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6 Mar

Why advertised rates are baloney


Posted by: Aneta Zimnicki

A while back, mortgage rates were simpler. They could be summarized in one simple table. Then regulations changed. And they changed again, and again….Now you need to be a detective to figure out what applies to your specific situation. That is why advertised rates are baloney. Because they don’t tell you the whole story.

The biggest regulatory change is the mortgage insurers’ criteria. The key changes in insurer criteria are: purchases only, no refinances (huge impact to consumers and their debt load forcing them into more expensive debt), maximum 25 year amortization, maximum $1M purchase price, must qualify at the benchmark rate (currently 5.34%), no single unit rentals (only duplex to fourplex, a huge impact to investors).

In response to this, the financing industry spun out a beast of mortgage product and rate categories. Here is a rundown of how a typical lender classifies rates.

Insured: Means borrower pays the mortgage insurance. For the most part, it implies a ‘high ratio’ mortgage, where the down payment is less than 20%. In this case, the property has to be owner-occupied or if multiple units (duplex to fourplex), at least one unit must be owner-occupied. Other permitted properties are full rental duplex to fourplex (minimum 20% downpayment) and second homes (owner-occupied). It must meet the insurer criteria (noted above), and refinances are not eligible in this category.

Because the borrower is paying mortgage insurance, it helps mitigate the risk to lender, so they are able to offer the best rates compared to the other categories. In a perverse way, it can look like borrowers with a lower down payment are rewarded with a better rate. But not necessarily, you have to look deeper into the math.

This rate category is most likely the one being advertised, but this is very misleading because it excludes a large portion of consumers.

Insurable: Means the lender ‘bulk insures’ their portfolio, to help mitigate risk, but lender pays the mortgage insurance instead of the borrower. The application must meet the insurer criteria, as note above. Since the lender pays for the insurance, the rate is slightly higher than the ‘insured’ category. Here you may see further rate stratification based on ‘loan to value’ (LTV) range from less than 65%LTV to 80%LTV, or, credit score (but has to meet minimum insurer credit guidelines). Applicants are qualified at the greater of the contract rate plus 2% or the benchmark rate (the dreaded ‘stress test’).

Uninsurable: Means does not meet insurer criteria. In general, this is refinances, purchases over $1M, single unit rentals, amortization over 25 years. The overwhelming majority of lenders qualify at the greater of the contract rate plus 2% or the benchmark rate (again the huge impact of the ‘stress test’ is seen here). Many lenders will use 30 year amortization to qualify. In this category, the lender can choose to be more flexible with qualifying and varied with their product offerings, although some do not stray far from creativity and innovation.

One of the biggest segments in this category is refinance, and typically has its own rate, which is higher than the ‘insured’ or ‘insurable’ group. Beyond that, a rate premium model is applied, for an array of situations. A rate bump is added to the base uninsurable rate, or some lenders choose to add a lender fee to the file instead.

This isn’t necessarily a bad thing, because now a more common sense, case by case type of underwriting is used, and gets you to a yes versus a flat-out decline. Lenders price out the risk accordingly, and you are paying only for the specific added risk you present to the lender. Premiums can be applied for situations like rental property, second home, self employed, amortization above 25 years, debt ratios, credit issues, loan amount, size of rental portfolio, rental income calculations. The rate bump can be small, starting at 0.05%, but it depends on the situation. If the situation is more complex, then the application may fall into B lender territory, which has slightly higher rates (but not unreasonable, considering the risk and flexible underwriting approach).

Beyond that, there are other subset categories and industry terms thrown at you.

Non-B20 compliant: Generally means not subject to the ‘stress test’, so qualifying at contract rate without the +2%. This field is narrowed down to non-federally regulated lenders, essentially credit unions. The rate is higher, but it can be the difference between being able to qualify or not. The rate falls in between B lenders and the 3 categories noted above.

‘No frills’: Lenders use various names for this slightly lower rate product (like ‘low rate’, ‘basic’). It may be a modest rate decrease, but it comes with restrictions like stricter penalty costs, fees or exit limitations. Sometimes this is what you see advertised as a special, and unsuspecting borrowers sign up without fully understanding the restrictions. In my opinion, often not worth putting yourself in such a mortgage prison.

Quick close: Specials from time to time, typically for 30 or 45 day closing. This is for ‘new business’, so not applicable to applications already submitted, approved or waiting for closing. You have to understand that lenders’ costs increase the longer the time horizon due to market uncertainty, in return you get the certainty of an approval and rate hold.

Conventional or low ratio: Potentially redundant term used with categories mentioned above. Usually means more than 20% down payment.

Switch or transfer: Moving your mortgage from one lender to another, without any changes to structure, such as no new funds out, no change in amortization. However, you and the property still have to qualify. Rate depends on the situation, as now what used to be ‘insurable’ may possibly not be. A skilled mortgage broker ninja may be able to get you ‘grandfathered’ into a better rate category.

Equity take out: When you need to take funds out of your mortgage. Because you are restructuring the mortgage, this is considered a refinance.

In summary, rates are clear as mud, right? The plethora of regulatory changes means having a broker in your corner is more important than ever. Spare yourself the trouble and leave the rate and mortgage solution deciphering up to the pro.