Dan Melson: August 2007 Archives

Better deals for the bank, that is.



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





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





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



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



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



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





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





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



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



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



Caveat Emptor




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



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



Their suggestions?





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





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



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



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



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



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



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





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





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



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



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





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





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



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



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



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



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



Caveat Emptor

Got a search engine hit for



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



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



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



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



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



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



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



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



Caveat Emptor


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



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



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



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



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



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



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



Caveat Emptor

Games Lenders Play, Part II

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





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



"Start rates as low as 1%!"



Loan amount $100,000 Payment $321.64

$200,000 $643.28

$300,000 $964.92

$400,000 $1286.56



Could this help save you money?





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



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



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



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





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





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



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





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





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



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



Caveat Emptor


Games Lenders Play, Part I

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



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



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



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



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



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



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

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



Caveat Emptor

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



The Trustor is the entity getting the loan.



The Beneficiary is the entity making the loan.



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



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



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



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



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



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



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



Caveat Emptor.



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



This one came from a search engine:





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





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



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



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



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



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



Caveat Emptor

Service Interruptions

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



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



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



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

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



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



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



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



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



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



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



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



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



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



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



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



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



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



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



Caveat Emptor.

The Best Loans Right NOW



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



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



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

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



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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



Caveat Emptor

From an e-mail:





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





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



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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



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

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



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



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



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



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



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



There is another alternative, if you are or have a loan officer that you trust. Get their credit information. After all, a buyer is in a position where the sellers are in fact considering extending credit. Income, FICO, credit score, other debts. Ask your loan person if they could do a loan for this buyer. Of course, if your loan officer is a bozo, or if the buyer's is, all bets are off under this option. Under RESPA, you can't make them so much as put in an application with any loan provider not of their choosing.



If the sellers are not concerned enough about the buyers' ability to qualify to be willing to accept a lowered sales price for better terms on the deposit, I'd say it's not very important to them. If they're not willing to keep looking for another buyer, they want to do business with this one, and they must be getting something worth their risk out of the prospective transaction.



I recently had an agent tell me that requiring a pre-approval was part of their due diligence. Nonsense. I'll go so far as to say it's preposterous. The deposit is real. Information on creditworthiness is real, if subject to more interpretation. Pre-Approvals and Pre-Qualifications are a waste of space in the file, approximately equivalent in worth to an attestation that there is indeed a screen door in this submarine. There is no rational reason to choose one buyer over another, or accept one offer and refuse another, that has its roots in the pre-qualification or pre-approval. There's nothing there that you can hold anyone responsible or accountable for if the buyer does not actually get the loan funded, and if there's nothing there you can hold anyone accountable for, it's not anything real. Which makes it purely a CYA on the part of agents. Some of them may think it means something real, but it doesn't. Those agents need to be educated.



I'll admit I hate being asked for pre-approvals, even though I should probably love it as the sign of an agent that doesn't know what they're doing. But all too many times in the current market, a listing agent that doesn't know what they're doing is a sign of not being in touch with the current market, that I'm spinning my wheels in any negotiations, because the listing agent has no idea what properties like this one are actually selling for. It feels like you're trying to get useful work done on a computer that's frozen up and gone to blue screen of death. Not useful, and not helpful to either my client or theirs. You do have the option of behaving like a recalcitrant mule. Nobody can make you stop, but it's not likely to be beneficial to your bottom line.



Caveat Emptor

No, this isn't the Hitchhiker's Guide to the Galaxy



But having written half a dozen articles roundly critical of the way in which these loans are generally sold, it's not unusual for me to get e-mail like this one:



Hi, Dan:



Okay, I'm absolutely PANICKED after reading your article on negative amortization loans as I have one! I thought it was an "option ARM" and that my entrusted Realtor's entrusted loan officer was wise beyond his years in his financial advice. He was semi-retired, wealthy, and said that this was the only loan he'd ever use for his own substantial real estate portfolio. I even reassured a good friend of mine who is economically savvy not to worry as it wasn't a negative amortization loan!



I purchased December of 2006. The home I was going to purchase was appraised at $780,000 eight months prior to my purchasing it for $570,000; I put $100,000 down, had a good credit score, but the stickler was my monthly income. I knew I would make a substantial bonus and raise June of 2007, so DELETED sold me on the Option ARM. The bonus was one third what I expected ($2700) and my raise was only 4% rather than 7%.



My question is this - what do I do now? Is the loan okay as long as I pay the principal and interest amount of payment? I've only been paying the minimum, but could swing it by squeezing. It's a high rate - 7.5%. And I would have a prepayment penalty if I refinanced. I'm a single mom, 46, with two kids and annual earnings of $64,000. I have $50k in savings.



Yes, I am that poor sap you speak of in your article, completely trusting, desperate for my dream house, blind sided and now stuck. Any advice would be helpful! Thanks so much...



First rule of getting out of holes: Stop digging! Pay at least the interest every month!



Now, let's look at your situation. You owe $470,000 on a $570,000 property. The real payment on that is $3286.30 per month, as opposed to a "nominal payment" of $1511.70 at 1%. Actually, by my calculations, you owe about $483,000 now and will over $527,000 by the time your pre-payment penalty expires, if you make just the minimum payment.



Now, let's consider what's actually available out there. Picking up one rate sheet at random, it shows a 30 year fixed rate loan at 6.375% costing half a point retail. Let's figure out if you're likely to qualify for that. $64,000 divided by 12 is $5333 per month. 45% of that is $2400. Both of those are potentially important figures. Let's assume your value is still $570k, so 80% of that is $456,000. Paying the penalty and costs of the loan via rolling it into your balance, I get that you'd be left with a balance of between about $507,000. The payment on the first mortgage would be $2845, which is more than you can apparently afford right there. On the other hand, many single parents have alimony and or child support that can be used if they so desire that they don't include in their income.



On the other hand, I'm not building fairy castles in the air. From the information presented, you can not afford the loan by standard measurements. The flip side of that is you don't have to qualify for the loan you already have, and you say that you actually can afford to keep making at least the interest only payments. As long as you do so, you're not digging yourself in any deeper. If you can actually afford to make at least the interest only payment, there is no reason to panic.



Furthermore, getting yourself that 6.375% fixed rate loan would cost you roughly $24,000 - $18000 plus in pre-payment penalties, about $6000 in loan costs. To save 1.125 percent, albeit fixing the loan. Your current cost of interest at the $483,000 balance is $36,225 per year. Cost of interest after refinancing: $32,321 per year. Interest savings $3904 per year. Your break even on this is about 6 years, 2 months - if you could qualify, which you don't appear to.



If you make the payments for the next 27 months until the penalty expires, that higher interest rate will have cost you roughly $8900, offset to a certain amount by lowered income taxes. But here's where everyone's getting ulcers right now: That 6.375 is a "right now today" good only until tomorrow morning at most. Not that I expect tomorrow's rates to be much different, but I won't know until I see them. The cold hard fact is that only some kind of deity might know at this point what the rates are going to be like in December 2009. I certainly don't, and neither does any other human agency with which I'm familiar. There's a lot of estimates out there, but nobody knows. Furthermore, with a negative amortization loan, you don't know what your rate will be a year from now, as most of these abominations adjust month to month. So no matter which way you choose, stay or refinance, there are pitfalls, and there's no way to tell the right decision except in retrospect - in December 2009.



In your situation, I'd probably sit tight. As bad as it is, the alternatives all look worse. I wouldn't refinance into a loan that took me six years to break even on the costs of, and I doubt whether anyone else should, either. Alternatively, keeping in mind the fourth solution to Getting Out of Paying Pre-Payment Penalties, some people might want to see if their current lender will refinance them into a thirty year fixed, although in your case that does not apparently help because you don't appear to qualify.



But your situation is not the same as the person who is only looking at a negative amortization loan. Like it or not, you've already done it. That narrows your choices to "What do I do from here?"



The first thing to set in motion is a consultation with your lawyer. I'm not a lawyer, but I've been reading about the courts ordering these abominations rescinded, brokers paying damages, etcetera. The wheels of justice grind slowly, but that means the sooner you start them grinding, the sooner they get there. It seems likely to me that there were some misrepresentations and gross negligence somewhere along the line there.



I think that the local market is likely to turn away from buyers and towards sellers very soon. So that colors my perceptions, and what may be appropriate for San Diego may not be appropriate elsewhere, but as long as you can make at least the interest only payment, and make it long enough such that your prepayment penalty expires, I think you're likely to see a profit on the sale of the property then, provided things go as I think they will. It might be rough in the mean time, and preliminary numbers indicate that you're not likely to be able to afford to keep the property then, but panicking rarely does any good. There's nothing you can do at this point that does not have significant and costly risks. But from what you've sketched out, holding on until the penalty expires seems to be the least risky, most attractive alternative to me.



Caveat Emptor

Just like Mohandas Gandhi and Genghis Khan and Attila the Hun were all human beings, lenders are all companies that make money by lending money to people who want it.



That's about the limit of the truth in that statement.



Lenders do, by and large, get their money to lend from the bond market. But not all lenders get their money from the same part of the bond market. Some get the money from low-risk tolerance folks looking for security, and willing to accept comparatively low rates. Some get the money from high risk tolerance folks looking for more return for their risk. Within each band, there are various grades and toughnesses of underwriting. A lender with tough underwriting will have a very low default rate, and practically zero losses. A lender with more relaxed underwriting will have more defaults, and higher losses, meaning they must charge higher rates of interest in order to offer the investors the same return on their money.



I have literally just finished pricing a $600,000 loan for a client with top notch credit and oodles of income (he's putting $800k down). Even A paper and with the yield curve essentially flat, I got variations of three eighths of a percent on where their par rate was. Every single one of them had significant differences in how steep the points/yield spread curve was (if you need these terms explained this is a good place). For one lender it was "offsheet pricing" below their lowest listed rate. This lender is more interested in low cost loans, and they take it for granted that folks will not be in their loans very long. This lender is appropriate for those who are likely to refinance within a few years. For another lender, it was "offsheet pricing" above their listed sheet prices. This lender specializes in low rates that cost multiple points, so they can market lower payments. For those few people who really won't sell or refinance for fifteen years, these are superior loans.



Which do you think is really better for the average client? Well, let's evaluate a 6.5 percent 30 year fixed rate loan that costs literally zero (I get paid out of yield spread, while rebating enough to the customer to cover all their costs), with a 5.875% 30 year fixed rate loan that costs $3400 plus two points. I always seem to be computing $270,000 loans here, but since this was "jumbo" pricing and a $270,000 loan is "conforming", which carries lower rates, I'll run through both.



The 6.5 percent loan is zero cost to the client. Nothing out of pocket, nothing added to the loan balance. Gross Loan Amount: $270,000. The 5.875% loan cost 1.875 points in addition to $3400 in closing costs. Gross loan amount $278,625. You have added $8625 to your mortgage balance to save yourself $98.40 per month. You theoretically are ahead after 88 months (7 years, 4 months), but not really even then.



Every so often I get a question that asks why they can't have A for the price of B. The answer is the same as the reason why you can't have a Rolls Royce for the price of a Yugo. Another funny thing about Rolls Royces is how expensive they are to maintain. A middle class person with a Rolls better plan on living in it. The funnier thing is, your friends, family and neighbors can't even see you in it, so there is no point in a "Rolls Royce" home loan except for utility, and if it's not paying for itself, then there is no utility (or negative utility, i.e. something you don't want), and therefore, money wasted.



Now, let's crank the loans through five years - longer than 95 percent plus of all borrowers keep their loans, according to federal statistics - and see which is really better for most borrowers. The 5.875% loan makes monthly payments of $1648.17. Over five years - 60 payments - they pay $98,890 and pay their balance down to $258,869. Total principal paid: $19,756. Actual progress on the loan (amount owed less than $270,000): $11,131. Interest paid: $79134, which assuming a 30 percent combined tax rate, saves you $23,740 on your taxes.



Now let's look at that 6.50 percent loan that didn't add a penny to your balance. Monthly payments of $1706.58, total over five years $102,395. Looking pretty awful, so far, right? But your total amount owed is now only $252,750. Total principal paid: $17,250. But this same number is also the actual progress! Interest paid $85,145, and assuming 30 percent combined tax rate, same as above, it gives you a tax savings of $25,543.



Now let's consider where you are after five years.



With the 5.875% loan, you saved $3505 on payments. But you also owe $6118 more, and the 6.5 percent loan saved you $1803 more on your taxes. Furthermore, if you've learned your lesson and rates are as low when you refinance or sell (6.5 percent on your next loan), it's going to cost you $397.67 per year from now on for that extra $6118 you owe! Net cost: $4416 plus nearly $400 more per year for as long as you have a home loan. Assuming that's "only" 25 years, your total cost is $14,358. I never spent so much money to save a little for a little while!



Now, let's consider that $600,000 loan in the same context. After all, the pricing really applies there (conforming rates are lower). Appraisal costs a little more, and so does title and escrow, for jumbo loans on million dollar houses. Let's say $3700 in costs. Your new 5.875% loan would be for $615,236 (disregarding rounding). Payment $3639.35, which over 5 years goes to $218,361 in payments. Crank it through 60 payments, and you've paid the loan down to $571,612. Principal paid $43,388, actual progress $28,388. Total Interest paid, $174,973, which assuming a combined 40% tax rate (higher income to qualify!) gives you a tax savings of $69,989.



At 6.50 percent, the payment on a $600,000 loan is $3792.40. Times 60 payments is $227,544. Crank the loan through those 60 payments, and you've paid the loan down to $561,666. Principal paid and actual progress made: $38,344. Total interest paid $189,209, which at the same combined 40% rate is a tax savings of $75,684.



With the 5.875% loan, you saved $9183 in payments. Yay! However, you owe $9946 more, paid $5695 more in taxes, and on your next loan, assuming it's at 6.5 percent, you pay $646.49 per year in additional interest. Total cost is $6458 plus $646 per year for as long as you have a home loan, which assuming that's 25 years equates to a total of $22,620!



Which of these two loans and lenders is better for you? Well, if you're going to stay 15 years or more and never refinance, the lender who wants to give you the 5.875% loan. That rate wasn't even available from the 6.5 percent lender. On the other hand, if you're like the vast majority of the population that refinances or sells within five years (for whatever reason) you really want the 6.5 percent loan whether you knew it before now or not, which also was not available from the 5.875 percent lender.



The billboards advertising rates aren't going to tell you cost, of course. They're trying to lure clients who don't know any better, and often they're playing games with the loan type as well. But when the rate spread between the rate their selling and APR is over 3 tenths of a percent, you know they're building a blortload of costs into it. Keep in mind that the examples I used were almost two full points, and they were each only about a 0.25% spread between rate and APR. You are never going to recover those costs in the time before you refinance. The lender who offers you 6.5 percent for zero cost is probably offering you a better loan.



Now, there were lenders targeting the markets between these two lenders, some that overlapped the whole market, and even another lender specializing in rates even lower and with higher pricing. Keep in mind that this article was limited to A paper 30 year fixed rate loans, which are limited in what they can possibly accept by Fannie Mae and Freddie Mac rules. Once you get out of the A paper market and especially down into sub-prime lenders, the diversity between offerings really multiplies, as the differences they are permitted in target market cover all parts of the spectrum. Some wholesalers walk into my office with the words, "Got any ugly sub-prime today?" Other sub-prime wholesalers ask me about "people that could be A paper but are willing to accept a prepayment penalty to get a lower rate" (I don't use those much). Some want short term borrowers, and their niche is the 2/28. Some want the thirty year fixed with a prepayment penalty. The ones who ask me about negative amortization loans, I throw out of my office but they're selling them somewhere. A lot of somewheres, judging from the evidence that they were 40 percent of purchase money loans here locally last year.



So lenders are not all the same. Indeed, every single one of them is different, and you need to shop enough different ones to find the program that's right for you, and ask lots of questions every time. Just asking about rate is not going to make you happy, as I hope I have just demonstrated. If you walk into their office, they're not going to tell you that you're not the client they're really looking for unless they just don't have any loans at all that you qualify for (and if you're in this category, do not blindly accept any recommendations they make. Most places, they're sending you to the place that pays the most for the referral, not the lowest cost provider).



Caveat Emptor.


Buying Real Estate Below Market

|

This question:



What real estate office can I trust to help buy below market house in (location) California in the year 2006?


brought someone to the site and I have not previously written a real answer to the question.



The short answer is "nobody."



This doesn't have to do with trust. It has to do with the facts of life and bad assumptions.



What is the definition of market price? It is the price at which a willing buyer and a willing seller exchange a property. In other words, what you buy it for is by definition the market price.



Everybody wants to buy real estate for less than it's really worth, just like everyone wants to sell it for more than it's really worth. Mathematically speaking, at least fifty percent of each have to fail, and the fact that you're even asking the question indicates that you have made incorrect assumptions.



Real Estate is not like stocks or bonds. No matter how big or how small your transaction, it's always a one on one transaction. If you are selling, you need to find one buyer willing and able to buy that property for a price you are willing to sell. If you are buying, you need to find one property where the owner is willing to sell at a price you are willing and able to buy it at.



This is not to say that the general market is irrelevant. If someone is pricing a more desirable home lower than you, you've overpriced your property. If the identical condo next door to the one you bought sold for ten percent less, you probably overpaid. But it's not for nothing that the mantra about the three most important things in real estate being "location, location, and location." No two properties are ever identical. Think condos, even. Which would you rather have: The one right next to the parking lot, the mailboxes, and the swimming pool, or the one way in the back where you have to walk a quarter mile from your car, and further from everything else? I assure you that a goodly portion of the population would choose the one you think of as less attractive. It's the choice of the individual buyer, and a real estate agent has to learn how to get the attention of the person who's most likely to be interested in that property.



I keep telling people that getting a good price at sale time is nice for both the buyer and the seller, but the really important thing is your amount of time in the investment. Let's go back a very few years. Homes in my neighborhood were worth maybe $180,000 at the time, and condos were worth maybe $65,000. Had people going around making low ball offers on everything. Offered maybe $55,000 for the condos, $150,000 for the homes. Nobody who wasn't desperate wanted to sell, of course, and that's just what they were checking for - desperation. Had they offered something vaguely reasonable, say $60,000 for the condos or $170,000 for the home, they likely would have gotten a property. At least one group of these people ended up not buying anything. Fast forward five years. Those same condos are worth $275,000, and those same homes are selling for $500,000. If the thought of missing out on $210,000 profit for the condos because you couldn't make $217,000 bothers you, then you seem pretty rational to me. If, on the other hand, the thought of missing out on an extra $20,000 you're not going to get for the single family residence makes you want to just throw $330,000 base profit (tripling your money!) out the window, please go waste someone else's time.



There is nothing wrong with desperation sales and offers that are desperation checks, so long as you are willing and able to then proceed to something more reasonable. Nobody wants to sell to somebody looking to flip a property, but they do want to sell for a reasonable price. That's why the property is on the market. Somebody offers me (or my client) fifteen percent less than the property is worth, I usually write something like "offer rejected. Why would I want to give you fifteen percent of my investment's value?" and append a list of comparables. When It's not mine, but my client's, I legally have to submit the offer, but nothing says I have to recommend they take it. Counteroffering just wastes time when the offer isn't even in the right ballpark. The ones who can come back with a reasonable offer want the property, or they wouldn't have made the offer. The ones just looking for the desperation sale aren't going to bother.



Now some potential buyers are only interested in desperation scenarios. That's fine, but you're going to work awfully hard and put in a lot of offers before you get one, and the ones with the most potential for quick profit are going to be the ones where there is a lot of work to be done. Additionally, right now the market just won't support CondoFlippers Inc.



Yes, I believe in hard bargaining. Judging from evidence I see around me, I'm one of a small percentage who does. But I'm willing to come from a reasonable starting position, although I do love it when my clients decide they want to put an offer in on a discount agent's listing, because the client I'm acting as buyer's agent for is going to think I walk on water when the transaction is over, while the sellers are going to find out first hand the truth of the adage "You get what you pay for".



Lest you think that your negotiation discount equals your profit, it isn't. It's a small part of your profit. Let's say you get the condo for $250,000 or you won't buy it at all, even though comparables are selling for $275,000. Let's say you intend to flip for $290,000, not that that's going to happen in this market, but let's say you succeed anyway. Your net is something like $268,000, after spending $253,000 or so to buy, and you spent about $5000 making the payments on the mortgage even if it did sell right away (more likely, given the realities, that you spend the entire "profit" on the mortgage payment!)



Now let's say, instead, that the market collapses twenty percent the day after you buy, down to $220,000. If you have a sustainable mortgage and bring in a tenant, your cash flow should be even or positive. Hold on to the darned thing for five years, and at historical seven percent average per year, the property is worth $308,000. Hold it ten years and it's worth $432,000 under the same assumptions. The first number gives you as much profit as the flipper even has a theoretical chance for, while the latter blows the flipper out of the water. Even after a price collapse, and because you've been in a sustainable situation this whole time, it really isn't critical how long the prices take to come back, because you're not under the gun of a deadline. So long as you have a sustainable cash flow, the risk is essentially nonexistent. It's when you have an unsustainable cash flow that you've got to worry. Say like, an empty unit where you've got to make the mortgage payment without rent because you're trying to flip it.



In fact, given a sustainable cash flow, unless property values collapse and stay down forever, the question is closer to when you're going to cash out and how much, rather than if. Southern California Real Estate has always moved in cycles. What's down today is up forty percent five years from now. The trick is being able to bridge the gap between now and then.



If some of the above seems like I'm attacking the "bigger fool" theory of real estate, consider this: Somebody's always the last, biggest, fool in line, and until you find a buyer, that person is you. It should be part of an agent's responsibilty to do their best to see that their clients aren't the only ones without a chair when the music stops. But for all too many of them, their thinking stops at the receipt of the commission check.



Caveat Emptor.

In the last week or so, nonconforming A paper has really been hit. While available conforming rates have actually gone down, nonconforming has gone up by over half a percent. Picking one of yesterday's rate sheet at random, I can do a 30 year fixed rate loan at 6.5 percent at retail par (in other words, no points to the consumer). I appear to have picked one of the worse spreads because I know I've got better than this, but the lowest fee from the same lender on the nonconforming table is 8 percent - which costs 2.5 points retail (I just priced one at 7.25 for 2 points retail).



Fannie and Freddie backed loans are doing just fine. The issue is that "stated income" loans of conforming size traditionally use the same rate table as larger "full documentation" loans. Since the real problem appears to be stated income - even at high credit ratings - tarring both customer classes with the sins of one is not exactly the most competitive thing that lenders can do. I can think of three or four possible fixes to the situation right off the bat. I expect that the smart folks who are paid the big bucks by the lenders to be able to think of all of these and more. I further expect the lenders will do something on the individual lender level as quickly as top management can agree upon what to do.



Now conforming is what those whose properties are worth up to 125% of the conforming limit of $417,000, or $521,250, should be looking for. This is most folks, even in high priced San Diego. As long as Fannie or Freddie likes your loan, rates are still good and the loans are easy to do. This is part of the reason for my mantra about "guard your credit and only sign up for loans you can afford."



For Fannie and Freddie, investing in mortgages is what they specialize in. In fact, it's the only thing they're allowed to do, assuming I understand correctly. Other investors are allowed to do other things, and right now The Word is out the mortgage investments aren't as secure as they usually are, so investors are panicking and doing other things even more than is rational. Panicked people do strange and silly things, as anybody who watches the financial markets knows. It'll likely settle out fairly soon. Meantime, the tightened supply of mortgage money means that if Fannie and Freddie don't like your loan, the price of the money is going to be higher.

Just got a search on "state of california fsbo questions to work directly with loan officers without a agent"



This isn't a problem. Whereas it is the same license, it is two entirely separate job functions. The fact that you are or are not working with an agent has absolutely nothing to do with whether you can get a loan.



This is not to say that some folks who do both might not attempt to trick or pressure you into signing an agency agreement. The way to deal with that is to contact these folks (the link is for California, but the principle applies elsewhere).



This is not to say you should be looking for real estate agent responsibilities from someone acting solely as your loan officer. This happens quite a bit; If they're not getting an agent's commission, you should not ask them to do an agent's work or assume an agent's responsibility. Asking you to sign a form that says they are acting purely as a loan officer and are not responsible for anything except the loan is reasonable. Loan officer legal responsibility is minimal to non-existent anyway; it's one of the reasons the loan business is so messed up and out of control. But asking a loan officer to do both jobs for the pay of the lesser is unacceptable. You don't do extra work for free, you don't assume extra responsibility for free. Why should you expect someone else to do so?



Now in California, we changed the law a couple of years ago so that in certain circumstances where the firm is licensed with the Department of Corporations, the loan officers do not have to be individually licensed. I've seen a lot of abuses out of such situations; the loan officer who isn't individually licensed isn't risking their individual ability to work in the profession, no matter how egregious the violation. Indeed, many firms licensed with the Department of Corporations instead of the Department of Real Estate have made a point of recruiting people new to the profession who don't know any better, and no one will tell them until they go work for a company with better practices, which most of them never do. These folks also don't know how much the company makes per loan, so they don't have to pay them as much. Best of all possible worlds from the company's view!



But so long as you only ask a loan officer to do the loan officer's job, there should be no problem with doing a loan on a For Sale By Owner property. After all, you don't need a real estate agent to refinance, do you?



Caveat Emptor.

The Best Loans Right NOW



6.5% 30 Year fixed rate loan, NO retail points, and NO PREPAYMENT PENALTIES!. Assuming a $400,000 loan, Payment $2528, APR 6.548! This is a thirty year fixed rate loan. The payment and interest rate will stay the same on this loan until it is paid off! 30 year fixed rate loans as low as 5.625%!



10 and 15 year Interest only payments available on 30 year fixed rate loans!



Zero closing costs loans also available!



Best 5/1 Loan trade-off: is higher. Don't bother.



Interest only, No points and zero cost loans also available!



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



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



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



100% financing a specialty.



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



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

Here's something useful, with many properties worth less than their purchase price. If you're one of those who paid more than the property is now worth, you can have your property re-assessed downwards in value - if you file by September 15, 2007.



Application For Changed Assessment - PDF Version

Application For Changed Assessment - Microsoft Word Version



If for some reason, one of the links doesn't work, here's the page I found it on: Assessment Appeals Board

The buyer's market is rapidly aging. Properties that are priced correctly are moving, and moving well. On properties with potential for profit, they're moving fast, and sometimes getting multiple offers. Of the last twelve properties clients of mine were seriously interested in, four went "Pending" before they put an offer in, and three more were situations where the listing agent claimed there were multiple offers, and in retrospect, I believe that contention. Bargain property is moving.



This isn't just personal experience. I do get a fair amount of exposure to the experiences of other agents. Four other full time agents in my office, and dozens of others through property scouting. Another agent in the office had a Notice of Default hit her listing. We told her she'd get an offer if the client reduced the price to where we told her. She didn't get one offer. She got four offers within forty-eight hours, and we were able to play them against each other to get almost the previous asking price. I wouldn't say that's a statistical argument that can be extended to the entire San Diego market, but with as much direct evidence as I've accumulated, I'd say it goes beyond merely anecdotal evidence. The market is getting ready to turn.



This isn't to say it's a great time to be a seller. It isn't. Many sellers - and listing agents - seem to have their heads stuck in the days of two years ago, where a highly upgraded property meant a major boost in selling price. No longer. The buyers out there now are highly sensitized to both price and condition, and they are looking for the best overall bargain. Not just beautiful, highly upgraded properties, but at a competitive price also. With the seller to buyer ratio having ballooned to 42 to 1 as of the start of August, they are getting both.



Here's what I'm telling my buyer clients: There's nothing out there right now that's worth getting emotionally attached to before the sale is consummated. If you like the property, make an offer of an amount you would be happy to pay for that property. If the seller will sell for a price you're happy with, great. If not, I'll find you something just as good where they will. If this seller won't deal, the next one will. A large proportion of sellers don't have any choice. They have to sell, most of them because they really couldn't afford the property in the first place. Security guards making $33,000 per year should not be getting $800,000 loans, to name one situation I walked into not too long ago.



What I've told prospective listings is "If you have any choice, don't". I've got signed instructions to keep my one listing as a "pocket listing" until next Spring. In other words, if I can bring him a buyer, great, but don't market the property via MLS or other mass media. But he doesn't have any particular need to sell. If he did have a need to sell, I'd tell him to make it as pretty as possible as cheap as possible, price it as low as he can stand, and be willing to negotiate his price so low it hurts - and maybe a little bit more. If he doesn't need to sell so bad that he's willing to do that - and he's doesn't - then he doesn't need to sell and should wait for a better market for sellers. The only way to attract a buyer is to out-compete the other 20,000 sellers out there for one of the about 500 serious buyers' business. Location and physical size are fixed. Condition and price are not. The buyers out there are highly sensitized to everything. Instead of a beautiful gourmet kitchen boosting the sales price by $25,000, what this market means instead is that an otherwise identical property is more attractive at the same price than one that hasn't got it. You are unlikely to get enough extra money to notice. What you are likely to get is the property sold, while the otherwise identical property sits on the market for the same price.



Indeed, the property in less than desirable condition is going to sell at a substantial discount, if it sells at all. There's starting to be substantial opportunity for flippers once again, albeit with the mirror image of the way things were going two years ago. Instead of buying at the market price and selling the upgraded property at a premium, now they're buying at a large discount and selling the upgraded property at about market price. It may be intelligent, but the average buyers out there aren't interested, and they're not willing to deal with the ten people who'd rather be foreclosed upon than take the only offer they're going to get to get to the one who will take the offer. I hate short sales and I admit it. Most of the profitable opportunities for buyers out there right now are nonetheless ugly properties in a short sale situation. Not just for flippers and investors, either. A family that wants a place to live that they're willing to fix up can do extra-ordinarily well for itself right now. It's better to buy at a discount now, when you are in complete control, than to hope for a premium when you eventually sell. This is also the historically normal way of the market.



The San Diego market has been on the bleeding edge of the national trends through this whole boom and bust cycle. The "good news" that came out of that was that all of the exotic programs that are usually dead were still available to the less ethical loan officers, at a point in the cycle where they're usually historical toast. The bad news was that while the rest of the country was still going gangbusters, we were basically banging our heads on concrete walls in trying to get short sales approved by lenders. Well, the lenders now have their heads in the right place to approve short sales, just when there's signs of a rebound in the local market.



Indeed, the slopes and inflections in trend lines had me believing we might see a small bit of recovery this year, and we actually have, if only at the most competitive edge of the market. Now, with the peak spring and summer season largely past us, I think we're going to see the buyer's market mostly continue until spring of next year. This means another several months where those buyers who are willing to come off the sidelines at a time of year when most buyers aren't are going to be able to drive hard bargains. Sellers can either choose to out-compete other sellers for the buyers that are out there, or have the property sit unsold until the market turns. Even in trendy, highly desirable communities, buyers currently have the power. As a seller, you can accept this or your property can sit unsold. The longer it sits unsold, the less bargaining power you have.



Here's the statistical run-down on the most recent six months: 13,272 properties sold, 3335 in escrow - versus 19,265 canceled, withdrawn, and expired. Assuming seventy percent of those in escrow eventually close, that's about a 43.5 percent probability of any sale at all - in the best time for sellers there is. On the other hand, the comparable figure last year at this time was 39.8% - and last year I didn't discount pending sales by thirty percent - I just took them as presumptive sales.



Furthermore, we're now in the period where most of the unsustainable loans that were written have already bitten the people they are going to bite. We're coming up on two years since the music stopped and everyone ran for the sidelines locally, which means that most of the two year fixed rate loans have already adjusted, and many, if not most, of the negative amortization loans have already hit recast. Furthermore, unless they've been living in a cave, and they haven't - they bought a home - almost everybody who has an upcoming adjustment they can't afford has figured it out. Their homes are already on the market. The difference between selling now, before the Trustee Sale, and later, after the Trustee has deeded it to the lender, are not large as far as the buyers are concerned. The only difference is that after the Trustee Sale, the lender knows how much money they're losing every day.



My point is this: There's only so much desperation out there, and we've already seen the largest influx of it into the sellers' listings here locally. San Diego is a resilient market, one of the most resilient in the country. People want to live here. People are willing to pay higher prices to live here. The ones making more income than national average - a large percentage with technology and biotech and defense and other highly paid industries here - can afford to pay those prices. That's the demand side. On the supply side, there just isn't a lot of dirt left. Unless we change our laws and attitudes about what constitutes a buildable lot and the acceptability of high density housing, there just isn't a lot of room for our population to grow further. We're hemmed in by immovable obstacles on about 330 degrees of the circle (The Pacific Ocean, Mexico, Camp Pendleton, and Cleveland National Forest). Since this is the United States, and we don't tell our citizens where they can live, the way we discourage people from living here is that the price will keep going up until enough people decide voluntarily that they're not willing to pay it. Thus far, we haven't lost as many people to out-migration this cycle as we did last cycle. Back in 1991 and 1992, U-Haul was essentially allowing people to move here for free, there was such a demand for their inventory on one way trips out. They haven't gone nearly so far of late.



I'm also seeing a lot more pent-up demand this cycle than we had last cycle. Instead of moving out, people are waiting for the market to hit bottom. Well, the local market isn't going down as far as most people think it is. As I've said, at the most competitive edge of the current market, sellers are seeing not only fast action but lots of interest. People are willing to pay those prices. People are very willing to pay those prices. Even with the psychological fear of further market decreases, those who are willing to buy are not only willing but also able to pay current prices. So much so that they're practically racing to be first in line when they find something that is a worthwhile bargain. What do you think is going to happen as soon as the average buyer, who's been holding off for two years, gets it into their head that the market may have hit bottom? Without the psychological fear that's keeping them on the sidelines now, expect to see a large influx of serious buyers, drastically curbing the ability of buyers to drive harder bargains. In short, a seller's market. It's a positive feedback effect. The more people come off the sidelines, the more strongly the market will turn, and the more people will want to come off the sidelines.



As I said yesterday in my loan market article, the gonzo 100% stated income low credit score programs are gone, and they're not coming back any time soon. This means you're not going to see the same kind of frenzy as drove the market three or four years ago. Personally, I doubt that sellers - or listing agents - are ever going to have that kind of power again. The loans that enabled that stuff are no longer being offered. People are going to have to have at least two of three things: Good credit score, a significant down payment, and ability to prove they make enough to afford the loan. Failing that, they're going to pay very high interest rates, high enough to keep them out of properties that they could otherwise qualify for. That's going to keep a damper on market increases, at least until the lenders develop collective amnesia again.



At this point, where most of the buyers who are going to buy this year are already out there in the market, I don't think the market is actually going to turn until next Spring. Meanwhile, those buyers who are willing to come off the sidelines now, before the market has actually turned, are going to be much happier than those who wait until the market has already turned. The time of very best bargains locally is already past, but since I don't know anyone with a time machine, we have to consider what we've got looking forward.



Caveat Emptor

While the subprime meltdown continues, A paper rates have actually dropped a little bit in recent weeks.



Subprime is in a world of hurt. Lenders are fleeing the market for below average credit in droves. It seems like every day, we lose the capability to do something or other, and the rates have gotten high as well. I just priced a 580 credit score on an 85% loan. Rate/term, no cash out. Six months ago, I could have found something around 7% par. Today's best rate? 10.7% at par.



The last several years, with real estate values rapidly appreciating, it was hard for lenders to lose money. Even if the property did go into foreclosure, it would have appreciated in the meantime, and the lender would get their money. That's no longer the case. Properties aren't appreciating, and as a result, subprime lenders are now having to price loans for the borrowers to bear the full risk of their low credit score.



I've been saying for some time that if you don't have good credit, the rates are going to have to rise. That prediction has now come true. As of when I'm writing this, I could do that same loan A paper at 6.25 at par. Cost of having a below average credit score? 4.45 percent! If your loan balance was $400,000, that equates to $17,800 per year in increased cost of interest!



Alternatively, that below average credit score means that instead of a $400,000 loan someone with good credit and a monthly income of about $7000 can afford, you can only afford a $265,000 loan. Instead of a 3 bedroom house with a decent size lot, you're in a two bedroom condo, at best! If you could have paid the bills but chose not to, you have only yourself to blame. It's hard for me to imagine anything but a house or a business that's worth spending that kind of money, and credit scores can be improved if you're willing to try.



Furthermore, it's getting harder to find subprime lenders willing to loan at high Loan to Value ratio (or CLTV). This means that you have to have a bigger down payment than someone with a better credit score. I can still do 100% loans, usually split 80/20, pretty darned easy if you qualify for A paper. It's getting to the point where it's a waste of breath to ask subprime lenders for 100% financing. This means that you can either have a substantial down payment, or you can improve your credit, or you can remain a renter. Given the economic advantages of home ownership, you don't want to remain a renter. Of the remaining two options, it's usually quicker and easier to improve your credit than it is to save 10% of the price of a $400,000 property. How quickly could you save $40,000 if you had to?



Stated Income, especially for low credit scores and high Loan to Value Ratios, is rapidly going the way of the dodo. 100 percent stated income is essentially gone. The lenders want you to have some serious equity, so that if the property gets foreclosed upon, they're likely to get their money back. The lower your credit score, the more of a down payment you're going to need. negative amortization loans are finally hitting this wall, as well. Not only do those lenders living on those abominations want a higher rate, they also want you to have enough equity so that they're going to get every penny when they foreclose. As a result, fewer people are willing to sign up for them, and fewer still qualify, a development I am all in favor of.



Lenders, specifically sub-prime lenders, have in the past few months suddenly re-awakened to the possibility that they're going to lose money in the real estate market. Those who have been advising people that they're not risking anything with 100% purchase money loans because "purchase money loans are non-recourse" are soon going to be the subject of court and regulatory action, not to mention that the lenders are no longer willing to cater to that line of thinking - at least not for those who have demonstrated that their credit rating isn't important to them.



It is not difficult to qualify A paper. I have in the past done A paper loans with 100% financing at a 630 credit score. More people qualify A paper than think they do - and if you'll work at it, getting yourself a thoroughly acceptable credit score of 680 or better usually doesn't take very long. Now, more than in the last few years anyway, being able to show that you make a habit of paying your bills on time is worth some serious money. It also means you can get the loan now, instead of several months in the future at best. And, as tomorrow's article will attest, you really want to buy now if you can.



Caveat Emptor

I wouldn't have believed this one if I hadn't been there when it happened.



Another agent has a listing where the property went into default. We just happened to find out about it; the seller tried to keep it a secret because they were embarrassed. Silly, but it happens. Suddenly, the sharks started swarming, of course.



One agent brought an offer in. Among other things, that offer called the property, "a dog." It's not a dog. It's not a place where I'd expect to find a billionaire living, but if someone gave it to me, I'd have no problems either living there as it sits, or renting it out.



Never insult a property you're interested in. It's smart to explain the facts of the situation that are in your favor, but calling the property "a dog" conveys no information, is completely subjective, and is usually construed by the owner as a direct personal attack. If you want them to agree to sell you the property - which should be the reason you made an offer - it's a great way to sabotage that goal. If it's got holes in the wall or cracks in the foundation, by all means remind them. But don't get personal.



Then this clown not only sabotaged his argument, but violated his fiduciary duty, by bringing in a competing offer.



This just blows my mind. Not only is the property now obviously not a dog, since you have multiple people clamoring to buy it. How many buyers can one agent work with at a time, anyway? My absolute limit is six. If two of them want the same property, there must be something pretty darned attractive about it.



This also increases the leverage the seller has, raises the sales price for the one that gets the property, and means that one of them doesn't get the property. How can this not be in violation of fiduciary duty?



No matter how good the bargain, as a buyer's agent, I never ever initiate showing a property to someone else until the first buyer has told me they're not interested. I can't stop them from seeing the property, but I can avoid personal responsibility for encouraging someone else to make a competing offer. Especially now - it's not like there's any shortage of bargains out there. Sure, the incidence of multiple offers has risen dramatically, and properties that are priced competitively are moving (both of these are signs of a buyer's market that's about to turn, by the way). Nonetheless, there's a lot of good stuff out there if you know what's really important and how to look. A buyer's agent should know both. That knowledge is a significant fraction of what we're selling. I found four great bargains, even considering the market, one morning two weeks ago, which was the last time I got out just on a general search, not associated with any particular client. All I had to do was get off my backside and out of my office and look. I don't accept clients if I haven't got the time to look for them.



This clown was thinking about getting paid, not the client's interest. Furthermore, unless he told them, which I will bet he didn't, those two sets of clients have no way of knowing that the agent has hosed both of them. It is one heck of a bargain as it sits. Either one of them should be ecstatically happy with it and a good bet to come back on their next transaction - provided they don't know how the agent hosed them.



Now in the case of this particular property, both the MLS and the foreclosure list are public knowledge. It's not like there's any deep dark secret about it. Perhaps this agent is even selling foreclosure lists as a way to procure business, and both clients independently spotted the property and asked about it. He still owes it to the client who put in the first offer to do what he can not to sabotage them. This is the one exception I can think of to Agents Refusing to Make an Offer on Real Estate. As a buyer's agent, I have a firm policy of one outstanding offer per property (As a listing agent, I love multiple offers and do everything I can to encourage them). It's a minor encouragement for fence sitters to pull the trigger now, when I tell them that if another of my clients makes an offer, I will decline to submit an offer from someone else until that one is off the table. This protects both clients by keeping them out of a bidding war I would have facilitated. I'll find the second client something else. In this market, there's nothing so good it's worth getting into a bidding war over.



Caveat Emptor


Good Evening!
My name is DELETED and my wife and I recently signed papers to purchase a property from DELETED in DELETED, CA. After our options, their lot premium, and the elevation charge, the house is listed at 425,000. We have 90,000 in incentive money to spend which we would like to lower the overall cost of the home to 335,000. We only receive the incentive money if we get the loan through (their in-house lender). We were interested in a 30yr fixed rate mortgage that is 100% financing and will pay the closing costs out of pocket. I feel like I am being stiffed by their loan guy. Back in late May or early June, he told me that we could get 30 yr 100% financing with HOA, Mello Roos, PMI, PITI out the door for $2889 on some 6.75 percent loan (which still seemed high to me) but just last week he told us that we are now looking at 7.8% with out the door payment of $3250 because 100% loans are harder to finance now. I guess my question is how do I not get stiffed by their loan agent and what proper steps do I take to ensure the best loan and rate for us? I think that 7.8% is ridiculously high for this market! Here is some background info on us:

Credit scores of 750-780 for both of us
21,000 in bank accounts
2 car loans with 3 yrs remaining on each (238 and 210 per month)
Current renters with 80k gross yearly combined salary
1st time homebuyers

Any help regarding this matter would be greatly appreciated! Thank you for your time and consideration. If there is any other information you need us to provide I would be more than happy to provide it.

First off, check with your local authority to see if you qualify for a Mortgage Credit Certificate. It looks likely. Whether or not the developer's lender participates is a question, but it's a question that needs answering.

Now this is definitely a situation where you needed a buyer's agent to deal with a developer. Unfortunately, at this point it's too late to get one involved, and kind of pointless, as you've already signed the contract. The work a buyer's agent does is pretty much moot. You've already signed that developer's contract. I'll bet a nickel they'll be able to keep your deposit if you back out, and likely sue for more. They are now in a win-win situation.

Here locally, I could tell you if it was a good idea to pay that developer's extra charges or just take their basic unit. Elevation premium? What's the view now, and is it likely to stay that way? Lot premium? How many extra square feet are you getting - or is it just a junk fee? You're not local to me, so I do not know.

What I can assess is numbers. Just picking a rate sheet at random (it will have changed by the time you see this), right now I've got an 80% first with zero points and no pre-payment penalty at 6.75%. On $268,000, that's $1738. The 30 due in 15 second would be at 7.75%, with a negligible cost, for a payment of $480. Assuming that your official purchase price is $425,000, add about another $443 for California property taxes and just a guess of $100 for homeowner's insurance, and that's a payment of $2761 plus Mello-Roos and HOA, which I have no way of knowing. Never choose loans by payment, but it cuts your cost of interest more than it cuts your payment.

However, at $425,000, you've got a first of $340,000 and a second of $85,000, giving us payments of $2205 and $609, respectively, and that's what we'd be looking at if you came to me for the loan right now. Add that $543 taxes and insurance, and your payments would be $3357. Not having that $90,000 in your balance makes a huge difference, and not just to the payment, but also to the cost of interest.

Here's another point on which developers hose unsuspecting buyers. Is that property, as it sits, going to be worth $425,000? Is it going to worth $335,000? If I were in your shoes, I'd hire an appraiser right now. here's one easy place to find an appraiser in California. That approximately $400 they'll cost is looking like a really cheap insurance policy, right about now. And you do want an independent opinion. The chances of that developer's appraiser rocking their boat are nil.

Here's one thing to seriously consider: Take their financing offer, even if it includes a pre-payment penalty, which I'm betting it will. Of course, if they offer you the option of buying it off with a higher rate, that's something you're going to want to do in this scenario. Then, providing the property is really going to be worth enough, refinance immediately. That pre-payment penalty isn't going to be $90,000, even with the costs of the new loan included. But you want an independent appraiser's opinion before you jump into this, to find out if it's likely you'll be able to refinance. What you're essentially doing is taking the $90,000 incentive money and then paying a toll of about $13,000 for the pre-payment penalty plus whatever the costs of the new loan are (the ones I outlined would be roughly $3000 if you accepted a 3 year penalty of $500 on the second, or $500 higher if you didn't). Net to you: roughly $73,000 - if the value of the property will cover the refinance, and you'll get better terms if the value is actually $425,000, because the Loan to Value Ratio won't be 100%. It'll be about 83%, which translates to an 80/5. Provided, of course, that the purchase contract says $425,000. If your official purchase price is $335,000, your monthly property taxes will be about $349, but then we're dealing with whether or not the lender will believe your appraisal. A paper lenders quite likely won't. Most of the time, your official sales price will be the full amount, but every once in a while developers like to throw a curve in. On one hand, a lower sales price reduces your property taxes, while on the other it means that you'll have difficulty refinancing for a while.

If you had a good buyer's agent, you'd likely already know the answers to all of these questions, and you likely wouldn't have fallen into a couple of traps, but that's water under the bridge. We have to deal with the situation as it exists, and figure out the best way to deal with the facts looking forward. If an appraiser tells you the value is there, I'd take their loan on a short term basis for the incentive money. If the appraiser tells you the value is not there, it's probably time to see a good lawyer about getting out of that contract. If you lose your deposit, that's usually not as bad as spending more than the property is worth and getting stuck with a rotten loan you can't refinance out of.

Caveat Emptor

from an email:



On a related note, I hope you might have some advice for us. My husband and I just sold our condo. But we are NOT buying at the moment. Instead we are renting. (Not sure where we are going to be 6 months out and buying does not sound like a good idea until we are settled again.) So we are spending a small part of the profit off the sale on retiring the only credit card debt we still have and putting the rest in a money market to earn interest until we can use it as a down payment on our next house.



However, with no credit card debt and no mortgage (and one car loan that will be paid off in about a year) I am afraid that by the time we buy a house, we won't be considered good credit risks because of not having loans we are paying on.



We DO have a credit card that we put some charges on and pay off every month. Is that enough? Or is there something else we should be doing now to make sure we remain credit-worthy for a mortgage loan?



We will be renting an apartment. Does that show up on the credit report?





In general you want to have two open lines of credit to have a credit score. This doesn't mean that you necessarily have to have a balance on either of those lines of credit.



What you're doing seems fine and like a good idea. It's a rough market; I probably wouldn't buy right now unless I knew I was going to stay (or keep it) five years or more. In general, rent does not show up on a mortgage provider's credit report. It probably will not count as an open line of credit.



The card you use, which I gather is what you use to maintain credit, needs to be an actual credit card, which appears to be the case. If it is a debit card, it doesn't count as a line of credit to determine whether you have two open lines of credit or not. If it is indeed a credit card, you've got one existing line of credit that you've had for a while. Keep it open, keep paying it off every month. This helps your credit score even if you never carry a balance.



However, instead of closing the (other) credit card you have a balance on, may I suggest that you simply pay it off but keep it open? Unless it has a yearly charge just for having it, it costs you nothing to keep it in your safe at home. This gives you one open line of credit, and because you've had it for a while, this is better than a new line of credit (length of possession of open lines is one factor determining credit scores, and over five years is best). You might want to use it once per six months or so just so they don't think you've canceled. As long as it's a regular credit card where if you pay it off within the grace period there is no interest charge, and that's your second open line of credit.



You also currently have a installment payment operative, which is fine as long as you keep paying it on time. Depending upon how much you're getting in interest on the money market, it may behoove you to ask for a payoff. If the money market is getting two percent taxable and you're paying five on the installment debt (not tax deductible), you may wish to consider paying it off. On the other hand, if either of the two above cards is a debit card, this is your second line of credit, so keep it open long enough to get something else.



I live in San Diego, which has several big credit unions, and I've had good experiences having my clients apply for credit cards with most of them (they're also a decent source for second mortgages and home equity lines of credit - that's where they're set up to compete best - but first mortgages I can usually beat them blindfolded, because it's not where they're set up to shine). There are also any number of available offers on the internet, but check out the fine print carefully. Credit Unions may not be absolutely the best credit cards available, but they tend to be shorter on the Gotcha! provisions.



(Internet searches for credit unions in Los Angeles turn up fifty or more; in the Bay area a similar number. You need to do your due diligence and you may not be eligible to join most, but I've found it worth doing as opposed to doing business with the major banks and credit card companies that advertise like mad. The money to advertise doesn't come from nowhere.)



This should help you make informed choices as to what to do given your current situation to maintain two open lines of credit and a good credit score. Please let me know if this does not answer all of your questions or if you have any further questions.



Caveat Emptor.

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



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



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

The Basics of 1031 Exchanges

|

Section 1031 of the IRS Code has to to with tax treatment on the exchange of one parcel of real estate for another. It's similar to Section 1035 which covers most non real estate exchanges. Car for a car. Boat for a boat. Business for a business. But section 1031 allows indirect exchanges (i.e. sell to one person for cash, take the cash and buy another property from another person) so long as you follow all the guidelines. After all, how often do folks want to trade two parcels directly? It happens, but not very often. Usually, if A is buying B's parcel, then even if B wants to replace it with another piece of real estate, it probably isn't owned by A.



Why would you want to do this? Taxes. No other reason but taxes. If the taxpayer makes the exchange according to the provisions, they defer the gain. But we're talking capital gains, not ordinary income, so keep in mind it's not worth going gonzo over. The maximum long term capital gains tax rate for most folks is 15 percent. Still, getting to keep 100 percent of your gains instead of 85 can be worthwhile, and when we're talking sometimes about multiple hundreds of thousands of dollars, that's quite a bit of motivation. It's nice to be able to invest and use those (potentially) tens of thousands of dollars, rather than basically forking them directly to the tax man.



Your primary residence is not eligible for 1031. Second homes are severely limited in eligibility (general rule: You can't occupy it more than 10 percent of total occupancy, although you get up to fourteen days per year. Check with your accountant for details. Matter of fact, check everything with your accountant. This is just a basic overview, and the devil is in the details). Section 1031 is for investment property, of whatever nature.



Section 1031 is not for "flipping". I am not aware of any explicit minimum general holding time, but the IRS looks hard when the held period is less than a year. 1031 Questions are good jumping off points for general audits. Be careful. If the properties are being sold between related parties, there is a two year minimum holding rule, and nobody can end up with cash. For this reason, 1031s with a related party transaction are tough. If it's a property you bought as investment that you later made into a personal residence (or vice versa) the minimum holding time is five years.



There are some significant complexities in duplexes where one unit is for personal use, or personal use dwellings where there's a home office. I've just gotten to the point where I don't understand the attractiveness or value of a home office deduction for many people, but they keep insisting upon trying for them.



Basically, there are three requirements for a standard "forward" 1031 Exchange. You can not have constructive receipt of the funds. You must designate replacement properties within 45 calendar days of the sale of the relinquished property, and you must consummate the sale within 180 days or before you file your tax return, whichever comes first.



Constructive receipt is a fancy way the IRS has of saying control of the funds. If escrow sends you the check, or if the check is in your name, you have constructive receipt of the funds and the 1031 will be disallowed. So what happens is that you need to pay an accomodator (most title companies have one) to act as trustee for the money, and the actual transaction is done in the name of the accomodator. If you see something about cooperating with a 1031 exchange at no cost to you as part of a sale or purchase, this is what it's about. Makes no difference to the other party in the transaction, but the Grant Deed has to be made out to (or by) the accomodator entity, not the people who are actually taking part in the transaction.



There are three rules I'm aware of to use in identifying replacement property. The 3 property, the 200 percent, and the 95 percent. Keep in mind that this is investment property, often commercial in nature, and that even within major metropolitan areas it can be difficult to replace the property with something similar within the time frame. This is one situation where the law is a lot more flexible than most of the people. As long as it's real estate within the United States not held for personal use, the law doesn't care what the use of the property you replace it with is, but lots of folks are trying to find something as specific to their purposes as possible. Also, in hot markets, there may be difficulties created with finding a property you can afford and that the seller will agree to sell to you in that time frame.



Keep in mind always that we're not necessarily talking a straight one property for one property exchange here. It can be multiple relinquished properties for one replacement (in which case the sale of the first relinquished property starts the clocks), it can be one relinquished for several replacement properties, or any mix of A properties now and B properties later, where A and B are nonzero, whole, and positive. Counting numbers, to use the technical mathematical name. For every additional property in the exchange, you can expect to spend more in fees to the accomodater, exclusive of all other costs to the transaction.



The first method of designating replacement properties is what's called the 3 property rule. You may designate up to three properties of any value, and as long as you actually acquire one or more that fits the parameters within 180 days, you're good to go. The second rule is any number of properties but no more than 200 percent of value. The final rule, 95 percent, is basically worthless and a good way to get in trouble, because unless you only designate one replacement property, you're not going to be able to acquire 95 percent of the total value of the designated properties. Identification of these properties must be precise and unambiguous. "Land at the corner of First and Main" won't work. You need something like a legal description or an Assessor's Parcel Number (APN).



Finally, you need to acquire the replacement property within 180 days of selling the property (or before filing your tax return for the year - this can require you to be forced to extend your taxes)



Where the person making the exchange wants to buy the replacement property before selling the relinquished property, that's called a "reverse" 1031 exchange. It's basically the same concept switched around. You have 45 days to designate which property will be sold (usually not difficult), and 180 days to actually sell it, which may be a problem in slow markets. Reverse exchanges are also more expensive, as they require accomodaters to take title to an actual piece of land, and they are not, in general, for the weak of wallet. Any financing must be non-recourse financing, because the accomodater is in title and they're not going to agree to be on the hook for the value of the loan if you can't sell the property. This can also cause a requirement for larger down payments.



There are also "partial" 1031 exchanges, where you end up with a replacement property but something else you didn't have before. In general, the replacement property must cost at least as much as the relinquished was sold for, the equity in the replacement property must be at least as large as the equity in the relinquished was, and the loan must be at least as large as the previous loan. If any of these three conditions is not satisfied, you've probably ended up with what the IRS code calls "The part of a like kind exchange transaction which is not like-kind exchange" but most accountants and other people in the real world call "boot," as in "you've got this, and that to boot." Boot is taxable, so if there's a lot of boot, it may defeat the purpose of a 1031 exchange.



There are a lot of pitfalls, and with typically large amounts under consideration, the IRS is notorious for being hard nosed about all the particulars of 1031 exchanges, whether they are forward or reverse. Don't try this without the aid of a tax professional, and for real estate purposes, an agent who has a good understanding can save your bacon. But if you do fulfill the requirements, it can be a good way of keeping money in your hands that you can continue to have invested in your new property, reducing your mortgage on that property, further saving you money, where otherwise nobody would be happy but the tax collectors.



Caveat Emptor.




 



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