Reuters Money

What mortgage brokers don’t tell you: Hidden penalties abound

There’s a host of information a mortgage broker or banker won’t tell you up front that may increase the cost of your financing.

You could pay much more on a mortgage than your initial quote rate based on a rating system used by government mortgage insurers Fannie Mae and Freddie Mac. Brokers and bankers rarely tell you this coming in the door. They want to lock you in to a loan as soon as possible. With rates rising, this is really important to know.

In the wake of the biggest real estate meltdown in American history, the devil’s in the details when you apply for a loan. This hidden rating system will penalize you with a higher rate if your credit score is low or you apply for certain types of loans. It’s being employed by Fannie Mae and Freddie Mac, the government’s captive mortgage entities, which account for about 80 percent of new loans now.

As of January 1, mortgage brokers and bankers have to tell you that you may not get the best rate if your credit report is flawed, although they may not give you essential details up front on what else could bump up your finance rate.

You need to ask about how you will fare in the Fannie/Freddie “risk-based pricing” regime, which is basically a computer-run scoring matrix run by your banker. Here are some factors that could raise your cost of credit:

• Credit scores (based on the FICO system) below 740.
• High loan-to-value ratios (the percentage of the property’s value that’s mortgaged). The more equity you have or the more money you put down, the lower your rate.
• Adjustable-rate, Interest-only or 40-year loans.
• Cash-out refinancings.
• Investment properties.
• Condominiums and cooperatives.
• Manufactured homes.
• Multiple-unit properties.

The risk-based pricing program evaluates the type of loan, your credit score and loan-to-value ratio and determine what “add-ons” will boost your quoted rate, if any.

Cheaper financial advice: Will you get what you pay for?

If brokers had to put their clients’ interest ahead of their own, those clients would pay more for financial advice and their investments, an industry group reported recently. A couple with $200,000 in retirement assets would pay roughly $460 more a year in additional fees.

The study was commissioned by the Securities Industry and Financial Markets Association (SIFMA), the group representing  megabrokers and banks, as part of its effort to influence a forthcoming rulemaking from the Securities and Exchange Commission. The SEC is supposed to report to Congress before the end of January 2011 about whether it should require brokers to be fiduciaries – professionals who are legally required to put their clients interests ahead of their own. Currently, fee-only financial advisors are typically fiduciaries, but brokers are required to meet lesser standards: They simply have to recommend suitable investments, and can put their own interests above their clients, say by recommending more expensive investment choices that pay commissions, as long as they are suitable.

Investor advocates criticized the study. ”It’s so incoherent as to defy objective evaluation,” Barbara Roper of the Consumer Federation of America wrote to the SEC. Knut Rostad, chairman of a financial advisors advocacy group, the Committee for the Fiduciary Standard, called the report “a fantastic mythology.” But IRA Hammerman, SIFMA’s general counsel, defended the study, which was performed by Oliver Wyman, a consulting company. “Retail investors deserve strong protections from a new uniform fiduciary standard without sacrificing choice of products and services or facing higher costs,” he said.

The premise of SIFMA’s study and position is that middle-income investors can get more affordable advice if they pay for it indirectly, through mutual fund sales fees and other commissions, for example. SIFMA also said that some investments, such as corporate and municipal bonds, are primarily traded through commission-charging brokers.  It would be hard for savers and investors to buy those products if the SEC came down hard on commissions.

But most observers aren’t expecting that. They believe the SECwill walk a fine line that doesn’t eliminate commissions. The Labor Department recently moved to apply the fiduciary standard to more pension plan advisors, including brokers. Commissions wouldn’t be prohibited, but would have to be collected only if they fit a client-first perspective and were fully disclosed. The SEC is likely to follow the Labor Department’s lead, suggests issue-watcher Ed Lynch, a fee-only retirement plan advisor with Dietz and Lynch Capital.

But a fiduciary standard that leaned on disclosures of potential conflicts isn’t really a fiduciary standard at all, says Rostad.  “If disclosures become the answer to addressing conflicts of interest, the fiduciary standard hasn’t been weakened, it’s been removed,” he said. Roper believes a disclosure-driven rule would offer existing brokerage clients greater protections, but “even if you improve the standard, you’re better off going to someone who is paid exclusively by you to be an advisor.”