Mortgage Blog

Will That Help Consumers?

Markets for financial services often don't work well for consumers. The trial and error
technique that consumers rely on in navigating many markets, such as food and
clothing markets, does not work well when transactions are large and
infrequent. Financial firms who expect to see a customer only once may have
little incentive to provide good service. Because of the complexity of many
financial products, consumers often have less information about the products
than those who sell it. The new consumer complaint facility created by the
Consumer Financial Protection Bureau (CFPB) can be viewed as an attempt to
offset these factors so that financial markets will work better for consumers.

The "Submit a Complaint" Facility

The new facility is deployed on CFPB's web site, where consumers can lodge a complaint
against any financial service provider from whom they have obtained a loan,
lease or other financial service. The consumer registers the complaint with
CFPB, who forwards it to the service provider, who responds to CFPB, who
delivers the response to the consumer who accepts or disputes it.

CFPB records each complaint with the name of the firm involved, the product, the
consumer's state and zip code, the date the complaint was received, the date it
was sent to the firm, the firm's response and whether it was timely, and
whether the consumer disputed the firm's response. While similar complaint
programs exist at the state level, the CFPB program is unique in its use of the
internet as its principal communication device, and in developing a data base
of complaints that is available to the public. The data base includes a
filtering system that allows users to sort data into the specific categories
they want to examine.

The data base grows by the day and the growth will accelerate as consumers become
increasingly aware of the facility. On August 24 when I accessed it, there were
279,498 complaints about the following products or services: mortgages 116,
335, credit cards 38,536, debt collection 36,231, bank accounts or service
34,905, credit reporting 34,625, student loans 8,509, consumer loans 7,896, and
payday loans 2,339. (Yes, I know the components don't quite add to the total,
but write your complaint to CFPB).

"Can I get a mortgage with a credit score of 450?"

If you get one, it won't be a mortgage you want.

Credit scores are calculated using a variety of models that have small differences
between them and generate similar but not identical scores. The range of scores
in most models is 300 to 850, with a score below 620 considered sub-prime, and
a score of 450 marking the subject as a deadbeat who no honest lender will
touch. If you have equity in your home, however, there are some predators who
will lend to you in the expectation that when you default, they will find ways
to shift the equity to themselves. Don't bother asking me who they are.

"What should my target credit score be if I want the lowest possible interest rate on a
mortgage?"

It depends on where you start, and on how much time you have to raise your score.

If you begin with a 620 and have 18 months, shoot for a 660 which will drop the
rate by about .375% (say 4.625% to 4.25%). If you begin with 680 and have 18
months, shoot for 720 which will drop the rate by about .125%. Some lenders
will drop the rate by another .125% at 780, but you can't get there from 680 in
18 months.

Note that credit scores are calculated from mathematical models, of which there are
many designed for different types of users. Mortgage lenders won't ordinarily
use the same model as auto loan lenders, and some mortgage lenders use
different models than others. Different models will generate different scores,
and while the differences are small, your target score should include a margin
of error of at least 5 points. This would make the targets discussed above 665
and 725.

Consumers looking to purchase a home within the near future face many decisions,
including how large a down payment to make. The down payment is the sale price
(confirmed by an appraisal) less the loan amount. In most cases, home purchasers
must have financial assets at least as large as the down payment they make.

Down Payment as an Investment:  Many consumers put down as little as possible
despite having the capacity to put down more because they view the down payment
as lost money. But that is a mistake. The down payment is an investment that
yields a return that is far above anything else available to consumers, and the
return is 100% risk-free. Here is an example:

Yes, mortgage lenders in the US will pay rebates to borrowers. This is a potentially
valuable option which, to my knowledge, is not offered anywhere else in the
world. But having options means having to make choices, and this is a difficult
one that borrowers often get wrong.

Rebates Defined:

A rebate is a credit granted to a borrower by a lender that can be used to pay
third party settlement charges and/or to fund the borrower's escrow account.
Rebates are the opposite of points, which are payments made by the borrower to
the lender, and are sometimes referred to as "negative points." Borrowers pay
for rebates by accepting a higher interest rate.

Combinations of Interest Rate and Points/Rebates:

The price sheets lenders distribute to their loan officers, showing multiple combinations if interest rate and
points/rebates, may or may not be shown to borrowers. However, borrowers have
access to such data on various web sites. As an example, if on July 11, 2014 you had called me to price a fixed-rate
mortgage, you would have seen many combinations of interest rate and points. If
the loan was for $300,000 on a single-family home valued at $400,000 and the
borrower's credit was excellent, the lowest rate of 3.5% was available with
points of $13,134, at 4%, the points were $344, and above 4% the lender offered
rebates: $10,499 at 4.5%, $17,731 at 5%, and $26,032 at 5.5%.

For most seniors, waiting until age 70 before collecting social security, as opposed to taking a smaller amount earlier, is an excellent investment. A typical senior who could draw $1350 a month at age 62, would see the draw increase to $2376 at age 70. Yet more than 2 of every 3 workers eligible for social security take it early. The major reasons are time preference, risk of non-payment, and income shortage. The last may be the most important, and for homeowners at least, it is the easiest to remedy.

Time Preference

Most people prefer money now to money in the future, even when all uncertainty connected with receiving money in the futurehas been eliminated. This time preference seems to be built into the human psyche. In addition, receiving money now eliminates the risk that the payments promised in the future will not actually be paid. Interest rates reflect both time preference and risk of non-payment.

One way to view the decision about taking social security early or late is to ask whether the implied interest rate received by the senior who waits is worth the risk? That rate is about 7-8%, meaning that the payment to the senior who waits rises by 7-8% a year. I view that as more than adequate compensation for the risk, which is very unlike the risk of not being paid on a note or a bond.