Getting a Mortgage

The money you borrow to buy a home usually costs more than the home itself. That is the most important thing you need to know. It’s easy to get so tied up negotiating the price of a home that the big savings that come with the right loan can be overlooked.

Mortgages are “complex financial instruments,” but don’t let a phrase like that one scare you. At their heart, mortgages are easy to understand. Put all the talk of “ARMs,” “rates,” and “junk fees” aside for the moment—we’ll get back to them—and look at the big picture.

When you get a mortgage, you are buying money, and just as when you buy anything, there is a markup. Sometimes the markup is high because you didn’t shop around; other times its high because the product simply costs more. It’s true with a car, and it’s true with a home loan.

Lenders, like carmakers, target their products for a specific audience. Some mortgages are geared toward “hard money”—that is, those borrowers who have a checkered financial past; these are called sub prime loans. Most mortgages are geared for the average borrower with the average home. However, some lenders go looking for borrowers who are “golden”—that is, they have a high income and a perfect credit history. In all but the most extreme cases there is someone out there who wants to lend you money. It’s your job to find the one with the best deal.

Information

If you want to dedicate yourself to getting the perfect loan, buy Mortgages 101: Quick Answers to Over 250 Critical Questions About Your Home Loan, by David Reed (American Management Association, 2004). David was a pioneer of Internet lending, and his vast experience comes through on every page.

Banks, Internet lenders, and mortgage brokers are all trying to get your business. What you want to do is match up good pricing with a relationship you believe in and are comfortable with for the long haul. If all goes well, you will go through a series of loans as you buy new homes and refinance the properties you already own. If you have a good relationship with a lender or broker, the process goes smoother.

My mortgage broker is one of my financial confidants. He has saved me a great deal of money over the years by keeping track of how much I’m paying in interest. If a better deal comes along, he notifies me and I can pounce on the opportunity. You should look for a lender or broker to be a part of your financial team. It’s not a necessity, but it is helpful.

Many consumers like the anonymity that the Internet provides when taking out a new home mortgage, and the rates can be excellent. If you are comfortable on the computer, this can be a good option. The local bank or a large national lender can also offer great service. There’s no one place to go; it’s where you feel at home and feel like you are getting the service and advice you need.
Banks make the vast majority of loans because they’ve been in their communities for years and have earned the trust of consumers. If you have been dealing with a bank for years, it knows your spending and saving habits and is comfortable with you in return.

A good way to shop for a lender is to get recommendations from friends, check with the Better Business Bureau, and then select one each: a bank, a broker, and a Web site. If one of the three makes you uncomfortable, add another one to that category.

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A mortgage broker does basically the same work as a bank’s loan officer: doing the paperwork, advising the consumer, and selling the loan. The difference is, the bank loan officer represents only that one institution, whereas a mortgage broker represents dozens. It’s similar to how insurance brokers are either company agents representing just one firm or independent agents representing many.

The price of the money you plan to borrow depends in large part on how you borrow the money. Shorter mortgages cost less than longer ones. Taking out a 15-year loan rather than a 30-year loan can save the borrower as much as half a percent in interest—say, 6 percent rather than 6.5 percent. The discount is given because the lender has taken on less risk. Less can go wrong over 15 years.

Advice
Avoid loans that come with a prepayment penalty. With those loans, you can’t refinance and get a lower rate unless a certain amount of time has passed or you pay the company a cash settlement, often running into thousands of dollars.

Adjustable rate mortgages, or ARMs, are also less risky for lenders. Because of that, ARMs start out with much lower payments than traditional fixed-rate mortgages. ARMs float up and down with the economic tide. When interest rates go up, the monthly payments go up, too. When rates go down, the mortgage costs the borrower less. When a traditional mortgage is going for 6 percent, an ARM may be had for 4 percent. A huge savings, but remember that over the years an ARM could end up costing the borrower much more.

There are also hybrid loans that start out fixed for five years and then float with the going rate for the next 25 years. Some loans require you to pay only the interest, not the principal. That means a much lower payment, but the borrower isn’t buying any of the home, just the home’s appreciated value. Some home mortgages last as long as 40 years, others as little as 10.
So which loan is best? There is no wrong or right answer. It’s like choosing between a minivan and a sports car. If you have three kids, a sports car probably isn’t a good idea. On the other hand, if your kids have moved out of the house, buying a minivan isn’t a particularly smooth move, either.

Warning
For most borrowers, the worst possible loan is one that comes with a balloon payment. These loans offer low monthly rates for a set period of time—say, three years—but at the end of the term the loan must be paid in full. Few homeowners have that kind of cash lying around, and if the market has had a downturn and the house is worth less, they may not be able to refinance. Many homes are repossessed because of these loans.

Most consumers still take out a conservative 30-year loan. They figure it’s safe, and they are right. However, that safety comes with a price tag, so don’t buy a 30-year mortgage unless you need it. If you know you will be transferred, retiring, or moving up, a 30-year loan often doesn’t make sense. Remember, the object is not always to pay off and own your home, but to finance its purchase. You may not want to own the home forever, or you may need quick access to cash. The purpose of a mortgage is to pay the least you can for the product you need. Don’t confuse your real life with a movie image of a mortgage-burning party.

Most mortgages these days are offered with a point or maybe a half point to be paid up front by the borrower. It’s called an origination fee. One point is 1 percent of the loan amount, so a one-point origination fee on a $200,000 loan will run the borrower $2,000. Many lenders offer the borrower a choice of paying the origination fee or a higher interest rate. Both are fine, although few refinances are done with any points being paid. What’s important is that you compare rates and points.

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I’ve been to only one mortgage-burning party, and it was held by a 20-something guy who sold his business and made millions. He was goofing on his friends. A nice party to attend, if a bit hard to take.

Often you’ll read in a newspaper ad about a loan that is extremely low cost compared with the others you’ve researched. If you take the time to read the small print, you’ll often see that the loan comes with a two- or three-point origination fee. In effect, you are paying some of the interest up front, and that’s why the loan sounds cheaper.

If you are truly confused about the whole process and are concerned that you may be getting cheated, consider hiring a lawyer to go over the papers with you. Although this is a highly unusual move, it’s better than sleepless nights or losing your home to crooks.

Insider Secret

When taking out a loan, you are going to see a whole list of fees; challenge them all. The legit ones are the cost of appraisals and credit report fees. A certain amount of money is spent on getting the papers around; there is a huge markup, but since it’s less than a hundred bucks, it’s generally nothing worth sweating over. To avoid paying junk fees, challenge every fee that is written down. If the fee you are challenging is bogus, you’ve got a good chance of having it removed with little effort.