Let's assume the previously-mentioned person needs $100,000 to purchase a home. An unscrupulous mortgage broker, looking to make as much money as possible on the borrower will find out how much the taxes and insurance will be on the property. Let's assume they are $230, which will be added to the person's monthly mortgage payment. Let's also assume that the market bears an interest rate of 6% for a 30-year fixed rate mortgage (more on terms later). Now, the mortgage broker says to the borrower who can only afford $1,000 monthly, "What if I get you into your house for less than $900, including taxes and insurance? Can we do the loan today?"
This person, dying for his chance at the American Dream, is going to jump at this, thinking the mortgage broker is his new best friend and ignoring the interest rate on the loan, altogether. What the broker, trying to steal every possible cent from this one deal, has done is sold the borrower a $100,000 loan at an interest rate of 7%, which creates a principal and interest payment of $665.30 monthly. Combine this with $230 in tax and insurance escrows for a monthly mortgage payment of $895.30, almost $105 less than what the borrower said he could afford - a pretty nice savings, the borrower will think.
Think about it; if you said you could afford no more than $1,000 per month, and the person, in whom you placed your trust, told you your payment would be $895, you'd probably be pretty excited, huh? What has really happened, though, is the mortgage broker has done the borrower, his valued customer, a great disservice.
Why, you may wonder. Because the market for this model bears an interest rate of 6%, and we're assuming the borrower has good credit (more on credit later). The loan officer could have offered the far better 6% rate, which would create a payment of $829. This is $66 less than the borrower's payment at 7%. Also, the 7% rate will cost the borrower an extra $792 each year ($66 times 12 months). That is nearly $4,000 over five years! All this, just so the mortgage broker could pocket a few hundred dollars more on this one deal.
So, what is the big secret? Simply put: bankers and mortgage brokers do not always offer the best possible interest rate, because they make money, when you get a higher interest rate than the market bears!
Remember, how I mentioned that other salesmen make money on commissions, so they want you to pay more than you really have to pay? It works the same way for mortgage brokers. They are paid what is called a Yield Spread Premium, which is a commission they receive, based on the difference in the interest rate they sell you, versus the lender's best rate on that particular day.
What's really disgusting about this, though, is that while a mortgage broker might make only a few hundred dollars for selling you this "bad" rate, you'll lose thousands of dollars because you took it! As I continue with this model below, look at how the Yield Spread Premium affects this deal. Pay careful attention how Yield Spread works, because this knowledge alone will save you tens of thousands of dollars.
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