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Springfield Business Journal Articles
Sarah Delano Pavlik and Tom Pavlik write a monthly column on legal and business issues for the Springfield Business Journal.


Their columns will be added here each month after publication.
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With low interest rates persisting, but with the possibility of higher rates on the horizon, you may be thinking about taking the plunge and buying your own home. Or, you might be refinancing to lock in a low rate on your existing home. However, what you likely don't know about residential financing can end up costing you money you might have otherwise saved.

One of the most obvious traps to avoid has to do with paying your mortgage through bi-monthly payments. The concept is simple. Instead of making a full payment every month, you make a half payment every two weeks. Since there are fifty-two weeks in a year, you make twenty-six half payments, or thirteen full payments - - rather than twelve if you paid every month. Of course, those extra payments allow you to pay off your loan faster and save significant money on interest. Some lenders or third parties advertise this service for several hundred dollars or even more. However, you can achieve the same result by simply making extra monthly payments. For example, increase the amount you pay each month by one-twelfth (8.33%). By increasing your mortgage payment by just over 8 percent, you shorten the life of your loan and save money at about the same rate you would with a bi-weekly loan. There simply is no need to pay someone for this service. Plus, you can sleep securely at night without worrying whether the third-party provider has taken your money to Las Vegas.

Escrowing for taxes and insurance is another trap for the unwary. Depending on the circumstances (largely how much equity you have in your home), your lender may add extra money to your monthly mortgage payment that goes into an escrow account. The lender collects these sums to pay your taxes, insurance, and other payments associated with home ownership. The lender is then responsible for the timely payment of your taxes and insurance. When escrowing, most lenders want to keep a cushion in the escrow account beyond the amount necessary to pay such costs. Federal law limits that cushion to approximately two months worth of the costs. However, why lose the time value of that money? Ask your lender to waive escrow, make those payments yourself, and let the money earn interest for you someplace else.

Along the same lines, avoiding Private Mortgage Insurance (PMI) is another way for the sophisticated borrower to save money. PMI is insurance that protects the lender, not you, if you default on your loan. As a rule of thumb, you will be required to pay for this PMI if your down payment or equity in the house is less than twenty percent of the purchase price. PMI costs vary depending on your own facts, but can be significant. Moreover, the cost of PMI is not deductible on your income taxes. If you can't come up with the twenty percent down payment, all is not lost. First, federal law states, in general, that once your loan balance equals eighty percent of your home's fair market value, you can have PMI cancelled. Second, the creative borrower can avoid PMI entirely. "Piggy Back" loans allow you to borrow, via a second mortgage loan, the funds necessary to meet the twenty percent threshold. Even though the interest rate on the second loan will likely be slightly higher, you might come out ahead versus paying the cost of PMI. Plus, the interest on this second mortgage will likely be deductible on your incomes taxes. Or, some (but by no means all) lenders will dispense with PMI in exchange for a higher interest rate. Given that the interest is deductible, it may be that you can still come out ahead. The best advice is to work with your lender and to run the numbers yourself to insure that you actually do come out ahead. Although not verified, some web sites have "calculators" that can run the numbers for you, such as the calculator at http://www.decisionaide.com.

Finally, make sure you know what your closing costs are. Closing costs can include discount points or origination fees, which are up-front payments that reduce the interest rate. Some advertised rates can only be obtained if you buy a point - - a point being one percent of the loan amount. Lenders must provide you with a statement of Annual Percentage Rate (APR), which is generally higher than the advertised rate. There are other closing costs, however, which are not necessarily factored into APR. The smart borrower understands exactly what charges he or she is paying beyond points. Often, these costs can turn an otherwise attractive loan into a bad deal. Shop around for the best package, ask if some of the costs can be waived, and make sure all of your questions are answered.
Posted in: April, 2004
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