Mortgages: September 2014 Archives

The scope of the problems that exist in the United States consumer mortgage market are huge. Enormously, mind-bogglingly, "How Big Is Space?" type huge. Yet, the problems are almost entirely on a retail level, when one provider works with one consumer. The system as a whole works, and it works extremely well. Consider:

Most consumers in Europe or any other country in the world would trade their loans for yours in a heartbeat. Rates there are typically around nine percent or so. Here, that's a ratty sub-prime rate. Mexican rates start at about fourteen percent. Hard money lenders here can sometimes do better than that.

No matter where you are in the United States, you have ready access to home loan capital. It's considered almost a one of our inalienable rights. Due to our secondary markets, as long as you can meet some pretty basic guidelines, you can find somebody eager to lend to you. You can find very long mortgage terms and very short terms. You can find loans without prepayment penalties, and you can choose to get a lower rate by taking a prepayment penalty. You may end up with something that's not as good as someone else if their situation is better, and the lender wants more money to compensate them for the risk of your loan, but even so, the rates here are better than almost anywhere else in the world.

Consumer protections are also better here than almost anywhere else in the world. There are federal laws that give you time to call off a transaction if you change your mind, disclosure requirements, consumer protections against builders with teeth in them, and a tort system that, if it does go overboard some times, still gives you an excellent chance at recovering what unethical people took from you. Many states (California, for instance) go well beyond mandatory federal consumer protections.

So keep this in mind when you see me or anyone else ranting on and on about the problems with our financial markets here. Consider a capital market willing to loan the average person several years worth of wages. I can get a family making $6000 per month a loan for nearly $400,000 on an A paper 30 year fixed rate basis - most expensive loan there is in the most favorable, hardest to qualify for loan market - no surprises, no prepayment penalties, no "gotchas!" of any kind, and I can do it without hiding or shading the truth in the least. That's more than every dollar they will make for the next five years, and this family is every bit as chased after as the richest person in the world (more actually, because there are more of them). When you stop and think about it, that's a pretty wonderful situation. For all of the rants I make, the unethical things that happen, and the problems that exist in our capital markets, they are pretty damned good, and have chosen a set of tradeoffs that appears to be working better than anywhere else in the world, at any other time in history.

Caveat Emptor

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real estate mortgage

Loans are declined, or actually, the next thing to it, all the time. It is pretty rare for a loan to be outright rejected; I do not recall ever having had a loan outright rejected. That's a sign of a loan officer who wasn't paying attention to guidelines when the loan was submitted. What happens far more often is that the underwriter puts conditions on it which cannot realistically be met. Documentation for more income than you make is probably the classic example of this. What usually causes this is that the underwriter finds a debt that didn't show up on the credit report and that you didn't tell your loan officer about, and so a loan with a marginal but acceptable Debt to Income Ratio became unacceptable. Or the appraisal comes in low, raising the cost or lowering the cash out due to a higher Loan to Value Ratio than the loan was priced for. Sometimes there is something that can be done about it; sometimes there isn't. If your loan officer can't think of anything to do about it, he'll tell you the loan was rejected. Sometimes they'll tell you that the quote that got you to sign up was rejected, also, but they have this other loan over here "that isn't much more expensive" that you do qualify for. Telling you that a loan was rejected is one of the best ways there is for a loan officer to do bait and switch.

Unfortunately, there really isn't anything you can do to verify that your loan was rejected, as opposed to bait and switched, or just couldn't meet underwriting guidelines. (Whether it had any chance of meeting underwriting guidelines is a subject for many more essays).

The first thing to do is realize that the fact you cannot meet guidelines for the loan that got you to sign up means that it is time to start shopping around again. That loan that got you to sign up does not exist as far as you are concerned. It's not like they are suddenly going to discover that the guidelines allow 5% higher debt to income ratio. If your loan officer is not a complete bozo, they will have gone over alternatives with the underwriter before telling you about the difficulty. If there's something they can do with a little bit more paperwork or a little more income, they're going to ask you if maybe you have the paperwork, or if you make $500 per year in some other fashion. A good loan officer told you about the loan because he believed you would qualify, but you don't. A bad loan officer told you about the loan because he thought he could use it to get you to sign up, and then pull a switch on you once he had the originals of all your paperwork and control of the appraisal that you've already paid for. There really is no good way to tell for sure. In either case, you are back to square one - shopping your loan. I would also think twice about staying with the same loan provider. He's told you about one loan he couldn't do to get you to sign up. Why not two?

So being told you don't qualify for the loan you thought you were going to get is always a sign that you need to start shopping your loan around again. That's why you don't ever give a loan officer your originals of anything. Even if somebody brings me an original, a copy is just fine and I can hand the original back. The only paperwork I need the originals of is the loan paperwork - the application I fill out and have you sign, and the disclosures associated with it. Such is not, unfortunately, the case with many loan providers. Do not ever allow your originals out of your hands. Once they've got them, many loan officers will hold them hostage to prevent you taking your loan elsewhere. It is to be admitted that it's a lot of work to do a loan. But they also dangled something you didn't qualify for in order to get you to sign up. The responsible party for their wasted work is themselves.

I used to encourage back up loans. With changes in the market making it costly to lock loans before we're certain they close, I no longer know anyone who will do back up loans - even I can't afford it any longer. And I also used to ask for a written promise to release your appraisal, but with Home Valuation Code of Conduct, that is no longer permissible. The changes that congress and other regulators have made (mostly in 2008-2010) are not for the benefit of consumers.

I've also dealt with Loan Providers Who Will Pay For Your Appraisal before. One way or another, you are paying for that appraisal. If you think you are getting it for "free", not only will you paying for that appraisal, you are paying for the appraisal of everyone who canceled their loan, too, and a good margin on top of that.

Caveat Emptor

Original here

"what happens to your equity when the bank forecloses" was a question I got.

The answer is that most, if not all, will be dissipated by the foreclosure.

Let's say you own a home currently valued at $500,000, that you owe $200,000 on it, and that you have a 6% loan. Now, for whatever reason, you can't make the payments, and for whatever reason, you don't sell while you have the opportunity before the trustee's auction.

I'm most familiar with California, but expect most other states to be similar. In California, you are going to be four months behind before the Notice of Default happens. So that is four payments of $1200. Furthermore, when you are fifteen days late you owe a 4% penalty, or $48, and when you are thirty days late, the missed payments start accruing interest. So at the point that the Notice of Default is possible, you owe $204,777.83.

From Notice of Default to Notice of Trustee's Sale is another 60 days, but before that happens, the bank is going to hit you with $10,000 to $15,000 in administrative fees for going into default. Check your contract; it's in there. Let's say $12,000, and now you owe $216,777.

Add another two months of delinquent payments, and penalties as of 15 days after. So as of the time the Auction actually happens, you owe $219,447. Furthermore, to make the auction happen, they will charge you about another $15,000. This covers the expenses of making the auction happen, of which the most noteworthy is the appraisal. At this point, you owe $234,447.

The appraisal bears special mention. Not only is there zero pressure to get a good value, the bank wants that appraisal to come in nice and low. They want the property to sell at auction, and if nobody bids 90% of the appraisal price, then they own it and have to go through the rigamarole of hiring an agent and selling it. So that appraisal is going to come in as low as is reasonable, to maximize the chance of it selling at auction. Every once in a while questions about low appraisals at trustee sales hit the site. The short answer is Microsoft Standard: "It's not a bug, it's a feature!" and from the bank's point of view, it is. So even though the property might sell for $500,000 in the normal course of things, the appraisal might come in at $440,000, meaning that someone has to bid $396,000 in order to buy the property at auction. The appraisal might be even lower, but let's say $440,000.

If someone bids $396,000 at auction (assuming they actually are able to consummate the transaction), they own the property. Less transfer costs, the bank gets maybe $380,000, of which the note is now for $234,000, and $300,000 of equity has dropped to $146,000.

But that's not usually what happens. What's usually happened is that the owners have financed it out to at least $375,000, hoping to be able to stave off foreclosure, and by similar math, they now owe roughly $425,000. How much do they get when the bank only got $380,000?

If the property doesn't sell at auction, the bank now owns it. Now they have to hire a listing agent, and offer a cooperating buyer's broker percentage, and while the listing agent looks for a buyer, the money owed keeps earning interest. Let's say the property eventually sells for $410,000, and the bank spends 7 to 8 percent of that getting it sold, so that their net is maybe $380,000. Even if you originally owed $200,000, by the time everything is said and done, you might owe $250,000 or more, leaving perhaps $120,000 coming back to the original owner. Keep in mind that in this example, you started with $300,000 of equity (60% of value!) based upon the sales of comparable properties. That's not a typical example. Even before the market decline, the percentage was typically 20% at most. With the market decline we've had, things are even worse than that for most folks.

Getting back to the example, if the owners were to short-circuit the whole process by selling successfully for that same $410,000 (almost 20% less than comparable properties might sell for) before the trustee's sale happens, and if they spend that same 7.5% to get it sold, they get about $380,000, of which they'll get to keep approximately $160,000, more than it is likely they will keep under the best possible outcome if the property went to trustee's sale. It's easy to sell reasonably maintained properties for 18% less than comparable properties are selling for. (Unfortunately, most people over-price their property even in this situation, not realizing how much time is going to hurt them)

So if you cannot afford your payments, and you're looking down the road at a trustee's sale, it is usually in your best interests to get the property sold before that happens. The lenders will generally be as accommodating as they reasonably can if you ask them and keep them in touch with what is going on. They don't make money on foreclosures - they lose large amounts of it even when the sale covers the note. Lenders don't want to foreclose. Thanks to California's Home Equity Sales Contract Act, once the Notice of Default hits, you are unlikely to be able to do business with investors except on an "emergency sale for 60% of value" basis (that being about what the those "Cash for houses" folks offer), so the sooner you act, the more money you will likely come away with.

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Hello, Mr. Melson,

I am one of your legion of fans of your www.searchlightcrusade.net website, having lucked into stumbling upon it by hyperlinking from another site. It is my goal to read EVERY ONE of your archived articles before I buy a house.

Yes, I wish you were here in DELETED, where I'd pay your going rate in a heartbeat to be my non-exclusive buyer's agent; but I must content myself with your archives to learn how to navigate this shark-infested swamp of BUYING A HOUSE. (Unless your services can guide me to such an agent here in DELETED.)

In hopes you can use this for a topic of one of your essays, yes, my husband and I are the proverbial "aging baby-boomers" looking to buy a house with his VA benefits and not interested (so as to be able to sleep nights) in anything but a 30-year fixed mortgage.

What makes us different from others in this category who might be writing to you is that we have no children, no family, no heirs but The Nature Conservancy; and we view our buying rural property as OUR LAST HOME with no relevant consideration for estate taxes, amortization, refinancing, ever paying it off, or any other usual
worries.

My question, should you be able to turn this topic into an article about Vietnam-era vets using their VA benefits to buy their final home with absolutely no intention of ever moving again and being able, through employment, disability benefits, and--soon--social security, to make the payments until we shuffle off this mortal coil,

WHY SHOULDN'T WE SHOP THE LOWEST PAYMENT WE CAN GET AND NOT THE TOTAL COST, AS WE HAVE LEARNED FROM YOUR ESSAYS?

Thank you from the bottom of my heart for your altruism in promoting consumer education on what has to be the most dangerous and confusing transaction any American consumer will ever undertake: BUYING A HOME.

Cordially,

Item the first, payment is trivial to lowball. Let's take a more or less standard example based upon rates back around the time I originally wrote this. I had a thirty year fixed rate loan at 6.00% for two points. Let's say you were buying a $300,000 home, and chose that 6.00% loan. $300,000 at 6.00% is $1847.16 per month. However, that transaction has closing costs of about $3500 in addition to those two points, plus the VA funding fee of half a point if you're not a disabled veteran. This gives a balance of $311,282. and a payment of $1866.30 (VA loans are allowed to roll up to 3% on top of purchase price into the loan). By pretending that $11000 plus doesn't exist, I could quote a lower payment, and most lenders do precisely because people do shop by payment. But you're either going to come up with it out of pocket or pay the higher costs. Actually, in this case, that's about $2300 cash you're going to need to make the transaction happen because you're above the 3% "roll in allowance", that they conveniently neglected to mention. Furthermore, these aren't the only games played with lowballing. Most people are amazed at how much it's possible to legally lowball a mortgage quote. Nor do the new proposed regulations change this. If you're shopping by payment, someone who writes an honest quote on the above is going to look like a more expensive loan than someone charging another point or so, who figures on cannibalizing your Good Faith Deposit and still rolling the maximum 3% into the loan, but pretends this money is going to come from out of the twilight zone. VA loans are just as subject to pretending real fees don't exist as any other loan.

VA do loans have another simplifying feature - they only come in fixed rate loans. I haven't kept close track, but last I knew, it was not allowed to get a VA guarantee on a ARM, hybrid, or balloon loan. This eliminates the trick of them telling you it's a "thirty year loan" while not mentioning that it's not a fixed rate for the entire time. And if you're looking for 100% financing, it's not like the lender is going to substitute something else, given the current lender fear of the market. But it has happened in the past that people were told they were getting a VA loan, but it turned out that wasn't the paperwork they signed.

Last issue on this point, there is the question of whether the rate was really locked, and for how long. Mortgage Loan Rate Locks are for a definite period. The longer you want to lock, the more it costs. So someone who knows it's going to take 45 days and quotes based upon a 45 day lock is going to be at a cost disadvantage to someone who pretends that a 15 day lock is going to be the same, and doesn't actually lock the loan, but lets it float. Six weeks from now when documents are ready, your rate is 6.75% because the market has shifted upwards and your loan was not in fact locked. Alternatively, they locked for 15 days and you ended up paying five or six tenths of a point in extension fees - significantly less that the upfront difference, which is usually about a quarter of a point.

At this update, lenders have made it extremely costly to lock a loan with them and then not fund it. It does not matter why; it only matters that a loan was locked and then had no loan actually funded. The way they discourage this is to levy a surcharge upon all future clients of that loan officer or office for a certain period, meaning you can't compete as well for future clients, so loan officers who want to offer low rates cannot lock until they are pretty certain your loan is actually going to fund. I get regular communications from the home office instructing me as to the consequences of locking a loan and failing to deliver it to the lender.

Item the second: People refinance, far more often than most people believe or are even willing to admit. You think that if you get that 6.00% loan today you're going to be happy forever. But then rates go down to where they can get 5.5% for that same two points, and they refinance. Or somebody comes along and sells them on a 5.5% loan that requires three or four points. There are VA loan companies that go around selling these, and they've got presentations that make it look like a good deal - which they are if you're one of the rare individuals who can resist them in the future. Problem is, they're going to be just as appealing then as they are now, and it's going to be just as good a deal then as it is now - providing you can resist future sales pitches beyond that. Let's look at how much money you've wasted if someone comes along and sells you a refinance a year from now:

Your choices: 6% for two points (plus VA funding and $3500 closing costs) versus 6.5% for zero points (plus VA funding and $3500 closing costs). Balance on loan 1 after 12 months is $307,459 Balance on loan 2 after 12 months is $301,615. You did save $740 in payments with loan 1, or $1150 in interest. The VA streamline does not require an appraisal, and can roll another 3% into your balance, so let's say you can get 5.5% for three points, which means a minimum of 1.5 points out of pocket, but you figure it's worth it to cut your payments. Your balance is now $316,680, and you spent $4700 plus in hard cash, to boot. $21000 plus in financing costs, to keep your payment low. If you get the "no points" loan to start with, your financing costs are $10650 in your balance and about $100 less out of your pocket, or roughly $15,000 - a difference of $6000, which is roughly $35 per month forever.

People really do get into this kind of refinancing loop, and actually it's worse than this because most people roll a month or two of payments in, plus the impound account. They just spend the money from the payment check they don't write and the impound account as well. I once spoke to a guy up in Riverside County who bought for just under $160,000, and the costs of serial VA streamline refinancing had driven his balance up over $230,000. This is real money. If they had just refinanced less often, or for lower costs, their payment would have been almost thirty percent lower, and he would have had sixty to seventy thousand dollars more equity in his property!

Issue the third: What happens in such a situation if you have a need for that money? It's gone. But aging people - particularly without heirs - develop needs for money. For instance, long term care expenses. I wrote a three part series on that quite some time ago, but they are still worth reading. one, two, three (The Republican congress later in 2006 repealed the so-called Waxman Amendment I reference in part two, but most states still do not have a partnership program). And it's not just long term care, either. You may have medical coverage and not need to worry about it, but I assure you that many seniors are not in such happy circumstances. You may be wishing at some point in the future that you had that equity available to you. I've met quite a few who did.

In short, there are a lot of traps lying in wait (or ready to be set) for the people who shop by payment. Whereas if you shop by the tradeoff between rate and cost, Ask the questions you need to ask. The payment is the byproduct of these more important items. Payment is, after all, determined by simple mathematics.

None of this is to say it may not be a good idea to buy the rate down as much as you can. If you have a history of not refinancing for ten years or longer, and you swear a pact in blood not to refinance ever, no matter how good the deal, it is a good idea to buy the rate down with points. It also reduces your cost of money over time, if you keep the loan long enough that you recover the cost of those points. The drawback is that this puts a lot of money into what is effectively a bet that you're not going to sell or refinance for a long time. If something about your situation changes before you've recouped the money, that money you sank into the rate is basically gone.

For most folks, this bet is a very poor one to make. It makes the odds of successfully completing an inside straight look good. The outcome is under your control, but the vast majority of people who make this bet voluntarily let the casino bank off the hook before they've recouped their wager investment. Nonetheless, it is a bet that can work out very well if you are a member of that tiny minority who does keep their loans long enough. In the example referenced above, the borrower who keeps the initial 6% loan the full term and pays it off will pay only $360,583 in interest, versus $389,042 for the 6.5% loan, a difference of $28,458, almost five times the difference in cost of procuring the loan. For your upfront bet investment of about $6200, you get your payment lowered by $61 per month and initial cost of interest by about $96 per month. If you keep the loan the full term of 360 months, you more than get your money back. But for the population in aggregate, that's a money losing investment, as the median time people keep their mortgages is about 28 months. Even if you double that, you're still on the losing end of the wager.

PS I am intentionally not taking into account the time value of money, or the alternative uses for the money, but $6000 invested at 10% per year turns into roughly $105,000 in 30 years, and $34,500 at 6%, which would, by the numbers alone, be another reason not to do it.

Caveat Emptor

Original article here

from an email:

On a related note, I hope you might have some advice for us. My husband and I just sold our condo. But we are NOT buying at the moment. Instead we are renting. (Not sure where we are going to be 6 months out and buying does not sound like a good idea until we are settled again.) So we are spending a small part of the profit off the sale on retiring the only credit card debt we still have and putting the rest in a money market to earn interest until we can use it as a down payment on our next house.

However, with no credit card debt and no mortgage (and one car loan that will be paid off in about a year) I am afraid that by the time we buy a house, we won't be considered good credit risks because of not having loans we are paying on.

We DO have a credit card that we put some charges on and pay off every month. Is that enough? Or is there something else we should be doing now to make sure we remain credit-worthy for a mortgage loan?

We will be renting an apartment. Does that show up on the credit report?

In general you want to have two open lines of credit to have a credit score. This doesn't mean that you necessarily have to have a balance on either of those lines of credit.

What you're doing seems fine and was a good idea when I originally wrote this in late 2005. Now (in 2010) I think that anyone who is in a position to buy and hasn't is crazy. It was a rough market; I probably wouldn't have bought unless I knew I was going to stay (or keep it) five years or more. In general, rent does not show up on a mortgage provider's credit report. It probably will not count as an open line of credit.

The card you use, which I gather is what you use to maintain credit, needs to be an actual credit card, which appears to be the case. If it is a debit card, it doesn't count as a line of credit to determine whether you have two open lines of credit or not. If it is indeed a credit card, you've got one existing line of credit that you've had for a while. Keep it open, keep paying it off every month. This helps your credit score even if you never carry a balance.

However, instead of closing the (other) credit card you have a balance on, may I suggest that you simply pay it off but keep it open? Unless it has a yearly charge just for having it, it costs you nothing to keep it in your safe at home. This gives you another open line of credit, and because you've had it for a while, this is better than a new line of credit (length of possession of open lines is one factor determining credit scores, and over five years is best). You might want to use it once per six months or so just so they don't think you've canceled. As long as it's a regular credit card where if you pay it off within the grace period there is no interest charge, and that's your second open line of credit.

You also currently have an installment payment operative, which is fine as long as you keep paying it on time. Depending upon how much you're getting in interest on the money market, it may behoove you to ask for a payoff. If the money market is getting two percent taxable and you're paying five on the installment debt (not tax deductible), you may wish to consider paying it off. On the other hand, if either of the two above cards is a debit card, this is your second line of credit, so keep it open long enough to get something else.

I live in San Diego, which has several big credit unions, and I've had good experiences having my clients apply for credit cards with most of them (they're also a decent source for second mortgages and home equity lines of credit - that's where they're set up to compete best - but first mortgages I can usually beat them blindfolded, because it's not where they're set up to shine). There are also any number of available offers on the internet, but check out the fine print carefully. Credit Unions may not be absolutely the best credit cards available, but they tend to be shorter on the Gotcha! provisions.

(Internet searches for credit unions in Los Angeles turn up fifty or more; in the Bay area a similar number. You need to do your due diligence and you may not be eligible to join most, but I've found it worth doing as opposed to doing business with the major banks and credit card companies that advertise like mad. The money to advertise doesn't come from nowhere.)

This should help you make informed choices as to what to do given your current situation to maintain two open lines of credit and a good credit score. Please let me know if this does not answer all of your questions or if you have any further questions.

Caveat Emptor

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