Michael Wagner Tricks and Tips Mortgage’s
Top 10 Mistakes in Real Estate Finance
This is an excellent question. We find that there is a great deal of public misunderstanding about underwriting guidelines, as if they were rules cast in stone. We sometimes refer to these people as “they-sayers.” For example, “They say you can’t get a mortgage if you’ve just changed jobs or employers.” Or, “They say you can’t get a mortgage if you’ve ever had a bankruptcy.”
There are many different sets of underwriting guidelines used to determine loan approvals. The most common guidelines are FHA … VA … FNMA (commonly called “Fannie Mae”) … and FHLMC (commonly called “Freddie Mac”). These guidelines make up the “rules” of the mortgage game. The guidelines and procedures change frequently, so it is critical that you choose to work with a mortgage consultant who keeps up with these ever-changing rules.
There’s an old saying that, “Rules are made to be broken.” While few lenders will actually “break” an underwriting guideline, some will bend them much farther than others in order to approve a loan application. At Best Mortgage, we have established relationships with “flexible” underwriters who look for ways to say “Yes” rather than “No.” You can make a big mistake if you go to a bank or mortgage company that offers only one way to approve a loan, with strict, “by the book” underwriting.
Some banks and mortgage companies boast that they can just walk down the hall to their in-house underwriter and get a quick loan approval. This tends to give uneducated borrowers the false belief that an underwriter who works for the same company as the loan officer will be a little more flexible.
We have found the exact opposite to be true. In-house underwriters often seem to be more cautious in their decision-making to avoid any appearance of impropriety. Some lenders even have a company policy of reviewing branch office loan files more strictly than those submitted by outside mortgage brokers. It some cases, it is even company policy to prohibit the loan officer and underwriter from directly discussing a loan file! And as in any office setting, it is always possible to have personality conflicts between the loan officer and the underwriter. If the underwriter is in-house, the loan officer has no choice but to work with him or her.
At Best Mortgage, we are constantly being solicited by the top “wholesale” mortgage lenders in the country. These lenders attempt to earn our business by offering us the best interest rates and customer service. One of the services offered to us is the ability to talk directly to the underwriters and discuss “What if …” scenarios. This allows us to review special situations with the underwriter who will actually be making the decision before we submit the loan file for approval.
Another advantage of working with a mortgage broker like Best Mortgage is that on the rare occasions when a loan application is “declined” by the first underwriter we send it to, we simply pull the file and take it to another underwriter and get the loan approved by a different lender. Loan officers with in-house underwriters have only one shot. If their underwriter says “No,” you’re out of luck and you have to start all over again with another mortgage company.
“I should apply for a mortgage at my bank. They already have my checking and savings accounts. Won’t it be simpler for them to provide my mortgage? Won’t they give me a special deal or some type of preferred rate?”
The interest rates, closing costs and loan programs offered to you by a commercial bank would typically be the same as they would offer to any loan customer who walked in off the street – regardless of where they bank. There are rarely any special considerations given (unless you happen to be someone like Bill Gates). In fact, many banks own and operate separate mortgage subsidiaries that aren’t really even part of the “bank.” The mortgage subsidiary does not have any greater access to your bank account records than any other mortgage company. In other words, they have to request verification of your account balances and loans through the same bureaucratic channels. This means your loan application process will not be simplified or viewed any differently than a bank verification request coming from an outside mortgage company.
The perception of many people who go to their bank’s mortgage subsidiary is that their mortgage payments will always be made to their bank, thus all of their financial needs can be met under one roof. The reality is that most banks, like virtually all mortgage companies, sell their mortgages on the “secondary market” through agencies such as “Fannie Mae.” You might start out making your loan payments to the local bank, only to have your loan sold to another loan “servicing” company a few months later. You would then have to mail your mortgage payment every month like most other borrowers.
A disadvantage of working with your local bank is that they have a limited number of loan products. As a licensed mortgage broker, Best Mortgage works with lenders all over the country, offering every kind of mortgage loan product imaginable. It is doubtful that a bank loan officer would always have the best loan program to meet your needs. You or the property you are buying might require a special loan program or flexible underwriting that the bank cannot offer.
Finally, it will probably cost you more to get a mortgage through your local bank because banks have big, expensive buildings to pay for and high overhead. They can’t compete with efficient, low-overhead mortgage brokers. Incidentally, many people have the mistaken impression that mortgage brokers earn their money by adding points on top of the fees charged by the bank. That is not the case at all. At Best Mortgage, we get our money at “wholesale” rates which are lower than the “retail” rates banks charge to their loan customers. They add a retail “mark-up” just like we do. In other words, we could get you a loan from your local bank and you would pay the exact same rate and fee that you would pay if you walked into that bank and applied for a loan through one of their retail oan officers. But why would you want a loan from your local bank when we can get you a lower interest rate by placing your loan with an out-of-state lender?
Private Mortgage Insurance (PMI) is required for most loans where the Loan-to-Value (LTV) ratio exceeds 80% of the property’s appraised value. In other words, any time you make a down payment of less than 20%.
PMI covers the lender’s risk on high LTV loans. It is essentially “foreclosure insurance” that pays any loss the lender incurs if you default on your loan and they are forced to sell your home at a foreclosure auction. While PMI may seem expensive to some borrowers, we are lucky we have mortgage insurance programs because many borrowers do not have access to enough cash to make a 20% down payment. Over the years, the cost of mortgage insurance has actually decreased. At one time, borrowers were required to pay as much as 1% of the loan amount up front at closing, plus a large monthly premium. PMI companies now offer plans that require as little as one month of mortgage insurance premiums to be paid at closing.
Before you make a final decision, take a close look at the true cost of making a 20% down payment just to avoid paying PMI – the money may actually be better spent elsewhere. For example, if you are pulling money out of stock mutual funds to make the down payment, what is the potential investment return that you are giving up? Diversification is the key to success in any investment program. Do you really want to have all your money tied up in your house?
If, after examining all of your options, you conclude that making a 20% down payment is still the best way for you to go, that’s fine! The point is, remember that there is more to life than simply avoiding PMI. Examine all of your options carefully before making such an important decision. That is actually the worst way to select a mortgage company.
“We’re buying a home and we know it’s smart to get ‘pre-approved’ for a mortgage before we make a purchase offer. We want to select a mortgage company and start the loan application process. The best way to do that is call around and find out who has the best interest rates today, right?”
You are unable to “lock-in” a loan rate at this point in your home search because you haven’t found a property yet, so any interest rate quote you receive is totally meaningless. Interest rates change daily, and sometimes even two or three times in a single day! Until the interest rate is locked, you have nothing. Some unscrupulous mortgage lenders take advantage of this situation and lure you in with what we call, “bait-and-switch” tactics. They promise unrealistically low interest rates to entice you into their office to sign a loan application – knowing full well that they won’t have to deliver on their bogus interest rate quote because you cannot possibly lock-in the loan that day. Once you’re a captive customer of that lender, when you’re finally ready to lock-in the rate, they shake their head sadly and say, “Unfortunately, rates have gone up” – then they lock your loan at a rate that may be much higher than you could get elsewhere.
Another problem with selecting a lender based on today’s interest rates is the competitive nature of the mortgage industry. A lender may “buy the market” one day by temporarily offering very low interest rates, and then for no apparent reason, “get out of the market” another day by suddenly boosting their interest rates. We see this happen all the time. A lender might have the best rates in town one day, and a few days later day that same lender might have some of the highest rates in town. Lenders do this for a variety of business reasons, which are beyond the scope of this booklet. But the bottom line is, Best Mortgage is a licensed mortgage broker dealing with a wide variety of lenders all over the country. We have access to the lenders offering the most competitive interest rates on any given day.
Interest rates are only one of the many factors to consider when selecting a mortgage company. As our name implies, we find the Best mortgage program to meet your needs and goals — which may be different than the loan program you thought you wanted. New loan products are constantly being introduced into the marketplace. There are many, many different loan programs available and there is no single “right” answer because every borrower’s needs and goals are unique. Unlike most mortgage companies that try to “sell” you a loan product that may or may not meet your needs, at Best Mortgage we offer lots of FREE information and advice educating you and helping you select from a number of financing options.
As we said on the previous page, interest rates are only one factor to consider in selecting a loan program. For example, most Adjustable Rate Mortgage (ARM) programs have very low “teaser” rates at the beginning of the loan, usually 2% to 3% below the true market interest rate of the loan. A “six-month” ARM (interest rate adjusts every six months) might start as low as 4.5%, but then increase to 8.5% within the first two years of the loan term. If you focus only on the low starting rate of the ARM, you lose sight of the fact that it may actually cost you more than a fixed-rate loan in the future.
You also need to keep in mind the total cost of the loan. You might be able to get a very attractive interest rate on a fixed rate loan, but if that rate will cost you 3 or 4 “points” (3% or 4% of the loan amount) the total cost of the loan may be simply too high to make financial sense. You’d be better off opting for a slightly higher interest rate and saving your cash to help cover the slightly higher monthly payments. Whenever you pay more than two points for a loan, it takes a long time before the accumulated monthly savings equal the amount of cash you have to spend up-front at closing.
These are some of the questions we help you answer when you work with Best Mortgage. You can’t be expected to be an expert in real estate finance – but we are. We’ll help you “crunch the numbers” and explore your options to find the best mortgage program and interest rate that meets your needs.
Most of the “closing costs” associated with purchasing your home are not controlled by the lender. These costs include items such as credit report fees, appraisal fees, escrow fees, title insurance fees, recording fees, etc. These are costs that anyone will be required to pay when purchasing a home or refinancing a mortgage – regardless of the loan amount or the lender they are using. These costs are for services usually provided by independent firms who are not affiliated with the mortgage company. It can get very confusing to try to compare these expenses, item by item, on estimates prepared by different banks and mortgage companies. Based on their individual experience, each loan officer will offer his or her best estimate as to what these closing costs will be and there will be differences between individual loan officers. At Best Mortgage we tend to make our estimates somewhat on the high side because we would rather have you pleasantly surprised to find that your actual closing costs are less than estimated, rather than the other way around.
When your loan officer prepares a “Good Faith Estimate” (GFE) of your closing costs, they will also include estimates for establishing your escrow account for future payment of property taxes, homeowner’s insurance and Private Mortgage Insurance (PMI), if it is required. These amounts are often called “Pre-Paid Escrows.” The property tax amount is established by the local governmental jurisdiction and will vary from house to house. Check with your Realtor to find out the actual tax amount on the home you are buying. Your homeowner’s insurance premium will be determined by the insurance company that you select. In addition to shopping between insurance companies, you can reduce your annual homeowner’s insurance premium by opting for a larger “deductible” and taking more financial risk yourself. You will be required to pay the first year’s worth of homeowner’s insurance at closing, and the mortgage company will collect two month’s worth of insurance premiums to be placed in your “escrow account.” Money accumulates in the escrow account each month until the tax and insurance bills come due, then the money is paid from the account to the appropriate insurance company and tax agency. The amount of Pre-Paid Escrows collected at closing depends on the month and day that your loan closes. Property taxes are pro-rated to the closing date. Typically, you will be required to pay between four and six month’s worth of property taxes at closing. Because of these variables, Pre-Paid Escrow estimates can vary widely from one loan officer to another. But it’s important to realize that your actual Pre-Paid Escrow amounts will be calculated by the escrow company at closing and they are not controlled by the loan officer and/or the mortgage company. Again, at Best Mortgage, we tend to estimate Pre-Paid Escrow expenses on the high side because we would rather have you pleasantly surprised to find that your actual expenses are less than estimated, rather than the other way around.
The most accurate way to compare mortgage companies (in terms of closing costs) is to ask about their specific fees for Loan Origination, Discount Points, Underwriting, Document Preparation, Processing, Lock-in fees, etc. Each mortgage company will have a different set of fees, and they may give them different names, but make sure you get a list of all loan fees you will have to pay at closing. You may get confused when comparing the “Points” charged by lenders. The term “point” is shorthand for percentage point, and it refers to a fee based on a percentage of your loan amount. For example, “One Point” equals 1% of your loan amount (e.g., $1,000 on a $100,000 loan). “Discount Points” are a form of pre-paid interest. The more points you pay up-front, the lower the interest rate on your loan. Now, be careful! Some lenders will quote a given interest rate at “one point,” meaning they are charging one discount point to reduce the interest rate on your loan – but they don’t tell you they are also charging a one point “Loan Origination Fee.” In reality, you would have to pay a total loan fee of 2%, or “two points” on your loan. At Best Mortgage, we don’t play that game. If your total loan fee on a particular loan would be a 1% origination fee plus 1 discount point, we would quote that to you as “two points” so there is absolutely no confusion about how much you would be paying in closing costs. Keep in mind that we can also close your loan with zero points and loan fees, if you choose to go with a slightly higher interest rate. And there is no such thing as a “lock-in fee,” at Best Mortgage. Lock-in fees are just a sneaky way to charge an extra point without calling it a “point” or origination fee.
There is no single “best” type of loan program. Every borrower is different, with their own individual needs and goals. You should get together with a mortgage consultant who can explain your many options among the different types of loan programs available. Each program has its own specific advantages and benefits. When making one of the most important financial decisions of your life, you must thoroughly explore all of your options. Some of the factors to consider include the length of time you expect to live in the home and/or keep the loan, the amount of liquid assets (cash) you have available for the down payment and closing costs, your current income and your prospects for increasing income in the future, etc.
If you pay off a loan in 15 years instead of 30 years you will definitely save thousands of dollars in interest expense. But it’s important to note that most of the savings come from repaying the loan in half the amount of time, not due to a significant savings in the interest rate. You might think that interest rates for 15-year loans would be much lower than the rates for 30-year loans because there is less risk to the lender due to the shorter loan term. But interest rates on 15-year fixed rate loans are typically only one-half percent lower than 30-year fixed rates, while the monthly payments are approximately 25% higher.
After taking out a 15-year loan, some borrowers find that the higher monthly payments are a little more difficult to work into their household budget than they had anticipated. An alternative is to take out a 30-year fixed rate loan, but pay it off in only 15 years by making extra payments to principal each month. That way, if you are ever short on cash one month you can fall back to the smaller 30-year payment. Read our Mortgage Q & A Archive for more information.
The old 2% “rule of thumb” comes from the days when banks routinely charged loan fees of two “points” (2% of your loan amount) in addition to the standard closing costs. To reduce your monthly payments enough to recover these costs within a reasonable period of time (2 to 3 years), you usually had to reduce your interest rate by at least 2%.
Today, borrowers have the option of refinancing a loan with zero points and loan fees. That significantly reduces your closing costs, and therefore reduces the amount of monthly savings required to recover those costs. You might find that it makes sense to refinance even if you are lowering your interest rate by only 1%.
There are many other reasons to refinance your mortgage besides simply lowering your interest rate. For example, you might want a “cash-back” refinance to pull equity out of your home to pay for home improvements, consolidate consumer debts, buy a rental property, pay for college, etc. You might want to refinance to switch from an Adjustable Rate Mortgage (ARM) to a fixed rate loan in order to eliminate interest rate uncertainty. Or, you might want to switch from a fixed rate loan to an ARM to temporarily lower your monthly payments in order to free up cash for other purposes. The possibilities are endless.
The bottom line is, before refinancing you should carefully review the total closing costs of the transaction. Even though the costs are typically added to your loan amount rather than coming out of your pocket, you are still paying them – you’re just giving up equity in your home rather than taking money out of the bank. You also need to consider what the new monthly mortgage payments will mean to your lifestyle and household budget. Only after you’ve “crunched the numbers” can you make an intelligent decision. At Best Mortgage, we help you analyze all of your options and guide you through the process to make sure you make the right choice. If now isn’t the right time to refinance, we’ll tell you so!
Many home buyers have sufficient income to buy a home, but they have trouble scraping together enough cash to cover the down payment and closing costs. Many first-time home buyers are surprised at how fast those costs add up. Depending on the price of the home, closing costs can run anywhere from 2% to 5% of the total purchase price. If you are struggling to come up with enough cash to close, it may be to your advantage to pay a slightly higher price for the home in exchange for the sellers paying some or all of your closing costs.
For example, let’s say you are considering buying a $250,000 home and your loan closing costs total $2,500. If you paid $252,500 for the house and the sellers paid all of your closing costs, that means you’d have to bring in $2,500 less cash at closing! Your loan amount would be slightly larger, but that would increase your payments by only about $20 per month. Which would you rather do, spend $2,500 today or pay an extra $20 per month for the life of the loan? Either way will work, but the point is: it’s YOUR choice.
If you are making a minimum down payment on the home (3% to 5%), the seller can pay up to 3% of the purchase price toward your “allowable closing costs.” If you are making a down payment of 10% or more, the seller can pay up to 6% of the purchase price toward your closing costs. Don’t ignore the possibility of negotiating seller-paid closing costs in your purchase offer. It is one of the most powerful, and often overlooked financing tools available to home buyers.