Getting a home-equity loan

1.Not knowing if your loan has a pre-payment penalty clause. If you are getting a "NO FEE" home-equity loan, chances are there's a hefty pre-payment penalty included. You'll want to avoid such a loan if you are planning to sell or refinance in the next three to five years.
2.Getting too large a credit line. When you get too large a credit line, you can be turned down for other loans because some lenders calculate your payments based upon the available credit--not the used credit. Even when your equity line has a zero balance, having a large equity line indicates a large potential payment, which can make it difficult to qualify for other loans.
3.Not understanding the difference between an equity loan and an equity line. An equity loan is closed--i.e., you get all your money up front and make fixed payments until it is paid if full. An equity line is open--i.e., you can get numerous advances for various amounts as you desire. Most equity lines are accessed through a checkbook or a credit card. For both equity loans and lines, you can only be charged interest on the outstanding principal balance.

Use an equity loan when you need all the money up front--e.g., for home improvements, debt consolidation, etc. Use an equity line when you have a periodic need for money, or need the money for a future event--e.g., childrens' college tuition in the future.
4.Not checking the lifecap on your equity line. Many credit lines have lifecaps of 18 percent. Be prepared to make payments at the highest potential rate.
5.Getting a home-equity loan from your local bank without shopping around. Many consumers get their equity line from the bank with which they have their checking account. By all means, consider your bank, but shop around before making a commitment.
6.Not getting a good-faith estimate of closing costs. See item number four above.
7.Assuming that your home-equity loan is fully tax-deductible. In some instances, your home-equity loan is NOT tax deductible. Do not depend on your mortgage company for information regarding this matter--check with an accountant or CPA.
8.Assuming that a home-equity loan is always cheaper than a car loan or a credit card. Even after deducting interest for income tax purposes, a credit card can be cheaper than a credit line. To find out, compare the effective rate of your home-equity line with the rate on your credit card or auto loan.

Effective rate = rate * (1 - tax bracket)
Example: The rate of the home-equity line is 12 percent,your tax bracket is 30 percent, your effectiverateis: .12 * (1 - .3) = .12 * .7 = .084 = 8.4 percent.
If your credit card is higher than 8.4 percent, the equity loan is cheaper.
9.Getting a home-equity line of credit when you plan to refinance your first mortgage in the near future. Many mortgage companies look at the combined loan amounts (i.e., the first loan plus the second) when refinancing the first mortgage. If you plan on refinancing your first, check with your mortgage company to find out if getting a second will cause your refinance to be turned down.
10.Getting a home-equity line to pay off your credit cards when your spending is out of control! When you pay off your credit cards with an equity line, don't continue to abuse your credit cards. If you can't manage the plastic, tear it up!

Refinancing your home

1.Refinancing with your existing lender without shopping around. Your existing lender may not have the best rates and programs. There is a general misconception that it is easier to work with your current lender. In most cases, your current lender will require the same documentation as other companies. This is because most loans are sold on the secondary market and have to be approved independently. Even if you have made all your mortgage payments on time, your existing lender will still have to verify assets, liabilities, employment, etc. all over again.
2.Not doing a break-even analysis. Determine the total cost of the transaction, then calculate how much you will save every month. Divide the total cost by the monthly savings to find the number of months you will have to stay in the property to break even. Example: if your transaction costs $2000 and you save $50/month, you break even in 2000/50 = 40 months. In this case you'd refinance if you planned to stay in your home for at least 40 months.

Note: This is a simplified break-even analysis. If you are refinancing considering switching from an adjustable to a fixed loan, or from a 30-year loan to a 15-year loan, the analysis becomes much more complex.
3.Not getting a written good-faith estimate of closing costs. See item number four above.
4.Paying for an appraisal when you think your home value may be too low. Have the appraisal company prepare a desk review appraisal (typically at no charge) to provide you with a range of possible values. Your mortgage company's appraiser may do this for you. Do not waste your money on a full appraisal if you are doubtful about the value of your home.
5.Using the county tax-assessor's value as the market value of your home. Mortgage companies do not use the county tax-assessor's value to determine whether they will make the loan. They use a market-value appraisal which may be very different from the assessed value.
6.Signing your loan documents without reviewing them. See item number nine above.
7.Not providing documents to your mortgage company in a timely manner. When your mortgage company asks you for additional documents, provide them immediately. They are doing what's necessary to get your loan approved and closed. Delays in providing documents can result in a costly delays.
8.Not getting a rate lock in writing. When a mortgage company tells you they have locked your rate, get a written statement which includes the interest rate, the length of the rate lock and details about the program.
9.Pulling cash out of your credit line before you refinance your first mortgage. Many lenders have cash-out seasoning requirements. This means that if you pull cash out of your credit line for anything other than home improvements, they will consider the refinance to be a cash-out transaction. This usually results in stricter requirements and can, in some cases, break the deal!
10.Getting a second mortgage before you refinance your first mortgage. Many mortgage companies look at the combined loan amounts (i.e., the first loan plus the second) when refinancing the first mortgage. If you plan on refinancing your first loan, check with your mortgage company to find out if getting a second will cause your refinance transaction to be turned down.

Why Are Mortgage Securities Important?

Mortgage securities can perform a number of valuable functions in emerging economies. Their introduction and use can improve housing affordability, increase the flow of funds to the housing sector and better allocate the risks inherent in housing finance.

In economies with pools of contractual savings funds, mortgage securities can tap new funds for housing. Institutional investors (pension, insurance funds) with long term liabilities are potentially important sources of funds for housing as they can manage the liquidity risk of housing loans more effectively than short-funded depository institutions. Although in some countries, these investors are also involved in loan origination and servicing, it is not their core mission or competency. Efficiencies can be gained through passive investment in mortgage securities by institutional investors, allowing depositories and specialist mortgage companies perform the other functions. An increase in the supply of funds can, all other things equal, reduce the relative cost of mortgage finance and improve accessibility to finance by the population.

Funding through the capital markets through issuance of mortgage securities can increase the liquidity of mortgages, thereby reducing the risk for originators and the risk premium charged by lenders. The ability to dispose of an asset within a reasonable time and value, a crucial factor to mobilize long term resources, is a service that capital markets, as opposed to banking systems, can provide. A frequently expressed reluctance of primary market financial institutions to offer housing loans is a lack of long term funds.[1] Access to the long term funds mobilized by institutional investors can reduce the liquidity risk of making long term housing loans, increasing their affordability and improving the access to funds for home buyers.

A third rationale for introducing mortgage securities is to increase competition in primary markets. The development of capital market funding sources frees lenders from having to develop expensive retail funding sources (e.g., branch networks) to mobilize funds. Securitization for example can allow small, thinly capitalized lenders who specialize in mortgage origination and servicing to enter the market. These lenders can increase competition in the market and can lower margins and introduce product and technology innovation into the market. The experience of Australia in the 1990s provides dramatic evidence of the power of capital-market funded lenders to change a market. The market entry of wholesale funded specialist lenders led to a reduction of 200 basis points in mortgage spreads during the 1994-1996 time period [Gill, 1997].

Increasing competition and specialization can in turn increase efficiency in the housing finance system. Greater specialization can lead to cost-savings and reduce spreads. The phenomenon of unbundling (Figure 1) has been associated with development of secondary mortgage markets. As the functional components of the mortgage process are unbundled, specialists emerge and obtain market share through scale economies in processing, access to information and technology and risk management.
[1] There is a degree of speciousness to this argument, however. In most countries, depository institutions have a core of long term deposits. Although the contracts may be short term, they are typically rolled over and can fund long term housing loans. An institution can provide a significant percentage of its loans for housing while accepting only a modest amount of liquidity risk. This statement frequently masks other reasons for not providing housing loans including high transactions costs, high perceived credit risk etc.).

Types of Mortgage Securities

What do we mean by mortgage security? There are a number of different types of instruments that can be used to tap the capital markets. In this paper we focus on 5 generic types.

a. Whole Loan Sales: Although not a security, the sale of whole loans can be an important way for primary lenders to raise funds and manage risk. Whole loan sales involve the sale of mortgages, either individually or more commonly in pools, to other lenders or investors. Examples of whole loan sales include the sale of pools in their entirety, participation or recourse basis, by savings and loan institutions in the US in the 1960s and 1970s.[1] Whole loans may be sold through brokers, relationships (e.g., the seller delivers loans on a regular basis to the buyer)) or wholesalers who aggregate loans from a variety of sources and sell them to investors.
b. Agency Bonds: These are bonds issued by agencies specialized in mortgage finance at a secondary (i.e., not the loan origination) level. Issuers include liquidity facilities which refinance primary market lenders (discussed below) and [the retained portfolio activities of] the mortgage GSEs in the US.[2] Their bonds are not specifically backed by mortgage loans but the assets of the issuers are almost entirely mortgages or loans backed by mortgages. The bonds are obligations of the issuers and can be straight or callable.
c. Mortgage Bonds: These are bonds that are issuer obligations and issued against a mortgage collateral pool. Investors have a priority claim against the collateral in the event of issuer bankruptcy. The issuer may be a specialized mortgage bank, as is the case in Denmark, Germany and Sweden, a commercial bank as is the case of Chile, Czech Republic or Spain, or a centralized issuer as is the case of France or Switzerland. The collateral pool may consist of all of the qualified assets of the issuer, as is the case with the German Pfandbriefe, a specified pool as in the case of US savings and loans and the recent issue by Halifax Bank of Scotland in the UK, or individual loans as in Chile and Denmark (the individual bonds are aggregated into large series). The bonds may be straight (non-amortizing) or pass-through (in which mortgage principal is “passed through” to investors as received from borrowers).
d. Mortgage Pass-through Securities: Pass-throughs (PTs) are securities issued against a specific collateral pool subject to cash flow matching. The balance on the PT is always equal to the balance on the mortgages in the pool and the cash flows received from borrowers are passed through to investors, with a delay and deduction for servicing and guarantee fees. Pass-throughs are typically not the liability of the issuer and feature credit enhancement through a variety of techniques described below. They may be issued by lenders or conduit institutions.[3] The best known PTs are the securities guaranteed by Ginnie Mae and those issued by Fannie Mae and Freddie Mac in the US.[4]
e. Mortgage Pay-through Securities: Pay throughs are multiple securities issued against a single collateral pool. They may be closed end, wherein there is a fixed collateral pool and all securities are issued at the outset of the transaction, or open end in which the collateral pool and securities can be increased over time (subject to constraints). These securities modify cash flows between borrowers and investors to meet the needs or requirements of investors. Examples of pay through securities include mortgage strips in which separate securities that are backed from either the principal and interest from a mortgage pool are sold, and collateralized mortgage obligations (CMOs) in which a number of securities that repay principal sequentially are issued. Most mortgage security issuance by banks in developed and emerging markets are pay-through structures.
[1] In participation agreements, the seller retains a portion of the pool and thus shares the risk with the purchaser on a pari-pasu basis. In recourse transactions, the seller retains some or all of the risk of default by agreeing to repurchase loans in default. The recourse may be limited to a certain amount or percentage of the pool balance.
[2] GSE stands for Government Sponsored Enterprise, a special class of institutions in the US. The GSEs are government chartered, limited purpose corporations that are owned by either their members or the general public. They enjoy a number of tax and regulatory privileges that translate into lower funding costs. The best known enterprises, Fannie Mae and Freddie Mac and the Federal Home Loan Banks are described in Lea, 1999.
[3] Conduits are centralized institutions that purchase loans from lenders and issue mortgage securities. Fannie Mae and Freddie Mac have conduit functions and there are over 20 major private conduits in the US as well.
[4] For more detail on mortgage security characteristics, see Fabozzi 1997, 2001.

Mortgage Securities in Emerging Markets

Despite its recognized economic and social importance, housing finance often remains under-developed in emerging economies. Residential lending is typically small, poorly accessible and depository-based. Lenders remain vulnerable to significant credit, liquidity and interest rate risks. As a result, housing finance is relatively expensive and often rationed. The importance of developing robust systems of housing finance is paramount as emerging economy governments struggle to cope with population growth, rapid urbanization, and rising expectations from a growing middle class.

The capital markets in many economies provide an attractive and potentially large source of long term funding for housing. Pension and insurance reform has created large and rapidly growing pools of funds. The advent of institutional investors has given rise to skills necessary to manage the complex risks associated with housing finance. The creation of mortgage-related securities (bonds, pass-throughs and more complex structured finance instruments) provide the multiple instruments by which housing finance providers can access these important sources of funds, better manage and allocate part of their risks.

The use of mortgage-related securities to fund housing has a long and rich history in the developed world. Mortgage bonds were first introduced in Europe in the late 18th century and are a major component of housing finance today [EMF, 2002]. Mortgage pass-through securities were introduced in the US in the early 1970s and along with more complex structured finance instruments now fund more than 50% of outstanding debt in that country [Lea, 1999]. Today, mortgage-related securities have been issued in almost all European and developed Pacific Rim countries.

There have been numerous attempts to develop mortgage securities to secure longer-term funding for housing in emerging economies. The view has been that such instruments can help lenders more efficiently mobilize domestic savings for housing, much as they do in the developed world. In addition, mortgage securities are also pursued to develop and diversify fixed-income markets as a supplement to government bonds for institutional investors.

Despite the strong appeal of financing housing through the capital markets, there are significant barriers to the development of mortgage securities in emerging markets. Their success is dependent on many factors, starting with a strong legal and regulatory framework and liberalized financial sector and including a developed primary mortgage market. Perhaps not surprisingly, the experience in developing mortgage securities in emerging markets has been mixed. This paper will review the experience of introducing mortgage securities in emerging markets and explore the various policy issues related to this theme.

The organization of the paper is as follows: First, we review the rationales for introducing mortgage securities to fund housing; Second, we list the many pre-requisites that underlie successful introduction; Third, we explore the role that government can play in developing these instruments, from both a theoretical and functional perspective. Fourth, we examine the experience of issuing mortgage securities in emerging markets through short case studies of their use. From this examination we then summarize the lessons learned from these experiences, both in general and with specific reference to the proper role of government. Finally, we offer observations on the way forward to increase the use of mortgage securities in emerging markets.

The note will also discuss the various forms of state related support (guarantees, liquidity support, mandatory investment, tax breaks, and issuing privileges) that have been offered in order to secure the credibility and affordability of nascent mortgage securities, but that may also raise significant concerns about contingent liabilities and market distortions. The regulatory dimension of mortgage securities and securitization companies is an important determinant of their success and will be addressed as well.

A Holiday Rush On Refinancings

You may be thinking about the holidays, but thousands of your fellow homeowners have been thinking about refinancing, rate reductions, cash-outs and money-saving debt consolidations.
For the past two weeks, they have been bombarding lenders with applications for mortgage refinancing -- driven by the most attractive rates in more than a year. Refinancings were up in mid-December by 60 percent over the corresponding period last year, and they accounted for more than half of all new mortgage applications -- the highest proportion since the spring of 2004.
Thirty-year fixed rates slipped below 6 percent two weeks ago, and although they have rebounded slightly, they are still nearly a percentage point below where they were last summer. Fifteen-year fixed-rate loans in the mid-to-upper 5 percent range are readily available to applicants with solid credit.
Could a holiday-season refi be in the cards for you? Maybe, but it probably depends on whether you fit into one of several categories where today's rates make a lot of sense:
? You have an adjustable-rate mortgage that's scheduled to reset into higher payments in the six months ahead. Your loan might be a payment-option mortgage, an interest-only mortgage originated in 2003 or 2004 with a three-year reset, or simply an adjustable tied to short-term Treasury rates that's already costing you more than the fixed-rate alternatives.
? You have a "piggyback" first-and-second mortgage package that was originally intended to let you purchase your house with a minimal or zero down payment while avoiding mortgage insurance premiums. But now the floating-rate second is above 8 percent and you want to bail.
? You need cash for a home improvement, a business investment or a vacation home now available at a bargain price. Even though the fixed rate on your first is below 6 percent, the opportunity to cash out thousands of dollars and refinance into a larger replacement mortgage is compelling, even if the rate is a little higher.
So many current homeowners fit into these categories that Anthony Hsieh, president of LendingTree.com, the online network of 200-plus mortgage companies, predicts that this month's refi boomlet could stretch into 2007 -- provided, of course, that rates remain close to 6 percent.
"This has legs," he said in an interview. "This is no head fake; it's for real" because mortgage money at 6 percent offers such exceptional problem-solving opportunities.
For example, Douglas G. Duncan, chief economist for the Mortgage Bankers Association, estimates that $1.1 trillion to $1.7 trillion of adjustable-rate mortgages are scheduled for payment resets in the coming 12 months, and that $600 billion to $700 billion is likely to be refinanced by homeowners eager to avoid higher monthly outlays.
Some of these loans are "nontraditional" mortgages that combine low initial payment periods with drastically higher payments after several years. For thousands of those borrowers facing big payment jumps -- 50 percent, 100 percent or more -- a refi into a fixed-rate mortgage is a no-brainer, according to Duncan.
Other people who purchased during the housing boom years using popular "3/1" adjustables in the mid-4 percent range for the initial three years now face significantly higher payments because short-term interest rates today are much higher.
Consider this example provided by LendingTree: Say you bought your house in late 2003 with a $200,000 "3/1" adjustable at 4.375 percent with a margin of 3.75 percent and a 20 percent down payment. Your principal and interest payments have been $998.57 for the first three years. But now you face a reset into a 7.53 percent rate on your $197,000 balance -- and a monthly payment hike of $383.
Your alternative: Refinance into a new 30-year, fixed-rate, $197,000 mortgage at 6.1 percent. Sure, your payment will be about $195 higher than your current 4.375 percent rate, but not what you would pay if you stuck with your current loan's post-reset rate.
Here's another scenario: Say you have a great rate on the $200,000 first mortgage that you took out in 2002 -- 5.5 percent. But you need $25,000 cash for kitchen remodeling or a business investment. On the one hand, you hate to get rid of a once-in-a-lifetime 5.5 percent rate. However, you have the opportunity to pull out the $25,000 with a refi, add it to the $192,500 balance on your current loan, and walk away with a new $217,500 replacement mortgage at 6.1 percent fixed for 30 years.
Your new monthly payment: About $184 higher than your current.
A gift from Santa? Hardly. Cash-out refis cost money. But your 6.1 percent fixed rate -- not far above 40-year record lows -- should still look good years from now.

By Kenneth R. Harney

A new way to pay off your house

Accelerator loans, common in Australia and the U.K. but new to the U.S., use special accounts that encourage borrowers to apply all extra money toward their mortgages. The savings can be big.
A different type of home loan, called a mortgage accelerator, has migrated to the United States. It uses home-equity borrowing and a borrower's paychecks to shorten the time until a mortgage is paid off, potentially saving tens of thousands of dollars in interest expense.
Not to be confused with biweekly programs that shorten a mortgage through extra payments, the mortgage-accelerator program is based on an approach common in Australia and the United Kingdom, where borrowers deposit their paychecks into accounts that, every month, apply every unspent dime against the mortgage loan balances.
In Australia, more than one-third of homeowners use mortgage-accelerator programs. In the U.K., it's about 25%. In the United States, (among the firms) now offering these mortgages (is) CMG Financial Services, whose offering is called the Home Ownership Accelerator.
The premise is that borrowers finance a purchase or refinance existing property using home-equity lines of credit. Borrowers then directly deposit their entire paychecks into the credit accounts. Monthly expenses, other than mortgage payments, are funded by draws against the lines of credit, whether those are through automatic bill payments, checks, cash withdrawals or credit cards. Even if borrowers end up not paying anything extra on the principal during a month, they still capture some interest savings because the average balances are less than they would have been with conventional loans.
Here's how it works
As an example, let's say your mortgage payment on a conventional fixed-rate mortgage is $2,000 and your monthly net income is $5,000. With the mortgage accelerator, even if you spend the $3,000 difference, your average mortgage balance for the month is $1,500 less than it was with the conventional mortgage. That's because the entire $5,000 is deposited in the loan account and you made draws of $3,000 for living expenses spread over the month. At a 7.75% loan rate, that saves you about $10 in interest expense that month.
Now, $10 here and $10 there does add up over time, although both loan programs have annual fees of $30 to $60, but the accelerator part of the mortgage lies in having all your net pay going against the mortgage and an assumption that you have a positive monthly cash flow -- meaning you don't spend as much as you make. A simulation calculator on CMG's Web site has stock assumptions that you may have 10%, 20% or even 25% of your net pay left over each month that you can apply to your mortgage balance.
Help for the undisciplined
Of course, all borrowers already have that money available with a conventional mortgage and without the cost of refinancing. A borrower would simply need the financial discipline to use all that money as an additional principal payment.
For the undisciplined, the mortgage-accelerator program makes the additional principal payments automatically. That's the real hook to this program: Unless you spend the money by drawing against the line of credit, your paycheck goes toward paying off the house.
Where a mortgage-accelerator loan program gives a homeowner additional flexibility, however, is in having a line of credit available if there is an emergency need for cash. If you make additional payments on a conventional 30-year fixed-rate loan, you can't borrow that money without taking out a home-equity line of credit or a home-equity loan. With the mortgage-accelerator program, you already have the line in place. That gives homeowners confidence that they can be aggressive in paying their mortgages and still have money readily available if a financial emergency crops up.
Homeowners could cobble together a payment plan similar to a mortgage accelerator on their own by taking out a conventional home-equity line of credit, but a mortgage product specifically structured for this approach to consumer finances has advantages.
Mortgage-accelerator loans have interest-only minimum payments during the first 10 years, although that goes against the idea of paying off a mortgage as fast as you can. After 10 years, the line of credit decreases by 1/240 each month over the remaining loan term (20 years multiplied by 12), forcing principal repayment until the loan is paid off.
Another argument for this approach to financing is that your idle cash is saving you the mortgage interest rate versus earning a low passbook-savings rate. Though short-term investing alternatives that pay higher rates do exist, the savings are automatic with the mortgage-accelerator program.
Now for the fine print
A home-equity line of credit is a variable rate, and the interest rate will fluctuate with changes in the underlying pricing index. Lifetime caps limit a homeowner's exposure to higher interest rates, with CMG's Home Ownership Accelerator limiting that risk to 5% over the starting rate…
Brooke Barnett, an "ownership accelerator specialist" at Rancho Funding, a San Ysidro, Calif., mortgage broker that offers the CMG loan program, calls the program ideal for financially savvy homeowners who spend less than they make each month.
The savvy part -- being able to earn the mortgage interest rate on idle cash instead of the low rates paid on checking and savings accounts -- attracts customers who take a big-picture view of their finances. Money that isn't going toward expenses is reducing the balance on the mortgage and, by doing that, reducing the interest expense.
Barnett suggests that a Home Ownership Accelerator loan could also be used in lieu of taking out a reverse mortgage. With enough equity in the property, a homeowner could avoid minimum payments over time using negative amortization up to the amount of the home-equity line of credit.
Closing costs on a mortgage-accelerator loan are about equal to the closing costs on a conventional 30-year fixed-rate mortgage. Like any refinancing decision, those costs are a factor, and the longer you plan to be in the house the easier it is to justify refinancing your mortgage loan.
The lenders expect homeowners to be less rate-sensitive about these accelerator mortgages because of the interest savings available through the program. The product is new enough in the U.S. market that it will take some time to validate that expectation.
Interest savings are still available the old-fashioned way by making additional principal payments on a conventional fixed-rate mortgage. Bankrate.com's mortgage payment calculator allows you to make additional-principal-payment assumptions on your mortgage, and you can then compare the interest savings against the results of the (CMG) calculator.
Excerpted from an article by Don Taylor, Bankrate.com
By Bankrate.com (Excerpts)