Intermediate Information: April 2008 Archives

Despite all the hype, rates (or, actually, the tradeoff between rate and cost) are pretty darned good right now. I'm at home right now, but yesterday, for someone with average credit (national median) and 20% down payment or equity, I could have locked a thirty year fixed rate loan at 5.875% with one total point, and delivered same in thirty days. Lest you not understand, that's very good by historical standards. Last summer the same loan was in the 6.5 range, and I remember not too long ago when rates in the sevens were considered good. Nice, sustainable fully amortized 5/1 hybrid ARMs that most people will never keep five years anyway are in the low 5s for the same cost (starting to look like a worthwhile alternative again).

But you'd never know it to look at the headlines. "Lender meltdown!" and "You can't get loans!" are things you see in the mass media every day. "Hard to get mortgage" returns 435,000 hits.

The truth is, there is a meltdown. Lenders have suddenly figured out that risky loans are risky loans, and since they have their sense of humor surgically removed upon hiring, now they're mentally trapped in a humorless game of Paranoia. People with marginal credit or little in the way of down payment are finding it difficult to buy, and since their former ability to qualify was priced into the market, this limits the demand for real estate, shifting the supply and demand equilibrium (aka price) down. The loan market controls the sales market, and when the loan market makes it harder to qualify than it has been, times get bad for sellers. People looking to buy for the first time have to save more, and the people who would have sold to them aren't going to be able to move up either.

So all of the marginal cases that subprime lenders were lining up to serve until about a year ago can't get loans, and even people that have A paper credit may be forced to consider subprime loans, if they can get anything at all, due to high Loan to Value Ratio. This has become very much a positive feedback situation. Falling demand triggers tightening of lending standards, causing values to fall, further exposing lenders to loss, causing them to tighten their standards further.

When a lot of people have fallen below lender thresholds for acceptable risk, they can demand loans all that they want, but the lenders isn't going to supply those loans. But the lenders still have that money. If they don't loan it out, they're still paying interest on it to their depositors, and the investors are going to be angry that their stock isn't paying any dividends. So they've got to find somewhere to lend it out that does meet their standards.

So if you are one of those people who do meet lender standards, they want to lend to you, and there aren't as many people eligible to compete for that lender cash, which means the money is cheap in terms of what it really costs. The margin over inflation is lower than it was in Summer of 2003, when the rate/cost tradeoffs were lower than they had been in fifty years. Lenders want to lend money. For those who qualify, money is cheaper now than it was then, because the 5.875% loan you get today is less expensive, when considered in the form of "rate minus inflation," than 5% was then.

Having observed a few market cycles before this in cyclical San Diego, let me ask what happens as soon as things stop getting worse? Lenders figure out that they've been overly paranoid, they loosen the standards just a little bit, and because the loan market controls the real estate market, real estate prices starts rebounding as the new people who can now qualify in the loan market enter the real estate market. That same market that the loan climate has been hampering, gets helped when the loan climate loosens just a little bit. San Diego has been on the bleeding edge of this whole phenomenon. I see a lot of evidence, and hear of a lot more (thus far, still anecdotal because official records take a while to catch up) that says we're ready for a turn

Indeed, that lending wedge is already present, in the form of new FHA limits of $697,500 locally, when their former limit of $362,000 locally had meant FHA loans couldn't finance anything above a two bedroom condo. The FHA program in its base form gives a government guarantee of the loan for loans up to 97% of the purchase price, and there are ways to make an FHA purchase with zero down. Lenders like government guarantees - it means that even if the property does get foreclosed upon, they'll probably get their every penny of their money back. (I should also mention that the VA loan limits have also been raised, and VA loans are a better deal if you're eligible. Never go FHA if you can go VA, and I'm getting wholesalers telling me they'll do VA loans up to 1.5 million dollars) The control upon this whole thing is, of course, the fact that all government programs require borrowers to qualify "full documentation". Stated income and NINA loans are not allowed by any government program. However, San Diego's local economy will more than support current pricing levels. More than enough people make more than enough money to qualify for home loans at current prices "full documentation", and when people figure out that the mass media's Fear and Greed campaign is misplaced, what do you think is going to happen?

Caveat Emptor

People sometimes ask how they can improve their credit if they have old collections on their credit record.

The answer is NOT to simply pay them. Paying off a five year old collection can cause your credit score to drop by 100 points.

You say that makes no sense? Well, here's the logic of it: Collections are weighted by how old they are; when your last activity was. They are weighted heaviest for the first two years, then somewhat lighter from two years to five, then lighter still after five years. If you pay it off, it's still a derogatory notation, because after all, you were way past due on it. But now the date it gets marked with is TODAY, and now you've got an absolutely fresh collection on your credit record. In other words, it comes back to bite you just as hard as it ever, for another two years.

So what you do is get a promissory letter of deletion. This says that if you pay $X, they promise to issue a letter of deletion. You need this promise in writing. Call or write the company involved, and come to an arrangement that if you pay however many dollars they want, they will give you a deletion letter. Tell them to send it to you at your current mailing address. Don't pay until you do have the promissory letter in your possession, lest your credit suffer the hit I discussed above.

Once you have the promissory letter in your possession, then pay the bill. Include a copy with the bill to remind them. They will wait until your payment clears. They should then issue an actual letter of deletion. This is on company letterhead, has a contact name and phone number and an authorized signature. It should be short and sweet, reference the account, and say "Please delete this account."

You then send copies of that letter to the credit reporting agencies (Experian, Equifax, and TransUnion) and get your account deleted. Once the account - and the negative reference - is deleted, it's like it never existed.

Now, if the company reneges on the deletion letter, you have the legal ability to sue them. That promissory letter is a legal contract, with offer, acceptance, and consideration, for a legal purpose, etcetera. Talk to a lawyer about the details, I'm just a loan officer who's helped people with this a few times.

This entire process does take a month or two. It's not something to try when you already have a mortgage loan in process; it's something to do before you apply. Trying to do this while you've got a loan in process is expensive, because you're going to blow your lock period and need to extend it, sure as gravity. Thirty days of extension for your loan lock is approximately half a percent of your loan amount, so on a $400,000 loan, that's $2000. Most collections are a lot smaller, and you may have to resign yourself to the hit on your credit in some instances, in which case you should probably wait and have it paid via the escrow process, where the loan will be funded and recorded before paying off that old collection hits your credit score by being brought up to the present day. Otherwise, you could find your loan denied due to credit score dropping, and discover that you're not getting another one on anything like comparable terms. Maybe you are not getting another loan at all, because your score has dropped too much. Be careful, plan ahead, and take care of old collection accounts ahead of time.

Caveat Emptor

I know 401k contributions impact a persons Adjusted Gross Income, thus would it also affect the amount a person could qualify for? If so, I will delay enrollment for a few months...

This depends upon what documentation you use to qualify. For most of those who are salaried or hourly W-2 employees, debt to income ratio is calculated using gross pay from w-2s and pay stubs. This is more more than half of the people out there. For these people, it doesn't matter, because the computation is based upon gross pay before any deductions - even withholding. The thinking goes that you can always stop retirement contributions if you need the money now to afford your mortgage .

For those who have to use the full federal tax forms to qualify however, the computation is based upon Adjusted Gross Income. This is basically three groups: The self-employed, commissioned sales people, and construction trades, the last being notorious for periods of unemployment between the end of one project and finding another project that's hiring. Adjusted Gross Income, or AGI, is after retirement contributions from taxable income, as well as business expenses and several other things are deducted. The reason for this is those people have more expenses that statutory employees, whether those employees are cube farm dwellers, have a corner office, or whatever. Lenders are well aware of this. The only reason why they're willing to accept taxes as proof of income is very few people will tell the IRS they make more money than they do when it means paying so many cents of every dollar they didn't make in taxes.

This can make it very difficult for people in these three groups to qualify via documentable income. This is the reason why stated income loans were created. I don't like them, but there is a reason why they exist. The rates are higher and the underwriting requirements are tougher, but without that, some people would never be able to qualify for a home loan, no matter how credit-worthy. As I've said before, stated income is subject to abuse, and you'd really rather qualify "full documentation" if there's any way you can, especially now when lenders are suffering stated-income-phobia and it can mean having to come up with tens of thousands of extra dollars down payment and pay an interest rate that might be two full percent higher than people who can qualify full documentation will pay, and might not be able to find a lender who will lend them all of the money they need for the purchase.

So it will make a difference if you're one of those who needs to use tax forms, but if you're someone who can use w-2s to qualify, it shouldn't.

Caveat Emptor