Your Mortgage : Lenders Vary on Up-Front Points
A couple of interesting questions concerning up-front points and so-called “negative amortization” recently arrived in the mail.
Nancy Adams says that she has bought, sold and refinanced homes in the pricey California market for years. Like most borrowers on the West Coast, she typically paid about two up-front points each time she took out a new loan.
A point is equal to 1% of the total loan amount.
But Adams, who recently retired to the less-expensive Cleveland market and reads this column in the Cleveland Plain Dealer, was shocked when she checked with lenders in her new neighborhood and was told she would have to pay three or four points in order to get a loan.
“All the banks tell me that three or four points is common in this part of the country,” she writes. “Are they telling the truth, or are they just being greedy?”
The banks are telling the truth. We called three local lenders in Cleveland, and all three said a borrower with a good credit record who’s looking for a $100,000 fixed-rate mortgage would probably have to pay about three points to get a loan.
Why would an Ohio lender demand more up-front points than a lender based in California?
“Well, the number of points that a lender can charge is mostly determined by local custom and market factors,” explained Mark Wilson, an economist with the United States League of Savings Institutions in Washington, D.C.
“Basically, lenders can charge as many points as the market will bear.”
Remember too that you could buy a nice home in Cleveland with a $100,000 loan, while that same house in pricey Los Angeles or San Francisco could easily cost you more than $300,000.
“A bank has to do just as much work to make a $100,000 loan as it does to make a $300,000 loan,” Wilson said.
“Whether you’re borrowing $100,000 or $300,000, the bank still has to fill out the same amount of paper work, pay the same amount for an appraisal, run a credit report on you and do all that other work.”
In other words, many lenders have to charge higher points on smaller loans in order to recoup their up-front processing costs.
Of course, you can usually save yourself a few hundred or even a few thousand dollars in up-front charges by checking with several banks, S&Ls;, mortgage brokers and mortgage bankers.
That’s because lenders raise or lower the points and interest rates that they charge based on a variety of factors--including the amount of money that they have to lend out, their overall financial health and their long-term financial game plan.
Finally, remember that most lenders are relatively flexible when it comes to setting the terms of your loan. For example, they might be willing to reduce the number of points you’ll have to pay up front if you agree to accept a slightly higher interest rate over the life of the loan.
Karen Block of San Diego read last week’s column on “lender-speak,” and agrees that understanding loan officers can be a difficult task.
“I’ve been shopping for an adjustable-rate loan, and a lot of the banks are talking about ‘negative amortization’ and ‘deferred interest,’ “she writes. “Can you please give me a plain explanation of what they are?”
Actually, “negative amortization” and “deferred interest” are one and the same.
Most fixed-rate loans don’t have the potential to negatively amortize, but many adjustable-rate mortgages do. It usually occurs when a “rate cap” or “payment cap” on the loan prevents the lender from raising your monthly payment fast enough to keep up with rising interest rates.
To show how negative amortization works, say that you took out a 30-year ARM with a starting rate of 9%. Your monthly payments for principal and interest would be about $805.
Now assume that rates soared to 13%, but you’ve got a fairly common payment cap that prevents the lender from raising your monthly payment by more than 7.5% at each adjustment period.
The cap would limit your re-adjusted payment to $865, about $241 short of the amount needed to pay off both the principal and interest charges on the loan.
The shortfall would be added to the outstanding balance of your loan each month, meaning that you’d owe more money--not less--every time you made a payment.
Although the dangers of having a loan that has the potential to negatively amortize are obvious, it’s important to note that such a loan can also provide some benefits.
First, the low introductory rate that most of these mortgages carry makes the loans easier to get. That means that you don’t have to earn as much in order to qualify for the loan.
Also, most lenders who make these loans will allow you to pay a little extra each month to avoid having the loan negatively amortize. It’s much like the way credit cards work: You can make the minimum payment that’s due, or you can pay a little extra to reduce your long-term finance charges.
You can’t get that kind of flexibility from a fixed-rate mortgage.
Average Rates for Residential Mortgages
Average rates for residential mortgages as of July 12, 1991.
Survey Conventional Mortgages Adjustable Mortgages Area 15 Year 30 Year Composite 1 Year Composite National 9.43% 9.74% 9.59% 7.22% 7.59% California 9.70 9.97 9.84 7.41 7.46 Connecticut 9.40 9.73 9.59 7.15 7.43 Wash. D.C. 9.28 9.63 9.47 6.90 7.35 Florida 9.44 9.77 9.61 7.13 7.44 Mass. 9.42 9.73 9.58 7.08 7.65 New Jersey 9.35 9.68 9.52 7.26 7.77 N.Y. Metro 9.44 9.75 9.61 7.26 7.67 New York 9.54 9.83 9.69 7.30 7.66 N.Y. Co-ops 9.70 10.04 9.93 7.74 8.14 Pa. 9.19 9.56 9.39 7.12 7.38 Texas 9.36 9.63 9.50 7.30 7.55
SOURCE: HSH Associates, Butler, N.J.
