Mortgages: July 2007 Archives

I read with great interest you article on the internet about pre-payment penalties. I find my self in a situation involving a pre-payment penalty and would appreciate your advice on this. I currently have a loan in which the prepayment penalty is up on DELETED. I have gone to another lender for a refinance and have been approved for a loan. Since this loan process occurred before the pre-payment penalty was up, my current lender has included it in the payoff demand information. My new lender has approved funding a loan with this penalty ($12,000) included. Documents are scheduled to be signed DELETED and the loan will be funded (13 days before the penalty expires). If I try to push back the date of my loan, my interest rate will go up, and I may not even qualify for a new loan since my FICA scores have dropped. My intention is to go through with the loan and have the loan person hold onto the payoff check until DELETED, after the pre-payment penalty has expired. I will then request a refund of this amount from my current lender. Do you think this strategy is viable or can you suggest an alternative without changing the the time schedule or amount of my new loan?

So you're want to be paying interest on two loans for two weeks?

Doing it your way is okay if you want to pay the penalty and are willing to pay interest and points and everything on the extra. If not, just have your loan provider get a rate lock extension. You'll pay about roughly a quarter of a point in fees, but that's less than the interest - or the penalty. Have your new lender get a payoff demand valid from expiration of the pre-payment penalty forward.

Your new lender is not going to tolerate being second in line for several weeks. Until that previous trust deed is paid off, the loan to value ratio is higher than their underwriting allows, and I'll bet that debt to income ratio is as well. Suppose there's a fire during those two weeks? Is there enough money in the insurance to pay both of them? The answer is no. Until that prior loan is paid off, the value of the property is exceeded by the loans against it. This is the purpose of escrow - and there's escrow in a refinance as well as in a purchase. You don't get that check - you only get what's left over after escrow does their job, which includes paying off the prior lender.

As to your personal situation, why has your FICO dropped? Credit scores don't drop without a reason, and one credit check isn't going to make that much of a difference. Basically, it looks like your lender is trying to make more money off you, and feeding you a line of nonsense to facilitate it. By boosting the loan amount, their compensation in the form of origination and yield spread rises. Okay, so 1% of $12,000 is only $120 - but that's $120 more for basically the exact same work. Not to mention the loan is funded now and they get paid now. Loans that are finished don't fall apart. I'd bet millions to milliamps that they're intending to fund your loan before the penalty expires. If they weren't, there's no reason to have you sign loan documents that early. I wouldn't have you sign until your right of rescission runs out concurrently with your penalty.

From the information given, this is not likely to be a lender with your best interests at heart. About the only thing I can even think of where it might be in your interest is if there's a notice of default or trustee's sale looming - and then we have to consider whether paying that penalty and all of the costs of the loan is really in your best interest. And since you didn't say anything about either one of these situations, I have to question the wisdom of basically volunteering to pay 6 extra months of interest plus loan costs. In this loan environment, I just have trouble believing that the new loan is going to save you that much money over the course of the time you are likely to keep it, let alone over the two weeks early you're paying it off. Even if you're at 8% now and moving to a 7 percent thirty year fixed rate without points, that's over $15,000 you are spending to save 1%. On a $300,000 loan, you're just getting close to breaking even at 5 years, which is longer than ninety or ninety five percent of everyone keeps their loans, and your balance is still higher. And yes, rates are going up, but neither I nor any other analyst I read is expecting that much higher, that quickly - even if your rate isn't locked, and rates that aren't locked aren't real.

Rate lock extensions cost money. But sometimes they're still the smart thing to do. In your case, it's spend approximately a quarter of a percent of your loan amount (depending upon lender policy), or three to four percent for six months interest that I can't see any compelling reason for you to owe.

Caveat Emptor


PS next time, you might contact me to give me a shot at your loan before you're in this position. I do loans all over California.

Article updated here

I found you on the Web after doing some research for my parents regarding short sales and foreclosures. I appreciate your straight talk regarding the whole loan and real estate process which I know they find incredibly intimidating. Right now, they're sort of putting their head in the sand regarding their financial problems. I have been trying to help them stay afloat but it's becoming tight.

My mom received a default letter from the lender last week since she was two months behind. She sent one payment last week and I wrote a check to her lender for this month's mortgage to bring her current. I told her I couldn't do this again. She wants to walk away from the house, I told her "bad idea." My parents can't make the payments anymore and I am wondering if they should sell or refi. Here are the stats:

They've got a 7% fixed for three years which they are about a year and a half into. The payment is plus or minus $3100. The mortgage is $468,000 with a $12,000 pre-payment penalty. I don't know how they got into this mess but seeing her struggle and cry each month is something I can't watch anymore. My father and she (they're in their early 60s) have 2 pensions and 2 Social Security payments they receive each month. They make enough to make their house payment but not enough to cover all the other bills. My mom's logic is - "If I didn't have the house payment I could pay my bills." I tell her that her home is more important, and looking at your articles it seems to me the consequence of not making your mortgage if far worse then not paying credit card and car loan debt. Their credit is good but they don't want the house because the mortgage is so high. They talk of renting but I am afraid if they walk away from the house-the consequences will be dire.

In your experience is their hope? I've offered to refinance with them, the three of us, but would that help? I already own a home with my husband - I imagine there are occupancy restrictions? I have good credit. If they sell, it would be short with the pre-payment penalty. Are their agents that would sell the house? I can't imagine they'd want to since there would be no money for a commission.

Here's the real crux of the matter: These folks owe $468,000 and have a payment of about $3115 at a seven percent interest rate. Those are cold hard facts. As of this writing, there just aren't any loans out there that will help them enough to be worth paying that pre-payment penalty. Oh, someone could do a negative amortization loan that makes it appear as if they can afford the loan for a while - with even more dire long term consequences. Someone could boost their interest rate by maybe a quarter of a percent in order to cut their payment slightly with an interest only payment - but then the hole would stay just as deep as it is, and all interest only payments eventually start to amortize. The longer it is before this happens, the worse the payment shock when it happens. Most interest only loans adjust upwards on the rate at the same time. Sudden forty percent increases are nothing out of the ordinary. Even a longer amortization isn't going to help very much - even assuming the interest rate doesn't change, by the time you add that prepayment penalty in there, you've got a payment of $2982, even assuming no loan costs or fees get rolled in.

The point I'm trying to make is that I can't see a way for them to really be able to afford this property. Matter of fact, I have a very hard time believing that the agent and loan officer who sold them on this situation didn't do something both illegal and unethical along the way, and your parents should consult a real estate attorney about that. Nor is refinancing with you on the loan likely to help. As of right now (July 2007), there just aren't any loans enough better than what they already have to be worth paying both the pre-payment penalty and the cost involved. Not to mention the fact that the appraisal is going to be problematic. Sure, there are appraisers willing to say that property is worth $500,000 when it isn't, but they're going to become a lot fewer very soon. And if you can't afford to make their payment as well as your own, putting yourself on their mortgage is a good way to sink your credit as well as theirs. Then you have problems down the line with your own property.

I sympathize with these folks and you, but the only way they're likely to get rid of unaffordable mortgage payments is to get rid of the property. Unless, of course, they've got enough cash sitting around somewhere to pay their mortgage down enough to make it affordable. However, if they could do that, why didn't they put the money in as a down payment? I'd need more information to be certain, but I strongly suspect that it's time to own up to the truth, which is that they have purchased too much house and they cannot afford it.

With that said, "walking away" is just about the worst thing you can do in most situations. Now the lender has to go through the whole dreary process of foreclosure, with is going to effectively kill their credit for seven to ten years, and might cause the interest rate on any other debt they have to rise. They need a lawyer to advise them on their situation. Anyone in this situation needs a lawyer, and I'm not a lawyer. With that said, the following options are usually better:

You can talk to the lender about the situation. They don't want to foreclose. They don't make money when they foreclose. In fact, they lose it by the railroad carload. If it'll keep them out of foreclosure, chances are good that the lender will agree to a temporary modification of the note while your parents sell the property. They may or may not agree to accept a short payoff as well. It'll depend upon the listing agent and the lawyer. And yes, banks will usually agree to allow agent commissions in short payoff situations - it gets the property sold, which means they lose less money than if it goes all the way through foreclosure and they have to hire an agent anyway.

Another option that can be worth exploring is the Deed in Lieu of Foreclosure. This is where you sign the property over to them in satisfaction of the debt. It has the advantage that it stops future hits to credit. Although Deed in Lieu is itself one of the deadly sins according to mortgage providers, it's not as bad as a Trustee's Sale in most cases, and you don't have all the individual derogatory reports of the late (non-existent!) payments between now and whenever the Trustee's Sale happens.

One thing to warn of is that all of this, except perhaps for the Trustee's Sale, is the cause for a 1099 to be issued for income through debt forgiveness. Your parents will probably owe taxes on this money, so I strongly advise them to consult a tax professional as well (As best I recall, it's ordinary income, the same as if they had earned it working). In some cases, there may be a deficiency judgment as well, while in others there may not be. Nonetheless, this money is likely to be for a much smaller amount than $468,000, so they can probably dig themselves out, given time, and without living completely poverty stricken and without completely torpedoing whatever financial future they may have.

I know you wrote to the loan officer, but with the rates and loans available right now - especially considering the late payments on the mortgage - there's nothing the loan officer can do that actually helps, although there are a lot of loan officers out there who would say they'd help. If they were sitting in my office, it would be time to put on my Realtor hat and talk about selling that property. I wouldn't be happy about it, but the universe doesn't particularly care about making me happy, and it's the best way I see out of a bad situation.

Caveat Emptor

Article UPDATED here

It seems every week I get asked about some new or revived trick that loan providers are pulling. The one thing they all have in common is that they are methods to avoid competing on price. What the basic terms are and how much it will cost you.



First of the big weapons in most loan provider's arsenal is the tendency to most folks have to shop loans based upon payment. Payment has no intrinsic relationship to interest rate, which is what the money is really costing you. But if you do tell people "$510,000 loan for $1498 per month" most people assume that payment covers the loan charges even though it doesn't. People who can afford $1500 per month payments go buy $510,000 properties based upon these payments, and only after they've signed the papers do they figure out that the catch is their balance owed is increasing by $2500 per month! negative amortization loans are the obvious problem here, but less ethical loan providers also use this fact to push interest only loans and temporary buydowns and loans that cost so much in discount points that it would take fifteen years to recover the cost through lower payments - and that is based upon straight line computation, not taking into account the time value of money.



The second tool is the desire of most folks to get something for nothing, or at least appear to get something for nothing. This covers not only mortgage Accelerators, but also Prepayment penalties and biweekly payment schemes and even debt consolidation. They show you an actual method whereby you might hypothetically have your mortgage or debts paid off in a fraction of the time and without apparent discomfort or compromising your lifestyle if you fit their profile and stick with their program. The slight of hand here is two-fold. First, these are distractions, and if you examined competitive products, you can tack these allegedly neat features onto just about any loan or do it yourself, while they're acting like their programs are somehow unique when they're not. Second, these programs see the lion's share of the benefits at least five years out - when for all practical purposes, nobody sticks with the program that long. I lumped pre-payment penalties in here, because they are an often hidden charge that brings the lender more money down the line when you refinance before it expires, or immediately when they sell your loan on the secondary market, but they don't show up anywhere on the loan paperwork as a figure in dollars you are being charged. at the time you agree to the loan. Nonetheless, most folks who accept pre-payment penalties end up paying them, and they are real dollars you end up paying.



The third tool in their arsenal is that if the cost of something isn't explicitly disclosed, most people will assume it's zero. If there's not an actual dollar figure associated with something, many people think it's somehow free. Many loan providers feel no need to disclose escrow charges, or lenders title insurance, among others. They'll mark it "PFC" as if they don't know how much it's going to be. The net result, as I've said before, is that you end up thinking that "$2495 plus third party charges and two of these points things" is cheaper than the provider who tells you they're going to deliver the exact same loan for $6000 all told (on a $300,000, loan, you're looking at over $10,000 worth of charges from the provider who didn't quote a total figure in dollars. People gripe about "junk fees" when the costs are real, but they've been deliberately lowballed. There never was a chance that they would end up not paying those fees - and they're high dollar value fees - but by not associating a dollar figure with these fees, less than ethical providers are causing people to think they're either free or something comparatively small, like the $2 per tire waste disposal fee.



All of these tricks feed upon ignorance. Ignorance of what they are really doing, ignorance of how financial markets work. The fact of the matter is that nobody is going to do a loan for free. There's a very hard line where it's not worth my while to do a loan - I'd rather spend the time doing something else. Same thing with every other provider in the known universe. For some providers it's more than others, while for other providers, it's less. Everyone wants to make more money for the same amount of work. Competing on price is not a way to get a high number of dollars per loan - so they will do everything in their power to avoid competing on price. But there really isn't any other reason to choose a loan, other than that it's offering the same terms at a better price. A loan is a loan is a loan, as long as it's on the same terms at the same price. It's not like one loan is a Jaguar while another is a Prius and a third is a Mustang, or one is a Craftsman while another is a Colonial and a third is a Cape Cod.



Loan providers that don't compete based upon price compete based upon hiding the gotcha!, or pretending it's not important. If you understand the gotcha! associated with a particular loan, and are fine with it, that's great. If you don't understand the gotcha! chances are that it's going to bite hard.



Caveat Emptor

Article UPDATED here

Most of the time, I'm talking and writing about the sort of loan the average borrower is looking for. Up to 125% of the single unit conforming loan limit of $417,000, which works out to $521,250, A paper guidelines are pretty much determined by Freddie and Fannie. There really aren't many breakpoints in policy. Some lenders charge extra for loans under $100,000 or so, but it's really all the same program. Even in pricey Southern California, this is most transactions. Even if you don't have a down payment, anything above 80% Loan to Value Ratio is going to get split into a conforming first and a second for the remainder, so you're still dealing with Fannie and Freddie. If Fannie Mae or Freddie Mac will buy the loan, the lender is happy with it. An acceptance from either of their automated underwriting programs is normally good as gold for getting the loan through. My lowest "no points" conforming rate is currently 6.875, which for a $522,000 property with no second loan, just property taxes and insurance, and no other debt, you'd have to be making $7550 per month to qualify for that loan, or $90,600 per year. Most people, even without debts, don't make that much. Add in an average amount of household debt, a higher rate second mortgage, and increase the loan amount, and you're looking at roughly $10,000 per month to qualify, even without the fact that the maximum allowable debt to income ratio decreases.



However, once you get above dollar amounts that Fannie Mae and Freddie Mac will buy, each lender has their own criteria for the so-called "Jumbo" loans. This used to be a lot more of a factor in 2003 and 2004 when the conforming limits were $322,700 and $333,700, respectively, and still a significant factor in 2005 when the conforming limit was $359,650 and the market was still hot. When the average purchase price is in excess of $500,000 and even 80% of it is well over the conforming loan limit, you've got yourself a jumbo. Furthermore, scenarios that would be perfectly acceptable A paper below the conforming limit - because Fannie and Freddie will buy them, thereby assuming the risk - can often be forced to go sub-prime once you get into jumbo territory. For instance, from one lender whom I've done 100% A paper with below the conforming limit, they won't touch 100% financing once it gets above $417,000. If your first loan amount is for $418,000 and you want 100% financing, your choices are 1) do it sub-prime 2) Find a down payment of at least 5% somewhere, or 3) find some other A Paper lender that will do 100% jumbos. Right now, with the lenders in a panic, that's tough.



Regular jumbos go up to about $650,000 or $750,000. These numbers haven't changed much in at least five years, and we're getting to the point where jumbo limits need to rise. It's one thing when it covers a huge band from $322,700 to $650,000. It's getting to be something else when the band has constricted at the bottom so that it doesn't start until $417,000. Let the conforming loan maximum get boosted again, and regular jumbo loans may become more rare than they are.



Above jumbo loan amounts is "super jumbo" territory. Now instead of being willing to go to 95% financing, albeit full documentation only, now 90% is as high as this particular lender will go. Matter of fact, in order to find a 100% program in super jumbo territory, I have to go to Alt-A programs, which is no longer A paper.



What's going on here? Quite simply, higher dollar value properties are harder to sell, and there's more risk of taking at least something of a loss on them. Furthermore, the lender is risking a higher number of their own dollars. They want the borrower to have some serious skin in the game to motivate them not to lose it. You can find lenders willing to go 100%, even now with the lenders in full panic mode. It will be expensive, no matter how good your credit, no matter how much you make. We can make things better by splitting the loans, but even so, expect the subordinate loans to have rates well into the double digits. Furthermore, you can bet on there being a pre-payment penalty on at least one of the loans, while if you bring a satisfactory down payment to the table, you can find rates that are much better, and without a pre-payment penalty. For example, using the same rate sheet, the add to the jumbo rates is 3/8ths of a point for super jumbo, which means you can have the same rates as a jumbo loan for an additional charge, or go up maybe an eighth of a percent on the rate for the same charge. 3/8ths of a point doesn't sound like much, but when you're talking $800,000 loans, it's a $3000 one time fee, or about $1000 extra per year in interest. However, since in order to qualify for an $800,000 loan at 7%, you've got to be making about $14,000 per month not including the effects of property taxes, homeowner's insurance, or other debts - probably around $18,000 minimum salary per month to qualify with those included - these are not loans for even your average white collar worker.



At $1,000,000 in loan amount, there's another break point in lender policy. For instance, the lender I've been covering closest won't touch anything above 80% financing. Period, end of sentence. Not as a first, not with a piggyback second, not at all. For A paper lenders, that's actually kind of generous. The next two A paper sheets I pulled out max out at 70% Loan to Value above a million. This means come in with 20 to 30% down payment - or go sub-prime, with higher rates and pre-payment penalties. When you're talking about million dollar loan amounts, pre-payment penalties can fund a fairly high end car. For instance, if you have (pinky finger extended, Dr. Evil style) one million dollars at 8%, a standard pre-payment penalty of six months interest is $40,000. Once again, these are not loans for your average person. Even if you have no other debts, by the time you get done with property taxes and homeowner's insurance, you're looking at $24,000 monthly income to qualify. Still, it's nearly two months income for a pre-payment penalty!



Just in case my readers include a significant number of the richest hundredth of a percent of the world population, there are usually break-points at 1.5 million, 2 million, and 3 million as well, and that's if the lender goes that high. The biggest residential loan I've ever done doesn't get into these categories. In practice, the rule seems to be the bigger the house, the bigger the down payment they have, not only in absolute terms but also in terms of percentage. If I got a request for a loan that big, I'd just go ask the wholesale executives if they can do it, and what it's going to take. I have a suspicion that most loans of this size end up being commercial loans in all but name, or perhaps even in name.



Nor is it just the guidelines that get tougher. Underwriting gets trickier the higher up on the scale you go. Loans with characteristics that would be a slam dunk if they were conforming become nightmares above the million dollar line. What's going on, of course, is that the underwriter is more reluctant to sign their name to a loan commitment that exposes the lender to five times as much loss. People get fired when those go sour, and they don't give out a whole lot of second chances for high dollar loan amounts going south. So when they write that commitment, that underwriter is going to make very certain all of their bases are covered.



Pretty much every loan program in existence has a maximum dollar value, above which the lender offering it has decreed that it does not exist. Sub-prime breakpoints are different from A paper - half a million and two million are the most common breakpoints there - but I've never found a loan program from any lender that didn't have a maximum dollar value they'd lend under that program. Even hard money lenders have maximum dollar amounts they'll lend, price and policy and underwriting breakpoints. The average person really has no need to be aware of these breakpoints, but if you do start hitting them, you'll figure it out in a hurry. Things that are easy on conforming loan amounts sometimes cannot be done at all once you're no longer in conforming loan territory.



Caveat Emptor

Hi Dan,

I was reading your article on "should you pay off your mortgage faster?" (DM: link here DELETED It'll be a fresh 30 year loan and I'm 44 years old so this discussion has interest, I don't really want to be making a mortgage payment at 74 ;).

I must be really dense but A: I don't get it and B: the table looks like it has an error in it to me.

Start with B: first - the investment column can't possible be correct. The assumption is you save or pre-pay $100 per month and invest at 8%. The amount for year 1 is $1,353.29, if you saved $100 per month at the end of a year you'd have $1,200 in principal + $100 * 12 months @ 8% + $200 * 11 months @ 8% + $300 * 10 months @ 8% etc. Even if you socked away the whole $1,200 on day 1 you'd only have $1,296 and have to pay taxes on $96.

What I don't get is this - by prepaying $100 on my mortgage I get a guaranteed return of 6% or 6.5%, whatever the mortgage rate is. I do not ever have to pay interest on that piece of principal again, it keeps on giving. Yes my payment stays the same but the amount going to principal increases by the amount of interest I am not paying due to the previous principal payment.

Now, the valid comparison to that is a risk free investment alternative no? I've got savings accounts currently yielding 4.5%, 5.3% and 5.4% APY, you might find 6% - might and it probably is an intro rate. Let's be generous and assume I can get the same rate of return on the savings as I pay on the mortgage and put that at 6%. If I pay $1,200 extra in principal on day 1 of the year I don't pay $72 in interest and can't deduct it. If instead I put $1,200 in a savings account on day 1 I earn that $72 in interest. It is a wash, The tax issue is a red herring since not paying the principal gives me a $72 interest deduction but the equal investment return is added to income so (72) + 72 = 0 Could it work out if you put the investment dollars at risk? Sure, but that is a gamble and an apples to oranges comparison.

I have different mental pots of money.

Pot 1 is investment dollars for retirement, 10% or so of income goes to a tax deferred account invested at various risk levels and doesn't get touched - ever. Until I retire at least!

Pot #2 home equity + the carrying cost on the mortgage which is the 25% or so of income that pays the PITI on the house.

Pot #3 is liquid reserves, currently about a years worth of #2's income requirements.

My goal is absolutely to eliminate the P&I part of PITI over time. With enough in pot #3 I'll be plowing as much as possible into principle reduction over the next few years once we get moved in and clear the costs associated with a new house such as drapes and furniture. I make a pretty decent salary but who knows how long that will last? As long as the job is secure I'll keep the current mortgage and pre-pay as much as possible. If a few years down the road I felt a little vulnerable to layoff or whatever I'd seriously consider refinancing the then smaller principle balance for a smaller required monthly nut and keep making the higher payments as long as the income stayed intact. Alternatively I may need to do that in 10 years anyway when my kid goes to College. What we are currently paying in private tuition from current income + available cash flow might be a bit short, or we may be ok - depends on where he goes. I'm a College administrator so if he goes here he gets a 100% tuition waiver, 50% at other state schools. And I did look at saving for College in one of the tax deferred accounts, we don't qualify for all the juicy ones based on family AGI. We could do a 529 but I've made the personal choice that we're better off driving the retirement savings and paying off the mortgage rather than killing ourselves to give the kid a free ride .

I like a guaranteed 6.5% return. With any luck the house will get worth more over time as well making the return even better. I played leverage to the max in 1999 when I bought a townhouse for 78K by assuming a mortgage, I just sold it 2 months ago and cleared $112K cash in my pocket, principle balance was 64K so 14K of the 112K was return of my principle payments. That was great but now we're in a little better position financially and I'd like to preserve it over time. I've owed huge piles of money to CC companies and auto loans in the past - don't ever want to go there again!

One other thought. Despite the current turmoil in the market houses do tend to be worth more over time. Probably not as good as the stock market if the time horizon is long enough but they do go up. In my case 60% of the asset value is borrowed so there is a leverage factor on the return. Here is the thought - under current tax rules that return is tax free where as the stock market return is not. It's all about risk tolerance I guess.

Upon examination, I think you're probably right, although I have assumed "a start of the month/year" program where the question was academic until you actually had some money to put to one place or the other; i.e. an initial $100 today and $100 every month, so a year from today you've got $1300 without interest. Kind of like the old problem where if you've got an eighty one foot wall and beams every nine feet, you need ten beams to have a real structure. One to start (at the zero point), and then another one every nine feet.

The pots of money idea is a good one, but most people shouldn't be limited themselves to theoretically risk free investments, especially once you've got your reserves. 1) They're not risk free 2) The big certainty if you don't take any risk is that you will make less than someone who did. Kind of like being chased by headhunters, and having a choice to sit there and be killed an eaten immediately or jump off a cliff into a river with crocodiles. Sure, the crocodiles might get you, or you might hit the rocks when you land and you might even drown. But if you do nothing, you're going in the stew-pot for certain.

Question: How do you think the bank or insurance company can afford to pay a return on the money? It doesn't come out of some hyperspatial vortex! They take this money and invest it in basically the same places you would. The difference is: They take the risk, they get the reward. This reward is plenty to pay their employee salaries, all the expenses of operating, plus your little pittance, and have plenty left over for the stockholders. If their results are adverse, what's going to happen to your money?

Question: If you never refinance, how hard do you think it's going to be to make a $1500 payment in thirty years? Assuming a 3.5% rate of inflation, about like paying $530 per month now. Shouldn't be difficult at all. If you do refinance, you are making a conscious choice that the other loan is, in total, a better deal for you. Sure you might not have a lot of income. My point is that with time and diversification, the assets you would accumulate from alternative investments will be more able to pay your loan out of interest than any money you saved.

Question: If you can't make the low payment, what will your equity situation be like? Once again, this is assuming you never refinance, but 29 years out, you'll owe roughly $15,000, and the property, assuming average 5% appreciation, while the property will be worth about 4.3 times as much. Even if you never paid a penny of principal down, that's well over a million in equity. This gives you options such as selling (take the money and run), a RAM (take the money and stay), etcetera. Stop thinking of money as something that pays the rent and other expenses, and start thinking in terms of what it can do.

Furthermore, it's not a risk free 6.5%. For most people, it's more like an effective margin of 4.7% or less. I'm not advising anyone to go out and strip equity without a very strong reason to do so so and a clear eye on potential consequences, but which after tax return sounds better to you: 4.7% or 7.2%? I agree with the NASD rule that prohibits member firms from accepting borrowed money for investments, but I have admit that it does work, at least for the numbers in theory. The 7.2% assumes investment income is all ordinary income, fully taxed every year. In point of fact, at least some is likely to be capital gains and some is likely to be deferred. The downside is that any investment return is purely speculative and you could lose your principal. You don't ever gamble with money you can't afford to lose, no matter what the long term odds. Nor do you put it all on the same bet, no matter how you split it up. On the other hand, the biggest risk is not taking any. Instead of paying off your mortgage, diversifying your money amongst a sufficient number of stock and bond investments is so likely to leave you with so much more in total net assets over the next twenty years that the expected exceptions are a statistical non-event.

Caveat Emptor

Article UPDATED here

I am continually confirming that a large percentage of people can't handle negotiations like an adult. They focus in on garbage and ignore what's really important.



I recently was going to deliver a loan that cost less, as well as being 3/8ths of a percent lower interest rate on exactly the same terms as the competition quoted. Furthermore, my quote was guaranteed where the competition's was not. However, because my company's compensation was disclosed while the competition's was not, they chose the other loan.



Real Estate loans are not something that the minimum wage fast food worker can toss off in a few seconds like filling a soda cup. If we get all of the paperwork just right with no hitches and everything works on the first pass and it doesn't take too long to price it, such a loan can be done in five to ten working hours. But doing so requires not just the right situation, but a lot of skill and a not inconsiderable amount of knowledge of the loan market.



Nobody does loans for free. Typical loan production, even at a busy brokerage, is three to six loans per loan officer per month. That's got to pay rent and utilities and the salaries of everyone from the receptionist to the CEO. Yes, I've done more, but if you investigate you're going to discover that for most loan officers, most of their time is spend prospecting and selling. That's part of the reason why most places have processors and transaction coordinators - to relieve sales folk of tasks that they don't have to do so they can go out and sell more with the time they save. I can point to lenders and brokerages where basically the only work that loan officers actually do is talk to prospects and clients. They don't price, they don't do the application, they don't process, they don't deal with underwriters or escrow or title, they don't attend signing - all they do is talk to the public. The reason for this is so they can talk to more prospects. The time of good sales folk is important, but some of these loan officers have no clue as to whether the loan is ultimately going to be approved. This is one of the reasons why people end up with different loans than they were originally told about. There was a reason why they weren't going to qualify for the loan on which the loan officer gave them a low quote, but the loan officer didn't know, and it's sure as gravity no one else is going to tell you between sign up and delivery, and at delivery, your choices are to sign these documents or don't. If you need that loan at that time, guess what? You are going to sign those loan documents and become part of the statistics.



Last month, I had some people call me through Upfront Mortgage Brokers (UMB). They had heard the UMB way was better, and it is better than most, but it requires you be able to deal with money like an adult. These people wanted a million and a half dollar loan with a low down payment. They had great credit and likely sufficient income, but they wanted an A paper loan with no pre-payment penalty. Now I can get zero down payment A paper loans with no pre-payment penalty no problem up to the conforming limit (currently $417,000), but above that, lenders start making it harder and harder, and there are three break points in most lender's rules between conforming loans and a million and a half. When I'm working under UMB rules, I have to negotiate every penny that my company is going to make up front, and I told these people that my company needed $5400 to make that loan worth our while. This was between three and four tenths of a point grand total, and that included credit and what the processor was going to make. But that sounded like "too much" to these people, who told me that they were going to the bank who "promised never to charge more than two points." When you do the numbers, they were telling me that $5400 was "too much" but $30,000 wasn't - not to mention the fact that I know this lender, and they'd have made another four percent on the secondary market with the loan they gave these people - $60,000. It's to be admitted that the lender I was going to put them with likely would have made about 2.5 percent, or a little under $40,000, selling their loan on the secondary market, but these lowered margins roughly $45,000 total that I and my lender would have made versus $90,000 that the other lender would charge translate directly to less cost, a lower interest rate, or some combination of the two (there is ALWAYS a trade off between rate and cost in mortgages). Indeed, the loan I quoted was better all around to the prospective client - but my compensation was disclosed and theirs wasn't. So this person, a highly paid professional who should have known better, went with the other provider.



So despite the fact that working to UMB guidelines actually lets me quote and deliver loans with slightly better pricing, I have discovered that it's mostly a waste of my time. The client is assuming pricing risk, all I get is a flat, pre-negotiated fee - but they know what that fee is, and it's not what most folks think of as "cheap." Never mind that it's a lot cheaper than the provider they ended up with, people seem to think that the $5400 they know about is somehow worse than the $30,000 they don't.



The smart thing to do, of course, is judge that loan based upon the net terms to you. Type of loan, rate, total cost, and whether there's a prepayment penalty. I can get my commission paid out of yield spread or rolling it into your balance, same as anyone else. You don't have to write me a check just because I'm working for known compensation. In fact, since that known compensation is less, I can get you a lower rate, or pay some or all of the closing costs that you'd end up paying through another provider - sometimes even both. But just because I can't hide my compensation in your new loan amount and rate, or pretend that I wasn't paid somehow, doesn't mean the other loan is better than mine.



Loans aren't free. If you don't understand how someone is getting paid, chances are they are making a lot more money than the loan officer who is willing to go over it. If this seems like too much work to you, judge competing loans by the terms to you: What type of loan is it? What is the rate? How much will it cost, grand total? Is there a prepayment penalty? Will they guarantee their quote, or are they just talking? Ask specific questions, and don't settle for anything other than specific answers. The usual modus operandi is to hide loan costs in your new loan amount after pretending that there aren't any until you go to sign documents. Just because nobody wants to talk about it doesn't mean the answer is "zero." Just because you don't have specific numbers doesn't mean it's going to be better for you - in fact, the opposite is the way to bet.



Caveat Emptor

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