Intermediate Information: January 2008 Archives

I knew this was coming.

With holders of second mortgages not wanting to go above 90% Loan to Value Ratio, sellers of Private Mortgage Insurance, (PMI) have the "less than 10% equity" market all to themselves. The rates had gotten surprisingly low (less than 1% for 100% financing), but there are two factors that combined to make this boost happen:

1) With the risk of default rising, the actuaries at the insurance companies legitimately have increased costs to worry about. With equity being stagnant right now, the risk that mortgage insurance is going to have to pay a claim has risen dramatically in the last year or so. It is nothing except fiscal prudence to raise insurance rates when the probability and likely magnitude of a claim both increase as they have. Insurance companies are so strictly regulated as to reserves and margins and everything else that they probably had no other legal option. This explains some fraction of the increase.

2) "All The Traffic Will Bear" You don't think these companies are in the business of putting their money on the line for free, did you? Furthermore, not only is Private Mortgage Insurance a "wide moat" operation (a business that's hard to get into), you don't see any large number of companies who currently want to get into it. Profit margins are comparatively low, and there is, to their way of thinking, a significant risk the market could get even worse than this. With second mortgage holders no longer lending above 90% CLTV, PMI providers not only have the field to themselves, but they're in a very high demand situation. Increasing demand plus essentially constant supply equals higher prices.

Here's a sample of the rate boosts I was notified of today:

30 year fixed, credit score 620-659, 97- 100% LTV old rate 96 basis points (.96%) new rate 170 basis points.

15 and 20 in the same situation go from 85 to 163 basis points (although I can't remember the last time I saw a 15 year loan with PMI).

Given a 5.75 fixed rate mortgage without points today (rates will change by the time you're reading this), this substantially increases the effective interest rate, from about 6.7% to almost 7.5.

Payment on a $300,000 balance? Goes from roughly $1990 (principal and interest plus PMI) to approximately $2175. That $185 makes a difference of about $415 in the minimum monthly income to qualify for the same loan, in the case of 100% financing. People who may have been able to qualify last week could be rejected in the future. Rates would have to drop by about a full percent to offset this, and between you, me, and however many thousands of other people read this, I don't think that's going to happen. Fed cutting the overnight rates or not, the macroeconomic market pressures are all upwards. Matter of fact, even with the new cut the Fed made yesterday, rates today are higher than they were just a few days ago.

For those whose loans are already funded with PMI, don't lie awake nights wondering when they're going to hit you for more money. The rates on existing loans is already under contract, and they're not able to raise the rates on PMI, as the terms are specified in your loan note - a legal contract. The lender can't alter any of the other terms, either - why should they be able to suddenly boost PMI? It's only for loans that have yet to be funded that the rate increase applies.

For those looking to sell real estate, this puts current owners who are willing and able to "carry back" part of the purchase price into an even stronger position, negotiations-wise. If the prospective buyers can pay you more money for your property or not buy anything, some will pay more money. It's still a situation to be just as careful about as ever, but every bit of leverage helps in negotiations.

As I've said in the past, having a down payment for real estate is not mandatory, but is an excellent idea. That same $300,000 loan at 5.75% only has a payment of $1751 if you've got 20% equity. PMI hits every first trust deed above 80% of the value of the property. Period. It's in the federal banking regulations. Some lenders will hide it in the note rate, but you're still paying it if you're in this situation. Good Credit, excellent credit, perfect credit - the only difference it might make is the exact cost, not whether or not you're paying it. Wouldn't you really rather make the lower payment? The extra money you pay for PMI doesn't do anything towards paying your principal down, either. If you didn't have to pay it, you could invest that money, use it to pay down your principal faster, or just have a good time. You'd be done in 227 months if you made a payment of $2175 on a $300,000 loan at 5.75% - less than 19 years, instead of 30.

If you're looking for a new loan, whether purchase or refinance, don't waste your time calling around trying to find one lender who'll let you slide without PMI. It will be there if the situation requires it - any first trust deed over eighty percent of the value of the property. It can be priced into the loan or broken out as a separate charge, but it will be there when the loan funds. However, there is no requirement to disclose PMI at sign up, or to disclose that a certain amount of what you're paying is PMI, and many loan originators are quite deft at hiding it or deflecting questions about it. Which is likely to be the better loan in the final analysis: The one who hides the real cost of the loan and its nature, or the one who tells you the whole truth in the first place?

Caveat Emptor

Got a question asking if zero cost loans really exist. They do. I've done several dozen myself, for clients who listened to me about the nature of the market.

Let me define what a zero cost loan is. It is a loan with a higher rate deliberately chosen so as to get a high enough rebate, or Yield Spread, to cover not only the loan provider's margin, but all closing costs you would normally have had to pay as well. Prepaid interest is not a cost; it's paying money that you would have owed anyway in a slightly different manner. Ditto an impound account. That is your money, not a cost of the loan. We are talking zero cost here, which is an entirely different thing from paying out some money that you would have had to pay anyway. But no money gets added to your loan balance. You pay the appraisal (if required) when the appraiser comes out, but you get the cost refunded upon funding for a net zero out of pocket. True zero cost. This does entail accepting a higher rate, and therefore higher payments than you might otherwise have gotten, but if you only intend to keep the loan a relatively short period of time, you start ahead by doing this and there is not enough time for the lower payments to break even. For instance, a while back I had a par rate of 6.25% on a thirty year fixed loan, but providing your balance was at least a couple hundred thousand, I could do 6.625% for literally zero cost. If you were planning to sell in two years but your current rate was eight percent, as many people have nowadays, but their credit has improved now to where they qualify A paper, this saves them a lot of money for literally zero cost, so there are no "sunk costs" to "recover"; it's pure profit from day one. I happen to think that with rates as volatile as they have been the last few years, it makes a lot of sense to choose a zero cost loan. If rates go down half a percent six months or a year from now, you can go get a rate that much lower for zero cost then. If you paid two points to get the rate, it's going to cost you the same two points again to benefit by as much. Since it's not likely to get the average person two points of benefit over the average loan holding period, those two points are at least partially wasted.

Now this is not to say that you shouldn't be on your guard when someone talks about a zero cost refinance. What most lenders mean when they say "zero cost" is "No money out of your pocket." But thousands of dollars can still get added to your loan balance, where you not only pay them, you pay interest on them. Many lenders will talk about putting money in your pocket, when what they are doing is adding not only that money but all the costs and all the points to your loan balance, and people who have been doing this every two years wonder why their loan balance is ten times their original purchase price. I call these Stealth Cash Out Loans. There is no such thing as a free lunch. You paid for the cash out; you're going to be paying for the cash out for many years, just the same as you paid for your closing costs in the previous paragraph with a higher rate than you would otherwise have gotten. The difference is that money added to your balance tends to stick around for as long as you own property, whereas a higher rate is over as soon as you sell or refinance that particular property. If you choose a zero cost loan, your balance should transfer straight across; you are continuing to pay it down as soon as you write the first check on the new loan. Whereas if you chose a loan that adds thousands of dollars in closing costs etcetera to your balance, it's going to be years of payments before you're back where you started.

A true zero cost loan not only has no net "out of pocket" expenses, it has literally zero added to your mortgage balance. They do exist, mostly for well-qualified A paper borrowers, despite what certain skeptics might say, and for most people, they are something you should strongly consider, whether you're planning a purchase or a refinance.

Caveat Emptor

Every so often I get questions about loan cosigners. The main borrowers do not qualify on their own, so they get someone - most often mom and dad - to cosign. Now this is a different thing, or so I understand, in the other major credit areas - automobiles, rent, etcetera. But this is about Real Estate.

The only time this usually makes a difference is in credit history. The main borrowers qualify on the basis of income, but don't have enough of a credit history to qualify. Sometimes they just don't have enough open credit to have a credit score. This is rare, but I did have one executive couple who made a habit of paying cash for everything (a good habit, I might add). They had precisely one open line of credit, a credit card they paid off every month, and the major bureaus require two lines in order to report a credit score. No credit score, no loan. It's that simple. Even there, the solution was to walk in to their credit union and apply for another, not to get a cosigner.

When you bring other folks into the loan, you're bringing their credit history, their potentially high payments, and every other negative they have into the loan. Most of the time, the folks who are willing to cosign do not materially aid the qualification process.

Pitfall number one: Lenders designate primary borrower by who makes the most money. If the cosigners make more money than the "real" borrowers, they now become the primary borrower, and it becomes a loan on investment property as far as the lenders are concerned, adding restrictions, raising the trade-off between rate and costs of the loan, and perhaps making the loan require a larger down payment. This does assume they won't live there, but usually if they were going to live there, they would have been on the loan in the first place.

Pitfall number two: The cosigners are overextended also. Sure, they make $10,000 per month, but they have payments of $5000 per month already. There's nothing left over where the bank sees them as having enough money left over to help you out. They may, in fact, have money to spare, particularly if they make a lot of money, but according to the standard ratios, they do not. You can't have the cosigners be stated income or NINA if the main borrowers are full documentation. If you have to downgrade to stated income in order to qualify, that is going to cost a lot of money through higher rate/cost trade-off. Obviously, better that you qualify for a lesser loan than that you don't qualify at all, but you don't want to downgrade if you don't have to.

Pitfall number three: This one hits the cosigners. They are agreeing to be responsible for your payments in the event you don't make them. Suppose they want to borrow money for something else. Especially if it's a large amount of money, as real estate payments tend to be. It really cramps their ability to qualify for other things. This works the other way, also. People come to me for real estate loans who have agreed to be cosigners for a car loan are responsible for the $400 per month for that loan. Many times, this means they don't qualify for the real estate loan. So we have to prove to their prospective lenders that the "true" borrowers are making the payments. This is usually not difficult, but if the cosigners wrote the check for the payment anytime in the last six months to a year, it can be problematic.

Pitfall number four: This also hits the cosigners rather than the main borrowers. Suppose a payment gets made late. It impacts the credit of the cosigners as well as the "real" borrowers. It doesn't matter if you're the "real" borrower or the cosigner, it hurts your credit just as much and for just as long. If you cosign, you want some kind of proof that payment is being made on time, every month. You shouldn't cosign if you don't have the resources to make that payment pretty much indefinitely. Furthermore, should the cosigners decide to cut their losses, it can take months before the monthly hits to the credit stop. If the "real" borrowers don't want to liquidate, the cosigners may have to go to court to get out of it, and the only people who are happy there are the lawyers.

Now suppose the loan being applied for has a Debt to Income Ratio maximum of forty five percent, and the cosigners make $10,000 per month, but they have expenses of $4300. This will mean that they only have $200 per month to contribute towards qualifying for the new loan. If the "real" borrowers weren't fairly close to qualifying without them, they aren't going to qualify with them. If they have expenses of $4600 per month, they have nothing to contribute to the loan qualification. In such cases, the work of asking them to apply is wasted.

Caveat Emptor

With rates having dropped in recent weeks, it seemed a good idea to go over the thought process behind a successful refinance. Other than the two issues, of loan to value and whether you're really able to qualify for a traditional mortgage loan, things are pretty similar to other refinancing mini-booms. I've seen some people claiming that you should go up to forty-five day rate locks instead of thirty, but I must disagree. With underwriting times at five days, you should not need longer than a thirty day rate lock (or purchase escrow) if you and your loan officer have your act together. Purchase loans go through different underwriters at most lenders, and they have no right of rescission. Even in summer 2003, when refinance underwriting was at 33 days, purchase loans were still getting turned in no more than four, and funded in two to two and a half weeks. Even refinance loans can still be done in under 30 days - if your loan officer submits a complete clean package to begin with, something there's no reason not to do in the case of a refinance. Furthermore, if you make a habit of submitting nice clean complete packages, underwriters will start cherry-picking yours out of the pile when they don't have enough work time left for a piece of garbage. You can't really control this or count on it, but it sure was nice to have the loans come back approved in three or four days, when the competition was taking four weeks. My median last year was seventeen calendar days from lock to fund - adding five days of underwriting only brings us to twenty-four (Don't forget the weekend), and that's forgetting that underwriting was talking a day or two even then. Longer rate locks are more expensive, so you don't want to pay for what you're not going to need. But you do have to have your ducks in a row from the beginning to make it happen.

There are two component costs of getting a loan done. The first is closing costs. This is what is necessary to pay all of those people that work on your loan. Appraisal, escrow, title, notary, processor - not to mention things like credit report charges and recording fees, and in some states, taxes levied upon mortgages. I knew things were getting cheaper with virtual escrow and flat rate title insurance upon refinances, but it was just a few days ago I really looked at how much this was. It's now running much lower than the $3400 rule of thumb I've been using. I quoted two yesterday, and the higher added up to just over $2800. Of these, the only ones that usually need to be paid in cash are the appraisal and the credit report. There are certainly lenders who offer to pay for the appraisal, but I've gone over the traps there before. The others can be rolled into your loan balance. Unfortunately, you'll be paying interest on it there so it's not something I like to recommend, but it can be done, and if you need to do it, it's part of the calculations on whether you should refinance. Actually, it's a part of that, either way.

The second part of the costs are in the points. Actually, this separates into origination and discount, where origination is more properly a closing cost, but most providers (including me!) quote origination and discount together in points verbally, but points of origination is computed exactly the same as points of discount, and when they're disclosed in writing on the paperwork, they add up to the number quoted, at least for the more ethical providers. Note that unless that quote is backed up with something like a Loan Quote Guarantee, these numbers don't mean anything you can hold the lender accountable for, so signing up for a backup loan is a really good idea.

If you choose a higher rate, the lender might not only not charge points, they might cover part or all of your closing costs.

There are other potential costs as well. If your current loan has a prepayment penalty, you can figure you're going to end up paying it in order to refinance. There are only four ways to get out of paying a prepayment penalty, and the two best are not having one or waiting for it to expire. The standard pre-payment penalty is six months interest, so if you've got a $200,000 loan at 6%, you can figure paying that penalty is going to cost $6000. Some penalties are only 80% of that amount, but either way this can entirely change the computation as to whether it's worthwhile to re-finance, and I can think of half a dozen instances off the top of my head where the client swore that they didn't have a pre-payment penalty - but they did. Sometimes this is a rude awakening as to whether the loan officer who got you that loan however long ago really did as good a job as you thought they did. In the illustrated case, it also adds $6000 to the cost of refinancing until it expires. This isn't the fault of your new loan officer - unless they're also the one who did your current loan, they had nothing to do with it. People have gotten angry at me to no good purpose any number of times on this point, when that pre-payment penalty had nothing to do with me. I didn't put them into that loan, I didn't put the loan contract with a pre-payment penalty in front of them, I didn't sign the contract without understanding it, and I certainly didn't get paid for doing that loan. Kind of like trying to blame your neighbor for the crimes of Attila the Hun.

There are other things that need or might need to get paid. Every refinance loan has thirty days interest attached to it. But this isn't a cost; it's only money you would have paid anyway. Some lenders will roll it into the loan and tell you that you "skip" a payment. This may be technically true, but is nonetheless incredibly dishonest. It's much more correct to say "you made one mortgage payment a little earlier." You never really skipped a payment, you only keep the money in your checking account because you added the amount of the payment to your balance. And of course, there's the impound account if you want one, to pay your taxes and homeowner's insurance. Avoid rolling this into your balance if you can.

Just because rates are lower now doesn't mean it's necessarily worthwhile to refinance. Let's work with an example. Let's say the property is valued at four hundred thousand - that's what the current appraisal will come in at. Current loans sum to $260,000, at six percent. No pre-payment penalty, the clients don't want an impound account (be thankful for the one thing the California legislature has done right in the last twenty years). Total closing costs, $2800. Plus whatever cost in points or minus whatever rebate you can get.

Here are some options available a couple days ago (Rates actually dropped again today), all retail rates for thirty year fixed rate loans:

at 6.125, a rebate of 7/10ths of a point or $1820, cutting closing costs to about $1000. But there's no benefit whatsoever to doing that. Not only does the cost of interest go up if they get this loan, they've spent $1000, and the cost of interest goes up to $1332.19 per month from $1300 even, assuming you roll it that $1000 into your balance, but even if you don't, you're not cutting your cost of interest. Unless you're in some kind of loan that's going to somehow get worse, like if the current loan is adjustable, there's no reason to do that. There's no benefit whatsoever, even though the overall tradeoff between rate and costs is now lower.

5.875% was retail par, no rebate but no points to get it either. Total cost $2800. Let's assume you pay it out of pocket, so your balance stays the same and you actually cut your cost of interest by $27.08 per month. Would you pay $2800 in order to save $27.08 per month on your mortgage? I wouldn't. Even without considering the time value of money, it takes 103 months - over 8.5 years - to break even. Most folks don't keep their loans three years, let alone eight, and if you haven't broken even by the time you sell or refinance, you're just out the money.

at 5.625%, you would have paid half a point. Assuming you pay it out of pocket, that's $1300. Added to $2800, that's $4100. You cut your cost of interest to $1218.75, so you're saving $81.25 per month, but when you divide it out into $4100, that works out to 50 months, not counting time value of money. I probably wouldn't invest $4100 for that, but some rational people with a long record of keeping loans ten years or longer might think it was a good investment.

At 5.375%, you would have paid 1.5 points - roughly $3900. Added to $2800, that's $5700. If paid out of pocket, it cuts your cost of interest per month by $135.42, which divides out to a breakeven of 42 months - three and a half years. It's not that good if you roll it into your balance - cutting your monthly interest savings to slightly less that $110, and your breakeven is moved back to essentially 52 months, still not considering time value of money. I wouldn't do that, but it doesn't mean there aren't rational people who would.

Notice that all of these rates but one are lower that what these people have now, but in no case have I been enthusiastic about the refinance from the client point of view.

You may have noticed I haven't used payment to compute any of this. That's because payment is much less important than most people seem to believe. Yes, you need to be able to make the payment, but with that said, You should never choose a loan based upon payment. Even if you were paying off other debt with payments of hundreds of dollars per month, you shouldn't choose your new loan based upon payment. Focus on the real costs of money - what money you need to spend to make the change, the difference it makes to the monthly interest. Even if you have a real cash flow problem you need to solve because you are barely able to make your current payments, you'll go a lot less wrong by focusing on cost of interest.

However, let's see what happens if these folks have forty-five thousand dollars at an average of eleven percent in consumer debt they want to pay off. True that the monthly payments are $800 and it's really crimping them. They're just barely making all the payments every month, and if anything happens like, say, a car repair bill, they'd be completely hosed. That is another reason for doing something, but it's not a reason to focus on payment, but only to make certain that the new payment falls within the range of what they can really pay. As it sits, their real ongoing cost of that money is $1300 plus $412.50, or $1712.50 per month. Many people will tell them that consolidating that debt moves it from non-deductible to deductible, but a strict reading of the tax code says that is not the case (deductible interest is based upon purchase price, normally amortized). I'm not going to tell you that people haven't gotten away with this deduction, but the IRS has had their eye on enforcing it of late, so I'm not going to assume you're getting a deduction out of it, and in fact, I'm going to assume the deductibility issue is a wash.

We haven't changed the basic rates, which are the sum up to the conforming loan limit (currently $417,000). Paying off consumer debt makes it into a "cash out" loan, and a balance that includes paying $305,000 of debts puts you over a seventy percent Loan to Value Ratio, possibly over eighty if you choose a high cost loan and or roll impound accounts into your balance as well. The lender whose sheet I got this from has a
adjustment - an additional charge for risk - of half a point for cash out loans between seventy and eighty percent of value, 3/4 of a point for 80% and over. So all of the above rates have their costs increased by half a point.

So 6.125% now only carries a rebate of two tenths of a point. The moderately good news is that this is on a larger amount of money, and the closing costs are the same (I deliberately picked these numbers so that the cost for the lender's policy of title insurance stayed the same on a refinance, but it usually won't) But I'm also going to presume that you don't have the money to pay these cash out of pocket - you have no choice but to roll loan costs into your balance. After all, if you had thousands of dollars sitting around cash why do you have all of these consumer debts? I'll still have you paying prepaid interest out of your pocket instead pf pretending to "skip" a payment, and no impound account, but you don't have the cash to pay everything out of pocket.

At 6.125, your closing costs are still $2800, and the slightly over $600 rebate you got means that the balance only increased to about $307,185. Total cost, of refinancing to you, $2185. Monthly interest charge is now about $1567.93 - so you're saving $144.57 in real money per month, never mind that the payment is going to have a much larger difference. Would you spend $2185 to make $145 per month, potentially for thirty years? I sure would! Your breakeven is just over fifteen months, and most folks keep the loan significantly longer than that! Every month you keep the loan over 15, you're $144.57 further ahead of where you would have been without refinancing.

At 5.875%, the loan costs half a point now. Your new loan balance would be $309,346.73 and change, which in the real world gets rounded to $309,350 and putting the difference of $3 plus loose change back into your pocket somehow, but I'm going to deal with the non-rounded number. You paid $4346.73 to get that loan done, and your monthly cost of interest goes to $1514.51. You're saving $197.99 per month, but you spent about twice as much to make it happen. Breakeven is not quite 22 months as opposed to your current situation, but longer than that as opposed to the competing loan, which is over $1000 to the good by the time this loan breaks even. Indeed, this loan won't catch its 6.125 competitor for 44 months or thereabouts. In the absence of other choices, I'd be willing to spend this money for this benefit for myself, but over three and a half years is a longer than median time to refinance. I'd rather have the 6.125 loan in this instance. You will get more benefit out of this loan in the long term if you keep it, but most people won't keep it long enough.

At 5.625%, this loan now costs one full point, and your new balance would be $310,909.09. Like it or not, you spent $5909 to get that loan. Your monthly cost of interest drops to $1457.39, saving you $255.11 per month. Breakeven: A little over 23 months. Everything that I said before about the 5.875% loan is also true for this one, except that because the monthly benefit is larger, it catches the 6.125 loan that is your best alternative thus far faster - a little over another ten months, or between 33 and 34 months until it's the best alternative thus far, and once it's in first place, it pulls away from the others quickly.

At 5.375%, this loan now costs two full points, and your new balance would be $314,081.63 if you chose it. You spent $9081.63 to get it, while your monthly cost of interest drops to $1406.82, saving you $305.68 per month. You break even after 29.7 months. If it were the only alternative other than "do nothing", I'd still be willing to do this for myself, but since it takes longer to catch up to some of its competitors, it wouldn't be my first choice from among the presented options. Mind you, if you kept it for the full 30 years, it would be the best possible alternative, but most folks don't keep their loan even three years, let along thirty. By the time this has broken even, the 5.625% loan is about seventeen hundred dollars to the good, and at $50.57 per month lower interest, you're looking at over 32 more months until this is the best alternative. 62 months is over five years. I'd rather do 5.625 for me in most circumstances, thank you very much.

Circumstances alter cases. If you have some knowledge about the future of the situation, any of these can be the best possible loan. For instance, if you know you're going to have to move and sell in two years, or if you're retiring (but staying put!) and it's going to be difficult to get loans from here on out, those would each alter which decision I'd recommend. If loan rates are expected to continue declining or even to be volatile in about this range, I'd choose a cheaper alternative trying to get as close to a True zero cost loan, while if all the top analysts are saying that rates aren't going to be this low for another ten years, I'd strongly consider paying the points to get the low rate.

There is more to the decision of refinancing than just rates, and choosing a mortgage loan by payment is one of the best ways I know of to waste large amounts of money. Unless rates nose-dive even further than this, like they did in 2003 (It sure was nice telling people I could get them 5.375% for literally zero cost when most of them were around 7%), for most people there probably isn't a choice that both saves you money and has you ahead of the game right away - and even so, that may not be the best choice in your situation. Calling loan officers to demand "What's your lowest rate?" isn't going to help anyone - especially not you. You need to have some good conversations with several loan officers

Caveat Emptor

With rates having nose-dived in recent weeks, we're experiencing a refinancing mini-boom. Now that rates have fallen by about a full percent from where they were most of the last year, people are waking up to the fact that refinancing now can save them some serious money. Things finally got low enough a couple days ago that I sent out individual e-mails to most of my clients for the past two years. Underwriting times are up to five business days - a full week. Mind you, refinancing booms are not going to save the lenders' who are in trouble, and 90 percent plus of the refinance dollars are just lenders feeding off each other. But the choice for any available lender is to offer the lower rates and compete for clients, or don't and lose them. It's not like people are settling for free toasters any more.

Unlike all of the recent refinancing booms, this time a lot more people have a couple extra issues.

The lesser one, measured by number of people who have this issue, is being able to qualify for a loan. A year ago, while make believe loans were still happening. people were being qualified for loans on the basis of being able to detectably fog a mirror. Loans for 100% of the value of the property were being done on a Stated Income basis by even A paper lenders. Forty and Fifty Year Loans, interest only, and even negative amortization loans - unsustainable loans were over half of all purchase loans locally. Anything to make it look like the payment was affordable, even if it wasn't. But if that's the only way the people were going to qualify for a loan, what happens when they're not available any longer? That's right - they're stuck with what they've got until they can qualify for something more traditional. Lower rates may help a few around the margins, but most of these folks who signed up for Make Believe loans are going to have to sell before they're going to get their lives back on track.

The other issue, that loan officers mostly haven't really had to deal with for years, is impacted Loan to Value ratios. When prices fall, as they have locally, that's a problem. Locally, the average properties are down about 25%, but that's an average only. So properties that people bought at the peak of the market might be 75% of the value they paid, and unless they put at least a 25% down payment into the property, they're "upside down", and owe more than the property is currently worth. Being upside-down is no big deal if you have a sustainable loan. You keep on keeping on, and eventually things will go back to normal. You pay the balance down, values will go back to at least where they were, and all will be right with the world. But if rates drop while you're upside down, you're not really in a position to take advantage of them. I've written an article on how you might be able to refinance if you're upside down, but those steps are not going to get you the great rates people who have more traditional loan situations will get. Even people who have been in their properties for much longer are finding out that they don't have anything like the amount of equity they had two years ago. Even if they bought a decade ago, if they've taken cash out, they may quite likely be in a situation where don't have twenty percent equity. When this happens, people are going to either split their new loan into two pieces or pay PMI. Since holders of second trust deeds are not currently willing to go above ninety percent of the value of the property, if you're above that threshold, it's PMI or no loan. I've talked to any number of people in the past week who don't want to pay PMI, and that's fine, if they don't mind not getting the loan. It's not like you're shopping for produce at the market, and can pick and choose what you want. PMI goes with all first mortgages over eighty percent of value - it's banking regulations. Regulated lenders cannot lend on those conditions without it. Some lenders may camouflage it with lender-paid mortgage insurance, but you're still going to pay it. Lenders don't have to tell you about it at sign-up, either, and they don't have to disclose the fact that lender paid mortgage insurance is built into the rate they quote. But don't let fear of PMI control you - just add the additional costs into the computations of whether a particular loan is better than another, or worthwhile at all.

Other than these two issues, things are pretty similar otherwise. I've seen some people claiming that you should go up to forty-five day rate locks instead of thirty, but I must disagree. With underwriting times at five days, you should not need longer than a thirty day rate lock (or purchase escrow) if you and your loan officer have your act together. Purchase loans go through different underwriters at most lenders, and they have no right of rescission. Even in summer 2003, when refi underwriting was at 33 days, purchase loans were still getting turned in no more than four, and funded in two to two and a half weeks. Even refinance loans can still be done in under 30 days - if your loan officer submits a complete clean package to begin with, something there's no reason not to do in the case of a refinance. Furthermore, if you make a habit of submitting nice clean complete packages, underwriters will start cherry-picking yours out of the pile when they don't have enough work time left for a piece of garbage. You can't really control this or count on it, but it sure was nice to have the loan come back approved in three or four days, when the competition was taking four weeks. My median last year was seventeen calendar days from lock to fund - adding five days of underwriting only brings us to twenty-four (Don't forget the weekend), and that's forgetting that underwriting was talking a day or two even then. Longer rate locks are more expensive, so you don't want to pay for what you're not going to need. But you do have to have your ducks in a row from the beginning to make it happen.

Caveat Emptor

"Trust Deed Incorrect Legal Description"

There are all kinds of legal descriptions. Lot, Block and Map, or just Lot and Map, are probably the most common. Sectional portions (Portion A of Section B of Township C, Range D) are probably next most common, followed by "metes and bounds", and often the two are mixed. Finally, in some areas of the country (like Southern California) there are remnants of prior systems here and there, like the Ranchos here, parishes in Louisiana, etcetera. What they all have in common is descriptions of the boundaries of the parcel concerned. Condominiums are based upon cubes of airspace exclusively with an undivided common interest in the communal property.

There are technically incorrect legal descriptions, and there are significantly incorrect descriptions. There are three main categories.

1) Descriptions that describe the land with some technical difference. Missing an easement, missing part of a defined lot, something like that. This is by far the most numerous of these errors and basically means nothing. The land the trust deed describes was pledged as security. Practically speaking, these might as well not have the imperfection, and if you fight in court, you're probably wasting your money. If the legal description is missing part of the land, but the whole thing is only one legally zoned lot, they're going to get the whole thing, by and large. If it's out in the country somewhere and not covered by things such as lot regulations, they might split the part that was covered by the description off from what wasn't covered. Obviously, only part of the property was pledged as security, right? But most of the time, the lot cannot legally be subdivided anyway, and the lender is likely to get the whole thing.

2) Descriptions that partially describe the property. There are three main subcategories: a) they describe part of the property, but not the whole thing b) they describe part of the property and part of some more, and c) they describe the entire property and some extra besides. Subcategory a, that describes part of the property but not the whole thing, usually count as the "technical difference" category. In other words, no big deal. Subcategory b, where they describe something extra as well, is only of special note if you owned the other piece of property, also, at the time the Trust Deed was signed. Otherwise, you deeded property you didn't own. Your neighbor may end up defending his title in court and coming after you for his expenses, but you can't deed away what you don't own. It's the part that you own that's important. Subcategory c, like b, is only interesting if you own the extra property as well. Then the lender might get a little extra! Otherwise, you can't deed away what you don't own.

3) Descriptions that describe another property. You can't deed what you don't own, so unless you owned the other piece of property as well, the lender is basically out of luck. It is to be noted that they're still going to do their best to come after you, and your neighbor may come after you for his expenses in defending his title, and the cops may be interested in you if they think you intended fraud.

Of course, the law varies and you should check with your lawyer and it's the court's decisions that are final. Your mileage may vary; these are just some rules of thumb.

Caveat Emptor

Because most loan providers will not guarantee their Federal Good Faith Estimates or California MLDS forms, I've been telling folks that the best suggestion (other than doing their loans myself, of course!) that I can give them is apply for a back up loan. But some mortgage loan providers will guarantee their quotes, and this article is about those guarantees, their limitations, and what to watch out for.

Loan officers are not the only ones who play games in the mortgage world. Borrowers do it. A lot of borrowers do it. Some are actually intending fraud, some just want a better loan and don't see anything wrong with painting their financial picture a little rosier than it is. Furthermore, there are reasons that lenders will decline loans that are not obvious. It has happened to me that I couldn't do a loan at all because of fairly obscure points that the borrowers weren't trying to conceal, they just didn't know they were important, and I didn't think to ask.

Keeping this in mind, loan providers are leery of offering guarantees, and indeed, since only an underwriter you will never meet or talk to can authorize the loan, for a loan provider to make a guarantee that there will be a loan is nonsense. The most they can say is, "Based upon my experience, I see no reason why this would not be approved," or, better, "Subject to underwriter approval, your terms will be this." That's a key phrase. Keep in mind that loan provider guarantees are few and far between, and as a result, there is no standard terminology to use. I, as a loan officer, cannot promise the loan. I can promise, however, that if the loan is approved as submitted, it will be on a given set of terms.

Now it happens that loan officers can manipulate you by submitting a loan that they know will not be approved. This is a lot of work and often "poisons the well" at that particular lender, but then they can tell you sorry, you do not qualify for that loan, but there's another one over here that you do qualify for, and now that you've already selected them, they are no longer competing on price, and they build a much higher margin into the newly proposed loan, secure in the knowledge that you're unlikely to be shopping other lenders at this point.

You can counter that by asking what the guidelines are for the loan they are submitting. What is the maximum debt to income ratio? How much income do you need to qualify? Ask them to compute it out for you, and watch what numbers they use. What loan to value ratio is the rate predicated upon? What does the property need to appraise for in order to make that happen? (This can also help you spot hidden fees, albeit rarely. Comparatively few loan officers will tell you how much it's really going to take to get the loan done.) How much time in the same line of work is required? Here's a whole list of questions you should ask prospective loan providers.

Now, as to the form the guarantee should take: It should include the type of loan, to include an industry standard name for that loan type, so other loan officers you shop with know right away what they are talking about. It should also include the cost to get that loan. How many points of origination, if any, and how many discount points, if any? How much in total closing costs? How long of a lock is included?

You should beware the term, "thirty year loan," unless the words "fixed rate" are in there. A thirty year fixed rate loan is the standard loan that most folks aspire to, but it's usually the highest rate out there. The words "Thirty year loan" describe an Adjustable Rate Mortgage (ARM), or a hybrid ARM. A few loan officers will even describe hybrid ARMs as "thirty year fixed rate mortgages," because they are fixed for an initial period. So ask them "how long is that fixed rate fixed for?" here is an example of one way to disclose it right. So you always want to ask, "How long is it fixed for?" if they do not volunteer the information.

If it's a balloon loan, that means you have to refinance or pay it off before the end of the loan. Mandatory, required, there is no more loan after that point. If it's an ARM or hybrid ARM, you also want the margin once it does start adjusting and the name of the underlying index to become part of the guarantee. You don't have to refinance hybrid ARMs, and you're welcome to keep them as long as you like what they adjust to, but most people refinance before the end of the fixed period or very shortly thereafter.

Finally, you most especially want whether or not there is a pre-payment penalty to be part of your guarantee, and if yes, the nature of that penalty. A loan with a prepayment penalty should be a much cheaper loan than one without, as you are looking at agreeing to pay about $12,000 around here if you refinance and likely if you sell. The phrase, "What would that be without the prepayment penalty?: is one of my favorites. But you have a right to know, and a loan with a prepayment penalty is likely not as good a loan as one a quarter to a half percent higher for the same cost, without a prepayment penalty. If you already know you're going to need to sell before it expires, it needs to be more than that. So make sure you find out, is there a prepayment penalty, yes or no? If Yes, how long is it for? Is it a hard penalty or a soft one, and does it strike from the first extra dollar or only after you pay down more than twenty percent in a year? These all make a difference, and you should be aware of their nature, and it should be honestly disclosed to you when you are shopping for a loan.

Caveat Emptor

I got an email raising a lot of issues. Some I'm going to deal with very quickly, others I'm going to spend some effort on, but nothing as in depth as a full article would have. I'm going to keep referring to material found in Credit Reports: What They Are and How They Work

I'm going to take the email in chunks:

Turns out I made the Two-Loan choice myself, independent of your article, a couple years ago. I was motivated to get a conforming first loan (~$322K @ 5.75%), and put the other ~$45K of a prior mortgage into a HELOC (besides, the HELOC rate was lower than the 30-yr fixed at the time!).

Well, times (and HELOC rates) have changed, and I now have ~$65K on my HELOC, and relatively tight budget.

That was 2003. considering that I had 30 year fixed rate loans at 5.375 percent or lower without any points for months and 5.25 for literally zero total cost for about one, you likely paid more than you needed to. There was a period in late August when rates spiked up, but I was calling the same clients back in December and into 2004, asking if they wanted to cut their rate for free. No prepayment penalty, no points. Those would have lowered the rate further.

HELOCs (Home Equity Lines Of Credit) have the disadvantage that they are month to month variable, based upon a rate that is controlled by the bank. On the downside, you're somewhat at their mercy. On the upside, the rate is based upon that lender's Prime Rate plus a margin fixed in your loan papers. They can't change your rate without changing everyone else's also. There is absolutely no legal reason I'm aware of why they can't set prime at twenty-four percent. There are plenty of economic reasons. Unfortunately, given the high demand low supply of money currently, the banks are competing for new business with a better margin, not a lower prime. They didn't cut rates every time Greenspan's Fed did, but they have religiously boosted prime every time the overnight rate has gone up since the Fed started raising it. Banks are making a killing in real historical terms right now with variable rate lending.

Fortunately, in most cases it's pretty easy to refinance a HELOC. Credit Unions are a great place for this; variable rate consumer credit is where they shine. There are some internet based lenders where you can obtain no cost, easy documentation HELOCs at rates right around prime, or even a bit below if you have the credit. Most HELOCs also have interest only options for five or ten years. Brokers really don't do a whole lot for HELOCs except keep lenders honest; there is not enough money in them to make them worth chasing and the lenders won't pay for them the same as for first trust deeds; it's too easy to refinance out of them. (Brokers can beat the stuffing out of credit unions on first trust deeds, however).

Unfortunately, your credit score is a problem now:

I have multiple credit card companies offering me low introductory rates (some 0%, some 2%) for short terms (up-to 1 year).

Why would I NOT want to take them up on their offer?

In truth, I've already done this a number of times in the past 12-18 months, always at 0%. So I've learned the "minimum payment" trade-off (and I wish congress hadn't forced CC companies to raise their minimum payment requirements!) [ last year, one fine bank only made me pay $10/month on their loan of ~$10K! Now I'm seeing minimum payments of 1-3 %]

The difference between cash flow and real cost, and the fact that each time you accept a new credit card thus, it is a MAJOR hit on your credit. Let's say you have two credit cards now that you have had for over five years, and get four new ones. Your FICO score modeling goes from over five years to about a year and a half on your length of credit history (the average of your accounts, except that five years is the maximum you get credit for an account). Open four more six months down the line, and now you have ten, with an average time open of just over a year. Furthermore, since most people move as much as they can into the new credit accounts, this gives major credit hits for being essentially maxed out on a card. Thirty to forty points on your FICO score per card, perhaps more. You say you've been doing this a while. Not to mince any words, I wouldn't want to have your FICO right now.

There are always two concerns when you're looking for the best deal. Minimize your costs, of which interest is far an away the largest, and be able to make your payments. I don't know if you have other payments here, but if so I would do everything I could to live cheaply enough, long enough to use the money I save to make a difference on both of those scores. In your position, I'd sell any cars I still have a payment on, just to get out of the payment. This is a concern I've been telling people about since 2003, when the rates on everything were so cheap. There is more than one way to do things, but you have to be prepared for the consequences of the way you chose. I had some clients up in Los Angeles about July of 2003. They wanted to cut their payments. I gave them the option of a conforming loan (like yours) with a HELOC, and they took it. As soon as the loans funded, the wife called me and said I deceived them about the loan, and they wanted me to pay for another loan. Unfortunately for their contention, I had a piece of paper in the file with their signatures saying exactly what I tell everyone else about this situation, that the rate on the HELOC is month to month variable and subject to change, and that they understood this was a risk and they elected to take it. It looks like you went in with your eyes open, but the risk didn't work out as you hoped. I'm trying to think of other strategies to help you out, but other than "live frugally for a while", it's all little stuff around the edges.

Tonight I'm "running the numbers" on whether a 2% rate (nondeductible) is better than an 8% (tax deductible). And according to my simple calculations (I'm an engineer, not a financial advisor!), it's a no-brainer (go for it!). For the $40K currently on the HELOC (other $25K is already temporarily in 0% accounts), the one-time transfer fee ($50-90/transfer) and lower interest amount (~$70/mo) is ~$200/month less than the deductible interest-only (minimum, ~$435, @ 8%) HELOC payment, AFTER adjusting for the tax deductibility (@ 30% [fed + state], ~$130 on $435).

My plan is that in months when my "income"/cash flow cannot cover all the minimum payments, I'll just use a HELOC check to cover the difference. That is, slowly transfer SOME of the debt back to the HELOC. But in the meantime, my theory goes, I'm paying down my principle faster than if I was just making "extra payments" on the HELOC.

Yes, in most cases you will make more progress, faster, this way, but at such a long-term cost as to make it prohibitive, particularly if you have to leave the credit lines open after you transfer the money out six months down the line. Lots of very silly folks do all kinds of weird and non-remunerative things because it's a deduction, but deductions are never dollar for dollar. If that were the only concern, 2% nondeductible beats 8% deductible by a huge factor. Given what's going on in the background, however, kind of a different story. All these newly opened lines of credit are going to drag you down for years. Make certain to pay it off before the adjustment hits; one month at 24% will kill almost all of your savings. Two months at 18% will more than kill it. Given what your score has likely dropped to, I'd bet that it's closer to the former than the latter.

I also finally had a 0% application turned down, due to "too much credit already, for your income level". So I imagine having all these cards may be hurting my credit score? But I'm not going to re-fi my house (or buy a new car?) anytime soon, so I think I don't care.

I imagine you're going to care. FICO scores require care and tending and time to rise back up. Close off any cards you opened for the zero interest period that you have paid off, and that will mitigate the damage. Keep only a few long standing accounts. But a large amount of damage is already done. When Credit Card companies are saying that, your FICO has dropped big time. Without running your credit, from the foregoing information, I'd guess you are below the territory where I can get a 100% loan, these days, even sub-prime (lower 500s). You might be below 500, where only hard money can lend to you.

Another concern is that HELOCs have "draw periods", usually 5 years, and you're about three years into yours. I'd be very certain to move it all back into the HELOC prior to the expiration of the draw period. Your credit card options are already getting worse, meaning that you're not getting the cards or not getting approved for enough to be useful. The HELOC's rate, by comparison, is set by a margin in an unalterable contract, and you're not going to be able to qualify for a new HELOC that's anywhere near as good while those card accounts are open. Move the money back in at least a couple months before the draw period expires and close the credit cards, and you might be able to get a new HELOC on decent terms.

Your credit is always vitally important. Guarding a very high credit score is something worth stressing about. You never know when you might need to apply for credit. Most credit cards, nowadays, can alter your rate if your score drops or if you make one late payment anywhere, not just on that card. A good credit score saves you money everywhere, from borrowing to insurance. In your situation, I'd be stocking up on pasta and Hamburger Helper while seeing what I could do to increase my income, so I could live cheap enough to pay my bills down enough that I'm not squeezed. It's your life, but that's the way I see it.

Caveat Emptor

(For full disclosure, the original email is below in a body).

Hi Dan,

While using Google to seek the wisdom of others regarding my current financial situation, I came upon an article of yours, and have now read at least a handful of others. In particular, "One Loan Versus Two Loans" caught my attention.

Turns out I made the Two-Loan choice myself, independent of your article, a couple years ago. I was motivated to get a conforming first loan (~$322K @ 5.75%), and put the other ~$45K of a prior mortgage into a HELOC (besides, the HELOC rate was lower than the 30-yr fixed at the time!).

Well, times (and HELOC rates) have changed, and I now have ~$65K on my HELOC, and relatively tight budget.

I have multiple credit card companies offering me low introductory rates (some 0%, some 2%) for short terms (up-to 1 year).

Why would I NOT want to take them up on their offer?

In truth, I've already done this a number of times in the past 12-18 months, always at 0%. So I've learned the "minimum payment" tradeoff (and I wish congress hadn't forced CC companies to raise their minimum payment requirements!) [ last year, one fine bank only made me pay $10/month on their loan of ~$10K! Now I'm seeing minimum payments of 1-3 %]

Tonight I'm "running the numbers" on whether a 2% rate (non-deductible) is better than an 8% (tax deductible). And according to my simple calculations (I'm an engineer, not a financial advisor!), it's a no-brainer (go for it!). For the $40K currently on the HELOC (other $25K is already temporarily in 0% accounts), the one-time transfer fee ($50-90/transfer) and lower interest amount (~$70/mo) is ~$200/month less than the deductible interest-only (minimum, ~$435, @ 8%) HELOC payment, AFTER adjusting for the tax deductibility (@ 30% [fed + state], ~$130 on $435).

My plan is that in months when my "income"/cash flow cannot cover all the minimum payments, I'll just use a HELOC check to cover the difference. That is, slowly transfer SOME of the debt back to the HELOC. But in the meantime, my theory goes, I'm paying down my principle faster than if I was just making "extra payments" on the HELOC.

Seems so obvious when I look at the numbers, that I cannot figure out why more people aren't doing it, or at least talking about it!

Why does a thorough website like yours not say anything about this (that I could find anyway)? Is it just to keep those low-rate credit offers coming? Am I missing something? I am really the only person to ever think of doing this? I also finally had a 0% application turned down, due to "too much credit already, for your income level". So I imagine having all these cards may be hurting my credit score? But I'm not going to re-fi my house (or buy a new car?) anytime soon, so I think I don't care.

Thanks for reading this far. If you post an article on this topic rather than replying, will I get a least a pointer to it in reply?

Again, thanks for considering a comment on my situation!

Identity withheld pending correspondence approval