Let me start by apologizing for the first 5 parts of this series! Unless you're a mortgage originator a line by line understanding of the "Good Faith Estimate" is a waste of time, most are a waste of paper!
My regular readers know that I believe that Regulation Z was a noble idea who's execution and implementation has confused and cruelly mislead the consumer. Consumers reliance on the APR, Annual Percentage Rate, has cost them unknown billions! Yes, the "B" word. In a feeble minded attempt at consumer protection HUD, the Department of Housing and Urban Devolvement, added to the confusion with the inclusion of the YSP, Yield Spread Premium, disclosures about 15 years ago, providing irrelevant useless information that implied a hidden evil. YSP came shortly before the infamous, "Section 32" laws that drove many lenders, who helped troubled people, most of whom succeed, out of high risk lending,. All in name only of consumer protection and fairness.
There is good news regarding the "Good Faith Estimate" and "Truth In Lending" disclosures! There is a lot of useful information along with the distortions on those forms. But, the information is not in the individual line items, rather it is in selected totals!
The reason the line items are irreverent is because mortgage brokers , honest ones, have to disclose cost in accordance with their suppliers labels, which vary. Mortgage bankers, banks, saving and loans, and credit unions are free to create their own labels, there is no common standard. Brokers also have to disclose the YSP which indicates their gross on the transaction when combined with origination points and fees but none of the other loan sources show this irreverent information. It is only the "Total Closing Cost" for any given loan that's reverent! If you're comparing 6.000% 30 year fixed rate loans, it's not the number of line items charges that's important, it's the total closing cost!Notice we're talking about "Est. Closing Cost" near the bottom of a "Good Faith Estimate" not the "Total Est. Funds needed to close!"
One of the most confusing things about the "Good Faith Estimate" is the necessary inclusion of the prepaid items. Prepaid cost are of course estimated, in fact they can't be totally known until after the loan is funded and recorded, and they will be what they will be! Two honest lenders can come up with widely varied estimated prepaids, and both be honorable and honest, and no matter which loan closes the final prepaids will be the same.
Loans should never be compared by their prepaids, prepaids are determined by the loan program, the property, and the date of closing and will not vary from one lender to another at closing! When comparing dissimilar loan programs the prepaid cost that are included don't really vary, because they are cost reverent to your owning the property. Programs that have fewer prepaids only postpone when you pay these costs, they don't eliminate them. To included prepaids when comparing loans only distorts the comparisons, by the lenders physic ability and / or integrity. Personally I've always tried to estimate prepaids high, particularly "prepaid interest. (See: Explaining Pre-Paid Interest ) this increases the APR, but protects the client from shock at closing which could require a couple of thousand dollars in unexcepted prepaid cost. Money that must be paid at closing that may legally have been omitted from the "Good Faith Estimate!" Money the buyer may not be able to pay because it was not anticipated.)APR is a distortion! The APR is calculated based on a fully amortized loan. Even if the "Good Faith Estimate" was perfect, unless you keep the loan a full thirty years and make every payment on time you'll be paying more then the APR indicates. The sooner the loan is paid off, the higher the actual loan cost!
It's rare that loans written in the last thirty years are amortized to completion. Homes are sold, equity is harvested (cash taken out), and loans are refinanced to lower rates, but rarely kept 15 to 30 years! When was the last mortgage burning party you attended? Paying off a mortgage one payment at a time is something our Grandparents did if you're under fifty that was your Great Grandparents. All most all mortgage loans are paid off in 5 to 7 years, some lenders would say 3 to 5 years.
Why, would anyone want to know the cost of a loan over 15 or 30 years when they are only going to keep it 3 to 7 years? APR, distorted or not, simply isn't reverent in today's market.
I have a suggestion. To compare any two or more mortgages collect selected information at the bottom of the "Good Faith Estimate" in "TOTAL ESTIMATED FUNDS NEED TO CLOSE" SECTION:
"Principal & Interest" $ ___________
"Mortgage Insurance" $ ___________
Sub Total these two numbers $ ___________
now multiply the sub total by the number of months you're likely to keep the loan say, 36, 48, 60, 72, or 84.
$ ___________
add
"Est. Closing Cost" $___________
Total cost over the likely life of loan $___________
Do the same thing for additional loans and simply compare the total cost.
If the loan is adjustable then determine the worst case scenario, raising the payments to the maximum the program's CAP limits allow over the term you're using. (APR is determined assuming that the index, that portion of the rate that changes, will be the same as it is today when the loan is adjusted, you shouldn't make that assumption.) Pay attention to the CAP's it doesn't matter if the loan can go up 6%, if during the time you keep it, it can only go up two per cent.
If there is secondary financing that varies from loan to loan compute the same information for the second in each case and add it to the first. In cases where the second is the same for each loan, such as a seller carry back it is not necessary to add it to each first to determine the best first.
There has been a lot of talk lately about 2-1 and 3-2-1 buy downs, simply compute the payments and cost to compare loans.
My program is flawed, but not nearly as much as APR! I don't take into account the time value of money (the interest or profit you might have made on the extra money you pay up front.) Nor do I consider the additional amortization (if your interest rate is lower you will have a lower payoff) experienced with a lower interest rate. I also don't consider prepayment penalties. I believe that the time value of money and the additional amortization just about offset each other. I don't believe most consumers have the extra cash available to make such decisions. I don't included prepaids because most expire in three years or less and I've suggest starting your comparisons at three years, if the prepaids are in force they will need to be included.
Once you've selected your loan add it's "Est. Closing Cost" to the highest "Est. Prepaids" you've been quoted for the best idea of how much money you'll need to close.
Most but not all consumers will find that the lowest closing cost is much better for them than the lowest rate, when a reasonable holding time is used to determine cost.
Bill
William J Archambault Jr
The Real Estate Investment Institute
For a printable PDF copy of my comparison work sheet subscribe to my Sporadic Real Estate Investor News Letter. Sporadic is the operative word I don't send out a lot of them. Just write "Subscribe" in the subject line and send it to sreinl@reii.org
