Advanced Personal Finance

There’s a way for a person feeling ‘borrower’s remorse’ to back out of certain home loans. It’s called the right of rescission and you can exercise it on home equity loans, HELOCs, some home refinancings.

The right of rescission gives you three business days to reconsider whether or not you want to take delivery of the money from a loan. If you change your mind in that time, you’re off the hook for loan. You also are entitled to the return of any fees you paid to originate the loan.

Not surprisingly, there are lots of details on exercising the right of rescission. There are timing rules, rules on which types of loans it applies to, and rules on exactly how to do it.

What’s a ‘business day?’

The three day clock starts the day after you ‘close’ the loan. Three stipulations must be met for the clock to start:

• You sign all the loan papers

• You receive all the loan disclosures

• You get a copy of the notice of right of rescission

Usually, all the stipulations are met at loan closing. The clock starts, then, the next business day. Importantly, a ‘business day’ is any day that’s not a Sunday or federal holiday. Saturday counts as a business day, even if the lender isn’t open for business that day.

For example, you sign and receive all the papers Thursday August 30, 2007. The clock starts Friday morning, goes through Saturday, stops for Sunday and Labor Day, and resumes Monday.

Only applies to certain loans

The right of rescission only applies to home equity loans, lines of credit, and refinances with a different lender. You can’t use it on non-primary houses, refinances with your current lender, or when you first take out a mortgage to buy the house.

Things get complicated when you do construction loans and piggyback loans. I’m not a loan officer, so I’m not going to get into those situations.

When you do a ‘cash-out’ refinance, even with your current lender, you can always exercise your right of rescission for the cash out piece. Of course, if the refinance is with a different lender, you can back out of the whole thing.

Exactly how to do it

You have to notify the lender in writing - a phone call won’t do. Interestingly, you only have to get the letter in the mail by the three day cut-off. It doesn’t have to be postmarked by that day. I wouldn’t try backing out of a loan based on that technicality though. If you’re going to do this, I’d make sure the letter got a postmark.

Since this letter must get to the right place, make sure you have a good address for the lender and the right department at closing. If multiple parties took out the loan (e.g. husband and wife), they all must sign the rescission letter.

So the next time you take out a home equity loan for that new car and then realize you’ll be paying on it for ten years and reconsider, keep this post on hand. Seriously, though, if you sign for a loan and later read some evil clause in the inch-thick packet of papers you got at closing, this might come in handy.

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The whole concept of PMI is irritating to me. Where else do you pay the insurance premiums to cover someone else’s risk? That’s exactly what’s happening with private mortgage insurance.

PMI is required when you buy a house with a mortgage but don’t have 20% for a down payment. It is actually insurance for the lender, but you pay the premiums. Nice, huh? In the event you default, the insurance pays the lender the difference between 20% and what you put down (they also still get to repossess the house of course).

Rates Vary Based on Down Payment

What I didn’t know until very recently is that the PMI rates you pay vary depending on how close you come to putting 20% down on your house. The closer you are to 20%, the less you pay. I know it makes sense, but it just never occurred to me.

You can use this quick estimate to figure your approximate premium:

If you’re down payment was: Divide your mortgage amount by:

5% 1500

10% 2300

15% 3700

Here’s an actual rate card from a PMI provider, but it’s a lot more detailed.

Canceling PMI

It used to be that insurers could keep charging you PMI even after you owned 20% of your house. That changed in 1999, though, and now insurers have to automatically cancel PMI once you get to 22% (with some exceptions, see below). But why pay those extra premiums? Pay attention and cancel your PMI as soon as you get to 20%. You have to request the insurance company cancel your coverage in writing.

Insurers don’t have to automatically cancel your coverage if any of these are true:

• It’s a VA or FHA loan
• You’ve been late on a payment
• Your loan was originated before July 29, 1999

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Using borrowed money, like from a HELOC, to invest in the stock market has to be one of the dumbest ideas I’ve ever heard. But, taken to its logical extreme, the advice commonly given to not pay off your mortgage early would have you do just that.

So maybe I should take my bank up on their offer:

(click to enlarge image)

Like I’ve pointed out a couple of times before, I believe strongly in paying off a mortgage as soon as is reasonable. By that I mean sending extra money each month toward principal curtailment or any of the other methods I’ve written about.

There’s a contrary school of thought that says you should not prepay your mortgage and instead invest that money into a low-fee index fund. The reasoning being you’ll get a better return in the stock market than you’re equivalent return based on your mortgage rate. Liz Pulliam Weston, Ric Edelman, and Walter Updegrave are all adherents to the ‘invest instead of pre-pay’ school.

Borrowing to invest

But taking that line of thinking to its logical conclusion, it would be a good idea to borrow additional money against your home (in the form of a HELOC, cash-out refi, or second mortgage) and put it to work in the stock market. Call me risk averse, but that’s insane. I actually had a friend do just that and he got smoked when the market dropped in 2000.

What people forget is that pre-paying your mortgage is a guaranteed return. Ok, maybe it’s only a guaranteed 6% return, but it’s a sure thing. The historical return on the S&P 500 is 10.4% (thanks MossySF). The mathematically savvy reader will note that 10.4% is greater than 6%. That 4.4% can be thought of as your risk premium. But for me personally, I’ll pay that 4.4% per year in exchange for having no mortgage payment.

One other quick thing. While in an emergency I can suspend my principal curtailment payments, you can’t do that with a HELOC payment. It sure would suck having to write a check each month to repay a loan while simultaneously watching a bear market destroy your portfolio.

Think I’ll stick with my 6% return.

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I know a way to reduce a mortgage balance by nearly $30,000 in four years. We’ve done it. Since we refinanced our house in early 2003 (original mortgage $190,800), we’ve reduced the balance to $163,400. We did it by sending our mortgage holder additional money each month toward principal curtailment.

There are two schools of thought on prepaying the mortgage, and I’m solidly in the ‘do it’ category. Before anyone points it out, I concede had I put the additional $200 each month into an S&P index fund, I would have done better than the 6% interest on my mortgage.

I don’t care.

I believe the piece of mind that will come with owning my home outright outweighs the amount we’ll be ‘missing out on.’

So for those interested in doing so, there are three easy ways to pre-pay your mortgage:

• Send in an additional amount each month with your regular payment. This is the method we use and if you pay by ACH/electronically, it’s particularly easy. Just tell the servicing company what additional amount you want deducted from your checking account and it’s done automatically. Doing it this way eliminates the temptation to skip sending in the extra amount during those ‘tight’ months if you pay by check.

• Make thirteen payments a year instead of twelve. This isn’t possible with all mortgage servicing companies (including mine), but it’s particularly useful if you get paid biweekly like I do. Twice a year you get paid three times in one month. Send that money to the mortgage instead of spending it.

• Put bonuses and/or tax refunds toward the principal balance. This takes a good bit of self-discipline. It’s hard to pretend you didn’t get that $1,200 back from the IRS.

It’s not for everybody, but if you’re inclined to pay down your mortgage quickly like me, these are three ways to do it.

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In reading about the housing market and the Bear Stearns hedge fund collapse, I’ve come to wonder about mortgage brokers. I mean, I know what a mortgage broker does. What I’m not sure about is why someone would use one.

What a Mortgage Broker Does

A mortgage broker matches lenders with borrowers. It’s as simple as that. They are not lenders themselves. The broker is supposed to guide borrowers through the mortgage process, helping determine funding options.

The biggest selling point I can find for brokers is they are more familiar with what I’d call ‘more complicated’ loans. Many borrowers don’t know about piggyback loans (a second loan on top of your primary mortgage, usually used to avoid PMI) and stuff like that. The idea is the mortgage broker is the ‘expert’ so the borrower doesn’t have to be.

In exchange for this guidance, the broker gets paid a percentage of the mortgage amount by the lender. Some also charge the borrower fees, though I understand this is less common.

What Does a Broker Add to the Process?

I can’t figure out what, exactly, the mortgage broker really adds to the home-buying process from a borrower’s perspective. There is an inherent agency problem with using one - they don’t have to get you the ‘best’ loan. They work with a stable of favored lenders. That strikes me as fertile ground for abuse.

Here’s what the National Association of Mortgage Brokers has to say:

Why choose a mortgage broker?

Over half of all Americans do. Brokers provide consumers with:

* Choice
* Convenience
* Knowledge

The consumer receives a knowledgeable professional through the complex mortgage lending process. The broker offers the consumer extensive choices and access to many different types of home loans.

What’s so “complex” about the mortgage process? I’m hardly an expert, but I’ve bought a house and refinanced it once. I didn’t find it complicated at all. And with the internet, it’s not like I have to visit a bunch of banks or call a list of lenders to get quotes.

I guess the answer lies in the NAMB’s second bullet - convenience. If you use a broker, they get a bunch of quotes and give them to you. And for this I’m (indirectly) being charged 0.5% and 1.25% of the loan amount (the average contingency fee charged to the lender)? No thanks. I’ll navigate the “arduous, costly, and seemingly impossible” mortgage loan process myself.

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