Shopping for a mortgage effectively requires an 8 step process, the first step being the decision about whether you should shop at all, as opposed to retaining a trusted advisor to do it for you. If you do it yourself, you must decide on the mortgage features you want, determine your market niche, formulate your pricing strategy, solicit price quotes, select the loan provider, lock the price, and protect yourself against wrong-doing until the closing.

   How to Shop For a Mortgage
September 24, 2003, Revised November 12, 2004, Revised May 17, 2007, November 7, 2008, Reviewed July 16, 2009, January 16, 2011

January 3, 2012 Update


This article was written years before I made the decision to develop the Certified Lender Network (CNL). The purpose of the network is to make life easier, safer and more productive for borrowers by changing the process. Hence, CNL makes this article (along with several others) outdated. I considered deleting it but decided that it would be useful to retain the article as it was along with parenthetical insertions on how CNL changes things. The insertions will be italicized. For a more complete description of the CLN, see
Finding a Mortgage on the Professor's Certified Lender Network.

Shopping for a mortgage effectively requires an 8 step process, the first step being the decision about whether you should shop at all, as opposed to retaining a trusted advisor to do it for you. If you do it yourself, you must decide on the mortgage features you want, determine your market niche, formulate your pricing strategy, solicit price quotes, select the loan provider, lock the price, and protect yourself against wrong-doing until the closing.

Step 1: Decide If You Are a Potential Shopper:


Not everyone is a potential shopper. Some will do a lot better entrusting that responsibility to someone else. Read the following statements, giving yourself 1 point if a statement marked (1) best describes you, 2 points if a statement marked (2) describes you best, and 1.5 points if you are in-between.

A1. I like to bargain and have no hesitancy in speaking up if I think someone is trying to take advantage of me.
A2. I avoid confrontation at all costs.

B1. I feel that I either know, or have the capacity to learn, as much about mortgages as I will need to know to take care of myself in the marketplace.
B2. I feel overwhelmed by the complexity of mortgages, and I don’t have the time, energy or desire to educate myself about them.

C1. When significant money is at stake, I like to control things myself.
C2. When significant money is at stake, I like to find someone I can trust to make critical decisions for me.

D1. I feel very comfortable using a computer.
D2. I am computer-phobic.

If your total score is above 6, find a mortgage broker to be your agent in shopping for a mortgage. I recommend Upfront Mortgage Brokers (UMBs) because they are prepared to provide this service at a set fee, negotiated in advance. Once the fee is established, your interest and that of the broker are closely aligned. See Upfront Mortgage Brokers.

Potential shoppers score 6 or lower. What follows is directed primarily at them.

2012 Update: CLN replaces the distinction between shoppers and non-shoppers with a distinction between borrowers who need help navigating the program and those who don't. Whether or not a borrower likes to bargain is not relevant to shopping on the CNL because there is no bargaining.

Step 2: Decide the Mortgage Features You Want:


Before entering the market, shoppers should decide the type of mortgage, term, points, down payment and lock period. For help on this, see my Tutorial on Mortgage Features.

You can’t compare prices of different loan providers accurately unless you can specify exactly what you are shopping for. When you shop for an automobile, you decide beforehand that you want, e.g., a 4-door Toyota Corolla with accessory package 101. You must do the same when you shop for a mortgage.

It is especially important to know exactly what you want before you lock the price. If you change your mind after you lock and market prices have risen in the meantime, many lenders will allow a change only at the higher price. See Changing the Loan After You Lock.

2012 Update: Shoppers on the CLN need not, indeed should not, decide on the type of mortgage they want, or the number of points they want to pay, before starting the process. Decision support directed to these issues is  part of the process.

Step 3: Determine Your Market Niche:


The interest rate and/or points on a mortgage vary with a number of borrower, property and transaction features. Loan officers quoting prices will assume the features commanding the lowest price. See What Market Niche Are You In?

The applicant who commands the lowest price has excellent credit, is a citizen or permanent resident alien, is purchasing or refinancing a single-family detached house as a primary residence, will not take cash out of the transaction if refinancing, will not have a second mortgage at closing, will escrow taxes and insurance, is the sole borrower (or, if one of several, all occupy the property), has enough cash from own sources to meet down payment requirements and settlement costs, has sufficient income to meet standard maximum ratios of housing expense and total expense to income, and can fully document required income and assets.

To obtain valid price quotes, shoppers must indicate all deviations between their deal and the lowest-price deal. Make a list of them, and whenever you are soliciting price quotes, you offer the list.

2012 Update: Shoppers on the CLN need not do this. They need only to full out the questionnaire and the system will place them in the proper niche automatically.

Step 4: Formulate Your Price Selection Strategy:


Selecting the best price on a mortgage is not like selecting the best price on a toaster. Mortgages have three (or more) price components, toasters only one.

Pricing Strategy on Fixed-Rate Mortgages (FRMs): Once you know your loan amount, assume an interest rate which I will call your "shopping rate" and find the total fees in dollars at that rate. The fact that interest rates are generally quoted in 1/8% facilitates this approach.

Total fees should include all charges by the lender and mortgage broker if there is one. Fees expressed as a percent should be converted into dollars by multiplying them by the loan amount. For example, if the loan is for $150,000 at 1 point ($1,500), with other lender fees of $800 and broker fees of $3,000, the total fee in dollars amount to $5300.

Ignore the cost of title-related services, and settlement services. If you are in an area in which it can pay to shop for them, you can do it after selecting the loan and lender. When it comes time, you can save money by buying your title insurance on-line from Entitle Direct. Hazard insurance you also buy on your own. Ignore any government charges, escrows and per diem interest because you can’t shop them.

You are now positioned to ask the loan provider “If these are my mortgage features and niche adjustments, what are your points and total fees at (say) 5.875%?” You must be clear that “total fees” refers to payments to the lender and the broker, excluding payments to third parties, per diem interest and escrows.

The best Shopping Rate for your purpose can only be found through trial and error. If you begin with a Shopping Rate that elicits larger total dollar quotes than you want to pay, for example, raise it. As your Shopping Rate goes up, the total dollar quotes will go down.

An alternative to soliciting total dollar quotes for a given Shopping Rate is to combine different rate and total dollars into a single measure of Interest Cost (IC). Economists call this measure an “internal rate of return”, or IRR. The Annual Percentage Rate (APR), which is a mandatory disclosure, is an IRR. The problem with the APR is that it is calculated over the entire term of the loan, which makes it a biased measure for borrowers with short horizons.

If you know you will be in your house for 10 years or longer, you can use the APR because the error is small. Otherwise, you should compare interest costs over your own shorter time horizon. You can do that using my calculator 9c Interest Cost Calculator: Comparing Two Fixed-Rate Mortgages.

There is one way to shop a single price that has become popular in recent years. This is to shop for the lowest interest rate with zero settlement costs. The lender pays all costs, including third party charges. This approach makes it almost as easy to compare mortgage prices as toaster prices. Just make sure all costs are covered except per diem interest, escrows, and transactions taxes. And make sure nothing is added to the balance. See Refinancing With a "No-Cost" Mortgage.

This is a great strategy if your time horizon is less than 5 years. The lender pays your settlement costs in exchange for higher interest payments, but these payments don’t go on long enough to wipe out the benefit. After about 5 years, however, the higher interest payments convert the strategy into a loser.

2012 Update: Shoppers on the CLN who have selected an FRM are provided with the decision support relevant to selecting a shopping rate, which makes the process a breeze.

Pricing Strategy on ARMs and Balloon Loans: Both ARMs and balloons have fixed-rates for some initial period. For balloons, that period is almost always either 5 or 7 years. For ARMs, it can range from a month to 10 years.

If you know that you will be out of the house before the initial rate period ends, you can use the same price selection strategy as on an FRM. As far as you are concerned, it is an FRM. In using calculator 9c to measure interest cost, enter the initial rate period as the period “you expect to stay in your house”. The calculator will ignore what happens after that period.

The problem is that virtually no one can be certain that they will be gone by the end of any initial rate period. Life has a bad habit of changing our minds. You should be aware of what can happen at the end of that period, and factor that into your decision process.

In the case of balloon loans, that is not difficult. At the end of the initial rate period, you must refinance at the market rate prevailing at that time. Since all balloons are equally bad in that regard, select the one that is the best deal over the initial rate period. The pricing strategy for a balloon thus turns out to be the same as that for an FRM.

ARMs, however, have built-in protections against rate increases after the initial rate period, and these may differ from one ARM to another. If two 5-year ARMs have the same interest cost over the 5 years, you want the one that exposes you to the least risk of rate increases at the end of 5 years.

Unfortunately, this is not easy to determine because it is affected by a number of ARM features and information on these features won’t be provided to you in a comprehensible form unless you ask. Print out Information Needed to Evaluate an ARM, and have the loan officer fill it in for any ARM you are considering. You then have what you need to use calculators 7b or 7c, and 9a or 9b. These calculators will tell you what will happen to your interest rate and monthly payment at the end of the initial rate period if 1) the interest rate index doesn’t change; 2) the index goes through the roof (a “worse case”); or 3) the index follows any other future scenario you choose to examine.

2012 Update: Shoppers on the CLN are provided with all the information about ARMs required to make informed decisions.

Step 5: Solicit Price Quotes:


In soliciting price quotes, you need to consider whether the quote is valid, and where you get it.

Validity: To be valid, mortgage price quotes must be:

*Complete, which means inclusive of lender and broker fees expressed in dollars, as well as those expressed as a percent of the loan. On adjustable rate mortgages (ARMs), it also means inclusion of information on features affecting the interest rate and payment when the initial rate period ends.

*Timely, which means that the prices are live at the time they are conveyed to the shopper.

*Niche-adjusted, which means that the prices are adjusted for all the ways in which the shopper’s transaction differs from the generic assumptions used by lenders in developing their best prices.

*Honest, which means that the loan provider would be willing to lock the rate and points quoted, rather than low-balling to get the business, and is willing to guarantee fixed-dollar fees.

2012 Update: All price quotes by the Certified Network Lenders meet thses specs.

Sources: One source of price quotes is individual loan officers recommended by your sales agent if it is a purchase transaction, or by other borrowers. Provide them with your Mortgage Features and Niche Adjustments. If you are shopping an ARM, include the blank table on Information Needed to Evaluate an ARM. Request that quotes include fixed-dollar fees, and that they be emailed or faxed.

A second source of price quotes is internet mortgage auction sites. These sites ask you to fill out a questionnaire covering the loan request, property, personal finances, and contact information. (It is their version of your Mortgage Features and Niche Adjustments). The sites use this information to select the lenders, usually up to 4, to whom the information is sent. The selected lenders then send price quotes to you based on the same information, hopefully on the same day.

This is a quick and easy way to obtain up to 4 price quotes. However, the niche adjustments may or may not be complete, they may not ask you about your mortgage preferences, and they may not include information on fixed-dollar fees or on important ARM features. Hence, you probably will need to request a second round. The integrity of the quotes is no more verifiable than those you get by directly soliciting loan officers yourself.

Auction sites include : Cityloans.com, Getsmart.com, Lendingtree.com, Lower My Bills.com, Interestratesonline.com, Loanapp.com, Loanatlas.com, Loanhounds.com, Loanweb.com, Lowestmortgage.com, Mortgageexpo.com, and Mortgagetrader.com.

A third source of price quotes is single-lender internet sites. They are less convenient than auction sites, since you can only get one quote per site. However, you choose your mortgage features, and the price quotes are more likely to be complete. Furthermore, if your loan is priced on-line it is an honest price. They can’t give you a low-ball quote to snare your business, then raise the price when you lock, because you can monitor the price when you lock.

Single lender sites vary greatly in the extent of their niche adjustments. The more questions they ask the user, the more complete the niche adjustment can be. However, many lenders are afraid to ask too many questions on their web sites for fear the user will become discouraged and leave.

The trick, therefore, is to determine whether the questions posed by a site have captured your particular Niche Adjustments. If you are buying a two-family house, for example, and you are asked about “Type of Property” with “Two-family house” one possible answer, then you know that they adjust for that.

To make it easier and safer to shop single lender sites, I developed the Upfront Mortgage Lender certification. The requirements include filling out a niche table, which allows a shopper to tell at a glance whether the niche into which the shopper falls is priced on-line by the lender. Complete pricing is also a requirement. As of January 16, 2011, there were 7 UMLs, see List of Upfront Mortgage Lenders.

2012 Update: The CLN is superior to all the sources cited above because the price information is complete, reliable and pulled together for easy comparison.

Step 6: Select The Loan Provider:


Lenders who price high often argue that service quality is equally important. “You wouldn’t hire a lawyer or an architect based strictly on price, would you?” The problem with this argument is that there is very little reliable information available to borrowers on the service quality of loan providers. Furthermore, there is no reason whatever to believe that lenders who price high provide better service.

There is one particular service, however, that shoppers may want to consider in making their final selection. This is the lender’s requirements for locking the price.

Some lenders refuse to lock until a borrower demonstrates commitment to the deal by completing one or more critical steps in the lending process, including an application. Other lenders will lock based on very little. We would expect that lenders who make it easy to lock would quote higher prices because they have higher lock costs. Some shoppers will lock with them as protection against a rate increase while they continue to shop for a better deal elsewhere. However, it doesn’t always work out that way.

If two lenders have the same price, but one will lock you today while the other won’t lock you for 3 days, you should go with the first. This is especially the case if you have no way to verify the validity of the changes in the market that occur over the 3 days.

2012 Update: Borrowers using the CNL will choose their lender based on price, on other information about themselves provided by the lenders, and (in time) on performance metrics developed by the site.

Step 7: Lock The Price:


Most borrowers lock as soon as possible, and you can’t get into trouble doing that. Allowing the price to “float” until shortly before closing can be either a good gamble, meaning that the odds are in your favor, or it can be bad gamble. Which it is has nothing to do with whether market interest rates go up or down over the period, because that is not predictable.

Allowing the price to float is a good gamble only if all the following conditions are met:

*You can afford the hit if market rates go up. If your income is only marginally adequate to qualify, it would be foolish to risk being disqualified by a rate increase.

*You can monitor your price day by day. In general, this is possible only if your specific deal is priced on the lender’s web site.

*The lender charges lower prices for shorter lock periods. This means that if the market is stable, your price will drop as the lock period shortens.

For example, you have 60 days to closing and the quote is 5% and 1 point for a 60-day lock, .875 points for a 45-day lock, .75 points for a 30-day lock, and .625 points for a 15-day lock. If you float until 5 days before closing and the market does not change, you save .375 points, the difference between the 60-day and the 15-day lock prices. Some mortgage brokers do this as a matter of course, ie, they “lock” the borrower at their own risk at the 60-day price but don’t lock with the lender until they can get the 15-day price.

This is a good gamble because you win if interest rates neither rise nor fall, but it remains a gamble because you lose if interest rates rise. If the lender charges the same price for a 15-day as for a 60-day lock, it is no longer a good gamble, since you don’t profit in a stable market. If you can’t monitor your price, it is a bad gamble because you are then at the mercy of the lender to tell you what the market price is.

Locking the price should end the shopping process, but unfortunately it doesn’t. When it comes to mortgages, “it isn’t over till its over”. If you don’t watch yourself, you can be victimized by “lender fee inflation” and/or by “contract knavery”.

2012 Update: A borrower locking the price on the CLN has access to the correct price of his loan until the lock, and therefore cannot be taken advantage of by lock delays.

Step 8: Cover Your Rear:


Borrowers need to be alert through the closing.

Lender Fee Inflation: When you lock the price of the loan, you are not locking the whole price. You are locking the market-sensitive part, consisting of interest rate and points. Lender fees specified in dollars are not market sensitive and are not locked. Further, such fees do not usually appear in media ads that show mortgage prices, and are seldom volunteered to shoppers. They are shown on the Good Faith Estimate of settlement (GFE), along with all other settlement costs. However, the GFE need not be provided to borrowers until three business days after receipt of an application. This is too late to help shoppers.

But it gets worse. Lenders are not bound by the numbers on the GFE, which are “good faith estimates”. The GFE concept made some sense with regard to third party services, such as title insurance. It never made any sense with regard to lender charges, however, because lenders know their own charges with certainty. The GFE has thus provided a cloak behind which some rogue lenders extract additional fees from unsuspecting borrowers. See Legal Thievery at the Closing Table.

This is not a problem if you are dealing with a mortgage broker. Brokers know the fees of each lender they deal with, and will not tolerate lenders taking advantage of their clients. Fee inflation puts no money in brokers’ pockets. The problem arises in dealing with lenders.

Some internet lenders include their fixed-dollar fees in their price quotes, and guarantee that these will be the fees charged at closing. This is a requirement to be certified as a UML.

In soliciting price quotes from other lenders, ask them to guarantee their fixed-dollar fees. If they agree and you want to push your luck, ask if they will include credit check and property appraisal charges, which they order but you pay for. They may be reluctant because these charges can vary from case to case. Your fallback is to ask them to guarantee not to mark them up. To make sure you have no surprises at closing, get it in writing. Fixed-dollar fees should be on the lock confirmation statement.

Note: A revised GFE that became effective in 2010 prevents lenders from  changing their fixed-dollar fees from those shown in  the GFE, and third party charges cannot be increased by more than 10%. Read The New GFE Will Help Borrowers.

Contract Chicanery: The mortgage note is a contract between the lender and the borrower, but ordinarily the borrower does not see the contract until the closing, and few read it even then. Generally this is not problematic, but it can be if the lender slips something in that disadvantages the borrower, without the knowledge of the borrower. This is contract chicanery.

When this happens, the offensive provision is likely to be in a rider to the contract. Judging from my mailbox, the most common such rider is a prepayment penalty. The inducement is a significant enhancement in the value of the note, part of which will probably go into the pocket of the loan officer.

It is remarkably easy to prevent this from happening. There is a line on the Truth in Lending (TIL) form you are given after you submit your application which says “If you pay off your loan early, you [ ] may [ ] will not have to pay a penalty.” If there is a check in front of “may”, it means that your loan does have a prepayment penalty, no maybes about it. If you have not agreed to a prepayment penalty, then is when you should catch it.

I also see contract chicanery in connection with adjustable rate mortgages (ARMs). In the typical case, the borrower is sold an ARM based on one or two features, and never confronts the remaining features which are included in the note. Unlike a prepayment penalty, which must come to light if the borrower tries to refinance, disadvantageous ARM features can remain undetected indefinitely. To prevent this, collect all the relevant information about the ARMs for which you shop. 

2012 Update: A borrower using the CLN will not encounter any of these problems because participating lenders know that the site has a "one-strike-you're-out" policy.

 

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