Beginner's Information: October 2006 Archives

Right now X is offering me a loan that looks something like this:

80/20 No down payment
On the /80: 6.5% FIXED interest for 30 years, interest-only payment option for 15 years
On the /20: 8.75% FIXED interest for 25 years (amortized to 30) 6-month lock for 1-point ($3800) refundable fee with float-down option

My response:

Devil is in the details.

Is there a pre-payment penalty?

They want 1 point to lock for 6 months? Cash, I presume? Quite frankly, the usual cost for locking in six months out is about three points. Nor is X usually that cheap on the lock (they have some excellent rates, but what they're quoting you is a market current quote for a 30 day lock. Long term rates are expected to rise, and long lock periods aren't free. There's something they are not telling you.)

What are the discount/origination on the underlying loan? How much are they going to charge in closing costs to get it done?

Will they guarantee their quoted costs (as in they eat the
difference if there is one, not you)? You might want to ask them all of the questions here

A developer's condo sell out is not the most difficult loan, but it's a long way from the easiest, as well. There are a lot of lenders that will not do them. Furthermore, what's being presented to you looks much cheaper than is likely to be true. If you insist on going with it, call me thirty days before the place will be done, and I'll do a back up loan, because I don't think what they're offering you is real.

he did get back to me as to what lender X's response was:

Is there any pre-payment penalty on this loan? NO.....

What is the total refundable cost for the 6-month lock? YOU PAY 1% UP FRONT AND IT IS REFUNDABLE IF YOU CLOSE WITHIN 6 MONTHS (emphasis mine)

How much will the closing costs be to get this loan done? I DON'T KNOW WHAT YOUR ESCROW AND TITLE COSTS WILL BE. YOUR LENDERS COSTS WILL BE APPROXIMATELY $1,200. (emphasis mine)

Is the rate being quoted based upon full documentation, stated income, NINA or EZ Doc? 100% FINANCING IS FULL DOC....

Do I have to pay any discount points, points of origination, or any other points to get the quoted rates? NO POINTS NOR ORIGINATION FEE (ONLY THE 1% LOCK IN FEE OF WHICH WE SPOKE) (I prefer no points)

Regarding third party costs, can you tell me, or will the papers you send me make clear, the following third party costs:
- Appraisal fee: THIS SHOULD BE AROUND $400 BUT IS PART OF THE $1,200 I QUOTED.

- Total title charges: ??????????

- Escrow fee: ???????????

The builder has already assigned an escrow and title company for the property — may I use this company with the Wells Fargo loan? YES!

How much, total, will I be expected to pay X upfront, out of my pocket, to get this loan? THE $400 FOR THE APPRAISAL AND THE 1% TO LOCK IN....

How much, total, if any, will be added to my mortgage balance on top of what is quoted? ????????????????? NOTHING IS ADDED TO YOUR MORTGAGE.

If I agree to this loan after reviewing the papers, are the rate and closing costs guaranteed, and will X cover the difference (if any) between the quote and the actual final cost? WE'VE BEEN IN BUSINESS SINCE X. WE CONTINUE TO STAND BY OUR COMMITMENTS. (emphasis mine)

Now for the emphasis points, last first
-This question of is the rate guaranteed requires a simple yes/no response. This evasive reply tells you the answer is no, but that they don't want to admit it. If this answer is not yes, none of the other stuff is written in anything more permanent than beach sand somewhere below the high tide line. It's funny they mention commitments. Neither a Good Faith Estimate nor a Mortgage Loan Disclosure Statement (the California equivalent) is a loan commitment, or any kind of commitment at all. Regulations leave so much room for the unethical to manouever without running afoul of the law that either one of those forms is nothing more than the loan officer or company wants it to be. A few are right on, and those companies will typically guarantee their quote. More are somewhere in the ballpark, amazingly enough usually noticeably on the low side. And quite a large fraction are nothing more than an exercise in creative writing. He didn't guarantee his quote. Tell me this: Two companies are bidding on doing building work for you. Both are large firms. The first company asks you all sorts of questions about specifications, and guarantees they'll get it done for $5000, and if there's a problem on their end, they will fix it for no additional money. The second says they think they can do it for $4500. Which would you feel more comfortable with? If you know anything about building contractors, the latter is a joke compared to the former. Lenders and estimates on the initial paperwork to get you to sign up are, if anything, worse.

-I do business with this lender. Their costs are $1295 not including the appraisal to brokers, who perform some of the services they charge their clients for performing. By the time you've added escrow and title, you're roughly at the $3400 mark.

-It's easy to talk a good game to most folks who aren't experienced with how the game is played. The point of this particular game is trying to lock you in with that 1 percent cash upfront payment, so that when clients discover that he's not going to be able to deliver what he's talking about, they'll be thinking about recovering/losing that money, rather than focusing your attention on getting the best loan. This is called creating a distraction, and is in accordance with the tell you anything to get you to sign up school of thought.

When it comes time to close, he'd be licking his chops due to the fact that the client paid $3500 (or whatever one point comes to) cash upfront, and when he delivered something different, the client believes they have no choice but to agree in order to save their money. I've offered people in that situation a loan that was more than 1 point better, and they still went with the guy who had rooked them out of the 1% upfront, because they're worried about that cash when they should be worried about the rate/cost tradeoff.

He also went to the builder's lender

If I'm interested in getting my monthly payments down lower and I consider getting a 5/1 ARM loan to do so, is that a completely horrible idea, or could I refinance into another 5/1 ARM after the first five years to continue getting a pretty good rate, if for example the 30-year fixed rates
have gone up a bunch in 5 years?

That's precisely what I've been doing for the past fifteen years. On the other hand, with the difference in rate/cost tradeoff being so narrow right now between a thirty fixed and a 5/1 (roughly a quarter of a percent interest rate wise), there's a strong argument to be made for the loan you never have to wonder about. Where I thought I would never have a thirty year fixed rate mortgage, I'd consider it if I were going to buy or refi right now. Don't know if I'd do it, but I'd think about it.

80/20 No-down 5/1 ARM
No pre-payment penalty
Total loan amount: $379,900

80%, $303,000: 5.25% fixed & interest-only for 5 years, payment: $1329.65
20%, $78,000: 9.5% fixed for 5 years, interest-only for 15 years, payment: $601.50

Total monthly payment: $1931.15

Aside from the fact that the putative loans total $381,000, which is likely picking nits, I don't believe that loan exists, as 5/1 ARMS are running up around 6.25% at "par" right now. I couldn't find a lender that is even offering 5.25, no matter how many points you paid, and that's wholesale. He attached some GFEs which show $4180 in points charges (plus $875 in pure junk fees and about $150 in well padded costs on the first loan and shorted the likely interest, in addition to all the real stuff), adds $5000 that he's evidently already paid to the closing costs, requires another $3200 plus at closing, and still comes up with final first loan of $303,920.

On the second, the loan required another $1140 in fees but a loan amount of only $75980, thereby balancing the 80/20 requirement correctly, at least, thereby negating the nitpick in the previous paragraph.

(I'd also shoot his agent for not negotiating any givebacks, given the current market, except I'm prepared to bet he didn't have one. I've covered some of these issues, precisely as they relate to this particular situation, at the end of this article), of which which I'll reproduce the relevant section here

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.

Now the market is falling, but it looks like to me the guy paid full asking price (since he's local to me, I can look), and the market is incredibly squishy on prices.

Now getting back to the loans, this is how lenders Play The Game of getting you to sign up. They are looking for you to build what salesfolk call commitment to a loan before they tell you the whole truth - usually by springing it on you at closing. They make it look better than it is for a while. They can do this because the only form that has to have correct accounting is the HUD 1, which comes at the very end of the process (It's usually prepared by the escrow officer. You should get a provisional when you sign loan documents and a final within 30 days of the end of the transaction). In the case of a purchase, this is usually at the last possible instant, which means that if you haven't prepared a back-up loan there is no time to get one before the deal goes south, which means your choices are limited to sign or lose the property, the deposit, and all that time and aggravation. This is providing that you even notice. Industry statistics say that somewhere around half the folks won't, and even on refinancing, where people can almost always just keep the loan they have without bad consequences, eighty-five percent or so of those who do notice will cave in and sign.

Caveat Emptor.

Most days I get loan wholesalers coming into my office. I'm always happy to talk with them, providing they want to talk about what I want to talk about. They usually want to talk about this gimmick and that gimmick and the other gimmick. They feed me lines about service and fast turn around and quick approvals and loan commitments. Ladies and gentlemen, these are all things that every lender should be capable of, and if someone hoses one of my clients, I'm no longer interested in doing business with them. Now, everybody makes mistakes, it's how they deal with mistakes that I am interested in. I'm very forgiving if they make their mistake good, completely unforgiving if they do not.



What I want to talk about is two things. The first is loan programs nobody else has, or that nobody else has in that category. Suppose a lender has a program to deal with people in default just like everyone else with only a small penalty. I'm all ears, and I make certain that goes into my database. I expect the rates for the underlying program to be higher, but that's cool. I'll price loans with them anyway, and if they're the best I can do for the client, I'll use them. Next time I have somebody in default, though, they get my first call, because they've got something nobody else does, or very few do.



The second thing I want to talk about is price. A loan with given terms is the same loan no matter who is carrying it. So long as they are both legal, my client sees no difference between National Well-Known Megabank and Unknown Lender from Nowhere. The loan is the same. If the rate is the same, what's important to my client is how much they have to pay in order to get it. This comes back to The Trade-off Between Rate and Cost. If one lender's par pricing is a little bit lower, I can either get the client the same rate cheaper, or I can get the client a lower rate for the same price. There is otherwise no difference between standard loan terms for the standard loan types. I can get the client a lower rate if they'll accept a prepayment penalty. If they want a true zero cost loan, the rate will be higher. How much higher or lower? That varies with time and the lender involved. But except for the rate printed on the contract and the cost to get that rate, these loans are the same.



Now wholesalers don't want to talk about price, and they don't want to compete on price. If they're competing on price, they're making less money in the secondary market. Less money for the same work. I can't blame them. Suppose I walked into your office and proposed cutting your pay by somewhere between twenty and fifty percent? Somehow, I don't think most of you would appreciate it. But now turn that around, because you're in my office now, shopping for a loan, and you want the loan with the terms you want at the best price possible. If I get a lower price from the lender, I can pass it on to you. I can maybe even make a little more money while still saving you some money. Aren't you entitled to a bonus when you make money for your company or their clients? Ask yourself this: If I saved you $1000 and $20 per month over the next best quote, would it break your heart if I made an extra couple hundred? When I'm out shopping, it doesn't bother me at all. By delivering the item on better terms to me, that company has earned whatever money they make.



This doesn't mean I necessarily look for the lowest price. Many times I'll buy something that is close to the top of the line? Why? Because it has something worth more than extra money to me. What is worth extra money in real estate? Getting you a better bargain. You spend three percent instead of one, but your $500,000 home sells for $25,000 more, or it sells when it perhaps would not sell under a less aggressive marketing plan. $25,000 minus 2% ($10,000) is $15,000 in your pocket because your agent can afford to market and negotiate more aggressively on your behalf, never mind the difference between selling and not selling. Can a full service agent guarantee a better result? No. But I can tell you through personal experience that I find it much easier to get a better bargain for my clients who are buyers from someone who listed with a discount brokerage or flat fee place, and my clients are probably going to think I'm superman before the deal is done. But note that the difference in price does have to be justified. A loan is a loan is a loan, as long as it's on the same terms.



A couple days ago, I got an email calling my attention to someone calling me an "alarmist", and furthering that with an accusation that I was trying to paint everyone else as a crook. Nope. There are a large number of basically honest practitioners out there, and a significant number of scrupulously honest ones. But there are also a fair number of people out there who, like my loan wholesalers, don't want to compete on price. Do I blame them? In most cases, no. As I said the day I launched, this is the way they were trained and they don't know a better way is possible. Plus they want a larger amount of money for the same work rather than a smaller. Many of them resist changes for the better for the consumer because it means they will make less money for the same work. Seems like every day there's a seminar advertising that they'll teach agents and loan officers how to attract clients without competing on price.



Well, suppose someone makes enough money per transaction to be happy, even though they are competing on price? Then what they want to do is attract more business, which is a part of what I'm trying to do here. More importantly, I'm trying to give you, my readers, the tools necessary to get yourself the best possible bargain. Nor am I trying to tell you that I'm purer than the driven snow, and I don't think I ever have. That is for you to judge with the tools I put out, and there's no way to know for sure unless and until I do a transaction for you.



How far you want to go with these tools is up to you. Real Estate transactions are the biggest transactions most folks undertake in their lives, and as a consequence, small percentages tend to be a lot of money by the standards of lesser transactions. If you only want to do a few easy things, they should save you some money. If you want to do the work for the whole nine yards, they should save you a lot more. But when you have the tools, you are better armed consumers, more likely to get bargains that are better for you, given your situation. Like all tools, they are to be evaluated on the basis of how well they do the job. If they are used properly and nonetheless fail you, you are right to fault them. If there are tools that do a better job, you are right to use those instead. But to say, essentially, "Pay no attention to that man behind the curtain!" is not the optimal response to the issue. Through issues clients and potential clients have brought me, I have encountered every single issue I raise here. There not only is a man behind the curtain, you need to keep your eyes on him and you need to learn how best to deal with him. That is what this site is about.



Caveat Emptor.