for You and Your Family - Compass Mortgage · money you spend to pay for interest on your mortgage loan and the number of hours that you must work to pay for it. If you’re with

V I G I L A N T M O R T G A G E M A N A G E M E N T TM

A Guide to Helping Bui ld a Secure Financial Future

for You and Your Family

Helping Our Clients Make

Wise Choices Along the WayTM

www.compmort.com

www.compmort.com©2004 Compass Mortgage. All rights reserved. Illinois Residential Mortgage Licensee: License # 5795

V I G I L A N T M O R T G A G E M A N A G E M E N T BY COMPASS MORTGAGE

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The Purpose of this Paper

The purpose of this paper is to dispel some of the mostcommon mortgage myths and to give you a no-nonsense guideto effective mortgage management. The principles that arecontained in this paper are applicable to those who own a homeand have a mortgage and also to those who are thinking aboutbuying a home at some point down the road.

We want you to be proactive and Vigilant in the management ofyour mortgage. The key is to limit interest expense and buildequity in your property. At Compass Mortgage, it is both ourresponsibility and privilege to help you think differently aboutyour mortgage and to set you on the path of Vigilance –because this is the path that will help you build a nest egg offinancial security for you and your family.

This paper has received critical acclaim from many financialadvisors and from local companies that have taken advantage ofour Corporate Account Program for their employees. In addition,this paper was summarized in an article entitled; Put Your MoneyWhere Your House Is, that ran in the Liberty Press newspaperthat is circulated to many communities in the western suburbsof Chicago.

Our hope is that by reading this paper you will, with knowledgeand information at your side, take action and be vigilant aboutmanaging your mortgage. It would be our great privilege, atCompass Mortgage, to help you do just that.

Are you being Vigilant or Ambivalent about managing your mortgage? Or are you not sure?

The difference can cost you a lot of money.

• The importance of being vigilant andproactive in the management of yourmortgage,

• The 7 questions that a vigilant mortgagemanager must be able to answer,

• The importance and priority of buildingequity in your property as part of thedecision criteria for refinancing,

• How to dispel the twin myths of zeroclosing costs and below market interest rates,

• How to dispel the myth that there issome time value associated with anexisting loan,

• How to get rid of private mortgageinsurance if you’re paying it today andhow to potentially avoid it in the first place,

• Why having a home equity line of credit inplace before you need it is a good idea,

• How to avoid loans with pre-paymentpenalties,

• The reason why bi-weekly mortgagepayments don’t make sense,

• Why you should avoid mortgageprotection insurance offers,

• An introduction to and how to think aboutinterest only mortgage loans, and finally,

• The great value of Compass’ internetbased Refinance Decision MakingCalculator as a tool to help you makewise choices with regards to yourmortgage.

The 12 key things that you’ll learn by reading this paper are:



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A Case Study in Vigilance

We recently completed a refinance for Compass clients, Jill andSteve (names were changed), this is their story. Their interest rateon a 30 year fixed rate mortgage was 7.375%, their principal andinterest payment was $1,568 and they paid $100 in privatemortgage insurance (because they put less than 20% down whenthey bought their house – they were able to put down 10%).

Over the course of 3 years, by making the required payment,their principal loan balance went from $227,000 to $220,000and their home value went from $252,000 to $309,000 (a 7%annual increase).

The combination of these two things: a smaller principal loanbalance and the appreciation of their home means that they nowhave enough equity in their home so that they don’t have to pay$100 each month for mortgage insurance.

The elimination of this payment plus an improved interest rate,at the time, of 5.75% on a new 30-year loan means theirmonthly payment is reduced by $384 each and every month.Pam and Don now have more than a few options of what to dowith the $384.

Compass recommends that they very seriously consider applying this$384 towards reducing their principal loan balance each month. Inother words, their payment stays the same as it does today - buteach and every month their total loan balance is reduced by anadditional $384.

Why should they do this? For 3 reasons: 1) it builds additionalequity in their home 2) it reduces Jill & Steve’s total interest by$157,000! 3) it reduces the term of their loan by 9 years and 4 months!

These are all very good things !

Why it makes sense to add an extra amount toyour mortgage payment each month to reducethe principal loan balance

If you recently refinanced and you have a good rate, we wouldencourage you to consider applying an additional amount toyour mortgage payment each month to reduce your principalloan balance (we would strongly advise you to stay away fromthe highly marketed bi-weekly mortgage payment plans – foran explanation of why and for more information please refer topage 13 of this paper).

For example of a loan amount of @180,000 (30 year fixed rate@ 6%), if you make an extra payment of $100 per month you

will save over $47,000 in interest expense and knock 5 yearsand 9 months off the term of your loan. If you make an extrapayment of $200 per month you will save over $76,000 ininterest expense and knock 9 years and 6 months off of the loanterm. If you decided in favor of a 15 year fixed rate mortgage @5.5% - compared to the 30 year option you would save over$123,000 in interest expense!

Consider this question – how many hours would you have to workto pay for $47,000 or $76,000 or $123,000 in interest expense ?

If you make $30 an hour (or the equivalent of about $62,000per year) – to pay $47,000 in interest expense you would haveto work 1,566 hours or 39 weeks! To pay $76,000 in interestexpense you would have to work 2,533 hours or 63 weeks! Topay $123,000 in interest expense you would have to work4,100 hours or 102 weeks!

If you think that’s depressing – the number of hours / weeksthat you would have to work to pay for this interest expense isgreatly under exaggerated – because our example assumes thatyour take home pay is $30 an hour – in other words, that youlive in a world where you don’t pay taxes !

The bottom line is that whether you make $30 an hour or $10an hour you must begin to think of interest expense as a realexpense and then make an association between how muchmoney you spend to pay for interest on your mortgage loan andthe number of hours that you must work to pay for it.

If you’re with me so far – right about now you should startgetting mad and my hope is that it will cause you to take actionand become Vigilant about managing your mortgage.

Do you know what the prevailing mortgageinterest rates are today?

Vigilant mortgage management demands that you have at leasta general idea of where mortgage interest rates are on anygiven day. When I say general idea – you should know within a1/2% point of the current market interest rate for 30 and 15year fixed rate mortgages if that’s what you currently have or fora 5/1 or 3/1 Adjustable Rate Mortgage if that’s the type of loanyou have today.

There are a wide variety of sources that will give you an idea ofwhat the prevailing interest rates are on any given day. On theinternet, I like the money.cnn.com site – once there, click onYour Money and then on Your Home). Also, most local papers, inthe home section, will publish the interest rates that mortgagelenders are "offering".



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You must be careful, however, when shopping for the “best” ratebecause there is ALWAYS a trade-off between the “best” rateand the costs (referred to as the closing costs) associated withgetting this rate.

As will be mentioned repeatedly throughout this paper – VigilantMortgage Management is all about building equity in yourproperty. If you are considering refinancing because yourcurrent interest rate is high compared to the prevailingmortgage interest rates – your strategy should be to get thebest rate and the lowest possible closing costs.

In the earlier example about making an additional payment eachmonth to reduce your principal loan balance, this objective canoften be accomplished by simply including the monthly savingsassociated with refinancing to a better interest rate to yourmortgage payment each month. Your payment stays the sameas it was before you refinanced – but now you are applying themonthly savings to reduce your principal loan balance each andevery month. This is how you can build equity in your propertyand reduce total interest expense.

Managing Interest Expense...

Paying interest on your mortgage loan has some advantages -the tax laws allow you to reduce your taxable income by theamount you pay in interest expense - however, like most thingsin life - too much of anything is usually not good for you. Andpaying too much interest on your mortgage is not good for yourfinancial future.

In an environment of investment uncertainty – there is somethingappealing about absolute certainty. If you commit to making anextra payment each month towards reducing your principal loanbalance the result is less interest and more equity – guaranteed.

Yes, there are other investment alternatives that promise higherreturns, but the key word is promise. As those of you who havehad money in the stock market know – the promised returns havefor the most part not materialized over the last couple of years.

We believe that taking a conservative approach with theinvestment in your home is a wise thing to do. The key is todiversify – investing in and building equity in your home is anexcellent way to diversify your investment portfolio.

The Road to Vigilance …Most people would agree that vigilance is better thanambivalence when it comes to most things in life. Ambivalenceimplies disinterest and not caring – being swept along by the

winds of change and not having any control over your finaldestination. Vigilance on the other hand implies taking directcontrol, being in charge, knowing precisely where you want togo and taking the necessary steps to get there. Whether thetopic is mortgage management, your career or healthmanagement - I think you would agree that vigilance is wise andambivalence can be detrimental.

Here is an easy 7-question test that you can take to determine ifyou’re being Vigilant or ambivalent about the management ofyour mortgage. Are you ready to take the test? Here we go:

If you don’t know the answer to any of these questions, or only acouple of these questions – that’s O.K. – because you are onyour way to getting these answers and moving in the rightdirection which is towards being Vigilant about managing yourmortgage.

Your home likely represents your largest single investment andthe mortgage on your home is likely your single greatest liability.Given this fact, doesn’t it make perfect sense to maximize thisinvestment and manage this liability?

What I have found, since I bought my first house almost 20years ago, is that a mortgage is not something that you do once,

Vigilant Mortgage Management Test1) What was the original loan balance on your

mortgage either when you bought your house orthe last time you refinanced?

2) Do you have a 30 year fixed, 15 year fixed, 3/1adjustable, 5/1 adjustable, or balloon type loanprogram?

3) What is your current interest rate?

4) Are you paying mortgage insurance (if you putdown less than 20% of the purchase price on yourproperty when you bought your house or when yourefinanced – then you probably are payingmortgage insurance) and if so how much are youpaying each month?

5)What is your current loan balance?

6)What is the approximate market value of your home?

7) How many more years do you intend to live inyour current house? (this will help us todetermine if a fixed rate loan or an adjustable rateloan is the better choice)



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then neatly file away in your file cabinet never to be looked atagain. There are some principles that can guide you and somegoals that you can establish for managing your mortgage, whichin turn will help you to build equity in your property and at thesame time minimize the amount of money you pay in interestexpense. Building equity in your home is important to yourfinancial future and is something that you can manage andcontrol to an extent that is not true with many of the otherinvestment alternatives.

Principle #1

Paying interest on your mortgage has it's benefits, but theadvantage of paying interest must be weighed against the factthat paying interest does absolutely nothing to help you buildequity in your property.

There are only 3 things that help you to build equity in yourproperty: 1) improvements that you make, 2) natural marketappreciation and 3) paying down your principal loan balance.

Improvements that you make, either things that you do yourself,also known as “sweat equity” or done by professionalcontractors that make your property more desirable willnecessarily cause the market value of your home to increase.

Market appreciation is a variable based on many different factors,but in general and on average the rule of thumb for real estate, isthat it will appreciate anywhere between 3% to 5% per year. Insome areas of the country, including the ChicagoLand area, wheredemand is considerably strong and the supply of housing is fixed toa large degree, double digit appreciation of housing is notuncommon. In 2003, according to the Illinois Association ofRealtors, the prices for single family homes in the greater Chicagoarea saw an increase of 8.4%. And according to the NationalAssociation of Realtors, the median price for a single family home inthe greater Chicago area stands at $170,800 for 2003, up from$158,100 in 2002.

Also, making regular extra payments towards reducing yourprincipal loan balance will contribute towards increasing theequity you have in your property. In our opinion this is a goodidea and is discussed in considerable detail throughout this paper.

When you buy a home the most important thing is location - when you own a home the mostimportant thing is equity.

Principle #2

Don’t ask me why – it was just one of those things that I paidattention to. I wanted to know when 1/2 of my principal andinterest payment went to reducing my principal loan balance(this is what I refer to as the Crossover Point). I think mycuriosity on knowing when the Crossover Point occurred was theresult of not seeing any substantial reduction in my principalloan balance after paying what seemed like a fortune on mymortgage each year. I thought to myself, where is all my hardearned money going? My curiosity caused me to do someanalysis, which led me to the discovery of this metric called theCrossover Point. It is a point in time that can be measured andused to help answer the question – where is all the moneygoing? It is also a great way to analyze alternative mortgagefinancing programs; i.e. a 30 year vs a 15 year mortgage loan.Consider this fact - if you have a 30 year fixed rate mortgageand your interest rate is somewhere in the 7's - every singlemonth for 20+ years you are paying more in interest expensethan you are in reducing your principal loan balance!

Let’s say that your monthly principal and interest payment is$1,000 - it isn't until year 21 or after you've made 240payments that $500 of your $1,000 goes towards reducing yourprincipal loan balance! I call this the Crossover Point - the pointat which more than 1/2 of your payment goes towards reducingyour principal loan balance. On a 15 year fixed rate mortgageand an interest rate in the 6's the Crossover Point happens inthe 5th year!

Principle #3

When does it make sense to refinance? This isthe million $ question and it really depends onyour specific situation. However, cutting throughall of the nonsense on this topic – there are only8 things that really matter –

A corollary to building equity in your property is tomanage the interest expense on your mortgage loan.There is a point in time, that I refer to as theCrossover Point, when more than 1/2 of yourmonthly mortgage payment goes towards reducingyour principal loan balance. You want to knowprecisely when this occurs and be aggressive aboutgetting there as quickly as possible.



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Remember the goal is not necessarily to lower your monthlypayment. If you ever get one of those annoying telemarketingphone calls from the mortgage company trying to convince youto refinance – the argument is always the same -they can helpyou to lower your monthly payment. While that may soundgood – it’s not really the point. The point is to build equity inyour property – period.

One very important thing to keep in mind when you’re thinkingabout refinancing is to pay the lowest possible closing costs.But be wary (your ears should go up!) if you’re offered a loanprogram with zero closing costs for all the reasons listed below.

Are Zero Closing Costs For Real?

No. The process of originating, processing, underwriting andapproving a mortgage loan costs money! If you, as a consumerof loan services, aren’t paying for these as itemized expenses –be assured that you are paying for them in the form of a higherinterest rate. In other words, you’ll be paying for it each andevery month that you have this loan in place. As my economicsteacher in college used to say; "there is no such thing as a freelunch". On the other hand, it rarely makes sense for you to payhigh closing costs or points to "buy down" the interest rate (ifyou are relocating and your company is willing to pay points –then we can use these to either "buy down" the interest rate orto be applied to covering closing costs). If you hear or see amortgage company offering below market interest rates – beassured the closing costs are high. If it sounds too good to bereal – it more than likely is!

1) the term of your existing loan; i.e. how manyyears does it take to amortize or pay off the loan,

2) your current loan balance, 3) your current interest rate, 4) the market value of your home, particularly

if you are currently paying Private Mortgage Insurance,

5) the term of the new loan, 6) the new interest rate, 7) the total “true” closing costs associated with

refinancing your existing mortgage and 8) how long you intend to live in the house that

you are refinancing

Don’t be "hood winked" into either of these two options – theyare not in your best interests and and don’t help you to buildequity in your property.

At Compass, our philosophy is to charge reasonable closingcosts that reflect the true costs of the services that we provideand, at the same time, secure for you the best loan program andmost competitive interest rate possible.

Principle #4

The beauty of managing the investment you have in your home isthat you have a measure of control over this investment that is nottrue with most other investment alternatives. You can buy propertythat is undervalued or has significant appreciation potential, youcan make improvements to increase the value of your home, andyou can make extra monthly payments towards reducing theprincipal loan balance on your mortgage in order to reduce interestexpense and build equity.

When you make an extra payment to reduce your principal loanbalance – you get a double benefit. The first benefit is that youhave reduced your principal loan balance by the amount of theextra payment – the other benefit is that the interest expense fornext month’s payment is now based on a smaller principal loanbalance. Your payment remains the same – but a greaterpercentage of your payment is applied towards reducing yourprincipal loan balance. This is the magic formula that helps you topay less interest, build more equity and amortize your loan in ashorter period of time. These are all very good things!

One of the real benefits of having equity in your home is that youhave the option and the opportunity to use this equity for importantpurposes. One of the most common purposes is to help financethe expense of college for your children. This is a legitimate andworthy use of the equity in your home and should be considered asone of your available options when the time comes for the kids togo to school.

You must think of your home as an investment –and manage it as you would any of your other investments



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Why it doesn’t make sense to pay points or highclosing costs to “buy down” the interest rate...

Some mortgage lenders may offer a lower interest rate buthigher fees, points, an origination fee or believe it or notsomething called a discount fee. In our way of thinking younever want to pay higher fees or points or a discount fee to "buydown" the interest rate - only in very rare circumstances does itmake sense to do so. The reason it is done - is because itworks. People want the best rate and will often times,unknowingly, pay high fees to get a lower interest rate. Lowrates that you see on the Internet or hear on the radio are done– because they want you to call. Then the selling starts andthe backpedaling begins and you find out that the deal that youthought you were going to get is not real and was never real!

For example on a 30 year mortgage with a loan amount of $200Kthe difference in your monthly payment between a rate of 6.125%and 6% is $18 per month. Compass’ standard closing costs, asan example, are approximately $1,470 (this includes title,appraisal, underwriting, credit, flood certification, loan processing).If you are paying substantially more than this in order to get to 6%;i.e. points or an origination fee then divide the difference in closingcosts by $18 and this will give you your payback. In other words itwill take X number of months to recover the higher closing costs.

One of the reasons that this doesn't make sense is that there isa possibility that you would refinance this loan, if the interestrates improve. It has happened a few times in the last 2 yearsand no one would have predicted this. If you pay high closingcosts it works against you in two ways - the first is that if youdecide to refinance you've effectively lost the extra money youpaid in closing costs, secondly when people buy down theinterest rate "artificially" it provides less of an opportunity torefinance to a lower rate if interest rates were to improve. Forexample it might make sense for you to refinance if rates get to5.625% on a 30 year if you're at 6.125% but not if you're at6%. This would be to your long-term disadvantage.

If all of this seems overwhelming – don’t give up - keepreading! We have a tool on our web site (Compass MortgageRefinance Decision Making Calculator) that will ask you toprovide answers to these key questions and give you a detailedanalysis of your specific situation.

Dispelling a commonly believed myth...I often hear people talking about what they believe to be thetime value of an existing loan. It goes something like this …

“I’ve had this loan for 8 years and I don’t want to start all overagain with another 30 year loan, and besides the interest rate isonly a 1/2 percentage point better.” For some reason peoplebelieve that there is intrinsic value in the length of time that aloan has been in place.

There are only 3 things that matter; 1) the interest rate, 2) thecurrent loan balance, and 3) the term of the loan.

For loans that have been in place for a while and a big dent hasbeen made in reducing the principal loan balance – a reduction ofas little as a 1/2 percentage point in the interest rate can save youa significant amount of money in interest expense. However, thekey is to keep your payment the same and apply the monthlysavings towards reducing your principal loan balance each month.If you just take the monthly savings and use it for other purposes –in most cases you will pay more in interest expense if you refinancewith a loan that has the same term even if the interest rate is better!

For example, lets say you had a bought a house 8 years ago for$210,000 and took out a 30 year fixed rate loan @ 7.25% for$165,000. Over this 8 year period you made the required principaland interest payment and didn’t make any additional payments toreduce your principal loan balance. The result is that the currentprincipal loan balance would be $148,320. If you refinanced thisamount on a new 30 year loan @ 6.75% your monthly paymentwould be $164 less – BUT – you would pay $50,000 more ininterest expense over the life of the loan!

On the other hand if you made the same monthly payment bytaking the $164 and applying it to reducing your principal loanbalance each month you would pay $25,000 less in interestexpense and reduce the term of your loan by almost 2 years! Ifyou refinanced to a 15 year fixed rate loan @ 6.25% you wouldpay $146 more each month but would reduce your interestexpense by over $67,000 and reduce the term of your loan by 7 years!

Refinancing without understanding the long-term implications isnot in your best interests. Again, the Compass MortgageRefinance Decision Making Calculator is easy to use and willgive you the information you need to make a wise choice onwhether or not it makes sense to refinance.

This is unequivocally false - the myth that thereis some magical value in the amount of time thata loan is in place, must be dispensed with forever– it is nonsense pure and simple!



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As demonstrated in this example, the fallacy of refinancing isthat a lower monthly payment can often mean greater totalinterest expense.

Remember the key is to build equity in your property and interestexpense, as detailed in Principle # 1, does nothing to build equityin your property. Think equity – this is the key to building foryourself and your family a secure financial future.

If you haven’t read Steven Covey’s book The 7 Habits of HighlyEffective People, I would strongly recommend it to you. In thisbook, the first 3 habits that Covey covers are: 1) being proactive;2) beginning with the end in mind and 3) doing first things first.

Each of these 3 habits is applicable to Vigilant MortgageManagement. Being proactive is really the same thing as beingVigilant – from a mortgage perspective it means taking steps tounderstand your current mortgage and then taking the necessarysteps to proactively manage it. Begin with the end in mind –means to look into the future and pick a year when you’d like toown your home and not have a mortgage – this should besomething less than 30 years. You can then calculate theadditional amount to be added to your payment each month tohave your loan fully paid off in the desired timeframe. Now thismay or may not happen – and the wisdom of fully paying off yourmortgage could be debated until the cows come home. Butthat’s not really the point – the key is that you have put togethera plan and you’re following it. The next habit, doing first thingsfirst, implies that you must understand your current loan programand then evaluate alternative programs based on your lifecircumstances and your financial objectives and then take actionif it works to your advantage.

What is Private Mortgage Insurance and how canyou stop paying it?

If you are currently paying Private Mortgage Insurance (PMI), youare doing so because you put down less than 20% of thepurchase price on the home that you bought. PMI is a good thing– because it provides a means for people to buy homes by puttingdown as little as 3% of their own money. However, PMI must bemanaged and you must be proactive about knowing what yourcurrent Loan To Value is – this is also known as the current LTV.

For example, if you bought your house 3 years ago for $200,000and put down $20,000, and took out a loan for $180,000 – yourloan to value would be $180,000 ÷ $200,000 or 90%. Based onthis LTV you would be paying about $117 per month for PMI. Inthis example, if you had a 30 year fixed rate mortgage @ 7.5%,

during this 3 year period you would have reduced your principalloan balance by $5,000 to a current balance of $175,000, and withmarket appreciation of 5% per year the market value of your housewould now be $231,000.

The new LTV calculation would be $175,000 ÷ $231,000 or 76%.

The reason that this is important – is that you should no longer bepaying $117 per month. That money should be in your pocket –not in the pocket of the company that provided the PrivateMortgage Insurance.

No one is going to come knocking on your door to remind you tocheck your current LTV to see if you have enough equity in yourproperty to stop paying PMI. It’s something that you have tomanage and pay attention to.

There are two ways to stop paying PMI. The most commonmethod is to refinance. You don’t necessarily refinance to stoppaying PMI – it is more commonly done to get a better interest rate– however, one of the additional benefits is that we will often findout when the appraisal is done that your property has appreciatedto the point where you now have at least 20% equity in your homeand can stop paying PMI.

If you have a great interest rate and loan program – and there is noneed to refinance you can apply to stop paying PMI. The burden ofresponsibility is yours to prove that you have 20% and sometimes22% equity in your property.

The step-by-step instructions on how to apply to cancel PMI canbe found at the following web site: www.privatemi.com

It should be noted that PMI will automatically cancel when theprincipal loan balance has been paid down by your regularprincipal and interest payments. However, this does not take intoconsideration the market appreciation of your home.

In the example provided – if you were to rely exclusively onprincipal loan reduction to stop paying PMI, and you made therequired payment each month with no additional amounts toreduce your principal balance it would take nearly 9 years to get to80% loan to value versus 3 years when the market appreciation ofyour home is taken into consideration!

That would translate into 72 X $117 or $8,424 that should havestayed in your pocket and not been paid to the Private MortgageInsurance company.

Is it better to have a fixed rate mortgage or anAdjustable Rate Mortgage (ARM)?

You are always better off with the lowest possible interest rate



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(provided you didn’t pay high closing costs to buy down the rate –this rarely works to your advantage). In almost all cases you canget a lower interest rate with an ARM – the trade-off is that thislower interest rate is for a limited time period after which the ratewill adjust based on the index (usually the 1 year Treasury Bill) anda margin (for many ARM’s the margin is 2.75%).

For example if you decided to do a 5/1 ARM @ 5% - the loanwould be amortized over a 30 year period – but it would only befixed for the first 5 years. In the 6th year the loan would adjustbased on the index and the margin. All ARM’s have a annualmaximum adjustment and a lifetime maximum adjustment or cap.Most ARM’s have a lifetime cap of either 5% or 6% over the startrate and an annual adjustment of 2%. Some ARM’s will have alifetime cap of 5% but can adjust up to 5% in the first year afterthe fixed period.

When interest rates are really low, and you intend to live in yourcurrent home for the foreseeable future, the best choice is oftena fixed rate mortgage. The choices here are pretty simple – 30,20, 15 or 10 year terms. I prefer either the 30 year or the 15year. The rate on a 20 year term is generally not greater than.25% lower than a 30 year and this is also true of the 10 yearvs. the 15 year. My preference is to have the flexibility of the 30vs. the 20 and the 15 vs. the 10 and then give myself the optionof making extra principal payments to reduce the amortizationperiod if my goal is to pay off the loan in 20 years or 10 years.

On the other hand, if you’re pretty sure (70% or greater) thatyou’re going to move within the next 3 to 5 years – then anARM might be the best choice.

If you own investment property – ARM’s are often the bestchoice, because you will likely be refinancing the property everycouple of years in order to get cash out of the property as it hasappreciated in value (this is referred to as a cash-out refinance).

There are a wide variety of ARM choices – they share thecommon characteristic of being fixed for a certain period of timeand then adjusting based on an index and margin. The mostcommon types of ARM’s are 5/1 the 3/1 and the 1/1. Thenumber before the slash indicates the fixed period – the numberafter the slash means that it will adjust on an annual basis.There are also ARM’s that adjust every 6 months and some thatadjust every month!

Suffice it to say that there are a wide variety of ARM choices that aredesigned to address almost ever possible borrower requirement.

Our job is to sort through all of the options and make

recommendations based on your specific circumstances, bothpersonal and financial.

Do Interest Only Mortgage Loans Make Sense ?

This is a relatively new phenomenon in the area of mortgagefinancing. Rather than amortizing your loan over the loan period,most commonly 30 years, an interest only loan will have a periodof time where you are only required to pay interest on the originalloan balance (usually 10 years and then the loan is fully amortizedfor the remaining 20 years). Most loans of this type don’t havepre-payment restrictions, so you can make additional payments toreduce the principal loan balance at any time. This of course willhave the direct effect of reducing your interest only payment thefollowing month.

Consider the following example. You are in the process ofpurchasing a property with a cost of $250,000. You can put 20%down, or $50,000, and will secure a mortgage for the balance of$200,000. You have been quoted a rate of 5% for a 5/1Adjustable Rate Mortgage (ARM) fully amortized over 30 years andthe same rate of 5% for a 5/1 ARM that is interest only for the first10 years. The monthly payment for the fully amortized loan is$1,074, the monthly payment for the interest only loan is $833, ora difference of $241 per month.

The question is whether or not this is a wise thing to do. In thecase of the fully amortized loan you are building equity each monthby reducing the principal loan balance. In the case of the interestonly loan your principal loan balance remains the same. Theanswer to the wisdom of one vs. the other is completely dependenton a number of factors, such as – your stage of life, your cash flowsituation, the extent to which your income is variable, your selfdiscipline in making extra payments to reduce the principal loanbalance as funds are available, the extent to which property valuesare appreciating or depreciating in the area where this house islocated and whether this is your principal residence or if it’s aninvestment property.

One of the advantages of an interest only loan is that you havethe option of making the minimum interest-only payment ormaking a principal reducing payment. A potential disadvantageof an interest only loan is that you are not "forced" to reduceyour principal loan balance and build equity in your property. Ifyou chose to invest the difference between the interest onlypayment and the fully amortized payment in an investment thatgoes bad – you have lost the equity that you would have built upbecause you didn’t make the principal loan reduction payments.



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The bottom line is that loans that are interest-only can give youflexibility and payment options that are not possible with the moretraditional fully amortized loans. But remember, that with flexibilitycomes responsibility, and you must evaluate this option in light ofall your other investments to make sure that you aren’t becomingmore speculative than is wise and prudent.

Does it make sense to have a 1st and 2nd mortgage as a way to avoid Private Mortgage Insurance?

A relatively new phenomenon in the mortgage financingbusiness gives borrowers the option of having a 1st mortgageand a 2nd mortgage vs. a larger 1st mortgage with PrivateMortgage Insurance (PMI). For example, lets say that thepurchase price of the home is $250,000. The borrower is ableto put down $12,500 or 5% of the purchase price and willborrow the balance of $237,500 or 95% of the purchase price.Under this scenario the monthly principal and interest paymenton a 30 year fixed rate loan @ 6.25% would be $1,462, inaddition the monthly cost for PMI would be approximately $154- making the total monthly cost for principal and interest andPMI $1,616.

The alternative to this would be something commonly referred toas an 80/15/5. Under this arrangement the 1st mortgage wouldbe 80% of the purchase price or $200,000, there would be a2nd mortgage (either a Home Equity Line of Credit or a HomeEquity Loan) for 15% of the purchase price or $37,500 plus theborrowers contribution of 5% or $12,500. Under this scenariothe monthly principal and interest payment on a 30 year fixedrate loan for $200,000 @ 6.25% would be $1,231, in additionthe monthly, interest only cost for a Home Equity Line of Creditfor $37,500 @ 6.0% (this rate is calculated as the prime ratewhich as of this printing is 4.0% + 2% for a LTV of greater than90%) would be $188 - making the total monthly cost forPrincipal and Interest $1,419.

The bottom line is that in looking at both of these scenarios theborrower is clearly better off with the 80/15/5 scenario with aprincipal and interest payment for the first mortgage and aninterest only payment on the HELOC totaling $1,419 vs. $1,616with the larger 1st mortgage and PMI. The monthly savingsamounts to $197.

There are two other advantages associated with the 80/15/5scenario in addition to a lower monthly payment, the first is thatthe interest on the 2nd mortgage can be used to reduce theborrower's taxable income vs. mortgage insurance, which is a

monthly expense with no tax advantage. The second advantageis that if you have mortgage insurance you have to prove thatyou have 22% equity in your property in order to stop payingPMI. Often times borrowers with PMI continue to pay thismonthly expense well past the time that they have 22% equity intheir property. There is no possibility of this happening whenyou don't have PMI to begin with!

In terms of managing two mortgages, it is our opinion, that thebest strategy is to make extra payments towards reducing theprincipal balance on the 2nd mortgage until this is paid off. Thereason you want to do this is that the interest rate on the HELOCwill adjust as the prime interest rate changes. Although thisdoes not appear to be a likely scenario any time soon - it isprudent to protect against the possibility that the prime rate willadjust upwards increasing the interest rate on the HELOC, andas a result your monthly payment.

In the above example, our recommendation would be to take the$197 savings associated with the 80/15/5 program vs. a 30year fixed with Private Mortgage Insurance, and apply either allor a portion of this amount to pay down the principal balance onthe 2nd mortgage.

The beauty of a HELOC is that once the principal balance on the lineis paid off - it is available for your use by simply writing a checkagainst the available balance. The advantage of having a HELOC inplace is discussed in considerable detail later in this paper.

The possible iterations of a 1st mortgage and a 2nd mortgageare numerous, for example if the borrower can put down morethan 5% than the 2nd mortgage becomes something less than15% so that the 1st mortgage, the 2nd mortgage and theborrowers contribution add up to 100%. When consideringwhether or not a 1st and 2nd mortgage is the right option foryou, it is important to remember that 3 conditions must alwaysbe satisfied, these are as follows: 1) the 1st mortgage can notbe greater than 80% of the purchase price or appraised value(whichever is less) of a new home purchase or 80% of theappraised value on a refinance; 2) the borrower must put down5% of the purchase price (or greater if the appraised value ofthe home is less than the purchase price) when purchasing ahome or have 5% equity in the property on a refinance; 3) theborrowers demonstrated credit history as reported on their mostrecent credit report must be in the good to excellent range.It should be noted that there are some loan programs where ahouse can be purchased with as little as a 3% down-payment(this would include FHA loans and conventional loans for buyers



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with excellent credit). It is even possible, with some very strictguidelines, for someone to buy a house with no money down.There are also programs where the seller contributes to thedown- payment for the buyer (AmeriDream and Nehemiah are thetwo most frequently used). And finally, there are no money downprograms for certain professions, i.e. teachers K -12.

This is a common misconception and one that we hear over andover. Unfortunately, many of the so-called financial gurusdispense information like this with such frequency – that it isbelieved to be the whole truth and nothing but the truth! Nothingcould be further from the truth. This kind of advice perpetuatesindecision, indifference and ambivalence – the very things thatthis paper seeks to remedy.

The bottom line is that every person’s circumstance is different,and must be evaluated on its own merits. We have made it veryeasy to do by developing what we think is the best mortgagemanagement tool ever invented! If you think there’s a better one –please let us know. By plugging your specific information into theCompass Refinance Decision Making Calculator – you’ll get resultsthat are meaningful. By evaluating these results you can thenmake a fully informed decision about the wisdom of refinancing.

The key point is this - the Compass Refinance Decision MakingCalculator (CRDMC) allows you to evaluate what you believe to betrue implicitly (the advantage of refinancing or conversely thedisadvantage of refinancing) and then compare that explicitly tothe objective results of running your scenario through the CRDMC.

It is only after having done this that you can bolding proclaim andshout from the rooftops that taking action (refinancing) or stayingput (not refinancing) is the best course of action.

Please – don’t take the easy way out, and don’t take the advice ofthe financial advisors with the best selling books – do your ownhomework – it will be well worth the time and effort. I guarantee it.

A Word About Home Equity Lines of Credit and Home Equity Loans …I believe it is also a good idea to have a Home Equity Line ofCredit (HELOC) available for your use in case of emergencies,temporary financial hardships or other legitimate needs: college,equity building investments, etc.

A HELOC is a 2nd mortgage on your home that allows you to

Another Myth to be Dispelled... Waiting toRefinance Until Interest Rates are 1% or 2% orMore - Lower Than Your Current Rate

write checks against an established line of credit for an approvedmaximum amount. For example, let’s say that you applied for andwere approved for a HELOC of $25,000. The beauty of a HELOCis that you’re approved to spend all $25,000 – but there are nointerest charges until you actually write a check against the line.The minimum payment on most HELOC’s is interest only; howeveryou can make additional payments to reduce the principal balanceat any time. Some HELOC’s have a “lock-in” feature that allowsyou to lock in a fixed interest rate and loan term for a portion of orentire amount of the line that has been used.

The interest rate on most HELOC’s uses the prevailing primeinterest rate as the baseline. If you have good credit and 20% orgreater equity in your property the rate will usually be at or slightlybelow the prime rate. If you have good credit and greater than10% equity in your property but less than 20% the rate willusually be prime + 1%. If you have good credit and less than10% equity in your property the rate will usually be prime + 2%.

As of this printing, the prime interest rate is 4%. If you have 20%or more equity in your property and you wrote a check against yourline for $5,000 and your interest rate was 4% the interest orminimum monthly payment would be approximately $17 (this iseasily calculated using the following formula: $5,000 X .04 ÷ 12 =$16.67). Additional payments can be made at any time to reducethe principal loan balance. This will also have the effect of reducingthe minimum interest only monthly payment the following month.

The best time to apply for and get a home equity line of credit iswhen you don’t need it! When you lose your job or you have atemporary financial setback or you need to pay the college bill andthat commission or bonus check wasn’t what you expected – it’scomforting to know that there is a safety net available for your use.

A Home Equity Loan is also a 2nd mortgage on your home and issimilar to a HELOC with the exception that you are approved for acertain loan amount and then you receive all the money up front.The interest rate is generally fixed and the term of the loan isdetermined up front. The fixed monthly payment of the HomeEquity Loan includes both principal and interest.

The home equity loan option is generally used, when there is a veryspecific purpose for the use of the money; i.e. an addition to yourhome, down payment for the purchase of a second home, etc.

If you are considering using a home equity line of credit or homeequity loan – please be cautious. Remember, the idea is to buildequity and not use all of the equity in your property. Vigilantmortgage management is the key to long-term success. So think



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of a home equity line of credit or a home equity loan as an option– but one that must be managed wisely.

A Word About Loans with Pre-Payment Penalties …Make sure that you completely understand the terms of the loanprogram that you are considering. In most circumstances it does notmake sense to sign up for a mortgage that has a prepayment penalty.

We have seen a number of cases where an unscrupulousmortgage lender will offer a below market interest rate and failto disclose to the borrower that this rate is based on signing upfor a loan program that has a prepayment penalty. Be verycareful – that you completely understand the terms of the loanprogram before you make any final commitment. Having saidthis – there are some loan programs that require a prepaymentpenalty and under certain circumstances it could be thedifference between getting approved for the loan or not buyingthe house or being able to refinance.

Loan programs that have prepayment penalties vary from lenderto lender but in general the penalty for prepayment will apply ifyou refinance and not if you sell your home, and the amount ofthe prepayment penalty will decline over time; i.e. the longer theperiod of time that the loan is in place - the less the prepaymentpenalty will be.

The bottom line is to avoid prepayment penalty loans – but if itis necessary in order to get the loan then go for it – but makesure that you completely understand the loan terms.

A Word About Bi-Weekly Payments …It is likely that you will receive or perhaps have already gottensomething in the mail offering you a bi-weekly payment plan. Becareful with these plans – they are nothing more than a cleverlydisguised marketing arrangement for the company promoting thisplan. Granted, they look good on the surface – however, they willgenerally charge a one-time setup fee and then a transaction feeevery time your payment is electronically withdrawn from yourchecking account. This is clearly a case of good vs. best. Theseplans are good – you can save money in interest expense – but is itthe best alternative?

Our recommendation is to contact your lender and set up anautomatic monthly withdrawal from your checking account, whichincludes the required monthly payment plus some additionalamount to be applied to reducing your principal loan balance. Youcan achieve the same objective as a bi-weekly payment plan by

taking your current monthly principal and interest payment –dividing it by 12 and adding this amount each month to yourrequired principal and interest payment.

The majority of the lenders that we work with allow you to do thisand to my knowledge do not charge for a set-up fee or atransaction fee. Rather than pay money to the bi-weekly serviceprovider, use this money and apply it to reducing your principal loanbalance.

A Word About Mortgage Protection Insurance...It is also quite likely that you will receive more than one letter fromcompanies in the insurance business that will attempt to sell you amarketing term for life insurance called Mortgage ProtectionInsurance. It is life insurance pure and simple. If you recentlybought your home or refinanced – when the mortgage is recordedand is part of the public record – companies in the insurancebusiness are able to access this information and use it as theirprospecting database. The message is always the same – if youdie how are you going to make the mortgage payments? Ourrecommendation is not to reply to one of these letters – but rathercall your life insurance agent or your financial planner and get acomprehensive analysis of your life insurance needs. This analysiswill take into consideration all of your liabilities and help you tofigure out how much insurance is necessary and prudent to protectyou and your loved ones in the event that there is a sudden andunexpected loss of income due to death.

When was the last time you reviewed your credit report?All of the information and principles that I have written about up tothis point are fundamentally based on one essential thing – yourcredit history. You can have tremendous equity in your propertyand make a lot of money and have relatively little debt compared toyour assets – but – if you are not paying your bills on time andbeing Vigilant about maintaining a good to excellent credit ratingyou will likely not be eligible for much of what has been discussedin this paper. How can that be? Because no one wants to loanyou “new” money – if you haven’t been responsible about honoringyour commitments with the “old” money that was loaned to youbefore. It’s really pretty simple. In my own experience of makingpersonal loans to people – some people have been faithful aboutpaying me back and honoring their commitments. Others, that Ihad every reason to trust, were less than faithful and came up withone excuse after another for why they couldn’t honor theircommitment. I wouldn’t hesitate to loan more money to those



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people that honored their commitments but would be foolhardy toloan more money to those who were unfaithful in repaying loansthat I had previously made to them, in full and on time. This sameprinciple and logic also applies to lending institutions.

It is a good idea to review your credit on a regular basis to seewhere you stand from a credit perspective and also to make surethat there are no surprises. If you are thinking about exchangingyour money for one of the many offers that you may receive forobtaining your personal credit report – proceed with caution. Theseservices are highly promoted and generate big money for thecompanies that are providing the information. The question is –how good is the information? In most cases the reports that youreceive are not acceptable to the vast majority of lendinginstitutions – and if you are applying for a loan your credit reportmust be pulled again from an acceptable source. If you areapplying for a loan – work with a lender that will provide this to youwithout cost or obligation. At Compass Mortgage, this is ourstandard operating procedure.

If your credit is not particularly good – there are really no quick fixes.Taking care of past mistakes NOW and making sure that you makeall future payments on time are really the only two ways to repairyour credit. It doesn’t happen over night, it does take time, buteventually your credit history will get better. As a friend of mine oncesaid, “the wheel turns slowly – but, it does turn”. That’s a wisephrase to keep in mind when working on restoring your credit.

If you have some blemishes on your credit and are thinking aboutusing the services of a debt consolidator or a credit repair company– again – proceed with caution. Most of these companies overpromise and under deliver and are not inexpensive! When it comesto repairing your credit – timely payments for all existing obligationsand the passage of time are your two greatest allies.

In SummaryIf you’re thinking to yourself great – but what do I do now? I ampleased to tell you about the Compass Mortgage RefinanceDecision Making Calculator and the Compass Mortgage PurchaseDecision Making Calculator. These Calculators will give youinformation, which will give you insight, which will give you theopportunity to make changes that will be to your advantage.

Both of these tools are available on our web site and enable ourclients to make wise choices on what mortgage program makesthe most sense for them when they buy a house and then to helpthem proactively manage their mortgage (reduce interest expenseand build equity in their property) during the time that they owntheir home.

Please find below the link to access the Compass MortgagePurchase Decision Making Calculator and the Refinance DecisionMaking Calculator:

http://www.ecompassmortgage.com/Calculators.asp

The principles and concepts contained in this paper are intended tocause you to take action and become Vigilant about managing yourmortgage. There are far too many people that are ambivalentabout managing their mortgage and we don't want you to be oneof them!

At Compass Mortgage we’re interested in not only helping you tosecure mortgage financing but to help you manage your mortgageover time.

If you’d like some help on analyzing your current mortgage todetermine if it is serving your best interests and to run yourscenario through our calculators – please feel free to give us a call.We are here to help and serve you.



I have written this paper as someone who has practiced the principles set forth herein forthe last 10 years and have been their great beneficiary.

Let’s put it this way, for 12 years I mismanaged my mortgage and didn’t know it. I waspaying too much in interest expense, I wasn’t building equity in my property, I was payingmortgage insurance much longer than I needed to and didn’t refinance as frequently as Ishould have because of misconceptions that I had about the wisdom of doing so and justplain bad advice.

It wasn’t until I met Dan Graham in 1995, who would in 1999 become the founder andpresident of Compass Mortgage, that he taught me and I learned the principles ofsuccessful mortgage management as they applied to my own home. As I began to applythese principles to build equity in my home and was assisted by the skyrocketing price ofreal estate in the western suburbs of Chicago, I started thinking about the idea of applying these same principles to other singlefamily homes that I would purchase with the idea of renting as investment properties.

I have purchased a number of single family homes as investments and have successfully applied the principles that are contained inthis paper.

If someone that graduated from college with a degree in Economics and earned his Masters in Business Administration, as I did, butcouldn’t effectively manage his mortgage for 12 years, then I thought there are probably a lot of other people that are doing a prettypoor job of this too!

In now my 4th year with Compass Mortgage, I wrote this paper with the idea of helping as many people, who care to learn, to do abetter job of managing their mortgage and in so doing help to build a secure financial future for themselves and their families.

My hope is that your reading of this paper will cause you to take action – which could be nothing more than being able to answer all7 questions in the Vigilant Mortgage Management Test on page 5. If you can answer all 7 questions you’d be in the great minority.In our experience less than 5% of the people that we talk to are able to answer all 7 questions. Once you have the answers – callus – we’ll help you figure out what makes the most sense for you. There is never any pressure or financial obligation until youdecide to move forward. Our job is to serve you and to do what is in your best interests. We’d appreciate the opportunity to workwith you.

Gary W. Braaten, Business Development Manager

About the Author...


V I G I L A N T M O R T G A G E M A N A G E M E N T BY COMPASS MORTGAGEV I G I L A N T M O R T G A G E M A N A G E M E N T BY COMPASS MORTGAGE

Compass Mortgage isa regional mortgagebanker located inWarrenville, IL. Weoriginate, process,underwrite, fund (wewrite the check forthe closing) and closeour loans. We offer awide variety ofresidential mortgageloan programs, including: conventional, jumbo, government insured (FHA), down paymentassistance, low and no down-payment, interest-only, bridge (when you’re selling andbuying), portfolio, construction and home equity loans. In other words, there is no reason togo anywhere else! We can address almost every circumstance.

We are growing and investing in the future. In April we moved into our new office inWarrenville, a facility that is about three times larger than our old building.

We have a wonderful staff of experienced and dedicated people that will go the extra mileto answer your questions with the goal of making your experience of working withCompass Mortgage one that will always exceed your expectations.

Our mission as a company is to help people secure needed residential mortgagefinancing for purchase of a home or to refinance an existing mortgage loan. We assist ourclients in making wise choices by providing them with all of the available options based ontheir specific financial and life circumstances. We are committed to helping the homeownership hopes and dreams of our clients come true and assist them in the managementof their mortgage and investment in their home over time.

Our business is built on the singular idea that each of our clients has infinite value andthat this value is independent of their financial and life circumstances. We strive to providea level of service that is second to none and in so doing earn your business for a lifetime.

Our success is based on one satisfied client – telling another. If we are given theopportunity to earn your trust and your business, the highest compliment that you couldgive us would be to refer each and every person that you know to Compass Mortgage. Itwould be our great privilege and honor to serve them, too.

For more information about Compass Mortgage and the information contained in this paperplease contact:

About Compass Mortgage

Compass Mortgage27755 Diehl Road, Suite 300 • Warrenville, IL 60555

Office: 630-393-9362 • Fax: 630-836-7350 www.compmort.com

“Since we are busy in our own worlds andhave virtually no knowledge of thecomplexitiesrelated to themortgageindustry it wasgreat to havesuch a crediblecompany likeCompass managing our affairs.”

Jerry & Claudia Root – Wheaton

“We haverefinanced withCompass threetimes. Theirstraight forwardapproach andgenuine concern

about what was best for us – was whatimpressed us the most.”

Kurt & Meg Tillman – Glen Ellyn

“We have workedwith Compassmortgage over thepast few years.Their expertise,p rofess iona l i smand exceptional

customer service made our mortgage andrefinancing process timely and efficient.”

Chad & Shauna Thorson – Wheaton

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“… always available to answer all of ourquestions. We were happy to have CompassMortgage workingfor us during ourfirst homepurchase.”

Mike & Wendy Murray – Bolingbrook

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Printed: May 2004

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for You and Your Family - Compass Mortgage · money you spend to pay for interest on your mortgage loan and the number of hours that you must work to pay for it. If you’re with