Mortgage interest is a big expense for American families. It is so big in fact that over 30 years you repay the bank a little over double the amount you originally borrowed. I suggest choosing your mortgage wisely.
What This Blog Is About
This blog is going to reveal my six finest techniques of negotiating a good deal on your mortgage and saving a fortune on mortgage interest. You don’t have to pay me for the information. Most of it is outlined in paragraphs to follow.
My techniques work for purchase mortgages and refinance mortgages. The method is very powerful and it will work on just about any loan. However, it is tailored for residential mortgages (excluding reverse mortgages) because residential mortgages are unique in the way you shop them.
The ATOMIC method will turn you into one of the most educated consumers on the market when shopping for mortgages because most people don’t have this knowledge. Lenders will no longer be fooling you with their offers. You’ll be comparing different offers as if you’re an industry insider. Revealing this information to you is not something your local bank loan officer would want me to do. An educated borrower, for most loan officers, is a pain. Therefore, pay close attention, take notes, and get ready to save a lot of money!
Armed with this information you will be one of the most powerful mortgage shoppers out there. No longer will a lender be able to temp you with what seems to be a good offer, while they sweep the costs under the rug in another section of the loan estimate. In contrast with uneducated shoppers, you will start receiving the best offers available out there on the market!
What the AMOTIC Method of Mortgage Savings Won’t Do For You
The ATOMIC method is a step-by-step, surefire way for you to save money. If you do the work required by my method, you will save money. What the ATOMIC method won’t do is teach you how to find good lenders to shop. That is a vast topic that deserves a whole separate section. I’m expecting for you to figure that out on your own. Make sure to put in a lot of research into the lenders you approach for quotes because if you’re comparing only high cost lenders, then the best offer you’ll get is the lowest of the high cost offers. If you’re in California and need a recommendation, message me privately and I’ll try to get back to you soon.
“What the ATOMIC method won’t do is teach you how to find good lenders to shop. You’re expected to do that on your own. Make sure to put in a lot of research into the lenders you approach for quotes.”
The ATOMIC method won’t tell you how to pick a specific type of mortgage (i.e. 30-Year Fixed vs. 20-Year Fixed). The method is designed to be implemented after you determine what type of mortgage is right for you. This is what a reputable mortgage professional can help you with, or perhaps your financial advisor. I suggest you spend a lot of time thinking about this question before you move on to implementing my ATOMIC Method of Mortgage Savings.
In conclusion, get ready to save a lot of money but also get ready to put in more than a few hours of your time. You’ll get better results by putting in more time, because doing a lot of research upfront is one of the best ways to prepare yourself for a successful negotiation.
Now that you know what the ATOMIC method consists of, its important that you understand that the letters represent features of mortgages. You must learn to compare features across various offers you receive. Just because APR of one mortgage is lower than that of another mortgage, it does not make that mortgage better nor worse. Likewise, it isn’t enough to just compare the closing costs of one loan to another. Other features must also be compared in your analysis, to ensure you’re seeing the full picture.
What Isn’t Covered
We are not going into a discussion of whether you should choose a fixed rate mortgage or an ARM. That decision is personal and a very important one.
Now, what you want to do is figure out which mortgage type fits your lifestyle the closest. At the least, try to narrow down your options to similar types of mortgages. Ideally you want to compare the same type of mortgage. Comparing a 30-year fixed mortgage to another 30-year fixed mortgage, that’s easy. While it’s still possible to compare a 15-year mortgage to a 30-year fixed, comparing an ARM to a fixed is much harder and I don’t recommend it.
If you’re comparing an ARM to a fixed rate mortgage toward the end of your loan shopping process, then realize you’ve made a mistake and should correct it immediately. If this happened to you, then do more research and choose the one type of mortgage that most closely aligns with your lifestyle and your future. That way you’ll get the best deal is by comparing apples to apples.
In this post I’ll teach you how to shop using the APR as one of the parameters. Remember, this number is one of many factors you need to consider when shopping for a mortgage because I want you to focus on getting the best overall deal.
Consumer Financial Protection Bureau’s definition is:
The APR that you see presented to you in loan estimates is calculated by a computer. Loan Processors, working for lenders, input information about the loan, most importantly–total costs, into a LOS (Loan Origination Software). The LOS then generates APR disclosures.
The annual percentage rate itself is not a reliable basis of comparison for mortgages and you can’t rely solely on this number for many reasons. The top three reasons are:
A lower APR loan might not be the best fit for you,
Loan Processors make mistakes; the disclosed number may be inaccurate.*
There are other very important things to consider, that we’ll cover using the ATOMIC method, so make sure to read the entire blog.
Are we still going to be using the annual percentage rate for loan shopping? Yes, we are, because it is still a useful indicator in our analysis.
We want a low APR.
A lower APR means lower total costs of the loan–including the interest you pay to the lender and their fees. Therefore, the lower the number, the better. If you’re comparing two identical loans side by side, take the one with the lower number because it will save you money.
the lower the costs of the loan, the lower the APR.
You’re now one step closer to being one of the most educated mortgage shoppers in your neighborhood. Remember, this number is one of many factors you need to consider when shopping for a mortgage. It is by no means the only thing to consider. Read my next blog post, about the “Time” factor, to improve your mortgage shopping skills.
If you’re interested in learning more about what is included in the APR, here are some resources:
* To quickly touch on point #3: The annual percentage rate calculation done by the LOS is based entirely on the input from the Loan Processor. Human error does cause big differences in these numbers, and there could be lenders that purposely understate closing costs to make their offer look better. If you don’t believe that lenders can do things like that, just look up the numerous cases of lenders being fined by the government for not following laws, guidelines, and procedures; you will find plenty of examples of, sometimes negligent, misconduct within the lending industry. Besides, software errors can cause problems too.
The longer the mortgage term, the higher the bank’s interest income. Borrowing money from a lender is a zero-sum game because every dollar the bank wins is a dollar you lose, and vice versa. Therefore, it is very important that you consider what we’ll call the “time factor” in your borrowing decision.
Mortgage Term – Understanding the Time Factor
The easiest way to understand the time factor is counting the number of periodic payments you’ll make (for most mortgages, 1 month = 1 period). Here are some common mortgage terms and their periodic payment schedules:
30 Year Mortgage = 360 Periodic Payments (30×12)
25 Year Mortgage = 300 Periodic Payments (25×12)
20 Year Mortgage = 240 Periodic Payments (20×12)
15 Year Mortgage = 180 Periodic Payments (15×12)
The easiest way for me to illustrate the impact of time on your mortgage is to show you an example, so let’s compare two mortgages that have the exact same interest rate of 5% and a balance of $100,000.
A 30 year fixed mortgage will have 360 payments of $1,073.64. Multiplying the two numbers together gives us a product of $386,510.40. That is how much you’ll end up paying the bank over 30 years. Let’s compare it to a 15 year fixed mortgage, that has 180 payments of $1,581.59. Multiplying the two numbers gives us a product of $284,686.20. Thus, it’s now very apparent that repaying the loan 15 years faster saves you $101,824.20. That’s a pretty penny! Wow!
How to Use the Time Factor to Your Advantage
You now know that paying the mortgage off faster will save you money. However, you also saw that the 15 year payment was 47% bigger than the 30 year payment. This is what keeps most people from getting a shorter term, even though it’s better to pay off the loan faster. If you can fit it within your budget, and if you have no other investment opportunities that can yield a return higher than the interest rate charged by the lender, then try to fit a shorter term mortgage payment into your budget.
There are a few things you can do to save money on interest. However, we’ll talk about that later. Here, we’re discussing how to compare mortgages to get the best deal, and you do that by comparing different loans with the same repayment period.
What I want you to do is review lenders’ offers, side by side, and make sure the loans you’re comparing have the same mortgage term (length). Don’t just compare a 30 year fixed offer to a 20 year fixed offer from the same lender. First, you need to select the mortgage term that most closely fits your lifestyle and then compare mortgages, of the same length, across different lenders.
The advantage of comparing loans with the same number of periodic payments is that you’re comparing apples to apples. Make sure to compare loans the way I’m teaching you because that is how you get a good deal! And again, I encourage you to spend a lot of time researching what mortgage term is right for you because not only will it let you stay within your budget, but you will be preparing yourself for a better negotiating experience.
Out of pocket money you pay the lender is a tough topic for most American families today. Generally, the more you’re willing to pay out of pocket, the better the offers from lenders get. Give, and you shall receive. Lenders like to get their income upfront, and you can save a lot over the long term.
This is not a full list of costs you can pay out of pocket, but I included the most important ones.
Purchase vs. Refinance
Before moving forward, we need to distinguish between two types of transactions: purchase and refinance. In a refinance where you have plenty of equity in your home, you will have an option of including some or all of 1-5 in your new mortgage. In a purchase, you won’t be able to include any of these in the loan because any funds used to cover 1-5 will take away from the money you’re using toward the down-payment. However, you’ll have an option of giving the lender more or less money toward the down-payment and loan discount points. Sometimes, the less out of pocket money you spend, the better, due to your personal financial situation. Sometimes not.
Loan Discount Points
These are the fees you can pay your lender, out of pocket, to bring down your interest rate. Let’s use a $100,000 loan amount as an example, with a fictional rate sheet for a 30 year fixed loan. You loan officer might give you the following options:
Subtract the products from each other and compare to the amount of out of pocket discount points.
You will need a mortgage calculator to do step #1. I also suggest comparing each loan scenario not only for the full term of the loan but for the amount of time you’ll most likely keep this loan. Since most people statistically payoff the loan by selling or refinancing within 7 years of origination, I suggest doing a calculation for 5 years and for 10 years, in addition to the full term. Below, I’ll give you an example using the full 30 year term.
We are going to use the zero discount point loan scenario #2 as our baseline.
The difference between product of #1 and #2 is $5,461 over 30 years. That means that you will end up paying $5,461 more by choosing loan #1, while you get $1,000 in credit from the lender (that can be applied toward reducing your closing costs). Doing further math, the bank will net $4,461 more from you over 30 years.
The difference between product of #3 and #2 is $8,050. That means you will pay $8,050 less to the bank over 30 years, but at a price of $1,000 upfront out of pocket. The bank will net $7,050 less from you in 30 years.
That’s how you do the math. The choice of which option is best for you is personal. Essentially, you’re choosing between borrowing $1,000 more from the bank or borrowing $1,000 less. Don’t forget to do the analysis for 5 and 10 years as well (60 and 120), to get a clear picture.
The down-payment amount is analysed in a similar way, but with additional nuances. Lenders adjust mortgage interest rates based on risk. The bigger the down-payment, the lower the risk, and vice versa.
Lenders release daily rate sheets that loan officers use to price your loan. The down-payment risk is separated into brackets (see below), based on the percentage of your down-payment in comparison to the purchase price and/or appraised value. The measure of this risk is quantified by applying a ratio called Loan-to-Value (LTV).
The way you calculate the LTV is by taking the loan amount and dividing by the appraised value. For example, $100,000 loan on a $150,000 home will have a LTV of 66%.
Interest rate risk brackets, that lenders use, are typically determined by the LTV, in the following (or similar) fashion:
There are exceptions to the rule, but generally, the lower the LTV, the lower the interest rate, and vice versa.
You will run the numbers the same way as in the loan discount points example above, with two exceptions:
Instead of using the $1,000 for discount points, you’ll use the extra money toward the down-payment.
You will add the monthly mortgage insurance payment (discussed below) to the periodic payment.
Stop adding mortgage insurance to the periodic payment after the time period when you’re allowed to cancel mortgage insurance, that way you won’t overstate the lifetime payment schedule of the loan.
In the beginning of the discussion on the down-payment, I mentioned there’s an additional nuance to consider. I was referring to Mortgage Insurance (MI). Depending on the type of loan you apply for, there are various types of MI:
Private Mortgage Insurance (PMI),
Mortgage Insurance Premium (MIP),
Borrower Paid MI (BPMI),
Lender Paid MI (LPMI),
Upfront Mortgage Insurance Premium (UFMIP).
There are a lot of variations of MI, but they all share one thing in common: any time your LTV is above 80%, MI will be required to be paid by either you (BPMI) or internally by your lender (LPMI). If paid internally by your lender, it will be reflected in a higher interest rate.
I won’t be discussing MI in detail, in this article, but keep in mind that it will be present if you put down less than 20% of the purchase price. You will be able to cancel MI once certain requirements are met (check with your lender), so make sure to factor MI into your analysis as well.
Thus, a bigger down-payment will not only yield a lower interest rate but also lower MI.
Prepaid Taxes and Insurance
Prepaid taxes and insurance is another place you might chose to invest out of pocket money. In some instances, such as on government loans or high LTV loans, prepaid taxes and insurance are a requirement of the loan. More commonly, you will have a choice of setting up an impound account (also called an escrow account) to pay your property taxes and insurance monthly.
Lenders generally give closing costs incentives to set up an impound account. Remember, impounds are not fees. Impounds are fund held for property tax payments made on your behalf by your lender.
Let’s set up a loan to use for our example. Again, the loan amount is $100,000 and the interest rate is 5%. The appraised value of the home is $150,000. We’re going to be using a purchase loan in this example, closing in the month of January. We’re going to estimate annual property taxes at $1,875 and insurance at $800 a year.
Impound Account Example (with out of pocket money)
Let’s look at an example where you set up an impound account so you get an idea of how it works.
First, the required impounds vary based on the month the escrow closes. In January, for example, lenders collect 7 months worth of impounds. They collect 9 months in September and 2 months in February. Lenders do that because they need to make sure there are enough funds in the impound account to pay for property taxes and insurance when they are due. You can request a Property Tax Impound Schedule from any Title/Escrow company to get the details. Here’s one I’m using for this example.
Mathematical Example for January
In our example, the amount of funds required to set up your impound account is $1,560.42. You arrive at that number by adding $1,875 and $800, then dividing the sum by 12, and multiplying the dividend by 7. Our calculation isn’t complete yet, because we need to factor in the incentive (i.e. lender credit) you receive for setting up an impound account.
Lenders typically give you 0.25 points as an incentive to set up an impound account. In our example, that would be $250 ($100,000 multiplied by 0.25%). Thus, the total out of pocket money needed to set up your impound account is $1,310.42 ($1,560.42 minus $250).
The lender will make your property tax and insurance payment for you. Essentially, you’re getting $250 to set up an impound account, in exchange for paying the lender for property taxes and insurance upfront. In this example, you would be getting a 16% return on your money by setting up an impound account ($250 divided by $1,560.42). However, you will also need to compare it to the costs and benefits of using that out of pocket money toward other concepts we’re discussing in this article, such as discount points.
Origination fees are completely lender dependent. There’s no method required to analyze these out of pocket costs. What you need to keep in mind is that each lender sets their fees differently. You need to compare these fees to each other, but also keep in mind that origination fees are only a small part of the big picture. For example, if Lender A is offering a loan with $2,000 in origination fees and $2,500 total out of pocket, while Lender B is offering a loan with $500 in origination fees with $3,500 out of pocket, then Lender A’s deal is better because the total charge is lower. However, remember that the other factors of the ATOMIC method must also be weighed in for your final decision. Out of pocket money should not be your only consideration (although, for some families this can be the only consideration; and that’s fine).
Title & Escrow Fees
Title and escrow fees are always paid out of pocket in a purchase transaction and sometimes paid out of pocket in a refinance. If a loan officer tells you title/escrow fees don’t have to be paid out of pocket, what they’re really saying is that the lender or seller is giving you credit to cover them. In general, you can look at title and escrow fees as out of pocket money.
Reducing title and escrow fees are one of the easiest ways to reduce paying money out of pocket, but it probably isn’t going to save you a whole lot of money because the profit margin on those items is rather small due to a lot of competition. A key thing to remember is that you can shop your own title/escrow fees in a refinance, but rarely can you shop title/escrow fees in a purchase in Southern California. In So. Cal. you’re usually required to use the title/escrow company of the seller’s choice.
What you can do is call around different title/escrow companies and get a few quotes from them, the same way you shop lenders. Some companies charge more than others, so you may discover that there’s a better deal out there.
The monthly mortgage payment is a very important piece of the puzzle when it comes to negotiating the best deal on your home loan. Not only does the monthly mortgage payment determine your ability to qualify for home, but most people build their budgets around their mortgage payment. Thus, pay full attention to the contents of this article.
Let’s assume that you followed my ATOMIC Method of Mortgage Savings to a tee and you’re now comparing mortgage payments. How do you know which mortgage is the best deal for you?
How is a Mortgage Payment Determined
The mortgage payment is a function of three things:
Therefore, before comparing one loan’s mortgage payment to another, you need to make sure these three variables are equal between the loans you’re comparing.
If you followed along up until now, all you have to do is put mortgage payments side by side. Again, just as in my previous articles, you need to make sure to look at the big picture. Don’t just compare mortgage payments to each other.
Something I want you to be mindful of is the Mortgage Term. A lender might present you with a 30 year ARM loan that has a lower interest rate. For example, a 7/1 ARM mortgage is common and is fairly easy to qualify for. At some stages of the economic cycle, the 7/1 ARM carries a much lower interest rate than a 30 year fixed loan. Just because the interest rate and mortgage payment are lower, doesn’t make it the best choice for you, and it probably isn’t.
If you don’t know where to start when determining what mortgage term is right for you, I wholeheartedly suggest you contact a trusted financial professional.
Little Differences Are NOT a Big Deal
Should a $10 difference between two mortgage payments matter to you? Probably not. $10 is only $120 a year and $3,600 over 30 years. Faced with a choice–save $10 a month or go with a lender you feel will provide you with better service, I suggest you prioritize service. Don’t grind your loan officer over $10. There’s probably nothing he can do for you anyway and it will just complicate your relationship. Steer clear of appearing cheap throughout the mortgage process, and be respectful to everyone involved. Carry yourself as an educated, frugal consumer.
Choosing better service over tiny monthly savings is especially important if you’re purchasing a home. In a purchase, you want to prioritize service because so many things can go wrong that working with a low cost, unresponsive lender can cause you serious financial losses. Even if you’re refinancing, do you want to save $10-20 a month but be stuck with an unbearable lender for the next 30 years? Of course you don’t. Good service matters.
The interest rate of a mortgage is one of the most important things to consider, although it shouldn’t be the only thing. You should pay special attention to the interest rate. The bigger the loan amount, the more the interest rate will make a difference.
What is an Interest Rate
The interest rate, also know as the Note Rate, is one of the variables that determines the total costs of the loan. For example, let’s test the monthly payment difference between 4% and 5%.
If we look at a $100,000 loan, the difference between the two interest rates is $59.41 a month. That’s $21,386.28 over 30 years. For a $500,000 loan, the difference is $297.03 a month, and $106,931.40 over 30 years. The difference ca be staggering. This is why we usually see a wave of refinances when market rates drop by even as little as half a percentage point–people save a lot of money by refinancing.
How Interest Rates Are Determined
Interest rates are a function of risk. The lender, like any prudent investor, looks at the risk-free investments available on the market (such as Treasury bonds). They then add a risk premium to compensate themselves for taking a chance on lending money to a prospective borrower.
While T-bonds are virtually 100% secure, mortgage notes are not. If the borrower defaults, the lender can technically recover their investment, but at a big cost. The lender will not receive monthly payments from a defaulting borrower for a period of time, will have to hire a law firm to foreclose on the house, and then have to pay a real estate agent to sell the home–in the meantime they would be experiencing loses in the form of “opportunity cost” (i.e. not earning a risk-free return from T-bonds while all this is happening). Therefore, the higher the lender’s risk, the higher the interest rate will be.
This is how lenders determine risk; they look at the following parameters:
Amount of equity in the home,
Borrower’s credit history,
Location of real estate,
Type of real estate being financed,
Local and nationwide market conditions.
For these reasons, you might compare two exact loans but see a big difference between interest rates based on who the borrower is, the type of real estate it is, the location, and the date the loan was written.
Closing costs are very difficult to determine ahead of time because they’re a collection of different expenses that arise for different reasons. The amount of fees depends on location of the property, the type of mortgage, and the price of your home. You can ballpark closing costs to be between 2% and 5% of the home value. In this article I’ll teach you how to minimize your closing costs and save money.
We’ll focus on the common closing costs in Southern California and discuss how to minimize them. Some of the closing costs here will overlap with those discussed in my previously published article, Out of Pocket Money, because they are interrelated.
Closing Costs Reduction
Below you will find ways to reduce closing costs.
The appraisal fee is non-negotiable. Lenders don’t make any money on your appraisal because this fee is paid directly to an appraisal company. The appraisal fee is usually paid upfront, out of pocket, by the borrower/buyer. In some rare cases, the lender will offer you a free appraisal. This lender’s service is almost always sub-par because they’re probably serving too many customers. In some cases, the lender will offer to pay for it upfront and charge you on the back end (that’s a good deal).
Closing / Escrow Fee
This fee is negotiable. You’re paying it to the title or escrow company for handling your transaction. You can negotiate this fee directly with the title/escrow company. If you’re in a purchase transaction, check your contract to see if you’re able to switch title/escrow companies. You can also try getting quotes from other title/escrow companies and then presenting the best quote to the title/escrow officer handling your transaction, because sometimes they will attempt to win your business by matching the best offer.
Credit Report Fee
The credit report fee is non-negotiable. Most lenders don’t charge the borrower upfront to run their credit and instead charge the borrower at closing. The lender doesn’t make any money on running your credit report and the entire fee goes to the credit reporting company.
The flood determination fee is non-negotiable. This fee is paid to a third party to determine if the property is located in a flood zone. If it is located in a flood zone, a separate flood insurance policy will be required to be paid for buy the borrower.
The home inspection fee is negotiable. We usually only see these fees in purchase transactions. You can shop this fee the same way you would shop lenders. However, the cost of the inspection is not as important as the quality of the report. A good report can uncover major issues, repairs, and deferred maintenance the home may need. You can use this report to negotiate a credit for repairs from the seller. I strongly suggest going with the home inspection company your real estate agent recommends and has had extensive experience with.
HOA Transfer Fee
The Homeowners Association (HOA) Transfer Fee is non-negotiable. This fee is present any transaction involving a homeowners association. This could be for a purchase or a refinances of a condominium or a planned unit development (PUD). The HOA has a right to charge for facilitating real estate transfers, as well as providing documents such as CC&Rs, Bylaws, Budgets, as well as copies of the master insurance policy. Like an appraisal, the borrower is usually paying this fee upfront.
Homeowners’ insurance is mandatory when using a mortgage because the lender always requires insurance coverage. You have the right to shop your insurance services provider and get the best deal for yourself. A good way of getting a deal on insurance is to bundle your auto and home insurance together, so call your insurance broker and get a quote. You may also want to ask your real estate agent for an insurance broker referral, then compare their quote to your broker’s.
Lender’s Policy Title Insurance
The lender’s policy title insurance is non-negotiable. Your lender is requiring for you to pay for this policy because it protects the lender from title issues. The only way to reduce this fee is to shop title companies. In a purchase, you usually have to go with the title company of the seller’s choice. In a refinance, you usually have the flexibility of using any title company you want.
Loan Specific Fees
Some loans, such as VA and FHA, have non-negotiable funding and/or upfront fees. These fees cannot be shopped for and are usually forwarded to a third party by the lender.
The origination fee is negotiable and is lender specific. It covers the lender’s administrative costs. However, reducing this fee is hard work and requires you putting a lot of pressure on the lender. A realistic way of negotiating this fee is to get a better total offer from another lender and use it as leverage for getting the origination fee waved or reduced.
The pest inspection fee is negotiable. It may be required by your lender. You can shop this fee the same way you would shop any other service.
Prepaid interest is non-negotiable. It is technically not a “fee” but rather the interest you will owe to the lender that will accrue between the closing date and the date of your first mortgage payment.
The processing fee is similar to the origination fee we discussed above. The same rules apply.
These fees are non-negotiable. Your local recording office is charging these fees for entering your transaction into the public records.
The underwriting fee is similar to the origination fee, therefore the same rules apply for negotiating it.