Intermediate Information: July 2007 Archives

On of the biggest time and money wasters in real estate is people that apply for the wrong loans - loans that they can never qualify for because they can't meet the guidelines, or can't prove they meet the guidelines, which amounts to the same thing. Often, loan officers are the worst offenders, judging by the people who come into my office with messes for me to clean up. They don't know how to submit a loan, or they know full well it won't be approved, but they get you to sign up by dangling this carrot, and then snatching it away, but now they've got you working with them and they end up with your business because they told you a fairy tale that sounded better than what the other guy talked about because he restricted himself to talking about loans he could actually deliver.



How do you know what mortgage market is best for you?



There isn't a cut and dried answer unless you're one of those folks who can qualify "A paper" full documentation. If you can do it, and a lot more folks can qualify this way than think they can, A paper full doc is the way to go. Because it's the least risky loan, the banks give you the best pricing. What if you can't make it, however?



The reasons why people fall away from A paper full doc is long. The two largest ones, however, are people who cannot prove they make enough money and people whose credit score isn't high enough. At a distance from that, the third reason why folks don't qualify, is late payments. A paper permits one thirty day late on the mortgage, or two on other credit. If you fall off the pace due to late payments, you have to go subprime.



A paper accepts only two ways of proving your income: Income tax forms and, for some employees not in construction or on commission, w-2s and year to date pay stubs. If, with the income taken from these forms does not qualify you according to A paper debt to income ratio considering your known debts (typically 45% back end ratio, but I've seen high seventies get accepted in some circumstances), you do not qualify full documentation. Think of full doc as being where you prove you're got enough income to make your payments. If you can't do full documentation, you have to go to stated income.



A paper also requires an absolute minimum credit score of 620. 619 is an automatic rejection from any A paper program out there. Some A paper may require higher credit scores (640 jumbo, 660 stated income, 680 for both), and if you haven't got it, you don't have the loan, either. If you don't have the relevant credit score, you're going to subprime.



A paper stated income is where you've got a good credit score and can prove that you've got a job (or a source of income) and you've had it for two years. You just can't prove you make enough money to justify the loan. You could be making it, though, and the lender agrees not to verify, although they will look at it to see if the income you claim is consistent with your profession. You're paying your bills on time, though, so lenders are willing to believe that you're living within your means, and therefore qualify for the loan. They are not agreeing to close their eyes if something indicates you cannot afford it or what your real income is; they're just not going to go out of their way to verify your income. They are going to have you sign an IRS form 4506, releasing your taxes to them. Don't worry too much about it. The IRS takes a minimum of 60 days to respond, and the loan will be done in thirty, if your provider is competent, and it's not fraud to overstate your income on a stated income loan. Dumb, maybe; fraud, no. The major reasons why "A paper" stated income falls out are low credit score, insuffient time with your source of income, and incompetent loan officers who allow the underwriters to find out that the client doesn't make that much. Low credit score goes to subprime, insufficient time in line of work goes to NINA, and loans with incompetent loan officers start over with another lender.



A paper NINA is a loan driven by the credit score and the situation you find yourself in. There is no debt to income ratio, and the personal qualification consists of a good credit report. Of course, you still have to have the appraisal and the rest of the documentation relating to the property. Furthermore, the rates are higher than stated income (which is in turn higher than full documentation), and the maximum Loan to Value Ratio is lower. Common fallouts are credit score too low (go to subprime), loan to value ratio too high (go to subprime) and something wrong with the property (go to hard money)



Subprime is an entirely different world than A paper. The standards are different, the qualifications are different, everything is different. Just because you can't go full documentation A paper doesn't mean you can't do it subprime. For one thing, typical subprime goes up to fifty percent debt to income ratio, and a few lenders will go higher - some as high as sixty percent! So even though the rates are higher, it may be easier to qualify.



Subprime also has another form of accepted income documentation: bank statements for the last six, twelve, or twenty-four months. When I started, this was always discounted, but of late personal bank statements have been accepted on the strength of 100 percent of the income they show. This rate will be higher than a borrower who can prove their income via one of the A paper methids, but is lower than stated income. Number one reason for falling out of subprime full documentation: Not enough income. Number two: sub-500 credit score. Number three: the underwriter believes that you manipulated your income on your bank statements. Not enough income goes to stated income subprime (with another lender, as if it was submitted full doc it cannot go stated income with that lender). Sub 500 credit score goes to hard money, which is where you might as well start when you find out, because regulated lenders can't touch you if you don't have at least one of your three credit scores above 500. If the underwriter thinks you manipulated your income, you or your loan officer have either got to convince them you didn't, which usually requires w2s at least, or you are going to another lender.



Subprime stated income is fairly wide open, with the proviso that a given credit score will have a higher rate and a lower maximum permitted loan to value ratio. Number one reason for falling you here is that you don't meet loan to value guidelines. Number two is you didn't state enough income in the first place, and you don't qualify by debt to income ratio guidelines. Number three is you stated too much income, and the underwriter doesn't believe you make that much money. They can always require income documentation - they don't have to let you state it without verification. At best, anyone suffering from any of these three problems can expect to have to go to another lender, because this lender will not now approve their loan. Maybe lose a little time if you're working with a broker who then submits the package elsewhere. Back to square one if you were working with a direct lender.



Subprime NINA is even more wide open. A loan officer has got to be a serious bozo to blow this one, but I clean up behind ones that went bad on a distressingly frequent basis.



Hard money is the last hope of the unfortunate. These folks don't care about your income, your credit score, or anything else. What they care about is that they can sell the house for enough to cover the loan if you default, and unlike regulated lenders, they will record that Notice of Default on the day you become eligible. Sometimes they are the only choice, but if you find yourself dealing with them you should really ask yourself if this loan is something you absolutely have to have, or if you just want it. If the answer is the latter, my advice is to reconsider getting the loan.



There you have it, something like a flowchart of what kind of loan you should apply for. These are far from the only reasons loans fall apart, of course, but they are the most common. A good loan officer knows enough of the tricks and traps to tell you the truth straight off, and apply to the appropriate loan first, without wasting your time and money. Bad ones don't.



Caveat Emptor.

This is definitely not a "Who you gonna call?"



I've done a couple articles in the recent past on the two ratios, debt to income and loan to value. Nonetheless, there exist a plethora of reasons why someone can be turned down for a loan even though they make it on the ratios.



The first of these is time in line of work. A paper looks for two years in the exact same line of work. One change that trips a lot of people is going from being employed by a company to being self employed in the same line of work. Believe it or not, a promotion can also sink a loan if your job title changed, for instance from salesperson to sales manager. If it was with the same company, it can sometimes be okay, but if you changed companies to get the promotion, that's a really tough loan. Subprime loans will accept shorter time periods.



Making payments on time is probably the biggest deal buster for A paper. In general, you are allowed no more than one mortgage late, or no more than two other lates. The reason does not matter. It does not matter how justified you were in not paying. The fact remains that you are reported as being late. The only way to remove them is for the company to admit it was in error in reporting you late. Many people will not pay the charge as it gets marked later and later and later. This is self defeating. Pay it now, dispute it afterwards. Yes, it's harder to get your money back - but the money it saves you on your home loan is typically much larger.



Store credit cards are one of the biggest headaches here. If you buy merchandise with a generic credit card, you've got the card company, who are neutral, looking at the transaction. Both you and the merchant are their customers, and the merchant needs to take credit cards. They're not going to quit taking them. If you use your store credit card, the dispute department is going to take the view that you bought that merchandise at their store and therefore you owe the money. I run across five or six store card problems for every generic card problem I encounter.



Bankruptcy is another deal buster. People in Chapter 13, or just out of Chapter 7. Most banks won't touch them. It's not really rational, but you there you are.



Reserves can be a deal buster, particularly for stated income loans. A paper stated income requires six months PITI reserves somewhere that you can get to it. Subprime is less demanding, but if you don't have the lender's requirements, you won't get the loan. Would you loan money to someone with absolutely no cash in the bank? Payment shock, where your monthly cost of housing is increasing, can increase the reserve requirements.



Related Party Transfers are another questionable point. All of the background for loans assumes that the transaction is between unrelated parties, who have no reason to cooperate in order to do the lender dirt. If you're buying the house from your brother, that assumption goes out the window. Some lenders will do them, others wont. Some will but charge extra. Others will but have special requirements. Whtever they are, you have to meet them.



The appraisal coming in low is another. The lender evaluates the property on a "lower of cost or market" basis. The Appraisal is the "market" part of that, and the lender will only loan money based upon the lower of these two methods of evaluation. I have people tell me all the time that their new purchase is worth $20,000 more than the appraised value (or the purchase price). No it isn't. By definition - it's worth what a willing buyer and a willing seller agree upon. The bank's evaluations are necessarily conservative, and they don't want to take over the property. They're not in that business. They want you to pay back the loan.



Late payments. Whatever you do, while the loan is in progress, keep making all your payments on time. Whether just indirectly due to the credit score dropping, or directly because now you've got a(nother) thirty day mortgage late, this can raise your rate or even break the loan.



Sourcing and seasoning of funds to close. Just because you've got $100,000 in the bank doesn't mean the bank is happy. Nobody rational keeps that kind of money outside of investment accounts. At least nobody rational who needs a loan - Bill Gates might. Lots of folks hide loans that way. The bank is going to what to see that you've had it a while (seasoning) or prove where you got it from (sourcing). If you really just got $400,000 from the sale of a previous property, you're going to have the escrow papers and HUD 1.



Final credit check: I have a set spiel I go through, "Until this loan is funded and recorded, don't breathe different without getting my okay. Make the payments you've been making. Make them on time. Don't take out any new credit. Don't allow anyone (other than mortgage providers!) to run your credit. Just before the loan gets recorded, the lender will pull a final credit report. Woe be unto the person whose situation has deteriorated, and it means we'll have to start all over again, if there even is a loan that makes sense."



Failures of verification. Three biggies here: employment, rent or mortgage, and deposit. I do not know why people bother lying, but they do. Don't you be one of them. World of hurt if the lender wants to prove a point.



Lines of credit/credit history/no credit score: Most lenders want to see at least 3 lines of credit with a 24 month history of making payments on time. Freezing your credit cards is a wonderful idea, but you need to use them to demonstrate a payment history. Once per month, I use mine for something small and stupid that I would otherwise pay cash for - just to show payment history (it also helps your credit score). Pay if off as soon as the bill gets there. Waivers for two lines of credit are fairly easy, but if a given bureau doesn't know you have two open lines of credit, they may not score your credit profile. If you don't have at least two credit score among the big three - no loan.



Property is structurally unsound, is not certified for habitation, unsuitable or not zoned for intended use, etcetera. Wouldn't you really find out about this before you have a very large debt to pay? Okay, this can cost you money, but it's a "Thank (deity) I found out now!" moment.



So there you have them, most of the most common reasons why loans - and therefore real estate deals - fall through.



Caveat Emptor.

I read with great interest you article on the internet about pre-payment penalties. I find my self in a situation involving a pre-payment penalty and would appreciate your advice on this. I currently have a loan in which the prepayment penalty is up on DELETED. I have gone to another lender for a refinance and have been approved for a loan. Since this loan process occurred before the pre-payment penalty was up, my current lender has included it in the payoff demand information. My new lender has approved funding a loan with this penalty ($12,000) included. Documents are scheduled to be signed DELETED and the loan will be funded (13 days before the penalty expires). If I try to push back the date of my loan, my interest rate will go up, and I may not even qualify for a new loan since my FICA scores have dropped. My intention is to go through with the loan and have the loan person hold onto the payoff check until DELETED, after the pre-payment penalty has expired. I will then request a refund of this amount from my current lender. Do you think this strategy is viable or can you suggest an alternative without changing the the time schedule or amount of my new loan?

So you're want to be paying interest on two loans for two weeks?

Doing it your way is okay if you want to pay the penalty and are willing to pay interest and points and everything on the extra. If not, just have your loan provider get a rate lock extension. You'll pay about roughly a quarter of a point in fees, but that's less than the interest - or the penalty. Have your new lender get a payoff demand valid from expiration of the pre-payment penalty forward.

Your new lender is not going to tolerate being second in line for several weeks. Until that previous trust deed is paid off, the loan to value ratio is higher than their underwriting allows, and I'll bet that debt to income ratio is as well. Suppose there's a fire during those two weeks? Is there enough money in the insurance to pay both of them? The answer is no. Until that prior loan is paid off, the value of the property is exceeded by the loans against it. This is the purpose of escrow - and there's escrow in a refinance as well as in a purchase. You don't get that check - you only get what's left over after escrow does their job, which includes paying off the prior lender.

As to your personal situation, why has your FICO dropped? Credit scores don't drop without a reason, and one credit check isn't going to make that much of a difference. Basically, it looks like your lender is trying to make more money off you, and feeding you a line of nonsense to facilitate it. By boosting the loan amount, their compensation in the form of origination and yield spread rises. Okay, so 1% of $12,000 is only $120 - but that's $120 more for basically the exact same work. Not to mention the loan is funded now and they get paid now. Loans that are finished don't fall apart. I'd bet millions to milliamps that they're intending to fund your loan before the penalty expires. If they weren't, there's no reason to have you sign loan documents that early. I wouldn't have you sign until your right of rescission runs out concurrently with your penalty.

From the information given, this is not likely to be a lender with your best interests at heart. About the only thing I can even think of where it might be in your interest is if there's a notice of default or trustee's sale looming - and then we have to consider whether paying that penalty and all of the costs of the loan is really in your best interest. And since you didn't say anything about either one of these situations, I have to question the wisdom of basically volunteering to pay 6 extra months of interest plus loan costs. In this loan environment, I just have trouble believing that the new loan is going to save you that much money over the course of the time you are likely to keep it, let alone over the two weeks early you're paying it off. Even if you're at 8% now and moving to a 7 percent thirty year fixed rate without points, that's over $15,000 you are spending to save 1%. On a $300,000 loan, you're just getting close to breaking even at 5 years, which is longer than ninety or ninety five percent of everyone keeps their loans, and your balance is still higher. And yes, rates are going up, but neither I nor any other analyst I read is expecting that much higher, that quickly - even if your rate isn't locked, and rates that aren't locked aren't real.

Rate lock extensions cost money. But sometimes they're still the smart thing to do. In your case, it's spend approximately a quarter of a percent of your loan amount (depending upon lender policy), or three to four percent for six months interest that I can't see any compelling reason for you to owe.

Caveat Emptor


PS next time, you might contact me to give me a shot at your loan before you're in this position. I do loans all over California.

Sometimes spam makes writing an article all too easy.



Here is a piece of spam I got today because my email at work contains "realestate.com", with identifying information taken out. This goes to show that the financial ignorance of most mortgage providers is astounding.

Thank you for your interest in the X Broker Program. Our program is designed to help you provide more value added service for your clients, increase your fee income and help you generate more loans. By simply providing a one page custom amortization and a completed one page enrollment form in your loan packages you will achieve a high enrollment ratio. By illustrating the three key benefits of the Bi-Weekly Payment Program for your clients, they will clearly see that your goal is to help them accomplish their financial goals sooner by saving thousands of dollars in interest, paying off their mortgages 5-10 years early and achieving a low effective interest rate. Please find enclosed an example of a custom calculator and our simple one page enrollment form.

Or the client can just make 13/12 of the regular payment, or make an extra payment once per year, and achieve the same result without any cost. This option without cost lets the customer choose to pay however much extra they can afford that month, or pay nothing extra if they're on a tight budget. As I computed in this article, the fact that you're making payments more often saves you almost nothing. It's the fact that you're making an extra mortgage payment per year that's saving you all that money.

Getting started is easy. All you have to do is pay a one time setup fee of $99. You will be provided with custom online tools and resources as well as training upon request. To sign up, just go to our online broker enrollment form and complete the required fields, shortly after you will receive an email with your broker code user name and password. Please be sure to save this email. Once you have these instructions you will be able to go to X.com and access your custom calculator and other online resources.

So I (the provider) pay a sign up fee of $99 for an internet driven startup. Cha-ching!

The X program is a great value at $395.00. You earn 300.00 on each enrollment, X retains only 95.00. We also charge a $3.75 per debit fee (emphasis mine). Our customers truly appreciate our one-time only enrollment fee, if the client moves, refinances or the loan gets sold, X will simply take them off the system and put them back on with the new loan information. Most customers prefer to pay the enrollment fee and choose the 3 debit option, where we will take an additional 135.00, 130.00 and 130.00 over the first three debits to comprise our one-time fee. We pay commissions on the 15th of the month for all enrollments on the system the month prior. Once you receive your approved broker email you'll be able to start signing up clients immediately.

Now we get to the real meat of what's going on. For me doing the work of signing someone up on the internet, they get $95 to start with, while dangling out a $300 stroke to mortgage providers to betray their clients by getting them to pay for something they could do themselves, with more flexibility, for free.



Then, once this is started, they make $3.75 per transaction, every two weeks, for an automated process that costs them somewhere between $0.25 and $0.50. Great work if you can get it. Three guesses who gets stuck with all the problems if they screw up.



This is one more reason why you want to shop your mortgage around and get multiple opinions. Anybody wants you to pay anything for a biweekly payment program, that is a red flag not to do business with them.



Caveat Emptor.

I found you on the Web after doing some research for my parents regarding short sales and foreclosures. I appreciate your straight talk regarding the whole loan and real estate process which I know they find incredibly intimidating. Right now, they're sort of putting their head in the sand regarding their financial problems. I have been trying to help them stay afloat but it's becoming tight.

My mom received a default letter from the lender last week since she was two months behind. She sent one payment last week and I wrote a check to her lender for this month's mortgage to bring her current. I told her I couldn't do this again. She wants to walk away from the house, I told her "bad idea." My parents can't make the payments anymore and I am wondering if they should sell or refi. Here are the stats:

They've got a 7% fixed for three years which they are about a year and a half into. The payment is plus or minus $3100. The mortgage is $468,000 with a $12,000 pre-payment penalty. I don't know how they got into this mess but seeing her struggle and cry each month is something I can't watch anymore. My father and she (they're in their early 60s) have 2 pensions and 2 Social Security payments they receive each month. They make enough to make their house payment but not enough to cover all the other bills. My mom's logic is - "If I didn't have the house payment I could pay my bills." I tell her that her home is more important, and looking at your articles it seems to me the consequence of not making your mortgage if far worse then not paying credit card and car loan debt. Their credit is good but they don't want the house because the mortgage is so high. They talk of renting but I am afraid if they walk away from the house-the consequences will be dire.

In your experience is their hope? I've offered to refinance with them, the three of us, but would that help? I already own a home with my husband - I imagine there are occupancy restrictions? I have good credit. If they sell, it would be short with the pre-payment penalty. Are their agents that would sell the house? I can't imagine they'd want to since there would be no money for a commission.

Here's the real crux of the matter: These folks owe $468,000 and have a payment of about $3115 at a seven percent interest rate. Those are cold hard facts. As of this writing, there just aren't any loans out there that will help them enough to be worth paying that pre-payment penalty. Oh, someone could do a negative amortization loan that makes it appear as if they can afford the loan for a while - with even more dire long term consequences. Someone could boost their interest rate by maybe a quarter of a percent in order to cut their payment slightly with an interest only payment - but then the hole would stay just as deep as it is, and all interest only payments eventually start to amortize. The longer it is before this happens, the worse the payment shock when it happens. Most interest only loans adjust upwards on the rate at the same time. Sudden forty percent increases are nothing out of the ordinary. Even a longer amortization isn't going to help very much - even assuming the interest rate doesn't change, by the time you add that prepayment penalty in there, you've got a payment of $2982, even assuming no loan costs or fees get rolled in.

The point I'm trying to make is that I can't see a way for them to really be able to afford this property. Matter of fact, I have a very hard time believing that the agent and loan officer who sold them on this situation didn't do something both illegal and unethical along the way, and your parents should consult a real estate attorney about that. Nor is refinancing with you on the loan likely to help. As of right now (July 2007), there just aren't any loans enough better than what they already have to be worth paying both the pre-payment penalty and the cost involved. Not to mention the fact that the appraisal is going to be problematic. Sure, there are appraisers willing to say that property is worth $500,000 when it isn't, but they're going to become a lot fewer very soon. And if you can't afford to make their payment as well as your own, putting yourself on their mortgage is a good way to sink your credit as well as theirs. Then you have problems down the line with your own property.

I sympathize with these folks and you, but the only way they're likely to get rid of unaffordable mortgage payments is to get rid of the property. Unless, of course, they've got enough cash sitting around somewhere to pay their mortgage down enough to make it affordable. However, if they could do that, why didn't they put the money in as a down payment? I'd need more information to be certain, but I strongly suspect that it's time to own up to the truth, which is that they have purchased too much house and they cannot afford it.

With that said, "walking away" is just about the worst thing you can do in most situations. Now the lender has to go through the whole dreary process of foreclosure, with is going to effectively kill their credit for seven to ten years, and might cause the interest rate on any other debt they have to rise. They need a lawyer to advise them on their situation. Anyone in this situation needs a lawyer, and I'm not a lawyer. With that said, the following options are usually better:

You can talk to the lender about the situation. They don't want to foreclose. They don't make money when they foreclose. In fact, they lose it by the railroad carload. If it'll keep them out of foreclosure, chances are good that the lender will agree to a temporary modification of the note while your parents sell the property. They may or may not agree to accept a short payoff as well. It'll depend upon the listing agent and the lawyer. And yes, banks will usually agree to allow agent commissions in short payoff situations - it gets the property sold, which means they lose less money than if it goes all the way through foreclosure and they have to hire an agent anyway.

Another option that can be worth exploring is the Deed in Lieu of Foreclosure. This is where you sign the property over to them in satisfaction of the debt. It has the advantage that it stops future hits to credit. Although Deed in Lieu is itself one of the deadly sins according to mortgage providers, it's not as bad as a Trustee's Sale in most cases, and you don't have all the individual derogatory reports of the late (non-existent!) payments between now and whenever the Trustee's Sale happens.

One thing to warn of is that all of this, except perhaps for the Trustee's Sale, is the cause for a 1099 to be issued for income through debt forgiveness. Your parents will probably owe taxes on this money, so I strongly advise them to consult a tax professional as well (As best I recall, it's ordinary income, the same as if they had earned it working). In some cases, there may be a deficiency judgment as well, while in others there may not be. Nonetheless, this money is likely to be for a much smaller amount than $468,000, so they can probably dig themselves out, given time, and without living completely poverty stricken and without completely torpedoing whatever financial future they may have.

I know you wrote to the loan officer, but with the rates and loans available right now - especially considering the late payments on the mortgage - there's nothing the loan officer can do that actually helps, although there are a lot of loan officers out there who would say they'd help. If they were sitting in my office, it would be time to put on my Realtor hat and talk about selling that property. I wouldn't be happy about it, but the universe doesn't particularly care about making me happy, and it's the best way I see out of a bad situation.

Caveat Emptor

Many people are uncertain as to what closing costs are.



Basically, they relate to the costs of doing the transaction. There are people who work on getting your loan through the process of approval and funding, and those people have got to be paid. Anytime you're talking about a fee for a service that needs to be performed in order to get a loan done, that's a closing cost. This includes even origination, which is normally quoted in points, as the fee that the loan provider takes for getting the loan done. Not all loans have origination fees, but I'd say that in excess of 95 percent of all subprime loans and at least two thirds of all A paper loans nationally do.



Every loan has closing costs. They are a fact of life. You can choose to accept a higher rate on your loan such that the lender will agree to pay your closing costs, but that is not the same thing as not having them. Indeed, you should be very wary of someone quoting you significantly lower closing costs that anyone else.



When you are talking about closing costs, the vast majority of all loan providers will pretend that so-called "third party" fees such as title, escrow, attorney fees in the states that use attorneys, appraisal, and notary fees do not exist. They will mark them "PFC" on the MLDS and then act all surprised when you complain about these extra fees that weren't on your beginning paperwork. I regularly have people tell me before they sign up for a loan that my fees seem high, compared to what everyone else is telling them. The difference, of course, is that I'm telling them about all the third party fees and the other folks they are talking to are doing their best to pretend those fees don't exist. They not only exist, but you're going to pay them as a part of any loan. Who would you rather do business with, someone who pretends it's going to cost you half as much as it will, or someone who tells you the real cost right at the start?



Now the critical difference between recurring and nonrecurring closng costs in that non-recurring happen once, to do your loan, and then they are done. Recurring closing costs are those things that happen every month, like interest, property taxes, insurance, and the impounds for doing them, if applicable. Mellow-Roos and homeowners association dues also fall within the definition of recurring, but those items I just named are about the extent of the recurring closing costs. Pretty much everything else is non-recurring. For example, you only need one appraisal, one notary fee, one escrow, and one title insurance policy per loan.



One thing that is often counted as a closing cost that should not be are discount points, which instead of being a charge for a service are a charge by the bank to give you a better rate than you would otherwise get. There is always a tradeoff between low rate and low cost. The lender will give you a lower rate if you pay for it, but they won't give it to you free.



Many times, folks buying a home get an allowance from the seller for Closing costs, and the wording can be critical. Non-recurring closing costs are far more limited than recurring, and just the impound account can add thousands of dollars to what you, as the seller, end up paying if you agree to recurring closing costs. It's up to you how bad you want to sell the property, but a buyer who needs you to pay recurring closing costs is likely not a very qualified buyer, and their loan is pretty likely to experience snags. I counsel my sellers to insist on substantial deposits and sharply limited escrow periods in such cases, and if the buyer is allowed discount points as part of what you're willing to pay, count on the fact that they are going to use the entire allowance you give them. If the buyer has a choice of allowing you to keep some of that money or buying themselves a lower rate, which also means lower payments, what do you think they're going to do?



Caveat Emptor (and Vendor).

Most of the time, I'm talking and writing about the sort of loan the average borrower is looking for. Up to 125% of the single unit conforming loan limit of $417,000, which works out to $521,250, A paper guidelines are pretty much determined by Freddie and Fannie. There really aren't many breakpoints in policy. Some lenders charge extra for loans under $100,000 or so, but it's really all the same program. Even in pricey Southern California, this is most transactions. Even if you don't have a down payment, anything above 80% Loan to Value Ratio is going to get split into a conforming first and a second for the remainder, so you're still dealing with Fannie and Freddie. If Fannie Mae or Freddie Mac will buy the loan, the lender is happy with it. An acceptance from either of their automated underwriting programs is normally good as gold for getting the loan through. My lowest "no points" conforming rate is currently 6.875, which for a $522,000 property with no second loan, just property taxes and insurance, and no other debt, you'd have to be making $7550 per month to qualify for that loan, or $90,600 per year. Most people, even without debts, don't make that much. Add in an average amount of household debt, a higher rate second mortgage, and increase the loan amount, and you're looking at roughly $10,000 per month to qualify, even without the fact that the maximum allowable debt to income ratio decreases.



However, once you get above dollar amounts that Fannie Mae and Freddie Mac will buy, each lender has their own criteria for the so-called "Jumbo" loans. This used to be a lot more of a factor in 2003 and 2004 when the conforming limits were $322,700 and $333,700, respectively, and still a significant factor in 2005 when the conforming limit was $359,650 and the market was still hot. When the average purchase price is in excess of $500,000 and even 80% of it is well over the conforming loan limit, you've got yourself a jumbo. Furthermore, scenarios that would be perfectly acceptable A paper below the conforming limit - because Fannie and Freddie will buy them, thereby assuming the risk - can often be forced to go sub-prime once you get into jumbo territory. For instance, from one lender whom I've done 100% A paper with below the conforming limit, they won't touch 100% financing once it gets above $417,000. If your first loan amount is for $418,000 and you want 100% financing, your choices are 1) do it sub-prime 2) Find a down payment of at least 5% somewhere, or 3) find some other A Paper lender that will do 100% jumbos. Right now, with the lenders in a panic, that's tough.



Regular jumbos go up to about $650,000 or $750,000. These numbers haven't changed much in at least five years, and we're getting to the point where jumbo limits need to rise. It's one thing when it covers a huge band from $322,700 to $650,000. It's getting to be something else when the band has constricted at the bottom so that it doesn't start until $417,000. Let the conforming loan maximum get boosted again, and regular jumbo loans may become more rare than they are.



Above jumbo loan amounts is "super jumbo" territory. Now instead of being willing to go to 95% financing, albeit full documentation only, 90% is as high as this particular lender will go. Matter of fact, in order to find a 100% program in super jumbo territory, I have to go to Alt-A programs, which is no longer A paper.



What's going on here? Quite simply, higher dollar value properties are harder to sell, and there's more risk of taking at least something of a loss on them. Furthermore, the lender is risking a higher number of their own dollars. They want the borrower to have some serious skin in the game to motivate them not to lose it. You can find lenders willing to go 100%, even now with the lenders in full panic mode. It will be expensive, no matter how good your credit, no matter how much you make. We can make things better by splitting the loans, but even so, expect the subordinate loans to have rates well into the double digits. Furthermore, you can bet on there being a pre-payment penalty on at least one of the loans, while if you bring a satisfactory down payment to the table, you can find rates that are much better, and without a pre-payment penalty. For example, using the same rate sheet, the add to the jumbo rates is 3/8ths of a point for super jumbo, which means you can have the same rates as a jumbo loan for an additional charge, or go up maybe an eighth of a percent on the rate for the same charge. 3/8ths of a point doesn't sound like much, but when you're talking $800,000 loans, it's a $3000 one time fee, or about $1000 extra per year in interest. However, since in order to qualify for an $800,000 loan at 7%, you've got to be making about $14,000 per month not including the effects of property taxes, homeowner's insurance, or other debts - probably around $18,000 minimum salary per month to qualify with those included - these are not loans for even your average white collar worker.



At $1,000,000 in loan amount, there's another break point in lender policy. For instance, the lender I've been covering closest won't touch anything above 80% financing. Period, end of sentence. Not as a first, not with a piggyback second, not at all. For A paper lenders, that's actually kind of generous. The next two A paper sheets I pulled out max out at 70% Loan to Value above a million. This means come in with 20 to 30% down payment - or go sub-prime, with higher rates and pre-payment penalties. When you're talking about million dollar loan amounts, pre-payment penalties can fund a fairly high end car. For instance, if you have (pinky finger extended, Dr. Evil style) one million dollars at 8%, a standard pre-payment penalty of six months interest is $40,000. Once again, these are not loans for your average person. Even if you have no other debts, by the time you get done with property taxes and homeowner's insurance, you're looking at $24,000 monthly income to qualify. Still, it's nearly two months income for a pre-payment penalty!



Just in case my readers include a significant number of the richest hundredth of a percent of the world population, there are usually break-points at 1.5 million, 2 million, and 3 million as well, and that's if the lender goes that high. The biggest residential loan I've ever done doesn't get into these categories. In practice, the rule seems to be the bigger the house, the bigger the down payment they have, not only in absolute terms but also in terms of percentage. If I got a request for a loan that big, I'd just go ask the wholesale executives if they can do it, and what it's going to take. I have a suspicion that most loans of this size end up being commercial loans in all but name, or perhaps even in name.



Nor is it just the guidelines that get tougher. Underwriting gets trickier the higher up on the scale you go. Loans with characteristics that would be a slam dunk if they were conforming become nightmares above the million dollar line. What's going on, of course, is that the underwriter is more reluctant to sign their name to a loan commitment that exposes the lender to five times as much loss. People get fired when those go sour, and they don't give out a whole lot of second chances for high dollar loan amounts going south. So when they write that commitment, that underwriter is going to make very certain all of their bases are covered.



Pretty much every loan program in existence has a maximum dollar value, above which the lender offering it has decreed that it does not exist. Sub-prime breakpoints are different from A paper - half a million and two million are the most common breakpoints there - but I've never found a loan program from any lender that didn't have a maximum dollar value they'd lend under that program. Even hard money lenders have maximum dollar amounts they'll lend, price and policy and underwriting breakpoints. The average person really has no need to be aware of these breakpoints, but if you do start hitting them, you'll figure it out in a hurry. Things that are easy on conforming loan amounts sometimes cannot be done at all once you're no longer in conforming loan territory.



Caveat Emptor

Hi Dan,

I was reading your article on "should you pay off your mortgage faster?" (DM: link here DELETED It'll be a fresh 30 year loan and I'm 44 years old so this discussion has interest, I don't really want to be making a mortgage payment at 74 ;).

I must be really dense but A: I don't get it and B: the table looks like it has an error in it to me.

Start with B: first - the investment column can't possible be correct. The assumption is you save or pre-pay $100 per month and invest at 8%. The amount for year 1 is $1,353.29, if you saved $100 per month at the end of a year you'd have $1,200 in principal + $100 * 12 months @ 8% + $200 * 11 months @ 8% + $300 * 10 months @ 8% etc. Even if you socked away the whole $1,200 on day 1 you'd only have $1,296 and have to pay taxes on $96.

What I don't get is this - by prepaying $100 on my mortgage I get a guaranteed return of 6% or 6.5%, whatever the mortgage rate is. I do not ever have to pay interest on that piece of principal again, it keeps on giving. Yes my payment stays the same but the amount going to principal increases by the amount of interest I am not paying due to the previous principal payment.

Now, the valid comparison to that is a risk free investment alternative no? I've got savings accounts currently yielding 4.5%, 5.3% and 5.4% APY, you might find 6% - might and it probably is an intro rate. Let's be generous and assume I can get the same rate of return on the savings as I pay on the mortgage and put that at 6%. If I pay $1,200 extra in principal on day 1 of the year I don't pay $72 in interest and can't deduct it. If instead I put $1,200 in a savings account on day 1 I earn that $72 in interest. It is a wash, The tax issue is a red herring since not paying the principal gives me a $72 interest deduction but the equal investment return is added to income so (72) + 72 = 0 Could it work out if you put the investment dollars at risk? Sure, but that is a gamble and an apples to oranges comparison.

I have different mental pots of money.

Pot 1 is investment dollars for retirement, 10% or so of income goes to a tax deferred account invested at various risk levels and doesn't get touched - ever. Until I retire at least!

Pot #2 home equity + the carrying cost on the mortgage which is the 25% or so of income that pays the PITI on the house.

Pot #3 is liquid reserves, currently about a years worth of #2's income requirements.

My goal is absolutely to eliminate the P&I part of PITI over time. With enough in pot #3 I'll be plowing as much as possible into principle reduction over the next few years once we get moved in and clear the costs associated with a new house such as drapes and furniture. I make a pretty decent salary but who knows how long that will last? As long as the job is secure I'll keep the current mortgage and pre-pay as much as possible. If a few years down the road I felt a little vulnerable to layoff or whatever I'd seriously consider refinancing the then smaller principle balance for a smaller required monthly nut and keep making the higher payments as long as the income stayed intact. Alternatively I may need to do that in 10 years anyway when my kid goes to College. What we are currently paying in private tuition from current income + available cash flow might be a bit short, or we may be ok - depends on where he goes. I'm a College administrator so if he goes here he gets a 100% tuition waiver, 50% at other state schools. And I did look at saving for College in one of the tax deferred accounts, we don't qualify for all the juicy ones based on family AGI. We could do a 529 but I've made the personal choice that we're better off driving the retirement savings and paying off the mortgage rather than killing ourselves to give the kid a free ride .

I like a guaranteed 6.5% return. With any luck the house will get worth more over time as well making the return even better. I played leverage to the max in 1999 when I bought a townhouse for 78K by assuming a mortgage, I just sold it 2 months ago and cleared $112K cash in my pocket, principle balance was 64K so 14K of the 112K was return of my principle payments. That was great but now we're in a little better position financially and I'd like to preserve it over time. I've owed huge piles of money to CC companies and auto loans in the past - don't ever want to go there again!

One other thought. Despite the current turmoil in the market houses do tend to be worth more over time. Probably not as good as the stock market if the time horizon is long enough but they do go up. In my case 60% of the asset value is borrowed so there is a leverage factor on the return. Here is the thought - under current tax rules that return is tax free where as the stock market return is not. It's all about risk tolerance I guess.

Upon examination, I think you're probably right, although I have assumed "a start of the month/year" program where the question was academic until you actually had some money to put to one place or the other; i.e. an initial $100 today and $100 every month, so a year from today you've got $1300 without interest. Kind of like the old problem where if you've got an eighty one foot wall and beams every nine feet, you need ten beams to have a real structure. One to start (at the zero point), and then another one every nine feet.

The pots of money idea is a good one, but most people shouldn't be limited themselves to theoretically risk free investments, especially once you've got your reserves. 1) They're not risk free 2) The big certainty if you don't take any risk is that you will make less than someone who did. Kind of like being chased by headhunters, and having a choice to sit there and be killed an eaten immediately or jump off a cliff into a river with crocodiles. Sure, the crocodiles might get you, or you might hit the rocks when you land and you might even drown. But if you do nothing, you're going in the stew-pot for certain.

Question: How do you think the bank or insurance company can afford to pay a return on the money? It doesn't come out of some hyperspatial vortex! They take this money and invest it in basically the same places you would. The difference is: They take the risk, they get the reward. This reward is plenty to pay their employee salaries, all the expenses of operating, plus your little pittance, and have plenty left over for the stockholders. If their results are adverse, what's going to happen to your money?

Question: If you never refinance, how hard do you think it's going to be to make a $1500 payment in thirty years? Assuming a 3.5% rate of inflation, about like paying $530 per month now. Shouldn't be difficult at all. If you do refinance, you are making a conscious choice that the other loan is, in total, a better deal for you. Sure you might not have a lot of income. My point is that with time and diversification, the assets you would accumulate from alternative investments will be more able to pay your loan out of interest than any money you saved.

Question: If you can't make the low payment, what will your equity situation be like? Once again, this is assuming you never refinance, but 29 years out, you'll owe roughly $15,000, and the property, assuming average 5% appreciation, while the property will be worth about 4.3 times as much. Even if you never paid a penny of principal down, that's well over a million in equity. This gives you options such as selling (take the money and run), a RAM (take the money and stay), etcetera. Stop thinking of money as something that pays the rent and other expenses, and start thinking in terms of what it can do.

Furthermore, it's not a risk free 6.5%. For most people, it's more like an effective margin of 4.7% or less. I'm not advising anyone to go out and strip equity without a very strong reason to do so so and a clear eye on potential consequences, but which after tax return sounds better to you: 4.7% or 7.2%? I agree with the NASD rule that prohibits member firms from accepting borrowed money for investments, but I have admit that it does work, at least for the numbers in theory. The 7.2% assumes investment income is all ordinary income, fully taxed every year. In point of fact, at least some is likely to be capital gains and some is likely to be deferred. The downside is that any investment return is purely speculative and you could lose your principal. You don't ever gamble with money you can't afford to lose, no matter what the long term odds. Nor do you put it all on the same bet, no matter how you split it up. On the other hand, the biggest risk is not taking any. Instead of paying off your mortgage, diversifying your money amongst a sufficient number of stock and bond investments is so likely to leave you with so much more in total net assets over the next twenty years that the expected exceptions are a statistical non-event.

Caveat Emptor

Every so often I run across a reference to a "rate buydown" I don't like to use them because they don't benefit the client, but I should explain them, what they are, and how they work.



A rate buydown is where for an upfront price, the lender agrees to give you a lowered interest rate for a time. 2/1/0 buydowns, where the rate is two percent lower the first year, one percent lower the second year, and then at the loan rate the third year, are the most common, but I've seen one year buydowns of two percent, two year buydowns of one percent for those first two years period, and any number of other tricks.



Now, this isn't free. A 2/1/0 buydown usually costs three points. In fact, what usually happens is the three points go into an escrow account somewhere where they pay out the money to make up the difference in interest to the lenders as the loan goes along. When the buydown period is over, the lender who originally funded your loan then gets to keep what's left over.



Now, here's what this means to you. Let's make this easy. Say you would have had a $291,000 loan, fixed at 7 percent, without a buydown. But with the buydown, you have a $300,000 loan at 5 percent the first year, six percent the second, and 7 percent from there on out. In order to really understand this, let's first take a look at your loan without a buydown:

Month 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24

Balance $291,000.00 $290,761.47 $290,521.55 $290,280.23 $290,037.50 $289,793.35 $289,547.78 $289,300.78 $289,052.34 $288,802.45 $288,551.10 $288,298.28 $288,043.99 $287,788.22 $287,530.95 $287,272.19 $287,011.91 $286,750.12 $286,486.80 $286,221.94 $285,955.54 $285,687.58 $285,418.06 $285,146.97

Payment $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03

Interest $1,697.50 $1,696.11 $1,694.71 $1,693.30 $1,691.89 $1,690.46 $1,689.03 $1,687.59 $1,686.14 $1,684.68 $1,683.21 $1,681.74 $1,680.26 $1,678.76 $1,677.26 $1,675.75 $1,674.24 $1,672.71 $1,671.17 $1,669.63 $1,668.07 $1,666.51 $1,664.94 $1,663.36

Principal -$238.53 -$239.92 -$241.32 -$242.73 -$244.14 -$245.57 -$247.00 -$248.44 -$249.89 -$251.35 -$252.82 -$254.29 -$255.77 -$257.27 -$258.77 -$260.28 -$261.79 -$263.32 -$264.86 -$266.40 -$267.96 -$269.52 -$271.09 -$272.67

Tot Int. $1,697.50 $3,393.61 $5,088.32 $6,781.62 $8,473.50 $10,163.97 $11,852.99 $13,540.58 $15,226.72 $16,911.40 $18,594.62 $20,276.36 $21,956.61 $23,635.38 $25,312.64 $26,988.40 $28,662.63 $30,335.34 $32,006.51 $33,676.14 $35,344.22 $37,010.73 $38,675.67 $40,339.02

Tot Prin $238.53 $478.45 $719.77 $962.50 $1,206.65 $1,452.22 $1,699.22 $1,947.66 $2,197.55 $2,448.90 $2,701.72 $2,956.01 $3,211.78 $3,469.05 $3,727.81 $3,988.09 $4,249.88 $4,513.20 $4,778.06 $5,044.46 $5,312.42 $5,581.94 $5,853.03 $6,125.70

Now let's look at it with the buydown:

Month 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24

Balance $300,000.00 $299,639.54 $299,277.57 $298,914.09 $298,549.10 $298,182.59 $297,814.56 $297,444.99 $297,073.87 $296,701.22 $296,327.01 $295,951.24 $295,573.90 $295,257.63 $294,939.77 $294,620.32 $294,299.27 $293,976.62 $293,652.36 $293,326.47 $292,998.96 $292,669.81 $292,339.01 $292,006.55

Payment $1,610.46 $1,610.46 $1,610.46 $1,610.46 $1,610.46 $1,610.46 $1,610.46 $1,610.46 $1,610.46 $1,610.46 $1,610.46 $1,610.46 $1,794.15 $1,794.15 $1,794.15 $1,794.15 $1,794.15 $1,794.15 $1,794.15 $1,794.15 $1,794.15 $1,794.15 $1,794.15 $1,794.15

Interest $1,250.00 $1,248.50 $1,246.99 $1,245.48 $1,243.95 $1,242.43 $1,240.89 $1,239.35 $1,237.81 $1,236.26 $1,234.70 $1,233.13 $1,477.87 $1,476.29 $1,474.70 $1,473.10 $1,471.50 $1,469.88 $1,468.26 $1,466.63 $1,464.99 $1,463.35 $1,461.70 $1,460.03

Principal $360.46 $361.97 $363.48 $364.99 $366.51 $368.04 $369.57 $371.11 $372.66 $374.21 $375.77 $377.33 $316.28 $317.86 $319.45 $321.05 $322.65 $324.26 $325.89 $327.51 $329.15 $330.80 $332.45 $334.11

Tot Int. $1,250.00 $2,498.50 $3,745.49 $4,990.96 $6,234.92 $7,477.35 $8,718.24 $9,957.59 $11,195.40 $12,431.66 $13,666.35 $14,899.48 $16,377.35 $17,853.64 $19,328.34 $20,801.44 $22,272.94 $23,742.82 $25,211.08 $26,677.71 $28,142.71 $29,606.06 $31,067.75 $32,527.79

Tot Prin $360.46 $722.43 $1,085.91 $1,450.90 $1,817.41 $2,185.44 $2,555.01 $2,926.13 $3,298.78 $3,672.99 $4,048.76 $4,426.10 $4,742.37 $5,060.23 $5,379.68 $5,700.73 $6,023.38 $6,347.64 $6,673.53 $7,001.04 $7,330.19 $7,660.99 $7,993.45 $8,327.56

It is also to be noted that in the very next month, your payments go to $1982.23, as opposed to the $1936.03 they would have been in the first place, and that they will stay there the rest of the loan, all 336 months should you keep it the rest of that time. Why? Because your balance is larger than it otherwise would have been, so the payment is higher, in this case by $46.20, due to the higher loan amount.



Finally, let's look at the differences:

Month 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24

Escrow Acct. $8,552.50 $8,176.27 $7,796.79 $7,414.04 $7,028.00 $6,638.63 $6,245.92 $5,849.83 $5,450.34 $5,047.43 $4,641.06 $4,231.22 $3,817.87 $3,647.29 $3,475.21 $3,301.60 $3,126.46 $2,949.78 $2,771.53 $2,591.72 $2,410.32 $2,227.32 $2,042.72 $1,856.50

Net cost $8,552.50 $7,982.95 $7,413.19 $6,843.21 $6,273.02 $5,702.62 $5,132.02 $4,561.21 $3,990.21 $3,419.02 $2,847.64 $2,276.08 $1,950.65 $1,687.67 $1,424.51 $1,161.18 $897.67 $633.98 $370.13 $106.11 -$158.09 -$422.44 -$686.97 -$951.65

What this means is that your lender's escrow account ends up with $1850 that they get to keep, on top of everything else they made from the loan. The final column is the net cost to you, what you paid to get it less the interest it saved you. Hey, look at this! In month 21 it goes negative! You must be saving money if you keep it that long, right?



Nope. This is a temporary and illusory savings phenomenon, and I don't know of any way to make it permanent. You see, the benefits stop in month 24. They are over. Kaput. Gone. That's all, folks. But you owe $6798.14 more (at the start of month 25, not illustrated above) than you would have without the buydown. There are exactly three possibilities as to what happens. First, that you keep the loan. Due to the extra interest you're paying every month, you are negative again in month 56, and it keeps getting worse the longer you keep the loan. After 120 months of the loan, you are $1755 down. This actually peaks in month 242 at $3351 negative, then starts decreasing, but you don't get it back before the loan is paid off.



The second possibility is if you refinance the loan. Let's say you get a really fantastic deal and refinance at 5 percent on a 30 year fixed rate loan, and I'll even give you that your higher balance doesn't cost you any more in fees. Your payment is $85.35 per month higher than it would otherwise have been, your interest charges $28.32 higher (and the difference represents you paying the principal off faster if you don't pay for a buydown). Your savings is gone in less than three years, and there's nothing you can do about it.



The third and final possibility is that you sell the house. You get $6798.14 less in your pocket. This means that you don't have $6798.14 earning money for you in the stock market. At ten percent your benefit is gone in less than a year and a half. If you take the money and buy another property, that's $6798.14 higher your loan balance will have to be. Let's say you get that same fantastic 5% loan we talked about two paragraphs ago on the new property. Guess what? The same math applies here also. There is no way to win in the end with a buydown, unless someone else pays for it (for example, seller paid closing costs).



So they are a piece of garbage. Why are buydowns attractive, and why do otherwise rational people sign up for them?



Because they lower the payment for a while. People choose loans based upon the payment. In particular, they choose loans based upon the payment in the first check they are going to have to write. Most people figure that the check they are going to have to write two or five years out isn't important. Unscrupulous lenders and loan officers know this. That's why the (censored) negative amortization loans are so popular, despite them being time-delayed financial poison. So don't shop for loans based upon the payment, and if someone starts talking about ways to cut the payment as opposed to the interest rate, put your hand on your wallet and leave. If they persist, drag them out into the sunlight and put a wooden stake through their heart. It's the only way to be sure.



Before I go, I want to mention one specific group that gets targeted for these things, and that is veterans. The Veterans Administration loan, aka VA loan, has the ability to roll (not coincidentally) three points closing cost over and above the cost of the home into the loan. Most military folks are busy learning their trade, which is usually not something having to do with finance. Indeed, I've never heard of any MOS that included this type of financial training. So when the loan officer whispers sweet nothings into their ear about cutting the payments for the first couple of years, they don't know any better and they sign right up. They could have used those three points for something potentially useful, like discount points that buy you a lower rate for the entire term of a VA loan. If you keep it long enough, they will eventually net you money and the VA only accepts fixed rate loans, not ARMS or hybrids. The veterans could just not pay those three points, and not start out with what is basically negative equity. But rate buydowns make a loan appear attractive on the surface to someone with insufficient financial training, while costing them money in the long term and allowing the initial lender to make more money than they otherwise would.



Caveat Emptor.