Mortgages: December 2005 Archives

I found this article by Ken Harney in the paper.

WASHINGTON - Call it funny money for the housing boom: Now you don't need actual cash in the bank to buy a house. All you need is somebody who says you've got money in the bank.



Need a hundred grand on deposit to convince a lender that you deserve a million-dollar mortgage? You've got it . . . even though you haven't really got it because you "rented" it from a company in Nevada for an upfront fee of 5 percent - $5,000.



Sound bizarre? Welcome to the wonder world of "asset rentals" now being investigated by bank and mortgage industry fraud experts. It works like this: Say your loan officer discovers that you lack the financial wherewithal needed to qualify for the mortgage you want. Rather than lose your business, however, the loan officer turns to a service that offers "asset rentals." For a flat fee of 5 percent of the amount you need, the service will verify to anyone who asks that the $100,000, $500,000 or $1 million in bank deposits you've claimed on your loan application documents are yours indeed.

I am sorry to say that this is not the first time I've encountered said phenomenon. Nor lenders. This is why assets require seasoning or sourcing. In other words, the lender requires you to show that you've had it and built it up over a period of time, or they want to know where and how you got it.



Most loans should not require a large amount of assets - A paper loans, the best loans of all, want one to two months Principal, Interest, Taxes, and Insurance (PITI) for full documentation (and I can usually get it reduced), or six months PITI for stated income loans. Neither of these is a large number if you're really making the money, and they can be in a variety of places.



Some sub-prime lenders, however, will take large amounts of money in an account somewhere as evidence that you can afford the loan. These loans usually end up looking more like a propagandized No Income, No Asset loan than anything else. They don't get the best rates and terms, even for sub-prime, and there's likely to be a nastily long pre-payment penalty on them as a GOTCHA! The loan provider, be it broker or lender, is likely to make a lot of money on them - In California there is a thing called section 32 limiting total loan compensation to six points, which on a $400,000 loan is $24,000, and many so-called "discount" real estate agents turn around and require their clients to do the loan with them. It doesn't do you a bit of good to save a couple thousand on the sale or purchase in order to get ripped for twenty on the loan, where it's easier to conceal it. I can point you to many of these so-called "discount" houses who do these loans all day, but they are not loans you should want. If a friend came to me and asked for one, I'd try my best to talk them out of it.



But wait! It gets better!

This and other e-mail pitches, copies of which were provided to me by mortgage industry recipients, carried the sender name of Loren Gastwirth, identified on the e-mail as vice president-marketing for Morgan Sheridan Inc. of Mesquite, Nev. The asset rental attachment carried the name Independent Global Financial Services Ltd., with an address in Las Vegas.



... to a Zexxis Co., with the same Mesquite, Nev., address on Loren Gastwirth's Morgan Sheridan card. When I called the number listed for Gastwirth, I received no reply, but instead heard back from a person identifying himself as Allen Paule. Paule is listed in corporate filings with the Nevada secretary of state as the "registered agent" for Morgan Sheridan, Independent Global Financial Services, and Zexxis Corp.



Paule said the asset rental and employment pitches - including downloadable attachments and forms carried on Morgan Sheridan's Web site - were not connected to his firms. He said, "somebody hijacked our Web site." He confirmed that a Loren Gastwirth works for Morgan Sheridan. And he also confirmed that Independent Global Financial Services, Morgan Sheridan and Zexxis Corp. have overlapping ownership and management. According to Nevada corporate records, a Paul Gastwirth is listed as president and director of Morgan Sheridan.



The Web site of Vault Financial Services Inc. of Las Vegas lists Paul Gastwirth as CEO of that firm, and president of Independent Global Financial Services, "a company specializing in asset rentals and enhanced credit facilities for individuals and companies worldwide."

In other words, they are playing a Nevada Corporation shell game. A long head swallowing tail chain of corporations, each of which is likely to be a shell set up to insulate criminals from the consequences of their actions. The stuff about "somebody hijacked our web site" is almost certainly bogus.



but it gets better yet!

That's where the asset rental service's "VOE" (verification of employment) program comes in. Essentially you indicate on a faxed form what annual or monthly income you or a home buyer client needs to qualify for a mortgage, and the asset rental company will verify to anyone who asks that you have been paid those amounts.



The cost: just 1 percent of the claimed annual income. "For example," says the pitch, "$100,000 of annual income - cost of $1,000. Minimum is $50,000." The e-mail came with attachments that directed payments for asset rentals and employment verifications to an account number at Wachovia Bank in Roanoke, Va

In other words, they're also volunteering to help you circumvent one of the most basic protections to the whole process, making sure for both the lender and the borrower that the borrower can afford the loan. If you cannot afford the loan, you are probably better off without it, although many people don't realize that this requirement is partially for their own protection. If you can't make the payments, you're going to get foreclosed on. If you get foreclosed on, you're likely to lose everything you put into the house and get socked with a 1099 form which the IRS will use to go after you for taxes as well.



Lest you not have realized this by now, all of this is FRAUD. Serious, felony level FRAUD. Lose your home and go to jail FRAUD.



I'm going to share a little secret with you, widely known within the industry but not in the general public. That real estate agent or loan officer getting you your house or your loan may not be the brightest financial lightbulb in the world. Many loan companies and real estate offices select for this, usually by only hiring people who have never been in the industry before. Some of them are even among the biggest names in the business. They select for sales ability and "make sales" attitude, not the knowledge (and more importantly, willingness) to say, "Wait a minute! Something is not right here!" Especially when it may cost them a commission. And hey, if the companies involved lose a few low-level sacrificial victims to lawsuits and the regulators, that's no skin off the owners' noses and they still get commissions out of it. These schemes are pitched to the agents and loan officers as a way to "save" a client. Sounds like it's in your best interest when you put it that way, right? It is not. The bank discovers this (and Nevada Corporations, among others, are a red flag that loan underwriters look very hard at) Most of these deceptions are discovered before the loan gets funded - meaning that the client they were helping to commit FRAUD wasted their money, and they have a case against the agent and employing broker, whose insurance will probably not cover the issue.



The ones that do get funded are even worse. When the bank discovers the FRAUD, they have a right to call the loan. This means you have a few days to repay the loan, or they take the house. All of those wonderful consumer protections the federal and state governments have enacted become mostly null and void, because you committed FRAUD. You can count upon losing all of your equity in the home, and getting thrown out with nothing. Furthermore, depending upon company policy of the lender, you may find yourself sued in court, and possibly even under criminal indictment. Judgements for FRAUD are nasty, and they don't go away. Convictions for FRAUD can really mess up your life completely and forever, not just in applying for credit, but in employment and other ways as well. If your loan is sold to another lender before the discovery happens, the probability rises even further, because the new lender is going to sue the old lender, who is going to take action against you as part of a defense that says they were acting in good faith. The shell corporations that pretended you worked for them or had deposits with them will be long gone (or untouchable) of course. You may have a claim against the agent, loan officer, broker or possibly even original lender, but if someone else beat you to it or they are out of business for some other reason, good luck in actually collecting.



In short, relying upon an agent or loan officer as an expert without doing your own due diligence is likely to get you in hot water. As good rules of thumb: Never lie. Never allow someone to lie on your behalf. No matter how desperate you are, it's likely to buy a lot more trouble than it's worth.



Caveat Emptor

UPDATED here

Ken Harney has a column I found in the local rag yesterday. It seems that there is (finally!) concern amongst the regulators for this risky loan which begs for trouble for consumer, lender, and the system as a whole when there are too many of them out there.



First off, Mr. Harney is wrong, or his editor really screwed up what he did write (The Washington Post? <sarcasm>Say it isn't so!</sarcasm>). Read the contract. The attraction of negative amortization loans has nothing to do with the actual rate. Zero. Zip. Zilch. Nada. It has everything to do with lower permitted payments. There is not one day, not one hour, not one second where the actual rate being charged is reduced even by a miniscule amount. But for a certain amount of time, the minimum payment is calculated as if the rate is lower than it actually is. This is why they are easy sells - because the average real estate consumer "buys" a loan based upon the payment. So when someone tells the average consumer that they can get a "$170,000 mortgage for $850 per month!", it sounds attractive and the majority of people won't investigate any further. A large portion will actively avoid anybody who tries to tell them what's really going on, as if the loan will somehow magically be alright if they manage not to hear about all the bad stuff.



Furthermore, the real rate on these loans is variable from day one. There literally is not one month where you can truly predict what the next month's payment will be. I have, and always have had, lower interest rate loans that are hybrid ARMS with truly fixed interest rate for five years or more, have lower costs to obtain them, and no hidden gotchas. Heck, from my first day in the business I've always had loans that fit all of the forgoing criteria and require interest payments only. If you cannot make a payment of at least the full amount of the monthly interest, it is quite likely you shouldn't make the purchase.



These loans do have a niche. But I can't think of a case where they should ever be the purchase money loan for a property. Even on refinances, they should be no more than one percent of total refinances - not the forty percent share of San Diego's purchase money market the last figures I saw had them having. Investment property, the rules should be somewhat looser, but still nowhere near 40 percent of the market is appropriate. If this were the securities or accounting industries, the regulators would be throwing people into jail over this, and shutting down offending companies completely and permanently. There's a world of hurt coming down the pike, and the prevalence of these pieces of garbage is going to greatly exacerbate the problems, particularly in high cost markets. Let's say, hypothetically, someone put 5% into a $500,000 home here in San Diego at the beginning of the year, at a nominal rate of 1%. They had one $400,000 mortgage and one $75,000 mortgage. Assuming the nominal rate on the first is 1% and that the second is "interest only" as is common, they would now owe $10,000 more on a home that is worth about $30,000 less. After three years, they owe a total of $505,000 even if the rates don't rise any more, which I can promise you they will. If values hold steady right now, their home is worth maybe $470,000, of which they would get about $440,000 if they sold without paying any closing costs for the buyer, which isn't happening right now. So under perfect theoretical conditions, they've gone from having $25,000 in the bank to having to come up with $65,000 just to get out from under. Since they likely can't, their credit is going to be ruined for ten years at least, plus they're going to get a love note from the IRS saying they owe taxes on $65,000 more income (which incidentally slides most folks into higher marginal brackets).



You can survive being "upside down", owing more on your mortgage than your house is worth, for a long time if you have the right loan. These are not the right loan for market conditions I see happening in the next few years. They are always risky, and mortgage lenders and brokers who do them do not have, in the aggregate, an even vaguely acceptable track record of disclosing their risks. Not that it's any great shakes of a prediction, but I predict that lawyers will be prosecuting a lot of these as civil cases in the next few years, and winning large judgments that are not going to be covered by insurance because it's neither an error nor an omission, but an intentional misrepresentation.



Under the right conditions, these can be useful loans. But the right conditions are rare, and when you have them, the lenders are not likely to approve the loan because the prospective borrower is not a good credit risk. In short, if you're approved for one of these, you almost certainly had better much options available to you. If negative amortization loans are actually appropriate for you, I'll bet a nickel your loan won't be approved. This is the kind of marketing strategy which has gotten many industries in serious trouble, and the lenders who are involved in this are likely to be hurting anyway when the house of cards they've been supporting comes tumbling down. Expect corporate bankruptcies, also.



Caveat Emptor.



P.S. If you haven't read anything on these previously, you might want to check out this article as well as this one.

UPDATED here

My article on Option ARM and Pick a Pay - Negative Amortization Loans is one of my most popular. It's number one for multiple search engines and several ways of running the search. If I don't get at least 20 hits a day on it, it must be a sign that the public has caught on to this loan's horrific gotcha! On the other hand, given the number that are still written, I can get very depressed at how small a percentage of the population does simple research.



I intentionally left a lot of what goes on with these things out of that post, simply because I want to keep these posts readable and comprehensible within the space of no more than half an hour. But I keep getting hits asking questions I didn't deal with, so here goes:



A Negative Amortization loan is defined as any loan where the minimum required payment is less than the interest charges. Regular loans pay off part of the balance every month, whereas negative amortization loans typically have an increasing balance because the difference between the interest charges and what you pay is added to your balance owed.



Because the name "Negative Amortization" causes some difficulty in marketing, they are sold by all kinds of friendly sounding names. "Option ARM" (if you look at my article on loan types here, these are the about the only "true" ARMs with a significant portion of the residential loan market). "Pick A Pay." "Option Payment." "Cash Flow ARM." I've seen all kinds of combinations of these, as well.



Negative Amortization loan rates are typically quoted based upon a "nominal" ("in name only") interest rate. This rate is not the rate of interest that the people who have them are really being charged. It's a thing for purposes of computing the minimum payment. In other words, the minimum payment is computed by using this rate instead of the actual rate that you are being charged. They are being marketed more heavily right now than at any time in the previous twenty-odd years. If you are quoted a rate of 1%, 1.25%, 1.95%, 2.95%, or anything else under about 5% right now, they are talking about a negative amortization loan. If you look at the Truth-In-Lending form, it will list an APR somewhere in the sixes, usually several entire percentage points above the nominal rate. Another way to tell is the presence of several "Options" for payment. If they talk about three of four payment options, guess what? They're talking about a Negative Amortization loan. Note that this is a different situation from "A paper" loans that have no prepayment penalty, in that you are explicitly given these payment options, and may not have any others. "A paper" loans, the minimum payment at least covers the interest (if it's an interest only loan) or actually pays the loan down, and anything extra you pay is applied to principal to pay the loan down faster. I pay extra every month but that's my decision, my choice of amount, not theirs. A negative amortization loan gives you a limited number of choices. Furthermore, there are more of the so-called "one extra dollar" prepayment penalties on negative amortization loans than any other loan type.



Negative Amortization is generally a bad thing because with over 95 percent of those who have them, over 95 percent of the time they are making the minimum payment. That's why they got them, because they couldn't afford the real payment. So their balance increases. They owe more money every month, and due to compound interest, every month the difference between what they owe and what they pay gets wider. This can only end one of three ways. They sell the house. They refinance the house. They get to "recast" point on the loan. None of these is good.



If you sell, the loans come out of proceeds, and the bank gets more money than you originally borrowed, usually plus a prepayment penalty. I keep using a $270,000 loan amount as an example, so let's look at what happens. The minimum payment will be $868.42. But your real rate is not fixed, and even if you've got a good margin and your rate doesn't rise in upcoming months (It will rise), your real rate is something like 6.2%. That very first month, your interest charge is $1395.00. You have $526.58 added to your loan balance. Take this out one year. Your principal has become $276,501.57, an increase of $6501.57. Now the minimum payment increases by 7.5% (another characteristic of this loan) to $933.56. Take it out another 12 months, now at 6.25% (and I'm being really stingy with rate hikes, given how much I think the underlying rates will go up) and you now have a balance of $283,561.76. Now you sell, and as opposed to selling it two years ago, you have $13561 less from the sale than you otherwise would have had. Plus a prepayment penalty of $9484.00, a total of $23,045 the loan has cost you not counting whatever your initial fees were. This is money you are not going to have to buy your next property with. Not to mention that if the rise in value doesn't cover it, you may find yourself short - getting nothing, and maybe even getting a 1099 form for the IRS that says you owe them taxes.



Let's say you don't sell, but refinance, and unlike roughly 70% of everyone with one of these loans, you actually make it to the end of the prepayment penalty period, three years. Your payment has been $998.70 for these 12 months, but your balance has still increased to $291,815.16. Let's say rates have magically dropped back to where they are now. You get a 30 year fixed rate loan at par at 5.875%. Your payment will be $1746.90, as opposed to $1597.15 if you just did that in the first place. But wait, it get's better!



In the fourth year, your payment goes to $1063.84. But nine months in, you hit the recast point! Your balance has grown to $297,000 - 10% over what it was to bein with. It's a thirty year loan, and now it starts amortizing at the real rate for the last 315 months, or until you manage to dispose of it, whichever comes first. Assuming your rate is still "only" 6.5%, your payment jumps to $1967.60 in the forty-sixth month, and this payment is no more fixed than your rate is, which is to say, not at all.



Let's say you have one of the loans with a higher recast - 20 percent instead of 10. Your balance goes to $299,010.60. Then the final year of artificially lowered payment, $1128.98 per month is applied to your loan, but it's accruing $1619.64 in interest and rising. Your loan balance is $305,077 at the end of your minimum payment period. Now your payment (assuming your real rate is still 6.5%, which I think unlikely) goes to $2059.90. If you're able to get a thirty year fixed rate loan at today's rates, your payment is $1825.35. If you couldn't afford $1600 per month in the first place, what make you think you'll be able to afford any of these alternatives? The needless increase in payment amounts to sucking $1.34 per hour out of your pocket, or if you want to think of it another way, you'd have to make $3.00 per hour - $500 plus per month - more to qualify at the end of the period with all that added to your loan, as opposed to right now. And that's assuming the rates are as low in five years, which I do not believe will be the case.



Additionally, I attended a credit provider's seminar last month, and as I said then, credit rating agencies are currently considering making the fact that you have a negative amortization loan to be a heavy negative on your credit report, all by itself. From the writing above, it should not be hard to see why. Someone who has a negative amortization loan is not making a "break-even" payment. Their balance is increasing. This indicates a cash-flow problem, and cannot go on indefinitely. When the lowered payments expire, they find themselves in a nasty situation, worse than it would be if they had just gotten a different loan in the first place. So if the fact that you have a negative amortization loan knocks you down sixty, eighty, or a hundred points, there is a good likelihood that you will not qualify for any loan nearly so good as you would otherwise have gotten. The last news I had was that they were looking at the modeling data for exactly how strongly it influences your chance of a 90 day late. I don't work for Fair-Isaacson, but my guess, based upon working with people who have negative amortization loans, is that it's going to be towards the higher end of the range I cited.



In short, because most people concern themselves with quoted payment, not interest rate and type of loan, these things are most often sold via marketing gimmicks and hiding their true nature. Those selling them do not concern themselves with what will happen to you after they've gotten their commission check. They are designed (and appropriate for) a couple of specific niches that most people do not fall into. Last set of figures I saw was that they are the primary loan on about 40 percent of all purchases here locally - and owner occupied purchase is not one of the niches they are designed for. An appropriate proportion of the populace to have these might be four tenths of one percent, a figure a hundred times smaller. Shop by interest rate and type of loan, and these look a lot less attractive. As I said, the real rate on these right now (if you've got a good margin) is about 6.2 percent. At par, loans are available that are really fixed for five years at about 5.5 percent, or thirty years at about 5.875 percent, no hidden tricks, no surprises, no gotcha!s. These are not only lower rate, but also better loans.



Caveat Emptor

UPDATED here

As of July 1, 2005, mortgage providers have to have explicit written authorization to run credit.



I am not certain of the political forces that made this bill, and it is still not clear to me whether this extends to non-mortgage credit providers. If it does, this is probably one of the niftiest consumer protection things to come down the pike in a long time. On the other hand, if it's limited to mortgage providers, then it's probably a stab at making life difficult for Internet brokerages, which may do business at a remove of thousands of miles.



An Internet broker employee is talking on the phone with a client, not physically in the client's presence. They can be some of the cheapest and best loan providers out there, if they are so minded (as I keep saying, a far more important concern is how low a provider is willing to go, not how low they can go. Internet brokerages can also be consummate ripoff artists). It becomes a real hardship on their business if they can't run credit without explicit written permission, whereas it's not a major issue with a more traditional brokerage or direct lender. A loan quote isn't real unless you can lock it right now. Your loan can't be locked without running credit. And I can't run your credit until I get a signed form that says you give me permission. No big deal if I'm sitting right there. A real pain if I'm in California and the client is in Florida. I'm not even certain facsimile permission (no original signature) is acceptable, as it's not something that enters into my current business. This means a delay potentially of days while the form gets back to the lender. So life for an ethical Internet broker suddenly gets a lot more difficult, while life for the crooks becomes no harder.



On the other hand, if the requirement for written permission extends to all providers of credit, then it becomes worth the game. Mind you, an adult should be aware of what's going to happen if they give a social security number to a car dealer, furniture store, or anyone else. I've never heard of anyone using it just for liar's poker ("Oooh, this is a good one - four 8s!"). If you give a merchant your social, then they are going to run your credit. Treat it as a mathematical certainty, because it might as well be.



Each time somebody runs credit, it's an inquiry - a ding on your credit. Inquiry dings are progressively damaging. They cause your score to go down, each and every time you have an inquiry, and the more inquiries you have, the more each new inquiry drives it down. There used to be a game among mortgage providers until the new rules a couple years ago - see if they could be the last ones to run your credit before it went under a threshold score, and some would run it multiple times if they could. Anybody running after that would be at a disadvantage.



With the new rules that every consumer should get down on their knees and give thanks to the National Association of Mortgage Brokers for getting through, consumers are now actually permitted to shop around for mortgage rates without getting dinged every time their credit is run - provided they run credit under a business code that say's "inquiry for mortgage." (So if you are mortgage shopping at a bank or credit union, be sure they run your credit under their mortgage inquiry code, and not a general inquiry code). All of the times it is run within fourteen days by mortgage providers count as exactly one inquiry. This gives consumers the ability to shop as much or more for a mortgage as they would for, say, a toaster oven, without being penalized.



But if the new rules apply to non-mortgage credit grantors also, this is a good thing. Here's why: Every time I start a loan, I have a set spiel that I go through. "Don't change anything, credit-wise, even if you think it will help. Don't buy anything. Don't charge anything on your credit cards. Make your normal payments - no more, no less, unless you ask me first. And don't allow anybody to run your credit for any reason. Don't even let them have your social. Because they will run your credit, I guarantee it."



On every home loan, one of the last things that will happen before your loan is recorded in official records at the county will be that the lender will run your credit again to make certain nothing has changed. And if anything has changed, you will very likely lose the loan (and the house if it's a purchase). Even if the escrow company has the money or it's actually been disbursed, the lender will pull it back. So there is a real need for prospective borrowers to understand that until the final documents are recorded with the county, they shouldn't so much as breathe differently.



For a certain personality type, being told she can't shop for curtains and furniture and paint for her new house is nothing short of torture, and so I've learned to be very explicit. "It's okay to look, to talk to the nice salesfolk, and to get an idea of what you want. But don't actually buy anything. Tell the nice salesman who says he just 'wants to get a head start on your order' that your mortgage loan officer said that you're right on the line, and anybody else runs your credit and drives you under the line the first consequence to the furniture or paint or drapery salesperson will be no order, because they're likely to cost you the loan.



So while you have a home loan pending, tell the nice salespersons that you're really protecting them by not giving him your social, because if they run your credit and cost you the loan you'll have to tell your uncle Bruno, who's best friends with Tony Soprano, about it. And we all know what happens then.



Back in the real world, things are not usually quite that bleak. But it's surprising how often people end up with higher rates and higher payments and worse loans because they didn't understand this one point. Suppose your monthly payment is $50 higher than you thought it would be, in addition to what you spent on the new stuff that caused money to go into that salesman's pocket. Doesn't that make you feel all Warm And Tingly towards that salesman? Didn't think so. And a certain percentage of the time, this new monthly payment you now have because you Bought Something means you Do Not Qualify for the loan. So: No loan. No house (if it's a purchase). No lower payment (if it's a refinance). No cash out of your equity (if that's what you were trying to do). And so now you've got this stuff, and no house to put it in. Now you've got to tap the vacation or retirement account to pay for it because you're not getting a refinance on reasonable terms. Not to mention all the times these people run credit and hurt people's credit scores without real permission when there's no mortgage loan in the offing. So I can put up with one segment of my industry have a slightly higher bar to jump over if that's the carrot.



Caveat Emptor



UPDATED here

When you have more than one loan on your property, there are some issues you should be aware of. Keep in mind the fact that some states still use the mortgage system, requiring court action to foreclose, as opposed to Deed of Trust, which does not. For practical purposes they are similar, yet I have never done significant work in a mortgage state so there may be small but significant differences.



Each loan is secured by a different Deed of Trust. Two loans, two Deeds of Trust. A Deed of Trust is a three way contract between the borrower (called the trustor), the lender (called the beneficiary), and a third party known as the Trustee, to whom title is nominally conveyed for purposes of selling the property if you default on the loan. The Trustee and the Beneficiary are often the same, and there while there is no legal impediment I'm aware of to the Trustor and Trustee being the same, I also cannot imagine a lender agreeing to it.



Trustees can be changed, and this is accomplished via a document known as "Substitution of Trustee," which is required to be recorded with the appropriate county in every state I've done business in.



Each Trust Deed operates independently of all others there may be against a given property. They take priority in order of date. When a Trust Deed is recorded against an property on which there already is an active Trust Deed, it automatically becomes a Second Trust Deed, if another happens it is a Third Trust Deed, and so on.



The reason they have the ordinal is because they are paid off in the order they happened. Suppose the property is sold, and the sale price is not sufficient to pay all of the debts. The trust deeds are not paid proportionally; The First Trust Deed is paid off in full before the holder of the Second Trust Deed gets a penny. Then the Second is paid before the third, and so on. This is why Second trust Deeds carry higher rates than First, because they are riskier loans for the lender. As I've said elsewhere, just because the property is sold doesn't mean you're clear. If there is not sufficient money from the sale to pay all debts, you can expect the lender to hit you with a form 1099, reporting that you have income from debt forgiveness, and you will be expected to pay taxes on it.



Now, if for whatever reason you pay off your First Trust Deed, the Second automatically goes into the first position, and any subsequent loan goes into second position. This is most common when people go to refinance the loan secured by their First Trust Deed. Even if you do not particularly want to pay off your Second Trust Deed, it may be the best thing to do. Because what happens if you just pay off the First Trust Deed (only) and get a new Trust Deed, is that the new Trust Deed will go into the second position. Unfortunately, in order to get the quoted rates for a primary loan, it is a requirement that the loan be in first position. If it's not in first position, they will not actually fund it. In short, no loan.



This is not necessarily an impasse. Many times, the holder of the second trust deed, because their loan was priced to be second in line anyway, may agree to Subordinate their loan to the new loan, which is a fancy way of saying stand in line behind the new trust deed holder.



They don't have to do this, and there is no way, other than paying off their loan in full, to force them to do so. Some companies never subordinate, while some others are never willing to stand second in line at all, and others are in both categories.



For those that will consider it, they are going to stipulate some conditions. First of all, the new loan is likely going to have to put the borrower into a position where it is easier, or at least no more difficult, to make payments and pay off the loan. So monthly payment usually cannot rise.



Second, they are going to want their trust deed to be in no worse of a position than it was when the loan was originally approved, as regards the value of the home being able to pay their loan off too if for some reason either loan is defaulted. They may even require than you agree to a higher rate, higher payments, or a different loan altogether - as I said, there is nothing you can do to force them to cooperate.



Assuming that they are willing to cooperate, they will require that the entire process on the prospective new loan be essentially complete - that is, ready to draw documents and fund when the Right of Rescission expires after three days, before they will even look at it. Some lenders take 48 hours to look at a subordination request, others take up to six weeks, and it can be even longer. For any given lender, it takes as long as it takes.



There is also going to be a fee involved. They have to pay their people to look at the loan situation and make certain it still falls within guidelines. They're the ones doing you the favor, they certainly are not going to do the favor for free. Whether the Subordination request is evenutally approved or not, the subordination fee is likely to be non-refundable, a sunk cost that you are not going to get back even if it's not approved.



Even more important than that, however, subordination takes time. No loan quote is real unless locked, all locks are for a specified period of time, no lock is good past the original period of time unless you pay an extension fee, and if you need to lock for a longer period of time in order to subordinate, either the rate, the cost, or possibly both will be higher. Since this can add anywhere from two days under idea conditions to six weeks or more for a refinance that takes three weeks to get approved and get funded in the best of times, this means a longer lock period becomes advisable. Most often, the extra costs mean that it's more cost effective to just pay off both loans rather than subordinating the second to the new loan.



Since Home Equity Lines of Credit are always secured by a trust deed, they count as any other second mortgage would. You'd be amazed how often people do not disclose Home Equity Lines of Credit even when directly asked about them. They are only hurting themselves, but they often get angry to no good purpose when, if they had been upfront about them, the loan officer could have designed around any difficulties. Furthermore, people are often resistant to the idea of paying off and closing Home Equity Lines, despite the fact that they are easy to get. I've had people stonewall, utterly in denial that this is a Deed of Trust opon their residence until I have the title company fax me a copy of the Trust Deed, and reference it with the Preliminary Report, and ask to see the Reconveyance (which is a fancy way of saying the piece of paper proving that the trust deed has been paid off). If it's a legitimate lien, we have to deal with it. Actually, we have to deal with it if it's not a legitimate lien as well, just in a different manner. On the other hand, about eighteen months ago I had some seasonal resident clients whose ex-caretaker had managed to take out a loan against the property. It does happen, and it's a mess, but most times it's just the people themselves who weren't told - and didn't figure out - that this financing agreement they signed for the pool or air conditioner or roof was a second trust deed on their house.



To summarize then, second loan means second trust deed, if you refinance they must be paid off or subordinated, and subordination takes time such that it may be better to pay it off than go through the rigamarole of subordination.



Caveat Emptor.

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