Mortgages: September 2008 Archives

Looking back, I suddenly discovered I don't have a clear explanation of Home Equity Loans and Home Equity Lines of Credit in any previous article. It's time to remedy that.

A Home Equity Loan, or HEL (pronounced "heel") is a one time loan, much like a car loan. You get the money all at once, pay it back so many dollars per month, and when it's paid, it's over. The most common Home Equity Loan is probably the 30/15, which is like a fully amortized thirty year fixed rate loan except that it's got a balloon payment at the end of fifteen years, when the remaining balance is due. Since very few people do not sell or refinance much sooner than that anyway, the fact that it has a balloon just isn't important to most folks. I do not know why, but the rates for true thirty year fixed rate loans are much higher than for 30/15s. Fifteen and twenty year fixed rate Home Equity Loans are also pretty common, these being truly fixed rate loans without balloon payments, but the payments for those are significantly higher, so many people are not willing to consider them.

A Home Equity Line of Credit, or HELOC (pronounced hee-lock) works more like a credit card than anything else. At one point in time, I actually had a VISA card linked to a HELOC. There is an initial draw, which can be $0, and your monthly payments are based upon your actual balance. If there is no balance, no payments. The main difference is where credit cards are usually indefinite period and you can keep charging on the card as long as you pay your bills and stay within your limit, HELOCs usually only have a five year initial "draw period" when you can actually take more money, followed by what is most commonly a twenty year repayment period where you are making payments, but cannot draw any additional money. Unlike Home Equity Loans, HELOCs are variable interest rate loans based upon the prime rate on a certain day of the month. Also unlike Home Equity Loans, HELOCs are lines of credit, where you can take more money as long as you are within the draw period and under your limit. Also, so long as you are within the "draw" period, the minimum payment is usually based solely upon the interest accruing in any given month. It's only after the draw period ends that most of these loans begin to amortize as far as the minimum payment is concerned, but you can always pay extra.

With both Home Equity Loans and HELOCS, they are assumed to be Second Trust Deeds, with a different kind of mortgage in first position. But because the closing costs can be much lower than for a regular first trust deed, it need not necessarily be so - you don't have to have another mortgage in front of them. Indeed, sometimes with comparatively small mortgages (usually under $100,000) it can save you money by selecting a Home Equity Loan or HELOC instead. Even if the rate for the Home Equity Loan is a quarter of a percent higher than for a fixed rate first mortgage, it can save you money by saving you $2500 in closing costs. Often, you can find competitively priced second mortgages where the closing costs are zero. So if you can save $2500 on a $100,000 balance, it'll take you ten years to recover the difference in closing cost at a quarter of a percent per year, if you buy with a traditional first mortgage, and most people refinance within three years anyway. In such cases, it can make sense to choose a Home Equity Loan or Line of Credit instead.

Home Equity Loans and HELOCs are priced upon the degree of risk that lender is assuming. If you're taking out a $100,000 loan on a half million dollar "free and clear" property, you can expect better rates than someone taking out the same loan when there's a $300,000 loan already in place. One thing to be aware of is that because Private Mortgage Insurance is typically not available, lenders for Home Equity Loans and HELOCs have significantly greater equity requirements, and they are not typically willing to insure any amount over 90% CLTV, or comprehensive loan to value ratio, at least not as of this writing. Given how badly they were burned by piggyback loans, I would not expect this to change any time soon.

Caveat Emptor

Article UPDATED here

This has been a noticeable phenomenon for at least the last year in San Diego, but I've been loath to talk about it because I didn't want to be giving fraudsters ideas. Most lenders have now put into place safeguards against this measure. As always, they do not distinguish between guilty and innocent, but the lender is the one risking their money. You have to show that you are a good risk.

The basic event is this: People have decided to relinquish their current property to the lender. It's not worth as much as the loan is for, so they see only a gain to be had there with current law declaring the income from forgiven debts non-taxable for the remainder of the year at least. Perhaps they couldn't afford their new payments after the teaser expired. Perhaps they could; they just don't understand what they are doing to their credit and the fact that the market is going to come back - sooner than they probably think. Perhaps it's a non-recourse loan and they see only the fact that they owe more than the property is currently worth.

But these people don't want to be homeless, and they do understand that after they have gone through foreclosure, not only are lenders going to be highly resistant to lending to them, but landlords are going to be reluctant to rent to them. So they hit upon what they think is a brilliant plan: Buy a new house before allowing the old one to go into foreclosure. After all, the degradation to credit hasn't happened yet! However, it is still fraud. These people have an actual plan to allow a property to be foreclosed upon, and a reasonable person would know that lenders would consider that in deciding whether to grant credit.

Unfortunately, there has been enough of this going on that lenders are no longer willing to let it go unchecked and unchallenged, so they are looking for evidence that new buyers of primary residences and second homes do not plan to "buy and bail". These are by no means the only measures they are taking, but they want one of about 3 things to be present.

• the ability to make both payments without any rental income
• a verifiable job change to a new commuting area, and the need to relocate (i.e. nothing in the same commuting area)
• significant equity in the current property, even by the standards of the down market

It should be noted that meeting any one condition is not a "get out of underwriting free" card. There are other checks being made upon the process, checks I am not going to discuss beyond saying that the transaction has to pass a "smell test." Being someone who doesn't like seeing bad real estate loans made, for a plethora of reasons, I welcome the return of the smell test. I've seen the aftermath of too many transactions that smelled worse that week old fish in dumpster on a hot day. You may think you're a "a special case," but every single one of those folks out there facing foreclosure or having gone through it already also thought that they were "a special case" then, and the ones trying this fraud think so again now.

These new restrictions have hurt, and will continue to hurt, legitimate investors by making it more difficult to qualify for the loans. It is nonetheless a fact of life brought upon us by the market. Furthermore, 20% down is pretty much an absolute minimum for buying investment property currently currently. Furthermore, even the lenders that were accepting loans for both a primary residence and a second home in the same commuting area have now stopped that practice. It was silly to start with, and it has only gotten worse of late, but people who want to avoid the constraints and requirements of investment property loans were eager for it. I just don't understand why lenders were willing to accommodate them. Either the charges and higher equity and qualification standards were necessary, or they were not. If they were necessary, why were the lenders bypassing them? If not, why did they exist in the first place?

I can understand people who don't want to be homeless. However, while "Buy and Bail" may not always be obvious before the fact, but it is afterwards, and the lenders are starting to take notice of foreclosures against other companies, and they are even writing in clauses that make their loan callable, by which I mean they can demand you pay that loan off in full, giving you 7 or 30 days to make the actual payment. Once again, this sort of clause is going to disadvantage people who have had the property a while and be intending no harm who do hit hard times: Job loss, disability, etcetera. Nevertheless, "Buy and Bail" is fraud, and the lenders are entitled to take whatever measures they think reasonable to insure that they don't lose their money to a suddenly unacceptable credit risk, as well as to return a reasonable return on that money. It may seem like cruelty to you, but I'd like to see some of the folks pulling it sentenced to an enforced residency in a government institution wearing funny pajamas, because games like this destabilize the mortgage market for everyone, and every time somebody pulls a game like this, someone who should be able to qualify for a loan is now unable to do so, further screwing up the home loan market for 300 million Americans.

Caveat Emptor

UPDATE: I got a question from Realtor Ricki Widlak of flhotproperties.comwho doesn't understand how people pull this, in that they're going to have another home loan on their credit report. The answer is that they claim they are going to be receiving $X in rent per month. They fake up a lease contract, usually between themselves and a family member or close friend. The added number of dollars per month from this entirely fictional contract makes it appear as if they qualify. However, because the lease is not real, they don't. Ergo, the qualify without rental income restriction.

He ends with this question: "How do people "walk away"? Who walks away from anything in this information age anyway? I just don't get it. These people are "leaving behind" their soc numbers, right?".

The answer to all of these questions is that lenders have no difficulty in identifying this phenomenon in retrospect - these people aren't getting away with anything, and some of the lenders are starting to follow the criminal prosecution route. But identifying the perpetrators in retrospect does not assist the lenders in not making bad loans in the first place, which is the situation the lenders want. So they raise the bar for qualification for everybody in order to weed out these bad apples. Yes, people who would otherwise qualify are getting turned down for loans. However, the lenders are not a court of law, where we'd rather a dozen guilty people go free than one innocent one be punished. In fact, the lenders have precisely the opposite view, especially in the current environment: They'd rather turn down a dozen good loans than accept one bad loan, and they are now writing their lending criteria accordingly.

Article UPDATED here

Fannie and Freddie have long had a policy that they would not fund investment property (non-owner occupied) beyond 10 loans. Although it did impact a certain number of investors, for most folks that rule just never came into play. There has been a formal announcement that they are going to reduce that limit to 4 loans, which is going to put an awful lot more investors in the position of needing a portfolio loan.

Portfolio loans are loans where the lenders originate the loan with the intention of holding it themselves. In recent years, this has been a very limited niche, and even those A paper loans written with the full intention on the part of the lender to hold it themselves were often underwritten to Fannie and Freddie standards, so that they could sell such a loan. Not that there were very many of those.

Portfolio loans largely went away because the tradeoff between rate and costs is much higher than the standard securitizable loans. In plain english, the rates are higher. When the lender originates a loan and sells it on Wall Street, it gets an immediate return of 2.5 to 4 percent on its money. Not as much as holding a six percent loan for the year, but they can turn right around and use the money to sell another loan. Lenders don't have any trouble getting four to six loan sales on the same money per year, some manage eight or better, and twelve is possible, if unlikely. Therefore, they make anywhere from 10% to maybe 25% per year by selling the loan repeatedly, as opposed to about six percent for holding it. Which of those do you think the average lender sees as more attractive, particularly if they also retain servicing rights and make money that way without risking any of their own?

So if the lender is not going to be able to sell the loan, but rather have its money tied up until you decide to sell or refinance the property, then they're going to want something more akin to the 10% or better return they get on their money by originating and selling the loans. Instead of something around six percent, portfolio loans are typically around eight percent or higher. Some people will tell me they don't want their loan sold. I ask why, and they tell me about the hassles and ending up with an unknown company. I explain that the contract is the contract, and the only differences if your loan is sold are the name on the check and the address on the envelope (or, if you pay online, the routing number you use). For those that still come back with "I don't want my loan sold," I then say, "Well, then it sounds like what you want is a portfolio loan. The interest rate will be two percent higher, meaning your payments will be (number) dollars per month higher, and your cost of interest will be (bigger number) instead of (smaller number)." Them's the facts. Some lenders will lie about it to get clients to sign up for their loan, but that doesn't change the facts. They can deliver a portfolio loan, or they can deliver a regular loan where the lender is still going to sell that loan. Which would you rather have, an honest discussion of alternatives or someone who chose one alternative without consulting you? Because the loan they deliver will be one or the other, and whether it's the choice you would have made is mostly a matter of luck.

To be completely honest, even portfolio loans can be sold. However, not being designed with standard loan packages in mind, it's harder. If the lender wants to sell portfolio loans, they have to negotiate each and every one individually, rather than in packages of fifty million dollars worth or so. It is a lot less likely to be worth their while to do so, and selling their portfolio loans can be one indicator that a lender is in trouble - providing that they offer portfolio loans in the first place. Not every lender does.

But for those that do, they allow that lender to make the underwriting decision by whether they are comfortable making such a loan, rather than whether or not it meets standardized criteria for Wall Street. This can enable those lenders who do offer portfolio lending to be able to make a certain specific loan, where a lender with its eyes fixed solely on Wall Street does not have the option of saying "Yes."

There are a fair number of loan niches that have always been portfolio loans. Many commercial loans, and loans for investors with over ten properties, to name two. Traditional "non-conforming" loans are not one of them, however. Just because Fannie and Freddie couldn't buy them doesn't mean nobody would. In fact, because they were underwritten to Fannie and Freddie standards in all matters except loan amount meant they were sought after, especially as opposed to subprime loans. But just because portfolio loans are not underwritten for Wall Street doesn't mean that the lenders can ignore Federal Reserve regulations, for instance the one about "Must be able to repay the loan from a source other than additional borrowing against the property". For that, you have to go hard money.

Final point: Because the interest rate for portfolio loans is higher, and therefore the cost of borrowing the money, there are going to be a lot of properties that would be a good investment for someone able to qualify under Fannie and Freddie's rules, where they would not be a good investment for someone who needs a portfolio loan. This is likely to constrain prices from rising to a small degree, and force rents to rise to a somewhat higher degree. If your landlord can't make it work on the basis of the rent you're paying, they have two real choices: Raise your rent or sell the property. Nor is the second alternative any kind of relief. If that landlord couldn't make it work, why would you think the next one can? That's assuming the purchaser doesn't plan to live in it themselves from day one. I have an inflexible rule with tenants where my clients don't want to keep them: They must be out before close of escrow. I suspect most buyer's agents are the same way. One of the fall-outs from the bursting of the real estate bubble that most people don't realize yet is that the economic factors which have kept rent increases low for the past decade or more are all going away. Furthermore, if someone is looking to buy an investment property, the cash flow is going to have to work from day one. If it won't, they're not going to buy it, and it will never become a rental property in the first place. On a $300,000 loan, a portfolio loan instead of a securitizable one means a difference of over $500 per month in the cash flow requirement, which translates to rent increases, and not just from the big landlords with portfolio loans.

Portfolio lending is set for a comeback. With Wall Street becoming ever pickier about the loans it wants to fund, and mortgage insurers restricting what they will insure, a strong lender with good reserves can make a lot of money in this environment by lending to selected borrowers with good credit and plenty of income, that "originate and sell" lenders cannot touch, because Wall Street isn't interested under current standards.

Caveat Emptor

Article UPDATED here

Well?

You would be amazed how often I encounter people who are certain they're getting a great deal on this loan that's in process, but they have no idea what that that deal is. All they really know is that their prospective loan provider sure acted like their friend.

Well, excuse me, but have you ever heard of Honest Iago? Any sales person is going to at least pretend to be your friend. The tricks are legion, and they're not evil, in themselves. But it's much easier to betray someone from a position of trust. "Don't worry, I'll take good care of you." Yes, and even better care of your wallet after it's in their pocket. A real friend may ask for your business, but they won't get upset if you can find a better deal somewhere else.

Loans are complex transactions, but there are three main things to know: Type of loan, interest rate, and the total cost to get that loan at that rate. You should be able to remember three things about one of the biggest transactions of your life, right? Beyond that, there's what the costs include, and whether there's a prepayment penalty, both of which are also important. The reason the existence or non-existence of a prepayment penalty is important should be obvious. A very large proportion of people who agree to even two year prepayment penalties end up paying them, and half of seven percent of $400,000 is $14,000 more that loan will cost you down the road. The equivalent of three and a half extra points, for crying out loud!

What a quote includes is equally important. Does it include appraisal, title, and escrow (or legal fees in those states that still require the use of attorneys)? There are all kinds of fees involved in a loan, but these are the three biggest, and because they are paid to third parties, the law allows the actual dollar amounts to be excluded from quotes. What sounds cheaper: $3022 or "$1405 plus third party fees". In this instance, it works out that they are exactly the same. Similarly, you want to find out if the dollar figure you are being quoted includes the dollar amount of any points you will be charged. Each point is one percent of the final loan amount, so if you've got a $400,000 loan when everything is said and done, you've paid $4000 for every point. If that's two discount points and one of origination, that's $12,000 on top of all the usual fees.

Force them to add in all the costs, and quote you in terms of what the loan amount is going to end up being after rolling all those costs into your loan, if that is what you intend to do. Make them quote your payments based upon that final loan amount, not the base loan amount. Those are the costs you are really going to end up paying, whether or not you wrote a check out of your account to pay them. Those are the payments you're really going to end up making. There are two sorts of mortgage consumers out there: The ones who insist upon understanding what they will really be paying, and suckers. Suckers sometimes stumble across someone who actually gives them a good loan at a good price, but it's blind luck, and far more often, they don't. Furthermore, just because you're not writing a check out of your account doesn't mean you're not paying those costs. You are, and the dollars you spend that way are every bit as real as the dollars left in your grocery bill, even if they are in much larger amounts for mortgage loan fees.

Every time I write an article like this, I get emails that say, "What if I'm doing business with a large reputable company?" Those are some of the worst. Those beautiful buildings, that plush carpet, those beautiful furnishings, those attractive salaries? Your fees are going to pay for those, along with the investor payouts that make that company so attractive to investors. They are competing upon the basis of advertising and reputation, not price, but a loan is not a vehicle. As long as it's on the same terms and conditions, it's exactly the same whether it is from National Megabank or the Bank of Nowhere. And terms and conditions are mostly standardized. The only real exception I'm aware of is the Islamic loan programs. So there is no reason not to force lenders to compete on price.

Now it is another misconception to think that the standard forms you get at the beginning of the transaction mean something. They don't. There are too many games lenders are allowed to play with those. The only way to be reasonably certain that they actually intend to deliver that loan on the terms they tell you about is to get them to give you a written loan quote guarantee, detailing:

-loan type (e.g. "thirty year fixed rate loan")
-interest rate (e.g. 6%)
-total maximum costs including third party fees and points (e.g $3022)
-whether there's a prepayment penalty. Yes or no. Not maybe. Not probably not. Yes or no.
-any conditions upon the guarantee. (almost always, "underwriter approval of the loan as submitted")

There should also be a statement that if they do not deliver the loan as described, they will pay any difference so that the net cost to you does not increase. Once you've got a guarantee with all of this, then and only then can you make a real comparison between loans. Companies that will not guarantee their quotes in writing are telling you that they cannot deliver what they talk about, that they are intentionally low-balling you in order to get you to sign up, and that they will add hundreds to thousands of dollars and quite possibly a higher interest rate when you go to sign the papers. I'm sure that makes you feel all warm and tingly and inclined to use them, right? If they could deliver that loan they are talking about, they would guarantee it. But if they won't guarantee their quote, you have no idea what loan they really intend to deliver. It's only if they will guarantee their quote that their loan can really be compared to other loans.

Loan rates and the prices to get them do change over time. They cannot be locked indefinitely, and the longer the lock, the more expensive the loan. Furthermore, all quote guarantees are going to be subject to locking while the rates are still in effect, which for A paper loans and lenders is no longer than the end of the day. But missing a day of work that costs you $300 to $500 in pay in order to intensively shop loans is likely to save you thousands of dollars.

Now, how to compare loans if one has a lower rate and the other has a higher cost. Figure out the difference in monthly interest charges, and divide the difference in closing costs by the difference in monthly interest. This will give you a break even figure in months. Due to time value of money and other factors such as the loan with higher costs will leave you with a higher balance, and therefore cost you additional interest later after you sell or refinance, add fifteen to twenty percent to this figure. Keeping in mind that most people only keep their loans two to three years, that will tell you if you're getting something worthwhile for that extra money. On the other hand, if the break even time is longer than the fixed period of the loan, you know it isn't.

Finally, it is to be admitted that getting a loan guarantee is the second best thing to make certain you get the loan they tell you about. There is a better one: Apply for a back up loan. If you have two loans ready to go, you're not relying upon the good intentions of one provider, and your choices are not limited to sign that one set of loan documents or you don't get a loan.

Caveat Emptor

Original Article here

My article Debunking the Money Merge Account Scam has been getting a lot of attention and a large amount of hate mail lately. The scamsters that sell these things love to send me hate mail for exposing the fact that their particular emperor has no clothes.

Here is the bottom line: The only benefit these programs actually get is about two weeks temporary reduction of principal per month, based upon your take-home pay. On a $200,000 mortgage at 6 percent, that is worth roughly $4.41 per month under ideal conditions. It will pay the mortgage off approximately three and a half months early. On a $400,000 mortgage at 7%, it's worth about $11.41 per month under optimum conditions, and will pay off your mortgage a little over five months early.

They programs do not give you the right to make extra payments, and they don't save you the money that those extra payments saves on your mortgage. Anyone who doesn't have a "first dollar" prepayment penalty can do that, any time they want, for free, and if you do have such a penalty, Mortgage Accelerators and Money Merge accounts will not prevent that penalty for being levied.

What they do is charge you anywhere from $2000 to $6000 as a sign up fee for these programs, and most of them require a Home Equity Line of Credit (HELOC) as well, increasing the cost of interest of whatever money is in them. Quite a few of them also require a monthly fee that varies from $1 up to about $8. I have yet to find one of these where the numbers say that the gain is not more than offset by the fees.

Suppose instead, you spend the sign up fee on a one-time pay-down of your mortgage. Instead of paying $2000 to $6000 for this program that gets you a few bucks per month, you spend that money on a one time pay-down of your mortgage. I have yet to find a scenario where that doesn't pay off your mortgage earlier, and have a lower balance the entire time it is in effect, so that if you do refinance or sell as most people do, you're ahead of the game the whole way.

The people selling these scams love to pull the ad hominem. They accuse me of not liking the program because people on this program won't want to refinance, and there's usually something in their accusation about how I cannot sell the program. Both of these claims are nonsense. I have idiots begging me to sell these things on a regular basis, and I could sign up with any one of them and make money. I have not done so, because these programs will not deliver, and my entire method of doing business is predicated upon doing the right thing for the client, so they are motivated not only to come back to me themselves, but also to send me anyone they care about. Furthermore, people on these programs refinance almost as often as anyone else. The difference in the numbers these programs make is a lot less than saving an eighth of a percent off the actual interest rate, and I can prove it. If I have a refinance that saves them money starting the day it happens, they're going to sign up just the same as anyone else.

The only effective selling tool these con artists have to sell these programs is the appearance of free money. They assume that the money for extra payments comes out of some hyperspatial vortex. They do generate a few dollars per month in interest savings through temporary payment reductions, but as I covered above, you're better off using the sign-up fee to pay the balance of your mortgage down. Any extra payments that do get made don't come out of a hyperspatial vortex - they come out of your checking account, which comes from your paycheck. Such money for extra payments is then not available for other things, whether it's a vacation, a new car, an alternative investment, or just blowing the money down at Joe's Bar. The extra money is the same, and you have the exact same right to use it to pay your mortgage down faster with or without one of these programs. If you have it extra to pay down your mortgage, you can do so regardless of whether or not you have paid the sign-up fee for one of these scams. If you don't have the extra money, then obviously it's not going to get paid to your mortgage, is it?

In fact, one of the things these folks never mention is that the entire question of whether to pay off your mortgage faster is an open one, subject to a lot of variables, and the numbers in most cases argue that you should not. If you can make more with an alternate investment than you save by paying your mortgage down, the default answer is going to be that you should go with that alternate investment. Since average return over time of bonds and stocks and other possible investments is considerably higher than the six percent interest of your average mortgage, with federal and state deductions for mortgage interest paid lowering the effective cost of the mortgage further, it's silly to pay down your mortgage faster unless there are other factors. A mortgage accelerator may actually lock you into that when there are better, smarter, more profitable alternatives available. Finally, even though paying your mortgage down may be the alternative best in line with your current situation and plan for your life, paying any kind of sign up fee or monthly maintenance for such a program is a waste of money when you have the perfect right to make those payments on your own, for free, at any time you choose. Any fee you are thinking about paying for one of these things is a waste of money. You are better off putting that fee towards a one time direct pay-down of your mortgage.

Caveat Emptor

Article UPDATED here

I'll keep hitting this and hitting this until everybody understands this critical point.

From email:

First of all, I love your website. It is just a plethora of information for first time buyers like me who wants to be an educated buyer. Although there will be some things that I won't be able to understand completely, I try my best to learn the things I need to and have to.

I am located in DELETED and a first time buyer. We went with DELETED for our lender after shopping around for quite sometime. Our closing date is (23 days from now). There has been tell tale signs that they might be charging us junk fees. Please tell me if this is just my imagination or if I have the right to feel this way. When we got the first Good Faith Estimate from them they listed their lender's fees and all the other fees. Now when we got the paper work to sign begin the loan approval process new fees showed up on the lender's fees. I know this is an estimate but should their fees be constant on all of the Good Faith Estimates? Second, I was told to believe that the rate they will quote us will be based on the middle credit score between the three credit score bureaus. They used the lowest credit score. I am worried that come closing day that new lender fees will pop up on the loan papers and god knows what else. Is there a reason for me to worry about this lender?

Yes, there are reasons to worry about this lender. There are reasons to worry about most lenders. To be perfectly fair, there are reasons to worry about most brokers, as well.

There is a fact that it is critical to understand in order to be a well-informed loan consumer. If you ever lose sight of this fact as a loan consumer, you are likely to be setting yourself up to get rooked. Conned. Taken. Lied to. That fact is that there are all kinds of incentives for loan providers to tell you about a better loan than they can deliver in order to get you to sign up, and there is a huge upside and no real downside to them for telling you about something better than they can really deliver.

Let me haul out a rate and cost sheet for one of my favorite lenders (This sheet was from when I originally wrote the article, and I kept the quote because it's an example I'm after) and favorite title and escrow companies. If you are buying a $400,000 property with 20% down, then with this lender I can lock and deliver a 30 year fixed rate loan at 6.00% with zero total points to the borrower and total real costs of $3022. That's the grand total in costs. Lender's fees, broker's fees, appraisal, escrow, title, notary, recording, etcetera. For traditional purchases, where everything is like the default ways of doing it, the seller would also pay a $750 escrow fee and a $1253 policy of owner's title insurance. There would be prepaid interest on the loan of $160 for every three days remaining in the month ($53.33 per day), and the costs of an impound account if you wanted that. If you were in my office ready to lock that loan as I write this, that's what I could guarantee in writing to deliver. If you wanted to buy the rate down, I could deliver 5.75% for about 0.8 total points, which translates to about an additional $2600 in dollars. If you wanted to buy it down further, I could deliver 5.50% for 2 points total, or about $6500 in addition to the initial quote above. That's what's real. I can prove it, because I could write a loan quote guarantee that says if the rate is higher or the cost is more, I pay the difference.

Now, let me illustrate how far it's legal to low-ball, keeping that initial real quote always in mind: 30 year fixed at 6% for $3022. First off, all "third party" fees mysteriously disappear, as do the lender imposed fees, and now I'm quoting total costs of $610 plus four things marked "PFC" on the Good Faith Estimate. If I decide to tell you about those lender imposed fees in order to make it "feel" more real, that changes the costs to $1405, plus, of course, those four pesky PFCs. Or three PFC's plus $1530. Sounds like a lot less than $3022, doesn't it? But it's going to be $3022 PLUS any "junk fees" I try to sneak past you. Make no mistake: You are going to pay for that appraisal, that escrow, and that title insurance policy. It's a fact of life, inflexible as gravity. But I don't have to tell you about it initially.

Now, let's start playing games with the rate, and I must emphasize that these are legal. I would face no penalty for any of them. First off, I can have a legitimate belief that rates are headed downwards, and I could use the rates that include a 15 day lock instead of thirty. A fifteen day lock costs less. So I could tell you that you're actually getting a rebate of an eighth of a point to pay your closing costs. Many loan officers will tell people this. However, when the loan takes twenty-five days to fund, now the clients are paying that eighth of a point due to extension fees. I can actually hit fifteen days most of the time from a standing start if the buyer and seller cooperate, but it's not something I can promise because if they don't cooperate in a timely fashion, there's nothing I can do to force either of them to work faster. So I don't use fifteen day locks.

But that's only the first game. Let's say I think rates are going down, so I don't lock, but I do tell you what I think rates will be when I have to lock, and I tell you that I can do 5.75 for zero points. That's also perfectly legal, if completely unethical. Once again, I'm thinking the rates will go down that much, and also thinking about getting to use the fifteen day lock. Lest it be unclear to you, my entire justification for this is raw naked optimism. But it's legal raw naked optimism. Actually, in order to cover myself, I'll say one tenth of a point net cost to you for the rate. That way, I haven't told you it's a no points loan when it may not be, but most consumers only ask about rate, not the cost to get it, being ignorant of the tradeoff between rate and cost. By the way, if I'm an unethical loan officer, I'm going to do my darnedest to keep a dollar figure from being associated with any points quote. Why? Because 5.5% for $1405 plus "two of those points thingies" sounds an awful lot cheaper to the average person than the real fact that 5.5% will cost them roughly $9500 altogether. Same loan for the same set of facts, but one way of putting it certainly sounds cheaper, doesn't it?

But suppose my raw naked optimism does not come true in the real world. Suppose the rates end up staying where they are now. This is actually better than what often happens, because you get 5.75% delivered for about three quarters of a point, because they don't lock the loan until they're ready to print final documents, and so they can use the fifteen day rate. Pretty cool, eh? You saved about five percent of one point, or roughly $160, off what the quote was. But remember, they did not, in fact, lock your loan. Suppose rates are higher in fifteen days, which is what I really do expect. Let's take a WAG and say that 5.75% gets delivered for 1.2 points, and the loan officer says, "Sorry, that's the best I could do." Now, failing to lock cost you four tenths of a point, or about $1300, and I've seen it much worse than this. In fact, since the loan officer didn't guarantee their quote, they then blow it up to 1.5 points, and they've just put an extra $1000 in their company pocket.

Now, type three games: Don't tell you about the pre-payment penalty they're sneaking in so that they can get paid more. Two year pre-payment penalty gets them roughly $1900 more in the company pocket if they're a broker, $6500 if they're a direct lender. These numbers go up for longer penalties. But when you get transferred in a year and a half, it costs you $6500 extra for that penalty when you have to sell your property. I can even give you a small part of that to make it look like my loan is better than the competition. "Sure, I'll pay for the appraisal," or give you tenth of a point back to reduce closing costs, while hiding this $6500 salami in your loan papers or even coming back after the loan has funded and asking you to sign a prepayment rider "for compliance."

There is a type four game: Games with the loan type. Suppose I tell you about a "thirty year loan at 5.5% for 1 point total." Sounds much better than any of the preceding, right? Except that what I'm talking about is a 5/1 ARM, not a thirty year fixed rate loan, and I'm still able to play all of those type one and type two games with this quote. I could be talking about a 3/1, a 1/1, or even a three month LIBOR loan with those words. Point of fact, I actually can lock, guarantee, and deliver a 5/1 at 5.5% for 1.2 points with a thirty day lock while I'm writing this, and a 5/1 is something you should probably consider very strongly, but it's not the same thing as a thirty year fixed rate loan.

Let's take it up a couple more notches. How does a "Forty year loan at 0.5% with a fixed payment of $735.70" sound, especially when the payment for that 6% thirty year fixed rate loan I talked about is actually $1918.57? Pretty good? And the forty years explains why the payments are so low? Well, congratulations! You've just signed yourself up for a negative amortization loan at a real rate of 8.2% right now, and not fixed at all. The payment is fixed, all right, but the interest rate isn't. Oh, and by the way, if you keep making that payment of $735.70 for three years, you'll owe $59,000 more while under threat of a pre-payment penalty that starts at $10,500 and gets bigger until it expires. Refinance then, and your payment goes to $2272.27 if the same thirty year fixed rate loan is available them. May not be too bad for some folks, but if you couldn't afford the $1918.57 in the first place, why would you think you can afford 20% higher payments than that in three years? I'd say it's more likely that you can afford $1918.57 now than $2272.27 then. But everything I actually told you about that loan was not only legal, but also true.

Enough horror stories for now. What can you do about this? Keep it in mind that the prospective lender has every incentive to play these sorts of games, and very little in the way of concrete incentives not to. People sign up for loans based upon who tells them about the best deal, and if that lender can't get you to sign up, there is an absolute ironclad guarantee that they don't make anything. If that loan officer is paid on commission, and the vast majority of all loan officers are, the choice is probably get money in their pocket or definitely no money in their pocket. But the cold hard fact is that without a written guarantee, none of the initial paperwork means a damned thing. Furthermore, most lenders are quite adept at avoiding giving you a guarantee. "We're a large ethical company that's been in business for 100 years and we honor our commitments." Sounds great, right? But neither a Good Faith Estimate nor a Mortgage Loan Disclosure Statement in California is any kind of a commitment. None of the forms you get at the start of the process is. Both forms say right on them that they are estimates. They could be accurate estimates or they may not be. The only thing that's required to be accurate is the HUD -1 form, and you don't get that, even in preliminary form, until you are signing final loan documents.

Now, some facts and industry statistics to illustrate why the incentives are there to tell you anything it takes to get you signed up. First off, the only universal guarantee in this whole situation is that if you don't sign up with them, they make nothing. Zero. Zilch. Nada. They've got bills they need to pay, same as you do. So you sign up, and they work on your loan for three weeks, and now it's time to sign papers, and they're not quite what you were led to expect. But you don't notice the difference. In fact, industry statistics say that over fifty percent of people don't notice at signing, and a substantial fraction of that never figures it out. I understand why; it wasn't easy for me to learn what's important, and I have an accounting degree. These forms are confusing to the uninitiated. Furthermore, the loan officer keeps you busy with a line of patter, and is talking about how much you're going to enjoy your new home, or what you're going to do with the money you're saving from the lower payment, meanwhile putting as many irrelevant and unimportant forms as possible in front of you to bury they important ones. This makes it more difficult to concentrate on those numbers swimming on that unfamiliar form. Some companies actually train their loan officers in how to distract the victims. I worked for one such company for about a month, until my loans started being ready to close and I discovered what they were up to when they showed me how to distract these people who were putting money in my pocket from how badly they were getting gouged.

Now, let's say you do notice. The situation is not the same situation as when you've signed up. If it's a purchase, you no longer have thirty days to get your loan. Indeed, your loan contingency has expired and you'll not only lose the purchase escrow, but your good faith deposit as well, if you don't sign those loan documents. You've been building up your emotions for the last three weeks thinking you're getting ready to move. You've put in your thirty days notice, you've packed up all your stuff, you've got the moving van reserved and the friends lined up, not to mention that you and your spouse are totally ready and emotionally psyched up to be owners!, and to be moving into this property. Darned few people will not sign purchase loan docs, even if they do notice the discrepancies. Industry statistics say less than 5%.

In a refinance, the motives are not as strong to sign loan documents that are less than it was indicated earlier. Most of the time you've got the house and you've got a loan you could keep, you just thought this one was better. But you've been told about this lower payment, or lower rate, or you need that cash out for your vacation that's starting next week or the remodeling contract that you've already signed. Your loan officer quite likely rolled thirty days of interest into the loan and told you that you would be "skipping a payment" (You never skip a payment, as I've explained many times), and so you've gone and spent the cash on a long weekend in Las Vegas. Now you don't have the money, and if you don't sign these documents, you won't have the money for your payment, never mind the kitchen remodel the contractor has already started or the nonrefundable tickets you put on your credit card. Finally, quite often the lender required a deposit that you're going to lose if you don't sign those loan documents. Industry statistics say that about 80% of refinances who notice major discrepancies in their final documents will sign anyway. All they have to do is sign their name, and it will all be over.

Now, whether you noticed and signed anyway, or didn't notice, you have just rewarded that loan provider for lying about that loan in the first place. They lied, you signed up, they got paid. Wow! It's like a license to print money! Not only that, but if they just play the game a little bit carefully, there's no legal liability or responsibility to you. I should note that there are a significant number of loan providers who do go over the top into illegal territory and liability, but it's not difficult to tell what is for all intents and purposes a huge whopping lie and stay legal (it is slightly more difficult if they're acting as your real estate agent for a purchase as well).

Now, what can you do about this? The absolute smartest thing you can do is apply for a back up loan at the same time you apply for the one you think you're going to actually get. This way, you can use the existence of another loan being ready to go to get leverage your bargaining position into a better deal for you. Now loan officers don't want to be back up providers - unless they think there's a real chance they'll end up with the business. In order to persuade them there is a real chance, for the business, you have to give them a real legitimate shot at being the primary provider. As my article on Getting a Loan Provider to Agree to be a Backup Loan says, if you're already signed up with someone else when you approach a loan officer about being a back up, you should expect to hear something that contains the word, "No." Failing that, I want to be paid something for my work, or I don't want to work. I'll want a deposit that I can keep if you don't do my loan.

The second best thing, which is an excellent supplement to the above, is a written Loan Quote Guarantee. Any quote that's backed up by a real guarantee is much stronger than one that's not. I don't care if the difference is three percent on the rate (and it won't be that high). I'd take the guaranteed quote over the one that isn't guaranteed, every time.

Finally, you can always insist upon answers to the same set of Questions for loan providers before you sign up. They can lie, and they can evade, but they are good and necessary questions to ask.

Caveat Emptor

Original Article here

With the down payment presenting the largest difficulty for most people want to buy right now, I am covering every base I can think of as a place to get a down payment. I have covered VA Loans (an article I need to completely revise to be more in line with changes since I wrote it) FHA loans which require a relatively small down payment, and Municipal first time buyer programs, some of which can take the place of a down payment. There are also seller carrybacks and lease with option to buy. There's also the traditional "Save it over time", and in some circumstances, you can also borrow from your retirement accounts or even take a withdrawal. You can even Sell Some Stuff. But there is at least one more entry to the pantheon.

Most people don't think of it, but a personal loan is one of the ways to get a down payment quickly. It has some notable drawbacks, but it can be done. Being unsecured, the interest rate is higher than real estate loans, and the repayment period is shorter, meaning higher payments.

A personal loan is a loan not secured by real property. Because it is not secured by real property, all the lender really cares about is the payments and whether you can qualify for the loan by underwriting guidelines including the payments for such a loan. Personal loans include car loans and student loans and just about every other type of installment debt out there, as well as personal lines of credit and even credit cards. Not all of these are a possibility for the subject at hand, which is rapidly acquiring a real estate down payment. CREDIT CARD CASH ADVANCES ARE RIGHT OUT!. But the possibility exists of borrowing enough to get a down payment with a personal loan.

This possibility includes both institutional loans from a bank or credit union, and "good in-law" loans from family members. Negotiate a loan contract, sign it, and be certain to disclose it to your mortgage lender on your mortgage application so that they know you're not trying to pull a fast one. The reason why mortgage lenders are obsessed with sourcing and seasoning of funds is because they don't want an undisclosed loan, which might mean that you cannot really afford the all of payments you're going to be making. But a fully disclosed personal loan is just like any other open credit. It has a repayment schedule, maturity date, etcetera. The mortgage lender looks at the situation, including the loan that got the down payment, according to lending guidelines, and if it appears you have the income to make those payments, they will approve the loan.

The major and irrefutable drawback to getting a personal loan for the down payment is that it impacts debt to income ratio. You have to account for the fact that you owe this money, and you are obligated to make those payments, and therefore, you cannot afford as big a real estate loan as you otherwise could. Since most people try to stretch their budget further than they should anyway, this can be a deal-killer. It can force you to buy a less expensive property than the one you have your heart set upon, or even than the property you could otherwise afford. Of course, if you don't have a down payment, you can't buy the property of your dreams either. But if you buy a property, especially while the market is down, leverage can mean you will be able to buy the property of your dreams much sooner and much easier, or in plain words, buying the less expensive property is smart if that's what you can afford now. Of course, if you've got more than enough income but no down payment, that's the situation where getting a personal loan for a down payment is a serious possibility. Say you're a doctor who just spent the last two years paying off your student loans ahead of schedule. You've got a great income, but you spent everything on getting rid of that debt, and as a consequence, you don't have much for the down payment, right when it will do you the most good.

It is possible, for some people who have a large down payment but are nonetheless getting a loan from somewhere (most likely a close relative), for the loan to be a subordinate real estate loan. This happens mostly when Mom and Dad are rich and doing estate planning. They loan Princess (their daughter) and her darling Husband some money to make it easier to buy. Note that the thing controlling it here is that lenders have guidelines that set maximum comprehensive loan to value ratio (CLTV), or the ratio of all loans secured by the property to the value of the property. Even though they may be in first position, lenders may not be willing to loan when there's another loan behind theirs on the property if the CLTV is higher than underwriting guidelines allow. It is necessary to make certain that the lender you apply with will permit any other contemplated loans. And even though Mom and Dad may be intending to forgive Princess' loan in accordance with gifting schedules, Princess and her husband still need to have an official repayment schedule on the loan and those putative payments must be taken into account on the debt to income ratio.

I must emphasize this again: DO NOT TAKE A CASH ADVANCE ON YOUR CREDIT CARDS!. Unless you have credit limits in the multiple hundreds of thousands, your credit score will plummet, and you will be unable to qualify for the loan no matter how much income you have. I will bet a nickel that someone will email me saying that they "did what you said," and that now they cannot qualify for the loan because their credit score is in the toilet. If you write me with such an accusation, I will drag you down to the zoo, where I will arrange for the elephants to do a line dance on your sorry carcass, and the rhinos to use what is left as a target for both ends. Taking a personal loan for a real estate down payment is playing with fire. If you're going to do it, make certain to follow lender and loan officer instructions exactly and carefully. There are a number of other pitfalls, that may not be as bad as the credit card cash advance but will still sink your loan. Getting a personal loan for a mortgage down payment is the mortgage equivalent of a circus high-wire act - one wrong move and the whole thing is a disaster where people get crippled for life even if they aren't killed outright. But if the numbers are right, and you and your loan officer are careful, it can work.

Caveat Emptor

Article UPDATED here

Or, Ways to Minimize Down Payment Requirements

(Continued from Part I which stated the issue)

But with loans so difficult to get right now, that makes it a wonderful time to buy, because the competition for properties is non-existent. In economist terms, demand is low. Many people are too scared to buy, and more people are unable to get the loan that would enable them to buy. But the rule of making a profit is "buy low, sell high." Even if you have no intention of ever selling, wouldn't you really rather buy that property for $300,000 today than $500,000 three years from now? At 6% interest, the difference in the cost of the loan is $12,000 per year. I'm sure you can think of things to do with $12,000 per year, not to mention three years sooner that you pay the loan off and your cost of housing goes down to property taxes plus maintenance - and three years earlier that you have this enormous, appreciating asset that is completely paid for. So what can you do now?

The first, most obvious thing, is an FHA loan. These go up to 97% of the value of the property, and I don't think I've ever seen a situation where the FHA ran out of money. Basically, anyone who hasn't defrauded the government is eligible. This loan, right now, is the broadest solution generally available for cash strapped buyers, essentially equivalent to the adjustable "monkey" wrench of loans. It can be combined with the $10,000 IRA withdrawal feature for buying a first time house or if your retirement plan document enables you to take a loan, it can even be combined with that (consult an accountant for details). Sellers can contribute up to six percent for closing costs, family can gift you up to six percent for down payment and closing costs (consult an accountant for details). The drawback is that you've got to have that three percent down payment from somewhere. The down payment assistance programs that enabled buying FHA without money down are essentially dead, at least for now, and the FHA and lenders do not want them brought back - they've had too large a percentage of defaults from people who don't put any of their own money into a property, and too many unscrupulous agents and loan officers need to go to jail because they've been telling people "You're not risking anything, and you're not putting any money into it, so just walk away if it doesn't work out." It's not for nothing that 100% financing has required a bad reputation in lending circles, but considering that Americans as a group are finding it ever harder to save anything, the requirement to come up with 3% can be a challenge. FHA loans also require an up-front funding fee (which can be rolled into the loan) and an ongoing financing insurance charge that is the equivalent of PMI. This is what pays for the government guarantee that is the reason that lenders will accept these.

The second option, a true magic bullet, is the VA loan. One dollar down moves you in. Closing costs, up to 3% over the cost of the property, can be financed as well. No financing insurance, no mucking about with scraping up the down payment from forty different places, no income limits, and I even know lenders that tell me they'll go up to 1.5 million dollars on a VA loan. The biggest problem with the VA loan is that you have to have earned it from military service, something fewer and are doing these days. I'm just starting to work with a client who'll be my first VA loan in longer than than I like to remember. Still, the VA loan has been much improved in the last couple years, and is a great way to get into a property now.

One sort of "piggyback second" still survives to 100% loan to value, and that is in the form of various municipal first time buyer assistance programs. These are funded by federal grant money but run by individual cities and counties (usually with help from the state). Not all of them take the same form, but the "silent second", where no payments are due, is the most common in my experience, and most of them will lend at 100% of the value of the property. The county of San Diego and most of the suburb cities have this kind of program, as well as several dozen other cities in southern California. Unfortunately, there are several catches: They all either take the form of an equity sharing arrangement, or interest accrues, and they all limit your ability to refinance. On the plus side, some of them are forgivable if you spend enough time in the residence. Back on the minus side - big minuses - there are income limits which vary with the locality, and they run out of money at Warp speed every time they get a new allocation. But if it works for you and you are able to get in on one, they are like the vorpal blade going snicker-snack.

Seller Carryback financing is another option, albeit considerably less attractive to most buyers and sellers. This is where the seller "carries back" a loan for part of the purchase price. Many are the pitfalls for both buyer and seller, and quite often, first trust deed lenders actually refuse to work with these because their underwriting standards include someone having the discipline and income to save the money for a down payment, rather than borrowing still more money.

Finally, there is the lease with option to buy, or "lease option". This is the last gasp alternative for a lot of reasons stemming from the fact that the contract is agreed upon now, but isn't actually consummated for quite some time. This is time and opportunity for things to go wrong, from the buyer deciding they don't want to buy to the seller deciding they don't want to sell, or at least not on those terms. Yes, there's a contract in place giving you legal rights, but the other side can usually contrive to make it more trouble than it's worth if they want to. However dangerous they may be, the lease option still does have the potential to make a sale happen, where without it both the buyer and the seller would be unhappy, unable to trade what they have for what they want.

The loan market will loosen again. Where it might have been too loose a couple of years ago, it's now too tight. Lenders are rejecting applications that are good risks, fully able to repay their loan, or simply telling their loan officer not to bother taking the application. Right now, in paranoid meltdown mode, they don't care, but when then things calm down a bit, they will because they are passing up profit. Unfortunately for those looking to get the best deals, when that happens, lots more people will be able to qualify for a loan and demand will shoot up, followed by price. Right now, things are a lot more affordable in my neck of the woods than an analysis of people's ability to pay suggests that they should be. This is because for the last two to three years, many people who want to buy have been scared of the market, unable to qualify for the loan, or unwilling to actually make their move. When this changes, the prices that people pay will start to rise, most likely pretty rapidly.

Caveat Emptor

Two years ago, the loan market was easy. It was like being one of those third world countries tapped into the IMF back in the nineties. Of course you could get a loan, and if you didn't make enough to handle the payments, the lenders were still eager to loan you that money.

Anyone who hasn't been hiding in a cave knows that's no longer the case. It's been like watching an ammunition depot self destruct in slow motion, Hollywood style. One load of ammo catches fire and cooks off spectacularly, thereby spreading the fire to the surrounding loads of ammo, which in turn cook off and spreads it to the ones further on down the line. One group of loans that should never have been made destructs, resulting in short sales and foreclosures, lowering the prices of property as more properties needed to sell than new buyers wanted to buy. This, in turn, made it more difficult for people who might have been okay otherwise to finance out of their nonetheless risky loans when the appraisals didn't come in, thereby causing more short sales and foreclosures, a positive feedback loop if ever I've seen one. Not in the terms of being desirable, but in the same sense of falling dominoes, progressive disaster, and nuclear chain reactions: one causes more.

On the other hand, in many areas of the country, those explosions have pretty much reached the edge of the ammunition depot. The people who are left have pretty much all managed to get themselves into stable, sustainable situations. They may not be as well off as they are two years ago, but they can handle what they've got.

The people who have really been burned by all of this is the lenders, and people who invest in lenders and mortgage backed securities. I say this not out of sympathy for them, because I and many others were warning of precisely what was going on while they joined the rush, but rather to help clarify and understand why lenders are so paranoid right now. Subprime lenders are essentially out of business - the customers the few remaining subprime lenders are looking for seem to be people who qualify A paper but don't realize it. It's gotten so bad that even lenders who kept sane and intelligent loan guidelines have been hurt by the meltdown.

Things tend to flow cyclically in the loan business. Two years ago, everything was riding high and loans were easy as the result of about fifteen years of nothing but good experiences with real estate loans. Losses were small by comparison with historical standards and minuscule by comparison with the present simply because prices had been rising that whole entire time. This encouraged lenders to serially relax their standards and their guard. Fifteen years is a long time in the lending business. Because fewer people stay in one job, or with one company, the critical mass of people who had been through the Savings and Loan meltdown in the late eighties and early nineties was now gone. They retired, they went into business for themselves (often as agents and brokers happy to encourage the new excesses), or they moved into another line of work. The low numbers of such people left at the lenders were insufficient to keep their co-workers, supervisors, and subordinates from going off the deep end with constantly loosening lending standards.

Indeed, those loosening lending standards were a major part of what drove the bubble. I have written about this more than once. The Mortgage Loan Market Controls the Real Estate Market. When lenders are loosening standards, more and more people find it easier to qualify for bigger and bigger loans, and what economists refer to as Demand for real estate increases. Drastically. But this was all driven in a vicious circle by rising values which fueled loosening standards which came right back around to fuel rising values. When the bubble stopped expanding, things started going wrong for the lenders. Because values were no longer rising, lenders stopped loosening standards. Because things had gotten way beyond sustainable and affordable levels, this meant values started falling, and lenders tightened standards because they were suddenly experiencing what are euphemistically called, "Adverse results," by which those describing it mean, "Those lenders lost their shirts - and their pants, socks, shoes, underwear, and quite possibly their first born children. What this means in the real world is that people couldn't afford their homes because they couldn't afford the current loan, they couldn't refinance, and they couldn't sell. A complete reverse of the vicious cycle I described a few sentences ago resulted, with tightening loan standards driving lowering values which in turn drove the lenders into further tightening standards. Instead of earning interest on the money they loaned out, the lenders have been losing the money they had in the first place. This is pretty much the state of the cycle right now.

So let's review what's available right now. Second trust deed lenders have been hurt the worst, because the first trust deed gets every penny they are owed before the lender on the second get a cent. Indeed, in quite a few cases, the first mortgage holder has emerged smelling like a rose and looking like a genius, while the lender that signed off on the second mortgage ends up completely broke. Second lenders, whether "piggyback" or "stand alone", HEL or HELOC, were the first to pull back on their lending standards. The rates weren't bad by historical standards last I checked, but they all want full documentation of income and max out just below ninety percent loan to value ratio, while in some cases limiting themselves to as low as sixty-five to seventy five percent loan to value, no matter how well you can afford the payments. Loan to Value Ratio doesn't keep the borrower from defaulting, although it can motivate borrowers to try harder, lest they lose the investment. It protects the lender from losing money in case of default. The problem has been way too many defaults, so second lenders have become completely paranoid about loan to value ratio. If you want to go above 90% loan to value, the only way to do that right now is with a single loan.

First trust deed lenders are, for the most part, perfectly willing to make loans to 100% of the value of the property providing they can get a guarantee, either government or Private Mortgage Insurance (PMI), issued on the loan. There are some exceptions to this. Declining markets subtract 5% off the maximum loan to value ratio. Extreme examples of this subtract ten percent, or even fifteen. Since the value of the property as far as the lender is concerned is the lesser of the purchase price or appraisal, this can mean you can't (or your prospective buyer can't) buy at that price even if you (they) do have 5%, 10%, or whatever is applicable to put down. Ladies, and gentlemen, I am very glad that the San Diego market has had the declining market designation removed. But so far as the loan amount is insured against loss, the lenders are willing to venture their money. Kind of like people who keep seven figures in savings accounts, because they're scared to take a loss, so they earn less than inflation in interest and pay ordinary income taxes on it. (Note: FDIC only insures the first $100,000 at any given institution).

The problem we're having right now is that all of the private mortgage insurers I'm aware of have, in the last month or so, gotten out of not only the 100% business but even the 95% business. So 90% of value is as high as "conventional" loans can go right now, because without that private mortgage insurance, lenders are too frightened. So you need 10% of property value in the form of down payment to buy without the government getting involved, 20% in some situations if you don't want to pay for mortgage insurance.

(Continued in Part II, dealing with solutions)

If you don't know the answer to this, don't be embarrassed. Lots of alleged professionals forgot the answers to these questions for several years, if indeed, they ever knew. It seems like quite a few still don't know the answer

Loan qualification standards measure whether or not you can afford a loan. By adhering to them, the lenders lower the default rates, and borrowers avoid getting into situations where foreclosure is all but certain. Lest you misunderstand, this is a good thing for both the lenders and the borrowers. It isn't like the lenders want to stand there like the Black Knight shouting "None Shall Pass!" They want to loan money - that's how they make profit. But unless you live in a cave, you may have heard of some problems with defaulted home loans of late. You may have heard they're a major problem for both the lenders and the borrowers. Guess what? They are.

From the lender's standpoint, of course, the important thing is that they prevent loaning money to people who can't afford to repay the loan, but the other isn't a trivial concern. Even if they get every penny back when they foreclose, foreclosures are still bad business, with negative impacts on cash available to lend, regulatory scrutiny, and not least important, business reputation.

Going through foreclosure is no fun from a borrower standpoint either. I don't think I have ever seen or even heard of a situation where somebody ended up better off from having gone through foreclosure than they would have been if the lender had just denied the loan in the first place. So whether you like it or not, the lenders are doing you a favor to decline your loan when you're not qualified.

There are many loan qualification standards, but the two most important ones are debt to income ratio, often abbreviated DTI, and loan to value ratio, often abbreviated LTV. The first of these is much more important than the second, but both are part of every single loan.

Debt to Income ratio is a measurement of how well your monthly pay covers your monthly payments. It is measured in the form of a percentage of your gross monthly pay, averaged over about the last two years. The permissible number can change somewhat depending upon credit score in some situations, and with enough in the way of assets in others, but the basic idea is you can afford to be paying out 43 to 45 percent of your monthly income in the form of fixed expenses - housing and consumer debt service. You can cancel cable or broadband internet, you can cancel your movie club or book of the month - but the items debt to income are concerned with are essentially fixed by your situation. You owe $X on student loans, and you're required to repay so many dollars per month. Your mortgage payment is this, your pro-rated property taxes are that, your homeowners insurance and car payments and credit cars are these others. There's no possibility of this money suddenly disappearing - you already owe it, and you are obligated to repay on thus and such a schedule.

Loan to value ratio is not a measure of whether you can afford the loan. It is a measurement of how likely the lender is to get its money back if you do default. With appraisal fraud and similar problems, it's not any kind of a magic bullet - but it is the best they have. When values are rising quickly and holding onto a property for six months generates a 10% profit, it shouldn't surprise anyone that the lenders are willing to take more risks with loan to value ratio than they are in situations like today in most of the country, where properties have been losing value and even if the borrowers had kept up the payments before default, they would still owe more than the property is worth.

Lenders aren't going to refinance on good terms if you're upside down or even close to it. But being upside down is not a big problem so long as you have a sustainable loan situation and can afford your payments. You keep making those payments, eventually you are going to have equity again. You try to get another loan after default and foreclosure, and you'll find out in a hurry that lenders are not forgiving. Kind of like the Wild Bunch in a way - mess with one, you mess with them all. Lots of folks are thinking that the smart thing to do is walk away when you're upside down. Even if they do have a non-recourse loan, they're going to find out soon enough that wasn't so smart. Making the payments on a sustainable loan lowers the balance, and values are going to come back - sooner than a lot of people think. Put the two together, and as long as you can hold out until you have equity again, you're better off making those payments.

These standards do, and always have, arisen out of "cut and try". Experience really is the best teacher - unfortunately getting that experience has a habit of being kind of rough. Experience may also be what you get when you didn't get what you wanted - in this case, a satisfactorily paid loan - but the lenders have regulators after them, and those regulators are sensitive to political pressures, and sometimes regulators won't let lenders do something they really do want to do - like loan money with a level of qualifications regulators look askance at - because if the lender makes enough bad loans, even if they survive financially, the regulators may decide they're doing something they shouldn't, and shut the lender down for predatory lending practices. It takes a long time and a lot of evidence to persuade lenders and regulators to relax standards, while a comparatively few bad experiences will have them toughening standards. Over-tightening lending standards has major bad effects upon everyone, including causing foreclosures that would not otherwise have happened, but it's hard to point to any specific victims and there's always idiots with a political axe to grind who will claim the people hurt by over-tightening standards were themselves victims of predatory practice. Right now, both lenders and regulators have been royally burned, and so they don't want to assume any risks they can avoid. This will likely change within a couple years, but for now, that's the way it is. You can learn what you need in order to qualify and get your loan approved, or you can go without. Right now, most lenders are too paranoid to care that having their standards too tight means they lose profit, because they've been burned too much, and the money they have in their accounts is not at risk from having made bad loans. When they make between six and eight percent per year on a successful loan, out of which they have to pay taxes, employee wages, facilities costs and everything else, a one in 100 chance of losing the entire investment to a bad loan is unacceptable.

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Article UPDATED here

Lots of people ask about first time buyer programs, government assistance, and other assistance. Mortgage Credit Certificate, municipal first time buyer programs, FHA, FHA Secure, even the VA loan.

The one thing they all have in common is that they require full documentation of income. You have to prove you make enough income to afford not only the loan, but the other costs of homeownership and your other debt service payments. Even ACORN. I may have a deep and abiding dislike for their politics, the partisan nature of how they use some of the money they get from the federal government, and the fact that they won't do business with small people like me, but they are sane enough that their loan guarantees require full documentation of income. The FHA allows a little irregularity on sourcing and seasoning of borrower funds, but it's hard as nails about documenting borrower income. You don't have to prove every penny you make, but you do have to prove you make enough.

All of these programs, without exception, are in place to encourage long term home ownership. The MCC and municipal programs (funded by federal funds) have an explicit goal of stabilizing neighborhoods. FHA and VA have the goals of expanding home ownership among those who need a little help on down payment. If you can't afford the payments, you're not going to be a homeowner very long. That wouldn't stabilize neighborhoods, and it wouldn't encourage long term home ownership - in fact, it would create problems that would likely follow you long enough to delay or discourage home ownership altogether. Therefore, they want to know that you can at least theoretically afford the loan you are biting off. Hence, full documentation of income.

What is acceptable documentation? Paystubs and W-2s or copies of income tax forms, depending upon exactly which profession you're in. The option of bank statements that exists with subprime loans is not acceptable, as they are too subject to manipulation and padding. Lenders accept paystubs and W-2s because there is a third party attesting to the fact that they paid you this money. They accept income tax forms because it's perjury to lie on tax forms, and more importantly, because declaring this income costs you money, in the form of taxes. $50,000 of income costs you more in taxes than $45,000 of income - and therefore you'd have to be pretty silly to declare more income than you actually make, because you'd be out the taxes without the income.

You also have to have a history of making the income. One paystub won't do. The usual standard is current and previous year, and your income is averaged on a monthly basis over that time frame. In some programs, they require three years of tax returns, even though you may be able to prove your income via paystubs and w-2s.

What does this mean? It means that they have a reasonable assurance that at the time of purchase, you can actually afford the payments on this property and all of your other debt, and be able to continue to afford them. Doesn't mean you won't lose your job tomorrow. Just means that as of the moment you have a documentable history of being able to afford what you're buying - and that even if you do lose your job, chances are good you'll find something comparable.

This frustrates the heck out of tax cheats, but also the self employed and other folks with large legitimate deductions, because it's adjusted gross income that is used, after all of the deductions and expenses and everything else.

It also means that when you're shopping for a property and hoping to use one of these programs, you have a hard ceiling on what you can afford under program guidelines, based upon loan rates, property tax rates, insurance, how much of a down payment you might have, and what your other debts are. Lenders pay a lot more attention to debt to income ratio than anything else when making a lending decision.

Suppose you're trying to plan ahead so you can afford as much property as possible, what's the best way to increase affordability? Usually, existing debt is the biggest obstacle, and paying down debts is usually the best way to increase what you can afford, providing you still have the necessary cash for closing costs and the required down payment. Basic money management advice: live within your means, don't charge anything you don't need to, and pay it off as quickly as possible. In California, $500 per month in existing monthly debt payments reduces the purchase price you can afford by roughly $75,000. By comparison, that's roughly the monthly payment on a $30,000 car or maybe $15-20,000 of credit card debt. This isn't a popular message - people don't want to hear about bad consequences or decisions they've made. It is nonetheless a fact of life.

So if you want to take advantage of any of the various governmental assistance or loan programs, you need to stay within a purchase budget. If you want to increase that budget, earn more money and declare it on your taxes, spend less, save more, and pay off any existing debts you may have.

Caveat Emptor