Buying and Selling: June 2006 Archives

Well, sometimes. Okay, most of the time. But not always.



Foreclosures: Bargain hunters beware!

Myth no. 1: A big spike in foreclosures is right around the corner...



...That's because in most of the country, anyone who has owned a home for even a year or two is likely sitting on enough equity to sell or refinance if the loan payments become unaffordable.

Used to be true. Not so much any more. When prices are going up 20% per year, this is true. When prices have slid about 10 percent since last year locally, anybody who bought for peak or near peak prices is in trouble, not to mention the folks in negative amortization loans that got into a situation where they can't afford the real payment, and now they owe thousands of dollars more than they paid. Nonetheless (as the article mentions) the banks want the loan repaid. They don't want to own the house. A "hard money" lender will foreclose fast and hard, but a regulated lender wants the loan repaid, and they'll pretty much take a loss anytime they foreclose, and it's always bad business, because it's always someone who won't use that bank, and who tells all their friends and family. The bank isn't going to have a representative there to tell their side of the story, so no matter how justified they were in foreclosing, it's bad for business. They will put it off as long as they possibly can.



It can take a couple of years after payments start being a problem before the lender decides to cut their losses and foreclose. Sometimes the individuals concerned go to heroic lengths to stay out of foreclosure, drawing out all their savings, even their retirements to meet the payment. They are usually ill-advised to do so; nonetheless I understand the emotional attachment that occurs. The peak for foreclosure is usually somewhere around the fourth year of the loan. Foreclosures are up now, locally, but look for them to start going up further at the end of 2007, as the option ARMs really took off in 2004.

Myth no. 2: Foreclosed houses sell for far less than their market value.



In a study of foreclosure sale prices in more than 600 counties nationwide in 2005, Christopher Cagan of data provider First American Real Estate Solutions found that, on average, foreclosed properties sold for about 15 percent less than comparable homes in the area that were not distressed. But in states where real estate prices have risen the most, including Arizona, California and Virginia, foreclosed properties sold for within 5 percent of full market value.

This is true. Furthermore, many foreclosure homes have maintenance and repair issues. If I can save my several tens of thousand dollars of equity by fixing the property up a little bit and cutting the price a little in order to sell it before foreclosure, I'll do it. On the other hand, if I bought it for $500,000 with a 5% down payment on a negative amortization loan, and now it's only worth $420,000, my investment is long gone, and any work I do and any money I spend is helping nobody but the bank. Some people may strip the copper out of the walls for scrap (I've seen what one such person left behind). Some people may even take a sledgehammer and break things in one last act of spite.



In highly appreciated areas, the auction is usually the worst time to buy. Get them from the owners before the lenders pile on all the default and foreclosure fees, while there is still something to save for the owner, equity-wise. Get them from the lenders as REOs after they fail to sell at auction. Depending upon who forecloses, that can wipe out entire trust deeds. For instance, if there's a first and a second on the property, and the first forecloses, that second is gone. Dust. History. Worthless paper with unimportant markings, basically good for fire starter. If it originally sold for $500,000, and there's a $400,000 first and a $75,000 second, but the property is only worth $420,000 now, that second holder is crazy if they show up to the auction to defend it, especially since the holder of the first has added thousands of dollars in fees, every penny of which gets paid before the second gets a penny. The second is unlikely to get a penny, and bidding on it is throwing good money after bad. It's a waste of an employee's time, if nothing else. For buyers at auction, there's a key phrase to remember: cash or the equivalent. You don't win the auction and then arrange financing; you have to have that first. This doesn't apply to sales before and after the auction. Nor does California's ninety percent rule.



Now, you are not (if you're smart) buying at auction sight unseen. You can usually make an appointment to see the property in the days before the auction. You should also look at other properties in the area. Know the market before you bid. Know what you intend to do with the property, know how much it's going to cost. Depending upon the law where you are, there may be a building inspection required, or perhaps you can take an inspector with you. This costs money, so you may want to preview once before you haul the inspector out there. Do your homework before you toss your money into the ring. That's what the people who make money at foreclosure auctions do. It's practically a full time job if you want to do well, and if you're not doing it all the time, a good agent is a lifesaver. Every situation is different, and it takes a certain amount of experience to know the best way to approach buying a given distressed property. You're competing with people who do this full time for a living. Ask yourself questions like "Why should I be willing to pay more for this property than Joe, who's been doing this for twenty years?" Auctions get crazy and emotional. If you have someone there to help take the emotion out of it, you are less likely to waste large sums of money. If you have someone there to help point out the pitfalls, you've probably just saved yourself every penny of their commission and thousands of dollars more besides. So long as they do what they say they will, of course.



Caveat Emptor.

UPDATED here

My aunt is going to move to a new condo and wants to sell her old one. I would like to buy her old condo as an investment and rent it out (as I am already a home-owner). This whole investment/rental buying is all new to me.

She has lived there about 5 years and the value has increased more than double. Obviously I would love to be able to keep her tax base. I am thinking about getting an interest only loan to help me get into this. Can I get a loan for 100% of value? My aunt will need the entire amount to purchase her new place. What suggestions do you have to make the loan process easier and pay the least amount in fees?

It is worth between 360,000 to 390,000 (we haven't yet got an appraisal, this is from comps in area). My wife and I currently have a house in (City) with a value of 650,000 and a mortgage of 400,000. We both work and have some extra income, maybe 400 a month that we could supplement against a renter. I think we could qualify for the loan, but then we would have to refinance our house to cover a down payment and closing costs. We don't have any savings to pull from. My wife hopes to retire in 2 years and I will in about 8 years.

Investment property is a different item from a personal residence, in several particulars. First off, even if it's residential, the loan is a riskier one to the lender. A loan on investment property is going to carry a surcharge of 1.5 to 2 discount points (one discount point is one percent of the final loan amount), over and above any other charges for the rate you choose. Furthermore, despite a lot of research, I don't know a single lender that will do a loan on investment property for more than 95 percent of the value, and most of them will only go 90 percent. The ones who will go 95 percent typically charge higher rates, and are to be avoided if you can. So you need a down payment of at least five percent and preferably ten.

The good news is that whereas you do not have savings to pay it, you do have a considerable amount of home equity. Depending upon your exact situation, either a "cash out" refinance or just taking out a HELOC (Home Equity Line Of Credit) might be in your best interest. It depends upon your current mortgage and your credit, and I cannot make a recommendation one way or another without looking at the market you're in for current comparables, running your credit, and seeing what can be done. If you've got good credit and income, and have had the good credit and income for some time, it's more likely to be in your best interest to simply take out the HELOC. I have some without prepayment penalties and are zero cost. If your credit or income has improved of late, it may be in your best interest to refinance, or if you've got an ARM that's about to adjust anyway. Assuming you're "A" paper, you may now be a conforming loan where you would not have been when you took it out, although taking the cash out could cause you to exceed, once again, the conforming limit.

Cash flow is also an issue with investment properties. If you don't have a tenant, you get zero credit for the rent at initial purchase from A papeer. If you do have a potential tenant, with a signed lease for at least one year, the lender will give you a credit of seventy-five percent of the proposed rent towards your cost of owning the home (principal, interest, taxes and insurance). Some subprime lenders will credit you with ninety percent, but their rates are typically higher in compensation. With the vacancy rate in urban California being about four percent, even ninety percent is a bit low, but the standards are what they are. I know many people who are making money hand over fist on rentals where the bank thinks they are paupers.

Now there is no such thing as an easy documentation investment property. Indeed, for any loan, for all real property you have to show the full breakdown for each property you own. You can state your overall income in most cases (and indeed, most folks with investment property have to do stated income due to the cash flow computations being so restrictive.)

In urban California, however, prices have gotten so high that I do not recall the last time I saw a single family residence being purchased for rental purposes that "pencilled out" with a positive cash flow. As I said in my article Cold Hard Numbers, this is one of the things that convinced me California real estate is overvalued.

Now, as long as you have the cash flow to last until rents catch up, this is fine. But you need to be very certain that you do have that cash flow. If you're buying for $360,000, this is a first loan at about 6.75 percent right now of $288,000, which gives a payment of $1868. Additionally, there's going to be Homeowner's Association dues of probably about $200, and taxes (assuming no Mello Roos) are about $375 per month, or about $200 if you can keep your aunt's tax basis. That sums to $2443 or $2268 if you can keep her tax basis. Now ask yourself how much similar units are renting for? If it's less than $2050 (or $1875 if you can keep the tax basis), your $400 per month isn't going to make up the difference. You might consider a negative amortization loan in this circumstance, but be advised that you're eating up your investment every month, the real interest rate is actually higher than the 6.75 percent, and prices may go down and not recover for several years, leaving you holding the bag for a big loss. It's a risk some folks are willing to take, others are not. I'm willing to do them for people in this situation, but only after I explain all the pitfalls (Option ARM and Pick a Pay - Negative Amortization Loansand Negative Amortization Loans - More Unfortunate Details cover most of them). Usually people who have been informed of the pitfalls decide that these loans are not for them, which is one of the reasons why I question whether the risks have been adequately explained to the forty percent of all local purchases being financed by these.

Indeed, given the fact that you're going to have to make payments on the Home Equity Line of Credit as well, it's difficult to see how your $400 per month of extra cash flow is going to stretch to cover. If your credit is decent, I can get you into the property, but that's not exactly doing you a favor if you find it impossible to make the payments.

Caveat Emptor

UPDATED here

The housing bubble is not the primary focus of this website, but to pretend it does not exist is plainly wishful thinking. One of the ongoing phenomenon that have been driving the bubble is the "Stated Income"loan, where the lender does not verify that the prospective borrower actually makes enough money to qualify for the loan, only that they have a source of income that could generate enough income. If you're working the night shift at 7/11, they're not going to believe you make $90,000 per year, but if you're a in a profession where some folks do make $90,000, you may be able to qualify "stated income" regardless of whether you actually make it or not.



Lest I be unclear on this subject, despite being known as "liar's loans" because people use them to lie about their income in order to qualify, it is not what they are intended for. Nor is "stated income" intended to help shifty or incompetent loan officers shaft lazy borrowers by not bothering to document income. They are intended for those who really do make the money, but because of the way that the income tax laws work and the way that lenders qualify people for loans based upon income, do not appear to. Business owners and the self-employed and people on commission get to legitimately write off a lot of expenses that the hourly or salaried employees do not. For instance, I write off a large percentage of my vehicle miles, office expenses, etcetera. I'm paying for business related expenses with pretax dollars, where most folks generally do not get to take this deduction. Being self-employed, if I was silly enough to want the home office deduction it would be easy enough to justify. Not to mention asset depreciation. All of these don't have much effect upon the money I have to spend, but they do have an effect on my tax forms, where it looks like I make a lot less than I effectively do. So instead of using my tax forms to qualify for a loan, sometimes I need to do a stated income loan in order to qualify for the loan, because the tax forms show a lower number than people making comparable amounts who are salaried. This is what stated income is for.



On the other hand, I'm sure that most of the adults reading this have seen the potential for abuse. When I can just tell the lender how much I make and they agree not to verify it, a certain number of people are going to say they make more than they do, and indeed, both stated income and NINA loans are often informally known as "liar's loans". Furthermore, since if the person getting the loan does not qualify, there is no loan and the loan officer does not get paid, there's a certain amount of pressure on the loan officer to get the loan done even if the prospective borrower does not qualify. Let's say they don't qualify, but the loan officer wants to get paid. So the loan officer puts them in for a stated income loan, says the clients make more than they do, and voila! funded loan. Clients get the loan where they would not have qualified by documenting their income, loan officer gets paid, bank gets a loan, and if it was a purchase, real estate agents get paid for their transaction and the seller goes happily on their way because they got their money.



A few years ago this kind of practice was an occasional thing. Of late, however, it has become endemic. And although if the clients really do make the money there is nothing wrong with it, if they don't make the money to qualify but they get the loan they are still going to have to make the payments. This reflects the reason for the rise of the negative amortization loan, where the minimum payment does not cover the interest charges. Either one of these is something a good loan officer does with a trembling hand and a lot of care. I always make certain that these folks really can make the payment they're going to have to make, but the vast majority out there do no such thing.



Well, it looks like everyone is going to have to, because of IRS Form 4506. Form 4506 is an item the clients sign, usually at the end of the loan process, that gives the lender and anyone they may sell the loan to access to your tax returns. IRS form 4506-T is basically the same thing, except that it gives access to a transcript (the numbers) rather than an actual copy. Signing form 4506 is mandatory. No signature, no loan. It's that simple.



Now it take the IRS about sixty days to respond to this request, so this has zero effect upon funding your loan. If your loan isn't funded withing thirty days of you signing the loan application, there's something wrong with that loan unless something external to the loan is holding them back and you should go apply for a back up loan. But for later on, it can have an effect.



One of the ways it can have an effect is on the loan provider's subsequent business. Traditionally, as long as the borrower made the first three payments on time, a loan broker was off the hook as far as borrower default. Lenders who have recently become much more nervous about their loan portfolios have recently started to change this, whereby a broker who put through a stated income loan (or any loan, for that matter) which is not subsequently borne out by the evidence of form 4506 is liable for the loan for the loan's full duration. Since form 4506 is never borne out by any stated income loan, else the client should be getting the better rates for full documentation, this means that every time any broker puts through a stated income loan, they are liable for the consequences to the lender.



Well, it shouldn't take much of an imagination to figure out the effects this is having upon the loan market. With the shifting of the consequences to the broker, the brokers are having second thoughts about doing stated income loans. Make no mistake, stated income was way out of control over the last couple of years. I've always been religiously careful about them, but that made me a member of a tiny minority of loan officers. Most of the loan officers out there have no clue as to what is an appropriate stated income loan, which has to a large extent put the brakes on stated income here locally. I'm not certain what effect this is having upon loan officers at direct lending houses, and there are a certain percentage of broker loan officers that are too clueless to understand what this means to them so they are going to keep right on doing them until the lawsuits pile up, but it's really starting to put the brakes on stated income loans here locally.



Now stated income loans have been a large proportion of what drove home prices upwards. It was an easy way for loan officers and real estate agents to get people into loans, and therefore properties, that they really could not afford and did not qualify for. Both easier sales and bigger commissions, as people want the better house with the higher price and tend to reward the agent and loan officer who can get them in, regardless of whether they can really afford it or not. People who did not really qualify, but this gets them the loan, and therefore that beautiful McMansion they've got their heart set on, despite the fact that they cannot really afford it. It really is easy to sell people on too much house, and very few of them really understand the implications. I've sat people down, taken them through the math, and they still signed up with the agent who promised to get them into the McMansion because they wanted it so much.



Well, with the lenders getting aggressive about enforcing financial consequences, every loan officer with the brains to understand that heavy objects fall is suddenly taking a hard look at their business practices. Now it's not just a question of "Get paid or don't get paid," it's a matter of whether the money they get paid right now is enough to balance out the money they are going to have to pay later to buy the loan back, and the answer is largely coming back "No!" Furthermore, there could be actions taken against licenses by lenders and not just by clients. That brings a completely different trade-off into the picture, and a lot of loan officers aren't liking what it says.



Now because the prevalence and easy availability of "stated income" loans has been one of the things driving the increase in the price of housing, essentially killing the stated income loan is not going to have a beneficial effect as far as sellers are concerned. It decreases, by some amount, the potential market of people who can afford to buy your property. Where before, the bottom line with most agents and loan officers was that anyone who wanted the property could probably be qualified for the necessary loan and was therefore a legitimate potential buyer, that is now changed. Since anytime you constrict your market of potential buyers, the equilibrium price of the market is going to fall, expect this to have a further deflationary effect upon property values. Indeed, there are a lot of factors that are conspiring against highly appreciated property values right now, but this one small item could well be what starts housing prices more notably downwards. Because it attacks a way of doing business that was at the heart of the run up in prices, this relatively small measure may be the pin that pops the housing bubble.



Caveat Emptor

UPDATED here

The bottom line on this question is always, "Whatever the courts say." Divorce law is complex, and different from state to state, and even when you think you've got a clear message in the law as written, the courts may interpret it differently, or there may be precedent that says otherwise, or even just some overarching concern you are not aware of. Even if the law is clear, it can usually be gotten around by the agreement of the parties. Consult your attorney.



With that said, there are a few rules of thumb to go over, valid in broad for most states in most situations.



Real Estate is usually owned by both partners in a marriage equally, even if one spouse acquired title prior to the marriage the second will be added by default when the marriage happens. The only thing that is usually held separate are inheritances - things that were inherited by one spouse or the other from relatives, and even those can often become joint property. Sometimes gifts to one spouse can also be held separate. One of the phrasings your learn from reading title reports are is "John Smith, who acquired title as a single man, and Jane Smith, husband and wife as joint tenants." This tells you John bought it before they were married, and Jane got added to title upon marriage by the effects of the law.



There are trusts and the like to frustrate this from happening, and most states have rules and law permitting them, but you have to talk to the lawyer, get the trust created, and most importantly, as it's the step that is most often omitted, transfer the assets to the trust in a timely fashion. I don't know how many folks I've seen who spent a couple of thousand dollars creating a trust and then didn't transfer the assets to it. Every penny they spent on that trust was wasted money.



Now, if Jane does not wish to be added to the property title, she may quitclaim it back to "John Smith, a married man as his sole and separate property." However, quitclaim deeds have this curious limitation in many states (California among them) that they only function with respect to the interest you have in the property as of the time you sign them. Since the new spouse has not yet been given the claim upon the property until the marriage takes place, the quitclaim cannot be signed until after the marriage in order to accomplish the desired goal, as Jane has not yet acquired the interest in the property. Jane can say she'll sign it after she's married, but if she changes her mind, that's a whole different legal struggle. If she signs it before the marriage, then since she subsequently acquired a claim to the property through the marriage, she now has an interest in the property through the eyes of the law. Let's even say John and Jane are ninth cousins, the only surviving family inheritors, but for whatever reason Jane quitclaims the property to John, but then they later get married. Jane now has a married woman's legal interest in the property. The quitclaim only applies to Jane's interest in the property at the time of the quitclaim, and has no effect upon any claims she may acquire later. The only way I am aware, in general, to deed away any rights you may acquire in the future is with a Grant Deed, and each state has its own laws as to how this may and may not be accomplished. On the other hand, a Quitclaim is a handy document if you may have the intention of acquiring some interest in the property back at a later time, as it generally doesn't make, for instance, buying the historic family homestead back from your wastrel brother problematic.



Now suppose John and Jane Smith get divorced, and the property was held jointly. Both John and Jane still have an interest in the property, and continue to hold an interest, even if the court orders them to sign a quitclaim, until they actually have done so. This is why it is better to get a court award of actual title rather than a court order for the other spouse to sign a quitclaim. Unfortunately, for some reason, most divorce courts are unwilling to award actual title rather than order the ex-spouse to sign the quitclaim. So whoever gets the title or possession is not able to do anything with the property without the ex-spouse's approval, unless and until that ex-spouse signs the quitclaim or the court awards the spouse in possession with clear title. I could tell stories of ex-spouses that disappeared, or pretended to disappear for years leaving the ex-spouse in possession unable to sell, unable to refinance, even unable in some circumstances to sign a valid lease. Not infrequently, the ex-spouse pops up years later wanting a better deal (that is, more money) as inducement to sign the quitclaim deed.



Until the ex-spouse signs the quitclaim, title companies will not insure either loans, either in support of refinancing or a sale, or actual sales transactions. No lenders policy of title insurance, no loan (in most states), and that kills the refinance, or the loan financing any sale. No policy of owner's title insurance, and I certainly won't pay my money for a property, and advise my clients in most stringent terms not to do so.



Now, let's say that the ex-spouse has signed the quitclaim but is still on the existing loan, which was taken out while you were still married. This isn't really a problem. In order to refinance, or deliver clear title on a sale, that loan needs to be paid off. The lender doesn't care how it gets the money, or from whom. That ex-spouse can drop off the face of the earth once the quitclaim is signed, and it really doesn't make any difference. Once they are out of the legal picture, they might as well be dead. On the other hand, both of you are responsible for the entire debt. It's not like some is His and some is Hers. Now, because this is true, sometimes ex-spouses also get their credit hit when things like a short sale subsequently happen, or foreclosures. To guard the ex-spouse who is giving up the rights to the property from this happening, many times the divorce court will order the ex-spouse who is retaining possession to refinance in order to remove the spouse who no longer has a legal interest in the property from future liability on the debt.



Many times, the court will order the ex-spouse retaining the property to buy the relinquishing ex-spouse out of the property, to give them some money or other goods in exchange for their interest in the property.



Often, especially if both spouse's incomes were used in order to qualify for the loan on the property, the remaining ex-spouse will not be able to qualify for the necessary loan on their own. In this case, the smart thing to do is usually sell the property. It is a real issue that because many former spouses are delinquent in their payment of alimony and child support, the lenders want to see a certain history (usually three months) of these items being paid before they will allow the income so generated to be used to help qualify the remaining ex-spouse for the new loan.



Keep in mind that all of the above are simply common concerns and happenings, and may have nothing to do with the situation you find yourself in in a divorce. Consult your attorney for real feedback of how the law and legal precedent apply to your situation.



Caveat Emptor.

UPDATED here

That was the wording of a search engine hit I got. It's not literally a death trap, of course, only much financial pain. But the hyperbole is forgivable in today's modern society and the state of the current market.



Other people may have other definitions of "housing bubble death trap," but when I'm talking about stuff like that, I'm talking about someone who bought too much house with an unstable (or insufficiently stable) loan.



I just picked a couple random streets in older lower middle class neighborhoods, and looked back a couple of years. I found a couple of homes that have sold twice or are on the market again.



A 3 bedroom home sold for $487,000 at the end of last year. It's back on the market now for $425,000. A condo sold for $285,000 at the end of 2004, and again just recently for $265,000.



Now just in case you don't understand, the owner doesn't get the full sale price, but they paid the previous sale price to buy it. Usual seller's expenses run about seven percent or so. So for the 3 bedroom home, the owner is only going to get about $395,000 to pay it off, even if they get full asking price. For the condo, the owner only got about $246,000.



Now, let's consider the sales involved. Either their down payment when they bought the home will cover it, or it won't. If it does, the homeowner is out about $92,000 in the first case, about $39,000 in the second. This doesn't include any prepayment penalties there may be or negative amortization it may have undergone, not to mention the cost of any payments they may have missed, etcetera, etcetera. There's always a reason people sell for a loss, and it's usually because they have no choice. They can't make the payments (and never could) or they have been transferred, have to get housing elsewhere, and can't make the payments. And what if the down payment won't cover the deficit? Well, at the end of the year they are likely to get a 1099 form that says they got income from forgiveness of debts. As I understand it, this is ordinary income, and it can knock you up to higher tax brackets, both federal and state, if your state has state income tax.



So why didn't the folks just refinance into something stable, you ask? They couldn't afford the payments on a stable loan. Furthermore, they couldn't refinance due to their situation. If you bought with anything close to 100% financing, and you lose $55,000 of value, well, banks don't like lending money for more than the property is worth. There's no security in it. Now there are 125% loans out there, but the rate is high and the terms are ugly. If you can't afford the rate at 100 percent, or 95 percent of value, you certainly can't afford the rate for over 100 percent. There are only two times that the value of a property means anything. One is when you buy or sell, and the value is whatever you paid for it, or your buyer pays. The other, alas, is when you refinance, and if you owe $480,000 on the property when similar properties are selling for $425,000, the odds of you getting a better loan with a lower payment are essentially non-existent.



Now if the folks are in a stable loan, and can make the real payments, it doesn't really matter what the property is worth right now. You're doing fine, whether you refinance or not. Refinancing might put you into a better situation, but if you can't refi, you're still doing okay. Yes, the prices are down and they're likely to go down more. It just doesn't matter if you don't intend to sell and don't need to refinance. Your cash flow is what it is, and if you really were okay with that to start with and the loan is stable, you're likely okay with it now. If you got a loan that was stable for three or five years long enough ago to worry about loan adjustment now (or soon), you've likely got plenty of equity in the property now. If, on the other hand, you did a 2/28 interest only a year and a half ago, then you're potentially looking at a payment adjustment in the next few months that's suddenly two percent higher and fully amortized, which could be thirty or forty percent difference in the payments. Ouch. Out of such scenarios are losing a property to foreclosure constructed, with consequences even worse than the ones I talk about above. Just the act of lender filing a Notice of Default usually adds thousands of dollars to what you owe, never mind any payments you may have missed or been late.



This then, is what I call the Housing Bubble Death Trap. People who bought too much house with unstable loans, then had the market recede a little on them. Now they are upside down (owe more on the property than it is worth) with a loan they cannot refinance and cannot afford, and they can't sell for as much money as they paid.



What are the loans to watch out for if you're buying. Anything like stated income, where you're not documenting that you make enough to qualify for the loan. Stated Income has legitimate usages, mostly for small business folk and those paid on commission, but should not be used nearly so often as it has been, of late. For all the people who have claimed otherwise (and used them for such), I have never seen a situation where I'd recommend any kind of negative amortization loan for the purchase of a property that you intend to live in. Stated Income Negative Amortization loans should scream out to anyone "WARNING, WILL ROBINSON! DANGER! DANGER! DANGER!" Short term (2 year) interest only loans are less clear-cut, but often a bad idea. These are sub-prime loans. I did a lot of 2/28 loans at six percent a couple of years back. They were intended as short term loans until folks' credit improved, and that's the way I explained them, emphasizing that fact that they have to make certain their credit score actually improves during those two years. They're going to be around 8 percent the first six months they adjust, and a $300,000 6 percent interest only has a payment of $1500 per month. If it adjusts to 8 percent and starts amortizing with 28 years left to go, that's a payment of $2240. I have a firm rule of no prepayment penalties longer than the fixed period of the loan, but I'm definitely the exception rather than the rule there among loan officers. If you were paying principal and interest all along, like most of my clients, you've got some breathing room (equity) in your property and the "payment shock" won't be nearly so bad, not to mention that if your score actually went up, you likely qualify A paper now.



Three year (or longer) fixed rate A paper probably gives you enough breathing room in all but the worst of all market collapses, and I prefer at least five, with thirty year fixed actually being my favorite loan right now, due to the fact that depending upon the lender and the client, I may actually be able to get them cheaper than anything else. This, however, is a short term pheonomenon of the moment, due to the yield curve being inverted, and once it straightens out, I'll be doing more hybrid ARMs again.



Caveat Emptor

UPDATED here

I've written articles on when you can't make your mortgage payment and how to react if you see foreclosure coming in time to do something about it, and even on Short Payoffs, but all of those are owner (seller) oriented. This is intended as a basic buyer's guide to getting a bargain from people who bit off more than they could chew, with emphasis on the current local market but applicability anywhere.



There are essentially four phases in the foreclosure process. The first is pre-default. They've made late payments or none at all, and there's no way they can keep the payments up, but they won't to the intelligent thing, which is sell for what they can get. Many people who own properties headed for default are deep in Denial. Yes, this is often because something bad happened to them for reasons beyond their control. I'd be happier if those sorts of things didn't happen, but the amount of rescuing that's going to get done is minimal. There are very few White Knights running around, and the ones who claim to be White Knights are usually blackguards. Unless the seller knows of some factor that is going to change, this is the smart time to deal with the problem. Before the Notice of Default is recorded, nobody really knows but the owner and the bank. Once the Notice of Default hits, all the sharks come out because everyone knows the owner is in Dire Circumstances. Let's face it: most folks will make the payments on their home even if they let every other bill slide. When someone can't make their mortgage payment, and it's public information as a Notice of Default is, everybody and their pet rock knows thet don't have any choice but to sell. They'll flood you with offers, but they won't be good offers.



Now if you're looking to buy at this stage, the thing to do is examine the Multiple Listing Service. "Motivated seller" and similar phrases are often code for "These people can't make their payments!", particularly in the current market with prices declining somewhat and many people who stretched beyond their means. It would be great to be able to get a list of properties that are sixty days or more delinquent, as this would include the folks in denial, but it just isn't going to happen. The only folks who know are the banks and the credit reporting agencies, and they are prohibited by privacy laws from disclosure. So at this point all you have to deal with are the people who are not in denial. Now when the market is rapidly appreciating, this is a good place to find a bargain, because once the Notice of Default hits, the sharks swarm, so if you can find these people before that, you're in a strong bargaining position if you correctly suspect they can't make their payments. The taxes being delinquent is often a good indicator of this, but there is no way to know for sure unless the people or their agent tell you, and the agent who tells you has just violated fiduciary duty. This can mean prospective buyers overplay their hands in negotiations, which is fine if you intend to move on if you can't get a "Manhattan for $24" type deal, but if it's a property you want and can make money on, overplaying your hand can poison the atmosphere. There aren't many "Manhattan for $24" type deals out there. There are a lot more good opportunities for someone willing to pay a reasonable price and hold the property a while or make improvements. Deals so good that they instantly make oodles of money, someone will usually come along and offer the poor schmoe on the other end a better deal, and if the poor schmoe has a decent agent who's looking out for their interests, they can switch to the other offer. Buyers and escrow companies don't like it, but it can be done. It's extra work for the listing agent, so they may not want to, and they may not have done the best set-up, but it can usually be done anyway.



The reason it's smart for sellers to sell at this time is that this is when they are going to get the best deal. The mere act of entering Default is likely to cost thousands of dollars. Furthermore, this is the phase with the most opportunity to find a property at a better than usual price for buyers, because most of these don't get to actual default. Someone will come along and make an offer, and a listing agent who gets an offer on one of these is likely to advocate taking the first reasonable offer, reasonable being defined as "anything vaguely in the neighborhood of the asking price," and the asking price itself is likely to be lower than it otherwise would be.



The second stage of the foreclosure process is default. The Notice of Default has been filed, and because it is a matter of public record, the sharks instantly react to the blood in the water. The seller is going to get dozens to hundreds or even thousands of solicitations. Also, once the property is in default, the bank can require the owner bring the Note entirely current in order to get out of default. Whether or not the property is listed, they're going to have agents offering to sell it for them, individual buyers who want those Manhattan for $24 deals, and lawyers offering to "protect" them by declaring bankruptcy. By the way, I've never heard of anyone who came out better in the end by declaring bankruptcy, so you probably don't want to do it if you're in this position. I know it's your home, and you're likely extremely emotionally attached to it, but declaring bankruptcy doesn't mean you don't owe the money when it comes to a Trust Deed. Every single one of these folks, lawyer, agent, or prospective buyer, knows that you're in default. Some owners are still in denial at this point, but all denial means at this point is that such an owner is not likely to take the best offer they'll get. It's at this phase that most "subject to" deals happen, usually with highly appreciated properties with significant equity over and above the trust deed. If the owners owe anything approaching the value of the property, that's a silly situation to do a "subject to" purchase for buyers, and most of the prospective buyers (those with decent advisors or agents or experience) won't do it if the equity is less than a certain amount or proportion of the value.



The third phase of a foreclosure is the auction. This is typically a very short period. Five days before the auction date itself, the owner loses the legal right to redeem the property, although the bank will usually let them until the last possible instant. There is also a legal requirement to vacate the property before the auction. "Subject to" deals can still go through as long as the bank will accept redemption. Now the auction itself requires cash or an acceptable equivalent. You don't go to the auction and then get a loan later. At the very least you have to have the loan prearranged and a check for the proceeds in hand. This can mean that the rate is significantly higher, and it can be difficult to refinance within the first year.



The fourth phase is after the auction. In California, if the property does not get a bid for at least ninety percent of appraised value, it does not sell and becomes owned by the bank. The bank doesn't want it; they're not in the real estate business and in fact, they are legally required to dispose of it within a certain time. In the current market, this can be the best place to acquire a property. The bank knows they're taking a loss, and the longer it goes, the bigger the loss. Mind you, because the bank usually takes a loss, few properties go to this stage. The lenders will usually do anything reasonable in order to avoid auction, but once it goes to auction, they want to get rid of it. They usually require a substantial deposit, but the purchase price can be the best of all.



One thing to be wary of in foreclosures is they are often in less the ideal condition, to say the least. These people know they are losing the house, and often that they are going to come away with nothing in the best realistic case. They have no incentive to take care of the property, and many actively work to mess it up. This is cause for care in purchasing them, and inspections, because not all of the damage may be obvious. Furthermore, many of them may have been unable to afford proper maintenance for some time before they lost the property. Purchasing a foreclosure can mean you will need a large reservoir of cash in order to fix up the property to habitable condition.



Caveat Emptor.

UPDATED here

"overpriced house offer rejected what next"



(Before I get started, I want to make it clear that I am using the same definition of worth found in this article)



Well, the seller obviously didn't feel that it was overpriced. Given that they were unwilling to sell for that, consider the possibility that you didn't offer enough.



It's human nature to always want to blame the other side. Given the state of real estate prices here in San Diego, I have considerable sympathy for buyers these days. On the other hand, if you look at the sales log, sales are still being made. This means willing buyers and willing sellers are coming to an agreement that both feel leaves them better off, and they are doing it at market prices.



The fact is, there are always at least two possibilities when an offer is rejected, and the truth may be a mixture of the two.



First, that the seller is being unreasonable. This happens a lot. Somebody thinks their property is worth more than it's worth. When people can buy better properties for less, they're not going to be interested in yours. In this situation, you're not likely to get any good offers. You'll get people doing desperation checks - coming in with lowball offers to see how desperate you really are. A very large proportion of these are people in my profession looking for a quick flip and the profit that comes with it, or other investors. Anybody looking at properties priced where this one should be priced is likely not even going to come look.



Second possibility, the buyer is the one being unreasonable. Properties like that one really are selling for the asking price, and you offered tens of thousands less. Some buyers do this because it's all they can afford. Some buyers do this because they want to get a "score". And some are just the standard "looking to flip for a profit" that I talked about in the previous paragraph. There is a point at which I tell all but the most desperate sellers that they're better off rejecting the offer completely than counter-offering. It saves time and effort, and the prospective buyer either comes back with a better offer, or they go away completely. Someone offering $250,000 for a $350,000 property is not likely to be the person you want to sell to. Even if you talk them up into a reasonable offer by lengthy negotiations, they're far more likely than not to try all sorts of games to get it back down as soon as you're in escrow. Better to serve notice right away that you won't play.



Now some bozo agents think that starting from an extreme position, whether high list price or lowball offer to purchase, gives them more leverage, or that somehow you're eventually likely to end up in the middle. This is bullsh*t. A transaction requires a willing buyer and a willing seller. Price the property to market if you want it to sell. Offer a market price if you want the property.



Now, the Quickflippers™ have had a distorting effect on this, and disconcertingly many of the properties being offered for sale are owned by people who bought with the intention of the quick flip for profit, rather than buy and hold. Many of those looking to buy still fall into this same category, and I suspect this is much the same in other formerly hot housing markets as well. They've become addicted accustomed to the market of the last few years, when a monkey could make a profit on a property six months after they paid too much money to purchase it. That is not the market we face today. This market favors the buy and hold investor. Actually, if you remember the spreadsheet I programmed a while back, I've pretty much confirmed that the market always favors the buy and hold investor, it's just been masked by the feeding frenzy of the past few years, where John and Jane Hubris could come off looking like geniuses when it was just a quickly rising market and the effects of leverage making them look good. It's just that the support for the illusions of Mr. and Mrs. Hubris has now been removed.



Now, what to do when your offer has been rejected. There are two possibilities. The first is to walk away. If the home really is overpriced, and there are better properties to be had for less money, you made a reasonable offer and were rejected, you're better off walking away. I don't want to pay more for a property than it's comparable properties are selling for, and I certainly don't want my clients to do so either. The sort of people who go around making desperation check offers walk away without a second thought with considerably less justification.



The second is to consider that the property might really be worth more than you offered. Okay, a 3 bedroom 1 bath home did sell for that price in that neighborhood, but when you check out the details, that was a 900 square foot home on a 5000 square foot lot and the one you made an offer on is a 1600 square foot home on a 9000 square foot lot, and in better condition with more amenities. It's a more valuable property, and you can refuse to see that from now until the end of the world and you're only fooling yourself. The reason you thought the property was attractive enough to make an offer was that it had something the others you looked at didn't, and most of these attractors add a certain amount of value to the property. The more value there is, the more folks are willing to pay for it. This is why one of the classical tricks of unethical agents is to show you a property that's out of your price range, then figure out a way to get a loan where you qualify for the payment. This property is priced higher because it has features that add more value and a reasonable person would therefore conclude that other reasonable persons would be willing to pay more for that property than others. Landscaping, location, condition, more room, amenities. There's something that the seller thinks reasonable people would be willing to pay more for. It's kind of like taking someone who can afford a $10,000 car and showing them a $25,000 one, then telling them they can get interest only or negative amortization payments to get them into it. You only thought you could afford the $400,000 home, but they've got a way that you can get into the $600,000 home, which obviously is going to have many things that the $400,000 home lacks. Consumer lust does the rest. Cha-ching! Easy sale, and the fact that they've hosed the client doesn't come out until long after those clients made a video for the agent on move-in day when they're so happy they've got this beautiful house that they didn't think they could afford (and really can't), and they gush gush gush about Mr. Unscrupulous Agent, who then uses this video to hook more unsuspecting clients - never mind that the original victims in the scam lost the house, declared bankruptcy, and got a divorce because of the position Mr. Unscrupulous Agent put them into. You want to impress me with an agent, don't show me happy clients on move-in day. Emotional high of being brand-new homeowners aside, any monkey of a loan officer can get anybody with quasi-reasonable credit into the property. What happens when they have to make the payments? More importantly, what happens when they have to make the real payments? Given the current environment, the question, as I keep saying here, is not "can I get this loan through?" but "Is it in the best interests of the client to put this loan through?" You want to impress me with an agent, show me a happy customer five years out "My agent found this property that fit within my budget, told me all about the potential problems he saw, got the inspections and loan done, and it's been five years now with no surprises, and the only problem I've had was one he told me about before I even made the offer."



Of course, the real value of the property may be beyond your range or reach. If your agent showed you something you could not reasonably acquire within your budget, you should fire them. I accept clients with a known budget, I'm saying I can find something they want within that range. If it becomes evident I was wrong (eyes bigger than wallet syndrome) the proper thing to do is inform the client that their budget will not stretch to the kind of property they want, and suggest some solutions, starting with "look at less expensive properties" and moving from there to "find a way to increase the budget" and finally to "creative financing options." That's a real agent, not "Start with creative financing options but somehow 'neglect' to mention the issues down the road."



There is no universal always works strategy for rejected purchase offers. It's okay to do desperation checks, but be aware that most sellers aren't desperate and that it's likely to poison the environment if the seller isn't that desperate. Poisoning the environment is okay if you're a "check for desperation and then move on" Quickflipper™, but if you're looking for a property you want and have found something attractive, it's likely to be counterproductive so that you may end up paying thousands more that you maybe could have gotten the property for if you'd just offered something marginally reasonable in the first place. Make a reasonable offer in the first place, and you're likely to at least get a dialog. And if the seller rejected what really was a reasonable offer for an overpriced property, the only one to lose is them. Move on. Their loss is someone else's gain.



Caveat Emptor (and Vendor)

UPDATED here