Mortgages: April 2018 Archives

An email:

Greetings, I've recently been pitched the idea of refinancing my home and investing in apartments, or more precise, a four-plex. The idea is to refinance and get a negative amortization loan on my house. With the money I pull out of my home, put a down payment on a four-plex, also with a negative amortization loan. That way, I am told, my payments would stay relatively the same on my home and I can have a positive cash flow from the four-plex. Along with the pitch I am told that I can refinance after five years and get another plan, or sell outright, the apartments. Their belief is that in five years, the apartments and my home would have gone up enough to offset the interest that I will not be paying in a negative loan.

I've read, on this site and elsewhere, that negative loans are not the way to go for most people. I'd like some more input as to what to do in my situation.

Here are the specifics in my case:
Home --- owe - 200k
worth - 600k
would get around 200-215 from refi
Apartments --- worth about 900k
downpayment would be 20%, or 180k
keep the money left over from refi in savings for emergencies

loans for both properties is a five year fixed rate of 7%
paying only 4.25% of it, with the rest being added to debt

Is it too good to be true?

Now I know how Hercules must have felt fighting the Hydra. Cut off one head, two more grow back.

This situation can be called many things, but "Too Good To Be True" is not among them. It not only isn't true, it isn't good.

Let's go over what's going on in the situation as proposed.

You would have a loan on your home for about $420,000, including closing costs. This is just over the (basic) conforming limit of $417,000, but negative amortization loans are not A paper and pay no attention to the conforming loan limit. A real principal and interest payment on that loan is $2794.28, of which you are paying $2066.15. Over the course of three years, your loan balance would increase to about $435,327.16, at which point that $15,200 and climbing pre-payment penalty is no longer hanging over your head. After 5 years, you owe $447,480. Total of payments to that point: $123,969.00.

On the apartment building, you would have a $720,000 loan at 7%. The real payment on that is $4790.19, of which you would be paying $3541.98. After three years, you would owe $746,275, at which point that pre-payment penalty of $26,100 (to start, and climbing) is no longer over your head. After your planned five years, you owe $767,109. Total of payments is $212,518.80.

Now, I'm going to compare and contrast with two other loans I really do have as I'm typing this, but will be out of date by the time anyone reads it. I should mention that I have difficulty believing that the investment property, especially, would not be at a higher rate than you have been quoted. I don't believe that these are zero points loans, but I'll even assume that they are, in order to have a fair compare and contrast. I know for a fact that this isn't even the best I can do, but I'm just picking the first rate sheet that comes to hand. This is with all costs included: loans I could lock at the time I originally wrote this. A 30 year fixed on $417,000 (maximum conforming) at 6.25%, and I could even give you about $750 to help cover your closing costs, but let's say net total cost to you is $3000, and therefore your net is $214,000 when all is said and done. The payment on this is $2567.54. There is no prepayment penalty on this loan. After 5 years, you owe $389,216.30 and your payments will total at $154,052.44.

The loan on the apartment building would be bumped all the way to 7.375% because it's non-conforming, and so that the yield spread covers the adjustments for investment property and 4 units. Every lender has these charges, and these are on the mild side. So you see why I do not believe the real rate on the investment property loan would end up being 7% without they charge you some pretty stiff figure in points. I'm not sure your real rate can be bought as low as 7% on such an Option ARM. This lender does both A and Alt A, and their adjustments on the Option Arm are a half point more expensive, which means even the highest rate on their sheet only buys your net retail points to one, but let's run with our assumptions as stated. Payment is $4972.87, after 5 years you will owe $680,400 and your total of payments will be $298,371.66.

Let's look at the end of those five years.

HOME Balance Total paid Net

Neg Am 447,480 123,969 571,439

30 fixed 389,216 154,052 543,268

difference -58,264 +30,083 -28,171

So you see that every dollar you saved on cash flow cost you two dollars in real terms. Lenders love this kind of math! Nor am I certain that this is really a fair comparison between the loans, but it's what I have to work with.

Now, lets do the apartments. As I said, I am as certain as I can possibly be that this is not a true and fair comparison between loans. I'm restricting myself to "no points" loans, and if that lender told you there were going to be no points on an option arm at 7% on a 4 unit investment property, I'd call him a liar to his face.

Apartments balance payments total

Neg Am 767,109 212,518 979,627

30 fixed 680,400 298,372 978,772

difference -86,709 +85,854 -855

So you see that, even giving this person every possible benefit of the doubt, you come out better on the thirty year fixed, even though I don't believe their loan really exists at the rates they stated.

Now I'm have not, thus far, allowed for the possibility that you wouldn't qualify for both loans, (with all the lovely potential for gain on the apartments) with both sets of fully amortized payments. There is a pretty serious monthly income zone ($3800 wide) where you would qualify for negative amortization but not fully amortized, at least "full documentation." It is to be noted, however, that these loans can be done independently of one another, dropping the monthly income range gap where you qualify for at least one full documentation to just over $800. I am intentionally ignoring the possibility of "stated income" loans because stated income is a very dangerous game to play in these circumstances (or anything similar). Also keep in mind, however, that property values don't have to go up in five years. It's a pretty reasonable bet, especially right now, but I don't think we're going to see more than 5% annualized for a while.

(At this update, rates are lower but stated income is completely unavailable, at least for now)

People sell Negative Amortization loans based upon apparent cash flow, not based upon how wonderful they are to your bottom line. When you consider them on anything other than a short term cash flow basis, their virtues become non-existent. They are popular because they are easy to sell to most people. Most folks think of cost in terms of the check they are writing every month, and that's just not all there is to it. There are also deferred costs - costs that have the potential to step out and grab you with a bill, in this case for another $85,000 that most people won't realize they owe. This is 2003 thinking in a 2011 world: "The equity increase will more than pay the difference." Except that it isn't necessarily so. Apartments have to cash flow, yes, but they have to cash flow in real terms, not something manipulated to make it look like you're making money. They don't appreciate except based upon their rental income net, and unless you get a clueless newbie for a buyer, that's what your offer is going to be (Any resemblance between this and the bigger fool theory is purely intentional).

It's much easier to persuade people to give the bank tens of thousands of dollars in equity that they might have someday, than it is to persuade them to write a larger check or endure negative cash flow in the first place. Persuading them to write the larger checks remains the correct thing to do in 99% plus of all cases. You can't fault loan officers and real estate agents as sales folk for making the easy sale - but you can fault them to the extent they represent themselves as analysts, consultants, or advisers, and I just don't see a whole lot of people in either of my professions representing themselves as straightforward sales persons. When I originally wrote this, I had a property one of my clients was in escrow on with about eighty business cards on the kitchen counter - and mine was one of about three cards on that counter with anything like a sales representation ("Loan Officer and Agent"). Some say things like "Real Estate Consultant", while others say things like "Relocation Specialist" or "Financial Vice President". It's all very deliberate to convince people to drop their defenses, because "I'm not a salesperson," but if you are going to represent yourself that way, you have a responsibility to comport yourself in accordance with that representation - and all the evidence I'm seeing says that this is not the case. I would like to see some civil cases make their way through the courts which fault agents and loan officers on the basis of their self-representation as something other than sales folk.

Actually, let me take that back. If they're acting as your real estate agent, they do have a fiduciary duty to you no matter what they're representing themselves as. Loan Officers do not in most of the country - which is one of the reason the loan side is so messed up - but Real Estate Agents do, and if they're also doing the loan, they have a responsibility to advise you that this appears to be beyond your means, and exactly what risks you may be taking with this purchase - something I'm seeing more evidence in contradiction of than in support of.

Negative amortization loans can serve a valid purpose as refinances in certain limited circumstances. They can help people avoid worse consequences than necessary, when the numbers are right for it. But as purchase money loans, they are like playing Russian Roulette with your financial future. Sure, the market might take off like it did a few years ago - but it also might sit stagnant for the next several years, or even decline a little. Even if it goes up, it may not go up enough to pay the extra money you now owe. Of all the scenarios listed, the market taking off at 10% plus gains per year is the least likely, in my opinion, at least for the forseeable future.

Caveat Emptor

Original article here

The only Pre-Approval I trust is one that I wrote myself.

I got this search engine hit:

pre-approved loan underwriter changes terms illegal

I have gone over these issues in discussing the pre-qualification.

Loan officers are salespersons. There is intense pressure on them from supervisors, brokers, stockholders and their own pocketbook to tell you what you want to hear. A large proportion of the people who ask me for a either pre-qualification or pre-approval already have a property in mind, and they get angry if I tell them it appears to be beyond their means. They should be kissing my shoes because I'm trying to keep them from making a half-million dollar mistake, or at least make certain they go into it with their eyes open, rather than just keeping my mouth shut and pocketing my commission. Most of these folks just go get their "Think Happy Thoughts" letter elsewhere.

Furthermore, if the loan officer is counting upon referrals from real estate agents for a living, if they tell people what they can really afford, they're getting the agent angry to no good purpose. This agent thinks they have a commission check all lined up, and the loan officer is trying to talk the buyer out of it, threatening that commission check. Most Real Estate Agents do not respond well to this, I'm sad to report. In that situation, I would be thinking, "Boy, I'm glad I found out now, before the default, when investigators and lawyers and courts get involved," but most agents (and their brokers) see only the immediate check that just evaporated. One such experience is all it takes before they not only stop referring to that loan officer, but try getting any clients they may have in common away from that loan officer. This may be short-sighted, but it is also human nature.

Not to mention the fact that nothing about a pre-approval or pre-qualification is binding. In fact, until the underwriter writes a loan commitment, there is nothing that says you have a loan at all. Furthermore, it's rare for loans to be rejected outright. What happens far more often is the underwriter puts one or more conditions that the applicant cannot meet on the loan commitment.

Furthermore, there is nothing about any loan that says the terms cannot change unless there's a rate lock in effect. If the loan isn't locked, it's not real. Quite often, loan officers will tell people their loan is locked when it's not. Locking paperwork can be easily faked.

Finally, while the new 2010 Good Faith Estimate makes lowballing on the costs more difficult in that it adds more hoops for the unscrupulous to jump through, it does not prevent the practice or stop it. Keep in mind that last word "estimate". Furthermore, they are not promising that you will get the loan. That requires a loan commitment written by an underwriter, and if further investigation by the underwriter reveals more questions they want answered in order to fund your loan, the underwriter can always add more conditions. None of the paperwork you get at loan sign up promises you will end up with a loan at all. You want to know why, consider that when the lender starts to verify the applicants information, they come across information indicating it's all fraudulent. This happens. It has happened to me, and it happens to loan officers somewhere in the United States every day.

Even with the best will in the world, I can't guarantee you've got a loan until I get the loan commitment from the underwriter. I can go through all the guidelines for a given program, and make certain the borrower meets every single one of them. It doesn't mean anything until the underwriter writes that loan commitment. I don't have the power to approve that loan - no loan officer does. Loan commitments are the exclusive province of the underwriter. A good loan officer can and does go through guidelines to ascertain whether there's an known reason that you will be turned down. If the underwriter rejects the loan, none of it means anything.

This is one of the reasons that I have written several articles explaining how to calculate what you qualify for, in terms of payment and in terms of purchase price, so that you will not be at the mercy of somebody who tells you, "Sure you can afford it," while qualifying you for a "stated income" negative amortization loan. The most mathematically correct and detailed of those articles is Should I buy a Home Part I, while the most accessible is How to Tell If You Can Afford This Property.

If you don't have a lock, the loan is not real, and it will fluctuate with the market - every day for A paper. Until mid-2009, I used to lock every single loan upon application, but the lenders have now made that practice financially prohibitive - a loan officer who does it can expect to pay "fall out fees" that drive their cost of business up until what they can offer consumers is no longer competitive with anyone. What I can still do is guarantee all fees except the tradeoff between rate and cost, and consult with a client upon the optimum time to lock those in, which now has to wait until after the loan commitment. Even that is not absolute, however. The loan officer cannot really promise you that loan until the underwriter writes a loan commitment with conditions you can meet. Even that can change if the underwriter discovers new information, but always remember that the loan officer is not the underwriter, and there are regulations preventing direct contact between consumers and underwriters. If the underwriter rejects the loan (or doesn't approve it), you still don't have that loan. You can choose another one, that you are likely to qualify for, or you can do without. I'll tell people that if the loan officer gets back to them within a week with a change, it's likely that they're honest and they really thought you qualified for the loan they told you about in the first place. If it takes them three weeks or longer, or if they spring it on you at closing, I wouldn't believe they were honest with sworn testimonials from George Washington, Abraham Lincoln, and Diogenes that they saw the whole thing, and it's not the loan officer's fault. It's not for nothing I tell people, "When There Is A Problem, It's Good If They Tell You Right Away"

Only when you have a lock agreement, loan costs guarantee, and a loan commitment from the underwriter do you have a deal going that somebody might be able to stand behind, in the sense of being able to hold them responsible if they don't deliver on exactly those terms, and even then there are limitations. Of course, what really used to happen with most loans (and still does with a large number) is that loan officers tell you about loans they have no prayer of being able to deliver in order to get you to sign up. This is despicable, but it's the way things are. There are reasons why the situation is complex, but that's no excuse for loan providers to play any additional games to obscure or confuse something that is already complicated enough. Part of the reason that I'm writing here is that I would like to change this for the better, but the power to demand real change is in the hands of consumers, not any individual provider.

Caveat Emptor

Original article here

Once upon a time, I received an email about the virtues of zero interest credit cards as opposed to Home Equity Lines of Credit. I've organized both the email and my response in order to facilitate understanding:

You raise a lot of issues. Some I'm going to deal with very quickly, others I'm going to spend some effort on, but nothing as in depth as a full article would have. I'm going to keep referring to material found in Credit Reports: What They Are and How They Work

I'm going to take the email in chunks:

Turns out I made the Two-Loan choice myself, independent of your article, a couple years ago. I was motivated to get a conforming first loan (~$322K @ 5.75%), and put the other ~$45K of a prior mortgage into a HELOC (besides, the HELOC rate was lower than the 30-yr fixed at the time!).

Well, times (and HELOC rates) have changed, and I now have
~$65K on my HELOC, and relatively tight budget.

That was 2003. considering that I had 30 year fixed rate loans at 5.375 percent or lower without any points for months and 5.25 for literally zero total cost for about one month, you likely paid more than you needed to. There was a period in late August when rates spiked up, but I was calling the same clients back in December and into 2004, asking if they wanted to cut their rate for free. No prepayment penalty, no points. Those would have lowered the rate further.

HELOCs (Home Equity Lines Of Credit) have the disadvantage that they are month to month variable, based upon a rate that is controlled by the bank. On the downside, you're somewhat at their mercy. On the upside, the rate is based upon that lender's Prime Rate plus a margin fixed in your loan papers. They can't change your rate without changing everyone else's also. There is absolutely no legal reason I'm aware of why they can't set prime at twenty-four percent. There are plenty of economic reasons why they won't. Unfortunately, given the high demand low supply of money currently, the banks are competing for new business with a better margin, not a lower prime. They didn't cut rates every time Greenspan's Fed did, but they have religiously boosted prime every time the overnight rate has gone up since the Fed started raising it. Banks are making a killing in real historical terms right now with variable rate lending.

Fortunately, in most cases it's pretty easy to refinance a HELOC. Credit Unions are a great place for this; variable rate consumer credit is where they shine. There are some internet based lenders where you can obtain no cost, easy documentation HELOCs at rates right around prime, or even a bit below if you have the credit. Most HELOCs also have "interest only" options for five or ten years. Brokers really don't do a whole lot for HELOCs except keep lenders honest; there is not enough money in them to make them worth chasing and the lenders won't pay for them the same as for first trust deeds; it's too easy to refinance out of them. (Brokers can beat the stuffing out of credit unions on first trust deeds, however).

Unfortunately, your credit score is a problem now:

I have multiple credit card companies offering me low introductory rates (some 0%, some 2%) for short terms (up-to 1 year).

Why would I NOT want to take them up on their offer?

In truth, I've already done this a number of times in the past 12-18 months, always at 0%. So I've learned the "minimum payment" trade-off (and I wish congress hadn't forced CC companies to raise their minimum payment requirements!) [ last year, one fine bank only made me pay $10/month on their loan of ~$10K! Now I'm seeing minimum payments of 1-3 %]

The difference between cash flow and real cost, and the fact that each time you accept a new credit card thus, it is a MAJOR hit on your credit. Let's say you have two credit cards now that you have had for over five years, and get four new ones. Your FICO score modeling goes from over five years to about a year and a half on your length of credit history (the average of your accounts, except that five years is the maximum you get credit for an account). Open four more six months down the line, and now you have ten, with an average time open of just over a year. Furthermore, since most people move as much as they can into the new credit accounts, this gives major credit hits for being essentially maxed out on a card. Thirty to forty points on your FICO score per card, perhaps more. You say you've been doing this a while. Not to mince any words, I wouldn't want to have your FICO right now.

There are always two concerns when you're looking for the best deal. Minimize your costs, of which interest is far and away the largest, and be able to make your payments. I don't know if you have other payments here, but if so I would do everything I could to live cheaply enough, long enough to use the money I save to make a difference on both of those scores. In your position, I'd sell any cars I still have a payment on, just to get out of the payment. This is a concern I've been telling people about since 2003, when the rates on everything were so cheap. There is more than one way to do things, but you have to be prepared for the consequences of the way you chose. I had some clients up in Los Angeles about July of 2003. They wanted to cut their payments. I gave them the option of a conforming loan (like yours) with a HELOC, and they took it. As soon as the loans funded, the wife called me and said I deceived them about the loan, and they wanted me to pay for another loan. Unfortunately for their contention, I had a piece of paper in the file with their signatures saying exactly what I tell everyone else about this situation, that the rate on the HELOC is month to month variable and subject to change, and that they understood this was a risk and they elected to take it. It looks like you went in with your eyes open, but the risk didn't work out as you hoped. I'm trying to think of other strategies to help you out, but other than "live frugally for a while", it's all little stuff around the edges.

Tonight I'm "running the numbers" on whether a 2% rate (nondeductible) is better than an 8% (tax deductible). And according to my simple calculations (I'm an engineer, not a financial advisor!), it's a no-brainer (go for it!). For the $40K currently on the HELOC (other $25K is already temporarily in 0% accounts), the one-time transfer fee ($50-90/transfer) and lower interest amount (~$70/mo) is ~$200/month less than the deductible interest-only (minimum, ~$435, @ 8%) HELOC payment, AFTER adjusting for the tax deductibility (@ 30% [fed + state], ~$130 on $435).

My plan is that in months when my "income"/cash flow cannot cover all the minimum payments, I'll just use a HELOC check to cover the difference. That is, slowly transfer SOME of the debt back to the HELOC. But in the meantime, my theory goes, I'm paying down my principle faster than if I was just making "extra payments" on the HELOC.

Yes, in most cases you will make more progress, faster, this way, but at such a long-term cost as to make it prohibitive, particularly if you have to leave the credit lines open after you transfer the money out six months down the line. Lots of very silly folks do all kinds of weird and non-remunerative things because it's a deduction, but deductions are never dollar for dollar. If that were the only concern, 2% nondeductible beats 8% deductible by a huge factor. Given what's going on in the background, however, kind of a different story. All these newly opened lines of credit are going to drag you down for years. Make certain to pay it off before the adjustment hits; one month at 24% will kill almost all of your savings. Two months at 18% will more than kill it. Given what your score has likely dropped to, I'd bet that it's closer to the former than the latter.

I also finally had a 0% application turned down, due to "too much credit already, for your income level". So I imagine having all these cards may be hurting my credit score? But I'm not going to re-fi my house (or buy a new car?) anytime soon, so I think I don't care.

I imagine you're going to care. FICO scores require care and tending and time to rise back up. Close off any cards you opened for the zero interest period that you have paid off, and that will mitigate the damage. Keep only a few long standing accounts. But a large amount of damage is already done. When Credit Card companies are saying that, your FICO has dropped big time. Without running your credit, from the foregoing information, I'd guess you are below the territory where I can get a 100% loan, these days, even sub-prime (lower 500s). You might be below 500, where only hard money can lend to you.

(At this update, there are no 100% loans except VA. Given current underwriting standards, someone with a sub-580 credit score basically can't get a loan without 30% equity/down payment)

Another concern is that HELOCs have "draw periods", usually 5 years, and (at the time he was) about three years into yours. I'd be very certain to move it all back into the HELOC prior to the expiration of the draw period. Your credit card options are already getting worse, meaning that you're not getting the cards or not getting approved for enough to be useful. The HELOC's rate, by comparison, is set by a margin in an unalterable contract, and you're not going to be able to qualify for a new HELOC that's anywhere near as good while those card accounts are open. Move the money back in at least a couple months before the draw period expires and close the credit cards, and you might be able to get a new HELOC on decent terms.

Your credit is always vitally important. Guarding a very high credit score is something worth stressing about. You never know when you might need to apply for credit. Most credit cards, nowadays, can alter your rate if your score drops or if you make one late payment anywhere, not just on that card. A good credit score saves you money everywhere, from borrowing to insurance. In your situation, I'd be stocking up on pasta and Hamburger Helper while seeing what I could do to increase my income, so I could live cheap enough to pay my bills down enough that I'm not squeezed. It's your life, but that's the way I see it.

Caveat Emptor

Original here

(For full disclosure, the original email is below in a body).

Hi Dan,

While using Google to seek the wisdom of others regarding my current financial situation, I came upon an article of yours, and have now read at least a handful of others. In particular, "One Loan Versus Two Loans" caught my attention.

Turns out I made the Two-Loan choice myself, independent of your article, a couple years ago. I was motivated to get a conforming first loan (~$322K @ 5.75%), and put the other ~$45K of a prior mortgage into a HELOC (besides, the HELOC rate was lower than the 30-yr fixed at the time!).

Well, times (and HELOC rates) have changed, and I now have
~$65K on my HELOC, and relatively tight budget.

I have multiple credit card companies offering me low introductory rates (some 0%, some 2%) for short terms (up-to 1 year).

Why would I NOT want to take them up on their offer?

In truth, I've already done this a number of times in the past 12-18 months, always at 0%. So I've learned the "minimum payment" tradeoff (and I wish congress hadn't forced CC companies to raise their minimum payment requirements!) [ last year, one fine bank only made me pay $10/month on their loan of ~$10K! Now I'm seeing minimum payments of 1-3 %]

Tonight I'm "running the numbers" on whether a 2% rate (non-deductible) is better than an 8% (tax deductible). And according to my simple calculations (I'm an engineer, not a financial advisor!), it's a no-brainer (go for it!). For the $40K currently on the HELOC (other $25K is already temporarily in 0% accounts), the one-time transfer fee ($50-90/transfer) and lower interest amount (~$70/mo) is ~$200/month less than the deductible interest-only (minimum, ~$435, @ 8%) HELOC payment, AFTER adjusting for the tax deductibility (@ 30% [fed + state], ~$130 on $435).

My plan is that in months when my "income"/cash flow cannot cover all the minimum payments, I'll just use a HELOC check to cover the difference. That is, slowly transfer SOME of the debt back to the HELOC. But in the meantime, my theory goes, I'm paying down my principle faster than if I was just making "extra payments" on the HELOC.

Seems so obvious when I look at the numbers, that I cannot figure out why more people aren't doing it, or at least talking about it!

Why does a thorough website like yours not say anything about this (that I could find anyway)? Is it just to keep those low-rate credit offers coming? Am I missing something? I am really the only person to ever think of doing this? I also finally had a 0% application turned down, due to "too much credit already, for your income level". So I imagine having all these cards may be hurting my credit score? But I'm not going to re-fi my house (or buy a new car?) anytime soon, so I think I don't care.

Thanks for reading this far. If you post an article on this topic rather than replying, will I get a least a pointer to it in reply?

Again, thanks for considering a comment on my situation!

Identity withheld by request

(UPDATE NOTE: After several years of it being unavailable, I've recently started getting lender solicitations for stated income loans again. I haven't done any of these new loans yet, but as much as I don't like stated income there is a legitimate market segment that it served: The self employed and those with large amounts of business deductions, who actually could afford these loans because they got to pay for things with "before tax" dollars while it is only "after tax" dollars that are considered by traditional underwriting standards. Given the growth in the self employment segment of the economy, somebody is going to decide they want the income from serving it and figure out appropriate controls to prevent its abuse. That does not alter the basic thrust of the article, however, which is that you will save money by providing full documentation if you can)

No matter which provider, no matter what type of loan you get, nobody is going to loan you money without the appropriate documentation. The more documentation you have that you are a good risk, the better the rate you are going to get, and the lower your costs are going to be.

Everybody hates filling out forms and providing documentation. When I originally wrote this, there was a billboard two blocks from my house advertising, "Stress free loans." Actually, these signs are all over. And I'll bet they bring in a lot of business. Low documentation loans are easy money - I could do them all day and all night, and make more money, and make the lender more money, while doing less work, than I can by hunkering down and actually serving my clients best interests. Those billboards say "stress free loans" which three words look like an English sentence meaning this will be easy, but the real translation to English reads, "Hello, I am a lowlife scum who wants to take advantage of lazy people who are too ignorant to know better by making a lot of money providing loans at higher interest rates and less favorable terms than they could obtain elsewhere, and putting a large proportion of my clients into loans that they cannot afford, from which point they will inevitably default and lose the property and whatever investment they may have made"

The fact is, that for something dealing with this much money, if there is documentation you can produce to prove that you are a better risk and gets you a better rate, you should be eager to present it. If I can spend half an hour instead of fifteen minutes filling out forms and as a reward I save $40 or more every month until the next time I decide to refinance, I want to fill out the extra papers. If I refinance every two years, I have essentially been paid $960 for a quarter hour of work. That works out to $3840 per hour. I don't know about you, the reader, but even when I'm completely inundated with clients, I don't make that kind of money per hour. I don't know any job that pays that much, unless you want to include wealthy investor. And let me tell you, the wealthy investors I've dealt with are eager to spend the extra time filling out said forms. It really is a "Rich Dad, Poor Dad" situation. They know it will Save Them Money, and don't have to be sweet talked into filling out one more form or providing a little more documentation. They've got it already copied for me, and if I want their business, I'd better buckle down and get to work on finding the loan with the best terms possible. If you, the reader, wish to be wealthy, you could do worse than emulate their example.

There are, when you get right down do it, three different levels of documentation. The lowest level of documentation is NINA, which is short for "No Income, No Assets." There are other names for it ("No Ratio" being the most common, while "ninja" was the creation of a reporter with samurai fever). This is a loan where the rate you get is purely driven by your credit score (as well as other factors, such as the equity in your home or down payment you're making, but those are constants endemic to the situation, not variables about which I am talking). You're not even documenting that you have a source of income. You're basically saying, "Here I am! Gotta love me!" to the bank, and they really do love you because you're filling their coffers by paying the highest rates for your loan. Guess what? You're still filling out all the forms (or somebody is doing so on your behalf, which they can do to the same extent on other loan types!), and you're still providing all the documentation on the property - how much it's worth, proving you own it, proving the taxes are current, etcetera. Owing to identity theft and homeland security laws, you can expect to have to provide two things that basically show that you are you. You can expect to deal with problems if the county doesn't show the taxes as current, your landlord or current mortgage holder shows you as being behind or that you have a history of being behind or the county doesn't show you officially in title of record, or any of a host of other potential problems, but hey, at least you didn't have to show that you've got a source of income!

The next level of documentation is a "Stated Income" loan. This is where you document that you've got a source of income, but not that said income is sufficient to justify the loan, so you tell the bank you make that much, and they agree not to verify the actual numbers. This is going to require two additional items: verification of employment, or a testimonial letter if you are self-employed, and reserves. Reserves are quickest to explain. Industry standard is money sufficient to pay the loan, your taxes, and your homeowner's insurance for six months, in a form that is sufficiently liquid such that the money can be accessed, for a long enough period that the bank will believe it isn't borrowed - and the bank will require documentation of its availability if it's in an account type such as 401k where access may be restricted. Verification of your employment is somebody in the HR department filling out a form on your behalf and verifying it over the phone. The testimonial letter for self-employed borrowers comes from your lawyer, accountant, or tax preparer on their letterhead saying that you really do have a legitimate business. It basically reads: "To whom it may concern. John Smith is self-employed as the owner of business X. He has been doing this for Y years. Based upon information provided to me, he will earn the same amount of money this year as last year." The person providing the testimonial must sign the letter. It really is only about three sentences, but that person is putting their business on the line for you if it's not true. So they tend to require evidence if you're coming to them for the first time to get this letter written and signed.

The bank is basically looking for two years in the same line of work or at the same company to approve this one. Subprime lenders - when we had those - would sometimes accept a year or even six months, although their terms will not be as favorable. What the bank is looking for is evidence that you can really afford the loan. The thinking goes like this: "He's got a source of income, He's got a good credit score, he's making all his payments, he's got money in the bank, okay, we think he's living with his means and can afford to pay us back. We'll lend him the money." There are variants on stated income of which "stated income, stated assets" is the most common, but these carry higher rates, higher charges, or both, in many cases actually end up looking more like a heavily propagandized NINA loan than anything else.

It is a misapprehension to believe that Stated Income Loans have no debt to income ratio or income requirement. They are precisely that: You are allowed to state your income, which the lender agrees not to verify, in exchange for paying a higher interest rate. It's still got to be believable within the context of your profession and locale, and if believable amounts of income do not justify the loan, then you can expect to have it rejected. This income must also be sufficient to convince the lender that you can make the payments upon all of your known debts according to lender guidelines, mostly having to do with the aforesaid debt to income ratio. For these reasons, while you can always move a "stated income" loan to "full documentation," going the other way is forbidden.

I've heard Stated Income (and NINA) commonly referred to as "liars loans", and they are often used for such, but that is not their intended use. As a matter of fact, people get in a lot of trouble with these loans, and many times it comes back on an unscrupulous loan officer or real estate agent trying to push something through for which their clients really aren't qualified. If you can't afford the payment, am I really doing you a favor by qualifying you for the loan? I submit that I most emphatically am not. Before they push such a loan through, an ethical loan officer using it for this purpose should sit down, tell the people what the real payment is going to be, and make certain they can afford it - and not just by words, either! The loan officer has responsibility to both the lender and the borrower, and putting somebody into a loan they cannot afford harms both of those parties. On the other had, I have run into situations where they borrowers were renting and their effective cost of housing was going to go down! And in that case, I submit that I probably are helping the clients. On the other hand, if you're doing Stated Income or NINA (especially on a purchase) and the loan officer doesn't sit you down and cover what the payment is going to be within a couple dollars per month, and make certain you're okay paying it, this is a red flag in no uncertain terms!

What Stated Income is meant for is self employed people and people working on commission who really do make the money, but have write-offs such that their taxes aren't going to show enough income. Or people who had a bad year, or large losses or high write offs one year, but are still basically solid. I am going to observe that regulating stated income out of existence is doing no favors for the people it is meant for, nor the market at large. I certainly understand why Stated Income and NINA have evaporated currently and agree with those reasons due to the abuses that have been practiced. However, it doesn't do anyone except politicians any good to pretend that there haven't been people who could have otherwise afforded their loans hurt by this development.

The highest form of documentation is Full Documentation (almost everyone says "full doc" because the unabbreviated phrase is a mouthful). This does not necessarily mean I've got to prove to the bank that you make every penny you actually make, but only that you make enough to justify the loan. The proof the bank will accept is very straightforward. Self-employed borrowers are still going to need that testimonial letter from stated income. They will additionally be asked for their federal income tax packet. This is all of the forms, front and back, that you sent to the IRS last April 15th, and perhaps the April 15th before that, too. It's got to be a signed copy, and it must include copies of any w-2s or 1099s that you get. People in the construction profession, as well as those who may be w-2 employees but work on commission will also need to furnish their taxes, and the bank's underwriter can always require it of anyone. It is to be noted that banks did not have to accept your loan on a stated income basis even when it was available - the underwriter could always require that you furnish full documentation.

Those people who are hourly or salaried employees of a company can usually get by the full documentation of income requirement with just w-2 forms. If you are a company employee, the last 30 days worth of pay stubs will also be required.

The basic rationale for this is simple. Very few people tell the IRS that they make more money than they do, because the consequence is higher taxes. So the bank is willing to use tax forms to prove your income. In the case of a w-2 employee, the company is telling the IRS that those are the wages it paid you, and therefore wants to deduct your wages as a business expense, and you went and paid taxes on it, so the bank will usually accept that. Similarly, your pay stubs should have year to date pay on them. Here the bank will accept the word, metaphorically speaking, of a third party without a stake in the outcome of the loan.

A subset of the full documentation loan is the streamline refinance. As the name indicates, it is available on refinances only, not purchases. There are a lot of limits on these loans, but when I get to do one it is the easiest of all loans. Basically, it's a case where the same lender is now offering better rates, and no equity is being taken out of the home, and they'll allow you to do it because otherwise you'll take this client elsewhere. 90 percent of a loaf is much better to them than none.

Within the sub-prime mortgage world (when it existed, which it probably will again - once again, it's a legitimate market that someone will decide they want the money from servicing), those lenders would often take the deposits from 12 consecutive months of bank statements (sometimes 6 or 24), usually discounted by a certain amount, and accept that as proof of income. This is called Lite or EZ doc, although there's nothing easy about it and as a matter of experience there are more fights with the underwriter and jumping through hoops here than with any other type of loan documentation. The rates are somewhat higher than for full documentation, but not nearly the rates for stated income. Mind you, sub-prime rates are higher in the first place as well. Furthermore, many of these sub-prime lenders would advertise the fact that "EZ doc rates same as full doc!" I shouldn't have to explain to adults that this phrase translates to English as they don't give the lower rates to true full documentation loans, now should I?

So, on the subject of documentation, I think you should be able to tell that the higher the quality of your income documentation, the lower the rate that you are going to get from a given lender. If you can qualify, a full documentation loan is probably going to save you more than enough money to pay you to do the extra paperwork, the amount of which is marginal anyway. The only reason not to do the extra paperwork is if you can't supply requisite proof, which is pretty much the reason why the lesser loan types such as stated income and NINA have been so abused and I can't find a single investor offering them today.

I should probably repeat one final time that as of this update, true full documentation loans are the only thing available. The others will almost certainly make a comeback at some point, but with some changes. They were badly abused by the marketplace, but the fact that they went away caused a lot of people who really could afford their loans to be unable to refinance, or unable to get a purchase loan. Eventually someone will decide they want the profit for serving this market segment and figure out a way, but until then, lesser documentation loans are gone.

And as one final warning: If a loan officer requires originals not only of the forms they ask you to sign (A couple of the standard forms require original signatures - really!), but of your own documentation, it is a BIG RED FLAG. I can't think of any client-supplied document that lenders will not accept copies of. The only reason to require your originals is that loan provider does not want you able to apply for a loan with someone else, so they're putting an end to your shopping, and once they've got them, good luck trying to get them back (at least until the loan is done so they get paid). A good loan officer needs good readable copies - not your originals. An ethical loan officer doesn't need or want custody of your originals any longer than is necessary to make good copies, and if you hand them a good readable copy in the first place, that isn't a problem.

Caveat Emptor

Original here