August 2007 Archives

Better deals for the bank, that is.



Ken Harney has a recent article Study Shows Loan Brokers' Better Side

But now a new, independent academic study has concluded the opposite: According to a team of researchers headed by Georgetown University's Gregory Elliehausen, home mortgage applicants with less-than-perfect credit pay lower financing costs when they obtain their mortgages through brokers rather than from loan officers directly employed by lenders. The same pattern holds true for African American, Hispanic and low-income borrowers.

The study was limited to subprime borrowers, but the results are not surprising:



Overall, broker loans cost 1.13 points less for first mortgages, 1.98 less for second mortgages



For borrowers in predominantly black areas, the difference was 1 point and 1.9 points, respectively.



For borrowers in predominantly hispanic areas, the difference was 2 points and 2.4 points. The explanation as to why this gap is larger is probably as simple as the fact that many of these folks limit themselves to dealing with spanish speakers.

Skolnik added, though, that the data overall could reflect that "brokers in general operate in a much lower-cost structure" compared with banks and retail mortgage companies that carry heavy overhead and employee costs. Moreover, he said, "brokers are far more agile and nimble than retail" lenders, when pushed to compete on pricing and terms.

That and any given lender may have anywhere from a dozen loan programs to fifty, all intended to hit specific niches and priced for given underwriting assumptions. A 3/1 is different from a 7/1 is different from a 30 year fixed, stated income is different from full doc is different from NINA. That's nine programs right there, and this is A paper stuff. Subprime is even more varied. It doesn't matter if you barely meet guidelines or soar through them. If you find a program with tougher underwriting guidelines that you still qualify for, than that lender will give you a better rate on the loan, because they will have fewer of them go sour, and therefore get a better rate on the secondary market. You can go around to all the lenders yourself - or you can go to a broker.



Furthermore, even if you're one of those so slick that you fit into the top loan category of the toughest lender, brokers can typically get you a better price. Why? Two reasons. First, the lenders don't have to pay broker's overhead, making it more cost effective for the lender to do the same business through the broker. Second, and more importantly, when you walk into a lender's office, they regard you as a "captive" client. Brokers know better. Brokers are not captive to anyone, and they know that you're not captive to them. A good broker's loan officer will price with at least a dozen lenders. I've shopped fifty or more for tough loans. Furthermore, there's an efficiency factor at work. After a while, a good loan officer learns which lenders are likely to have good rates for a given type of client. Which do you, as a client, think is likely to be the best use of your time and resources? Going to all those lenders yourself, or going to a few brokers?



This article of mine is also highly relevant to this discussion.



Caveat Emptor

(I do use one piece of non G-rated language below. I hope you'll agree with me that it was necessary to convey the proper sentiment)



USA Today had an oped, "3 ways to help borrowers without bailing them out"



Their suggestions?

Bankruptcy reform. About the only debt a bankruptcy judge can't modify is a home mortgage. Borrowers used to get into trouble not because of unsustainable mortgages, but because they lost a job or got ill. Now homeowners commonly fall behind because they can't keep up with their mortgages. Bankruptcy judges should get more latitude to rework mortgages along with other debt.

That's because it's a secured debt. Indeed, it's a debt secured by a specific asset.



Indeed, mortgages on owner occupied property are already subject to more and stronger protections than any other kind of debt. It takes a minimum of just under 200 days for a foreclosure to happen in California, and we're one of the shorter period states. Notice of Default can't happen until the mortgage is a minimum of 120 days late. Once that happens, it cannot be followed by a Notice of Trustee's Sale in fewer than sixty days, and there must be a minimum of 17 days between Notice of Trustee's Sale and Trustee's Sale. Absolute minimum, 197 days, and it's usually more like 240 to 300, and it is very subject to delaying tactics. There are lawyers out there who will tell you if you're going to lose your home anyway, they can keep you in it for a year and a half to two years without you writing a check for a single dollar to the mortgage company. It's stupid and hurts most of their clients worse in the long run, but it also happens. Pay a lawyer $500, and not pay your $4000 per month mortgage. Some people see only the immediate cash consequences, and think it's a good deal.



While all this is going on, the mortgage company is losing money. That money isn't free to them; at the very least it has opportunity costs - other things they could be doing with the money and earning a profit. But lenders are paying a daily fee for almost every penny in their portfolio. They make money off of the spread between what they pay and what they earn. But if their earnings are zero for this particular debt, they're losing money on this particular debt, and they've got to make it back elsewhere - which means that everyone who doesn't default is paying a premium on their loans for everyone that does. This would cause future mortgage rates to rise, further exacerbating the decline in housing values and putting even more people into trouble. If you don't understand this, you need to go back to high school or read an elementary economics text.



Now allow bankruptcy judges to play with mortgage indebtedness, and there just isn't anything they can do that doesn't result in the lender losing money involuntarily. This is a government taking of private property, explicitly and without possibility of exception for private use. Anybody remember the Fifth Amendment? If it doesn't protect all of us, it doesn't protect any of us. The Kelo decision, which generated a huge flap, at least had a public entity taking title before deeding it over to a private developer. None of these cases would have even that fig leaf. Not to mention that in many cases, the lenders themselves are victims of fraud to one degree or another. In a large fraction of these cases, the borrowers and loan officers were assisted by the lenders employees and policies, but in others they weren't and the lender is just as much a victim as someone who's been mugged - and now we want them to get mugged again by the legal system?



A few more things on this topic: Real estate, being for high dollar amounts, is one of the most profitable targets for scams and confidence games. I can see the general outlines of half a dozen scams that would be enabled by giving bankruptcy judges the ability to modify mortgage indebtedness. I mean legally. Most people wouldn't do it to start with, but the temptation of having your mortgage debt legally reduced, or the payments that go with it, would quickly become very attractive. Get your mortgage debt reduced by $100,000 because that's what you can afford to pay and now you can turn around and sell for a profit. Get your mortgage payment permanently reduced from $4000 to $2500 per month, and either you have a negative amortization loan imposed by judicial fiat, or you have a loan that the lender is stuck with that's only worth about sixty percent of its face value. Especially given the general non-enforceability of "due on sale" clauses, this is not only taking property from the lender, but it's essentially going to require them to hold it for the full term of the note, as nobody in their right mind is going to want to refinance or pay that loan off. Net result: everyone starts working these scams. You think the situation is bad now? If the lenders were subjected to that, rates would go sky high, minimum down payment requirements would skyrocket, and housing values would crash worse than stocks in the period 1929-1932, because nobody would be able to get a loan on any sort of terms even vaguely comparable to what we've got now. We'd have people putting their houses on credit cards, not only because the rate would be comparatively attractive but also because most folks would be able to get a credit limit high enough to finance 100% of a property. Statistical Abstract has there being 123 million pieces of real estate with a median price of $206,000, giving an approximate total value of $25.3 trillion dollars. Under such a scenario, I'd be surprised if prices didn't collapse by 80%, wiping out $20 trillion dollars in wealth directly, or about twice the size of the national debt. Second order effects would increase, if not multiply, the size of the loss. The Great Depression would look like an economic paradise by comparison. All because you want to give people "a little help" and don't think about the consequences.



Lenders will modify notes on their own without compulsion from the courts if you can come up with a scenario where it's in their best interest - by which I mean they'll get more of the money they loaned you back, complete with interest. And if you cannot supply such a scenario, the lenders are correct to foreclose as promptly as possible. That's not just their money. More than half of all Americans have bond investments. It spreads out the risk and the pain, but don't kid yourself that corporations are the only ones hurt. They're not.

Tax code changes. Sometimes, badly strapped homeowners can persuade lenders to reduce the size of a mortgage to reflect a home's plummeting value or the homeowner's inability to keep up with the payments. Sometimes, the lender forecloses and a homeowner can walk away with no house, but also no debt. That would seem to be the end of the story, but it isn't to the IRS, which often considers either action as income to the borrower, and sends a big tax bill. It makes sense to alter the code to keep the tax collector from making a bad situation worse.

I've written on this tax consequence several times in the past. There are good reasons why tax law and tax policy are written that way. What we're trying to do is give people the greatest reasonable incentive not to try scams of this nature. Not to go into debt figuring that if it all doesn't work out, they can just walk away. We're all supposed to be adults. One of the things adults are is responsible for their debts. This is one reason why lenders are willing to loan money - because there are concrete reasons why it is in the borrower's best interest to pay those loans back. Remove that fact, and you've removed the underpinnings of our entire banking system. If you don't understand the economic consequences of that, at least in broad, have the courts declare you legally incompetent and appoint a guardian. You are not competent for any economic matters. You shouldn't be voting. You probably shouldn't be crossing the street without supervision and assistance.



Lenders give great rates on real estate because secured real estate loans are comparatively low risk. Secured real estate loans are low risk because people will do basically anything not to lose their house. Take away the risk of losing their house, and people will do a lot less. It's effectively no longer a secured loan. Combined with the protections mortgages have already, rates will be higher than any credit card. For all the beating of breasts and loud flapping of keyboards that goes on, most people are still handling their loans. Yes, lenders lose lots of money every time a loan goes bad. Ninety-eight percent of all real estate loans are still performing. Let that change, and risk goes up, rates go up, and nobody can get a loan and nobody can make the payments, and nobody will be able to buy, so prices come crashing down in such a way that everything we've seen so far will be as flatulence in a hurricane compared to what will happen.



The number one thing that puts people into home ownership is the ability to get a loan. Rich folks are going to be able to afford property no matter what. Those of us who are somewhat less well off depend upon our ability to use someone else's money. Take away that, and watch ownership rates plummet. As a society, we'll go back to living in rented massive slum tenements, simply because that's what'll get built because the average person simply won't have the economic leverage to afford decent housing, or to incentivize those well enough off to finance housing to build the sort of housing we want. Lionel Barrymore's character in "It's a Wonderful Life" seems like a caricature to us, sixty years later, but it wasn't a caricature at all at the time. The people who made that movie saw stuff like that and its results on a daily basis. Many of them - the ones who never became big stars or powerful producers and directors - lived through it. It only seems like a caricature now because the lending environment has become such that the average person can easily get a loan.

Education and advice. Sometimes, a home could be saved if its owner only knew that it was possible to renegotiate the mortgage -- and that a lender might prefer getting smaller payments to no payments at all. Scores of state organizations and non-profit community groups are working to educate and counsel homeowners, and in many cases to help them renegotiate their mortgages to keep their homes.

And 100 percent of those people could be saved by people doing a very small amount of research before they signed the contract. No sometimes or occasionally about it. But people won't do it. A lot of the people who did these loans to themselves were warned, and chose to not to believe the warnings. Poor disclosure requirements, blind trust in someone who acted like their friend. Lack of elementary common sense. When someone tells you that your payment on an $800,000 loan is $2573 per month (and there are many loans even worse than that out there), all it takes is the mathematical ability of a fourth grader, at most, to realize that even if it's interest only, you're only paying 3.8 percent interest and there just aren't any other loans out there anything like that, and maybe there's something going on that you don't understand. I told hundreds of people first person (never mind the over two million visitors to my websites) about the perils of those loans, and the vast majority of them bought the complete bullshit that someone else fed them because they wanted that house and this was the only way they could "afford" the payments, so they did the loans with other people. If I had just kept my mouth shut and done ten percent of those loans, I'd be richer than if I had won the lottery, instead of scrabbling for the occasional person who wasn't looking to buy a property they couldn't afford.



I'm not saying don't counsel people on how to make the best of a bad situation. But that's happening now, without this prescription, making it a null act, simply posturing for the cameras. One of the great things about the internet is that you can find the information you're looking for if you will keep looking, and cross check its credibility. "I found it on the internet," may be a joke when it comes to serious research, but you can find the correct information if you keep looking and cross check credibility, rather than just believing whatever you may find on the Flat Earth Society website.



I'm saying that the best time to stop this problem was before it started. People will fool themselves. Indeed, one of the most important measures of how free a society is, is the ability of an adult to decide to do something stupid after being fully informed of the consequences. Indeed, that's also a good definition of an adult - someone competent to make their own mistakes.



However, the law and our governments aided and abetted the sharks who took advantage of these people by making them appear to be in compliance with extensive disclosure rules that allow the sharks to hide all of the really important and nasty things behind a smokescreen of unimportant trivia. The people got so bored of details that just aren't important that they signed off on things that killed them financially without reading, presuming it was more of the same nonsense. The stupidity wasn't informed stupidity, because the lenders and agents were able to conceal the real mechanics of what was going on, and what would happen in the future. This gave even the shadiest operations enough of a veneer of legitimacy to pass the casual inspection given by someone who wants to believe it. There was nothing in all of that government mandated paperwork that explained the consequences that would follow, as certain as gravity. If there was anything, it was obscured by all of the nonsense. I can write (and have written) a one page loan disclosure that would guarantee nobody would ever sign off on one of these things without being informed, in big bold type, about the consequences. Such a disclosure is found nowhere in the requirements of any state, and even if it was, government requirements would allow it to be hidden in hundreds of pages of stuff like equal opportunity housing and equal opportunity loan disclosures, things that everyone knows about, and it's often in the lender's interest to comply with anyway (I can't imagine anybody in this day and age being stupid enough to practice loan or housing discrimination, and even if they were that stupid, I can't imagine them getting away with more than a very few instances before the law put them out of business). How about re-writing the disclosure rules so the deadly traps are as obvious as possible, and the sharks can't hide deadly financial traps behind the insignificant minutiae?



This article got a lot longer than I wanted it to be. The point that I am trying to make is that it's very easy to make the damage orders of magnitude worse by trying to be compassionate after the fact, thinking that you're "only" damaging "major corporations who can afford it", when the fact of the matter is that these measures would bring our entire mortgage and real estate system to a screeching halt. The correct tack to take for the future is to make it impossible for people to fool themselves before they get into trouble. As for the present, yes, people are going to get hurt. But the system will work its way through the problems. I am opposed to any mass bail-out of lenders or those who voluntarily signed upon the dotted line. Especially if it's taxpayer financed. Indeed, I want to see the lenders and brokers who did this stuff sued and bankrupted by the investors and borrowers they suckered, and the money managers who should have known better sued and bankrupted by the people whose money they mismanaged. Such results discourage and prevent repeat performances of the sorts of things we have just lived through far more effectively than any mitigation proposal I've heard, with far less long term damage. Bail-outs allow the offenders to escape the full consequences of what they did, much like during the savings and loan crisis, which in many ways, set the stage for what's happening now. The best thing we can do, the best proposal I have heard, is to allow the consequences to happen. Otherwise, we'll be going through the same sorry mess, even worse, in a few years. As hard as it may be to stand by and watch people get hurt, I have yet to hear any better proposal that will help them without making the problem an order of magnitude worse.



Caveat Emptor

Got a search engine hit for

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

It's very hard to construct a scenario where using it as "purchase money" doesn't come out ahead. Not to say it can't be done, but it's highly unusual.



Here's the basic rule: You're allowed tax deductibility of the acquisition indebtedness, amortized, plus up to a $100,000 Home Equity Loan. For many years, the universal practice has been to deduct all of the interest on a "cash out" loan even though it's not permitted by a strict reading of the rules. That is now changing, and the IRS has served notice that they are going to be scrutinizing mortgage indebtedness to compare it to acquisition indebtedness, and disallowing anything over what they figure is the amortized amount of purchase indebtedness. For example, if you originally bought your property for $120,000 in 1991, and your original loans totaled $108,000, sixteen years later you might persuade the IRS that your deductible balance is about $85,000, as ten percent loans were common then. But if your property is now worth $500,000 and you've "cashed out" to $400,000, the IRS is likely to prove supremely skeptical of that deduction.



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



On the other hand, the search question postulates that you'll use the money to pay down what you owe, whether immediately at purchase or later on. After you put the money down, you'll have an improved equity situation, which means that you are likely to get a better price on the loan - a better rate-cost trade-off if you put the money down. Not guaranteed, but it is highly likely. If it's the difference between 100% financing and 99% financing, most lenders treat 99% financing the same as 100%. But if it's the difference between 100% financing and 95% financing, you're likely to get a better loan, or more likely a better set of two loans. Which means you either spent less in costs, got a better rate, or some trade-off of the two. Less money spent equals more money in your pocket, or more money for the down payment, which translates as more equity. Better rate means lowered cost of interest. The fact that it's on less money also means lowered minimum payments, although you shouldn't be shopping loans based upon payment. More importantly, you don't pay interest on money you don't owe. If your balance is $10,000 lower on a 6% loan, that's $600 less interest per year - $50 real savings per month.



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



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



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



Caveat Emptor

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A few days ago, I had an agent get angry at me about an offer below a range asking price. I had submitted the offer with extensive justification as to why it was an appropriate offer. Basically, this clown had overpriced the property, and thought that because he had put a range on it, people were somehow not supposed to make offers outside the range.



Just because you put range pricing on a property, does not, by itself, mean anything. As I've said before, you can ask for any price you want for your property. It doesn't mean the asking price is realistic. It means that you own the property and have the ability to put a price on the property that you want. This doesn't do you any good if the price is above what similar properties are selling for. Having been told it's for sale, buyers have the same options the seller does - they can offer any price they would be happy paying. The seller doesn't have to accept. In fact, the seller probably won't accept. If the buyer offers less than the property is really worth, than the seller is correct to reject the offer. On the other hand, if the buyer is offering what the property is really worth and the seller doesn't accept the offer, they are hurting only themselves.



Right now, most sellers and their agents are shooting themselves in both feet by overpricing the property. Right now there are some special circumstances in effect - the lending panic, the be precise. It's mostly psychological, as there are any number of very solvent lenders willing and able to fund loans, but hysterical reporting grabs attention (which is why they do it). The net effect is that many buyers who would otherwise be in the market are still sitting on the sidelines, and so the ratio of sellers to buyers locally has ballooned to 47 to 1. Imagine yourself in a situation where the ratio of men to women is 47 to 1. The social dynamics are going to favor the women. Even if she's a fat slovenly harridan at the tail end of middle age, she's going to have her pick of men. The men, for their part, are going to have be both good looking and well off to attract even the woman in the previous sentence, and keep working hard to keep the woman around. If you're not willing to do what it takes, and keep doing what it takes, you might as well not bother. Now imagine that people who want to sell are the men, and people who are willing to buy are the women. If you're not willing to out-compete the other 46 sellers, why is your property on the market? If you need to sell, then you need to do what is necessary to out-compete those other sellers. Make it pretty. Make it cheap. And you still better be willing to work when an offer comes calling. If you're not, get the property off the market until the climate changes. I don't think it's going to be long.



Range pricing a property at a value you're not willing to accept is a waste of everybody's time. There was a property on the market variable priced over $125,000 range, and my client made a very strong offer about $15,000 over the minimum. Lots of cash, good deposit, short escrow, no contingencies, etcetera. Under the circumstances, a very good offer considering what the property was really worth. Yet despite all the information we put in front of them, this seller kept countering at the same number, which was more than my client was willing to pay for that property. Net result: the whole process was a waste from the time we started driving to the property. Yes, they got a lot of activity, but since they weren't willing to sell for the price that generated the activity - or anything like that price - the property didn't sell. Since if the property doesn't sell, every penny you put into trying to sell is wasted, as is every second of your time, plus all of the carrying costs that you may incur. So the listing agent told me they'd had a dozen showings in a week - but if they're looking at the property because it's variable priced $75,000 below any offer the seller is willing to consider, well, self-stimulation may feel good but it doesn't produce anything. This entire situation is a failing on behalf of the listing agent, who is theoretically earning money because of their knowledge of the market and should know precisely how likely it is that buyers will agree to pay more than the comparable properties are selling for, which is to say, Not. Particularly in this market, which is still very weighted towards buyers, and will continue to be until Spring 2008, even after the lending panic subsides. Indeed, if you need to sell, you're almost certainly going to have to settle for less than comparable properties are asking. If you don't need to sell, get your property off the market, now. The sooner excess inventory clears, the sooner the turn towards sellers is going to happen. Not to mention your days on market keep climbing, and there's nothing beneficial about having a failed listing in a property's immediate past. The longer it sits unsold now, the harder it's going to be to sell for a good price later.



Properly used, variable or range pricing can increase the sales price of a property. But the catch is that it must still be priced correctly. Range pricing is not an excuse for a lazy or incompetent listing agent to build owner expectations above market level. The rule of thumb is that the bottom of the range should never be lower than a good "all cash, no contingencies" offer, and the top of the range should never be more than market plus a reasonable premium for dealing with the uncertainties of financing and contingencies. Both figures should be modified downwards if the seller is asking for something extra in the way of consideration from the buyer - for example, leasebacks of more than a week or two, seller contingencies, etcetera.



Matter of fact, the way the market is right now in most of the country, I'm inclining against range pricing. If it's priced correctly, that range is information I can use as a buyer's agent. Why would I want to hand the other side information I could put to use were I on the other side, especially when they already have the whip hand in negotiations? Range pricing is something that's primarily useful for sellers when the sellers have the power, and right now, it's the buyers that have the power. If it's not useful for the seller, why in the world would you want to put range pricing on a property? With blortloads of highly upgraded properties for sale right now, I have absolutely no hesitation in telling my buyer clients to offer what we think the property is worth to them under the circumstances, and let the sellers decide if they want to do what's necessary to get the property sold. If they don't want to play, somebody else will. Either way, the buyers are happy. This seller can either decide they'll be happy with an appropriate amount of money, or the property can sit unsold. Which is pretty much the situation as it always is.



Range pricing is not a panacea. Range pricing is not something lazy or fearful agents can use to "buy" a listing with impunity, confident it'll work out in the end (it won't). Range pricing is not an excuse not to price your property to market, or not to negotiate hard with all of the facts at your disposal (if you don't have enough favorable facts at your disposal as to what comparable properties are selling for, your negotiating position is not strong). Range pricing is a way to offer clues to buyers and get them to the table with an appropriate offer when sellers have significantly more negotiating power than buyers. Since in most of the country right now, sellers have no power, range pricing is something to use sparingly. There's nothing that says buyers have to offer you what you want. Not now, not ever. The only leverage sellers have over buyers is the fact that if this buyer won't offer something that is appropriate, somebody else will, and that's very weak leverage when there's 47 properties on the market for every buyer.



Caveat Emptor

Here's another advertisement that I've gotten in the mail:

"Pick a Pay, Any Pay!' The Revolutionary Option ARM!"



"Start rates as low as 1%!"



Loan amount $100,000 Payment $321.64

$200,000 $643.28

$300,000 $964.92

$400,000 $1286.56



Could this help save you money?

Let's see, given the real rate on these, there is negative amortization of about $500 to start with per month on the $300,000 loan, compounded over the three years the pre-payment penalty is in effect. Cost me $19,000 to "save" this money - even if the underlying rate doesn't rise. Not counting what it costs to do the loan. Or I refinance out of it and pay a pre-payment penalty of about $9200.



Doesn't matter the friendly sounding name you give it. An option ARM is a Pick-a-pay is a negative amortization loan.



What this guy (in this case) is hoping is that you'll be so enticed by this "low payment" that you won't ask questions. These are easy loans to sell to people who don't understand them, and impossible to those who do unless you're the person it's really designed for. Indeed, many prospective clients do not want the problems with this loan explained to them. It's like they've chosen to be insulated from reality for a time.



But this is no surgical anaesthetic. Most folks are going to want to be homeowners for the rest of their lives, and unless your income has increased commensurate with your loan balance (and prospective interest rate increases) I guarantee you that the pain will go on for quite a long time after the time of "affordable low payments". I'd rather not shoot myself in the foot in the first place.

You could also lower your monthly payments. Free yourself from high interest rate credit cards and debts with a loan that could reduce your monthly payments by hundreds of dollars and leave you with enough cash to buy a car, remodel, or pay property taxes. And don't forget that mortgage interest is usually tax deductible. So you could save more at tax time.

This is all true - and only a part of the story. Remember that the easiest way to lie is to tell the truth - just not all of it. What they're selling you is the seductive "cash now - pay later". This was how you probably got into the situation they're talking about. What most people do is then take the money out and spend it, and then when the payments get to be too much, refinance again. What are you going to do when the overall payments get larger (again) next time. What are you going to do when there's no more equity? What are you going to do when you can't afford the payments?



The consolidation refinance can be a real financial lifesaver, if you do it right, have a plan, stick to it, and pay everything off, or at least pay your mortgage down below where it was before you go acquiring more debt. Fiscal responsibility is not what they're selling here.

You've earned a 30-day break from payments!

By rolling it into your mortgage, where you pay points and fees on it and the loan provider gets a bigger commmission because of it. There is no such thing as a free lunch! You'll be better off if you stop looking for it. The bank is never going to give you one day that is free from interest, much less thirty. And because you don't make a payment now, you will be paying more later. Probably much more.



You're probably going to see a lot of recurring themes when I do these quasi-fiskings. That's because the lenders and real estate agents and everybody else keeps advertising the same misleading nonsense over and over and over again, they just say it in slightly different ways. As far as I am concerned, anybody who sends out one of these ridiculous things deserves to have their name engraved on my personal blacklist of people I will never do business with. I hope for your sake that you feel the same way.



Caveat Emptor

I was a little shy of ideas of stuff I wanted to write about, and too lazy to finish my research on some stuff I'm working on. But: I get the same junkmail and spam most of you folks do. They don't know who I am when they send it out. It's just that I know what's going on behind the scenes with this stuff.



So I thought I'd get out my calculator and deconstruct what's going on with the advertisements I've gotten in the mail over the last day or two.



The first one starts with "30 year fixed rate 5.125% (APR 5.42)" Well, computing that out, it converts to 10,100 of nonexcludable fees on a $300,000 loan (UPDATE: actually, I discovered later in light fine print that the APR is based on a loan amount of $359,650, the so called "maximum conforming" loan at the time, which means the imputed number of points are slightly higher). This works out to 2.71 points, assuming they get it done for the same $1700 or so of non-excludable fees everyone else has (Title, Escrow and appraisal charges are excluded from APR computation). I had that rate at 2.25 discount points at the time, so they're making about half a point extra if there's no prepayment penalty. So if there's no prepayment penalty that's not a bad loan, except that I called and found out there's a five year prepayment penalty on it. That's a good healthy (or unhealthy, depending upon your point of view) cha-ching of about two and a half or three points to the loan provider. Not to mention that the postcard was "old and the rates are higher now" according to the voice on the phone I talked to at the time, "so you should start the loan now before the rates go higher." The lowest rate they could do as we were talking? 5.375, which I could do for 0.75 discount points as I was talking to them - giving them as a loan provider almost two points in their pocket without the 2.5 to 3 points for a five year pre-payment penalty.



Then, after a faint dotted line designed to be overlooked, they tell you all about payments. $250,000 is $632.14 per month, $300,000 is $758.57 per month, etcetera. Going over to the calculator (even though I can tell you what's going on without it), I get a negative interest rate when I punch in thirty year amortization. I shouldn't need to explain to adults that something is wrong with that picture. Well, what's likely going on is that this is a forty year amortization, and indeed, when I punch in a forty year amortization I get an interest rate of 1%. So on top of being on a forty year amortization, the payments they are quoting are on a negative amortization loan. It is neither on the same rate nor term as the previously talked about loan. And that's the purpose of that thin dotted line that's designed to be missed. They want you to think payment B is connected to loan A, when in fact they are talking about a completely different loan. And indeed I can find that in small, very light print on the other side of the card, under some darker print about about $1000 "Best price guarantee." Voice on the phone explained that, "If you close and subsequently prove you qualify for a better rate with someone else, we'll pay you $1000." Well, first off, if they pay you $1000 to make three points on the loan, they are still $8000 plus to the good, and if I were the sort to be giving that sort of guarantee I'd have no problem wriggling out of it on any of several fronts. And if you refinance or sell within five years, you're out over $7600 in prepayment penalty. Since 95% of all clients sell or refinance within five years, if you've got to have the 5.125% rate, statistically you're better off paying somebody honest one point of origination as well as the lender discount points for no prepayment penalty. One point of origination works out to a little over $3000 on a $300,000 loan. This is less than the difference between the loan they advertised and the loan they theoretically had when I called the day after I got the card.



But the rate is voodoo magic to most people. Theoretically, you've got to be able to understand some mathematics to graduate high school, or at least be able to figure out how to get numbers out of a calculator. Nonetheless, what most people "buy" loans on is payment. This is well known factual information to everyone in the real estate industry. Very few people ever call saying, "Give me that rate." What most customers want is the payment. And when the advertising apparently links the cheap payment on a negative amortization loan to the "Thirty year fixed rate of 5.125%", most companies are doing what I call "lying by association". Most clients want to believe that the one goes with the other and that the listed item is a pretty good bargain, when in fact I have shown that not only do they have nothing to do within each other, but also that they are both the sort of loan I would wish my worst enemy in the loan business would get for some enemy of civilization like Chairman Mao. Then when Chairman Mao gets a lawyer (and enemies of civilization never have a problem getting competent lawyers), I get to watch the whole thing blow up on both of them from safe on the sidelines.



Oh, and this postcard also talks about "skip one or maybe 2 payments." As I cover in the second through seventh paragraphs of this article, you never really skip any payments, EVER. You can either pay them out of pocket or roll them into the costs of the loan. Anybody who represents otherwise is lying, with malice aforethought, unless they're going to whip out a checkbook and pay it out of their pocket. How likely do you think that is?



To avoid this trap: First, don't "buy" loans based upon payment. Second, get (or find) a calculator and use it, or even learn to do the calculations yourself. Third, ask the prospective loan provider the hard questions, and make sure that the question they answer is the one that you asked. Fourth, Shop Shop Shop around for a loan. And apply for a backup loan. Finally, always realize that with the kind of money loan providers make from loans, they will promise anything to get you to call, do anything to get you to sign up, and even though they never have any intention of actually delivering what's on the MLDS

there is little chance of you being able to get any kind of legal satisfaction from them.



Caveat Emptor

A mortgage is basically pledging an asset that you own as collateral for a debt. If you default on the debt, the lender takes your property. When you're talking about real estate in the state of California (and many others), this is generally accomplished by use of a Deed of Trust. There are three parties to a Deed of Trust: the trustor, trustee, and beneficiary.



The Trustor is the entity getting the loan.



The Beneficiary is the entity making the loan.



The Trustee is the entity which has the legal responsibility of standing in the middle and making sure the rules are followed. When the loan is paid off, they should make certain a Reconveyance is completed and sent to the trustor so they can prove it was paid off. If the beneficiary is not being paid, they are the ones who actually perform the work of the foreclosure.



One thing to keep in mind during all discussions of real estate and real estate loans is that the amounts of money involved are usually large - the equivalent of somebody's salary for several years on every transaction. The temptation to fudge the numbers or even outright lie to get a better deal, or to get a deal at all, is strong. Many people don't think they're really doing anything wrong by fudging things a bit, but this is FRAUD. Serious felony level FRAUD. Fraud, and attempted fraud are widespread. There are low-lifes out there who make a very high-class living at it (for a while). Every lender has to devote a large amount of resources to determining that each individual transaction is not being conducted fraudulently. To fail to do so would be to fail in their jobs to protect their stockholders and investors. I can, and probably will, tell stories about the most common sorts. But the reason everything in every real estate transaction is gone over with such a fine-toothed comb that adds thousands of dollars to the cost of the transaction is that people lie. Every hoop that anybody is asked to jump through has a reason why it exists, and often that is because somebody, usually MANY somebodies, have committed FRAUD based upon that particular point.



One of the conditions I must attach, implicitly or explicitly, to every quote for services, is that this is based upon the condition that you are telling me the truth, the whole truth, nothing but the truth, and are being honest and forthright in your presentation of the facts without trying to hide anything and are specifically calling my attention to anything that you suspect may be a problem. And because the list of what is relevant information is long, complex, and conditional upon factors that are often opaque to non-professionals, sometimes, people quite honestly don't realize that something is a fly in the ointment so they don't mention it. I, or any other professional practitioner, have no way of knowing that said fly exists unless you, the client, tell me about it. Therefore what I tell you initially does not account for said fly. This is not unethical, it is just a due to the fact that I don't have all of the relevant information.



When you're talking about residential real estate loans there are basically two absolute requirements as to the nature of the collateral. The first is land - land as in real estate. A partial, fractional, or partial ownership of a common interest in land (as in a condominium) are each sufficient unto the task. A rented space to park your mobile home is not.



To that real estate, there must be permanently attached in a way so as to prohibit removal, or at least make it an extended project, a residence in which people can live. We're all familiar with you basic site-built house. Personally, I'm a big believer in the virtues of manufactured housing. To paraphrase Robert A. Heinlein in precisely this context, imagine a car for which all the parts are brought individually to your home and assembled on site with ordinary portable tools in an environment which was not specifically designed to facilitate said assembly. How much would you expect to pay, and how would you expect it to perform? The correct answers are "A LOT more than for your house", and "not very well, in terms of either reliability, speed, or economy."



Nonetheless, when a lender looks at a house that's been moved to the site, they see one that can be moved away from the site as well, and they are skeptical because so many people have done precisely this. Furthermore, the way that residential real estate is valued is somewhat arcane. The lot itself may be worth $400,000 here in California because it has $150,000 of improvements on it in the form of a three-bedroom house on it, but take away that three-bedroom home, and the lot may be only worth a fraction of the amount. So they loan you money based upon a $550,000 value of the combination as it sits. Some time later, you back your truck up to the house and cart it off, and then default on the loan, leaving the bank a lot that may only get a value at sale of $80,000. Now imagine yourself as the bank employee who made the loan. How do you explain this to your boss? Over the years, many bank employees have had to explain this to their bosses, all the way up the chain of command to CEOs explaining to investors and stockholders. Lenders know that most people are honest - but they've got a duty to make sure you are among the honest ones. And if you subsequently lose your job and can't pay your mortgage, might you not be tempted to back the truck up and haul the house off somewhere if you could so the bank can't take it? There are good substantial reasons why many lenders won't approach manufactured housing as residential real estate, and the ones who do treat it as such charge higher than standard rates, and place further limitations on lending.



I've been personally eyeing a beautiful manufactured home that more than meets my family's needs, is in the middle of the area I want to live in, and is priced more than $100,000 lower than comparable sized and lower quality site built homes on smaller lots. Yet there is a reason for that lower price. It's not like that owner just decided to list it for $150,000 less than he could get. The home carries many higher costs. If I buy that home, I am going to be paying for it in the form of higher loan costs every month, and higher loan fees every time I refinance until I sell it, and fewer people able to buy the home when and if I do sell it as a result of loan constraints, and a I can expect lower eventual sales price as a consequence - which is the situation that owner is in right now. I have reluctantly decided that those costs outweigh the benefits. My decision is regretful, but until somebody comes up with a procedure that banks agree makes manufactured housing equal in every way to site built in their eyes, it is also firm.



Caveat Emptor.



(And I must say that if somebody comes up with such a procedure, you will be a gazillionaire, and deserve every last penny and then some. I hereby publicly forswear all claims of compensation for the idea of such a procedure. If you can make it work and it makes you rich, I won't ask for a penny, although any contribution you care to make voluntarily will be happily accepted. I just want to be able to say you got the idea from me, as part of my contribution to a better world)



real estate mortgage manufactured housing

This one came from a search engine:

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

This is one of the smart things you can do. Not necessarily the smartest, mind you, but smart. The question is if there's a better way to get a return on that money, wither by paying down a higher interest debt or by investing the money in a new asset. If you owe thousands of dollars on a credit card at twenty-four percent when your mortgage is at six, why would you want to pay down a tax deductible six percent instead of a non-deductible twenty four?



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



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



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



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



Caveat Emptor

This site (and my other one) have been experiencing service interruptions of late.



Furthermore, I've been trying to contact my hosting service for several months to send them money and upgrade my service plan, without response.



It's time to consider other hosting services. Actually, it's probably long past time, but the hosting service used to be so darned good I've been trying to stay with them - not to mention I'm going to have to go through a data port when I move.



My apologies if you are having difficulty accessing the site. I am trying to get it dealt with.

This sentence is a textbook illustration of the most effective way to lie. Tell the truth, but not all of it. Not that I'm trying to coach habitual liars, but I am going to deconstruct this astoundingly dishonest claim that I keep encountering. It's mostly used by less ethical loan officers trying to persuade someone not to shop around.



At the bottom-most level, all mortgage money does come from basically the same place. It's all investors looking for a return on their money in a historically well secured market where they are somewhat protected from taking a loss.



What happens to it after that, and whose hands it goes through, matters a lot. Just like saying all water comes from the ocean doesn't mean it's all drinkable, just because all mortgage money comes from investors doesn't mean it's all equal. The lender and loan officer make a huge difference.



Consumers cannot, in broad, go directly to mortgage investors and request a loan. Most of the investors wouldn't know how to do loans if it bit them. They don't have the actuaries, the underwriters, the tools, and the networks to get the best value for their money. That's where the lenders come in.



I'm not going to get into all the details of CMOs and MBSes- Collateralized Mortgage Obligations and Mortgage Backed Securities - how they are sold, how to price them, yada yada yada. It's something I am not involved in, and I don't really need to know as much as I do. Even when I was financial planner, the nuts and bolts just aren't that important to most investment portfolios. Two important things to note: The higher the interest rate, the better the price the lender will get from the investors, and the lower the rate, the lower the price. The higher the default and loss rates is expected to be, the lower the price, and the lower the default and loss rates are expected to be, the higher the price. Default and loss rates translate to "How tough are the underwriting standards?" Low interest rates at a lender usually means very tough underwriting, and fewer people qualify. High interest rates means relatively easy underwriting, and more people qualify.



What you really going on here is that the banks - the lenders - are the middlemen putting investors and consumers together. For this, they get paid. They get paid enough to pay for all those fancy offices and the executives' salaries and everything else the bank might have. Mortgage lending is big business. Lest it sound like I'm saying the fact they get paid is a bad thing, it's not. It makes the market far more efficient, as most individual investors can't afford an entire mortgage all at once, and individual borrowers would have a daunting problem in finding investors willing to lend money at a decent rate in their situation.



Each individual lender tries to hit a certain market segment. It works like branding in the consumer world, in that there are clients they are aiming at, and ones who are incidental to their business. Lending is a risk-based business, and the higher the risk to the lender, the higher the rate. What will happen the vast majority of the time with the vast majority of lenders is that they will sell the loans, whether or not they retain servicing rights. In other words, just because you have a loan with bank A doesn't mean they'll keep it. It is very rare for a lender to keep the loan. Even if they retain servicing (for which they get paid - and they're not even risking any money!), so that you keep sending that lender your payment, they don't hold the actual loan. Some lenders are interested in A paper, whether conforming with Fannie Mae and Freddie Mac, or nonconforming but to essentially the same standards. These loans are fairly uniform and highly commoditized, but lenders put their own stamps on them. One bank might have incredibly tight standards, but offer lower rates. They will have a record of fewer defaults, practically zero losses, and get a better price on their loan packages in the bond market. Another bank might be somewhat looser in their standards, and so not do as well on selling the loans, and they will charge a higher price, in the form of interest rate, in order to compensate.



This phenomenon expands out progressively farther in the A minus, Alt A, and subprime lending worlds. A paper has noticeable differences between lenders, while subprime's targets vary from the not quite A paper to those who specialize in the ugly loans to people with 501 credit scores, and even some lenders that will accept a borrower with only one FICO score at the 500 level. Almost all of them have their own niche, or niches, that they will underwrite to, trying for a mix of rates to borrower and underwriting standards for approval that results in fewer of their loans defaulting, and thus the ability to command a premium price in the bond market over and above what mostly equivalent lenders will give.



Below subprime is hard money. It's called hard money because before they fund your loan, they are recruiting individual lenders and syndicates who will hold your loan for as long as you have it. This is why hard money is typically multiple points up front, interest rates of thirteen percent and up, and three year hard prepayment penalties, as well as only going to about sixty-five or seventy percent of the property value at most. Without the lenders, every loan would be hard money.



No lender has the capability of running programs that are good fits for everyone. Some of them have a few dozen, some have only ten or twelve. This sounds like a lot, but it isn't. Every single loan type is a different program. Just to cover the most standard loan types for their market is usually between twenty and thirty. I can point to lenders with twenty-five or more different Option ARM programs.



This is where brokers come in. There's an old saying about how "If the only tool you have is a hammer, pretty soon all the problems start looking like nails." You walk into a direct lender's office, and they has a couple dozen programs focused on one segment of the market. You're not an ideal fit for any of their loan programs, but so long as you can qualify for any of them, they are going to keep your business rather than refer you to someone else. They're hammering nails, never mind that your problem is a threaded bolt. They get you pounded into the board. Yes, you get a loan, but you could qualify for a better one if you wandered into a different lender's office.



Brokers have lenders wandering into their offices. Lenders who will give the brokers better deals than they give their own loan officers, because they're not paying for the broker's expenses, and the broker knows better than to be a captive audience. The fact is that brokers are usually capable of getting a deal that's enough better that they can pay their expenses and salaries, still have profit left over, and nonetheless offer the client a deal enough better than the lender's own branches as to be worth the trip. Brokers also shop multiple lenders, looking for a better fit. If you're a top of the line A paper borrower, someone that any major bank has a good program for, the broker can still get you a better loan, but maybe only by an eighth to a quarter of a point. On a $300,000 loan, that's $375 to $750 in cost at the same rate for the exact same loan. If you're in a marginal A paper situation, the difference made is liable to be that you qualify A paper with a broker who knows where to shop, where you'd likely have to go subprime, with inferior options and a prepayment penalty, by walking into a bank office. You get into subprime situations, and I have seen pricing spreads of two and a half percent on the interest rate between the best lender for a given loan, and the rest of the pack. You can physically go to twenty or fifty different banks, fill out an application and furnish paperwork in each - or you can go to a broker.



The point is that no lender is both offering low rates and loose underwriting. As everything else having to do with money, it's always a trade off. The lenders charge higher interest rates, they get a better price for their loans. The lenders underwrite to tougher standards so they will have fewer defaults, and practically zero losses, they get a better price for their loans. The lenders need a certain margin to keep their owners happy, and a certain margin to keep investors happy, and neither one of those in the business of giving away money for less than it is worth.



The ideal thing for a given borrower is not an easy loan. Unless you're so high up on the ladder of borrowers (credit score, equity in the property, lots of documented income) that you'll qualify for anything easily. The ideal loan, where you get the best tradeoff of rate and cost, is to find the loan where you just barely scrape through the underwriting process. With average loan amounts in California being about $400,000 now, chances are that any extra time and effort you spend will be handsomely rewarded when you compute the hourly costs and payoffs.



So you see the partial truth of the title statement, and the utter falsehood. All mortgage money pretty much does start out in the same place. Nonetheless, what happens to it after that, before it gets to the consumer, renders the statement "All mortgage money comes from the same place" incredibly dishonest.



Caveat Emptor.

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There's a lot that gets written on this subject, mostly by loan officers looking for business. Well, don't think I'm not looking for business, but not with this post. Or if anybody calls me because of this, at least I'll know they understand how to do it right.



The basic come-on is this: Your home has appreciated in value, and is worth more than you paid for it, so now you have equity on the one hand. On the other hand, you have loads of consumer debt, whcih is costing you hundreds or even thousands of dollars per month, which is impacting your lifestyle. So you borrow on the equity in your home and save money on your payments as well as causing them to be tax deductible in most cases.



Let's illustrate with some numbers. Let's say Arnie and Annie have a $300,000 loan on a home that they bought six years ago, and comparable properties in the neighborhood are now selling for $600,000. This is 300,000 in equity.



On the other hand, because they are american consumers, Arnie and Annie have a hard time living within their means. They've got $15,000 in consumer credit, a $10,000 home imprevement loan, and two new SUVs with associated debt of $20,000 and $30,000. These are fairly typical numbers.



Arnie and Annie's mortgage payments are currently $1720 per month, because they refinanced to 5.25% two years ago when the rates hit bottom. Their monthly payments on the credit cards are $400. The payments on the SUVs are $500 and $600 per month, respectively. The payment on their $10,000 home improvement loan for landscaping is maybe $150. Arnie and Annie are forking out $3370 per month without taking into account stuff like property taxes, insurance, utilities, etcetera. It's really cramping their lifestyle.



Suppose they consolidate these loans into one payment on a thirty year home loan? All right, so it costs them anywhere from zero to $20,000 to get the loan done. Let's split the difference and say $10,000. That's about two points plus closing costs.



This has gone over the line into jumbo territory [no longer. As of 1/1/2006, the maximum conforming loan for single family residence is $417,000. On the other hand, rates are higher now :-( ] of a $385,000 loan. Were this a conforming loan amount, the rates would be lower, but with a 30 day lock, that'll get you 5.875% or thereabouts today on a thirty year fixed rate loan. The new payment is $2277. Voila! Despite the higher interest rate, Arnie and Annie are saving almost $1100 per month!



Or are they? On the credit cards, their monthly interest was $225; their $400 payment would have paid the cards off in less than five years. The interest on the SUVs was $333 total on the two, and their payments would have had them done in about five years. The home improvement was a ten year loan but even so their monthly interest was only $75. Now these are all thirty year debts. The monthly interest on their old home loan was $1312. The interest charges on their home loan is now $1884, where total interest was $1945 previously. So they are actually saving money on interest.



The difference is that now they're not paying the old loans off as fast - they've spread the principal over thirty years. In the meantime, the bank is getting all this lovely money in the form of interest from them, and if they refinance about every two years as most people seem to do, this is $85,000 more that they owe on their home, and that Arnie and Annie will pay points and fees on every time they refinance!



Let's assume Annie and Arnie beat the odds and don't refinance for five full years. This puts them ahead of 95 percent of the people out there. Let's look at where they'll be five years out if they make the minimum payment. They will owe $357,700 on their home. On the plus side, they will have had $66,000 to spend on other things (and they likely will, if they are typical americans). Total debt: $357,700



If they had continued making their previous payments, they would now owe $272,100. Plus they would be done with the SUV's and the credit cards and would only owe $6600 on the home improvement loan which they could now concentrate on. Total debts: 278,700.



Net difference: $79,000. Subtract that $66,000 they had real good time with (and nothing to show for), and they're still $13,000 in the hole.



They do have a $572 per month potential additional deduction. Assuming they are in the 28% tax bracket and get to deduct the full amount, that gives them $9,600 less that they owe the government in taxes. Net amount Annie and Arnie are out are out: $3400, in addition to being set up for higher fees on future loans, and having a loan balance $77,100 higher. Additional interest they will pay if they can get a loan at 5 percent even: $3855 per year.



Sounds like an awful bargain doesn't it? Many consumers have done this three and four times. I run across people who bought their home in the early 1970s, and have mortgage balances ten to twelve times the original purchase price.



Now, suppose instead of milking our equity for cash flow, where we're trying to minimize our monthly payments, we do it differently. Same situation, same numbers, but instead of spending that $993 per month, we use it to pay down our mortgage.



Actually, let's pay $3300 per month, so we still have $70 per month to spend elsewhere. After five years, we still owe $286,600. We got $4200 to spend elsewhere. And all of our other debts are gone. In addition, we got that $9600 in tax reductions. Net amount to us: $5800, although we still owe $8000 more, and if we get a 7% loan, that'll cost us $560 per year. Notice that at this point, the benefits, while tangible, are still fairly small. Furthermore, if we refinanced or sold before this point, as ninety-five percent of everyone does, any eventual benefits are likely to disappear.



But if we keep making that $3300 payment after those five years, and don't roll anything more into the loan, then the mortgage is paid off and we are debt free - the house is paid off, and the other debts are history - in less than ten more years! Now this relies upon us being thrifty and keeping those SUV's going and not charging up any more credit and not doing anything else to make the debt worse. In short, not giving in to the marketing culture. Many people say they don't. Few actually manage it.



So you see, even if you do it right, it takes years to show the benefits of this kind of refinance. This is years of doing something that they do not have to that most folks just won't do. If you have an unsustainable cash flow situation, by all means you've got to do something about it, but don't kid yourself that it's financially fantastic. On the other hand, if you're one of those who have to ability to make the scenario in the last paragraph (or something like it) happen, it's well worth doing.



Now this hypothesis is highly sensitive to initial assumptions. I previously assumed that Annie and Arnie are and always have been top of the line borrowers, able to qualify for anything. Suppose they weren't? Suppose they were in a C grade loan at 7.25%, but now they qualify A paper at 5.875. With a payment of $2070 per month formerly, of which $1812 was interest, the new loan saves them $1450 per month in mininmum payments and $561 in actual interest while still saving about $1209 on their taxes over five years. You'd have owed $288,000 on the old program, now even if you put in only the same $3300 per month in payments, you're $1400 ahead of where you would have been on the balance, and you still had about $400 per month to spend. On the other hand, if Annie and Arnie were A paper but now they are applying for a C grade loan, it cannot be justified on anything except "the cash flow keeps us out of bankruptcy!" because it's financial disaster.



Some alert people will have noticed I didn't explicitly include the $10,000 cost of the loan in the computations of whether you're better off. That's because it is gone, sunk, included in the computations of where you ended up. It was part of your initial loan balance if you did it, included in the ending balance, and therefore included in the computations of whether you were better off. Now, if the cost of doing the loan were lower, there would be somewhat larger benefits a little bit faster, and indeed a lower cost loan is probably a better idea for most people, even though it means the rate and payment will be slightly higher. See my article on Why You Should Ignore APR for more.



The important thing to remember is to not get distracted by the fact that your minimum monthly payment goes down, and see if you (and your prospective loan officer) can come up with a loan and a plan that really makes you better off down the line, instead of one that sucks the life out of you financially, like the vast majority of these scenarios do.



Caveat Emptor

From an e-mail:

I live in (City 1) and recently signed a work order on a semi-custom new construction house in (City 2). My wife and I make a combined 120K income and still can't afford a decent place in City 1. It was preapproved rather quickly from both the builder's mortgage company and a few outside companies and everything was moving along splendidly, until my employer decided to refuse to transfer me (something we had mutually decided on back in April). To make a long story short, the house will be built and ready to close in early November and 2 of mortgage companies are asking for a Relocation letter from my employer. Seeing as how I make 66% of the 120K combined salary, my plan is to tough it out here until I find (1) a job in City 2, or (2) a job here that will transfer me to City 2. My question is, if I can't supply them with a relo letter am I dead in the water? Do I have to scrap the loan (primary residence) and try to get a second home or investment loan? The broader question here, is how critical is any piece of documentation? Obviously W-2s and bank statements can be deal breakers, but what about the other stuff? I.E. relo letters, proof of homeowners dues, etc etc.

First off, you have an obvious potential issue with your current employer. If your work order was predicated upon a promise of transfer, you may have a case against them if you want one for the amount of any money you're out. Consult an attorney, preferably one that is licensed in both states. Obviously, this poisons the atmosphere, so you may not want to. On the other hand, you may have decided by now that you are done with them one way or the other.



Second, getting to the item of contention, the relocation letter. Every lender's guidelines are different. You didn't say how many lenders you had applied with, but few people apply for more than two loans. Any item the underwriter asks for can be a deal-breaker, especially if you can't provide it. What the underwriter is looking for is a coherent picture of someone who is going to be able to repay the loan. If the loan underwriter doesn't see a coherent picture of you being able to repay the loan under the circumstances it was submitted under, the loan will be declined. The underwriter can ask for anything they want. They can ask for proof your father gave birth to identical triplets, if they think it has some bearing on the loan. If you cannot furnish them what they want, and your loan officer can't shake an alternative or an exception out of them, the loan is dead.



Now they're not likely to ask for proof of something impossible and irrelevant like my example. Legally they probably could - Everybody has a biological father, so it's not discriminatory on the face of it. They're certainly not going to violate anti-discrimination lending laws by asking for something based upon race or sex. But they're in the business of making loans, which in many cases make more money for the developer than the sale. However, if the underwriter approves loans that go sour, they can expect to be held accountable by their employer, and so they require and are permitted a certain degree of necessary latitude on additional requirements in order to do their jobs. If I tell an underwriter that I make $2 million a year in the stock market, I'd better be able to furnish proof. If it's not relevant to the loan, I should keep my mouth shut about it because it's asking for trouble. Never tell an underwriter anything not absolutely necessary for loan approval.



It's a horrible lie about people from Missouri, but I tell people to think of underwriters as Missouri accountants. Their favorite sentence is, "Show me on paper." All loan approvals are based upon the potential borrower and their current status quo. In other words, the situation as it is, not as you hope it will be someday. Yes, when doing Verification of Employment they ask about prospects for continued employment, but that's just to establish that the employer isn't willing to admit they're about to fire you. They know that in the real world, people get told "Yes, we're going to keep Mr. X here forever" and next week Mr. X is applying for unemployment.



What the underwriter is looking for is a coherent picture of you occupying the property and working at your current employer. You're working in City 1 and living in City 2, which are not within daily commuting difference, but you applied for the loan as intending to make it your primary residence.



Given that they are requiring a letter of relocation, you have several options. I know it has happened in the past that employers who were not willing to relocate employees were nonetheless willing to write letters that said they were. This is stupid. This is fraud, and if the loan becomes non-performing the employer could potentially become liable for whatever the lender lost, not to mention that a lot of your protections as a consumer go out the window. Second, they could sign a letter that says you are going to be telecommuting from your new home. Yes, your job is in City 1, but you could legitimately be living in City 2 and still employed and doing your current job. Bingo, happy underwriter (probably). If your loan officers aren't complete idiots they will have asked you about this, so I presume the answer is no.



So now we're bringing in other issues as well. Now you have a husband living in City 1, while the wife and new home (and I presume wife's job) are now in City 2. Fact: husband needs a place to live in City 1. "What's that place to live going to cost him?" they ask. They take this answer and add it to the previously known total of your other monthly payments. Because you now have more in known monthly expenditures, now you may not qualify for the loan you were "pre-approved" for. Now, pre-approval doesn't really mean diddly-squat, and the developer knows it, so they likely required at least a decent sized deposit from you, so if you don't get the loan, you don't get the house, and you may have a substantial forfeiture. See my first paragraph. Furthermore, some underwriters may see a potential divorce situation here, so they may ask for some kind of testimonial from third parties that you're not getting a divorce.



Now, if you had a decent agent, he likely wrote your offer "contingent" upon your relocation. Unfortunately, if you're buying from a developer, your agent probably works for the developer, and so didn't do this. You may or may not have a case against the developer and the agent. Consult an attorney, but this is one area of many where buyer's agents really pay off.



(Even if they're inclined to trust me, I do not want to represent both sides in a sale, and will usually insist that one side go get another agent, or at least sign a release indicating that they realize I am working for the other party, not them, and have no responsibility as to their best interests. As your experience indicates, too many actions are a potential violation of fiduciary duty to one side if you do them and to the other if you don't. There are some agents who get greedy and do both sides, but usually they make their attorneys very happy. If your agent wants to do both sides of the transaction, that's never a good sign.)



However, what I suspect you really want is the house and the loan you signed up for. So I'm going to go on that presumption.



You make $10,000 per month. You may be able to get a friend to rent you a room in their home in City 1 for fairly cheap, so that there is not enough difference so you don't qualify for a loan. Several years ago before I met my wife, I rented a room out cheap to a friend who was in a situation not too different from yours. "A paper", you are permitted up to about about a forty-five percent debt to income ratio, and it can go higher if you have a high enough credit score such that DU or LP (Fannie and Freddie's automated loan underwriters) will buy off on it.



You could go to a different loan type, carrying a lower rate and hence a lower payment. Unfortunately, the debt-to-income limits on these are lower. Unlikely to work.



You could go to a "second home" loan. Unfortunately, the standards on those a a little tighter, and there may be an additional fee of a quarter point or even a half, and you're still going to have to show the underwriter a residence in City 1, which means the payment qualification issue raises it's ugly head here, also.



Finally, you can go to a sub-prime lender (where maximum Debt to Income ratio can be higher) or do a "stated income" loan. If you were working with a broker's loan officer as opposed to a direct lender or packaging house loan officer, either would be no sweat - you might not even have to do another application. The broker would simply withdraw your loan package and submit it elsewhere. Unfortunately, from a subsequent email, I know that you're not working with any brokers. Well, the developer probably has a sub-prime lender on tap as well, so that may be a low stress option. On the other hand, if they are a different branch of the "A paper" lender, they may not be able to do your loan either. Or, if you're lucky, the developer is acting like a broker in the first place rather than a direct lender.



One of the great rules of the business is that you cannot go from a higher documentation loan to a lower documentation loan on the same borrower at the same lender. If I submit to lender A "full doc," I cannot then later submit it to lender A "Stated Income." The reasons for this should be fairly obvious, and this is a no brainer without exceptions across the business.



For brokers, because the paperwork is in their name and not the lenders in the first place, this means no new reports. But since you're not working with brokers, what this means is that you're likely to need a completely new set of reports from the appraiser on down in the new loan company's name. This may be done on a retyping basis if you are lucky (see my essay on appraisals), or you may have to pay for completely new ones.



I strongly advise you NOT to quit your job, unless someone a lot more familiar with your situation and prepared to take the consequences of being wrong tells you otherwise. Here's why: You quit your job. Now you are unemployed. It does not matter if you've been doing what you're doing for forty years. Right now you are unemployed. As things currently sit, you do not qualify for the loan. Even if you've got a written offer of employment somewhere else, many lenders will not approve the loan until you have a pay stub to show for it. Since this means waiting several weeks at least, it's almost certainly outside your window of opportunity.



One final issue: here in California, it's illegal for a developer (or anyone else) to require that you do the loan with them in order to get the property. But it happens anyway (I've been told point blank by more than one developer's agent that if the client doesn't do the loan through them, the purchase contract will be cancelled. Many others won't tell you point blank, but they will throw obstacles up until you give up on the other loan), and it's a long hard slog to prove legally and it costs you thousands and you still don't get what you really wanted in the first place: the house you signed an order for. I am not certain the practice is even illegal in City 2, where you're buying (although from some things I've heard about that state's practices, I think it's probably legal). So you probably want to be certain you're not fighting the developer on this by finding your loan elsewhere. Unfortunately, you've already (probably) put a deposit down and you said in subsequent email that the home has appreciated while it was being built, so the developer has incentive to throw roadblocks in your path. Your transaction falls through and not only do they get to keep your deposit but they can turn around and sell the home for more. Preventing this kind of nonsense is what buyer's agents are for (it also gives you someone easy to sue if something goes wrong!). Unfortunately, most developers will not cooperate by paying a commission to buyer's agents for precisely this reason, which means that the average buyer will decline to pay an agent out of their own pocket and try to do the transaction on their own, which leads to situations like this.



Best of luck, and if this does not answer all of your questions, please let me know.

It has become very trendy to ask for pre-approvals on loans, because so many escrows are falling through. Unfortunately, as I have explained in the past, Loan Pre-Approval Means Nothing, and prequalification means even less. Both are literally wasted paper. As far as actually meaning anything you can hold someone to, they're useless. Worse than used toilet paper, which was actually put to some useful purpose once upon a time.



I never trust either a pre-qualification or pre-approval unless I did it. As I've said before, there is no accepted standard for either. Furthermore, I doubt there ever will be. Agents aren't asking for these pieces of waste paper because they're concerned about their listing clients. They're asking for them to cover their own backside so they don't get sued when the transaction falls apart.



Now there's no way on this earth that you can promise that owner that the transaction isn't going to fall apart. Accepting any offer always has some attached risk. If the buyer can't actually get the loan funded, the seller is out of luck as far as getting that purchase price for the property, and you'll have to go back to square one.



This isn't to say that the seller is out the whole amount. The buyer risked whatever good faith deposit, which should be at least enough to pay the costs of carrying the property for a month or two. This isn't to say that the seller is necessarily entitled to the deposit or that escrow will automatically remit it to them. There's rules about that. But the contract is very carefully written to limit the amount of time before the seller is entitled to the buyer's deposit. If you're concerned that the buyer may flake, or not be able to qualify, the correct thing to do is negotiate more of a deposit and more favorable terms for it to come to the seller in the purchase contract. If listing agents were really trying to protect their seller clients from failed transactions, they'd be focusing in on larger deposits and trying to get them paid to the seller while the property is still in escrow. That's real protection for the seller. Of course, many buyers will walk away from such terms, meaning that it goes from a possibility of that listing agent getting paid to no possibility of that listing agent getting paid.



Buyers understand the deposit in cash terms. They scraped and saved this money in real time, dollar by dollar. It's real to them, and they don't want to risk it. You've got a better chance of getting $10,000 more on the price with most buyers than of getting a $1000 higher deposit, or more favorable terms for forfeiture. Of course, a lot of buyers choose to go unrepresented or use the listing agent to represent them. Both are silly, when you understand what's really going on. But demanding a high deposit, or harsh terms of forfeiture, is a good way of scaring off potential buyers. Savvy buyer's agents understand that an increased deposit is a way to get a better price for their buyers. If you require a high deposit and harsh terms of forfeiture, you are discouraging certain buyers, shrinking the pool of potential purchasers, thereby lowering the likely eventual price.



Of course, being able to negotiate a good contract is a major part of what an agent's getting paid for. In some circumstances, high deposit will be appropriate. For instance, if the buyers are getting a really good price. If I'm getting a property $100,000 cheaper than comparables around it, I shouldn't mind putting up a bigger deposit, or agreeing to more stringent terms for forfeiture. On the other hand, if I'm paying top dollar for the property, I'm going to be a lot more guarded. Mind you, I don't make offers without evidence that my clients can qualify for the necessary loan, but I'm going to want that seller to assume more of the risk of the transaction falling through. If they're getting a good price, they should be willing to. If they're not so willing, they're basically saying that the transaction isn't worth the increased risk. Remarks about having your cake and eating it apply to this situation. I'm certainly willing to persuade my clients to offer a better deposit to get a lower overall price. But I'm also perfectly willing to tell an overaggressive seller to go jump in the lake if they want harsh terms for the deposit without my client getting something tangible in return. The reverse of each applies when I'm listing a property. If the buyer is offering - or willing to offer - a large deposit or terms that are generous to my client, I may counsel acceptance of such an offer where I wouldn't of an identical offer with a smaller deposit or less generous terms for its forfeiture. It tells me that the buyer is willing to risk something real if they can't qualify after tying up the property.