A recent run of low interest rates fueled a huge boom in refinancing that allowed many people to accomplish two things. They were able to take money out of their houses to use for other things and lower their interest rates on their mortgage. Here is a brief on mortgage refinancing.

The Basics

A mortgage is an agreement whereby a lender loans money out to a borrower in return for repayment of the money with interest and a security interest in the real estate. Real property consists of buildings and land. A security interest means that the borrower agrees to let the lender sell the property if he or she does not repay the loan.

This agreement is known as the security interest agreement. In the usual mortgage, the lender loans the money to the borrower to purchase the land or building. The lender then takes a security interest that allows the lender to foreclose or take over the property and sell it off as the borrower doesn’t make the payments on the loan.

Understanding The ARM

Generally speaking, people want to either save money, reduce risk, or raise money when they refinance. If they bought the house at a high interest rate refinancing with a lower interest rate can reduce their mortgage payments significantly.

Some mortgages are what are known as adjustable-rate mortgages or ARMs. This means that the interest rate, and thus the payments on the loan can go up when interest rate indexes go up.

Many people find this risk uncomfortable and wish to lock in a stable, and hopefully, significantly lower rate.

Additionally, some refinancing homeowners may want to shorten their mortgage payoff periods. Finally, refinancing is one of the major ways people can tap into the equity values in their real estate to raise cash. It may pay to check with the current mortgage holder to see if they would be willing to refinance the mortgage in order to keep the loan.

Getting a new mortgage to replace the old one is really much the same process as getting a mortgage in the first place. (Other options for using your home to raise cash such as a second mortgage and a home-equity loan are discussed elsewhere on CLF)

Refinancing has all of the same costs associated with it that a mortgage does. Real estate loans require application fees, attorney’s fees, appraisal fees, proof of insurance, and other possible fees such as mortgage insurance and home inspection costs.

Understanding Prepayment Penalties

However, the biggest problem in refinancing isn’t the fee, it’s a penalty in the form of a prepayment penalty. If your current mortgage has a prepayment penalty, then you may have to abandon the idea of refinancing. Many government loans do not have prepayment penalties, but private lenders may impose them on borrower’s. Basically, a prepayment penalty forces you to pay a penalty for paying off the loan early.

Like other loans, a mortgage starts with an application form. The application form is designed to produce information on two things – you, and the property you want to buy. For you, the bank is interested in employment and credit information. For the property, the lending institution is interested in how much it’s worth and what kind of house it is. This includes most importantly where the house is.

Many different federal laws come into play during the lending process. For example, your credit report and score are key elements in getting a mortgage. These important items are governed by the fair credit reporting act (FCRA). In addition, lenders may not discriminate based on certain factors including race, religion, and national origin (among other factors).

These protections are spelled out in the Equal Credit Opportunity Act as well as the Fair Housing Act. Since lenders rely so heavily on credit reports and credit score, if you only do one thing to try to improve your chances for a mortgage at the rate you want, that one thing would be to read your credit report before you apply.

Lenders are particularly interested in not only whether you pay bills, but also whether you pay them on time.

Under Federal Law, you have a clear right to access your credit file. You also have rights to request corrections of information that is not accurate. Contact information on the credit reporting agencies can be found online or in the Yellow Pages. If you have recently applied for credit only to be denied you have the right to receive a free copy of your credit report.

Lenders need to know how much you plan on borrowing. With conventional mortgages, this number is based on your available income and the property’s estimated value. The lender will require an appraisal. Appraisals count for a lot because the banker wants to be sure that if you fail to pay then the house can be sold to recover the balance of the loan.

The only way for the lender to be absolutely sure of the value of the house would be to sell the property, which is not practical. The second-best thing to do is compare your house with a certain number, usually at least two similar ones alike that have sold recently in the same general area. The appraisal can be a magic number for you as a borrower because usually the lender will lend up to a certain stated percentage of the value.

Usually this number is fairly high – think about 70% at least. However, if it is a second home or other issues come up, the lender may not be willing to lend as much. A mortgage is not necessarily the fastest way to raise cash since you should be prepared to wait 30 days before the money is transferred into your account.

If you are seeking a FHA or VA loan, plan on a longer time frame. They are also not the cheapest loans because you have the fees, the appraisal and the closing costs.

However, real estate, along with pension rights, are often the largest asset people have available. It is an option that should not be overlooked. Also interest rates on mortgages are among the lower ones that consumers may encounter.

Predatory Lenders is a term to describe so-called banks, private lenders, or lending institutions that take part in shady lending.

These predatory lenders take advantage of “low information” borrowers (which is actually the majority of borrowers) who don’t understand the contents of a loan agreement which has hidden clauses in it. These clauses set up the borrower for failure in a myriad of ways. We try to identify all of these sneaky tactics that these predators use and who they target.

Targets of Predatory Lenders

Predatory lenders target particular demographics that usually include the elderly, minorities, low income homeowners, or “low information homeowners” (people who are uneducated or ignorant to financial matters), and those borrowers who are in an desperate financial situation such as health crisis, or layoff status.

This does not mean that white 35 year old couples in upper-end neighborhoods don’t get taken by sneaky lending practices.

All statistics on these loans confirm that close to 50% of sub prime loans given to homeowners from these demographics should have been prime APR loans.

It is important to note that these horrid lenders actually look for homeowners that could be susceptible to their sneaky methods, and target them for their aggressive sales tactics.

Predatory Lending Tactics

These sub prime loan rates are much higher than typical prime rates and fleece the unsuspecting homeowner of their money. These ethically bankrupt and soulless lenders prey upon depressed neighborhoods by offering broke homeowners mortgage refinancing, or second mortgages that carry high APRs, inflating payments (aka. balloon payments) with no rate caps, and no consumer protection whatsoever.

In a typical conventional mortgage from a reputable lender will usually carry servicing fees of .5 – 1.5 percent of the principal amount borrowed, whereas a predatory lender will run these fees up as high as 5-7% of the principal lent. Of course these exorbitant fees are hidden in the loan agreement throughout the term in an attempt to dupe the borrower.

Many times the sub prime loan agreement will not only have extremely high fees, but carry brutally high penalties for delinquency (missed payments) that often result in premature “foreclosures” whereby the lender is given legal ownership of the distressed property as per the foul refinancing agreement.

Predatory lenders will advertise very aggressively in financially distressed neighborhoods flashing them with incentives such as free vacations, and other goods or services.

Another Dirty Loan Officer Tactic - Tied Selling

There is another tactic that sneaky loan officers used to use allot in the early days of banking, lending, and borrowing – it’s called Tied-Selling. I won’t go into allot of detail on this bad banking practice, because we have an article on the definition of Tied Selling here. If you don’t have time to read the post, you just need to know that Tied Selling is illegal almost everywhere.

When a bank or loan officer tell you that you may get approved for financing (a loan) IF you transfer all your financial interests to their bank, such as your mortgage, car loan, truck loan, 401K,(RSSP in Canada), and/or insurance policy – this is called Tied Selling and if this ever happens to you, you should report the bank or loan officer to the authorities right away.