Mortgage fraud abounds. Mortgage fraud abounds.

Friday, July 3, 2009

Applying for a Mortgage? Beware of the Loan Officer in Sheep's Clothing

If you have submitted a mortgage application and you've been notified that it has been approved, you might want to curb your enthusiasm. It's quite possible your loan officer is about to take you to the cleaners. Why? Because you probably don't have a clue how easily it can be done.

Think otherwise? Take this quick quiz.

The long and short of it is simply this. If you understand how mortgages are priced, you could easily save yourself thousands in undisclosed/under-disclosed lender fees every time you purchase a new home or refinance the old one. Given the fact that the average family buys a new home or refinances once every 3-5 years, over the next ten years you could conceivably save enough to buy a new car.

How much you stand to save depends on three important factors:

1. The size of your mortgage.

2. The lender you submit your application to, and

3. The truthfulness of loan officer you deal with.

While the first of these factors is obvious even to the unschooled, most borrowers fail to understand the importance of the last two. I say this because in the 15 years I was in the business, I rarely encountered a borrower who had even the vaguest idea how to shop for a mortgage.

The posts appearing in this blog are presented in natural order so if you read it from top to bottom you'll be able to take full advantage of it. Individual section titles appear in the left hand column for repeat access.

Unless or until Congress takes steps to require all lenders to provide a full disclosure of the fees they charge consumers for mortgage lender services, I have no intention of posting updates save for the comments readers make to individual posts.

Needless to say, I hope you find this as useful as those who continue to ask me for assistance. If you find this blog useful, please spread the word.

R. Harrison Scott

Postscript: I have done my level best to provide accurate information. If you find factual errors or misrepresentations, please don't hesitate to make direct comment or to email me with corrections. All comments are moderated, not because I wish to censor opposing views, but to ensure the discussion remains civil.

Update: The Federal Reserve has finally taken action to put an end to abusive mortgage pricing practices. Come April 1, 2011, lenders will no longer be allowed to price loans (raise interest rates on newly originated loans) to generate additional undisclosed/under-disclosed income via service release premiums. Thereafter, readers are advised to regard this blog as a historical reference because its content will no longer be relevant.

Tuesday, December 30, 2008

Quantifying Your Savings

After you’ve read this blog in its entirety, if you want to find out how just much money you will be saving, all you have to do is talk with a mortgage broker willing to provide you a Good Faith Estimate and, as you will discover, there is a compelling reason to get that Good Faith from a broker, not a direct lender.

When you approach the broker, keep in mind that your primary objective is to convince him that you just got off the turnip truck and don’t know the first thing about mortgages. Tell him that you are looking to buy a new home or refinance the one you currently own. Be prepared to provide him with all the basic information he would ordinarily need to prepare a Good Faith Estimate – the purchase price or estimated property value; if a purchase, the down payment you are prepared to make; how much money you will have left to cover closing costs; and an overview of your credit history but don’t offer any more information than that. Just answer his questions without elaboration and act like a sheep who is indifferent to getting sheered.

Once you’ve listened to him drone on about the bizillion options available to you (a strategy incidentally that clever loan officers employ not to inform but to overwhelm), ask him to prepare and fax you a Good Faith Estimate. Some brokers may refuse to do this but if you’ve done a good job convincing him that you’re mentally challenged, all you have to do is tell him that you don’t want any inquiries to show up on your credit report right now because repeated inquiries can lower your FICO score and stick to that stated conviction. In this day and age multiple inquiries could prove disastrous, especially if you have border line credit issues.

If the first broker you talk to won’t prepare a Good Faith without pulling your credit or submitting an application, keep at it until you find a broker who will.

There’s an easier option if you are one of those highly organized people who has an obsession about keeping records. You may very well be able to make a determination about your savings if you happen to have retained your paperwork from a past purchase or refinance. If you do that, make sure the lender you were dealing with was a broker. You won’t be able to determine if your lender overcharged you if you deal with anyone else.

Approaching the Game with the Proper Mind Set

Like all business relationships, the one you will have a loan officer is an adversarial one though I have a tendency to think that most consumers never really come to grips with this fact.

On one hand, you will naturally be interested in securing a mortgage at the lowest possible rate and at the lowest possible cost. Your adversary, the loan officer, will be interested in generating the highest possible commission. There’s nothing nefarious about this. It’s just a matter of competing interests and if you are to succeed in negotiating terms you need to know how the mortgage game is played.

When it comes to shopping lenders and mortgage, it’s different than shopping for any service provider or product because the process is easily overcomplicated by the number available options. Absorbing the information in this guide, you will be able to see clearly through these complexities and, thereby, recognize the bulk of the information you’re provided as nothing more than a meaningless distraction.

So what is it you will learn in reading this blog?

1. You will know not only which mortgage companies to use, but which ones you should avoid and why it’s to your advantage to avoid them.

2. You will know how mortgage companies generate exorbitant undisclosed or under-disclosed profits preying on the ill-informed.

3. You will know which fees you need to control.

4. You will know not only how mortgage rates are priced but how an intimate knowledge of mortgage pricing will help you secure the best available rate at the lowest possible cost.

5. You will also learn why the Good Faith Estimate you are provided at application isn't worth the paper it's printed on.

6. You will know how a mortgage broker’s initial and final Good Faith Estimates function just like lie detector printouts. Knowing how to interpret them, you can guarantee the broker is delivering a mortgage at the lowest rate and cost.

7. You will know that while a lender may require you to pay a discount fee, it NEVER makes sense to pay a discount fee to lower your monthly payment.

8. You will know how to minimize out-of-pocket expenses.

9. You will know how to use your final Good Faith Estimate to confirm that the loan officer is delivering the lowest available rate at the promised cost.

A Case in Point

A couple of years after I retired form the mortgage industry, I received a call from a family friend in Tallahassee, Florida and in the course of the conversation he revealed that he was in the process of refinancing a $350,000 mortgage on his home. He couldn’t escape a gut feeling that he was getting the run around and his discomfort was more than justified. Knowing and applying what I’m about to share with you he has over a five year period saved a little over $6,766 in excess interest payments.

I cite his experience for a couple of reasons. First, it’s important you understand that the savings I’m talking about isn’t a matter of nickels and dimes. Secondly, I think it’s important to understand that lender pricing abuse isn’t limited to the undereducated and/or less affluent. Make no mistake, lenders are equal opportunity abusers and given the opportunity, few can resist charging a consumer more for a mortgage than he needs to pay.

It’s common sense to understand that the costs associated with obtaining a larger mortgage will naturally be greater than the costs associated with a smaller one. If you are buying a $200,000 home and making a 20% down payment or refinancing a $160,000 loan, most loan officers will usually charge a 1% origination fee or $1,600. On the other hand, if you are in the market to buy a $1,000,000 home making the same 20% down payment or refinancing an $800,000 mortgage, that same 1% origination fee could run as high as $8,000.

It may, however, come as a surprise to you that if you deal with the right lender, you may be able to negotiate a significant reduction in the lender’s origination fee if you deal with the right lender and have excellent credit. This isn’t to say that the credit challenged borrower can’t negotiate a lower origination fee. It’s just easier if the loan officer knows you can easily take your business elsewhere.

If your loan is a no-brainer – you are salaried, have gobs of money in the bank, a solid work history and have in your hand your most recent paystub, the last two year’s W-2s, and past three months’ bank/retirement statements to show reserves – there’s no legitimate reason for the loan officer to charge you what he charges everyone else. You’ve basically done his work and there’s really no reason he can’t cut you a break. As you will soon discover, some loan officers are free to negotiate your origination fee, some are not.

What may come as a real surprise to you is that while the origination fee the loan officer charges may seem high, it is the least of your worries. If you don’t control what he stands to make in undisclosed or under-disclosed fees (overage), you will end up paying a great deal more over the long run. To understand then how the good doctor avoided paying over $6,700 in under-disclosed fees you will first need to come to grips why should you always buy your mortgage through a mortgage broker.

The Secret Rules Mortgage Companies Play By

Mortgage companies can be divided into two basic categories. They are either direct lenders or brokers. Banks like Bank America, mortgage banking firms like GMAC Mortgage, and portfolio lenders like Greentree are direct lenders. They not only originate (sell) mortgages to Wall Street, they fund each of the loans they originate using their own resources and then, more often than not, service them.

The second category – brokers - originate loans on behalf of direct lenders. They neither fund nor service the loans they sell.

Why is this important?

Simply this - direct lenders and brokers are required to abide by an entirely different set of rules when it comes to disclosure. While brokers are obligated to disclose all the profits they will generate originating your mortgage, direct lenders are not. As a result, when you deal with a direct lender, you will never really know if the rate you receive is the lowest one available at a given cost because you have no way to verify that they delivered what they represented they would deliver.

Dealing with a broker, however, you will always know if you’re loan is over priced because the law requires brokers to disclose that it is being overpriced. As a result, the Good Faith Estimates he provides at application and closing provide you the means to verify that he is delivering your mortgage at the best available rate and at the lowest available cost. Broker generated Good Faith Estimates are like lie detector printouts and can be put to good use once you know how to interpret them.

Putting the disclosure aside for a moment, it’s worth mentioning that there are a couple of additional advantages to working with a broker you may not be aware of.

1. Most brokers have correspondent relationships with multiple lenders so they can frequently offer better rates than a single direct lender because they have access to the broader mortgage market. By contrast, when you deal with a direct lender the rates you see are offered on a take-it-or-leave-it basis because their marketing department only offers a single set of rates per product. What is more, the rates a direct lender offers on any given day may or may not reflect the competitive market.

2. There’s still another advantage to using a broker. More often than not you can often obtain a lower rate from a broker representing a direct lender than you will get dealing directly with the direct lender yourself. The reason is simple.

The direct lender doesn’t have any overhead to cover when a broker originates a loan. They don’t have to rent office space, buy and maintain office equipment, or have to carry the cost of loan officers and support staff. While they do have to have a staff underwriter, the borrower has to pay an underwriting fee to cover that expense. Lastly, when it comes to loan documents, the consumer pays for that as well. In the end, direct lenders frequently offer lower rates to their brokers because it doesn’t cost them anything to generate the business.

Now that you understand that direct lenders and brokers have to abide by a different set of disclosure requirements and that the broker offers a better selection of rates, it’s important you learn why it’s to your advantage to understand how you can use the broker’s disclosure requirement to control your loan costs and, thereby, control your mortgage interest rate.

Mortgage Rates and What You Pay for Them

Regardless of the mortgage type (conventional, FHA, or VA), mortgage product (fixed, adjustable, interest only, or balloon), or your credit rating, the rates available on any given market day fall into one of three categories: discounted rates, par rates, and premium rates. In Table 1 “Discounted Rates” appear in blue; the black rate represents “Par” or fair market rate, and those appearing in red represent “Premium Rates”. Keep in mind that the rates shown do not necessarily reflect the current market.

Note: You will have to double click on the table to make it large enough to read.

The “par rate” shown in Table 1 represents the prevailing market rate. Put another way, the par rate is that interest rate that does not require you to pay discount points AND does not generate a rebate. When a loan is priced at par, the broker’s profit is restricted to an origination fee. Some brokers may attempt to also collect a “broker fee” but there’s no legitimate reason to think that you are obligated to pay that. If he insists on it, find another broker. Brokers will also charge a processing and underwriting fee. These fees really don’t constitute a source of profit because the broker has to pay his processor and the underwriting fee is a fee that’s passed on to the direct lender’s underwriter.

The discounted rates shown in the table are those rates offered BELOW par (or the prevailing market rate). Discounted rates are accompanied by a discount fee. The lower the rate you buy below par (fair market), the greater the fee.

Discount fees are not by definition retained by the broker or the direct lender. They are passed to the investor who buys your loan. Why? No investor will be interested in buying a mortgage with a lower than par rate unless they are offered a financial inducement to buy it.

Unscrupulous lenders have been known, however, to charge a discount fee and not deliver a lower rate. Instead of passing the discount on to the investor, the lender retains the fee as an additional profit. Unfortunately, in some regions of the country, the practice is a common one so if you agree to pay discount points you aren’t going to have any way to determine whether they are legitimate or not.

The solution? Never agree to pay discount points to lower your interest rate.

The premium rates shown in the table are those rates offered ABOVE par (or the prevailing market rate). Like par and discounted rates, loans carrying premium rates are usually accompanied by an origination fee. What separates them from a par and discount rates, however, is that they generate a lender rebate.

What most consumers fail to understand is that the rebates generated by premium rates are, more often than not, pocketed by the lender as overage - an undisclosed or under-disclosed profit. Next to refusing to pay discount points to lower your rate, eliminating or controlling overage will be the key to your ultimate success in negotiating the best mortgage terms. If you don’t control this, you will end up with a higher interest rate which ultimately means that your monthly payment will be not only higher, but in some instance dramatically higher.

I use the term “under-disclosed” as it relates to broker pricing because the rebate shown on a Good Faith Estimate is all too often misrepresented as a issue the borrower doesn’t have to concern himself with.

Borrower: “What the hell is this?”

Broker: “Oh, that. You needn’t worry about that. This is what the lender pays us to generate your loan. You don’t’ have to pay it so don’t worry about it.”

Understand that no direct lender is going to offer a rebate unless the broker sells a rate higher than the market (par) interest rate. This, therefore, should be of concern to you because a higher interest rate will translate into higher monthly payments and, over time, this could prove to be exceedingly expensive. If the rebate appearing on your Good Faith is not going to be applied to your closing costs, it constitutes overage and will go into the loan officer’s pocket.

As mentioned in the previous section, if you deal with a direct lender, you will have no way of knowing if your loan officer is using premium pricing to generate overage because direct lenders are not obligated to disclose rebates generated by higher than par interest rates. Some direct lenders have an internal policy that prohibits a loan officer from pricing loans to generate overage but this doesn’t prevent the lender’s marketing department from doing the same thing.

Keep in mind that rate sheets are designed for loan officers and as such they only tell the loan officer what a particular rate, when sold, will cost or will generate in the way of a rebate at a specific point in time. The dollar amounts appearing in the Table 1 show what the discount fee and rebate would be on a $100,000 mortgage. If you are in the market for a larger mortgage, e.g., $200,000, $300,000, or $400,000, double, triple or quadruple the amount shown.

Depending on the volatility of the financial markets, it’s also important to understand that mortgage rates and the discount fees/rebates paired to those rates may change several times a day. Given this it’s important to understand that on any given day and at any given moment the lowest rate at the lowest cost will ALWAYS be the par rate. If you center your decision on that you’ll never have to concern yourself about the broker using market volatility to justify an illegitimate boost in your rate.

Update: Fannie Mae is apparently taking steps to boost the cost of higher risk loans. Specifically, I'm told it is now requiring borrowers with credit scores below 690 to pay upwards of 3.25 discount points to secure an interest only loan on condominiums and that's not the only stipulation. To get even that deal borrowers are being required to put at least 20% down. It's important to remember that this additional cost is not supposed to go into the brokers or direct lender's pocket. It's passed on to Fannie Mae who ultimately passes it on to the mortgage backed securities investor in the form of a deep discount.

This development should not be taken lightly because unscrupulous loan officers could easily misrepresent the facts. If a loan officer tells you that you're going to have to pay discount points for any reason, make him provide you with a copy of the page in the Fannie Mae, Freddie Mac, FHA, or VA Seller's Guide that states that you're obligated to pay them. If he/she can't produce that documentation, you'll know that he/she is trying to generate additional income.

More on Discount Fees and Mortgage Pricing

In addition to understanding pricing options, it would be also good idea to keep a few additional things in mind when it comes to discount and rebate pricing.

I NEVER, EVER recommend paying a discount fee to buy a lower interest rate to reduce monthly payments. Again, the average family moves or refinances every 3-5 years. The reduction in monthly payments will not, therefore, save you any money until you have first recovered the cost of any discount fee and that normally takes 36-54 months.

For most, therefore, the anticipated savings is really nothing more than an illusion. You can, of course, ignore this and buy a lower than par rate but I don’t think it’s a wise decision. Besides that there is absolutely no way for you to know if the discount you are paying to lower your interest rate is actually being used to buy a lower rate. In extreme cases loan officers working for direct lenders and brokers have been known to charge discount fees without delivering a rate below market. Instead they deliver par or worse yet, a rate that also generates a rebate.

An underwriter will NEVER condition a loan approval on your willingness to accept an interest rate that generates a rebate. Rebate pricing has absolutely nothing to do with the loan approval process. It is an elective pricing practice driven by loan officers interested in generating additional income and/or consumers interested in using a rebate to reduce their out-of-pocket closing expenses.

To provide a little perspective here, some loan officers will try to convince you that a boost in the agreed upon rate with a statement something akin to the following:

“I’ve good good news and bad news. The good news is that your loan has been approved. Congratulations. The bad news is that since you had a bankruptcy ten years ago, had two or three mortgage lates, or a number of late payments on credit cards the underwriter has levied a requirement that you accept a higher rate (or pay a discount fee of XX).”

When you hear this it should raise a red flag. Remember, an underwriter may condition a loan approval on your willingness to accept a slightly higher rate at a slightly higher cost but those underwriting conditions NEVER result in a rebate.

An underwriter may condition a loan approval on your willingness to accept a higher interest rate or an add-on in the form of a discount fee, but again such conditions NEVER result in a rebate. Add-ons are legitimate costs the secondary market levies on loans that have proven to pose a greater risk for default, e.g., investor properties, a non-conforming property, loans of high loan-to-value, and loans to borrowers who have marginal credit.

If you are, therefore, told by a broker that the direct lender’s underwriter requires you to accept a higher rate for whatever reason, ask him if that rate will generate a rebate. If it does, then the adjustment in price has nothing to do with meeting an underwriting condition and everything to do with the broker’s desire to generate additional income. If told the rate offered will result in a rebate, let the broker know that the adjustment is unacceptable. If he insists this isn’t the case, tell him you will be taking your business elsewhere. If he balks at this threat, find a different broker. (Keep in mind that if you are dealing with a direct lender you will never know if the loan officer is telling you the truth or not because any rebate (overage) generated by an increased rate will never be disclosed on your closing documents.)

There is one other instance where a discount fee is justified and that’s if you want to lock your loan to guarantee delivery at the specified rate. The charge really isn’t a discount fee at all but while the entry of this fee on your Good Faith Estimate may appear as a separate line entry, sometimes it is entered as a discount.

To lock-in a rate, the direct lender your broker intends to submit your loan to must buy a forward commitment and in doing so they incur a cost. The cost will vary depending on the length of the lock-in period. No lock-in fee is required for immediate delivery which is normally 14 days prior to closing. A 30 day lock will normally run around ¼ point; a sixty day lock – ½ point.

Note: There are two exceptions to these guidelines that relate to the purchase and/or refinance of investor properties and second homes. Historically, investor mortgages experience a higher default rate than those used to purchase or refinance one's primary residence so you will more than likely be required to pay upwards of one and one half discount points to secure such a mortgage on an investment property.

Since the subprime mortgage meltdown, lenders have also been leary about loaning money on second homes because some borrowers have subsequently defaulted on the loans against their primary residences. As a result, I wouldn't be surprised if in the very near future lenders suspend the origination of second home loans altogether. At the very least if you're looking for second home financing, I suspect you'll have to pay a hard discount point or two that is passed onto the secondary market to offset their risk.

The Effect Credit Has on Mortgage Pricing

Mortgages are usually priced in tiers according to mortgage size and credit rating. Mortgages in excess of the prevailing conventional conforming limit (jumbo mortgages) carry slightly higher interest rates. Applicants with A+ credit obviously get to take advantage of the lowest pricing tier. Applicants with less than optimum credit have to accept slightly higher rates because their loans carry a higher risk.

This being said, while applicants with less than stellar credit may have to accept a higher interest rate, this does not mean they have to pay discount points or accept premium pricing. Every pricing tier has a par rate. If you insist on getting par, therefore, there’s no legitimate reason it can’t be delivered.

Table 2 illustrates what might be available on a given day to the borrower with A- credit. Note that the par rate is a quarter percent higher than the A+ credit tier shown in Table 1, but a par price is still available. The lesson to be learned here is that even is you have less spectacular credit, you don’t have to pay discount fees or accept rebate (premium) pricing. Given the current state of mortgage availability, the spread between the A+ and A- par rate will undoubtedly be higher.

Note: As with Table 1, double click table to read.

What's Your Mortgage IQ?

Here's a quick test of your mortgage IQ. If you don't know the answer to each and every one of the following questions, you would be well served to read through the blog. A couple of the questions relate to subsequent posts.

1. Which mortgage companies are required by law to provide full disclosure?

a. Direct Lender
b. Broker

2. Why is it important to know who is required by law to provide full disclose and who isn't.

a. Knowing this enables you to control costs.
b. If you don't control costs, you'll end up paying more closing costs than you need to.
c. If you don't control costs, you'll end up getting stuck with a higher interest rate than you need to.
d. All of the above.

3. Which rates generate a rebate?

a. Discount
b. Premium
c. Par

4. Which rates require you to pay a discount?

a. Rates that are lower than par.
b. Rates that are higher than par.
c. Par.

5. Which rates constitute a mortgage company’s greatest source of undisclosed/under-disclosed profits?

a. Discount
b. Premium
c. Par

6. Rebate pricing can be used to:

a. Line the pocket of the broker.
b. Eliminate the need to come out of pocket to cover closing costs.
c. Both

7. An underwriter may condition your loan’s approval on your willingness to accept a slightly higher interest rate?

a. True.
b. False.

8. An underwriter may condition your loan’s approval on your willingness to accept a slightly higher interest rate that generates a rebate?

a. True.
b. False.

9. An underwriter may condition your loan’s approval on your willingness to pay a discount fee that will NOT result in the delivery of a lower than par interest rate?

a. True.
b. False.

10. Origination fees are negotiable?

a. True
b. False

11. Origination fees are easier to negotiate if you are dealing with a direct lender?

a. True.
b. False

12. Par interest rates are only available to borrowers with excellent credit?

a. True.
b. False.

13. Rebate pricing will be disclosed on the broker’s Good Faith Estimate as

a. A “P.O.C.”
b. A “YSP or Yield Spread Premium”
c. A “SRP or Service Release Premium”
d. Any of the above.

14. When disclosed on the Good Faith Estimate provided at application, rebates are usually expressed as:

a. Dollar amounts.
b. A percent or percentage range.
c. Both.

15. The lowest rate at the lowest cost will always be:

a. The par rate.
b. A discounted rate.
c. A premium rate.

16. The only way to ensure you are getting the lowest rate is to control the broker’s income.

a. True
b. False

17. The single greatest source of under-disclosed lender income is derived from:

a. The origination fee.
b. Service Release and/or Yield Spread Premiums.
c. Underwriting and processing fees.

18. It costs more for the broker to originate a $500,000 loans than $100,000 loans.

a. True
b. False

19. Some brokers can deliver lower rates than their broker competitors?

a. True.
b. False.

20. Brokers have relationships with dozens of direct lenders.

a. True.
b. False

21. When you shop for a loan, it’s important to find the broker offering the lowest par rate on any given day.

a. True.
b. False


1. Broker.
2. All of the above.
3. Premium.
4. Rates that are lower than par.
5. Premium
6. Both. Premiums may be used to offset closing costs or pocketed by the loan officer as overage.
7. True but only if the secondary market requires that a premium be paid to offset risk.
8. False. Underwriters do not levy conditions to generate overage. Their role is to minimize risk, not generate overage.
9. True but only if you are buying an investment or property. If you are securing a mortgage on your primary residence, the answer would be false.
10. True.
11. False.
12. False. Any loan officer who insists that a par rate is not available is lying to you. Apart from investor properties, there is a par rate for every mortgage product.
13. Any of the above.
14. A percent or percentage range. Loan officers do this because to express them in real dollars raises a red flag.
15. The par rate.
16. True. If you control the broker’s income, you will control the rate that’s delivered.
17. Service Release and/or Yield Spread Premiums.
18. False. The lender’s cost to produce any loan is the same.
19. False. If you restrict your dealings to brokers who have been in business for at least five years, each will have access to the most competitive rates in your market area.
20. False. Brokers restrict their wholesale relationships to two or three main providers. The idea, therefore, that there is some advantage to dealing with a broker who claims to have dozens of such relationships is nothing but hot air.
21. True. It’s important, however, to keep in mind that loan officers frequently quote an undeliverable rate to get business in the door. When you shop, make sure you are asking for the rate associated with a 30 day lock-in guarantee.

Preparing Yourself to Submit An Application

If you are buying a home, know how much of a down payment you intend to make. If you are refinancing a home, get a sense of what your home is currently worth and what loan-to-value your loan will represent. This won’t have anything to do with the interest rate you secure, but it will be information the loan officer will need to estimate closing costs.

Think about how much money you want to take out of your pocket to apply to your non-recurring closing costs.

1. If you are buying a home, there are four ways to cover your closing costs. First, you can pay them out of pocket. Second, you can negotiate a agreement with the seller so he/she pays all or a portion of them. Third, you can accept a premium interest rate and use the accompanying rebate to cover them.

There’s a fourth possibility here that will depend on the real estate agent you’re working with. In some states real estate agents are allowed to credit a portion of their commission to cover buying closing costs. In those states where the practice is illegal, real estate agents can agree to reduce their commission, passing the savings on to the seller who, in turn, agrees to pass it along to the buyer.

2. If you are refinancing a home, you have similar options. You can pay them out of pocket, accept a premium interest rate and use the rebate to cover them, or you can finance them adding them to your mortgage balance. If you agree to accept a premium rate, you’ll want to make sure that you control size of the rebate because everything beyond what’s needed to cover your non-recurring closing costs will be pocketed by the broker as an additional profit unless you make arrangements to have that excess distributed to you in the form of a cashier’s check at closing. If you decide to add your closing costs to your mortgage balance, first understand that your payments will be higher because you will be financing a larger mortgage. Secondly, it's to your advantage to make sure more isn't being added to your mortgage balance than is absolutely necessary.

Advanced Game Play

When it comes to shopping lenders, it’s important to keep a number of things in mind.

1. If you want to make sure you are not paying more for your mortgage than you need to, restrict your shopping efforts to mortgage brokers. If you are a member of a credit union, check with their resident loan officer to find out if they are functioning as a direct lender or broker. If they fund and service member loans, they’re a direct lender. If not, they’re in the brokerage business. They have to abide by the same disclosure requirements that other brokers have to abide by.

2. Shopping rates is a fool’s game if you don’t concentrate on finding the broker offering the lowest par rate for the mortgage product you are looking for. This doesn’t mean that you can’t buy a higher rate to generate a rebate to cover your closing costs or a lower rate to reduce monthly payments. Par is just a reference point. Instead of asking the broker then what rates he has available, be specific. Ask him what the par rate is for the mortgage product you are looking for, e.g., 30 year fixed rate, 20 year fixed rate, 15 year fixed rate, adjustable, interest only, or 10, 7, or 5 year balloon.

It is also important to understand that the rate you are quoted over phone may not be deliverable. Old school loan officers, whether they work for a direct lender or broker, play a game called “Quote and Float”. Getting you to float with the market affords them the means to boost your rate at lock-in to generate additional undisclosed/under-disclosed income. If you lock-in a loan, the opportunity is lost. Here’s how the game is played.

a. To get business in the door, they quote an interest rate well below market to get you to complete an application. The loan officer knows that consumers are basically lazy. Once they’ve completed an application and forked out the appraisal and credit report fee, they’ll be sticking around until the bitter end.

It’s important for you to understand that no broker is going to be in a position to offer a mortgage rate lower than everyone else because brokers who have been in business for three or four years all have access to the same direct lenders. Put another way, no broker has a relationship with a direct lender who offers interest rates lower than the prevailing market.

b. So they don’t have to deliver the quoted rate at application they convince you that rates are dropping and that it would be foolish to lock-in or overprice the lock-in to make it exceedingly expensive.

c. On those rare occasions when borrowers insist on locking in their loan, the loan officer unable to deliver the quoted rate recommends a lock-in period knowing full well the loan won’t get approved and funded in time or, worse yet, doesn’t lock the loan in at all hoping rates will drop so the mortgage can be covered. Admittedly, the latter doesn’t happen very often but when it does the loan officer just blames his processor for not following through on the order knowing that you really don’t have any option but to go through with the transaction.

Given the fact that mortgage rates change from one day to the next, knowing that no broker is going to be in a position to deliver a rate substantially lower than the prevailing market, you will always be in a position to negotiate the lowest rate at the lowest available cost if you focus on shopping the par rate. In the end it doesn’t matter what the loan officer quotes, it’s what he delivers and you’re assured the best rate at the lowest possible cost, insisting on a par rate or by controlling the size of a paired rebate so you’re not paying more than you have to secure your loan. The specific broker you deal with, therefore, is pretty much irrelevant.

Speaking from personal experience, I guarantee you when you approach the shopping process comparing par rates, you will put each and every broker you talk to on notice that he/s not working with an ill-formed borrower. What’s more, he knows from the outset that he is going to have a problem boosting your rate to collect a rebate because you put him on notice that you understand the pricing game.

3. Once you have boiled the list of possible brokers down to two or three, concentrate on finding the one offering the lowest origination fee. I just refinanced a $108,000 loan on a property in California. I agreed to pay a 1% origination fee because the loan was a bit more complicated than most because I’m self employed and the loan officer was kind enough to drive out to the house to take the application and then at closing to deliver loan documents.

In addition to knowing that brokers originate loans for as little as $1,000, there’s also wisdom in knowing what you are actually paying for. When it comes to the origination of a mortgage, loan officers like to characterize themselves as service providers rather than salesman but the reality is that they are primarily salesmen. To understand why I say this, consider what they actually do.

a. They provide counseling. (Not needed if you know what you’re doing.)

b. Take an application. (At most an hour’s time.)

c. Prepare a Good Faith Estimate. (At most another 15 minutes.)

d. Tell you what documentation the underwriter will need to get your approved. (Usually this is provided already on their business card or a ready made flyer.)

e. Sometimes they actually collect the paperwork and pass it along to the loan processor. More often than not, your processor takes care of this.

f. Lock-in your loan if a lock-in is desired at application. (Another 15 minutes.)

g. Call you when your loan is approved. (Another 15 minutes.)

h. Lock-in your loan for delivery if the lock-in hasn’t already been ordered. (Another 15 minutes.)

i. Answer questions that come from borrowers and real estate agents regarding the progress of your loan. (All in, maybe an hour.)

In all, a loan officer isn’t likely to put in more than three hours of his time. Now that you know this, what value would you put on the service he has provided on an hourly basis? You might want to keep this in mind when you talk with the broker about his origination fee.

I cite this only because the broker’s cost and effort to originate a $500,000 loan isn’t any greater than the cost to originate mine. Now I doubt you’ll find a broker willing to originate a $500,000 loan for $1,080 but there’s little doubt in my mind you can find someone that will charge less than 1% ($5,000) which in many markets is a standard origination fee.

It’s also worth mentioning that when I refinanced my mortgage six months ago the broker I was dealing with told me that times were tough. How tough? Given tighter underwriting requirements brought about by the subprime mess, he was having to turn away eight out of every ten borrowers.

How does this help you? If you have excellent credit, you’re in the driver’s seat when it comes to negotiating what the broker is going to be paid for his services because he knows you can take your business elsewhere.

4. Once you have decided on the broker, the final step lies in verifying that he is going to deliver your mortgage on the agreed upon terms. Ask him to prepare a Good Faith Estimate at par so you can determine what your closing costs will be whether you intend to take advantage of rebate pricing or wish to buy a lower rate. The verification process is simple.

a. Is the origination fee shown the one you agreed upon?

b. Does the Good Faith show a discount fee? It shouldn’t, if you’re going for par pricing.

c. Does the Good Faith include a line item entry labeled P.O.C., Service Release Premium (SRP) or Yield Spread Premium (YSP). If the Good Faith includes one or more of these entries then he intends to sell you a rate above par to generate income above and beyond the specified origination fee.

5. Once the cost of a par loan has been established, only then can you seriously consider the possibility buying a premium rate to eliminate the need to come out of pocket to cover your closing costs. To do that the first thing you need to do is divide your total non-recurring closing costs by the intended loan amount. This is the percent rebate needed to eliminate the need to write a check to cover your closing costs. Once that percentage is calculated, ask the loan officer to tell you what interest rate will be needed to generate just enough of a rebate to cover those costs. Now have him prepare a second Good Faith at the premium interest rate.

Be careful when you do this because your loan officer may still see an opportunity here to generate additional income. If the rebate associated with a particular rate exceeds the amount of money that’s needed, let the broker know that you expect the excess to be distributed to you at closing. As long as the amount does not exceed 1%, the distribution to you is perfectly legal. If he informs you that he can’t do that, have him provide you with the reference from the Fannie Mae, Freddie Mac, FHA or VA seller guide that states that the practice is prohibited. He won’t be able to produce that but it, again, will put him on notice that you didn’t just get off that turnip truck.

The Closing: Trust but Verify

At closing you will not only be provided the broker’s final Good Faith Estimate, you will also be expected to approve and sign your HUD-1 Final Settlement Statement which itemizes all the expenses you will be incurring to secure your mortgage. Make sure the HUD-1 agrees with the final Good Faith Estimate.

If you discover that your mortgage broker is charging a YSP or SRP (rebate) and you didn’t agree to accept anything but par pricing, you basically have two options if you wish to close escrow.

1) Accept the interest rate, making sure the rebate is credited against your closing costs , or

2) Get the broker to direct the wholesale lender to redraw your loan documents at par. If you decide to go this route, don’t accept the idea that you are responsible for paying to get your loan documents redrawn. This is a direct result of the broker’s malfeasance and he should bear the cost. If he gives you a hard time over it, let him know that you will be registering and documenting your complaint with your state’s licensing authorities and contacting the local newspaper. They love to cover consumer stories that can be thoroughly documented.

Summing It All Up

1. Secure your mortgage through a mortgage broker that has been in business for a few years.

2. Focus your efforts on finding a broker willing to deliver a par rate for the mortgage product you are interested in.

3. Don’t be afraid to negotiate the broker’s origination fee.

4. Avoid being talked into paying discount points to secure a lower rate.

5. Never accept an interest rate higher than par unless the rebate the higher rate generates is going to be used to cover your closing costs. If the rebate exceeds the amount needed, make sure the excess is distributed to you at closing.

6. Verify that the broker is delivering your mortgage on the terms you have agreed upon by closely examining the Good Faith provided at application.

7. Lastly and most importantly, re-verify the terms of your mortgage examining both the Final Good Faith and HUD-1 Final Settlement Statement at closing.

A Final Note:

I've prepared three Good Faith Estimates to illustrate mortgage lender pricing abuse. I've posted them to the Files folder in a Yahoo Group I created for consumers to share their experiences. If you would like to comment privately, you can do that by sending an email through the group moderator or by dropping me an email at