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Picking Right Combination of Mortgage Rates, Fees

Multiple mortgage prices complicate shopping for the best deal

April 6, 2017

By JACK GUTTENTAG The Mortgage Professor (Tribune News Service)

How can a product have more than one price? If the transaction is not consummated entirely at one time but extends into the future, there can be a price to be paid now and a price that will be paid later.

This is the case with mortgages. The price paid now is lender fees including "points," while the price paid later is the interest rate.

This set up is what makes mortgages more difficult to shop for than, say, a one-price purchase like a new sofa.

Here is an example of how dual prices complicate shopping.

The two quotes below apply to a 30-year fixed-rate mortgage. Which of them is the better deal for the borrower?

In quote A, the interest rate is 4 percent and the lender fee is $4,000.

In quote B, the interest rate is 4.25 percent and the lender fee is $2,000.

The correct answer is that it depends on the borrower:
  • If the borrower is income-constrained, meaning that she is grappling with a high ratio of monthly housing expenses to income, she will prefer quote A because it provides a lower monthly mortgage payment.

  • If the borrower is cash-constrained, meaning that she is grappling with a shortfall of cash needed for down payment and other closing expenses, she will prefer quote B because it has a smaller cash requirement.

  • If the borrower is neither income-constrained nor cash-constrained, she should prefer the quote that will result in the lower cost during the period that is her best guess of how long she will have the loan. Borrowers with short time horizons should prefer B, while those with long horizons should opt for A.

This is a challenging decision.

Few borrowers have more than a vague idea of how long they will have a mortgage, calculating the cost accurately is beyond the capacity of most, and lenders don't help.

When we turn to reverse mortgages, the challenge is even greater because of the greater diversity in borrower objectives. In the forward market, borrowers use mortgages to buy houses and want to minimize the cost. That is it. In the reverse market, borrowers use mortgages to meet a variety of needs, each of which may involve a different objective or objectives.

For example, the borrower looking to supplement her income might select the reverse mortgage that provides the largest tenure payment -- the monthly payment that lasts until she dies or moves out of the house permanently. The borrower looking to acquire a reserve for contingencies might shop for the largest initial credit line, or perhaps the line after some period of non-use during which the line grows. In both cases, the borrower interested in minimizing the loss of equity by their estate might shop for the reverse mortgage that generates the lowest loan balance after some period.

Perhaps the best head-to-head comparison of a forward and a reverse mortgage is the case where both are used to purchase a house. Where the forward purchaser seeks to minimize loan costs, the reverse purchaser might have any of the following objectives:
  • Obtain the largest possible amount of cash at closing with a fixed-rate reverse mortgage.

  • Obtain the largest possible amount of cash at closing and after 12 months with an adjustable-rate reverse mortgage.

  • Incur the smallest loan balance after N years with a fixed-rate reverse mortgage.

  • Incur the smallest loan balance after N years with an adjustable-rate reverse mortgage.

A senior dealing with a single reverse mortgage lender might be offered different combinations of interest rate and origination fee from which they can select, but they probably will not be offered any performance measures related to their objectives. Further, selecting from among the offerings of one lender is not shopping.

The difficulties in shopping effectively for reverse mortgages provide a very strong case for multi-lender networks. Because they cover multiple lenders, such networks can offer shoppers more options from which to choose, and the performance measures that shoppers need to guide their selection.
About the Writer
Jack Guttentag is professor emeritus of finance at the Wharton School of the University of Pennsylvania.

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Copyright (c) 2017, The Mortgage Professor

Distributed by Tribune News Service.

This story was distributed by TNS - Tribune News Service
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