Mortgage pricing is a complicated process that allows loan officers who understand it to get the better of borrowers who don’t. The first step for any borrower looking for the best possible price is to learn how the process works.
Each mortgage type is priced separately.
A 30-year fixed-rate mortgage, or FRM, carries a different price than a 15-year FRM, and the same is true of each type of adjustable-rate mortgage, or ARM. Loans with special options, such as prepayment penalty or interest-only, are also priced separately.
Prices are multidimensional. Unlike most other products and services, the price of a mortgage has two or more dimensions: the interest rate, which is paid over the life of the loan, and upfront fees paid at closing.
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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 percent, mortgage insurance is required.
The complete price of an FRM, for example, might be 4 percent, 2 points, $500, and $80 a month in mortgage insurance. On ARMs, the complete price would also include the rate margin, rate adjustment caps, and maximum and minimum rates.
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 percent at negative-1.5 points (a rebate)
• 4.25 percent at 0 points
• 4 percent 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 three or four years and is short of cash does better with a higher rate and a rebate, which is used to pay other upfront expenses.
Decide on where you want to be on the rate/point spectrum and select a shopping rate. For example, shop a 4.25 percent 30-year FRM for the lowest points plus fixed-dollar fees. It is quite possible the lender with the best price on a 4.25 percent won’t have the best price on a 4 percent.
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 rather than wait until the next morning.
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 to a mortgage shopper may or may not be the posted price.
Some loan officers quote prices below posted prices to attract business. 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.
Make sure the prices you shop are posted prices. All price quotes by loan officers are suspect unless the loan officer accesses the price on his or her computer in your sight. Some websites, including mine, 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.
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.
Jack Guttentag is professor emeritus of finance at the Wharton School of the University of Pennsylvania.