Interest Rates 101
SCOTTSDALE ARIZONA BY Peter Medal
One of the first questions many of our clients want to ask mortgage professionals is "What is your interest rate?" To seduce a homebuyer into making an application, many mortgage companies will immediately quote an extremely low rate that is achievable only in a very limited circumstance, only to disappoint the borrower when they are ultimately unable to deliver this quoted rate. This practice is widely used in the mortgage industry and is called “Bait and Switch”. Widely used.
Although we fully appreciate the importance of interest rates to our customers, we also understand that the interest rate is only one element of a loan transaction and that in some instances the low interest rate quoted is compensated for by unusually high or unnecessary fees or is tied to loan program that is ill-suited to the borrower's needs. The lenders we recommend provide quality service and competitive interest rates. In addition they RETURN CALLS and keep the borrower INFORMED throughout the loan process. It never fails, when a client wishes to use an outside lender because of a “great rate” the experience at the end is less than fruitful. We have seen clients in tears at the closing table because the rate they were quoted and the actual rate they received on the day of the home closing was significantly different. We also have seen lenders “gouge” the buyer on the rate which yields the lender a significant commission on the “back end” or “Yield Premium Spread”.
How does “back end” or Yield Premium work?
Yield Spread Premium is indirectly paid by the buyer, because the payment made to the mortgage broker is a correlation between the par rate and the rate at which the loan is closed. In other words, the existence of Yield Spread Premium places the borrower and the mortgage broker at cross purposes, because the mortgage broker will endeavor to recover additional fees in the form of Yield Spread Premiums, which adversely impact the borrower because the Yield Spread Premiums increase his or her interest rate.
As an example, if a lender's base rate for a thirty year fixed rate mortgage is 7% on a given day and a mortgage broker "ties down" a borrower's loan at 7%, no payment or "Yield Spread Premium" is paid to the broker. On the other hand, if the lender's base, or par, rate for a thirty year fixed rate mortgage is 7% on a given day, but the mortgage broker "ties down" the borrower's loan at an above par rate of 8%, a significant cash payment in the form of a Yield Spread Premium will be paid to the mortgage broker (1% of the loan amount), which was made possible by the increase in the borrower's interest rate.
Has the yield premium been court tested? Find Out here!
Is the Yield Premium Spread a kick back to the mortgage broker? Click here for a mortgage broker’s interpretation of the Yield Premium Spread.
So rather than asking a lender “What is your interest rate?” a better suited question is….”Who much do you intend to make on the loan, front end and back end?”….a question like this to a mortgage loan officer really puts them on the spot. For an average loan a competitive lender will generally be amenable to making 1.5% to 2% of the total loan amount …. which is 1% for the origination fee (1% of the loan amount) and perhaps .5% to 1% on the back end or yield premium spread depending on the loan size and there target fee per loan. For smaller loans the broker is going to want to make a larger spread (1 to 2%) and for a larger loan size, obviously a lower spread (0.5%).
The key word here is REASONABLE COMPENSATION and like any business, mortgage brokers are going to try to get whatever the market can demand. A GMC dealer selling a 2002 Yukon for $35,000 isn't going to get a lot of sales if the dealer across town is selling the same model for $30,000. Luckily, competition will keep mortgage rates in check. The mortgage business is extraordinarily competitive. We see reasonable compensation for mortgage broker fees typically vary from one to two percent -- paid either by the borrower or through a YSP -- plus a reasonable processing fee. On large loan amounts, the percentage will drop. On small loan amounts, the percentage will be higher. Comparison shopping and a little knowledge will help protect you from getting gouged.
How does a mortgage broker work?
A mortgage broker is an intermediary between you and the lender. Like most middlemen, they add a markup to the wholesale cost and then you pay the retail rate. There's nothing wrong with this arrangement as long as the mortgage broker doesn't cut corners to increase his profit margins and provided that he hasn't priced a huge mark-up in his services.
We have compiled a brief “Mortgage Broker Checklist” to help you understand how to manage this process. In the good old days a mortgage broker would just charge you one point (1 percent of the loan amount) for their services. You may also have to pay an application fee. Nowadays GREED has set in and mortgage brokers mark up the rates at the retail level and earn a yield premium from the lender.
Most mortgage brokers don't reveal their compensation until required to by law -- when the loan application has been submitted. The amount of fees and charges that you pay in connection with your loan will be provided on the Good Faith Estimate that the mortgage broker is required to provide you under the Real Estate Settlement Procedures Act (RESPA).
This disclosure is only an estimate. The final amount will be disclosed on your HUD-1 or HUD-1A Settlement Statement. You are entitled under RESPA to request and receive a copy of the Settlement Statement, with actual closing costs, one day prior to closing.
The advantage to using a mortgage broker is that the broker can shop multiple lenders many of which are out of state. He's not a miracle worker and can't make someone with a bad credit history magically qualify for a low interest loan. Think of him more as a personal shopper who is helping you find a loan that's right for you.
If you want to negotiate your best deal with a mortgage broker, you should spend the time and money to know your credit score, review your credit report for errors and correct any errors on your report. To get a low interest rate, you will need to put your best foot forward. Knowing your credit score will help you understand whether or not you'll qualify for a lender's best rates. All three of the consumer reporting agencies 2 can provide you with a credit score along with a credit report.
Internet Mortgage Company Warning
Substantial savings can sometimes be achieved with an “internet mortgage company” but sometimes at the expense of major loss in service. We worked with one client whose internet bank was unable to close the loan for 30 days past the scheduled closing date. To make matters worse, the rate the gentlemen ended up with was a full one percentage point higher than his quoted rate he had initially. The comment we received from loan officer regarding the closing date was…”the closing date on your contract is just a target date, we ignore the closing date you Realtors put on your contracts”. Had he worked with “our local contact” his rate would have been ¾ percent lower and the loan would have closed on time. Thankfully he was living with his parents at the time and did not find himself homeless and the seller was intending to lease back the property for two months anyway or this transaction could have been a real nightmare.
Another concern with internet mortgage companies is over excessive “pre-payment penalties”. A typical pre-payment penalty is around 2 to 3 percent of the loan amount if the loan is paid off or refinanced within the first three years. We have seen some internet mortgage companies with pre-payments around 10 to 20% of the loan amount in the first five years.
The best way to choose a good mortgage broker is to seek out referrals from friends, family and business associates. People who have had a good experience will make a positive endorsement and referral. This should better your chances of choosing a professional and honest mortgage broker.
We believe we can best provide you with a fair and realistic rate quote by referring you with a local mortgage professional we have a predictable working relationship with. One who is:
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trained to evaluate your specific circumstances;
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that find the best loan program for your needs at a fair and competitive price
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has the resources to keep in touch with you throughout the process and keep you informed
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and cares enough to predictably and effortlessly funds and closes your loan on or before the scheduled closing date.
Peter Medal is a Real Estate Advisor with Allegiance Realty. For the past 14 years, Mr. Medal has been specializing in assisting homebuyers and sellers facilitate and negotiate residential real estate transactions in the metro Phoenix marketplace. He can be contacted at his office toll free at 1.888.523.7400.