February 2024 Archives

There's really nothing mysterious about this. There are some subsidiary tricks and issues, but the most important thing is obvious. The economic games theory is crystal clear, as is the research into what really happens. But most people don't like what the theory says, and think it somehow doesn't apply to their ego wonderful property.

Price the property correctly in the first place.

Negotiating strategies are variable. In seller's markets, your optimum marketing and negotiation strategies are significantly different than in buyer's markets. But every optimum strategy, in every market, starts with the same piece of advice. Price the property correctly from the moment it hits market. That price won't be the same price it would have been six months ago, and it won't be the same price it would be six months from now. But just because it changes over time does not mean there isn't an optimum price now, and now is when you're trying to sell it.

A good listing agent can keep you from under-pricing the property, and can keep you from giving away the farm or losing the sale in negotiations. But nobody can reliably get you more than the property is really worth, and the attempt is almost certain to end up costing you lots of money.

Here's how things work if you price the property correctly. You put it on the market, you get people coming by to view it because they can afford it and the basic numbers fit. If middle class properties are priced correctly, you're going to get offers within the first two weeks - probably more than one, even in the buyer's market we have going right now. You all negotiate in good faith, you reach an agreement with one of the prospective buyers, you go through escrow in about 60 days (30 days or less if there's no loan), and within ninety days the property is sold.

But when you over-price it, here's what happens: When buyers compare your property to the others that are available and competing with yours, yours falls short. Result: They make offers on other properties, not yours. It's as if you wanted to sell a $20 bill for $50. Guess what? It's precisely the same situation with a different commodity.

Time goes on. You spend money on the mortgage, the property taxes, the insurance, and the upkeep. Plus any number of other possibilities, for instance if there are HOA dues. Even if there aren't, let's consider a median sales price in the zip code my office is in: $390,000. Let's say you've got a loan for eighty percent of the value at 6%, pro-rated property taxes at 1.25%, and $100 per month for insurance. You paid $1560 in interest charges for one month. That's cash, right out of your checking account! I don't count the cost of principal because you're paying that to yourself, but pro-rated property taxes would be slightly over $400 per month, and add the $100 per month for insurance and you're well over $2000 that not selling for that month actually cost you, plus the phantom of another couple hundred dollars principal out of your checking account that you're essentially giving the bank to hold for you until the property sells - except that extra month decreases the eventual sales price. It's worse than this if your property is highly encumbered, or caught upon the fact that prices are receding in most of the country. That $390,000 property today would have been $500-$520,000 at the peak of the market, and lots of folks were buying then and are discovering now that those prices weren't real. So if your property doesn't sell for 4 months (the average days on market locally), that's nearly $10,000 out of your pocket that you're not getting back.

Actually, it's much worse than that.

Your period of highest interest is right when the property hits the market. The longer it's on the market, the fewer people will come by. The buyers who already looked have already made their comparison and decided they're not interested. The buyers who are new to the market will see that it's been on the market for thirty, sixty, ninety days or more and the idea foremost in their minds is going to be "What's wrong with it?" What's wrong with it is a completely preventable problem - It was overpriced when it hit the market. The only cure for this problem is expensive: cut the price further than the price it would have sold for in the first place.

The higher the "Days on Market" counter goes, the less inclined buyers will be to go view the property. Remember, at this point it's all numbers as far as the buyers are concerned. You can stage the house, paint it, remodel the kitchen, replace the carpet, landscape the yard, and nobody will notice because these don't translate to attention grabbing numbers. The property is what it is, has what it has, and the counter is ticking up, and every day this property sits . The only number you can change to induce people to come back is the asking price, and guess where it has to go? That's right: down. At this point, you have to give them a reason to come back and look that has its root in numbers. If you're now the cheapest property in your class in your area (or more precisely, the lowest asking price), that has a good chance of working. Maybe if you're now the second cheapest, you'll get a smaller amount of interest. But if there are still a significant number of lower prices in your class, this won't work. Nobody comes back to look at the 18th cheapest 3 bedroom home, even if there are 1000 others in the zip code, despite the fact that these numbers say you're in the best 2%. You've got to be priced significantly below the market to drag people back, where you didn't have to be nearly that low if you priced it correctly in the first place. Furthermore, attempting to negotiate the price back upwards is extremely unlikely to work. People came to look and made an offer based upon your implicit representation that the asking price would be an offer you'd be happy to accept, and if that turns out not to be the case, expect them to walk away no matter how hot the seller's market.

Tricks exist to reset Days on Market, of course. The various MLS affiliates are wise to most of them and getting better at catching them. Not to mention that the buyer's agent is going to check back and see if it's been on the market anytime recently, if they don't happen to recognize it off the top of their head. Listing Agents are becoming correspondingly more reluctant to play games to reset that Days on Market because they can lose the ability to place properties in MLS altogether when MLS catches them playing games. Buyer's agents are tired of this game, and many of them are perfectly willing to put their competition out of business by bringing their malfeasance to the attention of the MLS operator. I haven't done it yet, but I'm becoming more tempted in a couple of cases.

I see a lot of nonsense put into MLS by owners, and by agents who know better about how high the automatic valuations, CMAs, and appraisals for a given property are. These are all worthless. For one thing, this data can be manipulated, and sellers have just a little motivation to want it manipulated in their favor. More importantly, none of these influence sales price, and representations that they do or should is worthy of ridicule. What influences whether you get any offers, and from that, sales price is how good of a deal prospective buyers think they're getting, which in turn flows from the asking prices for comparable properties, as well as recent sales. If there's only two properties available for sale in the Zip Code that thousands of buyers want, sales prices are going to be increasing rapidly. Reverse this if the opposite situation applies. Incidentally, these are reasons a buyer's agent needs to be a fount of information on both the attractive points and the not-so-attractive ones.

With this information freshly in mind, what does all this say about the competence and ethics of an Agent who accepts the listing at a too-high price "to see if we can get it"? Nothing good. They're deliberately inducing the seller to harm themselves in order to get that listing. It's hard to put a monetary value on hurt feelings of betrayal when the agent starts pressuring them to drop the price the instant they have the signature on the listing agreement, but for a lot of folks, that's even worse than all of the cash it's going to cost them.

Lest anyone mistake me, this is no way relieves the need for an agent, and a good one. How many of the comparable properties that sold in your area in the last few months were you in? How familiar are you with all of the competing comparable properties? Try and put it on the market without that knowledge, and you're basically spinning the roulette wheel as to whether you're in the right ballpark, price-wise, with completely predictable downside if you're not. Who's your target buyer? What are the effective ways to attract their attention to the property? How to convince them they need to make a better offer? I guarantee that buyers don't care about "what you want to get" for the property! If real estate were easy and obvious, anyone could do it about as well as anyone else, and that is definitely not the case. Finding a good agent isn't trivial, and their pay isn't what most people think of as "cheap" but it will more than pay for itself in time and money.

The attitude of the seller is also critical. Sellers that expect to be treated like royalty are royally hosing themselves. If everything has to be convenient for you, you won't get as good a price as if you make everything convenient for the buyer, and in buyers markets, it often makes the difference between a good price and not selling at all. What are you willing to do in order to sell your property, to make it more attractive to buyers with special issues? Especially, what are you willing and able to do if it will get a higher price? Being willing and able to offer things that other sellers are not is an excellent way to appeal to buyers with special needs, perhaps even to the point where they have a choice of your property or none at all, no matter how many properties are "for sale" where the owner can't or won't. Do you think that might induce someone to offer a good price? To use some examples I've encountered recently, are you willing and able to carry back part of the purchase price? That's one way to give yourself an advantage over competing properties in any kind of market. Are you willing to work with someone who has a need for immediate occupancy? Can you carry the property for an extended escrow period if you're properly compensated for it? A good agent can use all of these, and others, as wedges to get the property sold, sooner and for a better price, but they can't do these things for you. You have to be willing and able to do them.

There are a few other things: Have the property ready to show before it hits the market, do what you can to enhance visual attractiveness (it's amazing the difference polishing furniture that's going to leave with you can make!), and especially make showings absolutely as easy as possible. It's a better sales tactic to get the family heirlooms and other valuables out and type, "Just Go!" in the showing instructions than just about anything else (although "5 minutes notice so we can leave!" is even more effective), and permissive or restrictive showing instructions can make all the difference. If you've got tenants in the property who want 24 hour notice, you're in a world of hurt in a buyer's market, and even in a seller's market you're going to find that your traffic and final sales price will suffer because of it. If you want to sell your rental for a good price, offer your tenants something that makes them willing to cooperate or get them out.

The asking price should take all of these factors, and more into account (and almost entirely as subtractions from a theoretically perfect sales situation), but choosing an optimum or near optimum asking price in the first place will make more difference than anything else, because the money a seller ends up with is about the time it takes to sell as well as final sale price.

Caveat Emptor

Original article here

It's the same reason the phone company doesn't want to compete, General Motors doesn't want to compete, Wal-Mart doesn't want to compete, Disney doesn't want to compete, and Microsoft will do everything in its power to appear as if it doesn't have to compete. They make less money when they have to compete, and they have to provide a better quality of product.

But people know that all of the above have competitive alternatives. If you don't like one brand of automobile, there are dozens of competing alternatives. Ditto retail outlets. "Kid safe entertainment" is a bit more of a niche market, but there are competitors if you'll look. Finally, we should all be aware that computer OS's are one of the biggest Drazi Wars there are. There is competition.

But many agents and loan officers make their living by pretending there is no competition, or by actively manipulating consumer choices to preclude the possibility of competition. This takes many forms, from requiring large deposits for loan officers through exclusive agreements with agents. There's nothing fundamentally evil about this - everyone needs to make a living. But there's nothing that says any particular consumer - by which I mean you - has to put up with it. Furthermore, the agent or loan officer who is confident enough to work without these devices is likely to be a better, stronger practitioner. Ask yourself who you'd more easily believe has more on the ball: Someone who tries to keep you from considering the competition, or someone who's happy to compete? If you were interviewing two applicants who want to work for you, who'd be more likely to get the job: The person who walks out as soon as they find out you're considering someone else as well, or the person who gets their act together and out-competes the other applicant? If you were interviewing with two companies who wanted to hire you, which offer would you be inclined towards: The one where you have to hide the other interview, or the one who's willing to compete head-on for your services?

Nobody's going facilitate competition for the job they want. Nonetheless, it is to your advantage to force them to compete. If you don't understand why, consider that for all the griping about various phone companies, the situation is far superior to what it was when there was only one. Here's a particularly poignant reminder of that era.

Here's the facts of the situation: If you're only going to talk to one provider, they can quote you anything they want. There is no check upon the situation. If I were the only loan provider in California, I could charge anything I wanted. I'd auction my services to the highest bidder, work a couple hours, one day a week, make as much money as I wanted and go on to spend the rest of the time having fun with my family. If anybody didn't like the level of service, that would be their problem. But that's not the case. In fact, the further it is from being the case, the harder I have to work, the less money I make per transaction, and the better the service I need to provide. It's also the case on the voluntary level, which is to say if you voluntarily restrict yourself to one potential provider, as well as the involuntary. If you only talk to one, there might as well be only one. It doesn't matter how many loan providers and real estate agents there are, what matters is how many you talk to.

People in the real estate business get told all the time that the way to success is to avoid competing, especially to avoid competing based upon price. If ever a week has gone by without some clown wanting to charge me a thousand dollars to learn how to avoid competing on price, or avoid competing, period, I certainly can't remember it. They work, by and large, on two levels - pretending you're the prospect's friend while engendering fear of the competition. "You know I'm your friend, George. You know there are sharks and cutthroats out there who will take your money and leave you high and dry, but you know I won't do that, George." And there are sharks and cutthroats out there. The guy talking to his pretend friend George here is one of them. This is the way he talks George out of checking up on him, comparing his services and prices to either objective standards or to any other provider's. Nor are women any superior - in fact, I've had a report of one of the worst sharks I'm aware of preaching a "female solidarity" line of attack to cut out her competition. Other sharks attack via ethnic or religious solidarity, or even political similarities. What these have in common is that none of them have anything to do with competence at real estate, and they may not have anything to do with conscience. I've seen people preaching the gospel about taking care of your fellow man while extorting thousands of dollars from their client's pockets. Newsflash: The sale of Indulgences went out with the Reformation, and for good reason, too. I'm certain it happens with other religions, as well, it's just that there's fewer members of those religions around here.

One of the ways I constantly see this abused is even people who should know better advising their readers to "ask someone you trust for a referral." Well, referrals are great - if the person making the referral knows what they're talking about. If they don't, it's just another goat lined up for sacrifice, willingly led in by the previous victim, If not worse. Here's an article from illustrating someone who used this process to gain victims (HT: FraudBlogger.com, who always has a relevant example of bad behavior handy). No matter how trusted the source, it still needs to be fully vetted - you need to do your own due diligence, and part of that is comparing them to some other potential service providers.

There just isn't any valid advantage from the consumer's point of view to forking over a large deposit or the originals of any documents to a loan provider. They don't need originals, and the only thing that large deposit does is give them some money to hang onto if you find a better loan. All of the better loan providers I'm aware of work on the basis of "fees at point of service," not requiring a deposit in advance. In fact, a cash deposit can induce people to accept loans that are many times the amount of the cash deposit worse than other, available loans. People understand that check they wrote out of their account is real money, where most of them are a little bit hazy about loan costs paid by rolling them into the loan balance. I saw someone pass by a loan I had that was four thousand dollars cheaper up-front and would have saved them $1000 per year they kept it because another lender already had a $1500 deposit from them. Here are a few more pointers on shopping for a real estate loan.

Admittedly, I have come to the reluctant conclusion that it is in the consumer's interest to list their property for sale via an Exclusive Right to Sell. However, this doesn't mean you shouldn't shop agents extensively before you make that commitment. This only means that you're going to make that commitment to one agent once you have done that research. Failing to do so risks locking your property up with an incompetent agent. When you ask "what's so bad about that?" ask yourself if you'd be happy taking ten to twenty percent less for the property (or worse!), after you keep paying the mortgage six more months? Around my area, with the median sale being $423,000 last month, and assuming a loan at six percent on eighty percent of value, not only does signing up with someone who can't get the job done cost you $42,000 on the sale, it'll cost you about $2200 cash for every month that property doesn't sell! Realize it or not, you're risking a lot of money on an agent, and just because you're not writing a check to them directly at sign up in no way changes this. However, I don't advise going with the agent who asks for a short term listing, either. That's an appeal to cowardice - decide by theoretically not deciding, and make no mistake, you are deciding when you sign a listing agreement for any period of time. This isn't to say you can't bargain the time for commitment down if you're willing to take a chance on a less experienced agent - it's just saying don't decide by pretending not to make a decision. That way lies disaster. Here are a few more tips about Shopping for a listing agent.

For buyer's agents, there really isn't a reason for an Exclusive Agency Agreement, except to allow an agent to wrap up your business for whatever period of time. There isn't hardly an excuse. The only place I can see it being an effective alternative for the consumer is if they're working the foreclosure market, and that agent is spending the money for all of the "quick notification" services so that the client doesn't need to. But the vast majority of the time, agents are locking in people who simply don't know any better with an exclusive agency agreement. I've seen listing agents who wouldn't show a property without an exclusive buyer's agency agreement - a clear violation of fiduciary duty to the seller, not to mention a huge Conflict of Interest if they actually want to put an offer in on that property. Non-Exclusive Agency Agreements protect the buyer's agent just fine, but they also give you the right to fire non-performers by just not wasting any more of your time. You can also use them to separate the wheat from the chaff among buyer's agents. Sign any number of Non-Exclusive agreements you want. The good agent will still do their work; while the lesser agents will select themselves out. While we're at it, here's a few more tricks to finding a good buyer's agent.

Agents and Loan Officers don't like this. It means they might not get the business when they're exposed for the buffoons that some of them are, and it means they might not make as much money for the time they put in. Nor is exercising your choices as an informed consumer simple - far from it. You also need to consider what agent services are worth how much to you. But considering the average price of real estate around here, and the cost of the loans that most people need in order to buy, doing proper diligence beforehand will save most people more money than they make in a month - perhaps more than they make in a year, possibly more. When you consider the differences in that light, the hourly pay for doing your due diligence about agents and loan officers and forcing them to compete is absurdly high.

Caveat Emptor

Original article here

Hi--I just found your site today. The best I've ever seen/read, etc. Thank You!! I do have a question I didn't see addressed regarding our current situation/dilemma:

Our present home, which we've lived in for 8 years, is worth around $180,000 (yes, it's a small town...), and we owe $105,000. My husband has been working for about 5 years now, & has a pretty good salary (around $100K) but we have a LOT of debt --mainly a result of having had 2 babies while in school. We have about $40 K in credit card debt, a $775/mo. student loan payment, & a $500/mo car loan which will be paid off in 18 months.

We've been planning on moving across town for a few years (MUCH better schools there), but had been holding out as long as we could with the idea that the longer we waited, the better house we'd be able to afford. And besides, the kids are still young, & their elementary school isn't intolerable, etc.

The problem is that the school situation DID become intolerable about 3 weeks ago, at which time I began to homeschool them, which is also intolerable! So we need to get this moving across town show on the road!

My question is this: I know we need to at least take out a home equity loan so that we can pay off the credit cards. Some of the rates are outrageous, and I'm sick of fighting with them. That would put our equity at $35,000. But since we want to move ASAP now, I assume we could just use the sale proceeds of the house to pay off the cards, & use the remainder as a down payment. Or, am I wrong? Our current debt to income ratio is so poor--will the lenders even consider our current plan to pay off that debt using sale proceeds, or will we have to refinance now & wait a period of time before pursuing a new house to show them that we're not just going to rack the debt up again? Oh, but we haven't incurred any new debt or put any new charges on the credit cards in about 3 years--does that make any difference?

Also, the houses in the neighborhoods we are looking at are around $300,000. I'd sure appreciate your advice on this. We really want to move immediately, but not if waiting until later, like this summer, would be be better...

Your situation is a classic example of the urge to hurry a situation, and how to come out better if you don't.

You don't mention how the market is in your area, or what your credit score is like, and yes, it does take a while for bills to show as paid off. It can take over sixty days. I see some options for you, all of which have drawbacks. This is a complex situation, and I don't have nearly all of the information it takes to recommend a particular solution.

You can refinance, sell, or do nothing with your current residence, and you'll want to rent it out if you don't sell. You can rent or buy a new property, although you do want to buy before long. There's some issues that need to be dealt with, and they take a little time to deal with them properly. You can rush the situation, but doing so will cost you some big bucks.

You don't mention what rents are in your current area. By the time you pay for the refinance, my guess is your balance would be $150,000, maybe a bit higher. I'm as certain as I can be without full workup information that you're in a sub-prime situation, which means you can choose a very high rate or a prepayment penalty that'll run you about another $5000 if you sell while it's in force. The high rate is the better choice, because it's only for a few months, but it also has implications for your debt to income ratio. The reason I ask about rents is that I'm wondering if they'll cover your mortgage on the place. The rate you'll get might be higher or lower, but let's assume seven percent. That's principal and interest of about $1000 per month, plus taxes and insurance. Now your husband makes plenty to afford some negative cash flow on the property if you folks have to and the rest of your debts are gone, but not a huge amount of it. You'll only get credit for seventy-five percent of the rent, as opposed to all of the expenses, but better to have it rented for a little bit of a theoretical loss than not to have it rented.

Whether you refinance or sell, it's going to take a grand total of about four months to get your bills showing as paid - about two months to get the refinance done, and two more months for your current finance companies to get off the dime and report the accounts as paid. It might be longer if you sell, depending upon how long it takes to get a good offer made and the sale consummated, then add two months. On the other hand, if your property is in good shape, vacant properties in good condition show very well. Understand that nothing happens immediately in real estate, and new regulations supposedly aimed at protecting consumers (while in reality protecting big banks from competition) have added at least a month to the time it takes to get a loan done.

With your new property, your debt to income ratio is going to sink your loan if your current bills aren't paid off. Unfortunately, A paper has an issue with paying off bills after your initial credit is run. If it's a credit card or other revolving debt, guidelines have issues with paying them off in order to qualify. If you pay off a credit card, the wisdom goes, you could turn it right around and charge it up again. Even if you pay it off and close it, the reality is that you could get another. So they qualify you based upon your current situation. Even paying off installment debt to qualify is at the discretion of the underwriter, and I have seen them turn it down. So you want to have the debt paid off, and showing as paid off, before you make the offer for a new place. That can take up to two months after they actually are paid off.

So you're going to want to wait at least two months after you pay the debt off before you make your offer on the house you want to purchase. This means either staying where you are for now, which I can see is unacceptable, or interim renting something in the area you want to live, which is likely to be better, and you might get a line on an extra-good deal if you are living in the area. Yes, you want to buy, but you don't have to do it all in one step.

So I'd most likely go rent a place - which gets you into the new school district now - while I tried to sell or refinance the current place. If you're not living there, be advised that a refinance is a cash out investment property loan, which carries higher rates and more difficulty. I'd probably try to sell instead, but that does place you at the mercy of the market, and not only do I not know your market, but (when this was originally written) we're still in the worst time of year for sellers. Which means settling for a lower price than you might otherwise get, but you will be rid of the debt without the headaches of being a landlord at a stressful time in your life. You can learn that situation later.

Now, if you sell, you get a down payment for the new place. If you refinance, you probably don't. Your credit score may dictate the sale option; I don't know. It should improve after everything is paid, but I can't guarantee that, and I definitely can't say by how much with the information I have. Better to plan on the status quo than to bet on it improving.

Now, a couple of months after the debts are paid, you'll be a a position to make an offer on a home you want to raise your family in. When I originally wrote this, If you had a semi-decent credit score (620 or above), 100 percent financing was no big deal deal, provided you stuck with a property and a loan you can document the ability to afford. If you've got serious credit issues, you're going to need a down payment. For the school year, you may want to delay until late spring or summer to give the kids some stability for the rest of the year. Worst time to buy, but you're looking at moving again in February if you get on the stick right now.

It's a real pain to move a household once, and here I am telling you to plan on moving twice. Let's look at what happens if you risk the solution that cuts the Gordian Knot.

Your husband is an attorney. I don't know what attorneys make around your area, but around here they can make several times $100,000. So somebody advises you to do stated income, state that you make several times what you do, and just make a bid right now on the home you want to raise your family in, while putting your current home up for sale. And if your credit score is decent, I could get such a loan done pretty easy at the time I originally wrote this. At this update. stated income has gone the way of the dodo and the only 100% financing generally available is the VA loan. However, let's consider what happens next in the original context.

Now you not only have your current debt load, but you also have the payments for a brand new $300,000 loan on a $300,000 house. In California, with good credit, that would have been 6.125% when this was originally written on the first, maybe a little under 10 percent on the second (Now it would be a little lower, but since second mortgages aren't going 100% loan to value, you'd have to have a down payment and accept PMI). $1460 on the first, $530 on the second, plus property taxes (California would be about $315 per month) and insurance of about $100, more or less. Total obligations added: about $2400 per month, on top of what you're paying now.

You don't say, but if you weren't struggling at least a little bit, you would have paid those debts off by now. So you are fairly close to the edge. My best guess as to your reserves: Non-existent. Now you have to come up with another $2400 per month. Where can it come from? Borrowing is the only thing that comes to mind. Charge up the credit cards, personal loans, payments start getting behind, your credit score drops - and it won't come back quickly if you start making those payments on time. Especially if mortgage payments on either place end up being late. Meanwhile everything is compounding, eating up your equity, even if the house sells fairly quickly. As I've said, we're still in the worst time of year for sellers. Its entirely possible you won't sell until Spring, no matter how good a job your listing agent does. In short, things get desperate quick. Not only is your cash flow unsustainable, you get motivated to sell for a lot loss money than you might have otherwise. With everything compounding, it's very possible that you end up selling to a shark for less than you need to get out from under your debts. This perpetuates the situation you're trying to get away from, and makes it worse because your credit is likely to take major hits.

So tempting as it is to take the situation at one go, you eliminate a lot of risk and stress by taking it in stages, and you render yourself a lot less of a target for the sharks of the real estate world. Yes, it adds something to your cash flow to go rent for a while, but not nearly so much as if you just bought straight away, and you give yourself a line of retreat if you have to take it.

There are a lot of things that could change this. As I've said, there's a lot of stuff I'd need to know before making a final recommendation for a client, but I've sketched out the biggest stuff that needs to be considered.

Caveat Emptor

Original here

In an attempt to debunk some of the slanders that are floating around out there, this article is an itemization of how lenders and brokers make money on loans.

The first method is obvious: Origination or discount points charged to the consumer. This is money that the person getting the loan is paying, or someone else is paying on their behalf. One point is one percent of the final loan amount, two points is two percent, and so on and so forth. There is an actual difference between origination and discount points, but they have become almost interchangeable in their usage by many lenders and loan officers who often claim origination is discount. Origination has to do with a fee charged for getting the loan done. It's not a trivial amount of work to get the loan done, and unless you're a close relative or have repeatedly saved their life, the person doing the loan is going to get paid somehow (and often, the family member or close friend gets rooked the most). If you're uncertain just how they are making money, you should ask. Discount points are theoretically a cost that the actual lender is charging in order to give you a rate better than you would otherwise get, but many brokers camouflage origination points as discount points and many banks also camouflage origination points as discount points. The former makes you think the bank is making the money when it's the broker, while the latter makes the consumer feel like the lender isn't charging them origination, but that you are actually getting something most consumers quantify as real for their money (This also makes you feel like you're getting something for nothing, always a good selling point to anything - suckers eat it up).

Related to this are junk fees or markups of legitimate fees that are required to get the loan done. I do not believe I've seen a fee that some lender or another hasn't tried to mark up. If in doubt as to whether there's a markup, insist upon paying it directly. If they can't explain exactly what it was for in easy to understand words, it's probably a junk fee. Again, real fees usually run to about $3400 on a loan, although many lenders and loan officers are adept at hiding this at loan sign up.

The second way that lenders and loan officers make money is in rebates, also known as yield spread. This is pretty much limited to brokers, as neither traditional lenders nor packaging houses get direct rebates from lenders. Once again, rebates can be thought of as negative discount points and discount points can be thought of as a negative rebate. There should never be both discount points and a yield spread on the same loan. It is fundamentally dishonest. If there is a yield spread, you are being charged origination, not discount. Period.

The third way that lenders make money is in the sale of the loan. This is usually far and away the largest amount of money made on a loan. It is only applicable to actual lenders, whether traditional or packaging house or correspondent. Brokers never "own" the loan, so they can't sell it. Mortgage loans, particularly grouped in vaguely compatible bunches varying from $50 million on up, are (usually) among the most secure of all investments (indeed, in terms of historical risk, only US Treasury bonds have been superior - but treasuries will have a rude awakening). Because they are very low risk, the lender makes a nice premium on them. As I originally wrote this, CMO bonds trading at 5% even were basically at par, while 6% bonds were earning about a 3 percent premium. At par means the bank gets the face value of what they're selling, whereas a 3% premium means they get a bonus - an extra $30 for every $1000 of bond value. For a $50 Million CMO offering, this is $1.5 Million. (There are other factors such as underlying quality, whether there is a pre-payment penalty, what tranches they may be assigned, and so on, but this is a basic article on the phenomenon.) By comparison, on a random fairly good "A Paper" lender's pricing sheet at the same time, 5% was not available and 5.25% carried a discount point and a half while carrying a premium on the secondary market of half a percent or so, so the lender was making two full percent on that loan at a minimum, and unlike a broker's yield spread, this is never disclosed to a borrower. Nor is there any limit as to how much this can be, but with even decent to good A paper lenders getting 2% or more, it shouldn't stretch your mind too much to find out that this number can go to 6 or 8 percent in the subprime and negative amortization markets. 6 percent on $50 million is $3 Million dollars the lender gets for selling $50 million worth of loans - this translates to about 100 regular 3 bedroom homes here in California. $30,000 each, over and above any points and fees these people may or may not have paid, and for holding onto the loan for maybe one month. Lenders are not hurting - and many even have the guts to badmouth brokers who may make $5000 while cutting the consumer's actual cost by $7500 to $10,000 and the bank still makes $15,000 per loan. (Note: these spreads and premiums used to be much larger years ago when people didn't reliably refinance or move about every two years).

What brokers do is essentially play these lenders off, one against another on a professional basis, to see which one will cut the best deal on your behalf, because brokers are never captive audiences while the lenders regard you as theirs from the time you walk in the door.

Also, the point needs to be again that cost of a rate is always inverse to the rate for precisely the reasons of yield spread and bond premium. The lower the rate, the higher the cost. The higher the rate, the lower the cost. Some lenders and brokers may have better cost/rate tradeoffs than others, but there is always a trade-off.

The last method of receiving traditional income is to actually hold the note and receive the interest. This is actually rare these days on the part of lenders. More often, what the lender will do is sell the loan itself while retaining servicing rights (for which they are paid, of course). Most often, the lender can make more money by selling the note to Wall Street - whether or not they retain servicing - than they can by holding the actual note themselves. Keep in mind that the premium they get from sale of the note is immediate, and they can "sell the same money" several times per year, as opposed to just holding on and collecting the interest as it accrues.

How can (and should) you compare a broker's offer, where compensation is disclosed, with a bank's offer where it is not? First off, make sure that they are on the same type of loan at the same rate. My questionnaire here is a good start.

(At this update, lenders have changed the market so that locking upon loan sign-up like I used to do will cost me and all my future clients large amounts of money, but I will go back to doing that immediately if the lenders change back). None of the standard federal or state forms are binding in this sense; not the Good Faith Estimate, not the Mortgage Loan Disclosure Statement, not the Truth-In Lending form, and not the application form itself. Furthermore, keep in mind that for all third party items, such as title, escrow, attorney fees, appraisal, etcetera, they are able to exclude them from the precomputed costs of doing the loan, so most lenders and loan providers do. Not coincidentally, these are the biggest items in the closing costs section of your loan. Insist upon full disclosure of each item, and ask them to guarantee the total.

And once you are certain that the loans you are being told about are actually the same loan or the same type of loan, then you can make the decision as to which is better by choosing the one that actually gives you, the prospective client, the better loan.

One more thing, the most important: Choose loans based upon the bottom line to you, not based upon how much the loan provider makes, or whether they even have to disclose it at all. If you were shopping for a refrigerator and got a price of $500 at store A versus $520 at store B for the same model, would you care that store B paid $40 more for the refrigerator wholesale, so their margin is lower? No, you'd buy the $500 refrigerator at store A. The same principle applies here. Choose the loan that delivers the best terms for you. Type of loan, interest rate, cost to get it, you need to consider all three, because there are always tradeoffs. Failure to consider any of them is a good way to end up with a rotten loan.

Caveat Emptor

Original here