, almost every one of them asks why the APR is higher than the interest rate they were quoted. They actually think the APR is the interest rate, and we have to explain to them what APR is, how it’s calculated, and why it isn’t very meaningful in a mortgage loan transaction.

When borrowers are evaluating different loan offers, the proper things for them to be comparing, from a quantitative perspective, are the interest rate, points, and closing costs. That’s it! Prepaid interest and escrows are timing items and should not influence the decision. A borrower should be able to line these items up and compare them in order to make an informed choice.

There has been a lot of talk about new updated disclosure documents that are being developed by Treasury, HUD and the Federal Reserve Board. These new disclosures are supposed to make it easier for potential borrowers to understand the terms of a mortgage loan transaction. It is my sincere hope that the parties responsible for determining the content of these disclosures recognize that APR is generally inappropriate for use in a mortgage loan transaction, and that there are other items that are far more useful when comparing different financing offers.

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The HARP Program That Should Have Been

October 13th, 2010

In the two years that we’ve been originating loans at Anchor Street Mortgage, the Number One reason we’ve had to turn down potential customers has been that their loan-to-value ratio (LTV), or their combined loan-to-value ratio (CLTV), is too high. Not surprisingly, many of these potential customers have second lien loans or HELOCs that they took out when property values were higher and lenders were giving out seconds like candy. At a time when many of these same people are struggling to stay current with their monthly mortgage obligations, they are unable to take advantage of today’s lower interest rates that would provide them with genuine relief.

In May of 2009, the federal government made the Home Affordability Refinance Program (HARP) available to borrowers whose loans were owned by Fannie Mae or Freddie Mac, the now government-owned mortgage purchasing entities. In theory, if you were a borrower whose loan was owned by Fannie or Freddie, and you were current on that loan, you would be eligible to refinance into a new HARP loan at higher LTVs (up to 125%, in theory) than would normally be allowed, and at market-level interest rates. Sounds great! And if the program had been constructed properly, it would have been wildly successful and would have literally helped millions of borrowers, a good many of them underwater (with LTVs or CLTVs over 100%).

Unfortunately, as with so many of the attempts by our government to “fix” the mortgage business, this one came up short as well. I’ll cover a couple of the minor mistakes first before I get to the biggie.

First of all, the program allowed borrowers whose loans had existing mortgage insurance to refinance into a new HARP loan, as long as they kept the same level of mortgage insurance on the loan. However, no one bothered to give that memo to the lenders. Most lenders do not allow borrowers paying mortgage insurance to participate in the HARP program, and the ones that do, only allow it if the borrower refinances with the same lender. The program should have allowed qualifying borrowers to go into their new HARP loan without mortgage insurance. Once you are already accepting high loan-to-value loans, you should be willing to eliminate mortgage insurance for ALL of the participants, not just the ones who didn’t have it initially (and many of whom took out second liens to avoid paying mortgage insurance in the first place – we’ll get to that).

Second, not all lenders participate in the program, or will only participate in it for their own loans, not for loans originated by anyone else. This is terrible for the consumer and should be unacceptable to our government. The Federal Housing Finance Authority (the overseer of Fannie and Freddie) should require all lenders that sell loans to Fannie Mae and Freddie Mac to participate in the HARP program, and to accept HARP-eligible loans from all lenders. Lenders should not be able to take advantage of the benefits of selling loans to Fannie and Freddie (without whom many of them wouldn’t be able to be in business in the first place), without also being required to participate in Fannie/Freddie sponsored programs that serve the public good.

However, by far the biggest flaw in the design of the program is not allowing second liens to be paid off as part of the newly refinanced loan. As I mentioned earlier, the majority of the potential customers that we have to turn down have second liens that bring their CLTV near or over 100%. However, these borrowers are current on both of their loans and are trying to stay that way. If you really want to keep them current and out of foreclosure, let them roll both of their liens into a Fannie Mae DU Refi Plus loan, or a Freddie Mac Relief loan. This would accomplish two very important goals:

1) Borrowers would be able to take advantage of today’s low rate environment and roll into a low interest rate first-lien which they’d have a much greater chance of paying. This would significantly reduce the number of potential foreclosure filings, and provide borrowers with meaningful relief without them having to modify, or default on, their existing loans.
2) All of the investors holding bonds backed by these riskier loans, especially the second liens, would be paid off 100 cents on the dollar. They wouldn’t have to record losses so they’d be more likely to start lending again, or investing in the mortgage sector, secure in the knowledge that they won’t have significant write-offs from their existing portfolio.

The government is already willing to go up to 125% LTV/CLTV on this program. So once they’ve made that conceptual leap, they should be willing to allow the second liens to be rolled into the program, and without mortgage insurance. If you want people to be able to afford the homes they are already in, this would be an important step forward. And based on the experience of this New Jersey-based mortgage broker, making the changes to the HARP program suggested in this article would help a great many borrowers throughout the country, at a time when they most need it.

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Welcome to our Blog!

August 17th, 2010

Welcome to the Anchor Street Mortgage Blog! In the coming weeks and months, we will be posting articles here that we hope you will find useful. Our postings will be targeted at two groups – potential customers who are in the market for a mortgage loan, and other mortgage professionals who are interested in staying current on aspects of the mortgage market that affect their business in real time.

As you know, this market changes on a daily basis, whether it be due to movements in interest rates, changes in lender requirements, government regulations, the economy, or other factors. The members of the Anchor Street Mortgage team have worked in every aspect of the mortgage business, from origination through servicing and capital markets. As a group, we have a unique collective perspective on the market that we will be sharing with you.

Please feel free to comment on any of our articles directly. Or, you can send your comments, thoughts, and suggestions to Evan via email at emitnick@anchorstreetmortgage.com.

We look forward to hearing from you!

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