Gene J. Puskar, file, Associated Press
In this file photo taken Feb. 20, 201, a new home development is shown in Canonsburg, Pa. The 30-year fixed-rate mortgage is the most common home loan, but is it the best?
Mortgage prices are affected by a variety of factors, some of which potential borrowers understand a lot better than others. For example, most mortgage borrowers understand that the price of a mortgage is different for different mortgage types. On Sept. 10, for example, the best interest rate on mortgages with no fees was about:
—4.5 percent for a 30-year fixed-rate;
—3.75 percent for a 30-year adjustable rate with the rate fixed for 5 years;
—3.5 percent for a 15-year fixed-rate.
Most potential borrowers also understand that prices vary over time as economic conditions change. For example, the best rate on a no-fee 30-year fixed-rate was about:
—9.7 percent in September 1990;
—3.3 percent in December 2012;
—4.5 percent in September 2013.
Many potential borrowers do not, however, understand how the price of a specific type of mortgage at a specific point in time varies with the features of the transaction. There is always a “best price” for a transaction that is viewed as least risky to an investor, and then there is your price, which could be the best price but may well be higher.
A number of transaction features affect the price. The state in which the property is located affects the price because of differences in state laws relating to foreclosures and other factors that affect the cost of servicing a mortgage. These price differences are small, however.
The borrower’s credit score has a major effect on price, as well as on the ability to qualify. This reflects the documented relationship between credit score and the probability of default.
Borrowers who refinance in order to take out cash also pay heavily for the privilege. The need to withdraw cash is viewed as an indicator of financial weakness, which increases the likelihood of default.
Loans secured by second homes are considered riskier than loans secured by a borrower’s primary residence. The underlying presumption is that if the borrower’s finances become strained, preserving the primary residence will have a higher priority. If the property is rented out, the price adjustment is even larger.
Loans secured by condominiums are considered riskier than loans secured by single-family loans. Condo owners bear additional risks associated with the financial status of the condominium project as a whole. Loans on 2- to 4-family homes are also priced higher because the additional units are rentals.
Borrowers shopping for a mortgage should compare the price of their loan with the best price, because there may be things they can do to reduce the price.
For example, a borrower with a credit score of 659 could reduce her mortgage price by raising her score by only 1 point, which might be possible merely by shifting some credit card balances from one card to another. Another borrower might find a less-costly way to raise cash once she realizes that the higher price of a cash-out refinance is paid on the entire new loan amount, not just on the loan increase required for the cash advance.
The price adjustment process also carries an important implication for borrowers who believe that they can shop for a mortgage by requesting loan officers or brokers to quote prices. Unless the request for a price quote is accompanied by a complete list of the relevant transaction features, the shopper will be quoted the unadjusted price. For many if not most borrowers, that is not helpful.
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So where can borrowers go to find out how the price of their transaction compares to the best available price? While the raw data are contained in the pricing systems of all lenders, distribution is limited to loan officers and mortgage brokers, who use it to price loans but (with some notable exceptions) not to educate borrowers. To fill this void, I recently added this facility to my website. To my knowledge, it is the only source of transaction-based price adjustments available on the Internet.
ABOUT THE WRITER
Jack Guttentag is professor emeritus of finance at the Wharton School of the University of Pennsylvania. Comments and questions can be left at http://www.mtgprofessor.com.
©2013 Jack Guttentag
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