What is Escrow?

As a homeowner in Des Moines , your fiscal responsibility extends beyond just making mortgage payments. You must also pay your home’s real estate taxes as they come due, as well as your homeowners insurance policy premiums.

Failure to pay real estate taxes can result in foreclosure. Failure to insure your home is a breach of your mortgage loan terms.

There are two methods by which you can pay your real estate tax and homeowners insurance bills.

The first method is to pay your taxes and insurance as the bills come due, usually semi-annually. Depending on your home’s tax bill size and the cost to insure your home, these payments can feel quite large — especially if you’ve failed to budget for them properly.

The second method of paying your taxes and insurance is to give your lender the right to pay them on your behalf, a process known as “escrowing for taxes and insurance”.

When you escrow your real estate taxes and homeowners insurance, you pay a portion of your annual obligation to your lender each month, which your lender then holds in a special account for you, and disperses to your taxing entities and insurance company as needed. Lenders prefer that homeowners escrow taxes and insurance because, in doing so, the lender is assured that tax bills remain current and that homes stay insured.

How to Calculate Your Escrow Payment

Want a discount on your next mortgage rate? Tell your lender that you’re willing to escrow.

To help calculate your monthly escrow payment to your lender, do the following :

1. Find your home’s annual real estate tax bill
2. Find your home’s annual homeowners insurance premium
3. Add the two figures and divide by 12 months in a year

The quotient is your monthly “escrow”; the extra payment you’ll make to your lender each month along with your regularly scheduled principal + interest payment. Then, when your tax bills and insurance premiums come due, your lender will make sure the payments are made on your behalf.

If you’re unsure whether escrowing is right for you, talk to your loan officer and/or financial planner. There are valid reasons to choose either path.

Simply Stated, a Way to Help Simplify Your Options

More commonly called APR, Annual Percentage Rate is a government-mandated mortgage comparison tool. It measures the total cost of borrowing over the life of a loan into dollars-and-cents.

A loan’s APR is printed in the top-left corner of the Federal Truth-In-Lending Disclosure, as shown above. When quoting an interest rate, loan officers are required by law to disclose a loan’s APR, too.

APR is meant to simplify the process of choosing between two or more loans. The theory is that the loan with the lowest APR is the “best deal” for the applicant because the loan’s long-term costs are lowest. However, the loan with the lowest APR isn’t always best.

APR makes assumptions in its formula that can render it moot.

First, APR assumes you’ll pay your mortgage off at term, at never sooner. So, if your loan is a 15-year fixed rate, its APR is based on a full 15 year term. If you sell or refinance prior to Year 15, the math used to make your loan’s APR becomes instantly flawed and “wrong”.

Here’s an Example:

Let’s compare two identical loans in Iowa — one with discount points and a lower interest rate; and one without discount points and a higher mortgage rate. The loan with discount points will have a lower APR in most cases. However, if the homeowner sells or refinances within the first few years, the loan with the higher APR would have been the better option, in hindsight.

Second, APR can be “doctored” early in the loan process.

Because the APR formula accounts for third-party costs in a mortgage transaction, and third-party costs aren’t always known at the start of a loan, a bank can inadvertently understate them. This would make the APR appear lower than what it really is, and may mislead a consumer.

And, lastly, APR is particularly unhelpful for adjustable-rate loans. Because the APR calculation makes assumptions about how a loan will adjust during its 30-year term, if two lenders use a different set of assumptions, their APRs will differ — even if the loans are identical in every other way. The lender whose adjustments are most aggressively-low will present the lowest APR.

Summarized, APR is not the metric for comparing mortgages — it’s a metric. For relevant comparison points, talk to your loan officer.

To Escrow or Not to Escrow?  That is the Question.

The financial responsibility of a homeowner — in Urbandale and everywhere else — extends beyond the mortgage’s basic principal and interest repayments.  Homeowners are also always responsible for the real estate taxes on the home and its insurance premiums as well.

The not-so-good news is that failure to pay taxes can lead to foreclosure, and failure to insure the property is breach of your mortgage contract.  Seriously, they’ll force place insurance on your property (which isn’t cheap!) if you don’t keep your own.  They’re very serious about this.

As a homeowner, you have a choice about how you manage your real estate tax and insurance bills.  You can choose to pay them from your own bank account when the bills come due, or you can choose to pay 1/12 of the annual bill to your mortgage servicer each month, and then let your servicer pay the bills on your behalf when they come due.

Not surprisingly, servicers prefer the latter method — it reduces two major lender risks:

1. That the home’s real estate taxes go delinquent and are sold to a third-party
2. That the home endures catastrophic damage during a lapse of insurance coverage

In theory, when the servicer is paying the bills, the home’s taxes are always current and the home’s insurance is always paid. This method of managing taxes and insurance is commonly called “escrowing”.

How is Your Escrow Payment Calculated?

To calculate a home’s monthly escrow payment is simple. Just take the sum of the annual real estate tax bills and insurance bill, then divide it by 12 months in the year.

As a example, a $4,000 annual tax bill with a $800 insurance policy = $4,800 annually = $400 paid into escrow monthly. These monies are collected as part of the regular mortgage payment along with the mortgage’s scheduled principal + interest payment.

Homeowners choosing to escrow generally get the lowest rate and lowest fee loans. This is because lenders often charge a premium to “waive escrow” (i.e. clients paying their own taxes and insurance). Escrow waiver fees vary between banks/lenders, but can range up to half-percent of the amount borrowed. The larger the loan, the stiffer the penalty in dollar terms.  Some mortgage professionals never even explain the pros and cons to clients.

Choosing to waive escrow can also raise your mortgage rate by up to 0.250 percent.

If you’re unsure whether escrowing is right for you, give me a call and/or a financial planner. There’s good reason to go either route depending on your profile.

Whatever you do, at least collect the facts and then make a decision.  You may be surprised the cost involved to pay your own taxes and insurance.

How Do Adjustable Rate Mortgages Work?  The Facts Might Surprise You.

If your adjustable rate mortgage is going to adjust this year, don’t go rushing to refinance it just yet. Your soon-to-adjust mortgage rate may actually go lower. It’s related to the math behind the ARM.

Here’s the quick-and-dirty explanation.

Conventional, adjustable rate mortgages share a common life cycle:

1. There’s a “starter period” in which the interest rate remains fixed
2. There’s an initial adjustment period after the starter period called the “first adjustment”
3. There’s a subsequent annual adjustment until the loan’s term expires — usually at Year 30.

The starter period will vary between 1 and 10 years, but at the point of first adjustment, conventional ARMs become the same. A homeowner’s new, adjusted mortgage rate is determined by the sum of some constant, and a variable. The constant is most often 2.25% and the variable is most often the 12-month LIBOR.

What’s An Adjustment Look Like?

As a formula, the math looks like this:

(Adjusted Mortgage Rates) = (12-Month LIBOR) + (2.250 Percent)

LIBOR is an acronym standing for London Interbank Offered Rate. It’s the rate at which banks borrow money from each other and, lately, LIBOR has been low. As a result, adjusting mortgage rates have been low, too.

Believe it or not, last year 5-year ARMs were adjusting to 6 percent or higher. Today, they’re adjusting to 3.375%!  Not too shabby.

Based on the math, it may be wise to just let your ARM adjust this year. Or, depending on how long you plan to stay in your home, consider a refinance to a new ARM.  Starter rates on today’s adjustable rate mortgages are exceptionally low in Iowa, as are the rates for fixed rate loans.

Either way, talk to me about making a plan. With mortgage rates as low as they’ve ever been in history, you as a homeowner have some interesting options. Just don’t wait too long. LIBOR — and mortgage rates in general — are known to change quickly.  If you’re ready to talk, please contact me at the information off to the right of this blog post! If you need help figuring out what your adjustable rate mortgage will be doing, I’d happy to help you figure it out.  It beats hoping things don’t skyrocket.

Your Interest Rate & APR Are NOT the Same

APR is an acronym for Annual Percentage Rate.  It’s a government-mandated calculation meant to simplify the comparison of mortgage options.

A loan’s APR can always be found in the top-left corner of the Federal Truth-In-Lending Disclosure.

Because APR is expressed as a percentage, many people confuse it for the loan’s interest rate.  It’s not.  APR represents the total cost of borrowing over the life of a loan.  “Interest rate” is the basis for monthly mortgage repayments.

The main advantage of APR is that it allows an “apples-to-apples” comparison between loan products. 

As an example, a 5.000 percent mortgage with origination points and fees will almost certainly have a higher APR than a 5.500 percent mortgage with zero fees.  In this sense, APR can help a borrower determine which loan is least costly long-term.

An APR Isn’t Always Your Best Comparison Option

First, different banks includes different fees into their APR calculations.  By definition, this spoils APR as a choose-between-lenders, apples-to-apples comparison method.

And, second, when calculating APR, “life of the loan” is assumed to be full-term.  When a 30-year mortgage pays off in 7 years or fewer — as most of them do — APR comparisons are rendered moot.

In other words, APR is just one metric to compare mortgages — it’s not the only metric.  The best way to compare your mortgage options is to review all the loan terms together and determine which is most suitable.

What is a Quitclaim Deed?

By its most common definition, a quitclaim deed is a document by which one person passes legal and financial ownership of a home to another person.

It’s also a way for an owner of a home to remove himself from the title to the property.

Often misspelled as “quick claim deed” or “quit claim deed”, quitclaim deeds have a multitude of applications, including:

• Assigning a home to a trust or entity
• Adding a partner to title after marriage
• Removing a partner from title after divorce

Consult a Professional

In order to quitclaim a property, the grantor must have the legal right to assign the property to a grantee, or else the quitclaim deed is worthless.  For example, you can’t quitclaim your interest in City Hall to your neighbor because you don’t actually own City Hall. 

This is where quitclaim deeds vary from warranty deeds (or grant deeds) — the types of transfers that occur when real estate is sold.  In instances of the former, the title to a home is guaranteed to be clear.

Before using a quitclaim deed on your own home, consult an estate planning attorney.  Transferring real property can trigger ruin a will, or trigger taxes — it’s important to consult a professional for help.

I live in a world of acronyms.

Seriously – when we start in the business, they should have a mortgage class related to just understanding all of the acronyms.  Even worse, mortgage professionals use these acronyms in conversation with clients.  I feel horrible for those individuals because it’s like we’re speaking a different language, right?

With that said, I’m going to start explaining some of the frequently used acronyms. Hopefully if you’re working with a mortgage professional, you’ll never hear these. However, every so often (too often in my opinion) you’ll hear lenders use these terms and leave you extremely confused. I don’t like being confused and I absolutely hate confusing clients.

So, What is a VOD?

VOD stands for Verification of Deposit.  Still confused?  A verification of deposit is a document from a bank that shows you have a certain amount of money in your bank account.  It is one piece to the stack of documentation a lender pulls together when approving you for a loan.

Why would a lender use a verification of deposit?

• It can be a substitute to bank statements.
• It doesn’t show each individual transaction on the account.
• Less paper. (Be green!)
• It provides a photographic shot of any given time.
• It also identifies any outstanding loans with that financial institution.

There are advantages of using a verification of deposit.  There are also disadvantages of using them.  This post is intended for you to understand what a VOD is, not when to use it.  If you’re working with a seasoned mortgage professional, you will never have to worry about it.

So, no more mystery mortgage talk. Now you know what a VOD is!

Seriously – when we start in the business, they should have a mortgage class related to just understanding all of the acronyms.

With that said, I’m going to start explaining some of the frequently used acronyms. Hopefully if you’re working with a mortgage professional, you’ll never hear these. However, every so often (too often in my opinion) you’ll hear lenders use these terms and leave you extremely confused. I don’t like being confused and I absolutely hate confusing clients.

So, what is an LOX? LOX stands for letter of explanation. Yea, I never really thought of it until now – but it’s sort of ridiculous that they had to use X as the last letter instead of an E. Doesn’t make much sense, huh? I guess it sounds sexier with an X. Moving on….

Often with files we see situations that need some explanation. If we don’t explain those situations before a loan gets to underwriting, there are two things that can happen.

1. The underwriter will request in their conditions (for the loan approval) to write a letter explaining what happened (LOX).
2. The file will be turned down because the underwriter thought it was a deal killer. Yea, seriously. This happens all the time with unexperienced mortgage professionals.

So, what are some examples of times when you need a letter of explanation in a file? Here’s a few:

• Change of mailing address (yes, just mailing).
• Credit inquiries within a certain time frame (often 120 days).
• Gaps of employment.
• Delinquencies on credit reports.
• Collections on credit reports.
• Reason for cash out on a cash out refinance.
• Improvements made to a home (to document increased value).
• Letters from employers for a raise/bonus.
• Explanation of bankruptcy, short-sale or foreclosure.
• Stating the property could be 100% rebuilt (from the City).
• Divorce situations.
• Explaining retirement benefit / pension for income

Here’s what I’ve learned in my five years of being a mortgage professional. If there’s a ‘problem‘ in a file, the underwriter will bring it to the surface. It always happens. The difference is if you address it up front and explain what happened and how it effects your ability to repay a mortgage. If you dodge it, it will only cause problems and delay a loan closing.

So, no more mystery mortgage talk. Now you know what a LOX is and hopefully you understand the importance of putting one together!

Have you heard the term Cap Rate?  Maybe by the water cooler?  Maybe in an investment book?  Maybe on a late night sales commercial?  Have you ever wondered what it means or how reliable it is?  

When buying an investment property, investors often consider the cap rate.  Often it serves as a part of the process but not the one and only component when evaluating a property.

Figuring the Capitalization Rate (a.k.a. ‘Cap Rate’) 

Annual Cash Flow / Cost (or property value) = Capitalization Rate

Annual Cash Flow is Gross Income – Fixed and Variable Expenses.  It does not take into consideration any debt service (the mortgage payment).

Here’s a quick example (via Wikipedia):
For example, if a building is purchased for $1,000,000 sale price and it produces $100,000 in positive net cash flow (the amount left over after fixed costs and variable costs are subtracted from gross lease income) during one year, then:

$100,000 / $1,000,000 = 0.10 = 10%

Your capitalization rate is 10%.

The cap rate comes most in handy when trying to figure out how quickly you’ll get your investment will pay for itself.  If you have a 10% cap rate, it’ll take 10 years.   With a 5% cap rate, it’ll take 20 years.  Make sense?

My Opinion:

Here’s my beef with cap rates.. It doesn’t take into consideration any debt service.  Most people I know use leverage (other peoples money).  If you’re leveraging someone else’s money, it’s a variable cost.  Depending on the terms you can get, it could make or break the numbers on a deal.  This is why I personally believe that a capitalization rate is a decent way to evaluate a property, but honestly – there are too many other variables to just look at this one evaluation technique. 

In the coming weeks, I’ll discuss other technique’s used to crunch the numbers on investment properties just to beef up your arsenal.  I’ll be the first person to tell you that if the numbers work – you take the deal.  If not – walk away.  Most importantly, build a team of professionals you trust that can help you protect your investment and manage it over time.

I’ve spent days pondering how to make this as funny as Stephen Colbert’s hilarious segment ‘Better Know a District’.  Very quickly, I realized that his humor is in his interviewing… so I guess I’m out of luck in that respect. However, I do know that too often terminology is used in the mortgage industry (much like other industries) where people assume that you know what their talking about.  I’m here to make these commonly used terms and make them easier to understand and explain.  So, here’s your first edition of Wealth With Mortgage’s ‘Better Know a Mortgage Term’.

Have you ever heard the term ‘Jumbo Loan’ and not understood what it was?  Why it costs more to get one?  Why the guidelines are different to qualify for one?  Well, you’re not the only one and I’m here to hopefully set the record straight!

Quickly defined, (via wikipedia) a jumbo mortgage is a loan with a loan amount above the industry-standard definition of conventional conforming loan limits.

Loan limits are set by Fannie Mae and Freddie Mac, two government sponsored enterprises of the US Government.  These limits are re-assessed every year by looking at the mean sales prices across the country.  If prices increase, a limit increase is seriously considered.  There are also areas designated as ‘High Cost Areas’ that have a higher limit set for borrowing, specifically 50% higher than the other parts of the country.  As of January 2008, these high cost areas are Alaska, Hawaii, Virgin Islands and Guam.

The most often asked question I get in the mortgage industry (related to this topic) is ‘Why does it cost more to get a jumbo loan?’ (normally referring to the interest rate).  Well… if you ask a loan officer in my business this question and they simply say ‘It’s a higher risk loan, so the lender assess a higher risk to you’ or an answer similar to this, they don’t understand the right answer.  Understanding where mortgage money comes from is what leads you to the RIGHT answer. 

Mortgage money comes from a secondary market.  At the end of the day, the lenders only have so much of their own money (a.k.a warehouse lines) that they can use.  They have to free up their capital so they can keep closing new business.  So, they go to wall street to convert the closed mortgages into mortgage backed securities (MBS).  Wall street’s job is to convert the mortgages into securities and they will assess you a fee for doing it each time.  Well, logically if you have TONS of loans to convert, the fee is VERY small on each individual loan.   Using the same logic, if you have a smaller group of loans going to wall street, the incremental cost is larger.  This is why you see a .25 to .50% higher rate on a jumbo loan.  Good stuff huh!!? 

Now, back to the question of risk.  Yes, a jumbo loan CAN be more risky.  This is why guidelines are often much different when qualifying for a jumbo loan.  Sometimes you have to have a lower debt ratio, higher credit score or even more money down.  I would address specific guidelines, but honestly – they can change almost weekly nowadays, so it wouldn’t be accurate anyway! 

Now go to the water cooler and impress your friends and co-workers with your new mortgage knowledge!

Please let me know if you’d like to have a term defined on the next edition of ‘Better Know a Mortgage Term’!