How Are You Going To Compare Loans Without Specific Numbers?

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You would be amazed how often I encounter people who are certain they're getting a great deal on this loan that's in process, but they have no idea what that that deal is. All they really know is that their prospective loan provider sure acted like their friend.

Well, excuse me, but have you ever heard of "Honest Iago"? Any sales person is going to at least pretend to be your friend. The tricks are legion, and they're not evil, in themselves. But it's much easier to betray someone from a position of trust. "Don't worry, I'll take good care of you." Yes, and even better care of your wallet after it's in their pocket. A real friend may ask for your business, but they won't get upset if you can find a better deal somewhere else.

Loans are complex transactions, but there are three main things to know: Type of loan, interest rate, and the total cost to get that loan at that rate. You should be able to remember three things about one of the biggest transactions of your life, right? Beyond that, there's what the costs include, and whether there's a prepayment penalty, both of which are also important. The reason the existence or non-existence of a prepayment penalty is important should be obvious. A very large proportion of people who agree to even two year prepayment penalties end up paying them, and half of seven percent of $400,000 is $14,000 more that loan will cost you down the road. The equivalent of three and a half extra points, for crying out loud!

What it includes is equally important. Does it include appraisal, title, and escrow (or legal fees in those states that still require the use of attorneys)? There are all kinds of fees involved in a loan, but these are the three biggest, and because they are paid to third parties, the law allows the actual dollar amounts to be excluded from quotes. What sounds cheaper: $3022 or "$1405 plus third party fees". In this instance, it works out that they are exactly the same. Similarly, you want to find out if the dollar figure you are being quoted includes the dollar amount of any points you will be charged. Each point is one percent of the final loan amount, so if you've got a $400,000 loan when everything is said and done, you've paid $4000 for each point. If that's two discount points and one of origination, that's $12,000 on top of all the usual fees.

Force them to add in all the costs, and quote you in terms of what the loan amount is going to end up being after rolling all those costs into your loan, if that is what you intend to do. Make them quote your payments based upon that final loan amount, not the base loan amount. Those are the costs you are really going to end up paying, whether or not you wrote a check out of your account to pay them. Those are the payments you're really going to end up making. There are two sorts of mortgage consumers out there: The ones who insist upon understanding what they will really be paying, and suckers. Suckers sometimes stumble across someone who actually gives them a good loan at a good price, but it's blind luck, and far more often, they don't. Furthermore, just because you're not writing a check out of your account doesn't mean you're not paying those costs. You are, and the dollars you spend that way are every bit as real as the dollars left in your grocery bill, even if they are in much larger amounts for mortgage loan fees.

Every time I write an article like this, I get emails that say, "What if I'm doing business with a large reputable company?" Those are some of the worst. Those beautiful buildings, that plush carpet, those beautiful furnishings, those attractive salaries? Your fees are going to pay for those, along with the investor payouts that make that company so attractive to investors. They are competing upon the basis of advertising and reputation, not price, but a loan is not a vehicle. As long as it's on the same terms and conditions, it's exactly the same whether it is from National Megabank or the Bank of Nowhere. And terms and conditions are mostly standardized. The only real exception I'm aware of is the Islamic loan programs. So there is no reason not to force lenders to compete on price.

Now it is another misconception to think that the standard forms you get at the beginning of the transaction mean something. They don't. There are too many games lenders are allowed to play with those. The only way to be reasonably certain that they actually intend to deliver that loan on the terms they tell you about is to get them to give you a written loan quote guarantee, detailing:

-loan type (e.g. "thirty year fixed rate loan")

-interest rate (e.g. 6%)

-total maximum costs including third party fees and points (e.g $3022)

-whether there's a prepayment penalty. Yes or no. Not maybe. Not probably not. Yes or no.

-any conditions upon the guarantee. (almost always, "underwriter approval of the loan as submitted")

There should also be a statement that if they do not deliver the loan as described, they will pay any difference so that the net cost to you does not increase. Once you've got a guarantee with all of this, then and only then can you make a real comparison between loans. Companies that will not guarantee their quotes in writing are telling you that they cannot deliver what they talk about, that they are intentionally low-balling you in order to get you to sign up, and that they will add hundreds to thousands of dollars and quite possibly a higher interest rate when you go to sign the papers. I'm sure that makes you feel all warm and tingly and inclined to use them, right? If they could deliver that loan they are talking about, they would guarantee it. But if they won't guarantee their quote, you have no idea what loan they really intend to deliver. It's only if they will guarantee their quote that their loan can really be compared to other loans.

Loan rates and the prices to get them do change over time. They cannot be locked indefinitely, and the longer the lock, the more expensive the loan. Furthermore, all quote guarantees are going to be subject to locking while the rates are still in effect, which for A paper loans and lenders is no longer than the end of the day. But missing a day of works that costs you $300 to $500 in pay in order to intensively shop loans is likely to save you thousands of dollars.

Now, how to compare loans if one has a lower rate and the other has a higher cost. Figure out the difference in monthly interest charges, and divide the difference in closing costs by the difference in monthly interest. This will give you a break even figure in months. Due to time value of money and other factors such as the loan with higher costs will leave you with a higher balance, and therefore cost you additional interest later after you sell or refinance, add fifteen to twenty percent to this figure. Keeping in mind that most people only keep their loans two to three years, that will tell you if you're getting something worthwhile for that extra money. On the other hand, if the break even time is longer than the fixed period of the loan, you know it isn't.

Finally, it is to be admitted that getting a loan guarantee is the second best thing to make certain you get the loan they tell you about. There is a better one: Apply for a back up loan. If you have two loans ready to go, you're not relying upon the good intentions of one provider, and your choices are not limited to sign that one set of loan documents or you don't get a loan.

Caveat Emptor


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About this Entry

This page contains a single entry by Dan Melson published on March 12, 2007 11:00 AM.

How to Effectively Shop for a Buyer's Agent was the previous entry in this blog.

Real Loans for Real People March 12, 2007 is the next entry in this blog.

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