Mortgage Shopping

Mortgage Shopping

Trying to find the best deal on a mortgage.

It isn't easy to do it right, as a summary of the major steps involved will demonstrate. This guide is based on the regulatory structure in September 2003. Reforms proposed by HUD, which were pending at the time this was written, should make shopping for a mortgage much easier. See RESPA/Proposals for RESPA Reform.

Step 1: Decide if You Are a Potential Shopper: Not everyone is a potential shopper. Some will do a lot better entrusting that responsibility to someone else. Read the following statements, giving yourself one point if a statement marked “1” best describes you, two points if a statement marked “2” describes you best, and 1.5 points if you are in between.

A1. I like to bargain and have no hesitancy in speaking up if I think- someone is trying to take advantage of me.
A2. I avoid confrontation at all costs.
B1. I feel that I either know or have the capacity to learn as much about mortgages as I will need to know to take care of myself in the marketplace.
B2. I feel overwhelmed by the complexity of mortgages, and I don't have the time, energy, or desire to educate myself about them.
C1. When significant money is at stake, I like to control things myself.
C2. When significant money is at stake, I like to find someone I can trust to make critical decisions for me.
D1. I feel very comfortable using a computer.
D2. I am computer-phobic.

If your total score is above six, find a mortgage broker to be your agent in shopping for a mortgage. I recommend Upfront Mortgage Brokers (UMBs) because they are prepared to provide this service at a set fee, negotiated in advance. Once the fee is established, your interest and that of the broker are closely aligned. See Upfront Mortgage Broker.

Potential shoppers score six or lower. What follows is directed primarily at them.

Step 2: Decide Which Mortgage Features You Want: Before entering the market, shoppers should decide on the type of mortgage, term, points, down payment, and lock period.

You can't compare prices of different loan providers accurately unless you can specify exactly what you are shopping for. When you shop for an automobile, you decide beforehand that you want, e.g., a four-door Toyota Corolla with accessory package 101. You must do the same when you shop for a mortgage.

It is especially important to know exactly what you want before you lock the price. If you change your mind after you lock and market prices have risen in the meantime, many lenders will allow a change only at the higher price.

Step 3:Determine Your Market Niche: The interest rate and/or points on a mortgage vary with a number of borrower, property, and transaction features. Loan officers quoting prices will assume the features commanding the lowest price. See Nichification/Generic Price Quotes.

For example, if you don't say anything about the property, the loan officer will assume it is a single-family detached house con-
structed on the site. If in fact it is in a low-rise condominium, a four-family structure, or a manufactured house, the price will probably be higher. To obtain valid price quotes, shoppers must indicate all such deviations between their deal and the generic deal.

Make a list of your “Niche Adjustments”—all the deviations between your deal and the generic assumptions. Whenever you are soliciting price quotes, you offer the list.

Step 4: Formulate Your Price Selection Strategy: Selecting the best price on a mortgage is not like selecting the best price on a toaster. Mortgages have three (or more) price components, toasters only one.

Pricing Strategy on Fixed-Rate Mortgages (FRMs): Once you know your loan amount, convert all upfront charges into a single total dollar figure. Multiply all upfront fees expressed as a percent of the loan times the loan amount. (This includes points, origination fee if there is one, and broker fee if it is defined as a percent.) Add fixed-dollar fees charged by the lender and broker. For example, if the loan is for $150,000 at one point ($1,500), with lender fees of $800 and broker fees of $3,000, total dollars amount to $5300.

Ignore the cost of title-related services and settlement services. If you are in an area in which it can pay to shop for them, you can do it after selecting the loan and lender. Also ignore any government charges, escrows, and per diem interest. You can't shop these. Hazard insurance you buy on your own.

When you have two price components—the interest rate and total dollars upfront—there are two ways to make a selection decision. One way is to fix the interest rate (call it your “shopping rate”) and ask for quotes on total dollars at that rate. It is convenient that interest rates are generally quoted in 1/8% increments.

You thus ask the loan provider “If these are my mortgage features and niche adjustments, what are your points and total fees at (say) 5.875%?” You must be clear that “total fees” refers to payments to the lender and the broker, excluding payments to third parties, per diem interest, and escrows.

The best shopping rate for your purpose can only be found through trial and error. If you begin with a shopping rate that elicits
larger total dollar quotes than you want to pay, for example, raise it. As your shopping rate goes up, the total dollar quotes will go down.

An alternative to soliciting total dollar quotes for a given shopping rate is to combine different rate and total dollars into a single
measure of Interest Cost (IC). Economists call this measure an “internal rate of return,” or IRR. The annual percentage rate (APR), which is a mandatory disclosure, is an IRR. The problem with the APR is that it is calculated over the entire term of the loan, which makes it a biased measure for borrowers with short horizons.

If you know you will be in your house for 10 years or longer, you can use the APR because the error is small. Otherwise, you should compare interest costs over your own shorter time horizon. You can do that using calculator 9c on my Web site.

There is one way to shop a single price that has become popular in recent years. This is to shop for the lowest interest rate with zero settlement costs. The lender pays all costs, including third-party charges. This approach makes it almost as easy to compare mortgage prices as toaster prices. Just make sure all costs are covered except per diem interest and escrows, and nothing is added to the balance. See No-Cost Mortgage.

This is a great strategy if your time horizon is less than five years. The lender pays your settlement costs in exchange for higher interest payments, but these payments don't go on long enough to wipe out the benefit. After about five years, however, the higher interest payments convert the strategy into a loser.

Pricing Strategy on ARMs and Balloon Loans: Both ARMs and balloons have fixed rates for some initial period. For balloons, that period is almost always either five or seven years. For ARMs, it can range from a month to 10 years.

If you know that you will be out of the house before the initial rate period ends, you can use the same price selection strategy as on an FRM. As far as you are concerned, it is an FRM. In using calculator 9c to measure interest cost, enter the initial rate period as the period you expect to stay in your house. The calculator will ignore what happens after that period.

The problem is that virtually no one can be certain that they will be gone by the end of any initial rate period. Life has a bad habit of changing our minds. You should be aware of what can happen at the end of that period and factor that into your decision process.

In the case of balloon loans, that is not difficult. At the end of the initial rate period, you must refinance at the market rate prevailing at that time. Since all balloons are equally bad in that regard, select the one that is the best deal over the initial rate period. The pricing strategy for a balloon thus turns out to be the same as that for an FRM.

ARMs, however, have built-in protections against rate increases after the initial rate period, and these may differ from one ARM to another. If two five-year ARMs have the same interest cost over the five years, you want the one that exposes you to less risk of a rate increase at the end of five years.

Unfortunately, this is not easy to determine because it is affected by a number of ARM features that won't be provided to you in a
comprehensible form unless you ask. Print out Information Needed to Evaluate an ARM from my Web site and have the lender fill it in for any ARM you are considering. You then have what you need to use calculators 7b or 7c and 9a or 9b. These calculators will tell you what will happen to your interest rate and monthly payment at the end of the initial rate period if 1) the interest rate index doesn't change, 2) the index goes through the roof (a “worse case”), or 3) the index follows any other future scenario you choose to examine.

Step 5: Solicit Price Quotes:

Validity: To be valid, mortgage price quotes must be:
• Complete, which means inclusive of lender and broker fees expressed in dollars, as well as those expressed as a percent of
the loan. On adjustable rate mortgages (ARMs), it also means inclusive of information on features affecting the interest rate and payment when the initial rate period ends.
• Timely, which means that the prices are live at the time they are conveyed to the shopper.
• Niche-adjusted, which means that the prices are adjusted for all the ways in which the shopper's transaction differs from the generic assumptions used by lenders in developing their best prices.
• Honest, which means that the loan provider would be willing to lock the rate and points quoted, rather than low-balling to get the business, and is willing to guarantee fixed-dollar fees.

Sources: One source of price quotes is individual loan officers recommended by your sales agent if it is a purchase transaction, or by other borrowers. Provide them with your mortgage features and niche adjustments. If you are shopping an ARM, include the blank table on Information Needed to Evaluate an ARM from my Web site.

Request that quotes include fixed-dollar fees and that they be e-mailed or faxed.

A second source of price quotes is Internet mortgage auction sites. These sites ask you to fill out a questionnaire covering the loan request, property, personal finances, and contact information. (It is their version of your mortgage features and niche adjustments.) The sites use this information to select the lenders, usually up to four, to whom the information is sent. The selected lenders then send price quotes to you based on the same information, hopefully on the same day.

This is a quick and easy way to obtain up to four price quotes. However, the niche adjustments may or may not be complete, they may not ask you about your mortgage preferences, and they may not include information on fixed-dollar fees or on important ARM features. Hence, you probably will need to request a second round. The integrity of the quotes is no more verifiable than those you get by directly soliciting loan officers yourself.

Auction sites include:
• CityLoans.com
• GetSmart.com
• LendingTree.com
• InterestRatesOnline.com
• LoanApp.com
• LoanAtlas.com
• LoanHounds.com
• LoanWeb.com
• LowestMortgage.com
• MortgageExpo.com
• MortgageTrader.com

A third source of price quotes is single-lender Internet sites. They are less convenient than auction sites, since you can only get one quote per site. However, you choose your mortgage features, and the price quotes are more likely to be complete. Furthermore, if your loan is priced on-line it is an honest price. They can't give you a low-ball quote to snare your business, then raise the price when you lock, because you can monitor the price when you lock.

Single-lender sites vary greatly in the extent of their niche adjustments. The more questions they ask the user, the more complete the