Wednesday, December 30, 2009

Lock or Float Your Interest Rate?

When it comes to guessing the best time to lock in a mortgage interest rate, I’ve seen easier games on the carnival midway. Hitting everything just right so as to capitalize on the best rates and costs is not impossible, but it can be quite daunting in today’s volatile market.

Before the recent downturn in the real estate industry, the movement of mortgage rates was relatively easy to predict. But now the key indicators that once predicted the movement of mortgage interest rates are not as closely linked to the actual rates on any given day. Making it further difficult to predict, rates may fluctuate by 25 or 30 basis points in a few hours or a few days. Even the experts confess to having greater difficulty giving advance notice of rate movements.

Interest rates are usually locked for 30 to 45 days, depending on the time stipulated in the purchase contract. At the same time, rate locks are available for 60 and 90 days while some lenders offer locks up to 180 days. Borrowers can expect to pay a premium for longer lock periods, and these prices can very widely between lenders. Most lenders require that the loan be locked between 7 and 15 days before closing.

First, Find a Home. Most lenders require an address to lock a loan. This is one way the lender knows the borrower is serious about actually purchasing their financing. When the rate is locked, the lender is committing their money to you at that price. Once that amount of money is committed, they can’t use it to secure someone else’s financing. So, lenders take rate locks very seriously.

Second, Track the Time. The average purchase contract is written for 30 days. But if your situation is different, you need to make certain that your rate lock won’t expire before your scheduled closing date. In fact it’s a good idea to check with your lender the seven days prior to closing just to make sure your loan will close before the rate expires. If there is a question about this, request a rate extension.

Third, Bank the Benefit and Sever any Surprises. Most borrowers find a rate they can live with and lock it in. This way, they know what their monthly payment will be and can budget for it. Further, they simplify their home buying experience by limiting the number of distractions they have while waiting to close.

There are still some buyers who can’t resist the urge to “play the market” and they will choose not to lock their rate but instead “float” it hoping for a market improvement and a lower rate. What they hope for is a dramatically lower rate. In the best real life scenario what they actually receive is a slightly lower rate, perhaps as much as .125%. Unfortunately in many cases the rate actually increases by the same 1/8th of a percentage point. You win some, you lose some. This is why most borrowers choose to lock their rate instead of float.

Having said all of this, some lenders offer a “float down” option for their interest rates. This option (usually accompanied by a fee…of course) allows the borrower to re-lock at a lower rate, should rates drop by a specified amount during the time their loan is in processing.

Fourth, Follow the Fed. Earlier this year the Federal Reserve announced plans to buy up more than $1 Trillion in mortgage-backed securities. The reason this is so important is because interest rates on fixed-rate mortgages are determined by mortgage-backed securities that are traded on the bond market. When demand for these instruments goes up, fixed interest rates drop, and vice-versa. This promise by the Fed has helped keep rates lower throughout the last few months of the year.

It is not certain what the Fed will do after the first of the New Year. What could happen (emphasis on the could) is that the market for mortgage backed securities could shrink a bit driving down the demand and causing rates to rise.

Tuesday, December 22, 2009

HUD Provides Transparency and Clarity for Borrowers

January 1, 2010 is more than the first day of the second decade of the 21st century, it is also the day new guidelines from the Department of Housing and Urban Development (HUD) go into effect. And with these guidelines it is hoped a new day of increased transparency and improved clarity for borrowers seeking their best options for home financing.

Until now many of the fees charged by lenders, title companies and third party providers could undergo dramatic changes between the time the loan was originated and the time it closed. These changes could amount to hundreds of dollars in additional money being charged to the borrower. Some of these increases were unavoidable. In most cases not only were they avoidable, but one set of fees was quoted to get the business while the actual fees were withheld until closing.

In 2005 HUD held a series of roundtable discussions with industry representatives, trade associations and consumer groups to discuss the impacts of these practices. After two and one half years, HUD its proposed rule changes on March 14, 2008. Since then HUD has received over 12,000 public comments in response to these proposed rules.

The hope of HUD is that these new rules will help consumers shop for the loan that is best for their needs. HUD believes that shopping leads to greater competition and that increased competition leads to lower prices.

Because loan fees have been at the center of this controversy, HUD has attempted to simplify the shopping process for borrowers. By dividing all loan fees into three categories it is hoped that borrowers will be able to make more wise decisions when making their choice for home financing.

Category One: These Fees Cannot Increase at Settlement

The lenders origination charge – this is the up front cost the lender charges to provide their services. In the past, this fee has seen dramatic increases, sometimes based on the difficulty of processing the borrower’s file.

The credit or charge (points) for the specific interest rate after it is locked – many lenders have made it their practice to “float” the interest rate until pricing improves and the yield they make increases. This spread is called the yield spread, or YSP. If pricing is worse, the points charged for the “promised” rate have historically increased. Mortgage Brokers will no longer be able to pass on an increased fee but instead will be held accountable to own up to their own risk when floating an interest rate.

Just what is the YSP? - A bit of background is required for this explanation. Under the new ruling, HUD has determined that YSP is harmful to consumers and must be disclosed to borrowers. Further, HUD has mandated that the YSP be disclosed in the form of a credit to the borrower on the Good Faith Estimate of closing costs. In order to keep their YSP, mortgage brokers must now offset this credit by increasing their origination charge. In contrast, Mortgage Bankers are not required to disclose YSP, because they do not earn a yield spread.

Category Two: Charges that can increase up to 10% at settlement

Required services the lender selects – this can include appraisal, inspections and appraisal reviews.

Title services and lender’s title insurance if the lender selects the title company or borrower uses a company the lender identifies.

Owner’s title insurance if the borrower uses a company the lender identifies.

Required services that the borrower can shop for and if they use a company identified by the lender.

Government recorded charges.

Category Three: Charges that can change at settlement

Required services that the borrower can shop for as long as the company is not identified by the lender.

Title services and lender’s title insurance so long as the borrower does not use the company the lender has identified.

Owner’s title insurance (if the borrower does not use the company identified by the lender.

Initial deposit for the escrow account.

Daily interest charges.

Homeowner’s insurance.

There are other ingredients to these new rules and all are designed to protect the borrower from harmful or predatory lending practices. For the complete HUD booklet on this subject click here.