Tighter Lending Standards

Many !nancial institutions have recently tightened their lending standards, so it is even
more critical to maintain as high a credit score as possible. A score in the mid-700s or
above will help make borrowers more likely to get the most favorable terms and interest
rate on a mortgage. Borrowers with a FICO score below 660 will likely be asked to
improve that score before a mortgage loan will be approved.

Down Payments
Funds for down payments should be in easily-accessible investments such as money
market funds and savings accounts to provide easy access to cash without penalty.

Low Down Payments

Advantages

Disadvantages

Allows you to buy instead of rent

Higher monthly payments

O"ers income tax savings for mortgage

interest and property tax deductions

Lenders generally require borrowers who put

down less than 20% of their homes purchase
price to buy mortgage insurance. This can
add 0.5-1% to the cost of the loan

Ties up less cash in a home that may not

appreciate as fast as other investments

Most mortgages o"ered with low down

payments are variable-rate or higher-interest
mortgages, resulting in more money paid out
over the life of the loan

A small amount of money controls a

greater percentage of the homes value
(the cash is more heavily leveraged)

Low Down & Zero Down Payment Programs

Due to the availability of better risk analysis tools, lenders have become more con!dent
in o"ering low down and zero down payment loans. To be granted these types of loans,
you typically need to have excellent credit and a good, solid income. Below is a
sampling of organizations that o"er low down and/or zero down payment programs.
Fannie Mae
Federal Housing Administration (FHA)
Freddie Mac
Housing and Urban Development (HUD)
Veterans A"airs (VA)

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Amortization Schedule
This chart is useful for !guring out what you can a"ord. Use it to calculate:
Monthly Payment

Loan Amount

1. Divide loan amount by $1,000

2. Multiply the result by the interest rate factor
1. Divide the monthly payment by the interest rate factor
2. Multiply the result by $1,000

Interest 15 Yr 30 Yr

Interest 15 Yr 30 Yr

Interest 15 Yr 30 Yr

3.00%

6.91

4.22

7.00%

8.99

6.65

11.00%

11.37

9.52

3.25%

7.03

4.35

7.25%

9.13

6.82

11.25%

11.52

9.71

3.50%

7.15

4.49

7.50%

9.27

6.99

11.50%

11.68

9.90

3.75%

7.27

4.63

7.75%

9.41

7.16

11.75%

11.84

10.09

4.00%

7.40

4.77

8.00%

9.56

7.34

12.00%

12.00

10.29

4.25%

7.52

4.92

8.25%

9.70

7.51

12.25%

12.16

10.48

4.50%

7.65

5.07

8.50%

9.85

7.69

12.50%

12.33

10.67

4.75%

7.78

5.22

8.75%

9.99

7.87

12.75%

12.49

10.87

5.00%

7.91

5.37

9.00%

10.14

8.05

13.00%

12.65

11.06

5.25%

8.04

5.52

9.25%

10.29

8.23

13.25%

12.82

11.26

5.50%

8.17

5.68

9.50%

10.44

8.41

13.50%

12.98

11.45

5.75%

8.30

5.84

9.75%

10.59

8.59

13.75%

13.15

11.65

6.00%

8.44

6.00

10.00%

10.75

8.78

14.00%

13.32

11.85

6.25%

8.57

6.16

10.25%

10.90

8.96

14.25%

13.49

12.05

6.50%

8.71

6.32

10.50%

11.05

9.15

14.50%

13.66

12.25

6.75%

8.85

6.49

10.75%

11.21

9.33

14.75%

13.83

12.44

2016 Financial Knowledge Network, LLC.

" EXERCISE
Using the amortization schedule on the previous page, calculate the answers to the
following questions:
1. Joe wants take out a home mortgage for $550,000. What will his monthly payment
be for a 30-year mortgage at 3.75% interest?
2. Scott and Patti want to take out a home mortgage for $700,000. What will their
monthly payment be for a 30-year mortgage at 4% interest?
3. What will Scott and Pattis monthly payment be if they decide to take out a 15year mortgage at the same interest rate as above?
4. Kelli has decided she can a!ord a monthly house payment of $3,500. Interest rates
are currently hovering around 4.25%. What is the maximum loan amount for a 30year mortgage she can have based on this criteria?
Answers can be found on page 43.!

2016 Financial Knowledge Network, LLC.

Home Purchase A!ordability Worksheet

Actual

Example 1

Example 2

$40,000.00

$115,000.00

$3,333.33

$9,583.33

A"ordable Monthly Debt

$1,200.00

$3,450.00

Subtract Monthly Debts

($250)

($450)

$950.00

$3,000.00

$807.50

$2,550.00

4.25%

4.25%

30 year

30 year

$164,126.02

$518,292.68

$6,565.04

$20,731.71

$40,000

$150,000

Subtract Closing Costs

($6,565.04)

($20,731.71)

Down Payment Amount

$33,434.96

$129,268.29

Gross Annual Income

Divide by 12
Gross Monthly Income
Calculate A!ordable
Monthly Mortgage
Payment

Multiply by .36

A"ordable Monthly
Housing Expense (PITI)
Multiply by .85
A"ordable Mortgage
Payment (PI) (Principal &
Interest Only)
%

Current Interest Rate

Term of the Loan
Calculate A!ordable
Loan Amount &
Closing Costs

A"ordable Loan Amount

(See Amortization
Schedule)
Multiply by .04
Closing Costs
Total Cash Available

Calculate A!ordable
Purchase Price

Add A"ordable Loan

Amount
Approximate A"ordable
Purchase Price

2016 Financial Knowledge Network, LLC.

+$164,126.02
$197,560.98

10

+$518,292.68
$647,560.97

Lending Terminology
Know Before You Owe
Starting in October 2015, lenders are required to provide easy-to-understand
summaries and estimates for the cost of your mortgage and settlement before you take
out the loan and before you purchase the property. This is part of the Know Before You
Owe initiative which began in 2011.
The Loan Estimate outlines the fees, taxes, and closing costs (including private
mortgage insurance) you should expect at settlement. By federal law, the lender is
required to provide it to you within three business days of receiving an application.
You will receive a Closing Disclosure, a detailed report of all actual costs at closing (also
known as settlement), at least three days prior to signing your mortgage paperwork.

Points
A Point is a fee assessed by a lender. Think of it as interest that is paid in advance. One
point is equal to 1% of the mortgage amount.
Generally, there is an inverse relationship between the number of points a lender
charges and the interest rate on the loan as follows:
The higher the points, the lower the interest rate
The lower the points, the higher the interest rate

Paying Points vs. No Points

Many !nancial advisors use the following formula to determine whether a no point/no
cost loan will save money over a loan that has points and/or fees.
1. Monthly Payment with Points and Fees
2. Monthly Payment on a No-Point, No-Fee Loan
3. Subtract Line 1 From Line 2
4. Enter the Cost of Points and Fees
5. Divide Line 4 by Line 3
6. The result is the number of months needed to
recoup your up-front costs
If you anticipate owning a home for a year or so longer than the number of months on
line 5, a loan with points and fees and a lower interest rate would be more cost e!ective.
Otherwise, the no-point/no-cost loan would be the better choice.!
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11

Annual Percentage Rate (APR)

The Annual Percentage Rate (APR) provides a way to compare loans with one another.
The APR represents the total loan cost including any points and fees. Lenders may
calculate APR di"erently, so the best way to compare loans is to match the rates and
then compare the total closing costs, including points and fees.
Note that the APR disclosed to a borrower assumes you will stay in the home for the
term of the loan. If you stay in the home for less time, the APR will actually be higher.
A formula for estimating APR is:

(Number of Points Factor A) + Quoted Interest Rate = APR

Estimated # of Years in Home Factor A
13+ years

7-12 years

4-6 years

3 years

2 years

1 year

" EXERCISE
1. Joe would like to purchase a home that he is planning to live in for 6 years. A
lender has o!ered him two di!erent interest ratesone at 3.75% with one point
and the other at 3.5% with three points. Which one is better for Joe?
Answer can be found on page 43.

Rate Lock

A Rate Lock provides guaranteed protection by a lender in case interest rates should
rise before you close on a home. Make sure a rate lock is in writing.
Rate locks vary, but consider a 60-day rate lock instead of a 30-day to 45-day rate lock.
Although a 60-day rate lock can add a bit more to the mortgage cost (either a slightly
higher interest rate or higher fees), it could prove bene!cial when the amount of time to
process a loan becomes longer.
If rates have fallen and the rate lock period is over, ask the lender to provide a better
rate. Sometimes a lender will refuse, and you risk forfeiting any points and fees paid if
they rescind on a mortgage loan. Shop around for lenders that collect smaller deposits
when a borrower locks in a rate, in case rates drop considerably and you want to back
out to obtain a lower-rate mortgage.

2016 Financial Knowledge Network, LLC.

12

Float-Down Option
A Float-Down option allows you to lock in a current rate, but o"ers an opportunity to
receive a new lower rate before closing if interest rates have dropped.
Not all lenders o"er a $oat-down option, so its important to ask about this feature when
shopping for a loan. If lenders do o"er this feature, they may charge an additional fee.

" EXERCISE
Linda locks in a 30-year, $550,000 mortgage at 4.5%, paid at $2,789 a month. If rates
decrease to 4.25%, Lindas monthly payment would then decrease by about $83 a month.
1. Assume Linda would pay $1,200 in fees that will not be refunded if she backs out
of the 4.5% loan. How long would it take for her to break even with the 4.25% loan?
2. Would it make sense for her to back out of the 4.5% loan?
Answers can be found on page 43.

Private Mortgage Insurance (PMI)

PMI protects lenders and investors from the increased risks in the event the borrower
defaults on low-down or zero-down-payment loans. Generally, if you put down less
than 20%, mortgage lenders require you to purchase private mortgage insurance (PMI).

Avoiding PMI
A way around having to pay PMI with less than 20% down is to obtain a second
mortgage at the same time that the !rst one is secured. See piggyback loan, discussed
later. Some lenders may include the cost of PMI in the loan amount, making the PMI
tax-deductible. This requires the borrower to purchase a single-payment life insurance
policy. The single premium payment is built into the interest rate of the loan.

Canceling PMI
Under federal law, lenders are required to cancel PMI automatically when equity
reaches the 22% level for loans made after July 29, 1999. But equity is !gured by only
using regularly scheduled payments and does not include price appreciation. Moreover,
federal law stipulates that homebuyers paying PMI can request that premiums be
cancelled when they reach the 20% equity level, as long as loan payments have been
made on time for two years.
In terms of valuing the property, many lenders are relying on broker price opinions or
CMAs instead of a full professional appraisal. If the lender requires a professional
appraisal, make sure the cost is worth it. It's important to verify your property value
online and with a real estate agent before spending time and money to try and cancel
PMI. Websites such as www.zillow.com provide regional data on home sales and trends.

Deducting PMI
The tax deduction for PMI has expired.!

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13

Prepayment Penalty
A prepayment penalty is a fee paid by the borrower to the lender if a loan is paid o"
within a certain number of years as disclosed by law in the mortgage contract.
This prepayment penalty is typically a $at percentage of the loan balance outstanding
or a certain number of months of interest.
Some lenders will waive their penalty for borrowers who re!nance or take out a new
mortgage with them. If planning on moving or re!nancing within a few years, you should
try and obtain a loan that does not have a prepayment penalty.

Title Insurance
Ownership of real estate is evidenced by a Title, a legal document that speci!es the
owner of a particular piece of real estate.
However, the title does not prove ownership. Because of legal complexities and speci!c
procedures required to transfer title, someone other than the person speci!ed in the
title document could have a superior claim to the real estate. Title defects can result
because of a defective probate or will, or even an incorrect description of the property
or a gap in the title records of the property. There could also be unrecorded liens
against the property or other defects to the title, such as easements.
Title insurance protects the buyer and lender against unknown defects in the title. For a
one-time fee, a company issues the insurance after doing a title search on the property.

Characteristics of Title Insurance

The maximum amount covered is usually the cost of the real estate
O"ers protection against title defects that were unknown before the insurance

purchase
Known title defects are listed and excluded
A single premium is paid at closing
The property is covered as long as the insured owns the property and the defect
occurred before the purchase of insurance

Impound Account
An impound or escrow account is an account in which a portion of the monthly
mortgage payment is held by the lender on the borrowers behalf for the payment of
future taxes, mortgage, and hazard insurance. Many lenders require this impound
account if the buyer has less than 20% equity in the property. In some cases, this
impound account is optional. But if the buyer decides against an impound account, they
will be required to budget for and make insurance and tax payments as they come due.

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Understanding Mortgages
Fixed Rate vs. Adjustable Rate Mortgage
The key to choosing the best loan is to consider how long you plan to stay in the house.
Generally, if you plan on staying in the home less than seven years, an ARM may save
interest. If you plan on keeping the home more than seven years, a !xed interest rate
mortgage is generally safer.

Fixed Rate Mortgage

This loan o"ers stable monthly payments that never change since the interest rate
remains the same throughout the term of the loan. Common loan terms for !xed
mortgages are 15, 20, and 30 years. Fixed rate mortgages generally have higher interest
rates than adjustable rate mortgages since the lender is committing money for a longer
period of time. These types of loans may be more di#cult to qualify for than adjustablerate loans. The general rule of thumb is that !xed rate loans are ordinarily considered a
better deal whenever the spread between !xed and adjustable rates narrows to two
percentage points or less.

Adjustable Rate Mortgage (ARM)

An ARM begins with a lower interest rate than a !xed mortgage, but can rise over time
along with ones payments if interest rates rise. The rate will vary based on an index plus
the lenders margin. ARMs may have a teaser interest rate that is advertised but this is
generally an introductory rate for promotional purposes. This rate usually adjusts
upward quickly.
The index is a $oating interest rate that is set to a standard. Common standards include
the interest rate on short-term U.S. Treasury debt securities and the LIBOR, the London
Interbank O"ered Rate, which is the rate banks charge each other for short-term
funding. Over 75% of ARMs are priced o" the Treasury one-year constant maturity. You
can access current !gures at www.federalreserve.gov/releases. The margin is a !xed
percentage rate that the lender adds to the index to arrive at the borrowers interest rate
for the period.
In addition, most ARMs have a periodic rate cap. This cap limits the amount that a
borrowers interest rate can increase from one period to the next (i.e. 1-2%). ARMs also
have a lifetime cap, which is the maximum interest rate the lender can charge over the
lifetime of the loan (i.e. 6%).
ARMs may make sense for borrowers when !xed rates are high and you dont plan on
staying in your house very long or are anticipating re!nancing later. ARMS are also
popular loans for borrowers who need to stretch to a"ord a home. However, you need to
decide whether the initial savings on an ARM is worth the higher risk if rates go up
considerably. These loans make sense for people who plan to stay in their home less
than !ve years.

2016 Financial Knowledge Network, LLC.

15

Other Types of Mortgage Loans

There are many di"erent types of loans. This chart lists some of the more popular types.
These loans o"er a low interest rate and a relatively "xed

Hybrid ARM payment. A 3/1 has a !xed monthly payment for three years and
3/1, 5/1, 7/1, or 10/1 then converts to a traditional adjustable rate mortgage based on
the market.

Adjustable Rate Mortgage with low introductory rates. These

Option ARM loans are essentially extinct after the housing crisis of the late
2000s. Negative amortization may occur with these loans.

With this type of loan, the interest rate changes only once. For
example, with a 7/23 loan, the interest rate changes at the end of 7
Two-Step of 7/23 or years. After 7 years, the borrower must pay the entire loan balance
5/25 (Balloon Reset) in a balloon payment, re!nance to a new loan, or the interest rate
on the existing loan resets, typically higher than the market rate.
A loan designed to help borrowers with a small down payment
avoid PMI. This is really two loans: A !rst trust deed for 80% of the
Piggyback property value and a second trust deed for about 10-15% of the
property value. The borrower must have the remaining 5-10% as a
down payment.
A seller, builder, or buyer can o"er to make a lump-sum payment

Buydown at the beginning of the loan that is used to subsidize the monthly
payments for the !rst couple of years.

This type of loan is designed for the "rst-time homebuyer.

Graduated Payment Monthly payments are smaller in the !rst few years and grow to
(GPM) their full level after three to !ve years.
Home Appreciation
Loan or Shared
Appreciation Mortgage
(HAL/SAM)

Lenders loan a homeowner money with minimal or zero interest.

The lender receives the original amount borrowed when you sell,
re!nance, or pay o" the loan. In addition, the lender receives an
agreed-upon percentage of the homes appreciation. If no
appreciation occurred, the lender will receive no extra money.

Pledged Asset
A mortgage using non-retirement accounts as collateral.
Mortgage
A zero-down loan o!ered to veterans and guaranteed by the VA.
Lenders receive a 2% service fee for processing the loan, so your
VA Loan rate should re$ect that as a discount. Because there is no money
down, rates may still be higher than a conventional loan, so be sure
to consider traditional mortgage options as well.
Generally used to consolidate credit card debt, this loan permits
No-Equity Loan borrowers with good credit to borrow as much as 125% of their
homes value.

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16