Intermediate Information: September 2007 Archives

In an attempt to debunk some of the slanders that are floating around out there, this article is an itemization of how lenders and brokers make money on loans.



The first method is obvious: Origination or discount points charged to the consumer. This is money that the person getting the loan is paying, or someone else is paying on their behalf. One point is one percent of the final loan amount, two points is two percent, and so on and so forth. There is an actual difference between origination and discount points, but they have become almost interchangeable in their usage by many lenders and loan officers. Origination has to do with a fee charged for getting the loan done. It's not a trivial amount of work to get the loan done, and unless you're a close relative or have repeatedly saved their life, the person doing the loan is going to get paid somehow (and often, the family member or close friend gets rooked the most). If you're uncertain just how they are making money, you should ask. Discount points are theoretically a rate that the actual lender is charging in order to give you a rate better than you would otherwise get, but many brokers camouflage origination points as discount points and many banks camouflage origination points as discount points. The former makes you think the bank is making the money when it's the broker, while the latter makes the consumer feel like the lender isn't charging them origination, but that you are actually getting something most consumers quantify as real for their money (This also makes you feel like you're getting something for nothing, always a good selling point to anything).



Related to this are junk fees or markups of legitimate fees that are required to get the loan done. I do not believe I've seen a fee that some lender or another hasn't tried to mark up. If in doubt as to whether there's a markup, insist upon paying it directly. If they can't explain exactly what it was for in easy to understand words, it's probably a junk fee. Again, real fees usually run to about $3400 on a loan, although many lenders and loan officers are adept at hiding this.



The second way that lenders and loan officers make money is in rebates, also known as yield spread. This is pretty much limited to brokers, as neither traditional lenders nor packaging houses get direct rebates from lenders. Once again, rebates can be thought of as negative discount points and discount points can be thought of as a negative rebate. There should never be both discount points and a yield spread on the same loan. It is fundamentally dishonest. If there is a yield spread, you are being charged origination, not discount. Period.



The third way that lenders and loan officers make money is in the sale of the loan. This is only applicable to actual lenders, whether traditional or packaging house. Mortgage loans, particularly grouped in vaguely compatible bunches varying from $50 million on up, are among the most secure of all investments (indeed, in terms of historical risk, only US Treasury bonds are superior). Because they are very low risk, the lender makes a nice premium on them. As I'm writing this, CMO bonds trading at 5% even are basically at par, while 6% bonds are earning about a 3 percent premium. At par means the bank gets the face value of what they're selling, whereas a 3% premium means they get an extra $30 for every $1000 of bond value. For a $50 Million CMO offering, this is $1.5 Million. (There are other factors such as underlying quality, whether there is a pre-payment penalty, what tranches they may be assigned, and so on, but this is a basic article on the phenomenon.) By comparison, on a fairly good "A Paper" lender's pricing sheet (the first one I grabbed), 5% is not available and 5.25% carries a discount point and a half while carrying a premium on the secondary market of half a percent or so, so the lender is making two full percent on that loan at a minimum, and unlike a broker's yield spread, this is never disclosed to a client. Nor is there any limit as to how much this can be, but with even decent to good A paper lenders getting 2% or more, it shouldn't stretch your mind too much to find out that this number can go to 6 or even 8 percent in the subprime and negative amortization markets. 6 percent on $50 million is $3 Million dollars the lender gets for selling $50 million worth of loans - this translates to about 100 regular 3 bedroom homes here in California. $30,000 each, over and above any points and fees these people may or may not have paid, and for holding onto the loan for maybe one month. Believe me, your lenders are not hurting - and many even have the guts to badmouth brokers who may make $5000 while cutting the consumer's cost by $7500 to $10,000 and the bank still makes $20,000 per loan. (Note: these spreads and premiums used to be much larger 30 years ago when people didn't reliably refinance or move about every two years).



What brokers do is essentially play these lenders off, one against another on a professional basis, to see which one will cut the best deal on your behalf, because brokers are never captive audiences while the lenders regard you as theirs from the time you walk in the door.



Also, the point needs to be again that cost of a rate is always inverse to the rate for precisely the reasons of yield spread and bond premium. The lower the rate, the higher the cost. The higher the rate, the lower the cost. Some lenders and brokers may have better cost/rate tradeoffs than others, but there is always a trade-off.



The last method of receiving traditional income is to actually hold the note and receive the interest. This is actually rare these days. More often, what the lender will do is sell the loan itself while retaining servicing rights (for which they are paid, of course). Most often, the lender can make more money by selling the note to Wall Street - whether or not they retain servicing - than they can by holding the actuial note themselves. Keep in mind that the premium they get from sale of the note is immediate, and they can "sell the same money" several times per year, as opposed to just holding on and collecting the interest as it accrues.



How can (and should) you compare a broker's offer, where compensation is disclosed, with a bank's offer where it is not? First off, make sure that they are on the same type of loan at the same rate. My questionnaire here is a good start. Note that the last explicit question, "Will you guarantee this rate at this cost and cover the difference, if any, yourself?" should be answered in writing, and if the answer is "No," that's a red flag as to what their business practices are. They know what it's really going to take to get the loan done. They know what rates are available for locking today, right now. If it's not locked, it's not real, and they're playing games with your loan. As to prospective loan providers who won't guarantee their Good Faith Estimates, I have a retort I use with potential clients to whom somebody else has sold nonexistent pie-in-the-sky: "Well, if he's not going to guarantee you a 5.75 30 year fixed rate loan with one point, how about if I don't guarantee you a 5.5 30 year fixed with no points?" If it's not personally guaranteed in writing, chances are they are jerking you around to get you to sign up. None of the standard federal or state forms are binding in this sense; not the Good Faith Estimate, not the Mortgage Loan Disclosure Statement, not the Truth-In Lending form, and not the application form itself. Furthermore, keep in mind that for all third party items, such as title, escrow, attorney fees, appraisal, etcetera, they are able to exclude them from the precomputed costs of doing the loan, so most lenders and loan providers do. Not coincidentally, these are the biggest items in the closing costs section of your loan. Insist upon full disclosure of each item, and ask them to guarantee the total.



And once you are certain that the loans you are being told about are actually the same loan or the same type of loan, then you can make the decision as to which is better by choosing the one that actually gives you, the prospective client, the better loan.



Caveat Emptor

Supply and Demand.



Now that I've given the short answer, it's time to explain the macro factors behind interest rate variations. But I'm going to keep referring to those first three words. It is a tradeoff between the supply of money and demand for it.



The most obvious thing influencing loan rates is inflation. This is a general environmental factor. If the inflation rate is higher, then other factors being equal, there will be fewer people willing to lend at a given rate, and more people willing to borrow. Who wouldn't want to borrow money if the money you have to pay back is actually worth less than they money you borrowed? All loans are priced such that a given inflation is part of the background assumptions of making it. If inflation is 4 percent, someone lending money at seven is making an effective 3 percent. If inflation is ten percent, they are losing that selfsame three percent. Which scenario would you prefer to loan money in? Which scenario would you prefer to borrow money in?



On the other hand, when inflation is high, loan rates usually rise to compensate. When the prime rate is twenty-one percent, that means that a business borrower has to make a minimum of twenty-one percent on the money just to break even. That's if they're a prime customer. Making twenty one percent is tough. The reason you borrowed ("rented") the money was because you have a use for it to make money. There's a lot fewer opportunities that make enough over twenty-one percent to make them worthwhile, than there are opportunities making enough over seven. This is one reason why inflation is a Bad Thing.



What alternatives exist is a major factor on the supply side, as well. If you absolutely must invest your money in US Government securities, that's where you're going to invest, and since you're increasing the supply of money to the treasury, the price is less. Supply and Demand. This is one of the many reasons why Congress' handling of the trust fund is a national disgrace. If they were private trustees, they would be help liable for not investing it where the best returns are. If, however, you think that stocks are looking more attractive now, that means that the supply of money for loans will shrink by whatever dollars you move out, and the rates will rise. The effect for any one person is small, but there are a lot of people in the market. In aggregate, it's many trillions of dollars. Supply and demand.



Savings rates means a lot, also. When there is a lot of new money coming available in the borrowers market that money is going to be cheaper to borrow, in the form of lower interest rates. This is partially why rates went down throughout 2002, and stayed down into 2003, and 2004. People who had been burned in stocks wanted nice "safe" mortgage bonds. When there is comparatively little new money coming into the market, the only source becomes old loans being paid off. Negative savings or negative investments in the bond market means that what money is coming off older loans is at least partially being used to fund the withdrawals. Competition for money gets fierce, and price - by which I mean interest rate - rises. Supply and Demand.



Competition for money is also a part of the demand side. When the government needs to borrow a lot, for instance, that increases the competition. Even on the scale of our capital markets, whether the government is breaking even or needs to borrow the odd $100 billion has a real and noticeable effect When they need to borrow $400 billion, you can bet it'll raise the cost of money. The government doesn't care, and the bureaucrats running the treasury have been told to get this money. They will do their jobs and get the money, whether it costs 4 percent, 14, or 24. Every time competition from the government drives up rates, a certain number of borrowers whose profit margin on the loan was likely to be marginal will drop out of the auction. But government spending rarely grows the tax base. It's those corporations and small businesses investing in future opportunities that grow the tax base, and they are the ones dropping out of the auctions as money gets more expensive. This is why government deficits are a Bad Thing. Supply and Demand.



The desirability of the alternatives is another factor on the demand side, as well. There's more than one way to make money for most. If it become prohibitively expensive to borrow (bonds), sell part ownership instead (stock). There is a point at which even the most die-hard sole proprietor needs the money, and just can't afford it as opposed to selling some stock to new investors. This can dilute earnings, and cause you to lose control of the company (there were multiple reasons why the high inflation period of the seventies and eighties was followed by the era of the corporate raider, but that's one part), but better to dilute your share of the pool by ten percent while increasing the size of the pool by fifteen. That is a net win, while borrowing the money at twenty-something percent is likely not.



Now, let us consider the money supply here in this country, and thence the state of likely interest rates. We have increased government borrowing. We have the social security trust putting decreasing amounts of money into the government. We have a national savings rate that's negative (and it is the overall rate, not just working adults that we're concerned with, here). More and more people are becoming comfortable with foreign investment. And mortgage bonds are looking jittery right now, with foreclosures up. Supply and Demand, remember?



Therefore, in my judgement, we are likely to see continued raises in the interest rate for some time. If you're on a short term loan that is likely to adjust in the next couple of years, the time to refinance is now, unless you're planning to sell before it adjusts. And if you had asked me a year ago if I'd ever be recommending thirty year fixed rate loans, I would have said, "Not likely". I'm recommending them now. When it's the same rate or higher to get a 5/1 ARM, there is no reason not to choose a thirty year fixed rate loan instead.



(If, on the other hand, you have a long term fixed rate loan, stay put. Once you've actually got the loan funded, they can't just draw the money back unless you do something like fraud or default. Even if you go upside down on your loan for a while, if you're already in a fixed rate loan, that's okay. The market price of the home only matters at loan time and at sales time. If you don't need a loan and you don't plan on selling, why should you care? Note to the young: home prices will rise again.)



Caveat Emptor

"Should People in their sixties take out a mortgage?"

The short answer is "Not if you don't have to." Now if I suddenly vanish, the explanation will be that the loan industry put a contract out on me.

Success in loans, and sales in general, is often attributable to selling people stuff they don't need. If you don't sell something, you don't eat. Getting people to call or stop by is expensive. The traditional idea of sales is that you have to make a sale at every opportunity, whether it really makes sense for the client or not.

The various tricks of selling a mortgage to retired folks is a case in point. "It's a cushion," "It's there in case you need it," and all sorts of other stuff to that effect. Combine this with the "If you wait until you need it, you won't qualify!" and most folks who don't know any better will cave in and apply.

This is exacerbated by the fact that most people seem to want to stay in the same home they raised their family in. This is very understandable, emotionally, and often the worst thing you can do financially.

Let's consider the typical three or four bedroom house with a yard, and the retired couple. It becomes more and more difficult, physically, for them to do the required routine cleaning, and even more difficult to do the maintenance and repairs that any home needs from time to time. Sometimes the kids are close enough and willing to help, sometimes they aren't. If their finances are tight in the first place, they get tighter and tighter over time.

Into this environment comes the guy with a Reverse Annuity Mortgage (RAM) to sell. This is a special kind of mortgage, with a special protection for the homeowner (here in California, and in many other states as well) that they cannot foreclose in your lifetime. You cannot be forced out. Well, what if you're sixty-five and live to 100, as a far larger proportion of today's 65 year olds will? That's thirty-five years they are locking this money up for, and there is always the possibility that by the time they consider the cost of selling, etcetera, there will be no equity.

Lending is a risk based business, and that kind of lending carries its own risks. Who pays for the risk to the lender? You do. Especially as opposed to the typical loan where half have refinanced in two years and ninety-five percent in five, this is a long term loan they are being exposed to. Yes, the recipient could get cancer and die in a few years, but they could well survive that. The lender has no way of knowing what the interest rate environment for the money will be in a few years. So either the rate the clients get is variable, or the clients pay a higher rate to have a fixed interest rate.

Once you start taking money out of the RAM, it starts earning interest. Since in the most common forms you are typically not making payments, it accrues interest. If you are making payments, it makes your cash flow even tighter, and you need to take more money. In either case, your balance is increasing, faster and faster with time, until you hit the limit, at which point you can no longer get additional money. This often happens surprisingly quickly, as you have the power of compound interest working against you. This all but guarantees that the family will have to sell the home, often for less than they could have gotten had they the luxury of a longer sale time. Furthermore, if keeping the home in the family is something you would like, a Reverse Annuity Mortgage is almost certain to torpedo the hope.

Contrast this with the swap down option. Suppose instead that adult children buy a small place suited to the parents needs such as a condominium, and the parents live there, while they live in the parents home. This minimizes cleaning, upkeep, and maintenance that the parents need done.

If this won't work, another option is selling the home and buying something smaller. Remember, a RAM will almost certainly cause the family to lose the home anyway. You get more mileage out of cashing in the equity by selling, and investing the equity, than you will from borrowing against the equity. Instead of working against you, compound interest is on your side. Most states have laws preserving property tax basis if that's something that is advantageous.

Let's say that with a $500,000 home, moving down to a $200,000 condo. Net of costs, you net at least $250,000 to invest, and let's say you do so at 7 percent, well below a well invested portfolio. This gets you $17500 per year, or about $1460 per month, indefinitely, and you keep both the condo and the $250,000. Contrast this with taking the $1460 per month out of your equity. Even if you can find a RAM at the same 7 percent, the entire equity is gone out of your home in a little over fifteen years, and that's without including initial loan charges.

Nobody can make you do this, and there are many reasons why you might not want to. But looking at it from a strictly financial viewpoint, it's hard to find the justification for a Reverse Annuity Mortgage.

As a resource, here's the AARP page on reverse mortgages, and here's another page with some good general information.

Caveat Emptor

From an email:

Anyway, my wife and I are about to purchase a place here in the X area and we've been hearing that "a tough loan" line due to the fact that I'm only 10 months into my new small business although I've been profitable the entire time. We're stuck doing No Doc/Stated Income setups - I think you called these "liars' loans" - and the rates are a bit painful.



My wife's scores... at 720 are the lowest we have and mine are (higher).

Well, the good news is that your credit scores place you in the highest band of credit scores. There is no category beginning higher than 720.



The difficulty is that you're running afoul of one of the background rules of the whole loan process. Fannie Mae/Freddie Mac rules limit A paper loans to those with two years in the same exact line of work. With some limitations, a good loan officer can sometimes get it approved for two years with the same employer, if they've been progressing normally within the company. Changing from a W-2 employee to self employed is a change that cannot be approved, at least from the point of view of A paper. A minus and Alt A rules are mostly similar. So you're looking at subprime if you're documenting income. Let's examine A paper documentation levels to see if they're a possibility.



Full Documentation: Requires documenting two years income same line of work. You can't; you've only been self-employed for ten months.



Stated Income: Requires documenting that you've had the same source of income for two years. Nope. Yes, these and NINA loans are often called "Liar's loans" in the business because the lender agrees not to verify your amount of income. That's because loan officers eager to make a commission on a loan where the client really doesn't qualify use these to qualify the client. The qualification standards are there for your protection as well as the lender's. Just because you can use these to qualify doesn't mean it's smart. Locally where I am we have a huge house of cards because loan officers use these to qualify clients for negative amortization loans. Yeah, the temptation to make a commission is there, but am I really serving the client's best interest by securing them a loan they can't really afford where even the payment they can't afford has them owing more money each month? I submit that the answer to this question is usually no. These are designed for self-employed folks and people on commission who make the money, they just have write offs and such so that they can't really document it. Using stated income to say you make money that you don't is a dangerous game. It's likely to result in foreclosure.



NINA: Requires a good credit score. This might be your ticket. On the other hand, you don't state how much of a down payment you have, percentage-wise. A paper NINA requires some equity in the property; I've never seen an actual A paper NINA approved with less than about ten percent equity. On the other hand, these are very easy loans to actually do. It's trying to qualify you for something better that's hard.



On the other hand, if we move down into subprime, the rules aren't set by Fannie and Freddie. There are subprime lenders with one year same line of work programs, and even a few with six month programs. On one hand, they're subprime loans, carrying a higher rate/cost tradeoff just by virtue of that. On the other hand, because you're documenting your income, you get a break for that.



One of the great universal things of the loan business is this: The looser the underwriting standards, the higher the rate, and the tighter the underwriting standards, the lower the rate. If a given lenders underwriting standards are looser, it's rates will be generally higher.



Now, given that you've only been self-employed for ten months, you're not going to have much of a paper trail. There are three possible ways that banks will accept to document income. W-2? Even if you have them, they're no longer applicable. Income tax forms? Given that it's September, counting back ten months leaves you starting the business in November of last year. Even if you had enough monthly income to qualify for that month and a half or two months, the tax forms effectively spread it across all of last year, and that's unlikely to show enough income. The third method of income documentation, unique to subprime, is bank statements. This, you might be able to do. Most subprime lenders have 24 and/or 12 month bank statement programs, and a large number have six month programs as well. The longer you can document for, the better the rate, but better six months than nothing.



Will this get you a better rate, at a better cost (two questions that always go together), than an A paper NINA? The answer to that is on a case by case basis. There is no way to be certain without pricing it around by the full details of your case, but there's a good chance, and you can get 100 percent financing this way.



I will warn you that bank statement programs (often called "EZ doc" or "lite doc") are THE most difficult loans to actually get approved. There are more problems with these than any other loan type. On the other hand, as I've covered elsewhere, if it gets you a better loan, the effort is likely to be worth it. Furthermore, there is a question of whether you qualify for the loan by the bank's standards. Some banks discount the amount of money coming into the account, some do not.



So which is the better alternative for you? I don't know without actually pricing it. I don't know for certain that either can be done for your situation without information like how much income your bank statements show, and how big your loan needs to be, and how much of a down payment you're making. Get a couple of good loan officers working on it in your area, and find out.



And yes, this is a tough loan situation. Both A paper NINA and subprime bank statement programs have their limitations. Failing that, you fall all the way back to subprime NINA, where somebody with your score can get 100 percent financing no worries, but the rates are rough on the pocketbook.

One of the casualties of the current lending meltdown is the high loan to value second mortgage.  With many properties locally having lost twenty percent or more of their value, a second mortgage on a property that ends up in default may well lose every single dollar the lender put into the loan.  It shouldn't surprise anyone that lenders don't want to get into that kind of situation.  Even though I (and most other credible analysts) are convinced that the values are stabilizing locally, the money markets are still in fear mode over the money they have lost or are on track to lose.

The result is that lenders of junior financing aren't nearly so willing to go to 100% financing any longer.  Even when the same lender is lending the money for both loans, the people who underwrite the second mortgages are (usually) a different division.  So when the property goes to foreclosure, the division who underwrote the first mortgage may end up with every dollar or nearly every dollar of their invested money, and they come up smelling like a rose.  The division that underwrote the second mortgage that got wiped out and came out with 10 cents on the dollar loses their shirts, and everybody gets fired.  The lender I've probably done the most business with just did away with all programs offering over 90% financing - doesn't matter the credit score or how much we can prove they make (UPDATE: My mistake - it was only subordinate financing over 90%, which further emphasizes my point).  This is going to impact how much business I do with them, of course, but they've decided they're not willing to accept the risk in order to get the business - which is their prerogative.

They're hardly alone.  It has been increasingly difficult to get second loans over the last couple of months.  With the situation as I've have discussed, and second mortgage lenders in the process of losing every penny they put into loans, they understandably don't want to do it.

There is an alternative.  There are still any number of lenders who will accept 100% financing on one loan with Private Mortgage Insurance (aka PMI).

Private Mortgage Insurance is an insurance policy that the borrower pays for but which insures the lender against loss.  It does get the borrower the loan, but that is the only good the borrower can expect to get out of PMI.  It does not prevent your credit rating from being ruined, it does not prevent any deficiency judgments that you may be liable for, and it definitely won't prevent the 1099 love note that tells the IRS you owe taxes on debt forgiveness.  All it does is shift the entity that loses the money from the lender to their insurer, so that if you default, you'll be dealing with the insurer instead of the lender via subrogation.

What  is going on here is that lenders are shifting the risks to insurers, who are in the business of taking risks via the Law of Large Numbers.  Yes, the insurers know they will lose a certain number of these bets, but they are comfortable that overall they will make money at it.  It is to be noted that lenders can improve their profit margins by self insuring, but they're not in the business of insurance.  I'm certain some of them insure themselves in one way or another, but they isolate the risks away from their lending divisions, which are in the business of making money by loaning it out and having those loans repaid in full.  When a lender loses a dollar because the loan wasn't repaid in full, that hits them where it really counts - bond rating, stock price, value of their mortgage bundles on the secondary market.  When an insurer loses a dollar due to paying a claim, that's part of their daily business.  They're in the business of paying claims, fully expecting premiums to more than pay for those claims.

As I said in One Loan Versus Two Loans, PMI is more expensive than splitting your mortgage into two loans, but when nobody wants to do second mortgages with less than ten percent down payment, the choices may narrow down to accepting PMI or not buying the property.  The only other alternative that comes to mind is a private party loan, either in the form of a Seller Carryback (which comparatively few people are willing and able to offer) or the "good in-law" loans that were popular before lenders started liberalizing their standards in the 1970s.

(I haven't been in the business that long.  I've never heard the phrase actually used by another professional, although I actually did a transaction that involved one earlier this year.  I learned it from textbooks, as even in the early nineties when I both bought my first property and went back for my accounting degree they were a fading memory)

Paying PMI does have the net effect of decreasing the loan that potential buyers will qualify for, so this development should cause some small amount of additional downwards pressure in prices.  For those interested in irony, the lenders are contributing to their own immediate losses by bailing out of the low equity financing market.  People who have to pay a higher effective rate for the money can't afford to spend as much for a property, which means that current owners, whether they're borrowers or lenders, won't be able to get as much money for them.

One last thing before I finish.  Don't get too hung up on the fact that you may end up paying PMI when experts (myself included) advise you not to.  It's one of those voodoo words and concepts like "points", that people freak out about because they've been warned about them but they don't really understand.  Just like points, many experts, myself included, often advise you not to pay PMI.  But if you have one loan that is over 80% loan to value ratio, you are going to be paying PMI in one form or another.  As I said in How Do I Get Rid of Private Mortgage Insurance (PMI)?, it can be a separate charge or camouflaged by being built into the rate, but you're still paying it.   There are advantages and disadvantages to each choice, as I explained in that article.  Choose your alternative with your eyes wide open and an understanding of the consequences, not because someone scares with with the voodoo phrase, "PMI."

Caveat Emptor

HI, My name is DELETED and my husband and I are searching for a way to get out of our Negative ARM loan before we get upside down.



Our problem right now is our loan to value. Our loan right now is at $547,367.80 and is only getting higher. Our house just appraised at $620,000.00. We have a prepayment penalty of $20,000.00 and would just like to get that covered. We feel we need a Jumbo loan if possible.



Our wish is to get into a 40 or 50 year fixed. My husband makes good money and I will be working in a couple of months making a decent income. Right now I am doing temp work. We can afford payments for our mortgage if we were to refinance but we are having a hard time finding someone who will take the risk with us. If there is a risk. We are just trying to get out of this loan that is going to end up taking our house from underneath us. Our credit is good and I feel there is a way something can be worked out



Can you help us?

I will try, if you're in California. First, let's stop and think a minute about your situation and what will benefit your pocketbook, rather than mine.

If you pay the penalty, your new loan is going to be approximately $570,000, even without points, something I truthfully don't think is going to happen the way jumbo rates are. Neither I nor any other loan provider can get you a loan that isn't available. $580,000 is more likely, considering prepaid interest, etcetera, unless you have some cash to pay it down. $570k and $580k are both within the band of 90 to 95%, so I have to price it as a 95% loan to value ratio.

But what if you don't have to pay the penalty? Now staying at or below 90% loan to value is a real possibility, and the loan can be priced as a 90% loan, giving better trade-offs. The way we might be able to do this is to check if we can get your current lender to refinance you. It'll likely mean renewing your prepayment penalty, but better that than paying $20,000 in penalty. Even if you end up with a higher rate than you might otherwise get because your lender doesn't have the lowest rates, $20,000 is almost four percent of your loan amount. Over the course of the 3 years of the new prepayment penalty (since that's standard for negative amortization loans), you'd have to save over a percent per year to break even with another lender. As I said in "Getting Out of Paying Pre-Payment Penalties", sometimes lenders will not require you to pay a penalty if you refinance with them and accept a new penalty.

In short, if we check with your current lender first, we might save you $20,000 cash plus the interest on it. So let's figure out who your lender is and ask.

The second alternative is to find out how long until the penalty expires. Make at least the interest only payments every month until your payment expires. How long do you have left on the penalty? If you've only got six months or a year left, rates just aren't low enough to make it worth your while refinancing right now, especially Jumbo loans, which even if your loan to value ratio was below 80% would still cost you nearly two points for a 7% loan. If you pay at least the interest only payment, you're not getting in any deeper. When the penalty expires, maybe rates and the market will be in better shape and you'll get a better loan. Matter of fact, with the current mostly psychological meltdown in the loan market, it's a moderately good bet, especially as opposed to just flushing $20,000 paying that penalty. If you have less than a year left on the penalty, I strongly urge you to make the interest only payments (or more), and come back to me about three weeks before it expires. From that point, by the time I can get your new loan funded, the penalty will have expired.

Even if you're only six months into your loan, we'd have to save you about about 1.5% on the rate for you to come out ahead by paying that penalty. $20,000 times 12/6 divided by $547,000 gives a current rate of 7.3%. As you'll see, a blended rate of 6.67 is about as low as I can get for this situation. Your rate would have to be at least 8.2% now for paying that penalty to be in your best interest.

The loan market today is a very different creature than it was a few months ago. Let's look at the alternatives, assuming your lender will waive prepayment with a new loan. Even so, let's look at a loan amount of $558,000, which is about where you're going to be with closing costs and one point.

At 90% CLTV, I currently have a 30 year fixed rate loan at 7.375%, with PMI of about 0.7% on top of that. At $558,000. Payment would be about $4180, of which roughly $325 is PMI, $425 is principal, and $3430 is straight interest. Real cost of the loan would be roughly $3755 per month. Even if I could get you a 40 year amortization at the same rate, the payment would be $3945, and at 50, the payment would be $3843.

Or we could split the loan into a 80% 30 year fixed rate first at 7.375 without PMI and a 10% second at 8.55%. Payment on the first, about $3426, of which $3048 is interest and $377 is principal (numbers don't add due to rounding to the nearest dollar). On that 30/15 second of roughly $62,000, the payment would be $479 and the interest $442 while the principal is $37. Real cost of the loan, roughly $3490 per month, $265 less, and more of it is likely to be tax deductible. Plus, in terms of payment, I've saved you more than the difference between the thirty and forty year amortization, and almost the difference between the thirty and fifty year amortization.

Or, we could split the loan into a conforming first at $417,000 with a $141,000 second, again on a 30/15. Now that first mortgage is at 6.125%, for a payment of $2534, of which $2128 is interest and $405 is principal. The rate on the second drops also, to 8.3%. Payment, $1064, of which $975 is interest and $89 is principal. Real cost of this loan, $3103 per month, and the total payment is only $3598, another $307 per month less than the second alternative and $582 less than the first alternative.

Before I close, it occurs to me to ask if you are actually able to make those payments. Because the fact is that you owe $547,000 right now, and that's a cold hard fact that nobody is going to change. Quite often, people get put into negative amortization loans because that's the only way they're going to make the payment on that much debt. If you cannot realistically make these payments, delaying the inevitable will only cost you more. As things sit, you might come away with a few thousand dollars if you sold now, and then you can buy something you can really afford. If you wait, things are going to get worse, and you're going to end up with a short payoff and a 1099 love note that says you owe taxes, plus maybe a deficiency judgment, having your credit ruined, and still not having the home of your dreams. This doesn't make me popular right now, but what people like you are going through now is the result of people in my professions who wanted to be rich and popular, rather than actually doing what was best for the clients. Were I in your shoes, I'd likely be asking a lawyer if there's some liability on the part of your lender and real estate agent.

Caveat Emptor