Last week I reported the results of a mortgage shopping expedition, but did not say much about how I got those results. This article is about shopping technique. Most of it is simple. In a highly imperfect market, an investment in the time needed to shop effectively can pay large dividends.
Shop online: Lenders generally are prepared to deliver the prices they post online. Prices shown in printed media are obsolete when they are published, while quotes offered over the telephone are worthless.
Shop on Friday: Because the market is highly volatile, valid price comparisons have to be made on the same day. You don’t shop lender A on Monday and lender B on Tuesday because prices are reset every morning.
My favorite day to shop is Friday because the prices lenders post on Friday hold until Monday, which gives me more time if I need it. If you shop any other weekday, you have to finish it all before prices are reset the following day.
Decide the instrument you want: On my Web site, I have tutorials on making this decision, which is affected not only by your personal preferences, but also by the market prices of the different instruments. Last week, for example, I advised against conforming adjustable-rate mortgages (ARMs) because all the lenders priced them higher than fixed-rate mortgages (FRMs). Once you know the type of instrument you want, you are ready to compare the prices of different lenders for that instrument.
Use interest rate as the benchmark: Lenders usually post interest rates in even multiples of 0.125 percent, which makes it easy to find a common rate offered by different lenders. The question then is: Which lender has the lowest cost for that rate? This is a little tricky because of the different kinds of data that lenders provide.
Comparing costs on FRMs: If two lenders offer, say, 5.5 percent on a 30-year FRM, the better deal is the one with the lower total lender fees. Lender fees consist of charges expressed as a percent of the loan, usually called "points," plus charges expressed in dollars. Dollar charges are usually broken down by category, but the total is the only number relevant to the borrower.
Some lenders will show total lender fees, which makes it easy, but others show points only. They must always show the annual percentage rate (APR), however, and this is an adequate substitute because it is calculated using all lender fees. If you compare two FRMs at the same rate, the one with the lower APR has the lower total lender fees. Note: APRs of FRMs with different interest rates are not comparable.
Comparing costs on ARMs: Borrowers who are 95 percent certain they will pay off their mortgage before the end of the initial rate period can use the same method to determine the best deal on an ARM as on an FRM: Select a common interest rate and compare total lender costs at that rate. You can compare different ARMs, or an ARM with an FRM. Note: On an ARM, you cannot use the APR as a proxy for total cost; you must get cost data from the lender.
If there is a significant probability that you will still have the mortgage at the end of the initial rate period, I suggest you use calculator 9a on my Web site to calculate interest cost over both the initial rate period and that period plus five years. Interest cost is a comprehensive measure of cost similar to the APR except that it can be calculated over any time period — the APR assumes all loans run to term.
To calculate interest cost over the longer period, you must know the features of the ARM that affect the future rate. These are the margin, index and rate caps. Upfront Mortgage Lenders (UMLs) disclose this information online, but most other lenders don’t. You have to get it by asking. Make sure the answer is in writing.
The calculator must be told what happens to the ARM rate index after the initial rate period ends. I recommend two polar assumptions: "Stable Index" and "Worst Case." Then for each ARM, you have one cost figure for the shorter period, and two for the longer period that bracket the possible outcomes.
Third-party services: The procedures described above do not take account of the cost of third-party services, including title insurance and appraisal. Borrowers are typically steered to service providers, many of whom will overcharge them. This is a weak point of the system that I have written about on many occasions. However, the largest third-party charge is title insurance, and in some cases, borrowers can now save money by purchasing their own title insurance online from www.entitledirect.com.
The writer is professor of finance emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.
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