Loan Structuring Options
Once you have determined what loan product makes the most sense for your scenario, there are a few more decisions to tailor-fit your mortgage to best match your needs. Keep in mind that not all these options are available on all mortgage products. To confirm which options make the most sense for your scenario, please speak with one of our loan originators:
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On a refinance, you can often add your closing costs on top of your loan amount rather than paying them at closing. This does not just apply to the actual costs, but also to the funding of your new escrow account. Using this fact, you can effectively walk away from a no cash-out refinance with extra cash in your pocket. After closing, the escrow account with your current lender will be refunded to you. Additionally, with proper timing and structuring, you could skip up to two mortgage payments (eg: you make the last payment to your current lender in January and your first payment to your new lender in April).
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Another consideration is whether or not to do a cash-out refinance or no cash-out refinance.
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A mortgage can generally be taken out on a 10yr, 15yr, 20yr, or 30yr term. What is the difference between a longer and a shorter term? A shorter term simply forces the borrower to pay back the mortgage more quickly. A longer-term allows you to pay it back faster than required (without penalty on the vast majority of products), you are just not required to. Critically, shorter-term mortgages will usually offer lower interest rates.
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Fixed vs Adjustable Rate Mortgages (ARMs)
On a fixed-rate mortgage, your interest rate will never change for as long as you keep the loan. With an ARM, the interest rate is fixed for a specified number of years, and then the interest rate could adjust up or down from there. While there is a lot we could discuss how that functions, the key to understanding ARMs is to understand what the "index" and the "margin" are. The index is a publicly accessible metric, beyond the control of the lender, that generally tracks interest rates. In the case of many ARMs, the index used is the SOFR. The index can vary as market conditions change, while the margin stays fixed. The margin is a pre-determined percentage set by the lender. The margin will stay the same for as long as you keep the loan.
While ARMs are not as predictable as fixed interest rate mortgages and are certainly more complicated, they are actually the dominant offering across much of Europe and other developed countries. The fixed interest rate period of an ARM could be as little as 3 years or as long as 10 years. The allure of ARMs is that, during this fixed interest rate period, the interest rate is generally lower than what you would get with a 30-year fixed (and generally the shorter the fixed interest rate period, the lower the rate offered during that period). So if you were to get an ARM and then either refinance it or sell your home before the end of the fixed interest rate period, an ARM could be a great way to save on interest without any risk. If you believe rates will be lower by the time the fixed interest rate period ends, an ARM would also allow your interest rate to decrease without needing to refinance (which requires qualification and has costs).
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Down Payment Amount (on a Purchase)
The amount of your down payment will affect your payment and could affect your interest rate, your mortgage insurance rate, your need for mortgage insurance at all, and potentially more. The effects will be determined by a number of factors, but most importantly your product selection.
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There are specific LTV thresholds that impact your interest rate. You will want to compare the interest rates to determine the ideal loan amount for your scenario.
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Escrowing Property Taxes and Homeowner's Insurance
When you escrow your property taxes and homeowner's insurance, that means the lender will collect a certain amount monthly as a part of your mortgage payment and pay the bills on your behalf when they become due. Given these bills can change over time, your mortgage payment can change over time when you escrow. At the end of the day, any money collected for these bills is your money. When your mortgage ends (by either paying it off, refinancing it, or selling your home), any funds left in your escrow account will be refunded to you.
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You may not have to escrow your property taxes, your homeowner's insurance, or both (although depending on the mortgage product or down-payment amount, you may have to). By choosing not to escrow, you become responsible for making sure your property tax and homeowner's insurance bills are paid on time and in full. Electing not to escrow may come with additional fees at closing.
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When you lock in an interest rate, you are really locking in all options available for your scenario at that time with the lender your rate is locked with. If you change your mind on an option discussed, say between doing a 15yr or 30yr mortgage, for example, you can pivot between those options at any time for the entirety of your lock-in period. Whether interest rates have gone up or down since the time you locked in, your rate and fee options with that lender will remain the same. Critically, you need your lock-in period to be in effect all the way through the closing of your transaction. A longer lock-in period comes with additional costs, so ideally we want to lock in for the shortest time period needed. While the lock can be extended if we end up needing more time, the cost of an extension can be significantly more expensive than it would have cost to select a longer lock-in period from the get-go.
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While the majority of transactions require an appraisal, it may be possible to close without needing one. In those cases, it may still make sense to get an appraisal. Many purchase agreements stipulate that, if the appraisal comes in lower than the purchase price, the buyer has a right to cancel the contract without consequence. Without an appraisal, this coverage would not apply. If a buyer were to get an appraisal, an appraiser could determine (in their opinion) the property is worth less than the purchase price - information a buyer may want to have. Additionally, this could be used to negotiate a lower purchase price with the seller.
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On the other hand, lenders use the purchase price or the appraisal amount (whichever is lower) as the home's 'value' in the LTV calculation. If the appraisal comes in lower than the purchase price, this could cause a worsening in financial terms. If you find yourself with this option, you will want to consult your loan originator and realtor to determine the best course of action.
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Lender Credit vs Discount Points
When discussing "the interest rate", it may initially sound like there is only one interest rate available that has a set amount of fees attached to it. In reality, there is a whole table of combinations with lower and higher interest rates. Higher interest rates can come with "lender credit", which are funds that can be applied to your closing costs (but not your down payment). Lower interest rates come with "discount points", which are extra costs required in exchange for obtaining a lower interest rate. Taking a lower interest rate with discount points will cost you more on day one, but will save you more every month. Taking a higher interest rate with lender credit will save you more from day one, but will cost you more every month. Or, you can always take the "par" interest rate, which is the interest rate with no discount points or lender credit (or at least the offer that comes closest to that). A few thoughts to consider when deciding which is best for your scenario:
1) How long will you keep this loan for? As an example, taking a higher interest rate with lender credit could save you $3,000 today but cost you $100/mo extra. If you end up refinancing your mortgage or selling your home in a year, then the higher interest rate would have only cost you an extra $1,200. On net, your decision to take the lender credit would have saved you $1,800. Alternatively, if you keep the loan for 5 years, taking the higher interest rate would cost you $5,000. On net, the decision to take the lender credit would have cost you $2,000 more than if you had not taken lender credit option.
2) There are two variables in this decision that can both be hard to predict: your personal future and the future of interest rates. Do you think you'll end up moving in the next few years? If yes, would you sell your home or turn it into a rental property? Will interest rates come down in the next few years? All we can do is answer these questions with our best judgment and have those answers inform our decision.
3) What is the breakeven time on the lender credit and discount point options? Using the numbers from 1), the answer would be 30 months. A short breakeven is good for going the discount point route, because you come out ahead when you keep the loan beyond the breakeven point. A short breakeven is bad for going the lender credit route, because you fall behind when you keep the loan beyond the breakeven point. Breakeven times can vary significantly, so you will want to discuss this for your specific scenario with your loan originator.
4) Would I qualify for a refinance in the future? If for any reason you expect a loss of income, you may be stuck with whatever mortgage you close with today.