The Basics of 1031 Exchanges

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Section 1031 of the IRS Code has to to with tax treatment on the exchange of one parcel of real estate for another. It's similar to Section 1035 which covers most non real estate exchanges. Car for a car. Boat for a boat. Business for a business. But section 1031 allows indirect exchanges so long as you follow certain guidelines. After all, how often do folks want to trade two parcels directly? It happens, but not very often. Usually, if A is buying B's parcel, then even if B wants to replace it with another piece of real estate, it probably isn't owned by A.

Why would you want to do this? Taxes. No other reason but taxes. If the taxpayer makes the exchange according to the provisions, they defer the gain. But we're talking capital gains, not ordinary income, so keep in mind it's not worth going gonzo over. The maximum long term capital gains tax rate for most folks is 15 percent. Getting to keep 100 percent of your gains instead of 85 is worthwhile, and when we're talking sometimes about multiple hundreds of thousands of dollars or even millions, that's quite a bit of motivation. It's nice to be able to invest and use those (potentially) tens of thousands of dollars, rather than basically forking them directly to the tax man, but there are additional costs to the 1031 exchange that you would not otherwise pay, costs that vary between a low of about $4000 per property involved in a straight exchange or $7000 per property in a 'reverse' exchange, and can be significantly higher. This erodes tax benefit in a hurry.

Your primary residence is not eligible for 1031 Exchange. Second homes are severely limited in eligibility (general rule: You can't occupy it more than 10 percent of total occupancy, although you get up to fourteen days per year. Check with your accountant for details. Matter of fact, check everything with your accountant. This is just a basic overview, and the devil is in the details). Section 1031 is for investment property, of whatever nature.

Section 1031 is not for "flipping". I am not aware of any explicit minimum holding time requirements for 1031 exchanges in general, but the IRS looks hard when the held period is less than a year. Questions arising from Section 1031 exchanges are good jumping off points for general audits - the IRS gets out the big magnifying glass to go over your taxes. Be careful. If the properties are being sold between related parties, there is a two year minimum holding rule, and nobody can end up with cash. For this reason, 1031s with a related party transaction are tough. If it's a property you bought as investment that you later made into a personal residence (or vice versa) the minimum holding time is five years.

There are some significant complexities in duplexes where one unit is for personal use, or personal use dwellings where there's a home office. I've gotten to the point where I don't understand the attractiveness or value of a home office deduction for many people, but people keep insisting upon trying for them.

There are three major requirements for a standard "forward" 1031 Exchange. You can not have constructive receipt of the funds. You must designate replacement properties within 45 calendar days of the sale of the relinquished property, and you must consummate the sale within 180 days or before you file your tax return, whichever comes first.

Constructive receipt is a fancy way the IRS has of saying control of the funds. If escrow sends you the check, or if the check is in your name, you have constructive receipt of the funds and the 1031 will be disallowed. So what happens is that you need to pay a 1031 accommodator (most title companies have one) to act as trustee for the money, and the actual transaction is done in the name of the accommodator. If you see something about cooperating with a 1031 exchange at no cost to you as part of a sale or purchase, this is what it's about. Makes no difference to the other party in the transaction, but the Grant Deed has to be made out to (or by) the accommodator entity, not the people who are actually taking part in the transaction.

There are three rules I'm aware of to use in identifying replacement property. The 3 property, the 200 percent, and the 95 percent. Keep in mind that this is investment property, often commercial in nature, and that even within major metropolitan areas it can be difficult to replace the property with something similar within the time frame. This is one case where the law is a lot more flexible than most of the people. As long as it's real estate within the United States not held for personal use, the law doesn't care what the use of the property you replace it with is, but lots of folks are trying to find something as specific to their purposes as possible. Also, in hot markets, there may be difficulties created with finding a property you can afford and that the seller will agree to sell to you in that time frame.

Keep in mind always that we're not necessarily talking a straight one property for one property exchange here. It can be multiple relinquished properties for one replacement (in which case the sale of the first relinquished property starts the clocks), it can be one relinquished for several replacement properties, or any mix of A properties now and B properties later, where A and B are nonzero, whole, and positive. Counting numbers, to use the technical mathematical name. For every additional property in the exchange, you can expect to spend more in fees to the accommodator, exclusive of all other costs to the transaction.

The first method of designating replacement properties is what's called the 3 property rule. You may designate up to three properties of any value, and as long as you actually acquire one or more that fits the parameters within 180 days, you've met this requirement. The second rule is any number of properties but no more than 200 percent of value. The final rule, 95 percent, is basically worthless and a good way to get in trouble, because unless you only designate one replacement property, you're not going to be able to acquire 95 percent of the total value of the designated properties. Identification of these properties must be precise and unambiguous. "Land at the corner of First and Main" won't work. You need something like a legal description or an Assessor's Parcel Number (APN).

Finally, you need to acquire the replacement property within 180 days of selling the property, and before filing your tax return for the year. This can and often does require the person undertaking the 1031 exchange to be forced to extend their taxes.

Where the person making the exchange wants to buy the replacement property before selling the relinquished property, that's called a "reverse" 1031 exchange. It's basically the same concept switched around. You have 45 days to designate which property will be sold (usually not difficult), and 180 days to actually sell it, which may be a problem in slow markets. Reverse exchanges are also more expensive, as they require accommodaters to take title to an actual piece of land, and they are not, in general, for the weak of wallet. Any financing must be non-recourse financing, because the accommodater is in title and they're not going to agree to be on the hook for the value of the loan if you can't sell the property. This can also cause a requirement for larger down payments.

There are also "partial" 1031 exchanges, where you end up not only with a replacement property, but also something else you didn't have before. For the exchange to qualify as for full deferral of the gain, the replacement property must cost at least as much as the relinquished was sold for, the equity in the replacement property must be at least as large as the equity in the relinquished was, and the loan must be at least as large as the previous loan. If any of these three conditions is not satisfied, you've probably ended up with what the IRS code calls "The part of a like-kind exchange transaction which is not like-kind exchange" but most accountants and other people in the real world call "boot," as in "you've got this, and that to boot." Boot is taxable, so if there's a lot of boot, it may defeat the purpose of a 1031 exchange.

One final thing I should mention is that a 1031 exchange can force you to delay filing your taxes. If you start the exchange in December, selling one property, and concluded it in June of the following year by buying the replacement but filed your taxes on April 15th, the IRA will disallow the deferral. The 1031 exchange must be absolutely complete before you file your taxes for the relevant year.

There are a lot of pitfalls to 1031 exchanges, and with typically large amounts under consideration, the IRS is notorious for being hard nosed about all the particulars of 1031 exchanges, whether they are forward or reverse. Don't try this without the aid of a tax professional, and for real estate purposes, an agent who has a good understanding can save your bacon. But if you do fulfill the requirements, it can be a good way of keeping money in your hands that you can continue to have invested in your new property, reducing your mortgage on that property, further saving you money, where otherwise nobody would be happy but the tax collectors.

Caveat Emptor

Original here

Several times a month I get calls and emails. Sometimes, it's even people stopping in. "I've heard you're good at finding bargains." Well, yes I am. "Please tell me the addresses of some bargains so I can drive by."

Well, facts are cheap in the age of transparency. I will quite joyously look at stuff on the internet, even set up an MLS Gateway or feed for someone on the speculation that they'll come back to me later for a showing or to make an offer. Setting up such a feed takes very little time, and about the expertise of an eleven year old that has learned to fill out internet forms. Oh, and MLS access. Can't forget MLS access. We've got a system that lets me custom define the search area now - I can click the corners of a search area I want on a map, and it will return only the results within that area. It's a really neat feature, and using it takes about ten seconds of training, and maybe ten minutes to do the whole thing. I'll happily do it as the possible prelude to a limited service commission, and even if the prospects end up using another agent, I've risked and lost nothing significant. No agency contract required, or even asked. I've even done it for folks who didn't want to give me their phone numbers so I could follow up. If they come back to make an offer, my compensation will be set in the offer paperwork.

But good analysis, experience, and expertise are not free - or even cheap. Furthermore, my time is valuable - and you're asking for a lot of it. I might find three or even four real potential bargains when I spend a full day searching - and that's in a target rich environment. Furthermore, I've got a lot of experience and a lot of knowledge to draw upon that many agents don't, and I look at a lot of properties. I can winnow 100 listings on the internet to twenty possibles in about an hour, go through them in about five hours, of which I might show a client who has made the commitment to work with me six, with usually one or two standouts among those. The rest will have something that to experienced, knowledgeable eyes, are reasons why it is not a viable choice for these particular clients. Maybe it's overpriced and I have reason to believe the owner won't negotiate. Maybe the location or surroundings have an unsolvable issue - one reason you can only tell a bargain by getting out of the office and looking at property. Given the area I work, most often there's something going on with the property itself that's not worth what it's going to cost to fix. I love the older East County suburbs of San Diego - they are good places to live, and when you consider what you get for what you spend, they blow the rest of the county away as far as value. Furthermore, I think the conditions are getting right for the housing buzz to rediscover them. But anytime you consider structures that mostly vary from thirty to eighty years old, you have to watch for maintenance and repair issues, and it really helps to know what you're looking for. Furthermore, it is always necessary to understand the market the property is being listed in. The only way you can do that is by having been in the properties that have sold recently, and the only way you can do that is to go out and look at them while they are still "for sale" because it's not likely the new owners will let you in after it sells.

What I'm trying to say is that the fact of the existence of a listing on MLS is cheap - basically free. You want me to send you addresses of properties for sale meeting certain criteria, that's easy and I'm happy to do it, no strings attached. Anything like that, that can be done by automated computer search, is not a part of what I'm really offering for sale, and I'll give it away on the speculation that sometimes, I'll make something when that person comes back to me to write an offer.

But the ability to recognize a bargain and equally important, what is not - that's the largest part of what I'm really selling as a buyer's agent. Winnowing those 100 listings to a few standout values is a valuable skill. If you don't agree with this, you shouldn't need or want that skill, and you shouldn't be talking to an agent about finding bargains. For people that want access to that skill, there is a fee - they must sign a standard non-exclusive buyers agency agreement. This is precisely equivalent to the difference between a computer programmer giving away some old boilerplate code for free - but they want to be paid for a brand new custom program. This requires all of the same things: Expertise, analysis, experience, knowledge of the area and the current market, the time it takes me to build, run, and debug the bargain-finding program in consultation with the client, and everything else that's involved. The mental ability to do those things did not suddenly appear one morning and it does not maintain itself. Furthermore, the liability for doing this if I make a mistake is huge. Agent mistakes cannot be undone by simply re-writing a few lines of code to work correctly, and having the ability to sue me and my insurance company if I do make that mistake is a huge benefit to the client in and of itself. If they make the mistake, they're stuck - and to be blunt, the probability of a non-professional making that mistake is both much larger than most home buyers believe and many times the probability that I will make that mistake - while if I make that mistake, they can get a lawyer and sue me for everything they might have lost, plus court costs, plus other damages ad nauseum. The idea isn't to sue, but rather not to make that costly mistake in the first place. An amazingly large percentage of buyers make mistakes of a magnitude that I find incomprehensible, all in the name of saving a fraction of what the mistake costs.

The ability to recognize a bargain property is a valuable skill. If you disagree with this, what reason do you have for looking at properties before you buy them? Why don't you simply pick out the cheapest property that meets your specifications on MLS, make an offer, come to an agreement, and pay the price, all sight unseen? Remember, you're claiming that the ability to recognize a bargain does not have value. Why would you want to take the time to look if there's no value in it? When there are ten thousand identical items in a warehouse or on the grocery store shelves, you grab one and get on with your life. You might look at the label to make certain it was manufactured to fill the need you have. You don't bother opening the box - if it's defective, you can just exchange it for another. They're all interchangeable.

But that isn't the case even on everything in the grocery store. There's a reason they wrap meat in transparent plastic - so you can see the piece of meat you're buying. To view the cut, how much fat is on it, how large a piece of meat it really is, how fresh it is - in short, the value of the meat. If you know what good meat looks like, you've seen people that have no clue as to what to look for choosing crummy meat that you've just rejected. It happens most of the times when I'm at the meat counter, as a matter of fact. It's why the grocery stores keep putting out bad cuts of bad meat. Somebody who doesn't know any better will buy it.

The same thing happens in real estate. I have dealt with people who bought into just about every bad situation imaginable - and now they're trying to unload the results of that onto someone else at a premium price. When I list a property, it's even my job to help them do so. But a significant percentage wouldn't even be selling if they had made the right choice in the first place!

The point I'm trying to make is this: Because the ability to find and recognize a bargain is a valuable skill, if you want it, you're going to pay for it. You can either pay me consultant rates by the hour, or you can pay me by doing the transaction with me. In either case, you're going to sign a contract that spells out exactly what that pay is. If you want bargains I've already found, those are valuable also. I can use the basic information as a lure to attract other people willing to work with me. If you buy it and you are not my client, the simple physical reality is that it's not available for people who are my clients. You got the benefit of my expertise without paying for it - and those who are willing to pay for it didn't. Contrary to something I read by a listing agent the other day, I have no responsibility to market the property - I haven't accepted agency, sub-agency, or anything else. When I'm acting as a buyer's agent, I have no obligation to any owner to sell their property. And until some prospective buyers sign my agency contract, I have no responsibility to them as far as locating and evaluating property. So if they're not going to sign my contract - and a non-exclusive agreement is all either one of us needs - I have no responsibility to give them the benefits of my expertise for free, any more than a lawyer or a computer programmer does.

As a matter of fact, that non-exclusive contract is me betting that I will find something sufficiently above and beyond the market that they want to buy it - because if they don't buy it, the contract says I don't make anything because they don't owe me anything. It's me betting that my expertise will cause them to want to stick with me - because if it doesn't or they don't want to, there's no reason they have to. If that bargain I find isn't a bargain, they can walk away with no obligations. But if it is a bargain, they use me as buyer's agent. The only reason to refuse to sign a non-exclusive agency contract is if you're not willing to work with the agent who brings you the bargain.

And that describes most of those who call or email. When asked to sign my non-exclusive contract, they'll say, "I'm working with someone." To which the answer is, "No, you're not. They're not doing the job. If they were, you wouldn't have come to me. What you are asking for is no different than asking one lawyer to do for free what you're paying another lawyer to do, or asking one computer programmer to do for free what you're paying someone else for. If you didn't think that what I do was somehow valuable to you, you wouldn't have contacted me and we'd both be doing something else right now. So your choice is this: Do you want to stick with someone who isn't doing the job, or do you want to work with someone who will get the job done, and will give you permission to fire him if he doesn't?"

Loyalty has a place. It's perfectly fine to give your Uncle Harry a chance to earn your business. But if Uncle Harry gives you his business card and tells you to call him when you've found the property you want to buy (or a property you may want to buy), he hasn't earned your business. In fact, he's told you he's unworthy of it. That's not an agent. That's a transaction coordinator, which many agents will charge you extra for so that they can go out prospecting and gladhanding for other business while the transaction coordinator does paperwork - the only real work their office does. But full service should be a lot more than a transaction coordinator doing paperwork in the office - and the office should pay for that coordinator out of what they make, not charge you extra for it. In this scenario, what expertise are you really getting? The ability to fill out all the paperwork on a checklist? It is important - but is it worth the thousands of dollars to you? Or is the ability to find you a bargain while discarding properties that aren't bargains what's really worth what a buyer's agent makes?

If you want a bargain on real estate, work with the buyer's agent who finds bargains you want to buy. The principle is the same one that says if you want the ditch Charlie digs, you pay Charlie to dig a ditch, not George. If you want the haircut Jane gives, you go to Jane's shop for her haircut - not down the street to Mary. And if John the mechanic isn't fixing your car correctly, you don't pay John and then ask Dave to do the work for free. You take your car away from John and take it down to Dave, and pay him for the work he does. It doesn't matter that John's mechanic shop has nifty uniforms, a funny advertising campaign, or anything else other than the mechanic who fixes your car so it runs right, which they don't. Dave fixes your car so that it runs right, you pay Dave, and you go back to Dave the next time it breaks down. If the funny advertising campaign is worth giving John some money, that's fine. But you're still going to have to pay Dave to fix your car, and he's going to want you to sign his service contract before he does any real work. The same thing applies to when you want to buy real estate. If Uncle Harry isn't doing the job you need him to do, you fire Uncle Harry and start working with someone else. Don't tell me you want me to find bargains for you but you're working with Uncle Harry. Get Uncle Harry to find you the bargains. If he's not doing that, your choice is really very simple: Suffer with Uncle Harry, or start working with someone who will do the job that he isn't.

When I'm looking to buy professional services, I don't look for the office with the lawyer with the neat ad campaign, computer programmers who act friendliest, or the doctor who talks about how to draw customers into their office. I look for the office who will demonstrate their expertise, keep me there by demonstrating their knowledge of the expertise I need, explain everything I need to know (preferably before I need to know it), advise me as to what my best choices are and the consequences of those choices. I want the office that finds other, better alternatives and offers them to me. That's sanity. That's what's valuable to me.

The same principle applies to real estate. If you want to do the searching yourself, that's fine. Here's your MLS gateway, call me if and when something pops up that you want me to get involved in. But if you want real expertise on the buyer's side of the transaction, that gateway is not what you want and you're going to have to agree to pay the agent who gives it to you. Because it is valuable, and if you didn't think it was valuable, you wouldn't be asking for it. I am not what most people think of as cheap - no good agent is. But I'm a lot less expensive than using a cheap agent. Or a bad one.

Caveat Emptor

Original article here

There is no such thing as the perfect time to buy. The perfect time to buy would mean that you have all kinds of leverage, and can make sellers give you pretty much the deal you want, but prices are nonetheless rising rapidly so that you will have a large amount of equity the first time you need or want to refinance, or if you need to relocate.

These two conditions never go together. If buyers have all the leverage, they are certainly not going to opt for increasing prices. Sellers can gripe and moan about it all they want, but when there is too much inventory prices are going to fall until that that excess is gone. Supply and Demand. In 2003 and 2004, there might have been 4000 residential properties on the market locally at any one time. When I originally wrote this, it was over 22,000 and I've seen it up to 25,000. That meant 18,000 additional sellers were competing for no more than the same number of buyers (fewer by my count). If they don't really want to sell, if they just want to sabotage other sellers by adding to apparent inventory, that's no skin off the buyers' noses. If sellers want to actually sell the property, they've got to compete in order to attract those potential buyers. It's not like buyers just go out there and buy the property whose owner's turn it is to sell. They buy the best property for them at the cheapest price. So sellers can either compete by having a cheaper price, or they can compete by having a better property. Most house bling does not recover the money you spend on it, even in a seller's market, but it might give you the wedge you need to attract a buyer in a buyer's market - provided that your property is no more expensive than the comparables. Most sellers are in denial about this. They've got something a little bit better than the comparables, they want to ask $50,000 more, and then they wonder why their property isn't selling.

If you're looking for a time when property prices are increasing by twenty percent per year, by all means wait. Those conditions are called "seller's markets," because people who are willing to sell can get buyers to do pretty much everything they want, including pay more than the last seller got. Most sellers want to hold when prices are going like that, and buyers are desperate to acquire. High demand, low supply.

Trying to time the market so that you buy at exactly the moment when it hits bottom is an exercise in futility. Trying to "Time the market," whether stocks, bonds, or real estate, is a recipe for disaster. It's great if it happens, but it's sheer luck, and anyone who tells you different is lying. By the time people realize that prices are really going up again, buyers will come out of the woodwork and we'll be in a seller's market again.

Buyer's markets, where sellers outnumber buyers, do not last long, in large part due to the fact that once everyone figures out that prices are no longer declining, now everybody suddenly wants to buy. Inventory has usually been shrinking for quite some time before that happens.

Buy while the ratio of sellers to buyers is in the thirties, while you can pick and choose your properties, and if one seller won't play ball, the one down the street who's a little more desperate will. If you need some special consideration, like a seller carryback of part of the purchase price, you can find sellers who will be willing to cooperate because that's the only way they will get the property sold. If you wait until the market heats up and there are only five sellers per buyer, they're a lot more likely to tell you to take a hike with special requests like that. If I want cash, why should I loan it to someone with poor credit money at a below market rate if it's likely that I'll find another buyer in a week?

The time of year may not be optimum. Other things being equal, Christmas season is always the best time of year to shop for a property, because nobody wants to move the Christmas tree. Most people have enough extra stuff going on at Christmas that they don't want to add another major item: buying or selling their home. Those sellers who have their property on the market need to sell. Spring is the best time for sellers, right when things start to warm up (so the very best seller season happens earlier in San Diego than I understand it does in Minneapolis)

Finally, there is one more factor: The Mortgage Loan Market Controls the Real Estate Market. When lenders are being picky about what circumstances they will loan money in, and incredibly picky about the loans they actually fund, the people who can actually qualify under those standards can drive a harder bargain than when the standards are 'fog a mirror slightly' and therefore everyone qualifies. This means that if you're one of those folks whom the lenders will fund, or who doesn't need a loan, you'll be able to pick up wonderful bargains when loan standards are tight.

Caveat Emptor

Original here

I refinanced my house and an existing lien was not discovered

Now the important question: Is it a valid lien, or has it really been paid, and just not released of record? If it has been paid, you don't owe money simply because the lien release on your property was not properly recorded. If you can prove it was paid off, either by yourself or a previous owner, you're out of the woods.

Since you are asking the question, however, I'm going to assume that it is a valid lien. Most are. You owe the money. It doesn't magically go away simply because the title company (or lawyer doing the title search) missed it.

Now, assuming you live in a title insurance state, it should make no difference to the state of your mortgage. You bought a lender's policy of title insurance as part of your transaction, and the title policy insures the lender from loss due to the extra lien.

You still owe the money, of course. Like any other bill, just because you neglected to pay it off or neglected to pay it on time does not mean you somehow don't owe the money. If it was in effect from before you bought the property, though, your owners policy of title insurance should kick in and pay it off. That's the way title insurance works - they tell you about known issues with your title, and then they insure (almost) everything else. They'll then go after the previous owner, of course. That's what subrogation is all about. They stepped in and paid to keep you from getting damaged, but they now assume the right to receive the money from the person who damaged you. If you live in an attorney title search state, my understanding is that you are going to have to sue the attorney involved, but suing attorneys is a tough proposition, and you can't recover the base lien, only increased damages resulting from that attorney's negligence. If the previous owner was really responsible for it, the title insurer is going to have to run them down and file a lawsuit, and quite often the previous owner has no assets that they can get at.

If the lien was your doing, as most are, you're going to have to start making an effort to pay that lien. How much of an effort depends upon whether you have a lender's policy of title insurance. If you do, it's really no huge deal, because the lender has access to the checkbook of a national megacorporation. If you don't, the lender can potentially force you to pay it in cash right now. They can also force you to refinance by calling your loan, or to take out a second mortgage to pay the lien off in many cases. It's possible they might just pay it and tack it on to your balance, usually boosting your payment in the process. Talk to a real estate lawyer in your state for details, but the lender is not generally going to leave an uncovered lien in place, when the pricing they gave you for that loan was predicated upon there not being such a lien. Since the lien predates their loan, it's almost certainly senior to it, by which I mean that if something happens and you have to sell the property to pay off the liens, it gets paid before your mortgage. The lender is not usually going to tolerate that.

Now suppose that you got a thirty year fixed rate loan at 3%, and suppose rates have gone up to seven and a half percent by the time you rediscover the lien. The lender can do better with that money from your loan, and so they are going to want to seize upon any excuse to make you pay it off. This, all by itself, is a really good reason to be careful with your liens.

If you intentionally hid the lien, the lender may even sue for fraud in many jurisdictions. If you intentionally hid it, for instance, it's quite likely that your policy of title insurance won't cover you or the lender, and the lender is going to be very unhappy about that.

Most people, however, don't intentionally hide a lien, they just forgot it was there, and when the title search comes up empty any worries in the back of their mind went away. If they even think about it, they mentally write it off. "Oh, I must have forgotten that I paid it." You still owe the money, and now that it's discovered, you're going to have to start paying on it, but if they've got lender's title insurance the lender shouldn't freak.

Missing liens is actually fairly rare, but once title insurers miss them, they usually will not be caught on subsequent title searches, because the title company will use the previous title search as a starting point (around here, they actually call them "starters", but I don't know how widespread the practice is) for their new title search. Sometimes they do catch them, and ask the previous title company for an indemnity (which basically says that the previous title company is still liable for having missed it).

Caveat Emptor

Original here

The overview is simple: The government has made it take slightly more effort to lie to consumers, while adding layers of delays that add an absolute minimum of a week - an average of three weeks - to the time it takes to do a loan. Meanwhile, lenders have changed the market in ways to hinder competition and make it tougher for the savvy consumer to find the real best deal.

In short, while a complete chump might be happy that the con artists have to work a little harder while ripping them off, the consumer who makes the effort of understanding what is going on has far less ability to ensure a positive result.

First the good news: the change for the better is the new government forms. It's been several years now since The new HUD 1 and Good Faith Estimate were approved, and they are more intuitive and easier for laypeople to understand than the old forms. There is also new verbiage on the forms that tells people that just because they applied for this loan in no way obligates them to actually complete it. That's also good

In exchange for that much good news, there is a litany of things that are worse. Let's start with the small stuff and build up to the most important.

First off, the Home Valuation Code Of Conduct (HVCC). Precisely how the Attorney General of one state used state funds to shake down Fannie Mae and Freddie Mac, provide cushy jobs for his political cronies and allies, and gain personal control over the way business is conducted in all fifty states should certainly be a subject for public scrutiny, but I'm mostly concerned with the impact upon the consumer. In exchange for allegedly freeing appraisers from "interference" by real estate agents and loan officers who want them to hit a specific number, consumers are now paying higher costs for appraisals, appraisers are getting less money for those same appraisals, an entire level of bureaucracy and political patronage has been created with control over the entire appraisal process. For our part, loan officers and real estate agents no longer have the ability to stop using a particular appraiser, no matter how terrible we know them to be - it's whomever the appraisal management company picks (i.e. the low bidder). As a loan officer, I am not allowed to so much as communicate with the appraiser except through an intermediary. And if they've chosen a really horrible comparable that unduly influences value in either direction, most of the appraisal management companies make it difficult or impossible to process that information into modifying the appraisal. I personally had an appraiser kill what should have been a perfectly good loan by choosing two trashed lender-owned properties as the prime comparables to a well maintained family home that was in a better location than either - and I couldn't choose another appraisal, another appraisal management company, or anything else. I had to tell the client I was real sorry about the money he wasted on the appraisal, but that was the limit of what I could do. Yeah, I could offer to pay for appraisals - by jacking my margin on loans enough to pay for the ones that don't work out. Lots of companies do that, with an added margin for themselves, of course - he who takes the risk always gets a reward, and when they set the terms they are going to set ones that result in a higher profit to them. But that's not the way I choose to do business. HVCC may eventually be repealed due to the problems with it being so blatant that they cannot be ignored. But it is a comparatively small issue in terms of real difference to consumers.

Yes, the others are more important than wasting several hundred dollars on a loan that now can't be done because the appraisal job was given to a bozo, despite whatever the loan officer may have wished. Oh, and it also delays the loan because I have to go through one Appraisal Management Company, and it takes as long as whomever they choose takes. Read on.

The elimination of stated income loans is not without its benefits. It was horribly abused, and those abuses are now a thing of the past. However, if you're a small business person or someone with a large amount in legitimate deductions, it means you may have to forego a lot of legitimate deductions on your income taxes in order to qualify for a loan, making it much more expensive to those consumers the stated income program was designed for. Especially if you bought the home you can really afford as opposed to the one your taxes say you can and you've got an adjustable loan. This elimination can, has and will continue to cost a noteworthy number of individuals who really could afford it their homes. It will continue to cost individuals who leave employment and go into business for themselves. It would have been better targeted by limiting it to people who are in the economic classes it was intended to serve. The cost of doing it the wrong but easy way isn't huge on a per capita scale, but it's highly concentrated in those consumers who are our best sources of economic growth.

The next issue hits everyone who applies for a loan. It lies with MDIA, an act put into place by Congress in 2009. It is allegedly to help the consumer by forcing the mortgage provider - broker or banker - to provide accurate information on their Good Faith Estimate and Truth In Lending forms. I say allegedly because that's not how it works in practice. I can't speak for their intent, but I can tell you what happens in practice. First, the mortgage provider tells the consumer whatever lie it takes to get the consumer to sign up, same as it has always been. Then, a week before final closing but too late for the consumer to actually get another loan that will fund in time for their purchase, they have to tell the consumer something resembling the truth. Even if it's only a refinance, the consumer has sunk the money into the loan for the appraisal and there is all the time and effort they spent getting the loan to that point, meaning that they are still unlikely to go look for another loan. Real difference to the consumer: not much. Difference to the unethical loan officer: They have to do one extra Good Faith estimate and Truth in Lending in order to get the money that results from telling the lie. Forms that their computers are perfectly capable of spitting out. In practice, the amount of disincentive for lenders to lie about their loan to get people to sign up is zero.

(oh, I'm sorry, I meant "forget to tell the consumer about all the fees they'll be paying". Not really. These loan officers know about every fee that's going to get paid. If they don't, I sure wouldn't do business with them)

Furthermore, this delays the loan. I just closed a loan where everything I put down on California's version of the Good Faith Estimate, the Mortgage Loan Disclosure Statement was exactly the same from day 1 to the day we were ready to close - and I moved heaven and earth and gave up $1000 plus just so we could close it and get on with our lives - only to find that the lender I had placed the loan with calculated the APR by a different way - not compliant with Regulation Z which governs such - simply to cover their backsides and force redisclosure. This forced a re-disclosure and a minimum waiting period of seven days just to get this loan about which absolutely nothing had changed from day one closed. Extensions of rate locks cost money - this one cost two tenths of a point, which the consumer ended up paying because the government wanted to "protect" them from the "Nasty Rapacious Loan Officer" who told them the truth in the first place. But the penalties on the lenders are enough that they want to force this re-disclosure, delaying the loan, even when the consumer has been told the exact truth in the first place. After all, it doesn't cost that lender any money to force the redisclosure and waiting period.

The complexity of underwriting standards has skyrocketed. Can't force anyone to make a loan, or dictate conditions under which it is made. Nonetheless, it seems every week there are more baroque little curlicues to the loan process trying to reassure nervous investors. Every one of these means trouble for some people, and at this point it's well-qualified people. All the government can and should do is what it has: provide an alternative in the form of FHA loans. They're intended for first time buyers, but you don't have to be a first time buyer to take advantage. If someone can't qualify conventional but can qualify FHA, they will pay the extra cost. Unfortunately, the lenders are adding their own little curlicues to FHA loans in order to short circuit this natural process - and it's not like FHA loans aren't baroque enough already.

This segues into the elimination of everything that isn't straight A paper vanilla loans or government insured loans. Actually, conforming A paper loans are essentially government insured now that the government owns Fannie and Freddie. But subprime is gone, Alt A is gone, and A minus is essentially gone. Fannie and Freddie have eliminated all but the first tier of their expanded approval programs for people who almost but don't quite fit their ideal models of who qualifies. I personally haven't had an expanded approval loan since but I understand they're not funding in the real world. The impression I get is very strongly "We don't want to do these any more, but we have to leave the possibility open as a political fig leaf. Good luck getting us to actually fund one."

This has implications for home ownership and home retention. Bad things happen to good people. Identity theft, illness, job loss, business failure. All of these now have a much higher probability of costing you your ability to buy a property, and of costing you the ability to retain that property for years after you work your way through the main problem. I really like hybrid ARMs and have done them for myself for a long time, but the probability of having something happen which completely sabotages any ability to refinance has become unacceptably high, in my opinion. You can save a lot of dough by using hybrid ARMs, but what happens if you can't refinance at all before the fixed period ends? Net result: consumers who would have been comfortable and saved money with hybrid ARMs are now forced to reconsider and choose fixed rate loans at higher rates of interest. Net result: higher costs to consumers and more income to lenders and investors.

All this increased complexity adds to the time it takes to do loans. When I started this website I could reliably get a purchase money loan funded in about two and a half weeks, and a refinance done in under 30 days (Right of Rescission basically adds a week to the time it takes to get refinances done). Until and unless things change, the thirty day escrow for purchases is history and the 45 day escrow is becoming increasingly difficult. Add a week to that time for refinances. I know loan officers who won't accept less than a sixty day escrow for purchases any more. This extra time costs consumers money, especially if they are buying or selling a property. If you're just refinancing, your living situation really isn't going to change - but if you need to move, the extended escrow period makes things more unsettled and more costly. If you don't believe me, you haven't bought or sold property recently.

All of these pale in comparison to something that has drawn precisely zero scrutiny from outside the mortgage industry: lenders are now charging brokers for loans that are locked and not delivered. It's not a figure in dollars charged immediately - it's a differential in the form of higher costs to get the same rate that the brokers and all of their future clients have to pay. The practical upshot to this is that those brokers who were working in favor of consumers can no longer lock the rate and cost upon application for the loan, which means they can no longer stand behind what they tell you when you sign up for the loan with a Loan Quote Guarantee. Lenders rationalize this by saying the failure to deliver on the lock costs them money, and it does - but they don't charge their own "in house" loan officers this differential.

The effect is to limit competition and make brokers unable to guarantee their quotes. Good luck getting that sort of guarantee from a traditional lender. It also makes it impossible for consumers to get a backup loan in case they have been lied to. Because I can't lock my loan until we're actually sure it's going to close, I certainly can't guarantee to beat the other guy when it comes to the final push - and if the rate cost tradeoff declines, a quote that's pure nonsense today may become realistic. On the flip side, a quote that's conservative today may become impossible if that rate/cost tradeoff goes up. Guess what? Each one of these events happens about fifty percent of the time. So another practical upshot is that there's no way to really know what's going to be delivered at closing unless we can lock the loan. Under these circumstances, people tend to take flight to the big comfortable names with lots of advertising, not the small broker doing the right thing with no overhead who really can deliver a better loan. Cost to consumers: High, as in multiple thousands of dollars. If lenders could and would really compete with brokers on price, there would have been no economic niche for brokers in the first place.

One by one, changes in the lending environment has demolished the usefulness of pretty much all of the concrete "do this, not that. Require this from your loan provider" type help that I have been trying to disseminate since day one on this website. The softer, contextual stuff still stands well, but the concrete step-by-step instructions, not so much. The practical upshot is that while the situation for the complete babes in the woods applying for a loan has improved slightly, the ability of the well-informed consumer to influence the lending process for a positive result has been severely eroded. Now more than ever, it comes down to the individual loan officer and their intentions. I'm not happy about it, but that's the business as it is today. I can adapt or I can get out of the business, and it's not like me getting out of the business would change things for the better.

Caveat Emptor

Original article here

People who talk about learning skills tend to discuss a model for learning called the conscious competence learning model.

It starts with unconscious incompetence. You not only don't know how to do something, you don't realize that it is a skill that requires learning. "Anyone can do that", people at this stage of learning will think, despite the fact that they never have. They have, in fact, no basis for comparison. A very few things are as simple as tripping over your own feet, but most aren't.

The next stage is the conscious incompetent. You still don't know how to do whatever it is, but at least you know that you don't know how. Maybe you've tried and fallen flat upon your face, maybe it's something that you instinctively know is beyond your training or ability. Back when I worked for the FAA and people would find out what I did for a living, it's was amusing to see how many people would immediately volunteer that they couldn't have done my job. For some reason, I don't get that now, despite the fact that the skills of being a good real estate agent are at least as difficult to acquire.

The next stage up the ladder is the conscious competent. Some preparation, supervision, a few botched tries, and then you do it right without anyone having to step in. But you've got to think - really pay attention, take your time and be careful about what you're doing.

The final stage is unconscious competence, where the skill becomes second nature. You're good at whatever it is. Most people over the age of two are at this stage as far as the skill of walking is concerned. They do it without considering how to move the muscles that make the legs and hips move. They walk whatever distance they need to without even paying attention. And here's an important point: Sometimes by not paying attention, people step on something or trip over something and get seriously hurt. They walk in front of a semi, or trip over the coffee table and fall through a window or just step on an oily patch that causes their feet to go out from under them and hit the back of their skull on the pavement.

It is my contention that nobody is up to unconscious competence when it comes to real estate.

In fact, if you think you've achieved unconscious competence at most of the core skills of real estate, you're almost certainly stuck on the first level - somebody who doesn't know what they don't know.

First off, real estate isn't one skill. It's at least half a dozen. The average client doesn't care about how good we are at attracting other clients. They care if we interact with them incorrectly, but I have yet to hear of a prospective client saying, "I want to sign up with someone who's great at prospecting for leads." They'll say things that amount to the same thing, like "I want to work with a top producer," or "I want to work with (insert heavily advertised brand here)" but there's a real difference of intent on the part of the consumer. They really don't care about lead prospecting competence per se. Yet this is probably the most discussed skill set on real estate websites. I don't understand why other agents think this is fascinating to clients, but by how often they talk about it, they evidently do. Maybe because it's one of the big focal points for every office - if you don't attract enough business, you're not going to be in the business. Nonetheless, clients don't really care about this one. You could be the worst prospector in the business, but somehow get enough clients to stay in business, and as long as you're good at everything else, the clients are going to be happy.

Then there are the interpersonal skills that most people have in fact developed by the time they're adults. Hello, how are you? Nice day, and so on from there until we get to the pinnacle of those skills, handling people so well that they never realize they've been handled. People care about this, and they know they care. Don't believe me? Whatever you do for a living, try calling your next prospect something nasty. You can't do real estate without these skills, but not only are they not the central job function for real estate licensees, but clients actually do not want somebody who is obviously too good at this. Why? They like the basic skills, but they don't like being played by sales persons, something that's happened to basically everyone by the time they're ready to buy real estate or get a loan. Nonetheless, many people choose agents and loan officers based upon feeling "a connection." *Buzz*. Wrong answer, thank you for playing. If a prospective agent isn't competent at the interpersonal dance, that's one thing. But 95% of all agents are quite good at it, and it doesn't mean a darned thing about their competence at real estate. Anybody with any competence at interpersonal skills can talk a good game in the office. They could be ready to crack that license prep course any day - not actually know a thing about real estate yet - and still manage to generate "a connection."

Then there's the paperwork and legal CYA stuff. I could name names of nationwide real estate firms that take months to cover these skills with new licensees, and brag about their training based upon that. The obvious snark that occurs to me every time I see one of their advertisements is, "How is being able to avoid legal judgments when you've hosed your client a virtue in the client's eyes?" In other words, it blows my mind that they actually brag about it to clients - and it also blows my mind that some people will actually choose them based upon advertising that essentially says, "We're good at the paperwork that allows us to not get sued for hosing our clients".

To be fair, paperwork is a real and necessary part of the career skills, but I'd like to see more emphasis upon actually doing a good job for the client, not disclosing everything in small print, hidden among 500 other sheets of paper at final document signing. There is stuff here that you're going to see on every transaction, or almost every transaction, but pretty much every real estate transaction is going to have something going on that is different from some hypothetical "typical" transaction, and if you aren't thinking about what you're doing, it's very likely you'll miss something important. Even if you are thinking carefully, you might miss something. People successfully sue agents every day, and the defendants are not all incompetent. Paperwork isn't a skill that gets clients a better bargain very often, and perfect paperwork doesn't mean the client didn't buy a vampire property or money pit, that they got a good bargain even if they didn't buy a vampire, that they sold for a good price in a timely fashion, or anything else except that the paperwork is perfect. The paperwork will usually tell them if they are careful enough and understand enough to read between the lines, but "careful enough" can be "reading documents for forty-six hours straight at final signing," and even then, it's pointless unless they've got the willpower to say "no" to the transaction at the last moment like that. Nonetheless, bad paperwork is what the attorneys of former clients find easiest to pin on real estate agents, and almost every judgment against an agent has "bad paperwork" behind it as the evidence. Paperwork is a necessary skill for agents, but it it's only evidence of a good or bad job - it isn't the good job or bad job itself.

Negotiation is a critical skill for agents, and many do actually study it. But for every agent I encounter who understands principles of negotiation, another is completely clueless and a third thinks negotiation is where you tell the other side everything about how the transaction is going to be. You should see some of the contracts my buyer clients were told to sign - take it or leave it - in the middle of the strongest buyer's market of the last generation. And these folks wonder why the property didn't sell. Actually, I'll bet that if you work with buyers, you wouldn't be surprised. I just randomly pulled up twenty listings in the zip code my office is in - and all but two had violations of RESPA right in the listing. Bare, baldfaced violations of RESPA - steering is illegal, no matter the form it takes. It's not only setting you up for a lawsuit, it's setting your client up for a lawsuit. If DRE wanted to put at least half the agents and brokerages in California out of business over steering, I think it would be pretty trivial. But I digress - I'm trying to talk about negotiation.

Everything about the transaction is negotiable, and refusing to negotiate anything can be grounds for losing an excellent offer. Price is not an independent variable, and it's not the most important of a series of completely independent points. It may be the central issue of a negotiation, but it influences everything else about the negotiation, and is in turn influenced by all those other factors. What does each side need, what do they want, what would they settle for, and what are they willing to give up in order to get it? If the answer to this last question is "nothing," then they must not want it very badly! There are many factors other than money, but they all inter-relate, and the person who can figure out something the other side wants that isn't money can use that to make both sides happier. Negotiation isn't just faxing offers back and forth, and in the context of real estate, it's a skill that takes a significant amount of practice as well as study to maintain. Furthermore, more than any other skill involved in real estate, negotiation never gets to be so strong a skill that you can do a good job without thinking about it. For one thing, on the other side of that negotiation is another agent who does the same thing. I always presume the other side is better at it than I am to start with. Evidence quite often proves this presumption to be nonsense, but you don't hose your client in negotiations by paying attention and being careful. Nor is there any metric for negotiation skills except how good the deal you get one particular client is, and since every property is unique, often the client has no real idea whether you should be nominated for negotiator of the year or pilloried for incompetence. I haven't heard of anybody being sued for poor or non-existent negotiation skills. I have heard of buyer's agents getting beat up by their brokers for doing too good of a job - lowering the commission.

The next skill is property evaluation. This is more important to buyer's agents than listing agents, but listing agents can benefit by knowing it as well. It breaks into several skill facets, each of which is a skill that requires instruction and practice. The most important facet of this is the ability to spot defects that are going to cost the client money - actual structural problems. Ask yourself: Is the fact that the agent tells you they're not an inspector going to make you feel better about buying a property where the roof caves in three weeks later? Is that going to absolve the agent of blame in your mind? Don't expect your agent to note everything that a contractor or inspector or engineer will - but they should tell you about everything they see, and they should see most of it, and it should come as part of a full service package, so you don't have to spend $300 getting an inspector out, or $600 for an engineer, not to mention put a deposit into escrow where you may not get it back for quite some time if the seller wants to be obstinate. This is a critical job skill - but you would be amazed at the number of highly agents whose advertising tells the world about how much real estate they sell who might as well be wearing a blindfold. Telling clients about defects makes it harder to really churn those numbers!

Furthermore, without a good agent who will tell you this stuff, you might have to do this multiple times. Instead, with a good agent you know about the problem before you consider putting an offer in - and instead of a costly drama that eats your life, you walk away unscathed and find another property that actually suits you. On the day I originally wrote this, I had persuaded a client to cross four properties off their list, all of which would have sent him through that cycle. Decorator's eye is another facet of this - helping the client stage a property - or helping buyers see the potential of a property despite poor staging. Poor staging wouldn't make nearly the difference it does if most agents weren't lacking in this truly important skill.

Rehabber's eye is related, yet a distinct sub-skill - helping the client see the property with a few changes, usually not very expensive ones. Location evaluation: How does the location of the property fit with the client's agenda? Schools, traffic, shopping, environmental noise and other factors. Sometimes, the client doesn't know their own agenda, as I have discovered upon many occasions. All of these are part of the core job function, all are skills that must be developed and practiced if you want them. They are also critical to how happy a client is going to be with an agent's work - particularly if you're working as a buyer's agent, as I usually am. But it seems that this whole group of critical skills gets neglected in favor of "Which property has one feature that makes Mrs. Client swoon with delight?" This approach is conceptually similar to "throw enough mud at the wall and eventually some will stick." Out of sheer frustration if nothing else. But I have yet to see a single brokerage train their clients for any of this entire group of skills. Indeed, most of the major chains seem to be doing their best to pretend these are not part of an agent's function. Here's the thing: I can get people to buy and sell properties without these skills, and never get sued successfully over them. But then it's completely hit or miss as to whether the client will really be happy with the property - and who do you think is going to get the blame if they're not? I had some clients insist upon buying property on the corner of two moderately busy streets last year - and I made certain to remind them of the traffic and noise throughout the transaction - giving them encouragement to change their mind if they weren't certain they were going to be happy with it. But I'll bet you a nickel they call me when it's time to sell it because these opportunities to change their mind also generated a real buy-in to the situation for them.

Marketing skill is more critical for listing agents, but buyer's agents need to know marketing as well. How do you get the attention of someone who will want to buy this property? How do you persuade them it's worth making an offer on? What are the available venues, and what actually works? Theory says that there is one buyer out there who will pay more for the property than anyone else - how do you get their attention or that of someone close to them? Get them to come look, get them to see value, get them to make an offer you're happy to accept, get them to carry through on the purchase? On the buyer's side, you've got to be able to counter the fecal matter - and I can count on the fingers of one hand all the properties I've been in the last year where I didn't find some obvious fecal matter in the way it was represented, or the things that the listing agent said in order to get it sold. (FYI: This fecal matter has an ugly habit of biting the disseminators later on.)

Did you think I was leaving market knowledge out? Here it is. How does the property compare to everything else around it? What's the general market for real estate like in the area? What else has sold lately, for how much, and what was it really like? It's too late now to get a viewing of all the comparables that sold within the last few months - the lock box is gone, the new owners have moved in, they're done with all that transactional nonsense, and the vast majority sure as heck aren't going to let random strangers poke around their new house. How many agents get off their backside, get into their car, go out and look, take notes, and remember? Most of the agents I've done business with never leave the office except for an actual showing generated by clients driving around, or surfing the internet, or even reading the "for sale" ads.

Showing clients only those properties they have asked to see is so backwards I have difficulty articulating precisely how messed up it is. A good agent knows the market, knows the comparables for sale, and knows how a given property compares. They might not have been in every single one, but they've been in enough for a good comparison. Patronizing an agent who hasn't done this, who doesn't make a habit of this, is like having half an agent - at most. How in the nine billion names of god are you going to help a client price a listing properly if you haven't looked at the competition? How in the name of ultimate evil are you going to know a property is or isn't worth making an offer on, and for how much? Yet people will do put up with this nonsense because they don't know any better. This is probably the agent skill that needs the most practice of all, and decays the most quickly if not practiced. There's this one neighborhood about three miles from my office that I haven't been into for almost three months, and I'm terrified I'm going to get a call for it before I can remedy the situation. There's nothing wrong with clients suggesting properties, and I firmly believe that no matter how messed up the property is, they should be given the opportunity to see any property that catches their eye - but doing that and only that takes zero advantage of the one thing good agents have that bad agents and 99.999% of the general public don't - precisely this expertise. It is this expertise that makes more difference than any other skill set in results for clients - whether selling or buying. You can't recognize either a bargain or the opposite without the context to put it in. You can't price a property right without knowing the competing properties and their relative strengths and weaknesses. But all too many people, both agents and general public, discount this difficult to acquire skill, thinking, "Anybody can do that!" Question: Which of the learning categories above does this place them into?

I don't know how many people I've met that seem proud to be stuck in unconscious incompetence. But just because you don't recognize the skill doesn't mean it doesn't exist, it doesn't mean that its lack won't bite you, and it most assuredly does not mean that its presence in others won't hurt you. For real estate transactions, to the tune of thousands of dollars at a minimum. Knowledge springs, not from the mental impenetrability of "Anyone can do that!", but rather from the admission that perhaps you might have something to learn.

Caveat Emptor

Original article here

I enjoy your blog very much and figured you would be a good person to ask this prepayment penalty question to.

Is there a prepayment penalty if you dont pay down the whole amount? For
instance, say I owe 620k and want to refinance this. Can I get a loan for
say 610k from another lender and leave 10k with the orignal lender?

Does that avoid the prepay penalty?


Have to admire the ingenuity, but it won't work. Here's why:

First, the penalty is triggered by paying a certain amount extra. There are two main trigger points for a prepayment penalty, usually known as "first dollar" and "twenty percent." "First dollar" prepayment penalties are uncommon, but they do exist. What such a penalty means is that if you pay one extra dollar of principal during the time the penalty is in effect, you will get hit for the penalty - usually six months interest on the prepaid amount. Not so bad if you pay an extra dollar and get hit with a three cent penalty, but you have to pay a substantial amount to get any noticeable good out of it. You pay $1000 extra, and that's $30 they're going to hit you with on a 6% loan. Pay off $100,000 at 6%, and they're going to have their hands out for $3000 extra.

The other trigger point, "twenty percent" lets you pay down the balance by up to twenty percent for any given year without triggering the penalty. Note that this includes not only any extra you pay, but normal amortization as well. If you have a $100,000 balance, and would normally pay $3000 down through regular amortizationduring the year, this leaves you with "only" $17,000 of extra that you can pay before the penalty starts hitting you. Most often for this type of trigger, the prepayment penalty will only be assessed on any amount over 20% of the balance, but I have seen these charge the full penalty once triggered. So paying off $20,001 of a $100,000 balance at 6% might, depending upon your loan contract, cause a $600.03 penalty to be assessed - but most often it will only be that three cents. In this case, paying off the loan in full would only cause the penalty to be assessed on $80,000 - $2400 instead of $3000. It's also something to be cognizant of that this 20% paydown applies to the balance as of the start of the loan year, which runs from contract anniversary to anniversary. Say you have such a penalty in effect for three years. The first year you only pay it down to $80,000, escaping the penalty. The second year, you can only pay it down to $64,000 - by 20% of the beginning amount for the year - before triggering the penalty. If you do so, in year three you can only pay it down as far as $51,200 without triggering that penalty. This type of trigger is used when the lender is mostly worried about a complete refinance or selling the property. (A "soft" prepay is one where the penalty is not due if you actually sell the property, but most loans with prepayment penalties have "hard" penalties that are assessed at a certain trigger level, no matter the reason.)

No matter whether your penalty trigger is "first dollar" or "twenty percent" though, you're not going to refinance without paying it off completely. Here's why: In order for the new loan to be first in line, the old loan has to be paid off completely. The rates and prices on home loans that we all see advertisements and such for are predicated upon them being first trust deeds. They can only do this by paying off the previous loan in full and having a Reconveyance of the Deed of Trust recorded. Not paying the old loan off completely means no Reconveyance, which in turn means no new loan because their Deed of Trust will not be first in line. You'd have to content yourself with the higher prices for a loan priced as a second trust deed.

There are only four ways to avoid a prepayment penalty that I'm aware of. 1) Don't accept one in the first place, 2) Don't sell or refinance until it expires if you do accept one, 3) Convince a court the lender has done you sufficient dirt for the court to order part of the contract voided (this takes a lot of dirt), or 4) Swap your old penalty period for a brand new one by refinancing with the same lender, if they will allow it (They don't have to).

Caveat Emptor

Original article here

One of the things I keep telling folks about the real estate market, whatever area you live in, is that it is controlled by the loan market. If you want to understand where real estate in general is headed, look at the loan market and the financial markets that generate them.

When I wrote this, the loan markets were in terminal panic mode. The lenders were looking for any restrictions they could slap on around the edges to mollify investors, and investors were shying away from any loan that had any element of risk. All non-governmentally guaranteed loans for more than 95% of value had disappeared, and the ones above 90% of value were very difficult to find and even more difficult to fund. This meant that VA loans and FHA loans were all that was left above 95% loan to value ratio, and stated income loans were dead, no matter how much sense they made for your situation, as nobody would fund them. Fannie and Freddie drastically curtailed their A minus programs (all but the first level of their expanded approval eliminated, and they don't want to actually fund even those). Outside of government loans, you've pretty much got to be A paper full documentation to get a loan at all.

This eliminates pretty much every type of loan that was a major player in the market when things were hot. It also severely restricts the numbers of new buyer in a position to buy. Since 100% Loan to Value ratio financing had been the almost universal financing vehicle for borrowers for the previous several years, this constricts the ability of prospective buyers to get the loans they need. Comparatively few people have money they could use for a down payment if they wanted to. Not everybody qualifies VA or FHA. VA requires military service, and FHA has policy limits on what they will fund.

Furthermore, all of the other loan programs to get 100% loan financing have gone away, and all of the supplemental programs to extend buyers' ability to qualify have rather sharp income limits, and those income limits are not going up at all. They actually effect San Diego less than most areas, but even here, they constrict the ability of buyers to qualify. Both the mortgage credit certificateand all of the municipal first time buyers programs have income limits that mean people can't make over a certain amount of income - and even if they have no other bills they can't qualify for the loan on property over a certain loan amount, because even if they have no other bills, their debt to income ratio will be too high from just the payment and taxes and insurance on the property. You can't cheat on this - all of these programs require full documentation of income. Above about $420,000, even if they conforming limit goes up, even if the prospective buyers make the maximum amount per year for the program and have no other bills, the people these programs are aimed at won't qualify because the debt to income ratio will be too high.

The moral of this story is simple: If you want to sell your property above a given price, you're not competing for first time buyers. You are competing for people who have sold (or are about to sell) their property for a profit and are now ready to move up. If the prospective buyers don't qualify for the necessary loan based upon debt to income ratio, they can't buy.

Any time you raise the price you want to sell by a certain amount, there are people that no longer qualify to buy your property. You have priced them out, and no matter how much they might want to buy your property, the fact remains that they cannot.

As for buyers making the median family income in San Diego of $81,800, their limit on loans is about $290,000. So unless they have a significant down payment, a family making $6000 per month is looking at a condominium. Just a cold hard fact.

There will always be buyers around the edges who are exceptions. People who have saved or inherited a substantial down payment in defiance of demographic trends. But those are the exceptions, and for every one of them, you have a dozen of more unqualified buyers engaged in wishful thinking. In the last year or so, I have spend a lot of time looking for loans unsuccessfully trying to get people into sustainable situations and save their property from foreclosure. At this point, until the lenders and investors calm down from their institutionalized panic, those loan programs aren't going to exist. Even having lots of equity may not help you unless you can afford a hard money loan.

Before you ask me what relevance this has to buying and selling, I'm going to answer: Every time a lending program goes away, there go some buyers who otherwise could have qualified. Right now, there is no stated income. Doesn't bother me much, as 95% or more of my clients have always been full doc, but for those who are used to the opposite ratio, it's the apocalypse. Ditto for sellers and listing agents who don't understand what it takes to qualify, and who price their properties as if the loan market for several years ago was still going gangbusters. When the property sits for months because the people who might buy can't qualify for that big of a loan, that's a problem.

With all this said, the people who do have the cash or the ability to qualify for a loan are in the driver's seat now. You may be getting tired of hearing this from me, but veterans can qualify for more loan than someone without military service for the same income due to the lack of mortgage insurance requirements. People with a large down payment are in an even stronger situation, and people who have both things going for them have an incredible amount of negotiating leverage. When the loan market will approve anyone who can fog a mirror, your competition is everyone who can fog a mirror. When the loan market wants to see guarantees and cold hard cash going into the property in the form of a down payment, your pool of available buyers is much smaller - and prices are lower because of it.

Caveat Emptor

Original article here

(This was originally published September 29,2005)

Here's another advertisement that I got in the mail:

"Pick a Pay, Any Pay!' The Revolutionary Option ARM!"

"Start rates as low as 1%!"

Loan amount $100,000 Payment $321.64

$200,000 $643.28

$300,000 $964.92

$400,000 $1286.56

Could this help save you money?

Let's see, given the real rate on these, there is negative amortization of about $500 to start with per month on the $300,000 loan, compounded over the three years the pre-payment penalty is in effect. Cost me $19,000 to "save" this money - even if the underlying rate doesn't rise. Not counting what it costs to do the loan. Or I refinance out of it and pay a pre-payment penalty of about $9200.

Doesn't matter the friendly sounding name you give it. An option ARM is a Pick-a-pay is a negative amortization loan.

What this guy (in this case) is hoping is that you'll be so enticed by this "low payment" that you won't ask questions. These are easy loans to sell to people who don't understand them, and impossible to those who do unless you're the person it's really designed for. Indeed, many prospective clients do not want the problems with this loan explained to them. It's like they've chosen to be insulated from reality for a time.

But this is no surgical anaesthetic. Most folks are going to want to be homeowners for the rest of their lives, and unless your income has increased commensurate with your loan balance (and prospective interest rate increases) I guarantee you that the pain will go on for quite a long time after the time of "affordable low payments". I'd rather not shoot myself in the foot in the first place.

More from the ad:

You could also lower your monthly payments. Free yourself from high interest rate credit cards and debts with a loan that could reduce your monthly payments by hundreds of dollars and leave you with enough cash to buy a car, remodel, or pay property taxes. And don't forget that mortgage interest is usually tax deductible. So you could save more at tax time.

This is all true - and only a part of the story. Remember that the easiest way to lie is to tell the truth - just not all of it. What they're selling you is the seductive "cash now - pay later". This was how you probably got into the situation they're talking about. What most people do is then take the money out and spend it, and then when the payments get to be too much, refinance again. What are you going to do when the overall payments get larger (again) next time. What are you going to do when there's no more equity? What are you going to do when you can't afford the payments?

The consolidation refinance can be a real financial lifesaver, if you do it right, have a plan, stick to it, and pay everything off, or at least pay your mortgage down below where it was before you go acquiring more debt. Fiscal responsibility is not what they're selling here.

You've earned a 30-day break from payments!

By rolling it into your mortgage, where you pay points and fees on it and the loan provider gets a bigger commission because of it. There is no such thing as a free lunch! You'll be better off if you stop looking for it. The bank is never going to give you one day that is free from interest, much less thirty. And because you don't make a payment now, you will be paying more later. Probably much more. You Never really skip a payment

You're probably going to see a lot of recurring themes when I do these quasi-fiskings. That's because the lenders and real estate agents and everybody else keeps advertising the same misleading nonsense over and over and over again, they just say it in slightly different ways. As far as I am concerned, anybody who sends out one of these ridiculous things deserves to have their name engraved on my personal blacklist of people I will never do business with. I hope for your sake that you feel the same way.

Caveat Emptor

Original here

You see it all the time at open houses and elsewhere. People who desperately need buyer's agents, but think of Buyer's Agents in the same way they think of automobile sales folk, and that's the complete opposite of the way it is.

They don't want to deal with an agent, because an agent will use high pressure tactics, convince them that this property is the one they want even if there's better stuff out there cheaper, and trick them into signing on the dotted line. Or so they think.

Actually, the person they fear is already part of the transaction. They're called the Listing Agent, and they're the one you're going to deal with regardless of whether you want an agent or not. It is their job to get that property sold. They have a fiduciary responsibility to the owner of that property to get it sold for the best possible price in the shortest amount of time. They only responsibility they have to the buyer is that they're not supposed to lie, mislead, or conceal the truth. Any of those are tough to prove even for egregious violations. If they can sell the property for $100,000 more than neighboring properties in better shape are selling for, they have done nothing else except their job. They have no responsibility to tell you there's a better deal around the corner. To a listing agent, the only importance of a better buy three blocks over is to hope you don't discover it. Despite all of this, many people will insist upon making their offers through the listing agent.

Lest you think I am kidding or in any way exaggerating, consider this: Within five miles of my office are at least 100 Planned Unit Developments (PUDs) built within the last three years. These are legally condominiums, but they have detached walls. Most often, the developer puts up a 1700 to 2000 square foot two story dwelling, separated by maybe six feet from the next dwelling over. In many of these, the first thing most of the inhabitants do every morning is greet their neighbors in the next unit over, then get out of bed. Not that I'm against condos - I'm not - but the townhome I bought in 1991 has more privacy than most of these, and it's got a shared wall. The inhabitants of PUDs usually - not always - have a small quasi-private back yard, and the units may or may not have shared walls. The garage is always within the walls of the unit, because they are packed so tight there is no room for a driveway or outside parking. The developer slapped on false granite counters and travertine floors at a cost of maybe $300 extra, and with their in-house agents who dealt swiftly and efficiently with those who come to look, sold them for $100,000 to $150,000 more than comparable dwellings sitting on 8000 square foot lots and without a homeowner's association (and association dues) to deal with. Those PUDs are not going to be new forever - and as a matter of fact there are a much larger than representative percentage of the new owners trying without much success to sell them. Whether they decided they didn't like their neighbors whom they practically share a master bedroom with, they want a place with a yard where they can build a pool or even just a horseshoe pit, or that they want to paint the place a slightly different shade of off-white (and can't), they are finding out the difficulties, and trying to sell. But they're asking the same kind of prices they bought them for, and without the massive marketing campaign the developer used, it's not working. When you're trying to sell 20 units on what used to be two lots totaling half an acre, you can afford the kind of marketing campaign that pulls in the suckers. At $520,000 each for twenty units that cost you $150,000 each to build, if you spend $100,000 on advertising, you'll make it back in spades. Not so much if you spent that $520,000 buying one of those units and now the market has declined and you need $570,000 to break even - and I'm finding my prospects single family homes on their own 8000 square foot lots for $420,000, where they can spend a lot less than $150,000 putting in travertine if they've got to have it.

A Buyer's Agent is not the person who's out to sell you their property no matter what. That's the Listing Agent's job. A Buyer's Agent is there to represent the buyer's interests, the same as the Listing Agent represents the seller's. Buyer's agents aren't car lot sales folk. They're like the folks who make a good living representing people who don't want to deal with car lot sales folk.

Buyer's Agents don't make their living selling one specific property. They make their living helping people to find and buy the property that is the best bargain for them. It is a Buyer's Agent's job to point out all of the little and not so little stuff I talked about two paragraphs ago, as well as a lot of other stuff I haven't talked about here. Buyer's Agents make their living getting buyers a better bargain - just like Listing Agents make their living getting sellers more money for their property. Real estate is a lot more costly than automobiles, and a lot more games get played. The Buyer's Agent is the one with the responsibility to say "Slow down, let's stop and check out everything else that's available, and consider the state that the market is really in - and where it's likely to go," not to capitalize upon the emotion of the moment and get the prospect sucker's signature upon dotted line before they walk off the lot. So long as they stick to a real budget, that Buyer's Agent gets paid about the same no matter what you buy - and the happier you are when it's all over, the more likely it is that they will get paid again when you send them your friends, or when you come back again when you're ready to move up or buy an investment property.

This is not to say that Buyer's Agent's won't play games; this is why I use and recommend non-exclusive buyer's agency agreements to stop most of them. These agreements give the buyer's agent everything they really need - assurance that if they find the property you want, they will be the one getting paid the buyer's agent commission - while not committing you to work only with them. If they waste your time, don't get the job done, if they act more like a Listing Agent, or if you just decide they're not putting your interests first, you stop working with them and that's the end of it. Unlike the exclusive agency agreement which locks you in to dealing with that agent, and four months after the last time you see them you might still be obligated to pay them a commission on a property somebody else showed you, the non-exclusive agreement lets you go your own way, and so you have nothing to lose by signing it, unless you're the sort who will stiff someone who's done work for you. Let's face it, the Buyer's Agent finds you a property you think is worthwhile, you are doing yourself no favors to ditch them in favor of your brother-in-law who didn't or couldn't do the same, or the discounter who doesn't do anything, but generously allows you to keep half the commission which they did precisely zero good for you to earn. Who do you think will get you the better deal: The agent who went around with you to ten or fifteen properties (and looked at forty others that weren't worth your time) and knows the market that property is competing against, or the agent who only leaves the office to cash commission checks? Who's going to negotiate harder? Who's going to have more negotiating power? Which agent is more likely to get your the better total bargain? There are exceptions, of course, and sometimes the long shot beats the triple crown winner, too. But that's not where smart money bets when the payoff is structured on strictly one to one odds, as it is here.

Now buyer's agents do get paid, but it's out of the commission that the seller has agreed to pay no matter who sells the property, or for what price. Buyer's Agents will make more difference to the sales price - not to mention the quality of the property you end up with - than any reduction in price you might get by agreeing not to use one. They're out there in the market all the time. They know the market you're in, and they know the tricks in ways that you, the buyer, are not going to equal, unless you spend the time it takes to learn everything they know. And unless you're a buyer's agent yourself, you pretty much can't. You've got your own living to make. What are the chances they could do better than you at your profession? The odds are not good; Even if they have the book learning, they don't have your experience. Why would you think the situation is any different when the roles get reversed?

Caveat Emptor

Original here

That question brought someone to the site. The answer is "Yes, they can". As a matter of fact, just because they have you sign those documents does not in any way obligate that lender to actually fund your loan.

There are two sections of conditions on every loan commitment. The loan commitment is what the underwriter writes up when the loan is approved. The first section is called "Prior to Docs", meaning before the final loan documents the customer signs at closing are generated. These should be all the stuff that's substantive in nature, that governs whether or not you qualify. Unfortunately, that is often not the case. The second section is called "prior to funding," or "funding conditions." This should be limited to simple procedural stuff like a final updated payoff demand, final verification of employment (they call and make sure you still work there), etcetera. However, more and more, conditions that more properly belong in "prior to docs" section are being moved to "prior to funding."

Why do they do this? Well, once you sign those documents you are more heavily committed to them. Once you sign, and the Right of Rescission (if any) expires, you are stuck with that lender. You no longer have the right to call it off. If you go elsewhere, to another lender, because they are taking too long, they can fund your loan and force you to live by the terms of the documents you signed. Bad business all around, and you're going to be dealing with two sets of high powered lawyers that the contracts you signed basically obligate you to pay for - but they work for the two different lenders!

One fact that many people don't understand is that it's a rare loan application which is rejected completely. I don't remember when I've ever had a loan application outright rejected. Of course, being a good loan officer, I'm going to be as careful as possible that the people will qualify before I submit their loan package, but this is far from universal. Many loan officers routinely tell people about loans and programs that they have no prayer of qualifying for, but there sure are some great rates attached, for all the good they will do you. Then the loan gets rejected but they sit on the rejection while they work the loan they had in mind for you all along, and come back and say, "This is the best I could do" at closing time, and an extremely high percentage of people will sign on the dotted line because they think they have no choice.

What happens much more frequently is that the loan gets approved, and the underwriter writes a loan commitment, but with conditions that cannot be met in this particular instance. The borrowers need to prove more income than they make is probably the classic example, but these "killer conditions" occur in every area of loan underwriting. More often than not, the loan officer is not really surprised by these, and most often, they won't ever tell you about them if they can avoid it. Why? Because that gives you a "heads up" that you're not going to get the loan you thought you were, and at a time when it's still very possible for you do go loan shopping elsewhere.

A good loan officer - both competent and ethical - will not tell you about a loan they don't think you're going to qualify for. My ambition is always to have the list of conditions, both "prior to docs" and "prior to funding", to be as short and unsurprising as I can possibly make it. This saves work and it saves time. Remember, every time that underwriter touches the file they can add more conditions, and they can also discover something that causes them to essentially reject the loan, by adding conditions the consumers in question cannot meet. If I can submit a file and the underwriter writes a commitment with only the standard and unavoidable prior to funding conditions, I am much happier because now I can request documents, have them signed, and get this loan done. You get this kind of commitment by sending all of the documentation they need in every loan all at once, in the beginning, but only that documentation. It's not necessarily a sign of incompetence if the underwriter puts some other conditions on it - probably somewhere close to half of my commitments have some condition the underwriter took it into their heads to require in this instance. Like any good loan officer, I avoid arguments with an underwriter if I can, so when they give me a condition I didn't anticipate, I figure out what I need to satisfy it and whether I can get it. But you learn when extra documentation will be required.

Since this was originally written, underwriting has gotten completely paranoid. I have had clients in the lender's ideal situation - high credit scores, low debt ratio, steady income, plenty of equity - given the underwriter runaround. Actually, this is basically every client. It has to do with investor paranoia, as the lenders are doing everything they can - not merely everything they reasonably should to persuade the investors these loans are not going to lose money and are therefore worth paying a higher price for. But in my experience the additional conditions seem to be falling almost entirely on the "prior to documents" (before you sign) side, rather than "prior to funding"

Many loans, particularly sub-prime, are done completely in the reverse fashion. The loan officer submits a bare application, without supporting documentation, and waits for the conditions, and boy do they get a blortload of conditions. Not too long ago I helped an experienced real estate agent in my office with his first loan. He insisted on doing it "the easy way," by which he thought he meant, "The lazy way," but he really meant, "The hard, stupid way." Despite my warning, he submitted a bare application to the lender and got seven pages of conditions, which were added to as time went by and he submitted documentation piecemeal. Took him two months and four times the work of just taking another day and submitting a complete loan package in the first place. If he had done that, the loan probably would have been finished in two and a half weeks. Some of the conditions were for stuff I had never encountered before. What was going on, of course, was that the underwriter had gotten it into his head that this was probably a dangerous loan to approve, and he wanted to be extra careful on the approval.

So what can the average person do to safeguard themselves against this happening? Well, you can't - not completely. The underwriter can always add conditions, and so can the funder. Even if the loan gets funded, they can pull the money back right up until the moment that trust deed gets recorded with the county. That's just the way it is. What you can do is ask for copies of the loan commitment, and of the outstanding conditions, those that have yet to be met. Refusal on the part of a loan officer to provide this is always a bad sign. Ditto the inability. I definitely wouldn't sign the loan papers without a copy of the outstanding conditions in my possession, and it may be smart to ask for copies of the conditions at several points in your loan. Yes, they can be faked, pretty easily, but then they are ammunition in your lawsuit if something goes wrong, and most of the bad loan officers are too lazy to fake them anyway. Before you even apply, you can ask questions about necessary income, what the program guidelines for debt to income and loan to value ratio are, etcetera. Much of the stuff in my article Questions You Should Ask Prospective Loan Providers is aimed at defusing that kind of situation. Remember, at sign up you have all the power, but at closing, the lender has all the power. They have the loan, and nobody else does. Many times, the loan they deliver at closing will have nothing in common with the loan that got you to sign up. I used to advise people to sign up for a back up loan, but even I can't do them anymore because of the high cost failing to deliver a locked loan carries.

Loan officers have people sign loan documents every day that there is no hope of actually funding a loan on. It doesn't make sense to me, but they do it, mostly because they are afraid if they break down and tell you they can't fund this loan, you will go elsewhere and they won't get paid. Signing loan documents more strongly commits borrowers to this loan, and as long as they keep trying, there's always the possibility that they will get paid. I have talked with people that were strung along for three months before they finally gave up and realized that this loan was not going to happen.

Caveat Emptor

Original here

One of the things people keep asking about is first time buyer programs. They exist, but lenders are not the first place to ask. Why? Because many, if not most lenders, actually charge a quarter of a point or so for first time buyers, in addition to their regular rates. They do this because so many of them fall out, and they want some money for their trouble. Also, interfacing with local first time buyer programs is a bit of a hassle, and it often takes much longer to close the loan, if it does close. Yes, you need to tell them if you are using a first time buyer program, but if you start at the lender you may get hit with the charge for your loan, and then find out at the last minute that that particular lender does not participate on the first time buyer program for that city.

The place to ask about first time buyer programs is the government of the city that you intend to buy in, usually the housing department, but sometimes the planning department. If you intend to buy outside of city limits, call the county housing department. Yes, you do need to know ahead of time where you're intending to buy. I know how many people hate to plan, hate to "limit themselves" and hate to do preparatory work, especially multiple sets with multiple cities if they're not certain where they will buy, but it's necessary if you want their assistance money.

Most first time buyer programs are funded with money that the municipality gets from the federal government. You'd think they would be similar, that funding would be consistent, and that participating lender lists would be mostly compatible. You could not be more wrong.

Once each city gets the money, they are still subject to federal oversight, but that is broad and there's a lot of latitude. One of the things that all of them have in common is that they charge a fee for a lender to participate every year. Unless that lender gets a lot of business through that program, it's not cost effective to automatically renew every year. I only routinely pay the fees for the much broader Mortgage Credit Certificate program every year - I wait until someone wants a given city's program before I pay the fees associated with that program. So the list of approved lenders is going to concentrate heavily on major direct lenders with offices in that city. This has the effect of limiting the competition, although brokers who are willing to sign up still have all of the advantages of brokers, because for the vast majority of these programs, it only matters that the originating office participate, not that the funding office does. Once I'm signed up with most programs, it does not matter what funding lender I use because originating office is what's important, not the actual funders of the loan.

Each and every first time buyer program will be different. Any similarities between any two programs are basically coincidence. Income limits, qualifying properties, amount of funding, how long it lasts into the fiscal year (or quarter), how much money they get from the federal government relative to the population and cost of living, and most importantly, whether they have any funds at the time you want them and qualify.

Even the form that the first time buyer program takes is wildly variable. Most common is a second (or third) mortgage with nominal payments and a nominal rate. For instance, one east county city requires a 3% interest only payment. Also very popular is a "silent" second (or third) mortgage with no payments, but it needs to be paid back in full if you sell, and in many cases, if you refinance. Some first time buyer programs work off of a "shared equity" basis, with no payments and no interest charged, but they own a fixed share of the property and are entitled to payment in full at sale, and in many cases, of the base loan amount plus appreciation if you refinance. This lessens the financial benefits of home ownership, because normally the appreciation belongs entirely to the homeowner. Nonetheless, without the program, you wouldn't have had any of the benefits of ownership, economic or otherwise. Still other cities have programs geared towards maintaining a pool of limited income housing in that area, and the price you sell for when you sell will be restricted, negating most of the financial benefits of ownership. Some programs are even tiered based upon income, and those making a lower amount will get more favorable terms that those who still qualify, but make more than people in the first group, and there may be more funding available for the lower tiers.

It all depends upon the locality where you buy, and if you apply and qualify for a first time buyer program in City A but end up buying outside of that City limits, you are out of luck. For this reason, you need to work with a buyer's agent who knows the programs and their boundaries and is careful about them. Just because it has the appropriate ZIP Code or telephone prefix does not necessarily mean anything, and I find properties with the wrong ZIP Code in MLS quite often. For instance, properties that are actually in northern Pacific Beach here in San Diego will quite often have the more upscale La Jolla Zip in MLS. Before making an offer, you can always call to make certain the property is within the boundaries covered by the program, of course. You want to double check, because you will pay a fee, usually several hundred dollars, when you apply to the first time buyer program, and I don't know of any that refunds the money if you don't qualify, if you are outside the area, or if you just don't get the funds because they are out of money right then.

Please note that one other feature all first time buyer programs have in common is that they require owner occupancy of a single occupancy dwelling. These are not intended to help investors grow their real estate empire. These programs are intended for people who would not otherwise be able to afford the property and intend to live in it. In some cases, moving out triggers a requirement for immediate repayment in full (and just when it got more expensive to refinance because it's now investment property, too!). In others, so long as you live in it for a given number of years, you can keep it going providing you don't break other rules. Every program has it's own little twists on the owner occupancy requirement. None of them permit you to buy residences suitable for more than one family, either. Duplexes, apartment buildings, and other multi-unit housing are disallowed from every program I've worked with.

First time buyer programs are not grants. I've dealt with them all over southern California, and I don't know of any that are outright grants. In many cases, that would be more cost effective, not only to the buyer but to the city as well, than the hoops that have to get jumped through. So I suspect that outright grants are prohibited by the enabling federal legislation, although I've never read the regulations.

Some first time buyer programs do have mechanisms for forgiveness of the loans after a certain period of time. The requirements and length of time vary. I've seen those that have the forgiveness feature be as short as five years and as long as fifteen.

Prospects for subordination if you refinance are also variable depending upon where you buy. Some require payment in full if you refinance at all, while others will allow themselves to be subordinated to new First Trust Deeds providing certain requirements are met. Chief among these are usually requirements that essentially prohibit cash out refinancing unless you pay off the first time buyer program.

One final caveat to these programs is that most of them will not pre-approve you. In other words, they won't look at your application before you've got a fully negotiated purchase contract. I know of only one program that will pre-approve applicants, and none that will commit funds before you have a fully negotiated purchase contract. If they run out of money in the meantime, that's just too bad. - you're out the application fee. For this reason, you need to stay on top of not only the program requirements and boundaries, but also the funding status as well. If they don't have any money when you actually have a contract to buy, you are wasting the time and money to apply.

Now I don't mean to say these programs are not worthwhile. They can and do make the difference between being able to afford the property and being forced to continue to ride the rest escalator. I should also note that they are basically a band-aid to treat the gaping economic wound caused by artificial restrictions to the housing supply. But if the conditions are right for the band-aid to help you, it certainly is nice and there is no reason why you shouldn't take advantage of it.

Caveat Emptor

Original here

I want to state that I am in no way shape or form an FHA loan guru. Between my general knowledge of loans and this information from someone who is an FHA guru, I think I can make some sense on the subject. Besides, one of the best ways to understand something better is trying to explain it to someone else.

FHA will guarantee loans up to 96.5% of the purchase value, not 100%. This means that you do need a minimum of 3.5% down from some source. The FHA will allow seller paid closing costs only of up to 6%, and the really cute thing is that they will also allow the down payment component to be a gift from family members or government agencies (provided they are not otherwise involved in the transaction). FHA loans can also be interfaced with some types of locally based first time buyer programs, although whether there is money in the budget at the time you apply for those programs is subject to funding, which usually goes quickly.

The first thing you need to understand about FHA loans is that they are intended to enable people to transition from renting to ownership of a primary residence. They are not intended to help anyone grow a real estate empire. For this reason, they will not work with investment property except in the case of non-profit organizations. Individuals looking to buy property via FHA loan must plan for it to be owner occupied. Second homes are only allowed where you already own a home elsewhere and can show an employment related need. Vacation homes are not allowed.

Refinancing is possible for existing FHA loans, up to a maximum of 95% (see Mortgagee Letter 2005-43) loan to value ratio, provided it was purchased via FHA owner occupied loan. The only exception allowing FHA refinance of non FHA loans is the FHA Secure plan. There is no prepayment penalty on FHA loans, and they can be refinanced into conventional loans anytime you can qualify for conventional financing. Most folks do refinance FHA loans into a conventional conforming loans as soon as they can, because FHA rates aren't as good as conforming and conforming loans don't carry financing insurance. It's something to be decided on a case by case basis, on the basis of what is best for a given homeowner.

I did say conforming loans. FHA had loan limits which has precluded them being a big player in most areas for at least a decade. With the decrease in housing prices that has hit many areas and new legislation raising the conforming and FHA loan limits, they are now a major player for first time buyers and people getting back into the market. Especially since traditional lenders are seemingly more fearful every day. Truthfully, I anticipate FHA loans as being what saves the bacon of traditional lenders and provides the upwards impetus to the market that will cause traditional lenders' fears to ease and relax their restrictions.

With loan limits preventing them from lending upon most single family residences these past few years, you'd think FHA would be friendlier to condominiums. Unfortunately, government bureaucracy being what it is, condos have to be approved by the FHA before they will fund loans upon them. Since relatively few developers care to do that, that means that most developments don't have blanket approval from the FHA. Some people think that if theirs is one of the few with FHA approval, this gives them a lock on FHA buyers and they attempt to extort a huge premium in the form of purchase price. I have seen people who intend FHA loans advised to get a list of FHA approved projects and work only from that list. This is nonsense.

Just because the FHA hasn't issued blanket approval to a condominium development doesn't mean that you can't get spot approval. The requirements, in addition to the usual ones, are no ongoing class action suits open or pending, and 60% or more owner occupancy for the complex. This last tends to be the most difficult requirement, as it's a little unusual that a particular complex has 60% owner occupancy, but there are many condominiums out there that can qualify even though the complex does not have pre-existing approval.

Like all government programs, FHA loans require full documentation of sufficient income to afford the loan. No stated income or lesser documentation loans will be funded or ever have been by this program. This is another reason they were unpopular in the Era of Make Believe Loans, as mortgage products for those with eyes bigger than their wallets proliferated, and agents and loan officers became accustomed to qualifying people for properties and loans far beyond their means. Now that that's all over and we're all back to solid fundamentals as far as loan qualification, you can decide to stay within the budget for a loan you can prove you can afford, you can put a significantly larger down payment on the property to qualify for conventional financing, or you can do without buying any property at all. But FHA does not do stated income loans and never has.

Matter of fact, the FHA doesn't do "interest only" financing, either. All FHA loans are fully amortized. However, the FHA does accept some hybrid ARMs as well as fixed rate financing. But no interest only, no stated income, no negative amortization. You must qualify for an FHA loan based upon the fully amortized payment and full documentation of income only, which eliminates most of the ways that people were being qualified for loans beyond their means during the Era of Make Believe Loans, and is one more reason why the FHA was not a major provider of loans in for several years.

Allowable debt to income ratios are 31% front end and 43% back end, according to the written guidelines. However, both can be individually waived upwards, higher even than conventional loan qualifying ratios of 36 and 45% respectively in the case of strong credit , high reserves, and a stable job, with high reserves being probably the most important factor. For instance, owner of a stable business of long standing. Nobody fires owners. Large amounts of money in retirement accounts is one way of getting the default debt to income ratio increased. The range of 45-49% (back end) is supposed to be reasonably possible to get the FHA to approve. Beyond that, exceptions are fewer and significantly harder to get. In my professional opinion, making it difficult to go higher is a good thing.

There is no requirement for reserves with an FHA loan at all. With that said, however, having reserves can be a major point in your favor, particularly above 43% back end ratio. People with hundreds of thousands of dollars in retirement accounts that they could fall back upon if they had to is something the FHA will consider while traditional lenders would not. They'll even allow non-monetary reserves, the most memorable example given to me being a collector of old motorcycles which could be sold. Jewelry, automobiles, and other non-liquid assets may be considered. Of course, it's a very good idea to source and season every dollar you're using to justify the transaction, but the FHA has even been known to accept "mattress money" for down payments (not generally reserves), which is unheard of in other loans.

Here's the really cool part about an FHA loan: It's not FICO driven. You technically don't even have to have a credit score in order to be approved. With that said, however, even when underwriting was at its loosest a sub-600 credit score made it difficult to get approved, and these days we're looking at 640 to 680 as a reasonable minimum. You can also use alternative credit , of which utility bills are probably the best example. Especially in some cultures, credit can be a thing that people aren't accustomed to having or using, so these capabilities are very helpful. You don't even have to be a citizen, but you do have to have the right to work in the United States. This is reasonable: If you don't have the right to work, how are you supposed to pay it back?

Prior bankruptcy is allowable. Chapter 7 with two years of seasoning and re-established credit, chapter 13 with one year payment history and court approval.

Even prior foreclosure is not an automatic disqualification from an FHA loan. They will, however, require documentation of extenuating circumstances such as major illness. Job transfer is explicitly disallowed as an acceptable extenuating circumstance, so people who walk away from properties thinking they're going to get an FHA loan are going to be disappointed. What the FHA really seems to be looking for is debilitating illness, either one which you personally went through, or one where you had to care for an immediate family member.

For how easy they are to work with for individuals, however, loan providers find themselves with many additional requirements, which is yet another reason FHA loans had been less popular while there were other choices. As of right now, in addition to everything else, in order to originate FHA loans, originators have got to go though an annual audit with an accountant who's specially certified FHA auditor. This audit costs a minimum of about $5000 just for the auditor, never mind the cost of the originator's own time or that of anyone else they may have to pay. The audit requirement is in the process being relaxed for originators (finally). The FHA does not permit an agent to hang their license with one broker for real estate and another for loans, either, and your FHA loan officer can not be your real estate agent. If your broker does both, however, it may be permitted. The extensive paperwork means fewer providers - especially discount providers - are interested due to the increased costs, which drives things exactly opposite to what you'd expect the government to want - it drives prices of FHA loans up, by restricting the supply of those willing to do them. It is hoped by many that FHA modernization will change some aspects of this, but that has been stalled in Congress for a very long time. It's pointless to speculate as to what will and will not be included in FHA modernization until Congress sends an actual bill to the president.

One thing not likely to change is the FHA's blacklist. It's not called that, but that's what it is. Once a real estate agent or loan provider is on their list, they are on it for life, and the FHA scrutinizes all transactions for anybody affiliated with it being on their "naughty" list. If someone should default on an FHA loan, the insurer is going to look for a reason not to pay the guarantee, which insures that every FHA foreclosure gets scrutinized for fraud and a number of other offenses. If the agent or loan officer was involved in such an offense, onto The List they go, and they are forever barred from transactions involving an FHA loan. For this reason, it's probably a good idea for consumers to ask about this in their first meeting with a prospective loan officer or real estate agent - on the phone would be better. Just say that you're going to be needing an FHA loan, so if they're on the FHA's "naughty" list, they might as well tell you now, because they're going to be wasting their time. If they try and talk you out of an FHA loan, well, that should tell you everything you need to know. FHA loans are equal or superior to anything that isn't conforming A paper, and if you haven't got the qualifications for that, FHA beats Alt A, and beats subprime like a drum (OK, so the VA is a better deal than FHA as well).

The FHA does not normally permit secondary financing, either in the form of second trust deeds or seller carrybacks. The one exception to this is in the FHA Secure program, which will have to be another article.

One final thing: FHA loans aren't free. There is an upfront cost of 1.75 points to fund the loan. This is over and above all other loan related fees. This pays for an insurance policy that insures the lender against loss, much like private mortgage insurance on conventional loans. In addition, there's an annualized cost of 0.55% on top of principal, interest, taxes, insurance, etcetera - and this is included in debt to income ratio calculations. This will continue until the loan to value ratio is 78% or less, and if the loan period is over 15 years, cannot be removed for five years. If the loan period is 15 years or less and the loan to value ratio is initially less than 90%, there will be no continuing (i.e. the annual component) mortgage insurance charged, but the only way to elude the 1.75 point initial charge is by having a loan to value ratio of 80% or less. Since in any of these cases, it's overwhelmingly likely there will be better choices available to the consumer, essentially all FHA loans are going to have this financing insurance. The continuing cost is one of the main reasons people refinance to non-FHA mortgages, incidentally.

With lenders fearful and paranoid about the state of the market, FHA loans are an excellent way to qualify someone for financing that's at least close to 100%. Given the state of the housing market, particularly the starter market, and the legislation increasing FHA limits, the FHA loan is a very powerful force for market stabilization, leading to market recovery. It's a good alternative for consumers who cannot currently qualify for conventional loan financing.

When I originally wrote this, there were down payment assistance programs in effect to enable what was essentially 100% financing. Those have been essentially dead since April 2008, when Congress did away with the provisions that allowed it except in the case of government agencies. Figure you're going to have to come up with your down payment out of your own funds somehow.

Finally, a caveat. Many sellers don't want to work with FHA or require higher offers in order to do so. They aren't as bad as they used to be, but FHA requirements for financing are still tougher than conventional financing rules - especially if you've got a condo that needs so-called "spot approval". This costs sellers money, and means their transaction isn't as certain as a conventional loan. If you're looking for a bargain or even just a better than average deal on purchase price, it's a good idea to avoid an FHA loan for that reason. Furthermore, many agents still have their heads in the old days when FHA financing was a nightmare for the seller. Especially if there are competing offers, expect seller preference to work against you if you're making an offer that includes FHA financing, and be prepared to need to offer significantly more than the competition if you want them to choose your offer over theirs. When I'm listing a property and the offers are otherwise equivalent, I would still prefer the buyers who are intending any other sort of financing over FHA loan buyers - and I explain why, in detail, to seller clients who are evaluating multiple offers.

Caveat Emptor

Original article here

(The original article was from September 2005)

From an email:

Anyway, my wife and I are about to purchase a place here in the X area and we've been hearing that "a tough loan" line due to the fact that I'm only 10 months into my new small business although I've been profitable the entire time. We're stuck doing No Doc/Stated Income setups - I think you called these "liars' loans" - and the rates are a bit painful.

My wife's scores... at 720 are the lowest we have and mine are (higher).

Well, the good news is that your credit scores place you in the highest band of credit scores. When this was originally written, there was no category beginning higher than 720. Now there is, but it's a pretty nominal difference in most cases.

The difficulty is that you're running afoul of one of the background rules of the whole loan process. Fannie Mae/Freddie Mac rules limit A paper loans to those with two years in the same exact line of work. With some limitations, a good loan officer can usually get it approved for two years with the same employer, if they've been progressing normally within the company. However, changing from a W-2 employee to self employed is a change that cannot be approved, at least from the point of view of A paper. A minus and Alt A rules are mostly similar. So you're looking at subprime loans. Let's examine A paper documentation levels to see if they're a possibility.

Full Documentation: Requires documenting two years income same line of work. You can't; you've only been self-employed for ten months.

Stated Income: Requires documenting that you've had the same source of income for two years. Nope. Yes, these and NINA loans were often called "Liar's loans" in the business because the lender agrees not to verify your amount of income. That's because loan officers eager to make a commission on a loan where the client really doesn't qualify on the basis of debt to income ratio commonly used these to qualify such clients. The qualification standards are there for your protection as well as the lender's. Just because you could use these to qualify doesn't mean it was smart. Most of the reason for the huge house of cards we had was due to unstable and unsustainable loans. Loan officers use these to qualify clients for negative amortization loans. Yeah, the temptation to make a commission is there, but am I really serving the client's best interest by securing them a loan they can't really afford where even the payment they can't afford has them owing more money each month? I submit that the answer to this question is usually no. Stated Income loans are designed for self-employed folks and people on commission who make the money, they just have write offs and such so that they can't really document it. Using stated income to say you make money that you don't is a dangerous game, as literally millions of people found out the hard way. It's likely to result in foreclosure. I am sorry it's completely unavailable as of this update because if it is used properly there are people it is both beneficial and necessary for, but it wasn't used properly in the vast majority of cases.

NINA: Requires a good credit score. This might be your ticket. On the other hand, you don't state how much of a down payment you have, percentage-wise. A paper NINA requires some equity in the property; I've never seen an actual A paper NINA approved with less than about ten percent equity. On the other hand, these were very easy loans to actually do when we had them. It was trying to qualify you for something better that was hard. Once again, however, they're completely unavailable at this update.

On the other hand, if we move down into subprime, the rules aren't set by Fannie and Freddie. When I first wrote this, there were subprime lenders with one year same line of work programs, and even a few with six month programs. On one hand, they're subprime loans, carrying a higher rate/cost tradeoff just by virtue of that, and subprime loans carry prepayment penalties by default. On the other hand, because you're documenting your income, you get a break for that. You probably would have ended up with a rate a quarter to half a percent higher, albeit with a prepayment penalty.

One of the great universal things of the loan business is this: The looser the underwriting standards, the higher the rate, and the tighter the underwriting standards, the lower the rate. If a given lenders underwriting standards are looser, it's rates will be generally higher.

Now, given that you've only been self-employed for ten months, you're not going to have much of a paper trail. There are three possible ways that banks will accept to document income. W-2? Even if you have them, they're no longer applicable. Income tax forms? Given that it's September, counting back ten months leaves you starting the business in November of last year. Even if you had enough monthly income to qualify for that month and a half or two months, the tax forms effectively spread it across all of last year, and that's unlikely to show enough income. The third method of income documentation, unique to subprime, is bank statements. This, you might be able to do. Most subprime lenders have 24 and/or 12 month bank statement programs, and a large number have six month programs as well. The longer you can document for, the better the rate, but better six months than nothing.

(I should note that at this update, I haven't done a subprime loan in the last 5 years, and even finding real subprime lenders has become extremely difficult, but they haven't been regulated out of existence like stated income and NINA so they are likely to return eventually)

Will this get you a better rate, at a better cost (two concerns that always go together), than an A paper NINA? If so, is the better rate worth the prepayment penalty to you? The answer to that was on a case by case basis when we had both. Now the NINA is nonexistent and the subprime is harder to find than an honest politician. There is no way to be certain without pricing it around by the full details of your case, but there's a good chance, and you can get 100 percent financing this way.

I will warn you that bank statement programs (often called by the misnomer "EZ doc" or "lite doc") are THE most difficult loans to actually get approved. There are more problems with these than any other loan type. On the other hand, as I've covered in Levels of Mortgage Documentation, or, Why You Should Demand to Do More Paperwork, if it gets you a better loan, the effort is likely to be worth it. Furthermore, there is a question of whether you qualify for the loan by the bank's standards. Some lenders discount the amount of money coming into the account, some do not.

So which is the better alternative for you? When we had both, I couldn't tell you without actually pricing it for your situation. I don't know for certain that either can be done for your situation without information like how much income your bank statements show, and how big your loan needs to be, and how much of a down payment you're making. Get a couple of good loan officers working on it in your area, and find out.

And yes, this was a always tough loan situation. Both A paper NINA and subprime bank statement programs have their limitations. Failing that, you fall all the way back to subprime NINA, where your credit would have formerly justified 100 percent financing, but it's as gone now as every other such program. Even when it was available however, the rates for subprime NINA were rough on the pocketbook.

Caveat Emptor

Original here

The HUD-1 Form

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I have mentioned this form several times in the past as the only form in the entire real estate loan process which is actually required to be accurate. Department of Housing and Urban development form 1, the so-called HUD 1 form, is required to be filed and correct for every real estate transaction. Whoever your provider is, this is the one and only form they cannot play games with. This article is goes over the form line by line, referencing previous entries.

The top section has to do with identifying information on your transaction. Your name, the name of the other party to the transaction, escrow numbers, name and address of lender, date of settlement.

The meat starts with line 100, the Summary of Borrower's Transaction, and line 100 the section on Gross amount due from borrower.

101 Contract Sales Price: Should be the same as on your purchase contract.

102. Personal property: Say you agree to pay $500 extra if they leave the sofa. Here's where that goes.

103. Settlement charges to borrower (line 1400) adds the costs of the transaction to the total.

106 and 107 are repayments for any taxes the seller may already have paid as of the date of settlement, but are not their responsibility as the time period covered includes some time after the effective date of sale.

120. Adds all the lines up to this together. The rest are simply blank lines that may or may not be a factor in your particular transaction. If they are a factor, it should be because you specifically agreed to pay them!

The 200 section is about stuff that is paid for, or on behalf of the borrower, or you have simply already paid.

201. Deposit or earnest money: The deposit you made, either with escrow (purchase) or the bank (on a refinance) to persuade them that this was a good transaction.

202. Principal amount of new loan(s): Check and make sure this matches your new Note. In some states, they may be able to combine the amounts of two loans here, but they shouldn't.

203. Existing loans taken subject to: If you're assuming a loan or something similar, it goes here.

204. Second mortgage loan: Compare against your new second mortgage amount.

205 and 206 are blank lines for things that may not be a factor in every transaction.

210 and 211 are for city and county taxes that have not yet been paid by the seller, but the cost has been incurred. Let's say today is September 1, and we're in California, where the property taxes run July 1 to June 30. On September 1, the seller owes two months of property taxes, but those taxes haven't been paid, and won't be due until November 1. So there will be a credit here from the seller to the buyer for two months of property taxes, which the seller is responsible for until the effective date of sale, but the buyer will have to pay on November 1. 212 to 219 are blank lines unless something special is relevant to your transaction.

220 is total paid by/for borrower: This is a total of everything paid by you or on your behalf.

300 Section tells if you are due money at settlement or have to come up with some. 301 is transferred from line 120, 302 from line 220. If 302 is larger, you get cash back. If 301 is larger, you have to provide the check in order to close.

The second column is a summary of the seller's transaction, if there is a seller and it's not just a refinance.

Section 400 is about what's due to the seller, starting with 401 Contract Sales Price, then 402 which is a mirror or 102, then 403, Impound Credit, which is rarely used, as it is pretty much applicable to loans being assumed.

406 and 407 are mirrors for 106 and 107, as are 408 to 418 mirrors of the 108 to 118 section. 420, Gross amount due to seller, is a summation of all of these.

The 500 section has to do with stuff the seller is paying other people.

501 is excess deposit, 502 is settlement charges to seller, 503 is loans that are being assumed.

504 and 505 are mortgage payoffs being made, 507 through 509 are blank spaces for things not applicable to every transaction.

510 and 511 are mirrors of 210 and 211, as 512 through 519 mirror 212 through 219, blank lines not applicable to every transaction.

Section 600 is analogous to but not mirroring section 300. Line 601 is line 420 brought down. Line 602 is line 520 brought down. The difference is line 603 cash to seller (This can be line 603 cash from seller in the case of a so-called "short sale")

All of this is good and necessary information, but The Really Good Stuff™ is all on page 2. The lines at the right list who is paying it (buyer or seller)

Section 700: division of commission

Line 701 is compensation to the listing broker, line 702 is to the selling broker (i.e. the buyer's broker, the people who "sold" the property), and line 703 total commission paid at settlement. I've never seen this paid by buyer, it's always been paid by seller.

Section 800 is items payable in connection with the loan itself. This doesn't mean that these are all the loan-related charges - far from it.

Line 801 and 802 are dollar amounts of points. If these aren't zero, divide them by the loan amount to make certain they are the numbers agreed upon.

Lines 800 through 1317 are linked on a 1:1 basis with the appropriate lines on the Good Faith Estimate (Mortgage Loan Disclosure Statement in California, but the explanation in that article refers you to the Good Faith Estimate). In an ideal world, the total of these should be exactly what was indicated on the Good Faith Estimate/Mortgage Loan Disclosure. There are some few items that are not under the loan officer's control (again, see the article on the Good Faith Estimate for which are and are not). A good rule is that if it isn't on the Good Faith Estimate/Mortgage Loan Disclosure in one form or another, it shouldn't be here. Compare it to the Good Faith Estimate/Mortgage Loan Disclosure to find discrepancies. Other than things like prepaid interest, which the loan officer does not control but should have a pretty accurate estimate of, the most difference there should be between the two documents is one big fee gets broken down into little fees. But if you're told, for example, that the $795 amalgamation of lenders fees was broken up into A, B, and C, make sure that A+B+C=$795, and do not allow additional fees to be lumped in. Grab a piece of scrap paper and take notes. Make certain these numbers jibe. It is easy to hide thousands of dollars in unsuspecting fees to clients in this page if you, the client, are not careful.

Line 1400 is a summation of these lines.

Once again, look hard at the numbers on these two pieces of paper. It is the only honest accounting many people get of the transaction, and the fact that it comes at the end of the transaction makes hiding all kinds of things easy. You, the client, are tired of the whole process and want it to be over, a fact which many loan officers and loan providers rely upon. Put your guard up for a few more minutes, long enough to be certain what you sign for here matches what you signed up for back at the start of the process.

Caveat Emptor

Original here

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