The interest rate is, of course, the stated interest rate on the loan you’re taking from the bank.  The APR, however, is more comprehensive because it includes many of the up-front costs of your mortgage.  These additional fees taken into account usually include loan origination fees, and underwriting fees.  The idea is to give you a better idea of the actual “interest” you’ll be paying once the extra costs are taken into consideration.  The bigger the spread between APR and the interest rate, the more those upfront fees are raising the effective cost of your mortgage.  That’s why banks are required to display this rate – so they can’t advertise a lowball interest rate and hide the fees that you’ll be charged.

Discount points that you pay up front can account for large differences between the APR and the stated interest rate.  A point represents 1% of the loan amount paid up front.  Because the lender gets a portion of his interest income straightaway, he is willing to lower the interest rate they you will pay over the life of the loan.  This, in turn, lowers your monthly payment, which is why discount points seem so attractive.  Whether or not paying points is worth it to you depends on the difference it will make in your monthly payment, and how long you plan to stay in the home you’re buying.  Figure up the monthly mortgage payment both with and without the points being paid.  Then compare the two amounts to find out how much you’re saving each month thanks to the points.  Divide that monthly savings by the amount you’re paying for the points to find out how many months it will take to break even.  If you think that you might not be in the house at that time, the points aren’t worth it.

Private Mortgage Insurance, or PMI, can also cause the APR to be higher than the interest rate.  Your lender will require PMI if your down payment is a small percentage of the loan, usually less than twenty percent of the value of the home you’re buying.

While the APR can provide a useful comparison between lenders to get an idea of the true cost of your mortgage, it has its limits.  Every financial institution, for example, figures APR differently; not all of them include the same upfront costs.  So a quick comparison between APR numbers isn’t enough – ask the lending institution what costs are included.  You should also get a good faith estimate from a prospective lender of the closing costs.  Also know that the APR is a much more meaningful comparison figure on a fixed rate loan than on an adjustable rate mortgage, because an ARM’s rate can change – and so will your costs.

How the 3 Day Right of Rescission Works

The law gives a borrower 3 full business days to rescind, or change his mind, after signing the loan documents. That means you can sign your loan docs on Monday, and if you go home and notice there’s a mistake on the loan documents and the interest rate is significantly higher than expected, you have 3 full days to fax in your notice of rescission to the lender and you won’t lose anything because of it.

An Example

The 3 full days begin the day after you sign your loan documents and do not include Sundays and federal holidays (list of U.S. federal holidays), but do include every other day, including Saturday. For example, if you sign your loan documents on a Thursday, the 3 days doesn’t begin until Friday. The first day is Friday, the second day is Saturday, you skip Sunday, and the third day is Monday (assuming Monday’s not a Federal holiday). In this example, you would have until Monday at midnight to send in a written notice of rescission to your lender.

The rescission notice can be anything typed or hand-written by you notifying your lender that you would like to rescind. Be sure to include your name, loan number, your lender’s name, and the current date and time on your notice. You can also find sample notices by searching Google for “Rescission notice.” The notice can be faxed or mailed to your lender.

If you mail the notice, the 3-day rule says it only has to be dropped into the mailbox by the rescission deadline. So, in the above example – your rescission period ends on Monday at midnight – you could drop the letter in the mailbox at 11:59 pm on Monday and you would have just made the deadline. Obviously they have no way of knowing whether you dropped it in the box at 11:59 pm on Monday or if you were a bit late and dropped it in at 12:01 am on Tuesday, but that’s the rule.

Another Example

Now let’s say you sign your loan documents on Friday, but the following Monday is a federal holiday. Your rescission period begins the day after signing, which would be Saturday in this case. We skip Sunday, but we also skip Monday since it’s a federal holiday. So day 2 would be Tuesday, and day 3 would be Wednesday. You would have until Wednesday at midnight to rescind in this example.

Calculate Your Funding Date Based on the Rescission Period

If you’re wondering when your loan will fund, it’s simple to calculate, it’s just the day after your rescission period expires. So, in the previous example, where Monday was a holiday and the rescission period expired on Wednesday at midnight, your loan would fund sometime on Thursday. The exact time really depends on a number of factors, but I’ve found it’s usually before noon.

When Your Right to Rescind Does Not Apply

It’s important to note that the 3-day right of rescission does not apply to all types of mortgages. Here are some examples of when the 3-day right of rescission does not apply:

1. Does not apply to purchase mortgages, only to refinances
2. Does not apply to refinances if you refinance with the same lender
3. However, if you refinance with the same lender and take cash out, it does apply to the cash out portion of the loan
4. Only applies to refinancing of your primary residence (doesn’t matter what type of home – i.e. manufactured, mobile, etc)
5. Does not apply when you borrow money for your business
6. Does not apply when you borrow from a state agency

It Gets a Bit More Complicated Now

Those are the basics of the law, however, there are some interesting quirks that you may never have to deal with, but we’ll share them anyway just in case . The 3-day clock doesn’t actually start ticking until 3 conditions have been met, however, in the vast majority of cases, all 3 of these things will happen on the signing day. Nonetheless, the conditions are:

1. Borrower must sign the loan papers
2. Borrower must receive a copy of all loan disclosures
3. Borrower must receive a copy of the Notice of Right to Rescind

In the rare case that your lender does not supply these on the day of your signing, the rescission period can run up to 3 years after your signing date. In such a case, should you decide to rescind, say, a year later, your lender’s security interest in the property becomes void and they must reimburse you for all finance charges collected over the life of the loan.

Additionally, the right to rescind applies to anyone with an ownership interest in the property. For example, if your husband is on Title, but will not be signing for the loan, he still has the right to rescind because the Title grants him ownership interest in the property.

Now, if you’ve really been paying attention up to this point – and bravo for you if you have – you may be wondering why the rule only requires that you drop your rescission notice in the mailbox by the deadline and not that the lender receives your notice by the deadline. Because your loan funds the day after your 3-days expire, and if you drop your rescission notice in the mailbox at 11:59 pm on the 3rd day, your loan will undoubtedly fund before the lender receives your notice.

Well, you’re right about this…in such a case you’d end up having to pay the lender right back. The law only requires that the lender be reasonably satisfied that the owners have not rescinded before releasing the funds from escrow. It ends up being a hassle for you and, especially, for your lender. That’s why it’s always a good idea to give your lender a call before the deadline if you plan to rescind. That way you can avoid the hassle of having to pay back the full amount of the loan. Incidentally, the potential for something like this to occur is just the reason your loan officer/broker may call you on the last day of your rescission period just to check that you haven’t decided to rescind or, in some cases, your lender may request written confirmation that you or anyone else with ownership interest in the property has not decided to rescind.

Waiving the Right of Rescission

While the 3-day right of rescission is designed to protect borrowers, it can also be a burden. The lender will not release funds from escrow until the day after the rescission period expires, but what if you need those funds immediately? What if your house was hit by a tornado and you need the funds to make repairs or you’ll have nowhere to live? In such a case, and only if you have a “bona fide personal financial emergency,” you can opt to waive your right of rescission and have your loan fund 3 days sooner.

If you’re interested in more information, you can check out the FDIC’s page on the topic of rescission at http://www.fdic.gov/regulations/laws/rules/6500-200.html#6500105

First Of All, What Are Points?

If you’ve read through the glossary, you may have come across the definition of Points. What you may have noticed is that the only real definition of a Point is a percentage of the total loan amount. The term points doesn’t necessarily mean closing costs, or rebate, or discount costs. Rather, quite literally, 1 point is equal to one percent of the loan amount. The problem with the idea of “paying points,” is that the phrase means, literally, “paying a percentage of the loan amount.”

What’s Really Wrong With The Promise of “No Points?”

The problem lies in the fact that “Points” is not the same as “Closing Costs,” something a lot of mortgage shoppers would be surprised to learn. So, promises of a refinance with no points makes great advertising and generates phone calls, but it does not mean there are no closing costs. It’s not what the promise of no points does say, but what that promise doesn’t say that makes this a form of bait and switch. The promise of no points says you won’t pay a percentage of the loan amount in closing…great, but it doesn’t say you won’t pay any up front closing costs, it also doesn’t say that your lender or broker can’t give you a higher interest rate and make you pay closing costs indirectly.

Understanding The Bigger Picture

When shopping for the best mortgage terms available, the focus should be on interest rate and total closing costs instead of terms like points, which may very well be so emphasized these days as nothing more than a marketing ploy. Mortgage companies understand that the average consumer doesn’t understand the details of a mortgage transaction well enough to recognize such ploys. An adequate understanding of the details of a mortgage transaction is essential if one expects to really find the best deal.

3-Day Right of Rescission – A period of 3 full business after the signing of a mortgage that the borrower has to rescind, or change his mind, and cancel the loan without any negative consequences.

PITI – Principal, interest, taxes, insurance. The total monthly payment if fully amortized. PITI also used to calculate reserve requirements for asset documentation (i.e. Full doc loan may have reserve req’t of 2 months PITI – if PITI is $3,000, minimum liquid assets required to qualify is $6,000).

LTV – Loan to Value – Percentage of a homes value owed on a mortgage. (i.e. If loan amount is $200,000 and home is worth $400,000, LTV = 50%. LTV of 100% would mean the mortgage amount is equal to the value of the property). Most mortgages have an upper limit on the LTV. LTV generally refers to one loan, even if there are multiple liens on a property. For example, with a first mortgage amount of $200,000, a second mortgage amount of $100,000, and a property value of $600,000 – First mortgage LTV = 33%, Second mortgage LTV = 17%.

CLTV – Combined Loan to Value – This is the total percentage of a home’s value owed on all mortgages combined. For example, first mortgage amount of $200,000, second mortgage amount of $100,000, and property value of $600,000 is 50% CLTV. If applying for more than one mortgage, there will be an upper CLTV limit on the combined loan amounts as well as an upper LTV limit on each individual loan amount.

DTI – Debt to Income Ratio – Represented as a percentage, this is the ratio between debts and income. There are two types of DTI:

1. Front End DTI (Also called “upper” or “top” DTI) – This is the ratio between monthly housing expenses and monthly gross income. Formula for Front-End DTI is: PITI / Gross Monthly Income
2. Back End DTI (Also called “lower” or “bottom” DTI) – This is the ratio between total monthly fixed expenses and monthly gross income. Formula for Back-End DTI is: (PITI + Non-housing-related Fixed Expenses) / Gross Monthly Income.

As a rule of thumb, its important to note that any expense appearing on a credit report will be factored into DTI calculations and any expense not appearing on a credit report will not be factored into DTI calculations. For instance, most utility bills do not show up on credit reports, and, as such, are not factored into DTI calculations.Upper limits on DTI generally fall around 35/50, or 35% max front-end DTI and 50% max back-end DTI. In other words, no more than 35% of gross income can go to fixed housing expenses each month, and no more than 50% of gross income can go toward all fixed expenses (housing included) each month.

VOE – Verification of Employment – This is a document completed by the borrower’s employer and submitted to the lender for the purposes of confirming employment history if required, and income, if required, as shown on the 1003.

1003 – Uniform Residential Loan Application – Pronounced Ten – oh – three. Four-page Mortgage application.

ARM – Adjustable Rate Mortgage – Any mortgage with an adjustable rate feature. Note: This includes any mortgage with a rate that may adjust at any time during the loan period. For example, a traditional 30-year fixed rate mortgage is not an ARM, however, a 5 year fixed is, because after the first five years, the rate begins to adjust for the remaining term of the loan.

Amortization – The characteristic of a loan that describes whether or not it will pay off and, if so, in how long. For example, 30 year amortization means the loan will reach a zero balance after 30 years (360 months). 10 year amortization means the loan will reach a zero balance after 10 years (120 months).

Negative Amortization – The characteristic describing a loan with a principal balance that increases over time. Generally, this type of loan involves a payment less than the actual amount of interest due. The difference between interest paid and interest due is added to the principal balance each month, resulting in negative amortization. A negatively amortized loan will never reach a zero-balance. Note that there is always a limit to the amount of negative amortization that can occur before the borrower is forced to refinance, make interest only payments, or make principal and interest payments.

Doc Type (see Doc Type articles) – Describes the level of documentation required to be provided to the lender as a qualification requirement for a given loan.

Interest-Only – A type of amortization in which the principal balance of the loan neither increases nor decreases. Each month, the payment is equal to the interest owed and no principal payment is made. With interest-only amortization, the principal balance on the loan will never change. Note that there is a limit on the interest only period. When such limit is reached, the borrower will have to refinance or make principal and interest payments.

Impounds – Also known as “escrows,” this is, usually, an optional loan feature that allows the borrower to opt to pay property taxes and insurance monthly, included in the mortage payment. The money that is paid is held in an escrow account until property taxes or homeowner’s insurance is due, at which time the money is paid out. Usually, if the borrower opts for impounds, the interest rate will be reduced about 1/8%. See Impound article for more information.

SIVA – Stated Income Verified Assets
SISA - Stated Income Stated Assets
NINA – No Income, No Assets

Underwriting – A stage in the loan approval process during which a bank or lender representative reviews all loan documents and makes a decision to approve the loan, decline it, or approve the loan subject to certain conditions.

Conditions / Conditional Approval – Common in brokered mortgage transactions, a conditional approval is issued when the underwriter feels fit to issue an approval, subject to certain conditions. Conditions may include things like submission of more income and/or asset documentation, submission of more legible copy of drivers’ license or social security card. For the purpose of expediting the approval process, a loan may be submitted without certain required documentation, in which case, assuming everything else is acceptable, a conditional approval will be issued subject to the submission of the missing required documents. This allows an underwriter to review a loan application without delay when the borrower may have trouble getting certain required documents submitted in a timely fashion.

Floor – When refering to interest rates, this is the lowest rate available on a selected loan program from a given lender. This almost always comes at significant cost to the borrower in the form of points.

Par (Par Rate) – The interst rate at which discount points are closest to 0. It’s important to note that although discount points may be near 0, in most cases the borrower will still incur costs.

YSP (Yield Spread Premium) – Also known as rebate. YSP is found in brokered mortgage transactions in which a rate higher than par is requested. In exchange for the higher interest rate, a lender will pay a rebate to the broker. It is the broker’s choice what to do with that rebate, however, it must be disclosed on the final closing documents. Also, if the broker is also a direct lender, there is no requirement to disclose YSP on final closing documents.

Points – Commonly confused term – a point is nothing more than a percentage. Many people tend to think of points as the same thing as closing costs; in fact, they are not the same thing. 1 Point is equal to 1% of the loan amount.(See article about points, basis points, etc…)

Basis Point – This is a method for pricing loans on the secondary market – most borrowers will never hear this term. 1 basis point = 1% of the loan amount. 100 basis pts is a par rate. Less than 100 is a cost, more than 100 is a rebate.

DTI is an acronym for Debt-to-Income Ratio and represents the ratio between a person’s monthly debt and his or her monthly income. Pretty simple, right? So how is it calculated and what does it have to do with mortgages?

There are two types of DTI, Front-end DTI and Back-end DTI. It’s important to note that, for the purpose of applying for a mortgage, these ratios are calculated based on your proposed monthly debt, not your current monthly debt. This means that the $2,000 a month you’re currently paying on your mortgage doesn’t make a bit of difference; all that matters is what you’ll be paying after you refinance.

Front-End DTI

Front-End DTI considers only your monthly housing-related expenses. Here’s the debt list:

• Monthly Mortgage Payment(s)
  • All monthly mortgage payments; if you have payment options each month, the payment you should use is usually the minimum payment no less than interest-only, however, some lenders have different requirements, so ask your broker or leave a comment to this post if you have any questions.
• Monthly Property Taxes
• Monthly Home Owner Insurance Payment
• Monthly Home Owner’s Association Dues

To figure Front-End DTI, add up all of the items above and divide by your monthly gross income.

Each lender may have slightly different Front-End DTI limits, but a reasonable number would be around 30% or so; meaning 30% of your monthly, before-tax income is going toward housing-related debts.

Back-End DTI

Back-End DTI takes into account all of your monthly debt payments, however, other than property taxes, home owner insurance, and home owner’s association dues, only debts appearing on your credit report count; so don’t worry about the $50 a month you contribute to your local tee-ball club, it won’t be counted. You may need a copy of your credit report to figure this one out, especially since that’s what the lender will use when qualifying you for a loan. Here’s the Back-End DTI list:

• Everything on the Front-End DTI list plus,
• All minimum monthly payments showing on your credit report
  • Remember, DTI takes into account what your monthly debt will be after you get a loan, not what it is now, so if you’re refinancing to pay off debt, don’t include the debts that you’ll be paying off

To figure Back-End DTI, add up the items on this list and divide by your monthly gross income.

Each lender has slightly different requirements for Back-End DTI limits; the max is usually around 45%, but some lenders will require 40% or below, and some will allow up to 50%.

This all seems pretty simple, but most of the time it’s not quite as easy as this. First of all, each lender has different DTI requirements. Also, if your income has recently changed or you receive income from various sources this calculation may be quite a bit more complicated. If you have trouble qualifying for a loan, instead of full-documentation, you may be able to use SIVA (Stated Income, Varified Assets), SISA (Stated Income, Stated Assets), NINA (No Income, No Asset Disclosure), or No Doc (No income or asset confirmation of any kind). The important thing is that your mortgage broker know the requirements at the lenders he does business with, otherwise, you may find yourself out of luck when he submits your loan with Full Documentation to a lender whose Full-Doc requirements you don’t meet. Once he submits it with full-documentation, he can’t resubmit it under anything else if it gets turned down; if that happens, he’ll have to submit your loan to another lender. If you can qualify at the other lender, you’ve still lost valuable time and may see a rate increase. That’s why it’s important your mortgage broker know what he’s doing.

Well, that’s a tough question to give a simple answer to, but I’ll do my best.

Borrowers are generally classified under two main categories, subprime and A-paper. Most simply, a subprime borrower is a borrower who’s credit (FICO) score is below 620; however, there’s some grey area that should be clarified.

Get Classified As A Subprime Borrower Lickety Split

Even if a borrower has a FICO score above 620, he/she may still be classified as subprime because of other factors. Some of the factors that cloud the definition of subprime are the following:

1. Late or missed mortgage payments in the past 12 months
   • Having late/missed mortgage payments in the past 12 months (at least 30 days late) is the easiest way to put yourself into the subprime category, even if your FICO score is excellent. There are very few A-paper lenders that will even consider lending to someone with even one late/missed mortgage payment in the past 12 months unless that borrower has other compensating factors, such as very high income ($10,000+) or very low LTV (Loan-To-Value: Ratio which describes the relationship between the desired loan amount and the value of the house). In layman’s terms, if you have even one late/missed mortgage payment in the past 12 months, you’ll only be able to qualify for the best rates if you make a lot of money, have otherwise impeccable payment history, low LTV and little debt. Even if you meet these conditions, you’ll be hard-pressed to find an A-paper lender that will give you the best rates available (I know of one right now).
2. High LTV:
   • LTV is an abbreviation of Loan-To-Value and represents the ratio between the desired loan amount and the present value of your house. If your LTV is above 80% you’ll have a hard time getting the best rates, although with a good mortgage broker you may still swing it. Once you get over 90% you drop into what’s called “Alt-A”, which describes the grey area between A-paper and subprime and is the classification reserved for borrowers with excellent credit histories, but less than desirable loan terms. The bank equates high LTV with high risk because in the event the bank has to foreclose on your home, there will be very little equity remaining to prevent the bank from losing money. For example, if your house is worth $300,000 and you get a loan of $298,000 and then foreclose, the bank will lose money if it has to go through the steps to sell the house at a discounted price at auction. The bank may only get $240,000 at auction if the house is in perfect condition, so before expenses, it’s already lost $58,000 ($298,000 loan amount – $240,000 sale price). Because of this, you should expect your interest rate to be higher at LTVs above 80%, and especially above 90%. You’re not technically considered a subprime borrower, but you’re in the grey area called “Alt-A” between subprime and A-paper (don’t ask me why these classifications are named as they are).
3. Bankruptcies or foreclosures in the past 24 months
   • If you’ve had a bankruptcy or foreclosure in the past 24 months, you’re going to be considered subprime. If it’s been more than 24 months since you declared bankruptcy or foreclosed, you may or may not be considered subprime.
   • If, in addition to a bankruptcy or foreclosure in the past 7 years, you have late/missed mortgage payments in the past 24 months – note that this is different from the 12 month limit described in #1 above - you’ll be considered subprime.
   • If your bankruptcy or foreclosure was more than 7 years ago, most banks won’t consider it at all.
   • Ultimately, if you’ve declared bankruptcy or foreclosed in the past 7 years, it is vital that you not be late on or miss any mortgage payments or you’ll put yourself in a very bad position.

A Couple Other Subprime Tidbits

• Two or three late/missed mortgage payments in a row is better than two or three late/missed mortgage payments spaced a month or more apart.
• For bankruptcies, the time frames noted above refer the the time since the bankruptcy was discharged, not the time since the bankruptcy was first filed.

There are quite a few factors that go into figuring what rate a borrower qualifies for. It’s important to know these things beforehand because if you’re the victim of unfortunate circumstances, such as being laid off from your job, you’ll know how to best manage your finance if it gets down to crunch time.

Become Educated On Your Finances

One more thing, bankruptcy was created to prevent the stifling of entrepreneurship, so I’m all for its existence, but if you’ve been through bankruptcy or foreclosure and you’re consistently missing mortgage payments, you need to educate yourself on personal finance. It’s never too late to turn your finances around, so check out my post about books that changed my life for a fresh start.