Asking the Right Question When Financing a Home

I have spent many years in consumer education, and in this time I have written a great deal in articles,  newspapers, magazines, and on the web trying to help people understand the homebuying and home financing process. One critically important element concerns the questions that a borrower should be asking in the shopping process.

Not surprisingly, many people ask the question, "What are your rates?" I would argue, however, that this question is one of the least important questions. This may come as a shock, but it is truer today than ever before. Here's an example of the wrong question.

Back in the '80s, fixed-rate loans were so expensive that no one wanted them. As a result, 100 percent of the business was doing various kinds of Adjustable Rate Mortgages (ARMs). There was a big difference between one ARM and another. The initial rate, the index, the margin, how often it adjusted, and how much it could adjust were all different. That was a lot of data to collect. So you would think that consumers made good choices, right? Wrong! Most consumers chose the worst loan. Why? They never asked the right question, which was:

"What is the likely performance of this index in the next five years?"

In this case, they bought the sales pitch that the 11th District Cost of Funds loan was the most "stable" index. They did not then connect the dots and say, "Wait a minute! Rates are dropping now and I do not want a stable index. I want a volatile one, one that will drop the fastest." 

And sure enough, for the next 5 years, those people who chose the most popular COFI paid 1 percent more every year than the borrowers who did ask the question and got a loan tied to Treasury Bills. One percent on a $300,000 loan is $3,000/year; for 5 years it is $15,000. Big mistake! Just because they didn't ask the right question.

Today, with the market dominated by Fannie Mae and Freddie Mac, there virtually is no price competition between lenders who are trying to be competitive. (Note: Not all are!!!) What has happened is that mortgages are now commodities. If you are lucky and you find, say, five competitive lenders, you would not find meaningful pricing differences between them.

Price shopping is pointless. You wouldn't call different post offices trying to get a deal on stamps, would you?  The price is 44 cents wherever you go. It is the same with mortgages. That actually is good news for shoppers, because it now allows them to concentrate on shopping for service, knowing that the base price is the same.

So how does one decide? Well, you can ask questions about experience, education, number of completed loans, how long they have been in the industry, and so forth. You also could ask if they are honest, but of course even the crooks would say, "Yes."

You can also ask this great question: "Do you work for a small company where I will get individualized attention, or were you just assigned to me at random by your large, impersonal bureaucracy?" (You might want to phrase that as several questions to get a more objective answer.)

All of these factors have an effect on the quality of advice you will get and the representative's ability to solve problems that arise. Good advice will save you many times the dollar amount you think you are saving using your method of shopping.

You also have no conception of the insight your representative has regarding when to lock in your rate.  Assume that in any 30-day period there are five "best days" to lock — most likely not today. I can assure you that there is a right answer, but it is almost impossible for you to do it successfully on your own. Stop wasting your time rate shopping and go for the quality of the service professional.

Finally, this word of advice:

Just because you don't understand it doesn't mean it isn't important.

Randy Johnson – Author of How to Save Thousands of Dollars on your Home Mortgage and Savvy Borrower
articles, Randy is a mortgage broker who has financed over $1 billion
in properties. He writes about home buying and real estate finance
topics for CreditBloggers.com.

Randy Johnson Randy is a Credit.com contributor and seasoned mortgage expert. He writes about home buying, mortgage laws and real estate finance issues. He has financed over $1 billion in properties, is the author of How to Save Thousands of Dollars on your Home Mortgage and he is a feature columnist for Savvy Borrower.