Home Finance Essentials

What mortgage brokers don’t tell you: Hidden penalties abound

By John F. Wasik (Reuters)
Author, The Cul-de-Sac Syndrome

There’s a host of information a mortgage broker or banker won’t tell you up front that may increase the cost of your financing.

You could pay much more on a mortgage than your initial quote rate based on a rating system used by government mortgage insurers Fannie Mae and Freddie Mac. Brokers and bankers rarely tell you this coming in the door. They want to lock you in to a loan as soon as possible. With rates rising, this is really important to know.

In the wake of the biggest real estate meltdown in American history, the devil’s in the details when you apply for a loan. This hidden rating system will penalize you with a higher rate if your credit score is low or you apply for certain types of loans. It’s being employed by Fannie Mae and Freddie Mac, the government’s captive mortgage entities, which account for about 80 percent of new loans now.

As of January 1, mortgage brokers and bankers have to tell you that you may not get the best rate if your credit report is flawed, although they may not give you essential details up front on what else could bump up your finance rate.

You need to ask about how you will fare in the Fannie/Freddie “risk-based pricing” regime, which is basically a computer-run scoring matrix run by your banker. Here are some factors that could raise your cost of credit:

• Credit scores (based on the FICO system) below 740.
• High loan-to-value ratios (the percentage of the property’s value that’s mortgaged). The more equity you have or the more money you put down, the lower your rate.
• Adjustable-rate, Interest-only or 40-year loans.
• Cash-out refinancings.
• Investment properties.
• Condominiums and cooperatives.
• Manufactured homes.
• Multiple-unit properties.

The risk-based pricing program evaluates the type of loan, your credit score and loan-to-value ratio and determine what “add-ons” will boost your quoted rate, if any.

A low FICO score — say below 620 — may add at least a half-percentage point to your loan. An interest-only loan may increase your rate by three quarters of a point. Those financing buying investment properties will likely pay the highest rates — up to one and three-quarter points more.

As with all loans, it pays to pull your credit report before you apply for a loan or refinance. Certain items such as record errors or bumping up against credit limits can be fixed fairly easily and raise your credit score. Outstanding bills such as medical debts may also hurt.

“We encourage people to be more informed,” says Dick Lepre, a senior loan officer with RPM Mortgage in San Francisco. “If they want the best rates they need to keep their credit score at or above 740. They must be vigilant about things such as medical collections which are often the result of confusion regarding medical co-payments.”

You can request a free credit report from www.annualcreditreport.com. Just be careful not sign up for credit monitoring services that will cost you additional monthly fees. The Federal Trade Commission spells out some of the pitfalls of so-called free services.

One other side effect of risk-based pricing: The stricter underwriting rules also make it more difficult to qualify for a loan, which is not much help to markets that are swimming in properties and won’t get back on their feet unless demand returns.

Hindsight seems to rule the day as the government struggles to alleviate the home crisis. If only the mortgage barons had some realistic underwriting standards five years ago. It would have prevented a lot of heartbreak.