Getting the Right Mortgage for You
By Ben Woolf

I hate surprises.  I like my gifts unwrapped, my parties planned and my clients to know what to expect when they come to my office to sign loan documents. 

I am a partner in a title company.  A large part of our business is helping people sign their loan documents when they are buying a home or refinancing.  Thankfully, the people who bring me business do a great job of preparing their customers, but too often in this industry people do not know what they are getting when they arrive to sign papers.  Consequently, they end up with less-than-desirable terms.  There are many reasons this can happen, such as fear that they won’t be able to understand the terms, disinterest, or simply not knowing what questions to ask. 

As an escrow officer I feel a responsibility to help my clients understand what they are agreeing to.  What should you be aware of?  What is it going to cost?  How do you avoid being surprised?  These are all important questions to ask before you arrive to sign papers.

I need to begin by saying that I believe any loan can be good if used in the right situation.  There is no such thing as a bad loan — only an inappropriate one.  It is important for the borrowers to first find either a loan broker or a lender who is honest and hard working to guide them through the loan process. 

One of the most important things a loan officer can do is ask a lot of questions.  Once the client’s needs have been identified, the loan officer can begin customizing a loan for that particular borrower.

One of the first decisions to make when getting a loan is deciding between a fixed rate mortgage (FRM) or an adjustable rate mortgage (ARM).  Just as it sounds, a FRM means the interest rate will never change for the life of the loan.  An ARM means at some point the interest rate will become variable and will adjust based on an index. 

There are many different indices and I would recommend doing a little research online if the borrower is considering an ARM.  (www.mortgage-x.com is a great resource to track the history of the different indexes.)  ARM’s have become quite popular, usually because the initial interest rate is lower than what you could get with a FRM.  However, many people are finding that their rates are no longer as attractive and are rising each month. 

For example, the Federal Reserve Board has raised a key index (the Prime Index Rate) to a five year high of 8.25%.  This tends to have a ripple effect on the other indices.  A borrower needs to understand that having an adjustable rate — especially in this market — most likely means that at some point the interest rate and consequently the payment will increase.

Another standard question concerns the length of the amortization of the note.  In other words, how long will the borrower have to pay back the loan?  The standard lengths are 15 and 30 years, and occasionally 20-year terms are offered.  Just recently, more lenders are offering 40-year mortgages, and just this spring, several lenders debuted 50-year terms as well. 

The easiest way to explain how this can affect you is that the longer the term, the more the borrower will pay because of interest.  Like ARMs, many borrowers are turning to longer terms to be able to “buy more house”.  They just need to be aware of the long term costs.   

For example, if a borrower buys a home for $200,000 at 6.5% interest, at the end of a 30-year note, the loan would of course be paid in full.  However, after 30 years on a 40-year mortgage the balance owed would still be more than $103,000 and on a 50-year note, more than $151,000!  At that same mark, they would have paid in interest about $255,000 on the 30-year note, nearly $325,000 on the 40-year note and more than $357,000 on the 50-year.

After determining how the interest will work and the length of the note, there are still several variables.  The first variable includes how the payments are calculated.  The default choice is a payment that will pay off the loan in equal installments over the life of the loan. 

More and more I am seeing people choose an interest only or a minimum payment option.  These two options allow the borrower to pay a reduced amount for some fixed period then resume paying off the principle over a shorter schedule.  For example, a 10-year interest only option with a 30-year note has the borrower paying off the loan in full over 20 years if they’ve only made interest payments those first ten.  A minimum payment is a set payment based on a low interest rate that often isn’t enough to cover even the interest owed.  It causes negative amortization, which means the amount you owe is more at the end of the year.  Whatever interest is not covered by the minimum payment is added to the loan. 

One last variable is whether the loan has a prepayment penalty, or “prepay.”  This means that the lender will charge a fee for the borrower to pay off the loan early.  There are two types of prepayment penalties: a hard and a soft prepay.  A hard prepay means you pay a penalty regardless of the reason for the prepayment, (e.g. the sale of the home, a refinance, a surprise inheritance, on anything else) whereas with a soft prepay, the lender will waive the fee if the prepayment is due to the sale of the property.  There are stipulations of course, but as long as it is a legitimate sale the penalty is waived. 

The most common penalties are either six months of advanced interest, or 5% of the original loan amount.  These can last any period of time but are usually three years or less.  The broker can usually get a better rate if the loan includes a prepay, so there is some benefit to the borrower.

After deciding on the terms of the note and understanding the variables, it’s time to think about how much this is going to cost.  When it comes to fees, this can be a delicate subject.  It’s difficult to define “normal” fees.  The problem is that each loan is unique, and as an escrow officer, I have no idea how much work has been needed. 

There are some things that can eliminate the surprises, though.  First, ask for a good faith estimate.  A broker should be able to provide an estimate of how much it is going to cost and what the monthly payments will be.  Remember that this an estimate, which means the numbers can change.  And second, don’t be afraid to ask about any of the fees.  Someone should be able to explain the reason behind each of the charges.

At the time of closing, these closing costs will be disclosed on a HUD-1 Settlement Statement (more commonly known as the “HUDs”).  HUDs are a summary of all credits and debits in the transaction.  On the second page of the HUDs, the closing costs are broken out into detailed accounting of all charges.  There are four main sections — realtor fees, lender and broker fees, prepaid and reserve accounts and title fees.  The charges on the HUDs should be close to the fees listed in the good faith estimate.

Finally, it is important to understand how a loan broker is paid.  A broker is a coordinator.  Brokers take a potential borrower and search through numerous lenders to find what they feel is the best deal.  They are then paid by the borrower, either through an origination fee or a broker fee.  In addition to what the borrower pays, the broker is also paid a premium by the lender.  This could be considered a finder’s fee and does not affect the closing costs of the borrower.  This is called a Yield Spread Premium (or YSP) and should be disclosed on the settlement statements.

Applying for a loan and understanding all of the variables can be a daunting task.  Although it is important to be informed, it’s very difficult to expect the borrower to know everything.  As mentioned previously it is important to find someone who is competent and honest who can guide you through the process.  But with some effort you can understand the basics and make sure that the loan you are agreeing to meets your needs.  This way it is possible to take away the surprises and come to the signing table prepared.