Beware of the Hidden Costs of Your Home Loan
Written by: Kristy Welsh
Last Updated: August 15, 2017
If you have gone through the home buying process, then you know there are lots of fees associated with a home loan. If you have not, this article will be an eye opener for you prior to jumping into a mortgage loan. The majority of the closing costs and fees are an integral part of every loan and can not be altered by the loan officer or mortgage company. But, there are fees and hidden costs that the loan officer is in complete control over. These fees are just gravy for the officer and mortgage company. Unfortunately, the typical consumer is unaware of these costs because they are hidden in the loan paperwork and closing documents.
Profitable Fees For a Mortgage Company
The following fees determine the profit on a loan and are in complete control of the loan officer or mortgage broker. There is no standard for these fees so the unscrupulous loan officer will try and make as much as possible from you with these fees. Most loan officers are not paid a salary, they are paid through commissions from every loan they originate that closes. This puts the pressure on them to make as much money as possible, wherever possible. Loan officers typically split the profits (usually 50/50) for each loan with the company for which they work. Therefore, every dollar they can squeeze out of you is 50 cents into their pocket. To originate a loan, the loan officer merely gets a client to fill out a loan application.
- Origination or Application Fees — These are fees for processing the mortgage application and may be a flat fee or a percentage of the mortgage. They usually are equal to one point. In fact, they are just a point called by a fancy name so the loan officer can charge more for the loan.
- Points — A point is equal to 1 percent of the amount borrowed. For example, one point on a loan amount of $50,000 is $500. Points can be payable when the loan is approved (before closing) or at closing. For FHA and VA mortgages, the seller-not the buyer-must pay the points. Even if you are not using an FHA or VA mortgage, you may want to negotiate points in the purchase offer. Some lenders will let you finance points, adding this cost to the mortgage, which will increase your interest costs. If you pay the points up front, they are deductible from your income taxes in the year they are paid. Different deductibility rules apply to second homes.
- Application Fees — Application fees are non-refundable and 100 percent pure profit for the mortgage broker. Walk out if they ask for an application fee up front. The only exception to this rule is if you have tough credit. In this case, the loan officer will have to do a lot of work before he can tell if your loan will go through. Time is money and he will want to be paid for this effort. If your loan gets denied without an application fee up front, the loan officer has put in a lot of hours for nothing.
- Points On the Back End — These are fees and commissions earned by the mortgage broker by selling you a loan whose interest rate is above the going rate.
The normal fees in the industry are an origination fee (1 point) plus one additional point. Some brokers have a limit on how much a loan officer can charge in fees-the loan application fee, the origination fee, and the points, but not all. However, there is no absolute hard and fast rules.
Getting Points on the Back End
Also known as yield-spread fees, these points on the back end are one of the ways a loan officer makes more funds available to the total loan "kitty." It is essentially a kick-back from the mortgage bank the loan officer is buying the loan from, earned by selling a customer a loan at an interest rate that is above the going rate.
Each day, loan officers receive rates from banks for all of their loan programs. Listed for each program is the par interest rate. The par interest rate is the interest rate at which the broker does not have to pay a fee to buy the loan and then sell it to you, nor does he receive a commission for selling you the loan at this rate. You might say that the par rate is loan equilibrium. The table below shows an example of the types of rates a bank might publish to their subscribing mortgage companies every day.
EXAMPLE RATE SHEET ON A 30-YEAR LOAN
In the above example, the par value for a 15-day lock is 7.0 percent. The numbers in parentheses are the points returned to the loan proceeds as additional funds to offset the costs of the loan (or as a commission for loan officer). Why would anyone knowingly pay this higher rate? To get a no-cost loan, which we will go over later in this article.
For example, if you wanted a $150,000.00 loan, but didn't have enough to cover the loan costs, you could bump up your interest rate to 7.5 percent, giving you: $150,000.00 x 1.5%/100 = $2,250.00.
This money will be credited to the loan proceeds at closing. What does this mean? It means that if your closing costs are $2,250.00, you won't have to lay out a dime to do the loan. Keep in mind, though, that if you are purchasing a home, you can't just up the interest rate to get your down payment. You must have enough money for the down payment.
And if you didn't know that the rate you were getting was higher than the par rate (meaning you paid full loan costs)? The loan officer gets that $2,250.00. Do some loan officers conveniently forget to tell you about this little loan surplus? Unfortunately, yes; it is one of the most profitable methods used by loan officers.
You've heard of those no-cost refinance loans? Forget it. There is no such thing. A broker must make money on every loan. Many well-intentioned loan officers honestly believe they are giving you a loan for free, but this simply is not the case.
In the example above, we showed you how you could get a loan at an interest rate above the par rate and get points on the back. The points on the back translate to extra funds available to pay the cost of the loan plus pay the loan officer a commission. So what's wrong with this? Nothing, but you are financing the "free cost" of the loan over the term of the loan (usually 30 years), which can double or triple the closing costs (by way of additional interest) as compared to pay the closing costs in cash.
How Do You Know if the Loan Officer is Increasing the Interest Rate?
It bears repeating that it is the loan officer who picks the interest rate he is going to sell you and, consequently, the commissions he will earn on the loan. If he is competing with another loan company to get your loan, he may not be greedy and not jack up the rate. But if you don't shop around, don't trust him to be honest. Some loan officers are completely up-front with you, but some aren't. Always shop around, especially if you have "A" credit. Some loan officers will charge you less if they know your loan will be a piece of cake to put through the system.
Take extra caution if you have less than stellar credit and must get a non-conforming loan, as these are typically the biggest target of shady loan officers. Desperate people have been known to have swallowed higher interest rates and 5 points in fees. This definitely is gouging.