How Not to Get Screwed on Your Mortgage

Mortgage lenders don’t like it when their customers know too much.

Take Ted Janusz, for instance. A former loan officer during the heyday of the predatory-lending frenzy in the mid 2000s, Janusz eventually resigned in disgust at the industry’s lack of ethics and wrote a book-length expose, Kickback, detailing lenders’ attempts to defraud their clients. Their chief strategy? Capitalize on the ignorance of the American public.

“The average person only gets a mortgage every seven years,” Janusz later told Businessweek. “How can you become good at something you do every seven years, especially if you’re dealing with somebody who knows all the ins and outs and is doing this several times a day?”

This means that those who don’t do their homework can find themselves at a disadvantage when sitting down to negotiate with a broker. Here are some pointers to help you level the playing field—and maybe even win—at the mortgage game.

1. Check Your Credit Report

For would-be homeowners, good credit is fundamental. That’s why, six months before you make an appointment with a broker, you need to order free copies of your credit score from all three credit agencies: Experian, Equifax, and TransUnion. These agencies make mistakes constantly. If you see something on your report that shouldn’t be there, get it taken off.

Also, be aware that credit standards are getting tighter. Most mortgage companies want to see at least a year’s worth of spotless credit before granting a loan. Folks with scores over 720 will naturally get the best interest rates.

However, even if you’re not a member of the perfect-credit elite, don’t despair: you can still improve your standing by making sure you don’t owe more than 30% of the available limits on any of your credit cards, and by not opening up any new lines of credit in the months leading up to the mortgage application. You want the bank to know that you’re not a credit addict, that you know how to put on the brakes and meet your financial obligations.

2. Shop around

If you were in the market for a car, you wouldn’t just go to the first lot you passed and pay whatever price the dealer quoted you. You’d look at several vehicles, visit other lots, and use the fierce competition among sellers as leverage to negotiate the best possible deal. Yet it’s amazing how many people don’t do the same when shopping for mortgages.

Remember, mortgage lenders are offering you a service. The competition is cutthroat. They can be very accommodating indeed once you let them know you’ve gone to other lenders and are willing to take your business elsewhere. You should use this fact to extract concessions when sitting down at the bargaining table.

What sorts of concessions? Well, first and foremost, you can get them to waive the in-house fees many of them will try to charge you. When banks are processing a mortgage application, they have to farm out many background checks to third parties, and it’s only fair that the applicant pay for these. Other charges, however, are bogus, because the work is done by the bank itself. Here, the lender is just trying to ratchet up the cost of the loan, and you are very much within your rights to ask that these charges be waived. These include fees for “document preparation,” “credit insurance,” and other non-services. If in doubt, have your lender explain the purpose of each additional charge, and when you ask that it be waived, have the lender put it in writing.

Also, remember that every part of the mortgage package is negotiable. The loan officer has something called a daily rate card, which shows the lowest available rate for all the mortgage products offered. Ask to see it.

Finally, while you obviously want to secure the best possible interest rate from the bank, you can extract concessions from the seller of the house, as well. Oftentimes, you can get him or her to pay a percentage of the total mortgage—say, 2 or 3%—and then use this towards the closing costs or to pay down the interest rate.

The moral? Be aggressive in your bargaining, and never be afraid to ask questions.

3. Pay off Those Credit Cards

When you go mortgage shopping, the first thing the lender does is check your Debt-to-Income Ratio. This number pools together all your outstanding debts (child support payments, student loans, credit-card balances, etc.) and measures them against your gross income. The lower your ratio, the lower the interest rate you can get. Banks know that people who aren’t leveraged up to the eyeballs are at less risk for defaulting on a loan.

From this, it logically follows that if you want a better interest rate, one of the best things you can do is minimize your debts before you ever talk to the mortgage broker. If you have a credit-card balance, pay it off. If you have a car loan, pay it down. A few thousand dollars today can save you tens of thousands over the long term.

To get the best rate, your Debt-to-Income Ratio shouldn’t be more than 36%, and the Federal Housing Authority suggests a maximum threshold of 41%. Anything higher, and your interest rates will spike.

Clearing your debt sheet not only helps you pay less in the short term, but it allows you to afford more house in the long term.

4. Beware of Private Mortgage Insurance

The law requires borrowers who put down less than 20% on a home to carry Private Mortgage Insurance (PMI). This insurance is designed to protect the bank, not you, and it can be very expensive.

Say you buy a $200,000 house with a 15% down payment. The PMI will come to about $500 a year. Put down just 5%, and it goes up to $1,500 a year. It thus behooves you to put down as big a down payment as you can.

But even if you can’t put down the full 20%, you still have other options if you want to avoid paying PMI. One possibility is to take out two loans: a higher-interest, short-term loan to cover whatever you need to make up the 20% down payment, and a long-term one to cover the remaining 80%. For example, if you only put 10% down, you would need a short-term loan for another 10%, and then a regular mortgage for the 80% still outstanding. Ask your loan officer to run the numbers for you.

Even if you do end up having to get PMI, you can often get the bank to cancel it for you once your equity in the house reaches 20%. (It’s automatically cancelled when it reaches 22%.) Get the broker to put the terms in writing before you sign.

5. Think Short

So you’ve got solid credit, you’ve played hardball with the loan officers, and you’re able to put down 20%. Why not go all the way and consider a shorter mortgage term?

As of right now, interest rates on 30-year fixed-rate mortgages are hovering around 4.75%, while those for their 15-year counterparts are at 3.82%. You don’t have to be a math Ph.D. to see how that can translate into huge savings over time.

The down side, however, is that your monthly payments will be higher, even though there will be fewer of them. Make sure you’re able to handle them comfortably, with enough cash left over in case of an emergency.

Posted by on August 22nd, 2013 at 10:02 am

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.