Intermediate Information: June 2007 Archives
what is a underwriter final "sign off" on the conditions
First off, it needs to be mentioned that a good loan officer gathers information and puts a full package, with all of the information an underwriter should need, before submitting the package to the underwriter. That's how you get loans through quick and clean. Give the underwriters all of the information you know they're going to need right up front.
Some clients don't understand this. They want to hang back and see if the basic loan will be approved before they do "all of this work." This is a good way to have to work much harder on the loan. Give it all to them in one shot, and they only look at your file once. You get a nice clean approval. The issue is that every time that underwriter looks at your file, there is a chance they will find something else that they want documented, some little piece of the picture they are uncomfortable with. The underwriter can always add more conditions. The cleaner the package, however, the less likely it is that they will.
There are some matters it's okay and routine to bring in later. Appraisal is probably the most universal of these. Title commitment (aka Preliminary Report) is probably second most common. These are completely independent of borrower qualification, and when they come in later, will generally not cause the underwriter to re-examine the whole file. But you want to submit the borrower's package as complete as possible, right up front. If the borrowers pay stubs show up later, the underwriter will look at the file, and if the income they document is even one penny less than the initial survey of the file, they will underwrite the whole thing again. A good loan officer submits complete packages, so the file only gets looked at once.
But every loan officer gets asked for additional conditions from time to time. With the best will in the world, sometimes they are going to miss something that the underwriter is going to want to see in this particular instance.
Loan conditions fall into two kinds: "Prior to documents" and "prior to funding". "Prior to docs" conditions are related to "Do you qualify for the loan" type stuff. Income documentation, property taxes, existing insurance for refinances, verification of mortgage, rents, employment, deposits, all of that good sort of stuff. Also appraisal, title commitment, etcetera. If there's something missing in the loan package, it should be a "prior to docs" condition. These conditions should be taken care of between the loan officer and the underwriter. The underwriter tells the loan officer what needs to be produced in order to approve the loan, and the loan officer goes and gets it. If the loan officer can't produce it, there is no loan.
This is not to say that a good loan officer can't necessarily think of another way to get the loan approved. Indeed, that's a significant part of being a good loan officer, almost as big as knowing what loans won't be approved, and not submitting a loan that won't be approved. This is a big game with many loan providers, by the way. They get you to sign up with quotes they know you won't qualify for, but when the loan is turned down (or, more commonly, the conditional commitment asks for something that the situation can't qualify for), they then tell you about the loan they should have told you about in the first place. Pretty sneaky, huh?
Getting back to the underwriter's conditions, a good loan officer knows how to work with alternatives. But at the bottom line, the loan officer has to come up with something that the underwriter will approve. It is the underwriter who has final authority. They write the loan commitment, which is the only thing that commits the money. In fact, most loan commitments are conditional upon additional requirements. The only universal to getting these conditions signed off is that the underwriter has to agree they have been met. As the underwriter agrees that the conditions have been met, one by one, the loan gets closer to final approval.
When the last prior to docs condition is satisfied, the loan officer orders loan documents. This is also when many of the less ethical of them actually lock the loan quote in with the lender. An ironclad rule is that if it isn't locked with the lender, it's not real, but that doesn't stop many loan officers from letting the rate float in hopes of the rates going down so they make more money for the same loan. Of course, if the rates go up, guess who gets stuck with the increase? It's not likely to be the loan provider.
When the loan documents arrive, the borrowers sign them with a notary and that's when the rescission clock begins. There is no federal right of recission on investment property, and none on purchases, but on owner occupied refinancing, there is (Some states may expand on the federal minimums).
Now there will be "prior to funding" conditions to deal with. "Prior to funding" should be reserved almost exclusively for procedural matters, and should be taken care of primarily between the escrow officer and loan funder. There are always going to be procedural conditions here, but many lenders are now moving more and more conditions to "prior to funding" as opposed to "prior to docs". Why? Because once you sign documents, you're more heavily committed. Psychologically, once most people sign loan documents they think they're all done. This is not, in fact, the case. Legally, once the right of rescission, if any, expires, you are locked in with that lender unless/until they decide your loan cannot be funded. Once rescission expires, you no longer have the ability to call the whole thing off. You are stuck.
This is not to say that an occasional condition can't be moved to "prior to funding." Especially on subordinations. I've saved my clients a lot of money by getting subordination conditions moved to prior to funding so the rescission clock will expire in a timely fashion to fund the loan within the lock period.
This is all well and good if the lender told you about everything and actually deliver the loan they said they would, without snags. On the other hand, I have stories. One guy I used to work with had the capper, and the reason he got into the business was he was certain he could do better. He signed documents on a purchase, and a week later they called and told him he had to come up with $10,000 additional money within twenty-four hours, or lose the loan, the property, and the deposit, and be liable for all of the fees. His father had to overnight him cash, which he then took into the bank for a cashier's check.
He is only the most extreme example. The loan is not done until the documents are recorded with the county. Until that happens, the money does not have to come, and even if it does, the lender can pull it back. One procedural thing that happens with literally every loan is a last minute credit check and last minute call to the employer to be certain you still work there. If the borrower has been fired, quit, or has retired, no loan. If the borrower's credit score dropped below underwriting standards, no loan. If the borrower has taken out more credit, the lender will then send the file back to the underwriter to see if they still qualify for the loan with the increased payments. So like I tell folks, until those documents are recorded, don't change anything about your life.
The many less than ethical loan officers don't help matters any. I was selling a property a while back, and the buyer signed documents on Tuesday. If I had been doing the loan, the loan would have funded and the documents recorded the next day. Unfortunately, I wasn't doing the loan. This guy's loan officer had quoted him a loan he couldn't qualify for, and ten days after he signed documents, I got a call saying he could only qualify if I knocked $20,000 off the purchase price. I kept the deposit and went looking for another buyer. This guy learned an expensive lesson. When you sign loan documents, require your loan officer to produce a copy of all outstanding loan conditions. Don't sign until and unless you get it. This guy had signed, and was now locked in with a lender who couldn't fund the loan on conditions he could meet. I had even warned his agent (I accepted the offer because I was willing to sell at that price, so I wanted the transaction to go through), but hadn't been believed. So both of us ended up unhappy.
If they give you a copy of all outstanding loan conditions, you should know if you can meet them. If you can't meet them or aren't certain, don't sign. Don't hesitate to ask for explanations. Some of this stuff gets pretty technical, but a good explanation should be easily understandable in plain English. It may be complicated, but there just isn't anything that can't be explained in plain English. If the explanation you get is gobbledegook, you've probably been lied to all along, and I hope you have a good back up loan ready.
When you have more than one loan on your property, there are some issues you should be aware of. Keep in mind the fact that some states still use the mortgage system, requiring court action to foreclose, as opposed to Deed of Trust, which does not. For practical purposes they are similar, yet I have never done significant work in a mortgage state so there may be small but significant differences.
Each loan is secured by a different Deed of Trust. Two loans, two Deeds of Trust. A Deed of Trust is a three way contract between the borrower (called the trustor), the lender (called the beneficiary), and a third party known as the Trustee, to whom title is nominally conveyed for purposes of selling the property if you default on the loan. The Trustee and the Beneficiary are often the same, and there while there is no legal impediment I'm aware of to the Trustor and Trustee being the same, I also cannot imagine a lender agreeing to it.
Trustees can be changed, and this is accomplished via a document known as "Substitution of Trustee," which is required to be recorded with the appropriate county in every state I've done business in.
Each Trust Deed operates independently of all others there may be against a given property. They take priority in order of date. When a Trust Deed is recorded against an property on which there already is an active Trust Deed, it automatically becomes a Second Trust Deed, if another happens it is a Third Trust Deed, and so on.
The reason they have the ordinal is because they are paid off in the order they happened. Suppose the property is sold, and the sale price is not sufficient to pay all of the debts. The trust deeds are not paid proportionally; The First Trust Deed is paid off in full before the holder of the Second Trust Deed gets a penny. Then the Second is paid before the third, and so on. This is why Second trust Deeds carry higher rates than First, because they are riskier loans for the lender. As I've said elsewhere, just because the property is sold doesn't mean you're clear. If there is not sufficient money from the sale to pay all debts, you can expect the lender to hit you with a form 1099, reporting that you have income from debt forgiveness, and you will be expected to pay taxes on it.
Now, if for whatever reason you pay off your First Trust Deed, the Second automatically goes into the first position, and any subsequent loan goes into second position. This is most common when people go to refinance the loan secured by their First Trust Deed. Even if you do not particularly want to pay off your Second Trust Deed, it may be the best thing to do. Because what happens if you just pay off the First Trust Deed (only) and get a new Trust Deed, is that the new Trust Deed will go into the second position. Unfortunately, in order to get the quoted rates for a primary loan, it is a requirement that the loan be in first position. If it's not in first position, they will not actually fund it. In short, no loan.
This is not necessarily an impasse. Many times, the holder of the second trust deed, because their loan was priced to be second in line anyway, may agree to Subordinate their loan to the new loan, which is a fancy way of saying stand in line behind the new trust deed holder.
They don't have to do this, and there is no way, other than paying off their loan in full, to force them to do so. Some companies never subordinate, while some others are never willing to stand second in line at all, and others are in both categories.
For those that will consider it, they are going to stipulate some conditions. First of all, the new loan is likely going to have to put the borrower into a position where it is easier, or at least no more difficult, to make payments and pay off the loan. So monthly payment usually cannot rise.
Second, they are going to want their trust deed to be in no worse of a position than it was when the loan was originally approved, as regards the value of the home being able to pay their loan off too if for some reason either loan is defaulted. They may even require than you agree to a higher rate, higher payments, or a different loan altogether - as I said, there is nothing you can do to force them to cooperate.
Assuming that they are willing to cooperate, they will require that the entire process on the prospective new loan be essentially complete - that is, ready to draw documents and fund when the Right of Rescission expires after three days, before they will even look at it. Some lenders take 48 hours to look at a subordination request, others take up to six weeks, and it can be even longer. For any given lender, it takes as long as it takes.
There is also going to be a fee involved. They have to pay their people to look at the loan situation and make certain it still falls within guidelines. They're the ones doing you the favor, they certainly are not going to do the favor for free. Whether the Subordination request is eventually approved or not, the subordination fee is likely to be non-refundable, a sunk cost that you are not going to get back even if it's not approved.
Even more important than that, however, subordination takes time. No loan quote is real unless locked, all locks are for a specified period of time, no lock is good past the original period of time unless you pay an extension fee, and if you need to lock for a longer period of time in order to subordinate, either the rate, the cost, or possibly both will be higher. Since this can add anywhere from two days under idea conditions to six weeks or more for a refinance that takes three weeks to get approved and get funded in the best of times, this means a longer lock period becomes advisable. Most often, the extra costs mean that it's more cost effective to just pay off both loans rather than subordinating the second to the new loan.
Since Home Equity Lines of Credit are always secured by a trust deed, they count as any other second mortgage would. You'd be amazed how often people do not disclose Home Equity Lines of Credit even when directly asked about them. They are only hurting themselves, but they often get angry to no good purpose when, if they had been upfront about them, the loan officer could have designed around any difficulties. Furthermore, people are often resistant to the idea of paying off and closing Home Equity Lines, despite the fact that they are easy to get. I've had people stonewall, utterly in denial that this is a Deed of Trust opon their residence until I have the title company fax me a copy of the Trust Deed, and reference it with the Preliminary Report, and ask to see the Reconveyance (which is a fancy way of saying the piece of paper proving that the trust deed has been paid off). If it's a legitimate lien, we have to deal with it. Actually, we have to deal with it if it's not a legitimate lien as well, just in a different manner. On the other hand, about eighteen months ago I had some seasonal resident clients whose ex-caretaker had managed to take out a loan against the property. It does happen, and it's a mess, but most times it's just the people themselves who weren't told - and didn't figure out - that this financing agreement they signed for the pool or air conditioner or roof was a second trust deed on their house.
To summarize then, second loan means second trust deed, if you refinance they must be paid off or subordinated, and subordination takes time such that it may be better to pay it off than go through the rigamarole of subordination.
One thing that is very common in the mortgage industry is masking loan costs by rolling them into your loan balance. People are less sensitive to being asked to roll this money into their loan balance than they are about writing a check out of their bank account. In the latter case, everybody understands that this is money you busted your backside to earn and save. In the former case, a lot of folks don't understand that the money is every bit as real.
Indeed, one of the standard ways to deflect questions about cost that seems to get taught to every loan officer by every loan provider is the phrase, "Nothing out of your pocket." Sounds like they mean there's no cost. That's not what it means. What it means is that they don't want to talk about what the loan is really going to cost, as they're going to have to do if you're writing a check. Therefore, they want to roll it into your balance on the refinance. Most people in most situations have had their property value increase since the last time they got a loan, which likely means there's plenty of equity to cover it.
For purchases, you can't really do this because your value is never more than the purchase price. There are only three places for loan costs to come from: Your pocket, your down payment, if you have one, which reduces to your pocket, and Seller Paid Closing Costs. Seller paid closing costs are an agent and loan officer favorite, because it makes it look like you're not paying them, even though you are. If nothing else, a smart seller would rather take $10,000 less in purchase proceeds than pay $10,000 of buyer's closing costs, on which they are going to pay commissions and taxes to boot.
This trick of making it appear like you're not paying closing costs is one of the best ways to get stuck with an awful loan, but most folks won't do the research until after they've already gotten burned. You are paying those costs in one fashion or another, I personally guarantee it. There is more than one way to pay them, but if you don't know how you are paying them, you are probably not paying them the way you want to, and you're almost certainly paying too much, to boot.
There is ALWAYS a trade-off between rate and cost in real estate loans. It can be very intelligent to pay some or all of your closing costs by accepting a higher rate, especially if you don't plan on keeping the loan very long. If you know you're going to sell or refinance within a few years, or think it likely that you will, it's likely to save you money if you accept a higher rate that has lower costs. On the other hand, if you're 100 percent certain that you're going to keep this particular thirty year fixed rate loan the rest of your life, sinking a couple of points into reducing the rate can be an excellent investment. However, be aware that if you later decide to refinance or sell after all, you're not going to get your previously sunk costs back.
People get talked into rolling multiple points into their loan because it reduces their rate, and therefore their payment, aka the check they're writing every month. Let's consider two rates and the associated costs I quoted earlier today, on a maximum conforming loan, thirty year fixed "A paper" (those rates are gone now, whether tomorrow's are higher or lower). 6.5 percent was 1.5 points, or $6255 in real money, plus about $3400 in total closing costs when you consider title and escrow and appraisal. You'll find a lot of loan providers will go a long way to avoid quoting you the actual cost of points in dollars. But at 7.00 percent, I could give them back about 15 basis points, or $625, towards reducing their closing costs of about $3400. So assuming a $417,000 loan, this person would really get:
However, that's dodging the real purpose of this essay. Suppose a loan officer was to pretend that these costs didn't exist when quoting you their loan rate. Their loan would appear to be cheaper, so that you would be very likely to sign up with them, but when the facts became apparent later on - that those costs exist in reality, whether your loan provider tells you about them up front or not - you're likely to continue with their loan anyway, because you don't have time to get another loan for one reason or another, or you just decide to stick with what you've started.
Furthermore, by pretending you don't have to pay loan costs, that makes it easier to get you to accept outrageous ones. Suppose your choices were to pay that $9700 in points and closing costs to get that 6.5% rate in cash, or you could pay $15,000 by rolling it into your loan balance. It is a sad fact that most people don't understand that this is about a point and a half more in costs that are every bit as real as dollars coming out of their checking account. However, most people are a lot more careful with dollars in their checking account because they understand that those dollars are real money. They had to earn it, dollar by dollar - in the form of so many minutes out of your life per dollar if you earn an hourly wage. Then they had to not spend it right away, as soon as they got their pay! Most folks figure they have something to be proud of if they save ten percent of their pay, but if you make $5000 per month, it takes over a year and a half to save $9700 if you save 10% of your gross pay. They understand that $9700 in terms of the nineteen months of their life it took them to save it. If they're just rolling it into the balance of their mortgage where it's being paid for by the fact that the home increased in value, it may be more than half again as much money, but a lot of folks somehow think it's not as real, and they'll accept rolling it into their balance much more readily than writing a check. It doesn't matter if you're writing a check or putting the money into your balance - a dollar is a dollar. By accepting the higher cost loan, not only are you wasting over $5000 of your money, but you're paying interest on it in the meantime.
If it's an expensive loan, it's an expensive loan, whether you're rolling it into your balance or out of your checking account. If you're paying too much money by rolling it into your balance, you're still paying too much money, and it's at least as bad as if you wrote a check or even counted out the cash. Doesn't matter whether you're writing a check or rolling it into your mortgage balance. So before you sign that loan paperwork, ask yourself if you'd be as happy with that loan if you had to write a check for every single dollar, or even count it out $20 at a time like an ATM machine. Chances are you'll be a lot more careful with your hard earned money.
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 , by itself, doesn't mean anything. It is not a contract, it is not a loan commitment, it is not a Note or Deed of Trust, and it definitely isn't a funded loan. It is 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 itself, it is 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.
When my husband and I bought our home 2.5 years ago (two bedroom condo) we qualified for the loan ($250,000) based on both our incomes. Then I had a baby and stopped working. We've never missed a payment or even been late, and we're getting by just fine by being frugal. However, our loan is a 5/1 ARM, and I'm skeptical of our ability to pay the adjustable rates once our fixed years are over. Our original plan (when we got the loan) was to see about refinancing at the end of those five years. (Five years worked well for us because my husband was still in school and we knew we'd be here about that long, if not longer.) However, now that we no longer have my income, all the mortgage calculators online are telling us that we can afford a loan of just about half the value of our home. What do we do in a situation like this? Is it possible to do anything other than sell our home once our five years are up?
A few other (maybe) pertinent details: currently we're paying interest only on our first mortgage (4.75%) and a principal and interest payment on our second mortgage (8.75%) Our home has gone up in value since we bought it, and we've made some improvements as well. Likely selling price right now (based on comparable properties that just sold in our area) is $325,000 to $340,000.
What do you think?
The first thing I want to ask someone in this situation is "How long do you have until reset?" The second would be, "Are you going to be able to afford the payments when it hits reset?" These two answers I'm fairly certain of, looking at the information provided. The third would be "Do you intend to change something about the situation before that time?" and "What's your market trends?" would be the fourth. In San Diego, I know the answer to four, but three is a guess, and you're not in San Diego or close to it.
You have the loan. It is already funded. You have lived up to all the qualifications you agreed to in order to get it funded. You don't have to do anything other than make the payments in order to keep this loan. If this were a 30 year fixed fully amortizing loan that you were already making the payments on, there would be no reason for you to do anything, because I certainly can't beat that rate today. Nobody can. If you have already got the loan and you can afford it indefinitely, you don't have a problem.
Unfortunately, that's not the case here. You're fine for now, but not forever. You have a known time approaching at which point you will be unable to make your payments. To make matters worse, there's no way to get that good of a rate now and it's not likely that there will be before your initial fixed period expires. That's the worst news.
The mildly bad news is that you're not paying your balance down much. Assuming you're not paying anything extra, you're not going to pay that $200,000 interest only first down by anything, and you've only paid the $50,000 second down by about $1000 now, and you'll only pay it down to about $47,800 by the end of the fifth year.
The mildly good news is that you've got 2.5 years left to do something with. You could go back to work, and if you do so now, you'll have two years continuous same line of work before the 5 years are up. Assuming you make as much as you used to, you should be able to afford the property.
This 2 1/2 years is time on your side. I keep telling folks time makes a great ally or a horrible enemy, but it's never neutral. Right now, it's on your side - giving you time to do something to change the situation. Once the adjustment hits, or even gets close, time will become your enemy. Don't waste time, but right now it is on your side.
The really good news is that your market has gone up, and you have a good amount of equity. This is about as surprising as gravity, but it is still good news. You're under 80% loan to value ratio if the numbers you gave me are valid. I wouldn't touch your loan right now, if I were you, but if you were in a sub-prime situation to start with, chances are good that you'd be A paper by now. You've got a 5/1 A paper loan with plenty of the initial fixed period left - but there's a lot of folks out there with 2/28 C paper. Especially if your adjustment had already hit, moving from 8% adjustable to a 6.5% thirty year fixed A paper without points (as of when I'm writing this) makes a lot of sense. Even if you don't want to sell o refinance now, know that that kind of equity means you've got some breathing room if you've got to have it.
The bad news is that if you sell, you're going to sacrifice some of that equity. It costs money to sell property. Assuming yours sells for $325,000, you'd probably only net roughly $299,000, of which your loans would eat $249,000, leaving you with $50,000 in your pocket. Right now, a lot of places are in a world of hurt for trying to sell, so your could be out more than that and still have to take a lower price in order to get it sold. If your condo was in San Diego, for instance, you'd be doing extremely well to net $35,000 from an actual sale right now, even if your condo really was worth $340,000. The condo market is just saturated with conversions. I think this will change soon enough to surprise a lot of people, but I don't know for sure.
Let's assume that you don't intend to return to work. If your loan was adjusting any time in the next year, it would be time to sell. However, you've got some time. If your market doesn't look like it's in danger of collapse, I'd probably wait. I don't know about where you are, but here in San Diego, I'd bet the market is going to be better for sellers next year than it is now. Most likely, more than enough better to justify waiting. If your market is just peaking, however, you've got a real issue, and you might want to get out now before you've lost all of your lovely equity.
One final possibility is planning to wait and refinance, doing the loan "stated income", telling the lender that you make more money than you do. This is dangerous. Quite aside from the fact that you are intentionally defeating one of the most important safeguards for your protection as well as the bank's, this is not what stated income was intended for, and you need to be careful that you're actually going to be able to make the payments without going backwards (in other words, no negative amortization). Better would be a fully amortized loan, but since you're already in the property, interest only is acceptable. If the situation is at least stable, why incur the costs of selling while the property meets your needs? However, at this point we do not know what the rates will be two and a half years from now. I don't know what the maximum rate you could afford is. I think 5/1 loans are going to stay about where they are now, in the low 6s. Can you afford even an "interest only" payment on a 6% loan ($1250/month on $250,000), which is roughly 1/3 more than you're paying now? 6.5%? 7%
This isn't a situation that can be tackled using only numbers, but the situation is not likely to be sustainable as it sits. You do have some choices on the table. The three most obvious are that you can go back to work, your husband can start making more money, or you can start making plans to sell the property. Any of them beat the default option, which is "do nothing and let the situation ambush us when time is up." And if you decide it's likely you'll be able to afford to refinance, keep an eye on rates. I think 30 year fixed rate loans are going up to the low 7s, but that's just a projection of where I think the capital markets and our economy are going. I could be very wrong. There is a point at which you will be unable to afford your property. If rates hit that point, your choices become basically, "Start the sales process now or wait?"
Figures don't lie, but Liars Sure do Figure!
With the loan rates being significantly higher than they were a couple of years ago, we've got a lot of people with loans in the low fives, interest rate wise. One of the tricks lenders are using to persuade them to refinance is Weighted Average Cost of Capital, which really does take a page out of corporate finance books, but ignores a lot of details and alternatives.
This was an actual example that someone put online as an argument to refinance:
$350,000 first at 5.25%
$100,000 second at 8.5%
$50,000 consumer debt at 12%
This person then used standard practice to compute a weighted average cost of capital of 6.575, and justify refinancing all of it into a new first at 6.25%. They also assumed a tax bracket of 40%, which is a little higher than most folks pay, even with state tax figured in. Furthermore, it just took for granted the fact that there's enough equity in the property to absorb the full amount of excess debt without PMI. Robert Heinlein introduced me to this kind of attitude in Stranger in a Strange Land, calling it "straining at flies and swallowing camels," which is an apt description of what's going on, which is basically theater.
What's really making the calculation work in favor of refinancing is that $50,000 at 12% without deductibility, and assuming a tax bracket higher than most people are in. Even the top federal bracket is 39.6%, so if you live in a state without income tax (quite a few), the article was overstating any possible current benefit. Furthermore, those states without income taxes tax mortgage loans on the basis of size, some of them pretty steeply. I just got an email from someone in one of those states back east, and for a mortgage under $250,000, the state was charging about $7000 in taxes. That's almost a 3% surcharge on the base mortgage, and if you're going to roll it into the balance, you're likely to be paying points up front. You're also paying interest on it basically forever.
Doing the calculation on the basis of pure interest rate calculation, like the manuals teach (I've got an accounting degree) ignores the costs of consumer loans. For corporate transactions, the costs are built into the the interest rate of the obligations. For consumers, this is not the case. You're going to be paying thousands of dollars for the privilege of refinancing - points and fees, and in many states, taxes. As I've made clear in the past, there is ALWAYS a Tradeoff between Rate and Cost in Real Estate Loans, and the standard WACC computations do not include cost of the loan in whether it's worthwhile, only the rate. This makes it seem like the rate with three or four points is necessarily better than the rate with none, when in reality it's likely to take eight to ten years before the lower rate pays for its cost in terms of interest savings. Most people will never keep a given real estate loan that long in their lives.
Now just for a moment, let's give the author of that article everything they're asking for. In order to be able to absorb this debt without PMI, the property has to be worth $625,000 minimum, plus 125% of whatever fees and prepaids get rolled into the balance.
What this means is that I could, without touching that 5.25% first, refinance that second into a 30/15 at around 7.25%, and still get paid half a point yield spread to do a very easy loan that costs the consumer less than $1000 all told. You see, not only do we get a price break for the bigger equity loan, but because it's only 80% Loan to Value Ratio (actually CLTV), and so we get a price break of
$350,000 at 5.25%, 40% aggregate tax bracket, 70% of the loan, =2.205% contribution from this
$150,000 at 7.25%, 40% aggregate tax bracket (on 2/3) 20% of loan = 0.870% contribution
$150,000 at 7.25% non deductible on 1/3 10% of amount =0.725%
2.205%+0.870%+0.725%=3.8% weighted average cost of capital, which essentially ties the projected 3.75% on 6.25% which is 40% deductible, but the lowered cost more than covers the difference in interest - $250 per year - for ten full years, just based upon the difference in closing costs, never mind points or cost of interest on the increased balance.
So why do loan officers push a full refinance when there are better options? Quite simply, they make a lot more on first mortgages than second, so it's in their best interest to make it seem like refinancing a first is in your best interest, even when it clearly is not. Second mortgages are something I'll do for existing clients, but it's not business I chase because I just can't make enough to make it worthwhile, and chances are that a credit union is going to do about as well as I can. First mortgages, however, are a different matter - and not just for me. The projected first mortgage would make me roughly 7 times what that second does, and my margins are low by comparison with the rest of the industry.
Because of facts like this, you need to know enough to think about alternatives like refinancing a second and leaving a low interest rate first untouched. This is also why you need to talk to more than one potential provider, to increase your chance of getting one of them to give you a better way of doing things.
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