Five Things Your Mortgage Lender Won't Tell You

1. The Facts about "No-Cost" Loans

2. Finding the Lowest Interest Rate Is Not Always the Best Deal

3. The Difference Between Lenders and Brokers

4. How a Pre-Qualification Compares to a Pre-Approval

5. What are Good Faith Estimates in Relation to Rate Quotes

What You Really Want to Know Are Four Things

1. The Facts about "No-Cost" Loans

The reality is that there is nothing free in this life, everything costs, either now or later. A loan or mortgage company does not work for free and need to make a profit to stay in business.

Even if the loan officer and the company were willing to do the loan at a true "no cost'', there are other "hard'' costs involved in the loan. These include items such as attorney's fees, title search, intangible taxes, recording fee; just to name a few and must be paid by someone.

About the only way this can be done is through a concept called "Above Par Pricing.''

Most people have heard of paying "discount points'' to buy a rate down. This occurs when you (the buyer/borrower) can pay a discount point (a ''point'' is 1% of the loan amount) to the lender so the buyer/borrower could get a lower rate.

You see, mortgages are priced just like bonds. There is a "par'' price and then there is a discount price and an above par price. If a mortgage company provides a loan where the rate is above par, the mortgage company receives a premium. This is usually called a "Yield Spread Premium."

In a ''No Cost'' Loan, the mortgage company uses the yield spread premium to cover all of the costs of the loan and the mortgage company's profit as well.

So, does this mean the mortgage company is cheating or ripping-off the consumer? No. not at all. It all boils down to options.

For instance, on a purchase the borrower has three options:

1. Pay the closing costs on his own, with no help from the seller or lender.

2. Negotiate for the seller to pay the closing costs. This usually means the purchase price has to be raised.

3. Pay a slightly higher interest rate on the loan and have lower cash out-of-pocket and maybe a lower purchase price on the home, too.

On a refinance, the borrower has three options as well:

1. Pay the closing costs on his own, with no help from the seller or lender.

2. Add the closing costs to the loan. When the closing costs are added to the loan they are then being financed into the loan amount. This reduces the borrower's equity.

3. Pay a slightly higher interest rate on the loan and have no cash out-of-pocket and not invade their equity

Any of these options can be beneficial or detrimental depending upon the individual borrower's situation.

That is why a competent mortgage professional will ask many questions before proposing a loan program and providing an interest rate.

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2. Finding the Lowest Interest Rate Is Not Always the Best Deal

Some loans have very attractive interest rate (also known as teaser rates) but you may be hit with higher up-front charges. Points and or origination fees are the most common ways to lower the rate and charge up front costs. When searching for a mortgage, ask the lender if they are charging points or origination fees. Points and origination fees are calculated as a percentage of the loan amount. See example below.

ARM rates adjust differently depending on the loan program. The ARM rates may adjust as often as every 6 months but in most case they adjust after 1, 2, 3, and 5 years. With interest rates at a historic low interest rates on ARMS are far more likely to go up when they adjust. The Balloon Mortgage requires the borrower to pay the loan off when it matures.

There are many lending tactics to sell the borrower on a low rate and then charge outrageous fees and costs. Do not fall into the "bait and switch'' lending ploy.

However, most lenders do have good adjustable rate loans that are preferable in certain borrowing situations. Some loan programs will allow you to select from several monthly payment options. One of these could be having your payment recomputed every month based on the loan balance, so your minimum payment will actually be reduced each month.

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3. The Difference Between Lenders and Brokers

Mortgage Lender vs. Mortgage Broker. There are strong feelings on both sides, let's try to show you both sides of the argument.

First, let's define what we're talking about:

A Mortgage Lender, in theory, is loaning their own money. Lenders are usually, but not always, large national or regional banks or a mortgage company that is a direct affiliate of that bank.

A Mortgage Broker is in the business of placing loans with a wide variety of mortgage lenders. They are not loaning their own money, but are acting as "brokers'' for the wholesale lenders with whom they do business.

An easy way to compare a mortgage lender to a mortgage broker is to look at the insurance industry. Your neighborhood Allstate or State Farm agent does a great job of offering you their own company's products. If you need something other than their company's products, you need to go to an independent insurance agent who can offer you the products of a number of insurance carriers.

If you are a major customer of the bank, that is you have substantial deposits with the bank, you may be able to get a special deal on a mortgage loan only because the bank does not want to lose your deposits. Occasionally, a banker may have a loan program unique to them - this may offer you a limited advantage. A disadvantage of the banker is that they only offer their own loan programs, and if your situation does not fall into one of their limited programs, they cannot help yell.

A banker has "in-house underwriting.'' That means the person that actually approves your loan works for the company. This is usually touted as meaning the banker can give you faster service and sometimes this is true. However, when the underwriter is in North Carolina and is underwriting loan applications from five states, how much of an advantage is it when you are here in Illinois? In addition, if the banker's underwriter declines your loan application for any reason, what can the loan officer do? Nothing! They cannot send the loan to another company. Your only option is to transfer the loan to another company. That means you practically have to start all over.

Additionally, most bankers do not really loan their own money. They do close the loan using their own money, or money borrowed from a warehouse line of credit. Then they almost immediately, usually within one to five days, sell your loan to someone else and are immediately paid back the money they put out to fund your loan.

The Mortgage Broker does not loan their own money. They search the marketplace to try to find the best combination of loan program and rate to fit an individual borrower's situation. This means that a Broker is not limited to just the few programs their own company may offer (like the bank). The Broker has the full range of programs available to as many wholesale lenders as they choose to do business. If one wholesale underwriter does not like your loan, the broker can simply send your loan to another lender for consideration. You are not stuck with only one person's opinion of your loan.

One question frequently asked is, doesn't it cost more to do business with a Broker? That is a falsehood many mortgage bankers like to keep going.

One reason it appears that way has to do with Yield Spread Premium discussed earlier.

There is a little known quirk in the law that says a mortgage broker must reveal all of their compensation, including yield spread premium received. That same law also says that a Lender does not have to reveal any yield spread premium they receive.

Example:

A Broker offers you a 30-year fixed rate loan at say 7-1/4% interest rate. Let us also say that the Broker is going to pay all of your closing costs totaling to $1,900. The Broker is required to disclose on the Good Faith Estimate and the Closing Statement all of the funds they are receiving, so they will show that they are receiving, say $3,250 in yield spread premium. Keep in mind, in our example, the broker is covering $ 1,900 of your costs, so the broker is making $1,350 for doing your loan.

Now, a Lender is going to do the same loan for you at the same rate and term, and the lender is going to cover your closing costs. The closing statement will show that the lender is paying $1,900 in costs for you, but since they are not required to show yield spread premium, it appears that they are really good people and are not making a dime on your loan.

It is the same loan, probably eventually going to be packaged and sold to the same company.

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4. How a Pre-Qualification Compares to a Pre-Approval

Sometimes potential borrowers will think they have something worthwhile when they receive a Pre-Qualification from a lender or broker. You will here people say something like "I've already been pre-qualified for a $120,000 loan, so now I can focus on just checking the rates.''

However, a Pre-qualification is worthless. Anybody can give you a pre-qualification. It does not mean anything - it has no value to you.

Why? Because all a pre-qualification means is that someone took the word of a potential borrower regarding their income, debts and credit standing and said, based upon what you are telling me, you fit within the parameters of some possible loan program.

You can call five mortgage companies this afternoon and get five pre-qualifications. The problem is trying to get any of those five companies to honor that pre-qualification. Since none of the information has been verified, there is no way to force any company to honor any pre-qualification.

What you want and what you need is a Pre-Approval.

A Pre-Approval is based on solid, verified information about your situation, credit, income, savings, and debt and is based on the specific requirements of a specific loan program. A Pre-Approval in the form of a Loan Commitment is money in the bank.

A  Loan Commitment/Pre-Approval usually means that your loan application has been presented to an underwriter or has been submitted to one of the few electronic underwriting systems and has received an approval.

With a Pre-Approval in hand, your ability to negotiate on the purchase price of a home goes way up. Your agent has submitted your offer on the home of your dreams, but so have two other potential buyers. Which one does the home seller take? Assuming all bids are about equal, your agent has presented, along with your contract offer, your written pre-approval for a loan to buy this house. The other bidders did not.

Whose offer is the seller more likely to take? The one with the guaranteed closing or the one that has to wait to get their loan approval.

The down side of a pre-approval is that in order to get one, your are going to have to make a full- blown mortgage application with a mortgage company. Nobody, except a complete fool, would provide a potential client with a Mortgage Loan Commitment (Pre-Approval) without having that potential borrower complete and execute (sign) a full application and all disclosures; gather basic information and documents; and present the information to someone with the ability and authority to say "Yes'' to the loan application.

5. What are Good Faith Estimates in Relation to Rate Quotes

Many lenders will refuse when asked ''Give me your best rate on a 30 year fixed rate and send me a Good Faith Estimate.'' Why?

Because preparing a Good Faith Estimate for someone who is not seriously considering making a loan application is a waste of the lender's or broker's time and the caller's time. A Good Faith Estimate without an application is not worth the trouble for most lenders to go through.

It is a lot like a Pre-qualification, it's meaningless. You cannot hold a lender, or anyone else for that matter, to the numbers. In addition, since the mortgage company does not have complete information about the borrower and their situation, everybody involved knows ahead of time that the numbers cannot be right.

Moreover, interest rates change daily, sometimes more than once in 24 hours. So any rate someone receives today will not be good tomorrow. No one can lock-in an interest rate without an application.

Why is it so hard to give an accurate estimate of the costs?

That is because the actual costs of a $100,000 loan, for example, are different for a FHA 30 year fixed rate than a conventional 30 year fixed rate, and different for a non-conforming 30 year fixed rate.

If that same $100,000 loan is an 80% loan to value refinance, the cost will be different than if it is a 100% purchase.

All of the following factors effect the interest rate: loan to value, purchase, rate and term refinance, cash out refinance, with or without an escrow account, owner occupied, second home, rental property, fully documented income verification, stated income, no income verification, and borrower's credit. In addition to all of the factors above, other things like which closing attorney will be uses; which county the property is located in; what day of the month closing is in; which insurance company is writing the hazard insurance policy; mandatory home owner association dues; and more go into the actual cost of the loan.

There are certain costs that are going to be the same regardless, which mortgage company you select. Fees to record the loan documents at the courthouse run generally between $45 and $60 depending on the number of documents. Appraisals are usually pretty much the same based on loan type.

Also, its not a good idea to rely on percentages of the loan amount as a guide to closing costs either. There is no good rule of thumb. For example, the appraisal, credit report, attorneys fees, recording fees, survey, tax service, flood certification, courier, etc. will be roughly the same dollar amounts on virtually any loan from $50,000 to $300,000. But as a percentage the numbers change dramatically.

Let us take something as simple as an appraisal. A conventional appraisal usually costs around $250 - $350. Using $250 - that's a full half-percent (.50%) of a $50,000 loan, but Only 1/10th on a percent (.10%) of a $250,000 loan.

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What you really want to know are four things:

Yes, there are loads of companies that will give you a rate quote over the phone and fax a Good Faith Estimate to you with little or no hard information from you.

The good mortgage companies are not so desperate for your business that they have to misquote you. They don't hope to bait and switch you with low costs on a good faith estimate today in order to get you in the door only to find some excuse not to give you that deal tomorrow.

The good mortgage companies are willing to disclose the real costs of a loan to a legitimate potential client. But the good companies also don't want to mislead that potential client. They prefer to give a very high level of service to their serious clients. That service starts with a careful and complete analysis of the client's needs and wants, then offering that client detailed information, including all costs and interest rates on a number of possible options to help the client make the best and most informed decision for that client's unique circumstances.

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