How to Shop For Your Mortgage Loan-Part 3

The two previous editions of this newsletter outlined
steps you can take to put you in a good position to
select your mortgage lender and the loan product that
will serve you the best.


Those steps were:
1. Know your outcome.
2. Be realistic.
3. Choosing a lender.
4. Deciding on a loan product.
5. Assessing rates and costs.

There are a couple of other items that would be
important to assess as you do your loan research.


A. Understand the trade-off between paying a
higher interest rate and zero points vs. paying a
lower interest rate and some points.

When you are offered a zero-point loan, you need
to realize that you are not getting something for
free.

A lender may be willing to create a loan for you
without requiring you to pay discount points (a
fee designed to "buy-down" the interest rate) or
to pay origination points (a fee designed to pay
the mortgage originator for their services).

The lender will absorb the cost of paying the
origination fee, but they will charge you, the
borrower, a slightly higher interest rate for doing
so.

Let's take a look at an example based on a loan
amount of $300,000:

30-year fixed rate of 6.625% with zero points, or
30-year fixed rate of 6.375% with a loan fee of 1 point.

Payments at 6.625% will be $1,920.93. Payments
will be lowered to $1,871.61 at the 6.375% rate, but
it will cost you $3,000.00 to obtain the lower rate
(1% of the loan amount = 1 point).

If you compare the 1/4% reduction of interest rate
vs. the cost, it would take you 4 years to recoup your
investment of the 1 point fee.

If you compare the difference in payments of $49.32
per month to the cost of $3,000.00, you will
calculate that it will take almost 61 months to recover
the 1 point cost.

So, if you have the resources to pay the loan fee,
and you plan on keeping the loan in place for at
least 4-5 years, it would be wise to go with the
lower interest rate. After the break-even points,
all the benefits of the lower interest rate will work
in your favor.

Whenever you are offered choices of interest
rates and loan fees, you should do a similar
analysis so that you have a good idea of the
wisdom of paying a higher interest rate, or paying
higher loan fees.

It is an important consideration as you finalize
the terms of your loan so that it is suitable for you
based on your time horizons.


B. Be sure to ask about whether there will be a
prepayment fee on your loan.

A prepayment fee, also known as a prepayment
penalty, is a clause included in your loan contract
that allows the lender to charge an additional fee
if you pay the loan off within the first three or five
years (depending on the clause).

The typical clause allows you to pay up to 20%
of the original loan amount each year without
paying any prepayment fee. If you should pay
more than the 20%, or pay the loan in full - which
is much more likely - you would be subject to
paying 6 months interest on the amount over
the 20%.

Let's do a calculation based on a loan amount
of $300,000 at 6.625%:

You would be allowed to pay 20%, that is $60,000,
with no penalty. If you paid the loan in full, the
remaining $240,000 would be subject to a 6 month's
interest charge.

Your prepayment fee would be $240,000 times
6.625% (.06625), which gives you the annual
interest, divided by 2, which gives you the figure
for 6 months. $240,000 x .06625 / 2 = $7,950.00.

If you even think that there is a likelihood that you
will pay off the loan within the prescribed 3- or 5-
year period, you would be much better negotiating
the prepayment fee away at the beginning of the
transaction.

Although each loan program may offer different
terms, a good rule of thumb may be that it would
cost you 1/4 point more in the loan fees at
origination to keep the prepayment clause out of
your loan contract.

The math becomes very simple at this point. Pay
$750 more at loan origination (1/4 of 1% of $300,000)
to avoid any possibility of paying as much as $7,950.00
if you were to pay off the loan early.

If you are convinced, however, that you will keep the
loan beyond the 3- or 5-year period, you can save
the additional fee at loan origination and never have
to deal with the prepayment fee either.

Ask lots of questions of your mortgage representative.

Make sure that they explain things so that you can
understand them. If they are unable to clearly
communicate the concepts and the math, you are
facing a situation where the loan product may not
be providing the benefits that you expect.