Intermediate Information: August 2007 Archives

Better deals for the bank, that is.



Ken Harney has a recent article Study Shows Loan Brokers' Better Side

But now a new, independent academic study has concluded the opposite: According to a team of researchers headed by Georgetown University's Gregory Elliehausen, home mortgage applicants with less-than-perfect credit pay lower financing costs when they obtain their mortgages through brokers rather than from loan officers directly employed by lenders. The same pattern holds true for African American, Hispanic and low-income borrowers.

The study was limited to subprime borrowers, but the results are not surprising:



Overall, broker loans cost 1.13 points less for first mortgages, 1.98 less for second mortgages



For borrowers in predominantly black areas, the difference was 1 point and 1.9 points, respectively.



For borrowers in predominantly hispanic areas, the difference was 2 points and 2.4 points. The explanation as to why this gap is larger is probably as simple as the fact that many of these folks limit themselves to dealing with spanish speakers.

Skolnik added, though, that the data overall could reflect that "brokers in general operate in a much lower-cost structure" compared with banks and retail mortgage companies that carry heavy overhead and employee costs. Moreover, he said, "brokers are far more agile and nimble than retail" lenders, when pushed to compete on pricing and terms.

That and any given lender may have anywhere from a dozen loan programs to fifty, all intended to hit specific niches and priced for given underwriting assumptions. A 3/1 is different from a 7/1 is different from a 30 year fixed, stated income is different from full doc is different from NINA. That's nine programs right there, and this is A paper stuff. Subprime is even more varied. It doesn't matter if you barely meet guidelines or soar through them. If you find a program with tougher underwriting guidelines that you still qualify for, than that lender will give you a better rate on the loan, because they will have fewer of them go sour, and therefore get a better rate on the secondary market. You can go around to all the lenders yourself - or you can go to a broker.



Furthermore, even if you're one of those so slick that you fit into the top loan category of the toughest lender, brokers can typically get you a better price. Why? Two reasons. First, the lenders don't have to pay broker's overhead, making it more cost effective for the lender to do the same business through the broker. Second, and more importantly, when you walk into a lender's office, they regard you as a "captive" client. Brokers know better. Brokers are not captive to anyone, and they know that you're not captive to them. A good broker's loan officer will price with at least a dozen lenders. I've shopped fifty or more for tough loans. Furthermore, there's an efficiency factor at work. After a while, a good loan officer learns which lenders are likely to have good rates for a given type of client. Which do you, as a client, think is likely to be the best use of your time and resources? Going to all those lenders yourself, or going to a few brokers?



This article of mine is also highly relevant to this discussion.



Caveat Emptor

This one came from a search engine:

amortization of real estate loans early payoff based on a lump sum payment

This is one of the smart things you can do. Not necessarily the smartest, mind you, but smart. The question is if there's a better way to get a return on that money, wither by paying down a higher interest debt or by investing the money in a new asset. If you owe thousands of dollars on a credit card at twenty-four percent when your mortgage is at six, why would you want to pay down a tax deductible six percent instead of a non-deductible twenty four?



Similarly, if you've can earn ten percent somewhere else with the money, why do you want to pay your six percent loan down? Net of taxes, a six percent loan costs you about 4.5 percent, depending upon your tax bracket. Even if the return is not tax deferred, the net return on ten percent is somewhere over seven percent for most folks. Say you are in the twenty-eight percent tax bracket and the ten percent is completely taxed every year. $10,000 over the course of 15 years will turn into $28,374 if invested. If it's fully tax deferred, it turns into $41,772. For comparison with other numbers later on in the essay, at twenty-seven years the numbers are $65,352 and $131,099, respectively. Not half bad.



Suppose you've got the cash flow to instead buy another property? That puts the power of leverage to work for you, and if you can rent out one of your properties or something, possibly multiply your money by a factor of ten within a few years. When you put ten percent down, and your new property appreciates ten percent while giving you a few dollars per month of cash flow, that's smart investing. At seven percent annual appreciation (historical average), you've doubled your purchase price in a little over ten years. A three hundred thousand dollar property will likely be a six hundred thousand dollar property in about ten years (It's just numbers), while you've paid the loan down from $270,000 to about $226,000. Even if your expenses of selling are seven percent, your gross is $558,000, less the $226,000 you've paid the loan down to, and you've come away from the property with $332,000, not counting those few dollars per month you netted after paying your expenses. Sure there are places and properties that don't pencil out, and being a landlord is a headache, but as you can see the potential rewards are substantial if it does "pencil out".



Now, let's say you do this every nine years on a three to one split, and 1031 Exchange the first two at least. After nine years you have $281,267 pre-tax, net in your 1031 account. You then turn around and buy three $600,000 properties. You end up with three loans of about $506,000 each. Assuming net zero cash flow on the properties, after nine more years, you have three loans at $434,100, netting you $1,775,286 into your 1031 accounts, which you then roll into three more properties each at $1.2 million purchase price. Your loans are $1,000,000 each, but you rent them for enough money to break even on expenses. After nine years, you sell all of these properties, and end up with just a little under $10,750,000 net of sales costs in your pocket before tax, which at long term capital gains rates (15%) nets you $9.13 million or thereabouts. Now, you did start with three times as much money, and nobody in their right mind sells off nine highly appreciated properties in one year, and you did have the headaches of being a landlord on an increasingly widespread basis for those twenty-seven years, but this illustrates the money to be made for the same investment. Patience and leverage working for you over time are far more powerful than any quick flip.



But assuming there are no better alternatives, it is a smart idea to pay down your mortgage. Here's why: Let's say your balance is $270,000 at six percent, and you pay your loan balance down by $10,000. Your regular payment was $1618.78, and it still is, but interest is $1350 of that. Only $268.78 would normally be applied to principal. Yeah, you've just sent them about six months of payments - but it just paid your loan down by three years of principal payments. Assuming you never sell and never refinance and never pay an extra penny again, you will be done in month 324 - saving yourself thirty-six payments for a total savings of $58,276. Not to mention that if you do refinance, you'll pay lower fees. Not in the league of some of the alternatives above, but still a nice return on investment. Definitely beats spending the money.



Caveat Emptor

There's a lot that gets written on this subject, mostly by loan officers looking for business. Well, don't think I'm not looking for business, but not with this post. Or if anybody calls me because of this, at least I'll know they understand how to do it right.



The basic come-on is this: Your home has appreciated in value, and is worth more than you paid for it, so now you have equity on the one hand. On the other hand, you have loads of consumer debt, whcih is costing you hundreds or even thousands of dollars per month, which is impacting your lifestyle. So you borrow on the equity in your home and save money on your payments as well as causing them to be tax deductible in most cases.



Let's illustrate with some numbers. Let's say Arnie and Annie have a $300,000 loan on a home that they bought six years ago, and comparable properties in the neighborhood are now selling for $600,000. This is 300,000 in equity.



On the other hand, because they are american consumers, Arnie and Annie have a hard time living within their means. They've got $15,000 in consumer credit, a $10,000 home imprevement loan, and two new SUVs with associated debt of $20,000 and $30,000. These are fairly typical numbers.



Arnie and Annie's mortgage payments are currently $1720 per month, because they refinanced to 5.25% two years ago when the rates hit bottom. Their monthly payments on the credit cards are $400. The payments on the SUVs are $500 and $600 per month, respectively. The payment on their $10,000 home improvement loan for landscaping is maybe $150. Arnie and Annie are forking out $3370 per month without taking into account stuff like property taxes, insurance, utilities, etcetera. It's really cramping their lifestyle.



Suppose they consolidate these loans into one payment on a thirty year home loan? All right, so it costs them anywhere from zero to $20,000 to get the loan done. Let's split the difference and say $10,000. That's about two points plus closing costs.



This has gone over the line into jumbo territory [no longer. As of 1/1/2006, the maximum conforming loan for single family residence is $417,000. On the other hand, rates are higher now :-( ] of a $385,000 loan. Were this a conforming loan amount, the rates would be lower, but with a 30 day lock, that'll get you 5.875% or thereabouts today on a thirty year fixed rate loan. The new payment is $2277. Voila! Despite the higher interest rate, Arnie and Annie are saving almost $1100 per month!



Or are they? On the credit cards, their monthly interest was $225; their $400 payment would have paid the cards off in less than five years. The interest on the SUVs was $333 total on the two, and their payments would have had them done in about five years. The home improvement was a ten year loan but even so their monthly interest was only $75. Now these are all thirty year debts. The monthly interest on their old home loan was $1312. The interest charges on their home loan is now $1884, where total interest was $1945 previously. So they are actually saving money on interest.



The difference is that now they're not paying the old loans off as fast - they've spread the principal over thirty years. In the meantime, the bank is getting all this lovely money in the form of interest from them, and if they refinance about every two years as most people seem to do, this is $85,000 more that they owe on their home, and that Arnie and Annie will pay points and fees on every time they refinance!



Let's assume Annie and Arnie beat the odds and don't refinance for five full years. This puts them ahead of 95 percent of the people out there. Let's look at where they'll be five years out if they make the minimum payment. They will owe $357,700 on their home. On the plus side, they will have had $66,000 to spend on other things (and they likely will, if they are typical americans). Total debt: $357,700



If they had continued making their previous payments, they would now owe $272,100. Plus they would be done with the SUV's and the credit cards and would only owe $6600 on the home improvement loan which they could now concentrate on. Total debts: 278,700.



Net difference: $79,000. Subtract that $66,000 they had real good time with (and nothing to show for), and they're still $13,000 in the hole.



They do have a $572 per month potential additional deduction. Assuming they are in the 28% tax bracket and get to deduct the full amount, that gives them $9,600 less that they owe the government in taxes. Net amount Annie and Arnie are out are out: $3400, in addition to being set up for higher fees on future loans, and having a loan balance $77,100 higher. Additional interest they will pay if they can get a loan at 5 percent even: $3855 per year.



Sounds like an awful bargain doesn't it? Many consumers have done this three and four times. I run across people who bought their home in the early 1970s, and have mortgage balances ten to twelve times the original purchase price.



Now, suppose instead of milking our equity for cash flow, where we're trying to minimize our monthly payments, we do it differently. Same situation, same numbers, but instead of spending that $993 per month, we use it to pay down our mortgage.



Actually, let's pay $3300 per month, so we still have $70 per month to spend elsewhere. After five years, we still owe $286,600. We got $4200 to spend elsewhere. And all of our other debts are gone. In addition, we got that $9600 in tax reductions. Net amount to us: $5800, although we still owe $8000 more, and if we get a 7% loan, that'll cost us $560 per year. Notice that at this point, the benefits, while tangible, are still fairly small. Furthermore, if we refinanced or sold before this point, as ninety-five percent of everyone does, any eventual benefits are likely to disappear.



But if we keep making that $3300 payment after those five years, and don't roll anything more into the loan, then the mortgage is paid off and we are debt free - the house is paid off, and the other debts are history - in less than ten more years! Now this relies upon us being thrifty and keeping those SUV's going and not charging up any more credit and not doing anything else to make the debt worse. In short, not giving in to the marketing culture. Many people say they don't. Few actually manage it.



So you see, even if you do it right, it takes years to show the benefits of this kind of refinance. This is years of doing something that they do not have to that most folks just won't do. If you have an unsustainable cash flow situation, by all means you've got to do something about it, but don't kid yourself that it's financially fantastic. On the other hand, if you're one of those who have to ability to make the scenario in the last paragraph (or something like it) happen, it's well worth doing.



Now this hypothesis is highly sensitive to initial assumptions. I previously assumed that Annie and Arnie are and always have been top of the line borrowers, able to qualify for anything. Suppose they weren't? Suppose they were in a C grade loan at 7.25%, but now they qualify A paper at 5.875. With a payment of $2070 per month formerly, of which $1812 was interest, the new loan saves them $1450 per month in mininmum payments and $561 in actual interest while still saving about $1209 on their taxes over five years. You'd have owed $288,000 on the old program, now even if you put in only the same $3300 per month in payments, you're $1400 ahead of where you would have been on the balance, and you still had about $400 per month to spend. On the other hand, if Annie and Arnie were A paper but now they are applying for a C grade loan, it cannot be justified on anything except "the cash flow keeps us out of bankruptcy!" because it's financial disaster.



Some alert people will have noticed I didn't explicitly include the $10,000 cost of the loan in the computations of whether you're better off. That's because it is gone, sunk, included in the computations of where you ended up. It was part of your initial loan balance if you did it, included in the ending balance, and therefore included in the computations of whether you were better off. Now, if the cost of doing the loan were lower, there would be somewhat larger benefits a little bit faster, and indeed a lower cost loan is probably a better idea for most people, even though it means the rate and payment will be slightly higher. See my article on Why You Should Ignore APR for more.



The important thing to remember is to not get distracted by the fact that your minimum monthly payment goes down, and see if you (and your prospective loan officer) can come up with a loan and a plan that really makes you better off down the line, instead of one that sucks the life out of you financially, like the vast majority of these scenarios do.



Caveat Emptor

From an e-mail:

I live in (City 1) and recently signed a work order on a semi-custom new construction house in (City 2). My wife and I make a combined 120K income and still can't afford a decent place in City 1. It was preapproved rather quickly from both the builder's mortgage company and a few outside companies and everything was moving along splendidly, until my employer decided to refuse to transfer me (something we had mutually decided on back in April). To make a long story short, the house will be built and ready to close in early November and 2 of mortgage companies are asking for a Relocation letter from my employer. Seeing as how I make 66% of the 120K combined salary, my plan is to tough it out here until I find (1) a job in City 2, or (2) a job here that will transfer me to City 2. My question is, if I can't supply them with a relo letter am I dead in the water? Do I have to scrap the loan (primary residence) and try to get a second home or investment loan? The broader question here, is how critical is any piece of documentation? Obviously W-2s and bank statements can be deal breakers, but what about the other stuff? I.E. relo letters, proof of homeowners dues, etc etc.

First off, you have an obvious potential issue with your current employer. If your work order was predicated upon a promise of transfer, you may have a case against them if you want one for the amount of any money you're out. Consult an attorney, preferably one that is licensed in both states. Obviously, this poisons the atmosphere, so you may not want to. On the other hand, you may have decided by now that you are done with them one way or the other.



Second, getting to the item of contention, the relocation letter. Every lender's guidelines are different. You didn't say how many lenders you had applied with, but few people apply for more than two loans. Any item the underwriter asks for can be a deal-breaker, especially if you can't provide it. What the underwriter is looking for is a coherent picture of someone who is going to be able to repay the loan. If the loan underwriter doesn't see a coherent picture of you being able to repay the loan under the circumstances it was submitted under, the loan will be declined. The underwriter can ask for anything they want. They can ask for proof your father gave birth to identical triplets, if they think it has some bearing on the loan. If you cannot furnish them what they want, and your loan officer can't shake an alternative or an exception out of them, the loan is dead.



Now they're not likely to ask for proof of something impossible and irrelevant like my example. Legally they probably could - Everybody has a biological father, so it's not discriminatory on the face of it. They're certainly not going to violate anti-discrimination lending laws by asking for something based upon race or sex. But they're in the business of making loans, which in many cases make more money for the developer than the sale. However, if the underwriter approves loans that go sour, they can expect to be held accountable by their employer, and so they require and are permitted a certain degree of necessary latitude on additional requirements in order to do their jobs. If I tell an underwriter that I make $2 million a year in the stock market, I'd better be able to furnish proof. If it's not relevant to the loan, I should keep my mouth shut about it because it's asking for trouble. Never tell an underwriter anything not absolutely necessary for loan approval.



It's a horrible lie about people from Missouri, but I tell people to think of underwriters as Missouri accountants. Their favorite sentence is, "Show me on paper." All loan approvals are based upon the potential borrower and their current status quo. In other words, the situation as it is, not as you hope it will be someday. Yes, when doing Verification of Employment they ask about prospects for continued employment, but that's just to establish that the employer isn't willing to admit they're about to fire you. They know that in the real world, people get told "Yes, we're going to keep Mr. X here forever" and next week Mr. X is applying for unemployment.



What the underwriter is looking for is a coherent picture of you occupying the property and working at your current employer. You're working in City 1 and living in City 2, which are not within daily commuting difference, but you applied for the loan as intending to make it your primary residence.



Given that they are requiring a letter of relocation, you have several options. I know it has happened in the past that employers who were not willing to relocate employees were nonetheless willing to write letters that said they were. This is stupid. This is fraud, and if the loan becomes non-performing the employer could potentially become liable for whatever the lender lost, not to mention that a lot of your protections as a consumer go out the window. Second, they could sign a letter that says you are going to be telecommuting from your new home. Yes, your job is in City 1, but you could legitimately be living in City 2 and still employed and doing your current job. Bingo, happy underwriter (probably). If your loan officers aren't complete idiots they will have asked you about this, so I presume the answer is no.



So now we're bringing in other issues as well. Now you have a husband living in City 1, while the wife and new home (and I presume wife's job) are now in City 2. Fact: husband needs a place to live in City 1. "What's that place to live going to cost him?" they ask. They take this answer and add it to the previously known total of your other monthly payments. Because you now have more in known monthly expenditures, now you may not qualify for the loan you were "pre-approved" for. Now, pre-approval doesn't really mean diddly-squat, and the developer knows it, so they likely required at least a decent sized deposit from you, so if you don't get the loan, you don't get the house, and you may have a substantial forfeiture. See my first paragraph. Furthermore, some underwriters may see a potential divorce situation here, so they may ask for some kind of testimonial from third parties that you're not getting a divorce.



Now, if you had a decent agent, he likely wrote your offer "contingent" upon your relocation. Unfortunately, if you're buying from a developer, your agent probably works for the developer, and so didn't do this. You may or may not have a case against the developer and the agent. Consult an attorney, but this is one area of many where buyer's agents really pay off.



(Even if they're inclined to trust me, I do not want to represent both sides in a sale, and will usually insist that one side go get another agent, or at least sign a release indicating that they realize I am working for the other party, not them, and have no responsibility as to their best interests. As your experience indicates, too many actions are a potential violation of fiduciary duty to one side if you do them and to the other if you don't. There are some agents who get greedy and do both sides, but usually they make their attorneys very happy. If your agent wants to do both sides of the transaction, that's never a good sign.)



However, what I suspect you really want is the house and the loan you signed up for. So I'm going to go on that presumption.



You make $10,000 per month. You may be able to get a friend to rent you a room in their home in City 1 for fairly cheap, so that there is not enough difference so you don't qualify for a loan. Several years ago before I met my wife, I rented a room out cheap to a friend who was in a situation not too different from yours. "A paper", you are permitted up to about about a forty-five percent debt to income ratio, and it can go higher if you have a high enough credit score such that DU or LP (Fannie and Freddie's automated loan underwriters) will buy off on it.



You could go to a different loan type, carrying a lower rate and hence a lower payment. Unfortunately, the debt-to-income limits on these are lower. Unlikely to work.



You could go to a "second home" loan. Unfortunately, the standards on those a a little tighter, and there may be an additional fee of a quarter point or even a half, and you're still going to have to show the underwriter a residence in City 1, which means the payment qualification issue raises it's ugly head here, also.



Finally, you can go to a sub-prime lender (where maximum Debt to Income ratio can be higher) or do a "stated income" loan. If you were working with a broker's loan officer as opposed to a direct lender or packaging house loan officer, either would be no sweat - you might not even have to do another application. The broker would simply withdraw your loan package and submit it elsewhere. Unfortunately, from a subsequent email, I know that you're not working with any brokers. Well, the developer probably has a sub-prime lender on tap as well, so that may be a low stress option. On the other hand, if they are a different branch of the "A paper" lender, they may not be able to do your loan either. Or, if you're lucky, the developer is acting like a broker in the first place rather than a direct lender.



One of the great rules of the business is that you cannot go from a higher documentation loan to a lower documentation loan on the same borrower at the same lender. If I submit to lender A "full doc," I cannot then later submit it to lender A "Stated Income." The reasons for this should be fairly obvious, and this is a no brainer without exceptions across the business.



For brokers, because the paperwork is in their name and not the lenders in the first place, this means no new reports. But since you're not working with brokers, what this means is that you're likely to need a completely new set of reports from the appraiser on down in the new loan company's name. This may be done on a retyping basis if you are lucky (see my essay on appraisals), or you may have to pay for completely new ones.



I strongly advise you NOT to quit your job, unless someone a lot more familiar with your situation and prepared to take the consequences of being wrong tells you otherwise. Here's why: You quit your job. Now you are unemployed. It does not matter if you've been doing what you're doing for forty years. Right now you are unemployed. As things currently sit, you do not qualify for the loan. Even if you've got a written offer of employment somewhere else, many lenders will not approve the loan until you have a pay stub to show for it. Since this means waiting several weeks at least, it's almost certainly outside your window of opportunity.



One final issue: here in California, it's illegal for a developer (or anyone else) to require that you do the loan with them in order to get the property. But it happens anyway (I've been told point blank by more than one developer's agent that if the client doesn't do the loan through them, the purchase contract will be cancelled. Many others won't tell you point blank, but they will throw obstacles up until you give up on the other loan), and it's a long hard slog to prove legally and it costs you thousands and you still don't get what you really wanted in the first place: the house you signed an order for. I am not certain the practice is even illegal in City 2, where you're buying (although from some things I've heard about that state's practices, I think it's probably legal). So you probably want to be certain you're not fighting the developer on this by finding your loan elsewhere. Unfortunately, you've already (probably) put a deposit down and you said in subsequent email that the home has appreciated while it was being built, so the developer has incentive to throw roadblocks in your path. Your transaction falls through and not only do they get to keep your deposit but they can turn around and sell the home for more. Preventing this kind of nonsense is what buyer's agents are for (it also gives you someone easy to sue if something goes wrong!). Unfortunately, most developers will not cooperate by paying a commission to buyer's agents for precisely this reason, which means that the average buyer will decline to pay an agent out of their own pocket and try to do the transaction on their own, which leads to situations like this.



Best of luck, and if this does not answer all of your questions, please let me know.

No, this isn't the Hitchhiker's Guide to the Galaxy



But having written half a dozen articles roundly critical of the way in which these loans are generally sold, it's not unusual for me to get e-mail like this one:

Hi, Dan:



Okay, I'm absolutely PANICKED after reading your article on negative amortization loans as I have one! I thought it was an "option ARM" and that my entrusted Realtor's entrusted loan officer was wise beyond his years in his financial advice. He was semi-retired, wealthy, and said that this was the only loan he'd ever use for his own substantial real estate portfolio. I even reassured a good friend of mine who is economically savvy not to worry as it wasn't a negative amortization loan!



I purchased December of 2006. The home I was going to purchase was appraised at $780,000 eight months prior to my purchasing it for $570,000; I put $100,000 down, had a good credit score, but the stickler was my monthly income. I knew I would make a substantial bonus and raise June of 2007, so DELETED sold me on the Option ARM. The bonus was one third what I expected ($2700) and my raise was only 4% rather than 7%.



My question is this - what do I do now? Is the loan okay as long as I pay the principal and interest amount of payment? I've only been paying the minimum, but could swing it by squeezing. It's a high rate - 7.5%. And I would have a prepayment penalty if I refinanced. I'm a single mom, 46, with two kids and annual earnings of $64,000. I have $50k in savings.



Yes, I am that poor sap you speak of in your article, completely trusting, desperate for my dream house, blind sided and now stuck. Any advice would be helpful! Thanks so much...

First rule of getting out of holes: Stop digging! Pay at least the interest every month!



Now, let's look at your situation. You owe $470,000 on a $570,000 property. The real payment on that is $3286.30 per month, as opposed to a "nominal payment" of $1511.70 at 1%. Actually, by my calculations, you owe about $483,000 now and will over $527,000 by the time your pre-payment penalty expires, if you make just the minimum payment.



Now, let's consider what's actually available out there. Picking up one rate sheet at random, it shows a 30 year fixed rate loan at 6.375% costing half a point retail. Let's figure out if you're likely to qualify for that. $64,000 divided by 12 is $5333 per month. 45% of that is $2400. Both of those are potentially important figures. Let's assume your value is still $570k, so 80% of that is $456,000. Paying the penalty and costs of the loan via rolling it into your balance, I get that you'd be left with a balance of between about $507,000. The payment on the first mortgage would be $2845, which is more than you can apparently afford right there. On the other hand, many single parents have alimony and or child support that can be used if they so desire that they don't include in their income.



On the other hand, I'm not building fairy castles in the air. From the information presented, you can not afford the loan by standard measurements. The flip side of that is you don't have to qualify for the loan you already have, and you say that you actually can afford to keep making at least the interest only payments. As long as you do so, you're not digging yourself in any deeper. If you can actually afford to make at least the interest only payment, there is no reason to panic.



Furthermore, getting yourself that 6.375% fixed rate loan would cost you roughly $24,000 - $18000 plus in pre-payment penalties, about $6000 in loan costs. To save 1.125 percent, albeit fixing the loan. Your current cost of interest at the $483,000 balance is $36,225 per year. Cost of interest after refinancing: $32,321 per year. Interest savings $3904 per year. Your break even on this is about 6 years, 2 months - if you could qualify, which you don't appear to.



If you make the payments for the next 27 months until the penalty expires, that higher interest rate will have cost you roughly $8900, offset to a certain amount by lowered income taxes. But here's where everyone's getting ulcers right now: That 6.375 is a "right now today" good only until tomorrow morning at most. Not that I expect tomorrow's rates to be much different, but I won't know until I see them. The cold hard fact is that only some kind of deity might know at this point what the rates are going to be like in December 2009. I certainly don't, and neither does any other human agency with which I'm familiar. There's a lot of estimates out there, but nobody knows. Furthermore, with a negative amortization loan, you don't know what your rate will be a year from now, as most of these abominations adjust month to month. So no matter which way you choose, stay or refinance, there are pitfalls, and there's no way to tell the right decision except in retrospect - in December 2009.



In your situation, I'd probably sit tight. As bad as it is, the alternatives all look worse. I wouldn't refinance into a loan that took me six years to break even on the costs of, and I doubt whether anyone else should, either. Alternatively, keeping in mind the fourth solution to Getting Out of Paying Pre-Payment Penalties, some people might want to see if their current lender will refinance them into a thirty year fixed, although in your case that does not apparently help because you don't appear to qualify.



But your situation is not the same as the person who is only looking at a negative amortization loan. Like it or not, you've already done it. That narrows your choices to "What do I do from here?"



The first thing to set in motion is a consultation with your lawyer. I'm not a lawyer, but I've been reading about the courts ordering these abominations rescinded, brokers paying damages, etcetera. The wheels of justice grind slowly, but that means the sooner you start them grinding, the sooner they get there. It seems likely to me that there were some misrepresentations and gross negligence somewhere along the line there.



I think that the local market is likely to turn away from buyers and towards sellers very soon. So that colors my perceptions, and what may be appropriate for San Diego may not be appropriate elsewhere, but as long as you can make at least the interest only payment, and make it long enough such that your prepayment penalty expires, I think you're likely to see a profit on the sale of the property then, provided things go as I think they will. It might be rough in the mean time, and preliminary numbers indicate that you're not likely to be able to afford to keep the property then, but panicking rarely does any good. There's nothing you can do at this point that does not have significant and costly risks. But from what you've sketched out, holding on until the penalty expires seems to be the least risky, most attractive alternative to me.



Caveat Emptor

Just got a search on "state of california fsbo questions to work directly with loan officers without a agent"



This isn't a problem. Whereas it is the same license, it is two entirely separate job functions. The fact that you are or are not working with an agent has absolutely nothing to do with whether you can get a loan.



This is not to say that some folks who do both might not attempt to trick or pressure you into signing an agency agreement. The way to deal with that is to contact these folks (the link is for California, but the principle applies elsewhere).



This is not to say you should be looking for real estate agent responsibilities from someone acting solely as your loan officer. This happens quite a bit; If they're not getting an agent's commission, you should not ask them to do an agent's work or assume an agent's responsibility. Asking you to sign a form that says they are acting purely as a loan officer and are not responsible for anything except the loan is reasonable. Loan officer legal responsibility is minimal to non-existent anyway; it's one of the reasons the loan business is so messed up and out of control. But asking a loan officer to do both jobs for the pay of the lesser is unacceptable. You don't do extra work for free, you don't assume extra responsibility for free. Why should you expect someone else to do so?



Now in California, we changed the law a couple of years ago so that in certain circumstances where the firm is licensed with the Department of Corporations, the loan officers do not have to be individually licensed. I've seen a lot of abuses out of such situations; the loan officer who isn't individually licensed isn't risking their individual ability to work in the profession, no matter how egregious the violation. Indeed, many firms licensed with the Department of Corporations instead of the Department of Real Estate have made a point of recruiting people new to the profession who don't know any better, and no one will tell them until they go work for a company with better practices, which most of them never do. These folks also don't know how much the company makes per loan, so they don't have to pay them as much. Best of all possible worlds from the company's view!



But so long as you only ask a loan officer to do the loan officer's job, there should be no problem with doing a loan on a For Sale By Owner property. After all, you don't need a real estate agent to refinance, do you?



Caveat Emptor.