Shopping For The Best Mortgage Rates
Published: Saturday, September 01 2012
Saving Thousands! With Robert Palmer.
Good morning. And welcome to this week's edition of "Saving Thousands." I'm Robert Palmer. And as always, I'm here to help you save money by making better financial decisions. Each week we look at the tricks and distractions that financial services companies use to get us, as consumers, to overpay.
This week we're going to look at the mortgage industry, and how they prevent consumers from shopping around. We'll break down shopping for a mortgage loan into simple, easy to understand steps. I'll explain the truth about APR, or annual percentage rate, and look at a housing scam that resulted in fines of over $7 million.
But before we get into the distractions, we're going to take a look at the simple process of shopping for a mortgage. Spring and summer represent the busy home-buying season. And with record low prices and record low rates, I think a lot of viewers will be setting out to purchase a home this year.
Every week on the show, I talk about how important it is to shop around. When it comes to buying a home, a lot of consumers are intimidated by the process of shopping and comparing mortgage loans. I completely understand these fears. But today, I'm going to break down the process into these simple steps to allow anyone to shop for the best mortgage like a pro. So let's get right in.
Step one, select three mortgage companies to consider. Most likely, your real estate agent will recommend a lender. It's also a good idea to check with your bank or credit union. And then choose at least one other lender to compare.
According to the National Association of Realtors, 2/3 of home buyers take the very first mortgage they're offered and don't consider any other options. This is a huge mistake. Think about it. If the first lender you choose is going to overcharge you by $5,000, or even $10,000, you would never know because you have nothing to compare the fees and interest rate to. It's always important to have at least three companies, so you can compare them side by side.
Once you've chosen at least three lenders to compare, the second step is to request a quote from each lender. It's very important to let each lender know you're shopping around. This will encourage each company to give you the best quote possible. Most lenders think they don't need to compete for your business. They know that more than likely you're one of the 2/3 of home buyers that will pay the fees without question and without shopping around.
As a smart consumer, we need to use this to our advantage. We need to make companies compete to earn our business. You'll need to ask each lender the right questions and find out what the best mortgage loan is for you. Whether that's a 15-year loan or a 30-year loan, if you should put 5% down or 20%, all these factors will cause the quotes to be different. So once you've determined the loan type, term, and down payment that's best for you, make sure you ask for the same loan at all three companies. This way will be easier to compare each quote side by side.
Most lenders will usually need to pull your credit and check other basic information before giving you a reliable quote. As we discussed earlier on other shows, having your credit pulled multiple times in this situation will not hurt your credit score.
The third step happens once you provide a lender with this basic information to qualify, and they're ready to give you the quote. They'll provide you with an estimate outlining all of the closing costs involved with the transaction. A lender should never charge you for preparing this quote. And be wary of any lender with an upfront application fee.
So let's take a look at the good faith estimate, or GFE. This is the form used by mortgage lenders to quote the fees associated with the loan. This form is broken down into a number of sections, each dedicated to a different group of fees.
The first two sections are the most important because these are the fees the lender will be charging you for the mortgage. The next section break down the fees charged by other providers and are not directly controlled by the lender. Let's take a look at the section of the forms that are not controlled by the lender in more detail.
Sections four and five are dedicated to title insurance. This is provided by a settlement agent or attorney who will actually perform the closing on your mortgage loan. Title insurance protects you and the lender against title defects to make sure you will actually own the home you're purchasing.
Section six is other required services you can shop for. This would be items like surveys on the property, home inspections, other things you decide you'd like to purchase. And, again, in most cases these are at your discretion as the buyer.
Section seven and eight are government fees and recording fees. These are charged by the state and the local counties as taxes. In the state of Florida, we have higher taxes here because we don't have a state income tax. The lender has no control over the amounts charged in box seven and eight.
Finally, section nine is the initial deposit into your escrow account. This is to collect the money up front, so the lender can pay your property taxes and homeowner's insurance each year as a part of your loan. If you elect to not have an escrow account, this will be zero. And if you are escrowing, the amount collected would be the same for any lender you do business with.
Be careful. Some lenders will try to change these charges to make their loan appear cheaper. But the numbers in these boxes have no bearing on the actual cost of the loan because you as the consumer are ultimately in control of the charges in these sections.
When comparing the cost of each loan, it's important to focus only on sections one and two. The rest of the fees, as we just explained, are out of the lender's control and are disclosed for illustration purposes only. Unfortunately, all these other sections can become a distraction. Some homebuyers get caught up on all the other fees and looking at the total fees, when really we have to focus just on adding up box one and two because as we're comparing the different estimates, it's pretty easy to identify the loan with the lowest fees.
But what do you do if two loans have different interest rates? What if the loan with the lowest fees doesn't have the lowest interest rate? We'll tackle this issue and more when we get back.
Stay tuned. We'll be right back with more "Saving Thousands" with Robert Palmer.
Welcome back. So just what do we do when the mortgage loan with the lowest fees doesn't have the lowest interest rate? This is one of the key issues that makes shopping for a mortgage loan difficult. There are unlimited combinations of rates and fees. So how do you compare a loan with lower fees and a higher rate to the loan with higher fees and the lower rate?
Well, this is where the annual percentage rate, or APR, comes into play. The purpose of the APR is to calculate the total cost of the loan by adding the upfront costs to the yearly interest costs and then expressing the total cost as an interest rate. Please remember that APR is not the rate you pay on the mortgage loan. The monthly interest is calculated using the note rate. And the APR is merely there to express the total cost of the loan that is both the upfront fees and the interest. The form each lender will provide you to show you the APR for the loan you're applying, is the Truth in Lending form, or often called a TIL or till, by mortgage professionals.
I'm going to give you some examples and try to help you understand just what the annual percentage rate is and also look at some of its shortcomings when it comes to shopping for a loan. The APR is the calculation designed by regulators to help you as consumers compare mortgage loans. But instead, it's become one of the most important parts of the mortgage process.
The basic idea behind the annual percentage rate is simple. It's the combination of all the finance charges associated with the loan and the interest rate charged. Unfortunately, few people understand just how this process works or just what the APR really represents.
When you obtain a mortgage loan, there are three potential sets of costs-- the interest rate, which is determined by the note rate on the loan; the finance charges, which are the fees you pay up front on the good faith estimate, such as lender fees and buy-down costs; and then, finally, there's mortgage insurance. When you borrow more than 80% of a home's value, you're forced to carry mortgage insurance, which increases the cost of the loan. So let's take an example.
Let's say you can get Loan A at an interest rate of 3% with no up-front lender fees. Or you could get Loan B at a 3% interest rate with $5,000 in up-front lender fees. Your choice would be a no brainer. You would choose Loan A.
But what if Loan B had a lower interest rate, say 2.5% with the $5,000 in fees? This makes the decision a little tougher. The APR calculation was designed to allow consumers to compare these two loans.
So how exactly is the APR calculated? It's a pretty complex financial calculation. But we can do a simple, rough calculation that will help you understand the idea behind the APR.
Let's go back and look at Loans A and B. Because Loan A has no fees, the note rate and the APR will be the same, 3%. Well, with Loan B this isn't going to be the case. The APR calculation goal is to show you the cost of the upfront fees by factoring them into the rate.
The first step is to take the upfront fees and spread them over the life of the loan. If you're applying for a 15-year loan with $5,000 in fees, the cost of those fees becomes $333 per year. That's the $5,000 divided by the 15 years. So if we were to borrow $100,000, that $333 per year is the equivalent of 0.33%. We take the $333 and divide by the $100,000 loan amount.
So if we add this to the actual interest rate from the note of 2.5%, plus the 0.33% that the $5,000 equals when spread over 15 years, you get a total cost of 2.833%. See how it's increased the cost of the loan. But we have to make sure we're looking at the overall picture.
This scenario is actually worse because if you had not spent that $5,000 on fees, you could have borrowed $5,000 less, which would allow you to save all that interest over the next 15 years. Think about it. Some people believe that if they pay for the fees out of pocket and don't finance them, they won't pay interest on that money. But if you're $5,000 had not been spent on fees, it would have gone to reduce the loan balance from $100,000 down to $95,000. So we do pay interest on that money. And by adding $5,000 in financed fees in this example, it basically doubles the cost because of the fee plus all the interest you're going to pay over the next 15 years on the extra $5,000.
These fees forced you to borrow this extra money. So for our rough estimate, we actually need to double the $5,000 and use a total cost of $10,000. This is 10% of our $100,000 loan. And when we spread the 10% over the life of the loan, it equals 0.67%. This would actually raise our interest rate up over 3%, showing that this is less cost effective than taking the 3% loan with zero lender fees.
I know the APR can be confusing. But hopefully I've illustrated that at the end of the day it shows you the cost of the fees over the term of the loan. The interest rate paid on those fees and the interest on the loan all combined into one standard rate that you can use to compare loans that have different interest rate and fee combinations. The APR will be provided to you on the Truth in Lending form by each of the lenders who give you a quote.
So let's recap. As a smart mortgage shopper, we need to obtain quotes from three different lenders. We never take the first loan we're offered without comparing it to others. And we let companies know we're shopping around. Finally, we use the annual percentage rate, or APR, to compare loans that have different combinations of rates and fees.
After the break, I'll show you how to avoid some schemes that increase the cost of your home loan. Some of these scams were settled with HUD recently for over $7 million. We'll also look at a new bureau designed to help protect consumers from predatory lenders. So stay tuned.
We'll be right back with more "Saving thousands" with Robert Palmer.
As I said earlier in the show, most home buyers take the first loan they're offered, which is often from their realtor's quote unquote "preferred lender." You may believe that working with their preferred lender will give you access to the best possible mortgage and that there's no reason to shop around.
But what if the agent is receiving some kind of undisclosed incentive from the mortgage company just for referring you? Many times these type of recommendations come from agents who want what's best for you as the consumer. But there are times when they're steering you to a particular lender because it's what's best for the real estate agent and not for you.
Let's take a look at two recent cases that were in the news that were settled by the Department of Housing and Urban Development, that's HUD, for over $7 million in penalties. According to HUD, real estate agents received illegal kickbacks and fee splitting in return for recommending clients to these companies. These are unfortunate situations.
And the only way you could protect yourself from falling victim to one of the schemes is to shop around for your mortgage, as we've said. If your real estate agent's preferred lender is, in fact, giving you the best deal, then they should have no problem with you shopping around. In fact, they should encourage it. When there are schemes like this happening, you can't blindly trust anyone. And you owe it to yourself to do your research and shop around.
According to HUD, Prospect Mortgage operated a series of sham companies whose sole purpose was to provide real estate agents with a share of the profits earned on each mortgage in return for them referring clients. HUD claims that they created hundreds of these sham companies. And they had no employees, and they were created to try and circumvent laws intended to prevent real estate agents from accepting kickbacks in return for referring mortgage companies their clients.
Now, no fault was admitted. And they didn't say they did anything wrong. But they did agree to stop the practices and to pay HUD $3.1 million in fines. All of the buyers who were subject to this scheme probably paid more for their mortgage because of this fee splitting.
Think about it. These type of arrangements increase the cost of the mortgages. When a lender has an arrangement to pay 50% of the profit on the loan under the table back to the real estate agent, they have to charge you twice as much to absorb these costs. The only reason these kind of arrangements can even exist is because so few consumers shop around.
Another similar case, according to HUD, involved Fidelity National Financial and kickbacks through referral of title insurance business. HUD claims that Fidelity National Financial paid real estate agents kickbacks disguised as a combination of licensing and sublicensing fees for online software. According to HUD, the fees were actually being paid for the referral of real estate settlement business. Again, Fidelity admitted no fault. But they did agree to pay HUD $4.5 million in fines.
In most of these cases, consumers believed the referrals were being made with their best interest in mind. But in reality, they were being made to earn the alleged kickbacks. And while neither company admitted fault or to breaking the law, they did pay a total of $7.6 million in penalties.
And you know, at the end of the day, whether the kickbacks were illegal or not is irrelevant. What matters is that there are real estate agents who recommend companies to their clients in return for money in their own pocket. I don't think any of us want to overpay for mortgage or any other costs associated with getting a loan just so your real estate agent can increase their profits on the transaction.
There's a lot of information available to you on the internet. So you can do your own research, find reviews on Realtors, title companies, insurance companies, mortgage lenders, and much, much more. Doing your homework can protect you from being overcharged and taken advantage of.
By reading about what others experience and digging into what company's promises mean for you will empower you on your journey to find the best financial products available. Again, shopping around is the only way we can be sure to protect ourselves. While most agents do have your best interest in mind, there's just no way to know what the situation is on your particular loan. But there's a very easy solution. As we said earlier, by getting the three quotes, it will become very evident to you very quickly if you're getting a great deal or if maybe you're caught up in some kind of kickback scheme that's increasing the cost of your mortgage loan.
We talked about two very high profile cases that involved very large fines from HUD. Well, unfortunately, there's a lot more of these cases that never get investigated. And because the government recognizes how important this is and how critical these types of schemes were in the financial meltdown of 2005 and six, they've actually created a new bureau whose sole purpose is to protect consumers from financial service providers. The new bureau is called the CFPB, or Consumer Financial Protection Bureau.
It's very exciting. The new bureau actually just recently received an appointment of its new director, which means they can get under way. The goal of the bureau is to educate consumers about financial products, while also doing a better job of regulating and making sure that financial services companies are playing by the rules. HUD can only do so much when it comes to enforcement, where the CFPB's job will be to not just find the very large-scale settlements, like the two we just talked about, but to find the smaller companies who are breaking the law, the smaller companies who are overcharged consumers by using schemes that prevent consumers from shopping around through the use of referrals.
So, again, I'm excited to see the CFPB's journey as they get going. I really hope they can make a difference in consumers' lives. I really hope they can help empower us all and encourage us to shop around, while also preventing companies from breaking the rules and raising the costs for unknowing consumers.
When we come back, we'll look at some questions that came in through the website, as well as show you how you can write in if you have questions or topics you'd like to see covered here on "Saving Thousands."
We'll be right back with more "Saving Thousands" but Robert Palmer.
We had two great questions come in this week off of Facebook. Joe asked, "When purchasing a new home, how far in advance should you get your pre-approval?" Well, Joe, this is a great question. And, unfortunately, right now, it can take up to six months to find the perfect home because of all the short sales and foreclosures. So we recommend you get pre-approved as much as six months before you're ready to move into your new home. If you're thinking about buying a home during this summer, now is the time to get pre-approved and get the process started.
Kim wrote, in and asked about which website or service I recommend for tracking your credit score and credit report online. Well, Kim, this is a great question. And I'm actually going to dedicate an entire segment in next week's show just to that.
So if you have a question that you'd like covered here on "Saving Thousands," you can contact us at Facebook.com slash SavingThousands and post your question on our wall. Or you can tune into my radio show Saturday mornings on FM 96.5 WDBO.
One thing to keep in mind between now and next week's show is with the free credit reporting companies online, most of them are signing you up for a service in order to give you the free credit score or free credit report. These services usually cost around $20 a month. So realize that these services are anything but free.
Next week I'll be right back here on central Florida's TV 27, Saturday morning at 10 am to answer your questions and cover all the topics about financial services and ways we can be better consumers and smarter shoppers. I'm Robert Palmer. And once again, thanks for tuning in.
Be sure to join us again next week as Robert Palmer shares more ideas on how you can save thousands while making everyday decisions. That's next Saturday at 10 am, right here on central Florida's TV 27.
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