July 2010 Archives

One thing that is very common in the mortgage industry is masking loan costs by rolling them into your loan balance. People are less sensitive to being asked to roll this money into their loan balance than they are about writing a check out of their bank account. In the latter case, everybody understands that this is money you busted your backside to earn and save. In the former case, a lot of folks don't understand that the money is every bit as real.

Indeed, one of the standard ways to deflect questions about cost that seems to get taught to every loan officer by every loan provider is the phrase, "Nothing out of your pocket." This does not mean there's no cost. That's not what it means. What it means is that they don't want to talk about what the loan is really going to cost, as they're going to have to do if you're writing a check. Therefore, they want to roll it into your balance on the refinance. Most people in most situations have had their property value increase since the last time they got a loan, which likely means there's plenty of equity to cover it.

For purchases, you can't really do this because your value is never more than the purchase price. There are only three places for loan costs to come from: Your pocket, your down payment, if you have one, which reduces to your pocket, and Seller Paid Closing Costs. Seller paid closing costs are an agent and loan officer favorite, because it makes it look like you're not paying them, even though you are. If nothing else, a smart seller would rather take $10,000 less in purchase proceeds than pay $10,000 of buyer's closing costs, on which they are going to pay commissions and taxes to boot.

This trick of making it appear like you're not paying closing costs is one of the best ways to get stuck with an awful loan, but most folks won't do the research until after they've already gotten burned. You are paying those costs in one fashion or another, I personally guarantee it. There is more than one way to pay them, but if you don't know how you are paying them, you are probably not paying them the way you want to, and you're almost certainly paying too much, to boot.

There is ALWAYS a trade-off between rate and cost in real estate loans. It can be very intelligent to pay some or all of your closing costs by accepting a higher rate, especially if you don't plan on keeping the loan very long. If you know you're going to sell or refinance within a few years, or think it likely that you will, it's likely to save you money if you accept a higher rate that has lower costs. On the other hand, if you're 100 percent certain that you're going to keep this particular thirty year fixed rate loan the rest of your life, sinking a couple of points into reducing the rate can be an excellent investment. However, be aware that if you later decide to refinance or sell after all, you're not going to get your previously sunk costs back.

People get talked into rolling multiple points into their loan because it reduces their rate, and therefore their payment, aka the check they're writing every month. Let's consider two rates and the associated costs I quoted the day I originally wrote this, on a maximum conforming loan, thirty year fixed "A paper" (those rates are gone now, whether tomorrow's are higher or lower). 6.5 percent was 1.5 points, or $6255 in real money, plus about $3400 in total closing costs when you consider title and escrow and appraisal. You'll find a lot of loan providers will go a long way to avoid quoting you the actual cost of points in dollars. But at 7.00 percent, I could give them back about 15 basis points, or $625, towards reducing their closing costs of about $3400. So assuming a $417,000 loan, this person would really get:

However, that's dodging the real purpose of this essay. Suppose a loan officer was to pretend that these costs didn't exist when quoting you their loan rate. Their loan would appear to be cheaper, so that you would be very likely to sign up with them, but when the facts became apparent later on - that those costs exist in reality, whether your loan provider tells you about them up front or not - you're likely to continue with their loan anyway, because you don't have time to get another loan for one reason or another, or you just decide to stick with what you've started.

Furthermore, by pretending you don't have to pay loan costs, that makes it easier to get you to accept outrageous ones. Suppose your choices were to pay that $9700 in points and closing costs to get that 6.5% rate in cash, or you could pay $15,000 by rolling it into your loan balance. It is a sad fact that most people don't understand that this is about a point and a half more in costs that are every bit as real as dollars coming out of their checking account. However, most people are a lot more careful with dollars in their checking account because they understand that those dollars are real money. They had to earn it, dollar by dollar - in the form of so many minutes out of your life per dollar if you earn an hourly wage. Then they had to not spend it right away, as soon as they got their pay! Most folks figure they have something to be proud of if they save ten percent of their pay, but if you make $5000 per month, it takes over a year and a half to save $9700 if you save 10% of your gross pay. They understand that $9700 in terms of the nineteen months of their life it took them to save it. If they're just rolling it into the balance of their mortgage where it's being paid for by the fact that the home increased in value, it may be more than half again as much money, but a lot of folks somehow think it's not as real, and they'll accept rolling it into their balance much more readily than writing a check. It doesn't matter if you're writing a check or putting the money into your balance - a dollar is a dollar. By accepting the higher cost loan, not only are you wasting over $5000 of your money, but you're paying interest on it in the meantime.

If it's an expensive loan, it's an expensive loan, whether you're rolling it into your balance or paying it direct out of your checking account. If you're paying too much money by rolling it into your balance, you're still paying too much money, and it's at least as bad as if you wrote a check or even counted out the cash. Doesn't matter whether you're writing a check or rolling it into your mortgage balance. So before you sign that loan paperwork, ask yourself if you'd be as happy with that loan if you had to write a check for every single dollar, or even count it out $20 at a time like an ATM machine. Chances are you'll be a lot more careful with your hard earned money.

Caveat Emptor

Original article here

One thing prospective home buyers need to understand and don't is that there is always a reason for a low asking price. There is always a reason for a low asking price. Sometimes that reason is something you can deal with, sometimes it isn't, but until you know, you're risking your money on an unknown.

Look at the situation from the seller's point of view: They have this valuable property. They want to get as much money for it as they possibly can. So unless it's your mother or favorite uncle or similar family member giving you a deal on property they've owned forever, get religion about the fact that there is a reason why they're asking fifty thousand dollars less than all the comparable properties. It could be that there's a broken slab. It could be that there's a condemnation about to start. It could be the golf course is about to close, or that a chemical manufacturing plant is about to get built. It could be something you can't see that will cost loads of money down the road, such as a broken water pipe undermining the foundation. It could be any number of things. Sometimes the reason is because their agent persuaded them to put a low asking price on it as one way to get lots of suckers to come out and bid against each other and run the price up (That rarely works, though).

Usually, the asking price on properties of this sort should be even lower. It only seems low because you don't know what's wrong with it and what it's going to take to fix the problem - if it can be fixed. Lots of prospective buyers don't seem to understand this. The "get rich quick" scams never point it out - doing so would severely restrict their supply of people willing to plonk down hundreds to thousands of dollars for whatever "system" they're trying to sell. But it's true, nonetheless. There are any number of reasons for a low asking price, but there's always a reason.

Every once in a while, the reason is "because they need a quick sale." Right now this is fairly common. But just because they tell you that doesn't make it true. Even if it is true, doesn't mean it's the only reason, or that you know the reason why they need a short sale. Just because you know one reason, doesn't mean you necessarily know all the reasons for the low asking price.

If you read between the lines on MLS, you can often figure out what the reason is before you even go out to a property - or at least an agent who does this all the time can. But it takes careful reading, and thinking about what they're really saying - or what they're not saying. Keep your eyes open when you visit the property, and the reason for a low asking price usually becomes obvious - or at least one such reason does. Fairly often, there are one or more secondary issues that aren't so obvious that may well cost even more to fix than the obvious issue that leaps out and grabs you.

If you're certain you know what the issues are, and you are able to deal with them, that's what people call an opportunity. But that is a very different thing from walking in cold and taking somebody's word for the fact that the little old lady who used to live here needs to sell because the nursing home needs the next month's payment (Hint: this doesn't happen. Granny can get a Reverse Annuity Mortgage if she's that desperate, and whereas I recommend against RAMs in almost all cases, this is one exception where they are the lesser of two evils, as compared to just giving away a big chunk of equity).

When there's a low asking price, be thinking in terms of things that most buyers can't deal with. Defects that prevent some or all loans from being funded. Probate where there is no money to rectify even safety and habitability issues. Things that prevent your average buyer from actually carrying through on an intention to buy a given property.
Sometimes, as with lender owned properties, it's merely that no one knows if there are problems or not. Maybe it's just cosmetic stuff like paint and carpet, maybe it's a bad floor plan, and maybe it's something a lot more serious. Get yourself a good buyer's agent and go into the property with your eyes open. Be religious about investigating the property; you're risking the full purchase price, not just the down payment, whether you realize it or not. Plus interest due on the loan, of course. Buying a property like this is always a risk - but it's what insurance underwriters call a speculative risk. As opposed to a "pure risk" where there is only opportunity for loss, speculative risk means there is opportunity for gain, as well. Gambling is the poster child for speculative risk so you need to understand it's a gamble, but when you buy a property of this sort, there is opportunity for both gain and loss. It's never difficult to understand the opportunity for gain - people will stand in line to point those out to you. It's the opportunity for loss that you've got to watch out for. A good buyer's agent will save your backside on this score more often than most people would believe.

Caveat Emptor

Original article here