September 5, 2013

Mortgage pricing is a complicated process, which allows loan officers who understand it to get the better of borrowers who don’t. The first step for any borrower looking to obtain the best possible price is to learn how the pricing process works. 

Each Mortgage Type Is Priced Separately

A 30-year fixed-rate mortgage (FRM) carries a different price than a 15-year FRM, and the same is true of each type of adjustable rate mortgage (ARM). Loans carrying special options, such as prepayment penalty or interest-only, are also priced separately. 

Prices Are Multi-Dimensional

Unlike most other products and services, the price of a mortgage has 2 or more dimensions: the interest rate which is paid over the life of the loan, and upfront fees paid at closing. Fees are of two types: those expressed as a percent of the loan, called “points”, and those expressed as a fixed dollar amount. In addition, if the borrower’s equity or down payment is less than 20%, mortgage insurance (MI) is required. The complete price of an FRM, for example, might be 4%, 2 points, $500 and $80 a month MI. On ARMs, the complete price would also include the rate margin, rate adjustment caps, and maximum and minimum rates.  

Implication For Shoppers: Avoid lenders who quote incomplete prices. 

Prices Are Rate/Point Schedules 

Instead of offering a single price, mortgage lenders offer a schedule of rate/point combinations. On a 30-year FRM, for example, they might offer: 

4.5% at -1.5 points (rebate)

4.25% at 0 points

4% at 2 points 

Some lenders offer 10 or more combinations. This allows borrowers to select the combination that best meets their needs. For example, a borrower who expects to have the mortgage for 12 or more years and has the cash required does best by paying points to lower the rate. A borrower who expects to sell after 3 or 4 years and is short of cash does better with a higher rate and a rebate, which is used to pay other upfront expenses. 

Implication For Shoppers: Decide on where you want to be on the rate/point spectrum and select a shopping rate. For example, shop a 4.25% 30-year FRM for the lowest points plus fixed-dollar fees. It is quite possible that the lender with the best price on a 4.25% won’t have the best price on a 4%. 

Prices Are Volatile

Mortgage prices are volatile. Lenders reset their prices every morning, primarily based on changes in secondary market prices the previous day. If price changes in the secondary market during the day are unusually large, lenders will adjust again during the day rather than waiting until the next morning. 

Implication For Shoppers: Make sure you are being quoted today’s prices rather than yesterday’s, and bear in mind that prices will be different tomorrow. While the lender with the best price today will probably also have the best price tomorrow, this holds only if you are comparing posted prices.  

Posted Prices May Differ From Quoted Prices

Posted prices are those a lender is prepared to commit itself to at the time. The prices quoted by a loan officer (LO) to a mortgage shopper may or may not be the posted price. Some LOs quote prices below posted prices in order to attract business, a practice called “low-balling”. They can do this because the market will change before they are obliged to deliver. Lenders are not committed to a price until they lock it, which ordinarily they won’t do until the borrower has submitted an application and been approved.  

Implication For Shoppers: Make sure the prices you shop are posted prices. All price quotes by LOs are suspect unless the LO accesses the price on his computer in your sight. Some web sites, including this one, display posted prices only. 

Prices Are Adjusted For Transaction Features

Every mortgage price is unique to a specific transaction. Among the transaction features that affect the price are the loan size, the ratio of loan amount to property value, the borrower’s credit score,  type of property, state location of property, type of occupancy, whether the borrower is taking cash out on a refinance, and length of lock period.  

Unless all the factors that affect your price are taken into account, the price quoted to you, even if it is a posted price, will invariably be too low. In calculating the price, the lender will assume that the features that are not known are those that generate the lowest price. This is another type of low-balling.   

Implications For Shoppers: Unless the source of a price quote has asked you about all the transaction features that affect the price, it is safe to assume that you are being low-balled. Shoppers without the patience to provide all the required information invite the abuse. 

Shoppers should also know how each transaction feature affects their price separately, since they may have options in how they structure the transaction. Unfortunately, there is no place they can now go for that information. Soon there will be, stay tuned.