Avoiding Borrowing Pitfalls

(from Freddie Mac)

1. Say NO to "easy money."  Borrowers should beware if someone claims "credit problems won't affect the interest rate."  Avoid solicitations for loans that sound too good to be true.  If it sounds too good to be true, it probably is. If a solicitation is really interesting, get it in writing!
   If you are not provided a line-by-line explanation of the lender's Good Faith Estimate (GFE), you may want to seek another lender.  Unrealistically high or suspiciously low closing costs and pre-paid expenses (tax and insurance escrows) are usually the first tip-off.
   As a general rule, if you have good credit, most $150,00 to $300,000 home loans will require payment of 3% to 4% of the loan amount in closing costs and pre-paid expenses.  Those with bruised credit can be expected to pay 4% to 6% in closing costs and pre-paids -- but never any more than that -- for the same loan amount.  The exception might be if discount points are being used to lower the interest rate.  Larger loan sizes will cost somewhat less as a percentage of the loan amount, and smaller loan sizes shall cost somewhat more.
    

2. Shop around.  (or have a trusted broker shop for you)  Borrowers should talk to several lenders to find the best loan for which they qualify.  A loan product or lending practice may not seem predatory until compared with a similar loan product offered by other lenders.
   Ask the lender or broker to explain their Truth In Lending (T-I-L) disclosure.  You will notice that the Annual Percentage Rate (APR) will be higher than the interest rate being charged.  That is because specific expenses incurred during the first year are expressed as additional interest on the T-I-L.  This does not change the interest rate on the loan, it is merely an expression of the additional finance charges and is required by law.  When comparing interest rates, always shop the APR which is a more accurate indication of the true costs.  (see notes on the next item regarding manipulation of these data.) 
    

3. Understand the loan terms. Borrowers should compare loan terms from different lenders. Understand the best loan terms available in the marketplace and compare the APR (annual percentage rate) of loans from different lenders. The APR takes into account both the interest rate and the points and fees of the loan. A nonprofit housing counselor or a lawyer can review the information with a borrower.
   It is important to also consider the interest rate caps on adjustable rate mortgages.  Conforming ARMs will have a lifetime cap of 5% above the start rate, while non-conforming ARMs may have 7% lifetime caps (over and above the start rate).  First year and incremental caps will also vary from as low as 2% to as much as 5% for the first interest rate change.  This cap rate is added to the start rate, so be prepared to pay a much higher payment after the fixed period of the Adjustable Rate Mortgage expires.
   Recently, some wily Option ARM pitchmen have been grossly understating APR in their advertising.  This deception may be calculated into their GFEs as well, so the initial APR may be grossly underestimated.
   For example, an Option ARM with a 1% Start Rate cannot possibly have a 1.25% APR!  Their fine print goes on to "clarify" the deception by stating that the APR is "subject to change on the date of closing".  Of course it is.  That is precisely when it matters most!  The APR on most conforming Option ARMS should be somewhere between 5% and 6% at the current fully-indexed rate -- the only meaningful interest rate whenever considering such loan products. 
    

4. Find out about prepayment penalties. Borrowers should know if the loan offered to them has a prepayment penalty. Prepayment penalty should be a choice, not a requirement.
   While it is true that it should be a choice rather than a requirement, PrePayment Penalties (PPP) protect both the borrower and the lender.  A PPP is intended to keep the borrower from needlessly refinancing their loan for the first few years.  A PPP also protects the lender from losing money when a borrower commits to refinancing with another lender (possibly in an equity striping scheme).  You should have the option of buying out any PPP through payment of an additional fractional discount point.  Minnesota law requires that PrePayment Penalties are enforceable only when refinancing, and cannot be enforced if the borrower sells the property.  This is called a "soft" prepay.  Federally chartered lenders had been under the impression that they could charge higher "hard" prepayment penalties, but they are being challenged by the Attorney General.  Other State laws will vary, and PPPs may reach as high as 6%.
   I mentioned Option ARMs above, so I will touch on them once again. Any Pre-Payment Penalties on Option ARMS merely serve to inflate the yield spread premium paid to the loan broker.  It increases their profit on the loan, but does little for the borrower in most instances (unless closing costs are being paid from these proceeds).  Placing PPPs on an Option ARM in a rising market is a very bad idea!
   WARNING: Never accept a three year PPP on a two-year ARM!  This sort of deceptive practice is intended to offer lower start rates, but require the borrower to take a punishing interest rate hike after two years.  In this case, even the APR may appear deceptively low.
    

5. Make sure documents are correct. Be cautious of someone who offers to falsify a borrower's income information to qualify for a loan. Borrowers should never falsify information or sign documents that they know to be false.
   Loan or mortgage fraud is a serious problem, and carries harsh penalties.  Borrowers must be aware of this fact if they intend to "fudge" income numbers or falsify employment information.  Unfortunately, the laws and penalties does not stop unscrupulous lenders from falsifying documents or forging signatures.  Deal only with a lender who is duly licensed and abides by a strict code of ethics.  Exercise caution whenever dealing with a loan officer who is operating under the blanket license of a lender or broker, they may not be held accountable for their actions. You can check the validity of individual licenses with the Commerce Department in your State.  You can also check whether the lender is a member in good standing with any professional organizations of which they are members.  The same precautions may be extended to real estate agents.
    

6. Make sure documents are complete. A borrower should not sign documents that have incorrect dates or blank fields. Be wary of promises that a lender will "fix it later" or "fill it in later."
   This is another aspect of loan fraud.  If you are asked to sign a blank or undated document, ask the lender to fill in the blank or mark it with an "X" or a series of Xs, then both you and the lender should initial all changes.  This is less important on simple disclosures, but it is extremely important on any enforceable contracts!
    

7. Ask about additional fees. Borrowers should question any items they didn't ask for. Borrowers should also beware if they are told that single premium credit insurance is required get a loan, or that purchasing it will help loan approval. Review every fee and compare different lenders' fees to ensure the most competitive loan terms.
   Never purchase single premium credit insurance, pure and simple.  Be very careful when a lender also offers other forms of insurance, including homeowner's hazard insurance.  These will NEVER improve your chances of obtaining a loan approval!  Go over the Good Faith Estimate (GFE) with the lender -- line by line.  If there are a number of additional fees that are not easily explained, ask that they be removed.  Obviously, legitimate fees are non-negotiable, but "junk fees" most certainly are!  I, for example, gather the cost of credit reports, flood certifications, and other legitimate fees and combine them into a "broker fee" which I often describe to my borrowers as my "junk fee" (much to the chagrin of others in the lending business).
    

8. Understand the total package. Ask for written estimates that include all points and fees. The situation may not seem abusive until when everyone gets to the closing table. If any fees or charges differ from what was previously disclosed, delay the closing until all terms of the loan are clearly understood.
   Go over the details of the loan at the time of your application.  Often times, it is difficult to accurately assess the borrowers qualifications if they have damaged credit, so any estimate may be little more than a pie-in-the-sky guess until the loan actually passes the scrutiny of an underwriter. Whereas it is easier said than done to provide a solid estimate under these circumstances, your final interest rate should never vary by more than one half percent or the discount point should never vary by more than half a point.  Predatory lenders routinely change the rate and term of a loan from their original estimates by substantial amounts, including changing the entire loan program knowing that many borrowers may have no choice to back away from the closing table.  This is especially true when it comes to real estate purchases, since to not close the transaction in a timely manner may further obligate the buyer to legal action by the seller.  Review the final HUD-1 Settlement Statement a day or so before the actual closing date to avoid unpleasant surprises.
    

9. Work with credit counselors. A borrower should get all the facts before deciding to combine credit card or other debts into a home loan. Beware of scam credit counseling/ credit consolidation agencies ? unfortunately, not all credit counseling agencies are acting in your best interests. Talk to a community based consumer credit counseling agency or housing counselor before signing the loan documents.
   We can never say this often enough.  Many credit counselors and other credit advisors have only one purpose in life -- to take your money.  From our experience, not many of the community-based organizations are sufficiently trained to offer much assistance either, but at least they won't bleed you dry.
    

10. Protect home equity. If borrowers are taking equity out of their property, they should take out the minimum amount needed. The equity in a home is a source of wealth, which builds up slowly over time.
    This too, is very important.  If you are refinancing your home or taking out a home equity line of credit to pay off other debt, please leave 5% or more of the equity in your home.  Then change your spending habits so as to spend responsibly.  You don't want to rely on repeating this exercise every few years.
     

11. If you?re not sure, don't sign! Get advice first! Talk to a community based consumer credit counseling agency or housing counselor.
    Signing disclosures is not a problem, they are acknowledgements that you make to a lender regarding the various laws that apply to the transaction.  However, signing contracts and agreements which obligate you to the terms of the loan can be a big mistake; especially when you are not allowed to make an informed decision.
    I routinely review Good Faith Estimates that borrowers bring in from other lenders.  If the estimate appears to be accurate and the loan looks like a good deal (and when the company is a forthright lender), I make no attempt whatsoever to "steal" loans from other honest brokers and bankers.
    If, on the other hand, it is apparent to me that the borrower is being grossly overcharged, deceived, or placed in an compromising position or awkward situation; I will take their application and shop their loan for them.  I will take loans away from greedy cheats!