Mortgages: August 2013 Archives

My take on the matter is "mostly no", but they do have some uses.

The one advantage that they usually carry a lower interest rate. There have been exceptions to this, just as there have been exceptions to the 5/1 hybrid ARM carrying lower rates than a thirty year fixed rate loan. There was a period not too long ago where for exactly the same cost I could deliver a 30 year fixed rate loan three eighths of a percent lower in the interest rate than the best fifteen year fixed rate loan then being offered. I just checked again, and the world has gone back to normal in this regard with the 15 year loan being lower interest rate for the same cost. So that is one benefit - lowered interest rate and lowered cost of interest. For a $300,000 loan amount, that would save you $1125 per year in interest charges, or $93.75 per month to start with, and increasing as time goes by. Solid benefit. Mathematical Fact.

Now let's consider the drawbacks. The first is that the payments are much higher. Why? Because you have to pay that principal off in half the time. I'm considering rates to be had at wholesale par when I originally wrote his article, but these are equally valid in other contexts. On a $300,000 loan at 4.75% for a fifteen year loan, you're paying $2333.50 per month, versus $1633.47 at 5.125% on a thirty Suppose you have unexpected expenses, lose your job, or take a pay cut. On a fifteen year loan you are still obligated to make that additional $700 payment every month. The payment isn't twice as big, and it does save you a very large chunk of change if you pay your loans off. But there's nothing stopping you from voluntarily paying extra on a thirty year fixed rate mortgage, either. A month before, I was telling people who wanted fifteen year loans to do exactly that. If the rate on the thirty year fixed rate loan is lower (as it was then), it's a 100% gain to get a thirty year fixed rate loan and simply add extra to the principal payment every month. Plus you have the option of not doing it if your finances change.

Let me make another observation: most folks don't pay loans off - even 15 year loans. Statistically, the number of folks who haven't sold or refinanced before five years is is less than ten percent. Some situation will arise which makes it better to pay off that loan early, via a sale or refinance. When it happens and you have been adhering to a fifteen year payoff schedule (whether you have a fifteen year loan or thirty year fixed rate loan you've been paying extra on), you get a large extra chunk of cash back on a sale, or you owe a lot less on a refinance. Bully for you, good show, and all that. But don't kid yourself that it led to an earlier payoff of your loan.

If you're the sort of person who is just buying their primary residence, going to pay it off without ever refinancing, just going to spend the extra money when the loan is paid off, and would never consider investment property or alternative investments, that's about the limit in complexity we're talking about here. Verdict: yes, get a fifteen year loan. But if any of those assumptions is not valid, then we've got some more work to do.

First off, if you're the sort of person who is looking to get into investment property, especially more than one: Higher minimum payments hit your debt to income ratio (and cash flow) hard. It would be very easy for me to come up with a scenario where you would be accepted on three or four thirty year fixed rate loans, putting the power of leverage to work for you where it does a lot more good, where you would be rejected for a second 15 year loan, simply because the debt to income ratio doesn't work. With the unavailability of stated income, this is going to bite an awful lot of people and keep biting. Where you could have your own property and three investment properties all with positive cash flow on thirty year loans, you could quite likely be stuck with your own property and possibly one investment property on fifteen year loans, and even if the loans were approved, be in serious negative cash flow land. Negative cash flow is a very bad thing for real estate investors - it's the number one reason why real estate investors are forced to do bad things they don't want to do, like sell in a tough market. If you've got positive cash flow and sustainable loans, the question is "How long is it going to be before I sell for a huge profit?" not "can I hold on another month?"

Second, we haven't considered a hypothetical alternative investment yet. Let's look at this very situation, and suppose we can earn an annualized 9% with alternative investments (right now, with the financial markets in the state they are in, I would bet on the historical average of about 10% being too low, for people with the guts to buy into a down market). Let's consider what happens when we take that extra $700 per month the fifteen year loan would require, and invest it. After 15 years, it has become $264,770 - which is actually more than enough to offset the difference in what you owe ($204,868 versus zero), despite the fact that the thirty year loan carries a higher interest rate. Start investing that $2333.50 you were paying every month to the fifteen year lender in exactly the same investment at exactly the same yield. Carry it out another fifteen years, and where both loans are paid off, that thirty year loan and invest the difference strategy has netted you $1,281,520.44, versus $883,009.86 if you waited the fifteen years to start investing while you paid off your property, a difference of almost fifty percent. Mind you, this does presume you actually make that investment every month, but if you're just treating it as an abstract problem to see which use of the same money nets you more money at the end point, the thirty year mortgage and invest the difference strategy really does come out way ahead. In the real world, nothing pays a smooth 9%, and there will be fluctuations - but those fluctuations are more likely to benefit the strategy that starts investing earlier.

If this seems counter-intuitive, consider that by taking the fifteen year loan, you're taking money you could earn 9% on, and using it to pay off a tax-deductible 4.75% debt. Doing that doesn't make a whole lot of sense to me, and the numbers in the previous paragraph don't even take into account tax deductions for home interest, which will cause even more advantage to the thirty year loan. An accountant probably wouldn't bother running the numbers unless you insisted upon knowing exactly how much it would cost you..

One final item before I go: It is much harder to recover the cost of points on a fifteen year loan than on a thirty. Most people never do get the money they spend back on thirty year loans, but on fifteen year loans, it can be truly horrid. For the rates in effect today, it takes over half again as long to recover the cost of two points on a fifteen year fixed rate loan as it does on a thirty year fixed - and since the loans are for a shorter period, you won't get them back as many times over, even if you do keep the loan long enough to pay it off. I have seen many rate sheets where the payment actually works out lower for a higher interest rate, due to the costs of buying the rate down. In such circumstances, you literally never recover the additional costs. Watch your actual costs, and things that may not be costs like prepaid interest and money to seed an Impound Account. On fifteen year loans, they become proportionally much more important than on thirty year loans when they find they way into your mortgage balance, especially if the payment was something you only marginally qualified for to begin with.

Caveat Emptor

Original article here

One thing that is very common in the mortgage industry is masking loan costs by rolling them into your loan balance. People are less sensitive to being asked to roll this money into their loan balance than they are about writing a check out of their bank account. In the latter case, everybody understands that this is money you busted your backside to earn and save. In the former case, a lot of folks don't understand that the money is every bit as real.

Indeed, one of the standard ways to deflect questions about cost that seems to get taught to every loan officer by every loan provider is the phrase, "Nothing out of your pocket." This does not mean there's no cost. That's not what it means. What it means is that they don't want to talk about what the loan is really going to cost, as they're going to have to do if you're writing a check. Therefore, they want to roll it into your balance on the refinance. Most people in most situations have had their property value increase since the last time they got a loan, which likely means there's plenty of equity to cover it.

For purchases, you can't really do this because your value is never more than the purchase price. There are only three places for loan costs to come from: Your pocket, your down payment, if you have one, which reduces to your pocket, and Seller Paid Closing Costs. Seller paid closing costs are an agent and loan officer favorite, because it makes it look like you're not paying them, even though you are. If nothing else, a smart seller would rather take $10,000 less in purchase proceeds than pay $10,000 of buyer's closing costs, on which they are going to pay commissions and taxes to boot.

This trick of making it appear like you're not paying closing costs is one of the best ways to get stuck with an awful loan, but most folks won't do the research until after they've already gotten burned. You are paying those costs in one fashion or another, I personally guarantee it. There is more than one way to pay them, but if you don't know how you are paying them, you are probably not paying them the way you want to, and you're almost certainly paying too much, to boot.

There is ALWAYS a trade-off between rate and cost in real estate loans. It can be very intelligent to pay some or all of your closing costs by accepting a higher rate, especially if you don't plan on keeping the loan very long. If you know you're going to sell or refinance within a few years, or think it likely that you will, it's likely to save you money if you accept a higher rate that has lower costs. On the other hand, if you're 100 percent certain that you're going to keep this particular thirty year fixed rate loan the rest of your life, sinking a couple of points into reducing the rate can be an excellent investment. However, be aware that if you later decide to refinance or sell after all, you're not going to get your previously sunk costs back.

People get talked into rolling multiple points into their loan because it reduces their rate, and therefore their payment, aka the check they're writing every month. Let's consider two rates and the associated costs I quoted the day I originally wrote this, on a maximum conforming loan, thirty year fixed "A paper" (Rates are much lower now, but the principle remains the same). 6.5 percent was 1.5 points, or $6255 in real money, plus about $3400 in total closing costs when you consider title and escrow and appraisal. You'll find a lot of loan providers will go a long way to avoid quoting you the actual cost of points in dollars. But at 7.00 percent, I could give them back about 15 basis points, or $625, towards reducing their closing costs of about $3400. So assuming a $417,000 loan, this person would really get:

However, that's dodging the real purpose of this essay. Suppose a loan officer was to pretend that these costs didn't exist when quoting you their loan rate. Their loan would appear to be cheaper, so that you would be very likely to sign up with them, but when the facts became apparent later on - that those costs exist in reality, whether your loan provider tells you about them up front or not - you're likely to continue with their loan anyway, because you don't have time to get another loan for one reason or another, or you just decide to stick with what you've started.

Furthermore, by pretending you don't have to pay loan costs, that makes it easier to get you to accept outrageous ones. Suppose your choices were to pay that $9700 in points and closing costs to get that 6.5% rate in cash, or you could pay $15,000 by rolling it into your loan balance. It is a sad fact that most people don't understand that this is about a point and a half more in costs that are every bit as real as dollars coming out of their checking account. However, most people are a lot more careful with dollars in their checking account because they understand that those dollars are real money. They had to earn it, dollar by dollar - in the form of so many minutes out of your life per dollar if you earn an hourly wage. Then they had to not spend it right away, as soon as they got their pay! Most folks figure they have something to be proud of if they save ten percent of their pay, but if you make $5000 per month, it takes over a year and a half to save $9700 if you save 10% of your gross pay. They understand that $9700 in terms of the nineteen months of their life it took them to save it. If they're just rolling it into the balance of their mortgage where it's being paid for by the fact that the home increased in value, it may be more than half again as much money, but a lot of folks somehow think it's not as real, and they'll accept rolling it into their balance much more readily than writing a check. It doesn't matter if you're writing a check or putting the money into your balance - a dollar is a dollar. By accepting the higher cost loan, not only are you wasting over $5000 of your money, but you're paying interest on it in the meantime.

If it's an expensive loan, it's an expensive loan, whether you're rolling it into your balance or paying it direct out of your checking account. If you're paying too much money by rolling it into your balance, you're still paying too much money, and it's at least as bad as if you wrote a check or even counted out the cash. Doesn't matter whether you're writing a check or rolling it into your mortgage balance. So before you sign that loan paperwork, ask yourself if you'd be as happy with that loan if you had to write a check for every single dollar, or even count it out $20 at a time like an ATM machine. Chances are you'll be a lot more careful with your hard earned money.

Caveat Emptor

Original article here

For all of the rants I post about bad business practices, there are a lot of things the mortgage industry gets right. One of these looks like a red flag not to do business with them, and may seem like a cruel trick, but it is neither.

With every single loan that is done, you, the client, will get a package in the mail from the actual lender. It looks very official, and in fact it is.

Depending upon lender policy, it usually contains intentional mistakes on things such as the loan type, rate of the loan, or the points involved.

And every so often, I get a panicked phone call because I forgot to warn the client the package was coming.

The point of this particular package is not what it appears to be.

You see, every so often, some criminal wanders into some loan office and applies for a loan on a property they don't own. Sometimes loan brokers actually go out and meet the client in their home, but other sorts of loan providers sit in their office and business comes to them. Therefore, the bank has really no way of knowing if this is the actually the person who owns or even lives in the property. So they mail a loan package to the owner of record.

The idea is that if you haven't applied for a loan, you're going to speak up. You're going to call the bank, the broker, and everyone else asking, "What the heck is going on? Is somebody else trying to get a loan on my property?"

This is the point of the particular package. It's an anti-fraud measure meant to catch criminal activity before the lender is out hundreds of thousands of dollars. And it has just worked.

Caveat Emptor

Original here

This was originally published in 2005, but is one facet of the meltdown that is still going on, unfortunately.

I found this article by Ken Harney in the paper.

WASHINGTON - Call it funny money for the housing boom: Now you don't need actual cash in the bank to buy a house. All you need is somebody who says you've got money in the bank.

Need a hundred grand on deposit to convince a lender that you deserve a million-dollar mortgage? You've got it . . . even though you haven't really got it because you "rented" it from a company in Nevada for an upfront fee of 5 percent - $5,000.

Sound bizarre? Welcome to the wonder world of "asset rentals" now being investigated by bank and mortgage industry fraud experts. It works like this: Say your loan officer discovers that you lack the financial wherewithal needed to qualify for the mortgage you want. Rather than lose your business, however, the loan officer turns to a service that offers "asset rentals." For a flat fee of 5 percent of the amount you need, the service will verify to anyone who asks that the $100,000, $500,000 or $1 million in bank deposits you've claimed on your loan application documents are yours indeed.

I am sorry to say that this is not the first time I've encountered said phenomenon. Nor lenders. This is why assets require seasoning or sourcing. In other words, the lender requires you to show that you've had it and built it up over a period of time, or they want to know where and how you got it.

Most loans should not require a large amount of assets - A paper loans, the best loans of all, want one to two months Principal, Interest, Taxes, and Insurance (PITI) for full documentation (and I can usually get it reduced), three to four months if there is a "payment shock" issue. "Stated income" loans are no longer available, but when we had them, six months PITI was the standard requirement. Neither of these is a large number if you're really making the money, and they can be in a variety of places.

Some sub-prime lenders, however, will take large amounts of money in an account somewhere as evidence that you can afford the loan. These loans usually end up looking more like a propagandized No Income, No Asset loan than anything else. They don't get the best rates and terms, even for sub-prime, and there's likely to be a nastily long pre-payment penalty on them as a GOTCHA! The loan provider, be it broker or lender, is likely to make a lot of money on them - In California there is a thing called section 32 limiting total loan compensation to six points, which on a $400,000 loan is $24,000, and many so-called "discount" real estate agents turn around and require their clients to do the loan with them. It doesn't do you a bit of good to save a couple thousand on the sale or purchase in order to get ripped for twenty on the loan, where it's easier to conceal it. I can point you to many of these so-called "discount" houses who do these loans all day, but they are not loans you should want. If a friend came to me and asked for one, I'd try my best to talk them out of it.

But wait! It gets better!

This and other e-mail pitches, copies of which were provided to me by mortgage industry recipients, carried the sender name of Loren Gastwirth, identified on the e-mail as vice president-marketing for Morgan Sheridan Inc. of Mesquite, Nev. The asset rental attachment carried the name Independent Global Financial Services Ltd., with an address in Las Vegas.

... to a Zexxis Co., with the same Mesquite, Nev., address on Loren Gastwirth's Morgan Sheridan card. When I called the number listed for Gastwirth, I received no reply, but instead heard back from a person identifying himself as Allen Paule. Paule is listed in corporate filings with the Nevada secretary of state as the "registered agent" for Morgan Sheridan, Independent Global Financial Services, and Zexxis Corp.

Paule said the asset rental and employment pitches - including downloadable attachments and forms carried on Morgan Sheridan's Web site - were not connected to his firms. He said, "somebody hijacked our Web site." He confirmed that a Loren Gastwirth works for Morgan Sheridan. And he also confirmed that Independent Global Financial Services, Morgan Sheridan and Zexxis Corp. have overlapping ownership and management. According to Nevada corporate records, a Paul Gastwirth is listed as president and director of Morgan Sheridan.

The Web site of Vault Financial Services Inc. of Las Vegas lists Paul Gastwirth as CEO of that firm, and president of Independent Global Financial Services, "a company specializing in asset rentals and enhanced credit facilities for individuals and companies worldwide."

In other words, they are playing a Nevada Corporation shell game (There is a reason Nevada Corporations are a red flag for underwriters). A long head swallowing tail chain of corporations, each of which is likely to be a shell set up to insulate criminals from the consequences of their actions. The stuff about "somebody hijacked our web site" is almost certainly bogus.

but it gets better yet!

That's where the asset rental service's "VOE" (verification of employment) program comes in. Essentially you indicate on a faxed form what annual or monthly income you or a home buyer client needs to qualify for a mortgage, and the asset rental company will verify to anyone who asks that you have been paid those amounts.

The cost: just 1 percent of the claimed annual income. "For example," says the pitch, "$100,000 of annual income - cost of $1,000. Minimum is $50,000." The e-mail came with attachments that directed payments for asset rentals and employment verifications to an account number at Wachovia Bank in Roanoke, Va

In other words, they're also volunteering to help you circumvent one of the most basic protections to the whole process, making sure for both the lender and the borrower that the borrower can afford the loan. If you cannot afford the loan, you are probably better off without it, although many people don't realize that this requirement is partially for their own protection. If you can't make the payments, you're going to get foreclosed on. If you get foreclosed on, you're likely to lose everything you put into the house and get socked with a 1099 form which the IRS will use to go after you for taxes as well.

Lest you not have realized this by now, all of this is FRAUD. Serious, felony level FRAUD. Lose your home and go to jail FRAUD.

I'm going to share a little secret with you, widely known within the industry but not in the general public. That real estate agent or loan officer getting you your house or your loan may not be the brightest financial light bulb in the world. Many loan companies and real estate offices select for this, usually by only hiring people who have never been in the industry before. Some of them are even among the biggest names in the business. They select for sales ability and "make sales" attitude, not the knowledge (and more importantly, willingness) to say, "Wait a minute! Something is not right here!" Especially when it may cost them a commission. And hey, if the companies involved lose a few low-level sacrificial victims to lawsuits and the regulators, that's no skin off the owners' noses and they still get commissions out of it. These schemes are pitched to the agents and loan officers as a way to "save" a client. Sounds like it's in your best interest when you put it that way, right? It is not. The bank discovers this (and Nevada Corporations, among others, are a red flag that loan underwriters look very hard at) Most of these deceptions are discovered before the loan gets funded - meaning that the client they were helping to commit FRAUD wasted their money, and they have a case against the agent and employing broker, whose insurance will probably not cover the issue.

The ones that do get funded are even worse. When the bank discovers the FRAUD, they have a right to call the loan. This means you have a few days to repay the loan, or they take the house. All of those wonderful consumer protections the federal and state governments have enacted become mostly null and void, because you committed FRAUD. You can count upon losing all of your equity in the home, and getting thrown out with nothing. Furthermore, depending upon company policy of the lender, you may find yourself sued in court, and possibly even under criminal indictment. Judgments for FRAUD are nasty, and they don't go away. Convictions for FRAUD can really mess up your life completely and forever, not just in applying for credit, but in employment and other ways as well. If your loan is sold to another lender before the discovery happens, the probability rises even further, because the new lender is going to sue the old lender, who is going to take action against you as part of a defense that says they were acting in good faith. The shell corporations that pretended you worked for them or had deposits with them will be long gone (or untouchable) of course. You may have a claim against the agent, loan officer, broker or possibly even original lender, but if someone else beat you to it or they are out of business for some other reason, good luck in actually collecting.

In short, relying upon an agent or loan officer as an expert without doing your own due diligence is likely to get you in hot water. As good rules of thumb: Never lie. Never allow someone to lie on your behalf. No matter how desperate you are, it's likely to buy a lot more trouble than it's worth.

Caveat Emptor

Original here

Hello,

When my husband and I bought our home 2.5 years ago (two bedroom condo) we qualified for the loan ($250,000) based on both our incomes. Then I had a baby and stopped working. We've never missed a payment or even been late, and we're getting by just fine by being frugal. However, our loan is a 5/1 ARM, and I'm skeptical of our ability to pay the adjustable rates once our fixed years are over. Our original plan (when we got the loan) was to see about refinancing at the end of those five years. (Five years worked well for us because my husband was still in school and we knew we'd be here about that long, if not longer.) However, now that we no longer have my income, all the mortgage calculators online are telling us that we can afford a loan of just about half the value of our home. What do we do in a situation like this? Is it possible to do anything other than sell our home once our five years are up?

A few other (maybe) pertinent details: currently we're paying interest only on our first mortgage (4.75%) and a principal and interest payment on our second mortgage (8.75%) Our home has gone up in value since we bought it, and we've made some improvements as well. Likely selling price right now (based on comparable properties that just sold in our area) is $325,000 to $340,000.

What do you think?

You have the loan. It is already funded. You have lived up to all the qualifications you agreed to in order to get it funded. You don't have to do anything other than make the payments in order to keep this loan. If this were a 30 year fixed fully amortizing loan that you were already making the payments on, there would be no reason for you to do anything, because that rate is very hard to beat by enough to make it worth refinancing. If you have already got the loan and you can afford it indefinitely, you don't have a problem.

Unfortunately, that's not the case here. You're fine for now, but not forever. You have a known time approaching at which point you will be unable to make your payments. To make matters worse, even with rates the lowest they have been in fifty years right now you're not going to qualify to refinance. That's the worst news. If you were in a situation where your current income was enough to qualify for a new loan, this would be fixable at your convenience. Unfortunately, again that is not the case.

The mildly bad news is that you're not paying your balance down much. Assuming you're not paying anything extra, you're not going to pay that $200,000 interest only first down by anything, and you've only paid the $50,000 second down by about $1000 now, and you'll only pay it down to about $47,800 by the end of the fifth year.

The mildly good news is that you've got 2.5 years left to do something with. You could go back to work, and if you do so now, you'll have two years continuous same line of work before the 5 years are up. Your husband could also start making more money, as is common the first few years out of school. Or some combination of the two. Assuming you make as much as you used to, you should be able to afford the property. Doesn't really apply to these folks, but if rates are lower than the last time you got a loan it can really help. On the flip side, if they're higher, that's can be a real problem.

This 2 1/2 years is time on your side. I keep telling folks time makes a great ally or a horrible enemy, but it's never neutral. Right now, it's on your side - giving you time to do something to change the situation. Once the adjustment hits, or even gets close, time will become your enemy. Don't waste time, but right now it is on your side.

The really good news is that your market has gone up, and you have a good amount of equity. This is about as surprising as gravity, but it is still good news. You're under 80% loan to value ratio if the numbers you gave me are valid. I wouldn't touch your loan right now, if I were you, but if you were in a sub-prime situation to start with, chances are good that you'd be A paper by now. You've got a 5/1 A paper loan with plenty of the initial fixed period left - but there's a lot of folks out there with 2/28 C paper. Especially if your adjustment had already hit, moving from 8% adjustable to a 5% or less thirty year fixed A paper without points (as of this update) makes a lot of sense. Even if you don't want to sell or refinance now, know that that kind of equity means you've got some breathing room if you've got to have it.

The bad news is that if you sell, you're going to sacrifice some of that equity. It costs money to sell property. Assuming yours sells for $325,000, you'd probably only net roughly $299,000, of which your loans would eat $249,000, leaving you with $50,000 in your pocket. Right now, a lot of places are in a world of hurt for trying to sell, so your could be out more than that and still have to take a lower price in order to get it sold. If your condo was in San Diego, for instance, you'd be doing extremely well to net $35,000 from an actual sale right now, even if your condo really was worth $340,000. The condo market is just saturated with sales that people couldn't really afford. I think this will change soon enough to surprise a lot of people, but I don't know for sure.

Let's assume that you don't intend to return to work. If your loan was adjusting any time in the next year, it would be time to sell. However, you've got some time. If your market doesn't look like it's in danger of collapse, I'd probably wait. If your market is on the road to recovery, selling later would be better. Most likely, more than enough better to justify waiting. If your market is just peaking, however, you've got a real issue, and you might want to get out now before you've lost all of your lovely equity.

One former possibility was planning to wait and refinance, doing the loan "stated income", telling the lender that you make more money than you do. This was always dangerous. Quite aside from the fact that you are intentionally defeating one of the most important safeguards for your protection as well as the bank's, this is not what stated income was intended for, and you need to be careful that you're actually going to be able to make the payments without going backwards (in other words, no negative amortization). Furthermore, stated income is gone and with the way the government is pretending it was always evil, may not come back for a long time. Better would be a fully amortized loan, but since you're already in the property, interest only is acceptable. If the situation is at least stable, why incur the costs of selling while the property meets your needs? However, at this point we do not know what the rates will be two and a half years from now. I don't know what the maximum rate you could afford is. Can you afford even an "interest only" payment on a 6% loan ($1250/month on $250,000), which is roughly 1/3 more than you're paying now? 6.5%? 7%? Finally, no interest only loan is interest only forever. Getting another interest only loan is recycling the problem you find yourself facing now.

This isn't a situation that can be tackled using only numbers, but the situation is not likely to be sustainable as it sits. You do have some choices on the table. The three most obvious are that you can go back to work, your husband can start making more money, or you can start making plans to sell the property. Any of them beat the default option, which is "do nothing and let the situation ambush us when time is up." And if you decide it's likely you'll be able to afford to refinance, keep an eye on rates. A point at which it makes sense to refinance could come at any time. I think the rates today are a freak low caused by a perfect storm economically, but there's nothing that says they cannot go even lower. Unfortunately, since you're not able to refinance right now due to low income, even the best rates ever aren't going to be any help to you, as your debt to income ratio is going to prevent a new loan from being approved. You somehow need to start making more money, enough more in time enough to be able to afford your property, or your best option is going to be to sell before you lose the property after the loan adjusts.

Caveat Emptor

Original article here

Or: Figures don't lie, but Liars Sure do Figure!

NOTE: At this update, rates on first trust deed loans are about as low as they have ever been while rates on second mortgages aren't particularly low. However, that won't last forever and we are likely to see a fresh round of this nonsense in the near future. The figures are unchanged from when I originally wrote the article, but it's the attitude that's important.

We've got a lot of people with loans in the low fives, interest rate wise, and we will soon have another wave of people with interest rates in the high fours. Lenders and loan officers need to have someone refinance now in order to get paid. One of the tricks they use to persuade folks with low interest loans to refinance is Weighted Average Cost of Capital, which really does take a page out of corporate finance books, but ignores a lot of details and alternatives.

This was an actual example that someone put online as an argument to refinance:

Current situation:

$350,000 first at 5.25%
$100,000 second at 8.5%
$50,000 consumer debt at 12%

This person then used standard practice to compute a weighted average cost of capital of 6.575, and justify refinancing all of it into a new first at 6.25%. They also assumed a tax bracket of 40%, which is a little higher than most folks pay, even with state tax figured in. Furthermore, it just took for granted the fact that there's enough equity in the property to absorb the full amount of excess debt without PMI. Robert Heinlein introduced me to this kind of attitude in Stranger in a Strange Land, calling it "straining at flies and swallowing camels," which is an apt description of what's going on. Theater.

What's really making the calculation work in favor of refinancing is that $50,000 at 12% without deductibility, and assuming a tax bracket higher than most people are in. Even the top federal bracket is 39.6%, so if you live in a state without income tax (quite a few), the article was overstating any possible current benefit. Furthermore, those states without income taxes tax mortgage loans on the basis of size, some of them pretty steeply. I just got an email from someone in one of those states back east, and for a mortgage under $250,000, the state was charging about $7000 in taxes. That's almost a 3% surcharge on the base mortgage, and if you're going to roll it into the balance, you're likely to be paying points up front. You're also paying interest on it basically forever.

Doing the calculation on the basis of pure interest rate calculation, like the manuals teach (I've got an accounting degree) ignores the costs of consumer loans. For corporate transactions, the costs are built into the the interest rate of the obligations. For consumers, this is not the case. You're going to be paying thousands of dollars for the privilege of refinancing - points and fees, and in many states, taxes. As I've made clear in the past, there is ALWAYS a Tradeoff between Rate and Cost in Real Estate Loans, and the standard WACC computations do not include cost of doing the loan in whether it's worthwhile, only the rate. This makes it seem like the rate with three or four points is necessarily better than the rate with none, when in reality it's likely to take eight to ten years before the lower rate pays for its cost in terms of interest savings. Most people will never keep a given real estate loan that long in their lives.

Now just for a moment, let's give the author of that article everything they're asking for. In order to be able to absorb this debt without PMI, the property has to be worth $625,000 minimum, plus 125% of whatever fees and prepaids get rolled into the balance.

What this means is that I could, without touching that 5.25% first, refinance that second into a 30/15 at around 7.25% (lower today), and still get paid half a point yield spread to do a very easy loan that costs the consumer less than $1000 all told. You see, not only do we get a price break for the bigger equity loan, but because it's only 80% Loan to Value Ratio (actually CLTV), and so we get a price break of

$350,000 at 5.25%, 40% aggregate tax bracket, 70% of the loan, =2.205% contribution from this
$150,000 at 7.25%, 40% aggregate tax bracket (on 2/3) 20% of loan = 0.870% contribution
$150,000 at 7.25% non deductible on 1/3 10% of amount =0.725%
2.205%+0.870%+0.725%=3.8% weighted average cost of capital, which essentially ties the projected 3.75% on 6.25% which is 40% deductible, but the lowered cost more than covers the difference in interest - $250 per year - for ten full years, just based upon the difference in closing costs, never mind points or cost of interest on the increased balance.

So why do loan officers push a full refinance when there are better options? Quite simply, they make a lot more on first mortgages than second, so it's in their best interest to make it seem like refinancing a first is in your best interest, even when it clearly is not. Second mortgages are something I'll do for existing clients, but it's not business I chase because I just can't make enough to make it worthwhile, and chances are that a credit union is going to do about as well as I can. First mortgages, however, are a different matter - and not just for me. The projected first mortgage would make me roughly 7 times what that second does, and my margins are low by comparison with the rest of the industry.

Because of facts like this, you need to know enough to think about alternatives like refinancing a second and leaving a low interest rate first untouched. This is also why you need to talk to more than one potential provider, to increase your chance of getting one of them to give you a better way of doing things.

Caveat Emptor

Original article here

I've been looking around for an answer to this but my searches haven't returned anything useful.

Say you buy a house and with that house you finance in a pool. House was $210,000 and pool is $40k. $250k mortgage. Okay, so two years later (the average!) you decided to refinance. Especially since you didn't get a good deal in the first place because you wanted a new house and to get the incentive you decided it was okay to finance with the company the builder tells you to finance with. Anyway, in those two years the housing market slumps a bit but for the most part after that time your house doesn't loose value. At the same time, the pool does not add value to your house. Comps in the area put your house at $220,000 but you still owe $245k. Is it possible to refinance? Was all the refinance hype only because the markets kept going up? Is this the reason why people who got an bad loan, maybe thinking they could refinance, are going to loose their house because no one will refi a house that isn't worth more than it was when you bought it?

No, the refinancing craze was only partially because values kept going up. Rates kept going down as well. What this combination meant was that not only were better rates coming along all of the time, but that people who were stretching to the utter limit for 100% financing could refinance into more favorable loans as their equity picture improved. If you bought for $180,000, and comparable properties are selling for $360,000 now, that's 50% equity even if you didn't have a down payment. So people who bought for $180,000 were refinancing into single loans without PMI once values hit $225,000. Let's use the rates when I originally wrote this as a comparison. Instead of a first for $144,000 at 6.25% and a second for $36,000 at 9%, with payments of $886.64 and $289.67, even if the rates are absolutely the same and you refinance after 18 months for the $177,000 you owe (paying closing costs out of pocket), when your appraisal says $225,000, that's one loan at 6.25%, with a payment of $1089.82. This cuts $86.49 off the monthly payment, which is how most people think, and cuts your monthly cost of interest by $81, which is how smarter people think. It probably isn't worth refinancing at anything like par for such relatively small savings, but rates were dropping at the same time. This led a lot of unethical agents and loan officers to lead a lot of clients down the primrose path by saying things like "real estate always increases in value," and "You can hold on for a year, right? You'll have equity and we'll be able to refinance you." Lots of folks have a tendency to assume trends of the moment are going to continue, and it's amazing how consistently they get burned by this assumption.

A lot of what I wrote for the original article is no longer true, but there are two new twists: a cluster of special programs from Fannie Mae and Freddie Mac allowing refinancing up to 125% of value for loans originally done "A paper" and Mortgage Loan Modification for loans that were originally sub-prime or variable rate, basically renegotiating your existing loan. As a note, the so-called "minor" modifications of forbearance and displacing any missed payments to the end of the loan have over a forty percent recurrence of default within about a year. In plain english, unless your situation has changed permanently for the better (e.g. found a better job, or recovered your previous one) or you have fully worked through the one time problem that got you into trouble (e.g. temporary disability that is now in the past), all you're likely to be doing is delaying the inevitable. Most people need at least an interest rate modification that puts them at a bearable debt to income ratio. Better the bank do this than lose money through a default. On the other hand, many people want their principal modified, which is not likely to happen - one case in sixty are the statistics I'm hearing, all of them having to do with the "killer Ds" of death, disability and divorce. The bank might as well lose the money they'll lose by foreclosing. At least that way, they know their losses are at an end.

Rates as I write the update are the lowest they have ever been, but prior to that tumble due to the financial meltdown, had been broadly rising for a while. People don't like refinancing when it will raise their rates, and quite often, they can't afford to refinance, even if they have to, if the payment is going to go up. This has caused many lenders to get desperate, and is certainly one of the reasons for the way the negative amortization loan had been pushed. Loan Officers don't get paid unless they are originating new loans this month, and negative amortization loans look wonderful on the surface, when all you know about is the minimum payment. (I've also published an article debunking the Weighted Average Cost of Capital scam some lenders are also using to persuade people to refinance out of low rates into high ones).

If your equity situation has deteriorated due to decline in property value, however, it can be a real problem. Outside of the two alternatives I talk about above, both of which are temporary, lenders don't want to risk money in situations where Loan to Value ratio doesn't support them getting all of their money back if you default. The problems created by declining value are far deeper than the benefits that arise when prices are rising rapidly. When the loans total $500,000 and the property is only worth $420,000, that's a problem. That's a real problem. Lenders do not want to lend more than a property is worth. The highest financing regularly available is 100% of value, even when the market was going gonzo with Make Believe Loans and 80% is the highest refinance I'm seeing now. The situation I have just illustrated is a 120% financing situation. On a straight refinance, that's not going to happen. Period.

Now before anyone goes too far off the deep end, being upside down is no problem at all if you don't need to sell or refinance. You just keep making the payments and everything is fine. It may be possible that real estate won't eventually return to the pattern of appreciation we've come to expect these last hundred odd years, but that's not the way the smart money is betting. You will have equity again. I was upside down myself for a little while after I bought in 1991. It was no big deal. I just kept making those payments, and the prices came back. By the time I had a reason to refinance, I was back at 80% loan to value. For those people who have sustainable loans, being upside-down is a non-event.

Where it becomes a serious problem is when you've got an unsustainable loan. Whether it's negative amortization, or something somewhat less hazardous to your financial future such as a 2/28 or something short term interest only, you're looking at a time when refinancing is going to be pretty much mandatory. If you could have afforded the payment it's going to adjust to, you could have had a sustainable loan. But people have a tendency to stretch too far and buy more of a property than they can really afford.

There used to be more options and potential options if you needed to refinance while you're upside down. The one involving the least amount of mental effort was and is to come up with the difference in cash. Most people don't want to do this even if they have it, but it's an option. Actually, it's a pretty good option if you have that cash.

There second option for refinancing was a 125% equity loan piggybacked onto an 80% first loan. The first problem was that the terms on these were ugly. It's not likely to cut your interest rate or your payment, and they are all full recourse loans, where purchase money loans are mostly non-recourse. This doesn't work for a lot of people, not the least of the reasons for which is that the lenders that were offering these when prices were increasing rapidly have largely withdrawn them from the market now that prices have been decreasing. 125% loans were a function of a rapidly increasing market. I can't remember the last time I had a wholesaler offer me one. Still, if you're in trouble it can be on option worth asking your current lender about - the worst that can happen is they tell you those are no longer available. The situation is this: If you can't make your payment now and go into default, they lose money. If you can afford the payments on the 80/125 combo loan, and don't go into default, they won't lose money, not to mention they potentially move you from a non-recourse purchase money loan to a full recourse refinance, a very good thing from the lender's viewpoint. Easier to do a loan modification, but this option might be available.

In some circumstances, it is conceivable if highly unlikely that the holder of a second trust deed may agree to subordinate their loan to a new first. They're not going to agree if your payment or the loan amount on the new first increases, so you're going to have to pay all closing costs out of pocket. The amount on the new first is also obviously going to be above 80% of value, so you're likely to have PMI on it, but if it gets you from a 2/28 that's adjusted to 9% to a 30 year fixed at 7, it's probably worth doing. If the second goes from sitting behind a $410,000 first at 9% to sitting behind a $410,000 thirty year fixed at 7%, it has become more likely that second loan is going to be repaid in full, where if you default on the first trust deed that second is likely to be completely wiped out. Obviously, the holder of the second would rather not do this - they'd rather be refinanced out of their losing position. But nobody is going to come along and rescue them from their bad decision making if the property is only worth $420,000 and you owe $495,000. If you need to refinance your first in order not to lose the property, the holder of the second can either agree to subordinate, step up to the line themselves and be on the hook for the full amount, or be wiped out completely when the first forecloses. The options for them might all be bad, but subordination is the least bad.

The next option is the worst of all possible worlds: default and foreclosure. This is something you want to avoid if there's any way around it. Slightly better is a Deed in Lieu of Foreclosure, where you sign the title of the property over to the lender. Lenders may or may not allow this if you're upside down, though. Typically, they want to have at least a little bit of theoretical equity in order to agree to a Deed in Lieu. On the other hand, if they avoid the money that the whole default and foreclosure process costs, they may agree. A Deed in Lieu does hit your ability to get a future real estate loan, although it's not nearly so bad of a hit to that or your general credit as a foreclosure, particularly if you can see it coming and take action before you have a spate of late payments. Most folks won't.

Finally, if you need to refinance and can't, you can get yourself a good listing agent and execute a sale subject to a short payoff. This has potential consequences for your financial situation that start at 1099 love notes and might include a deficiency judgment. This is definitely not something to try "For Sale By Owner" or even with a discount listing agent. You're going to need an on the ball full service agent in order to make it happen, because the lender isn't going to listen to you as the owner, and a discounter is unlikely to be willing and able to devote the time necessary to get the lender to approve it. The big advantage to this is that it doesn't hit your credit nearly so badly as a foreclosure, perhaps less even than Deed in Lieu, and if you want another real estate loan sometime in the next decade, you would probably rather do a short sale than go through foreclosure.

None of these situations where you need to refinance a mortgage you can no longer afford, but owe more than the property is worth, is a good situation to be in. But if you take action before you've got late payments or a notice of default, let alone a notice of trustee's sale, you can get away surprisingly little damaged. The worst thing that can happen, will happen if you don't do something to fix an untenable situation before it gets that far.

Caveat Emptor

Original article here

With many people pushing various "cash back to the buyer" schemes in real estate, a note of caution is needed. Actually, it's more like an entire symphony of caution. Because if there is a loan involved, you run the risk of committing fraud.

Some people reading this won't care. "What the lender doesn't know won't hurt them," is something I've heard and seen too many times to count. After all, that lender is just some nameless faceless megacorporation, not anybody they care about.

To those people, I say, "The FBI will make you care." Given the spate of abuses, and the current level of panic at many lenders and investment houses, even if your transaction comes off without a hitch and the lender gets repaid in full, you may find yourself on the business end of an investigation. The kinds of real estate and loan places that are willing to pull so-called "harmless" fraud are also willing to pull no holds barred fraud where the entire idea is to defraud the lenders. Where you have the lenders losing money, and a pattern of abuses, you have potential for the FBI to become interested in all of a businesses transactions, and once the FBI starts looking, rebate fraud is so easy to spot that a seven year old could probably do it. They find a known shady brokerage, and it becomes what military pilots call a "target rich environment." It's worth the resources to investigate all of that brokerage's transactions.

Here's what happens. A wants some cash to fix the property up, and so arranges with B to jack the price enough higher so that B can rebate the difference to A. A then procures 100 percent financing on the increased price, B gets the increased price, and rebates it to A.

Alternatively, A writes an offer with a real estate licensee who rebates part of their commission, while providing lesser "services". Usually, the question I want to ask those rebaters I encounter is "Why do you make more than minimum wage?" The answer is because suckers who think in terms of cash in their pocket don't understand what they're getting into.

In either case, this cash back somehow doesn't get disclosed to the lender, and it needs to be. Because if the official purchase price is $X, but B is giving A back $Y under the table, the real purchase price is $X-Y. If the lender knows about the cash back, they will treat the purchase price as being $X-Y. At the very most, for 100% financing, they will only lend $X-Y. Since this defeats the purpose of the cash back, the sorts of people who do this predictably will not disclose it to their lenders.

This is fraud. Even so-called "harmless" fraud where the people fully intend to repay the entire loan (and eventually do) is still fraud. The lender doesn't have to lose a single penny in order for you to have committed fraud. The definition of fraud is "An act of deception carried out for the purpose of unfair, undeserved, and/or unlawful gain, esp. financial gain." The legal definition is a little more complex, "All multifarious means which human ingenuity can devise, and which are resorted to by one individual to get an advantage over another by false suggestions or suppression of the truth. It includes all surprises, tricks, cunning or dissembling, and any unfair way which another is cheated," but is essentially similar. Had you told that lender about the cash back, they would have treated the purchase price as being less than the official price. Hence, fraud.

Now there are all manner of crooks out there encouraging people to do this (and other things). I've seen numerous advertisements for various "real estate investment systems", and people who represent themselves as real estate professionals and real estate investors and real estate authorities and even real estate licensees who urge people to commit federal felonies for various reasons on the surface that always reduce to "So the crook can make money." Whether it's through a commission they wouldn't have because the client can't be persuaded to do it the legal way, or money they intend to make selling their "Foolproof System!" to thousands of pure deluded fools, they do a lot of damage. Nor does it get you off the hook if you were following the advice of alleged professionals, as lots of people in federal prison can testify. Even if you didn't know it was illegal, even if people you had reason to trust told you it was legal, you are still responsible.

The rebate itself is not illegal, according to my best understanding. Once again, I'm not a lawyer and I don't even play one on TV, so check that out thoroughly, but it is my best understanding. The illegality happens when you deceive the lender, either by omitting information a reasonable person would agree is relevant, or by actively saying something that isn't true.

It's more than possible to get cash back and be compliant with the law - it just defeats the purposes most people have in mind with cash back, which is to make the lender think they paid more for the property than they really did, and so lend a greater amount of money or on more favorable terms, or both, than the lender otherwise would have, had they known about the cash back. In other words, FRAUD

If you inform the lender, they will treat the purchase price as being the official price less the rebate. So if the official price is $400,000, but you're getting $20,000 back, the price the lender will lend based upon will be $380,000, and it doesn't matter if the appraiser says it's worth $400,000, or $400 million. $380,000 will be 100% financing, not $400,000, $360,000 will be 95% financing not 90%, and I'm certain you can figure the rest. Lenders evaluate property based upon the LCM principle, which is Lesser of cost or market. You only paid $380,000 in real terms, which makes it a $380,000 property at most. It doesn't matter whether this rebate is direct from the seller, or some third party. They look at it in terms of "How much of your hard earned money are you actually going to part with?" If some cash is coming back to you, you aren't really parting with whatever number is on the purchase contract, are you?

Where most lenders will cut a certain amount of slack is in closing costs. If the money is not actually coming back into the buyer's pocket, but instead being used to pay for costs of the purchase transaction or costs of the loan, most lenders will give that their reluctant blessing. Because all parts of the transaction are subject to negotiation as to who gets what and who pays what, the lender will usually understand that in order to get that price, the seller agreed to pay this cost or that cost. I don't expect this to last forever because I can point to a lot of abuses that are happening, but it happens to be the case right now. I believe that sooner or later, lenders will clamp down on this practice and refuse to allow it, but for right now, most of them are still willing to do so.

Even the most forgiving of lenders, however, draws a bright and hard line if any of that cash finds its way back into the buyer's pocket. So make certain it doesn't, or that the lender knows about it. And make certain that the lender has been notified in writing of every penny that's paid on the buyer's behalf by anyone else for closing costs. Because you don't have to be directly involved in a conspiracy to get drawn into a fraud investigation, and once it gets started, you can never be certain you won't be sitting in a courtroom somewhere, charged with fraud and conspiracy and anything else they can think of to throw at you. Even assuming you win, it's going to be a big hit to your wallet and a bigger one to your reputation. Not to mention the little detail of some time of your life spent wearing prison clothing as a "guest" at Club Fed.

Caveat Emptor

Original article here