“Recently we refinanced our home. After making payments for a few months, they raised our payment by $350. It seems that they underestimated our escrows…If we had known that our payment would be this high, we would not have refinanced. Do we have any recourse against the lender?”

I’m not a lawyer but I doubt it. If the loan officer deliberately low-balled the escrow estimate to get you to sign, it would be fraud, but you could never prove it was not an innocent mistake. In all likelihood, it was an innocent mistake–one you should have caught.

On numerous occasions, I have scolded borrowers who were “payment myopic,” meaning that they made decisions based strictly on changes in the monthly mortgage payment. People suffering from payment myopia are capable of doing really dumb things, like refinancing into a higher-rate mortgage because a simultaneous extension of the term reduces the payment.

Refinance decisions based on the mortgage payment plus the escrow payment take payment myopia one step closer to blindness. Escrow payments consist of insurance premiums on a homeowner policy you purchased, and property taxes, which are set by local authorities. Refinancing doesn’t affect either, so they should not figure at all in the refinance decision.

How much help can a co-signer provide?

“Can I borrow more if I have a co-signer, who won’t live in the house but has much better credit than me?”

A co-signer with good credit cannot overcome your bad credit. Where the income used to qualify comes from more than one person, the lower of the credit scores is used in pricing the loan. That would be your score.

While a co-signer cannot improve the credit score used to price the loan, the co-signer’s income may be added to yours in determining the size of loan for which you qualify. On FHA loans, 100 percent of the co-signer’s income can be used to raise the qualifying loan amount, up to the FHA loan limit in the county in which the property is located.

Note, however, that the co-signer’s debt is added to your debt in determining the qualifying loan amount. If your combined debt is high, his inclusion could add little or nothing to the qualifying loan amount.

On conventional (non-FHA and non-VA) loans, the picture is very different. Most conventional loan programs don’t allow non-occupant co-signers at all. Those that do typically limit the incremental income to 50 percent of the co-signer’s income, but they include 100 percent of the co-signer’s debt. As a result, there aren’t many co-signers on conventional loans.

How do you allocate excess funds?

“Please settle a dispute. On one property I have an old 6.6 percent mortgage with a small balance and only five years to go, and on another property I have a relatively recent 30-year mortgage at 6.25 percent. Most of the payment on the first mortgage is principal, while most of the payment on the second is interest. I say that any excess funds we apply should go to the 6.25 percent mortgage because so little of the payment is being applied to principal, but my wife thinks we should apply excess funds to the higher-rate mortgage.”

Score one for your wife. You should allocate excess funds to the higher-rate loan.

The composition of the scheduled payment changes over time, as you note. Early in the life of a mortgage, most of the payment goes to interest, but as the balance falls over time, an increasing share goes to principal.

For example, your old loan with a $20,000 balance at 6.6 percent and seven years to run has a payment of $298, of which $188 goes to principal and $110 to interest. Your new loan of $50,000 at 6.25 percent with 29 years to run has a payment of $312, of which $52 goes to principal and $260 to interest.

However, if you add to your scheduled payment, 100 percent of the increment goes to principal in both cases. If you add $100, the principal payments on the two loans would rise to $288 and to $152, respectively. You would earn 6.6 percent on this $100 if you applied it to the first loan, and 6.25 percent if you applied it to the second. 

In short, how your scheduled payment is being divided as between principal and interest should have no bearing on how you allocate excess funds.

The writer is Professor of Finance Emeritus at the Wharton School of the University of Pennsylvania.  Comments and questions can be left at www.mtgprofessor.com.

***

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