Mortgages: March 2008 Archives

People sometimes ask, "Why should the lender care where I got the money for the down payment? I earned it, it's mine - cash is cash!"

They're right as far as they go. In general, the lender doesn't care whether you got your cash. It could have been by selling off your first-born child, moonlighting as a drug dealer, or embezzling the funds from your employer. It's not usually a good idea to get a real estate loan if you're facing criminal charges (and you must disclose it if you are), but if you aren't facing charges, the lenders don't really care.

What they do care about is money appearing for no known reason just prior to purchasing real estate. Quite often that money is an undisclosed loan, on which you are going to have to make payments, which are going to influence the debt to income ratio under which you qualified for the loan you want them to issue you. Debt to income ratio is the most critical measure of loan qualification. If you're going to be making payments of $400 to pay back the person who loaned you that money, the lender is required to consider whether the money you are making is going to enable you to pay back that loan as well as their own.

So the lender is going to want to know where any sudden influx of money in the last few months came from. This is called "sourcing" the money. They want to know where it came from. Did you sell another property? Then they want evidence, in the form of a HUD 1 that shows that money. Did you get a bonus? Let's see the remittance advisory. Did you sell stock? Did you sell your collection of rare Roman gold coins? Each of these has paperwork to attest to the fact, and the lender will want to see it.

If some friend or family member wants to make an actual gift, that's fine also. What the lender will require is a letter from that person stating that this money is a gift and comes with no strings attached. What they're looking for is an explanation that doesn't involve the money being obtained through a loan.

If you've had the money for a while, or have been building it up over time, your account statements will demonstrate that fact. Six months ago, you had $100,000. Since then, you've saved another $3000, earned another $5000, and your balance is now $108,000. This is called "seasoning" the funds. Nobody wants to have a loan sitting around longer than necessary - particularly not a loan for a significant amount of money. Seasoning the funds reassures the lender that this is not an undisclosed loan.

Suppose the money in your checking account that suddenly appeared two weeks ago is a loan? That isn't necessarily insurmountable. Let's get the loan paperwork out there where the lender can see it, examine the repayment schedule, figure out what it does to your ability to make the payments on this new real estate loan you want. If you qualify by debt to income ratio with these payments included, it's pretty likely your loan will be approved. There are exceptions, but I'm going to let those go uncovered, because I'm not real big on telling the general public how to get fraudulent loans accepted. There might be politicians reading this, and letting them know all the answers to that would be irresponsible of me.

The main reason why we have to source and season cash in every transaction is quite simply so people aren't able to hide the fact that they've recently gotten a loan. It seems paranoid at first, but it isn't paranoia if people are out to get you, and lenders have gotten burned many thousands of times over this point. People quite often don't even think it's wrong to keep silent, even though it is fraud. So if they don't require sourcing and seasoning of funds, the lender grants the loan based upon known information, only to later discover that the borrower is unable to make payments due to also needing to make payments on an undisclosed personal loan.

Caveat Emptor

Article UPDATED here

Mortgage Accelerators, or Money Merge Accounts, have become the thing that everyone's pushing of late. I have gotten so much junk mail about this from more originators (who don't know who I am) and wholesalers (who should) in the last few days that I'm going to have another whole go at the entire concept. The claim most often advanced is "pay off your mortgage in a fraction of the time!" In fact, typical numbers say they're only going to do a fraction of the good done by biweekly payment programs, which effectively make one extra payment per year. Money merge accounts or Mortgage Accelerators (to use the term I originally learned years ago) have been pushed and over-promised so badly of late that I hope whoever manages to do an elementary search will be able to find a voice of sanity.

These wasteful loans that waste a homeowner's money are fast becoming the current market's negative amortization loan as far as marketing goes. These things are being pushed hard, consumers are being led to expect far greater results from them than they are likely to achieve, with the results being that those consumers who sign up for them are wasting their money. If they're not as bad as negative amortization loans, that's still damning with faint praise if ever there was such a thing. Not as bad as the loan that encouraged people to buy a more expensive property than they could afford, put them more deeply into debt with every passing month, ruined their credit ratings, and caused them to lose the property they over-extended to buy, as well as setting the United States as a whole up for the worst financial crisis we've experienced in the past eighty years. Well, it is kind of a high bar for lenders to get over, and they haven't done it here - but that's not due to concern for consumers.

What goes on with these accounts is complex, and they're not all identical. The basic idea is the same, however. You create a special account of some nature, where you deposit your entire paycheck in the mortgage account, where it lessens the amount of interest you pay on a day-to-day basis. Then you pay your other expenses of living out of the account, gradually increasing the amount back up until the next time you get paid. The idea is that by paying down the balance with your entire paycheck, less interest accumulates and people making the same regular payments will pay their balances down faster with the same balance.

Sounds like a cute idea, right? If it was free, they would be a pure gain for the consumer. Unfortunately, they're not free, and I've never yet seen one that wasn't more costly than it could possibly be worth.

Lenders like these things for a lot of reasons. Most obviously, they're getting pretty much all of a consumer's banking business. Checks come in, go out, clear or don't; all those lovely fees. In the vast majority of all cases, there's the initial cost and interest expense of an associated home equity line of credit. This also raises the bar to make it more difficult for a consumer to refinance away from their loan if someone offers them a better deal. Furthermore, there's usually an explicit charge of about $3500 to set the thing up. I'll show where this money would be better spent on a direct paydown of the mortgage.

Also, the people who sell these things have these beautifully intricate presentations. While people are watching the money whizzing about between one account and another, they're usually not considering whether those figures are reasonable, typical, or even anything like the numbers they personally experience.

Most importantly if consumers are shopping for a new loan, their attention is distracted from the most important part of shopping for a loan - getting the best possible tradeoff between rate and cost, focusing instead on this fascinatingly complex toy that doesn't make nearly the difference most of the people pushing it say it will. Taking the attention of consumers off the question of what rate they are getting, on what type of loan, at what cost, means that they don't have to compete nearly so hard to give you the most competitive rate-cost tradeoff. In plain English, their loans can charge a higher rate of interest. In fact, this difference will cost the typical borrower far more than they could ever hope to save via a money merge account. I'll go over that in this article, as well.

So, first off, let's consider what typical numbers are. Here in San Diego, the median property sale is $558,000. In order to qualify for the loan, consumers need a back end Debt to Income ratio of 45%. Front end will most typically be around 36%, with property tax, insurance, vehicle payments, credit cards, student loans etcetera. I'll be really nice and say 32% - chances are that if it's lower than that, the people would have bought a more expensive property. I'm going to assume 20% down payment or equity, which is, if anything, larger than typical. We'll postulate a rate of 6%, which is probably a hair higher than most folks with conforming loans have - and more favorable to the money merge account - and I'm going to put it all into one loan even though that's theoretically a jumbo loan amount, just to give the money merge/mortgage accelerator every possible benefit of the doubt. After all the smart thing to do is split the loan amount, which leaves roughly $30,000 out of this account in a higher interest rate loan, and so the scenario envisioned is more beneficial to the Money Merge than what happens in the real world.

This gives a loan of $446,400. At 6 percent, the payment would be $2676.40. Assuming 32% front end ratio, that's a gross monthly pay of $8365. I don't have withholding tables, so I'll use the actual tax rate for couples making slightly more than $100,000 per year with about $55,000 taxable, which is $7400, plus about $8700 in Social security taxes, plus state taxes which I will assume to be roughly $2000. This money gets withheld - it never comes to you in the form of a check. Since you don't get it, when your check goes into the money merge, it doesn't help you pay the interest. This leaves $81,900, or $6825 in take home pay. I'm not going to worry about other deductions like health care, or how your pay is structured, which further erode the benefit. I'm just going to assume it hits your account in full on the first day of the month, maximizing benefit, although I'm still going to assume all of the excess goes out every month. If nothing else, for investment accounts. It's pretty silly to have your money paying off a 6% tax deductible debt when you can have it earning about 10% elsewhere! But this isolates the benefit gained from the actual Money Merge, and separates it from any benefit derived from making extra payments, which is another way the people selling these play "hide the salami" with consumers, distracting them from what's really causing the benefit - the extra payment, which almost anyone can do, anytime they choose, for free. I'm even going to assume that you don't have an impound account, so the money you eventually spend for property taxes and homeowner's insurance goes to help the money merge as well.

So you get $6825, less the payment of $2676.40, leaves $4148.60. Over the course of the month, money goes out to pay for all of your expenses. They people who sell money merge accounts urge you to leave paying your monthly bills as late as possible to get the maximum benefit from these accounts, completely ignoring the costs of the occasional late payment this is going to cause, as well as detrimental effects upon your credit when it does happen. In fact, a certain amount of these bills are going to wrap into the next month, meaning that under the conditions we've agreed upon, you write that check to your investment account for this month and pay that bill out of your next month's pay if you're smart. Since you're going to write that particular check ASAP if you're smart, that's going to diminish the effects of the $4148.60. But I'm going to be nice and give you a $1000 "cushion" that you carry into the account from month to month (again, you won't do this if you're smart), while the $4148.60 is going to be paid out evenly over the course of the month, giving you a mean daily amount of $2074.30, plus $1000, or $3074.30 per month of temporary principal reduction. This reduces your interest paid by $10.37 that first month! I'm going to assume this is pure gain, every month, and that it continues to compound. If you do this every month for thirty years, you'll actually pay off that loan a grand total of three months early, and the last payment is reduced to a shade over $400! All of this hooting and hollering and shouting and frustration over three months of paying your mortgage off - in an absolutely optimized, perfectly favorable environment where the Money Merge account didn't cost you a penny in set up fees or monthly cost. And even in this ideal situation, with the maximum reasonable advantage compounding over the course of the entire mortgage, out of $963,000 in payments, the money merge saves you about $10,000 at the very end - just over 1% of total payments, heavily discounted for time value of money thirty years from now. That's not the "pay your mortgage off in twelve years for the same payment!" come on used by the most popular of these! Were I the regulatory authorities, I'd be looking very hard at their advertising!

But most people don't pay their mortgage off in this fashion, and these accounts are not free - or at least I've never heard of one that was. Most people refinance or sell within three years. When they do that, the accounts have to be set up again - which requires new set-up fees. In the example given above, that $10.37 per month compounding for three years is worth $407.92 - and that's if there are no countervailing expenses.

In point of fact, most of these accounts charge a monthly fee that ranges from roughly $1 to whatever they think they can get away with. Plus, there's an upfront cost that ranges from $1995, the cheapest I've seen, up to nearly $6000 depending upon the plan, with most seeming to fall in about the $3500 range. Plus, most of them require you to use a special Home Equity Line Of Credit (HELOC), which costs money in and of itself. The rates on HELOCs are higher than for regular mortgages, forcing you to effectively pay a penalty in interest of having $2000 or $5000 or whatever it is at a higher rate of interest, by usually about 2%. Keep in mind that this is ongoing, and for the entire month. The $2.30 to $8.30 per month this costs directly soaks off a large percentage of the $10.37 putative gain you get. Not to mention whatever the initial costs of the HELOC are. Some are cheap - I've seen others that had thousands of dollars in upfront costs. The HELOC costs, both upfront and monthly, are not relevant to the few plans that don't require HELOCs, but most do.

So with a middle of the line account, you've spend $3500 just to set the money merge (or mortgage accelerator) up, versus $407.92 in benefits over three years, which is longer than most people keep a given loan. Would I do that? Not on your life or mine! Why should I expect one of my clients to do so?

Now, let's consider some alternatives. Remember I told you the money merge account saves you $10.37 per month in optimal conditions, which works out to just about $10,000 saved at the end of thirty years? Well, let's ask ourselves, "What would be my benefit if I just took the $2000 the cheapest one of these costs me and instead used it for direct principal reduction?" In other words, what if you added that $2000 to your regular mortgage payment once? The answer is, for the example above, that you pay off your mortgage four and a half months early, as opposed to about 3.8, saving an additional $1800! Using the upfront costs for the cheapest of these that I'm aware of pays the mortgage off sooner than the accelerator account! After the three years that's all most people keep their mortgage, you're still $1985 and change ahead of the poor stupid schmoe who signed up for the accelerator account! For a middle of the line $3500 set up fee, the difference, mutatis mutandis, is $3780 and growing at the end of three years, to the point where that mortgage is paid off 6.7 months early, as opposed to the mortgage accelerator's 3.8, saving thousands of dollars more than the "accelerator"! This doesn't count the monthly costs, HELOC set up fees, or additional HELOC interest charges that the vast majority of these accounts require, and which do siphon off the benefits as noted above.

Keep in mind that with all of this, I've been building a "best reasonable case" to maximize the money merge's advantages. I've mentioned several assumptions that I was making in the account's favor. If any of them changes, the putative benefits basically vanish entirely, or even go decidedly negative.

Now, let's ask ourselves if getting distracted by a mortgage accelerator caused us to not shop as aggressively, or not pay as much attention to the tradeoff between rate and cost as I should have, and as a result, I end up with a mortgage rate that is a mere 1/8th of a percent higher for the same cost. An eighth of one percent is the smallest rate bump in the "A paper" world, and quite often I see differences of a quarter to half a percent for the same loan between various A paper lenders when I'm shopping a loan. What would that cost me if I could have had 5.875% for the same cost instead, even keeping the benefits of the accelerator?

The answer is $35.77 per month on the payment, but more importantly, $46.50 the first month on the interest, and this adds up to $1641.77 less interest paid over the three years most people keep the mortgage, while the $10.37 per month benefit of the money merge put the 6% loan as having a balance that's actually $20 lower. Not counting fees of the money merge account, or anything else - just pure difference on the actual cost of that loan, in the form of interest you paid that you wouldn't have had to. How does that sound: Even if everything about the money merge was free, you'd be getting a $20 lower balance over three years in exchange for having spent $1600 more on interest. If you offered people $1600 for $20, what proportion do you think would take you up on it? If you offered them $20 for $1600, how many suckers do you think would go for it, even if you personally begged ten million people?

For those of you who may be loan officers - or real estate agents - reading this, can you point to one single putative benefit that you would think worth the cost that lenders charge to sign up for these programs yourself? As I've said, I can't. There is nothing here that justifies the wild ways in which these are being marketed, and the ridiculous promises that are being made about them. In point of fact, I can think of only a few possible reasons to sell these:

• Eyes only for a commission check (probably number one in terms of the overall market)


• You don't understand what's going on, took some marketers word, and haven't done the numbers yourself (hardly a recommendation of your services or professionalism)


• You just don't care about your clients welfare

A year and a half ago, when these started being marketed, I wrote about the broad outlines. Never had the urge to hose a client by selling one, so didn't really investigate any further, although I wrote that the benefits were quite minimal as compared to the costs a few months later. But the ridiculous promises and over-aggressive marketing these have been subjected to in recent weeks have finally motivated me to do a rigorous analysis, and what I see is not "merely" of minimal benefit in even the scenarios most amenable to said benefit, but actually costs more than any putative benefit. I can see precisely zero justification for counseling any client in any situation to pay the money that every one of these I have yet encountered to set it up, as the benefits derived from any of these programs with which I'm familiar never do manage to equal the opportunity costs.

Now before I sign off, the point needs to be made that the psychology the account engenders in the consumer is likely to be beneficial, rewarding themselves psychologically for making what are extra payments on the mortgage, and as far as that goes, the account does accomplish something praiseworthy. But the vast majority of all mortgage borrowers can make extra payments of principal any time they want, for free, and when you consider these accounts strictly on the basis of actual numerical advantage over real alternatives, the costs of the program are literally never recovered.

Caveat Emptor

Article UPDATED here

Effective April 1st and for the rest of 2008, Fannie Mae and Freddie Mac will be buying loans above the current limit of $417,000. The is a result of the economic stimulus package signed by President Bush on February 13th. They will begin purchasing Fixed Rate Mortgages on April 1, 2008, and hybrid ARMs on May 1, 2008. Due to the length of time it's taking to actually fund said loans, several major lenders are now offering the opportunity to register and lock the new loans. The new limits, which vary by Metropolitan Statistical Area, do not appear on either Fannie or Freddie's web page yet, but the FHA Mortgage Limits page seems to have correct data for every county I checked, which was about four counties.

Fannie and Freddie have recently announced their policy as to what they will and will not fund as far as these loans go. In fact, Fannie seems to be taking the lead, issuing the letter I've seen.

The standards are significantly more restrictive than Fannie and Freddie's standards for conforming loans. The first difference is no automated underwriting, at least not yet. You have to live and die by the specified underwriting standards, including debt to income ratio, which under automated underwriting I've seen much higher than guideline approved for people with stable income like government pensions, good assets and good credit. Here's the quote:

All loans must be manually underwritten. The jumbo-conforming loan limits, eligibility, and underwriting guidelines will be added to Desktop Underwriter® in a future release.

Keep in mind that that the Jumbo Conforming loan, as currently written, expires at the end of 2008. I suspect there'll be some sort of extension going in to 2009, but at this point there is no guarantee there will be anything. For those who are wondering, this doesn't mean the loan will vanish or anything. It just means that there won't be any new ones funded after that unless something happens to extend the program - which I do expect but cannot guarantee. It would be pretty pointless to have this be one of the keystones of the economic stimulus package if everybody concerned intended to let it collapse at the end of the year - and the Federal Reserve, at least, knows that.

The written standards themselves are more strict as far as loan to value ratio goes. Freddie (at least) is still perfectly willing to buy mortgages at 100% financing for purchase money conforming loans - it's just the actual lenders who are not willing to fund them in the first place. Credit scores down to 620 are at least theoretically possible for conforming loans, but "jumbo conforming" purchases are limited to 90% with a credit score of 700, 80% with a credit score of 660. Those are fixed rate. hybrid ARMs are limited to the 80%, and require a 660 credit score. For Fannie and Freddie's "Limited Cash Out" definition, which is essentially a rate term refinance, 75% is as high as they will go. Cash Out Refinances, Fannie and Freddie won't buy, even on a primary residence. On second homes and investment property, 60% is as high as they will go, even for purchase money or "limited cash out".

For Jumbo Conforming, all housing debts must be in "0x30" status for the past twelve months, which is mostly a little bit stricter than the conforming standard. This means that you can't have any rent or mortgage payments that were 30 days or more late - not just on this property, but on any property you owned or rented in the last twelve months.

Thus far, the only two loan products that I'm certain will be included are the fully amortized fifteen and thirty year fixed rate loans, and the fully amortized 5/1 ARM. The 5/1 Interest Only for ten years that they have also included is not a standard loan product. The 7/1 and 10/1 appear on some rate sheets, though, so I'm thinking that the specifications are minimums: In other words, it must be fixed rate for at least five years, it must begin amortizing within 10 years. Indeed, I've just had this mostly confirmed by a couple conversations with wholesalers. Also, interest only fixed rate mortgages are specifically disallowed, but The Word is that interest only periods of up to 10 years are acceptable for those as well, and that the prohibition applies only to fixed rate loans that don't begin amortizing for longer than ten years. For instance, a loan that was unamortized for its full term would be unacceptable to Fannie and Freddie, which is nothing new. Fannie and Freddie have always required that the client begin actually paying off the loan at some point be built into the loan structure.

Some folks are making a big deal out of "no consolidation of existing first and second liens," in the guidelines, but that just goes to show how little A paper they've done these last few years. That's a standard criterion for Fannie and Freddie's Limited Cash Out refinances. So anyone that has an existing Second Trust Deed is going to have to subordinate the existing loan. I don't know that refinancing each loan simultaneously would be rejected, but the Official Word I have is that Subordination Is Your Only Option. That would be a loan killer if the current second mortgage holder refused.

Residential mortgages are for 1 to 4 units, but for Jumbo Conforming loans, Fannie and Freddie won't buy anything financing more than one inhabitable unit. Condos, townhomes, and PUDs are all fine, but no two, three, or four unit properties under a single title or deed of trust. Interestingly, Co-ops are also disallowed by the guidelines for Jumbo Conforming loans.

Finally, rates are higher than regular conforming rates. For fixed rate mortgages, there's a minimum of a quarter of a percent hit on the rate, as opposed to regular conforming mortgages. That's a price hit direct from Fannie and Freddie. The actual differences on the price sheets I've gotten are much higher than that. The thirty year fixed rate loans seem to be about 1.25% higher for the same cost as conforming, the fifteen year fixed rate about 1.5%. That the differential is actually higher for the shorter term loan is astonishing to me, and I can't think of a reason why at the moment. For hybrid ARMs, the pricing adjustment from Fannie and Freddie is three quarters of a percent, and the actual difference seems to be about 1.75% higher for the same cost. However, for fixed rate loans, this is about 1 full percent lower than regular "non-conforming" rates, while the "non-conforming" rate pricing for hybrid ARMs seem pretty similar to jumbo conforming. For fixed rate mortgages, at least, this provides a constructive alternative for full documentation type loans above the regular conforming limit, which have suffered severely by association with stated income loans these past several months. They're no longer completely joined at the hip. Now, up to San Diego's limit of $697,500 anyway (limits in your area may vary), full documentation loans are going to get a better loan than "stated income" borrowers.

I've had my suspicions from day one of this whole thing that Fannie and Freddie don't really want to fund these loans, but they want to stay on Congress' good side in case they ever need something. There's no longer a legal commitment that the US government will backstop Fannie and Freddie as far as losses go, but there is a strong feeling that they will, and doing the bidding to Congress at least this much gives them the moral ability to go to Congress for relief if this all goes south on them. "We did this because you wanted us to!" may not obligate the taxpayers directly, but many corporations have received public assistance on far weaker claims - while if they refused, Congress could well decide not to bail out what are, in fact, privately held corporations that are run for profit. So Fannie and Freddie have made the fact that they're not happy with this quite clear to those with the skill to read between the lines - but they're going to go along as far as they are with what the government wants them to do, because you're never certain that you won't need help somewhere along the line.

Caveat Emptor

UPDATE 5/8/2008: Fannie and Freddie have changed things a bit, and now the temporary Jumbo Conforming Loan rates have dropped like a rock, to the point where there's only a quarter to a half point difference in cost between them and regular conforming at the same rate. Now that will make a difference for full doc borrowers. Stated Income is non-conforming, and those rates are still significantly higher. I've said all along that Jumbo borrowers were suffering by association with stated income, due to the fact that both traditionally used the same rate table for A paper borrowers. Now that Jumbo Conforming loans have broken that association, the rates (up to the new limit) have dropped. This is about as surprising as gravity.

how soon should I start shopping around to refinance my home? I have a 2yr interest only and it's up in (four months)

Okay, the 2/28 loans which you are describing all have prepayment penalties for at least two years. Figure it's going to cost you 6 months worth of interest, on top of the cost of the refinance, if you refinance before the penalty expires.

(OK, you could have specifically bought it off by accepting a higher rate, but that's unlikely to have been the case)

That said, about three weeks before the penalty expires you can start the refinance process. Be advised that until the day the penalty expires, the current lender will be quoting a higher payoff, but once it has actually expired, the payoff should be correct, at least in theory. You should not sign final loan documents until such time as your penalty will expire with or prior to your Right of Rescission expiring. No more than two to three days prior to expiration.

Indeed, sometimes lenders will want to keep charging penalties even after they're no longer due. I'm not certain if they just don't update the payoff correctly or what, but I've seen lenders try to charge penalties a month after they expired. Once they've got your money, they can make you pay a lawyer and go to court to get it back.

For this reason, I would avoid "cash out" refinances any time within three months after the penalty expires. Matter of fact, if you're refinancing during that period, not only don't refinance for cash out, but don't have an impound account for taxes and insurance, and don't plan to put any money at all into the loan balance if you can avoid it. Here's why: When escrow officer goes to request a payoff from the soon to be former lender, the payoff quote may include the penalty even if it's no longer due. if they money they have from the current lender covers the whole thing, they have two choices. Pay it and have a completed transaction (not to mention getting their company paid), or don't, and leave everybody hanging. If they pay it, this means that you, the consumer, only get a much smaller amount of money, but I'm disgusted at how often consumers are shorted by the loan process, and this is one more way it happens. You're expecting $20,000 cash, and that $20,000 was the entire reason you did the loan. Comes the proceeds check, and you've only got a check for $9000. You want the other $11,000, you're going to have to go through the whole process again. Not the kind of situation you want to be in. Not the kind of situation I want my clients to be in.

If, however, the escrow officer does not have enough money available to them to pay off the loan plus the penalty, they have no choice but to leave the transaction at that stage until the quote is correct. They won't let it sit - they'll find out what's going on and everybody involved will be doing what's necessary to resolve the conflict between the two issues. Not having any more money in the loan than necessary to pay off the old loan is a good way to insure that the escrow officer won't pay a penalty you don't owe.

Don't let the rush to pay off the old loan cause you to cut corners on either your shopping for a new loan or asking all the questions you should ask prospective loan providers. Rushing into a refinance because your loan is going to readjust is one of the best ways to waste large amounts of money that there is. To illustrate, let's look at a larger than average loan amount that sees a huge jump in the actual rate. $400,000 at 6%, and it goes to 9%. This makes a difference of $33.33 per day, or $1000 per entire month. That's the equivalent of a quarter point on the cost - basically nothing on the scale of differences between subprime loans, and not very much on the scale of differences between A paper loans. I'll usually beat the retail branch of the lender I place a loan with by at least twice that. If it makes a difference of 0.25%% on the rate, that's $1000 per year that you're going to be stuck with the new loan. If you're still a subprime borrower, multiply that by the length of your new prepayment penalty in years. Doesn't it sound worthwhile to take an extra day which your old lender bills you $33 extra for, to shop the loan around for real and ask the hard questions that enable you to save $2000 or more on the new loan. Even if you're putting the money into your balance, you're still paying the extra. Not only that, but you're paying interest on it as well. On the scale of costs for a new loan, paying the soon to be former lender for a few more days at the increased cost is likely to be a wonderful investment if it gives you the opportunity to find a better loan.

On a note of personal relevance, at the time this is written rates are higher than they were two years ago, and you're in an interest only loan now, while interest only loans are difficult to do right now. Your payment is probably going to end up higher, especially if you roll loans costs in. If the reason you were in an interest only loan was that your debt to income ratio couldn't qualify for the real payment on a sustainable loan, that refinance is probably not going to happen for you. With prices having decreased locally by 25 to 30 percent, your loan to value ratio may not support refinancing either. If a refinance is not going to happen, and you can't afford your current payment, it's time to sell now. The new FHA Secure program helps some people, but requires documenting enough income to afford all of your payments. You owe what you owe and the rates are the rates. If the numbers don't work, get it sold.

One more piece of advice: Start improving your credit score now. Four months is plenty of time to bring your credit score up fifty points or more. If you can get into "A paper" loan territory, where penalties are much less common, you'll be much happier with your new loan than you are with this one. If you're in subprime territory and able to improve your loan to an "A paper" loan, your rate may go down despite the fact that the rates are higher.

As I cover in Getting Out of Paying Pre-Payment Penalties, if you're willing to refinance with the current lender, either directly or through a loan broker, your lender may be willing to waive the penalty in favor of sticking you for a brand new prepayment penalty on a larger amount. This is usually making a bad situation worse. As I said, you're likely to get a higher rate, be limited to an amortized payment on the new loan, and the new loan amount is likely to be higher (people in the situation usually roll the costs in), and all without even the benefit or lowering the tradeoff between rate and cost like penalties usually do. This seems pretty much the definition of lose-lose-lose-lose to me. Longer prepayment penalty on a higher balance at a higher rate, without getting any benefits in exchange. This is kind of why the best way to deal with prepayment penalties is not to accept them in the first place.

Caveat Emptor

Article UPDATED here

NOTE: With the changes in the mortgage market, there are no backup loans any more. I won't do them and I don't know anyone else who will. The costs have ballooned too much; not only in the form of costs that don't get reimbursed if the loan doesn't fund, but in the form of higher rates the lenders charge me and all my future clients when I lock loans that don't fund

I have repeatedly advised my readers to sign up for a back-up loan if they can find somebody willing. So every once in a while, I get email like this:

Hi! Would you be willing to do my backup loan? I'm already signed up with my brother-in-law but you tell people to get a backup loan so I'm asking you.

No loan officer with any sanity is going to agree to that request. You've already made up your mind who is doing your loan. You are not honestly shopping your loan, and you're kidding yourself if you think you are. You're not likely to evaluate your brother-in-law's loan critically when it comes to final signing, you're just going to sign on the dotted line. So the back-up loan officer is going to spend hundreds of dollars and a lot of time pushing your loan through for zero prospect of getting paid. Suppose your asked you to work through the weekend, and maybe a couple extra nights, spend about a week's worth of your own pay, but that you wouldn't be paid, you wouldn't get a bonus, and it wouldn't be considered at your next review. That's essentially what you're asking them to agree to with the above scenario. There is no carrot whatsoever in the case of loan officers, because (unlike employers) you're not paying them at any other time, either. Quite frankly, I'd rather spend the time trying to find another client, or with my family, or doing anything else. I'm not interested in wasting my time on backup loans like that, and neither is any other loan officer.

The first thing you have to do if you're hoping for someone to agree to be a backup loan provider is give them an honest chance at being the primary loan. You have to shop them before you have signed up with anyone. You have to have the whole loan officer conversation with several loan officers: what you've got, where you want to get to, your situation, etcetera. Don't forget to ask the Questions You Should Ask Prospective Loan Providers. They go out and price the loan, and get back to you with what they can do. If you are actually signed up with someone else prior to this point, you have not honestly shopped your loan, and no loan officer in the world is going to agree to provide a backup, not to mention that you have placed yourself completely at the mercy of the loan officer you signed up with. There never was any real chance that other loan officers could actually earn your business. It's like going to an auto dealer and asking them to special order a car for you, despite the fact that you've already paid another dealer, are not going to put down a deposit, and indeed, really want to do business with the other dealer, but hey, you want them to do this for you on the chance that other dealer cannot deliver. If you have any doubts, why did you order with the other dealer, or more precisely, why did you sign up with your brother in law for the loan? Especially prior to checking with anyone else? And if you have any doubts about your brother in law, why are you waiting until now to shop your loan?

So after honestly shopping your loan, you obviously need to make a choice. Now the reason I advise people to get a back-up loan is because everything you are told when you make that choice could very well be a lie. With the majority of loan companies, either the federal Good Faith Estimate or the California MLDS are subject to all kinds of misrepresentation, intentional misquoting, etcetera. If this were not the case, there would be no need to sign up for a back up loan. The purpose of signing up for a back up loan is to give yourself another option if, when you go to sign final documents, the loan they actually offer you a contract for is different from the loan they dangled to get you to sign up, that they have been talking about all this time but at the moment of truth they don't really have it. Whether it's a different rate, has closing costs thousands of dollars higher, thousands of dollars added to your loan amount that they conveniently "forgot" to tell you about, has a pre-payment penalty when they told you it didn't, is a completely different kind of loan than they told you about in the first place, or even all of the above, the loan isn't what got you to sign up. In some cases, they don't have a loan at all, and are stringing you along in hopes that they will have a loan Real Soon Now. If you only have one loan ready to go, your options are limited to "sign on the dotted line or don't." If you've made a substantial deposit on a property you are buying and all of a sudden you don't have a loan, guess what? You will probably lose that deposit. So people will sign on the dotted line, even for refinances, when it's not the same loan they were led to believe they were getting in the first place. Hence, my advice to sign up for a back-up loan. That gives you the option of signing the other loan officer's loan contract, and the mere fact that someone else also has a loan ready to go is much better leverage than anything else you can do to get them to produce the loan they said they had in the first place. You can use the first loan officer's loan as a club for your back-up, too, if need be.

But if you're not going to evaluate your primary loan officer's loan critically, if you're not going to go through the paperwork and make sure that rate, terms, and costs is indeed, as described, that back-up loan officer has just wasted all of their work, and all of their money. Excuse them if they are less than enthusiastic about doing that when there is no prospect of getting paid. It's not like they are being paid an hourly wage. If that loan doesn't close, they get nothing for all that time and effort. People work to earn money, even if they really do like their job. What you need to do is give them reason to believe that you are going to end up signing for their loan. The best way to convince them of this is if the prospective backup loan officer is certain themselves that the primary loan isn't really going to be able to deliver the loan they're promising you.

So what you've got to do, preferably before you make a final choice for your primary, is ask your number two prospect about your number one prospect's loan. Does loan officer number two think offer number one is deliverable? I assure you that good loan officers know what is and isn't really deliverable. Whether the answer is "Yes" or "No", you've got some useful information. If the answer is "Yes," you know that what the low bid is talking about is possible. Whether they will actually deliver it or not is a different question. The way to bet is that they will not, unless they are willing to offer you a written Loan Quote Guarantees. If you ask for a Loan Quote Guarantee, most lenders and loan officers will not give you one. Instead, they will try to distract you with BS about how they are thus and such reputable company, and they honor their commitments. This is nonsense. Neither the Good Faith Estimate, Mortgage Loan Disclosure Statement, Truth In Lending form, or any of the other standard forms that you get at loan sign up, is in any way a commitment or a guarantee. They are only estimates, and they may be accurate estimates or they may be the biggest lie since the invention of the one night stand. Furthermore, loan officers don't write loan commitments. That is the exclusive province of underwriters, whom you will never communicate with directly. The most that loan officers can promise is that if the underwriter approves it, the loan will be on a given set of terms, and that is the sort of Loan Quote Guarantee you should look for.

Now, if the second lowest loan provider says "no," that the lowest's rate is not deliverable, that is your opening. "Well, tell you what, Mr. Loan Officer," you say, "If you're certain that loan quote is not deliverable, and that yours is, how about you agree to be my back-up loan provider? If they don't deliver on those terms, as you say they won't, and you do deliver on yours, I'll take your loan. What do you say?"

What they are most likely going to do, of course, is try and talk you into being the primary, and to forget this nonsense about back-up loans. After all, he (or she) is a sales person. If you do what they want, this puts them in the cat-bird seat thirty days down the line instead of your number one choice. And you know, if they are willing to give a Loan Quote Guarantee and the number one choice isn't, I'd probably make them my primary. Ask anyone who's dealt with construction contractors if they'd rather take a bid of $X that is just an estimate, or $X plus 5% that has good solid guarantees behind it? Same principle here. The one that's willing to guarantee their work gets the business, or at least first crack at it.

Now suppose number two won't agree to provide a back-up? Then ask number three. Suppose number one is going to try to hinder your back up loan? You need to explain that you fully intend to go with them, and that if they provide the loan on the terms they told you about, they are going to get the business, but you're providing yourself with an insurance policy, just in case they won't, and their attempts to sabotage that insurance policy are likely to force you to cancel your loan with them. Tell them that if they are really going to deliver what they said they would, their loan will be better than the competition's, so there will be no reason to choose the other loan, so their attempts to obstruct or sabotage the other loan have you thinking that maybe you should cancel their loan, because their actions are indicative of being nervous about their own loan. Be blunt, be truthful, and carry through on your threat to cancel if they keep being an obstacle to the back up. If they need to obstruct a worse loan, it's because they have no intention of delivering the better one. Carry through on your promise to cancel - and then go find yourself a new insurance policy, aka backup loan provider.

Signing up for a back up loan is the cheapest, smartest thing you can do to protect yourself in one of the largest dollar value transactions of your life. But if there isn't a real possibility of getting the business, no loan officer in the world is going to agree to be your back up. You need to demonstrate to them that there is a real possibility of their loan being the one you actually sign the loan contract for at the end of the process, or they are not going to be interested. The type of email that is referenced at the top of the article isn't to protect yourself. It's to mollify your conscience, because you know you didn't really shop your loan around, and you know you're going to pay more than you need to, unless you get struck by pure dumb luck. The point of reading the consumer education here is that you don't want to rely on pure dumb luck.

Caveat Emptor

Original here

Got an email alerting me to this fact. The e-mail was gobbledegook as far as making any sense but I went to the FHA home page and they had better information.

It appears as if the FHA, through OFHEO, has opted to maximally raise their limits, to 125% of the median sales price in their Metropolitan Statistical Area (MSA). For a very few MSAs, the limit is the legal maximum of $729,750.

For the first time, conforming loan limits are not going to be one number for the 48 contiguous states. This is a very welcome and long overdue development, even if it does make life more complicated. Go to the FHA Mortgage Limits page to find out how much the limits are going to be in your area.

I wrote an article about waiting for the limits and how Fannie and Freddie, and the FHA separately, are going to have to decide what they're actually going to fund. FHA's limits have now been announced, but we're still waiting for Fannie Mae and Freddie Mac are going to react. Keep in mind that they are 98% privately held corporations. They want to stay on Congress' good side because they do have some moral or historical claims on the taxpayer if they get in trouble doing what Congress wants them to do, but the final decision as to what they will fund belongs to them. Now that the FHA has made their announcement, I would look for Fannie and Freddie to be making their decisions as to what they will and will not fund fairly quickly, and that will set the limits as to what a conventional conforming loan is.

Caveat Emptor

UPDATE: I just went the the Credit Union, and not only they but the bank next door are doing something we used to call "Betting on the come" when I was a controller. They're advertising "Jumbo loans for Conforming Rates!" This is fundamentally dishonest. What they're doing is taking applications based upon what they think Fannie and Freddie will do. However, if they guess wrong, they're not going to actually fund the loan, especially given the two percent divergence between conforming and jumbo rates for A paper at the same price. Bottom line: They're trolling for clients with incredibly misleading advertising, and if Fannie and Freddie don't come through according to what these institutions expect, there's going to be a large number of very angry people.

I enjoy your blog very much and figured you would be a good person to ask this prepayment penalty question to.

Is there a prepayment penalty if you dont pay down the whole amount? For
instance, say I owe 620k and want to refinance this. Can I get a loan for
say 610k from another lender and leave 10k with the orignal lender?

Does that avoid the prepay penalty?

No.

Have to admire the ingenuity, but it won't work. Here's why:

First off, the penalty is triggered by paying a certain amount extra. There are two main trigger points for a prepayment penalty, usually known as "first dollar" and "twenty percent." "First dollar" prepayment penalties are uncommon, but they do exist. What such a penalty means is that if you pay one extra dollar of principal during the time the penalty is in effect, you will get hit for the penalty - usually six months interest on the prepaid amount. Not so bad if you pay an extra dollar and get hit with a three cent penalty, but you have to pay a substantial amount to get any noticeable good out of it. You pay $1000 extra, and that's $30 they're going to hit you with on a 6% loan. Pay off a $100,000 at 6%, and they're going to have their hands out for $3000 extra.

The other trigger point, "twenty percent" lets you pay down the balance by up to twenty percent for any given year without triggering the penalty. Note that this includes not only any extra you pay, but normal amortization as well. If you have a $100,000 balance, and would normally pay $3000 down through regular amortizationduring the year, this leaves you with "only" $17,000 of extra that you can pay before the penalty starts hitting you. Most often for this type of trigger, the prepayment penalty will only be assessed on any amount over 20% of the balance, but I have seen these charge the full penalty once triggered. So paying off $20,001 of a $100,000 balance at 6% might, depending upon your loan contract, cause a $600.03 penalty to be assessed - but most often it will only be that three cents. In this case, paying off the loan in full would only cause the penalty to be assessed on $80,000 - $2400 instead of $3000. It's also something to be cognizant of that this 20% paydown applies to the balance as of the start of the loan year, which runs from contract anniversary to anniversary. Say you have such a penalty in effect for three years. The first year you only pay it down to $80,000, escaping the penalty. The second year, you can only pay it down to $64,000 - by 20% of the beginning amount for the year - before triggering the penalty. If you do so, in year three you can only pay it down as far as $51,200 without triggering that penalty. This type of trigger is used when the lender is mostly worried about a complete refinance or selling the property. (A "soft" prepay is one where the penalty is not due if you actually sell the property, but most loans with prepayment penalties have "hard" penalties that are assessed at a certain trigger level, no matter the reason.)

No matter whether your penalty trigger is "first dollar" or "twenty percent" though, you're not going to refinance without paying it off completely. Here's why: In order for the new loan to be first in line, the old loan has to be paid off completely. The rates and prices on home loans that we all see advertisements and such for are predicated upon them being first trust deeds. They can only do this by paying off the previous loan in full and having a Reconveyance of the Deed of Trust recorded. Not paying the old loan off means no Reconveyance, which in turn means no new loan because their Deed of Trust will not be first in line. You'd have to content yourself with the higher prices for a loan priced as a second trust deed.

There are only four ways to avoid a prepayment penalty that I'm aware of. 1) Don't accept one in the first place, 2) Don't sell or refinance until it expires if you do accept one, 3) Convince a court the lender has done you sufficient dirt for the court to order part of the contract voided (this takes a lot of dirt), or 4) Swap your old penalty period for a brand new one by refinancing with the same lender, if they will allow it (They don't have to).

Caveat Emptor

Article UPDATED here