Mortgages: June 2008 Archives

For all the fact that I rant on about problems in out national mortgage market here in the United States, the problems are mostly on a retail level. Almost in their entirety, they have to deal with what happens when one consumer meets one provider, and I believe that they will vanish when the consumers are informed of the facts, and take the time to make rational, informed choices.

The fact is that for mortgage providers, there are strong incentives to lie to consumers. "Everybody else does it, too - how else am I going to compete?" Also, real closing costs seem high. Real closing costs are high enough that many states with so-called "predatory lending laws," limiting the amount in total charges as a percentage of the mortgage, either have already repealed them or are considering repealing them so that their residents can get loans. I can talk to people about closing costs that have been significantly reduced by contracts I have with service providers, and they'll say, "Costs seem high." Well, yes, closing costs are about $3000, but I'm giving you the real numbers, and what I tell people about up front actually covers what my clients will be asked to pay. Would you rather have that, or would you rather you were told, "nothing out of pocket"? Just because it's usually possible to roll them into your mortgage, where you pay interest on them for a very long time, instead of the money coming out of your checking account doesn't mean you somehow didn't pay this money. The state of mortgage cost disclosure in this country is abominable.

So we can take it as proven that there's an incentive for loan officers to minimize costs of their loan in conversation with you. Many will tell you anything it takes to get you to sign up with them, do anything they can to force you to stay with them (signing fees or lock fees up front are common, and THE BIGGEST RED FLAG I KNOW, and requiring you to give them original documents is almost as common and almost as large). They will penalize you out of spite if you decide you don't want their loan when you realize what it's really costing.

From almost the first moment a consumer talks to some mortgage providers, they are lied to. The fact is that as long as the rate that they quote you is available, the providers won't be held responsible if you don't get it. If you ask them what their rate is on a 30 year fixed rate mortgage without points and they reply with a the rate that's available on a 30 year loan that's fixed for one month at a time with five points, that's actually legal. They can sign you up for the former, deliver the latter 30 days later, and with rare exceptions that they are adept at avoiding, not get in legal trouble. They can tell you all about a loan that's based upon completely different qualifications than the ones you possess, in order to get you to sign up. And many loan officers, from the largest, "most reputable" banks on down to the smallest brokers working out of their home, make a habit of it. The examples I give above may be more extreme than usually happens, but it's a matter of degree, not kind, and I have seen every single rotten trick that I tell you about, pulled on prospective clients by other loan officers in the most extreme way I talk about. Furthermore, blatantly unethical is still blatantly unethical, whether they're stealing multiple tens of thousands of dollars from you, or "just a few thousand between friends." If you found out you were victimized by a Nigerian 419 scam, I'm sure you'd feel much better to find out that you were only taken for $3000, where it could have been $30,000, right? This is no different. No, let me take that back - it's worse. If the loan provider were honest, your patronage would still have put a lot of money in their wallets, and they lie and backstab to get more?

The first thing to keep in mind is that all of the incentives are aligned for them to tell you ANYTHING in order to get you to sign up with them. The fact is, many people, once they sign the initial papers, consider themselves committed to that provider, and won't switch no matter what. At the end of the process, many loan providers are adept at hiding the crucial things you should study carefully in amongst the sometimes dozens of pieces of trivial paper that you have to sign. A large portion of people victimized in this way never notice that the loan delivered had three points more than the loan they signed you up for. A few more only realize it weeks later when they get a statement loan balance is much higher than they thought, and it's too late to do anything about it. And of those people who do notice that something is amiss when they're actually signing the final documents, eight to nine out of ten will cave in and sign. They're tired of the whole process, all they have to do to have it be over is sign right there on the dotted line. And if it's a purchase, the consumers are under a deadline. It's the thirty-ninth day of a thirty day escrow, and if they don't sign these loan documents right now, they not only don't get the house, they also lose their deposit and the extra money they've been paying to keep the escrow open while the loan officer got his (or her) stuff together and decided exactly how much in extra charges to stick them for. The leverage available to the consumer in such a situation is Zero. Zilch. Zip. Nada.

I'm going to make what seems like a heretical suggestion here. This is truly radical. The resistance in some quarters (particularly loan officers) to this suggestion is enormous. I can already hear howls of outrage already from loan officers and their bosses. Furthermore, I can hear millions of consumers griping about the paperwork involved already, and I haven't even said it yet - except to fewer than a dozen clients who took this advice and are forever grateful to me.

Apply for a back-up loan.

It isn't precisely a walk in the park to do the extra paperwork, I'll admit. But it isn't thirty years in purgatory either. There are issues to be aware of (most notable being the appraisal, about which more in another column), and extra charges to put up with from the appraiser, escrow and title companies. $100 to $200 if you handle it right, $500 or a little more if you don't. But this is likely the most cost effective insurance policy a consumer can buy today, and I'm going to harp on it until something changes this fact. (New proposed RESPA revisions aren't nearly good enough, and are focused on the wrong place).

You see:

Every so often I encounter a client who I'm certain has been lied to, and believes every word of it. I know what rates really are available, and at what cost (and there is always a tradeoff between rate and cost). And this person has been quoted something where, if it were true, that loan officer not only isn't going to make money but is actually going to pay hundreds or thousands of dollars of their own money in order to get it for the client. Unless John or Jenny Consumer is a close relative or the loan officer literally owes them their life, it doesn't take a genius to figure out that that's not going to happen. (Some of the worst taking advantage of someone that I've observed on the part of loan officers has been from Uncle Bob, the first cousin they grew up with, or even Sister Sue, but I digress). So every once in a while, I volunteer to act as a back up loan. They cooperate with me for the paperwork, and I will do the work, knowing full well that if their primary loan goes through as advertised, it's all a waste of my time, effort, and money.

Every single time it's been my loan that they ended up getting.

Furthermore, there have been a lot of other situations where I wasn't 100 percent sure - the rate existed, and it was possible the loan officer might deliver something similar if they were willing to settle for a lot less compensation than most loan officers, and so I didn't make the offer, and they came back to me weeks later with "Can you still do that loan you talked about?" (The answer to this is ALWAYS no. Rates at every bank vary daily, and often within a day - even the sub prime lenders that publish rate books good for months have adjustments that change daily. This is part of the importance of a rate lock. But usually I can do something similar, and sometimes better if the rates have gone down).

Most consumers do not realize that there is not necessarily any correlation at all between the loan you sign an application for and the loan that gets delivered with the approved documents ready for a notarized signature. It's completely dependent upon the good will and good faith of that particular loan officer and the company they represent. Some are completely honest. Some are looking for extra bits and pieces of cash to pick up around the edges. And some will take the odd arm and leg from you if they figure they have the opportunity. Even those few companies that do guarantee their rates and closing costs up front are difficult to collect from if they should be stretching the truth. If I had a dollar for every time I told somebody that I didn't believe a rate was real and they responded, "I've got the paperwork on it," as if that settled the question (or made any difference at all), I would have quite a few dollars. Oh, most of the time from most companies, if they sign you up for a thirty year fixed rate mortgage, they will actually deliver a thirty year fixed rate mortgage, and the rate will generally be at least close, albeit with two points and $2000 in extra closing costs they somehow forgot to mention (Quoth the loan officer: "Clumsy me!"). But until then, they'll be throwing around all kinds of rates on all kinds of loans just to get you to call, to come in, or sit down and talk. Once that happens, they are confident that their salesfolk will get you signed up.

If you have a back up loan, you've got something else waiting to go. Another arrow in your quiver. Plan B. Your fallback position is defended. You're not going to lose the house and the deposit and the extra money to prolong escrow if you don't sign these papers right now. You're not going to have to choose between completely missing the lowest rates available since your grandparents were children and are now unavailable and paying $6000 more than you were told for your refinance. You're not hanging out there all alone at the end of the process after discovering that your trust was completely misplaced Here you have a solid, bona fide alternative. Imagine yourself with the ability to say, "No, I'll just sign the other papers instead." You'd be amazed at the leverage this gives you, with both companies if need be.

If you want to watch someone experience a truly amazing level of discomfort, tell your average loan officer or real estate agent that you're signing up for a back up loan with someone else. Most of them will say literally anything and do their absolute best to talk you out of it. I'll admit, even I would be momentarily nonplussed. I would hope that I would respond with "Okay. How do you want to handle the appraisal?" (assuming that it hadn't already been done) secure in the knowledge that I actually intend to deliver the loan I said on precisely those terms. You see, given the circumstances, I don't think you're doing anything wrong. If you asked me, I'd have to agree you were simply being prudent. Because until I actually put the final documents in front of you for your signature, there literally is no way for me to prove that I intend to deliver that loan on those terms. (There are a lot of red flags that if a consumer runs across them mean the loan officer isn't going to deliver the loan promised, but a competent loan officer can conceal them. There's also one thing that happens on every loan that looks like a big red flag, but isn't one at all). There's a lot of paper I can put in front of you that makes it look like I intend to deliver the loan I promised. None of it actually means anything in the way of a guarantee. At the present time, the only form or piece of paperwork that a loan officer cannot play games with is a form called the HUD-1 - and that doesn't come until the very end of the process. So until then, what you're really relying upon is the loan officer's good will to deliver the loan they signed you up for, on the terms you signed up for. Some fully intend to deliver the exact terms of every loan, and some will tell you anything to get you to sign up. Guess which the short-term dynamics of the marketplace favor. Here's a hint: If the loan officer can't get you to sign up for a loan, there's an absolute gold-plated guarantee they won't make anything.

If you shop multiple alternatives like you should for a mortgage, it's quite likely somebody is going to tell you that the best rate you've been quoted doesn't really exist, at least not at the level of closing costs indicated. That's your perfect opening. Ask them "So will you be my back up loan?" They're going to try to talk you into going with them, of course, and forgetting that other guy, not to mention all this heretical, unheard-of, ridiculous nonsense about back up loans. Disregarding the fact that a back-up loan gives you leverage over them, a way to force them to actually deliver what you sign up for or something similar, they want you to put money in their pocket and not the other loan officer's.

Not too long ago, I had one of my clients tell me that somebody had told her I wouldn't be making anything if I delivered the loan I promised. "Okay," I thought, "She has a fair enough concern. There's no way for her to know I actually intend to deliver this loan, and certainly no way real way to prove it until the HUD 1 is ready at signing. Just because it's me doesn't mean anything to her until I've actually got the track record of delivering what I quote." Keeping this in mind, I told her something consistent with what I'm telling you right now. I told her to offer to do the loan documents to make the other guy her backup if he was that certain - if he was wrong, the only cost would be that his work would be uncompensated, something loan officers get used to, and if he was right, he'd be right there ready to close his loan and get paid. (The other loan officer declined. She ended up with my loan - on exactly the terms quoted at time of lock).

Indeed, in my experience, it is more likely that the person who tells you something isn't real may well be telling you the truth. Getting angry at them is about like getting angry at someone who's trying to prevent you from being conned. The constructive response is to make them your back up loan. This doesn't mean that the person who gave you the best quote necessarily doesn't intend to deliver. They could just be comfortable making less per loan than the competition, or the competition could be telling you it isn't deliverable even if it is because they want you to sign up with them. This doesn't mean you shouldn't get back to the guy who gave you the low quote with some pretty pointed questions, including the information that you're signing up for a back-up loan. Make the calls and stick to your guns. Maybe you'll end up signing up with the second guy as a primary and find a different provider for your back up. It'll depend upon factors I can't see from here - the best guide being that someone unwilling to deal with having two lenders working the deal is not likely to be telling you the whole truth. But find the back up loan, if you can. If you can't, it likely means that the guy who quotes you the lowest rate is quoting you something that at least exists, and he could potentially deliver if he actually wants to. But there is no way to prove he wants to. Which is precisely the reason you need the backup.

Word to the wise: Do follow up on both loans. Sign the application documents for both loan officers; provide your copies to both of them. And make certain, to the extent you can, that both loan officers are actually doing their work. The backup loan is useless as leverage if it's not actually ready to go at about the same time as the primary. (This is one indicator as to which of the two loan officers knows what they're doing. It has happened that on the last day to sign and still fund within deadline, I had my back-up loan ready to go, and the primary loan officer didn't have theirs ready despite a head start. So I suppose I can't prove the other loan wasn't real - but it sure wasn't ready on time, and that's unreal enough to be another reason why you want to apply for a back up loan!

Caveat Emptor

Original here

real estate mortgage backup loan consumer education

With a few lenders starting to loosen their requirements slightly in San Diego, it's becoming increasingly obvious that the bottom is behind us. However, the issue has now become, "I don't have much of a down payment. How do I buy now so I can get into something before the market goes crazy again?"

There are several programs that exist that enable buyers to lower their down payment requirements. All of them have their limitations, but if you can jump through their hoops, they remove the need to save for a huge down payment.

The first of these are VA Loans. Right now, VA loans are the magic bullet. No down payment requirement, and you can even finance closing costs up to 3% on top of the purchase price right into the loan. Furthermore, there is not only no PMI, but the VA only charges a half point to fund the loan, and that's waived with 10% or larger disability. Additionally, the conforming limit with VA loans is no longer applicable - I've had wholesalers tell me they would accept VA loans up to (potentially) $1.5 million dollars. There are no income limits, either, but you do have to qualify full documentation. However, because there's no PMI, no need to split loans, and no ongoing charges for the loan, by debt to income ratiopeople with VA loan eligibility can afford almost ten percent larger loans than people applying for FHA loans, and about twenty percent larger loans than high loan to value conventional conforming loans (Below 80% loan to value ratio, conventional loans will most likely have a lower tradeoff between rate and cost). The biggest drawback is that you have to have served in the military or be serving, something comparatively few people do as opposed to former times. San Diego is a military town, and I've only dealt with one VA loan in the last year or so. It was formerly true that FICO credit score was not considered in VA loan qualification, but this has changed in the last year or so. How low a credit score they will work with is up to individual lender policy. Some lenders want a minimum of 580, others won't talk to you unless you've got a 680. The higher their qualification standards, of course, the lower the rate/cost tradeoff they offer will typically be.

Best of all from a longer term standpoint, because there is no seller participation needed in the VA loan program, it doesn't matter whether the seller is willing to do extra things in order to get the property sold. This means you aren't constricted in which property you choose, and it does enable you to end up with a better bargain on the property of your choice.

Many locally based first time buyer programs take the form of loaning you a down payment. If you're buying a $300,000 property and the city you're buying in will loan you $60,000 for the down payment (usually in the form of a silent second), then you only need a $240,000 regular loan, which leaves you with an 80% loan to value ratio, and you are then able to qualify for a classic conforming A paper loan on your property. The drawbacks of these programs are two. First, budgetary constraints. As of a couple weeks ago, all the local municipalities were out of money for these until the new allocation comes in (usually in the fall and spring). If there's no money left in the budget when you want to apply, you're not going to get one. Second, income limits. These all have income limits, which vary with the program and municipality. Since like all other government programs you have to qualify for these via full documentation of income and proving you make enough for the payments via income tax forms, this can disqualify you or severely constrict what you qualify for, and the various municipal governments do put other strings on these programs. Nonetheless, the Cities of San Diego, El Cajon, and Santee have these programs in place, as does the County of San Diego for unincorporated areas, as well as administering the same program for Lemon Grove, Imperial Beach, Poway, and many other cities. Like VA loans, because there's no need for sellers to contribute to these financially, buyers who use these don't end up paying for it in the purchase price of their property, or by a limited selection of sellers with the wherewithal.

FHA Loans are not, in their basic form, a zero down payment program. They will only allow up to 97% of the purchase price. Furthermore, they charge a point and a half upfront and half a percent annualized per year for financing insurance. The good news is that you're still getting a very low down payment loan with comparatively low cost financing insurance. This is a government program, so you have to qualify via full documentation of income, and many properties are not eligible for FHA financing. The FHA also keeps what is functionally a blacklist, so you can find out that because your real estate agent, loan officer, etcetera contributed to fraud some time back, this particular transaction is not going to fly FHA. The FHA does allow seller paid closing costs of up to six percent, but if you think you're not going to pay for this via increased sales price, I've got some beachfront land in Florida. That means higher cost of interest, higher property taxes, and less equity if you sell or refinance. Furthermore, not every seller is going to be willing or able to work with people who want seller contribution for closing costs.

Down payment assistance programs are targeted at FHA loans, providing the 3% down payment via a reciprocal loan paid back by the seller at close of escrow, although FHA is not the only loan type they work with. Once again, not every property owner is going to be willing or able to work with these programs, and if you think the money that sellers furnish for these programs doesn't result in a higher sales price, I own a bridge in Brooklyn I'm willing to sell on very reasonable terms. More than the amount of the loan you get, because they're offering something not everyone can. You have to be careful to disclose everything to everybody in these situations, and the purchase offer and subsequent counters have to be written very carefully.

Seller carrybacks are comparatively rare right now, as few sellers have significant equity. The ones who do and want to sell are likely to be able to wait until things get better, and so most of them are. Asking for a carryback is a major request on a purchase contract, because if that seller loans you $X, those dollars are not available for them to use purchasing their next property, or whatever investment they wanted to put the money into - they're still tied up in this one. Sellers willing and able to offer a carryback can command premium pricing, even in this sort of market, because many buyers will have exactly two choices: buy this property, or don't buy anything. They are also assuming a significant risk of non-payment and ending up in second position on a non-performing debt, which can cause them to lose every dollar they have invested.

Finally, as of a few days ago, some lenders are once again willing to go 95% loan to value ratio for conventional conforming A paper loans, where before that the down payment requirements were ten to fifteen percent. There will be PMI, you are required to qualify full documentation, and the limit is the "regular" conforming limit of $417,000 as opposed to the "jumbo conforming" or "temporary" limits ($697,500 in San Diego). But once again, you can do this with basically any residential property that's not too expensive, and the seller needn't be willing and able to financially contribute to the loan. There are a lot of properties out there that FHA will not touch, no matter how helpful the seller is willing to be. As long as it's an inhabitable residential structure meeting requirements, conforming loans will potentially work - if you've got 5% down. Nor do they require that the seller be willing and able to help out. 5% down is not usually a huge amount. For example, a couple each borrowing $10,000 from retirement accounts (as allowed by the rules) has a downpayment of 5% of $400,000, which buys a pretty decent place nowadays.

As you can see, there are drawbacks to all of these, as well as advantages. You would be well advised to consider an agent who is also a loan officer, because everything from the initial offer onwards has to be carefully written to remain within the limits of what lenders will work with and will fund. More than once I've had people come to me forty-five days into a thirty day escrow where the only way to make it happen was start by renegotiating the contract. Since the sellers were completely frustrated at this point and just wanted out, needless to say it didn't happen. So there is a limit to the ability to repair incorrectly written purchase contracts. Nonetheless, these options are there, are available, and I have funded loans on them in the past. Given the current state of the market and its likely state a year or two from now, making use of them can mean that you're going to end up much better off than waiting to save that down payment. If the market appreciates in value ten to fifteen percent between now and whenever you have enough for a "normal" down payment, you definitely didn't help your cause by waiting.

Caveat Emptor

Article UPDATED here

On of the biggest time and money wasters in real estate is people that apply for the wrong loans - loans that they can never qualify for because they can't meet the guidelines, or can't prove they meet the guidelines, which amounts to the same thing. Often, loan officers are the worst offenders, judging by the people who come into my office with messes for me to clean up. They don't know how to submit a loan, or they know full well it won't be approved, but they get you to sign up by dangling this carrot, and then snatching it away, but now they've got you working with them and they end up with your business because they told you a fairy tale that sounded better than what the other guy talked about because he restricted himself to talking about loans he could actually deliver.

How do you know what mortgage market is best for you?

There isn't a cut and dried answer unless you're one of those folks who can qualify "A paper" full documentation. If you can do it, and a lot more folks can qualify this way than think they can, A paper full doc is the way to go. Because it's the least risky loan, the banks give you the best pricing. What if you can't make it, however?

The reasons why people fall away from A paper full doc is long. The two largest ones, however, are people who cannot prove they make enough money and people whose credit score isn't high enough. At a distance from that, the third reason why folks don't qualify, is late payments. A paper permits one thirty day late on the mortgage, or two on other credit. If you fall off the pace due to late payments, you have to go subprime.

A paper accepts only two ways of proving your income: Income tax forms and, for some employees not in construction or on commission, w-2s and year to date pay stubs. If, with the income taken from these forms does not qualify you according to A paper debt to income ratio considering your known debts (typically 45% or less back end ratio, but I've seen high seventies get accepted in certain circumstances), you do not qualify full documentation. Think of full doc as being where you prove you're got enough income to make your payments. If you can't do full documentation, you have to go to stated income.

A paper also requires an absolute minimum credit score of 620. 619 is an automatic rejection from any A paper program out there. Some A paper may require higher credit scores (640 jumbo, 660 stated income, 680 for both), and if you haven't got it, you don't have the loan, either. If you don't have the relevant credit score, you're going to subprime.

A paper stated income is where you've got a good credit score and can prove that you've got a job (or a source of income) and you've had it for two years. You just can't prove you make enough money to justify the loan. You could be making it, though, and the lender agrees not to verify, although they will look at it to see if the income you claim is consistent with your profession. You're paying your bills on time, though, so lenders are willing to believe that you're living within your means, and therefore qualify for the loan. They are not agreeing to close their eyes if something indicates you cannot afford it or what your real income is; they're just not going to go out of their way to verify your income. They are going to have you sign an IRS form 4506, releasing your taxes to them. Don't worry too much about it. The IRS takes a minimum of 60 days to respond, and the loan will be done in thirty, if your provider is competent. It is exceedingly dumb to over-state your income on stated income, because you're still going to have to make the payments on that loan. The major reasons why "A paper" stated income falls out are low credit score, insufficient time with your source of income, and incompetent loan officers who allow the underwriters to find out that the client can't prove they make that much. Low credit score goes to subprime, insufficient time in line of work goes to NINA, and loans with incompetent loan officers start over with another lender.

A paper NINA is a loan driven by the credit score and the situation you find yourself in. NINA is also called "no ratio", because there is no debt to income ratio, and the personal qualification consists of a good credit report. Of course, you still have to have the appraisal and the rest of the documentation relating to the property. Furthermore, the rates are higher than stated income (which are in turn higher than full documentation), and the maximum Loan to Value Ratio is lower. Common fallouts are credit score too low (go to subprime), loan to value ratio too high (go to subprime) and something wrong with the property (go to hard money)

Subprime is an entirely different world than A paper. The standards are different, the qualifications are different, everything is different. Just because you can't go full documentation A paper doesn't mean you can't do it subprime. For one thing, typical subprime goes up to fifty percent debt to income ratio, and a few lenders will go higher - some as high as sixty percent! So even though the rates are higher, it may be easier to qualify. Subprime lenders have also become a lot more scarce on the ground in the last year, and the ones that still exist are mostly looking for A paper clients that don't realize they qualify A paper. With that said, subprime loans do exist, but it's no longer "warm body" qualification.

Subprime also has another form of accepted income documentation: bank statements for the last six, twelve, or twenty-four months. This is highly useful to the self-employed who may not be entirely forthcoming on their taxes. When I started, this was always discounted, but of late personal bank statements have been accepted on the strength of 100 percent of the income they show. This rate will be higher than a borrower who can prove their income via one of the A paper methods, but is lower than stated income. Number one reason for falling out of subprime full documentation: Not enough income. Number two: sub-500 credit score. Number three: the underwriter believes that you manipulated your income on your bank statements. Not enough income goes to stated income subprime (with another lender, as if it was submitted full doc it cannot go stated income with that lender). Sub 500 credit score goes to hard money, which is where you might as well start when you find out, because regulated lenders can't touch you if you don't have at least one of your three credit scores above 500. If the underwriter thinks you manipulated your income, you or your loan officer have either got to convince them you didn't, which usually requires w2s at least, or you are going to another lender.

Subprime stated income is fairly wide open, with the proviso that a given credit score will have a higher rate and a lower maximum permitted loan to value ratio. Number one reason for falling you here is that you don't meet loan to value guidelines. Number two is you didn't state enough income in the first place, and you don't qualify by debt to income ratio guidelines. Number three is you stated too much income, and the underwriter doesn't believe you make that much money. They can always require income documentation - they don't have to let you state it without verification. At best, anyone suffering from any of these three problems can expect to have to go to another lender, because this lender will not now approve their loan. Maybe lose a little time if you're working with a broker who then submits the package elsewhere. Back to square one if you were working with a direct lender.

Subprime NINA is even more wide open. A loan officer has got to be a serious bozo to blow this one, but I have cleaned up behind more than one that went bad.

Hard money is the last hope of the unfortunate. These folks don't care about your income, your credit score, or anything else. What they care about is that they can sell the house for enough to cover the loan if you default, and unlike regulated lenders, they will record that Notice of Default on the day you become eligible. Sometimes they are the only choice, but if you find yourself dealing with them you should really ask yourself if this loan is something you absolutely have to have, or if you just want it. If the answer is the latter, my advice is to reconsider getting the loan.

There you have it, something like a flowchart of what kind of loan you should apply for. These are far from the only reasons loans fall apart, of course, but they are the most common. A good loan officer knows enough of the tricks and traps to tell you the truth straight off, and apply to the appropriate loan first, without wasting your time and money. Bad ones don't.

Caveat Emptor

Original here

I have just gotten an email from one of my wholesalers (who shall remain publicly unnamed) removing the "declining market" designation from San Diego loans!

This particular lender is still not willing to do 100% loans, but they will go 95% for conventional conforming and this also removes the requirement to reduce the appraised value for loan purposes.

I do not know how long it will be before everyone, or indeed, anyone else, follows suit, but this is certainly an encouraging sign, and the first official notice that we've had that we've seen bottom.

Believe it or not, I was typing an article with the words, "When will we see a loosening of lending standards? I don't know but I wouldn't be surprised if it happened today." It'll run tomorrow, providing I finish it.

I did predict this several months ago and re-emphasized it a few days ago. You never know market top or market bottom from official statistics until significantly after it has passed.

UPDATE: For those who may not understand, this means that this lender has seen evidence that the market is no longer declining. Other lenders are likely to follow suit. The practical effect is to make it easier to get loans, which means that now people with 5% down payments are now eligible for conventional financing. Since we were in an environment where 10 to 15% down payment was required (outside government guarantee), this means more people are able to be in the market, hence, there will be more people in the market. Therefore, demand increases, raising the price equilibrium point. Because of that, we can expect further rounds of loosening of lender policy to follow, now that this first step has been taken, each of which makes it cumulatively easier to qualify for loans, thereby boosting demand further in the future.

To someone not familiar with financial markets and the way lenders think, it may appear I'm building castles upon a shaky foundation, when in reality these effects are each very likely consequences of the one before it. It will take some more time before lender policy is back where it should be, but each step adds to the forward momentum. We're not going back to "fog a mirror" anytime in the next fifteen years, but I do expect to see 100% conventional financing for full doc conforming borrowers above 680 credit score within a couple years.

In the last couple of years a movement has arisen, led by certain well meaning academics, that says negotiating a loan broker's total revenue is sufficient to get consumers a better loan. As far as they go, they are even correct - it is a better alternative than you find with the vast majority of the loan providers out there, because it removes the ability to arbitrarily boost their own compensation by kickbacks, markups, and just delivering a more expensive loan. This arrangement, which I will call compensation pricing for the purposes of this article, encourages consumer to choose the loan provider who is willing to represent that they make less money than any other. Note that this is not the same thing as actually making less money than any other loan provider.

Most consumers don't understand loan accounting. In the past I have gone over loan accounting as many as three times at and after closing with a given client because they didn't understand what were and were not costs despite me having explained it at loan sign up. I've explained it in person, then again over the phone, then to the guy's accountant, who himself had difficulty understanding the accounting on the HUD-1. For instance Impounds are not a cost, and thankfully, California now has a law that lenders can't charge for not having them. Nonetheless, for those people who do want an impound account after I explain that they are not costs but do require seed money up front, they still often want to count that seed money as a cost. They're not. Impound accounts are that property owner's own money being held to pay that property owner's property tax and homeowner's insurance, bills that that property owner would have even if there was no loan at all on the property. When the loan is paid off, the money in the impound account is promptly returned to the homeowner.

Prepaid interest is another example of money that people do not understand. It is money they would owe in any case. If they choose not to write a check for the month that they refinance, that interest charge has to be paid somehow. It is possible to roll it into the loan balance in most cases, but that is NOT "skipping a payment". You will never EVER skip a monthly payment as long as you have a loan. If you choose not to write a check, you are simply adding it to your mortgage balance.

These two items (assuming the consumer does not pay them out of pocket with a check) can easily add seven or eight thousand dollars to a $400,000 balance, but they are not costs of the loan. They are money that has to be accounted for because they are active and ongoing parts of the loan environment. The new lender is usually perfectly willing to add loaning you this money to your loan balance because they will earn interest on it, but they are in the business of loaning money for interest - they're not going to loan it to you for free. Furthermore, there are immediate cash flows back in your favor in each case. Assuming you currently have an impound account, you'll be getting that money back in the form of a check within a few weeks from the former lender, roughly offsetting the money you borrowed today. Unless your loan has a prepayment penalty, take that check and use it to pay your loan down when you get it, and you'll be roughly even on the impound account money. The same applies to prepaid interest - if you don't want to write that check, but roll it into your loan balance instead, you will then have a month where you don't make a loan payment. You emerge essentially even - except for the fact that you're now owe more money, which you'll be paying paying interest on essentially forever. It's exactly the same as if you had taken "cash out" in a refinance.

But essentially everything else is a cost of the loan itself. Appraisal, title, escrow, notary, processing, underwriting, recording, etcetera. That loan provider should know what they will cost, but most consumers have no real idea. That loan provider also knows what loans are really available, but unless that consumer is a loan broker themselves, they really don't. Various sites publish weekly averages, but that's always what the rates were, not what they are, and are highly misleading in any case. The best loans available, so called "A paper" which a minimum of 75% of all borrowers should qualify for, have their rates change every day at a minimum, and sometimes several times per day, and as of a few months ago, now vary with credit score of the applicant and loan to value ratio as well. Furthermore, all of these services that I'm aware of are based upon a national average, and even for the national lenders there are variations in the rates between the states due to some states making it more expensive to do business than others.

I cannot hit too hard on this point: That loan provider should know what they can deliver, but the consumer does not, because the informational resources available to them are nowhere near real time, and not nearly so concrete as the loan provider's ongoing experience with their lenders and third party service providers.

Compensation pricing leaves the consumer assuming pricing risk on the loan. The first implication of this is that even though you have negotiated their company revenue, they can still lowball their quotes. You've mutually agreed that they're going to make $2500 for doing this loan - but they're still competing with Larry the Loan Low-baller, and they know it. The vast majority of competitive pricers offered what looks like a cheaper loan will switch, regardless of whether it really is better. The incentives for low-balling and pretending that costs they you are going to pay do not exist, but guess what? You're still going to pay them. Quoting a shorter rate lock period than necessary to deliver the loan means that they can pretend you're going to end up with a cheaper loan, but what happens if rates rise between quote and lock?

A subsidiary weakness of compensation pricing is "What does it include?" When negotiating compensation pricing, I have to include processing because sometimes I do my own when I want something handled just so, and even when I don't, I use an in-house processor. Since I'm negotiating total company revenue, I have to include that in my negotiations. Somebody who uses strictly contract processing can exclude processor cost from negotiations in compensation pricing, because that money is going to a third party they can show a receipt for. Were any direct lenders to negotiate compensation pricing, it would have to include all their lender imposed fees such as underwriting and document generation, as well as secondary loan market premium they expect to receive from the loan (a number which would vary with developments in the financial markets as the loan progresses, by the way). Brokers usually are significantly cheaper than direct lenders, but these numbers would appear to amplify that difference far more than warranted, and is a reason you'll fly to the moon by flapping your arms before direct lenders honestly negotiate their total compensation in this manner.

This leads into another weakness of compensation pricing. The FTC did some research a while back which directly highlighted this fact, that choosing the lowest loan provider compensation does not translate into the best loan. Focusing on loan provider compensation takes your eye off the ball of the best bottom line to you, the consumer. If that loan broker is going to make $2500 for your loan, no matter what, do you think the broker is motivated to aggressively price your loan with every possible lender and find you the best possible price on that loan, or are they motivated to go with the loan they can get through underwriting most easily? It really does make a huge difference, if they take the time time to understand the niches a given lender is aiming at. More than once, by shopping the right lender I've come in with quotes that would enable me to tack on two points of compensation to my company revenue and still deliver a better loan than my competition. Not to mention I was willing to assume the pricing risk, and they weren't.

Compensation pricing also assumes that the broker or lender is honest about their revenue. Given the facts in the second through fifth paragraphs of this article, that one is worth more laughs than Robin Williams and Bill Cosby combined have gotten over the course of their entire careers.

What is the alternative to the consumer retaining pricing risk? The lender (or broker) assuming it, of course. It really doesn't take much more information. The lender indicates in writing the loan type or characteristics, the interest rate, the total cost, and whether or not there is a prepayment penalty attached, then guarantees in writing that they will pay anything above that level. Note that all of this information is necessary, and four things really isn't a lot to remember. rate and cost are always a tradeoff for any given loan type, so ignoring one to concentrate upon the other makes your shopping for a loan a complete waste of time. Making certain you're talking about the loan type you want is a real good idea unless you're willing to risk getting stuck with something else, and the presence or absence of a prepayment penalty (and for how long!) can make a huge difference. Two percent on the rate is not at all unusual, so failing to nail them down as to whether there's a prepayment penalty is a real problem. Here's a list of Questions you should ask every provider you shop before you sign up for their loan.

Furthermore, focusing on guaranteed pricing means that you're focusing on what's really important to know: How much money this loan is going to cost you over time. You're zeroing in on the bottom line to you, not extraneous and distracting information about how much someone is going to make providing it. Wal-Mart makes more per item than most of their competition, but people shop there in droves. Why? Because the bottom line is better for them, the customers. If I offer to sell you the exact same television $100 cheaper than my competition, which set are you going to buy? Do you even care if I'm going to make $50 more than the other salesperson? The situation is the same with loans.

Quote guarantees are not a panacea. It can be exceedingly difficult to enforce them right when you need the loan, so I still recommend a back up loan if you are at all unsure of that loan provider's intent to deliver the loan they promise. There are limitations upon the best of quote guarantees, as loan officers are not loan underwriters and cannot write loan commitments. The loan officer cannot promise you the loan; they can promise you the rate and cost provided the underwriter approves it, and they can go over the main guidelines with you to make certain there isn't a known reason for the loan to be rejected.

But by forcing the lender to assume pricing risk, you are far more likely to end up with a better loan out of the process, because they have to tell you about the real costs and the real rate that they have reason to believe you will qualify for. If they don't, the difference comes out of their pocket, not yours, whereas in any other pricing scheme, who do you think is going to get stuck for the difference? For this reason, I'll recommend any guarantee that forces the lender to assume pricing risk over any loan quote that does not. Even if the other quote is lower, without that pricing guarantee what evidence do you have that they intend to deliver that lower quote? There is no sufficient answer to that question. If they intend to deliver, they should be willing and able to guarantee pricing.

I assume pricing risk on every loan I quote.

Caveat Emptor

First off, neither the California Mortgage Loan Disclosure Statement nor the Federal Good Faith Estimate are promises, commitments, or anything more than your loan provider wants them to be. Quite often, they're nothing more than a fictional story told to get you to sign up for their loan. It's amazing and disgusting how much it's legal for lenders to lowball their quotes.

That said, there are three explanations as to why your rate is higher. They're not mutually exclusive by any means, but it has to be at least one of the three.

The one that reflects on you is that you somehow misrepresented your situation when you were getting that loan quote. In that case, you are no one's victim except your own. It is pointless to lie to a loan officer, and if you don't know the answer, you should say "I don't know" instead of making one up. This does happen, but it's probably the rarest of the three answers, and you should know if you did it. If you didn't do this, what's left is one or both of two common loan officer sins.

The less abusive of these is that the loan officer failed to lock the loan. This is either rank stupidity or frustrated avarice. Shorter rate locks are cheaper, and there's always the hope that rates will go down, so they can make more money on the same loan they quoted you. Of course, rates can go up, also, and they do so about fifty percent of the time. When that happens, they can either make less money, often to the point where delivering the original loan would cost them thousands of dollars, or they can deliver a loan with a higher rate. Since we're living in the real world here, which of these alternatives do you think is going to happen?

The more abusive alternative is that you were deliberately lowballed. There is always a tradeoff between rate and cost for real estate loans, and the person who gave you that quote told you about a loan that didn't exist. Either it always carried a rate much higher than you were told, or the loan officer ignored potentially many thousands of dollars it was going to cost all along. I see this happening literally every time I check a loan quote forum. I do business with eighty lenders, among which are the lenders who are most keen to compete based upon price. I know what's deliverable and what is not, every other loan officer I respect knows what is and is not deliverable, and I can't imagine anyone in their right mind wanting to do business with anyone who doesn't know whether what they quote is deliverable. It's not exactly confidence inspiring to be told essentially, "I can get you this loan, but I don't know if it really exists." I'm sure you'd line up for that loan like it was free beer, right?

Not really. But loan officers do this because none of the paperwork you get at the beginning of the loan process is in any way binding. Not for price, not for a loan at all. In fact, the only form that's required to give an accurate accounting of the costs is the HUD 1, which you don't get even in preliminary form until you are signing final loan documents. Loan officers do this because once you have signed up for their loan, you are likely to sign the final loan documents no matter how bad they are. Why is that? Because thirty days or so have gone by, you've got a deposit at risk that you're going to lose if you don't sign, and you're not going to get that house that you wanted badly enough to put yourself in debt for thirty years. I assure you that loan officers know that they will have you over a barrel when you go to sign final documents. Many of them are counting upon that from the day you sign up, and they'll tell you anything at loan sign up in order to get you to choose their loan, because it's not like any of this is binding on them.

Let me get one other thing out of the way to clear the air: You didn't get a higher rate because you somehow didn't qualify for the lower rate. The way people qualify for loans is based upon debt to income ratio and loan to value ratio, and of those two ratios, debt to income ratio is much more important. The lower the debt to income ratio, the more qualified you are. Debt to income ratio is a measure of the ratio of how your housing and expenses compare to your overall income. Lower interest rate means lower payments. Lower payments mean lower debt to income ratio, and hence, you become better qualified the lower the interest rate that is available. Counter-intuitive though it may be, it's easier to qualify you for a lower interest rate than a higher one. Any loan officer who offers you an excuse that you didn't qualify for the lower rate has just flat out told you that they are a liar.

What really happens is that while this loan officer was spinning you a tale of how great the rate you were supposedly going to get was (a loan officer's version of, "Yes I'll respect you in the morning"), in amongst all that creative storytelling, they neglected to account for the money you really are going to be paying, or even the money they admitted you were going to be paying.

However, we're dealing in the real world here. That money still needs to be paid.

There are three ways to pay it: Borrower cash, rolling it into your mortgage balance, or by giving you a higher rate. They have to tell you if they want more cash, and you may not have it. There's only so much equity in the property, particularly on a purchase where there is no playing valuation games via a compliant appraiser. But since there is always a tradeoff between rate and costs, they can always create some more cash by sticking you with a higher rate, resulting in more cash available to pay for the things you were going to be paying from the very first. Often it means they'll make more money as well, for providing this "service", because "you were such a hard loan." Sticking you with a higher rate is often the only way they can pay for all the things that need to get paid. Yes, this means that you end up paying more for the low-ball deceiver's loan than for a loan where you were quoted something honest.

All of this is nothing more than practical effects of the common phenomenon of lenders low-balling their quotes to get you to sign up with them, knowing that when the time comes to actually deliver that loan, they will have all of the power and you will have none, which is a 180 degree reversal from the situation at sign up. They have this loan that you need right now, where anyone else will take time you probably don't have. If rates have gone up (once again, this happens about fifty percent of the time), even the lowest cost, most ethical provider in the world might not be able to deliver what this scumbag is offering you by signing his loan right now. If he's got the originals of your documents, you can't take your loan elsewhere. Finally, most people are tired of the whole loan thing by the time it comes to sign documents. Many folks won't examine the final documents carefully - figures I've seen say that over fifty percent of all borrowers literally never figure out that they were hosed by their lender, and on the ones who do figure it out, about eighty five percent will sign anyway because signing means they're done.

The games that lenders play are legion. They can lure you in with talk of low rate that exists, but costs you more than you'll ever recover. Whether they deliver that rate and soak you on the cost end, or switch it off for a higher one to pay the costs and make more money, is up to them. I see lenders quoting full documentation conforming loans for people who are known to be stated income, temporary conforming ("Jumbo conforming") or even non-conforming loans. Even for people who are full documentation and would have qualified if that loan existed at the costs they told you about, this need to raise the rate can move you to over to being a stated income loan because you no longer qualify full documentation at the higher rate. With stated income loans under the constraints they've encountered in the last few months, this not only means higher rates, but quite often means that no loan can be done, something completely alien to the thinking of many agents and loan officers who became accustomed to the Era of Make Believe Loans, and they haven't yet gotten their heads out of that mindset.

How can you avoid this? Ask all these questions of every loan provider, know what the red flags are if you encounter them, and take steps to protect yourself from being lowballed. A written loan quote guarantee is good, but can be hard to enforce immediately. Better yet is to apply for a back-up loan, so you have two loans ready to go. This is leverage to force one or the other of them to actually deliver something better than they are trying to.

You don't need to get victimized by any of the things that go on in the world of mortgage loans. But you have to understand that they do happen, and you have to take specific steps to prevent it from happening to you. Otherwise, you're just trusting to luck, and judging by what people have brought me from other providers, you'd need less luck to win the lottery so you can pay cash for the property.

Caveat Emptor

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