Mortgages: April 2015 Archives

Somebody asked, "What are my legal options when there's a change on a good faith estimate."

Short answer: Sign the documents or don't. Same thing with a Mortgage Loan Disclosure Statement here in California. Neither one means anything binding; that's why they call the one an estimate. Nonetheless, because there is a perception that they mean something, that people think the lenders are trying to disclose everything fully. The fact is that some are while others aren't, and there is no correlation with size of the lender, how well known they are, or even what the loan officer at the next desk over is doing.

The fact is that if the loan officer cannot persuade you to sign up with them, there is a guarantee that neither they nor their company will make anything. This creates an incentive to tell you whatever it takes to get you to sign up. Once signed up, most folks consider themselves committed or bound to that lender, and stop looking around.

But the only documents that mean anything, legally, all come at the end of the loan process. Note, Trust Deed, HUD-1. So you can see the motivation exists to pull a bait and switch, or more often just not to tell the whole truth. Nor will they point out the differences at closing from what you signed up for. That would get you upset to no good purpose, from their point of view. The fact is that a majority of borrowers don't take the time to spot the difference, and of those who do, some just don't understand how to spot the difference. Of those who do take the time, and do spot the difference, most will cave in and sign just to be done with the process, and of course there are those who are trying to purchase who won't get the property and will lose the deposit if they don't sign.

The fact is that these forms are estimates. They may or may not be accurate estimates. In some cases, the loan provider tells you about every single dollar you're going to need up front, in others they might as well be telling you the loan is going to be done for free at a rate two percent below any real loan out there. If they can't get you to sign up, they don't make anything, so the incentives are for them to over-promise and under-deliver. In other words, tell you about something better than what you'll end up with. The loan officers know what it's going to take to get the loan done - or they should know, anyway. But they often tell you a fairy tale that might as well begin "Once upon a time..." to make it seem like their loan is better than the competition, because if they can't get you to sign up, they don't make anything.

This has improved somewhat with the new 2010 Good Faith Estimate, but there are still enough loopholes that a loan provider who is so minded can drive a supertanker through them.

Now, the fact is that the vast majority of people out there go out shopping for loans in the wrong fashion. They find someone they think they can trust, because they are family, because they are the scoutmaster, or because they go to church with them. Exactly what type of loan will they deliver, and at what rate? With what costs? It is always a trade-off between rate and cost on any given loan type.

Even less likely to get a good rate at a decent cost are the people who do shop around, but won't give loan officers a chance to figure out what's really the best loan for them. The first group of people might stumble onto someone trustworthy who gives them a good loan at a reasonable rate for a reasonable cost; these people are going to fall for the biggest lie, because a loan officer can always tell you about a better loan than really exists and they are motivated to get you to sign up. They call around asking about the lowest rate or the lowest payment, and don't want to hear anything else out of the loan officer. They are going to get ripped off by whomever tells the most attractive lie.

The fact is that it's going to take a good, in depth conversation about your situation for a loan officer to figure out the best loan for you, and you want to have that conversation with at least three or four loan officers. Why? Because the first one could have told you exactly what they thought you wanted to hear. Ditto the second. Keep going until you hear a couple of different suggestions. Furthermore, once they've given you their suggestions, ask about the other suggestions you heard in the past. Don't shop by lowest payment; that's a good way to get stuck with an abomination like the so-called Option ARM or another loan type that you don't want. Don't shop by interest rate alone, because you'll get stuck with a loan that has six points and you'll never save enough money on the payments to recover those sunk costs. Shop by the trade-off between rate and cost, because there always is one.

At the end of the process, the lender has all the power. You need or want this loan, and they're the ones with it ready to go. In the case of a purchase, you've got a deposit you're going to lose and a home you wanted that you won't get if you don't sign the loan documents. If you sign the documents, you are stuck with the loan, that quite likely isn't on the terms you were originally told about. I pointedly did not say "promised" because the earlier forms are not promises unless somehow guaranteed, and with changes in the market it has become almost impossible to guarantee a quote.

One of the most important articles I have written is Questions You Should Ask Prospective Loan Providers, and the most important question in that list is "If I say I want this right now, will you personally guarantee this rate with those closing costs, and will you cover the difference (if any) between the quote and the actual final cost?" You won't get a flat "Yes." If you do get a flat "yes", they're making a promise on something that is not under their control, and I wouldn't trust it as far as I can throw an aircraft carrier. What you're hoping for is something like "Subject to full underwriting approval, yes we will guarantee this quote as to closing costs. Tradeoff between rate and the cost to get a rate changes every day, and we will discuss when to lock and the tradeoffs that are currently available once we have a loan commitment." This is a simple sentence that makes a specific guarantee subject to a reasonable condition, as loan officers never know if a prospective borrower is intentionally hiding or shading something at loan sign up. If you get a response full of nonsense about how long they have been in business, how they honor their commitments, or any such equivalent claptrap, then they are trying to buffalo you. None of the forms you get when you initially inquire about the loan is a loan commitment in any way, shape or form. I'd rather have a higher quote that was guaranteed than a lower one that wasn't, and I strongly suggest you adopt that attitude as well. For an illustration as to why: If the quote is guaranteed, there's no incentive to stick you with a rate an eighth of a percent higher so they can make a little more money - they're going to have to make it good. There's no incentive to pad the closing costs with junk, because they've got to turn right around and give it back to you. If I offered you a choice between two envelopes, one transparent where you can see the $100 bill (guaranteed), and the other one opaque where I told you there might be any amount from zero up to $110 in it (not guaranteed), which envelope would you choose? The same thing applies to loans. If they can't get you to sign up, they are guaranteed to make nothing, and this creates incentives to tell you about a better loan than they can really deliver.

So (if you can't find someone who guarantees their quotes) how do you force the loan provider to deliver the loan they told you about in the first place? You can't. I used to advise people to get a back-up loan, but once again changes in the loan industry have sabotaged this. It is no longer economically feasible for loan officers to do back up loans. On refinances, you may need to walk away and start over after two or three months of working on your loan. Unfortunately, on purchases you are pretty much stuck with the first loan provider you choose because there is a deadline on making the purchase happen. The power to control the transaction belongs with the consumer, but Congress and the major lenders making large campaign contributions have used the "loan crisis" as an opportunity to remove it from them.

The loan provider is going to make money, or they won't do your loan. Judge loans by the benefits and costs to you, not by how much they loan provider is making, or whether they even have to disclose it (brokers do, direct lenders do not). The important thing to you is that you were delivered a thirty year fixed rate loan at 6.5 percent without paying any points, as opposed to 6.625% with one point and higher costs, not that loan provider A had to tell you they made $4000 by doing it while loan provider B doesn't have to tell you anything. Sounds obvious, but I have seen people who chose the higher rate at more cost for the same loan, even stuck themselves with a prepayment penalty where my loan had none, because they thought I was making too much. In point of fact, I would have made a fraction of what the other guy did make, and by the only universal measure - delivering a loan with a lower rate, lower cost, or both - I performed work considerably more valuable to my client. So don't shoot yourself in the foot like that.

Caveat Emptor

Original here

Every so often I get questions about loan cosigners. The main borrowers do not qualify on their own, so they get someone - most often mom and dad - to cosign. Cosigners are a different thing, or so I understand, in the other major credit areas - automobiles, rent, etcetera. But this is about Real Estate.

The only time this usually makes a difference is in credit history. The main borrowers qualify on the basis of income, but don't have enough of a credit history to qualify. Sometimes they just don't have enough open credit to have a credit score. This is rare, but I did have one executive couple who made a habit of paying cash for everything (a good habit, I might add). They had precisely one open line of credit, a credit card they paid off every month, and the major bureaus require two lines in order to report a credit score. No credit score, no loan - it's that simple. Even there, the solution was to walk in to their credit union and apply for another, not to get a cosigner.

When you bring other folks into the loan, you're bringing their credit history, their potentially high payments, and every other negative they have into the loan. Most of the time, the folks who are willing to cosign do not materially aid the qualification process.

Pitfall number one: If the cosigners make more money than the "real" borrowers, they now become the primary borrower, and it becomes a loan on investment property as far as the lenders are concerned, adding restrictions, raising the trade-off between rate and costs of the loan, and perhaps making the loan require a larger down payment. This does assume they won't live there, but usually if they were going to live there, they would have been on the loan in the first place.

Pitfall number two: The cosigners are overextended also. Sure, they make $10,000 per month, but they have payments of $5000 per month already. There's nothing left over where the bank sees them as having enough money left over to help you out. They may, in fact, have money to spare, particularly if they make a lot of money, but according to the standard ratios, they do not. You can't have the cosigners be stated income or NINA if the main borrowers are full documentation. If you had to downgrade to stated income in order to qualify (back when stated income was available), that would cost a lot of money through higher rate/cost trade-off, not to mention requiring a larger down payment in most circumstances, going to a higher cost portfolio lender, whether you're in a line of work that's eligible for stated income under current guideline. Obviously, better that you qualify for a lesser loan than that you don't qualify at all, but you don't want to downgrade if you don't have to.

Pitfall number three: This one hits the cosigners. They are agreeing to be responsible for your payments in the event you don't make them. Suppose they want to borrow money for something else. Especially if it's a large amount of money, as real estate payments tend to be. It really cramps their ability to qualify for other things. This works the other way, also. People come to me for real estate loans who have agreed to be cosigners for a car loan are responsible for the $400 per month for that loan. Many times, this means they don't qualify for the real estate loan. So we have to prove to their prospective lenders that the "true" borrowers are making the payments. This is usually not difficult, but if the cosigners wrote the check for the payment anytime in the last six months to a year, it can be problematic.

Pitfall number four: This also hits the cosigners rather than the main borrowers. Suppose a payment gets made late. It impacts the credit of the cosigners as well as the "real" borrowers. It doesn't matter if you're the "real" borrower or the cosigner, it hurts your credit just as much and for just as long. If you cosign, you want some kind of proof that payment is being made on time, every month. You shouldn't cosign if you don't have the resources to make that payment pretty much indefinitely. Furthermore, should the cosigners decide to cut their losses, it can take months before the monthly hits to the credit stop. If the "real" borrowers don't want to liquidate, the cosigners may have to go to court to get out of it, and the only people who are happy there are the lawyers.

Now suppose the loan being applied for has a Debt to Income Ratio maximum of forty five percent, and the cosigners make $10,000 per month, but they have expenses of $4300. This will mean that they only have $200 per month to contribute towards qualifying for the new loan. If the "real" borrowers weren't fairly close to qualifying without them, they aren't going to qualify with them. If they have expenses of $4600 per month, they have nothing to contribute to the loan qualification. In such cases, the work of asking them to cosign is wasted.

Caveat Emptor

Original here

An e-mail I got from a single mother I spent two months working with before she found a special low income program for a property she wouldn't have been able to afford through me. The first paragraph is her addition to me on the front of a forwarded message. I've redacted information that might lead to specific identification of the culprits or their victim.

(I haven't been paid anything on this, nor did I expect to be, despite the fact that they told her that I would be to close the deal. She felt obligated to me, but who wants to stand in the way of a single mom finding and affording a better property?).

Dan - This is an FYI. I really wouldn't recommend this program for any of your other clients, or if you do get them involved that you warn them that things stand a good chance of not going as promised. Judging by what is happening to me, I doubt that you ever received your commission from these people.

-----Original Message-----

Good Morning DELETED,

My name is DELETED and I've purchased a condo at DELETED. My close date was supposed to be June 28th. On June 28th I went to DELETED Title and signed off on all the final paperwork and had my bank wire them over $7,000.00. My first scheduled move-in date was on Friday, June 29th. I had to cancel (the move - DM) because it wasn't recorded yet. On Saturday, June 30th I drove over to the DELETED Sales office (my phone and internet has been shut off and transferred) and spoke with DELETED. My next scheduled move-in date was Monday, July 2nd from noon - 4 pm. I asked him if I had to change my plans again and he said "No - because you were supposed to close on the 28th of June and I can go online and see that you have wired your money and completed your paperwork I am going to make an exception and give you your key and let you move in on Monday."

Early Monday morning (we) started bringing all of our boxes and furniture downstairs. At 9 am I rented a U-haul. At 11:30 I went over to the Sales office for my key. I had scheduled someone to pickup and deliver the appliances I purchased for 12:30 pm. (The person who had promised the move in) was "in a meeting" and nobody seemed to know anything about my key. By 1 pm I was quite upset because I still had no answers and only 3 hours left to accomplish my move in.

DELETED sent someone down to try and make things right. I don't think a sobbing woman in their office was very good for business. They went over to the Uhaul place and had the truck reserved until Friday of this week and bought a lock for it. They told me that they would pay my rent and that I could get reimbursed for food if I kept the receipts. Hopefully they will really do this. (it occurred to me later that they also promised me a key and broke that promise) DELETED is calling DELETED (Title officer) twice a day for a status update and what they keep telling me is that the paperwork from the City has not yet been received.

Can you tell me if there is a reason for this and when I might expect this paperwork to be completed?

I'm in a bit of a panic now (to put it mildly) because I need to be out of the apartment so they can clean and paint it over the weekend. I have so little information, I don't know whether to put my things in storage, board my pets and get a hotel for my son and myself. This is also very stressful because most of my money is tied up in the condo and I'm bleeding what little money I have left....sleeping in an apartment on my couch and hoping that the truck on the street in front of my complex doesn't get ticketed or worse yet robbed. Hauling everything back up two flights of stairs was pretty much out of the question (For health reasons - DM).

I feel absolutely miserable. It would be quite ironic to wind up homeless after all this.

If you can shed any light on what is going on, or help me plan what to do next I would appreciate it. I'm really in the dark here.

My phone and internet are at the new place. I had been taking vacation time to move in, but I don't see the point now, so I'm back at work trying not to worry.

This is, unfortunately, not an atypical experience. Public program means you're on a bureaucratic schedule. It's not that bureaucrat's money that's getting spent. They don't get paid any different whether your loan funds and you get your property today, next week, or never.

Furthermore, it has been my experience that companies with the ability to use restricted provider public programs are often looking to boost their profit margin, and because the competition is restricted, they can often get it. That's one of the reason that FHA (among others) is looking to reduce their annual audit requirements, so that the small brokerages and those with thinner profit margins might be willing to sign up and endure the hassles. I've seen loan firms charge two extra points and over half a percent higher rate because the competition was mostly eliminated, and what was left was other high margin places. Special programs nobody else has are a license to print money, particularly if access to those programs is restricted by the government. The fewer providers who can do it, the less competition there is, and usually, the higher the mark up they want in order to for the privilege of being one of the lucky selected beneficiaries.

This is not to say that all public housing programs are difficult, or delayed, or costly. There are individual providers who provide just as good a product at just as good a price. However, the statistics seem to be a much higher than usual incidence of delays, costly extras, and just plain gouging going on due to restricted competition.

This is also not to say in any way, shape, or form that public programs aren't worth it. The lady could never have afforded this unit, part of an income restricted program, without a municipal government stepping up to the line on her behalf. Those with a knowledge of economics may realize that this means the other units were made more expensive due to this, likely pricing out other potential buyers so that this particular person could have a better unit. Robbing Peter (and Penny and Porgy and Poppy and pretty much everyone else) to pay Paul and the bureaucrats helping Paul, but that's a matter of housing policy supported by the voters, and my choice is to help Paul or not to help Paul. Peter, etcetera have already been robbed and they're not getting the money back. The bureaucrats will be paid exactly the same whether I help Paul or not. The only question will be exactly who gets this benefit, and I think that under the circumstances I might as well help Paul get them. And if Paul doesn't take it, somebody else will. From the perspective of a given individual's available options, such programs definitely assist people in affording housing superior to what they could otherwise afford.

However, you need to realize that there are likely to be delays and unexpected extras in a program like this. One of the requirements of many of these programs is a certain maximum amount of total assets - but if that's all you can have and you have to use some of them for down payment and closing costs, this can mean you're cutting it really tight as far as other expenses go. Indeed, on this scale, paying for an extra few weeks rent at your old place can be a real hardship - but that's the cold hard fact of what happens quite often. If you put in your thirty days notice to the landlord, you're stuck when escrow doesn't close on time. If you don't put in your thirty days to the landlord, you're stuck paying rent for the extra month, costing (in this case) a minimum of about 15% of her total liquid assets, never mind what was left over after what she put in her down payment.

There is no universal guide to this situation, and what works in some situations may be totally inappropriate in others. One of the best things is an elected ally in the bureaucrat's chain of command. Another is the willingness of a family member to step in with a gift or extend an interest free loan if you require it, because pretty much all of these first time buyer programs have income and asset limits, and if your cash falls short, everything you paid is pretty much wasted. You won't get the property, and you're unlikely to get that money back.

Anytime the government - city, county, state or federal - limits the providers who can work with a given program, they create a pricing differential between that program and the general market, as well as creating a situation where those providers have an assured income from people who don't have any other choice. Given this, the incentive to provide good competent quality work at a competitive price is pretty much absent, leading to situations such as this poor lady's. These programs all keep a list of their special participants, but sometimes there are ways for others to participate. It never hurts to ask, and it may very well prevent situations like this one.

Caveat Emptor (literally!)

Original article here

An email:

Hi Dan,

I was reading your article on "should you pay off your mortgage faster?" (DM: link here DELETED It'll be a fresh 30 year loan and I'm 44 years old so this discussion has interest, I don't really want to be making a mortgage payment at 74 ;).

I must be really dense but A: I don't get it and B: the table looks like it has an error in it to me.

Start with B: first - the investment column can't possible be correct. The assumption is you save or pre-pay $100 per month and invest at 8%. The amount for year 1 is $1,353.29, if you saved $100 per month at the end of a year you'd have $1,200 in principal + $100 * 12 months @ 8% + $200 * 11 months @ 8% + $300 * 10 months @ 8% etc. Even if you socked away the whole $1,200 on day 1 you'd only have $1,296 and have to pay taxes on $96.

What I don't get is this - by prepaying $100 on my mortgage I get a guaranteed return of 6% or 6.5%, whatever the mortgage rate is. I do not ever have to pay interest on that piece of principal again, it keeps on giving. Yes my payment stays the same but the amount going to principal increases by the amount of interest I am not paying due to the previous principal payment.

Now, the valid comparison to that is a risk free investment alternative no? I've got savings accounts currently yielding 4.5%, 5.3% and 5.4% APY, you might find 6% - might and it probably is an intro rate. Let's be generous and assume I can get the same rate of return on the savings as I pay on the mortgage and put that at 6%. If I pay $1,200 extra in principal on day 1 of the year I don't pay $72 in interest and can't deduct it. If instead I put $1,200 in a savings account on day 1 I earn that $72 in interest. It is a wash, The tax issue is a red herring since not paying the principal gives me a $72 interest deduction but the equal investment return is added to income so (72) + 72 = 0 Could it work out if you put the investment dollars at risk? Sure, but that is a gamble and an apples to oranges comparison.

I have different mental pots of money.

Pot 1 is investment dollars for retirement, 10% or so of income goes to a tax deferred account invested at various risk levels and doesn't get touched - ever. Until I retire at least!

Pot #2 home equity + the carrying cost on the mortgage which is the 25% or so of income that pays the PITI on the house.

Pot #3 is liquid reserves, currently about a years worth of #2's income requirements.

My goal is absolutely to eliminate the P&I part of PITI over time. With enough in pot #3 I'll be plowing as much as possible into principle reduction over the next few years once we get moved in and clear the costs associated with a new house such as drapes and furniture. I make a pretty decent salary but who knows how long that will last? As long as the job is secure I'll keep the current mortgage and pre-pay as much as possible. If a few years down the road I felt a little vulnerable to layoff or whatever I'd seriously consider refinancing the then smaller principle balance for a smaller required monthly nut and keep making the higher payments as long as the income stayed intact. Alternatively I may need to do that in 10 years anyway when my kid goes to College. What we are currently paying in private tuition from current income + available cash flow might be a bit short, or we may be ok - depends on where he goes. I'm a College administrator so if he goes here he gets a 100% tuition waiver, 50% at other state schools. And I did look at saving for College in one of the tax deferred accounts, we don't qualify for all the juicy ones based on family AGI. We could do a 529 but I've made the personal choice that we're better off driving the retirement savings and paying off the mortgage rather than killing ourselves to give the kid a free ride .

I like a guaranteed 6.5% return. With any luck the house will get worth more over time as well making the return even better. I played leverage to the max in 1999 when I bought a townhouse for 78K by assuming a mortgage, I just sold it 2 months ago and cleared $112K cash in my pocket, principle balance was 64K so 14K of the 112K was return of my principle payments. That was great but now we're in a little better position financially and I'd like to preserve it over time. I've owed huge piles of money to CC companies and auto loans in the past - don't ever want to go there again!

One other thought. Despite the current turmoil in the market houses do tend to be worth more over time. Probably not as good as the stock market if the time horizon is long enough but they do go up. In my case 60% of the asset value is borrowed so there is a leverage factor on the return. Here is the thought - under current tax rules that return is tax free where as the stock market return is not. It's all about risk tolerance I guess.

Upon examination, I think you're probably right, although I have assumed "a start of the month/year" program where the question was academic until you actually had some money to put to one place or the other; i.e. an initial $100 today and $100 every month, so a year from today you've got $1300 without interest. Kind of like the old problem where if you've got an eighty one foot wall and beams every nine feet, you need ten beams to have a real structure. One to start (at the zero point), and then another one every nine feet.

The pots of money idea is a good one, but most people shouldn't be limited themselves to theoretically risk free investments, especially once you've got your reserves. 1) They're not risk free 2) The big certainty if you don't take any risk is that you will make less than someone who did. Kind of like being chased by headhunters, and having a choice to sit there and be killed an eaten immediately or jump off a cliff into a river with crocodiles. Sure, the crocodiles might get you, or you might hit the rocks when you land and you might even drown. But if you do nothing, you're going in the stew-pot for certain.

Question: How do you think the bank or insurance company can afford to pay a return on the money? It doesn't come out of some hyperspatial vortex! They take this money and invest it in basically the same places you would. The difference is: They take the risk, they get the reward. This reward is plenty to pay their employee salaries, all the expenses of operating, plus your little pittance, and have plenty left over for the stockholders. If their results are adverse, what's going to happen to your money?

Question: If you never refinance, how hard do you think it's going to be to make a $1500 payment in thirty years? Assuming a 3.5% rate of inflation, about like paying $530 per month now. Shouldn't be difficult at all. If you do refinance, you are making a conscious choice that the other loan is, in total, a better deal for you. Sure you might not have a lot of income after retirement. My point is that with time and diversification, the assets you would accumulate from alternative investments will be more able to pay your loan out of interest than any money you saved.

Question: If you can't make the low payment, what will your equity situation be like? Once again, this is assuming you never refinance, but 29 years out, you'll owe roughly $15,000, and assuming average 5% appreciation, the property will be worth about 4.3 times as much. Even if you never paid a penny of principal down, that's well over a million in equity. This gives you options such as selling (take the money and run), a RAM (take the money and stay - which I generally advise against), a move "down market", etcetera. Stop thinking of money as something that pays the rent and other expenses, and start thinking in terms of what it can do.

Furthermore, it's not a risk free 6.5%. For most people, it's more like an effective margin of 4.7% or less. I'm not advising anyone to go out and strip equity without a very strong reason to do so so and a clear eye on potential consequences, but which after tax return sounds better to you: 4.7% or 7.2%? I agree with the NASD rule that prohibits member firms from accepting borrowed money for investments, but I have to admit that it does work, at least for the "average over time" numbers in theory. The 7.2% assumes investment income is all ordinary income, fully taxed every year. In point of fact, at least some is likely to be capital gains and some is likely to be deferred. The downside is that any investment return is purely speculative and you could lose your principal. You don't ever gamble with money you can't afford to lose, no matter what the long term odds. Nor do you put it all on the same bet, no matter how you split it up. On the other hand, the biggest risk is not taking any. Instead of paying off your mortgage, diversifying your money amongst a sufficient number of stock and bond investments is so likely to leave you with so much more in total net assets over the next twenty years that the expected exceptions are a statistical non-event.

Caveat Emptor

Original article here

(Note: This article is a reprint of one of the earliest articles I wrote, from a time when rates were higher. The principles, however, are quite valid - and even reinforced by the fact that rates now are much lower)

The Truth-In-Lending is a form that can or does provide some useful information, but the useful information it provides is both smaller than most people think, and not in the numbers everybody looks at.

The first thing to be aware of is right below the title. "This is neither a contract nor a commitment to lend." They are telling you right there that this is an estimate. It may or may not be an accurate estimate. That depends upon the loan officer and the provider they work for. Again, the relationship between this form at the beginning when you apply for the loan and the loan that is actually delivered with the final documents can be extremely tenuous, even with the new rules that went into effect at the beginning of 2010..

The APR in the very first box is the result of an attempt by Congress to compress what is fundamentally at least a two-dimensional number into one linear measurement. It is intended to help give you a direct, one number measurement of the effective interest rate, given the expenses. But, in order to this it has to make some assumptions.

The first of these is that you're never going to sell the property, or at least not until after the period of the loan. Back in the early 1970s with stable secure jobs for a large portion of the populace not only in government but in private industry as well, and people living their whole lives in their first house, this was a reasonable assumption. No longer. The median time for ownership duration is about nine and a half years.

The second of those is that you're not going to refinance. This also was not an unreasonable assumption back in the early 1970's. Our habits as a society have changed since then. The fact is that the median age of mortgages (half older, half younger) is currently under 3 years. Only something like 4 percent of all mortgages are older than 5 years. I'll have other implications of these facts later, in other essays.

But by making this assumption, that you're never going to sell and never going to refinance (despite already having done so several times) and just make that minimum payment every month for thirty years, it allows the illusion that you're going to spread those costs out over thirty years, when the appropriate time frame is much shorter. This is a dangerous illusion. To give a specific example, because it means that, when measured by APR, a 5.5% loan with closing costs plus two points looks like a better loan than a 6 % loan with closing costs but no points. In fact, it is quite likely that the 6% loan is a better idea, and a 6.5% loan where the lender pays your all of your closing costs for you may be better yet.

Let's go through the calculation involved. Let's give the more expensive loan at a lower rate the benefit of every doubt. Assume they're both thirty-year fixed rate loans, so you'll actually keep getting benefits as long as you keep the loan. Assume the base loan we're looking at is $270,000, the same figure I've used elsewhere. This can be either an existing loan, or a purchase where you need $270,000 beyond your down payment to cover purchase price and costs of buying.

As we computed in looking at the Good Faith Estimate, the closing costs of doing this loan are somewhere in the neighborhood of $3400 or so. But "third party" costs, such as escrow and title, are excluded from APR calculation, so we're going to deduct about half of that, or $1700, from them when we calculate APR. I'm also going to assume that you actually pay all of your "prepaid" and "reserve" items out of pocket, which keeps things simple. Your actual loan amount in the case of the 5.5% loan with two points is $278,980, and your monthly payment is $1584.02. Your actual loan amount in the case of the 6% loan is $273,400, and your monthly payment $1639.17. The third loan has a payment of $1706.58 on a balance of $270,000 even. The APRs (a complex calculation) work out to 5.742, 6.059, and 6.500 percent, respectively. Looks like the first is a better bargain, right?

Your actual interest expense the first month is $1278.66 the first month for the first loan, $1367.00 for the second. This is a difference of $88.34, and this number is actually going to increase for the first several years of the loan. The rest of the money is a principal payment. Equity. Money you don't owe anymore. The principal paid the first month on the first loan is $305.36; on the second is $272.17, a difference of 33.19 the first month in the first loans favor. For the third loan $1462.50 represents interest and only $244.08 is principal. This is really looking like you make the right choice with 5.5%, correct?

But let's look at two years from now - about the age of the median mortgage. I'm going to use the loan in the middle as baseline.

Loan 1 has paid $2130.05 less in interest, and $806.37 more in principal than Loan 2. Looks great, right? But they also paid $5580 more for the loan, or which $4773.36 remains on their balance. Remember, fifty percent of the people have sold or refinanced at this point. When you sell or refinance, The Benefits Stop. But the cost is sunk. You paid it in full two years ago. And at this point if you sell this home, you will actually get $4773.36 less in your pocket than in if you had taken the 6% loan. This is somewhat compensated for by the fact that you spent $2130.05 less in interest expense. But you're still $2643.31 down as compared to the 6%, and there's no way around that. Meanwhile, the 6% loan itself lags the 6.5% loan by $414.07 at this point in time.

And if you refinance, it gets even worse. You're now paying interest on the $4773.36 in higher balance for the rest of the time you're got your home. Let's say the rate is 5% now because you got an even better deal. This means $238.67 per year, $19.89 per month extra that you're going to pay for as long as you have that loan, all for benefits that you don't get anymore and never paid for their costs in the first place. This is truly the gift that keeps on giving, isn't it? To the lenders.

Now let's look 5 years out, when over 95% of the people will have sold or refinanced.

At this point for loan 1, you have saved $5353.23 in interest and paid down $2044.02 more in principal, right? Yes, but you paid $5580 more for the first loan than you would have for the second, and you still owe $3535.98 of this difference. If you sell, you will get $3535.98 less to put in your pocket, although that will be more than balanced out by the interest you saved. Net profit to you of choosing the first loan: $1817.25, neglecting tax treatment. Boy did you make the right choice, right? But remember that over ninety five percent of everyone who made the same choice you did never made it to this point. Furthermore, if you're like most people and you intend to buy some other property where the transaction includes a loan, that loan will have a starting balance $3535.98 higher to start with than if you'd chosen loan number 2 in the first place. Assume you got a great rate on your new home: 5% even. This means you're now paying $176.80 per year in interest that you wouldn't be paying if you'd simply chosen Loan 2 in the first place. Assuming you intend to own property for the rest of your life, in a little over ten years your gain is gone.

On the other hand, you are doing safely doing better with loan 2 than 3 at this point. The difference in interest you've paid has more than made up for the difference in starting balance. Whether you refinance or sell, it's going to be difficult to make up $4122.80 with the interest based upon $1660.98. Assuming 5%, this is $83.05 per year it amounts to 50 years to recover. Loan 3 shows up pretty well against loan 1, though. $5196.96 difference in balance times 5% per year is $259.85. Divide the $1479.49 by this number and get that in 5.69 additional years, your benefits from loan 1 as opposed to loan 3 will be gone.

If you get a great deal and refinance instead of selling, that extra $3535.98 that you still owe on that mortgage is still there, and will be for as long as you own that home. Assume you got a really great deal of 5%. This means $176.80 per year of extra interest expense - just from the fact that your balance is higher because of sunk costs to pay for benefits that have stopped. Assume you keep your home another five years, so altogether you've had it ten years since the initial loan. This has cut your gain to $933.25.

This happens all the time. It is not uncommon for me to talk with people who bought their homes in the 1970s, have refinanced ten or twelve times, and now owe more than ten times their original purchase price, a good portion of which is directly attributable to unrecovered closing costs of the refinances. Here's the point: closing costs and points stick around, sometimes a long time after the benefits you got from them are gone, and people refinance or more often than most people admit. The only loan that can be ahead from day one is the true zero cost loan.

(At this update, I need to note that the Democratic-controlled Congress of 2009-2010 did everything in their power to make the true zero cost loan illegal, to make such loans appear as if they cost money when they don't, and to define terms in such a way as to prevent loan officers who offer true zero cost loans from calling them "zero cost" even though when you really crank the numbers, they are zero cost to the consumer).

Loans that have closing costs and even points will, in general, pay for those costs eventually, and more than pay for them if you hang onto it long enough, but you're sinking a significant amount of money in the bet upfront, money which is going to be around in your balance a long time. Furthermore, people don't hang onto these loans as long as they think they will, and very few people hang onto them long enough to see profits from high closing cost loans. Finally, the rate at which a zero cost loan can be done varies from day to day, and by quite a lot over time. Let's say six months from now I can do a 6% loan no cost. It costs you zero, and now if you're loan 3, you've got the same loan at a lower balance than the guy who chose the 6% loan 2 above, whom I can't necessarily help with those better rates.

Then three years down the line, rates really drop, and I can do 5.5% for no cost. A call to both loan 2 and loan 3 nets borrowers who are eager to cut their rate for zero cost, but I still may not have anything that helps 1 in the sense of being worth the cost of doing it. Now loan 1, loan 2, and loan 3 all have the same rate, but loan 3 owes the least amount of money, therefore has the lowest payment, and has the most equity in their home.

Here's another dirty little not very secret, but rarely publicly acknowledged, fact: People don't always refinance into a lower rate when they refinance. If you've been a homeowner 15 years or so, chances are reasonable that you've done it - possibly more than once. Don't worry, I'm not going to pillory you in public over it, but if you won't admit it to yourself then there's not a lot that can be done for you. People have various reasons for refinancing into higher rates, some of them reasonable, some of them relating to necessity, and some quite frivolous. But you'd be amazed at how often people looking to refinance expect me to believe stories that numbers show to be obvious fiction about how often they've refinanced a property. This is math, and if the numbers tell me you've been making payments on this loan for two years when you tell me five, I'll bet millions to milliamps that if I go check the public records that are maintained on every piece of real property in the country I'll find that Trust Deed recorded two years ago. Now, it's okay to tell some lies of certain kinds to your loan officer, and assuming that any prepayment penalty has expired, this is probably one of them. No harm, no foul. What a typical loan officer cares about is getting paid, and if you're withholding or correct information doesn't make a difference to that, there's been no harm done. A good loan officer will add, "Putting the client into a better position" to that first, paramount concern, and if the information you withheld would have resulted in a different answer to this question, you have only yourself to blame. (Looking for altruists in business is both pointless and hazardous to your financial health. Businesspersons donate huge amounts of time and money and energy to charities or other works for the public good. But we're at work to Make Money. I am very good at what I do and getting better because I want to Make More Money, and mistakes do the opposite of Make More Money). But you need to be completely honest with that wonderful person you see in the mirror every day who follows you around twenty-four hours every day, shares in all of your triumphs and joys, and has to deal with all of your mistakes for the rest of your life. Otherwise you're going to waste a lot of money on mortgages making the same mistakes over and over again.

Getting back to the actual Truth-In-Lending form, finance charge assumes you keep the loan the full term, as I have explained. Amount financed is subject to the same limitations as the Good Faith Estimate, and in fact assumes that the Good Faith Estimate is honest and accurate. So is the Finance charge. Neither of these, nor the Total of Payments, which is simply the sum of these two, is any more valid than the Good Faith Estimate this form is based upon. Do NOT use the Truth-In-Lending or APR as a way to compare loans, numbers-wise. Many people do precisely this because it's such a simple looking, apparently easy to understand form. But if it's based upon a Good Faith Estimate that's not accurate, it means nothing. Zip. Nada. Garbage In, Garbage Out.

Nope, the minimal information provided by this form is in the details that start about halfway down.

Demand Feature: If checked, this means the lender can require that you repay the loan in full, with a certain number of days (usually 30) notice. It can also mean there's a balloon on the loan.

Variable Rate Feature: if checked, this means that at some point, if you keep the loan long enough, become a variable rate loan. I've seen loans that went as long as ten years before a variable rate kicked in, or it can be right away. It all depends upon the loan you agree to.

Credit Life and Credit Disability are two products that I would generally recommend against unless it's the only life or disability insurance you can get. Some states do not permit them to be a requirement of the loan - and in those cases where the lender would otherwise require one or both, you won't get the loan as a result. (On the other hand, without these state prohibitions, many lenders would require them much more often, costing consumers in the aggregate billions. Just like everything else in mortgages, it's a tradeoff with winners and losers no matter what you choose.) Both of these products typically pay any benefits directly to the lender, when you want them to come to you or your family. Buying your own life insurance or disability insurance is typically a much better idea.

Property and Flood Insurance The lender can and will require you to maintain proper insurance on the property as a condition of your loan. In California, they cannot require this be for the full amount of the loan, but they can and will require you to maintain coverage for the amount of full replacement costs - what it would take to rebuild your property as it is from the ground up. Many lenders delegate the responsibility for making sure this is done on their behalf to big administrative operations that cover the whole country, and they are ignorant of individual state law even for such major states as California. Be polite, but firm, when they tell you they are looking for coverage in the full amount of the loan. Flood insurance is a separate policy that can also be required if the property is on a flood map. The lender can either demand your loan in full immediately or purchase insurance on your behalf and force you to pay the bill if you fail to show them continuing proof of adequate coverage.

SECURITY: The first box should be checked for purchases, the second for refinances. In rare cases I do see somebody taking out a loan on a home that is free and clear to get a better rate than they would on a new property they're buying, because they'll get a better rate that way. In this case, the second box should be checked.

Filing Fees are for filing the papers with the county recorder, and should be the same as listed on the Good Faith Estimate

Late Charge basically discloses what your penalty for any late payments will be. It is expressed as a percentage of your normal monthly payment.

Prepayment penalty: Should tell you honestly whether there will be a prepayment penalty on the loan, but often doesn't. Says nothing about the duration of it. Forget the second line. All of the costs to get you the loan are sunk and nonrefundable from the time you sign the papers. All of the interest that you pay as it is due is gone forever. You'll never see it again. They earned it. They're not going to give it back. I've never heard of a loan where in the initial contract the borrower was promised a rebate of part of those costs if they paid off early. Banks did make a lot of offers to discount loans if you paid them off in the late seventies and early eighties, but these were offers made at a later time, long after loan papers were signed, by the banks because they were losing their shirts buying money at 14% or so when it was already loaned several years earlier to customers at 6%. It wasn't a part of the contract in the first place.

Assumption: This means that if you sell the property, the buyer can keep your loan in effect. The VA loan is the only one out there that is generally assumable by the buyer if you sell, but there are some other loans that are assumable as well. It's not usually a good idea to let a buyer assume the loan, but there may be no alternative. The reason: You can still be liable for these if you do allow them to be assumed.

Then there's a line where there are two final square boxes to check, where "* means an estimate" and "all dates and numerical disclosures except the late payment disclosures are estimates. Expect the second box to be checked. It's all based upon the Good Faith Estimate. If they're stretching the truth there, the numbers here are going to be similarly distorted. And if it's not checked, that's "an inadvertent oversight" and unlikely to be prosecuted. Which is as it should be - unless there's a pattern of it, which is the case with all too many loan providers.

Caveat Emptor

Original here

Another relevant article: The Difference Between Note Rate (APY) and APR

I hear it and read it all the time - advice that says to pre-emptively reject the possibility of paying points. People that talk to me about loan rates that tell me they will not consider any loan that requires paying points.

What they're thinking is that they don't want to pay origination. They don't want to pay for the person who gets their loan approved, figuring that the interest rate is enough for the bank. Here's a cold hard fact: Nobody does loans for free. The interest you are paying does not go to the bank who does your loan. It goes to the actual investor who furnishes the money. And here's the fallacy that completely guts the advice: What has become the most common system of loan origination, where the originator is separate from the investor, has become the most common system because it is cheaper for the consumers. Despite Congress' recent attempt to eliminate brokers as competition for big lenders, brokers are still far cheaper.

Once upon a time, all residential mortgages were done by lenders who intended to hold them for the life of the loan. There was no origination. There was no discount. The Rate was The Rate, and they would give you whatever rate they were offering everybody else that week - if you qualified - as they wanted to make a certain comparatively high margin on the money. If you didn't qualify for The Rate, there were alternatives but none of them was advantageous. In any case, The Rate wasn't that great, but there weren't many alternatives at all, and all the banks charged about the same Rate, and there was pretty much always a prepayment penalty of some sort because they had to be certain they'd make enough money via interest to pay their employees for doing the loan.

This started changing a very long time ago, with the advent of Fannie Mae (and its younger sibling, Freddie Mac). Nonetheless, the two GSEs didn't work in a way that made their role obvious to the consumer until about thirty to forty years ago. The fact that they bought mortgages, allowing lenders to loan what was essentially the same money over and over again meant that rates went down, but also as part of the same phenomenon that lenders were no longer making money from the interest rate of holding those mortgages. The upshot was that consumers now had a choice: In order to get the cheaper rates made possible by the GSEs, they had a choice: They could pay origination, or they could accept a higher rate, such that the lender who did their loan received either a bond premium or yield spread premium, which amounts to a different piece of the same thing. The advice not to pay points for a mortgage actually dates from this period, as holdouts equivalent to today's portfolio lenders came up with what was an advertising slogan that made it look like dealing with agency lenders was actually costing you more, when in reality agency lenders were saving consumers money over the longer term, albeit with slightly higher upfront costs. But when it's saving you as much as two percent per year over the portfolio lenders of yesteryear (who began charging points themselves because they could), it doesn't take long to see that paying a point of origination, or one percent of loan amount upfront in order to get a rate two percent lower with the agency lender was a much better deal than the alternative.

Once started, the advice to not pay points took on a life of its own. After all, what's not to like about not paying for something? But origination points pays for a real service, and if it saves you money in your particular context, then it is worth paying. But if you reject in blanket fashion the possibility of paying points, then you never consider the very real possibility that it might save you money. Nor, in the modern world, is not paying origination a real possibility. I can make my money in the form of points, I can make it via an explicit dollar figure charge that amounts to the same figure, or I can jack up the rate and make the money when the secondary loan market pays me more than the face value of the bond because the interest rate is above that of similar mortgages. Note that there is no option that says "your lender doesn't make money for doing your loan." If your lender doesn't make money, they don't stay in business. I don't do free loans. Nobody does free loans. If I'm not going to make money anyway, I'd prefer to stay home and play with the dog and teach the girls about TANSTAFL, because plainly there are an awful lot of naive children somehow getting through the educational system without absorbing this critical concept. Pretty much everyone else in the loan industry needs to make a living also. Refuse to pay origination, and you're back in the old days of portfolio lenders - with a rate two percent or so above the agency lenders for the same loans.

Points actually come in two forms. As well as origination, there is discount. Origination is going to be paid on every loan. It can come from a figure in points you are being charged that amount to a certain number of dollars, it can come from an explicit number of dollars you are being charged (that amounts to the same number of dollars as the points do), or it can come from jacking the rate up so as to receive yield spread (which must be disclosed) or a secondary market bond premium (which does not). It literally does not matter to me how I make my money - it's still the same number of dollars - but it is going to be made or neither I nor anyone else is going to do your loan. Some companies charge more origination than others, but if they can deliver a loan that is likely to save you money overall, that higher origination is worth paying. Don't lose sight of the forest because you're obsessed with one particular tree, and origination is not the only way that loan providers make money. Not too long ago, I had someone bring me a HUD-1 form where the lender hid eight thousand dollars of unnecessary additional charges in plain sight where the borrower couldn't recognize it, in addition to the $1500 they claimed was all they were making via origination. Nor do all forms of origination have to be disclosed. Direct lenders and correspondent brokers do not have to disclose what they make when they sell the loan to the final investor and so advice telling you not to pay points or not to pay origination allows them the ability to cut out other loan providers, at least with the gullible, which is most of the public. Deciding which loan you take based upon what the lender is apparently making is a recipe for being completely conned. Evaluate the loan in terms of the bottom line to you.

I happen to think it's both fair and a good idea to charge origination in terms of points. When I set the rate and cost of your loan, I'm risking more for a bigger loan - and working harder, too. If I make a mistake in pricing the loan, I have to pay a figure in points in order to make it good. If your credit score suffers a sudden drop, the difference isn't a flat fee - it's a charge in points. If you don't get me information I need promptly, or the lenders are just so snowed under that we need to extend the rate lock, that's a charge in points. The bigger the loan, the more work it is to get it accepted by the investor. Conforming loans are, by and large, the easiest - but that's not to say they're easy with the current paranoid lending environment. Non-conforming loan amounts these days are like pulling teeth without anesthesia and it gets worse from there. The points charge for origination may go down in steps for larger loans, but for everyone in the industry, you're going to find that the bigger the loan, they larger the number of absolute dollars the lender needs to make it worth their while. They can hide it, lie about it, or risk scaring children of legal age away by honestly disclosing it, but I promise you that you are going to pay it in the final analysis.

Discount is an explicit charge for getting a lowered rate. This figure is always expressed in points. I can translate it into dollars for you, but the actual charge is a certain percentage of the final loan amount. Paying discount is pretty much optional, and the answer to the question of whether you should (and how much) changes with the type of loan, your situation, how long you're planning or likely to keep a particular loan, and the tradeoffs between rate and cost available at any given point in time. Discount points can be thought of as negative yield spread or bond premium, and yield spread or bond premium can be thought of as negative discount points. You cannot have discount points on a loan with yield spread or one where the loan officer says they will make what they need to on the secondary market. What you are paying in such cases is origination, not discount.

In neither case is cutting points out of a loan a matter of negotiating skill. Cutting points down is a matter of effectively shopping your loan and asking the right questions of prospective loan providers and nailing them down as to exactly what they are really offering and paying attention to the answers. You're probably not going to see huge differences of three points for the same rate or a full percent lower on the same loan for the same cost unless you're comparing yourself to someone who doesn't shop their loan effectively, but saving half a point on a $400,000 loan at the same rate is $2000, and saving an eighth of a percent for the same cost is $500 per year for as long as you keep the loan. I don't know about you, but that's more than enough to motivate me to spend the necessary time and effort to shop for a better loan.

In any case, evaluate loans in terms of the bottom line to you, not by how much the provider makes or has to disclose that they make. How much it's going to be in points and closing costs to get the loan done in the first place, versus what it is going to cost you in interest charges every month. They're not going to yield a single unequivocal answer, but rather breakeven points, or "How long do I have to keep this loan in order to get back my initial investment via lowered monthly cost of interest?" When you're refinancing, a zero cost loan is the only thing that can be ahead from day one, but even an ardent fan of zero cost loans like myself is finding them hard to justify in the current market, because the rate cost tradeoff is so shallow on that part of the tradeoff curve. In plain English, when you break even on increased costs in six or eight months due to lowered cost of interest, it's very hard for me not to recommend you pay those slightly higher costs, knowing that the median time people keep loans is about 28 months, and they'll get their money back four times over in that period, and keep getting it back all over again every six or eight months they keep the loan.

By the way, if someone won't guarantee their costs, how are you going to get those figures that gives you the answer of which loan is most likely best for you? The lender knows, or should know, what they can really deliver. You don't, except for what they tell you. If you're not going to follow this model, you're in the same position as the woman who goes to the singles bar looking for Mr. Right. What she's going to find is Mr. Right Now, the sleaze ball who says anything to get her into bed with him and leaves her feeling dumped on and used. The parallels are exact. Nothing wrong with it if all you're looking for is a quick roll in the hay - but I've never heard of anybody who went loan shopping with the intention of getting screwed.

If you don't nail them down with a written guarantee, loan providers can and will lie, omit charges that you are going to pay, and just flat out pull promises out of their backside in order to get you to sign up for a loan. The new RESPA rules only a little more difficult to lie, and it you don't sign up for their loan in the first place, there is no way they're going to get paid for doing that loan.

What I hope you take away from this article is simple: The idea that it may be to your benefit to pay points on a loan, and rejecting the possibility only encourages prospective loan providers to lie about what loan they are really going to deliver. Instead, nail them down as to exactly what they're willing to offer, whether they're willing to guarantee it, and what the limitations upon that guarantee are. Once you have this information, you have the information necessary to decide whether paying points is in your best interest - because it might very well be.

Caveat Emptor

Original article here

I am continually confirming that a large percentage of people can't handle negotiations like an adult. They focus in on garbage and ignore what's really important.

I recently was going to deliver a loan that cost less, as well as being 3/8ths of a percent lower interest rate on exactly the same terms as the competition quoted. Furthermore, my quote was guaranteed where the competition's was not. However, because my company's compensation was disclosed while the competition's was not, they chose the other loan.

Real Estate loans are not something that the minimum wage fast food worker can toss off in a few seconds like filling a soda cup. If we get all of the paperwork just right with no hitches and everything works on the first pass and it doesn't take too long to price it, such a loan could be done in five to ten working hours when I first wrote this. With complications due to new regulations and overly paranoid lenders that have arisen since, thirty working hours and 45 days seems to be about the minimum for a loan now. And getting it done in minimum time requires not just the right situation, but a lot of skill and a not inconsiderable amount of knowledge of the loan market.

Nobody does loans for free. Typical loan production, even at a busy brokerage, is three to six loans per loan officer per month. That's got to pay rent and utilities and the salaries of everyone from the receptionist to the CEO. Yes, I've done more, but if you investigate you're going to discover that for most loan officers, most of their time is spent prospecting and selling. That's part of the reason why most places have processors and transaction coordinators - to relieve sales folk of tasks that they don't have to do so they can go out and sell more with the time they save. I can point to lenders and brokerages where basically the only work that loan officers actually do is talk to prospects and clients. They don't price, they don't do the application, they don't process, they don't deal with underwriters or escrow or title, they don't attend signing - all they do is sell the loan. The reason for this is so they can talk to more prospects. The time of good sales folk is important, but some of these loan officers have no clue as to whether the loan is ultimately going to be approved. This is one of the reasons why people end up with different loans than they were originally told about. There was a reason why they weren't going to qualify for the loan on which the loan officer gave them a low quote, but the loan officer didn't know, and it's sure as gravity no one else is going to tell you between sign up and delivery, and at delivery, your choices are to sign these documents or don't. If you need that loan at that time, guess what? You are going to sign those loan documents and become part of the statistics.

Not too long ago, I had some people call me through Upfront Mortgage Brokers (UMB). They had heard the UMB way was better, and it is better than most, but it requires you be able to deal with money like an adult. These people wanted a million and a half dollar loan with a low down payment. They had great credit and likely sufficient income, but they wanted an A paper loan with no pre-payment penalty. At the time, I could get zero down payment A paper loans with no pre-payment penalty no problem up to the conforming limit, but above that, lenders start making it harder and harder, and there are three break points in most lender's rules between conforming loans and a million and a half. When I'm working under UMB rules, I have to negotiate every penny that my company is going to make up front, and I told these people that my company needed $5400 to make that loan worth our while. This was between three and four tenths of a point grand total, and that included credit and what the processor was going to make. But that sounded like "too much" to these people, who told me that they were going to the bank who "promised never to charge more than two points." When you do the numbers, they were telling me that $5400 was "too much" but $30,000 wasn't - not to mention the fact that I know this lender, and they'd have made another four percent on the secondary market with the loan they gave these people - $60,000 in addition to the 2 points they charged. It's to be admitted that the lender I was going to put them with likely would have made about 2.5 percent, or a little under $40,000, selling their loan on the secondary market, but these lowered margins roughly $45,000 total that I and my lender would have made versus $90,000 that the other lender would charge translate directly to less cost, a lower interest rate, or some combination of the two (there is ALWAYS a trade off between rate and cost in mortgages). Direct lenders can price your loan to make anything they want on the secondary market - and they don't have to tell you about a penny of it, unlike brokers. Indeed, the loan I quoted was better all around to the prospective client - but my compensation was disclosed and theirs wasn't, despite the fact that what we were going to make was chump change compared to everyone else. So this person, a highly paid professional who should have known better, went with the other provider.

So despite the fact that working to UMB guidelines actually lets me quote and deliver loans with slightly better pricing than my usual way, I have discovered that it's mostly a waste of my time. The client is assuming pricing risk, all I get is a flat, pre-negotiated fee - but they know what that fee is, and it's not what most folks think of as "cheap." Never mind that it's a lot cheaper than the provider they ended up with, people seem to think that the $5400 they know about is somehow more than the $30,000 they don't.

The smart thing to do, of course, is judge that loan based upon the net terms to you. Type of loan, rate, total cost, and whether there's a prepayment penalty. I can get my commission paid out of yield spread or rolling it into your balance, same as anyone else. You don't have to write me a check just because I'm working for known compensation. In fact, since that known compensation is less, I can get you a lower rate, or pay some or all of the closing costs that you'd end up paying through another provider - sometimes even both. But just because I can't hide my compensation in your new loan amount and rate, or pretend that I wasn't paid somehow, doesn't mean the other loan is better than mine.

Loans aren't free. If you don't understand how someone is getting paid, chances are they are making a lot more money than the loan officer who is willing to go over it. If this seems like too much work to you, take comfort in the fact that you're not wasting time scrutinizing the wrong thing.

The intelligent way to compare competing loans by the terms to you: What type of loan is it? What is the rate? How much will it cost, grand total? Is there a prepayment penalty? Will they guarantee their quote, or are they just talking "bigger better deal" to get you to sign up? Ask specific questions, and don't settle for anything other than specific answers. The usual modus operandi is to hide loan costs in your new loan amount after pretending that there aren't any until you go to sign documents. Just because nobody wants to talk about costs or how much they're making doesn't mean the answer is "zero." Just because you don't have specific numbers doesn't mean it's going to be better for you - in fact, the opposite is the way to bet. Nail them down before you sign that loan application.

Caveat Emptor

Original article here

Got a search for "mortgage closing documents do not sign changes."

Unfortunately for this person, the documents you get at closing are what legal folks call a contract of adhesion. This means you can either accept it, sign, and adhere to all the terms as presented, or you can walk away. Basically your choice is to take it or leave it, in exactly the form presented.

Now on those rare occasions someone actually has the intelligence and good sense to walk away from a situation where the terms have been changed, the prospective loan provider does have the option of offering you a better deal as incentive to do business with them. Like, say, the loan they originally talked about to get you to sign up with them. Mind you, they don't have to, and the costs of that other loan may mean that they would rather do no loan than that loan. Furthermore, they've got to re-draw the appropriate paperwork.

I'm not a lawyer, but the way contracts of adhesion were explained to me is that if there is any legal ambiguity, it will be interpreted in your favor. This doesn't mean you can claim you thought it meant something different than the average person would understand; this means that if there is a legally ambiguous wording that could legitimately be interpreted two different ways, and you and your lender disagree as to the meaning, the courts will generally rule in your favor. Once again, the law is different from place to place and the courts have the final say; check with your lawyer.

In the loan world, it is much more common than not to be offered a loan contract at final signing which differs in some material form from the loan terms that were described to you in the beginning. The loan provider will generally offer you a loan of the same type, and usually at the same rate, but most often the costs to get that rate will be significantly higher than were listed on the Good Faith Estimate or Mortgage Loan Disclosure Statement. Neither one of these forms is in any way, shape or form a legal commitment, nor are any of the other forms you get at the beginning of the loan process, such as the Truth In Lending Advisory. This has improved for consumers somewhat since the new rules for the 2010 Good Faith Estimate became effective, but there are companies out there who have the loopholes completely wired to let them pull a legal "bait and switch" like the worst of the bad old days.

The only thing that means anything is the loan contract, or Note, that you are offered at the end of the process, together with the HUD-1 form, which is the only accounting of the loan required to be correct and complete.

The difference between the initial teaser loan they talked about and loan contract they actually got approved is one of the reasons why the less than ethical providers out there often want a cash deposit for the loan, particularly if their rates are not particularly competitive and they know it. If they're nervous someone will come along behind them and offer you a better deal, they want a cash deposit so that they still get something if you pull out, and many folks obsess about the cash deposit to the point where I could offer them a deal that saves them several times the cash deposit, and they still wouldn't switch. This isn't to say not to pay the twenty dollars or whatever it costs them for the credit report, this is to say don't deposit the appraisal fee (several hundred dollars, which should be paid at point of service) or even part of a point "to be refunded if the loan funds within (a certain amount of time)". Chances are the loan isn't that great, particularly not the real loan they are really going to offer, and that's why they want to lock you in by having something to hold over you if you don't sign on the dotted line at the end of the process.

Caveat Emptor

Original article here

I keep getting hits for this, so people must want it explained. Loan Amortization is nothing more than the process of paying the loan off by regular payments over time. Leave it to the experts to come up with a fancy word for an everyday process, eh?

A loan which is fully amortized (or fully amortizing) is one which the required payments will pay it off in full by the end of the term of the loan. Fixed rate loans are the classic example of this. A thirty year fixed rate loan is a classic example. It has 360 payments of equal amount, at the end of which the loan will be paid off, assuming you have made all the payments on time. The last payment may be somewhat smaller due to the fact that they may round the payment up to the next penny, and over thirty years it makes a difference.

However, most hybrid ARMs are also fully amortizing loans. The difference between these and the fixed rate loan is that the rate, and therefore the payment, is fixed only for the first few years, and after that the rate varies based upon an underlying index. Nonetheless, the loans are still calculated to pay off the entire balance by the end of the loan. You are welcome to keep them after the fixed period if you want to, but few people do.

Balloon loans are partially amortized. Their payments are calculated as if they were a longer loan than they are. Because they amortize based upon a longer loan period, the regular payments do not pay the loan off in its entirety by the end of the loan. Unlike the hybrid ARM, these loans are over in a shorter period of time, and you do not have the option of keeping them. You must either pay the loan off in full, whether by paying it or by refinancing, or sell the property.

I don't see it in a federally approved list of loan terms, but I have heard interest only loans called delayed amortization. These loans, whether fixed rate or hybrid ARM, have interest only payments for a given time, and then amortize over the remainder of the loan. For instance, a five year interest only loan is then paid off (amortized) over the remaining twenty five years of the loan. Note that when they start to amortize, they will then have payments that are higher than the equivalent fully amortized loan, because the balance is paid off over a shorter period. They will also typically carry a higher interest rate (most subprime lenders - when we had real subprime - charged 1/4 percent higher interest rate for an interest only loan, and there are additional limitations on availability. "A paper" lenders have an explicit adjustment, which may be a cost in points or may be a slightly higher rate. Whichever it is, it shifts the tradeoff between rate and cost upwards).

If there were such a thing as an interest only loan that stays interest only until you refinance, it would be an unamortized loan. Years ago, I was invited by a company to take a seminar because they offered these to financial planners clients. Fortunately, when I checked NASD regulations, I found out that what they were trying to sell was prohibited. The interest rates they were talking about were very high as well. The reason I said "fortunately" about finding out NASD regulations prohibited what they were doing is that I later found out that they were a scam and shut down by the regulators. I might have found out had I done all my due diligence, or it's possible I might not have. Either way, I'm glad I didn't have any clients with them.

Finally, there is the negative amortization loan, where if you make the minimum payment your loan balance actually increases, effectively digging yourself deeper into whatever hole it was that motivated you to do it. There are circumstances where they are the best thing to do given the situation, but in my opinion, (at least for owner occupied property) it should be a temporary solution of last resort.

Caveat Emptor

Original here

One of the things that has constricted the most with the current paranoid lending environment is the ability to use rental income to qualify for a mortgage. It seems that lenders are seizing upon any excuse to deny income from rental property. Since the denial of rental income usually means that debt to income ratio is too high to qualify for a new loan, this means that if all of the ts are not crossed or if any i is left undotted, you don't qualify for the loan you're applying for.

The lenders do not have an unreasonable concern. Due to bad advice telling people to walk away from upside-down real estate (Seriously, don't walk away from upside down real estate if you can avoid it), and the phenomenon of "buy and bail" the lenders are losing money. It is not unreasonable of them not to want to lose money, and if you're planning to stiff your current lender, that is quite rightly something they should expect you to disclose and they are within their rights to guard against. It is a reasonable position to take that someone who stiffs one lender is more likely to stiff a second. Indeed, the entire credit model currently used is based off this well-documented fact. If you're planning to stiff someone, even though you haven't yet, that's something a reasonable person would agree should be grounds for rejecting your loan.

However, loan standards have gone completely overboard. One phenomenon that was (barely) tolerable when it was just a requirement for government loans was the requirement for appraisals on all property a loan applicant might own. Even if there's a stable, fixed rate loan in place with a positive cash flow, for the last couple years FHA loans and VA loans have both required exterior appraisals on other property the loan applicant might own. Furthermore, the standard for acceptance is a minimum of 30% current equity! As you can imagine in the current market, even if someone bought six or seven years ago, this can be hard in a lot of cases. Someone with an 800 credit score and thirty year fixed rate loan on their investment property, and 28% equity cannot get credit for rental payments, no matter how positive the cash flow! Is that brain dead or what? These people have taken care of their credit rating their whole life, invested frugally, managed their money well, have no late payments, have a positive cash flow every month on the investment property, have eighty or a hundred thousand dollars net equity even in a severely trashed market (as in that's what they'd get if they sold their $400,000 property), and the situation is even completely sustainable because the loan they have now is never going to adjust. Nonetheless, because they are being tarred with a broad brush of general market trouble, these folks cannot afford to buy a new property in the area their employer moved them to, thousands of miles away. If you know of a set of circumstances more likely to encourage people to do something shady, I'd like to hear about it.

At a cost of $300 per rental property appraisal, that's a not inconsiderable additional cost, either, especially since it has to be paid before the new loan funds in most cases. However, due to limits built into government loan programs, this didn't strike all that often when it was just official government loans. Now that the feds have their fingers into Fannie Mae and Freddie Mac, however, it's been expanded to include the entire A paper loan market, as even non-conforming loans tend to copy the standards expressed by Fannie and Freddie in all particulars except loan amount. The only exceptions currently being made are in portfolio loans, with all of their disadvantages, chief of which is a higher interest rate. We should all send Chris Dodd, Barney Frank, and other unindicted co-conspirators (including Barack Obama) a note of heavily sarcastic thanks for preventing the overhaul of Fannie and Freddie long enough so the government could take them over after ruining them. Maybe if all the guilty parties would take the campaign contributions made to encourage them to do this and use it to ameliorate the fallout, it might amount to a tenth of a percent of the damage they did, and are continuing to do.

In short, getting credit for rental income on an investment property has now become incredibly difficult when you're applying for a loan. This has the effect of artificially constricting the real estate market, because the mortgage market controls the real estate market, and it also constrains the start of any recovery. People in good solid situations cannot qualify to buy investment property, and the loan standards are making it harder for them to qualify for buy a new primary residence if their employer has transferred them or they've had to move to get a new job. The alternative of selling the previous property has a lot of reasons against it right now (off the top of my head, adding to supply in an oversupplied market, turning temporary losses on paper into hard losses with permanent consequences, and having to give up extra equity in order to compete with other properties on the market). Lest you misunderstand the socioeconomic consequences of this, it isn't the rich folks with mansions in La Jolla, Rancho Santa Fe, or up on Mt. Helix who are getting toasted by this. The people getting hurt are the middle class folk in the corporate trenches who work hard, save their money, and have to go where their job is.

Once upon a time, this was a legitimate use for stated income loans (and "no ratio" or NINA loans as well). The lenders would (and will) only allow a 75% credit for rental income, despite vacancy ratios consistently in the 2-3 percent range in markets like San Diego and New York. It is very possible to be making money hand over fist, even showing such on your taxes, and still have the accounting lenders use in loan qualification show you as losing what was left of your shirt and undershorts every month. Unfortunately, once people figured out the illegitimate uses to which stated income could be put, it was only a matter of time until lenders stopped accepting stated income loans and regulators started regulating it out of existence. There are no longer any lenders offering stated income loans that I am aware of. Federally Regulated institutions cannot, and since people who needed them went to few remaining institutions like a shot, they got nervous about stated income being too large a proportion of their portfolio and stopped offering them.

If you need a loan but are unable to qualify because of these ridiculous requirements, what can you do? Well, most people can't really create thirty percent equity while at the same time coming up with a down payment. Even if they've got the cash for one, they don't have the cash for both. For those in such situations, there are some serious decisions that need to be made: whether to sell their former residence so they can buy now, rent for a while until they do have the required thirty percent equity, or pay higher rates for portfolio loans. A general knowledge of phenomena like leverage and the fact that Buyer's Markets Are A Great Time For Moving Up (but a lousy time for moving down) gives me general ideas of what's likely to be best, but every situation needs to be evaluated individually, and there is no such thing as a risk free move. Anything options you might have - including to do nothing - all have their downside risks.

If you can meet the basic qualification (30% equity on all investment properties), you can prevent something stupid from disqualifying you. All monies received on rental properties need to have a paper trail leading back to the renter - especially deposit checks. Do not accept cash if you can avoid it. If you can't avoid it, create a receipt and make a copy of everything, and have the tenant sign everything, including that receipt for money they are paying you. Include a clause about cooperating with any mortgage applications you may submit in your rental agreements. Lenders are requiring a canceled deposit check, and the only way to get that may be from the tenant. All leases should be for at least a one year period. I hate to say it, but it may be worth paying a management company to manage your property in order to have third party verification of the accounting, even though lenders are increasingly skeptical of any third party attestations. There have been too many attestations that did not tell "the truth, the whole truth, and nothing but the truth."

It isn't impossible to get credit for rental income, but due to the current environment, most lenders are making it far more difficult than it should be. Take action ahead of time, and be aware that having a rental property can severely impact your budget for buying a new primary residence, particularly if you don't have the required equity. Better to limit yourself in the first place to something you will be able to afford per current underwriting guidelines, because otherwise you are risking the deposit and any money you spend investigating that property. If the lender won't give you credit for rental income, a property that you thought you had good reason to believe within your reach can be completely beyond the realm of possibility.

Caveat Emptor

Original article here

A few years ago, underwriting standards were way too loose. Lenders were competing for loans, and the presumption was that with real estate having continued to gain in value, it was difficult to actually lose money on real estate. Needless to say, that presumption has now changed. Lenders are stuck on the horns of a dilemma. They have had massive losses on real estate loans, yet real estate loans offer a very large profit center. Furthermore, because The Mortgage Loan Market Controls the Real Estate Market, the more they constrict lending policy, the more money they lose on those people who have no choice but to sell. It's a tragedy of the commons type situation, though, as any given lender loosening their loan policy exposes themselves to the risk of a bad loan, while only reaping a fraction of the benefit on their existing loans.

Therefore, the individually rational decision for them is to be very careful that the loans they do make are going to be repaid. And boy are they. Underwriting standards have become completely paranoid. Things that were not an issue at any time in the last ten years are becoming "Loanbusters." There have been quite a few additions to that category of late.

To give an example, I spent three full days arguing about a rental property my client had 2000 miles away. Because the client had accepted a cash deposit as opposed to a check, they did not want to give my client credit for the monthly rental, despite the fact that the property had been rented for several months. With the rental income, my client was able to satisfy debt to income ratio requirements and the new loan was no risk at all. Without the rental income, debt to income ratio was too high. The client had everything else - bona fide transfer from employer, plenty of income documentation, time in line of work, etcetera, and remember that the property had been rented for several months - with canceled rental checks to boot. But because the basic underwriting standard is to demonstrate payment of a deposit via a canceled check in order to credit rental income, I had to argue the case - along with the reasons for the underwriting standards - up four levels in the process before I got to someone with the authority and understanding of the reasons for the underwriting standards to agree to an alternative standard my client could meet.

You can help yourself in advance of applying for a loan. Have a paper trail for all money - especially anything having to do with any rental property you might own. Document all of your income, especially on your taxes. Pretty much every single loan done right now is requiring IRS form 4506T. The only exceptions I'm aware of are portfolio lenders, and damned few of them. Be careful moving your money around, and be certain there is a paper trail sourcing all money that appears on any of your bank statements. Where did the money come from? Also be aware that just because you made $X this month does not mean lenders will necessarily accept your income as being $X per month. In general, income is averaged over the previous two years, so if you've had a big raise you were counting upon for loan qualification, you might not get full credit for it. In case of doubt or dispute, the numbers on your tax form - that you reported to the IRS and paid taxes on - becomes the ultimate fall back.

It has become more expensive to get a loan, and more problematical. Investment properties, in particular, are creating many problems. Since for several years, government loans required exterior appraisals on investment property (at a cost of about $300 each), even if they weren't involved in the current loan application. They want to see 30% equity on every property - difficult in the current market. Fortunately, people with investment property have always been comparatively rare on VA and FHA loans due to limits built into those programs. In the last two weeks, however, these standards have spread to conventional Fannie Mae and Freddie Mac loans, a much bigger problem. Once again, portfolio lenders may be the only alternative. Since portfolio lenders tend to have significantly higher rates, not having 30% equity on an investment property can mean you can't get a loan that makes it worthwhile to refinance, and it might mean you can't qualify to buy a property, even if the investment property is thousands of miles away from your current job. Is this brain damaged, or what? However, it's the way things are right now - and I guarantee your loan officer isn't any happier about it than you are.

Rates are great right now - so much so that it's easy for most people to find better loans than the one they've got. Actually qualifying for that loan is much more problematical, and by "qualifying" I mean meeting all of the underwriting and funding standards so that you actually get that loan. The best loan quote in the world isn't going to do any good if the loan can't be funded. My processor is telling me stories of other loan officers she works with that are losing sixty to seventy five percent of the loans they work with. If you don't think that's having an effect on the prices they have to charge and the margin they need on successful loans, you'd better think again. They can only work on so many loans at once!

The importance of this is much greater for purchases than it is for refinances. On a refinance, you still have your existing loan. If the new loan doesn't get funded, it's usually not such a big deal. You still have the property, you still have the existing loan, and you can try again. On a purchase, you've got a good faith deposit at risk on a ticking clock. One loan getting rejected can mean you lose the deposit, the property, and anything you've spent investigating it.

Given this, what advice do I have to give? Underwriting standards and flexibility vary from lender to lender. Because one lender is not willing to compromise on an issue doesn't mean that nobody is. However, for the average person applying with a direct lender, it's a matter of cut and try. If the loan fails, you have to start all over, and that includes paying for a new appraisal. A new inspection, too, if you have to find a new property because the seller got tired of waiting and sold to someone else. All of this is wasteful of money, not to mention your time and patience.

Brokers, however, have already had experience with what lenders are being hardcore and unreasonable about what issues, and which are acting in a matter closer to sane. Furthermore, if you're the one where they find out with a problem at a particular lender, they can resubmit the loan package elsewhere, and because the appraisal is done in their name, they don't need a new appraisal, and brokers can usually use exactly the same loan package except for one piece of paper.

You also want to choose a loan officer who has the time to argue your case with a particular lender, and motivation to do so. If you're one of fifty loans that month, the loan officer doesn't have the three days I spent arguing with underwriters so that you can get the great rate you have locked in - not to mention losing time on a purchase contract if you have to resubmit to a new lender. If your buyer's agent does loans themselves, it might be worth considering for this reason alone. I would like to think I would have argued just as hard anyway, but I wasn't just arguing about a loan that meant a standard commission to me. I was arguing over a loan that meant not only that, but an agency paycheck as well, and the house my new friends had their heart set on, the months of work we spent picking it out and negotiating the sale, and their deposit. I had all the motivation I could possibly want. My processor was floored that I argued it up as far as I did, and that it worked. Most of the loan officers she works with were letting arguments drop a lot earlier than that. Quite a few are basically just wringing their hands in despair. That seems to be consistent with the stories I'm hearing from consumers elsewhere.

Caveat Emptor

Original article here

The short answer is "Because it costs less". It costs more money to get a lower rate - simple fact. It takes time to recover the extra money you spend to get a lower rate via that lowered cost of interest, and most folks don't keep their loans long enough.

There is always a trade-off between rate and cost on a given loan type. If you want the thirty year fixed rate loan half a percent lower than everybody else is getting, you're going to pay for it in the form of discount points. The higher cost always goes with the lower rate. You might as well consider it a law of nature in the same league as gravity, because it is a law of economics. If you don't want to pay high costs, you end up with a higher rate. End of story. There are all kinds of games that can be played with loan quotes, but the fact of the matter is that of the tens or hundreds of thousands of rate sheets I've seen from over two hundred different lenders from A paper all the way down to hard money, every single one of them conforms to this fundamental truth. A 6.00 percent loan will cost more from the same lender at the same time than a 6.50 percent loan of the same type. Some lenders have different trade-offs than others because they are aiming at different target markets. I could tell you about lenders that rarely have a rate below par on their sheet, and lenders that rarely have a rate above par, par being the point at which there are no discount points to get the rate, but no yield spread either. Some lender's par may be lower than others, or higher. The par on a completely different loan type, or loan program, will be different. Par varies with time, the qualifications of the borrower, the type of loan they desire, the type of documentation they are providing, and other concerns as well.

The cost of a loan is sunk - spent at the beginning in order to get that loan. Once you have the loan, the money you spend to get it is gone, whether you paid it out of pocket or rolled it into your balance. If you sell or refinance before you have recovered it via lower interest costs, you don't get it back. Actually, if you roll it into your balance, the money isn't gone, because you still owe it and you're paying interest on it. If you sell the property, it will mean you get less money, and if you refinance again, your balance will still be higher than if you hadn't added that money to your balance. Paying it out of your pocket is no better, because you could be investing that money, likely at a higher rate of return than the rate on most loans.

Now here's a very old rate sheet I saved from a random lender. The rates are very different now. All of the lock periods I am quoting to were thirty days. I'm going to presume a $400,000 total loan, as if you're doing a cash out refinance to a specific loan to value ratio, but the principles are the same no matter the loan size.

Alternatively, If you owe $400,000 and roll the costs into the balance, it becomes the following. Actually, the costs are mostly higher because points are computed based upon final loan amount, while I was too lazy to recompute from the previous example. Also, the maximum conforming loan is $417,000 currently (in most areas - San Diego, among others, is higher), so going over that would cause the rates to rise notably, but assuming you have a 7% interest rate now, this is how quickly you would recover the costs of the new loan:

People shop loans by payment. They shouldn't, but they do. Furthermore, a lot of people seem to get quite a stroke out of bragging that they have a low interest rate. But if you add $19,000 to your balance and only keep the loan long enough to recover $15,000 in interest, you've gotten a negative 20% return on your money - not including the time value of money. Furthermore, this money usually equates to the fact that you're going to have a higher balance and end up paying more money and higher interest on your next loan.

It may be counter-intuitive, but it is easier to qualify for a loan with a lower rate, because the payments are lower, and therefore the Debt to income ratio is better. So any time somebody tells you that you didn't qualify for the same loan at a lower rate, you know it's nonsense. If you qualify for the program at all, you qualify more easily with a lower payment. This begs the question of whether you qualify for the program at all - your credit score could be too low, or it might not allow a loan to value ratio or debt to income ratio or any of many other situations you find yourself in, but if you qualify for the program, you will qualify at the lower rate. It may be smarter to want the higher rate, but that can be effectively eliminated by debt to income ratio.

So that's why low and zero cost loans are not popular. Most people focus in on either payment or interest rate, and when they discover that the low or zero cost loan means a higher interest rate, they're not interested. Relating to the ease of qualification issue on purchases, most people also try to stretch their budget to buy a more expensive house than they should. This makes lower cost, higher rate loans even less likely - even if the people were interested, accepting a lower cost loan would mean they can't have the house they've got their hearts set upon. But if you don't keep the loan long enough to recover the additional costs, you're wasting money. On refinances, only a true zero cost loan can have you ahead immediately, but advertising or selling zero cost loans is like King Canute trying to command the tide to turn. Most people aren't interested.

There are other considerations. At this update, rates are so low they're unlikely to be bettered ever, and if you're in the property you're going to spend the rest of your life in (and never take cash out), it makes sense to spend some money to buy the rate down. If you're not intending to sell any time soon, it's likely to be a good idea to pay part of a point or even a full one, as you're likely to be keeping the loan longer, and the median time between refinancing is likely to rise. Nonetheless, there are limits on the size of any bet you want to make, and when you pay costs up front for a loan rate, you are making a bet with your lender that you're going to keep it long enough to more than recover those costs. For quite a few years now, the lenders have been winning the vast majority of those bets.

Caveat Emptor

Original article here

One of the things that is really helping military families afford good properties is the military housing allowance and the way that lenders treat it, making it much easier for them to qualify with regards to debt to income ratio, while the magic bullet of VA loans makes loan to value ratio essentially a non-issue. Between these benefits, the military is sitting pretty for being able to afford housing.

I should mention that this math helps non-military getting a housing allowance just as much, but there are relatively few people outside of the military receiving a housing allowance.

Receiving a housing allowance actually works out far more advantageously for purposes of loan qualification than if they just paid them the extra money. $X basic salary plus $Y housing allowance is demonstrably more money than a salary of $X+Y as far as qualifying for a real estate loan goes. Here's how it works.

To start with, the housing allowance is generally non-taxable. I'm sure you know that's not the case with your basic salary. The $Y extra you get in allowance really is $Y, not the much lesser amount that you would get to keep if paid that in salary.

On top of that, the housing allowance is "soaked off" against the expenses of housing on a dollar for dollar basis. In other words, compute your cost of housing - principal and interest on the loan, taxes, insurance, Homeowner's Association dues, Mello-Roos, etcetera. Add them all up. From this, subtract housing allowance. If the housing allowance is more than actual cost of housing, we're all done. You made it, at least on the basis of debt to income ratio. If the costs are more than the allowance, all is not lost. At this point, you have to add in other debt service to whatever is left, but then so long as you are less than the normally allowed debt to income ratio as compared to your regular salary, you still qualify. Is this a great country, or what?

Here's a concrete example of how it all works: Let's say you make $3000 per month salary from the military. In addition to that, you get a $2000 housing allowance. You have other monthly debts of $250, and you want to buy a property where the monthly expenses of owning it (principal and interest on sustainable loan, taxes, and insurance, or PITI) are $2500. If you made that $5000 per month as a regular working schmoe, you would be told you aren't likely to qualify. Your "front end" ratio would be 50%, and adding the other monthly debt service makes 55%. Normal guidelines are 45% "back end" (housing plus all other debt service) for conforming loans, and you're way over that on the front end alone. Maybe in some circumstances such as disability or retirement income with a "walks on water" credit score, that might be accepted by one of the automated loan underwriting systems, but under manual underwriting rules you are dead in the water.

As the beneficiary of that housing allowance, however, things are quite different. The $2000 housing allowance draws off housing expense dollar for dollar, not at the 45% ratio of the rest of your salary. Instead of $1 enabling you to have forty-five cents of housing expense, it enables your to have $1. So subtract $2000 housing allowance from $2500 housing expense, and you have $500 left over.

If housing allowance was $2500 against that $2500 housing expense, or to use the general case, if housing expense was less than or equal to housing allowance, we'd be done, at least on the grounds of debt to income ratio. We're not done yet in this case, but the remaining $500 of housing expense plus $250 of other debt service equals $750, which divided by $3000 regular income yields a 25% back end ratio. Since this is less than 45%, bing! Debt to Income ratio works - by which I mean that you are over the most important hurdle in loan qualification.

So there you have an example where somebody making exactly the same number of dollars does not qualify where someone getting part of their salary via a housing allowance does. Since the military is pretty much the only folks that get paid that way (I can't remember the last time I had anyone not in the military with a housing allowance), advantage: military.

A couple of caveats need to be mentioned and emphasized right now. As should be obvious to the mathematically inclined, Comparatively small amounts of difference make much larger differences to debt to income ratio. Change the PITI payment to $3000, and your debt to income ratio stands at 40 percent, getting close to the ultimate edge of qualification.

You should also be careful that you really can make the payment on the loan. Foreclosure is no fun, as millions can attest right now. Make certain you really can make the payment, considering your family's lifestyle and other bills that may not be monthly debt but would be difficult to eliminate. I have written multiple times warning Never Choose A Loan (or a Property) Based Upon Payment.

Because I am normally careful to quote in terms of purchase price and loan amount and interest rate, I want to say why I did it this way, quoting in terms of payment, in this case. It's a complex subject, and the math gets hairy very quickly, and varies constantly and from market to market and time to time as interest rates and home prices change. Judging by my traffic, people are going to be reading this article months from now, if not years. I wanted a concrete, easily understood example of the subject that's not going to be completely out of line six months from now when the rates have changed and some housing markets are recovering strongly while others are in the process of crashing.

I also should observe that companies looking to help their employees while conserving costs can do this every bit as much as the military does by carving off a portion of the salary and paying it in the form of housing allowance - but in order to do that, they'd have to admit these people were employees. Pay the social security taxes lots of companies are manipulating the law to avoid, give them all the rights contractors don't have in employment. Of course, the reason why that happens is due to government action. Every time the legislature or some judge adds another cost to having employees or makes it more difficult to terminate those who need to be terminated, they give corporations another reason to avoid hiring them in the first place.

Caveat Emptor

Original article here