Mortgages: August 2007 Archives

(I do use one piece of non G-rated language below. I hope you'll agree with me that it was necessary to convey the proper sentiment)



USA Today had an oped, "3 ways to help borrowers without bailing them out"



Their suggestions?

Bankruptcy reform. About the only debt a bankruptcy judge can't modify is a home mortgage. Borrowers used to get into trouble not because of unsustainable mortgages, but because they lost a job or got ill. Now homeowners commonly fall behind because they can't keep up with their mortgages. Bankruptcy judges should get more latitude to rework mortgages along with other debt.

That's because it's a secured debt. Indeed, it's a debt secured by a specific asset.



Indeed, mortgages on owner occupied property are already subject to more and stronger protections than any other kind of debt. It takes a minimum of just under 200 days for a foreclosure to happen in California, and we're one of the shorter period states. Notice of Default can't happen until the mortgage is a minimum of 120 days late. Once that happens, it cannot be followed by a Notice of Trustee's Sale in fewer than sixty days, and there must be a minimum of 17 days between Notice of Trustee's Sale and Trustee's Sale. Absolute minimum, 197 days, and it's usually more like 240 to 300, and it is very subject to delaying tactics. There are lawyers out there who will tell you if you're going to lose your home anyway, they can keep you in it for a year and a half to two years without you writing a check for a single dollar to the mortgage company. It's stupid and hurts most of their clients worse in the long run, but it also happens. Pay a lawyer $500, and not pay your $4000 per month mortgage. Some people see only the immediate cash consequences, and think it's a good deal.



While all this is going on, the mortgage company is losing money. That money isn't free to them; at the very least it has opportunity costs - other things they could be doing with the money and earning a profit. But lenders are paying a daily fee for almost every penny in their portfolio. They make money off of the spread between what they pay and what they earn. But if their earnings are zero for this particular debt, they're losing money on this particular debt, and they've got to make it back elsewhere - which means that everyone who doesn't default is paying a premium on their loans for everyone that does. This would cause future mortgage rates to rise, further exacerbating the decline in housing values and putting even more people into trouble. If you don't understand this, you need to go back to high school or read an elementary economics text.



Now allow bankruptcy judges to play with mortgage indebtedness, and there just isn't anything they can do that doesn't result in the lender losing money involuntarily. This is a government taking of private property, explicitly and without possibility of exception for private use. Anybody remember the Fifth Amendment? If it doesn't protect all of us, it doesn't protect any of us. The Kelo decision, which generated a huge flap, at least had a public entity taking title before deeding it over to a private developer. None of these cases would have even that fig leaf. Not to mention that in many cases, the lenders themselves are victims of fraud to one degree or another. In a large fraction of these cases, the borrowers and loan officers were assisted by the lenders employees and policies, but in others they weren't and the lender is just as much a victim as someone who's been mugged - and now we want them to get mugged again by the legal system?



A few more things on this topic: Real estate, being for high dollar amounts, is one of the most profitable targets for scams and confidence games. I can see the general outlines of half a dozen scams that would be enabled by giving bankruptcy judges the ability to modify mortgage indebtedness. I mean legally. Most people wouldn't do it to start with, but the temptation of having your mortgage debt legally reduced, or the payments that go with it, would quickly become very attractive. Get your mortgage debt reduced by $100,000 because that's what you can afford to pay and now you can turn around and sell for a profit. Get your mortgage payment permanently reduced from $4000 to $2500 per month, and either you have a negative amortization loan imposed by judicial fiat, or you have a loan that the lender is stuck with that's only worth about sixty percent of its face value. Especially given the general non-enforceability of "due on sale" clauses, this is not only taking property from the lender, but it's essentially going to require them to hold it for the full term of the note, as nobody in their right mind is going to want to refinance or pay that loan off. Net result: everyone starts working these scams. You think the situation is bad now? If the lenders were subjected to that, rates would go sky high, minimum down payment requirements would skyrocket, and housing values would crash worse than stocks in the period 1929-1932, because nobody would be able to get a loan on any sort of terms even vaguely comparable to what we've got now. We'd have people putting their houses on credit cards, not only because the rate would be comparatively attractive but also because most folks would be able to get a credit limit high enough to finance 100% of a property. Statistical Abstract has there being 123 million pieces of real estate with a median price of $206,000, giving an approximate total value of $25.3 trillion dollars. Under such a scenario, I'd be surprised if prices didn't collapse by 80%, wiping out $20 trillion dollars in wealth directly, or about twice the size of the national debt. Second order effects would increase, if not multiply, the size of the loss. The Great Depression would look like an economic paradise by comparison. All because you want to give people "a little help" and don't think about the consequences.



Lenders will modify notes on their own without compulsion from the courts if you can come up with a scenario where it's in their best interest - by which I mean they'll get more of the money they loaned you back, complete with interest. And if you cannot supply such a scenario, the lenders are correct to foreclose as promptly as possible. That's not just their money. More than half of all Americans have bond investments. It spreads out the risk and the pain, but don't kid yourself that corporations are the only ones hurt. They're not.

Tax code changes. Sometimes, badly strapped homeowners can persuade lenders to reduce the size of a mortgage to reflect a home's plummeting value or the homeowner's inability to keep up with the payments. Sometimes, the lender forecloses and a homeowner can walk away with no house, but also no debt. That would seem to be the end of the story, but it isn't to the IRS, which often considers either action as income to the borrower, and sends a big tax bill. It makes sense to alter the code to keep the tax collector from making a bad situation worse.

I've written on this tax consequence several times in the past. There are good reasons why tax law and tax policy are written that way. What we're trying to do is give people the greatest reasonable incentive not to try scams of this nature. Not to go into debt figuring that if it all doesn't work out, they can just walk away. We're all supposed to be adults. One of the things adults are is responsible for their debts. This is one reason why lenders are willing to loan money - because there are concrete reasons why it is in the borrower's best interest to pay those loans back. Remove that fact, and you've removed the underpinnings of our entire banking system. If you don't understand the economic consequences of that, at least in broad, have the courts declare you legally incompetent and appoint a guardian. You are not competent for any economic matters. You shouldn't be voting. You probably shouldn't be crossing the street without supervision and assistance.



Lenders give great rates on real estate because secured real estate loans are comparatively low risk. Secured real estate loans are low risk because people will do basically anything not to lose their house. Take away the risk of losing their house, and people will do a lot less. It's effectively no longer a secured loan. Combined with the protections mortgages have already, rates will be higher than any credit card. For all the beating of breasts and loud flapping of keyboards that goes on, most people are still handling their loans. Yes, lenders lose lots of money every time a loan goes bad. Ninety-eight percent of all real estate loans are still performing. Let that change, and risk goes up, rates go up, and nobody can get a loan and nobody can make the payments, and nobody will be able to buy, so prices come crashing down in such a way that everything we've seen so far will be as flatulence in a hurricane compared to what will happen.



The number one thing that puts people into home ownership is the ability to get a loan. Rich folks are going to be able to afford property no matter what. Those of us who are somewhat less well off depend upon our ability to use someone else's money. Take away that, and watch ownership rates plummet. As a society, we'll go back to living in rented massive slum tenements, simply because that's what'll get built because the average person simply won't have the economic leverage to afford decent housing, or to incentivize those well enough off to finance housing to build the sort of housing we want. Lionel Barrymore's character in "It's a Wonderful Life" seems like a caricature to us, sixty years later, but it wasn't a caricature at all at the time. The people who made that movie saw stuff like that and its results on a daily basis. Many of them - the ones who never became big stars or powerful producers and directors - lived through it. It only seems like a caricature now because the lending environment has become such that the average person can easily get a loan.

Education and advice. Sometimes, a home could be saved if its owner only knew that it was possible to renegotiate the mortgage -- and that a lender might prefer getting smaller payments to no payments at all. Scores of state organizations and non-profit community groups are working to educate and counsel homeowners, and in many cases to help them renegotiate their mortgages to keep their homes.

And 100 percent of those people could be saved by people doing a very small amount of research before they signed the contract. No sometimes or occasionally about it. But people won't do it. A lot of the people who did these loans to themselves were warned, and chose to not to believe the warnings. Poor disclosure requirements, blind trust in someone who acted like their friend. Lack of elementary common sense. When someone tells you that your payment on an $800,000 loan is $2573 per month (and there are many loans even worse than that out there), all it takes is the mathematical ability of a fourth grader, at most, to realize that even if it's interest only, you're only paying 3.8 percent interest and there just aren't any other loans out there anything like that, and maybe there's something going on that you don't understand. I told hundreds of people first person (never mind the over two million visitors to my websites) about the perils of those loans, and the vast majority of them bought the complete bullshit that someone else fed them because they wanted that house and this was the only way they could "afford" the payments, so they did the loans with other people. If I had just kept my mouth shut and done ten percent of those loans, I'd be richer than if I had won the lottery, instead of scrabbling for the occasional person who wasn't looking to buy a property they couldn't afford.



I'm not saying don't counsel people on how to make the best of a bad situation. But that's happening now, without this prescription, making it a null act, simply posturing for the cameras. One of the great things about the internet is that you can find the information you're looking for if you will keep looking, and cross check its credibility. "I found it on the internet," may be a joke when it comes to serious research, but you can find the correct information if you keep looking and cross check credibility, rather than just believing whatever you may find on the Flat Earth Society website.



I'm saying that the best time to stop this problem was before it started. People will fool themselves. Indeed, one of the most important measures of how free a society is, is the ability of an adult to decide to do something stupid after being fully informed of the consequences. Indeed, that's also a good definition of an adult - someone competent to make their own mistakes.



However, the law and our governments aided and abetted the sharks who took advantage of these people by making them appear to be in compliance with extensive disclosure rules that allow the sharks to hide all of the really important and nasty things behind a smokescreen of unimportant trivia. The people got so bored of details that just aren't important that they signed off on things that killed them financially without reading, presuming it was more of the same nonsense. The stupidity wasn't informed stupidity, because the lenders and agents were able to conceal the real mechanics of what was going on, and what would happen in the future. This gave even the shadiest operations enough of a veneer of legitimacy to pass the casual inspection given by someone who wants to believe it. There was nothing in all of that government mandated paperwork that explained the consequences that would follow, as certain as gravity. If there was anything, it was obscured by all of the nonsense. I can write (and have written) a one page loan disclosure that would guarantee nobody would ever sign off on one of these things without being informed, in big bold type, about the consequences. Such a disclosure is found nowhere in the requirements of any state, and even if it was, government requirements would allow it to be hidden in hundreds of pages of stuff like equal opportunity housing and equal opportunity loan disclosures, things that everyone knows about, and it's often in the lender's interest to comply with anyway (I can't imagine anybody in this day and age being stupid enough to practice loan or housing discrimination, and even if they were that stupid, I can't imagine them getting away with more than a very few instances before the law put them out of business). How about re-writing the disclosure rules so the deadly traps are as obvious as possible, and the sharks can't hide deadly financial traps behind the insignificant minutiae?



This article got a lot longer than I wanted it to be. The point that I am trying to make is that it's very easy to make the damage orders of magnitude worse by trying to be compassionate after the fact, thinking that you're "only" damaging "major corporations who can afford it", when the fact of the matter is that these measures would bring our entire mortgage and real estate system to a screeching halt. The correct tack to take for the future is to make it impossible for people to fool themselves before they get into trouble. As for the present, yes, people are going to get hurt. But the system will work its way through the problems. I am opposed to any mass bail-out of lenders or those who voluntarily signed upon the dotted line. Especially if it's taxpayer financed. Indeed, I want to see the lenders and brokers who did this stuff sued and bankrupted by the investors and borrowers they suckered, and the money managers who should have known better sued and bankrupted by the people whose money they mismanaged. Such results discourage and prevent repeat performances of the sorts of things we have just lived through far more effectively than any mitigation proposal I've heard, with far less long term damage. Bail-outs allow the offenders to escape the full consequences of what they did, much like during the savings and loan crisis, which in many ways, set the stage for what's happening now. The best thing we can do, the best proposal I have heard, is to allow the consequences to happen. Otherwise, we'll be going through the same sorry mess, even worse, in a few years. As hard as it may be to stand by and watch people get hurt, I have yet to hear any better proposal that will help them without making the problem an order of magnitude worse.



Caveat Emptor



UPDATE: Welcome Daily Pundit readers and thank you Bill.

Article UPDATED here

No, this isn't the Hitchhiker's Guide to the Galaxy



But having written half a dozen articles roundly critical of the way in which these loans are generally sold, it's not unusual for me to get e-mail like this one:

Hi, Dan:



Okay, I'm absolutely PANICKED after reading your article on negative amortization loans as I have one! I thought it was an "option ARM" and that my entrusted Realtor's entrusted loan officer was wise beyond his years in his financial advice. He was semi-retired, wealthy, and said that this was the only loan he'd ever use for his own substantial real estate portfolio. I even reassured a good friend of mine who is economically savvy not to worry as it wasn't a negative amortization loan!



I purchased December of 2006. The home I was going to purchase was appraised at $780,000 eight months prior to my purchasing it for $570,000; I put $100,000 down, had a good credit score, but the stickler was my monthly income. I knew I would make a substantial bonus and raise June of 2007, so DELETED sold me on the Option ARM. The bonus was one third what I expected ($2700) and my raise was only 4% rather than 7%.



My question is this - what do I do now? Is the loan okay as long as I pay the principal and interest amount of payment? I've only been paying the minimum, but could swing it by squeezing. It's a high rate - 7.5%. And I would have a prepayment penalty if I refinanced. I'm a single mom, 46, with two kids and annual earnings of $64,000. I have $50k in savings.



Yes, I am that poor sap you speak of in your article, completely trusting, desperate for my dream house, blind sided and now stuck. Any advice would be helpful! Thanks so much...

First rule of getting out of holes: Stop digging! Pay at least the interest every month!



Now, let's look at your situation. You owe $470,000 on a $570,000 property. The real payment on that is $3286.30 per month, as opposed to a "nominal payment" of $1511.70 at 1%. Actually, by my calculations, you owe about $483,000 now and will over $527,000 by the time your pre-payment penalty expires, if you make just the minimum payment.



Now, let's consider what's actually available out there. Picking up one rate sheet at random, it shows a 30 year fixed rate loan at 6.375% costing half a point retail. Let's figure out if you're likely to qualify for that. $64,000 divided by 12 is $5333 per month. 45% of that is $2400. Both of those are potentially important figures. Let's assume your value is still $570k, so 80% of that is $456,000. Paying the penalty and costs of the loan via rolling it into your balance, I get that you'd be left with a balance of between about $507,000. The payment on the first mortgage would be $2845, which is more than you can apparently afford right there. On the other hand, many single parents have alimony and or child support that can be used if they so desire that they don't include in their income.



On the other hand, I'm not building fairy castles in the air. From the information presented, you can not afford the loan by standard measurements. The flip side of that is you don't have to qualify for the loan you already have, and you say that you actually can afford to keep making at least the interest only payments. As long as you do so, you're not digging yourself in any deeper. If you can actually afford to make at least the interest only payment, there is no reason to panic.



Furthermore, getting yourself that 6.375% fixed rate loan would cost you roughly $24,000 - $18000 plus in pre-payment penalties, about $6000 in loan costs. To save 1.125 percent, albeit fixing the loan. Your current cost of interest at the $483,000 balance is $36,225 per year. Cost of interest after refinancing: $32,321 per year. Interest savings $3904 per year. Your break even on this is about 6 years, 2 months - if you could qualify, which you don't appear to.



If you make the payments for the next 27 months until the penalty expires, that higher interest rate will have cost you roughly $8900, offset to a certain amount by loweerd income taxes. But here's where everyone's getting ulcers right now: That 6.375 is a "right now today" good only until tomorrow morning at most. Not that I expect tomorrow's rates to be much different, but I won't know until I see them. The cold hard fact is that only some kind of deity might know at this point what the rates are going to be like in December 2009. I certainly don't, and neither does any other human agency with which I'm familiar. There's a lot of estimates out there, but nobody knows. Furthermore, with a negative amortization loan, you don't know what your rate will be a year from now, as most of these abominations adjust month to month. So no matter which way you choose, stay or refinance, there are pitfalls, and there's no way to tell the right decision except in retrospect - in December 2009.



In your situation, I'd probably sit tight. As bad as it is, the alternatives all look worse. I wouldn't refinance into a loan that took me six years to break even on the costs of, and I doubt whether anyone else should, either. Alternatively, keeping in mind the fourth solution to Getting Out of Paying Pre-Payment Penalties, some people might want to see if their current lender will refinance them into a thirty year fixed, although in your case that does not apparently help because you don't appear to qualify.



But your situation is not the same as the person who is only looking at a negative amortization loan. Like it or not, you've already done it. That narrows your choices to "What do I do from here?"



The first thing to set in motion is a consultation with your lawyer. I'm not a lawyer, but I've been reading about the courts ordering these abominations rescinded, brokers paying damages, etcetera. The wheels of justice grind slowly, but that means the sooner you start them grinding, the sooner they get there. It seems likely to me that there were some misrepresentations and gross negligence somewhere along the line there.



I think that the local market is likely to turn away from buyers and towards sellers very soon. So that colors my perceptions, and what may be appropriate for San Diego may not be appropriate elsewhere, but as long as you can make at least the interest only payment, and make it long enough such that your prepayment penalty expires, I think you're likely to see a profit on the sale of the property then, provided things go as I think they will. It might be rough in the mean time, and preliminary numbers indicate that you're not likely to be able to afford to keep the property then, but panicking rarely does any good. There's nothing you can do at this point that does not have significant and costly risks. But from what you've sketched out, holding on until the penalty expires seems to be the least risky, most attractive alternative to me.



Caveat Emptor

Article UPDATED here

While the subprime meltdown continues, A paper rates have actually dropped a little bit in recent weeks.



Subprime is in a world of hurt. Lenders are fleeing the market for below average credit in droves. It seems like every day, we lose the capability to do something or other, and the rates have gotten high as well. I just priced a 580 credit score on an 85% loan. Rate/term, no cash out. Six months ago, I could have found something around 7% par. Today's best rate? 10.7% at par.



The last several years, with real estate values rapidly appreciating, it was hard for lenders to lose money. Even if the property did go into foreclosure, it would have appreciated in the meantime, and the lender would get their money. That's no longer the case. Properties aren't appreciating, and as a result, subprime lenders are now having to price loans for the borrowers to bear the full risk of their low credit score.



I've been saying for some time that if you don't have good credit, the rates are going to have to rise. That prediction has now come true. As of when I'm writing this, I could do that same loan A paper at 6.25 at par. Cost of having a below average credit score? 4.45 percent! If your loan balance was $400,000, that equates to $17,800 per year in increased cost of interest!



Alternatively, that below average credit score means that instead of a $400,000 loan someone with good credit and a monthly income of about $7000 can afford, you can only afford a $265,000 loan. Instead of a 3 bedroom house with a decent size lot, you're in a two bedroom condo, at best! If you could have paid the bills but chose not to, you have only yourself to blame. It's hard for me to imagine anything but a house or a business that's worth spending that kind of money, and credit scores can be improved if you're willing to try.



Furthermore, it's getting harder to find subprime lenders willing to loan at high Loan to Value ratio (or CLTV). This means that you have to have a bigger down payment than someone with a better credit score. I can still do 100% loans, usually split 80/20, pretty darned easy if you qualify for A paper. It's getting to the point where it's a waste of breath to ask subprime lenders for 100% financing. This means that you can either have a substantial down payment, or you can improve your credit, or you can remain a renter. Given the economic advantages of home ownership, you don't want to remain a renter. Of the remaining two options, it's usually quicker and easier to improve your credit than it is to save 10% of the price of a $400,000 property. How quickly could you save $40,000 if you had to?



Stated Income, especially for low credit scores and high Loan to Value Ratios, is rapidly going the way of the dodo. 100 percent stated income is essentially gone. The lenders want you to have some serious equity, so that if the property gets foreclosed upon, they're likely to get their money back. The lower your credit score, the more of a down payment you're going to need. negative amortization loans are finally hitting this wall, as well. Not only do those lenders living on those abominations want a higher rate, they also want you to have enough equity so that they're going to get every penny when they foreclose. As a result, fewer people are willing to sign up for them, and fewer still qualify, a development I am all in favor of.



Lenders, specifically sub-prime lenders, have in the past few months suddenly re-awakened to the possibility that they're going to lose money in the real estate market. Those who have been advising people that they're not risking anything with 100% purchase money loans because "purchase money loans are non-recourse" are soon going to be the subject of court and regulatory action, not to mention that the lenders are no longer willing to cater to that line of thinking - at least not for those who have demonstrated that their credit rating isn't important to them.



It is not difficult to qualify A paper. I have in the past done A paper loans with 100% financing at a 630 credit score. More people qualify A paper than think they do - and if you'll work at it, getting yourself a thoroughly acceptable credit score of 680 or better usually doesn't take very long. Now, more than in the last few years anyway, being able to show that you make a habit of paying your bills on time is worth some serious money. It also means you can get the loan now, instead of several months in the future at best. And, as tomorrow's article will attest, you really want to buy now if you can.



Caveat Emptor

Veterans Administration, or VA loans, are government guaranteed loans available to veterans and active duty members of the armed services, that enable them to purchase homes for no money down. In fact, VA loans go up to 103 percent of purchase price to allow for some closing costs as well.



VA loans are a unique creature in the world of mortgages. Because there is a government guarantee on the loan, they are available, usually at the same rate/cost tradeoff, whether your credit is perfect or abysmal. They have a qualification limit equal to the conforming loan limit from Fannie Mae and Freddie Mac, $417,000 as of this writing.



Now, the Veterans Administration runs a website where you can get all kinds of information on VA loans, but I'm going to touch some high points.



VA loans are available both for purchase and for refinance. There is a streamlined program for pure interest rate reductions that can sometimes be at documents in as little as a week. This is called the Interest Rate Reduction Refinance Loan program, or IRRRL, but usually just called a VA streamline. There is, or so I understand, a cash out program as well, but I've never done one of those.



All VA loans have two important feature: Government Guarantee and Assumability. The government will guarantee a certain percentage (usually 25% of the original loan amount), which is more than enough to persuade most lenders that these are loans worthy of a fairly low rate, as they are low risk. A person with a VA loan can allow anyone else to assume it, with the approval of the lender and the VA. They have to prove they qualify for the loan, and the veteran still has responsibility for the loan, and it does count against the total of all VA loans that individual is allowed. Last I checked, prepayment penalties on VA loans were prohibited.



Now the bad news. Even with the government guarantee, the rate/cost trade-off isn't the best. Most VA lenders want at least two discount points for their VA loans, a fact which makes low cost and zero cost VA loans problematical. Even with those discount points, the rate will probably not be as good as A paper. Veterans with good credit, particularly if they have a good amount of equity or a decent sized down payment, will generally be able to obtain a better rate at a lower cost in the A paper marketplace. Even so called A paper "jumbo" loans over the $417,000 limit, or A paper "stated income" loans, will usually have a significantly lower rate/cost trade-off than the VA loan. They're better than just about all sub-prime loans, but they lose out to A paper.



If you have good credit but not much of a down payment, the VA loan can be an option worth exploring. VA loans have no mortgage insurance requirement (aka PMI), that purpose being served by the government guarantee, and so splitting your loan into a first and a second mortgage in order to avoid mortgage insurance, with the second being at a higher rate, is generally not necessary, and your full loan amount can be at the lower rate of the first mortgage. But be careful, because once again, most VA lenders want their two discount points, and maybe more. You might want to read my article on the Trade-off between Rate and Cost in Real Estate Loans and Why You Should Ignore APR for more as to why. Nevertheless, this could go either way and is well worth shopping the loan both ways.



If you have rotten credit, a VA loan can be the only way you can purchase a home, particularly if you have no down payment. Since credit is irrelevant and there's a government guarantee, I used to know a couple lenders that didn't bother to run credit for VA loans. Even the ones that do, it's just a checked box that plays no part in the decision making and underwriting process. Furthermore, you get a rate of a sort that would normally be available only to someone with a much higher credit score than yours.



Now in addition to relatively high closing costs, there are some other games that get played with Veterans Administration loans, of which the Rate Buydown is probably the most pernicious and widespread. But if you're one of those veterans who thought they could never be approved for a loan on a home, VA loans can make it happen where nothing else could.

UPDATE 2/14/2008: With 100% financing programs difficult to come by right now, the fact that second trust deeds don't want to lend over 90% of the value of a property currently, and PMI rates skyrocketing, VA loans have become the absolute best route for 100% financing as of this update. I did the math, and the fact that VA loans are the only 100% financing available right now without PMI or lender paid mortgage insurance saves someone making San Diego Area Median Income over $600 per month, which works out to qualifying for the loan with over $1400 per month less income - $17,000 per year.

I have written a new article, most recently updated here, about the VA loan's status in the new lending and buying market

Caveat Emptor

Original here