Q: I enjoyed your recent column that appeared in our local paper.
I’ve just gone through a refinancing and found myself wondering about certain questions I should have asked. The main question was whether my loan had a pre-payment penalty. Also, I wanted to know whether there was a time limit when costs are absorbed into the loan with no payback. But, most importantly, I don’t really know all the questions to ask and what traps I should avoid when refinancing.
I suppose I should have asked these questions before I refinanced.
A: Glad you enjoy our column. As you’ve come to realize, all of these questions should have been asked early in your loan application process. Nevertheless, you make a good point about what questions a person should ask as they prepare to finance or refinance a loan, and perhaps by explaining these issues to you, we’ll help other readers who are about to refinance.
Let’s start with your first question, which is a about a prepayment penalty. A prepayment penalty is a fee that the lender assesses if you pay off your loan within the first few years of the term. The fee generally declines over time to zero, sometimes in 2 years, 4 years or 6 years.
Borrowers liked prepayment penalties when interest rates were significantly higher than they are today. That’s because the lender offer a prepayment penalty in exchange for a lower interest rate. The borrower would opt into the prepayment penalty and if he or she refinanced in the first two or four years, the penalty would kick in.
But there are other fees involved with a refinance, and many of these will vary from lender to lender.
All lenders in your state will charge the same amount for recording fees or mortgage transfer tax fees. Title company closing fees and survey charges are also the same, or are very similar. Likewise, the amounts held back by a lender for real estate taxes and insurance premiums are also virtually the same.
Variable fees may relate to the loan application, loan processing, document preparation, document transaction, tax service fees, flood certification fees, credit review and approval fees, underwriting fees, loan review costs, appraisal costs and other fees that generally lenders list but may or may not cover fees they pay unrelated third parties.
In some instances, some of these fees might be about the same from one lender to another, but in other cases, all of these costs might add up to $1,500 with one lender but $3,000 to another lender. By examining each line item, you can see which lender is charging what in fees.
Obviously, if you are refinancing or buying a home and need a loan, you need to know what the interest rate is on the loan. Preferably, you should try to compare the same loan products between two lenders. That is, you should compare a 30-year fixed rate loan from one lender to a 30-year fixed rate loan from a second lender.
If you’re looking at loans that carry an adjustable rate (ARMs) versus a fixed-rate mortgage, you need to make sure you understand the differences between them to compare the loan costs and how the loan products work. For example, if you decide you want price out a 7-year ARM, you need to know that the loan interest rate will be fixed for 7 years, but that in the eighth year, the interest rate will reset.
Here’s where loan products can be different. One lender can fix the new interest rate according to the London Interbank Offer Rate (LIBOR) and add 2 percentage points to that interest rate to get your new rate. Another lender can offer you the same product with LIBOR but add 3 percentage points to the interest rate change.
Assuming all things are equal, the first lender’s new interest rate 8 years down the line will be one percentage point lower than the second lender. Other differences might be that one lender will cap the possible change in the interest rate by 2 percentage points when the rate change date comes along, while the other one might not. Finally, one lender may cap the maximum amount your loan rate might go up during the term of your loan at 6 percentage points and another one might be at a lower number.
Each of these changes can affect your loan costs significantly over time. Years ago when property values were going up and borrowers elected to get variable interest rate loans or other loan products that could cause borrowers great headaches, we would ask these borrowers how they planned to deal with the uncertainties of these loan products. They’d answer that they would sell their properties and make money on their sales. Well, over the last seven years that strategy didn’t work out too well. The bottom line is that you can’t always sell real estate when you want to or even when you have to.
When you apply for a loan, the lender should give you certain documents. These documents should outline all aspects of your loan including fees, expenses and whether your loan has a prepayment penalty. Make sure you look over the Truth-in-Lending Statement and the Good Faith Estimate of Closing Costs. These two documents will give you quite of bit of information. When you get the loan documents from your lender, you must read them carefully. While the government claims that you’ve received good disclosures with these documents, most borrowers are confused by them.
Take the time to review these two documents carefully, understand the fees that they are disclosing, and the loan terms the lender is offering. If you can’t follow the disclosures, make sure you go over them with your loan officer before you sign them.
Your loan officer should be happy to assist you in understanding the documents. If he or she doesn’t clarify the information for you, you might want to ask a friend or relative to explain them to you. If that doesn’t work for you, then you might want to find a loan officer who has a better ability to explain the documents to you.