Mortgage-shopping 101 Have you done your homework

CHICAGO Some people would rather eat ground glass than face the process of applying for a mortgage. It seems so ... complicated. Intimidating. Paperwork-laden.

It can, indeed, be all of the above, so it behooves a homebuyer, particularly a first-timer, to study up before taking the plunge.

Nonetheless, even with large sums and long-term commitments at stake, the cowed borrower may sign up for whatever loan sounds attractive even if it's not the most appropriate financial solution.

"People just want it to be over; they want to open a small vein and let it be over, and off they go," said Julie Garton-Good, a longtime real estate agent in Florida whose book, "All About Mortgages: Insider Tips to Finance Your Home" (Kaplan Business, 1994), is being revised for publication next year of its fourth edition.

Other people won't even make it to the starting line. They presume that their lower incomes or bruised credit records disqualify them from homeownership. That's not necessarily so.

"Don't prejudge your situation," said David Reed, an Austin, Texas, mortgage banker and the author of "Mortgages 101: Quick Answers to Over 250 Critical Questions About Your Home Loan" (AMACOM, 2004).

"I have come across people who didn't apply (for a mortgage) when they could have," said Reed. "Let somebody in the industry tell you what's going on."

In any case, though, consumers must understand what they're signing up for, considering the amount of money at stake, both authors say. Recently they chimed in with their opinions of six common questions a first-time borrower ought to consider. There's plenty more to be learned, but they offer these topics to chew on.

1. Egad, where do I start?

"I tell people to begin with the end in mind," Garton-Good said. "They don't search for the mortgage that's going to benefit their situation and their time frame of ownership."

She means that finding a mortgage, or at least getting a firm understanding of one's credit picture, should precede the hunt for the home, itself.

Obtain your credit report; one way to do that is through annualcreditreport.com, a site created and maintained by the three major credit-reporting companies: TransUnion, Experian and Equifax.

The credit report should contain information about your financial life: credit-card history, other loans you've had, court judgments, etc. Mistakes in your report could drastically change your mortgage picture, the authors say. You'll also need to order (for a nominal charge) your actual credit score from one of the three companies; however, when you get around to applying for a loan, your loan officer should give it to you, Reed said.

"You just don't know where you are in the game until you review your credit," Reed said. "The credit bureaus report information; they don't verify it or see if it's true. You need to go in and see if there are mistakes."

And such mistakes tend to generate nearly legendary tales from consumers about how complicated it was to correct them.

"Mistakes tend to happen when people have common names," Reed said. "If you're a John Smith in Chicago, it's possible that a John Smith in Naperville might have a collection from a finance agency" that shows up as a problem in the Chicagoan's credit report.

But sometimes, there are just plain old mistakes, and fixing errors of any kind in a credit report requires documentation, not just your say-so, Reed said.

A quicker way to get an error fixed might be to ask your mortgage rep to handle the process, Reed said.

"Lenders can fix errors much quicker than consumers can," he said. "Lenders and mortgage brokers have relationships with these reporting bureaus, and they can fix it faster than you can."

You'll also need to know your credit score, which typically requires paying a fee to the credit bureaus. But Reed says there's a common misunderstanding that their score dictates a specific interest rate on a loan.

"That's wrong," he said. "Interest rates depend on a variety of factors. Credit scores don't `approve' or `decline' anyone."

Lower scores needn't disqualify a borrower, but they might make their loans more costly, Reed said.

2. OK, how do I find a lender?

The typical advice is to ask friends and others to recommend someone they've worked with. It's still good advice, the authors say. Another option is through your bank, where you have a track record.

Reed said that experienced real estate agents usually can recommend lenders, and that though there's a common perception that the agent is getting some kind of referral fee for doing it, that shouldn't be the case.

"That's against the law," he said. Instead, agents have another reason for keeping a short list of reliable lenders and their representatives.

"They refer clients because they don't want their deal to blow up," he said. "Top loan officers get on that short list because they're good. If you screw up, you're off the list."

You should also know the difference between a mortgage banker and broker, they said. Mortgage bankers use their own funds that is, the savings accounts of their bank customers to fund home loans, though they may have other sources. Mortgage brokers work out home loans between any number of lenders and borrowers; they "broker" them.

Loan officers of either stripe can vary in competence, and Reed and Garton-Good urge borrowers to shop around, they said.

"You have to ask, what kinds of products (loans) do you have?" Garton-Good said. "Ask them, how will you get paid? By the time you get down to a particular product, ask them, how much are you making, are you getting an incentive to sell this kind of loan?"

It's not a crime to make a profit from a loan. That's how business works, of course. But if you're not comfortable with what you hear, keep shopping, Garton-Good said.

3. I'm not sure I know what kind of loan I need. And what factors make the differences between all the kinds of mortgages, anyway?

Even if it seems that a given lender might be offering dozens of kinds of mortgages, "lenders really have only two types of loans fixed-rate and adjustable," Reed said.

Here's the short version of the difference: Fixed-rate loans have the same interest rate year after year, whether 15-year mortgages or 30-year or whatever the term of the loan. Adjustable-rate loans, or ARMs, adjust. And that's where the confusion comes in, the two authors said.

Borrowers might come across loans that carry such names as 3-1 ARMs or 5-1 ARMs, or 7-1s.

"A 3-1 ARM, for example, is an adjustable-rate mortgage (whose monthly payment and interest rate are) fixed for the first three years, and it adjusts annually after that time," Garton-Good said.

Such hyphenated loans have been extremely popular in the recent past because those introductory rates were low, enabling many people to buy.

"Now, those loans, many of them, are adjusting through the ionosphere," Garton-Good said. "If they had gotten a 5-1 or a 7-1, it would have given them more time." Though it probably would have carried a higher monthly payment initially.

"Unfortunately, people buy (homes) with their gut and justify with their wallet," she said. "They are so tied up in obtaining the home, that financing becomes an afterthought."

The changes in monthly ARM payments aren't divined through voodoo, the authors said. Lenders adjust the rates according to changes in agreed-upon indexes, such as U.S. Treasury rates or the London Inter-Bank Offered Rate (LIBOR) or another indexes that can go up or down based on inflation and market factors.

To adjust the mortgage payment, the lender combines the index with the margin his profit.

Commonly, those margins hover between 2 and 2.75 percent, Reed said. And though a borrower might worry that the indexes will go sky-high, usually there are caps on the charges, he said.

"I've never been a big fan of ARMs," said Reed. "Generally, when fixed-rates are low, like they are now, first-time buyers should take the fixed rate.

"I'm not saying never, never, never, though," Reed said. "A 5-1, for example, might make sense because a first-time buyer is likely to move relatively soon sooner than somebody buying his third or even fourth house. A 5-1 might have a rate that's half a percent lower than a 30-year fixed."

4. Some are offering rates that are incredibly lower than others are offering. Shouldn't I just take the lowest interest rate?

No, according to the authors.

"There is so much more to the story. It's not just the interest rate," Garton-Good said.

"People see a low, introductory teaser rate, and say, I'll take it, not knowing any more about the product," she said. "That loan, if its rates are unrealistically low, could have pre-payment penalties (triggered when the borrower pays off the loan early) or other fees that could amount to thousands of dollars."

Or sometimes the consumer sits down with the lender to get that incredibly low rate, only to be told that he or she doesn't qualify.

"I've lost deals before to lenders who are quoting interest rates that just aren't there," Reed said. "I'm not talking about an eighth of a percent, but 1 or 2 percent that I just can't match because it's just not available in the marketplace.

"When you get a disparity like that, there's something wrong. They're not comparing apples to apples."

5. I can get loans that have better rates if I pay points. What's a point?

A "point" is 1 percent of the loan amount. It's a fee, called a "buy-down," that a borrower can pay to get a lower interest rate. The more points, the lower the rate.

Consumers can get a "permanent" buy-down by paying points. But there's also a temporary buy-down, which is a fixed-rate mortgage that starts at a reduced rate and then increases to its final fixed rate, Reed said. For instance, such a temporary rate for two years would be called a 2-1 buydown.

6. I'm told that to get a loan with my small down payment, I'll have to pay PMI. What's that?

PMI, or private mortgage insurance, is a tradeoff that consumers must make to buy a home with relatively little money down.

"In a conventional mortgage, if they don't have 20 percent down to offset the lender's risk, they'll be asked to pay PMI (on the difference between the actual down payment and 20 percent)," said Garton-Good. The insurance pays covers the difference if the borrower defaults on the loan. And it differs from general "mortgage insurance," which would pay off the loan if the borrower were to die.

"There are different ways to pay PMI. They can wrap it into the loan or they can pay an upfront premium until they have 20 percent equity (the difference between the appraised value of the home and the outstanding loan on it)," she said.

Garton-Good said consumers who are paying PMI should monitor how much equity they're building. "A lot of consumers forget that they're paying it, and the lender isn't going to arrive at their doorstep and say, you now have 20 percent equity."

Reed said some consumers sidestep PMI by taking out multiple mortgages, or "piggyback" loans. For example, on a $150,000 house, they might get a loan for 80 percent of the price, or $120,000; then they would get a second loan for 10 percent of the price, or $15,000; and they would put down the remaining 10 percent, or $15,000 of their own money.

The upside to that is that all of the interest is tax-deductible, Reed said. But there are fees to consider for such multiple mortgages, and Reed said he regards PMI as "not such a bad thing."

"On a $200,000 fixed-rate note, that insurance payment would be about $83 a month," Reed said. "That's not such a lot."