Re-shopping a home mortgage loan can save you money, but it can also become a costly mistake. Elizabeth Warren and Amelia Warren Tyagi explain when to sign and when to run from a home refi contract. From their book All Your Worth: The Ultimate Lifetime Money Plan.
1. Arm Yourself Before You Call. You can save a lot of time in the long run and make things a lot easier if you get ready before you start shopping.
- Clean up your credit report. The mortgage lender will start by ordering a copy of your credit report, so your best bet is to clear up any errors ahead of time. Order a copy of your credit report from each of the three big credit bureaus: Equifax, Experian, and TransUnion. (Depending on where you live, you can get your report for free or for a very low fee.) Steer clear of anyone who offers to clean up your credit report for you; they charge a lot of money, and most of them don’t do any good anyway. This is strictly a do-it-yourself job.If you find any errors, notify the credit bureau immediately. Here are some common errors to look out for: mistakes in your name, Social Security number, and other personal information; accounts that are not yours; bankruptcies that are more than 10 years old, and other negative information that is more than 7 years old (by law, the credit bureau is required to remove that information); credit inquiries that are more than 2 years old; missing notations when you’ve disputed a charge; list of credit card and mortgage accounts that are in good standing; closed accounts that are incorrectly listed as open. According to a recent poll, 1 in 4 credit reports contains an error serious enough to keep you from getting a good loan, so be sure to take the time to check your credit report before you apply for the mortgage.
- Gather your financial information. Gather your pay stubs, tax returns, bank statements, and the like. You’ll need this before you can finalize your applications, so you might as well gather it ahead of time. You can usually get a more accurate quote if you have all the information at the time you apply.
- Find out your current mortgage balance. This should be listed on your monthly mortgage statement. If you’ve thrown that out, then call the mortgage company and ask.
- Learn how much your house is worth. The lenders will need to know this so they can calculate a “loan-to-value ratio” (which tells them how much equity you have in the house). The more equity you have, the better your interest rate. Eventually you will need an official estimate of the value of your house, but having a general sense ahead of time can help you with your shopping. So check out the open houses in your neighborhood and take a look at the real estate section of the newspaper so you get a ballpark estimate of what your house is worth.
2. Get multiple quotes. Before you buy something big — say, a washing machine or a new television — you probably check prices at two or three stores. Well, your mortgage probably costs 200 times more than your washing machine, so you should talk to 400–600 mortgage companies, right? Okay that’s a bit much, but you get the point — shopping hard for a mortgage can save you far more money than shopping for pretty much anything else. So put in the time to get it right. Here’s our rule of thumb: Five quotes before you quit. Five different mortgage companies with lots of information and plenty of range to compare. And if the quotes are all over the place, then you may want to get five more. The bottom line is that the time you spend here pays off big time.
3. Never forget that the mortgage broker does NOT work for you. The mortgage broker, like an insurance broker, gets you price quotes from a lot of different places, and gets a commission for his services. So far, so good. But, mortgage brokers (unlike most insurance brokers) often get extra commissions from the lender if they talk you into taking a mortgage with a higher interest rate than you actually qualify for. That’s right: They get kickbacks for steering you to a bad deal. And it’s perfectly legal, so you’d better beware.
Yes, it is your money. Yes, you choose which lender will have your mortgage. Yes, the broker will tell you that he “checked with all the banks” and that he found you “a great deal.” But the fact is, mortgage brokers are a lot like car salespeople. The more you pay, the more they make. A recent study at Harvard Law School showed that people who went to mortgage brokers paid, on average, over $1,000 more than people who went directly to the mortgage lender.
Does this mean you should never use a mortgage broker? Not necessarily. There are some reputable brokers who will give you a perfectly fair quote. (And there are some mortgage companies that will steer you to a bad deal if you don’t use a broker.) But you should never count on a lone broker, a single Web site, or just one lender to show you all your options. The lesson is straightforward: You must get on the phone and get quotes from several different sources. If you’re not sure if a particular company is a mortgage broker, just ask. And keep asking questions until you are sure you have the best deal.
4. Do not increase the amount of money you borrow. There are lots of people (including a number of so-called financial experts) who will tell you that it’s smart to “cash out” your home equity and take on a bigger mortgage. Well, we’re here to tell you it isn’t smart. In fact, it is just plain dangerous. You are not “cashing” anything. You are just borrowing money that you will have to pay back someday — and you are doing it in the most dangerous way possible. If something goes wrong and you can’t pay, the mortgage company gets to take away your house. Remember this simple rule: When you refinance your mortgage, don’t let the bank talk you into taking on a single dollar of new debt.
5. Watch out for fees, points, and other fine print. Picture this: a team of lawyers fanning out through a forest to lay bear traps, which they carefully cover over with leaves. Then switch the image: The forest is really just a mortgage agreement, and the leaves are just words to cover up what they are doing. But the traps are real, and you need to make sure that they aren’t in your contract. Here’s a list of the questions to ask, along with the answers you want to hear:
- What is the interest rate? By law, every mortgage lender must quote you the annual interest rate. (You may also be quoted the Annual Percentage Rate, or APR, which lumps certain fees into the total cost.) Once you have the annual interest rate, you can make an apples-to-apples comparison on the interest rate, which is probably the most important part of the loan. Here’s a rule of thumb: Unless you have recently declared bankruptcy or have really bad credit (and we’re not talking about a couple of late payments), if someone wants to charge you more than the average market rate (which is listed in the newspaper and available at www.freddiemac.com), this is probably a bad deal.
- How many points are on the loan? A “point” is just jargon for an extra fee of 1% of the total amount of the mortgage loan. Generally speaking, there is a tradeoff between points and interest rate: A loan with fewer points will have a slightly higher interest rate, and vice versa. If you think you will sell the house or refinance again in the near future, then your best bet is usually to avoid the points and pay the higher rate.Regardless of how long you plan to stay in the house, you should steer clear of any mortgage that charges more than 1–2 points. Don’t assume that all big lenders charge about the same fees. Not long ago, when most companies were charging less than 1 point on refinancing, Wells Fargo reportedly charged some customers as much as 10–12 points!
- What are the closing costs, origination costs, and other fees? Ask for a “Good Faith Estimate” of closing, origination, and other costs, and use this information when you do your comparison shopping. If the fees are unduly large, or if the estimate is in a range that is too wide to be useful (for example, we heard of one company that tells people that the fees are anywhere from $0 to $12,000!), walk away. This isn’t a company you can trust for the next 30 years.
- How long is the payoff period? The typical mortgage payoff period is 30 years. But if someone tries to steer you to a 40-year loan or an “interest-only” loan (where you never pay off your mortgage!), run the other way. And if you have a relatively short time left to pay on your mortgage — 15 years or less — get a 10-year or 15-year loan, rather than a 30-year. Lower monthly payments are great, but not at the cost of keeping you in debt for more years than necessary.
- Is this a fixed or variable rate? If rates are low, then it is a good idea to lock in the rate for as long as you plan to live in your house. You will pay slightly more for a fixed-rate loan, but the security is worth it; the rate on a variable loan can go up at any time. If you think you will stay in this house for the rest of your life, get a 30-year fixed-rate mortgage. If you are pretty sure you will move on in a few years, you might consider a mortgage that is fixed just for the first 5 or 7 years, which tends to be cheaper than a 30-year fixed loan. Brokers call such mortgages ARMs, for adjustable rate mortgages. At the end of the 5- or 7- year period, the rate can vary, but by then you will have sold the house and moved on. But stay away from any ARM that lasts less than 5 years; the risk that rates will rise while you’re still living there is just too high. And if you’re not really sure whether you’ll move or stay put, your safest bet is still a 30-year fixed loan. It costs a little more, but 30 years of easy sleeping is well worth the price.
- Is there a balloon payment? If the answer is yes, walk away. A “balloon payment” is a giant payment that will be required of you at some point in the future (on top of your usual monthly payments). These are notorious scams that have cost countless homeowners tens of thousands of dollars in extra fees, and many have even lost their homes.
- Is there a prepayment penalty? If the answer is yes, walk away. If you need to sell your home, or if you want to refinance to obtain a better rate in the future, a prepayment penalty leaves you at the mercy of your mortgage company — paying extra for the privilege of paying off your loan.
- Is there a Yield Spread Premium (YSP)? This is industry-speak for the kickback that gets paid to brokers for steering you to a bad deal. Ask if the loan has a YSP. If the answer is yes, walk away. And if you can’t get a straight answer, run away. These aren’t people you want to deal with.
- Do I have to take out Private Mortgage Insurance (PMI)? When you buy a home with a small down payment (less than 20% of the purchase price), most lenders require that you take on Private Mortgage Insurance (PMI). If you get in trouble and the bank forecloses, the PMI will pay the mortgage company off. It doesn’t benefit you and it doesn’t help you hold on to your house, so it’s really only there to help the mortgage lender, not you.
ABOUT THE AUTHORS
Elizabeth Warren is a chaired professor at Harvard Law School. She has appeared on numerous television shows, including Dr. Phil and the Today show. Amelia Warren Tyagi is a former consultant with McKinsey & Company, and has written for Time, USA Today, and several other publications; she is also a regular commentator on Marketplace. Elizabeth and Amelia are mother and daughter coauthors of All Your Worth: The Ultimate Lifetime Money Plan (Copyright © 2005 by Elizabeth Warren and Amelia Warren Tyagi) and The Two-Income Trap: Why Middle-Class Parents Are Going Broke.
MORE ARTICLES BY THE AUTHORS
- Read the Introduction to All Your Worth: The Ultimate Lifetime Money Plan
- See the book’s Table of Contents