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

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

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

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

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

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

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

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

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

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

Caveat Emptor

Original Article here

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

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

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

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

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

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

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

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

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

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

Caveat Emptor

Original article here

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

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

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

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

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

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

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

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

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

Caveat Emptor

Original article here

There are actually several distinct marketplaces consumers can obtain their funds from, and several types of providers. John the wealthy highly salaried person with great credit and a substantial down payment should not and usually does not obtain his mortgage from the same funds providers as his twin brother Jim, the self-employed, always-broke person with terrible credit and no down payment. They may deal with the same employee at the same business, but the funds and parameters for using those funds, are entirely different.

In order to make sense later on, I've first got to acquaint you with two concepts: yield spread and pre-payment penalty. The yield spread is what then lender pays the person or company who does the paperwork for your loan in order to give them an incentive to choose that lender, loan type, and rate, as well as any of several other reasons. The yield spread is based upon the rate of the loan, the type of the loan, and other factors as well

Yield Spread is explicitly associated with the premium (amount over face value) that the actual lender will receive when they sell the loan. I find it entirely and intentionally misleading that the government now requires brokers to treat yield spread as a cost and added to other costs of the loan while not requiring that direct lenders disclose secondary market premium at all. The new 2010 Good Faith Estimate adds Yield Spread as a cost when under the new rules it is an offset, lowering the cost of the loan to the consumer. This has the effect of making broker originated loans appear more expensive than they are, while allowing direct lender loans to continue to hide this method in which they get compensated on basically every loan.

Prepayment penalty is a penalty you agree to pay if you sell your home or refinance before a certain period of time has passed. Industry standard is six months interest, with some lenders making this 80 percent of six months interest. Usually (not always) they will let you pay a certain amount over the normal, agreed upon principal per year without triggering the penalty, but if you sell or refinance out of their loan, the penalty is always triggered for the duration of the penalty. Some lenders will actually phase it out in stages, although this is not common.

Lest it be not plain to you, a prepayment penalty is a thing to avoid if you reasonably can. Let's say you get transferred and need to sell the house in six months, and that you have a $200,000 loan at 6%. That's six thousand dollars less that you will receive from the sale of your home, not to mention that the average person refinances every two years, which is typically the shortest pre-payment penalty. If you need to refinance within two years, that's six thousand dollars of your equity gone for no good purpose. Mind you, if you need the loan, and it gets you the loan, so be it. It's still a thing to avoid.

The top of the food chain from the point of view of consumers are the so-called A paper lenders. This market is controlled by the two federally chartered giants, Fannie Mae and Freddie Mac. Lenders who participate in these markets lend in full accordance with Fannie Mae and Freddie Mac rules, because they want to be able to sell the loan to them. In many cases, they actually do sell them seamlessly by retaining the servicing rights, and the consumer never knows they have done it. In others, they retain the loans entire, and in still others, they sell them off entire. They do this for many reasons, but mostly to raise cash so they can do more loans. In any case, the only difference it should make to you, the consumer, is where to address the check and who to make it out to. Unlike the other markets, if the secondary market pays a premium in this market it does not automatically mean that there will be a pre-payment penalty. Although they will pay a higher yield spread if the loan officer sticks the client with a pre-payment penalty (and the longer the prepayment penalty is, the more they will pay). WARNING! Many loan officers will not tell you about it unless asked ("Why bring up a reason not to choose your loan?" is a direct quote I've heard any number of times) and some will flat out lie even if you ask. This is not ethical, but they know they can almost certainly get away with it. There really is no reason why an A paper loan should have a prepayment penalty, except that a loan officer wanted to get paid more. The new rules make this more difficult, but it is still happening, mostly because consumers aren't very careful. ALWAYS be careful about pre-payment penalties; they are an excellent way for lenders to sock you with thousands to tens of thousands of dollars in extra revenue that will end up coming out of your wallet.

It is not difficult to qualify for an A paper loan. As long as you're not taking equity out of the home, they can go through with credit scores as low as 620 for a full documentation loan, although there are caveats. Despite what you read in Internet pop-ups, according to National Mortgage Reporting a 620 credit score is 100 points below the national average. So even someone with modestly below average credit can still qualify for an A paper loan. There are minimum equity requirements, however. Also, it until recently it didn't matter if you were King Midas who had never failed to pay a bill immediately in full or someone who barely staggered over the line into qualification by the computer models put out by Fannie Mae and Freddie Mac. That has now changed with risk based pricing, such that credit score and equity picture can cause you to be assessed a differential, but the differential is a lot better than going sub-prime or Alt A. There is nothing better than A paper.

The next market below A paper is called A minus. The rates are a little bit higher, and there are prepayment penalties anytime the lender pays a yield spread. A minus is still a program associated with Fannie and Freddie for the "almost but not quite" people, although the window of qualification has become a lot narrower of late.

Then comes the so-called Alt A, which are typically loans for fairly unusual circumstances. At this update, Alt A really isn't available due to Wall Street being more nervous than a cat at a rocking chair convention, but I'm going to leave the rest of what I originally wrote untouched because it will come back: The credit scores here go down to about 580, although there is less standardization. The worst, most dangerous, absolutely awful loan in the world comes from the "Alt A" world. There are all kinds of friendly sounding names for it, like "Option ARM", "pick a pay", and such things, but they are all negative amortization loans at their heart - you end up owing more than you borrow. They sound benign: "pick your monthly payment!" But in fact most people choose the minimum monthly payment which capitalizes and then amortizes more money into your loan every month. Every single one I've ever heard about carries a prepayment penalty. Once upon a time, I saw ads for these abominations every day all over the internet. If anybody quotes you a mortgage rate below 3%, or a payment that seems too low to be true, I will bet you millions to milliamps they are trying to sell you one of these abominations. There are still loan providers out there that do nothing but these - they're easy to sell to unsuspecting victims because the minimum payment is so small, and most people shop for a home loan based upon payment. There really isn't space here to go over everything that's wrong with them (or where they may be appropriate), but except in certain special circumstances, RUN AWAY! And do not do business with that person! They have just proven themselves unworthy of your business. Fortunately, the Negative Amortization loan has now had regulatory controls placed on it, and lenders have figured out that these loans aren't as good for their bottom line as they thought, due to a high default rate that was as predictable as falling objects hitting something.

(Every so often, a representative from a new lender walks into my office. I'm always glad to talk to them so long as they answer my questions in a straightforward way, but I have one inflexible rule. As I just said, it doesn't happen much any more, but if the first thing they talked about was a Negative Amortization loan - no matter the happy sounding name they call it by, I throw them out and do not allow them to return. I think it indicative of the state of things in the Negative Amortization world that the one time I had a client who would actually benefit from this thing, and I took the time to tell him exactly where all of the traps I knew about were, give him strategies to turn it to maximum benefit, and he agreed that he wanted to do it - not one of the five companies I tried would actually approve the loan despite him meeting all of the written loan guidelines.)

The final niche that comes from regular lenders is called sub-prime. Until recently, in the world of sub prime lending you could do a lot of things that higher rungs on the ladder will not allow you to do. As in A minus or Alt A, anytime the lender pays a yield spread there will be a pre-payment penalty, and I think I've run across exactly one sub prime loan that didn't have a prepayment penalty in my whole time as a loan officer. However, the people who subsidize sub prime lenders just didn't have a whole lot of choice. That has now changed. Unless you've got a very high down payment or amount of equity, subprime is being about as strict as A paper with qualification standards. However, if you don't qualify for a better market, this is typically the only way you're actually getting a home loan, be it because of low credit, low equity, or what have you. The rates are high, but it's that or nothing. Sub prime loans are very lucrative - the average lender or broker specializing in them usually makes about 5 points - 5 percent of the loan amount - on each and every loan. I've had people thank me so profusely I was almost embarrassed when I got them a loan on something more closely resembling a typical margin from higher niches. The lines between A minus, Alt A, and sub prime are blurring more and more as time goes on. When I first wrote this, it was to the point now where if someone said they did sub prime, that usually meant Alt A and A minus as well - it's just a matter of where on the spectrum a given client sat. Nowadays, what that same provider is looking for is an A paper borrower who doesn't realize they are A paper, or whom they can make think is not an A paper prospect.

The final niche is Hard Money. These are not typical lenders, in fact, they have almost nothing in common with traditional lenders. They are agents for individual investors, sometimes even loaning you their own personal money. The rates for this start an absolute rock bottom of about 13 percent, and go up from there. Typically there will be a front-end charge of about 5 percent of the loan amount, and a prepayment penalty of about 7%. These are loans for people with sub 500 credit scores, people with homes that have been damaged in some way and must make repairs before a regular lender will touch the property, and so on and so forth. The equity requirements are large - 75 percent of the value of the home based upon a conservative appraisal is about the highest a hard money lender would ever go, and all of the ones I'm aware of now have an absolute limit of 65%. Lenders in markets higher up the chain are in the business of making loans, and are likely to cut you as much slack as practical if you have some difficulty making payments, as they are not in the business of foreclosures. A hard money lender has no such constraint. They will foreclose on your home immediately and without a second thought. One way or another, they will get their money back and then some. WARNING! It is common practice on the part of hard money lenders to have you sign the Note and Deed of Trust "conditional" upon them finding an investor. The person signing the documents thinks the loan is done, and that their situation (usually a time critical one) is resolved, and everything is all roses now, but it isn't. They may still want you to pay for multiple appraisals, jump through multitudinous hoops, and still not give you the loan in the end. This is just their way of binding you to them so that you don't or can't go elsewhere. Not that this is completely unknown in the higher niches (in fact, some lenders market their services to real estate agents and brokers based upon this practice - people who are true loan officers learn that this is not a good idea), but it's not common, as it is here.

There are three main types of places to go to get a loan. The first is a regular lender. The second is what I call a "packaging house", although in practical terms it is very similar to a regular lender. The third is a broker or correspondent. Each has their advantages and disadvantages.

A regular lender is what you think of when you think of a bank. Most of the big names are regular lenders. They typically have their own offices, often mingled with other banking functions. They have their own funds, wherever they've gotten them from, and they have executives and such that put together their own loan programs, complete with criteria for approving or not approving a given loan. These people do loans with at least the possibility of keeping them in mind, and some do keep every loan they do, while others sell almost every loan. The good news is that they'll typically be slightly more willing to make exceptions around the edges (whether or not the loan is a good one for you!). The bad news, from the consumer point of view, is that they consider you a captive from the moment you walk in the door. Even if they know of another lender with better pricing or a program that suits your needs better, they're still going to keep you "in-house". And their loan pricing is such that it's going to pay for all of the salaries and benefits for all of the people in the office, and the beautiful office itself and all of its contents.

A "packaging house" is like a regular lender except that they do their loans with the explicit intention of selling off every single one, either immediately or a few months down the line. Practical difference to consumer: there's a 100% chance you're going to end up making payments to someone else. In other words, no big deal. Packaging houses are lending their own money - they are not brokers. The difference is that a traditional lender is at least set up for long term servicing - the packaging house is not. Some sell immediately, some wait for one payment (better price in the secondary market), some wait three payments, as this gets them an even better price when they sell the loan. This is nothing to fear. The original lender recently sold my own home loan. The only difference is that now I write the check to company B instead of company A, and mail it to place X instead of place Y. California has stronger consumer mortgage protection laws than the federal government, but there are laws in place nationwide for the consumer's protection that avoid payments being unjustly marked late because your mortgage was sold.

A broker is not lending their own money, but is being paid instead to put the loan together and get it to the point where it is funded, at which point they are out of the picture. A packaging house could, in theory, decide to keep a particular loan - there is no legal impediment. They just don't do it. A broker doesn't have this option - it's not their money being loaned, but instead that of a regular lender or a packaging house. On the down side, a broker has somewhat less leverage to get underwriters to make exceptions to the rules (although the difference is academic for those outside this narrow range). There is also a lot of variation on quality. You'll find the very best loan officers in the country working as loan brokers - and the very worst, as well. On the up side, a broker always has at least the ability to get you a lower price than the other alternatives, although they may not have the willingness. Correspondents are a cross between brokers and packaging houses. They've got multiple providers like brokers - but the company also has a line of credit they use to fund your loan so they receive the secondary market premium rather than merely whatever yield spread there may be. They're still putting your loan through a particular lender's underwriting and funding program, but they fact that they initially fund your loan themselves allows them to act more like a direct lender.

The first reason for this is that a good broker shops many different lenders to find the program that's priced best for you. This is less important but still very noticeable at the A paper level (A paper had pretty standardized rules) then it is for borrowers whose situations (either through credit, or through needing to do something A paper doesn't support) need to go to markets lower down on the totem pole. A traditional lender or packaging house puts you in the program they have that they feel is the best fit - they won't go outside the company. A broker may shop fifty lenders or more to find the one program at the one lender that fits you best. Second, I (as a broker) get better pricing from the lenders, either regular or packaging house, than their own loan officers. Why? Partially because they're not paying my support expenses - office rent, furnishings, support staff salaries, etcetera. Mostly because it's my customer, and I can and will take my customer elsewhere if they don't give me the best possible deal. As a broker, I am never held captive by any single lender, and they know it, and they know I know it, where once a member of the public walks into their office, they consider you "captive" business, whereas at any point in the process, I can take my paperwork back from the lender and take you to someone else. Used to be, I usually didn't even need you to fill out anything new. That has now changed with the new Home Valuation Code of Conduct which means appraisals are no longer portable (What? You thought it was for consumers?).

Still, I do have the option of moving the loan, so they give me better pricing than they give you, and they don't play games because I've got more business every week that they want, whereas they're not going to see you again for a couple years, if ever. The upshot is: every week when I do the family shopping, I hit three or four supermarkets all competing for my business within a mile and a half from my home. Because of this competition, I can save pretty good money buying the things that each market has good sales on, and if the quality at one market isn't so hot on some sale merchandise, I will get a pretty good price at one of the others. Mortgage brokers work on the same principle. I do the running around and quality check for you, and because this is what I do for a living, I can spot the bad stuff a lot easier than you can. When I do my grocery shopping, I always make a point of checking what the banks in the supermarkets are offering on their mortgage deals, and I always smile because I'm always getting somebody a better price on the same loan from that same lender.

Caveat Emptor

Original here

My article Debunking the Money Merge Account Scam has been getting a lot of attention and a large amount of hate mail lately. The scamsters that sell these things love to send me hate mail for exposing the fact that their particular emperor has no clothes.

Here is the bottom line: The only benefit these programs actually get is about two weeks temporary reduction of principal per month, based upon your take-home pay. On a $200,000 mortgage at 6 percent, that is worth roughly $4.41 per month under ideal conditions. It will pay the mortgage off approximately three and a half months early. On a $400,000 mortgage at 7%, it's worth about $11.41 per month under optimum conditions, and will pay off your mortgage a little over five months early.

They programs do not give you the right to make extra payments, and they don't save you the money that those extra payments saves on your mortgage. Anyone who doesn't have a "first dollar" prepayment penalty can do that, any time they want, for free, and if you do have such a penalty, Mortgage Accelerators and Money Merge accounts will not prevent that penalty for being levied.

What they do is charge you anywhere from $2000 to $6000 as a sign up fee for these programs, and most of them require a Home Equity Line of Credit (HELOC) as well, increasing the cost of interest of whatever money is in them. Quite a few of them also require a monthly fee that varies from $1 up to about $8. I have yet to find one of these where the numbers say that the gain is not more than offset by the fees.

Suppose instead, you spend the sign up fee on a one-time pay-down of your mortgage. Instead of paying $2000 to $6000 for this program that gets you a few bucks per month, you spend that money on a one time pay-down of your mortgage. I have yet to find a scenario where that doesn't pay off your mortgage earlier, and have a lower balance the entire time it is in effect, so that if you do refinance or sell as most people do, you're ahead of the game the whole way.

The people selling these scams love to pull the ad hominem. They accuse me of not liking the program because people on this program won't want to refinance, and there's usually something in their accusation about how I cannot sell the program. Both of these claims are nonsense. I have idiots begging me to sell these things on a regular basis, and I could sign up with any one of them and make money. I have not done so, because these programs will not deliver, and my entire method of doing business is predicated upon doing the right thing for the client, so they are motivated not only to come back to me themselves, but also to send me anyone they care about. Furthermore, people on these programs refinance almost as often as anyone else. The difference in the numbers these programs make is a lot less than saving an eighth of a percent off the actual interest rate, and I can prove it. If I have a refinance that saves them money starting the day it happens, they're going to sign up just the same as anyone else.

The only effective selling tool these con artists have to sell these programs is the appearance of free money. They assume that the money for extra payments comes out of some hyperspatial vortex. They do generate a few dollars per month in interest savings through temporary payment reductions, but as I covered above, you're better off using the sign-up fee to pay the balance of your mortgage down. Any extra payments that do get made don't come out of a hyperspatial vortex - they come out of your checking account, which comes from your paycheck. Such money for extra payments is then not available for other things, whether it's a vacation, a new car, an alternative investment, or just blowing the money down at Joe's Bar. The extra money is the same, and you have the exact same right to use it to pay your mortgage down faster with or without one of these programs. If you have it extra to pay down your mortgage, you can do so regardless of whether or not you have paid the sign-up fee for one of these scams. If you don't have the extra money, then obviously it's not going to get paid to your mortgage, is it?

In fact, one of the things these folks never mention is that the entire question of whether to pay off your mortgage faster is an open one, subject to a lot of variables, and the numbers in most cases argue that you should not. If you can make more with an alternate investment than you save by paying your mortgage down, the default answer is going to be that you should go with that alternate investment. Since average return over time of bonds and stocks and other possible investments is considerably higher than the six percent interest of your average mortgage, with federal and state deductions for mortgage interest paid lowering the effective cost of the mortgage further, it's silly to pay down your mortgage faster unless there are other factors. A mortgage accelerator may actually lock you into that when there are better, smarter, more profitable alternatives available. Finally, even though paying your mortgage down may be the alternative best in line with your current situation and plan for your life, paying any kind of sign up fee or monthly maintenance for such a program is a waste of money when you have the perfect right to make those payments on your own, for free, at any time you choose. Any fee you are thinking about paying for one of these things is a waste of money. You are better off putting that fee towards a one time direct pay-down of your mortgage.

Caveat Emptor

Original article here

I have a landlord, that is always harassing me every 2 weeks, for the past 2 years, on the upkeep of the property, and wants to have inspections. Also want me to mail them all their mail. Most of which is Bank stuff. I am fed up, and thinking they are under a Owner Occupied Loan. Is there a way I could find out? And who do I complain to, if I decide to?

It is a misconception to think that just because someone moves out, they can no longer have an owner occupied loan.

In fact, the typical owner occupancy agreement that is required in order to get owner occupied financing is only a twelve month occupancy. When I buy or refinance today, I agree to live in it for twelve months in order to get those rates. After I have met that requirement, I can move out, rent it out, and there is absolutely nothing wrong with it. That loan contract is in effect, I have lived up to all of my obligations as far as owner occupancy, and I can keep that loan as long as I maintain my end of the other parts of the contract. It is fraud to claim I'm living there, or intend to live there, for those twelve months if I do not actually live there, but once I've met that twelve month occupancy requirement I can go live in Timbuktu so long as I get my loan payments in on time, properly insure and maintain the property, pay taxes in a timely fashion, etcetera.

Now it is possible, as I discovered once upon a time, that if you have an owner occupied loan with lender A, that same lender may refuse to give you another owner occupied loan on a different property. In this case, it was refinance the loan on the other property, or accept a second home loan on property A. But notice how, even then, the lender did not force them to refinance despite the fact that they hadn't lived in the other property for years. They just offered the owner the choice of accepting a slightly less favorable loan (Second home financing, still much better than investment property) or refinancing the existing owner occupied into another occupancy type. Or, being brokers, we could submit the package to another lender. There are circumstances where each of these three possibilities may be the best choice. The lenders do not share this data between each other; indeed, my understanding is that they cannot legally do so. It was only applying for a second owner occupied loan from the same lender that brought this on, and not every lender even does this much. If thirty year fixed rate loans are the only type you ever apply for, it is theoretically possible to legitimately have a new owner occupied loan starting each and every time you have met the minimum time for owner occupancy for the previous lender. In extreme cases, it might be possible to get upwards of twenty owner occupied loans all in force at the same time, while having honored your contractual requirements for each and every one.

The minimum owner occupancy requirement can be different. One year is by far the most common, but there is no reason that I am aware of why it cannot be longer, if that is what is specified in the contract. However, I do not know of any lenders that requires you to refinance or requires you to pay a surcharge if you move out once you have met the required period of owner occupancy specified in your Note.

Caveat Emptor

Original article here

With the down payment presenting the largest difficulty for most people want to buy right now, I am covering every base I can think of as a place to get a down payment. I have covered VA Loans, FHA loans which require a relatively small down payment, and Municipal first time buyer programs, some of which can take the place of a down payment. There are also seller carrybacks and lease with option to buy. There's also the traditional "Save it over time", and in some circumstances, you can also borrow from your retirement accounts or even take a withdrawal. You can even Sell Some Stuff. But there is at least one more entry to the pantheon.

Most people don't think of it, but a personal loan is one of the ways to get a down payment quickly. It has some notable drawbacks, but it can be done. Being unsecured, the interest rate is higher than real estate loans, and the repayment period is shorter, meaning higher payments.

A personal loan is a loan not secured by real property. Because it is not secured by real property, all the lender really cares about is the payments and whether you can qualify for their loan by underwriting guidelines including the payments for such a loan. Personal loans include car loans and student loans and just about every other type of installment debt out there, as well as personal lines of credit and even credit cards. Not all of these are a possibility for the subject at hand, which is rapidly acquiring a real estate down payment. CREDIT CARD CASH ADVANCES ARE RIGHT OUT!. But the possibility exists of borrowing enough to get a down payment with a personal loan.

This possibility includes both institutional loans from a bank or credit union, and "good in-law" loans from family members. Negotiate a loan contract, sign it, and be certain to disclose it to your mortgage lender on your mortgage application so that they know you're not trying to pull a fast one. The reason why mortgage lenders are obsessed with sourcing and seasoning of funds is because they don't want an undisclosed loan, which might mean that you cannot really afford the all of payments you're going to be making. But a fully disclosed personal loan is just like any other open credit. It has a repayment schedule, maturity date, etcetera. The mortgage lender looks at the situation, including the loan that got the down payment, according to lending guidelines, and if it appears you have the income to make those payments, they will approve the loan.

The major and irrefutable drawback to getting a personal loan for the down payment is that it impacts debt to income ratio. You have to account for the fact that you owe this money, and you are obligated to make those payments, and therefore, you cannot afford as big a real estate loan as you otherwise could. Since most people try to stretch their budget further than they should anyway, this can be a deal-killer. It can force you to buy a less expensive property than the one you have your heart set upon, or even than the property you could otherwise afford, at least by debt to income ratio. Of course, if you don't have a down payment, you can't buy the property of your dreams either. But if you buy a property, especially while the market is down, leverage can mean you will be able to buy the property of your dreams much sooner and much easier, or in plain words, buying the less expensive property is smart if that's what you can afford now. Of course, if you've got more than enough income but no down payment, that's the situation where getting a personal loan for a down payment is a serious possibility. Say you're a doctor who just spent the last two years paying off your student loans ahead of schedule. You've got a great income, but you spent everything on getting rid of that debt, and as a consequence, you don't have much for the down payment, right when it will do you the most good.

It is possible, for some people who have a large down payment but are nonetheless getting a loan from somewhere (most likely a close relative), for the loan to be a subordinate real estate loan. This happens mostly when Mom and Dad are rich and doing estate planning. They loan Princess (their daughter) and her Darling Husband some money to make it easier to buy, often planning to forgive the debt in accordance with federal gift guidelines. Note that the thing controlling it here is that lenders have guidelines that set maximum comprehensive loan to value ratio (CLTV), or the ratio of all loans secured by the property to the value of the property. Even though they may be in first position, lenders may not be willing to loan when there's another loan behind theirs on the property if the CLTV is higher than underwriting guidelines allow. It is necessary to make certain that the lender you apply with will permit any other contemplated loans. And even though Mom and Dad may be intending to forgive Princess' loan in accordance with gifting schedules, Princess and Darling Husband still need to have an official repayment schedule on the loan and those putative payments must be taken into account on the debt to income ratio.

One more thing I should mention is that if you're going to do this, the personal loan needs to be in place before you apply for the real estate loan. Contract signed, funds dispersed, at least one payment made, preferably two or more, and preferably reported to the major agencies. Failure to do any of these is a potential failure point for the real estate loan. The only exception is if you're trying for a subordinate loan, and the lenders have been especially unforgiving of that lately. I've had people I did the primary loan with a private money second previously, unable to refinance even with the same lender. Yes, this means that if you can't get the real estate loan, you still have this loan which you didn't want. This whole idea of personal loans to get a real estate down payment is risky and has downsides. It is not something to try if you have a better alternative, and not without careful scrutiny of all the numbers beforehand, and even then it can fail. It is a risk.

I must emphasize this again: DO NOT TAKE A CASH ADVANCE ON YOUR CREDIT CARDS!. Unless you have credit limits in the multiple hundreds of thousands, your credit score will plummet, and you will be unable to qualify for the loan no matter how much income you have. I will bet a nickel that someone will email me saying that they "did what you said," and that now they cannot qualify for the loan because their credit score is in the toilet. If you write me with such an accusation, I will drag you down to the zoo, where I will arrange for the elephants to do a line dance on your sorry carcass, and the rhinos to use what is left as a target for both ends. Taking a personal loan for a real estate down payment is playing with fire. If you're going to do it, make certain to follow lender and loan officer instructions exactly and carefully. There are a number of other pitfalls, that may not be as bad as the credit card cash advance but will still sink your loan. Getting a personal loan for a mortgage down payment is the mortgage equivalent of a circus high-wire act - one wrong move and the whole thing is a disaster where people get crippled for life even if they aren't killed outright. Having the numbers be right for it is not a common occurrence. But if the numbers are right, and you and your loan officer are careful, it can work.

Caveat Emptor

Original article here

If you don't know the answer to this, don't be embarrassed. Lots of alleged professionals forgot the answers to these questions for several years, if indeed, they ever knew. It seems like quite a few still don't know the answer

Loan qualification standards measure whether or not you can afford a loan. By adhering to them, the lenders both lower the default rates and have some assurance the loans they make will be repaid, while borrowers avoid getting into situations where foreclosure is all but certain. Lest you misunderstand, this is a good thing for both the lenders and the borrowers. It isn't like the lenders want to stand there like the Black Knight shouting "None Shall Pass!" They want to loan money - that's how they make profit. But unless you live in a cave, you may have heard of some problems with defaulted home loans of late. You may have heard they're a major problem for both the lenders and the borrowers. Guess what? They are.

From the lender's standpoint, of course, the important thing is that they prevent loaning money to people who can't afford to repay the loan, but the other isn't a trivial concern. Even if they get every penny back when they foreclose, foreclosures are still bad business, with negative impacts on cash available to lend, regulatory scrutiny, and not least important, business reputation.

Going through foreclosure is no fun from a borrower standpoint either. I don't think I have ever seen or even heard of a situation where somebody ended up better off from having gone through foreclosure than they would have been if the lender had just denied the loan in the first place. So whether you like it or not, the lenders are doing you a favor to decline your loan when you're not qualified.

There are many loan qualification standards, but the two most important ones are debt to income ratio, often abbreviated DTI, and loan to value ratio, often abbreviated LTV. The first of these is much more important than the second, but both are part of every single loan.

Debt to Income ratio is a measurement of how well your monthly income covers your monthly payments. It is measured in the form of a percentage of your gross monthly pay, averaged over about the last two years. The permissible number can change somewhat depending upon credit score in some situations, and with enough in the way of assets in others, but the basic idea is you can afford to be paying out 43 to 45 percent of your monthly income in the form of fixed expenses - housing and consumer debt service. You can cancel cable or broadband internet, you can cancel your movie club or book of the month - but the items debt to income are concerned with are essentially fixed by your situation. You owe $X on student loans, and you're required to repay so many dollars per month. Your mortgage payment is this, your pro-rated property taxes are that, your homeowners insurance and car payments and credit cars are these others. There's no possibility of this money suddenly disappearing - you already owe it, and you are obligated to repay on thus and such a schedule.

Loan to value ratio is not a measure of whether you can afford the loan. It is a measurement of how likely the lender is to get its money back if you do default. With appraisal fraud and similar problems, it's not any kind of a magic bullet - but it is the best they have. When values are rising quickly and holding onto a property for six months generates a 10% profit, it shouldn't surprise anyone that the lenders are willing to take more risks with loan to value ratio than they are in the reverse situation. Many properties have lost value and even if the borrowers had kept up the payments before default, they would still owe more than the property is worth.

Lenders aren't going to refinance on good terms if you're "upside down" or even close to it. But being upside down is not a big problem so long as you have a sustainable loan situation and can afford your payments. You keep making those payments, eventually you are going to have equity again. You try to get another loan after default and foreclosure, and you'll find out in a hurry that lenders are not forgiving. Kind of like the Wild Bunch in a way - mess with one, you mess with them all. Lots of folks are thinking that the smart thing to do is walk away when you're upside down. Even if they do have a non-recourse loan, they're going to find out soon enough that wasn't so smart. Making the payments on a sustainable loan lowers the balance, and values are going to come back - sooner than a lot of people think. Put the two together, and as long as you can hold out until you have equity again, you're better off making those payments.

These standards do, and always have, arisen out of "cut and try". Experience really is the best teacher - unfortunately getting that experience has a habit of being kind of rough. Experience may also be what you get when you didn't get what you wanted - in this case, a satisfactorily paid loan - but the lenders have regulators after them, and those regulators are sensitive to political pressures, and sometimes regulators won't let lenders do something they really do want to do - like loan money with a level of qualifications regulators look askance at - because if the lender makes enough bad loans, even if they survive financially, the regulators may decide they're doing something they shouldn't, and shut the lender down for predatory lending practices. It takes a long time and a lot of evidence to persuade lenders and regulators to relax standards, while a comparatively few bad experiences will have them toughening standards. Over-tightening lending standards has major bad effects upon everyone, including causing foreclosures that would not otherwise have happened, but it's hard to point to any specific victims and there's always idiots with a political axe to grind who will claim the people hurt by over-tightening standards were themselves victims of predatory practice. Right now, both lenders and regulators have been royally burned, and so they don't want to assume any risks they can avoid. This will likely change within a couple years, but for now, that's the way it is. You can learn what you need in order to qualify and get your loan approved, or you can go without. Right now, most lenders are too paranoid to care that having their standards too tight means they lose profit, because they've been burned too much, and the money they have in their accounts is not at risk from having made bad loans. When they make between six and eight percent per year on a successful loan, out of which they have to pay taxes, employee wages, facilities costs and everything else, a one in 100 chance of losing the entire investment to a bad loan is unacceptable, and although the default rates on newer loans is practically zero, they're still working through the bad stuff made during the Era of Make Believe Loans.

Caveat Emptor

Original article here

The easy, general rule is that legitimate expenses all have easily understood explanations in plain english, they are all for specific services, and if they are performed by third parties, there are associated invoices or receipts that you can see.

Let's haul out the Mortgage Loan Disclosure Statement (California) or Good Faith Estimate (elsewhere), and go right down them line by line. Now, to be certain, it's the HUD 1 form that's really definitive, but if it's not on the earlier form it shouldn't be on the HUD 1.

Origination is not a junk fee. It can be excessive, but it is a real fee to pay a real service. Relating to this is Yield Spread on the HUD 1, which is what the lender will pay the broker for a loan on given terms. Origination plus yield spread plus line 808 (Mortgage Broker Commission) is what the loan provider makes if they are a broker. If they're a lender, they make a lot more, and they can hide it more easily. Yield Spread and Origination and Broker's Commission are disclosed on the HUD 1, while the price on the secondary market is not disclosed anywhere, and if you're talking to a direct lender, they don't have to disclose Origination or Yield Spread because there may not be any; they can decide to be paid entirely off the premium the loan sells for in the secondary market - and then they tell you you're buying it down from there with discount points. This is why I keep telling people to shop for loans based upon the terms to you. If you evaluate it on the basis of loan provider's compensation, a broker who has to disclose compensation of $4000 is going to look like a worse bargain that the direct lender who does not apparently make anything but turns around and sells your loan for a $25,000 premium. In this example, the broker's loan is likely to be about a point and a half to two points cheaper to you, but if you evaluate it on the basis of who has to tell you how much they make, you lose.

This has gotten an order of magnitude worse this year as the new 2010 Good Faith Estimate treats Yield Spread (for brokers) as a cost and requires it be included in the computation of costs. It isn't a cost at all - it's now money that actually reduces your cost. But bankers used political contributions and connections to require it to be done that way, thereby making a direct lender loan appear more attractive than it is when compared to a broker originated loan by someone who doesn't understand this - which is to say the vast majority of the American population. Nor do direct lenders have to so much as disclose how much they are going to make selling the loan on the secondary market. The politicians have deliberately obscured actual cost to the consumer in favor of aiding one class of loan provider over another. I'm planning an article that directly compares the exact same loan done on a correspondent or direct lending basis versus a broker originated loan.

Loan Discount Fee is the fee you pay in order to get an interest rate lower than you would otherwise be offered. It is not junk, but you probably don't want to pay it, as most folks never recover the money they pay to get the lower rate via the lower payments and interest rate charges. Note that you are actually getting something for your money - lowered cost of interest over the life of the loan. It's just that it takes longer than most people realize to recover the money you spend upfront. I never pay discount points for anything except a 30 year fixed rate loan that I'm going to keep at least ten years.

Appraisal Fee is not junk. There is an appraiser who needs to get paid for doing the appraisal. Before this year, many times this got marked PFC on the MLDS/GFE, to make it look like a given loan provider was cheaper than they were. Make no mistake, there's going to be a figure in the range of $400 associated with it eventually, but because it's performed by a third party, the loan provider could (and usually did) pretend it doesn't exist as part of the charges until you have to pay it.

Credit Report is not junk. It's not free to run credit, you know.

Lender's Inspection Fee is usually (not always) junk. You're paying the appraiser. If you're smart, you're paying a building inspector before you buy, and the lender often makes you do it even if you don't want to. Every once in a while, there's a home with a documented pest or structural problem that the owner wants to refinance, and that's where this comes in as non-junk.

Mortgage Broker Commission/Fee: Is all a part of how the broker gets paid. Around here it's origination and yield spread, but this could be part of what a broker gets paid. Origination plus Yield Spread plus this line is the total of what they get paid. If these are larger at closing than when you signed up, that's par for the course most places, unless they guaranteed their fees up front in writing. I do it. I know one other company that does it. Those who are members of Upfront Mortgage Brokers guarantee the total of the items that are their fees, but not the rest of the form. For anyone else, they can and most will change the numbers on these forms within very broad limits (and to illustrate with an example someone recently brought into my office, the difference between one quarter of a point and three points on a $450,000 loan is over $12,000).

Tax Service Fee is not junk, unfortunately.

Processing fee is not junk but it may be negotiable. When it's imposed by the lender, it's not. When it's imposed by the broker, it's to pay the loan processor, which may be negotiated sometimes. Often, some places pretend they're not charging it, while adding a larger margin to origination or discount. It is a real fee, however.

Underwriting fee is real. Lenders charge it to cover paying the underwriters.

Wire Transfer Fee is real, because it costs money to wire money. If you don't need it, don't get it.

Prepaid Interest (line 901) is definitely not junk. This is interest, exactly the same as you're going to pay every month of your loan.

Mortgage Insurance Premium is not junk but may be avoidable.

Hazard Insurance premiums are not junk, either. This money is to put a policy of homeowner's insurance (or renew an existing policy) on the property. Lenders having been burned a few times in the distant past, the insurance policy needs to be in effect from the exact instant they commit their money - half a microsecond later is not good enough for them.

County property taxes are not junk, either (darn!). If you buy during certain periods of the year (e.g. April through June in California), you'll need to reimburse your seller for property taxes they already paid.

VA Funding fee is charged by the VA on VA loans only. Not junk, but if it's not VA, it doesn't have this. As I remember, if you're 10% or more disabled this can get waived.

Reserves deposited with lender are not junk, either. They will be used to pay your fees as they become due. It isn't the lender who owes property taxes and homeowner's insurance. It's you. They're just holding the money.

Title charges: Settlement or Closing Escrow Fee is a real charge to pay the escrow company. Like Appraisal fee, this is often marked PFC, but something like $500 plus $1 per thousand dollars is common.

Document Preparation Fee is mostly real, and actually the lenders do most of it these days. When the title or escrow company need to do it, they will charge fairly steep rates (I've seen $200 for a single sheet document), but you are a captive audience unless you discuss it beforehand.

Notary Fee is to pay the Notary. It's real. It often fell into the PFC trap, previously discussed for Appraisals and Escrow, but you really do need certain documents notarized. Sometimes you can save some money by finding a less expensive notary, but this can bring up other issues, like getting everyone to the same place at the same time.

Title Insurance is real. If it's a purchase, there will actually be two policies of title insurance purchased, one for the new owner and one for the lender. This insures against unknown defects in the title of your property, and yes, title claims happen every day. Lenders won't lend without one. Title insurance is another one of those third party fees that got marked PFC so that less scrupulous loan officers could appear to be less expensive than their competition.

I'm going to mention subescrow fees here, even though they aren't preset onto the form, and are not only junk but also avoidable if your agent did their job. The title company charges them because they are usually asked to do work that is, properly speaking, the realm of the escrow company. But if you choose a title company and escrow firm with common ownership, they will likely be waived.

Government Recording and Transfer Charges are not junk. They are charged by the county, and they are not avoidable, nor should you want to. Recording fees and tax stamps (if applicable) are just part of the cost of doing business. Beware of one provider pretending it doesn't exist while another honestly discloses it.

Additional Settlement Charges. Pest Inspection is the only one on the form, and it is not junk. You want a pest inspection if you're buying the property. The lender can require it in some circumstances upon refinance.

Now, you'll notice that of the permanently etched items on the form, there's not a lot of junk, but everybody keeps talking about high junk fees. What are these, and where are they?

Well, most of the things that people talk about as junk fees aren't junk fees. These are fees like Appraisal fee, escrow, credit report, notary, etcetera. These are, incidentally, half or more of the closing costs for most loans. They may have been hidden from you on the initial form, but they're not junk. They are essential parts of the process, and if you don't see explicit dollar values associated with them, somebody is trying to lie about their fees by not telling you about all of them. It's not like you're going to somehow not pay them. They're just pretending you're not in order to get you to sign up with them.

This has diminished significantly this year with the advent of the 2010 Good Faith Estimate. The regulators may be intentionally deceiving consumers about the costs of broker loans versus the cost of direct lender loans, but they did one thing to the benefit of the consumer - if it's not on the Good Faith Estimate, there are now fewer circumstances where the lender is permitted to raise what they disclose, so there is less pretending a loan is going to be all but free and then socking people for $12,000 in closing costs.

Nonetheless things that really are junk fees are a real problem, but the reason they're not among those listed on the form is that the items listed on the form are mostly real. It's the extra stuff that gets written into the extra lines that you've got to watch out for. It was fine and legitimate for a loan officer to write "Total of lenders fees $995" or however much it was, although the new 2010 Good Faith Estimate no longer permits this. On the HUD 1, these should be broken out into separate charges, but this way the loan officer only has to remember one number. As long as they add up correctly, no harm and no foul, and it doesn't make any difference to you whether it's underwriting and document generation or spa visits for their senior management, it's part of doing business with that lender. What is probably not legitimate is to start writing all kinds of other fees. Miscellaneous fees. Packaging fees. Marketing fees. Legitimate Messenger fees should be something you know about because you need them at the time they happen. But the majority of messenger fees are the title/escrow company trying to get you to pay for daily courier runs that happen anyway. If you choose the right title/escrow combination, you should be able to avoid them in most cases.

It is also a common misconception that all junk fees are lenders junk fees. I don't impose junk fees on my clients, and I do my best to keep title and escrow from doing so. However, coming into situations other loan officers have left behind where it's best to simply go with what's already in place, title companies and escrow companies, in general, appear to impose about an equal amount in junk fees with most loan providers. This is also changing now with the new Good Faith Estimate which makes lenders and loan officers liable for the extra fees - as a result of which title and escrow companies who don't want to lose business are cleaning up their act. I have told more than one title and escrow representative that the first time I end up paying their extra fees out of my pocket will be the last dime their company sees from my clients. Multiply this by the number of loan officers in the country, and you can see that they've suddenly gotten a powerful incentive to treat broker clients, at least, honestly.

Caveat Emptor

Original here

(This is an updated reprint of an article written in February 2007. The Era of Make Believe Loans that made it easier to qualify people for inflated loan amounts ended abruptly a few days later, but the sort of thinking that set people up for later default is still with us)

Not very long ago, a woman who was impressed by my website called because she wanted to get pre-qualified for a loan. "Great!" I told her, and proceeded to ask about her income and her monthly obligations and everything else, and came up with a figure of about $220,000 that she could realistically afford. If you're familiar with San Diego, you know that that's a 1 bedroom condo, or maybe a small two bedroom in a not so wonderful area of town. With a Mortgage Credit Certificate, it got to maybe $260,000. If she bought somewhere there was a Locally based first time buyer program also, that would add whatever the amount of the program was, but the only one with money actually in the budget was a place she didn't want to live. If we went so far as to go interest only, we might have boosted the base loan amount as high as $300,000. Severe fixer houses might be had for $350,000 or so - and she had the literature for a brand new $700,000 development. She had her upgrades and drapery all picked out, too. So I tried to be gentle in pointing out that the property appeared to be a bit more than she could afford.

Was she grateful? Heck no! She then asked, "How am I supposed to afford a house with that?" She was spitting mad! She acted like I was personally standing there saying "None Shall Pass!" (about a minute and a half in). "Well, if you won't qualify me for a house, I'll go find someone who will!"

I'm sure she did find someone to tell her she could have a $700,000 loan if she wanted it. Put negative amortization together with Stated Income or NINA, and there are any number of people out there who will not only keep their mouths shut about the consequences to you, but aid and abet you in staying ignorant about those consequences - at least until they've got their $25,000 commission check. And you know, I can do that loan also, if you don't mind that real interest rate adds $100,000 to what you owe over the course of three years and the payment all of a sudden adjusts to over four times what you can afford, and you lose the property and your credit is ruined for at least ten years. Not to mention the fact that rarely do people allow the mortgage payment to go south on its own.

There is no conspiracy keeping you away from home ownership. There is no smoke filled back room deal setting the price of properties such as the one she wanted out of her reach. Lest you be unaware, here in Southern California, we haven't been building enough new housing for the people who want to live here for thirty years now. Those desirable properties are highly priced because they are scarce, and the prices are where they are because that's where the supply of such properties balances the number of people who want them badly enough to pay those prices. Notice that I did not say, "The number of people who can afford those prices." This is intentional. If you want them bad enough, there are lots of loans out there, and at the time, there were lenders eager to make them, such that you could have that dream house - for a while. But the way financing works is like the laws of physics. Specifically, like gravity. It's there, all the time, pulling away, and there is no analog to the ground that holds us up. Think of it as an very tall elevator shaft going both directions from where you start. This month's interest is gravity, pulling you down. What you're paying is like the upward thrust of a rocket, pushing you up. When you make an investment (and a property is an investment), you want to go up, but if pull down is more than thrust up, you start going down instead. Furthermore, we are talking in terms of acceleration, not just velocity. If down is more than up next month, too, you're now going down even faster. And so on and so forth.

But the elevator shaft is never infinite going down, and now ask yourself what happens when you're going down, at a speed you've been building up for months and months, and the elevator shaft ends? I've been watching old cartoons on TV sometimes, and I've noticed that they usually don't show Wile E. Coyote's impact any more, but what just happened to you makes the time he got caught under the anvil, the lit cannon, and the huge falling rock look like a love tap.

Real estate agents don't set prices. The market does that in accordance with supply and demand. In southern California, there's twenty million plus people demanding housing and not enough being built. You want to change this, take it up with politicians. All buyers agents can do is try and find the best bargain out there, while listing agents are trying to get the most possible money.

Your budget is your budget. You make what you make. You spend what you spend. Your savings is what you have saved plus what it has made. You can afford more for a home if you make more, spend less, save your money, and invest it effectively. If you don't do these things, you can't afford as much. Indeed, most people kill their budget voluntarily, by spending more than they need to. It isn't my opinion that matters, or anyone else's. All of these are cold hard numbers. You know what you make, you know what you spend. If you could do better, that's something for you and your family to work with. All a loan officer can do is work with the numbers as they are.

These numbers give the payments you can afford and your down payment. The rates are what they are. The variations in available rates are smaller than most people think. Actually, the largest difference in rates and their associated costs is how much the loan providers want to make for doing your loan (and whether they will admit it). Not the only difference, but the largest one. The second largest difference is in finding the loan program that is the best fit. When you put all of these factors together, if you come up with variations of more than half a percent for the same loan at the same cost, then I will bet money that either the higher quote wants to gouge you badly, the lower rate is not quoting something they can really deliver, or possibly both. The point is this: If someone working with real numbers says that you can afford $X, any pre-qualification or pre-approval you get that's more than about 5% different should set alarm bells ringing.

So now let's revisit Ms. Eyes Bigger Than Her Wallet. She thinks all she has to do is say "Abracadabra!" and the whole thing will work out. But the interest rate is what it is, which means the monthly cost to have that loan is fixed - if she didn't bump it up by wanting something she can't afford. That lender is run by some pretty smart people, who understand all of this extremely well. They have the assistance of some very sharp lawyers in writing those loan contracts. One thing I can absolutely guarantee is that if they don't get their money - all of their money - you will be even unhappier than they are. The upshot is that the vast majority of the people who think they're solving their problems with a wave of some magical wand and the phrase, "Abracadabra!" are in fact doing something Unforgivable to their own financial future, roughly equivalent to pointing that magic wand at their own finances and mangling the pronunciation to "Avada Kedavra"

Caveat Emptor

Original article here

People always assume they'll be able to refinance later. Even most of my articles have it as an implicit assumption.

But what if you can't refinance later?

There are situations where it happens. Many situations, as millions of people are finding out now. When I originally wrote this I was getting large numbers of search engine hits from people who were looking to refinance into another negative amortization loan, but Wall Street had figured out that they weren't good investments by then. Currently, it's due to over-reaction to losses that were,at the root, the lenders and investor's own fault - but the practical upshot is that millions of people who should be able to qualify to buy or refinance cannot. But people don't pay attention to most real estate problems until they're smacked in the face with a cold haddock. With a half million dollar investment on the line, this is roughly equivalent to pigs following a swineherd to the slaughterhouse, but people still do it.

It is one thing for an investor who can afford to lose the entire investment to make a bet on the future of the market. If they win, they win. If they lose, the investment may be gone but they've still got a place to sleep for the night. It was a calculated risk where the dice came up snake eyes. Never any fun to have happen, but survivable. Furthermore, in order to be able to win, it must be possible for you lose.

It is something entirely different to counsel someone to make a bet they cannot afford to lose. If the consequences of a losing bet include homelessness, bankruptcy and might as well be permanent damage to your credit rating which makes it impossible to get started again, that's a different category of bet.

Real Estate loans, done wrong, are a "bet the farm" type bet - on something that nobody involved in the decision making process can control. Not the consumer, not the loan officer, and definitely not the real estate agent who says, "I know someone who can do the loan, and the Payments will be affordable.

There are several things that can prevent someone from successfully refinancing. Some of them may be somewhat under consumer control; most of them are not. These include:

Time in line of work: You can change employers and not fall afoul of this, but changing from employee to self-employed (or vice versa) can mean you don't qualify. Changing careers because the economy means there's no demand for what you used to do is also a turndown for at least two years - potentially forever if the new career doesn't make enough.

Documentation of income can mess you up more than anything else, often for the same reason that time in line of work does. You were getting a regular paycheck and a W-2, now you've gone to self employed, the clients have been a little slow in paying, and you've been very certain to take all of the legal deductions on your tax form. Good for your tax bill, not so hot for your ability to qualify for a loan, particularly if you've had to put more than usual on credit. Once again, the interest expense for business items may be deductible, but it can also put a huge crimp in your debt to income ratio. Not to mention that stated income loans are no longer available anywhere I'm aware of, making life difficult for the small business owner who wants to buy real estate.

Changing from owner occupied to investment property can sink you, particularly with a loan to value ratio over 80 percent. Your employer says you can keep your job, but you've got to move to Timbuktu, which means you can't live here any more, and because you can't live here, you no longer qualify for "owner occupied" loans

Loan guidelines change over time. This one has been a killer problem for a lot of folks of late, as when I first wrote this, guidelines had tightened more in the previous few months than they loosened in the previous ten years, and it's continued to the point where it's gotten ridiculous. No more stated income, no more 100% conventional financing, no more 95% conventional financing (I am currently aware of exactly one lender who will do it, and their rates aren't the best), as neither PMI companies nor second mortgage lenders will touch it right now. The only way to go above 90% loan to value is FHA, VA, or seller carryback, and even that last may not be acceptable to some lenders, and when you refinance most carryback sellers expect to be paid in full. The down payment assistance programs are dead. Even if you are one of the folks who still theoretically have significant equity, you may not be able to refinance into something sustainable.

Then there are market problems. If the property has lost value from when you bought, you may owe more than the property is worth. For quite a while I;ve been writing about what a pain it is to refinance when you're upside down, as well as the fact that it's not likely to be an improvement over what you've already got, even with Fannie and Freddie's 125% refinancing program.

I wrote Losing Property Value with Highly Leveraged Properties in March 2006 (updated just a few months ago), when people were still in denial about the problem, or thinking it was somebody else's problem. But the problem is always a possibility, and it's no respecter of anyone's stress level. Life is what happens while you're making other plans.

With this in mind, at least for your own principal residence, you want to have a sustainable, fully amortized loan in place, with a fixed period of at least five years. Actually, I'd be more comfortable with shorter fixed periods now that the air is out of the market. Even if we do lose a little bit more, which I don't think we will here locally, by the time three years are up, values are very likely to be at least 20% higher - and you will have paid down the loan by several thousand dollars. But most people who chose shorter fixed period loans, or Option ARMS (which have no fixed period at all) was the low initial payment allowed them to appear to qualify for the loan for a more expensive property than they could really afford. This is precisely the reverse of how it needs to be done: Figure your purchase price budget using an available thirty year fixed rate loan, and then if you want a loan with a shorter fixed period in order to save interest and closing costs, you still want to stay within the same purchase budget, not choose a loan because that's the only way you can afford the payments on this property that's way beyond your budget. Lest you now have figured it out yet, that's a recipe for personal disaster of a sort that takes many years to recover from, and some people never do recover from it.

For this reason, having an unsustainable loan, where the payments are going to adjust to something you cannot afford later, can change the answer to "Is it a good idea to refinance?" from "No - the available tradeoffs between rate and cost don't save me any money (or don't save enough)" to "Yes - I need to move to a more sustainable loan, and if I don't do it now, I may not be able to qualify later." If the market value of the property may be ripe for deflation, if your employment or income may become unstable or undocumentable, if your payments are predictably going to adjust to something unaffordable within two to three years - in all of those situations I have advised people that refinancing may not put them into what appears to be a better situation now, but if they wait, their current loan is going to become unaffordable and there is a serious chance they will not be able to qualify for another loan when it does. Sometimes the situation can be as simple as loan guidelines are likely to tighten up later - I predicted the demise of 100% conventional financing as a consequence of market deflation almost five years ago. Being temporarily "upside down" on your mortgage or having insufficient equity to refinance well under current guidelines is not a big deal if your loan is a fixed rate fully amortized loan, or even a medium term hybrid ARM. The loan is in place, on terms that you can handle. You keep on making those payments, your lender is happy, your pocketbook can handle it, your loan balance decreases, and prices will come back - sooner than a lot of people think, in the current media hullabaloo. In a year, or two, or three, you'll have equity, be able to sell for a profit, your job or income will be stable and documentable again, and the rough patch will be behind you. It's what happens when you need to refinance now and can't that gets folks into trouble.

Caveat Emptor

Original article here

One of the things that always seems to be aiming to confuse mortgage consumers is advertising based upon whether the loan is fixed rate, and for how long.

First, I need to acquaint you with two concepts: amortization and term. The term of the loan is nothing more than how long the loan lasts. How many months or years from the time the documents are signed until it is done. At the end of the term, the loan is over. In some cases, the payoff schedule (or amortization) will not pay the loan off in this amount of time, leaving you with a balance which you must pay off at that time. When this happens, it is known as a "balloon payment."

Amortization is the payoff schedule. In other words, if the term was long enough (it isn't always) how long would it take you to pay the loan off with these payments?

There are four basic types of home loans out there. The first is the "true" fixed rate loan, the second is the "true" ARM, or Adjustable Rate Mortgage, the third is the hybrid, which starts out fixed but switches to adjustable, and finally, the Balloon.

"True" Fixed rate loans have the interest rate fixed for the entire life of the loan. Loan term of a true fixed rate loan is always the same as amortization period. Until you pay it off or refinance, the rate never changes. They are most commonly fixed for thirty years, but are fairly common in fifteen year variety, and widely available in 25, 20, and even 10 year variants, and the 40 year loan is one of those things lenders bring in and out of availability depending upon how badly they need it to sell loans. The shorter the period, the lower the rate will be in comparison to other loans available at the same time, but the higher the payment, as you have to get the entire principal paid off in a much shorter period of time. I seem to always use a $270,000 loan amount, so let us consider that. Making and holding a few background constraints constant, when I originally wrote this the rates from a random lender for a thirty year fixed rate loan was 6.25% at par (no points, no rebate). The 20 was 6.125, the 15 year 5.75. The 15 sounds like a better deal, right? But where the payment on the 30 year fixed rate loan was $1662.43, the payment on the 20 year fixed rate loan was $1953.88, and the payment on the 15 year loan was $2242.11 So you may not be able to afford the payment on the 15 year loan. (This particular lender didn't have 25 or 10 year loans.)

Some thirty year fixed rate loans are available with interest only for a certain period, usually five years, and then they amortize over the last 25 years of the period. Some people do this because they expect a raise in their income over the next few years, and some just do it for cash flow reasons, planning to sell or refinance before the end of the fifth year. Using the example in the preceding paragraph, this would have you making a monthly payment of $1406.25 for the first five years, then $1781.11 for the last twenty-five.

If there is a pre-payment penalty on a thirty year fixed rate loan, it is typically in effect for five years. Considering that over 50% of everybody will refinance or sell within two years, and over 95 percent within five, this is an awfully long time for a pre-payment penalty to be in effect. Practically everyone with a five year pre-payment penalty is going to end up paying it.

"True" Adjustable Rate Mortgages, or ARM loans, are adjustable from day one. The interest rate is, from the time the loan starts, always based upon an underlying rate or index, plus a specified margin. There is no fixed period whatsoever on a "true" ARM. This makes them in general hard to sell, because people cannot plan their mortgage payments, and except for the Negative Amortization loans sold on the basis of a temporarily low payment, these loans have always been very rare.

(If someone offers you a rate that appears way below market rates, like 1%, they are offering you a Negative Amortization loan. The 1% is a "nominal" or "in name only" rate, the real rate on these is month to month variable from the start based upon an underlying index, making this a "true" ARM.)

If there is a prepayment penalty on a "true" ARM, it must therefore be for a longer period than the fixed period, which is zero. You are taking a risk that you will have to pay a pre-payment penalty because the rate did something that you did not anticipate, and you may not be able to afford the payments if the rates change but the penalty is still in effect.

Rate adjustments on ARMs can be monthly, quarterly, biannually, or annually, with monthly being most common, including for every Negative Amortization loan I've ever seen.

The third category is the hybrid loan. Hybrids are often called Adjustable Rate Mortgages, and most loan officers are really talking about hybrids when they discuss ARMs. You should ask if uncertain, but in general, everybody from the lender on down calls them ARMs (I myself almost always call them ARMs), but when you get down to the technical details, they are a hybrid. Hybrids start out fixed rate for a given period, then become adjustable. The overall term of the loan is usually thirty years, but the forty is more likely to be available for hybrid ARMs than for fixed rate. Unlike Balloons, if you like what they adjust to, you are welcome to keep hybrids for as long as they fit your needs. There is no requirement to refinance a hybrid after the fixed period.

Hybrids are widely available with 2, 3, 5, 7 and 10 year initial fixed rate periods, and they may also be available "interest only" for the period of fixed rate at a slightly higher interest rate. Two years fixed is typically a subprime loan, and while five and seven and ten year fixed periods are available from some subprime lenders, they are more commonly "A paper" loans. Three is common both subprime and "A paper". Once they begin adjusting, "A paper" typically (not always!) adjusts once per year, while every hybrid subprime I've ever seen adjusts every six months.

WARNING: I often see hybrid loans advertised and quoted as "fixed" rate loans, and you find the fact that they are hybrid ARMs buried in the fine print somewhere. Yes, they are "fixed rate" for X number of years. But this is fundamentally dishonest advertising. This is one of the reasons I keep saying that any time you see the words "Fixed rate," you should immediately ask the question "How long is the rate fixed for?" Please go ahead and ask, for your own protection. Ethical loan officers know that people get sold a bill of goods on this point every day, and so they're not offended. And you don't want to do business with the unethical ones, right?

Now, I am a huge fan of hybrid loans myself. When I originally wrote this, I went so far as to say that I would never have a thirty year fixed rate loan on my own home unless the rates do something economically unprecedented. Well, that has now changed due to the stringency of qualification requirements and how people's economic circumstances can change to make it impossible to qualify for a new loan. You get a lower interest rate because you're not paying for an insurance policy that the rate won't change for thirty years, without jacking up the minimum payment to something you may not be able to afford. Most people voluntarily abandon their thirty year interest rate insurance policy (also known as "Thirty year fixed rate loan") within about two years anyway. So why would I want to spend the money for that policy in the first place, when I'm likely to only use two or three or five of those years?

Nonetheless, particularly with subprime loans, you need to be careful. I have seen precisely one subprime loan in my life without a pre-payment penalty, and I've seen a lot of loans (at least thousands, maybe tens of thousands - I wasn't counting at the time - where your average real estate agent has seen maybe a few dozen, and your average bank loan officer maybe a few hundred). Many loan providers, even "A Paper" loan providers will stick you with a three or five year pre-payment penalty on a two year fixed rate loan. Why? Because it increases their commission. So if you take one of these loans, you will have a period of time when you don't know what the rate will be doing, but if you refinance or sell during that period, you will have to pay your lender several thousand extra dollars. This puts many people on the horns of a dilemma - whether to keep making payments they can't afford, or pay the pre-payment penalty. The bank wins either way.

One final point about hybrid loans. Once they adjust, they all adjust to the same rate plus the same margin. Unless you need the lower payment to qualify for the loan, it makes no sense to pay three points to buy the rate down on a five year hybrid ARM (or anything else) when it takes eight to ten years to recover the cost of your points. Why? Because you'll never get the money back! When the rate adjusts on the loan you paid three points for (IF you keep it that long), it goes to the same rate as the loan where they would have paid all of your closing costs. Judging by the evidence, most people don't understand this.

The final category of loan that I'm going to discuss here is the Balloon. This is a loan where the amortization is longer than the term. So if the amortization is thirty years, you make payments "as if" it were a thirty year loan, but since the actual term of the loan is shorter, you will have to sell, refinance, or somehow make extra payments to pay it off before the loan term expires. The thing I don't understand is that Balloon rates are typically higher than the comparable hybrid ARM, despite the fact that you either have to come up with a large chunk of cash at the end or sell or refinance prior to that. This makes them a less attractive loan. Furthermore, pre-payment penalties are every bit as common. Balloons are widely available in five and seven year terms with thirty year amortization, and I've seen three and ten, as well. Probably the most common "balloon" loan, though, is for those who do a fixed rate second mortgage, where the best loan available is usually a thirty year amortization with a fifteen year balloon. Since over half of everybody has refinanced within two years anyway, and 95 percent within five, the fact that it's got a fifteen year balloon payment just doesn't affect a whole lot of people, and it shouldn't scare anyone off.

WARNING!: I have seen Balloon Loans mis-advertised in the same way as I talked about with hybrid ARMS a few paragraphs ago. I regard this as even more misleading than advertising hybrid's as fixed. Unfortunately, many states do not have good regulations on rate advertising, and in many others, enforcement is lax. When a loan provider advertises, the entire game is to get you to call, and then control what you see and what you learn from that point on. Your best protection from this is to talk to other loan providers. Shop around, compare offers, tell them all about each others' offers. If something is not real, or it has a nasty gotcha!, if you talk to enough people, somebody will likely tell you about it. If you only talk to one person, you're at their mercy. Even if you somehow ask the right question to discover the gotcha!, the people who do this have long practice in distracting you, or answering another question that somehow seems similar enough that you let it go.

Caveat Emptor



Original here

Everybody knows that you want the lowest rate, and everybody knows that you don't want to pay any money you don't have to, in order to get it. However, not everybody makes the connection that it is always a tradeoff between the two. At any given point in time, each home lender has its own set of tradeoffs in place.

There are two components to the costs of a loan: Closing costs and points. Points have to do with the cost of the money. Closing costs relate to the work that has to be performed in order to get the loan done. These are not junk fees, although junk fees do happen.

Let us consider for a moment the home loan. You want to buy a home for your family, but don't have enough cash. Without somebody willing to loan you the difference, you cannot buy. You check with your family, your friends, your neighbors and they're all tapped out (or say they are). But there's a bank over there willing to loan it if you meet their terms.

The banks are not being altruists, of course. They're making a good chunk of change for doing so. But you would not believe the amount of complaints I hear out sympathetically about how this evil horrible bank is charging all this money and making people jump through all these hoops to get this money ("They want a pay stub! Actually they want two pay stubs! What is the problem with these nazis?"). Fact is that this bank is doing you a favor, risking hundreds of thousands of dollars on you so that you can own a home for your family. They are doing something for you that all of your friends and family were unwilling or unable to do: loan you the money to buy a home. I'd say that puts them pretty high on my "nifty list", not "Nazis", but it's your life. When you think about it, they're doing you a favor by making certain you can afford the payments on the loan (It's more than many agents and many loan officers will do), as well as insuring that if something goes wrong and you can't afford the loan, they'll get most of their money back. Real Estate is not sold on a whim. Just after the market peaked, another agent in my office had a listing of an $800,000 home. The family involved makes about $60,000 a year. Their interest alone was 76% of their gross pay, never mind property taxes and insurance. An unscrupulous agent sold them the house based upon the ability to flip it whenever they wanted, and found them a similar loan agent to get them a negative amortization loan so they've got about fifteen hundred dollars a month being added to their mortgage and they still can't make the payment. But real estate is not like stock; you can't sell it at will. The market cooled just a little bit. They lost their entire investment before they even came to us, and they came to our office to get it sold before worse things happened, and we did everything that could be done, and still nobody wanted to buy it until the price was reduced.

There's a lot of this out there. You would likely be amazed at the loans a competent loan officer can still qualify people for, and that if you understood what you were getting into, you'd drag them into the sunlight and run a wooden stake through their hearts before running away, instead of believing them to be your friend. I'd have gotten an extra client a week, at least, if I didn't sit down with the people to find out what they can really afford before I showed them the $800,000 house that's going to get me paid a Huge Pile Of Money, when I really should be telling them about 2 or 3 bedroom condominiums, or even telling them to continue renting. It's hard to get a client enthusiastic about a 900 square foot 2 bedroom condo when someone else is showing them a 5 bedroom 2800 square foot House! With It's Own Yard! No Shared Walls! and telling them they Know Someone Who Can Get The Loan! Well, I could have gotten them the loan, too, if they really wanted it, but it really doesn't help them if they can't make the payments. The world will catch up to those other agents and loan officers, and I put a certain value on the good opinion of the man in the glass.

Getting back to the issue of closing costs, there is work that has to be done before you get your loan. The people who do that work are entitled to be paid. You don't work for free. They're not going to work for free. As I have covered elsewhere, realistic closing costs without junk fees are about $3400, and can easily be higher. The bank is not just going to absorb these costs because they're going to make money off the loan. They have money, and if you want them to loan it to you, you need to meet their conditions.

Each home loan, whether the lender intends to sell it or not, has a value on the secondary market. They also cost the lender a certain amount (they have to pay for all money they lend, whether by borrowing or by opportunity cost). Based upon these two facts, the lender sets a level of discount points or rebate for each rate for each type of loan. When you pay discount points, you are actually paying the lender money in order to buy a rate that you would not otherwise be able to get. When there is a rebate, it means that the lender will pay out money for a loan done on those terms. A rebate can be thought of as a negative discount, and vice versa. Whatever the level it is set at by the lender, there's going to be an additional margin so that the broker or loan officer can get paid, even if the loan officer is an employee of that lender. This margin is not necessarily smaller by going direct to a lender - actually a broker usually has a better margin than that lender's own loan officers. As I say elsewhere, the supermarket banks often have their best rates posted, and I'm usually getting someone a better loan (lower cost/rate tradeoff) with the same lender.

But within a given type of loan, the lender always sets the loan discount higher for the lowest rate. The lower the rate, the higher the discount and the higher the rate the lower the discount. Choose the lowest rate, and pay not only closing costs but the highest discount as well. Whether it's coming out of your checkbook or being added to your mortgage, you are still paying it. Choose a somewhat higher rate, and there will be no discount points, just closing costs. There's a name for this rate where there's no points but no rebate; it's called par. Rates below par involve discount points, rates above par will get you some or all of your closing costs paid by the bank or broker.

Many people will want the lowest rate; after all that has the lowest payment. But it is (or should be) the client's choice, not a choice made for them by the loan officer. It's actually easier to qualify for lower rates, because the payment is lower. However these lower rates can be costly, because the fact is that the median mortgage age in this country is about two years, and fewer than 5% of all loans are more than 5 years old. This means there's a 50% chance you've refinanced (or sold and bought a new home) within two years, and over 95% within 5 years. The exact numbers vary over time, but I see no reason for these consumer habits to change. Furthermore, I'm a consumer, and so are you. There are people who bought a place and paid off their 30 year loan and now own the property free and clear, but they are rare these days. Much more common is the person who bought their house in the 1970s, has refinanced ten or twelve or fourteen times, and now owes ten times the original purchase price. More common yet is the person who's on the third, fourth, or fifth house since then. You might be one of the first group, or you might not be, pretend you are, and be hurting only yourself. It's likely to be a costly illusion.

Let's look at three different 30-year fixed rate loans. All of them start from needing $270,000 in loan money. Rates are lower now than when I first wrote this, but the comparison of results is still valid.

Loan 1 gets a 5.5% rate, but has to pay two points to get it, so his loan balance starts at $270,000 plus $3400 plus two points, or $278,980. He paid $8980 to get his loan. Loan 2 gets a 6% rate at par, and his loan balance starts at $273,400, because he only had to pay $3400 to get the loan. Finally, Loan 3 chooses a 6.5% loan where all closing costs are paid for him by the bank or broker. His loan balance starts at $270,000.

Your first month interest with Loan 1 is $1278.66, and principal paid is 305.36, on a payment of $1584.02. Loan 2 pays $1367.00 interest and $272.17 principal with a loan payment of $1639.17. Loan 3 is going to pay interest of $1462.50, principal of $244.08, and have a total payment of $1706.58. So far, it's looking like Loan 1 is the best of all possible loans, right? But look two years down the line when 50 percent of these people have refinanced or sold:

Remember, the original balance was $270,000. Loan 1 has paid $2130 less in interest the Loan 2, while Loan 3 has paid $2301.92 more. Furthermore, Loan 1 has paid down $7728 in principal, while Loan 2 has only paid down $6921 and Loan 3 still less at $6237. It's really looking like Loan 1 was the best choice.

But remember, 50% of all loans have refinanced or sold within two years. When you refinance or sell, the benefits you paid money to get stop. But the costs to get those benefits are sunk on the front end, and you're not getting them back. Look at the balance of Loan 1. The person who chose this still owes $271,251 - $1251 than they did before they chose the loan in the first place. Furthermore, his balance is $4773 higher than loan 2, and even though he paid $2130 less in interest, he's still $2643 worse off. Furthermore, whether he refinances or sells and rolls the proceeds over into a new property, the new loan is going to be for $4773 more money than Loan 2's new loan. Assume everybody got a really fantastic new loan at 5%. Loan 1 is going to have to pay $238 more per year to start with in interest expense for his new loan, simply because his remaining balance on the old loan was higher. Loan 3 is in even better shape than Loan 2. He's paid $2301.92 more in interest, but his balance is $2715.99 lower, for a net benefit over loan 2 of $414, not to mention that his interest costs on his new loan will be almost $136 lower simply because his starting balance is lower.

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

At this point, Loan 1 has saved $5353 in interest relative to Loan 2, while Loan 3 has spent $5783 more. Loan 1 has cut his balance difference to $3535 more than Loan 2, so he looks like he's ahead! Furthermore, Loan 3 is really lagging, having paid $5783 more in interest although the difference in balance is only $1660 to his good.

Well, loan 2 is ahead of loan 3 pretty much permanently at this point. Assuming all three refinance or sell and buy a new property with a 5% loan right now, Loan 3 is only going to get back $83 per year of the $4122.80 he's down relative to Loan 2. Especially considered on a time value of money, that's permanent. But despite Loan 1 being ahead of Loan 2 right now, Loan 2 will get back almost $177 per year. Ten years on, assuming a ver low 5% rate, loan 2 is back to even, and most of us are going to be property holders the rest of our lives. Consider also that 95% of the people who chose loan 1 NEVER got this far - they never broke even in the first place.

The point I'm trying to get across is that money you roll into your balance hangs around a very long time. And you're sinking potentially many thousands of dollars into a bet that most people lose. Yes, if you keep the loan long enough, the lower rates (at least for thirty year fixed rate loans) will pretty much always pay for themselves, several times over in many cases. The other point I'm trying to make is that most people don't keep their loan long enough for the benefits to pay for their costs to get those benefits.

As a final consideration, consider what happens if one year later interest rates are one-half percent lower. I can get Loan 3 the same loan that Loan 2 has for zero cost. He's got the same interest rate as Loan 2, whom I can't help right now, but a lower balance - neither one of his loans cost him anything. And it has happened that the rates dropped down to where I could get someone 5.5% on a thirty year fixed rate loan for zero - lender pays me enough to pay all the closing costs. Net to them, zip. Suppose rates do this again. I call Loan 2 and Loan 3, and now they've both got 5.5 %, but this doesn't help Loan 1. Now Loan 2 has the same as Loan 1, while only adding $3400 to his balance to get it, as opposed to Loan 1 adding nearly $9000, and Loan 3 has the same loan without adding a dime to his balance. Who's in the best position?

Caveat Emptor

Original article here

The short answer is not only "yes" but "damned straight"

I refinanced my house, and the lender put as one of my payoffs my Acura lease that I have 3 years left, whick equals about $19,000. I told him that was a lease and not a credit card, and he said he would take it off. I'm supposed to get my money tomorrow wired to me, but when he sent me a good faith estimate to sign today the Acura lease was still there. He said I would have to take it like that cause he forgot. I'm not gonna pay $20,000 on a 3 year lease left for a 30 year fixed rate refi!!! In the end I will have paid over $40,000 for a car I will only have for 3 more years. Can he do this to me? I need the money and signed everything else??? Please help

The first thing you have to understand is that THE most important measure of whether you can likely afford a loan is your debt to income ratio. If you make $5000 per month gross and you have to pay $3000 of it in debt service that's a 60% debt to income ratio.

Debt to income ratio is total cost of housing PLUS contracted monthly outlays divided by gross monthly income. It includes student loans, car leases as well as car purchase payments - everything you have contracted to pay out on a periodic basis. They want to measure how well you can afford to make payments out of continuing income. In the email quoted above, I see warning signs of being over-extended already.

For myself, I don't like the idea of refinancing a short term debt into a long term debt. I don't like suggesting it to clients - while debt consolidation refinance can be powerfully beneficial, there are huge traps that most people fall into. The benefits only happen if you keep making the equivalent of the same payments, and only if you keep doing it longer than the consolidated debts would have lasted. If you're doing it for reasons of cash flow, the only justification is to keep yourself out of bankruptcy. This person seems to understand that debt consolidation is generally a bad thing, but wants some cash out that they really can't afford.

That is the only reason a loan officer should broach the idea of debt consolidation. Unfortunately, it happens far too often because loan officers are paid on the basis of loan size. Larger loan equals bigger paycheck. Also, all too many consumers understand only cash flow, and that cutting their payments means they apparently have more money to spend on entertainment, travel, toys, or whatever else their personal desires point them towards.

The basic challenge illustrated, however, is that in order to qualify for the loan, this person does not make enough money - or hasn't proven they make enough money - to satisfy the underwriting guidelines on debt to income ratio. In plain English, they cannot afford the loan they are contemplating. Perhaps they could afford it if they only had the home loan, but they have car payments, car leases, student loans, credit cards, and installment payments on other goods as well. All of these are contracted monthly outlays. You must continue to pay them.

(Believe me, you don't want to tell a prospective lender you want to stiff existing creditors! They don't take it well)

The homeowners nonetheless want the money. The email didn't say why, but I strongly suspect it's a desire rather than a need. So the loan officer is trying to find a way to get it to them by qualifying them for the loan. It's within the context of serving the client's perceived "needs", and yet it rarely serves client interests. There are damned few loan officers who reflexively use this kind of red flag as a reason to sit and and consider whether the client real interests are served by the loan; after all, if the answer is "no" they don't have a loan and they don't get paid. I try, and I usually find out later that they got a worse loan from someone else because they didn't want to tell me they appreciated my concern but wanted to do it anyway. Nonetheless, if loan officers supposedly have a fiduciary responsibility (and we do) it should be an obvious requirement for situations where the client may be compromising their long term ability to afford the loan. I doubt the results of the Era of Make Believe Loans would have been so devastating if consumers in this situation had some mandatory protections in the form of counseling on the effects of getting this money. This is one thing that should have been done in response to the overextension of credit to so many homeowners, and wasn't. Might have something to do with the fact that the big banks make large campaign contributions, while homeowners, not so much.

There are tricks that enable the lowering of debt to income ratio, and debt consolidation is the chief of those. It has perils for the consumer, but it does exist. By spreading the principal payments over 30 years (and usually by lowering the interest rate), debt to income ratio can be greatly lowered. This gets the loan approved, which means the consumer gets the money they want and the loan officer and their company get paid. Win-win in the present tense. All too many of these, however, sabotage that homeowner's financial future - it just takes a while for that to be apparent.

Keep in mind, the question is not "Do they owe this money?" They do. There is no question about that. Nor are their existing debts the moral responsibility of a real estate loan officer. The question is whether a way to restructure the debt exists that both qualifies this homeowner for the new loan they want, and does not unduly compromise their financial future. The question for the lender and the underwriter, however, is even more concrete: Does the new loan or loan structure comply with underwriting guidelines such that there is a reasonable expectation of future payments being made on time? That is the bottom line. If the projected monthly payments are too high, the answer to the question is "no", so people go looking for ways to lower those monthly payments and change the answer to "yes."

A $500 car payment that would have been paid off in 3 years may add only $100 or so to a real estate loan payment. If the homeowner makes $5000 per month, that cuts their debt to income ratio by about 8% right there. For a loan officer, 8% off Debt to Income Ratio is a huge amount, and I've seen situations where debt consolidation cuts 20% off a Debt to Income ratio. When 45% is the cutoff, consolidating debt can make a huge difference in a homeowner's ability to qualify. The trick is for it not to lock the consumer into a situation where a year from now they've got to have a new car to get to work because the old one disintegrated, and there's just no way they can afford it. The lender and underwriter do not care about that. They care whether the projected monthly cost of housing plus debt service is within guidelines.

I don't know by how much, but its apparent this person is in that kind of situation. They want the money, but given their other debts, they can't afford it without consolidating their other payments into the loan. The homeowners have the right to refuse, but then the lender has the right to refuse to fund the loan. It is a strict quid pro quo: cut your payments by this much (in addition to whatever other underwriting requirements there may be) and we will fund your loan. Don't, and we won't. While declining to consolidate may be the smart thing to do in many situations, most consumers decide they want whatever benefit the loan has enough that they decide to do what the lender requires. It is the homeowner's choice, but the bottom line is that if you want the loan in such a situation, then yes you have to do it.

Caveat Emptor

Somebody asked me about a deferred payment mortgage for a purchase. The long and the short of the story is that they don't have any cash to put down, and they can't qualify for the payments under any kind of reasonable debt to income ratio.

A few years ago, in the era of Make Believe Loans, we could have gotten this person a loan. It wouldn't have been the smartest thing in the world, but we could have done it. I'm confident I would have turned him off the idea back then too, as I did many others who hated me then but may now be reconsidering. Most have figured out that the loan officers who had a policy of "just shut up and get paid for putting the loan through" were not their friends after all.

Even then, however we would have to have dealt with calculating debt to income ratio, as well as the fact that purchase money loans evaluate the property on a lower of cost or market basis, where the appraisal is the "market" and the official purchase price is "cost." Since it's the lesser of the two values that is used, there is never equity at purchase in excess of whatever down payment you make, at least as far as the lender is concerned.

A paper fixed rate loans use the fixed rate of the loan for calculating front end ratio. They are permitted to use a higher rate than actual, but not a lower one. If your rate is 6%, and they use 6.25% because the rate isn't actually locked on a $300,000 thirty year fixed rate loan, the number they will use is $1847.16. This is not an arbitrary number; it's the most important measurement of whether or not you can afford the loan. The front end ratio, which is the loan payment itself, is not generally a deal breaker if it's too high, but the back end ratio, which is the loan combined with taxes, insurance, homeowner's association, and all your other monthly debt service, is a deal breaker - as well as the most important measurement of whether you can afford the loan. Those other numbers are all fixed based upon your situation. You owe what you owe, property taxes are what they are, and you only make what you make - or actually, as far as the lender is concerned you make what you can prove you make. I've written against overstating your income from the very first on this site.

Why do they use the higher number? As insurance against available rates going higher. If rates decline and you can actually lock in something better (or for a lower cost), no problems ensue. But if that payment goes up at all when you go to lock the loan, that means the file has to go through another complete underwriting. One dollar per month or ten thousand, it makes no difference. Up is up. So to avoid that, loan officers who are not complete doofuses add a quarter percent or so to the rate they expect in order to generate a "qualifying rate" and "qualifying payment" with some room for error when the loan isn't locked. That way if things do get worse, the whole process doesn't have to start all over again. (Regular readers will understand it's really about the tradeoff between rate and cost, but a higher cost for the same rate also triggers re-underwriting, albeit focused on cash to close rather than debt to income ratio)

When you move to A paper ARMs, the allowable back debt to income ratio actually goes down, usually to 38% from 45%. Not only that, but the rate used to compute the payments is usually much higher than actual. The calculations require the use of, not the initial rate on the note, but the final, fully indexed rate on the note. They use current rate for the underlying index the ARM is based upon, plus the rate margin. Say the initial loan rate is 5.25% but the underlying index is at 4.75% plus a margin of 2.25%, they will use 7% for the purposes of determining whether or not you actually qualify for the loan. In the $300,000 example above, this means they'll use $1995.91, even though the actual rate and payment is lower - and due to lower maximum debt to income ratio, the ceiling on what you can afford at a given income level will be lower. Depending upon the lender, they may even add a bit of a margin to that qualifying rate. This makes it significantly harder to qualify for an A paper hybrid ARM than a fixed rate loan, even though the rates and payments are lower, and is certainly one reason why there aren't more of these loans out there. Nonetheless, this procedure they use for qualification does mean that someone who manages to qualify should be able to afford whatever the payment eventually adjusts to.

One of the reasons subprime loans got so popular was that they stopped using this method of determining whether an applicant qualified for the loan. The subprime lenders started qualifying applicants based strictly upon the minimum initial payment, despite the fact that they knew good and well that the payment was going to adjust upwards at a known time. Even if the initial payment was "interest only" or negative amortization. They just assumed that the people would get raises, be able to refinance with increased equity, or just be able to lift themselves up by their own bootstraps, or something else equally hope based. Three strong verses of "Kumbaya" would have been about as intelligent, but it worked so long as Wile E. Coyote didn't look down. It shouldn't be a surprise to anyone that this is one of the reasons why subprime crashed so hard, especially in conjunction with stated income loans. Because this made it absurdly easy to qualify for a loan, especially a larger loan than people could really afford, subprime loans were ridiculously popular for a while, even among people who should have been able to qualify for A paper had they limited their budget to what they could afford. When the adjustments hit, it was predictable as gravity that those folks who qualified subprime couldn't make their payments. When the market values stopped rising so quickly that they supported serial refinancing, it didn't take very long for large scale problems to emerge. In the overall scheme of things, subprime loan qualification was good for real estate agents who wanted easy commission checks, irresponsible loan officers, and people with the sense to cash out of the market while things were still going crazy. For the people who applied for subprime loans, not so much.

You should want to qualify with the toughest standards you can meet, preferably A paper full documentation, and even the A paper ARM standards if you can, but this concept was a little bit difficult to get across to the people who already had their hearts set on a property that was way too expensive for them, especially when everyone else is encouraging the speculative atmosphere. It got to the point where newspapers were running articles on "What's a fair margin over index for negative amortization loans," when the correct response would have been, "RUN AWAY."

The whole situation is enough to make you understand exactly how many people outsmarted themselves in pretty much the same wise as the people pictured in this clip:

Unlike the fictional characters portrayed, however, the consequences for borrowers who get in too deep does not end when the director yells, "Cut!" You might want to bear this in mind when figuring out exactly how much loan you can really qualify for. Even the subprime lenders who survived have now figured it out, proving that even the silliest English Knight ("Ca-niggit") can learn when the pain gets bad enough.

Caveat Emptor

Original article here