The hidden costs behind your home loan — and how to minimize them (Forbes)
Aug 31, 2018
With U.S. interest rates inching upward but still near historic lows, many homebuyers believe they’re getting the deal of a lifetime on their mortgages. As the co-founder of a digital mortgage platform, I’ve noticed that most people aren’t aware of the behind-the-scenes inefficiencies that have actually made the cost of lending higher than ever. It’s gotten so bad that, according to the Mortgage Bankers Association (MBA), independent mortgage lenders posted a net loss on home loan originations in quarter one of 2018.
Should consumers really care, so long as the offers for “no-cost” refinance and “low-cost” purchase loans keep coming in? Yes — because the cost of lending gets passed to consumers, whether they know it or not.
What ‘No Cost’ Really Means
When lenders offer a “no-cost” loan, what they usually mean is a loan that eliminates some or all of the upfront closing costs normally due at signing. That can be a mighty attractive proposition for cash-strapped borrowers, given that, in my experience, typical closing costs average between 1% and 3% of the home purchase price. (For a $275,000 home, which is just below YCharts’ reported current U.S. median price, that would be anywhere from $2,750 to $8,250.)
Lender fees, which help recoup the time and expense incurred by the lender to verify your creditworthiness and prepare your loan package, can be a big part of the closing costs. The rest is made up of third-party costs over which your lender has little control, like fees for an appraisal that confirms the value of the home, a title search to make sure the property is free and clear and the transfer of the property deed into your name.
While a no-cost loan saves you money up front, you’ll pay those costs later, and then some, in the form of a higher interest rate. For example, a lender might offer a 4% interest rate for qualified borrowers who pay their closing costs up front, but a 4.33% rate for the same loan with “no upfront costs.” Even a seemingly small interest rate hike that adds less than $100 a month to your mortgage payment can add tens of thousands of dollars over the life of the loan. That’s money you could use to buy a car, fund your child’s education or invest in your retirement.
Generally speaking, you’ll save money over the long term if you can afford to pay closing costs up front. But whether you pay now or later, home loans are more expensive than they’ve ever been.
Just before the housing bubble burst in quarter four of 2008, mortgage lenders spent an average of $4,810 to manufacture a single loan, according to one MBA report. Per MBA data, over the last 10 years, that cost has skyrocketed to nearly $9,000 per loan. This number represents real costs, like overhead and salaries for mortgage personnel, so lenders can’t just “write it off.” But neither can they expect consumers to show up to the closing table with twice as much as they used to pay for lender fees. Instead, all that extra cost gets rolled into your mortgage interest rate.
A lender that offers mortgage rates starting at 3.875% didn’t come up with that number out of thin air; rather, it calculated that 3.875% is as low as it can go and still remain profitable. If lenders can reduce their costs, they can offer more competitive rates to consumers and still turn a profit.
The Root Problem
So, what’s behind the huge cost increases that are trickling down from the lender to the consumer? Simply put, I believe that the mortgage industry has been comparatively slow to innovate.
Smart devices that use data and artificial intelligence to make complex tasks easy have become part of our everyday lives. Instead of pulling the car over to check a map or change a CD, we can now navigate to our destination, sort through our music collection and take a hands-free call with a few simple voice commands.
Unfortunately, the mortgage industry generally operates more like your local DMV than the latest smart car. Many lenders still rely on antiquated, expensive, paper-based systems that weren’t built for the complex mortgage regulations and consumer protections introduced in the wake of the housing bubble collapse. Their manual processes are often time-consuming and prone to errors. In many cases, data is not shared or used effectively between the consumer and the systems used by the mortgage professional, underwriter, title company, real estate agent and other key participants in the mortgage.
Make no mistake: mortgages are extremely complicated. Every borrower is different, and so is every property. Lenders should strive to achieve a marriage of sophisticated technology and industry know-how to automate the mortgage back office, as I believe that is what will ultimately give consumers the more transparent experience they deserve at lower rates that reflect reduced lender costs.
Consumer Demand Is Key
I predict that until lenders adopt digital mortgage technology, consumers will keep eating the cost of mortgage inefficiency. It’s important that consumers be aware of the cost issue and recognize that they have options when it comes to choosing a lender and a loan.
Frustration, sky-high closing costs (whether paid upfront or through higher interest rates) and long closing times do not have to define the home loan experience. When looking for a lender, choose one that has invested in its ability to deliver a modern, cost-effective mortgage — so you don’t find yourself spending decades paying off hidden fees with money you could put into a college tuition savings account or 401(k).