This is one of those commercial gambits I keep seeing that has nothing intrinsically wrong with it, and yet it is most often a tactic employed by the more costly loan providers. In short, sharks and scam artists.
The basic come-on is this: Loan provider offers to pay for your appraisal if you do the loan with them. They often use such come ons as “free appraisal!”
TANSTAAFL. Repeat after me. TANSTAAFL. There Ain’t No Such Thing As A Free Lunch. “Free” stuff has an ugly habit of being the most expensive there is, and this particular come-on is no exception. Offer you a few hundred with the left hand while picking multiple thousands out of your pocket with the right. If you want to be an educated consumer, engrave TANSTAAFL upon your soul.
What’s going on here is that they are trying to make it look like you’re getting something free. You’re not. They may front the cash for the appraisal, but in all but a few cases you’re going to get explicitly charged in the end. Even for those people whose final loan papers does not show an appraisal charge, they are charging it to you somewhere else. Odds are that they’re charging it about ten times over somewhere else. Either in origination or yield spread, one way or another you are going to pay for this appraisal. Actually, you are likely going to pay for that appraisal several times over. People are strange about cash. Many folks, if told they don’t have to lay out $300 to $500 for an appraisal, will choose loan providers where the proposed rate is 1/4 to one half a percent (or more!) higher than competing loans, with closing costs thousands of dollars higher. They are getting the cost of that appraisal all right. In this scenario, they’re making half a point to one point more than anyone else on the same loan, plus all of the extra closing costs. That’s if they’re a broker. If they’re a direct lender, the difference is between a point and a half and two and a half points, more if there’s a prepayment penalty!
Low cost loan providers do not pay for your appraisal. The loan providers who pay for the appraisal are paying not only for your appraisal, but the appraisal of all the people who cancel, and a good margin besides. Not to mention that this loan provider completely controls the appraisal, leaving them in control of what happens if you actually notice their huge fees when you go to sign loan documents, and decide you want to go somewhere else. This is one of the ways that loan providers avoid competing on price, by pretending to give you something for free. I say “pretend” because they are not giving you anything for free. I do not understand that normally competent adults who are well aware what “free” really means in other contexts will think it means they’re getting a benefit. But just like the “buy one, get one free” offers that jack the price up threefold first, this is only a good bargain if the few hundred dollars it saves you stays saved, rather than giving you $400 with one hand while taking $6000 with the other, through higher loan rates and costs. Rate and cost trade-offs on real estate loans vary constantly. You can’t know what the best bargain is right now unless you price it out right now.
Caveat Emptor
How Soon After You Purchase A Home Can You Refinance?
Legally, immediately.
With that said, there are economic reasons why it may not be a good idea for you to refinance.
If you have a prepayment penalty, you’re going to have to save a lot of money to make it worth paying that penalty. Suppose you have a rate of 7 percent, and an penalty of eighty percent of six months interest, that’s a prepayment penalty of 2.8 percent of the loan amount. So, in order to make it worth refinancing in that instance, you have to save at least 2.8 percent of your loan amount in addition to the costs of getting the loan done, all before the prepayment penalty would have expired anyway. So if it’s a three year prepayment penalty, you have to cut almost a full percent off your rate just to balance out the prepayment penalty. The higher the rate you’ve got now, the bigger the penalty and the more you’ve got to save in order to make it worthwhile. On the other side of the argument, the longer the prepayment penalty is for, the easier it is to save enough to justify paying it. If you’ve got a five year prepayment penalty, you’re likely to get transferred or need to sell or somehow end up paying it anyway.
Second, your home has not appreciated yet, especially not in the current market. You bought for $X, and your home is still worth $X, and you haven’t paid the loan down much yet, so your equity situation is essentially unchanged. In fact, since relatively few loans are zero cost, you’re either going to have to put money to the deal or accept a higher rate than you might otherwise get. Don’t get me wrong; Zero Cost Refinancing is a really good idea if you refinance often. But when you go from a loan that takes money to buy the rate down to a loan where the lender is paying for all of the costs of getting it done, you’re not going to get as good of a rate unless the rates are falling. As of right now, they have been going through a broad and more or less steady increase for the last two years. If you or someone else paid two points to get the rate on your current loan, you are not getting those two points back if you refinance. They are sunk costs, gone forever when you let the lender off the hook. If rates had been going down for the same amount of time, it might be a good idea to refinance, but that is not the case right now.
If you got your current loan based upon a property value of $400,000 and total loans of $380,000, that’s a 95 percent Loan to Value Ratio. So your property is still worth $400,000, you’ve only paid the loan down $400. That’s still a ninety five percent Loan to Value Ratio; more actually, as doing most loans is not free. So unless your credit score has gone way up, you can now prove you make money where you couldn’t before, or you have a large chunk of cash you intend to put to the loan, chances are not good that refinancing is going to help you. If your credit score has gone from 520 to 640, on the other hand, or you now have two years of tax returns that prove your income, or you did win $100,000 in Vegas and you want to pay your loan down, then it can become worthwhile to refinance, even in a market like this one where the rates are generally rising. Unfortunately for loan officers like me, that does not describe the situation most people find themselves in.
One more thing that can influence whether it’s a good idea to refinance is your rental and mortgage payment history. If when you got your current loan, you had multiple sixty day lates on your credit within the past two years, and now they are all more than two years in the past, that can make a really positive difference in the rate you qualify for. On the other hand, if you had an immaculate history before and now you’ve had a bunch of payments late thirty days or more, then it’s probably not going to be beneficial to refinance.
Cash out refinancing is one thing many people ask about surprisingly soon after they close on their home. Now if you have a down payment, tt’s better to put aside some of the down payment for use in renovations rather than to initially put it towards a purchase and then refinance it out, as it saves you the costs of doing a new loan. If the equity is there and if you have the discipline to take the money and actually do something financially beneficial with it, it can be a very good idea. If you’re just taking the money to pay off debts so you can cut your payments and run up more debts, it’s probably not a good idea, even if your equity situation supports getting the cash out. It often can and does in a rising market. In the current market where values are retreating, not so much. If you bought any time in the last two years, it is unlikely that you have significantly more equity now than when you bought, making the whole situation unlikely to be of benefit.
A lot of situations have something or other that makes them an exception to the general rules of thumb. The only way to know for certain if the general rules apply to your situation is have a good conversation with a loan provider or two.
Caveat Emptor
Cash Back From The Seller to the Buyer in Real Estate Sales
Yesterday I dealt with a very disturbing phone call from a would be client. He was very happy with the way I found bargain properties, and wanted me to find him such a property. All very well and good. But he said that a condition of the transaction had to be that he would receive cash back from the seller in order to rehabilitate the property while financing the entire amount. This is not so good.
I am well aware there are all kinds of self-proclaimed real estate gurus out there, many of whom push precisely this sort of strategy. That does not change the fact that it is FRAUD.
The lender evaluates a property based upon accounting principles, which is to say Lesser of Cost or Market. Whichever is less, the cost of the property or the market value. Market value is measured by the appraisal. It’s not perfect, and it’s not foolproof, but it’s the best thing there is. Cost is measured by purchase price – the price at which a willing buyer and a willing seller exchanged the property. It has to be worth that much or the buyer would not have been willing to pay it, would they? It can’t be worth more or the seller wouldn’t have sold, would they?
Manipulating either purchase price or appraised value for financial purposes such as justifying a higher loan amount is fraud. Since there is no other rational reason to do that, it’s pretty universal that manipulating appraisal value or purchase price is fraud.
Many people have all kinds of rationalizations why doing this sort of thing is permissible. “Real Estate goes up in value,” “It’ll be worth that much eventually,” and “It’ll be worth that after the renovations!” being very common. None of these addresses that fact that that’s not the situation now, and the lender is lending based upon the value now, not later.
The purchase price, in particular, is the purchase price because that it how much money the buyer is paying and how much money the seller is receiving. But if the purchase price is $400,000 but the seller is returning $20,000 to the buyer, then the real purchase price is not $400,000, is it? The seller is only getting $380,000, and the buyer is only paying $380,000. If it was a cash transaction with no loan involved, there would be no doubt. If I hand you $400,000 and you hand me back $20,000, I’ve only given you $380,000, not $400,000, and there’s no doubt about it. You’ve only got $380,000. Only the fact that there is a lender in the middle of most transactions gives any leeway to confuse the issue, and if you’re hiding something about a transaction in order to induce some other party to perform a financial action they would not otherwise, that is a textbook definition of fraud.
Lest there be any mistake, you do have to hide it. If the terms of the purchase contract state that there will be this rebate, the lender will treat the purchase price as $380,000, and underwrite the loan based upon a $380,000 purchase price. Telling the entire truth defeats the possibility of it working, and once you have neglected to inform the lender of this significant fact, you are committing fraud.
Some people will cite the example of Seller Paid Closing Costs as justification for this, but that is an entirely different matter. Indeed, traditionally lenders treated seller paid closing costs, over and above the seller’s usual share, as reducing the purchase price. It is only the last few years, when it has been pointed out that everything about real estate transactions is negotiable, and that the seller must have been willing to pay those costs in order to consummate that transaction, that the lenders began to allow it. But it is to be noted that all of that money is going to third parties, people who are being paid for their services in making the transaction happen, none back from the seller to the buyer.
Consider instead this scenario: Jim and Joe trade the stock of corporation A. The public sale price of that stock is $100 per share, but as soon as Jim has Joe’s money, he quietly hands Joe back $20. The price Joe is paying Jim for the stock is $80, but to the observer unaware of the side transaction, it’s $100. It’s going to appear to the general public that both Jim and Joe consider that to be a fair trading price, and people will often be willing to pay both Joe and Jim that $100 per share price because it looks like that’s the price, or think they’re really “getting a deal” if Joe or Jim will sell to them for $98.
Now lest we be unclear, as soon as the side transaction comes to light, the SEC and FBI are going to sweep in and both Joe and Jim are going to find themselves charged with share price manipulation, which is to say, fraud.
The situation I’ve described as defrauding the lender in this instance is no different at the root. You are hiding a part of the transaction in order to induce the lender to give you a larger loan than they otherwise would have.
Now, before I leave this subject, I want to ask you what kind of an agent or loan officer you’d trust to commit fraud upon someone? When such activities are discovered, such agents and loan officers lose their license and usually go to jail. Do you want to do business with a loan officer or real estate agent who commits fraud? Who deserves to lose their license and go to jail? If they’re willing to lie and commit fraud upon one part of the transaction at the lender’s expense, why would they be unwilling to lie and commit fraud at someone else’s expense? For instance, yours? If I were to point out some agent or loan officer who is under indictment for fraud, and is going to lose their license and go to jail as soon as the verdict comes back, I’m sure you’d all go right out and book a transaction in a hurry with them right now, right?
Now this would-be client quickly lost interest when I explained all of the above. He said, “I’ll get back to you on the property!” and hung up. He’ll find someone to help him out, no doubt about it. But that’s one transaction a good professional wants no part of. I’m better off without him. And I’m confident that if he actually pulls a few of these transactions, one day he’ll go to jail and be a convicted felon, and that is as it should be.
Caveat Emptor
Annuities, Fixed and Variable
One of the most discounted investments available is the annuity.
An annuity can be thought of as the opposite of a life insurance policy. Instead of creating an lump sum of money, an annuity liquidates one by providing you instead with a stream of income.
The original idea is simple. Suppose you get a lump sum of money, and you have no immediate use for it. What’s more, you think you might waste it if it’s just sitting in the bank. So you decide to invest it with an insurance company, who will then pay you so much money per month, every month.
The real kicker, or reason for doing this, lies in the options for payoffs. These fall into three basic categories. Period certain, life, and life with period certain.
Period certain means you’ll get payments every month for however many years. If you die, your heirs get them. When that number of years is over, so is your payout.
Life payouts equally straightforward. You (or you and your spouse in joint life payouts) get those payments every month until you die. When you die, they stop. You could get hit by a bus the next month, or live another 150 years. However long it is, the payments continue for the full amount of time, and stop as soon as your life is over.
Life with period certain means that the payments will continue for your entire life, however long that is, but there will be a period of some number of years where if you are hit by that bus, your heirs will continue to get payments. This is highly useful to people who have minor children, who are thus assured that their children will continue to get something if they die.
The idea of either of these last two options is that you have an insurance company guaranteeing that you will not outlive the income you get from this money. This can be a very psychologically comforting thing for all sorts of people in all sorts of situations, who are thereby assured that they will have something to live on.
Annuities come in two flavors of beginning, immediate and deferred. Immediate means that here is this lump sum of money, annuitize me (start sending me a monthly check) right now. Deferred means I’m investing it with you, and I may invest more with you later, but let’s just let it grow for now as I don’t have any immediate need for the money. You can also withdraw money from a deferred annuity without annuitizing, but the tax treatment is not as favorable (mostly ordinary income on a last in, first out basis)
Annuities also come in two flavors of investment, fixed and variable. Fixed annuities are merged into the general assets and liabilities of the insurance company. You invest with them, they will guarantee you a fixed return, usually somewhere in the range of four to seven percent. Of course they turn around and invest your money and usually earn about 11 percent or so, but they assume the risk. The only risk you have is that the insurance company goes completely bust, but for this reason there are several rating services for insurance companies as to financial strength. One form of fixed annuity, Equity Indexed Annuities, are very popular right now with certain segments of the financial services industry, but any guarantee you can find in any fixed annuity can be found, usually in superior form with a superior product, in variable annuities. However, sales commissions for fixed annuities are much higher, so if you go to the insurance agent on the corner, you’re probably going to hear about a fixed annuity, especially if you don’t shop around.
In variable annuities, you assume the investment risk while the company still furnishes the insurance component. This is done via investing them in a set of mutual fund-like sub-accounts. Once annuitized, they make use of an assumed rate of return (ARR) on the underlying investment, which is usually between four and six percent. The higher an ARR you choose, the higher your initial payout, but if the results are less than ARR your payments can usually be reduced. Most if not all companies offering variable annuities do offer a minimum payout guarantee, and if your actual rate of return exceeds the ARR, your payments will be increased (indeed, this happens more often than not, within my experience). Variable annuities require not only an insurance license, but a securities license (NASD Series 6 or Series 7) in order to sell them, and are therefore usually purchased from financial advisors. The reason is because now you are assuming investment risk. I will caution the reader that while variable annuity sales commissions are not larger than advisor’s mutual funds, there is no reduction for higher investment amounts, so there may be incentive for some advisors to recommend variable annuities when mutual funds might be more appropriate. I have also seen “fee-only” planners take a fee for preparing an investment plan, then a commission for recommending these, where someone working on straight sales charge still gets the commission, but prepares the plan as “part of the package.” Nonetheless, when reading articles in the financial press, especially the “self-help” financial press, there is a heavy tendency to exaggerate the downsides of variable annuities, and the hypothesis that best explains the reasoning is that variable annuities require a financial professional to work with you as an individual. If you are working with a professional you trust, you’re not nearly as likely to go back to the bookstore or magazine stand for generic drivel with no fiduciary responsibility towards you. Admittedly, some advisors abuse it – and when they are caught, they are prosecuted and the insurance they are required to carry pays. The generic advice in books, newspaper, and magazines never has this responsibility in the first place. They are specifically exempted by the Investment Company Act of 1940.
I read a lot of, well, crap about variable annuity expenses. Most of it in the financial press, which should know better. How they have this expense and that expense and the other expense. The fact is that there are expenses associated with all annuities. The only additional expense that the variable annuity has that the fixed annuity does not is the expense of running the mutual fund-like sub-accounts, which actually average a bit lower than the equivalent mutual fund upon which these are usually based. Every other expense is part of every annuity – indeed, most of them are part of every insurance contract. Administration, Insurance, etcetera. They buy the stuff that makes an annuity an interesting and potentially worthwhile investment – that guarantee that you won’t outlive your money, among other possibilities. But because you’re dealing with something regulated by the SEC, the agent and the company have to tell you about them in variable annuities, whereas with every other insurance policy, they are a “black box” into which money goes and insurance comes out. Furthermore, variable annuities have a protection that fixed annuities do not. If the insurance company does encounter difficulty (rare for strong insurers), the variable sub-accounts are not assets of the insurance company, and cannot be attached by other creditors. They are yours.
Most companies offering annuities offer several options, depending upon what a prospective client really needs, and in what proportions. When I was in the business, the company whose variable annuities I most often sold when variable annuities were appropriate had twelve different annuities, offering this option or that option, depending upon which fit the clients needs, and they all had the same underlying subaccounts. On the other hand, I was appointed with a multitude of annuity companies, most of which I found had something to offer a certain client that was superior for that client’s purposes to other offerings. Furthermore, variable annuity offerings evolve over time. I ran across a reference to one that I used to sell in its II and III editions the other day, and it’s now in the VI form due to regulatory changes and a couple of product improvements.
On the pure investment scale, variable annuities have two significant upsides and one significant downside as opposed to mutual funds. The downside is easiest to explain. As previously discussed, they have a so-called “MIE” expense and charge ratio that goes from about one and a quarter to one and two-thirds percent per year (although some designed for asset-based management fees go as low as forty basis points), as opposed to 12-b-1 fees for most mutual funds are about a quarter of a percent per year.
The first upside is the fact that all monies invested in an annuity earn money tax deferred. This means that you’re not paying taxes on money invested in annuities as you go, only when you withdraw it. This has the minor downside associated that it’s all ordinary income, none of it capital gains, and capital gains may be taxed at a lower rate. Nonetheless, because you’re not losing a fraction of your gains, you are earning interest on your taxes for those years until it’s time to pay, as opposed to paying taxes on your earnings, after which they are gone. Depending upon various assumptions, this direct trade-off between higher MIE charges and deferred taxes will have a mutual fund theoretically leading an equivalent variable annuity sub-account for about fifteen years (I can get results varying from ten years to twenty-two without unduly torturing the assumptions), after which the variable annuity sub-account (net after taxes and redemption) will take the lead. This does not take into account investment re-balancing, which would work in favor of the variable annuity sub-account, as moving money between those has no tax consequences, something that mutual funds cannot say.
On the other hand, if you’re talking about money that is tax-deferred by definition, such as IRA, Roth IRA, and many other sorts, the variable annuity sub-account does not gain the the benefit of the first advantage I just listed, as it is already present. Nonetheless, many very smart people nonetheless have tax deferred money in variable annuity subaccounts. Why? That’s the second upside I was going to mention. Because the managers of mutual funds have to sometimes make decisions for the fund based upon tax consequences to shareholders, as opposed to strictly what’s the smartest thing to do, investment-wise, as a large proportion of their shareholders investment dollars are not tax-deferred. But every last dollar invested in variable annuity subaccounts is tax deferred. So variable annuity subaccounts will usually outperform the equivalent mutual fund as far as investment return. I’ve seen estimates that range anywhere from fifty basis points to 150 basis points (0.5% to 1.5%) per year for the average of this number, depending upon who is doing the estimating. Given the 100 to 140 basis point difference in MIE vs. 12-b-1 charges, considered as a pure investment, this aspect of variable annuity subaccounts is likely to fall short of mutual fund returns considered from a strict “how many dollars do you end up with?” standpoint. Note, however, that the MIE buys some guarantees (insurance) in the areas of minimum returns, locking in high investment values, lifetime payouts, etcetera, which mutual fund 12-b-1 fees do not. If you’re prepared to undertake a lot more risks, mutual funds will probably (but only probably) come out ahead. If you want some guarantees, the variable annuity sub-account has a lot to be said for it. I know of many people who were looking to retire based upon mutual fund account balances in 1999, who are still down major percentages of what their portfolio value was then. If they had invested in a variable annuity, that 1999 value might have only been 99 percent of the mutual fund value, but they would still have every penny of it and then some.
Caveat Emptor
Recurring Problem
I try to update the site Monday Wednesday and Friday. Sometimes, however, when I try to go to the login screen I get a note that the string is too long and cannot log in.
If anyone knows Word Press well enough to advise me on the problem, that would be appreciated. Interestingly, it has not happened yet on the Dan Melson Author site, which runs off a different installation of WP on the same server.
Disasters and the Mortgage
after Katrina I am upside down with my mortgage.
my house is uninhabitable. My flood insurance check
doesn’t payoff the mortgage. How can i get a short payoff
due to financial hardship – i.e. relocation loss of jobs and
steady income?
This is one of the hard truths about mortgages. They are a contract between you and the lender to pay back a certain amount of money that you borrowed in order to purchase that property. They have nothing to do with any unforeseen hardship, and if you do not pay that money back, in full and on schedule, you can anticipate negative consequences no matter how good the underlying reason. Especially to your credit, and those are going to be long term consequences indeed.
Now unforeseen disasters, like Katrina, Earthquakes, floods, fires etcetera, are one of the biggest reasons why things go wrong with your ability to repay that money. Something happens to the property and now you can’t live in it, and you do need to pay for housing elsewhere. Furthermore, in widespread disasters like floods and earthquakes, since your job may no longer be there, you may have to relocate a considerable distance away in order to find work, and have difficulty paying your mortgage even if your property, in particular, came through just fine.
There are several issues that trap the unwary or uninformed consumer. Homeowner’s Insurance in general is the first of these. Many lenders in other states have requirements that the property be insured for the full amount of all mortgages against the property. This requirement is illegal in California (and a few other states), and actually is counter-productive as this implies that the objective is to pay off the lenders, when the objective of insurance is to repair the damage. The phrase that California lenders look for in the policies of homeowners insurance that any lender can and all lenders do require is “Full replacement value.” In other words, the insurer must agree to bring the property back to being in the same condition it was in prior to the covered event that caused the damage. Nonetheless, there are many properties where this kind of coverage is not available, most often due to their location in areas vulnerable to periodic fires. In such instances, you can expect lenders to require significantly larger down payments and charge higher interest rates, if they are willing to lend against the property at all. Since in the current “Everybody buys with 100 percent financing” trend this severely impacts your ability to sell your property, and therefore the value you will receive for it, you should be advised of the difficulty before you purchase the property, no matter how much you have for the down payment. An agent who doesn’t tell you about this issue on properties where it is an issue is either incompetent, or not looking out for your best interest.
Another issue with homeowner’s insurance is that you must keep the insured amount reflective of your home’s current value. If you bought ten years ago here in San Diego, you probably paid about $150,000 for a three bedroom single family residence. I don’t know of any single family residences below about $350,000 now, and most are in the mid 400s or higher. The insurance companies, quite reasonably I might add, take the position that even if you have “full replacement value” coverage, your home is only insured for $150,000, and is worth $450,000, you are not insuring it for the full value and will not pay the full bill for any repairs even if it is only for $100,000. In such a case, it’s been a while since I went over the figures that are the legal basis for the math, but in this particular instance, I get that the insurance company will pay $41,666 out of that $100,000 repair bill in this particular instance. The threshold is legally if you had the property insured to at least eighty percent (80%) of its actual value, they will pay the full bill, but you only had it insured to 33 percent of the value, and therefore they will only pay 33/80ths of the bill. So once every couple of years (more often in markets rising 20% per year!) talk to your insurance company about making certain your property is properly insured. Yes, you’ll pay more money, but it is a trivial amount compared to the cold hard fact above. My first property has multiplied in value by about three and one half times, and the difference between the insurance premium then and the insurance premium now is less than fifty percent. Now some insurers (mine among them) have a good record of not invoking the 80 percent rule I’m talking about here and paying the full amount, but this is a matter of company policy, not legal requirement, and it can be changed at any time and no matter how benevolent they are, if the disaster is bad enough they will have no choice. Furthermore, those folks who keep their coverage updated are de facto paying for those who don’t under such a policy, and for those who do make a habit of keeping their insurance coverage updated may find more competitive rates with other insurers.
Two things everybody needs to be warned about is that no regular policy of homeowner’s insurance, not even the vaunted H.O.3 policy with the H.O. 15 endorsement, covers against flood or earthquake. If possible flood or earthquake is an issue where you are, you need to buy a special policy to be covered by them. Flood and earthquake policies usually have a higher deductible than a basic homeowner’s policy, and the reason for this is simple: solvency of the insurer and price of the insurance. Flood and earthquake are typically widespread devastating disasters that make for major damage over a widespread area. If the deductible was smaller, the price of the added policy would need to be much higher, as paying off such claims strains the financial resources of even the strongest insurer. Now if you’re buying on stable soil atop the highest ridge line for miles around, flood insurance is probably not a worry for you. I sit roughly two tenths of a mile from a creek bed, but the amount of territory it drains is relatively small, only a of couple square miles, as the big watercourses go well away from where I sit and there are large hills between me and them. On the other hand, being in California, I’ve had earthquake insurance since the day I bought the property.
One more thing with flood insurance: There is a federally mandated thirty day waiting period between application and payment of premium and the time it goes into effect. This is to prevent, for instance, people in New Orleans waiting until there is a hurricane headed their way and rushing out and buying flood insurance, then canceling it and asking for a return of their premiums afterwards. I think the thirty day requirement is waivable to the extent that it can go into effect on the day you buy your property, but talk to your insurance agent.
Now, one final thing to be aware of. The value of the land itself is not insured, only the value of the improvements to that land. If a flood goes through your land, the land will still be there afterwards (and research riparian rights sometime if you’re worried it will not be – another thing a good agent should warn you about if it’s relevant). So if, like many in San Diego, you bought the property for $500,000, but it only cost the builder $200,000 to put the property together, the value of the land is obviously $300,000, right? Well, your mortgage is for eighty percent or ninety percent of the value of the improvements plus the land. Let’s say 80%, $400,000, although I suspect that’s on the low side of both mean and median. So when a disaster destroys the improvements (i.e. the home) and your insurer sends you a check to rebuild those improvements, that $200,000 check is obviously not going to cover the full amount of the mortgage. What do you do?
Well, that’s where the importance of a good insurance policy, that will cover the costs of housing while you rebuild in addition to the costs of rebuilding the home in the first place, comes in. You’ll also need to learn the value and importance of managing cash flow versus amount you may owe, but that’s a subject for another essay and you should consult a good professional financial person if you haven’t learned this before said happens in any case. Trying to learn that financial skill “as you go” is a recipe for guaranteed disaster. Furthermore, no matter how good your policy of insurance is, there is always a deductible and there are always extra expenses of rebuilding that you need or desire to undertake because it’s the best and cheapest time to do so. This illustrates the value of building up and maintaining an emergency fund that you can access, because even if the finished property will be worth far more, no regulated lender will touch a refinance for cash out while the property is still under repair. A “hard money” lender might lend you new money, but they require so much equity in the property “as it sits right now” that this is not an option for the vast majority of all property owners. And in the meantime, you must keep up all payments required under the original loan contract you agreed to.
Caveat Emptor
Issues with Relocation Loans
Sooner or later, a pretty fair proportion of the population are going to get an offer for a much better job, but the catch is that job is located in another city on the opposite end of the country. What are the major issues relating to the mortgage?
Well, first off, the relocating spouse may not have the job until they actually report for their first day at work. Many times people are told “Go there and you’ll have a job,” and when they get there, they don’t. So no matter how much time you have in that line of work, until you actually have the job things are iffy and you can expect loan underwriters to reflect that. The job offer letter may or may not get the job done – it usually doesn’t. Usually they want at least an employment contract, sometimes (particularly A paper) the first pay stub as well. It can be rough, and a waste of money to rent, but over the lifetime of a loan with a higher interest rate, it may pay off to actually wait until you’ve got that first pay stub.
Now just because the one spouse has a job offer doesn’t mean the other spouse will get a job in their field. Sometimes they work in a field where there is no problem finding work, like health care. Sometimes they work in a field where moving means they don’t have a career, and they’re going to have to start all over in some other field. If you worked in a distillery and you’re moving to Salt Lake City, you’re probably going to need a career change. If that job is similar enough to the one you left behind, that’s cool. But if you used to be a bookkeeper and now you’re a retail clerk, they you do not have two years in the same line of work. Chances are your family is not going to be able to use your income to help qualify for the loan. They are not going to be able to use it at all until you have a job that has income. Since this can take a while, you really might be better advised to rent for a month or two (or even six, if that’s the shortest lease you can find). If, of course, one spouse isn’t working and doesn’t plan to, this isn’t really an issue.
Next, there are the issues with the property in the old city. Many times, especially in a buyer’s market like now, the property has not yet sold, becoming a drag upon your ability to qualify for a new loan. If you can rent it, that’s certainly one solution, but most lenders will only allow 3/4 of the monthly rent to be used to qualify you for a new loan, but will charge all of the expenses against this. Considering that around here it’s tough to get a positive cash flow for a rental property in actual terms, you can imagine how tough it is when your monthly income from the property is chopped by 1/4, and how much more you will need to be making, in order to justify the loan.
Another thing is that most folks expect to be able to use the entire amount of the new salary to qualify, and that’s not the way it works. If you made $6000 per month for the past two years, one month at $9000 isn’t going to move that monthly average income up very much. The computation is done on a weighted average basis – you’ve got 23 months at $6000 per month, or $138,000, and 1 month at $9000, which when added makes for a grand total of $147,000, or about $6125. Often newly relocated folks have to settle for sub-prime loans when they are normally A paper so that they can use bank statements or something else to qualify. And of course there is always stated income, but there are rules for that, especially A paper.
Caveat Emptor
Issues Relating to One Spouse Qualifying For A Loan On Their Own
“I am married but want to refinance my house only in my name. What do I have to do?”
This is actually pretty easy, and there are at least two ways to potentially accomplish this, depending upon lender policy and the law in your area.
Most lenders policies require the property to be titled in a compatible manner to the loan. Some few do allow the spouse to be on title and not a party to the loan, in which case they will be required to sign the Trust Deed, although not the Note. Most lenders, however, will require that if you are the only one on the loan, the property be titled in your name exclusively. So your spouse will be required to sign a quitclaim to “Jenny Jones, a married woman as her sole and separate property” (Or “John Jones, a married man as his sole and separate property). If you don’t like the title being this way, that’s fine and don’t sweat it. You can quitclaim it back to “John and Jenny Jones, husband and wife as joint tenants with rights of survivorship” as soon as the loan records. What matters is that the people agreeing to the loan, as of the moment the Trust Deed comes into effect, is reflected in the official title of the property.
For those intelligent individuals whose property is in living trusts, this is also a common feature of getting a loan on the property. The lender will usually require it be quit-claimed from “John and Jenny Jones, trustees of the Jones Family Living Trust” to either the sole individual who qualified for the loan, as in the previous paragraph, or to “John and Jenny Jones, husband and wife as joint tenants with rights of survivorship.”
All of that is the easy part. Now comes the hard part. If one spouse wants to be the only one on the loan, then they must qualify on their own. Only their income may be used. However, since most debts in a marriage are in the names of both partners, typically they are going to going to be charged for most debts on their qualification sheets. This really is no big deal if that particular spouse is earning all of the money anyway, but in most cases these days, both spouses are working, and they want to buy the biggest home they can, so it can be difficult to qualify them for that home based upon the income of only one spouse. Here’s a typical scenario: He makes $5600 per month, she makes $5000. They have two $400 per month car payments and $120 per month in credit card minimum payments. But he has rotten credit, so they are hoping to secure a loan on better terms. By A paper full documentation guidelines, she only qualifies for a PITI payment of $1330 ($5000 times 45%, minus $920), which might get a one bedroom condo in a not so hot area of town. So then they have to go stated income in order to qualify for the loan on the home they really want. As a couple they qualify for payments of $3850 ($10,600 times 45%, minus $920), which will get a decent single family residence in an okay area of town. You, the readers, can guess which of the two properties the average couple in this situation is going to shop for. Unfortunately, many times her profession is not one where the lender will believes she makes twice what she really does without verification. This is a real issue, especially if they went and got a prequalification from someone who figured both of their incomes in the equation, so here they are with a purchase agreement and they can’t qualify like they thought they could. This is one reason I’ve learned never to trust someone else’s pre-qualification of a buyer, because in this situation, the only way to make it happen is to put John, with his rotten credit, on the loan. Because he makes more money than Jenny, he will be the primary borrower, and so the loan will be based upon John’s bad credit history, not Jenny’s above average FICO. There are ways to potentially get around this, but sometimes they work and sometimes they don’t, at least in the sense of getting John and Jenny a better rate on their loan, or of qualifying them to get a loan at all. Better to get John’s credit score up where he will qualify for a good loan beforehand, of course, but usually these folks want a loan now so they can get this home they’ve already signed a purchase contract on. The ability to improve credit scores in a short period of time is limited, and it’s even more limited if John and Jenny are short on cash, which is usually the case.
These can all be issues with the spouse who makes less money, also. Reverse the incomes, so that John, with his bad credit, makes $5000 per month and Jenny, with her good credit, makes $5600. So at least Jenny is primary on the loan, now, but most people are not in professions where the lender will believe they make almost twice what they really do, so stated income A paper doesn’t fly, and John and Jenny have to go sub-prime because if you put him on the loan, both spouses must qualify A paper and John doesn’t. Sub-prime means higher rates and a pre-payment penalty, unless you buy off the prepayment penalty with an even higher rate.
Now, in point of fact many borrowers these days are ones that have settled upon a property before they even considered a loan, and are determined to get that property no matter what they have to do. Alternatively, they may have talked to someone about loans who gave them a budget which was in fact accurate, but they liked this property so much that they are utterly ignoring that budget. Such people are going to end up with bad loans. They want more house than they can really afford, and they want it now. I can get the loan for them, any competent loan officer can get it for them, but there will be consequences down the road, because there are still those pesky payments they have to make (or negative amortization that builds up. Or both). A loan you cannot afford is a course for disaster, and the longer you’re on it, the worse the disaster gets.
But so long as a couple is qualifying for a loan where they really can make the payments, it’s all okay. The one thing that bites a fair number of people is divorce, where one ex-spouse figures that because he (or she) qualified all by themselves so they should be able to make the payments all by themselves. But the loan officer used stated income without telling them, and once that other income is gone, it turns out that they can’t make the payments. Not only can they not make the payments, they cannot qualify to refinance now. Typically, most people live in denial about this for way too long, ruining their credit to where they can no longer qualify for the loan on the lesser property they would have been able to get if they had done the smart thing in the first place.
So one spouse qualifying for a loan on their own has some real issues to be aware of, and that will turn and bite you if you’re not careful enough.
Caveat Emptor.
Buyer’s Markets
One of the phenomena that I am encountering is fear of the market in buyers. They are concerned that prices are falling, and that they will lose some or all of their investment.
Well, the first thing to understand is that buyer’s markets are not the time for “flippers”. You are not going to buy the property and make a profit after the expenses of selling in six months. That’s a seller’s market, and buyer’s markets don’t work that way. Two years ago, most prospective buyers were using the f-word (“flip”). Now, those people who were buying to flip are caught flat-footed by a market that has turned, like deaf kids in a game of musical chairs. The signs were there, but they were just a little too greedy.
Nonetheless, a buyer’s market is the best time to buy for everyone else, and here’s why: Inventory. Turnover Rate. Market Saturation. Supply and Demand. Instead of being the kings of the world, sellers have now turned into the beggars. The ratio of sellers to buyers locally is approximately 36 to one and climbing, as 960 properties were listed but only 397 purchase agreements were reached last week. Imagine you’re in an environment where there are 36 people of the opposite sex for every one of yours. I’m assuming you’re interested in the opposite sex, but even if you’re not, you should be able to understand the implications. That one woman with 36 men to choose from is going to be able to get just about anything and everything she wants. Even the woman who would be completely ignored in other circumstances is going to have multiple, attractive suitors. Alternatively, the one man with 36 women to choose from is going to end up pretty darned happy, even if he is short, fat, ugly, middle aged and balding.
The sellers in this market don’t really have the option of choosing other sellers, as it doesn’t help them. They have real estate, they want cash. Just like how that short fat ugly balding middle aged guy does pretty well for himself when there are 36 women for every guy, so does the buyer who has cash, or can get it via their power to get a loan.
Prices are likely to drop for a while, but you will never again have this ratio of sellers to buyers, and the market could turn at any time. If you wait for the market to turn around before you put in a bid, you will be much less sought after. Right now, the power of the market puts buyers in control of the transaction. If this seller isn’t quite desperate enough to do what you want them to, the one down the street or around the corner is. Like the 36 men to every woman scenario, if this man isn’t able or willing to meet the woman’s full wish list, she can move on to someone who is.
Buyer’s markets don’t last long. The last one was less than a year, and only about two months that buyers had peak power. If you buy for a little more than market bottom, so what? The only time value of the property is important is when you sell and when you refinance, and I’ve already told you this is not a flipper’s market. But once other potential buyers get the idea that there are bargains to be had, they will come out of the woodwork, and the vast majority of your purchasing power will be gone when the ratio of sellers to buyers drops to four to one. And soon after that, they turn back into seller’s markets. When that happens, watch the prices – and the profits – shoot back up.
Miss the window for buyer’s markets, and you’ll pay for it later. Any market is always most lucrative when everybody else wants to do the exact opposite of what you’re doing. Pick and choose your properties with care, and you will do very well when the market turns, whether that is next month or next year. Right now, you have your pick of sellers, and your pick of their properties, and the leisure to consider. When the ratio of sellers to buyers drops, it gets much harder to find these kinds of bargains, and much harder to get in before someone else has locked it in by getting an accepted offer.
Caveat Emptor
Mutual Funds: What They Are And How They Work
For being the most popular investments in the country, many people have a “black box” picture of mutual funds. Money goes in one end and more money (usually) comes out the other.
Mutual companies in general are a very old concept. The Egyptians had them in ancient times, mostly for insurance purposes. For one time investments, they go back at least to Europe in the middle ages. But it wasn’t until 1924 in the United States that somebody had the bright idea of making it a continuing thing, an actual business planned around the continual making of communal investments. (The very first mutual fund is still going, by the way, as a member of one of the bigger advisory fund families.) Regulation of mutual funds and similar entities dates to the Investment Company Act of 1940.
The basic concept is this: A group of people get together and pool their investment money, and invest it as a group. They all own a portion of the entire pool of investments.
This buys a lot. It buys economies of scale, as the costs to trade 10,000 shares are significantly less than 100 times the cost of trading 100 shares, and way less than 10,0000 times the cost of trading a single share. It buys instant diversification, as the group has plenty of money to split among enough investments so that the failure of any one will not unduly hurt them. It buys (theoretically) top tier money management, because there’s enough money in the group such that the cost to pay such a person isn’t prohibitive, as it is to average investors on their own. Furthermore, there is no need to purchase an even number, or even an integer number of shares, so you can invest any amount that is at least whatever minimum the group agrees upon. You can typically buy mutual fund shares in increments as small as one one thousandth of a share, so if you want to invest $507.63 exactly, that’s not a problem as long as it’s above the minimum investment, or minimum additional investment, whichever is applicable.
Because there are costs to the group associated with adding a new investor or making a new investment, they do have rules about minimum initial investment and minimum additional investment. For some “no-load” funds, the minimum investment can be several thousand dollars. For advisors funds, where there is a sales charge, the minimums are typically smaller, something along the lines of $250 or $500, as the sales charges discourage short term trading. Indeed, some of the advisors funds will accept initial investments as small as $25, as long as you agree to monthly investments.
The math of mutual fund share price is mostly important to the accountants, not the investors. Initially, it’s quite arbitrary. There is a given pool of investment dollars, and the group, or investment company, decides that share price is going to be $10.00 or $25.00 or whatever. Note that, with mutual funds, there is no practical difference between $1000 buying one hundred $10 shares or forty $25 shares. It’s just a matter of record-keeping. There is a minor record keeping argument for setting initial share price low, but it’s mostly important for record keeping.
During each trading day, the number of shares is kept constant. Whether or not there is any trading activity, any new investment, or any redemption, the number of shares stays constant until the end of the trading day. At the end of the day, the fund computes the value of the underlying investment, divides by the number of shares for that trading day, and that becomes the share price. At this point, the end of the trading day, any redemptions or new investments take effect If someone wants to redeem a given number of shares, the company sends them share price times number of shares. If someone wants to redeem a given amount of money, the fund divides that by the share price and redeems that number of shares. If someone invested money in the fund that day, the purchase takes effect at the end of day price. You can buy a given number of shares (providing you sent them at least enough money) or, more commonly, you can invest a certain number of dollars, which will be divided by the share price to calculate the number of shares you bought. For these reasons, among others, short-term trading mutual funds of any sort is a pointless way to waste money, and Exchange Traded Funds are a method for extorting money from the gullible (If you must day trade, S&P and similar option based alternatives are superior). Mutual funds are for investors who intend to hold for a while.
As time goes on, there are several sorts of events that influence share price. First off, that the underlying pool of investments fluctuates in value, going up and going down with supply and demand. This happens whether that investment is bonds, stocks, or both. Bond prices and stock prices change every day, with supply and demand and market conditions. Always, within a given day, the number of shares in the fund is constant. At the end of the day, the effects of the market and any trading the fund did are taken into account, and the end of day share price is computed, and all of the day’s transactions in shares take place at the end of the market day. In order to be processed by the fund on that day, any orders to buy or redeem shares must be received by the fund prior to market close, or they get the next day’s share price. There have been people criminally convicted and sent to jail on this point, for gaming the share price.
The second thing that happens to influence share price is income. Every so often, one of the fund’s underlying investments will pay a dividend (stocks) or make an interest payment (bonds). Each one of the fund’s shares (not shareholders!) is entitled to an equal share of this money. Say that the fund gets a million dollars over the course of a certain period, and there are ten million shares outstanding. Each of the shares will get a payout of approximately ten cents. I say approximately, because there are other concerns involved. Now, because this money has been received over a period of time, and until the payout was included in the overall value of the fund, the price per share will be reduced by whatever the payout is (and all funds hold at least a small amount of cash). So if the price per share was $15.00 before a $.10 per share payout, it will be $14.90 afterwards. Some shareholders will have elected to receive income in cash, and some will have elected to have it automatically reinvested (each share’s payout purchasing 1/149th of a share in this example), but in either case, this has tax consequences for the investors unless they made their investment from within a tax deferred account such as an IRA (among many others), and the money remains within that account.
The third thing that has an impact upon share price is capital gains (and losses!). If the fund invested $1 million by buying 50,000 shares of ABC company at $20 per share, and ABC company goes to $30 per share, the value of those shares has increased to $1.5 million. So long as the fund management holds onto those 50,000 shares of ABC, it’s just a paper increase, and if there are ten million shares of the fund outstanding, that means that each share of the fund effectively owns fifteen cents of ABC, and five cents of that is an unrealized gain.
But let’s say that the share price of ABC goes to $50 per share, and the fund management decides that it’s time to sell those 50,000 shares. Now they sold for $2.5 million, and of that, they cost $1 million to buy (This is usually stated by saying that those 50,000 shares had a basis of one million dollars) But the remaining 1.5 million dollars is profit for the fund. If there are still ten million shares outstanding, that’s a 15 cent per share capital gain. Assuming there are no other capital gains or losses for the period, the fund declares a fifteen cent capital gain. Just like income received, if the share price was $15.15 before, it will be $15.00 after. Some investors will have chosen a payout, and some will have chosen to reinvest. The ones who have chosen a payout will get a check of fifteen cents multiplied by however many shares of the fund they own, while the ones who have chosen to reinvest will each get one one hundredth of a share per share they already own. Whichever they have chosen, unless the investment comes from and remains within a tax deferred account such as an IRA, there will be tax consequences for the individual investors.
Most mutual funds are not “stand-alone” investment companies. They are members of a family of funds, theoretically investing only in a particular investment niche. This allows the entire fund family to amalgamate their marketing efforts and administration. Particularly with advisory funds, most investors should find a single fund family that meets their needs to stay within, in order to minimize sales charges. The family may or may not have input as to a given fund’s management team. Nonetheless, each fund has its own board of directors, and there is not usually anything legally binding a particular fund (“investment company”) to a particular fund family if the investors and fund management really want to leave.
Now there are some potential weaknesses of mutual funds. The fact that there are tax consequences for investors is not an issue while still holding most other sorts of investments, at least not to the same degree. So most mutual funds find themselves with incentives to do something, or not do something they would otherwise have done, due to tax consequences to their investors. Furthermore, most mutual funds are way too dilute. The optimum number of investments, according to mathematical models, is between twenty and thirty, and given that the overwhelming majority of investors who invest in mutual funds have invested in several different ones, a smaller number of investments per fund is more appropriate than a larger number. It being that time of year right now, I just got a statement from one of my funds listing over 400 holdings. There are reasons I continue to invest in that fund and that family, but I’m certainly not happy about that aspect.
Nonetheless, even with these weaknesses, a mutual fund’s ability to deliver immediate diversification, economies of scale, and professional management with only a modest investment, well within the capabilities of beginning investors, are excellent reasons why most investors should strongly consider them as an investment vehicle, especially starting out. That they are also very liquid, and not subject to large purchases and redemptions significantly influencing share prices, can give even a large investor with “high risk” predilections reason to park money there for a time.
Caveat Emptor