Mortgages: October 2021 Archives

This is a warning to those who purchase restricted sale property. I've gotten a couple of calls for refinancing these in the past couple months, and I've never covered this subject.

A restricted sale property is one where the identity of who can buy it and/or at what price they can buy it is restricted. Many local first time buyer programs restrict the conditions under which the property can be sold. The purchaser must be someone who has themselves qualified for their first time buyer program, the purchase price cannot be above the original purchase price plus a certain margin (usually reflecting a given percentage of Average Median Income for a given Metropolitan Statistical Area), or both.

These are by no means the only restricted sale programs. Many academic institutions have such property upon the grounds of their original endowment. There is a covenant which runs with the land that only faculty members or employees of the college or academy are allowed to purchase the property. I'm sure there are business employee restrictions and others.

This is a classic "good news - bad news" situation. At purchase, it's good news (mostly) because you typically get a far lower price than other, equivalent property, meaning you can afford it when you couldn't otherwise. At sale, however, it means you can't sell for a true market price because either the general public is prohibited from buying or the sales price is restricted by the bargain you made in order to purchase.

What this means is that if lenders have to foreclose upon such a property, they are pretty much up the creek. Such a property is unlikely to sell at auction, they can't just hire an agent and put it on MLS. If the property got beat up before the foreclosure (as happens quite often), it may not be something any of those eligible to purchase it are interested in.

Since it's not generally marketable, most lenders don't want to touch restricted sale properties. This means your loan choices are going to be restricted from the day you sign the purchase contract on. You will probably not be able to get a purchase money loan with most financial institutions. You almost certainly won't be able to refinance on favorable terms, even if everyone who bought without such a restriction can.

Typically, there are only one or two financial institutions willing to touch such a property, if any, and only through their own internal loan officers rather than through any brokers they may do business with. What's going on is that the restricted sale entity (usually a municipality or educational institution) has contracted with them to somehow take care of the problem if there is a foreclosure. This usually takes the form of taking over the property themselves and buying out the lender's Note.

For refinances, all of the above applies, even more strongly because one lender already has the indemnity contract; any others that you might have been able to choose between do not. This means your choices are limited to "refinance with that lender or not at all". Not a good situation to be in as regards to getting a good rate for a reasonable cost. Whatever they feel like offering you is what you get. Nor do you get the standard rates everyone else gets from that lender. You're not in the same situation as everyone else. You're in a special program where nobody else can lend to you because your property cannot be sold to the general public. You're almost certainly stuck with that one lender. It's not like you can go somewhere else.

Due to this lack of competition, expect the rates on loans for such properties to be above market average. Some are fairly close, but it seems an average of half to three quarters of a percent higher on the rate is what you're going to pay when you finance such a property. Furthermore, the only ones able to refinance may be the current lender, as nobody else has that indemnity contract from the restricted sale entity. Lender's don't want to take over your property - they want the loan to be repaid. But they must be able to take over your property and sell it on the market for a market price in order to accept your loan. Anything else is a violation of their duty to their stockholders and bondholders, as well as a violation of federal banking regulations. Since they can't do this, it shouldn't surprise anyone that most lenders can't touch a restricted sale property.

Caveat Emptor

Original article here

pfadvice talks about debunking a money myth and perpetuates one of his own. He took issue with someone refinancing to lower their monthly payment, insisting instead that the term of the loan was all important.

His point is understandable in that because folks tend to buy more house than they can really afford, they also tend to obsess about that monthly payment. The solution to this is simple to describe but it takes someone with more savvy and willpower than most to bring it off: don't buy more house than you can afford.

Actually, there is nothing that is all important, but if I had to pick thing as most important, it would be the tradeoff between interest rate and cost and type of loan. This is always a tradeoff. They're not going to give you a thirty year fixed rate loan a full percent below par for the same price as loan that's adjustable on monthly basis right from the get-go.

This tradeoff varies from lender to lender and also varies over time. Nor is it the same for borrowers with different credit, equity, or income situations, but it is always there. For a given borrower at a given time, any program which you can qualify for will have the rate/cost tradeoff built in. If you want them to pay your closing costs, you're going to have to accept a higher rate than if you're willing to pay two points. It is the relationship between whatever loan you have now, and the loans that are available to you, that determines whether it's a good idea to refinance. Focus on the real cost of the money: The interest rate, which determines what the cost of borrowing the money will really be, and the total upfront cost to get that loan, which breaks down into points and closing costs.

If you have a long history of keeping every mortgage loan you take out five years, ten years, or longer, then perhaps it might make sense for you to take out a thirty year fixed rate loan and pay some points. To illustrate, I'm going to pull a table out of an old article of mine because I'm too lazy to do a new one.

I'm intentionally using an old table, and rates are different now. The point is to examine your current loan in light of what's available to you now, and determine whether there's a loan that's worth the cost of doing. Maybe your equity situation has improved. Maybe your creditworthiness has improved. It's possible that something has deteriorated, and the loans that are available also vary over time with the state of the economy. If you've got a prepayment penalty that hasn't expired, remember to add the cost of getting out of that loan to the cost of your refinance, because it certainly changes the computations by adding a large previously sunk cost to the cost of your new loan. Whatever it is, the loans available to you now will be the total result of all of how all of the factors in the situation have changed.

I'm going to keep the example simple, assuming no prepayment penalties, and the third column is cost of discount points (if positive) or how much money you would have gotten in rebate (if negative), assuming the $270,000 loan I usually use. Add this to normal closing costs of about $3400 to arrive at the cost of your loan, thus:

(I had to break this table into two parts to get it to display correctly)

In the next tables, I've modified the results based upon some real world considerations. Point of fact, it's rare to actually get the rebate (typically, the loan provider will pocket anything above what pays your costs), and so I've zeroed out those costs. You take a higher rate, you're just out the extra monthly interest. The fourth column is your new balance, the fifth is your monthly payment. For the second table, I've duplicated rate and new balance for the first two columns, the third is your first month's interest charge (note that this will decrease in subsequent months), the fourth is how much you save per month by having this rate, and the fifth and final column is how long in months it will take you to recover your closing cost via your interest savings as opposed to the cost of the 6.375% loan, which cost a grand total of $25 (actually, this number will be slightly high, as interest savings will increase slowly, as lower rate loans pay more principal in early years).

However, let's look at it as if your current interest rate is 7 percent. Your monthly cost of interest is $1575, there, so let's see how long it takes to actually come out ahead with these various loans.

In short, since you're recovering costs quickly, it would make sense for folks with a rate of 7 percent to refinance in this situation, no matter how long they have left on their loan. For $25 total one time cost, they can move their interest rate down to 6.375, saving them $140 plus change per month. It's very hard to make an argument that that's not worthwhile. On the other hand, I would have been somewhat leery of choosing the 5.625% loan, as more than fifty percent of everyone has refinanced or sold within two years. However, if I have a solid history of going five years between refinancing, it makes a certain amount of sense, at least considered in a vacuum. Considered in light of the real world, rates fluctuate up and down. So I tend to believe that if I don't pay very much for my rate, I'm likely to encounter a situation within a few years where I can move to a lower rate for zero, or almost zero, whereas if I paid the $8125 for the 5.625%, rates would really have to fall a lot before I can improve my situation.

Do not make the mistake of thinking that the remaining term of the loan is more important than it is. You now have (assuming you took the 6.375% loan) $140 more per month in your pocket. Your payment will go down by more than that, but you're actually saving $140 per month in interest. It's up to you how you want to spend it. If you want to spend it paying down your loan more quickly, you can do that (providing you don't trigger a prepayment penalty, of course - but the loans I quoted didn't have one). Let's say you were two years into your previous loan. Your monthly payment was $1835.00. If you keep making that payment, you'll be done in 288 months; 48 months or 4 full years earlier than you would have been done under the original loan. So long as you don't trigger a prepayment penalty, you can always pay your loan down faster. Just write the check for the extra dollars and tell the lender that it's extra principal you're paying. I haven't made just the minimum payment since the first time I refinanced.

Many folks focus in on the minimum payment. By doing this, you make the lenders very happy, and likely your credit card companies as well. Not to mention that you are meat on the table for every unethical loan provider out there. It is critical to have a payment that you can afford to make every month, and make on time. But once you have that detail taken care of, look at your interest charges and how long you're likely to keep the loan, not the minimum payment or the term of the loan.

Caveat Emptor

Original here

How do I keep my home after filing bankruptcy. The Mortgage company wants to foreclose?

I want to know if there is anyway to keep the home even after filing chapter 7 bankruptcy. I want to know if there is any program that can assist me.

Bankruptcy does not effect your current mortgage. The only thing that will cause you to go into foreclosure is not keeping up your mortgage payments, period.

You don't have to include your mortgage in chapter 7, and it's not usually a good idea to do so if you have significant equity. Leave it out, and you even have a mechanism to restore your credit already in place, while limiting the damage the bankruptcy does. The larger the percentage of your lines of credit you include, the worse the hit is. Furthermore, if you have an open mortgage when your bankruptcy concludes, you're establishing post bankruptcy credit history, the best way to rebuild your credit. The poor folks who have to go get a new credit card get dinged even harder post bankruptcy for each turndown, so that each successive application lowers the probability their next one will be accepted. Positive feedback to a negative end. Vicious cycle.

Talk with a real lawyer in your state to be certain. I'm not a lawyer, and I don't even play one on TV. However, my understanding is that Mortgages are debt secured by a specific asset - the property. Keep up the payments on that (or bring it current if you haven't) and general creditors with unsecured debt cannot touch that asset in most states and most situations. There are exceptions, but owner occupied residential real estate is one of the most protected assets there is. The fact that it is a loan secured by a specific asset can also be used to avoid compromising the mortgage holder's interest.

The upshot is that if you make your payments on the property, and keep them current, quite often it can sail through a bankruptcy untouched. People will often let everything else go to keep making the payments on their mortgage - one of the reasons why mortgage rates are so favorable, compared to unsecured credit. Another issue I should mention is that while A paper does care about non-mortgage late payments, subprime generally doesn't. As long as you keep your mortgage payments current, you can often secure a loan on surprisingly good terms, even though it'll likely have a prepayment penalty. So keep your mortgage current if you can.

None of this is intended to encourage bankruptcy. But if you're heading for bankruptcy anyway, you want to limit the damage. The more lines of credit you can keep intact through the process, the better off you are in general. If you have six open lines of credit and only need to discharge one, that's much better for you than if you have to discharge all six. Your mortgage is the most important of these for restoring future credit and your own personal residence is protected from creditors more strongly than any other asset you may have. If you can keep that one debt current, it's usually making the best of a bad situation to do so, even if you have to let everything else go.

Caveat Emptor

Original article here

One of the casualties of the lending meltdown is the high loan to value second mortgage. With many properties locally having lost twenty percent or more of their value, a second mortgage on a property that ends up in default may well lose every single dollar the lender put into the loan. It shouldn't surprise anyone that lenders don't want to get into that kind of situation. Even though I (and most other credible analysts) are convinced that real estate is now undervalued, the money markets are still in fear mode over the money they have lost or are on track to lose.

The result is that lenders of junior financing aren't nearly so willing to go close to 100% financing any longer. Even when the same lender is lending the money for both loans, the people who underwrite the second mortgages are (usually) a different division. So when the property goes to foreclosure, the division who underwrote the first mortgage may end up with every dollar or nearly every dollar of their invested money, and they come up smelling like a rose. The division that underwrote the second mortgage that got wiped out and came out with 10 cents on the dollar loses their shirts, and everybody gets fired. I don't have one single subordinate loan program offering over 90% financing - doesn't matter the credit score or how much we can prove the clients make. The lenders have all decided they are not willing to accept the risks of a high loan to value second mortgage. That's their prerogative - they who have the gold make the rules for lending it. With the situation as I've have discussed, and second mortgage lenders in the process of losing every penny they put into loans, they understandably don't want to do it.

There was an alternative for quite a while. There were, for quite a while, still any number of lenders who would accept 100% financing on one loan with Private Mortgage Insurance (aka PMI). That has been gone for a couple years now. In fact, for a couple months it was really difficult to get financing over 85%, but then they started removing the declining market indicator in July 2008, and now it's pretty easy to get 90% conventional financing, and I have a couple of ways to get to 95%. Considering that FHA financing only goes to 96.5% and is far more difficult to get, this means that the difference between conventional financing and FHA is small in terms of down payment, and considering the premium FHA-eligible properties command, being able to go conventional may save you money despite a PMI rate that's higher than for government loans (VA loans have become the only widely available 100% financing)

Private Mortgage Insurance is an insurance policy that the borrower pays for but which insures the lender against loss. It does get the borrower the loan, but that is the only good the borrower can expect to get out of PMI. It does not prevent your credit rating from being ruined, it does not prevent any deficiency judgments that you may be liable for, and it definitely won't prevent the 1099 love note that tells the IRS you owe taxes on debt forgiveness. All it does is shift the entity that loses the money from the lender to their insurer, so that if you default, you'll be dealing with the insurer instead of the lender via subrogation.

What is going on here is that lenders are shifting the risks to insurers, who are in the business of taking risks via the Law of Large Numbers. Yes, the insurers know they will lose a certain number of these bets, but they are comfortable that overall they will make money at it. It is to be noted that lenders can improve their profit margins by self insuring, but they're not in the business of insurance. I'm certain some of them insure themselves in one way or another, but they isolate the risks away from their lending divisions, which are in the business of making money by loaning it out and having those loans repaid in full. When a lender loses a dollar because the loan wasn't repaid in full, that hits them where it really counts - bond rating, stock price, value of their mortgage bundles on the secondary market. When an insurer loses a dollar due to paying a claim, that's part of their daily business. They're in the business of paying claims, fully expecting premiums to more than pay for those claims.

As I said in One Loan Versus Two Loans, PMI is more expensive than splitting your mortgage into two loans, but when nobody wants to do second mortgages with less than ten percent down payment, the choices may narrow down to accepting PMI or not buying the property. The only other alternative that comes to mind is a private party loan, either in the form of a Seller Carryback (which comparatively few people are willing and able to offer) or the "good in-law" loans that were popular before lenders started liberalizing their standards in the 1970s.

(I haven't been in the business that long. I've never heard the phrase actually used by another professional, although I actually did a transaction that involved one not too long ago. I learned it from textbooks, as even in the early nineties when I both bought my first property and went back to college for my accounting degree they were a fading memory)

Paying PMI does have the net effect of decreasing the loan that potential buyers will qualify for, so this development should cause some small amount of additional downwards pressure in prices. For those interested in irony, the lenders are contributing to their own immediate losses by bailing out of the low equity financing market. People who have to pay a higher effective rate for the money can't afford to spend as much for a property, which means that current owners, whether they're borrowers or lenders, won't be able to get as much money for them.

One last thing before I finish. Don't get too hung up on the fact that you may end up paying PMI when experts (myself included) advise you not to. It's one of those voodoo words and concepts like "points", that people freak out about because they've been warned about them but they don't really understand. Just like points, many experts, myself included, often advise you not to pay PMI. But if you have one loan that is over 80% loan to value ratio, you are going to be paying PMI in one form or another. As I said in How Do I Get Rid of Private Mortgage Insurance (PMI)?, it can be a separate charge or camouflaged by being built into the rate, but you're still paying it. There are advantages and disadvantages to each choice, as I explained in that article. Choose your alternative with your eyes wide open and an understanding of the consequences, not because someone scares with with the voodoo phrase, "PMI."

Caveat Emptor

Original article here

HI, My name is DELETED and my husband and I are searching for a way to get out of our Negative ARM loan before we get upside down.

Our problem right now is our loan to value. Our loan right now is at $547,367.80 and is only getting higher. Our house just appraised at $620,000.00. We have a prepayment penalty of $20,000.00 and would just like to get that covered. We feel we need a Jumbo loan if possible.

Our wish is to get into a 40 or 50 year fixed. My husband makes good money and I will be working in a couple of months making a decent income. Right now I am doing temp work. We can afford payments for our mortgage if we were to refinance but we are having a hard time finding someone who will take the risk with us. If there is a risk. We are just trying to get out of this loan that is going to end up taking our house from underneath us. Our credit is good and I feel there is a way something can be worked out

Can you help us?

I will try, if you're in California. First, let's stop and think a minute about your situation and what will benefit your pocketbook, rather than mine.

If you pay the penalty, your new loan is going to be approximately $570,000, even without points. The issue is that neither I nor any other loan provider can get you a loan that isn't available. $580,000 is more likely, considering prepaid interest, etcetera, unless you have some cash to pay it down. $570k and $580k are both within the band of 90 to 95%, so I have to price it as a 95% loan to value ratio. 95% loans are problematic for jumbo loan amounts. I don't have any such programs over 90% - but it turns out that I do actually have a refinance that can be done on a "jumbo conforming" up to 90%, albeit with PMI.

So suppose you don't have to pay the penalty? Now staying at or below 90% loan to value is a real possibility, and the loan can be priced as a 90% loan, giving better trade-offs. The way we might be able to do this is to check if we can get your current lender to refinance you. It'll likely mean renewing your prepayment penalty, but better that than paying $20,000 in penalty. Even if you end up with a higher rate than you might otherwise get because your lender doesn't have the lowest rates, $20,000 is almost four percent of your loan amount. Over the course of the 3 years of the new prepayment penalty (since that's standard for negative amortization loans), you'd have to save over a percent per year to break even with another lender. As I said in "Getting Out of Paying Pre-Payment Penalties", sometimes lenders will not require you to pay a penalty if you refinance with them and accept a new penalty.

In short, if we check with your current lender first, we might save you $20,000 cash plus the interest on it. So let's figure out who your lender is and ask.

The second alternative is to find out how long until the penalty expires. Make at least the full interest payments every month until your payment expires. How long do you have left on the penalty? If you've only got six months or a year left, rates just weren't low enough when I originally wrote this to make it worth your while refinancing, especially Jumbo loans, which even if your loan to value ratio was below 80% would have still cost you nearly two points for a 7% loan. If you pay at least your current "interest only" payment, you're not getting in any deeper. When the penalty expires, maybe rates and the market will be in better shape and you'll get a better loan. Matter of fact, waiting was a moderately good bet that would have paid off back when I originally wrote this, especially as opposed to just flushing $20,000 paying that penalty. If people had less than a year left on the penalty, I was urging them to make the interest only payments (or more), and come back to me about three weeks before it expired. Conditions have changed now. In fact, at this update, rates are much better than when I originally wrote this article. For "Jumbo conforming", rates below 5% are very possible, but I don't know how much longer that will be the case

Even if you're only six months into your loan, we'd have to save you about about 1.5% on the rate for you to come out ahead by paying that penalty. $20,000 times 12/6 divided by $547,000 gives a current rate of 7.3%. As you'll see, a blended rate of 6.67 is about as low as I could have gotten for this situation when I originally wrote this. Your rate would have to had to have been at least 8.2% when I originally wrote this for paying that penalty to have been in your best interest.

The loan market today is a very different creature than it was a couple years ago. Let's look at the alternatives, assuming your lender will waive prepayment with a new loan. Even so, let's look at a loan amount of $558,000, which is about where you're going to be with closing costs and one point.

Before I close, it occurs to me to mention that before refinancing, you have to be certain you are actually able to make the new payments. Because the fact is that you owe $547,000 right now, and that's a cold hard fact that nobody is going to change. Quite often, people get put into negative amortization loans because that was the only way they're going to make the payment on that much debt even for a little while. If you cannot realistically make these payments, delaying the inevitable will only cost you more. As things sit, if you sell you might come away with a few thousand dollars if you sold now, and then you can buy something you can really afford. If you wait, things are going to get worse, and you're going to end up with a short payoff and a 1099 love note that says you owe taxes, plus maybe a deficiency judgment, having your credit ruined, and still not having the home of your dreams. This doesn't make me popular right now, but what people like you are going through now is the result of people in my professions who wanted to be rich and popular, rather than actually doing what was best for the clients. Were I in your shoes, I'd likely be asking a lawyer if there's some liability on the part of your lender and real estate agent.

Caveat Emptor

Original article here

One of the things I hear a lot is that people are getting cash in their pocket from a refinance rate where there is no rebate. "I'm not paying any closing costs!" they proudly tell me, "The bank is putting money in my pocket."

Chances are that's not what's going on. In fact, when the client gives me the chance to investigate, I find out that they are paying huge fees, which are all being added to the balance of the mortgage. But what they remembered was that the lender was also going to give them $1200 or $1500 in cash and add that to the balance on top of everything else.

For "A Paper" loans, Fannie Mae and Freddic Mac define the difference between a cash out and rate/term refinance. On a rate/term refinance, a client can have all costs of the loan covered, both points if any and closing costs. A client can have an impound account set up to pay property taxes and homeowner's insurance out of the proceeds. They can have all due property taxes and insurance paid. The client can have all interest paid for 30 to 60 days. And the client can get up to one percent of the loan amount or $2000, whichever is less, in their pocket. In addition to this, if the old lender had an impound account, the client will receive the contents in about 30 days.

Let's say you have a $270,000 loan on a $300,000 property - small for most parts of California and some other places, but large for most places in the country.

Here in California, yearly property taxes would be about $3600 on that. Insurance is about $1000 per year, monthly interest is $1237.50. I originally wrote this in September, so if you finished your refinance on that day, your first payment would be November 1. You'll make five payments before both halves of your property tax are due, and they want a two month reserve, so 12 months plus 2 months is fourteen months minus five months is nine months reserves they will want in property taxes (Actually, three months reserve plus the first half-year paid through escrow despite the fact you would normally have until December 10th). $3600 divided by twelve times nine months is $2700. Let's say Insurance is due in April, so they'll want eight months of that. $1000 divided by twelve times eight months is $666.67. Plus two points and $4500 in closing costs the lender charges, and they actually may have told you about it, but they emphasized the cash you are getting in your pocket so that is what a lot of people remember.

Even without the cash out, this works out to a new loan amount of $270,000 plus $2700 plus $666.67 plus $1237.50 plus $4500 plus two points which works out to $284,800 as your new balance without a penny in your pocket. If they gave you $1500, your new balance becomes $286,330 (remember the two points apply to the $1500 also!) which will probably be rounded to $286,350. Subtract $270,000, and they have added $16,350 to your mortgage balance but hey, you got to skip a month's payment and got $1500 in your pocket!

As I have said many times, however, money added to your balance tends to stick around a long time, and you are paying interest on it the whole time. Furthermore, lenders and loan originators love this because their compensation is based upon the loan amount. All because you allowed yourself to get distracted by the cash in your pocket. This is fine if it is what you want to do and you go in with your eyes open, but chances are if someone were to tell you "I'm going to add $16350 to your mortgage balance to put $1500 in your pocket and allow you to skip writing a check for one month!" you wouldn't agree to do it. Even if the rate is getting cut so your payment is $75 per month less.

For loans lower down the food chain (A minus, Alt A, subprime and hard money) the lenders set their own guidelines on what is and is not cash out, but Fannie and Freddie's definition is more strict than the vast majority.

So when somebody tells you they are going to put money in your pocket as part of the closing cost, ask them precisely how much is going to be added to your mortgage balance. Print out the list of Questions You Should Ask Prospective Loan Providers, and ask every single one. Because chances are, they are trying to pull a fast one, and once you are signed up, they figure they have you.

Caveat Emptor

Original here

Got a search engine hit for

do I make a big down payment on a home or should make a lump sum payment after the mortgage

Here's the basic rule: You're allowed tax deductibility of the acquisition indebtedness, amortized, plus up to a $100,000 Home Equity Loan. For many years, the universal practice has been to deduct all of the interest on a "cash out" loan even though it's not permitted by a strict reading of the rules. That is now changing, and the IRS has served notice that they are going to be scrutinizing mortgage indebtedness to compare it to acquisition indebtedness, and disallowing anything over what they figure is the amortized amount of purchase indebtedness. For example, if you originally bought your property for $120,000 in 1996, and your original loans totaled $108,000, sixteen years later you might persuade the IRS that your deductible balance is about $85,000, as ten percent loans were common then. But if your property is now worth $500,000 and you've "cashed out" to $400,000, the IRS is likely to prove, well, skeptical of that deduction.

The other reason not to use your down payment money for a down payment is to save it for repairs and upgrades. There's only so many places that the money might possibly come from, and your own pocket heads the list. Cash back from the seller not disclosed to the lender is fraud, and if you do disclose cash back to the lender, you've defeated the only rational purpose for it, because they will treat the purchase price as being the official price less the cash back. You're not legally getting any extra net cash from the seller. Period. If you put the money down and then try to refinance it out, the refinance becomes a "cash out" refinance - the least favorable of the three types of real estate loan. Unless the rates have gone down or your equity situation has improved, you'll get better rates on a purchase money loan, not to mention not spending the second set of closing costs for the refinance because you only did the purchase money loan. Furthermore, at this update, lenders really don't like "cash out" loans - they are coming up with all kinds of obstacles to throw in the way. So if you need the money for repairs or to make the property livable, you're probably going to want to keep it in your checking account rather than using it as a down payment.

On the other hand, the search question postulates that you'll use the money to pay down what you owe, whether immediately at purchase or later on. After you put the money down, you'll have an improved equity situation, which means that you are likely to get a better price on the loan - a better rate-cost trade-off if you put the money down. Not guaranteed, but it is highly likely. A few years ago, 100% financing was generally available. It's not, any more unless you're eligible for a VA Loan, and FHA loans loans go up to 96.5%. For conventional lenders, I've got a couple that will go 95% if the PMI underwriter will accept you. If it's the difference between 95% financing and 94% financing, every lenders I know of treats 94% financing the same as 95%. But if it's the difference between 95% financing and 90% financing (or 95% and 80%, especially), you're likely to get a better loan. Which means you either spent less in costs, got a better rate, or some trade-off of the two. Less money spent equals more money in your pocket, or more money for the down payment, which translates as more equity. Better rate means lowered cost of interest. The fact that it's on less money also means lowered minimum payments, although you shouldn't be shopping loans based upon payment. More importantly, you don't pay interest on money you don't owe. If your balance is $10,000 lower on a 6% loan, that's $600 less interest per year - $50 real savings per month.

If for some reason you want to pay extra, and you're holding on to the money so your minimum payment will be higher, don't. Most loans allow you to pay at least a certain amount extra, and if you're one of those unfortunates with a "first dollar" prepayment penalty, I have to ask, "Why?" There are occasionally reasons to accept a so called "80 percent" pre-payment penalty. There's never a reason to accept a "first dollar" penalty. Not to mention that your lump sum will get hit with the penalty anyway, where if you used it as a down payment, it wouldn't.

If you think rates will go down, that's fine, but I've got to ask "What if they don't?" If they do go down enough to make it worthwhile to refinance, you can always do so. But you should want something you'll be happy with even if they don't.

Finally, I should note that there are arguments against paying off your mortgage faster. Paying extra on your mortgage does sabotage the gain you get from leverage. You could typically take the money and invest elsewhere at a higher rate of return. Psychologically, however, there's a peace of mind to be had from not owing money, or not owing so much money. The only sane way to define wealth is by how long you could live a lifestyle comfortable to you if you stopped working right now, and if you don't owe as much money, that time frame that determines your real wealth is obviously longer. In short, you're better off by the only sane way to measure.

The point is this: There are arguments to be made on both sides, and the circumstances can be altered by the specifics of your situation. My default conclusion remains that if your mind is made up that you're using a certain amount of money to reduce debt on the property, either from necessity or because you want to, then you might as well use it in the form of purchase money down payment.

Caveat Emptor

Original article here

It shouldn't be any surprise to anyone with the headlines of the last few years that shopping for a mortgage loan has radically changed. Indeed, a lot of the regulatory changes seem directly aimed at what were the best lending practices - ways to force loan providers to change away from those best business practices.

I'm going to say this more than once in this essay: There are now significant costs for failed loans, costs that brokers and correspondents are now going to be forced to pay. This means that one way or another, consumers are going to be forced to pay them. There are two groups that can be required to pay them: People whose loan succeeds and is funded, or people whose loan fails and is not funded. Individual broker policy is going to determine which group of that broker's loan applicants pays for the costs of failed loans: The ones whose loan succeeds, or the ones whose loan fails. To determine which sort of broker you'd rather apply with, ask yourself "Do I want my loan to succeed?" If so, apply with a broker whose policy requires the failed loans applications to pay for the failed loans. If you don't want your loan to succeed I must ask, "Why are you applying?"

I need to do some political background and warmup in order to make sense later on. I need to tell you what has changed in the background, why it has changed, and what this means for the consumer. I did warn NAMB (the mortgage brokers association) that brokers were going to be used as the scapegoat for everything. It was the only way the bankers could avoid criminal indictment, public outrage, and the mob and pitchfork crowd known as Congress. President Obama, who is on one hand inciting the mob with pitchforks while on the other hand pretending to be the banker's friend, was one of those Senators at the heart of the reasons for the meltdown. You have only to examine the public record of the period from 2003 to the time everything started unraveling to find out who tried to reform the system in time to avert catastrophe and who stood in the way of reform. Old principle: The best way to avoid being the target of political lynchings for a disaster is to lead them yourself.

Not that lenders need a political reason to come after brokers and correspondents. It's a classic love-hate relationship. Lenders hate brokers in general, without whom their margins and profits on mortgage loans would be much higher, but they love the profits from the individual loans brought to them specifically by those same brokers. To give you an analogy from a time before the internet, once upon a time airlines used to regularly get together every year to try and set the prices for summer vacation fares higher than market, so they all would make a lot more money per ticket if they hung together as an industry. However, every year, the airlines as individuals would decide they wanted all the money in profits they would get from lowering their individual airlines ticket prices to attract people away from the competition. It was comical in a way, watching the same show year after year, with the same outcome. The airlines tried for years to get the federal government involved so that they could give their price-fixing the authority of law, but even Jimmy Carter was too smart for that - in fact it was he who deregulated the airlines rate and fare structure completely, resulting in an explosion of air travel as air travel suddenly became a lot more affordable. Lenders relationship to brokers is a lot like that. Sure, brokers bring them a lot of money and profit - but if there was some way to completely eliminate brokers, they would make a lot more money for every loan they did.

The difference between that situation and this is that the lenders and those who want to help them do away with brokers have gotten a lot more intelligent in the last thirty years. Instead of trying to accomplish their goals directly, they are raising the costs of doing business as a broker to make it harder for brokers to compete, and they have enlisted to aid of the government to that end. The government, in return for bribes known as "campaign contributions" has been only too happy to help, under the guise of "protecting consumers" which in fact, has been the exact opposite of protecting the consumers. It's as if they were designing changes to harm lenders and brokers who work in a way most aligned with consumer interests.

Let me go back to the dim and far off times of an just a few years ago. Effectively Shopping for A Real Estate Mortgage Loan was trivial: Get quotes, sign up with the one who was willing to guarantee their quote in writing for the best tradeoff between rate and cost. I could lock a loan based upon a verbal representation that you wanted it, and do the application and everything else afterwards. If you were concerned about whether the originator you signed up with intended to honor their guarantee, you could get a backup provider. This was pretty darned easy for a loan officer to set themselves up in compliance with. There was a good alignment between the way that the market worked and the needs and desires of the average consumer. No need for a deposit, no need to commit yourself to a single lender who could well be lying and it was extremely easy to provide good transparent loans and actually deliver the exact loan - rate and cost - of what got the consumer to sign up because I could lock that loan when right when that consumer said they wanted it.

Let me go over what has changed, which is two big things, each with multiple consequences for the loan originator who acts in accordance with consumer interests. The first is that lenders have acquired permission from regulators to discriminate against brokers with respect to loan fall out. Oh, they don't call it that - but that doesn't alter the fact that it is discrimination. The fig leaf being used to conceal - not very effectively - this discrimination is the secondary loan market. The lenders themselves don't hold the loan, but rather sell them to Fannie Mae, Freddie Mac, and Wall Street investment firms - whether directly or not. So when you lock a loan with a given lender, that lender is ordering the money from the secondary market so that they will have it when it's time to loan it to you. What happens when you don't actually get the loan? Well, the bank still ordered it, and Wall Street still supplied it and expects to get paid.

However, there has always been and still is a certain "slop" built into those contracts, with costs paid only when the "slop allowance" was exceeded. The lenders and Wall Street both know damned well that not every dollar ordered is going to be used in a funded loan, which is one thing they pay actuaries a lot of money for, and the actuarial estimates are usually almost frighteningly close on their "money ordering" contracts. The banks, however, are turning around and charging the brokers and correspondents for basically the full marginal cost for every single loan that doesn't fund, while allowing their "in house" loan officers to free ride, making uncharged use of the "slop allowance" built into the contract. This discrimination essentially transfers all of the costs for locked but undelivered loans onto brokers and their clients. It is costing consumers large amounts of money, but the regulators are permitting them to do it. Nor do the lenders penalize in any way their own loan officers who fail to achieve the same level of response they require out of brokers and correspondents. I've said for a long time that the best and the worst loan officers all work for brokers. That has changed - the only way for a bad loan officer to survive is to become a direct lender employee, working in a bank branch.

This means that if you lock a loan with a broker or correspondent, they're going to be forced to pay the lender they locked that with a fee if you don't carry through. So in order to protect our real customers - the ones that end up with a funded loan that actually gets the brokerage paid - brokers and correspondent lenders are having to be very careful with which loans they actually lock. Let me be very plain about how far reaching this is: What matters is that there is a lock without a funded loan. It does not matter why. It doesn't matter that the consumer decided they just didn't want it, that someone else had a better rate (or said they did), that the consumer could not in fact qualify for the loan at all, that the appraisal came in too low to fund the loan, that the lender rejected the consumer's application for an unforeseeable reason, or any other excuse. What matters is that there was a lock but not a funded loan. This has the effects of raising a broker's costs - which means they have to raise prices to compensate, or make certain it isn't our actual clients who end up with a funded loan who pay those costs. This, in turn means that the way to success for a broker or correspondent is going to be putting the costs for failed loans upon the people whose loans fail. Failure to do that means that the people whose loans succeed are going to be pay for the people whose loans fail. Not to mention that the loan officer who has more than a low percentage of loans fail is going to be facing higher costs for all of their new loans, because the lenders are going to be requiring a higher premium to do business with them.

In short, you can pick a low-cost loan provider, OR you can pick a loan provider where there's no risk and no cost if your loan falls apart. There will be no loan providers where both options exist - those places in denial of these changes are out of business now. The costs for failed loans exist, and someone has to pay them. It can either be the people whose loans fail, or it can be the ones whose loans succeed. Ask yourself if you want your loan to succeed or if you want your loan to fail to tell you which sort of broker you should be looking to apply with.

The second major change impacting lending practices is the Home Valuation Code of Conduct (hence HVCC), and the genesis of this is even more shadowy than that of the changes due to fall-out. I don't like it, but neither I nor anyone else in the lending business has the option of ignoring it. It is the new law of the land, having to do with the way that appraisals are handled. First, there isn't going to be any more developing a relationship between a good loan officer and appraiser with the idea of protecting the clients. It's not going to stop the bad loan officers or appraisers from doing everything they have done in the past, but it will stop the good stuff. Instead of ordering an appraisal through a specific appraiser, loan officers now have to order through appraisal management companies. This means I no longer have the ability to stop using bad appraisers - the ones who waste client money, the ones who produce substandard appraisals the underwriters reject, the ones who take so long to produce the report that I have to extend the rate lock because of their delay.

Second, the loan officer who orders the appraisal is now obligated to pay for it, which means that loan officer has a choice of either getting money in advance, or of charging successfully funded loan clients enough to pay for all of the appraisals of unsuccessful loan applicants as well as their own appraisals. The loan officer is prohibited from having the client write the check directly to the appraiser. Finally, most lenders as well as Fannie Mae and Freddie Mac are now requiring that the appraisal be written in the name of the actual lender instead of the broker. This means that despite the fact that I must pay the appraiser for the appraisal, the actual lender owns that appraisal, and if I want to change the lender for some reason, I have to get that lender to release it. Not likely. Even if the lender rejected the loan, getting them to release the appraisal is just about impossible. This means I have to pay for another appraisal if I want to try again with another lender, which really means the consumer has to pay for another appraisal as well, and there's no guarantee the second appraisal is going to be good even if the first one was. The appraisers are happy about this feature, as are the lenders. Consumers, not so much. It's not good business, and it's not good government. It is, however, what we're now stuck with.

So what does this all mean to consumers?

First, it means that those loan providers who really do provide low cost loans are going to have to get enough money from consumers to cover the cost of the appraisal before they order it. We should all be adults here, which means we should understand that if the loan provider doesn't do this, when your loan funds you are going to be paying not only the costs for your own appraisal, but a higher margin to cover those appraisals that did not result in funded loans. Make your choices of loan provider accordingly.

Second, it means that low cost loan providers can no longer guarantee to lock their best rate/cost tradeoffs immediately. I'm sorry, but if I lock every loan on a verbal indication that you want it, too many of them are going to fall out, which means I'm going to be liable for not only the appraisal costs of those loans that fail, but all of the costs that the lenders I lock with will charge me for failing to deliver that loan. Furthermore, if I have a high fall out ratio, the lenders will charge me extra to lock the loan and possibly even refuse to do business with me at all. This means I wouldn't be able to offer low cost loans - in fact, I'd be lucky to do much better than the lenders themselves. All of this is real money, and neither I nor anyone else can stay in business without paying those costs somehow. Since your loan officer has stayed in business thus far, you can safely assume they've got a plan in place for paying those costs. If you don't understand what it is (in other words, through being asked to pay some money up front for the appraisal, and waiting to lock until there is a reasonable assurance that loan is actually going to fund), then if your loan funds, you are going to be paying an extra margin for all of that loan provider's loans that don't fund, in addition to the specific costs of your own loan. In other words, by insisting upon no risk to yourself - no risk of losing the appraisal money, no risk of not getting the rate you're quoted - you will waste an awful lot of money if your loan actually funds. And lenders are permitted to lie to get you to sign up, same as always. Even with the new rules for the Good Faith Estimate, it's not that much harder to lie to consumers at loan sign up, and the loan officers who want to have the loopholes completely figured out.

Third, it means you're going to have to be very careful about Questions you ask your loan provider. Be very through, and insist upon specific answers. Beware of misdirections like "we honor our commitments" because nothing you get at loan sign up is in any way, shape, or form a commitment. What I'm having to talk about now is "What I could guarantee to deliver if I could lock your loan right now", because unfortunately, neither I nor any other loan officer can any longer lock loans until reasonably assured they will fund. Those loan officers who do lock everything early are going to be providing much higher cost loans, and that is for the very short period of time until lenders refuse to do business with them due to unpaid fall-out fees.

It's a situation of the sort made famous by Catch 22. Loan officers can protect the interests of the loans that fund, or the loans that don't fund - but protecting the interests of the loans that fund means you get a lot fewer loan applications, and scare off a lot of uninformed borrowers who haven't considered the consequences of their choices.

This is precisely the situation that lenders want to foster with regards to brokers and correspondents - because the average loan consumer isn't informed, hasn't considered the consequences of their choices, and is very hesitant to write a check for that appraisal upfront when they're not certain they're going to get a funded loan. It is nonetheless the intelligent thing to do, and failing to do so is going to cost you a lot of extra money.

"Might as well go back to the lender's themselves!" you say. Let's do something I don't usually do: Mention names and specific examples. Let's consider a $400,000 purchase money loan on a $500,000 property for someone with a absolute dead average median FICO score of 720, primary single family detached residence in San Diego California with a 60 day lock. All loan quotes were current as of when I wrote the original article for this:

Citi: 5.125 with one eighth of a point discount plus their normal origination which they won't detail online.

Ditech was quoting 4.625% for 2.1 points - but they're not telling you how long the lock is for. I'm not seeing if that includes origination, so even though I believe that the answer to whether it includes origination is really "No", I'll act as if it's "yes"

Chase was 5.375 for one point discount, 4.875% for two.

Union quoted me a lot of different loans, none of which are competitive (6% with one point on a fifteen year fixed rate loan - and fifteen year rates are lower than a thirty year loan everywhere else right now)

I couldn't get Bank of America to quote online.

GMAC wouldn't actually quote either - referring me to a phone number.

Same story with Flagstar

Wells Fargo wants me to sign up for rate alerts, but they won't give me an actual quote either

By comparison, at the exact same time I was able to get my clients the same 30 year fixed rate loan at 5.125% with no origination and no discount - no points at all. I made my normal money per loan off the secondary market premium with no borrower cost. If you're willing to pay origination but no discount, the rate was 4.75%. On a sixty day lock, which I've never needed in my life - but that's the shortest some of the lenders are willing to tell us about, so let's play fair. To nail down the difference in pricing absolutely, I've got 4.625% for 1.25 total points discount plus origination. So the closest any of the direct lenders can possibly come to what I really can offer at the same rate is at least 85 basis points more expensive, and I'm not certain a couple of them aren't quoting to a credit score twenty to forty points higher than I am. To put this into dollar terms, 85% of a point is about $3400 in this case. Nor were the credit unions any better on their rates than the major lenders. You want to just waste an absolute minimum of $3400 by applying with a direct lender because that's easy, be my guest, but that's the minimum difference it could possibly have been on this direct comparison. In reality, you're likely talking $7500 to $10,000 difference in costs for the same rate.

Why is it so much? Brokers are more efficient. Nobody expects me to have a beautifully landscaped building, plush carpet, beautiful furniture, a well-paid receptionist, etcetera. I make money when I fund loans. Bank employees make money whether they're funding loans or not. Get the idea?

No matter how much more efficient brokers are though, things have gotten a lot tougher for brokers of late, and consumers are now have to take a lot of the risks that lenders and brokers and correspondents (oh my!) were formerly assuming on their behalf. But the best and cheapest place to get a loan delivered to quoted specifications is still find a good broker. Getting a good loan is going to become a lot more a matter of developing a good relationship with that broker. This isn't to say "Don't shop around,", this is saying, "Shop effectively" because the game with phone quotes or email quotes that most consumers are playing that they think is getting them great loans is in fact, costing them an awful lot of money as opposed to what they could be getting by slowing down and having a real conversation with prospective loan providers. I don't often make $3400 (the minimum difference from the actual example above) for a day's work, which equates to a yearly gross of $680,000 for a day spent shopping your loan effectively. Someone making $680,000 per year doesn't need a loan for a $500,000 property, so I suspect the time it takes to slow down and have the full conversation will pay for itself for those folks, too.

As I said at the beginning of this article, the changes in the market in the last year are such that they are almost calculated to drive the low cost loan provider with consumer driven practices of a year ago out of the business. I'm not happy about any of these changes, but I have two choices: Do what is necessary to change, or leave the business. It won't help me or consumers to leave the business. All it would do is leave me broke and competing for limited employment opportunities while the consumers I would otherwise serve are left at the mercy of less ethical higher cost providers.

Now more than ever before, the sign of a good low cost loan provider is one who doesn't ask their serious loan applicants who really want a loan to pay for the costs of the unserious jokers who are just shopping ad nauseum for the sort of loan officer that's going out of business as we speak. As I said, these extra costs exist. They have to get paid somehow. You can choose a loan provider who makes the failed loans pay their own costs, or you can choose a loan officer who makes the successful loans pay for the costs of the failed loans. Everybody else is going to be out of business. And all of the consumers that kid themselves otherwise are wasting thousands, if not tens of thousands of dollars.

Caveat Emptor

Original article here

Many folks have no idea how qualified they are as borrowers.

There are two ratios that, together with credit score, tell how qualified you are for a loan.

The more important of these two ratios is Debt-to-Income ratio, usually abbreviated DTI. The article on that ratio is here. The less important, but still critical, ratio is Loan to Value, abbreviated LTV. This is the ratio of the loan divided by the value of the property. For properties with multiple loans, we still have LTV, usually in the context of the loan we are dealing with right now, but there is also comprehensive loan to value, or CLTV, the ratio of the total of all loans against the property divided by the value of the property.

Common breakpoints on Loan to Value ratio are 70 percent, 80 percent, 85 percent, 90 percent, 95 percent, 96.5 percent (for FHA) and 103% (for VA). Some lenders may have others. If you're between two break points, LTV always treats you as being at the next higher break point. For instance, 82% Loan to value will require you to qualify as if your loan to value was 85%.

Note that for instances where you may be borrowing more than eighty percent of the value of the home, splitting your loan into two pieces, a first and a second, is usually going to save you money, if the loans to do so are actually available. See here for an example, but government loans ( VA and FHA) are an exception to this. At this update I am unaware of any second loan program that will loan over ninety percent of the value of the property, meaning one loan with PMI may be your only option.

The maximum loan to value ratio you're going to qualify for is largely dependent upon your credit score. The higher your credit score, the lower your minimum equity requirement, which translates to lower down payment in the case of a mortgage.

Credit score, in mortgage terms, is the middle of your credit scores from the 3 major bureaus, reported upon a scoring model proprietary to a company called Fair-Issacsson. If you have an 800, a 480, and a 500, the middle score, and thence your credit score, is 500. If the third score is 780 instead of 500, your score is 780. If you only have two scores, the lenders will use the lower of the two. If you have only one score, most lenders will not accept the loan. I've never seen scores that divergent, but that doesn't mean it couldn't happen. Usually, the three scores are within twenty to thirty points, and a 100 point divergence is fairly unusual. Despite what you may have heard or seen in advertising, according to Fair Issacsson (who set the parameters) the national median credit score is 720. See my article on credit reports for details.

In order to do business with a regulated lender, you need a minimum credit score of 500. There are tricks to the trade, but if you don't have at least one credit score of 500 or higher, you're going to a hard money lender or family member.

Exactly what the limits are for a given credit score is variable, both with time and lender, even when you get into A paper. Subprime lenders (when we had true subprime) would go higher than A paper, but the rates would have also been higher. Nonetheless, there are some broad guidelines. At 500, only subprime lenders will do business with you, and they will generally only go up to about 70 percent of the value of the home. A few will go to 80 percent, but this is not a good situation to be in. Note that at this update, true subprime is basically non-existent. It isn't the lenders; it's the investors behind those lenders not being willing to loan money. The shenanigans that were worked with bond ratings mean that nobody wants to take a chance, and there are people with legitimate needs for subprime loans that neither I nor anyone else can help right now because of it. I hope the so-called ratings agencies get sued and the investors win everything.

When I first wrote this, at about 580 credit score, you could find subprime lenders willing to lend you 100 percent of the value of the home, provided you could do a full documentation loan. These days, subprime won't go over about 80% of value, period. 580 also used to be where Alt-A and A minus and government program (VA and FHA) lenders start being willing to do business with you. These days, you're more likely looking at 620 to 660 for those.

At 620, the A paper lenders start being willing, in theory, to consider your full documentation conforming loan. They won't do cash out refinances or "jumbo" loans until a minimum of 640, but they will do both purchase money and rate term refinances at 620 or higher. Below about 660, you can expect to be limited to about an 80% loan to value in the current financial environment.

At 640 is where subprime lenders used to start considering 100 percent loans for self-employed stated income borrowers. Not any more. Stated Income is essentially dead, although I'm starting to see a few portfolio lenders that will consider stated income loans. I haven't submitted any so I don't know how hostile the underwriting process is firsthand, but I would not expect it to be friendly.

660 is now where A paper will start considering conforming loans above 80% loan to value. The PMI companies are really leery of accepting credit scores below that, and there are heavy hits on the tradeoff between rate and cost below about 740, but they are obtainable. Furthermore, expect that someone whose credit is lower than 720 will probably not be able to get PMI on loans 90% or higher of the purchase price.

It is to be noted that just because you can get a loan for only so much equity, it does not follow that you should. Whereas the way the leverage equation works does tend to favor the smaller down payment, at least when prices are increasing, it can also sink your cash flow. So if the property is a stretch for you financially, it can be a smarter move to look at less expensive properties to purchase. I have seen many people recently who stretched to buy "too much house" only to lose everything because they bought right at market peak with a loan they could not keep up. Many of these not only lost every penny they invested, but also owe thousands of dollars in taxes due to debt forgiveness when the lender wrote off their loan.

Right now, there is only one commonly available purchase loan that will support 100% financing: The VA loan, which actually goes to 103% to allow the financing of some closing costs. FHA loans require a 3.5% down payment, and I can do conventional conforming purchase money loans with a 5% down payment, albeit with a PMI and a highly restrictive choice of lenders. 90% financing is very commonly available on conforming loans ($417,000 minimum, higher in certain high cost areas such as San Diego where I work). For loans above the conforming limits, sometimes I can get financing above 80% (up to 90%) .

There are other ways to buy with a smaller down payment: Seller Carrybacks and some municipal first time buyer programs to name the two most common, but both of these start a long time before you've got a purchase contract, and your agent had better be able to write and negotiate a purchase contract the right way or you're going to find yourself dead in the water. Acting within narrow time windows is typically also necessary.

There are other factors that are "deal-breakers", but so long as your debt to income ratio is within guidelines and your loan to value is within these parameters, you stand an excellent chance of getting a loan. All too often, questionable loan officers will feed supremely qualified people a line about how they shouldn't shop around because they're a tough loan and "you don't want to drive your credit score down." First off, the National Association of Mortgage Brokers successfully lobbied congress to do consumers a major favor on that score a few years back. All mortgage inquiries within a fourteen day period count as the same one inquiry. Second, the vast majority of the time it's just a line of bull to keep people from finding out how overpriced they are or to keep you from consulting people who may be able to do it on a better basis. I've talked to people with 750 plus credit scores, twenty years in their line of work, and a twenty percent down payment who had been told that, when the truth is that a monkey could probably get them a loan! By shopping around, you will save money and get more information about the current status of the market.

Caveat Emptor

Original here

Many people have no clue how qualified they are as buyers, or borrowers.

There are two ratios that, together with the credit score, determine how qualified someone is for a loan.

The first, and by far the more important, is debt to income ratio, usually abbreviated DTI. This is a measurement of how easy it will be for you to repay the loan given your current income level. One point that needs to be made is that this ratio protects you as much as it does your lender. You've got to be able to make those payments, and if you can't, you're going to suffer far worse consequences than simply not getting the loan. Better for you as well as the lender to deny a loan with an unmanageable debt to income ratio.

The debt to income ratio is measured by dividing total monthly mandatory outlays to service debt into your gross monthly income. Yes, due to the fact that the tax code gives you a deduction for mortgage interest, you qualify based upon your gross income. This ratio is broken into two discrete measurements, called front end ratio and back end ratio, for underwriting standards. The front end ratio is the payments upon the proposed loan only (i.e. principal and interest), whereas the back end ratio adds in all debt service: credit cards, installment loans, finance obligations, student loans, alimony and child support, and property taxes and homeowner's insurance on the home as well. With the current paranoid lending environment, the front end ratio has become significant where it was formerly almost ignored. I have seen front-end ratio become a real concern in a couple of recent loans. The thing that will break most loans, however, is the back end ratio.

As to what gets counted, the answer is simple. The minimum monthly payment on any given debt is what gets counted. It doesn't matter if you're paying $500 per month, if the minimum payment is $60, that's what will be counted.

"Can I pay off debt in order to qualify?" is a question I see quite a lot and the answer depends upon your lender and the market you're in. For top of the market A paper lenders, who have to underwrite to Fannie Mae and Freddie Mac standards, the answer is largely no. If you pay off a credit card where the balance is $x, there's nothing to prevent you going out and charging it up again. Even if you close it out completely, the thinking (borne out in practice, I might add) is that you can get another one for the same amount trivially. "Won't they just trust me to be intelligent and responsible?" some people will ask. The answer is no. Actually, it's bleep no. A paper is not about trust. A paper is about you demonstrating that you're a great credit risk. Even installment debt is at the discretion of the lender's guidelines. If they believe that what you really did was borrow money from a friend or family member who expects to be repaid, expect it to be disallowed. Therefore, the time to pay off or pay down your debts is before your credit is run and before you apply for a loan.

For subprime loans (when real subprime existed), the standards were looser. As long as they could see where the money was coming from, they would usually allow the payoff in order to qualify.

Many folks thought that stated income loans didn't have a DTI requirement. They did, when they existed. As a matter of fact, stated income was even less forgiving than full documentation loans in this regard. As I keep telling folks, for full documentation, I don't have to prove every penny you make, I only have to prove enough to justify the loan. If what I proved before falls short, but the client has more income, I can always prove more. For stated income, we had to come up with a believable income for your occupation, and then the debt to income ratio is figured off of that. Even if the lender agreed not to verify income, they were still going to be skeptical if you change your story. "You told me you make $6000 per month three days ago. Now you're telling me you make $7000 per month. Which is it? Please show me your documentation!" In short, this loan had now essentially changed to a full documentation loan at stated income rates. Nor were they going to believe a fast food counter employee makes $80,000 per year. There are resources that tell how much people of a given occupation make in the area, and if you were outside the range it would be disallowed. So you had to be very careful to make certain the loan officer knew about all the monthly payments on debt you're required to make. Sometimes it doesn't show up on the credit report and the lender found out anyway.

Debt to income ratio has nothing to do with utilities (unless you're in the process of paying one of them back). Utilities are just living expenses, and you could, in theory, cancel cable TV if you needed to. Once you owe the money, you are obligated to pay it back.

As for what is allowable: A paper maximum back end debt to income ratios vary from thirty-eight to forty-five percent of gross monthly income. I'm a big fan of hybrid adjustables, but they are, perversely, harder to qualify for under A paper rules than the standard 30 year fixed rate loan despite the lower payments. This is because there will be an adjustment to your payment at a known point in time, and you're likely to need more money when it does. Note that for high credit scores, Fannie Mae and Freddie Mac have automated underwriting programs with a considerable amount of slack built in.

Some things count for more income than you actually receive. Social security is the classic example of this. The idea is that it's not subject to loss. Once you're getting it, you will be getting it forever, unlike a regular paycheck where you can lose the job and many people do.

Subprime lenders would usually, depending upon the company and their guidelines, go higher than A paper. It's a riskier loan, and you could expect to pay for that risk via a higher interest rate, but even with the higher rate, most people qualified for bigger loans subprime than they will A paper. Some subprime lenders would go as high as sixty percent of gross income on a full documentation loan.

Whatever the debt to income ratio guideline is, it's usually a razor sharp dividing line. On one side you qualify, on the other, you probably don't. If the guideline is DTI of 45 or less, and you are at 44.9, you're in, at least as far as the debt to income ratio goes. On the high side, waivers do exist but they are something to be leery of. Whereas many waivers are approved deviations from guidelines that may be mostly a technicality, debt-to-income ratio cuts to the heart of whether you can afford the loan, and if you're not within this guideline, it may be best to let the loan go. You've got to eat, you probably want to pay your utility bills, and you only make so much. Debt to Income ratio is there for your protection as much as the bank's.

Caveat Emptor

Original here

The companion article on Loan to Value Ratio is here.

Having written several articles on Negative Amortization Loans, telling of the details of what is wrong with them, and even destroying the myth of Option ARM cash flow, I sometimes get asked if I would like to see them banned completely.

Well, given the pandemically misleading marketing that surrounds these loans, and pandemically poor disclosure requirements, I am tempted. It only takes one person losing their life savings and having their financial future ruined to make a very compelling story, and I've seen a lot more than one and read about many more. Furthermore, it's almost a moot point right now. The requirements for offering them are onerous and nobody does.

However, when you ask if they should be banned outright, I have to answer no.

Part of this is my libertarian sympathies. Adults should be allowed to make their own mistakes. But there are economic and a realpolitik reasons as well.

The fact of the matter that just because Negative Amortization loans are oversold under all of the friendly-sounding marketing names such as Option ARM, Pick a Pay, and even 1 Percent Loan (which they are not), does not mean that there is no one for whom they are appropriate or beneficial. People for whom these are appropriate do exist. Consider someone with crushing consumer debt, and no significant usable equity on a home they've owned for a while. They sell the home, they end up with nothing and still have the consumer debt. They can't refinance cash out. But if you put them into an Option ARM for a while, you remove from several hundred to over a thousand dollars per month from their cash flow requirements. In three years, they will pay off or pay down those consumer debts, and then you refinance to put them back on track, and the money that has accumulated means nothing compared to what they've paid off. Yes, if the market collapses they're likely to be in trouble, but if you don't do it, they're in trouble at least that bad now. It's a narrow niche, but it does exist.

Consider also someone starting a business. Cash flow insolvency is what kills most start-up businesses. Until the customer base builds, they don't have enough money to pay the bills. Lower monthly cash flow requirements on their house can mean the difference between success and failure of their business, far outweighing the cost of the extra money in their balance that they accumulated. Furthermore, the fact is that when their cash flow gets tight, they're not making the mortgage payment anyway. They are likely to lose both business (through insolvency) and property (through foreclosure) if the business fails anyway, and the lowered cash flow requirements of the Negative Amortization loan may give the business more of a chance to succeed, and once it is profitable it will pay back the investment many times over.

There's still a need to really explain what's going on, and all of the drawbacks of the loan, but people in these two circumstances really do have a valid possibility of it being in their best interest. Banning negative amortization loans completely takes away that option, thereby hurting those people.

When I first wrote on this subject, I didn't think it was politically possible to ban these loans that have now cost millions of people their homes, their credit rating, and their life savings. So far that is holding up. They're not actually banned; it's just that no investors are willing to take a chance on loaning money for them right now. Furthermore, due to the cries of the wounded beast, the law now mandates some tough disclosure requirements for them - some few of which are for the benefit of the consumer.

Disclosure requirements are is an approach that will work. That is, at this point, what really killed the negative amortization loan sales. The scumbags who made a habit of selling these now have to tell the prospective victims in easy to understand language and easy to read print about all of the problems they are letting themselves in for with these loans, very few people are going to sign on the dotted line. I originally suggested this: "Caution: If you accept this loan, the 1% is a nominal, or in name only, rate. You are really being charged a rate of X%, and this rate will vary every single month. If you make the minimum payment, your loan balance will increase by approximately $Y per month at current rates, or Z percent within five years. You will have to pay this money back in lump sum if you sell, or with higher payments at a later date. If you cannot afford full payments now, you will unlikely be able to afford them in the future after your balance has increased. There is a three year prepayment penalty on this loan, and if you sell the property or refinance within that time, you will pay a penalty of approximately $A in addition to whatever additional balance has accrued. It is currently under consideration that the mere fact that you have one of these loans will have significant derogatory effect upon your credit rating, even if you never make a late payment, due to financial difficulties encountered by borrowers with this kind of loans in the past." I could go on in bullet points for a couple of pages, but I trust you get my point. What the government did in fact do is technical and shorter, but similar. Enough so that with some less stringent warnings in writing from the federal government, the least any marginally competent adult is going to do is find out what's really going on.

Furthermore, the only way disclosure requirements could be fought by the industry is behind closed doors. The only way it stays behind closed doors is if nobody raises a political stink, and it's easy to raise a political stink about stuff like this. Newspapers and television reporters and bloggers all converge on the issue, and the industry is left in the awkward position of crying because they have to tell the truth. That doesn't play well with the American public. The way this plays with the American public is the major reason for the successes of Porkbusters, among others. Despite some very entrenched and very powerful enemies lining up against them, they've won on a couple of big issues because of the power of the idea that the American people have that the truth should be told. Take the tack that all you want is for the industry to tell the truth, and watch the political wind die out of their sails. David beats Goliath pretty reliably in American politics when the issue is "Do I have to tell the truth?"

To summarize, it is tempting to try to ban negative amortization loans. But it is far better social and economic policy to go the disclosure route instead, and far more likely to be politically successful.

Caveat Emptor

Original here

One of the standard arguments I hear about Negative Amortization and Option ARM loans is that they "give the client the option to make a smaller payment if they need to." This so-called "Pick A Pay" benefit is a real benefit, but it's an expensive benefit, one that the client will pay for many times over. They are better off just managing their money well to begin with.

Let's go into some details. Let's consider someone with a $400,000 loan on a $500,000 property, and dead average credit score, and to keep the playing field level, let's price loans with the same 3 year "hard" prepayment penalty. When I originally wrote this, I had a 30 year fixed rate loan at 6.00 percent, less than one point total net cost to the consumer. The equivalent Option ARM/"Pick A Pay"/negative amortization loan was actually a little above 7.5 percent real rate, although it carried a nominal rate of 1%. Furthermore, removing the prepayment penalty would make a difference of about an eighth of a percent to the rate on the thirty year fixed, while I have yet to see a Negative Amortization loan that even had the option of buying the penalty off completely, and this loan carries higher closing costs to boot.

Now, let's crank some numbers. That thirty year fixed rate loan has a payment of $2398.21. Nothing ever changes unless you change it by selling or refinancing. The first month, $2000.00 even is interest and $398.21 is principal. You pay for a year, $23,866.38 in interest and $4912.05 in principal is gone, and you've made payments totaling $28,778.43. You are also free to pay down up to twenty percent of the loan's principal in any year without triggering the prepayment penalty.

Plugging in 7.5% for the real rate to keep the math a little easier, the Negative Amortization Loan has four payment "options" of $1286.56, $2500.00, $2796.86 or $3708.05. These options represent "nominal" payment, "interest only" payment, "30 year amortization" payment, and "15 year amortization" payment. Actually, the last three options will vary every month, but let's hold them constant just to make my point. As a matter of fact, if you don't make a habit of paying at least the thirty year amortization payment, the options for payment will increase over time, even before reset. The chances of people making the thirty year amortized payment in the real world are minuscule, as I make clear in my first article on this subject, Option ARM and Pick a Pay - Negative Amortization Loans, but let's play the game, just to see how it turns out if you give the advocates everything they ask for and more.

Crank the numbers through for twelve months, and you've paid $29,874.96 in interest, $3687.34 in principal, and made $33,562.30 in total payments. This is the "going along, making the loan payments" that the advocates are talking about. Here's a table, comparing this to the 30 year fixed rate loan:

When you put it in those terms, I don't think there's any question which loan a rational person would rather have. But that's not the situation the advocates would have us believe is beneficial, at least not with this particular argument. Let us presume that two months out of that year - and to keep the math as simple and as favorable to their argument as possible, let's make them the last two months - that you decide you have the need to make minimum payments, and let's see what happens. you've paid $29884.40 in interest, lost all but $657.30 in principal payments, and made $30,541.70 in total payments. Now, if you're making the minimum payment more than one month out of six, most folks should agree it's not an "occasional" thing, it's more of a "regular occurrence" thing, which situation I have already done the math to refute any claims of advantage. Here is a table comparing that "2 month short pay" option to the thirty year fixed rate loan:

Look very carefully at that "total paid" row. The thirty year fixed has saved you $1763.27 in total payments. Now, this begs the question of what you're paying it out of, but if you haven't got the income to make the payments from somewhere, you shouldn't have the loan. It's not good for you. So we're assuming that money is coming from somewhere, and as I have illustrated, if you'll just not spend it as it comes in and set a little bit aside in case something happens to your cash flow, that 30 year fixed rate loan leaves you with $1763.27 of your hard-earned money in your pocket. Not to mention just an all around better situation, as evidenced by the rest of the second table.

Let's even add in another scenario: The Negative Amortization loan with the two 'short' payments versus a thirty year fixed rate loan with a five year interest only option. Those were available at 6.25% back then.

Leaving you with $5,541.70 in lowered real payment, even taking the two 'short pay' months. You could put $3000 of that towards paying the loan down without triggering the penalty, plus have $2500 plus still in you pocket, and be thousands of dollars better off in every particular - more money in your pocket, less money owed on the loan.

Now, given the fact that these loans have basically nothing to recommend them to clients, why do alleged professionals keep pushing them off on the public? Well, two reasons, both of them having to do with money. $$$. Coin of the realm. Specifically, commission checks.

First off, it should come as no surprise to anyone that lenders are willing to pay very high yield spreads for negative amortization/Option ARM/"Pick a Pay" loans. The yield spreads start at about 3 and a quarter percent of loan amount, and go up to 4 percent, with most clustering in the higher part of the range. By comparison, that thirty year fixed rate loan pays 1 percent. On a $400,000 loan, like the one in the example, that's the difference between a $4000 check and a $15,000 check. Doesn't that make you feel good that they left you twisting slowly in the wind so that they could make $11,000 extra? Didn't think so.

The second reason that people do this to you is that it makes it look like you can afford a larger, more expensive property than you really can. Most people tell professionals how much property they can afford in terms of monthly payment. Well, shopping for a property or a loan by monthly payment is a disastrous thing to do, as the first part of this article, among many others, illustrates. But let's say you tell the Realtor that you can afford $2500 per month. Most people are thinking of mortgage payments in the same terms as rent payments, when most people can afford a higher mortgage payment than rent, but let's use these numbers. Let's just use that numbers, and have insurance and property taxes call it a wash. For $2500 per month payments, you can make real payments on a $410,000 property, or you can make minimum payments on a $775,000 property. At 3% buyer's agent commission, assuming they are only representing you and didn't list the property, and assuming they do the loan as well, they can get checks totaling about $16,400 for the buyer's agent commission and loan in the first situation, or $52,300 in the second. Not to mention I don't have to tell the client to limit themselves to what their pocketbook can afford in the second situation. Even here in San Diego, that $775,000 property is a beautiful five or six bedroom 2800 square foot home with all of those nice little extras like travertine floors, three car garage, marble counter-tops, etcetera, in a highly sought after area of town with great schools, whereas the $410,000 property has linoleum floors, no garage, Formica counter-tops, and is in a neighborhood with marginal appeal and probably not so wonderful schools. Which do you think sounds like a more attractive property and an easier sale, for what the typical buyer thinks of as the same payment? Which property do you think the typical buyer is going to select, particularly if they have never had all of this explained to them?

Finally, for pure loan officers, it's a way of appearing to compete on price without really competing on price. The average person is told about this great 1% payment of $2500 when the real payment for a thirty year fixed rate loan (allowing for the fact that this has become a jumbo loan) is $4771.80, and they just aren't looking at little things like two extra points of origination or higher closing costs, as it just doesn't make that much difference to the payment. They can also slide in a higher margin over index that gets them an even higher yield spread, and it doesn't influence that minimum payment at all, which is the only thing this client has their eyes on. So what if the final payment comes in at $2600 (making the loan officer roughly $35,000 or more)? So what if their loan balance is increasing by $2000 per month? Most people just do not and will not do the work that enables them to spot this trap. Scary, isn't it? But we've now seen the evidence that people will not do their homework ahead of time, to the tune of millions of foreclosures on this runaway train wreck of a loan.

Caveat Emptor

Original here

Read your article on negative arm loans, and for the person who only owns a residence and most real estate investors it will not work. I own several properties, and the parcel to be refinanced is ocean front...so is going up in value more than the negative arm would be when refinanced after prepay penalty period. Cash out would be used to pay off other mortgages, thereby increasing my cash flow for a few years. Does your advice against negative arms apply in my situation?

I believe he's referring to this article.

This is actually an excellent question, and the answer is ... maybe. At least it is not a clear "no", unlike so much of what the Negative Amortization loan is misused for. This largely goes beyond the scope of what I'm trying to do with this site, but I'll take a swing at it.

The fact is that I can construct a scenario that goes either way, and the implicitly high appreciation rate you mention has surprisingly little to do with it.

The positive is that your other loans are paid off! To use Orwell-speak, this is maximum plusgood.

The negative is that this loan now includes every dollar you previously owed. Furthermore, there may be negative tax connotations to the fact that all of your interest expense now comes from one property, as opposed to being able to directly match it against individual properties with individual incomes. If interest against one property is greater than the income for that one property, you may not be able to take it all, as it's definitely a "cash-out" loan of the sort that the IRS has been limiting to partial deductibility. I'm not clear on all the implications of the tax code here (and I'd like to be educated), so consult with a CPA or Enrolled Agent. Plus it definitely becomes a full recourse loan, no matter the original circumstances.

Furthermore, your new loan won't magically create any "lake" of dollars. In order to pay off the other loans, it's going to have to be the size of all of them combined, plus any prepayment penalties, plus all costs of doing the loan, plus potential pre-payment penalties for the Negative Amortization loan.

Now consider: If you make payment option one (the "nominal" or "as if your rate was 1 percent" payment), you are allowing compound interest to work against you. This is the force Einstein described as "the most powerful force in the universe", and it's working on the whole dollar amount of every single one of your current loans and then some.

Ouch.

No matter which payment you're making, the rate you are being charged, (aka "what the money is costing you") is not fixed, but variable month to month. As far as most commercial property loans are concerned, this is no big deal. They're pretty much variable at "prime plus" anyway. However, I expect the MTA and COFI (upon which Negative Amortization loans are based) to continue rising as government borrowing increases, whereas I'm not so certain about prime.

Now with all this said, it's still very possible to construct winning scenarios, depending upon a variety of factors. You mention short-term cash flow, and that is certainly one possible justification. If short-term cash flow is all you're looking for, and the money it will cost you later on is no big deal because you're planning to buy down the prepayment penalty and sell in a short period of time. Yeah, you've added to your balance but you've got plenty of equity and you'd rather have a few hundred per month now than multiple thousands later. Think of it as a cash advance.

One of the things that negative amortization loans can do for you is make it easier for you to qualify for more loans on more properties. Because in loan qualification, the bank will only give you credit for 75 percent of prospective rents while dinging you for the full value of payments, taxes, fees, maintenance, etcetera, this can make it much harder to qualify than is realistic, given that in many markets the vacancy factor is less than five percent. You actually pay more, but you're not obligated to. Particularly because many people own investment properties for the capital gain rather than the income potential (i.e. price speculation, rather than monthly income). On the other hand, just because a property has been appreciating rapidly does not mean it will continue to do so, beachfront or not. The market nationwide is very different now than was previously. I can point to beachfront property here locally that's lost a lot of value since early 2005. Price speculation is great when it works (which is most of the time), but is really scary when it doesn't. It's a reward for risk-taking, so don't lose sight of the fact that it is a risk.

One other factor of doing this is that it can cause taxes on a sale to exceed net proceeds. Suppose you intend to sell the beachfront property in a couple of years, and it doesn't gain any more ground from where it is right now. Many properties were bought for less than 10% of their current value. Let's say you bought for ten percent of current value. If your loan is for eighty percent, and you pay six to seven percent in sale costs, you're getting ninety-three to ninety four percent of value, leaving a net of thirteen or fourteen. But you owe long term capital gains of eighty-three or eighty-four times twenty percent - almost seventeen percent! This can force you to take another loan out, against one of those "free and clear" properties lest you owe the IRS penalties. Yes, 1031 (or 1035) and even a potential personal residence exclusion can modify or nullify this, but so can all the depreciation you may have taken over the years, and if you intended to 1031 the property that would tend to contra-indicate any reasons you had for the negative amortization loan.

Now, to be honest, my experience with commercial loans is limited, and I've never done a negative amortization commercial loan. What few clients I've had in that market have had different goals in mind, and being as I'm a sustainability type loan officer, I tend to attract sustainability type clients, where Negative Amortization loans are more indicative of a speculative ("risk taker") type. I understand what's going on, but it isn't my primary approach to the issues. There are circumstances on investment properties where, unlike your primary residence, it can be appropriate. Unfortunately, without full specifics, including time schedules, goals, reasons for holding investments, other investments, risk tolerances, etcetera, it's difficult to tell if yours is one of them. My experience in dealing with people is telling me one thing, my sense of ledger evaluation is hinting at a different answer. But I hope I've given you a clear idea of the kinds of issues you need to look at with professional help.

Caveat Emptor

Original here