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.
WIDE VARIETY OF HOME LOANS OFFERED
Here are some of the most popular mortgage products available:
– 30-year fixed. This is the traditional mortgage, with stable monthly payments that never change. With current rates so low (in the mid-7 percent range) this is probably the best choice if you’re planning to stay put for seven years or longer.
– 15-year fixed. All the advantages of the 30-year loan, plus a lower interest rate and you’ll own your home twice as fast. It can also be used as a forced savings plan. But with today’s modest real estate appreciation, your money could earn a better return elsewhere. Also, the tax advantages of a 15-year are reduced.
– Buydowns. A seller, builder or buyer can offer to make a lump-sum payment at the beginning of the loan that will be used to subsidize the monthly payments for the first few years. It’s a good way to assist first-time buyers.
– Piggyback. This loan was developed to help borrowers with a small down payment avoid private mortgage insurance (PMI). It’s actually two loans: a first trust deed for 80 percent of the property value and a second trust deed for about 10 to 15 percent of the property value. The borrower must have the remaining 5 to 10 percent as a down payment. The interest rate on the second loan has a higher interest rate, but it still ends up being cheaper than paying for PMI. There are also tax advantages, because the payments on the second loan are deductible and PMI is not.
– Lo-doc or no-doc loans. For those who can’t stand all the paperwork, these loans require minimal documentation. But to qualify, you’ll need a hefty down payment (often 25 percent or more) and be willing to pay higher fees or a higher interest rate.
– Graduated payment. Designed for first-time buyers, these loans offer smaller monthly payments in the first few years to help people get adjusted to homeownership. After three to five years, the payments grow to their full level. The bad news is that the shortfall each month gets added to the loan balance. This is called negative amortization.
– Hybrid ARMs. These increasingly popular ARMs, also called a 3-1, 5-1, 7-1 or 10-1 loan, offer the best of both worlds: a lower interest rate (like ARMs) and a relatively fixed payment.
– No-equity loans. Typically used to consolidate credit-card debt, these loans permit borrowers with good credit to borrow as much as 125 percent of their home value.
