Comparing ARM Features

What are the most important features to evaluate when shopping for an ARM? Many mortgage experts advise that you watch the indexes and choose your loan according to how interest rates are headed (remember, the interest on your loan is pegged to one particular index). There are just two main types of index you need know about, a leading index (leads the interest rate trend) and a lagging index (stays behind the trend).

The rationale is simple: If interest rates are falling, the leading index will take you more quickly in that direction (reduced payments). If rates are rising, the lagging index won't take you there so quickly (higher payments). One popular leading index is the One- Year Treasury Bill Index, and a popular lagging index is llth District Cost of Funds Index.

How do you find out what direction the indexes are moving? Ask lenders or mortgage brokers to tell you. And ask which indexes their loans are pegged to. Alternatively, log on to one of the following websites: www.freddiemac.com, or www.hsh.com, www.loan-shark.com, or www.microsurf.com.

Another important feature to inquire about is the lender's margin. As we saw earlier, this is the profit added by the lender to determine the rate you'll pay. When you know the index rate, you add on the margin rate to arrive at the loan's market rate (the lender has already done this). Your initial ARM rate will typically be a few percentage points below the market rate, a move designed to win your business (often called a teaser rate). Low initial ARM rates, attractive at the beginning, can rise steeply in the course of a few years.

For example: Index rate 5.5 percent; Margin rate 2.75 percent; market rate 8.25 percent (add index and margin). However, withthis ARM you might start off paying only 6.25 percent (2% lower than market rate), which will rise at its adjustment, after one year, perhaps by 2 percent. Usually, however, it is still best to go with the lowest-margin loan, but you must consider this feature in combination with the index, because an attractively low margin coupled with a high index might not be such a good deal, whereas a higher margin and a lower index might overall be a less expensive loan.You need your lender or broker to work with you in comparing these features.

The third feature you'll need to compare and understand is the initial interest rate on the ARMs available to you, and what can happen to their rates in the short term and long term. I mentioned earlier that typically there has been a 2 to 3 percent difference between initial ARM rates and conventional FRM rates. So, here the important questions to ask include: How often can the loan be adjusted? By how much can it be adjusted periodically? What is the lifetimecap on the loan?

Points, Fees, and Closing Costs

When you go for either type of home loan you are presented with a litany of fees. Some are hard to understand but are small enough not to have to worry too hard about. However, one fee that can be significant, and that you'll see again and again as you compare mortgages, is points.

In truth there are two different fees referred to as points and you need to be able to distinguish them. However, either type of point is always 1 percent of the loan amount. On a loan of $100,000 one point is equal to $1,000; on a $90/000 loan, it's $900 .

First, many lender's charge an origination fee in points commonly 1 point. This is simply a fee that goes to the lender for processing the loan , and it is usually paid at closing (settlement). It might be negotiable. Try .

The second kind, better known, is called discount points. But this is a misnomer; it isn't a real discount at all. The term was created by enders, who see charging this fee as a way to discount the interest rate-keep it lower than it might otherwise be. You may see this figure quoted along with the loan rate. When a lender advertises an FRM loan at "8% / 30 1+2" you are being offered a fixed rate mortgage with an 8 percent interest rate over 30 years, plus one point origination fee and two discount points. So, if you borrow $100,000 with this loan , you'll pay $1.000 to the lender as the origination fee, plus $2,000 to the lender in discount points-a points total of $3,000. Some lenders put these two points fees together. In this case it would be presented simply as "3 Pts".

The number of points charged varies from lender to lender and from loan to loan. It is an important criterion to keep in mind when shopping around. And always it is wise to question lenders you feel certain you understand all the fees you'll have to pay.

Even before you make a forma1 application, ask lenders for a Good Faith Estimate of Closing Costs (all lenders use this form) At this early stage such a request might seem premature to some lenders, but many will provide preliminary estimates for most of the costs involved. The form in question details all the various fees you will be responsible for. Later, when you make the loan application, the lender has three days to send you this and other required forms , including Truth-in-Lending information, and the HUD booklet Buying Your Home. But it makes better sense, to get this information early, long before the lender is required to give it to you.

Again, points and lender fees are not carved in stone. When dealing with mortgage brokers or mortgage bankers, especially, these costs are almost always negotiable to some degree. A broker or lender might well decide to give up part of the profit in order to get your business particularly when you make it known that you can get as good a loan-or better-elsewhere. Some loan professionals are tough; others are willing to make concessions, even on interest rates, but only for borrowers who bother to demand the best deal.

What's more, you frequently have the option of paying extra points in return for a lower interest rate. For example, with the loan we looked at earlier, you might well be able to get the lender to reduce the 8 percent rate to 7.75 percent if you offer to pay one more point (an extra $1,000). This is called buying down the rate. Ask about such options. But also ask the lender to reduce the lender fees, just as an incentive to get your business.

Closing Costs

These costs are many and varied. That's why, typically, you should expect to spend an additional 5 to 7 percent over the loan amount.Closing costs are generally considered to include the fees paid to the lender (lender fees), such as points and lender's attorney fees, butinclude also fees that are unrelated to the lender, such as title insurance and homeowner's insurance fees.

When making your application, I advise that you question the necessity of each individual fee, and ask for a waiver on each one as you go down the list. Of course, some cannot be waived, but others can, and they often are, for borrowers who will negotiate. And,when faced with the risk of losing a prequalified borrower, hardly any lender would be so dumb as to reject all your requests.

The following list will give you approximations of many of the fees for which you are likely to be responsible: Loan application(sometimes negotiable—$0-400), origination fee (negotiable; usu-ally 1% of loan amount; some lenders don't charge this as a separate fee), appraisal ($250), credit check ($50-$75), lender's attorney ($300-$500; ask for this to be waived completely), title insurance ($650), survey ($600), homeowner's insurance ($350), recording($75), tax service ($75), state transfer tax ($0-$750). Discount points(negotiable—0-$4,000), homeowner's attorney (negotiable—$400-$1,250). And there are others.

Loan Lock-ins

Locking in (a lock-in) means getting a guarantee from the lender that the interest rate, terms, and costs you've been quoted will be honored for a certain period of time. I advise you to get this guarantee in writing. The reason you would want to lock in is because you don't want surprises later, especially if you suspect interest rates are headed up.

Lenders policies on lock-ins differ, so ask, and get a clear explanation. Most importantly, keep in mind that the rates and terms quoted to you at application (including points) may not be the ones you get when you go to settlement—unless you have a lock-in Lock-ins, as you would expect, have a life; they expire after 30- 45 or 60 days, typically (though some lenders offer a ridiculously low10-day lock-in). A 45-day lock-in period should give you and the seller sufficient time to settle. But 60 days is better than 45, and 90 is better than 60. However, if you suspect that interest rates are falling you may not want to lock in the loan until you are ready to go to settlement (when rates might be lower). Solid research, and informing yourself well about conditions in the market, are your best ways to judge such things.

On your first contact with a lender it is a good idea to ask for a blank copy of the lender's lock-in form. Then, show it to your attorney. Some such forms are worthless; they contain escape clauses that allow the lender to get out of the obligation if certain market changes occur. Your attorney should easily spot these clauses.

On this same point, there is another important reason to seek out and engage a good real estate attorney. Such attorneys can advise you on financial aspects of a loan (conditions, points, closing costs etc), not ) just on the loan contract's terms of purchase. But borrowers rarely use or question their attorney in this way—a wasted opportunity that carries no extra cost!

Unfortunately, lock-ins aren't always free. Many lenders will charge you a fee to lock-in. This can be a flat fee or a percentage of the loan amount. Whether or not you have to pay for it, ask if the lender will honor a drop in interest rates. That means that if rates go down, the lender will allow your locked-in rate to float down too . Some will do this, some won't. Most won't, unless you request it.