Trying to find the best deal on a mortgage.
It isn’t easy to do it right, as a summary of the major steps involved will demonstrate. This guide is based on the regulatory structure in September 2003. Reforms proposed by HUD, which were pending at the time this was written, should make shopping for a mortgage much easier. See RESPA/Proposals for RESPA Reform
Step 1: Decide if You Are a Potential Shopper or looking to Pre-Qualified to know how much home you can afford: Not everyone is a potential shopper. Some will do a lot better entrusting that responsibility to someone else. Read the following statements, giving yourself one point if a statement marked “1” best describes you, two points if a statement marked “2” describes you best, and 1.5 points if you are in between.
A1. I like to bargain and have no hesitancy in speaking up if I think someone is trying to take advantage of me.
A2. I avoid confrontation at all costs.
B1. I feel that I either know or have the capacity to learn as much about mortgages as I will need to know to take care of myself in the marketplace.
B2. I feel overwhelmed by the complexity of mortgages, and I don’t have the time, energy, or desire to educate myself about them. C1. When significant money is at stake, I like to control things myself.
C2. When significant money is at stake, I like to find someone I can trust to make critical decisions for me.
D1. I feel very comfortable using a computer.
D2. I am computer-phobic.
If your total score is above six, find a mortgage broker to be your agent in shopping for a mortgage. I recommend Upfront Mortgage Brokers (UMBs) because they are prepared to provide this service at a set fee, negotiated in advance. Once the fee is established, your interest and that of the broker are closely aligned. See Upfront Mortgage Broker. Potential shoppers score six or lower. What follows is directed primarily at them.
Decide which Mortgage Features You Want
Before entering the market, shoppers should decide on the type of mortgage, term, points, down payment, and lock period. You can’t compare the prices of different loan providers accurately unless you can specify exactly what you are shopping for. When you shop for an automobile, you decide beforehand that you want, e.g., a four-door Toyota Corolla with accessory package 101. You must do the same when you shop for a mortgage. It is especially important to know exactly what you want before you lock the price. If you change your mind after you lock and market prices have risen in the meantime, many lenders will allow a change only at the higher price.
Determine Your Market Niche
Step 3: : The interest rate and/or points on a mortgage vary with several borrowers, property, and transaction features. Loan officers quoting prices will assume the features commanding the lowest price.
For example, if you don’t say anything about the property, the loan officer will assume it is a single-family detached house constructed on the site. If in fact, it is in a low-rise condominium, a four-family structure, or a manufactured house, the price will probably be higher. To obtain valid price quotes, shoppers must indicate all such deviations between their deal and the generic deal. Make a list of your “Niche Adjustments”-all the deviations between your dealer and the generic assumptions. Whenever you are soliciting price quotes, you offer the list.
Step 4: Formulate Your Price Selection Strategy
Selecting the best
price on a mortgage is not like selecting the best price on a toaster. Mortgages have three (or more) price components, toasters only one. Pricing Strategy on Fixed-Rate Mortgages (FRMs): Once you know your loan amount, convert all upfront charges into a single total dollar figure. Multiply all upfront fees expressed as a percent of the loan times the loan amount. (This includes points, origination fee if there is one, and broker fee if it is defined as a percent.) Add fixed dollar fees charged by the lender and broker. For example, if the loan is for $150,000 at one point ($1,500), with lender fees of $800 and borrower fees of $3,000, total dollars amount to $5300. Ignore the cost of title-related services and settlement services. If you are in an area in which it can pay to shop for them, you can do it after selecting the loan and lender. Also ignore any government charges, escrows, and per diem interest. You can’t stop there. Hazard insurance you buy on your own. When you have two price components-the interest rate and total dollars upfront-there are two ways to make a selection decision. One way is to fix the interest rate (call it your “shopping rate”) and ask for quotes on total dollars at that rate. Conveniently, interest rates are generally quoted in 1/8% increments. You then ask the loan provider “If these are my mortgage features and niche adjustments, what are your points and total fees at (say) 5.875%?” You must be clear that “total fees” refer to payments to the lender and the broker, excluding payments to third parties, per diem interest, and escrows.
The best shopping rate for your purpose can only be found through trial and error. If you begin with a shopping rate that elicits larger total dollar quotes than you want to pay, for example, raise it. As your shopping rate goes up, the total dollar quotes will go down an alternative to soliciting total dollar quotes for a given shopping rate is to combine different rates and total dollars into a single measure of Interest Cost (IC). Economists call this measure an “internal rate of return,” or IRR. The annual percentage rate (APR), which is a mandatory disclosure, is an IRR. The problem with the APR is that it is calculated over the entire term of the loan, which makes it a biased measure for borrowers with short horizons.
If you know you will be in your house for 10 years or longer, you can use the APR because the error is small. Otherwise, you should compare interest costs over your own shorter time horizon. You can do that using any mortgage calculator that will give you the full amortization schedule. There is one way to shop a single price that has become popular in recent years. This is to shop for the lowest interest rate with zero settlement costs. The lender pays all costs, including third-party charges. This approach makes it almost as easy to compare mortgage prices toaster prices. Just make sure all costs are covered except per diem interest and escrows, and nothing is added to the balance. Ser No-Cost Mortgage. This is a great strategy if your time horizon is less than five years.
The lender pays your settlement costs in exchange for higher interest payments, but these payments don’t go on long enough to wipe out the benefit. After about five years, however, the higher interest payments convert the strategy into a loser. Pricing Strategy on ARMs and Balloon Loans: Both ARMs and balloons have fixed rates for some initial period. For balloons, that period is almost always either five or seven years. For ARMs, it can range from a month to 10 years.
If you know that you will be out of the house before the initial rate period ends, you can use the same price selection strategy as on an FRM. As far as you are concerned, it is an FRM. In using calculator 9c to measure interest cost, enter the initial rate period as the period you expect to stay in your house. The calculator will ignore what happens after that period. The problem is that virtually no one can be certain that they will be gone by the end of any initial rate period. Life has a bad habit of changing our minds. You should be aware of what can happen at the end of that period and factor that into your decision process. In the case of balloon loans, that is not difficult.
At the end of the initial rate period, you must refinance at the market rate prevailing at that time. Since all balloons are equally bad in that regard, select the one that is the best deal over the initial rate period. The pricing strategy for a balloon thus turns out to be the same as that for an FRM. ARMS, however, have built-in protections against rate increases after the initial rate period, and these may differ from one ARM to another. If two five-year ARMs have the same interest cost over the five years, you want the one that exposes you to less risk of a rate increase at the end of five years. Unfortunately, this is not easy to determine because it is affected by several ARM features that won’t be provided to you in a comprehensible form unless you ask.
Step 5: Solicit Price Quotes:
To be valid, mortgage price quotes must be complete, which means inclusive of lender and broker fees expressed in dollars, as well as those expressed as a percent of the loan. On adjustable-rate mortgages (ARMS), it also means inclusive of the information on features affecting the interest rate and payment when the initial rate period ends.
Timely, which means that the prices are live at the time they are conveyed to the shopper. Niche-adjusted, which means that the prices are adjusted for all how the shopper’s transaction differs from the generic assumptions used by lenders in developing their best prices. Honest, which means that the loan provider would be willing to lock the rate and points quoted, rather than low-balling to get the business, and is willing to guarantee fixed-dollar fees.
Sources: One source of price quotes is individual loan officers recommended by your sales agent if it is a purchase transaction, or by other borrowers. Provide them with your mortgage features and niche adjustments. If you are shopping for an ARM, include the blank table on Information Needed to Evaluate an ARM from my Web site. Request that quotes include fixed-dollar fees and that they be emailed or faxed.
The second source of price quotes is Internet mortgage auction sites These sites ask you to fill out a questionnaire covering the loan request, property, personal finances, and contact information. (It is their version of your mortgage features and niche adjustments.) The sites use this information to select the lenders, usually up to four, to whom the information is sent. The selected lenders then send price quotes to you based on the same information, hopefully on the same day. This is a quick and easy way to obtain up to four price quotes. However, the niche adjustments may or may not be complete, they may not ask you about your mortgage preferences, and they may not include information on fixed-dollar fees or important ARM features. Hence, you probably will need to request a second round. The integrity of the quotes is no more verifiable than those you get by directly soliciting loan officers yourself.
Auction sites include:
Mortgage Landers Options
The third source of price quotes is single-lender Internet sites. They are less convenient than auction sites since you can only get one quote per site. However, you choose your mortgage features, and the price quotes are more likely to be complete. Furthermore, if your loan is priced online it is an honest price. They can’t give you a low ball quote to snare your business, then raise the price when you lock, because you can monitor the price when you lock. Single-lender sites vary greatly in the extent of their niche adjustments. The more questions they ask the user, the more complete the niche adjustment can be. However, many lenders are afraid to ask too many questions on their Web sites for fear the user will become discouraged and leave. The trick, therefore, is to determine whether the questions posed by a site have captured your particular niche adjustments. If you are buying a two-family house, for example, and you are asked about Type of Property” with “Two-Family House” as one possible answer, then you know that they adjust for that. The following are some Internet sites that provide fairly complete niche adjustments, though no two are the same.
Select the Loan Provider That Works For You
Step 6: Lenders who price high often argue that service quality is equally important. “You wouldn’t hire a lawyer or an architect based strictly on price, would you?” The problem with this argument is that there is very little reliable information available to borrowers on the service quality of loan providers. Furthermore, there is no reason whatever to believe that lenders who price high provide better service. There is one particular service, however, that shoppers may want to consider in making their final selection. This is the lender’s requirement for locking the price.
Some lenders refuse to lock until a borrower demonstrates a commitment to the deal by completing one or more critical steps in the lending process, including an application. Other lenders will lock based on very little. We would expect that lenders who make it easy to lock would quote higher prices because they have higher lock costs. Some shoppers will lock with them as protection against a rate increase while they continue to shop for a better deal elsewhere. However, it doesn’t always work out that way. If two lenders have the same price, but one will lock you today while the other won’t lock you for three days, you should go with the first. This is especially the case if you have no way to verify the validity of the changes in the market that occur over the three days
Mortgage Price Lock
Most borrowers lock as soon as possible, and you can’t get into trouble doing that. Allowing the price to “float” until shortly before closing can be either a good gamble, meaning that the odds are in your favor or a bad gamble. It is has nothing to do with whether market interest rates go up or down over the period because that is not predictable.
Allowing the price to float is a good gamble only if all the following conditions are met:
You can afford the hit if market rates go up. If your income is only marginally adequate to qualify, it would be foolish to risk being disqualified by a rate increase.
You can monitor your price day by day. In general, this is possible only if your specific deal is priced on the lender’s Web site. • The lender charges lower prices for shorter lock periods. This means that if the market is stable, your price will drop as the lock period shortens, For example, you have 60 days to closing and the quote is 5% and one point for a 60-day lock, 875 points for a 45-day lock, 75 points for a 30-day lock, and .625 points for a 15-day lock. If you float until five days before closing and the market does not change, you save 375 points, the difference between the 60-day and the 15-day lock prices. Some mortgage brokers do this as a matter of course, i.e., they “lock” the borrower at their own risk at the 60-day price but don’t lock with the lender until they can get the 15-day price. This is a good gamble because you win if interest rates neither rise nor fall, but it remains a gamble because you lose if interest rates rise If the lender charges the same price for a 15-day as for a 60-day lock, it is no longer a good gamble since you don’t profit in a stable market. If you can’t monitor your price, it is a bad gamble because you are then at the mercy of the lender to tell you what the market price is. Locking the price should end the shopping process, but unfortunately, it doesn’t. When it comes to mortgages, “it isn’t over till it’s over.” If you don’t watch yourself, you can be victimized by “lender fee inflation” and/or by “contract chicanery.”
Watch Your Back
Lender Fee Inflation: When you lock the price of the loan, you are not locking the whole price. You are locking the market-sensitive part, consisting of interest rate and points. Lender fees specified in dollars are not market-sensitive and are not locked. Further, such fees do not usually appear in media ads that show mortgage prices and are seldom volunteered to shoppers. They showed the Good Faith Estimate of settlement (GFE), along with all other settlement costs. However, the GFE need not be provided to borrowers until three business days after receipt of an application. This is too late to help shoppers.
But it gets worse. Lenders are not bound by the numbers on the GFE, which are “good faith estimates.” The GFE concept made some sense about third-party services, such as title insurance. It never made any sense about lender charges, however, because lenders know their charges with certainty. The GFE has thus provided a cloak behind which some rogue lenders extract additional fees from unsuspecting borrowers. See Mortgage Scams and Tricks/Strictly Lender Scams/Pad the GFE. This is not a problem if you are dealing with a mortgage broker. Brokers know the fees of each lender they deal with and will not tolerate lenders taking advantage of their clients. Fee inflation puts no money in brokers’ pockets. The problem arises in dealing with lenders. Some Internet lenders include their fixed-dollar fees in their price quotes and guarantee that these will be the fees charged at closing. These lenders include ELOAN.com, HomeLoanCenter.com, IndyMac com, Mortgage.com, and Mortgage ETrade.com.
In soliciting price quotes from other lenders, ask them to guarantee their fixed-dollar fees. If they agree and you want to push your luck, ask if they will include credit check and property appraisal charges, which they order but you pay for. They may be reluctant because these charges can vary from case to case. Your fallback is to ask them to guarantee not to mark them up. To make sure you have no surprises at closing, get it in writing. Fixed-dollar fees should be on the lock confirmation statement.
Contract Chicanery: The mortgage note is a contract between the lender and the borrower, but ordinarily the borrower does not see the contract until the closing, and few read it even then. Generally, this is not problematic, but it can be if the lender slips something that disadvantages the borrower, without the knowledge of the borrower. This is contract chicanery. When this happens, the offensive provision is likely to be in a rider to the contract. Judging from my mailbox, the most common such rider is a prepayment penalty. The inducement is a significant enhancement in the value of the note, part of which will probably go into the pocket of the loan officer.
It is remarkably easy to prevent this from happening. There is a line on the Truth in Lending (TIL) form you are given after you submit your application that says, “If you pay off your loan early, you  may I will not have to pay a penalty.” If there is a check-in front of “may,” it means that your loan does have a prepayment penalty, no maybes about it. If you have not agreed to a prepayment penalty, then that is when you should catch it.