Beginner's Information: July 2007 Archives
There are a fair number of specific helpful suggestions to make in helping you purchase a home. All of them revolve around the loan. Let's face it, the loan is far and away the most hypothetical and uncertain part about most real estate transactions. If there is a non-loan related problem, chances are that you really didn't want to buy that particular property anyway. Most of the time, these problems mean that you would be buying into trouble, and nothing but. Unless you have specialized knowledge in sorting out that particular problem, it's likely to be more expensive than any money you saved through reduced purchase price.
A poor loan officer can always botch a loan, of course, and even the best may not be able to push it through if you are a marginal enough case. So how do you improve your case standing?
The first thing is to get a credit score above 720. If you're there already, keep doing what you're doing. Even if you're not there yet, it's easier to improve than most people think, although it takes time. Make all of your credit payments on time, especially any mortgages and rental payments. These are the most important things to mortgage lenders. Note that you make a payment a few days later than it is due, and you may even pay a penalty, but the lender will not report it as late until 30 days later, and that's when it counts as late to everyone else. In order to qualify for the A paper loan, at the top of the market, the general rule is no more than two 30 day late payments on revolving debts within two years, or one 30 day late on mortgages or rent.
Most lenders want you to have three lines of credit, and a twenty-four month credit history. Not all of them need to be still open, but if you don't have at least two open lines of credit, a given reporting bureau may not report a score, and if you don't have two different scores from the three big bureaus, only a few sub-prime lenders will give you a loan. The longer your particular lines of credit are open, the higher your score will be. So if you keep opening new lines of credit, expect your score to be low.
Revolving credit balances should be kept low, less than half of their limit. There is a significant hit if your credit line is more than half its limit, and the higher you go, the worse it is. If you have two $5000 limit credit cards, it is much better to have $1500 on each than $3000 on one and nothing on the other. It make even more difference if you have $2000 balance on each as opposed to $4000 on one. And if you're one of those people who keeps doing the "transfer your balance to a new card and get zero interest for six months" thing, it will really impact your credit in a negative way, because if your credit balances sum to $8000, that's usually what the limit on the new card will be, and so you've got a brand new credit card that's maxed out, which is a major hit on your credit.
One of the best ways to improve your credit score relatively quickly is to use your credit regularly but pay it off every time you get a bill. Once per month, charge something small that you know you will be able to pay off when the bill arrives. This may still take some months to improve your score, but better months than years.
The next way to improve your ability to afford a house is not to have any large monthly payments. The best rates are for full documentation loans, where you prove to the lender that you make enough money to be able to afford all of your payments. "A paper" lenders will allow you to have total monthly payments of 38 to 45 percent of your gross monthly income. Some sub-prime lenders will go to 55 percent. If your family makes $6000 per month, this means that total payments can be up to $2700 for certain A paper loans, up to $3300 for sub-prime and still qualify full documentation. This also means that the more income you can document, the more house you can afford.
This number includes not only the amount of the mortgage, but also the property taxes, homeowners insurance, association dues (if applicable), and anything else you may need to pay in order to keep the home, as well as car payments, credit card payments, and any other debts you may have. This means that somebody with other payments of $80 per month can afford a lot more house than somebody with other payments of $900 per month. This should be intuitive, but you'd be surprised how often people don't realize it.
The final thing that is helpful is a down payment. The larger your down payment, the less you have to borrow. Lending money is a risk-based business. Up to a point, the lower the ratio of loan balance to value of the property will help you get a lower interest rate and more favorable terms, because the bank will be more certain of getting all of their money back. A 5% down payment is better than none. 10% is better than 5%. The first 5% makes the most difference, but every bit helps. Of course the larger your down payment, the less you have left over for other purposes. It seems to be a phenomenon today that people don't want to risk any more of their own money than they have to, and 100% loans can be done right now, although how much longer that will be the case is anyone's guess. Still, people who make a habit of saving money are always in a stronger position that those who do not.
Now just because you are missing one or more of these does not mean you do not qualify for a mortgage. People in much worse situations than this get mortgages all the time. The vast majority of the time, somebody claiming you're a difficult loan is only looking to pad their pocket at your expense. Loans much worse than I'm talking about here are done on a routine basis. But making yourself a better prospect can certainly save you a lot of money.
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I've seen a fair number of questions on impound accounts in the last several months. An impound account, also known by the confusing term escrow account because the lender is holding it in escrow, is money that you give the lender in order to pay the property taxes and homeowner's insurance on the property.
The first thing to note and emphasize is that money going into an impound account is not a cost of doing the loan. It is your money. You own it. It will be used solely to pay your property taxes and insurance. At the conclusion of the loan, whether you paid it off with cash or refinanced or or sold the property, you get this money back. The lender is required to send you the check within sixty days of loan payoff.
An impound account is meant to address any lender's two largest worries in regards to a loan: Uninsured destruction of the property or losing the property to an unpaid property tax lien.
The problem with an uninsured destruction should be obvious. The structure is destroyed or heavily damaged and no money exists to rebuild. The borrower doesn't have it and the bank isn't going to throw good money after bad. Here in California, the average property is worth maybe $500,000 or so, but without the home sitting on it, the property may only be worth fifty to a hundred thousand. Within ten miles of my office sit hundreds, probably thousands, of new homes that sold for $700,00 and up even though they sit on a lot that's less than 5000 square feet (0.115 Acres). Many condominiums are over $400,000. Given the location, a 5000 square foot lot may be $200,000, but it's not $500,000, and the lender will take a loss even on the $200,000 because they're not in the business of real estate. They loan $500,000, it burns down without insurance, they lose $350,000. People also lose their jobs over this.
Property tax liens are a major issue as well. They automatically take priority over everything else, and the rules about what the condemning governmental entity has to do are much looser than they are for the bank. They will usually do quite a bit over the minimum, but they will sell the property most of the time, no matter how minimal the best bid. Minimum auction amounts, etcetera go out the window. Many times this situation can require the lender to step in and pay the property taxes, intending to turn around and sell the property themselves merely to take a smaller loss.
A lender wants you to pay property taxes and homeowner's insurance, and they want to know you've paid them. They encourage this via the method of impound accounts. The theory is simple. Every month you pay the lender, in addition to your actual loan payment, an amount equal to your pro-rated property taxes and homeowner's insurance, and they will pay these when they are due.
No lender is perfect about these, and some are less so than others. A large percentage of the biggest and worst messes I have ever dealt with came about as the result of the lender somehow messing up the inpound account. Others have arisen because even though the lender acted within the law, the client got angry about something. Sometimes it's for a good reason, sometimes it's not.
Because lenders want you to have them, however, they are ubiquitous, and every lender I know of charges extra on your loan if you do not want to do an impound account. Usually this amount is about one quarter of a discount point. On a $500,000 loan, this amounts to a charge of over $1250 just to not have any impounds.
On the other hand, in places where property values are high, you can have to come up with $5000 or more at loan time just to adequately fund an impound account. Here's a computation of how much you need to fund it works. The lender will divide the annual property taxes and homeowner's insurance by twelve. This will be the monthly payment. The lender is legally able to hold up to two months over the amount required to make the payments, and they want this reseve. So they will look at the projected payments for the next year and figure out how many months they need up front to always have two months worth in reserve. I'm writing this on February 3, and California taxes were due on the first even though they are not past due until April 10th. But the lender uses February first to calculate even though they won't actually make the payment until early April (they earn interest on the money, whether or not they pay any. Some states require that interest be paid, but it is typically something small and worthless like two percent).
February first is usually when the lenders here in California figure will be the low point of the account for the whole year. But if you closed on a loan today, February 3rd, you wouldn't make your first payment on that loan until April first, and of course, they cannot count on you making your February payment right on the first. So they are going to figure that you will make payments on the first of every month April through January, ten months, before they have to pay your property taxes. Since they have to pay twelve months, and they get to keep two in reserve, that's fourteen months of payments they want to have on February first. Fourteen minus ten is four months that you will have to come up with in advance, or have rolled into the cost of your loan. On a $500k property, that's about $2000 for property taxes even in a basic tax zone, and if your insurance is $1200 per year, you'll have to come up with another $400 for that. $2400 into the impound account.
It gets better. Because the property taxes are due within two months of your purchase, you're going to have to come up with your pro-rated share right up front as well as paying for an entire year of insurance. Since California requires six months property taxes at a time, that adds almost another five months taxes and twelve months insurance up front. Total cost of this in the example given: $3700. Actually, this is due whether you have an impound account or not. Total you need just for property taxes and homeowner's insurance: $5900.
It can be worse. Suppose you were closing on a refinance in October. You originally bought in February. You are only going to make two payments (December and January)before the insurance is due, so your impound total for the insurance alone $1000 for insurance. You are going to have to come up with $3000 to pay the first half of your property taxes, plus because you only have two payments before the second half is due, another $3000, or six months payments for that. Total due, $7000.
There are really only two methods for coming up with the money for an impound account: Bring in the cash from somewhere else, or have the lender loan it to you, adding it to your loan balance. Except in rare circumstances where you are refinancing the same property with the same lender (and usually not even then), existing impound accounts cannot be used to "seed" the new account. This is because it's your money, held in trust. The rules for these accounts are rigid, and I'm not certain I understand well the rules about whether a bank even has the option of rolling one impound account into another.
This typically means that you have to come up with a good chunk of change out of your pocket for a short period, or add the additional amount into your loan, where you'll be paying for it as long as you have a loan on the property. Every situation is different, but most often I prefer to either come up with the money myself or not have an impound account. The extra charges may be sunk as opposed to refundable, but I'm not paying interest for thirty years on thousands of dollars.
Furthermore, if you are adding the money to create the new impound account to your loan balance, since it's going in before the computation of points, it can add another $50 to $100 to your costs of the loan per point you're paying. Minor in and of itself, but adding insult to injury if the loan has points involved. More to the point is that adding impound creation it to your loan balance means there may be a couple years before your balance gets as low as it was before the refinance, just from this. Indeed, the fact that it raises your loan balance is the worst thing about the impound account issue. On the other hand, unless you have a "first dollar" prepayment penalty, what you can do is turn around and put the check for the previous impound account when it arrives into paying down the new loan. It typically won't bring you even, and it won't reduce your contractual payments on the new loan (although that is usually a good thing), but it will ameliorate the damage to your loan balance.
Initial loan closing is not your only opportunity to start an impound account if you want one. If you don't have one to start with, the lenders will be very happy to let you start one later. I've literally never heard of a lender saying anything but "YES!" (usually with a pump of the fist) to a request for an impound account. Why? Because now they know that your taxes and insurance will be paid, and get to use your money, and after you paid a fee for no impounds. Oh, happy banker!
If you want to cancel an impound account, expecially within a year of whenever the loan was funded, you can expect to pay the "no impounds" fee, possibly prorated, but usually just the whole thing. Roll thousands of dollars into your loan balance where you'll be paying interest on it and then pay a lender's charge for no impounds? Ouch!
Can you force the bank not to do any of this? Not really. They don't have to lend you money. Yes, they are in the business of lending money, but if they don't loan it to you, they'll find other uses for it. Somebody else is always willing to accept the bank's terms. You try to violate guidelines that lenders have established in order to lend you the money, and you'll be told, "Sorry but you don't qualify." The golden rule of loans is that those with the money make the rules.
Furthermore, those lenders who didn't require this would be at a competitive disadvantage as regards rates, because their loan portfolio would be a significantly riskier one, and they would have to increase their rates to compensate for this. You could qualify for a better rate or lower closing costs somewhere else. Better to not argue. Assuming that I already have an impound account, all the extra I lose is a maximum of sixty days interest. Two months interest on $5000, even at ten percent, is $83. That's a lot cheaper than either of any of the alternatives.
I am continually confirming that a large percentage of people can't handle negotiations like an adult. They focus in on garbage and ignore what's really important.
I recently was going to deliver a loan that cost less, as well as being 3/8ths of a percent lower interest rate on exactly the same terms as the competition quoted. Furthermore, my quote was guaranteed where the competition's was not. However, because my company's compensation was disclosed while the competition's was not, they chose the other loan.
Real Estate loans are not something that the minimum wage fast food worker can toss off in a few seconds like filling a soda cup. If we get all of the paperwork just right with no hitches and everything works on the first pass and it doesn't take too long to price it, such a loan can be done in five to ten working hours. But doing so requires not just the right situation, but a lot of skill and a not inconsiderable amount of knowledge of the loan market.
Nobody does loans for free. Typical loan production, even at a busy brokerage, is three to six loans per loan officer per month. That's got to pay rent and utilities and the salaries of everyone from the receptionist to the CEO. Yes, I've done more, but if you investigate you're going to discover that for most loan officers, most of their time is spend prospecting and selling. That's part of the reason why most places have processors and transaction coordinators - to relieve sales folk of tasks that they don't have to do so they can go out and sell more with the time they save. I can point to lenders and brokerages where basically the only work that loan officers actually do is talk to prospects and clients. They don't price, they don't do the application, they don't process, they don't deal with underwriters or escrow or title, they don't attend signing - all they do is talk to the public. The reason for this is so they can talk to more prospects. The time of good sales folk is important, but some of these loan officers have no clue as to whether the loan is ultimately going to be approved. This is one of the reasons why people end up with different loans than they were originally told about. There was a reason why they weren't going to qualify for the loan on which the loan officer gave them a low quote, but the loan officer didn't know, and it's sure as gravity no one else is going to tell you between sign up and delivery, and at delivery, your choices are to sign these documents or don't. If you need that loan at that time, guess what? You are going to sign those loan documents and become part of the statistics.
Last month, I had some people call me through Upfront Mortgage Brokers (UMB). They had heard the UMB way was better, and it is better than most, but it requires you be able to deal with money like an adult. These people wanted a million and a half dollar loan with a low down payment. They had great credit and likely sufficient income, but they wanted an A paper loan with no pre-payment penalty. Now I can get zero down payment A paper loans with no pre-payment penalty no problem up to the conforming limit (currently $417,000), but above that, lenders start making it harder and harder, and there are three break points in most lender's rules between conforming loans and a million and a half. When I'm working under UMB rules, I have to negotiate every penny that my company is going to make up front, and I told these people that my company needed $5400 to make that loan worth our while. This was between three and four tenths of a point grand total, and that included credit and what the processor was going to make. But that sounded like "too much" to these people, who told me that they were going to the bank who "promised never to charge more than two points." When you do the numbers, they were telling me that $5400 was "too much" but $30,000 wasn't - not to mention the fact that I know this lender, and they'd have made another four percent on the secondary market with the loan they gave these people - $60,000. It's to be admitted that the lender I was going to put them with likely would have made about 2.5 percent, or a little under $40,000, selling their loan on the secondary market, but these lowered margins roughly $45,000 total that I and my lender would have made versus $90,000 that the other lender would charge translate directly to less cost, a lower interest rate, or some combination of the two (there is ALWAYS a trade off between rate and cost in mortgages). Indeed, the loan I quoted was better all around to the prospective client - but my compensation was disclosed and theirs wasn't. So this person, a highly paid professional who should have known better, went with the other provider.
So despite the fact that working to UMB guidelines actually lets me quote and deliver loans with slightly better pricing, I have discovered that it's mostly a waste of my time. The client is assuming pricing risk, all I get is a flat, pre-negotiated fee - but they know what that fee is, and it's not what most folks think of as "cheap." Never mind that it's a lot cheaper than the provider they ended up with, people seem to think that the $5400 they know about is somehow worse than the $30,000 they don't.
The smart thing to do, of course, is judge that loan based upon the net terms to you. Type of loan, rate, total cost, and whether there's a prepayment penalty. I can get my commission paid out of yield spread or rolling it into your balance, same as anyone else. You don't have to write me a check just because I'm working for known compensation. In fact, since that known compensation is less, I can get you a lower rate, or pay some or all of the closing costs that you'd end up paying through another provider - sometimes even both. But just because I can't hide my compensation in your new loan amount and rate, or pretend that I wasn't paid somehow, doesn't mean the other loan is better than mine.
Loans aren't free. If you don't understand how someone is getting paid, chances are they are making a lot more money than the loan officer who is willing to go over it. If this seems like too much work to you, judge competing loans by the terms to you: What type of loan is it? What is the rate? How much will it cost, grand total? Is there a prepayment penalty? Will they guarantee their quote, or are they just talking? Ask specific questions, and don't settle for anything other than specific answers. The usual modus operandi is to hide loan costs in your new loan amount after pretending that there aren't any until you go to sign documents. Just because nobody wants to talk about it doesn't mean the answer is "zero." Just because you don't have specific numbers doesn't mean it's going to be better for you - in fact, the opposite is the way to bet.
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