Taxes, Insurance and Home Loan Rates

Risk and servicing value play a central role in what rate an Arizona home buyer receives on their home mortgage.  Every Phoenix Area mortgage lender evaluates both of these items when determining what a borrowers rates will be.  Let’s jump in feet first to explore how this works.

Impounding Taxes and Insurance on Your Arizona Home Loan 

Have you ever wondered why the mortgage rate or fees on a mortgage go up when a buyer chooses not to have their taxes and insurance included in their monthly mortgage payment?  Oftentimes, clients like to pay their tax and insurance bills on their own rather than having them included as a part of their mortgage payment.  Their thought process is simple and logical.  If they keep that money in an interest bearing account until tax and insurance bills are due, they can make a little interest while the money sits there.  Guess who has the EXACT same thought process?  Lenders!   If you do not give them a few extra bucks in the form of tax and insurance payments every month as a part of your mortgage payment that they can invest in an interest bearing account themselves they (the lender) will need to make an adjustment to account for the loss in future income.

East Coast vs. West Coast (and no not a hip hop battle)

What about this – have you ever compared your Phoenix Arizona Mortgage rate to your uncle Bob’s Washington DC mortgage rate (if you have an uncle Bob in DC that is a pure coincidence!).  Mortgage interest rates are different in different regions/states.  Why?  Lenders evaluate the risks associated with lending on real estate in various geographic areas.  Based on what the Phoenix Arizona Real Estate market has gone through in recent years, lender’s are understandably a bit more cautious when passing out mortgage money in the desert vs. in a marketplace such as our nations capital where Real Estate values have been far more steady.

It All Boils Dow to a Rate That Fits

Taking the two factors above into consideration (along with others such as credit score, loan amount, occupancy type etc…) all mortgage lenders establish what is called a “servicing value” along with a risk tolerance for each specific mortgage being extended to a home buyer.  Essentially mortgage lenders use a servicing value to determine how much a particular mortgage is worth to them.  They use a risk model to make sure they are protected relative to the risk associated with a particular mortgage scenario.  Servicing and risk translate directly into what rate and fees are charged on an Arizona mortgage.

Like all other businesses, mortgage lenders have a profit model that must be met on each mortgage loan in order to stay in business and keep helping homeowners reach their dreams.

Why Does My Rate Depend on Taxes?

Example:
Let’s consider a loan application for a Tempe Arizona mortgage client that does not want to include tax and insurance payments in their mortgage (aka – no “impounds”).  The best way to make sense of this is to compare and contrast the Tempe mortgage client to a Washington DC mortgage client that is going to include taxes and insurance in their payments.  We also need to pretend that you are the lender.  For a minute, take a look at this from the mortgage lender’s perspective.  You job is to make sure to that each loan meets your established profit model and that you are protected with regard to your risk model.  How would you view these two mortgage clients?

Since the Tempe home buyer is not going to be giving you an extra $200 per month in the form of property tax and homeowners insurance payments, you need to adjust for the fact that you will not be able to invest those funds and earn a small return.  How do you make this adjustment?  Simple, you either slightly increase the buyer’s interest rate or charge a small fee to the buyer to account for the lost future income.  How about the fact that they are in Tempe Arizona (recently declining market) vs. Washington DC (recently stable market)?  Your risk model would state that you are more at risk in Tempe, Arizona relatively speaking (although this is changing with the way the Arizona Real Estate market is going right now).  How would you (the mortgage lender) adjust for the geographic related risk?  Easy, the same way as you did with the taxes and insurance.  Higher risk is always absorbed in the mortgage world (and just about every other world) with higher consumer costs – you would increase the rate or fees on the mortgage loan.  In short, the mortgage rate for the Tempe buyer would be slightly higher than the Washington DC buyer due to the fact that the Tempe buyer is not impounding taxes and insurance and that they are in what in the recent past has been a riskier market to lend in.

Are Arizona Buyers Getting a Raw Deal?

With regard to the adjustments made due to no tax and insurance impounds many Phoenix area buyers may be quick to shout out an emphatic “YES.”  Let’s look at this the right way.  The answer is certainly “NO” they are not getting the short stick.  Think of it this way – mortgage lenders give borrowers the choice and opportunity to get a lower mortgage rate by choosing to give the mortgage lender tax and insurance payments monthly.  The lender is passing this income earning opportunity onto Arizona home buyer in the form of a rate that is lower than if taxes and insurance are not collected.

What would be “wrong” is if lenders just said that everyone gets the same rate regardless of whether or not they chose to include taxes and insurance payments in their mortgage payment.  If they did that, guess which rate all buyers would get?  You got it!  A higher rate.

With regard to the market related adjustment this just is what it is.  Many markets in the US are dealing with this.  Arizona fell a bit further than most (no secret there).  However, with the turnaround we are experiencing my guess is that the adjustment for Arizona being a “declining” market has its days numbered.   This adjustment is purely based on historical performance and not present performance.  As a result, we won’t see it disappear until our Arizona Real Estate market has been heading in the direction it’s heading in now for at least several months.

Does Servicing and Risk Cost an Arizona Buyer?

In many cases the adjustments are very small (.125% to rate etc…).  The adjustments gets larger for any buyer in any state when we are talking about a Conventional loan and we are dealing with low credit scores and/or investment property.  As your Phoenix Arizona Mortgage Lender I want to help make sure you understand everything you need to in order to be comfortable with your home loan.  Please call or email me with any questions.

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By Jeremy House

 

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