Lies Mortgage Shoppers Hear

December 2, 2002, Revised July 16, 2004, December 18, 2007, January 16, 2011

Mortgage shoppers may hear outright lies, such as "this loan has no prepayment penalty", or "the rate is locked". More often, they hear ambiguous statements that are designed to deceive, such as "the lender is paying my fee". Often, borrowers are deceived by not being told what they should be told.  Sometimes borrowers deceive themselves.

The Different Kinds of Lies

"I am about to shop the market for the mortgage I need to finance my home purchase. Is there a danger that people won’t tell me the truth? Any lies I should look out for in particular?"

I had a lot of trouble answering this question. The dictionary defines a lie as an untrue statement meant to deceive. On this definition, it was not difficult to come up with a number of lies told by loan providers. I quickly realized, however, that most of the worst deceptions that pervade the mortgage market are not based on untrue statements.

In many cases, the statements designed to deceive are either true or ambiguous. While the law may view such deceptions in a different light than those based on false statements, from my perspective as a consumer advocate, there is little difference. In addition, there are “lies of omission”: information known to be important to the borrower that is deliberately withheld. They are perhaps the most common of all. Finally, borrowers sometimes lie to themselves, acting on false assumptions that they believe (or hope) to be true.

I am going to address all of these types of lies, beginning with some that meet the dictionary definition of untrue statements meant to deceive.

Outright Lies Mortgage Shoppers Hear

“This loan has no prepayment penalty.” Many borrowers have told me that when they took out their current loan, their broker or loan officer told them that they had no prepayment penalty. When they went to refinance some time later, however, they discovered that they were indeed subject to a penalty.

I did not place much credence in these tales at first. Brokers have pointed out to me that borrowers often accept a prepayment penalty to get a lower interest rate, then conveniently forget that they had agreed to it. However, I have now seen well-documented cases and am convinced that some borrowers are lied to about prepayment penalties.

It is lucrative, and easy if the borrower is trusting. A broker, for example, might collect an additional .5 to 1 point (1 point is 1% of the loan amount) for a loan with a prepayment penalty. Although the Truth in Lending (TIL) disclosure form indicates whether or not the loan has a prepayment penalty, the disclosure is very poorly designed. See Disclosure Rules On Prepayment Penalties.

Moral: To make sure you don’t have a prepayment penalty, check the TIL carefully. If it says you MAY have a penalty, it means you DO have a penalty.

“The Rate is Locked”. Some mortgage brokers tell their clients that the interest rate has been locked with the lender when that is not the case.

Locking the mortgage rate assures borrowers that the interest rate they have agreed to pay will be honored at closing, even if market rates rise in the meantime. The lock also protects against a change in points, although it may not cover lender fees expressed in dollars.

The brokers who lie about locking the loan do it to increase their markup. For example, the lender providing the loan selected by your broker might quote 6% plus 1 point for the 60-day lock you require, but the lender’s quote for a 10-day lock might be 6% plus 0.5 points. The lying broker tells you that you are locked for 60 days at 6% plus 1 point. If the market doesn’t change, the broker locks 10 days from closing at .5 point, and pockets the other .5%. See Did You Pay For Insurance You Didn't Get?

Brokers rationalize this lie by saying that they are assuming the lock risk themselves, and will deliver the “locked” rate and points to the borrower even if they have to take a loss. In a stable or declining rate market, they can get away with this, perhaps for years at a time.

But sooner or later interest rates will suddenly spike. Brokers locking at their own risk will not be able to deliver loans at the promised rate. Borrowers unfortunate enough to have relied on them will be left unprotected. They will either have to pay the higher market rate, or cancel the transaction.

Moral: Borrowers who lock through brokers should insist on receiving the rate lock commitment letter from the lender identifying them as the applicant.

“You will get the market price on the day you lock”. A shopper who accepts an offer from a loan provider is warned that the price quoted is subject to change with the market. Prices adjust every day, and sometimes more than once a day. The final price, says the loan provider, will be the market price on the day the loan is locked.

How is the market price determined on that day? Why, the loan provider tells you what it is. This reminds me of Big Julie in Guys and Dolls, who used dice that had no spots. He didn’t need spots to know what number came up, he said, because he remembered where the spots were.

If you made your selection of the loan provider before the lock day, and you have no independent way to verify the market price, you might as well be playing dice with Big Julie. Many loan providers systematically overstate the price on the lock day. The worst offenders are those who systematically understate the price earlier for the purpose of snaring you.

Moral: Favor loan providers who have web sites that allow you to check your market price at any time. Otherwise, monitor changes in market rates between the day of your quote and the day you lock. Check Today's Prime Conforming Wholesale Rates.

“You do better with an FHA”. Why would a loan officer or mortgage broker say this if it weren’t true? Because they specialize in FHAs and don’t want to lose the sale, or they can earn a higher fee on an FHA, or both.

FHA loans are for borrowers who can't meet a 3% down payment requirement and have poor credit. Borrowers who can put 10% or more down and have good credit will usually have lower costs with a conventional loan. (The costs in such comparisons include the interest rate, upfront fees and mortgage insurance). The best loan type for borrowers who fall in the middle depends on the specifics of the case. See Who Should Take an FHA Mortgage? And FHA Mortgages: A 2009 Update.

Much of the unjustified “steering” applies to these in-between cases that are close to the line. However, I have seen FHAs with 20% down and good credit.

Moral: If you can put 3% down, or you have good credit (a FICO score of, say, 700 or higher), don’t let anyone steer you to an FHA without considering alternatives.

“You need an adjustable rate mortgage (ARM) to qualify”. Why would a loan officer tell an applicant that she needs an ARM when she doesn’t? Most likely because the loan officer works for a depository institution that much prefers ARMs, and pays larger commissions on ARMs. Furthermore, finding ways to qualify a marginal borrower on a fixed-rate mortgage (FRM) may be challenging and time-consuming. Why bother if you don’t have to?

The interest rate used to calculate the mortgage payment used in qualifying borrowers is usually lower on ARMs than on FRMs. Nonetheless, applicants who are told that they can’t qualify at the FRM rate, and who don’t want to risk future rate increases on an ARM, should know that they may have options.

The inability to qualify for an FRM means that the interest rate on the FRM brings the ratio of housing expense to income, or total expense to income, above the maximums. Typical maximum ratios are 28% and 36%, respectively. (Housing expense includes the mortgage payment, mortgage insurance, hazard insurance and property taxes; total expense is housing expense plus monthly debt service.)

Maximum expense ratios, however, are "guidelines", not absolute limits. The limits may be waived if the borrower is only marginally over the housing expense ratio but well below the total expense ratio. They may also be waived if the borrower has an excellent credit record or is making a substantial down payment.

A borrower with excess cash, furthermore, can use it in various ways to reduce housing expense. For example, they can “buy down” the interest rate by paying higher upfront fees. See Do I Need an Adjustable Rate Mortgage to Qualify?

Moral: Borrowers who want FRMs but are told they need an ARM to qualify, should seek the opinion of other loan providers.

Deceiving With the Truth

Now I want to consider a more sinister type of lie: statements that are either true or ambiguous, yet designed to deceive.

“The APR on your cash-out refinance is...” I begin with this one not because it is the most important but because it is a perfect example of how a factually correct statement can be used to misinform. And it even carries the imprimatur of the Federal Government!

Smith has a 6.5% mortgage with a balance of $250,000 and needs $25,000. She refinances at 7%, borrowing $275,000 with $25,000 “cash-out”. Assuming no points or other fees, the lender reports an APR on this cash-out refinance of 7%. And so it is.

The problem is that Smith is led or allowed to infer that she is paying 7% for her $25,000, which is not the case. To get the $25,000, Smith had to raise the rate on $250,000 from 6.5% to 7%. If this were taken into account in the calculation, the APR would be almost 12%. The misinformation might cause Smith to overlook that a second mortgage for $25,000 might be a lot cheaper. See The APR on a Cash-Out Refinance.

Moral: Ignore the APR on a cash-out refi, but assess the cost against that of a second mortgage. You can do this with calculator 3d Mortgage Refinance Calculator: Cash-Out Refi Versus Second Mortgage.

“This is a no-cost loan”. Strictly speaking, there is no such thing as a no-cost loan. Borrowers always pay settlement costs, one way or the other. Nonetheless, the statement is not always intended to deceive, although sometimes it does. It depends on the situation.

One situation in which it is reasonable to assume an intent to deceive is where “no-cost” is used to describe a loan on which settlement costs are added to the loan balance. The borrower is paying the costs but borrowing the money needed for the purpose. Calling this “no-cost” is outrageously misleading.

The term “no-cost” is also used to describe a loan on which the borrower agrees to pay an interest rate high enough that the lender will pay the settlement costs. In this case, the lender pays the costs, but there is a quid pro quo consisting of higher interest payments by the borrower in the future.

If borrowers understand that they are compensating the lender for paying the settlement costs, referring to such loans as “no-cost” is not deceitful. It is deceitful only when the loan provider suggests that the borrower is getting a free ride. See No-Cost Mortgages.

Moral: Don’t take a no-cost loan without making a side-by-side comparison with the same loan on which you pay the costs and receive a lower rate. View the costs as an investment on which you can calculate a return using calculators 11c Mortgage Points Calculator: Rate of Return on FRMs. or 11d Mortgage Points Calculator: Rate of Return on ARMs.

Note: Sometimes borrowers taking out “no-cost” loans suspect skullduggery when they discover that the settlement costs that lenders agree to pay on no-cost loans do not include per diem interest -- interest from the day of closing to the first day of the following month. It isn’t skullduggery. Lenders never pay per diem interest because it is an interest charge rather than an upfront fee, and it is not known until the closing date is set. Lenders also don’t pay tax and insurance escrows, because monies in escrow are owned by the borrower.

“The lender is paying my fee.” The concept of a free mortgage broker is very similar to that of a no-cost loan – or a free lunch. There is no such thing, but the statement may or may not be a lie, depending on circumstances.

If the statement is meant to convey the impression that the borrower has no stake in the lender’s payment to the broker, it is deceitful. Lenders pay the borrower’s broker fees for the same reason that they may pay the borrower’s settlement costs: because the borrower compensates the lender with a higher interest rate. See Ignore Lender Payments to My Broker?

On the other hand, if the borrower understands that he is paying for the broker fees in a higher rate paid to the lender, there is no deceit. A good test is whether the broker offers an option of a lower interest rate with the borrower paying the broker’s fee.

Moral: Insist on a rate quote on which you pay the total broker’s fee, which you can compare to the quote on which the lender pays the fee.

Lies and Self Deception

Mortgage shoppers are often deceived by lies, but more often by a twisting of the truth.

“My biweekly plan will save you money”. This statement can be viewed as true, false, or somewhere in-between, depending on the context. The critical issue is whether it is meant to deceive recipients into believing that they will receive more from a biweekly mortgage than is actually delivered.

On a biweekly payment plan, you make half the monthly payment every two weeks. That means that over a year, you make 26 half payments, which is the equivalent of 13 monthly payments. The additional monthly payment cuts the term of your loan and reduces your total interest bill.

But you can accomplish the same thing on your own. If you make an extra monthly payment every year, the result will duplicate that of a biweekly program. If you add 1/12 of the mortgage payment to each monthly payment, which amounts to an extra payment over the year, you will actually pay off the loan a little sooner than with a biweekly.

But doing it yourself requires self-discipline, while a biweekly program provides the discipline for you. That is all it provides. See Biweekly Payment Programs: the Lender's or Your Own?

Moral: If you want to accelerate the repayment of your mortgage, compare a biweekly program with an extra-payment plan of your own.

“You can trust me”. All mortgage brokers and loan officers attempt to convey the message, directly or indirectly, that they are trustworthy. Often it is true, but since most mortgage shoppers have no way of knowing whether it is or not, prudence dictates that they assume it to be a lie. Most of the mortgage brokers and loan officers with whom borrowers deal have a financial incentive to charge them as much as possible, which is reason enough to be cautious.

Mortgage brokers make their money from the spread between what you pay and the wholesale price quoted by the lender. For example, the lender quotes 6% and zero points to the broker, and the broker quotes 6% and 2 points to you, for a 2-point spread. (Points are an upfront charge expressed as a percent of the loan). Brokers do their best to avoid disclosing the wholesale prices, which would reveal their spreads.

An exception is Upfront Mortgage Brokers (UMBs), who set a price for their services and pass through the wholesale loan prices. This method of pricing eliminates the broker’s incentive to over-charge you. See Upfront Mortgage Brokers.

The majority of loan officers employed by lenders have the same financial incentive as mainstream brokers to extract as high a price as possible from borrowers. Loan officers work off price sheets showing rates and points, which are not disclosed to borrowers. A loan officer who can sell a mortgage at a price higher than the price on the sheet will share the increment, termed an “overage”, with the lender. See What Is a Mortgage Overage? The system is the same for loan officers employed by large mortgage broker firms.

Moral: Unless you have specific information to the contrary, assume that the loan provider you deal with has a financial incentive to charge as much as possible.

“The FHA wouldn’t insure the mortgage if the house wasn’t sound.” This may be less a lie than an erroneous assumption made by home-buyers. The assumption is reasonable. FHA requires a property appraisal, and that homes meet certain "minimum property requirements".

The fact is, however, that FHA does not guarantee the value or condition of a home. FHA appraisals and property requirements are intended to protect FHA, not the homebuyer. Since 2000, all purchasers of existing houses taking an FHA mortgage must, before the date of the sales contract, sign a statement acknowledging that FHA does not warrant the condition of the house. See Is FHA Responsible For the Leaky Roof?

Moral: Anyone taking an FHA mortgage to purchase an existing house should first have the house inspected.

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