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. So that except for any cash you get, your loan balance should not increase by a single penny.
Even on a zero cost loan, you’re likely going to write a check or even more than one, but they are for things like Prepaid interest. Prepaid interest is not a cost; it’s paying money that you would have owed anyway in a slightly different manner, a little sooner than you otherwise would have, and you will get it back by not having a payment the next first of the month. Matter of fact, prepaid interest is the reason there is no payment due on the first of the next month. You’re not skipping a payment. You never skip a payment, and any contention to the contrary is reason enough not to do business with that particular loan provider. You generally have the option of rolling prepaid interest (along with other prepaids) into your mortgage, but then you’re paying interest on it and it’s stuck in your balance forever. 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 the lender absorbing money that you would have had to pay anyway. But in a true zero cost refinance, no money gets added to your loan balance. $X before the refinance, and $X after, not $X+6000. You will likely need to pay for the appraisal (if required) out of pocket when the appraiser comes out, but you get that 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 when they do. 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.
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 (including multiple points) 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. Here is a list of Questions to Ask Prospective Loan Providers in order to pin down what they are really offering.
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 who qualify for them, they are something you should strongly consider, whether you’re planning a purchase or a refinance.
UPDATE: Due to Dodd-Frank, these can no longer be called “zero cost loans” because they cost the lender yield spread – which is a red herring if ever there was one – but they are still zero cost to the consumer, and they still exist.
Caveat Emptor
What Pre-Approval For A Mortgage Loan Should Mean
People are understandably hazy on the difference between pre-qualification and pre-approval. Pre-qualification is a non-rigorous process whereby somebody says that based upon the information as presented to them, it appears you’ll qualify for the loan.
Pre-approval should be more rigorous. For A paper, it should mean that you’ve fed the final loan information, including qualifying rate, income information, credit, etcetera through one of the automated underwriting programs, and it has come back with an “accept”. All that is needed is the actual information on the property, and the actual underwriting.
Now due to the nature of the loan and real estate market, very few people actually get a pre-approval. Why? It costs money to do all of that, and takes a lot of time. Furthermore, it’s based upon a qualifying rate. If rates go up, you have two choices: live with a higher rate or pay more money to buy the rate down, and sometimes no matter how much money you pay, the old qualifying rate isn’t available. You can’t lock the loan with any lender that I am aware of until you have a specific piece of real estate, so your rate will float between pre-approval and a fully negotiated agreement to purchase.
Furthermore, people have an unfortunate habit of stretching to the very limit to buy more house than they should. If you attempt to build in a little margin on the pre-approval, you’re going to qualify them for less money than someone else.
Now with sub-prime lenders, they don’t have Fannie and Freddie’s programs to fall back upon, and if Fannie and Freddie will approve you, you shouldn’t be getting a sub-prime loan. So in most cases, they have to go through essentially a full underwrite of the file, and agree to pay a cancellation fee if you don’t fund within X number of months. Remember also what I told you about having an underwriter do part of their work now, part later. Every time they pick up that file is a real possibility that they will find something wrong that is a good reason not to fund the loan, or imposing a condition that the borrower cannot meet. Result: Dead loan, and in this case where you thought you had it covered, it really ticks off the client, understandably so. I’m a broker; I can always submit elsewhere, but direct lenders are stuck, and the client doesn’t exactly like paying that cancellation fee, either.
Now many seller’s agents are getting tired of getting left at the altar because a pre-qualification means so little, and are starting to demand a pre-approval with offers. Maybe a couple of years ago they would have gotten it; not in the buyer’s market we have today. I submit an offer on behalf of a client, they are required to submit it in any case. In today’s buyer’s market, sellers are (or should be) eager to accept any qualified offer, but most seller’s agents wouldn’t know what a qualified buyer was if it bit them. Income documentation? Credit Score? Debt to income ratio? They are happily clueless, and they don’t know how to negotiate for an appropriate deposit, with appropriate controls on who gets it and when. Furthermore, they don’t want to drive off potential buyers, although this is exactly what requiring a pre-approval does. A good buyer’s agent knows better in this current market, knows they aren’t really necessary no matter what the listing says, but on the other hand they don’t want to waste time with an unqualified buyer in the first place, and many of them have no more clue than listing agents what a qualified buyer looks like.
I’ve told you before that a large number of listing agents are lazy clods whose skills are mostly limited to getting the seller’s signature on the listing agreement. They don’t want to do the work they have more than once, and will drive off willing buyers who actually are decently strong, hoping for someone like King Midas to roll in so they only have to do the work once. Never mind that if they do it right, most of the time the clearances and such only have to be done once. But in the current market, driving off any willing buyer with a decent chance of qualification is a good way to have the property sit for months. Every so often, when I’m calling around to check about showing properties, an agent will tell me that they have two offers. Right. After it sits for six months, suddenly two separate groups decide it’s worth buying when everything else on the market is languishing? If the two offers are real and not a figment of someone’s imagination, neither one of them is good, or it would have accepted it and the property would be in escrow. If such offers are real, they’re desperation checks from the sharks.
But even in a seller’s market, requiring a pre-approval is counterproductive, and may mean that you are disallowing the person who would give you or your client the best offer, and may indeed be a well-qualified buyer. Yes, it may stop you from dealing with some of the “riff-raff”, but the work it saves you could cost your client thousands of dollars, and you signed on to do that work. So if you’re a potential seller, ask questions about this potential situation.
Caveat Emptor
What I Look For In a Mutual Fund Family
Reading the papers, I see all kinds of garbage about mutual funds. Probably the biggest single piece of garbage is that only the so-called “no load” funds are any good. They focus only on the cost of the “loaded” fund, as if there is no benefit to be had from the fact that the “load” pays a professional advisor to help you out. Indeed, it has been well established by DALBAR that net returns of investors with paid advisors, in aggregate, tend to significantly outperform those of investors without.
It’s not just investment knowledge, no matter how much people protest that they know every bit as much as the professionals. If you aren’t, you don’t. It’s investor psychology and not being so emotionally involved in the problems and knowing what to do in the first place so as not to spend so much of your money on basic mistakes. This isn’t play money you’re working with, and if it was, the experience wouldn’t help when it came to making real investments. When you don’t get do-overs, and the time you’ve lost and wasted is the worst thing about the situation, and when the average investor makes three avoidable mistakes costing twenty percent or more of their portfolio value, five percent plus a quarter of a percent per year doesn’t look like such a bad investment. On the same theory that a lawyer who represents himself has a fool for a client, show me a financial advisor who handles his own “big money” without paying for advice and I’ll show you an advisor to stay away from.
With that said, some people are bound and determined to do it all themselves. That’s fine, so long as you admit to yourself that it’s likely to cost you money, and that the ego thing is more important to you than the money.
What I look for, what most professionals look for, in a mutual fund family, is three things. Good Asset Class coverage. Sticking to a fund’s stated modes. Willingness to change a fund management if the performance lags the class over time.
Good Asset Class coverage has to do with the standard categories of funds. Small versus large versus mid cap. Value versus Income versus growth. Bonds versus stocks. I want to see funds within the family that “hit the corners”. Large Cap Growth, Small Cap Growth, Large Cap Value, Small Cap Value, Investment bond, Government bond, “High Yield” bond (aka “junk”), Income, and preferably multiple international choices as well. I may not put money in every category, but I want it available to me. I insist that Value be Value, not “growth and income.” Real Value funds are harder to “sell” laypersons on, but long term, they tend to outperform growth.
The second thing I want is that the management sticks with the fund’s asset class, and doesn’t play funny games with the definition. I don’t like funds that break type to chase today’s returns. A full explanation as to why is beyond the scope of this essay, but For a quick illustration: A few years ago, there was a very hot no-load fund family. Literally top of the demand curve. Everyone wanted their funds. They advertised like hell to attract business, and it worked. They got almost fifty percent of the money coming into mutual funds for a while – and every single fund of theirs put their money into basically the same companies. I did a comparison on them and could not find two of their funds with less than a forty percent investment overlap. This was basically using increased demand to drive price, and hence, temporary paper returns. But this couldn’t last, and they went from being the darlings of the market to absolute bottom in one year.
The third of the most important things that I look for is willingness to replace a bad fund manager on behalf of the family management. I’m not looking for immediate replacement if they lag the class for one quarter. I’m looking for family management that is willing to replace someone that consistently lags the class over time. This is harder to get than you might think. Typically by the time that someone has risen to fund manager, they’ve been with the family for a while and know where most of the bodies are buried. “Charlie” who heads the family goes golfing every week with “George” who’s doing a rotten job and deserves to be replaced, but you don’t fire your golfing partner. It’s all among friends, right? Well, no. It’s my money this clown is wasting.
There are a couple other things that are highly beneficial. Limited number of investments, preferably a maximum number set in the prospectus. Twenty to thirty investments is the optimal tradeoff between diversification and dilution, and most funds are too dilute. Availability of Sector funds is also a big plus. But none of them is as important as the big three.
Caveat Emptor
What Fees Can You Recover If Your Loan Is Denied?
“What mortgage fees can i recover after loan denial” was a search I got. The answer is basically, “None.”
Indeed, one of your search criteria should be mortgage providers that don’t charge anything up front, except maybe a credit check fee. Those are about $20, and you should be prepared to spend that $20 several times over while you’re shopping lenders. If you’re worried about twenty dollars when you are applying for a mortgage, chances are that you shouldn’t apply.
Now many lenders want you to make a deposit that varies from a few hundred dollars to one or even two percent of the loan amount. Deposits are charged by lenders who want to get you committed to the loan, and they do it for at least two reasons. The first is psychological commitment. Usually when I mention things like that, I get people who immediately come back with, “Those kind of mind games don’t work with me!” I’m not looking for an argument, and with most folks, I don’t know their past history well enough to come up with an example, but this phenomenon is essentially universal as far as humans go, and those few not subject to it are probably suffering from some other more debilitating psychological problem. In fact, the normal progression of a loan is a series of commitments upon your part. The decision to talk to potential providers. The application.
After the application, lenders want the originals of your documentation and money. The original documents are requested so that you cannot shop or apply for a loan elsewhere. I, as a loan officer, do not need your original documents for anything I can think of at the moment. I need the original of the loan application and a couple other items you fill out with me, but not of your pay stubs, your taxes, your insurance bill, or any other documents you have pre-existing. Copies are just fine for any lender I do business with, so long as they are clean and readable.
The next step is to get money out of you. If all they want is the credit report fee of about $20, that’s fine and normal. Credit Reports cost money, and if you’re just shopping around, a loan provider has two choices: raise their loan prices slightly so that they charge those people who finalize their loans more, or charge folks whatever the cost is to run credit when they apply.
But many loan providers want more than the credit check fee. A lot more. They want a deposit that varies from several hundred dollars to one percent of the loan amount, even two percent in some cases. They might say it’s for the appraisal, and usually at least part of it does go to the appraiser. Nonetheless, you should not give it to them. I’ve had my clients tell me about the tales they’ve been told, about how that money is to pay the appraiser. The appraisal should be paid for when the appraiser does the work. As I’ve said before, you want to be the one who orders the appraisal, and therefore controls it. I’ve had clients tell me about loan providers who only use “in house” appraisers. Well, those “in house” appraisers are drawing a salary and requiring “in house” appraisers is usually indicative of lenders who aren’t competitive on price.
The reason they really want larger amounts of money out of you upfront is two-fold. First, it builds that psychological commitment I talked about a while back. Second, it makes you financially committed to a loan, which tremendously raises the level of psychological commitment. It means they’ve got some of your cash. Most people don’t really understand loans, not deep down where it really matters. Consider, for a moment, which you would rather have: $400 cash, or a loan that costs $5000 less (not so incidentally making a difference of $25 on the monthly payment), but is otherwise identical. Dispassionately sitting there on the monitor in front of you, the choice seems obvious. You’re going to have to pay that $5000 back sometime, and in the meantime you’re paying interest on it. But move it to a situation where these potential clients have already put down a $400 deposit with an overpriced loan provider, and the vast majority of them won’t sign up for my loan, even though I’m willing to guarantee my loan quote and the other company isn’t willing to guarantee theirs. Why? Because they’re thinking of that $400 in cash that came out of their checking account, not the $5000 in extra balance on their mortgage. Companies want that deposit to stop you from going elsewhere, to a loan provider that can do the loan (or, more importantly, is willing to do the loan) for much less money. Practically speaking, they’re not only guaranteeing themselves a certain amount of money, they are guaranteeing that the client won’t change their mind about their loan.
So do you get it back if the loan is denied? Nope. At least I’ve never been told about an instance where it happened. That money was a good faith deposit. Legally, it was an incentive for that loan provider to do the work of that loan, all of which costs money. Provably costs money, I might add. The loan processor doesn’t work for free. The underwriter doesn’t work for free. The escrow officer doesn’t work for free. The appraiser doesn’t, the title company doesn’t. Nobody works for free. Phone calls and copies and word processors to generate all of your documents from the title commitment to the loan documents. Some documents are the same for every loan and can be computer generated. Others, like the title commitment, require humans to enter literally everything on them.
Now, a deposit isn’t necessary. In fact, you can find loan providers out there (I’m one of them) who routinely work the whole loan on speculation of it funding. They might ask you to pay for the credit report up front, but everything else is paid for as the work is done. You write the check to the appraiser when they do the work. You might ask the advantages to the consumer of this. That advantage is that these loan providers are not holding your money hostage. This means that if the loan falls apart because the loan provider told you they could do the loan and they couldn’t, they’re out the money, not you. This means that if you find a more competitive loan, there’s no reason why you can’t apply for that one instead. This means if your back up loan is ready to go and this one isn’t, all you’ve spent is the $20 for a credit check. You’re not out hundreds to thousands of dollars that were in the deposit.
So if a loan provider asks for a large cash deposit up front to begin the loan, chances are that you shouldn’t give it to them. Particularly if they won’t guarantee their loan quote, chances are they are trying to lock you into their loan by holding your money hostage, and when you discover at closing that they tacked thousands of dollars onto the loan charges that they conveniently “forgot” to tell you about or pretended didn’t exist (“Escrow’s a third party charge. We don’t have to tell them about it until afterwards”), and now you are facing a choice between forfeiting your deposit and signing off on a loan that’s not what you agreed to when you gave them that deposit. Better not to face that choice, by not agreeing to pay anything beyond the credit fee up front.
Caveat Emptor
“We’ll Beat Any Quote” in Mortgage Loans
Just like “we’ll beat any deal!” in any other competitive sales endeavor, this is a game. Actually, it’s even more of a game for loans than it is anywhere else, used cars included. What they are hoping is that you’ll go there last, and tell them what the best thing you’ve been quoted, and then they can sell you on their loan and most people will go with them, because “we’re here, not there.”
The first issue is that anyone can give a low quote. It’s like the old joke, “Your lips are moving.” Unless they guarantee that quote, that’s all they’re doing: flapping their gums. All a quote is is an estimate, and I’ve more than adequately covered the games it is legal to play with a Good Faith Estimate (or MLDS in California). By itself, A low quote means nothing. Loan officers can, legally, quote you one loan and deliver a completely different loan at a completely different rate with a completely different (higher, or course) closing cost. Without some kind of Loan Quote Guarantee, a quote isn’t worth the paper a verbal contract is printed on.
The second issue is that even if they are quoting a loan they intend to deliver, unless they are quoting to the exact same standard, the quote game favors the lender who pretends third party costs don’t exist, who pretends that you’re not going to get zonked for the add-ons that you are going to get zonked for at the end of the process, the lender who quotes based upon a loan that you do not qualify for. Are you going to pay these costs? Absolutely. Would you rather know about them at the beginning, so you can make an informed choice, or get blindsided at closing (assuming you even notice)?
The third issue is that they are looking for safe harbor, and they’re hoping you give it to them. If someone brings them everyone else’s quotes, they know what everyone else has talked up, how big the lies are that the prospect has been told, and they just have to tell one that’s a little bit better. This is trivial when you’ve got all that information you’ve been freely given. This is called false competition. You’ve metaphorically given them a mark, and told them to “tell a more attractive story than this one.” Easy enough in a storytelling context – tell the same story with a little more sex – and even easier with loans.
A good loan officer has no need to know what quote you’ve been given to tell you what the best loan they can deliver is. Tell them to quote you the best loan they can without this information. Ask them if they’ll guarantee that quote, because a quote that isn’t guaranteed – as in they pay any difference, not you – is worthless. That’s how you can choose the best rate that can really be delivered, not by allowing someone the advantage of knowing how much they have to lie to get the business.
Caveat Emptor
Today’s Turkey
Over at my other site, I’ve got a feature called “Hot Bargain Properties” Being as the market is swinging more strongly to the buyers every day, it’s what you might call a “target rich environment”. On the other hand, there are still folks in denial, and just plain “What were you thinking” moments. Since a typical realtor won’t talk down anything, no matter how ridiculous, I thought I’d post one of those. The format is similar to my Hot Bargain Properties posts.
**
General: East County, 3 Bedroom, 2 Bathroom Asking price $575,000.
Why you should be interested: You shouldn’t. Nobody should. It’s a nice house, and if it were somewhere else, it might be worth every penny. But here it is an uninhabitable waste of property tax money every six months. At $575,000, that’s roughly $600 per month, $3600 spent twice per year.
Selling Points: It’s gorgeous on the inside. Spacious rooms, beautiful kitchen, nice brand new carpet. The whole property is basically brand new. Pity that ten feet outside your front door is a neighborhood that looks like it came from Deliverance. I haven’t seen the inbred mutant banjo player yet, but I keep looking every time I drive through on my way to something else.
Why I think it’s a potential bargain: I don’t. If somebody gave me this property, I’d give to some charity or deed it back to the county immediately. Less trouble than trying to sell it for $1, or finding a deaf person who wants to buy it. The only way you might be able to live here is inside a hundred foot deep multilayered bunker.
Obvious caveats: The fact that it’s less than a quarter-mile off the departure end of the main use runway of an airport might be something you’d like brought to your attention, as if you wouldn’t know immediately. I don’t know how they sold the other homes in the development. Maybe the wind had shifted on that day and the planes were using the crossing runway. I don’t know why I wasted pixels taking a picture, but I had to wait for a Piper Cherokee to clear the picture window. It filled the whole thing. I love small planes, but there is no way I could stay here one night. The noise was bad enough with just the little trainers that were hopping around the pattern. This airport gets some fairly large aircraft and corporate jets, and has a regular traffic in retired World War II planes (and older!), all of which are noisier than most people would believe. I worked at that airport, and I know of two crashes in the field that used to be where this development sits. Just a matter of time before someone falls out of the sky on one of these homes.
Why it hasn’t sold already: Left as an exercise for the reader. Actually, it’s a private sale, not from the developer, so it did sell once. Go Mark Twain one better. Idiots. School Boards. The owners of these. I’d say two better and name the developer, but evidently the universe developed bigger idiots. Or a bigger fool. You can look out the window at runway centerline, for crying out loud.
If you keep it ten years and it averages only 5% annual average appreciation per year: Based upon a $575,000 asking price, this property will be worthless.
Fact you should be aware of: Open your eyes and look around. Feel the vibrations from the aircraft overhead! Reach out and touch one! (Actually, please don’t try. You might be able to!)
Obvious way to enhance value or appeal of property: Getting rid of the airport would be one, but I know the provenance of that airport land. Isn’t going to happen. The county not only makes a mint off of that airport, but in order to close it they would have to pay the federal government at least billions and I believe tens of billions of dollars. Not. Going. To. Happen.
I’m a buyer’s agent, so I’m not afraid to make fun of stuff like this. If this owner came to me to list it, I’d probably make like one of Ted Striker’s seatmates in Airplane!
Don’t call me on this one. Please, I’m begging you. Properties like this are a Realtor’s version of Slasher movies. You’re stuck in a roomful of rabid dogssharks lawyers and their idiotsshills clients, and nobody else gets out alive!
Caveat Emptor, for the love of humanity!
UPDATE: I forgot to mention that they are building a freeway that will come within one block of this property!
When The Appraisal Is Below The Purchase Price for Real Estate
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what happens when house doesn’t appraise?<BR />
</blockquote>
I presume this question meant “for the necessary value according to the lender’s guidelines”.
Lenders base their evaluation of a property upon the standard accountant’s “Lower of Cost or Market.” This is intentionally a conservative system, because the lender is betting (usually) hundreds of thousands of dollars upon a particular evaluation, and if something goes wrong, they want to know that they’ll be able to get their money back.
When you’re buying, purchase price is cost. When you’re refinancing, there is no cost basis, we’re working off of purely market concerns, except that for the first year after purchase, most lenders will not allow for a price over ten percent increase on an annualized basis. Six months, no more than five percent. Three months, about two and a half. Mind you, if you turn around and sell for a twenty percent profit three months later, the new lender is going to be just fine with the purchase price, as long as the appraisal comes in high enough.
But as far as a lender is concerned, you can see that no matter what the appraisal, the property is never worth more than purchase price on a purchase money loan. There is a transaction between willing buyer and willing seller on the books and getting ready to happen. It doesn’t matter if the appraisal says $500,000 and you’re buying it for $400,000. The lender will base the loan parameters upon a value of $400,000.
But what happens if the appraisal comes in lower than the agreed purchase price? For example, $380,000 instead of $400,000? Then the lender considers the value of the property to be $380,000, no matter that you’re willing to go $20,000 higher. You want to put $20,000 of your own money (or $20,000 more) to make up the difference, that’s no skin off the lender’s nose. Matter of fact, they are happy, because it means they still have a loan, where they would not otherwise.
Keeping the situation intact, if you planned to put $20,000 down (5%) on the original $400,000 purchase price, the loan is probably still doable, albeit as a 100% <a href=”http://www.searchlightcrusade.net/2007/08/loan-qualification-standards-l-3.html”target=”_blank”>loan to value</a> transaction instead of a 95% one, which means it will be priced as riskier and the payments on the loan(s) will doubtless be higher than originally thought. The same applies if you were going to put $40,000 (10% of the original purchase contract) down, except that the final loan will be priced as a 95% loan ($360,000 divided by $380,000 is 94.74 percent, and loans always go to the next higher category).
Suppose you don’t have the money, or won’t qualify for the loan under the new terms? That’s why the standard purchase contract in California has a seventeen day period where it’s contingent upon the loan (many sellers agents will attempt to override this clause by specific negotiation). If you get the appraisal done quickly, you have a choice. You can attempt to renegotiate the price downwards. How successful you will be depends upon several factors. But if you’re still within the seventeen days, the seller should, at worst, allow the deposit to go back to you, and you go your merry way with no harm and no foul, except you’re out the appraisal fee. This is not to say that the seller or the escrow company has to give the deposit back; they don’t. You may have to go to court to try and get it back, depending upon the contract. The escrow company is not responsible for dispute resolution. If the two sides cannot agree, they will do nothing without orders from a court. If the seller wants to be a problem personality, you can’t really stop them without going through whatever mediation, arbitration, and judicial remedies are appropriate.
Suppose the appraisal comes in low on a refinance? Well, that’s a little more forgiving in most cases around here, at least with rate/term refinances where you’re just doing it to get a better loan. If you have a $300,000 loan and you thought the property was worth $600,000 but it’s only worth $500,000, that just doesn’t make a difference to most loans. Your loan to value ratio is still only sixty percent, and it probably won’t make a difference to residential loan pricing (commercial is a different story, and if you have a low credit score it might also make a real difference). On a cash out loan, it can mean you have to choose between less favorable terms and less cash out, however, especially above seventy to eighty percent. There are ways to <a href=”http://www.searchlightcrusade.net/2007/05/the-appraisal-and-appraisers.html”target=”_blank”>prevent wasting money on an appraisal</a>, but once it comes in, it is what it is. If the underwriter sees one appraisal that’s too low, they’re going to go off that value, and if you bring another appraiser in, the underwriter will usually average the two values, so even if the second appraiser says $400,000, the underwriter who has seen a $380,000 property will value it at $390,000 (not to mention you pay for two appraisals). And a low appraisal can mean that the reason you were refinancing becomes impossible, so you’re better off walking away.
Caveat Emptor
What is Loan Amortization?
I keep getting hits for this, so people must want it explained. Loan Amortization is nothing more than the process of paying the loan off by regular payments over time. Leave it to the experts to come up with a fancy word for an everyday process, eh?
A loan which is fully amortized (or fully amortizing) is one which the required payments will pay it off in full by the end of the term of the loan. Fixed rate loans are the classic example of this. A thirty year fixed rate loan has 360 payments of equal amount, at the end of which the loan will be paid off, assuming you have made all the payments on time. The last payment may be somewhat smaller due to the fact that they may round the payment up to the next penny, and over thirty years it makes a difference.
However, most hybrid ARMs are also fully amortizing loans. The difference between these and the fixed rate loan is that the rate, and therefore the payment, is fixed only for the first few years, and after that the rate varies based upon an underlying index. Nonetheless, the loans are still calculated to pay off the entire balance by the end of the loan. You are welcome to keep them after the fixed period if you want to, but few people do.
Balloon loans are partially amortized. Their payments are calculated as if they were a longer loan than they are. Because they amortize based upon a longer loan period, the regular payments do not pay the loan off in its entirety by the end of the loan. Unlike the hybrid ARM, these loans are over in a shorter period of time, and you do not have the option of keeping them. You must either pay the loan off, whether by paying it or by refinancing, or sell the property.
I don’t see it in a federally approved list of loan terms, but I have heard interest only loans called delayed amortization. These loans, whether fixed rate or hybrid ARM, have interest only payments for a given time, and then amortize over the remainder of the loan. For instance, a five year interest only loan is then paid off (amortized) over the remaining twenty five years of the loan. Note that when they start to amortize, they will then have payments that are higher than the equivalent fully amortized loan, because the balance is paid off over a shorter period. They will also typically carry a higher interest rate (most subprime lenders charge 1/4 percent higher interest rate for an interest only loan, and there are additional limitations on availability).
If there were such a thing as an interest only loan that stays interest only until you refinance, it would be an unamortized loan. Years ago, I was invited by a company to take a seminar because they offered these to financial planners clients. Fortunately, when I checked NASD regulations, I found out that what they were trying to sell was prohibited. The interest rates they were talking about were very high as well. The reason I said “fortunately” about finding out NASD regulations prohibited what they were doing is that I later found out that they were a scam and shut down by the regulators. I might have found out had I done all my due diligence, or it’s possible I might not have. Either way, I’m glad I didn’t have any clients with them.
Finally, there is the negative amortization loan, where if you make the minimum payment your loan balance actually increases, effectively digging yourself deeper into whatever hole it was that motivated you to do it. There are circumstances where they are the best thing to do given the situation, but in my opinion, (at least for owner occupied property) it should be a temporary solution of last resort.
Caveat Emptor
Incorrect Legal Descriptions on a Trust Deed
“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. They 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
I’m Sorry, Did You Think Your Good Faith Estimate (Or Mortgage Loan Disclosure Statement) Meant Anything?
Somebody asked, “What are my legal options when there’s a change on a good faith estimate.”
Short answer: Sign the documents or don’t. Same thing with a Mortgage Loan Disclosure Statement here in California. Neither one means anything binding; that’s why they call the one an estimate. Nonetheless, because there is a perception that they mean something, that people think the lenders are trying to disclose everything fully. The fact is that some are while others aren’t, and there is no correlation with size of the lender, how well known they are, or even what the loan officer at the next desk over is doing.
The fact is that if the loan officer cannot persuade you to sign up, there is a guarantee that neither they nor their company will make anything. This creates an incentive to tell you whatever it takes to get you to sign up. Once signed up, most folks consider themselves committed or bound to that lender, and stop looking around.
But the only documents that mean anything, legally, all come at the end of the loan process. Note, Trust Deed, HUD-1. So you can see the motivation exists to pull a bait and switch, or more often just not to tell the whole truth. Nor will they point out the differences at closing from what you signed up for. That would get you upset to no good purpose, from their point of view. The fact is that a majority doesn’t take the time to spot the difference, and of those who do, some just don’t understand how to spot the difference. Of those who do take the time, and do spot the difference, most will cave in and sign just to be done with the process, and of course there are those who are trying to purchase who won’t get it and will lose the deposit if they don’t sign.
The fact is that these forms are estimates. They may or may not be accurate estimates. In some cases, the loan provider tells you about every single dollar you’re going to need up front, in others they might as well be telling you the loan is going to be done for free at a rate two percent below any real loan out there. If they can’t get you to sign up, they don’t make anything, so the incentives are for them to over-promise and under-deliver. In other words, tell you about something better than what you’ll end up with. Now the loan officers know what it’s going to take to get the loan done – or they should know, anyway. But they often tell you a fairy tale that might as well begin “Once upon a time…” to make it seem like their loan is better than the competition, because if they can’t get you to sign up, they don’t make anything.
Now, the fact is that the vast majority of people out there go out shopping for loans in the wrong fashion. They find someone they think they can trust, because they are family, because they are the scoutmaster, or because they go to church with them. Exactly what type of loan will they deliver, and at what rate? With what costs? It is always a trade-off between rate and cost on any given loan type.
Even less likely to get a good rate at a decent cost are the people who do shop around, but won’t give loan officers a chance to figure out what’s really the best loan for them. The first group of people might stumble onto someone trustworthy who gives them a good loan at a reasonable rate for a reasonable cost; these people are going to fall for the biggest lie, because a loan officer can always tell you about a better loan than really exists and they are motivated to get you to sign up. They call around asking about the lowest rate or the lowest payment, and don’t want to hear anything else out of the loan officer.
The fact is that it’s going to take a good, in depth conversation about your situation for a loan officer to figure out the best loan for you, and you want to have that conversation with at least three or four loan officers. Why? Because the first one could have told you exactly what they thought you wanted to hear. Ditto the second. Keep going until you hear a couple of different suggestions. Furthermore, once they’ve given you their suggestions, ask about the other suggestions you heard in the past. Don’t shop by lowest payment; that’s a good way to get stuck with an abomination like the so-called Option ARM or another loan type that you don’t want. Don’t shop by interest rate alone, because you’ll get stuck with a loan that has six points and you’ll never save enough money on the payments to recover those sunk costs. Shop by the trade-off between rate and cost, because there always is one.
Now at the end of the process, the lender has all the power. You need or want this loan, and they’re the ones with it ready to go. In the case of a purchase, you’ve got a deposit you’re going to lose and a home you wanted that you won’t get if you don’t sign the loan documents. If you sign the documents, you are stuck with the loan, that probably isn’t on the terms you were originally told about. I pointedly did not say “promised” because the earlier forms are not promises unless somehow guaranteed, and very few loan providers guarantee their quotes. Chances are, if they won’t guarantee their quotes, they are not telling the entire truth about the loan they are telling you about.
The most important question on this page of Questions You Should Ask Prospective Loan Providers is “If I say I want this right now, will you personally guarantee this rate with those closing costs, and will you cover the difference (if any) between the quote and the actual final cost?” You won’t get a flat “Yes.” If you do get a flat “yes”, they’re making a promise on something that is not under their control, and I wouldn’t trust it as far as I can throw an aircraft carrier. What you’re hoping for is something like “Subject to full underwriting approval, yes we will guarantee this quote as to rate, type of loan, and total cost.” This is a simple sentence that makes a specific guarantee subject to a reasonable condition, as loan officers never know if a prospective borrower is intentionally hiding or shading something at loan sign up. If you get a response full of nonsense about how long they have been in business, how they honor their commitments, or any such equivalent claptrap, then they are trying to buffalo you. None of the stuff when you initially inquire about the loan is a loan commitment in any way, shape or form. I’d rather have a higher quote that was guaranteed than a lower one that wasn’t, and I strongly suggest you adopt that attitude as well. For an illustration as to why: If the quote is guaranteed, there’s no incentive to stick you with a rate an eighth of a percent higher so they can make a little more money – they’re going to have to make it good. There’s no incentive to pad the closing costs with junk, because they’ve got to turn right around and give it back to you. If I offered you a choice between two envelopes, one transparent where you can see the $100 bill (guaranteed), and the other one opaque where I told you there might be anywere up to $110 in it (not guaranteed), which envelope would you choose? The same thing applies to whether the loan is at 6.5 percent with no points and no more than $3400 of closing costs guaranteed, or 6.375% with no points and no more than $3000 of closing cost, but not guaranteed. From my experience, the first quote intends to deliver a better loan than the second quote.
So (if you can’t find someone who guarantees their quotes) how do you force the loan provider to deliver the loan they told you about in the first place? You can’t.
Now the loan provider is going to make money, or they won’t do your loan. Judge loans by the benefits and costs to you, not by how much they loan provider is making, or whether they even have to disclose it (brokers do, direct lenders do not). The important thing to you is that you were delivered a thirty year fixed rate loan at 6.5 percent without paying any points, as opposed to 6.625% with one point and higher costs, not that loan provider A had to tell you they made $4000 by doing it while loan provider B doesn’t have to tell you anything. Sounds obvious, but I have seen people who chose the higher rate at more cost for the same loan, even stuck themselves with a prepayment penalty where my loan had none, because they thought I was making too much. In point of fact, I would have made a fraction of what the other guy did make, and therefore, by the only universal measure, I performed work considerably more valuable to my client. So don’t shoot yourself in the foot like that.
Now expect to spend a little bit extra (about a $100 retyping fee, if you’re the one who orders the appraisal and therefore controls it) on the second loan. That $100, together with the extra time you spend getting the other loan through, is the best, cheapest, most cost-effective insurance policy you can buy anywhere for any financial purpose. It will not indemnify you for your losses, but the odds are overwhelming that it will certainly keep you from losing several times as much, by giving the loan providers a concrete incentive to deliver the best loan they really can deliver. From my experience, and that of my clients who have brought me more horror stories than most folks believe, I would judge it unlikely that either loan quote will be as good as the loan the loan provider originally talked about, unless one company or the other guaranteed their quote, but with another loan ready to go, chances are you’ll get something a lot closer to what they talked about in the first place. Even if you can find a loan provider who will guarantee their quote, a backup loan is a really good idea, because going to court to force them to deliver is costly and time consuming, and you need that loan now. The existence of the other loan is an excellent reason to actually produce that loan they talked about way back on day one, with the initial Good Faith Estimate or Mortgage Loan Disclosure Statement. Because no matter how little they make with the loan they told you about, if they don’t produce it they will make nothing.
Caveat Emptor