Sifting out surprises in mortgage fine print
Getting a mortgage is often the single largest financial transaction in a person's life. Yet borrowers, presented with a dizzying array of legal documents full of complex conditions, can find the process daunting.
Just ask Peter S. Milewski, director of mortgage insurance at state agency MassHousing, who recently refinanced his own home.
"I'm in the business, and it probably took me 1 to 1 1/2 hours to go through the documents to make sure I knew what I was signing," he recalled. "Even then, I probably didn't understand every single sentence."
The huge spike in foreclosures nationwide is a dramatic demonstration of what can happen when borrowers don't understand what they're signing, or can't afford their mortgages.
"These contracts are not written to protect the consumer. They are written to protect the lender," said Joan Gray Anderson, co-director of the University of Rhode Island Center for Personal Finance Education. "The longer and more complicated they are, the more rights are being taken away."
Indeed, the documents can be so dense that some borrowers don't even bother to read them. A survey by financial publishers HSH Associates found only 38 percent of respondents read all their mortgage papers, while nearly 9 percent did not ready any. Yet those documents can contain some zingers, saddling unsuspecting homeowners with spiking mortgage payments, huge prepayment penalties, and Draconian remedies for missed mortgage payments.
According to mortgage experts, there are four key documents borrowers should carefully scrutinize in any mortgage closing.
The truth-in-lending statement, which shows not only how much you are borrowing but also how much the financing will cost you over the life of the loan. It will outline a payment schedule and total number of payments required. The document also will have an annual percent rate, which will be higher than the rate in your note because it includes additional costs, such as points and fees. A truth-in-lending statement should be sent to the borrower within three days of applying for a loan. A second copy is supposed to be sent to borrowers before closing, although sometimes these documents don't arrive until the actual closing.
The HUD-1 settlement statement, which outlines actual settlement costs, ranging from origination fees to title insurance. Borrowers should carefully review each fee listed on this document. "Not all of these fees are negotiable, but some are," Milewski said.
The note, which includes all the critical financial information such as interest rate, payment schedule, and - in the case of an adjustable rate mortgage - the method for adjusting rates in the future.
The actual mortgage. It can run 25 pages and include all kinds of conditions that buyers agree to but almost never review, including clauses on hazardous waste, required occupancy of the property, and even recognized ways of communicating with the lender, said Ruth Dillingham, an attorney with First American Title Insurance Co. in Boston.
By law, a set of final disclosures - including the HUD-1 - is supposed to be available to the borrower before closing, but that doesn't always happen. The legal documents prepared for signing won't show up until the actual closing. This doesn't leave borrowers much time, but at each step it is important to compare each document to the others, and to the loan application and the commitment letter, to make sure that the terms are consistent.
Failure to do so can be costly, said Richard D. Olson, president of Aura Mortgage Advisors, a nonprofit mortgage broker affiliated with Boston
He cites the case of a woman who thought she was getting a 30-year fixed-rate mortgage. She signed the documents without realizing that her mortgage was an ARM, only to discover the problem when her monthly payments suddenly jumped.
Borrowers with fixed-rate loans are likely to encounter fewer surprises because the terms of their loan don't change periodically. Those with adjustable rate mortgages, however, need to contend with myriad details governing future rate changes, which can mean the difference between an affordable payment schedule and foreclosure.
Here are some key items that should be verified at every mortgage closing:
Interest rate. In a fixed-rate mortgage, the rate doesn't change. So any language that refers to "initial" rate or "rate changes" means that you need to dig deeper to find out exactly what those changes might be.
Change or reset date. Some borrowers have been dismayed to find that their low "teaser" rates were only in effect for a month, a week, or sometimes just 24 hours. More typically, rates change annually or stay in place for a period of years before switching over to a more frequent reset.
Payment amount. "People have a bad habit of payment shopping," said Bankrate.com's Greg McBride, meaning they tend to consider only the initial payment schedule. To avoid surprises, ask for a worst-case or "fully indexed" payment scenario, which shows monthly payments at the highest possible rates.
Prepayment. Some lenders impose expensive prepayment penalties if you pay off your loan entirely as a result of refinancing, sale of the home, or a sudden windfall. Any penalties should be noted in the truth-in-lending statement and in the note.
Index and margin. Mortgages specify the index that will be used to calculate new rates. One common index is the London Inter Bank Offering Rate (LIBOR). The amount added to the index to determine the new mortgage rate is called the margin. An adjustable mortgage that uses the six-month LIBOR, now at about 5.5 percent, and which has a margin of 2.25 percentage points, would add up to a new rate of 7.75 percent.
Cap. If you want to know how bad it can get, check the caps. These are the limits on the amount a mortgage rate can rise or fall. One cap applies specifically to the initial adjustment from the introductory rate. Thereafter, the periodic cap limits the rate change in any single adjustment. A 2-percentage-point periodic cap, for example, means that your 5 percent mortgage won't increase to more than 7 percent at the next reset. The lifetime cap sets the maximum rate that could ever be charged.
Balloon payments. Some mortgages, particularly for people with limited funds for down payment, are designed with payment schedules that are longer than the term of the loan. That means that the borrower faces a large payment or balloon when the loan matures. Such mortgages can work well for people expecting to own their homes for a brief period, but can create problems when homes are hard to sell.
Have problems with the way your mortgage documents deal with these terms? Then don't sign. Ditto if you simply have questions about the way the documents are written. You may not be able to get your lender to change the terms of your loan, but starting over is better than being saddled with a mortgage debt you can't afford.
MassHousing's Milewski routinely recommends that people spend the money to hire a real estate attorney. That $500 to $1,000 "may sound like a lot of money, but it is a very small investment when you think about those hundreds of thousands of dollars that you are borrowing," he said.
