This was a comment on Real Estate Sellers Giving A Buyer Cash Back. The interesting thing is proposing hourly pay instead of commission for agents.


That makes a lot of sense. Disclosing (net) cash back to the lender changes the purchase price, which also changes the buyer's basis in the property - sorting out the tax situation nicely as well. And when a buyer is bringing a down payment to the table, they should be able to vary it as necessary to keep the LTV where they want it.

Speaking of choosing buyer's agents, though, I wonder what your opinion is of paying one by the hour (instead of via commission)? In the future day when I might be in a position to buy, there's a local buyer agency (who actually maintains a reasonably informative blog about the local market) that has the option to work that way and I'd welcome a third-party perspective on the pros and cons.

My view of them is -

Pro:
1. For buyers is willing to do their own research and self-direct their search, they can get the specific parts of the buyer's agent package they want a-la-carte, without having to buy the whole package.

2. Since the agent's compensation isn't driven by the price of the property selected (or the commission a seller is offering) there's significantly greater incentive alignment between a buyer and their agent.

Con:
1. If the buyer/agent relationship doesn't work out for whatever reason, a buyer still ends up spending cash for the hours used.

He's got some good points. Here are some more that I see:

First off, when do you fork over the money? Up front? Is the up-front money refundable? How easily? This could quite easily be a tool for locking up exclusive business. They do a rotten job, but you've already got $5000 on deposit with them, so you figure you might as well get what good you can out of what you've got spent. Commissions are contingent upon an actual finished transaction. In other words, I've got to get the job done in order to get paid a commission. I don't have to get it done to get paid an hourly rate.

Second, it occurs to me that this may be something aimed at getting more money: The hourly pay on top of the commission. It never ceases to amaze me the number of people who don't realize that buyer's agents get paid out of the listing agents commission. This is called a cooperating buyer's broker (CBB) fee, and it is paid to the broker, who then sends a part of it to the agent. What happens to the buyer's agent part of the commission? Is it used as an offset, is it refunded point-blank (running squarely into the issue of fraud if there's a loan), or what? The most reasonable way would be as an offset against outstanding hourly, and the remainder rebated for closing costs only. However, 2.5 to 3% of the purchase price can be an awful lot for a buyer to pay in closing costs, even with seeding an impound account in California. The buyer is likely to end up basically using the money to buy the rate down further than is really beneficial, simply because there's no other benefit they can legally get out of that money. So I tell you not to waste your money buying the rate down too far, then I give you the choice of that or forfeiting the rest of it to no good purpose. Does anyone else see the contradiction here?

Third, what is the basis for billable hours? Is it time actually spent with the client, or is it time spent working on the client's file? If the client isn't present, how does the client verify the figures?

The time I actually spend with clients is a fairly small proportion of all the work I spend on them. Maybe 20 percent, at the very most. Consider the parable of the iceberg: What you get is a lot more than what you see at first glance. Last week, I spent six hours looking for one set of clients, and another couple hours on-line winnowing before that. It took us less than two hours to view the properties I decided were worth showing them. Do I charge based upon my time spent, or based upon actual face time?

Now ask yourself, does the basis for billable hours constitute a hindrance to effective job performance? I have thought about it, and "face time" billing would cause most agents - and their supervising brokers - to be a lot less generous with their "file time". But "File time" is what makes a good agent. If I bill based upon "file time", I've got to be able to show what I did with that time, and I'm going to be running head on into clients who won't believe I spend the time I've spent, or at least say they don't, no matter how good the documentation. But does billing by "file time" give agents incentive to pad their time sheets? It seems likely to me that it would. Does billing by "face time" give agents an incentive to go as slowly as possible? Seems likely to me that it would, when the clients incentives are directly opposite. Not all agents would abuse either one of these, but enough would.

Here's another issue: Agents don't get all of what they "make". Brokerages have expenses, and they're entitled to make a profit on what they provide. Agents individually have expenses, some of which are fixed, and some of which are variable. If we work on an hourly basis, how much do we add for overhead? Are the clients going to be receptive to it? Even if I bill by "file time" there's a lot of stuff I couldn't bill for, but is nonetheless essential to the proficient practice of real estate. As any accountant or business school graduate will tell you, you have to recover the costs somehow in order to stay in business, and the way they generally do it is by building an overhead allowance into billing. I occasionally do consulting work at $150 per hour. Even with the more efficient, longer relationship of finding a client a property, I'd need to bill at least $70 per hour to end up with a middle class living at the end of the month. I strongly suspect most folks wouldn't be inclined to pay those kind of wages without evidence of value provided in advance. This would discourage clients from signing up with newer agents or brokerages who might very well do a better job than someone long established who has gotten lazy. Without a proven track record (as in "known to them"), how are you going to persuade the average schmoe who has only been told that, "Real Estate agents don't even need any college!" to fork over $70 per hour before they've seen the work? Commissioned salespersons have to get the job done before they get paid. Not so hourly workers. I realize business people do it all the time, as I've been on both ends of that, but most folks aren't business people, and even the ones who are tend to take a different approach to their personal affairs. Finally, can I really justify billing my consulting work $150/hour while only billing actual buyer clients at half that rate? I'm not going to reduce the consulting rate. If my time is worth $150 per hour (as my consulting clients have told me it is), it's worth $150 per hour. You willing to pay $150 per hour for my expertise, sight unseen? Other people have and will again, but that enlisted military man that walked into our office this afternoon might have some difficulty. I suspect most people would rather let me keep the buyer's agent commission. What if we're billing by "face time"? I'd have to charge a much higher number of dollars per hour to pay for my preparation time. Fact.

Let's ask if most people are likely to be adult enough to pay for something everyone else is offering "free", or at least where they don't have to write a check for money they have painstakingly saved? If the abomination that is Internet Explorer doesn't persuade you on that score, I've got my experience with Upfront Mortgage Brokers to fall back upon, and I can tell you that the answer is most emphatically no, at least in the aggregate. Every time I've had somebody ask about doing a loan on the UMB mandated basis of known fixed compensation, they've ended up canceling the loan. The UMB actually lets me offer cheaper loans than my normal "fixed loan type - known rate - guaranteed costs" because the client bears the risk of late loans, somehow mis-adding adjustments, etcetera. With UMB, I agree to get the loan done for a fixed amount of total compensation - but the clients know what that number is, and it isn't what most people think of as "cheap". With my normal guarantee, I assume the pricing risks, but I have to include the costs of those risks in my retail pricing. Upshot: The loans are slightly more expensive, but people like them much better. In fact, they can't sign up for them fast enough. The only possible reason I can find for this difference is that they don't have an explicit figure for how much I and my company are making (gross - the net is much lower).

Choosing or not choosing a loan based upon the fact that it seems the loan company is making a lot of money is a great way to shoot yourself in the wallet, but you'd probably be amazed at how many people do it. People tell themselves that the loan company is "making way too much money" off their loan and end up choosing the lender who offers something at a higher rate that costs thousands of dollars more - but doesn't have to disclose how much they make. I've not only seen it in action - it's been proven by government research. here is the research paper from the FTC. (Thanks to Russell Martin of http://www.smartmortgageadvice.com)

All of the preceding are not reasons to refuse to offer hourly compensation. They are simply reasons why I wouldn't expect a lot of it. The final consideration is this: Most agents are independent contractors, not hourly employees. Would hourly compensation create a situation where the Labor Board would rule that this hourly pay pushes agents over the line into an employer-employee relationship with their brokers? Given how most brokerages require their agents to do other things that are on the list of bullet points of statutory employees (regular required meetings, etcetera), it seems likely to me that it would be enough extra that FLRB might well rule that the agents involved are now statutory employees. This would change everything about the broker-agent relationship from its long-established norm (Brokerages would have to pay overtime, Social Security taxes, minimum wage. Holidays. Minimum time off. Etcetera. They might even have to deal with agent's unions). I don't say that agents couldn't work on an employee basis, but all of these added costs to the brokerage would certainly tend to make the wall of getting started higher for new agents, and harder to negotiate, thereby artificially restricting the number of agents. This would have the effect of limiting competition. I don't think that's a good idea for consumers, although the big chains would certainly love it, as it would make it harder for independents to compete.

If you think paying by the hour is a way to get superior real estate services cheaper, I have some land in Florida. Who's going to charge low hourly rates? Unprepared, less qualified agents. It might work out to be a little less, and people who have the intestinal fortitude to move quickly without being goosed on the biggest transaction of their lives might save a little bit in that the agent or brokerage's total compensation is a little less than it otherwise would have been, but where is the level of the value they provided in order to earn that money likely to be? I submit to you that I have reason to believe it would be considerably lower in the aggregate. More than enough lower to place their patrons in the unenviable position of buying the real estate equivalent of the Yugo.

In short, I see a whole lot of drawbacks, many of which are fairly well buried, while only a few advantages, which may be obvious but are outweighed for the vast majority of the population by the drawbacks. I might be willing to do it for the right client who asks, but I'm certainly not going to advertise it.

Caveat Emptor

Original article here

An email:

Greetings, I've recently been pitched the idea of refinancing my home and investing in apartments, or more precise, a four-plex. The idea is to refinance and get a negative amortization loan on my house. With the money I pull out of my home, put a down payment on a four-plex, also with a negative amortization loan. That way, I am told, my payments would stay relatively the same on my home and I can have a positive cash flow from the four-plex. Along with the pitch I am told that I can refinance after five years and get another plan, or sell outright, the apartments. Their belief is that in five years, the apartments and my home would have gone up enough to offset the interest that I will not be paying in a negative loan.

I've read, on this site and elsewhere, that negative loans are not the way to go for most people. I'd like some more input as to what to do in my situation.

Here are the specifics in my case:
Home --- owe - 200k
worth - 600k
would get around 200-215 from refi
Apartments --- worth about 900k
downpayment would be 20%, or 180k
keep the money left over from refi in savings for emergencies

loans for both properties is a five year fixed rate of 7%
paying only 4.25% of it, with the rest being added to debt

Is it too good to be true?


Now I know how Hercules must have felt fighting the Hydra. Cut off one head, two more grow back.

This situation can be called many things, but "Too Good To Be True" is not among them. It not only isn't true, it isn't good.

Let's go over what's going on in the situation as proposed.

You would have a loan on your home for about $420,000, including closing costs. This is just over the (basic) conforming limit of $417,000, but negative amortization loans are not A paper and pay no attention to the conforming loan limit. A real principal and interest payment on that loan is $2794.28, of which you are paying $2066.15. Over the course of three years, your loan balance would increase to about $435,327.16, at which point that $15,200 and climbing pre-payment penalty is no longer hanging over your head. After 5 years, you owe $447,480. Total of payments to that point: $123,969.00.

On the apartment building, you would have a $720,000 loan at 7%. The real payment on that is $4790.19, of which you would be paying $3541.98. After three years, you would owe $746,275, at which point that pre-payment penalty of $26,100 (to start, and climbing) is no longer over your head. After your planned five years, you owe $767,109. Total of payments is $212,518.80.

Now, I'm going to compare and contrast with two other loans I really do have as I'm typing this, but will be out of date by the time anyone reads it. I should mention that I have difficulty believing that the investment property, especially, would not be at a higher rate than you have been quoted. I don't believe that these are zero points loans, but I'll even assume that they are, in order to have a fair compare and contrast. I know for a fact that this isn't even the best I can do, but I'm just picking the first rate sheet that comes to hand. This is with all costs included: loans I could lock at the time I originally wrote this. A 30 year fixed on $417,000 (maximum conforming) at 6.25%, and I could even give you about $750 to help cover your closing costs, but let's say net total cost to you is $3000, and therefore your net is $214,000 when all is said and done. The payment on this is $2567.54. There is no prepayment penalty on this loan. After 5 years, you owe $389,216.30 and your payments will total at $154,052.44.

The loan on the apartment building would be bumped all the way to 7.375% because it's non-conforming, and so that the yield spread covers the adjustments for investment property and 4 units. Every lender has these charges, and these are on the mild side. So you see why I do not believe the real rate on the investment property loan would end up being 7% without they charge you some pretty stiff figure in points. I'm not sure your real rate can be bought as low as 7% on such an Option ARM. This lender does both A and Alt A, and their adjustments on the Option Arm are a half point more expensive, which means even the highest rate on their sheet only buys your net retail points to one, but let's run with our assumptions as stated. Payment is $4972.87, after 5 years you will owe $680,400 and your total of payments will be $298,371.66.

Let's look at the end of those five years.



HOME
Balance
Total paid
Net
Neg Am
447,480
123,969
571,439
30 fixed
389,216
154,052
543,268
difference
-58,264
+30,083
-28,171


So you see that every dollar you saved on cash flow cost you two dollars in real terms. Lenders love this kind of math! Nor am I certain that this is really a fair comparison between the loans, but it's what I have to work with.

Now, lets do the apartments. As I said, I am as certain as I can possibly be that this is not a true and fair comparison between loans. I'm restricting myself to "no points" loans, and if that lender told you there were going to be no points on an option arm at 7% on a 4 unit investment property, I'd call him a liar to his face.



Apartments
balance
payments
total
Neg Am
767,109
212,518
979,627
30 fixed
680,400
298,372
978,772
difference
-86,709
+85,854
-855

So you see that, even giving this person every possible benefit of the doubt, you come out better on the thirty year fixed, even though I don't believe their loan really exists at the rates they stated.

Now I'm have not, thus far, allowed for the possibility that you wouldn't qualify for both loans, (with all the lovely potential for gain on the apartments) with both sets of fully amortized payments. There is a pretty serious monthly income zone ($3800 wide) where you would qualify for negative amortization but not fully amortized, at least "full documentation." It is to be noted, however, that these loans can be done independently of one another, dropping the monthly income range gap where you qualify for at least one full documentation to just over $800. I am intentionally ignoring the possibility of "stated income" loans because stated income is a very dangerous game to play in these circumstances (or anything similar). Also keep in mind, however, that property values don't have to go up in five years. It's a pretty reasonable bet, especially right now, but I don't think we're going to see more than 5% annualized for a while.

(At this update, rates are lower but stated income is completely unavailable, at least for now)

People sell Negative Amortization loans based upon apparent cash flow, not based upon how wonderful they are to your bottom line. When you consider them on anything other than a short term cash flow basis, their virtues become non-existent. They are popular because they are easy to sell to most people. Most folks think of cost in terms of the check they are writing every month, and that's just not all there is to it. There are also deferred costs - costs that have the potential to step out and grab you with a bill, in this case for another $85,000 that most people won't realize they owe. This is 2003 thinking in a 2011 world: "The equity increase will more than pay the difference." Except that it isn't necessarily so. Apartments have to cash flow, yes, but they have to cash flow in real terms, not something manipulated to make it look like you're making money. They don't appreciate except based upon their rental income net, and unless you get a clueless newbie for a buyer, that's what your offer is going to be (Any resemblance between this and the bigger fool theory is purely intentional).

It's much easier to persuade people to give the bank tens of thousands of dollars in equity that they might have someday, than it is to persuade them to write a larger check or endure negative cash flow in the first place. Persuading them to write the larger checks remains the correct thing to do in 99% plus of all cases. You can't fault loan officers and real estate agents as sales folk for making the easy sale - but you can fault them to the extent they represent themselves as analysts, consultants, or advisers, and I just don't see a whole lot of people in either of my professions representing themselves as straightforward sales persons. When I originally wrote this, I had a property one of my clients was in escrow on with about eighty business cards on the kitchen counter - and mine was one of about three cards on that counter with anything like a sales representation ("Loan Officer and Agent"). Some say things like "Real Estate Consultant", while others say things like "Relocation Specialist" or "Financial Vice President". It's all very deliberate to convince people to drop their defenses, because "I'm not a salesperson," but if you are going to represent yourself that way, you have a responsibility to comport yourself in accordance with that representation - and all the evidence I'm seeing says that this is not the case. I would like to see some civil cases make their way through the courts which fault agents and loan officers on the basis of their self-representation as something other than sales folk.

Actually, let me take that back. If they're acting as your real estate agent, they do have a fiduciary duty to you no matter what they're representing themselves as. Loan Officers do not in most of the country - which is one of the reason the loan side is so messed up - but Real Estate Agents do, and if they're also doing the loan, they have a responsibility to advise you that this appears to be beyond your means, and exactly what risks you may be taking with this purchase - something I'm seeing more evidence in contradiction of than in support of.

Negative amortization loans can serve a valid purpose as refinances in certain limited circumstances. They can help people avoid worse consequences than necessary, when the numbers are right for it. But as purchase money loans, they are like playing Russian Roulette with your financial future. Sure, the market might take off like it did a few years ago - but it also might sit stagnant for the next several years, or even decline a little. Even if it goes up, it may not go up enough to pay the extra money you now owe. Of all the scenarios listed, the market taking off at 10% plus gains per year is the least likely, in my opinion, at least for the forseeable future.

Caveat Emptor

Original article here

The only Pre-Approval I trust is one that I wrote myself.

I got this search engine hit:

pre-approved loan underwriter changes terms illegal

I have gone over these issues in discussing the pre-qualification.

Loan officers are salespersons. There is intense pressure on them from supervisors, brokers, stockholders and their own pocketbook to tell you what you want to hear. A large proportion of the people who ask me for a either pre-qualification or pre-approval already have a property in mind, and they get angry if I tell them it appears to be beyond their means. They should be kissing my shoes because I'm trying to keep them from making a half-million dollar mistake, or at least make certain they go into it with their eyes open, rather than just keeping my mouth shut and pocketing my commission. Most of these folks just go get their "Think Happy Thoughts" letter elsewhere.

Furthermore, if the loan officer is counting upon referrals from real estate agents for a living, if they tell people what they can really afford, they're getting the agent angry to no good purpose. This agent thinks they have a commission check all lined up, and the loan officer is trying to talk the buyer out of it, threatening that commission check. Most Real Estate Agents do not respond well to this, I'm sad to report. In that situation, I would be thinking, "Boy, I'm glad I found out now, before the default, when investigators and lawyers and courts get involved," but most agents (and their brokers) see only the immediate check that just evaporated. One such experience is all it takes before they not only stop referring to that loan officer, but try getting any clients they may have in common away from that loan officer. This may be short-sighted, but it is also human nature.

Not to mention the fact that nothing about a pre-approval or pre-qualification is binding. In fact, until the underwriter writes a loan commitment, there is nothing that says you have a loan at all. Furthermore, it's rare for loans to be rejected outright. What happens far more often is the underwriter puts one or more unmeetable conditions on it.

Furthermore, there is nothing about any loan that says the terms cannot change unless there's a rate lock in effect. If the loan isn't locked, it's not real. Quite often, loan officers will tell people their loan is locked when it's not. Locking paperwork can be easily faked.

Finally, while the new 2010 Good Faith Estimate makes lowballing on the costs more difficult in that it adds more hoops for the unscrupulous to jump through, it does not prevent the practice or stop it. Keep in mind that last word "estimate". Furthermore, they are not promising that you will get the loan. That requires a loan commitment written by an underwriter, and if further investigation by the underwriter reveals more questions they want answered in order to fund your loan, the underwriter can always add more conditions. None of the paperwork you get at loan sign up promises you will end up with a loan at all. You want to know why, consider that when the lender starts to verify the applicants information, they come across information indicating it's all fraudulent. This happens. It has happened to me, and it happens to loan officers somewhere in the United States every day.

Even with the best will in the world, I can't guarantee you've got a loan until I get the loan commitment from the underwriter. I can go through all the guidelines for a given program, and make certain the borrower meets every single one of them. It doesn't mean anything until the underwriter writes that loan commitment. I don't have the power to approve that loan - no loan officer does. Loan commitments are the exclusive province of the underwriter. A good loan officer can and does go through guidelines to ascertain whether there's an known reason that you will be turned down. If the underwriter rejects the loan, none of it means anything.

This is one of the reasons that I have written several articles explaining how to calculate what you qualify for, in terms of payment and in terms of purchase price, so that you will not be at the mercy of somebody who tells you, "Sure you can afford it," while qualifying you for a "stated income" negative amortization loan. The most mathematically correct and detailed of those articles is Should I buy a Home Part I, while the most accessible is How to Tell If You Can Afford This Property.

If you don't have a lock, the loan is not real, and it will fluctuate with the market - every day for A paper. Until mid-2009, I used to lock every single loan upon application, but the lenders have now made that practice financially prohibitive - a loan officer who does it can expect to pay "fall out fees" that drive their cost of business up until what they can offer consumers is no longer competitive with anyone. What I can still do is guarantee all fees except the tradeoff between rate and cost, and consult with a client upon the optimum time to lock those in, which now has to wait until after the loan commitment. Even that is not absolute, however. The loan officer cannot really promise you that loan until the underwriter writes a loan commitment with conditions you can meet. Even that can change if the underwriter discovers new information, but always remember that the loan officer is not the underwriter, and there are regulations preventing direct contact between consumers and underwriters. If the underwriter rejects the loan (or doesn't approve it), you still don't have that loan. You can choose another one, that you are likely to qualify for, or you can do without. I'll tell people that if the loan officer gets back to them within a week with a change, it's likely that they're honest and they really thought you qualified for the loan they told you about in the first place. If it takes them three weeks or longer, or if they spring it on you at closing, I wouldn't believe they were honest with sworn testimonials from George Washington, Abraham Lincoln, and Diogenes that they saw the whole thing, and it's not the loan officer's fault. It's not for nothing I tell people, "When There Is A Problem, It's Good If They Tell You Right Away"

Only when you have a lock agreement, loan costs guarantee, and a loan commitment from the underwriter do you have a deal going that somebody might be able to stand behind, in the sense of being able to hold them responsible if they don't deliver on exactly those terms, and even then there are limitations. Of course, what really used to happen with most loans (and still does with a large number) is that loan officers tell you about loans they have no prayer of being able to deliver in order to get you to sign up. This is despicable, but it's the way things are. There are reasons why the situation is complex, but that's no excuse for loan providers to play any additional games to obscure or confuse something that is already complicated enough. Part of the reason that I'm writing here is that I would like to change this for the better, but the power to demand real change is in the hands of consumers, not any individual provider.

Caveat Emptor

Original article here

Once upon a time, I received an email about the virtues of zero interest credit cards as opposed to Home Equity Lines of Credit. I've organized both the email and my response in order to facilitate understanding:

You raise a lot of issues. Some I'm going to deal with very quickly, others I'm going to spend some effort on, but nothing as in depth as a full article would have. I'm going to keep referring to material found in Credit Reports: What They Are and How They Work

I'm going to take the email in chunks:


Turns out I made the Two-Loan choice myself, independent of your article, a couple years ago. I was motivated to get a conforming first loan (~$322K @ 5.75%), and put the other ~$45K of a prior mortgage into a HELOC (besides, the HELOC rate was lower than the 30-yr fixed at the time!).

Well, times (and HELOC rates) have changed, and I now have
~$65K on my HELOC, and relatively tight budget.

That was 2003. considering that I had 30 year fixed rate loans at 5.375 percent or lower without any points for months and 5.25 for literally zero total cost for about one month, you likely paid more than you needed to. There was a period in late August when rates spiked up, but I was calling the same clients back in December and into 2004, asking if they wanted to cut their rate for free. No prepayment penalty, no points. Those would have lowered the rate further.

HELOCs (Home Equity Lines Of Credit) have the disadvantage that they are month to month variable, based upon a rate that is controlled by the bank. On the downside, you're somewhat at their mercy. On the upside, the rate is based upon that lender's Prime Rate plus a margin fixed in your loan papers. They can't change your rate without changing everyone else's also. There is absolutely no legal reason I'm aware of why they can't set prime at twenty-four percent. There are plenty of economic reasons why they won't. Unfortunately, given the high demand low supply of money currently, the banks are competing for new business with a better margin, not a lower prime. They didn't cut rates every time Greenspan's Fed did, but they have religiously boosted prime every time the overnight rate has gone up since the Fed started raising it. Banks are making a killing in real historical terms right now with variable rate lending.

Fortunately, in most cases it's pretty easy to refinance a HELOC. Credit Unions are a great place for this; variable rate consumer credit is where they shine. There are some internet based lenders where you can obtain no cost, easy documentation HELOCs at rates right around prime, or even a bit below if you have the credit. Most HELOCs also have "interest only" options for five or ten years. Brokers really don't do a whole lot for HELOCs except keep lenders honest; there is not enough money in them to make them worth chasing and the lenders won't pay for them the same as for first trust deeds; it's too easy to refinance out of them. (Brokers can beat the stuffing out of credit unions on first trust deeds, however).

Unfortunately, your credit score is a problem now:


I have multiple credit card companies offering me low introductory rates (some 0%, some 2%) for short terms (up-to 1 year).

Why would I NOT want to take them up on their offer?

In truth, I've already done this a number of times in the past 12-18 months, always at 0%. So I've learned the "minimum payment" trade-off (and I wish congress hadn't forced CC companies to raise their minimum payment requirements!) [ last year, one fine bank only made me pay $10/month on their loan of ~$10K! Now I'm seeing minimum payments of 1-3 %]

The difference between cash flow and real cost, and the fact that each time you accept a new credit card thus, it is a MAJOR hit on your credit. Let's say you have two credit cards now that you have had for over five years, and get four new ones. Your FICO score modeling goes from over five years to about a year and a half on your length of credit history (the average of your accounts, except that five years is the maximum you get credit for an account). Open four more six months down the line, and now you have ten, with an average time open of just over a year. Furthermore, since most people move as much as they can into the new credit accounts, this gives major credit hits for being essentially maxed out on a card. Thirty to forty points on your FICO score per card, perhaps more. You say you've been doing this a while. Not to mince any words, I wouldn't want to have your FICO right now.

There are always two concerns when you're looking for the best deal. Minimize your costs, of which interest is far and away the largest, and be able to make your payments. I don't know if you have other payments here, but if so I would do everything I could to live cheaply enough, long enough to use the money I save to make a difference on both of those scores. In your position, I'd sell any cars I still have a payment on, just to get out of the payment. This is a concern I've been telling people about since 2003, when the rates on everything were so cheap. There is more than one way to do things, but you have to be prepared for the consequences of the way you chose. I had some clients up in Los Angeles about July of 2003. They wanted to cut their payments. I gave them the option of a conforming loan (like yours) with a HELOC, and they took it. As soon as the loans funded, the wife called me and said I deceived them about the loan, and they wanted me to pay for another loan. Unfortunately for their contention, I had a piece of paper in the file with their signatures saying exactly what I tell everyone else about this situation, that the rate on the HELOC is month to month variable and subject to change, and that they understood this was a risk and they elected to take it. It looks like you went in with your eyes open, but the risk didn't work out as you hoped. I'm trying to think of other strategies to help you out, but other than "live frugally for a while", it's all little stuff around the edges.


Tonight I'm "running the numbers" on whether a 2% rate (nondeductible) is better than an 8% (tax deductible). And according to my simple calculations (I'm an engineer, not a financial advisor!), it's a no-brainer (go for it!). For the $40K currently on the HELOC (other $25K is already temporarily in 0% accounts), the one-time transfer fee ($50-90/transfer) and lower interest amount (~$70/mo) is ~$200/month less than the deductible interest-only (minimum, ~$435, @ 8%) HELOC payment, AFTER adjusting for the tax deductibility (@ 30% [fed + state], ~$130 on $435).

My plan is that in months when my "income"/cash flow cannot cover all the minimum payments, I'll just use a HELOC check to cover the difference. That is, slowly transfer SOME of the debt back to the HELOC. But in the meantime, my theory goes, I'm paying down my principle faster than if I was just making "extra payments" on the HELOC.


Yes, in most cases you will make more progress, faster, this way, but at such a long-term cost as to make it prohibitive, particularly if you have to leave the credit lines open after you transfer the money out six months down the line. Lots of very silly folks do all kinds of weird and non-remunerative things because it's a deduction, but deductions are never dollar for dollar. If that were the only concern, 2% nondeductible beats 8% deductible by a huge factor. Given what's going on in the background, however, kind of a different story. All these newly opened lines of credit are going to drag you down for years. Make certain to pay it off before the adjustment hits; one month at 24% will kill almost all of your savings. Two months at 18% will more than kill it. Given what your score has likely dropped to, I'd bet that it's closer to the former than the latter.

I also finally had a 0% application turned down, due to "too much credit already, for your income level". So I imagine having all these cards may be hurting my credit score? But I'm not going to re-fi my house (or buy a new car?) anytime soon, so I think I don't care.

I imagine you're going to care. FICO scores require care and tending and time to rise back up. Close off any cards you opened for the zero interest period that you have paid off, and that will mitigate the damage. Keep only a few long standing accounts. But a large amount of damage is already done. When Credit Card companies are saying that, your FICO has dropped big time. Without running your credit, from the foregoing information, I'd guess you are below the territory where I can get a 100% loan, these days, even sub-prime (lower 500s). You might be below 500, where only hard money can lend to you.

(At this update, there are no 100% loans except VA. Given current underwriting standards, someone with a sub-580 credit score basically can't get a loan without 30% equity/down payment)

Another concern is that HELOCs have "draw periods", usually 5 years, and (at the time he was) about three years into yours. I'd be very certain to move it all back into the HELOC prior to the expiration of the draw period. Your credit card options are already getting worse, meaning that you're not getting the cards or not getting approved for enough to be useful. The HELOC's rate, by comparison, is set by a margin in an unalterable contract, and you're not going to be able to qualify for a new HELOC that's anywhere near as good while those card accounts are open. Move the money back in at least a couple months before the draw period expires and close the credit cards, and you might be able to get a new HELOC on decent terms.

Your credit is always vitally important. Guarding a very high credit score is something worth stressing about. You never know when you might need to apply for credit. Most credit cards, nowadays, can alter your rate if your score drops or if you make one late payment anywhere, not just on that card. A good credit score saves you money everywhere, from borrowing to insurance. In your situation, I'd be stocking up on pasta and Hamburger Helper while seeing what I could do to increase my income, so I could live cheap enough to pay my bills down enough that I'm not squeezed. It's your life, but that's the way I see it.

Caveat Emptor

Original here

(For full disclosure, the original email is below in a body).

Hi Dan,

While using Google to seek the wisdom of others regarding my current financial situation, I came upon an article of yours, and have now read at least a handful of others. In particular, "One Loan Versus Two Loans" caught my attention.

Turns out I made the Two-Loan choice myself, independent of your article, a couple years ago. I was motivated to get a conforming first loan (~$322K @ 5.75%), and put the other ~$45K of a prior mortgage into a HELOC (besides, the HELOC rate was lower than the 30-yr fixed at the time!).

Well, times (and HELOC rates) have changed, and I now have
~$65K on my HELOC, and relatively tight budget.

I have multiple credit card companies offering me low introductory rates (some 0%, some 2%) for short terms (up-to 1 year).

Why would I NOT want to take them up on their offer?

In truth, I've already done this a number of times in the past 12-18 months, always at 0%. So I've learned the "minimum payment" tradeoff (and I wish congress hadn't forced CC companies to raise their minimum payment requirements!) [ last year, one fine bank only made me pay $10/month on their loan of ~$10K! Now I'm seeing minimum payments of 1-3 %]

Tonight I'm "running the numbers" on whether a 2% rate (non-deductible) is better than an 8% (tax deductible). And according to my simple calculations (I'm an engineer, not a financial advisor!), it's a no-brainer (go for it!). For the $40K currently on the HELOC (other $25K is already temporarily in 0% accounts), the one-time transfer fee ($50-90/transfer) and lower interest amount (~$70/mo) is ~$200/month less than the deductible interest-only (minimum, ~$435, @ 8%) HELOC payment, AFTER adjusting for the tax deductibility (@ 30% [fed + state], ~$130 on $435).

My plan is that in months when my "income"/cash flow cannot cover all the minimum payments, I'll just use a HELOC check to cover the difference. That is, slowly transfer SOME of the debt back to the HELOC. But in the meantime, my theory goes, I'm paying down my principle faster than if I was just making "extra payments" on the HELOC.

Seems so obvious when I look at the numbers, that I cannot figure out why more people aren't doing it, or at least talking about it!

Why does a thorough website like yours not say anything about this (that I could find anyway)? Is it just to keep those low-rate credit offers coming? Am I missing something? I am really the only person to ever think of doing this? I also finally had a 0% application turned down, due to "too much credit already, for your income level". So I imagine having all these cards may be hurting my credit score? But I'm not going to re-fi my house (or buy a new car?) anytime soon, so I think I don't care.

Thanks for reading this far. If you post an article on this topic rather than replying, will I get a least a pointer to it in reply?

Again, thanks for considering a comment on my situation!

Identity withheld by request

(UPDATE NOTE: After several years of it being unavailable, I've recently started getting lender solicitations for stated income loans again. I haven't done any of these new loans yet, but as much as I don't like stated income there is a legitimate market segment that it served: The self employed and those with large amounts of business deductions, who actually could afford these loans because they got to pay for things with "before tax" dollars while it is only "after tax" dollars that are considered by traditional underwriting standards. Given the growth in the self employment segment of the economy, somebody is going to decide they want the income from serving it and figure out appropriate controls to prevent its abuse. That does not alter the basic thrust of the article, however, which is that you will save money by providing full documentation if you can)

No matter which provider, no matter what type of loan you get, nobody is going to loan you money without the appropriate documentation. The more documentation you have that you are a good risk, the better the rate you are going to get, and the lower your costs are going to be.

Everybody hates filling out forms and providing documentation. When I originally wrote this, there was a billboard two blocks from my house advertising, "Stress free loans." Actually, these signs are all over. And I'll bet they bring in a lot of business. Low documentation loans are easy money - I could do them all day and all night, and make more money, and make the lender more money, while doing less work, than I can by hunkering down and actually serving my clients best interests. Those billboards say "stress free loans" which three words look like an English sentence meaning this will be easy, but the real translation to English reads, "Hello, I am a lowlife scum who wants to take advantage of lazy people who are too ignorant to know better by making a lot of money providing loans at higher interest rates and less favorable terms than they could obtain elsewhere, and putting a large proportion of my clients into loans that they cannot afford, from which point they will inevitably default and lose the property and whatever investment they may have made"

The fact is, that for something dealing with this much money, if there is documentation you can produce to prove that you are a better risk and gets you a better rate, you should be eager to present it. If I can spend half an hour instead of fifteen minutes filling out forms and as a reward I save $40 or more every month until the next time I decide to refinance, I want to fill out the extra papers. If I refinance every two years, I have essentially been paid $960 for a quarter hour of work. That works out to $3840 per hour. I don't know about you, the reader, but even when I'm completely inundated with clients, I don't make that kind of money per hour. I don't know any job that pays that much, unless you want to include wealthy investor. And let me tell you, the wealthy investors I've dealt with are eager to spend the extra time filling out said forms. It really is a "Rich Dad, Poor Dad" situation. They know it will Save Them Money, and don't have to be sweet talked into filling out one more form or providing a little more documentation. They've got it already copied for me, and if I want their business, I'd better buckle down and get to work on finding the loan with the best terms possible. If you, the reader, wish to be wealthy, you could do worse than emulate their example.

There are, when you get right down do it, three different levels of documentation. The lowest level of documentation is NINA, which is short for "No Income, No Assets." There are other names for it ("No Ratio" being the most common, while "ninja" was the creation of a reporter with samurai fever). This is a loan where the rate you get is purely driven by your credit score (as well as other factors, such as the equity in your home or down payment you're making, but those are constants endemic to the situation, not variables about which I am talking). You're not even documenting that you have a source of income. You're basically saying, "Here I am! Gotta love me!" to the bank, and they really do love you because you're filling their coffers by paying the highest rates for your loan. Guess what? You're still filling out all the forms (or somebody is doing so on your behalf, which they can do to the same extent on other loan types!), and you're still providing all the documentation on the property - how much it's worth, proving you own it, proving the taxes are current, etcetera. Owing to identity theft and homeland security laws, you can expect to have to provide two things that basically show that you are you. You can expect to deal with problems if the county doesn't show the taxes as current, your landlord or current mortgage holder shows you as being behind or that you have a history of being behind or the county doesn't show you officially in title of record, or any of a host of other potential problems, but hey, at least you didn't have to show that you've got a source of income!

The next level of documentation is a "Stated Income" loan. This is where you document that you've got a source of income, but not that said income is sufficient to justify the loan, so you tell the bank you make that much, and they agree not to verify the actual numbers. This is going to require two additional items: verification of employment, or a testimonial letter if you are self-employed, and reserves. Reserves are quickest to explain. Industry standard is money sufficient to pay the loan, your taxes, and your homeowner's insurance for six months, in a form that is sufficiently liquid such that the money can be accessed, for a long enough period that the bank will believe it isn't borrowed - and the bank will require documentation of its availability if it's in an account type such as 401k where access may be restricted. Verification of your employment is somebody in the HR department filling out a form on your behalf and verifying it over the phone. The testimonial letter for self-employed borrowers comes from your lawyer, accountant, or tax preparer on their letterhead saying that you really do have a legitimate business. It basically reads: "To whom it may concern. John Smith is self-employed as the owner of business X. He has been doing this for Y years. Based upon information provided to me, he will earn the same amount of money this year as last year." The person providing the testimonial must sign the letter. It really is only about three sentences, but that person is putting their business on the line for you if it's not true. So they tend to require evidence if you're coming to them for the first time to get this letter written and signed.

The bank is basically looking for two years in the same line of work or at the same company to approve this one. Subprime lenders - when we had those - would sometimes accept a year or even six months, although their terms will not be as favorable. What the bank is looking for is evidence that you can really afford the loan. The thinking goes like this: "He's got a source of income, He's got a good credit score, he's making all his payments, he's got money in the bank, okay, we think he's living with his means and can afford to pay us back. We'll lend him the money." There are variants on stated income of which "stated income, stated assets" is the most common, but these carry higher rates, higher charges, or both, in many cases actually end up looking more like a heavily propagandized NINA loan than anything else.

It is a misapprehension to believe that Stated Income Loans have no debt to income ratio or income requirement. They are precisely that: You are allowed to state your income, which the lender agrees not to verify, in exchange for paying a higher interest rate. It's still got to be believable within the context of your profession and locale, and if believable amounts of income do not justify the loan, then you can expect to have it rejected. This income must also be sufficient to convince the lender that you can make the payments upon all of your known debts according to lender guidelines, mostly having to do with the aforesaid debt to income ratio. For these reasons, while you can always move a "stated income" loan to "full documentation," going the other way is forbidden.

I've heard Stated Income (and NINA) commonly referred to as "liars loans", and they are often used for such, but that is not their intended use. As a matter of fact, people get in a lot of trouble with these loans, and many times it comes back on an unscrupulous loan officer or real estate agent trying to push something through for which their clients really aren't qualified. If you can't afford the payment, am I really doing you a favor by qualifying you for the loan? I submit that I most emphatically am not. Before they push such a loan through, an ethical loan officer using it for this purpose should sit down, tell the people what the real payment is going to be, and make certain they can afford it - and not just by words, either! The loan officer has responsibility to both the lender and the borrower, and putting somebody into a loan they cannot afford harms both of those parties. On the other had, I have run into situations where they borrowers were renting and their effective cost of housing was going to go down! And in that case, I submit that I probably are helping the clients. On the other hand, if you're doing Stated Income or NINA (especially on a purchase) and the loan officer doesn't sit you down and cover what the payment is going to be within a couple dollars per month, and make certain you're okay paying it, this is a red flag in no uncertain terms!

What Stated Income is meant for is self employed people and people working on commission who really do make the money, but have write-offs such that their taxes aren't going to show enough income. Or people who had a bad year, or large losses or high write offs one year, but are still basically solid. I am going to observe that regulating stated income out of existence is doing no favors for the people it is meant for, nor the market at large. I certainly understand why Stated Income and NINA have evaporated currently and agree with those reasons due to the abuses that have been practiced. However, it doesn't do anyone except politicians any good to pretend that there haven't been people who could have otherwise afforded their loans hurt by this development.

The highest form of documentation is Full Documentation (almost everyone says "full doc" because the unabbreviated phrase is a mouthful). This does not necessarily mean I've got to prove to the bank that you make every penny you actually make, but only that you make enough to justify the loan. The proof the bank will accept is very straightforward. Self-employed borrowers are still going to need that testimonial letter from stated income. They will additionally be asked for their federal income tax packet. This is all of the forms, front and back, that you sent to the IRS last April 15th, and perhaps the April 15th before that, too. It's got to be a signed copy, and it must include copies of any w-2s or 1099s that you get. People in the construction profession, as well as those who may be w-2 employees but work on commission will also need to furnish their taxes, and the bank's underwriter can always require it of anyone. It is to be noted that banks did not have to accept your loan on a stated income basis even when it was available - the underwriter could always require that you furnish full documentation.

Those people who are hourly or salaried employees of a company can usually get by the full documentation of income requirement with just w-2 forms. If you are a company employee, the last 30 days worth of pay stubs will also be required.

The basic rationale for this is simple. Very few people tell the IRS that they make more money than they do, because the consequence is higher taxes. So the bank is willing to use tax forms to prove your income. In the case of a w-2 employee, the company is telling the IRS that those are the wages it paid you, and therefore wants to deduct your wages as a business expense, and you went and paid taxes on it, so the bank will usually accept that. Similarly, your pay stubs should have year to date pay on them. Here the bank will accept the word, metaphorically speaking, of a third party without a stake in the outcome of the loan.

A subset of the full documentation loan is the streamline refinance. As the name indicates, it is available on refinances only, not purchases. There are a lot of limits on these loans, but when I get to do one it is the easiest of all loans. Basically, it's a case where the same lender is now offering better rates, and no equity is being taken out of the home, and they'll allow you to do it because otherwise you'll take this client elsewhere. 90 percent of a loaf is much better to them than none.

Within the sub-prime mortgage world (when it existed, which it probably will again - once again, it's a legitimate market that someone will decide they want the money from servicing), those lenders would often take the deposits from 12 consecutive months of bank statements (sometimes 6 or 24), usually discounted by a certain amount, and accept that as proof of income. This is called Lite or EZ doc, although there's nothing easy about it and as a matter of experience there are more fights with the underwriter and jumping through hoops here than with any other type of loan documentation. The rates are somewhat higher than for full documentation, but not nearly the rates for stated income. Mind you, sub-prime rates are higher in the first place as well. Furthermore, many of these sub-prime lenders would advertise the fact that "EZ doc rates same as full doc!" I shouldn't have to explain to adults that this phrase translates to English as they don't give the lower rates to true full documentation loans, now should I?

So, on the subject of documentation, I think you should be able to tell that the higher the quality of your income documentation, the lower the rate that you are going to get from a given lender. If you can qualify, a full documentation loan is probably going to save you more than enough money to pay you to do the extra paperwork, the amount of which is marginal anyway. The only reason not to do the extra paperwork is if you can't supply requisite proof, which is pretty much the reason why the lesser loan types such as stated income and NINA have been so abused and I can't find a single investor offering them today.

I should probably repeat one final time that as of this update, true full documentation loans are the only thing available. The others will almost certainly make a comeback at some point, but with some changes. They were badly abused by the marketplace, but the fact that they went away caused a lot of people who really could afford their loans to be unable to refinance, or unable to get a purchase loan. Eventually someone will decide they want the profit for serving this market segment and figure out a way, but until then, lesser documentation loans are gone.

And as one final warning: If a loan officer requires originals not only of the forms they ask you to sign (A couple of the standard forms require original signatures - really!), but of your own documentation, it is a BIG RED FLAG. I can't think of any document that lenders will not accept copies of. The only reason to require your originals is that loan provider does not want you able to apply for a loan with someone else, so they're putting an end to your shopping, and once they've got them, good luck trying to get them back (at least until the loan is done so they get paid). A good loan officer needs good readable copies - not your originals. An ethical loan officer doesn't need or want custody of your originals any longer than is necessary to make good copies, and if you hand them a good readable copy in the first place, that isn't a problem.

Caveat Emptor

Original here

What Consumers Need To Know About Mortgages (A Guide About What Really Happens From a Mortgage Insider) is now available on Amazon!

Kindle edition only $4.99 through February 28th!

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There is an entire chapter devoted to how not to inadvertently sabotage your own mortgage application.

How to not waste thousands of dollars choosing the wrong mortgage

418 pages covering everything consumers need to know from basics like credit score, to how your application is evaluated, to how to handle the process from start until the loan funds and is recorded. Real snags and stumbling points people have brought me over the last ten years of running this website, with common sense solutions.

Want to know how to improve your application? It's inside.

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Man From Empire Cover

(I do apologize that the physical book edition is pricier than I'd like. It will drop with larger print runs)

When we sold our home just over a year ago we were talked into selling for a bit more than the original offer so the person could get money back to do renovations... I objected based on percentages and stuff and my realtor and the other realtor agreed to commissions based only on the original agreed to asking price. Then I could not find any other reason to object, after all, if the loan officer was willing to loan that much money, what reason was it for me to say nay?

But now I hear it is illegal to do this? Yikes? Have you heard of this?

What should I do now?

The same thing anyone should do when they discover they may have inadvertently violated the law: Talk to a lawyer.

For all of this article, please keep in mind that I am not a lawyer. I don't even play one on TV. Not in California nor in any other state, and the laws and precedents can be different from place to place. So please double check everything with someone who is a lawyer, and if there is a conflict, follow their advice.

That said, my understanding is that it is not illegal per se for a seller to give a buyer cash back. If I hand you $500,000 cash - or something worth $500,000 to you - and you hand me back title to the property and $50,000 cash, or something worth $50,000 to me, there is absolutely nothing wrong with it. It's a free exchange, willingly agreed to by competent legal adults. No harm is done.

Where illegality does come into it is when there is another party to the transaction to whom it is not disclosed. In most real estate transactions, there is a lender involved. That lender is loaning what is usually a very large sum of money based upon the representations which were submitted to them. To intentionally and materially falsify those representations in order to persuade a lender to make a loan they would not otherwise make is a textbook case of FRAUD. Loan fraud is, literally, a federal offense. Go to jail for a while, and be a convicted felon for the rest of your life. Whether it's done by lying (stating something that isn't true) or by omission (failure to inform the lender of relevant facts) does not matter. Furthermore, due to the fact that fraud is a felony, there's a good likelihood of adding conspiracy in there - another federal felony offense.

The potential offense here is in failing to disclose the cash back to all parties in the transaction. If it is disclosed to the lender and issues the loan anyway, there is neither a criminal offense nor a civil tort, at least according to my best understanding.

The reason this fraud happens is because if the cash back is disclosed to the lender, then they will treat the purchase price as being the purchase price less the cash back amount. If the purchase contract says $400,000, but the seller is giving the buyer $20,000 back, it isn't really a $400,000 purchase price, is it? Net to the seller is only $380,000. Net cost to the buyer is only $380,000. That looks like a $380,000 piece of property to me, not a $400,000 one. The lender will take the same point of view, and base all of their calculations off of a $380,000 purchase price at most.

What that means is that if the buyers are not putting at least $20,000 down, they are over 100 percent of the value of the property. Which means the borrowers loan amount will be reduced accordingly. In fact, as I have said in Seller Paid Closing Costs (or, When Your Prospective Buyer Has No Money), it's better for both the buyer and the seller if they don't do this, because it is in both of their interests to use the lower purchase price that results from making the official price lower by the cash back amount.

In short, this whole charade is worse than self-defeating if it is disclosed to the lender, because if it is disclosed the lender will only lend based upon the net purchase price: "official" price less the cash back. If the cash back (or equivalent things such as paying buyer debts) are disclosed to the lender, I cannot think of a reason to do it, because whatever purpose you wanted to achieve with the cash back will be defeated. If the buyer wanted the cash to fix the property, they're either going to have to take it out of their down payment money or, dollar for dollar, out of the cash they got back, in order to have the same loan to value ratio that the loan was underwritten for. $400,000 official price minus $20,000 cash back is $380,000. So if the buyers put $20,000 down, the loan and the transaction would be doable only as 100% financing (not available as of this update except under a VA loan), and the net benefit the buyers got out of their down payment is zero. Alternatively, they can just take the $20,000 cash and apply it to the purchase price, over and above the $380,000 the lender will base their loan calculations on. Net benefit to doing all of this: Zero. Furthermore, there are drawbacks for both the seller and the buyer. It actually hurts them to do this if they disclose it to the lender.

What was the purpose of that $20,000 again? If it wasn't a down payment, the buyers will need to come up with $20,000 for a down payment from somewhere else. If it was a down payment, well, why not do the transaction "straight" in the first place? I assure you that a lender to whom this is disclosed will see it this way. Why not just reduce the official sales price by $20,000, pay less in commissions, lower fees, less capital gains, and have the buyer have a lower sales price, which translates into lower property taxes in a lot of places?

Which is precisely the reason this whole thing does not get disclosed to the lender. The buyers are trying to have their cake and eat it, too. They only want to pay $380,000 for the property, and have the lenders think that they paid $400,000, so they can borrow as if they paid $400,000. In other words, a material misrepresentation of the situation in order to induce the lender to make a loan they would not otherwise have made.

In short, FRAUD.

It is mostly the buyers, their agents, and loan officers who pull this kind of nonsense. Some of them are thoroughly blatant about soliciting this kind of crime. I don't know what they're thinking, but this is not harmless, this is not minor, and it has been explained to licensees. I can only presume a willful disregard of the rules. It can be difficult for sellers to even know who the buyer's lender is going to be, and it really isn't any of their business. Nonetheless, if the lender can show that sellers were a party to the deception (side agreements aside from the main contract are pretty much proof on the face of it), they can be dragged into the mess. Actually, sellers and their agents can be dragged in quite easily, side agreement or no, but side agreements are the equivalent of a smoking gun still in your hand while standing over a corpse. So if you're going to insist upon a side agreement, also insist that it be disclosed to the lender and proof that it was disclosed to the lender. Better still to make it all a part of the main contract. Optimum is not to give or ask for cash back in the first place. It sets you up for a criminal fraud investigation, and no matter how innocent you may be in fact, I have been told by someone who found out the hard way that they are no fun to endure. If you're a professional, it shows up in records as a complaint against your license, and I'm not even certain it comes off when you're found not culpable.

Caveat Emptor

Original article here

I keep running into people who paid money for a get rich quick seminar and are looking to buy property for zero down and immediately sell it for a $50,000 profit. Somebody With A Testimonial Told Them How It Could Be Done.

Sorry folks but the people with the real secrets to getting rich don't sell them for $199 at the Holiday Inn. They didn't do it during the stock market bubble, and they're not doing it now in real estate. As I told people back then regarding the stock market, don't confuse a rising frothy market with investment genius. And that rising frothy market has now changed. Deals like that do happen, but they're always less common than the People With Testimonials will admit, and they are snapped up quickly. Usually they never make it as far as the Multiple Listing Service. Before they're even entered into the database of available properties, they are sold, and they rarely fall out of escrow because the people who buy them know what they are doing.

Consider, for a moment, yourself on the opposite side of the transaction. You're not going to intentionally sell your valuable property for less than it is worth, are you? And if you're buying, you're certainly not going to pay more than market value, are you? Remember that Wile E. Coyote ended up at the bottom of the canyon under a rock for more reasons than that the Author was on The Other Side. "Super Genius!" Says so right there on the label. But betting large amounts of money on The Stupidity Of The Other Side is a mark's game.

About the only reliable source of "quick flips" for profit are distress sales. In no particular order, most of these are people in foreclosure, estate sales where neither the estate nor the heirs can keep the payments up long enough to sell normally, and where somebody's been transferred and has to sell now. The requirements are that they have large amounts of equity, not short sales or even lender-owned property, and the need for a quick sale.

These people get mobbed by prospective buyers, and by agents looking to represent them in the sale. Everybody wants something for nothing, and one of each group is going to get it. One agent is going to get a transaction where if it gets as far as the MLS, all he's got to do is type it in and bingo, the buyers will line up. One buyer is going to get to buy below market. Usually, they're the same person. The multimillionaire brokers all usually each have at least one going on.

The issue for these buyers in distress sales that is rarely addressed until it gets to actually making the deal is that they're going to need a certain amount of cash that they are prepared to lose. Putting myself in the position of the person who has to sell, I'm not going to give this person the sole shot at buying if I'm not pretty certain he can deliver. The only way to measure this is cash - how much they can put down on the property. How much of a deposit they can make that I can keep if they can't qualify. Remember that in this case the one thing a distress seller cannot afford is a buyer who can't consummate the deal quickly - unless the seller is going to get to keep something substantial for the experience. If you don't want to buy on those terms, than at that price someone else will. The multimillionaire real estate brokers, for instance. There are a lot of people who make a very good living at foreclosures because they go around from foreclosure to foreclosure offering cash for a below market price. Matter of fact, they pretty much saturate the foreclosure market. The chances of a seller in this position accepting an offer without a substantial cash forfeiture for nonperformance are basically identical to the chances of them having a listing agent that doesn't understand the situation. And quite often, that listing agent makes an offer themselves, in violation of all that is ethical.

Get religion about this point: There is ALWAYS a reason for a low asking price. Usually, a noticeably low asking price should be even lower than it is. Unless they're a philanthropist looking for some random person to donate money to, this seller wants to get as much for the property as they can. What they're hoping for is a buyer who doesn't know what a really bad situation they're getting into. "A cracked slab? How bad could it be?" is probably the classic example of this (The answer was about $300,000 in one case, but it could be as low as $20-25k). These sellers have been dealing with the situation. They've had a reason to become intimately familiar with the problems. They're hoping for an unsuspecting buyer whose agent wants an easy transaction and will not explain to them, or simply does not know, what those buyers are getting themselves into. I could certainly keep my mouth shut and do more transactions, easier, if I didn't take the time to tell my buyers everything I know about what they're getting into. I just had a buyer who loved the floor plan so much on a property with mold infestation right out in the open that he wanted to make an offer, even after I told him "Anywhere from ten to two hundred thousand to fix, maybe more, and probably at the upper end of that because you can see how it has spread". Luckily, his wife talked him out of it. The universe knows that most of these good deeds don't go unpunished. But that's what I'm theoretically getting paid for, and as often as I do my job and it causes them to get angry and I don't get paid, it's preferable to the eventual consequences of not doing the whole job and getting paid for it.

There's a newsletter I get from the State of California every three months. It's always got a long list of people who are losing their licenses. So if your agent tries to really explain something like this, listen to them. They're not trying to talk you out of the Deal Of The Century so that someone else can get it (the Deal of the Century in real estate comes around surprisingly often if you can afford it). They're trying to make certain you go in with your eyes open. It's likely to be a better agent than the guy who thinks "Okay, I've told you that the hill is known to be unstable, so I'm covered. It's not my fault that you didn't instantly understand all of the implications."

(On the Mold House: In the meantime, I called and left a message for the agent, and she returned my call and left a very accusatory, defensive message about "What is the documentation for your accusation of mold damage?" Opening my eyes, you silly ostrich - it's clearly visible - Eeewww! - right there, and there, and there, and there's moisture coming out at the bottom of the wall downstairs. My guess is that it's coming from the standpipe in the walls of the upstairs hall bath. I look forward to seeing her name on the List of Dishonor)

The typical property where there is real potential for quick profit is going to require work. Work as in physical labor that you're going to have to do, or pay someone else to do. Not to be sexist, but "The husband died (or became disabled) and the wife couldn't keep it up," is a cliché because it is so common. Sometimes the work is easy - carpet, new paint, clean up the yard and bingo! The property jumps in value! Sometimes the work is harder, and the profit is larger. And sometimes the buyer is basically going to have to tear the house down and start over. There is always a reason why the seller didn't do the work so they could make the profit themselves. Sometimes it's because they're lazy, sometimes it's because they can't. Sometimes it's because the work was risky, sometimes because it was expensive, and sometimes it's because the seller can get some poor fool to buy it who doesn't realize that they're going to have to make an investment that isn't worth the payoff.

Caveat Emptor

Original here

I have found your blog to be very informative. I was out riding my bike and rode past a house for sale. In a few minutes of Internet research I've found out a bit about it. The property is bank owned and it sounds like a property in need of repair. However the information I have found out doesn't add up.

From a real estate web site listing recent sales in the area, I found out that the property last sold for 5% less than the asking price. Apparently the sale happened in October.

The house is now listed in the local MLS service, and the text of the listing leads me to believe that the house was listed in December. It seems from what I have read on your site a foreclosure takes at least 3 months, and this house apparently was back in the hands of the bank and listed two months after it sold.

The house is priced well below the market and within my budget, but that the bank got it back that quickly raises a giant red flag for me. Also, given that the MLS listing says the sale is as-is and that there are no contingencies allowed raises another red flag.

How if they don't accept contingencies do you do a home owners inspection? Pay for one before making an offer, and risk you'll be throwing the money away if the seller doesn't take your offer? Or do a home inspection after they accept your offer, and forfeit your deposit if the inspection covers up a big problem.

Actually, foreclosures are perfectly fine for a first time buyer if you've got the wherewithal to work with them.

Lender owned, which means it didn't sell at auction, is an entirely different story than buying at the auction. You can make offers with contingencies for inspection, usually for seven or ten days, and providing it's an attractive offer otherwise, the lender may very well accept. You're always risking the inspection money on any property, because if it comes out that the house is messed up, you still have to pay the inspector. For lender owned (REO) properties, you don't need to forego an inspection contingency. Financing contingencies are also very doable - I've got one in escrow now with both, and I'm working on another. If it wasn't possible, they would reject the offer out of hand, and they haven't. Disallowing an inspection contingency makes the property worth a lot less, because a lot fewer people are willing or able to handle the risks involved. If your particular property is specifically disallowing inspection contingencies, it tells me they know about a problem, and it's almost certainly a big one. It can still be worked, but get yourself a really top-notch buyer's agent. It's worth paying them (or paying them extra) yourself if you need to, because you'll make more on this property, and they will earn it, because there's a lot more liability for them on this kind of property.

If you're looking at an REO, be aware before you even step onto the property that there are going to be maintenance issues. More often than not, there are even sabotage issues. Furthermore, because the lender doesn't live there and almost certainly knows less about the property than an inspection will reveal, they are exempt from transfer disclosures. They are not for Mr. and Ms. Upper Middle Class looking for the perfect house, they are not for Mr. and Ms. Just Barely Scraping Into The Property, and they are not for Mr. and Ms. Fumblefingers, Mr. and Ms. No Time, or even Mr. and Ms. Procrastinate. But if you've got the inclination and the skill or the cash to fix it, foreclosures can be quite lucrative. Foreclosures are always a risk - the more so because the current owner literally does not know and has no way of knowing what the condition of the property really is. That lender has never lived in it, so they cannot disclose things that most owners would know and be required to disclose. Furthermore, the lender usually requires some addenda of moderate obnoxiousness or worse, aimed at getting the deposit and limiting your opportunity to exit the contract - and making the property value even lower, as such addenda are a thing of negative value to most folks. But if you've got the resources to make that risk a manageable one, you can pick them up well below the price of properties with similar characteristics.

Lender sales are pretty much always "as is." However, I have successfully negotiated repairs and allowances for repairs upon multiple occasions. They are more limited in nature than most, due to the "as is" nature and most lender's unwillingness to put more money into the property, but it is very possible if you discover defects that make the property less than fully inhabitable within the definition of the law. Hot and cold running water, working electricity and heat (Not air conditioning, however), total enclosure of the dwelling area, and active fire hazards can all be negotiated even in "as is" properties. There really is no such thing as a pure "as is" sale.

You might also want to read my article, "Why There Is Money in Fixer Properties" if you haven't already.

Caveat Emptor

Original article here


As a seller, a purchase offer is not money in your pocket. As a matter of fact, accepting the wrong purchase offer can cost you tens of thousands of dollars if the buyers can't consummate.

I recently dealt with clients making an offer on a property where the comparable sales run in the $350,000 to $370,000 range. The ask is $380,000, which isn't outrageous in and of itself, but Seller Paid Closing Costs are so endemic that they are essentially priced into the market, at least up to a price of half a million dollars or so where first time buyers peter out. My clients initially offered a price a bit above the lower end of the comparables, and paying their own closing costs. The owners rejected that but my clients really liked the property, so we sweetened it to what was essentially a full price offer, without any appraisal contingency, and the mechanics of my clients' offer (larger than necessary down payment) were such that there wouldn't be any obstacle to getting the loan and closing the transaction unless the appraisal had come in under $330,000.

But when I called the agent on the phone to make certain they got it, she was quite snippy, implying that they have offers for tens of thousands more. Well, I don't know that she had the greatest negotiation technique in the world, because it completely turned me and my clients off of the property.

What I do know is that people offering way over asking price are not, in my experience, coming in with large down payments. In fact, when I have dealt with them, they were mostly first time buyers who were asking for seller paid closing costs, and even sometimes Down Payment Assistance back when it was still available. Basically, the deal is "We'll give you a really great price if you pay for all the ancillary costs we don't have the cash for." And these transactions result in everybody being happy and even noticeably higher commissions for the agents, as commission is paid on the full sales price.

So far, so good. But what if the appraisal is lower than the purchase price? The comparables in this instance are all between $350,000 and $370,000, as I said. Even moving up in the square footage department and adding another bedroom won't boost that much, as the property is already above average for the neighborhood - anything much more would make for a misplaced improvement.

The upshot of all of this is that the appraised value is not likely to be sufficiently high to support the loan value, unless the competing buyer has a much larger than required down payment, which they can then use the excess of to pay the amount that the sales price is over the appraisal on a dollar for dollar basis. As I've said, this isn't likely to be the case where someone is offering significantly above the asking price. People who have somehow acquired the money for more of a down payment understand that this is real money, far more than people with a minimal down payment planning on simply having higher payments.

So unless the appraiser commits fraud, the value is going to come in between $350,000 and $370,000. Let's be generous and say $370,000. Lender's evaluate value on an "LCM" or "lesser of cost or market" basis. Since the appraisal will be beneath the purchase price (if the agent's representation was truthful), the lender will treat the value as being the appraised value, which we have posited to be $370,000. Let's say the purchase price is $400,000. For a 100% Loan to Value Ratio loan, which are not available right now, the lender will only lend $370,000. For a VA loan, which will go to 103% for veterans of the armed services, the limit would be $381,100, including loan costs, and everything else including the VA funding fee - the real limit is $375,550 for the buyer's purposes. For FHA loans, the maximum loan limit would be $363,525, and that includes the 1.75 points the FHA charges - the real limit is $357,050. For conventional conforming, the effective loan limit is either 90% ($333,000) or maybe 95% ($351,500).

So, assuming a $400,000 purchase price, to make a VA loan fly, the purchaser has to have a down payment of at least $24,500, and that's assuming they're not paying any loan charges, at least not themselves. For the FHA, they would need $43,000. For conventional, maybe they could get by with $49,000, but it's more likely they would need $67,000. All of these figures are exclusive of any transaction costs the buyer is paying, of course.

If that buyer doesn't have that cash, that transaction is not going to happen. You might as well reject it to begin with, because if you accept it, all that is going to happen is that you're going to waste six weeks or more Waiting for Godot. It is my usual experience that buyers with down payments of the size indicated understand that dollars are dollars, no matter what form they are in, and are unlikely to offer prices much over asking. There are exceptions, but not many. The reason people end up paying more than asking price is because they need something special from the seller, and therefore the seller who is willing and able to give it to them can extort a higher price for that property in return, and the most common reason why buyers need these sort of concessions is because they haven't got the cash necessary for the down payment plus closing costs. Therefore, in order to induce the seller to give them the extra they need in some wise, they offer a higher official purchase price that nets the seller what they want after the givebacks. Unfortunately, if that higher purchase price is not supported by the appraisal, the buyer then has to come up with more cash - and we just posited that they don't have it. Prognosis for the transaction: not good. So perhaps it might be a good idea to require a buyer to come up with some evidence that they do in fact have the necessary cash to make the transaction happen. When I write a buyer qualification letter, that is one of the essential parts it must contain: Evidence of cash to close. When I have a listing, that's one of the things I want to see before I advise accepting an offer: Evidence of cash to close.

I should also mention that all things being equal, it is not in the seller's interests to pay buyer costs, even if they get a dollar for dollar higher price. Why? Agent commissions, title insurance, and several other costs are dependent upon the official sales price. You net more money from a $370,000 sale with no givebacks than you do from a $380,000 sale with $10,000 in givebacks. Furthermore, for the buyer, property taxes are based upon that official sales price. Making the official sales price $10,000 higher means the buyer pays more in property taxes. There is nothing wrong with the practice of givebacks, so long as it is properly disclosed to the lender and approved by them, but it can cost both the buyer and the seller significant amounts of money.

Too many agents became used to the Era of Make Believe Loans, and don't understand yet the implications of it being over. Whether you're a buyer or a seller, you want to consult a loan officer on whether or not the loan for a given purchase offer is likely to be able to be done. Of course, if your agent is a good loan officer, you're already ahead of this game.

Caveat Emptor

Original article here

You would think these nitwits would learn. You would think they'd all be out of the business. Sadly, that is not the case.

It started innocently enough. It always starts innocently.

This was an email I got (specifics redacted).

Hi Dan, I came across your blog looking for information on what to do when your mortgage loan might not go through at the very last minute. I live in DELETED, and realize your in the San Diego area, but you really opened my eyes on the subject and I had to let you know. We are in escrow with a close date of DELETED, and our VA lending agent no longer works with the company after 2 months of paperwork, assurances and promises. The newly appointed agent says they don¹t know how DELETED was going to close the loan and everything is falling apart. DELETED went as far to say he could close the loan in 5 days to use as a negotiating tool to get a contract with the seller which won us the house. We never heard of getting a back up loan or a purchase money loan? It¹s not over yet, but any advice would be GREATLY appreciated as we are 1st time home buyers and really feel taken.

My response

(name deleted),
VA loans are dead simple providing you have the following qualities:

-VA eligibility

-sufficient income to cover the payments and other debt (see debt to income ratio)

-acceptable loan to value ratio. In the case of VA loans, this can be up to 103% of the purchase price or appraised value, whichever is lower. This is the only widely available "no down payment" loan right now.

-Property that meets VA and FHA standards (No holes in walls or cracks in windows, subfloors all covered, etcetera)

-enough time to get the government bureaucrats to do what they need to.

Unfortunately, there's a lot of loan officers and real estate agents out there who still don't understand how the market has changed. I have always built client affordability and a budget into my transactions from day one, but the reason we're having problems is that a lot of my competitors didn't.

Here's what you need to do: Find out if there is a reason this transaction is not going to fly.

Obvious reasons why it definitely would not fly:

  • Can't document enough income for a long enough time
  • something wrong with the property
  • property appraises way too low
  • no VA eligibility


There are other possible reasons, but those are the main ones. If there is such a reason, bail out NOW. If there isn't such a reason, find someone who knows what they're doing IMMEDIATELY. Alas, I don't know anyone in DELETED, but I believe my company does business there. The good news is you still have almost a month, which should be enough time.

If this property doesn't work out for you, may I suggest finding DELETED or DELETED and asking one of those fine gentlemen to be your agent? They're both ethical agents who won't be searching for properties you can't afford and who do know competent loan officers. I can get their contact information if needed, but they're both easy to find online. Tell them I sent you - they both know I neither ask for nor accept referral fees, but that the occasional free client I send their way will disappear if they mistreat anyone I send.


I went out looking at property, and when I came back this email was there:

Thanks for your quick reply Dan, I know you must be busy, and I really appreciate all your information.

The only factor the new agent is citing is that we do have a high income to debt ratio. We know this. Everyone knows this, and it has not changed since we started the process 2 months ago. The first loan agent was going to get by this by paying down one of our high credit cards with seller money. We asked for 4% back from seller for this reason which they agreed to. Done. Now the new lending agent is saying that won't fly, that we can't pay down the debt we have to pay it off, and the 4% is 2000 short of our credit card debt. So she does not know how she can do it but is getting back to us today.

We have not talked to our real-estate agent yet, but we will today as well. Would you recommend we contact your mortgage company in the mean time to try to push through and cover ourselves?

Oh my.

Lions and Tigers and Bears and people trying to commit fraud. Oh, my!

My heart goes out to this person, especially as they are a veteran, but there's very little I can do beyond make them aware of some facts before things get any worse.

This is fraud. No maybe about it. I have written about this before in Real Estate Sellers Giving A Buyer Cash Back is Defrauding the Lender. If the purchase price is $400,000 but the seller is returning cash back to the buyer under the table, then the buyer isn't really paying $400,000, are they? Nor is the seller really getting $400,000, are they?

here's the legal definition of fraud:

All multifarious means which human ingenuity can devise, and which are resorted to by one individual to get an advantage over another by false suggestions or suppression of the truth. It includes all surprises, tricks, cunning or dissembling, and any unfair way which another is cheated.

Now if they don't disclose that 4% cash back, they are misleading the lender and the government into believing that the property is worth more than it is. In other words, fraud. Furthermore, the former loan officer evidently hadn't disclosed it from the fact that the new loan officer is saying the lender isn't buying off on it now.

(I should say that the Department of Veteran's Affairs apparently allows this, but they are not lenders or loan officers, and whether the lenders would accept it is another matter. They can add other requirements if they so desire, and I would not expect this to pass muster with any lender I am aware of, as it violates generally accepted accounting principles (GAAP). Truth be told, I've never tried to get such a thing accepted, but I would try if the client really needed it and understood what needed to happen and the dangers to them. Even if the VA and the lender both permit it, it must be disclosed to them and approved by the underwriter in order for it not to be fraud. For standard conforming "A paper" loans, and for that matter even subprime ones, cash to the buyer from the seller, or cash to pay the buyer's debts, is strictly forbidden. Finally, considering such things from a dispassionate neutral point of view such as "are they a good idea?" or "Is the consumer likely to be able to repay the loan?" or "Is this a good risk for the lender?", I have to agree with GAAP - the answer is no, and the prognosis is that given the consumer's financial habits, this is setting them up for failure. But "good idea" and "legal" are two distinctly different concepts.)

Whatever the lender's fraud policy may be, the government comes down on people who participate in mortgage fraud that involves VA or FHA guarantees like a ton of bricks. Just because the VA permits it doesn't mean it isn't fraud if the lender doesn't, or didn't approve it in this particular case. They are going to throw the book at you. Have you ever seen the list of government regulations? Ouch, both literally and figuratively.

Let's suppose the buyer and seller do not commit fraud, fully disclosing the cash back to the lender and the government. If they do this, the lender and the government will both treat the purchase price as being the appropriate amount less than whatever cash is going from seller to buyer. As I said in When The Appraisal Is Below The Purchase Price for Real Estate, this will mean the borrower basically has to make up the difference in cash. Net result, the buyer/borrower needed that 4% cash not to pay off their consumer debt, but for the down payment on the property. Net gain to the buyer from that money: Zero. Nada. Zip. Zilch.

Both the loan officer and real estate agent and their brokerages need to hear about this, at a minimum. The loan officer for actively planning a fraudulent transaction, the real estate agent for not speaking up and putting their foot down, because they should have known better, but were keeping their mouth shut to get a bigger commission check.

Now that stated income is, to use Miracle Max's wonderful phrase, "mostly dead", there seems to be no shortage of nitwits trying this fraudulent trick to get loans and transactions through. It is not a minor violation that nobody cares about. It goes straight to the heart of the notion of property value, and the lender's expectation that if you do default, they will be able to get their money back by selling the property. This trick fraudulently persuades a lender to accept more risk than they are aware of, or worse, tricks them into taking a risk that they would reject were they in full command of the truth. That's fraud.

It also goes right to the heart of whether the client can afford the property. In this case, they clearly can not. If they could, there would be no need to commit fraud in order to generate a false picture of them being able to afford it. Debt to income ratio is there for the borrower's protection as much as the lender's.

Here's the rest of my response to the clarification:

Your loan officer has hosed you badly. I really hope it's not going to end up losing your deposit. If so, in your place I would talk to their company about paying it in your stead. Their loan officer was trying to make a fraudulent transaction fly; that's failure to supervise. If they don't promptly agree to indemnify you in writing, talk to a lawyer. Actually, talk to a lawyer anyway. But if your loan contingency is still in effect you may be able to get out of it without losing your deposit.

I don't know your situation or your state's law or the contract you signed on this, and I definitely am not a lawyer. Talk to your real estate agent about getting out of the contract RIGHT NOW because this transaction is not going to happen.

Once you're out of the contract, I'd fire that agent if I were in your shoes. He helped negotiate the contract, he should have known it was fraudulent and the requirements for making it legal and the consequences thereof.

After sober reflection several hours later, I am, if anything, madder than I was. I would be ready to do violence to these two twits for what they did to someone who not only wants to put money in their pocket, but served our country, so it's a good thing they're not here in front of me. If it were me, or some situation I had an interest in (legal standing), I'd certainly make a written complaint to the regulatory authorities. I want these clowns gone, out of business, locked up in prison so they can't attempt to repeat this nonsense with some other innocent client who doesn't know any better, and I want their enablers and those who fail to supervise them gone, too. Helping someone with their home buying is a trust, and I have no more sympathy for those who knowingly and willfully violate that trust than I do for pedophile priests.

I'm not here to act like the Black Knight, shouting "None Shall Pass!" That didn't work out too well. But you need to consider 1) Can you really afford it? 2) Is it consistent with your financial habits?, and 3) Is it fully disclosed to everyone it needs to be? That lender is loaning out hundreds of thousands of dollars based upon their understanding of the situation. If that understanding is not in full accordance with what is actually going on, that's a problem. A big problem that's likely to come back and bite you and everyone else involved.

Caveat Emptor

Original article here

The first thing to understand is that the entire machine of loans is completely impersonal. I don't mean that you're necessarily just one more cog in the machine to your loan officer, as I can't remember encountering a loan officer who thought like that. But the mechanisms of whether your loan in particular is approved have precisely zero to do with whether you're a good or virtuous person, whether you deserve a chance, or anything other than how well you fit the profile of someone who can repay this loan. Understand that. Your bank doesn't give a damn if you're black, white, brown, red, yellow, or pink with purple polka dots. They care about green - money. They don't care whether you're a man or a woman, what your sexual orientation is, or anything else. They make their decisions based upon how well you fit the profile of someone who can repay the loan. How much you make, how stable that income is, how much of that income is obligated to other payments, how well you manage credit and a host of other factors. Except as I will note later, they don't care how much equity is in the property. Banks are not in the business of owning property, and they lose money when they have to foreclose no matter how much equity is in the property. They're in the loan business. They care about whether you fit the profile of someone who will repay that loan. Not having enough equity for the loan guidelines will lose you a loan, but having more won't get your loan approved. In the course of funding well over a thousand loans from dozens of lenders, I have never seen or heard race, ethnicity, sex, or orientation of the applicants mentioned in any sort of communication other than by government mandate for gathering the information. If it weren't required by the government on a mandated government form, I have precisely zero evidence that anyone at any lender I have ever submitted a loan to cares. What they want to know is whether you fit the profile of someone who will repay that loan.

How do you fit the profile? Earn a steady income from a consistent source. Save enough for a down payment that fits the underwriting profile, which varies from zero to twenty percent or so. Manage your credit well. Make your payments on time. Don't try to borrow more than you can afford to repay. Be able to document everything. I'll go over all of this in considerable detail later in the book, but the criteria are all financial. The rest doesn't matter. The banks don't care if you're Democrat or Republican, statist or anarchist, or which way you put your toilet paper rolls in the bathroom dispenser.

Coming Soon from Amazon

I've found several of your mortgage articles very helpful, and wondered if you could help me find a way to solve the dilemma I've been presented with by a loan officer at my bank. My husband is Active Duty DELETED, and is getting out in August of this year. We've found a house we want to buy in the state we'll be moving to, but when I went to the bank I was told no lender would touch him with less than a year in the service and no promise in writing of a job in DELETED. He doesn't have any credit history, but mine is fair (I haven't seen my FICO score recently but I do believe it to be over or around 620). I can provide w2s, income tax records, rental history (never a late payment), etc, but I cannot provide proof of the future. Is it true that we're simply out of luck? Where should I turn from here? I'd be very grateful for any information you can provide to me or post on your website, so far this seems to be a unique dilemma...

You have run smack into the question at the heart of every loan: How are you going to pay the money back?

This is understandably a cause for concern for the lenders. They don't want to make loans that aren't going to be paid back, and in order to pay them back, you've got to have or be able to get money from somewhere.

What they are looking for is a regular source of income, and you don't apparently have one. You're not going to keep the one you have, and you haven't (officially) got a new one.

There used to be loans for people in such situations. They were called NINA or No Ratio loans, because there is no income stated or verified, and no debt to income ratio. However, (even when they existed) NINA loans had lower allowable loan to value ratios (100% financing was impossible to find for NINA loans, and I always did think such requests were over the top) and the rates are higher than full documentation or even stated income. Full documentation shows that you have had and are likely to keep a good stable source of income, and documents that you've made enough in the last two years. Stated Income (when it existed) showed that you at least had the same stable source of income for two years, and usually that you had some money in the bank. NINA loans were driven purely off the Loan to Value situation and your credit score. You were essentially telling the bank, "Here I am! Gotta love me!" You were not providing any kind of documentation that you are able to repay the loan.

(NINA loans have been regulated essentially out of existence. "Mostly dead" to quote Miracle Max in "The Princess Bride", at least for residential consumers. Commercial loans is another matter entirely, leaving me to wonder exactly how much of a favor regulations banning the residential item are doing the consumer. Yeah, they were badly abused - but now people in your situation can't get real estate loans no matter how careful and how responsible they are, no matter how much money they have in the bank or in other negotiable assets, etcetera)

Your husband's lack of credit history and the fact that your score is only about 620 do not help. There is no evidence in your email that you are working outside the home.

Now I understand how tempting it is, especially right now, to buy a home. The two of you are getting out and looking to start your post-military life together, and you want to move right in to your new home, and start your new lives all at once.

This is, unfortunately, the kind of desire that quite often leads to disaster. Have you considered what happens if you don't get work? What if you do get it, but delayed several months? Or what if they keep promising to hire you in a few months but it just never quite happens? Meanwhile, that mortgage have to be paid, and you're not likely to be able to pay them working fast food. Meanwhile, the fact that you have this house is tying you to that location and its commuting area, where maybe you could find something that would support your family if you were able to move.

The fact is that buying real estate is something to do when you're certain you are stable enough to make those payments - as in you already have the money coming in, or solid reason to believe it will be coming in. A written offer of employment might be such reason - it isn't always. Cousin Bob saying, "Sure, we'll take you on!" isn't. Even though he's family, Cousin Bob needs to feed his own kids before he feeds you. Friends, old military buddies, former employers - I've seen more than enough examples of people who thought they had a job but didn't than you'd care to know about. You might have a job when they're willing to promise it in writing - they can be held responsible for that in court if they fail to follow through. If they haven't given you such a written guarantee, there is a reason why they haven't.

The one thing that messes up your entire financial situation, worse than anything else is failing to pay a real estate loan on time, now and for the next several years, . I have seen credit scores drop by 150 points for one thirty day late payment. If it gets to the point of a notice of default, or foreclosure, the consequences last for years. Plus you still owe the money, even though you haven't got it.

Once upon a time I wrote an article called, "When You Should Not Buy Real Estate." You fall into the third category I mention, those without a sufficiently stable income. You might also fall into the insufficient time to benefit category. As much as I like putting people into houses and such, the fact of the matter is that you buying a property right now would be very likely to mess you up financially for a very long time. Move into a rental for a little while, unpleasant as it may be. That way, if you have to change your plan, you are free to pick and leave if you need to. Having a property ties you to it and it to your wallet until it is satisfactorily disposed of, something hard to arrange on good terms right now in large portions of the country. On a $500,000 property like most around here, you are risking $500,000. With purchase money loans, there are limits on your liability and the lender's ability to get a deficiency judgment in most states. Nonetheless, to go into a house purchase with the idea of sticking the lender for the difference if it doesn't work out is at least a close cousin to fraud - and it might be fraud itself. This sort of thinking is one of the primary reasons behind the bubble in many parts of the country - and is false to boot. One way or another, you will almost certainly pay for a lender's loss. Since I'm presuming you don't want to do that, better to just not do this until you are a little more stable.

If you could afford to pay cash, this would not be a concern. But if you could afford to pay cash, the loan would not be a stumbling point. Also, some folks might ask, "what if I can make the payments off of a minimum wage job?" which is not the case anywhere in California. To be fair, being able to make payments off minimum wage does change matters, but be careful that minimum wage jobs are obtainable in your area. If there's 26% unemployment except for four weeks per year, you may not be able to get a minimum wage job, even if you've got the time for it. Furthermore, be careful that you're not biting off more in property taxes than you can chew. California's property taxes are comparatively low, ratewise. Clueless renters come here from other states and think, "Wow, they're only paying $4000 per year on a $400,000 property!" and think there's plenty of room to raise property taxes. But somebody making California's minimum wage of $9.25 per hour makes $18,500 per year - and $4000 is 22% of that person's gross wages. Senior citizens will lose their homes in droves if the tax rates ever rise - not to mention property values would drop like a rock, thus turning it into a self-defeating measure. Nonetheless, other states do have much lower property values - and much higher property tax rates. Clueless politicians also think "Property tax rates are too low - let's raise them!" - there hasn't been a year since Prop 13 passed in 1978 that some group of elected idiots haven't tried something or other to get around it and crash property values. This thinking that makes it difficult for investment properties to cash flow is also one of the reasons why there is upwards pressure on rents and an under-supply of rental properties.

Caveat Emptor

Original Article here

Every so often I'll say something about misplaced improvements. You may be wondering what a misplaced improvement is.

Simply put, it's something that stands out above the surrounding properties so far that they pull it down. Like having a mansion in a neighborhood of shanties. Yes, it's still a gorgeous house and yes, the functionality is exactly the same, but as soon as your walk out the front door you feel like you're in a third world country.

Repeat after me: Real Estate is only worth whatever I can get someone to pay for it. Real Estate is only worth whatever I can get someone to pay for it. One more time, with feeling: Real Estate is only worth whatever I can get someone to pay for it.

Got that? Good. Now ask yourself, would you be willing to pay more for a beautiful mansion surrounded by other beautiful mansions, or would you be willing to pay more for a beautiful mansion surrounded by cardboard boxes? The vast majority of the people out there want to look out of their beautiful mansion and see other beautiful mansions. I understand that even in the areas of the world where most folks live in shanties, the mansions of the wealthy are clustered together.

Probably the most egregious example of a misplaced improvement I've ever seen was this turkey. Yes, ladies and gentlemen, a Realtor really is making fun of a property. Beautiful brand new 2000 square foot home - actually an entire development of about 30 of them - less than a quarter mile off the departure end of the main use runway at a busy general aviation airport. That airport is open 24 hours per day, 365 days per year, and it has to by the terms of the land grant. I love small planes, and I couldn't have lived there. Plus you have to drive through a white trash neighborhood to get there, and there's now a freeway within about 75 yards. I have zero idea how the developer sold most of them. There shouldn't have been a housing development there at all. If they had to put something in, they should have run a road in off the other side and put in an industrial park or something, but I know of at least two crashes in the field where this development used to be. A travel trailer hook up would have been a misplaced improvement.

Misplaced improvements aren't always that much of a waste. Matter of fact, if a buyer isn't looking at a property for its investment value, but rather for something like housing five or six kids as cheaply as practical, they can be a good way to find a property that meets your needs less expensively than comparable properties. Why? Because everything around it drags it down, where most like properties are surrounded by other properties of comparable features. You never want to buy the best house on the block if investment is your criterion - but you might want to if you're just trying to find housing for a family of seven and you don't make two million dollars per year. The drawback is that it won't be in the best neighborhood.

For instance, I found a gorgeous 5 bedroom 3 bathroom property in a sixty year old business route neighborhood, surrounded by trailer parks and older offices and apartments. Some nincompoop had wasted at least $60,000 fixing it up to look like some big executive's entertainment house - but the chance of some big executive buying the property was nil. Across the street was an old office building with chunks out of the stairs, the neighbors all look lower middle class, and there's a trailer park entrance at the end of the block. So I can guarantee that the target market wasn't interested, which is too bad, because it really was a nice place. The guy was asking $80,000 above what I thought the market might actually support, and he eventually lost the property because he couldn't afford the payments on a vacant property and nobody was willing to pay what he wanted. If he had asked what the neighborhood would support, it would have sold quick to some working family who needed somewhere for their kids to sleep. But the brand new kitchen and travertine floors were just wasted money on the owner's part. Before you improve a property, if selling for a profit is your intention, always look around at the rest of your neighborhood to see if there's anybody else with that level of improvements and general quality of material. If not, you're wasting your money. Don't waste your money, because I guarantee you that potential buyers are going to look around before they make an offer.

Some misplaced improvements aren't as extreme. Just before I wrote this, I found a beautiful property for a couple of my clients that was nonetheless a misplaced improvement. This was beautifully refurbished 3 bedroom 1.75 bathroom home in a neighborhood where those go for $450-460 thousand. The ask was a little over 550, and let me tell you, it was gorgeous. It might have been the nicest kitchen I'd ever seen in a property of that price range, the public areas were beautiful and open, and had a nice mountain view. The bathrooms were new and extremely attractive, not to mention a downright cozy place to take baths, and the bedrooms were great, too. Everything was just wonderfully laid out, and it even had an atrium that lit up the middle of the house. The owners did everything right except one: They didn't consider the neighborhood, which really was a pretty good neighborhood, but houses in this configuration and with this square footage just weren't selling for anything like 550. I consulted an appraiser, who said that if everything was as I described, they might have been able to justify as much as 510 on the appraisal. My clients were looking for a nice place to live and entertain for the rest of their lives, and they had a large down payment, so the fact that it wouldn't appraise for 100% of purchase price was not an insurmountable obstacle, like it would be to someone without much of a down payment - which is to say 90% of everyone out there looking. Furthermore, it had sat vacant for seven months with no action (typical for misplaced improvements). We put an offer in, trying to jaw it down to something not too hugely above the neighborhood, and despite all of the evidence I cited, the owners blew us off. I understand that nobody likes to take a loss, but it's not the buyer's problem if you do, just like it's none of their concern how much you might be making. Residential properties are only worth what they are worth, and whereas this one didn't have many of the usual mandatory deductions, there really is no way to make a silk purse out of a sow's ear. The neighborhood is the neighborhood, and this one wasn't Rancho Santa Fe, but rather an early sixties upper middle class development that had not updated with the times.

Misplaced improvements can be frustrating as anything to sell. Even if you do get an offer for $550,000, when the appraisal comes in at $490,000, that's all the lender will loan on. In fact, the vast majority of lenders won't fund if the total encumbrances are more than the appraisal, so even if you are in a position to offer a seller carryback for part of the price, it's just not going to work unless the down payment is at least equal to the difference between the appraisal and purchase price with a normal down payment left over. How many people do you think want to put down $60,000 of their own money just so they can go through the hassle of obtaining 100% financing (when 100% financing could be obtained), plus the additional money lenders are now requiring for a 5% or more down payment? How many people are even going to have $60,000 extra to put down if they wanted to? Vanishingly few right now. What happens to most accepted offers is they waste 30 to 60 days in "pending," and then they fall out of escrow and you are back to square one. It's just a cold hard fact that if the proposed down payment won't at least cover the difference, you almost certainly don't have a transaction.

The way appraisers find comps is not by going out five, ten, or fifteen miles to find the comparable properties. Comps almost always have to be within one mile, and lenders prefer with half a mile, sold within the last three months. Further out, the appraiser is going to have to justify picking those properties as opposed to closer ones. The character of the neighborhood has to be very similar as well as the characteristics of the properties.

Often, in the case of misplaced improvements, someone suggests appraisal fraud. By some strange coincidence, this is almost always the owner, the listing agent, or both. Find an accommodating appraiser (The one good thing about the new HVCC standards is that I don't get this request as often). Except that appraisal fraud is, well, fraud. Not to mention a violation of fiduciary duty, unless the buyer is stupid enough to choose to be unrepresented, and even there a good case can be made in law that this nasty seller and their agent took advantage of this poor ignorant buyer. No. Thank. You. There are reasons why there are limits to the lengths good agents will go to to make a transaction happen, and this is one of those cases where those limits are short, sharp, and crystal clear.

So we have seem that misplaced improvements are a disaster for the seller, while being a limited opportunity for a certain class of buyer, but they are tough transactions to make happen for a listing agent, and there is no glory in them. The seller is not going to be happy with the sales price, and it's almost certainly going to take longer than everything else around it to sell. I'm brutally frank with owners of misplaced improvements, because if they don't want to listen to what I tell them, they're not going to price the property appropriately or negotiate in the proper frame of mind, both of which are classic ingredients of a failed listing. Failed listings don't do anything good for anyone, and I prefer not to be a part of them. I'm not going to get paid, and everybody's going to end up angry at everyone else, which means it's likely to cost me some future clients also. I'd rather walk away before it gets started.

Caveat Emptor

Original article here

The original article was written when rates were higher. Rates are lower now so the answer is slightly different, the thought process to make that decision is the same.

I have an adustable rate mortgage (5.875) which is set to adjust in DELETED. My prepayment penalty I'm told expires DELETED (same time). My first goal is to lock in a fixed rate asap. My second goal is to cash out any equity, but not necessary. I've recently been hearing horror stories about people losing their homes over their rate adjustment. Should I refinance now and bite the bullet on the prepayment penalty? or Attempt to refinance quickly as soon as the penalty expires?

later:


my credit score is 712. My current mortgage is 244,000.00 and homes of the same model are selling between 255 - 265,000.00. What more can you tell me?

The answer to this depends partly upon stuff I don't know, and partly upon stuff nobody knows yet.

5.875 is good enough that you probably don't want to give it away before you have to, especially since you're going to pay $5700 to $7200 in penalties. 6.25 is about where A paper 30 year fixed rate loans with no points rates were when I originally wrote this, so over the next year, and it will cost about another $1000 in interest between now and then, as well.

The problem is that nobody knows what rates will be like when your fixed period and prepayment penalty expire. Nobody knows what your property value might be then either. Nor do I understand your local real estate market well enough to even guess (it's a long way from Southern California!).

It's going to be hard to get enough back in 18 months to pay for a pre-payment penalty. On the other hand, this could be balanced out if rates end up being much higher then, or if your equity situation is likely to deteriorate.

One thing I can tell you for certain is that there's no easy answer yet. Every answer I give is going to depend upon things nobody knows yet.

Let's assume rates are going up. Otherwise there would be no point to this conversation. If rates are the same or lower than they are now, any money you spend on refinancing or a prepayment penalty now is wasted.

But if we postulate a rate of 7% when your pre-payment penalty expires, that will cost you roughly $17,100 per year on $244,000. 6.25% of $250,000 (your loan with your penalty added) is roughly $15,600. You save approximately $1500 per year on your interest by refinancing now, if this assumption on interest rates is correct. However, refinancing now will cost you about $7000. $7000 divided by $1500 per year is roughly 4 years 8 months after that to get your money back. I wouldn't do it. That's about six years you've got to keep your loan to break even on the cost of refinancing now, and it's conditional upon things happening that nobody knows.

You don't have a whole lot of equity currently, and if your market falls further, you could be upside down, in which case you're going to have to pay your loan down in order to refinance. If there's no way you could come up with that money, that's another reason to consider refinancing now. However, you would be guaranteed to use up pretty much all of your equity by refinancing now. At this update, refinancing at 100% loan to value ratio isn't going to happen except for a VA Interest Rate Reduction Refinance Loan (IRRRL), and the person writing the original question was not in a VA loan because as far as I'm aware, they only permit fixed rate loans.

In your position, I'd just sit tight. Of course that's very hard psychologically, because you are leaving yourself open to the vagaries of the market, which are not under anybody's personal control. Otherwise the federal Reserve Board and company would lower rates every time they wanted to refinance their own personal loans, and that's just not the way it happens, because that's not the way it works. But spending that much money now and over the next eighteen months just in case rates go up and it saves you enough money over the next six years to break even just doesn't make financial sense. Most folks don't keep their loans that long, which means you've wasted whatever portion of the sunk costs you haven't gotten back.

Just one word in closing: There is not and never has been a legitimate reason for a loan officer to stick someone with a credit score over 680 with a prepayment penalty. The only excuse I can come up with is that the borrower requested one in order to get a slightly better tradeoff between rate and cost. You can choose to accept one if you want, but my experience says that most folks end up paying them, and the penalty is a lot more than you're likely to save by accepting one.

Caveat Emptor

Original article here

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