Thanks for visiting The Mortgage Reports. To stay absolutely current on mortgage markets and important guideline changes, be sure to take my free daily email alerts.

When home buyers opt to "escrow taxes" with a lender, there's a dollar-cost to starting that escrow account. It can add significant costs to a final HUD-1 Settlement Statement, depending on the time of year.

Defining "Escrow Your Taxes"

First, let's answer the question "What does it mean to pay taxes in escrow?"

Paying taxes in escrow is a two-sided agreement between homeowner and lender:

1. Homeowner pays 1/12 of his annual real estate tax bill to the lender each month
2. Lender holds the homeowner's payments in a reserve account, and pays the home's real estate taxes when they come due

Most lenders wants homeowners to escrow because it ensures the taxes actually get paid. As such, lenders penalize people that opt to pay their own taxes, without bank help.  The penalty is a fee and it's known as "waiving escrows".

The fee to waive escrows can be as high as 0.25 percent of your loan size, or $250 per $100,000 borrowed.

Starting Your Tax Escrow Can Be Costly

Meanwhile, seeding an escrow account can be costly, depending on the season, with the schedule dictated by the local taxing authority.  In Southeastern Ohio, we're entering the Expensive Season.

Because semi-annual tax bills due in June and July, lenders want to make sure there's enough money on-hand to pay the pending bills.  In Hamilton, Warren, Butler and Clermont counties, up to 8 months of tax reserves are required for mortgages closing in the months of May and June, and November and December.

The reserves are broken up into two parts:

1. 6 months worth to pay the semi-annual tax bill
2. 2 months worth of reserves in case tax bills increase unexpectedly

My experience is that most homeowners understand the "one-twelveth" part of paying escrows each month, as well as the reason why seeding an escrow accounts gets more costly as bills come closer to their due date.

It's the "extra 2 months of reserves" that throws folks for a curve.  Here's the explanation.

Lenders Want Your Tax Bill, Plus Some Extra

Real estate taxes tend to increase over time.  Homeowners know it, and lenders know it, too.  It's inevitable.  Therefore, instead of running the risk of holding too little tax money, lenders aim to hold too much.

This way, if-and-when tax bills rise, lenders are using your "excess" instead of their own.  And so long as taxes increase by less than 16.67% annually, the banks should never be short on your funds.

When you're planning for your closing, don't forget to budget for escrow reserves.  If you want help with your math, call or . I'll do my best to walk you through it.

Editor's Note: The chart above does not apply to refinances. Refinances in the Cincinnati area have a slightly different escrow reserve chart. The theory is the same, the withholding is different.

ARM-holding homeowners often assume that when their mortgage is about to adjust, it's time to refinance it -- no matter what.

The math,  however,  says otherwise.

If your adjustable rate mortgage is due to reset in 2009 and 2010, the smart play may be to let it change.  After all, adjustable-rate mortgages have been adjusting downward for pretty much all of 2009 and there are no closing costs on a ARM adjustment like there would be for a brand-new fixed rate mortgage.

Here's how most conforming ARMs work:

1. For some fixed period of time, the homeowner's mortgage rate is constant
2. When the fixed time period ends, the mortgage rate adjusts to a new rate based on some pre-determined formula
3. On each subsequent adjustment anniversary, the mortgage rate re-adjusts on the same,  pre-determined formula

The pre-determined formula by which ARMs adjust is something similar to:

And just what is the "variable" and the "constant"? It depends on your mortgage.

The variable and constant can be just about anything, really -- favorable-to-the-bank numbers or favorable-to-the homeowner numbers.  This is a frightening reality for people that aren't aware of how their own ARM works either because it was never explained to them, it was never explained to them clearly, or because they forgot the explanation altogether.

However, if you have a home loan that's set to adjust in 2009 or 2010, the chances are extremely high that your ARM is structured in what is now the "standard" for conforming ARMs.  This is because practically every 3-year ARM, 5-year ARM and 7-year ARM made from 2003 to 2009 carries the same variable-constant formula.

• The variable is usually the 1-year LIBOR -- currently near 1.5 percent
• The constant is usually 2.250 percent

All homeowners with expiring conforming ARMs are facing at the same basic math for their respective adjustments. The math is in the chart above.  Most ARMs are adjusting down near 4.000 percent.

Some are even below 4 percent.

But,  just because your mortgage rate might adjust lower in 2009 or 2010 doesn't mean you should automatically let it.  Even with a falling-rate adjustment, there are certain situations in which you may want to convert an existing ARM into a fixed-rate mortgage:

1. If you intend to eventually pay off your home loan in full
2. If your ARM changes from "interest only" to "principal + interest" upon adjustment
3. If you lose sleep over keeping an uncertain household budget

And, because conforming ARMs adjust annually, the same "Should I Refinance My ARM" question will come up again next year.  If LIBOR returns to its historical average near 5 percent, the pending adjustment most certainly won't be lower.

Letting your mortgage adjust to the market may be a smart decision for this year, but foolish for the years ahead.

Therefore, in the end, allowing your ARM to adjust lower makes sense for the same reasons why a person would take ARM in the first place -- the risk of adjustment was worth it versus lower monthly payments along the way.

If your ARM is due for adjustment and you want to know whether it's better to refinance or let the adjustment occur, and we can talk about making a plan.

LIBOR can change suddenly and overnight so what makes sense today might not make sense when your loan is due to adjust 4 months from now. Having a plan with contingencies in a place is the best way to manage an ARM's adjustment.

Signing mortgage paperwork can be unsettling for people. No matter how many times a person has signed a HUD-1 Settlement Statement in their lifetime, there's something about that form that makes them mentally drop on the deck and flop like a fish.

Settlement statements are confusing, no bones about it.  And for good reason:

• The HUD-1 is cryptic. It doesn't come with line-by-line instructions like an IRS form
• The HUD-1 bares no little resemblance to its "preview" -- the Good Faith Estimate
• Most people never see HUD-1 Settlement Statements  but for their own closing(s)

However, the settlement statement section that repeatedly confuses homeowners the most is the one known as "Prepaid Items".  A "prepaid item" is exactly what its name implies -- a payment related to the mortgage, collected before the payment's actual due date.

There are 10 types of prepaid items, listed in Sections 900 and 1000 of the settlement statement. The most common ones are:

• Advance mortgage interest paid from the closing date to month-end
• Real estate taxes paid into an escrow account
• Homeowners insurance paid into an escrow account
• Dues paid to a condo or homeowners association

More simply, prepaid items are home-related costs that would have been due anyway -- new home loan or not.

Prepaid items on a settlement statement are costs not related to the process of getting a mortgage. This is what distinguishes them from closing costs on a settlement statement.  By contrast, closing costs are fees assigned by lenders, title companies and governments.  They are incurred only because of the new home loan.

For rate shoppers, this is an important distinction. It simplifies comparisons.

Because prepaid items are paid irrespective of lender choice, Sections 900 and 1000 of a Good Faith Estimate can be specifically excluded from your comparisons.  In addition, excluding Sections 900 and 1000 has the secondary impact of thwarting loan officers that understate their prepaid items on purpose to make their respective GFEs look "cheaper".  If you ignore prepaid items anyway, sales tactics like that won't fool you.

Settlement statements won't get simpler for the layperson but separating closing costs from prepaid items may.  Just ask yourself: "Is this a charge that I would have to pay anyway, even if I wasn't starting a new mortgage?"

If the answer is "yes", the charge is a prepaid item.

"Can you run payments for me?"

It's one of the most common questions that my home-buying clients ask me.  They find a home in, say, Montgomery and want to know what their monthly mortgage payment look like.

Some loan officers find it tedious to calculate mortgage payments, but I happen to enjoy it.  See, I know that despite there being 20 million other places to look for payment information, my clients choose to call me. 

It's what I'm here for, after all, and my clients know that I'm going to make the homebuying process as simple as possible for them.  Doing the math is just one way I do it.

Then, when the math is done, I'll usually send over a few Microsoft Excel formulas as a follow-up.  Sometimes, when my clients have questions at odd hours and I'm not around, it comes in handy.

1. How to calculate the monthly mortgage payment on a P+I loan
2. How to calculate the monthly mortgage payment on an Interest Only loan
3. How to calculate the monthly principal paid to the mortgage
4. How to calculate the annual principal paid to the mortgage

The four screenshots below show these formulas in action.  The part that begins with is what goes into the Excel formula bar.  You are welcome to copy these for your own use.

Read the rest of this entry »

On January 22, 2008, mortgage rates fell quickly and without warning.  They touched levels not seen in 5 years and then stayed there for a period of 28 hours.

During those 28 hours, homeowners around the country received calls from their mortgage guy. 

The call went something like this:

Mortgage Guy: "Mortgage rates plunged.  You should consider a refinance to lower rates."

Homeowner: "Hey, thanks for calling me!  What are rates?"

Mortgage Guy: "The 30-year fixed is priced at 5.125% with no points.  It hasn't been this low in 5 years."

Homeowner: "Awesome!  Let me think about it -- I'll call you tomorrow with the go-ahead."

When "tomorrow" came, though, the 5.125% wasn't available anymore. 5.125% had become 5.500%.  Markets had already reversed.  And then some.

When those 28 hours were over, the 30-year fixed mortgage had already started a journey that would bring it from 5.125% to 6.375% in less than a month.  This happened because the Fed Funds Rate had just been lowered farther and faster than at any time in history and because the economic stimulus package had just passed.

The combined impact of these economic jumpstarts made markets fearful of long-term inflation and inflation is the enemy of long-term mortgage rates.

That said, there's been a ton of recession talk lately and that is proving to be a positive for the short end of the mortgage rate curve.  The recession fears translate into lower mortgage rates on shorter-term mortgage products like ARMs.

A quick sampler of the bad-news-for-the-economy, good-news-for-ARMs headlines:

• The number of people filing for unemployment is at a 2-year high
• Ben Bernanke says some banks could be in trouble
• The talk of a soft economy is catching up with consumers

Because of headlines like this, ARM interest rates are steadily slipping.  They haven't reached January's levels, but it's close. 

If the trend continues, homeowners may just get a second chance to capture the interest rate savings they missed out on just a few weeks ago.

Consider this your advance notice, folks.  Make like a boy scout and get prepared for a dip should it ever come.

This time, when your mortgage guy calls, be ready for it.

This time, when your target interest rate hits, be ready to grab it.

This time, have a remortgage plan in place and be ready to execute it. 

The best way to be prepared is to talk with your mortgage guy in advance.  Have the talk today, if you have time. 

Give your loan officer permission to grab whatever that certain mortgage rate is for you the moment it becomes available.  He'll just handle it and you won't have to worry about missing the train. 

Now, many Americans don't have mortgage guys because so many loan officers have moved on to other careers.  If you've been orphaned and don't have a personal loan officer, ask a friend for a referral.  Or, drop me an email and I'll be happy to assist.

The mortgage markets wait for no one so when a door opens, be ready to step through.  With some advance planning, the step can be an easier one.

One advantage of using interest only loans versus amortizing loans is that it opens the door to more sophisticated financial planning. 

One way in which that's possible is that interest only loan payments are re-calculated each month based on how much money you are currently borrowing. 

The industry term for the re-calculation is "recasting".

For an interest only, the monthly payment is calculated according to the following formula:

(Outstanding Loan Size) * (Annual Interest Rate) / (12 months)

A $400,000 loan size at 6.000%, therefore, yields a monthly payment of $2,000. 

If an extra principal payment is made on the loan, the new loan payment will reflect a new, lower outstanding loan balance.

Therefore, paying an extra $1,000 to a $400,000 interest only loan at 6.000% reduces next month's mortgage by $5.00. 

Now, before you say, "Wow. Five dollars. Maybe I'll go the movies. By myself.", note that $5 per month is $60 annually and $60 is six percent of $1,000. 

The payment savings per dollar "invested" is exactly equal to the interest rate.

Read the rest of this entry »

Quick note to residents of non-Cook County residents in Chicagoland: your next tax bill is due June 1.

The upcoming payment takes on added significance if you're in the middle of a refinance and you are planning to escrow, though.  Heads up!  Your cash required for closing may be significantly higher than what you expect.

Here's why.

Your new lender wants ample reserves in order to pay your June 1 real estate tax bill for you, and your subsequent bill September 1.

Therefore, they will require you to populate your new escrow account with 11 months of "T&I" (taxes & insurance).

(A quick Escrow Reserve Chart for all Chicagoland counties not named Cook is at right.)

On June 1, your new lender will disburse 6 months worth of reserves to pay your bill, leaving you with 5 months left in your escrow account.

When your July 1 mortgage payment is made, it adds one month to the reserve pile.  In August, your payment adds one more.

By then, you will have 7 months worth of reserves in the account.

Now, sometime towards the end of August, your new lender will pay your tax bill and you will be left with somewhere around one month's worth of reserves.  This is because tax bills tend to go up over time and if your individual bill was higher than anticipated, that extra reserve month may have been spent.

In September, with each mortgage payment, you'll start building your reserves again -- one month at a time -- to get ready for the following June.  That's when the lender will pay your real estate taxes for you again.

Now, back to the May closing.

When a home loan closes in May, the first payment on that home loan is made in July (in most cases).  According to the chart above, that means that -- at closing -- the borrower is required to bring 11 months of reserves to the table.

11 months of reserves is a lot of money!  It can be a huge imposition on a family that wasn't prepared to make that sort of payment in one lump sum -- especially if they live in a county like Will County where taxes can exceed 2 percent of a home's value.

The good news is, though, that paying the 11 months in advance is only a temporary strain.  Shortly after your closing, the former lender will refund whatever existing escrow reserve was held with them.

Of course, that doesn't help today with the 11 months worth of cash-to-close.

If you plan to escrow your taxes and insurance and don't have the money required to populate your new account, make sure to talk with your lender prior to closing. With enough advance notice, your lender can make accommodations to help you out.