While basic understanding of the "book smarts" within the mortgage industry will help you understand specific terminology, loan programs, and features, there is so much more you will need to know in order to make an informed financial decision.
My approach to providing education strives to further your understanding beyond the "book smarts" of the mortgage industry, and learn the valuable "street smarts" that will help you achieve the best possible results, while avoiding the most common pitfalls that non-informed Borrowers and Real Estate Professionals have experienced.
The Mortgage Street Smarts behind Mortgage Quotes:
There are few industries (if any) which attempt to confuse their targeted Clients (over what they are actually buying) more than the Banking/Lending industry. As Consumers, we are exposed to mortgage advertisements via our televisions, radios, computers, mailboxes, and even on computerized billboards. Banks across the country attempt to identify the specific "hot buttons" that will make a potential Client buy their mortgage products, and then they advertise accordingly.
These same advertising gimmicks then trickle down to Mortgage Companies (who sell the Bank's loan programs), and eventually to some Loan Officer's who work for the Mortgage Companies and/or Banks. It bears noting that many modern-day Loan Officers avoid subjecting their Borrowers to these "shell game gimmicks" (although sadly, not all Mortgage Professionals can be relied upon to conduct themselves in this manner).
This article is meant to assist Borrower's (and Real Estate Professionals who may have an influence over these Borrowers) in their quest to understand what their lending options truly are on any given day.
There are 2 categories of "cost" associated with a mortgage:
1. Cost-to-Acquire: These "Non-Recurring Closing Costs" (NRCC's) are specifically related to the up-front fees that are as charged to create the new mortgage loan. Examples of these costs include (but are not limited to):
b. Title Insurance
d. Origination / Discount Points
i. Flood Certification
j. And others...
NOTE: These NRCC's are charged on every new loan...the question is: who pays for them?
2. Ongoing Cost of Borrowing the Money: This ongoing cost is expressed in the form of a numeric interest rate (which ultimately affects the monthly payment and overall finance charges the Borrower must pay to the Bank).
Let's say we have a Borrower who would like to obtain a mortgage loan of $350,000. For ease of mathematics, let's say that the typical Non-Recurring Closing Costs (NRCC's) to create a loan of this size are $3,500. If the Borrower decides to pay 1 point (in addition to their standard NRCC's), then the additional fee would be $3,500 (since 1 point = 1.00% of the new loan amount). On any given day, this particular Borrower should have 3 different choices provided by his/her Mortgage Professional. These choices are:
In the table above, Option B displays the standard interest rate on a given day with the Borrower paying all of the typical NRCC's on his/her own. From there, we can easily assess the trend (which is the general rule of lending):
• The more you pay up-front, the less you pay along the way (Option A)
• The less you pay up-front, the more you pay along the way (Option C)
Earlier, I mentioned that the advertising methods used by Banks tend to cater towards pushing the right "hot buttons" of a given Consumer. If the Bank (or Loan Officer) feels that their prospective Borrower is rate and/or payment sensitive, they will likely quote Option A. Conversely, if the Bank (or Loan Officer) feels that their prospective Borrower is fee (closing cost) sensitive, they will quote Option C.
Ultimately, regardless of which Option is selected, it rarely affects the Bank (or Loan Officer) in terms of profitability.
In the above referenced table,
• The cost difference between Options A & B = $3,500
o $7,000 - $3,500 = $3,500
• The monthly payment difference between Options A & B = $51.23
o $1,747.50 - $1,696.27 = $51.23
• The estimated "break-even period" would then be 68.23 months (5.69 years)
o $3,500 cost difference divided by $51.23 payment difference = 68.23 months
o 68.23 months divided by 12 months in a year = 5.69 years
• Conclusion: In this particular example, if the Borrower intended on keeping his/her loan for over 5.69 years, it would likely make sense to pursue Option A (due to the fact that their ongoing savings would eventually catch up to the extra money paid up front).
So how do you know if you are working with the right Professional?
• Ideally, you will work with either a Direct Lender or Wholesale Mortgage Broker who has the ability to "shop" between multiple Investors on any given day.
• By doing so, your Mortgage Professional has the ability to determine which Investor has the best overall pricing (by doing the "shopping" for you)
• If you are working with one single Bank (i.e. one single Investor), your Mortgage Professional will not have the ability to shop around for you. In fact, even if this Mortgage Professional knows that the pricing from their Employer (Bank) is not the best, they will still feel compelled to sell their Bank's loan to you (because that is their only option, and that is what they are paid to do)
• Before you insist on a quote, allow your Mortgage Professional to learn more about the specifics of your risk profile (i.e. your credit score, amount of equity in the home, debt-to-income ratio, liquid assets, etc.)
o People who insist on immediately asking "what's your rate?" or "what are your fees?" without allowing the Loan Officer to understand what they are working with are unknowingly perpetuating the "shell game" that is used by unethical Loan Officers!
o This Loan Officer doesn't want you to hang up on them (or walk away), so they are likely to answer your question if pressured to do so. The fact is however, that if they provide you a quick answer without knowing what they are working with, they will probably end up being wrong (and you will end up getting angry and claim that you were "bait & switched"). The reality is that all of this could have been avoided by simply allowing the Loan Officer to do his/her job (which is to interview you before providing you a quote!)
• Work with a Mortgage Professional (Loan Officer) whom you feel you can trust.
• Consider working "by referral only" when selecting a Loan Officer. This method will benefit you in multiple ways:
o You met this Loan Officer through a trusted source (as opposed to rolling the dice randomly by logging on to a website, answering an advertisement, and/or walking into a Bank and selecting the first person who was available)
o This particular Loan Officer has an added level of accountability to the person who referred you to them (the last thing this Loan Officer would want to do is to mistreat you and risk losing that ongoing referral source!)
• Work with a Mortgage Professional (Loan Officer) who provides multiple choices (like the ones detailed in the table above)
• Ideally, your Mortgage Professional will calculate the numbers for you (to help you determine your break-even point, and therefore which option will be best for you).
o A Mortgage Professional should never assume that their Borrower understands how to calculate the mathematics associated with these Mortgage Loan options on their own.
• Never be afraid to ask questions and/or request clarification (remember: this is your money...do your diligence and choose wisely!)
• If your Mortgage Professional fails to ask you how long you intend on keeping your new mortgage, they are not fully equipped to provide guidance on which option is best
o Example: In the table above, Option A would not make sense if you intended on selling your property in 4 years (since you would not keep your loan long enough for your monthly savings to "break-even" with your up-front costs).
Additional advertising myths:
• There is no "magic bank" that always has the lowest interest rate each and every day!
• There is no "magic bank" that always has the lowest closing costs each and every day!
It is heavily recommended that you look beyond the advertising gimmicks of the major Banks, Credit Unions, and "Dot Com Mortgage Companies". Learn the facts and avoid getting hooked in by a clever marketing campaign. Remember the universal rule of any type of business:
REVENUE - EXPENSE = PROFITS
If a Bank is spending hundreds of millions of dollars on marketing costs, they need to make up for these EXPENSES by increasing their REVENUE in order to maximize their PROFITS (and keep their Shareholders happy). Like moths drawn to an open flame, millions of Borrowers are drawn towards the light of their local Banks...only to eventually get burned in the process.
For more information on topics like this, please feel free to visit www.MortgageStreetSmarts.com (an educational resource for Borrowers, Real Estate Agents, and Financial Professionals)
To see if you qualify (and to obtain a current market interest rate quote), click here for a secure online loan application form.