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December 2, 2002, Revised July 16,
2004
"I
am about to shop the market for the mortgage I need to finance my home purchase.
Is there a danger that people won�t tell me the truth?
Any lies I should look out for in particular?"
I had a lot of
trouble answering this question. The
dictionary defines a lie as an untrue statement meant to deceive.
On this definition, it was not difficult to come up with a number of lies
told by loan providers. I quickly realized, however, that most of the worst
deceptions that pervade the mortgage market are not based on untrue statements.
In many cases, the
statements designed to deceive are either true or ambiguous.
While the law may view such deceptions in a different light than those
based on false statements, from my perspective as a consumer advocate, there is
little difference. In addition,
there are �lies of omission�: information
known to be important to the borrower that is deliberately withheld.
They are perhaps the most common of all.
Finally, borrowers sometimes lie to themselves, acting on false
assumptions that they believe (or hope) to be true.
I am going to
address all of these types of lies, beginning with some that meet the dictionary
definition of untrue statements meant to deceive.
Outright
Lies
�This
loan has no prepayment penalty.� The
refinance boom has uncovered a sizeable number of borrowers who claim that when
they took out their current loan, their broker or loan officer told them that
they had no prepayment penalty. When
they went to refinance some time later, however, they discovered that they were
indeed subject to a penalty.
I
did not place much credence in these tales at first.
Brokers have pointed out to me that borrowers often accept a prepayment
penalty to get a lower interest rate, then conveniently forget that
they had agreed to it. However, I
have now seen well-documented cases and am convinced that some borrowers are
lied to about prepayment penalties.
It
is lucrative, and easy if the borrower is trusting.
A broker, for example, might collect an additional .5 to 1 point (1 point
is 1% of
the loan amount) for a loan with a prepayment penalty.
Although the Truth in Lending (TIL) disclosure form indicates whether or
not the loan has a prepayment penalty, it is easy to overlook.
Besides, most borrowers don�t read the TIL.
Moral:
To make sure you don�t have a
prepayment penalty, check the TIL.
�The
Rate is Locked�.
Some mortgage brokers tell their clients that the interest rate has been
locked with the lender when that is not the case.
Locking the
mortgage rate assures borrowers that the interest rate they have agreed to pay
will be honored at closing, even if market rates rise in the meantime.
The lock also protects against a change in points, although it does not
cover lender fees expressed in dollars.
The brokers who
lie about locking the loan do it to increase their markup.
For example, the lender providing the loan selected by your broker might
quote 6% plus 1 point for the 60-day lock you require, but the lender�s quote
for a 10-day lock might be 6% plus 0.5 points.
The lying broker tells you that you are locked for 60 days at 6% plus 1
point. If the market doesn�t
change, the broker locks 10 days from closing at .5 point, and pockets the other
.5%.
Brokers
rationalize this lie by saying that they are assuming the lock risk themselves,
and will deliver the �locked� rate and points to the borrower even if they
have to take a loss. In a stable or
declining rate market, they can get away with this, perhaps for years at a time.
There is a lot of it going on right now.
But
sooner or later interest rates will suddenly spike.
Brokers locking at their own risk will not be able to deliver loans at
the promised rate. Borrowers
unfortunate enough to have relied on them will be left unprotected.
They will either have to pay the higher market rate, or cancel the
transaction.
Moral: Borrowers
who lock through brokers should insist on receiving the rate lock commitment
letter from the lender identifying them as the applicant.
�You
will get the market price on the day you lock�.
A shopper who accepts an offer from a loan provider is warned that the
price quoted is subject to change with the market. Prices adjust every day, and sometimes more than once a day.
The final price, says the loan provider, will be the market price on the
day the loan is locked.
How is the market
price determined on that day? Why,
the loan provider tells you what it is. This
reminds me of Big Julie in Guys and Dolls, who used dice that had no spots. He didn�t need spots to know what number came up, he said,
because he remembered where the spots were.
If you made your
selection of the loan provider before the lock day, and you have no independent
way to verify the market price, you might as well be playing dice with Big
Julie. Many loan providers
systematically overstate the price on the lock day.
The worst offenders are those who systematically understate the price
earlier for the purpose of snaring you.
HUD may soon issue
new regulations that require lenders to provide objective evidence that they are
giving borrowers the market price on the lock day.
Pending this, however, borrowers must protect themselves.
Moral: Favor
loan providers who have web sites that allow you to check your market price at
any time. Otherwise, monitor
changes in market rates between the day of your quote and the day you lock.
Check the daily average rates shown on www.hsh.com.
�You
do better with an FHA�. Why
would a loan officer or mortgage broker say this if it weren�t true?
Because they specialize in FHAs and don�t want to lose the sale, or
they can earn a higher fee on an FHA, or both.
FHA loans are for
borrowers who can't meet a 5% down payment requirement and have poor credit.
Borrowers who can put 10% or more down and have good credit will usually
have lower costs with a conventional loan.
(The costs in such comparisons include the interest rate, upfront fees
and mortgage insurance). The best
loan type for borrowers who fall in the middle depends on the specifics of the
case.
Much of the
unjustified �steering� applies to these in-between cases that are close to
the line. However, I have seen FHAs
with 20% down and good credit.
Moral: If
you can put 5% down, or you have good credit (a FICO score of, say, 700 or
higher), don�t let anyone steer you to an FHA without considering
alternatives.
�You
need an adjustable rate mortgage (ARM) to qualify�.
Why would a loan officer tell an applicant that she needs an ARM when she
doesn�t? Most likely because the
loan officer works for a depository institution that much prefers ARMs, and pays
larger commissions on ARMs. Furthermore,
finding ways to qualify a marginal borrower on a fixed-rate mortgage (FRM) may
be challenging and time-consuming. Why
bother if you don�t have to?
The interest rate
used to calculate the mortgage payment used in qualifying borrowers is usually
lower on ARMs than on FRMs. Nonetheless,
applicants who are told that they can�t qualify at the FRM rate, and who
don�t want to risk future rate increases on an ARM, should know that they may
have options.
The inability to
qualify for an FRM means that the interest rate on the FRM brings the ratio of
housing expense to income, or total expense to income, above the maximums.
Typical maximum ratios are 28% and 36%, respectively.
(Housing expense includes the mortgage payment, mortgage insurance,
hazard insurance and property taxes; total expense is housing expense plus
monthly debt service.)
Maximum
expense ratios, however, are "guidelines", not absolute limits.
The limits may be waived if the borrower is only marginally over the
housing expense ratio but well below the total expense ratio. They may also be
waived if the borrower has an excellent credit record or is making a substantial
down payment.
A
borrower with excess cash, furthermore, can use it in various ways to reduce
housing expense. For example, they
can �buy down� the interest rate by paying higher upfront fees.
Moral:
Borrowers who want FRMs but are
told they need an ARM to qualify, should seek the opinion of other loan
providers.
Deceiving
With the Truth
Now I want to
consider a more sinister type of lie: statements
that are either true or ambiguous, yet designed to deceive.
�The
APR on your cash-out refinance is...�
I begin with this one not because it is the most important but because it is a
perfect example of how a factually correct statement can be used to misinform.
And it even carries the imprimatur of the Federal Government!
Smith has a 6.5%
mortgage with a balance of $250,000 and needs $25,000.
She refinances at 7%, borrowing $275,000 with $25,000 �cash-out�.
Assuming no points or other fees, the lender reports an APR on this loan
of 7%. And so it is.
The problem is
that Smith is led or allowed to infer that she is paying 7% for her $25,000,
which is not the case. To get the
$25,000, Smith had to raise the rate on $250,000 from 6.5% to 7%.
If this were taken into account in the calculation, the APR would be
almost 12%. The misinformation
might cause Smith to overlook that a second mortgage for $25,000 might be a lot
cheaper.
Moral: Ignore
the APR on a cash-out refi, but assess the cost against that of a second
mortgage. You can do this with
calculator 3d on my web site.
�This
is a no-cost loan�. Strictly
speaking, there is no such thing as a no-cost loan.
Borrowers always pay settlement costs, one way or the other.
Nonetheless, the statement is not always intended to deceive, although
sometimes it does. It depends on the situation.
One situation in
which it is reasonable to assume an intent to deceive is where �no-cost� is
used to describe a loan on which settlement costs are added to the loan balance.
The borrower is paying the costs but borrowing the money needed for the
purpose. Calling this �no-cost�
is outrageously misleading.
The term
�no-cost� is also used to describe a loan on which the borrower agrees to
pay an interest rate high enough that the lender will pay the settlement costs.
In this case, the lender pays the costs, but there is a quid pro quo
consisting of higher interest payments by the borrower in the future.
If borrowers
understand that they are compensating the lender for paying the settlement
costs, referring to such loans as �no-cost� is not deceitful.
It is deceitful only when the loan provider suggests that the borrower is
getting a free ride.
Moral:
Don�t take a no-cost loan without
making a side-by-side comparison with the same loan on which you pay the costs
and receive a lower rate. View the costs as an investment on which you can calculate a
return using calculators 11c or11d on my web site.
Note: Sometimes
borrowers taking out �no-cost� loans suspect skullduggery when they discover
that the settlement costs that lenders agree to pay on no-cost loans do not
include per diem interest -- interest from the day of closing to the first day
of the following month. It isn�t skullduggery. Lenders never pay per diem
interest because it is an interest charge rather than an upfront fee, and it is
not known until the closing date is set. Lenders
also don�t pay tax and insurance escrows, because monies in escrow are owned
by the borrower. And they don�t
pay mortgage insurance because this depends on how much the borrower puts down.
�The
lender is paying my fee.�
The concept of a free mortgage broker is very similar to that of a
no-cost loan � or a free lunch. There
is no such thing, but the statement may or may not be a lie, depending on
circumstances.
If
the statement is meant to convey the impression that the borrower has no stake
in the lender�s payment to the broker, it is deceitful. Lenders pay the borrower�s broker fees for the same reason
that they may pay the borrower�s settlement costs:
because the borrower compensates the lender with a higher interest rate.
On
the other hand, if the borrower understands that he is paying for the broker
fees in a higher rate paid to the lender, there is no deceit.
A good test is whether the broker offers an option of a lower interest
rate with the borrower paying the broker�s fee.
Moral:
Insist on a rate quote on which you
pay the total broker�s fee, which you can compare to the quote on which the
lender pays the fee. Calculate an investment return on the fee as suggested in
the previous moral.
Lies
and Self Deception
Mortgage
shoppers are often deceived by lies, but more often by a twisting of the truth.
�My
biweekly plan will save you money�. This
statement can be viewed as true, false, or somewhere in-between, depending on
the context. The critical issue is
whether it is meant to deceive recipients into believing that they will receive
more from a biweekly program than is actually delivered.
On a biweekly
payment plan, you make half the monthly payment every two weeks.
That means that over a year, you make 26 half payments, which is the
equivalent of 13 monthly payments. The
additional monthly payment cuts the term of your loan and reduces your total
interest bill.
But you can
accomplish the same thing on your own. If
you make an extra monthly payment every year, the result will duplicate that of
a biweekly program. If you add 1/12
of the mortgage payment to each monthly payment, which amounts to an extra
payment over the year, you will actually pay off the loan a little sooner than
with a biweekly.
But doing it
yourself requires self-discipline, while a biweekly program provides the
discipline for you. That is all it provides.
Moral:
If you want to accelerate the
repayment of your mortgage, compare a biweekly program with an extra-payment
plan of your own.
�You
can trust me�.
All mortgage brokers and loan officers attempt to convey the message,
directly or indirectly, that they are trustworthy.
Often it is true, but since most mortgage shoppers have no way of knowing
whether it is or not, prudence dictates that they assume it to be a lie. Most of the mortgage brokers and loan officers with whom
borrowers deal have a financial incentive to charge them as much as possible,
which is reason enough to be cautious.
Mortgage brokers
make their money from the spread between what you pay and the wholesale price
quoted by the lender. For example,
the lender quotes 6% and zero points to the broker, and the broker quotes 6% and
2 points to you, for a 2-point spread. (Points
are an upfront charge expressed as a percent of the loan).
Brokers do their best to avoid disclosing the wholesale prices, which
would reveal their spreads.
An exception is
Upfront Mortgage Brokers (UMBs), who set a price for their services and pass
through the wholesale loan prices. This
method of pricing eliminates the broker�s incentive to over-charge you.
UMBs are listed on my web site.
The majority of
loan officers employed by lenders have the same financial incentive as
mainstream brokers to extract as high a price as possible from borrowers.
Loan officers work off price sheets showing rates and points, which are
not disclosed to borrowers. A loan
officer who can sell a mortgage at a price higher than the price on the sheet
will share the increment, termed an �overage�, with the lender.
The system is the same for loan officers employed by large mortgage
broker firms.
Not all lenders
try for overages or share them with loan officers.
In particular, the practice is much less common in internet-based lending
where borrowers seek out lenders, than it is in �street lending� which is
more dependent on aggressive salesmanship.
The problem is
that there is no way for shoppers to know whether a particular loan officer has
a financial interest in over-charging them or not.
I intend to remedy this in the near future with the development of
�Upfront Mortgage Lenders� (UMLs), which will be a list of lenders in whom
borrowers can have confidence. UMLs
will meet a number of requirements, one of which is to disclose exactly how
their loan officers are compensated.
Moral:
Unless you have specific
information to the contrary, assume that the loan provider you deal with has a
financial incentive to charge as much as possible.
�The
FHA wouldn�t insure the mortgage if the house wasn�t sound.�
This may be
less a lie than an erroneous assumption made by home-buyers.
The assumption is reasonable. FHA
requires a property appraisal, and that homes meet certain "minimum
property requirements".
The
fact is, however, that FHA does not guarantee the value or condition of a home.
FHA appraisals and property requirements are intended to protect FHA, not
the homebuyer. Since 2000, all
purchasers of existing houses taking an FHA mortgage must, before the date of
the sales contract, sign a statement acknowledging that FHA does not warrant the
condition of the house.
Moral:
Anyone
taking an FHA mortgage to purchase an existing house should first have
the house inspected.
Copyright
Jack Guttentag 2003
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