Mortgages: December 2020 Archives

One of the questions we ask all the time is whether to do your financing as one loan or two loans. Until comparatively recently, one loan was the default option, but people have been learning that splitting their home financing up into two loans can save them significant amounts of money. Unfortunately, this was just in time for second lenders to get burned by the loss in values. As of this revision, currently no lender that I'm aware of is funding second mortgages over 90% CLTV. When this changes, I'll go back to preferring two loans.

There is significant resistance to the idea of having two mortgages on the part of some people. I have never had a conversation where somebody came out and said why they didn't want to split their mortgage into two pieces, but I can offer some hypotheses. Two loans is two sets of paperwork, two checks to write, twice as much paperwork to fill out and twice as many things to keep track of. If I can't show them concrete benefit, they don't want to do it.

In the cases where equity is or is going to be less than 20% of the value of the house, this is not difficult. Sometimes if the client is in a subprime situation anyway, a loan between eighty and ninety percent can sometimes be marginal, but loan amounts at or above ninety percent of the value of the home are pretty much universally better as two loans.

To illustrate why, let us consider a $300,000 home with a $300,000 loan. Let us posit that your credit score is right on the national median (720), and we desire a Full documentation 30 year fixed rate loan for the primary loan, and a thirty day lock, and that this is purchase money.

When I originally wrote this, I used a price sheet on a random "A paper" lender from my deleted files a few days old, and priced accordingly. I'm retaining those numbers even though they are no longer applicable except as an illustration. Since A paper price sheets change every day, this is intentionally stuff that is based upon outdated rates, used as an example lest somebody in the Department of Real Estate otherwise construe this as a solicitation. Furthermore, I was pricing at "par", no discount or rebate, so no points, to create a real comparison at the same cost. It wouldn't be a valid comparison if I was pricing a loan package that took two points against a loan with all closing costs paid.

If we priced it at par when I originally wrote this, this would have been 6.375%. To this would be added a charge for PMI of about 2.25% on the entire value of the loan, making your effective rate 8.625%. Furthermore, the PMI component is not deductible. Your payment is $1871.61 plus $562.50 PMI for a total of $2434.11, or which only $1593.75 is potentially tax deductible. If you want to make it deductible by using lender paid mortgage insurance, the payment goes to $2333.36 with potential tax deductions of $2156.25, so that's a benefit right off, but you then have to actually refinance in order to get rid of PMI as opposed to having it removed administratively or by simple appraisal if and when your home value appreciates sufficiently. Nonetheless, most people do refinance so I'll assume this is what you do.

Now let's price it out as two loans. Par is 5.875 percent for the 80 percent loan. Doing the second as a 30/15 gives a rate of 8.75. This means it's thirty year amortization, but the balance is due in fifteen years as a balloon - so you either have to pay it off by then or refinance by then. Nobody does 30 year flat fixed rates on 100 percent seconds at any kind of decent rate. Better to do is as a 30/15 second. Doing it as a variable rate home equity line of credit gave a rate of 8.75 also.

The payment is $1419.69 on the first, fixed for thirty years, and $472.02 on the second. Total payment $1891.71, potential tax deduction $1175.00 plus $437.50 for a total of $1612.50.

Comparing the one loan versus two loans directly, and assuming you're in the 28 percent marginal tax bracket with standard deduction of $9600 and assuming your other deductions of $5000 and you did get to deduct 100% of mortgage interest, for one loan you get a tax savings of $5975, plus principle paid down of $2211 - but your total payments are $28,000.32 over the year. Net total cost to you is $19,814. For splitting it into two pieces, you get tax savings of $4130, remaining principal paid down of $3448 total, and total payments is only $22,700. So your net total cost is $15,123 - a savings of $4691, plus you owe $1237 less next year, on which you will pay $74 less interest.

So you see, there are concrete advantages to having your loan split into two pieces.

Loan officers, however, typically get paid either zero or a small flat fee for the second mortgage, whereas they get a percentage for the first mortgage, so they may be motivated to sell you on doing one loan to increase their compensation. As you can see, this is not usually in your best interest. Matter of fact, if your loan is above the conforming loan limit (currently $417,000 for a single family residence) it can be beneficial to you so split it into a conforming loan and a second for that reason alone. If you shop around, you increase the chances of finding a loan officer who will do the loan from the point of view of what works best for you, rather than what best lines their own pockets.

I must stress that at this update, second mortgages where the total of all loans is more than 90% of the value of the property are not being offered anywhere that I am aware of. But that will change eventually, and when it does, two loans will likely once again be the superior option.

Caveat Emptor

Original here

There are a fair number of specific helpful suggestions to make in helping you purchase a home. All of them revolve around the loan. Let's face it, the loan is far and away the most hypothetical and uncertain part about most real estate transactions. If there is a non-loan related problem, chances are that you really didn't want to buy that particular property anyway. Most of the time, non-loan problems mean that you would be buying into trouble, and nothing but. Unless you have specialized knowledge in sorting out that particular problem, it's likely to be more expensive than any money you saved through reduced purchase price.

A poor loan officer can always botch a loan, of course, and even the best may not be able to push it through if you are a marginal enough case. So how do you improve your case standing?

The first thing is to get a credit score above 740. You can get most of the same loans with scores as low as 680, but there is a cost differential now where there wasn't before. If you're there already, keep doing what you're doing. Even if you're not there yet, it's easier to improve than most people think, although it takes time. Make all of your credit payments on time, especially any mortgages and rental payments. These are the most important things to mortgage lenders. Note that even though you may make a payment a few days later than it is due, and you may even pay a penalty, but the lender will not report it as late until 30 days later, and that's when it counts as late to everyone else. In order to qualify for the A paper loan, at the top of the market, the general rule is no more than two 30 day late payments on revolving debts within two years, or one 30 day late on mortgages or rent.

Most lenders want you to have three lines of credit, one or more of which have a twenty-four month credit history. Not all of them need to be still open, but if you don't have at least two open lines of credit, a given reporting bureau may not report a score, and if you don't have two different scores from the three big bureaus, it's very hard to find a lender in the current environment. Even during the Era of Make Believe Loans, only a few sub-prime lenders would give people without credit scores a loan - and they're mostly out of business now. The longer your particular lines of credit are open, the higher your score will be. So if you keep opening new lines of credit, expect your score to be low.

Revolving credit balances should be kept low, less than half of their limit. There is a significant hit if your credit line is more than half its limit, and the higher you go, the worse it is. If you have two $5000 limit credit cards, it is much better to have $1500 on each than $3000 on one and nothing on the other. It make even more difference if you have $2000 balance on each as opposed to $4000 on one. And if you're one of those people who keeps doing the "transfer your balance to a new card and get zero interest for six months" thing, it will really impact your credit in a negative way, because if your credit balances sum to $8000, that's usually what the limit on the new card will be, and so you've got a brand new credit card that's maxed out, which is a major hit on your credit. Furthermore, the opening of new credit accounts itself impacts the credit score in a significantly negative way.

One of the best ways to improve your credit score relatively quickly is to use your credit regularly but pay it off every time you get a bill. Once per month, charge something small that you know you will be able to pay off when the bill arrives. Something you'd buy anyway, with cash if you didn't have the card. This may still take some months to improve your score, but better months than years.

The next way to improve your ability to afford a house is not to have any large monthly payments. The best rates are for full documentation loans, where you prove to the lender that you make enough money to be able to afford all of your payments. "A paper" lenders will allow you to have total monthly payments of 38 to 45 percent of your gross monthly income, depending upon loan type. Some sub-prime lenders, back when we had them, would go to 55 or even 60 percent. If your family makes $6000 per month, this means that total payments can be up to $2700 for certain A paper loans, up to $3300 for sub-prime and still qualify full documentation. This also means that the more income you can document, and the less money you owe in payments, the larger the loan and therefore more expensive the house you can afford.

This number includes not only the amount of the mortgage, but also the property taxes, homeowners insurance, association dues (if applicable), and anything else you may need to pay in order to keep the home, as well as car payments, credit card payments, and any other debts you may have. This means that somebody with other payments of $80 per month can afford a lot more loan, and therefore a lot more house than somebody with other payments of $900 per month. This should be intuitive, but you'd be surprised how often people don't realize it. It has become something that cannot be gotten around with the death of stated income loans, and for most people, I'd have to agree that's a very good thing. There were some people for whom Stated Income loans were appropriate, even necessary, but they were abused so badly that regulators were correct to remove them. It was the least bad course.

The final thing that is helpful is a down payment. The larger your down payment, the less you have to borrow. Lending money is a risk-based business. Up to a point, the lower the ratio of loan balance to value of the property will help you get a lower interest rate and more favorable terms, because the bank will be more certain of getting all of their money back. Even when we had conventional 100% financing, a 5% down payment was better than none. 10% is better than 5%. I have one way to get 95% conventional financing now, but it's not competitive for people who have 10% or more. The first 5% makes the most difference (that difference currently being from "can't do it unless you're eligible for VA" to "there is a way"), but every bit helps. What is likely to be even more important is that with a lower rate on borrowing less money, your debt to income ratio also improves because your payments are less. Of course the larger your down payment, the less you have left over for other purposes. It seems to be a phenomenon today that people don't want to risk any more of their own money than they have to. 100% loans (except for VA loans) cannot be done be done right now, but I still get people who won't buy without one. As I keep writing, the loan market controls the real estate market, so when 100% loans make a comeback, expect the market to rise spectacularly. You'd really rather be in a property before that happens. People who make a habit of saving money are always in a stronger position that those who do not.

Caveat Emptor

Original here

real estate mortgage credit consumer education

With a few lenders starting to loosen their requirements slightly in San Diego, it's becoming increasingly obvious that the bottom is behind us. However, the issue has now become, "I don't have much of a down payment. How do I buy now so I can get into something before the market goes crazy again?"

There are several programs that exist that enable buyers to lower their down payment requirements. All of them have their limitations, but if you can jump through their hoops, they remove the need to save for a huge down payment.

The first of these are VA Loans. Right now, VA loans are the magic bullet. No down payment requirement, and you can even finance closing costs up to 3% on top of the purchase price right into the loan. Furthermore, there is not only no PMI, but the VA only charges a half point to fund the loan, and even that is waived with 10% or larger disability. Additionally, the conforming limit with VA loans is no longer applicable - I've had wholesalers tell me they would accept VA loans up to (potentially) $1.5 million dollars. There are no income limits, either, but you do have to qualify full documentation. However, because there's no PMI, no need to split loans, and no ongoing insurance charges for the loan, by debt to income ratio people with VA loan eligibility can afford almost ten percent larger loans than people applying for FHA loans, and about twenty percent larger loans than high loan to value conventional conforming loans (Below 80% loan to value ratio, conventional loans will most likely have a lower tradeoff between rate and cost). The biggest drawback is that you have to have served in the military or be serving, something comparatively few people do as opposed to former times. San Diego is a military town, and I've only dealt with one VA loan in the last year or so. It was formerly true that FICO credit score was not considered in VA loan qualification, but this has changed. How low a credit score they will work with is up to individual lender policy. Some lenders want a minimum of 580, others won't talk to you unless you've got a 680. The higher their qualification standards, of course, the lower the rate/cost tradeoff they offer will typically be.

Many locally based first time buyer programs take the form of loaning you a down payment. If you're buying a $300,000 property and the city you're buying in will loan you $60,000 for the down payment (usually in the form of a silent second), then you only need a $240,000 regular loan, which leaves you with an 80% loan to value ratio, and you are then able to qualify for a classic conforming A paper loan on your property. The drawbacks of these programs are two. First, budgetary constraints. As of a couple weeks ago, all the local municipalities were out of money for these until the new allocation comes in (usually in the fall and spring). If there's no money left in the budget when you want to apply, you're not going to get one. Second, income limits. These all have income limits, which vary with the program and municipality. Since like all other government programs you have to qualify for these via full documentation of income and proving you make enough for the payments via income tax forms, this can disqualify you or severely constrict what you qualify for, and the various municipal governments do put other strings on these programs. Nonetheless, the Cities of San Diego, El Cajon, and Santee have these programs in place, as does the County of San Diego for unincorporated areas, as well as administering the same program for Lemon Grove, Imperial Beach, Poway, and many other cities. Like VA loans, because there's no need for sellers to contribute to these financially, buyers who use these don't necessarily end up paying for it in the purchase price of their property, or by a limited selection of sellers with the wherewithal.

FHA Loans are not, in their basic form, a zero down payment program. They will only allow up to 96.5% of the purchase price, but they also allow family gifts of up to 6% of the cost of the home. Furthermore, they charge a point and a half upfront and a little over half a percent annualized per year for financing insurance. The good news is that you're still getting a very low down payment loan with comparatively low cost financing insurance. This is a government program, so you have to qualify via full documentation of income, and many properties are not eligible for FHA financing. The FHA also keeps what is functionally a blacklist, so you can find out that because your real estate agent, loan officer, etcetera contributed to fraud some time back, this particular transaction is not going to fly FHA. The FHA does allow seller paid closing costs of up to six percent, but if you think you're not going to pay for this via increased sales price, I've got some beachfront land in Florida. That means higher cost of interest, higher property taxes, and less equity if you sell or refinance. Furthermore, not every seller is going to be willing or able to work with people who want seller contribution for closing costs.

Until the latter part of 2008, there were Down Payment Assistance Programs targeted at FHA loans, providing the 3% down payment via a reciprocal loan paid back by the seller at close of escrow, and although FHA was not the only loan type they worked with, it was the lion's share of what they did. Once again, not every property owner is going to be willing or able to work with these programs, and if you think the money that sellers furnish for these programs doesn't result in a higher sales price, I own a bridge in Brooklyn I'm willing to sell on very reasonable terms. More than the amount of the loan you get, because they're offering something not everyone can. You have to be careful to disclose everything to everybody in these situations, and the purchase offer and subsequent counters have to be written very carefully. However, these programs are now prohibited by the FHA, officially because the default rate was too high.

Seller carrybacks are comparatively rare right now, as few sellers have significant equity. The ones who do and want to sell are likely to be able to wait until things get better, and so most of them are. Asking for a carryback is a major request on a purchase contract, because if that seller loans you $X, those dollars are not available for them to use purchasing their next property, or whatever investment they wanted to put the money into - they're still tied up in this one. Sellers willing and able to offer a carryback can command premium pricing, even in this sort of market, because many buyers will have exactly two choices: buy this property, or don't buy anything. Those sellers agreeing to carrybacks are also assuming a significant risk of non-payment and ending up in second position on a non-performing debt, which can cause them to lose every dollar they have invested.

Finally, a few lenders are once again willing to go 95% loan to value ratio for conventional conforming A paper loans, where for a while there the down payment requirements were ten to fifteen percent. There will be PMI, you are required to qualify full documentation, and the limit is the "regular" conforming limit of $417,000 as opposed to the "jumbo conforming" or "temporary" limits. But once again, you can do this with basically any residential property that's not too expensive, and the seller needn't be willing and able to financially contribute to the loan. There are a lot of properties out there that FHA will not touch, no matter how helpful the seller is willing to be. As long as it's an inhabitable residential structure meeting requirements, conforming loans will potentially work - if you've got 5% down. Nor do they require that the seller be willing and able to help out. 5% down is not usually a huge amount. For example, a couple each borrowing $10,000 from retirement accounts (as generally allowed by the rules - check with your accountant or tax preparer) has a down payment of 5% of $400,000, which buys a pretty decent place nowadays.

As you can see, there are drawbacks to all of these, as well as advantages. You would be well advised to consider an agent who is also a loan officer, because everything from the initial offer onwards has to be carefully written to remain within the limits of what lenders will work with and will fund. More than once I've had people come to me forty-five days into a thirty day escrow where the only way to make it happen was start by renegotiating the contract. Since the sellers were completely frustrated at this point and just wanted out, needless to say it didn't happen. So there is a limit to the ability to repair incorrectly written purchase contracts. Nonetheless, these options are there, are available, and I have funded loans on them in the past. Given the current state of at least my local market and its likely state a year or two from now, making use of them can mean that you're going to end up much better off than waiting to save that down payment. If the market appreciates in value ten to fifteen percent between now and whenever you have enough for a "normal" down payment, you definitely didn't help your cause by waiting.

Caveat Emptor

Original article here

Purchase Money: This is a loan that enables you, in combination with your down payment, to actually purchase the property. If you spend cash to buy the property and get a loan the next day, that is not a purchase money loan. Whether it is or is not a purchase money loan has significant tax consequences everywhere, and significant legal consequences almost everywhere.

Rate/Term Refinance: This is a refinance that does not put money in your pocket for other purposes. As it is more usually defined, this is a refinance that does not put significant numbers of dollars in your pocket. These loans typically have the best rates of the three purposes. For A paper rate/term, you are allowed to pay off an existing first mortgage against the same property, you are allowed to borrow enough money to "seed" a new impound account, you are allowed enough money to pay up to one month of prepaid interest, and you are allowed up to 1% of the new loan amount, or $2000, whichever is less, to be put into your pocket for other purposes. In order to qualify as rate/term, A paper cannot do anything with an existing second (or third) mortgage, unless every last cent of that second (or third) mortgage was spent in acquiring the property, a fact which can force you to either do a cash out refinance or to subordinate your existing second mortgage to a new first trust deed. Sub-prime may have more forgiving definitions regarding other debts, but choosing a sub-prime loan because it allows your new loan to be defined as a rate/term refinance is like voting Cthulhu for President because you're tired of voting for the lesser of two evils. Sub-prime loans have pre-payment penalties by default, and generally carry higher rates.

The difference in tradeoffs between rate and cost can be small to non-existent between rate/term and cash out refinances, particularly at lower loan to value ratios. The difference also varies depending upon credit score, size of loan, and individual lender policy, but it can be quite steep. The point is to get an honest discussion of your options beforehand, not simply to sign up with some lender who pretends that the difference doesn't exist.

Cash Out Refinance is any refinance that does not meet the definition of rate/term. It puts cash in your pocket, it pays off other debts, it includes or combines or refinances a home equity loan or home equity line of credit that you took out for improvements or to pay other debts. Violating any of the requirements to be considered rate/term means that the loan becomes a "cash out" loan. Cash out refinances will usually have the least favorable set of rate and cost trade offs, what the uneducated think of as "highest rates" of these three purposes, at least at higher loan to value ratios. Depending upon the lender, cash out loans with loan to value ratios under seventy to sixty percent may have the same rate structure as rate term refinances. Cash out refinances also usually have slightly tougher underwriting guidelines than either of the other two categories. One specific example that trips a significant number of people is that there cannot have been anyone added to title in the last six months.

Caveat Emptor

Original here

First off, neither the California Mortgage Loan Disclosure Statement nor the Federal Good Faith Estimate are promises, commitments, or anything more than your loan provider wants them to be. Quite often, they're nothing more than a fictional story told to get you to sign up for their loan. It's amazing and disgusting how much it's legal for lenders to lowball their quotes.

That said, there are three explanations as to why your rate, cost, or both are higher. They're not mutually exclusive by any means, but it has to be at least one of these three.

The one that reflects on you is that you somehow misrepresented your situation when you were getting that loan quote. In that case, you are no one's victim except your own. It is pointless to lie to a loan officer, and if you don't know the answer, you should say "I don't know" instead of making one up. This does happen, but it's probably the rarest of the three answers, and you should know if you did it. If you didn't do this, what's left is one or both of two common loan officer sins. They're not mutually exclusive; it can be both.

The less abusive of these is that the loan officer did not lock the loan. When I originally wrote this, I said, "This is either rank stupidity or frustrated avarice. Shorter rate locks are cheaper, and there's always the hope that rates will go down, so they can make more money on the same loan they quoted you. Of course, rates can go up, also, and they do so about fifty percent of the time. When that happens, they can either make less money, often to the point where delivering the original loan would cost them thousands of dollars, or they can deliver a loan with a higher rate. Since we're living in the real world here, which of these alternatives do you think is going to happen?"

Since then the market has changed, especially for brokers and correspondents. Every loan that is locked that does not result in a funded loan under that lender costs that loan officer and their future clients money in the form of higher costs for every loan, raising the tradeoff between rate and cost for their loans to the point they may no longer be competitive even with bank branches, much less other brokers and correspondents. Net result: Brokers and correspondents are having to be very careful which loans they lock, which means uncertainty for you, the client. What, you thought the regulators were looking after consumer interests? They're looking after the interests of large institutions, who want to put brokers and correspondents out of business because brokers and correspondents offer cheaper loans than they do.

The more abusive alternative is that you were deliberately lowballed. There is always a tradeoff between rate and cost for real estate loans, and the person who gave you that quote told you about a loan that didn't exist. Either it always carried a rate much higher than you were told, or the loan officer ignored potentially many thousands of dollars it was going to cost all along. I see this happening literally every time I check a loan quote forum. I do business with eighty lenders, among which are the lenders who are most keen (or least unwilling) to compete based upon price. I know what's deliverable and what is not, every other loan officer I respect knows what is and is not deliverable, and I can't imagine anyone in their right mind wanting to do business with anyone who doesn't know whether what they quote is deliverable. It's not exactly confidence inspiring to be told essentially, "I can get you this loan, but I don't know if it really exists." I'm sure you'd line up for that loan like it was free beer, right?

Not really. But loan officers do this because none of the paperwork you get at the beginning of the loan process is in any way binding. Not for price, not for a loan at all. In fact, the only form that's required to give an accurate accounting of the costs is the HUD 1, which you don't get even in preliminary form until you are signing final loan documents. Loan officers do this because once you have signed up for their loan, you are likely to sign the final loan documents no matter how bad they are. Why is that? Because thirty days or so have gone by, you've got a deposit at risk that you're going to lose if you don't sign, and you're not going to get that house that you wanted badly enough to put yourself in debt for thirty years. I assure you that loan officers know that they will have you over a barrel when you go to sign final documents. Many of them are counting upon that from the day you sign up, and they'll tell you anything at loan sign up in order to get you to choose their loan, because it's not like any of this is binding on them.

Let me get one other thing out of the way to clear the air: You didn't get a higher rate because you somehow didn't qualify for the lower rate. The way people qualify for loans is based upon debt to income ratio and loan to value ratio, and of those two ratios, debt to income ratio is much more important. The lower the debt to income ratio, the more qualified you are. Debt to income ratio is a measure of the ratio of how your housing and expenses compare to your overall income. Lower interest rate means lower payments. Lower payments mean lower debt to income ratio, and hence, you become better qualified the lower the interest rate that is available. Counter-intuitive though it may be, it's easier to qualify you for a lower interest rate than a higher one. Any loan officer who offers you an excuse that you didn't qualify for the lower rate has just flat out told you that they are a liar. (Note that "true" sub-prime allows a higher debt to income ratio than A paper, but 50% instead of 45 is not a major difference)

What really happens is that while this loan officer was spinning you a tale of how great the rate you were supposedly going to get was (a loan officer's version of, "Yes I'll respect you in the morning"), in amongst all that creative storytelling, they neglected to account for the money you really are going to be paying, or even the money they admitted you were going to be paying.

However, we're dealing in the real world here. That money still needs to be paid.

There are three ways to pay it: Borrower cash, rolling it into your mortgage balance, or by giving you a higher rate. They have to tell you if they want more cash, and you may not have it. There's only so much equity in the property, particularly since there are no playing valuation games via a compliant appraiser. But since there is always a tradeoff between rate and costs, they can always create some more cash by sticking you with a higher rate, resulting in more cash available to pay for the things you were going to be paying from the very first. Often it means they'll make more money as well, for providing this "service", because "you were such a hard loan." Sticking you with a higher rate is often the only way they can pay for all the things that need to get paid. Yes, this means that you end up paying more for the low-ball deceiver's loan than for a loan where you were quoted something honest.

All of this is nothing more than practical effects of the common phenomenon of lenders low-balling their quotes to get you to sign up with them, knowing that when the time comes to actually deliver that loan, they will have all of the power and you will have none, which is a 180 degree reversal from the situation at sign up. They have this loan that you need right now, where anyone else will take time you probably don't have. If rates have gone up (once again, this happens about fifty percent of the time), even the lowest cost, most ethical provider in the world might not be able to deliver what this scumbag is offering you by signing his loan right now. If he's got the originals of your documents, you can't take your loan elsewhere. Finally, most people are tired of the whole loan thing by the time it comes to sign documents. Many folks won't examine the final documents carefully - figures I've seen say that over fifty percent of all borrowers literally never figure out that they were hosed by their lender, and on the ones who do figure it out, about eighty five percent will sign anyway because signing means they're done.

The games that lenders play are legion. They can lure you in with talk of low rate that exists, but costs you more than you'll ever recover. Whether they deliver that rate and soak you on the cost end, or switch it off for a higher one to pay the costs and make more money, is up to them. I see lenders quoting full documentation A paper conforming loans for people who are known to be stated income, temporary conforming ("Jumbo conforming"), non-conforming loans, or even decidedly sub-prime. Even for people who are full documentation and would have qualified if that loan existed at the costs they told you about, this need to raise the rate can move you to over to being a stated income loan because you no longer qualify full documentation at the higher rate. With stated income loans now gone, this not only means higher rates, but quite often means that no loan can be done, something completely alien to the thinking of many agents and loan officers who became accustomed to the Era of Make Believe Loans, and they haven't yet gotten their heads out of that mindset.

How can you avoid this? Ask all these questions of every prospective loan provider, know what the red flags are if you encounter them, and take steps to protect yourself from being lowballed. A written loan quote guarantee used to be good, but even the most ethical provider in the world can't issue one without locking the rate, which the market has made costly for their future business. I used to tell people to get a back-up loan, but back up loans are dead. Even I cannot economically do them any longer. The only practical solution is to stop rate shopping by telephone and have a real problem solving conversation with prospective loan officers.

If someone goes over cost components for your loan and rate, chances are they are being more honest than someone who doesn't. If it's investment property and they tell you there's a point and a half surcharge from the lender right up front, they are likely being honest. Such adjustments exist, and you're going to pay the ones that apply to your loan. Period. Therefore, you're better off knowing what they are. You should still choose the loan that has the lowest bottom line to you, but choose the one with the real bottom line, not the one that looks lower because the person quoting you "forgot" the adjustments. If someone told you about the adjustments that apply to your loan, ask other prospective lenders about those adjustments. Even they're "included" in the quote you still want to know how much they are. Why? Because once you know this information, it may become apparent to you that the loan you are being quoted is not the real loan you will end up getting.

You don't need to get victimized by any of the things that go on in the world of mortgage loans. But you have to understand that they do happen, and you have to take specific steps to prevent it from happening to you. Otherwise, you're just trusting to luck, and judging by what people have brought me from other providers, you'd need less luck to win the lottery so you can pay cash for the property.

Caveat Emptor

Original article here

Many people think that mortgage interest works like rent: paid in advance before you live in the property for the month.

This is not the case.

Mortgage interest is paid in arrears. As you begin the month, interest begins accruing. It accrues throughout the month, and the payment is due at the beginning of the following month. The reason for this is that the interest is unearned until you have actually borrowed the money throughout the month. You could win the lottery, write a best seller, sign a contract a with professional sports team, or any number of other farfetched but real possibilities for suddenly acquiring a windfall of cash enabling you to pay that loan off. You could also refinance, in which case that lender is only entitled to the interest from the days you had their loan.

When you refinance, however, or even when you take out an initial purchase money loan, you will generally be required to pay the interest for the remainder of the month on that new loan in advance. The reason for this is quite simple administrative - it gives the lender some time to set all the bookkeeping on that account up, gives them a full month at least between initializing the loan and the time any money should be hitting their account in payment of that debt.

So when you refinance, you make an upfront payment to the old lender for the part of the month they held your loan during the month, and to the new lender for the time they held your loan. Say the new loan funds and pays off the old loan on June 15th. You will pay the interest from June 1st to 15th to the old lender, and from June 15th though the 30th to the new lender. You never, ever, get a free month, because interest never stops, at least so long as you owe the money. In point of fact, I tell people to think of it as making their normal payment early, as in this case they're writing the check they normally would have written July 1st two weeks early on June 15th. It's really just the interest owed, but since most folks don't keep their loan more than a few years, there usually isn't a large proportion of principal in their regular payment anyway. Therefore, if you think of it as your regular payment, paid early, it'll usually be a little bit less. There are usually one or two days of overlapping interest, which is why most escrow officers won't request funds on a Friday. You don't want to be paying interest on two loans over the weekend to no good purpose.

So why do lenders use the "skip a month of payments!" come on? Some will even use, "Skip two payments!" Because a new loan is being originated, they can (generally) roll that money into the balance on your new loan where you not only pay the money, but you pay interest on it for as long as you owe that money. Make you feel all warm and cuddly? Didn't think so. Anyone who uses the "skip a payment!" promise to get you to refinance has just told you point blank that they're a dishonest crook. However, since most people don't know how to translate loan officer speak into English, they get away with it disgustingly often. The state of financial education in this country is a national disgrace. Of course, it's to the benefit of certain political groups to have voters believing that there is such a thing as a free lunch.

You never really skip a loan payment when you refinance. If you try, all you're really doing is adding it to your balance. You can decide to pay your balance down at loan inception and pay closing costs out of pocket, and while an accountant or financial planner will generally tell you there are better uses for the money, it can be a very smart thing to do if your circumstances are right for it.

Caveat Emptor

Original article here

You've probably heard the horror stories, and I've mentioned the possibility more than once. Some unsuspecting person is looking at properties beyond their price range, and it therefore has all kinds of attractive features that properties which are in their price range do not have. They are just about to regretfully but firmly put the notion of buying this particular property out of their heads when the Real Estate agent whispers seductively, "I can see that you want it, so let me show you how you can afford it!"

There are all kinds of reasons why this happens. Bigger commission check for the bigger sale certainly is one, but a far bigger concern to most of the predators who do this is that it's an easy immediate sale. Instead of having to take those folks around to dozens more properties that are in their price range (and perhaps lose them to some other agent taking advantage of an opportunity in the meantime), while the clients agonize about the trade-offs of linoleum versus carpet in the bathroom and kitchen, and maybe if they'll keep looking just a little while longer they'll find one that is perfect despite the market, so they're not going to make an offer today, thank you very much, this predator has shown them the equivalent of the holy grail, provided the clients do not understand the downsides of the loan that is necessary to procure that property.

There is a reason why I advise people shopping for a property to make a budget based upon what they can afford based upon current rates on 30 year fixed rate loans costing no more than one point total, or at the very most a fully amortized 5/1 ARM, and stick to it (It's actually harder to qualify for the 5/1, due to lower debt to income ratio guidelines). That's the maximum price you will offer - end of discussion. Even if you, the client, end up applying for another type of loan that has lower payments, if you could make the payment on a thirty year fixed rate loan, you are pretty certain you are not getting in over your head. But shop by sales price, not payment. It's not like the sharks haven't figured out that suckers shop by payment - so don't be a sucker. "Creative financing" has become so pervasive and so varied that shopping by the payment the real estate agent has posted, or tells you about, is severely hazardous to your financial health. Maximum purchase price you are willing to consider should be the most important thing buyers discuss with their agents, and the budget must be quoted in terms of purchase price, not monthly payment. There are too many games that can be played with monthly payment, and just when I think I have them all covered, another one pops up.

Indeed, the very head of the list of reasons why buyers should fire an agent is that the agent showed them a property which can not reasonably be gotten for the sales price limit they told the agent about. You tell me that your limit is $320,000, it might be okay to show you a property listing for $340,000 or even $350,000 if buyers have enough power to bargain it down to the agreed maximum and are willing to walk away if they can't. In a seller's market, of course, it would likely rule out anything where the ask is over $325,000. But if the agent show you a property listing for $450,000, simply ask to be taken home or back to your vehicle immediately, and then inform them that their services are no longer required and that you desire them to make no further efforts to contact you. Were I shopping for a property, I would demand to know the asking prices before I went, and not only fire the agent but also refuse to go if they cannot show me why they think this property can be obtained for the total cost limits we have agreed upon. Not monthly payment limits, sales price.

So what loans should not be used to purchase a property? Well keep in mind that this list assumes that your loan providers are telling the truth about the kind of loan they are working on for you, an assumption that, judging by a dozen or so different e-mails I've gotten from people who were scammed, is increasingly iffy. Furthermore, if you are a real financial and loan expert, there are reasons why these warnings may not apply, particularly if the property in question is investment property, but those sorts of experts should know the exceptions, should not be looking to this website for advice, and are always able to accept the financial consequences of not following these guidelines (in other words, they have the ability to absorb the losses).

The absolute head of the list, the loan that should never be used for purchase of a primary residence is the negative amortization loan. Known by many other friendly sounding names such as "pick a pay", "Option ARM", "COFI loan," "MTA loan," and "1% loan" (which it is not), this loan is a truly horrible choice for the vast majority of the population (99%+). It was only approved by regulators to service a very small niche market, and if you are a member of that niche market, chances are that your Option ARM will not be approved by the lender! This loan is usually sold strictly on the basis of the fact that the minimum payment is lower than any other type of loan, making it look like clients can afford a loan that they cannot, in fact, afford. This low payment is based upon a low nominal, or "in name only" rate that is not the real rate the money is accumulating interest at. In fact, the real rate that you are being charged is currently at least 1.5 percent above equivalent rates for thirty year fixed rate loans, as well as being month to month variable. How often do you think people who are being fully informed of the loan would agree to accept a rate a full 1.5 percent higher on a fully variable loan than what they would have gotten on a thirty year fixed rate mortgage, and with a prepayment penalty also? The lenders pay very high yield spreads for doing these loans, and the bond market pays even higher premiums, so many lenders push them hard, and many wholesalers push them even harder. Despite being warned that I was not interested in any loans that feature negative amortization, three new potential wholesalers had gotten themselves thrown out of my office in the month prior to originally writing this. I guess they weren't interested - or able - to compete with other lenders on real loans. Fortunately, now that the chickens have come home to roost on this "Nightmare Mortgage," very few lenders are quite so eager - or even willing - to offer them. The lenders lost a blortload of money on them, investors aren't buying the bonds, and the federal government has made them very difficult to sell. I hope that continues because the absurdly low percentage of people who saved their homes after signing up for a negative amortization loan is completely unacceptable. And although this loan is gone now, I'm leaving it in because I thought it had been permanently staked through the heart in the early 1990s too.

The Interest only 2/28 does have one redeeming factor, as compared to the negative amortization loan: At least your balance isn't getting higher every month. With the average loan around here being about $400,000, a rate of 5.5% would have the payment being $1833. But if that's all you can afford, what happens in two years when the rate adjusts and it starts amortizing, and if the market stays right where it is today, the payment goes to $2771, an increase of 51%? You haven't paid the principal down. There's a pre-payment penalty stopping you from selling or refinancing until it does adjust. If prices have appreciated enough to pay the costs of selling you might not come out so bad, but what if they haven't, or if prices have actually gone down? This is not the sort of bet that someone with a fiduciary relationship should make, as real estate prices increasing in two years is not something you can make a risk free bet on. Millions of people are finding that out right now.

The next loan on the list is the 3/27 Interest Only. This does offer you one more year to get your act together and start making more money to make the payments with than the 2/28. The downside is that it actually adjust higher due to the increased interest only period. In the example above, the payment would adjust to $2804, an increase of just under 53%. This also means you have another year for the value of the property to do the historically normal thing and appreciate a little. Still doesn't mean it's a bet somebody with a fiduciary responsibility should be making with your finances.

The scamster's new favorite substitute for the essentially extinct negative amortization is the buydown, because it allows them to quote a lower payment and a lower interest rate, because they can pretend that the initial rate and payment are what is important. Most suckers will only look at now, and be far less concerned with a year or two down the line ("and maybe the horse will learn to sing"). Make no mistake - that rate and payment will rise in one year, and will almost always rise again in two. So not only are you stuck with what's probably a higher loan rate than you can otherwise get, but you paid good money - more than you will recover - for that temporarily lowered rate.

The next type of loan to be wary of is anything stated income or even lesser levels of documentation (NINA or "no ratio" loans). These loans are great and wonderful if you really are making that money and really can make those payments, but don't let the temptation to buy a more expensive property lead you to exaggerate what you really make, or allow a loan officer to exaggerate what you really make, in order to qualify for the loan. Remember, you are still going to have to make those payments, and if you can't, the bad things that will happen more than counterbalance the nicest thing that might happen. Again, millions of people are discovering this right now. As of this update, I know of no loan providers offering a stated income loan. The downside to this is that the people stated income was designed to serve now can't get a loan at all. The upside is that people it's inappropriate for can't be seduced into something that's most likely going to ruin their financial future.

Somewhat less dangerous are interest only loans with a longer term or extended amortization loans. A five, seven, or ten year interest only period, while much more endurable than a two or three, is still not a certain bet of making a profit. Same thing with a forty or fifty year amortization loan. Given the way the rate structure is applied by most lenders, these loans are given out by lenders wishing to cover questionable lending practices to people who do not qualify for interest only loans according to bond market guidelines. Still, if it's got a good long fixed period of at least five years, you are paying the balance down and it's a reasonable bet that you will be able to sell for a profit before the adjustment hits. Not a certain bet, but a reasonable one, as in "the odds of making a profit or being able to refinance on more favorable terms before the payment becomes something you cannot afford are definitely on your side."

The ordinary 2/28 and 3/27 are dangerous enough for most fully informed adults. Using the interest only examples above, the 5.5% rate actually becomes 5.25% fully amortized, as it's a less risky loan for the lender. The initial payment becomes $2208, which does pay the loan down some, but then the payment becomes $2691 (in the case of the 2/28) or $2678 (3/27) holding the market constant as it sits and keeping other background assumptions constant. If you cannot afford these smaller jumps when they happen, at least you've got several thousand dollars that you have paid the principal down to use for closing costs on the new loan or towards the costs of selling, but be aware that the market is never reliable in its fluctuations over a short period of time, and using these loans for a purchase can and many times has meant that when the fixed period ran out, those people who choose these loans are in the unenviable position of being unable to afford their current payments, being unable to refinance, and being unable to sell for enough to break even when you consider the costs of selling.

There is nothing really wrong if you can afford the thirty year fixed rate loan but deliberately choose some other loan. I do this myself to save money on interest charges, which is the real major cost of the loan, but as narrow as the gap in rates was when I originally wrote this, even I might have chosen a thirty year fixed rate loan if I had needed to refinance. It's not being able to afford the sustainable loan that will kill you. If not a thirty year fixed rate loan, at least a fully amortizing ARM with a fixed period of at least five years. I do like the 5/1 ARM, however, and rates for it are once again becoming attractive - as in significantly lower than the thirty year fixed rate loan.

The most important things about any loan is the interest you are being charged for the money you are borrowing, how long it lasts, and the cost in dollars of getting that loan done, not a lower minimum payment that, certain as gravity, has a gotcha! engraved on it that will cause you to regret getting that loan. Unfortunately, we cannot go back to the past with information we learn in the future, and real estate loans are especially unforgiving of borrowers who do not understand the future implications of their current loan decisions.

As a final note, I have structured this essay around the loan to purchase a property, but the arguments work just as strongly and just as universally for so-called "cash out" refinances as they do for purchase money loans.

Caveat Emptor

Original here

When I wrote explaining why borrowers should consider a 5/1 ARM, because the tradeoff between rate and cost is lower for that loan, and most people don't keep their loans 5 years anyway, so having a likely need to refinance 5 years out is not an additional cost for most people with mortgages.

Costs for a loan break into two categories: The cost to get the loan done ("closing costs"). This pays for everything that needs to happen so that the loan gets done. These costs may vary from place to place, but they are absolutely mandatory - they are going to get paid. For instance, on a $400,000 refinance with full escrow, my clients are going to pay $2945 in closing costs, when you really include everything. Many lenders will try to pretend some or all of the closing costs don't exist in order to get people to sign up, but they do. I can save some money with virtual escrow in some cases, but $2945 is real. The proof is that I can put it in writing and guarantee not to go over. Lenders don't want to do this, but if they're not willing to put it in writing that they'll pay anything over that, the reason is because they know it's going to be more when it comes down to it at the end of the loan.

The other cost is the cost for the rate. There is always a tradeoff between rate and cost. If you want the lower rate, it is going to cost you more money. If you are willing to accept a higher rate, you can save money on the cost for the rate, to the point where it can reduce or eliminate the closing costs you're going to have to pay. Zero Cost Real Estate Loans exist - I've done dozens. I love them because they save my clients money.

NOTE: Since I wrote this Congress has changed the law to discriminate against brokers by making Yield Spread legally a cost of the loan, despite the fact that it adds zero to the amount the consumer pays and in fact can mean that what the loan actually costs the consumer is reduced. So technically, a broker can no longer deliver a zero cost loan. However, we can deliver a loan where you don't actually pay any money - either out of pocket or through increased loan balance. A matter of semantics and sounds to your average cynical but uneducated consumer like I'm weaseling in order to hose them later. If not for the law meant to confuse matters, it would be easier and more straightforward for consumers to understand. Not to mention that a broker who funds their own loans as a correspondent or a direct lender can still legally claim that their loan doing what is for all practical purposes the same thing isn't technically yield spread, and therefore doesn't magically become a cost because the government says yield spread is a cost. Thank Barney Frank and Christopher Dodd for "protecting" you.

You can lump the loan provider's profit in with the costs for the rate, as origination points, or in with the cost of the loan, as an origination fee, and pay it via Yield spread (if you're a broker) or even (in the case of a direct lender or correspondent) hide it in the fact that you're going to make a huge profit selling that loan on the secondary market, but I guarantee you it's going to get paid somehow. Nobody does loans for free, for the same reason you wouldn't work if you didn't get paid.

These costs are going to get paid. End of discussion. The costs are slightly different in states with different laws, but necessary costs are going to get paid. They can get paid out of pocket or they can get paid by rolling them into your loan balance but they are going to get paid. Most people don't understand loan costs which aren't paid by cash, and think that they are somehow "free", but that is not the case. Not only did you pay it, but it increases the dollar cost of any points you may pay, you're going to pay interest on it, and (less importantly) it's going to increase your payment amount.

The genesis of this whole thing was a guy I thought I had talked into a 5/1 ARM when I originally wrote this (rates are lower now). I went through this whole process of explaining why the rate/cost tradeoff for a 30 year fixed rate loan was not going to help him, and then a couple days later, he called me saying he'd found a thirty year fixed rate loan at 5.5, saving him three quarters of a percent on the interest rate and almost $400 on the payment. Remember that at the time, I had 5.5 available as well (rates are lower at this update). So I'm going to keep that exact same table:

The problem with the rate of 5.5% is that for a $600,000 loan, those closing costs are going up to $3475 (lender and third party costs are higher above the conforming limit) in order to get the loan done, and at the time, based upon current loan amount, 2.6 points would cost $16,100 and change. But he had gone to a loan officer who did his math as if that $19,585 (my loan quote at that time for that rate - I suspect the competitor's was higher) was going to magically disappear like one of a David Copperfield's illusions. He calculated payments and savings as if there were no costs - based upon the current balance and new interest rate and amortization period. Of course, this makes it look like the client was saving a lot of money $382 off the payment and three quarters of a percent off the rate, give him a whole new thirty years to pay off the loan, and pretend the costs of the loan aren't going to happen to get the guy to sign up. You'd think that somebody who reads this website every day would know better, but that does not appear to have been the case. In point of fact, the competing loan officer still has not told the guy how much his closing costs are or how much that 5.5% rate is going to cost him through him. I'll bet it's more than I would charge, but I don't know.

Psychologically speaking, what the competing loan officer is doing is smart. Because there's incomplete information available to the prospect, and I'm straightforwardly admitting how much it's going to cost (which is a lot, as most people who aren't billionaires or politicians think about money), an indefinite, uncertain number sounds like it might be less, even though it won't end up that way. Furthermore, by pretending costs don't exist, he has raised the possibility in the client's mind that there won't be any, because most people don't know how much lenders can legally lowball. There will be costs,and I'm willing to put my money where my mouth is that I have honestly represented mine. If this other loan officer could really deliver that loan at a cost lower than I can, there would be no reason for him to prevaricate, obfuscate, or attempt to confuse the issue. I've written before about how you can't compare loans without specific numbers, and there is no doubt in my mind that this other loan officer knows what those numbers really are - he just doesn't want to share that information, and the way our public consciousness about loans works, he can most often get away with it. It's still scummy behavior, and takes advantages of loopholes in the disclosure laws to practice bait and switch, knowing that when the deception comes to light (at closing) most people won't notice, and most of those who do notice will want to be done so badly they'll sign on the dotted line anyway.

Now what's really going to happen in 99% plus of all cases is that the costs are going to get rolled into the balance of the loan. The client certainly isn't going to be prepared to pay them "out of pocket" if they're not expecting those costs. So here's what happens: The client ends up with a new loan balance of $619,585 (Probably higher, because they're likely to roll the prepaid interest in as well, and quite likely the money to seed the impound account, but I'll limit myself to actual costs). In fact, the difference in payment drops to $290 when you consider cost, and $115 of that difference is directly attributable to starting over on the loan period, stretching out the repayment period to an entirely new thirty year schedule of payments (even though he was only two years in), completely debunking any serious consideration of payment as a reason to refinance. But lets compare cost of money, in the form upfront costs ($19,585 to get the new loan, versus zero to keep the loan he's got) and ongoing interest charges ($3125 per month on the existing loan, versus $2840 per month on the new loan). In this case, you're essentially spending nearly $20,000 in order to save $285 per month on interest. Straight line division has that taking sixty-nine months to break even. Actual computation of the progress of the respective loans cuts a month off that, to sixty eight months. As compared to a national mean time between refinances of 28 months, and this particular prospect is currently looking to refinance after less than that. In good conscience, I cannot recommend a loan where it's going to take him almost six years to break even, and by not considering the costs involved in getting that rate, he's setting himself up to waste probably half or more of the nearly $20,000 it's going to cost him to get that loan.

In fact, if this prospect were to refinance again in 28 months (once again, national median time), he would have spent $19,585 in order to save himself $7847. That doesn't sound like a good deal to me, and it shouldn't sound like a good deal to you. But here's the real kicker: The balance of the loan he refinances in two years is $19,250 higher. Let's assume it takes a low rate, rather than a cash out refinance to lure him into refinancing again, so he gets a 5% loan to refinance again. The extra $19,250 he owes will continue to cost him money, even thought the benefits of the refinance he is considering end when he refinances again or sells the property. At 5% for a putative future loan, that $19,250 extra he owes will cost him $962.50 per year extra on the new loan. Even if he sells in order to buy something else, that's $19,250 the client needs to borrow, and pay interest on, that he otherwise would not. Even if the client waits a full five years to refinance again, he's only saved roughly $16,400 in interest, and the additional balance owed on the new loan has actually increased slightly, to $19,280 (Remember, he's two years into the existing loan, hence $115 of phantom payment savings which keeps reducing his balance if he keeps paying it)

Failing to consider the fact that most people are not going to keep their new loan as long as they think they will is the gift that keeps on giving - to lenders. I run across people in their forties and fifties who have done this, all unsuspecting, half a dozen times or more, running up eighty to a hundred thousand dollars in debt for nothing but the cost of refinancing, and at 6% interest, that's $4800 to $6000 per year they're spending in interest on that debt. A more careful analysis says that the calculus of refinancing should emphasize finding a rate that helps you for a lower cost, but that's not the way lenders get paid the secondary market premium, and that's not the way that loan officers get paid to do lots of loans. Therefore, if you find someone who will go over these numbers with you and tell you it's not a good idea to refinance when it isn't, that loan officer is quite a valuable treasure because they're going to keep you from wasting all that money to no good purpose.

A good rule of thumb is that if a zero cost loan won't put you into a better situation, it is unlikely that paying costs and points to get the rate down is really going to help you either. You are unlikely to recover those costs and points before you sell or refinance your property. If a loan that's free doesn't buy you a better loan than you've got, then the current tradeoff between rate and cost isn't favorable to refinance. There may be reasons to do so anyway - cash out, ARM adjustment, etcetera, but chances are against you getting a rate that is enough better to justify the cost. When you consider how often most people refinance or even actually sell and move, it's hard to make a case for anything other than low cost loans and hybrid ARMs. I understand the people who want the security of a fixed rate loan and a low fixed rate - especially with the loan qualification standards as fussy as they currently are. But that rate, especially, is likely to come with a cost that they will never recover before they voluntarily let the lender off the hook. Good mortgage advice takes this into account, with the net result that the folks don't end up in debt to the tune of $80,000 to $100,000 extra, and spending thousands of dollars per year just on interest for money they shouldn't owe in the first place. No, they never wrote a check for it, but it's money they spent, and if they had needed to write a check for it, they probably wouldn't have spent the money in the first place. Kind of like having a credit card with a balance owing of $80,000 or more, just for the unrecovered costs of refinancing, but people don't realize it because it's not broken out of the total cost and balance of their mortgage, and nobody educates them as to where they would be if they hadn't made these mistakes. I try to teach my clients what they need to know to avoid that situation, so they don't find themselves victimized by it.

Caveat Emptor

Original article here

Yet that is exactly what you want them to do.

To avoid competing on price, they have all kinds of distractions they offer to make life more convenient, but not cheaper. They offer automatic payment options, the convenience of having your mortgage at your corner financial institution, biweekly payments, mortgage accelerators, and even negative amortization loans, which offer the apparent benefit of lower payments, which many uneducated consumers believe is price, at the price of a much higher interest rate than you would otherwise be able to get, which is the price the lender really cares about, and the one you should also.

There is always a trade-off between rate and cost for a given type of loan. That doesn't mean that different lenders won't have different trade-offs. Some are less willing to compete on price than others, so they tell you about how great their service is, how you are such a difficult loan that nobody else can do, or how easy their paperwork is, or how easy their loans are to qualify for. As a matter of fact, the lender with the easiest paperwork and loosest qualification standards will usually have the highest price trade-off, because their loans are statistically more likely to default, and therefore have to bring in a higher interest rate in order to have the same return.

Just like branding in the world of consumer products, which is also in effect for mortgages (why else would National Megabank be spending all that money for commercials? They expect to make a profit on it!), all of these little extra bells and whistles increases the price they can charge consumers for their loans, which is to say, the rate that you get, and the cost to get that rate.

So long as the terms are comparable, a loan is a loan is a loan. Provided that it has no hidden gotchas, a 5.875% thirty year fixed rate loan is exactly the same loan from National Megabank as it is from the Lender You Have Never Heard Of. No pre-payment penalty, and lower costs for the same rate? That's the lender I'll choose. It should be the same one you choose as well. It doesn't matter to me what name I make the check out to, or what address I put on the envelope. It shouldn't matter what routing symbol you put on the automatic payment, either, if that's what floats your boat. Lower rate for the same cost on the same loan? Same situation. Everything else is window dressing.

(Okay, it doesn't often matter to me. There are lenders that I'll bet you've heard of where I won't place my client's loans no matter how good the price due to some issues with their lending practices. But those lenders trend heavily to be the ones with massive consumer ad campaigns that don't really try very hard for broker generated business, anyway, because brokers learn to stay away from them fast. Nor are they usually competitive on price, because they're aiming for the "consumers shopping by name recognition" market).

So how do you force lenders to compete based on price? It's actually very simple. Ignore all of the stuff that they try to distract you with, like low payments for a while or mortgage accelerators or biweekly payment programs. Those are bait, and they serve the same purpose as bait: To get you to take the hook. Think about the things that happen to the fish after it takes the hook. That's you, if you take the hook. Concentrate on the type of loan, the rate, and the cost to get that loan. Here is a list of Questions You Should Ask Prospective Loan Providers. Ask all of them with every conversation you have about what is the right loan for you, and the best rate and cost they can deliver on that type of loan. After you have settled on one loan with one provider, it is then okay to ask about the bells and whistles that lenders (and every other sales organization) love to distract you with. If you want auto-pay, or biweekly payments, or a mortgage accelerator, these are just as much in the lender's best interest to offer you as they are convenient for you to have. I wouldn't pay for them, but many people think they're nice to have, and that's fine. Just don't let them distract you from what's really important: The price of the money you're buying.

Caveat Emptor

Original here

This visitor came from a search engine on this search:

amortization of real estate loans early payoff based on a lump sum payment

This is one of the smart things you can do. Not necessarily the smartest, mind you, but smart. Unless you have a pre-payment penalty, you can always pay more than your minimum payment, and often even if you have penalty, you can pay some extra without triggering it. The question is if there's a better way to get a return on that money, whether by paying down a higher interest debt or by investing the money in a new asset. If you owe thousands of dollars on a credit card at twenty-four percent when your mortgage is at six, why would you want to pay down a tax deductible six percent instead of a non-deductible twenty four?

Similarly, if you can earn ten percent somewhere else with the money, why do you want to pay your six percent loan down? Net of taxes, a six percent loan costs you about 4.5 percent, depending upon your tax bracket and other deductions. Even if the return is not tax deferred, the return net of taxes on ten percent averages somewhere over seven percent for most folks. Say you are in the twenty-eight percent tax bracket and the ten percent is completely taxed every year. A lump sum of $10,000 will over the course of 15 years turn into $28,374 if invested. If it's fully tax deferred, it turns into $41,772. For comparison with other numbers later on in the essay, at twenty-seven years the numbers are $65,352 and $131,099, respectively. Not half bad.

Suppose you've got the cash flow to instead buy another property? That puts the power of leverage to work for you, and if you can rent out one of your properties or something, possibly multiply your money by a factor of ten within a few years. When you put ten percent down, and your new property appreciates ten percent while giving you a few dollars per month of cash flow, that's smart investing. At seven percent annual appreciation (historical average), you've doubled your purchase price in a little over ten years. A three hundred thousand dollar property will likely be a six hundred thousand dollar property in about ten years (It's just numbers), while you've paid the loan down from $270,000 to about $226,000. Even if your expenses of selling are seven percent, your gross is $558,000, less the $226,000 you've paid the loan down to, and you've come away from the property with $332,000, not counting those few dollars per month you netted after paying your expenses. Sure there are places and properties that don't pencil out, and being a landlord is a headache, but as you can see the potential rewards are substantial if it does "pencil out".

Now, let's say you do this every nine years on a three to one split, and 1031 Exchange the first two at least. After nine years you have $281,267 pre-tax, net in your 1031 account. You then turn around and buy three $600,000 properties. You end up with three loans of about $506,000 each. Assuming net zero cash flow on the properties, after nine more years, you have three loans at $434,100, netting you $1,775,286 into your 1031 accounts, which you then roll into three more properties each at $1.2 million purchase price. Your loans are $1,000,000 each, but let's say you rent them for enough money to break even on expenses. After nine years, you sell all of these properties, and end up with just a little under $10,750,000 net of sales costs in your pocket before tax, which at long term capital gains rates (15%) nets you $9.13 million or thereabouts. Admittedly in this example you did start with three times as much money, and nobody in their right mind sells off nine highly appreciated properties in one year, and you did have the headaches of being a landlord on an increasingly widespread basis for those twenty-seven years, but this illustrates the money to be made for the same investment. Patience and leverage working for you over time are far more powerful than any quick flip.

But assuming there are no better alternatives, it is a smart idea to pay down your mortgage. Here's why: Let's say your balance is $270,000 at six percent, and you pay your loan balance down by $10,000. Your regular payment was $1618.78, and it still is, but interest is $1350 of that. Only $268.78 would normally be applied to principal. Yeah, you've just sent them about six months of payments - but it just paid your loan down by three years of principal payments. Assuming you never sell and never refinance and never pay an extra penny again, you will be done in month 324 - saving yourself thirty-six payments for a total savings of $58,276. Although you need to time discount the money significantly, that's still a pretty decent return on the money. Not to mention that if you do refinance, you'll pay lower fees. Not in the league of some of the alternatives above, but still a nice return on investment. From a financial management standpoint, it definitely beats just spending the money.

Caveat Emptor

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