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How Not To Get Screwed When Shopping For A Mortgage:

Mortgage rates are the lowest they’ve been since May 2013, according to Freddie Mac . The good news is that buyers can now get a 30-year fixed rate mortgage for as little as 3.69%. The bad news is that eager homeowners are wading into a thick sludge of documents, come-ons and deception.
The two most popular styles of mortgages are fixed and adjustable interest. A fixed interest loan remains the same over the (usually) 30-year term. An adjustable interest loan fluctuates annually based on certain indices. So, if the rate on the one-year Treasury Constant Maturity jumps, your interest rate will too. Not surprisingly, in this environment of record low rates, adjustable loans are not very popular. There are also “hybrid” loans which feature a fixed rate for a certain period of time (usually 3-10 years), and an adjustable rate thereafter.
True, most of the more questionable loans, like stated income, interest-only and negative amortization have faded from the scene in the wake of the 2008 financial crisis. Typically unconventional or “hard money” lenders (private individuals lending on the asset rather than the borrower’s ability to repay) will offer these. Consumer finance protection regulations have nearly forced banks and conventional lenders out of this space, but there are still plenty of traps set for unsuspecting mortgage shoppers, especially those in hot pursuit of a bargain.
Whether you’re looking for a $300,000 mortgage or a $3 million mortgage, here’s how to make sure that when shopping for a loan, you don’t overspend.
Cheaper Isn’t Necessarily Better
Mortgages can be risky and secured by the thing that matters most– your home. Rather than search for the cheapest option, focus on reliability. Ads touting low rates from anonymous companies are often bait and switch scams. Reviews are easily forged and unless independently verified, should not be trusted.
Once you find the home, you’ll usually have 30 to 45 days to secure a loan. Avoid the person who sounds so nice on the phone, offers a too-good-to-be-true deal, charges a $350-700 application fee and never calls back. This will waste your time, money and your chance of acquiring the property. Instead, get your ducks in a row by working with a lender who will properly vet your loan application. You can either go directly to a conventional bank or use a mortgage broker who will shop around for you to find the lender that best suits your needs.
It also helps if the banker is close to home. A local lender will understand the property value and state or county-specific underwriting guidelines. A local lender will also have better relationships with the realty and title companies to speed the documentation process.
“A mortgage transaction requires a great deal of coordination,” says mortgage expert Adam Rosenblatt at New Penn Financial. “A local lender with local relationships can make the process much more fault resistant.”
The Swiss Cheese Pre-Approval
Although plenty of lenders will insist you need a “pre-approval” letter, many won’t verify the buyer is approved for a loan before issuing the letter. Insiders call this a “Swiss cheese” loan approval. It’s one of the most dangerous traps in the home buying process.
“There are pre-approval letters and there are pre-approval letters,” says Jim Shindell, Chair of the Real Estate Group at Bilzin Sumberg. “Once the commitment letter to the seller’s agent is presented, the financing contingency protection in the sales contract is often wiped away, as long as the property appraises at a sufficient value,” says Mr. Shindell.
If your lender then declines your loan application and the appraisal value is adequate, you could potentially lose not only the home but also your deposit money.
Pre-approval letters are an unregulated corner of the industry and even the biggest banks are perpetrators. The real danger lies in the risk that the buyer has been provided a very convincing letter which appears to guarantee financing, when there are likely many critical items that have been ignored. This oversight results in a meaningless letter and false sense of security for the buyer.
The seller’s realtor may pressure the buyer for a pre-approval or loan commitment letter. If you’re in this position and cannot produce something legitimate, walk away.
“If a buyer has concerns about approval, I suggest getting real assurance from the lender that they really are going to come through and the only thing left to consider is the appraisal,” says Mr. Shindell.
The experts advise it’s best to partner with a lender who takes time to collect all documentation (tax returns, paystubs, etc.) and thoroughly underwrites your complete file before issuing any kind of letter.
Know What’s Going To Hurt (And Help) Your Application
These days mortgage approvals require exhaustive documentation. Loan applications can run upward of 50 pages with each page containing something to prevent the loan, or force an insanely high interest rate. It’s crucial to address any red flags before submitting the application.
Income: There’s no set amount of money needed to qualify but you must prove you earn enough (through a financial statement or a tax return) to repay the loan. “It’s really not what you earn, it’s what you show,” says Mr. Rosenblatt. Lenders will also take a close look at your debt. In general, to qualify for a $500,000 loan with a 20% down payment, you should probably have a stable annual income of at least $144,000 per year with less than $1,000 per month in debt payments.
Property Type: A primary residence is considered less risky than an investment or vacation home. But the location of the property is the most critical factor. Some states have additional restrictions and underwriting guidelines. It’s important to know the rules in the state where the property is located.
Down Payment: The amount of down payment required will vary from lender to lender. Sometimes, a greater down payment will create a lower interest rate, and sometimes not. “This inverse relationship will vary from lender to lender,” says Peter Alongi, a Senior Manager at HSBC Bank USA. “In a Fannie Mae loan, if the program allows you to qualify for a 10% down payment and you put down 20% there is no benefit realized, but it varies.”
Credit: You’ll need a credit score of 740 to get the best rate, but even a score of 620 can secure a loan. If you have appropriate income and down payment, your credit score shouldn’t be a problem. However, if you’ve had any serious credit problems in the last ten years (like a bankruptcy or foreclosure) be prepared to clearly explain.
Divorce and Child Support: For income verification, lenders will look at alimony or child support payments alongside debt. Meaning if 45% of your income goes toward alimony or child support, and your loan allows a maximum debt-to-income ratio of 45%, you might not have room for any more debt. Conversely, if alimony is the only income received, this money can’t be counted until received regularly for at least six months – a rule called ‘seasoning’.
Miscellaneous: Little things can also ding you. Co-sign a $600 per month lease? Even if you’re not the one making the payment, the lender will count the responsibility against your income. Take a deduction for business expenses on your tax return? If you earned $100,000 and deducted $25,000 for meals and entertainment, the bank assumes it costs you that much to do your job and your income is $75,000 (not the full $100k). And remember, every state has slightly different rules.
Look Out For Hidden Costs
Most lenders will charge between $500 and $1500 to process, underwrite and close a loan. “A good way to understand how much you’re being charged is to review the good faith estimate, which must provide a breakdown of fees,” says Mr. Alongi. “As a federal requirement, a lender must provide a good faith estimate within 72 hours of application submission.”
According to Mr. Rosenblatt: “Regulators have made it nearly impossible for legitimate lenders to charge garbage fees and remain compliant. But of course that doesn’t mean every lender is compliant.”
Also pay attention to your loan’s annual percentage rate (APR) which calculates the interest rate plus fees. “When comparing loans, if the interest rates are similar and the APR is different, then more fees are being charged,” says Mr. Alongi. With this understanding, you can negotiate to reduce some fees.
Refinancing comes with other hidden cost dangers. Telemarketers are aggressively pushing refinanced loans that might bring your costs down by less than $100 per month but the transaction will amount to $5,000 in fees, which will come right out of your equity. Make sure you thoroughly do the math before agreeing to anything. If a deal sounds too good to be true, it probably is.
Vanessa Grout