For many prospective homebuyers, the details of mortgage financing are just about as foreign and obscure as quantum physics. According to a recent survey by Zillow Mortgage Marketplace, prospective homebuyers answered basic mortgage finance questions incorrectly 46% of the time.
- 44% admitted they were not confident in their comprehension of the mortgage process;
- 57% did not understand how adjustable rate mortgages (ARMs) work;
- 34% were not aware loan terms vary from lender to lender, lender fees are negotiable and different lenders charge different fees for appraisals and credit reports;
- 55% did not know mortgage rates are constantly fluctuating;
- 45% believed they should always purchase mortgage discount points (prepaid interest) regardless of the length of time they intended to keep their home;
- 37% were under the impression that pre-approval for a loan is synonymous with obtaining permanent financing; and
- 42% believed Federal Housing Administration (FHA) loans are only available to first time homebuyers.
first tuesday take: The lack of financial proficiency in a majority of prospective homebuyers is nothing new, and the above survey results are consistent with the conclusions of the Federal Reserve Bank of Atlanta in their April 2010 paper, Financial Literacy and Subprime Mortgage Delinquency: Evidence from a Survey Matched to Administrative Data.
However, these survey responses patently reiterate the need for agents to come to the homebuyer’s assistance when the homebuyer is blindly navigating the labyrinthine corridors of mortgage lending institutions.
Do not expect lenders to clear the murky waters of misunderstanding on behalf of homebuyers. This would be akin to entrusting a sheep to the care of a ravenous wolf. Agents must be quick to remind homebuyers that the financial goals of the homebuyer are diametrically opposed to that of the lender, who is in an inherently adversarial position when considering the best financial interests of the homebuyer.
Thus, the homebuyer must be well-equipped with an understanding of mortgage financing before entering what is essentially a battle (albeit one that is disguised as a pleasant, affable meeting with the lender’s loan officer). And while it is always prudent for the homebuyer to independently brush up on mortgage fundamentals to cement his personal understanding, the buyer’s agent who negotiated the purchase (which likely requires purchase-assist financing to close) is a financial ally who is duty bound to the homebuyer to steer him through the financing process. Remember, when a homebuyer hires a real estate licensee, he does so with the expectation the agent will help him get the best home available – and for the least amount of money, which implicitly includes mortgage financing.
The first step of the agent’s financial guidance would take the form of a casual counseling session to gauge a homebuyer’s understanding of the nature and impact of a mortgage. Nothing about loans is standard. It is that misconception held by some agents which lenders exploit at great cost to the homebuyer, a common situation which is entirely avoidable by a well-informed agent and buyer.
Next, depending on the homebuyer’s level of financial aptitude as determined during the counseling session, the agent can discuss the fundamental aspects of mortgage financing the homebuyer is unsure about, such as:
- the mathematics of renting versus owning [For a discussion comparing the costs of renting and owning, see the June 2010 first tuesday article, Renting vs. buying: the GRM.];
- down payment requirements on both conventional and private mortgage insurance (PMI) or FHA-insured financing options;
- the positive and negative attributes of fixed rate mortgages (FRMs) and adjustable rate mortgages (ARMs) [For more information on the FRM vs. ARM comparison, see the May 2011 first tuesday article, The iron grip of ARMs on California real estate.];
- the use of a mortgage inquiry worksheet when interviewing the lender’s representative to get a handle on the various loan terms, conditions and costs offered by the lender [See first tuesday Forms 320 and 320-1]; and
- what a monthly housing payment comprises — principal, interest, taxes and insurance, known as PITI. [For more commentary on the need for selling agents to educate their buyers about the mortgage decisions they make, see the September 2010 first tuesday article, The era of the financially illiterate homebuyer.]
In regards to the commonly held belief that loan terms are static from lender to lender, a prudent agent must advocate for the homebuyer to apply for pre-approval ASAP with several lenders on starting the home buyer’s hunt for a home. After receiving pre-approval, the homebuyer is then to submit loan applications to multiple lenders on opening escrow on the eventual purchase. Just as they would for any substantial purchase, prudent homebuyers should interview numerous lenders to determine the unique financing options offered by each, and compare the cost estimates received from each lender. The difference between one lender’s loan package and another’s can easily equal tens of thousands of dollars over the life of a mortgage.
After multiple applications have been submitted, the homebuyer can then compare and ultimately close on the loan with more advantageous terms. This keeps dollars in the homebuyer’s pocket – and, most importantly for the industry, breeds goodwill for his agent and others. [For more information on aggressively shopping around for a mortgage, see the May 2010 first tuesday article, Shop, shop, shop until you drop.]
Re: “Homebuyers Still Clueless About Mortgages” from the National Mortgage Professional.