Navigating the vast landscape of mortgage products and the associated disclosure requirements can be challenging, especially for those who may be new to the industry or looking to broaden their understanding. For mortgage professionals, it is essential to have a clear grasp of the various loan products available and the critical disclosures that accompany them. This guide aims to provide an overview of some common mortgage products, including their benefits, risks, and the key disclosures required by law.
30-Year Fixed-Rate Mortgage
The 30-year fixed-rate mortgage is one of the most popular mortgage products in the United States. It offers homebuyers a fixed interest rate that cannot be raised once the loan is finalized. Part of the reason this offering is so popular is its consistency. 30-year fixed-rate products offer steady, uniform monthly payments stretched across the entire lifespan of the loan.
Key Benefits:
- Predictable monthly payments make budgeting easier for homebuyers.
- Borrowers are protected from interest rate fluctuations over time.
Drawbacks:
- As 30-year fixed-rate mortgages have a long lifespan, borrowers may end up paying more total interest over the life of the loan when compared to shorter-term loans.
- Another drawback of the product’s long lifespan is that it will take many years for homebuyers to build equity in the property.
Disclosure Requirements:
- Loan Estimate (LE): This must be provided within three business days of receiving the loan application. LEs specifically outline the estimated interest rate, monthly payment, and total closing costs for the product.
- Closing Disclosure (CD): CDs must be issued at least three business days before closing, detailing the final loan terms and costs. This gives borrowers a chance for a final review and to confirm their decision to move forward.
Adjustable-Rate Mortgages (ARMs)
Unlike fixed-rate mortgages, ARMs feature an interest rate that changes periodically based on market conditions. Typically, ARMs start with a fixed rate for a set period (ex: 5, 7, or 10 years), after which the rate will adjust annually to better mirror the current state of the market.
Key Benefits:
- ARMS typically begin with lower initial interest rates compared to fixed-rate mortgages, meaning that – at least in the loan’s early stages – regular payments are generally somewhat lower.
- The homebuyer could see significant potential savings overall, if interest rates decrease over the life of the loan.
Drawbacks:
- On the other side of the coin, monthly payments could increase significantly if interest rates rise instead of fall.
- This fluidity in interest rates does create inherent uncertainty in long-term financial planning due to potential rate changes. ARMs are essentially a market ‘gamble’ on the part of borrowers that interest rates will fall in the future.
Disclosure Requirements:
- Loan Estimate (LE) and Closing Disclosure (CD): These documents must reflect the terms of the ARM, including the index, margin, adjustment periods, and caps on rate increases.
- ARM Disclosure: This explains how ARMs work, including when and how the interest rate and payment may change. As ARMs are inherently somewhat more complex than fixed-rate loans, borrowers must be made aware of the possibility of loan course corrections – whether positive or negative – as time goes on.
Refinancing
Refinancing involves replacing an existing mortgage with what is essentially a brand new loan. This option can be put into motion for a number of reasons: to secure a lower interest rate, change the loan term, or access home equity.
Key Benefits:
- A successful refi has the potential to lower a borrower’s monthly payments and/or pay off the mortgage faster.
- Borrowers can also access necessary cash for hardships or large purchases by initiating a ‘cash-out’ refinance.
Drawbacks:
- Closing costs for refinances are generally substantially higher than ‘traditional’ purchase loans. These costs can potentially offset savings, depending on the situation.
- In essence, refinancing a loan creates an extension of the existing loan term. By ‘starting over’ in this manner, borrowers may end up paying more interest over time.
Disclosure Requirements:
- Loan Estimate (LE) and Closing Disclosure (CD): These documents must outline the new loan terms and all associated costs up front, just as with fixed-rate and ARM loans.
- Right of Rescission: For most refinances, borrowers have a three-day period in which they may cancel the transaction after closing, no questions asked and without penalty. This is a legal protection under the Truth in Lending Act (TILA). This right only applies to certain types of loans, such as (most) refis, HELOCs, and home equity loans.
Home Equity Line of Credit (HELOC)
A HELOC is a revolving line of credit that is secured by the existing equity in a borrower’s home. Borrowers can draw upon the credit as needed during the draw period, and are only required to pay interest on the amount borrowed. HELOCs are not intended for minor purchases and are usually utilized for large expenditures like home improvements or emergencies.
Key Benefits:
- HELOCs offer flexibility to borrow as needed, up to the credit limit. For homeowners with built-up equity looking to improve their home or needing cash due to unforeseen events, HELOCs can be a lifesaver.
- The interest on HELOCs may be tax-deductible. Borrowers should consult a tax advisor to confirm that their line of credit qualifies for tax-deductible status.
Drawbacks:
- As with ARMs, HELOCs feature variable interest rates. This means that payments can potentially increase in the future due to market fluctuations.
- HELOCs essentially drain a property of borrower equity. This is not a concern if the borrower pays off the HELOC to re-establish equity. However, the home could be at risk if the borrower cannot make payments.
Disclosure Requirements:
- HELOC Disclosure: This disclosure must include the terms of the line of credit, such as the draw period, repayment period, and how the minimum payment is calculated. As highlighted above, an outstanding payment on a HELOC places said home in jeopardy, so it is crucial that borrowers are aware of this danger and fully understand payment information.
- Periodic Statements: HELOCs are accompanied by regular statements that show the outstanding balance, payment due, and other key account information.
VA Loans
VA loans are government-backed mortgages that are designated for veterans, active-duty service members, and certain members of the National Guard and Reserves. These loans often require no down payment and have favorable terms.
Key Benefits:
- No down payment is required in most cases.
- Borrowers do not need to purchase private mortgage insurance (PMI), as VA loans do not mandate this requirement.
Risks:
- VA loans are specific to eligible veterans and military members and not available to the general public.
- Some VA loans have a VA funding fee, depending on the situation. This fee can generally be rolled into the loan, but it can be up to 3.3% of the total loan and its inclusion may be confusing, especially for older veterans.
Disclosure Requirements:
- Loan Estimate (LE) and Closing Disclosure (CD): These documents must outline the terms of the VA loan, including any funding fee, if applicable.
- VA Loan Disclosure: VA disclosures include the benefits and obligations associated with the VA loan. Although VA loan terms are generally agreeable when compared to traditional loans, they are still loans, and borrowers must be aware of all risks and liabilities.
Buydowns
A mortgage buydown allows the borrower to reduce the interest rate on their mortgage temporarily, or permanently, by paying an upfront fee at closing. One common example is the ‘2-1’ buydown, where the rate is reduced by 2% in the first year and 1% in the second year. This allows borrowers to ease into the loan payment process, assisting in budgeting during the loan’s early lifecycle.
Key Benefits:
- Lower initial payments can make homeownership more affordable in the early years.
- Buydowns can also help borrowers qualify for a loan they might not otherwise afford, as long as they are able to raise the initial fee. This can be helpful for borrowers whose budgets are somewhat tight now, but are expecting an influx of cash or higher income later, for whatever reason.
Drawbacks:
- While overall payments will be lessened in the loan’s initial year or years, buydown fees can be a costly upfront obligation.
- Once the buydown period ends, the borrower must be prepared for higher ‘normal’ payments.
Disclosure Requirements:
- Loan Estimate (LE) and Closing Disclosure (CD): As with other options, buydown disclosures must clearly indicate the specific loan arrangement. In regard to the uniqueness of the buydown process, disclosures must spell out its impact on payments over time.
- Buydown Agreement: This agreement outlines the terms and conditions of the buydown, including exactly how the payments will adjust once the buydown period has ended.
Homes for Heroes Program
‘Homes for Heroes’ is a national program that was created shortly after 9/11 and helps firefighters, EMS professionals, law enforcement, military personnel, healthcare workers, and teachers save on their real estate transactions. The program connects these everyday heroes with real estate agents, lenders, and other professionals who offer significant savings.
Key Benefits:
- Mortgage professionals that are partnered with Homes for Heroes are able to secure discounts on real estate services, including reduced lending fees and closing costs.
- Applying for the program can lead to substantial savings for eligible heroes.
Drawbacks:
- Although Homes for Heroes has helped thousands of homebuyers save over $134 million on their mortgage products, the program is limited to specific professions.
- The program is designed to help members of the above professions, but discounts are not uniform or based in law. They are not guaranteed and can vary based on the professionals and services involved.
Disclosure Requirements:
- Loan Estimate (LE) and Closing Disclosure (CD): Standard disclosures apply, as Home for Heroes is a mission program and not an ‘official’ type of loan. Any discounts or rebates should be clearly indicated, as part of the overall terms.
- Program Disclosure: For homebuyers making use of the program, an explanation of the benefits, eligibility criteria, and any potential costs associated with the program should be included
Gain Product Knowledge = Gain Customer Trust
Understanding the similarities and differences between various mortgage products and their associated disclosure requirements is crucial information for any prepared mortgage professional. Each product comes with its own set of benefits, risks, and specific disclosures designed to protect both the lender and the borrower. Staying informed about these products and ensuring compliance with disclosure regulations is key to providing exceptional service and maintaining trust with clients. By familiarizing yourself with these common mortgage products and their requirements, you’ll be better equipped to guide your clients through the mortgage process confidently and transparently.