Intermediate Information: June 2008 Archives
A few days ago, another agent in my office got an offer and brought it to me for feedback. The listing was range priced over a $30k range, and priced correctly, so there was a lot of activity on it. The offer was for $30k beneath the bottom of the range, with a note saying that this was for a single dad with three kids, and that was all they could afford, but they really loved the property, and were so excited that that they were each going to get their own room, and so on, gushing for several paragraphs.
In logic circles, this is called the appeal to pity. "Please take pity on me." However, we had every reason to believe that we would be seeing better offers on the property very soon - it hadn't even hit its first weekend on the market, and there had been roughly 15 viewings and six phone calls from agents whose clients had seen the property.
I advised them to counter hard at the high end of the range pricing. It's no concern of current owners what that buyer can and cannot afford. The first two things that ran through my mind were the large amount of activity at an early date, and the likelihood that this was a low-ball flipper's offer. It's not like there's any criminal penalties for creative fiction accompanying an offer. The next two thoughts were if they like the property that much, come talk to me about ways to stretch what you can afford. Two ideas: Mortgage Credit Certificate and Municipality based assistance programs, and both could have been applied to this property, as in it was eligible, there was available money in the program budgets, and each of them stretched the buyer's ability to pay by at least enough, let alone if applied for together. If both were already accounted for, bid on something less expensive; it's not like there is any shortage of properties for sale. Maybe somebody has to share a room; maybe there are fewer amenities, maybe they just don't love it quite as much. None of these is the owner's problem.
Yes, I'm always looking for hidden bargains, but this time I was on the side of the owner, or rather, the owner's agent, and furthermore, the property was correctly priced and seeing strong activity. Neither of those are characteristic of hidden bargains. Furthermore, appeal to pity is a bad negotiating tool.
So here's the situation: Somebody comes up to you and asks you to sell your property for far less than you can get, because they are so deserving, and you want this underdog to succeed against the odds. "Help me, I'm really in need." The appeal is no different at the root than a pan-handler's pitch.
I've given money to panhandlers in my time, too, and doubtless will again. I'm a complete sucker for the ones with kids. But that's maybe $5 or $10, possibly even $20 at the most. Panhandlers are not effectively asking for $40,000 or so out of my pocket, much less my client's pocket. My client has neither a Red Cross nor a Salvation Army Shield on their door. They are not obligated to settle for much less than they could get for a valuable property. In this case, the difference was for something like 70% of their actual net equity, and it is a violation of the fiduciary trust that my client has placed in me, and I have accepted, not to point this out. If it were several months on, and this was looking like it might be the best offer the property would get, that would be one thing. But it was a brand new listing with strong enough activity that there was even hope of a little bit of a bidding war. It's not like the prospective buyer was homeless, and even if they were, there are more logical things to do first than buy a four bedroom detached home, not to mention it would be tough getting verification of rent, which all lenders are going to want.
But I also counseled the other agent not to reject the offer completely, and not to counter until the third day. The high counter signals, in no uncertain terms, that the owner's bargaining position is very strong. It's even a good idea to explain why it's very strong. But in this market, especially, you get buyers looking for a bargain because they might be able to get one. My buyers do it. Why not others? By the third day, there might be another offer on the table. Not that the absence of other offers stops some agents from pretending that there are other offers, but I've always found that the best policy is not to lie when the truth will do, and the truth will always do, because you should tailor your response to what the truth is. This may sound strange coming from a member of the profession that describes condemned buildings as "needing a little TLC", but if you want to do well in negotiations, never overplay your hand (and tell the buyer that the building is condemned. Condemnation is a recorded instrument, so it's not like you can plead ignorance). Real estate is almost entirely public information. If there is a dissonance between how you act, what you say, and what the public information says, good agents will pick up on it. This is not poker. The other side can see most of your cards, and has the option of getting up and walking away from the table at any time, and good agents will counsel their clients to do exactly that if the situation calls for it. The idea is a willing buyer and a willing seller coming to a mutually beneficial arrangement.
So the other agent took the offer to the client, and jointly they decided to mostly follow my advice. The prospective buyer walked away, they got two more offers before the third day. And a couple days later, well, remember that first group of two thoughts I had? Well, we found out that that particular prospective buyer was buying with intent to flip; he had flipped at least four properties in the previous year or so. His low offer and all the histrionics surrounding it was simply a ploy for more profit.
A couple of weeks ago, I got an email asking Save For A Down Payment or Buy Now?, and I wrote a two part article on the subject. Part 2 of Save For A Down Payment or Buy Now? Gave an alternative strategy to make affordability accelerate faster. But there was an obvious, related concern that I let go because it was a very complex calculation, and that was, "What's the effect of waiting to buy on my financial situation down the line?"
This wasn't an easy problem to program, even in a spreadsheet. I'm decent with spreadsheets, but for a lot of the calculations I had to do it by brute force repetition. Had I been able to do certain functions on spreadsheets that I used to do with matrices back in the really dim times, it would have been far easier, but the area I ended up using was three sheets totaling about 60,000 cells. Most of it was change one thing, copy and paste a row or column segment, then change another. It wasn't that hard mentally, but the finished product certainly makes a microprocessor work for a living!
I also had to make some simplifications to the problem. In order to make the problem manageable, I had to assume that you hold onto your home, once you have bought, at least until the end of the scenario, and also that you never refinance. I had to program it with smooth inflation, smooth appreciation, smooth increases in federal income tax standard deductions, and smooth increases in auxiliary prices. Anyone over the age of thirty ought to know how dangerous that is. But adding those random elements made the problem beyond the scope of what I could realistically do. I also had to postulate no major changes in income or property tax law, and I had to ignore the effects of state income taxes. Besides, the idea was to isolate the effects of the variable under consideration, how waiting to buy a home influences your financial situation down the line. I also had to choose a set period to terminate at, and arbitrarily chose 30 years.
Actually, this is two discrete problems when you really look at it, and they really are disjoint, and no matter how much the folks who sell Reverse Annuity Mortgages might try to link them, they are separate cases. What happens if you keep living there, versus what happens if you decide to sell and move somewhere else when you retire.
Nonetheless, the following simulations are all as representative as I can make them. Except for the effects of state income tax, they are in line with current California computations.
Example 1: Suppose you're talking about a San Diego Condo. $300,000 present purchase price, no down payment but you can save $500 per month for a down payment in the future if you don't buy now, and this amount increases proportional to salary increases. The property continues to appreciate at 4.5% whether you buy or not, association dues are $250 per month and general inflation is 4%, and you can get 7.2% return, net of taxes (10% minus an assumed marginal tax rate of 28%), on the money you save for a down payment. Whenever you buy, you can get a 6% first mortgage, and a 9% second if you need it. I'm also going to assume that in order to see any financial benefit, you're going to have to sell at a cost of seven percent of value. Furthermore, you're stable in your profession, seeing a 3% compounded annual raise in income, and equivalent rent is $1400 per month currently.
*Still owe 1 final payment after thirty years if you buy today. "Housing" is how much your costs of housing will be in 30 years if you bought at the indicated time is, and assumes you refinance for zero cost into the same rate you have now. Waiting cost is as opposed to buying now. Finally, the savings column has to do with how much you are saving per month over what the equivalent rent will be in 30 years, namely $4540.76 in this case.
Please keep in mind that the table is the net result 30 years out; the only time variable in the equation is precisely when you bought the exact same condo. Now there is some mildly strange stuff that goes on. For instance, starting 25 years out, there's a period where, under the stated assumptions, your saving for a down payment actually starts to increase in value faster than the property. But by that point, you've missed the optimum time to buy by, well, 25 years. Keep in mind that money will be worth less than a third of what it is today in thirty years ($1 then will be worth 30.8 cents now), but you are still saving significant amounts of money on your future housing payments by buying as soon as practical.
Now let's look at the situation if you decide to sell your home and go live somewhere else:
Net equity is what you have left after 7% costs of selling, liquidation assumes that you are taking out 360 equal monthly payments based upon the same return I assumed your money could earn before you bought. Net benefit is the number of dollars difference it makes to your financial position in the future 30 years from now if you buy at the indicated time. Notice that starting 25 years out, it actually hurts you to buy from then on out, as opposed to just letting the investments you were saving for a down payment run. Waiting cost is how much it hurt your future financial position to delay purchase by that much, so if you wait five years, you end up with over $100,000 less in your pocket.
Now let's do a second example: Still in San Diego, but you're going to buy a starter single family residence that would cost $450,000 today. Nudge assumed appreciation up to 5.5%, cut association dues out but raise property taxes and insurance costs appropriately. Oh, and the equivalent rent now starts at $2000, and general inflation I'm going to assume to be 3.5%. Actually, based upon the past seventy years, everything that has happened has been, over time, more favorable to home ownership than this.
Once again, let's look at the situation if you keep living in the property after 30 years first.
Equivalent rent would be $5613.59. Once again, the last three columns are all monthly streams, and they do have a steady worsening the entire time, mostly because your saving for a down payment does not start to catch up to the increase in property values during the simulation period. In other words, the longer you wait, the worse it gets. Indeed, affordability is monotonically decreasing the entire time. That's math geek for "Quit waiting, it only gets worse." Even though a dollar then is only worth 35.6 cents now, wouldn't you like as many 35.6 cents in your pocket as possible?
Now let's examine if you decide to sell this starter home in retirement, and go live somewhere else.
Now it is to be noted, as you may have seen under the first table, a point in time exists starting 26 years out where you will be better off just keeping your down payment money socked away in alternative investments, as opposed to actually using it to buy your home.
I'm planning to start using this sheet with prospects, under assumptions they can set - If they think inflation is going to average 7%, or appreciation only 3%, the sheet can accommodate that. I've played with the sheet over a few dozen simulations, and due to leverage, the numbers appear quite powerfully in favor of buying the best home that you can actually afford, right now. Interestingly enough, however, these number also strongly suggest that as close to 100% financing as you can manage initially will outperform larger down payments, and that's something that seems quite counter-intuitive to the usual run of financial planning. Instead of using it for your down payment, financing 100% of your purchase if you can seems to make your money work harder. Well, I can put a lot of caveats on that, because metaphorical bumps in the road happen, and nobody knows exactly when or how these disasters will strike. If you do, you can plan for it, and could you please drop me an email in warning? When you're just looking at the raw numbers, however, the advice they give is quite strongly to buy the best property you can afford as soon as you can, putting down as little of a down payment as you can, and making the minimum payments while salting away the rest for a rainy day. But be very careful not to stretch too far, because one thing you can count on, even in Southern California, is that it will rain sometimes.
I just went out doing some general market scouting. Looked at ten properties, and at least three were of a sort that I've started calling "vampire properties." One more reason you want a good buyer's agent.
Like a mythical vampire, these properties are very charming on the surface, luring in the innocent victims with brand new flooring, new roof tiles, and new paint. All the relatively cheap stuff that inexperienced buyers love. There might even be a new spa in the back yard. They call the listing agent and fall in love with the property. They put in an offer, which is quickly accepted, buy the property and move in.
Then the troubles start. Those brand new roofing tiles get ripped off the rotten substructure the first time a good wind comes up. The new owners notice that the travertine floor tiles are separating, and eventually, when one comes loose, find that there's a two inch wide crack in the foundation that runs the width of the house. That beautiful new tile in the bathroom has to come out because they discover the green board is rotten, and the framing boards as well.
It'd be better if the property was sucking your blood. At least that's covered by health insurance if you've got it. But it's got its fangs permanently embedded in your bank account, instead. None of this stuff is covered by home owner's insurance, new home warranties, or anything else. Your home owner's insurance might replace the roof tiles (pulled off by wind, which is usually a covered peril), but the rotten structure underneath is your problem, caused by the normal wear of time.
In most cases, I find it hard to believe that the previous owners didn't know about this stuff. That's what the brand new facade is about. They figured a quick surface fix - the home owner's equivalent of a cheap paint job over a rusted car body - and they unload the lemon on some unsuspecting chump and walk away. Quickly.
For any of those sort of people reading this, I've got to tell you that the lawyers will find you. But for the buyers in the situation, the lawsuit - which will take years, even assuming that they win and if the judgment is paid - is a poor substitute for not getting into the property in the first place. Particularly if, as seems to be the usual case, they stretched to the extreme limit of their budget or beyond in order to afford the property.
It is far preferable, to all parties, to have the issues dealt with before the sale is consummated.
Now most buyer's agents aren't licensed inspectors, and I'm not one of the few. You still want an full-on building inspection. That doesn't mean agents can't spot stuff before you have a purchase contract, come up with a deposit, and spend hundreds for an inspection. All of this is called "buy in," and works off of a phenomenon psychologists call cognitive dissonance. You've said you want it, you work really hard and jump through all of these hoops to get it, and when you find out how bad it really is, you keep going because you are so mentally committed, because you've done all this stuff. If it's something I can spot, wouldn't you rather find out before you do all of that work?
The listing agent certainly won't tell you. They'll have you sign a standard disclaimer advising you to get an inspection. Yes, they have to help fill out the disclosures, but if they're not licensed inspectors, they can't be blamed for not knowing, can they? Their responsibility is to get the best possible deal for the sellers. They have very little responsibility to the buyer. You can't blame listing agents for doing their job (You can blame them for lying).
It's almost inevitable that the owners of vampire properties price the property like something out of Big Al's Discount Used Car Lot. "Cream puff, baby! One owner, a little old lady who only lived in it on Sundays." They want top dollar and then some. I understand, but I'm not going along and neither are my clients if I can help it. I saw one today where the list price was $40,000 more than it should have been if it wasn't a vampire. The agents should know better, assuming they are not deliberately "buying a listing." Price it to market if you want to move, and that includes a hefty discount for not being the one who has to hassle with fixing it. If you want that money in your pocket yourself, fix the problem yourself. You'll also interest a better grade of potential buyer, not to mention more buyers than just the simpleton who happened to win the lottery.
I'd rather deal with a property where the issues are out in the open. I also found one property today that has a crack across the living room floor, out in the open due the aftermath of an obvious flood, but I can find buyers who know how to deal with that (If the lot is level, it's not such a big deal, and can often be fixed surprisingly cheap). You don't have a listing agent pretending to drool over beautiful flooring that is going to have to be replaced anyway. Furthermore, it indicates that the listing agent, at least, doesn't have their head stuck in the Land of Wishful Thinking, so if I take a client who is interested despite the flaws out to the view the property, we're all pretty much on the same page as to what's going on with the property, and we have the makings of a reasonable negotiation. If the listing agent is in the Land of Wishful Thinking, I'm wasting my time to look and the client's also if I show it to them.
Vampire properties are out there. In markets such as this one, they are both increasingly common and deadly to your financial future. You want somebody whose job it is to look past the beautiful surface to the very real issues beneath. If you buy a vampire, it's worse than a disastrous marriage, because the financial consequences are likely to follow you long after your abusive partner is history.
My general rule of thumb is "Remodel for your own enjoyment. If you're lucky, you'll get some of your money back when your sell." The remodeling industry has made a very large amount of money seducing people into believing they will recoup their investment, or more than their investment. But as you can see here, it's a rare remodeling project that returns more than the cost. Therefore, don't remodel with the idea of making a profit, because you won't. Not a single one of those multipliers is greater than 1.
But there are times when remodeling to sell makes dollars and sense.
Mostly, it's when the existing stuff is so outdated that Ms. Newlywed takes one look and flees in terror from the Uranium Yellow or Art Deco Pink and Blue that's been out of favor since before her mother was born. Maybe it was fine thirty years ago when you bought it, and you've gotten used to it, but now it's fifty years old and you've just never motivated yourself to do anything about it. If the kitchen is straight out of 1955, and the bathrooms look like they were last decorated when Hawaiian kitsch was the hot new fad (memo to the young: Eisenhower was President), it's probably a good idea to do something about that before you try to sell - "Try" being the important word. Because people looking for their dream home aren't interested, and these properties sit on the market. If they eventually sell, they will sell for way below everything else on the market, first because of the visible age, second because it sat on the market and you had to reduce the price further and further while paying carrying costs for months. These are the sorts of homes rehabbers and flippers look for, because they can make a profit on them. If you have the money, why wouldn't you want that profit for yourself?
For buyers, if you're willing to buy something that's solid but older, you can get one heck of a deal as well as being able to remodel at whatever pace you're comfortable with. Truthfully, most folks I talk to have at least some plans for as soon as they buy, anyway. If you're planning to install new kitchen cabinets and granite counters anyway, what does it matter if what's there is ancient or poorly laid out?
The first level of remodeling is to clean, shine, and repair any surfaces that need it. This is a straightforward extension of the "carpet and paint" principle. New paint and carpet are cheap, and have a great return on investment. If the formica is burned or chipped, if the tile is broken, if it's dull and dingy, make it shine. It always amazes me that people with hardwood floors will leave them looking like they haven't been polished since they were laid down in 1932. Strip them, sand them, polish them - before you put the property on the market. It's a lot cheaper than replacing or laying new carpet. They will look beautiful. They will make people want your house. Not everyone, of course, but how many buyers do you need? If you've got something lots of people see as desirable, flaunt it.
Sometimes, there just isn't any choice but to take it to the next level. Stoves built in to the countertop and cooking ovens in the cabinets are so 1958. If there aren't any good matches for marred, gouged, or broken surfaces, you probably want to re-do the whole surface. Keep in mind that labor costs are pretty much a constant, and the largest expense of most jobs. You want to spend $4500 resurfacing the bathroom in plastic and linoleum, or $5800 resurfacing it in Travertine and nice tile? Add a moderately upscale toilet for a couple hundred bucks, and you've got a bathroom that looks like it comes out of Sunset magazine rather than an episode of the Flintstones. Somebody who flees in terror from the latter is likely to be attracted to the former. Even if they don't flee in terror from the Flintstones bathroom, most folks are going to be much more attracted to the Sunset magazine bathroom.
Keep in mind, also, that the new stuff you put in has to go with whatever you're keeping. If you've got a Mediterranean paint scheme, Art Deco counters are not going to work for most prospective buyers, and they're the ones you're trying to please at this point. Just sayin'. The more vanilla you keep it, the fewer prospective buyers you will alienate.
Don't go overboard. It can be a real temptation to spend $25,000 or more on new kitchen appliances, but you're not going to get your money back. Keep in mind that most appliances are personal property, so (in the absence of the contract specifying otherwise) you can take them with you when you go. However, in cases like that it's more common than not that those appliances remaining will be written into any purchase offer, and if you agree to leave them, you have to. If you don't want to leave them, away goes the purchase offer to no beneficial effect. If two-thirds of the gourmet kitchen that attracted a buyer is going away when you move out, it's not likely to do you much good in selling your property. I always ask my buyers why they're willing to pay more for the kitchen when most of it is going away. There are idiots who insist they don't want a buyer's agent, but betting on that is a bet you don't need to make - and quite often lose.
Poor lighting can kill a sale without the buyers ever realizing why. It's dark, it's cavelike, it feels old - they don't want it. Just leaving the drapes open makes a huge difference. Replacing the lighting - particularly if you use CFL so you don't have to necessarily have to rewire for a bigger load - can be very cost effective.
If you're going to remodel anyway, clean up your lines of sight and floor plan if you can. The longer the uninterrupted lines of sight, the bigger the property "feels". The less complex the floor plan, the more open and larger it will feel. If you have to go through three switchbacks to get through the kitchen, that's a bad thing. Separate but connected "areas" are better than room dividers which are in turn better than walls, at least in the public areas of your property. If you're remodeling anyway, fix it.
One of the overlooked and relatively cheap remodels is the closet. Basic closets from fifty years ago are tiny by modern standards. People today have more stuff, and they want places to put it. People who get very interested in modern new kitchens and beautiful new bathrooms can just as easily get turned off by small closets. If they see a standard post-war closet arrangement (a three foot space between walls of two bedrooms, with half going to one bedroom and half to the other), they'll quite likely think that isn't enough closet space. "Next property! These closets are too small." Put a modern closet design in, with shoe holders drawers and cabinets and half size hanging spaces that efficiently use the space, and for most people, that's a horse of a different color. Closets are a bigger concern with more people than most folks give credence to, and they're way cheaper than most other remodels.
In some cases, remodeling may not get your money back, but it may be the difference between selling quickly and not selling for months, if at all. It's very hard to track this sort of information, and harder still to assign a dollar value to it. Keep in mind that a $200,000 mortgage at 6% costs $1000 per month, and property taxes and homeowner's insurance add to that. Not to mention that the longer it's on the market, the more you have to mark the property down in order to sell. At these prices, four months make a difference of about $6000 in carrying costs alone, never mind what you have to mark the property down to interest people in it with over a hundred days on the market!
Remodeling isn't the license to print money it's been portrayed as - except for the remodeling industry. Small budgets are more likely to recover large fractions of what you spend than larger ones. Unless the property is significantly behind the times, remodel for your own enjoyment, because you won't get as much back as you spend.
There have always been real estate transactions that fall apart. The reasons why they fall apart are as varied as the people who enter into the transaction in the first place. Let's get back to the very basics for a moment. An offer to purchase is a representation that a given prospective buyer would be at least willing to purchase the property on the terms you are offering. Accepting that offer to purchase means that the seller is at least willing to sell it on the same terms that the buyer is offering to buy upon. If one or the other of these parties is not willing to consummate the deal on those terms, why was there both offer and acceptance? There was offer and acceptance, or there isn't anything more than negotiations to fall apart. People fail to reach agreement all the time. That's not what this article is about. It's about what happens to prevent the transaction from being completed after you have a valid contract.
The last credible figure I heard was that 50 percent of all escrows in San Diego County are falling apart. This means that one out of every two contracts don't happen. A few years ago, the proportion was a small fraction of that - I can't find it online, but I seem to remember 11%. This increase is both outrageous and preventable.
The first reason transactions fail is new information. It isn't cost effective or a good negotiations tool for a buyer to spend money on inspection and appraisal before there is an acceptable contract. When this information comes in, you can expect there to be a reassessment of the transaction, because you can expect there to be something about the property that does not conform to reasonable expectations. I certainly can't remember any transactions I've had where the inspections didn't reveal anything new. I've had them where what was revealed was trivial enough to ignore, but never a one where there was nothing. Transfer disclosures from the current owner to the prospective buyer are another of the possibilities for new information to crop up.
All of this new information can indicate a need to subsequent negotiations when it comes to light. If the buyer thinks it's small enough that they are willing to accept the transaction "as is", they can choose to let the transaction continue on the track it's on. If it's big enough that they're unwilling to deal with the situation, they can also choose to walk away. The vast majority of the time, the sanest response is some new negotiations based upon the new information. This isn't normally about things like overall sales price, it's about getting the property into the condition and functionality that the buyer thought they were getting in the first place. Either party can be obstreperous and unreasonable at this point, effectively killing the transaction.
There's also the issue of cold feet, and the related issue of "grass is greener" syndrome. Either one can apply to either party in the transaction. In the first, the buyer decides they don't want to buy or the seller doesn't want to sell after all. In either case, they weren't really "sold" on the benefits of the transaction to them. "Grass is greener" is where they still want a deal, just not this deal. Those happen when markets are asymmetric in power. A few years ago, it was sellers who wanted to bail out of contracts they had duly negotiated because someone offered them a higher price. More recently, it's been buyers trying to pull out because they think they've found a better deal somewhere else. Both are vile. It's not a sin to want the best possible deal, but once you enter into a legal contract you should be prepared to honor your representation that you want that deal. Both of these phenomena are the fault of poor agents, and both are a good way to waste a lot of money in legal expenses when their clients are sued for specific performance. I don't want any part of agents that don't take appropriate steps to prevent either one of these in their clients, and I take note when I hear about them. It's also a reason not to take an attitude of "no quarter!" in negotiations. My client signed that offer or contract because those terms will make them happy. If the other side decides they need to bail out because the terms are odious, my client isn't happy.
Closer to the point is ability to perform. This can be a seller who can't or won't or doesn't meet their obligations in a timely fashion. Delivering good title to the buyer is kind of important to the transaction, and it does occasionally happen that the seller can't do this. Or they don't have the money to make needed repairs, or just won't get off their backside to actually do it.
But far more commonly, it's the ability of the buyer to perform their obligations under the contract that kills the transaction. I have heard about occasional buyers who couldn't or wouldn't or didn't perform on other scores, but the most central of these in the current market, and the reason for at least 90% of the rise in failed transactions, is that the buyer cannot qualify for the necessary loan.
The Era of Make-Believe Loans is over, but judging by the evidence, there's an awful lot of people who haven't figured this out yet. That's the first thing I want to find out when I get a new buyer into my office: What's the evidence of their ability to qualify for the necessary loan? How much do they make, what are their other payments, what is their credit score, how much do they have for a down payment, and is there anything about their situation which might be a cause for concern during the loan process? I don't want to give them the third degree, but I want to be confident I'm not wasting their time or mine, and that I'm not setting them up for a failed transaction. Failed transactions don't make clients happy, they waste the client's money, and they aren't any good for my business, either.
A year or so ago, if somebody came into my office with a 580 to 600 credit score and two years in the same line of work, chances were excellent that a loan could be done - even 100% financing. That is not the case currently, and the time to plan the loan is before the clients fall in love with the property they can't afford.
Lest I be unclear, 100% financing isn't completely gone, but you have to plan more carefully now, and often the purchase contract must be written in certain ways to make it acceptable to everyone who needs to be involved. Write the purchase contract wrong, and you might have killed the deal before it begins because there's something there that's not going to be acceptable to the lender, and sometimes it can prevent other folks from signing off on the deal as well. Furthermore, if the required steps in the contract are going to cause the seller to balk, you're better off finding out before you've got a contract.
The loan environment, especially for loans above 80% loan to value ratio, has changed drastically in the last year, and all of the changes thus far have been in the nature of making qualification more difficult. In my area, appraisal values are arbitrarily reduced by all lenders I'm aware of currently, and if you're not careful, you can find yourself in a situation where 85% loan to value is the maximum that can be done (This just changed - see below). Since the proportion of buyers that have that kind of down payment is rather small, and the proportion of those who want to invest it in the property if they do have it is even smaller, that can be a problem.
Even the government programs like VA and FHA with their low down payment requirements have their stumbling blocks. Not only do they require a buyer to qualify via full documentation of income (as do ALL government-based loan programs), but there are subsidiary requirements as well. Some properties are not eligible, period. Some people (and some companies) can't be involved, period. Investment property and second homes are iffy to doubtful with the VA and practically non-existent for FHA. It's a real good idea to know if you're going to hit one of these roadblocks before you are sixty days into a transaction that's not going to happen, and now we're all going to pay lawyers to fight over the deposit.
When I list a property, I want real information that tells me a loan is doable for this borrower before I advise my client to accept a given offer. Pre-qualification is a joke and even pre-approvals aren't anything to put stock in. The only examples of either that I trust are ones that I wrote, because I know what went into them. However, Steering is illegal. I can't require the buyer to get their loan through me or even to talk to me (or anyone else of my choosing). What I can do is require their loan officer fill out my form and provide documentation that enables me to determine whether a loan is doable or not. If I can't find a lender that can fund that loan, we've got a problem. It's kind of important to know this before we counter.
Unfortunately, we've had ten years where loan money was easy to get, no matter how ridiculous the transaction, and it's left a very strong imprint on many agents. Many have literally know no other environment, and they're finding it hard to make the necessary mental changes. I haven't been in the business ten years, either, but I do understand how the loan environment has tightened up and its effects upon my clients. Even the agents who have been in the business much longer may have no real grasp of the loan environment and often they're just checking off the box that says, "pre-qualification" on the checklist because that shows they did their due diligence. That isn't going to fly anymore. It may or may not help them when they're defending against a lawsuit, but it certainly isn't going to make their future ex-client happy about the thousands of dollars they lost, either because they couldn't qualify or because their prospective buyer couldn't.
When will we see a loosening of lending standards? I don't know but I wouldn't be surprised if it happened today (Okay, I was a little bit surprised when the email that was the first official notice from any lender came in as I was typing this paragraph! This will make it easier for properties that don't qualify FHA or VA to sell). It isn't important, because we're not going back to Make-Believe loans any time soon. Be careful before the contract, and you'll have a lot less chance of getting bitten by the obstacle of a loan that cannot be done.
As I wrote a few days ago, the buyer's deposit is always at risk. This is just a fact of real estate transactions. I could pretend it's not so, but that wouldn't keep the deposit from being at risk - it would just make me a liar. Nonetheless, because it's cash that the buyer had to forego spending that money in order to painstakingly set it aside a few dollars at a time, they understand that the deposit is real money in no uncertain terms, where most don't have that same understanding about a loan that's probably fifty times bigger and just as real. It may be comparatively rare that the buyer's deposit is actually forfeit (As of yet, I haven't lost one), but by recognizing this fact and planning for it, I can protect a client's deposit far more effectively than anyone who pretends otherwise.
The first rule is to be careful writing the offer. I want to make certain that all offers (and counteroffers) consist of something my client qualifies for and that I can make happen. This is one of the best reasons why real estate agents want to know enough that they could do loans, even if they don't. If I wasn't a loan officer, I'd consult a loan officer before writing an offer. Review client qualifications and necessary loan guidelines before the offer is written. If the issues of whether the client can qualify and what needs to happen so they do qualify have already been solved, you start the transaction with the largest part of the road to successful completion already paved.
Related to this is the issue of a client getting cold feet, which is one of the most common ways to lose a deposit. The best way to solve this is by showing them enough properties that they really understand the value offered by this one. Some agents believe in pressure sales and glossing over problems with the property. I believe in meeting these issues head on. The first thing I tell folks at our first meeting is that there is no such thing as a perfect property. They need to decide what they're willing to live with and what they aren't, and how much they're willing to pay for not doing so. It's my job to make certain they understand what the issues are with a given property, and that they'd be happy paying the necessary price to live there. All of an agent's nightmare scenarios start with talking someone into buying a property they don't like, so I'm not going there ever. This also solves the "cold feet" before we make an offer, where someone who doesn't understand these issues is going to be in danger of cold feet at every bump in the road.
The main issue with all of the buyer contingencies is time. You have a certain number of days to deal with those contingencies. When I get them done well before the time limit, the time limit isn't a problem.
For the loan contingency, I want an automated underwriting decision ASAP. Usually, there are reasons not to do this before we've got that fully executed purchase contract, but once we have that contract, there's no reason whatsoever not to do it that day.
I also want to order inspection and appraisal immediately, to meet those contingencies. I've got seventeen days for those. If I've got the appraiser and inspector out there the next day, I should have their report within two to three business days after that. Any subsequent negotiations needed due to those reports, I can start on right away. If the seller isn't going to be reasonable (or reasonable enough), we can find out about it right away and if the buyer decides to walk away based upon these reports or subsequent negotiations, we're in a much better position to argue that they should retain the deposit than if it were twenty-five days into the transaction and now the deposit is in jeopardy regardless of whether the contingencies have been released in writing or not. All parties agreed the contingencies ran for seventeen days in the purchase contract, and if that period is up, there's an argument to be made that the deposit is forfeit. I'm not a lawyer, so I don't know if it's a good, valid, legal argument, but if the whole issue is moot because we're done on day ten, the argument never gets started.
While this is all going on, I'm getting any final loan stuff together. This includes Preliminary Title Report and Escrow information. That complete loan package should be submitted before I go home on the day I get the appraisal. If it's not done by then, something major is wrong. I can submit loan packages with the appraisal "to follow", but it's better to submit them complete in the first place, even if it does mean I've got to pay for color copies. Every time an underwriter touches a file, they can add conditions. Those conditions can effectively make a loan impossible, and far more loans are approved with impossible conditions than flatly rejected. Also, submitting a loan with minimal information is itself one of the best ways to raise red flags in an underwriter's mind, or would be if raising red flags in the underwriter's mind was a good thing. It isn't. Once red flags get raised, expect them to throw as many roadblocks at you as they can. Better to submit a clean, complete loan package as soon as possible. Doing the extra work right off the bat really does save you a lot of future work.
Even when refinances are running several weeks, purchases are usually no more than two days for underwriting. If you submitted a clean complete file, any prior to documents conditions you do get will minimal and trivial, and the funding conditions should be just the absolutely standard cookie cutter stuff. I don't like getting anything other than the routine funding conditions that happen on every transaction, because it means I have to get those conditions and wait a couple of days for the underwriter to get back to the file. This waste of time is my fault if it happens, but with the best will in the world, it will happen to you a pretty significant percentage of the time. It's not a disgrace, it's just something to avoid if you can get ahead of how underwriters think. You can always mark time if you have to, but you can't get it back once it's gone.
I believe in giving the seller and their agent a reasonable amount of time to hang themselves, but once the loan is submitted, I'm going to be asking about their responsibilities if I haven't gotten evidence they're done yet. Allowing them to hang themselves doesn't mean letting them hang my client. I want to see that termite inspection in particular before the end of seventeen days. The standard contract has the buyer responsible for section 2 work. It's never happened to me, but it's very possible that there's enough section 2 work needed to call the transaction into question. After seventeen days, this becomes more difficult for the buyer.
As soon as possible, I order the closing documents and get them signed. Even if you're not ready and able to close the transaction as a whole, this is a good idea. Something that's already done correctly isn't going to be an issue if my client gets called away on business - particularly out of the country as does happen. Notary work becomes a real issue outside the United States - it must be done at a US Consulate or Embassy. There is no exception for "Buyer had to leave the country" (or even just "go out of town") written into the time frames and contingencies on that purchase contract. I suppose you could ask for one, but it will make most sellers more than a little nervous, for tolerably obvious reasons. Better to know and plan in advance, but life happens. Better not to be bit if it does.
If I can get all the ducks in a row before the contingency period expires, not only does this preserve my buyers rights and give us an advantage in subsequent negotiations, but preserves as much as possible of my client's options to exit the transaction while preserving their right to recover the deposit. If I can close the entire transaction before the end of the contingency period, that makes me very very happy, and not just because I get paid sooner. It means that the issue of my client losing the deposit for walking away never comes up..
By finishing everything before the end of the contingency period, I've also preserved as much as possible of the right of specific performance in case the seller gets cold feet. It happens. Not so much right now, but a few years ago in the crazy seller's market, it happened because sellers thought they could get a higher price. If my buyer client is happy with the state of the contract as it sits, their lawyer can quite likely argue specific performance of the contract, and maybe recover legal costs too. Not my place to say whether or not, as I'm not a lawyer. I only know that lawyers seem to be much happier with agents that keep this information in mind.
If I can't close it before the end of contingency period (and I recently had signed loan documents sitting at escrow for two weeks while we waiting for the sellers to finish termite work), I still want to get together with my clients before the contingency period expires, put the evidence in front of them, and have them make a choice to continue or abort the transaction. Just because the contingencies haven't been released in writing is no reason that a seller's lawyer can't argue that they were released anyway. Much better if the argument never comes up because it's a moot point.
There is nothing I can do that generates an ironclad, foolproof guarantee that my client won't lose their deposit. But doing things the right way, quickly, can certainly make it a lot less likely than pretending that tje deposit isn't at risk. Lawyers and judges are the only ones who can answer the question of whether it has been forfeited, but it the issue is resolved without them getting involved, everybody is going to be happier. Neither party should have signed the purchase offer if they didn't want the transaction to happen on those terms set forth in the contract. Therefore, making it happen quickly, reliably, cleanly, and before the deadlines have passed is the best way to prevent making anyone unhappy.
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