Mortgages: November 2013 Archives

One of the casualties of the lending meltdown is the high loan to value second mortgage. With many properties locally having lost twenty percent or more of their value, a second mortgage on a property that ends up in default may well lose every single dollar the lender put into the loan. It shouldn't surprise anyone that lenders don't want to get into that kind of situation. Even though I (and most other credible analysts) are convinced that real estate is now undervalued, the money markets are still in fear mode over the money they have lost or are on track to lose.

The result is that lenders of junior financing aren't nearly so willing to go close to 100% financing any longer. Even when the same lender is lending the money for both loans, the people who underwrite the second mortgages are (usually) a different division. So when the property goes to foreclosure, the division who underwrote the first mortgage may end up with every dollar or nearly every dollar of their invested money, and they come up smelling like a rose. The division that underwrote the second mortgage that got wiped out and came out with 10 cents on the dollar loses their shirts, and everybody gets fired. I don't have one single subordinate loan program offering over 90% financing - doesn't matter the credit score or how much we can prove the clients make. The lenders have all decided they are not willing to accept the risks of a high loan to value second mortgage. That's their prerogative - they who have the gold make the rules for lending it. With the situation as I've have discussed, and second mortgage lenders in the process of losing every penny they put into loans, they understandably don't want to do it.

There was an alternative for quite a while. There were, for quite a while, still any number of lenders who would accept 100% financing on one loan with Private Mortgage Insurance (aka PMI). That has been gone for a couple years now. In fact, for a couple months it was really difficult to get financing over 85%, but then they started removing the declining market indicator in July 2008, and now it's pretty easy to get 90% conventional financing, and I have a couple of ways to get to 95%. Considering that FHA financing only goes to 96.5% and is far more difficult to get, this means that the difference between conventional financing and FHA is small in terms of down payment, and considering the premium FHA-eligible properties command, being able to go conventional may save you money despite a PMI rate that's higher than for government loans (VA loans have become the only widely available 100% financing)

Private Mortgage Insurance is an insurance policy that the borrower pays for but which insures the lender against loss. It does get the borrower the loan, but that is the only good the borrower can expect to get out of PMI. It does not prevent your credit rating from being ruined, it does not prevent any deficiency judgments that you may be liable for, and it definitely won't prevent the 1099 love note that tells the IRS you owe taxes on debt forgiveness. All it does is shift the entity that loses the money from the lender to their insurer, so that if you default, you'll be dealing with the insurer instead of the lender via subrogation.

What is going on here is that lenders are shifting the risks to insurers, who are in the business of taking risks via the Law of Large Numbers. Yes, the insurers know they will lose a certain number of these bets, but they are comfortable that overall they will make money at it. It is to be noted that lenders can improve their profit margins by self insuring, but they're not in the business of insurance. I'm certain some of them insure themselves in one way or another, but they isolate the risks away from their lending divisions, which are in the business of making money by loaning it out and having those loans repaid in full. When a lender loses a dollar because the loan wasn't repaid in full, that hits them where it really counts - bond rating, stock price, value of their mortgage bundles on the secondary market. When an insurer loses a dollar due to paying a claim, that's part of their daily business. They're in the business of paying claims, fully expecting premiums to more than pay for those claims.

As I said in One Loan Versus Two Loans, PMI is more expensive than splitting your mortgage into two loans, but when nobody wants to do second mortgages with less than ten percent down payment, the choices may narrow down to accepting PMI or not buying the property. The only other alternative that comes to mind is a private party loan, either in the form of a Seller Carryback (which comparatively few people are willing and able to offer) or the "good in-law" loans that were popular before lenders started liberalizing their standards in the 1970s.

(I haven't been in the business that long. I've never heard the phrase actually used by another professional, although I actually did a transaction that involved one not too long ago. I learned it from textbooks, as even in the early nineties when I both bought my first property and went back to college for my accounting degree they were a fading memory)

Paying PMI does have the net effect of decreasing the loan that potential buyers will qualify for, so this development should cause some small amount of additional downwards pressure in prices. For those interested in irony, the lenders are contributing to their own immediate losses by bailing out of the low equity financing market. People who have to pay a higher effective rate for the money can't afford to spend as much for a property, which means that current owners, whether they're borrowers or lenders, won't be able to get as much money for them.

One last thing before I finish. Don't get too hung up on the fact that you may end up paying PMI when experts (myself included) advise you not to. It's one of those voodoo words and concepts like "points", that people freak out about because they've been warned about them but they don't really understand. Just like points, many experts, myself included, often advise you not to pay PMI. But if you have one loan that is over 80% loan to value ratio, you are going to be paying PMI in one form or another. As I said in How Do I Get Rid of Private Mortgage Insurance (PMI)?, it can be a separate charge or camouflaged by being built into the rate, but you're still paying it. There are advantages and disadvantages to each choice, as I explained in that article. Choose your alternative with your eyes wide open and an understanding of the consequences, not because someone scares with with the voodoo phrase, "PMI."

Caveat Emptor

Original article here

HI, My name is DELETED and my husband and I are searching for a way to get out of our Negative ARM loan before we get upside down.

Our problem right now is our loan to value. Our loan right now is at $547,367.80 and is only getting higher. Our house just appraised at $620,000.00. We have a prepayment penalty of $20,000.00 and would just like to get that covered. We feel we need a Jumbo loan if possible.

Our wish is to get into a 40 or 50 year fixed. My husband makes good money and I will be working in a couple of months making a decent income. Right now I am doing temp work. We can afford payments for our mortgage if we were to refinance but we are having a hard time finding someone who will take the risk with us. If there is a risk. We are just trying to get out of this loan that is going to end up taking our house from underneath us. Our credit is good and I feel there is a way something can be worked out

Can you help us?

I will try, if you're in California. First, let's stop and think a minute about your situation and what will benefit your pocketbook, rather than mine.

If you pay the penalty, your new loan is going to be approximately $570,000, even without points. The issue is that neither I nor any other loan provider can get you a loan that isn't available. $580,000 is more likely, considering prepaid interest, etcetera, unless you have some cash to pay it down. $570k and $580k are both within the band of 90 to 95%, so I have to price it as a 95% loan to value ratio. Right now, that can't be done on jumbo loans, and since your loan is neither owned by Fannie and Freddie nor underwritten to Fannie and Freddie standards, the 125% refinance program is unavailable to you. I don't have any such programs over 90% - but it turns out that I do actually have a refinance that can be done on a "jumbo conforming" up to 90%, albeit with PMI.

So suppose you don't have to pay the penalty? Now staying at or below 90% loan to value is a real possibility, and the loan can be priced as a 90% loan, giving better trade-offs. The way we might be able to do this is to check if we can get your current lender to refinance you. It'll likely mean renewing your prepayment penalty, but better that than paying $20,000 in penalty. Even if you end up with a higher rate than you might otherwise get because your lender doesn't have the lowest rates, $20,000 is almost four percent of your loan amount. Over the course of the 3 years of the new prepayment penalty (since that's standard for negative amortization loans), you'd have to save over a percent per year to break even with another lender. As I said in "Getting Out of Paying Pre-Payment Penalties", sometimes lenders will not require you to pay a penalty if you refinance with them and accept a new penalty.

In short, if we check with your current lender first, we might save you $20,000 cash plus the interest on it. So let's figure out who your lender is and ask.

The second alternative is to find out how long until the penalty expires. Make at least the full interest payments every month until your payment expires. How long do you have left on the penalty? If you've only got six months or a year left, rates just weren't low enough when I originally wrote this to make it worth your while refinancing, especially Jumbo loans, which even if your loan to value ratio was below 80% would have still cost you nearly two points for a 7% loan. If you pay at least your current "interest only" payment, you're not getting in any deeper. When the penalty expires, maybe rates and the market will be in better shape and you'll get a better loan. Matter of fact, waiting was a moderately good bet that would have paid off back when I originally wrote this, especially as opposed to just flushing $20,000 paying that penalty. If people had less than a year left on the penalty, I was urging them to make the interest only payments (or more), and come back to me about three weeks before it expired. Conditions have changed now. In fact, at this update, rates are much better than when I originally wrote this article. For "Jumbo conforming", rates below 5% are very possible, but I don't know how much longer that will be the case

Even if you're only six months into your loan, we'd have to save you about about 1.5% on the rate for you to come out ahead by paying that penalty. $20,000 times 12/6 divided by $547,000 gives a current rate of 7.3%. As you'll see, a blended rate of 6.67 is about as low as I could have gotten for this situation when I originally wrote this. Your rate would have to had to have been at least 8.2% when I originally wrote this for paying that penalty to have been in your best interest.

The loan market today is a very different creature than it was a couple years ago. Let's look at the alternatives, assuming your lender will waive prepayment with a new loan. Even so, let's look at a loan amount of $558,000, which is about where you're going to be with closing costs and one point.

Before I close, it occurs to me to mention that before refinancing, you have to be certain you are actually able to make the new payments. Because the fact is that you owe $547,000 right now, and that's a cold hard fact that nobody is going to change. Quite often, people get put into negative amortization loans because that was the only way they're going to make the payment on that much debt even for a little while. If you cannot realistically make these payments, delaying the inevitable will only cost you more. As things sit, you might come away with a few thousand dollars if you sold now, and then you can buy something you can really afford. If you wait, things are going to get worse, and you're going to end up with a short payoff and a 1099 love note that says you owe taxes, plus maybe a deficiency judgment, having your credit ruined, and still not having the home of your dreams. This doesn't make me popular right now, but what people like you are going through now is the result of people in my professions who wanted to be rich and popular, rather than actually doing what was best for the clients. Were I in your shoes, I'd likely be asking a lawyer if there's some liability on the part of your lender and real estate agent.

Caveat Emptor

Original article here

Yes, it sounds like a scam to me, too. But it's real.

This isn't to say that there are scammers out there promising the same thing. But there is a legitimate program that accomplishes this. Actually, there are no fewer than six such legitimate programs - three from Fannie Mae, three from Freddie Mac, all sourced in the Help For Homeowners Program. I don't think it's going to help a large number of people, but I'm going to talk about it in order to help the ones it does help separate fact from fiction.

There are technical differences in the programs, governing the relationship of your current loan servicer and the loan originator you apply for the refinance with. But the programs are essentially similar, and use the same rate structure. Which of these three programs you apply for makes no difference to whether a consumer qualifies, or the rate cost tradeoffs offered by a particular mortgage originator. What's that they say about a difference that makes no difference?

It doesn't really matter who you choose to refinance with, or which of the three programs you end up with - the rate structure is the same. So if you do qualify, shop normally for the best loan for you. You don't get any discounts or preferences by going through the same loan servicer you currently have - but the deals that are being offered are very different from originator to originator. Yes, different programs, but same underlying rate structure and your loan ends up being owned by the same people. The only difference is the tradeoff between rate and cost that a given provider offers. In short, if someone offers you a better deal and is willing to stand behind their quotes with something real, there is no rational reason not to do business with them. Ask prospective loan providers all the same questions and see which one is the best.

No matter which of these programs you apply for, they have the following restrictions in common

First, your loan must be currently held by Fannie Mae or Freddie Mac or underwritten to Fannie/Freddie Standards. This means you have to have qualified by their standards originally - these programs will not help or refinance people who got subprime loans! They will ask privacy act questions (Freddie Mac more so than Fannie Mae), so I'm including these links for convenience - use them at your own risk.

Does Fannie Mae Own Your Loan?

Does Freddie Mac Own Your Loan?

Alternatively, you can run a search for the two websites through the search engine of your choice, and find these exact pages through the main webpage of the respective government corporation. They're each one click from the main webpage, although the correct Fannie link is a bit more difficult to spot than the Freddie one.

Second, the original application can have contained no misrepresentations or fraud. This restriction essentially eliminates folks who qualified via stated income procedures. If you could have documented the income to qualify, why didn't you? In every case, it would have gotten you a better rate or a lower cost for that rate. The reason people got stated income loans is that they couldn't.

Third, you must qualify normally for the refinance with one exception. You must qualify on the basis of Debt to Income Ratio, and practically speaking, the automated underwriting program has to accept your loan. The only requirement that has been relaxed is Loan to Value Ratio. This isn't a charity program; it's loss mitigation for Fannie and Freddie. They're not just throwing taxpayer money at a problem - these programs are intended to keep them from losing money by enabling people who would qualify for a new loan if values hadn't receded so much and keeping them in their home rather than going through the foreclosure process and saturating the market and causing still more waves of this. A thoroughly intelligent business alternative for the lenders - much the same reason the lenders finally got serious about loan modification. But individual banks couldn't offer refinancing programs of this nature unless they wanted to become portfolio lenders, which most of them don't and can't. It had to be the underlying investors that offered these programs, something Wall Street is loath to do but Fannie and Freddie can be instructed to do by the federal government.

Fourth, there are potentially issues with loan subordination. Lots of folks got a first mortgage for 80% of the value of their home through Fannie or Freddie, with a balance of up to 20% of the value on the property through a second mortgage. Alternatively, if they did put the full twenty percent down, they got an equity loan in order to take cash out at some later time. If you have a second mortgage and refinance your current first, the second mortgage automatically slides up to first secured position, and your new loan would take second place. That's not acceptable to Fannie or Freddie, and for good reason. So if you do have a second mortgage, the holder of that second mortgage must to agree to subordinate to your new loan in order to be acceptable to Fannie or Freddie. Fannie and Freddie are not allowed to pay off second mortgages under these programs - that's not a risk they have currently taken; they're not going to throw even more money at the program and take more risk. As I said, this isn't charity, this is loss mitigation. Some second mortgage holders may not agree to subordinate. There is nothing that can be done to force them. All you can do is explain why it is in their best interest and hope they see reason. Some second mortgage holders may demand conditions upon their subordination and you must satisfy those conditions to get them to agree to subordinate. One condition that I would expect to get is that the balance on the first mortgage not increase, which means you have to pay closing costs out of pocket if you do have a second mortgage - no rolling them into the balance of your new mortgage.

I need to take a moment here to explicitly state: the 125% maximum loan to value ratio applies to the first mortgage only. It's fine under these programs if there's a second mortgage that sends the comprehensive loan to value ratio (or CLTV) above 125% - so long as the holder of that second mortgage agrees to subordinate.

Finally, there are PMI issues. It isn't necessarily that there is no PMI. What is the case is that Fannie and Freddie will allow your current PMI status to continue. What this means is that if you're not paying PMI currently, your new loan will not have a new PMI requirement imposed. If you are paying PMI currently, the current PMI provider must agree to continue the status quo (mostly they will; insurance companies aren't idiots and they're mostly not constrained by regulations that didn't forsee this situation). For example, let's say your loan was originally funded as a ninety percent loan to value purchase money loan. Such a loan would have had PMI in some form, either regular or lender paid. If your value went up at some point and your PMI requirement was removed due to a loan to value ratio that was below eighty percent, there will be no PMI on your refinanced loan. If your PMI is still in effect, it would need to be carried over from the existing loan to the new loan, but it would not be increased if the current situation was less favorable than the original situation. Normally, if you were now in a ninety-five or one hundred percent or even above 100% loan to value situation (as many people whose values have declined would be), the risk to the PMI provider would increase, and therefore they would charge more money in order to undertake that risk. That is not the case with these special programs. The PMI providers are already on the hook for these losses; again, this is a way that might mean they don't have to lose that money. If they're smart, they will accept the risk of transferring the existing PMI to the new loan. As I said earlier, these are insurance companies, not securitized lenders or investors subject to Federal Reserve and SEC rules. Mostly, they are smart, and therefore willing and able to accept the change. They may impose conditions of their own, like the balance not increasing by more than a certain amount, but mostly they are likely to accept the risk.

Finally, to re-emphasize, if there is currently no PMI on your loan, there will be no PMI required on the new loans under these programs, even though Fannie and Freddie and every other lender in the country would normally require PMI with a first mortgage with over an eighty percent loan to value ratio. The reason why this would normally be so has to do with Federal Reserve regulations - but with the Federal Government basically owning Fannie and Freddie now, and the Federal Reserve having its own reasons for wanting to help clean up this mess, regulations can get modified or exceptions.

One other word of caution: The better your credit score, the better your payment record, the better your loan to value ratio, the better the loan you can expect to receive. Someone with a 780 credit score and an eighty-two percent loan to value ratio can expect a better loan (lower rate/cost tradeoff) than someone with a 620 credit score and a 124% loan to value ratio. Those who have been more responsible will get something better than those who have been less responsible. But these loans do actually stand a decent chance of helping someone who needs it, providing they're in the group that's been targeted by the program

As I said, I don't really expect these programs to help a large percentage of the people in trouble, but even a small percentage of many millions is tens to hundreds of thousands, and I am certainly not opposed to these programs helping those people they can help. These programs are not charity; they have been put into place with a rational, ruthless eye towards Fannie and Freddie not losing money they would otherwise lose if they hadn't undertaken these programs. If they will potentially help you, start contacting loan originators and asking about Fannie and Freddie's 125% loan refinancing programs. Even I'm not certain about all of the various program names (I only care about the ones I can do - but as I said at the beginning of the article, which of these programs you apply for is irrelevant to the consumer - only Fannie and Freddie really care about the differences between their three programs each, because the rate structures are the same, the qualifications are the same, etcetera. Doesn't matter whether you apply through your current loan servicer, another lender, a broker, or a correspondent - shop for the best deal and the best loan for you and your situation). Loan originators will know what you're talking about, and applications are now being accepted for these programs.

Caveat Emptor

Original article here

Disclaimer: Yes, I have been doing these loans under the programs aimed at broker and correspondent originators.

One of the things I hear a lot is that people are getting cash in their pocket from a refinance rate where there is no rebate. "I'm not paying any closing costs!" they proudly tell me, "The bank is putting money in my pocket."

Chances are that's not what's going on. In fact, when the client gives me the chance to investigate, I find out that they are paying huge fees, which are all being added to the balance of the mortgage. But what they remembered was that the lender was also going to give them $1200 or $1500 in cash and add that to the balance on top of everything else.

For "A Paper" loans, Fannie Mae and Freddic Mac define the difference between a cash out and rate/term refinance. On a rate/term refinance, a client can have all costs of the loan covered, both points if any and closing costs. A client can have an impound account set up to pay property taxes and homeowner's insurance out of the proceeds. They can have all due property taxes and insurance paid. The client can have all interest paid for 30 to 60 days. And the client can get up to one percent of the loan amount or $2000, whichever is less, in their pocket. In addition to this, if the old lender had an impound account, the client will receive the contents in about 30 days.

Let's say you have a $270,000 loan on a $300,000 property - small for most parts of California and some other places, but large for most places in the country.

Here in California, yearly property taxes would be about $3600 on that. Insurance is about $1000 per year, monthly interest is $1237.50. I originally wrote this in September, so if you finished your refinance on that day, your first payment would be November 1. You'll make five payments before both halves of your property tax are due, and they want a two month reserve, so 12 months plus 2 months is fourteen months minus five months is nine months reserves they will want in property taxes (Actually, three months reserve plus the first half-year paid through escrow despite the fact you would normally have until December 10th). $3600 divided by twelve times nine months is $2700. Let's say Insurance is due in April, so they'll want eight months of that. $1000 divided by twelve times eight months is $666.67. Plus two points and $4500 in closing costs the lender charges, and they actually may have told you about it, but they emphasized the cash you are getting in your pocket so that is what a lot of people remember.

Even without the cash out, this works out to a new loan amount of $270,000 plus $2700 plus $666.67 plus $1237.50 plus $4500 plus two points which works out to $284,800 as your new balance without a penny in your pocket. If they gave you $1500, your new balance becomes $286,330 (remember the two points apply to the $1500 also!) which will probably be rounded to $286,350. Subtract $270,000, and they have added $16,350 to your mortgage balance but hey, you got to skip a month's payment and got $1500 in your pocket!

As I have said many times, however, money added to your balance tends to stick around a long time, and you are paying interest on it the whole time. Furthermore, lenders and loan originators love this because their compensation is based upon the loan amount. All because you allowed yourself to get distracted by the cash in your pocket. This is fine if it is what you want to do and you go in with your eyes open, but chances are if someone were to tell you "I'm going to add $16350 to your mortgage balance to put $1500 in your pocket and allow you to skip writing a check for one month!" you wouldn't agree to do it. Even if the rate is getting cut so your payment is $75 per month less.

For loans lower down the food chain (A minus, Alt A, subprime and hard money) the lenders set their own guidelines on what is and is not cash out, but Fannie and Freddie's definition is more strict than the vast majority.

So when somebody tells you they are going to put money in your pocket as part of the closing cost, ask them precisely how much is going to be added to your mortgage balance. Print out the list of Questions You Should Ask Prospective Loan Providers, and ask every single one. Because chances are, they are trying to pull a fast one, and once you are signed up, they figure they have you.

Caveat Emptor

Original here

Got a search engine hit for

do I make a big down payment on a home or should make a lump sum payment after the mortgage

Here's the basic rule: You're allowed tax deductibility of the acquisition indebtedness, amortized, plus up to a $100,000 Home Equity Loan. For many years, the universal practice has been to deduct all of the interest on a "cash out" loan even though it's not permitted by a strict reading of the rules. That is now changing, and the IRS has served notice that they are going to be scrutinizing mortgage indebtedness to compare it to acquisition indebtedness, and disallowing anything over what they figure is the amortized amount of purchase indebtedness. For example, if you originally bought your property for $120,000 in 1996, and your original loans totaled $108,000, sixteen years later you might persuade the IRS that your deductible balance is about $85,000, as ten percent loans were common then. But if your property is now worth $500,000 and you've "cashed out" to $400,000, the IRS is likely to prove, well, skeptical of that deduction.

The other reason not to use your down payment money for a down payment is to save it for repairs and upgrades. There's only so many places that the money might possibly come from, and your own pocket heads the list. Cash back from the seller not disclosed to the lender is fraud, and if you do disclose cash back to the lender, you've defeated the only rational purpose for it, because they will treat the purchase price as being the official price less the cash back. You're not legally getting any extra net cash from the seller. Period. If you put the money down and then try to refinance it out, the refinance becomes a "cash out" refinance - the least favorable of the three types of real estate loan. Unless the rates have gone down or your equity situation has improved, you'll get better rates on a purchase money loan, not to mention not spending the second set of closing costs for the refinance because you only did the purchase money loan. Furthermore, at this update, lenders really don't like "cash out" loans - they are coming up with all kinds of obstacles to throw in the way. So if you need the money for repairs or to make the property livable, you're probably going to want to keep it in your checking account rather than using it as a down payment.

On the other hand, the search question postulates that you'll use the money to pay down what you owe, whether immediately at purchase or later on. After you put the money down, you'll have an improved equity situation, which means that you are likely to get a better price on the loan - a better rate-cost trade-off if you put the money down. Not guaranteed, but it is highly likely. A few years ago, 100% financing was generally available. It's not, any more unless you're eligible for a VA Loan, and FHA loans loans go up to 96.5%. For conventional lenders, I've got a couple that will go 95% if the PMI underwriter will accept you. If it's the difference between 95% financing and 94% financing, every lenders I know of treats 94% financing the same as 95%. But if it's the difference between 95% financing and 90% financing (or 95% and 80%, especially), you're likely to get a better loan. Which means you either spent less in costs, got a better rate, or some trade-off of the two. Less money spent equals more money in your pocket, or more money for the down payment, which translates as more equity. Better rate means lowered cost of interest. The fact that it's on less money also means lowered minimum payments, although you shouldn't be shopping loans based upon payment. More importantly, you don't pay interest on money you don't owe. If your balance is $10,000 lower on a 6% loan, that's $600 less interest per year - $50 real savings per month.

If for some reason you want to pay extra, and you're holding on to the money so your minimum payment will be higher, don't. Most loans allow you to pay at least a certain amount extra, and if you're one of those unfortunates with a "first dollar" prepayment penalty, I have to ask, "Why?" There are occasionally reasons to accept a so called "80 percent" pre-payment penalty. There's never a reason to accept a "first dollar" penalty. Not to mention that your lump sum will get hit with the penalty anyway, where if you used it as a down payment, it wouldn't.

If you think rates will go down, that's fine, but I've got to ask "What if they don't?" If they do go down enough to make it worthwhile to refinance, you can always do so. But you should want something you'll be happy with even if they don't.

Finally, I should note that there are arguments against paying off your mortgage faster. Paying extra on your mortgage does sabotage the gain you get from leverage. You could typically take the money and invest elsewhere at a higher rate of return. Psychologically, however, there's a peace of mind to be had from not owing money, or not owing so much money. The only sane way to define wealth is by how long you could live a lifestyle comfortable to you if you stopped working right now, and if you don't owe as much money, that time frame that determines your real wealth is obviously longer. In short, you're better off by the only sane way to measure.

The point is this: There are arguments to be made on both sides, and the circumstances can be altered by the specifics of your situation. My default conclusion remains that if your mind is made up that you're using a certain amount of money to reduce debt on the property, either from necessity or because you want to, then you might as well use it in the form of purchase money down payment.

Caveat Emptor

Original article here

It shouldn't be any surprise to anyone with the headlines of the last few years that shopping for a mortgage loan has radically changed. Indeed, a lot of the regulatory changes seem directly aimed at what were the best lending practices - ways to force loan providers to change away from those best business practices.

I'm going to say this more than once in this essay: There are now significant costs for failed loans, costs that brokers and correspondents are now going to be forced to pay. This means that one way or another, consumers are going to be forced to pay them. There are two groups that can be required to pay them: People whose loan succeeds and is funded, or people whose loan fails and is not funded. Individual broker policy is going to determine which group of that broker's loan applicants pays for the costs of failed loans: The ones whose loan succeeds, or the ones whose loan fails. To determine which sort of broker you'd rather apply with, ask yourself "Do I want my loan to succeed?" If so, apply with a broker whose policy requires the failed loans applications to pay for the failed loans. If you don't want your loan to succeed I must ask, "Why are you applying?"

I need to do some political background and warmup in order to make sense later on. I need to tell you what has changed in the background, why it has changed, and what this means for the consumer. I did warn NAMB (the mortgage brokers association) that brokers were going to be used as the scapegoat for everything. It was the only way the bankers could avoid criminal indictment, public outrage, and the mob and pitchfork crowd known as Congress. President Obama, who is on one hand inciting the mob with pitchforks while on the other hand pretending to be the banker's friend, was one of those Senators at the heart of the reasons for the meltdown. You have only to examine the public record of the period from 2003 to the time everything started unraveling to find out who tried to reform the system in time to avert catastrophe and who stood in the way of reform. Old principle: The best way to avoid being the target of political lynchings for a disaster is to lead them yourself.

Not that lenders need a political reason to come after brokers and correspondents. It's a classic love-hate relationship. Lenders hate brokers in general, without whom their margins and profits on mortgage loans would be much higher, but they love the profits from the individual loans brought to them specifically by those same brokers. To give you an analogy from a time before the internet, once upon a time airlines used to regularly get together every year to try and set the prices for summer vacation fares higher than market, so they all would make a lot more money per ticket if they hung together as an industry. However, every year, the airlines as individuals would decide they wanted all the money in profits they would get from lowering their individual airlines ticket prices to attract people away from the competition. It was comical in a way, watching the same show year after year, with the same outcome. The airlines tried for years to get the federal government involved so that they could give their price-fixing the authority of law, but even Jimmy Carter was too smart for that - in fact it was he who deregulated the airlines rate and fare structure completely, resulting in an explosion of air travel as air travel suddenly became a lot more affordable. Lenders relationship to brokers is a lot like that. Sure, brokers bring them a lot of money and profit - but if there was some way to completely eliminate brokers, they would make a lot more money for every loan they did.

The difference between that situation and this is that the lenders and those who want to help them do away with brokers have gotten a lot more intelligent in the last thirty years. Instead of trying to accomplish their goals directly, they are raising the costs of doing business as a broker to make it harder for brokers to compete, and they have enlisted to aid of the government to that end. The government, in return for bribes known as "campaign contributions" has been only too happy to help, under the guise of "protecting consumers" which in fact, has been the exact opposite of protecting the consumers. It's as if they were designing changes to harm lenders and brokers who work in a way most aligned with consumer interests.

Let me go back to the dim and far off times of an just a few years ago. Effectively Shopping for A Real Estate Mortgage Loan was trivial: Get quotes, sign up with the one who was willing to guarantee their quote in writing for the best tradeoff between rate and cost. I could lock a loan based upon a verbal representation that you wanted it, and do the application and everything else afterwards. If you were concerned about whether the originator you signed up with intended to honor their guarantee, you could get a backup provider. This was pretty darned easy for a loan officer to set themselves up in compliance with. There was a good alignment between the way that the market worked and the needs and desires of the average consumer. No need for a deposit, no need to commit yourself to a single lender who could well be lying and it was extremely easy to provide good transparent loans and actually deliver the exact loan - rate and cost - of what got the consumer to sign up because I could lock that loan when right when that consumer said they wanted it.

Let me go over what has changed, which is two big things, each with multiple consequences for the loan originator who acts in accordance with consumer interests. The first is that lenders have acquired permission from regulators to discriminate against brokers with respect to loan fall out. Oh, they don't call it that - but that doesn't alter the fact that it is discrimination. The fig leaf being used to conceal - not very effectively - this discrimination is the secondary loan market. The lenders themselves don't hold the loan, but rather sell them to Fannie Mae, Freddie Mac, and Wall Street investment firms - whether directly or not. So when you lock a loan with a given lender, that lender is ordering the money from the secondary market so that they will have it when it's time to loan it to you. What happens when you don't actually get the loan? Well, the bank still ordered it, and Wall Street still supplied it and expects to get paid.

However, there has always been and still is a certain "slop" built into those contracts, with costs paid only when the "slop allowance" was exceeded. The lenders and Wall Street both know damned well that not every dollar ordered is going to be used in a funded loan, which is one thing they pay actuaries a lot of money for, and the actuarial estimates are usually almost frighteningly close on their "money ordering" contracts. The banks, however, are turning around and charging the brokers and correspondents for basically the full marginal cost for every single loan that doesn't fund, while allowing their "in house" loan officers to free ride, making uncharged use of the "slop allowance" built into the contract. This discrimination essentially transfers all of the costs for locked but undelivered loans onto brokers and their clients. It is costing consumers large amounts of money, but the regulators are permitting them to do it. Nor do the lenders penalize in any way their own loan officers who fail to achieve the same level of response they require out of brokers and correspondents. I've said for a long time that the best and the worst loan officers all work for brokers. That has changed - the only way for a bad loan officer to survive is to become a direct lender employee, working in a bank branch.

This means that if you lock a loan with a broker or correspondent, they're going to be forced to pay the lender they locked that with a fee if you don't carry through. So in order to protect our real customers - the ones that end up with a funded loan that actually gets the brokerage paid - brokers and correspondent lenders are having to be very careful with which loans they actually lock. Let me be very plain about how far reaching this is: What matters is that there is a lock without a funded loan. It does not matter why. It doesn't matter that the consumer decided they just didn't want it, that someone else had a better rate (or said they did), that the consumer could not in fact qualify for the loan at all, that the appraisal came in too low to fund the loan, that the lender rejected the consumer's application for an unforseeable reason, or any other excuse. What matters is that there was a lock but not a funded loan. This has the effects of raising a broker's costs - which means they have to raise prices to compensate, or make certain it isn't our actual clients who end up with a funded loan who pay those costs. This, in turn means that the way to success for a broker or correspondent is going to be putting the costs for failed loans upon the people whose loans fail. Failure to do that means that the people whose loans succeed are going to be pay for the people whose loans fail. Not to mention that the loan officer who has more than a low percentage of loans fail is going to be facing higher costs for all of their new loans, because the lenders are going to be requiring a higher premium to do business with them.

In short, you can pick a low-cost loan provider, OR you can pick a loan provider where there's no risk and no cost if your loan falls apart. There will be no loan providers where both options exist - those places in denial of these changes are out of business now. The costs for failed loans exist, and someone has to pay them. It can either be the people whose loans fail, or it can be the ones whose loans succeed. Ask yourself if you want your loan to succeed or if you want your loan to fail to tell you which sort of broker you should be looking to apply with.

The second major change impacting lending practices is the Home Valuation Code of Conduct (hence HVCC), and the genesis of this is even more shadowy than that of the changes due to fall-out. I don't like it, but neither I nor anyone else in the lending business has the option of ignoring it. It is the new law of the land, having to do with the way that appraisals are handled. First, there isn't going to be any more developing a relationship between a good loan officer and appraiser with the idea of protecting the clients. It's not going to stop the bad loan officers or appraisers from doing everything they have done in the past, but it will stop the good stuff. Instead of ordering an appraisal through a specific appraiser, loan officers now have to order through appraisal management companies. This means I no longer have the ability to stop using bad appraisers - the ones who waste client money, the ones who produce substandard appraisals the underwriters reject, the ones who take so long to produce the report that I have to extend the rate lock because of their delay.

Second, the loan officer who orders the appraisal is now obligated to pay for it, which means that loan officer has a choice of either getting money in advance, or of charging successfully funded loan clients enough to pay for all of the appraisals of unsuccessful loan applicants as well as their own appraisals. The loan officer is prohibited from having the client write the check directly to the appraiser. Finally, most lenders as well as Fannie Mae and Freddie Mac are now requiring that the appraisal be written in the name of the actual lender instead of the broker. This means that despite the fact that I must pay the appraiser for the appraisal, the actual lender owns that appraisal, and if I want to change the lender for some reason, I have to get that lender to release it. Not likely. Even if the lender rejected the loan, getting them to release the appraisal is just about impossible. This means I have to pay for another appraisal if I want to try again with another lender, which really means the consumer has to pay for another appraisal as well, and there's no guarantee the second appraisal is going to be good even if the first one was. The appraisers are happy about this feature, as are the lenders. Consumers, not so much. It's not good business, and it's not good government. It is, however, what we're now stuck with.

So what does this all mean to consumers?

First, it means that those loan providers who really do provide low cost loans are going to have to get enough money from consumers to cover the cost of the appraisal before they order it. We should all be adults here, which means we should understand that if the loan provider doesn't do this, when your loan funds you are going to be paying not only the costs for your own appraisal, but a higher margin to cover those appraisals that did not result in funded loans. Make your choices of loan provider accordingly.

Second, it means that low cost loan providers can no longer guarantee to lock their best rate/cost tradeoffs immediately. I'm sorry, but if I lock every loan on a verbal indication that you want it, too many of them are going to fall out, which means I'm going to be liable for not only the appraisal costs of those loans that fail, but all of the costs that the lenders I lock with will charge me for failing to deliver that loan. Furthermore, if I have a high fall out ratio, the lenders will charge me extra to lock the loan and possibly even refuse to do business with me at all. This means I wouldn't be able to offer low cost loans - in fact, I'd be lucky to do much better than the lenders themselves. All of this is real money, and neither I nor anyone else can stay in business without paying those costs somehow. Since your loan officer has stayed in business thus far, you can safely assume they've got a plan in place for paying those costs. If you don't understand what it is (in other words, through being asked to pay some money up front for the appraisal, and waiting to lock until there is a reasonable assurance that loan is actually going to fund), then if your loan funds, you are going to be paying an extra margin for all of that loan provider's loans that don't fund, in addition to the specific costs of your own loan. In other words, by insisting upon no risk to yourself - no risk of losing the appraisal money, no risk of not getting the rate you're quoted - you will waste an awful lot of money if your loan actually funds. And lenders are permitted to lie to get you to sign up, same as always. Even with the new rules for the Good Faith Estimate, it's not that much harder to lie to consumers at loan sign up, and the loan officers who want to have the loopholes completely figured out.

Third, it means you're going to have to be very careful about Questions you ask your loan provider. Be very through, and insist upon specific answers. Beware of misdirections like "we honor our commitments" because nothing you get at loan sign up is in any way, shape, or form a commitment. What I'm having to talk about now is "What I could guarantee to deliver if I could lock your loan right now", because unfortunately, neither I nor any other loan officer can any longer lock loans until reasonably assured they will fund. Those loan officers who do lock everything early are going to be providing much higher cost loans, and that is for the very short period of time until lenders refuse to do business with them due to unpaid fall-out fees.

It's a situation of the sort made famous by Catch 22. Loan officers can protect the interests of the loans that fund, or the loans that don't fund - but protecting the interests of the loans that fund means you get a lot fewer loan applications, and scare off a lot of uninformed borrowers who haven't considered the consequences of their choices.

This is precisely the situation that lenders want to foster with regards to brokers and correspondents - because the average loan consumer isn't informed, hasn't considered the consequences of their choices, and is very hesitant to write a check for that appraisal upfront when they're not certain they're going to get a funded loan. It is nonetheless the intelligent thing to do, and failing to do so is going to cost you a lot of extra money.

"Might as well go back to the lender's themselves!" you say. Let's do something I don't usually do: Mention names and specific examples. Let's consider a $400,000 purchase money loan on a $500,000 property for someone with a absolute dead average median FICO score of 720, primary single family detached residence in San Diego California with a 60 day lock. All loan quotes were current as of when I wrote the original article for this:

Citi: 5.125 with one eighth of a point discount plus their normal origination which they won't detail online.

Ditech is quoting 4.625% for 2.1 points - but they're not telling you how long the lock is for. I'm not seeing if that includes origination, so even though I believe that the answer to whether it includes origination is really "No", I'll act as if it's "yes"

Chase was 5.375 for one point discount, 4.875% for two.

Union Bank quoted me a lot of different loans, none of which are competitive (6% with one point on a fifteen year fixed rate loan - and fifteen year rates are lower than a thirty year loan everywhere else right now)

I couldn't get Bank of America to quote online.

GMAC wouldn't actually quote either - referring me to a phone number.

Same story with Flagstar

Wells Fargo wants me to sign up for rate alerts, but they won't give me an actual quote either

By comparison, at the exact same time I was able to get my clients the same 30 year fixed rate loan at 5.125% with no origination and no discount - no points at all. I made my normal money per loan off the secondary market premium with no borrower cost. If you're willing to pay origination but no discount, the rate was 4.75%. On a sixty day lock, which I've never needed in my life - but that's the shortest some of the lenders are willing to tell us about, so let's play fair. To nail down the difference in pricing absolutely, I've got 4.625% for 1.25 total points discount plus origination. So the closest any of the direct lenders can possibly come to what I really can offer at the same rate is at least 85 basis points more expensive, and I'm not certain a couple of them aren't quoting to a credit score twenty to forty points higher than I am. To put this into dollar terms, 85% of a point is about $3400 in this case. Nor were the credit unions any better on their rates than the major lenders. You want to just waste an absolute minimum of $3400 by applying with a direct lender because that's easy, be my guest, but that's the minimum difference it could possibly have been on this direct comparison. In reality, you're likely talking $7500 to $10,000 difference in costs for the same rate.

Why is it so much? Brokers are more efficient. Nobody expects me to have a beautifully landscaped building, plush carpet, beautiful furniture, a well-paid receptionist, etcetera. I make money when I fund loans. Bank employees make money whether they're funding loans or not. Get the idea?

No matter how much more efficient brokers are though, things have gotten a lot tougher for brokers of late, and consumers are now have to take a lot of the risks that lenders and brokers and correspondents (oh my!) were formerly assuming on their behalf. But the best and cheapest place to get a loan delivered to quoted specifications is still find a good broker. Getting a good loan is going to become a lot more a matter of developing a good relationship with that broker. This isn't to say "Don't shop around,", this is saying, "Shop effectively" because the game with phone quotes or email quotes that most consumers are playing that they think is getting them great loans is in fact, costing them an awful lot of money as opposed to what they could be getting by slowing down and having a real conversation with prospective loan providers. I don't often make $3400 (the minimum difference from the actual example above) for a day's work, which equates to a yearly gross of $680,000 for a day spent shopping your loan effectively. Someone making $680,000 per year doesn't need a loan for a $500,000 property, so I suspect the time it takes to slow down and have the full conversation will pay for itself for those folks, too.

As I said at the beginning of this article, the changes in the market in the last year are such that they are almost calculated to drive the low cost loan provider with consumer driven practices of a year ago out of the business. I'm not happy about any of these changes, but I have two choices: Do what is necessary to change, or leave the business. It won't help me or consumers to leave the business. All it would do is leave me broke and competing for limited employment opportunities while the consumers I would otherwise serve are left at the mercy of less ethical higher cost providers.

Now more than ever before, the sign of a good low cost loan provider is one who doesn't ask their serious loan applicants who really want a loan to pay for the costs of the unserious jokers who are just shopping ad nauseum for the sort of loan officer that's going out of business as we speak. As I said, these extra costs exist. They have to get paid somehow. You can choose a loan provider who makes the failed loans pay their own costs, or you can choose a loan officer who makes the successful loans pay for the costs of the failed loans. Everybody else is going to be out of business. And all of the consumers that kid themselves otherwise are wasting thousands, if not tens of thousands of dollars.

Caveat Emptor

Original article here

Many folks have no idea how qualified they are as borrowers.

There are two ratios that, together with credit score, tell how qualified you are for a loan.

The more important of these two ratios is Debt-to-Income ratio, usually abbreviated DTI. The article on that ratio is here. The less important, but still critical, ratio is Loan to Value, abbreviated LTV. This is the ratio of the loan divided by the value of the property. For properties with multiple loans, we still have LTV, usually in the context of the loan we are dealing with right now, but there is also comprehensive loan to value, or CLTV, the ratio of the total of all loans against the property divided by the value of the property.

Note that for instances where you may be borrowing more than eighty percent of the value of the home, splitting your loan into two pieces, a first and a second, is usually going to save you money, if the loans to do so are actually available. See here for an example, but government loans ( VA and FHA) are an exception to this. At this update I am unaware of any second loan program that will loan ninety percent or more of the value of the property, meaning one loan with PMI may be your only option.

The maximum loan to value ratio you're going to qualify for is largely dependent upon your credit score. The higher your credit score, the lower your minimum equity requirement, which translates to lower down payment in the case of a mortgage.

Credit score, in mortgage terms, is the middle of your credit scores from the 3 major bureaus, reported upon a scoring model proprietary to a company called Fair-Issacsson. If you have an 800, a 480, and a 500, the middle score, and thence your credit score, is 500. If the third score is 780 instead of 500, your score is 780. If you only have two scores, the lenders will use the lower of the two. If you have only one score, most lenders will not accept the loan. I've never seen scores that divergent, but that doesn't mean it couldn't happen. Usually, the three scores are within twenty to thirty points, and a 100 point divergence is fairly unusual. Despite what you may have heard or seen in advertising, according to Fair Issacson the national median credit score is 720. See my article on credit reports for details.

In order to do business with a regulated lender, you need a minimum credit score of 500. There are tricks to the trade, but if you don't have at least one credit score of 500 or higher, you're going to a hard money lender or family member.

Exactly what the limits are for a given credit score is variable, both with time and lender, even when you get into A paper. Subprime lenders (when we had true subprime) would go higher than A paper, but the rates would have also been higher. Nonetheless, there are some broad guidelines. At 500, only subprime lenders will do business with you, and they will generally only go up to about 70 percent of the value of the home. A few will go to 80 percent, but this is not a good situation to be in. Note that at this update, true subprime is basically non-existent. It isn't the lenders; it's the investors behind those lenders not being willing to loan money. The shenanigans that were worked with bond ratings mean that nobody wants to take a chance, and there are people with legitimate needs for subprime loans that neither I nor anyone else can help right now because of it. I hope the so-called ratings agencies get sued and the investors win everything.

When I first wrote this, at about 580 credit score, you could find subprime lenders willing to lend you 100 percent of the value of the home, provided you can do a full documentation loan. These days, subprime won't go over about 80% of value, period. 580 also used to be where Alt-A and A minus and government program (VA and FHA) lenders start being willing to do business with you. These days, you're more likely looking at 620 to 660 for those.

At 620, the A paper lenders start being willing, in theory, to consider your full documentation conforming loan. They won't do cash out refinances or "jumbo" loans until a minimum of 640, but they will do both purchase money and rate term refinances at 620 or higher. Below about 660, you can expect to be limited to about an 80% loan to value in the current financial environment.

At 640 is where subprime lenders used to start considering 100 percent loans for self-employed stated income borrowers. Not any more. Stated Income is essentially dead, as I don't know of even any portfolio lenders) that will make stated income loans.

660 is now where A paper will start considering conforming loans above 80% loan to value. The PMI companies are really leery of accepting credit scores below that, and there are heavy hits on the tradeoff between rate and cost below about 740, but they are obtainable. Furthermore, expect that someone whose credit is lower than 720 will probably not be able to get PMI on loans 90% or higher of the purchase price.

It is to be noted that just because you can get a loan for only so much equity, it does not follow that you should. Whereas the way the leverage equation works does tend to favor the smaller down payment, at least when prices are increasing, it can also sink your cash flow. So if the property is a stretch for you financially, it can be a smarter move to look at less expensive properties to purchase. I have seen many people recently who stretched to buy "too much house" only to lose everything because they bought right at market peak with a loan they could not keep up. Many of these not only lost every penny they invested, but also owe thousands of dollars in taxes due to debt forgiveness when the lender wrote off their loan.

Right now, there is only one commonly available purchase loan that will support 100% financing: The VA loan, which actually goes to 103% to allow the financing of some closing costs. FHA loans require a 3.5% down payment, and I can do conventional conforming purchase money loans with a 5% down payment, albeit with a PMI and a highly restrictive choice of lenders. 90% financing is very commonly available on conforming loans ($417,000 minimum, higher in certain high cost areas such as San Diego where I work). For loans above the conforming limits, sometimes I can get financing above 80% (up to 90%) .

There are other ways to buy with a smaller down payment: Seller Carrybacks and some municipal first time buyer programs to name the two most common, but both of these start a long time before you've got a purchase contract, and your agent had better be able to write and negotiate a purchase contract the right way or you're going to find yourself dead in the water. Acting within narrow time windows is typically also necessary.

For refinance loans, I'm finding it's not helping a lot of people but Fannie Mae and Freddie Mac do have a 125% of value refinance option for people whose original loan was underwritten in accordance with their standards. In general, however, refinance loans are limited to about 80% loan to value.

There are other factors that are "deal-breakers", but so long as your debt to income ratio is within guidelines and your loan to value is within these parameters, you stand an excellent chance of getting a loan. All too often, questionable loan officers will feed supremely qualified people a line about how they shouldn't shop around because they're a tough loan and "you don't want to drive your credit score down." First off, the National Association of Mortgage Brokers successfully lobbied congress to do consumers a major favor on that score a few years back. All mortgage inquiries within a fourteen day period count as the same one inquiry. Second, the vast majority of the time it's just a line of bull to keep people from finding out how overpriced they are or to keep you from consulting people who may be able to do it on a better basis. I've talked to people with 750 plus credit scores, twenty years in their line of work, and a twenty percent down payment who had been told that, when the truth is that a monkey could probably get them a loan! By shopping around, you will save money and get more information about the current status of the market.

Caveat Emptor

Original here

Many people have no clue how qualified they are as buyers, or borrowers.

There are two ratios that, together with the credit score, determine how qualified someone is for a loan.

The first, and by far the more important, is debt to income ratio, usually abbreviated DTI. This is a measurement of how easy it will be for you to repay the loan given your current income level.

The debt to income ratio is measured by dividing total monthly mandatory outlays to service debt into your gross monthly income. Yes, due to the fact that the tax code gives you a deduction for mortgage interest, you qualify based upon your gross income. This ratio is broken into two discrete measurements, called front end ratio and back end ratio, for underwriting standards. The front end ratio is the payments upon the proposed loan only (i.e. principal and interest), whereas the back end ratio adds in all debt service: credit cards, installment loans, finance obligations, student loans, alimony and child support, and property taxes and homeowner's insurance on the home as well. With the current paranoid lending environment, the front end ratio has become significant where it was formerly almost ignored. I have seen front-end ratio become a real concern in a couple of recent loans. The thing that will break most loans, however, is the back end ratio.

As to what gets counted, the answer is simple. The minimum monthly payment on any given debt is what gets counted. It doesn't matter if you're paying $500 per month, if the minimum payment is $60, that's what will be counted.

"Can I pay off debt in order to qualify?" is a question I see quite a lot and the answer depends upon your lender and the market you're in. For top of the market A paper lenders, who have to underwrite to Fannie Mae and Freddie Mac standards, the answer is largely no. If you pay off a credit card where the balance is $x, there's nothing to prevent you going out and charging it up again. Even if you close it out completely, the thinking (borne out in practice, I might add) is that you can get another one for the same amount trivially. "Won't they just trust me to be intelligent and responsible?" some people will ask. The answer is no. Actually, it's bleep no. A paper is not about trust. A paper is about you demonstrating that you're a great credit risk. Even installment debt is at the discretion of the lender's guidelines. If they believe that what you really did was borrow money from a friend or family member who expects to be repaid, expect it to be disallowed. Therefore, the time to pay off or pay down your debts is before your credit is run and before you apply for a loan.

For subprime loans (when real subprime existed), the standards were looser. As long as they could see where the money was coming from, they would usually allow the payoff in order to qualify.

Many folks thought that stated income loans didn't have a DTI requirement. They did, when they existed. As a matter of fact, stated income was even less forgiving than full documentation loans in this regard. As I keep telling folks, for full documentation, I don't have to prove every penny you make, I only have to prove enough to justify the loan. If what I proved before falls short, but the client has more income, I can always prove more. For stated income, we had to come up with a believable income for your occupation, and then the debt to income ratio is figured off of that. Even if the lender agreed not to verify income, they were still going to be skeptical if you change your story. "You told me you make $6000 per month three days ago. Now you're telling me you make $7000 per month. Which is it? Please show me your documentation!" In short, this loan had now essentially changed to a full documentation loan at stated income rates. Nor were they going to believe a fast food counter employee makes $80,000 per year. There are resources that tell how much people of a given occupation make in the area, and if you were outside the range it would be disallowed. So you had to be very careful to make certain the loan officer knew about all the monthly payments on debt you're required to make. Sometimes it doesn't show up on the credit report and the lender found out anyway.

Debt to income ratio has nothing to do with utilities (unless you're in the process of paying one of them back). Utilities are just living expenses, and you could, in theory, cancel cable TV if you needed to. Once you owe the money, you are obligated to pay it back.

As for what is allowable: A paper maximum back end debt to income ratios vary from thirty-eight to forty-five percent of gross monthly income. I'm a big fan of hybrid adjustables, but they are, perversely, harder to qualify for under A paper rules than the standard 30 year fixed rate loan despite the lower payments. This is because there will be an adjustment to your payment at a known point in time, and you're likely to need more money when it does. Note that for high credit scores, Fannie Mae and Freddie Mac have automated underwriting programs with a considerable amount of slack built in.

Some things count for more income than you actually receive. Social security is the classic example of this. The idea is that it's not subject to loss. Once you're getting it, you will be getting it forever, unlike a regular paycheck where you can lose the job and many people do.

Subprime lenders would usually, depending upon the company and their guidelines, go higher than A paper. It's a riskier loan, and you could expect to pay for that risk via a higher interest rate, but even with the higher rate, most people qualified for bigger loans subprime than they will A paper. Some subprime lenders would go as high as sixty percent of gross income on a full documentation loan.

Whatever the debt to income ratio guideline is, it's usually a razor sharp dividing line. On one side you qualify, on the other, you probably don't. If the guideline is DTI of 45 or less, and you are at 44.9, you're in, at least as far as the debt to income ratio goes. On the high side, waivers do exist but they are something to be leery of. Whereas many waivers are approved deviations from guidelines that may be mostly a technicality, debt-to-income ratio cuts to the heart of whether you can afford the loan, and if you're not within this guideline, it may be best to let the loan go. You've got to eat, you probably want to pay your utility bills, and you only make so much. Debt to Income ratio is there for your protection as much as the bank's.

Caveat Emptor

Original here

The companion article on Loan to Value Ratio is here.

Having written several articles on Negative Amortization Loans, telling of the details of what is wrong with them, and even destroying the myth of Option ARM cash flow, I sometimes get asked if I would like to see them banned completely.

Well, given the pandemically misleading marketing that surrounds these loans, and pandemically poor disclosure requirements, I am tempted. It only takes one person losing their life savings and having their financial future ruined to make a very compelling story, and I've seen a lot more than one and read about many more.

However, when you ask if they should be banned outright, I have to answer no.

Part of this is my libertarian sympathies. Adults should be allowed to make their own mistakes. But there are economic and a realpolitik reasons as well.

The fact of the matter that just because Negative Amortization loans are oversold under all of the friendly-sounding marketing names such as Option ARM, Pick a Pay, and even 1 Percent Loan (which they are not), does not mean that there is no one for whom they are appropriate or beneficial. People for whom these are appropriate do exist. Consider someone with crushing consumer debt, and no significant usable equity on a home they've owned for a while. They sell the home, they end up with nothing and still have the consumer debt. They can't refinance cash out. But if you put them into an Option ARM for a while, you remove from several hundred to over a thousand dollars per month from their cash flow requirements. In three years, they will pay off or pay down those consumer debts, and then you refinance to put them back on track, and the money that has accumulated means nothing compared to what they've paid off. Yes, if the market collapses they're likely to be in trouble, but if you don't do it, they're in trouble at least that bad now. It's a very narrow niche, but it does exist.

Consider also someone starting a business. Cash flow insolvency is what kills most start-up businesses. Until the customer base builds, they don't have enough money to pay the bills. Lower monthly cash flow requirements on their house can mean the difference between success and failure of their business, far outweighing the cost of the extra money in their balance that they accumulated. Furthermore, the fact is that when their cash flow gets tight, they're not making the mortgage payment anyway. They are likely to lose both business (through insolvency) and property (through foreclosure) if the business fails anyway, and the lowered cash flow requirements of the Negative Amortization loan may give the business more of a chance to succeed, and once it is profitable it will pay back the investment many times over.

There's still a need to really explain what's going on, and all of the drawbacks of the loan, but people in these two circumstances really do have a valid possibility of it being in their best interest. Banning negative amortization loans completely takes away that option, thereby hurting those people.

When I first wrote on this subject, I didn't think it was politically possible to ban these loans that have now cost millions of people their homes, their credit rating, and their life savings. So far that is holding up. They're not actually banned; it's just that no investors are willing to take a chance on loaning money for them right now. Furthermore, due to the cries of the wounded beast, the law now mandates some tough disclosure requirements for them - some few of which are for the benefit of the consumer.

Disclosure requirements are is an approach that will. That is, at this point, what really killed the negative amortization loan sales. The scumbags who made a habit of selling these now have to tell the prospective victims in easy to understand language and easy to read print about all of the problems they are letting themselves in for with these loans, very few people are going to sign on the dotted line. I originally suggested this: "Caution: If you accept this loan, the 1% is a nominal, or in name only, rate. You are really being charged a rate of X%, and this rate will vary every single month. If you make the minimum payment, your loan balance will increase by approximately $Y per month at current rates, or Z percent within five years. You will have to pay this money back in lump sum if you sell, or with higher payments at a later date. If you cannot afford full payments now, you will unlikely be able to afford them in the future after your balance has increased. There is a three year prepayment penalty on this loan, and if you sell the property or refinance within that time, you will pay a penalty of approximately $A in addition to whatever additional balance has accrued. It is currently under consideration that the mere fact that you have one of these loans will have significant derogatory effect upon your credit rating, even if you never make a late payment, due to financial difficulties encountered by borrowers with this kind of loans in the past." I could go on in bullet points for a couple of pages, but I trust you get my point. What the government did in fact do is technical and shorter, but similar. Enough so that with some less stringent warnings in writing from the federal government, the least any marginally competent adult is going to do is find out what's really going on.

Furthermore, the only way disclosure requirements could be fought by the industry is behind closed doors. The only way it stays behind closed doors is if nobody raises a political stink, and it's easy to raise a political stink about stuff like this. Newspapers and television reporters and bloggers all converge on the issue, and the industry is left in the awkward position of crying because they have to tell the truth. That doesn't play well with the American public. The way this plays with the American public is the major reason for the successes of Porkbusters, among others. Despite some very entrenched and very powerful enemies lining up against them, they've won on a couple of big issues because of the power of the idea that the American people have that the truth should be told. Take the tack that all you want is for the industry to tell the truth, and watch the political wind die out of their sails. David beats Goliath pretty reliably in American politics when the issue is "Do I have to tell the truth?"

To summarize, it is tempting to try to ban negative amortization loans. But it is far better social and economic policy to go the disclosure route instead, and far more likely to be politically successful.

Caveat Emptor

Original here

One of the standard arguments I hear about Negative Amortization and Option ARM loans is that they "give the client the option to make a smaller payment if they need to." This so-called "Pick A Pay" benefit is a real benefit, but it's an expensive benefit, one that the client will pay for many times over. They are better off just managing their money well to begin with.

Let's go into some details. Let's consider someone with a $400,000 loan on a $500,000 property, and dead average credit score, and to keep the playing field level,let's price them with the same 3 year "hard" prepayment penalty. When I originally wrote this, I had a 30 year fixed rate loan at 6.00 percent, less than one point total net cost to the consumer. The equivalent Option ARM/"Pick A Pay"/negative amortization loan was actually a little above 7.5 percent real rate, although it carries a nominal rate of 1%. Furthermore, removing the prepayment penalty would make a difference of about an eighth of a percent to the rate on the thirty year fixed, while I have yet to see a Negative Amortization loan that even had the option of buying the penalty off completely, and this loan carries higher closing costs to boot.

Now, let's crank some numbers. That thirty year fixed rate loan has a payment of $2398.21. Nothing ever changes unless you change it by selling or refinancing. The first month, $2000.00 even is interest and $398.21 is principal. You pay for a year, $23,866.38 in interest and $4912.05 in principal is gone, and you've made payments totaling $28,778.43. You are also free to pay down up to twenty percent of the loan's principal in any year without triggering the prepayment penalty.

Plugging in 7.5% for the real rate to keep the math a little easier, the Negative Amortization Loan has four payment "options" of $1286.56, $2500.00, $2796.86 or $3708.05. These options represent "nominal" payment, "interest only" payment, "30 year amortization" payment, and "15 year amortization" payment. Actually, the last three options will vary every month, and trend upwards under these market circumstances, but let's hold them constant just to make my point. As a matter of fact, if you don't make a habit of paying at least the thirty year amortization payment, the options for payment will drift up over time. The chances of people making the thirty year amortized payment in the real world are minuscule, as I make clear in my first article on this subject, Option ARM and Pick a Pay - Negative Amortization Loans, but let's play the game, just to see how it turns out if you give the advocates everything they ask for and more.

Crank the numbers through for twelve months, and you've paid $29,874.96 in interest, $3687.34 in principal, and made $33,562.30 in total payments. This is the "going along, making the loan payments" that the advocates are talking about. Here's a table, comparing this to the 30 year fixed rate loan:

When you put it in those terms, I don't think there's any question which loan a rational person would rather have. But that's not the situation the advocates would have us believe is beneficial, at least not with this particular argument. Let us presume that two months out of that year - and to keep the math as simple and as favorable to their argument as possible, let's make them the last two months - that you decide you have the need to make minimum payments, and let's see what happens. you've paid $29884.40 in interest, lost all but $657.30 in principal payments, and made $30,541.70 in total payments. Now, if you're making the minimum payment more than one month out of six, most folks should agree it's not an "occasional" thing, it's more of a "regular occurrence" thing, which situation I have already done the math to refute any claims of advantage. Here is a table comparing that "2 month short pay" option to the thirty year fixed rate loan:

Look very carefully at that "total paid" row. The thirty year fixed has saved you $1763.27 in total payments. Now, this begs the question of what you're paying it out of, but if you haven't got the income to make the payments from somewhere, you shouldn't have the loan. It's not good for you. So we're assuming that money is coming from somewhere, and as I have illustrated, if you'll just not spend it as it comes in and set a little bit aside in case something happens to your cash flow, that 30 year fixed rate loan leaves you with $1763.27 of your hard-earned money in your pocket. Not to mention just an all around better situation, as evidenced by the rest of the second table.

Now, given the fact that these loans have basically nothing to recommend them to clients, why do alleged professionals keep pushing them off on the public? Well, two reasons, both of them having to do with money. $$$. Coin of the realm. Specifically, commission checks.

First off, it should come as no surprise to anyone that lenders are willing to pay very high yield spreads for negative amortization/Option ARM/"Pick a Pay" loans. The yield spreads start at about 3 and a quarter percent of loan amount, and go up to 4 percent, with most clustering in the higher part of the range. By comparison, that thirty year fixed rate loan pays 1 percent. On a $400,000 loan, like the one in the example, that's the difference between a $4000 check and a $15,000 check. Doesn't that make you feel good that they left you twisting slowly in the wind so that they could make $11,000 extra? Didn't think so.

The second reason that people do this to you is that it makes it look like you can afford a larger, more expensive property than you really can. Most people tell professionals how much property they can afford in terms of monthly payment. Well, shopping for a property or a loan by monthly payment is a disastrous thing to do, as the first part of this article, among many others, illustrates. But let's say you tell the Realtor that you can afford $2500 per month. Most people are thinking of mortgage payments in the same terms as rent payments, when most people can afford a higher mortgage payment than rent, but let's use these numbers. Let's just use that numbers, and have insurance and property taxes call it a wash. For $2500 per month payments, you can make real payments on a $410,000 property, or you can make minimum payments on a $775,000 property. At 3% buyer's agent commission, assuming they are only representing you and didn't list the property, and assuming they do the loan as well, they can get checks totaling about $16,400 for the buyer's agent commission and loan in the first situation, or $52,300 in the second. Not to mention I don't have to tell the client to limit themselves to what their pocketbook can afford in the second situation. Even here in San Diego, that $775,000 property is a beautiful five or six bedroom 2800 square foot home with all of those nice little extras like travertine floors, three car garage, marble counter-tops, etcetera, in a highly sought after area of town with great schools, whereas the $410,000 property has linoleum floors, no garage, Formica counter-tops, and is in a neighborhood with marginal appeal and probably not so wonderful schools. Which do you think sounds like a more attractive property and an easier sale, for what the typical buyer thinks of as the same payment? Which property do you think the typical buyer is going to select, particularly if they have never had all of this explained to them?

Finally, for pure loan officers, it's a way of appearing to compete on price without really competing on price. The average person is told about this great 1% payment of $2500 when the real payment for a thirty year fixed rate loan (allowing for the fact that this has become a jumbo loan) is $4771.80, and they just aren't looking at little things like two extra points of origination or higher closing costs, as it just doesn't make that much difference to the payment. They can also slide in a higher margin over index that gets them an even higher yield spread, and it doesn't influence that minimum payment at all, which is the only thing this client has their eyes on. So what if the final payment comes in at $2600 (making the loan officer roughly $35,000 or more)? So what if their loan balance is increasing by $2000 per month? Most people just do not and will not do the work that enables them to spot this trap. Scary, isn't it? But we've now seen the evidence that people will not do their homework ahead of time, to the tune of millions of foreclosures on this runaway train wreck of a loan.

Caveat Emptor

Original here

Read your article on negative arm loans, and for the person who only owns a residence and most real estate investors it will not work. I own several properties, and the parcel to be refinanced is ocean front...so is going up in value more than the negative arm would be when refinanced after prepay penalty period. Cash out would be used to pay off other mortgages, thereby increasing my cash flow for a few years. Does your advice against negative arms apply in my situation?

I believe he's referring to this article.

This is actually an excellent question, and the answer is ... maybe. At least it is not a clear "no", unlike so much of what the Negative Amortization loan is misused for. This largely goes beyond the scope of what I'm trying to do with this site, but I'll take a swing at it.

The fact is that I can construct a scenario that goes either way, and the implicitly high appreciation rate you mention has surprisingly little to do with it.

The positive is that your other loans are paid off! To use Orwell-speak, this is maximum plusgood.

The negative is that this loan now includes every dollar you previously owed. Furthermore, there may be negative tax connotations to the fact that all of your interest expense now comes from one property, as opposed to being able to directly match it against individual properties with individual incomes. If interest against one property is greater than the income for that one property, you may not be able to take it all, as it's definitely a "cash-out" loan of the sort that the IRS has been limiting to partial deductibility. I'm not clear on all the implications of the tax code here (and I'd like to be educated), so consult with a CPA or Enrolled Agent. Plus it definitely becomes a full recourse loan, no matter the original circumstances.

Furthermore, your new loan won't magically create any "lake" of dollars. In order to pay off the other loans, it's going to have to be the size of all of them combined, plus any prepayment penalties, plus all costs of doing the loan, plus potential pre-payment penalties for the Negative Amortization loan.

Now consider: If you make payment option one (the "nominal" or "as if your rate was 1 percent" payment), you are allowing compound interest to work against you. This is the force Einstein described as "the most powerful force in the universe", and it's working on the whole dollar amount of every single one of your current loans and then some.

Ouch.

No matter which payment you're making, the rate you are being charged, (aka "what the money is costing you") is not fixed, but variable month to month. As far as most commercial property loans are concerned, this is no big deal. They're pretty much variable at "prime plus" anyway. However, I expect the MTA and COFI (upon which Negative Amortization loans are based) to continue rising as government borrowing increases, whereas I'm not so certain about prime.

Now with all this said, it's still very possible to construct winning scenarios, depending upon a variety of factors. You mention short-term cash flow, and that is certainly one possible justification. If short-term cash flow is all you're looking for, and the money it will cost you later on is no big deal because you're planning to buy down the prepayment penalty and sell in a short period of time. Yeah, you've added to your balance but you've got plenty of equity and you'd rather have a few hundred per month now than multiple thousands later. Think of it as a cash advance.

One of the things that negative amortization loans can do for you is make it easier for you to qualify for more loans on more properties. Because in loan qualification, the bank will only give you credit for 75 percent of prospective rents while dinging you for the full value of payments, taxes, fees, maintenance, etcetera, this can make it much harder to qualify than is realistic, given that in many markets the vacancy factor is less than five percent. You actually pay more, but you're not obligated to. Particularly because many people own investment properties for the capital gain rather than the income potential (i.e. price speculation, rather than monthly income). On the other hand, just because a property has been appreciating rapidly does not mean it will continue to do so, beachfront or not. The market nationwide is very different now than was previously. I can point to beachfront property here locally that's lost a lot of value since early 2005. Price speculation is great when it works (which is most of the time), but is really scary when it doesn't. It's a reward for risk-taking, so don't lose sight of the fact that it is a risk.

One other factor of doing this is that it can cause taxes on a sale to exceed net proceeds. Suppose you intend to sell the beachfront property in a couple of years, and it doesn't gain any more ground from where it is right now. Many properties were bought for less than 10% of their current value. Let's say you bought for ten percent of current value. If your loan is for eighty percent, and you pay six to seven percent in sale costs, you're getting ninety-three to ninety four percent of value, leaving a net of thirteen or fourteen. But you owe long term capital gains of eighty-three or eighty-four times twenty percent - almost seventeen percent! This can force you to take another loan out, against one of those "free and clear" properties lest you owe the IRS penalties. Yes, 1031 (or 1035) and even a potential personal residence exclusion can modify or nullify this, but so can all the depreciation you may have taken over the years, and if you intended to 1031 the property that would tend to contra-indicate any reasons you had for the negative amortization loan.

Now, to be honest, my experience with commercial loans is limited, and I've never done a negative amortization commercial loan. What few clients I've had in that market have had different goals in mind, and being as I'm a sustainability type loan officer, I tend to attract sustainability type clients, where Negative Amortization loans are more indicative of a speculative ("risk taker") type. I understand what's going on, but it isn't my primary approach to the issues. There are circumstances on investment properties where, unlike your primary residence, it can be very appropriate. Unfortunately, without full specifics, including time schedules, goals, reasons for holding investments, other investments, risk tolerances, etcetera, it's difficult to tell if yours is one of them. My experience in dealing with people is telling me one thing, my sense of ledger evaluation is hinting at a different answer. But I hope I've given you a clear idea of the kinds of issues you need to look at with professional help.

Caveat Emptor

Original here

(This is a reprint originally from December 2005. I have reasons for reprinting it even though these loans are not currently available)

My article on Option ARM and Pick a Pay - Negative Amortization Loans is one of my most popular. It's number one for multiple search engines and several ways of running the search. If I don't get at least 20 hits a day on it, it must be a sign that the public has caught on to this loan's horrific gotcha! On the other hand, given the number that are still written, I can get very depressed at how small a percentage of the population does simple research.

I intentionally left a lot of what goes on with these things out of that post, simply because I want to keep these posts readable and comprehensible within the space of no more than half an hour. But I keep getting hits asking questions I didn't deal with, so here goes:

A Negative Amortization loan is defined as any loan where the minimum required payment is less than the interest charges. Regular loans pay off part of the balance every month, whereas negative amortization loans typically have an increasing balance because the difference between the interest charges and what you pay is added to your balance owed.

Because the name "Negative Amortization" causes some difficulty in marketing, they are sold by all kinds of friendly sounding names. "Option ARM" (if you look at my article on loan types here, these are the about the only "true" ARMs with a significant portion of the residential loan market). "Pick A Pay." "Option Payment." "Cash Flow ARM." I've seen all kinds of combinations of these, as well.

Negative Amortization loan rates are typically quoted based upon a "nominal" ("in name only") interest rate. This rate is not the rate of interest that the people who have them are really being charged. It's a thing for purposes of computing the minimum payment only. In other words, the minimum payment is computed by using this rate instead of the actual rate that you are being charged. They are being marketed more heavily right now than at any time in the previous twenty-odd years. If you are quoted a rate of 1%, 1.25%, 1.95%, 2.95%, or anything else under about 5% right now, they are talking about a negative amortization loan. If you look at the Truth-In-Lending form, it will list an APR somewhere in the sixes or higher, usually five or more entire percentage points above the nominal rate. Another way to tell is the presence of several "Options" for payment. If they talk about three of four payment options, guess what? They're talking about a Negative Amortization loan. Note that this is a different situation from "A paper" loans that have no prepayment penalty, in that you are explicitly given these payment options, and may not have any others. "A paper" loans, the minimum payment at least covers the interest (if it's an interest only loan) or actually pays the loan down, and anything extra you pay is applied to principal to pay the loan down faster. I pay extra every month but that's my decision, my choice of amount, not theirs. A negative amortization loan gives you a limited number of choices. Furthermore, there are more of the so-called "one extra dollar" prepayment penalties on negative amortization loans than any other loan type.

Negative Amortization is generally a bad thing because with over 95 percent of those who have them, over 95 percent of the time they are making the minimum payment. That's why these people got them, because they couldn't afford the real payment. So their balance increases. They owe more money every month, and due to compound interest, every month the difference between what they owe and what they pay gets wider. This can only end one of three ways. They sell the house. They refinance the house. They get to "recast" point on the loan. None of these is good.

If you sell, the loans come out of proceeds, and the bank gets more money than you originally borrowed, usually plus a prepayment penalty. I keep using a $270,000 loan amount as an example, so let's look at what happens. The minimum payment will be $868.42. But your real rate is not fixed, and even if you've got a good margin and your rate doesn't rise in upcoming months (It will rise), your real rate is something like 6.2%. That very first month, your interest charge is $1395.00. You have $526.58 added to your loan balance. Take this out one year. Your principal has become $276,501.57, an increase of $6501.57. Now the minimum payment increases by 7.5% (another characteristic of this loan) to $933.56. Take it out another 12 months, now at 6.25% (and I'm being really stingy with rate hikes, given how much I think the underlying rates will go up) and you now have a balance of $283,561.76. Now you sell, and as opposed to selling it two years ago, you have $13561 less from the sale than you otherwise would have had. Plus a prepayment penalty of $9484.00, a total of $23,045 the loan has cost you not counting whatever your initial fees were. This is money you are not going to have to buy your next property with. Not to mention that if the rise in value doesn't cover it, you may find yourself short - getting nothing, and maybe even getting a 1099 form for the IRS that says you owe them taxes.

Let's say you don't sell, but refinance, and unlike roughly 70% of everyone with one of these loans, you actually make it to the end of the prepayment penalty period, three years. Your payment has been $998.70 for these 12 months, but your balance has still increased to $291,815.16. Let's say rates have magically dropped back to where they are now. You get a 30 year fixed rate loan at par at 5.875%. Your payment will be $1746.90, as opposed to $1597.15 if you just did that in the first place. But wait, it gets worse!

In the fourth year, your payment goes to $1063.84. But nine months in, you hit the recast point! Your balance has grown to $297,000 - 10% more than what it was to begin with. It's a thirty year loan, and now it starts amortizing at the real rate for the last 315 months, or until you manage to dispose of it, whichever comes first. Assuming your rate is still "only" 6.5%, your payment jumps to $1967.60 in the forty-sixth month, and this payment is no more fixed than your rate is, which is to say, not at all.

Let's say you have one of the loans with a higher recast - 20 percent instead of 10. Your balance goes to $299,010.60. Then the final year of artificially lowered payment, $1128.98 per month is applied to your loan, but it's accruing $1619.64 in interest and rising. Your loan balance is $305,077 at the end of your minimum payment period. Now your payment (assuming your real rate is still 6.5%, which I think unlikely) goes to $2059.90. If you're able to get a thirty year fixed rate loan at today's rates, your payment is $1825.35. If you couldn't afford $1600 per month in the first place, what make you think you'll be able to afford any of these alternatives? The needless increase in payment amounts to sucking $1.34 per hour out of your pocket, or if you want to think of it another way, you'd have to make $3.00 per hour - $500 plus per month - more to qualify at the end of the period with all that added to your loan, as opposed to right now. And that's assuming the rates are as low in five years, which I do not believe will be the case.

I attended a credit provider's seminar, and as I said then, credit rating agencies are currently considering making the fact that you have a negative amortization loan to be a heavy negative on your credit report, all by itself. From the writing above, it should not be hard to see why. Someone who has a negative amortization loan is not making a "break-even" payment. Their balance is increasing. This indicates a cash-flow problem, and cannot go on indefinitely. When the lowered payments expire, they find themselves in a nasty situation, worse than it would be if they had just gotten a different loan in the first place. So if the fact that you have a negative amortization loan knocks you down sixty, eighty, or a hundred points, there is a good likelihood that you will not qualify for any loan nearly so good as you would otherwise have gotten when you decide to refinance. It may even mean that if you go want another negative amortization loan, your margin may be higher next time. The last news I had was that they were looking at the modeling data for exactly how strongly it influences your chance of a 90 day late. I don't work for Fair-Isaacsson, but my guess, based upon working with people who have negative amortization loans, is that it's going to be towards the higher end of the range I cited.

In short, because most people concern themselves with quoted payment, not interest rate and type of loan, these things are most often sold via marketing gimmicks and hiding their true nature. Those selling them do not concern themselves with what will happen to you after they've gotten their commission check. They are designed (and appropriate for) a couple of specific niches that most people do not fall into. Last set of figures I saw was that they are the primary loan on about 40 percent of all purchases here locally - and owner occupied purchase is not one of the niches they are designed for. An appropriate proportion of the populace to have these might be four tenths of one percent, a figure a hundred times smaller. Shop by interest rate and type of loan, and these look a lot less attractive. As I said, the real rate on these right now (if you've got a low margin) is about 7 percent. When I originally wrote this, loans were available that are really fixed for five years at about 6 percent, or thirty years at about 6.5 percent, no hidden tricks, no surprises, no gotcha!s. I can do even better than that now. These are not only lower rate, but also better loans.

Caveat Emptor

Original here

No, this isn't the Hitchhiker's Guide to the Galaxy

But having written half a dozen articles roundly critical of the way in which these loans are generally sold, it's not unusual for me to get e-mail like this one:

Hi, Dan:

Okay, I'm absolutely PANICKED after reading your article on negative amortization loans as I have one! I thought it was an "option ARM" and that my entrusted Realtor's entrusted loan officer was wise beyond his years in his financial advice. He was semi-retired, wealthy, and said that this was the only loan he'd ever use for his own substantial real estate portfolio. I even reassured a good friend of mine who is economically savvy not to worry as it wasn't a negative amortization loan!

I purchased December of 2006. The home I was going to purchase was appraised at $780,000 eight months prior to my purchasing it for $570,000; I put $100,000 down, had a good credit score, but the stickler was my monthly income. I knew I would make a substantial bonus and raise June of 2007, so DELETED sold me on the Option ARM. The bonus was one third what I expected ($2700) and my raise was only 4% rather than 7%.

My question is this - what do I do now? Is the loan okay as long as I pay the principal and interest amount of payment? I've only been paying the minimum, but could swing it by squeezing. It's a high rate - 7.5%. And I would have a prepayment penalty if I refinanced. I'm a single mom, 46, with two kids and annual earnings of $64,000. I have $50k in savings.

Yes, I am that poor sap you speak of in your article, completely trusting, desperate for my dream house, blind sided and now stuck. Any advice would be helpful! Thanks so much...

First rule of getting out of holes: Stop digging! Pay at least the interest every month!

Now, let's look at your situation. You owe $470,000 on a $570,000 property. The real payment on that is $3286.30 per month, as opposed to a "nominal payment" of $1511.70 at 1%. Actually, by my calculations, you owe about $483,000 now and will owe more than $527,000 by the time your pre-payment penalty expires, if you make just the minimum payment.

Now, let's consider what's actually available out there. When I originally wrote this, one rate sheet picked at random showed a 30 year fixed rate loan at 6.375% costing half a point retail. Let's figure out if you're likely to qualify for that. $64,000 divided by 12 is $5333 per month. 45% of that is $2400. Both of those are potentially important figures. Let's assume your value is still $570k, so 80% of that is $456,000. Paying the penalty and costs of the loan via rolling it into your balance, I get that you'd be left with a balance of between about $507,000. The payment on the first mortgage would be $2845, which is more than you can apparently afford right there. On the other hand, many single parents have alimony and or child support that can be used if they so desire that they don't include in their income.

At this update, 30 year fixed rate loans can be had for a considerably lower rate of about 4 percent for about half a point - the lowest rates since my grandparents first bought a house. That yields a payment of $2245. The bad news is that values have declined almost everywhere, so it's likely that you cannot refinance due to that. It's possible that the 125% loan to value ratio HARP loans may help, but Fannie and Freddie don't generally hold negative amortization loans. But that's the lowest payment we can figure on ever being able to refinance you into.

I'm trying not to build fairy castles in the air. From the information presented, you can not afford the loan by standard measurements. The flip side of that is you don't have to qualify for the loan you already have, and you say that you actually can afford to keep making at least the interest only payments. As long as you do so, you're not digging yourself in any deeper. If you can actually afford to make at least the interest only payment, there is no reason to panic.

Getting yourself that 6.375% fixed rate loan would have cost you roughly $24,000 - $18000 plus in pre-payment penalties, about $6000 in loan costs. To save 1.125 percent originally, about 3% now, albeit fixing the loan. Your current cost of interest at the $483,000 balance is $36,225 per year. Cost of interest after refinancing: $32,321 per year. Interest savings $3904 per year. Your break even on this is about 6 years, 2 months - if you could qualify, which you don't appear to. Even the 4 % loan has a breakeven of about 20 months, which is good, but that's if you can do it, and I'm not at all certain you qualify.

If you make the payments for the next 27 months until the penalty expires, that higher interest rate will have cost you roughly $8900, offset to a certain amount by lowered income taxes. But here's where everyone's getting ulcers right now: Rates and the costs of getting them aren't set in stone - they're all "right now today" good only until tomorrow morning at most. Not that I expect tomorrow's rates to be much different, but I won't know until I see them. The cold hard fact is that only some kind of deity might know at this point what the rates are going to be like when your prepayment penalty expires. I certainly don't, and neither does any other human agency with which I'm familiar. There's a lot of estimates out there, but nobody knows. Furthermore, with a negative amortization loan, you don't know what your rate will be a year from now, as most of these abominations adjust month to month. So no matter which way you choose, stay or refinance, there are pitfalls, and there's no way to be certain of the right decision except in retrospect - when your penalty expires - at which point today's rates will no longer be available.

In your situation, I'd probably sit tight. As bad as it is, the alternatives all look worse. I wouldn't refinance into a loan that took me six years to break even on the costs of, and I doubt whether anyone else should, either. Alternatively, keeping in mind the fourth solution to Getting Out of Paying Pre-Payment Penalties, some people might want to see if their current lender will refinance them into a thirty year fixed without charging the penalty, although in your case that does not apparently help because you don't appear to qualify.

But your situation is not the same as the person who is only looking at a negative amortization loan. Like it or not, you've already done it. That narrows your choices to "What do I do from here?"

The first thing to set in motion is a consultation with your lawyer. I'm not a lawyer, but I've been reading about the courts ordering these abominations rescinded, brokers paying damages, etcetera. The wheels of justice grind slowly, but that means the sooner you start them grinding, the sooner they get there. It seems likely to me that there were some misrepresentations and gross negligence somewhere along the line there.

My local market colors my perceptions, and what may be appropriate for San Diego may not be appropriate elsewhere, but as long as you can make at least the interest only payment, and make it long enough such that your prepayment penalty expires, I think you're likely to see a profit on the sale of the property then, provided things go as I think they will. It might be rough in the mean time, and preliminary numbers indicate that you're not likely to be able to afford to keep the property then, but panicking rarely does any good. There's nothing you can do at this point that does not have significant and costly risks. But from what you've sketched out, holding on until the penalty expires seems to be the least risky, most attractive alternative to me.

A couple of other options: A short sale or a loan modification. The first gets you out of the situation by accepting the immediate damage when there may not be any reason to do so; the second keeps you in the property and buys you time, but nobody knows for certain whether most market will recover enough in the bought time so that it will turn out better than accepting the damage in the first place. Every situation, in every market, is different. I can't give a universal answer as to what's likely to be best because there isn't one.

Caveat Emptor

Original article here

(This is a republish of one of the first articles I wrote back in early summer of 2005. Everything I wrote then still applies. I am grateful that lenders have for the most part, stopped offering these, as they were always the worst sort of Make Believe loan, and expecting them to be sold on any other basis than the temporarily low payment was one of the larger examples of wishful thinking I have seen in my life. They are still legal, however, so expect them to get brought back out eventually. The disclosure requirements have been stiffened a bit, but in my opinion, not nearly enough. The body of the article is almost exactly what I wrote back then)

I am not exactly certain how to start this essay. I'm kind of in a position analogous to writing Hitler's biography in late 1940. We know at this point he's a miserable excuse for a human being, but we don't have the evidence discovered in the last four and a half years of the war as to how sick he truly was.

The negative amortization loan is in a very similar situation. It's a miserable excuse for a loan, causing a lot of damage, but we don't yet know how much. With most housing market gurus finally agreeing with what I've been saying for the last year, talking about a need for a readjustment in real estate prices, we are pretty certain that there's going to be a drastic re-evaluation of the home market soon. We are missing the data of exactly how bad it's going to be.

The negative amortization loan, with all its friendly sounding synonyms (Option ARM, Pick Your Payment, 1% loan, and variations and combinations thereof), is an idea that comes around periodically, and right now happens to be one of those times. Last time was the mid 1980s, and we had people driving their cars through the lobbies of savings and loan buildings in protest after they got hit with this loan's GOTCHA! If you see ads on the Internet or elsewhere advertising "$200,000 loan for $650 per month!" (or something similar) one of these abominations is what they're trying to hook you with.

These loans look, at first glance, to be wonderful - too good to be true. That is because they aren't true. Furthermore, given the fact that loan officers and real estate agents want to get paid, and the damage isn't apparent to the average consumer until well down the line, the unscrupulous ones sell a lot of these. I can point to loan and real estate offices where they do no other kinds of loans. Why? Because given the fact that most people shop for a loan or a home based upon the monthly payment, these are the easiest loans in the world to sell, and how many homes do you usually buy from a given real estate agent anyway? Cash flow is important, but watching only cash flow ends up in Ponzi schemes, Enron, and negative amortization loans.

I want to make very clear that yield spread is not a reason not to do a given loan. If a loan officer shops around and does the work to qualify you for a better loan on the same terms while increasing their compensation, they deserve to be paid that money. But you need to do your due diligence, also. Bottom line, no loan officer or real estate agent can rip you off without your consent. Make sure it's a better loan by making an apples to apples comparison based upon what you, the client, are actually getting. For example, if one provider is getting you a loan at 5.5%, that looks to be better than 6.5% at first glance, correct? But if the first loan is only fixed for two years, and has two points on it as well as $4000 of closing costs and a five year prepayment penalty, while the second loan is fixed for thirty years and the lender is paying all of your closing costs with no prepayment penalty, I submit that the second loan is the better loan. The negative amortization loan, piece of garbage that it is, compares favorably with no other loan available today. The yield spread varies between three and four points on these things, with most of the lenders tending towards the higher end of that spectrum in order to compete. To give you a comparison, in order to get four points of yield spread on any other type of loan, I have to stick people with an interest rate at least two full percent higher than the going rate!

Basically, what this loan does is give you three or four options for your payment every month. The lowest of these is the bank allowing you to make a payment as if your interest rate was somewhere between one and two percent, with most of them now congregating towards the lower end of the spectrum in order to compete with one another. This low rate of 1% or so IS NOT YOUR REAL RATE. IT IS NOT WHAT YOU ARE ACTUALLY BEING CHARGED! I don't know how many people I've talked to that were being taken for a ride and asked me, "Isn't there any way this is the real rate?" THE ANSWER IS NO. Let's pretend you are a bank officer. Remember, you're one sharp person, and you have another whole group of very sharp people watching what you do. If for an equivalent amount of risk, you can get about 7 percent somewhere else with a different investment, are you going to give some poor sap I mean someone you don't know a 1% loan that messes the heck out of your quarterly usage of capital bonus? Not to mention your boss's? Not on planet Earth.

The second payment option will be to make a payment based upon an interest only loan at the real rate you are being charged. I've seen the piranha that sell these loans trying to prey on each other extolling the virtues of COFI or MTA loans, depending upon which they have. The fact is that they've each got their limitations, and their upsides and downsides as opposed to the other. The problem with each and every one of these is that they are month to month variable from the beginning. There is no period where your real rate is fixed. You will never know next month's rate until it happens. Thus far in my career, I've always had loans that are fixed for three to five years, at rates lower than this rate that the loan is really charging you. In other words, this second payment option is based upon a rate that changes every month, based upon the movement of an underlying index plus a margin.

The third payment option is to make an amortized payment based upon that same month-to-month rate. This is roughly analogous to a standard thirty-year loan, except that it is not fixed, and unless you make a payment of at least this much, next month's payment options are going to be worse. The fourth and final payment option given by most lenders who do these is for the client to make a fifteen-year payment. Before we move on, the point needs to be made that almost nobody actually makes the payment for either of these options, much less makes these payments habitually as opposed to the other options. These payments are higher, and are not good selling points for this loan. If the client could afford to make these payments, there are better loans to be had. This is a metaphorical fig leaf to cover their naked taking advantage of you. "Well, he could make (or could have made) this payment but didn't. It's not my fault." The reason they didn't make the payment, Mr. Unscrupulous Realtor, is because YOU told them they didn't have to. You SOLD them the house based upon the nominal payment, not the real cost. You got a bigger commission by making it look like they could afford more house than they really can. Unless they start making drastically more money at some point, they are likely to lose the house, and they may lose it anyway. I know you think it's not your problem, but some ex-client with a good lawyer is going to make it your problem.

Now, what happens if you make each of these payments? Obviously, if you make the payment for either the third or fourth option, you are paying your loan down. If you make the payment for the second option, that is basically a break-even, except that next months payments will be computed based upon one fewer month with which to pay the loan off.

What happens for 95 percent of the people who do these loans 95 percent of the time is they make payment option one. What happens in this case, where the client is making a payment that is less than the amount of interest on the loan for that month? The bank isn't going to just eat the difference. That interest has to go somewhere.

Where it goes is into the balance of the loan. This means the balance for your loan - the amount you owe the bank - goes up every month that you make this payment option. Furthermore, next month it earns interest also. Next month the difference between what you pay and what you are charged gets higher, and even more money is applied to your loan balance. You're being bit by compound interest. This is the first reason why the lenders will pay loan officers who do these loans so much. The lender knows that in the vast majority of all cases, the clients will end up owing them more money than they originally borrowed.

Furthermore, every single one of these loans that I know of has a three-year prepayment penalty. This means that even after you figure out that you've been taken for a ride, you're either still stuck with them for the rest of three years or you're going to pay a penalty amounting to thousands of dollars. Not a bad position for a lender to be in for leading you down the primrose path, is it?

I haven't even gone over recast provisions (the 1% rate, even though it's nominal, not real, doesn't last forever), and various other lurking GOTCHA!s. I hear a lot of arguments from the various lazy lowlifes who make a habit of doing these loans rationalizing what they're doing. "Those old loans had no cap. Now there's a nine percent cap" The fact is that if the client could afford six percent, there are other better loans to be doing. "They'll more than make up for it in increased equity as prices rise." Well, maybe, IF the market continues to rise, which is unlikely at the current time and never something you should bet other people's financial health upon. It's a crapshoot, at best, and the prevalence of these loans is one reason why the market is so overheated. In any event, the client is going to end up owing more money. Unless they're going to sell and not be a homeowner any more, they're going to have to pay the loan sometime, and in the meantime the longer they keep it, the worse it gets. What happens in three years if home prices are lower and the loan gets recast and now they cannot refinance out of it? Another refrain I hear from these people: "It's the only way to get them into a home!", meaning it's the only way for them to earn a commission (or, more often, the way for them to earn a bigger commission). The clients still end up owing more money at the end of the pre-payment penalty, and it'll keep getting worse the longer they keep the loan. They're still going to need to pay it back, unless they sell, and sell at a sizable profit. Furthermore, if they couldn't afford a reasonable loan in the first place when they needed to borrow $X, what makes you thing they're going to be able to afford a reasonable loan three years down the line when they owe $Y more. This is not a stable, sustainable situation for the client! Maybe in a case like this, they should continue renting. Of course, that doesn't get you a commission, does it, Mr. Unscrupulous Realtor? It certainly doesn't encourage the client to stretch beyond their means and get you a bigger commission, either, does it?

For any loan officer who does these reading this, face it: These things are a way to mess up your client who is putting money into your pocket. These put the clients into worse situations than when they started. You are betting upon factors beyond your control to save both you and them. One of these days, probably very soon, these are going to come back and bite you hard. Violation of fiduciary duty. All it takes is one of your clients getting into a bad situation who gets a good lawyer, and your career is toast along with your pocketbook.

For those of the general public reading this, I hope I've opened your eyes to some of the pitfalls of this loan. I encourage you to ask questions if you have them. But this loan is one that is designed for a narrow set of circumstances tailored around cash flow for a limited amount of time (and the one time I actually had a client who was in the situation where he could actually benefit from a negative amortization loan, none of the companies I submitted it to would approve it. This tells me that who they say it is for and what they really want are two separate things). Negative Amortization loans are abused by being misapplied because it's such an easy loan to sell to those who do not understand the way they work, and all because people shop for a loan based upon payment. So don't shop for a loan based upon payment. And if anyone offers you one of these loans, drag them into the sunlight, drive a wooden stake through their heart, and RUN AWAY! Somebody who offers you one of these is not your friend.

Caveat Emptor

Original here

what happens if partner refuses to pay his half of the mortgage?

The lender will hold you each responsible for payment in full. They don't care who pays; only that they get the full amount every month. That's the long and the short of it. You both agreed to the loan contract, and if it's not paid in full there will be all of the consequences: Hits to your credit, notice of default, foreclosure.

This is basically blackmail on the part of your partner but a disturbing number of partnerships have this phenomenon occur. The only way I know of to recover the money is through the courts, which takes forever and costs more money. Even when you have a judgment, it can be difficult to actually get the money if they have taken certain steps to place it beyond your reach. Talk to an attorney right now, keep good records, and send everything Certified Mail.

Unfortunately, there are no method except time that I am aware of to repair the damage to your credit once it has been done. You just have to wait it out. For that reason, it is usually cost effective to loan your partner the money, even at zero percent interest.

What if you don't have the money for both halves of the payment? Well, that's a real question, and the answer is found in the article What Happens When You Can't Make Your Real Estate Loan Payment. This is not a good situation to be in. Talk to that attorney about liquidating your investment. It takes time and a lot of money if your partner doesn't want to.

What can you do to prevent this from happening? Pick a good partner that won't pull this nonsense. Spend the money to protect yourself up front with a partnership agreement. But the fact is that if your partner wants to be a problem personality, you really can't stop them in the short term. Not that it makes any difference to your pocketbook, but sometimes it's not intentional. People do fall on bad times for reasons not under their control.

Corporations are another step people take to protect themselves from this sort of thing, but that brings in all sorts of further problems. How the corporation qualifies for a loan is often a significant problem, and many times practically speaking, is insurmountable.

Borrowing money in partnership with someone else is something to be done with a lot of forethought and preparation, otherwise there's nothing you can do when bad things happen.

Caveat Emptor

Original here

after Katrina I am upside down with my mortgage. my house is uninhabitable. My flood insurance check doesn't payoff the mortgage. How can i get a short payoff due to financial hardship - i.e. relocation loss of jobs and steady income?

This is one of the hard truths about mortgages. They are a contract between you and the lender to pay back a certain amount of money that you borrowed in order to purchase that property. They have nothing to do with any unforeseen hardship, and if you do not pay that money back, in full and on schedule, you can anticipate negative consequences no matter how good the underlying reason. Especially to your credit, and those are going to be long term consequences indeed.

Unforeseen disasters, like Katrina, Earthquakes, floods, fires etcetera, are one of the biggest reasons why things go wrong with your ability to repay that money. Something happens to the property and now you can't live in it, and you do need to pay for housing elsewhere. Furthermore, in widespread disasters like floods and earthquakes, since your job may no longer be there, you may have to relocate a considerable distance away in order to find work, and have difficulty paying your mortgage even if your property, in particular, came through just fine.

There are several issues that trap the unwary or uninformed consumer. Homeowner's Insurance in general is the first of these. Many lenders in other states have requirements that the property be insured for the full amount of all mortgages against the property. This requirement is illegal in California (and a few other states), and actually is counter-productive as this implies that the objective is to pay off the lenders, when the objective of insurance is to repair the damage. The phrase that California lenders look for in the policies of homeowners insurance that any lender can and all lenders do require is "Full replacement value." In other words, the insurer must agree to bring the property back to being in the same condition it was in prior to the covered event that caused the damage. Nonetheless, there are many properties where this kind of coverage is not available, most often due to their location in areas vulnerable to periodic fires. In such instances, you can expect lenders to require significantly larger down payments and charge higher interest rates, if they are willing to lend against the property at all. Since this adversely effects the owner's ability to sell their property, you will therefore likely get such a property for a lower purchase price than you would otherwise - but you will also have the same difficulty when selling it. You should be advised that this difficulty will persist before you purchase the property, no matter how much you have for the down payment. An agent who doesn't tell you about this issue on properties where it is an issue is either incompetent, or not looking out for your best interest.

Another issue with homeowner's insurance is that you must keep the insured amount reflective of your home's current value. If you bought fifteen years ago here in San Diego, you probably paid about $150,000 for a three bedroom single family residence. I don't know of any single family residences below about $250,000 now, and most are in the mid 300s or higher - let's say $450,000. The insurance companies, quite reasonably I might add, take the position that even if you have "full replacement value" coverage, your home is only insured for $150,000, and is worth $450,000, you are not insuring it for the full value and will not pay the full bill for any repairs even if it is only for $100,000. In such a case, it's been a while since I went over the figures that are the legal basis for the math, but in this particular instance, I get that the insurance company will pay $41,666 out of that $100,000 repair bill in this particular instance. The threshold is legally if you had the property insured to at least eighty percent (80%) of its actual value, they will pay the full bill, but you only had it insured to 33 percent of the value, and therefore they will only pay 33/80ths of the bill. So once every couple of years (more often in markets rising 20% per year!) talk to your insurance company about making certain your property is properly insured. Yes, you'll pay more money, but it is a trivial amount compared to the cold hard fact above. My first property multiplied in value by about three and one half times, and the difference between the insurance premium then and the insurance premium now is less than fifty percent. Some insurers (mine among them) have a good record of not invoking the 80 percent rule I'm talking about here and paying the full amount, but this is a matter of company policy, not legal requirement, and it can be changed at any time and no matter how benevolent they are, if the disaster is bad enough they will have no choice. Furthermore, those folks who keep their coverage updated are de facto paying for those who don't under such a policy, and for those who do make a habit of keeping their insurance coverage updated may find more competitive rates with other insurers.

Two things everybody needs to be warned about is that no regular policy of homeowner's insurance, not even the vaunted H.O.3 policy with the H.O. 15 endorsement, covers against flood or earthquake. If possible flood or earthquake is an issue where you are, you need to buy a special policy to be covered by them. Flood and earthquake policies usually have a higher deductible than a basic homeowner's policy, and the reason for this is simple: solvency of the insurer and price of the insurance. Flood and earthquake are typically widespread devastating disasters that make for major damage over a widespread area. If the deductible was smaller, the price of the added policy would need to be much higher, as paying off such claims strains the financial resources of even the strongest insurer. Now if you're buying on stable soil atop the highest ridge line for miles around, flood insurance is probably not a worry for you. I sit roughly two tenths of a mile from a creek bed, but the amount of territory it drains is relatively small, only a of couple square miles, as the big watercourses go well away from where I sit and there are large hills between me and them. On the other hand, being in California, I've had earthquake insurance since the day I bought the property.

One more thing with flood insurance: There is a federally mandated thirty day waiting period between application and payment of premium and the time it goes into effect. This is to prevent, for instance, people in New Orleans waiting until there is a hurricane headed their way and rushing out and buying flood insurance, then canceling it and asking for a return of their premiums afterwards. I think the thirty day requirement is waivable to the extent that it can go into effect on the day you buy your property, but talk to your insurance agent.

Now, one final thing to be aware of. The value of the land itself is not insured, only the value of the improvements to that land. If a flood goes through your land, the land will still be there afterwards (and research riparian rights sometime if you're worried it will not be - another thing a good agent should warn you about if it's relevant). So if, like many in San Diego, you bought the property for $500,000, but it only cost the builder $200,000 to put the property together, the value of the land is obviously $300,000, right? Well, your mortgage is for eighty percent or ninety percent of the value of the improvements plus the land. Let's say 80%, $400,000, although I suspect that's on the low side of both mean and median. So when a disaster destroys the improvements (i.e. the home) and your insurer sends you a check to rebuild those improvements, that $200,000 check is obviously not going to cover the full amount of the mortgage. What do you do?

Well, that's where the importance of a good insurance policy, that will cover the costs of housing while you rebuild in addition to the costs of rebuilding the home in the first place, comes in. You'll also need to learn the value and importance of managing cash flow versus amount you may owe, but that's a subject for another essay and you should consult a good professional financial person if you haven't learned this before said happens in any case. Trying to learn that financial skill "as you go" is a recipe for guaranteed disaster. Furthermore, no matter how good your policy of insurance is, there is always a deductible and there are always extra expenses of rebuilding that you need or desire to undertake because it's the best and cheapest time to do so. This illustrates the value of building up and maintaining an emergency fund that you can access, because even if the finished property will be worth far more, no regulated lender will touch a refinance for cash out while the property is still under repair. A "hard money" lender might lend you new money, but they require so much equity in the property "as it sits right now" that this is not an option for the vast majority of all property owners. And in the meantime, you must keep up all payments required under the original loan contract you agreed to. Yes, it's a hardship. But it's what you agreed to do when you signed that mortgage contract.

Caveat Emptor

Original here

This is one of those commercial gambits I keep seeing that has nothing intrinsically wrong with it, and yet it is most often a tactic employed by the more costly loan providers. In short, sharks and scam artists.

The basic come-on is this: Loan provider offers to pay for your appraisal if you do the loan with them. They often use such come ons as "free appraisal!"

TANSTAAFL. Repeat after me. TANSTAAFL. There Ain't No Such Thing As A Free Lunch. "Free" stuff has an ugly habit of being the most expensive there is, and this particular come-on is no exception. Offer you a few hundred with the left hand while picking multiple thousands out of your pocket with the right. If you want to be an educated consumer, engrave TANSTAAFL upon your soul.

What's going on here is that they are trying to make it look like you're getting something free. You're not. They may front the cash for the appraisal, but in all but a few cases you're going to get explicitly charged in the end. Even for those people whose final loan papers does not show an appraisal charge, they are charging it to you somewhere else. Odds are that they're charging it about ten times over somewhere else. Either in origination or yield spread, one way or another you are going to pay for this appraisal. Actually, you are likely going to pay for that appraisal several times over. People are strange about cash. Many folks, if told they don't have to lay out $300 to $500 for an appraisal, will choose loan providers where the proposed rate is 1/4 to one half a percent (or more!) higher than competing loans, with closing costs thousands of dollars higher. They are getting the cost of that appraisal all right. In this scenario, they're making half a point to one point more than anyone else on the same loan, plus all of the extra closing costs. That's if they're a broker. If they're a direct lender, the difference is between a point and a half and two and a half points, more if there's a prepayment penalty!

Furthermore, in that packet of papers you're asked to sign will almost certainly be a form where you agree to pay for the appraisal if the loan doesn't close. Practical effect: To hold you hostage at the end of the loan.

New appraisal standards that took effect in May 2009 require the lender to pay the appraiser. This is a good thing in that the appraiser who has done the work should expect to get paid, not stiffed for the bill when escrow doesn't close. However, the lenders have a choice: They can require a deposit for all loans, or they can jack up their profits per loan, effectively forcing those clients whose loans close to pay for the appraisals of those clients whose loans don't close.

Low cost loan providers do not pay for your appraisal. The loan providers who pay for the appraisal are paying not only for your appraisal, but the appraisal of all the people who cancel, and a good margin besides. Not to mention that this loan provider completely controls the appraisal, leaving them in control of what happens if you actually notice their huge fees when you go to sign loan documents, and decide you want to go somewhere else. This is one of the ways that loan providers avoid competing on price, by pretending to give you something for free. I say "pretend" because they are not giving you anything for free. I do not understand that normally competent adults who are well aware what "free" really means in other contexts will think it means they're getting a benefit. But just like the "buy one, get one free" offers that jack the price up threefold first, this is only a good bargain if the few hundred dollars it saves you stays saved, rather than giving you $400 with one hand while taking $6000 with the other, through higher loan rates and costs. Rate and cost trade-offs on real estate loans vary constantly. You can't know what the best bargain is right now unless you price it out right now.

Caveat Emptor

Original here