For over three years the news has been filled with discussions of foreclosures, mortgage fraud, derivatives, the failure of Freddie Mac and Fannie Mae, mortgage backed securities, tranches, and robo-signing yet Tuesday the results of a survey conducted by Zillow Mortgage Marketplace reveal that nearly half of the home buyers it surveyed were unable to answer basic questions about mortgages or the mortgage process.

Zillow and Ipsos a global survey-based market research company asked 1,005 randomly selected U.S. adults to gauge the level of their knowledge about mortgages and to answer questions about the costs, eligibility, and processes involved in obtaining financing. A subgroup of 168 respondents within the group was identified as prospective homeowners.  Respondents were given a series of eight true or false questions about mortgages, for example:

"Only first-time homebuyers are eligible for FHA loans."

"Your annual percentage rate (APR) is a yearly rate that reflects the true cost of your mortgage and includes your interest rate, points, mortgage insurance, and other fees." 

More than half (57 percent) of prospective home buyers who were polled did not understand how adjustable rate mortgages (ARMs) work. When asked if interest rates on 5/1 ARMs always reset higher after five years, the majority of home buyers incorrectly answered yes.   

More than one-third (37 percent) of prospective home buyers believed that pre-qualifying for a loan means they have secured financing when it is merely the first step in the process where the lender estimates the size of a loan for which a buyer can qualify. Nearly half believed that they should always buy mortgage discount points rather than recognizing it as a decision based on factors such as how long the buyer plans to stay in the house.

More than two in five (42 percent) of the polled prospective home buyers do not understand that Federal Housing Administration (FHA) loans are available to ALL buyers. Instead, they believe only first-time buyers qualify. Additionally, one-third (34 percent) of the prospective home buyers believe lenders are required by law to charge the same fee for credit reports and appraisals rather than their being a negotiable item from lender to lender.

"Most people wouldn't jump out of a plane if they didn't know how to use a parachute, yet each year many buyers commit to the largest loan they will take out in their lifetimes without understanding essential information about mortgages," said Zillow Mortgage Marketplace Director, Erin Lantz. "By simply spending a few hours researching how a mortgage works, and by shopping around for the most competitive rates and fees, buyers can save a lot of money."

Interestingly, the survey responses provided by Zillow include only those from the subgroup of 168 prospective homebuyers.  For this small sample the margin of error is +/-7.6 while for the group as a whole the margin is +/-3.1 percentage points 19 times out of 20. It would have been instructive to know how the answers of the prospective buyers measured up against the answers from the non-buyers in the survey.  That they considered themselves buyers should indicate a level of involvement in the process that might make them more knowledgeable than non-buyers.  If that is indeed the case then the other answers must have been truly appalling. In any case, lenders should keep in mind that many borrowers lack basic financial literacy and accept the responsibility of educating them before closing the loan.

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