“Does a mortgage broker make more money with an option ARM than with a fixed-rate mortgage? I went to the broker looking for a 30-year fixed deal and allowed him to talk me into an option ARM — with a three-year prepayment penalty that I didn’t find out about until the closing. I have perfect credit and didn’t need the lower payment; I have been making the fully amortizing payment every month. Did he steer me into that loan because he made more money on it?”
In all likelihood, yes. The price of a 30-year fixed-rate mortgage is difficult to conceal; the borrower knows what the rate is and what it means. On an option ARM, the principal price is the margin, which most borrowers don’t understand and which isn’t a required disclosure.
The margin is the number that is added to the rate index every month, starting in month 2, to determine the new rate. Paradoxically, because margins don’t fluctuate with the market, option ARMs are the easiest type of mortgage to shop — if you know the secret, which is to shop the margin.
But if you don’t know that secret, and if you place yourself in the hands of a loan provider intent on making as much as possible from the deal, the option ARM is the perfect vehicle for such skullduggery.
For example, assume a competitive margin in your case was 2 percent. If the broker raised it to 3 percent, without any discussion with you, the price paid by the lender would rise by about 2.5 points. That’s 2.5 percent of the loan amount, and it would all go in the broker’s pocket.
Unless, of course, you were dealing with an Upfront Mortgage Broker (UMB), or a broker who adhered to upfront principles. In that case, you and the broker would have agreed on the broker compensation before selecting a loan type, and there would be no reason for the broker to steer you to an inappropriate loan. In the unlikely event that you decided you wanted an option ARM and were willing to pay the higher margin, the 2.5 points would have gone in your pocket rather than the broker’s.
When the Deal Sours, How Much of the Advance Can the Broker Keep?
“I took an advance of $500 from the customer, locked the loan, sent the loan file to the lender, and ordered the title and appraisal. Because the borrower’s credit was weak, the lender imposed numerous conditions and document requests, which annoyed the borrower and caused him to drop me and go to another loan provider. Given my investment of time and money, can I keep the $500?”
Contract law governs this type of situation. You can keep the $500 if your agreement with the borrower regarding the purpose and disposition of the money stipulates that you can. I assume, however, that you don’t have a written agreement with the borrower, and that your oral agreement was ambiguous.
If I were arbitrating such a case, I would allow you to defray any out-of-pocket costs you incurred on behalf of this borrower. On the other hand, I would not allow you to retain any payment for your time and effort. If you expect that, you should have a written agreement that states it.
Does a HELOC Adversely Affect Your Credit Score?
“Is it true that taking out a HELOC has negative impact on the credit score? More so then a refinance or second mortgage?”
A HELOC adversely affects your credit score if you are using a large portion of your total line. HELOCs are viewed as revolving credits, similar to credit cards, where there is a balance and a maximum balance. The ratio of the first to the second is used as a measure of financial strength.
The rationale for using the ratio in connection with credit cards is clear cut. Borrowers who max out their credit cards are often in, or heading towards financial distress. The case for using the ratio in connection with HELOCs is weaker, I think, because HELOCs today are often used as a substitute for single-payout mortgages where the total amount is extended at the outset.
Under the existing rules, a one-time payout loan does not affect the credit score, only the payment record does. But a HELOC taken out for the full amount at the outset will negatively affect the score at the outset. Then, as the balance is paid down over time, the score will rise.
The writer is professor of finance emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.