June 2024 Archives

For years when the market was hot, in all of my conversations on mortgages with prospects, there was one subject that came up over and over and over again (and still does), and that is the subject of payment. "But that loan over there only has a payment of $1450! The payment you are quoting is $2700! The other guy has a better loan!" Then I tiredly have to tell them about negative amortization loans and what is really going on, and why my 6% thirty year fixed rate loan was a better loan.

Usually, they didn't believe me. Over 80% of people were in denial when I was done explaining how a negative amortization loan works. They so desperately wanted the Negative Amortization loan to be a real payment, and they trusted the guy trying to sell it to them. After all, he told them all about his little girl's soccer game, or whatever irrelevancy he used (like all the good sales books tell him to) to make him seem like a trustworthy human being. So I'll tell them about what is usually my favorite loan, the 5/1 ARM, but with an interest only rider instead of fully amortized. "Now I shopped eighty lenders for real loans and real payments that you would actually qualify for. Of all those lenders, this 6% was the best thirty year fixed rate loan for no more than one total point. But I have got this other loan over here that another lender is willing to give you. It's at 5.375%, and the payment is interest only to start with, so you'll only be writing a check for about $2015. How does that sound?" They'll say it sounds better but not as good as that other loan that the other guy is offering. Then I'll tell them the downsides, "That's okay, because this loan's rate will adjust starting in five years, and at the same time, it'll start to amortize, meaning your payments will go up. If the index stays where it is now, it will jump to 7.25% that first month after five years, and your payment will be over $3250 in that sixty-first month. Furthermore, you'd have had to pay over three points discount to get that rate. So adding $10,000 extra to your balance, and suddenly having payments $1200 per month higher, is the price you pay for cutting your payment about $650 per month. What do you think the price is for cutting your payment by $1250?"

Well, as I've covered elsewhere, the price for a negative amortization loan in these circumstances, by whatever friendly sounding name they have for it, is a real rate two percent higher than you could have gotten, a balance that increases by about $70,000 over a five year period, and a prepayment penalty for the first three years, while your real rate isn't fixed even for one month, let alone 5 years.

Selling by payment is the number one trick of unscrupulous people. You go out car shopping, and someone says you can get a $20,000 car for $608 per month, while the lot down the street says you can get a $25,000 car for $303 dollars per month, that second car sounds fantastic, right? Never mind that the loan is based upon a ten year repayment, and the interest rate is two percent higher than the three year loan the first car was based upon. Never mind that the second car dealer is actually going to give you a payment of $339 after they soak you for $3000 in bogus fees simply because you are so happy you got this wonderful car for what these suckers think of as half the price, and you're so happy with that payment that you don't watch what they're doing as closely as you normally would, because, after all, you're getting this car for about half price! Except that you aren't.

Real estate, and real estate loans, are no different. You've got to be able to make that payment - the real payment, not the minimum payment. If someone's quoting you a payment that much lower for the same thing, there is a reason. But it is amazing the number of people who would never fall for the low payment line of patter out on the used car lot when they're talking about a car will fall for it the nice plush office in real estate that some of that money they soaked their suckers for bought. Those few I can get to own up admit to thinking of the mortgage loan as something akin to rent, which is kind of like thinking of your car payment like you would think of bus fare. Hey, here comes a bus that's seventy-five cents cheaper than the express bus right here - but this other bus is jam-packed, you can't get off until the driver's shift is over, and it's going in the wrong direction!

Payment is not price. Many people know this but forget to apply it. The amounts at stake in real estate are usually many times the amount at stake in any other product aimed at consumers, and the chance of banks giving away that kind of money are correspondingly lower. The great rule that applies everywhere else applies equally strongly for real estate: Sales folk who try to sell by payment are trying to get you to pay too much, and not just for the item you are purchasing, but for the loan as well. I have helped folks who first bought their houses in the seventies for forty thousand dollars, and who now have four hundred thousand dollar mortgages on the same property. They have refinanced ten or twelve times and now they need to sell and are netting $20,000 instead of $450,000 they would have had if they had simply been more careful.

One thing to remember is that you can never go backwards in time with what you know today. What is important is not just the type of loan, but the interest rate and the cost it takes to get it. Mortgage loans are not free - all of the people whose help is required do not work for free and you - the borrower - are going to pay for every penny they make in one way or another.

Your greatest friend once you own a home is inflation, particularly if you've got a fixed rate loan. You only borrowed $X. Just because these dollars are now worth less does not increase the number of dollars you borrowed. If you have a fixed rate loan, or at least long enough to get through the period of inflation, you don't care that the interest rates on new loans are 14%. On a thirty year fixed rate loan, you've got this nice 6% loan locked in for as long as you care to keep it. Matter of fact, back in the late seventies, lenders offered these folks a much cheaper payoff to those folks who paid off such a mortgage early. But four years of ten percent inflation and that $400,000 loan is worth about $273,000 by the standards of the day you took it out, and all the folks who were laughing at you because your monthly cost of housing went from $1650 rent to $3000 mortgage are now paying $2350 rent and getting none of the deductions you are, while your costs are fixed and theirs are still riding the escalator up, and if they want to step off now, that property with a $400,000 loan is now $5100 per month!

Nonetheless, choosing a loan based upon payment is financial suicide. If you cannot afford a real loan with a steady payment on the house you want, instead of a loan that messes you up for life, consider buying a less expensive property. Yes, everyone likes house bling, and the more expensive of a house you buy, the more leverage works in your favor. But, as millions of folks are finding out the hard way right now, if you can't make the real payment on a real loan, you are at the mercy of the market, and the market has no mercy.

Caveat Emptor

Original here

PS: I actually like the 5/1 fully amortized and use it for myself. But I'm also aware of the potential downsides and understand what could happen - I'm just comfortable with the risks and like the lower rates for the same cost it usually has.

One of the things I keep getting told by people is that my loans are the same as everybody else's. When I originally wrote this, I had quoted a 5.625% with no points, and got told, "That's the same rate someone else quoted me!"

Rate, yes, but what's the cost of getting that loan? There's always a tradeoff between rate and cost, and focusing only on the rate ignores half of that very important equation.

It turned out that they other folks wanted to charge him more than a point for the exact same loan I was able to do for no points. Seeing as this was a $340,000 balance payoff, it was the difference between a new balance of $343,000, with a payment of $1974.50 and monthly cost of interest of $1607.81, versus about $346,500 with a payment of $1994.64 and monthly cost of interest of $1624.22. Don't think that's a lot? Then consider the difference of $3500 in what you owe and $16.41 per month in cost of interest, every month you keep the loan.

I've heard similar things from people I was offering a lower rate to, for less money. For instance, that was a 5.375% loan with a bit less than a point at that time. So for actually a bit less than a balance of $346,500, he could have had an interest rate of 5.375. In the interest of keeping things simple, I'll even use the same balance when it would have been a little less. That drops the payments to $1940.30 and the monthly cost of interest drops to $1552.03, saving over $70 per month! If you keep it a statistical average 28 months, that saves you $1960! If you keep it the full 30 years, that's a difference of over $19,000! But I can't tell you how many times I've heard, "Is that all you can save me?" Hello! Do you really need a better reason than thousands of dollars?

It just doesn't seem like all that much, because people think in terms of payment. Clever salesfolk will seize upon this as a method of selling inferior loans to people who don't know any better. Salesfolk, after all, get the difference in pay for the loan right away. Therefore, they understand in their bones what a big difference those small differences make over time. If you multiply it out, you should understand as well. This is all real money coming out of your pocket!

Far and away the biggest component of any new loan is what you already owe, or what you've agreed to pay to acquire the property. The fact that the base loan is for $300,000 or so can make differences seem small, but I guarantee it wouldn't seem small if someone was asking you for $3500 cash out of your pocket (not to mention most providers lying about cost)! I've said this before, but don't let cash make you stupid. $70 per month is $70 per month, every month for as long as you keep the loan, and money added to what you owe with this loan will quite likely still be there when you sell or refinance, converting it into a strict liability. That's money you won't have, and additional interest you'll pay because you don't have it! The fact that the base loan is a hundred times bigger may make the costs of doing the loan seem minor, but it doesn't make them any smaller in actual size.

The differences may appear to be marginal, but they're not. Would you rather add $3500 to what you owe, where you'll pay interest on it, or keep it in your pocket, or at least out of your mortgage balance? No, it's not paying off your mortgage entirely, but it is saving you money. Over time - and most people will have mortgages for the rest of their working lives - it makes a substantial difference. If you refinance every three years like most people have been doing for the last generation, this makes a difference of $35,000 over thirty years. Would you like that money in your pocket? If not, well I can certainly always charge you more than my normal costs - it never hurts my feelings to be paid extra. Don't like that idea? Then perhaps that money is important to you, after all.

Caveat Emptor

Original article here

The answer is a modified no. The same answer applies to property that is only structurally damaged, but not condemned.

That condemnation is a matter of public record. I've seen any number of them while perusing title records. It shows up kind of prominently on the title commitment, which every regulated lender is going to require.

It is a rule of regulated lenders that they will only lend upon the state of the property right now. If a house is condemned, you can't sell it to anyone as a house. Furthermore, with a condemned house on the property, it really isn't vacant land, either. It's less valuable than bare land, as you have an expense that vacant land does not. You have to pay for demolishing the structure and hauling away the garbage. You'll occasionally hear agents (me included) talking about "land less demolition and haul-away" describing properties like this.

In the case of structurally damaged but repairable property, regulated lenders won't deal with it as a house either, although some may deal with it as if it were vacant land, less the cost of demolition and haul away. It depends upon lender policy.

The only place to get loans upon structurally unsound or condemned property is a hard money lender. They don't have the Securities and Exchange Commission to answer to, and only much smaller responsibility to the Federal Reserve Board. Many of them are individuals holding the loans in their own name. They can do almost anything they want. If one of them can be convinced that the property can be marketed for a given sum, they will typically loan based upon that sum. It's all a matter of what they want to do.

Hard money lenders will loan a maximum of only up to about seventy-five percent of whatever the marketable value of the property is, and the rates are unfriendly, to say the least. However, they may choose to lend in situations where a regulated lender can not. They can be your only option other than no loan at all. Most brokers will have at least a couple hard money lenders available to them, but your average direct lender cannot. As a final note however, before doing business with a hard money lender, you want to think long and hard and consult some experts as to whether you should - whether it's a good idea or not. It's well and good if this is a temporary thing and you can see an exit strategy to selling or more normal financing. But all too often, it's simply a way to delay the inevitable and make it worse at the same time.

Caveat Emptor

Original here

A few years ago, I wrote up a spreadsheet for buying versus renting a home.

I got reminded of it a couple days ago with a nonsense article out of an alleged financial paper, so I went back and found that, yes, indeed, I did still have a copy.

I just uploaded it for those who might want to play with the numbers themselves.

BuyHomevsRent.xls

It's in Excel 97. I suppose I could convert it forward, but my current copy of Excel has no problems with it.

It compares cost of renting and investing the difference versus a home purchase. I wrote three different scenarios into the spreadsheet: Never refinance, refinance every five years but keep making payments with an eye towards having zero balance thirty years after you originally bought, and refinance every five years and make the minimum payment on the new thirty year loan.

The sheet "Front" should be where you start, in case one of the others comes up. You enter your own values for the numbers down the left side of the sheet.

Purchase Price and down payment should be self explanatory
value adjustment was a feature I put in to adjust to what other, equivalent properties might sell for
assumed appreciation of the property
interest rate of the first mortgage (TD=Trust Deed)

interest rate of the second mortgage: given the market at the time, I assumed anything over 80% of value (Lesser of Cost or Market, i.e. lower of appraisal or purchase price) would be on a second trust deed. These days, second mortgages over 90% CLTV are not available. If you're all one loan, simply enter the interest rate of that loan in both loan rate boxes.

property tax
yearly property tax increase

monthly cost of Homeowner's Association dues plus insurance (add in things like Mello-Roos payments here too),
Assumed rate of inflation
what it would cost to rent an equivalent property instead

the cost of refinances I wrote about earlier (I assumed a standard closing cost figure - no points, no rebate from yield spread)

your standard deduction on federal taxes based on your filing status. The year I wrote this, the standard deduction for married filing jointly was $10,100. For 2020 it will be 24,200. If your status is something else, you can look up your standard deduction any number of places. The point is, you get this much of a deduction anyway - it's not accurate giving benefits from the home ownership deduction until you have actually exceeded the deduction everyone gets.

Value of your other federal income tax deductions. Just as it's not accurate giving benefits until you exceed the standard deduction, it's not an accurate comparison to withhold other deductions over the standard amount that you'd get.

Your marginal federal income tax rate - what you paid on your final dollar of income for the year. The spreadsheet does lose accuracy if your marginal rate changes due to the deduction - or would change without it - but that's a small effect and trying to compensate would have been extremely speculative, especially given how much playing with where certain deductions and credits peter out on the income scale.

Finally, the assumed rate of return of an alternative investment into which you would put 100% of the difference between the monthly payments of buying versus renting (as well as the down payment money). Speaking as someone who still had financial planning clients at that point, that's a ridiculously generous assumption, but you might be one of the exceptions.

Caveat Emptor

Original article here