Mortgages: January 2007 Archives

Loans are declined, or actually, the next thing to it, all the time. It is pretty rare for a loan to be outright rejected; I do not recall ever having had a loan outright rejected. That's a sign of a loan officer who wasn't paying attention to guidelines when the loan was submitted. What happens is that the underwriter puts conditions on it which cannot realistically be met. Documentation for more income than you make is probably the classic example of this. What usually causes this is that the underwriter finds a debt that didn't show up on the credit report and that you didn't tell your loan officer about, and so a loan with a marginal but acceptable Debt to Income Ratio became unacceptable. Or the appraisal comes in low, raising the cost or lowering the cash out due to a higher Loan to Value Ratio than the loan was priced for. Sometimes there is something that can be done about it; sometimes there isn't. If your loan officer can't think of anything to do about it, he'll tell you the loan was rejected. Sometimes they'll tell you that the quote that got you to sign up was rejected, also, but they have this other loan over here "that isn't much more expensive" that you do qualify for. Telling you that a loan was rejected is one of the best ways there is for a loan officer to do bait and switch.



Unfortunately, there really isn't anything you can do to verify that your loan was rejected, as opposed to bait and switched, or just couldn't meet underwriting guidelines. (Whether it had any chance of meeting underwriting guidelines is a subject for many more essays).



The first thing to do is realize that the fact you cannot meet guidelines for the loan that got you to sign up means that it is time to start shopping around again. That loan that got you to sign up does not exist as far as you are concerned. It's not like they are suddenly going to discover that the guidelines allow 5% higher debt to income ratio. If your loan officer is not a complete bozo, they will have gone over alternatives with the underwriter before telling you about the difficulty. If there's something they can do with a little bit more paperwork or a little more income, they're going to ask you if maybe you have the paperwork, or if you make $500 per year in some other fashion. A good loan officer told you about the loan because he believed you would qualify, but you don't. A bad loan officer told you about the loan because he thought he could use it to get you to sign up, and then pull a switcheroo on you once he had the originals of all your paperwork and control of the appraisal that you've already paid for. There really is no good way to tell for sure. In either case, you are back to square one - shopping your loan. I would also think twice about staying with the same loan provider. He's told you about one loan he couldn't do to get you to sign up. Why not two? At a minimum, I'd want a good back up loan.



So being told you don't qualify for the loan you thought you were going to get is always a sign that you need to start shopping your loan around again. That's why you don't ever give a loan officer your originals of anything. Even if somebody brings me an original, a copy is just fine and I can hand the original back. The only paperwork I need the originals of is the loan paperwork - the application I fill out and have you sign, and the disclosures associated with it.



Now I mentioned the appraisal, and you need to be careful here too, so that you don't end up paying for two appraisals. Now every time I write something about controlling the appraisal, some appraisers who want you to pay for two appraisals come on to the site and start defending their interests (i.e. $ in their pocket). Well, a good loan provider who fully intends to deliver the loan he talks about has no problem promising in writing to release the appraisal if he can't do the exact loan he talked about. Once the appraisal is released, it only costs a re-typing fee (about $100), not a whole new appraisal fee, to take your loan somewhere else. Without a release, you have to pay for a whole new appraisal - so you're out the money for two appraisals. But don't choose an loan provider because they will front money for an appraisal. I've dealt with Loan Providers Who Will Pay For Your Appraisal before. One way or another, you are paying for that appraisal. Not only are you paying for that appraisal, you are paying for the appraisal of everyone who canceled their loan, too, and a good margin on top of that.



Caveat Emptor

UPDATED here

"what happens to your equity when the bank forecloses" was a question I got.



The answer is that most, if not all, will be dissipated by the foreclosure.



Let's say you own a home currently valued at $500,000, that you owe $200,000 on it, and that you have a 6% loan. Now, for whatever reason, you can't make the payments, and for whatever reason, you don't sell while you have the opportunity before the trustee's auction.



In California, you are going to be four months behind before the Notice of Default happens. So that is four payments of $1200. Furthermore, when you are fifteen days late you owe a 4% penalty, or $48, and when you are thirty days late, the missed payments start accruing interest. So at the point that the Notice of Default is possible, you owe $204,777.83.



From Notice of Default to Notice of Trustee's Sale is another 60 days, but before that happens, the bank is going to hit you with $10,000 to $15,000 in administrative fees for going into default. Check your contract; it's in there. Let's say $12,000, and now you owe $216,777.



Add another two months of delinquent payments, and penalties as of 15 days after. So as of the time the Auction actually happens, you owe $219,447. Furthermore, to make the auction happen, they will charge you about another $15,000. This covers the expenses of making the auction happen, of which the most noteworthy is the appraisal. At this point, you owe $234,447.



The appraisal bears special mention. Not only is there zero pressure to get a good value, the bank wants that appraisal to come in nice and low. They want the property to sell at auction, and if nobody bids 90% of the appraisal price, then they own it and have to go through the rigamarole of hiring an agent and selling it. So that appraisal is going to come in as low as is reasonable, to maximize the chance of it selling at auction. Every once in a while questions about low appraisals at trustee sales hit the site. The short answer is Microsoft Standard: "It's not a bug, it's a feature!" and from the bank's point of view, it is. So even though the property might sell for $500,000 in the normal course of things, the appraisal might come in at $440,000, meaning that someone has to bid $396,000 in order to buy the property at auction. The appraisal might be even lower, but let's say $440,000.



If someone bids $396,000 at auction (assuming they actually are able to consummate the transaction), they own the property. Less transfer costs, the bank gets maybe $380,000, of which the note is now for $234,000, and $300,000 of equity has dropped to $146,000.



But that's not usually what happens. What's usually happened is that the owners have financed it out to at least $375,000, hoping to be able to stave off foreclosure, and by similar math, they now owe roughly $425,000. How much do they get when the bank only got $380,000?



If the property doesn't sell at auction, the bank now owns it. Now they have to hire a listing agent, and offer a cooperating buyer's broker percentage, and while the listing agent looks for a buyer, the money owed keeps earning interest. Let's say the property eventually sells for $410,000, and the bank spends 7 to 8 percent of that getting it sold, so that their net is maybe $380,000. Even if you originally owed $200,000, by the time everything is said and done, you might owe $250,000 or more, leaving perhaps $120,000 coming back to the original owner.



Now, if the owners were to short-circuit the whole process by selling successfully for that same $410,000 (almost 20% less than comparable properties might sell for) before the trustee's sale happens, and if they spend that same 7.5% to get it sold, they get about $380,000, of which they'll get to keep approximately $160,000, more than it is likely they will keep under the best possible outcome if the property went to trustee's sale.



So if you cannot afford your payments, and you're looking down the road at a trustee's sale, it is usually in your best interests to get the property sold before that happens. The lenders will generally be as accommodating as they reasonably can if you ask them and keep them in touch with what is going on. They don't make money on foreclosures; they don't want to foreclose. Thanks to California's Home Equity Sales Contract Act, once the Notice of Default hits, you are unlikely to be able to do business with investors except on an "emergency sale for 60% of value" basis (that being about what the those "Cash for houses" folks offer), so the sooner you act, the more money you will likely come away with.



Caveat Emptor



UPDATED here

If that title seems to be damning with faint praise, it's accurate. I'm not going to issue any kind of blanket endorsement for them, but they aren't as bad as I feared when I first heard about them. They are definitely not something that will actually benefit most property owners, no matter how attractive the idea is.



Here's the press release: California Company Announces 'No Mortgage Payment for 12 Months'. Basically, they are promising a period of no payments that can be as little as three months or as long as 36.



So I called and checked them out. I can't find any evidence of the sort of attitude that are present in people who make a habit of selling negative amortization loans, and no evidence of legal shenanigans either (although I'd want to do more research before selling it myself, as I may do in March 2007 when they broaden the availability to brokers).



What appears to be going on is this: You refinance for an amount of money that covers not only what you need for pay off current bills, your current mortgage, put whatever cash in your pocket, etcetera, but also the prospective payments for however many months. The payments are based upon the increased amount, of course! Also, because it's for a larger amount, and hence, underwritten based upon a higher Loan to Value Ratio, as well as possibly Debt to Income Ratio (due to the higher principal amount), it might bump you down one or more categories in the quality of loan, and there will very probably be increased costs attributed to the increased loan amount, including addditional adjustment charges and the fact that these are always cash out refinances, might bump your costs half a point or possibly even more.



The excess goes into an escrow account, administered by a third party, where it earns interest while disbursing the monthly payments to the lender. The account has to be funded with enough to pay principal and interest for however many months you want to be free from payments, of course, and if you're expecting it to earn as much interest as it is costing you, well, I have a bridge in Brooklyn you might be interested in...



It appears that you can attach one of these to basically any loan from any lender. The only requirement is that the period of fixed payments has to be at least equal to the amount of time you want free from having to make payments. This is a very different thing from period of fixed interest rates, and the person I talked to on the phone offered me a negative amortization loan to go with it. I was quite proud of myself for being polite to him after that.



While I was on the phone, I did some price comparison between what's available to me and what they offered. I gave them a scenario of an 80% loan of $280,000 for a 720 credit score on a thirty year fixed rate loan. I've got 5.75 with one point total; they were talking about 5.875 with one and a quarter to one and a half points, although they were pretty slippery about being locked into any kind of actual quote. Considered in the context of the loan I was talking about, that's about an extra $1400 up front, not considering any possible junk fees, and approximately another $440 per year for what is otherwise the same loan. But even if they inflated that at signing by some reasonably standard amount, it's better than a lot of the other loans people are being sold right now.



Yes, it's higher than what I have available. Actually, I expected the difference to be greater. They are not selling great rates at a low cost with this program. What are they selling? Freedom from responsibility! Free Money (or so people think)! No mortgage payments for a year! Let the Good Times Roll!



I've kvetched enough about negam loans, and these really aren't any different in principle, but there is a large difference of degree. The underlying loans really are no different at the root from whatever type of loan you might care to name. At least if you make the underlying loan a good one, you're not being raked over the coals for 8% when you can have less than 6.



This program is, however, taking example of the fact that many people don't think of equity as "real money." But if you wanted to do one in conjunction with a purchase, you'd have to make a down payment at least to match the deferred payments. Is that money "real" enough for you? If you sold the property instead or refinanced for the cash out to make those payments, that money would be in your pocket instead. Is that "real" enough for you?



What does it cost? from their website

5. What is the cost for 12MoDef?

MPD, Inc. will submit a demand to Escrow for the 12MoDef service fee. The fee is $995 for 12 month deferral, $1495 for 24 month deferral or $1995 for 36 month deferral. This cost is typically paid by the borrower.

So in addition to all the regular costs for the loan, and of course, setting aside the equity to make the payments, and the increased interest costs down the line due to your loan amount increasing, this costs $1000 to $2000. I keep saying this, but I was expecting worse.



I am not enamored of some of the marketing tricks they are using to sell these, either. from their website

Miller notes that for clients close to retirement age, the freedom of 12MoDef, allows them to take advantage of "maxing out" their 401K contributions as well.

This must be some new definition of "advantage" with which I was previously unacquainted. Given their logic, this being for short term additional savings just prior to retirement, you're not adding that much, due to the short term nature of the issue in investment terms, you only have only a short period to compound, and in fact, the last time I checked, NASD rules specifically prohibited a licensed investment firm accepting your money in such circumstances. Not to mention it increases your future housing cash-flow requirements by more than the increase in your monthly income might reasonably be. After hauling out a spreadsheet, I couldn't find a reasonable scenario that worked, both in the sense of expected return and being sufficiently low risk to literally "bet the farm" on.



Delay is Denial digging you in deeper. If you can't afford the payments for the house you are living in, you probably need to do something else instead.



What uses do I see for this product? Primarily 1031 Exchanges, where someone may have restricted cash flow but does have a chunk of cash, and similar investment property situations. For investors and speculators, this would be a good way to stretch you leverage, albeit at a significantly increased risk, as should be plain to everyone reading this site by now. The current market is not really right for it, but being able to use equity in properties this way in rapidly appreciating markets might certainly be a way to make more money.



Perhaps there might be other times when it would make sense as well, but I can't think of another situation where it would be something I'd make a habit of considering. Of course, if someone asks me for it, once they're released to brokers, I'm more than libertarian enough to say, "Sign this saying that you acknowledge being told about these downsides and being advised to consult a financial advisor, and certainly I'll do it for you."



Caveat Emptor

UPDATED here

Purchase Money: This is a loan that enables you, in combination with your down payment, to actually purchase the property. If you spend cash to buy the property and get a loan the next day, that is not a purchase money loan.



Rate/Term Refinance: This is a refinance that does not put money in your pocket for other purposes. As it is more usually defined, this is a refinance that does not put significant numbers of dollars in your pocket. These loans typically have the best rates of the three purposes. For A paper, you are allowed to pay off existing loans, you are allowed to borrow enough money to "seed" a new income account, you are allowed enough money to pay up to one month of prepaid interest, and you are allowed up to 1% of the new loan amount, or $2000, whichever is less, to be put into your pocket for other purposes. In order to qualify as rate/term, A paper cannot do anything with an existing second (or third) mortgage, unless every last cent of that second (or third) mortgage was spent in acquiring the property, a fact which can force you to either do a cash out refinance or to subordinate your existing second mortgage to a new first trust deed. Sub-prime may have more forgiving definitions regarding other debts, but choosing sub-prime loan because it allows your new loan to be defined as a rate/term refinance is like voting Cthulu for President because you're tired of voting for the lesser of two evils. Sub-prime loans have pre-payment penalties by default, and generally carry higher rates.



Cash Out Refinance is any refinance that does not meet the definition of rate/term. It puts cash in your pocket, it pays off other debts, it includes or combines or refinances a home equity loan or home equity line of credit that you took out for improvements or to pay other debts. Cash out refinances will usually have the least favorable set of rate and cost trade offs, what the uneducated think of as "highest rates" of these three purposes, at least at higher loan to value ratios. Depending upon the lender, loan to value ratios under seventy to sixty percent may have the same rate structure as rate term refinances. Cash out refinances also usually have slightly tougher underwriting guidelines than either of the other two categories.



Caveat Emptor

UPDATED here