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Thursday, August 31, 2006

Mortgage Brokers: Banking On Your Money

The word “mortgage” is derived from a French word meaning “death pledge.” By contrast, today we see the mortgage as a dull and tedious fixture of everyday life. Few people buy new homes without mortgages, after all, and almost everyone takes out a mortgage at least once in his or her life. But beneath their ho-hum exterior lies a danger worthy of their sordid translation.

A mortgage is, essentially, a loan—usually the most money you will borrow in your lifetime—secured on the collateral of real property, that is, your home. If you can't make the payments, you and your family will not only be evicted from the property, but you'll damage your credit for a very long time to come, making it significantly harder and more expensive to buy real estate, a car, or even get a good job since corporate employers check credit nowadays.

When looking for someone to mortgage your property to, you have two options: a mortgage lender (i.e. a bank) or a mortgage broker. Because many people are intimidated by all the numbers and legalese, most mortgages are executed through brokers. Brokers find lenders for you and do most of the work you'd have to do yourself otherwise. As with any other broker, the mortgage broker is just a middleman who makes most of his profits on mark-up.

Because of the volume of his business, the broker is entitled to wholesale rates from lenders that the general public is not. Of course, for his clients, he'll inflate the figures right back up again and pocket the difference, plus charge you a very high fee for his services. If you find an ethical mortgage broker you will end up paying just about the same amount of money that you would if you dealt with a bank directly. But in an industry where the broker keeps whatever fees he can get you to pay either immediately or over the long-term, even the most ethical of us would need to examine our own definition of honesty.

What It Costs:

The cost of the mortgage will depend on the amount of the loan, the term of the mortgage, your credit score and the interest rate. If you have an excellent credit history, the interest rate you're given will correspond very closely to the mortgage rate specified by the federal government. If you have a less than perfect credit score, you will get quoted a higher interest rate to reflect the additional risk that the bank considers you to represent, plus whatever other random fees the broker can conjure up.

While the precise definition is somewhat obscure, suffice it to say that the government rate is what the lender must end up "making" from the mortgage. So if all lenders have to make the same amount, how can they compete? By undercutting each other's advertised interest rates—the only figure too many people consider when looking for a mortgage—and recouping the difference in the down payment and the typical flood of service fees: application, processing, underwriting, origination, etc.

Even under this charade of competition, you will still find that advertised interest rates don’t differ by more than 0.5% – 1.0%. A 0.5% difference in a $100,000 loan will amount to tens of thousands of dollars in the course of its term, which is way too much money to recover with a few token fees. If you find two brokers who offer you interest rates that differ by 2% or 3% for an identical loan, rest assured one of them is a scam artist.

In the end, for someone with a good credit score, the final cost will be virtually the same everywhere, but how you settle this cost, that is, how much you pay "now" and how much you pay "later", can vary widely among different mortgage plans. Many times you can get a lower interest rate by giving the bank money immediately. This “early payment” money is usually expressed in terms of "points". One point is one percent of the loan amount, so if you're borrowing $100,000 with 2 points down, you'll have to put up $2,000. You'll also have to pay any incidental fees up front, which are usually flat, but may sometimes be a percentage of the loan, especially if the down payment and the interest rate are both discounted dramatically. One of the ways that mortgage brokers have a field day is by charging you extra points on your mortgage which go directly to the broker – but more on this later.

Fortunately, the down payment, the interest rate, and most (though not always all) of the fees will be distilled into one simple figure: the annual percentage rate, or APR. Lenders and brokers are required by federal law to provide the APR on their mortgage plans, which will disclose the "effective" interest rate on the mortgage once the down payment and the fees are taken into account. So while one broker may offer an interest rate 0.25% lower than his competition, the difference between the two APR's will probably be a lot less, and the balance may even be tipped towards the competitor. While the APR makes comparison shopping for mortgages easy, you have to consider it alongside your personal situation. If, for instance, you don't plan on keeping a house for very long, you would probably choose a mortgage with a low down payment, even though the exact same APR, or indeed a slightly lower one, may be offered elsewhere.

Another thing you'll want to consider is tax deductibility. Down payments are usually tax deductible, but only for the year in which the mortgage is made. Consult a tax professional to help you determine what refunds you may be eligible for.

The Mortgage Broker Says:

"I am an extensively trained, honest, and dedicated professional who offers my customers an interest rate that's far lower than any of my competitors'. Since you'll never find a lower rate anywhere else, financing with me is a no-brainer. I will disclose all the charges up front and never mislead or trick you into signing an unfair agreement. All I want is to help you get the money you need or purchase the home you and your family have always dreamed of. Don’t worry if your credit is less than perfect – I know people and I’ll take care of you."

The Snitch Says:

"The mortgage broker’s dream is someone with an excellent credit score who comes to the mortgage broker with no knowledge of how the process works. Then the mortgage broker can arrange for a low rate, charge the client a high rate, and keep a big commission on the difference, plus whatever fees he can convince the client to pay at closing.

Realistically, most people with excellent credit just go to the bank or credit union for a loan. There is no reason to even play games with mortgage brokers. The people who come to mortgage brokers are usually people with “dings” on their credit. Mortgage brokers don’t want clients with terrible credit because then they actually do have difficulty finding a lender. What they like is clients with fair credit who are glad to get any mortgage at all – then they can explain that they went through hell and back again but at the end “sold” you to the lender. There are computers mortgage brokers have in which they enter in a client’s financial data and then I matches them up with lenders whose criteria are satisfied. Mortgage brokers have access to all sorts of expensive lenders, from private investors to high-risk banks to regular banks that would have given you a loan anyway, at a higher rate and with more points due at closing.

Mortgage brokers love to lie to you about your credit score. There are 3 credit bureaus and each has a different score for you. Most lenders use the middle score. The mortgage broker will probably use the lowest score to help convince you that your credit is terrible and you should take anything this “hero” can get you. Your middle score can be significantly better than your lowest score.

Another favorite trick of mortgage brokers is telling you that you’re getting one rate and then as close as possible to the closing informing you that you’re getting a significantly higher rate – usually when it’s too late to find alternative financing. In the “Protecting Yourself” section, below, we discuss how to deal with this.

If the mortgage broker is legitimate—and that's a big "if"—his rates are going to be pretty much the same as everyone else's, despite all his grandstanding. Sure, he may offer a lower rate by a quarter of a percentage point or so, but even then he'll recoup it through higher fees and down payments. Because the federal government specifies a rate that all lenders have to follow, you'll never find any staggering difference in price between brokers.

Of course, as with any business involving huge transactions of money, especially one as prevalent as the mortgage industry, you're going to find your share of crooks. Most mortgage crooks, however, are subtler than their likes in other industries. Brokers make their money in two ways: from the "front end" of the loan and the "back end" of the loan.

The "front end" comprises all those miscellaneous fees—application, processing, origination, etc.—that basically add up to one big broker fee. The "back end" is the money made on the mark-up between the wholesale rate he gets from the lenders and the re-inflated rate he gives you. All brokers profit from this mark-up, but the devious ones negotiate privately with lenders for what's called a "yield spread", a cash incentive for the broker to sucker you into as high an interest rate as possible. You might not think getting a pushover to bite at a 7.50% rate when the industry standard is 7.25% is such a terrible thing, but when hundreds of thousands of dollars are involved, it can cripple or break anyone's budget. The lender makes tens of thousands of dollars in extra profit from this, and will happily throw the broker a grand or two for his efforts. Other unscrupulous brokers will charge you the standard interest figure, but tack on additional points to the down payment as if he were offering a premium rate. Most people are too confused by mortgages to look anywhere beyond the interest rate and won't notice as the broker swindles them out of thousands of dollars in cash.

For all the standards the government sets for banks, and for all the strict control it exercises over mortgage rates, regulation for brokers doesn't even exist at the federal level. Many states require no license, training, registration, or certification of any kind to become a mortgage broker. Because of this complete lack of accountability, you have no way of knowing whether your broker is a clueless incompetent or a shameless grifter."

Protecting Yourself:

The best thing you can do is improve your credit to a score of approximately 650 or better so that you can use a bank and forget the mortgage broker altogether. You will never hear the mortgage broker tell you to go out of your way to improve your credit. They’ll tell you to just pay your bills on time. This keeps you good enough to get a loan but not so good that your local banker will ask you to sit down and make a deal.

If you’re buying new construction or otherwise have time until you need to make a commitment, order your credit reports and dispute anything on there which is not true and correct anything that can make you look better. Pay all your bills on time and pay more than the minimum payment on credit cards. This will improve your credit score a lot. Read on the Internet about specific methods of improving your credit. It’s a big job but worth a fortune when the bank agrees to give you a mortgage at prime.

All that being said, nothing can have a more devastating impact on your financial future than an ill-advised mortgage, so don't even think about signing anything until you shop around. When comparing brokers, remember not to consider the APR in isolation. You'll have to take your personal situation into account, not to mention the bevy of fees that don't always show up on the APR—such as the title fee, the appraisal fee, and the escrow fee—which put together can total thousands of dollars. Within three days of your application, however, government regulation requires the lender/broker to provide you with what's called a "good-faith estimate". This is a comprehensive invoice of all the costs involved in the mortgage and its closing. Weigh the APR and the good-faith estimate together when shopping for a mortgage, and do not commit to anything before you're given a good-faith estimate.

Unfortunately, good-faith estimates are, as the name implies, just estimates. Worse still, they may not always be in good faith. Because there are no laws against providing an inaccurate estimate, many brokers will knowingly set their estimates much lower than the figures that will show up in your contract on closing day. The best way around this is to "lock in" all the fees with your chosen lender beforehand. You can do it 30, 60 or 90 days in advance – for a fee, of course.

No matter what you choose, if any nasty surprises rear their heads on closing day, don't sign anything without first discussing everything with your broker. If his explanations don't satisfy you, cancel the closing. A botched deal may seem like a disaster, but spending the rest of your life in debt is much worse.

Sometimes brokers will "float" rates to potential clients, meaning they'll quote a rate considerably below market value in hopes conditions will improve before closing day. If it does, no one knows any better, but if it doesn't, he'll probably mention something about a new rate maybe five minutes before you're due to sign the papers. Do whatever you can to lock in the rates the broker offers you before the closing. If he seems hesitant to commit to anything, you should consider taking your business elsewhere.

You may be able to reduce or eliminate some of the listed fees by pursuing alternatives other than those suggested by the broker or his lender. Title insurance, for instance, can be purchased from many companies, but the lender or broker will usually suggest an "affiliated" title insurance firm, and most people will capitulate for the sake of convenience. Of course, it's more convenient for the lender / broker than anyone else, since he pockets the kickback culled from a grossly inflated fee. If you insist on signing with another title insurer, however, he'll give in pretty quickly, since that kickback is only a fraction of what he makes on the mortgage altogether.

Be sure to check whether the mortgage agreement includes a prepayment penalty. A prepayment penalty is a surcharge for paying back all or part of the loan before the payment is due. The longer you take out a loan, the more interest accumulates for your creditor, so he stands to lose money if you pay him back too early. This is why many brokers slip a prepayment penalty clause into the paperwork. Still, most brokers will reduce or eliminate a prepayment penalty if you press the matter, rather than risk losing your business completely.

Ask if the mortgage broker is willing to sign on as your agent. An agent has many duties to his principal (you), including honesty and full disclosure. The mortgage broker does not work for you and has no more duty to tell you the truth and act in good faith than any store clerk would, unless he agrees to be your agent. Don’t be surprised if many brokers act like they have no idea what you’re talking about and make up some law that requires them to be fully honest, or some other excuse not to become liable to you as your agent.

Above all, when choosing a broker, stay on your guard and use common sense. If a small-time broker tries to sell you a drastically lower APR than his more established competitors, walk away. Even when dealing with a reputable broker who is offering industry standard rates, you should always be careful, given what's at stake. You might want to consider hiring a real estate lawyer to examine the documents before you sign them. It'll run you a couple hundred dollars beyond what you're already paying in fees and the down payment, but signing a contract you don't understand can cost you much more.

Just Because You Were Curious:

Brokers are not a necessary evil. Not all of them are evil, it's true, but none of them are necessary. If you deal directly with a lender and bypass the middleman, you run a much lower risk of an extortionate mark-up sneaking into your bill. Either way, don't run to a broker just because you're scared of numbers or don't want to read any paperwork. No matter whom you do business with, broker or lender, read everything carefully and calculate exactly how much you'll be paying, and when. If a broker can tell you're just using him as a substitute for caution and patience, he'll exploit you for everything he can take. Of course, even the most honest brokers and lenders will tell you it's best to sign with them, but never forget that the only person who can decide just what is best for you is you.

Posted by admin on 08/31 at 12:29 PM

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