Mortgages: June 2014 Archives

(This was originally published March 18th, 2006. I've added a couple updates, but otherwise it's as published. It's still very relevant, and if there's anyone that wants to tell me I didn't nail it, please speak up)

Somebody wrote a comment about going upside-down on their mortgage:

What happens if the property value falls and becomes far less than the loan ammount? (POP) Lets say you get a loan for $280,000 on a home that was $330,00 and then three years later is is only worth $150,000, but you still owe $250,000 on it?

Now "upside-down" in the context of a mortgage is just slang for owing more than the property is theoretically worth. This is a tough situation to be in, and there's not much that can be done while you're in it except get through it. Before, yes. After, yes. During, no.

I've predicted that this is going to be a widespread phenomenon over the next few years, and it's going to cause a world of hurt, but it doesn't need to include YOU, unless this has already happened, and I thought Sandy Eggo, where I live, to be on the bleeding edge of bubble problems, and appraisers are still able to justify near peak values even here.

Surviving being upside down is actually pretty easy if you have the correct loan. I bought near the peak of the last cycle, and was upside down myself for little while. If you take nothing else away from this article, understand that the only time your current home value is important is when you sell or when you refinance. If you don't need to either sell or refinance, it does not matter what the value of your home is. It could be twenty-nine cents. It's still a good place to live. You've still got the loan you always did. You should be able to keep on keeping on until the situation corrects. Prices will come back sooner or later.

The key is to have a sustainable loan. I did. I had a five year fixed period, during which time the market recovered and I paid down my loan. By the time I went to refinance, five years later, things were better.

This is the real sin of the local real estate and mortgage industry. Yeah, the bubble's going to pop, and everybody knows it. Actually, it's already had significant price deflation. But if they had been putting folks into longer term sustainable loans, they'd be fine. Instead we've had about forty percent of purchase money loans being negative amortization and another forty percent being two year fixed interest only loans. The period of low payments for the former, and the fixed, interest only periods for the latter, are going to expire while prices are still down. That would be tolerable if the people could make the new payment, but if they could have made the new payment, they would have been in longer term fixed rate fully amortizing loans in the first place. What's going to happen next is kind of like when Wile E. Coyote looks down.

I've been telling people there are no magic solutions to the problem for over three years now. If you borrow the money, you're going to have to pay it back. Make the payments now or make them later, and the later it gets the worse it will be. There is no such thing as free lunch, and those who pretend that there is are not your friends. The Universe knows how much more money I could have made by keeping my mouth shut and screwing the customer. $200,000 is a conservative estimate. Instead of struggling to convince people to do the smart thing these last eighteen months, I could have been glad-handing everyone in sight and making a mint off of ignorant people. But then there would be court dates looming in my future (those in my profession who were not so careful are going to be in for a hard time, and I hope you'll forgive my schadenfreude when it happens. Those con artists masquerading as professionals stole a lot of money from me and from the people who became their clients by convincing them they could afford more house than they could, or by not admitting to the tremendous downside of what they were offering the client. "No, he just wants you to do business with him and he can't do what I'm doing." I could have gotten the loans, as I informed more than one of the clients I lost, and on better terms, but I wanted them to know the downsides. So I lost the business to the con artist who pretended there wasn't one. There were downsides, but people want to believe the con artist).

What to do if it has become obvious you're headed for the canyon? Figure out what your payment is going to do for the next several years. Determine if you're going to be able to make that payment before it happens to you. If not, refinance now if you can, sell if you can't. Pay the prepayment penalty if you have to, because given a choice between a prepayment penalty and foreclosure, the former is much better.

If you want to refinance, find a long term fixed rate loan. Minimum of five years fixed, fully amortized. Since thirty year fixed rate loans are actually about the same rate as 5/1 ARMS right now, I've been recommending the thirty year fixed for almost everyone. This is a loan that never changes, and you never have to refinance because the payment is going to jump.

(UPDATE: 5/1s are now significantly cheaper than thirty year fixed rate loans again)

The critical factor for refinancing is the appraisal. The critical factor for the appraisal is how much value can be justified by the appraiser. In order to justify the value, there have to be comparable recent sales (not more than one year old) in your neighborhood. The appraisers don't always have to choose the most recent; they have the option of choosing better matches for your home. May the universe help you if there are model matches selling for less in your condominium complex, because there the lender is going to insist on the most recent sales. All the more reason to act now, while you can, rather than wait and hope.

(UPDATE: With Home Valuation Code of Conduct the appraisal has become the source of more problems than any other aspect of a real estate or mortgage transaction)

If you're already over the chasm and prices have fallen, consult some local agents about selling. Short payoffs are no fun, but in the vast majority of cases, they're better than foreclosure if you're not going to be able to make your payments. At least when they're done, they're done. Foreclosure is a hole that keeps on draining you long after you've lost the house, and after it's cost you thousands of dollars more than a short sale (and if sale prices continue down, that 1099 love note from the lender after the foreclosure is going to be worse). As for waiting, well, if it's an honest consensus that things are coming right back, but here in San Diego the Association of Realtors had not yet admitted there's price deflation despite it going on for almost a full year. They've been playing games with reported figures to make it seem like things are rosy. There are obvious motivations for this, not all of which are explained by self-interested greed, but it's not something you can paper over and ignore indefinitely.

Who's to blame for the impending train wreck? I'm not really into blame, but here are several targets. Unscrupulous lenders and agents bear a lot of blame, but not the exclusive burden. Panic and greed on behalf of the buyers is certainly a significant part. And if several folks are telling you that the best loan they have is five and a half or six percent or even six and a half, shouldn't a normal, rational adult be suspicious of an offer that's theoretically at one percent? I can maybe believe somebody who offers something a quarter of a percent better than the competition. Half a percent might be just barely possible at the same price. Somebody who offers money, of all things, that's less expensive by an interest rate factor of five isn't telling you the whole truth. (Unfortunately, in this case, these loans are so easy to sell on the basis of minimum payment and nominal rate, it got to the point where these loans were what the vast majority of agents and loan officers were talking about)

As a final note, 125% loans do exist (UPDATE: Not really, anymore, but for a while, there was a 125% refi in place program enacted by Fannie and Freddie, if your loan was backed by them), but they are ugly. Very ugly. Not as ugly as Negative Amortization, but ugly, and the payments and interest rates aren't any more stable than the real terms on those Negative Amortization loans. They don't do stated income, either, or non-recourse loans. You stiff those folks, they will get the money out of you.

Prices are going to come back up. It's as predictable as the fact that they were going to fall. Can't tell you when, anymore than I could tell you when exactly they would start falling. (UPDATE: Housing recovery is ready to happen, whenever the government pulls it's head out of where it is right now) Doesn't mean it won't happen. The trick is to have a sustainable situation in the meantime, and this means a loan with payments you can make every month, month after month, indefinitely until the loan is paid off or you have the ability to refinance or sell. If you've got this, someday you'll be telling yourself how happy you are that you bought that property. If you don't have it, get it. If you can't get it, get out.

Caveat Emptor

(I originally published this March 18, 2006, but most of it is still highly relevant.)

from an email:

First let me say that I really learned a lot from your postings/articles/website; its awesome that a resource like yourself exists.

Now to the problem. I recently refinanced and the mortgage broker lied to me about many, many things. I was sold a negative amortization mortgage. The broker provided me a chart showing my payment schedule for 30 yrs; it showed my payment split between interest & principal. I was told that my rate was fixed for 5 yrs and that it would go up to as high as 9% after the 5 yr period. When the closing came and I inquired about the 9% highlights in the docs and the negative amortization disclosures he stated that they didn't apply to me or this loan. He pointed to the section of the doc that stated that my payments would be fixed for 5 years and that my interest rate would also be fixed for that 5 year period. After closing I received the docs from the lender which outlined the fact that I had 4 choices for payments and when I called for the explanation I almost died. The broker apparently didn't really understand the loan at all; he has now offered to refinance me without any fees...but I am supposedly stuck with the prepayment penalty. When the broker and I originally discussed the penalty he explained that I would probably want to refinance at the end of the 5 yr period anyways so I shouldn't worry about it. The broker also took my lead from a mortgage company he was working with when I originally inquired about the refinance. About 2 weeks into the process he told me that he had quit his job @ the mortgage company and was now out on his own as a broker (emphasis mine DM). Only now did I just realize that he really didn't have the ownership of my lead as his original employer paid for it & provided it to him during his employment. I'm sure that his original employer would be very disappointed to learn that he had taken the business with him when he resigned.

Now that the problems been explained my questions are as follows; Can I sue the broker to recover the refinance fees and the prepayment penalty?

Can the broker that lied to me and provided all the false info be sued or charged; can he lose his mortgage brokers license?

Any advice as to what I can do/what I should do at this point? Thanks in advance for any info you can provide. Please let me know if you respond directly to emails or if I need to go to a specific website to look for a reply.

There are several issues raised here. The largest major red flag is about the Negative Amortization Loan Disclosures. If it didn't apply to your loan, why did they present them to you? There isn't a good answer to that question. If something does not apply to your loan, you are within your rights to not sign. If they don't apply to your loan, then the lender doesn't need it. I don't have my clients sign negative amortization disclosures for thirty year fixed rate loans, or anything else to which they don't apply. There are any number of disclosures that legally have to be filled out for every loan and sometimes multiple disclosures for basically the same purpose. I had to do four "equal opportunity" disclosures for my most recent loan. But those are utterly harmless, simply informing you of your rights. A negative amortization disclosure isn't. With that, they can prove that you were told that your loan was negative amortization, and you must have been expecting it, because you signed it, didn't you? That's the lawyer's logic.

I am rapidly becoming more aware of a trend with unscrupulous mortgage lenders: Instead of putting bad stuff in the actual Note, they are adding it on as part of the all the disclosures people have to sign, hiding it in packs of supplemental stuff along with all of the standard stuff that everyone knows have to get signed. Sometimes, they are even coming back to people after funding and asking them to sign horrible things, prepayment penalties and negative amortization disclosures, among others, "for compliance." I want to see a standard booklet or checklist of forms that actually are required by law for every loan, so that innocent consumers who are trying to do the best they can know what is and isn't required by law.

If disclosures do not apply to your loan, do not sign them. They don't need it to fund your loan. There is no reason why someone who's getting an amortized, or even interest only loan, needs to sign a negative amortization disclosure. Just refuse to sign. If it doesn't apply to your loan, then they don't need it to fund your loan. If they then fund your loan and it is negative amortization, you have a good case, so they're not likely to fund it. Refusing to sign stuff that does not apply to your loan protects you.

Now, as to the broker not understanding that the loan was negative amortization: I suppose it's possible. There are people out there in my industry who are mind-numbingly stupid. But the odds are overwhelmingly in favor of the likelihood that they lied to you. There are required submission forms on every loan that most consumers will never see, but it's a requirement for the loan officer to fill them out. They are filled out and submitted with your loan package, and they quite clearly indicate all the relevant facts of your loan.

Now, as to your options going forward. There's nothing wrong with people quitting their employers and going into business for themselves, if they provide good loans at a good cost. Yes, his former employer may want to sue him for the commission he earned, and such might be one way of extracting vengeance, if such is your mindset, but it's not going to help you at all. Nor should you care about who "owned" the lead. You as a consumer are not obligated to anyone except the provider who delivered the best loan at the lowest real cost. And of course the broker who did your loan wants to get paid again with a new loan. Since they are claiming to be stupid enough to drop your state's average IQ by twenty points, you may have to give him directions as to exactly which tall building or cliff you want him to jump off of. They have proven that they are not worthy of your business or anyone else's. Please do make a formal written complaint to your state department that regulates mortgages. In most states it's the Department of Real Estate, but if it's not, they will know who to direct you to. This person should lose their license and be barred from the industry for life over this. Unfortunately, your complaint alone probably won't do it, but people who get multiple complaints do lose their licenses, and sometimes, one is enough, if it's egregious enough.

The next issue is what can the writer of this email sue for? I'm not a lawyer, but every adult in the United States should know the answer to that question is "anything at all," or even "nothing." The better question is where are you likely to recover money, and how much? Once again, I'm not a lawyer and you should talk to one, but I strongly doubt that you've got a good case for anything in civil court. He's got all of those documents you signed ("the weight of the evidence"), and even if you get some jury to agree that you are owed money, it's likely to be overturned upon appeal. This is why unscrupulous folks want you to sign all those documents.

What do you want to do? You indicate your interest rate is fixed, and it must have been low enough to be attractive. If this is the case, make your monthly payments on time, and make the fully amortized payment, usually the third payment option on Negative Amortization ("Pick A Pay") loans. However, I don't believe that is likely to really be the case. I have never once seen one of these abominations where the real interest rate was fixed, or where the real interest rate was competitive with amortized loans. The attraction of these loans is low payment, and the real interest rate is usually at least 1.5% more than I could get the same person on a fully amortized 5/1 ARM, and right now thirty year fixed rate loans are about the same as the 5/1 ARM. People who don't know any better get the low payment, the bank gets your signature on a loan that's 1.5 percent higher than you could have gotten, and people who don't know any better will line up and fight for these loans! They are easier to sell than free beer to people who don't know any better! The hard thing is selling them something else when other providers are telling them about Option ARMs. So you're probably going to want to refinance, as over a three year period, 1.5 percent rate differential will save you a lot more than the pre-payment penalty.

I answer question emails directly. It may take me a few days, but I do answer them, provided they don't get lost in the spam filter. If it's an issue I haven't covered before, or only tangentially, I do like to use questions as the basis for new articles, but I answer questions asked via email by return email. If there are already good answers on my site, I'll send you the link, because it was obviously too hard to find it. If there aren't, you'll get your question answered before any article appears.

Please ask if this does not answer all of your questions!

Caveat Emptor

Original here

I am continually horrified how many people shop their loans by APR, just as I am by people shopping their loan based upon payment. Why? Because in either case, you're setting yourself up to spend a lot of money in closing costs that most people will never recover. But you shouldn't choose a loan based upon APR, just like you should never choose a loan based upon payment.

There is always a tradeoff between rate and cost in real estate loans. If you want a lower rate, you're going to spend more in up-front costs to get it. This is a law of finance on the same order as the law of gravity, or Newton's laws of movement. Some lenders and originators have different tradeoffs, for better or worse, but they are always present. The question of rate should never be asked or answered on its own, but always in conjunction with the costs it takes to get that rate. If you keep a loan long enough, yes, you will eventually get back your upfront investment, but most people don't keep their loans nearly long enough.

Let's illustrate by example. Picking a random rate sheet from one lender as I wrote the original article (rates are much lower now), I had one thirty year fixed rate loan with a rate of 5.00 percent, and assuming an existing loan payoff of $350,000, and rolling costs only into the balance, an APR of 5.484, and payment of $1993. Looks better at first glance than a loan at 5.625%, with a payment of $2056 and an APR of 5.764. As other alternatives, 6.00 percent is available with a payment of $2119 and an APR of 6.048, or 6.375% with a payment of $2184 and APR of 6.375.

But here's what may not be apparent. As a matter of fact, it isn't apparent to most consumers. That 5.00 percent loan cost 4.8 points to get, and involved paying over $21,300 in total costs to buy the rate down that far. You're almost up against California rules limiting the total costs of a loan to 6% of total loan amount. The loan at 5.625% is done with a single point, and costs a grand total of $7070 to get done. The loan at 6.00% requires no points, and costs a grand total of $3500. Finally, the loan at 6.375% is a true zero cost loan.

What this means is that that getting that 5.00 percent rate is a nonrefundable $21,300 bet that you will keep that property and that loan long enough that the money you save in interest every month will be more than that upfront cost. It takes 141 months for that loan to do that as opposed to the 5.625% loan - almost twelve years - when you consider time value of money. It takes 108 months - nine years - before it pulls even with the no points loan at 6.00, and 92 months - over seven and a half years - before it pulls even with the zero cost loan at 6.375%. The 5.625% loan (a $7000 bet) doesn't start in first place either, but it does get there a lot more quickly. It takes 55 months - four and a half years to pull in front of the 6.00% loan, and 53 months to pull in front of the zero cost 6.375% loan. That poor 6.00 percent loan for no points is the only one that's never the absolute best choice - it takes the exact same 55 months to pull in front of the zero cost loan as the 5.625 takes to catch it, but since you're only betting $3500, at least you've lost less if you refinance or sell before break even, which most people do. Last time I checked (a few months ago), the median age of mortgages in the United States was 28 months - just about half the time that any of the other loans takes to pull even with the 6.375% loan that doesn't cost a penny, either out of pocket or rolled into the balance.

Let's consider how much money you'll be out if you refinance after 28 months with that 5.00 percent loan (or sell the property), like approximately half the population will. Your balance is $18,860 higher than the zero cost 6.375% loan, while on the plus side you have saved $1288 in payments. On the minus side, however, if you get another loan, you still have to pay interest on that $18,860. Whether it's because you sold that property and bought another, or a refinance loan comes along that you like better, it means a loan balance $18,860 higher even if you don't pay points on the new loan. You're still paying for your old loan, while all of your benefits stopped on the day you let your old lender off the hook by selling or refinancing. Admittedly, the chance of this happening is lower as you get to lower and lower rates, but it's still a bad bet, in my estimation. People not only sell, they want cash out, they want debt consolidation, the list goes on and on. If you get another 5% loan, you're paying $943 extra per year because of that higher balance. Alternatively, if you kept the extra in your pocket and invested it elsewhere, a 9% rate of return would mean it would cost you $1697 that first additional year. So far, I haven't worried about tax deductibility, but it works against the higher cost loan, making the picture even less favorable.

I need to note that these were honest calculations. The ones you encounter won't always be. Sometimes, they're based upon the payoff balance - in other words, calculate the payment for that 5% loan as if you were going to pay all of the costs in cash, even though the loan officer probably knows that's not going to happen. This would allow them to quote a payment of $1879. It also assumes they're giving you an honest quote on your MLDS (California) or Good Faith Estimate (the other 49 states) is accurate, as the APR is calculated given that information. If the underlying document is inaccurate, and I've covered how badly lenders can legally lowball, then the resulting payment and APR calculations will therefore be too low.

Now the difference between the two numbers, APR and APY, can give you a certain amount of information if you know how to use it, assuming that the loan officer tells you the truth, unlikely though that may be in some cases. I'm going to assume you've got a financial calculator or can do the calculations yourself, because none of the ones I've seen on the web are up to this task. Furthermore, this is only an approximation of the actual computation method, so there will be a small amount of slop in the calculations, but much smaller than the eighth of a percent fixed rate loans quotes are permitted to be erroneous. Using the term of the loan, the payment, and the contractual note rate (APY), tell your calculator to compute principal value of the loan - in other words, the new balance. This may not be accurate in and of itself, and that will tell you there's something funny going on with the numbers. Then repeat the calculation with APR substituted, which should give you the balance less the cost of loan, albeit with third party fees (appraisal, escrow, title) still in the amount as those are excludable from APR calculations under Federal Reserve Regulation Z. The difference in the two numbers tells you the fees the lender is charging - or the ones they're willing to tell you about, anyway.

Note that the "spread" or difference between APY and APR gets larger as costs get higher or the term of the loan being contemplated gets shorter. The reason is that these costs have to be paid off over a shorter period of time. It also increases for smaller loans and decreases for larger ones. If you have to pay them off over fifteen years instead of thirty, the difference gets much larger. That 5.00 percent loan that had an APR of 5.484 with a thirty year loan term goes to 5.834 with a fifteen year loan term - not quite twice the difference, but nasty enough!

Despite the fact that the person refinances about every three years, APR is always calculated upon the consumer keeping the loan for the full term, which isn't likely. Ninety-five percent of everyone has sold or refinanced within about seven years, and this number climbs towards an effective 100% for loans that begin adjusting before that. Sure, you could theoretically keep a hybrid ARM (although not a Balloon) after the adjustment, but nobody does.

With that in mind, let's calculate APRs of each of these loans assuming you'll refinance after 36 months - significantly longer than the fifty percent mark where half of the country has refinanced or sold the property. The 6.375% zero cost loan still has an APR of 6.375 - because it has no costs to recover. The The APR on the 6.00 percent "no points" loan, which only has $1800 of non-excludable costs (see Regulation Z), doesn't go up much - to 6.391. The 5.625% loan you can have for one point jumps up to 6.643 APR, and the APR on that loan that the people shopping by APR or payment will choose - the one with a 5.00 percent contractual interest rate - skyrockets to 8.663%! If you only end up keeping it three years - beating out median age of loans in the country by better than 25% - this loan is the worst of the choices I have presented, not just by calculation of money spent, but even by calculating APR honestly.

If I had to pick a few things I could pack into a sixty second public service announcement to tell all 300 million people in this country about real estate loans, the fact that they're severely unlikely to keep the loan for anything like the full term would be one of those things. People just assume that they're going to keep a loan for the full term, but then they don't actually do it. Meanwhile, all of the calculations that are made presume that they will, even though that presumption is nonsense, and making those calculations on that basis will actually cause many consumers to make erroneous decisions, because they paint the facts as something other than what they are. If gravity was a tenth of what it is, we could all fly in the manner of Daedalus as described by myth. But those pesky facts keep getting in the way, and over half the people who take out thirty year financing don't keep it for even one tenth of the full term. If you're wasting nearly nineteen thousand dollars of your money every three years, as the people here did once, those facts will have an ugly tendency to bite you just as hard as they will any modern day imitator of Icarus.

Caveat Emptor

Original article here

I've written a lot here about how to manage your mortgage so that you control it instead of it controlling you.

Let's consider what happens when that project fails.

If you don't pay your mortgage, on time, no big deal at first. The lenders don't like it, but there's a grace period built in. Make your payment within the grace period and you're golden. Fifteen days later, the first consequence is that you owe the lender a late payment penalty. It's a doozy, typically four to six percent, depending upon where you live. Here in California, it's four percent. Doesn't sound like so much, but four percent for fifteen days is the equivalent of ninety-six percent annualized interest, over three times the most horrible credit card I'm aware of. I don't like paying ninety-six percent interest, and neither should you. Don't get fifteen days late if you can help it. But once you've paid the penalty and brought yourself current, nobody knows and nobody cares.

Suppose you get to thirty days delinquent - one full month. At this point longer term consequences set in. First off, your lender marks your credit as being thirty days late on your mortgage. This is a big negative as far as everyone goes, and can easily make a difference of 100 points or more on your credit score. Additionally, if you are applying for a mortgage loan (or plan to), you just got a "1x30". For A paper, this means that if your credit is otherwise perfect, you barely slide through. For subprime, this makes a difference on your rate. It takes two years for this to work its way out of affecting your mortgage application, even if your credit score recovers.

Most people end up being thirty days late for several months in a row, each month hurting their credit score, before it goes to sixty days late. They missed one payment and struggle but manage to make several more before they miss another. Occasionally, they go straight to two months late. Either way, it's a Bad Thing. A single "1x60" might scrape through A paper if there's no cash out and your credit is otherwise perfect. Otherwise you are subprime for at least two years. In the subprime world, a "rolling 30" is generally not as bad as a 60 day late, but both are steps down from even a "1x30" and a "rolling 60" is worse. It gets worse yet if you pay your way current and then backslide again. And of course, you are paying penalties and interest is accruing on your loan and you're falling further behind every time you are late. This amounts to a notable chunk of change very quickly. So none of this is good.

On the other hand, depending upon the state you live in, until you get to ninety or 120 days late the situation doesn't become dire. Each state's foreclosure law is different, but once the lender has the option of marking you in default, the situation gets uglier. It is a common misconception that lenders like foreclosing. In actuality, only so-called "hard money" lenders will usually start foreclosure immediately upon eligibility, especially if you've been talking to them about your situation. If they have some real reason to believe yours will eventually become a performing loan again, regulated lenders will cut you significant slack, by and large. It costs lenders a lot of money to foreclose and there's always the risk they end up stuck with the property, so they'll usually give you as much leeway as they reasonably can. One thing I keep telling people who want a loan approved based upon the equity in the property alone is "The lender doesn't want your house. They want to make loans that are going to be repaid. The lender is not in the business of foreclosure. They don't make any money on it."

Nonetheless, even the most forgiving lender is going to eventually hit you with a Notice of Default. At this stage, things are starting to move towards a resolution that nobody likes, you least of all. At this stage, you are now liable for a large amount in extra fees that was written into your contract to cover the lender's cost of going through the foreclosure process. At this point, the lender has the right to require you to pay the loan all the way current, with all fees, in order to get them to rescind the notice. Refinancing becomes almost impossible, except with a hard money lender, and unless something about your situation has suddenly changed from what caused it to get to this point, that is only delaying the inevitable and making it worse.

As soon as that Notice of Default is recorded, your situation becomes part of public record. You are going to get calls and letters and everything else coming out of the woodwork. One category is going to be lawyers, who will typically tell you they can keep you in the house a long time without payments by declaring bankruptcy. Well, this is true as far as it goes, but it's not going to make the situation any better. As a matter of fact, it will steadily get worse. Just because you go into bankruptcy doesn't mean that the penalties and fees and interest go away or stop accruing. They are still there, and they keep coming. I'm not a lawyer, and you should consult both a lawyer and an accountant if you are in this situation. Nonetheless, bankruptcy is not something I would even consider in this situation without something highly unusual going on.

The second group that will contact you are the "hard money" lenders, looking to lend you money at 15% with five points upfront and a hefty pre-payment penalty, to buy your way out of the situation. Once again, unless something about your situation has suddenly changed, not a long term solution, and it only makes it worse.

Another group that's going to call is investors looking for a distress sale. They want you to sell it to them for less than it would otherwise be worth. This is actually something I might consider. Yes, I lose some money, but that's better than going through denial with the lawyer for a year and a half while any equity I might have left gets frittered away in interest and fees and penalties, not to mention paying the lawyer.

The final category, and one with a significant overlap from the previous, is real estate agents looking to sell the property for you. Assuming you're not deep in denial, this is probably the best option as to least unfavorable resolution. The drawback is that it depends upon whether somebody will make an offer in a timely fashion, a factor which is not under your control. No matter how great the price, no matter how hard my agent works, there might not be an offer. It happens.

Of course, you also have the option of doing nothing. It's not a good option, and if you don't do something it pretty much guarantees that you're going to suffer the worst possible fate. But it is an option. Better is to take action before it gets even this far. What the best action is depends upon your situation and whether whatever caused your inability to pay is transient and in the past, continuing, or permanent.

If you do nothing, eventually a Notice of Trustee's Sale will follow the Notice of Default. In California, there are a minimum of sixty days between Notice of Default and Notice of Trustee's Sale, and it easily be more. Seventeen days after the Notice of Trustee's Sale, the property gets sold at auction (unless you've somehow brought it current or sold the property). There are some protections in place here in California. The lender must perform an appraisal, and for the property to sell at auction, the minimum bid is ninety percent of this amount. Nonetheless, these are typically very conservative appraisals by design. At this point, the lender wants the property sold at auction, because if it doesn't sell, they own it, and they don't want to own the house. They are in the loan business, not the real estate business. So a house that may be actually worth $500,000 on the open market gets appraised at $400,000, and sold for $360,000. If the loan was for $250,000, that's $140,000 of equity you allowed to be taken from you because you were in denial, when you probably could have saved most of it. And if the loan with penalties and fees and interest was $450,000, that's worse, and not only because you forfeited $50,000 you could have gotten, and not only because they may be able to go after you in court for their loss in some situations.

You see, because the lender took a $90,000 loss, they want to write it off on their taxes. And in order for them to do this, they have to hit you with a form that says you got away with $90,000 from them. This is taxable income!. As of this writing, there's a temporary tax law repealing it, but that repeal will expire, and your state may get in on the action as well. So normally, the IRS comes after you for the tax on the $90,000. IRS liens are one of the things that is not discharged by bankruptcy, and it stays with you forever. Ten years absolute minimum for any purpose. Sometimes your lawyer, CPA or Enrolled Agent will get you an "offer and compromise" that cuts your liability, but that's technically taxable income also and may be subject to another round of this crud. It it seems like to you the system is rigged so you can't win, you're right. The loan was an obligation you agreed to, and took the money for, and taxes are on obligation of anyone who is a citizen or resident.

The smart thing to do? As soon as you realize that you can't make your payment, take a long look at your situation and decide if this is something that's going to get enough better to make a difference, or not. Then figure out how much equity in the property you have.

If the situation is likely to improve, and you'll start making your payments in thirty days because hey, you just started your new job, that's one thing. Most of the time, however, most folks lie to themselves on this issue, for a variety of reasons. Remember: Denial Digs Deeper, and makes the situation worse.

Even if selling the property isn't going to net you anything, it's still worth doing as it gets you out from under the situation. Your credit score stops dropping, you quit getting marked late by your lender, you quit getting socked with penalties and interest and fees you can't pay. The IRS obligations you are incurring stop.

Particularly if you have significant equity built up, the sooner you contact a real estate agent to sell, the better off you will usually be. You are going to lose the house if you don't sell. The sooner you sell, the lower the penalties and fees and extra interest you are charged by the lender will be. This translates into dollars in your pocket - dollars you are likely to need. If you can sell before the Notice of Default is filed, so much the better, as that's thousands of dollars right there. You don't have the luxury of taking your time about it, though. Taking the first reasonable offer is highly advised, and you have more time to get a reasonable offer if you start sooner. Once a Notice of Default is filed, it's a matter of public record and so your bargaining situation gets a lot worse because the buyer should know that you are over a barrel, metaphorically speaking, assuming their agent does their homework. Considering that it's two or three clicks of the mouse, it's easy homework to do and even the greenest new agent is going to catch it more often than not.

Trying the various delaying tactics with a lawyer is likely to end up costing you more than a quick sale. Even if you remain in bankruptcy for five years or more, within about a year and a half at most, the lender will almost certainly persuade the court to cut the home and loan out of the bankruptcy as a secured debt, and sell it. Since the loans and penalties and fees and interest kept accruing all this time, you end up with less money - or none, along with a little love note from the IRS that says "You owe us thousands of dollars! Pay up NOW!"

Every situation is different. At a minimum, consult a loan officer, lawyer, accountant, and real estate agent in your area. But when all is said and done, what I've talked about is the way most of these end up.

Caveat Emptor

Original here

Related article on "Short Payoffs".

We aren't married. How do we buy a house together?

It is highly advisable that you consult an attorney as to how you want to hold title, but that advice holds true even for a married couple. To protect partners acting in good faith from those acting in bad, some kind of partnership agreement that gives the other parties rights to recover any extra they paid to keep the partnership out of trouble, if one or more of the partners can not or do not make their share of the payments on time. But that's extra, not a part of the purchase or finance processes, and you can certainly buy a property with basically anyone. It's one of the most basic of rights here in the United States. Convicted felons, jail inmates, illegal aliens, and people who have never set foot in the United States can all buy property here, as long as they have the money or can persuade someone to lend it to them.

The fact that people are not married means basically nothing to the loan qualification process, either. The guidelines are exactly the same either way. Yes, there are complex variables as to how you qualify, and what loan you qualify for. But people who are married but aren't going to be living together are treated the same as two random business partners, except that married people can put all of their joint information on one application. You can have any number of people on title to a property, or responsible for a mortgage. The major thing to watch out for is that they must qualify as a group, and almost always under the same set of qualifications. If one person has to do stated income, they all might as well be stated income, because they're not going to get full documentation rates anyway - or at least that was the case when we had stated income. The same thing still applies to credit: the weakest partner determines the loan qualifications you use and whether you qualify - exactly the same as if they were married.

Caveat Emptor

Original here

One of the consumer attitudes I encounter constantly is the feeling that if you cannot afford the loan, the lender will not loan you the money. This safety zone common sense sort of reliance upon lender policy as a backstop is not only false, but one of the best ways to get in trouble with real estate there is. Even with lender meltdown going on, the only thing you're safe in assuming is that the lenders want their loan to be repaid in the event of default.

Once upon a time it may have been true. Back in the dim times fifty years ago, lenders required down payments, and retained their loans for the full duration. This provided at least two levels of protection for the lender. First, if people did default upon their loan, that down payment was a cushion for the lender in that the property was genuinely worth more than the lender had at risk. All real estate loans were done "full documentation", where the borrower proved they made enough money to make the payments and repay the loan. Underwriting rules were designed to filter out those whose employment was not stable enough, those who couldn't afford the loans, and those whose creditworthiness was marginal. Of course, back then most folks worked for The Company their whole lives, too.

At the same time, however, real estate was far more affordable. The inability to get a loan on good terms meant that you were a little further away from the middle class house of your dreams, that you were going to have to save a little more, work a little harder, and perhaps settle for something less than you really wanted, but you could still have a good property. 800 square feet on a fifth of an acre, instead of 1200 square feet on half an acre. These really were typical property choices available then. You saved until you had forty or fifty percent down, instead of twenty, and then you maybe had to look a little bit harder, but it could be done, and people paid cash for their properties all the time. A three or five thousand dollar property was something that people could save the money to pay cash for, even at seventy five cents per hour.

That's not the case now. Even though people may make $40,000 per year, and the family has two incomes, they are not content with the lifestyle of fifty years ago that enabled people to save a down payment within a couple of years. Nor is employment as stable. People don't work forty years for The Company any longer.

The changes on the lender end have been even more profound. Lenders discovered making stock valuations rise as a primary method of becoming wealthy. Where once the most important thing to the stockholders was to have every single loan repaid in full, now it becomes more important to have portfolio growth, which makes potential investors willing to pay more for existing stock. Then it became unnecessary to actually hold loans until they ran their course, as investors were willing to pay more than the face value of the loan for the rights to receive payment! Those nice dependable mortgage bonds were good as gold! Matter of fact, the money the lenders received by selling the loans was (and is) several times higher than they made by holding the loans. True, they might only make three to four percent from selling the obligation, as opposed to seven percent for the obligation itself, but they could do it in two to three months, as opposed to the entire year. In fact, they could go through the process four, five, or even six times per year: Receive a loan application, provide the funds on a short term basis, and then sell to investors for a three to four percent markup. Instead of earning seven to eight percent on their money per year, they were now earning twenty or twenty five. They could even retain servicing rights and make money there, as the investors had no idea how to run the loans, and make even more money. Stock prices would show the effects of growth, as investors expected them to be able to keep in up, and current stockholders could cash out for huge gains by selling part or all of their holdings.

However, you now have a new group of stockholders, who bought - or held existing investments - in the belief that this growth curve could be maintained. They want that growth to keep going - however are they going to sell for a big profit if it doesn't? If the growth doesn't continue, how are performance awards to management going to be paid?

And so it goes. Growth begets a need for more growth. Now there's nothing wrong with growth - quite the contrary - but when the expectations shift over time from a two or three percent annualized growth curve, to eight or ten or even thirteen percent, it creates an expectation that no one wants to fall short on. Furthermore, other people with money, seeing the rewards, join in the lending business. Joe made fifty percent in two years with Bank of Nowhere in Particular! Let's all invest in that bank! They'll double our money in three years!

The fact of the matter is that there is only so much revenue growth that can be had in any given set of economic conditions. When you try to overshoot that amount, it can come from very few places. First, it can come at the expense of the competition. Unfortunately for that hope, the lending market grew ever more competitive, not less, until the last few years. Second, it can come from places that weren't a part of the market previously - in other words, people who were not good credit risks or who would not have applied in previous markets. The reason most of those would not have applied is that they are less credit worthy, and they know it as well as the lenders do. Third, growth can come through individual loans being larger, being willing to loan more money per property. This has also happened, but you cannot loan more per property without subsequently having more at risk, although the lenders have learned how to solve this. Remember that we discussed them selling the loans? Well, that's how the lenders limit their risks - by selling to someone else for cash. Let them assume the risks!

So we have increased competition for borrowers, including those who may not have been as solidly credit worthy as a previous day's client. There are more lenders competing for limited pools of borrowers, and pressure to qualify the borrowers for increased loan amounts, because, after all, that's how the bank makes money.

Furthermore, shifts in consumer habits played into this. People don't live in the same house for as long, and they don't keep loans nearly so long as they once did. Where they once lived in the same house from the time they bought it until they died, now the first house they buy in their twenties is a "starter," and then they sell that and buy a trade-up when the family expands a little, then another when they move up the corporate ladder, and this leaves out the effects of transfers and changing employers. Furthermore, they refinance and take cash out when they want a bigger SUV or a European vacation, and then they take more money out when the rates go down because they can afford a larger loan on the same payments.

The increased prevalence and availability of the stated income loan played right into this. Certainly, some people in your profession make that much, but what if you're not one of them? Simply say that you are! After all, you're in that profession, right? Furthermore, there is no payoff for telling people that they don't qualify. They've made up their mind that they want that three thousand square foot six bedroom house, and if you tell them they don't make enough, they're not going to give up their dream house! They'll just find another way to do it, so someone else will get that loan! That nice, wonderfully wonderfully large loan that means a huge commission check to the loan officer and a forty thousand dollar premium on the secondary market for the lender!

Traditionally, the check upon this was the fact that the borrower had to actually make the payments on the loan once they had it, which limits their ability and willingness to sign for more loan than they can handle. However, competition between lenders once again found a way: First, the interest only loan, and then the negative amortization loan solved that problem for a while, particularly as sub-prime lenders made their qualification for the loan based solely upon the initial minimum payment. Whereas when A paper lenders underwrite a hybrid ARM that's interest only for a given amount of time, they will base their computations upon a fully amortized loan payment, and even assume the rate will rise, that was not the case in the sub-prime world. Sure they've bought the property on a 2/28 interest only loan with a three year prepayment penalty, and they bought in a flat or declining market, and they are not going to pay the principal down any in two years, and the property isn't going to be worth any more, so it's unlikely they will be able to refinance, and they certainly won't be able to afford the payments when they adjust, so they're going to lose the house, but hey! You got a commission check and your lender sold the loan (at a fat markup due to the prepayment penalty), and your employer won't have any money at risk when they do default! What's not to like?

The Era of Make Believe Loans, as I call it, is now completely over. But how is a consumer going to protect themselves in that sort of environment? Obviously, you've got to start by figuring out a budget and sticking to it. This is hard. This is very unpopular, as far as real estate professionals go. When I sit down with people's finances and tell them what they can afford with a sustainable loan, the first words out of their mouths are usually, "I can't afford anything I want with that!" A certain percentage of them just walk out right there, sure that they can find someone else who will tell them they can afford more.

As I've just covered, they certainly can find someone who will tell them that they can afford more. However, the reason I sit down and go through the numbers, including today's rates, what they make, how much they spend, is to show them precisely what they can afford. When somebody shows you real numbers and you deny those numbers, and are certain you can afford more, you are essentially performing magical thinking. "I want it and I deserve it, and this other guy tells me I can just pull myself up by my bootstraps and fly up to get it!"

However, loans aren't magical. In fact, there is nothing magical about loans. You may get a negative amortization payment that you can afford for a while, but the money that you are not paying does not just vanish into thin air. It may be held in abeyance for a while, but it is there, and it will turn around and bite you. You wanted a $600,000 home for a $2000 monthly payment, and you got it for a little while. However, you now owe $680,000 and the property (which you put $50,000 down on) is now only worth $540,000. It doesn't take a genius to see what happens next. Even if the property increased in value by $100,000, it costs you $55,000 to sell the property and you have to pay $15,000 of their closing costs so that they can qualify for the loan, and that fifty thousand dollars you put down has turned into nothing.

A rapidly increasing market, such as we had for several years ending about the end of 2004, covers a multitude of sins and mistakes. If the property doubled in price over three years, you came away with $400,000 and you were very happy! Unfortunately, this is not the type of market we are in now, nor are we likely to have that sort of market any time again in the foreseeable future. It's always a bad idea to bet on it, because you never know it's going to happen ahead of time.

So what are you going to have to do? As I said earlier, figure out what your real budget is in terms of purchase price and stick to it. If you can't afford anything you want, then want less. Insist upon sustainable loans, and qualifying for them full documentation. Full documentation loans have better interest rates anyway. Fully amortized loans, where you are paying principal and interest, have lower interest rates, as well, and if you stick with A paper guidelines, you get better interest rates and can usually avoid pre-payment penalties.

"I just won't buy anything if I can't afford what I want!" some of you are saying. Right now, with prices retreating somewhat, it may even make a limited kind of sense for those with strong credit and stable prospects. However, the market here locally is not going to retreat that much more. Indeed, where prices are is currently being masked by a stubborn type of seller and a not very competent or honest stripe of real estate agent. It doesn't matter that three fourths of the sellers want $X for property of given characteristics, if the sales that are taking place are $100,000 lower. If this seller won't sell, someone else will, and it is the sale that actually happens that tells where the market is, not the hundred comparable properties where the asking price is $100,000 higher.

However, real estate, even in markets that are rising just slightly, is such a fantastic investment due the the effects of leverage, that I've been telling people that I do not anticipate the local market going much lower, . Indeed, very smart investors are swarming, intending to hold the property five years or so instead of flipping it. Yes, we've lost about thirty percent from peak prices, more in some niches. When things turn around a turn which has been delayed by our current government's economic mismanagement, they're going to turn hard - and the longer it takes the stronger it's going to be. People who decide to sit on the sidelines because they can't afford anything that they want will discover themselves to have been priced out of what they could have afforded then. If you've got a family of three and don't want a two bedroom condo even as a temporary situation, what are you going to do when you can't afford that?

Caveat Emptor

Original here

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Caveat Emptor

Original here

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

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

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

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

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

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

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

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

Caveat Emptor

Original article here

Racial Gap in Loans Is High in California.

I can give a variety of reasons for this.

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

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

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

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

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

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

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

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

Caveat Emptor

Original here

Banker loans are better deals - for the bank.

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

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

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

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

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

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

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

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

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

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

Caveat Emptor

Original here

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

The Trustor is the entity getting the loan.

The Beneficiary is the entity making the loan.

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

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

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

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

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

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

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

Caveat Emptor

Original here

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

real estate mortgage manufactured housing

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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


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


• You just don't care about your clients welfare

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

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

Caveat Emptor

Original article here

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

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

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

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

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

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

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

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

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

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

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

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

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

Caveat Emptor

Original here

This is definitely not a "Who you gonna call?"

I've done a couple articles on the two ratios, debt to income and loan to value. Nonetheless, there exist a plethora of reasons why someone can be turned down for a loan even though they make it on the ratios.

The first of these is time in line of work. "A paper" from Fannie Mae and Freddie Mac looks for two years in the exact same line of work. One change that trips a lot of people is going from being employed by a company to being self employed in the same line of work. Believe it or not, a promotion can also sink a loan if your job title changed, for instance from salesperson to sales manager. If it was with the same company, it can sometimes be okay, but if you changed companies to get the promotion, that's a really tough loan. Subprime loans will accept shorter time periods, but subprime is almost nonexistent today.

Making payments on time is probably the most common deal buster for A paper. In general, you are allowed no more than one mortgage late, or no more than two other lates within the last two years, a late being defined as thirty days or more delinquent. The reason does not matter. It does not matter how justified you were in not paying. The fact remains that you are reported as being late. The only way to remove these reports is for the company to admit it was in error in reporting you late. Many people will not pay the charge as it gets marked later and later and later. This is self defeating. Pay it now, dispute it afterwards. Yes, it's harder to get your money back - but the money it saves you on your home loan is typically much larger.

Store credit cards are one of the biggest headaches here. If you buy merchandise with a generic credit card, you've got the card company, who are neutral, looking at the transaction. Both you and the merchant are their customers, and the merchant needs to take credit cards. They're not going to quit taking them. If you use your store credit card, the dispute department is pretty much guaranteed to take the view that you bought that merchandise at their store and therefore you owe the money. I run across five or six store card problems for every generic card problem I encounter.

Bankruptcy is another deal buster. People in Chapter 13, or just out of Chapter 7. Most banks won't touch them. It's not really rational, but you there you are.

Reserves can be a deal buster. There actually is a reserves requirement for regular full documentation A paper, but it's pretty much a non-issue as responsible people get uncomfortable if they can't lay hands on a month's mortgage payment. Reserves were really an issue for stated income loans when we had stated income loans. A paper stated income required six months PITI reserves somewhere that you can get to it. Subprime is less demanding, but if you don't have the lender's requirements, you won't get the loan. Would you loan hundreds of thousands of dollars to someone with absolutely no cash in the bank? Payment shock, where your monthly cost of housing is increasing, can increase the reserve requirements. You were paying $1200 per month for housing, now you'll be paying $2000. That takes some adjustments to lifestyle, and some people take a while to adjust.

Related Party Transfers are another questionable point. All of the background for loans assumes that the transaction is between unrelated parties, who have no reason to cooperate in order to do the lender dirt. If you're buying the house from your brother, that assumption goes out the window. Some lenders will do them, others wont. Some will but charge extra. Others will but have special requirements. Whatever they are, you have to meet them.

The appraisal coming in low is another. The lender evaluates the property on a "lower of cost or market" basis. The Appraisal is the "market" part of that, and the lender will only loan money based upon the lower of these two methods of evaluation. I have people tell me all the time that their new purchase is worth $20,000 more than the appraised value (or the purchase price). No it isn't. By definition - it's worth what a willing buyer and a willing seller agree upon. The bank's evaluations are necessarily conservative, and they don't want to take over the property. They're not in that business. They want you to pay back the loan. That's the business they're in.

Late payments. Whatever you do, while the loan is in progress, keep making all your payments on time. Whether just indirectly due to the credit score dropping, or directly because now you've got a(nother) thirty day mortgage late, this can raise your rate or even break the loan.

Sourcing and seasoning of funds to close. Just because you've got $100,000 in the bank doesn't mean the bank is happy. Nobody rational keeps that kind of money outside of investment accounts. At least nobody rational who needs a loan - Bill Gates might. Lots of folks attempt to hide loans that way. The bank is going to what to see that you've had it a while (seasoning) or prove where you got it from (sourcing). If you really just got $400,000 from the sale of a previous property, you're going to have the escrow papers and HUD 1.

Final credit check: I have a set spiel I go through, "Until this loan is funded and recorded, don't breathe different without getting my okay. Make the payments you've been making. Make them on time. Don't take out any new credit. Don't allow anyone (other than mortgage providers!) to run your credit. Just before the loan gets recorded, the lender will pull a final credit report. Woe be unto the person whose situation has deteriorated, and it means we'll have to start all over again, if there even is a loan that makes sense."

Failures of verification. Three biggies here: employment, rent or mortgage, and deposit. I do not know why people bother lying, but they do. Don't you be one of them. World of hurt if the lender wants to prove a point. Don't quit your job, don't change anything about your employment. I once had a guy quit to become an independent contractor two days before the loan was funded. Guess what? No loan.

Lines of credit/credit history/no credit score: Most lenders want to see at least 3 lines of credit with a 24 month history of making payments on time. Freezing your credit cards in ice is a wonderful idea, but you need to use them to demonstrate a payment history. Once per month, I use mine for something small and stupid that I would otherwise pay cash for - just to show payment history (it also helps your credit score). Pay if off as soon as the bill gets there. Waivers for two lines of credit are fairly easy, but if a given bureau doesn't know you have two open lines of credit, they may not score your credit profile. If you don't have at least two credit score among the big three - no loan.

Property is structurally unsound, is not certified for habitation, unsuitable or not zoned for intended use, etcetera. Wouldn't you really find out about this before you have a very large debt to pay? Okay, this can cost you money, but it's a "Thank (deity) I found out now!" moment. Finding out now means you can change your mind while it's still the seller's $400,000 problem, before it's your $400,000 problem.

So there you have them, most of the most common reasons why loans - and therefore real estate deals - fall through for people that are otherwise qualified.

Caveat Emptor

Original here

how soon should I start shopping around to refinance my home? I have a 2yr interest only and it's up in (four months)

Okay, the 2/28 loans which you are describing all have prepayment penalties for at least two years. Figure it's going to cost you 6 months worth of interest, on top of the cost of the refinance, if you refinance before the penalty expires.

(you could have specifically bought it off by accepting a higher rate, but that's unlikely to have been the case)

That said, about three weeks before the penalty expires you can start the refinance process. Be advised that until the day the penalty expires, the current lender will be quoting a higher payoff, but once it has actually expired, the payoff should be correct, at least in theory. You should not sign final loan documents until such time as your penalty will expire with or prior to your Right of Rescission expiring. No more than two to three days prior to expiration.

Indeed, sometimes lenders will want to keep charging penalties even after they're no longer due. I'm not certain if they just don't update the payoff correctly or what, but I've seen lenders try to charge penalties a month after they expired. Once they've got your money, they can make you pay a lawyer and go to court to get it back.

For this reason, I would avoid "cash out" refinances any time within three months after the penalty expires. Matter of fact, if you're refinancing during that period, not only don't refinance for cash out, but don't have an impound account for taxes and insurance, and don't plan to put any money at all into the loan balance if you can avoid it. Here's why: When escrow officer goes to request a payoff from the soon to be former lender, the payoff quote may include the penalty even if it's no longer due. if the money they have from the current lender covers the whole thing, they have two choices. Pay it and have a completed transaction (not to mention getting their company paid), or don't, and leave everybody hanging. If they pay it, this means that you, the consumer, only get a much smaller amount of money, but I'm disgusted at how often consumers are shorted by the loan process, and this is one more way it happens. You're expecting $20,000 cash, and that $20,000 was the entire reason you did the loan. Comes the proceeds check, and you've only got a check for $9000. You want the other $11,000, you're going to have to go through the whole process again. Not the kind of situation you want to be in. Not the kind of situation I want my clients to be in.

If, however, the escrow officer does not have enough money available to them to pay off the loan plus the penalty, they have no choice but to leave the transaction at that stage until the quote is correct. They won't let it sit - they'll find out what's going on and everybody involved will be doing what's necessary to resolve the conflict between the two issues. Not having any more money in the loan than necessary to pay off the old loan is a good way to insure that the escrow officer won't pay a penalty you don't owe.

Don't let the rush to pay off the old loan cause you to cut corners on either your shopping for a new loan or asking all the questions you should ask prospective loan providers. Rushing into a refinance because your loan is going to readjust is one of the best ways to waste large amounts of money that there is. To illustrate, let's look at a larger than average loan amount that sees a huge jump in the actual rate. $400,000 at 6%, and it goes to 9%. This makes a difference of $33.33 per day, or $1000 per entire month. That's the equivalent of a quarter point on the cost - basically nothing on the scale of differences between subprime loans, and not very much on the scale of differences between A paper loans. I'll usually beat the retail branch of the lender I place a loan with by several times that amount. If it makes a difference of 0.25% on the rate, that's $1000 per year that you're going to be stuck with the new loan. If you're still a subprime borrower, multiply that by the length of your new prepayment penalty in years. Doesn't it sound worthwhile to take an extra day which your old lender bills you $33 extra for, to shop the loan around for real and ask the hard questions that enable you to save $2000 or more on the new loan? Even if you're putting the money into your balance, you're still paying the extra. Not only that, but you're paying interest on it as well. On the scale of costs for a new loan, paying the soon to be former lender for a few more days at the increased cost is likely to be a wonderful investment if it gives you the opportunity to find a better loan.

On a note of personal relevance, at the time this was originally written, written rates were higher than they were two years previous, and the person who asked was in an interest only loan, while interest only loans were extremely difficult to get then (and harder now). The payment is likely going to end up higher in such circumstances, especially if you roll loans costs in even if the interest rate (i.e. actual ongoing cost of money) is lower. If the reason a borrower is in an interest only loan was that their debt to income ratio couldn't qualify for the real payment on a sustainable loan, that refinance is probably not going to happen for you. With prices having decreased locally by 25 to 30 percent, your loan to value ratio may not support refinancing either. If a refinance is not going to happen, and you can't afford your current payment, it's time to sell now. The FHA Secure program helps some people, but requires documenting enough income to afford all of your payments, and the 125% refinance programs Fannie and Freddie have out have the same restrictions. You owe what you owe and the rates are the rates. If the numbers don't work, get it sold. (On the plus side, due to underwriting paranoia the rates for those who can qualify at this update are very low)

One more piece of advice: Start improving your credit score now. Four months is plenty of time to bring your credit score up fifty points or more. If you can get into "A paper" loan territory, where penalties are much less common, you'll be much happier with your new loan than you are with this one. If you're in subprime territory and able to improve your loan to an "A paper" loan, your rate may go down despite the fact that the rates are higher.

As I cover in Getting Out of Paying Pre-Payment Penalties, if you're willing to refinance with the current lender, either directly or through a loan broker, your lender may be willing to waive the penalty in favor of sticking you for a brand new prepayment penalty on a larger amount. This is usually making a bad situation worse. As I said, you're likely to get a higher rate, be limited to an amortized payment on the new loan, and the new loan amount is likely to be higher (people in the situation usually roll the costs in), and all without even the benefit of lowering the tradeoff between rate and cost like penalties usually do. This seems pretty much the definition of lose-lose-lose-lose to me. Longer prepayment penalty on a higher balance at a higher rate, without getting any benefits in exchange. This is kind of why the best way to deal with prepayment penalties is not to accept them in the first place.

Caveat Emptor

Original article here