The mortgage industry is complicated and constantly changing. In order to get the best deal possible for your home it is important to understand how the market works and how lenders and loan originators make their money. In doing this you will be able to make educated decisions that affect your financial well-being.
Mortgages loans in the United States are regulated by three congressionally appointed entities (corporations). These organizations are Fannie Mae, Freddie Mac, and Ginnie Mae. Together they set the limits for borrowing, known as the conforming loan limit. They also purchase and insure mortgage debt ensuring that lenders have the funds necessary to grant loans. These lenders pool their loans and sell them to investors on the secondary mortgage market; this is where the majority of profits are made. Here are the basics you’ll need to understand before refinancing your mortgage.
Mortgage Rate Secrets
Mortgage rates move up and down on a daily basis. There are a number of factors that contribute to rising or falling mortgage interest rates. When people talk about mortgage rates they’re not just talking about one rate; “mortgage rates” are made up of many different interest rates.
Mortgage rates come from not only the Prime Rate, but Treasure Bill Rates, Treasury Notes, Bonds, the Federal Funds Rate, the LIBOR index, 6 month CDs, and Fannie Mae/Ginnie Mae Security Rates just to name a few. Interest rates are influenced by the laws of supply and demand. When the demand for credit is high, interest rates go up. The opposite is also true, when the economy slows and the demand for credit goes down so do interest rates.
You may have heard about the “Mortgage Crisis” in the United States. The mortgage industry’s problems are threatening to drag the US economy into a recession; however, this is good news for interest rates. Bad economic news usually results in lower interest rates where favorable economic conditions result in higher rates. Another way of approximating the direction mortgage rates are headed is to look at bond prices. Bond prices and mortgage rates tend to move in opposite directions. When bonds are up, mortgage rates are down, vice versa.
Debt to Income Ratio
The mortgage rate you receive is determined not only by economic conditions but by your credit and qualifying ratios. Debt to Income Ratio is simply your total debt divided by your total monthly income before deductions. Most traditional lenders do not want your Debt to Income Ratio higher than 40%; however, some bad credit lenders have been known to approve loans as high as 60%. The rule-of-thumb with your debt ratio is typically the less debt you have the better your mortgage rate will be.
Credit History Secrets
Credit scores are one of the most confusing and intimidating aspects of refinancing your mortgage. When you submit your application for a new mortgage the broker will run a merged credit report from all three credit bureaus. They do this because the three credit bureaus of Equifax, Experian and Trans Union do not share information well. This report provides three credit scores and your mortgage application will be based on the median credit score. (You have three credit scores because you have three credit reports…one from each credit bureau)
Suppose Your Credit Scores Are:
Experian FICO – 701
TransUnion Empirica – 708
Equifax Beacon – 688
Your mortgage application will be based on the FICO score of 701. The rule-of-thumb when qualifying for a traditional, conforming mortgage loan is that you need a credit score of at least 620. Anything less than 620 and you’re considered a sub-prime borrower. If your credit score is 720 or better you have excellent (A+) credit.
If your credit scores are low there are steps you can take to raise them before applying. There are three types of debt you need to consider. These types include mortgage debt, installment debt, and revolving debt. Installment debt is anything with fixed payment amounts such as your car payment and revolving debt can change on a monthly basis like your credit cards. You should pull all three of your credit reports by visiting the website annualcreditreport.com; recent legislation requires all three credit bureaus to provide you with a free copy of your credit reports each year at this site.
Thirty five percent of your credit score is based on your history of making on-time payments. If you have any 30 day late payments on your credit report this will drag down your credit score. Never let a mortgage payment go 30 days late….ever. You can improve your credit score by shuffling your revolving debt (credit cards) so that you have not used 50% of your limit. Some credit cards may not report their limits and if you have one like this on your credit report it is damaging your score because the credit bureau considers the card maxed out. If your credit limits are not accurately reflected on your credit reports contact the credit card company and ask them to correct the discrepancy.
The final piece of the puzzle that makes up your qualifying ratios is Loan-to-Value Ratio. Your Loan-to-Value Ratio or LTV is calculated by dividing your mortgage amount by the appraised value of your property. The higher the LTV, the less equity you have in your home and the greater a risk you are for the lender. If you have less than 20% equity or have a LTV greater than 80%, your lender could require you to purchase Private Mortgage Insurance (PMI) to qualify for your loan.
Private Mortgage Insurance (PMI)
This “insurance” does nothing for you as a homeowner besides draining your wallet. PMI protects the lender from certain losses due to foreclosure. This insurance is often expensive and can add hundreds of dollars to your monthly payment. Fortunately, there are ways around Private Mortgage Insurance and your best bet for avoiding this unnecessary expense is what’s known as an 80/20 or piggyback loan.
Piggyback loans are essentially two mortgages…the first for 80% and the second for the remaining 20%. The downside of using an 80/20 loan is that the mortgage rate on your second loan will be higher due to increased risk for the lender. You will need to weigh the pros and cons of paying this higher mortgage rate against the expense of PMI premiums.
This is the first article in a series of articles entitled “Mortgage Refinancing Secrets.” You can learn more about your refinancing options, including costly mistakes to avoid with my free video tutorial. Register today using the DVD link at the top of this page.