Today’s low interest rates make borrowing money cheap. But watch
out for those mortgage fees.
NEW YORK (CNN / Money) –
If low mortgage rates have motivated you to invest in a picket fence of your
own, you’re in good company. Homes continue to sell at breakneck speed,
and rising property values have homeowners feeling flush.
But before you bid on your piece of the American Dream, it’s important
to remember that mortgages still come chock full of fees, surcharges and closing
costs. Lenders, after all, are in the business of making money.
There are lots of sneaky ways mortgages can end up costing more than you think.
Take a look at these 6 dirty secrets of mortgage loans, and make sure no one’s
taking you for a ride.
- You might not have to pay PMI. The average down payment on a home by first
time buyers stands at around 10 percent of the purchase price, according
to Freddie Mac. And whenever your down payment is below 20 percent of the
price, you must pay private mortgage insurance (PMI), along with principal
and interest payments. Besides adding another $100 to $150 to your monthly
payment, here’s another downer. PMI can’t be deducted from your
taxes come April, unlike mortgage interest.
What you may not realize is that
you can take out two mortgages and avoid PMI altogether. Assuming you put
10 percent down, the first mortgage would
cover 80 percent of the home’s cost, and the second would cover 80 percent
of the home’s cost, and the second would cover the remaining 10 percent.
In effect, that second loan bumps your down payment to the magic 20 percent
threshold. Bingo: No PMI. (Sometimes, people use an 80-15-5 setup, with 5 percent
down and a second loan for 15 percent of purchase price.)
Of course, that means
you now pay two mortgages each month, not one, and the 10 percent mortgage
will have a higher interest rate than your 80 percent loan,
said Frank Nothaft, chief economist at Freddie Mac.
Still, you’ll avoid
PMI and you may save come April 15th, when you deduct mortgage interest. It
depends on where interest rates stand and your tax situation.
Ask your lender to crunch the numbers to see which method puts money back in
- Close at the start of a month and your closing costs climb. With
any mortgage, you are obligated to pay interest until the principle on your
loan is repaid
in full, starting with the date you close on your home.
But it’s conventional in the mortgage business to set up interest payments
in arrears, to coincide with complete calendar months, said Doug Duncan, a
spokesperson for the MBAA. That means any time between your closing date and
your first full monthly payment on a purchase mortgage is “extra” time,
and you’ll pay interest on those days up front at the closing table.
That can sting.
Keep in mind, though, that when you close at the start of
the month, your closing costs are higher, but your first mortgage payment
isn’t due until
a month later than it would be if you closed at the end of the month. So you
won’t save any money overall by closing latter, but you do have to cough
up less cash upfront.
“If you pay on a monthly basis, and close on the 25th of the month,
then you have about 5 or 6 days extra interest payments,” Duncan said. “But
if you close on the 5th, you’ll pay 25 or 26 days worth of interest.”
- Lenders may try to muscle you into an ARM. Consumers often qualify to borrow
much more money with an ARM, or adjustable rate mortgage, than with a fixed
rate mortgage, said Eric Tyson, author of “Mortgages for Dummies.” That’s
why lenders and brokers often push ARMs aggressively. Larger loans make for
larger commissions, after all..
But many consumers don’t realize the
risk inherent with ARMs. The loan has an extra low, fixed interest rate for
a short, set period of time. One
or two years for an ordinary ARM, and five or seven years for a 5:1 or 7:1
But after the honeymoon is over, the loan rate may balloon. It will the
fluctuate in tandem with mortgage rates, which bob up and down according
to the whims
of the economy and the Federal Reserve. Each ARM has a rate cap, so there’s
a ceiling on the interest you might have to pay. But that cap can be set unaffordably
high for the borrower.
Generally, it’s advisable to opt for a 30 year
fixed rate mortgage over an arm if you plan to stay in your home for more than
five to seven years.
- PMI laws are picky. Private mortgage insurance on any mortgage
issued after July 1999 automatically cancels when you reach 22 percent equity
in your home,
in accordance with the Homeowners Protection Act of 1998. You can also request
in person to stop paying it when you hit the 20 percent threshold.
private loans, you must have that equity because of payments you’ve
made toward the principal, not because of appreciation in the value of your
home. But if you have a loan owned by Fannie May or Freddie Mac, the guidelines
are more consumer friendly. You can reach 20 percent equity through principal
payments and home value appreciation, which makes it easier to dump your PMI.
Homeowners’ Protection Act also specifies that lenders must notify
homeowners when their equity reaches 20 percent. But the law applies only to
mortgages issued after July 1999. Mortgages issued before that don’t
require notification so it’s up to you to remain vigilant.
- You can sometimes
avoid a jumbo mortgage. The Federal Housing Finance Board raises the maximum
allowable size for a standard mortgage each year, known
as the “conforming loan limit.” Currently, the conforming loan
limit stands at $300,700.
Any loans larger than that, which are becoming more
common in today’s
hot housing market, are considered to be a non-conforming or jumbo loan. Thing
is, jumbo loans generally force you to add 20 to 25 basis points to the interest
rate you’d pay on a standard sized loan, said Jay Brinkmann, a financial
economist at the Mortgage Bankers Association of America (MBAA).
That’s because such loans can’t
be bought by Freddie Mac or Fannie Mae and because high cost properties have
more volatile prices, so homeowners
must compensate the bank for that risk.
But there is one way to work the system.
The conforming loan limit rises at
the end of each calendar year, using a formula. Which makes the change relatively
predictable. Your loan gets classified
as a standard or Jumbo loan when you close. Typically 60 days or so after you
make an offer on the house. If your loan amount is on the edge, and the new
limit lets you take a standard rather than a jumbo loan, you might consider
waiting to buy until November (the idea being that you probably won’t
close until the new year).
- Broker fees may be negotiable. Mortgage brokers are
a bit like car dealers. They buy mortgages at wholesale prices and mark them
up to retail prices.
Brokers must by law disclose what they make in commissions
in a good faith estimate before you sign on the dotted line. But if you’re
willing to play hardball, there is room for negotiation.
On a standard sized
loan, a reasonable markup ranges between 1 and 1.5 percent, Tyson said. On
a jumbo loan, you may have more leeway to negotiate that down.