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September 24, 2003, Revised November
12, 2004
Shopping for a mortgage effectively isn�t easy. Reforms
proposed by HUD, which were pending at the time this article was first drafted,
and which promised to make the process much easier, were never enacted.
Step 1: Decide If You Are a
Potential Shopper:
Not
everyone is a potential shopper. Some
will do a lot better entrusting that responsibility to someone else.
Read the following statements, giving yourself 1 point if a statement
marked (1) best describes you, 2 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 6, 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 Brokers.
Potential
shoppers score 6 or lower. What
follows is directed primarily at them.
Step
2: Decide the Mortgage Features You Want:
Before entering the market, shoppers should decide the type of
mortgage, term, points, down payment and lock period.
You can�t
compare 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 4-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.
Step 3:
Determine Your Market Niche:
The
interest rate and/or points on a mortgage vary with a number of borrower,
property and transaction features. Loan
officers quoting prices will assume the features commanding the lowest price.
See What
Market Niche Are You In?
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 4-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 deal
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 1 point
($1,500), with lender fees of $800 and broker 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 shop these. 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.
It is convenient that interest rates are generally quoted in 1/8%
increments.
You
thus 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� refers 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 rate 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 calculator 9c on my web site.
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 as
toaster prices. Just make sure all
costs are covered except per diem interest and escrows, and nothing is added to
the balance. See Another
Look at No-Cost Refinance.
This
is a great strategy if your time horizon is less than 5 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 5 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 5 or 7 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 5-year ARMs have the same interest cost over the 5 years, you want
the one that exposes you to the least risk of rate increases at the end of 5
years.
Unfortunately,
this is not easy to determine because it is affected by a number of ARM features
and information on these features won�t be provided to you in a comprehensible
form unless you ask. Print out
Information Needed to Evaluate an ARM, and have the loan officer fill
it in for any ARM you are considering. You
then have what you need to use calculators 7b or 7c, and 9a or 9b.
These calculators will tell you what
will happen to your interest rate and monthly payment at the end of the initial
rate period if 1) the interest rate index doesn�t change; 2) the index goes
through the roof (a �worse case�); or 3) the index follows any other future
scenario you choose to examine.
Step 5: Solicit Price Quotes:
In soliciting price quotes,
you need to consider whether the quote is valid, and where you get it.
Validity: 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 inclusion of 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 the ways in which 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 an ARM, include the blank table on Information Needed
to Evaluate an ARM. Request
that quotes include fixed-dollar fees, and that they be emailed or faxed.
A 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 4, 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 4 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 on 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 : Cityloans.com, Getsmart.com, Lendingtree.com,
Interestratesonline.com, Loanapp.com, Loanatlas.com, Loanhounds.com, Loanweb.com,
Lowestmortgage.com, Mortgageexpo.com, and Mortgagetrader.com.
A
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 on-line 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� 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 exactly
the same: Citimortgage.com, ELOAN.com, Homeloancenter.com, Indymac.com,
Infoloan.com, Mortgage.com, Mortgagebot.com, Mortgage.ETrade.com, and
Wamuhomeloans.com.
To make it easier to shop single
lender sites, I developed the �Upfront Mortgage Lender� certification.
The requirements include filling out a niche table, which allows a
shopper to tell at a glance whether the niche into which the shopper falls is
priced on-line by the lender. Complete
pricing is also a requirement. At
this writing, only ELOAN.com complies fully.
Step
6: Select The Loan Provider:
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 requirements for locking the price.
Some
lenders refuse to lock until a borrower demonstrates 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 3 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 3 days.
Step 7: Lock The Price:
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 it can be bad
gamble. Which 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 1 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 5
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, ie, 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 its over�.
If you don�t watch yourself, you can be victimized by �lender fee
inflation� and/or by �contract knavery�.
Step 8: Cover Your
Rear:
Borrowers need to be alert through the closing.
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 are shown on 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 with regard to third party services, such
as title insurance. It never made any sense with regard to lender charges,
however, because lenders know their own charges with certainty.
The GFE has thus provided a cloak behind which some rogue lenders extract
additional fees from unsuspecting borrowers.
See Legal
Thievery at the Closing Table.
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 in 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 which says �If
you pay off your loan early, you [
] may [ ] 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 is when you should
catch it.
I also see contract chicanery in
connection with adjustable rate mortgages (ARMs).
In the typical case, the borrower is sold an ARM based on one or two
features, and never confronts the remaining features which are included in the
note. Unlike a prepayment penalty,
which must come to light if the borrower tries to refinance, disadvantageous ARM
features can remain undetected indefinitely.
To prevent this, collect all the
relevant information about the ARMs for which you shop.
Copyright
Jack Guttentag 2004
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