Mortgages: March 2018 Archives

I keep reading stuff on the internet advising people who are upside down to just walk away if they are a upside down on their mortgage. This has got to be right up there with the worst financial advice I have ever heard.

Here's the thinking: You owe more than the property is worth, and the loan is non-recourse. So the thinking goes that if you just stop making payments and walk away from the property, you're essentially paying yourself the difference.

Not so.

First off, debt forgiveness is taxable income. You borrow $500,000 for a home, that's exactly the same as the lender handing you $500,000. If they only get $400,000 back when the home sells, that's $100,000 of taxable income to you. While it is true that there is currently a temporary federal amendment to the tax code still on the books at this point in time, it will expire, and your state may not have such an amendment. The lenders really don't like this as it encourages people to lose them money, and contrary to campaign propaganda, it isn't the Republicans who have been dancing to the tune of the lender's lobby.

Second, your credit is going to take a hit that is going to last up to ten years. Not seven, not two. From Form 1003, the federally required loan application. Every single real estate loan through a regulated lender must use this form. Some of the "Thirteen Deadly Questions" on page four of the form:

a. Are there any outstanding judgments against you?

b. Have you been declared bankrupt within the past 7 years?

c. Have you had property foreclosed upon, or given title or given deed in lieu thereof within the last seven years?

...

e. Have you been obligated on any loan resulted in foreclosure, transfer of title in lieu of foreclosure, or judgment?

f. Are you presently delinquent or in default on any federal debt or any other loan, mortgage, financial obligation bond or loan guarantee?

Look at question e again. There is no time limit. You will be answering that question "Yes" for the rest of your life. How do you think "I quit making payments because the value of the house decreased" is going to wash as an explanation to an underwriter? If you want your loan approved, even forty years from now, I strongly suggest you have done everything you possibly could to make good on the debt. Judgments typically last ten years, as does the notation, "Settled account." You are going to have a period of two years where lenders can't touch you, even if they want to, it can be ten years before they're willing to take a chance, and you're going to be sweating the fall-out to question e for the rest of your life, because that is cause for extra underwriter scrutiny, and a lender being unwilling to approve even minor variations forever.

Here's something lots of folks aren't considering: It's true that purchase money loans are non-recourse in California and many other states. That's a good thing, as far as it goes. But there are limitations upon that. One of the limitations is fraud. here's the legal definition of fraud:

All multifarious means which human ingenuity can devise, and which are resorted to by one individual to get an advantage over another by false suggestions or suppression of the truth. It includes all surprises, tricks, cunning or dissembling, and any unfair way which another is cheated.

Did you "shade the truth" on your loan application? Lots of folks did. This is a big problem, and one reason why I have always hated stated income loans. Just because the lender doesn't hit it today when the property sells, doesn't mean it goes away. The lender has a minimum of three years to file a suit. They may file a suit even on comparatively small amounts of several tens of thousands of dollars, hoping that you don't show up in court. If you don't show up, the default judgment is entered against you, and that is very hard to overturn. If you lied on your loan application, that turns even a non-recourse loan into a recourse loan. They can go after savings, retirement assets, pension plans, attach your paycheck, you name it. Even if they don't want the rigamarole themselves, they can sell the rights to collect, or even put them out to law firms looking for a bounty on whatever they can get out of you.

Furthermore, if there's some reason to do so, they can pass the paperwork on for criminal investigation. Fraud carries criminal penalties, and it's the government footing all the bills of pressing the case.

Now here is another reason why you shouldn't walk away: If you do so, you are taking all of these consequences and bringing them into the here and now of concrete consequence of actions that have already been taken. But the real estate market is cyclical. Just keep making your payments, and it will come back. Maybe there are some exceptions to this, but I'm not aware of any.

Let's look at a personal experience I had with my first property. Bought for $90,000 in 1990, value peaked at $106,000 the next year, then crashed to $63,000. I didn't buy "zero down" like probably the majority in the recent price run-up, but the principle is the same. Some people thought they should walk away. Having lived through four previous cycles locally, I just kept on keeping on with the payments. By 1996, the property was worth more than I paid again, and not too long after, people who had just kept on keeping on with their payments were in a position to sell for a huge profit.

Had I sold while the property market was down in the nineties, I would have suffered most if not all of these consequences. By just making the payments, I effectively let time fix the market for me.

By making those payments, all you're doing is sitting on a temporary loss on paper, as opposed to turning it into a hard loss with real world consequences. The paper loss has precisely zero importance - unless you sell while the market is down. The only times the value of the property is important is when you refinance, and when you sell. It doesn't matter what the value is at other times - unless you make it matter by choosing to sell. If you've got a sustainable loan, keep making the payments, and in two years or five, you'll be in a position for make money again when you sell. What's hurting the real estate markets badly is excess supply and low demand, caused by people who have no choice but to sell, and fewer buyers than usual. What happens when these conditions go back to a more normal market? That's right, the prices go back right where they were - if not higher.

Furthermore, if you get out by selling short or through foreclosure, it's not like you're going to be able to jump back into something else any time soon. Absolute minimum two years, as above, and perhaps much longer than that. You jump out of an upside-down mortgage, and you're going to be sitting out the absolute sweetest time to be in the market - right when it starts to recover. You sell or allow foreclosure, and you turn that theoretical paper loss of $100,000 into a real concrete loss of $100,000. That's permanent, and you're out of the market until lenders are willing to take another chance on you, which could be never. But, if you stay in the property, when it starts gaining value again, you're still in the market. I know lots of people that turned $30,000, $50,000, $100,000 or more of temporary paper losses into profits several times the size, simply by holding on and allowing the market time to recover. Profit or loss on an investment is measured solely by price at acquisition versus price at disposition. If you buy for $500,000 and sell for $300,000, it makes precisely zero difference that it was worth $700,000 at some point in the middle. Similarly, if you buy for $300,000 and sell for $500,000, the fact that the property was worthless at some point between is irrelevant to the fact that you still made a $200,000 profit.

If you have an unsustainable loan, there are options to deal with the problem. Refinance if you can. If you can't, call your lender and see what you can work out, or try a loan modification. For their part, lenders are trying to keep the problem from getting worse than it has to be, and every time someone takes a loss because they couldn't hang on, the lenders take the exact same loss if not worse. There are limits to what they are willing to do, but I am amazed at some of the deals they really have accepted because they believe it is better than what will happen if they don't. Which situation would you rather be in: able to hold on and eagerly awaiting the market comeback that's going to happen, and will benefit those than hang on, or stuck with a bad situation permanently because you couldn't stand the thought of being upside-down on paper?

Caveat Emptor

Original article here

In talking about loan modification, I have said it is not a panacea. Let's look at why not, and situations where it just flat out is not going to work.

Loan modification is a strategy for the lender to mitigate their loss, not a "be kind to borrowers" holiday. The lender has to make out better by agreeing to the loan modification than anything else they could do. This means if they can get all of their money by foreclosing, but won't get all of their money via a loan modification, then they will foreclose. The first rule of getting a loan to pay for a property is that the lender always gets every penny of their money first. If they hadn't loaned it to you, you wouldn't have the property in the first place!

The obvious situation where a loan modification is not appropriate is where you have the ability to refinance in a more normal fashion. If you have the ability to refinance into something more sustainable, I'd suggest doing so without delay. The fact that you don't want to or may be hoping for something better is unimportant. What you're trying to do is keep your property, and not kill your credit-worthiness. If you are able to refinance, get it done.

The second situation is if you have 20% or more equity. In such cases, the lender is going to tell you to sell or refinance the property if you can't make the payments. Never mind that the market is down and it's a rotten time to sell, if the sale of the property will clearly net the lender their money, they are probably not going to agree to a loan modification. Plus, if you do sell, you come away with some cash. If you decide not to sell despite the lender's advice, they will foreclose. They're still going to get their money - which is what you agreed to when you took out the loan - before you get a penny, and you're still not going to have the house. I've written before about what happens to equity under foreclosureThe fact that you don't want to is basically irrelevant. Here's the situation: You owe them their money. You agreed to pay it back in order to get custody of their money and buy the house. They want it; They have shareholders to whom they have a fiduciary duty to get the best return on their money.

The third situation is if you have no income, or a clearly insufficient income to ever pay the loan back. If you're unemployed, there's not an income there to make the payments with. If you were a million dollar per year stockbroker, but now you're a minimum wage employee, you're not going to keep your million dollar property. You are asking them to modify the loan to help both you and the lender. But if the debt to income ratio is not going to work at any reasonable rate of interest, why should they modify your loan if there is no ability to make the modified payments? If all you can afford is 0% interest for the forseeable future, it's only going to get worse from here on out. They might as well bite the bullet and foreclose, because modifying the loan isn't going to do them any good. You''re still going to need to be foreclosed upon.

The fourth situation is new debts - particularly voluntary ones. Some folks see themselves headed off the edge and charge up a storm on all their credit cards, and take out loans for cars, furniture, etcetera. They figure that bankrupt for an additional $100,000 isn't any worse. They're wrong, by the way. If you only have one debt you can't pay, but four credit cards all with zero balances and you go to bankruptcy, you only included 20 percent of your lines of credit in the bankruptcy, and that hurts your credit a lot less than including those four cards and five more tradelines. The person who goes bankrupt with only one bad line of credit while keeping several good ones will probably still have open lines of credit, to boot, and therefore the means of re-establishing payment history. The zero balance credit cards will likely move you to a higher interest rate and more unfavorable terms if you declare bankruptcy, but they will quite likely want you to remain their customer. After all, they got every penny they were due from you!

But if you just took out another $20,000 in debt, that is, in the lender's eyes, evidence of irresponsibility. You already can't make your debt payments, and you go out and get some more? In cases like this, they're not very forgiving of the behavior. Why should they modify their loan when to their eyes you are simply likely to go out and get yourself further into debt?

Loan modification is a possible way out when you cannot refinance, there is no equity, and you have an income and have been behaving responsibly. You just got caught by circumstances beyond your control. If any of these do not apply, you shouldn't expect your lender to agree to bail you out by modifying the loan, when there is clearly no incentive from their point of view in doing so, and they're just going to lose more money if they do. They're not being mean when they refuse to modify a loan. They are simply facing the facts of the way that they lose the least amount of money.

Caveat Emptor

Original article here

I keep talking with people who don't understand that a higher interest rate on a refinance can result in a lower payment even though the cost of money goes up. In fact, they don't understand why refinancing tends to lower the payment at all.

Before I go any further, I need to reiterate my standard warning that you should Never Choose A Loan (or a House) Based Upon Payment. There are all kinds of games lenders and loan officers can play to manipulate your apparent payment.

Now, as to why refinancing tends to lower the payment: It's actually very simple: Because you are extending the period of the loan. You're spreading the repayment of the principal over an entirely new thirty year period starting today, and going out thirty years from now, instead of thirty years from whenever you originally started.

Let's say you took out a home loan five years ago for $300,000 at 6% on a thirty year fixed rate basis. Your payment has been $1798.66, and assuming you've just been going along and making minimum payments, you have paid your principal down to $279,163. Even adding $3500 in closing costs into your loan balance, if you refinance again at exactly the same rate, your payment will drop to $1611.72. If you divide the cost by the payment savings, it looks like you break even in less than two years!

However, that isn't a valid calculation. What you're doing is taking a loan with a remaining period of 25 years, adding $3500, and swapping it for a brand new 30 year loan, serving no purpose except to extend the period for which you have borrowed the money by 5 years. Your monthly cost of interest actually goes up, because you owe $3500 more on the new loan at the same rate, not to mention that $3500 is real money you paid to get the loan done for no real benefit! Your total of remaining payments goes up by over $40,000! Even if you keep making the same payments ($1798.66), you have added nine months to your loan! This also leaves aside all kinds of games that can be played with payment in the short term.

Never choose a loan based upon payment. If you will remember this one rule, you will save yourself from more than fifty percent of the traps out there. Loan officers and real estate agents and everything else tend to sell by payment. You do need to be able to afford the payment, and I mean not just now but what it's going to go to in five years. With that said, however, remember the fact that payment can be extended out practically indefinitely. Used to be with credit cards taking 26 years to pay off by minimum payments, you could be paying off a restaurant meal 25 years after the crop it was processed into fertilizer for was harvested, costing you five to ten times the original cost of the meal. The same principle applies for real estate loans. Unless it's a cash out loan, or a higher interest rate, you're likely to cut the payment just based upon the fact that you are extending the term.

I have also said this before, but just because they quote you a lower payment to get you to sign up for the loan doesn't mean it'll be that low when you actually go to sign documents. In a case like this, it is very possible for them to conveniently "forget" to tell you about prepaid interest, impound accounts, third party and junk fees, and origination points, all of which will add to the balance on your loan and have the effect of raising the payment reflected upon the final documents. So you sign up expecting your payment to drop by $180 plus, and at final signing, you've paid $10,000 more than they told you about and you are only lowering your payment by $80, but it's all done and it would be wasted effort if you don't sign these final documents, so you do - blissfully unaware that you have actually done something worse than wasting that $13,000 you added to your balance to get your loan done. This is real money, despite the fact that it didn't come out of your checkbook - you've just added $13,000 to what you owe, removing $13,000 in real money to what you have. In fact, you've just added about $75,000 to the actual costs of paying off your property! And the loan company got paid to talk you into this!

If you're not sure if you should refinance, one of the questions to ask yourself is "What would happen if I keep making the same payments as now? Would I be done sooner, or would it take longer?" It's hardly a foolproof question, but taking a financial calculator to closing, and plugging the new balance and interest rate reflected on the new loan documents together with your old payment, and seeing whether it results in a quicker payoff, is certainly one good check upon the ability of slick operators to sell you a bill of goods. This doesn't work for cash out or consolidation loan refinances, obviously, but for "rate/term", where the attraction is is simply a lower payment or lower interest rate, it's certainly one question worthy of asking. An answer that's less than your current total doesn't mean it's a smart loan to be doing, but a longer payoff is a pretty universal indicator that it's not.

Refinancing to lower your rate can certainly be a major benefit to you, as I've said before, but you need to crank the numbers to see if it actually helps your situation, as opposed to stretching out your loan term to make it seem like your costs have gone down, when in fact they have done no such thing. With thousands and tens of thousands of dollars on the line, it might even be smart to pay a disinterested expert to run the calculations. Let's say you pay $200 for an hour of their time, which saves you from making that $75,000 mistake I describe above. The downside is you wrote a check for $200. The upside is that you don't end up writing checks for $75,000 more than you needed to. If you understand finance yourself, the computations aren't difficult, and that $40 financial calculator will save you as often as you ask it questions, although you might have to feed it a $2 battery occasionally. If you aren't certain how to do the calculations, or what calculations you need to do, by all means give your accountant a call.

Caveat Emptor

Original article here

It is nice to have a tool that I can use to keep people in their homes, rather than going through foreclosure or short sales, and killing your credit and ability to qualify for a home loan for a minimum of two years. That is the Loan Modification Program. It's very little comfort when turning someone away because there is nothing I can do to tell myself, "I didn't do it to them. I was trying to talk people out of it before it became a problem." Loan Modification gives me a tool with a pretty decent success rate (sixty to ninety percent, depending upon the lender). It's not a panacea, it doesn't work miracles, and it doesn't work for everyone. It also costs money. With that said, it's a much lower cost than a short sale or foreclosure, and it will work for more people than probably any other measure to prevent those results in people on a course for them.

A Loan Modification program is a modification to an existing loan. Because the lender is already on the hook for major losses, it's a lot easier to get pushed through than a new loan. If you are upside-down on your mortgage, it is a way to get your loan changed into something you can make the payments on without the lenders agreeing to write down the value of the principal, which just isn't happening for the most part. Loan to Value Ratio just isn't an issue. The idea is to reach a Debt to Income Ratio that enables you to make and stay current on your payments in the future. Most lenders are modifying loans for a debt to income ("front end") ratio in the low thirties - while some are modifying for a "back end" ratio in the high thirties. The idea is that this enables you to be current on the loan and stay in the property, while it turns the loan into a performing asset for the lender, preventing them from losing more money than they have to.

Lots of folks want the principal of the loan written down. The problems with this are two-fold. First, it becomes an immediate loss for that lender - a hard loss. They were owed $400,000, and now they are only owed $300,000. That's $100,000 in company equity gone. Second, it provides an opportunity for current owners to make a profit on money that was previously owed to that lender. If the person is able to sell for $350,000 (whether immediately or years later), they still make $50,000 less the expense of selling the property, while the lender is just out in the cold for that extra money. You get them to give you money so you make a profit? Lenders don't like that math. The chances of them agreeing to do a principal reduction are very slim. The figure quoted was 1.6% of mortgage modifications that actually happen include some sort of principal reduction - one in sixty - and those typically include issues like death or disability of the main breadwinner. Do you want to spend the $3000 to $7000 modification costs for a one in sixty chance, or do you want to do it correctly with an approach that is about 60% or higher (depending upon your lender) likely to work?

What lenders are often willing to do is modify the loan in such a way as to reduce the interest rate, or payments owed, in some fashion. This doesn't magically give you money, but it does make the dire consequences of owing too much money bearable. It is far better in most cases for your long term financial health than walking away or going through foreclosure. If you owe $400,000 at 8%, reducing that interest rate to 6% will make as much difference to affordability as reducing your principal by $75,000 and starting the loan over combined. Not to mention that every successful loan modification is a relief from delinquency. You start over on the newly modified loan completely up to date on your payments.

Here is the lender's situation: They are on the hook for the value of the loan. If you go through a short sale, they lose money - about a fifth of the value of the loan on average. This is an immediate charge against the company's book value. For properties that go through foreclosure, the percentage loss is about doubled, in aggregate. Nationally, foreclosures cost lenders $47,000 to $61,000 per property, in addition to the lowered value from being a foreclosure. If they agree to modify your loan, it's a hit against future income, but it is not a direct hit on the book value of the company, and it turns a non-performing asset into a performing asset as soon as you've made a payment or two - much quicker than foreclosure. Finally, it gives them at least a glimmer of hope down the road of recovering all of their money - a very good hope, in my opinion, as the market will recover in time - and keeps them from losing more money than they have to now. It also, not coincidentally, locks you into keeping the loan with them for the forseeable future, because nobody else is going to refinance an upside-down loan.

This is nothing short of a financial lifesaver: Let us compare the situation now with the situation in the early nineties. I bought my first property for $90,000 in 1990. It peaked in value at about $110,000, then slid straight down to $63,000 in 1994. I was upside down for a little while. But I didn't sell, and I didn't walk away. Had I done so, I would have lost $27,000 plus the costs of selling - turned a theoretical loss on paper into a concrete loss with major real world consequences. Instead, having a sustainable loan with payments I could make, I kept making those payments. By 1996, I was in the black again. Had I short sold, I would have locked in that loss, and my name would have been mud with lenders and I would not have gotten another loan after the short sale. Basically, by just keeping on making the payments, I kept from locking in a 30% or more loss, and turned it into over a 100% gain when the market recovered. Which situation would you rather be in: Ruin your financial future when you don't have to, or keep making the payments even though you may temporarily be upside down so you can eventually make a big profit? The property I had was the one I was tied to. I could have walked away, locked in that 30% plus loss, and been unable to get another loan for a minimum of two years, and have my credit cause me to be stuck with horrible loans for ten years (which would have cost me more than $27,000, if I could have gotten loans), or I could stick with the obligations I agreed to when I signed on the dotted line for that loan, have patience, and be rewarded when the market turned back up to the tune of better than 100% profit.

Now add being unable to make the payments to the situation I was in back then. That is the situation that lots of folks are in today. They not only cannot refinance, they can't make their current payments, either. Without something like loan modification, their situation is like Comet Schumaker-Levy 9, locked into a collision course with Jupiter, and nothing short of a miracle will break them off that course for disaster. You can use search engines to pull up some pretty spectacular images of what happened there.

Which of those situations would you rather be in? This market we are in now is a market in which the people who do the right thing (keep the property until the market recovers, instead of throwing it away because they happen to be upside-down on paper) will be rewarded when the market has worked through the immediate problems.

Funny how karma works sometimes.

Caveat Emptor

Original article here

One of the things I'm seeing more of in MLS listings and developer advertising, among other places, is the phrase "$X in closing cost credit (or "$X in free builder upgrades" given for using preferred lender"

Sounds like a bargain, right? Just use their lender and you get this multi-thousand dollar credit. After all, "All Mortgage Money Comes From The Same Place!" Free money, right?

Well possibly, but not very likely. What most companies are looking to do with this advertising is give people a reason not to shop around. They hope that because most people think that "All Mortgage Money Comes From The Same Place", the average customer will just stay there to apply for a loan. Many builders and conversion companies will throw roadblocks in your way if you try to use another lender. They cannot legally require you to use their loan company (at least not in California), but they can make it exceedingly difficult to go elsewhere. I've been told by builder's representatives on two occasions that I was wasting my time with a loan, because "If they don't use our lender, they won't get the property!" despite already having a signed purchase agreement. Roadblocks take all sorts of turns. They won't let the appraiser in. They won't cooperate with requests for information, without which the other loan is going nowhere. And so on and so forth.

The builders wouldn't give those incentives to use their lender, or throw roadblocks in your way when they're trying to sell you a property, if they weren't making more money with the loan. Quite often, they're making more money on the loan than they are from the sale. Put you into a loan half a percent above market, stick a three year prepayment penalty on it, and voila, anywhere from a 6 percent premium to perhaps 10 percent. To give you a comparison, around here an average brokerage makes 2.5 to 3 percent from a transaction, and industry average loan compensation is just over two percent. But the average consumer is distracted by these "free" upgrades or closing costs that they don't realize how badly they've been raked over the coals. If I can get you that $400,000 loan half a percent cheaper and with no prepayment penalty, I'm saving you $2000 per year for certain, and very likely about $12,000 on the prepayment penalty.

Furthermore, on some of the builder's loans I've analyzed, they're getting you a rate that would carry a point and a half retail rebate, even without the prepayment penalty. This means on a $400,000 loan at that rate, the lender would be paying you a $6000 incentive to do that loan, more than covering normal closing costs and a broker's normal margin. Have no fear, that builder is doing quite well for having loaned you that money. But that's okay, because it was "free", right?

What can an average person do about this sort of thing? As I've said before, builders often throw roadblocks in the way of outside lenders, and there's not a lot that you or anyone else can do about this fact.

The thing to keep in mind is to shop your loan, and to choose your loan based upon the bottom line to you. There is always a tradeoff between rate and cost, but the provider who can get you the loan a quarter percent cheaper for the same cost or at the same rate for $2000 less cost is the one you want.

Many people want brand new homes if they can get them. Given the realities about Mello-Roos and how prevalent homeowner's associations are in more recent developments, I'm not certain I understand this. It's one thing to deal with Mrs. Grundy when you're all cheek by jowl in a condominium high rise. It quite another thing to deal with her complaints because you left your garage door open ten minutes longer than the rules say, you want to paint your detached home a couple shades darker or lighter than everyone else, or whatever's got her dander up today.

I do have a trick or two up my sleeve for when I'm a buyer's agent in new developments. It's my job to outmanouever the selling agents the builder has on staff (who tend to be heavy hitting salesfolk). But they are dependent on some things that change from transaction to transaction, so I can't really describe them in any kind of universal terms. Writing an offer contingent upon an outside loan is good but has its limits. Builders who throw roadblocks have that one wired; they wait for the contingency to expire at which point they've either got your deposit or your loan business as you are so desperate not to lose your deposit you'll do almost anything, particularly since most folks don't understand how much that loan is really likely to cost them. But if you want the property, you can be forced to give in to these demands, which on a $500,000 property effectively add anywhere from $20,000 to $40,000, and possibly more, to the purchase price - an addition that most new development buyers would do well to consider in their computations of whether to buy in that development at all.

Caveat Emptor

Original here

I have in the past told people to ignore APR. APR should not be used to compare between loans. Not only is it a one dimensional number used to measure what is fundamentally a two-dimensional trade-off between rate and costs, but it is computed based upon you keeping the loan for the entire period - no refinancing, no selling the property, not even paying off the loan earlier. Basically, nobody does this. Why pay attention to a number that doesn't tell the entire picture, and wouldn't apply to you even if it did?

But there is something that the difference between the putative APR and note rate can tell you: How big the costs of the loan are. Don't read too much into this. As I may have mentioned a time or two, at loan sign up, these are only the rate and fees that they are admitting to. The APR is subject to every bit of low-balling that the Good Faith Estimate (or Mortgage Loan Disclosure Statement in California) is. Furthermore, be advised that prospective loan providers are permitted a lie, I mean an error, of a full eighth of a percent for fixed rate loans, twice that for ARMs. So be aware that unless you are careful to nail down prospective loan providers by asking all the right questions and requiring a quote guarantee, what you get won't be any more accurate than political spin.

Where this is primarily useful is in reading advertisements. Not that mortgage rate advertisements are a good place to be looking for loans, but people will persist no matter how much I warn them against it.

APR does not include all costs. Federal Reserve Regulation Z allows mortgage providers to exclude third party costs from the calculation. This includes escrow, title, and appraisal costs at a minimum, as well as notary and processing costs, if they are performed by outside providers. I'm going to assume a 6% thirty year fixed rate loan. For such a loan processed "in house" for $400 would have an APR of 6.056, while the same loan where the $600 processing was "contracted out" instead would have an APR of 6.044. Note that you pay $200 more for the loan with the lower APR! You therefore need to know what's included and excluded when comparing APRs. For the same reason, a loan where there's a difference of $1000 in fees due to one loan's title company, escrow company, or appraiser padding their pockets while those associated with the other loan don't, will not show up under APR calculations. If other factors are the same, the expensive loan will have precisely the same APR as the cheap one.

With all that said, let's look at a thirty year fixed rate loan, starting from a $300,000 balance, with $1500 of closing costs included per regulation Z, first, with all closing costs included, then paying all costs but no points (par), then with one point, then two points. These are rates that were really the best available when I wrote this, but seem very high now.

Note that a loan with two full points is pretty expensive. It costs almost $9400 in actual costs, never mind impounds or prepaid interest that you may also be adding to your balance and paying interest on. Nonetheless, it boosts APR over note rate by less than 1/4 of a percent, and that the actual APR keeps going down even though the costs are skyrocketing. This means that for people who shop by APR, loan providers will advertise a loan with even more points. Even though you'll never recover the costs of those points, if all you look at is APR, the lower rate looks better.

Now let's hold everything else constant, but pretend that you have a choice between refinancing a $300,000 balance on a 6% thirty year fixed rate loan with all costs paid, where you pay the costs but no points (par), with one point, and with two points. This is never going to actually happen - the cost differentials you will shop between will not be that broad. If there's that much difference between the loans you're being offered, something is wrong. It could any of a number of things - I can't tell exactly what without a lot more information. This much variance should never happen - I'm doing this solely for illustrative purposes, so you can see how costs influence APR. There is always that tradeoff between rate and costs, and they are more likely to discover physics that repeals gravity than economics that repeals this relationship.

With that said, here's the comparison.

Now keep in mind, that every number here in this article is as correct as I can make it. This is, once again, to illustrate how various factors influence APR, not to illustrate the games that can be played with APR.

What other factors influence APR?

The size of the loan makes a difference. A $100,000 loan with $1500 of included costs (per Reg Z) at a note rate of 6% has an APR of 6.142, while a $400,000 loan with the same costs has an APR of 6.035. Note that this is a pretty low-cost loan, but it makes a real difference to comparatively small loan amounts. The difference ordinary costs make for smaller loans is one reason why folks with smaller loan balances should focus far more on cost than rate. Given that most people don't keep their loans longer than about three years, it can be very difficult to recover increased initial costs of doing the loan via lowered interest costs.

The basic note rate also influences how much the same cost influences APR. A $300,000 loan with $1500 in non-excludable costs (under reg Z) at 9% has an APR of 9.056, a difference of (actually) 556 basis points higher, while the 6% loan with the same costs has an APR of 6.046, an actual difference of only 463 basis points. Lower note rate means that the same costs influence APR less.

The term of the loan makes a huge difference. If that same thirty year fixed rate loan at 6% in the previous paragraph was a 15 year loan, it would have an APR 6.078. Not only can this mean that at shorter loan terms, a lower cost loan with a higher note rate can actually have a higher APR, if further illustrates how counter-productive paying attention to APR is. When the APR is computed as if you allocated those costs over the term of the loan, and most people sell the property or refinance in three years or less, the proper term to compute spreading those costs over is two or three years, not thirty. If cutting that period in half, from 30 years to 15, almost doubles the APR spread, what do you think cutting the period still further does? I'll tell you: If you only keep that same loan three years, the effective APR is 6.333 - and this is a very inexpensive loan. That two point loan from the first example at 5.875 that gets you the low payment has an effective APR of 7.549 if you refinance it after three years! Not only that, but you're going to be paying for it in the form of higher interest costs on a higher balance for as long as you have a home loan, and probably quite a while thereafter. By comparison, let me call your attention to that true zero cost loan at 6.75% from the same example, which has an APR of 6.750, no matter what period it is computed over. If you're going to refinance or sell in three years, which of these loans do you think it makes more sense to choose?

Caveat Emptor

Original article here

One of the things you get with every mortgage loan quote is an APR, or Annual Percentage Rate. There is even its own special form, the federal Truth-In-Lending (TILA) form, required at application for every loan.

This was mandated by congress back in the early 1970s as a way to give consumers some way to compare between competing loans of equal rate, and it is governed by Federal Reserve Regulation Z.

The problems with APR are threefold. First off, it is computed from numbers on the Good Faith Estimate (or Mortgage Loan Disclosure Statement in California), which are often intentionally and legally under-stated. "Mis-underestimated," to use Former President Bush's famous phrase in an entirely different context where it is not a good thing. If the numbers on the Good Faith Estimate are incorrect, the computations that result in the APR will be similarly incorrect.

Here is a routine example, from an unfortunate soul I encountered awhile ago. They told him they were going to do his $230,000 loan for 3/8ths of a point and $1895, which works out to about $3400 total, APR was listed as 6.136 on a 6% loan when he signed up. But when the final documents were ready, the interest rate was 1/4 percent higher, the points were 2.25 points, and the closing costs were actually over $4000. Total cost: $9400 added to his mortgage, and the APR on final documents was 6.568 on a 6.25% loan. It stands out in my memory because I had been competing for his business. He came back to me during his three day right of rescission. Unfortunately, rates had moved up and by that point I couldn't do anything he liked better, so he rewarded the company who misquoted his loan (to use technical parlance, lied) by getting them paid. Unfortunately, you can't go backwards in time with what you learn at the end of the process. You need to be right the first time.

The second reason to ignore APR is that it is an attempt to compress what is fundamentally at least a two-dimensional number into a one dimensional number. Remember back in school when you learned graphing on a "number line" and then a Cartesian Plane? Which of them contains more information? The Cartesian Plane, of course. APR is an attempt to force a Cartesian Plane onto number line. In order to do it, you need to make some assumptions, and you still lose a lot of information.

The third, most important reason to ignore APR is that the assumptions that Congress and the Federal Reserve mandate were reasonably based on the reality of the 1960s, which has now changed. Back then, people bought homes they were going to live in for the rest of their lives, and re-financing was much less common. People are now living in homes about nine years on the average, and refinancing about every two to three years. But the regulation still reads that the costs of doing the loan, which are included in the APR calculation, are assumed to be spread out over the entire term of the loan, even with ARMs and hybrid ARMs, which almost nobody keeps after the initial fixed period. With the term of most loans being 30 years, and the average person refinancing about every two years, this computation makes absolutely no sense as it exists today. The costs of the loan should be spread over the period that the person getting the loan is likely to keep it, not the entire theoretical term of the loan.

Let us look at the earlier example in this light. Let's assume that the loan delivered to the unfortunate con victim above was a five year ARM, and compute APR as if he's going to keep it the full five years of the fixed period, rather than the thirty years he theoretically could keep it. The APR would have been listed as 7.067% on the final documents.

Let us go a step further and assume that instead of keeping his loan 5 full years, like less than 5 percent of the population, he keeps it for something close to the national median of two years, and compute APR based upon that. His final documents would have listed an APR of 8.293 percent.

To offer a better strategy: At the time, I could have done the loan at zero total cost to him - literally nothing. Zero added to his mortgage, he pays for the appraisal but is reimbursed when the loan funds - at 6.75%, APR 6.750 no matter how you compute. Yes, the payment is $17.75 per month higher than what he ended up with. But he wouldn't have added $9400 to his mortgage balance. Let's compare these two loans five years out, when 95 percent of the population has sold or refinanced and is no longer reaping the benefits of that payment that's lower by $17.75 per month. If he has the zero total cost loan I could have put him into his balance is $215,914.00, and he has paid $89,506 in payments. The loan he ended up with, he's going to owe $223,449, and he's paid $88,441 in payments. Okay, he's saved $17.75 per month, about $1065 total, in payments. But he owes $7535 more. If he sells the property and puts it all in a savings account, he would have been permanently ahead by $6470 if he initially chose the higher rate, higher payment, but lower cost loan. Not to mention that he would get $7535 extra all at once, as opposed to little dribbles of $17.75 per month that most people would never notice. If he buys another house, or if he keeps this home but refinances, he owes $7535 less with the zero cost loan. Let's say he gets a really great loan next time, with a thirty year fixed rate of 5%. That $17.75 per month he "saved" on his payment for five years is still going to cost him $376.75 per year, $31.40 per month for as long as he keeps the new loan. This is what comes from relying upon APR as a valid measurement of a loan.

This is not nitpicking. The so-called 2/28 and 2/38 were the most common subprime loans nationwide, when we had subprime. They are subprime hybrid ARMS with an initial two year fixed period. People get into them because they don't have the money for a down payment, or because they can't qualify for A paper. Considering that they're all straining to buy as much house as they possibly can get a loan for, this means they're in the subprime market. According to SANDICOR figures I saw a while back, something like 40% of all purchase money loans locally in the years from 2004 to 2007 being negative amortization loans which have no truly fixed period and are practically impossible to keep longer than five years with the best will in the world. Another thirty percent plus, according to SANDICOR, were interest only, so my estimate is that subprime lenders have at least eighty percent of the purchase money market locally, and probably fifty percent or more of the refinance market. With the vast majority of these loans being of the short-term variety as illustrated above, APR is worthless as a measure of a loan.

Caveat Emptor

P.S. Just as a parting shot, let us consider the above situation in the context of a fifteen year loan at 6.00 percent that, to be insanely generous to the $9400 closing cost loan, the gentleman will keep until he pays it off completely. APR for the $9400 closing cost loan: 6.779 percent. APR for the zero closing cost loan at 6.75% remains 6.750. That's not a typo, the loan with the higher rate has the lower APR, and this is common for fifteen year loans. Payment for the $9400 in closing costs loan: $2052.67. Payment for the loan with higher rate but zero closing costs: $2035.29. That's not a typo, either. The higher rate loan has a payment that's $17.38 per month lower, because you didn't add $9400 to the loan balance that you've got to pay back.

Original here

I got a search for "which states allow prepayment penalties". I'm not aware of any that don't. If you are, I'd like to know. Any such states should immediately be renamed "Denial".

I really hate prepayment penalties, for a large number of reasons. Nonetheless, to make them illegal would not be in the best interests of consumers.

I know this isn't popular. Economics isn't about popularity. It's about cold hard facts of human behavior. Pre-payment penalties are an incentive that get lenders (investors really) to do loans when otherwise, they wouldn't. Understand that making pre-payment penalties illegal means that the people trying their hardest to get a loan to buy a home to raise their family... can't.

Let's examine one common situation. Let's consider a hypothetical couple, the Smiths, who don't have much of a down payment (or can just barely scrape it together), and have difficulty qualifying for the loan. They want to become owners rather than renters, and it is in their best interests to do so.

The cold hard fact of the matter is that nobody does loans for free. Real Estate loans are complex creatures, and they don't just magically appear out of some hyperspatial vortex upon demand. I may cut my usual margin if I'm the buyer's agent as well, but that's because I've found I'm going to do a large portion of the work anyway, have to ride herd on the loan officer, and stress out because it's a major part of the transaction that can really hurt my clients that is not only not under my control, but I cannot monitor with any degree of confidence I'm being told the truth. I keep telling folks that the MLDS or GFE don't mean anything if the lender doesn't want them to. They are not contracts, they are not loan commitments, they are not the Note or Deed of Trust, and they definitely aren't a funded loan. They are supposed to be a best guess estimate of your loan conditions, but with all the limitations and wiggle room built into them, the regulators might as well not have bothered. By themselves, they are worthless. None of the paper you get before you sign final loan documents means anything unless the loan officer wants it to. Unless the loan officer guarantees it in writing that says that someone other than you will eat any difference in rate and costs, what you have is a used piece of paper with some unimportant markings on it. If I, as a better more experienced loan officer than the vast majority of loan officers out there, cannot monitor what another loan officer is doing with any degree of confidence, do you want to bet that you can?

So we have some folks who can just barely stretch to do the loan. In order to buy them a little space on their payments, so that any bill that comes in isn't an absolute disaster they cannot afford, and also so I can get paid without it coming out of the money these people don't have, I talk to them about the situation and we all agree to put a two year pre-payment penalty on the loan. This buys them a lower rate with lower payments, without adding anything to their loan balance. They don't owe any more money, they get a lower rate, I get paid, and they didn't have to come up with money they don't have. Everybody wins, whereas without the prepayment penalty they would be paying anywhere from $50 to $200 per month more, and perhaps they couldn't qualify. No loan, no property, no start to the benefits of ownership. They certainly wouldn't have that $50 to $200 per month cushion that's likely to save their bacon from their first emergency. Leaving aside the issue that most folks want to buy more house than they can afford, that really stinks from the point of view of the people that those who would outlaw prepayment penalties altogether say they are trying to help, those who are trying to buy a home and just barely qualify.

Another common situation: Many folks have a long mortgage history, and they are comfortable in the knowledge that they will not refinance or sell within X number of years. They're willing to accept a pre-payment penalty in order to get the lower rate at a lower cost. They want that $200 per month in their pocket, not the bank's, and they are willing to accept the risk that they may need to sell or refinance in return. After all, if they don't sell or refinance within the term of the penalty, it cost them nothing. Zip. Zero. Nada. For all intents and purposes, free money. I may advise against it, but it is their decision to make or not make that bet, not mine, not the bank's, not the legislature's, and definitely not some clueless bureaucrat's, let alone that of some activist who only understands that lenders make money from prepayment penalties, and not the benefits that real consumers can receive if they go into it with their eyes open.

Pre-payment penalties get abused. Badly abused. I know of places that think nothing of putting a three year pre-payment penalty on a loan with a two year fixed period. There is no way on this earth anyone can tell those folks truthfully what their payments will be like in the third year. I may be able to tell them what the lowest possible payment could be, but not the highest. I've seen five year prepayment penalties on two and three year fixed rate loans, and that situation is even worse. I've heard of ten year prepayment penalties on a three year fixed rate loan. I've seen even A paper lenders slide in long prepayment penalties on unsuspecting borrowers that mean they several extra points of profit when they sell the loan. So there are some real issues there.

With this in mind, there are some reforms I could really get behind. The first is making it illegal for a prepayment penalty to exceed the length of time that the actual interest rate is fixed. Regardless of what the contract says, once the real interest rate starts to adjust, no prepayment penalty can be charged (This would have meant no prepayment penalties on Option ARMS, among other things). The second is putting a prepayment penalty disclosure clause in large prominent type on every one of the standard forms, and making it mandatory that the loan provider indemnify the borrower if the final loan delivered does not conform to the initial pre-payment penalty disclosure. In other words, if I tell you there's no pre-payment penalty and there is one, I have to pay it for you. If I tell you there's a two year penalty, and it's a three year penalty, I have to pay it if you sell or refinance in the third year (in the first two years, it's your own lookout because you agreed to that from the beginning).

But to completely abolish the pre-payment payment penalty is not in the best interest of the consumers of any state. Show me a state that has abolished them completely, and I'll show you a state that has hurt its residents to no good purpose. Sometimes there is a good solution to a problem, as I believe I have demonstrated here. It's just not necessarily the first one that springs to mind.

Caveat Emptor

Original article here

Sometimes spam makes writing an article all too easy.

Here is a piece of spam I got, probably because my email at work contains "realestate.com", with identifying information taken out. This goes to show that the financial ignorance of most mortgage providers is astounding.

Thank you for your interest in the DELETED Broker Program. Our program is designed to help you provide more value added service for your clients, increase your fee income and help you generate more loans. By simply providing a one page custom amortization and a completed one page enrollment form in your loan packages you will achieve a high enrollment ratio. By illustrating the three key benefits of the Bi-Weekly Payment Program for your clients, they will clearly see that your goal is to help them accomplish their financial goals sooner by saving thousands of dollars in interest, paying off their mortgages 5-10 years early and achieving a low effective interest rate. Please find enclosed an example of a custom calculator and our simple one page enrollment form.

Or the client can just make 13/12 of the regular payment, or make an extra payment once per year, and achieve the same result without any cost. This option without cost lets the customer choose to pay however much extra they can afford that month, or pay nothing extra if they're on a tight budget. As I computed in Prepayment Penalties and Biweekly Payment Schemes, the fact that you're making payments more often saves you almost nothing. It's the fact that you're making an extra mortgage payment per year that's saving you all that money.

Getting started is easy. All you have to do is pay a one time setup fee of $99. You will be provided with custom online tools and resources as well as training upon request. To sign up, just go to our online broker enrollment form and complete the required fields, shortly after you will receive an email with your broker code user name and password. Please be sure to save this email. Once you have these instructions you will be able to go to DELETED.com and access your custom calculator and other online resources.

So I (the provider) pay a sign up fee of $99 for an internet driven startup. Cha-ching!

The DELETED program is a great value at $395.00. You earn 300.00 on each enrollment, DELETED retains only 95.00. We also charge a $3.75 per debit fee (emphasis mine). Our customers truly appreciate our one-time only enrollment fee, if the client moves, refinances or the loan gets sold, X will simply take them off the system and put them back on with the new loan information. Most customers prefer to pay the enrollment fee and choose the 3 debit option, where we will take an additional 135.00, 130.00 and 130.00 over the first three debits to comprise our one-time fee. We pay commissions on the 15th of the month for all enrollments on the system the month prior. Once you receive your approved broker email you'll be able to start signing up clients immediately.

Now we get to the real meat of what's going on. For me doing the work of signing someone up on the internet, they get $95 to start with, while dangling out a $300 stroke to mortgage providers to betray their clients by getting them to pay for something they could do themselves, with more flexibility, for free.

Then, once this is started, they make $3.75 per transaction, every two weeks, for an automated process that costs them somewhere between $0.25 and $0.50. Great work if you can get it. Three guesses who gets stuck with all the problems if they screw up.

This is one more reason why you want to shop your mortgage around and get multiple opinions. Anybody wants you to pay anything for a biweekly payment program, that is a red flag not to do business with them. It is a good thing to do in some circumstances, but it's not worth paying any extra money for. Unless you've got a "first dollar" prepayment penalty, you can accomplish the same thing on your own, with more flexibility, and without paying a cent. And if you do have such a penalty, it'll cost more than making the extra payment will save.

Caveat Emptor

Original here

My husband and I are completely debt free right now. However, we are wanting to buy a house in the future and I see that as quite probably requiring a loan.

What should I do to make sure that we don't get dinged for having no credit? (A problem my husband has had in the past — ended up needing his mother to cosign for him on an auto loan because he chose to go completely credit card less during college after discovering he could not handle them well)

Without open credit, you won't have a score at all. No score, no loan with any regulated lenders - hard money becomes your only option. It's as simple as that. I can get people with horrible credit loans on better terms than I can people with no credit.

In order to get a credit score, you need two open lines of credit. Three is better, because sometimes one will not be reported to one of the three major bureaus. Car loans count. Installment loans count. Those stupid "Pay no interest for twelve months" accounts count, although they really do hurt your credit. But the best thing to have is credit cards, because you usually only apply once and you can then keep them forever, giving you a long average duration of credit. Read my article on Credit Reports: What They Are and How They Work for what goes into a credit score.

What you do for this is go out and apply for two credit cards. Not store cards, unless you can't get regular credit cards. I've seen many times the rate of problems with store cards that I have with regular credit cards. They don't need to be big lines of credit - $500 to $1000 is more than plenty. I have found credit unions to be a good place to send my clients to for this purpose, as San Diego has several excellent large credit unions, at least one of which any resident of the county can join. They may not be absolutely the lowest rate, but they're usually pretty low. Furthermore, the rate doesn't matter if you don't carry a balance, which you shouldn't. More importantly, credit unions usually have fewer gotchas in the fine print, usually no annual fee, and they want their members who want them to have credit cards, so they're more inclined to give members the benefit of the doubt.

Once per month, use each credit card for something small that you would buy whether you had the credit card or not - you'd just pay cash otherwise. No larger than 10% of your total credit line on the card. I usually pay for a meal out at a cheap family restaurant (in the range of $30 or so for two adults and two kids). As soon as the bill gets there, write the check and pay it off. Costs you a stamp but it builds your credit. Or you can do online bill pay if you'd rather. I've heard too many horror stories and dealt with their aftermath too often for that to be attractive to me.

If your husband has trouble with cards, keep his copies of your cards in a safe place, and you be the one who goes out and uses them. He still gets the benefits if they're joint cards.

Caveat Emptor

Original article here

That was a question I got. The answer is that it doesn't make a difference, but it used to be one more way you could be conned or cozened into buying a more expensive property than you could really afford. Until recent regulations that were long overdue took effect, lenders who work in markets that are less than A paper perform qualification calculations based upon the initial payment. Furthermore, I'm about 180 degrees from convinced that this was ever really helping anyone.

Here's how it works and why it works. Some lenders formerly performed their calculations as to whether or not a specific borrower qualifies based only upon the initial payment. Let's say the loan contemplated is an interest only 2/28 at a teaser rate of 6% that's going to jump to 8% in two years when it starts amortizing (even if the underlying index stays exactly where it is), and the loan amount contemplated is $250,000. This makes for an initial monthly payment of $1250. Because this fits within the guideline Debt to Income Ratio guidelines, usually 50% for sub-prime, they can qualify and get the loan approved. But in two years when the loan adjusts and starts to amortize, the payment jumps to $1866.90. This is not certain, but it's far from the worst case possible. It is what will happen if the financial indexes don't change, and so a good default guess, as nobody knows where the indexes will be in two years. If you know where the indexes will be in two years, please call me. With that knowledge and mine, we can make enough money for our grandchildren to retire on. Guaranteed. Because nobody else knows where the market will be in two years.

So the upshot is that even though the payment is predictably going to increase by essentially fifty percent (49.35) in two years, to a level this particular prospective borrower does not qualify for, this loan would likely be approved under sub-prime guidelines that were in effect when this article was originally written.

There were banking regulation changes made to change the qualification procedure, forcing all lenders, rather than only "A paper" ones, to perform their qualification computations based upon the fact that the payments on these loans are certain to increase. These regulations were long overdue in my honest opinion, but don't thank your congresscritter - they came from the Fed. Under previous guidelines, this loan would be approved. Actually, the directive that forces "A paper" to underwrite these loans based upon the higher payments formerly came from Fannie and Freddie, not the regulators, and this is also one reason why hybrid ARMS at a lower interest rate are actually harder to qualify for than fixed rate loans in the "A paper" world.

Nor is this 2/28 teaser loan what is generally meant by a "buydown", although it is one of the things the phrase has been misapplied to. A true buydown is a temporary reduction in rate on a fixed rate loan, purchased by means of discount points paid up front. As I explained in the linked article, these buydowns typically cost more than they are really worth to the client in terms of dollars. Indeed, they are most often used in conjunction with VA Loans, where because up to three percent of closing costs over and above purchase price can be rolled into the loan with no money out of the veteran's pockets, the typical borrower sees only the reduction in payments, not the costs, which are real and they did pay, albeit, due to an accounting trick, with money out of their future equity and not with money out of their savings. They're still going to owe that extra money, and be paying interest on it until they pay it back.

However, due to the fact that most people shop houses and loans based upon payment, the reduction in payments makes it look like they can afford a more expensive house than they should in fact buy. That temporary buydown is going to expire, certain as gravity, and the clients are going to end up making those higher payments. There is precisely zero uncertainty about it. If they can't afford them, the bad consequences will still happen, precisely as if the buydown had never been. All of the tricks of the past decade to defuse this were based upon falling interest rates and rapidly rising real estate values. Lest you not understand, these are never acceptable reasons for betting someone else's financial future, as so many agents and loan officers did. If you are a real estate and financial sophisticate who understands the risks, it is one thing to bet your own financial future. It is never acceptable to bet the future of someone else, particularly if they are not an expert, without a frank discussion of those risks and advising them to get the opinions of disinterested experts.

This whole idea of temporary buydowns is bad because it allows the less scrupulous real estate professionals to encourage buyers and borrowers to overextend themselves. Now that the general public has finally woken up to the downsides of negative amortization loans and stated income loans, these are one of the few remaining ways to make it appear as if people qualify for a more expensive property because of a higher dollar value loan, than they do in fact qualify for by objective consideration of the guidelines. This particular way of pushing the guidelines isn't as extreme as the previously mentioned ones, and doesn't push the bottom line on what they can make it look like people can afford by as much, but if these people could sell people based upon what they really qualify for, they wouldn't be playing these sorts of games with the numbers. It was also these people that the change in regulations was squarely aimed at.

Furthermore, if these folks could really afford the full payments on the loans being contemplated, there are better loans to be doing. Without that interest only rider on the 2/28, I could buy the interest rate down by at least a quarter of a percent on the same loan type. For that matter, I can quite likely get a thirty year fixed rate loan for that same borrower at a lower rate than the 2/28 will jump to in the default case of the underlying indexes going exactly nowhere. For the true temporary buydown, without my borrowers paying those three points of upfront cost, I could cut those borrowers real, permanent rate on that fixed rate loan by at least three quarters of a percent, probably more. Whether even that is worth doing is highly questionable, but at least it's an open question worthy of discussion with a possible case for "yes" that a reasonable person can defend with numbers, not a mathematically certain "no way!" Show me someone who uses buydowns for their clients habitually, and I'll show you a serial financial rapist.

In short, temporary buydowns don't really help anyone, except maybe the seller who can unload their house to someone who shouldn't be able to qualify. Not buyers or borrowers, who are encouraged to stretch beyond their means through their use. Not lenders, brokers, or agents, due to these problems that people were in denial about for a very long time coming home to roost, meaning that those who practice in this manner will very likely be subject to auditors and regulators in the near future, and quote probably lose their licenses. I think that's a good thing.

Caveat Emptor

Original article here

This is a little harder than shopping for buyer's agents, so congress critters might not be able to do it. But it's nowhere near as tough as high school algebra, so even if you're a politician you can just get your child, grandchild, niece or nephew to help you. High school aged children of your friends would work also. And if you're a politician who doesn't have any friends with children, you've got worse problems than getting the best home loan.

This problem actually breaks into two cases, one where you are looking for a purchase money loan and one where you are looking for a refinance.

For purchase money loans, the first step probably should not be an internet quote shop. Whether it's one of the ones where lenders advertise their lowest rates or one of the ones where you ask for four quotes (and get four hundred companies calling you), neither one of these is likely to be a good use of your time. At this point, you are trying to find out what loans are available to you, and how much of a loan you can afford based upon those loans. What you want is not someone who's trying to sell you their loan, what you want is someone who will tell you what's going on in the loan market right now, and how much you can afford (assuming the rates don't change).

What you need is a good conversation with a loan officer or six. At this stage, you're not willing to sign up for any loan, but you are looking for information that tells you whether or not that loan officer is likely to be a good prospect when you are. Are they willing to take you through the process verbally, and explain the results that they get and how they got them? They should use your salary as a starting point, move through a debt to income ratio and subtract from that your current monthly obligations, to arrive at what your monthly budget is for housing. From there, they can use current interest rates, as well as approximate tax rates and insurance costs, to show how much you can afford per month for housing. I would insist that they perform this computation based upon currently available rates for a fully amortized thirty year fixed rate mortgage with no more than one point of combined origination and discount. If you then want to choose an alternative loan type, and there may be reasons why you want to strongly consider doing so, you nonetheless know that you can afford the loan for the property you are considering, and that you're not getting in over your head with a loan that's going to turn around and bite you.

Now, just because the first loan officer gives you a number you are happy with is no reason to stop shopping. You want to have this same conversation with several different loan officers. The reason is confirmation. There is a large amount of pressure to qualify you for the largest loan possible, especially in the highly priced urban markets where most of the country lives. A little bit of difference can make a lot of difference on the property you think you can afford, which makes it a lot more likely that the average person will come back to them for the loan. They said they could get you a loan for $500,000, while the guy down the street said they could only get you a loan for $470,000. If, by some mysterious coincidence about as rare as gravity or air, people decide they want to stretch their budget to the maximum or beyond, who do you think most people in that situation will come back to? Most people buy a property at the highest possible end of the range they've been told they can afford. Actually, the most common thing that happens around here is that they'll go back to the people who said they qualified for $500,000 to see if there's any way they can stretch it so that they can qualify for this $530,000 (or $800,000) property they've gotten their hearts set upon. Since loan officers learn this pretty quick but you're still going to have to live with the consequences, you want to make certain they're not overpromising what you can deliver.

There are all kinds of incentives for loan officers to inflate pre-qualifications for loans. They get a higher probability of a larger commission check. There aren't any real reasons to give you the real numbers, as opposed to those highly inflated ones, except not wanting you to go through foreclosure and lose the property. The foreclosure thing is months to years away, and not certain, while the commission check is here and now and their benefit, as opposed to your problem. By the way, if you're one of those people who manage to beat the numbers and get through buying a property more expensive than you can afford, you're going to be thinking that loan officer walks on water and is your best friend in the world, because they got the loan through that "nobody else could." This is preposterous, but it's amazing the way that human psychology works, isn't it? With the way prices were climbing in 1996 through 2004, there were an awful lot of loan officers who got used to "betting on the market," and winning, because even if their client could not, in fact, afford the loan, they could refinance on more favorable terms when the rates dropped and the owner's equity went to more than fifty percent due to the general market. And if the rates didn't move by enough to save their house, they could still sell for enough to make what seemed like a mint. The predictable result was that these clients think that these loan officers are wonderful. Unfortunately, that's not the market we have today. That is unlikely to be the market we have at any point in the near future. As a result, you have these same people doing business with these same loan officers today, and losing their shirts as well as their homes.

What you need is to keep going, and keep having these conversations with loan officers. Why? The first one may have been the Marquis of Queensbury, but then again they may have been the Marquis de Sade. What you need is evidence. Evidence of confirmation. Evidence of consistency. Evidence that both they and all of the other loan officers you meet with are performing these pre-qualification upon the basis of sound loan underwriting and rates that are actually available and not too expensive in terms of up front cost, that they are remembering to make allowances for the expenses of property taxes and home owner's insurance, and association dues and Mello Roos and everything else that may be relevant. You're going to pay these things. Prospective loan officers should make appropriate allowances up front, because they're going to be part of what's coming out of your paycheck.

What's a sufficient number of conversations? At least three in any case, but I would keep going until I had talked with loan folks that have at least two or three significantly different approaches to your loan. Negative amortization is right out, of course, and you can cross anyone who suggests one off your list of possible loan providers (at this update, thankfully, those abominations that wrecked millions are essentially gone), but while you should do the calculations of what you can afford based upon a thirty year fixed rate loan, in most markets there are other loans such as a fully amortized 5/1 that are well worth considering, and that will serve most people better in most situations. Every single loan there is has its advantages and disadvantages. The disadvantage to the thirty year fixed is that it is almost always significantly higher rate than other alternatives, and more people than not keep exchanging one thirty year policy of insurance that their rate won't change for another thirty year policy every two years. The question I would like to ask those people is "Why buy the thirty year guarantee in the first place?" Why not buy the three or five or seven year guarantee, if that's all you're going to use? Right now the costs may be very comparable, but the shorter fixed period loans are usually much cheaper. You want to budget as if you're going to that 30 year fixed rate loan (the most expensive there is), but there are many reasons why something else may suit your needs better when it gets right down to it.

Similarly, why spend money buying the rate down if you're not likely to keep it long enough to recover the money you spend in the first place? Spending $8000 in points, especially if you roll it into your loan where you're going to have to pay interest on it, may cut your monthly interest charge from $1960 to $1833. However, it takes between six to seven years to break even when you consider interest on the remaining (higher) balance.

It's possible one loan officer will cover several approaches. Much as it pains me to tell you this because I habitually do that, you should still talk to more than one loan officer. You want more than one person's word for one what is available in the way of rates and the costs to get them, and it is always a Trade-off between low rates and high costs. Not understanding that there is always a trade off between the rates available and the costs to get them is the most critical piece of knowledge that causes most mortgage borrowers to make bad choices that cost them tens of thousands of dollars.

Furthermore, you want confirmation of what loans and rates are available to you. If three or four loan officers independently tell you the same things, you've got a pretty good idea that they're approaching it correctly and giving you real information. The ones that make it up are likely to do base their usually inflated numbers upon different markups and mis-assumptions. Find a financial calculator on the web or buy one or use a spreadsheet, and check their numbers yourself. This is one of the largest sums of money you will be dealing with in one transaction in your life. You owe it to yourself to take the time and do the research to be certain you are getting good information. Due to the fact that real estate loans are very large amounts of money, and the loan transactions are very complex, there are a certain percentage of people in the industry who will use this opportunity to skim money effectively back into their pocket. These amounts of money, quite large by most standards, can be camouflaged under the cover of the much larger amounts of a very complex real estate transaction. Even the most honest loan officer is in the business to make money. This is in almost direct conflict with your desire to get the best loan possible at the lowest costs, but the loan officer who actually delivers the best loan to you has earned every penny of what they make, whatever it is.

Once you have credible, verified data on how much of a property you can afford, then you can start looking for buyer's agents, and actually looking at properties. Keep in touch with loan officers who you might be working with during the shopping process. Why? Rates can change. Actually, rates will change, and the higher up the scale and more highly qualified you are, the more often they tend to change. Sub-prime rate sheets might stay constant for a month or longer, with a modifier that may change or may not. Top of the line "A paper" changes every business day, at a minimum. Maybe not grossly, but it does change. I saw rates on 30 year fixed rate loans with equivalent costs go from about 5.25 to 6.625 in one month during late summer 2003. If you did the math based upon 5.25 and you qualified for $500,000, you only qualify for about $430,000 at 6.625. That is data that is supremely important to your property hunting. Do not allow a real estate agent to tell you that you can afford more than your real budget. Ever. If they say they can't find all of your desired characteristics within that budget and in your area, ask them for alternative suggestions. Compromising what you want is better than foreclosure. Going without is better than foreclosure. Fire the agent immediately if they won't work within your budget. When you find something you like and have a purchase contract, your procedure becomes very comparable to a refinance. The differences are comparatively small.

For refinances, you have a property already. There is an existing loan that has to be paid off. If you're in a purchase situation, you should already be in contact with several lenders, and you don't really care about any existing loans on the property because they aren't your problem.

But now is the time when you want to do some intensive lender shopping. Furthermore, you really want to compare what everybody has at the same point in time, if it's at all practical. For instance, generally the available rates will be a little bit lower in the middle of the week. They will more often than not be higher on Monday, Friday, and Saturday than they are on Tuesday, Wednesday, and Thursday. This isn't always true, especially if the financial markets are reacting to some large event, but it seems that it happens more often than not.

In a purchase situation, talk to your existing prospects and keep adding others until you get enough of them. For refinances, you want to move quickly in order to be a fair comparison. Whether you are buying or refinancing, ask every one of them this set of questions you should ask prospective loan providers. What you are looking to do at this point is choose who you are going to sign up with. Before you do that, you want to cross-check what every single loan officer tells you with the available evidence. Weigh what you know against what you are told by any given loan provider, and what that loan provider tells you as compared to other loan providers. Most often, the preponderance of the evidence will clearly support the ones you should sign up with.

Now, I know I said this earlier. Not only does it bear repeating as many times as I can find an excuse for, the folks interested only in refinancing might have been skipping ahead. Remember that you can get the a loan officer who's the equivalent of the Marquis of Queensbury, but more of them are closer to the Marquis de Sade, and most will be somewhere in between. The bigger the lie they tell you, the more likely it is you will sign up with them. The government really did try to change this with the 2010 Good Faith Estimate, but they can still low-ball the hell out of that tradeoff between rate and costs to get you to sign up. Sure, it's possible you might walk away at document signing, although not likely. If you don't sign up with them, they are guaranteed not to make any money.

When I first wrote this article, it was possible and feasible to lock every loan at sign up. That has now changed to the point where even I cannot do it any longer. If I lock a loan and don't actually fund and deliver it, the lender charges me (which really means all my future clients) a stiff penalty. This is now universal even for direct lenders, so good loan officers who are trying to deliver a lower cost loan are not locking at sign up any longer. The only lenders who can lock at sign up are those who have built inflated margins into their loans, so that they can pay for those charges out of the increased profits they're making. There is now a decision making process on when to lock a loan that I take every client through.

There is always a Trade off between rate and cost in real estate loans. It's like gravity. Exactly what the available trade offs are varies over time, and varies from lender to lender at any one time. Remember, that lender can low ball you pretty badly to get you to sign up, and once you sign up, you're not likely to discover that they did low ball you until time to sign documents. Very few people continue to look at the market once they have chosen a provider. The reason many loan providers want a deposit is so they can hold that money hostage for you signing the final documents. Unless no one else can do your loan, I would never even consider putting up a deposit with a lender. What they're telling you by requiring a deposit is that they want you to stop shopping. If they are telling you about a loan that really exists, and their loan prices really are good, there is no reason for a loan to require a deposit. You will pay for the appraisal when it happens, but that's less than a deposit.

I do advise you to ask your other prospective providers about whether the loan you choose is deliverable, however. Mind you, there's a strong incentive for them all to say "no" but then ask them "why isn't this loan deliverable?" If the answer starts discussing wholesale pricing and lender incentives and bonuses that they have and others do not, listen carefully. What that loan provider makes is tied up in how costly your loan is really going to end up being. When they explain why the loan margin really isn't there to deliver the competition's lower quote, listen to them. Then take it back to the people who provided that quote and say, "convince me you can actually do this". This includes making enough money to make it profitable for them - at least a couple thousand dollars. The provider making this money is not a problem and not a reason to try and negotiate it down - what they make does not equate to "profit" let alone what the people doing your loan actually get to spend. Remember, you've already decided this was the best loan available based upon the bottom line to you! What it is is insurance that they will actually deliver this loan they are talking about because nobody does free loans. My clients who ask this find out exactly what loan from what lender I'm basing my quote upon and much I plan to make on the loan - and if that's a problem for them, they can go get someone else's more expensive one!

On a regular basis, I hear various folk advising people that they can avoid all this by "just picking a large, reputable provider." Nonsense. This is wishful thinking at its worst. Large scale reputation is established by advertising. Think about that for a moment. "Large reputable providers" spend millions per week trying to get the suckers to come in. Who pays for that? It certainly isn't the people who work there! "Large reputable providers" will sit you down in a nice comfortable chair in a beautiful office, and lull you with talk of how well they are going to take care of you. Somehow, they manage to deflect the conversation away from exact numbers and exact quotes. You can't compare loans without specific numbers. Then, this "large reputable company" is going to deliver a loan with a rate that's a quarter of a percent higher and costs you two points more than you could have had, not to mention higher fees - and they'll still be low-balling you! Trusting yourself to a "large reputable company" without the exact same due diligence isn't avoiding the issues of shopping a loan in that jungle out there - it's intentionally delivering yourself into the hands of the head-hunters. These companies do not compete on price. They compete on the basis of serving cattle who want to be comfortable. Serving them up to be slaughtered. On a $400,000 loan, you just wasted $8000 up front, and $1000 per year. Glad you could avoid that hassle, glad to avoid talking to sales people, glad you could avoid taking half a day off work to shop loans? You've paid handsomely for that avoidance. Kind of like committing suicide because somebody might murder you.

The main issue in all of this is finding the loan on the best terms available to you. The main obstacle to that is the fact that lenders can low ball their quotes shamelessly, and it's legal, so it takes some serious research to figure out what is likely to be real from what is not. The new rules for 2010 change a lot of that, but still leave gaping loopholes that any loan officer who tries can sail an ocean liner through.

When I first wrote this, I said "Unless there is something external holding the whole process back, such as "Your house isn't going to be finished for two more months," I will bet money that a loan done in thirty days or less is better than one that takes sixty days or longer." This is still a valid principle in that the loan that is done faster is likely to be better. The problem is that new government rules and regulations and Wall Street required underwriting checks inspired by their new requirements have added a minimum of about 3 weeks to the time it takes to do a loan since then. I used to be able to reliably fund a purchase money loan in 21 days or less without any extraordinary effort, a refinance in three extra days to cover the right of rescission. The way the process has been externally complicated, it is questionable if even the best loan officer trying their hardest will have the loan funded within 45 days of application. Sixty days is more likely. Plan for this. It's just a fact of life - one more "service" provided by your elected representatives. But better sixty than ninety or more.

You need to do your due diligence up front. Real estate loan rates change every day, and whatever reason it was that caused you to need or want a loan is almost certainly time critical. For purchases, you've got a purchase contract that's good for only so many days before they'll start charging extensions. For refinances, if it's to get cash out, you have a time critical need for that money, and if you don't get it on time, you're likely to have to pay it out of your checking account or put it on a credit card, if you can. For refinances without cash, just to get a lower rate, those attractive rates are not going to last forever, The one thing I can guarantee is that the available rates are not going to be the same by the time you go to sign documents at the end of the process. If the lender doesn't deliver what they talked about, it's going to cost you a large amount of money. Therefore, you really want to do enough due diligence to give them a reason to actually deliver that loan they talked about in order to get you to sign up.

Caveat Emptor

Original Article here

do your property taxes go up in California when you refinance your property?

This is one of those urban legends. People are concerned that because the house is appraised by the lender, the assessor is somehow going to find out that their property is worth more and send their tax bill soaring.

However, thanks to Proposition 13 in California, the formula for property taxes has little to do with current market value or what the home is really worth. The formula is based upon the purchase price plus two percent per year, compounded. If you can document that your home is worth less than this amount, contact your county assessor's office. But if it's worth more, they cannot increase it beyond this number.

Indeed, certain family transfers can preserve this lower tax basis. Mom and dad deed it (or will it) to the kids, and the kids keep paying taxes on it based upon a purchase price of perhaps $60,000 (Plus thirty-odd years of compounding at two percent, so maybe $115,000) when comparable homes may be selling for $600,000.

There are two major exceptions. First, a sale. If you sell it to someone else, then repurchase, you don't get the old tax basis back. Second, improvements. If you take out a building permit, the assessor will add the current value of your improvements to your tax bill. This can, in situations like the previous paragraph, result in a tax bill that literally doubles if you add a room. Indeed, this is one of the main reasons for the growth of the unlicensed contractor industry, because licensed ones have to make certain the permits are in order, and homeowners are trying to sneak one over on the county. This is why a very large proportion of properties in MLS have the notation that "this addition may not have been permitted." They know good and well that the addition wasn't permitted, and quite likely isn't to code, either. If it's built to code it's usually grandfathered in to subsequent updates. Subsequent owners can get forgiveness as innocent beneficiaries who bought the house like that, and so the purchase price included the value of that room (and occasionally, the state finds it worth its while to go after the previous owner for back taxes and possible penalties, and I believe that the incidence of this will likely increase dramatically in the next couple of years). If it's not built to code, however (an offense unlicensed contractors often commit), the subsequent owner can be looking at a large mandatory repair bill, or perhaps even demolishing the addition they paid for if the county inspector deems it unsound. You want to be very careful about properties with the "addition may not have been permitted" disclosure.

Other states, by and large, still follow the assessment model California used to follow, pre-Proposition 13. They have county records of the property characteristics, and evaluate the home based upon those characteristics, whence comes your assessment, and hence, your property tax bill. This still encourages unlicensed contractors and working without required permits, with effects much the same as the previous paragraph, which is definitely not good, but in this case subsequent owners have nothing but incentive to keep improvements off the county books, where in California, subsequent owners have motivation to want improvements updated into county records. I am not aware of any state which follows a model whereby refinancing will alter your tax bill.

Caveat Emptor

Original here

I have to admit to being conflicted. The numbers say no. The psychology says yes. Let's examine both.

Most first mortgages out there are between six and seven percent, and tax deductible at a marginal rate of about 28%. If you're one of those folks with something in the low fives or even below, enjoy it while you've got it, because the odds of getting something better when you move to a more expensive home or need to refinance are pretty slim.

I'm going to do the numbers based upon 6 percent, with 28% marginal deductibility. This has limits; to wit if your mortgage interest gets to be low enough that you don't hit the threshold where it is worthwhile to itemize, but instead take the standard deduction, that deductibility didn't do you any good. But above that threshold, which is most people, every dollar in interest you spend gives you back 28 cents. I'm also going to assume a 30 year fully amortized mortgage.

Obviously, you don't want to pay an effective 4.32 percent interest rate for no good reason at all, but this does not take place in a vacuum. If you didn't use that money to pay down your mortgage, you could use it to invest elsewhere. For instance, let's assume you could make 8% net on average if you invested this money elsewhere. This is a reasonable average when you consider ordinary income tax, capital gains tax, and possibly a certain amount of tax deferment.

Now, some people might think to add in the difference in interest paid, but that is not correct. The payment is constant. Whatever you didn't pay in interest was already applied to principal. To count it again would be double counting.

Let's say you've got $100 extra per month, and a $400,000 loan. I'm going to go yearly 10 years out, then at 5 year intervals. The median time in a property is about 9 years, which means a whole new set of decisions about which property to buy. This is only a valid experiment so long as all of the starting assumptions stay constant, and when you have a whole new set of decisions about which property to buy and for how much, all of that goes out the window, as it is no longer controlled only by the variables chosen at start. Truth be told, refinancing should probably halt the experiment as well.

For the below, I have just summarized the differences. Extra principal is how much more you've paid the loan down with the extra amount, if you did so. Tax cost is the total tax cost of the interest you didn't pay. Investment is how much the money you'd have if you didn't pay the extra towards your mortgage, but socked it away in an investment account. Gain/loss is the net result, positive if you came out ahead by adding to the payments, negative if you should have invested the money.

As you can see, the numbers come out fairly strongly for not taking the extra and making payments, but instead finding an alternative investment for the money. Don't get me wrong - the return on investment of paying your mortgage off is guaranteed, while the return on alternative investments is anything but. Still, diversification and reasonably prudent risk calculation together with due diligence build a case for the alternative investment that has probability so strongly on your side it might as well be mathematical certainty over the long haul. Any time you have cash, whether it's an extra $100 you made this week or $100,000 you made investing over the last 20 years, you always have the option of taking it out of the other investment and paying off your mortgage. But the numbers come out pretty strongly for the alternative investment.

However, the psychology says yes. There's a major sense of accomplishment in paying off the property. Furthermore, once you don't owe the money, you've got it in the form of equity, as opposed to cash, which is all too easy to spend. In fact, most folks will fall off either the investment wagon or the extra payments wagon over time. Money you don't owe cannot be called due. If there's a temporary setback in the market, extra payments make it that much less likely you'll ever be upside down or in an impacted equity situation, although you could also apply the cash from the investment account to your equity or to the rest of your finances, to keep from having to do a cash out refinance. Finally, there's the reduced stress from being mortgage free for (in this case) thirty six months earlier, if you are one of those rare people who actually manages to pay their mortgage off.

I also have a spreadsheet that compares the net financial result between never refinancing, refinancing every 5 years and keeping a target of paying all loans off in 360 months from the time you bought, and refinancing every 5 years but making the minimum payment. In the vast majority of cases, the last situation comes out better, largely due to the effects of leverage, but leverage is always a two-edged sword. If things go the way you want, it makes them even better. If things don't go the way you want, it makes them even worse. There are lots of folks getting bit hard by over-leveraging real estate right now. The usual numbers say that making larger payments is likely not the best use you have for the money. But there is a certain psychological comfort in owing less and paying off the mortgage sooner. Furthermore, in a down market like right now, making larger payments might mean you end up able to sell or refinance when you need to, without those potentially nasty consequences of being upside-down.

Caveat Emptor

Original Article here

This has been a noticeable phenomenon for quite a while in San Diego. I've been loath to talk about it because I didn't want to be giving fraudsters ideas. Most lenders have now put into place safeguards against this measure. As always, they do not distinguish between guilty and innocent, but the lender is the one risking their money. Keep in mind Real Estate loans are not about the "benefit of the doubt", they are about proving to the bank that they are likely to get their money repaid with interest.

The basic event is this: People have decided to relinquish their current property to the lender. It's not worth as much as the loan is for, so they see only a gain to be had there with current law declaring the income from forgiven debts non-taxable. Perhaps they couldn't afford their new payments after the teaser expired. Perhaps they could; they just don't understand what they are doing to their credit and the fact that the market is going to come back - sooner than they probably think. Perhaps it's a non-recourse loan and they see only the fact that they owe more than the property is currently worth.

But these people don't want to be homeless, and they do understand that after they have gone through foreclosure, not only are lenders going to be highly resistant to lending to them, but landlords are going to be reluctant to rent to them. So they hit upon what they think is a brilliant plan: Buy a new house before allowing the old one to go into foreclosure. After all, the degradation to credit hasn't happened yet! However, this is still fraud. These people have an actual plan to allow a property to be foreclosed upon, and a reasonable person would know that lenders would consider that in deciding whether to grant credit.

Unfortunately, there has been enough of this going on that lenders are no longer willing to let it go unchecked and unchallenged, so they are looking for evidence that new buyers of primary residences and second homes do not plan to "buy and bail". Since this was originally written, there have been stronger requirements put into place: First, there has to be significant equity in the current property. Fannie and Freddie both require 30% equity in the existing property in order to lend on a new one. They also want to see either the ability to make both payments without any rental income or a verifiable job change to a new commuting area, and the need to relocate (i.e. nothing in the same commuting area). There are portfolio lenders out there who will waive the 30% equity requirement, but they are very careful about the circumstances and even more careful if the move is within the same commuting area.

Meeting these basic conditions is not a "get out of underwriting free" card in the current paranoid environment. There are other checks being made upon the process, checks I am not going to discuss beyond saying that the transaction has to pass a "smell test." Being someone who doesn't like seeing bad real estate loans made for a plethora of reasons, I welcome the return of the smell test. I've seen the aftermath of too many transactions that smelled worse that week old fish in dumpster on a hot day. You may think you're a "a special case," but every single one of those folks out there facing foreclosure or having gone through it already also thought that they were "a special case" then, and the ones trying this fraud think so again now.

These new restrictions have hurt, and will continue to hurt, legitimate investors and purchasers by making it more difficult to qualify for the loans. It is nonetheless a fact of life brought upon us by the market. Furthermore, 20% down is pretty much an absolute minimum for buying investment property currently currently. Furthermore, even the lenders that were accepting loans for both a primary residence and a second home in the same commuting area have now stopped that practice. It was silly to start with, and it has only gotten worse of late, but people who want to avoid the constraints and requirements of investment property loans were eager for it. I just don't understand why lenders were willing to accommodate them. Either the charges and higher equity and qualification standards were necessary, or they were not. If they were necessary, why were the lenders bypassing them? If not, why did they exist in the first place?

I can understand people who don't want to be homeless. However, while "Buy and Bail" may not always be obvious before the fact, but it is afterwards, and the lenders are starting to take notice of foreclosures against other companies, and they are even writing in clauses that make their loan callable, by which I mean they can demand you pay that loan off in full, giving you 7 to 30 days to make the actual payment. Once again, this sort of clause is going to disadvantage people who have had the property a while and be intending no harm who do hit hard times: Job loss, disability, etcetera. Nevertheless, "Buy and Bail" is fraud, and the lenders are entitled to take whatever measures they think reasonable to insure that they don't lose their money to a suddenly unacceptable credit risk, as well as to return a reasonable return on that money. It may seem like cruelty to you, but I'd like to see some of the folks pulling it sentenced to an enforced residency in a government institution wearing funny pajamas, because games like this destabilize the mortgage market for everyone, and every time somebody pulls a game like this, the lender's reaction hurts many others who should be able to qualify for a loan and are now unable to do so, further screwing up the home loan market for 300 million Americans.

After this was originally published, I got a question from Realtor Ricki Widlak who doesn't understand how people pull this, in that they're going to have another home loan on their credit report. The answer is that they claim they are going to be receiving $X in rent per month. They fake up a lease contract, usually between themselves and a family member or close friend. The added number of dollars per month from this entirely fictional contract makes it appear as if they qualify. However, because the lease is not real, they don't. Ergo, the qualify without rental income restriction.

He ends with this question: "How do people "walk away"? Who walks away from anything in this information age anyway? I just don't get it. These people are "leaving behind" their soc numbers, right?".

The answer to all of these questions is that lenders have no difficulty in identifying this phenomenon in retrospect - these people aren't getting away with anything, and some of the lenders are starting to follow the criminal prosecution route. But identifying the perpetrators in retrospect does not assist the lenders in not making bad loans in the first place, which is the situation the lenders want. So they raise the bar for qualification for everybody in order to weed out these bad apples. Yes, people who would otherwise qualify are getting turned down for loans. However, the lenders are not a court of law, where we'd rather a dozen guilty people go free than one innocent one be punished. In fact, the lenders have precisely the opposite view, especially in the current environment: They'd rather turn down a dozen or more good loans than accept one bad loan, and they are now writing their lending criteria accordingly.

Caveat Emptor

Original article here

For a long time, Fannie Mae and Freddie Mac had a policy that they would not fund investment property (non-owner occupied) beyond 10 loans for a given investor. Although it did impact a certain number of investors, for most folks that rule just never came into play. They have now reduced that limit to 4 loans, which is putting an awful lot more investors in the position of needing a portfolio loan.

Portfolio loans are loans where the lenders originate the loan with the intention of holding it themselves. In recent years, this has been a very limited niche, and even those A paper loans written with the full intention on the part of the lender to hold it themselves were often underwritten to Fannie and Freddie standards, so that they could sell such a loan. Not that there were very many of those.

Portfolio loans largely went away because the tradeoff between rate and costs is much higher than the standard securitizable loans. In plain english, the rates are higher. When the lender originates a loan and sells it on Wall Street, it gets an immediate return of 2.5 to 4 percent on its money. Not as much as holding a six percent loan for the year, but they can turn right around and use the money to sell another loan. Lenders don't have any trouble getting four to six loan sales on the same money per year, some manage eight or better, and twelve is possible, if unlikely. Therefore, they make anywhere from 10% to maybe 25% per year by selling the loan repeatedly, as opposed to about six percent for holding it. Which of those do you think the average lender sees as more attractive, particularly if they also retain servicing rights and make money that way without risking any of their own?

So if the lender is not going to be able to sell the loan, but rather have its money tied up until you decide to sell or refinance the property, then they're going to want something more akin to the 10% or better return they get on their money by originating and selling the loans. Portfolio loans have a higher rate for the same cost; albeit a much smaller difference than when I first wrote this article. Some people will tell me they don't want their loan sold. I ask why, and they tell me about the hassles and ending up with an unknown company. I explain that the contract is the contract, and the only differences if your loan is sold are the name on the check and the address on the envelope (or, if you pay online, the routing number you use). For those that still come back with "I don't want my loan sold," I then say, "Well, then it sounds like what you want is a portfolio loan. The interest rate will be higher, meaning your payments will be X dollars per month higher, and your cost of interest will be higher." Them's the facts. Some lenders will lie about it to get clients to sign up for their loan, but that doesn't change the facts. They can deliver a portfolio loan, or they can deliver a regular loan where the lender is still going to sell that loan. Which would you rather have, an honest discussion of alternatives or someone who chose one alternative without consulting you? Because the loan they deliver will be one or the other, and whether it's the choice you would have made is mostly a matter of luck.

To be completely honest, even portfolio loans can be sold. However, not being designed with standard loan packages in mind, it's harder. Selling portfolio loans is a harder thing than what Fannie and Freddie do, as the ways in which portfolio loans are underwritten is not written to some broad industry standard. Selling portfolio loans is more common now than it was a couple of years ago, but the same lender generally retains servicing. Not every lender offers portfolio loans, as they are a different thing entirely to the corporate finance people than the standardized loans Fannie and Freddie require.

But for those that do, they allow that lender to make the underwriting decision by whether they are comfortable making such a loan, rather than whether or not it meets standardized criteria for Wall Street. This can enable those lenders who do offer portfolio lending to be able to make a certain specific loan, where a lender with its eyes fixed solely on Wall Street does not have the option of saying "Yes."

There are a fair number of loan niches that have always been portfolio loans. Many commercial loans, and loans for investors with over ten properties, to name two. Traditional "non-conforming" loans are not one of them, however. Just because Fannie and Freddie couldn't buy them doesn't mean nobody would. In fact, because they were underwritten to Fannie and Freddie standards in all matters except loan amount meant they were sought after, especially as opposed to subprime loans. But just because portfolio loans are not underwritten for Wall Street doesn't mean that the lenders can ignore Federal Reserve regulations, for instance the one about "Must be able to repay the loan from a source other than additional borrowing against the property". For that, you have to go hard money.

Final point: Because the interest rate for portfolio loans is higher, and therefore the cost of borrowing the money, there are going to be a lot of properties that would be a good investment for someone able to qualify under Fannie and Freddie's rules, where they would not be a good investment for someone who needs a portfolio loan. This is likely to constrain prices from rising to a small degree, and force rents to rise to a somewhat higher degree. If your landlord can't make it work on the basis of the rent you're paying, they have two real choices: Raise your rent or sell the property. Nor is the second alternative any kind of relief. If that landlord couldn't make it work, why would you think the next one can? That's assuming the purchaser doesn't plan to live in it themselves from day one. I have an inflexible rule with tenants where my clients don't want to keep them: They must be out before close of escrow. I suspect most buyer's agents are the same way. One of the fall-outs from the bursting of the real estate bubble that most people don't realize yet is that the economic factors which kept rent increases low for the las t decade or more are all gone now. Furthermore, if someone is looking to buy an investment property, the cash flow is going to have to work from day one. If it won't, they're not going to buy it, and it will never become a rental property in the first place. On a $300,000 loan, a portfolio loan instead of a securitizable one means a difference of over $500 per month in the cash flow requirement, which translates to rent increases, and not just from the big landlords with portfolio loans.

Portfolio lending is set for a comeback. With Wall Street becoming ever pickier about the loans it wants to fund, and mortgage insurers restricting what they will insure, a strong lender with good reserves can make a lot of money in this environment by lending to selected borrowers with good credit and plenty of income, that "originate and sell" lenders cannot touch, because Wall Street isn't interested under current standards.

Caveat Emptor

Original article here