Prepayment Penalty Options - You may be offered a lower rate if you choose to take a pre-payment on your mortgage loan. Companies will have a couple options as far as the pre-payment penalty in which you can choose from. The most common being a hard pre-payment penalty which will require you to pay a certain amount of money if you pay your mortgage off in a set period of time. A soft pre-payment penalty usually allows you to sell your loan during the pre-payment term and not have to pay a penalty.
There are many different pre-payment penalty set-ups in regards to them being hard and soft, with some being a combination of the two.Since loans that have a 3 year prepayment penalty often pay the mortgage broker the maximum commission, if you still want a pay option type loan, and you want to avoid the prepayment penalty, many times a honest broker would be willing to credit you a portion of the commissions to save towards the prepayment penalty in the event that you sell or refinance your home before the 3 yrs. For example, if the broker can give you X loan and make 2%, OR he could offer you a pay option which gives you the flexibility to make the payment you want (with a prepay penalty however) and it pays the broker 4%, perhaps they would be willing to credit you the 2%, still make the same amount of $ that they would have on your alternative option, yet give YOU the power to decide what your monthly payments will be.
Lenders that have pre-payment penalty features on their loans generally do not like to have their pre-payment penalties bought out. The number one reason for taking a considerably higher rate to avoid a pre-payment penalty is because you are planning to sell the house quickly or refinance to a new loan quickly. Lenders prefer for you to stay in your mortgage with them for long periods of time so that they can earn more money. By applying prepayment penalties to loans, the lenders can keep their borrowers for longer periods of time on average. Some people will still sell or refinance again before their prepayment penalty period is up, however the lender will make their money then from the prepayment penalty.
If you plan on moving or refinancing before the prepayment penalty expires, it's a good idea to avoid getting one. The advantage to a prepayment penalty is that you will recieve a lower interest rate. If you don't plan on moving or refinancing, it may be in your best interest to consider having a prepayment penalty on your mortgage.
Make sure you ask and are completely aware of any pre-payment penalties on your loan before you get to closing. If you are choosing to go ahead with an adjustable rate mortgage (ARM) you should make sure that your pre-payment penalty does not exceed your fixed rate portion or your loan. An example would be if you choose a 2/28 ARM (rate is fixed for 2 years and then adjusts every year thereafter for the next 28 years) you probably do not want to have a 3, 4, or 5 year pre-payment penalty on your loan. Many times after your fixed portion of your ARM is up you will choose to refinance to either another ARM loan or a fixed rate loan and you don't want to get stuck still having a pre-payment penalty.
If you are taking an adjustable rate mortgage (ARM) with a prepayment penalty make sure that the penalty is not longer than the fixed period of the ARM because some arms may go up between 5 and 6% after the initial adjustment and at that point it would be in your best interest to be able to refinance without penalty after the initial fixed period.
Some states have laws specifically prohibiting pre-payment penalties. Other states have laws that limit pre-payment penalties. Be sure to ask your preferred mortgage professional about the laws in your state.
If you do choose to accept a pre-payment penalty make sure you review the terms of the penalty at the closing. There are different amounts and calculations for the penalty that can be assessed. Sometimes it is six months worth of interest, or it could be a percentage of the balance. There are also different terms for what is considered pre-payment. It might only be considered pre-payment if you pay the loan off in full and sometimes it is if you pay down more than 20% of the balance in any 12 month period.
Should You Pay Points? - Should you pay "points" to get a better rate?
Do you plan on keeping your loan for a while? Then it may make sense to "buy" a lower interest rate by paying one or more "points."
Even if youre unsure of how long you plan to keep your mortgage before you move or refinance, paying points now for a lower rate may make sense. For example, do you have a high-paying job now but you think you might change careers in the next few years? Talk it over with a qualified Mortgage Planner. Its part of a Mortgage Planners job to help you find the right loan for your means and goals.
If you look at a comparison of 2 different loan programs, one with points and one without points, laid out by a mortgage professional, you will be able to see your total cost of the loan for each program. The most important factor here is the amount of time you plan to hold this property before refinancing or selling. This will help you make the decision rather quickly.
For borrowers with ample cash and low return on investment for their cash, paying additional points to buy down an interest rate may be a good idea. One should always consult with a loan officer to analyze the cost of the buy-down and the amount saved with the lower buy-down rate over the life of the loan. A knowledgeable loan officer can show a homeowner the number of years the homeowner needs to keep the loan in order to recoup the cost of the buy-down, and thereby allowing the homeowner to make an informed decision.
Paying points may decrease your debt to income ratio
Paying points to get a lower rate when refinancing into a long term fixed mortgage often makes good sense. The points can normally be financed into the loan instead of paid out of pocket. Over the long haul, money saved from the lower interest rate will more than make up for the principal added by the points.
You should also seek the services of a qualified tax consultant regarding the tax consequences of prepaid interest.
While it is not a traditional means to do business, a great broker will be honest and upfront to you about the points they receive on the front (points paid by the borrower at closing) and points on the back ("yield spread" points paid by the lender at closing). Generally these points are all revealed at closing, so it can be helpful to negotiate this prior to that date.
When you pay "points," you pay interest in a lump sum upfront to get a lower rate on your fixed rate mortgage. Each point costs 1% of the mortgage amount. The more points you pay, the lower your mortgage rate. So, which is the best for you? More points and a lower rate? Or fewer points and higher rate? To decide, you need to consider: (1) Whether you can afford to make the upfront payment now for points. (2) The length of time expect to have the mortgage. The longer you plan to have your mortgage, the more it makes sense to pay for points now because you'll have a long time to benefit from the lower rate.
There are basically two types of buy-downs, a permanent buy-down and a temporary buy-down. A permanent buy-down entitles the homeowner to a lower interest rate for the life of the loan. A temporary buy-down gives the borrower a lower interest rate for the first two or three years of the loan term. A common temporary buy-down is the "2-1 Buy-Down", which gives the homeowner a discounted rate of 2% below his mortgage note rate in the first year of the loan, 1% below the qualified note rate in the second year, and the note rate for years 3 to 30. For example, consider a borrower qualifying for a 30-year fixed rate mortgage of $200,000 at 7% interest rate, with the option of a 2-1 Buy-Down that costs 2.25 points, without the buy-down, the borrower's monthly payment would be $1,330 for the life of the loan. With the 2-1 buy-down, at the cost of $4,500 (2.25 points = 2.25% of the loan amount), the borrower interest rate for the first year is 5% (2% below qualified note rate of 7%) and the monthly payment for the first year is $1,074, 6% (1% below note rate) and a monthly payment of $1,199 for the second year, and 7% (qualified rate) and monthly payments of $1,330 for the remainder of the loan term.
Another commom Temporary Buy-Down is the 3-2-1 Buy-Down, which works very much like the 2-1 Buy-Down, except in that it gives the borrower 3% below qualified rate in the first year, 2% below in the second year, 3% below in the third, and the normal note rate for the rest of the loan term.
When deciding weather or not to pay points to get a lower rate you should also look at your “break even point”. One point is equal to 1% of your loan amount. If paying that extra point lowers your rate then your savings are in a lower monthly payment. The break-even point is the amount of time it takes for that monthly savings to exceed the total initial investment of the point. When comparing different loan scenarios and options with your mortgage broker, have them calculate your break-even time for each scenario. You want the break-even point to be shorter than the amount of time you plan to spend in that mortgage (if you plan to sell or refinance in the future)
The most common buy down is the 2-1 buy down. In the past, for a buyer to secure a 2-1 buy down they would pay 3 points above current market points in order to pay a below market interest rate during the first two years of the loan. At the end of the two years they would then pay the old market rate for the remaining term.
As an example, if the current market rate for a conforming fixed rate loan is 8.5% at a cost of 1.5 points, the buy down gives the borrower a first year rate of 6.50%, a second year rate of 7.50% and a third through 30th year rate of 8.50% and the cost would be 4.5 points. Buy down were usually paid for by a transferring company because of the high points associated with them.
In today's market, mortgage companies have designed variations of the old buy downs rather than charge higher points to the buyer in the beginning they increase the note rate to cover their yields in the later years.
As an example, if the current rate for a conforming fixed rate loan is 8.50% at a cost of 1.5 points, the buy down would give the buyer a first year rate of 7.25%, a second year rate of 8.25% and a third through 30th year rate of 9.25% , or a three quarter point higher note rate than the current market and the cost would remain at 1.5 points.
Another common buy down is the 3-2-1 buy down which works much in the same ways as the 2-1 buy down, with the exception of the starting interest rate being 3% below the note rate. Another variation is the flex fixed buy down programs that increase at six month interval rather than annual intervals.
As an example, for a flex fixed jumbo buy down at a cost of 1.5 points, the first six months rate would be 7.50%, the second six months the rate would be 8.00%, the next six months rate would be 8.50%, the next six months rate would be 9.00%, the next six months the rate would be 9.50% and at the 37th month the rate would reach the note rate of 9.875% and would remain there for the remainder of the term. A comparable jumbo 30 year fixed at 1.5 points would be 8.875%.
Points are normally tax deductible whether you or the seller actually pay for them. Points on a refinance are not deductible in the same way. On a refinance you normally have to spread your deduction out over the amortization of your loan (check with your tax advisor).
If you are tight on funds for closing opting for a loan with the lowest upfront cost and no discount points may cost may be right for you. Over the life of the loan you may be paying out more money however enabling you to provide for your families immeditate needs.
