When it comes to making the most expensive purchase most people will ever make, too many home buyers miss out on substantial savings.
But as a new report shows, shopping around for a mortgage can save a homeowner several thousand dollars over the life of the loan. It can have more of an effect on a rate than a buyer’s credit score or down payment amount.
Ralph McLaughlin, chief economist at Haus, a start-up company that co-invests with home buyers as an alternative to traditional mortgages, studied more than 8.5 million mortgage originations from 2012 to 2018 using Freddie Mac data. He found more than a 75-basis-point spread — a basis point is 0.01 percentage point — exists across lenders for identical buyers. He also discovered a more than 45-basis-point spread across metropolitan areas for identical buyers.
“The variation in mortgage rates is driven much more immediately by lender and property location than by reasonable borrower improvements in credit score, debt-to-income, and down payment amounts,” McLaughlin wrote in the report.
To understand what this means, take two buyers with identical credit scores, debt-to-income ratios and down payment amounts who are each buying a $500,000 house. Buyer A goes with the lender the real estate agent recommends and is quoted an interest rate of 3.85 percent. Buyer B calls several lenders and obtains a wide range of quotes. After negotiations with the lenders, they obtain an interest rate of 3.1 percent. Because Buyer B spent a bit more time than Buyer A on shopping for a mortgage, they will save more than $75,000 over life of the loan.
McLaughlin said his interest in the topic was personal as much as professional.
“Basically, I really wanted to understand from a very selfish standpoint what are the things that I could do as a potential home buyer to help get the best mortgage rate,” he said.
One of the more unexpected discoveries he made was how a borrower’s location affects the mortgage rate they are quoted. According to the data, borrowers in Dubuque, Iowa; Springfield, Ill.; and Lima, Ohio, get some of the cheapest mortgage rates, while borrowers in Sandusky, Ohio; McAllen-Edinburg-Mission, Texas; and Danville, Va., get some of the most expensive.
“The surprising thing was why rates are higher in some areas than others,” he said. “That’s not a question that I definitely answered here. But … it does look like the local bank competition might matter in some places, and it might matter because in many areas there are people who can’t really shop around with the slew of national lenders.”
Because some borrowers won’t qualify for mortgages from big national lenders, they are stuck with local lenders, which can have a significant effect on the rate they are quoted.
“For some borrowers, it may be tough to shop around and utilize the Internet [to shop the] competition because maybe they’re not skilled at using a scanner, uploading documents,” McLaughlin said. “You and I might take these things for granted. We have the skills to be able to do that. We have reliable Internet. But there is a non-trivial amount of the U.S. population that doesn’t have reliable access, that maybe doesn’t have a scanner or isn’t well adapted from a technological standpoint.”
For those who are looking to buy a home and are fortunate to live in a place where there is local bank competition, the good news is you don’t have to wait months, sometimes years, to improve your credit score or increase your down payment amount to get a lower mortgage rate. All you need to do is shop around.
That’s not to say credit score has no effect on a mortgage rate. McLaughlin found that increasing your credit score from bad (less than 600) to very good (greater than 750) can lower your mortgage rate by 42 basis points and increasing your down payment from 5 percent to 20 percent can lower your mortgage rate by 20 basis points.
“I think what surprised me the most was … just by the fact of where you live and who you decide to bank with can make up to over a 100 basis points difference or over one percentage point difference in your mortgage rate,” McLaughlin said. “That’s a non-trivial amount, especially over the life of a mortgage.”
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