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)

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)

The Fed lowered the Fed Funds Rate by a quarter-percent to 2.000% this afternoon.

Because it is tied to the Fed Funds Rate, Prime Rate also fell by a quarter-percent. Prime Rate is now 5.000%.

Holders of home equity lines of credit and credit card debt benefited from the change and will see lower interest costs in next month’s statements.

Mortgage rate shoppers are also benefitting.

Each time the Federal Reserve cuts the Fed Funds Rate, it’s meant to stimulate the economy in growth. Too much stimulation can create too much growth and that often leads to inflation (which causes mortgage rates to rise).

This is one reason why mortgage rates had not fallen over the past few months. Each Fed Funds Rate cut made it more likely that the economy would overheat in the second half of 2008.

So, because the Federal Reserve signaled that a rate-cutting “pause” may be ahead, investors are reducing expectations for a Fed-induced inflation cycle for later this year, pushing rates lower.

The FOMC’s next scheduled get-together is a two-day meeting June 24-25, 2008.

Source
Parsing the Fed Statement
The Wall Street Journal Online
April 30, 2008
https://online.wsj.com/internal/mdc/info-fedparse0804.html

RealtyTrac released Q1 2008 foreclosure statistics and the data follows an interesting statistical phenomenon most commonly known as the “80/20 Rule”.

The 80/20 Rule states that 80 percent of the effects come from 20 percent of the causes.

In this case, 80 percent of bank repossessions in the first three months of 2008 came from 20 percent of the states in the union.

Accounting for 156,463 repossessed homes nationwide:

1. California (40,023 homes)
2. Texas (14,935 homes)
3. Michigan (12,016 homes)
4. Ohio (10,299 homes)
5. Florida (10,185 homes)
6. Georgia (8,265 homes)
7. Arizona (7,956 homes)
8. Colorado (7,022 homes)
9. Tennessee (4,533 homes)
10. Indiana (4,446 homes)
11. Illinois (4,216 homes)

Overall, 0.55 percent of homes were repossessed by banks in the first quarter.

It’s good to see that Virginia is not on this Top 10 … or Top 11 list. Although, we weren’t that far down, coming in at number 14 with 3,639 foreclosed homes. That’s a rate of 1 foreclosed home for every 246 households.

In three weeks, the Federal Open Market Committee will meet again and markets anticipate another cut to the Fed Funds Rate.

Based on data compiled by the Federal Reserve Bank of Cleveland at the close of business yesterday, traders put the probabilities of the Fed’s next move at:

• 62 percent chance that the Fed Funds Rate falls to 2.000%
• 36 percent chance that the Fed Funds Rate falls to 1.750%

Currently, the Fed Funds Rate is 2.250%.

Cuts to the Fed Funds Rate are meant to stimulate the economy by lowering borrowing costs for banks, businesses, and consumers. When less money is spent on interest payments, more money is available for goods and services and that tends propels the economy forward.

And, because Prime Rate is tied to Fed Funds Rate, home equity lines of credit and credit cards grow “cheaper” when the FFR falls. That can makes financed home improvement projects a little less expensive.

Cuts to the Fed Funds Rate, however, do not equal cuts to mortgage rates - this is a pretty common misconception.

Mortgage rates are based on the price of mortgage bonds and — although it exerts an influence — the Federal Reserve does not set the prices for mortgage bonds any more than it sets the price for other investments such as stocks or mutual funds.

Since September 2007, the Federal Reserve has lowered the Fed Funds Rate by 3 percent. Over the same period of time, conforming mortgage rates have been mostly unchanged.

News sources like to use the term “credit crunch” in describing the U.S. economy, but they rarely define what a credit crunch is and what it means for Americans.

A credit crunch is when the amount of available loans suddenly decreases over a very short period of time.

Usually, it follows a period of lending which, in hindsight, becomes known for its “easy money”.

The start of a credit crunch often coincides with consumer loans starting to go bad and lenders losses starting to mount.

The realization that more losses are ahead forces lending institutions to tightening their respective lending guidelines.

Since the current credit crunch began in mid-2007, Americans looking for credit now face:

• Higher credit score requirements on auto loan applications
• Higher fees and interest rates on credit cards
• Larger downpayment requirements on their home purchases

And now, the newest symptom of the credit crunch: the largest buyer of mortgage loans — Fannie Mae — has instituted a new, 580 minimum score requirement for all mortgage applicants.

As consumer delinquencies mount and the economy continues to sputter, getting access to credit will likely get tougher for every American — good credit and bad.

And that’s the defining characteristic of a credit crunch.

Source
Credit Crunch
Wikipedia, April 8, 2008
https://en.wikipedia.org/wiki/Credit_crunch

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.

For a lot of homebuyers, calculating a prospective mortgage payment is an online experience. For example, a search on Google for “mortgage calculator” returns 39 million options.

Some people, however, prefer to plan on their local hard drive using spreadsheets. For these people, the hardest part is often figuring out what formulas to use.

Interest Only Payments

Home loans with interest only payments are much more simple to calculate than amortizing loans.

Using the graphic at right as a guide, enter your loan size and your interest rate into two separate spreadsheet cells.

Then, create a third cell and input the following formula that calculates the “Monthly Payment”. The formula is:

= (Loan Size) * (Interest Rate) / 12

Principal + Interest Payments

For a home loan with (principal + interest) payments, the formula is a little bit more complicated than with an interest only home loan.

Using the graphic at right as a guide, enter your loan size, your interest rate and the duration of your home loan into three separate spreadsheet cells.

Then, create a fourth cell and input the following formula that calculates the “Monthly Payment”. The formula is:

= - PMT(Interest Rate/12, Loan Term in Months, Loan Size)

For additional spreadsheet formulas and more in-depth reporting, explore your software’s “Help” feature to see what you can find.

Many homeowners are entitled to two major tax deductions — one for annual interest paid on a home loan, and another for real estate tax bills paid to government.

Calculating your approximate tax credit is basic:

1. Add mortgage interest paid and real estate taxes paid together
2. Find your marginal tax rate
3. Multiple your tax bracket by the sum of Step 1

So, for a homeowner that paid a combined $13,000 in mortgage interest and real estate taxes last year, and who is in the 28% marginal tax bracket, a tax credit of $3,640 may be due from the IRS.

This credit is one reason why some people sometimes refer to “after-tax mortgage rates”. An after-tax mortgage rate is the adjusted interest rate after the IRS doles out credits and is calculated as follows:

(After-Tax Mortgage Rate) = (Mortgage Rate) * (1 - Marginal Tax Rate)

The same homeowner with a 6.000% mortgage rate, therefore, has an after-tax mortgage rate of 4.32%.

Because not every homeowner is eligible for mortgage interest and/or real estate tax deductions, and because not every homeowner should claim them, you should consult with your accountant to see how tax credits fit into your tax liability schedules.

Federal income taxes are highly personal and require the attention of an experienced professional.

Adjustable Rate Mortgages are mortgages for which the interest rate is subject to change over time according to pre-defined rules.

ARM is a common acronym for Adjustable Rate Mortgage and every ARM has similar features:

1. An initial fixed period during which the mortgage rate doesn’t change
2. An initial interest rate that is charged during the initial fixed period
3. An index that is used to calculate the new interest rate after an adjustment. An index is a variable and is usually assigned to LIBOR or Treasuries.
4. A margin that is a constant added to the index to calculate the new interest rate after an adjustment. Margins vary from 1.500% to 6.999%, depending on the type of mortgage.
5. Caps which define the limits by which an ARM can adjust during any given adjustment phase, and during its life. Caps can prevent ARMs from adjusting too far too fast and can vary from 2.000% to 5.000%.

Now that we understand the “parts” of an ARM, we can understand how it works.

ARMs are generally named for their initial fixed rate period. A “5-year ARM”, for example, means that the mortgage interest rate will not change for the first five years.

After the initial fixed period, an ARM adjusts to its new interest rate according to the following formula:

(New Interest Rate) = (Index) + (Margin)

So, if the index is LIBOR (which is 4.82% right now) and the margin is 2.250%, the new rate on the adjusting ARM will be 7.07%. The loan will also adjust according to the same formula on every 1-year anniversay thereafter.

Of course, there are variation of ARMs that differ from the one described above, but this definition fits most of them.