Finding a mortgage lender entails more than just acquiring the lowest interest rate. Just ask Elena Loutskina, a professor of business administration at the Darden School of Business at the University of Virginia. "Education is the most crucial thing if the customer wants to be protected," she recently told Investopedia.
In the difficult and sometimes perplexing world of house buying, Loutskina spoke extensively about what buyers need to know, what questions to ask, and how to select the best mortgage provider. The following is an edited transcript of our talk.
Lenders come in a variety of shapes and sizes.
Investopedia: Elena, thank you for agreeing to chat with us. Let's start with the fundamentals. What is the definition of a mortgage lender?
Loutskina: At the same time, the question is simple and difficult. In the mortgage industry, several parties are executing various sections of the value chain. Some, such as a bank, mortgage broker, mortgage firm, or an internet portal like LendingTree, deal directly with borrowers.
Others may originate mortgages, and they may or may not be the same company. Mortgage brokers, for example, do not originate loans. Mortgages are financed by a variety of players, who also provide the funds that go to the borrower.
Then there are those who keep mortgages on their books throughout the term or maturity of the debt, which can be up to 30 years.
All of these jobs, for example, may be filled by a bank. It could communicate with the borrower, initiate the loan, fund it, and keep the mortgage until it matures. Alternatively, each duty might be handled by a separate company. For instance, the procedure might begin with a mortgage broker before moving on to a bank that initiates the loan. This is the lender who started it all. The bank can either maintain the loan on its books or sell it to a third party, such as Fannie Mae or Freddie Mac. Instead of a bank, the originator might be a financial or mortgage firm that originates the mortgage by borrowing money from a wholesale market or other financial organizations.
The identity of the lender gets increasingly hazy at this point. Who is it, exactly? Is it someone with whom you communicate in order to obtain your loan? Is it underwritten by someone? Is it someone who funds it from the start? This is where things start to become a little hazy.
Investopedia: It's true that it can be perplexing. I realize that various actors may be involved in each phase. How can the customer make sense of it all?
Loutskina: I'm not sure why borrowers need to understand every stage of the mortgage origination process. My mortgage, for example, was moved many times between financial institutions without affecting my financial commitments.Borrowers should concentrate on locating reputable agents, such as banks or mortgage brokers, who will provide them with a quote and then focus on the finest conditions available.
Issues with Ineffective Enforcement and Shadow Banks
Investopedia: You wrote on the financial crisis of 2009 in 2015, mentioning the history of poor enforcement of existing rules prior to the disaster. So, let me ask you two questions. What is the current state of inconsistent enforcement, and how does it relate to the shadow banking problem? Both of these appear to have the potential to influence consumers' lending decisions.
Loutskina: There were distinct discrepancies in regulatory exposure and enforcement between banks and financial firms, which we noticed. Deposits are not carried by financial institutions. They are also not subject to the same level of regulation since they do not accept deposits and are not guaranteed by the Federal Deposit Insurance Corporation (FDIC). Shadow banking institutions, also known as non-depository financial intermediaries, perform the same tasks as banks.
Following the financial crisis, the Consumer Financial Protection Bureau (CFPB) was founded, which drastically altered the enforcement equation. Regulations can now be implemented since there is a real threat targeted at nonbanks sign.
They also need to ask a lot of questions, such as "What will my monthly payment be?" "Will it stay fixed in the long run?" "Do I need mortgage insurance?" you might wonder. "How will the escrow account work?" says the narrator. On a front-end level, this is the best protection for the customer.
Where to Look for a Lender
What should homeowners consider when looking for a mortgage provider, according to Investopedia?
Loutskina: The most apparent piece of advise is to avoid borrowing money from dodgy people whose identities you can't check. Aside than that, the differences between Bank of America, University of Virginia Credit Union, BBVA Bank, and Lending Tree are minimal.
It's all about the price. Consumers should cast a wide net, in my opinion. Reach out to your local bank, internet portals, and local mortgage brokers, and inquire about what they have to offer. It's a low-cost search that will help you better comprehend the range of costs accessible on the market. You'll be able to bargain with this broad-net technique.
Investopedia: Are there any other issues that customers should be aware of?
Loutskina: Consumers must be aware of the trade-offs they might make in terms of up-front points and mortgage interest rates. Borrowers pay a percentage of the entire amount as an up-front cost for the origination. Some people prefer to pay a charge up front in exchange for a lower interest rate throughout the life of the loan—for example, 30 years. Others wish to avoid paying the origination fee and even have some of the closing costs covered by the lender. However, this will be at the cost of a higher interest rate.
Investopedia: What about the property you wish to buy's appraisal? What does that have to do with anything?
Loutskina: It's critical. Find out if your lender will demand an evaluation or appraisal of the property's value, and how important it will be in deciding whether or not to lend you the money. When you have a strong credit history and a 20% down payment, lenders are less likely to need an appraisal these days.
You shouldn't be surprised if you sign a contract to buy a house with no conditions and then go for a property appraisal, only to find out that the appraisal is low and the mortgage lender refuses to approve your loan.
The Cost of an Appraisal That Isn't Visible
Investopedia: Why wouldn't a lender request a property appraisal?
Loutskina: Appraisals are necessary for lenders, but they are costly. Appraisals, which entail having someone visit to the sellers' house to ensure that the property worth is more than the mortgage amount, so protecting banks from the danger of nonpayment, are costly, and the borrower is ultimately responsible for them.
An appraisal's cost is factored into the mortgage points, closing expenses, and interest rate. Lenders may elect not to incur the additional cost if the buyer has a solid credit score and a down payment of greater than 20%. When it comes to lenders' risk, a decent credit score and a 20% down payment may be adequate mitigating considerations.
As Part of the Process, Pre-approval
Investopedia: Is there a way to get pre-approval? That is a question that is commonly asked. Is it beneficial to the borrower?
Loutskina: Yes, I believe so. Pre-approval allows you to see if you qualify for this amount of money based on your credit history and income. Pre-approval allows the lender and the borrower to reach an agreement without making a formal commitment.
Borrowers might conceive of pre-approval as a lender's provisional approval. "If what you're saying me is true, and the house is worth as much as you're prepared to spend for it, then I'll grant you this loan today on these terms." Borrowers in the mortgage market, on the other hand, are typically attempting to determine how much they can borrow in March in order to close on a home in July or August. Between March and July or August, a lot of time will have passed. Situations are subject to change. The financial situation of lenders might alter at any time. Borrowers' intentions to purchase a home may alter.
A pre-approval offer (but not a commitment) is usually valid for 90 days. A borrower's pre-approval gives them a good idea of how much they can borrow and on what terms. However, don't be shocked if a bank decides to renegotiate by the time you're ready to sign a contract. I recommend that consumers remain in touch with their mortgage agent (lender) to ensure that the March commitment is still valid in June or July.
Borrowers might pay a fee to lock in their mortgage terms. In essence, they may purchase insurance in the event that anything unexpected occurs between now and August, and market circumstances alter. Borrowers should be informed, however, that if their credit history deteriorates dramatically or their home assessment value falls short of the bank's expectations, the bank may still adjust the mortgage terms.
By locking in the mortgage terms, a borrower ensures that, regardless of changes in credit history or home value, they will be able to get a loan under the pre-approved terms. They do not, however, have to get into a mortgage loan contract if they do not sell their prior home or if their new home does not pass the inspection.
Is the Holy Grail the Lowest Interest Rate?
Investopedia: The purpose of house purchase appears to be to obtain the lowest feasible mortgage rate. Is this, in the end, the most crucial factor to consider when selecting a lender?
No, Loutskina. Three variables, in my opinion, are intertwined. The amount of the loan in relation to the property value and the interest rate are the two most crucial factors. The bigger the down payment, the lower the bank's risk. You should expect relatively cheaper interest rates in this area. However, when your down payment disappears, your interest rate may rise. You may not have a choice in some cases, or you may choose to take out a larger loan since the interest rate situation is so favorable.
The third component is the points you pay up front for a loan origination. It's one thing if you have the funds available right now for a down payment and to cover the points. It's a different story if you don't. The second trade-off that borrowers must make is between paying larger points (fees) up front and paying a higher interest rate throughout the life of the loan.
Those are the three most crucial aspects. Others may include the fact that not every bank would be prepared to pre-approve you in March and finish the sale in August. You must ensure that the bank will adhere to its original agreements.
The last 18 months have shown us how quickly economic conditions may shift. I believe banks will be hesitant to commit to originating a mortgage six months down the road on a set of fixed terms.
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