Intermediate Information: April 2007 Archives

The housing bubble is not the primary focus of this website, but to pretend it does not exist is plainly wishful thinking. One of the ongoing phenomenon that have been driving the bubble is the "Stated Income"loan, where the lender does not verify that the prospective borrower actually makes enough money to qualify for the loan, only that they have a source of income that could generate enough income. If you're working the night shift at 7/11, they're not going to believe you make $90,000 per year, but if you're a in a profession where some folks do make $90,000, you may be able to qualify "stated income" regardless of whether you actually make it or not.



Lest I be unclear on this subject, despite being known as "liar's loans" because people use them to lie about their income in order to qualify, it is not what they are intended for. Nor is "stated income" intended to help shifty or incompetent loan officers shaft lazy borrowers by not bothering to document income. They are intended for those who really do make the money, but because of the way that the income tax laws work and the way that lenders qualify people for loans based upon income, do not appear to. Business owners and the self-employed and people on commission get to legitimately write off a lot of expenses that the hourly or salaried employees do not. For instance, I write off a large percentage of my vehicle miles, office expenses, etcetera. I'm paying for business related expenses with pretax dollars, where most folks generally do not get to take this deduction. Being self-employed, if I was silly enough to want the home office deduction it would be easy enough to justify. Not to mention asset depreciation. All of these don't have much effect upon the money I have to spend, but they do have an effect on my tax forms, where it looks like I make a lot less than I effectively do. So instead of using my tax forms to qualify for a loan, sometimes I need to do a stated income loan in order to qualify for the loan, because the tax forms show a lower number than people making comparable amounts who are salaried. This is what stated income is for.



On the other hand, I'm sure that most of the adults reading this have seen the potential for abuse. When I can just tell the lender how much I make and they agree not to verify it, a certain number of people are going to say they make more than they do, and indeed, both stated income and NINA loans are often informally known as "liar's loans". Furthermore, since if the person getting the loan does not qualify, there is no loan and the loan officer does not get paid, there's a certain amount of pressure on the loan officer to get the loan done even if the prospective borrower does not qualify. Let's say they don't qualify, but the loan officer wants to get paid. So the loan officer puts them in for a stated income loan, says the clients make more than they do, and voila! funded loan. Clients get the loan where they would not have qualified by documenting their income, loan officer gets paid, bank gets a loan, and if it was a purchase, real estate agents get paid for their transaction and the seller goes happily on their way because they got their money.



A few years ago this kind of practice was an occasional thing. Of late, however, it has become endemic. And although if the clients really do make the money there is nothing wrong with it, if they don't make the money to qualify but they get the loan they are still going to have to make the payments. This reflects the reason for the rise of the negative amortization loan, where the minimum payment does not cover the interest charges. Either one of these is something a good loan officer does with a trembling hand and a lot of care. I always make certain that these folks really can make the payment they're going to have to make, but the vast majority out there do no such thing.



Well, it looks like everyone is going to have to, because of IRS Form 4506. Form 4506 is an item the clients sign, usually at the end of the loan process, that gives the lender and anyone they may sell the loan to access to your tax returns. IRS form 4506-T is basically the same thing, except that it gives access to a transcript (the numbers) rather than an actual copy. Signing form 4506 is mandatory. No signature, no loan. It's that simple.



Now it take the IRS about sixty days to respond to this request, so this has zero effect upon funding your loan. If your loan isn't funded withing thirty days of you signing the loan application, there's something wrong with that loan unless something external to the loan is holding them back and you should go apply for a back up loan. But for later on, it can have an effect.



One of the ways it can have an effect is on the loan provider's subsequent business. Traditionally, as long as the borrower made the first three payments on time, a loan broker was off the hook as far as borrower default. Lenders who have recently become much more nervous about their loan portfolios have recently started to change this, whereby a broker who put through a stated income loan (or any loan, for that matter) which is not subsequently borne out by the evidence of form 4506 is liable for the loan for the loan's full duration. Since form 4506 is never borne out by any stated income loan, else the client should be getting the better rates for full documentation, this means that every time any broker puts through a stated income loan, they are liable for the consequences to the lender.



Well, it shouldn't take much of an imagination to figure out the effects this is having upon the loan market. With the shifting of the consequences to the broker, the brokers are having second thoughts about doing stated income loans. Make no mistake, stated income was way out of control over the last couple of years. I've always been religiously careful about them, but that made me a member of a tiny minority of loan officers. Most of the loan officers out there have no clue as to what is an appropriate stated income loan, which has to a large extent put the brakes on stated income here locally. I'm not certain what effect this is having upon loan officers at direct lending houses, and there are a certain percentage of broker loan officers that are too clueless to understand what this means to them so they are going to keep right on doing them until the lawsuits pile up, but it's really starting to put the brakes on stated income loans here locally.



Now stated income loans have been a large proportion of what drove home prices upwards. It was an easy way for loan officers and real estate agents to get people into loans, and therefore properties, that they really could not afford and did not qualify for. Both easier sales and bigger commissions, as people want the better house with the higher price and tend to reward the agent and loan officer who can get them in, regardless of whether they can really afford it or not. People who did not really qualify, but this gets them the loan, and therefore that beautiful McMansion they've got their heart set on, despite the fact that they cannot really afford it. It really is easy to sell people on too much house, and very few of them really understand the implications. I've sat people down, taken them through the math, and they still signed up with the agent who promised to get them into the McMansion because they wanted it so much.



Well, with the lenders getting aggressive about enforcing financial consequences, every loan officer with the brains to understand that heavy objects fall is suddenly taking a hard look at their business practices. Now it's not just a question of "Get paid or don't get paid," it's a matter of whether the money they get paid right now is enough to balance out the money they are going to have to pay later to buy the loan back, and the answer is largely coming back "No!" Furthermore, there could be actions taken against licenses by lenders and not just by clients. That brings a completely different trade-off into the picture, and a lot of loan officers aren't liking what it says.



Now because the prevalence and easy availability of "stated income" loans has been one of the things driving the increase in the price of housing, essentially killing the stated income loan is not going to have a beneficial effect as far as sellers are concerned. It decreases, by some amount, the potential market of people who can afford to buy your property. Where before, the bottom line with most agents and loan officers was that anyone who wanted the property could probably be qualified for the necessary loan and was therefore a legitimate potential buyer, that is now changed. Since anytime you constrict your market of potential buyers, the equilibrium price of the market is going to fall, expect this to have a further deflationary effect upon property values. Indeed, there are a lot of factors that are conspiring against highly appreciated property values right now, but this one small item could well be what starts housing prices more notably downwards. Because it attacks a way of doing business that was at the heart of the run up in prices, this relatively small measure may be the pin that pops the housing bubble.



Caveat Emptor.


I have found your blog to be very informative. I was out riding my bike and rode past a house for sale. In a few minutes of Internet research I've found out a bit about it. The property is bank owned and it sounds like a property in need of repair. However the information I have found out doesn't add up.

From a real estate web site listing recent sales in the area, I found out that the property last sold for 5% less than the asking price. Apparently the sale happened in October 2006.

The house is now listed in the local MLS service, and the text of the listing leads me to believe that the house was listed in December of 2006. It seems from what I have read on your site a foreclosure takes at least 3 months, and this house apparently was back in the hands of the bank and listed two months after it sold.

The house is priced well below the market and within my budget, but that the bank got it back that quickly raises a giant red flag for me. Also, given that the MLS listing says the sale is as-is and that there are no contingencies allowed raises another red flag.

How if they don't accept contingencies do you do a home owners inspection? Pay for one before making an offer, and risk you'll be throwing the money away if the seller doesn't take your offer? Or do a home inspection after they accept your offer, and forfeit your deposit if the inspection covers up a big problem.

Actually, foreclosures are perfectly fine for a first time buyer if you've got the wherewithal to work with them.

Lender owned, which means it didn't sell at auction, is an entirely different story than buying at the auction. You can make offers with contingencies for inspection, usually for seven or ten days, and providing it's an attractive offer otherwise, the lender may very well accept. You're always risking the inspection money on any property, because if it comes out that the house is messed up, you still have to pay the inspector. For lender owned (REO) properties, you don't need to forego an inspection contingency. Financing contingencies are also very doable - I've got one in escrow now with both, and I'm working on another. If it wasn't possible, they would reject the offer out of hand, and they haven't. Disallowing an inspection contingency makes the property worth a lot less, because a lot fewer people are willing or able to handle the risks involved. If your particular property is specifically disallowing inspection contingencies, it tells me they know about a problem, and it's almost certainly a big one. It can still be worked, but get yourself a really top-notch buyer's agent. It's worth paying them (or paying them extra) yourself if you need to, because you'll make more on this property, and they will earn it, because there's a lot more liability for them on this kind of property.

If you're looking at an REO, be aware before you even step onto the property that there are going to be maintenance issues. More often than not, there are even sabotage issues. Furthermore, because the lender doesn't live there and almost certainly knows less about the property than an inspection will reveal, they are exempt from transfer disclosures. They are not for Mr. and Ms. Upper Middle Class looking for the perfect house, they are not for Mr. and Ms. Just Barely Scraping Into The Property, and they are not for Mr. and Ms. Fumblefingers, Mr. and Ms. No Time, or even Mr. and Ms. Procrastinate. But if you've got the inclination and the skill or the cash to fix it, foreclosures can be quite lucrative. Foreclosures are always a risk. But if you've got the resources to make that risk a manageable one, you can pick them up well below the price of properties with similar characteristics.

You might also want to read my article, "Why There Is Money in Fixer Properties" if you haven't already.

Caveat Emptor

RESPA (Real Estate Settlement Procedures Act) prohibits an agent from requiring you to have other services performed by outside companies. RESPA also prohibits an agent from accepting payment (kickbacks) from third party service providers. Nonetheless, these are major problems in the real estate world.



It is an unfortunate fact that many agents care far more about the little bit of extra they get from third party service providers than they do about their fiduciary responsibility to the client who helps put potentially many thousands of dollars in your pocket.



For instance, never take a real estate agent's unsupported word about a loan officer. It happens on a routine basis that I talk to people in other parts of California where I'm not set up to be their real estate agent (kind of hard for me to show someone a property in Redding when I'm in San Diego), but thanks to the modern age, I am perfectly capable and set up to be their loan officer. Approximately one real estate agent in three completely refuses to cooperate with me as a loan officer, despite the fact that I'm getting their client a better loan than the loan officer this person wants them to use. I can have written authority for the information, and they won't give it to me. Okay, so I go through the escrow company - no big deal in most cases.



I can understand and sympathize with this attitude, if what they were worried about was my ability to do the loan at all. After all, if the loan isn't ready at the end of the escrow period, this transaction they've spent so much effort on falls apart.



So I tell them what I'm going to tell you in another essay: Have your friend do the back up loan, if you're so certain I'm full of it. If they were worried about a client's best interest, they'd sign off on that in a heartbeat. I know that's my attitude in those rare cases where I'm the agent but not the (primary) loan officer. This guy delivers, my client is very happy and has gotten a better loan and I have served my client's interests. This guy doesn't deliver, my loan is ready to go, the client doesn't lose his deposit, and I've still served my clients interest.



There is only one motivation that I can think of for what happens consistently: the agent keeps carping at my client to cancel the loan with me. Let's consider what this means.



No matter how unlikely the agent thinks it is that I'll deliver exactly that loan, with cancellation, the probability I can deliver it goes to zero. So I can now guarantee that this client to whom he has a fiduciary responsibility doesn't get the lower rate loan I was working on. Greatest possible benefit to client: zero. Downside: higher payments, higher costs, worse loan, zero leverage on other loan officer to deliver the loan he said he would.



Furthermore, no matter how good a loan officer, there's always a chance something goes astray, and for whatever reason the loan doesn't get approved. He's now exposing his client to the possibility that his friend, the loan officer, won't have a loan ready to go. If this happens, client loses house, deposit and other time and money invested. Possible benefit to client: $100 retyping fee for the appraisal saved. Possible downsides to client: no house, lose deposit, fees for appraiser, inspectors, etcetera wasted. Furthermore, the agent loses his prospective commission - several thousand dollars.



So what could cause an agent to want his client to cancel my loan? The only thing I can think of that explains the whole shenanigan is that this agent is in line for a payoff. Can I prove it? Absolutely not. Have I tried to think of alternative explanations that make sense? Many times. Maybe I'm missing something here (if so, email it to me), but I sure can't see a benefit to the client or the agent.



Here's another thing. Title and escrow companies. There are a variety of services escrow companies are supposed to provide the transaction - but title companies are actually the ones set up to provide many of these services. So the title company charges a sub escrow fee, messenger fees, etcetera for performing those services. But, they will waive those fees (not charge them) IF the escrow company in the transaction happens to be one they own.



Hey, I think, a pretty nifty way I can save my clients several hundred dollars! Makes me more valuable to them! And since kickbacks from title and escrow are illegal as well as unethical (according to RESPA and the Code of Conduct as well as good business practice, respectively) I certainly can't see a benefit to me for urging them to choose otherwise.



(And I am truly sorry to anyone reading this who works at an independent escrow company. As far as I can determine, you're just as competent as the title company escrows, and no more intrinsically expensive. But it's really hard for your company to compete when choosing your competition saves my client money that's usually about equal to the base escrow cost. Plus the fact is that it's a violation of my fiduciary duty if I don't tell them this)



You wouldn't believe the resistance I get from agents who obviously want their client to choose one particular escrow company, and one particular title company that aren't affiliated. True, it is the sellers who have the right to choose title and escrow companies. But that's the seller's right, not the seller's agents. And a failure to inform them of obvious ways to save money by choosing an escrow company that will save your clients this money is a violation of fiduciary duty.



I just finished fighting one not too long ago where the seller supposedly wanted to choose an escrow company whose name just happened to be the same as the name of the real estate office that the seller's agent worked for (I.e. X Real Estate and X Escrow company). Now it may be possible that they are unaffiliated with that real estate office, and it may be possible that they are set up to handle all of the duties that cause the title company to charge those extra fees. So my client's counter-offer included the following phrase



"Since the seller has chosen title and escrow companies unaffiliated with each other, seller is to be solely responsible for all sub escrow, messenger, and additional fees assessed by the title company above the cost of the title policy."



It even gives them an out - if the escrow company is set up to handle these services that are supposedly their responsibility, and does so that the title company doesn't charge for them, it makes no difference to either client.



This guy didn't want to present the counter to his client. He specifically asked me to drop that wording. I knew exactly what this meant, particularly in the case of the escrow company that just happened to share the name of his real estate brokerage. No evidence admissible in court, of course. But I had to threaten to have my boss call his broker with the clear intimation that my next call would be to Department of Real Estate in order just to get him to present the offer to his client. Do you think it's possible he failed to inform his client about this trivial way to save money? How likely do you think it that there was some kind of payment going on off the books? All of this is illegal.



There are two companies that provide the vast majority of all home warranties, at least in this area. I can't even name another home warranty company off the top of my head. Each of them is affiliated with a particular title company. The policies are the same, as far as I can tell. Somebody wants to know the differences, I tell them to consult an insurance expert (The expert I consulted concurred with my opinion). But one of these insurance carriers is more expensive. If I'm representing the buyer, I don't care - his coverage is going to be pretty much the same. If I'm representing the seller, I'll tell them to please consult a licensed casualty insurance agent, but B is less expensive as far as I can tell. Why then, do I keep seeing sellers who are volunteering A? I can't believe a fully informed client is volunteering to spend more money for the buyer's benefit in order to buy coverage that looks to be the same.



The long and the short of this post is that just because it's illegal under the law doesn't mean it doesn't happen. Just because that agent has a fiduciary responsibility to you under the law doesn't mean they take it seriously.



What can you do?



Well, choose an escrow company that's affiliated with your title company, or an escrow company that's affiliated with a title company, and choose that title company too. On refinances as well, do not allow your loan provider to choose title and escrow who are unaffiliated with one another (to be honest, I haven't helped buy or sell property outside of California, so have no idea how this works in an attorney state). Look for something like "X Land Title" and "X Escrow." This will save you hundreds of dollars.



Ask not just your real estate agent, but also your insurance agent about home warranty policies. Or look in the Yellow pages under Home Warranty Coverage and call around if you're selling a property. Do this BEFORE you have an offer.



And above all, don't just go with your agent's recommendation on a service provider. It's unethical, illegal, and just plain bad business practice, but that doesn't stop a certain number from having their hand out behind your back. And it's just as likely to be the highly accredited agents with years in the industry who are doing this.



Caveat Emptor.



Housing Bubble Death Trap

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That was the wording of a search engine hit I got. It's not literally a death trap, of course, only much financial pain. But the hyperbole is forgivable in today's modern society and the state of the current market.



Other people may have other definitions of "housing bubble death trap," but when I'm talking about stuff like that, I'm talking about someone who bought too much house with an unstable (or insufficiently stable) loan.



I just picked a couple random streets in older lower middle class neighborhoods, and looked back a couple of years. I found a couple of homes that have sold twice or are on the market again.



A 3 bedroom home sold for $487,000 at the end of last year. It's back on the market now for $425,000. A condo sold for $285,000 at the end of 2004, and again just recently for $265,000.



Now just in case you don't understand, the owner doesn't get the full sale price, but they paid the previous sale price to buy it. Usual seller's expenses run about seven percent or so. So for the 3 bedroom home, the owner is only going to get about $395,000 to pay it off, even if they get full asking price. For the condo, the owner only got about $246,000.



Now, let's consider the sales involved. Either their down payment when they bought the home will cover it, or it won't. If it does, the homeowner is out about $92,000 in the first case, about $39,000 in the second. This doesn't include any prepayment penalties there may be or negative amortization it may have undergone, not to mention the cost of any payments they may have missed, etcetera, etcetera. There's always a reason people sell for a loss, and it's usually because they have no choice. They can't make the payments (and never could) or they have been transferred, have to get housing elsewhere, and can't make the payments. And what if the down payment won't cover the deficit? Well, at the end of the year they are likely to get a 1099 form that says they got income from forgiveness of debts. As I understand it, this is ordinary income, and it can knock you up to higher tax brackets, both federal and state, if your state has state income tax.



So why didn't the folks just refinance into something stable, you ask? They couldn't afford the payments on a stable loan. Furthermore, they couldn't refinance due to their situation. If you bought with anything close to 100% financing, and you lose $55,000 of value, well, banks don't like lending money for more than the property is worth. There's no security in it. Now there are 125% loans out there, but the rate is high and the terms are ugly. If you can't afford the rate at 100 percent, or 95 percent of value, you certainly can't afford the rate for over 100 percent. There are only two times that the value of a property means anything. One is when you buy or sell, and the value is whatever you paid for it, or your buyer pays. The other, alas, is when you refinance, and if you owe $480,000 on the property when similar properties are selling for $425,000, the odds of you getting a better loan with a lower payment are essentially non-existent.



Now if the folks are in a stable loan, and can make the real payments, it doesn't really matter what the property is worth right now. You're doing fine, whether you refinance or not. Refinancing might put you into a better situation, but if you can't refi, you're still doing okay. Yes, the prices are down and they're likely to go down more. It just doesn't matter if you don't intend to sell and don't need to refinance. Your cash flow is what it is, and if you really were okay with that to start with and the loan is stable, you're likely okay with it now. If you got a loan that was stable for three or five years long enough ago to worry about loan adjustment now (or soon), you've likely got plenty of equity in the property now. If, on the other hand, you did a 2/28 interest only a year and a half ago, then you're potentially looking at a payment adjustment in the next few months that's suddenly two percent higher and fully amortized, which could be thirty or forty percent difference in the payments. Ouch. Out of such scenarios are losing a property to foreclosure constructed, with consequences even worse than the ones I talk about above. Just the act of lender filing a Notice of Default usually adds thousands of dollars to what you owe, never mind any payments you may have missed or been late.



This then, is what I call the Housing Bubble Death Trap. People who bought too much house with unstable loans, then had the market recede a little on them. Now they are upside down (owe more on the property than it is worth) with a loan they cannot refinance and cannot afford, and they can't sell for as much money as they paid.



What are the loans to watch out for if you're buying. Anything like stated income, where you're not documenting that you make enough to qualify for the loan. Stated Income has legitimate usages, mostly for small business folk and those paid on commission, but should not be used nearly so often as it has been, of late. For all the people who have claimed otherwise (and used them for such), I have never seen a situation where I'd recommend any kind of negative amortization loan for the purchase of a property that you intend to live in. Stated Income Negative Amortization loans should scream out to anyone "WARNING, WILL ROBINSON! DANGER! DANGER! DANGER!" Short term (2 year) interest only loans are less clear-cut, but often a bad idea. These are sub-prime loans. I did a lot of 2/28 loans at six percent a couple of years back. They were intended as short term loans until folks' credit improved, and that's the way I explained them, emphasizing that fact that they have to make certain their credit score actually improves during those two years. They're going to be around 8 percent the first six months they adjust, and a $300,000 6 percent interest only has a payment of $1500 per month. If it adjusts to 8 percent and starts amortizing with 28 years left to go, that's a payment of $2240. I have a firm rule of no prepayment penalties longer than the fixed period of the loan, but I'm definitely the exception rather than the rule there among loan officers. If you were paying principal and interest all along, like most of my clients, you've got some breathing room (equity) in your property and the "payment shock" won't be nearly so bad, not to mention that if your score actually went up, you likely qualify A paper now.



Three year (or longer) fixed rate A paper probably gives you enough breathing room in all but the worst of all market collapses, and I prefer at least five, with thirty year fixed actually being my favorite loan right now, due to the fact that depending upon the lender and the client, I may actually be able to get them cheaper than anything else. This, however, is a short term phenomenon of the moment, due to the yield curve being inverted, and once it straightens out, I'll be doing more hybrid ARMs again.



Caveat Emptor

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About this Archive

This page is a archive of entries in the Intermediate Information category from April 2007.

Intermediate Information: March 2007 is the previous archive.

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