The APR is intended to make it easier to compare lenders and loan options.  One should be able to call and inquire as to what a lender’s APR is and go with the lowest one.  Unfortunately, despite repeated attempts by regulators to establish usable and consistent standards, the APR does not represent the total cost of borrowing nor does it really create a comparable standard.  Some lenders will manipulate the APR, either intentionally or unintentionally by omitting certain fees from the APR, thus reducing the rate.

The best way to find the lowest rate and cheapest closing costs is to ask just that.  By asking a lender to break those out separately, you can better analyze and size up their offer.  As I mentioned in my previous article “Let’s Go Shopping”, requesting a Good Faith Estimate is the best way to accomplish this.

This is where the marketing aspect comes in.  Some lenders will use this compensation to subsidize the fees they normally charge.  That is why you can find lenders with lower rates and higher fees or higher rates and lower fees.  One way or another, you end up paying for it.  Essentially you’re just financing it into the rate, with less due out of pocket at closing.  If you shop long and hard enough, you can find the best of both worlds: a lender with low fees and low rates.

All of this is assuming a loan with no points as points should only be paid to buy the rate down.  However, this is usually not a wise investment.

Believe it or not, 65% of all mortgages in America are originated by mortgage brokers.  Because many of those brokerages are small businesses, they can keep their overhead low and effectively lower their margins.  This means lower rates and closing costs for consumers.  Although lenders quietly solicit mortgage business, it costs them much more to originate a loan as they have to maintain a larger staff to do so.  Therefore, they rely on thousands of mortgage brokers who in turn have “mortgage sales people” to find the business.  The lender pays the broker a commission for finding, processing, and delivering the loan to them. 

But not all mortgage brokers were created equal.  You still want to shop for the best deal as some charge unnecessary origination fees for their services.  But don’t be fooled, the lender is paying them for their services so you shouldn’t have to.

A bi-weekly mortgage is set up so that your mortgage payment is automatically debited out of your checking account every two weeks, thus making 26 payments a year.  This is actually just one additional payment per year (26 payments divided by 2 equals 13 payments a year instead of the normal 12).  Of the bi-weekly mortgages we offer, most come at a higher rate, typically .25% higher.  Some even have set-up fees and ongoing monthly “administrative” fees. 

Using a loan amount of $150,000 at 6% over 30 years set up as a bi-weekly loan, it took off 5.6 years paying the loan off in 24.4 years.  It also saved $32,855 in interest versus a traditional 30 year loan.  This assumes you stay in this mortgage for a long time to reap the benefits as well as recoup any fees associated with the loan.

Now what happens when you just make one extra payment a year on your own?  Using the same numbers as above, $150,000 at 6% over 30 years is $899 P&I per month so that would be an extra $899 a year.  But what if you just don’t have an extra $899 left over at the end of the year, especially around the holidays?  Well, the good news is you don’t have to.  The trick is, divide the monthly P&I payment by 12 and add that to your monthly payment each month (using round numbers, $899 divided by 12 equals $75 so the total monthly payment would be $974)  This scenario takes off 5.4 years and pays the loan off in 24.6 years, slightly longer than the bi-weekly.  But the real benefit is that you save $36,853 which is $3,998 more than the bi-weekly due to the way the loan is compounded.

So don’t be fooled by the touted advantages of the bi-weekly loan.  Use simple elementary level math to do the work for you!

We then look at the equity position.  Depending on the type of loan (rate/term refi, cash-out refi, or purchase), the rate can be higher or lower depending on the credit score and equity position.

A true no-cost refinance is one in which the lender literally picks up all of the fees, with exception to your escrows (assuming you escrow taxes and insurance) and pro-rated interest.  So you don’t pay any fees; no appraisal, no credit report, no title search, nothing.

So how does the lender do it?  Understanding this requires knowing how lenders are compensated.  Most lenders are compensated by the banks and mortgage companies to whom they sell or broker loans.  Typical compensation for a lender who wants to be competitive is .75 – 1% of the loan amount.  This means that for a $200,000 loan, the lender would be paid $1500 – 2000 for originating the loan.  Each day, lenders receive rate sheets from all of the banks and mortgage companies showing what the compensation is at different rates.  So if at 6% the lender is getting paid 1%, then at 6.125% they would be paid approximately 1.5%, and at 6.25% they would be paid approximately 2%.  As you can see, the higher the rate at which they lock you, the more they are paid.

That is where the no-cost refinance comes in.  Whereas a traditional refinance involves a locked rate based on specific closing costs, the no-cost refinance is at a higher rate with no closing costs.  The lender actually quotes you a higher rate and uses the compensation to pay for the closing costs.  Using the example above, at 6.25% the lender is getting paid $4000 by the bank or mortgage company for originating your loan.  If the total closing costs are only $1600, the lender nets $2400 compensation from your loan, and you paid nothing to do it.  Or did you?

You see, you haven’t yet, but you will.  That’s because when you choose a no-cost refinance option, you’re getting a rate that is .25-.375% higher.  So you’re basically financing the closing costs in the interest rate, something that can add up over time.  Let’s take a look at an example.  The interest on a $200,000 loan at 6% = $1000/month and a $200,000 loan at 6.25% = $1041.67.  So the difference between the traditional refinance and the no-cost refinance is $41.67 higher each month.  That means that if closing costs run $1600, you would start losing on this option after 38 months, which is the break even ($1600/41.67=38.4).

So longer term a no-cost refinance may cost more, but in times where the Fed is cutting rates and they are expected to drop, you may want to choose this option as you can refinance over and over without trying to guess the bottom.

More importantly, rates change daily and they can change quickly. Some mortgage professionals have recently noted that their rate quotes have only had shelf lives of three to four hours before market changes have deemed them inaccurate.

How does a consumer navigate fast changing markets in order to refinance their existing loan or purchase a home with the most favorable terms possible?

1. Plan – Define your needs ahead of time, do not wait until the last minute. This is especially true of home purchases.
2. Consult – Talk to your mortgage professional on a regular basis so they can interpret recent market events to you and communicate how those events can affect you.
3. Execute – When you have defined your needs and have determined that now is the best time to move forward, don’t shop yourself out of a good loan! What does this mean? It is easy to get caught up in shopping for the best rate, but it is not uncommon for home owners to miss locking their loan at a great rate because they are in search of better rates that do not exist or that they do not qualify for. It is important to shop to insure you are getting the best rate possible, but set limits to the number of companies you are going to consider doing business with and be careful of having your credit report needlessly and more times than is necessary!