Tag Archives: closing costs

Temporary Interest Rate Buydowns

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photo by Tobias Baur

I was quoted in This Strategy to Cut Mortgage Rates is Becoming Popular in Bay Area — but There are Pitfalls in the San Francisco Chronicle (paywall). It opens,

When first-time buyers Rachel Shatto and Randy Nelson purchased a home in Oakland in May, they negotiated an interest rate buydown that effectively lowered their mortgage rate, and thus their monthly payment, for the first two years.

Although the seller made a lump-sum payment for the short-term rate decrease at closing, they increased their purchase price to compensate for it. This temporary rate buydown left them with more cash to pay for repairs and improvements the first couple of years, Shatto said.

Both temporary buydowns, which effectively lower the rate for one to three years, and permanent ones, which reduce it for the life of the loan, have become more popular since interest rates started soaring last year.

In June, 2.8% of 30-year fixed-rate loans funded by Freddie Mac had temporary buydowns, up from near zero a year ago but down from a peak of 7.6% in December 2022, shortly after rates spiked above 7% for the first time in more than two decades. After dipping as low as 6.14% in February, they surged above 7% again in August and now stand at 7.18%.

Buydowns are most common on new homes. When rates rise, builders frequently offer temporary or permanent buydowns as one of several incentives buyers can choose from.

A survey of builders in August asked what has been the most effective way to get buyers off the sidelines. The No. 1 answer, cited by 69% of respondents, was mortgage-rate buydowns, said Ali Wolf, chief economist with Zonda, a new-home data and consulting firm that did the survey. Only 22% said price cuts.

“When they lower prices, buyers already under contract at a higher price tend to cancel their contracts and it becomes a vicious cycle,” Wolf said.

Landsea Homes is offering buydowns on select homes in select communities including the newly opened Alameda Marina. “We are only able to offer them on homes that we can deliver within 30 to 60 days,” said Josh Santos, Landsea’s Northern California division president. “I’d say 75% of our buyers in the last 60 days” chose buydowns in lieu of other incentives such as options, upgrades or homeowners association dues.

Some sellers are also offering them on existing homes that have been sitting for a while.

Whether they make sense for buyers depends on myriad factors including their overall finances, the cost versus savings, how long they plan to stay in the home, whether they spend or invest their monthly savings, who’s actually paying for them, and future interest rates, the last of which is unknowable.

Borrowers should make sure they understand how buydowns work, the potential pitfalls and other ways to save money on a mortgage.

How permanent buydowns work

A permanent rate buydown is fairly straightforward. The buyer pays fees, called discount points, to reduce the interest rate — and therefore the monthly payment — forever.

One discount point equals 1% of the loan amount. To lower the note rate by 1 percentage point, a buyer today might pay around three points to four points. This cost can vary widely depending on the day, the lender and other factors, said Westin Miller, branch manager with Pinnacle Home Loans in Santa Rosa.

To figure out how long it would take for your monthly savings to equal the points paid, divide the total upfront fee by your monthly mortgage payment (or plug the numbers into an online mortgage discount points calculator).

Suppose a buyer can permanently lower the rate on a $700,000 mortgage to 6.5% from 7.5% by paying three points, or $21,000. That would lower the monthly payment by about $470 a month.

Divide $21,000 by $470 you get 36 months, which is the breakeven point. A borrower who kept the loan for more than three years would come out ahead. The longer it was kept, the bigger the benefit.

If a buyer knew for sure that rates were coming down soon, it might be better to take the higher rate with no points and refinance when rates drop, although refinancers will generally have to pay some closing costs again.

“If you are going to sell or refinance in a few years, paying points doesn’t make sense,” said Jeff Ostrowski, a Bankrate analyst.

Some buyers get permanent buydowns because they need a lower rate to qualify for a loan, said Jason Barnes, mortgage sales supervisor with U.S. Bank in Campbell.

Buyers pay for permanent buydowns, but in a slow market they might be able to negotiate a credit from the seller at closing to help pay for it.

How temporary buydowns work

With a temporary buydown, the borrower typically takes out a 30-year fixed-rate loan but makes payments based on a lower interest rate during the first one, two or three years in exchange for a one-time payment that is deposited into an escrow account at closing.

The upfront payment is about equal to the interest savings during the discount period.

During this period, the borrower makes payments at the lower rate and the mortgage servicer draws from the account to make up the difference. At the end of the discount period, the borrower makes the full payment.

Suppose the note rate is 7.5%. With a 1/0 buydown, the buyer makes payments based on a 6.5% rate the first year and 7.5% in years two through 30.

With a 2/1 buydown the borrower pays at 5.5% the first year, 6.5% the second year and 7.5% in all remaining years.

Three-year buydowns are available but not too popular because of the steep price.

The borrower generally must qualify for the loan based on the note rate stated in the loan agreement, in this case 7.5%.

Most lenders require sellers to pay for temporary buydowns, meaning the cost comes out of their proceeds at closing. If the buyer has no choice between a true seller-paid buydown and a lower price, there’s little reason not to take the buydown.

In competitive situations, buyers might need to increase their purchase price to cover some or all of the buydown payment, in which case they’re paying for it indirectly. Here the cost/benefit analysis gets more complicated.

A real-life example

When Shatto and Nelson bought their “cute little 1927 Tudor revival” in Oakland, they took out a 30-year loan with a 2/1 buydown from LaSalle Mortgage, Shatto said. They’re paying based on a rate of 4.125% for the first year, 5.125% the second and 6.125% thereafter.

Over the first two years, the buydown will save them $15,470 in interest, which was the cost of the buydown.

Although the seller paid for the buydown, the buyers paid a higher price to compensate, said their agent Lindsay Ferlin of Red Oak Realty.

Did they make a good deal? Here’s one way to look at it.

They paid $866,000 and, with a 20% down payment, and borrowed $692,800. Had they not used a buydown and paid $15,470 less, they would have borrowed $680,424 with 20% down.

With the higher loan amount, they’d repay an extra $27,071 over 30 years — consisting of $14,695 in interest and $12,376 in principal. But during the first two years, they’d save a total of $15,470, and most people don’t keep a mortgage for 30 years.

“Outside of a few cases, this does not have a significant economic benefit for borrowers,” said David Reiss, a professor of real estate law at Brooklyn Law School. “It’s a little bit of smoke and mirrors. I don’t think it improves their financial condition other than in a few cases where you have a low income in the present and expect it to grow significantly after a couple of years.”

Housing Affordability and GSE Reform

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Jim Parrott and Laurie Goodman of the Urban Institute have posted Making Sure the Senate’s Access and Affordability Proposal Works. It opens,

One of the most consequential and possibly promising components of the draft bill being considered in the Senate Banking Committee is the way in which it reduces the cost of a mortgage for those who need it. In the current system, Fannie Mae and Freddie Mac (the government-sponsored enterprises, or GSEs) deliver subsidy primarily through the level pricing of their guarantee fees, overcharging lower-risk borrowers in order to undercharge higher-risk borrowers. While providing support for homeownership through cross-subsidy makes good economic and social sense, there are a number of shortcomings to the way it is done in the current system.

First, it does not effectively target those who need the help. While Fannie Mae and Freddie Mac are both pushed to provide secondary market liquidity for the loans of low- and moderate-income (LMI) borrowers in order to comply with their affordable housing goals and duty to serve obligations, almost one in four beneficiaries of the subsidy are not LMI borrowers (Parrott et al. 2018). These borrowers receive the subsidy simply because their credit is poorer than the average GSE borrower and thus more costly than the average guarantee fee pricing covers. And LMI borrowers who pose less than average risk to the GSEs are picking up part of that tab, paying more in the average guarantee fee than their lower-than-average risk warrants.

Second, the subsidy is provided almost exclusively through lower mortgage rates, even though that is not the form of help all LMI borrowers need. For many, the size of their monthly mortgage is not the barrier to homeownership, but the lack of savings needed for a down payment and closing costs or to cover emergency expenses once the purchase is made. For those borrowers, the lower rate provided in the current system simply does not help.

And third, the opacity of the subsidy makes it difficult to determine who is benefiting, by how much, and whether it is actually helping. The GSEs are allocating more than $4 billion a year in subsidy, yet policymakers cannot tell how it has affected the homeownership rate of those who receive it, much less how the means of allocation compares with other means of support. We thus cannot adjust course to better allocate the support so that it provides more help those who need it.

The Senate proposal remedies each of these shortcomings, charging an explicit mortgage access fee to pay for the Housing Trust Fund, the Capital Magnet Fund, and a mortgage access fund that supports LMI borrowers, and only LMI borrowers, with one of five forms of subsidy: a mortgage rate buy-down, assistance with down payment and closing costs, funding for savings for housing-related expenses, housing counseling, and funding to offset the cost of servicing delinquent loans. Unlike the current system, the support is well targeted, helps address the entire range of impediments to homeownership, and is transparent. As a means of delivering subsidy to those who need it, the proposed system is likely to be more effective than what we have today.

If, that is, it can be designed in a way that overcomes two central challenges: determining who qualifies for the support and delivering the subsidy effectively to those who do. (1-2, footnote omitted)

This paper provides a clear framework for determining whether a housing finance reform proposal actually furthers housing affordability for those who need it most. It is unclear where things stand with the Senate housing finance reform bill as of now, but it seems like the current version of the bill is a step in the right direction.

Can I Refinance?

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photo by GotCredit.com

LendingTree quoted me in Can I Refinance? Refinance Requirements for Your Mortgage. It opens,

While there are many reasons to refinance a mortgage, one of the biggest factors at play is whether or not you’ll be able to get a better interest rate. When interest rates drop, homeowners are incentivized to refinance into a new mortgage with a lower rate and better terms because it can potentially save them a boatload of money over the course of their loan.

Not only can refinancing save money on interest payments, but it can lead to lower monthly payments, or be a way to get rid of a pesky primary mortgage insurance requirement once you’ve earned enough equity in your home. Homeowners can also tinker with their repayment timeline when they refinance, choosing to lengthen their loan term or even shorten it to pay off their home faster.

The first question before you refinance your mortgage is simple: Does it make financial sense? Refinancing a mortgage comes with the same closing costs and fees as a regular mortgage, so you must stand to earn more by refinancing than you’ll pay to do it.

If you’ve had the same mortgage rate since the aughts or earlier, chances are you could have much to gain by refinancing in today’s lower rate environment.

The average interest rate on a 30-year, fixed-rate mortgage hit a low point of 3.31% on Nov. 21, 2012 and hasn’t budged all too much since then. Rates currently stand at 4.32% as of Feb. 8, 2018. By comparison, rates were routinely in the double digits in the 80s and early 90s.

Will rates continue on the upward trend? Unfortunately, nobody knows. But rate behavior will very likely play a key role in your decision.

Once you’ve decided refinancing makes financial sense, the next question should be this: What does it take to qualify? That’s what we’ll cover in this guide.

If you hope to refinance before rates climb any further, it’s smart to get your ducks in a row and find out the refinance requirements for your mortgage right away. Keep reading to learn the minimum requirements to refinance your mortgage, how your credit score may come into play and what steps to take next.

Can you refinance your home?

Lenders consider three main criteria when approving consumers for a home refinance – income, equity, and credit.

  • Debt and income.
  • Equity. Equity is important because lenders want to confirm possibly getting their money back out of your home if you default on your mortgage.
  • Credit. Any lending situation will involve a credit check. “They look at your credit score to see if you have the willingness to pay your mortgage back – to see if you’re creditworthy,” said David Reiss, Professor of Real Estate Law at The Center for Urban Business Entrepreneurship at Brooklyn Law School. “Do you have a low credit score or a high credit score? Do you pay your bills on time?” he asked. “These are all things your lender needs to know.”

While the above factors play a role in whether you’ll qualify to refinance your home, lenders do get fairly specific when it comes to how they gauge your income to determine affordability. Since the amount of income you need to qualify for a new mortgage depends on the amount you wish to borrow, lenders typically use something called “debt-to-income ratio” to measure your ability to repay, says Reiss.

Your debt-to-income ratio (DTI)

During the underwriting process for a conventional loan, lenders will look at all the factors that make them comfortable extending you a loan. This includes your income and your debt levels, says Reiss. “Debt-to-income ratio is an easy way for lenders to determine if you have too many debt payments that might interfere with your home mortgage payment in the future.”

To come up with a debt-to-income ratio, lenders look at your debts and compare them with your income.

But, how is your debt-to-income ratio determined? Your debt-to-income ratio is all of your monthly debt payments divided by your gross monthly income.

In the real world, someone’s debt-to-income ratio would work something like this:

Imagine one of your neighbors has a gross monthly income of $4,000, but they pay out $3,000 per month toward rent payments, car loans, child support, and student loans. Their debt income ratio would be 75% because $3,000 divided by $4,000 is .75.

Reiss says this factor is important because lenders shy away from consumers with debt-to-income ratios that are considered “too high.” Generally speaking, lenders prefer to loan money to borrowers with a debt-to-income ratio of less than 43% but 36% is ideal.

In the example above where your neighbor has a monthly gross income of $4,000, this means he or she may have to get all debt payments down to approximately $1,700 to qualify for a mortgage. ($1,700 divided by $4,000 = .425 or 42.5%).

There are exceptions to the 43% DTI rule, according to the Consumer Financial Protection Bureau. Some lenders may offer you a mortgage if your debt-to-income ratio is higher than 43%. Situations, where such mortgages are offered, include when a borrower has a high credit score, a stellar record of repayment or both. Still, the 43% rule is a good rule of thumb to follow when it comes to traditional mortgages.

Other financial thresholds

If you plan to refinance your home with an FHA mortgage, your housing costs typically need to be less than 29% of your income while your total debts should be no more than 41%.

However, the U.S. Department of Housing and Urban Development, which oversees FHA loans, also notes that potential borrowers with lower credit scores and higher debt-to-income ratios may need to have their loans manually underwritten to ensure “adequate consideration of the borrower’s ability to repay while preserving access to credit for otherwise underserved borrowers.”

Mortgage broker Mark Lewin of Caliber Home Loans in Indiana even says that in his experience, individuals with good credit and “other compensating factors” have secured FHA loans with a total debt-to-income ratio of 55%.

Of course, those who already have an FHA loan may also be able to refinance to a lower rate with no credit check or income verification through a process called FHA Streamline Refinancing. Your debt-to-income ratio won’t even be considered.

A VA loan is another type of home loan that has its own set of debt-to-income requirements. Generally speaking, veterans who meet eligibility requirements for the program need to have a debt-to-income ratio at or below 41% to qualify. However, you may be able to refinance your home with an Interest Rate Reduction Refinance Loan from the VA if you already have a VA loan. These loans don’t have any underwriting or appraisal requirements.

Equity requirements

Equity requirements to refinance your mortgage are typically at the sole discretion of your lender. Where some home mortgage companies may require 20% equity to refinance, others have much lighter requirements.

To find out what your home is worth and how much equity you have, you typically need to pay for a home appraisal, says Reiss. “Appraisals are typically required because you have to be able to prove the value of your home in order to refinance, just like you would with a traditional mortgage.”

There are a few exceptions, however. Mortgage refinancing options that may not require an appraisal include:

  • Interest Rate Reduction Refinance Loans from the VA
  • FHA Streamline Refinance
  • HARP (Home Affordable Refinance Program) Mortgages

Explaining loan-to-value ratio, or LTV

Loan-to-value ratio is a figure determined by assessing how much you owe on your home in relation to its value. If you owe $80,000 on a home worth $100,000, for example, your LTV would be 80% and you would have 20% equity in your home.

This ratio is important because it can determine whether your lender will approve you for a refinance. It can also determine the interest rates you’ll pay and other terms of your loan. If you have less than 20% equity in your home, for example, you may face higher interest rates and fees when you go to refinance.

Having less than 20% equity when you refinance may also cause you to have to pay PMI or private mortgage insurance. This mortgage insurance usually costs between 0.15 to 1.95% of your loan amount each year. If you have less than 20% equity in your home already, you’re already likely to be paying for this coverage all along. However, it’s still worth noting that, if you refinance with less than 20% equity, this coverage will once again get tacked onto your mortgage amount.

Is 80% LTV mandatory?

Your LTV and equity aren’t the end-all, be-all when it comes to your loan refi application. In fact, Reiss says that lenders he has experience with don’t absolutely require borrowers to have 20% equity or a loan-to-value ratio of 80% — so long as they score high on other measures.

“If you meet the lender’s requirements in terms of income and credit, your loan-to-value ratio doesn’t matter as much — especially if you have excellent credit and a solid payment history,” he said. However, lenders do prefer lending to consumers who have at least 20% equity in their homes.

Reiss says he always refers to 20% equity as the “gold standard” because it’s a goal everyone should shoot for. Not only does having 20% equity in your home when you refinance help you avoid paying for the added expense of PMI, but it can help provide more stability in your life, says Reiss: “Divorce, disease, and death in the family can and do happen, but having equity in your home makes it easier to overcome anything life throws your way.”

For example, having more equity in your home makes it easier to refinance into the best rates possible. Having a lot of equity is also ideal when you have to sell your home suddenly because it means you’re more likely to turn a profit and less likely to take a loss. Last but not least, if you have plenty of equity in your home, you can access that cash for emergency expenses via a home equity loan or HELOC.

“Home equity is a big source of wealth for American families,” he said. “The more equity you have, the more resources you have.”

Fortunately, many households are enjoying greater home equity today, as home values have continued to increase since the housing crisis.

Your credit score

The third factor that can impact your ability to refinance your home is your credit score. When a lender decides whether to give you a mortgage or not, they typically offer the best rates to people with very good credit, or with FICO scores of 740 or higher, according to Reiss.

“The lower your credit score, the higher your interest rate may be,” he said. “If your credit score is bad enough, you may not be able to refinance or get a new mortgage at all.”

The FICO scoring model’s main website, myFICO.com, seems to echo Reiss’ comments. As it notes, a “very good” score is any FICO score in the 740-799 range. If you earn a 740+ FICO, you’re above the national average and have a greater likelihood of getting credit approval and being offered lower interest rates.

Don’t stress about getting a perfect 850 FICO score either. In reality, rates stop improving much once you pass 740.

Foreclosure Alternatives

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Realtor.com quoted me in 3 Foreclosure Alternatives: What to Do Before Your Mortgage Goes Underwater. It opens,

Maybe you’ve missed a couple of monthly mortgage payments. Maybe a notice of default from your lender is looming right now. You understand the severity of the situation, but what most homeowners don’t know is that foreclosure is not the only option you have when you’re no longer able to afford your house.

The first step for anyone in risk of foreclosure is to get in contact with your lender. This shows that you are aware of the problem and committed to finding a solution—and trust us, that will go a long way. The earlier you reach out, the greater shot you have of amicably rectifying the problem.

After you speak with your lender, your lender will lay out your options, including the foreclosure alternatives that you might be able to take advantage of. Let’s take a closer look at some of the alternatives so you—and your credit history—don’t suffer the ultimate blow.

1. Standard sale or rental

If your home is currently valued at more than you owe and if you are up to date on your mortgage payments (but you anticipate that paying your mortgage could become a problem), you can hold out as long as possible for a buyer.

You can also try to rent out the home to cover the mortgage payments until the house sells, says Carolyn Rae Cole, a Realtor® with Nourmand & Associates. In the end, virtually all homes eventually sell—it’s just about pricing.

2. Short sale

When a home has fallen in value and is priced so low that there isn’t enough equity to cover the mortgage, you might have the option to conduct a short sale. It’s also known as going “underwater.” This means the lender agrees to accept less than the amount the borrower owes through a sale of the property to a third party.

A short sale works like this: A specialist brokers a deal with the mortgage lender to sell the home for whatever the market will bear. If the amount of the sale is for less than what’s owed on the mortgage, the lender gets the money from the sale and relinquishes the remaining debt. (This means you won’t owe anything else.) In a short sale, the lender usually pays for the seller’s closing costs. A traditional sale takes about 30 to 45 days to close after the offer is accepted, whereas a short sale can take 90 to 120 days, sometimes even longer.

Sellers will need to prove hardship—like a loss of primary income or death of a spouse—to their lender. In addition to explaining why they’re unable to make mortgage payments, sellers will have to provide supporting financial documents to the lender to consider for a short sale.

3. Deed in lieu of foreclosure agreement

A deed in lieu of foreclosure is a transaction between a lender and borrower that effectively ends a home loan. Essentially both parties agree to avoid a lengthy foreclosure proceeding by the borrower voluntarily turning over the home’s deed to a lender, says professor David Reiss of Brooklyn Law School
. The lender then releases the borrower from any further liability relating to the mortgage. However, if the property is worth significantly less than the outstanding mortgage, the lender may require the borrower to pay a portion of the remaining loan balance.

You might be eligible for a deed in lieu if you’re experiencing financial hardship, can’t afford your current mortgage payment, and were unable to sell your property at fair market value for at least 90 days.

Bottom line: This agreement is a negotiated solution to a bad situation—borrowers who have fallen behind on their payments are going to lose their house and the lender is not getting paid back in full.

Obamas Buy Their Rental

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2011 portrait by Pete Souza of the Obama family

Realtor.com quoted me in Former President Obama Finally Buys the DC Home He’s Renting: 6 Smart Reasons Why. It reads, in part,

Former President Barack Obama has decided that buying beats renting. The former first family have surprised many by purchasing the Washington, DC, house they’ve been leasing and living in since January, coughing up $8.1 million to call the place their own.

After vacating the White House, the Obamas had moved into the 6,441-square-foot, nine-bedroom, 8.5-bath mansion, located at 2446 Belmont Road NW in the tony neighborhood of Kalorama. The neighborhood has since become the place for the new political elite, with Jared Kushner and Ivanka Trump moving into a luxe rental a couple of blocks away, and Secretary of State Rex Tillerson snapping up a $5.6 million Colonial Revival down the street.

The reason the Obamas decided to stick around DC in the first place was so their younger daughter, Sasha, then a freshman at posh Sidwell Friends, could finish up high school there. With only three years to go, renting seemed to make sense so that the Obamas could easily pick up and move once she’s done.

But apparently, there’s been a big change of heart. Why?

On its surface, their decision seems a bit puzzling, given Sasha now has only two–and-a-half years to go. In real estate, the general rule is that it makes sense to buy a home only if you plan to stay put for five years, because this allows time for your house to appreciate, which helps you recoup hefty closing costs.

“People who sell after a year or two of ownership will often find that they have lost money on their purchase,” explains David Reiss, research director at the Center for Urban Business Entrepreneurship at Brooklyn Law School.

Nonetheless, real estate agents and other experts we spoke to say there could be plenty of reasons it’s smarter for the Obamas to buy rather than rent, even for this short span of time. Here are a few possibilities to ponder.

Reason No. 1: They’re making a commitment to DC

As presidential spokesman Kevin Lewis explained in a statement, “Given that President and Mrs. Obama will be in Washington for at least another two and a half years, it made sense for them to buy a home rather than continuing to rent property.”

Granted, you can read a whole lot into that “at least” if you want. After all, as Atlanta Realtor® Bruce Ailion explains, “Many buyers think they will only be in a property for two to three years and end up living there three to seven years. That is common.”

And it might be an indicator that our former commander in chief isn’t ready to shed the political life quite yet.

“Perhaps they want to keep a foothold in Washington, DC, for other reasons with regard to political advocacy and involvement,” says Florida Realtor Cara Ameer.

Reason No. 2: In certain markets, 2.5 years is long enough to make a profit

While 2.5 years might not be long enough to profit on a home in general, that rule varies widely by neighborhood, based on rent levels, home prices—and how quickly both are going up. And this is one hot neighborhood.

It isn’t known exactly what the Obamas were paying in monthly rent, but estimates hover at around $22,000. It’s entirely possible that the former first couple did the math and determined that buying made far more financial sense, and that mortgage payments would be less of a monthly nut. (To find out what’s best for you, you can crunch the numbers in an online rent vs. buy calculator.)

*     *     *

Reason No. 5: This home will sell for a premium—he’s a former president, after all!

“It was always a little perplexing why the Obamas would ever rent if they planned to stay for anything longer than a year,” contends Washington, DC, real estate agent Rachel Valentino.

Her reason: “While they’re buying at market value, they can eventually financially benefit on the back end, where a buyer will pay significantly more for the celebrity factor. We aren’t Southern California, where every house has that star appeal. So, I can only imagine what a buyer will eventually pay to own a piece of history.”

Reason No. 6: Profits aren’t everything

“One lesson we can draw from this story is that buying a home should not always be seen as a financial transaction,” says Reiss. “Sometimes we buy a home because it’s best for our family at a particular time. Sometimes we buy a home because we fall in love with it. And sometimes those are the best reasons of all to buy a home, profits be damned.”

Mortgage Broker v. Loan Officer

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photo by https://401kcalculator.org

MagnifyMoney.com quoted me in Mortgage Broker vs. Loan Officer: The Best Way to Shop for a Mortgage (must scroll down). It opens,

When you need to take out a loan to buy a home, you generally have two options. You can work with a lender’s loan officer or hire a mortgage broker. Loan officers and mortgage brokers are not the same thing, although the terms are often used interchangeably.

Loan officers work for a bank or a lender and will only be able to show you mortgage options from that financial institution. In contrast, mortgage brokers are individuals or firms that are licensed by a state to act as middlemen between you and multiple banks or mortgage lenders. Because brokers aren’t beholden to a particular lender, they can shop around and try to find you a loan with terms that best fit your circumstances.

Why should you consider working with a mortgage broker?

One of the biggest benefits to working with a mortgage broker is that they take over the job of shopping for a loan. You might be able to do this on your own, and in some cases, you could find a better loan than the broker, but it can be a time-consuming and complicated process.

A broker can help collect and organize the documents you need to apply for a mortgage, such as your proof of employment and income, tax returns, a list of your assets and debts, and credit reports and scores. The broker can then use the information to look for loans, compare rates and terms, and apply for mortgages on your behalf.

Casey Fleming, a mortgage adviser and author of “The Loan Guide: How to Get the Best Possible Mortgage,” says one of the big benefits is that brokers are generally “on your side,” while a loan officer represents the lender’s interest. Brokers are also incentivized to find you a loan that meets your needs and see the deal through closing because they don’t get paid until you close on the home.

Additionally, brokers might have access to lenders that don’t work directly with consumers, meaning you wouldn’t be able to get a loan from the lender even if you tried. And in some cases, brokers can leverage their relationship with a lender to get it to waive fees you’d otherwise have to pay.

Are there risks involved with using a mortgage broker?

While working with a broker could be a good idea, there are potential drawbacks to consider. “Not all brokers are created equal,” says Fleming. “Many have only a few sources for loans, and may not be able to find the best pricing.” There are also some mortgage lenders that don’t work with brokers and will only offer loans directly to consumers (through one of the lender’s loan officers).

Using a mortgage broker can also be expensive. Although you may find the services are worth paying for, consider the costs of using a broker:

Mortgage broker fees

Mortgage brokers are often paid in one of two ways. You may be able to choose how you’d like to pay the broker, or opt for both payment methods.

Some mortgage brokers will charge you a commission based on the loan you take out, often about 1% of the loan. For example, that’s a $3,000 fee on a $300,000 mortgage loan. You’ll pay this fee as part of your closing costs when you close on the home.

Other brokers may offer you a fee-free mortgage. However, what likely happens in this case is that the mortgage broker arranges a loan with a higher interest rate, leaving room for the lender to give the broker a cut. This route could cost you more over the lifetime of the loan but might be the better option if you want to minimize costs now.

Where to find a good mortgage broker

“Word of mouth is very useful when it comes to finding a good [mortgage broker],” according to Professor David Reiss, a real estate law professor at the Brooklyn Law School in Brooklyn, N.Y. You could ask friends or family members who’ve recently bought a home if they used a mortgage broker, as well as your real estate agent if he or she can recommend a broker.

However, don’t settle for the first recommendation you receive. The Federal Trade Commission recommends interviewing several brokers and trying to find one who’ll be a good fit for your home search.

Ask about their experience with buyers like you in the area, the fees they charge, and how many lenders they work with. “You want to know whether the mortgage broker can find competitive mortgage products, is well organized so that loans close in a timely manner, and whether it keeps away from bait-and-switch tactics that can be so difficult to deal with when buying a home,” says Reiss.

Preparing for Surprise Closing Costs

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photo by Chris Potter

The Wall Street Journal quoted me in Buying a Home? Prepare for Surprise Closing Costs. It opens,

Note to house hunters on a budget: A home’s sale price isn’t really the sale price—there are lots of closing costs and expenses that jack up the final number.

According to online real-estate listings site Zillow, buyers typically pay between 2% and 5% of the purchase price in closing costs. So if a home costs $300,000, that buyer can expect to pay between $6,000 and $15,000. Since the financial crisis, there’s more transparency on the part of lenders when disclosing the costs associated with a mortgage, so buyers know in advance how much they’ll need for the closing. But experts say that might not be enough.

Lender fees are only one part of the total cost of homeownership. Buyers must also pay appraisers, home inspectors and settlement agents, as well as the cost of title insurance, homeowners insurance and property taxes. And the fees don’t stop at the closing. Utilities, regular home maintenance and unexpected repairs add up as well—and can derail even the most experienced buyer.

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Here are a few considerations to help you avoid surprises at the closing table.

Stash your cash. There is no real rule of thumb as to how much money buyers should put aside in addition to the balance of the purchase price and closing costs. But the more, the better. “You definitely want an emergency fund,” says David Reiss, a Brooklyn Law School professor who specializes in real estate. “Appliances have a habit of breaking right after you buy a house.”

Close on the last day of the month, or just before. One of the fees due at closing is prepaid interest, the daily interest charge accruing between the closing and the day on which your first mortgage payment is due. Closing on the last day of the month reduces this upfront cost.

Get an estoppel letter from the association. Your real-estate agent or attorney may obtain this letter, which lists the maintenance fee, when it’s due, any required escrows or membership fees and whether a special assessment has been levied. Review this letter carefully, and compare it with the purchase contract to make sure all fees are apportioned accurately between buyer and seller.