X-Pert Information: December 2007 Archives

Our home isn't worth what we owe. So say you were just an average person selling and buying a house, meaning you put your house up for sale, get a contract to purchase on it then go put in offer in on a new house. Then you generally get a pre-approval, then the loan from a lender for the new house prior to closing on the old house. You then go to the closing sign the papers for your old house and then afterwards sign the papers for the new house. How would the lender giving you the new loan know that you were short selling the old house when everything happens the same day? It's not going to show up on my credit for at least 30 days and by that time I will already own the new house. Get it? Is this possible?

This is not the first time such a scam has been tried.

The loan application asks you about what property you own now. Falsify it, and you're likely going to spend a few years in Club Fed. Since it's unlikely you'll make mortgage payments there, this will compound the problem (Just try this on the judge: "I couldn't pay because I was in jail for lying about my financial situation, so it's not my fault!")

Furthermore, the current mortgage is going to show up on your credit.

The condition the underwriter is going to put on the new loan approval is going to go something like "Show property has been sold and debt paid in full"

Believe me, they're going to investigate. They're going to want a copy of the purchase contract and a payoff on the loan for it. Since the debt isn't going to be paid in full, they're going to figure out that you've got a short sale going on. It's not going to happen "same day" if there's a short sale. They're going to want to verify that the other lender is not going to pursue a deficiency judgment. If you're still going to owe the other lender money, the payments are going to hit your debt to income ratio (DTI).

All that said, if you come clean about the situation starting with your loan application with the new lender, it's possible you'll still be approved - just not the same day you close on your sale. They're going to want something that says your current lender isn't going to pursue the deficiency, but it is possible. Theoretically speaking. They're also going to want to figure out what you're going to owe the Revenuers, and how you're going to pay it. Then they're going to take that into account in underwriting the new loan.

(NB: With HR 3648, the Mortgage Forgiveness Debt Relief Act of 2007, this may be zero on the federal level but there may still be consequences on the state and local level. Check with your CPA or EA for more information)

But trying to hide the situation is pretty much going to be a guaranteed rejection. Furthermore, whether or not you intended fraud, if you'll look up the legal definition of fraud, what you were asking about falls well within that definition. I wouldn't be surprised to find the FBI paying you a visit. In fact, I'd be surprised if they didn't. Banking fraud having to do with amounts at risk large enough to finance real estate is a serious felony. ALWAYS tell the truth, the whole truth, and nothing but the truth on a loan application. Better to be rejected based upon the truth than accepted based upon fraud.

If you wait until the short sale is consummated to apply for a new loan, there are 13 questions on page 4 of the standard form 1003, the Federal Loan Application. At a minimum, questions a, d, and f (having to do with judgments, lawsuits, and delinquencies) are going to have interesting possibilities, but there is no question that directly asks about a short sale. It does shows up on your credit report for 10 years, as debt not paid in full. Mortgage debt not paid in full, amplifying the failure in the eyes of mortgage lenders. If there's a deficiency judgment, that will show up as well, for ten years from the date of the judgment. I can't recall ever having dealt with someone in this situation; but it's definitely a factor a reasonable person might want to consider in deciding whether to grant you additional credit, right? If your worthless brother-in-law wanted to borrow $1000 despite having stiffed you on other debts in the past, you'd be within reason to consider that fact in your decision as to whether or not to loan the money. Particularly if the purpose of this loan was directly in line with the purpose of prior defaults. The situation is no different with mortgage lenders.

Caveat Emptor

Just got another in a long series of emails about this horrid product: (identifying details redacted)

Learn How To Make More Money Per Client ($500-$1000)

In This Workshop You Will Learn Why The Most Successful Mortgage & Real Estate Professionals Across The Country Partnering With DELETED?

To Maximize their Income

To Gain and instill Loyalty with current and past clientele

To Exponentially amplify their business success

A Win/Win decision that will impact your business and your client's lives

Because the Demand for Mortgage Protection Insurance is exploding across the country

You notice how "helping your clients" is nowhere on the list of benefits?

Here's another ad of theirs I found online, in the help wanted section:

DELETED is now looking for former Account Executives of Direct Mortgage Lenders, former Account Executives for Title companies & Current Life insurance salespeople that are licensed. DELETED Insurance is offering a new way for Mortgage companies to add an additional revenue stream to their company. We are offering Mortgage protection to them to sell to their clients. You will be responsible of managing your pipeline and territory management. This position is 100% commission. We offer the highest commission splits in the business. First year earning potential can be a 6 figure income. There is also opportunity for you to become an area sales manager in your area. If you are familiar with Mortgage protection insurance or Mortgages, you will know why mortgage professionals will say yes to this product.

Notice how they say they'll take currently licensed people, but those are not the candidates they're really looking for? There's a reason for that. People who have been around the insurance business know about this market sector's history of abuse, and how it always seems to be the sales people who take the fall when the regulators shut it down, while the higher ups walk because they "have it right here in writing that we told those people what they were doing was illegal," while winking at anything that brings in more sales, if not actually encouraging it - just not in writing.

and one more ad, on lendertalk

I am offering Mortgage companies to sell mortgage protection insurance.

Here now simple it is to sell.

1. get your lifie insurance license (sic)
2. sell to past and exsisting clients (sic)
3. Earn 80% of the total commission
4. wrap the first year premium into the loan (emphasis mine)
5. Never have to meet the client
6. everything is done at the time of close
7. Recieve check 72 hours after closing (sic)

average commission is $650

Look forward to speaking with you on this.

At purchase, you can't really put the premium into the mortgage. The only way to do so is fraud. You're either paying for it in cash, or you're paying for it by effectively decreasing your down payment. You cannot do it in conjunction with 100% financing, unless the seller is paying, and I wouldn't want my clients doing so. At refinance, it's at least a possibility. But does a sane financial planner want you increasing your mortgage by about $1000, paying interest on it and possibly kicking the loan over into the next higher Loan to Value category (thereby effectively raising the rate on the whole loan) so that you can purchase the most awful policy of life insurance going? Additionally, many states have rules on buying insurance with borrowed money, and agents knowingly accepting such. California is one of these. This entire pitch element would appear soliciting someone to break the law, perhaps in multiple particulars. Experienced agents know this - newly licensed ones may not.

In order to understand what's going on with this product, you have to understand what Mortgage Protection Insurance is and what it is not. First, what it is not: It is not Private Mortgage Insurance (PMI). Private Mortgage Insurance is an insurance policy that insures the lender against loss, which you pay for as long as you require it. Private Mortgage Insurance can be a required item in getting a certain loan, and as much as I detest it, for loans above 90% of the value of the property, it's the only real alternative as of this writing, for reasons I go into in 100% Financing or Low Down Payment or Low Equity: PMI May Be The Only Option.

Mortgage Protection Insurance is a decreasing term life insurance policy, which is supposed to pay the lender off directly in the event of your demise. It is not required by any lender. If lenders were going to require some insurance policy, they'd require disability insurance, which is needed three times more often than life insurance, with worse longer term consequences for loan viability. Lenders do not waive requirements or fees for Impound Accounts because you buy Mortgage Protection Insurance. As I said, disability is a far more common cause of lender losses than life insurance. But I got email from someone in California who was told that by a loan officer who wanted to sell Mortgage Protection Insurance (FYI, in California it is a prohibited practice to require an Impound Account, or to charge a higher fee for not having one. Yes, this means that we all pay for it with a slightly higher rate/cost tradeoff. But we all have to live within the law, and my point is that purchasing Mortgage Protection Insurance makes no difference to the impound account, despite what this person was told).

This is a very lucrative field as far as making money goes, as you can see not only from the advertisements above but also a on-line search. The ability of practitioners and sales persons to make money is not an indication that a product is bad, but it is a sign of potential abuse. Any time you have the potential for a lot of money by cutting not very many corners, it's a warning sign that says in no uncertain terms to be careful.

The first real objection I have to this product is that decreasing term life insurance is probably the worst life insurance policy that it's possible to buy, and I'm telling you this from the point of view of someone who wants life insurance and can't get it on any kind of reasonable terms (This is not an invitation to a solicitation. I tried very hard to get life insurance on reasonable terms when I was licensed, because I understand what a good investment it can be). First off, it's term life insurance, with all the issues inherent in term insurance: rising cost of insurance, no use of tax advantages, likelihood of voluntary cancellation, likelihood of wasting every single penny you pay. Now add the fact that as your overall cost of insurance goes up, your coverage goes down. It doesn't take any kind of genius to tell you that increasing revenue for decreasing liability is an insurance company's dream scenario, while not being nearly so wonderful from the consumer's point of view. At some point before the insurance company's risk of (decreasing!) payout becomes significant, actuarially speaking, the vast majority of consumers simply cancel. Their premium tables are calculated to encourage this.

Next to consider, we have health considerations. Entropy hits us all. More and more health conditions start happening as we get older. It's scary to think about, but right now is probably the best health you will be in for the remainder of your life, and you're buying a policy of life insurance where the benefits decrease in absolute terms when most people need them to at least stay constant, if not increase. Inflation isn't going to stop because you bought a policy of life insurance. Thirty years ago, $25,000 was a fairly serious policy. These days, most companies don't sell amounts that small, and the ones that do, charge much higher rates for such small policies. The more you understand about financial planning, the more you understand that your ability to profit from life insurance is likely to increase as you age, not decrease. But when you go to buy more later, because you've finally figured all this out, you find out (as I did) that now you've got health conditions that either disqualify you, or raise your rates outrageously. And you want to buy decreasing term insurance?

There are also estate tax considerations. The Congress of 2001 understood the need for estate tax reform, but in order to get the votes to pass it, the advocates had to accept a sunset date of December 31, 2010, after which time everything goes back to the way it was prior to the reform. The people who passed that legislation knew that Congress was going to have to revisit the issue before it expired. Unfortunately, here it is December of 2007, and the current Congress has made it plain they're not going to do anything, which wipes out the possibility of reform prior to the start of the next Congress in 2009, and if nothing happens to shake the current incumbents out of their state of lethargy during the next election, there we are at the sunset date with nothing happening, and the situation resets to where it was before 2001. Ouch. As I've said, I'd rather have AMT reform because estate tax is essentially voluntary, but most people seem to volunteer to pay estate tax, which is and remains the highest rate taxation in the country, and it has crushing implications. The value of a life insurance policy, unless you've done the work necessary to avoid volunteering for estate tax, is part of your taxable estate. In this case, your family will owe taxes on on it, and the lowest bracket is almost forty percent, just on the federal level. Lots of folks assumed that estate tax was going to be going away, as that was the obvious signal sent by the Congress back then, but that's looking less and less likely given the current Congress and the unlikelihood of change in the next one. Maybe it's just me, but I don't see any advantage to paying off the mortgage only to have my heirs forced to visit a loan shark in order to pay the taxes.

But the ultimate killer objection to this product is the fact that it's just plain a bad idea to take life insurance proceeds (that can be completely tax free if you take the steps) and pay them to anyone except your chosen beneficiary. I've gone over this before, in Mortgage Life and Disability Insurance. What your heirs can do with such money, prudently invested, completely shatters any consideration of taking the money and paying off the mortgage, which your heirs can nonetheless decide to do with any policy. Why in the world would you want to take that decision out of their hands with a policy that dedicates the benefit if you should die to that lender? You buy life insurance to benefit your family, not your mortgage lender! Even if you understand nothing about leverage and how it works, this just isn't good financial planning!

So if anyone tries to sell you this product, just say, "no thank you!" and indicate in no uncertain terms that you will not be purchasing this product, and if it's a requirement to get the loan done, you're going to go elsewhere to get your loan. I'm not saying life insurance isn't a good thing - in fact, I'm saying the exact opposite - but you don't want to buy this particular sub-species of policy.

Caveat Emptor