| How Lenders advertising on
TV could Deceive You
Why Do I Have to Pay for This?
Americans love things that are
free, or appear to be. Yet my experience in over 40 years in business is that companies
never give things away. There's always a cost somewhere, sometime. The latest of these
"free" gimmicks involves the mortgage industry. One lender's TV ad's say,
"We don't think you should have to pay to borrow money."
The fact is that there are
dozens of people who are involved in the processing, underwriting, and funding of each
loan, plus appraisers and title and escrow officers. None of them works for free. Now this
company is a public company so its financial statements are available. They show that the
company had revenue of $135,000,000 last year. Where did that some from if the customers
are getting free loans? So how is it that they are able to make this offer?
Here's how. When that lender
funds a loan, say for $200,000, they are able sell that loan to another lender or agency
like FannieMae for $203,000. In effect, FannieMae is paying the $3,000 closing costs so
you don't have to.
Now you might ask why FannieMae
would do that. The answer is that the free loan has a rate that is higher than the market
rate. In a typical case, if the market rate is 6 percent, a $200,000 loan that has a rate
of 6.375 percent is worth $203,000 because the borrower will pay more interest every
month. Let's run through the numbers.
On a market rate loan of
$200,000 the interest over ten years is $111,263. But the total interest paid on the
6.375% loan is $118,746. So FannieMae paid $3,000 more for that loan but got back $7,483
in extra interest. That's a huge return, a Return on Investment (ROI) of over 20 percent
per year! If someone were to keep the loan for 30 years, the added interest is $17,510,
all on a $3,000 investment.
Clients seldom ask how lenders
are able to do this, but when they do they are told that the interest is
"slightly" higher. .375 percent doesn't sound like much and in fact the
difference in monthly payment is only $49, but as we have seen that "slightly"
higher rate turns into $7,483. Does $7,483 sound like "slightly" more to you?
You can see that you'd be better off getting a cash advance on a credit card and paying
the closing costs yourself.
That part of the business is so
lucrative that the entire industry is doing everything they can to do loans just like
that. They only make 6 percent on the $200,000 but make over 20 percent on the $3,000.
Heck, I would like to have a business like that. I'll put up the $3,000 and the borrowers
will pay me $50 per month for thirty years! What a deal!
I'll leave it up to you to
decide whether this is deceptive advertising or not. But my point is that the hook on
deals like this is that the customer doesn't have to pay up front. For millions of
American consumers, this seems to them to be a better deal. And it seems that almost none
of them ever ask what the long-term costs are going to be. And so it costs them more in
the long run and the lenders are rubbing their hands in glee.
I'd like to comment a little
more on this company's financials. They also show that the company paid out $47,617,000 in
Sales and Marketing expense. I'm not sure what expenses are included in this
classification, but it doesn't seem to me that the borrowers benefit from that $47
million. All it did was attract them to the company. They do benefit from the $66 million
that is classified as Operations, which I take to mean the processing and funding of
loans. But that's only 50 percent of their revenue.
By comparison, small mortgage
brokers like my company spend very little on advertising and promotion because it is way
too expensive for us. Instead, we spend 100 percent on our clients.
Be careful out there.
©2005 Savvy Borrower,
Randy Johnson |
