Mortgages: January 2006 Archives

Minorities get higher rates.



They add that the fact minorities are more likely to borrow from institutions specializing in high-priced loans could mean they are being steered to such lenders or that some lenders are unwilling or unable to serve minority neighborhoods.





What they describe is called redlining. It is illegal. HUD really gets their panties in a bunch over it, too. Mostly what actually happens is that the lenders simply aren't chasing certain kinds of business. If any comes to them, they deal with it like anyone else. This is standard marketing procedure. Figure out who you're trying hardest to serve, and really chase that segment. If anyone else wants to come to you, that's wonderful and you serve them the same as any other customer, but they're still not someone you're going out of your way to attract.



One thing that the article explicitly said: This does not include/compensate for credit scores. Working with people in the flesh, I have experienced the fact that there is a difference between how various groups handle credit. Often, the urban poor have some difficulty in meeting the requirements for open and existing lines of credit. They are more likely to have failed to make the connection between credit reporting and future qualifications for credit, having at some point made a decision not to pay a creditor. Often, they are more pooly educated about their options or think they're a tough loan when they're not. This extends into the general population, although it's less prevalent. I have a friend I went to high school with. He and his wife make over $160,000 per year between them in very secure jobs they have held for over a decade each. Their credit score is about 760. The loan officer they were originally working with told them they were a tough loan to try and scare them into not shopping with anyone else. The reality is that the only question is what loan is best for them because they easily qualify for anything reasonable. This is far more common than most people think. The current standard is that if you have two or three open lines of credit and your credit score is above 640 - sixty plus points below national average - I can get 100 percent financing, and the possibility doesn't disappear completely until you go below 560 (whether it's smart is a question for the individual situation, but I can get a loan done if it is). With increasing equity, I can usually get a loan done even for credit scores below 500 (two hundred points below national average!). Now, the better your situation, the better your loan (e.g. rate, terms, closing costs, etc.) will be, but the question is not usually "Can I do a loan for these folks?" but "Can I find them better terms than anyone else?" and "Should I do this loan or is it really putting them in a worse situation than they're in?"



Quite often, the loan provider that urban poor go to is the one who advertises where they see it - basically, the lender who chases their business, usually by advertising in that area or in that language. Every other lender is still available to them, but they go to the place whose advertising they see. They think "This guy wants my business. He does business with people like me all the time. He can get me the loan." The problem is that all too often, this loan provider has chosen to chase this market precisely because the people in it, most often urban poor, do not understand they've got other choices, and do not understand effective loan shopping, and so this loan provider makes six percent (the legal limit in California) on every loan plus kickbacks and arrangements under the table. They make more on one loan than I do on half a dozen for roughly the same amount of work, and the loan they do are not as good for their client as others that can easily be found.



Most people are better loan candidates than they think they are, and qualify for better loans than they think they do. It's more often the property they have chosen that creates an untouchable situation than the people themselves. Even then, there are usually options available.



(I got a ten minute lecture a while back from a nice young couple telling me they "deserved" a rate of four to five percent on a 100% loan for a manufactured home sitting on a rented space, because it was "the same rate everyone else is getting". Well, if it had been on a regular house sitting on owned land I could have gotten them that loan on very desirable terms, but nobody does 100 percent on manufactured homes, and if there's no ownership interest in the actual land involved then it's a loan secured by personal property, not real estate, and it becomes a personal loan, for which the rates are much higher.)



So keep this in mind if and when you're in the market for a real estate loan, and shop multiple lenders, and shop hard. Remember that all of the times your credit is run in a two week period for mortgage purposes only counts as one inquiry, whether it is just once or whether it's five dozen times. A loan provider does not have to run credit themselves to get a quote, but the information must be complete, accurate, and in a form they can use.



Keep in mind that the loan market changes constantly. A quote that's good today almost certainly will not be good tomorrow. If it's not locked, it's not real, and a thirty day lock is not valid unless extended on the thirty-first day, for which you will pay an extension fee if necessary. So shop hard, with a real sense of urgency, get it done quick, and make your loan provider get it done quick. Any additional stress will more than pay for itself (and the longer the loan takes, the greater the opportunity for stress, too). Apply for a back-up loan, and if it's ready first, it's probably a good idea to go with your backup. Sight unseen, I will bet money that a loan done in thirty days or less from the time you say that you want it is a better loan than the loan that takes sixty days or more.



Caveat Emptor.

UPDATED here

Games Lenders Play, Part V

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Hello, I've been reading your website for awhile now, and have found it very helpful as I'm learning to navigate this crazy loan process! I had a question I was wondering if you could write about/answer.

We currently have a mortgage and a secondary line of credit on our condo (we didn't have a down payment, so we had to do it like this). We have been here one year, and the home values in our complex have gone up about $70,000 - $100,000 in that time period. (We live in Southern California.)

Recently we got a notice in the mail telling us that they can reduce our monthly payments ("by as much as $1,500!)" if we refinance with them. Frankly, it sounds way too good to be true, and I have a feeling they're not really telling us the truth in this notice. But it did raise a question in my mind: would it be wise to attempt to refinance, in the hopes that our higher valued home would allow us to refinance with only one mortgage, instead of two? I'm not even sure if that's possible...I'm having a hard time understanding how refinancing works. I should mention that we are currently in an interest-only loan, with no prepayment penalties. Our first loan is 4.75%, and our secondary line of credit is 6.375%.

Any help would be greatly appreciated.


Your feelings that they aren't telling the whole truth are justified.

Refinancing is the process of replacing one loan for another on the same piece of property. The idea is that the terms of the new loan are more advantageous to you than the terms of the existing loan. There are three main issues that you need to be aware of, however. The first is that there are always costs associated with doing the new loan. The second is that there may be a prepayment penalty to get out of the existing loan. The third is to make certain the terms you are moving to are enough better, for your purposes, than the existing terms to justify the costs associated with the first and second issues.

You state that you're in California, which is where I work. Realistic costs of doing the loan are about $3500 with everything that is necessary. This doesn't include origination, to pay the loan provider for the work they do on the loan, or discount, to pay for a rate the lender might otherwise not offer. I explain those costs, the difference between them, and many of the games lenders play in my article on Good Faith Estimate, part I. There will also be the possibility of you having to come up with some prepaid items, explained in Good Faith Estimate Part II.

Note that not every loan has points. I actually think that, given most client's refinancing habits, it's usually better to pay for a loan's cost, and the loan provider's compensation, through Yield Spread. Yield spread can be thought of as negative discount points, and discount points can be thought of as negative yield spread. Discount points are a fee charged by the lender to give you a rate lower than you would otherwise have gotten. Yield Spread is a premium paid by the lender for accepting a rate higher that you would otherwise have gotten, and can be used to pay the loan provider and/or loan costs. Each situation must be considered upon its own merits, of course.

Now, let's take a look at your specific situation. Your current first mortgage is at 4.75% interest only. You don't mention what sort of loan this is (updated via email: it's a 5/1 Interest Only ARM), but there is no such thing as a thirty year fixed rate interest only loan. At most they are interest only for a certain period, usually five years, before they begin to amortize over the remaining twenty-five. On the other hand, you said you bought one year ago, and that rate didn't exist on thirty year fixed rate loans then and it doesn't exist now. (Via later email, the first mortgage is a 5/1 Interest Only ARM). Your second loan is a line of credit at 6.375. I'm also guessing that either you, or the person who sold to you, paid a good chunk of change in discount points to buy the rate down, and I'm hoping it wasn't you.

Now, there's no way that this is a loan that's going to serve you indefinitely at that rate. There hasn't been a 30 year fixed rate loan comparable to that available since Spring of 2004, with any lender I know of, no matter how many points you paid. So what you have is at most a hybrid ARM (Yes, 5/1 Interest Only). No worries; I love hybrid ARMs. They are the only loans I consider for my own property in most circumstances. But they do have one weakness. There is likely to come a time when it is in your best interest to refinance, because after the fixed period the rate on them adjusts every so often, based upon a stated index plus a contractual margin, and the sum of these two is likely to be significantly higher than the rate for refinancing into another hybrid ARM.

Now what are they offering you? They're talking about cutting your payment by $1500 or more. But there just aren't any rates that much lower than yours available. Nothing even vaguely close. I don't think I could get you a 4.75% rate, even fully amortized, right now. So how are they going to cut your payment?

The only hypothesis I can come up with that is not contradicted by available evidence is that they are offering you a loan with a negative amortization payment. I explain those in these articles:

Option ARM and Pick a Pay - Negative Amortization Loans and Negative Amortization Loans - More Unfortunate Details

There is more information on marketing games with this loan type in these articles: Games Lenders Play (Part II) and Games Lenders Play (Part IV).

Finally, there are a few more issues that may not be relevant to everyone in these articles: Regulators Toughen Negative Amortization Loans? and Negative Amortization Loan Issues on Investment Property

One thing to understand is that when lenders are sending out advertising, they are not looking for Truth, Justice, and the American Way. They're looking to get paid for doing a loan, and most lenders will do anything to get you to call, and then to get you start a loan. The Creative Fiction on many Good Faith Estimates and Mortgage Loan Disclosure Statements is only the start of this. If you find a loan provider who will pass up loans that they could otherwise talk you into because it doesn't put you into a better situation, keep their contact information in a very safe place, because you've found a treasure more valuable than anything Indiana Jones ever discovered. A valuable treasure that you can and should nonetheless share with friends, family, and anybody you come into contact with because you want them to stay in business for the next time you need them. Most lenders and loan providers could care less if they are killing you financially - what they care about is that they get paid. A negative amortization loan pays between three and four points of yield spread. Assuming your loan is $300,000, they would be paid between $9000 and $12000 not counting any other fees they charge you for putting you into a loan where the real rate is at least 1.5 percent higher than the rate you're paying now, and month to month variable. Warms the cockles of your heart, right? Didn't think so.

In short, they're offering you a teaser no better than a Nigerian 419 scam for most people in your situation. My advice is not to do anything unless you're coming up on the end of your fixed period, in which case you need to talk with someone else, who might have your interests somewhere closer to their heart than the Andromeda Galaxy.

Caveat Emptor

UPDATED here

Bridge Loans

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One of the things I'm seeing a lot of these days is blanket advice on bridge loans.



A bridge loan is a loan that you take out with the explicit intention of having it be short term. The most common situation is a loan against property A, which you own but plan to sell, so that you can put a down payment on property B right now.



The motivation for this comes from the fact that people get paid to do bridge loans, and they are typically very easy loans to do. Frankly, the people making the recommendation make more money by doing the bridge loan than by not doing it, and they are not motivated to do the calculations and legwork to see which is the better deal for the consumer.



When it comes to money, blanket recommendations of any sort are automatically suspect, and usually wrong. Every situation is different, and there can be factors that cause an ethical professional to recommend something in one case where they would recommend against in another superficially similar one.



Bridge loans are no exception. The advantage is that they make you a more qualified buyer, and can get you better rates on the loan for the new property. The disadvantage is that their closing costs are just as high as any other loan. So you're spending about $3500 extra plus points plus junk fees (if any). They are also, by definition, cash out refinances. The rate-cost tradeoff for cash-out refinances is less favorable, all things considered, than purchase money loans.



The next major issue that arises is that they can make it more difficult to qualify for the loan on the new property, which can often mean that you need to go stated income or NINA when you might otherwise have qualified full documentation, which means you got a higher rate on the new property anyway, and that you're going to want to refinance your new purchase as soon as Property A sells anyway, sending another set of loan costs down the drain. Don't get me wrong, I love to do loans, and my pocketbook loves for me to do loans, but it's a good loan officer's job to look after your interests first.



Finally, choosing a bridge loan can force a choice upon you: A good loan that puts you in the position of having a need to sell within a specified time frame, and a mediocre loan that may not. The best (lowest) rates are for short term loans. Always have been, always will be. However, if the market sours, this can cause you to either accept an offer you would not have otherwise considered, or flush another set of closing costs down the toilet, when if you had chosen the mediocre loan, you would have been okay indefinitely.



Let's crunch some numbers. Let's say you have a property currently worth $250,000 that you bought for $125,000 and have paid down to $100,000. You want to upgrade to a $400,000 property now that your promotion and raise have settled in.



The first thing you do is pull cash out to 80 percent. On a 30 day lock of a 30 year conforming fixed rate loan, assuming you've got good credit, this is about a 6.5 rate without points, and you'll actually get about $96,500 of that $100,000 you take out. I looked at shorter term fixed rate loans as well, but with the yield curve inverted right now since you're planning to sell, anything without a prepayment penalty is about the same, and a prepayment penalty is contra-indicated, as it means you'll have to pay thousands of dollars when you do sell.



You take and put that $96500 down on a new home purchase loan on a $400,000 home. It's over 20% down, so no PMI concerns, and no splitting into a second loan. But because you've got that $200k loan sitting over there, now you have to go stated income on the loan for the new home. This means your rate is about 6.75 without points. Soak off another $3500 in loan costs, plus purchase costs of maybe another $1000. You now have two loans, one for $200k at 6.5 and one for about $312,000 at 6.75. Now the original home sells. Let's say you got full value of $250,000. You pay 5% in real estate commission, and maybe 2% more in other costs. That's $17,500, so you get $32,500 in your pocket. You have three choices, two of them productive. You can 1) Spend the money, 2) Invest the money, or 3) Use it on the other mortgage. Now a paydown, where you just plop the money down and keep making your same old current payment is a good idea (Unless there's a "first dollar" prepayment penalty), but most folks are obsessed with lowering their payment. So they take that $32500, and of which $3500 is loan expenses, and (because now they can do full documentation), they end up with something like a $283,000 loan at 6.25 percent, assuming rates don't move. Total cost of loans: $10,500 assuming you pay no points for any of your loans. Perhaps possible for someone with above average credit. Not likely if your credit is below average.



Suppose instead, that you just leave that $100,000 loan sit on your original property. You're still going to have to do stated income on the new loan on the new property. But instead, you go with a 80 percent first, 15 percent second because you can come up with $25,000 until the first property sells. Same 6.75 rate on the first, and the second is an interest only at about 10.25, just to use the same lender whose sheet I happened to pull from the stack for the exercise. Loan costs, $4000 without points, which I priced the loan to avoid. First house sells, you get $132,500, replace the $25,000, and pay off that second, leaving you a $320,000 loan and about $47,500, holding cost assumptions constant ($1000 in non-loan costs). You could do a paydown, leaving $272,500 balance on a 6.75 loan, or you could take $3500 in closing costs and refinance to 6.25, just as above, leaving a balance of $276,000 if you don't pay any points. Total loan costs, $7500 and you only have to avoid paying points twice (once, as opposed to twice, if you take the paydown option. It takes a little under 37 months to break even on your interest savings). Furthermore, in less than hot markets, it gives you greater leverage with your seller to pay some part of your closing costs: "Do this, or I don't qualify". They have the home on the market for a reason, and they can help the buyer in hand or they can hope for another buyer to come along.



In this example, not doing a bridge loan saves you about $6500, less the additional interest (about $512/month) for the second mortgage until your first home sells, but plus approximately $541 per month interest every month between the time you initially refinance your original property and the time it finally sells, a longer period of time. Plus one set of possible mortgage points. So it's not difficult to construct scenarios where it's a good idea not to.



Let's look at a different scenario, however. Let's say instead of upgrading, you're already in the $400,000 home, and looking to downsize to a $100,000 condo. Furthermore, let's say you bought for $200,000 and are now down to $160,000 owed, just to keep the proportions consistent. You borrow out to $265,000 (paying $3500 in loan costs), which you qualify for full doc at 6.25. You then pay cash for the condo (including $1000 for purchase transaction costs, and you've still got $500 in your pocket). Furthermore, an all cash, no contingency transaction is a powerful negotiating tool for a seller to give you a good price. Then when your original property sells, costing you say 7%, or $28,000, in selling costs. You net $107,500 in your pocket. If you did no bridge loan, let's still assume you can come up with $25,000 on the short term, and you still qualify full documentation. Your rate on the condo is 6.375 without points, holding assumptions consistent. Then you sell the first property for the same $400k, paying the same 7% ($28,000) and paying off the $80,000 loan on the condo as well as replacing the $25,000. Net still $107,500 in your pocket, less additional interest charges for a little longer period, but you cut your stress level and put yourself in a stronger bargaining position, which is likely to be worth doing.



There are any number of reasons and factors to do a bridge loan or not to do a bridge loan. You may not have a minimum down payment without a bridge loan. That's probably the most common, as not all properties and purchases are eligible for 100 percent financing, and some require as much as a forty or even fifty percent down. The way a necessary transaction is structured. The presence or absence of 1035 exchange considerations is often a factor. Your credit score may limit you, or your ability to qualify full documentation may dictate the advantage lies in a different direction. Every situation has the potential for factors that may dictate an answer other than that given by pure numerical computation, and there are therefore, no valid blanket answers to the question of whether or not to do a bridge loan.



Caveat Emptor.

UPDATED here


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 intereact 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.

UPDATED here

Reserves

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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 is a 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 banks, 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.

UPDATED here

Many folks have no idea how qualified they are as borrowers.



There are two ratios that, together with credit score, tell how qualified you are for a loan.



The more important of these two ratios is Debt-to-Income ratio, usually abbreviated DTI. The article on that ratio is here. The less important, but still critical, ratio is Loan to Value, abbreviated LTV. This is the ratio of the loan divided by the value of the property. For properties with multiple loans, we still have LTV, usually in the context of the loan we are dealing with right now, but there is also comprehensive loan to value, or CLTV, the ratio of the total of all loans against the property divided by the value of the property.



Note that for instances where you may be borrowing more than eighty percent of the value of the home, splitting your loan into two pieces, a first and a second, is usually going to save you money. (See here for an example)



The maximum loan to value ratio you're going to qualify for is largely dependent upon your credit score. The higher your credit score, the lower your minimum equity requirement, which translates to lower down payment in the case of a mortgage.



Credit score, in mortgage terms, is the middle of your credit scores from the 3 major bureaus. If you have an 800, a 480, and a 500, the middle score, and thence your credit score, is 500. If the third score is 780 instead of 500, your score is 780. If you only have two scores, the lenders will use the lower of the two. If you have only one score, most lenders will not accept the loan. Now, I've never seen scores that divergent, but that doesn't mean it couldn't happen. Usually, the three scores are within twenty to thirty points, and a 100 point divergence is fairly unusual. Despite what you may have heard or seen in advertising, according to Fair Issacson the national median credit score is 720. See here for details.



In order to do business with a regulated lender, you need a minimum credit score of 500. There are tricks to the trade, but if you don't have at least one credit score of 500 or higher, you're going to a hard money lender or family member.



Now, exactly what the limits are for a given credit score is variable, both with time and lender, even when you get into A paper. Subprime lenders will go higher than A paper, but the rates will also be higher. Nonetheless, there are some broad guidelines. At 500, only subprime lenders will do business with you, and they will generally only go up to about 75 percent of the value of the home. A few will go to 80 percent, but this is not a good situation to be in.



Currently, at about 580 credit score, you can still find subprime lenders willing to lend you 100 percent of the value of the home, providing you can do a full documentation loan. At 580 is also where Alt-A and A minus lenders start being willing to do business with you, although they won't go 100 percent until higher credit scores.



At 620, the A paper lenders start being willing, in theory, to consider your full documentation conforming loan. They won't do cash out refinances or "jumbo" loans until a minimum of 640, but they will do both purchase money and rate term at 620 or higher. They may not go 100 percent of value until 680, but they will go about eighty or maybe higher.



At 640 is where subprime lenders will start considering 100 percent loans for self-employed stated income borrowers. Not too long ago, I could find these down to 600, but the lenders have been raising these requirements of late. For w2 stated income (essentially, people who get a salary and don't want to document income) the minimum for 100 percent is about 660 now. Mind you, if you can document enough income, it is in your interest to do so.



660 is where A paper will start considering conforming stated income loans. They may not go above 75 percent of value, but they won't just reject you out of hand. At 680, they will consider jumbo stated income.



Now, it is to be noted that just because you can get a loan for only so much equity, it does not follow that you should. Whereas the way the leverage equation works does tend to favor the smaller down payment, at least when prices are increasing, it can also sink your cash flow. So if the property is a stretch for you financially, it can be a smarter move to look at less expensive properties to purchase. I have seen many people recently who stretched to buy "too much house" only to lose everything because they bought right at market peak with a loan they could not keep up. Many of these not only lost every penny they invested, but also owe thousands of dollars in taxes due to debt forgiveness when the lender wrote off their loan.



There are other factors that are "deal-breakers", but so long as your debt to income ratio is within guidelines and your loan to value is within these parameters, you stand an excellent chance of getting a loan. All too often, questionable loan officers will feed supremely qualified people a line about how they shouldn't shop around because they're a tough loan and "you don't want to drive your credit score down." First off, the National Association of Mortgage Brokers successfully lobbied congress to do consumers a major favor on that score a few years back. All mortgage inquiries within a fourteen day period count as the same one inquiry. Second, the vast majority of the time it's just a line of bull to keep people from finding out how overpriced they are or to keep you from consulting people who may be able to do it on a better basis. I've talked to people with 750 plus credit scores, twenty years in their line of work, and a twenty percent down payment who had been told that, when the truth is that a monkey could probably get them a loan! By shopping around, you will save money and get more information about the current status of the market.



Caveat Emptor.

UPDATED here

Many people have no clue how qualified they are as buyers, or borrowers.



There are two ratios that, together with the credit score, determine how qualified someone is for a loan.



The first, and by far the more important, is debt to income ratio, usually abbreviated DTI. This is a measurement of how easy it will be for you to repay the loan given your current income level.



The debt to income ratio is measured by dividing total monthly mandatory outlays to service debt into your gross monthly income. Yes, due to the fact that the tax code gives you a deduction for mortgage interest, you qualify based upon your gross income. This ratio is broken into two discrete measurements, called front end ratio and back end ratio, for underwriting standards. The front end ratio is the payments upon the proposed loan only (i.e. principal and interest), whereas the back end ratio adds in all debt service: credit cards, installment loans, finance obligations, student loans, alimony and child support, and property taxes and homeowner's insurance on the home as well. The front end ratio is almost ignored; I cannot remember an instance of when front-end was a deal-breaker. The thing that will break most loans is the back end ratio, to the point where some lenders don't really care about the front end ratio anymore.



Now, as to what gets counted, the answer is simple. The minimum monthly payment on any given debt is what gets counted. It doesn't matter if you're paying $500 per month, if the minimum payment is $60, that's what will be counted.



"Can I pay off debt in order to qualify?" is a question I see quite a lot and the answer depends upon your lender and the market you're in. For top of the market A paper lenders, who have to underwrite to Fannie Mae and Freddie Mac standards, the answer is largely no. If you pay off a credit card where the balance is $x, there's nothing to prevent you going out and charging it up again. Even if you close is out completely, the thinking (borne out in practice, I might add) is that you can get another one for the same amount trivially. "Won't they just trust me to be intelligent and responsible?" some people will ask. The answer is no. Actually, it's bleep no. A paper is not about trust. A paper is about you demonstrating that you're a great credit risk. Even installment debt is at the discretion of the lender's guidelines. If they believe that what you really did was borrow money from a friend or family member who expects to be repaid, expect it to be disallowed. Therefore, the time to pay off or pay down your debts is before your credit is run and before you apply for a loan.



For subprime loans, the standards are looser because the lender controls the money. As long as they can see where the money is coming from, they will usually allow the payoff in order to qualify.



Now many folks think that stated income loans don't have a DTI requirement. They do. As a matter of fact, stated income is even less forgiving than full documentation loans in this regard. As I keep telling folks, for full documentation, I don't have to prove every penny you make, I only have to prove enough to justify the loan. If what I proved before falls short, but if the client has more income, I can always prove more. For stated income, we still have to come up with a believable income for your occupation, and then the debt to income ratio is figured off of that. Even if the lender is agreeing not to verify income, they're still going to be skeptical if you change your story. "You told me you make $6000 per month three days ago. Now you're telling me you make $7000 per month. Which is it? Please show me your documentation!" In short, this loan has now essentially changed to a full documentation loan at stated income rates. Nor are they going to believe a fast food counter employee makes $80,000 per year. They have resources that tell them how much people of a given occupation make in the area, and if you're outside the range it will be disallowed. So you need to be very careful to make certain the loan officer knows about all the monthly payments on debt you're required to make. Sometimes it doesn't show up on the credit report and the lender finds out anyway. This has nothing to do with utilities (unless you're in the process of paying one of them back). That's just living expenses, and you could, in theory, cancel cable TV if you needed to. Once you owe the money, you are obligated to pay it back.



As for what is allowable: A paper maximum back end debt to income ratios vary from thirty-eight to forty-five percent of gross monthly income. I'm a big fan of hybrid adjustables, but they are, perversely, harder to qualify for under A paper rules than the standard 30 year fixed rate loan despite the lower payments. This is because there will be an adjustment to your payment at a known point in time, and you're likely to need more money when it does. Note that for high credit scores, Fannie Mae and Freddie Mac have automated underwriting programs with a considerable amount of slack cut in.



Some things count for more income than you actually receive. Social security is the classic example of this. The idea is that it's not subject to loss. Once you're getting it, you will be getting it forever, unlike a regular paycheck where you can lose the job and many people do.



Subprime lenders will usually, depending upon the company and their guidelines, go higher than A paper. It's a riskier loan, and you can expect to pay for that risk via a higher interest rate, but even with the higher rate, most people qualify for bigger loans subprime than they will A paper. Some subprime lenders will go as high as sixty percent of gross income on a full documentation loan.



Whatever the debt to income ratio guideline is, it's usually a razor sharp dividing line. On one side you qualify, on the other, you probably don't. If the guidline is DTI of 45 or less, and you are at 44.9, you're in, at least as far as the debt to income ratio goes. On the high side, waivers do exist but they are something to be leery of. Whereas many waivers are approved deviations from guidelines that may be mostly a technicality, debt-to-income ratio cuts to the heart of whether you can afford the loan, and if you're not within this guideline, it may be best to let the loan go. You've got to eat, you probably want to pay your utility bills, and you only make so much. Debt to Income ratio is there for your protection as much as the bank's.



Caveat Emptor.



The companion article on Loan to Value Ratio is here.

UPDATED here


Read your article on negative arm loans, and for the person who only owns a residence and most real estate investors it will not work. I own several properties, and the parcel to be refinanced is ocean front...so is going up in value more than the negative arm would be when refinanced after prepay penalty period. Cash out would be used to pay off other mortgages, thereby increasing my cash flow for a few years. Does your advice against negative arms apply in my situation?


I believe he's referring to this article.

This is actually an excellent question, and the answer is ... maybe. At least it is not a clear "no", unlike so much of what the Negative Amortization loan is misused for. This largely goes beyond the scope of what I'm trying to do with this site, but I'll take a swing at it.

The fact is that I can construct a scenario that goes either way, and the implicitly high appreciation rate you mention has surprisingly little to do with it.

The positive is that your other loans are paid off! To use Orwell-speak, this is maximum plusgood.

The negative is that this loan now includes every dollar you previously owed. Furthermore, there may be negative tax connotations to the fact that all of your interest expense now comes from one property, as opposed to being able to directly match it against individual properties with individual incomes. If interest against one property is greater than the income for that one property, you may not be able to take it all. I'm not clear on the implications of the tax code here (and I'd like to be educated), so consult with a CPA or Enrolled Agent.

Furthermore, your new loan won't magically create any "lake" of dollars. In order to pay off the other loans, it's going to have to be the size of all of them combined, plus any prepayment penalties, plus all costs of doing the loan, plus potential pre-payment penalties for the Negative Amortization loan.

Now consider:
If you make payment option one (the "nominal" or "as if your rate was 1 percent" payment), you are allowing compound interest to work against you. This is the force Einstein described as "the most powerful force in the universe", and it's working on the whole dollar amount of every single one of your current loans and then some.

Ouch.

No matter which payment you're making, the rate you are being charged, (aka "what the money is costing you") is not fixed, but variable month to month. As far as most commercial property loans are concerned, this is no big deal. They're pretty much variable at "prime plus" anyway. However, I expect the MTA and COFI (upon which Negative Amortization loans are based) to continue rising as government borrowing increases, whereas I'm not so certain about prime, which for most banks is comparatively high by real and historical standards.

Now with all this said, it's still very possible to construct winning scenarios, depending upon a variety of factors. You mention short-term cash flow, and that is certainly one possible justification. If short-term cash flow is all you're looking for, and the money it will cost you later on is no big deal because you're planning to buy down the prepayment penalty and sell in a short period of time. Yeah, you've added to your balance but you've got plenty of equity and you'd rather have a few hundred per month now than multiple thousands later. Think of it as a cash advance.

One of the things that negative amortization loans can do for you is make it easier for you to qualify for more loans on more properties. Because in loan qualification, the bank will only give you credit for 75 percent of prospective rents while dinging you for the full value of payments, taxes, fees, maintenance, etcetera, this can make it much harder to qualify than is realistic, given that in many markets the vacancy factor is less than five percent. You actually pay more, but you're not obligated to. Particularly because many people own investment properties for the capital gain rather than the income potential (i.e. price speculation, rather than monthly income). On the other hand, just because a property has been appreciating rapidly does not mean it will continue to do so, beachfront or not. The market nationwide is entering a very different mode than it's been in for the last few years. I can point to beachfront property here locally that's lost a lot of value since early 2005. Price speculation is great when it works (which is most of the time), but is really scary when it doesn't. It's a reward for risk-taking, so don't lose sight of the fact that it is a risk.

One other factor of doing this is that it can cause taxes on a sale to exceed net proceeds. Suppose you intend to sell the beachfront property in a couple of years, and it doesn't gain any more ground from where it is right now. Many properties were bought for less than 10% of their current value. Let's say you bought for ten percent of current value. If your loan is for eighty percent, and you pay six to seven percent in sale costs, you're getting ninety-three to ninety four percent of value, leaving a net of thirteen or fourteen. But you owe long term capital gains of eighty-three or eighty-four times twenty percent - almost seventeen percent! This can force you to take another loan out, against one of those "free and clear" properties lest you owe the IRS penalties. Yes, 1031 and even a potential personal residence exclusion can modify or nullify this, but so can all the depreciation you may have taken over the years, and if you intended to 1035 the property that would tend to contra-indicate any reasons you had for the negative amortization loan.

Now, to be honest, my experience with commercial loans is limited, and I've never done a negative amortization commercial loan. What few clients I've had in that market have had different goals in mind, and being as I'm a sustainability type loan officer, I tend to attract sustainability type clients, where Negative Amortization loans are more indicative of a speculative ("risk taker") type. I understand what's going on, but it isn't my primary approach to the issues. There are circumstances on investment properties where, unlike your primary residence, it can be very appropriate. Unfortunately, without full specifics, including time schedules, goals, reasons for holding investments, other investments, risk tolerances, etcetera, it's difficult to tell if yours is one of them. My experience in dealing with people is telling me one thing, my sense of ledger evaluation is hinting at a different answer. But I hope I've given you a clear idea of the kinds of issues you need to look at with professional help.

Caveat Emptor

UPDATED here

Working with a borrower all day today. Truly ugly situation because he doesn't have a long history of credit, and this is the major obstacle to getting the loan done. He actually makes the money, and has a sufficient history of making the money to justify the loan "full documentation". But: He only has one usable line of credit, and it is only 9 months old. Most lenders require a minimum of three tradelines, at least one of which must be open for 24 months.



On the other hand, there exists a method to help this person. What he is going to do is approach close relatives with long term stable, paid up lines of credit, and ask if he can be added to one of their revolving accounts as a co-user. He does not have to get a charge card, or actual access to the account, he just needs to be added to the account as a co-borrower, and he will get the benefit of however long the trade-line has been open. He doesn't even have to know the account number (and the credit report omits several digits, so he doesn't get it there, either).



This has two effects. First, he will get the benefit of the length of the trade lines, and second, he will get the benefit of the tradelines being paid promptly and on time for however long. Preferably, these are low limit and low to zero balance accounts, because he will be dinged for any necessary payments on his debt-to-income ratio. But it will likely raise his credit score significantly (I would guesstimate at least sixty points) by giving him a several year history of on-time payments, as well as giving him an adequate history of tradelines.



Nor is this fraudulent in any way, shape or form. This is being done in full consultation with the lender. The lender has been notified in writing and approved of this. It may seem like I'm always going off about fraud, but in this case something that may appear a little shady actually turns out to be something that both the bank and the regulators can live with. So if you're thinking that loans are always about NO NO NO, here's a very strong YES to go along with it.

Caveat Emptor

UPDATED here

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About this Archive

This page is a archive of entries in the Mortgages category from January 2006.

Mortgages: December 2005 is the previous archive.

Mortgages: February 2006 is the next archive.

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