Recently in Mortgages Category

Scapegoating, anyone?Brian Brady notes Barney Frank's misplaced quest for one.

1- Prohibition of "yield spread premium" as compensation to originators.

2- Mandatory licensing of mortgage originators by a Federal registry or state regulator. This Bill does direct the Office of Thrift Supervision to establish a registry for bank employees who originate loans.

3- Ability to repay the loan must be established. Limits on cash-out refinances and a determination of a net tangible benefit to the borrower will apply.

4- Mandatory "pre-funding counseling" for certain "high-cost" loans by a certified HUD counselor.

All of these are severely brain damaged. In Zero Cost Real Estate Loans, I talk about what a good idea for the average consumer that using yield spread to pay your loan costs can be. Yes, you end up with a higher rate. But if you refinance every two years, the money you spend in interest doesn't even approach the money you don't spend on loan costs. Provision 2 is just a sop to the big lenders, to make brokers lives more difficult, while allowing them to scapegoat their bottom level employees who also take loan applications. I talk more a couple paragraphs down about the first part of provision 3, but the second part is another sop to big banking. If someone owns an asset, they should be able to manage their mortgage as they see fit. I can tell a prospective client that they don't appear to be able to afford something and advise them of such, but they're supposedly competent adults and my proper role, like that of an accountant, is advisory, not compulsory. But these sorts of loans lose a lot of money for lenders who over-compete for business in order to attract customers, whom they can hope to retain while selling them to marketers.

I went over the problems with the fourth proposal in Is This Supposed to be Helpful Legislation?, along with links to what others were saying.

Just this morning, Barry Campbell over at enrevanche pointed me to a new Business Week article that says North Carolina's infamous predatory lending laws may travel.

I don't do business in North Carolina and never have. But they have a 6% aggregate limit on total fees for a loan. When, even with negotiated discounts, it takes just over $3000 to get a loan done (closing costs), you tell me how many $50,000 loans are going to get done, with a 6% aggregate limit. Oh, and I I wasn't aware of this, but "The North Carolina Home Loan Protection Act bans penalties for borrowers who pay off their mortgages early," so that can't be used to cover the costs either, as I go over in Keeping Pre-payment Penalties Legal. One more factor: I believe North Carolina is a survey state, which adds something like $400 more to loan fees. I also believe it's a mortgage tax state, levying a tax on mortgages and refinancing. I don't know what that runs but I doubt it's less than hundreds of dollars.

I have to admit, the idea of nothing but full documentation loans has a certain appeal. Keeps me from having to compete with people who'd do every loan stated income, and sell everyone a house too expensive for them to afford. Furthermore, I'll bet that the entire difference between North Carolina and the national average in foreclosures would be due to this one difference. But self-employed people (with large amounts of deductions) and real estate investors (only get credit for 3/4 of rent, among other issues), both of which have problems qualifying under full documentation lending standards, might disagree with me.

So what's the issue? As I go over in Manufactured, Modular, and Site-Built Homes: How Lending Practices Drive the Sales Market, constricting the availability of loans constricts the price of housing. Were these practices to be mandatory elsewhere in the nation, that 25-30% deflation we've had in California would be just the beginning, and all of the other high cost areas as well (as what drives the cost of living up, except in DC and NYC, seems to be an abundance of successful entrepreneurs). Furthermore, real estate becomes a much less attractive capital investment, so it would have to become more of a "cash flow" investment, putting increased upwards pressure on rents just when some rental markets (like southern California) are set to explode upwards anyway.

Here's the REAL issue that politicians keep tap-dancing around, because they don't want to offend wealthy, campaign contributing lenders and real estate brokerages: There is no substitute for due diligence on an individual level. People have got to take the time to understand what they're getting into. They are legal adults, theoretically competent to manage their own affairs. If they're not capable of being responsible, why are they permitted to vote, drive cars, and sign loan Notes for hundreds of thousands of dollars? But there is no real financial education in the United States, except for those who make a career out of it, and all too often, that license is a cover for activities that would make any self-respecting shark shudder.

I read a posting just a few days ago on how one real estate practitioner built a very successful career at least partially upon a point he seemed inordinately proud of: Not asking people what their plans were. People don't like discussing their plans with folks. But it is precisely discussing future plans that enables a real professional to know what he or she should recommend to the client. Without that, even the most conscientious of us isn't much more than a sales person. You just want me to shut up and get you a million dollar home, I'm cool with that - but I am entitled to protect myself by asking you to agree that I have furnished you with no false promises of you being able to afford it, or that it's really worth what you paid in comparison to other properties at the time.

There is no substitute for real loan disclosure at the time of application, something the legislative branch has been expanding loopholes for for the last thirty years that I'm aware of, all in the name of "helping the consumer" but really in aid of campaign contributions from big chain brokerages and large mortgage lenders. Quite frankly, of the major household names in both, there's really only one that I haven't seen evidence of pervasive unethical practices that would amount to systematic fraud in any other industry, but legal loopholes, lax supervision requirements, and unwillingness to go for the real perpetrators keep these folks in business, occasionally sacrificing a few low echelon goats while those higher up make millions to hundreds of millions per year. That's why I finally got disgusted enough to start this website.

But it seems that comparatively few politicians really understood the lessons of Economics 101, or at least, they understand the benefits of campaign contributions more, and that's why you can't seem to keep a bad idea down.

Caveat Emptor

We have several rental properties that we own (more than 10). When we were younger, before we got married, we both moved around a lot and bought houses, moved, stayed a year or so and did it again. I of course don't have to mention why we did this (no money down, low fixed rates, etc.) However, now I am running into a dilema. I am finding that no one wants to refi or do purchase money loans now that we have 10+ mortgages. I need good rates to make my cash flow work. I have recently herniated one of my discs and have been out of work for almost 3 months, so I need to take money out of our house that is paid for, but no one wants to do it. Any suggestions on how to get around that? My credit scores range from 763-805, so that is defintaely not the problem. Any advice would be greatly appreciated as I am down to crunch time in needing to get some money.

Bad situation.

The reason for this problem is that whereas nationally, vacancy rates are much lower, and here in high cost California they are only running about 4 percent, the bank will only allow 75 percent of rent to be used in the calculation of whether you qualify or do not. Furthermore, on the negative side they charge the full payment, taxes, and homeowner's insurance, as well as maintenance. Now, here in the high cost areas of California if there is a rental property bought within the last three years that's turning a profit, I'd like to know about it. But for properties purchased several years ago here, and nationally in many markets, there are people making money hand over fist on rental properties whom the bank believes must be cash destitute. There is no way they will qualify for a mortgage loan without tweaking something.

There are two main ways to solve the problem.

10 mortgages (assuming you still own the properties) gives one serious status as a real estate investor. The loan should then be able to be done. Not necessarily A paper, but subprime with that kind of a credit score and a prepayment penalty will give them comparable - perhaps even better rates. Furthermore, on investment properties, there's a minimum of about a 1.5 point to 2 point hit on the loan costs just due to the fact that it is investment property. So refinancing an investment property is not something you want to do often. If you can't go 10 years between refinances, something is probably wrong. Especially given the extremely narrow spread between long term loans like the 30 year fixed rate loan and shorter term fixed rate hybrids, for investment property a 30 year fixed rate loan is likely the way to go.

But the key part is "real estate investor."

This is a business. You're going to need an accountant to attest to the fact that you've been operating this business at least two years. But that gives you standing as at least partially self-employed as the operator of a real estate investment business.

Which gives you an out to do stated income, possibly even A paper. You're going to have to state that you earn more income than you do. Given the environment today, a good loan officer looking to cover themselves is going to want you to acknowledge that you can make whatever the payment is really going to be. I don't care if you need $6000 per month to qualify and you tell me that you make $12,000 per month, or $120,000. Any time you are looking at stated income, you're looking at a situation that is vulnerable to abuse, both from the point of view of a consumer being put into a loan they really cannot afford, and from the point of view of a bank lending money based upon a credit score and source of income that really may not be there. This one is especially vulnerable to the latter concern in the current market, and I would likely take a real careful look at any bank statements that pass through my hands to make certain it's not patently disprovable. If it makes a borrower uneasy, well half of the reason is to protect them. Stated Income may be colloquially called "liar's loans", but that is not what they are intended for, and in this case you are intentionally overstating income in order to qualify under unrealistic underwriting rules. Furthermore, not every lender will permit this.

The second approach is NINA - a No Income, No Asset loan, also known as "no ratio" - meaning no debt to income ratio. These are much easier to do for the loan officer, as they're completely driven off credit score, but carry higher rates. Nor do you have to state a higher income than you make, as there is no debt to income ratio computation on these loans. On the other hand, especially if you're talking about your personal residence, as long as you're in a low loan to value situation, you may get a better rate from an A paper lender without a prepayment penalty, as opposed to doing a subprime loan with a pre-payment penalty.

There is serious potential for abuse in this situation, even if it is theoretically allowed under the rules. So be very upfront about what is going on with anyone you come into contact with. You, as a loan applicant, should never be dealing directly with the underwriter - as an anti-fraud measure, every lender I'm aware of prohibits it and cancels any loan in process if you to interact with the underwriter. But this is allowed by the nature of stated income and NINA loans. Self-employed people and commissioned salesfolk have to file taxes, also, and tax forms are the preferred method for documenting income. Nonetheless, because there are significant deductions that would not otherwise be allowed due to the fact that you're paying your bills with "before tax" money whereas most folks are paying with "after tax" money, it does make sense to do it this way. Provided you don't talk yourself into a loan that you cannot really afford.

Caveat Emptor

Originally here

Thanks again for the terrific posts. I've learned more about mortgages in the past two months than I ever dreamed I might.

I am looking to buy my first home soon, and have myself in a good credit position to do so. My credit score is over 800 and I have no back-end debt - no car payments, alimony, student loans, etc. My annual salary is well over $100K, and while my down payment will not be as much as I would like, I should be able to put up 20% of the purchase price.

Before I shop for a loan, I have some questions and would appreciate your insight.

1. Do monthly "subscriptions" such as landline phone bill, cable, internet, cell phone, etc. come into consideration? As I have no cell phone and no cable (and don't intend to get them), I see my monthly expenses in this regard as significantly lower than most other borrowers.

2. Do my retirement savings come into play? I have saved conscientiously for several years and between IRA's and pension funds (fully vested) I have a significant amount put away.

Thanks again for the teachings

Gosh, I didn't think a dream client like this existed any more!

In general, there are only three instances when reserves really come into play. They are:

1) Stated Income. Since you are not documenting your income, for a true stated income loan they are looking for evidence that you are living within your means. The measurement that has evolved is six months PITI (Principal Interest Taxes and Insurance) in a form where you can get to it - savings accounts, investments, something. If you have a retirement account, such as a 401, IRA or similar, most lenders will allow you to use a discounted amount, most often 70 percent, as the money would require the payment of taxes and penalties. Roth IRAs may be treated differently, as the rules are different. There are Stated Income Stated Assets loan programs, but when you get right down to it, those loans look more like heavily propagandized NINA (No Income, No Assets, aka No Ratio loans) than they do a true Stated Income.

2) Payment shock. If your payments are going to be much higher than rent was (or previous payments were), many lenders will require two to three months reserves of PITI payments in reserves.

3) Cash to close. No matter what the loan, the underwriter is going to be looking at the loan to make certain that you have the cash to close, and any reserve requirements are in addition to this. If your loan is going to require a certain amount of cash, either in the form of down payment or loan costs or most often, for prepaid interest or an escrow account, then the underwriter wants to see evidence you've got it. It's no good for the bank for the loan to be approved, the documents printed and signed, the notary paid, and then the loan doesn't close because you didn't really have the cash. Seller paid closing costs are getting to be a really touchy point with many lenders, by the way, as they indicate the property may not really be worth the ostensible sales price.

In any of these cases, the underwriter is going to want to see evidence as to where the money came from. They want to know that you've either built it up over time or have had it for quite some time or that you can document where you got it from. What they are looking at with these requirements is the possibility that you got a loan from somewhere that you're going to have to pay back, and the payments on which may mean you no longer qualify under Debt to Income ratio guidelines.

Mind you, it never hurts to have money socked away. But it's not worth any huge amount of contortions to prove. For A paper lenders, the guidelines are razor sharp, and excessive reserves are not a part of them. You've either got the required amount or you don't, and the fact that you have $100 million in investment accounts isn't relevant - and it may cause some underwriters to start wondering why you're not paying for the property in cash or putting more of a down payment (Anytime you give an underwriter more information than required, you run the risk that they will ask you questions about it). Some subprime lenders may approve a loan they would not otherwise have approved, or maybe offer better terms than they might otherwise, but there have been enough adverse experiences with this that it is becoming more rare.

Monthly subscriptions (utilities, etcetera) are why the permissible debt-to-income ratio (DTI) isn't higher. You can cancel cable TV, you can cancel dish network, you can cancel pay per view, you can cancel magazines, although most folks want phone, gas, and electricity. They do not count against your DTI, just payments that you are required to make to keep the accounts on money you have borrowed current. So if you owe the utility company money because you got behind on your payments, that will count, but not the money to keep the utilities current.

Caveat Emptor

Originally here

if our house is being foreclosed, can they take our retirement or make us sell our cars?

we both have 2006 cars that are paid off. Can they take our cars or make us sell them to pay them some money?
Can they place a judgment to take our retirement 401k?

Depends upon the law in your state, and whether the loans you have are subject to recourse.

Here in California, purchase money loans are not subject to recourse. Providing you don't commit fraud or any of the other things that void this protection, once they take the property, that's it. If your loan was purchase money, used to buy the property, they shouldn't be able to win a deficiency judgment after foreclosure.

However, this isn't likely to be as innocent a situation as all that. Can't make the mortgage payment, but have two vehicles less than two years old which are all paid off? That says "cash out loan" to me!

I am unaware of any circumstance under which a "cash out" loan is not full recourse. It's not like you did it by accident. Now, if as I suspect may also have been the case, false promises were made to you as to your payment, interest rate, etcetera, that's a matter to take up with the people who did your loan. Actually, probably better to have your lawyer take it up with their lawyer. But that doesn't mean the current holder of that loan isn't entitled to their money.

If, as I suspect, you "cashed out" to pay for those cars, then you've got a full recourse loan, and they can pursue a deficiency judgment. Once they've got that, talk to a lawyer about whether they can get court approval to take your vehicles. But they're going to get the deficiency judgment if they try. That one is pretty cut and dried. Unless there's something reasonably unusual going on, for which consult a lawyer, you're likely to be better off agreeing to it in the first place, rather than forcing them to pay attorney's fees and having the judgment say you've got to pay their attorney fees as well as your own, in addition to the base deficiency. My understanding is that safe harbors for assets in this case are intentionally as few as the legislature can make them.

One of those few safe harbors, though, though, is likely to be retirement accounts. Retirement accounts are a protected asset class, and while I suppose it's possible for a creditor to get at them, I've never heard of a case of them being successful, at least not until you start withdrawing from those accounts. Once it gets withdrawn, of course, the money you withdraw is ordinary income, and therefore, fair game. This can lead to the sort of situation computer programmers call a deadly embrace. They can't get at the retirement account as long as the money is in there, you can keep the money in the retirement account, but if you try and withdraw it for use, they can then get at it. They can't get it until you try to use it, but they can get it if you do. Usually, people in this situation negotiate a settlement

Caveat Emptor

What do the mortgage companies mean when they say they can not insure you house loan.? What is the danger to the homeowner?

I have been in the new home for over a year now and they just now told me that they could not insure my loan. They said they made a mistake and overlooked something in my credit. I do not know what dangers I face now because of this.

You say you've been in the property a year, so I'm going to presume you're talking about an existing loan, rather than a new loan. The loan you used to buy the property, and what they're talking about is that the PMI company rejected the application to insure your loan, and they just now realized the problem.

That loan contract is binding to both sides. They accepted that loan contract with you. Once it's funded and recorded, they can't back out. Unless the contract has a call "feature" they can't pull your loan just because they feel like it after it's recorded, so the loan you've got now should be fine for you. It's no coincidence lenders are adding call features to more and more loans, to give them a bail out clause should they decide to. But if you don't have such a clause, as long as you keep making all your payments on time, keep the insurance and property taxes up, and all that, they can't force you to do anything. The lender can offer you incentives, as lenders did back in the late seventies and early eighties, such as offering you a reduced payoff if you'll refinance or sell, but they can't force you to do anything as long as you continue to hold up your end of the bargain. The time for them to talk about qualifications is before the loan is funded and recorded. Afterwards, they can't do anything about it, any more than they can do something if values drop (which they have, another reason why they want you to find another lender), if you lose your job, if you decide to change lines of work, etcetera. The qualification process is not open-ended.

There is one more way they can get out of it. If you committed fraud or perjury or something else during the loan qualification process, and they gave you the loan based upon those false representations. Having a loan called is no fun. There's a reason I keep telling people to tell the truth, and nothing but the truth in loan paperwork. In addition to possible criminal charges, you'll have between 7 and 30 days to get the money somewhere when your loan is called for this reason. If the rate is higher, if the closing costs are huge, even if you can't get that loan, it's not the lender's problem. They are within their rights if you misrepresented yourself in a material way.

What they're likely trying to do in this case, where you haven't told me of such a reason, is stampede you into refinancing, since without PMI they can't sell your loan on the secondary market. Unfortunately for them, they're stuck at this point unless you let them off the hook, and they'll have to hold your loan themselves and hope you don't default.

There's a fair amount of this sort of thing going on right now, as the lenders that gave out 'warm body' loans suddenly realize the consequences. Don't draw any lines in the sand without talking to a lawyer first, but if I understand your situation, they can't force you to refinance or anything. It's more than a little slimy of them to do this, of course. But a certain percentage of borrowers will panic and do something they don't need to.

Caveat Emptor

Legally, immediately. This also applies to refinance loans.



With that said, there are economic reasons why it may not be a good idea for you to refinance.



If you have a prepayment penalty, you're going to have to save a lot of money to make it worth paying that penalty. Suppose you have a rate of 7 percent, and an penalty of eighty percent of six months interest, that's a prepayment penalty of 2.8 percent of the loan amount. So, in order to make it worth refinancing in that instance, you have to save at least 2.8 percent of your loan amount in addition to the costs of getting the loan done, all before the prepayment penalty would have expired anyway. So if it's a three year prepayment penalty, you have to cut almost a full percent off your rate just to balance out the prepayment penalty. The higher the rate you've got now, the bigger the penalty and the more you've got to save in order to make it worthwhile. On the other side of the argument, the longer the prepayment penalty is for, the easier it is to save enough to justify paying it. If you've got a five year prepayment penalty, you're likely to get transferred or need to sell or somehow end up paying it anyway.



Second, your home has not appreciated yet, especially not in the current market. You bought for $X, and your home is still worth $X, and you haven't paid the loan down much yet, so your equity situation is essentially unchanged. In fact, since relatively few loans are zero cost, you're either going to have to put money to the deal or accept a higher rate than you might otherwise get. Don't get me wrong; Zero Cost Refinancing is a really good idea if you refinance often. But when you go from a loan that takes money to buy the rate down to a loan where the lender is paying for all of the costs of getting it done, you're not going to get as good of a rate unless the rates are falling. Loan rates went through a broad and more or less steady increase in 2004-2006, although they seem to have leveled off for about the last year. If you or someone else paid two points to get the rate on your current loan, you are not getting those two points back if you refinance. They are sunk costs, gone forever when you let the lender off the hook. If rates had been going down for the same amount of time, it might be a good idea to refinance, but that is not the case right now.



If you got your current loan based upon a property value of $400,000 and total loans of $380,000, that's a 95 percent Loan to Value Ratio. So your property is still worth $400,000, you've only paid the loan down $400. That's still a ninety five percent Loan to Value Ratio; more actually, as doing most loans is not free. So unless your credit score has gone way up, you can now prove you make money where you couldn't before, or you have a large chunk of cash you intend to put to the loan, chances are not good that refinancing is going to help you where it really counts, in the cost of money. If your credit score has gone from 520 to 740, on the other hand, or you now have two years of tax returns that prove your income, or you did win $100,000 in Vegas and you want to pay your loan down, then it can become worthwhile to refinance, even in a market like this one where the rates are generally rising. Unfortunately for loan officers like me, that does not describe the situation most people find themselves in.



One more thing that can influence whether it's a good idea to refinance is your rental and mortgage payment history. If when you got your current loan, you had multiple sixty day lates on your credit within the past two years, and now they are all more than two years in the past, that can make a really positive difference in the rate you qualify for. On the other hand, if you had an immaculate history before and now you've had a bunch of payments late thirty days or more, then it's probably not going to be beneficial to refinance.



Cash out refinancing is one thing many people ask about surprisingly soon after they close on their home. If you have a down payment, tt's better to put aside some of the down payment for use in renovations rather than to initially put it towards a purchase and then refinance it out, as it saves you the costs of doing a new loan. Furthermore, "cash out" loans have generally less favorable rate/cost tradeoffs than "purchase money." If the equity is there and if you have the discipline to take the money and actually do something financially beneficial with it, it can be a very good idea. If you're just taking the money to pay off debts so you can cut your payments and run up more debts, it's probably not a good idea, even if your equity situation supports getting the cash out. It often can and does in a rising market. In the current market where values have been retreating and are ready to stabilize, not so much. If you bought any time in the last two years, it is unlikely that you have significantly more equity now than when you bought, making the whole situation unlikely to be of benefit.



A lot of situations have something or other that makes them an exception to the general rules of thumb. The only way to know for certain if the general rules apply to your situation is have a good conversation with a loan provider or two.



Caveat Emptor

Original here

How do I keep my home after filing bankruptcy. The Mortgage company wants to foreclose?

I want to know if there is anyway to keep the home even after filing chapter 7 bankruptcy. I want to know if there is any program that can assist me.

Bankruptcy does not effect your current mortgage. The only thing that will cause you to go into foreclosure is not keeping up your mortgage payments, period.

You don't have to include your mortgage in chapter 7, and it's not usually a good idea to do so if you have significant equity. Leave it out, and you even have a mechanism to restore your credit already in place, while limiting the damage the bankruptcy does. The larger the percentage of your lines of credit you include, the worse the hit is. Furthermore, if you have an open mortgage when your bankruptcy concludes, you're establishing post bankruptcy credit history, the best way to rebuild your credit. The poor folks who have to go get a new credit card get dinged even harder for each turndown, so that each successive application lowers the probability their next one will be accepted. Positive feedback to a negative end. Vicious cycle.

Talk with a real lawyer in your state to be certain. I'm not a lawyer, and I don't even play one on TV. However, my understanding is that Mortgages are debt secured by a specific asset - the property. Keep up the payments on that (or bring it current if you haven't) and general creditors with unsecured debt cannot touch that asset in most states and most situations. There are exceptions, but owner occupied residential real estate is one of the most protected assets there is. The fact that it is a loan secured by a specific asset can also be used to avoid compromising the mortgage holder's interest.

The upshot is that if you make your payments on the property, and keep them current, quite often it can sail through a bankruptcy untouched. People will often let everything else go to keep making the payments on their mortgage - one of the reasons why mortgage rates are so favorable, compared to unsecured credit. Another issue I should mention is that while A paper does care about non-mortgage late payments, subprime generally doesn't. As long as you keep your mortgage payments current, you can often secure a loan on surprisingly good terms, even though it'll likely have a prepayment penalty. So keep your mortgage current if you can.

Caveat Emptor

what happens if partner refuses to pay his half of the mortgage?

The lender will hold you each responsible for payment in full. That's the long and the short of it. You both agreed to the loan contract, and if it's not paid in full there will be all of the consequences: Hits to your credit, notice of default, foreclosure.

This is basically blackmail on the part of your partner, and a disturbing number of partnerships have this phenomenon. The only way I know of to recover the money is through the courts, which takes forever and costs more money. Even when you have a judgment, it can be difficult to actually get the money if they have taken certain steps to place it beyond your reach. Talk to an attorney right now, keep good records, and send everything Certified Mail.

Unfortunately, there are no method except time that I am aware of to repair the damage to your credit once it has been done. You just have to wait it out. For that reason, it is usually cost effective to loan your partner the money, even at zero percent interest.

What if you don't have the money for both halves of the payment? Well, that's a real question, and the answer is found in the article What Happens When You Can't Make Your Real Estate Loan Payment. This is not a good situation to be in. Talk to that attorney about liquidating your investment. It takes time and a lot of money if your partner doesn't want to.

What can you do to prevent this from happening? Pick a good partner that won't pull this nonsense. Spend the money to protect yourself up front with a partnership agreement. But that won't protect you if you didn't do it in advance, and the fact is that if your partner wants to be a problem personality, you really can't stop them in the short term. Not that it makes any difference to your pocketbook, but sometimes it's not intentional. People do fall on bad times for reasons not under their control.

Corporations are another step people take to protect themselves from this sort of thing, but that brings in all sorts of further problems. How the corporation qualifies for a loan is often a significant problem, and many times practically speaking, is insurmountable.

Borrowing money in partnership with someone else is something to be done with a lot of forethought and preparation, otherwise there's nothing you can do when bad things happen.

Caveat Emptor

Original here

I've seen more changes in the lending industry in the last six months than the previous five years. But those changes simply restored us to the place we were a few years ago.

Loans are easy to get, rates are good. For all the howling and gnashing and grinding of teeth you see in the media, and elsewhere, I can get loans at rates that are very low, historically speaking. I can get 100% financing quite easily, and not just government programs, either.

You just have to be able to prove you can afford the payments.

Actually, let me modify that. You don't have to prove you can afford the payments. You can get "stated income" and NINA financing. There's actually quite a lot of it out there, and the rates have even fallen a bit in the last couple weeks. The lenders are perfectly willing to make stated income and NINA loans. Want one? I can get it, even A paper, provided you've got the credit score.

You just have to have enough equity that the lender isn't worried about losing the money they loan you.

All you need is one or the other. And that's the rub. Starting a few years ago, and increasing until the house of cards started collapsing back in the beginning of the year, many real estate agents and loan officers stopped worrying about whether or not their client could really afford the property. The question was could they get the loan funded, and let the client worry about whether they could really afford it later.

The relaxation of lending standards was like manna from heaven to the less ethical members of my professions. Agents could sell people who could barely afford a condominium in reality a beautiful huge detached house with its own yard in an affluent community with great schools, and loan officers could make it look like they could afford the payments. Talk about your easy sale! The clients expect a chintzy little condo in a rough neighborhood, and the agents shows them a beautiful five bedroom home half a block from the beach, and says they can get it for the monthly payment they told the agent they could make. Prices skyrocket! People who bought a couple years ago and are strapped for bills refinance into these ridiculously low payments while getting cash out for all of the toys they can imagine! New SUV? How about two new SUVs! Some loan officer needs to get paid for a loan, and everybody has a thirty year fixed rate loan they got in Summer 2003 at 5.25%? Offer to cut the payment in half!

Never mind that the real interest rates on these loans was much higher. People just naturally assumed that if they kept making the payments, they'd pay the loan down, and eventually, off. After all, that's what loans are! Except that wasn't the case in this particular instance. That small minimum payment, way below the real cost of interest, caused thousands of dollars to be added to the loan balances, where the above market interest rate could be charged on that money also - and the lenders could report all of this as income, doing wonderful things for their revenue and stock prices!

Some others may not have gone in for negative amortization loans in a big way. Instead, they put people into "interest only" loans where the loan and interest rate was fixed for two, or maybe even three years. They may have used stated income, or they may not, but they put people in unsustainable loans where the clients could barely afford the initial payment, and never mind thinking about what would happen, sure as gravity, when the adjustment hit. When the loan started to amortize at the same time the rate jumped by two percent, they affect to be somehow surprised that their former clients cannot afford the payments!

Or perhaps they used stated income only because the clients had two thousand dollars of other debt service per month. Well, hello! debt to income ratio is the most critical measure of whether someone qualifies for a loan there is. It protects the lender, and it also protects the borrower, and this intentionally short-circuited it. Yes, they could have afforded the property if they didn't have have this debt. It's not a distraction, it's the central, single most important issue in whether or not they qualify for that loan!

For those who were taken advantage of thusly, may I recommend finding a competent real estate attorney? The last few months have seen some very interesting court decisions. One in Ohio started it off by ordering a negative amortization loan rescinded due to failure to disclose its nature sufficiently. There are all kinds of class action suits going on, which may be the first worthwhile use to which I've seen them put in twenty years. I would not be surprised at all to see some real estate brokers successfully sued over basically the same issues (actually, I'm anticipating it with a fair amount of schadenfreude), and I also expect the regulators to get pretty heavily involved. Licenses are going to be lost, and even a few jail cells are going to be filled.

All of that is neither here nor there, really. My point is that the only thing that's changed is that the lenders have woken up to the fact that was evident all along - that they were the "deep pockets" who were liable to eat most of these losses from the price collapse, and from people who couldn't make payments on unsustainable loans, particularly after the payment started adjusting. The lending standards that contributed to the bubble are gone, and they are not coming back any time soon. Forget about them. That was then. This is now.

The lending standards in effect now are very livable. Bankers transported from the seventies - or even the early nineties - would be horrified at how lax they are. Until 1997, there was precisely one lender that would loan 100 percent of the value of the property (when they bailed out of the 100% loan market in late 2005, it was the first sign that collapse of the lending market had actually started). I've still got at least a dozen lenders who will go 100% now, but they want to see proof you can afford the payments. Failing that, they want to see enough equity (which means down payment in the case of purchases for you real estate agents reading this), so that if the loan were to go south, that lender would still get their money.

This means real affordability and down payment have become a lot more important to the purchase market, and if you're looking at a refinance, you had better be able to afford the real payments. If you can't, you better have equity. If you don't have either, that refinance is not going to happen. I just checked two wholesaler databases, and neither one had a 100% stated income loan, even with verified asset reserves.

If, on the other hand, you're willing to restrict yourself to properties you can really afford, welcome to ownership! As I've said, I've got any number of 100% loan to value ratio programs if you'll do this, and have credit that isn't putrid! As I covered a few weeks ago, affordability has increased a lot, and that's just judging by asking prices. When you judge by actual sales prices, things are more affordable yet!

The catch is that if you can only afford the payments on $300,000, then $300,000 is all you're going to be able to borrow. I've been selling my clients what they can really afford all along - the only difference it makes to me is that I'm no longer competing with the jokers that can only sell houses by showing clients the beautiful property they can't afford. I've been telling people about real, sustainable loans all along. The only difference this makes to my loan business is that I'm not competing with jokers who sell negative amortization loans by the minimum payment to unsuspecting people who don't understand what's going on.

What this means is that lazy agents and loan officers are going to have to bite the bullet and sell the client a property they can really afford with a loan they can really afford. Agents can have people make offers on property they can't afford, but they're wasting their time and the clients'. Loan officers can tell people about this loan and that loan they used to have, but they're wasting their time and the clients'. Possibly the clients deposit, inspection, and appraisal money too, in both cases. The loans to make this nonsense happen do not exist any longer.

On the other hand, 100% financing still exists for those who can afford the payments. But they have to be able to actually afford the payments. This means working within a budget, and settling for what you can afford within that budget. Settling is a very hard message to send someone who's going to be spending six figures on a property and is all emotionally tied up with how they want it to be beautiful, and in a great neighborhood with wonderful schools and all of the usual things that have buyers gushing - particularly when everyone else is telling them they don't have to settle. They really did have to settle, all along, and those that believed ethical practitioners when they were told that are doing just fine, thank you, while those who didn't are in real trouble. The real world has come crashing back into real estate. The fantasy may have been nice while it lasted, but the real world always comes crashing back.

Among those real world facts that have come crashing back is that all of the long term benefits of owning over renting are just as real, just as relevant, and just as true, as I painted them back when I wrote those articles. Let's review a few:

Should I buy a Home?, Leverage in Real Estate - Making a Decent Investment Spectacular, Why Renting Really Is For Suckers (And What To Do About It) (and its counterpoint, When You Should Not Buy Real Estate), Save For A Down Payment or Buy Now?, The High Cost of Waiting To Buy A Home, Real Estate: Getting From Where You Are To Where You Want To Be.

My local market in San Diego County has been on the bleeding edge of all of this, because it's such a desirable place to live, and our housing supply is probably the second most constricted in the nation (after Manhattan, and although the City of San Francisco also has a decent claim it covers a much smaller area). Between natural obstacles to growth and zoning codes constricting the building of new housing, I think we've had about all the downwards adjustment we're going to get. If you can't afford to buy a detached house, buy a condominium, townhome, or PUD (indeed, how dead the condo market has been the last three summers has been directly attributable to two factors: Over-conversion or apartments, and the fact that lazy agents were selling people properties they couldn't afford because it was easy), or think seriously about moving out of town, because with the number of people who want to live here, it's only the current meltdown in lending that's causing the hiccough in prices (and what effect do you think over-conversion of rentals will have on the rental market?). With local housing demand trends going the way they are going, even the prices at the peak of the bubble two years ago are going to look pathetically cheap in a few years, and that's pretty much the facts of the matter, albeit perhaps not so strongly where there's still room and the building codes to allow growth People are able to qualify here locally. Right now, the only thing preventing them is irrational Fear and Greed, exactly opposite to but caused by exactly the same psychological factors I wrote about in February 2006, back when everybody else thought the market was still going gangbusters, and updated here. But psychological fear and greed are difficult to maintain. It's not going to be very much longer before people figure out, en masse, that the economic basis is there to support those few sales that are actually happening. Actually, the economic basis is more than there to support current prices - I'd look for a significant bounce in prices next spring and summer, and even if I'm wrong about the exact timing, the price turn-around is coming. Buy something you can really afford, and be ready to see it increase in value.

If you buy something you can really afford, the moderate increases in value I expect to see will leverage your money favorably, such that you will be better able to afford something more expensive, more quickly, than if you saved your money, even if you invested those savings in the stock market. Even if you never move up, the fact that you have fixed your costs of housing now means that if you can afford those costs now, you will be even better able to afford those costs in the future, assuming inflation and all of those other economic factors we've gotten accustomed to these last fifty years. Homes are not going to continue at today's prices any more than candy bars are still ten cents, or that you're going to be happy working for today's wages thirty years from now. What's going on right now is an opportunity for buyers, and an opportunity for those who would like to be able to continue to afford to live here for the rest of their lives. If you decide to wait until event prove me right, that's your prerogative, but neither I nor anyone else will be able to bring the market back to today's state. The moving finger writes and moves on.

Caveat Emptor

Hi Dan wondering if you could help me out I'm getting a lot of different answers from a lot of people and I'm really searching for help I bought my house brand new (three years ago) for 550,000, and (the next year) I refinanced into a mta loan. which at that time was around 4.25% and now is 7.125%. I have a hard prepay of $12,000.00 which expires in (fifteen months) house just appraised for $775,00 balance on 1st loan 440,000 balance on 2nd 148,000. should I ride the next 15 months out to avoid pre pay or refinance now into a fixed. The rate on the second is prime plus zero.

First off, a disclaimer. A precise infallible answer depends upon the rates when your prepayment penalty expires, something that is not currently known. I have my opinions, as does everyone else. But I don't know; nobody does. It also depends upon what comparable homes are selling for then, which determine your appraisal, and how long you keep the new loan.

Your rate moving like that is one of the many reasons I recommend so strongly against negative amortization loans. The person who did your loan at the time had to know that, due to the nature of the mta yours is based upon, the rates were already set to rise into the sixes for certain, and likely further, as older months were dropped from the average in favor of newer (and they're even higher now). Were it fully explained, would anyone rational agree to take a loan where you get a lower rate for six months, but then the rate rises inexorably, as the treasury rates the loan is based upon had already been rising, to a level that is well above what is available on A paper three or five year fixed? And with a three year prepayment penalty, so you're in precisely this sort of situation?

"No points" thirty year fixed rate loans are sitting right around 6.375 right now, and you're at 75% Loan to Value. The bad news is you're definitely a jumbo loan (although this might change soon as I expect the Fed to raise it, see the last item here, as the conforming limit is $417,000. This boosts your rate more than a tad, depending upon the lender, to 7.25 percent right now if you're going to do it without points (usually this spread is much less). I prefer to discuss loans without prepayment penalties or points, but it might be in your best interest to pay a little to buy the rate down if you refinance. I'm going to use seven, as it makes the math slightly easier.

The good news is your loan to value ratio. According to the numbers you gave me, you're below 80 percent, even with the prepayment penalty. You owe $588,000 (If you bought for $550,000, the turkey did this negative amortization loan scammed you out of a lot of money), and the prepayment penalty boosts this to $600,000. Assuming you have enough liquid reserves to put up the money for interest and impounds, this means the costs of doing your loan are going to put you at about at $605,000 new balance (perhaps a bit below, but let's keep the math as friendly as possible).

Basically, it cost you $17,000 to save yourself an eighth of a percent on the interest rate. Under more normal circumstances, I wouldn't even put that one through the calculator. No way that's in your best interest. But your real rate on that MTA is going to keep rising - by at least another quarter percent due to increases already on the books, more likely half. I'll use 7.5 as your mean rate. Furthermore, the second is at 8 percent, likely to soon be 8.25. Monthly interest under the current loan at that rate: $2750 for the first, $987 for the second as it is. Monthly interest on the new loan, $3530. It saves you $200 per month in interest, albeit with a higher payment, $4025 as opposed to what you've got now. I am assuming you have documentation that you make enough money to justify the loan in the underwriter's eyes, and that your credit score is about average. On the other hand, divide $17,000 by $200 per month, and you get 85 months to break even on the cost of doing it.

However, this decision does not take place in a vacuum. You can't let that negative amortization loan go forever. In fifteen months, I think equivalent rates will be higher (as lenders fail and there's less competition for consumers), which translates to to adding an unknown cost to waiting. When I wrote the original, I believed prices would slide further, something I no longer believe. In fact, I think we're likely to see a recovery of at least a quarter of what we've lost in the next fifteen months. Any of these prognostications is an educated market guess, no more, and I could be way off. The appraisal would come in just under $700,000, but let's say $700,000. Your first, for $560,000, would be at 7.5%, and for your second, I'll presume you get a new HELOC on the same terms, on which the balance would be about $33,000. Interest on first and second, at 7.5% and 8.25% respectively, comes to $3500 plus $227. The payment on the first would be $3915, plus $227 (assuming interest only HELOC) for a total of $4142. So $12,000 saved if you wait, versus about $200 per month less in interest charges per month if you dive in. Divide that out and it comes out to 60 months. Five years. If you keep the new loan five years, approximately, or more, you'll be better off refinancing now. If you keep it less than five years, you're better off waiting is what the calculations say. Plus chop off the $200 per month you save starting right now for the next fifteen months, and the answer turns into forty five months or a little less, being your time until break-even.

I'm a reasonable risk taker. Were I plopped down in your situation, I have to tell you I would probably hang tight until the prepayment penalty expires. Roll the dice and bet on my personal ability to come up with a good loan. On the other hand, you may not be as much of a risk-taker as I am. The stuff I quoted you for refinancing now is available now, no suppositions about it. The rates could well be higher in fifteen months than I have estimated, perhaps much higher, or they could be lower (although I don't think so with increased federal borrowing). You need to decide what your level of comfort is. If you're the sort that is averse to risk, refinancing now could pay for itself just in peace of mind, because you're not worrying about it. That's why I always offer a 30 year fixed rate loan, no matter how wide the interest rate spread is between that and my favorite hybrid ARM, which is usually a better buy, although not now. There are folks who just won't sleep nights. In real terms of cost of money, the difference comes out to about $7 per night, and my sleep is worth more than that, so I presume yours is, as well.

Caveat Emptor

Original here

Got a search for that, and it occurred to me that it is a valid question. The answer is yes.



The degree varies. You can simply contact the bank to make yourself responsible for payment. They are usually happy to do this, although unlike revolving accounts you typically will not receive back credit on your credit score for the entire length of time the trade line has been open. Nonetheless, if the bank reports the mortgage as paid as part of your credit, it can help you increase your credit score, so long as the mortgage actually gets paid on time every month. One 30 day late is plenty to kill any advantage for most folks. This is typically free. Hey, the bank has one more person to pay the mortgage! This is often used as a way to start rebuilding credit after a bankruptcy or other financial disaster. A friend or family member qualifies for the loan, then adds the person looking to recover to the loan later.



If you want to go one better than that, you can actually modify the deed of trust to make yourself responsible for payment, although it really has no measurable benefit as opposed to simply agreeing to be responsible, and it costs money to notarize and record the modification.

It is entirely possible you'll encounter someone who is thinking only of the bonus they get for referring you to the loan department, or someone in the loan department who wants an easy commission. These folks will want you to go through a full refinance, and tell you that's the only way. To be 100% fair, many lenders don't go out of their way to tell their employees about this. Nevertheless, the lender loses nothing, as you're not taking anyone off, the people who qualified for the loan are still on it. You're only adding someone who, no matter how poor their credit and debt to income ratio may be, nonetheless is a legal adult and might have the money to make or assist in making the payment if something happens to all the other holders. Therefore, the lender can only gain in likelihood of the loan being repaid in full and on time, and that's what's important to them.

Unless you can get a better rate by doing so, I would advise against a full re-qualification for the mortgage just to add someone. It's a lot of hassle and expense for no particular gain. If you want to get me paid, I'm cool with that, but there are better ways to accomplish the gain to your credit at far less expense.

Caveat Emptor

Original here

The negative amortization loan is a very popular loan with certain kinds of real estate agents and loan officers. It has two great virtues as far as they are concerned. First, it has a low payment, and despite the fact that people should never choose a loan - or a house - based upon payment, the fact is that most people do both, and the negative amortization loan enables both sorts to quote a very low payment considering how much money their client is borrowing. Furthermore, because it has this very low minimum payment, it enables these agents and loan officers to persuade people to buy properties that they cannot really afford. When someone says, "I'll buy it if the payment is less that $3000 per month," this brand of agent goes to a loan officer that they know will reach for a negative amortization loan, without explaining this loan's horrific gotcha, or actually, gotcha!s. Instead of someone ethical explaining that the real rate and the real payment are way above $3000, and this is only a temporary thing, they keep their mouth shut and pocket the commission.

This commission is, incidentally, far larger than they would otherwise make, and that's the second advantage to these loans from their point of view. When the pay for doing such a loan is between three and four percent of the loan amount, with most of them clustering around 3.75%, and they can make it appear like someone can afford a much larger loan, that commission check blows the one for the loan and the property that this customer can really afford out of the water. When they can make it appear like someone who really barely qualifies for a $400,000 loan can afford a $775,000 loan, and the commission on the $400,000 loan is at most two percent of the loan amount, that loan officer is making over twenty-nine thousand dollars, as opposed to between four and eight thousand for the sustainable loan, and that real estate agent (assuming a 3% commission per side) is making over twenty-three thousand dollars as a buyer's agent for hosing their client, as opposed to $12,000 for the property the client can really afford. Not to mention that if they were the listing agent as well, not only have they made $46,000 for both sides of the real estate transaction, but they have found a sucker that can be made to look as if they qualify for that property, making their listing client extremely happy - the more so because one of listing agents standard tricks is talking people into upping their offers based upon how little difference it makes on the payment. Ladies and gentlemen, if the property is only worth $X, it's only worth $X, and it doesn't matter a hill of beans that an extra $20,000 only makes a difference of $50 on the minimum payment for an Option ARM, as these loans are also called. Indeed, Option ARM (aka negative amortization) loan sales were behind a lot of the general run-up in prices of the last few years. By making it appear as if someone could afford a loan amount larger than they really can, this sort of real estate agent and loan officer sowed at least part of the seeds by making people apparently able, and therefore willing, to pay the higher prices because the minimum payment they were quoted fit within their budget. When someone ethical is showing you the two bedroom condo you can really afford, fifteen years old with formica counters and linoleum tile floors, these clowns were showing the same people brand new 2800 square foot detached houses with five bedrooms, granite counters, and travertine or Italian marble floors. Talk about the easy sale! Someone who's not happy about what they can really afford now finds out there's a way they can apparently afford the house of their dreams!

So now that the Option ARM has finally been generally discredited by all the damage it has been doing to people these past three to four years, and has become well known, and deservedly so, by the moniker "Nightmare Mortgage," among others, this type of agent and loan officer are jumping for joy and shouting from the rooftops that a couple of professors have done apparently some work showing that "the Option ARM is the optimal mortgage." It was reported in BusinessWeek, which would have reason to celebrate if this defused the mortgage crisis, and therefore the credit and spending crunch that comes with it.

The problem is that the "Option ARM" these professors are talking about has very little in common with the Option ARMs, or more properly, negative amortization loans that are actually sold for residential mortgages. If you read their research, the loans they describe actually look a lot more like commercial lines of credit secured by real property. There really isn't much more in common between the two than the name.

The characteristics the professors describe in their ideal loan include first, it being the lowest actual rate available. This is not currently the case. In fact, since I've been in the business, it has NEVER been the case - or even close to being the case. The nominal rate can't be beat, but the nominal rate is not the actual interest rate you are being charged. Ever since the first time I was approached about one of these by a lender's representative, I have always had loans at lower rates of interest, with that rate fixed for a minimum of five years. For the last year and a half or so, I've had thirty year fixed rate loans - the paranoid consumer's dream loan, which usually carries a higher interest rate than anything else - at lower real rates of interest than Option ARM. When you're considering the real cost of the loan, it's the interest you're paying that's important. The lender, or the investor behind them, isn't reporting the payment amount as income. They're reporting the cost of interest to the buyer as income, and that's what they're paying taxes on as well. But because people don't know any better than to select loans on the basis of payment, lenders can and do get away with charging higher rates of interest on these. The suckers pay a higher rate of interest than they could otherwise have gotten, and their balances are going up, which means they're effectively borrowing more money all the time, on which they then pay the inflated interest rate that is the real cost of this money. What more could you ask for, from the lenders and investors point of view?

Now there is a real actuarial risk associated with these loans, as well, which does increase the interest rate that the lenders need to charge. This is that because there is an increased risk that the borrower's balance will eventually reach beyond their ability to pay, a risk which is exacerbated by how these loans are generally marketed and sold, a larger number of borrowers will default than would be the case with other kinds of loans. So these loans aren't all fun and games from the lenders point of view, either - as said lenders have been finding out firsthand for the last several months as the loans go into default. This leads us to the second dissimilarity between these loans as they exist, and the loans said to be optimum by the professors research, and this one is a real problem from the lender's point of view.

You see, the professors' study assumes that the lender can simply foreclose as easily and as quickly as sending out an email. That's not the way it works. First of all, foreclosure takes time, and it costs serious money. The law is set up that way. To quote something I wrote on August 23rd, 2007:

It takes a minimum of just under 200 days for a foreclosure to happen in California, and we're one of the shorter period states. Notice of Default can't happen until the mortgage is a minimum of 120 days late. Once that happens, it cannot be followed by a Notice of Trustee's Sale in fewer than sixty days, and there must be a minimum of 17 days between Notice of Trustee's Sale and Trustee's Sale. Absolute minimum, 197 days, and it's usually more like 240 to 300, and it is very subject to delaying tactics. There are lawyers out there who will tell you if you're going to lose your home anyway, they can keep you in it for a year and a half to two years without you writing a check for a single dollar to the mortgage company. It's stupid and hurts most of their clients worse in the long run, but it also happens. Pay a lawyer $500, and not pay your $4000 per month mortgage. Some people see only the immediate cash consequences, and think it's a good deal.

So that loan is non-performing for a time that starts at just under nine months, and goes up from there. This costs the lenders some serious money - money which they expect to be actuarially compensated for, which is to say, everybody pays a higher rate so that the lender doesn't lose more money on defaults than they make on the higher rate. I checked available rates on loans this afternoon, and for average credit scores on reasonable assumptions, the closest the Option ARM came to matching the equivalent thirty year fixed rate loan was 80 basis points (8/10ths of a percent), and that wasn't an apples to apples comparison, as the Option ARM had a three year "hard" prepayment penalty, while that thirty year fixed rate loan had none, as well as the Option ARM had the real rate bought down by a full percent by a lender forfeiting sixty percent of the usual commission for the loan to buy the real rate down. How often do you think that's going to happen? Sure, the *bleeping* Option ARM had a minimum payment of about $1011 on a $400,000 loan, as opposed to $2463 for the thirty year fixed rate loan fully amortized, but the real cost of money was $2350 per month, as opposed to $2083 for that thirty year fixed rate loan, and the equivalent payment for the Option ARM was, that accomplishes the same thing $2463 does for the thirty year fixed (theoretically paying the loan off in thirty years, providing the underlying rate remains the same), was $2675. Not to mention that the thirty year fixed rate loan has the cost of money locked in for the life of the loan, where that *bleeping* Option ARM can go as high as 9.95%, and the prepayment penalty for that *bleeping* Option ARM starts out at $14,100, and is more likely to go higher than lower for the three years it's in effect. You can't just handwave $14,100 that the majority of people who accept a prepayment penalty are going to end up paying, for one reason or another.

Another characteristic of the Option ARM envisioned by the professors is a so-called "soft" prepayment penalty, where no penalty is due if the property is actually sold, rather than refinanced. That's not the case with the vast majority of real-world Option ARMs. With only one exception I'm aware of, they're all "hard" pre-payment penalties, and the one lender who offered the "soft" penalty has discovered it's not a popular alternative, because they had to charge a higher nominal rate in order to make it work. Since the minimum payment was higher, and it wasn't quite so easy to qualify people quite so far beyond their means, that particular lender had been contracting operations, even while the rest of the Option ARM world was going gangbusters. Indeed, their parent company sold that lender earlier this year, because they just weren't getting any profit out of them, and at one point, they had been a very major subprime lender (They were extremely competitive on 2/28s and 3/27s and their forty year variants, as well as versus other subprime lenders on thirty year fixed rate loans). Until I checked their website just now, I was not certain whether they're even still in business. I haven't heard from my old wholesaler in eighteen months now.

The Option ARM envisioned by the professors lacks the "payment recast" bug present in all current Option ARMs. Indeed, under all currently available Option ARMs, it is difficult to avoid this issue, because they recast in five years no matter what. Furthermore, they professors' assumptions as to the longevity of the loan were open ended - essentially infinite in theory, although no loan given to individuals can be open ended in fact because we're all going to die someday, and most of us are going to want to retire before that, at which point these loans would definitely not be paid down to a point where they're affordable on retirement income under anything like our current system.

One final crock to the whole Option ARM concept as envisioned by the professors seems to be that the borrower gets a reserve amount if ever they default. The obvious retort is "Not in the real world." That is contrary to every practice of lending as it currently exists. That is the very basis of the real estate financing contract - the lender gets every penny they are due, first, and the borrower/purchaser/owner gets everything that's left over. As the authors themselves note, this does create a moral hazard for the lenders. Furthermore, and I must admit I'm not certain I'm reading the relevant passage correctly, another characteristic of the "Option ARM" they propose is that the lender gets primary benefit of any gain in value, and at least under certain circumstances, takes primary risk for any loss. In case you were unaware, this would completely sabotage the benefits of leverage that are the main reason why real estate is a worthwhile investment. This would certainly make the communities that make their living off selling other sorts of investment happy. Lenders, and especially current owners, not so much. Furthermore, I'm pretty certain that if they think about the economic consequences of this, real estate agents and loan officers don't want this to happen, either.

Those aren't all of the differences or relevant caveats, by any means. I took quite a few notes that I haven't yet covered, but it's bedtime, and by this point it should be obvious to anyone who took the trouble to read through the above that there really isn't a whole lot in common between the Option ARM as the contracts are currently written, and it is currently marketed and sold, and the loan of the same name as envisioned by the professor's research, except that name. Any claim that said research rehabilitates the Option ARM aka Negative Amortization Loan aka Pick a Pay aka "1% loan" aka (several dozen words of profanity), is based upon nothing more than the similarity in labeling, as if claiming a Chevette was the same thing as a Corvette, because they're both Chevrolets. Someone reading the professors' research would not recognize anything like the loan they are promulgating in any Option ARM currently on the market, because those currently offered are not based upon any of the same principles.

Caveat Emptor

Postscript: Lest I be misunderstood, I had previously come to a lot of the same conclusions that the professors had, although I had never integrated it into a single article, here or anywhere else. A lot of what they conclude, while pretty much theoretical, has some significant real world applications. Indeed, I have said several times in the past that leverage works best when it's maximized, and when you pay as little as possible towards paying off the loan, although that one result has to be modified for real world considerations like mortality, morbidity, and various psychological factors, which the professors mention in passing but do not really address or answer. I think I have some real academic appreciation for the value of Professors Piskorski and Tchistyi's work, and what went into it, and the results they have achieved. I had to dust off some portions of my brain (and mathematical textbooks!) that I haven't used in almost twenty five years, which was a treat of a certain kind once I got into it. Nonetheless, the products that go by the same name in the current world of loans have nothing to do with what these two distinguished gentlemen are talking about. The loan product I'm aware of that comes the closest is, as I said, a line of credit on commercial real estate.

pfadvice talks about debunking a money myth and perpetuates one of his own. He took issue with someone refinancing to lower their monthly payment, insisting instead that the term of the loan was all important.



His point is understandable in that because folks tend to buy more house than they can really afford, they also tend to obsess about that monthly payment. The solution to this is simple to describe but it takes someone with more savvy and willpower than most to bring it off: don't buy more house than you can afford.



Actually, there is nothing that is all important, but if I had to pick thing as most important, it would be the tradeoff between interest rate and cost and type of loan. This is always a tradeoff. They're not going to give you a thirty year fixed rate loan a full percent below par for the same price as loan that's adjustable on monthly basis right from the get-go.



This tradeoff varies from lender to lender and also varies over time. Nor is it the same for borrowers with different credit, equity, or income situations, but it is always there. For a given borrower at a given time, any program which you can qualify for will have the rate/cost tradeoff built in. If you want them to pay your closing costs, you're going to have to accept a higher rate than if you're willing to pay two points. It is the relationship between whatever loan you have now, and the loans that are available to you, that determines whether it's a good idea to refinance. Focus on the real cost of the money: The interest rate, which determines what the cost of borrowing the money will really be, and the total upfront cost to get that loan, which breaks down into points and closing costs.


If you have a long history of keeping every mortgage loan you take out five years, ten years, or longer, then perhaps it might make sense for you to take out a thirty year fixed rate loan and pay some points. To illustrate, I'm going to pull a table out of an old article of mine because I'm too lazy to do a new one.

rate 5.625 5.750 5.875 6.000 6.125 6.250 6.375 6.500 6.625 6.750 6.875 7.000

discount/rebate 1.750 1.250 0.625 0.250 -0.250 -0.750 -1.250 -1.500 -2.000 -2.250 -2.500 -3.250

cost $4725.00 $3375.00 $1687.50 $675.00 -$675.00 -$2025.00 -$3375.00 -$4050.00 -$5400.00 -$6075.00 -$6750.00 -$8775.00

Now I'm intentionally using an old table, and rates are different now. The point is to examine your current loan in light of what's available to you now. Maybe your equity situation has improved. Maybe your creditworthiness has improved. It's possible that something has deteriorated, and the loans that are available also vary over time with the state of the economy. If you've got a prepayment penalty that hasn't expired, remember to add the cost of getting out of that loan to the cost of your refinance, because it certainly changes the computations by adding a large previously sunk cost to the cost of your new loan. Whatever it is, the loans available to you now will be the total result of all of how all of the factors in the situation have changed.


I'm going to keep the example simple, assuming no prepayment penalties, and the third column is cost of discount points (if positive) or how much money you would have gotten in rebate (if negative), assuming the $270,000 loan I usually use by default. Add this to normal closing costs of about $3400 to arrive at the cost of your loan, thus:



(I had to break this table into two parts to get it to display correctly)

Rate 5.625 5.75 5.875 6 6.125 6.25 6.375 6.5 6.625 6.75 6.875 7

Points/Rebate $4,725.00 $3,375.00 $1,687.50 $675.00 ($675.00) ($2,025.00) ($3,375.00) ($4,050.00) ($5,400.00) ($6,075.00) ($6,750.00) ($8,775.00)

Total cost $8,125.00 $6,775.00 $5,087.50 $4,075.00 $2,725.00 $1,375.00 $25.00 ($650.00) ($2,000.00) ($2,675.00) ($3,350.00) ($5,375.00)

New Balance $278,125.00 $276,775.00 $275,087.50 $274,075.00 $272,725.00 $271,375.00 $270,025.00 $270,000.00 $270,000.00 $270,000.00 $270,000.00 $270,000.00

Payment $1,601.04 $1,615.18 $1,627.25 $1,643.22 $1,657.11 $1,670.90 $1,684.60 $1,706.58 $1,728.84 $1,751.21 $1,773.71 $1,796.32

rate 5.625 5.750 5.875 6.000 6.125 6.250 6.375 6.500 6.625 6.750 6.875 7.000

New Balance $278,125.00 $276,775.00 $275,087.50 $274,075.00 $272,725.00 $271,375.00 $270,025.00 $270,000.00 $270,000.00 $270,000.00 $270,000.00 $270,000.00

Interest* $1,303.71 $1,326.21 $1,346.78 $1,370.38 $1,392.03 $1,413.41 $1,434.51 $1,462.50 $1,490.63 $1,518.75 $1,546.88 $1,575.00

$saved/month $130.80 $108.29 $87.73 $64.13 $42.47 $21.10 $0.00 ($27.99) ($56.12) ($84.24) ($112.37) ($140.49)

break even 62.11922112 62.5610196 57.99355825 63.54001705 64.15695892 65.17713862 0 0 0 0 0 0

Now, I've modified the results based upon some real world considerations. Point of fact, it's rare to actually get the rebate (typically, the loan provider will pocket anything above what pays your costs), and so I've zeroed out those costs. You take a higher rate, you're just out the extra monthly interest. The fourth column is your new balance, the fifth is your monthly payment. For the second table, I've duplicated rate and new balance for the first two columns, the third is your first month's interest charge (note that this will decrease in subsequent months), the fourth is how much you save per month by having this rate, and the fifth and final column is how long in months it will take you to recover your closing cost via your interest savings as opposed to the cost of the 6.375% loan, which cost a grand total of $25 (actually, this number will be slightly high, as interest savings will increase slowly, as lower rate loans pay more principle in early years).



However, let's look at it as if your current interest rate is 7 percent. Your monthly cost of interest is $1575, there, so let's see how long it takes to actually come out ahead with these various loans.

Rate 5.625 5.75 5.875 6 6.125 6.25 6.375 6.5 6.625 6.75 6.875 7

Loan Cost $8,125.00 $6,775.00 $5,087.50 $4,075.00 $2,725.00 $1,375.00 $25.00 $0.00 $0.00 $0.00 $0.00 $0.00

New Loan $278,125.00 $276,775.00 $275,087.50 $274,075.00 $272,725.00 $271,375.00 $270,025.00 $270,000.00 $270,000.00 $270,000.00 $270,000.00 $270,000.00

Saved/month $271.29 $248.79 $228.22 $204.63 $182.97 $161.59 $140.49 $112.50 $84.38 $56.25 $28.13 $0.00

Breakeven 29.94960403 27.23218959 22.29233587 19.9144777 14.89346561 8.50926672 0.177945838 0 0 0 0 0

In short, since you're recovering costs quickly, it would make sense for folks with a rate of 7 percent to refinance in this situation, no matter how long they have left on their loan. For $25, they can move their interest rate down to 6.375, saving them $140 plus change per month. It's very hard to make an argument that that's not worthwhile. On the other hand, I would have been somewhat leery of choosing the 5.625% loan, as more than fifty percent of everyone has refinanced or sold within two years. On the other hand, I have a solid history of going five years between refinancing, so it makes a certain amount of sense, considered in a vacuum. Considered in light of the real world, rates fluctuate up and down. So I tend to believe that if I don't pay very much for my rate, I'm likely to encounter a situation within a few years where I can move to a lower rate for zero, or almost zero, whereas if I paid the $8125 for the 5.625%, rates would really have to fall a lot before I can improve my situation.



Do not make the mistake of thinking that the remaining term of the loan is more important than it is. You now have (assuming you took the 6.375% loan) $140 more per month in your pocket. Your payment will go down by more than that, but you're actually saving $140 per month in interest. It's up to you how you want to spend it. If you want to spend it paying down your loan more quickly, you can do that (providing you don't trigger a prepayment penalty, of course!). Let's say you were two years into your previous loan. Your monthly payment was $1835.00. If you keep making that payment, you'll be done in 288 months; 48 months or 4 full years earlier than you would have been done. So long as you don't trigger the prepayment penalty, you can always pay your loan down faster. Just write the check for the extra dollars and tell the lender that it's extra principal you're paying. I haven't made a minimum payment since the first time I refinanced!



Now some folks focus in on the minimum payment. By doing this, you make the lenders very happy, and likely your credit card companies as well. Not to mention that you are meat on the table for every unethical loan provider out there. It is critical to have a payment that you can afford to make every month, and make on time. But once you have that detail taken care of, look at your interest charges and how long you're likely to keep the loan, not the minimum payment.



Caveat Emptor

Original here

There are several possible options to deal with this issue, depending upon the exact situation.



For A paper, both spouses must qualify, credit score-wise. The way around this is a quitclaim to the spouse who has a good credit score as sole and seperate property. The catch is that then the good credit score spouse has to qualify for the loan on their own. If the other spouse is the one that makes all the money, if the good score spouse is in a profession where the needed income isn't believable for stated income, or a whole list of other possible reasons, you may have to go sub-prime.



For sub-prime, the spouse who makes more money is the one that will be used as the determination, so as long as the second spouse is in the same vague general ballpark, scorewise, you can still use both incomes to qualify. If one spouse makes slightly more money but the other spouse has a much higher credit score, it can be to your advantage to do it stated income with the spouse who has the better score primary. You can't do this if one spouse is a doctor and the other works fast food, but you can if they're both in the same industry, or in industries where the incomes are roughly comparable, so long as the job titles and employment history don't render the claim unbelievable. The classic example of this working is both spouses in sales, paid on commission. In some instances, a quitclaim can still be the way to go.



Now if you do a quitclaim, the property doesn't have to stay quitclaimed. As soon as the loan funds, you can quitclaim it back to husband and wife as joint tenants with rights of survivorship, or whatever you want. Quite a few spouses are understandably reluctant to give up all ownership interest, but it's a temporary measure; it doesn't have to stay that way. As soon as the loan funds, you get the spouse who qualified for the loan to quitclaim it back to husband and wife, or the trust, or however they want the vesting to be. The better escrow officers I work with will usually have the quitclaim back made up and sent out for signatures without even being asked (I found this out one time when my clients didn't want it quitclaimed back, and called me when they got the form in the mail. I just told them to shred it, and called the escrow office to tell them not to bother).



Caveat Emptor

One of the casualties of the current lending meltdown is the high loan to value second mortgage. With many properties locally having lost twenty percent or more of their value, a second mortgage on a property that ends up in default may well lose every single dollar the lender put into the loan. It shouldn't surprise anyone that lenders don't want to get into that kind of situation. Even though I (and most other credible analysts) are convinced that the values are stabilizing locally, the money markets are still in fear mode over the money they have lost or are on track to lose.

The result is that lenders of junior financing aren't nearly so willing to go to 100% financing any longer. Even when the same lender is lending the money for both loans, the people who underwrite the second mortgages are (usually) a different division. So when the property goes to foreclosure, the division who underwrote the first mortgage may end up with every dollar or nearly every dollar of their invested money, and they come up smelling like a rose. The division that underwrote the second mortgage that got wiped out and came out with 10 cents on the dollar loses their shirts, and everybody gets fired. The lender I've probably done the most business with just did away with all programs offering over 90% financing - doesn't matter the credit score or how much we can prove they make (UPDATE: My mistake - it was only subordinate financing over 90%, which further emphasizes my point). This is going to impact how much business I do with them, of course, but they've decided they're not willing to accept the risk in order to get the business - which is their prerogative.

They're hardly alone. It has been increasingly difficult to get second loans over the last couple of months. With the situation as I've have discussed, and second mortgage lenders in the process of losing every penny they put into loans, they understandably don't want to do it.

There is an alternative. There are still any number of lenders who will accept 100% financing on one loan with Private Mortgage Insurance (aka PMI).

Private Mortgage Insurance is an insurance policy that the borrower pays for but which insures the lender against loss. It does get the borrower the loan, but that is the only good the borrower can expect to get out of PMI. It does not prevent your credit rating from being ruined, it does not prevent any deficiency judgments that you may be liable for, and it definitely won't prevent the 1099 love note that tells the IRS you owe taxes on debt forgiveness. All it does is shift the entity that loses the money from the lender to their insurer, so that if you default, you'll be dealing with the insurer instead of the lender via subrogation.

What is going on here is that lenders are shifting the risks to insurers, who are in the business of taking risks via the Law of Large Numbers. Yes, the insurers know they will lose a certain number of these bets, but they are comfortable that overall they will make money at it. It is to be noted that lenders can improve their profit margins by self insuring, but they're not in the business of insurance. I'm certain some of them insure themselves in one way or another, but they isolate the risks away from their lending divisions, which are in the business of making money by loaning it out and having those loans repaid in full. When a lender loses a dollar because the loan wasn't repaid in full, that hits them where it really counts - bond rating, stock price, value of their mortgage bundles on the secondary market. When an insurer loses a dollar due to paying a claim, that's part of their daily business. They're in the business of paying claims, fully expecting premiums to more than pay for those claims.

As I said in One Loan Versus Two Loans, PMI is more expensive than splitting your mortgage into two loans, but when nobody wants to do second mortgages with less than ten percent down payment, the choices may narrow down to accepting PMI or not buying the property. The only other alternative that comes to mind is a private party loan, either in the form of a Seller Carryback (which comparatively few people are willing and able to offer) or the "good in-law" loans that were popular before lenders started liberalizing their standards in the 1970s.

(I haven't been in the business that long. I've never heard the phrase actually used by another professional, although I actually did a transaction that involved one earlier this year. I learned it from textbooks, as even in the early nineties when I both bought my first property and went back for my accounting degree they were a fading memory)

Paying PMI does have the net effect of decreasing the loan that potential buyers will qualify for, so this development should cause some small amount of additional downwards pressure in prices. For those interested in irony, the lenders are contributing to their own immediate losses by bailing out of the low equity financing market. People who have to pay a higher effective rate for the money can't afford to spend as much for a property, which means that current owners, whether they're borrowers or lenders, won't be able to get as much money for them.

One last thing before I finish. Don't get too hung up on the fact that you may end up paying PMI when experts (myself included) advise you not to. It's one of those voodoo words and concepts like "points", that people freak out about because they've been warned about them but they don't really understand. Just like points, many experts, myself included, often advise you not to pay PMI. But if you have one loan that is over 80% loan to value ratio, you are going to be paying PMI in one form or another. As I said in How Do I Get Rid of Private Mortgage Insurance (PMI)?, it can be a separate charge or camouflaged by being built into the rate, but you're still paying it. There are advantages and disadvantages to each choice, as I explained in that article. Choose your alternative with your eyes wide open and an understanding of the consequences, not because someone scares with with the voodoo phrase, "PMI."

Caveat Emptor