December 2007 Archives

At a very young age, my parents bought me a book of Aesop's Tales. Aesop has gone out of style, probably because these are stories with a moral lesson, and it seems the modern society is actively averse to moral lessons. But one of the ones that has stuck with me was the tale of the dog with a bone and the reflection in the water.

It happened that a Dog had got a piece of meat and was carrying it home in his mouth to eat it in peace. Now on his way home he had to cross a plank lying across a running brook. As he crossed, he looked down and saw his own shadow reflected in the water beneath. Thinking it was another dog with another piece of meat, he made up his mind to have that also. So he made a snap at the shadow in the water, but as he opened his mouth the piece of meat fell out, dropped into the water and was never seen more.

It is precisely this mistake that I'm writing about, and it applies to all real estate transactions. The dog's mistake wasn't that he wanted more. That's normal and natural, and I've certainly never done business with anyone who didn't. The dog's mistake was wanting the other benefit as well as his own, and not realizing he placed the benefit he thought he already had on the line in order to obtain it. But, as he discovered, the goodie that the dog in the water had was only a reflection of his own goodie. In order for the dog to have his own goodie, the dog in the water had to receive his. They are mirror images of the same thing, and one cannot exist without the other.

A lot of what gets written alleging to be good financial advice violates this very simple lesson.

Some things are a cost of doing business. If I don't pay for all the things that enable me to serve my clients, I'm out of the real estate business. Yes, they cost money, but if I didn't spend that money, my income would be zero. For consumers, this includes things like property taxes and HOA dues and Mello-Roos. If you want that property, they are inseparably attached. It is correct to include them in calculations as to whether a property is worth acquiring or worth keeping; it is not only pointless but counterproductive to try and get out of paying them.

This applies to the costs of acquisition and selling, as well. Be certain you understand the real costs involved. They may be large, or seem large, but doing without any of the professional services that have evolved is likely to end up being a lot more expensive in the end. If one is cheaper than another, there is a reason. Find out why; and while it may be that someone is just comfortable making less money, other explanations are such as they do not provide important services that really do make a difference are more likely to be closer to the truth. Don't expect them to tell you this, though, especially since most people will just believe fairy tales like "full service - discount price", and won't investigate why prices or loan quotes are lower. It shouldn't surprise any adult that sometimes it's worth paying extra. If this were not true, none of us would have our own cars, let alone seven seat luxury model vehicles. Cars are about the most expensive mode of transportation there is, but the vast majority of all adults in this country own and drive at least one. Including me. The reason is because the abilities they convey are more valuable than the costs they entail. if you don't pay the cost, you don't get the benefit, and yet many people will fool themselves into trying.

Most importantly, though, the lesson applies to negotiations for the sale of real estate. There's nothing wrong with making the best deal you can, but once you have the contract, honor your end of the bargain. Negotiate issues revealed later reasonably, and in good faith, based upon their own merits. It sometimes happens you find out the other side is getting something fantastic out of the deal. That's not a problem. It's a benefit. Insurance they're going to carry through with their end of the deal, which is a good thing because you wouldn't have signed off on it unless you thought you were getting about the best deal possible, right?. Real estate transactions are based upon making both sides happy with their side of the deal. You can't force someone to sell a property to you or buy it from you. Even attempting that is a felony. There can be circumstances that make it more likely someone will accept a proposal that they might not in other circumstances they would not, and very few people have unlimited time, money, or energy for a transaction to happen. But whatever the other person - other people - in the transaction are getting out of it, those benefits belong to them, and if it appears as if those benefits are in jeopardy, the other side can usually get out of a purchase contract. It may cost them something in some instances, such as the deposit, but successful suits for specific performance are rare, and more so where there's a competent agent involved on that side. Not to mention all those court costs.

The practical upshot of all this is that if you fail to act in good faith, that good deal that you thought you were getting is completely gone, and there's a significant chance you'll end up spending thousands of dollars on legal action as well. Figure that if the other side wants out, they can get out. In fact, many over-aggressive later negotiations give the other side grounds to exit the contract without penalty. Nobody's going to buy a property where they can't run the water or flush the toilets, but once the sellers agree to fix that problem in an acceptable manner, don't try to get anything extra out of them. If the septic system is bad, they can either install a new one, (maybe) fix the existing one, or hook the property up to the sewer. Asking them to re-plumb the entire house is not (usually) reasonable, and asking them to re-wire the entire house is, in the immortal words of Monty Python (Book of Armanents, chapter two, verses nine through twenty one), right out. If you find out you're not getting such a great deal, then you're likely to be the one looking to exit the contract, and if they fail to give you satisfaction with a newly discovered issue, maybe you should want to. There's nothing wrong with exercising the inspection and appraisal contingencies, assuming you have them in the contract, or forcing the buyer to consummate the transaction or get out of the way of someone who will, or getting the lender to deliver the loan they said they would.

Greed envy is one of the banes of a successful transaction, and if you don't have a successful transaction, you don't have anything positive, and you quite likely have significant extra expenses. To go back to the dog and the bone, a failed real estate transaction is worse, because not only have you lost your bone, you've lost everything you spent in obtaining it, and you still don't have what you wanted, whether it is your new property or cash for your property or new financing. If you make your initial choices based upon the benefits to you, the fact that someone else is getting a benefit as well is not something to cause you heartburn and make you want to take it away from them. That way lies disaster. Instead, think of it as insurance that you're going to be getting that benefit that you wanted enough to sign the contract or loan application in the first place. And if you're not going to be getting the benefit you thought you were, maybe you're the one who's going to want out.

Caveat Emptor

I got a search for how one spouse could sign while the other was out of town, and act on their behalf. Since both spouses usually need to sign real estate papers, this is a real concern.

Actually, almost anybody you designate can sign for your real estate transaction, whether or you're available. The usual thing is you're out of town for some reason when closing happens, and so your spouse signs for both of you, themselves in their own right, and you by Power of Attorney, but it covers all kinds of situations, and not just real estate.

The document required for this is called a Power of Attorney. You must sign it and have it notarized that it was really you that did so. In it, you designate one particular person who has the right to undertake an action or group of actions, and they then act on your behalf, as your "attorney" for this matter.

Powers of Attorney can be made for all sorts of things, not just real estate transactions. For instance, pretty much everyone should have a Durable Power of Attorney for Health Care. Powers of Attorney can be very broad and ongoing or limited to one specific action in a limited range of time. You set this up at the point in time when you execute it. Whatever terms you set up when you signed it are binding, both upon you and the person you designate. Most stationery and office supply stores have ready made ones where you just fill in a few blanks and you're ready to have it notarized. I've seen ones with boxes for check marks, but those are dangerous in my opinion, as when a particular check mark was placed on there is a matter for considerable legal dispute.

It is a misconception to believe that this person must always be an actual licensed attorney. In general, they need not be an actual attorney, only a competent adult. I'm sure there are circumstances when being an attorney is necessary, but it is not necessary most of the time. There may be circumstances where you may want a licensed attorney even where it is not legally necessary, but there's a major difference between being legal and being smart.

I've seen not only spouses used, but other relatives, close friends, and professionals such as accountants and attorneys. Note that the person you designate does not have to accept, and does not have to act even if they accept. The idea is to get their consent first, and make certain they know your mind in the matters you designate them for.

Extremely important: You really need to trust the person you designate to act in your best interest. If they sign something that you would not have, you are still stuck, as long as it is within the mandate of that power of attorney. Whatever contract they signed on your behalf, you have to live up to the terms. Your designate doing something you would not have is a side issue between you and the person you designated. That person with your power of attorney designate's signature on a contract can force you to live up to that contract, which is how it should be. Otherwise, nobody would accept powers of attorney, and they would be regarded as one more way to run a scam. They're not supposed to be a scam at all, it's intended to be a way for one person to do another person's business legitimately.

Caveat Emptor

Our home isn't worth what we owe. So say you were just an average person selling and buying a house, meaning you put your house up for sale, get a contract to purchase on it then go put in offer in on a new house. Then you generally get a pre-approval, then the loan from a lender for the new house prior to closing on the old house. You then go to the closing sign the papers for your old house and then afterwards sign the papers for the new house. How would the lender giving you the new loan know that you were short selling the old house when everything happens the same day? It's not going to show up on my credit for at least 30 days and by that time I will already own the new house. Get it? Is this possible?

This is not the first time such a scam has been tried.

The loan application asks you about what property you own now. Falsify it, and you're likely going to spend a few years in Club Fed. Since it's unlikely you'll make mortgage payments there, this will compound the problem (Just try this on the judge: "I couldn't pay because I was in jail for lying about my financial situation, so it's not my fault!")

Furthermore, the current mortgage is going to show up on your credit.

The condition the underwriter is going to put on the new loan approval is going to go something like "Show property has been sold and debt paid in full"

Believe me, they're going to investigate. They're going to want a copy of the purchase contract and a payoff on the loan for it. Since the debt isn't going to be paid in full, they're going to figure out that you've got a short sale going on. It's not going to happen "same day" if there's a short sale. They're going to want to verify that the other lender is not going to pursue a deficiency judgment. If you're still going to owe the other lender money, the payments are going to hit your debt to income ratio (DTI).

All that said, if you come clean about the situation starting with your loan application with the new lender, it's possible you'll still be approved - just not the same day you close on your sale. They're going to want something that says your current lender isn't going to pursue the deficiency, but it is possible. Theoretically speaking. They're also going to want to figure out what you're going to owe the Revenuers, and how you're going to pay it. Then they're going to take that into account in underwriting the new loan.

(NB: With HR 3648, the Mortgage Forgiveness Debt Relief Act of 2007, this may be zero on the federal level but there may still be consequences on the state and local level. Check with your CPA or EA for more information)

But trying to hide the situation is pretty much going to be a guaranteed rejection. Furthermore, whether or not you intended fraud, if you'll look up the legal definition of fraud, what you were asking about falls well within that definition. I wouldn't be surprised to find the FBI paying you a visit. In fact, I'd be surprised if they didn't. Banking fraud having to do with amounts at risk large enough to finance real estate is a serious felony. ALWAYS tell the truth, the whole truth, and nothing but the truth on a loan application. Better to be rejected based upon the truth than accepted based upon fraud.

If you wait until the short sale is consummated to apply for a new loan, there are 13 questions on page 4 of the standard form 1003, the Federal Loan Application. At a minimum, questions a, d, and f (having to do with judgments, lawsuits, and delinquencies) are going to have interesting possibilities, but there is no question that directly asks about a short sale. It does shows up on your credit report for 10 years, as debt not paid in full. Mortgage debt not paid in full, amplifying the failure in the eyes of mortgage lenders. If there's a deficiency judgment, that will show up as well, for ten years from the date of the judgment. I can't recall ever having dealt with someone in this situation; but it's definitely a factor a reasonable person might want to consider in deciding whether to grant you additional credit, right? If your worthless brother-in-law wanted to borrow $1000 despite having stiffed you on other debts in the past, you'd be within reason to consider that fact in your decision as to whether or not to loan the money. Particularly if the purpose of this loan was directly in line with the purpose of prior defaults. The situation is no different with mortgage lenders.

Caveat Emptor

I am currently living with my parents and they wish to deed of gift their house to me but they still have a remaining mortgage on it. Is it possible to do this or do they have to pay off the mortgage first? Thanks

They can gift the house to you without paying off the mortgage. However, the mortgage still has a valid lien on the property, and must be paid or they can and will foreclose.

The mortgage will still be in the names of the people who signed the paperwork (your parents) and therefore any credit benefit or dings will also belong to them. You could find yourself in the unenviable position of being unable to refinance, despite having made the payment for however long, because you're not getting credit for making those payments. Read the contract: it is possible that the loan is assumable. Even if it isn't, it's possible the lender will agree to add you to the list of those responsible (This can only help them; they're not letting your parents off unless/until you do a full refinance. Of course, adding you to the loan doesn't earn anyone a commission, so they might tell you that you need to refinance as it gets them paid, or helps them make a quota)

Quitclaiming is both legal and extremely simple, but has potentially severe tax consequences. Please check with an accountant in your area first. I'd also tell you to check with a lawyer, because each state has its own laws about the effects of how property is held. Nor will quitclaiming the property help if the purpose is to shelter assets from legal action, and if this is to enable your parents to qualify for Medicaid, all fifty states have "lookback" periods of at least thirty months, where the state will recover the value of any assets disposed of in that time frame.

If you are the party quitclaiming a property on which there is a mortgage, be advised that you are still responsible for payment of that mortgage. The lender has your signature on a contract that says, "I agree to pay..." They may or may not have other signatures, but all it means if they do is that other people will join in your misery. This happens all the time. Husband and wife divorce, one keeps the property, the other quitclaims but is still on the mortgage. Time goes by, and the ex-spouse who retained the property and the mortgage fails to make all of the payments on time. Bad consequences ensue for the "innocent" ex-spouse. I have seen this feature used maliciously by vengeful ex-spouses. I would advise requiring a spouse who retains the property to refinance solely in their own name, and if they are unable to qualify, requiring the property be sold. The other spouse is also entitled to a share of equity in many states.

If the property ends up being sold through a Short Payoff, the lender is almost certainly going to drag the "innocent" ex-spouse (whose signature is still on the dotted line) back into the situation. Basically like being an Alabama fieldhand prior to the Civil War or a male whose girlfriend decides not to have an abortion (Admittedly she puts up with nine months of pregnancy, but thereafter puts the child up for adoption and walks away - he gets hit with a lien for child support from the county for 18 years). Despite not having lived in or owned the property for years, they're still tied to that property by that piece of paper they signed. The ex-spouse wasn't the owner, so they had no ability to control or influence the sale, but they're still on the mortgage, so the lender can get their money out of them.

Finally, for as long as you remain on the mortgage, it will hit your debt to income ratio. You are obligated to make those payments, so it's a part of your credit-worthiness. Especially considered in conjunction with likely alimony and child support in the case of a divorce, you may have difficulty qualifying for another property, even ones that would have been well within your means before.

Caveat Emptor

I got a question about "what does it mean if my loan is not funded after right of rescission?"

It likely means your loan provider lied to you, probably from day one. Once you have signed documents, there shouldn't be anything but procedural matters left. Things that cannot be taken care of earlier. Things like final payoff coordination, the escrow officer using funds to pay homeowners insurance. Every once in a while, a good loan officer will get a subordination moved to prior to funding because it's on the way, but it is necessary to start the three day right of rescission now in order to fund on time under the lock.

Every once in a while, it'll be because of something happening to you in the meantime. Lenders who are risking hundreds of thousands of dollars don't just sit there and presume nothing has changed since the first time they checked it out. They are going to check again, right before they put the money to the loan, to make certain that nothing the loan was based upon has changed. So sometimes while they are doing a final Verification of Employment (making certain you still work there), the answer comes back that the borrower doesn't. The final credit check comes back with a score that no longer qualifies under that program. These are not the loan officer's fault, except inasmuch as they didn't warn you not to do whatever it was. Whether you quit your job or were fired, the result is no loan. So I always tell folks not to change anything about their life or credit without checking with me first. Neither I nor they can really do anything about layoffs, of course, but the point is not to voluntarily do anything that messes up your loan.

The vast majority of the time, however, what's going on is that the loan officer never had the loan. There's some condition holding it back that you, the borrower, can't meet. They have a choice between hoping to get around it or going out and actually finding a loan that you can qualify for and telling you about that instead. I shouldn't have to draw you a picture as to which choice they will likely make. Many times, they were teasing you with a loan that you had no hope of qualifying for as an incentive to get you to sign up. This is a standard "trick". They get you wanting that loan, which sure sounds good, and you apply. Unfortunately, that loan was never real, or never something you had a chance of qualifying for, but now they've got you signed up. Now you've done their paperwork, and you're mentally committed to their loan.

Now if it's an honest mistake, they are not going to have you sign documents. They're going to come back and tell you as soon as there is a condition they can't meet on loan qualification. But the question was about when you have signed documents and the loan doesn't fund. They can keep stringing you along, hoping it will happen, or they can come clean and tell you they can't do the loan. In the first instance, they might still get paid. In the second, they likely won't, because if you're smart you'll go elsewhere. Needless to say, this can waste a lot of time getting "one more document" from you or jumping through one more hoop. If the loan doesn't fund at the end of the rescission period and you are not certain as to why, you've probably been had. This is why I always tell people to ask for a copy of all outstanding conditions on the loan commitment before you sign final loan documents. Ask them to explain them, too. You see, once you sign loan documents and the rescission period expires, you're stuck with that loan provider. You can't go elsewhere unless and until they give up. Even if you have a back-up loan waiting to go, they can't do anything until the other loan funds or gives up, which could be weeks. Not a bad situation for an unethical loan provider to be in. In the meantime, the seller cancels your purchase and you're out the deposit. Or the rates go up and you're not getting a refinance on anything like the terms you might have really qualified for at the start of the process.

Caveat Emptor

"challenging underwriters mistakes in housing loan paperwork" was a search that I got.

You can't challenge them. Butting heads with an underwriter is stupid and counterproductive. There's only one person who gets a vote, and it's not you, whether you are an applicant, processor, or loan officer. The underwriter may not be the original application of the saying "a majority of one," but it certainly fits the situation.

Now keep in mind that as an applicant, you will never communicate directly with your underwriter. It is an anti-fraud measure constant throughout the industry. If someone tells you that you are talking to your loan's underwriter, either they are lying or the loan has just been rejected on procedural grounds.

If a loan officer believes that the underwriter has made a mistake in the underwriting of the loan, it is far more constructive to find out what it was - on what grounds the client was rejected. Actually, loans usually are not flatly rejected, they simply come back with conditions the client cannot meet. A loan that actually gets rejected usually has further adverse consequences for the borrower's credit, and is usually pretty good evidence that the loan officer was promising something they couldn't deliver.

Now it happens that underwriters, like loan officers, mis-compute things, miss things, and misconstrue things. This is one of the hardest lessons for a loan officer to learn: NEVER tell the underwriter anything that they do not absolutely have to know in order to approve the loan. The client has a rich uncle that gives them $10,000 every year? The client makes millions in the stock market as well as their salary? The client simply has millions in assets and they could buy the property for cash if they wanted? I wouldn't breathe a word of any of this to the underwriter. Not a peep, if I had my druthers. The underwriter will start asking all kinds of questions, asking for all kinds of documentation, both on the existing assets or income and on the likelihood of it continuing. If you're familiar with how the stock market works, you might have an appreciation for how hard it can be to prove that you're going to have income from it in the future. That underwriter isn't interested in trends or suppositions or even the fact that it's happened the last twenty years in a row. They want proof it's going to happen in the coming years. When accountants won't write a testimonial (trust me, they won't), you're probably out of luck.

Now sometimes the underwriter comes back with conditions that are beyond the bounds of reason. Dealing with this is part of my job, but it's more akin to a negotiation than a confrontation. I've got to get them to tell me what has them concerned, and see if there isn't some other way to reassure them. Remember, if the loan goes sour, both the underwriter and I are going to hear about it. It may cost them their job, and I may have to come up with thousands of dollars to pay the lender. Not to mention that the client isn't exactly happy. The underwriting process, properly used, is as much for the protection of the client as the lender.

So what I've got to do is find out what concern caused the underwriter to place this condition on the loan, and then a more reasonable alternative may suggest itself. If you ask in the right way, conditions can be changed if the request is reasonable. But you've got to know what you're doing. If the alternative you suggest does not adequately address the underwriter's concerns, they are within not only their rights, but also in full compliance with regulations where you are probably not, to refuse to make the change. Sometimes the underwriter and the loan officer disagree as to the computation of income, for example. By definition, the underwriter is right - unless I can persuade them that my way is better. Just human nature, you can't do that by challenging them, you have to persuade.

Now it is possible to run into an intransigent underwriter. That's one reason why brokers have the advantage over direct lenders, who are stuck with the same group of underwriters all the time. I can pull the loan and resubmit it elsewhere. Given that particular lender isn't going to approve the loan anyway, they won't fight too hard, although on several occasions I have had the lender come back and issue an exception on their own when I do that, but the ability and willingness to actually take it elsewhere is essential to this. And it is sometimes possible to go over a given underwriter's head and get an exception from the supervisor, but it tends to poison the well when you attempt this, whether it is successful or not. When you're asking for special consideration for your clients, they tend to look much harder at all of your clients. I've seen a couple loan officers talk themselves into one approval through an exception with the supervisor, only to have their other loans that were going through smoothly kicked back out for further underwriting. So you have one happy client, and three or four that otherwise would have been happy and who now are not. Sounds great if you're that one client, but how would you like to be one of those three or four others? Not a good situation for anyone to be in. Taking the approach of collaboration works better.

Caveat Emptor

My aunt is going to move to a new condo and wants to sell her old one. I would like to buy her old condo as an investment and rent it out (as I am already a home-owner). This whole investment/rental buying is all new to me.

She has lived there about 5 years and the value has increased more than double. Obviously I would love to be able to keep her tax base. I am thinking about getting an interest only loan to help me get into this. Can I get a loan for 100% of value? My aunt will need the entire amount to purchase her new place. What suggestions do you have to make the loan process easier and pay the least amount in fees?

It is worth between 360,000 to 390,000 (we haven't yet got an appraisal, this is from comps in area). My wife and I currently have a house in (City) with a value of 650,000 and a mortgage of 400,000. We both work and have some extra income, maybe 400 a month that we could supplement against a renter. I think we could qualify for the loan, but then we would have to refinance our house to cover a down payment and closing costs. We don't have any savings to pull from. My wife hopes to retire in 2 years and I will in about 8 years.

Investment property is a different item from a personal residence, in several particulars. First off, even if it's residential, the loan is a riskier one to the lender. A loan on investment property is going to carry a surcharge of 1.5 to 2 discount points (one discount point is one percent of the final loan amount), over and above any other charges for the rate you choose. Furthermore, despite a lot of research, I don't know a single lender that will do a loan on investment property for more than 95 percent of the value, and most of them will only go 90 percent. The ones who will go 95 percent typically charge higher rates, and are to be avoided if you can. So you need a down payment of at least five percent and preferably ten.

The good news is that whereas you do not have savings to pay it, you do have a considerable amount of home equity. Depending upon your exact situation, either a "cash out" refinance or just taking out a HELOC (Home Equity Line Of Credit) might be in your best interest. It depends upon your current mortgage and your credit, and I cannot make a recommendation one way or another without looking at the market you're in for current comparables, running your credit, and seeing what can be done. If you've got good credit and income, and have had the good credit and income for some time, it's more likely to be in your best interest to simply take out the HELOC. I have some without prepayment penalties and that are zero cost. If your credit or income has improved of late, it may be in your best interest to refinance, or if you've got an ARM that's about to adjust anyway. Assuming you're "A" paper, you may now be a conforming loan where you would not have been when you took it out, although taking the cash out could cause you to exceed, once again, the conforming limit.

Cash flow is also an issue with investment properties. If you don't have a tenant, you get zero credit for the rent at initial purchase from A papeer. If you do have a potential tenant, with a signed lease for at least one year, the lender will give you a credit of seventy-five percent of the proposed rent towards your cost of owning the home (principal, interest, taxes and insurance). Some subprime lenders will credit you with ninety percent, but their rates are typically higher in compensation. With the vacancy rate in urban California being about four percent, even ninety percent is a bit low, but the standards are what they are. I know many people who are making money hand over fist on rentals where the bank thinks they are paupers.

Now there is no such thing as an easy documentation investment property. Indeed, for any loan, for all real property you have to show the full breakdown for each property you own. You can state your overall income in most cases (and indeed, most folks with investment property have to do stated income due to the cash flow computations being so restrictive.)

In urban California, however, prices have gotten so high that I do not recall the last time I saw a single family residence being purchased for rental purposes that "penciled out" with a positive cash flow. As I said in my article Cold Hard Numbers, this was one of the things that convinced me California real estate was overvalued.



Now, as long as you have the cash flow to last until rents catch up, this is fine. But you need to be very certain that you do have that cash flow. If you're buying for $360,000, this is a first loan at about 6.75 percent right now of $288,000, which gives a payment of $1868. Additionally, there's going to be Homeowner's Association dues of probably about $200, and taxes (assuming no Mello Roos) are about $375 per month, or about $200 if you can keep your aunt's tax basis. That sums to $2443 or $2268 if you can keep her tax basis. Now ask yourself how much similar units are renting for? If it's less than $2050 (or $1875 if you can keep the tax basis), your $400 per month isn't going to make up the difference. You might consider a negative amortization loan in this circumstance, but be advised that you're eating up your investment every month, the real interest rate is actually higher than the 6.75 percent, and prices may go down and not recover for several years, leaving you holding the bag for a big loss. It's a risk some folks are willing to take, others are not. I'm willing to do them for people in this situation, but only after I explain all the pitfalls (Option ARM and Pick a Pay - Negative Amortization Loansand Negative Amortization Loans - More Unfortunate Details cover most of them). Usually people who have been informed of the pitfalls decide that these loans are not for them, which is one of the reasons why I question whether the risks have been adequately explained to the forty percent of all local purchases being financed by these (or were when the article was originally written).

Indeed, given the fact that you're going to have to make payments on the Home Equity Line of Credit as well, it's difficult to see how your $400 per month of extra cash flow is going to stretch to cover. If your credit is decent, I can get you into the property, but that's not exactly doing you a favor if you find it impossible to make the payments.

Caveat Emptor

Not interested? Most people aren't when it's talking about how they got taken advantage of in the past. First off, it's in the past so it is over and done with, and there's no use dwelling on it, right? Second, there's the ego thing. Nobody who's been bragging about what a great deal they got likes to find out they've been had. Taken for a ride. Conned. Big time.

Anyone reading this who isn't interested in improving what happens next time can tune out now, because that's what the rest of this article is about: educating you in how to shop for a loan and what the tricks are, and if you've never had a real estate loan but want one someday, chances are you'll benefit from reading it to. If you're the sort of person who isn't interested in improving your future loan, chances are you're not a regular reader because helping folks understand their financial options for next time is the most consistent thing I do here.

On a very regular basis people tell me how they got taken advantage of by a loan provider. Actually, a lot of them think they're bragging about what a great deal they think they got, when in their situation, I wouldn't take that loan if the bank paid me. High points charges that stick around in the balance essentially forever. Points on hybrid ARM loans (3/1, 5/1 and 2/28 are the most common). Prepayment penalties, especially needless prepayment penalties, or prepayment penalties that last longer than the period of fixed interest rate. Fixed rate loans where hybrid ARMS are more appropriate. Long terms where a shorter term would be more in your best interest. Most loan officers are looking for an easy sale, and no loan officer ever complains that a sale was too easy to make. Failing an easy sale, they'll look for any sale. If they don't get you signed up for any loan, they don't make any money. They are not responsible for your best interest, they are responsible for making money and not stepping over legal limits which are very different (in the sense of being less restrictive to loan officers) than most members of the public believe. If ever a loan officer tells you that in your circumstances, they wouldn't refinance, make sure you get their contact information and put it someplace you will be able to find it when you go looking for your next loan.

First off, if your credit score is above about 660 and you have a prepayment penalty, chances are excellent that you were taken for a ride. People with credit scores above 660 should usually be A paper, not subprime. A paper does not need a prepayment penalty except when the loan officer wants to get paid more. A 2 year prepayment penalty is worth a good chunk of change on the secondary bond market - usually about 4% of the loan amount. This means that if you have the $270,000 loan I use as the default here, they made almost $10,000 over and above the normal price spread when they sold your loan. And even when they retain servicing rights, lenders sell loans over 95 percent of the time. At the very least, you should get some kind of benefit for accepting a prepayment penalty A paper. A current "maximum conforming" loan of $417,000 would be worth almost $17,000 more to the lender with a prepayment penalty than without. This, all by itself, is often a reason they stick folks in subprime situations. If you think you're A paper, make them show you the turn-down from the automated loan underwriting program before you even consider a subprime loan.

If your credit score is below 620, you're almost certainly stuck with a loan where you have a prepayment penalty by default. Buying it off is usually a good idea, but buying them off isn't free. Between 620 and 659, there's some wiggle room as to whether you will get an A paper loan.

But most people never undertake the three most important steps they can to get a better loan. They don't shop multiple lenders. They don't ask for a guaranteed quote. And they certainly don't sign up for a back up loan.

I've been looking for a new place to hang my license, and the one thing (other than looking for loan officers who don't understand the way the business works) that most of the firms have in common is that they don't want to compete on price. They know they may have to the first time, but they want the client that just automatically comes back to them that they can soak for two or three points on every loan, in addition to whatever they earn for the prepayment penalty. I understand this yearning very well; it's a normal human desire to want to make more for the same amount of work, and also to lock up the customer for the future. If all you think about is how easy the loan is to get, you are these firms' favorite type of client. Guess what? You may not see their extra $10,000 or $15,000 as a separate charge on any of your paperwork, but it is there and you are paying it, and someone who knows what they are looking for can find it. Most folks would never dream of paying $50 for the same toaster that everyone else is buying for $13.99 at Target, but the way loans are priced is confusing at first sight, and people don't want to sort it out. It's pretty easy, actually. Figure out what kind of loan you want and qualify for, then price the rate/cost trade-offs of that loan type amongst the various loan providers. Figure break-evens on the extra cost of the lower rate. One rule I have never encountered an exception to is that if a loan provider pushes a low payment to sell a loan, they are a crook. If they sell by interest rate, they may be worth talking to, providing the loan type is what you're looking for. If they sell by the Tradeoff between rate and cost, they're definitely worth talking to. And if someone suggests a different type, hear them out but make certain they tell you all of the details. There is always a reason why one loan is significantly cheaper than another loan

Another very common tactic used to induce your business is advertising. Remember the loan ads that went "Lost another one to (mega corporation which shall remain nameless)"? That particular mega corporation is not competitive rate-wise or underwriting wise with others. Joe ShadyBroker who earns six points on every loan can often deliver better rates than they can. What they were trying to via their advertising is create the illusion of low prices by telling you they have low prices. Then, when you call and they quote the superficially low payment due to a rate where you have to pay three points to get it, they've got the average potential client suckered. Because their payment on a 2/28 loan with a 3 year prepayment penalty where you have to pay three points to get the rate is lower than mine on a thirty year fixed with zero points, people will sign up. Why? Because it looks more attractive to them at first glance. Get the calculator and the checklist of questions and ask the questions and do the math. Nobody can take advantage of you without your consent, but those who allow themselves to be intimidated by numbers are giving their consent. Actually, with most places, it's like begging, "Oh, please, I want to pay thousands of dollars more to get a higher interest rate!"

If someone doesn't ask questions like "how long are you planning to keep it?" or "how long do you usually keep real estate loans?", especially if they just launch right in to a spiel based upon a low payment, they are a cash-sucking Vampire. They may be an intelligent vampire doing what they are doing in full cognizance of what it does to you, or they may be an innocent vampire who doesn't really understand the business and who is being controlled by a green-blooded master cash-sucking vampire, but in either case you don't want to do business with them. Yes, these are sales questions. Yes, they get you talking to a salesperson, who then has a possible opening to talk you into something that may not be in your best interest. If they don't ask the questions, I guarantee that they're trying to push you into something that isn't in your best interest. Which is better: Not talking to a salesperson and being certain of being messed with, or talking to a salesperson and possibly being messed with? Note that there is no option that says "Don't talk to a salesperson and not get messed with." If their people don't know enough to help you from their own knowledge, those salesfolk were probably intentionally hired because they didn't know any better. It is not a crime to make money. They are looking to make money, I am looking to make money, everybody in every line of business is looking to make money, including your employer - that's how they pay you. If I were independently wealthy and never needed or wanted to make money again, I certainly wouldn't be doing real estate loans, and neither would anyone else. You can take the attitude that you're going to pay a reasonable amount, and while you can take steps to hold that amount down and make certain it doesn't get outrageous, you know you're going to pay what it costs, or you can take the attitude that a cheaper quote means you'll actually get that rate at that cost when the overwhelming probability is that they're lying to get you to sign up. You need to look gift horses in the mouth. If someone's quoted fees are lower or higher than everyone else's, there is a reason. If they're too low, it's probably because they're pretending that a large percentage of what you are going to pay doesn't exist, because that gets people to sign up. Ask them if they will guarantee their total fees and the rate in writing. If the answer is no, they are lying. Actually, most of the liars won't tell you "no" in response to that question. They'll tell you some line about how they're a major corporation or how they honor their commitments or any of several other lines that mean absolutely nothing. The MLDS and Good Faith Estimate are not commitments. Major corporations pull the same games as everyone else. In fact, they usually get away with playing even worse ones than Joe ShadyBroker because of their "name recognition".

So shop around. Ask every single prospective loan provider every single question in this article. Pull out the calculator to see if it's believable, to see if the numbers work. Ask them if they'll guarantee the quote, subject to underwriting. And then go out and apply for a back-up loan as well, because even if you've got a guarantee, it's difficult to enforce, and impossible within the time frames most folks need the loan to be done.

The typical savings of being a savvy consumer is literally thousands of dollars every time you get a real estate loan. You may not see the savings directly on the HUD-1 at closing, but they will be present nonetheless. If you don't accept a prepayment penalty, that's thousands of dollars you've saved yourself down the line when you've been transferred and need to sell. If you get a rate that's a quarter of a percent lower on a $270,000 loan, that's $675 interest you are saving per year. That's a couple of car payments; perhaps enough to let you buy for cash next time you need a car. If you invest the difference over the potential lifetime of your mortgage, a difference of over $127,000! If you save yourself the two extra points of origination that they were going to charge you, that's over $5500 that either is in your pocket, and that you can invest or spend on other things, or $5500 that isn't in your mortgage balance, where you're going to pay hundreds of dollars in interest on it per year ($357.50 per year at 6.5% interest), in addition to owing the base sum.

My point is this, folks. If I were a financial advisor trying to score an extra quarter percent commission off of you, most of you would be upset. Many people are so upset by 0.25% 12b1 fees in mutual funds that they won't pay the advisor who would save them a lot more money than the 0.25% per year simply by simply reminding them of sound investment principles. If I were a car salesperson trying to pad the cost of the car you were interested in by $5500, a large percentage of the population would most likely slug me. But because real estate transactions are complex and people don't want to take the time to understand them, they unwittingly walk into situations like this, and many people do so repeatedly throughout their lives, making the same mistakes every two years. The dollar amounts are large enough that even small differences are thousands of dollars. If you're not going to guard your pocketbook, most loan providers will pick it.

Now the workman is worthy of his or her hire. The person who gets you the loan is entitled to be paid. Judge the loans on the bottom line to you; how much it costs and what you will get. The proof that they got you a better deal was that they delivered a better loan, not that they made less money. And if the person who does your loan can make an extra half-point while actually delivering you a loan that is the same rate on the same loan at less cost than the other provider, haven't they earned that money? You came out ahead because of their work - had you gone with any other loan, you would have paid more or had a higher rate. They made more. Definition of win-win. There is a loser here, by the way, but you'll never know who it was. It is the lender that the broker you didn't sign up with would have put you with. But by finding you a program you fit better, the loan officer you did sign up with got you a better deal and made more money. It happens every day, if you make the effort to look for it, and go about it in the right fashion.

Caveat Emptor

I got a question about legal late payments in California.

Unfortunately, there really is no such thing as a legal late payment. You borrowed the money, signed a contract, and it accrues interest according to that contract. You owe this money, and it only gets worse if you don't pay it. There is some wiggle room so you don't get unduly hit for a day or two late, or if the right to receive payments is sold, but that's about it.

The law gives you some wiggle room in the timing of the payments. First off, the laws of California and most other states give you fifteen days after the due date to pay the mortgage before a penalty can be assessed. I know of a lot of people who make consistent use of this. If it's due on the first, it's supposed to be there on the first, but many people take advantage of the fact that there is no penalty as long as it's paid within fifteen days of due date (i.e. before the sixteenth), and consistently mail their payment on the tenth or twelfth.

Now if you miss it by even one day, the penalty is up to four percent of the amount due here in California. As you might guess, most lenders charge the maximum penalty. When you compute it out, four percent times 360 divide by 15 is ninety-six percent annualized. I had my check get lost in the mail once and the lender waived the penalty when they called me on the eighteenth because I always paid on the first or before, but they didn't have to do that. I got the distinct impression that if I were the kind of person who pays on the twelfth or fourteenth every month, they would not have waived the penalty.

Now, there is also some wiggle room on when the new lender receives it if your contract is transferred between lenders. Because once upon a time some unscrupulous lenders would sell notes back and forth between their own subsidiaries because it made them more likely to get late fees, or even able to foreclose on appreciated property when there were relatively few protections for borrowers in law. Mind you, you still have to send it on time, but if it gets hung up in forwarding between lenders, that's not your issue. Within sixty days, the old lender must forward the payment promptly, and it counts as received when the old or the new lender receives it, whichever is first. It's still better to send to the new lender at the new address if you have it or know it.

In short, although there are some small period where payment is allowed to be delayed due to one factor or another, it is never to your advantage to do so. Make your payments on time.

Caveat Emptor

One topic I haven't covered yet here is homesteading. This has nothing to do with the Homestead Act of 1862 that encouraged settling the western United States.

A declaration of Homestead basically protects your equity. In many cases, you may not even have to file a declaration to receive the benefits, but whether this is so is complex. If you file, you remove the ambiguity.

A homestead declaration may only be filed upon a primary residence, and only if you own it. Rental property, second homes, and property held for business purposes is not eligible. Law between the states varies, as does the exemption amount

How it works is pretty consistent. First off, it protects no equity arising from dates prior to declaration. If you are in one of those situations where you have to explicitly declare homestead instead of it happening de facto, you have to actually declare it before the incident happens. You get in a traffic accident that's your fault, and go out and declare homestead the next day, it won't help you protect your equity against that particular lawsuit.

Note that it protects your equity, not your asset value. If the home is worth $500,000 (as is often the case in San Diego) but you owe $400,000, you have $100,000 of equity. How much it protects is dependent upon your state law and exact situation. Default protection in California is $50,000, but it can be up to $150,000 if you or your spouse are 55 or older, disabled, or have income less than $15,000 per year.

It can also prevent sale of the property in some, although not all situations. In California, the judgment creditor usually has to get a court order, after they have won the judgment, in order to sell the property. I'm not a lawyer, so I'm not going to presume to advise anyone on what those circumstances are.

Now, there is some question in some minds as to whether a homestead declaration inhibits enforcements of Deed of Trust, so many lenders will require an abandonment of homestead prior to funding their loan. You can always re-declare as soon as the loan funds, anyway. I know that some folks have fought this issue in court, costing the lenders money to pay their lawyers, so it's hard to blame the lenders for requiring it. You can refuse to do this, but they can also refuse to give you the loan. It's their money, and they are the arbiters of how they lend it out.

Caveat Emptor

Just got a search "how can I tell if my prepayment penalty applies to selling my home"

Read The Full Note. You need to do this before you sign it. I know that many people are just thinking "Sign this and I get the house!" or "Sign this and I get the money!" but a lot of loan providers - often the very biggest - scam their customers by talking about one loan with very favorable characteristics, and when it comes time to sign they actually deliver a completely different loan with a prepayment penalty, burdensome and unfavorable arbitration requirements (I've seen stuff that amounted to "the bank chooses the arbitrator"), and any number of other unfavorable terms, not to mention having a higher rate and three times the cost, and being fixed for two years as opposed to the thirty they told you about.

Any loan officer can make up all sorts of paperwork along the way to lull you into a sense of security. The only paperwork that means anything are the papers you actually sign at closing with a notary present. The Trust Deed, the HUD-1 form, and the Note. Concentrate on these three items. The HUD-1 contains the only accounting of the money that is required to be correct (things like do you need to come up with more money than you were told?). And the Note contains all the other information on the loan that your provider might actually deliver. Notice that wording - I said might deliver. Just because you sign the Note doesn't necessarily mean you get any loan, let alone the one that Note is talking about, but these are the terms you're agreeing to now, and most Notes do actually fund. They can't change the terms without getting you to sign a different Note. But once you sign and the Right of Rescission (if applicable) expires, you are stuck. Get that other loan - the one your loan provider has been talking about up to now - out of your head. This is the moment of truth as to what they actually intend to deliver. The majority of the time, the loan they actually deliver is significantly different from the loan they were talking about before now, and this document is where the truth lies. Amount of the loan (does that match what you were told?). Length of the loan. Period of fixed interest. What the fixed rate is, and how the rate will be computed after the rate starts adjusting. The Payments: how closely do they match what you were told? Payments are a lot less important than the interest you are being charged, but if the payments are $20 more than you were told (or if the interest rate is different), you were basically lied to. If the real loan was available and the principal correctly calculated, the payment should be within $1. $20 off gives the loan provider literally thousands of dollars to soak you for extra fees in, even if the rate is correct. A competent loan officer knows what loans are really available and whether you are likely to qualify, and can calculate pretty closely how much money it takes to get the loan done. From this flows the payment. Payment is a lot less important than most people think, but you do need to be able to make it, every month. Furthermore, that's how most people shop for loans and how unethical loan officers sell bad loans. Shopping by payment is a good way to end up with a bad loan. Many loan officers will tell you about this nice low payment, and conveniently neglect to mention the fact that if you make this low payment, you'll owe the bank $1200 more at the end of the month than at the beginning of the month.

So take the time to read the entire Note before you sign. There are all sorts of things lenders slip in. I worked for a very short period at a place that trained its people in how to distract you from the numbers on this and the HUD-1 and the Trust Deed. This is a legally binding contract you are entering into, you are agreeing to everything it says, and there aren't a whole lot of methods of getting out of it if you don't like what it says later. Once the loan funds, you are stuck with the terms, the costs, and everything else. The only way out, in general, is to refinance, which means paying for another set of loan costs and quite likely the prepayment penalty on this loan. Multiple thousands of dollars. So don't allow yourself to be distracted. Read the Full Note.

Caveat Emptor

I've written articles on when you can't make your mortgage payment and how to react if you see foreclosure coming in time to do something about it, and even on Short Payoffs, but all of those are owner (seller) oriented. This is intended as a basic buyer's guide to getting a bargain from people who bit off more than they could chew, with emphasis on the current local market but applicability anywhere.

There are essentially four phases in the foreclosure process. The first is pre-default. They've made late payments or none at all, and there's no way they can keep the payments up, but they won't do the intelligent thing, which is sell for what they can get. Many people who own properties headed for default are deep in Denial. Yes, this is often because something bad happened to them for reasons beyond their control. I'd be happier if those sorts of things didn't happen, but the amount of rescuing that's going to get done is minimal. There are very few White Knights running around, and the ones who claim to be White Knights are usually blackguards. Unless the seller knows of some factor that is going to change, this is the smart time to deal with the problem. Before the Notice of Default is recorded, nobody really knows but the owner and the bank. Once the Notice of Default hits, all the sharks come out because everyone knows the owner is in Dire Circumstances. Let's face it: most folks will make the payments on their home even if they let every other bill slide. When someone can't make their mortgage payment, and it's public information as a Notice of Default is, everybody and their pet rock knows that don't have any choice but to sell. They'll flood you with offers, but they won't be good offers.

Now if you're looking to buy at this stage, the thing to do is examine the Multiple Listing Service. "Motivated seller" and similar phrases are often code for "These people can't make their payments!", particularly in the current market with prices declining somewhat and many people who stretched beyond their means. It would be great to be able to get a list of properties that are sixty days or more delinquent, as this would include the folks in denial, but it just isn't going to happen. The only folks who know are the banks and the credit reporting agencies, and they are prohibited by privacy laws from disclosure. So at this point all you have to deal with are the people who are not in denial. Now when the market is rapidly appreciating, this is a good place to find a bargain, because once the Notice of Default hits, the sharks swarm, so if you can find these people before that, you're in a strong bargaining position if you correctly suspect they can't make their payments. The taxes being delinquent is often a good indicator of this, but there is no way to know for sure unless the people or their agent tell you, and the agent who tells you has just violated fiduciary duty. This can mean prospective buyers overplay their hands in negotiations, which is fine if you intend to move on if you can't get a "Manhattan for $24" type deal, but if it's a property you want and can make money on, overplaying your hand can poison the atmosphere. There aren't many "Manhattan for $24" type deals out there, because if you wait that long, someone else already has taken it. There are a lot more good opportunities for someone willing to pay a reasonable price and hold the property a while or make improvements. Deals so good that they instantly make oodles of money, someone will usually come along and offer the poor schmoe on the other end a better deal, and if the poor schmoe has a decent agent who's looking out for their interests, they can switch to the other offer. Buyers and escrow companies don't like it, but it can be done. It's extra work for the listing agent, so they may not want to, and they may not have done the best set-up, but it can usually be done anyway.

The reason it's smart for sellers to sell at this time is that this is when they are going to get the best deal. The mere act of entering Default is likely to cost thousands of dollars. Furthermore, this is the phase with the most opportunity to find a property at a better than usual price for buyers, because most of these don't get to actual default. Someone will come along and make an offer, and a listing agent who gets an offer on one of these is likely to advocate taking the first reasonable offer, reasonable being defined as "anything like the asking price".

The second stage of the foreclosure process is default. The Notice of Default has been filed, and because it is a matter of public record, the sharks instantly react to the blood in the water. The seller is going to get dozens to hundreds or even thousands of solicitations. Also, once the property is in default, the bank can require the owner bring the Note entirely current in order to get out of default. Whether or not the property is listed, they're going to have agents offering to sell it for them, individual buyers who want those Manhattan for $24 deals, and lawyers offering to "protect" them by declaring bankruptcy. By the way, I've never heard of anyone who came out better in the end by declaring bankruptcy, so you probably don't want to do it if you're in this position. I know it's your home, and you're likely extremely emotionally attached to it, but declaring bankruptcy doesn't mean you don't owe the money when it comes to a Trust Deed. Every single one of these folks, lawyer, agent, or prospective buyer, knows that you're in default. Some owners are still in denial at this point, but all denial means at this point is that such an owner is not likely to take the best offer they'll get. It's at this phase that most "subject to" deals happen, usually with highly appreciated properties with significant equity over and above the trust deed. If the owners owe anything approaching the value of the property, that's a silly situation to do a "subject to" purchase for buyers, and most of the prospective buyers (those with decent advisors or agents or experience) won't do it if the equity is less than a certain amount or proportion of the value.

The third phase of a foreclosure is the auction. This is typically a very short period. Five days before the auction date itself, the owner loses the legal right to redeem the property, although the bank will usually let them until the last possible instant. There is also a legal requirement to vacate the property before the auction. "Subject to" deals can still go through as long as the bank will accept redemption. Now the auction itself requires cash or an acceptable equivalent. You don't go to the auction and then get a loan later. At the very least you have to have the loan prearranged and a check for the proceeds in hand. This can mean that the rate is significantly higher, and it can be difficult to refinance within the first year.

The fourth phase is after the auction. In California, if the property does not get a bid for at least ninety percent of appraised value, it does not sell and becomes owned by the bank. The bank doesn't want it; they're not in the real estate business and in fact, they are legally required to dispose of it within a certain time. In the current market, this can be the best place to acquire a property. The bank knows they're taking a loss, and the longer it goes, the bigger the loss. Mind you, because the bank usually takes a loss, few properties go to this stage. The lenders will usually do anything reasonable in order to avoid auction, but once it goes to auction, they want to get rid of it. They usually require a substantial deposit, but the purchase price can be the best of all.

One thing to be wary of in foreclosures is they are often in less the ideal condition, to say the least. These people know they are losing the house, and often that they are going to come away with nothing in the best realistic case. They have no incentive to take care of the property, and many actively work to mess it up. This is cause for care in purchasing them, and inspections, because not all of the damage may be obvious. Furthermore, many of them may have been unable to afford proper maintenance for some time before they lost the property. Purchasing a foreclosure can mean you will need a large reservoir of cash in order to fix up the property to habitable condition.

Caveat Emptor

I was thinking we were ready for a recovery here in San Diego, but if these go through unamended, that will not be the case. Just in time to be the Grinch that Stole Christmas, the Federal Reserve has decided to perform a gigantic belly-flop into a situation that was already being dealt with, and make it worse.

From the AP story:

Sen. Chris Dodd, D-Conn., chairman of the Senate Banking Committee and contender for his party's presidential nomination, called the Fed proposal a "significant step backwards." Rep. Barney Frank, D-Mass., said it shows that the Fed is "not a strong advocate for consumers, and two, there is no Santa Claus. People who are surprised by the one are presumably surprised by the other."

And these are the Democrats, who never met a government regulation they didn't like.

Alright, enough hyping it up and let's get to what's available, which isn't much yet.

Here's the Press Release, and from the Federal Reserve website, here is the summarized version (actual text not available either in Federal Register or on Federal Reserve website yet)

The proposal would establish a new category of "higher-priced mortgages" that should include virtually all subprime loans.1 The proposal would, for these loans:

* Prohibit a lender from engaging in a pattern or practice of lending without considering borrowers' ability to repay the loans from sources other than the home's value.

* Prohibit a lender from making a loan by relying on income or assets that it does not verify.

* Restrict prepayment penalties only to loans that meet certain conditions, including the condition that the penalty expire at least sixty days before any possible payment increase.

* Require that the lender establish an escrow account for the payment of property taxes and homeowners' insurance. The lender may only offer the borrower the opportunity to opt out of the escrow account after one year.

The proposal would, for these and most other mortgages:

* Prohibit lenders from paying mortgage brokers "yield spread premiums" that exceed the amount the consumer had agreed in advance the broker would receive. A yield spread premium is the fee paid by a lender to a broker for higher-rate loans.

* Prohibit certain servicing practices, such as failing to credit a payment to a consumer's account when the servicer receives it, failing to provide a payoff statement within a reasonable period of time, and "pyramiding" late fees.

* Prohibit a creditor or broker from coercing or encouraging an appraiser to misrepresent the value of a home.

* Prohibit seven misleading or deceptive advertising practices for closed-end loans; for example, using the term "fixed" to describe a rate that is not truly fixed. It would also require that all applicable rates or payments be disclosed in advertisements with equal prominence as advertised introductory or "teaser" rates.

* Require truth-in-lending disclosures to borrowers early enough to use while shopping for a mortgage. Lenders could not charge fees until after the consumer receives the disclosures, except a fee to obtain a credit report.

Let's take these bullet point by bullet point, and consider their effects upon consumers and the marketplace. Actually, let's take the first two together:

Prohibit a lender from engaging in a pattern or practice of lending without considering borrowers' ability to repay the loans from sources other than the home's value.

Prohibit a lender from making a loan by relying on income or assets that it does not verify.

Goodbye, not only Stated Income loans, but NINA loans (aka "no ratio") as well.

I'm not going to pretend stated income hasn't been abused, seeing as how I've been one of the loudest voices condemning it for the past several years. Both Stated Income and NINA nonetheless have their uses, and do help significant and increasing segments of the population. Indeed, they are necessary for increasing segments of the population. Here's why: When documenting income, there are only three acceptable ways to do it. A paper is limited to income reported on the Adjusted Gross Income line of form 1040 (or the equivalent line of forms 1040A and 1040EZ), or for certain salaried employees, W-2 forms. To this, subprime adds the ability to document income via bank statements, but they don't give credit for 100% of income, and it's only net income that finds its way onto bank statements. This makes bank statements a bad way to try and qualify for a loan, because there are a lot of situations and loans where a consumer could qualify by real income, they cannot qualify based upon bank statements. Qualification by bank statements is also subject to a lot of abuse and manipulation, so I don't like to do it as it can leave me vulnerable to a scam artist.

But if you make commission or are in construction or are a contract employee or aren't an employee at all (i.e. self-employed), all of which are large and growing fractions of the population, the only acceptable way to document income is with a 1040. But if you look at form 1040, there's a whole lot of stuff that gets deducted from income prior to this determination, not to mention a lot of other expenses are deducted on Schedule C (among others) and never show up on the main 1040 at all. Upshot: People who have to qualify via form 1040 are penalized in their ability to qualify for loans. It is very common for self-employed people to be making the money to afford the loan, but to be unable to document it. This rule would prevent those people from obtaining that loan. I have seen circumstances where the secretary could document more income than the owner of the business - and it wasn't that he was hurting or that it was a new business - it was a going concern and he was donating more than the secretary's base salary to charity every year.

Similarly, the allowance for income from investments in entirely nonsense: three percent per year. For crying out loud, savings bonds pay more than that. If I have a million dollars in investments, my income had darned well better be above $30,000. What's going on is that this is a safe harbor allowance because the investment markets are unpredictable, but it's not a realistic estimate.

Finally: What about the people who got into their current homes and current loans through stated income? How in the nine billion names of god are they supposed to refinance out of their current nightmares if nobody can do stated income or NINA loans for them? This starts the tidal wave of foreclosures we just averted all over again. I realize that it's theoretically for sub-prime loans only, but expect this proposal to have a major negative impact on every local market, if enacted.

Next up:

Restrict prepayment penalties only to loans that meet certain conditions, including the condition that the penalty expire at least sixty days before any possible payment increase.

I can get behind this. In fact, I've been begging for a mostly stronger version of this for years - that no prepayment penalty can last longer than the period of fixed interest rate. Focus on the real cost of money, dadgum it! (The way the Fed puts this merely emphasizes once again that they are bankers rather than economists or financial planners). It's possible for a loan like a thirty year fixed with an initial interest only rider to increase the payment without changing the fact that it's the same rate but that's a comparatively rare thing. How about combining the two restrictions? Negative Amortization loans have a low fixed payment, but the interest rate is variable from day one. But if the Fed won't take my suggestion, I'll take what I can get.

Require that the lender establish an escrow account for the payment of property taxes and homeowners' insurance. The lender may only offer the borrower the opportunity to opt out of the escrow account after one year.

And the Fed is back to putting their foot in their mouth (after stepping in dog doo). There have been so many impound account problems over the years that many states (California among them) have dealt with the issue and actually prohibited lenders from requiring an impound account, or even from pricing the loan differently if the consumer doesn't want one. Lest there be any doubt, this is one of the few things that the state legislature of California has done right in the last thirty years. This proposed regulation is incompatible with California state law as it exists. Upshot: I'm not a lawyer, so I'm not certain. It could be that there's no more new loans in California until the discrepancy is resolved. This is a regulation to protect bankers from themselves and from the saner moments of various state legislatures. It also raises the opportunity cost of refinancing, because as I explained in my article on Impound Accounts, the consumer has to either roll this money into the balance of their new loan (where they'll pay interest on it for as long as they have a loan) or come up with thousands of additional dollars in cash until they get the check from their old impound account. Like I've said many times, the Fed is composed of bankers, and makes its decisions for the benefit of bankers, not consumers. This proposal serves nobody but bankers.

Prohibit lenders from paying mortgage brokers "yield spread premiums" that exceed the amount the consumer had agreed in advance the broker would receive. A yield spread premium is the fee paid by a lender to a broker for higher-rate loans.

This I can live with. Not that it's not subject to manipulation, but I can live with it. As I've said when I explained Yield Spread, I just plan to make my money on origination and rebate the money for the yield spread to the consumer. Alternatively, I can "pad" what I actually expect to make by a little bit when I have the consumer sign off on the yield spread. Tell them I'm going to make a full point when I'm actually looking to make eight tenths, or three quarters when it's really a half. Of course, this is bankers trying to make brokers appear less competitive by distracting consumers from the net terms to them, because if I deliver the loan I originally said I would, it makes no difference to the consumer if I make two dollars or two million via yield spread. If my loan wasn't the best they were offered, they'd have gone with someone else. One small side benefit is that it might keep some idiots from floating the rate while telling the consumer it was locked.

Two more at once:

Prohibit certain servicing practices, such as failing to credit a payment to a consumer's account when the servicer receives it, failing to provide a payoff statement within a reasonable period of time, and "pyramiding" late fees.

* Prohibit a creditor or broker from coercing or encouraging an appraiser to misrepresent the value of a home.

I find it mind-boggling that these are not already prohibited by the Federal Reserve. I thought they were. Rock. Gravity. Use your imagination. Of course, this will have no impact upon state chartered institutions, but California must have dealt with this one a long time ago.

Prohibit seven misleading or deceptive advertising practices for closed-end loans; for example, using the term "fixed" to describe a rate that is not truly fixed. It would also require that all applicable rates or payments be disclosed in advertisements with equal prominence as advertised introductory or "teaser" rates.

I find it mind boggling that this wasn't done years ago. I've written about this many times. Must be all those congressional campaign contributions the lenders make. Once again, however, absolutely no effect upon state-chartered lending institutions.

Require truth-in-lending disclosures to borrowers early enough to use while shopping for a mortgage. Lenders could not charge fees until after the consumer receives the disclosures, except a fee to obtain a credit report.

Second part first, about not charging fees until after consumer receives disclosures: This is actually good. However, it's not a common problem, and it doesn't prohibit deposits, which a lender can then keep after they fork over the disclosures. Deposits are not fees. Once an unscrupulous lender has the money, good luck getting it back. This is why the more ethical loan providers are strictly "fees at time of service." You pay for the credit report when it is pulled. You pay for the appraisal when the appraiser does the work. You pay for the survey (in those states where it's required) when the surveyor does the work. But if the lender has your money, they can hold it hostage, even if it's not technically theirs yet. Practical effect in limiting unscrupulous practices: zero. In fact, it provides the unscrupulous with a bit of ready made misdirection. "It's just a deposit - we can't charge any fees until we give the disclosures" then immediately charge the fees out of the deposit even though the disclosures are pure nonsense.

Which is another problem. As I have gone over ad nauseum, none of the initial disclosures is in any way binding. Here is a very partial list of how lenders legally lowball each and every one of the initial disclosure forms. Truth-In-Lending, in particular, is based upon figures in the Good Faith Estimate or California MLDS, which are thus subject to low-balling. As any high school student who's ever messed up their chemistry or physics experiment can tell you, if you are basing your calculations upon bad measurements, the answer is going to be wrong. Logically, faulty premises produce a faulty conclusion. Or to quote the old programmer's maxim: Garbage In, Garbage Out. It doesn't matter how you get there. The mathematical calculations used to generate the Truth In Lending form require that the numbers used to generate the base document be complete and accurate. Since that is not the case, Truth in Lending is a joke, and for most practical purposes, you should ignore APR.

All in all, this looks somewhat like hearing Mighty Mouse's famous, "Here I come to save the Day!", only to look around and see Tennessee Tuxedo (If you're not familiar, the fact that he was voiced by Don Adams of Get Smart fame should tell you all you need to know, but the cartoon penguin was even more of a bungler). The good stuff should have been taken care of decades ago, the rest is more menace than anything else. "The Federal Reserve will not fail!" If only! I'm starting to think that Peter Sellers is not dead, only in hiding, secretly running the Federal Reserve as Inspector Closeau. It would explain a lot.

"overpriced house offer rejected what next"



(Before I get started, I want to make it clear that I am using the same definition of worth found in this article)

Well, the seller obviously didn't feel that it was overpriced. Given that they were unwilling to sell for that, consider the possibility that you didn't offer enough.



It's human nature to always want to blame the other side. Given the state of real estate prices here in San Diego, I have considerable sympathy for buyers these days. On the other hand, if you look at the sales log, sales are still being made. This means willing buyers and willing sellers are coming to an agreement that both feel leaves them better off, and they are doing it at market prices.



The fact is, there are always at least two possibilities when an offer is rejected, and the truth may be a mixture of the two.



First, that the seller is being unreasonable. This happens a lot. Somebody thinks their property is worth more than it's worth. When people can buy better properties for less, they're not going to be interested in yours. In this situation, you're not likely to get any good offers. You'll get people doing desperation checks - coming in with lowball offers to see how desperate you really are. A very large proportion of these are people in my profession looking for a quick flip and the profit that comes with it, or other investors. Anybody looking at properties priced where this one should be priced is likely not even going to come look.



Second possibility, the buyer is the one being unreasonable. Properties like that one really are selling for the asking price, and you offered tens of thousands less. Some buyers do this because it's all they can afford. Some buyers do this because they want to get a "score". And some are just the standard "looking to flip for a profit" that I talked about in the previous paragraph. There is a point at which I tell all but the most desperate sellers that they're better off rejecting the offer completely than counter-offering. It saves time and effort, and the prospective buyer either comes back with a better offer, or they go away completely. Someone offering $250,000 for a $350,000 property is not likely to be the person you want to sell to. Even if you talk them up into a reasonable offer by lengthy negotiations, they're far more likely than not to try all sorts of games to get it back down as soon as you're in escrow. Better to serve notice right away that you won't play.



Now some bozo agents think that starting from an extreme position, whether high list price or lowball offer to purchase, gives them more leverage, or that somehow you're eventually likely to end up in the middle. This is bullsh*t. A transaction requires a willing buyer and a willing seller. Price the property to market if you want it to sell. Offer a market price if you want the property.



Now, the Quickflippers™ have had a distorting effect on this, and disconcertingly many of the properties being offered for sale are owned by people who bought with the intention of the quick flip for profit, rather than buy and hold. Many of those looking to buy still fall into this same category, and I suspect this is much the same in other formerly hot housing markets as well. They've become addicted accustomed to the market of the last few years, when a monkey could make a profit on a property six months after they paid too much money to purchase it. That is not the market we face today. This market favors the buy and hold investor. Actually, if you remember the spreadsheet I programmed a while back, I've pretty much confirmed that the market always favors the buy and hold investor, it's just been masked by the feeding frenzy of the past few years, where John and Jane Hubris could come off looking like geniuses when it was just a quickly rising market and the effects of leverage making them look good. It's just that the support for the illusions of Mr. and Mrs. Hubris has now been removed.



Now, what to do when your offer has been rejected. There are two possibilities. The first is to walk away. If the home really is overpriced, and there are better properties to be had for less money, you made a reasonable offer and were rejected, you're better off walking away. I don't want to pay more for a property than it's comparable properties are selling for, and I certainly don't want my clients to do so either. The sort of people who go around making desperation check offers walk away without a second thought with considerably less justification.



The second is to consider that the property might really be worth more than you offered. Okay, a 3 bedroom 1 bath home did sell for that price in that neighborhood, but when you check out the details, that was a 900 square foot home on a 5000 square foot lot and the one you made an offer on is a 1600 square foot home on a 9000 square foot lot, and in better condition with more amenities. It's a more valuable property, and you can refuse to see that from now until the end of the world and you're only fooling yourself. The reason you thought the property was attractive enough to make an offer was that it had something the others you looked at didn't, and most of these attractors add a certain amount of value to the property. The more value there is, the more folks are willing to pay for it. This is why one of the classical tricks of unethical agents is to show you a property that's out of your price range, then figure out a way to get a loan where you qualify for the payment. This property is priced higher because it has features that add more value and a reasonable person would therefore conclude that other reasonable persons would be willing to pay more for that property than others. Landscaping, location, condition, more room, amenities. There's something that the seller thinks reasonable people would be willing to pay more for. It's kind of like taking someone who can afford a $10,000 car and showing them a $25,000 one, then telling them they can get interest only or negative amortization payments to get them into it. You only thought you could afford the $400,000 home, but they've got a way that you can get into the $600,000 home, which obviously is going to have many things that the $400,000 home lacks. Consumer lust does the rest. Cha-ching! Easy sale, and the fact that they've hosed the client doesn't come out until long after those clients made a video for the agent on move-in day when they're so happy they've got this beautiful house that they didn't think they could afford (and really can't), and they gush gush gush about Mr. Unscrupulous Agent, who then uses this video to hook more unsuspecting clients - never mind that the original victims in the scam lost the house, declared bankruptcy, and got a divorce because of the position Mr. Unscrupulous Agent put them into. You want to impress me with an agent, don't show me happy clients on move-in day. Emotional high of being brand-new homeowners aside, any monkey of a loan officer can get anybody with quasi-reasonable credit into the property. What happens when they have to make the payments? More importantly, what happens when they have to make the real payments? Given the current environment, the question, as I keep saying here, is not "can I get this loan through?" but "Is it in the best interests of the client to put this loan through?" You want to impress me with an agent, show me a happy customer five years out "My agent found this property that fit within my budget, told me all about the potential problems he saw, got the inspections and loan done, and it's been five years now with no surprises, and the only problem I've had was one he told me about before I even made the offer."



Of course, the real value of the property may be beyond your range or reach. If your agent showed you something you could not reasonably acquire within your budget, you should fire them. I accept clients with a known budget, I'm saying I can find something they want within that range. If it becomes evident I was wrong (eyes bigger than wallet syndrome) the proper thing to do is inform the client that their budget will not stretch to the kind of property they want, and suggest some solutions, starting with "look at less expensive properties" and moving from there to "find a way to increase the budget" and finally to "creative financing options." That's a real agent, not "Start with creative financing options but somehow 'neglect' to mention the issues down the road."



There is no universal always works strategy for rejected purchase offers. It's okay to do desperation checks, but be aware that most sellers aren't desperate and that it's likely to poison the environment if the seller isn't that desperate. Poisoning the environment is okay if you're a "check for desperation and then move on" Quickflipper™, but if you're looking for a property you want and have found something attractive, it's likely to be counterproductive so that you may end up paying thousands more that you maybe could have gotten the property for if you'd just offered something marginally reasonable in the first place. Make a reasonable offer in the first place, and you're likely to at least get a dialog. And if the seller rejected what really was a reasonable offer for an overpriced property, the only one to lose is them. Move on. Their loss is someone else's gain.



Caveat Emptor (and Vendor)

If you read the papers and the congressional record on the current housing crisis, you might think yield spread is the central culprit for the entire meltdown. You would be wrong.

Yield spread is a beneficial tool, offered voluntarily by lenders, that is an alternative to consumers paying all of the costs of a mortgage themselves.

No matter who does your loan, broker or direct lender, they need to get paid for doing it. If they cannot make money at it, they won't be in the business of doing loans. There are high cost loans and low cost loans, and any number of ways of paying those costs, but there is no such thing as a free loan, and anybody who pretends otherwise is either a naive child or lying through their teeth. There are a very few loan providers out there who will finish loans on which they don't make anything in order to keep their promise about the terms of that loan to clients, but there has never been a loan in the history of the world where the provider planned not to make anything.

Yield spread arises as a by-product of the price that the lender receives on the secondary market. For thirty year fixed rate conforming loans, as of a couple days ago, at 5.5%, lenders were making about 20 cents per hundred dollars over the actual dollar value, in addition to the roughly $1.30 per hundred dollars the lowest priced lender I had was charging brokers. For a $300,000 loan, this means they were making roughly $4500 for a loan where the broker did all the work from attracting the customer onwards through the rest of the loan (the rate cost three points in the one direct branch I saw last week, so they'd be making about $9600 there). None of this covers all the fees for service, aka closing costs, or loan price adjustors. This is purely from the act of putting the money to the deal. At 6.00%, the lenders were making about $1.56 per $100 of loan amount directly, and that's about where wholesale par was, the loans that brokers could do without any explicit charge for the money. The direct branch wanted a point and a half to do that loan. Finally, at 6.5, they were making about $2.31 per hundred dollars directly from the secondary market, and they were agreeing to give brokers about seventy-five cents of that in the form of Yield Spread.

What this boils down to is that wholesale lender is looking to make about 1.5% of the loan amount, no matter what loan the consumer is put into, merely for the act of loaning the money. It is out of the difference between the number the wholesale lenders charge, and what their retail lending branches charge, that brokers make their living. If brokers can get the loan done for less than the retail branch, and still make money, the consumer comes out ahead.

There is no requirement for lenders to offer Yield Spread. They don't do so to enable brokers to hose customers that they would rather have walking into their own retail branches. They do it to compete for the business of people who have discovered that using brokers is actually a way to get the same loan cheaper. They do so because other lenders do so. Because they really want that $1.50 per hundred dollars loaned, they'll willingly give up most of any amount over that to encourage brokers to come to them, rather than the other lender. As I've said, in loans there is no difference in brand names. It's just money. So long as the terms are the same, it really doesn't matter if you're making the check for payments out to "International Megabank, Inc" or "Fifty-Third Bank of Podunk," and that really is the only difference. In fact, using brokers as a way to expand their reach is one of the ways small lenders can become major players quickly, without the expense of opening branches. More than one major household name has done precisely that. By the way, this $1.50 per hundred dollars loaned is very low by historical standards - it was roughly $2.50 twelve months ago, and twelve months before that it was more like $4.00. But there's a lot of money chasing not very many borrowers right now. Nor is any of this in any way evil. As a matter of fact, it has enabled much lower interest rates for consumers than the traditional lending model where the lenders held the loans for the duration.

Nor do lenders like paying yield spread. They'd rather have the entire secondary market premium for themselves. They offer it for one reason and one reason only: Because the brokers would otherwise take their clients to a different lender who did offer it. Most brokers operate on a set margin per loan, especially the better ones. The good ones are willing to disclose this margin, the bad ones will do everything they can to hide it. This margin may vary between loans. If borrower A is a slam-dunk A paper borrower, that loan can be done a lot more easily than a sub-prime borrower who needs to qualify based upon bank statements, and will eat up a lot less of my time and therefore, the loan should be done on a thinner margin. Whatever this margin is, it can be paid via origination (a charge for doing the application and getting the loan done), it can be paid via flat dollar charge to the borrower, it can be paid via yield spread, or it can be paid via a combination of these. But it is going to get paid. When I quote a loan, I quote it in terms of terms and total cost to the consumer, including what I make, and if I'm not going to make enough to make it worth my while to leave home, I'd rather not do the loan. Others quote higher, building a bit in that they're prepared to negotiate away if the client asks. Still others just make believe that they're going to deliver the loan on better terms than they will actually deliver it to get you to sign up with them - but the chances of anyone actually pricing the loan so as not to make anything are zero. Consumers looking to tell the difference between better and worse providers should ask for a Loan Quote Guarantee, as well as all the other Questions you should ask loan providers.

Yield spread is nota cost paid by consumers. It doesn't show up anywhere in the list of charges they pay. Were its disclosure not mandated by federal law, the consumer would have absolutely no evidence of its existence except, possibly, the absence of other charges or the fact that they have been paid without the consumer having to shell out a dime. I agree with the disclosure law, by the way. Indeed, I want to expand it to require lenders to disclose the secondary market premium they would be paid assuming they sold the loan. Now consumers do pay for yield spread indirectly, of course, with increased interest charges during the life of the loan. But they pay those same charges whether incurred as a result of a broker earning yield spread or a lender being able to make the money on the secondary market. Furthermore, paying those charges will be to the consumer's benefit if the increased charges for interest offset or more than offset the higher fees they would have to pay in order to get a lower rate. Most consumers do not keep their loans long enough to justify the higher fees for a lower interest loan. Similarly, if the loan is going to go to from a fixed or set rate to a variable rate loan before the higher costs for a lower rate have been recouped, whatever wasn't recovered before that happens has been wasted, as all the loans of a given type reset to the same rate when they adjust - doesn't matter whether you got a zero cost loan out of Yield Spread, or you paid five points to buy the rate down, and therefore the payment. But the 4.875% 3/1 that closes today will in three years reset to the exact same rate and payment as they 6.25% 3/1. Well, not exactly. Because assuming they did what most borrowers do and roll those costs into the loan, that 4.875% loan will have a higher balance owed than the one that was initially 6.25%, and therefore will have a higher payment when they both reset. So yield spread has done the latter borrower a favor by helping them control overall loan costs.

Let's look at what happens if we count yield spread as part of the costs of the loan. First off, it makes it appear as if loans including yield spread are more expensive than ones without. This gives direct lenders an advantage over brokers. Let's consider an actual real world example: A few days ago, a retail lending branch offered one of my prospects a 6.125% loan for one point, while he came back to me and I locked him into for 6.125% for ZERO points, a price which included me making about nine tenths of a point in yield spread. Assuming closing costs are the same (in fact, mine are lower than theirs), here's what the client sees now on a loan with a $300,000 loan payoff. (I'm also going to assume anything other than actual costs, such as prepaid interest, are paid out of pocket)

item payoff closing cost origination new balance payment

lender $300,000 $2900 $3060 $305,960 $1859.05

broker $300,000 $2900 $0 $302,900 $1840.46

This reflects reality. The client ends up with a loan balance $3060 lower, and a payment $18.59 lower, through getting exactly the same thirty year fixed rate loan through me as he would have gotten through that lender.

But if I have to count yield spread as a part of the cost of the loan to the consumer despite the fact that he's not paying it, here's what the sheet looks like:

loan payoff closing cost origination yield spread "total cost" new balance payment

lender $300,000 $2900 $3060 $0 $5960 $305,960 $1859.05

broker $300,000 $2900 $0 $2726.10 $5626.10 $302,900 $1840.46

Note that it now looks like the consumer is paying almost as much for the broker loan as for the lender loan. They're not. Keep in mind that this is for exactly the same thirty year fixed rate loan at 6.125% - except that the consumer's loan balance if they go through the broker ends up $3000 lower. That $2726.10 in yield spread is not a cost to the consumer. Indeed, Yield Spread is only a cost to the lender. Note that the consumer's balance and payments in no way reflect yield spread, and my client has been told about it, but really doesn't care. Being a rational consumer, he shopped for the loan on the best terms to him and his family. He doesn't care if I'm making ten cents or ten million dollars. All he cares about is I get him the exact same thing for a cost that is thousands of dollars less. But if Yield Spread is listed as part of the cost on the Good Faith Estimate (or MLDS in California), then it appears as if that lender's loan is a lot more competitive than it really is, i.e. $5950 to $5626, not the reality of $5960 to $2900. Furthermore, this was an uncommonly broad difference, that still looks like the broker is offering a better loan. Far more common is a differential spread of half a point or so. If the price differential were only half a point, the broker's loan would look more expensive, while being in fact less expensive to the consumer who doesn't know yield spread is an accounting phantom as far as they are concerned. The consumer would still be saving money with the broker - about $1500, a full 25% of the actual costs of the loan, but listing yield spread as a cost makes it appear as if the lender's loan is cheaper when it is in fact more expensive.

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