Northern Virginia Real Estate Blog

In the widest definition possible, amortization (pronounced: am-ohr-tih-ZAY-shun) is the scheduled process by which a loan’s principal balance pays down to $0.

The opposite of an amortizing loan is an interest only loan for which there is no scheduled principal repayment schedule.

With respect to mortgages, amortization is what determines how much of a monthly payment goes to principal, and how much goes to interest. Amortization schedules are the same for all fixed rate, non-interest only home loans including 15- and 30-year fixed rate mortgages, as well as all non-interest only ARMs.

Monthly principal and interest payments on a mortgage are based on the mathematical formula above, where:

• P = principal
• A = payment
• r = monthly interest rate
• n = number of payments

Now, if you’ve ever paid on an amortizing home loan, you don’t need to use the formula to know that mortgage amortization schedules are dramatically front-loaded with interest.

In other words, in the early years of loan, the interest due on a mortgage is relatively high versus the principal due. And, if you’ve ever heard someone say, “You don’t pay down much of a loan in the first few years,” now you know — mathematically — why that is.

This interest-heavy mortgage repayment schedule helps banks to collect as much loan interest as possible up-front, offsetting potential loan losses.

But, just because the bank sets an amortization schedule doesn’t mean that a homeowner can’t change it. In any given month, a borrower can prepay extra principal to the lender, thereby changing the formula and accelerated the loan payoff date.

There are calculators online that do the prepayment math for you, but before making extra payments, talk with your loan officer or financial advisor first. Prepaying your mortgage could trigger a stiff penalty from your lender, or put your liquid assets at risk. Prepayment is not a bad plan, but it may be a bad plan for some.

(Image courtesy: Mortgage News Daily)

A home inspection is a complete, top-to-bottom, visual check-up of the structure and systems of a house. 

It is meant to be an objective determination of a home’s condition.

A home inspection usually takes 3-6 hours to complete, depending on the size of the home. 

During the inspection process, the inspector will examine all of the following components of a home:

• Home exterior including doors, decks, and vegetation
• Heating and cooling systems for leaks and efficiency
• Electrical systems for safety and soundness of design
• Plumbing systems for venting, distribution, and drainage

In addition, the inspector will review the roofing system, the home’s interior, and several other parts of the property.

A home inspection may be ordered by a home owner or by a home buyer.

For a home owner, an inspection can detail a home’s shortcomings and provide a roadmap for repairs.  This can help a person prepare his home for sale because “major issues” can be addressed in advance of listing.

For a home buyer, a home inspection physically reviews a home under contract, identifying structural flaws that may impact the home’s desirability.  This is essential for the negotiation process because no home is “perfect” – even new ones!  

A home inspection highlights potential long-term trouble spots and the likelihood for expensive home repairs.  This is why real estate professionals often recommend inspecting a home immediately after signing a purchase contract.

To find a qualified home inspector in your area, ask your real estate agent for a referral, or visit the American Society of Home Inspectors Web site.

Source
American Society of Home Inspectors
Frequently Asked Questions on Home Inspections
http://www.homeinspector.org

(Image courtesy: Anderson Home Inspections)

Most homeowners make four housing-related payments each month:

1. Principal on a mortgage
2. Interest on a mortgage
3. Taxes on the real estate owned
4. Insurance for the real estate owned

Collectively, these payments are known by the acronym PITI but don’t let it fool you — a homeowner’s monthly expenses are still called PITI even if one or more of the elements doesn’t apply.

For example, a homeowner with an interest only mortgage does not pay principal each month.

Additionally, condo owners typically don’t pay homeowners insurance — they pay a monthly assessment and/or maintenance fees to an association instead.

But regardless for what it stands, determining a comfortable PITI should be every homeowner’s starting point when looking for a new home. PITI is the monthly housing cost, after all, and by knowing what fits in your budget, it’s a lot easier to compare homes and their related expenses.

It’s certainly better than asking the bank “how much home can I afford” — all that’s going to tell you is the P and the I. As a homeowner, you need to know all four.

PITI is most commonly pronounced pee-eye-tee-eye.

(Image courtesy: Contractor-Books.com)

Loan-to-value is a math formula that represents the relationship between how much a home is “worth” and how much money is borrowed against it.

Loan-to-value is often abbreviated as “LTV” and is one of the many factors that lenders consider when underwriting a mortgage application.

The math formula is straightforward:

In the LTV equation, Loan Size is the amount of money borrowed from the bank and Home Value is the lower of the home’s purchase price or appraised value.

Home loans with low loan-to-value ratios are usually less risky for banks. This is one reason why mortgage rates tend to be more favorable for home buyers and homeowners when their respective LTVs are low.

Typically, a “low” LTV loan is one in which the loan-to-value is 80 percent or less. In some instances, however, 70 percent is considered “low”. The cut-off point depends on the mortgage lender and the mortgage product.

On a home purchase, the one way to lower LTV is to make a larger downpayment, thereby reducing the LTV equation’s numerator. Buying a home for below-market value would not reduce LTV, for example, because the purchase price would be used as the equation’s denominator.

On a home loan refinance, the denominator is always the home’s appraised value.

In the world of real estate, Days On Market is the number of days between when a home lists for sale and when it goes under contract.

It is often abbreviated as DOM.

Average Days on Market is a similar statistic but instead of applying to one home in particular, it applies to all homes in a given neighborhood, ZIP code, or city.

Average DOM is calculated by adding the number of days for which every listed home in an area was available for sale, and then dividing that number by the total number of listings.

In a buyer’s market, Average Days On Market is often elevated. This is because homes don’t sell as fast as during a seller’s market when the Average DOM can be quite low.

For buyers and sellers of real estate, Average Days On Market can be a strong indicator of home prices. When Average DOM falls, home prices tend to increase.

More commonly called “points”, discount points are up-front fees charged by mortgage lenders in exchange for lower mortgage rates.

The cost of one point is one percent on the loan size and discount points appear on Line 802 of the HUD-1 Settlement Statement.

As a general guideline, each point paid lowers a mortgage lender’s offered interest rate by 0.250%.

For example, a $200,000 home loan offered at 6.000% can be had for 5.750% if the borrower agrees to make an up-front payment of one point ($2,000).

In addition to lowering your interest rate, discount points (as well as other closing costs) may be tax-deductible, too. Therefore, be sure to provide any settlement statements from the previous calendar year to your accountant during Tax Season.

Each month, the Commerce Department and the National Association of REALTORS release national housing data.

The former’s release is called the New Residential Sales report and the latter’s is called the Existing Home Sales report.

Both reports highlight the “median sales price”, the point at which half of the homes in the U.S. sold for more, and half sold for less.

Last month, the median sales prices were as follows:

• Existing homes: Down 8.2 percent
• New homes: Down 2.7 percent

The very definition of “median”, however, makes this data point useless for national housing statistics.

If a large amount of homes are sold in regions where home prices are traditionally high, the median sales price will trend higher.

If a large amount of homes are sold in regions where home prices are traditionally low, the median sales price will trend lower.

Again, all that the median sales price tells us is the price point at which half the homes in the country sold for more, and half sold for less.

Real estate is a local phenomenon and so grouping the entire country’s supply of homes together makes little sense. A home in San Francisco has little to do with a home in Omaha.

To get a true gauge of your local market, talk to a real estate agent that knows the local market well. You’ll not only get meaningful statistics about a neighborhood, but you’ll get good insights, too.

When a buyer and seller reach agreement on a home sale, the buyer typically puts a small amount of money into a trust account.

This up-front deposit is more commonly known as “earnest money”.

A sales contract’s earnest money requirement will vary from contract to contract. It can be as high as 10 percent of the purchase price and could be as low as $500; earnest money is a negotiable item between buyers and sellers.

Some factors that can influence earnest money amounts include:

• Market conditions: Stronger markets often call for more earnest money
• Buyer economics: First-time buyers often give less earnest money
• Seller psychology: Skeptical sellers often ask for more earnest money

No matter how large or how small, however, earnest money is supposed to give the seller a sign of good faith that the buyer wants to purchase the home.

To this end, earnest money can be forfeited if the buyer later “backs out” of the deal, or breaches the terms of the purchase agreement. Breaching, however, is infrequent.

This is because most purchase contracts are written with buyer-focused “outs” called “contingencies”.

A typical contingency is that the seller must provide a clean title policy to the buyer, or that the buyer must secure financing prior to given date, or that the home must pass a satisfactory inspection.

If any of these contingencies cannot be met, the purchase agreement is voided and earnest money returned to the buyer.

When contingencies are met, however, earnest money becomes a deposit and is applied directly to the buyer’s bottom line at settlement. If the buyer is expected to have $50,0000 for the closing, for example, the true bottom line is $50,000 minus the earnest money deposit.

Earnest money customs vary from state to state, city to city, and even locale to locale. Be sure to ask your real estate agent and/or real estate attorney for professional counsel before signing purchase contracts.

The earnest money you save may be your own.

(Pronounced: NEGH-ah-tive am-ohr-tih-ZAY-shun)

Negative amortization is the process by which a loan’s principal balance increases on a month-over-month basis.

This is in contrast to a “typical” amortization schedule in which the principal balance decreases.

Negative amortization is an optional feature on some home loans.

These mortgages are usually referred to by the brand names “Option ARM”, “Pick-a-Payment”, or “Payment Option ARM”.

Many industry veterans collectively call refer to these types of mortgages as “Neg-Am” loans.

When a Neg-Am mortgage statement arrives each month, the homeowner can choose his preferred payment structure.

1. Pay the minimum balance due only
2. Pay the interest due only
3. Pay the principal + interest payment on a 30-year amortization schedule
4. Pay the principal + interest payment on a 15-year amortization schedule

Choice #1 is like making a “minimum payment” on a credit card. It is the only option that adds to the principal balance so, therefore, it is the only negative amortization option of the four payment choices.

In this sense, negative amortization is a choice and not a certainty.

In the early 2000s, Neg-Am loans grew popular as home affordability products. Many homeowners made the minimum payment each month and found that their mortgage balance had swelled.

Some of these homeowners lost their homes.

Because of their complex structure and potentially devasting consequences, NegAm home loans have been dubbed “nightmares” by several media publications.

However, many sophisticated homeowners have successfully applied NegAm loans to help meet their financial goals.

Like all home loans, NegAm products are a better fit for some homeowners than others. Some likely candidates include:

• 100%-commissioned salesperson who want better control over tax deductions
• Owners of multiple investment properties who want better control over cash flow
• Investors who seek leverage in real estate and who clearly understand market risk

Homeowners with questions about negative amortization loans should seek counsel from a qualified mortgage professional.

As a homeowner, your financial obligations extend beyond your monthly mortgage payment. Periodically, you are also required to pay real estate taxes and homeowner’s insurance premiums.

Each month, you pay your mortgage payment to a company called a “mortgage servicer” (because they “service” your mortgage each month).

In addition to the risk of not getting paid by homeowners, servicers also face two other risks related to homeowners:

1. That a homeowner’s real estate tax bill will become delinquent and will be sold to a third-party
2. That a homeowner’s residence will face catastrophic damages during a lapse in insurance coverage

But these risks can be mitigated.

Rather than assume that homeowners will pay on time, mortgage servicers can pay these bills on the homeowner’s behalf when they come due while passing that cost on as a mortgage statement line-item.

This service is commonly called “escrow”.

The escrow payment varies from homeowner to homeowner, of course. It’s the sum of the amounts due annually for real estate taxes and insurance, divided by 12 months in the year.

That yields a monthly amount which is then added to the homeowner’s mortgage statement each month, and added to a bucket of funds held on reserve by the servicer.

For example, a $3,000 tax bill with a $600 insurance policy = $3,600 in costs annually = $300 monthly paid into escrow monthly.

A $1,500 mortgage payment, therefore, would require a $1,800 check to be written to the mortgage servicer each month.

When a mortgage servicer “escrows” on behalf of a homeowner, it knows that taxes and insurance will get paid on time, thereby protecting its own interests. This is one reason why some mortgage lenders offer lower rates and/or fees for borrowers that choose to escrow.

If you’re unsure about whether escrowing is right for you, be sure to ask questions. As with all financial decisions, there are reasons to choose either route.