Intermediate Information: November 2007 Archives

That was a question I was asked via email.

The answer is "No." You don't have to lose your home in bankruptcy. I've done loans for many clients who kept their homes through bankruptcy. But they kept their mortgage payments current, or close enough to current.

The condition that causes you to lose your property is called foreclosure. The specifics vary from state to state, but here in California, the lender has the option of marking you in default when you are 120 days in arrears on your mortgage.

Default causes you to lose some rights, and the lender to gain some. Since properties can go into arrears literally for years before they go into default, this seems appropriate. You could theoretically stay at 90 days behind throughout the whole term of your mortgage (except the first 90 days), and the lender can't really do too much about it except hit your credit. Please, don't try this at home. This is for purposes of hyperbolic illustration only. It really does kill your credit rating. Refinancing (or getting another loan after you sell) will be extremely difficult, and the rates will be sky high if you can get it.

But at the point you enter into default, your lender can require that you bring the loan completely current in order to get them to rescind the default. A Notice of Default, or NOD, is a matter of public record, and if one is recorded against your property, you can count on getting hundreds of solicitations from bankruptcy attorneys, hard money lenders, real estate agents, and just plain sharks. Additionally, the lender is going to hit you with thousands of dollars in fees when they put you into default. These go into what you owe.

Here in California, if you don't bring the loan current within sixty days, the lender has the option of dropping a Notice of Trustee's Sale on you. This publicly recorded document basically says "Bring it current now, or we're going to sell it at auction." Actually, at this point they can require you to pay them off in entirety to make them go away, and I don't know anyone except hard money lenders that will refinance you out of default. They can do this because you signed a Deed of Trust when you got the loan. Things are different in states that still use the mortgage system - there, the lenders have to go through the courts, which you're also going to end up paying for. The Notice of Trustee's Sale will tell the owner to be out at least five days prior to the auction. You also lose the legal right to redeem the loan at that point, although most lenders will keep working with you until the gavel falls. There must be a minimum of 17 days between Notice of Trustee's Sale and the actual auction. This is called foreclosure.

Bankruptcy is a different process entirely, and has to do with solvency, the ability to make required contractual payments on all of your debts. Within limits, you can choose to enter or not enter bankruptcy, and which creditors are and are not included in the bankruptcy. It's usually better not to include everything in the bankruptcy, because post bankruptcy credit history is critical re-establishing your credit. No matter what else, if you can stay current on the loan against your personal residence, that has more rights of preservation against other creditors than anything else (usually). Please consult an attorney in your state - there may be differences in the rules, or you may fall into one of the exceptions, and there are all kinds of relevant details I'm not going into here.

If you can hang onto your personal residence, and keep the loan current through bankruptcy, you not only (usually) get to keep your property, but you have a ready made mechanism to rebuild your credit. Those monthly payments you keep making to your mortgage lender? They count for credit re-establishment. In fact, if you have zero balance credit cards or revolving lines of credit, you can often choose not to include them in the bankruptcy, get to keep them, and all that nice jazz having to do with duration of credit, etcetera. You might want to read my article Credit Reports: What They Are and How They Work for more.

Foreclosure and bankruptcy are two different issues that often go together - but not necessarily. The law gives consumers a lot of protections on their primary residence, even through bankruptcy, but if you go into default on your mortgage, it's very hard to keep your home if you're in bankruptcy also.

I have seen people fresh out of Chapter 7 bankruptcy qualify for an A paper loan. It's unusual, but it does happen. What usually causes it to happen is that they have one or two lines of credit, often business related, and they file bankruptcy promptly, rather than spending months getting their credit dinged because they're in denial, and they keep everything else is current.

But if you keep your mortgage payments current, whatever else happens, frequently you will emerge from bankruptcy with your property.

Caveat Emptor

If I am buying a foreclosed home for 220k of which 200k is being financed, and the home comes back at being valued at 285k from my mortgage company, am I still required to pay PMI? If so, how in the future would I be able to eliminate it?

At purchase, the lender treats the value as being the lesser of cost (i.e. purchase price) or market (i.e. appraisal value).

So if your purchase price is $220k, that's the most the lender will consider the property to be worth at purchase. You will be required to pay PMI for any single loan amount over $176,000, or eighty percent of this. Since second mortgage lenders don't want to loan over ninety percent of the value of the property right now, you can either come up with a couple thousand dollars more, or accept PMI.

A couple years ago the wisdom was just to refinance in a few months. Lots of luck with that in the current market. In the current market, lenders are reverting to their standards of several years ago, which is that unless you spend some major sum upgrading it, the most a lender will believe within one year of purchase is 10%. Were I in your shoes, I'd plan on waiting a year, then doing whatever your state law says is necessary to remove PMI. This might be pay for an appraisal, this might be get a broker's price opinion based upon recent comps, but there have just been too many people over-evaluating property in return for some special compensation (i.e. accepting bribes to return a higher number on the value). They want to see some time to season the transaction between purchase and evaluation. Scam artists don't want to hang onto the property for a year.

Private Mortgage Insurance (PMI) is not a good thing, but it may be the only way to get the loan in the current environment, as I discuss here.

You do have the option with a lot of lenders of converting to LPMI, or lender paid mortgage insurance. This folds PMI right into the basic rate of your loan, so (unlike regular PMI), it usually becomes tax deductible. On the other hand, because it's written into the basic Note rate, it has a disadvantage that unlike regular PMI, you need to actually refinance to get rid of it. Since most people spend thousands of dollars to refinance, this isn't a good bargain unless you figure the rates to go down. I don't, or at least not much. Were somebody to put a gun to my head and force me to make a bet right now, in November 2007, I'd bet they were going up over the next twelve months. If I were to decide to accept LPMI, I'd almost certainly want a true zero cost loan now, with the loan I'm getting for the purchase. I would accept the higher rate that comes with it, and quite likely a hybrid ARM as well instead of a thirty year fixed rate loan. The reason for this is that I'm never going to recover closing costs through lowered cost of interest in only one year. In other words, accepting LPMI means I've made up my mind to refinance in a year, or sooner if I can find a lender that will do it, and that I'm not going to willingly pay any loan costs that take longer than a year to recover. Furthermore, if I can get even a slightly lower rate by accepting a shorter term hybrid ARM, that's worth a good idea under these circumstances. As I said, If I'm accepting that I'm going to refinance in a few months, I'm going to want a loan with costs as low as I can get it, and it just isn't important to me to have a thirty year fixed rate loan in such circumstances. Makes no sense to worry about having it be fixed for the entire duration if the loan you're getting will go away in a few months regardless.

If I was getting a loan for the purchase where I'm paying closing costs and points to buy it down, regular PMI is the way to go. That can be removed without a full refinance. If I have to refinance in a year to remove LPMI, the vast majority of those loan costs will be wasted, because I need to refinance to get rid of LPMI, and when I do, I'm letting the lender off the hook for the rest of that loan period, and if I haven't yet recovered the closing costs, I certainly won't get any additional benefit from my current rate after I refinance!

Caveat Emptor

The majority of the protections that folks have are aimed at helping non-professionals have a chance in the complex and nearly incomprehensible maze that is real estate. The legal presumption is basically that you are a babe in the woods, and can easily be led astray by the fast-talking real estate broker and the big bad mortgage lender. And actually, this isn't too far off. I have seen enough to know that however bad a choice Negative Amortization loans are for 99 percent of the population, an unscrupulous agent and/or an unscrupulous loan provider can talk 95 percent plus of the public into getting one of them simply by accentuating the low payment and not mentioning the fact that your balance increases, among other things that most folks regard as inimical about them. Particularly in combination, each of them hoping for a big commission (the agent from a house beyond what the client can really afford, the loan provider from the associated loan), they reinforce each other's credibility beyond all but the most sceptical of laypersons to withstand.



When you get into investment property, however, this isn't just your personal residence any more. This is no longer something every living person needs, a place to live.



You are now intending to make money.



You are now in business. You are a businessperson. It does happen, of course, but it is difficult to have much sympathy for a businessperson who doesn't know enough to conduct business of that nature. Some Poor Guy who wants to get in on the American Dream is entitled to significant legal protection against all the sharp and smooth operators out there. But once you get out of the realm of personal use and get into the realm of making money, now you are telling the world that you know something about this (or at least that you should know something).



You have promoted yourself into the realm of sophisticated user. The legal presumption is no longer that you are a babe in the woods, although you may be every bit as much of one as the person in the earlier example. But because you have promoted yourself to someone trying to make money, many of the protections and disclosure rules do not apply.



It's not like you went out and got a real estate license (unless you did) or passed the bar, which automatically gives you the right to a broker's license in most states. There are still significant protections even there. But if they wanted to push the point, your agent and loan provider could probably eliminate half the forms you're asked to sign. The three day right of rescission goes away because instead of being presumed to require consultation with professional experts, you are presumed to be a professional expert. Why are you in the business if you're not an expert?



Needless to say, this point has become quite the illuminator of experience for many folks who see others making money via real estate investments, and think, "That's easy! I can do it too!" All too often, people who may be used to the protection afforded the general public get burned when they are presumed to be experts by the law. Not that the government has done a particularly good job of protecting the general public, but the sharks in those waters have to make it look reasonable. The sharks who swim in the waters of investment property have no such limitation. They talked you into a bad loan? For your own personal use, you have the three day right of rescission and many banking laws designed to require that the bank show something that can be construed as a benefit to you, the borrower. Lower payment, lower interest rate, something that persuades a judge that a rational person might have done this. The person with an investment property doesn't have even that protection. So what if it leads to bankruptcy? You did it. You must have had some reason.



I am not a lawyer, and I am exaggerating a small amount for effect. Real Estate investments, handled correctly, can make you a humongous amount of money. The point I'm trying to make is that they can also lose the unwary a lot of money. The amount of loose money available in real estate for the picking is the lure for a large number of professional sharks.



Caveat Emptor

Problems with Multiple Mortgages

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We have several rental properties that we own (more than 10). When we were younger, before we got married, we both moved around a lot and bought houses, moved, stayed a year or so and did it again. I of course don't have to mention why we did this (no money down, low fixed rates, etc.) However, now I am running into a dilemma. I am finding that no one wants to refi or do purchase money loans now that we have 10+ mortgages. I need good rates to make my cash flow work. I have recently herniated one of my discs and have been out of work for almost 3 months, so I need to take money out of our house that is paid for, but no one wants to do it. Any suggestions on how to get around that? My credit scores range from 763-805, so that is definately not the problem. Any advice would be greatly appreciated as I am down to crunch time in needing to get some money.

Bad situation.

The reason for this problem is that whereas nationally, vacancy rates are much lower, and here in high cost California they are only running about 2.5 percent, the bank will only allow 75 percent of rent to be used in the calculation of whether you qualify or do not. Furthermore, on the negative side they charge the full payment, taxes, and homeowner's insurance, as well as maintenance. Now, here in the high cost areas of California if there is a rental property bought within the last three years that's turning a profit, I'd like to know about it. But for properties purchased several years ago here, and nationally in many markets, there are people making money hand over fist on rental properties whom the bank believes must be cash destitute. There is no way they will qualify for a mortgage loan without tweaking something.

There are two main ways to solve the problem.

10 mortgages (assuming you still own the properties) gives one serious status as a real estate investor. The loan should then be able to be done. Not necessarily A paper, but subprime with that kind of a credit score and a prepayment penalty will give them comparable - perhaps even better rates. Furthermore, on investment properties, there's a minimum of about a 1.5 point to 2 point hit on the loan costs just due to the fact that it is investment property. So refinancing an investment property is not something you want to do often. If you can't go 10 years between refinances, something is probably wrong. Especially given the extremely narrow spread between long term loans like the 30 year fixed rate loan and shorter term fixed rate hybrids, for investment property a 30 year fixed rate loan is likely the way to go.

But the key part is "real estate investor."

This is a business. You're going to need an accountant to attest to the fact that you've been operating this business at least two years. But that gives you standing as at least partially self-employed as the operator of a real estate investment business.

Which gives you an out to do stated income, possibly even A paper. You're going to have to state that you earn more income than you do. Given the environment today, a good loan officer looking to cover themselves is going to want you to acknowledge that you can make whatever the payment is really going to be. I don't care if you need $6000 per month to qualify and you tell me that you make $12,000 per month, or $120,000. Any time you are looking at stated income, you're looking at a situation that is vulnerable to abuse, both from the point of view of a consumer being put into a loan they really cannot afford, and from the point of view of a bank lending money based upon a credit score and source of income that really may not be there. This one is especially vulnerable to the latter concern in the current market, and I would likely take a real careful look at any bank statements that pass through my hands to make certain it's not patently disprovable. If it makes a borrower uneasy, well half of the reason for qualification standards is to protect them. Stated Income may be colloquially called "liar's loans", but that is not what they are intended for, and in this case you are intentionally overstating income in order to qualify under unrealistic underwriting rules. Furthermore, not every lender will permit this.

The second approach is NINA - a No Income, No Asset loan, also known as "no ratio" - meaning no debt to income ratio. These are much easier to do for the loan officer, as they're completely driven off credit score, but carry higher rates and require larger amounts of equity, either via down payment or appreciation since purchase. Nor do you have to state a higher income than you make, as there is no debt to income ratio computation on these loans. On the other hand, especially if you're talking about your personal residence, as long as you're in a low loan to value situation, you may get a better rate from an A paper lender without a prepayment penalty, as opposed to doing a subprime loan with a pre-payment penalty.

There is serious potential for abuse in this situation, even if it is theoretically allowed under the rules. So be very upfront about what is going on with anyone you come into contact with. You, as a loan applicant, should never be dealing directly with the underwriter - as an anti-fraud measure, every lender I'm aware of prohibits it and cancels any loan in process if you to interact directly with the underwriter. But doing this is allowed by the nature of stated income and NINA loans. Self-employed people and commissioned salesfolk have to file taxes, also, and tax forms are the preferred method for documenting income. Nonetheless, because there are significant deductions that would not otherwise be allowed due to the fact that you're paying your bills with "before tax" money whereas most folks are paying with "after tax" money, it does make sense to do it this way. Provided you don't talk yourself into a loan that you cannot really afford.

Caveat Emptor.

Transaction Case Study

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I had been corresponding irregularly with this gentleman during his hunt. It happens he lives outside of California, and I only work inside California, so I wasn't professionally involved. However, when he sent me the email telling me how it all worked out, I thought it it would make a good case study to show how several things I write about actually happen, how to deal with them, and that even if you don't do everything I write about, you can still get quite a bit of benefit out of this. I obtained his permission to run it with identifying details removed. I'm going to break it up into more digestible blocks, and comment upon what he did right and what he could have done better, had he wanted to spend the effort.

Hello Dan,

Thought I'd drop you a note and complete the circle so to speak. We've corresponded a handful of times since about May. I'm in DELETED, sold my $200K townhouse and contracted to have a new house built. I used your site a lot to come up to speed on mortgage matters, I've only had 1 mortgage in my life which was for the townhouse 8 or 9 years ago. That one was an FHA ARM I assumed so this new one was a new deal entirely for me.

Research is always good. That puts him ahead of at least 90% of everybody, right there.

We signed the contract to build around May 1 and closed on a nice shiny new 3,100 square foot, 5 bedroom house on a .31 acre lot on October 1. It's been a wild month what with moving and all but we're now firmly in and very happy with the new digs. Mortgage wise we went with the builders affiliated lender, it's a moderately large regional builder not one of the publicly traded ones. I would have liked to have had the opportunity to shop around a lot but the way they write these contracts makes their lender pretty enticing with a $15K credit towards closing costs.


A $15k credit towards closing costs? On a $200,000 loan? Real is $3000-3500, plus whatever you decide to pay in points. That's about 6 points of buying the rate down. And 6.125, what he ended up with, is available in my neck of the woods for less than a point. Rates are down from where they were in the summer, but even then, I think 1.2 points was as high as I got for that rate. Real, effective savings for using the builder's lender: about $6000. Not exactly chicken feed, and at least it was a net savings. All too often, people let cash make them stupid about real estate, and this is one of the biggies. We didn't cover whether the builder's loan had a pre-payment penalty, but the builder's loan having a prepayment penalty would have eaten all those savings and more, besides.

A better way to handle it is as a direct credit on the sales price of the house. Of course, you need to have already negotiated your best bargain before you bite off on that, or they'll give you $15,000 with one hand, while taking $20,000 away with the other.

So here is how it all worked out. Initially we got a GFE from the lender which is of course worthless at the start since you can't lock a rate 4 months ahead of time. The initial GFE was for 5.875%, 30 year fixed with a single point origination fee. Then over the summer the whole subprime mess hit the mortgage market hard. My loan was never going to be a problem with a loan amount of $215K against a purchase price of $430K but we were sweating bullets over the rate for a while . I got my initial firm rate lock the last few days of July at 6.5% with the same 1 point and 30 year fixed term. That was just under 75 days from the initial closing date of 10/8, I believe (you'd know ;)) the 75 day locks are a little more expensive than the shorter term ones. This lender lets you lock at the first opportunity and for my loan type that was 75 days, then they'll let you re-lock once between then and closing at no extra charge. I watched the rates every day and I was subscribed to DELETED daily rate alert so I could see the daily trends as the bond market did all sorts of gyrations up and down .

The longer the lock is for, the more expensive it is, yes. That said, for A paper loans, it's not very difficult to lock for up to 270 days out. On the other hand, for longer locks, you're likely to make a non-refundable deposit.

This is describing the "float down" option that lenders have, and which may or may not be included with a lock at a direct lender - their way of luring in customers, and that's fine. Broker clients don't get this (at least I've never heard of a broker who could offer it), but brokers can pull the loan and resubmit elsewhere, no matter how much lenders try to stop the practice (It's so rare that ways they try don't do much good). What they're doing with the float down is getting people committed without having them feel committed. Unless you're working a back up loan that's going to be ready at the same time, you're committed. Here's the proof of that pudding: What happens if they completely hose you on the loan? Who else is going to parachute drop in with another loan ready to sign? Answer: Nobody. Therefore, you're committed to that lender.

.

My closing date got moved up to 10/1 at some point and then we got to September. On 9/7 (I think this was the week) which was a Friday bonds had had a rally that week anticipating fed action. The DELETED rate had dropped from 6.5 to 6.375 to 6.25, I checked with my Broker and he offered 6 & 1/8. I held off till Monday since the bonds had rallied even more on Friday thinking it might drop a smidge more. No dice, Monday had the same 6.125 so I re-locked at that rate, 1 origination point and 30 year fixed - or so I thought.

If he's working for the broker, he wouldn't be working for the developer. He might be a loan officer, but he's not a broker. I've never made $15k on a single loan - ever. My company has never made half that amount, even on loans several times the size and apparent difficulty. That builder is not offering you $15k of incentives to use his lender if they're only making a couple thousand that a broker would from that loan. That builder is getting the direct lender's stroke from selling that loan on the secondary market.

That said, this is pretty good work on the lock.

Now, at every turn in this process I'd see other options. Initially he asked me if I had any interest in interest only, "certainly not" was my reply. Each time I receive a GFE there were blocks for the interest only option. I know in the past they've done A LOT of interest only 5 year fixed period loans. But I wanted a 30 year fixed, the rates are hardly any different these days and I do want to actually payoff my loan eventually! :-)

Oh, you will pay off your loan eventually. That's one feature all loans have. Lenders use interest only to make the payments seem a little more affordable. Of course, when the interest only period expires, your loan amortizes over a shorter period, and the payments are even less affordable than they would have been.

Unless you can afford the property with a fully amortized, you're well advised not to buy it with an interest only. They always bump the rate for interest only, and usually it's grounds for a loan originator to make a little more money, or at least try to. Even if you can afford the fully amortized payment when it does adjust, only go interest only if you have a plan that's going to make you more money than it costs you.

So closing day arrives. We trundle over to the brokers office and meet the person from the title company who is serving as the closer. She begins reviewing docs, might have been the first piece of paper of maybe the second - "and here is your note, 6.5% rate with interest only for 5 years" Wait, STOP - that isn't my loan, my loan is a 30 yr 6.125 rate!!! So she calls the broker and they look it over . Oh, so sorry, someone dropped the ball and drew up the papers incorrectly. It took them an hour to redraw the entire package up the way it should have been in the first place. The broker was very apologetic and did offer, without me asking, to waive their document processing fee which was a few hundred bucks. All's well that ends well but it makes you wonder. The loan they prepared in error had the slightly higher rate and no origination point so the costs were a couple thousand less for the higher rate. So I don't think they were trying to screw me totally but the fact remains it was a totally different loan from what we had discussed all along.

6.5%, even interest only, on a 5/1 would have made them something like 2.2 points of yield spread, had they been a broker. It makes a difference of something between 3 and 4% of the loan amount on the secondary market. That's why no origination on that loan. If you had signed those papers, they would have sent out for caviar! That and of course, the fact that they were giving you a $15,000 allowance which you weren't close to using all of. That said, always judge and compare loans by what is best for you. If someone can make more money while delivering me a loan with a better bottom line, they've earned every penny of whatever they make. Lender compensation is not something for consumers to worry about.

This is very good, that you caught the difference and stood your ground, however. Yes, your signing agent made it easy on you, but you still did it. People don't believe this really happens, but it happens all the time, and over fifty percent of all people it happens to do not notice, and of those, something like 85% won't stand their ground.

Caveat Emptor

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About this Archive

This page is a archive of entries in the Intermediate Information category from November 2007.

Intermediate Information: October 2007 is the previous archive.

Intermediate Information: December 2007 is the next archive.

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