Looking for a loan
There's a mortgage for every kind of buyer--but today's choices can overwhelm
At online mortgage lender HomeLoanCenter.com, there's been a big shift recently. In the first half of last year, more than 80 percent of borrowers chose the tried-and-true fixed-rate mortgage. But in the first six months of this year, that figure slid to just half, as homeowners increasingly turned to new kinds of loans, such as ones that combine fixed and adjustable rates and even one that lets borrowers select their payment terms every month. "It's mind-boggling how many choices there are," says Anthony Hsieh, HomeLoan's chief executive. "It's changing very, very rapidly."
These days, it's almost as if there are as many mortgage options as homes to buy. Today's borrowers have unmatched opportunity to select a loan best suited to their individual needs, much like getting a suit custom tailored (chart, Page 58). But that variety also means it's harder than ever for borrowers to sort things out. "The increase in loan products is a benefit," says Douglas Duncan, chief economist at the Mortgage Bankers Association. But "when you get bewildered, that represents a risk to you, and you may not take that risk."
What's changing the landscape is a confluence of technology, regulatory changes, and financial engineering. Advances in computing power have made it possible to analyze massive amounts of consumer data, allowing a better understanding of the behavior and risk presented by different types of borrowers. In turn, that allows products to be tailored accordingly. Meanwhile, behind the scenes and invisible to borrowers, greater sophistication has emerged in a financial marketplace where trillions of dollars' worth of mortgages are traded among lenders and investors. This marketplace allows lenders to replenish their vaults, enabling more--and more varied--loans.
For most borrowers, size of the monthly payment still remains the driving factor in their loan choice. As interest rates have ticked up in recent months, borrowing costs have increased, spurring more people to embrace nontraditional loans as a way to keep the lid on payments. In general, these loans offer lower rates--and hence lower payments--because borrowers agree to shoulder some of the risk of rising interest rates. Their growing popularity can be seen in the sliding share of the market held by the mainstay fixed-rate loans. Once accounting for the great bulk of all loans, they're now down to about two thirds.
To sort through the maze, here is some advice:
Narrow the universe. To cull today's offerings to a manageable number, it still pays to ask traditional questions: How long do you expect to be in the property? What payment can you afford? How much risk of higher payments in the future are you comfortable assuming, especially at a time when today's low interest rates are likely to rise?
Realize there' s no free lunch. Attractive features invariably come at a cost, which may not be apparent. For instance, on any loan, a lower rate can typically be had, but at the expense of higher upfront fees. Likewise, a new flavor of fixed-rate loan, which offers a 40-year term, means lower monthly payments compared with the 30-year standby--but much higher total costs over time.
Craft a household budget. It may be a pain, but track your income and expenses. You'll probably learn where to harmlessly cut spending to save money. But most important, you'll put yourself on an equal footing with lenders--because household spending will guide their decision about your application.
If you're confused, take heart, because today's choices are befuddling even to sophisticated borrowers. Duncan tells of being approached by the head of a large firm with several thousand employees, for help with deciphering today's crop of adjustable-rate mortgages. Duncan's advice: Dig into details of the financial yardstick on which future rate adjustments will be based. "[That's] asking a lot of consumers, to sit down and do that," he says. "But it has a benefit."
This story appears in the December 6, 2004 print edition of U.S. News & World Report.
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