Basic training

Searching for a home loan felt a little like preparing for a battle to
first-time home-buyer Berna Zarate.

“The whole thing makes you feel defensive, like a babe in the woods,” says
Zarate, a technology employee recruiter in Anaheim, Calif. “I was pretty
overwhelmed. You just cross your fingers and hope you’re not going to get
ripped off.”

Actually, there’s more you can do. Whether you’re buying for the first time
or refinancing for the 10th time, here’s how you can save time, money and
frustration in the often-unsettling mortgage process.

Shop for a loan, not a lender

You may have a strong, long-term
relationship with your bank, but that doesn’t mean it will give you the best
deal. Most loans are sold on the secondary market, so the financial
institution that gives you the loan might not be the one that owns and
services it for the next 30 years.

Long gone are the days when your only decision was whether to get a fixed
or an adjustable. Today, there are loans for first-time buyers, loans for
people who plan to move in a few years, loans to eliminate private
mortgage-insurance requirements, loans that mix the advantages of both fixed
and adjustable. Do some homework and figure out which loan is right for you.

HSH Associates sells a Homebuyer’s Kit for $20, including a 54-page booklet
on shopping for a loan. Call 800-UPDATES. To get started, you can check out
the accompanying summary of loan types.

The more knowledgeable you are before you approach lenders, the better deal
you’re likely to get. A loan officer will take you more seriously if you ask,
“What’s the rate for an adjustable with 10 percent down, linked to the 6-month
LIBOR (London Interbank offered rates) with a margin of no more than 2.75 and
a 21-day lock?”

If you ask, “Hey, what’s a margin, anyway?” an unscrupulous lender will
smell blood in the water.

Work the phones

Interview lenders over the telephone before meeting with
them in person. Lenders and brokers may want you to meet in person (to
pressure you into filling out an application) but if you know what type of
loan you’re looking for, there’s no reason you shouldn’t comparison shop via
phone.

Fixed versus ARM

Fixed-rate loans look like a good bet these days.
Interest rates are hovering at about 7.4 to 7.6 percent for fixed-rate loans,
and the spread compared with adjustable-rate loans has dropped below 2
percentage points, making fixed-rate loans a better value.

ARMs still deserve consideration. First, they’re easier to qualify for,
have lower starting interest rates and often have lower loan fees. If you plan
to move within five years, an ARM will probably be cheaper than a fixed-rate
loan. A compromise could be a so-called hybrid ARM, which offers fixed
payments for three to seven years and then adjusts to current interest rates.

Make ’em work for it

Let lenders and brokers know you’re shopping
around. If a loan officer knows you’re shopping (particularly with large banks
or S&Ls, which often offer the most competitive rates) they’re more likely to
cut to their best offer.
But be skeptical, particularly if someone quotes you a rate that is more
than half a percentage point lower than the others.

Lender checkup

The mortgage industry is increasingly dominated by small-
and medium-size brokers and mortgage bankers, rather than the big familiar
banks and S&Ls that once handled most loans. It’s crucial that you check out a
company’s past.

The need to do a background check on your mortgage broker or lender was
illustrated by the recent crackdown by state regulators against Irvine,
Calif.-based Preferred Credit Corp., which was fined $1 million for
withholding customers’ loans proceeds for up to two weeks while still charging
interest.

What’s the point? If you really want to shock your broker or loan officer,
ask what kind of rebate or yield spread premium he or she is getting on the
loan.

Brokers typically get paid in two ways: the fees, or points, and an
often-overlooked rebate brokers receive from the lender. This back-door rebate
is paid when brokers sell you a loan with an above-average interest rate.
Other times, rebates are paid for by including a prepayment penalty clause in
the loan agreement or some other lender-friendly feature.

For example, if a broker can sell you a fixed-rate loan at 8.1 percent when
the average rate is 7.8, the broker might earn an additional 1 percent in
fees. The rebate is paid by the lender, but the cost is passed on to you in
the form of a higher rate.

Brokers are required to disclose the rebate before the borrower signs the
paperwork, but the disclosure doesn’t have to be part of the good-faith
estimate of loan costs you receive when you first apply for the loan. In the
final disclosure form, it may be listed ambiguously as a “yield spread
premium.”

There’s nothing improper about the rebate, as long as you know about it.
Remember to ask. And take the rebate into account when negotiating with the
broker over his fee. If you are paying the broker a 2 percent loan fee
upfront, and the lender is paying him another 1 percent rebate, that’s a 3
percent fee, which is pretty high. Ask the broker to reduce your interest rate
or fees.

How much should a broker get? The size of the fee varies, based on the loan
size, but 1 to 2 percent of the loan amount is usually enough. Take into
account how complicated your loan is. If you barely qualify and the loan
officer has to scramble for approval, a higher fee may be appropriate. For a
no-hassle refinance, you should expect to pay less. Generally speaking, if a
broker is pocketing more than 2 percent in profits (including the rebate, but
not “hard” costs like appraisal, credit, title, etc.) you deserve an
explanation.

Variable rates

There’s more flexibility in interest rates than you may
think. The same loan with the same lender can have many different interest
rates, ranging more than a full percentage point. The key difference will be
in the loan fees. Higher interest rates have lower fees and vice versa.

Keep that in mind when a loan officer tells you at the last minute he can’t
offer you the promised loan at the promised rate because it’s no longer
available. More than likely, you can still get the lower rate, but it will
mean the broker will have to accept a smaller fee.

No-cost loans

With no-cost loans, the closing costs (appraisal, credit,
points, etc.) are built into the mortgage by charging you a slightly higher
interest rate, usually an additional 0.5 percentage points. It’s a great
option if you won’t stay in the house very long or plan to refinance.

If the average interest on a fixed-rate loan is 7.5 percent, the no-cost
equivalent would likely be about 8 percent. Watch out for prepayment-penalty
clauses, which are increasingly common with no-cost loans.

And don’t forget to inquire about the broker’s rebate. Just because you’re
not paying any fees doesn’t mean you shouldn’t care. Most no-cost loans
require a rebate of about 2 to 2.5 percent to cover closing costs and the
broker’s profit. If you’re paying more, chances are you can negotiate a lower
interest rate.

Unpleasant surprises

Too often, when you sit down to sign the loan
documents, you discover the interest rate, points or some other feature is not
what you expected. Borrowers are at their most vulnerable point when sitting
down to sign the paperwork, and a shady lender may try to exploit your
disadvantage. There are some steps you can take to reduce your risks.

After your loan is first approved, get a loan commitment in writing. It
should spell out the size, interest rate, fees and other details of the loan.
If possible, include an expected closing date.

Get the rate lock-in in writing, too. Otherwise, the interest rate on your
loan may be subject to change until the day you sit down to sign the
paperwork.

Get a receipt for all fees you must pay upfront, including the terms under
which the money will be refunded in the event that the loan doesn’t close.

Take notes during or immediately after conversations with loan
representatives. It will help refresh your memory later and may be helpful if
you end up disputing the terms.

Multiple applications

This is a tough one. There’s no doubt that
applying for a loan with two lenders will give you the upper hand. You can
play the lenders against one another and negotiate down the interest rate and
costs.

The downside is that you’ll have to pay double application costs, and
if lenders find out you’re applying someplace else (and they often do) they
may not work as hard on your loan.

Early bird

Most people sit down to sign their loan papers a day or two
before escrow closes. But unless you are under a tight deadline, arrange to
have the documents sent to you a week or two early. It will cut down on the
stress and enable you to read the papers without everyone looking over your
shoulder. Also, if you discover any surprises, there may still be time to fix
them.