The state's real estate regulatory agency, the Department of Real Estate (DRE), is cracking down on mortgage brokers who claim to offer "no-cost" and "no fee" loans.
According to DRE spokesman Pablo Wong, "advertising claims by brokers of 'no cost' or 'no fee' loans are patently misleading and are in violation of the State of California Business and Professional Code Section." That's because borrowers are actually paying a higher interest rate on the so called "no cost" loan in exchange for not having to pay fees or closing costs up front when the loan is secured.
No matter what lenders claim, "there is no free lunch," Wong said.
Since last year, when these types of ads first began to appear, the Sacramento-based regulatory agency fired off warnings to more than 100 mortgage brokers around the state who were making "no-cost" claims in their advertising.
"We usually receive compliance when we contact these lenders," said Thomas L. Pool, deputy commissioner of the DRE. But "it is still a big problem," he said. This is in part because there are only three staff members at the DRE who are monitoring advertising practices. There are an estimated 5,000 to 10,000 licensed mortgage brokers in the state. The DRE doesn't know the exact number because real estate agents also broker loans and the license is the same.
With rising interest rates and a variety of new home loan packages, competition has heated up among lenders and mortgage brokers. They are scrambling to make loans at a time when the number of homeowners refinancing their old loans has plummeted.
In response to this competition, lenders devised the "premium loan" package. With these home loans, mortgage brokers are given a rebate from the bank or savings and loan that actually makes the loans. The rebate goes to pay the closing costs such as title insurance, escrow fees, appraisal and credit reports and the fee charged by the broker. But the loans come with a higher interest rate than the standard mortgage.
Premium loans are what prompted some brokers to advertise "no-cost" loans. But DRE officials say the loans come with a cost that may actually be more than a standard loan when the fees and closing costs are paid up front.
For example, a purported "no cost" $200,000, 30-year fixed-rate loan with closing costs of $2,500 and a $2,750 commission to the mortgage broker would cause the monthly payments to go up $83.73 a month because of the higher interest rate. Using this example to make his case, Pool said this loan "represents an extra $30,142 in loan payments paid over the life of the loan--how could you call that 'no cost' ".
To understand the true costs of such loans, Santa Ana accountant Steven R. Olmsted says that a more detailed analysis is necessary, which includes tax considerations and how long the borrower intends to keep the loan.
He analyzed several loan packages and concluded that people who hold their loans for less than five years would be better off financially with the purported "no cost" loan than the traditional mortgage where fees are paid up front.
"You don't reap the benefits of that reduced interest rate with a traditional loan until the sixth year," said Olmsted. "And keep in mind that most California homeowners keep their loans less than that," he said.
This is why some mortgage brokers have criticized the DRE for interpreting the "no-cost" claims too narrowly. They argue that if the borrower pays nothing up front then indeed it is a "no cost" loan.
Moreover, they worry that the DRE's regulatory actions may discourage people from taking advantage of this type of loan. For many borrowers, a loan that requires no out-of-pocket cash is very popular.
Some in the industry have no objection to what the DRE is doing. "It's important that borrowers know exactly what they are getting," said Ann Carlton Bose, president of the Los Angeles County chapter of the California Assn. of Mortgage Brokers. "There are real costs (with the no-cost loan) so why try to fool the consumer into thinking that there aren't."
Said the DRE's Pool: "Of course, there will be circumstances where choosing the premium-priced loan product will be advantageous to the borrower, but the point is to make sure to not mischaracterize the loan in advertising."
He also said that some brokers fail to disclose exactly how the loan works. By law, the brokers are obligated to disclose that they have received a rebate because of the higher interest rate.