Dan Melson: January 2013 Archives

That's one of the questions I've been asked, and it deserves an answer. Know that there is some flexibility to the answer, as there are embedded trade offs. You don't need as much of an income, or as high of a credit score, if you have a larger down payment. A sufficiently high credit score can also mean that you can afford a more expensive property, as higher credit scores get better interest rates, and therefore, lower payments for the same property. On the flip side, if you have monthly bills that consume a large amount of your income, you cannot afford to pay as much for a property. When I originally wrote this, there was another tradeoff involved in whether you can prove sufficient income via the traditional means of w-2s or income tax forms, as the alternative loan forms do not give rates as good, and most have higher down payment requirements. However, stated income loans are gone, at least for now. Finally, most of this only applies if you want or need a loan. If you intend to pay 100% of the price with cash, you can buy anything legal that you desire with your cash, and the hurdles become much smaller. So admittedly this only applies to 99.9999% of first time home buyers.

The first thing any buyers need if they want a loan for the property is a source of income. If you want a loan, you've got to have money coming in from somewhere to make the payments. Preferably, it's a documentable, regular source of income, such as paychecks or income from a business on which you report taxable income. I suppose I should mention that tax cheats have difficulty getting good quality home loans, because I have dealt with a few people I suspect of that. Don't worry, I'm not an IRS employee and I won't turn you in. But all lenders must report loan transactions, and every real estate transaction is a matter of public record. If you make a major purchase or take out a major loan, the IRS can take an interest in you. Just saying.

You income, together with whatever amount you have for a down payment, gives you a budget for a property. The vast majority of the loan is driven off two ratios, debt to income and loan to value. These two ratios together will determine minimums for everything else about your loan. If your credit score was not horrible, a down payment was pretty much optional for several years during the Era of Make Believe Loans, although it has since become essentially mandatory as the VA loan is the only loan out there where most lenders are willing to fund loans without a down payment.

You will need at least a few thousand dollars for a good faith deposit, and probably another thousand at least for appraisal, inspections, and miscellaneous stuff. The once-upon-a-time rule of thumb about a 2% earnest money deposit has long gone by the wayside, but a good deposit is often evidence that you are serious about your ability to consummate the deal, and might get you a lower price in negotiations. I will argue against my listing clients accepting any offer, no matter how good, without a deposit, and most sane real estate agents agree with me.

The larger the down payment, the lower you can expect the needed income to be, and the better the interest rate you are likely to get at any given time. In order to make a difference on the terms of your loan, the required down payment generally goes in increments of 5%. 3.5% for an FHA loan is the absolute minimum for most people currently, but you will get a better deal from conventional loans that require a minimum of 5% down (But as few lenders as will do that, they can charge higher rates than others). 10% will get you better terms than you would get for 5% down, 15% will get you better terms than ten, and the really major differences happen if you can put 20% down. More still will get you better terms yet, but 20% is the big dividing line.

If you want to take advantage of a governmental first time buyer assistance program, either the Mortgage Credit Certificate or a locally based buyer assistance program, you need to be very careful about staying within what you can prove you can afford via tax forms. Stated Income, or documenting your income via bank statements, is not an option on any of those programs and never has been. Using creative financing options, such as negative amortization loans, with such programs is similarly forbidden. First time assistance programs are not designed to encourage irresponsibly buying a more expensive property than you can afford; they are designed to help you stretch what you can afford just a little further. Know what you can afford in terms of sales price, because agents and loan officers can too easily manipulate payment quotations. Rules of thumb based upon income (2.5 times income, four times income, whatever) are garbage, and the entire concept is a good way to get into trouble. This article will help you compute what you can afford, once you know the approximate rates for current thirty year fixed rate loans.

You will need to be able to document a two year history of housing payments. Since you have never bought before, this means rent. No fun to have had to enrich someone else for a couple of years, but there are valid reasons why lenders require a history of regular housing payments on time. If you can document that you've been paying regular rent to your parents, grandparents, or what have you, that can count, although lenders will usually demand copies of the canceled checks rather than accepting their word for it.

You will also need a history of credit payments. Mortgage lenders want to see evidence that you have the habit of paying your debts on time regularly. The usual criteria is three total lines of credit, one open for at least 24 months, the other two for at least six months. These can be revolving lines of credit such as credit cards, or installment debt such as car payments or student loans. Note that they do not necessarily have to still be open, but whatever balances and monthly payments you still have will be counted against your debt to income ratio.

Also, you generally need at least two open lines of credit in order to have credit scores reported by the major credit bureaus. Ideal is two long term credit cards with very small balances. The way I handle this is to charge one thing per month for about $20 or so that I would normally pay cash for, and pay the bill in full when it arrives. You will need an appropriate credit score for what you are trying to do. What score is sufficient will depend upon the exact characteristics of your transaction. Better scores will lower your rate, and therefore your payments, but the best thing that can be said about a 580 credit score (which some lenders will accept for FHA loans) is that it isn't putrid. Unfortunately for those who want to buy now without any cash, the lenders have now figured out that them being on the hook for 100% of the value of the property is a good way to lose money. I do anticipate 100% financing returning eventually, but "eventually" could be years, and even A paper has introduced differentials to the tradeoff between rate and cost based upon credit score, where until recently, as long as you staggered over the line into qualification, you'd get the same rates and costs as King Midas.

The last things I will mention that will stand you in good stead are also optional: An educated layperson's knowledge of the process (I would like to think being a regular reader here will help with that), a investigative attitude, and the willingness to shop effectively for services, both loan and real estate. There seems to be popular resistance to this, but getting a good buyer's agent will not only save your backside, it'll make a real difference to the quality of the property you end up with as well as to how much you pay.

Caveat Emptor

Original here


Many people think that mortgage interest works like rent: paid in advance before you live in the property for the month.

This is not the case.

Mortgage interest is paid in arrears. As you begin the month, interest begins accruing. It accrues throughout the month, and the payment is due at the beginning of the following month. The reason for this is that the interest is unearned until you have actually borrowed the money throughout the month. You could win the lottery, write a best seller, sign a contract a with professional sports team, or any number of other farfetched but real possibilities for suddenly acquiring a windfall of cash enabling you to pay that loan off. You could also refinance, in which case that lender is only entitled to the interest from the days you had their loan.

When you refinance, however, or even when you take out an initial purchase money loan, you will generally be required to pay the interest for the remainder of the month on that new loan in advance. The reason for this is quite simple administrative - it gives the lender some time to set all the bookkeeping on that account up, gives them a full month at least between initializing the loan and the time any money should be hitting their account in payment of that debt.

So when you refinance, you make an upfront payment to the old lender for the part of the month they held your loan during the month, and to the new lender for the time they held your loan. Say the new loan funds and pays off the old loan on June 15th. You will pay the interest from June 1st to 15th to the old lender, and from June 15th though the 30th to the new lender. You never, ever, get a free month, because interest never stops, at least so long as you owe the money. In point of fact, I tell people to think of it as making their normal payment early, as in this case they're writing the check they normally would have written July 1st two weeks early on June 15th. It's really just the interest owed, but since most folks don't keep their loan more than a few years, there usually isn't a large proportion of principal in their regular payment anyway. Therefore, if you think of it as your regular payment, paid early, it'll usually be a little bit less. There are usually one or two days of overlapping interest, which is why most escrow officers won't request funds on a Friday. You don't want to be paying interest on two loans over the weekend to no good purpose.

So why do lenders use the "skip a month of payments!" come on? Some will even use, "Skip two payments!" Because a new loan is being originated, they can (generally) roll that money into the balance on your new loan where you not only pay the money, but you pay interest on it for as long as you owe that money. Make you feel all warm and cuddly? Didn't think so. Anyone who uses the "skip a payment!" promise to get you to refinance has just told you point blank that they're a dishonest crook. However, since most people don't know how to translate loan officer speak into English, they get away with it disgustingly often. The state of financial education in this country is a national disgrace. Of course, it's to the benefit of certain political groups to have voters believing that there is such a thing as a free lunch.

You never really skip a loan payment when you refinance. If you try, all you're really doing is adding it to your balance. You can decide to pay your balance down at loan inception and pay closing costs out of pocket, and while an accountant or financial planner will generally tell you there are better uses for the money, it can be a very smart thing to do if your circumstances are right for it.

Caveat Emptor

Original article here

You've probably heard the horror stories, and I've mentioned the possibility more than once. Some unsuspecting person is looking at properties beyond their price range, and it therefore has all kinds of attractive features that properties which are in their price range do not have. They are just about to regretfully but firmly put the notion of buying this particular property out of their heads when the Real Estate agent whispers seductively, "I can see that you want it, so let me show you how you can afford it!"

There are all kinds of reasons why this happens. Bigger commission check for the bigger sale certainly is one, but a far bigger concern to most of the predators who do this is that it's an easy immediate sale. Instead of having to take those folks around to dozens more properties that are in their price range (and perhaps lose them to some other agent taking advantage of an opportunity in the meantime), while the clients agonize about the trade-offs of linoleum versus carpet in the bathroom and kitchen, and maybe if they'll keep looking just a little while longer they'll find one that is perfect despite the market, so they're not going to make an offer today, thank you very much, this predator has shown them the equivalent of the holy grail, provided the clients do not understand the downsides of the loan that is necessary to procure that property.

There is a reason why I advise people shopping for a property to make a budget based upon what they can afford based upon current rates on 30 year fixed rate loans costing no more than one point total, or at the very most a fully amortized 5/1 ARM, and stick to it (It's actually harder to qualify for the 5/1, due to lower debt to income ratio guidelines). That's the maximum price you will offer - end of discussion. Even if you, the client, end up applying for another type of loan that has lower payments, if you could make the payment on a thirty year fixed rate loan, you are pretty certain you are not getting in over your head. But shop by sales price, not payment. It's not like the sharks haven't figured out that suckers shop by payment - so don't be a sucker. "Creative financing" has become so pervasive and so varied that shopping by the payment the real estate agent has posted, or tells you about, is severely hazardous to your financial health. Maximum purchase price you are willing to consider should be the most important thing buyers discuss with their agents, and the budget must be quoted in terms of purchase price, not monthly payment. There are too many games that can be played with monthly payment, and just when I think I have them all covered, another one pops up.

Indeed, the very head of the list of reasons why buyers should fire an agent is that the agent showed them a property which can not reasonably be gotten for the sales price limit they told the agent about. You tell me that your limit is $320,000, it might be okay to show you a property listing for $340,000 or even $350,000 if buyers have enough power to bargain it down to the agreed maximum and are willing to walk away if they can't. In a seller's market, of course, it would likely rule out anything where the ask is over $325,000. But if the agent show you a property listing for $450,000, simply ask to be taken home or back to your vehicle immediately, and then inform them that their services are no longer required and that you desire them to make no further efforts to contact you. Were I shopping for a property, I would demand to know the asking prices before I went, and not only fire the agent but also refuse to go if they cannot show me why they think this property can be obtained for the total cost limits we have agreed upon. Not monthly payment limits, sales price.

So what loans should not be used to purchase a property? Well keep in mind that this list assumes that your loan providers are telling the truth about the kind of loan they are working on for you, an assumption that, judging by a dozen or so different e-mails I've gotten from people who were scammed, is increasingly iffy. Furthermore, if you are a real financial and loan expert, there are reasons why these warnings may not apply, particularly if the property in question is investment property, but those sorts of experts should know the exceptions, should not be looking to this website for advice, and are always able to accept the financial consequences of not following these guidelines (in other words, they have the ability to absorb the losses).

The absolute head of the list, the loan that should never be used for purchase of a primary residence is the negative amortization loan. Known by many other friendly sounding names such as "pick a pay", "Option ARM", "COFI loan," "MTA loan," and "1% loan" (which it is not), this loan is a truly horrible choice for the vast majority of the population (99%+). It was only approved by regulators to service a very small niche market, and if you are a member of that niche market, chances are that your Option ARM will not be approved by the lender! This loan is usually sold strictly on the basis of the fact that the minimum payment is lower than any other type of loan, making it look like clients can afford a loan that they cannot, in fact, afford. This low payment is based upon a low nominal, or "in name only" rate that is not the real rate the money is accumulating interest at. In fact, the real rate that you are being charged is currently at least 1.5 percent above equivalent rates for thirty year fixed rate loans, as well as being month to month variable. How often do you think people who are being fully informed of the loan would agree to accept a rate a full 1.5 percent higher on a fully variable loan than what they would have gotten on a thirty year fixed rate mortgage, and with a prepayment penalty also? The lenders pay very high yield spreads for doing these loans, and the bond market pays even higher premiums, so many lenders push them hard, and many wholesalers push them even harder. Despite being warned that I was not interested in any loans that feature negative amortization, three new potential wholesalers had gotten themselves thrown out of my office in the month prior to originally writing this. I guess they weren't interested - or able - to compete with other lenders on real loans. Fortunately, now that the chickens have come home to roost on this "Nightmare Mortgage," very few lenders are quite so eager - or even willing - to offer them. The lenders lost a blortload of money on them, investors aren't buying the bonds, and the federal government has made them very difficult to sell. I hope that continues because the absurdly low percentage of people who saved their homes after signing up for a negative amortization loan is completely unacceptable. And although this loan is gone now, I'm leaving it in because I thought it had been permanently staked through the heart in the early 1990s too.

The Interest only 2/28 does have one redeeming factor, as compared to the negative amortization loan: At least your balance isn't getting higher every month. With the average loan around here being about $400,000, a rate of 5.5% would have the payment being $1833. But if that's all you can afford, what happens in two years when the rate adjusts and it starts amortizing, and if the market stays right where it is today, the payment goes to $2771, an increase of 51%? You haven't paid the principal down. There's a pre-payment penalty stopping you from selling or refinancing until it does adjust. If prices have appreciated enough to pay the costs of selling you might not come out so bad, but what if they haven't, or if prices have actually gone down? This is not the sort of bet that someone with a fiduciary relationship should make, as real estate prices increasing in two years is not something you can make a risk free bet on. Millions of people are finding that out right now.

The next loan on the list is the 3/27 Interest Only. This does offer you one more year to get your act together and start making more money to make the payments with than the 2/28. The downside is that it actually adjust higher due to the increased interest only period. In the example above, the payment would adjust to $2804, an increase of just under 53%. This also means you have another year for the value of the property to do the historically normal thing and appreciate a little. Still doesn't mean it's a bet somebody with a fiduciary responsibility should be making with your finances.

The scamster's new favorite substitute for the essentially extinct negative amortization is the buydown, because it allows them to quote a lower payment and a lower interest rate, because they can pretend that the initial rate and payment are what is important. Most suckers will only look at now, and be far less concerned with a year or two down the line ("and maybe the horse will learn to sing"). Make no mistake - that rate and payment will rise in one year, and will almost always rise again in two. So not only are you stuck with what's probably a higher loan rate than you can otherwise get, but you paid good money - more than you will recover - for that temporarily lowered rate.

The next type of loan to be wary of is anything stated income or even lesser levels of documentation (NINA or "no ratio" loans). These loans are great and wonderful if you really are making that money and really can make those payments, but don't let the temptation to buy a more expensive property lead you to exaggerate what you really make, or allow a loan officer to exaggerate what you really make, in order to qualify for the loan. Remember, you are still going to have to make those payments, and if you can't, the bad things that will happen more than counterbalance the nicest thing that might happen. Again, millions of people are discovering this right now. As of this update, I know of no loan providers offering a stated income loan. The downside to this is that the people stated income was designed to serve now can't get a loan at all. The upside is that people it's inappropriate for can't be seduced into something that's most likely going to ruin their financial future.

Somewhat less dangerous are interest only loans with a longer term or extended amortization loans. A five, seven, or ten year interest only period, while much more endurable than a two or three, is still not a certain bet of making a profit. Same thing with a forty or fifty year amortization loan. Given the way the rate structure is applied by most lenders, these loans are given out by lenders wishing to cover questionable lending practices to people who do not qualify for interest only loans according to bond market guidelines. Still, if it's got a good long fixed period of at least five years, you are paying the balance down and it's a reasonable bet that you will be able to sell for a profit before the adjustment hits. Not a certain bet, but a reasonable one, as in "the odds of making a profit or being able to refinance on more favorable terms before the payment becomes something you cannot afford are definitely on your side."

The ordinary 2/28 and 3/27 are dangerous enough for most fully informed adults. Using the interest only examples above, the 5.5% rate actually becomes 5.25% fully amortized, as it's a less risky loan for the lender. The initial payment becomes $2208, which does pay the loan down some, but then the payment becomes $2691 (in the case of the 2/28) or $2678 (3/27) holding the market constant as it sits and keeping other background assumptions constant. If you cannot afford these smaller jumps when they happen, at least you've got several thousand dollars that you have paid the principal down to use for closing costs on the new loan or towards the costs of selling, but be aware that the market is never reliable in its fluctuations over a short period of time, and using these loans for a purchase can and many times has meant that when the fixed period ran out, those people who choose these loans are in the unenviable position of being unable to afford their current payments, being unable to refinance, and being unable to sell for enough to break even when you consider the costs of selling.

There is nothing really wrong if you can afford the thirty year fixed rate loan but deliberately choose some other loan. I do this myself to save money on interest charges, which is the real major cost of the loan, but as narrow as the gap in rates was when I originally wrote this, even I might have chosen a thirty year fixed rate loan if I had needed to refinance. It's not being able to afford the sustainable loan that will kill you. If not a thirty year fixed rate loan, at least a fully amortizing ARM with a fixed period of at least five years. I do like the 5/1 ARM, however, and rates for it are once again becoming attractive - as in significantly lower than the thirty year fixed rate loan.

The most important things about any loan is the interest you are being charged for the money you are borrowing, how long it lasts, and the cost in dollars of getting that loan done, not a lower minimum payment that, certain as gravity, has a gotcha! engraved on it that will cause you to regret getting that loan. Unfortunately, we cannot go back to the past with information we learn in the future, and real estate loans are especially unforgiving of borrowers who do not understand the future implications of their current loan decisions.

As a final note, I have structured this essay around the loan to purchase a property, but the arguments work just as strongly and just as universally for so-called "cash out" refinances as they do for purchase money loans.

Caveat Emptor

Original here


Many agents seem to answer this question differently depending upon whether their client is the prospective buyer or seller, according to what they think will make the client most comfortable. When their client is making an offer, "No, your deposit could never possibly be at risk," while when their client is evaluating an offer, "And besides, if they renege or can't bring it off, you get to keep the deposit." Both of these are false, misleading, and practicing law without a license.

The cold hard fact is that the deposit is always at risk, but there is absolutely no guarantee that a jilted seller will get it, either. The answer to "Is the deposit at risk?" from a real estate agent can never honestly be anything other than "Yes."

For buyers, the deposit is "at risk." Otherwise, what would be the point of having it? If it couldn't be lost, why would it need to go into escrow? Just to prove the buyer has a couple thousand dollars to their name? I can do that with a Verification of Deposit. The only reason to make a deposit on a purchase offer is that it is at risk, and no listing agent in their right mind is going to accept any purchase offer where there is no deposit - even if the buyer is doing a "one dollar down" VA loan. That seller is risking a minimum of a full month of all carrying costs (usually much more) upon your representation that you want the property, and they are entitled to keep your deposit if certain conditions are met. For sellers, no you don't automatically get the deposit if the buyer flakes out. There are burdens upon you and your agent, and contingencies, aka escape clauses for the buyer, built right into the purchase contract. You don't want to allow those clauses, that's your choice, but you'll severely restrict the number of people willing to make offers as well as the price you will actually get. Even if the seller negotiates the payment of the deposit to them as part of the contract, the buyers can still sue to get it back. This is the real world and an offer is being made with real money and real consequences to that money. If you're unable to come to terms with that fact, stay a renter, because that fact is not going to change. For agents, if the only way you can make a sale is to misrepresent the deposit, it doesn't take a great fortune teller to see a courtroom in your future.

For buyer clients, I can do a lot to keep a deposit from being forfeit - any agent and loan officer can. Get out in front of all the contingency issues and any other reason that my client might decide they don't want to purchase the property, and get them dealt with right away, during the contingency period. Loan, appraisal, inspection, I want them all done before their contingency expires, or at the absolute minimum, a loan commitment with contingencies I'm certain we can meet. As of this writing, I have not yet lost any buyer deposit money. Nonetheless, since no agent can honestly guarantee the deposit will not be lost, I cannot and will not pretend that I'm some kind of exception to the law. The only way I could make such a guarantee is by putting up my own money as a surety, and if my client lost a deposit for a reason that was in any way my fault, I hope I would reimburse them (Until it happens and I'm facing an actual choice, there's no way to be certain). But it's not my investment, and if the investment succeeds, I'm not going to share in the proceeds (I'm given to understand that's illegal, at least in California), and one of the essential, unchangeable facts about investment is that there is no such thing as a risk free investment. If you don't understand this, any money or assets you may have can be considered a temporary thing, and you have no business in a profession with responsibility for other people's money. Anyone willing to say that there is no risk is either a fool or a crook. Nor is it likely your agent or anyone will reimburse you, especially for situations beyond their control, or if you misrepresent your situation or miss deadlines.

For listing clients, the same thing applies: Get what I need to done right away, and keep after that buyer's agent to remove contingencies in a timely fashion. If they won't remove contingencies when they are supposed to be removed, it tells me all I need to know. It's my client's call, but I know what my recommendation is going to be. I want the transaction to work, but I also want my client to get that money if it doesn't. Incidentally, Deposit issues are one reason of many that nobody should ever be willing to accept dual agency.

The bottom line is like something out of quantum physics: Schrodinger's Cat. Ideally, you want the sale to go through and record and for everybody to be happy because it all turned out exactly as agreed. Unfortunately, that's not perfectly predictable or knowable in advance. If it was, no real estate transaction would ever blow up, and the deposit would not be an issue. There are laws and procedures, and things agreed to in the purchase contract, that you have to be a real estate lawyer to offer an informed opinion about, and the judge, arbitrator, or whatever making the decision to make a definitive ruling. Escrow has custody of the money, but they're not going to do anything without mutual agreement of the buyer and seller. Either side can potentially decide to be stubborn and force the matter to arbitration, court, or whatever is appropriate, and all the consequent expenses of the legal system (which additional money is also at risk as the usual agreement is that prevailing party is entitled to legal expenses). And the legal system runs in incomprehensible ways for unpredictable reasons - the one thing that seems to be a constant is that if the judge wants the ruling to go a certain way, they can probably find a precedent to justify it if they try.

The point is this: The deposit is at risk. It is not "safe", and it does not necessarily belong to the seller either. Since this is cash, people understand that it is real money, because they had to scrimp, save, and set every single dollar in it aside from other uses, so they get understandably nervous about it. It represents a great vacation, a down payment on a new car, or something else very desirable that they're giving up, and they're putting at risk of forfeiture. Against this, the seller wants it if the transaction fails. There are ways to protect it, and ways to endanger it, and you've got both agents working to their client's advantage. As with any other competitive or potentially competitive situation, that makes the result indefinite until the game is complete. It isn't common in my experience that the deposit is forfeit, but it does happen. And anybody who tells you otherwise is either lying or hopelessly incompetent. Nonetheless, real estate is such a powerful investment that you are well advised to come to terms with the risk, because it's a necessary risk in order to buy real estate.

Caveat Emptor

Original article here


When I wrote explaining why borrowers should consider a 5/1 ARM, because the tradeoff between rate and cost is lower for that loan, and most people don't keep their loans 5 years anyway, so having a likely need to refinance 5 years out is not an additional cost for most people with mortgages.

Costs for a loan break into two categories: The cost to get the loan done ("closing costs"). This pays for everything that needs to happen so that the loan gets done. These costs may vary from place to place, but they are absolutely mandatory - they are going to get paid. For instance, on a $400,000 refinance with full escrow, my clients are going to pay $2945 in closing costs, when you really include everything. Many lenders will try to pretend some or all of the closing costs don't exist in order to get people to sign up, but they do. I can save some money with virtual escrow in some cases, but $2945 is real. The proof is that I can put it in writing and guarantee not to go over. Lenders don't want to do this, but if they're not willing to put it in writing that they'll pay anything over that, the reason is because they know it's going to be more when it comes down to it at the end of the loan.

The other cost is the cost for the rate. There is always a tradeoff between rate and cost. If you want the lower rate, it is going to cost you more money. If you are willing to accept a higher rate, you can save money on the cost for the rate, to the point where it can reduce or eliminate the closing costs you're going to have to pay. Zero Cost Real Estate Loans exist - I've done dozens. I love them because they save my clients money.

NOTE: Since I wrote this Congress has changed the law to discriminate against brokers by making Yield Spread legally a cost of the loan, despite the fact that it adds zero to the amount the consumer pays and in fact can mean that what the loan actually costs the consumer is reduced. So technically, a broker can no longer deliver a zero cost loan. However, we can deliver a loan where you don't actually pay any money - either out of pocket or through increased loan balance. A matter of semantics and sounds to your average cynical but uneducated consumer like I'm weaseling in order to hose them later. If not for the law meant to confuse matters, it would be easier and more straightforward for consumers to understand. Thank Barney Frank and Christopher Dodd for "protecting" you.

You can lump the loan provider's profit in with the costs for the rate, as origination points, or in with the cost of the loan, as an origination fee, and pay it via Yield spread (if you're a broker) or even (in the case of a direct lender or correspondent) hide it in the fact that you're going to make a huge profit selling that loan on the secondary market, but I guarantee you it's going to get paid somehow. Nobody does loans for free, for the same reason you wouldn't work if you didn't get paid.

These costs are going to get paid. End of discussion. The costs are slightly different in states with different laws, but necessary costs are going to get paid. They can get paid out of pocket or they can get paid by rolling them into your loan balance but they are going to get paid. Most people don't understand loan costs which aren't paid by cash, and think that they are somehow "free", but that is not the case. Not only did you pay it, but it increases the dollar cost of any points you may pay, you're going to pay interest on it, and (less importantly) it's going to increase your payment amount.

The genesis of this whole thing was a guy I thought I had talked into a 5/1 ARM when I originally wrote this (rates are lower now). I went through this whole process of explaining why the rate/cost tradeoff for a 30 year fixed rate loan was not going to help him, and then a couple days later, he called me saying he'd found a thirty year fixed rate loan at 5.5, saving him three quarters of a percent on the interest rate and almost $400 on the payment. Remember that at the time, I had 5.5 available as well (rates are lower at this update). So I'm going to keep that exact same table:

30F Rate30F Cost5/1 rate5/1 Cost
5.5%2.65.25%1.5
5.875%1.85.5%0.9
6.25%0.25.875%0

The problem with the rate of 5.5% is that for a $600,000 loan, those closing costs are going up to $3475 (lender and third party costs are higher above the conforming limit) in order to get the loan done, and at the time, based upon current loan amount, 2.6 points would cost $16,100 and change. But he had gone to a loan officer who did his math as if that $19,585 (my loan quote at that time for that rate - I suspect the competitor's was higher) was going to magically disappear like one of a David Copperfield's illusions. He calculated payments and savings as if there were no costs - based upon the current balance and new interest rate and amortization period. Of course, this makes it look like the client was saving a lot of money $382 off the payment and three quarters of a percent off the rate, give him a whole new thirty years to pay off the loan, and pretend the costs of the loan aren't going to happen to get the guy to sign up. You'd think that somebody who reads this website every day would know better, but that does not appear to have been the case. In point of fact, the competing loan officer still has not told the guy how much his closing costs are or how much that 5.5% rate is going to cost him through him. I'll bet it's more than I would charge, but I don't know.

Psychologically speaking, what the competing loan officer is doing is smart. Because there's incomplete information available to the prospect, and I'm straightforwardly admitting how much it's going to cost (which is a lot, as most people who aren't billionaires or politicians think about money), an indefinite, uncertain number sounds like it might be less, even though it won't end up that way. Furthermore, by pretending costs don't exist, he has raised the possibility in the client's mind that there won't be any, because most people don't know how much lenders can legally lowball. There will be costs,and I'm willing to put my money where my mouth is that I have honestly represented mine. If this other loan officer could really deliver that loan at a cost lower than I can, there would be no reason for him to prevaricate, obfuscate, or attempt to confuse the issue. I've written before about how you can't compare loans without specific numbers, and there is no doubt in my mind that this other loan officer knows what those numbers really are - he just doesn't want to share that information, and the way our public consciousness about loans works, he can most often get away with it. It's still scummy behavior, and takes advantages of loopholes in the disclosure laws to practice bait and switch, knowing that when the deception comes to light (at closing) most people won't notice, and most of those who do notice will want to be done so badly they'll sign on the dotted line anyway.

Now what's really going to happen in 99% plus of all cases is that the costs are going to get rolled into the balance of the loan. The client certainly isn't going to be prepared to pay them "out of pocket" if they're not expecting those costs. So here's what happens: The client ends up with a new loan balance of $619,585 (Probably higher, because they're likely to roll the prepaid interest in as well, and quite likely the money to seed the impound account, but I'll limit myself to actual costs). In fact, the difference in payment drops to $290 when you consider cost, and $115 of that difference is directly attributable to starting over on the loan period, stretching out the repayment period to an entirely new thirty year schedule of payments (even though he was only two years in), completely debunking any serious consideration of payment as a reason to refinance. But lets compare cost of money, in the form upfront costs ($19,585 to get the new loan, versus zero to keep the loan he's got) and ongoing interest charges ($3125 per month on the existing loan, versus $2840 per month on the new loan). In this case, you're essentially spending nearly $20,000 in order to save $285 per month on interest. Straight line division has that taking sixty-nine months to break even. Actual computation of the progress of the respective loans cuts a month off that, to sixty eight months. As compared to a national mean time between refinances of 28 months, and this particular prospect is currently looking to refinance after less than that. In good conscience, I cannot recommend a loan where it's going to take him almost six years to break even, and by not considering the costs involved in getting that rate, he's setting himself up to waste probably half or more of the nearly $20,000 it's going to cost him to get that loan.

In fact, if this prospect were to refinance again in 28 months (once again, national median time), he would have spent $19,585 in order to save himself $7847. That doesn't sound like a good deal to me, and it shouldn't sound like a good deal to you. But here's the real kicker: The balance of the loan he refinances in two years is $19,250 higher. Let's assume it takes a low rate, rather than a cash out refinance to lure him into refinancing again, so he gets a 5% loan to refinance again. The extra $19,250 he owes will continue to cost him money, even thought the benefits of the refinance he is considering end when he refinances again or sells the property. At 5% for a putative future loan, that $19,250 extra he owes will cost him $962.50 per year extra on the new loan. Even if he sells in order to buy something else, that's $19,250 the client needs to borrow, and pay interest on, that he otherwise would not. Even if the client waits a full five years to refinance again, he's only saved roughly $16,400 in interest, and the additional balance owed on the new loan has actually increased slightly, to $19,280 (Remember, he's two years into the existing loan, hence $115 of phantom payment savings which keeps reducing his balance if he keeps paying it)

Failing to consider the fact that most people are not going to keep their new loan as long as they think they will is the gift that keeps on giving - to lenders. I run across people in their forties and fifties who have done this, all unsuspecting, half a dozen times or more, running up eighty to a hundred thousand dollars in debt for nothing but the cost of refinancing, and at 6% interest, that's $4800 to $6000 per year they're spending in interest on that debt. A more careful analysis says that the calculus of refinancing should emphasize finding a rate that helps you for a lower cost, but that's not the way lenders get paid the secondary market premium, and that's not the way that loan officers get paid to do lots of loans. Therefore, if you find someone who will go over these numbers with you and tell you it's not a good idea to refinance when it isn't, that loan officer is quite a valuable treasure because they're going to keep you from wasting all that money to no good purpose. (Here's one guy who will for my California readers)

A good rule of thumb is that if a zero cost loan won't put you into a better situation, it is unlikely that paying costs and points to get the rate down is really going to help you either. You are unlikely to recover those costs and points before you sell or refinance your property. If a loan that's free doesn't buy you a better loan than you've got, then the current tradeoff between rate and cost isn't favorable to refinance. There may be reasons to do so anyway - cash out, ARM adjustment, etcetera, but chances are against you getting a rate that is enough better to justify the cost. When you consider how often most people refinance or even actually sell and move, it's hard to make a case for anything other than low cost loans and hybrid ARMs. I understand the people who want the security of a fixed rate loan and a low fixed rate - especially with the loan qualification standards as fussy as they currently are. But that rate, especially, is likely to come with a cost that they will never recover before they voluntarily let the lender off the hook. Good mortgage advice takes this into account, with the net result that the folks don't end up in debt to the tune of $80,000 to $100,000 extra, and spending thousands of dollars per year just on interest for money they shouldn't owe in the first place. No, they never wrote a check for it, but it's money they spent, and if they had needed to write a check for it, they probably wouldn't have spent the money in the first place. Kind of like having a credit card with a balance owing of $80,000 or more, just for the unrecovered costs of refinancing, but people don't realize it because it's not broken out of the total cost and balance of their mortgage, and nobody educates them as to where they would be if they hadn't made these mistakes. I try to teach my clients what they need to know to avoid that situation, so they don't find themselves victimized by it.

Caveat Emptor

Original article here

For Sale By Owner Issues

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I've been taking a long look at the world of For Sale By Owner and similar concepts lately. With the digital revolution, you always want to be watching the tide to figure out if you're in a business that's about to go the way of milk delivery and diaper service - a few left, but only a tiny fraction of the size they were. Since blogs and online magazines replacing or at least greatly supplementing mainstream journalism is one thing I'm constantly reading about, it might be good information to know if my real career is about to go the way of journalism.

At this point, I'm not worried about needing to change professions. The world of For Sale By Owner (FSBO) does seem to be figuring out the legal ramifications fairly well. There are resources available to get most, if not all, of the legally required disclosures for sellers to avoid future liability to the buyers. I'm going to go on record as believing from the things that I have read and seen that they are not as assiduously practiced as they are by people with real estate agents working for them. Reading the groups, I am seeing all kinds of whining about "Do I have to disclose X?" "Do I really have to disclose Y?" Sometimes, the stuff is minor and inconsequential (leaky toilet, drippy faucet), but a lot of times it's pretty major as well (water leak in/under slab, lead based paint, asbestos, "minor" cracks in the slab). Mind you, I've heard similar whining from real estate agents, particularly new ones. But the real estate agents at least want to be in business (and not sued) for a long professional career with many transactions every year, and so have motivation to disclose everything they find out about, lest one transaction cost them their license. Many individual owners, it seems, even the ones who have been made aware of the legal requirement to disclose, are hoping to get through the one transaction unscathed. After all, they hope they're going to be long gone when the problem crops up. To this, I say, don't count on it, and failure to disclose can often make your legal liability worse than it needs to be.

Needless to say, this is a big "let the buyer beware," when dealing with FSBO properties. You're standing across the table from someone with an immediate motivation to not tell you about whatever metaphorical bodies are buried in the property because once told you may not still want to buy, and most particularly you may wish to reduce your offering price. They have only a hazy motivation to tell you - the indefinite threat of perhaps some legal action sometime in the future, when they may or may not have assets you can even go after. If that doesn't make you uneasy, something is wrong.

One area FSBO is falling short in is picking an appropriate asking price. By the evidence, this is not only lack of information but also homeowner ego speaking here. Some people are not aware of what their home is really worth, or if they are aware then they are ignoring the evidence. Speaking from personal experience, persuading people to put an appropriate asking price on their property is one of the most difficult parts of the listing interview. Also significantly, in the long seller's market we had, many real estate professionals were making a lot of money buying "For Sale By Owner" properties that were under-priced, and immediately "flipping" them for $30,000 to $50,000 profit, often more. Here's the math for a property that sells for $460,000 but should have sold for $500,000: In the latter case, assuming you pay a standard 5%, you paid a $25,000 commission, split between the buying and selling brokers. But you come away with a net that's $15,000 higher. I personally know of several sales where an agent purchasing a FSBO property then sold it again before escrow was even completed for profit of $75,000 or more.

There is still some of that going on, but the problem with most FSBO properties seems to be over-pricing the market, rather than under. Their neighbors house sold for $500,000, and by god they are going to get $525,000. Never mind that the neighbor house has an extra bedroom, an extra bathroom, 800 more square feet, sits on a corner lot that's twice the size, and most importantly, sold when demand was high and supply was low. They are going to get that price, come hell or high water. So they put that out as the asking price, and they wonder why the one or two people to express an interest vanish as soon as they've seen it. The reason is simple: They've priced themselves out of the market. There are better homes to be had for less money. In a fast rising market, this may be a survivable defect. When prices are rising as fast as they were, the market would catch up to anything that was vaguely reasonable. That has changed now. It's bad enough with people who have a real estate agent for their listing. Two of the hardest fights with listing clients in this market are keeping the property priced to the market, and getting them to accept what in today's market is a good offer rather than hoping for previous years' "bigger fool." Seems that most people who don't have an agent are just in denial. There's a FSBO two doors down the block from a corner listing we had where I held an open house. Even with me drawing the traffic to him, he didn't get a single offer because his asking price was too high. That's fine if you would be happy and able to stay if the property doesn't sell. If you're not in that situation, it's not.

Another area where FSBO properties are falling short is in marketing. They've got an internet advertisement and a sign in the yard. Maybe they've got an advertisement in the paper (usually the wrong one), and maybe they are holding open houses. All of these are nice. None of these are optimal. First thing is that internet advertisement you have is often on one site where even internet savvy buyers don't necessarily see it. Even if that is free, it's probably worth money to list on a co-operating network of sites. For Sale By Owner signs in the yard are more bait for agents than a prospective buyer. I'll put a sign out there when I get a listing also - it does catch a few people, and a sign with an agent or broker's name on it keeps other agents from bothering you. But it's a long shot at actually selling the property.

There are places to advertise your property to actually sell it, and there are places where agents advertise their business to attract new clients. Most of the FSBO ads I see seem to be in the latter sort of place. I don't think I recall a "For Sale By Owner" ad in the places where I'd expect it to generate significant actual interest in buying that particular property. There are reasons for this. The ones that are likely to generate interest require more lead time. I don't mind spending the money (especially amalgamating my listing with other listings in the office). Even if it sells before then, it helps the office generate more clients we're going to go out and show similar properties with, and I get a certain proportion of those. But For Sale By Owners tend to balk, as they are thinking one transaction. There are also resources that make an Open House effective, but are not cost effective for somebody looking to sell one house.

Number one resource for actually selling the property is the Multiple Listing Service (MLS). Put it out there where the agents who the buyers come to will see it. My primary specialty is buyer's agent. I know they are ready, willing and able to buy a property. Do I even take them to look at "For Sale By Owner" properties? Not unless I know ahead of time that the seller will pay my commission. Nor does any other buyer's agent I know of. Before you "For Sale By Owner" types start cursing us, remember first, we've got to make a living so we'll be there for the next buyer. Second, we're actually living up to our fiduciary responsibility when we do this, as I've got their signature on a piece of paper that says they'll pay me if you don't. So unless your property is priced far enough under the market to justify the expense on my client's part, your property is not a contender, and I'd better be prepared to justify the expense on my client's part in court, so your under-pricing the market has got to be by more than my commission. Furthermore, going back to legal requirements, I've got to figure that there is a higher than usual chance that the seller will not make all the necessary disclosures, or perhaps won't tell the complete truth and nothing but the truth on them. This puts my clients, and through them, me in a bind: Sure my clients can and will sue you, but if you don't have the money my insurance is likely going to end up paying out, because even though I've done everything I reasonably could have done, you didn't have an agent.

Given that the Multiple Listing Service is far and away the best tool for selling any given property, if you're not on it, you're missing out on buyers. If you don't have a selling agent's commission listed on Multiple Listing Service that is at least what is specified in the default Buyer's Agent Agreement in your area, you are missing out on buyers. If you don't have an agent at all, you are missing more buyers. Because I, like other buyer's agents, want to be certain we're not wasting our time. I've done a real pre-qualification or even a preapproval on my buyers (if the transaction doesn't actually go through, I don't get paid by anyone). Compare that with Mr. P, whom I sent away the night before I finished this essay. He's out there looking at houses he wants to buy, but the fact is that given the situation he should continue renting. A competent loan officer such as myself who was less ethical could maybe get him the loan anyway, or maybe not. It would certainly be an uphill fight. So he's out low-balling "For Sale By Owner" properties on his own today. The one who's desperate enough to sell at that price needs the transaction done with the first buyer who comes along, and is going to spend at least a month finding out there's only a small chance of the transaction actually going through, a month that they likely don't have to spare. The other For Sale By Owners are likely to get mightily annoyed with him, but he's the customer they're most likely to get.

There are also issues of timeliness and context and negotiations to consider. Putting your property on the market for the wrong price is a recipe for disaster, because by the time you figure out that the buyers aren't interested at that price, your "days on market" counter is so high that they're not interested, period. Agents know - because they're dealing with the issues all the time - what is a good response in this situation to a given event, and the good ones understand a lot more about keeping negotiations appropriate, so as not to lose what really is a good offer.

Caveat Emptor (and Vendor)

Original here

Yet that is exactly what you want them to do.

To avoid competing on price, they have all kinds of distractions they offer to make life more convenient, but not cheaper. They offer automatic payment options, the convenience of having your mortgage at your corner financial institution, biweekly payments, mortgage accelerators, and even negative amortization loans, which offer the apparent benefit of lower payments, which many uneducated consumers believe is price, at the price of a much higher interest rate than you would otherwise be able to get, which is the price the lender really cares about, and the one you should also.

There is always a trade-off between rate and cost for a given type of loan. That doesn't mean that different lenders won't have different trade-offs. Some are less willing to compete on price than others, so they tell you about how great their service is, how you are such a difficult loan that nobody else can do, or how easy their paperwork is, or how easy their loans are to qualify for. As a matter of fact, the lender with the easiest paperwork and loosest qualification standards will usually have the highest price trade-off, because their loans are statistically more likely to default, and therefore have to bring in a higher interest rate in order to have the same return.

Just like branding in the world of consumer products, which is also in effect for mortgages (why else would National Megabank be spending all that money for commercials? They expect to make a profit on it!), all of these little extra bells and whistles increases the price they can charge consumers for their loans, which is to say, the rate that you get, and the cost to get that rate.

So long as the terms are comparable, a loan is a loan is a loan. Provided that it has no hidden gotchas, a 5.875% thirty year fixed rate loan is exactly the same loan from National Megabank as it is from the Lender You Have Never Heard Of. No pre-payment penalty, and lower costs for the same rate? That's the lender I'll choose. It should be the same one you choose as well. It doesn't matter to me what name I make the check out to, or what address I put on the envelope. It shouldn't matter what routing symbol you put on the automatic payment, either, if that's what floats your boat. Lower rate for the same cost on the same loan? Same situation. Everything else is window dressing.

(Okay, it doesn't often matter to me. There are lenders that I'll bet you've heard of where I won't place my client's loans no matter how good the price due to some issues with their lending practices. But those lenders trend heavily to be the ones with massive consumer ad campaigns that don't really try very hard for broker generated business, anyway, because brokers learn to stay away from them fast. Nor are they usually competitive on price, because they're aiming for the "consumers shopping by name recognition" market).

So how do you force lenders to compete based on price? It's actually very simple. Ignore all of the stuff that they try to distract you with, like low payments for a while or mortgage accelerators or biweekly payment programs. Those are bait, and they serve the same purpose as bait: To get you to take the hook. Think about the things that happen to the fish after it takes the hook. That's you, if you take the hook. Concentrate on the type of loan, the rate, and the cost to get that loan. Here is a list of Questions You Should Ask Prospective Loan Providers. Ask all of them with every conversation you have about what is the right loan for you, and the best rate and cost they can deliver on that type of loan. After you have settled on one loan with one provider, it is then okay to ask about the bells and whistles that lenders (and every other sales organization) love to distract you with. If you want auto-pay, or biweekly payments, or a mortgage accelerator, these are just as much in the lender's best interest to offer you as they are convenient for you to have. I wouldn't pay for them, but many people think they're nice to have, and that's fine. Just don't let them distract you from what's really important: The price of the money you're buying.

Caveat Emptor

Original here

First of all I love the information on the site. I've done some research into buying a home and have talked to several people who have bought homes and I can never believe the stories I've heard. My response is always "why didn't you just walk out . . it's only a $2000 deposit . . . you're paying that in the first year with the difference in interest you are getting now" but after reading your site it seems to me you would have to get lucky to find a good mortgage broker and get a good loan where what you are told is what you get. The rule seems to be if you want a house "getting screwed" is just a part of the process. In this market (DELETED) you would need to be especially lucky to find someone who is willing to be honest . . . it's a risk and, again, it seems to me being honest is will just lead all clients to the fibbers who, frankly, tell people what they want to hear.

Anyway, back in May 2003 I was looking for a house and a friend of mine was looking to invest $70,000 (that he got from another land sale) so he wouldn't have to pay taxes on it. We ended up buying a $150,000 home where I live now. By "we", I mean "he" because my name couldn't be on the loan for tax purposes (at least that's what they told us . . . it's hard to get good information). And, I know, I know, I have no rights and he can do whatever he wants and I understand that. If anything I've had a place to live where the rent was relatively low (but it sucks that I didn't get a house when they were affordable). I've been living in this house and paying the mortgage for more than 3 years now. I'm in a much better financial situation now and I'd like to buy the house from him. He also has another $70,000 from another land sale (I'm not sure of the details but suffice to say he is thinking about paying off the mortgage). Anyway, once all this happens I want to buy the house from him at a price way below market (similar houses are now around $300,000 but there is no way I'm paying $300,000 when I could have gotten it for $150,000 when I moved in). My question is: can a seller also be a lender? Where do I start? I've talked to a few people and they won't touch it . . . in fact, they have no advice whatsoever beside for me to move out and get my own house (which they would be happy to help me with). What are the tax implications of all this?

Thanks again.

If it was inevitable that you would get screwed as part of doing a real estate transaction, most of the information on this website would be useless and pointless. Furthermore, if it was inevitable, I'm not certain it would be appropriate to call it "getting screwed," if it happened on every transaction - it would simply be the way things are. But that is not the case - better outcomes are possible, and not uncommon. What I'm trying to do here is give folks the tools to get correct relevant information, make rational informed choices, find honest competent service providers (it is not as difficult as I may make it seem sometimes, but neither is it easy!), and in general have a better outcome, which is the target you really want to hit. How much effort you want to spend is up to the individual reader. If you want to do only the easiest and most basic items, it should still make a significant difference. If you want to go whole hog, you should see much larger benefits.

Now, as to your specific situation, here are the issues I see:

First off, I have never heard of a situation where you cannot be on the title "for tax purposes." The only tax purposes that would serve is allowing the other person to get the entire deduction, which he would anyway from being the only person on the loan. As soon as the loan is recorded, there is no reason why there could not have been a quitclaim from him to him and you (in whatever manner you desired to hold it, most likely tenants in common in this case). This would have started the clock on having you on title, and since you cannot refinance for cash out within six months of having your name put on title via quitclaim, this constrains your options as well as putting you at your friend's mercy. You may have been paying the mortgage, but even if you can prove it this is unlikely to give you any legal rights if your friend decides not to play it straight. That's what I'm told anyway - talk to a lawyer in your state to be certain.

The next issue, relatively minor, is that you have no verifiable history of paying either rent or mortgage payments at this point. Those checks you have been writing to pay the mortgage in your friend's name? Well, that mortgage is being reported as paid, but your name is not on it. Rent? Not there either.

However, assuming this really is a friend who intends to play it straight with you, this situation is very workable. If it was someone who wanted to work you over, you would be well and truly hosed. You bought for $150,000, of which your friend furnished $70k. The loan for the remainder that you have been paying for sure looks like your contribution to me! By my reading, this makes him approximately 7/15ths owner, and you 8/15ths, but if your friend has been playing it straight, he's done you a pretty big favor not just by tying up his money in the down payment, but by allowing his credit to be used for your loan. This has effects on his debt to income ratio if he wants another loan, among other things. I wouldn't mind ceding him a larger share of ownership were I in your shoes.

Whatever the amounts of ownership you agree upon, however, you are also going to need to agree on a method for valuation. Assuming you're not actually going to sell the property (in which case the net sale price would be the value) I'd probably agree to something like the average of a Comparative Market Analysis of sold properties in your area, and an appraisal. Appraisals are not what you could get on the market in the current conditions, and don't try to think that they are, but both measurements can be manipulated. Pay for each of them in equal shares. As compared to each of your investments, it's small potatoes, and a worthwhile guard.

You have an agreed valuation, and an agreed upon share of ownership. Out of that, you currently have a loan on your share, but that should probably be your issue, not the partnership's. So from that, you can figure what your friend's current share of ownership is, and therefore what he is due upon buy out. You should still have a pretty good ownership equity, roughly $80,000 by the rough amounts and ownership shares in the previous paragraph. So you need to come up with about $80,000 to pay off the current loan, plus about $140,000 (again, by the computations as to ownership share above, subject to revision per your agreement) to pay off your friend. Total owed: $220,000.

Your friend actually want to go from owner to lender, and I don't know of anything wrong with that, although in all truth I've never encountered it before in this context (seller carrybacks happen all the time in this market). Furthermore, he wants to invest an additional $70,000 in being the lender. Whereas this will not qualify for 1031 tax deferred treatment as far as I can see (consult a tax professional), this means you are going to have two loans on the property, one from a regular lender, and one from your friend. The specifics of this are difficult to see without more information, and shopping your situation around (I'm not licensed in your state, so I can't put my wholesalers through that for no potential pay off!). It could well be that your friend's loan ends up in second position, but it strikes me as more likely appropriate for a first, as the guidelines for Home Equity Loans and Home Equity Lines of Credit are more likely to have this whole situation be acceptable to your lender for the balance.

As to the structure of the transaction, it's going to look like a sale, but don't expect real estate agents to want to work through that without a commission, which you are probably not going to want to pay, because all of the hard work to the transaction is kind of irrelevant in your case. On the other hand, good loan officers do these all the time. However, the commission structure for Home Equity Loans and Lines of Credit leaves them not making a whole lot of money unless you agree to pay them a flat fee for going through all of this, and for all the times I tell people that transactions aren't as difficult as some loan providers would have you believe, this is a very difficult transaction. I normally work on less than one point of total compensation for loans but I'd probably want to see about $6000 in order to put this transaction through, and that's if everything else is perfect. I don't know about your state's predatory lending law (most states have one, limiting total loan costs to a certain percentage of the loan), which may well prevent them from getting paid enough to make the transaction worthwhile for them. By comparison, on a loan of about $80,000 plus transaction costs, which is what the computations above suggest, California's predatory lending law limits total cost of the loan (and also total lender compensation via another law) to $4800. In most cases, direct lenders can basically ignore this by jacking the rate up so that they can sell the loan for more on the secondary market, but brokers cannot. And whereas that's way more than plenty in most situations, in this case it is not.

On top of everything else, this is a related party transaction. You are effectively selling from a partnership to one of the partners. That is going to mandate shopping lenders not only for price, but for willingness to do the transaction based upon the situation.

When I first wrote this, the loan was difficult but possible in that way. Today, I wouldn't even try without an upfront compensation agreement. You're going to need a very flexible lender. A paper Fannie Mae/Freddie Mac is right out, and due to changes in the market flexibility in lending standards is mostly a thing of the past. I might be able to find a portfolio lender that'll do it, or maybe not. We are going to have to document an awful lot of stuff, and there are a number of points on which the loan can fall apart. You're also probably going to want this to be a short term loan without a pre-payment penalty, so that you can refinance after you've been on title six months or so, because you'll be able to get a better rate then (unless rates have skyrocketed). All this stuff adds to the complexity, and whether the loan will get funded or not is not something I can control by paying attention to underwriting guidelines like I can in other cases. This requires a lender who's willing to issue some waivers and exceptions, and I might have to submit this loan several times to different lenders over a period of months before it actually funds. That's probably the reason nobody wants it: They can't get paid enough to make it worthwhile. The predatory lending law may have good intentions, but in this particular case it's making life difficult for the consumer because brokers and correspondents can't get paid enough to make it worth their while, and any given direct lender (especially the ones that consumers see, which tend strongly toward the A paper cookie cutter loan tailored to the pickiest of secondary market guidelines) is unlikely to have sufficiently flexible guidelines. You could go to a hard money lender, of course, but those rates are about fourteen percent or so, which causes most consumers to say, "Never mind!"

There is one other alternative. He could use that cash to buy you out, at which point he is left with basically his current loan, and I think this might even qualify for 1031 deferral (but consult a qualified tax professional before doing anything). If he can't rent it out for enough to have a positive cash flow under those circumstances, something is very badly wrong. He verifies that you've been paying rent/mortgage/whatever, and away you go with $70,000 or so in your pocket and all the leverage a qualified buyer has in a very strong buyer's market, and yours becomes a very easy transaction. I think you could do very well for yourself, given what little I know of your particular market at this point in time.

Caveat Emptor

Original here

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amortization of real estate loans early payoff based on a lump sum payment

This is one of the smart things you can do. Not necessarily the smartest, mind you, but smart. Unless you have a pre-payment penalty, you can always pay more than your minimum payment, and often even with a penalty. The question is if there's a better way to get a return on that money, whether by paying down a higher interest debt or by investing the money in a new asset. If you owe thousands of dollars on a credit card at twenty-four percent when your mortgage is at six, why would you want to pay down a tax deductible six percent instead of a non-deductible twenty four?

Similarly, if you can earn ten percent somewhere else with the money, why do you want to pay your six percent loan down? Net of taxes, a six percent loan costs you about 4.5 percent, depending upon your tax bracket. Even if the return is not tax deferred, the net return on ten percent averages somewhere over seven percent for most folks. Say you are in the twenty-eight percent tax bracket and the ten percent is completely taxed every year. A lump sum of $10,000 will over the course of 15 years turn into $28,374 if invested. If it's fully tax deferred, it turns into $41,772. For comparison with other numbers later on in the essay, at twenty-seven years the numbers are $65,352 and $131,099, respectively. Not half bad.

Suppose you've got the cash flow to instead buy another property? That puts the power of leverage to work for you, and if you can rent out one of your properties or something, possibly multiply your money by a factor of ten within a few years. When you put ten percent down, and your new property appreciates ten percent while giving you a few dollars per month of cash flow, that's smart investing. At seven percent annual appreciation (historical average), you've doubled your purchase price in a little over ten years. A three hundred thousand dollar property will likely be a six hundred thousand dollar property in about ten years (It's just numbers), while you've paid the loan down from $270,000 to about $226,000. Even if your expenses of selling are seven percent, your gross is $558,000, less the $226,000 you've paid the loan down to, and you've come away from the property with $332,000, not counting those few dollars per month you netted after paying your expenses. Sure there are places and properties that don't pencil out, and being a landlord is a headache, but as you can see the potential rewards are substantial if it does "pencil out".

Now, let's say you do this every nine years on a three to one split, and 1031 Exchange the first two at least. After nine years you have $281,267 pre-tax, net in your 1031 account. You then turn around and buy three $600,000 properties. You end up with three loans of about $506,000 each. Assuming net zero cash flow on the properties, after nine more years, you have three loans at $434,100, netting you $1,775,286 into your 1031 accounts, which you then roll into three more properties each at $1.2 million purchase price. Your loans are $1,000,000 each, but you rent them for enough money to break even on expenses. After nine years, you sell all of these properties, and end up with just a little under $10,750,000 net of sales costs in your pocket before tax, which at long term capital gains rates (15%) nets you $9.13 million or thereabouts. Now, you did start with three times as much money, and nobody in their right mind sells off nine highly appreciated properties in one year, and you did have the headaches of being a landlord on an increasingly widespread basis for those twenty-seven years, but this illustrates the money to be made for the same investment. Patience and leverage working for you over time are far more powerful than any quick flip.

But assuming there are no better alternatives, it is a smart idea to pay down your mortgage. Here's why: Let's say your balance is $270,000 at six percent, and you pay your loan balance down by $10,000. Your regular payment was $1618.78, and it still is, but interest is $1350 of that. Only $268.78 would normally be applied to principal. Yeah, you've just sent them about six months of payments - but it just paid your loan down by three years of principal payments. Assuming you never sell and never refinance and never pay an extra penny again, you will be done in month 324 - saving yourself thirty-six payments for a total savings of $58,276. Not to mention that if you do refinance, you'll pay lower fees. Not in the league of some of the alternatives above, but still a nice return on investment. From a financial management standpoint, it definitely beats just spending the money.

Caveat Emptor

Original here


I got this email the other day, responding to one of my Hot Bargain Properties posts on my other site:


I am currently working with a coworker with no agreement. However, she has offered to rebate 50% of her commission. Are you negotiable with your commission?

I am very ready to buy a place at a bargain or discounted price. I have been pre approved by DELETED for $550 but I do not want to spend more than $525, preferably around the $450 range.

I have sufficient liquid funds for 10% down and have an excellent credit score...score 3 months ago was 752.

Let me know.

I do have lower cost and commission rebate packages for when buyers bring me transactions that have the property at least settled upon. The reason is that not only is there much less work to be done done, but I'm providing a lot less value in those circumstances. I'm not going out and going over dozens of properties, eliminating eighty percent of them before taking them around to see the good stuff. I'm not doing background checks on all those properties, looking for issues. At the point that the property is settled on, at least half of the value a good buyer's agent brings in is already moot. We've already dealt with the issue of which property (or properties) are worthy of making an offer on. Now we're down to negotiations, where I still provide a lot of value, facilitation of the transaction, which any real estate agent worthy of their license can do, and looking out for problems, which starts earlier when I'm locating the property, but when you have title companies and building inspectors and appraisers getting into the act and getting paid, it becomes easy. It's no longer a matter of spotting the issue before an offer is made, it's a matter of dealing with the issue if and when it pops up. Much easier, much less time consuming, and much less liability on my part. When you've decided to make an offer before I even come into the picture, there is no issue with whether my representations caused you to make an offer on the property when you would not otherwise have done so. I haven't been sued yet, but that's the number one cause of real estate lawsuits. Sometimes it's an unscrupulous agent telling the folks that the airport is going to close, but sometimes it's also people who think the agent said something they did not in fact say, and sometimes it's people who make something up due to buyer's remorse. If you've already decided to make an offer, that whole issue is gone. Liability? Much less. Amount of work done and time invested? Way less. Amount of value provided to buyers? Also much lower. So yes, I'll work for less in those situations.

When I'm responsible for finding the property, I retain the entire commission.

Yes, consumers getting half the buyer's agent commission seems like a good idea on the face of it. One to 1.5 percent of a purchase price in the hundreds of thousands of dollars. But how much value do those agents really provide? Consider: Did that agent find them something as interesting as the property they emailed me on? If the agent they were working with was finding them properties like that, there would be no need and no interest in working with me, and they wouldn't be asking about this property I found. If that agent spent enough time shopping the market that she even knows what is and is not a bargain, this person would never have contacted me. Does she look for problems and issues or does she just say "Here is the living room," and try to talk you into making an offer on every property? What value is that other agent providing you? If the answer is, "not much," then no wonder she's willing to rebate half the commission! As far as she's concerned, the half she does keep is free money for going around and looking with you. My goal is that my clients end up with at least 10% they would not have had without me - either a better property for the same money, or the same value property for a lower price, or some combination of the two. Now, if getting half of a two point five percent commission via rebate sounds better than saving 10% of the value of the property, or getting a property 10% more valuable for the same price, by all means keep shopping agents who rebate commission. If getting a property that is worth more, or paying less for the same property, is what you are after, you need someone who is likely to deliver that, and those discounters business model does not allow them to invest the time and energy to do so. Quite frankly, if they don't make a habit of it, they aren't likely to have the necessary expertise, even if they wanted to.

You may ask about how this squares with my attitude about loans. Yes, I'm one of the deepest loan discounters there is. That's because a loan is a loan is a loan, as long as it's on the same terms, and most folks qualify for better loans than they get. A thirty year fixed from National Megabank is the same loan as a thirty year fixed from the Bank of Nowhere in Particular, provided the rate, costs, and terms are the same. Only difference is who you make the check out to.

Real estate is on the polar opposite end of that scale. No two properties are alike. Especially in the current market, the difference between shopping smart and not doing so is multiple tens of thousands of dollars, far more than a commission rebate. I don't rebate buyer's commissions because I provide more than that in value. In my estimation, and that of the people who are working with me, it's money well spent. You get what you pay for.

Good buyers agents make a habit of looking for real bargains, whether or not they have a client it's appropriate for. It's called market knowledge. With market knowledge, a good agent can not only identify the ones that are bargains, you are able to negotiate better terms on those bargains. Good buyer's agents usually have bargains they know about that they just haven't found the appropriate client for yet. If you'd like to work with them and get shown these bargains, or have them go looking for bargains specifically for you, there is a price to be paid, and that price is that they make a little more money than the do-nothing discounter. You don't pay it, at least not directly, the listing agent does, and through them, the seller. If you believe that the final price might be somewhat higher to reflect that, you would have some justice on your side, provided you don't consider the value in locating the bargain property, the value in negotiating for a better price, and the value in avoiding problems before they happen, or dealing with them in initial negotiations rather than at the end of escrow. If you don't see the value, then not only are you saying that you don't see the solution, but that you don't understand that there is an issue. This indicates someone on the first level of competence: The unconscious incompetent. Not only do you not know how to do it, you don't realize that there is acquired knowledge and acquired skill involved.

Now a good agent who knows they provide value should have no difficulties asking only for a non-exclusive buyer's agent contract. if you don't like what that agent does, if you do not agree that there is value in that agent's approach, this leaves you free to stop working with them at any time and go work with someone else. If the agent doesn't perform, as in find and deliver a property that you agree is more "bang for the buck" than you would otherwise have gotten, by all means go work with the bump on a log who splits the buyer's commission with you.

If you want a Yugo agent that breaks down in the middle of the transaction and leaves you stranded, that's no skin off my nose, but you are not the client I'm looking for and the bargains I find are for my clients. I am neither obligated nor inclined to share them with people who want to use some other agent. Go find them yourself if you don't think I'm providing value. Just the knowledge that something like that is available should be a large amount of help. But if you can't, perhaps you might consider that perhaps I might be providing a certain amount of real value for my pay?

Very few people reading this are likely to be receiving minimum wage for their employment. If you are not prepared to concede that it is possible for more skilled, more knowledgeable people to deliver a more valuable product, whether that product is service or commodity, what possible justification do you have in making more than minimum wage? For that matter, unless you are one of those people whose work has to be done on site, why isn't your job being done by some subsistence level worker in a Fifth World hellhole? Even if we limit ourselves in the application of this principle to qualified and licensed people here in the United States, my guess is that your boss could probably hire other people to do your job more cheaply, but his additional investment in you probably makes him more money than that cheap replacement worker would save, and that's the reason you are worthy of your pay. This very same reason is why I am also worthy of my pay.

By the characteristics they are claiming, the person with the email at the top of the article is a very qualified buyer. Don't you think that should be working with someone who knows how to use that as leverage to get them a better bargain? Suppose they weren't so qualified. Don't you think it might be in their best interest to have an agent who knows how to structure a transaction so that it can work, and can help avoid wasting time and money on properties and transactions where it can't and sellers who do not have the option of working with them in the requisite way?

Or you can pay full price for a mediocre property, and console yourself with a rebate for much smaller amount of cash, that when you consider the entire situation, is a fraction of the money that came out of your pocket but didn't have to. Pay too much, and get a check back for at most a fifth of it in cash. Sound like a good deal to you? Maybe you didn't pay cash for the property, but then you've got a loan, and you paid additional fees based upon the size of that loan, and interest because you borrowed that money, and more in property taxes because you paid more than you should have. All of this eats away at money you would otherwise have in your pocket and equity that you would otherwise have in the property. Just because there's no explicit dollar figure on it doesn't make it any less real. How would you feel about writing a check drawn directly on your net worth for some unknown amount? Not so hot? That's what you are doing by using some bump on a log discounter who basically allows you to keep a percentage of what they provided no real value to earn. This is one of the largest transactions of your life. Scrimping on the compensation of the person who has the knowledge and skills to save you many times what they cost is almost as intelligent as OJ Simpson hiring a cheap lawyer. Even though I hope that you haven't been accused of murder, using a less skillful agent means you wasted money. Even though that's not a crime and you did it to yourself, it's still nothing beneficial to your overall financial picture.

Caveat Emptor

Original here

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This page is a archive of recent entries written by Dan Melson in January 2013.

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