March 2007 Archives

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 it's 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. Quite recently, 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 qualify you 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 get 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 can get them the loan, too, if they really want 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 staying in business.

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 the cost because they're going to make money off the loan.

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 in this country is about two years, and fewer than 5% of all loans are less 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. 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. 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:


Interest paid

Principal Paid


Interest difference

Balance difference

Net $
Loan 1







Loan 2







Loan 3







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.


Interest paid

Principal Paid


Interest difference

balance difference

net $

Loan 1







Loan 2







Loan 3







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

I just went out looking at properties for clients. It's still a very strong buyer's market. From the showing attitudes I got, though, you'd think it was still 2003 and sellers were lords of the earth, not in a buyer's market where competition for buyers is fierce. One wanted two hours notice. Another wanted four. Two others another wanted twenty-four. Another was "make appointment," and one was even "property shown with accepted offer," which added a little humor to my day - but caused me to un-check it from my list of properties to view, and this won't change until that does or the asking price goes so low that my clients can't help but get a deal. Can you say, "Pig in a poke?" I'm pretty certain that's not the message the owners wanted to send, and their listing agent should have explained it to them. You want me to recommend my clients buy something sight unseen, it had better be priced for the worst case scenario. Sixty to seventy percent of comparable properties is about the most I might consider.

Ladies and gentlemen, when I'm scouting properties I want to go now. I have the time now, the properties are on the active list now, which means they are hoping to attract buyers now. If I print a list of fifteen properties to scout, that's because there's something that drew me to them now - not yesterday, not tomorrow. I go scouting where and when I have a need - a buyer's desire - and time. Sometimes this happens on not much notice. Always, there's the possibility the property gets withdrawn, expired, canceled, or goes pending between now and tomorrow. The kinds of properties I'm looking for are susceptible to all of these. I used to try printing out my lists day before - and it wasted so much of my time that I stopped. My time is valuable - I've only got 24 hours per day, same as everyone else. You want my attention in the form of eyeballs and footprints checking out your property, you'll make it easy for me to do so. Do not give me any wasted breath about virtual tours - what I'm looking for usually isn't there. What I'm looking to avoid certainly isn't there. I hope I don't have to explain to anyone reading this about photographic manipulation or a listing agent's descriptions of the property. There is no even vaguely acceptable substitute for physically looking at the property. My buyers are hiring me because they trust my judgment, and they want me to weed out the turkeys before they waste their valuable time. There is nothing so precious to my business as the time my buyers give me to show them good stuff. I have learned the hard way to go out and inspect the property myself before I take my buyers.

So when I can make the time, out I go. I choose them now, and I go now. If I leave the office at noon and have to be back at 3 pm and the optimum route puts me past your place at 1 pm, you're not getting four hour notice. If you want 4 hour notice, I'm not dropping by. I may hit your neighborhood again next week or the week after, but if in the meantime I've found my buyers have found something they like, then they're not in the market any longer and I'm not looking for them - not to mention I've still got the conflicts between the constraints you imposed and my own. One thing I guarantee you is that when a buyer wants to make an offer, it takes a spectacular bargain and a rare agent to say, "But you haven't seen this other one yet," and I'm not going to say it if I haven't seen your property myself, because by saying it, I am risking my credibility to zero beneficial effect should it turn out to not be so spectacular. Furthermore, when you're looking for half a dozen buyers, you have zero time to waste. It takes literally every second I can find, make, beg, borrow, or steal to find good appropriate properties for that many at once.

Whether you realize it or not, showing restrictions are part of the whole attractiveness of the property, and they don't help your case. Every time they cause someone like me to bypass your property, they cost you money in terms of a delayed sale and missing potential buyers. If prospective listing agents do not explain this to you, toss them out. I strongly suggest my listing clients relocate anything so valuable that they're worried about it to someplace where people looking at your property can't get to - Mom's, storage, a safe, any place you consider safe. Anything else that might wander off will cost less than making your house less accessible. With modern lock boxes, a record is made of which agents were in the property, and we're pretty darned careful about our good name - with buyers or without.

If you're so nervous that you're going to have to hover in the background, your property is a lost cause. Been there, done that. I refuse to deal with aggressive sellers or listing agents while I'm discussing a property's virtues and faults with my clients. There is nothing to be gained for either one of us. I don't have a responsibility to either the listing agent or the seller, even though the seller is paying me. I'm not going to be quiet, I'm not going to agree with you, and if I have to wait until later to discuss your property, you can bet I'm going to include overly aggressive sellers among the downsides to this property. It might give me reason to counsel my buyers to do a low ball desperation check. It won't enhance the value of your property in either my eyes or that of my clients.

This is just as much the case for the do it yourself buyer, the "phone the listing agent now" buyer, and any other sort of buyer or person with the attention of prospective buyers. Most folks act now because they want to go now, and if your property is not available to view now, they will go view other properties now. If they find one they like, you missed out. If they don't view your property, they're not going to make a good offer. Every missed opportunity is a potential buyer you're wasting, and right now, good qualified buyers are scarce, at least in my neck of the woods. It doesn't take many missed buyers to make a failed listing, and if it happens, you did it to yourself. By making your property unavailable, you raised the cost of doing business with you higher than the model match down the street with an asking price $10,000 higher. The hoops someone has to jump through to view your property are as much a part of the asking price as the dollar value you put on the listing. Restrictive viewing can cut your traffic and prospects more than adding $20,000 to the list price. Sometimes $40,000, and it can be six figures at the higher end of the market, but I'm aiming this at the average seller. So ask yourself if requiring 4 hour notice is worth that much money to you.

It's not easy to have your home always ready, I know. It's a real pain to always be on guard, never leave something it doesn't belong, never leave dishes in the drain or a full trash can in sight. If you've got a pet, particularly a dog, it's difficult to keep them cleaned up after and confined to the appropriate area every time you leave the house. May The Force Be With You if you've got children, because you're going to have to be a superhero to make it work. But even if your home isn't perfect, better that potential buyers see it in an imperfect state than that they don't see it. Agents like me learn to look past transient stuff like toys on the floor. If the buyers see it imperfect, it's possible they'll make an offer anyway. If it's likely to be a less attractive offer, it's still an offer, and you can choose to accept it, negotiate, or blow it off. Advantage: yours. If they don't see it at all, you're not getting an offer, or at least not any kind of offer worth considering unless you're desperate.

Sales is a game of inches, if not millimeters or microns. Particularly big ticket items like real estate. Sometimes sales are won or lost over incredibly trivial differences - and viewing restrictions are not a trivial difference. It's like the difference between a fourteen foot wall and an open door. Many people can't get over fourteen foot walls at all, others think it's too much effort, and still others see no reason why any effort they do make will be rewarded. So you want to present an open door to all potential buyers. Every little increase in the barriers you put in their way will cause a certain percentage of prospective buyers to not want to bother - and you'll never know if that's the one that would have made the best and highest offer for your property.

Caveat Emptor

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

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

Now, as to why refinancing tends to lower the payment: It's actually very simple: Because you are extending the period of the loan.

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

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

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

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

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

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

Caveat Emptor

Ground Floor Fixer!

General: Central San Diego, 2 bedroom 1 bath. Asking price between $175,000 and $200,000. I think an offer of $160,000 net would get it sold.

Why you should be interested: Two bedroom condo near everything, priced less than most ones.

Selling Points: Smaller units in comparable complexes nearby are actually selling in the $230,000-250,000 range.

Why I think it's a potential bargain: The ugly surfaces are putting people off. It's dated, the carpet and other floors need replacing and the walls need painting. If these folks had the money to do it, they could get a lot more money. They haven't, and so they can't.

Obvious caveats: I'm going to warn you that it's ugly right now.

Why it hasn't sold already: It is ugly. Investors buy this sort of place and sell it for $80,000 profit less $15,000 in expenses.

If you keep it ten years and it averages only 5% annual average appreciation per year: Based upon a purchase price of $160,000, the property would be worth approximately $260,000. If you held it those ten years before selling, you would net about $120,000 in your pocket (not including increased value from updates!), assuming zero down payment. As opposed to renting the $1000 per month most comparable currently available rental and investing the difference at 10% per year tax free, you would be approximately $60,000 ahead of the renter, after the expenses of selling.

Fact you should be aware of: Dark inside and needs work!

Obvious way to enhance value or appeal of property: Carpet, paint, modernize kitchen and bathrooms.

This property does appear to be eligible for a first time buyer Mortgage Credit Certificate provided your family income is not more than $82,800 or $96,600. Ask me for more details, on this or any other property.

I'm a buyer's Realtor®. I find places like this that can be gotten at bargain prices. I save you money while getting paid out of the listing agent's commission, not costing you a penny. Nor are these the only bargains I find. In order to protect everyone's best interests, I require a Non-Exclusive Buyer's Agent Agreement. This is a standard California Association of Realtors form that leaves you are free to work with other agents, but if I find the property you want, I'm the agent you'll use. That's fair, and there is no reason not to sign such an agreement unless you're an agent yourself.

Contact me: Action Realty 619-449-0723, ask for Dan or email danmelson (at) danmelson (dot) com. Ask me to find a bargain that fits you!

The Best Loan Right NOW

5.875% 30 Year fixed rate loan, 0.6 points total, and NO PREPAYMENT PENALTIES!. Assuming a $400,000 loan, Payment $2366, APR 5.947! This is not an Option ARM! This is a thirty year fixed rate loan. The payment and interest rate will stay the same on this loan until it is paid off! 30 year fixed rate loans as low as 5.25%! Zero points and zero closing costs loans also available!

Best 5/1 Loan trade-off: 5.625% 0.9 total points. Assuming $400,000 loan, payment of $2303, APR 5.721. 5/1 ARM loans available as low as 5.125%! This is not an Option ARM! This is a real loan with a real payment that actually pays your loan down, and the rate is fixed for five years!

No points and zero cost loans also available!

These are actual retail rates at actual costs available to real people! I always guarantee the loan type, rate, and total cost as soon as I have enough information from you to lock the loan (subject to underwriting approval of the loan). I pay any difference, not you. If your loan provider doesn't do this, you need a new loan provider!

All of the above loans are on approved credit, not all borrowers will qualify, based upon an 80% loan to value and a median credit score on a full documentation loan. Rates subject to change until rate lock.

Interest only, stated income, bad credit and other options also available. If you need a mortgage, chances are I can do it faster and on better terms than you'll actually get from anyone else in the business.

100% financing a specialty.

Please ask me about first time buyer programs, including the Mortgage Credit Certificate, which gives you a tax credit for mortgage interest, and can be combined with either of the above loans!

Call me. EZ Home Loans at 619-449-0070, ask for Dan. Or email me: danmelson (at) danmelson (dot) com

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 loan rate determination 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 appears to be making a comeback. The shorter the period, the lower the rate will be 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, a few days ago from a random lender 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 is $1662.43, the payment on the 20 year fixed rate loan is $1953.88, and the payment on the 15 year loan is $2242.11 So you may not be able to afford the payment on the 15 year loan. (This particular lender doesn'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 loan (also known as "Option ARM" or "Pick a Pay") these loans are 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 becoming more common again for subprime. 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. I will go so far as to say that I will never have a thirty year fixed rate loan on my own home (unless the rates do something economically unprecedented, anyway). 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 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 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 second fixed rate 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.

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

I am not exactly certain how to start this essay. I'm kind of in a position analogous to writing Hitler's biography in late 1940. We know at this point he's a miserable excuse for a human being, but we don't have the evidence discovered in the last four and a half years of the war as to how sick he truly was.

The negative amortization loan is in a very similar situation. It's a miserable excuse for a loan, causing a lot of damage, but we don't yet know how much. With most housing market gurus finally agreeing with what I've been saying for the last year, talking about a need for a readjustment in real estate prices, we are pretty certain that there's going to be a drastic re-evaluation of the home market soon. We are missing the data of exactly how bad it's going to be.

The negative amortization loan, with all its friendly sounding synonyms (Option ARM, Pick Your Payment, 1% loan, and variations and combinations thereof), is an idea that comes around periodically, and right now happens to be one of those times. Last time was the mid 1980s, and we had people driving their cars through the lobbies of savings and loan buildings in protest after they got hit with this loan's GOTCHA! If you see ads on the Internet or elsewhere advertising "$200,000 loan for $650 per month!" (or something similar) one of these abominations is what they're trying to hook you with.

These loans look, at first glance, to be wonderful - too good to be true. That is because they aren't true. Furthermore, given the fact that loan officers and real estate agents want to get paid, and the damage isn't apparent to the average consumer until well down the line, the unscrupulous ones sell a lot of these. I can point to loan and real estate offices where they do no other kinds of loans. Why? Because given the fact that most people shop for a loan or a home based upon the monthly payment, these are the easiest loans in the world to sell, and how many homes do you usually buy from a given real estate agent anyway? Cash flow is important, but watching only cash flow ends up in Ponzi schemes, Enron, and negative amortization loans.

I want to make very clear that yield spread is not a reason not to do a given loan. If a loan officer shops around and does the work to qualify you for a better loan on the same terms while increasing their compensation, they deserve to be paid that money. But you need to do your due diligence, also. Bottom line, no loan officer or real estate agent can rip you off without your consent. Make sure it's a better loan by making an apples to apples comparison based upon what you, the client, are actually getting. For example, if one provider is getting you a loan at 5.5%, that looks to be better than 6.5% at first glance, correct? But if the first loan is only fixed for two years, and has two points on it as well as $4000 of closing costs and a five year prepayment penalty, while the second loan is fixed for thirty years and the lender is paying all of your closing costs with no prepayment penalty, I submit that the second loan is the better loan. The negative amortization loan, piece of garbage that it is, compares favorably with no other loan available today. The yield spread varies between three and four points on these things, with most of the lenders tending towards the higher end of that spectrum in order to compete. To give you a comparison, in order to get four points of yield spread on any other type of loan, I have to give people an interest rate at least two full percent higher than the going rate!

Basically, what this loan does is give you three or four options for your payment every month. The lowest of these is the bank allowing you to make a payment as if your interest rate was somewhere between one and two percent, with most of them now congregating towards the lower end of the spectrum in order to compete with one another. This low rate of 1% or so IS NOT YOUR REAL RATE. IT IS NOT WHAT YOU ARE ACTUALLY BEING CHARGED! I don't know how many people I've talked to that were being taken for a ride and asked me, "Isn't there any way this is the real rate?" THE ANSWER IS NO. Let's pretend you are a bank officer. Remember, you're one sharp person, and you have another whole group of very sharp people watching what you do. If for an equivalent amount of risk, you can get about 7 percent somewhere else with a different investment, are you going to give some poor sap I mean someone you don't know a 1% loan that messes the heck out of your quarterly usage of capital bonus? Not to mention your bosses? Not on planet Earth.

The second payment option will be to make a payment based upon an interest only loan at the real rate you are being charged. I've seen the piranha that sell these loans trying to prey on each other extolling the virtues of COFI or MTA loans, depending upon which they have. The fact is that they've each got their limitations, and their upsides and downsides as opposed to the other. The problem with each and every one of these is that they are month to month variable from the beginning. There is no period where your real rate is fixed. You will never know next month's rate until it happens. Thus far in my career, I've always had loans that are fixed for three to five years, at rates lower than this rate that the loan is really charging you. In other words, this second payment option is based upon a rate that changes every month, based upon the movement of an underlying index plus a margin.

The third payment option is to make an amortized payment based upon that same month-to-month rate. This is roughly analogous to a standard thirty-year loan, except that it is not fixed, and unless you make a payment of at least this much, next month's payment options are going to be worse. The fourth and final payment option given by most lenders who do these is for the client to make a fifteen-year payment. Before we move on, the point needs to be made that almost nobody actually makes the payment for either of these options, much less makes these payments habitually as opposed to the other options. These payments are higher, and are not good selling points for this loan. If the client could afford to make these payments, there are better loans to be had. This is a metaphorical fig leaf to cover their naked taking advantage of you. "Well, he could make (or could have made) this payment but didn't. It's not my fault." The reason they didn't make the payment, Mr. Unscrupulous Realtor, is because YOU told them they didn't have to. You SOLD them the house based upon the nominal payment, not the real cost. You got a bigger commission by making it look like they could afford more house than they really can. Unless they start making drastically more money at some point, they are likely to lose the house, and they may lose it anyway. I know you think it's not your problem, but some ex-client with a good lawyer is going to make it your problem.

Now, what happens if you make each of these payments? Obviously, if you make the payment for either the third or fourth option, you are paying your loan down. If you make the payment for the second option, that is basically a break-even, except that next months payments will be computed based upon one fewer month with which to pay the loan off.

What happens for 95 percent of the people who do these loans 95 percent of the time is they make payment option one. What happens in this case, where the client is making a payment that is less than the amount of interest on the loan for that month? The bank isn't going to just eat the difference. That interest has to go somewhere.

Where it goes is into the balance of the loan. This means the balance for your loan - the amount you owe the bank - goes up every month that you make this payment option. Furthermore, next month it earns interest also. Next month the difference between what you pay and what you are charged gets higher, and even more money is applied to your loan. You're being bit by compound interest. This is the first reason why the lenders will pay loan officers who do these loans so much. The lender knows that in the vast majority of all cases, the clients will end up owing them more money than they originally borrowed.

Furthermore, every single one of these loans that I know of has a three-year prepayment penalty. This means that even after you figure out that you've been taken for a ride, you're either still stuck with them for the rest of three years or you're going to pay a penalty amounting to thousands of dollars. Not a bad position for a lender to be in for leading you down the primrose path, is it?

I haven't even gone over recast provisions (the 1% rate, even though it's nominal, not real, doesn't last forever), and various other lurking GOTCHA!s. I hear a lot of arguments from the various lazy lowlifes who make a habit of doing these loans rationalizing what they're doing. "Those old loans had no cap. Now there's a nine percent cap" The fact is that if the client could afford six percent, there are other better loans to be doing. "They'll more than make up for it in increased equity as prices rise." Well, maybe, IF the market continues to rise, which is unlikely at the current time and never something you should bet other people's financial health upon. It's a crapshoot, at best, and the prevalence of these loans is one reason why the market is so overheated. In any event, the client is going to end up owing more money. Unless they're going to sell and not be a homeowner any more, they're going to have to pay the loan sometime, and in the meantime the longer they keep it, the worse it gets. What happens in three years if home prices are lower and the loan gets recast and now they cannot refinance out of it? Another refrain I hear from these people: "It's the only way to get them into a home!", meaning it's the only way for them to earn a commission (or, more often, the way for them to earn a bigger commission). The clients still end up owing more money at the end of the pre-payment penalty, and it'll keep getting worse the longer they keep the loan. They're still going to need to pay it back, unless they sell, and sell at a sizable profit. Furthermore, if they couldn't afford a reasonable loan in the first place when they needed to borrow $X, what makes you thing they're going to be able to afford a reasonable loan three years down the line when they owe $Y more. This is not a stable, sustainable situation for the client! Maybe in a case like this, they should continue renting. Of course, that doesn't get you a commission, does it, Mr. Unscrupulous Realtor? It certainly doesn't encourage the client to stretch beyond their means and get you a bigger commission, either, does it?

For any loan officer who does these reading this, face it: These things are a way to mess up your client who is putting money into your pocket. These put the clients into worse situations than when they started. You are betting upon factors beyond your control to save both you and them. One of these days, probably very soon, these are going to come back and bite you hard. Violation of fiduciary duty. All it takes is one of your clients getting into a bad situation who gets a good lawyer, and your career is toast along with your pocketbook.

For those of the general public reading this, I hope I've opened your eyes to some of the pitfalls of this loan. I encourage you to ask questions if you have them. But this loan is one that is designed for a narrow set of circumstances tailored around cash flow for a limited amount of time (and the one time I actually had a client who was in the situation where he could actually benefit from a negative amortization loan, none of the companies I submitted it to would approve it. This tells me that who they say it is for and what they really want are two separate things). Negative Amortization loans are abused by being misapplied because it's such an easy loan to sell to those who do not understand the way they work, and all because people shop for a loan based upon payment. So don't shop for a loan based upon payment. And if anyone offers you one of these loans, drag them into the sunlight, drive a wooden stake through their heart, and RUN AWAY! Somebody who offers you one of these is not your friend.

Caveat Emptor

Continued from Part I

Interview lots of agents. Once again, my experience is that the agents at small independent brokerages tend to be sharper than the ones at large chains, but that's only true in the aggregate, and the large chains do have lots of suckers wandering into their offices, which translates to captive audiences they can direct your way. You may be more likely to get a quick "lay down" sale with large chain, but if you don't, the agents who work the independents will almost always serve your interests better. I know that I speak most strongly against Dual Agency, but that's from a buyer's point of view. If the buyer is silly enough to go in unrepresented, as someone using a dual agent is, that's no skin off your nose. Matter of fact, it's likely to be less skin off your nose. On the other hand, many agents push unqualified buyers on their listing clients precisely because they will get both halves of the commission if it actually closes. Me, I'd want to remove that incentive. Put it into the contract that they agree to do this listing for a flat 3% contingent upon successful close, and if the buyer is unrepresented, I keep the buyer's agent commission, or all except half a percent, reasonable considering the extra work they will do (You don't want them shooing away a sucker, either). This also removes the incentive such agents have to discourage viewings by people they don't represent, sit on offers represented by other agents or not pass them on, or all sorts of other games that get played because they want both halves of the commission. So if they won't agree to work for the listing commission only, I'd advise you to cross them off your list. I'll admit this is guilt by association, but there is no way of telling that any one listing agent won't play any of the games that discourages other agents from bringing their clients to your property, which you want to get sold, and for the best possible price, not to the one who causes your agent to be paid double.

You want an agent who knows where the buyers are, and where the good buyers are. About 70% of people searching for a home start their searches on the internet, but these are not necessarily the best buyers. The ones who look in the internet are looking numbers. The ones who start by driving around your neighborhood want to live in your neighborhood. The ones who start with the monthly shill magazine are usually somewhere in between. The ones who start with the Sunday paper are vary over the spectrum from absolute sucker to moderately savvy, while clumping at the ends of it. And the ones with buyer's agents vary also, depending upon the attitude of that buyer's agent. Some of them (grin) are absolutely the most dedicated to getting the best bang for the buck there is to be had, while other agents' devotion seems to be primarily towards obtaining a large commission check soon. I actually know a couple traps for encouraging the latter sort, but pardon me if I don't share them. Some things a guy's just gotta keep to himself. It's my job!

One of the things you want to use to interview agents is how to stage your property - what to do in order to make it show better. In general, you want it to be uncluttered, have nothing in it you can't live without on a daily basis (if you're living there), and nice clean walkways and lines of sight. All of this makes it feel bigger. Some agents will tell you they hire professional stagers, while others will want to wait until after the listing contract is signed. First off, you're not going to hire the stager if you don't hire the agent. Second, what you're looking for is some evidence they really know what they're doing. It costs me nothing to walk through a property and tell you how to make it more appealing to buyer's and their agents, and it demonstrates product knowledge to someone who has no idea whether I'm the best Realtor ever or the most recent product of Shake and Bake Real Estate School. Before a good agent will do that, however, they're going to ask about your budget in time and money for staging. If your budget is less than a stager costs, it does no good to say they'll hire a stager unless they also pay the stager, in which case you're liable to be reimbursing them if the listing fails. You don't want the agent who pussyfoots around and flatters you - you want the one who tells the bald truth. This is not about flattering your ego - it's about your wallet. If your ego is more important to you than that kind of money, you're looking for the wrong professional - you want a sycophant. Your search for a listing agent is not just a fact check - it's an effort check and, most importantly, an attitude check.

You want to interview an agent for what they're going to do about publicizing your property. Most searches start on the internet, but putting them in MLS automatically or semi-automatically puts them in most of the biggest property sites, including IDX, which is the thing most members of the general public mean when they say MLS. The major difference is that IDX doesn't have information that the general public doesn't need to know, like showing instructions. Many of the larger, national houses for sale sites are based upon local IDXs. There are exceptions. I have a rule here about not mentioning specific providers, so I won't. Over seventy percent of all house hunting searches start on the internet, so even the smaller providers can be worthwhile, but it has to be some website people make a habit of visiting that site for that reason in order to predictably do you good. Agent and Agency websites are not likely a source of good traffic. Searchlight Crusade gets 4000 to 5000 visits most days, and averaged 635 this last week - almost 20,000 per month. These are far more than most agency websites, and I got not one contact from my website on my last listing, because that's not why people visit my sites. I did get traffic from the other places I advertised, of course. What I'm saying is that websites under the control of any given agent or agency are not likely to be where people go. I've got an IDX link on my site - but people don't use it that much. Even if it's Major Chain Real Estate, web searchers don't want to make a habit of going there, preferring some place "more comprehensive" or "more neutral." Individual websites such as www.1234mainstreet are a joke for selling a property. Unless they are already looking for your specific property - in which case they'll find it easily anyway - they're not going to find a "Selling my house" website. You're just not going to get very high on more general search terms unless you're darned lucky, or control another high page rank site or two. This is not to say "don't bother." This is simply to say that individual agent, agency, or "selling my house" websites are not something to pin any significant amount of hope on. If I thought was worth such hopes and likely to sell the property, it'd make a listing agent's job much easier. You might get lucky - but that's not a bet that's likely to pay off. Kind of like buying a lottery ticket. Someone always gets lucky, but for every lucky schmoe who wins the grand prize, there are forty million poor dumb schmoes out there with worthless paper. The odds for smaller websites selling your property aren't that bad - but they're not great, either. For example: I've had one worthy property on my agent radar for eight months now in case I found a buyer for it, and I just found out it's got a website. Does that website seem like something you want to invest all your hopes in? Didn't think so.

You also want to make sure your agent hits all the relevant dead tree publications. They may not be as powerful as they once were, but paper media is still important, and the buyers from there are often buyers you'd rather have, as opposed to internet junkies. Whatever the prospective agent says they intend to do, insist that it be incorporated into the listing contract if you choose them. You are betting a large amount of money upon their competence, whether you realize it or not. All they have at stake is a paycheck. You have your biggest investment on the line.

One of the reasons why you want to interview multiple agents is pricing advice. Some agents have no clue where the market really is. They'll be happy to take the listing at any vaguely reasonable price you want, or even above. But we know what happens if you overprice a property - it sits unsold. This costs money. Others will tell you it's not worth as much as it is, so they have an easier sale, but you end up short-changed. Others will take the listing at any price you say, but start arguing you to reduce it way earlier than they should. What you want is evidence. You want strong solid examples of recent sales in your market and what's out there available right now - the properties you are competing against for the available buyers. You want someone who is going to compare your property to those with a cold calculating eye. You don't want to be high on the asking price, but you don't want to be low, either. Preferably this someone will be an agent who has actually seen and been in at least some of those other properties before they sold. Compare and contrast. I know it's a lot to ask, but try to step aside from pride of ownership and approach it from a buyer's perspective. Unless you're some kind of a celebrity, the fact that it's yours means nothing to the prospective buyer.

The critical point I'm trying to make is that pricing is not easy, and the pricing discussion should be cause for some real give and take. Pricing discussions without evidence, without serious examination of the property and comparables, and pricing discussions that don't end up with as many good arguments for going lower as for going higher are likely to result in bad pricing decisions. Maybe a couple of agents get hot under the collar. Maybe you do, maybe more than once. So long as it is for the right reasons, this is a good thing. The agent who argues persuasively, even passionately, and with evidence, for setting a different listing price is likely to be a much better agent than one who accepts a listing for whatever price you want. The agent who's too high and mighty to justify their reasoning should be informed that their services are not desired, and in your snootiest English butler accent. Don't choose the agent who promises or agrees to the highest listing price. That's called "buying a listing," and it's a recipe for disaster. Pricing is part science, but part art as well, and it doesn't have to be perfect for an optimum result - just close. What you're looking for here is not only product knowledge, but attitude. The one who cites the most evidence and argues with you the hardest may be the very best agent to list with, even if they are thousands or tens of thousands below other agents. Then again, they may not. It depends upon who displays the most evidence, the most knowledge on the state of your market, and the right attitude. The agent who tells you your property is worth a little less is not your enemy. They may just be lazy, but if they can provide evidence for their contention, that's not the way to bet. They may be your very best friend in the entire world. If the market won't pay a higher price for your property, they are saving you the expense of having the property sit unsold - thousands of dollars. When is the last time one of your friends saved you that kind of money, at the risk of not getting a paycheck? They are risking their paycheck, make no mistake. Because out of every ten price discussions, six people in your shoes won't want to hear it and won't consider hiring them. Takes no small amount of professionalism to tell you anyway, don't you think?

You do want to ask about is whether an agent shows their own listings to their buyer prospects, and why or why not. I'm not talking about the people who call out of the blue about your listing, I'm talking about people they have an existing buyer broker agreement with. I would actually prefer a "no" answer, were I looking for a listing agent, but the reasoning on why is more important. My answer is that I don't unless the sellers are so desperate that they want to price that low. Most of my listings do not, the way things are, need to be priced to attract buyer's agents like me. Therefore, I'll freely admit - to contracted clients - that there are better bargains out there. I don't ever want to let my listings get that desperate that they need to attract my buyers. My job is to sell it for the best possible price as soon as possible, and if it gets that far, I haven't done either half of that job. If all listing agents had this attitude, it'd make life a lot more difficult for buyer's agents. Nor is it my job to be fair to prospective buyers when I'm listing - unless I've already got a contractual obligation towards them. If a prospective listing agent is willing to hose people they have a buyer's agreement with, that's not a good sign for how they're going to behave towards you. But absent that exception, my job as a listing agent is to get the property sold for the best price in the shortest time. I have a listing contract that spells out my responsibility to that owner - and listing contracts conquer all, as far as agent loyalties go. I can refer even my contracted buyers to someone else for negotiations, releasing both of us from obligation, if they're sure they want to put an offer in. I cannot do that for the people I have a listing contract with. Whether you are buying or selling, you should know that the seller has a right to expect the listing agent's absolute loyalty within the confines of the law. They can't lie about the property. They have to tell the truth as they know it. Beyond the reservations set down in the law, their job is to get the most money out of the quickest sale. Period. Anything else translates as a way to hose your listing clients.

No matter how good any one agent sounds, no matter how much pressure they put on you to get you to sign the listing contract right now, don't do it. There's nobody that much better than the competitors. Take your time and make your decision when there's not anybody pushing you. Unless you have a short deadline to sell, you'll come out better. If you do have a short deadline, you might want to be more intensive and more concentrated in your search, but cutting down on the number of agents interviewed is not a good response to the situation. It's even likely to be counter-productive. Don't let the agent's urgency to get the listing infect you or stampede you. Until you hire them, that agent has no reason to hurry. Their motive for building urgency is to stampede you into listing with them. Rhinos stampede. So unless you're a large blundering near-sighted herbivore with small sycophantic hangers-on, don't let yourself be stampeded.

One technique some sellers with plenty of time might consider is the short term listing. Sixty days with an agent to see what kind of traffic they drag in, sixty days for that agent to demonstrate exactly how well they look after your interests. Takes all the pressure out of choosing an agent, right? You can always change to someone else, right?

Wrong. The agents in the area with any kind of a clue are going to know that you've been through 4 agents in the last eight months. There are also complications in when a given buyer may have been introduced to the property, so which agent is entitled to the commission becomes a bone of contention. Most contracts give the agent the commission for ninety days after their listing expired, if they provided the introduction. Meanwhile, you've got someone else who now has an exclusive right to sell. It's bad business for someone to insist upon a commission they haven't earned, but I am continually reminded how many bad businesspersons are out there. If you've got to do it, insist upon some short hold over period of no more than seven days, and don't list it again until that period has expired. It may be overcautious, but it could save you being in the middle of a nasty court fight. Furthermore, this is a tactic that's completely unsuitable for people with a limited time in which to sell. Every time you change the listing agency, the promotion is essentially starting over from scratch. Finally and most importantly, most people suffer inertia. They'll renew that listing contract whether or not the agent has actually done enough to earn their business. Agents know this; that's why they propose the short term listing. It's a trap into which most people are only too happy to fall - the trap of not making a decision, or making it on the cheap, under the guise of postponing the day of reckoning. Most folks are better off getting into all of the issues right up front, and making the difficult choices. If you're really looking hard in the first place, with an eye towards committing yourself, you still may not make absolutely the best choice. But the hard choice will be better than the choice which really isn't a choice, as short term listings are. Why? Because before you commit yourself, you're going to know that agent is at least competent.

Let me go over some of the agents you might meet.

Our old friend Martin MLS figures putting a sign in the yard and the listing in MLS is enough. Most of the searches come off the internet, right? He's right as far as he goes, but that's not how to obtain the buyers who are interested in the property because it's where it is or because of something it has. That's the way you find the buyers who want the lowest price. Furthermore, if listing it on MLS was all there was to it, there would be no reason to pay your agent more than $100 or so. Martin's a rotten agent. I know, because I used to be Martin. Briefly. I know better now.

Tina Teaser uses her listings to make contact with buyers. That's what she really wants. She'll tease you with showings while talking up other properties when you're not there. Unfortunately for you, when yours goes into escrow she doesn't have any other means of attracting buyers, so she doesn't want your property to actually sell. Showings are good, but then she has a whole stable of properties she wants to show them, rather than losing her opening wedge with the buyers who really furnish her income. Unfortunately, there's no easy way to spot Tina. Only a very careful examination of her attitude when you're vetting agents, or watching her in action. If you get dozens of lookers and no offers, something is likely to be wrong. That something could be that you're overpriced, or it could be Tina.

You may remember our old friends Gary and Gladys Gladhand, who get their business by making it seem like a social obligation to give them your listing. Repeat after me: "I don't owe anyone my listing." Now repeat it over and over again until you can look into Gary or Gladys' eyes and demand, "What are you going to do for me?" With that said, Gary and Gladys can be very effective listing agents if they pass all of the attitude tests. That social pressure approach works wonders on most people. Just remember that Gary and Gladys get their pool of suckers from the same social pool you swim in, and aren't always smart enough not to poop where they eat. Most buyers aren't savvy enough to realize what Gary and Gladys did or tried to do - but it only takes one who is. You also need to be concerned about them turning into Sherrie Shark or Tina Teaser.

Billy Buy is remarkably amiable about the list price. Whatever you want to ask, he's certain he can get it. Owners see dollar signs, and sign on the dotted line. For about the first two weeks of the listing contract, you may wonder what he's actually doing. Then he walks in and starts pressuring you to drop the price, after wasting your period of highest interest. Billy's worse than a rotten agent. He's a menace, because after he's "bought" your listing, you're going to have to drop lower than the price you should have set in the first place, in order to attract the same kind of traffic and interest you should have had in the first place - if Billy knows how to attract them, which is highly doubtful. Most Billys make most of their sales after they've gotten the owners to drop price below market. Only way to spot Billy is to have that hard talk about pricing. You may not ID the agent as Billy, but you'll figure out you're wasting your time with him.


Sherrie Shark is a variation on Billy. She's okay with you setting the price too high, because once you get desperate enough, she or someone she knows will make a low ball offer and turn a flipper's profit on your property. Sherrie regards any offers that do come in for what the property is worth to be poaching on her turf - she earned this payoff fair and square by her lights. Fortunately for her, she can dismiss them as "low balls" - right up to the day she thinks you're desperate enough and springs her trap, Sherrie is also the Agent Most Likely To Pretend Offers Never Happened. Offers come in and go directly from the fax machine to the trash can - if they get printed out in the first place. This happens with just about every agent who wants both halves of the commission, but with Sherrie, it's an automatic reflex. The only way to spot Sherrie is to have all those pricing discussions I mentioned earlier. By the way, you should never sell to your listing agent. They're not a disinterested party. I know of places that advertise they'll buy your property if it doesn't sell. Once you know about agents like Sherrie, you should realize the nature of that trap. If an ethical agent wants to make an offer, they'll refuse the listing in the first place, or wait until you're listed with someone else. If you really want Sherrie's kind of low ball offer, I can bring in any number of people and save you the time and money in between listing with Sherrie and the springing of her trap, and they are even happy to pay my agency commission, so you come out ahead in every way.

Donnie Discounter may actually be the way to go in a voracious seller's market like we had three years ago. Sign in the yard, listing in MLS, and presto! It sells quick and for less commission than you would have paid. Of course, if your property is curb-appeal challenged, or if the market isn't a strong seller's market, Donnie is worse than useless, he'll be a waste of your time of highest interest. Nor will he be a strong advocate on your behalf. He doesn't really understand your market. He's just turning numbers in the computer. He isn't going to help you stage, he isn't going to do much to set your property apart, and he's definitely dependent upon internet based bargain shoppers to get his listings sold. Chances of you getting the highest practical number of dollars in your pocket: Not good. If a property sells for $510,000 full commission, you end up with more money in your pocket than if it sells for $500,000 through Donnie. Strong buyer's specialists love Donnie. He makes their clients so happy!

Sometime during this process, somebody may recommend you just sell it yourself. Possible, I must admit. Some people do a creditable job, if they prepare enough. But not likely. Most people have a deadline that's too short, and won't spend the effort required. They don't have time to prepare and they'll try to shortcut the process, in which case they either sit on the market unsold, or make some buyer's agent very happy. Listing property is a job, and it does take work. I'm learning more with every property. I figure I'll have it completely wired sometime around 2117.

Fannie Friendly isn't particularly hard to spot. She just makes you feel like you're her special friend, and that you'll be essentially kicking a puppy if you tell her know. All she is saying is give guilt a chance. Not really much different than Gary and Gladys Gladhand, except buyers are rarely guilted into buying a property. You've got what is likely to be your biggest asset on the line. Forget guilt, and forget Fannie.

There is something to be said for considering a buyer's specialist. Actually, there's a good deal to be said. However, since I am one, I won't say it. We may not be the absolute strongest listing agents, but we're definitely a long way from the worst. Even if you don't want to hire us, it can be worth a couple hundred dollars to have one of us come in and price the property.

As a closing thought, when you are listing a property, time is not your friend. Even if you have a good long time in which to sell, agents in the area are going to know that property has been on the market forever. The longer it takes to sell, the worse the price. The whole notion of "let's just see if we can get a higher price" is the most common way home owners talk themselves into getting less money than they could, and taking longer to sell, with all of the costs associated with both. If you approach it with the firm idea that you are dealing with one of the biggest investments of your life, and ask the hard questions and take the time to hash out the hard details in the first place, chances are you will end up much happier. Don't allow emotion into the decision, don't allow ego in, don't allow friendship or love or anything else beside what is likely to have the best results for you color your decision. Odds are that you will end up much happier. If you're looking for a guarantee, I can't give it to you. One of the things agents learn is that weird stuff happens. But this is certainly the way the dice will fall the vast majority of the time.

Caveat Emptor

This is the final article in this series, and the most difficult. The reason is very simple: Unlike shopping for buyer's agents or shopping for loans, you have to make a binding choice - it is in your best interest to make a binding choice - before you obtain the result you want. With buyer's agents or loan officers, you can judge by actual results - the bargain properties they show you and the loan they actually deliver when the trust deed is all ready to go. Shopping for an effective listing agent is always a leap of trust. It shouldn't be a huge leap into the unknown, but it's a lot easier to talk a good game than it is to deliver.

Now, the important thought to remember as you read this article and shop for a listing agent is this: You might get what you pay for. You won't get what you don't pay for. Make certain you understand what the level of services provided are by a given agent before you sign on the dotted line, whether their fees are contingent upon a successful sale or are paid up front with no guarantees. I wouldn't sign on the dotted line without compensation being contingent upon a successful sale. If they're not confident enough of their abilities to bet their paycheck, I wouldn't bet on those abilities either. Of course, the contingency commission will be for a higher dollar amount, but ask yourself this: Suppose you got $10,000 for successfully completing a project at work, nothing for failing. Is your motivation to get it done, and get it done sooner, more or less than if you get a flat $5000 in advance whether you complete it successfully or not? Would you be willing to put in more effort? Spend more money? Be more aggressive? I assure you that real estate agents have basically the same motivational attitude as the rest of the world.

Most people do not take sufficient account of the time critical factor: Nothing happens immediately in real estate. If you have ninety days to get the house sold, you've really only got about sixty to get an accepted offer - maybe less. Just because some loan officers make it a religion to get the loan done in 30 days or less doesn't mean it's common. I have seen many articles in financial publications advocating sixty day locks at a minimum, because so many people have been burned by shorter locks. Not only does this waste money, it gives incompetents way too much time to not come up with the loan they talked about. Based upon no other information, I will bet you money that a loan funded in thirty days or less is a better loan than one that takes sixty days or more. I'm not a gambling man. I've just seen enough of the industry to understand that I'll win way more than fifty percent of these bets. The quicker everything moves, the better off everyone is, but even in the most optimistic scenario, this means that if you need the property sold in ninety days, you need an accepted offer within sixty. If you need an accepted offer within sixty days, you need an initial offer you can negotiate within forty-five to fifty days. I just opened Escrow March 21 on a negotiation that started February 7th (all of my responses were same business day, but the other side wasn't nearly so punctual). Forty-two days is definitely on the marathon end of negotiations, but you do need to make allowances for the time it takes. Furthermore, all of your advertising (except MLS and internet) takes anywhere from three days to thirty to appear. So from the time you know you need to sell in 90 days, you may really only have thirty to forty-five days to make it happen.

You need to have figured out what your time frame for selling is. If you need the transaction done in ninety days, we've already seen that you really have about fifty at most to attract a buyer. If you have to sell in thirty days, you really waited too long to list it. If you have to sell in sixty days, you've got maybe three weeks to get an offer. If it's rented with tenants and your cash flow is positive, you don't have a real deadline, but having tenants in a property you're trying to sell raises its own issues. Otherwise, until the whole thing is finished, as in grant deed signed, loan funded, old loan paid off and you get your money and your Reconveyance, you are paying mortgage and property taxes, either insurance or homeowner's dues, and possibly several other monthly fees. To pick lower than typical numbers, on a property in California that you bought for $200,000 and has a loan for that same amount at 6%, that's roughly $1600 per month it's costing in money out of your checking account. Most folks can't add $1600 to their monthly cost of living for very long. A $400,000 property with a $400,000 loan would be roughly $3100. If it doesn't sell before your reserves run out, you've got yourself a real problem.

The absolute first thing people look at is price. If your asking price is more than people are willing to pay for a property of those characteristics in that neighborhood, the buyers and their agents are going to ignore you. In fact, your traffic will largely be governed by the relationship between your asking price and everyone else's, in conjunction with your days on market counter. Price it right in the first place, and you get lots of traffic your first days on the market. Wait until later, and you'll not only miss out on your time of highest interest, you'll have to go lower to attract the same level of interest. So if you've got a short deadline, I'd be careful to price under the market. What's a short deadline? That's determined by how long properties are taking to sell. If it's selling in three days, you're likely to be okay as long as you don't overprice. If the average property is sitting for ninety days or more and you need to have it not just in escrow but sold in ninety, I'd offer it up below the comparables were I you.

Condition can mean a lot more than square footage or number of bedrooms and bathrooms. Sometimes the first thought in my head when I drive up or walk in the door is, "It may be larger, or it may have this or that where the competing property doesn't, but I like the other place more because it looks better." I assure you that I'm not alone, and that "The buyer will be able to spend $20,000 fixing it and have a million dollar property," does not justify a $980,000 price tag in anyone's mind. Get that whole idea out of your head. If you want the money fixing it up is going to bring, do the work yourself. Price the property for its value and condition now. In other words, even if you're right, you have to spend the $20,000, and be the one to deal with the hassle of making it happen yourself, in order to get that $980,000 net. But it's hard to quantify condition. Even most agents don't look at enough properties to be certain. I'm out there looking at a minimum of twenty per week, which means I know what the ones that sold recently looked like, but if you're outside my normal stomping grounds it's going to take me at least two trips looking in your area to figure the optimum listing price. That's a cold hard truth. I see something listed with an agent outside the county or even a different part of the county, the odds are that agent has no clue what they should have listed it at. In urban areas such as San Diego, even a few miles away can be bad news. I'm not certain which is worse: an agent thinking "La Jolla" when the property is in Santee or an agent thinking "Santee" when it's in La Jolla. The former will overprice the property, resulting in the property sitting unsold, and possibly all kinds of unpleasant consequences. The latter will underprice the property, resulting in less money than you could have gotten, and usually way less net. There aren't any rules of thumb you can follow - you just have to know the neighborhoods, and even though these neighborhoods are only fifteen miles apart, anyone who tells you they know both is lying. There's too much for one agent to know. I've lived here essentially my whole life, and it takes me two "fishing trips" to neighborhoods I've known my whole life in order to start really understanding enough about that neighborhood professionally, that I can start spotting which properties are bargains and which are not. The markets change way too fast for anyone to keep track of too much area. I might believe someone could understand the entire Manhattan condo market. Doubt it, but I might, although I'd be more inclined to trust the agent who said they specialize in a smaller area. I wouldn't believe they could understand Brooklyn or the Bronx as well. Where population is less dense, which San Diego definitely is, I'd say about quarter million population, tops. Out in rural areas, probably less than a third of that. I'd want to see something that indicates your neighborhood or area is one the agent really makes a habit of working.

Your time of highest interest is right when your property hits MLS. The vast majority of buyers are out there looking at what hit MLS this week, or today, not what hit six weeks ago. The feelings I hear most buyers articulate is that the good stuff gets found quickly. This is something which is generally true - most of the good stuff does get found quickly - but not universally true. Some of the good stuff slips through under the radar. Some stuff becomes a worthwhile bargain when the seller gets real on the asking price after their deadline to sell has already passed. It may be crazy, but I've heard people talking about blowing off properties that looked like great bargains because they saw that the "Days on Market" counter was too high for their tastes. So you want to keep this in mind. Your agent is required to put your property in as quickly as possible once they have the listing contract, unless you instruct them in writing not to. If your deadline to sell is not looming too quickly, it can be a good thing to delay the actual listing until your longer term advertising is ready to appear! You don't want the advertising to appear first, but the property gets stronger traffic if the "days on market" counter says 4 when the ads appear than it does at 45 when those potentially interested see the ad.

Open houses are worth doing, but not worth doing too often. I want to do one the weekend after a property hits MLS without fail, and before that I want the neighborhood to know there's going to be an open house. When the neighbors bring you a buyer, that's a good way to sell the property for more than the typical MLS searcher. The latter is looking for a bargain. The former wants to live in this neighborhood, and already has a connection to it. I may also do an open house aimed at brokers and agents that first week, during the week, and a caravan is a good idea also - which is another possible reason to delay the listing appearing on MLS if either takes more than a few days to arrange. On the other hand, if there's an open house every weekend at Joe's house, there's no urgency. Many agents do open houses to meet new buyer prospects - that's really why they want a listing. I used to space them about four weeks. Now, I'm most often waiting at least six, and it seems to work better for actually getting interested buyers.

Broker caravans and broker open houses can help also, but the require the agent be willing to actually share the commission with a buyer's agent. If they're not, you're wasting your time, and likely turning off prospective buyers as well. If you can do these the week it hits MLS, you're ahead of the game.

If you're getting the idea that agents shouldn't list more than one property per week, you're getting the right idea. Actually, one listing per week is likely too many to service well in the current market - because if they price it right, the average property is not going to sell in three days. In strong seller's markets where things do sell that quickly, yes, one listing per week is doable. In buyer's markets where things are sitting ninety days and more on average, you are begging to become neglected with a listing per week agent unless you're paying the highest commission to your lister. If someone has more than four to six listings at any one time, I'd cross them off the my list.

Continued in Part II

The HUD-1 Form


I have mentioned this form several times in the past as the only form in the entire mortgage process which is actually required to be accurate. Department of Housing and Urban Development form 1, the so-called HUD 1 form, is required to be filed and correct for every real estate transaction. Whoever your provider is, this is the one and only form they cannot play games with. This article is goes over the form line by line, referencing previous entries.

The top section has to do with identifying information on your transaction. Your name, the name of the other party to the transaction, escrow numbers, name and address of lender, date of settlement.

The meat starts with line 100, the Summary of Borrower's Transaction, and line 100 the section on Gross amount due from borrower.

101 Contract Sales Price: Should be the same as on your purchase contract.

102. Personal property: Say you agree to pay $500 extra if they leave the sofa. Here's where that goes.

103. Settlement charges to borrower (line 1400) adds the costs of the transaction to the total.

106 and 107 are repayments for any taxes the seller may already have paid as of the date of settlement, but are not their responsibility as the time period covered includes some time after the effective date of sale.

120. Adds all the lines up to this together. The rest are simply blank lines that may or may not be a factor in your particular transaction. If they are a factor, it should be because you specifically agreed to pay them!

The 200 section is about stuff that is paid for, or on behalf of the borrower, or you have simply already paid.

201. Deposit or earnest money: The deposit you made, either with escrow (purchase) or the bank (on a refinance) to persuade them that this was a good transaction.

202. Principal amount of new loan(s): Check and make sure this matches your new Note. In some states, they may be able to combine the amounts of two loans here, but they shouldn't.

203. Existing loans taken subject to: If you're assuming a loan or something similar, it goes here.

204. Second mortgage loan: Compare against your new second mortgage amount.

205 and 206 are blank lines for things that may not be a factor in every transaction.

210 and 211 are for city and county taxes that have not yet been paid by the seller, but the cost has been incurred. Let's say today is September 1, and we're in California, where the property taxes run July 1 to June 30. On September 1, the seller owes two months of property taxes, but those taxes haven't been paid, and won't be due until November 1. So there will be a credit here from the seller to the buyer for two months of property taxes, which the seller is responsible for until the effective date of sale, but the buyer will have to pay on November 1. 212 to 219 are blank lines unless something special is relevant to your transaction.

220 is total paid by/for borrower: This is a total of everything paid by you or on your behalf.

300 Section tells if you are due money at settlement or have to come up with some. 301 is transferred from line 120, 302 from line 220. If 302 is larger, you get cash back. If 301 is larger, you have to provide the check in otder to close.

The second column is a summary of the seller's transaction, if there is a seller and it's not just a refinance.

Section 400 is about what's due to the seller, starting with 401 Contract Sales Price, then 402 which is a mirror or 102, then 403, Impound Credit, which is rarely used, as it is pretty much applicable to loans being assumed.

406 and 407 are mirrors for 106 and 107, as are 408 to 418 mirrors of the 108 to 118 section. 420, Gross amount due to seller, is a summation of all of these.

The 500 section has to do with stuff the seller is paying other people.

501 is excess deposit, 502 is settlement charges to seller, 503 is loans that are bing assumed.

504 and 505 are mortgage payoffs being made, 507 through 509 are blank spaces for things not applicable to every transaction.

510 and 511 are mirrors of 210 and 211, as 512 through 519 mirror 212 through 219, blank lines not applicable to every transaction.

Section 600 is analogous to but not mirroring section 300. Line 601 is line 420 brought down. Line 602 is line 520 brought down. The difference is line 603 cash to seller (This can be line 603 cash from seller in the case of a so-called "short sale")

All of this is good and necessary information, but The Really Good Stuff™ is all on page 2. The lines at the right list who is paying it (buyer or seller)

Section 700: division of commission

Line 701 is compensation to the listing broker, line 702 is to the selling broker (i.e. the buyer's broker, the people who "sold" the property), and line 703 total commission paid at settlement. I've never seen this paid by buyer, it's always been paid by seller.

Section 800 is items payable in connection with the loan itself. This doesn't mean that these are all the loan-related charges - far from it.

Line 801 and 802 are dollar amounts of points. If these aren't zero, divide them by the loan amount to make certain they are the numbers agreed upon.

Lines 800 through 1317 are linked on a 1:1 basis with the appropriate lines on the Mortgage Loan Disclosure Statement. In an ideal world, the total of these should be exactly what was indicated on the Mortgage Loan Disclosure Statement. There are some few items that are not under the loan officer's control (again, see the article for which are and are not). A good rule is that if it isn't on the Mortgage Loan Disclosure Statement in one form or another, it shouldn't be here. Compare it to the Mortgage Loan Disclosure Statement to find discrepancies. Other than things like prepaid interest, which the loan officer does not control but should have a pretty accurate estimate of, the most difference there should be between the two documents is one big fee gets broken down into little fees. But if you're told, for example, that the $795 amalgamation of lenders fees was broken up into A, B, and C, make sure that A+B+C=$795, and do not allow additional fees to be lumped in. Grab a piece of scrap paper and take notes. Make certain these numbers jibe. It is easy to hide thousands of dollars in unsuspecting fees to clients in this page if you, the client, are not careful.

Line 1400 is a summation of these lines.

Once again, look hard at the numbers on these two pieces of paper. It is the only honest accounting many people get of the transaction, and the fact that it comes at the end of the transaction makes hiding all kinds of things easy. You, the client, are tired of the whole process and want it to be over, a fact which many loan officers and loan providers rely upon. Put your guard up for a few more minutes, long enough to be certain what you sign for here matches what you signed up for back at the start of the process.

Caveat Emptor.

Truth In Lending and APR


The Truth-In-Lending is a form that can or does provide some useful information, but the useful information it provides is both smaller than most people think, and not in the numbers everybody looks at.

The first thing to be aware of is right below the title. "This is neither a contract nor a commitment to lend." They are telling you right there that this is an estimate. It may or may not be an accurate estimate, but most often it isn't, since it is based upon the Mortgage Loan Disclosure Statement, with all of the games that lenders play with those. It's no better than the MLDS form. Remember, Garbage In, Garbage Out. How accurate the MLDS is depends upon the loan officer and the provider they work for. Again, the relationship between this form at the beginning when you apply for the loan and the loan that is actually delivered with the final documents can be extremely tenuous.

The APR in the very first box is the result of an attempt by Congress to compress what is fundamentally at least a two-dimensional number into one linear measurement. It is intended to help give you a direct, one number measurement of the effective interest rate, given the expenses. But, in order to this it has to make some assumptions

The first of these is that you're never going to sell. Back in the early 1970s with stable secure jobs for a large portion of the populace not only in government but in private industry as well, and people living their whole lives in their first house, this was a reasonable assumption. No longer. The median time for ownership duration is about nine and a half years.

The second of those is that you're not going to refinance. This also was not an unreasonable assumption back in the early 1970's. Our habits as a society have changed since then. The fact is that the median age of mortgages (half older, half younger) is currently about two years. Only something like 4 percent of all mortgages are older than 5 years. I'll have other implications of these facts later, in other essays.

But by making this assumption, that you're never going to sell and never going to refinance (again, for the fifth time) and just make that minimum payment every month for thirty years, it allows the illusion that you're going to spread those costs out over thirty years, when the appropriate time frame is much shorter. This is a dangerous illusion. To give a specific example, because it means that, when measured by APR, a 5.5% loan with closing costs plus two points looks like a better loan than a 6 % loan with closing costs but no points. In fact, it is quite likely that the 6% loan is a better idea, and a 6.5% loan where the lender pays your all of your closing costs for you may be better yet.

Let's go through the calculation involved. Assume they're both thirty-year fixed rate loans, so you'll actually keep getting benefits as long as you keep the loan. Assume the base loan we're looking at is $450,000, the same figure I've used elsewhere. This can be either an existing loan, or a purchase where you need $450,000 beyond your down payment to cover purchase price and costs of buying.

As we computed in looking at the Good Faith Estimate, the closing costs of doing this loan are somewhere in the neighborhood of $3400 or so. But "third party" costs, such as escrow and title, are excluded from APR calculation, so we're going to deduct about half of that, or $1700, from them when we calculate APR. I'm also going to assume that you actually pay all of your "prepaid" and "reserve" items out of pocket, which keeps things simple. Your actual loan amount in the case of the 5.5% loan with two points is $462,650, and your monthly payment is $2626.89. Your actual loan amount in the case of the 6% loan is $453,400, and your monthly payment $2718.36. The third loan has a payment of $2844.31 on a balance of $450,000 even. The APRs (a complex calculation) work out to 5.685, 6.035, and 6.500 percent, respectively. Quick Side point: Loan 1 has a difference between the stated rate of less than .2 percent, despite the fact it has two full points on it as well as normal closing costs. So when you see on where the difference is more than that, it measn they're adding even more in points and fees, and that's just what they tell you to get you to sign up. Returning to the main point, looks like the Loan 1 is a better bargain, right?

Your actual interest expense the first month is $2120.48 the first month for the first loan, $2267.00 for the second loan. This is a difference of $88.34, and this number is actually going to increase for the first several years of the loan. The rest of the money is a principal payment. Equity. Money you don't owe anymore. The principal paid the first month on the first loan is $506.41; on the second is $451.36, a difference of $55.05 the first month in the first loan's favor. For the third loan $2437.50 represents interest and only $406.81 is principal. This is really looking like you make the right choice with 5.5%, correct?

But let's look at two years from now - about the age of the median mortgage. I'm going to use the loan in the middle as baseline.

Loan #

Interest paid

Principal paid

Remaining balance

Diff in int pd

Diff in bal

Net $ to you
Loan 1






Loan 2







Loan 3







Loan 1 has paid less in interest, and more in principal than Loan 2. Looks great, right? But they also paid $9250 more for the loan, or which $7912.78 remains on their balance. Remember, fifty percent of the people have sold or refinanced at this point. When you sell or refinance, the benefits for the lower rate stop. But the cost is sunk. You paid it in full two years ago. And at this point if you sell this home, you will actually have $7912.78 less in your pocket than in if you had taken the 6% loan. This is somewhat compensated for by the fact that you spent $3532.83 less in interest expense. But you're still $4379.95 down as compared to the 6%, and there's no way around that. Meanwhile, the 6% loan has more than paid for itself (only had a quarter the cost of the 5.5% loan) as opposed to the 6.5% loan by this point in time.

And if you refinance, it gets even worse. You're now paying interest on the $7912.78 in higher balance for the rest of the time you're got your home. Let's say the rate is 5% now because you got an even better deal. This means $395.64 per year, $32.97 per month extra that you're going to pay for as long as you have that loan, all for benefits that you don't get anymore and never paid for their costs in the first place. This is truly the gift that keeps on giving, isn't it?

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

Loan #

Interest paid

Principal paid

Remaining balance

Diff in int pd

Diff in bal

Net $ to you
Loan 1







Loan 2







Loan 3







At this point for loan 1, you have saved in interest and paid down more in principal, right? Yes, but you paid more for the first loan than you would have for the second, and you still owe $5860.53 of this difference. If you sell, you will get $5860.53 less to put in your pocket, although that will be more than balanced out by the interest you saved. Net profit to you of choosing the first loan: $3018.12, neglecting tax treatment. Boy did you make the right choice, right? But remember that over ninety five percent of everyone who made the same choice you did never made it to this point. Furthermore, if you're like most people and you intend to buy some other property where the transaction includes a loan, that loan will have a starting balance $5860.53 higher to start with than if you'd chosen loan number 2 in the first place. Assume you got a great rate on your new home: 5% even. This means, even if the money doesn't cost you anything in points, that you're now paying $293.03 per year in interest that you wouldn't be paying if you'd simply chosen Loan 2 in the first place. Assuming you intend to own property for the rest of your life, in a little over ten years your gain is gone.

On the other hand, you are doing safely doing better with loan 2 than 3 at this point. The difference in interest you've paid has more than made up for the difference in starting balance. Whether you refinance or sell, it's going to be difficult to make up $9638.54 with the interest based upon 659.05. Assuming 5%, this is $32.95 per year, which means it takes over 300 years to recover, and I don't know anyone seriously planning to live that long, even discounting the time value of money.

Now, if you get a great deal and refinance instead of selling, that extra $5860.53 that you still owe on that mortgage is still there, and will be for as long as you own that home. Assume you got a really great deal of 5%. This means $293.03 per year of extra interest expense - just from the fact that your balance is higher because of sunk costs to pay for benefits that have stopped. Assume you keep your home another five years, so altogether you've had it ten years since the initial loan. This has cut your gain to $1552.97.

This happens all the time. It is not uncommon for me to talk with people who bought their homes in the 1970s, have refinanced ten or twelve times, and now owe more than ten times their original purchase price, a good portion of which is directly attributable to unrecovered closing costs of the refinances. Here's the point: closing costs and points stick around, sometimes a long time after the benefits you got from them are gone, and people refinance or more often than most people admit. The only loan that CAN be ahead from day one is the true zero cost to the consumer. Everything else will pay for itself eventually, and more than pay for itself if you hang onto it long enough, but you're sinking a significant amount of money in the bet upfront, money which is going to be around in your balance a long time. Furthermore, people don't hang onto these loans as long as they think they will, and very few people hang onto them long enough to see profits from high closing cost loans. Finally, the rate at which a zero cost loan can be done varies from day to day, and by quite a lot over time. Let's say six months from now I can do a 6% loan no cost. It costs you zero, and now if you're loan 3, you've got the same loan at a lower balance than the guy who chose the 6% loan 2 above, whom I can't necessarily help right now.

Then three years down the line, rates really drop, and I can do 5.5% for no cost. A call to both loan 2 and loan 3 nets borrowers who are eager to cut their rate for zero cost, but I still may not have anything that helps 1 in the sense of being worth the cost of doing it. Now loan 1, loan 2, and loan 3 all have the same rate, but loan 3 owes the least amount of money, therefore has the lowest payment, and has the most equity in their home.

Here's another dirty little not very secret, but rarely publicly acknowledged, fact: People don't always refinance into a lower rate when they refinance. If you've been a homeowner 15 years or so, chances are reasonable that you've done it - possibly more than once. Don't worry, I'm not going to pillory you in public over it, but if you won't admit it to yourself then there's not a lot that can be done for you. People have various reasons for refinancing into higher rates, some of them reasonable, some of them relating to necessity, and some quite frivolous. But you'd be amazed at how often people looking to refinance expect me to believe stories that numbers show to be obvious fiction about how often they've refinanced a property. This is math, and if the numbers tell me you've been making payments on this loan for two years when you tell me five, I'll bet millions to milliamps that if I go check the public records that are maintained on every piece of real property in the country I'll find that Trust Deed recorded two years ago. Now, it's okay to tell some lies of certain kinds to your loan officer, and assuming that any prepayment penalty has expired, this is probably one of them. No harm, no foul. What a typical loan officer cares about is getting paid, and if you're withholding or correct information doesn't make a difference to that, there's been no harm done. A good loan officer will add, "Putting the client into a better position" to that first, paramount concern, and if the information you withheld would have resulted in a different answer to this question, you have only yourself to blame. (Looking for altruists in business is both pointless and hazardous to your financial health. Businesspersons donate huge amounts of time and money and energy to charities or other works for the public good. But we're at work to Make Money. I am very good at what I do and getting better because I want to Make More Money, and mistakes do the opposite of Make More Money). But you need to be completely honest with that wonderful person you see in the mirror every day who follows you around twenty-four hours every day, shares in all of your triumphs and joys, and has to deal with all of your mistakes for the rest of your life. Otherwise you're going to waste a lot of money on mortgages making the same mistakes over and over again.

Getting back to the actual Truth-In-Lending form, finance charge assumes you keep the loan the full term, as I have explained. Amount financed is subject to the same limitations as the Good Faith Estimate, and in fact assumes that the Good Faith Estimate is honest and accurate. So is the Finance charge. Neither of these, nor the Total of Payments, which is simply the sum of these two, is any more valid than the Good Faith Estimate this form is based upon. Do NOT use the Truth-In-Lending as a way to compare loans, numbers-wise. Many people do precisely this because it's such a simple looking, easy to understand form. But if it's based upon a Mortgage Loan Disclosure Statement that's not accurate, it means nothing. Zip. Nada. Garbage In, Garbage Out.

Nope, the minimal information provided by this form is in the details that start about halfway down.

Demand Feature: If checked, this means the lender can require that you repay the loan in full, with a certain number of days (usually 30) notice. It can also mean there's a balloon on the loan.

Variable Rate Feature: if checked, this means that at some point, if you keep the loan long enough, become a variable rate loan. I've seen loans that went as long as ten years before a variable rate kicked in, or it can be right away.

Credit Life and Credit Disability are two products that I would generally recommend against unless it's the only life or disability insurance you can get. Some states do not permit them to be a requirement of the loan - and in those cases where the lender would otherwise require one or both, you won't get the loan as a result. (On the other hand, without these state prohibitions, many lenders would require them much more often, costing consumers in the aggregate billions. Just like everything else in mortgages, it's a tradeoff with winners and losers no matter what you choose.) Both of these products typically pay any benefits directly to the lender, when you want them to come to you or your family. Buying your own life insurance or disability insurance is typically a much better idea.

Property and Flood Insurance The lender can and will require you to maintain proper insurance on the property as a condition of your loan. In California, they cannot require this be for the full amount of the loan, but they can and will require you to maintain coverage for the amount of full replacement costs - what it would take to rebuild your property as it is from the ground up. Many lenders delegate the responsibility for making sure this is done on their behalf to big administrative operations that cover the whole country, and they are ignorant of individual state law even for such major states as California. Be polite, but firm, when they tell you they are looking for coverage in the full amount of the loan. Flood insurance is a separate policy that can also be required if the property is on a flood map. The lender can either demand your loan in full immediately or purchase insurance on your behalf and force you to pay the bill if you fail to show them continuing proof of adequate coverage. FYI: by Federal Law, flood insurance coverage doesn't kick in for 30 days after you pay the premium.

SECURITY: The first box should be checked for purchases, the second for refinances. In rare cases I do see somebody taking out a loan on a home that is free and clear to get a better rate than they would on a new property they're buying, because they'll get a better rate that way. In this case, the second box should be checked.

Filing Fees are for filing the papers with the county recorder, and should be the same as listed on the MLDS

Late Charge basically discloses what your penalty for any late payments will be. It is expressed as a percentage of your normal monthly payment.

Prepayment penalty: Should tell you honestly whether there will be a prepayment penalty on the loan, but often doesn't. Says nothing about the duration of it. Forget the second line. All of the costs to get you the loan are sunk and nonrefundable from the time you sign the papers. All of the interest that you pay as it is due is gone forever. You'll never see it again. They earned it. They're not going to give it back. I've never heard of a loan where in the initial contract the borrower was promised a rebate of part of those costs if they paid off early. Banks did make a lot of offers to discount loans if you paid them off in the late seventies and early eighties, but these were offers made at a later time, long after loan papers were signed, by the banks because they were losing their shirts buying money at 14% or so when it was already loaned several years earlier to customers at 6%. It wasn't a part of the contract in the first place.

Assumption: This means that if you sell the property, the buyer can keep your loan in effect. The VA loan is the only one out there that is generally assumable by the buyer if you sell, but there are some other loans that are assumable as well. It's not usually a good idea to let a buyer assume the loan, but there may be no alternative. The reason: You can still be liable for these if you do allow them to be assumed.

Then there's a line where there are two final square boxes to check, where "* means an estimate" and "all dates and numerical disclosures except the late payment disclosures are estimates. Expect the second box to be checked. It's all based upon the Mortgage Loan Disclosure Statement, which is nothing but an estimate, and in most cases is intentionally a drastic underestimate. If they're stretching the truth on that form, the numbers on the Truth In Lending are going to be similarly distorted. And if it's not checked, that's "an inadvertent oversight" and unlikely to be prosecuted. Which is as it should be - unless there's a pattern of it, which is the case with all too many loan providers.

Caveat Emptor

(Continued from Part I)

Below the "Estimated Closing Costs" line, there are three more sections. The first is "Items required by lender to be paid in advance." These are not negotiable - they are what they are, and except for mortgage insurance or PMI, correct accounting should be the same no matter who the loan provider is. Of course that doesn't stop many providers from playing games to make it look like their loan is cheaper. Sometimes the items in this segment or the one below it may not be exactly knowable in advance, but many lenders make intentionally small misrepresentations.

"901 Interest for (blank) days at $(blank) per day." This is a good example of a fee that isn't exactly knowable in advance. On a refinance, until the current lender comes back with a payoff demand (which are usually in the form of $X, plus $ABC.DE interest per day after Date 1, invalid after Date 2), all I can do is estimate. It should be a pretty accurate estimate if I have last month's statement. On either a purchase or refinance, when the lender's loan funder sends to the funds for the new loan, they will tell how much prepaid interest the escrow company needs to collect, which is also in a comparable form. The same thing applies to that figure as well. Until the actual quote is in our hands, all we can do is estimate closely.

The reason for line item 901 is simple. Unlike rent, mortgage interest and payments are made in arrears. They can't charge you interest until they earn it. You could win the lottery, get an inheritance, or receive some other large windfall, and decide to pay your loan off (or down). You could also sell your house or refinance it. This would affect the amount of interest the current lender is owed. So you borrow the money at the beginning of the month, it accrues interest all month long, and you make a payment at the end of the month. So when you buy a house on March 15th, the lender is going to require you to pay interest on the loan from March 15th through the 31st in advance. This gives them a chance for their servicing department to set everything up. On April first, the loan will start accruing interest normally, and your first regular payment will be due after the end of April - May first to be precise.

When you refinance on March 15, you must pay the old lender for interest due between March 1st and March 15th, which has accrued since the last time you paid them on March 1st. You must also pay the new lender for the interest due from March 16th through March 31st. Between the old lender and the new lender, this figure can never be anything but the whole entire month worth of interest, and there will always be one or two days of overlap between the time they get the funds from the new lender and the time they are disbursed to the old lender. Around the beginning of the month, it can be two months interest if the old lender hasn't received your payment yet or hasn't credited it yet. You borrowed the money from them for the time in question. They are entitled to be paid. They're not going to let you keep it out of the goodness of their hearts, especially not when you're leaving them.

As you can see from the above, you never actually skip a month (or two) in your payments when you buy or refinance your home. It is not going to happen. What is happening is that your new lender is paying for this interest out of their pocket and adding it to the loan balance where you will be paying interest on it for a very long time. Pretty sneaky, huh? Well, you do have the option of making a payment to cover this line, or any other line on this whole form. Many providers will not tell you this because they can't run up the loan amount (and their compensation) if you make these payments. If you decide to make the payment to cover this line, it will be the interest portion of your normal monthly payment, prorated between the two loans in the case of a refinance, or prorated on that portion of the month you have a loan in the case of a purchase. In most cases, I tell people to think of it as their normal monthly payment paid early, because that is what is going on, and a reasonable approximation of the dollar amount.

The most common game played with this line is to decrease the number of days of interest you'll actually be paying. Let's say you're planning this on June 1st, and your loan provider tells you "don't worry about it. We're going to close on July 1st". First off, the chances of this actually happening as planned on any particular day are slim. Second, it's pointless to try. If you do close on July 1st, the lender is going to ask for all the interest for the month of July up front, and your loan starts working normally August first with your first payment being due September first. Third, I've learned the easy way (from watching other people make this mistake, not wanting to lose clients of my own) never delay closing - it always gives something else a chance to pop up, and it's amazing how often something does. It's amazing how often something new pops up at the last minute without this gratuitous opportunity. If you can close it now, do so. Once those loan documents are recorded, the bank can't call the money back unless you violate the contract.

As I have said, on a refinance the number of days prepaid interest can never be anything less than the entire month. Period. Somebody writes anything less than 30 days on this line, they're trying to pull the wool over your eyes. On a purchase, look thirty days out or to the last day for close of escrow according to the contract, and estimate the number of days left in that calendar month. There's the number that should be written. If a loan officer can't do it in thirty days, chances are they can't do it at all on the quoted terms or anything similar, and chances are they were playing games with you from the first. The only general exceptions to this are when refinance is booming. For instance, during the summer of 2003 the delay between complete loan package being submitted to the bank and the underwriter actually looking at it for the first time got to be more than thirty days right there, never mind the time it took for everything else. And even then I could usually run purchases through another department in close to a normal time frame. If you're not writing a check to cover prepaid interest, and you have a $270,000 loan at six percent, that's $1350 getting added to your loan when you may not want it to be, and you'll typically be paying interest on that for a very long time.

"902 Mortgage Insurance Premium" This is another one of those lines that needs discussion. First off, the odds of it really needing to happen, or being in your best interest if it does, are vanishingly small. In the hundreds of loans I've pushed through I've never actually had a loan that included mortgage insurance. It was never the best thing to do for the client.

Let's take a step back and ask, "What is mortgage insurance?" It's an insurance policy that the lender makes you, their client, buy for their benefit so that if you default they get the full amount of their loan. The usual threshold for this is 80 percent of the appraised value of the house. Mortgage insurance is never tax deductible when it's a separate charge, and is always charged based upon the full amount of the loan, and the amount of the loan expressed as a percentage of the value of the home. The larger the loan, the more you pay, the higher your loan value as a percentage of your home's value, the more you pay. It is commonly assessed as a separate charge, but can be expressed as a rate surcharge on the loan interest you'd pay anyway (in other words, say a 6.625% rate on your loan instead of 6%).

"What good does mortgage insurance do me, the consumer?" you may ask. The short answer is it gets you the loan. It gets you the loan when you would be turned down without it. After that, it's just money out of your pocket every month. Mortgage Insurance, also called Private Mortgage Insurance or PMI, is primarily a thing that happens in the A paper world (sub prime loans are usually incrementally priced to cover the higher risk, as the lenders there are in the business of taking those risks for appropriate compensation), and more importantly, it's usually avoidable.

PMI is only charged if the first mortgage exceeds 80% of the value of the home. But if I split even a 100% loan into two pieces with the first mortgage 80 percent or below, it goes away. Yes, the second mortgage will be at a higher interest rate, and yes, the closer to 100 percent of the home value it gets the higher that rate gets. But this tends to be on significantly smaller amounts of money, and this is an interest expense - deductible in most cases. The difference in total interest expense and total monthly payment tends to be in favor of doing this even without mortgage insurance or tax treatment factored in. So when I'm shopping a given loan around, sometimes I don't always even ask about doing the loan as one loan.

"With all this against mortgage insurance, why does it still happen?" you ask. At last the critical question. Lenders usually pay yield spread to brokers or commission to their own loan officers based upon the amount of the first loan. Pay for a second is typically (not always) a flat amount or zero. Your loan provider makes more money by doing it all as one loan. The loan provider wants to make more money and sticks you with the bill. Just warms your heart, doesn't it? Didn't think so.

"903 Hazard Insurance Premium" This is mostly for purchases, the yearly hazard insurance or homeowner's insurance premium. Any sane lender is going to require you to pay your insurance premium through escrow or before closing. They do not want there to be even a fractional second when their investment in the property is not insured. Of course, you don't want this either. I can't imagine paying the current cost of housing around here and not insuring the investment. So they're not asking for anything outrageous on this line. Unless you are one of those people who won't insure their properties, the extra cost to you is zero.

"905 VA Funding Fee" I haven't done a VA loan in three years. All I remember is that it's charged by the VA on VA loans, not by the lender. If it's applicable, it's going to be the same no matter what lender is doing it.

The final section is reserves of money held by the lender to be used to pay your expenses. This is your money; they're just holding it for you in order to make sure these items get paid on time. If you sell the property or refinance you should get this money back.

These are once again, not truly costs of the loan, unless you roll them into your mortgage where you're going to pay interest on them basically forever. The lender may (and most do) require that you hold up to two months reserves in this account. Ironically, this section of comparatively small amounts is one of the most tightly regulated aspects of the entire MLDS, and the whole escrow or reserves account thing is optional - although most lenders require a small fee for no reserve account. Many prospective loan providers, however, use the "safe harbor" rule of six months taxes and two months insurance, so make certain you're not penalizing the company who actually tells you the full truth, as the safe harbor rule is less than the vast majority of these quotes should be. In my experience, Escrow or Reserve accounts are usually more trouble than they are worth. I'm just going to explain quickly, and not with any dollar figures because 1) they vary too much, and for good reason 2) they are not, properly speaking, costs of the loan. As I said, they are your money, just being held by the bank for your expenses. When you sell the home, refinance it, or pay off the loan, you get the remaining contents of these accounts back.

"1001 Hazard Insurance Premium" in most cases, count the number of payments from the time the refinance is effective to the time that the yearly premium is due (usually on the anniversary of the date you bought the property), subtract it from 14. Multiply this number by your monthly premium. Even for purchases, the lenders will generally want a month or two of reserves.

"1002 Mortgage Insurance Premium Reserves" See my comments for line 902. If an early premium on this is due, compute it the same way as your prorated hazard insurance.

"1003 School Tax" California doesn't have it as a separate line item, or at least I can't recall seeing it broken out. Matter of fact, neither of the other states I've done loans in does either.

"1004 Taxes and Assessment reserves" This is the part to make certain your property taxes are paid on time. Same method of computation as line 1001. The lenders really don't want the city, county, or state repossessing the property out from under them.

"1005 Flood Insurance Reserves" Some homes require flood insurance in order to get a loan. Same method for computing as line 1001. If you live in or near an old riverbed, especially with dams and such on the river, research "riparian rights" sometime when you want another real world horror story.

Then there is a line about Compensation to Broker, which may be disclosed here or above. Some will try not to disclose it at all. Once again, you're looking for honest disclosure here, not the lowest number. This line makes no difference to you unless you're the one paying it. This didn't used to be required, but lenders and packaging houses got it put through in order to make the deal a broker offers you look worse in your eyes, thus handicapping brokers in their ability to compete. The thing that's important to you is what happens to you - the loan you are getting. When comparing offers, scrutinize the terms of your loan carefully, not what the broker is making on the deal. It's not like the packaging houses and many lenders aren't turning around and making even more money off the secondary market, just that that particular amount isn't disclosed anywhere.

There is a sum of all the things the client is paying to the broker versus paid to others. I wonder if this might not backfire on the lending and packaging houses that got this part added. They're going to show a line of fees paid almost entirely to them, whereas the only things paid to or from an actual broker are origination fees (if any), processing fee (my processor works for me or for the brokerage, not the lender), and broker's rebate to client (if any, and which if it exists is something paid by me the broker to you the client - a good thing in most client's opinion). Psychologically a telling advantage, even if it doesn't really mean anything. No matter who gets it, you're paying it, right? Concentrate on the loan with the best terms for you

At the bottom of page one, there are subtotals for fees paid to others and fees paid to brokers, and then an overall total. Then there's a section which says "Compensation to Broker," explicitly adding "(Not Paid Out of Loan Proceeds)". In other words, this isn't coming out of your pocket, although they could certainly give you better terms by reducing their compensation in the vast majority of cases. But the fact that one broker is making more than another (or is required to state explicitly what they make, whereas a direct lender or "packaging house" originating their own loans is not) does not mean you're not getting a better loan from them. Some brokers get discounts others do not. Some brokers disclose honestly and completely, others do not. Examine the loan you are getting - all of the terms, rates and conditions, and decide based upon those which loan is better. That's what makes a difference to you. The rest is a matador's red cape - a distraction from what is important.

Page two of this two-page form starts with section I, which is a short accounting of the money. My inclination is not to trust this any more than anything on the Good Faith Estimate. In other words, whether this is accurate is likely to be a function of your particular loan officer's good will more than anything else. Once again, the only form where there are real penalties for being inaccurate is the HUD-1, which comes at the end of the loan, not the beginning. But it's a good intention, nonetheless, and perhaps one of these years it'll actually mean something even if your loan officer is Simon LeGreedy or has a nose fourteen miles long. Proposed loan amount less costs, less other stuff of yours that's getting paid off, less the purchase price of the home or payoff of existing loan. The idea is to give you an explicit "you're going to get this much cash" or "you must pay this much cash to make this balance"

Section II is something I want to draw your attention to: Proposed interest rate is a good thing to have, although there is no more guarantee that this is the rate you're going to get than a federal Good Faith Estimate. But it has a choice of two things to check off "Fixed Rate" or "Initial Variable Rate". Just because Fixed Rate is checked does not mean the loan they are discussing is fixed rate for the full duration of the loan. Let me repeat that: Just because Fixed Rate is checked does not mean the loan they are discussing is fixed rate for the full duration of the loan. It might be fixed for thirty years - or it might be fixed for three months. This is a good place for unscrupulous loan officers to offer misleading information verbally, while checking the correct box doesn't usually mean a whole lot.

Section III is proposed term of the loan. If something less than 360 months is written here (or whatever the amortization of the loan is in years), it's telling you there's a balloon at the end. Once again, there is no way to verify that if 360 months is what is written, it's real.

Section IV is proposed loan payment. Ideally it's computed based upon the amounts given in the previous three sections. Verify that it at least makes mathematical sense by running these numbers through an amortization calculator, or doing the calculation yourself. Many loan officers will play games with the payment because people shop loans based upon payment.

This section is just bookkeeping, really, except sometimes you can spot your loan provider playing games if you pay attention. Remember, if this is a purchase I really hope for your sake you know your purchase price. If it is a refinance, I hope you know what your statement says your balance is. From this you can get to an approximate payoff by prorating your monthly interest. Once you have this figure, look up above on this form for the total of closing costs and prepaid items. Sometimes in a purchase your seller will give you a certain amount of credit for closing costs, so if this is applicable you can subtract those. This is the Amount You Have to Come Up With. Now subtract off new first mortgage amount, and second mortgage amount (if any), but add any closing costs for the second mortgage. The figure that is left is the Check You Need To Have. This is cold hard cash you have to come up with in order to make this all happen as described.

One of the most common tricks I've seen is for loan officers to tell clients and prospective clients they can roll the costs into the loan so they don't have to come up with cash. Despite being told this is what the client intends to do, they then give you, the client a payment quote in the third column here based upon you paying all of these costs out of your pocket - with the Check You Need To Have. In short, they're acting like all those closing costs have mysteriously vanished somewhere, like they're lurking in the Bermuda Triangle waiting to ambush some poor unsuspecting sap who will never be seen again. This poor sap is you. You're going to pay them somehow. They generally can be rolled into the loan, but make sure the loan provider gives you a payment based upon real numbers. Most people shop for a loan based upon payment because they don't know any better. This gives loan providers incentive to play games here, and the vast majority do.

Loan officers know that most clients shop for loans based upon payment quoted. This is the not the best or smartest thing for you to be doing, but it is nonetheless what most people shop based upon. So many loan providers will play a lot of games to be able to quote you a low payment. And this is one of the games they play, quoting you a payment based upon the loan without the closing costs of the loan added in. If you have a financial calculator, use it. If you can do the math yourself, better. Otherwise, go out and do a web search for financial calculators or mortgage calculators. Automobile loan sites will probably be programmed incorrectly (different assumptions), but pick a couple of others and punch the numbers in. Make certain that the real loan amount you're going to need jibes with the payment they quote at the rate they quoted. Of course, this all assumes that they're being upfront and otherwise honest and are not going to hit you with three points out of the blue, but you do the best you can with what you have. Oh, and now that you're done applying for your loan I strongly suggest you find someone willing to act as a back-up loan provider so that you can offer the person who just gave you this form a concrete reason not to hit you with those three extra points.

Section V: does the loan have a prepayment penalty, and on what basis? I'm glad to see this section here. I'll be even gladder if and when I see evidence the answers mean anything in the sense of legal penalties for lying. Lying about prepayment penalties has been rampant for a long time. Lying about prepayment penalties is a good way to make an absolutely awful loan look pretty good. Lying about prepayment penalties gets someone to sign up with the loan provider who lies because of this. And when you find out at the end of the loan process, when they present the loan documents, that they were lying (if you even notice, which many are expert at making sure you don't!), you may not have any good alternatives to signing those documents anyway.

Section VI basically tells you the lender cannot require credit life insurance or disability insurance. Many lenders would if they could. Not that disability insurance is a bad idea - quite the opposite in fact (I'm of two minds on credit life insurance, and this is not the place for that essay).

Section VII requires you the client to tell them, the lender about all the other liens on the property and hints at penalties for dishonesty. Not that the lender or broker is going to take your word for it, of course. But the gall this amazes me: requiring a consumer to be accurate on this or face penalties, pay for the loan, etcetera when many brokers and lenders could submit the form to the Pulitzer committee for consideration in the category for best short fiction.

Section VIII is about Article 7, which covers loan amounts so small as to be irrelevant for all practical purposes in California. There's also a bit about whether or not a broker is lending their own money. This is potentially both confusing and interesting, but beyond the scope of this essay. It's good that they are requiring license numbers now. In California, you can easily look them up for past violations online at (many other states have similar registries). Not that someone without past violations is pure, and not that someone with them necessarily intends to do anything dirty to you. But it's good information to know. Another good place to check them out is with the Better Business Bureau, which compiles information on every business, members or not, at You'll need a business name and address, phone number, or web site. Now, if they've got one strike against them, they could easily have been caught in circumstances beyond their control. But a pattern of abuses is a clear warning. A few days ago, I decided to risk $50 for a business card order with a company that has a truly awful rating BBB rating. The cards arrived two days later and I couldn't be happier with any aspect of the transaction. But my next order from them won't be any bigger until they have established a track record with me (and also I with them so they can see a long history of orders they want to keep coming, and which will stop if their service isn't satisfactory).

Section IX explicitly tells you, the client, that this is not a loan commitment. This is good, so far as it goes. As I said in Part I, I've spoken to many otherwise intelligent people who somehow had acquired the idea that because a loan provider filled out a Good Faith Estimate, it meant the loan was a Done Deal. It most certainly does not mean anything of the sort. No real estate loan officer EVER writes a loan commitment, and it's been that way for at least a couple of decades. Loan commitments are the exclusive province of the underwriter, who is intentionally and for anti-fraud reasons isolated from the client (i.e. the underwriter is not allowed to communicate with you directly). The most an ethical loan officer will say is "my experience does not show me anything that should cause you to have a problem"

Now, here's the rub, and an indication of what this section really should say. Does it not stand to reason that if the loan is not a Done Deal at all, it most particularly is not a done deal on the exact stated terms? This form is supposed to be an estimate. It may be a good estimate, given on a loan that has already been locked, and that the loan provider intends to guarantee in that they will pay any difference, not you. I do this, and I know of one other company. More commonly it's just a convenient story that gets you to sign up with that provider and they couldn't deliver a loan on those terms if they wanted to, which they don't. There is no way to be sure it's good until you get the HUD-1 at the end.

Caveat Emptor

Yesterday, I spent several hours showing properties I had found to a couple of investors. One was a lender owned fixer, fairly priced at $440k. It needed carpet, paint, landscaping, and some facade work. The last comparable sale in the neighborhood was $575,000. There was also another lender owned property in a neighborhood where similar properties in good condition were going for $460,000 to $480,000. This one was also pretty fairly priced at $380k. The first one needed maybe $30 to $40k in work, the latter about $20k. It took me a lot of hours to find properties where there was a good profit to be made buying near or even at the asking price in this market. Not enough for these people. They had to put in offers for eighty thousand less. Needless to say, these offers were dead on arrival. Complete waste of my time.

The reason these properties were fairly priced was that the owners had taken a realistic look at the state of the market and the condition of the properties, and decided they wanted to sell the properties sooner, rather than later. They were justifiably upset at the low-ball offers, given that they had actually priced the properties correctly, a rare thing in this market. Even if these people now follow up with a reasonable offer, I have reason to believe that these wells have been poisoned. It's going to take something basically equal to the asking price from these people. They have marked themselves as being unable to be dealt with on a reasonable basis. Other folks might be able to start the negotiations lower, but not them. Maybe not me, either, despite the fact that I was just the agent, making it worse than a complete waste of my time, a likely destroyer of some of my most valuable information - the location of profitable properties.

Low-balls are not the way you acquire the property you've got your heart set on. Low-balls are not the way you acquire property that is already bargain priced. If it is already bargain priced, all you're going to do is deal yourself completely out of the picture, where you could have made a nice profit if you had offered something reasonably close. Low-balls are the way to acquire property where the owner is so desperate, they'll take anything and you can't hardly help but make a profit. Lest you be unclear on this fact, lender owned properties are not good targets for successful low-balls. That lender wants to get rid of the property, but they've always got money, and unless they're facing the regulatory deadline, that offer is going to be rejected 100 percent of the time. If they are facing a regulatory deadline, somebody internal will have already snapped it up.

If you're going to insist upon low-balling, the way I found those properties is not the way to do it. No need to invest time driving around inspecting the properties, or the effort of going into records. Just write an offer. Write lots of offers - no need to be picky. At that price, you'll make a profit if they accept, have no fear. But, if you're going to offer that far below market, you're going to have to kiss a lot of frogs before you find one that's desperate enough to turn into a prince, and most of the frogs are going to be mad. Real quick now: What's your first reaction to being told you're not worth what you think? "You're not a college graduate, you're a high school dropout!" It's more effective to write dozens of offers sight unseen, and give yourself a few days after acceptance for inspections if you're really worried about it. 99 out of 100 will just be angry and insulted, and that's all the further it will go.

You can raise the hit rate, of course, and a good buyer's agent is invaluable for this. But the best targets for this are not those who have priced the property reasonably. Hit the people whose properties have been on the market for a long time because they're overpriced. Best is if they've expired off MLS at least once, and if they've changed listing agencies. Twice is better, more is ideal. Multiple drops in the asking price are also a good indicator of a good time to low ball. Of course, you've got to watch the market over time for that information, because even most MLS registries don't give you this information directly. There is no way around market knowledge, but the way to get a low-ball offer accepted is to be the first under the wire after the the owners realize they are desperate. There is no universal indicator of desperation, or everyone would be doing it. If you're going to do this right, you have to have some things going for you that everyone doesn't - patience and persistence, and the ability to slave away on those offers. It takes as long as it takes, and likely candidates can and will be pulled out of the the available pool at any time. Even if they aren't, the owners can and will simply refuse your offer the vast majority of the time. If you get frustrated, you're doing it wrong. This isn't like being a used car dealer. The marks have an alleged professional on their side. If the listing agent were a real pro, they'd have persuaded them to price it right for the market and condition in the first place, and it would have sold before you got to it, but they're going to be good enough to recognize your desperation check when they see it. In order to consider accepting the offer or even seriously negotiating, the owners have got to have suddenly realized how desperate they are. That's the magic ingredient to getting a low-ball accepted. There is no magic way to telling when this has happened, or everybody would be doing it. Think of yourself as a telemarketer with a very low conversion ratio, but when it does hit, you've got one heck of a paycheck.

Caveat Emptor

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

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

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

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

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

Once per month, use each credit card for something small that you would buy whether you had the credit card or not - you'd just pay cash otherwise. No larger than 10% of your total credit line on the card. I usually pay for a meal out at a cheap family restaurant (in the range of $20 to $30 for two adults and two kids). As soon as the bill gets there, write the check and pay it off. Costs you a stamp but it builds your credit. Or you can do online bill pay if you'd rather. I've heard too many horror stories and dealt with their aftermath too often for that to be attractive to me.

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

Caveat Emptor

Five Bedroom Fixer With Pool Next To Good School!

General: Urban East County, 5 bedroom 2 bath. Asking price between $425,000 and $450,000. I think an offer of $400,000 net would get it sold.

Why you should be interested: Five bedroom home on a quiet street. Walk around the corner for elementary school, and the high school is one of the best going. Back yard deck and vinyl bottom below ground pool.

Selling Points: Five bedrooms, nice open family room with high ceilings, back yard pool for the kids.

Why I think it's a potential bargain: It's dated, and the carpet needs replacing and the walls need painting. If these folks had the money to do it, they could get a lot more money. They haven't, and so they can't.

Obvious caveats: Back Yard is essentially filled by pool and deck. Front yard could be used for play, but is not currently fenced.

Why it hasn't sold already: Not attractive in appearance.

If you keep it ten years and it averages only 5% annual average appreciation per year: Based upon a purchase price of $400,000, the property would be worth approximately $650,000. If you held it those ten years before selling, you would net about $310,000 in your pocket (not including increased value from updates!), assuming zero down payment. As opposed to renting the $2200 per month most comparable currently available rental and investing the difference at 10% per year tax free, you would be approximately $240,000 ahead of the renter, after the expenses of selling.

Fact you should be aware of: Dark inside and needs updates

Obvious way to enhance value or appeal of property: Carpet, paint, modernize kitchen and bathrooms, fence the front yard so kids have a place to play.

This property does not appear to be eligible for a first time buyer Mortgage Credit Certificate provided your family income is not more than $82,800 or $96,600. Ask me for more details, on this or any other property.

I'm a buyer's Realtor®. I find places like this that can be gotten at bargain prices. I save you money while getting paid out of the listing agent's commission, not costing you a penny. Nor are these the only bargains I find. In order to protect everyone's best interests, I require a Non-Exclusive Buyer's Agent Agreement. This is a standard California Association of Realtors form that leaves you are free to work with other agents, but if I find the property you want, I'm the agent you'll use. That's fair, and there is no reason not to sign such an agreement unless you're an agent yourself.

Contact me: Action Realty 619-449-0723, ask for Dan or email danmelson (at) danmelson (dot) com. Ask me to find a bargain that fits you!

That was a question I got. The answer is that it shouldn't make a difference, but it does. You see, lenders who work in markets that are less than A paper perform qualification calculations based upon the initial payment, at least until some pending regulations take effect. Furthermore, I'm about 180 degrees from convinced that it's really helping anyone.

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

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

There are banking regulation changes pending to change the qualification procedure, forcing all lenders, rather than only "A paper" ones, to perform their qualification computations based upon the fact that the payments on these loans are certain to increase. These regulations are long overdue in my honest opinion, but they are not in effect as of this writing. Under current guidelines, this loan would be approved. Actually, the directive that forces "A paper" to underwrite these loans based upon the higher payments currently comes from Fannie and Freddie, not the regulators, and is one reason why hybrid ARMS at a lower interest rate are actually harder to qualify for than fixed rate loans in the "A paper" world.

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

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

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

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

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

Caveat Emptor

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

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

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

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

Now, just because the first loan officer gives you a number you are happy with is no reason to stop shopping. You want to have this same conversation with several different loan officers. The reason is confirmation. There is a large amount of pressure to qualify you for the largest loan possible, especially in the highly priced urban markets where most of the country lives. A little bit of difference can make a lot of difference on the property you think you can afford, which makes it a lot more likely that the average person will come back to them for the loan. They said they could get you a loan for $500,000, while the guy down the street said they could only get you a loan for $470,000. If, by some mysterious coincidence about as rare as gravity or air, these people decide they want to stretch their budget to the maximum or beyond, who do you think most people in that situation will come back to? Most people buy a property at the highest possible end of the range they've been told they can afford. Actually, the most common thing that happens around here is that they'll go back to the people who said they qualified for $500,000 to see if there's any way they can stretch it so that they can qualify for this $530,000 (or $800,000) property they've gotten their hearts set upon.

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

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

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

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

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

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

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

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

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

Now, I know I said this earlier. Not only does it bear repeating as many times as I can find an excuse for, the folks interested only in refinancing might have been skipping ahead. Remember that you can get the a loan officer who's the equivalent of the Marquis of Queensbury, but more of them are closer to the Marquis de Sade, and most will be somewhere in between. All of those quotes, and that nice paperwork like the Good Faith Estimate and Truth in Lending Advisory are basically so much hot air and so much used paper unless they are backed by an effective Loan Quote Guarantee. The bigger the lie they tell you, the more likely it is you will sign up with them. Sure, it's possible you might walk away at document signing, although not likely. If you don't sign up with them, they are guaranteed not to make any money.

There is always a Trade off between rate and cost in real estate loans. It's like gravity. Exactly what the available trade offs are varies over time, and varies from lender to lender at any one time. Remember, that lender can low ball you pretty badly to get you to sign up, and once you sign up, you're not likely to discover that they did low ball you until time to sign documents. By that time, you may have no real choice but to sign the documents you are presented, a fact which many lenders and loan officers are counting on. If the loan they delivered at signing is not exactly the loan they promised at loan lock, the only reason they did not tell you earlier is that they did not want you to have an opportunity to go shop elsewhere. They knew within a week of getting your information. To tell you how endemic this problem is within the industry, let me make a wager: I am not a gambling man, but I'll bet money that I could go into 95 of 100 loan offices chosen at random, audit their 100 most recently funded loans, and find significant discrepancies between the Mortgage Loan Disclosure Statement (or Good Faith Estimate) they got at sign up and the HUD-1 at loan signing in 80 of them. This isn't because they didn't know what the rates would be. They should have locked your loan as soon as you said you wanted it. They knew what the rates were then. Why didn't they lock? Why didn't they tell you what it would really be? The games played are legion, but it's rare that clients emerge better off for them having been played. Furthermore, I am not a gambler. This bet is like the guy who bets even money there will be at least one shared birthday in a group of fifty people, for which the probability is over 97%. The reason many loan providers want a deposit is so they can hold that money hostage for you signing the final documents. Unless no one else can do your loan, I would never even consider putting up a deposit with a lender. What they're telling you by requiring a deposit is that they want you to stop shopping. If they are telling you about a loan that really exists, and their loan prices really are good, there is no reason for a loan to require a deposit. You will pay for the appraisal when it happens, but that's less than a deposit.

The best remedy for this situation, where loan providers can basically say almost anything it might take to get you to sign up, is to sign up for a back up loan, if you can find someone willing to do so. In order to get someone to agree to be a backup provider, you've got to give them a real solid shot at the loan in the first place. Then, once you know who your first choice provider is going to be, go around and ask the other lenders, in order from next best to worst quote, if they think that loan is real and deliverable. If they all say it is, you know that your primary provider has at least quoted you something they might be able to deliver. If they say it's deliverable, follow up by asking why they couldn't beat it or at least meet it. The answers to these two questions should dispel any doubts about why you didn't do business with them.

Most of the time, however, most of the prospective loan providers will say it isn't. After all, they're trying to get you to sign up with them. That's your opening to ask if they'll be your backup provider. After all, if the other quote really isn't deliverable, you'll be signing their paperwork at the end. Every time I've said it's not, I've put my money and time where my mouth was, and every time I've ended up with the loan at the end of the process. For those people who honestly shopped their loans around, this has literally never failed to get me paid for a funded loan, and I've been backup for every category of loan provider from some of the biggest Wall Street banks down to credit unions and other brokers.

You do need to get both sets of paperwork filled out, and do everything necessary so that both loans are ready to go. If you only work on one loan for twenty-eight days of a thirty day lock, only one loan will be ready. The back-up loan is useless to you if it's not ready to go at the same time as the primary. If the back-up is not ready to go at the same time, you're signing the primary loan papers whether they deliver what they said or not. If the primary isn't ready to go, you're signing the back-up's loan papers whether they deliver what they said or not. Signing up for two loans also gives each of the loan officers concrete reason to make certain to deliver your loan on time.

As soon as you have selected your loan providers, lock both loans and order the appraisal. You'll pay an extra fee for having it typed for two loan providers, but that $100 or so is literally the cheapest, most cost-effective insurance policy you can buy. Not having it is likely to cost you thousands of dollars.

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

The main issue in all of this is finding the loan on the best terms available to you. The main obstacle to that is the fact that lenders can low ball their quotes shamelessly, and it's legal, so it takes some serious research to figure out what is likely to be real from what is not. Once you've done that, it's time to make your choices and get those loans locked in. If the loan isn't locked, the quote doesn't matter - it's not real. It's certainly still possible to get burned, but far less likely, particularly if you sign up for a back up loan and have both loans ready to go. Once the loans are locked, get the paperwork and anything else you need done. Unless there is something external holding the whole process back, such as "Your house isn't going to be finished for two more months," I will bet money that a loan done in thirty days or less is better than one that takes sixty days or longer.

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

Caveat Emptor

California has just replaced the one page federal Good Faith Estimate with a two page Mortgage Loan Disclosure Statement. Regulations for filling it out are similar to the federal Good Faith Estimate, especially as the only thing a recent seminar we paid for on changes in the business had to say was, "If you give the client a Good Faith Estimate, you will be held to have complied with federal regulations but not state of California regulations." Which implies that California didn't alter the existing federal standards so much as add a few more lines, the effects of which are to leave all of the games loan providers play with the federal Good Faith Estimate intact, as well as adding a couple more.

I've actually had some looks at abuses of the Mortgage Loan Disclosure Statement now, and they are essentially the same abuses the Good Faith Estimate still suffers from in other states. The abuses of the Federal Good Faith Estimate and the fact that pretty much all of them are actually legal had been something that took time to soak in back when I first got into the business, although a short stint with a Company Which Shall Remain Nameless was a real education. It appears that the regulations for the Good Faith Estimate part are unchanged, which translates into english as "Excrement." Furthermore, I'm certain that somewhere in Sacramento lobbyists are paying bribes campaign donations so that just this or that little detail can be changed "just a little in a way that doesn't really make a difference," and eventually the cockroaches will have even more ways to game the system.

Many people think the forms you get at the beginning of the loan are binding, or in some legal way, indicative of the loan you'll actually end up with. If I had a dollar for every time people have told me, "I've got the quote in writing," in response to my telling them a rate wasn't available, it would make a real difference on my mortgage. The fact is that neither a MLDS nor a Good Faith Estimate in the other forty-nine states means anything unless the person or provider giving it is willing to stand behind it with a guarantee that they will pay any difference, not you. I can point to many, many loan offices - the vast majority, as a matter of fact - who intentionally misrepresent the loan on the beginning paperwork. I don't know how many people tell me, "I'm sure Super-Colossal Mega Bank intends to honor its commitments." By themselves, neither the MLDS nor the Good Faith Estimate are in any way, shape, or form a commitment. It's not an underwriter's loan commitment, it's definitely not signed loan documents, and it most definitely is not a funded loan. The Truth In Lending form doesn't mean anything either, as it's based upon numbers in the MLDS. Garbage in, Garbage out. The only form that means anything is the so-called HUD 1, a two page form required by the federal government, but you don't get that, even in provisional form, until you sign loan documents. There are guarantees that can make the MLDS mean something, but without those guarantess, the MLDS is a used piece of paper with unimportant markings.

The first page of this new form is similar to the Federal Good Faith Estimate. The first major difference is that there is no explicit loan or rate quoted at the top, and the broker or lender must disclose whether each given cost of the loan is paid to the broker or to someone else. There is no explicit line item (as there is on the Good Faith Estimate) for "Estimated Closing Costs" to explicitly sum all of the things that are actual fees or costs of the loan, as opposed to reserve requirements or things that are your fees paid in advance, such as property taxes. Your property taxes are the same whether you have lender A, lender B, or no loan at all. Ditto your homeowner's insurance, school taxes (if any) and flood insurance (if any). Setting a form where they are part of a total to be compared, rather than apart from that total, is just offering the loan provider one more opportunity to play games or distract you from the really important information.

On the line above where all of this starts, there should be written a total loan amount, an interest rate, and a term (360 months for all 30 year loans, whether it is fixed for the full term or not - numbers less than 360 mean that the loan is due in full in less than 360 months. This can be one clue that they're trying to hit you with a balloon payment loan). As I have said elsewhere on this site and will continue to stress, just because a mortgage provider puts these numbers on an MLDS does not mean that they have any intention of actually delivering them. I think bait and switch is the official company game of many providers. The MLDS, along with the Good Faith Estimate it's based on, is THE most abused loan document, bar none. It's supposed to be a real estimate of what the loan is going to be like, based upon the loan officers best estimate. In practice, it's become nothing more serious than the loan provider wants it to be. In many cases with many providers, it's almost like a joke: "(giggle) and this is what we had to tell him in order to get him to sign up! (loud guffaws)" and this carries through the rest of the document as well. The relationship of the loan described on the MLDS to the loan that is actually available and that said provider will actually deliver is completely arbitrary and up to the provider within very broad limits. Because at the end of the process, the client has very little leverage to get the provider to deliver the loan they talked about to get you to sign up. Unless, of course, you signed up for a backup loan like I keep telling you to do.

Now, it is also important to note that with two exceptions, all of the fees below are commonly held in abeyance until the end of the loan process, and you don't owe them if you don't end up refinancing or purchasing with that company. They can be added to your loan balance instead of being paid out of pocket. It is the biggest red flag I know of for a loan provider to ask you for money up front beyond the credit report.

The first actual line item on the Good Faith Estimate is "801 Loan Origination fee." This is an explicit fee charged by the loan provider who signs you up. It can be expressed in dollars, but it is more commonly expressed in terms of "points". One point is one percent of the final loan amount. Put another way, if you have a loan for $198,000 plus one point, the way to do the computation is $198,000 times 100, divide by 99 (100 minus the total number of points), which equals $200,000. It's probably not unethical if the loan officer uses $199,980 ($198,000 plus 1%, or $1980) on a quick calculation, just a desire to get an approximate answer quickly. It's still not mathematically correct. Now, if as is common, the loan provider only writes down 1% here rather than converting it to dollars as well, it can appear as if that loan is much cheaper at first glance or to the uninitiated than it actually is. If you've got a loan that's $200,000, leaving the estimate as one point without an explicit dollar figure is a way of making it look like the loan actually costs you about $2000 less than it will. Two points without an explicit dollar figure is twice as much ("The other guy wanted $5000 to do my $300,000 loan, but this guy only wants $3000 and two of these point thingies. What a great deal!" You would be amazed and dismayed how often I have to explain even to people who know what points are that $3000 plus two points on a $300,000 loan is about $9000). Nor is this figure, whether expressed as points, dollars, or both, carved into anything more than silly putty. I worked for a short time at a Company Which Shall Remain Nameless, and one of the things that got me yelled at several times, and one of the many reasons I left, was that I violated company quoting policy by actually adding in all of the little miscellaneous adds for half a point here and a quarter point there that the customer was going to get hit with at the end of the process anyway, and telling the customer about them up front. Finally, there is no reason why this line has to be more than zero in all cases, and indeed I've done more loans without than with points, but that's a subject for another article.

The next line is "802 Loan Discount". In theory, this is supposed to be used only for actual discount points charged by the lender. In practice, it is used almost interchangeably with "Loan Origination Fee" on the line above (not without some justification in fact, which is beside the point of this essay). Once again, watch out for whether the figure in points is converted into an actual dollar value. Again, there is no reason why this line has to be nonzero, and I've done more loans without than with.

"803 Appraisal Fee" in California is $350 to $450 for the average home, depending upon what that particular appraiser charges for that particular job. It is legitimate and correct to mark this as PFC (prepaid finance charge) so long as the loan officer gives you an approximate figure. Unless they have a contract with a particular appraiser, it's not under the loan officer's control. This is another place where many providers play "hide the closing costs." Quoting from one less than ethical example "Hey, I'm not the one charging it and if it makes my loan look better than the guy stupid enough to tell the client, that's not my problem." I tell people with average homes that it's likely to be about $400. The abuse that happens here is that this is one of those things that's called a "third party charge" - paid to a third party service provider. As such it is not included in total fees when calculating APR on the "Truth In Lending Statement", and will almost certainly not be included in any computation of total fees by your loan provider (Other than me, I know exactly one company that includes it). The vast majority of those billboards advertising "Total fees $X" really mean "Total fees $X plus third party fees," not to mention the fact that they're going to give you a rate which gives them an Earth-Shatteringly Large Rebate (see my essay on rates and points when it's posted for more). It is not unethical for the loan provider to ask you to pay the appraiser at the time the appraisal is performed, provided the person being paid is an external appraiser (see my essay on the appraisal for in depth reasons).

"804 Credit Report" is usually somewhere around $20. Single Individuals buying a house on their own are cheaper than two married people, but unmarried individuals must each be run separately, and so it may be a little more than $20 if you're buying a house with your brother, parents, or whatever. It is neither unusual nor unethical for the loan provider to ask you to pay for this up front. So long as the check is written to the credit reporting service, there's nothing wrong. And there is a rule now in effect that we must have explicit written consent to run credit from every person, so don't get angry with your loan provider for following it.

"805 Lender's Inspection Fee" is charged by the lender to have one of their inspectors go out and take a look and make certain the house isn't falling down. It is common for the lender's fees to be ignored by a broker, and then you'll get another MLDS from the lender that discloses this, and the correct summary of the costs is the sum of the numbers on the two sheets - not that anyone will tell the client that. On the other hand, Lender's Inspection Fee is not necessarily charged on every loan. Many lenders will rely upon the appraiser's work in this, and not do one of their own, particularly on refinances. Since (assuming you're sane) you're going to want a building inspection yourself in the case of a purchase, the lender may make it a condition that they get a copy. And, I will admit as a broker that although I do disclose a total of all lender's fees I know about, I don't always break them out into categories and may amalgamate them all under one category. (I can ask a lender what their fees are, and one will tell me A, B, and C adding to $750. The next one will tell me A, D, and E adding to $780. The third might tell me B, E, and F adding to $995. And so on. The brokerage I work for is approved with well over fifty lenders. I maintain that as long as I disclose the total amount, most clients don't care whether it's going to underwriting or document preparation or spa visits for the CEO. It's just not important to them where it goes. It's a fee they've got to pay to do business with that lender and get that loan. Whereas I will help them consider the total cost in comparison to the cost of other options, this total is not subject to negotiation).

"808 Mortgage Broker Fee" (there is no line 806 or 807 on the form). This is another fee potentially charged by a brokerage. Just because it's not, or listed as zero, here doesn't necessarily mean you're not going to end up paying it. One trick I've seen is leaving it blank at the beginning, then at the end it's "We charged that based on how difficult your loan was. You don't expect us to work for free, do you?" Trust me, they're not working for free, although I don't think you need an astronomical level of trust for you to believe this.

"809 Tax Related Service Fee" I've never had to include it as a separate line item even if present. It's usually amalgamated and lumped in with something else, if it's applicable.

"810 Processing Fee" This is what they pay to the nice person who processes your loan and coordinates your transaction while the loan officer is off doing other loan officer things. This varies, but I'd be very suspicious of anything less than $300. I know brokers that say to charge $600 when they pay the processor $300. My attitude towards that is that at least they're telling you, the consumer, about it up front. Better that than being told $300 and hit for $600 at the end. The processor knows what they make. The broker knows what he pays the processor. Don't worry if the processor gets the whole thing. It's not your concern, and it's not really negotiable, and whereas you have the option of going elsewhere, the elsewhere you go has the option of lying to get you to sign up.

"811 Underwriting fee" is charged by the bank to pay their underwriters. It's also a good category for brokers who hate pointless detail to lump all of a lender's fees together in. If it is broken out, as a direct lender should do, be suspicious of anything less than three to four hundred dollars - typical actual underwriter's fees. But just because he's showing $995 here where everyone else is showing $400 doesn't mean he's overpriced. Just to mention it, if you are doing a first and second mortgage simultaneously with the same lender, the lender's fees will go up by about $500 to cover the second. If the second is being done with a different company, they're probably going to charge a whole other set of lenders fees.

"812 Wire transfer fee" is charged by the escrow/title company to wire the money into your account for immediate availability. Otherwise, it's going to be a few days before the check clears. If it isn't something advantageous to you, don't get it. Most of the time it probably isn't necessary, but considering daily interest on typical amounts of real estate transactions, it may be a good investment. Last time I had this done for a client it was a little under $25. The lenders fees I've talked about elsewhere usually include a charge for wire transfer between them and escrow or title, but this doesn't cover sending it on to you.

Below this are several blank lines. An ethical loan provider will use them to disclose that he's getting a rebate from the bank (assuming he's getting such a rebate) or tell you that the price quoted includes a rebate to you from them reducing the price, if such is the case. (Most of the loans I have done tend to have this feature. You'll find out why in a different essay). Just because provider A is getting a bigger rebate does not mean provider B has a better loan. It happens quite often that one broker shops a better lender or works a little harder. A 5.5 % loan with $3500 in total closing costs is a better loan than the same loan type with the same terms at 6% with $5000 in total closing costs, even if the broker in the first case is getting paid $10,000 more by the lender, to pick an extreme figure. Now it's unlikely that there's that much of a difference in broker compensation when the one is delivering a better loan, and if there is that much of a difference I'd bet millions to milliamps that the loan terms are different. But the point is for you, the consumer, to look hard at the actual terms of the loan involved - that's what's important to you. There was just a study released a few months ago about how most people would just choose the loan where the broker made less money, or where a loan provider's compensation wasn't disclosed, rather than the loan that's actually better for them (If anybody finds a link to it, send it to me. I tried and couldn't find it again among my search engine results). If we weren't all adults here, I might need to make the point that if the loans are otherwise the same, the broker in the first case earned every penny of his extra pay by finding you a better loan on the same terms and qualifying you for it. But we are all adults here, so you know that.

There also may be other fees listed here. I've only done significant business in three states, but there really is no need for anything else that I've seen. Additional fees in this area usually amount to a "Loan Officer's Latte Fee", or a "This is going to make me miss my surfing!" fee. If they actually list them, at least they're telling you up front instead of keeping it a deep dark secret that the consumer has no way of knowing about. Every once in a while, I'll see somebody write something like "Amalgamation of lenders fees" rather than using line 805, 811, or 1105 to cover it.

Finally, some states require a survey if none has been done for a certain period of time, usually ten years. California does not, and it's very rare for it to be required otherwise, usually due to ongoing boundary disputes which must usually be resolved before the loan funds. This will cost $300 to $400 if required, possibly more.

So when we look at this section, we are left with midpoint fees of $400 for the appraisal, $20 for the credit report, about $800 between line 805 and 811 and miscellaneous other lender imposed fees, and $500 for processing. Believable total, thus far, $1720, plus the amount for any points you pay, less any rebate to you. $2220 or so if you're doing a simultaneous first and second, $2500 or more if you are getting a first and second from different lenders.

The next section is title fees. These are the fees you are charged by the title company for doing the work necessary and writing appropriate policies of title insurance upon the transaction. Title insurance is a part of every real estate transaction in California, although I am given to understand there are still states where it isn't necessarily so. And even in California, if you're silly enough to buy the property for cash and insist that you don't want any kind of coverage in case it turns out later that the seller didn't really own it, or in case what you think you see is not necessarily what you got, it is possible to do a transaction without title insurance. Otherwise, when you buy the property, the seller should, as a condition of the sale, buy you an owner's policy of title insurance. When you get a loan on the property or refinance that loan, the lender will require you to buy them a lender's policy of title insurance.

"1101 Closing or Escrow Fee" depends upon the company and type of escrow. Many loan officers will write PFC, but ethical ones should tell you what it costs. Middle of the road is $450 for a refinance, the same plus $1 per thousand dollars of purchase price, divided by two for a purchase, because it is split two ways between buyer and seller. Like the appraiser's fee, attorneys fees, and title insurance, this is a third party fee that is excluded from the calculation of APR, and it's not under the lender's control unless there's a contract. Still they should let you know how much it's going to be, as it's not like there's any possibility of you not having to pay either an attorney or an escrow company, and many will pretend it doesn't exist or try not to give you a dollar value, as $X plus unknown escrow charges sounds cheaper than $X plus 450 for refinances or $X plus $375 for a purchase.

"1105 Document Preparation Fee" somewhere between $100 and $200 in most cases, this covers the cost of generating the mortgage documents. Will be covered in total lender's fees if that's accounted for elsewhere. Grant Deeds, etcetera usually prepared by the escrow or title company for the process will be extra, usually about $50 or so per document.

"1106 Notary Fees" $100 to $150 is reasonable, and about the range of what the various mobile notary services charge. Even if your loan officer agrees to act as notary, this is likely to be charged. You may or may not be able to save yourself money by taking it somewhere yourself as state laws are different, but if you do, you're going to have to cover it out of pocket, and you're going to have to deal with the issue of the notary's business hours, taking time off work, everybody who's party to the loan being there to sign, etcetera, not to mention the fact that getting loan documents signed is something that is always time critical.

"1107 Attorney Fees" Some states require the use of actual attorneys to do the escrow and/or title functions. Luckily, California isn't one of them. Attorneys are more expensive. I haven't done any actual work in these states but from what I can tell $800 is about average. Disclaimer: the company I was working for at the time may have had a contract for reduced rates to which I wasn't privy. Like appraiser fees, escrow fees and title fees, this is a third party fee excluded from APR calculation, and can be marked PFC, but the loan officer should give an known dollar value, as the company should have a contract with the attorney's office. Once again, unethical providers will try to keep a dollar value from finding its way onto the paper because it looks cheaper that way.

"1108 Title Insurance: Like Appraisal, Escrow, and Attorney's Fees, this is a third party charge, and as such is excludable from the calculation of APR. A dishonest loan officer will mark it PFC without telling you how much, as once again, $X plus unknown title fees sounds cheaper than actually adding the title charges from the rate book to the paper. In the case of a purchase, the seller should purchase an owner's policy for the buyer, and the buyer's lender will require the buyer to purchase a lender's policy of title insurance, which should be heavily discounted because it's the same title search under slightly different rules of relevance. In the case of a refinance, the lender will require the borrower to purchase this. I took an average of the costs to the nearest dollar between several rate books, but they companies are really pretty comparable in most cases. If the property had a policy of title insurance issued on it within five years (the vast majority of properties in California qualify, as only about three percent of all mortgages are older than that), the owner's policy will cost the seller about $1400 base rate, and the concurrent lender's policy will cost the purchaser about $650 or so for an average property. In the case of a refinance, the lender's policy would cost about $900-1000.

So adding this section up at the mid points, in the case of a refinance you have $450, plus $150 plus $125 plus $950, totaling $1675. In the case of a purchase, you're talking about $375 plus $200 (somebody is going to have to do a Grant Deed) plus $125 plus $650 (remember, the seller usually pays for owner's policy of title insurance, and we're talking about a Good Faith Estimate for a loan, which the seller doesn't need unless he's buying another property) totaling about $1350.

I'm going to lump two sections into one here.

"1200 Recording Fees" charged by the county recorder. Should be the same for every lender. In San Diego County it's currently $63.

"1202 City /County Tax Stamps" Some city and county governments have an intangibles tax on mortgages.

"1203 State Tax/Stamps" Some states have an intangibles tax on mortgages, computed based upon the dollar amount of the loan. California does not. Usually it's the states without state income tax. If your state charges this it will be the same no matter your lender. If you're in such a state and one company gives you an estimate that's different from everybody else, that's a matter for investigation.

"1302 Pest Inspection" On refinances, if something raises a red flag with the lender, they will require a pest inspection. There may also be areas of the country where it is required of every loan, but I've never heard of one. On a purchase, you're going to want a pest inspection anyway. There is potential for abuse (somebody charges you $200 and orders a $100 inspection), but it's relatively small potatoes, and most just won't bother when it's so much easier to hide big ticket scams elsewhere. Order it yourself from an approved vendor if you're concerned.

So the section total is $63.

Below these sections on the Federal Good Faith Estimate, but not the MLDS as they have taken it out, is a line "Estimated Closing Costs". This really was the total of all the closing costs associated with the loan. I keep telling folks that the numbers which go onto this sheet may be fictional or incomplete, but if they are actually complete and correct then the number here on this line was the most important one on the whole sheet. This was the total of the costs you were really paying to get your loan. Some call it the "total of non-recurring closing costs." If you pay attention to nothing else on this sheet, (begin Groucho Marx accent) chances are that you're being taken for a ride (end Groucho accent). But this is the most important single number. Adding the midpoint estimates from the sections we come up with $1720 if you're getting one loan on a refinance to $1675 or $1898 plus $63 plus any charges for points. Using consistent assumptions, this makes for a total for a refinance cost of $3460 for a typical single family residence in San Diego. The totals for a purchase under these assumptions is $3130. If you're buying a small condo, these numbers will be a little smaller, whereas if you're buying something upscale, they will be somewhat larger. None of these numbers account for points you're paying or rebate you're getting, of course.

Just to make an important point again, this sounds like a lot more than $1658 plus third party fees, doesn't it? If offered the choice between buying one item for $3460 and buying the same item for $1658 plus third party fees, most people think the second choice sounds cheaper. However, as I've just demonstrated these are exactly the same given comparable assumptions. And there's a lot of leeway in those third party fees for junk fees if your loan provider wants to make use of them to pad their own pocket, not to mention they could trivially be much higher if your loan provider doesn't choose third party providers wisely. Insist upon actual numbers.

Continued in Part II

Continued from Part 1: Preparation and Part 2: Process

This is about the long term consequences of the decision to buy or not to buy a home, and economic benefits analysis into whether you should want to buy. In order to answer the question of whether it's better to buy or rent and invest the difference, you need to compare the costs and benefits of owning to the costs and benefits of renting over a comparable time frame. If you know you're moving in three years or less, it can be hard to come out ahead, just due to transaction costs. On the other hand, if you've got the wherewithal to turn it into a rental property after any future move you already know you're going to make, that can make the owning calculation move decisively in favor of owning. Be advised, all the headaches of being a landlord are greatly magnified if you're not within easy commuting distance to keep an eye on the property yourself. Also, if you cannot achieve positive cash flow on a rental property, odds are good that you should sell it. This isn't a blanket recommendation, just a rule of thumb.

Now it happens that I've programmed a spreadsheet to answer the "buy or rent" question in a time dependent manner, which is the only way it really can be answered. I'll assume we're talking about a $450,000 home and 90% loan, split into two pieces to avoid PMI. I'm going to pull a few more assumptions out of my hat, but I'm going to do my best to make them reasonable assumptions. 6.5 first trust deed, 10% second for any loan amount over 80 percent of value. Five percent annual property appreciation (perhaps a tad low in the long term), 1.2% yearly property tax (darned close for most California properties), yearly tax increases of two percent (Prop 13's legal maximum in California), non-deductible homeowner's expenses of $120 per month, 4 percent inflation, $1500 in non-housing deductions on Schedule A of your IRS forms, marginal tax rate of twenty-eight percent, and a return net of taxes on any alternative investment with the same money of ten percent. I also assume you're married (That makes a difference on how much your default deduction is).

I'm going to neglect state income taxes, but they make buying more attractive. They would functionally move the equation in favor of home ownership, but the effects are relatively minor in most cases. Furthermore, because investments are only worth your net proceeds after you actually sell them, I'm going to deduct seven percent of the theoretical market price of your home investment in any given year before I compare the net benefit of buying a home to renting and investing the full difference between renting and putative mortgage. This is questionable to be sure, as most people will just spend at least a certain percentage, but I'm in the mood to be generous. You'll see why in a moment.

I'm also going to assume here, very unrealistically, that you never refinance, but that's actually a middle of the road assumption, as far as net benefit goes. The actual spreadsheet also works a couple of other assumptions, and refinancing every five years and making a minimum payment usually comes out better, while refinancing every five years and keeping a thirty year payoff goal usually comes out worse.

Here are the net results:































































Monthly Rent






























































Net Benefit































Yes, after 30 years you are 1.3 million dollars better off from having bought a $450,000 home, as opposed to continuing to rent for that whole period. Not to mention that you own it free and clear for the cost of maintenance plus property taxes, as opposed to paying over $6800 per month rent.

This is a fascinating study in leverage. Now let's look at a slightly different scenario. Suppose you don't have a down payment, as many folks here locally don't, and suppose the property loses $50,000 in value the day after you buy it, as many here locally are fearing right now.































































Monthly Rent






























































Net Benefit































Or you're still almost as much better off by buying as you are in the first set of circumstances - a powerful reason not to wait if buying is appropriate for you. We don't know that prices are going down further. I believe they are likely to, but what if they don't?

I've been playing with this spreadsheet for weeks now. Under the basic assumptions I've listed above, it's kind of hard to be ahead of the game by buying a house instead of investing in the stock market after less than two years under any kind of reasonably average assumptions. On the other hand, it's very difficult not to be ahead after five to seven years, and way ahead after ten.

After thirty years, most sets of even vaguely reasonable assumptions have you so far ahead by buying the home that if you didn't watch over my shoulder as I built the spreadsheet, a reasonable person would be sceptical. Heck, I knew which calculation the numbers favored, but I really never stopped to think how strongly they worked in favor of home ownership. It is difficult to come up with a reasonable set of assumptions and starting numbers where you aren't ahead by significantly more than the original purchase price of the home. Yes, we're all aware of the issues with inflation, and the ratio illustrated here, with a 4 percent rate of inflation, is a little more than three to one (which remembering the rule of 115, seems reasonable, so the first approximation check validates this). So what this means is that by purchasing a $450,000 house that you're going to live in for the rest of your life now, you're adding more than $400,000 in today's dollars to your net worth in thirty years. Actually, it's usually more. That safe, conservative, middle of the road net result after thirty years from the first example converts to about the same number of right now dollars! No flipping, no games, no wild schemes, no re-zoning jackpots and no wealthy benefactors to come along and pay you twice what it's worth. In fact, in this scenario you never talk to another real estate or loan person as long as you live, and you've still effectively "gifted" yourself with almost ninety percent of the property's purchase price immediately upon taking possession.

This should persuade most folks that they should want to buy a home, and that you don't want anyone else to. After all, the more poor schmoes there are, the better this will work for the rest of us. Actually, that last crack about poor schmoes isn't true, because the law of supply and demand is always in effect. But is shows how good for the overall economic health of the nation encouraging home ownership is.

Caveat Emptor.

This is really more of an investment related article than mortgage or real estate.

Class-action lawyers pounce in US subprime crisis

"We are considering litigation, no question," he said. "We have already had numerous discussions with some very, very large pension systems throughout the country on this."

I would look into investor lawsuits aimed at the managers who invested in these bonds. There wasn't any shortage of people warning that these were not solid investments. I was one of them. But I guess these managers dominant philosophy was out of, "How to Look Like a Financial Genius for Six Months (and an Idiot Forever)."

On the other side, Bear Stearns profits up, calms subprime jitters

But even that article has a warning:

But in that turmoil is a big opportunity for Bear Stearns and other Wall Street investment banks. Molinaro said he expected to see large, bulk sales of distressed mortgages over the next several months.

Subprime mortgage troubles could still spread pain but probably not recession

"We're seeing a lot of pain. We're not seeing carnage," Costello says.

Subprime alone won't sink Wall Street bankers

Subprime loan business accounts for just 3% of Lehman's revenue, and the current troubles translate into a potential hit to earnings of just 4%, according to an estimate published by Bank of America analyst Michael Hecht. Bear Stearns, which reports its results today, has the largest earnings risk at 5%. But most of the others have an even more trivial 2% earnings exposure, Hecht found.

One editorial I largely agree with:

Mortgage lenders can't claim that no one told them so

And one with it's head largely you-know-where:

Opposing view: The market is working

Spin, spin, spin. Whip the rats faster, we must not be spinning enough.

One thing I fervently hope: This mess results in some industrial strength disclosure requirements for negative amortization and stated income loans. I personally would like to see increased disclosure requirements for ARMs in general, as well as interest only loans. And I'm talking about plain language explanations right up front when people apply for the loans. If you can't sell the loan and the property with a frank discussion of what's going on, you shouldn't be selling either the loan or the property.

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, capital gains, 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, but socked it away in an investment account. Gain/loss is the net result, positive if you came out ahead by making the payments, negative if you should have invested the money.















Extra Prin














tax cost










































As you can see, the numbers come out fairly strongly for not taking the extra and making payments.

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 manages to pay their mortgage off.

Now, 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 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, and occasionally, 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

Continued from Part 1: Preparation

I am considering buying a home, although I have not made up my mind on the subject. This is not due to indecision, but rather due to a lack of necessary information. There are many factors to be considered in my case, and in order for me to make an informed decision about buying, I need to solve for several variables involving cost.

My questions to you involve what steps I can take to solve those variables. Should I begin with a pre-qualification or loan approval? Will a lender invest time and resources in me when I have no specific property in mind, and I may ultimately decide to continue renting? Should I start by speaking with realtors in order to guage what is available in my price range? Will realtors invest time and resources in me when I have no loan arranged and I may ultimately decide to continue renting?

Also, what is the proper sequence of action for someone who is seeking to collect all the relevant information in order to make reasoned decisions about buying a home?

Well, as I said in Part I, a major question is whether you can trust real estate agents to answer the question honestly. Some will, most won't. If they tell you to buy, they make money. If they tell you to keep renting, they don't. Mind you, if you can afford to buy, the numbers are overwhelmingly in favor of that, as we'll see in Part 3. Nonetheless, one trusts that you see the potential for abuse.

Nobody should have a specific property in mind when they first approach an agent. Smart buyers won't make an offer without looking at a certain number of properties first. The only exception is if you're buying the old family home from your parents or something. You've agreed on the price, and the terms, and now you're going to pay an agent to make sure all the paperwork is done and filed correctly and the inspections are done and all of that sort of stuff. This is a smart thing to do, by the way, but most people in this kind of transaction seem determined to save money when a low percentage agent's fee or some flat fee would be an astoundingly good investment.

You needn't worry about whether lenders and agents will "invest time in you." Those who are unwilling to spend time on you in such circumstances should be avoided. Yes, I want my time to be spent on people who really want to buy and are capable of buying, which is why a basic prequalification is among the first things I usually do. I don't want to waste your time showing you stuff you can't, or shouldn't, afford any more than I want to waste my own. But there's a lot you can do to qualify yourself, so that you know how strongly you're inclined to buy, and approximately how expensive a property. This way, you know that the agent or lender isn't leading you down the primrose path with properties you cannot really afford. This is a severe problem right now, especially in expensive areas. I've said it before and I'll say it again. You need to know how much house you can really afford in a sustainable situation, and you have to make certain your agent knows and sticks within your budget. The one who shows you the five bedroom house, when you can really only afford the three bedroom condo, is not your friend. I'd fire such an agent the first time they showed you something you could not reasonably get for your known housing budget (which is one reason I recommend against Exclusive Buyer's Agent Agreements, and don't ask for them unless I'm giving clients something beyond MLS listings for their exclusive commitment). The agent who shows you the three bedroom condo you really can afford when everybody else is showing you the five bedroom house you can't, is your friend, whether the "Oooohhh" factor is there or not, and even if the "Eeewww!" factor is there. Curb appeal is how sellers sucker buyers (and yes, when I'm a listing agent I'll help you with that in every way I can. It's the most important part of my job to help my client get the best deal they can. But right now I've got my buyer's agent hat on, and my job is to help buyers see the diamonds in the rough and not pay more than they're worth).

Once you've done your self-qualification, that's when I'd go find a real estate agent. I wouldn't worry about an actual lender's prequalification as long as you know what your credit score is. A good agent is going to do a prequalification anyway, and if they're a loan officer as well, they'll set you up there. An agent who doesn't do loans should be able to provide recommendations for someone to do the prequalification, and if they don't recommend the same loan provider for the loan as did the prequalification, I'd go back and check with the provider who did the prequalification anyway, as well as finding other prospective loan providers, not to mention pointedly not accepting the new recommendation for a loan provider. Despite the fact that I'm a loan officer who also does real estate, I'm not sure I'd trust a real estate agent with my only loan application. I came to being an actual real estate agent from being a loan officer for several years first - and then I went and learned how to do real estate. The average real estate agent who does loans never spent an apprenticeship doing loans, never learned the ins and outs, and has no clue whether they can deliver what they put on the Mortgage Loan Disclosure Statement (California's replacement for the federal Good Faith Estimate). They just figure "It's the same license, so I can, and it's an easy way to earn a lot more money from the same clients!" They don't really know loans, they've just figured out that it's a way to make more money. Furthermore, there are too many shady personalities out there, and way too many real estate agents think they know how to do loans but don't. There are a fair number of crooks and incompetents and just plain gladhanders, who only care about whether they're getting a commission on this particular offer, out there, but most of what I do as a real estate agent can be plainly seen and understood by my clients. What a loan officer does is much less transparent to even the most sophisticated borrowers until it is too late to change to another provider. I've seen way too many people burned by only applying for a loan with one provider. I've only ever not been able to do one loan on the terms quoted and locked (and I did my darnedest to help the provider who could, where most loan providers in my shoes would have obstructed to the best of their ability, as I've also learned by bitter experience), but I've seen a lot of people who applied with the loan provider who talked a better deal but who couldn't deliver any loan at all, much less the one they talked about. Many times they have come back to me in desperation two days before escrow expires, or seven days after it was supposed to expire, and I can't always help them in time then. Always apply for a back up loan, especially if it's for a purchase.

Take any newspaper advertisements you see about rate, however, with great heaping cargo ships full of salt. I'll cover what's really available later on, but for now what you need to know is that loan companies advertise with teasers like Negative Amortization Loans and short term ARMs and hybrid ARMs that takes five points to buy the rate and you still won't get it when it comes time to sign the final papers. The whole idea is to get you to call, so that they can get you to sign up, and when they deliver something different at the end of the process, your choices are poor and their accountability is practically nonexistent. I don't think I've ever seen a real rate on a real loan that I would be willing to get for myself advertised anywhere, in any medium. Even the so-called "best rate" websites and newsletters are notorious for cheating. I've gone right down the line calling them and asking about loans that were supposedly the standards they were quoting to, and gotten not one answer that was within half a percent of the rate quoted on the website or in the newsletter. Nor were any of the websites or newsletters I've complained to (or my company complained to, when I worked for an internet lender that was signed up with them) interested in enforcing the rules. I don't know one single loan provider who advertises actual rates that they can actually deliver anywhere. Those few companies who are actually willing to do it have all quit advertising in disgust and gone to finding clients in other ways.

Continued in Part 3: Consequences

This is something I probably should have dealt with some time ago.

A seller carryback is when the seller agrees to "carry back" some part of the purchase price themselves. In other words, instead of getting the full sales price of the property (less outstanding liens), the seller accepts a certain amount of the purchase price in the form of a promissory note from the buyer. This note is usually secured by the property, making it a "purchase money" loan for purposes of determining recourse, which means there usually isn't recourse on the buyer. Furthermore, the seller's trust deed is usually in second or third position, behind the primary loan and possibly a secondary loan.

The reason behind doing this is that some buyers cannot qualify for a sufficient loan, or have credit sufficiently bad that no lender is willing to loan them the necessary percentage of the value, considering the down payment they have (usually zero). But in the current environment, every last potential buyer is heavily sought after, and some sellers are willing to do whatever it takes to make the transaction happen. Particularly as being willing and able to do a seller carryback is one tool for being able to get full price from a buyer who needs one.

As an example, let's consider someone with a 520 credit score and less than 5% down payment in the current lending environment. They might be able to get 80% financing full documentation, or perhaps 70% stated income. But all they've got is less than 5. If the seller wants to do business with them, it takes a carryback to make the deal happen. If the buyer needs a carryback, he's got to be willing to meet the seller's terms for making it happen. This gives the seller who is willing and able to do a carryback access to potential buyers that sellers who are unwilling and unable to do so do not have. Furthermore, it gives those sellers who are willing and able to carryback part of the purchase price leverage in negotiations to get a higher price than they otherwise would have. Not every seller has the option of a carryback. Matter of fact, right now relatively few have that ability. The ratio of buyers to sellers is in the high 20s right now locally - but the ratio of buyers to sellers willing and able to do a carryback may be 1:2 or lower.

Lest there be any doubt, a carryback is not something you keep secret. You don't need to shout it from the rooftops, but at a minimum, all of the lenders involved have to be notified in writing as to what's going on, and have to accept it, also in writing. There are some lenders who will not permit them at all, even though their loan takes priority. There are other lenders who will accept them but impose conditions. They are all going to want to see a loan repayment schedule, and include that in debt to income ratio calculations. It may be possible, in theory, for a "silent second" type carryback to be approved, but the lender wants to see something that seller is getting in return for extending financing, and most such loans will not meet the underwriter's "smell test," particularly not in the current loan environment, which has gone within a couple of weeks from being far too permissive to completely paranoid, as the lenders scramble to avoid consequences of years of bad decision-making. Trying to game the system in this environment in order to get a higher debt to income ratio through the system is highly likely to be interpreted as fraud.

I've mentioned that sellers' trust deeds will be occupying second or even third position, which means that in the event of default the loans occupying higher positions are paid in full, before there is one penny paid on the seller's. It therefore behooves sellers to be extraordinarily careful about extending financing, as if the people were able to qualify for the full amount of financing they need with regular lenders, chances are that they would have done so. Furthermore, if the holders of the higher priority trust deeds foreclose, your deed will be wiped out by the action of the trustee's sale. Concrete example: A $500,000 purchase is financed 80/10/10: 80% ($400,000) on a first trust deed, 10% ($50,000) on a conventional second trust deed, and 10% ($50,000) on a seller carryback. The seller discovers that they're in over their head, and even if prices don't recede the property only nets $450,000 at auction. Less the costs of the trustee's sale, that first trust deed gets all of their money (or at least most) the second trust deed might get some of theirs, but there is no way that you're going to see a penny of yours. Even if prices go back to ballooning like they were three years ago and the property is now worth $700,000 after two years, you might not see any of your money unless you go to the trustee's sale armed with cash to defend your interests - just like any other holder of a junior trust deed.

Servicing can be a real issue as well. Do you know the proper way to service that loan in the state you are operating in without missing any i-dottings or t-crossings? If not, you could lose most or possibly even all of your rights under the loan contract. Professional servicing organizations exist, but they 1) cost money that cuts into your margin, and 2) make mistakes anyway, which you are responsible for. Not too long ago I fought and won a battle with an out of state servicing company that was violating California law. If I had wanted to, I could have sued both them and the holder of the note as well as making criminal complaint. Servicing requirements are deadly serious.

With all that said, many sellers right now are in a situation where a carryback means, "Hey, I might get the money, where if I didn't, I definitely wouldn't." If this describes your situation, a carryback might be something you should consider.

Lest you not understand, most sellers want cash, not a loan. It's very hard to use a loan, particularly a private loan of dubious quality, to assist you in buying your next property. You can't just spend a promissory note like you can cash. There are loan buying services out there, but most of the time the amount you get will be heavily discounted, particularly if you cannot document a history of on-time payments and you are in a bad credit situation. It is this fact which sellers who are able to offer carryback financing leverage in order to get better deals.

There are those out there who like carryback financing. Most often, they are real estate sharks. What they are hoping is that they will get their twelve percent for a couple of years, during which time value will go up, and when they turn around and foreclose, having not only been paid their above market interest but also having leveraged that loan into renewed ownership of the property at an appreciated price. Another one of the tricks is to use the existence of the carryback as leverage to get a price significantly above market for the property from desperate buyers who can't get anything else, and as soon as the buyer has made the payments for a few months, sell the note. However, the note buyers have caught on to that little trick, and in the current environment of decreasing or stagnant prices, they are balking at paying full price or anything like it for those notes.

And that's where I'll stop, lest I inadvertently release more scams into the wild. Suffice it to say that there is sufficient potential for abuse in the practice of carrybacks that lenders have become very sensitized to the possibilities, and have taken what they feel are appropriate steps to limit their potential for losses due to the abuses that have taken place in the past.

Caveat Emptor

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You would be amazed how often I encounter people who are certain they're getting a great deal on this loan that's in process, but they have no idea what that that deal is. All they really know is that their prospective loan provider sure acted like their friend.

Well, excuse me, but have you ever heard of "Honest Iago"? Any sales person is going to at least pretend to be your friend. The tricks are legion, and they're not evil, in themselves. But it's much easier to betray someone from a position of trust. "Don't worry, I'll take good care of you." Yes, and even better care of your wallet after it's in their pocket. A real friend may ask for your business, but they won't get upset if you can find a better deal somewhere else.

Loans are complex transactions, but there are three main things to know: Type of loan, interest rate, and the total cost to get that loan at that rate. You should be able to remember three things about one of the biggest transactions of your life, right? Beyond that, there's what the costs include, and whether there's a prepayment penalty, both of which are also important. The reason the existence or non-existence of a prepayment penalty is important should be obvious. A very large proportion of people who agree to even two year prepayment penalties end up paying them, and half of seven percent of $400,000 is $14,000 more that loan will cost you down the road. The equivalent of three and a half extra points, for crying out loud!

What it includes is equally important. Does it include appraisal, title, and escrow (or legal fees in those states that still require the use of attorneys)? There are all kinds of fees involved in a loan, but these are the three biggest, and because they are paid to third parties, the law allows the actual dollar amounts to be excluded from quotes. What sounds cheaper: $3022 or "$1405 plus third party fees". In this instance, it works out that they are exactly the same. Similarly, you want to find out if the dollar figure you are being quoted includes the dollar amount of any points you will be charged. Each point is one percent of the final loan amount, so if you've got a $400,000 loan when everything is said and done, you've paid $4000 for each point. If that's two discount points and one of origination, that's $12,000 on top of all the usual fees.

Force them to add in all the costs, and quote you in terms of what the loan amount is going to end up being after rolling all those costs into your loan, if that is what you intend to do. Make them quote your payments based upon that final loan amount, not the base loan amount. Those are the costs you are really going to end up paying, whether or not you wrote a check out of your account to pay them. Those are the payments you're really going to end up making. There are two sorts of mortgage consumers out there: The ones who insist upon understanding what they will really be paying, and suckers. Suckers sometimes stumble across someone who actually gives them a good loan at a good price, but it's blind luck, and far more often, they don't. Furthermore, just because you're not writing a check out of your account doesn't mean you're not paying those costs. You are, and the dollars you spend that way are every bit as real as the dollars left in your grocery bill, even if they are in much larger amounts for mortgage loan fees.

Every time I write an article like this, I get emails that say, "What if I'm doing business with a large reputable company?" Those are some of the worst. Those beautiful buildings, that plush carpet, those beautiful furnishings, those attractive salaries? Your fees are going to pay for those, along with the investor payouts that make that company so attractive to investors. They are competing upon the basis of advertising and reputation, not price, but a loan is not a vehicle. As long as it's on the same terms and conditions, it's exactly the same whether it is from National Megabank or the Bank of Nowhere. And terms and conditions are mostly standardized. The only real exception I'm aware of is the Islamic loan programs. So there is no reason not to force lenders to compete on price.

Now it is another misconception to think that the standard forms you get at the beginning of the transaction mean something. They don't. There are too many games lenders are allowed to play with those. The only way to be reasonably certain that they actually intend to deliver that loan on the terms they tell you about is to get them to give you a written loan quote guarantee, detailing:

-loan type (e.g. "thirty year fixed rate loan")

-interest rate (e.g. 6%)

-total maximum costs including third party fees and points (e.g $3022)

-whether there's a prepayment penalty. Yes or no. Not maybe. Not probably not. Yes or no.

-any conditions upon the guarantee. (almost always, "underwriter approval of the loan as submitted")

There should also be a statement that if they do not deliver the loan as described, they will pay any difference so that the net cost to you does not increase. Once you've got a guarantee with all of this, then and only then can you make a real comparison between loans. Companies that will not guarantee their quotes in writing are telling you that they cannot deliver what they talk about, that they are intentionally low-balling you in order to get you to sign up, and that they will add hundreds to thousands of dollars and quite possibly a higher interest rate when you go to sign the papers. I'm sure that makes you feel all warm and tingly and inclined to use them, right? If they could deliver that loan they are talking about, they would guarantee it. But if they won't guarantee their quote, you have no idea what loan they really intend to deliver. It's only if they will guarantee their quote that their loan can really be compared to other loans.

Loan rates and the prices to get them do change over time. They cannot be locked indefinitely, and the longer the lock, the more expensive the loan. Furthermore, all quote guarantees are going to be subject to locking while the rates are still in effect, which for A paper loans and lenders is no longer than the end of the day. But missing a day of works that costs you $300 to $500 in pay in order to intensively shop loans is likely to save you thousands of dollars.

Now, how to compare loans if one has a lower rate and the other has a higher cost. Figure out the difference in monthly interest charges, and divide the difference in closing costs by the difference in monthly interest. This will give you a break even figure in months. Due to time value of money and other factors such as the loan with higher costs will leave you with a higher balance, and therefore cost you additional interest later after you sell or refinance, add fifteen to twenty percent to this figure. Keeping in mind that most people only keep their loans two to three years, that will tell you if you're getting something worthwhile for that extra money. On the other hand, if the break even time is longer than the fixed period of the loan, you know it isn't.

Finally, it is to be admitted that getting a loan guarantee is the second best thing to make certain you get the loan they tell you about. There is a better one: Apply for a back up loan. If you have two loans ready to go, you're not relying upon the good intentions of one provider, and your choices are not limited to sign that one set of loan documents or you don't get a loan.

Caveat Emptor

This is easy. Much easier than effectively shopping for a loan or a listing agent. So easy that a congresscritter can do it. So easy that congressional leadership can do it.

The only thing possibly moderately difficult to understand is that finding a good Buyer's Agent takes place in two steps, not one.

The first thing to do is figure out your situation. What do you want in a property, and what is your budget? I've written several articles to help you determine your budget, but the one piece of data they are missing, because they have to be, is what the rates that are available to you are. Unless you're sure that you fall into the topmost category - great credit score, no late payments or anything, and you're looking to buy something well beneath what you can prove that you can afford, you can only find this out by having good conversations with several loan officers. Rate advertisements are teasers, aimed at getting you to call, useless in reality. I have never seen one for a loan that 1) actually existed, and 2) that I would consider signing up for, even if I could get paid for it.

Then, make a list of agents you might like to work with. This can certainly include Uncle Bob, your neighbor, or your poker buddy, but you want more than one agent on the list. My experience is that agents at the big chains are (in the aggregate) not up to the standards of the ones working at independent brokerages, but your mileage may vary. Also, I am a Realtor, but that's for reasons completely unrelated to competence or ethics. I'll believe that Realtors are superior to non-Realtors when the boards of Realtors start handing out penalties for non-compliance with the code of ethics that mean something. Ditto all of those little "designations" that have been cooked up to parallel the ones financial planners get. Unlike many financial planning designations, some of which are graduate degrees of one value or another, these are marketing efforts cooked up to fool a gullible public. The qualifications for the real estate designations are laughable in the context of ChFC (Chartered Financial Consultant) and other designations that require five to ten graduate level college courses to attain.

Then, have a good conversation with those agents. The first thing you should ask, on the phone, is whether they require an Exclusive Buyer's Agent Agreement, or whether they will accept a Non-exclusive Buyer's Agent Agreement. If they require an exclusive agreement, that should be the end of the conversation, and cross their name off of your list. If you sign an exclusive agreement, you are locking your business up with that agent. You are putting yourself in their hands completely. The only reason that you should even consider an exclusive agreement is if you are asking for something special that costs money - for instance, expedited foreclosure lists (The free lists are a waste of time, because they're already flooded before you get them. The subjects of the free lists have said, "no" to literally hundreds of others before you even got the list, so unless you've got something very special in the way of an offer, you are wasting your time.)

There is absolutely no good reason not to sign a standard Non-Exclusive Buyer's Agreement. You risk nothing by signing. You lose nothing by signing. You can have any number of them in effect, and as long as you don't sign any exclusive agreements, you're fine. All you do is assure the person whose services you use that if they find and help you purchase the property you like, then they will get paid. The only reason not to sign such an agreement is if you're looking to stiff a good agent who finds you the property you like so that you can use a discounter on the transaction, and that's shooting yourself in the foot. The money you get back is unlikely to be as much as the difference the good agent will make in negotiations, or the trouble the good agent will save you.

One more thing any buyer's agreement you sign should have: An explicit release if they are the listing agent for the property you decide to put an offer on. It is a very bad idea for buyers to accept a dual agent, because the agent has a responsibility to the sellers, but nearly so deep of one to you. They're on the other side. I wouldn't pick a quarterback that played for the opposition, and neither should you. Tell them to pick a side and stay on it, and as they already have a listing agreement, they've already chosen the other side. It's great for them and for the sellers that they've sold the property, but their desire to get paid double does not outweigh your right to representation with responsibility to you and no conflicts with other duties.

Tell them what you want in a property, where you would like to live, and what your budget is. Then ask them if it's a realistic, and see what they say. If they say yes, that's great, but wait until you hear it more than once before you celebrate. Many agents will tell you yes, figuring that it's easier to raise your budget than lower your expectations, especially once you have seen this beautiful property that they "just happen" to know someone who can get the loan for. Nor is this a straight yes/no question. They might tell you an unqualified yes, as desirable properties possessing those characteristics you want are available in that area below your budget. They might tell you that such properties are available, but that they are scarce and you must act expeditiously. They might tell you that you're going to need a fixer to get those characteristics, or that you're likely to need to compromise some of them. Or they might tell you that what you want is sufficiently beyond your budget that an alternative approach is probably called for.

Now, whatever the first agent tells you, don't swallow it whole. Get some evidence. If they show you literature for brand new beautiful properties just being sold out that are less than your budget right where you want to live, that's evidence. If they execute an MLS search and the only things that pop up in your budget are out of area properties being cross-marketed, that's evidence. The worse the news they tell you, the more likely it is to be true. Sales persons do not like to be bearers of bad tidings, especially before their commission is paid. But if they're willing to give you evidence that your expectations need to be adjusted downward, that is evidence that this is probably someone who takes their fiduciary duty seriously, and that is an agent you probably want to work with.

Notice that I said an agent, not the agent. There's a reason for this. Remember that non-exclusive agreement you signed? Remember that I told you it's fine to sign more than one? Here's the good thing about signing more than one: Now you have multiple agents looking for that special property that will make you happy. You won't pay any more for this than for one agent, because they are all competing for your business and the same commission check. This is the stage at which the agents are actually competing for your business, by looking for the property you want. You don't have to decide who gets paid up front. You wait until one of them brings you what you want. Furthermore, the agents will self-select or disqualify themselves to a large extent.

Let's say you signed seven non-exclusive agreements. One is Teresa Top Producer, who slams clients into the first property that's even a rough fit. She'll take you shopping one day, try hard to sell you every property, and get upset if you don't make an offer on the first day. By "try hard to sell" I don't mean anything so crass as the hard sell. What happens is she talks up everything she mentions, very little if any compare and contrast, and whatever she does, no calling your attention to defects or undesirable items. In fact, she'll do her best to distract you or get you to ignore them. For savvy, patient, intelligent buyers, Teresa is not a good fit as an agent, and you're going to realize it after one or two properties. And here's another great thing about the non-exclusive agreement: You just stop working with her, and she's out of the picture!

The second person you sign an agreement with is Martin MLS. Martin does an MLS search, and wants you to go around with him to every property on that list. He sets up an automatic notification to you of every property that fits some basic criteria that gets listed, and he wants to go check out every one with you. Lest you not have figured it out while reading the last two sentences, Martin's approach is basically throw a lot of mud at the wall and hope that if he throws enough, a little bit will stick. Martin may or may not have any real idea of the spread and breadth of your market, and he may or may not be able to recognize a real bargain when it bites him, but he probably has a good idea of the general state of the market. You'll get the same idea pretty quickly by working with Martin, after you see fifteen or twenty properties that seem pretty much to run into one another - except for the ones that are drastically over-priced. You get the idea that working with Martin is not an effective use of your time, and soon, you stop, at which point Martin's out of the picture.

The third person you sign up with is Benny Bump. Benny's got his own unique way of making transactions happen. Actually, it's not at all unique. It's common enough to have a general slang term among Realtors. What Benny does is take you to three or four properties that look like war zones, comparatively speaking. These are not desirable properties on the scale you're using. They fall well short of desirable on one scale or another, and usually on several scales. Then, just as you are despairing of ever finding something you like, Benny Bumps you by showing you this absolutely gorgeous property in perfect condition. "Yes!" you happily cry, having quite predictably come to the conclusion that You Want This One, and you'll Do Whatever It Takes to get it. You may or may not notice right away that the price is way above the budget you stated to Benny, and he's counting on you not caring when he whispers that he knows how to get the loan, or knows someone who can. The vast majority of people who meet Benny will fall for "The Bump", and most of the ones who don't fall for it will not realize what a vicious, unethical trick it is. You, being that one in a hundred or so who is smart enough to realize what he has done, inform Benny that his services are no longer desired.

I have said it before, and I will say it again. You should demand to know the asking price of every single property before you agree to view it, and if the agent can not explain why that property might be obtained within the budget they agreed to work with, that is an offense not only worthy of firing them, but one for which financial prudence demands firing them. You can't fire someone who you've signed an exclusive agreement with except by waiting out the agreed upon period. You can fire someone whom you have signed a non-exclusive agreement at any time by Just. Not. Working. With. Them.

The fourth person you signed with is Rhonda Rebater. Rhonda is a discount agent sits in her office, and waits for you to bring her the property you like to her for negotiations. She'll usually also expect you to meet the appraiser, meet the inspector, etcetera, nor will she shop services for effective value. Quite often, Rhonda has her hand out to these people behind your back. Not necessarily for a lot of money in any one place, but her whole approach to the business is based upon volume. And she does quite a lot of volume, because people who think in terms of cash in their pocket (that rebate of some portion of the buyer's broker's commission that Rhonda gives them back) are her legitimate prey, and they flock to her in droves, like politicians to campaign contributions. If you're savvy enough in the business that the value provided by a good agent is negligible, why don't you get licensed and earn yourself the entire buyer's broker commission? Because Rhonda has little real market knowledge, she's a very weak negotiator on your behalf, and because her business model is predicated upon high volume, she's an awful guardian of your interests as the transaction goes along. So Rhonda may not be precisely out, but she's not likely to go out and find you a real value.

The fifth agreement you signed is with the team of Gary and Gladys Gladhand. Gary and Gladys get their business from social groupings. Gary has a bowling team and a softball team and he's a soccer coach and Gladys is PTA president and girl scout troop leader and organizer of the party circuit. And, of course, their ads are all over the place. "Mr. and Mrs. East Side" on the East Side and "Mr. and Ms. West Side" on the West. Together, their objective is to know enough people, and make certain all of these people know that they are Realtors, that they are always getting referrals from these folk because "of course" they'll use Gladys and Gary, and walk-ins from those stupid enough to believe their advertising. You may have come to them as Uncle Gary and Aunt Gladys, because normally Gary and Gladys don't allow non-exclusive agreements, and they will almost certainly balk at the no dual agency release, even from a relative. Their whole business approach is predicated upon not competing for your business, and locking out the competition so that they don't have to compete by making it a social obligation to do business with them. In point of fact, Gary and Gladys may be decent or good listing agents, but are extremely unlikely to be strong buyer's agents, because all of this schmoozing takes a lot of time that could more productively - from potential buyers' point of view - be spent obtaining market knowledge and finding bargains. Their approach is reasonable on the surface: You want a house and their listing wants to sell a house for too much money and they want to get paid both halves of that commission, so there just isn't any reason not to make everybody happy, is there? But a good buyer's agent is going to be the one that looks at every single property, whether they listed it themselves or not, with a cold, rational, logical mind and clear eyes for comparative value. I don't list many, but I rarely show one of my listings to one of my buyer's clients, because my listings are priced to the market and the situation. This means that while they're not over-priced, they're not the greatest bargains in the market, either. I only need to price low enough to attract people foolish enough to sign an exclusive agreement with one of these problem agents, not to attract a cold, steely-eyed buyer's specialist. Gary and Gladys are going to show you all of their own listings (except the ones that are obviously unsuitable) first, then, all of the listings with other agents in their office that might interest you, and then they are going to start acting an awful lot like Martin MLS: Throw enough mud at the wall, eventually some of it might stick. Are any of these tactics likely to generate a superior value from a buyer's point of view? Not on Planet Earth.

Now, you got really lucky, and beat the odds. Out of the seven you signed up with, you've actually got two agents that are going to do their job by going out and looking for the best values in your current market by actually looking at them and comparing them to each other, from the standpoint of your needs and your desires and your budget. The ratio of these agents in the real world is much lower than that. If you don't have at least a couple agents left on your list when you're done vetting, go out and find more. You can sign any number of non-exclusive agreements, at any time.

When these folks show you a property, they show it to you with context in mind. They're willing to say bad things about every property, not just the ones they don't want to sell you, even though they should only be showing you superior values. They're going to compare and contrast virtues and defects. Lest I be unclear, it is precisely for these virtues that you have been vetting your candidate agents. You can only see real evidence as to whether they are present or absent in action, not during the interview process. Knowing enough to sign a non-exclusive agreement gets you the ability to find the defects in the five agents who didn't do what you wanted, and you didn't need to commit yourself to any of them before you observe them under fire. Instead, you know enough to understand that there is no real need to commit to anyone until you make an offer.

Now, which one of these two agents gets paid? That depends upon which one of them does a better job of finding you the property you want. Best trade-off of those things you want in a property versus price. Of course, you won't be sure exactly what price you can get it for until you go through the negotiations. And it is possible that one of the others really does have something good, if not nearly so likely. In my experience, Martin MLS will eventually get the job done, if you have enough patience or he gets lucky. Rhonda Rebater will be there if you get frustrated enough to take matters into your own hands. And it is possible that Gary and Gladys Gladhand have something you like, but it is unlikely to be a superior value. Teresa Top-Producer and Benny Bump are deadly poison, as far as buyers are concerned, and once you discover this hidden attribute, you should give thanks that nothing you saw with them was attractive to you. But none of these others has gone out and physically looked at all those properties, which gives those two good buyer's agents you did find an unbeatable amount of market knowledge, which they can then turn around and use to your benefit in negotiations. When they can tell you what the bad points in a property are as compared to the other stuff, you have evidence that they can explain it to the agent on the other side of the transaction. Except for those owners who just won't listen to reason because they want their property to be worth more than it is and they are not going to entertain evidence to the contrary, this evidence is powerful stuff, and can make a huge difference on the price you end up paying, even on a property that is legitimately an above average value to start with.

Caveat Emptor

I am considering buying a home, although I have not made up my mind on the subject. This is not due to indecision, but rather due to a lack of necessary information. There are many factors to be considered in my case, and in order for me to make an informed decision about buying, I need to solve for several variables involving cost.

My questions to you involve what steps I can take to solve those variables. Should I begin with a pre-qualification or loan approval? Will a lender invest time and resources in me when I have no specific property in mind, and I may ultimately decide to continue renting? Should I start by speaking with realtors in order to guage what is available in my price range? Will realtors invest time and resources in me when I have no loan arranged and I may ultimately decide to continue renting?

Also, what is the proper sequence of action for someone who is seeking to collect all the relevant information in order to make reasoned decisions about buying a home?

Well, a major question is whether you can trust real estate agents to answer the question honestly. Some will, most won't. If they tell you to buy, they make money. If they tell you to keep renting, they don't. One trusts that you see the potential for abuse.

The question here of "Should I Buy A Home" really separates into two basic questions: "How much home do I qualify for?" and "Is there a better alternative, financially?" You can then decide if buying or renting is the better alternative for you.

Qualifying yourself to buy a home, or to use better phrasing, figuring out how much home you should buy, is easier than most folks think. You can look in the classifieds section or on any number of internet sites to find out what the asking prices for properties like ones you might want to buy are in that neighborhood.

The personal information needed is easily available. First, you need to know how much you make per month, as you make mortgage payments monthly. Next, how much your mandatory payments are. Third, about what your credit score is.

Most people know how much they make per month. Now, "A paper" guidelines go between thirty-eight and forty-five percent of gross income for your total of all required monthly debt payments. Subprime lenders will go up to anywhere between fifty and sixty, with most limiting your debt to income ratio to fifty or fifty-five percent. I'd recommend staying within A paper guideline, but calculators are easy to use. So multiply your monthly income by thirty-eight percent, forty-five percent, fifty percent, and fifty five percent. This gives you a set of four numbers, which you may call anything, but I'm going to name A0, B0, C0, and D0. They correspond to what should by standard current loan guidelines be easy total debt service payments for most folks, moderate payments, difficult payments, and extreme payments.

Now most people have recurring debt of some sort. Credit card payments, car payments, furniture payments, etcetera. This does not include monthly bills that you are paying as you go. You know what your monthly obligations are. Whatever this number is, call it $X. Subtract $X from each of those four numbers above, so that you have the numbers that you really have available to spend on housing in each of these four scenarios. I'm going to call these numbers created by subtraction A1, B1, C1, and D1.

Now these numbers you have must cover all the recurring costs of owning a home. These include not only the principal and interest payments on the loan, but property taxes, homeowner's insurance, homeowner's association dues if applicable, Mello-Roos districts here in California, and anything else that may be applicable where you want to buy. Within the industry, the acronym most often used for this is the PITI payment, for Principal Interest Taxes Insurance, with the understanding that it includes anything else necessary as well. Association dues and Mello-Roos districts are a function of where you buy. Every condominium or coop is going to have Association dues or some equivalent. Mello-Roos districts are limited time property tax districts assessed to pay for things like municipal water and sewer service for new developments. Most newer developments here in California have them, and the equivalent districts are becoming more and more prevalent in newer developments elsewhere. Homeowner's Insurance is mandatory if you're going to have a loan - no lender is going to lend money on an uninsured property, but note that even the best homeowner's policy does not include flood or earthquake coverage, so if you're buying in an area where that is a consideration, the extra cost of a flood policy or earthquake policy is probably worth it. Condominium owners should have a master policy of homeowner's insurance paid for by their association dues, but it's still a good idea to have an individual policy for your unit, which is a standard policy form called an HO-6 policy here in California.

Property taxes are paid to city, county, state and possibly utility districts, but your county tax collector should be able to quote overall rates. There is no way to cover all the possibilities from here, but you can make an estimate, if nothing else by calling the county and asking. Note that they usually quote taxes in terms of a percentage tax value per year. Multiply assessed value by tax rate to get a per year tax bill, then divide by twelve to get a per month value. In California, there's a rule of thumb that property taxes per month are approximately one dollar per thousand dollars purchase price per month in most places (it will be more if there's been a bond issue approved or any number of other circumstances), so take the last three digits off the purchase price and that is usually close to your monthly tax liability. $250,000 purchase price? $250 per month. $500,000 purchase price? $500 per month.

By subtracting off all those figures, you get a range of monthly payments for the loan that you can actually afford. Call these A2, B2, C2, and D2. Armed with these and your credit score, you can figure out what kind of rate you might qualify for. Right now thirty year fixed rate A paper purchase money loans of no more than eighty percent of the value of the home can be had without points at something between 6.5 and 6.75 percent. Make allowances for a significantly higher rate for the last twenty percent if you don't have a down payment, and for the whole amount if your credit is below average, or if you cannot document income via w-2s or income reported to the IRS for the last couple of years. I will soon have an article here that might be helpful in gauging how much of a loan you'll qualify for. You can usually get significantly lower rates by being willing to accept a hybrid ARM as ooposed to a thirty year fixed rate loan (I've been doing it for fifteen years), but right now with the yield curve the way it is, the difference is marginal.

Knowing the payment you can afford, the interest rate, and the term of the loan, you can calculate how much of a loan you can afford. Knowing any three of principal, interest rate, payment, and term, a loan calculator can tell you the fourth. Do this with your four values, A2, B2, C2, D2, and you get four potential loan principal amounts, A3, B3, C3, and D3. These correspond to loan amounts where the payment should be easy, moderate, hard but doable, and a real stretch. To this, add any money you have available for a down payment, and subtract projected purchase costs (maybe $1000 plus 1 percent of home value). This gives you four values A4, B4, C4, and D4. These correspond to the purchase price of the homes you can afford under those four prospective loan amounts. You can then compare these amounts with what is available, and at what price, in those areas you might wish to buy.

Continued in Part 2: Process.
Finished in Part 3: Consequences

One of the things I have to deal with on a continuing basis is people calling me because they like something they saw on one of my websites, but they have no intention of doing business with me.

Most common is would be buyers calling me, "Just tell me the address of that Hot Bargain Property." That's not how it works, as I explain in literally every one of those posts. It isn't luck I find those properties. It's dedication and skill. I spend a lot of time looking, not just in MLS, but in public records and physically going out and looking at them. I've spent a lot of time learning what to look for and how to look for it in all three places. Maybe, if I had personal need of their professional services, I might consider a barter - mine for theirs. But in point of fact, I suspect a large percentage of the calls I get of being lazy agents (A receptionist answering the phone in the background saying the name of a certain major chain is a dead giveaway).

There is a reason these properties are of interest. I'm going out and finding properties that are noteworthy bargains, even by the standards of a buyer's markets. If it could be done by any random person with MLS access, anybody who could type could do it. I can do it, in large part, because I make a habit of doing it and most others won't. It is work. If George digs a ditch, you don't pay Charlie. You pay George. Same principal here. The reason I'm worth more than the discounter, in terms of what I find, how well I negotiate, and everything else, is a function of all of the work I do that helps me find good properties, spot problems, know the micro-markets I work in, understand what is critical and what is not. If you find the property yourself without any help from me, yes I'll discount my services for negotiation and facilitation because you're not getting the largest part of the value I provide, and I'm not risking the largest source of agent lawsuits. Otherwise, I am providing more value to you than the discounter and am therefore worth more pay. And I'm providing it, not that discounter. I'm not going to give out the locations of the special bargains I find to anyone not willing to work with me. Like I said, George digs a ditch for you, you pay George, not Charlie. You want to pay Charlie, get Charlie to dig the ditch. But he not only can't, he won't.

Borrowers will call about my Real Loans for Real People. They want to know what lender that's with. Well, I hate to break it to you, but the loan I have is the loan I have. Credit Unions, National Megabank, etecetera may use the phrase "cut out the middleman" to try to get you to avoid brokers, but that's not the way it works. Even if I gave you the name of the lender, very few of them give their loan officers actually get rates as low as brokers from their headquarters. Why? Because they're not paying my overhead, and my clients aren't captive to them. They regard their clients as captive because comparatively few people shop loans effectively. They go to big name lenders, who have no more programs than other lenders, and comparatively little imagination. They may or may not have the most appropriate loan program for a given client. Usually not. Big lenders mostly compete on the basis of name recognition and consumer comfort. A broker may be a middleman, but we function more like discount outlets. And the specific stuff I get is for my clients. If you want it, you've got to be one of them. If you weren't interested, you wouldn't have called.

What I'm trying to get at is this: Trying to cut out the person who provides the value you're interested in is counter-productive. Even if I told you what lender a particular loan was with, rates change at least every day, and it's unlikely they will offer as good a deal through their dedicated loan officers, even if they are the right fit for your loan. Trying to cut out the person whose market knowledge and work enabled them to recognize a bargain means that even if you know what property it is, you're in a weaker position on negotiations. Net result, you get some money back, but you also paid a higher price than you needed to in order to get it. The latter is almost certainly more than the former - probably by a good bit. Once again, if you want George to dig a ditch for you, or if you want George's ditch, pay George, not Charlie. You'll come out better, even if George wants a few bucks more than Charlie. If Charlie's ditch was something you wanted, you wouldn't have needed to get George involved. Chances are, even if you buy Charlie's ditch, you're going to want George to fix it, so the money you paid Charlie is wasted.

Caveat Emptor

I'll keep hitting this and hitting this until everybody understands this critical point.

From email:

First of all, I love your website. It is just a plethora of information for first time buyers like me who wants to be an educated buyer. Although there will be some things that I won't be able to understand completely, I try my best to learn the things I need to and have to.

I am located in DELETED and a first time buyer. We went with DELETED for our lender after shopping around for quite sometime. Our closing date is (23 days from now). There has been tell tale signs that they might be charging us junk fees. Please tell me if this is just my imagination or if I have the right to feel this way. When we got the first Good Faith Estimate from them they listed their lender's fees and all the other fees. Now when we got the paper work to sign begin the loan approval process new fees showed up on the lender's fees. I know this is an estimate but should their fees be constant on all of the Good Faith Estimates? Second, I was told to believe that the rate they will quote us will be based on the middle credit score between the three credit score bureaus. They used the lowest credit score. I am worried that come closing day that new lender fees will pop up on the loan papers and god knows what else. Is there a reason for me to worry about this lender?

Yes, there are reasons to worry about this lender. There are reasons to worry about most lenders. To be perfectly fair, there are reasons to worry about most brokers, as well.

There is a fact that it is critical to understand in order to be a well-informed loan consumer. If you ever lose sight of this fact as a loan consumer, you are likely to be setting yourself up to get rooked. Conned. Taken. Lied to. That fact is that there are all kinds of incentives for loan providers to tell you about a better loan than they can deliver in order to get you to sign up, and there is a huge upside and no real downside to them for telling you about something better than they can really deliver.

Let me haul out a rate and cost sheet for one of my favorite lenders (This sheet will be outdated by the time anyone reads this) and favorite title and escrow companies. If you are buying a $400,000 property with 20% down, then with this lender I can lock and deliver a 30 year fixed rate loan at 6.00% with zero total points to the borrower and total real costs of $3022. That's the grand total in costs. Lender's fees, broker's fees, appraisal, escrow, title, notary, recording, etcetera. For traditional purchases, where everything is like the default ways of doing it, the seller would also pay a $750 escrow fee and a $1253 policy of owner's title insurance. There would be prepaid interest on the loan of $160 for every three days remaining in the month ($53.33 per day), and the costs of an impound account if you wanted that. If you were in my office ready to lock that loan as I write this, that's what I could guarantee in writing to deliver. If you wanted to buy the rate down, I could deliver 5.75% for about 0.8 total points, which translates to about $2600 in dollars. If you wanted to buy it down further, I could deliver 5.50% for 2 points total, or about $6500. That's what's real. I can prove it, because I could write a loan quote guarantee that says if the rate is higher or the cost is more, I pay the difference.

Now, let me illustrate how far it's legal to low-ball. First off, all "third party" fees mysteriously disappear, as do the lender imposed fees, and now I'm quoting total costs of $610 plus four things marked "PFC" on the Good Faith Estimate. If I decide to tell you about those lender imposed fees in order to make it "feel" more real, that changes the costs to $1405, plus, of course, those four pesky PFCs. Or three PFC's plus $1530. Sounds like a lot less than $3022, doesn't it? But it's going to be $3022 PLUS any "junk fees" I try to sneak past you. Make no mistake: You are going to pay for that appraisal, that escrow, and that title insurance policy. It's a fact of life, inflexible as gravity. But I don't have to tell you about it initially.

Now, let's start playing games with the rate, and I must emphasize that these are legal. I would face no penalty for any of them. First off, I can have a legitimate belief that rates are headed downwards, and I could use the rates that include a 15 day lock instead of thirty. A fifteen day lock costs less. So I could tell you that you're actually getting a rebate of an eighth of a point to pay your closing costs. Many loan officers will tell people this. However, when the loan takes twenty-five days to fund, now the clients are paying that eighth of a point due to extension fees. I can actually hit fifteen days most of the time from a standing start if the buyer and seller cooperate, but it's not something I can promise because if they don't cooperate in a timely fashion, there's nothing I can do to force either of them to work faster. So I don't use fifteen day locks.

But that's only the first game. Let's say I think rates are going down, so I don't lock, but I do tell you what I think rates will be when I have to lock, and I tell you that I can do 5.75 for zero points. Once again, I'm thinking the rates will go down that much, and also thinking about getting to use the fifteen day lock. Lest it be unclear to you, my entire justification for this is raw naked optimism. But it's legal raw naked optimism. Actually, in order to cover myself, I'll say one tenth of a point net cost to you for the rate. That way, I haven't told you it's a no points loan when it may not be. By the way, I'm going to do my darnedest to keep a dollar figure from being associated with any points quote. Why? Because 5.5% for $1405 plus "two of those points thingies" sounds an awful lot cheaper to the average person than the real fact that 5.5% will cost them roughly $9500 altogether. Same loan for the same set of facts, but one way of putting it certainly sounds cheaper, doesn't it?

But suppose my raw naked optimism does not come true in the real world. Suppose the rates end up staying where they are now. This is actually better than what often happens, because you get 5.75% delivered for about three quarters of a point, because they don't lock the loan until they're ready to print final documents, and so they can use the fifteen day rate. Pretty cool, eh? You saved about 5% of a point, or roughly $160, off what the quote was. But remember, they did not, in fact, lock your loan. Suppose rates are higher in fifteen days, which is what I really do expect. Let's take a WAG and say that 5.75% gets delivered for 1.2 points, and the loan officer says, "Sorry, that's the best I could do." Now, failing to lock cost you four tenths of a point, or about $1300, and I've seen it much worse than this. In fact, since the loan officer didn't guarantee their quote, they then blow it up to 1.5 points, and they've just put an extra $1000 in their company pocket.

Now, type three games: Don't tell you about the pre-payment penalty they're sneaking in so that they can get paid more. Two year pre-payment penalty gets them roughly $1900 more in the company pocket if they're a broker, $6500 if they're a direct lender. These numbers go up for longer penalties. But when you get transferred in a year and a half, it costs you $6500 extra for that penalty when you have to sell your property. I can even give you a small part of that to make it look like my loan is better than the competition. "Sure, I'll pay for the appraisal," or give you tenth of a point back to reduce closing costs, while hiding this $6500 salami in your loan papers or even coming back after the loan has funded and asking you to sign a prepayment rider "for compliance."

There is a type four game: Games with the loan type. Suppose I tell you about a "thirty year loan at 5.5% for 1 point total." Sounds much better than any of the preceding, right? Except that what I'm talking about is a 5/1 ARM, not a thirty year fixed rate loan, and I'm still able to play all of those type one and type two games with this quote. I could be talking about a 3/1, a 1/1, or even a three month LIBOR loan with those words. Point of fact, I actually can lock, guarantee, and deliver a 5/1 at 5.5% for 1.2 points with a thirty day lock while I'm writing this, and a 5/1 is something you should probably consider very strongly, but it's not the same thing as a thirty year fixed rate loan.

Let's take it up a couple more notches. How does a "Forty year loan at 0.5% with a fixed payment of $735.70" sound, especially when the payment for that 6% thirty year fixed rate loan I talked about is actually $1918.57? Pretty good? And the forty years explains why the payments are so low? Well, congratulations! You've just signed yourself up for a negative amortization loan at a real rate of 8.2% right now, and not fixed at all. The payment is fixed, all right, but the interest rate isn't. Oh, and by the way, if you keep making that payment of $735.70 for three years, you'll owe $59,000 more while under threat of a pre-payment penalty that starts at $10,500 and gets bigger until it expires. Refinance then, and your payment goes to $2272.27 if the same thirty year fixed rate loan is available them. May not be too bad for some folks, but if you couldn't afford the $1918.57 in the first place, why would you think you can afford 20% higher payments than that in three years? I'd say it's more likely that you can afford $1918.57 now than $2272.27 then. But everything I actually told you about that loan was not only legal, but also true.

Enough horror stories for now. What can you do about this? Keep it in mind that the prospective lender has every incentive to play these sorts of games, and very little in the way of concrete incentives not to. People sign up for loans based upon who tells them about the best deal, and if that lender can't get you to sign up, there is an absolute ironclad guarantee that they don't make anything. If that loan officer is paid on commission, and the vast majority of all loan officers are, the choice is probably get money in their pocket or definitely no money in their pocket. But the cold hard fact is that without a written guarantee, none of the initial paperwork means a damned thing. Furthermore, most lenders are quite adept at avoiding giving you a guarantee. "We're a large ethical company that's been in business for 100 years and we honor our commitments." Sounds great, right? But neither a Good Faith Estimate nor a Mortgage Loan Disclosure Statement in California is any kind of a commitment. None of the forms you get at the start of the process is. Both forms say right on them that they are estimates. They could be accurate estimates or they may not be. The only thing that's required to be accurate is the HUD -1 form, and you don't get that, even in preliminary form, until you are signing final loan documents.

Now, some facts and industry statistics to illustrate why the incentives are there to tell you anything it takes to get you signed up. First off, the only universal guarantee in this whole situation is that if you don't sign up with them, they make nothing. Zero. Zilch. Nada. They've got bills they need to pay, same as you do. So you sign up, and they work on your loan for three weeks, and now it's time to sign papers, and they're not quite what you were led to expect. But you don't notice the difference. In fact, industry statistics say that over fifty percent of people don't notice at signing, and a substantial fraction of that never figures it out. I understand why; it wasn't easy for me to learn what's important, and I have an accounting degree. These forms are confusing to the uninitiated. Furthermore, the loan officer keeps you busy with a line of patter, and is talking about how much you're going to enjoy your new home, or what you're going to do with the money you're saving from the lower payment. This makes it more difficult to concentrate on those numbers swimming on that unfamiliar form. Some companies actually train their loan officers in how to distract the victims. I worked for one such company for about a month, until my loans started being ready to close and I discovered what they were up to when they showed me how to distract these people who were putting money in my pocket from how badly they were getting gouged.

Now, let's say you do notice. The situation is not the same situation as when you've signed up. If it's a purchase, you no longer have thirty days to get your loan. Indeed, your loan contingency has expired and you'll not only lose the purchase escrow, but your good faith deposit as well, if you don't sign those loan documents. You've been building up your emotions for the last three weeks thinking you're getting ready to move. You've put in your thirty days notice, you've packed up all your stuff, you've got the moving van reserved and the friends lined up, not to mention that you and your spouse are totally ready and emotionally psyched up to be owners!, and to be moving into this property. Darned few people will not sign purchase loan docs, even if they do notice the discrepancies. Industry statistics say less than 5%.

In a refinance, the motives are not as strong to sign loan documents that are less than it was indicated earlier. Most of the time you've got the house and you've got a loan you could keep, you just thought this one was better. But you've been told about this lower payment, or lower rate, or you need that cash out for your vacation that's starting next week or the remodeling contract that you've already signed. Your loan officer quite likely rolled thirty days of interest into the loan and told you that you would be "skipping a payment" (You never skip a payment, as I've explained many times), and so you've gone and spent the cash on a long weekend in Las Vegas. Now you don't have the money, and if you don't sign these documents, you won't have the money for your payment, never mind the kitchen remodel the contractor has already started or the nonrefundable tickets you put on your credit card. Finally, quite often the lender required a deposit that you're going to lose if you don't sign those loan documents. Industry statistics say that about 80% of refinances who notice major discrepancies in their final documents will sign anyway. All they have to do is sign their name, and it will all be over.

Now, whether you noticed and signed anyway, or didn't notice, you have just rewarded that loan provider for lying about that loan in the first place. They lied, you signed up, they got paid. Wow! It's like a license to print money! Not only that, but if they just play the game a little bit carefully, there's no legal liability or responsibility to you. I should note that there are a significant number of loan providers who do go over the top into illegal territory and liability, but it's not difficult to tell what is for all intents and purposes a huge whopping lie and stay legal (it is slightly more difficult if they're acting as your real estate agent for a purchase as well).

Now, what can you do about this? The absolute smartest thing you can do is apply for a back up loan at the same time you apply for the one you think you're going to actually get. This way, you can use the existence of another loan being ready to go to get leverage your bargaining position into a better deal for you. Now loan officers don't want to be back up providers - unless they think there's a real chance they'll end up with the business. In order to persuade them there is a real chance, for the business, you have to give them a real legitimate shot at being the primary provider. As my article on Getting a Loan Provider to Agree to be a Backup Loan says, if you're already signed up with someone else when you approach a loan officer about being a back up, you should expect to hear something that contains the word, "No." Failing that, I want to be paid something for my work, or I don't want to work. I'll want a deposit that I can keep if you don't do my loan.

The second best thing, which is an excellent supplement to the above, is a written Loan Quote Guarantee. Any quote that's backed up by a real guarantee is much stronger than one that's not. I don't care if the difference is three percent on the rate (and it won't be that high). I'd take the guaranteed quote over the one that isn't guaranteed, every time.

Finally, you can always insist upon answers to the same set of Questions for loan providers before you sign up. They can lie, and they can evade, but they are good and necessary questions to ask.

Caveat Emptor

There are actually several different kinds of listing agreements. They get their names from the rights conferred when you sign the contract. The vast majority of agreements concluded are either Exclusive Right to Sell or Exclusive Agency.

Exclusive Right To Sell means that no matter who buys the property, that agent will get the listing commission. There is an intelligent reason why most listings are Exclusive Right to Sell: If I can spend all that money and time doing the work to sell your property, and then you can not pay me for it, well, let's just say I'm not going to be so enthusiastic about spending that money and that time if the prospective buyer can then go straight to the seller and I get nothing for my efforts. Some agents won't accept other kinds of listings. Other agents will only do so on a flat, up front fee basis, as opposed to deferring their fee unless and until the property actually sells. If you want a good agent to devote their full energy to selling your property, this is the kind of listing contract for you. If there is one particular person you think might buy direct from you, the owner, that can be handled via an Exclusive Right with Exception, which designates one of more persons who are exceptions to having to pay the agent, but even that is a marginal idea. Yes, it might save you a commission. But it will definitely create some doubt in the agent's mind, and less willingness to spend what they might really need to in order to get a sale made. Better to get a solid yes - or no - from that person who is an exception ahead of time. If they really want the property, they won't have any problem committing saying they want it when you ask them. And you can't sell to more than one person, right? So you shouldn't be wondering about somebody you found when you contact an agent. And before you condemn agents for acting like this, ask yourself how hard you would work at your job in order to maybe get paid, or maybe not.

Exclusive Agency means that you won't pay agent commission if you sell it yourself, but you will pay if they, or some other agent, brings you the buyer. Any agent with a buyer is presumed to have been procured through the listing agent's marketing efforts. Nonetheless, this does allow for random people to knock on your door and buy the property direct from you - despite the fact that the listing agent's efforts were what alerted them to the existence of the property. Since most agents have been burned on this one or know someone who has, few agents want to accept this style of agency without requiring you to at least pay for their efforts, and they are mostly not the top-notch ones. But if you really want to exercise the escape clause in having to pay the agent, count on being on your own through the negotiations and escrow process. A very large proportion of prospective buyers who will go around your agent to negotiate with you directly are sharks, unqualified buyers unable to buy, or possess some other characteristic that's going to cost you a large amount of money, time and frustration.

Limited Service listings are popular with discounters, but they typically do not work on the basis of commission delayed and contingent upon a successful sale. They want their money up front. Cash, check, or, sometimes, charge. Furthermore, the reason they are called limited service listings is because they are not fulfilling all of the services that real estate agents are normally expected to fulfill, and their responsibility to you is also much lower. Might be a good thing to do if you're a former real estate agent who knows how to do it, but the average client doesn't know how much they don't know. The pitch is "save money!" but that's not how it usually works out. When the agent on the other side is a discounter, a good buyer's agent knows that their client is going to end up very happy. The same thing applies when a good listing agent gets someone represented by a commission rebate buyer's agent. One more thing I should mention: A lot of both types make their living by shifting their work onto the full service agent that they presume is going to be on the other side of the transaction. What happens if there is no such full service agent - in other words, if the other side is using a limited service discounter also? The work needs to get done, and neither agent is going to do it. You're going to do it yourself or pay a lawyer - and paying a lawyer to avoid paying a real estate agent full commission is like spending a dollar to save a part of a dime.

Open Listings are listings where there is no single agent that has a right to get paid. Of course, no one has the responsibility to act on the owner's behalf, either. Not to market the property, not to make certain you get the best deal possible, and not to represent your best interests in other ways. Therefore, most agents and discount listing services usually want a flat fee in advance for open listings. It may be small or relatively small, but it's cash upfront. There may or may not be a listed payment to buyer's agents in open listings, and therein lies the horns of a dilemma. You don't list a buyer's agent commission and buyer's agents avoid you because there is nothing in it for all of their hard work. You list a low one, and they're still going to take their buyers elsewhere. You list a good one, and they'll bring their buyers all right - while working on their buyer's behalf to get them a better deal. Kind of like an arms race, except it's not life or freedom at stake, only money. Still, you just invited a bigger, better equipped army than yours into the fight, on the other side.

Probate is a special purpose listing when the property is being controlled by the estate of someone who died. Probate listings almost always go to full service agents because the probate judges are looking to get the best deal possible. There are often debts and there are almost always tax bills, and there are always heirs looking to get the most money possible. Probate is a real pain to deal with, and it takes forever, because the courts are involved. Nor are they necessarily great deals. For most local probates as of this writing, the court or the heirs have set a minimum bid that's more than the property is worth, because they evaluated the property on the basis of the prices when the owner shuffled off the mortal coil. However, with declining values, they're only hurting themselves. There's one not too far from my office where I had a client it would have been perfect for - except that the minimum bid is at least $40,000 more than the property was worth on the market back then. It had been on the market for a good long while before I found it, and it's still on the market today, more than six months later. If they'd priced it $20,000 lower, it probably would have sold within a month of going on the market. By the time I found it, prices were diverging by $40,000. Now, it's more than that.

There you have them, the major types of listing agreements, their major advantages and drawbacks.

Caveat Emptor

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. 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.

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 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 loans 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.

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 require 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

Great Open Floor Plan in Quiet Neighborhood!

General: Urban East County, 3 bedroom 2 full baths. Asking price between $400,000 and $425,000. I think you might get it for $370,000 or possibly a little less.

Why you should be interested: Solid house (with two car garage!) in quiet neighborhood with good schools for an affordable price. Neighborhood is stable, and the few that come on the market sell quickly.

Selling Points: Large kitchen and dining room, 2 full baths. Walled, covered patio could be easily enclosed for more space. Side yard for boat or RV parking!

Why I think it's a potential bargain: This is a solid property at a great price. Last sale on the street was over $550,000.

Obvious caveats: The inside garage access is through a bedroom. Kitchen could use an update, as could both bathrooms.

Why it hasn't sold already: I don't know. But the neighbors are trying to get friends interested, and that's always a good sign of a bargain!

If you keep it ten years and it averages only 5% annual average appreciation per year: Based upon a purchase price of $370,000, the property would be worth approximately $600,000. If you held it those ten years before selling, you would net about $290,000 in your pocket (not including increased value from updates!), assuming zero down payment. As opposed to renting the $1700 per month most comparable currently available rental and investing the difference at 10% per year tax free, you would be approximately $160,000 ahead of the renter, after the expenses of selling.

Fact you should be aware of: Just that this house does not appear to be a good candidate for expansion.

Obvious way to enhance value or appeal of property: Update the kitchen and bathrooms, enclose the patio.

This property appears to be eligible for a first time buyer Mortgage Credit Certificate provided your family income is not more than $82,800 or $96,600. Ask me for more details, on this or any other property.

I'm a buyer's Realtor®. I find places like this that can be gotten at bargain prices. I save you money while getting paid out of the listing agent's commission, not costing you a penny. Nor are these the only bargains I find. In order to protect everyone's best interests, I require a Non-Exclusive Buyer's Agent Agreement. This is a standard California Association of Realtors form that leaves you are free to work with other agents, but if I find the property you want, I'm the agent you'll use. That's fair, and there is no reason not to sign such an agreement unless you're an agent yourself.

Contact me: Action Realty 619-449-0723, ask for Dan or email danmelson (at) danmelson (dot) com. Ask me to find a bargain that fits you!

The Best Loan Right NOW

5.75% 30 Year fixed rate loan, 1 point total, and NO PREPAYMENT PENALTIES!. Assuming a $400,000 loan, Payment $2334, APR 5.885! This is not an Option ARM! This is a thirty year fixed rate loan. The payment and interest rate will stay the same on this loan until it is paid off! 30 year fixed rate loans as low as 5.25%! Zero points and zero closing costs loans also available!

Best 5/1 Loan tradeoff: 5.5% 0.9 total points. Assuming $400,000 loan, payment of $2271, APR 5.623. 5/1 ARM loans available as low as 4.875%! This is not an Option ARM! This is a real loan with a real payment that actually pays your loan down, and the rate is fixed for five years!

No points and zero cost loans also available!

These are actual retail rates at actual costs available to real people! I always guarantee the loan type, rate, and total cost as soon as I have enough information from you to lock the loan (subject to underwriting approval of the loan). I pay any difference, not you. If your loan provider doesn't do this, you need a new loan provider!

By comparison with last week, the rates are significantly lower. However, due to the nature of what caused it, I expect this to be a temporary effect.

All of the above loans are on approved credit, not all borrowers will qualify, based upon an 80% loan to value and a median credit score on a full documentation loan. Rates subject to change until rate lock.

Interest only, stated income, bad credit and other options also available. If you need a mortgage, chances are I can do it faster and on better terms than you'll actually get from anyone else in the business.

100% financing a specialty.

Please ask me about first time buyer programs, including the Mortgage Credit Certificate, which gives you a tax credit for mortgage interest, and can be combined with either of the above loans!

Call me. EZ Home Loans at 619-449-0070, ask for Dan. Or email me: danmelson (at) danmelson (dot) com

Agencies issue subprime guidance: sources

At issue is whether regulators will force lenders to qualify subprime borrowers based on their ability to make the highest possible monthly payments during the life of the loan, instead of the initial lower rate, according to banking experts.

I have more than once likened the current subprime underwriting guidelines to a mutual financial suicide pact. But it's more similar to a game of "russian roulette" in which you keep making money as long as you're in the game, but if that revolver hits the loaded chamber they'll be picking your financial remains out of the wall for decades.

an email I got March 1 from a wholesaler: (identifying information redacted)

Wall Street does not want Subprime loans. As you may already know the subprime market is being hammered and many subprime lenders have gone out of business. Wall Street investors have either stopped buying subprime loans or have substantially increased the yields they require on the loans they purchase. Some of the reluctance to purchase higher risk loans has also effected the Alternative loan market.

Today, I received notices from two investors that they were suspending their purchases of Alt. loans.

Subprime and Alt loans - Watch for these industry changes:

Elimination or, much stricter underwriting guidelines on Stated Income loans for W2 employees.

Raising the FICO and underwriting requirements for all 100% financing. Currently, borrowers with as low as 580 FICOs can find 100% financing; that is likely to be eliminated very soon.

Stricter underwriting requirements for First-Time borrowers. Elimination of underwriting guideline exceptions for Subprime and Alt loans.

If you are working with pre-approved borrowers that require 100% financing or have marginal credit (below 620) those borrowers should be re-qualified to make sure that financing is still available.

Now Alt loans means Alt-A. Specifically, negative amortization loans, the only thing from that market that has a significant share of the loan market. This has got to be one of the most telegraphed financial changes of the last century. This site got at least two hits yesterday from people looking for employment selling these repossessions waiting to happen.

The coming meltdown of the loan industry has got to be the most telegraphed happening in the history of finance. And they could have gotten out by accepting less profit and tightening their underwriting standards, thereby drastically limiting their losses. But the ability to shift the risks to others by selling the loans got them too greedy, and they're getting caught by it as the investors turn around and want to know why this excrement was misrepresented as more worthy than it was.

Subprime is in a world of hurt as well, with the feds wanting them to underwrite the loan according to the payments that the people are going to end up paying, not just the first few payments.

Long and the short is look for a large smoking hole where the lenders who have popularized the shaky lending practices of the last few years used to be.

The Backlog is Gone

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Just a note that with today's post, I have exhausted the backlog of my articles. From now on, new articles will appear at the rate of three to four per week, most weeks. On those days when I don't have a new article, I will "bring forward" one of the older articles that isn't too time sensitive. It would do no good in the vast majority of cases to reprint the Hot Bargain Properties posts, or the Real Loans for Real People. But the stuff that's on a more enduring scale, I will reprint on those days when there's nothing new.

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, 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 fixers 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," or "The number of people who can afford those payments." This is intentional. If you want them bad enough, there are lots of loans out there, and lenders eager to make them, such that you can 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 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. But it isn't my opinion that matters. 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. 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 on the rate 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, I'll bet money that 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

People ask for referrals all the time, and many folks will stumble all over themselves to provide referrals. Some of them really are excellent providers. Others are not so good, but the person providing the referral has an agenda of their own, and you have to be aware of the possibility. Never give anyone your business without shopping it around just because someone referred you to a certain provider.

In many cases, the reason why you are referred to Company X Realty or Company Y Loans has nothing to do with any allegations of them being an efficient, diligent, effective or inexpensive provider of those services. Number one on the list of reasons why people tell you about X Realty or Y Loans is because company X or company Y refers business back to them. This isn't illegal, but when you ask a real estate agent for a referral to a low cost mortgage provider and you get referred to one of the ones that's competing on the basis of consumer name recognition, you should realize that the mortgage providers with national advertising campaigns are not among the low cost providers. For analogous reasons, I usually advise people to stay away from the national realty chains, even if they're not local to me. But I digress. The point is that the person who refers you to this person is effectively getting paid by referring you to them. Not exactly a sterling reason to trust their motivations in making this referral.

Indeed, this is one of the ways that lenders in particular avoid competing on price. Ladies and gentlemen, so long as it is the same type loan on the same terms, a loan is a loan is a loan. The only real difference is the tradeoff between rate and cost, or, in other words, price. But lenders do not want to compete on price, because that means they don't make very much money. In fact, they want to avoid competing on price, and the captive audience from referral business is one prime example of how they do it. Joe Realtor sends Jane Lender business because Jane refers business right back to Joe Realtor, and because the client has been told that Jane Lender gives great loans at a great rate, the client doesn't shop loan providers like they might otherwise have done, leaving Jane a freer hand to charge a higher markup.

These are not the only reasons why referrals happen. For instance, here in San Diego, many real estate agents will refer to one particular loan officer because they know that loan officer won't tell the client any inconvenient truths, such as, "You cannot really afford this house." They refer to this loan officer because that loan officer will just keep their mouth shut and put the negative amortization loan through, and everybody gets their commission check. But this sort of thing happens in markets where there are affordability issues for the average person.

Finally, explicit kickbacks are illegal, and there are limits on how often Joe and Jane can buy each other dinner out or whatever arrangement they have to transfer wealth, but that doesn't mean it doesn't happen sometimes. After all, there aren't any Department of Real Estate employees following Joe and Jane around 24 hours per day, so this kind of stuff gets hidden all the time. I've had more than one blatantly illegal offer of referrals for kickbacks since I've been in the business. Some of these folks are brazen. No, there's no percentage in turning them in, either. This is one of those situations the saying about, "No good deed goes unpunished," was invented for. One guy who did turn someone in years ago told me about the thousands of dollars in legal fees he incurred, plus three years of investigation that shows up on your license as an unresolved complaint. No thank you. Sometimes, you have to content yourself with remaining apart from any illegalities, while warning people that this sort of thing does happen.

Caveat Emptor

I had made a request to repair that included $3700 credit for closing costs. I wanted to get things done like safety issues and more critical maintenance issues done. Our estimate said that it would be about $4900 to do all the maintenance we were looking for. The seller was doing a bit, but not all.

The seller apparently balked at giving us any credit. He felt they conceded all they could. Anyway, my agent convinced them to at least counter. I was a bit angry at the initial balk. (the emotion part of the deal). After the initial anger, I went looking for problems and found one that frightened me. My agent had given me the inspection report from the seller's purchase of the home six years ago. There were things on there that were still a problem two years later. Primarily, high water pressure in the house (with the dire warnings of damage to pipes and fixtures as the potential side affect). Secondly, ants. The report six years ago had mentioned ants. Every time I looked at the house, (we visited it 5 times), I always saw ants not many usually only 1 sometimes 2. So, my residual anger ballooned these concerns way up. My ignorance was on the pipes. I have since talked to one plumber and an extended family member who is a retired contractor, home builder and home inspector. It was his comments that alleviated my fears about the pipes and allowed me to calm down a bit. He basically said, "Wow, six years of a pressure test - and it passed. Great! We usually only do two hours." He also said, get a regulator on it, but you shouldn't have a problem.

So, emotions, ignorance and too much time to think - nearly killed the deal.

Sometimes, people get all worked up over the little stuff.

On the other hand, sometimes people don't get worked up when they should. This person wasn't clear, but I'd get upset if my agent tried to placate me with a six year old inspection. If it's just compare and contrast with a brand new inspection, fine. But if someone else paid that inspector, they may not have any responsibility to you, and you want them to be responsible to you. I wouldn't accept the inspection that the previous prospective buyer had done. Sometimes, agents trying to make sure a transaction goes through will try to give you an existing inspection, because they know what problems that will show. This is always the hallmark of a commission grabber, and you should fire them. Then start looking for something else.

An inspection around here will almost always reveal some defect which wasn't dealt with in the first round of negotiations that resulted in the purchase contract. Usually, they're dinky little stuff. Replace one light bulb, brace the water heater, maybe replace the garbage disposal. Sometimes, however, it is major work: rotting substructure to the roof, foundation damage, etcetera.

It does not matter if it is major or minor. It needs to be fixed. The way I usually explain minor stuff to sellers is, "You don't want to lose a $500,000 sale over $30 in repair work, do you?" It does sound rather silly, doesn't it?

If it's major, it still needs to be fixed. Here's a new defect in your property that causes it to be worth less than the agreed upon price. You can often get the buyer to accept the property for a lesser price - estimated cost of repairs plus an allowance for them being the person who has to deal with it. You're not getting out of major repairs on the cheap unless the buyer's agent hoses their clients. I want a reliable contractor out there to give my buyers an estimate for major repairs, and you'll find that's about par for the course. As the seller, you can have your choice between fixing it, giving them an allowance that makes your buyer happy, or losing the transaction.

Lest you think, "I'll just forget about that prospective buyer," even in seller's markets the next one that comes along is likely to find exactly the same set of defects and want exactly the same set of repairs, which is going to cost - you guessed it - pretty much the same amount of money. The only differences are one, in the meantime, you've spent some money on your mortgage, taxes, etcetera, and two, the earlier offer is usually the better one. In other words, same situation, but you're out more money.

Somebody's going to ask about "as is" sales. They really don't make much difference to this fact. I'm not going to let a buyer put in an offer on an "as is" property without an inspection contingency. The inspection shows something major that we didn't already know about, the choice is going to be give us an allowance, fix the problem, or lose the transaction. It's only an actual "as is" sale if the inspection doesn't reveal anything new and major. Matter of fact, selling "as is" is a red flag that tells me the seller probably knows about something major, unless it's a lender-owned property. If it is lender owned, "as is" and "without warranty" are the ways that business is done. Otherwise, it really doesn't mean a lot beyond that you are indicating that you would rather give an allowance than pay for repairs.

For buyers, you don't need to freak out about every last little thing. If you're getting a screaming deal, the fact that you need to put a handrail up in the stairway at a cost of a couple hundred bucks shouldn't cause you to pull out of the deal. If the owner doesn't want to make repairs, be willing to accept the cost plus something reasonable to represent your time and the decreased utility in the meantime. Don't demand triple the cost of major repairs unless you really are going to have to spend that much sitting in hotels and eating out until the work is done.

A reliable contractor is your best friend in subsequent negotiations. First off, it should tell you what it really is going to cost. If they've said that it's going to cost $7500 to fix, that's better information than any agent or inspector can give you. This does wonders for peace of mind, knowing that it's going to be $7500 to fix the problem after you're in title, not $75,000.

An allowance for construction work from the seller can be a great opportunity if you've got some cash left in your pocket after the sale. For example, if you're going to have to replace the green board in the bathroom anyway, it doesn't cost that much more to add some nice updates and upgrades. An extra $500 for better materials can really go a long way. When you go to sell, more money in your pocket. In the meantime, a much nicer bathroom. Even more to the point, one much more aligned with your personal tastes.

Every negotiation after the initial purchase contract is at least as dependent upon the good will of both parties as the initial purchase contract. If one party or the other thinks they got the worst of the initial negotiations, you can expect that to be reflected in how far they are willing to go for you when the inspection reveals defects. You want the person on the other side of the transaction to be thinking they get a decent bargain, one that they would make again. That way, they won't want to blow it off before it happens, by being unreasonable about the repair negotiations. Yes, this is one more reason that you want a buyer's agent to help with negotiations.

Caveat Emptor

All too often, these days, I have to tell desperate people who've found me on the internet some bad news.

Nobody can match the rates they've got at a price worth doing.

This is just a sample of what I've seen:

I bought a house in DELETED in Aug 04. It was my first house, and I was pumped about it. Now, it's become a liability. I want to leave soon, and pursue an (advanced degree). I've been extensively preparing for my (test), and I expect to qualify for some 'almost top-tier' schools out east. So what do I do with my house? Bad market = hard for me to sell.

I am looking to rent my house out. The largest hurdle comes from the fact that DELETED has very low rents, and very high housing prices. To give you an idea, a typical 4-plex has a yearly NOI of around 5% of the total property cost. Yeah, a 5% return. My mortgage (I'll detail it later) costs $1500/month (PITI). Market rent is about $1k-$1200/mo. I looked at other mortgages, but it seems to me that most brokers are a waste of oxygen. You say what you need, and then they offer you a loan that makes them the most commission. I had a few people try to talk me into a Neg AM/option ARM loan. I did some math... Total waste of money. What I need is something to lower my payment while I hedge my position.

Rents are increasing, and I believe that the market will be less of a buyers market in a few years. I am working with a mentor and put together a Lease to Own deal, which may solve my issues, but I would like a Plan B.

My house is worth no less than $268k (zillow estimate, I think it's low. $275k would be better) I owe ~$253k

I have an 80/20. The 80 is 5.125% interest only for 5 years, then goes ARM on me. The 20 is a HELOC currently at 10.125%. My FICO is between 750-775. The property is located at DELETED. It is a normal detached house. This would only be a refinance for a few years, until I can sell the property in a better market, but if a locked option presents itself, I would continue to rent that place forever! I don't need any cash out money, but I will take any available, because I am getting around 10% return on my Funds.

Now this particular person makes some errors in his thinking and in the email, but they're forgivable in non-professionals. The meat of the matter is that he, like so many, cannot afford the current payments under the new circumstances.

This guy has a 5.125% interest only loan. Last I checked (a few days ago) I could just barely do that with one lender for something north of four points, and could not do 5.00 at all. Even if adding roughly $15,000 to his loan amount was worth keeping the same interest rate a little longer, just the fact of adding $15,000 to his loan is going to raise his payments.

In this case, like so many, there literally is no loan I can do for this person that's worth the cost of doing it. I could cut his payment for a while with a negative amortization loan, but only at the cost of raising his real interest rate about 3%, which means it's really costing him about $6000 per year extra, while sticking him with a prepayment penalty in the area of $8,000. A classic case of pay me now, keep paying me, and pay me later, too. Well, I couldn't do that to anyone, much less someone wearing the uniform in times of war, as this man is. Even if this guy had been in California, I would have told him the same thing I did: There's no loan out there right now that will help him in the classical sense of the word help. What he needs is cash flow and time. A negative amortization loan would provide that, but at a much higher cost later - too steep for me to believe it's worth paying. A lower interest rate or longer amortization or even interest only might help some people, but none of those options make sense for someone who has already got 5.125% interest only. I can tie 5.125 by adding over four points plus closing costs to his loan, but I don't need to consult my rate sheets or get out the calculator to know that adding $15,000 to break even on the interest rate is not going to really help him.

Now, this is not to say that refinancing into a higher rate is never justified. If it was going to do something he needed it to do and it makes sense in other ways, yes, I can see it. For instance, if he was going bankrupt due to some bills, but consolidation will prevent that from happening, it might be the lesser of two evils. But that doesn't appear to be the case.

Now when his loan hits it's first adjustment, chances are pretty much 100% that I'll be able to do something worth the cost of doing it. But that adjustment would be to roughly 7.25% if it happened right now. Whatever it is, the way that rate adjustments work is underlying index plus a set margin, determined by your contract. Lenders think of hybrid ARMs as teaser rates; they're always offering rates less than the index plus the margin to start with. Which is one reason to be careful with hybrid ARMs. I love them, I do them for myself; but they will go up when they adjust.

This man is only one of millions out there in similar situations. I can't speak to his specifics, but there were lots of people who bought with loans such that they could only afford the payment interest only or worse. The fact of the matter is that they were poorly advised, or not advised at all if they kept everything quiet and never told the person who might have warned them. They probably should not have bought the property they did, but somebody talked them into it. In most cases, it was someone with a fiduciary responsibility to them who should have known better.

I don't have a problem with interest only loans as purchase money. I do have a problem with negative amortization loans as purchase money for a primary residence. Interest only, though, can be okay if they can afford the fully amortized payment but choose not to. For instance, this gentleman could have afforded more, but was getting a better return on his money elsewhere. Sophisticated user and all that. He knew the risks going in, and chose to take them.

However fantastic an investment real estate is, however, it is not a risk free investment, and sometimes the bet does go sour. Members of the real estate profession were doing all they could to push rapidly appreciating prices, and members of the loan profession were doing everything in their power to aid and abet. Both groups were pushing past results to illustrate future performance, and I saw or heard the phrase, "nobody loses money on real estate," so often and in so many places I stopped getting angry at it for a while. Both groups were pushing people into bigger and bigger loans for bigger and bigger properties, and more and stronger bidding wars, and rationalizing it on any basis that happened to be convenient and hadn't been debunked in the client's presence within the last fifteen minutes.

Once again, I'm embarrassed by members of my professions, and not just for their avaricious advice to the unwary, but also for their limited understanding of economics and markets. Trusted professionals are supposed to know better. People with fiduciary relationships are supposed to know better. People earning thousands of dollars more for their "expertise" per transaction should definitely know better.

So what do you do if your payment goes up, and the best rates available to you don't help the situation enough?

Sell for what you can get.

Right now, this is a really rotten thing. Many markets are in the tank completely. If you don't have to sell, you shouldn't be in the market when there's thirty sellers per buyer. That being said, if you can't make the payment, selling is the least bad alternative available to you. Even a short sale is not as bad as being foreclosed upon, and if you don't make the payments somehow, foreclosure is going to happen. It's only a question of when. You want to have sold before that happens.

There are a very few exceptions. But pretending that you are one of them when you're not is a good way to take a very bad situation and make it worse. The first rule of getting out of holes is to stop digging, and denial digs deeper.

Please, if you're in a hole, don't keep digging.

Caveat Emptor


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