Mortgages: March 2015 Archives

what happens when house doesn't appraise?

I presume this question meant "for the necessary value according to the lender's guidelines".

Lenders base their evaluation of a property upon the standard accountant's "Lower of Cost or Market." This is intentionally a conservative system, because the lender is betting (usually) hundreds of thousands of dollars upon a particular evaluation, and if something goes wrong, they want to know that they'll be able to get their money back.

When you're buying, purchase price is cost. When you're refinancing, there is no cost basis, we're working off of purely market concerns, except that for the first year after purchase, most lenders will not allow for a price over ten percent increase on an annualized basis. Six months, no more than five percent. Three months, about two and a half. Mind you, if you turn around and sell for a twenty percent profit three months later, the new lender is going to be just fine with the purchase price, as long as the appraisal comes in high enough.

But as far as a lender is concerned, you can see that no matter what the appraisal, the property is never worth more than purchase price on a purchase money loan. There is a transaction between willing buyer and willing seller on the books and getting ready to happen. It doesn't matter if the appraisal says $500,000 and you're buying it for $400,000. The lender will base the loan parameters upon a value of $400,000.

But what happens if the appraisal comes in lower than the agreed purchase price? For example, $380,000 instead of $400,000? Then the lender considers the value of the property to be $380,000, no matter that you're willing to go $20,000 higher. You want to put $20,000 of your own money (or $20,000 more) to make up the difference, that's no skin off the lender's nose. Matter of fact, they are happy, because it means they still have a loan, where they would not otherwise.

Keeping the situation intact, if you planned to put $20,000 down (5%) on the original $400,000 purchase price, the loan is probably still doable (or was when this was originally written in mid 2006, and 100% financing will almost certainly be back), albeit as a 100% loan to value transaction instead of a 95% one, which means it will be priced as a riskier loan and the payments on the loan(s) will doubtless be higher than originally thought. The same applies if you were going to put $40,000 (10% of the original purchase contract) down, except that the final loan will be priced as a 95% loan ($360,000 divided by $380,000 is 94.74 percent, and loans always go to the next higher category as far as loan to value ratio goes).

Suppose you don't have the money, or won't qualify for the loan under the new terms? That's why the standard purchase contract in California has a seventeen day period where it's contingent upon the loan (many sellers agents will attempt to override this clause by specific negotiation). If you get the appraisal done quickly, you have a choice. You can attempt to renegotiate the price downwards. How successful you will be depends upon several factors. But if you're still within the seventeen days, the seller should, at worst, allow the deposit to go back to you, and you go your merry way with no harm and no foul, except you're out the appraisal fee. This is not to say that the seller or the escrow company has to give the deposit back; they don't. You may have to go to court to try and get it back, depending upon the contract. The escrow company is not responsible for dispute resolution. If the two sides cannot agree, they will do nothing without orders from a court. If the seller wants to be a problem personality, you can't really stop them without going through whatever mediation, arbitration, and judicial remedies are appropriate.

Suppose the appraisal comes in low on a refinance? Well, that's a little more forgiving in most cases around here, at least with rate/term refinances where you're just doing it to get a better loan. If you have a $300,000 loan and you thought the property was worth $600,000 but it's only worth $500,000, that just doesn't make a difference to most loans. Your loan to value ratio is still only sixty percent, and it probably won't make a difference to residential loan pricing (commercial is a different story, and if you have a low credit score it might also make a real difference). On a cash out loan, it can mean you have to choose between less favorable terms and less cash out, however, especially above seventy to eighty percent loan to value ratio.

Once an appraisal happens, it is what it is. If the underwriter sees one appraisal that's too low, they're going to go off that value, and if you bring another appraiser in, the underwriter will usually average the two values, so even if the second appraiser says $400,000, the underwriter who has seen a $380,000 appraisal will value it at $390,000 (not to mention you pay for two appraisals). And a low appraisal can mean that the reason you were refinancing becomes impossible, in which case you're better off walking away.

What can you do about a low appraisal? Your options reduce to four: You can come up with more cash than you initially planned. This option is not available to most purchasers, but it is there. You can renegotiate the purchase price. Not too long ago, when the quality of appraisals was better and more controllable, this was a very good option, but right now with Home Valuation Code of Conduct, a low appraisal means a lot less than it used to regarding leverage to renegotiate price. You can begin the process again with a new lender, hoping the new appraisal comes in higher - assuming the seller will wait. Or you can walk away and look for a different property.

Caveat Emptor

Original here

A while ago, I wrote Sourcing and Seasoning of Funds. You'd think I have a set spiel I give out, and I do. But I had a case where I didn't think I'd need it, and it burned me. Nice clean loan, plenty of down payment all sourced and seasoned, and then almost $100,000 appears in the account on the last statement as I'm getting ready to close it. Instant can of worms - Oops.

Any time money mysteriously appears, the mortgage loan underwriter is going to take an interest. I don't need all your financial statements, I just need enough to get the loan approved. But don't go dumping large amounts of money into the account, just like you shouldn't go apply for a non-mortgage loan while a mortgage loan is in process.

These two items are related because whenever a large amount of money appears, the underwriter's presumption is that you got another loan. Whereas there is nothing inherently wrong with doing so, when you get a loan, you're going to have to make payments. Those payments affect your debt to income ratio, the most important measure by which you qualify for a loan. The underwriter is going to want to know what the terms of that loan are, how much the payments are going to be, whether those payments are fixed or variable, and all of the other things that help them determine whether you qualify for this new loan even with making the payments for that other loan.

So when a large amount of money appears, the underwriter wants to see sourcing and seasoning of those funds. They want to know where the money came from and how you got it and how long you've had it. If it was a gift, they want to know how the person who gave it to you got it, and they want evidence that no repayment is expected. If you can't provide this information, the presumption is going to be that you got a personal loan of some sort. Obviously, if it's a loan, you're going to have to make payments. The payments are going to add to your monthly debt service, which adds to your monthly cost of housing to determine your debt to income ratio. Every dollar you add to monthly cost of housing or debt to income ratio is a dollar that might mean you don't qualify for the loan on your new property.

It's a horrible lie about people from Missouri, but think of underwriters as Missouri accountants. If you want them to believe anything but the worst possible interpretation of a given fact, they want you to show them on paper. That's their favorite phrase: "Show me on paper." It doesn't matter how much down payment you have, it doesn't matter how much equity in case of default. Lenders are not in the business of repossessing property; they are in the business of making loans that are going to be repaid. Especially in the current environment, they don't want to take any risks that your property is going to be one more property in their already too high inventory of lender owned properties.

When you move money from one account to another, you need to show that it has been in the previous account for a while, or where you got it from. You're going to need a paper trail back just as far as all of your other funds on this new money. If you got it from selling your previous property, the underwriters are going to want to see the HUD 1 form from that transaction. If it's a gift, they want a signed letter attesting to this fact from the donor, as well as a source of that money. If you got it from selling something else, the underwriter is quite likely going to ask for copies of the bill of sale. If you're going to be buying property in the near future (or refinancing), keep all the paperwork from anything you sell. And for crying out loud, before you move any large amounts of money around, talk to your loan officer about what you're going to need in order not to kill your loan. Even if you've got all the paperwork, it can make the difference between an easy, straightforward loan, and one where the underwriter takes it into his head that there's something funny going on. You really don't want them to do that, because when it does happen, they can start demanding more and more information, imposing more and more conditions to approving your loan, and in general, delaying your transaction and making the completion of it difficult. Every time one of their loans goes south, an underwriter is potentially in danger of losing their job - so when they think something may be not quite right, they are going to protect their job by requiring all of the information they can think of that might show something isn't quite copacetic. If they should find something specific they can point to, your loan will be declined, and your credit file could very well get an 'attempted fraud' tag. You don't want that, as it can lead to your loan being rejected not just at that lender, but everywhere. So you need to be very careful, and very clean, about moving money around, especially so within six months of applying for a mortgage.

My loan? The client had the paperwork necessary to satisfy the underwriter. Loan funded, he's living there today. But not everyone has that level of paperwork. Better not to raise the flag in the first place by showing the underwriter the statements for the money you actually intend to use for the down payment.

Caveat Emptor

Original article here

One of the things that most mortgage and real estate consumers get mixed up on is the distinction between low-balling and junk fees. Junk fees are when they add fees that really aren't necessary to what you're paying. Low-balling is when there's an essential cost (or the associated rate) that either gets underestimated or they somehow neglect to tell you about. This can also take the form of costs such as subescrow fees which happen because your representatives did not choose your service providers with your best interests in mind.

A lot of this has abated since the 2010 Good Faith Estimate became required, but there are still loopholes that unethical people can drive a truck through.

As I said in Mortgage Closing Costs: What is Real and What is Junk?, "The easy, general rule is that legitimate expenses all have easily understood explanations in plain English, they are all for specific services, and if they are performed by third parties, there are associated invoices or receipts that you can see." In my experience, the vast majority of what extra fees that appear on the HUD 1 despite not being on the earlier forms are not the result of junk fees being added for no good reason, but are the result of real fees that your agent or loan provider knew were going to need to get paid, should have known the amount, and chose not to tell you about them or chose to tell you they would be less than they are. In short, low-balling is a much worse problem in the industry than junk fees. I've had people tell me my closing costs seemed high, because despite the fact that I have negotiated for discounts from providers, other loan providers were quoting significantly lower costs. What's going on is not that my costs are high - in fact they're pretty darned low when you compare the fees clients actually end up paying - but the fact that a large proportion of my competitors will pretend that a large percentage of those costs aren't going to happen. The penalties for this, in case you weren't aware, are pretty much non-existent. It's harder now to cross the is and dot the ts of increasing what was quoted on the Good Faith Estimate, but the real crooks have the entire process honed to a science.

The reason they do is is to make it appear for the moment as if their loan is more competitive than it is. What happens is that because it appears that their loan is cheaper for the same rate, people will sign up for their loan. They then invest the six to eight weeks necessary to fund that loan working with that loan provider. By the time they discover the real costs and the rate of that other loan are going to be much higher than they were initially quoted, there's no time to go back and get another loan - and that's if the people notice, and industry statistics say that over half of the people do not realize even massive discrepancies between the initial quote and eventual loan delivered.

This is why most loan providers don't want to tell you what your loan is really going to cost. It isn't that the extra is junk or in any way unnecessary. It's that they want their loan to appear more competitive that it may really be. All of the incentives are lined up in favor of this behavior - they got you to sign up, didn't they? - and there is no penalty in law. Of those people who do notice discrepancies, eight to nine out of ten will give in and sign anyway. For the unethical, their experience is that 90 to 95% of the people who sign up because of their false quote will consummate the loan and they will make money - and they make so much per funded loan that they're doing ten times better than the ethical people who practice full disclosure. That the ethical people are almost certainly going to end up cheaper is your incentive to do what it takes to find them.

This principle applies also to many agents' "estimate from proceeds of sale" form. Despite the fact that the default purchase contract and usual custom may have the seller paying for certain items, such as a home warranty plan and an owner's policy of title insurance, many agents will leave these costs off the estimate. Unless you're selling a fixer in utterly "as is" condition, you're going to end up paying for a home warranty plan. Unless the buyer's agent utterly hoses them, leaving that agent completely open to lawsuits, you're going to pay for an owner's policy of title insurance. Unwillingness to do so is a universal deal killer unless the buyers are getting a price more than good enough to make it worth their while to pay for it themselves. Even if they've deliberately chosen escrow and title providers such that you're going to pay subescrow costs, they'll likely leave those costs off their estimates. Why? To make it seem like you're getting a better deal from them than you actually are.

I've seen more than a few people who signed up with other agents or loan providers based upon ridiculous low-balls (and over-estimates of sale price). Without exception, these people end up paying every single one of those loan costs. It's not like the people who do the work are going say, "Oh well, it's not like we want to get paid for all this work we did." In the case of sales transactions, that's if it sells - and it's very unlikely to sell at all if it's overpriced. Nonetheless, this gives the person who gives the great line of patter - a supposedly "bigger better deal" - a large advantage in getting people to sign up with them. By the time the clients learn the truth, it's too late. Most people don't want to do the research up front to find out what's really going on. They wait until after they've already been hosed to do the research they needed to do in the first place.

Caveat Emptor

Original article here

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

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

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

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

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

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

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

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

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

Caveat Emptor

Original article here