Wednesday, November 23, 2005

Local Banks vs. Mortgage Companies: Which is better?

A topic of debate in the last few years has been the perceived benefits or disadvantages between using a local bank to finance your home purchase and using a mortgage company.

Some people are convinced that their local bank can provide better customer service, interest rates, or closing costs. In some cases, this may be true. Banks provide incentives to borrowers who have large balances on their depository accounts or otherwise provide a large source of income for the bank. If you have numerous accounts with high balances, your local bank may provide incentives to reduce your closing costs, interest rate, or both. These programs vary widely from bank to bank, so it is best to check into the matter with your local bank and determine what incentives they provide.

Mortgage companies generally have the advantage of being able to offer wholesale interest rates. When you finance your home purchase through a mortgage company, you will not actually be making your housing payments to that company. Instead, the mortgage company provides your loan applications to numerous large banks. At that point, the loan officer at the mortgage company determines which bank will provide you with the best offer and places your mortgage at that bank.

Financing your purchase in this way has a few advantages. First of all, these large banks offer a sort of “Wal-Mart” mentality on their interest rates. Because they have such a huge volume of mortgages, they are able to offer lower interest rates while still meeting their profit goals. Additionally, mortgage companies often receive further incentives from these banks if they send a certain volume of loans to the bank each month, which translates into more savings for the borrower.

The way a mortgage company makes their money is not from interest, but from a fee the bank pays them on each loan that they send to the bank or from fees the mortgage company may charge you up-front to do your mortgage. The fee that comes from the bank is governed by the interest rate you are charged. For example, today I could do your mortgage through Interfirst Bank. On a 30-year fixed mortgage, they might pay me 1% of the value of your loan if I give you a 6% interest rate. This is because my company sends so many loans to them that they give us a bonus on the amount of money they will pay us for placing your mortgage with them.

As I examine what other banks in my area are offering right now, this is about .375% lower than what you could obtain locally. Rate reductions of only .25% can save you a lot of money in interest over the long run. For example, if you borrow $150,000 on a 30-year fixed loan at 6.5% interest, you can expect to pay $948.10 per month in principle and interest on your loan. If you are able to reduce that rate to 6.125%, your payment goes down to $911.42. That means that over the course of the year, you will save approximately $435 on your mortgage payment. This may not seem like much cash, but that extra $36 per month can be used for gas, savings, or anything else you might prefer. Over the course of five years, the difference becomes more visible. You pay about $2,150 less in mortgage payments if you have financed at the lower rate.

Additionally, if you look at it from the standpoint of total interest that you are paying, the overall amount of interest that you pay is substantially reduced by even a small reduction in your interest rate. For example, on the loan I previously mentioned, at 6.5%, you can expect to pay a total of $47,302 in interest in the first five years that you pay on the loan. If you are able to obtain a better offer of 6.125%, that amount comes down to $44,480. Some people say “well, that is only about $3,000 over the first 5 years”, but as you pay on the mortgage, the difference gets larger as time goes by. Generally, if you are purchasing a home that you intend to retire in and occupy long-term, you will want to be as picky about the interest rate as possible.

On the other hand, if you work with a mortgage company on your loan, you will not have the luxury of being able to walk into a building, speak with your favorite bank teller, and pay your mortgage, as you might do with a local bank. If you have a customer service issue or question, you will have to dial an 800 number or get on the internet. Most of the banks that mortgage companies work with provide fast customer service and you can use the internet to access information about your loan and pay your bill monthly online, so the process is really not more difficult, it is just a less personal experience.

Generally, I advise borrowers to shop with two local banks and two reputable mortgage companies. Your real-estate agent should be able to advise you on good companies and banks in your area. This will actually expose your mortgage application to several dozen banks, which gives you a much better chance of obtaining the best possible value on your mortgage.

Tomorrow, we will talk about some of the differences in available loan programs offered by mortgage companies and local banks and the differences in credit and income restrictions between the two types of institutions.

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