Mortgages: November 2012 Archives

There's a lot that gets written on this subject, mostly by loan officers looking for business. Well, don't think I'm not looking for business, but not with this post. Or if anybody calls me because of this, at least I'll know they understand how to do it right.

The basic come-on is this: Your home has appreciated in value, and is worth more than you paid for it, so now you have equity on the one hand. On the other hand, you have loads of consumer debt, which is costing you hundreds or even thousands of dollars per month, which is impacting your lifestyle. So you borrow on the equity in your home and save money on your payments as well as causing them to be tax deductible in most cases, or at least so the traditional thinking goes. In actuality, it's only the actual purchase money where the debt is tax deductible, while cash out is not. My understanding is that the IRS has been starting to crack down on this.

Let's illustrate the situation with some numbers. Let's say Arnie and Annie have a $300,000 loan on a home that they bought in 1998, and comparable properties in the neighborhood are now selling for $600,000. This is 300,000 in equity.

On the other hand, because they are American consumers, Arnie and Annie have a hard time living within their means. They've got $15,000 in consumer credit, a $10,000 home improvement loan, and two new SUVs with associated debt of $20,000 and $30,000. These are fairly typical numbers.

Arnie and Annie's mortgage payments are currently $1720 per month, because they refinanced to 5.25% in 2003 when the rates hit bottom. Their monthly payments on the credit cards are $400. The payments on the SUVs are $500 and $600 per month, respectively. The payment on their $10,000 home improvement loan for landscaping is maybe $150. Arnie and Annie are forking out $3370 per month without taking into account stuff like property taxes, insurance, utilities, etcetera. It's really cramping their lifestyle.

Suppose they consolidate these loans into one payment on a thirty year home loan? All right, so it costs them anywhere from zero to $20,000 to get the loan done. Let's split the difference and say $10,000. That's about two points plus closing costs.

This adds up to a $385,000 loan. When I originally wrote this article, that was a jumbo loan amount, but that is no longer the case. With a 30 day lock, that would have gotten you 5.875% or thereabouts when I originally wrote this on a thirty year fixed rate loan. The new payment: $2277. Voila! Despite the higher interest rate, Arnie and Annie are saving almost $1100 per month!

Or are they? On the credit cards, their monthly interest was $225; their $400 payment would have paid the cards off in less than five years. The interest on the SUVs was $333 total on the two, and their payments would have had them done in about five years. The home improvement was a ten year loan but even so their monthly interest was only $75. Now these are all thirty year debts. The monthly interest on their old home loan was $1312. The interest charges on their home loan is now $1884, where total interest was $1945 previously. So they are actually saving money on interest.

The difference is that now they're not paying the old loans off as fast - they've spread the principal over thirty years. In the meantime, the bank is getting all this lovely money in the form of interest from them, and if they refinance about every two years as most people seem to do, this is $85,000 more that they owe on their home, and that Arnie and Annie will pay points and fees on every time they refinance! Meanwhile, Annie and Arnie are quite often out charging up more debt they'll consolidate into their home loan, and they'll keep doing this trick for as long as they can.

Let's assume Annie and Arnie beat the odds and don't refinance for five full years. This puts them ahead of 95 percent of the people out there. Let's look at where they'll be five years out if they make the minimum payment. They will owe $357,700 on their home. On the plus side, they will have had $66,000 to spend on other things (and they likely will, if they are typical Americans). Total debt: $357,700.

If they had continued making their previous payments, they would now owe $272,100. Plus they would be done with the SUV's and the credit cards and would only owe $6600 on the home improvement loan which they could now concentrate on. Total debts: 278,700.

Net difference: $79,000. Subtract that $66,000 they had real good time with (and nothing to show for), and they're still $13,000 in the hole.

They do have a $572 per month potential additional deduction, assuming they are willing to risk the wrath of the IRS as the "cash out" is not supposed to be deductible and the IRS is getting better at picking it up. Assuming they are in the 28% tax bracket and get to deduct the full amount, that gives them $9,600 less that they owe the government in taxes. Net amount Annie and Arnie are out are out: $3400, in addition to being set up for higher fees on future loans, and having a loan balance $77,100 higher. Additional interest they will pay because of the higher balance if they can get a loan at 5 percent even: $3855 per year.

Sounds like an awful bargain doesn't it? Many consumers have done this three and four times, or more. I run across people who bought their home in the early 1970s, and have mortgage balances ten to twelve times the original purchase price.

That's doing it wrong. Now I'm going to talk about doing it right. Suppose that instead of milking our equity for cash flow, where we're trying to minimize our monthly payments, we do it differently. Same situation, same numbers, but instead of spending that $993 per month, we use it to pay down our mortgage.

Actually, let's pay $3300 per month, so we still have $70 per month to spend elsewhere. After five years, we still owe $286,600. We got $4200 to spend elsewhere. And all of our other debts are gone. In addition, there's that illicit $9600 in tax reductions. Net amount to us versus the "do nothing" option: $5800, although we still owe $8000 more, and if we get a 7% loan, that'll cost us $560 per year. Notice that at this point, the benefits, while tangible, are still fairly small. Furthermore, if we refinanced or sold before this point, as ninety-five percent of everyone does, any benefits we may have gotten in the future disappear.

But: If we keep making that $3300 payment after those five years, and don't roll anything more into the loan, then the mortgage is paid off and we are debt free - the house is paid off, and the other debts are history - in less than ten more years! This relies upon us being thrifty and keeping those old SUV's going and not charging up any more credit and not doing anything else to make the debt worse. In short, not giving in to the marketing culture, not forking over money you don't have, not running up the payments on consumer stuff again. Many people say they won't. Few actually manage it.

So you see, even if you do it right, it takes years to show the benefits of this kind of refinance. This is years of doing something that they do not have to that most folks just won't do. If you have an unsustainable cash flow situation, by all means you've got to do something about it, but don't kid yourself that it's financially fantastic. On the other hand, if you're one of those who have to ability to make the scenario in the last paragraph (or something like it) happen, it's well worth doing.

Now this hypothesis is highly sensitive to initial assumptions. I previously assumed that Annie and Arnie are and always have been top of the line borrowers, able to qualify for anything. Suppose they weren't? Suppose they were in a C grade loan at 7.25%, but now they qualify A paper at 5.875. With a payment of $2070 per month formerly, of which $1812 was interest, the new loan saves them $1450 per month in minimum payments and $561 in actual interest while still saving about $1209 on their taxes over five years. You'd have owed $288,000 on the old program, now even if you put in only the same $3300 per month in payments, you're $1400 ahead of where you would have been on the balance, and you still had about $400 per month to spend. On the other hand, if Annie and Arnie were A paper but now they are applying for a C grade loan, it cannot be justified on anything except "the cash flow keeps us out of bankruptcy!" because it's financial disaster.

Some alert people will have noticed I didn't explicitly include the $10,000 cost of the loan in the computations of whether you're better off. That's because it is gone, sunk, included in the computations of where you ended up. It was part of your initial loan balance if you did it, included in the ending balance, and therefore included in the computations of whether you were better off. Now, if the cost of doing the loan were lower, there would be somewhat larger benefits a little bit faster, and indeed a lower cost loan is probably a better idea for most people, even though it means the rate and payment will be slightly higher. See my article on Why You Should Ignore APR for more.

The important thing to remember is to not get distracted by the fact that your minimum monthly payment goes down, and see if you (and your prospective loan officer) can come up with a loan and a plan that really makes you better off down the line, instead of one that sucks the life out of you financially, like the vast majority of these scenarios do.

Caveat Emptor

Original here

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

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

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

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

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

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

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

The main reason why we have to source and season cash in every transaction is quite simply so people aren't able to hide the fact that they've recently gotten a loan. It seems paranoid at first, but it isn't paranoia if people are out to get you, and lenders have gotten burned many thousands of times over this point. People quite often don't even think it's wrong to keep silent, even though it is fraud. So if the lender doesn't require sourcing and seasoning of funds, the lender grants the loan based upon known information, only to later discover that the borrower is unable to make payments due to also needing to make payments on an undisclosed personal loan. Neither the lender nor the FBI fraud unit are very happy if that happens, and neither will you be.

Caveat Emptor

Original article here

Racial Gap in Loans Is High in California.

I can give a variety of reasons for this.

First off, especially in Los Angeles but to a lesser extent throughout the state, there is a huge "Spanish speaking only" community. When you limit yourself to speakers of a language which isn't the nation's primary business tongue, you limit your ability to find loan officers who will treat you honestly and fairly and find you the best possible loan. I speak reasonable Spanish myself, but not nearly enough to do a loan.

Second, those who speak Spanish only are ripe pickings for unscrupulous loan officers and real estate agents. Because they do not understand English, the language the regulations are written in, they have less understanding of what is a complicated and confusing process for anyone who is not a practicing professional. In fact, I can name a lot of alleged professionals who speak English and are nonetheless limited in the comprehension of the process to judge by the evidence.

Third, those who speak Spanish only have a lesser understanding of their rights under the law, and since the vast majority of all loan documents are in English (a few lenders are starting to generate a few documents in Spanish, but not every document, and it will never be the main copy of anything), they have a lesser understanding of what they are agreeing to.

(Gee, I hope the preceding helps the "Spanish only" lobby of separatists understand what they're setting up for the people whose benefit they are allegedly advocating.)

But more importantly than all of the preceding, real estate and loans are "sales connection" businesses. Because most people do not shop for homes or home loans in a rational fashion. "I can't be rational! This is far too important for that!" Seems silly, but it's true. People buy or do business with you because you have made them more comfortable, or because they think you can do something nobody else can or will for them. They do business because they connect with you on some level, not because what you're offering is the best thing out there.

Identity politics exacerbates this. There are agents out there (often but not always necessarily of the same ethnicity) whose niche market is "black folks", or "Spanish speakers" or "Koreans". Some people will do business just because you're the same, or because they feel some kind of cultural connection. Others will do business because that agent or loan officer helped their brother, or friend, whether said brother was the toughest deal in creation or the easiest thing they ever did. And if your brother had to do something, or had something happen, it's only normal it should happen to you, too - right? One of the standard phrases in the sales lexicon is "My you were tough, but we got it done! How about some referrals." This by itself is not evil. But if you've taken advantage of someone as if they were a tough loan when in fact they were not and could have gotten a better deal from someone else, you're lining your pocket at your client's expense. Everybody deserves to get paid for a job well done. But when my contacts in the escrow and title business tell me about people who only serve this ethnic market or that ethnic market who have six percent state of California limits on their compensation externally applied to every single loan they do, or how these people consistently have a sales compensation a full percent above the market, that tells me something: that these alleged professionals are taking undue advantage of their target market. Many of these people they are targeting literally have no way of knowing there is something better out there. Are their tactics illegal? No. Unethical? In at least some cases. Taking advantage of client ignorance? Definitely.

The process of purchasing, selling, or financing real estate is byzantine, with rules and regulations that get more complex every year. The average citizen has difficulty understanding the things that may be relevant to their particular transaction (I've had to explain to lawyers how they got taken in their previous transaction). To most people, the whole thing is like some immensely complicated magical ritual. Place the proper documents at the foot of the underwriting god, dance three time sunwise and four times widdershins round the appraisal every day for a fortnight, pray with the high priests of insurance, and you get your house.

It has elements in common, I will admit. But the processes of real estate sales and real estate loans are coldly, brutally, logical once you understand them. Unfortunately, the odds of understanding are stacked even further against those who are apart from the majority of society. Those who are concerned with minorities having inferior loans would have more success in connecting the people to the mainstream of society than in considering further burdensome anti-discrimination legislation.

Caveat Emptor

Original here

Better deals for the bank, that is.

Ken Harney has an article Study Shows Loan Brokers' Better Side

But now a new, independent academic study has concluded the opposite: According to a team of researchers headed by Georgetown University's Gregory Elliehausen, home mortgage applicants with less-than-perfect credit pay lower financing costs when they obtain their mortgages through brokers rather than from loan officers directly employed by lenders. The same pattern holds true for African American, Hispanic and low-income borrowers.

The study was limited to subprime borrowers, but the results are not surprising:

Overall, broker loans cost 1.13 points less for first mortgages, 1.98 less for second mortgages

For borrowers in predominantly black areas, the difference was 1 point and 1.9 points, respectively.

For borrowers in predominantly hispanic areas, the difference was 2 points and 2.4 points. The explanation as to why this gap is larger is probably as simple as the fact that many of these folks limit themselves to dealing with Spanish speakers.

Skolnik added, though, that the data overall could reflect that "brokers in general operate in a much lower-cost structure" compared with banks and retail mortgage companies that carry heavy overhead and employee costs. Moreover, he said, "brokers are far more agile and nimble than retail" lenders, when pushed to compete on pricing and terms.

That and any given lender may have anywhere from a dozen loan programs to fifty, all intended to hit specific niches and priced for given underwriting assumptions. A 3/1 is different from a 7/1 is different from a 30 year fixed, stated income is different from full doc is different from NINA. That's nine programs right there, and this is A paper stuff. Subprime is even more varied. It doesn't matter if you barely meet guidelines or soar through them. If you find a program with tougher underwriting guidelines that you still qualify for, than that lender will give you a better rate on the loan, because they will have fewer of them go sour, and therefore get a better rate on the secondary market. You can go around to all the lenders yourself - or you can go to a broker.

Furthermore, even if you're one of those so slick that you fit into the top loan category of the toughest lender, brokers can typically get you a better price. Why? Two reasons. First, the lenders don't have to pay broker's overhead, making it more cost effective for the lender to do the same business through the broker. Second, and more importantly, when you walk into a lender's office, they regard you as a "captive" client. Brokers know better. Brokers are not captive to anyone, and they know that you're not captive to them. A good broker's loan officer will price with at least a dozen lenders. I had shopped fifty or more for tough loans, even before automatic pricing engines. Furthermore, there's an efficiency factor at work. After a while, a good loan officer learns which lenders are likely to have good rates for a given type of client. Which do you, as a client, think is likely to be the best use of your time and resources? Going to all those lenders yourself, or going to a few brokers?

This article of mine is also highly relevant to this article's subject matter.

Caveat Emptor

Original here

A mortgage or Deed of Trust (they're not the same!) is basically pledging an asset that you own as collateral for a debt. If you default on the debt, the lender takes your property. When you're talking about real estate in the state of California (and many others), this is generally accomplished by use of a Deed of Trust. There are three parties to a Deed of Trust: the trustor, trustee, and beneficiary.

The Trustor is the entity getting the loan.

The Beneficiary is the entity making the loan.

The Trustee is the entity which has the legal responsibility of standing in the middle and making sure the rules are followed. When the loan is paid off, they should make certain a Reconveyance is completed and sent to the trustor so they can prove it was paid off. If the beneficiary is not being paid, they are the ones who actually perform the work of the foreclosure.

One thing to keep in mind during all discussions of real estate and real estate loans is that the amounts of money involved are usually large - the equivalent of somebody's salary for several years on every transaction. The temptation to fudge the numbers or even outright lie to get a better deal, or to get a deal at all, is strong. Many people don't think they're really doing anything wrong by fudging things a bit, but this is FRAUD. Serious felony level FRAUD. Fraud, and attempted fraud are widespread. There are low-lifes out there who make a very high-class living at it (for a while). Every lender has to devote a large amount of resources to determining that each individual transaction is not being conducted fraudulently. To fail to do so would be to fail in their jobs to protect their stockholders and investors. I have told many stories about the most common sorts. But the reason everything in every real estate transaction is gone over with such a fine-toothed comb that adds thousands of dollars to the cost of the transaction is that people lie, cheat and steal with such large amounts under consideration. Every hoop that anybody is asked to jump through has a reason why it exists, and often that is because somebody, usually many somebodies, have committed FRAUD based upon that particular point.

One of the conditions I must attach, implicitly or explicitly, to every quote for services, is that this is based upon the condition that you are telling me the truth, the whole truth, nothing but the truth, and are being honest and forthright in your presentation of the facts without trying to hide anything and are specifically calling my attention to anything that you suspect may be a problem. And because the list of what is relevant information is long, complex, and conditional upon factors that are often opaque to non-professionals, sometimes, people quite honestly don't realize that something is a fly in the ointment so they don't mention it. I, or any other professional practitioner, have no way of knowing that said fly exists unless you, the client, tell me about it. Therefore what I tell you initially does not account for said fly. This is not unethical, it is just a due to the fact that I don't have all of the relevant information..

When you're talking about residential real estate loans there are basically two absolute requirements as to the nature of the collateral. The first is land - land as in real estate. A partial, fractional, or shared ownership of a common interest in land (as in a condominium) are each sufficient unto the task. A rented space to park your mobile home is not.

To that real estate, there must be permanently attached in a way so as to prohibit removal, or at least make it an extended project, a residence in which people can live. We're all familiar with you basic site-built house. Personally, I'm a big believer in the virtues of manufactured housing. To paraphrase Robert A. Heinlein in precisely this context, imagine a car for which all the parts are brought individually to your home and assembled on site with ordinary portable tools in an environment which was not specifically designed to facilitate said assembly. How much would you expect to pay, and how would you expect it to perform? The correct answers are "A LOT more than for your house", and "not very well, in terms of either reliability, speed, or economy."

Nonetheless, when a lender looks at a house that's been moved to the site, they see one that can be moved away from the site as well, and they are skeptical because many people have done precisely that. Furthermore, the way that residential real estate is valued is somewhat arcane. The lot itself may be worth $400,000 here in California because it has $150,000 of improvements on it in the form of a three-bedroom house on it, but take away that three-bedroom home, and the lot may be only worth a fraction of the amount. So they loan you money based upon a $550,000 value of the combination as it sits. Some time later, you back your truck up to the house and cart it off, and then default on the loan, leaving the bank a lot may only have a value at sale of $80,000. Now imagine yourself as the bank employee who made the loan. How do you explain this to your boss? Over the years, many bank employees have had to explain this to their bosses, all the way up the chain of command to CEOs explaining to investors and stockholders. Lenders know that most people are honest - but they've got a duty to make sure you are among the honest ones. And if you subsequently lose your job and can't pay your mortgage, might you not be tempted to back the truck up and haul the house off somewhere if you could so the bank can't take it? There are good substantial reasons why many lenders won't approach manufactured housing as residential real estate, and the ones who do treat it as such charge higher than standard rates, and place further limitations on lending.

When I originally wrote this, I was personally eying a beautiful manufactured home that more than meets my family's needs, was in the middle of the area I want to live in, and was priced more than $100,000 lower than comparable sized and lower quality site built homes on smaller lots. Yet there was a reason for that lower price. It's not like that owner just decided to list it for $150,000 less than he could get. The home carries many higher costs. If I had bought that home, I would be paying for it in the form of higher loan costs every month, and higher loan fees every time I refinance until I sold it, and fewer people able to buy the home when and if I do sell it as a result of loan constraints, and a I can expect lower eventual sales price as a consequence - which is the situation that owner was in when I was looking at it. I reluctantly decided that those costs outweigh the benefits. My decision was regretful, but until somebody comes up with a procedure that banks agree makes manufactured housing equal in every way to site built in their eyes, it is also firm.

Caveat Emptor

Original here

(And I must say that if somebody comes up with such a procedure, you will be a gazillionaire, and deserve every last penny and then some. I hereby publicly forswear all claims of compensation for the idea of such a procedure. If you can make it work and it makes you rich, I won't ask for a penny, although any contribution you care to make voluntarily will be happily accepted. I just want to be able to say you got the idea from me, as part of my contribution to a better world)

real estate mortgage manufactured housing

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

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

(one way of looking at it with considerable merit was that the Era of Make Believe Loans was scamming investors, while these merely scam consumers)

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

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

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

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

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

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

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

So you get $6825, less the payment of $2676.40, leaves $4148.60. Over the course of the month, money goes out to pay for all of your expenses. The people who sell money merge accounts urge you to leave paying your monthly bills as late as possible to get the maximum benefit from these accounts, completely ignoring the costs of the occasional late payment this is going to cause, as well as detrimental effects upon your credit when it does happen. In fact, a certain amount of these bills are going to wrap into the next month, meaning that under the conditions we've agreed upon, you write that check to your investment account for this month and pay that bill out of your next month's pay if you're smart. Since you're going to write that particular check ASAP if you're smart, that's going to diminish the effects of the $4148.60. But I'm going to be nice and give you a $1000 "cushion" that you carry into the account from month to month (again, you won't do this if you're smart), while the $4148.60 is going to be paid out evenly over the course of the month, giving you a mean daily amount of $2074.30, plus $1000, or $3074.30 per month of temporary principal reduction. This reduces your interest paid by $10.37 that first month! I'm going to assume this is pure gain, every month, and that it continues to compound. If you do this every month for thirty years, you'll actually pay off that loan a grand total of three months early, and the last payment is reduced to a shade over $400! All of this hooting and hollering and shouting and frustration over three months of paying your mortgage off - in an absolutely optimized, perfectly favorable environment where the Money Merge account didn't cost you a penny in set up fees or monthly cost. And even in this ideal situation, with the maximum reasonable advantage compounding over the course of the entire mortgage, out of $963,000 in payments, the money merge saves you about $10,000 at the very end - just over 1% of total payments, heavily discounted for time value of money thirty years from now. That's not the "pay your mortgage off in twelve years for the same payment!" come on used by the most popular of these! Were I the regulatory authorities, I'd be looking very hard at their advertising! Yes, you can pay it off in 12 years by making massive extra payments, but people without a money merge can do exactly the same thing by simply sending in more money.

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

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

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

Let's consider some alternatives. Remember I told you the money merge account saves you $10.37 per month in optimal conditions, which works out to just about $10,000 saved at the end of thirty years? Well, let's ask ourselves, "What would be my benefit if I just took the $2000 the cheapest one of these costs me and instead used it for direct principal reduction?" In other words, what if you added that $2000 to your regular mortgage payment once? The answer is, for the example above, that you pay off your mortgage four and a half months early, as opposed to about 3.8, saving an additional $1800! Using the upfront costs for a direct paydown instead pays the mortgage off sooner than the accelerator account, and that's for the cheapest of these that I'm aware of !

After the three years that's all most people keep their mortgage, the person who just uses a $2000 sign up fee is still $1985 and change ahead of the poor stupid schmoe who signed up for the accelerator account! For a middle of the line $3500 set up fee, the difference, mutatis mutandis, is $3780 and growing at the end of three years, to the point where that mortgage is paid off 6.7 months early, as opposed to the mortgage accelerator's 3.8, saving thousands of dollars more than the "accelerator"! This doesn't count the monthly fees most mortgage accelerators charge, HELOC set up fees, or additional HELOC interest charges that the vast majority of these accounts require, and which do siphon off the benefits as noted above.

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

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

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

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

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


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


• You just don't care about your clients welfare

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

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

Caveat Emptor

Original article here

First off, let me say that your site has been very informative and helpful. I stumbled across your blog looking for information on ARM vs. 30 year fixed loans and ended up reading every article.

One issue I have never really seen addressed is joint loans. When a couple, married in this case, gets a loan, which FICO score do they use?

Right now, my wife is a nursing student, when she graduates in August we want to buy a new home that is significantly more expensive than our current home. Our combined salaries at that point should be somewhere around 120K. I have been told by a mortgage professional in our first phone conversation that being a student counts for "years in line of work", but we would have to wait until she receives her first paycheck from her new job before we could count her income. We just accepted an offer on our current home last week, and will have enough cash to put down 10% in the price range we are looking at (200-300 K). If we want to buy before she is employed, but has an offer so we know her salary, what are our options? It seems to me that we would be in a situation where we are doing a Stated Income type loan.

The answer to this is that whoever make more money is the primary borrower. This works with a couple as well as other arrangements. It's a very simple answer, but you'd be amazed how often I have to repeat it for trainee loan officers. Of course we all want to use whichever score is better, but it's the person who makes more money whom the lender will consider to be the primary borrower. It's their income that's providing the main source of income with which to pay back the loan.

Now as far as A paper goes, it's kind of academic. If you want to use both incomes for the loan, you both have to qualify. This can be an issue when one spouse forgets to pay bills and the other is as a-retentive as I am about it. Over time, spouses credit reports tend to track one another more and more closely, as they switch from single credit accounts to joint accounts. If it's a joint account, doesn't matter who forgot to pay the bill - you both take the hit. On the other hand, even long-married spouses don't tend to have exactly the same score, and in many cases they have intentionally segregated the credit accounts for precisely this reason, that one spouse is better about paying bills. So one spouse has a 760, and the other spouse has a 560. Ouch.

It is to be noted that the superior solution is to have the responsible spouse pay all of the bills, which results in two high credit scores. Why is this important? If one of you has a 760, they may qualify A paper. If the other has a 560, you have a choice: go sub-prime (if you can find it), or have the high scoring spouse be the only person on the loan. In other words, when you're talking about A paper, you both have to meet the credit score minimums, or you don't qualify as a couple.

This has implications. Suppose you have a 760 score spouse who makes $3000 per month, and a 560 score spouse who makes $5000 per month, you have a choice: Qualify based upon $3000 per month, go stated income (assuming it ever comes back), or drop to sub-prime (if you can find it).

$3000 per month doesn't qualify for a lot of house most places. So if you're thinking 3 bedroom house, you can be stuck with small one bedroom condo - if you want the best rates. Most people don't want to accept that.

The second alternative is going stated income. As of this update, stated income is essentially extinct. It's not quite illegal, but nobody actually does it because they can't sell the loan and the agencies that rate financial assets consider it a junk asset. This only works if the necessary income for the loan is believable for someone in that occupation. Even if it comes back someday, somebody who makes $3000 per month is not likely to be in a profession where $8000 per month is a believable income, and most people tend to overbuy a house rather than under-buy, regardless of the fact that under-buying is a lot more intelligent in most cases. Furthermore, you are committing fraud if the lender finds out and wants to prosecute.

The third solution is to go sub-prime, where you'll qualify, but get a higher rate and almost certainly a prepayment penalty. At this update, sub-prime lenders who will lend to someone with a lower credit score are difficult to find, and the down payment requirements are stiff. Furthermore, a single borrower with a 760 credit score gets a better loan, with proportionally less of a down payment, than the couple in this case - the primary borrower has a 560 score, remember - but they just won't qualify for as large of a loan because they can't afford the payments. Most people want to buy the more expensive property with a crummy loan rather than buy the property one spouse can afford, but it's just not on the list of options for most folks right now. The down payment, particularly for low credit scores, tends to be a major issue. Except for VA loans, 100% financing or anything close to it is very difficult to get.

Once upon a time, you might also have gone NINA, which is a "here I am - gotta love me!" approach where income is not verified, nor employment history. The loan you get is based totally upon your credit score and equity picture (how much of a down payment you make, in the case of a purchase). The rate was higher than stated income and the restrictions on equity were greater, but sometimes it was the best loan people could actually get. Unfortunately for those people, NINA went away even before stated income.

Now, as to what you were told, student does not, in general, count as time in line of work. Sometimes, exceptions are made for advanced professional degrees - medical doctor and lawyer and nurse - and have actually gotten easier than since I first wrote this. Even so, the lender is going to be careful because many folks get their degree and their license, then end up finding they can't stand the work. That's one of the main reasons for the two years line of work requirement. As a question to make why this more clear: How are you going to compute her average monthly income over the last two years? That is the way full documentation loans are justified. Some sub-prime lenders will accept it (not the better ones), or the person who told you this could just be planning to substitute a stated income loan based upon your income. The fact is, that unless you're talking ugly sub-prime, they're not going to accept your wife's income until there's some time actually working it. Many people graduate school and never work in the field. They don't pass licensing, or they decide soon after they start that it's not for them. When this happens, they generally end up not being able to afford the loan - and that's not something the lender wants.

As I keep telling folks, there are a lot of shysters out there in the mortgage profession. The easiest way to get people to sign up is to promise the moon, and until you get the final loan paperwork you have no way of knowing whether they intend to deliver what they said.

Caveat Emptor

Original here