Mortgages: December 2008 Archives

(This was originally published December 13, 2005. I'm reprinting it because it shows how utterly predictable the housing meltdown was)

Ken Harney has a column I found in the local rag yesterday. It seems that there is (finally!) concern amongst the regulators for this risky loan which begs for trouble for consumer, lender, and the system as a whole when there are too many of them out there.

First off, Mr. Harney is wrong, or his editor really screwed up what he did write (The Washington Post? <sarcasm>Say it isn't so!</sarcasm>). Read the contract. The attraction of negative amortization loans has nothing to do with the actual rate. Zero. Zip. Zilch. Nada. It has everything to do with lower permitted payments. There is not one day, not one hour, not one second where the actual rate being charged is reduced even by a minuscule amount. But for a certain amount of time, the minimum payment is calculated as if the rate is lower than it actually is. This is why they are easy sells - because the average real estate consumer "buys" a loan based upon the payment. So when someone tells the average consumer that they can get a "$170,000 mortgage for $850 per month!", it sounds attractive and the majority of people won't investigate any further. A large portion will actively avoid anybody who tries to tell them what's really going on, as if the loan will somehow magically be alright if they manage not to hear about all the bad stuff.

Furthermore, the real rate on these loans is variable from day one. There literally is not one month where you can truly predict what the next month's payment will be. I have, and always have had, lower interest rate loans that are hybrid ARMS with truly fixed interest rate for five years or more, have lower costs to obtain them, and no hidden gotchas. Heck, from my first day in the business I've always had loans that fit all of the forgoing criteria and require interest payments only. If you cannot make a payment of at least the full amount of the monthly interest, it is quite likely you shouldn't make the purchase.

These loans do have a niche. But I can't think of a case where they should ever be the purchase money loan for a property. Even on refinances, they should be no more than one percent of total refinances - not the forty percent share of San Diego's purchase money market the last figures I saw had them having. Investment property, the rules should be somewhat looser, but still nowhere near 40 percent of the market is appropriate. If this were the securities or accounting industries, the regulators would be throwing people into jail over this, and shutting down offending companies completely and permanently. There's a world of hurt coming down the pike, and the prevalence of these pieces of garbage is going to greatly exacerbate the problems, particularly in high cost markets. Let's say, hypothetically, someone put 5% into a $500,000 home here in San Diego at the beginning of the year, at a nominal rate of 1%. They had one $400,000 mortgage and one $75,000 mortgage. Assuming the nominal rate on the first is 1% and that the second is "interest only" as is common, they would now owe $10,000 more on a home that is worth about $30,000 less (and in December 2008, nearly $200,000 less). After three years, they owe a total of $505,000 even if the rates don't rise any more, which I can promise you they will (Yep, even though they've now dropped again). If values hold steady right now, their home is worth maybe $470,000, of which they would get about $440,000 if they sold without paying any closing costs for the buyer, which isn't happening right now. So under perfect theoretical conditions, they've gone from having $25,000 in the bank to having to come up with $65,000 just to get out from under. Since they likely can't, their credit is going to be ruined for ten years at least, plus they're going to get a love note from the IRS saying they owe taxes on $65,000 more income (which incidentally slides most folks into higher marginal brackets).

(In December of 2008 - they could get maybe $300,000 of the $505,000 they owe, and the debt forgiveness for short sales expires December 31. $205,000 of taxable income on top of suffering through this disaster of losing their home)

You can survive being "upside down", owing more on your mortgage than your house is worth, for a long time if you have the right loan. Negative amortization loans are not the right loan for market conditions I see happening in the next few years. They are always risky, and mortgage lenders and brokers who do them do not have, in the aggregate, an even vaguely acceptable track record of disclosing their risks. Not that it's any great shakes of a prediction, but I predict that lawyers will be prosecuting a lot of these as civil cases in the next few years, and winning large judgments that are not going to be covered by insurance because it's neither an error nor an omission, but an intentional misrepresentation.

(December 2008: not a lot of cases yet. Perhaps because few of the victims can afford a retainer?)

Under the right conditions, these can be useful loans. But the right conditions are rare, and when you have those conditions, the lenders are not likely to approve the loan because the prospective borrower is not a good credit risk. In short, if you're approved for one of these, you almost certainly had better much options available to you. If negative amortization loans are actually appropriate for you, I'll bet a nickel your loan won't be approved. This is the kind of marketing strategy which has gotten many industries in serious trouble, and the lenders who are involved in this are likely to be hurting anyway when the house of cards they've been supporting comes tumbling down. Expect corporate bankruptcies, also.

(December 2008: not to mention $700 billion of bailout money that is essentially gone with no great effects upon the mortgage market)

Caveat Emptor.

P.S. If you haven't read anything on these previously, you might want to check out this article as well as this one.

Original here

an email:

If you think it's worthwhile, how about an article that explains the HUD hope to homeowners program in plain(er) English. I don't consider myself terribly dumb, but I can't quite figure out who qualifies and who doesn't. One the one hand it sounds magic -- get new smaller loan! But it also sounds like your existing lienholders have to agree, which I can't imagine they'd be happy to do outside of very specific circumstances. Also, it sounds like if you do sell, you give a portion of the forgiven equity back to HUD (seems fair), but some of the things I've read seem to disagree on how much. Also one article I read "you need to not be able to pay your exiting mortgage without help". That seems very subjective. Is there an actual yardstick for that? Debt-to-income? Something else?

The program is effective from October 1, 2008 to September 30, 2011. However, it is about 99% political theater. It's not actually going to help a lot of people.

The HUD Hope for Homeowner's Program Page

Cost-Benefit Analysis

Lender considerations:

Given their fiduciary responsibilities and financial obligations, lenders will assess their portfolio and perform a cost-benefit analysis to determine the feasibility of offering this program to struggling homeowners.

1. Affordability versus value: lenders will take a loss on the difference between the existing obligations and the new loan, which is set at 96.5 percent of current appraised value. The lender may choose to provide homeowners with an affordable monthly mortgage payment through a loan modification rather than accepting the losses associated with declining property values.
2. Borrower eligibility: Lenders that determine the H4H program is a feasible and effective option for mitigating losses will assess the homeowner's eligibility for the program:

The existing mortgage was originated on or before January 1, 2008;
Existing mortgage payment(s) as of March 1, 2008 exceeds 31 percent of the borrowers gross monthly income;
The homeowner did not intentionally default, does not have an ownership interest in other residential real estate and has not been convicted of fraud in the last 10 years under Federal and state law; and
The homeowner did not provide materially false information (e.g., lied about income) to obtain the mortgage that is being refinanced into the H4H mortgage.

The first thing to note is that you cannot have "provided materially false information (e.g. lied about income)" in order to get your current loan.

Right off the bat, that eliminates everyone who did a stated income loan. There has never been a stated income loan where people could document their income to be at that level - if they had the documentation, they'd get the better rates for full documentation.

Now let's take a look at the other requirements

  • lenders will take a loss on the difference between the existing obligations and the new loan, which is set at 96.5 percent of current appraised value. The lender may choose to provide homeowners with an affordable monthly mortgage payment through a loan modification rather than accepting the losses associated with declining property values.
  • Existing mortgage payment(s) as of March 1, 2008 exceeds 31 percent of the borrowers gross monthly income;
  • The homeowner did not intentionally default, does not have an ownership interest in other residential real estate and has not been convicted of fraud in the last 10 years under Federal and state law;

So yes, it is debt to income ratio that determines affordability.

The lender has to write down principal of the loan to 96.5% loan to value ratio. This money is just gone. It explicitly states that Mortgage Loan Modification instead is the lender's choice. I can tell you: That's what they would rather choose. If they write down the principal, that money is gone, completely and irrevocably, without any possibility of recovery. Just as I wrote for the article on loan modification: they're not likely to agree to that. They agree to let you off the hook for money you borrowed and you still owe, and you have the opportunity to make a profit from it? Lenders don't do many principal write-downs on loan modification, and they're not going to agree to them for Hope for Homeowner's, either. Unless you're suffering one of the "killer Ds": Death of primary breadwinner, Disability of primary breadwinner, or Divorce, the chances are better of flying to the moon by flapping your arms. The only difference between a principal write-down on loan modification (than one in sixty chance, as explained in the article on loan modification) and "Hope for Homeowners" is that the government can make money, too. Quite frankly, in their shoes, I'd rather give it to the homeowner alone. At least that doesn't furnish a bureaucracy that wants to make itself permanent. When I originally checked, only 7 percent of borrowers had loans with lenders who were participating at all. That percentage may have gone up, but that doesn't mean they'll write down principal for you.

The lender will disclose to the homeowner the benefits of the program:
  • Home retention,
  • New affordable mortgage based on current appraised value,
  • 3.5 percent equity

The lender will also disclose to the homeowner the costs of the program:


  • 3 percent upfront mortgage insurance premium and a 1.5 percent annual premium,

  • Equity and appreciation sharing with the Federal government, and

  • Prohibition against new junior liens against the property unless they are directly related to property maintenance

The second group is more important. After the lender gives up all that money, the federal government gets paid for insuring the new loan? And either the lenders have to give up the 3% extra or people basically have to come up with cash in order to make this happen? If people had the cash, how likely is it they would be delinquent on their mortgage? Where is someone who tried for months to keep their loan current and is giving up because their finances are exhausted going to get 3% cash? Most of them didn't have 3% cash when they bought the property! And you're going to try to convince them to come up with 3% cash rather than walk away? Good luck with that.

Negotiations Between Borrowers and Lien Holders

If the lender refinancing the loan does not hold the senior mortgage lien, it will need to secure an agreement from the existing lien holder to waive all prepayment penalties and default fees on the existing loan and accept the loan proceeds from the H4H loan as payment in full. The loan amount (including the 3 percent UFMIP) for the new H4H loan cannot exceed 96.5 percent of the current appraised value of the property.

The lender will engage existing subordinate mortgage lien holders to extinguish all subordinate liens on the subject property. To entice subordinate lien holders to participate in the negotiation process and release their liens, FHA has the authority to share its future appreciation entitlement with them.

So they get back a portion of what they give up, while the federal government gets a share. Let me see: Would you like to give me $100 if the federal government promised to give you $50 back? Would that strike you as a wise bargain to make voluntarily? Didn't think so. The feds couldn't make it mandatory, lest they fall afoul of the Fifth Amendment, but how many lenders are going to voluntarily agree to this when there are other options available (i.e. loan modification)?

Step 3: Originating an H4H Mortgage

Nothing worth commenting upon.

Upon sale of the property, the homeowner will use their sale proceeds to pay off the H4H mortgage as well as the shared equity and shared appreciation mortgages.

FHA will provide instructions to the settlement agents regarding subordinate lien holders who are entitled to a portion of any appreciation. The lien holder that previously held the highest priority will receive payment up to the full dollar amount of its interest, not to exceed the amount of available appreciation, and so on, until all prior lien holders are satisfied or the amount of available appreciation is exhausted. All remaining appreciation is remitted to FHA.

In instances where the homeowner failed to make the first payment on their new H4H mortgage, the H4H statute prevents FHA from paying claim benefits to anyone holding the mortgage.

And in the meantime, these subordinate lenders receive no interest, have no claim upon the property, and may have to watch you take out subordinate liens on the property? And this is superior to going through foreclosure immediately for them how? Plus going through foreclosure makes it an involuntary loss versus a voluntary one, having implications with shareholders, taxes, etcetera.

Another HUD page here gives no further additional useful information, but a lot of political spin, even if you follow all the links.

Don't waste your time waiting for Hope for Homeowners to help you. Unless your family has had Death, Disability or Divorce happen to it, it's not going to help, and it also lets lenders who lied to you to get you to sign up for a loan off the hook. Normal loan modification has a discovery process that can force lenders who committed unethical actions to agree to better modifications than you are likely to get through Hope for Homeowners. And When Loan Modification Will Not Help, or Is Not Appropriate, neither will Hope for Homeowners.

Caveat Emptor

Of all the issues having to do with a mortgage, the appraisal generates more overblown problems than any other part of the process. It's also one of the most critical areas to handle correctly. There are reasons for this: It (along with perhaps the relatively cheap credit report) is the only thing a consumer has to pay for, as in money out of their pocket, before the mortgage is complete. Everything else is (or should be) done "on spec" by the mortgage provider. It is also a weapon used against the consumer by many mortgage providers.

In order to understand appraisals, you need to understand where everybody is coming from. An appraisal is a necessity for lenders. It tells the market valuation of the property in neutral terms. It is one of the essential anti-fraud steps of the process, as well as telling the lender how much the property might sell for in ideal conditions (which a foreclosure most certainly is not). It is the "market" part of the "lower of cost or market" valuation, which is driven into accountants and bankers starting with their first classes on the subject. Think about it. Just because you might be willing to pay $700,000 for the house next door to your parents (or for your parents old house itself) does not mean someone else will if you fail to make the payments. I have encountered at least two instances where a prospective borrower was definitely attempting to defraud a lender - and an appraisal caught it. There have been others where a reasonable person would have been less certain, but some of those instances were likely attempted fraud. Because of these, anytime somebody wants me to press for a drive-by or computer appraisal, a little blip goes off in my little bank of warning signal detectors. The lenders aren't stupid. They know that lesser appraisals are cheaper, and employing the more expensive alternative requiring the consumer to write a check for several hundred dollars is going to cause some people to go elsewhere. It is the judgment of these highly experienced people who have been trusted to loan hundreds of thousands of dollars at a blow that an appraisal costs them less than an increased probability of the things it is designed to prevent. And when a loan officer like me presses them for a lesser appraisal, a little blip goes off on their radar screen, also. I can't read minds, but I've had more success in getting lesser appraisals by keeping my mouth shut and letting the lender decide it's safe enough on their own, then I have by asking for one.

You should not expect a mortgage provider to pay for an appraisal, like many will for a credit report. Unlike a credit report, an appraisal is several hundred dollars, and they don't it get back if the loan doesn't fund. My attitude, born of experience, is "If this customer is not sold enough on the benefits of the loan to front the money for the appraisal when I'm putting in a much larger investment of my time and administrative and support costs, then this isn't a good investment." Other people you may never meet such as the title company, escrow company, underwriters, processors, etcetera are also working in the background - and nobody gets paid if you change your mind, aren't qualified, find a better deal, whatever. If they are hourly or salaried employees that do get paid, somebody else is investing the money to pay them. I may not have a fiduciary responsibility to all of them, but that doesn't mean I don't have any moral responsibility to see that their work is rewarded.

Furthermore, some lenders actually do prohibit brokers from paying the appraiser directly as an anti-fraud measure - and that's one pointless piece of information I can ignore by having the necessary attitude to succeed in business. This does not mean that your mortgage provider isn't doing their best to balance the competing interests - that of an appraiser's right to get paid for what they do, versus a consumer's desire not to pay for something that doesn't help them. And twice in my career I have refunded appraisal fees out of my own pocket to customers who told me the truth as they knew it, but didn't know to tell me something else (both fairly obscure points) that prevented the loan from going through. Because I didn't ask, I felt morally obligated to compensate their loss. This is not a legal requirement, and is not common - I've asked literally dozens of loan officers from all kinds of loan providers whether they've ever rebated an appraisal fee for any reason when a loan didn't go through. So far, two others have said yes. Most look at me and answer "no" as if I'm some kind of alien from another planet. So go into the appraisal with a clear idea that if the loan fails, you're not getting the money back. Period. That way you may be pleasantly surprised, but you won't be expecting something unrealistic.

You should not expect an appraiser to work for free. It may not be rocket science, but it is an exacting field where in order to become licensed you must spend at least two years of your life as an apprentice, with an income of basically nothing. As a result, there is usually a shortage of appraisers. I'm often amazed that appraisals aren't more expensive. On the other hand, many of them want to get paid for work that sabotages the loan it's supposed to support. There is a Big Thing in appraiser's association circles about how they hate loans with a minimum appraisal required, and explicit minimum appraisals actually are illegal. The appraisers, being normal humans, ideally want to be able to run their appraisal off the easiest comparable property values and let the chips fall where they may. On the other hand, there have been literally dozens of cases in my experience where choosing different but still comparable properties for comparison and doing a little more work netted the value necessary to make the loan work - the appraiser just didn't want to be bothered, something that is against the grain of good business practice - and they are supposedly businesspeople. I have also seen this abused by a broker who wanted to make more on loans - if the appraisal came in for $40,000 more, this broker got a bigger rebate from the bank, and thus, made another $1200 on the loan. Lenders for their part do not want appraisals ordered where the appraisal is going to come in at a certain minimum no matter what the property is worth. But it isn't a sign of good business practice to expect to be paid where your work is going to sabotage a substantial investment that others have already made in a project, as a below value appraisal does. It is naïve to expect that loan provider to continue to supply you with business, when you've just cost their former prospect several hundred dollars and kept that prospect from getting their loan, as a result of which the loan provider's investment is lost, and furthermore you have left the loan provider to face all of the negative ramifications of an unhappy consumer. So some sort of compromise needs to be worked out among the competing interests of a consumer that doesn't want to pay for something he doesn't have to or that does no good, an appraiser that wants to get paid for the work, a lender that wants an honest appraisal, and a loan provider that wants an investment to pay off.

The one that I have found that works best is not a minimum appraisal. Besides being illegal, asking for a minimum appraisal is a violation of my fiduciary duty to the lender. Instead, what I'll do is write something along the lines of "If comparables do not support a value of $X, please re-confirm the order prior to performing the appraisal." It isn't bulletproof, by any means. But it gives everybody the best shot at a fair shake without giving anybody carte blanche, and it prevents the vast majority of the problems. The appraiser does most of his or her work before going out to the house in question, checking sales of comparable properties in the Multiple Listing Service that they subscribe to. If the "comps" don't support $X, and the loan collapses, he's lost some work time. For a businessperson, this should be no big deal, and what they've lost is a small fraction of what other people working on this loan have lost. Furthermore, I'm going to keep sending business to that appraiser. If the comps support $Y, which is less than $X, and I can re-work the loan or find another loan and get the consumer to sign off on it based upon $Y (something that is far easier to do before the consumer gets angry at writing a $400 check and not being able to get the loan on the terms promised), the loan proceeds and the appraiser gets paid, and everybody is happy. If the comps support $X and the appraiser gets paid, everybody is happy - unless the actual appraisal comes in lower, and this does happen where a property is not as well cared for as most, doesn't have standard features, etcetera. There's nothing that can be done. You thought your home was worth $X, and it isn't. End of story. The loan provider took every precaution they legally could. The appraiser took every precaution to protect you that they legally could, and now they're entitled to be paid. It's no fun for anybody - consumer, loan provider, or appraiser. I will put up with this a few times for an appraiser who makes a habit of calling me when the comps are low. I'll keep sending them business. Chances are it's not their fault. On the other hand, every so often I'll get a call from some appraiser who gave me three "hop, pop and drops" (as in "hop on over, pop the consumer for the bill, and drop a uselessly low appraisal on them") in quick succession, and wonders why his phone isn't ringing. And of course, the various appraisers organizations are trying to pass legislation or regulations that basically give them the right to come back with any old appraisal they want to, and make it even more difficult to ask them to perform in accordance with good business practice.

An appraisal is not what your house will sell for. There are any number of subjective factors an appraiser cannot take into consideration, or cannot account for fully. The types of things they look at are objective. Size of the lot. Square feet of the house. Number of bedrooms. Number of bathrooms, and so on. These have all got measurable, objective answers. Cleanliness of rooms and condition of paint are hard to measure objectively. Nonetheless, potential buyers take them into consideration to a much greater degree than an appraiser.

One fact you should know about the appraisal: They're good for a maximum of three to six months, measured from the date of the appraisal to the date the loan funds, which is likely to be thirty days or more after you apply. Usually three months is the limit if no loan was actually funded based upon that appraisal. If it's older than the lender's underwriting guidelines allow, every lender in the known universe is going to require a new one, unless your loan is one of the fortunate few that doesn't require an appraisal.

The most important fact every homeowner or homebuyer needs to know about an appraisal: The entity that orders the appraisal, controls the appraisal. If you pay for it, you're entitled to a copy. That doesn't mean you're going to be able to take it to another loan provider and use it. The appraiser will require both a release from the previous loan provider (who after all, is responsible for giving them business), and a retype fee of about $100, possibly more. Whether the loan provider will release it is problematical. They are not required to. Some won't, no matter how good the reason. Some want to be paid, first. Even the most liberal and ethical aren't going to release it if you've simply found a better deal. Remember, they've invested some serious resources in making this loan happen based upon your representation that you wanted it.

In another essay, I advise you to apply for a back up loan every time you buy a property or intend to refinance. Now I'm going to tell you the second smartest thing that you can do: Make certain you're the one who orders the appraisal and owns it. Now some loan providers use only their own "in house" appraisers and require the appraisal to be paid for up front, when you fill out the loan application. They do this to make certain they keep control of the appraisal, so no other loan provider can use it, obliging you to pay a second appraisal fee if you want to go somewhere else. Unless you can get them to agree in writing to release the appraisal (they won't), this is a giant red flag not to do business with that provider. The appraiser should be someone you have the option of choosing, and should be paid at point of service when the appraiser comes out to the home. (Don't choose an appraiser who's a family member, however. Lenders frown on this. Expect some pointed questions or having to get another appraisal if your name and the appraisers names are similar.)

Even other loan providers will try to slip in and assume ownership of an appraisal. If you want to control the appraisal, you must order it direct from the appraiser yourself, and if your loan provider provided the recommendation, the appraiser still might consider themselves bound if they get a significant amount of business there. On the other hand, as I also state in another essay, time is always a critical factor in every loan. The appraisal holds the whole process up if it's not done promptly, and a reasonable appraiser is going to put his priorities on getting the appraisals done from the people he gets business from on a consistent basis. So if you're going to order it yourself, order it immediately, or even on your own before you start the loan process if you know the parameters. This is difficult in the case of purchases, but very possible in the case of refinances. On the other hand, purchases are less time critical. Warning!: There are different kinds of appraisals, and different qualification levels of appraisers. There isn't space here to cover them all. If you order the wrong kind of appraisal or order it from the wrong kind of appraiser, it's useless. Just because 90% plus of all appraisals are the same kind from the same grade of appraiser or better doesn't mean yours is one of them. The best way to handle this situation is to give the loan provider no more than two business days to give you the parameters for the appraisal, and be preparing the ground ahead of time by telephoning appraisers. Somebody that will charge $450 and do it within two days is almost certainly a better value than someone who will charge $350 and take two weeks. Immediately upon receipt of parameters from your loan provider, order your appraisal. That exact second. Don't even put the phone down. As I said, time is critical. Some loan providers will not allow you to do this, insisting upon being the one to order the appraisal. This is a red flag. You probably want to take your business elsewhere. Handling the appraisal correctly is not trivial for a consumer, who after all is not usually a real estate professional, but if you handle it correctly, you put yourself in a position of much greater leverage.

Caveat Emptor

Original here


I have never had someone tell me they wanted more information than this letter provides. I also require the prospective loan officer to fill if out for prospective purchasers of my occasional listings.

DELETED (Mortgage Corporation)
Address DELETED
City and ZIP DELETED
Phone DELETED

My name is Dan Melson and my License number with the Department of Real Estate is DELETED. I have funded in excess of one thousand real estate loans

This is to certify that I have performed initial investigation as to whether Mr. Client and Ms. Client are eligible for the contemplated loan and purchase under the purchase contract being submitted on (property address)

I have run their credit score with all three major credit reporting agencies. Credit scores as of DATE are



Person
Equifax
Experian
TransUnion
Primary Borrower
XXX
XXX
XXX
Co-Borrower
XXX
XXX
XXX

The credit report lists their current monthly debt service as being a total of $X/month, and according to Mr. Client and Ms. Client, they have no other debts.

I have in my possession copies of paystubs for current year and w-2s or tax forms for the prior year, acceptable to lenders for documentation of income. These indicate pay for the last thirty days as well as year to date pay and prior year.

Total Income for the period to be averaged $X (DELETED months)

This indicates an average monthly income of $X

This monthly income, per (details of specific loan) guidelines, allows a total debt service plus housing of up to $X per month.

Projected Property Taxes: $X/month
Homeowner's Insurance: $X/month
HOA Dues: $X/month
Mello-Roos: $X/month

Fully Amortized Loan Payment: $X/month ($X at Y%, type of loan, pricing date)

Total of housing and other debts : $X/month

Since this is less than the total allowance based upon income, I have reason to believe Mr. Client and Ms. Client will qualify for the loan based upon Debt to Income Ratio. Projected back end Debt to Income Ratio: X%

The Allowed Loan to Value Ratio for contemplated loan per lender guidelines is X%.

I have in my possession current bank and other asset statements indicating the presence of liquid assets in the amount of over $X

Projected down payment: $X
Projected loan closing costs: $X (includes loan closing costs including all third party costs as well as points, if any)
Projected impound account and prepaid: $X
Other projected expenses: $X (Inspection and anything else I know we'll need)

Total: $X

Accordingly, Mr. Client and Ms. Client appear to be in possession of sufficient cash to fund the projected down payment and other closing costs.

Therefore, according to known underwriting guidelines applicable to the specific loan indicated above, having verified and tested Debt to Income Ratio, Loan to Value Ratio, Credit Score, and cash to close, I have a reasonable basis to believe that Mr. Client and Ms. Client will qualify for the above contemplated loan in a timely fashion to complete the contemplated purchase in a timely fashion.

Sincerely


Dan Melson, Loan Officer
DELETED (Mortgage Corporation)
Address DELETED
City and ZIP DELETED
Phone DELETED
Fax DELETED

This website does not speak for my brokerage, therefore I do not use their name here, but those are filled in on the real thing. Actually, I use computer generated letterhead. This is the precise equivalent of an accountant's testimonial letter. Whomever it is given to needs to be able to contact me with questions, and I am responsible for specific details I mention. Without those details, I might add, whatever paper this is printed upon is completely worthless.

I write every one of these specific to a given property and a given purchase contract and loan pricing as of a given date, and usually with quite a bit of wiggle room on the actual rate and cost. It doesn't do any good to write that the loan depends upon getting financing that may not be available tomorrow if the rates rise even slightly. It certainly doesn't do anyone any good to write that "Mr. Client and Ms. Client are pre-approved for a loan up to $X" without specifying the parameters I used to justify that statement. Debt to Income Ratio, Loan to Value Ratio, Size of loan, size of payment, estimated closing costs, estimated cash to close, specific tradeoffs between rate and cost that vary daily (at least) - all of these have an effect upon whether the prospective buyer will qualify for this loan under this proposed contract today. Without all of this information, the seller's determination as to whether to grant credit by signing that purchase contract is missing some vital information. It's not that any prequalification or pre-approval is actually worth anything, in the sense of being able to hold that loan officer responsible for any and all failed loans, but they can be held responsible for material misrepresentation. Without a representation or relevant facts used to reach the conclusion, what assurance have you that the person who wrote it didn't just flip a two-headed coin? "Sure, they qualify!" (I'll figure out what they really qualify for later, but they sure are happy with me for saying they qualify...)

The whole idea of such a letter is that the person to whom it is presented can go to any competent loan officer and ascertain whether or not this loan can be done. I have never had anyone call me for more information or for verification - which means one of three things must apply: 1) The people on the other end can tell that the loan can be done, 2) They're just putting it in the file for CYA, 3) They're just doing it so they can illegally refer people to a specific loan provider who refers the clients back to them.

I'd like to see this or something like it standardized across the industry. If you're going to write a letter, you might as well write one that means something, that contains enough information for the person on the other end to be able to make a reasonable determination of whether this is, in fact, a reasonable transaction that has every likelihood of becoming a fully consummated transaction. That is the only possible excuse for requiring such a letter in the first place - your client's best interest. You can satisfy your client interest without violating RESPA - all you need is the information to know whether the loan officer writing the letter based that letter on solid facts or not.

Caveat Emptor

Article UPDATED here


Cash to close has always been an underwriting standard, but more people are running into it as a reason why they cannot buy that property, why their buyers cannot perform, and why they can't get that refinance approved. With lender requirements as to what they will and will not loan on, not to mention impacted equity situations, "cash to close" has become more important than it has been for a decade. Whether you are a buyer, seller, agent for either, loan officer, or someone who wants to refinance the property you already own, you need to be aware of the requirements for "How much cash needs to be there to make this loan happen?" If you anticipate them and structure the transaction correctly, said transaction will have a lot fewer stumbling points.

In the past (a year or so ago), 100% financing was routine, and with seller paid closing costs, the buyers often literally did not need a penny to buy property. Indeed, such was one reason the real estate market got so wildly out of hand. Not the only reason, nor the main one, but when people could believably say, "You haven't got any money in it, so just walk away if anything goes wrong," they could get a lot of takers, even when that's a lie precisely equivalent to the con man's "trust me!"

Right now, the only generally available 100% financing is the VA loan, and 100% stated income financing, which was the gravy train for many god-awful real estate agents and loan officers, might as well be story on the lines of a Greek myth in the current environment - stories of what they called hubris abound in Greek Mythology.

Furthermore, lenders are looking hard at seller paid closing costs. They're desperate to make what they think of as good loans, so they're still mostly giving these a pass - but there are more instances of snags with them now than I can remember hearing of at any time in the recent past.

The upshot is that you have to consider "Cash to Close." You have to remember it and keep it always just as much in mind as loan to value ratio, credit score and debt to income ratio. Not only do you have to have the money for the down payment, you've got to have all the cash you need to close the transaction. This is a prior to documents condition: the lender will not so much as generate loan documents for signature until you and your loan officer can demonstrate that you have enough cash to actually make the down payment and everything else that you are going to need to pay to make the transaction happen.

The largest component of all is usually the down payment: 3.5% of the purchase price for FHA financing, 5 to 20 percent or more for conventional financing, depending upon what's available to you and some choices that get made. Right now, 10% is pretty much the minimum for conventional financing (that is, financing where the government does not get involved), and that involves private mortgage insurance unless and until the down payment reaches 20% of the purchase price. There are exceptions in some municipal first time buyer programs, but those are not "generally available" in that they run out of money at Warp Speed whenever they do get an allotment.

Closing costs for the loan are another component of cash to close. It takes money to pay the people and companies working on your loan. For a rule of thumb, I use $3500 even though it's probably going to be less than that, excluding discount points, which are used to buy the rate down, and impound account money. Title insurance, escrow fees, appraisal, processing fees, lender fees of various kinds, government fees such as recording, and usually a charge for origination, itself usually measured in points. These all have to get paid, or your loan doesn't get done. Nobody is going to agree to pay these costs for you unless they get something for it in the form of a higher interest rate.

There is always a tradeoff between rate and cost in real estate loans - you don't get a lower rate without paying for it, and you don't get costs paid for without agreeing to a higher rate in exchange. Points are measured as a percentage of the gross loan amount. If, for example, you're paying two points to buy the loan rate down, then after you've added in all the closing costs and impound fees and anything else that applies, this amount is only 98% of your total loan amount. On purchases, you're going to have to have this two percent of the loan amount in cash if you want to buy that rate down, effectively adding to your down payment requirements. So even though I've taken this slightly out of order here, in reality, points are the last things figured into the loan, assuming that there are any.

Impound accounts are seed money for paying your property taxes and homeowner's insurance, giving the lender assurance that they will be paid on time and in full, thereby not jeopardizing the lender's interest in your property through unpaid property taxes or having the property damaged or destroyed while uninsured. Many people like having these details taken care of by just writing a slightly larger monthly check in the first place. They are your money, but the lender wants enough money to seed these accounts so that they will have enough in them to pay these charges when they are due. As I have said and demonstrated, impound accounts can be several thousand dollars, and lenders can, in many states, charge extra for not having them.

Finally, there are the buyer costs of the purchase. Around here, they really aren't much - half the purchase escrow, recording costs and a few other minor things. I generally include them in the closing costs of the loan (as above), but they really are different. In other areas of the country, however, the rules are different and the traditions are that the buyers pay more of the costs of transference. Neither way is necessarily right or necessarily wrong; it's more a matter of what everybody is used to, and the fact that the usual method for your area is what the rest of the market is priced for.

On purchases, all of this money can only come from cash in addition to the down payment, or by moving cash away from money that would otherwise be used for the down payment. For refinances, if there is enough equity then these costs can usually be rolled into your new loan amount - but do not confuse that with not paying those costs. You are not only paying all of those costs, you are paying interest on them and they are still in your loan balance until you find enough in the way of payments to pay them off. Don't Roll Mortgage Refinance Costs Into Your Balance If You Wouldn't Pay Them Cash. And to further drive this point home, as many people are discovering now that they don't have this equity on refinancing, they are having to come up with thousands of dollars if they hope to get that loan actually funded. Real refinancing is not a case of blindly rolling what may potentially be tens of thousands of dollars into your loan balance. It's okay if you have the equity and make a conscious choice that this is the best way to handle it for you; it is not okay if by doing so you merely get to pretend that it isn't real money.

Down payment plus closing costs plus impounds plus buyer costs, plus points (if any) equals cash to close. You need to have this money available in cash, and you have to be able to convince the loan underwriter of its provenance - sourcing or seasoning the funds. Where did all of this money come from? The lender wants to know that it is not from an undisclosed loan, which you're going to have to make payments on, possibly thereby putting the entire transaction into the realm of unaffordability because your debt service is now too high a proportion of your income. You are going to have to show you got the money from some source that is not a loan, or that you have built it up and saved it over time. The lender is going to ask for supporting documentation, of course. For refinancing, there is at least potentially a little more leeway, if you've got equity in the property you can borrow further against that equity as an equivalent to cash, in order to close that loan. But that is a very different thing from not needing the cash in the first place, which is a pipe dream. For purchases, this very elementary, completely foreseeable difficulty is probably at fault in at least half of the transactions that are failing to close - all because lazy agents and loan officers got used to sloppy practices and are having difficulty weaning themselves away. Cash to close is real, and it's something that everyone needs to concern themselves with, lest they be made very unhappy when the entire transaction falls apart because the cash to close wasn't there to begin with.

Caveat Emptor

Article UPDATED here

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This page is a archive of entries in the Mortgages category from December 2008.

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