In my never-ending quest to educate the public about the mortgage industry, I have set down some subjects that are definitely either unknown or misunderstood by the average borrower. This is the third report on items I consider important if you are either holding a mortgage or about to take out your first mortgage. Here is what I am going to cover:
1. APR: Annual Percentage Rate, which was set up originally for autos and doesn't do the job it was intended to do for housing.
2. Which day is the wrong day to close an escrow and why? When is the best time to close a loan and why?
3. Names mean nothing in the mortgage industry.
4. How, when and why to lock a loan.
5. The difference between a mortgage broker and a mortgage banker.
Some of the above might seem trivial, but failure to understand can be hazardous to your wealth. Let's see what I am talking about.
Annual Percentage Rate was easy when it came to cars, not so in the mortgage business. Cars are financed over 3, 5 or 7 years for the most part and that is that. They are straight-line loans that have the same payment every month until paid off. Not so in the mortgage industry. In the auto industry, APR will give you a good idea of the annual cost of your loan. Not so in the mortgage industry. Why?
The annual percentage rate is measured by subtracting the closing costs, including points, from the loan and then dividing the actual interest payment by the new balance of the loan. The Government doesn't feel that closing costs are part of the loan, so when you take them out, the APR has to be higher. (Not always)
$200,000 loan at 6% has $12,000 in interest
Closing costs of $2,000 means the loan is $198,000
Dividing $12,000 (interest) by $198,000, you get 6.06% as the APR
The larger the difference between the interest rate and the APR, the larger the closing costs, which means you are probably paying points, as they are the variable in the equation.
The problem comes with variable loans. You can't predict where the variable will be for the life of the loan, so you use the fully indexed rate at the time of closing: the margin plus the index. You then subtract the closing costs and do as above. This is a fictitious number because it is a variable. It is even worse when you have a fixed portion for a period of time and then it becomes a variable.
Five-year arm at 6% (fixed for 5 years and then becomes a variable)
With a fully indexed rate of 5% (margin and index at time of closing)
Because you blend five years at six percent and 25 years at five percent, your APR will be less than your start rate (more silliness).
When it comes to APR's, take them with a grain of salt or examine them to see exactly how the figure was calculated. Do not take them as anything more and don't try to measure the value of the loan by comparing APRs.
The wrong day to close a real estate transaction involving a loan is Monday, or even worse Tuesday following a three-day holiday. Why? Because when you are refinancing, you are paying both loans until it closes. In most states, you must fund a loan the day before it closes. The day before Monday is always Friday, meaning you are paying interest on both loans for two days instead of one. No need. Purchases work the same way, only you just pay on your loan from the day it funds, so no need to add an extra day of interest.
The best time to close a loan is at the end of a month because all lenders look at the figures relating to their business and always make an extra push at the end of every month. They will overlook some conditions of the loan, once in a while. They will forgo some additional fees, once in a while. And generally, they will entice the brokers to get some additional business by rate concessions, which can help get you a lower rate, again once in a while. It rarely, if ever, happens at the beginning of the month.
Big banks, well known mortgage lenders, and heavily advertised brokers do not have better rates than other lenders; they are just better known. Many of the big nationally known advertisers actually have rates that are higher than your hometown mortgage broker. Some don't do loans, just sell names to brokers, while others specialize in areas they don't advertise. Home Savings and Loan, which doesn't exist any more as they were bought by Washington Mutual, was actually a lender that did a large amount of poor credit loans.
The other strange aspect of the mortgage industry is that different departments of the same lender will have different rates. Most major banks have retail and wholesale divisions and some even a correspondence group. Retail goes to the public, wholesale takes loans from mortgage brokers, and correspondent departments buy loans from mortgage bankers. At any given time, one of the three can have significantly better rates than the other two. We can sell to a lender, or broker to the same lender, and what determines what we do is the rate of each sector.
To add to the confusion, one division generally has loans for full documentation loans, which are loans with tax returns or W-2's supplied by the borrowers; stated income and verified assets, which means they don't require proof of income, only of liquid assets; and lastly, stated income and stated assets where they don't verify either. At any time, stated income and stated assets, which should have the worst rates, actually have the best rates.
I have competed against a large bank for purchase loans for celebrities and have lost every time, because they refuse to be beaten on these loans. They absolutely will not do a refinance for the same client at a good rate, so I always get the refinance.
The missing statement after the previous four paragraphs: "Who knew?" The job of getting you a loan under the best possible scenario is a lot harder than you thought.
As we come to the end of this discussion, it is important to know that locking a loan has timing implications. Loans can be locked for 12 or 15 days, 25 or 30 days, 45 or 60 days, and in some cases even longer. The longer out the lock, the higher the rate, so it is important to understand the implications of locking. You lock a loan to prevent the rate from going higher, and in some cases that means it will not go any lower as well. It is customary to lock a loan for 25 or 30 days to preserve the rate you want and to give enough time to complete the transaction. If you run over the lock period, it can be extended, but it costs to do it. Most brokers or bankers will absorb the cost for the first extension, but will pass on the cost of other extensions to the borrowers. Loans must flow, so everyone has to do their job, including the borrower. When a borrower is asked to supply some information, it should be done in a very speedy manner.
If you are willing to chance locking the loan, you can wait until it is approved and then you can lock it for 12 or 15 days. This can save you 1/8th or more on the rate if the market is moving in your direction. You will be given suggestions as to when you should lock, but it is your decision. Keep an eye on the bond market so you know when it is time to move and then do so. Never have the words “Time is money” been so relevant.
Mortgage brokers are companies that broker all of their loans to banks, mortgage bankers or other major lenders. They act as a middleman and attempt to get you the best terms and conditions on your loan. They are paid by the lender (rebate) or by the borrower (points) or both. They deliver the loan to the eventual lender and if they wish to cancel a lock they have to "pull the loan" from the lender, get it back, and then send it to another lender. This makes it more difficult to try and get a better rate than the one that was locked.
Mortgage bankers have their own "warehouse line" and fund their own loans. They then sell them to lenders and make a profit on the sale. They can also charge the borrower points if the borrower wants a rate under the going market.
Bankers can act quicker than brokers when trying to get a lower rate, as they haven't shipped the loan to the end lender and therefore, do not have to wait to get it back. The loan package will not be shipped until the loan has closed.
They can break the lock with one lender and re-lock with another without additional effort. The reason they are reluctant to do this is if they break too many locks, they will lose their locking privileges.
As the layers of the mortgage industry are peeled off, hopefully you are becoming a better and wiser borrower. My feeling is that the better you are, the easier it is to get you to understand the concepts that can move you along as you head out on the road to financial freedom. As always, I welcome your questions.