Beginner's Information: December 2007 Archives

I got a search for how one spouse could sign while the other was out of town, and act on their behalf. Since both spouses usually need to sign real estate papers, this is a real concern.

Actually, almost anybody you designate can sign for your real estate transaction, whether or you're available. The usual thing is you're out of town for some reason when closing happens, and so your spouse signs for both of you, themselves in their own right, and you by Power of Attorney, but it covers all kinds of situations, and not just real estate.

The document required for this is called a Power of Attorney. You must sign it and have it notarized that it was really you that did so. In it, you designate one particular person who has the right to undertake an action or group of actions, and they then act on your behalf, as your "attorney" for this matter.

Powers of Attorney can be made for all sorts of things, not just real estate transactions. For instance, pretty much everyone should have a Durable Power of Attorney for Health Care. Powers of Attorney can be very broad and ongoing or limited to one specific action in a limited range of time. You set this up at the point in time when you execute it. Whatever terms you set up when you signed it are binding, both upon you and the person you designate. Most stationery and office supply stores have ready made ones where you just fill in a few blanks and you're ready to have it notarized. I've seen ones with boxes for check marks, but those are dangerous in my opinion, as when a particular check mark was placed on there is a matter for considerable legal dispute.

It is a misconception to believe that this person must always be an actual licensed attorney. In general, they need not be an actual attorney, only a competent adult. I'm sure there are circumstances when being an attorney is necessary, but it is not necessary most of the time. There may be circumstances where you may want a licensed attorney even where it is not legally necessary, but there's a major difference between being legal and being smart.

I've seen not only spouses used, but other relatives, close friends, and professionals such as accountants and attorneys. Note that the person you designate does not have to accept, and does not have to act even if they accept. The idea is to get their consent first, and make certain they know your mind in the matters you designate them for.

Extremely important: You really need to trust the person you designate to act in your best interest. If they sign something that you would not have, you are still stuck, as long as it is within the mandate of that power of attorney. Whatever contract they signed on your behalf, you have to live up to the terms. Your designate doing something you would not have is a side issue between you and the person you designated. That person with your power of attorney designate's signature on a contract can force you to live up to that contract, which is how it should be. Otherwise, nobody would accept powers of attorney, and they would be regarded as one more way to run a scam. They're not supposed to be a scam at all, it's intended to be a way for one person to do another person's business legitimately.

Caveat Emptor

I got a question about legal late payments in California.

Unfortunately, there really is no such thing as a legal late payment. You borrowed the money, signed a contract, and it accrues interest according to that contract. You owe this money, and it only gets worse if you don't pay it. There is some wiggle room so you don't get unduly hit for a day or two late, or if the right to receive payments is sold, but that's about it.

The law gives you some wiggle room in the timing of the payments. First off, the laws of California and most other states give you fifteen days after the due date to pay the mortgage before a penalty can be assessed. I know of a lot of people who make consistent use of this. If it's due on the first, it's supposed to be there on the first, but many people take advantage of the fact that there is no penalty as long as it's paid within fifteen days of due date (i.e. before the sixteenth), and consistently mail their payment on the tenth or twelfth.

Now if you miss it by even one day, the penalty is up to four percent of the amount due here in California. As you might guess, most lenders charge the maximum penalty. When you compute it out, four percent times 360 divide by 15 is ninety-six percent annualized. I had my check get lost in the mail once and the lender waived the penalty when they called me on the eighteenth because I always paid on the first or before, but they didn't have to do that. I got the distinct impression that if I were the kind of person who pays on the twelfth or fourteenth every month, they would not have waived the penalty.

Now, there is also some wiggle room on when the new lender receives it if your contract is transferred between lenders. Because once upon a time some unscrupulous lenders would sell notes back and forth between their own subsidiaries because it made them more likely to get late fees, or even able to foreclose on appreciated property when there were relatively few protections for borrowers in law. Mind you, you still have to send it on time, but if it gets hung up in forwarding between lenders, that's not your issue. Within sixty days, the old lender must forward the payment promptly, and it counts as received when the old or the new lender receives it, whichever is first. It's still better to send to the new lender at the new address if you have it or know it.

In short, although there are some small period where payment is allowed to be delayed due to one factor or another, it is never to your advantage to do so. Make your payments on time.

Caveat Emptor

Just got a search "how can I tell if my prepayment penalty applies to selling my home"

Read The Full Note. You need to do this before you sign it. I know that many people are just thinking "Sign this and I get the house!" or "Sign this and I get the money!" but a lot of loan providers - often the very biggest - scam their customers by talking about one loan with very favorable characteristics, and when it comes time to sign they actually deliver a completely different loan with a prepayment penalty, burdensome and unfavorable arbitration requirements (I've seen stuff that amounted to "the bank chooses the arbitrator"), and any number of other unfavorable terms, not to mention having a higher rate and three times the cost, and being fixed for two years as opposed to the thirty they told you about.

Any loan officer can make up all sorts of paperwork along the way to lull you into a sense of security. The only paperwork that means anything are the papers you actually sign at closing with a notary present. The Trust Deed, the HUD-1 form, and the Note. Concentrate on these three items. The HUD-1 contains the only accounting of the money that is required to be correct (things like do you need to come up with more money than you were told?). And the Note contains all the other information on the loan that your provider might actually deliver. Notice that wording - I said might deliver. Just because you sign the Note doesn't necessarily mean you get any loan, let alone the one that Note is talking about, but these are the terms you're agreeing to now, and most Notes do actually fund. They can't change the terms without getting you to sign a different Note. But once you sign and the Right of Rescission (if applicable) expires, you are stuck. Get that other loan - the one your loan provider has been talking about up to now - out of your head. This is the moment of truth as to what they actually intend to deliver. The majority of the time, the loan they actually deliver is significantly different from the loan they were talking about before now, and this document is where the truth lies. Amount of the loan (does that match what you were told?). Length of the loan. Period of fixed interest. What the fixed rate is, and how the rate will be computed after the rate starts adjusting. The Payments: how closely do they match what you were told? Payments are a lot less important than the interest you are being charged, but if the payments are $20 more than you were told (or if the interest rate is different), you were basically lied to. If the real loan was available and the principal correctly calculated, the payment should be within $1. $20 off gives the loan provider literally thousands of dollars to soak you for extra fees in, even if the rate is correct. A competent loan officer knows what loans are really available and whether you are likely to qualify, and can calculate pretty closely how much money it takes to get the loan done. From this flows the payment. Payment is a lot less important than most people think, but you do need to be able to make it, every month. Furthermore, that's how most people shop for loans and how unethical loan officers sell bad loans. Shopping by payment is a good way to end up with a bad loan. Many loan officers will tell you about this nice low payment, and conveniently neglect to mention the fact that if you make this low payment, you'll owe the bank $1200 more at the end of the month than at the beginning of the month.

So take the time to read the entire Note before you sign. There are all sorts of things lenders slip in. I worked for a very short period at a place that trained its people in how to distract you from the numbers on this and the HUD-1 and the Trust Deed. This is a legally binding contract you are entering into, you are agreeing to everything it says, and there aren't a whole lot of methods of getting out of it if you don't like what it says later. Once the loan funds, you are stuck with the terms, the costs, and everything else. The only way out, in general, is to refinance, which means paying for another set of loan costs and quite likely the prepayment penalty on this loan. Multiple thousands of dollars. So don't allow yourself to be distracted. Read the Full Note.

Caveat Emptor

If you read the papers and the congressional record on the current housing crisis, you might think yield spread is the central culprit for the entire meltdown. You would be wrong.

Yield spread is a beneficial tool, offered voluntarily by lenders, that is an alternative to consumers paying all of the costs of a mortgage themselves.

No matter who does your loan, broker or direct lender, they need to get paid for doing it. If they cannot make money at it, they won't be in the business of doing loans. There are high cost loans and low cost loans, and any number of ways of paying those costs, but there is no such thing as a free loan, and anybody who pretends otherwise is either a naive child or lying through their teeth. There are a very few loan providers out there who will finish loans on which they don't make anything in order to keep their promise about the terms of that loan to clients, but there has never been a loan in the history of the world where the provider planned not to make anything.

Yield spread arises as a by-product of the price that the lender receives on the secondary market. For thirty year fixed rate conforming loans, as of a couple days ago, at 5.5%, lenders were making about 20 cents per hundred dollars over the actual dollar value, in addition to the roughly $1.30 per hundred dollars the lowest priced lender I had was charging brokers. For a $300,000 loan, this means they were making roughly $4500 for a loan where the broker did all the work from attracting the customer onwards through the rest of the loan (the rate cost three points in the one direct branch I saw last week, so they'd be making about $9600 there). None of this covers all the fees for service, aka closing costs, or loan price adjustors. This is purely from the act of putting the money to the deal. At 6.00%, the lenders were making about $1.56 per $100 of loan amount directly, and that's about where wholesale par was, the loans that brokers could do without any explicit charge for the money. The direct branch wanted a point and a half to do that loan. Finally, at 6.5, they were making about $2.31 per hundred dollars directly from the secondary market, and they were agreeing to give brokers about seventy-five cents of that in the form of Yield Spread.

What this boils down to is that wholesale lender is looking to make about 1.5% of the loan amount, no matter what loan the consumer is put into, merely for the act of loaning the money. It is out of the difference between the number the wholesale lenders charge, and what their retail lending branches charge, that brokers make their living. If brokers can get the loan done for less than the retail branch, and still make money, the consumer comes out ahead.

There is no requirement for lenders to offer Yield Spread. They don't do so to enable brokers to hose customers that they would rather have walking into their own retail branches. They do it to compete for the business of people who have discovered that using brokers is actually a way to get the same loan cheaper. They do so because other lenders do so. Because they really want that $1.50 per hundred dollars loaned, they'll willingly give up most of any amount over that to encourage brokers to come to them, rather than the other lender. As I've said, in loans there is no difference in brand names. It's just money. So long as the terms are the same, it really doesn't matter if you're making the check for payments out to "International Megabank, Inc" or "Fifty-Third Bank of Podunk," and that really is the only difference. In fact, using brokers as a way to expand their reach is one of the ways small lenders can become major players quickly, without the expense of opening branches. More than one major household name has done precisely that. By the way, this $1.50 per hundred dollars loaned is very low by historical standards - it was roughly $2.50 twelve months ago, and twelve months before that it was more like $4.00. But there's a lot of money chasing not very many borrowers right now. Nor is any of this in any way evil. As a matter of fact, it has enabled much lower interest rates for consumers than the traditional lending model where the lenders held the loans for the duration.

Nor do lenders like paying yield spread. They'd rather have the entire secondary market premium for themselves. They offer it for one reason and one reason only: Because the brokers would otherwise take their clients to a different lender who did offer it. Most brokers operate on a set margin per loan, especially the better ones. The good ones are willing to disclose this margin, the bad ones will do everything they can to hide it. This margin may vary between loans. If borrower A is a slam-dunk A paper borrower, that loan can be done a lot more easily than a sub-prime borrower who needs to qualify based upon bank statements, and will eat up a lot less of my time and therefore, the loan should be done on a thinner margin. Whatever this margin is, it can be paid via origination (a charge for doing the application and getting the loan done), it can be paid via flat dollar charge to the borrower, it can be paid via yield spread, or it can be paid via a combination of these. But it is going to get paid. When I quote a loan, I quote it in terms of terms and total cost to the consumer, including what I make, and if I'm not going to make enough to make it worth my while to leave home, I'd rather not do the loan. Others quote higher, building a bit in that they're prepared to negotiate away if the client asks. Still others just make believe that they're going to deliver the loan on better terms than they will actually deliver it to get you to sign up with them - but the chances of anyone actually pricing the loan so as not to make anything are zero. Consumers looking to tell the difference between better and worse providers should ask for a Loan Quote Guarantee, as well as all the other Questions you should ask loan providers.

Yield spread is nota cost paid by consumers. It doesn't show up anywhere in the list of charges they pay. Were its disclosure not mandated by federal law, the consumer would have absolutely no evidence of its existence except, possibly, the absence of other charges or the fact that they have been paid without the consumer having to shell out a dime. I agree with the disclosure law, by the way. Indeed, I want to expand it to require lenders to disclose the secondary market premium they would be paid assuming they sold the loan. Now consumers do pay for yield spread indirectly, of course, with increased interest charges during the life of the loan. But they pay those same charges whether incurred as a result of a broker earning yield spread or a lender being able to make the money on the secondary market. Furthermore, paying those charges will be to the consumer's benefit if the increased charges for interest offset or more than offset the higher fees they would have to pay in order to get a lower rate. Most consumers do not keep their loans long enough to justify the higher fees for a lower interest loan. Similarly, if the loan is going to go to from a fixed or set rate to a variable rate loan before the higher costs for a lower rate have been recouped, whatever wasn't recovered before that happens has been wasted, as all the loans of a given type reset to the same rate when they adjust - doesn't matter whether you got a zero cost loan out of Yield Spread, or you paid five points to buy the rate down, and therefore the payment. But the 4.875% 3/1 that closes today will in three years reset to the exact same rate and payment as they 6.25% 3/1. Well, not exactly. Because assuming they did what most borrowers do and roll those costs into the loan, that 4.875% loan will have a higher balance owed than the one that was initially 6.25%, and therefore will have a higher payment when they both reset. So yield spread has done the latter borrower a favor by helping them control overall loan costs.

Let's look at what happens if we count yield spread as part of the costs of the loan. First off, it makes it appear as if loans including yield spread are more expensive than ones without. This gives direct lenders an advantage over brokers. Let's consider an actual real world example: A few days ago, a retail lending branch offered one of my prospects a 6.125% loan for one point, while he came back to me and I locked him into for 6.125% for ZERO points, a price which included me making about nine tenths of a point in yield spread. Assuming closing costs are the same (in fact, mine are lower than theirs), here's what the client sees now on a loan with a $300,000 loan payoff. (I'm also going to assume anything other than actual costs, such as prepaid interest, are paid out of pocket)

item payoff closing cost origination new balance payment

lender $300,000 $2900 $3060 $305,960 $1859.05

broker $300,000 $2900 $0 $302,900 $1840.46

This reflects reality. The client ends up with a loan balance $3060 lower, and a payment $18.59 lower, through getting exactly the same thirty year fixed rate loan through me as he would have gotten through that lender.

But if I have to count yield spread as a part of the cost of the loan to the consumer despite the fact that he's not paying it, here's what the sheet looks like:

loan payoff closing cost origination yield spread "total cost" new balance payment

lender $300,000 $2900 $3060 $0 $5960 $305,960 $1859.05

broker $300,000 $2900 $0 $2726.10 $5626.10 $302,900 $1840.46

Note that it now looks like the consumer is paying almost as much for the broker loan as for the lender loan. They're not. Keep in mind that this is for exactly the same thirty year fixed rate loan at 6.125% - except that the consumer's loan balance if they go through the broker ends up $3000 lower. That $2726.10 in yield spread is not a cost to the consumer. Indeed, Yield Spread is only a cost to the lender. Note that the consumer's balance and payments in no way reflect yield spread, and my client has been told about it, but really doesn't care. Being a rational consumer, he shopped for the loan on the best terms to him and his family. He doesn't care if I'm making ten cents or ten million dollars. All he cares about is I get him the exact same thing for a cost that is thousands of dollars less. But if Yield Spread is listed as part of the cost on the Good Faith Estimate (or MLDS in California), then it appears as if that lender's loan is a lot more competitive than it really is, i.e. $5950 to $5626, not the reality of $5960 to $2900. Furthermore, this was an uncommonly broad difference, that still looks like the broker is offering a better loan. Far more common is a differential spread of half a point or so. If the price differential were only half a point, the broker's loan would look more expensive, while being in fact less expensive to the consumer who doesn't know yield spread is an accounting phantom as far as they are concerned. The consumer would still be saving money with the broker - about $1500, a full 25% of the actual costs of the loan, but listing yield spread as a cost makes it appear as if the lender's loan is cheaper when it is in fact more expensive.

Furthermore, listing yield spread as a cost has some other effects. Suppose you live in an area where the cost of housing is about $60,000 to $80,000 or less. Under the same bill in congress proposing to count yield spread as a cost to consumers even though it is not, is a provision limiting total costs of loans to six percent. Six percent of $60,000 is $3600. Six percent of $80,000 is $4800. There literally is not a loan that a broker can do under these limits. I can't keep the doors open on $700 per loan, which is all that's left after those $2900 of fixed closing costs at the low end. It's not like I get to spend every dollar the company makes on my family. Even at the higher end, it's probably not worth my while to accept a loan on which I can only make $1900. Effect: Brokers in those areas go out of business, but direct lenders are still in business, lessening competition. They can jack up the rates until the secondary market will pay them enough, and secondary market premiums aren't part of costs, even in the artificial environment of this new bill. Result: Rates rise, lending margins rise, competition is less. Big Winner: direct lenders, who clean up with all the extra money they make. Big Loser: brokers, who go out of business. Of course, consumers lose, too, as do real estate agents because prices are lower as a direct result of higher rates, but hey, that's okay because the bankers who bundle million dollar campaign contributions made out!

Suppose you live in an area, such as I do, where the cost of housing and loans is enough higher for this not to be a danger. One cold hard fact is that there are still people who bought years ago that bankers have a free field with because brokers cannot legally do their loans and still make enough money to keep the doors open. Consider a $200,000 loan, where 6% is $12,000, so the maximum loan cost just isn't a factor. Such a person, realizing that they've owned this property ten years and refinanced five times, decides they want a zero cost loan, because they'll come out better. Well, a broker can still get them a loan that doesn't really cost them anything, but brokers no longer are legally capable of calling it a zero cost loan, because legally, yield spread is a cost. All we can do is call it by some name that sounds like a legalistic way to lie. So now lenders can advertise "true zero cost loans," and brokers are breaking the law if they try, despite the fact that they offer the same loan at zero real cost to the consumer with a rate a quarter of a percent less than the lender will. Indeed, for all the low cost options, the lenders now appear to be cheaper than brokers even though they are not. Also found in this same legislation currently in Congress is a provision to make it illegal for brokers to get part of their compensation via yield spread and part via origination. This is the vast majority of my current loan business, because it's the range where the Tradeoff between rate and cost is best for consumers. Say I figure I need eight tenths of a point to make a loan worthwhile for me to do. If the yield spread for the rate the customer chooses is three tenths of a point, I need a half point of origination to make it work. But now I can't do this loan the simple way. I have to charge eight tenths origination, and even though I agree to rebate the three tenths of a point of yield spread to the consumer - in other words, it's going into the borrowers pocket, not mine or anyone else's, it still legally counts as a cost of the loan. So the new accounting with the requirement of adding double counting the yield spread to the official cost of the loan makes it look like the broker's loan costs 1.1 points, even though the consumer is only paying five tenths net, getting three tenths of a point in their pocket. If the trade off was seven tenths of yield spread to one of origination, it looks like a 1.5 point loan by this new accounting, even though the consumer is only paying one tenth of a point. Result: Consumers are going to have to have an accounting degree to realize that the broker's loan, which looks more expensive, is in fact the cheaper loan.

Needless to say, this is the exact opposite of what the government should be looking to do. But the mortgage banking industry has much bigger pockets than the mortgage broker industry, and they realized quite early on in this whole meltdown that if they painted brokers and yield spread as bad and controlled the narrative and their bought friends in congress controlled congressional testimony, they could make this entire housing meltdown for which they were more responsible than any other group into a public relations opportunity to restore the dominance of residential lending they had forty years ago. Bankers don't like paying yield spread, and they don't like competing with brokers, whose costs are lower because nobody expects brokers to have flawlessly landscaped offices with three inch think carpet, security guards, and armored bank vaults, or to wear $2000 suits. They do so only through what they saw as a tragedy of the commons type mechanism, where they could compete for broker's business at the costs of lessening their own margins, or not get any. Of course, this tragedy for lenders was a boon for consumers, but their responsibilities are to their own bottom line, and if they can legally shackle brokers, not to mention legally keeping their competition among other lenders from competing for broker business, those lenders are all better off.

Who's not better off? Well, basically everyone. Lessened competition, loan documents that make it appear as if one provider's loans are more expensive than actual while not making equivalent disclosures about other provider's loans, all of this translates into higher loan prices for consumers. It may seem penny ante to object to consumers paying a few hundred dollars extra here, a few thousand dollars extra there, but when you put it together across 100 million units or more, this translates into hundreds of billions per year, all sliced into fewer pie portions because the lending industry just effectively got a lot smaller, and with brokers diminished the costs of entry just got a lot steeper for any new lenders who want a piece of the action.

Yield spread is a tool, and a highly beneficial one from consumer's point of view. It has been one of the largest contributing factors in the rise of brokers, and through brokers, of making mortgages more affordable to consumers. It is not a cost to the consumer, and should not be treated as such, although it should be disclosed, as it is required to be. It can be misused, as it was in the case of negative amortization loans, but the ultimate indictment there goes back to the lenders who offered the loans and the high yield spreads, with regulators and mortgage brokers solely in supporting roles. Indeed the best way to fix this entire problem for the future would be to fix the disclosure rules to make the process clear to the consumer, as I wrote last month in How to Avoid A Repeat of the Housing Market Mess - but if Congress starts to fix those, nobody would be able to hose the consumers, and (sarcasm on) we can't have that, can we?

Caveat Emptor

Got a search for that, and it occurred to me that it is a valid question. The answer is yes.

The degree varies. You can simply contact the bank to make yourself responsible for payment. They are usually happy to do this, although unlike revolving accounts you typically will not receive back credit on your credit score for the entire length of time the trade line has been open. Nonetheless, if the bank reports the mortgage as paid as part of your credit, it can help you increase your credit score, so long as the mortgage actually gets paid on time every month. One 30 day late is plenty to kill any advantage for most folks. This is typically free. Hey, the bank has one more person to pay the mortgage! This is often used as a way to start rebuilding credit after a bankruptcy or other financial disaster. A friend or family member qualifies for the loan, then adds the person looking to recover to the loan later.

If you want to go one better than that, you can actually modify the deed of trust to make yourself responsible for payment, although it really has no measurable benefit as opposed to simply agreeing to be responsible, and it costs money to notarize and record the modification.

Unless you can get a better rate by doing so, I would advise against a full re-qualification for the mortgage just to add someone. It's a lot of hassle and expense for no particular gain. If you want to get me paid, I'm cool with that, but there are better ways to accomplish the gain to your credit at far less expense.

Caveat Emptor.

So what else is available, besides the thirty year fixed?

There are many kinds of loan out there. Here's a quick overview:

A Paper

In addition to the thirty year fixed, there are several other varieties of fixed rate loan available, and several that are not. Commonly available are five year fixed, ten year fixed, fifteen year fixed, twenty year fixed, and twenty-five, as well as forty making a comeback.

I tend to avoid them all with my clients, except for the thirty year fixed. You can always pay more if you have more money that month, but you cannot always pay less. The shorter the term, the lower the interest rate should be, as not only are they guaranteeing the rate will not change for a lesser period, but the shorter the term, the more principal you are paying every month and the less risky the loan is. Nonetheless, they are also harder to qualify for because the minimum payment is higher.

For instance, if you have $2000 per month payment that you qualify for, then at 6.5 percent interest rate, here are the amounts you qualify for:

term 40 30 25 20 15 10 5

amount $341,600 $316,400 $296,200 $268,200 $229,500 $176,100 $102,200

Thirty year fixed rate loans also come in interest only loans, usually for five years.

A paper loans also come in Balloon Loans, with thirty year amortization, where you make payments "as if" if were a thirty year fixed rate loan, but they are due in full after five or seven years (a few ten year balloons exist, and fifteen year balloons are almost exclusively Home Equity Loans). The shorter the balloon period, the lower the rate should be.

A paper loans also come in hybrid ARMs, with thirty year amortization and payoff term, but shorter fixed period. Unlike Balloons, you are welcome to keep them the full thirty years if you want to, but most folks want to refinance or sell before the adjustment begins. One, three, five, seven and ten years are commonly available fixed terms. Once they begin adjusting, they are based upon an underlying index plus a margin above that, and the vast majority of A paper hybrids adjust once per year. For A paper, this is usually the US Treasury rate or the one year LIBOR. COFI, COSI, and MTA are Alt-A negative amortization loans, not A paper, and all three varieties are the same stuff from different outhouses. There are probably a hundred times more negative amortization loans than there should be, because they are so easy for those in search of a quick commission check to sell by the payment when you slap a friendly sounding label like "Pick a pay" on them.

Finally, there are some few A paper that are true ARMS, or so close that they might as well be. Month to month loans, three month loans, and six month loans. Their adjustments are usually on the same basis as hybrid ARMs, and they have thirty year amortizations. Some are even available in interest only.

Sub-prime loans come in more flavors. The most common are fixed for two years, the next most for three. Both come in thirty and forty year amortization periods, as well as interest only. Interest only usually carries a higher rate for the fixed period, because they are riskier loans from the lender's point of view, but the payment is lower. These are usually called 2/28, 2/38, 3/27 and 3/37 loans, for the fixed period and the remaining term thereafter. Interest only variants are all 2/28 or 3/27, and when they begin adjusting. Some sub-prime lenders also offer 5/25 and 7/23 programs. Once they adjust, all of these loans adjust every six months, which is one way to usually tell if you have a sub-prime or A paper hybrid ARMs, as the latter almost always adjust once per year, although a few lenders also have A paper hybrids that adjust at six month intervals.

Sub-prime loans also have thirty and forty year fixed rate loans, with some thirty year fixed rates having an interest only option, usually carrying a quarter of a point higher interest and an interest only period of five years. Nonetheless, the rate spread between sub-prime hybrid and sub-prime fixed is usually larger than the spread between A paper hybrid and A paper fixed. Where you might get the A paper thirty year fixed for one percent above the rate of a 5/1 ARM, the difference between a 3/27 and a 30 year fixed is usually closer to two percent (this is by recent standards. When I initially bought in 1991, I was offered a choice between 5.75 percent 5/1 and 11 percent 30 year fixed)

I tend to like the five year fixed for myself and my A paper clients. It saves a lot in interest, and you've got five years where nothing can change, which is a longer period than most folks go without refinancing, and it's usually only about an eighth percent or so more expensive, interest wise, than the 3/1 while being a quarter percent or so cheaper than a 7/1. For the sub-prime clients, I tend to prefer the 2/28 if I think they'll be A paper at the end of two years, the 5/25 if not and if I can find it (3/27 if I can't). Of course, if you really want to pay the higher rates for a long term fixed rate loan, I may believe you're wasting money, but it's your money to waste, and you're the one making the payments.

Two final types worth covering are the HELOC ("he-lock"), or Home Equity Line Of Credit, and HEL ("heal"), or Home equity Loan. They are usually used as Second Trust Deeds, the second loan on a property. A HELOC is a variable rate interest loan, usually prime plus a margin, and there is often an interest only period. It is a line of credit, and so long as you stay within your credit limit, the initial underwriting covers it. Nobody does fixed rate HELOCs; what they do when you "fix the rate" is fix that part of it you've already taken out and lower the maximum available credit. HELOCs have two phases, a draw period, when you can take more out (up to the approved limit), and a repayment period, when you're repaying what you took. Most folks end up selling or refinancing, however. Home Equity Loans are one time, fixed rate loans. I've seen all sorts, but the most common is a 30 year amortization with a 15 year balloon, although the twenty year fixed is almost as common. You need to refinance, sell, or pay the loan off prior to the end of fifteen years, lest the lender call the note.

Caveat Emptor

pfadvice talks about debunking a money myth and perpetuates one of his own. He took issue with someone refinancing to lower their monthly payment, insisting instead that the term of the loan was all important.



His point is understandable in that because folks tend to buy more house than they can really afford, they also tend to obsess about that monthly payment. The solution to this is simple to describe but it takes someone with more savvy and willpower than most to bring it off: don't buy more house than you can afford.



Actually, there is nothing that is all important, but if I had to pick one thing as most important, it would be the tradeoff between interest rate and cost and type of loan. This is always a tradeoff. They're not going to give you a thirty year fixed rate loan a full percent below par for the same price as loan that's adjustable on monthly basis right from the get-go.



If you have a long history of keeping every mortgage loan you take out five years, ten years, or longer, then perhaps it might make sense for you to take out a thirty year fixed rate loan and pay some points. To illustrate, I'm going to pull a table out of an old article of mine because I'm too lazy to do a new one.

rate 5.625 5.750 5.875 6.000 6.125 6.250 6.375 6.500 6.625 6.750 6.875 7.000

discount/rebate 1.750 1.250 0.625 0.250 -0.250 -0.750 -1.250 -1.500 -2.000 -2.250 -2.500 -3.250

cost $4725.00 $3375.00 $1687.50 $675.00 -$675.00 -$2025.00 -$3375.00 -$4050.00 -$5400.00 -$6075.00 -$6750.00 -$8775.00

Now I'm intentionally using an old table, and rates are higher now. I'm assuming no prepayment penalties, and the third column is cost of discount points (if positive) or how much money you would have gotten in rebate (if negative), assuming the $270,000 loan I usually use by default. Add this to normal closing costs of about $3400 to arrive at the cost of your loan, thus:



(I had to break this table into two parts to get it to display correctly)

Rate 5.625 5.75 5.875 6 6.125 6.25 6.375 6.5 6.625 6.75 6.875 7

Points/Rebate $4,725.00 $3,375.00 $1,687.50 $675.00 ($675.00) ($2,025.00) ($3,375.00) ($4,050.00) ($5,400.00) ($6,075.00) ($6,750.00) ($8,775.00)

Total cost $8,125.00 $6,775.00 $5,087.50 $4,075.00 $2,725.00 $1,375.00 $25.00 ($650.00) ($2,000.00) ($2,675.00) ($3,350.00) ($5,375.00)

New Balance $278,125.00 $276,775.00 $275,087.50 $274,075.00 $272,725.00 $271,375.00 $270,025.00 $270,000.00 $270,000.00 $270,000.00 $270,000.00 $270,000.00

Payment $1,601.04 $1,615.18 $1,627.25 $1,643.22 $1,657.11 $1,670.90 $1,684.60 $1,706.58 $1,728.84 $1,751.21 $1,773.71 $1,796.32

rate 5.625 5.750 5.875 6.000 6.125 6.250 6.375 6.500 6.625 6.750 6.875 7.000

New Balance $278,125.00 $276,775.00 $275,087.50 $274,075.00 $272,725.00 $271,375.00 $270,025.00 $270,000.00 $270,000.00 $270,000.00 $270,000.00 $270,000.00

Interest* $1,303.71 $1,326.21 $1,346.78 $1,370.38 $1,392.03 $1,413.41 $1,434.51 $1,462.50 $1,490.63 $1,518.75 $1,546.88 $1,575.00

$saved/month $130.80 $108.29 $87.73 $64.13 $42.47 $21.10 $0.00 ($27.99) ($56.12) ($84.24) ($112.37) ($140.49)

break even 62.11922112 62.5610196 57.99355825 63.54001705 64.15695892 65.17713862 0 0 0 0 0 0

Now, I've modified the results based upon some real world considerations. Point of fact, it's rare to actually get the rebate (typically, the loan provider will pocket anything above what pays your costs), and so I've zeroed out those costs. You take a higher rate, you're just out the extra monthly interest. The fourth column is your new balance, the fifth is your monthly payment. For the second table, I've duplicated rate and new balance for the first two columns, the third is your first month's interest charge (note that this will decrease in subsequent months), the fourth is how much you save per month by having this rate, and the fifth and final column is how long in months it will take you to recover your closing cost via your interest savings as opposed to the cost of the 6.375% loan, which cost a grand total of $25 (actually, this number will be slightly high, as interest savings will increase slowly, as lower rate loans pay more principle in early years).



However, let's look at it as if your current interest rate is 7 percent. Your monthly cost of interest is $1575, there, so let's see how long it takes to actually come out ahead with these various loans.

Rate 5.625 5.75 5.875 6 6.125 6.25 6.375 6.5 6.625 6.75 6.875 7

Loan Cost $8,125.00 $6,775.00 $5,087.50 $4,075.00 $2,725.00 $1,375.00 $25.00 $0.00 $0.00 $0.00 $0.00 $0.00

New Loan $278,125.00 $276,775.00 $275,087.50 $274,075.00 $272,725.00 $271,375.00 $270,025.00 $270,000.00 $270,000.00 $270,000.00 $270,000.00 $270,000.00

Saved/month $271.29 $248.79 $228.22 $204.63 $182.97 $161.59 $140.49 $112.50 $84.38 $56.25 $28.13 $0.00

Breakeven 29.94960403 27.23218959 22.29233587 19.9144777 14.89346561 8.50926672 0.177945838 0 0 0 0 0

In short, since you're recovering costs quickly, it would make sense for folks with a rate of 7 percent to refinance in this situation, no matter how long they have left on their loan. For $25, they can move their interest rate down to 6.375, saving them $140 plus change per month. It's very hard to make an argument that that's not worthwhile. On the other hand, I would have been somewhat leery of choosing the 5.625% loan, as more than fifty percent of everyone has refinanced or sold within two years. On the other hand, I have a solid history of going five years between refinancing, so it makes a certain amount of sense, considered in a vacuum. Considered in light of the real world, rates fluctuate up and down. So I tend to believe that if I don't pay very much for my rate, I'm likely to encounter a situation within a few years where I can move to a lower rate for zero, or almost zero, whereas if I paid the $8125 for the 5.625%, rates would really have to fall a lot before I can improve my situation.



Do not make the mistake of thinking that the remaining term of the loan is more important than it is. You now have (assuming you took the 6.375% loan) $140 more per month in your pocket. It's up to you how you want to spend it. If you want to spend it paying down your loan more quickly, you can do that (providing you don't trigger a prepayment penalty, of course!). Let's say you were two years into your previous loan. Your monthly payment was $1835.00. If you keep making that payment, you'll be done in 288 months; 48 months or 4 full years earlier than you would have been done. So long as you don't trigger the prepayment penalty, you can always pay your loan down faster. Just write the check for the extra dollars and tell the lender that it's extra principal you're paying. I haven't made a minimum payment since the first time I refinanced!



Now some folks focus in on the minimum payment. By doing this, you make the lenders very happy, and likely your credit card companies as well. Not to mention that you are meat on the table for every unethical loan provider out there. It is critical to have a payment that you can afford to make every month, and make on time. But once you have that detail taken care of, look at your interest charges and how long you're likely to keep the loan, not the minimum payment.



Caveat Emptor.

Just got another one of those desperate consumer fishing calls.

First off, she said she had to have an Option ARM. I told her I had them available to me, but...

She interrupted me to say she had to have it Stated Income, or if necessary, no documentation. Yes, I told her, even those are still available, but...

She interrupted me again, wanting to know if they were no points and no prepayment penalty. I said that while I hadn't done a loan with a prepayment penalty in years, Option ARMS without prepayment penalties don't exist. She then said, "We've come to the end of the conversation," and hung up.

Obviously, she's been burned by someone. Just as obviously, someone else gave her a shopping checklist for a loan, or she made it up herself. She wants it all, she's not going to settle until she gets it, and she's not going to let some horrible awful salesperson lead her astray like last time. In fact, she's so determined on this point that she's not going to let anyone try to save her, either.

As regular readers have no doubt figured out by now, here's her history. She didn't tell me this, but It doesn't take much if you understand the way the market has gone these past few years.

She either bought a property more expensive than she could really afford, or refinanced a property she already owned, and could not afford to buy now, for cash out. Not understanding that minimum payment is not the same thing as the cost of the money, and that you should Never Choose A Loan (or a House) Based Upon Payment, she signed upon the dotted line, not really understanding anything that was going on except that she wanted that house, or that cash.

Along she went, happy as a clam, until she got smacked upside the head with the real cost of money, aka the interest rate she was paying. Gravity never quits, and compound interest working against you is even worse than that.

And here's where it gets really sad. Instead of figuring out her mistake, or cutting her losses, she is determined to repeat the mistake. So determined that she's not going to let anyone stop the process before it gets even worse than it is today, however bad that is. She didn't mention anything about loan to value ratio, but I'll bet it was higher than the 80% that's the most anyone will do one of those stated income now (if debt to income ratio wasn't outside of any acceptable range there would have been better loans to do in the first place). What's the definition of insanity again?

The loan she wants is not going to happen. But that won't stop people from telling her that they can do it, figuring once they get an application and psychological investment, not to mention hundreds of dollars of her cash, then they come up with something else at final loan signing, chances are that she'll sign it and they'll get paid. I went over this just a few days ago. The loan they'll get her probably won't be as bad as what she wants, but it's unlikely to do her any good. She owes what she owes. If she could afford the loan, she wouldn't need stated income or negative amortization, and she probably wouldn't have needed them in the first place.

Furthermore, she's shopping her loan from a checklist of things somebody told her were good or bad, completely ignorant of the fact that she can't have them all. There's a reason I tell people they need to ask all the questions on this list from a prospective loan provider. It's not a simple matter of shopping your loan until you get everything on a shopping list. Some things do not go together at all, like negative amortization loans without a prepayment penalty. In all cases, there are tradeoffs between A and B, C and D. You decide which you want more, or which you don't want more, or, in the case of points and cost vs. rate, where on the spectrum of the tradeoff between rate and cost you want to be. Some providers may give you a better set of tradeoffs than others, but those tradeoffs still exist, and pretending they don't is a good way to end up with a putrid loan. Somebody will tell you about a loan that doesn't exist in order to get you to sign up with them.

Before you can ask the questions, however, you've got to let a professional have a reasonable chance at figuring out the best loan for your situation. In order to do that, you've got tell them enough information so they know what your situation is. Then you can ask those questions and give me the third degree, and if you're smart, you're going to shop it around until you get a couple or three different opinions, and cross check the information each provides against the other. You might still get conned, especially if you don't make the effort of comparing and cross-checking answers. But as I went over in The Ultimate Consumer Horror Story, if you won't talk to sales persons, as in real conversations, I can pretty much guarantee you're coming away with your own private version of the Nightmare (mortgage) on Elm Street.

Caveat Emptor

I got a search for "which states allow prepayment penalties". I'm not aware of any that don't. If you are, I'd like to know. Any such states should immediately be renamed "Denial".



I really hate prepayment penalties, for a large number of reasons. Nonetheless, to make them illegal would not be in the best interests of consumers.



Let's examine why. Let's consider a hypothetical couple, the Smiths, who don't have much of a down payment, and have difficulty qualifying for the loan. They want to become owners rather than renters, and it is in their best interests to do so.



The cold hard fact of the matter is that nobody does loans for free. Real Estate loans are complex creatures, and they don't just magically appear out of some hyperspatial vortex upon demand. I may cut my usual margin by half if I'm the buyer's agent as well, but that's because I've found I'm going to do a large portion of the work anyway, have to ride herd on the loan officer, and stress out because it's a major part of the transaction that can really hurt my clients that is not only not under my control, but I cannot monitor with any degree of confidence I'm being told the truth. I keep telling folks that the MLDS or GFE don't mean anything. They are not contracts, they are not loan commitments, they are not the Note or Deed of Trust, and they definitely aren't a funded loan. They are supposed to be a best guess estimate of your loan conditions, but with all the limitations and wiggle room built into them, the regulators might as well not have bothered. By themselves, they are worthless. None of the paper you get before you sign final loan documents means anything unless the loan officer wants it to. Unless the loan officer guarantees it in writing that says that someone other than you will eat any difference in costs, what you have is a used piece of paper with some unimportant markings on it. If I, as a better more experienced loan officer than the vast majority of loan officers out there, cannot monitor what another loan officer is doing with any degree of confidence, do you want to bet that you can?



So we have some folks who can just barely stretch to do the loan. In order to buy them a little space on their payments, so that any bill that comes in isn't an absolute disaster they cannot afford, and also so I can get paid without it coming out of the money these people don't have, I talk to them about the situation and we all agree to put a two year pre-payment penalty on the loan. This buys them a lower rate with lower payments, without adding anything to their loan balance. They don't owe any more money, they get a lower rate, I get paid, and they didn't have to come up with money they don't have. Everybody wins, whereas without the prepayment penalty they would be paying $200 per month more, and perhaps they couldn't qualify. No loan, no property, no start to the benefits of ownership. They certainly wouldn't have that $200 per month cushion that's likely to save their bacon from their first emergency. Leaving aside for a moment the issue that most folks want to buy more house than they can afford, that really stinks from the point of view of the people that those who would outlaw prepayment penalties altogether say they are trying to help, those who are trying to buy a home and just barely qualify.



Many folks have a long mortgage history, and they are comfortable in the knowledge that they will not refinance or sell within X number of years. They're willing to accept a pre-payment penalty in order to get the lower rate. They want that $200 per month in their pocket, not the bank's, and they are willing to accept the risk that they may need to sell or refinance in return. After all, if they don't sell or refinance within the term of the penalty, it cost them nothing. Zip. Zero. Nada. For all intents and purposes, free money. I may advise against it, but it is their decision to make or not make that bet, not mine, not the bank's, not the legislature's, and definitely not some clueless bureaucrat's, let alone that of some activist who only understands that lenders make money from them, and not the benefits that real consumers can receive if they go into it with their eyes open.



Pre-payment penalties get abused. Badly abused. I know of places that think nothing of putting a three year pre-payment penalty on a loan with a two year fixed period. There is no way on this earth anyone can tell those folks truthfully what their payments will be like in the third year. I may be able to tell them what the lowest possible payment could be, but not the highest. I've seen five year prepayment penalties on two and three year fixed rate loans, and that situation is even worse. I've heard of ten year prepayment penalties on a three year fixed rate loan. I've seen even A paper lenders slide in long prepayment penalties on unsuspecting borrowers that mean they get an extra six or eight points of profit when they sell the loan. So there are some real issues there.



With this in mind, there are some reforms I could really get behind. The first is making it illegal for a prepayment penalty to exceed the length of time that the actual interest rate is fixed. Regardless of what the contract says, once the real interest rate starts to adjust, no prepayment penalty can be charged (This means no prepayment penalties on Option ARMS, among other things). The second is putting a prepayment penalty disclosure clause in large prominent type on every one of the standard forms, and making it mandatory that the loan provider indemnify the borrower if the final loan delivered does not conform to the initial pre-payment disclosure. In other words, if I tell you there's no pre-payment penalty and there is one, I have to pay it for you. If I tell you there's a two year penalty, and it's a three year penalty, I have to pay it if you sell or refinance in the third year (in the first two years, it's your own lookout because you agreed to that from the beginning).



But to completely abolish the pre-payment payment penalty is not in the best interest of the consumers of any state. Show me a state that has abolished them completely, and I'll show you a state that has hurt its residents to no good purpose. Sometimes there is a good solution to a problem, as I believe I have demonstrated here. It's just not the first one that springs to mind.



Caveat Emptor.