"I don't want an education in mortgages; I just want to know enough to save as much money as possible on my new mortgage. Also, as an African-American, I want to avoid being taken advantage of. Any chance you can distill what I need to know into one article?"
Here are some quick and dirty suggestions for vulnerable borrowers who want to save money but don't want to make the process into a life's work.
Determine Your Status as a Borrower Before You Search For a Loan: You may not qualify, which is a common occurrence in a market that has become very demanding in the wake of the financial crisis. Or you may qualify, but not for the best prices possible. In the first case, you must wait until you have strengthened your application, and in the second case you may elect to wait in order to earn a lower price.
Our housing finance system is weak in providing this service because it is hard to make money at it. You can get a partial answer at the sites of Upfront Mortgage Lenders (UMLs). Enter the requested information about yourself, record the prices you get, then do it again with higher credit scores and larger downpayments. UMLs are listed on my site.
A new site, www.home-account.com, charges a fee for access to a borrower grading system covering not only credit and downpayment but also your debt-to-income ratio and cash reserves. Further, in each case where you fall short, the system will advise you on exactly what you need to do. The system is a work-in-process and I am involved in it as an adviser, director and shareholder.
Don't Respond to Solicitations by Loan Providers: I use the term "loan provider," or LP, to mean the individual mortgage broker or loan officer with whom you deal. The best LPs get repeat business and referrals from past customers and don't need to solicit, but all predators solicit because that is the only way they can get customers. Conclusion: You will likely do better selecting an LP blindly from the Yellow Pages than allowing yourself to be solicited.
Don't Shop Prices With LPs Who Make More If You Pay More: Most LPs charge what they can, putting themselves in a conflict position with the borrower. They seldom discriminate and most are equal-opportunity overchargers, but African-Americans often pay more because LPs can more often get away with charging them more.
To avoid this conflict situation in dealing with a mortgage broker, you must negotiate the broker's fee in advance, with the fee inclusive of any payments to the broker by the lender. Upfront Mortgage Brokers (UMBs) do this as a matter of course, they can be found at www.upfrontmortgagebrokers.org. With the broker's total fee set, the broker cannot increase his compensation by getting you to pay more for the mortgage.
To avoid this conflict situation in dealing with a lender, you must price shop at the lender's Web site rather than with the LP. If you can find your price online, you are not exposed to LP gamesmanship, and you can monitor the price until is locked.
However, while all lenders have Web sites, very few allow borrowers to find their own price on their sites. The UMLs cited earlier do, which is what distinguishes them as UMLs. In addition, www.home-account.com allows you to shop among a group of mortgage banks, and www.mortgagemarvel.com allows you to shop among a group of credit unions and community banks.
Mortgage Selection: If you expect to be in your house for seven years or more, the best deal is a 15-year fixed-rate mortgage (FRM). The rate is currently running about 0.625 percent below that of the otherwise comparable 30-year. But of course, you must be able to afford the higher payment on the 15-year loan.
If you expect to be out of the house within six years, select a 5/1 adjustable-rate mortgage (ARM) on which the initial rate holds for five years and then adjusts annually. The rate currently is running about 1.125 percent below that on a 30-year FRM. And since all ARMs have 30-year terms, the initial payment is well below that on the 15- and 30-year FRMs.
Avoid loans with an interest-only option if you can. On a 30-year FRM, the option will raise the rate by about 0.5 percent.
Cash Allocation: Cash is needed for a downpayment, points, other settlement costs, and cash reserves. You have much more discretion over the first two, which also have a major impact on the price of the loan. In today's market, the price is particularly sensitive to the downpayment, expressed as a percent of the lower of sale price or appraised value. On a refinance, it is equal to appraised value less the loan balance. Increases in downpayment result in decreases in the interest rate, mortgage insurance premium, or both.
Set aside the cash you will need for transaction costs other than points and cash reserves, then select the highest downpayment pricing notch point (PNP) you can afford. The PNPs are 3 percent, 5 percent, 10 percent, 15 percent, 20 percent, 25 percent and 30 percent.
If you can afford 22 percent, for example, select 20 percent because the extra 2 percent will not affect the price. The "leftover" 2 percent can be used more effectively to buy down the interest rate. With 20 percent down, 2 percent of property value is the equivalent of 2.5 points, which can buy down the rate on a 15-year mortgage by about 0.375 percent. But don't buy down the rate unless you expect to be in the house for four years or longer.
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.
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