Dan Melson: October 2014 Archives

Been reading some of your informative tips. I am looking at refinancing and getting a $378000 mortgage. Now in the case of having a 3 yr prepay penalty, vs paying 1.5% in points to make it a 1 yr prepay, am i right in assuming it's wiser for me to pay the points than accept a three yr prepay when i know I will sell/move within 2 yrs? Any info you can provide would be great. I'm wondering if I'm missing something here.

I think they (sic) points would cost me around $5800.

I compute 1.5 points on $378,000 as being approximately $5756.

Here in California, the maximum prepayment penalty is six months interest, and that is the industry standard nationwide for when there is a prepayment penalty. A few lenders will pro-rate it, but for the vast majority, they will charge the same penalty on the day before it expires as on day one. This is pure profit, and they're generally not going to turn down pure profit any more than most people will turn down a bonus. So if your interest rate is 6 percent, you're going to pay a 3 percent prepayment penalty if you sell or refinance before the prepayment penalty expires. For Negative Amortization loans, the prepayment penalty is based on the real rate, not whatever fake come-on "nominal" rate they told you about.

On some loans, the prepayment penalty is triggered by paying any extra money. One extra dollar and GOTCHA! But probably eighty percent of loans with prepayment penalties give you the option of paying it down a certain amount extra each year, usually 20 percent, without triggering the prepayment penalty. (That's 20% of the balance at the beginning of the year, but making a flat payment of 20% will trigger the penalty because you're also paying it down with your monthly payments).

Assuming that it is a case of you won't move in less than one year, this is equivalent to the prepayment penalty on a loan with interest rate of between 3.05% (100 percent prepayment penalty) and 3.81% (80% prepayment penalty). Since even the 1 month LIBOR was a little over 3.8 percent when I originally wrote this, it was a cut and dried case of pay the point and a half.

Of course, if there is a possibility that you will need to move in less than one year, paying these 1.5 points could well be a costly exercise in futility. I can't begin to gauge that risk without more information. But if you're in any number of professional situations ranging from the military to corporate executive, this is common.

Given that you're talking about prepayment penalties, you're likely in a subprime situation. Subprime, when I originally wrote this, had a fairly uniform rate of 1.5 points of cost equals 3/4 of a percent on the interest rate. I'm going to assume you're getting about a 6.25% rate. If you decided to buy it off via rate, you'd be looking at a 7% rate. These days, the few subprime lenders still in business are looking for "A paper" borrowers who don't realize they're "A paper" borrowers.

Let's punch in the two loans. $383,750 (balance with 1.5 points) at 6.25% gives you a payment of $2362.81. Running it out 24 months gives you a balance of $374,467. You have spent $56,708 on payments.

378,000 at 7% gives you a payment of $2514.84. Running it out 24 months gives you a balance of $370,043.00, and you've spent $60,356 on payments, while paying your balance down $7957.

Now, assume you sell the home for $X at the end of this period. The first loan saves you $3648 in interest. The second loan gives you $4424 more in your pocket in two years. The second loan, with the higher interest rate and higher payment, as opposed to the higher balance, nonetheless saves you $776 as opposed to the loan with the lower interest rate, and also leaves you more money with which to buy your next home, which means lower cost of interest on your next home loan, as well. Of course, this is subject to some pretty significantly naked assumptions as I don't know anything more about your situation. Furthermore, it assumes that your income is not marginal, and that you would qualify for both loans. It is perfectly possible that you would qualify for the lower payment, and hence the lower rate would be approved, but not be able to qualify for the higher payment associated with the higher rate (The reverse is not the case). Finally, I assumed that because you know you're going to have to move in two years, you are looking at a two or three year ARM in the first place, as opposed to a longer fixed term.

I hope this helps you. If you have any further questions, please let me know.

Caveat Emptor

Original here

That's way up there on the list of complaints buyer's agents get. Probably number one, definitely no lower than number three, and it's only going to get worse when the markets recover. There's really only one honest response:

"Well, duh."

I'm talking about the one where the owner fixed it up and made it beautiful. Those properties are the equivalent of a hot chick in a singles bar. Their owner has gone to the trouble of making them visually attractive to the vast majority of potential buyers. People are visually oriented - as you should know if you've ever watched the crowd interact with said hot chick. She may be an abusive gold-digging stone cold female dog with enough external baggage to fill an freight train all by herself, but that's not visually obvious; people see the attractive surface and they want it. In case you're female, I'm informed by some people I know that this effect is even stronger with respect to "hot dudes". So feel free to mentally switch the sex when I talk about "hot chicks", it's just as applicable.

You are always competing with other buyers. If someone else is attracted to the property to the point of making an offer, the owner is going to choose the offer that's most attractive to them. Most of the time, this will be the one for highest number of dollars. There are ways to be the offer chosen without being the high bidder, but they do not work every time or even close to every time.

The "hot chick" property is not one where you get a bargain. If everyone finds it attractive, expect everyone to be making offers. The owner and their agent are going to do their dead level best to get prospective buyers to stumble over each other fighting to put in the offer for the highest price. The only way to win that game is not to play. If you must put an offer in on such a property, make it an attractive offer, but one that you would be happy to have accepted. Refuse to bid against everyone else - offer what the property is worth to you. Look for things other than cash that the seller may be interested in. I know I'm always looking for something about the seller's situation that tells me something else is important to them. A more certain transaction, a willingness to work with special seller requirements, whatever. There isn't always such a hook, but where it is present I want to offer it to them.

The property where you get a bargain - I mean the type of bargain where you're thinking "Score!" ten years later - is to look beneath the surface. Instead of looking for the property where everything is already perfect, look for the property where the underlying basics are there but the owner hasn't put the finishing touches on it that make it obviously attractive to everyone. The solid construction with good layout in a neighborhood where most properties are more visually attractive. You make a few improvements over time, and you have a huge profit in just a few years if you decide to sell, or are the envy of your friends who ask "How did you manage to afford such a wonderful property in this expensive neighborhood?" The answer is that you were looking for the right things, where the person looking for the property that everybody wants is mortgaged up to their eyeballs and not as happy with the results because it's got some problems he ignored because it was "just so beautiful!". He managed to pick up that hot chick with all her baggage, where you went after the quieter lady with her head on straight and a healthy sense of humor. It's amazing how often such a lady turns out to be a lot more beautiful than the "hot chick" once you understand what you're seeing. This works in real estate, too.

All of the best negotiating techniques work much better when you're the only offer than they do when there are a dozen. It's very hard to get someone to accept an offer for $20,000 or $50,000 less than another offer on the table. It doesn't work every time, or close to every time. Upon those occasions when I successfully did it, I can tell you it was by selling something else the seller was interested in.

You've got a lot more bargaining power when you're the only offer on the table. The property is on the market because the owner has decided they want to sell, that their best interest lies in selling. If the alternative is another offer that's for just as much money (or more) you're not in a strong bargaining position. If the alternative is maybe not selling, they're going to be a lot more willing to compromise with you.

The way to successful buying in real estate is to find a property you think would be good, and making an offer you would be happy to have accepted. Some sellers are not disposed to be rational. Some, like the owners of the metaphorical "hot chick" property, have a reasonable and rational expectation of better offers than other owners. If they won't take an offer you're happy to have accepted, the intelligent thing to do find another property. Getting emotionally attached and thinking you've got to have a particular property because "it's so beautiful" is a recipe for disaster - just like marrying the "hot chick" in order to secure a one night stand, and for essentially the same reason.

Caveat Emptor