Mortgages: June 2006 Archives

I got a search hit for that and, amazingly enough after 150+ articles, I've never dealt with this subject head on. So here goes.



One point, either discount or origination, is one percent of the final loan amount. After all of the loan amounts and fees and what have you are added, for a loan with one point, multiply the amount by 100 and divide by 99, and that will be your final loan amount. For a loan with two points, multiply by 100 and divide by 98. The general formula is multiply by 100 and divide by (100-n) where n is the total number of points.



Points come in two basic sorts, discount and origination. Origination is a fee your loan provider charges for getting the loan done. Some brokers quote in dollars, most quote in points because it sounds cheaper than an explicit dollar cost. Most brokers out there charge one point of origination. To contrast this, direct lenders do not have to disclose how much they are going to make on the secondary loan market. And many direct lenders still charge origination. Judging the loan by how much the provider makes (or tells you they make) is a good way to end up with a bad loan. My point is that it's the rate, type of loan, and net cost to you that are important, not how much the guy is getting paid for doing your loan. Remember two things here, and they will save you. First, loans are always done by a tradeoff between rate and cost. For the same type of loan, the more points you pay the lower your rate will be, and vice versa. Second, remember to ask about "What would it be without a prepayment penalty?" It's a good way to catch people who are trying to slide one over on you, and the lenders pay a lot more for loans with a penalty, and the lenders make a lot more on them when they sell them to Wall Street, so they often do them on what looks like a much thinner margin until you ask the question "What would it be without the prepayment penalty?" Remember it.



Discount points are an explicit charge in order to offer you a lower rate than you would otherwise have gotten. To use an example I ran across today, six point five percent with one point, seven percent without. On a four hundred thousand dollar loan, that's essentially four thousand dollars, either out of your pocket where you're not earning money on it, or added to your mortgage balance where you are making payments and paying interest.



Is it a good idea to pay discount points, or is it a better idea to pay the higher rate? That depends upon the loan type and how long you keep it. Let's say the loan is $396,000 without the point, $400,000 with, just to keep the math easy. Your monthly interest charge on the first loan is $2310, on the second it's $2166. On the other hand, you pay $361 principal on loan 2, only $324 on loan 1. Here's the bottom line, though: You've got to get that $4000 back before you sell or refinance. Just a straight line computation, that second loan saves you $181 the first month. $4000/$181 per month is about 22 months to break even (and it's a little faster than that, because loan 2 pays off more principal per month). On the other hand, even after you've theoretically "broken even" there is a period where if you sell or refinance, you will inexorably lose money because you're paying interest on a balance that's higher than it would have been.



But now let's run the actual numbers. If the above loan is a thirty year fixed and you keep it four years, you're well ahead. You've saved yourself $6944 in interest and your balance is only $2159 higher. $6944 - $2159 = $4785. Even if your next loan is at ten percent, you're only losing $215.90 per year. Especially when you consider that at a cost of money now versus later, you'll never make it up, because you can invest that $4785 you saved and it'll pay more interest than that.



On the other hand, let's say the rate was only fixed for two years. After that, it is a universal feature of hybrid ARMs that they all adjust to the same rate. You are theoretically ahead by $363, but because of your higher balance, even if the loan adjusts to five percent, you're losing $154 per year due to your higher balance, and there is nothing you can do about it. Play now, pay later.



There is no cut and dried answer about whether it's to your benefit to pay points. I tend not to do it, myself, because rates do vary a lot with time, and money sticks around in your balance. If I've got a zero or low cost loan and the rates drop half a percent, it's worthwhile to refinance for free. If I have a loan I paid a point for, I'm going to have to pay that same point again to see a benefit on refinancing, and as we've already discussed, if you don't keep the loan long enough, you've wasted your money. The median time between refinances is right about two years right now. I see no reason to pretend I'm any different from everyone else, but some folks do have a history of keeping loans a long time. You need to make your own choice to fit your own situation.



Caveat Emptor.

UPDATED here

I got a question about "what does it mean if my loan is not funded after right of rescission?"



It likely means your loan provider lied to you, probably from day one. Once you have signed documents, there shouldn't be anything but procedural matters left. Things that cannot be taken care of earlier. Things like final payoff coordination, the escrow officer using funds to pay homeowners insurance. Every once in a while, a good loan officer will get a subordination moved to prior to funding because it's on the way, but it is necessary to start the three day right of rescission now in order to fund on time under the lock.



Every once in a while, it'll be because of something happening to you in the meantime. Lenders who are risking hundreds of thousands of dollars don't just sit there and presume nothing has changed since the first time they checked it out. They are going to check again, right before they put the money to the loan, to make certain that nothing the loan was based upon has changed. So sometimes while they are doing a final Verification of Employment (making certain you still work there), the answer comes back that the borrower doesn't. The final credit check comes back with a score that no longer qualifies under that program. These are not the loan officer's fault, except inasmuch as they didn't warn you not to do whatever it was. Whether you quit your job or were fired, the result is no loan. So I always tell folks not to change anything about their life or credit without checking with me first. Neither I nor they can really do anything about layoffs, of course, but the point is not to voluntarily do anything that messes up your loan.



The vast majority of the time, however, what's going on is that the loan officer never had the loan. There's some condition holding it back that you, the borrower, can't meet. They have a choice between hoping to get around it or going out and actually finding a loan that you can qualify for and telling you about that instead. I shouldn't have to draw you a picture as to which choice they will likely make. Many times, they were teasing you with a loan that you had no hope of qualifying for as an incentive to get you to sign up. This is a standard "trick". They get you wanting that loan, which sure sounds good, and you apply. Unfortunately, that loan was never real, or never something you had a chance of qualifying for, but now they've got you signed up. Now you've done their paperwork, and you're mentally committed to their loan.



Now if it's an honest mistake, they are not going to have you sign documents. They're going to come back and tell you as soon as there is a condition they can't meet on loan qualification. But the question was about when you have signed documents and the loan doesn't fund. They can keep stringing you along, hoping it will happen, or they can come clean and tell you they can't do the loan. In the first instance, they might still get paid. In the second, they likely won't, because if you're smart you'll go elsewhere. Needless to say, this can waste a lot of time getting "one more document" from you or jumping through one more hoop. If the loan doesn't fund at the end of the rescission period and you are not certain as to why, you've probably been had. This is why I always tell people to ask for a copy of all outstanding conditions on the loan commitment before you sign final loan documents. Ask them to explain them, too. You see, once you sign loan documents and the rescission period expires, you're stuck with that loan provider. You can't go elsewhere unless and until they give up. Even if you have a back-up loan waiting to go, they can't do anything until the other loan funds or gives up, which could be weeks. Not a bad situation for an unethical loan provider to be in. In the meantime, the seller cancels your purchase and you're out the deposit. Or the rates go up and you're not getting a refinance on anything like the terms you might have really qualified for at the start of the process.



Caveat Emptor.

UPDATED here

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

First off, a disclaimer. A precise infallible answer depends upon the rates when your prepayment penalty expires, something that is not currently known. I think thirty year fixeds will be in the low sevens, but I might as well be sorting through animal entrails to get that answer. I also think that the five year hybrid ARMS will stay about where they are, or perhaps even decrease a tad once the fed announces that they are done with hikes. But I don't know; nobody does. It also depends upon what comparable homes are selling for then, which determine your appraisal, and how long you keep the new loan.

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

"No points" thirty year fixed rate loans are sitting right around 6.75 right now, and you're at 75% Loan to Value. The bad news is you're definitely a jumbo loan, as the conforming limit is $417,000. This boosts your rate a tad, depending upon the lender, to 6.875 or 7.00 percent without points. I prefer to discuss loans without prepayment penalties or points, but it might be in your best interest to pay a little to buy the rate down if you refinance. I'm going to use seven, as it makes the math slightly easier.

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

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

However, this decision does not take place in a vacuum. You can't let that negative amortization loan go forever. In fifteen months, I think equivalent rates will be about 7.25, which translates to 7.5 percent for your loan. Furthermore, I believe prices will be a little lower then, so in order to refinance, you're likely to have to split into two loans. Assume prices are 10 percent lower. Any of these prognostications is an educated market guess, no more, and I could be way off. The appraisal would come in just under $700,000, but let's say $700,000. Your first, for $560,000, would be at 7.5%, and for your second, I'll presume you get a new HELOC on the same terms, on which the balance would be about $33,000. Interest on first and second, at 7.5% and 8.25% respectively, comes to $3500 plus $227. The payment on the first would be $3915, plus $227 (assuming interest only HELOC) for a total of $4142. So $12,000 saved if you wait, versus about $200 per month less in interest charges per month if you dive in. Divide that out and it comes out to 60 months. Five years. If you keep the new loan five years, approximately, or more, you'll be better off refinancing now. If you keep it less than five years, you're better off waiting is what the calculations say. Plus chop off the $200 per month you save starting right now for the next fifteen months, and the answer turns into forty five months or a little less, being your time until break-even.

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

Caveat Emptor.

UPDATED here

"challenging underwriters mistakes in housing loan paperwork" was a search that I got.



You can't challenge them. Butting heads with an underwriter is stupid and counterproductive. There's only one person who gets a vote, and it's not you, whether you are an applicant, processor, or loan officer. The underwriter may not be the original application of the saying "a majority of one," but it certainly fits the situation.



Now keep in mind that as an applicant, you will never communicate directly with your underwriter. It is an anti-fraud measure constant throughout the industry. If someone tells you that you are talking to your loan's underwriter, either they are lying or the loan has just been rejected on procedural grounds.



If a loan officer believes that the underwriter has made a mistake in the underwriting of the loan, it is far more constructive to find out what it was - on what grounds the client was rejected. Actually, loans usually are not flatly rejected, they simply come back with conditions the client cannot meet. A loan that actually gets rejected usually has further adverse consequences for the borrower's credit, and is usually pretty good evidence that the loan officer was promising something they couldn't deliver.



Now it happens that underwriters, like loan officers miscompute things, miss things, and misconstrue things. This is one of the hardest lessons for a loan officer to learn: NEVER tell the underwriter anything that they do not absolutely have to know in order to approve the loan. The client has a rich uncle that gives them $10,000 every year? The client makes millions in the stock market as well as their salary? The client simply has millions in assets and they could buy the property for cash if they wanted? I wouldn't breathe a word of any of this to the underwriter. Not a peep, if I had my druthers. The underwriter will start asking all kinds of questions, asking for all kinds of documentation, both on the existing assets or income and on the likelihood of it continuing. If you're familiar with how the stock market works, you might have an appreciation for how hard it can be to prove that you're going to have income from it in the future. That underwriter isn't interested in trends or suppositions or even the fact that it's happened the last twenty years in a row. They want proof it's going to happen in the coming years. When accountants won't write a testimonial (trust me, they won't), you're probably out of luck.`



Now sometimes the underwriter comes back with conditions that are beyond the bounds of reason. Dealing with this is part of my job, but it's more akin to a negotiation than a confrontation. I've got to get them to tell me what has them concerned, and see if there isn't some other way to reassure them. Remember, if the loan goes sour, both the underwriter and I are going to hear about it. It may cost them their job, and I may have to come up with thousands of dollars to pay the lender. Not to mention that the client isn't exactly happy. The underwriting process, properly used, is as much for the protection of the client as the lender.



So what I've got to do is find out what concern caused the underwriter to place this condition on the loan, and then a more reasonable alternative may suggest itself. If you ask in the right way, conditions can be changed if the request is reasonable. But you've got to know what you're doing. If the alternative you suggest does not adequately address the underwriter's concerns, they are within not only their rights, but also in full compliance with regulations where you are probably not, to refuse to make the change. Sometimes the underwriter and the loan officer disagree as to the computation of income, for example. By definition, the underwriter is right - unless I can persuade them that my way is better. Just human nature, you can't do that by challenging them, you have to persuade.



Now it is possible to run into an intransigent underwriter. That's one reason why brokers have the advantage over direct lenders, who are stuck with the same group of underwriters all the time. I can pull the loan and resubmit it elsewhere. Given that particular lender isn't going to approve the loan anyway, they won't fight too hard, although on several occasions I have had the lender come back and issue an exception on their own when I do that, but the ability and willingness to actually take it elsewhere is essential to this. And it is sometimes possible to go over a given underwriter's head and get an exception from the supervisor, but it tends to poison the well when you attempt this, whether it is successful or not. When you're asking for special consideration for your clients, they tend to look much harder at all of your clients. I've seen a couple loan officers talk themselves into one approval through an exception with the supervisor, only to have their other loans that were going through smoothly kicked back out for further underwriting. So you have one happy client, and three or four that otherwise would have been happy and who now are not. Sounds great if you're that one client, but how would you like to be one of those three or four others? Not a good situation for anyone to be in. Taking the approach of collaboration works better.



Caveat Emptor.

UPDATED here

Every so often I run across a reference to a "rate buydown" I don't like to use them because they don't benefit the client, but I should explain them, what they are, and how they work.



A rate buydown is where for an upfront price, the lender agrees to give you a lowered interest rate for a time. 2/1/0 buydowns, where the rate is two percent lower the first year, one percent lower the second year, and then at the loan rate the third year, are the most common, but I've seen one year buydowns of two percent, two year buydowns of one percent for those first two years period, and any number of other tricks.



Now, this isn't free. A 2/1/0 buydown usually costs three points. In fact, what usually happens is the three points go into an escrow account somewhere where they pay out the money to make up the difference in interest to the lenders as the loan goes along. When the buydown period is over, the lender who originally funded your loan then gets to keep what's left over.



Now, here's what this means to you. Let's make this easy. Say you would have had a $291,000 loan, fixed at 7 percent, without a buydown. But with the buydown, you have a $300,000 loan at 5 percent the first year, six percent the second, and 7 percent from there on out. In order to really understand this, let's first take a look at your loan without a buydown:

Month 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24

Balance $291,000.00 $290,761.47 $290,521.55 $290,280.23 $290,037.50 $289,793.35 $289,547.78 $289,300.78 $289,052.34 $288,802.45 $288,551.10 $288,298.28 $288,043.99 $287,788.22 $287,530.95 $287,272.19 $287,011.91 $286,750.12 $286,486.80 $286,221.94 $285,955.54 $285,687.58 $285,418.06 $285,146.97

Payment $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03

Interest $1,697.50 $1,696.11 $1,694.71 $1,693.30 $1,691.89 $1,690.46 $1,689.03 $1,687.59 $1,686.14 $1,684.68 $1,683.21 $1,681.74 $1,680.26 $1,678.76 $1,677.26 $1,675.75 $1,674.24 $1,672.71 $1,671.17 $1,669.63 $1,668.07 $1,666.51 $1,664.94 $1,663.36

Principal $238.53 $239.92 $241.32 $242.73 $244.14 $245.57 $247.00 $248.44 $249.89 $251.35 $252.82 $254.29 $255.77 $257.27 $258.77 $260.28 $261.79 $263.32 $264.86 $266.40 $267.96 $269.52 $271.09 $272.67

Tot Int. $1,697.50 $3,393.61 $5,088.32 $6,781.62 $8,473.50 $10,163.97 $11,852.99 $13,540.58 $15,226.72 $16,911.40 $18,594.62 $20,276.36 $21,956.61 $23,635.38 $25,312.64 $26,988.40 $28,662.63 $30,335.34 $32,006.51 $33,676.14 $35,344.22 $37,010.73 $38,675.67 $40,339.02

Tot Prin $238.53 $478.45 $719.77 $962.50 $1,206.65 $1,452.22 $1,699.22 $1,947.66 $2,197.55 $2,448.90 $2,701.72 $2,956.01 $3,211.78 $3,469.05 $3,727.81 $3,988.09 $4,249.88 $4,513.20 $4,778.06 $5,044.46 $5,312.42 $5,581.94 $5,853.03 $6,125.70

Now let's look at it with the buydown:

Month 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24

Balance $300,000.00 $299,639.54 $299,277.57 $298,914.09 $298,549.10 $298,182.59 $297,814.56 $297,444.99 $297,073.87 $296,701.22 $296,327.01 $295,951.24 $295,573.90 $295,257.63 $294,939.77 $294,620.32 $294,299.27 $293,976.62 $293,652.36 $293,326.47 $292,998.96 $292,669.81 $292,339.01 $292,006.55

Payment $1,610.46 $1,610.46 $1,610.46 $1,610.46 $1,610.46 $1,610.46 $1,610.46 $1,610.46 $1,610.46 $1,610.46 $1,610.46 $1,610.46 $1,794.15 $1,794.15 $1,794.15 $1,794.15 $1,794.15 $1,794.15 $1,794.15 $1,794.15 $1,794.15 $1,794.15 $1,794.15 $1,794.15

Interest $1,250.00 $1,248.50 $1,246.99 $1,245.48 $1,243.95 $1,242.43 $1,240.89 $1,239.35 $1,237.81 $1,236.26 $1,234.70 $1,233.13 $1,477.87 $1,476.29 $1,474.70 $1,473.10 $1,471.50 $1,469.88 $1,468.26 $1,466.63 $1,464.99 $1,463.35 $1,461.70 $1,460.03

Principal $360.46 $361.97 $363.48 $364.99 $366.51 $368.04 $369.57 $371.11 $372.66 $374.21 $375.77 $377.33 $316.28 $317.86 $319.45 $321.05 $322.65 $324.26 $325.89 $327.51 $329.15 $330.80 $332.45 $334.11

Tot Int. $1,250.00 $2,498.50 $3,745.49 $4,990.96 $6,234.92 $7,477.35 $8,718.24 $9,957.59 $11,195.40 $12,431.66 $13,666.35 $14,899.48 $16,377.35 $17,853.64 $19,328.34 $20,801.44 $22,272.94 $23,742.82 $25,211.08 $26,677.71 $28,142.71 $29,606.06 $31,067.75 $32,527.79

Tot Prin $360.46 $722.43 $1,085.91 $1,450.90 $1,817.41 $2,185.44 $2,555.01 $2,926.13 $3,298.78 $3,672.99 $4,048.76 $4,426.10 $4,742.37 $5,060.23 $5,379.68 $5,700.73 $6,023.38 $6,347.64 $6,673.53 $7,001.04 $7,330.19 $7,660.99 $7,993.45 $8,327.56

It is also to be noted that in the very next month, your payments go to $1982.23, as opposed to the $1936.03 they would have been in the first place, and that they will stay there the rest of the loan, all 336 months should you keep it the rest of that time. Why? Because your balance is larger than it otherwise would have been, so the payment is higher, in this case by $46.20, due to the higher loan amount.



Finally, let's look at the differences:

Month 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24

Escrow Acct. $8,552.50 $8,176.27 $7,796.79 $7,414.04 $7,028.00 $6,638.63 $6,245.92 $5,849.83 $5,450.34 $5,047.43 $4,641.06 $4,231.22 $3,817.87 $3,647.29 $3,475.21 $3,301.60 $3,126.46 $2,949.78 $2,771.53 $2,591.72 $2,410.32 $2,227.32 $2,042.72 $1,856.50

Net cost $8,552.50 $7,982.95 $7,413.19 $6,843.21 $6,273.02 $5,702.62 $5,132.02 $4,561.21 $3,990.21 $3,419.02 $2,847.64 $2,276.08 $1,950.65 $1,687.67 $1,424.51 $1,161.18 $897.67 $633.98 $370.13 $106.11 -$158.09 -$422.44 -$686.97 -$951.65

What this means is that your lender's escrow account ends up with $1850 that they get to keep, on top of everything else they made from the loan. The final column is the net cost to you, what you paid to get it less the interest it saved you. Hey, look at this! In month 21 it goes negative! You must be saving money if you keep it that long, right?



Nope. This is a temporary and illusory savings phenomenon, and I don't know of any way to make it permanent. You see, the benefits stop in month 24. They are over. Kaput. Gone. That's all, folks. But you owe $6798.14 more (at the start of month 25, not illustrated above) than you would have without the buydown. There are exactly three possibilities as to what happens. First, that kou keep the loan. Due to the extra interest you're paying every month, you are negative again in month 56, and it keeps getting worse the longer you keep the loan. After 120 months of the loan, you are $1755 down. This actually peaks in month 242 at $3351 negative, then starts decreasing, but you don't get it back before the loan is paid off.



The second possibility is if you refinance the loan. Let's say you get a really fantastic deal and refinance at 5 percent on a 30 year fixed rate loan, and I'll even give you that your higher balance doesn't cost you any more in fees. Your payment is $85.35 per month higher than it would otherwise have been, your interest charges $28.32 higher (and the difference represents you paying the principal off faster if you don't pay for a buydown). Your savings is gone in less than three years, and there's nothing you can do about it.



The third and final possibility is that you sell the house. You get $6798.14 less in your pocket. This means that you don't have $6798.14 earning money for you in the stock market. At ten percent your benefit is gone in less than a year and a half. If you take the money and buy another property, that's $6798.14 higher your loan balance will have to be. Let's say you get that same fantastic 5% loan we talked about two paragraphs ago on the new property. Guess what? The same math applies here also. There is no way to win in the end with a buydown, unless someone else pays for it (for example, seller paid closing costs).



So they are a piece of garbage. Why are buydowns attractive, and why do otherwise rational people sign up for them?



Because they lower the payment for a while. People choose loans based upon the payment. In particular, they choose loans based upon the payment in the first check they are going to have to write. Most people figure that the check they are going to have to write two or five years out isn't important. Unscrupulous lenders and loan officers know this. That's why the (censored) negative amortization loans are so popular, despite them being time-delayed financial poison. So don't shop for loans based upon the payment, and if someone starts talking about ways to cut the payment as opposed to the interest rate, put your hand on your wallet and leave. If they persist, drag them out into the sunlight and put a wooden stake through their heart. It's the only way to be sure.



Before I go, I want to mention one specific group that gets targeted for these things, and that is veterans. The Veterans Administration loan, aka VA loan, has the ability to roll (not coincidentally) three points closing cost over and above the cost of the home into the loan. Most military folks are busy learning their trade, which is usually not something having to do with finance. Indeed, I've never heard of any MOS that included this type of financial training. So when the loan officer whispers sweet nothings into their ear about cutting the payments for the first couple of years, they don't know any better and they sign right up. They could have used those three points for something potentially useful, like discount points that buy you a lower rate for the entire term of a VA loan. If you keep it long enough, they will eventually net you money and the VA only accepts fixed rate loans, not ARMS or hybrids. The veterans could just not pay those three points, and not start out with what is basically negative equity. But rate buydowns make a loan appear attractive on the surface to someone with insufficient financial training, while costing them money in the long term and allowing the initial lender to make more money than they otherwise would.

Caveat Emptor

UPDATED here

(I have noticed a fair number of hits to this article that, judging by their search query, probably want the article on What Happens When You Can't Make Your Real Estate Loan Payment instead)



I got a question about legal late payments in California.



Unfortunately, there really is no such thing as a legal late payment. You borrowed the money, signed a contract, and it accrues interest according to that contract. You owe this money, and it only gets worse if you don't pay it. There is some wiggle room so you don't get unduly hit for a day or two late, or if the right to receive payments is sold, but that's about it.



The law gives you some wiggle room in the timing of the payments. First off, the laws of California and most other states give you fifteen days after the due date to pay the mortgage before a penalty can be assessed. I know of a lot of people who make consistent use of this. If it's due on the first, it's supposed to be there on the first, but many people take advantage of the fact that there is no penalty as long as it's paid within fifteen days of due date (i.e. before the sixteenth), and consistently mail their payment on the tenth or twelfth.



Now if you miss it by even one day, the penalty is up to four percent of the amount due here in California. As you might guess, most lenders charge the maximum penalty. When you compute it out, four percent times 360 divide by 15 is ninety-six percent annualized. I had my check get lost in the mail once and the lender waived the penalty when they called me on the eighteenth because I always paid on the first or before, but they didn't have to do that. I got the distinct impression that if I were the kind of person who pays on the twelfth or fourteenth every month, they would not have waived the penalty.



Now, there is also some wiggle room on when the new lender receives it if your contract is transferred between lenders. Because once upon a time some unscrupulous lenders would sell notes back and forth between their own subsidiaries because it made them more likely to get late fees, or even able to foreclose on appreciated property when there were relatively few protections for borrowers in law. Mind you, you still have to send it on time, but if it gets hung up in forwarding between lenders, that's not your issue. Within sixty days, the old lender must forward the payment promptly, and it counts as received when the old or the new lender receives it, whichever is first. It's still better to send to the new lender at the new address if you have it or know it.



In short, although there are some small period where payment is allowed to be delayed due to one factor or another, it is never to your advantage to do so. Make your payments on time.



Caveat Emptor.

UPDATED here

There has been a recent proposal for a 15% interest credit for homeowners rather than a deduction of all of the mortgage interest.



Now a credit is a direct allowance off of taxes you owe, but it doesn't effect any of those wonderful measures on what the income cutoffs are for certain other deductions, the way a homeowner's deduction does. On the other hand, there's no "magic" number of dollars of deductions you need to accumulate before it's worthwhile for file a Schedule of Itemized Deductions (Schedule A) as opposed to just taking the standard deduction. So it helps more people, but it helps them less. Furthermore, such a proposal would greatly restrict the amount of property tax that is deductible as well. Right now property tax and the homeowner's interest deduction mutually reinforce (by adding) within the itemized deductions category. Take homeowner's interest out of that, and the deduction for property tax suffers (unless of course, you make that a credit as well). On the other hand, many married couples, particularly in lower cost areas of the country, get no help now from these two deductions where they would on a direct credit. Back to the first hand, most people, particularly homeowners, are above the 15% income tax bracket. So such a move would likely help a few more people, but help those it helps by a considerably lessened amount.



(It is to be noted in passing that none of this makes a direct difference to non-owner occupied property, which falls under a different set of rules)



It has been said (correctly, in my opinion) that current tax policy amounts to a subsidy of real estate prices, in that due to the deductibility of interest and property tax, you are effectively paying less than the "true" market cost of your home, and therefore are being subsidized by the government, and so those with lower interest and property tax deductions are effectively subsidizing those with higher deuctions. Given my political proclivities (vaguely libertarian), I am hardly in a position to argue that taking away this deduction is unjust.



However, this was a choice that Congress intentionally took over half a century ago to subsidize home ownership as a public good. Having just completed preliminary work on a program that gives an honest, complete answer to which of some competing investment options is likely to be better (and fiddled with the assumptions and relationships quite a bit) home ownership has, even without the tax deductions, some advantages that are hard to overcome in the medium to long term. In an area that currently has homes selling for around $500,000, the difference between buying a home and not buying a home can easily get to be well over a million dollars down the line. I knew most of the relationships involved, and I was surprised at how strongly the numbers came out in favor of home ownership.



Now perhaps giving people an incentive to do something that is in their long term best interest (without making it mandatory) has some value in the public policy arena. Nonetheless, when AICPA and other financial planning organizations came out against abolishing the estate tax, I took a point of view that said "If it's good for the clients, it will be good for us" and have stuck with it despite having left the financial planning profession. There are things I'd rather the government do with any prospective money, like index Alternative Minimum Tax to inflation, but if my choice is limited to thumbs up or thumbs down on the idea of abolishing estate tax, both of my thumbs are emphatically up.



In the same light, let us examine whether making this change would be good for the average person.



Married couple with two kids making $36,000 (basically, poverty level) per year between them, with a small mortgage on a manufactured home on an eighth of an acre and light property taxes will see some benefit. If their mortgage is $800 per month and their property taxes $100, their deductions don't hit the minimum to make it worthwhile to file for itemized deductions as opposed to standard. But they could still take the credit. So they would see some benefit of about $1000.



Married couple with two kids making middle class wages of $70,000 per year. Let's say their mortgage is $2000/month and their taxes are $300 per month. Currently, their interest deductions would be about $21,000 from this. depending upon their exact situation, they get the benefit of $21,000 plus $3600 is $24,600, minus $10,000 is 14,600, times 28 percent tax rate is $4088. This would be replaced by a flat 15 percent credit (on the mortgage only) or about $3150. Say bye-bye to almost $1000 per year of disposable income.



Say we have a married couple making $150,000 per year, with $5000 per month of housing expenses. Let's say they can deduct $4600 of it now, or $55200, minus $1000, times 28% tax rate is $12,656 of tax savings. By comparison, the credit would give them (holding assumptions constant) about $7400. Farewell to $5200 for them.



The theme runs consistently. The people it helps see maybe $1000 per year of benefit, and they are actually comparatively few, albeit likely to be lower income. Far more people would be hurt, many of them significantly, although the argument can certainly be made that they can afford it more. I don't think anybody feels a huge amount of intense sympathy for a couple making $250,000 per year that that lose $10,000 of it either via this proposal or a limit on the mortgage interest deduction (unless, of course, they're the $250,000 per year couple).



So on a social benefit model, this looks like a definite loser on the balance. If we're talking ridding ourselves of subsidies, the 15% credit is a subsidy too, albeit a lesser one, and I'll bet (sight unseen) that there will be ways to game it.



Disclosure: I'm in real estate. Professionally, I'll admit I want prices to continue to rise, all other things being equal.



Nonetheless, the amount of screaming out of various real estate organizations since this proposal first aired, you'd thin it was the apocalypse or something. It's not. Investors may get hit, which I'd rather not happen, either, but they're not the ones the deduction is aimed at. The same goes for speculators holding the bag at the wrong time. I've seen a couple of accusations hurled at the Bush administration that this is largely a blow aimed at the heavily Democratic real estate industry, much as I also saw accusations leveled at the Clinton administration that they were taking shots at the heavily Republican financial planning industry. I think both sets of accusations are about equally valid. But from a real estate function, both agents and loan providers are going to continue to do just fine, and we're not the ones this piece of public policy is aimed at, either.



The thing I most want is a wealthier public. I'll admit that I don't see how changing this will make the public wealthier - if anything, somewhat the reverse - but if it can be shown, or designed such that the public becomes wealthier by it, then those in my profession and allied ones are the least of my concerns, because any time the home owning public gets wealthier, so do we.



Caveat Emptor.

Originally here

You raise a lot of issues. Some I'm going to deal with very quickly, others I'm going to spend some effort on, but nothing as in depth as a full article would have. I'm going to keep referring to material found in Credit Reports: What They Are and How They Work



I'm going to take the email in chunks:

Turns out I made the Two-Loan choice myself, independent of your article, a couple years ago. I was motivated to get a conforming first loan (~$322K @ 5.75%), and put the other ~$45K of a prior mortgage into a HELOC (besides, the HELOC rate was lower than the 30-yr fixed at the time!).



Well, times (and HELOC rates) have changed, and I now have

~$65K on my HELOC, and relatively tight budget.

That was 2003. considering that I had 30 year fixed rate loans at 5.375 percent or lower without any points for months and 5.25 for literally zero total cost for about one, you likely paid more than you needed to. There was a period in late August when rates spiked up, but I was calling the same clients back in December and into 2004, asking if they wanted to cut their rate for free. No prepayment penalty, no points. Those would have lowered the rate further.



HELOCs (Home Equity Lines Of Credit) have the disadvantage that they are month to month variable, based upon a rate that is controlled by the bank. On the downside, you're somewhat at their mercy. On the upside, the rate is based upon that lender's Prime Rate plus a margin fixed in your loan papers. They can't change your rate without changing everyone else's also. There is absolutely no legal reason I'm aware of why they can't set prime at twenty-four percent. There are plenty of economic reasons. Unfortunately, given the high demand low supply of money currently, the banks are competing for new business with a better margin, not a lower prime. They didn't cut rates every time Greenspan's Fed did, but they have religiously boosted prime every time the overnight rate has gone up since the Fed started raising it. Banks are making a killing in real historical terms right now with variable rate lending.



Fortunately, in most cases it's pretty easy to refinance a HELOC. Credit Unions are a great place for this; variable rate consumer credit is where they shine. There are some internet based lenders where you can obtain no cost, easy documentation HELOCs at rates right around prime, or even a bit below if you have the credit. Most HELOCs also have interest only options for five or ten years. Brokers really don't do a whole lot for HELOCs except keep lenders honest; there is not enough money in them to make them worth chasing and the lenders won't pay for them the same as for first trust deeds; it's too easy to refinance out of them. (Brokers can beat the stuffing out of credit unions on first trust deeds, however).



Unfortunately, your credit score is a problem now:

I have multiple credit card companies offering me low

introductory rates (some 0%, some 2%) for short terms (up-to 1 year).



Why would I NOT want to take them up on their offer?



In truth, I've already done this a number of times in the past 12-18 months, always at 0%. So I've learned the "minimum payment" trade-off (and I wish congress hadn't forced CC companies to raise their minimum payment

requirements!) [ last year, one fine bank only made me pay $10/month on their loan of ~$10K! Now I'm seeing minimum payments of 1-3 %]

The difference between cash flow and real cost, and the fact that each time you accept a new credit card thus, it is a MAJOR hit on your credit. Let's say you have two credit cards now that you have had for over five years, and get four new ones. Your FICO score modeling goes from over five years to about a year and a half on your length of credit history (the average of your accounts, except that five years is the maximum you get credit for an account). Open four more six months down the line, and now you have ten, with an average time open of just over a year. Furthermore, since most people move as much as they can into the new credit accounts, this gives major credit hits for being essentially maxed out on a card. Thirty to forty points on your FICO score per card, perhaps more. You say you've been doing this a while. Not to mince any words, I wouldn't want to have your FICO right now.



There are always two concerns when you're looking for the best deal. Minimize your costs, of which interest is far an away the largest, and be able to make your payments. I don't know if you have other payments here, but if so I would do everything I could to live cheaply enough, long enough to use the money I save to make a difference on both of those scores. In your position, I'd sell any cars I still have a payment on, just to get out of the payment. This is a concern I've been telling people about since 2003, when the rates on everything were so cheap. There is more than one way to do things, but you have to be prepared for the consequences of the way you chose. I had some clients up in Los Angeles about July of 2003. They wanted to cut their payments. I gave them the option of a conforming loan (like yours) with a HELOC, and they took it. As soon as the loans funded, the wife called me and said I deceived them about the loan, and they wanted me to pay for another loan. Unfortunately for their contention, I had a piece of paper in the file with their signatures saying exactly what I tell everyone else about this situation, that the rate on the HELOC is month to month variable and subject to change, and that they understood this was a risk and they elected to take it. It looks like you went in with your eyes open, but the risk didn't work out as you hoped. I'm trying to think of other strategies to help you out, but other than "live frugally for a while", it's all little stuff around the edges.

Tonight I'm "running the numbers" on whether a 2% rate (nondeductible) is better than an 8% (tax deductible). And according to my simple calculations (I'm an engineer, not a financial advisor!), it's a no-brainer (go for

it!). For the $40K currently on the HELOC (other $25K is already temporarily in 0% accounts), the one-time transfer fee ($50-90/transfer) and lower interest amount (~$70/mo)

is ~$200/month less than the deductible interest-only (minimum, ~$435, @ 8%) HELOC payment, AFTER adjusting for the tax deductibility (@ 30% [fed + state], ~$130 on $435).



My plan is that in months when my "income"/cash flow cannot cover all the minimum payments, I'll just use a HELOC check to cover the difference. That is, slowly transfer SOME of the debt back to the HELOC. But in the meantime, my theory goes, I'm paying down my principle faster than if I was just making "extra payments" on the HELOC.

Yes, in most cases you will make more progress, faster, this way, but at such a long-term cost as to make it prohibitive, particularly if you have to leave the credit lines open after you transfer the money out six months down the line. Lots of very silly folks do all kinds of weird and non-remunerative things because it's a deduction, but deductions are never dollar for dollar. If that were the only concern, 2% nondeductible beats 8% deductible by a huge factor. Given what's going on in the background, however, kind of a different story. All these newly opened lines of credit are going to drag you down for years. Make certain to pay it off before the adjustment hits; one month at 24% will kill almost all of your savings. Two months at 18% will more than kill it. Given what your score has likely dropped to, I'd bet that it's closer to the former than the latter.

I also finally had a 0% application turned down, due to "too much credit already, for your income level". So I imagine having all these cards may be hurting my credit score? But I'm not going to re-fi my house (or buy a new car?) anytime soon, so I think I don't care.

I imagine you're going to care. FICO scores require care and tending and time to rise back up. Close off any cards you opened for the zero interest period that you have paid off, and that will mitigate the damage. Keep only a few long standing accounts. But a large amount of damage is already done. When Credit Card companies are saying that, your FICO has dropped big time. Without running your credit, from the foregoing information, I'd guess you are below the territory where I can get a 100% loan, these days, even sub-prime (lower 500s). You might be below 500, where only hard money can lend to you.



Another concern is that HELOCs have "draw periods", usually 5 years, and you're about three years into yours. I'd be very certain to move it all back into the HELOC prior to the expiration of the draw period. Your credit card options are already getting worse, meaning that you're not getting the cards or not getting approved for enough to be useful. The HELOC's rate, by comparison, is set by a margin in an unalterable contract, and you're not going to be able to qualify for a new HELOC that's anywhere near as good while those card accounts are open. Move the money back in at least a couple months before the draw period expires and close the credit cards, and you might be able to get a new HELOC on decent terms.



Your credit is always vitally important. Guarding a very high credit score is something worth stressing about. You never know when you might need to apply for credit. Most credit cards, nowadays, can alter your rate if your score drops or if you make one late payment anywhere, not just on that card. A good credit score saves you money everywhere, from borrowing to insurance. In your situation, I'd be stocking up on pasta and Hamburger Helper while seeing what I could do to increase my income, so I could live cheap enough to pay my bills down enough that I'm not squeezed. It's your life, but that's the way I see it.



Caveat Emptor.

UPDATED here

(For full disclosure, the original email is below in a body).

Hi Dan,



While using Google to seek the wisdom of others regarding my current financial situation, I came upon an article of yours, and have now read at least a handful of others. In particular, "One Loan Versus Two Loans" caught my attention.



Turns out I made the Two-Loan choice myself, independent of your article, a couple years ago. I was motivated to get a conforming first loan (~$322K @ 5.75%), and put the other ~$45K of a prior mortgage into a HELOC (besides, the HELOC rate was lower than the 30-yr fixed at the time!).



Well, times (and HELOC rates) have changed, and I now have

~$65K on my HELOC, and relatively tight budget.



I have multiple credit card companies offering me low

introductory rates (some 0%, some 2%) for short terms (up-to 1 year).



Why would I NOT want to take them up on their offer?



In truth, I've already done this a number of times in the past 12-18 months, always at 0%. So I've learned the "minimum payment" tradeoff (and I wish congress hadn't forced CC companies to raise their minimum payment

requirements!) [ last year, one fine bank only made me pay $10/month on their loan of ~$10K! Now I'm seeing minimum payments of 1-3 %]



Tonight I'm "running the numbers" on whether a 2% rate (non-deductible) is better than an 8% (tax deductible). And according to my simple calculations (I'm an engineer, not a financial advisor!), it's a no-brainer (go for

it!). For the $40K currently on the HELOC (other $25K is already temporarily in 0% accounts), the one-time transfer fee ($50-90/transfer) and lower interest amount (~$70/mo)

is ~$200/month less than the deductible interest-only (minimum, ~$435, @ 8%) HELOC payment, AFTER adjusting for the tax deductibility (@ 30% [fed + state], ~$130 on $435).



My plan is that in months when my "income"/cash flow cannot cover all the minimum payments, I'll just use a HELOC check to cover the difference. That is, slowly transfer SOME of the debt back to the HELOC. But in the meantime, my theory goes, I'm paying down my principle faster than if I was just making "extra payments" on the HELOC.



Seems so obvious when I look at the numbers, that I cannot figure out why more people aren't doing it, or at least talking about it!



Why does a thorough website like yours not say anything about this (that I could find anyway)? Is it just to keep those low-rate credit offers coming? Am I missing something? I am really the only person to ever think of doing this? I also finally had a 0% application turned down, due to "too much credit already, for your income level". So I imagine having all these cards may be hurting my credit score? But I'm not going to re-fi my house (or buy a new car?) anytime soon, so I think I don't care.



Thanks for reading this far. If you post an article on this topic rather than replying, will I get a least a pointer to it in reply?



Again, thanks for considering a comment on my situation!

Identity withheld

Just got a search "how can I tell if my prepayment penalty applies to selling my home"



Read The Full Note. You need to do this before you sign it. I know that many people are just thinking "Sign this and I get the house!" or "Sign this and I get the money!" but a lot of loan providers - often the very biggest - scam their customers by talking about one loan with very favorable characteristics, and when it comes time to sign they actually deliver a completely different loan with a prepayment penalty, burdensome and unfavorable arbitration requirements (I've seen stuff that amounted to "the bank chooses the arbitrator"), and any number of other unfavorable terms, not to mention having a higher rate and three times the cost, and being fixed for two years as opposed to the thirty they told you about.



Any loan officer can make up all sorts of paperwork along the way to lull you into a sense of security. The only paperwork that means anything are the papers you actually sign at closing with a notary present. The Trust Deed, the HUD-1 form, and the Note. Concentrate on these three items. The HUD-1 contains the only accounting of the money that is required to be correct (things like do you need to come up with more money than you were told?). And the Note contains all the other information on the loan that your provider might actually deliver. Notice that wording - I said might deliver. Just because you sign the Note doesn't necessarily mean you get any loan, let alone the one that Note is talking about, but these are the terms you're agreeing to now, and most Notes do actually fund. They can't change the terms without getting you to sign a different Note. But once you sign and the Right of Rescission (if applicable) expires, you are stuck. Get that other loan - the one your loan provider has been talking about up to now - out of your head. This is the moment of truth as to what they actually intend to deliver. The majority of the time, the loan they actually deliver is significantly different from the loan they were talking about before now, and this document is where the truth lies. Amount of the loan (does that match what you were told?). Length of the loan. Period of fixed interest. What the fixed rate is, and how the rate will be computed after the rate starts adjusting. The Payments: how closely do they match what you were told? Payments are a lot less important than the interest you are being charged, but if the payments are $20 more than you were told (or if the interest rate is different), you were basically lied to. If the real loan was available and the principal correctly calculated, the payment should be within $1. $20 off gives the loan provider literally thousands of dollars to soak you for extra fees in, even if the rate is correct. A competent loan officer knows what loans are really available and whether you are likely to qualify, and can calculate pretty closely how much money it takes to get the loan done. From this flows the payment. Payment is a lot less important than most people think, but you do need to be able to make it, every month. Furthermore, that's how most people shop for loans and how unethical loan officers sell bad loans. Shopping by payment is a good way to end up with a bad loan. Many loan officers will tell you about this nice low payment, and conveniently neglect to mention the fact that if you make this low payment, you'll owe the bank $1200 more at the end of the month than at the beginning of the month.



So take the time to read the entire Note before you sign. There are all sorts of things lenders slip in. I worked for a very short period at a place that trained its people in how to distract you from the numbers on this and the HUD-1 and the Trust Deed. This is a legally binding contract you are entering into, you are agreeing to everything it says, and there aren't a whole lot of methods of getting out of it if you don't like what it says later. Once the loan funds, you are stuck with the terms, the costs, and everything else. The only way out, in general, is to refinance, which means paying for another set of loan costs and quite likely the prepayment penalty on this loan. Multiple thousands of dollars. So don't allow yourself to be distracted. Read the full Note.



Caveat Emptor.



UPDATED here