For the seasoned, or second home buyer, this page is specifically for you. I promise if you follow along to the end, you will find great value in it.
Once you have outlined your purchase and financial goals, you will need to gather all your facts for your purchase. These facts should include the following.
The most important is your credit score, then income, and then the amount you have saved or funds available for your down payment and closing cost. The difference in credit score can best be shown in the bracket of rates that a lender offers you. A person with an 805-credit score could see rates more than one half a percent better than a person with a 621-credit score.
I know many of you have been to your local car dealership, and when you asked about rates and financing options, the typical sales-persons reply is “what would you like your payment to be?” Well there you go, the shell-game begins. With a mortgage loan, it should never be a shell-game for you, however often it may become one without your knowledge.
Understand the difference in rates and total cost for your loan. The total cost includes, closing cost, rate, and the amount of interest you will pay for the duration of that loan.
Duration, this should be defined in your financial goals prior to your purchase. Let’s face it, how many people do you know who have kept their original mortgage loan for the full thirty years? How is this purchase going to impact your retirement? Is this purchase going to enhance your retirement or take from it? This is something we should talk about in great length in your planning stages, before your purchase. Duration is important to factor in, as it will give you direction to whether you need to be accelerating your mortgage loan or contributing more to your retirement plan over the next several years.
To help you better understand this, look at my financial math page the contacting the “Rule of 25/50” and the “Rule of 72”
Down payment and closing funds, generally these funds come from savings, stock portfolios, and proceeds from a sale of another property. If you do plan on using retirement funds for your purchase, please see my page on “When to Use Retirement Funds.” The amount you put down factors your loan to value (LTV) this also impacts the interest rate you may be offered by the bank or lender.
Monthly income combined, will determine the amount of total mortgage you will be able to qualify for, calculated by your debt to income ratio. Your debt to income ratio (DTI) also impacts the interest rate you may be offered by the bank or lender.
Total loan amount will also impact the rate you are offered. The smaller the loan amount, the higher the rate. A lender or service mortgage provider makes money of the yield spread from the secondary market. For simplicity, if Fannie Mae is giving money to the lender–let’s use 1%– and the lender or bank charges the borrower 4%, the lender, makes 3%. So, earning 3% on a $400,000 loan is much greater than 3% on a $100,000 loan per month. With this in mind, the lender is able to offer a discounted rate based on loan volume or size.
Here is an example – of how best to use this information.
Note: this is not an offer for a rate of any kind, but
simply an illustration for math purposes and understanding
some basic function for a mortgage loan.
A borrower enters into a purchase and sales agreement for $199,000 and the borrower has a high credit score and ample savings. They want to figure out if it would be better to put down 20% or 25%. We have to look at a handful of items to make our best decision. For our example, let’s look at the items that will affect our interest rate we will be offered. Since our credit score is high and our DTI is good, we are in good shape.
So, let’s focus on loan amount and loan to value. These are two completely different items a bank or lender uses to calculate rate or cost of the interest rate. Most lenders have a break point in loan amount at $150,000. A loan amount below that, we see a 0.25% higher interest rate. In other words, with all the above criteria being equal, a loan amount of $149,000 will see an interest rate of 4.25% versus a loan amount of $151,000–which would see an interest rate of 4%.
You will also see a rate difference of 0.125% for the greater down payment, 25% down would be better than 20% down. Working with these two factors, the loan amount of $159,200 with the down payment of 20% would see an interest rate of 4% and the loan amount at $149,250. With 25% we would be seeing a rate of 4.125%. The overall difference in interest paid for the 30 year term is $3,420 in favor (less) of 25% down even at the higher rate.
Now let’s use the same money, and at closing, the buyer only puts down the 20% and receives the 4% interest; then the first month after closing, our borrower puts down that extra 5% ($9,950) towards the principle balance of the loan. Our borrower will actually pay off the loan in approximately 26 years and save over $23,000 in interest.
This is just one the many scenarios one should run when they ask the right questions and get all the facts. You may also find your 5% down may do better in a good investment elsewhere. Getting advise from a good CPA or your investment/stock portfolio manager maybe prove to be very beneficial.
If you have any questions or would like further assistance please contact us directly and we will try our very best to help wherever possible.
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