In the new paradigm, the agent finally takes control
Is it the selling agent’s place to screen and inform his homebuyer of the financial “facts of life” to make up for the failures of family and the education system?
Yes! At first glance, providing this information may seem like a stretch of duties to those brokers and their agents looking to quickly churn fees from inexperienced buyers. On the contrary, brokers and agents who understand and appreciate the new real estate paradigm already underway also understand the failure of the system is the burden agents and brokers must work with. A homebuyer in the unenviable position of staring down a lender in a potential foreclosure proceeding learns quickly his lender is not in his court; the selling agent, however, as the fiduciary of this homebuyer has the legislated responsibility to protect and inform him. [For more information on the new real estate paradigm, see the May 2010 first tuesday article, Looking through the window towards recovery: a real estate paradigm shift — Part I and Part II.]
A homebuyer who approaches a real estate licensee for assistance in purchasing a home does so with the expectation the broker or agent will help him get the best home available for his money — based on his savings and monthly income. Implicit in this expectation is the agent’s duty to break down known facts about the asymmetry of information now benefitting the lender at his homebuyer’s expense, since a purchase-assist loan will nearly always be involved.
A blanket math test — such as the one the Fed recommended — may seem like an intrusion or even be insulting to some buyers who do not want to feel put on the spot by their agent probing their understanding of finance for deficiencies he is to cover with advice. However, given the odds stacked against the mathematically challenged homebuyer, it behooves brokers and agents to identify them among their clients and prepare these buyers for entrance into the world of real estate by educating them as thoroughly as possible on the mortgage process and that money game. This education counteracts the homebuyer’s natural inclination to simply sign on the dotted line — as is too often permitted by the thoughtless and unfaithful broker or agent acting on behalf of the buyer.
About your mortgage…
The initial counseling session a selling agent has with a homebuyer needs to include a “diagnosis” of the homebuyer’s financial understanding. Selling agents trying to gauge a homebuyer’s understanding of the financial impact of a mortgage and determine how much the homebuyer will need to be taught by the agent by asking a series of very general questions, including:
- Do you currently budget your monthly spending?
- Have you considered how a mortgage will impact your current spending patterns?
- Do you consider yourself good with money?
- Have you considered the difference in the costs of being a renter versus the costs of being an owner?
- What purchase price and monthly payment do you feel you can manage?
Agents looking to gather resources for discussing family budgets and mortgage topics can find related information on various government websites, including the:
- California Department of Real Estate (DRE);
- Federal National Mortgage Association (FNMA), called Fannie Mae;
- Federal Home Loan Mortgage Corporation (FHLMC), called Freddie Mac;
- U.S. Department of Housing and Urban Development (HUD); and
- mortgage and loan calculators used to compare different rates and terms. [See the first tuesday Journal Online for an online loan and mortgage calculator.]
Agents can discuss with buyers the key aspects of mortgage financing to help them make a sustainable mortgage choice, including:
- the difference between renting and owning [For more information on 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 (including loans with PMI) and FHA-insured financing options;
- maximum allowable monthly housing payments as a ratio of the homebuyer’s total income, known as the debt-to-income (DTI) ratio, under both conventional and FHA-insured financing options [For a comparison of the allowable DTI ratios under conventional and FHA-insured loans, see the July 2010 first tuesday article, The true costs of a default-insured mortgage.];
- getting pre-approved for a mortgage before making an offer on a home, including a discussion of what acquiring a pre-approval entails [For more information on aggressively shopping around for a mortgage, see the May 2010 first tuesday article, Shop, shop, shop until you drop.];
- how to read and understand an estimate of the loan costs disclosed by lenders, called the good faith estimate of costs [For more information on the 2009 changes to the good faith estimate, see the January 2010 first tuesday article, HUD’s new GFE.]
- the benefit of choosing an FRM over an ARM, including the interest rate and payment adjustments and resets accompanying ARMs (especially pertinent during this low-interest FRM environment since ARM rates will inevitably go up and increase a homebuyer’s mortgage payment) [For more information on the FRM vs. ARM comparison, see the June 2010 first tuesday Form of the Month;
- what a monthly housing payment comprises — principal, interest, taxes and insurance, known as PITI, in addition to any HOA fees and special assessments, called Mello-Roos, and how the component parts of the payment impact the price paid for a home and a homebuyer’s immediate and long-term budget;
- whether the homebuyer should include the ownership costs of property taxes and hazard insurance in the monthly payments made to the lender and their effect on the loan amount available to the homebuyer;
- PMI or, if FHA-insured, MIP requirements, if the down payment is less than 20%, and how this default insurance affects the price a homebuyer can pay for a home and the monthly housing payment to the lender [For more information on the impact of default-insured mortgages, see the July 2010 first tuesday article, The true costs of a default-insured mortgage.];
- how much and who will pay the numerous lender fees associated with the mortgage, called discount or origination fees, the actual costs of appraisal and credit reports and other lender fees for necessary steps taken to process any loan, collectively called junk fees;
- the period over which the payments of principal and interest are calculated, called the amortization period, with an emphasis on the bulk of the interest being paid in the early years of the loan, resulting in a slower increase in equity build-up by principal reduction than commonly perceived;
- whether the homebuyer (or seller of the property) will be penalized for paying off the loan early, known as a pre-payment penalty, and how this may affect negotiations with the seller for his sale of the property;
- how credit behavior and resulting credit scores impact mortgage rates and availability [For more information about credit reports and scores, see the June 2010 first tuesday article, The FICO score delusion];
- the amount of closing costs in addition to the required down payment, and who is to pay them (with instructions on negotiating for the seller to pay);
- what happens if there is an illness, death, the loss of a job or other financial emergency in the household affecting the ability to pay on a mortgage, and the necessity of budgeting for such emergencies, including considering unemployment mortgage insurance programs available through local insurance agencies;
- higher utility bills for homeownership than for renting an apartment unit; and
- the necessity of building a reserve of funds to pay for periodic maintenance expenditures such as landscaping, yard work, painting, roof, heating-ventilation-air-conditioning (HVAC) systems, water heaters, plumbing or electrical issues. [See first tuesday Form 306]
After the agent discusses these aspects of financing with the homebuyer, he then sends off his homebuyer to discuss pre-approvals with at least two lenders, armed with a list of questions for the homebuyer to ask and force lender transparency. [For more information on the topics buyers should discuss with lenders, see the June 2010 first tuesday Form of the Month; see first tuesday Form 320]
Fiduciary, not a general financial consultant
While an agent best serves his homebuyer and himself by educating his homebuyer, on the flipside of the coin, an agent does not want to advise the homebuyer on his general financial portfolio beyond the ownership and financing of real estate. The goal of the homebuyer counseling session is to arm the homebuyer with readily available knowledge he can use to mitigate the risk of a foreclosure born of ignorance and overextension, such as happened during the Millennium Boom. A homebuyer’s real estate agent does not need to make detailed forays into financial considerations separate from the mortgage and real estate purchase transaction.
Even without going into specific financial transactions outside of the mortgage and property pricing, the agent, in his diligence, can provide the homebuyer with a valuable shield against both the homebuyer’s ignorance and a mortgage lender’s attempts to conceal the financial ramifications of a real estate loan. Agents depend on the dealings of knowledgeable buyers and sellers to keep the market travelling on the track of moderate (and sustainable) real estate cycles. Only when brokers and agents help educate and advise their buyers and sellers will we reduce the risk of unnecessary defaults and foreclosures, and with that the massive disruption of vicious cycles brought about by the lack of foresight in structuring sales transactions and mortgages. Lenders have much adjusting to look forward to, and selling agents should be the driving force.
For additional reading on this topic, see the Federal Reserve Bank of Chicago article, Cognitive Abilities and Household Financial Decision Making.