Beginner's Information: April 2007 Archives

The only one I trust is one that I wrote.



I got this search engine hit:





pre-approved loan underwriter changes terms illegal





I have gone over these issues in discussing the pre-qualification.



Loan officers are salespersons. There is intense pressure on them from supervisors, brokers, stockholders and their own pocketbook to tell you what you want to hear. A large proportion of the people who ask me for a either pre-qualification or pre-approval already have a property in mind, and they get angry if I tell them it appears to be beyond their means. They should be kissing my shoes because I'm trying to keep them from making a half-million dollar mistake, or at least make certain they go into it with their eyes open, rather than just keeping my mouth shut and pocketing my commission. Most of these folks just go get their "Think Happy Thoughts" letter elsewhere.



Furthermore, if the loan officer is counting upon referrals from real estate agents for a living, now they're getting the agent angry to no good purpose. This agent thinks they have a commission check all lined up, and you're trying to talk the buyer out of it, threatening that commission check. Most Real Estate Agents do not respond well to this, I'm sad to report. I'm thinking, "Boy, I'm glad I found out now, before the default, when investigators and lawyers and courts get involved," but most agents see only the immediate check that just evaporated. One such experience is all it takes before they not only stop referring to that loan officer, but try getting any clients they may have in common away from that loan officer. This may be short-sighted, but it is also human nature.



Not to mention the fact that nothing about a pre-approval or pre-qualification is binding. In fact, until the underwriter writes a loan commitment, there is nothing that says you have a loan at all. Furthermore, it's rare for loans to be rejected outright. What happens far more often is the underwriter puts an unmeetable conditions on it.



Furthermore, there is nothing about any loan that says the terms cannot change unless there's a lock in effect. If the loan isn't locked, it's not real. Quite often, loan officers will tell people their loan is locked when it's not. Locking paperwork can be easily faked.



Finally, unless you have a written Loan Quote Guarantee, the loan officer can always decide to sock you for more in fees. The games that can be played with the Good Faith Estimate (Mortgage Loan Disclosure Statement in California), Truth-in-Lending, and all of those other forms you get when you sign up are legion. None of these forms means anything, really, in any objective sense.



Even with the best will in the world, I can't guarantee you've got a loan until I get the loan commitment from the underwriter. I can go through all the guidelines for a given program, and make certain the borrower meets every single one of them. It doesn't mean anything until the underwriter writes that loan commitment. I don't have the power to approve that loan - no loan officer does. Loan commitments are the exclusive province of the underwriter. A good loan officer can and does go through guidelines to ascertain whether there's an obvious reason that you will be turned down. If the underwriter rejects the loan, none of it means anything.



This is one of the reasons that I have written several articles explaining how to calculate what you qualify for, in terms of payment and in terms of purchase price, so that you will not be at the mercy of somebody who tells you, "Sure you can afford it," while qualifying you for a "stated income" negative amortization loan. The most mathematically correct and detailed of those articles is Should I Buy a Home Part I, while the most accessible is Can I Afford This Property?.



The stages in this process are first, the lock. If you don't have a lock, the loan is not real, and it will fluctuate with the market - every day for A paper. Once you have a lock, then it is possible to get a loan quote guarantee that means something. Even that is not absolute, however. A real loan quote guarantee is written contingent upon underwriter approval. The loan officer cannot really promise you that loan until the underwriter writes a loan commitment with conditions you can meet. What I can do, however, with a loan quote guarantee is say, "If the underwriter approves it, the loan will be on these terms" If the underwriter rejects the loan (or doesn't approve it), you still don't have that loan. You can choose another one, that you are likely to qualify for, or you can do without. I'll tell people that if the loan officer gets back to them within a week, it's likely that they're honest and they really thought you qualified for the loan they told you about in the first place. If it takes them three weeks or longer, or if they spring it on you at closing, I wouldn't believe they were honest with sworn testimonials from George Washington, Abraham Lincoln, and Mohandas Gandhi that they saw the whole thing, and it's not the loan officer's fault.



Only when you have a lock agreement, loan quote guarantee, and a loan commitment from the underwriter do you have a deal going that somebody might be able to stand behind, in the sense of being able to hold them responsible if they don't deliver on exactly those terms, and even then there are limitations. Of course, what really happens most of the time is that loan officers tell you about loans they have no prayer of being able to deliver. This is despicable, but it's the way things are. There are reasons why the situation is complex, but that's no excuse for loan providers to play any additional games to obscure or confuse something that is already complicated enough. Part of the reason that I'm writing here is that I would like to change this for the better, but the power to demand real change is in the hands of consumers, not any individual provider.



Caveat Emptor

Mortgage and Real Estate Red Flags

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This is going to be one of those occasional posts that gets expanded and reposted from time to time. This list is not exhaustive, although over time it is intended to become closer. If you have one, send it to me (danmelson at this domain name)



Any of these is sufficient reason, all by itself, not to do business with that company or person, to cancel your loan if in progress, or to go get another backup loan.







Any actual lie



Up front application fees, or sign up fees.



Up front lock fees.



Up front appraisal fees, as opposed to at the point of appraisal.



Any up front fee beyond credit report.



Requiring the originals of your documents.



Trying to sell you a Negative amortization loan, under any of its names, without explaining in detail all of the gotchas



Not locking your rate, or letting it float



On stated income or NINA loans, not giving a real idea of what the payment is going to be, and making sure you can afford it.



On full documentation or EZ documentation loans, needing to document more money than you make.



Requiring you to pay an "in house" appraiser (Who is receiving a salary)



Not allowing you to choose an appraiser if you want to.



Not allowing you to order the appraisal.



Consistently using the same phrase in response to a question. "Nothing out of your pocket" ($30,000 added to your mortgage) and "Thirty Year Loan" (note the absence of the words "fixed rate") are two that are sufficiently pervasive as to merit independent mention.



An answer to a question that is somehow similar, instead of to the question you asked. Especially if said obviously intended to distract and mollify you, or is a pat phrase you've heard them use before.



You check their calculations on a couple of calculators and the numbers are both consistent and different from what you were quoted as a payment. (Some web calculators lie, but they usually lie in slightly different ways, although note that an auto payment calculator uses different first payment assumptions).





Buying:



Use of non-standard forms when standard forms are available



Asking you to sign an Exclusive Buyer's Agent Agreement before they've shown you anything.



Asking you to sign an Exclusive Buyer's Agent Agreement at all without furnishing you something special (i.e. daily foreclosures lists, or some service you would otherwise have to pay for).



Not finding out what your budget range is and sticking with it. For example, if you've got $30,000 for a down payment and closing costs, can qualify for a $270,000 loan, they shouldn't show you anything that you cannot get for $300,000 total, including all costs you need to pay.



Not finding out what you actually make, and what your current monthly obligations add up to. This lets me, as the real estate agent, know what I'm really dealing with here, even though I have no real need to know if I'm not doing the loan. In case you haven't gotten the idea, there are a lot of mortgage folks out there who may not have your best interest at heart, and "stated income" loans allow for a lot of sins. You can get offended at invasion of privacy if you want, but I'd be grateful - This is one part of the system checking another, looking out for you, when they could just grab their commission and bow out of the picture.



Promising to find houses below market value. I do my best, but so does every other agent out there. This is something nobody can guarantee, and they're usually gone before the public even has a chance.



Telling you about "money in your pocket" when you ask about closing costs



Selling:



Use of non-standard forms where standard forms are available.



Excessive pressure to sign listing agreement immediately (Some pressure is normal and to be expected)



Not being upfront about their business model. I've got an article about business models in the real estate industry (there are 2 basic, and many variations). Each has situations they are best for, and situations they are not so great for. You want to know if it fits your situation.



Not running advertisements for your property. This helps them generate clients as much as it helps you sell your house.



Not holding at least one open house per month on a weekend date. Sometimes this is tough during the holiday season, but there's no excuse for the rest of the year. Especially during the summer, if they want to take a three week vacation, there should be someone else there to take up the slack. Perhaps it might be unproductive if you live in a thinly inhabited area, but anywhere within the commuting area of a major city, this is a minimum.

Mortgage - Questions you must ask every provider about every loan when you are shopping. Permission is hereby granted to print this out and use it for non-commercial purposes so long as no alterations are made and copyright is preserved.



(Disclaimer: This list is trying to be as exhaustive as possible, but is likely missing some important questions. If you have one that I missed, send it to me: danmelson at this domain name)



Is there a prepayment penalty?



If so, for how long and under what terms?



What is the interest rate?



What is the amortization period?



Is there a possibility that the note will be due in full before the amortization pays it off? (Vaguely equivalent to "is there a balloon?" but a broader question)



Is the payment interest only, or principal and interest?



(if interest only) how long is it interest only, and what happens afterward?



Is there any possibility of negative amortization (the balance increasing) if I make the minimum payment? (See my post on the Negative Amortization Loan at the bottom of this article)



Is the nominal rate different from the real rate of interest I would be charged?



How long is the rate fixed for?



(If fixed for less than the full period of the loan) What is the rate based upon when it adjusts, what is the margin, and how often does it adjust?



What is the industry standard name for this loan type?



Is the rate you are quoting me based upon full documentation, stated income, NINA or EZ Doc?



(If full or EZ doc) Assuming I have other monthly payments of $X (where $X is your other monthly payments), how much monthly income do I have to document in order to qualify? (If this is more than you make, Warning!)



How many points TOTAL will I have to pay to get that rate.



How many points of origination will I be charged?



How many discount points will I have to pay?



What are the closing costs I will have to pay?



(because they are allowed to omit third party costs from all estimates and totals, you must add the answers to the next three questions to the previous question unless the provider specifically includes them)



How much will the appraisal fee be?



How much will total title charges be?



How much will the escrow fee be.



Who will my title company be?



Who will my escrow company be?

(If escrow company is not owned by title company, i.e. same name, be prepared for unknown additional title charges).



How much, total, will I be expected to pay out of my pocket?



How much, total, will be added to my mortgage balance?



With everything added to my mortgage balance, what will my payment be?



How long of a rate lock is included with this quote?



What do you need in order to lock this loan?



If I say I want this right now, will you personally guarantee this rate with those closing costs, and will you cover the difference (if any) between the quote and the actual final cost?



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After you have finished talking to this person, go check out the numbers. If you have a calculator that can handle mortgage calculations, use it. If you're able to do the calculations yourself, even better. Otherwise, do a web search for payment calculators or mortgage calculators or amortization calculators, and try out a couple of different ones (because some web calculators on lenders sites are programmed to lie!). This is math - there is only one right answer! The numbers should come out the same except for rounding errors! If the difference is more than five dollars in any case, that's a red flag! (You should also make certain the reason for the difference is not operator error. For instance, automobile payment calculators assume a different first payment than mortgage calculators, but student loan calculators should be compatible with mortgages.)



Copyright © 2005 Dan Melson all rights reserved.

The other day I quoted a loan to someone, and they chose a 5/1 loan at 6 percent with .05 points of discount, and they told me the closest competition was 6.375 with more discount than that. Then when I tried to lock the loan with the lender, I discovered a transient compliance problem that prevented that lender from accepting loans from us for about a week. No biggie, I thought, I'll just go with the second best. It's not as if the competition was even close. So it became a loan that would cost about one tenth of a point of discount instead of only 5%. Difference (on a $500,000 loan): About $250. However, this particular client had opted for the Upfront Mortgage Broker Guarantee, where my compensation is a fixed amount, instead of my standard Loan Quote Guarantee, where if it's not precisely the loan I quote, I have to eat the difference. So I did the ethical thing under those circumstances, and called the client right away to let them know that the pricing was a little different. They then canceled the loan, despite having been specifically counseled about the risks of the plan they chose.



Now the loan they would have gotten was still a much better loan than the competition was offering, and I would have been legally compliant had I just waited and socked them with the difference at closing. Even the Upfront Mortgage Brokers would have accepted the facts had the client complained - if, indeed, they had even noticed. I could have kept my mouth shut and gotten a loan, and at least 95% of all loan providers would say I was stupid for not doing so.



But let's look at it through your eyes: Wouldn't you rather be told, weeks in advance, so that you know what you're really getting? So that if you so desire, you can go shopping for something better? Isn't it better than having it sprung upon you at closing? Isn't this the sign of someone you want to be doing business with?



Some people may feel it's a sign of someone who's springing a little change now in preparation for springing a bigger change later. Except that I don't have to tell you about the changes now. There is absolutely no legal requirement. The fact that your loan provider does tell you right away is a sign that they are going well past the legal requirements. The vast majority of all loan providers are pretending that thousands of dollars in fees and adjustments and even barefaced low-balls don't exist - and you're getting all angry and disappointed because someone who's delivering something thousands of dollars cheaper than the competition is telling you weeks in advance about a $250 difference between the initial quote and the numbers he's going to stand behind with a Loan Quote Guarantee that's still way less than the competition, which isn't willing to issue the guarantee even on the higher quotes?



The problem with the loan industry is that lenders can tell you about one set of numbers to get you to sign up - numbers that they know good and well they are not going to deliver - and then thirty days later when they actually have your loan ready, deliver something completely different, secure in the knowledge that they have this unbeatable advantage of you having actually given them this thirty days to get ready. Entire business plans are drawn up based upon the fact that they can lie, and conveniently "forget" to tell consumers about all of these additions to what the consumer is actually going to end up paying, and consumers will reward them by not only signing up, but signing on the dotted line when it's time.



Now, take a step back and ask yourself: Is someone who comes right back and tells you about the difference within a couple of hours playing that game? Not likely. If they give you a real loan quote guarantee based upon the revised numbers, any future games they are playing are pointless. In fact, if they tell you that the difference came about in the locking process, you can be more confident that they actually have locked your loan, itself a huge problem with the industry. If I haven't locked your loan, I can pretend that the difference isn't going to happen because the rates might go down, can't I?



When people come back right away and tell you about issues in your loan, you should become more comfortable with them, not less. The less ethical ones can pretend the issues don't exist for weeks, until they spring all these differences on you at closing while distracting you with a thousand other things so that you don't notice what you're signing. In fact, the sooner they tell you about an issue, the more likely it is they are doing their best to be honest.



Caveat Emptor

For all the fact that I rant on about problems in out national mortgage market here in the United States, the problems are mostly on a retail level. Almost in their entirety, they have to deal with what happens when one consumer meets one provider, and I believe that they will vanish when the consumers are informed of the facts, and take the time to make rational, informed choices.



The fact is that for mortgage providers, there are strong incentives to lie to consumers. "Everybody else does it, too - how else am I going to compete?" Also, real closing costs seem high. Real closing costs are high enough that many states with so-called "predatory lending laws," limiting the amount in total charges as a percentage of the mortgage, either have already repealed them or are considering repealing them so that their residents can get loans. I can talk to people about closing costs that have been significantly reduced by contracts I have with service providers, and they'll say, "Costs seem high." Well, yes they are expensive, but they're real, and what I tell you about up front actually covers what my clients will be asked to pay. Just because we allow you to roll them into your mortgage, where you pay interest on them for a very long time, instead of the money coming out of your checking account doesn't mean you somehow didn't pay this money.



So we can take it as proven that there's an incentive for loan officers to minimize costs of their loan in conversation with you. Many will tell you anything it takes to get you to sign up with them, do anything they can to force you to stay with them (signing fees or lock fees up front are common, and THE BIGGEST RED FLAG I KNOW, and requiring you to give them original documents is almost as common and almost as large). They will penalize you out of spite if you decide you don't want their loan.



From almost the first moment a consumer talks to some mortgage providers, they are lied to. The fact is that as long as the rate that they quote you is available, the providers won't be held responsible if you don't get it. If you ask them what their rate is on a 30 year fixed rate mortgage without points and they reply with a the rate that's available on a 30 year loan that's fixed for one month at a time with five points, that's actually legal. They can sign you up for the former, deliver the latter 30 days later, and with rare exceptions that they are adept at avoiding, not get in legal trouble. They can tell you all about a loan that's based upon completely different qualifications than the ones you possess, in order to get you to sign up. And many loan officers, from the largest, "most reputable" banks on down to the smallest brokers working out of their home, make a habit of it. The examples I give above may be more extreme than usually happens, but it's a matter of degree, not kind, and I have seen every single rotten trick that I tell you about, pulled on prospective clients by other loan officers in the most extreme way I talk about. Furthermore, blatantly unethical is still blatantly unethical, whether they're stealing multiple tens of thousands of dollars from you, or "just a few thousand between friends." If you found out you were victimized by a Nigerian 419 scam, I'm sure you'd feel much better to find out that you were only taken for $3000, where it could have been $30,000, right? This is no different. No, let me take that back - it's worse. If the loan provider were honest, your patronage would still have put a lot of money in their wallets, and they backstab you to get more?



The first thing to keep in mind is that all of the incentives are aligned for them to tell you ANYTHING in order to get you to sign up with them. The fact is, many people, once they sign the initial papers, consider themselves committed to that provider, and won't switch no matter what. At the end of the process, many loan providers are adept at hiding the crucial things you should study carefully in amongst the sometimes dozens of pieces of trivial paper that you have to sign. A large portion of people victimized in this way never notice that the loan delivered had three points more than the loan they signed you up for. A few more only realize it weeks later when they get a statement loan balance is much higher than they thought, and it's too late to do anything about it. And of those people who do notice that something is amiss when they're actually signing the final documents, eight to nine out of ten will cave in and sign. They're tired of the whole process, all they have to do to have it be over is sign right there on the dotted line. And if it's a purchase, the consumers are under a deadline. It's the thirty-ninth day of a thirty day escrow, and if they don't sign these loan documents right now, they not only don't get the house, they also lose their deposit and the extra money they've been paying to keep the escrow open while the loan officer got his (or her) stuff together and decided exactly how much in extra charges to stick them for. The leverage available to the consumer in such a situation is Zero. Zilch. Zip. Nada.



I'm going to make what seems like a heretical suggestion here. This is truly radical. The resistance in some quarters (particularly loan officers) to this suggestion is enormous. I can already hear howls of outrage already from loan officers and their bosses. Furthermore, I can hear millions of consumers griping about the paperwork involved already, and I haven't even said it yet - except to fewer than a dozen clients who took this advice and are forever grateful to me.



Apply for a back-up loan.



It isn't precisely a walk in the park to do the extra paperwork, I'll admit. But it isn't thirty years in purgatory either. There are issues to be aware of (most notable being the appraisal, about which more in another column), and extra charges to put up with from the appraiser, escrow and title companies. $100 to $200 if you handle it right, $500 or a little more if you don't. But this is likely the most cost effective insurance policy a consumer can buy today, and I'm going to harp on it until something changes this fact



You see:



Every so often I encounter a client who I'm certain has been lied to, and believes every word of it. I know what rates really are available, and at what cost. And this person has been quoted something where, if it were true, that loan officer not only isn't going to make money but is actually going to pay hundreds or thousands of dollars of their own money in order to get it for the client. Unless John or Jenny Consumer is a close relative or the loan officer literally owes them their life, it doesn't take a genius to figure out that that's not going to happen. (Some of the worst taking advantage of someone that I've observed on the part of loan officers has been from Uncle Bob, the first cousin they grew up with, or even Sister Sue, but I digress). So every once in a while, I volunteer to act as a back up loan. They cooperate with me for the paperwork, and I will do the work, knowing full well that if their primary loan goes through as advertised, it's all a waste of my time, effort, and money.



Every single time it's been my loan that they ended up getting.



Furthermore, there have been a lot of other situations where I wasn't 100 percent sure - the rate existed, and it was possible the loan officer might deliver something similar if they were willing to settle for a lot less compensation than most loan officers, and so I didn't make the offer, and they came back to me weeks later with "Can you still do that loan you talked about?" (The answer to this is ALWAYS no. Rates at every bank vary daily, and often within a day - even the sub prime lenders that publish rate books good for months have adjustments that change daily. This is part of the importance of a lock. But usually I can do something similar, and sometimes better if the rates have gone down).



Most consumers do not realize that there is not necessarily any correlation at all between the loan you sign an application for and the loan that gets delivered with the approved documents ready for a notarized signature. It's completely dependent upon the good will and good faith of that particular loan officer and the company they represent. Some are completely honest. Some are looking for extra bits and pieces of cash to pick up around the edges. And some will take the odd arm and leg from you if they figure they have the opportunity. Even those few companies that do guarantee their rates and closing costs up front are difficult to collect from if they should be stretching the truth. If I had a dollar for every time I told somebody that I didn't believe a rate was real and they responded, "I've got the paperwork on it," as if that settled the question (or made any difference at all), I would have quite a few dollars. Oh, most of the time from most companies, if they sign you up for a thirty year fixed rate mortgage, they will actually deliver a thirty year fixed rate mortgage, and the rate will generally be about comparable, albeit with two points and $2000 in extra closing costs they somehow forgot to mention (Quoth the loan officer: "Clumsy me!"). But until then, they'll be throwing around all kinds of rates on all kinds of loans just to get you to call, to come in, or sit down and talk. Once that happens, they are confident that their A salesmen (see my essay on A salesmen and B salesmen) will get you signed up.



If you have a back up loan, you've got something else waiting to go. Another arrow in your quiver. Plan B. Your fallback position is defended. You're not going to lose the house and the deposit and the extra money to prolong escrow if you don't sign these papers right now. You're not going to have to choose between completely missing the lowest rates available since your grandparents were children and are now unavailable and paying $6000 more than you were told for your refinance. You're not hanging out there all alone at the end of the process after discovering that your trust was completely misplaced Here you have a solid, bona fide alternative. Imagine yourself with the ability to say, "No, I'll just sign the other papers instead." You'd be amazed at the leverage this gives you, with both companies if need be.



If you want to watch someone experience a truly amazing level of discomfort, tell your average loan officer or real estate agent that you're signing up for a back up loan with someone else. Most of them will say literally anything and do their absolute best to talk you out of it. I'll admit, even I would be momentarily nonplussed. I would hope that I would respond with "Okay. How do you want to handle the appraisal?" (assuming that it hadn't already been done) secure in the knowledge that I actually intend to deliver the loan I said on precisely those terms. You see, given the circumstances, I don't think you're doing anything wrong. If you asked me, I'd have to agree you were simply being prudent. Because until I actually put the final documents in front of you for your signature, there literally is no way for me to prove that I intend to deliver that loan on those terms. (There are a lot of red flags that if a consumer runs across them mean the loan officer isn't going to deliver the loan promised, but a competent loan officer can conceal them. There's also one thing that happens on every loan that looks like a big red flag, but isn't one at all). There's a lot of paper I can put in front of you that makes it look like I intend to deliver the loan I promised. None of it actually means anything in the way of a guarantee. At the present time, the only form or piece of paperwork that a loan officer cannot play games with is a form called the HUD-1 - and that doesn't come until the very end of the process. So until then, what you're really relying upon is the loan officer's good will to deliver the loan they signed you up for, on the terms you signed up for. Some fully intend to deliver the exact terms of every loan, and some will tell you anything to get you to sign up. Guess which the short-term dynamics of the marketplace favor. Here's a hint: If the loan officer can't get you to sign up for a loan, there's an absolute gold-plated guarantee they won't make anything.



If you shop multiple alternatives like you should for a mortgage, it's quite likely somebody is going to tell you that the best rate you've been quoted doesn't really exist, at least not at the level of closing costs indicated. That's your perfect opening. Ask them "So will you volunteer to be my back up loan?" They're going to try to talk you into going with them, of course, and forgetting that other guy, not to mention all this heretical, unheard-of, ridiculous nonsense about back up loans. Disregarding the fact that a back-up loan gives you leverage over them, a way to force them to actually deliver what you sign up for or something similar, they want you to put money in their pocket and not the other loan officer's.



Not too long ago, I had one of my clients tell me that somebody had told her I wouldn't be making anything if I delivered the loan I promised. "Okay," I thought, "She has a fair enough concern. There's no way for her to know I actually intend to deliver this loan, and certainly no way real way to prove it until the HUD 1 is ready at signing. Just because it's me doesn't mean anything to her until I've actually got the track record of delivering what I quote." Keeping this in mind, I told her something consistent with what I'm telling you right now. Offer to do the loan documents to make the other guy her backup if he was that certain - if he was wrong, the only cost would be that his work would be uncompensated, something loan officers get used to, and if he was right, he'd be right there ready to close his loan and get paid. (The other loan officer declined. She ended up with my loan - on exactly the terms quoted at time of lock).



Indeed, in my experience, it is more likely that the person who tells you something isn't real may well be telling you the truth. Getting angry at them is about like getting angry at someone who's trying to prevent you from being conned. The constructive response is to make them your back up loan. This doesn't mean that the person who gave you the best quote necessarily doesn't intend to deliver. They could just be comfortable making less per loan than the competition. And this doesn't mean you shouldn't get back to the guy who gave you the low quote with some pretty pointed questions, including the information that you're signing up for a back-up loan. Make the calls and stick to your guns. Maybe you'll end up signing up with the second guy as a primary and find a different provider for your back up. It'll depend upon factors I can't see from here. But find the back uploan, if you can. If you can't, it likely means that the guy who quotes you the lowest rate is quoting you something that at least exists, and he could potentially deliver if he actually wants to. But there is no way to prove he wants to. Which is precisely the reason you need the backup.



Word to the wise: Do follow up on both loans. Sign the application documents for both loan officers; provide your copies to both of them. And make certain, to the extent you can, that both loan officers are actually doing their work. The backup loan is useless as leverage if it's not actually ready to go at about the same time as the primary. (This is one indicator as to which of the two loan officers knows what they're doing. It has happened that on the last day to sign and still fund within deadline, I had my back-up loan ready to go, and the primary loan officer didn't have theirs ready despite a head start. So I suppose I can't prove the other loan wasn't real - but it sure wasn't ready on time, and that's unreal enough to be another reason why you want to apply for a back up loan!



Caveat Emptor



The scope of the problems that exist in the United States Mortgage market are huge. Enormously, mind-bogglingly, "How Big Is Space?" type huge. Yet, the problems are almost entirely on a retail level, when one provider works with one consumer. The system works, and it works extremely well. Consider:



Most consumers in Europe or any other country in the world would trade their loans for yours in a heartbeat. Rates there are typically around nine percent or so. Here, that's a ratty sub-prime rate. Mexican rates start at about fourteen percent. Hard money lenders here can sometimes do better than that.



No matter where you are in the United States, you have ready access to home loan capital. It's considered almost a one of our inalienable rights. Due to our secondary markets, as long as you can meet some pretty basic guidelines, you can find somebody eager to lend to you. You can find very long mortgage terms and very short terms. You can find loans without prepayment penalties, and you can choose to get a lower rate by taking a prepayment penalty. You may end up with something that's not as good as someone else if their situation is better, and the lender wants more money to compensate them for the risk of your loan, but even so, the rates here are better than almost anywhere else in the world.



Consumer protections are also better here than almost anywhere else in the world. There are federal laws that give you time to call off a transaction if you change your mind, disclosure requirements, consumer protections against builders with teeth in them, and a tort system that, if it does go overboard some times, still gives you an excellent chance at recovering what unethical people took from you. Many states (California, for instance) go well beyond mandatory federal consumer protections.



So keep this in mind when you see me ranting on and on about the problems with our financial markets here. Consider a capital market willing to loan the average person several years worth of wages. I can get a family making $6000 per month a loan for nearly $400,000 on an A paper 30 year fixed rate basis - most expensive loan there is in the most favorable, hardest to qualify for loan market - no surprises, no prepayment penalties, no "gotchas!" of any kind, and I can do it without hiding or shading the truth in the least. That's more than every dollar they will make for the next five years, and this family is every bit as chased after as the richest person in the world (more actually, because there are more of them). When you stop and think about it, that's a pretty wonderful situation. For all of the rants I make, the unethical things that happen, and the problems that exist in our capital markets, they are pretty damned good, and have chosen a set of tradeoffs that appears to be working better than anywhere else in the world, at any other time in history.



Caveat Emptor



The easy, general rule is that legitimate expenses all have easily understood explanations in plain english, they are all for specific services, and if they are performed by third parties, there are associated invoices or receipts that you can see.



Let's haul out the Mortgage Loan Disclosure Statement, and go right down them line by line. Now, to be certain, it's the HUD 1 form that's really definitive, but if it's not on the earlier form it shouldn't be on the HUD 1.



Origination is not a junk fee. It can be excessive, but it is a real fee to pay a real service. Relating to this is Yield Spread on the HUD 1, which is what the lender will pay the broker for a loan on given terms. Origination plus yield spread plus line 808 (Mortgage Broker Commission) is what the loan provider makes if they are a broker. If they're a lender, they make a lot more, and they can hide it more easily. Yield Spread and Origination and Broker's Commission are disclosed on the HUD 1, while the price on the secondary market is not disclosed anywhere, and if you're talking to a direct lender, they don't have to disclose Origination or Yield Spread because there (usually) isn't any; they are paid directly off the premium the loan sells for in the secondary market. This is why I keep telling people to shop for loans based upon the terms to you. If you evaluate it on the basis of loan provider's compensation, a broker who has to disclose compensation of $4000 is going to look like a worse bargain that the direct lender who does not apparently make anything but turns around and sells your loan for a $25,000 premium. In this example, the broker's loan is likely to be about a point and a half to two points cheaper to you, but if you evaluate it on the basis of who has to tell you how much they make, you lose.



Loan Discount Fee is the fee you pay in order to get an interest rate lower than you would otherwise be offered. It is not junk, but you probably don't want to pay it, as most folks never recover the money they pay to get the lower rate via the lower payments and interest rate charges. I never pay discount points for anything except a 30 year fixed rate loan that I'm going to keep at least ten years.



Appraisal Fee is not junk. There is an appraiser who needs to get paid for doing the appraisal. Many times this gets marked PFC on the MLDS/GFE, to make it look like a given loan provider is cheaper than they are. Make no mistake, there's going to be a figure in the range of $400 associated with it eventually, but because it's performed by a third party, the loan provider can (and often does) pretend it doesn't exist as part of the charges until you have to pay it.



Credit Report is not junk. It's not free to run credit, you know.



Lender's Inspection Fee is usually (not always) junk. You're paying the appraiser. If you're smart, you're paying a building inspector before you buy, and the lender usually makes you do it even if you don't want to. Every once in a while, there's a home with a documented pest or structural problem that the owner wants to refinance, and that's where this comes in as non-junk.



Mortgage Broker Commission/Fee: Is all a part of how the broker gets paid. Around here it's origination and yield spread, but this could be part of what a broker gets paid. Origination plus Yield Spread plus this line is the total of what they get paid. If these are larger at closing than when you signed up, that's par for the course most places, unless they guaranteed their fees up front in writing. I do it. I know one other company that does it. Those who are members of Upfront Mortgage Brokers guarantee the total of the items that are their fees, but not the rest of the form. For anyone else, they can and most will change the numbers on these forms within very broad limits (and to illustrate with an example someone recently brought into my office, the difference between one quarter of a point and three points on a $450,000 loan is over $12,000).



Tax Service Fee is not junk, unfortunately.



Processing fee is not junk but it may be negotiable. When it's imposed by the lender, it's not. When it's imposed by the broker, it's to pay the loan processor, which may be negotiated sometimes. It is a real fee, however.



Underwriting fee is real. Lenders charge it to cover paying the underwriters.



Wire Transfer Fee is real, because it costs money to wire money. If you don't need it, don't get it.



Prepaid Interest (line 901) is definitely not junk. This is interest, exactly the same as you're going to pay every month of your loan.



Mortgage Insurance Premium is not junk but is avoidable.



Hazard Insurance premiums are not junk, either. This money is to put a policy of homeowner's insurance (or renew an existing policy) on the property.



County property taxes are not junk, either. Rats. If you buy during certain periods of the year (e.g. April through June in California), you'll need to reimburse your seller for property taxes they already paid.



VA Funding fee is charged by the VA on VA loans only. Not junk, but if it's not VA, it doesn't have this. As I remember, if you're 10% or more disabled this can get waived.



Reserves deposited with lender are not junk, either. They will be used to pay your fees as they become due.



Title charges: Settlement or Closing Escrow Fee is a real charge to pay the escrow company. Like Appraisal fee, this is often marked PFC, but something like $500 plus $1 per thousand dollars is common.



Document Preparation Fee is mostly real, and actually the lenders do most of it these days. When the title or escrow company need to do it, they will charge fairly steep rates (I've seen $200 for a single sheet document), but you are kind of a captive audience unless you discuss it beforehand.



Notary Fee is to pay the Notary. It's real. It often falls into the PFC trap, previously discussed for Appraisals and Escrow, but you really do need this stuff notarized. Sometimes you can save some money by finding a less expensive notary, but this can bring up other issues, like getting everyone to the same place at the same time.



Title Insurance is real. If it's a purchase, there will actually be two policies of title insurance purchased, one for the new owner and one for the lender. This insures against unknown defects in the title of your property, and yes, title claims happen every day. Lenders won't lend without one. Title insurance is another one of those third party fees that gets marked PFC so that less scrupulous loan officers can appear to be less expensive than their competition.



I'm going to mention subescrow fees here, even though they aren't preset onto the form, and are not only junk but also avoidable if your agent did their job. The title company charges them because they are usually asked to do work that is, properly speaking, the realm of the escrow company. But if you choose a title company and escrow firm with common ownership, they will likely be waived.



Government Recording and Transfer Charges are not junk. They are charged by the county, and they are not avoidable, nor should you want to. Recording fees and tax stamps (if applicable) are just part of the cost of doing business. Beware of one provider pretending it doesn't exist while another honestly discloses it.



Additional Settlement Charges. Pest Inspection is the only one on the form, and it is not junk. You want a pest inspection.



Now, you'll notice that of the permanently etched items on the form, there's not a lot of junk, but everybody keeps talking about high junk fees. What are these, and where are they?



Well, some of the things that people talk about as junk fees aren't junk fees. These are fees like Appraisal fee, escrow, credit report, notary, etcetera. These are, incidentally, half or more of the closing costs for most loans. They may have been hidden from you on the initial form, but they're not junk. They are essential parts of the process, and if you don't see explicit dollar values associated with them, somebody is trying to lie about their fees by not telling you about all of them.



Nonetheless things that really are junk fees are a real problem, but the reason they're not among those listed on the form is that the items listed on the form are mostly real. It's the extra stuff that gets written into the extra lines that you've got to watch out for. It is fine and legitimate for a loan officer to write "Total of lenders fees $995" or whatever it is. On the HUD 1, these should be broken out into separate charges, but this way the loan officer only has to remember one number. As long as they add up correctly, no harm and no foul, and it doesn't make any difference to you whether it's underwriting or spa visits for the CEO, it's part of doing business with that lender. What is probably not legitimate is to start writing all kinds of other fees. Miscellaneous fees. Packaging fees. Marketing fees. Legitimate Messenger fees should be something you know about because you need them at the time they happen. But the majority of messenger fees are the title/escrow company trying to get you to pay for daily courier runs that happen anyway. If you choose the right title/escrow combination, you should be able to avoid them in most cases.



It is also a common misconception that all junk fees are lenders junk fees. I don't impose junk fees on my clients, but even coming into situations other loan officers have left behind, title companies and escrow companies, in general, appear to impose about an equal amount in junk fees with most loan providers.



Caveat Emptor.

No matter which provider, no matter what type of loan you get, nobody is going to loan you money without the appropriate documentation. The more documentation you have that you are a good risk, the better the rate you are going to get, and the lower your costs are going to be.



Everybody hates filling out forms and providing documentation. There's a billboard two blocks from my house advertising, "Stress free loans." Actually, these signs are all over. And I'll bet they bring in a lot of business. Low documentation loans are easy money - I could do them all day and all night, and make more money, and make the lender more money, while doing less work, than I can by hunkering down and actually serving my clients best interests. Those billboards say "stress free loans" which three words look like an English sentence meaning this will be easy, but the real translation to English reads, "Hello, I am a lowlife scum who wants to take advantage of lazy people who are too ignorant to know better by making a lot of money providing loans at higher interest rates and less favorable terms than they could obtain elsewhere."



The fact is, that for something dealing with this much money, if there is documentation you can produce to prove that you are a better risk and gets you a better rate, you should be eager to present it. If I can spend half an hour instead of fifteen minutes filling out forms and as a reward I save $40 or more every month until the next time I decide to refinance, I want to fill out the extra papers. If I refinance every two years, I have essentially been paid $960 for a quarter hour of work. That works out to $3840 per hour. I don't know about you, the reader, but even when I'm completely inundated with clients, I don't make that kind of money per hour. I don't know any job that pays that much, unless you want to include wealthy investor. And let me tell you, the wealthy investors I've dealt with are eager to spend the extra time filling out said forms. It really is a "Rich Dad, Poor Dad" situation. They know it will Save Them Money, and don't have to be sweet talked into filling out one more form or providing a little more documentation. They've got it already copied for me, and if I want their business, I'd better buckle down and get to work on finding the loan with the best terms possible. If you, the reader, wish to be wealthy, you could do worse than emulate their example.



There are, when you get right down do it, three different levels of documentation. The lowest level of documentation is NINA, which is short for "No Income, No Assets." There are other names for it ("No Ratio" being the most common). This is a loan where the rate you get is purely driven by your credit score (as well as other factors, such as the equity in your home or down payment you're making, but those are constants endemic to the situation, not variables about which I am talking). You're not even documenting that you have a source of income. You're basically saying, "Here I am! Gotta love me!" to the bank, and they really do love you because you're filling their coffers by paying the highest rates for your loan. Guess what? You're still filling out all the forms (or somebody is doing so on your behalf, which they can do to the same extent on other loan types!), and you're still providing all the documentation on the property - how much it's worth, proving you own it, proving the taxes are current, etcetera. Owing to identity theft laws, you can expect to have to provide two things that basically show that you are you. You can expect to deal with problems if the county doesn't show the taxes as current, your landlord or current mortgage holder shows you as being behind or that you have a history of being behind or the county doesn't show you officially in title of record, or any of a host of other potential problems, but hey, at least you didn't have to show that you've got a source of income!



The next level of documentation is a "Stated Income" loan. This is where you document that you've got a source of income, but not that said income is sufficient to justify the loan, so you tell the bank you make that much, and they agree not to verify the actual numbers. This is going to require two additional items: verification of employment, or a testimonial letter if you are self-employed, and reserves. Reserves are quickest to explain. Industry standard is money sufficient to pay the loan, your taxes, and your homeowner's insurance for six months, in a form that is sufficiently liquid such that the money can be accessed, for a long enough period that the bank will believe it isn't borrowed - and the bank will require documentation of its availability if it's in an account type such as 401k where access may be restricted. Verification of your employment is somebody in the HR department filling out a form on your behalf and verifying it over the phone. The testimonial letter for self-employed borrowers comes from your lawyer, accountant, or tax preparer on their letterhead saying that you really do have a legitimate business. It basically reads: "To whom it may concern. John Smith is self-employed as the owner of business X. He has been doing this for Y years. Based upon information provided to me, he will earn the same amount of money this year as last year." The person providing the testimonial must sign the letter. It really is only three sentences, but that person is putting their business on the line for you if it's not true. So they tend to require evidence if you're coming to them for the first time to get this letter written and signed.



The bank is basically looking for two years in the same line of work or at the same company to approve this one. Sub prime lenders may take a year or even six months, although their terms will not be as favorable. What the bank is looking for is evidence that you can really afford the loan. The thinking goes like this: "He's got a source of income, He's got a good credit score, he's making all his payments, he's got money in the bank, okay, we think he's living with his means and can afford to pay us back. We'll lend him the money." There are variants on stated income of which "stated income, stated assets" is the most common, but these carry higher rates, higher charges, or both, in many cases actually end up looking more like a heavily propagandized NINA loan than anything else.



I've heard Stated Income (and NINA) commonly referred to as "liars loans", and they are often used for such, but that is not their intended use. As a matter of fact, people get in a lot of trouble with these loans, and many times it comes back on an unscrupulous loan officer or real estate agent trying to push something through for which their clients really aren't qualified. If you can't afford the payment, am I really doing you a favor by qualifying you for the loan? I submit that I most emphatically am not. I'll admit to having used the loans for that purpose in the past, but an ethical loan officer using it for this purpose should sit down, tell the people what the real payment is going to be, and make certain they can afford it - sometimes they're renting and their effective cost of housing is going to go down! And in that case, I submit that I probably am helping them if I push the loan through. On the other hand, if you're doing Stated Income or NINA (especially on a purchase) and the loan officer doesn't sit you down and cover what the payment is going to be within a couple dollars per month, and make certain you're okay paying it, this is a red flag in no uncertain terms!



What Stated Income is meant for is self employed people and people working on commission who really do make the money, but have write-offs such that their taxes aren't going to show enough income. Or people who had a bad year, or large losses or high write offs one year, but are still basically solid.



The highest form of documentation is Full Documentation (almost everyone says "full doc" because the unabbreviated phrase is a mouthful). This does not necessarily mean I've got to prove to the bank that you make every penny you actually make, but only that you make enough to justify the loan. The proof the bank will accept is very straightforward. Self-employed borrowers are still going to need that testimonial letter from stated income. They will additionally be asked for their federal income tax packet. This is all of the forms, front and back, that you sent to the IRS last April 15th, and perhaps the April 15th before that, too. It's got to be a signed copy, and it must include copies of any w-2s or 1099s that you get. People in the construction profession, as well as those who may be w-2 employees but work on commission will also need to furnish their taxes, and the bank's underwriter can always require it of anyone. It is to be noted that banks do not have to accept your loan on a stated income basis - they can require that you furnish full documentation.



Those people who are hourly or salaried employees of a company can usually get by the full documentation of income requirement with just w-2 forms. If you are a company employee, the last 30 days worth of pay stubs will also be required.



The basic rationale for this is simple. Very few people tell the IRS that they make more money than they do, because the consequence is higher taxes. So the bank is willing to use tax forms to prove your income. In the case of a w-2 employee, the company is telling the IRS that those are the wages it paid you, and therefore wants a deduction for, and you went and paid taxes on it, so the bank will usually accept that. Similarly, your pay stubs should have year to date pay on them. Here the bank will accept the word, metaphorically speaking, of a third party without a stake in the outcome of the loan.



A subset of the full documentation loan is the streamline refinance. As the name indicates, it is available on refinances only, not purchases. There are a lot of limits on these loans, but when I get to do one it is the easiest of all loans. Basically, it's a case where the same lender is now offering better rates, and no equity is being taken out of the home, and they'll allow you to do it because otherwise you'll take this client elsewhere. 90 percent of a loaf is much better to them than none.



Within the sub-prime mortgage world, they will often take the deposits from 12 consecutive months of bank statements (sometimes 6 or 24), usually discounted by a certain amount, and accept that as proof of income. This is called Lite or EZ doc, although there's nothing easy about it and as a matter of experience there are more fights with the underwriter and jumping through hoops here than with any other type of loan documentation. The rates are somewhat higher than for full documentation, but not nearly the rates for stated income. Mind you, sub-prime rates are higher in the first place as well. Furthermore, many of these sub-prime lenders will advertise the fact that "EZ doc rates same as full doc!" I shouldn't have to explain to adults that this translates to English as they don't give the lower rates to true full documentation loans, now should I?



So, on the subject of documentation, I think you should be able to tell that the higher the quality of your income documentation, the lower the rate that you are going to get from a given lender. If you can qualify, a full documentation loan is probably going to save you more than enough money to pay you to do the extra paperwork, which is marginal anyway. The only reason not to do one is if you can't supply requisite proof.



And as one final warning: If a loan officer requires originals not only of the forms they ask you to sign (A couple of the standard forms require original signatures - really!), but of your own documentation, it is a BIG RED FLAG. I can't think of any document that lenders will not accept copies of. The only reason to require your originals is that loan provider does not want you able to apply for a loan with someone else, so they're putting an end to your shopping, and once they've got them, good luck trying to get them back (at least until the loan is done so they get paid). A good loan officer needs good readable copies - not your originals.



Caveat Emptor!


There are actually several distinct marketplaces consumers can obtain their funds from, and several types of providers. John the wealthy highly salaried person with great credit and a substantial down payment should not and usually does not obtain his mortgage from the same funds providers as his twin brother Jim, the self-employed, always-broke person with terrible credit and no down payment. They may deal with the same employee at the same business, but the funds and parameters for using those funds, are entirely different.



In order to make sense later on, I've first got to acquaint you with two concepts: yield spread and pre-payment penalty. The yield spread is what then lender pays the person or company who does the paperwork for your loan in order to give them an incentive to choose that lender, loan type, and rate, as well as any of several other reasons. The yield spread is based upon the rate of the loan, the type of the loan, and other factors as well.



Prepayment penalty is a penalty you agree to pay if you sell your home or refinance before a certain period of time has passed. Industry standard is six months interest, with some lenders making this 80 percent of six months interest. Usually (not always) they will let you pay a certain amount over the normal, agreed upon principal per year without triggering the penalty, but if you sell or refinance out of their loan, the penalty is always triggered for the duration of the penalty. Some lenders will actually phase it out in stages, although this is not common.



Lest it be not plain to you, a prepayment penalty is a thing to avoid if you reasonably can. Let's say you get transferred and need to sell the house in six months, and that you have a $200,000 loan at 6%. That's six thousand dollars less that you will receive from the sale of your home, not to mention that the average person refinances every two years, which is typically the shortest pre-payment penalty. If you need to refinance within two years, that's six thousand dollars of your equity gone for no good purpose. Mind you, if you need the loan, and it gets you the loan, so be it. It's still a thing to avoid.



The top of the food chain from the point of view of consumers are the so-called A paper lenders. This market is controlled by the two federally chartered giants, Fannie Mae and Freddie Mac. Lenders who participate in these markets lend in full accordance with Fannie Mae and Freddie Mac rules, because they want to be able to sell the loan to them. In many cases, they actually do sell them seamlessly by retaining the servicing rights, and the consumer never knows they have done it. In others, they retain the loans entire, and in still others, they sell them off entire. They do this for many reasons, but mostly to raise cash so they can do more loans. In any case, the only difference it should make to you, the consumer, is where to address the check and who to make it out to. Unlike the other markets, if the lender pays a yield spread in this market it does not automatically mean that there will be a pre-payment penalty. Although they will pay a higher yield spread if the loan officer sticks the client with a pre-payment penalty (and the longer the prepayment penalty is, the more they will pay). WARNING! Many loan officers will not tell you about it unless asked ("Why bring up a reason not to choose your loan?" is a direct quote I've heard any number of times) and some will flat out lie even if you ask. This is not ethical, but they know they can almost certainly get away with it. There really is no reason why an A paper loan should have a prepayment penalty, except that a loan officer wanted to get paid more.



It is not difficult to qualify for an A paper loan. As long as you're not taking equity out of the home, they can go through with credit scores as low as 620 (full documentation) or 660 (stated income), although there are caveats. Despite what you read in Internet pop-ups, according to National Mortgage Reporting a 660 credit score is more than forty points below the national average. So even someone with modestly below average credit can still qualify for an A paper loan. There are minimum equity requirements, however. And it doesn't matter if you are King Midas who has never failed to pay a bill immediately in full or someone who barely staggers over the line into qualification by the computer models put out by Fannie Mae and Freddie Mac. This is it. The top. You all have the exact same rate choices. There is nothing better.



The next market below A paper is called A minus. The rates are a little bit higher, and there are prepayment penalties anytime the lender pays a yield spread. Then comes the so-called Alt A, which are typically loans for fairly unusual circumstances. The credit scores here go down to about 580, although there is less standardization. The worst, most dangerous, absolutely awful loan in the world comes from the "Alt A" world. There are all kinds of friendly sounding names for it, like "Option ARM", "pick a pay", and such things, but they are all negative amortization loans at their heart - you end up owing more than you borrow. They sound benign: "pick your monthly payment!" But in fact most people choose the minimum monthly payment which capitalizes and then amortizes more money into your loan every month. Every single one I've ever heard about carries a prepayment penalty. I see adds for these abominations every day all over the internet. If anybody quotes you a mortgage rate below 3%, or a payment that seems too low to be true, I will bet you millions to milliamps they are trying to sell you one of these (despite the fact that there are other loans out there below 3% right now). There are still loan providers out there that do nothing but these - they're easy to sell to unsuspecting victims because the minimum payment is so small, and most people shop for a home loan based upon payment. There really isn't space here to go over everything that's wrong with them (or where they may be appropriate), but except in certain special circumstances, RUN AWAY! And do not do business with that person! They have just proven themselves unworthy of your business.



(Every so often, a representative from a new lender walks into my office. I'm always glad to talk to them so long as they answer my questions in a straightforward way, but I have one inflexible rule. If the first thing they talk about is a Negative Am loan - no matter the happy sounding name they call it by, I throw them out and do not allow them to return. I think it indicative of the state of things in the Negative Am world that the one time I had a client who would actually benefit from this thing, and I took the time to tell him exactly where all of the traps I knew about were, give him strategies to turn it to maximum benefit, and he agreed that he wanted to do it - not one of the five companies I tried would actually approve the loan.)



The final niche that comes from regular lenders is called sub prime. And in the world of sub prime lending you can do a lot of things that higher rungs on the ladder will not allow you to do. As in A minus or Alt A, anytime the lender pays a yield spread there will be a pre-payment penalty, and I think I've run across exactly one sub prime loan that didn't have a prepayment penalty in my whole time as a loan officer. However, the people who subsidize sub prime lenders just don't have a whole lot of choice. This is typically the only way they're actually getting a home loan, be it because of low credit, low equity, or what have you. The rates are high, but it's that or nothing. Sub prime loans are very lucrative - the average lender or broker specializing in them usually makes about 5 points - 5 percent of the loan amount - on each and every loan. I've had people thank me so profusely I was almost embarrassed when I got them a loan on something more closely resembling a typical margin from higher niches. The lines between A minus, Alt A, and sub prime are blurring more and more as time goes on. It is to the point now where if someone says they do sub prime, that usually means Alt A and A minus as well - it's just a matter of where on the spectrum a given client sits.



The final niche is Hard Money. These are not typical lenders, in fact, they have almost nothing in common with traditional lenders. They are agents for individual investors, sometimes even loaning you their own personal money. The rates for this start an absolute rock bottom of about 13 percent, and go up from there. Typically there will be a front-end charge of about 5 percent of the loan amount, and a prepayment penalty of about 7%. These are loans for people with sub 500 credit scores, people with homes that have been damaged in some way and must make repairs before a regular lender will touch the property, and so on and so forth. The equity requirements are large - 75 percent of the value of the home based upon a conservative appraisal is about the highest a hard money lender will go, and most are less. Lenders in markets higher up the chain are in the business of making loans, and are likely to cut you as much slack as practical if you have some difficulty making payments, as they are not in the business of foreclosures. A hard money lender has no such constraint. They will foreclose on your home immediately and without a second thought. One way or another, they will get their money back and then some. WARNING! It is common practice on the part of hard money lenders to have you sign the Note and Deed of Trust "conditional" upon them finding an investor. The person signing the documents thinks the loan is done, and that their situation (usually a time critical one) is resolved, and everything is all roses now, but it isn't. They may still want you to pay for multiple appraisals, jump through multitudinous hoops, and still not give you the loan in the end. This is just their way of binding you to them so that you don't or can't go elsewhere. Not that this is completely unknown in the higher niches (in fact, some lenders market their services to real estate agents and brokers based upon this practice - people who are true loan officers learn that this is not a good idea), but it's not common, as it is here.



There are three main types of places to go to get a loan. The first is a regular lender. The second is what I call a "packaging house", although in practical terms it is very similar to a regular lender. The third is a broker. Each has their advantages and disadvantages.



A regular lender is what you think of when you think of a bank. Most of the big names are regular lenders. They typically have their own offices, often mingled with other banking functions. They have their own funds, wherever they've gotten them from, and they have executives and such that put together their own loan programs, complete with criteria for approving or not approving a given loan. These people do loans with at least the possibility of keeping them in mind, and some do keep every loan they do, while others sell almost every loan. The good news is that they'll typically be slightly more willing to make exceptions around the edges (whether or not the loan is a good one for you!). The bad news, from the consumer point of view, is that they consider you a captive from the moment you walk in the door. Even if they know of another lender with better pricing or a program that suits your needs better, they're still going to keep you "in-house". And their loan pricing is such that it's going to pay for all of the salaries and benefits for all of the people in the office, and the beautiful office itself and all of its contents.



A "packaging house" is like a regular lender except that they do their loans with the explicit intention of selling off every single one, either immediately or a few months down the line. Practical difference to consumer: there's a 100% chance you're going to end up making payments to someone else. In other words, no big deal. Packaging houses are lending their own money - they are not brokers. The difference is that a traditional lender is at least set up for long term servicing - the packaging house is not. Some sell immediately, some wait for one payment (better price in the secondary market), some wait three payments, as this gets them an even better price when they sell the loan. This is nothing to fear. The original lender recently sold my own home loan. The only difference is that now I write the check to company B instead of company A, and mail it to place X instead of place Y. California has stronger consumer mortgage protection laws than the federal government, but there are laws in place nationwide for the consumer's protection that avoid payments being unjustly marked late because your mortgage was sold.



A broker is not lending their own money, but is being paid instead to put the loan together and get it to the point where it is funded, at which point they are out of the picture. A packaging house could, in theory, decide to keep a particular loan - there is no legal impediment. They just don't do it. A broker doesn't have this option - it's not their money being loaned, but instead that of a regular lender or a packaging house. On the down side, a broker has somewhat less leverage to get underwriters to make exceptions to the rules (although the difference is academic for those outside this narrow range). There is also a lot of variation on quality. You'll find the very best loan officers in the country working as loan brokers - and the very worst, as well. On the up side, a broker always has at least the ability to get you a lower price than the other alternatives, although they may not have the willingness.



The first reason for this is that a good broker shops many different lenders to find the program that's priced best for you. This is less important but still very noticeable at the A paper level (A paper had pretty standardized rules) then it is for borrowers whose situations (either through credit, or through needing to do something A paper doesn't support) need to go to markets lower down on the totem pole. A traditional lender or packaging house puts you in the program they have that they feel is the best fit - they won't go outside the company. A broker may shop fifty lenders or more to find the one program at the one lender that fits you best. Second, I (as a broker) get better pricing from the lenders, either regular or packaging house, than their own loan officers. Why? Partially because they're not paying my support expenses - office rent, furnishings, support staff salaries, etcetera. Mostly because it's my customer, and I can and will take my customer elsewhere if they don't give me the best possible deal. As a broker, I am never held captive by any single lender, and they know it, and they know I know it, where once a member of the public walks into their office, they consider you "captive" business, whereas at any point in the process, I can take my paperwork back from the lender and take you to someone else. Most times, I don't even need you to fill out anything new. So they give me better pricing than they give you, and they don't play games because I've got more business every week that they want, whereas they're not going to see you again for a couple years, if ever. The upshot is: every week when I do the family shopping, I hit three or four supermarkets all competing for my business withing a mile and a half from my home. Because of this competition, I can save pretty good money buying the things that each market has good sales on, and if the quality at one market isn't so hot on some sale merchandise, I will get a pretty good price at one of the others. Mortgage brokers work on the same principle. I do the running around and quality check for you, and because this is what I do for a living, I can spot the bad stuff a lot easier than you can. When I do my shopping, I always make a point of checking what the banks in the supermarkets are offering on their mortgage deals, and I always smile because I'm always getting somebody a better price on the same loan from that same lender.



Caveat Emptor.






do your property taxes go up in California when you refinance your property


This is one of those urban legends. People are concerned that because the house is appraised by the lender, the assessor is somehow going to find out that their property is worth more and send their tax bill soaring.

However, thanks to Proposition 13 in California, the formula for property taxes has little to do with what the home is really worth. The formula is based upon the purchase price plus two percent per year, compounded. If you can document that your home is worth less than this amount, contact your county assessor's office. But if it's worth more, they cannot increase it beyond this number.

Indeed, certain family transfers can preserve this lower tax basis. Mom and dad deed it to the kids, and the kids keep paying taxes on it based upon a purchase price of perhaps $60,000 (Plus thirty-odd years of compounding at two percent, so maybe $115,000) when comparable homes may be selling for $600,000.

There are two major exceptions. First, a sale. If you sell it to someone else, then repurchase, you don't get the old tax basis back. Second, improvements. If you take out a building permit, the assessor will add the current value of your improvements to your tax bill. This can, in situations like the previous paragraph, result in a tax bill that literally doubles if you add a room. Indeed, this is one of the main reasons for the growth of the unlicensed contractor industry, because licensed ones have to make certain the permits are in order, and homeowners are trying to sneak one over on the county. This is why a very large proportion of properties in MLS have the notation that "this addition may not have been permitted." They know good and well that the addition wasn't permitted, and quite likely isn't to code, either. If it's built to code, subsequent owners can get forgiveness as innocent beneficiaries who bought the house like that, and so the purchase price included the value of that room (and occasionally, the state finds it worth its while to go after the previous owner for back taxes and possible penalties, and I believe that the incidence of this will likely increase dramatically in the next couple of years). If it's not built to code, however (an offense unlicensed contractors often commit), the subsequent owner can be looking at a large mandatory repair bill, or perhaps even demolishing the addition they paid for if the county inspector deems it unsound. You want to be very careful about properties with the "addition may not have been permitted" disclosure.

Other states, by and large, still follow the assessment model California used to follow, pre-Proposition 13. They have county records of the property characteristics, and evaluate the home based upon those characteristics, whence comes your assessment, and hence, your property tax bill. This still encourages unlicensed contractors and working without required permits, with effects much the same as the previous paragraph, which is definitely not good, but in this case subsequent owners have nothing but incentive to keep improvements off the county books, where in California, subsequent owners have motivation to want improvements updated into county records. I am not aware of any state which follows a model whereby refinancing will alter your tax bill.

Caveat Emptor

I recently went to a "direct from the providers" seminar on credit reports and credit scores.



Some of this information has changed from previous information, and some of it will change in the future. Credit Reporting, FICO scores, and related items are an evolving knowledge, as they figure out how to more perfectly predict future performance of potential debtors.



A FICO score is nothing more or less than a prediction of the likelihood of a particular consumer having a 90 day late in the next 24 months. It is a snapshot, based upon your position and your balances as reported at the exact moment it was run.



I learned a bit more about the various other credit reports besides mortgage. They emphasize different things (naturally) and score differently. Auto scores go to 900, where mortgages range 300 to 850. Landlord tenant screens are different from a mortgage score. Revolving credit screens are different than mortgage screens. Finally, and most important, the "Consumer Screen" reports you get on yourself will always have a higher credit score than the ones mortgage providers run.



Inquiries are 10 percent of your credit score. They only go back twelve months. Whereas I've been informed in the past that additional inquiries will get you zonked, that is not the case currently. Depending upon your length of credit history, after three to five "hard" inquiries in the last twelve months, they quit counting. now. A hard inquiry is done at your request for reasons of granting credit. Fewer is better. Longer history of credit means they will allow you more inquiries.



Mortgage inquiries, if done within the correct time frames, still only count as one, no matter how many. Automobile inquiries also count differently than other inquiries.



Types of credit used is 10%. They're looking for a reasonable balance between types. The absolute worst type of account to have is from one of those zero interest finance companies. You know the ones, "Buy this sofa now and no payments and no interest for twelve months." People who are broke but need or want stuff now do this, and that's why the hit happens. They are deferring payment. You suffer guilt by association.



15 percent is length of credit history. How long you have had revolving accounts divided by the number of revolving accounts you have had. You have three cards that have all been going for thirty years, that's a better picture than five cards of which four are brand new.



I've been telling people not to close open accounts. This is confirmed as not a good thing to do. Closing an open account can cause your credit to drop by as much as 80 points in some circumstances. If it doesn't cost you anything, don't close it.



Balances is thirty percent of your score. There are significant hits at fifty and seventy five percent of your credit limit on each card. Significantly, a small balance is a little bit better than zero, even. This is one reason you want to charge something you'd buy anyway to your credit card, just make sure you pay it off when the bill comes. Some credit cards (specifically charge cards in particular, not to mention any specific names of charge card companies where the balance is due in full every month) will report your high balance as being your limit, which can have the effect that you appear to the reporting agency as "maxed out" if you've charged something big. So make certain your credit limit is being accurately reported. If your balance is incorrectly reported, in general the only way to correct it quickly is with a letter from the provider, signed and on their letterhead, saying "Your balance as of (date)is $X"



Payment history is 35 percent of your score. This is divided into three categories: 0-6 months, 7 to 23 months, and 24 months or older. If you have had a delinquent credit reported within 6 months, you are getting the full impact in terms of lowering of credit score. Between 7 and 23 months is a lesser impact. Over 24 months is still less impact.



Important: DO NOT PAY OFF OLD COLLECTION ACCOUNTS! It can cause a 100 point drop in your score. Here's why. You owed $X to company A, and five years ago they sent it out for collection. Now you go back and pay it off, and the date it's marked with is TODAY. It's gone from being over two years old to being current as of now, bringing the full impact to bear once more. The one exception to this is a deletion letter. If you get a deletion letter on their letterhead signed by them saying "Please delete this account," you can make it vanish off your credit report as if it never was. Note that you may still have to pay off collection accounts, but do it as a part of escrow, where the loan is done before your credit is hit.



There are tools out there that can be used to analyze and tell you how to improve your score or how best to improve it with a given amount of money.



Bankruptcy: Three things determine what kind of credit score you'll have coming out of bankruptcy. 1) Percentage of trade lines you include in the bankruptcy. More is worse, lower is better. Including half your trade lines will not hurt you nearly so bad as including all your trade lines. 2) Number of inquiries. If you've still got one or two open lines you didn't include, you may not need more after discharge and you won't go apply for more. The poor schmuck who includes everything needs more to start a credit history, and is dinged HARD for each turndown inquiry. 3) Post bankruptcy payment history: if you included everything in the bankruptcy, you have no history until you get more credit. Can you say, "Vicious Circle," boys and girls? Knew you could. No payment history is even worse than a bad payment history, but any reports of delinquencies after bankruptcy hits you much harder than if you were never bankrupt and had a late.



Last individual points:



Rate on credit card does not affect FICO score.



Nor does salary, occupation, employment history, title, or employer.



Credit Repair Services cost a lot of money for things you can do for free.



If you are disputing a medical collection (only) it doesn't count on your score.



Finally, a note about a likely coming change. If you are a regular around here, you may realize what a hole negative amortization loans can be. There is a high likelihood that in the near future the fact that you possess a negative amortization loan will be counted heavily against you, score-wise. The reasons this change is coming is obvious: Your payment every month is not covering your interest charges. This is not a situation that can go on indefinitely, and it is indicative of someone who is likely to be in over their head.



Caveat Emptor

Why You Should Ignore APR

|

One of the things you get with every mortgage loan quote is an APR, or Annual Percentage Rate. There is even its own special form, the federal Truth-In-Lending (TILA) form.



This was mandated by congress back in the early 1970s as a way to give consumers some way to compare between competing loans of equal rate, and it is governed by Federal Reserve Regulation Z.



The problems with APR are threefold. First off, it is computed from numbers on the Mortgage Loan Disclosure Statement, which are often intentionally and legally under-stated. "Mis-underestimated," to use President Bush's famous phrase in an entirely different context where it is not a good thing. If the numbers on the Good Faith Estimate are incorrect, the computations that result in the APR will be similarly incorrect.



Here is a routine example, from an unfortunate soul I encountered awhile ago. They told him they were going to do his $230,000 loan for 3/8ths of a point and $1895, which works out to about $3400 total, APR was listed as 6.136 on a 6% loan when he signed up. But when the final documents were ready, the interest rate was 1/4 percent higher, the points were 2.25 points, and the closing costs were actually over $4000. Total cost: $9400 added to his mortgage, and the APR on final documents was 6.568 on a 6.25% loan. It stands out in my memory because I had been competing for his business, and offered to do a back up loan because I was certain the first quote wasn't real. He didn't want to do the paperwork for a back-up loan, but he came back to me during his three day right of rescission. Unfortunately, rates had moved up and by that point I couldn't do anything he liked better, so he rewarded the company who misquoted his loan (to use technical parlance, lied) by getting them paid. Unfortunately, you can't go backwards in time with what you learn at the end of the process. You need to be right the first time.



The second reason to ignore APR is that it is an attempt to compress what is fundamentally at least a two-dimensional number into a one dimensional number. Remember back in school when you learned graphing on a "number line" and then a Cartesian Plane? Which of them contains more information? The Cartesian Plane, of course. APR is an attempt to force a Cartesian Plane onto number line. In order to do it, you need to make some assumptions, and you still lose a lot of information.



The third, most important reason to ignore APR is that the assumptions that Congress and the Federal Reserve mandate were reasonably based on the reality of the 1960s, which has now changed. Back then, people bought homes they were going to live in for the rest of their lives, and re-financing was much less common. People are now living in homes about nine years on the average, and refinancing about every two years. But the regulation still reads that the costs of doing the loan, which are included in the APR calculation, are assumed to be spread out over the entire term of the loan, even with ARMs and hybrid ARMs, which almost nobody keeps after the initial fixed period. With the term of most loans being 30 years (some 40 now), and the average person refinancing about every two years, this computation makes absolutely no sense as it exists today. The costs of the loan should be spread over the period that the person getting the loan is likely to keep it, not the entire theoretical term of the loan.



Let us look at the earlier example in this light. Let's assume that it's a five year ARM, and compute APR as if he's going to keep it the full five years of the fixed period, rather than the thirty years he theoretically could keep it. The APR would have been listed as 7.067% on the final documents.



Let us go a step further and assume that instead of keeping his loan 5 full years, like less than 5 percent of the population, he keeps it for something close to the national median of two years, and compute APR based upon that. His final documents would have listed an APR of 8.293 percent.



To offer a better strategy: At the time, I could have done the loan at zero total cost to him - literally nothing. Zero added to his mortgage, he pays for the appraisal but is reimbursed when the loan funds - at 6.75%, APR 6.750 no matter how you compute. Yes, the payment is $17.75 per month higher than what he ended up with. But he wouldn't have added $9400 to his mortgage balance. Let's compare these two loans five years out, when 95 percent of the population has sold or refinanced and is no longer reaping the benefits of that payment that's lower by $17.75 per month. If he has the zero total cost loan I could have put him into his balance is $215,914.00, and he has paid $89,506 in payments. The loan he ended up with, he's going to owe $223,449, and he's paid $88,441 in payments. Okay, he's save $17.75 per month, about $1065 total, in payments. But he owes $7535 more. If he sells the property and puts it all in a savings account, he would have been permanently ahead by $6470 if he initially choses the higher rate, higher payment, but lower cost loan. Not to mention that he would get $7535 extra all at once, as opposed to little dribbles of $17.75 per month that most people would never notice. If he buys another house, or if he keeps this home but refinances, he owes $7535 less with the zero cost loan. Let's say he gets a really great loan next time, with a thirty year fixed rate of 5%. That $17.75 per month he "saved" on his payment for five years is still going to cost him $376.75 per year, $31.40 per month for as long as he keeps the new loan. This is what comes from relying upon APR as a valid measurement of a loan.



This is not nitpicking. The so-called 2/28 and 2/38 are the most common subprime loans nationwide. They are subprime hybrid ARMS with an initial two year fixed period. People get into them because they don't have the money for a down payment. With a dozen agents in my office, I can't tell you when the last time I saw a first time buyer who had the money for a down payment. Considering that they're all straining to buy as much house as they possibly can get a loan for, this means they're in the subprime market. According to SANDICOR figures I saw a while back, something like 40% of all purchase money loans locally in the last year being negative amortization loans which have no truly fixed period and are practically impossible to keep longer than five years with the best will in the world. Another thirty percent plus, according to SANDICOR, were interest only, so my estimate is that subprime lenders have at least eighty percent of the purchase money market locally, and probably fifty percent or more of the refinance market. With the vast majority of these loans being of the short-term variety as illustrated above, APR is worthless as a measure of a loan.



Caveat Emptor



P.S. Just as a parting shot, let us consider the above situation in the context of a fifteen year loan that, to be insanely generous to the $9400 closing cost loan, the gentleman will keep until he pays it off completely. APR for the $9400 closing cost loan: 6.779 percent. APR for the zero closing cost loan remains 6.750. That's not a typo, the loan with the higher rate has the lower APR. Payment for the $9400 in closing costs loan: $2052.67. Payment for the loan with higher rate but zero closing costs: $2035.29. That's not a typo, either. The higher rate loan has a payment that's $17.38 per month lower, because you didn't add $9400 to the loan balance that you've got to pay back.

Copyright 2005-2017 Dan Melson. All Rights Reserved

 



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This page is a archive of entries in the Beginner's Information category from April 2007.

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