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October 25, 1999
"You keep saying
that home buyers ought to shop for the best mortgage terms, but suppose
your credit rating sucks? Won't I have trouble finding a lender who will
even deal with me, let along find a lot of them who will compete for my
business? The one mortgage broker I spoke to said he might be able
to find me a loan but that it would be a lot of work on his part, and
there was a clear intimation that he wouldn't be bothered if I went to
other brokers. How should I deal with this situation?"
From a
mortgage broker's point of view, the best customers are those who place
themselves wholly in the broker's hands, without shopping other sources.
Hence, what the broker told you was self-serving. It might or might not be
true.
There are three major factors that
determine whether loan applicants with poor credit can profit by shopping.
The first is the size of the loan they are looking for. Brokers make most
of their money by charging points, which are expressed as a percent of the
loan amount. A one-point charge on a $200,000 is $2,000 whereas the same
charge on a $50,000 loan is only $500. Since brokers can make more on
large loans, they are more willing to compete to get the loan, and to
struggle with lenders to gain an approval.
The second factor is just how bad
the applicant's credit is. Many people have expectations about their
credit that are way off base. I had a letter from a consumer recently who
dreaded getting a credit report because three years earlier she was late
one time in paying a gas bill. In contrast to her expectations, her rating
was very high. It works the other way too. Many consumers harbor the
notion that their late payments haven't hurt them because they paid
eventually, which is not the case.
You can get at least a rough idea
of how good or bad your credit is from several internet sites that provide
this as a free feature. A few of them are: www.mortgagequotes.com,
www.mortgageit.com, and www.quickenmortgage.com.
The third thing you need to assess
is your financial status, relative to the amount you plan to spend on a
house. For this purpose,
use my affordability calculator. It will show you, for different sale
prices, the minimum cash, minimum income, and maximum debt to qualify,
disregarding your credit. If your credit is poor, your financial position
must be correspondingly stronger. Having income that is above the minimum
is good, but having more cash is even better. A large down payment is the
most effective way to neutralize bad credit.
If you are looking for a small
loan (say, below $100,000), and if your credit rating is poor and your
financial status marginal, then your best course may be to place yourself
in the broker's hands. This makes you completely vulnerable, so you should
say a little prayer that your broker is one of the good guys rather than
one of the predators.
In all other circumstances, you
should shop. Indeed, it is more important for poor-credit borrowers to
shop than it is for strong-credit borrowers because the gains from
shopping are greater. To illustrate this point, on October 7 of this year,
I shopped for a $200,000 30-year fixed-rate loan at zero points in
California. For this purpose I used www.microsurf.com,
a mortgage referral site that provides quotes for borrowers with credit
ratings ranging from A to D.
The results are striking. The
difference between the rate quoted by the highest and lowest-rate lenders
ranged from 0.625% on loans to A borrowers to 4.75% on loans to D
borrowers! Indeed, a D borrower who shopped could do better than a B
borrower who didn't!
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Borrower
Rating
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Lowest Rate
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Highest
Rate
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Spread
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A
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7.875%
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8.50%
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0.625%
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B
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8.99
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11.62
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1.63
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C
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9.50
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12.00
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2.50
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D
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10.25
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15.00
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4.75
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Borrowers with poor credit are
thus more vulnerable to being duped because the market in which they
operate is less efficient. And a major reason the market is less efficient
is that borrowers with poor credit are more reluctant to shop.
Copyright Jack Guttentag 2002
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