July 13, 2008
The Hidden Costs of Borrowing Money
July 13, 2008
Before choosing a Lender for your Home Loan it is very important to know how these companies operate. The competition between lenders is fierce, particularly when business is a little slow. Loan Originators are in most cases paid on commission, so they can be tempted to deceive the public to make a loan, just like anyone (including Realtors), because they are competing with others for their income.
NO ORIGINATION FEES: This marketing technique is being used in Anchorage to make one Lender look better than another. Origination Fees are normally 1% of the loan amount and this is the main source of the loan originator’s salary, but not the only source. So how can a loan originator be paid if they don’t charge an origination fee? Some Lenders use the practice of “Bait and Switch” to overcome this ‘free’ service. That is, they quote you a certain interest rate when you first visit (bait), but this rate goes up before closing (switch). In other words, you pay for your “free” loan origination with a higher interest rate, and the loan originator is rewarded separately for obtaining this higher rate.
VA, FHA and Conventional rates can change daily, or the discount points to obtain the rate can change. Alaska Housing (AHFC) rates also change daily, but AHFC never resells the loan to a third party. I have heard of Lenders who will say you don’t qualify for an Alaska Housing program (or not tell you that you do) because, if you did, it would be less profitable to them. When a loan is sold to a third party, additional income comes to the originator.
INTEREST RATES: This is the basic cost of borrowing money. Money is the biggest business in the world. No wonder Jesus overturned the money-changers’ tables in the Temple when he became angry at their practices! I feel the same way sometimes. The bottom line is that there are honest Loan Originators and Lenders, and not so honest ones too. Beware of this!
For an interest rate to become “unchangeable” for your closing in 30 to 60 days time, lenders can ‘Lock-In’ a rate after most of the contingencies of your application have been cleared. Sometimes they charge a fee for this. The problem for them is that, if you don’t close, they have to pay a penalty for not using the “locked-in” money.
Here is another “Lender Secret” not commonly known. Each day, lenders publish for their loan originators a sheet of interest rates and discount points (determined by their sources of money) and the amount of “kick-back” the money source will give if a loan is processed at the quoted interest rate. Therefore, on a given day, one Lender may be offering 6.25% for no kick-back but another offering 6.50% and receiving a bonus from their money source. If the originator can bump your rate further prior to closing, there may well be an additional bonus.
If the Lender “sells” your loan to another company, there is also a “Service Release Premium” paid to your lender by that company. On the other hand, if you deal directly with a Bank, such as Wells Fargo, lending its own money, this service release doesn’t apply.
DOCUMENT PREPARATION FEES: This is a more recent “gouging” technique used by some lenders. I have noticed over the last few years that these fees are on the rise. They vary from $125 to $500. A reasonable fee is $200.
Document Preparation fees are just another way to increase the lender’s income, rather like baggage handling fees at the airport. Other fees can also creep into some lenders’ charges: “Processing Fee” (whatever that means), Underwriting Review Fee, and others that have no place with mainstream lenders. Be careful about these charges, and who has to pay for them. Under VA, for example, the document fees to not hurt the buyer applying for the loan but are a mandatory charge to the seller!
PREPAYMENT PENALTY: A penalty for early payoff of your mortgage (i.e. paying off the loan before its 15 or 30 year term) is illegal in Alaska. However, lenders in the Lower 48 often include a prepayment penalty using a marginal legal argument that Alaska Law does not apply to them. Last year, one of my clients sold a home and, at the moment before closing, learned that their Indy Mac loan had a prepayment penalty of $21,000 - - - gulp! This came out of their closing proceeds because they couldn’t back out of the sale at that stage. Beware of Out-of-State lenders!
SUB-PRIME: Sub-prime mortgages are like sub-prime beef. That is, they are made for people who cannot afford prime beef, and they are tough to swallow. The Sub-Prime market was made for people who shouldn’t be borrowing anyway. It was a slick move by lenders to capitalize on the human weakness of people with poor money management skills. We now see the results of that disaster – Lenders are still trying to recover from some ‘embarrassing’ loans originated right here in Anchorage.
The Sub-Prime product is now almost extinct. Like the Polar Bear, the ice melted out from under it. The bottom line is that if you need a sub-prime mortgage, don’t do it. Get financial advice, get your credit and balance sheet in order, and look forward to a real juicy steak next year.
Throughout the business world there are both reputable and disreputable people and companies. In my view, gaining a sense of trust is crucial to business relationships. I use my ‘gut instinct’ a lot in my dealings with people, and like to find the ones who are basically “straight shooters”. Bottom line -- there are many ways in which a lender makes money, nothing is ‘free’, and you need to exercise caution when obtaining your home loan.
