You know what they say in the military, knowledge is power. Corny, I know, but I’m going to give you more than enough knowledge to level the playing field when talking to mortgage brokers and loan officers. In order to not get taken advantage of, you have to understand the underlying components of the mortgage industry and the bond market. Most of these individuals are great people, but they can sometimes be fast-talking, throw around jargon like “treasury rates,” and act like they just rolled off Wall Street because they got a discount suit at Men’s Wearhouse. This post doesn’t have any tricks or secrets to getting a BOGO 50% off promotion this weekend, but it can help teach you some of the rules and jargon your mortgage broker uses…to sound, well, like a mortgage broker. Note: no hair gel was harmed in the making of this blog post.
What Mortgage Rates are Based On
This is really simple. The reason mortgage brokers make it appear like it isn’t is because they likely don’t understand, haven’t been taught, or can’t expose what mortgage rates are based on. The 10-year treasury rate is a conservative, U.S. Bond rate that has a return that incorporates risk, time, and required gain over a 10-year period. Because lenders have a long-term timeframe to invest, they could expect to receive the 10-year treasury rate of return when employing their capital in the bond market as a minimum rate of return. Mortgages are also long-term and are thought of as bond with annuity interest payments to lenders. The rate of return lenders receive when lending for a mortgage must beat the 10-year treasury rate of return to make it worth their while of tying up capital. In reality these lenders will likely sell the mortgage on the secondary market to Fannie Mae or Freddie Mac, but the return will still have to beat the 10-year treasury rate. Thus, because mortgages are long-term bonds for lenders, they must beat the baseline U.S. Government-backed 10-year treasury bond. Many lenders have told me the rate has nothing to do with the bond market, but only my credit score and debt-to-income (D/I) ratio; when I hear this, I usually find a different lender who understands the debt instrument they are selling. While the individual rate you are quoted will increase as risk increases for the lender (a lower credit score and higher D/I), mortgage rates are seen as long-term bonds to lenders and, therefore, will always follow the 10-year treasury market.
How The Bond Market Works
This is a no-nonsense blog to empower military members to financial freedom, not a journal on the edge-of-your-seat academics of the bond market. However, a critical part of empowerment to those investing in real estate is to ensure they’re not being taken advantage of by mortgage brokers along the way. Relationships matter. If you find a broker who shoots you straight, and who you can trust, build them into your network and develop a mutually beneficial, professional relationship (refer your friends their way!). If you’re going to shop around and negotiate for mortgages (next section), you have to have a baseline understanding of how the bond market works that drives their prices. In general terms, it’s relatively simple. In a stable market, all things being equal with a low fear index and positive economic outlook, most investors will choose to pull money from bonds and invest in the stock market for a higher rate of return with a baseline or low level of risk. However, in times with increasing levels of fear (economic turmoil, potential war, or black-swan financial events), those same investors will pull money out of the risky stock market for guaranteed, safe, low-risk returns in the bond market. As more individuals/institutions invest in the bond market their prices increase and their yields (rates of return) decrease – mortgage rates will also decrease. As more individuals/institutions invest in the stock market, pulling money out of the bond market, bond prices decrease and their yields (rates of return) increase -mortgage rates will also increase.
Shopping Around
As the customer, you have every right to submit applications with multiple lenders and shop around for the best rate. In fact, you can share your current loan estimate or quoted rate from one lender with other potential lenders to see if they can beat it. You are the customer, but many lenders forget that. They may not want you to shop around, they may be pushy, insist that it isn’t right to waste their time by submitting an application if you’re not serious about intending to proceed with them, etc., etc., etc. Well, these are all hard sales tactics. These cheap ploys may have worked in the 1980’s, but you’re the customer, lenders aren’t doing you any favors, and it’s actually kind of sad to hear them read from a prompt binder like a zombie, and sometimes, kind of funny to heard the same pre-rehearsed sales tactics over and over.
You’re not wasting their time, you’re doing your due diligence by shopping around. As long as they provide the lowest rate, you’d be happy to go with that particular lender. In fact, they shouldn’t waste your time by not giving you the lowest rate possible the first time instead of requiring any back and forth. Again, knowledge is power, and you can’t advocate for yourself if you don’t know the rules, tactics, and games some players in the real estate industry are playing. In business, especially in real estate, if anyone stands to make money during a transaction there’s a potential angle they may have. That’s why it’s extremely important to find trusted personnel to work with when building your team, including real estate agents, lenders, and property inspectors. Going into the conversation armed with an understanding of the game and rules is half of the battle. This is the same reason you don’t let your battle buddies go to a used car dealership alone – protect them from that 29.9% interest rate on a 2008 BMW 3 Series with 240,000 miles! But, I digress…
Red Flags: Loan Originator Tricks
Speaking of hard sales tactics, here are a couple of red flags that will initially make me pump the brakes and start asking questions when speaking with a loan originator.
- Origination Fee & Discount Points: A lender will quote a rate but not speak to the loan origination fee or discount points associated with that rate. A loan origination fee is expressed as a percentage of the total loan and is one of the ways lenders make money when providing you with a loan. They may offer an unusually low rate, but not speak to the thousands of dollars that rate will cost you. For simple math, a 1% loan origination fee on a $200,000 loan is $2,000. Similarly, a lender may talk about a loan rate, but not mention the amount of “points” it will take a buy-down to that lower rate. The discount points associated with a mortgage rate increase the closing costs of the loan (unless they are rolled into the loan amount), but will give you a lower interest rate so you’ll pay less per month in interest over the life of the loan. Discount points are also expressed as a percentage of the total loan and are a form of pre-paid interest on the loan. Each situation and deal is different, but calculate your break-even carefully by using your planned holding period to see if it makes sense to pay upfront to buy down an interest rate. Usually, if you’re only planning on holding a short period of time, the monthly interest savings don’t outweigh the increased upfront costs associated with discount points. Once you apply for a loan, ask for the lender to send you a loan estimate, which will have a break down of the origination fees, discount points, and other fees you can/cannot shop for. If a lender is hesitant to send you a loan estimate, they have something to hide…red flag!
2. Pushy Loan Officers: I know I mentioned this before, but it’s worth re-iterating as a stand-alone red flag. If at any point, a loan officer gets pushy, tries to guilt you into not shopping around, or tries to “close the deal,” I go even slower. The quicker the lender tries to rush me through the process, the more reason it would give me to pause, slow down, and generate additional options. Once you find your team of trusted professionals, you likely won’t have to experience any of these red flags with lenders, but until you do, it’s important to know what to look out for. Making savvy financial decisions requires muscle memory from repetition, but so does knowing what to look out for when dealing with lenders (or anyone involved in a real estate transaction for that matter). Unfortunately, there are people who wake up every morning with the intent to take advantage of members of the military because of their guaranteed paychecks and requirements for basic needs in a new, unfamiliar area (place to live, car to drive, things to do, etc.). Knowledge is your first line of self defense. “Chad,” the pretend finance bro on the phone isn’t a Math genius or financial wizard. He sat through 20 hours of online classes, has a prompt binder to deal with questions from potential customers, and has a preset program to generate loan estimates. See below for an online pre-licensing Mortgage Loan Originator education package from OnCourse Learning.
Conclusion
Building your real estate team with trusted agents, knowing the rules of the game, and having background knowledge will empower you to advocate for yourself during the initial phases of real estate transactions. There’s a lot more to cash flowing investment properties and building your rental portfolio than getting a mortgage; however, the amount you cash flow, the required down payment, and the closing costs are all at stake during the financing phase. Each rental property is like a small business, and you want it to run as lean as possible; you can’t do that without trimming away excess closing costs and getting the absolute lowest rate possible. So far we’ve gone over finding the right deal with the 1% Rule, using leverage to increase your ROI, and understanding the mortgage industry fundamentals behind that leverage. We’ll go over the various types of residential real estate investments in a follow-on post. Read on!