Helping Yourself Qualify for a Home Loan

There are a fair number of specific helpful suggestions to make in helping you purchase a home. All of them revolve around the loan. Let’s face it, the loan is far and away the most hypothetical and uncertain part about most real estate transactions. If there is a non-loan related problem, chances are that you really didn’t want to buy that particular property anyway. Most of the time, these problems mean that you would be buying into trouble, and nothing but. Unless you have specialized knowledge in sorting out that particular problem, it’s likely to be more expensive than any money you saved through reduced purchase price.

A poor loan officer can always botch a loan, of course, and even the best may not be able to push it through if you are a marginal enough case. So how do you improve your case standing?

The first thing is to get a credit score above 720. If you’re there already, keep doing what you’re doing. Even if you’re not there yet, it’s easier to improve than most people think, although it takes time. Make all of your credit payments on time, especially any mortgages and rental payments. These are the most important things to mortgage lenders. Note that you make a payment a few days later than it is due, and you may even pay a penalty, but the lender will not report it as late until 30 days later, and that’s when it counts as late to everyone else. In order to qualify for the A paper loan, at the top of the market, the general rule is no more than two 30 day late payments on revolving debts within two years, or one 30 day late on mortgages or rent.

Most lenders want you to have three lines of credit, and a twenty-four month credit history. Not all of them need to be still open, but if you don’t have at least two open lines of credit, a given reporting bureau may not report a score, and if you don’t have two different scores from the three big bureaus, only a few sub-prime lenders will give you a loan. The longer your particular lines of credit are open, the higher your score will be. So if you keep opening new lines of credit, expect your score to be low.

Revolving credit balances should be kept low, less than half of their limit. There is a significant hit if your credit line is more than half its limit, and the higher you go, the worse it is. If you have two $5000 limit credit cards, it is much better to have $1500 on each than $3000 on one and nothing on the other. It make even more difference if you have $2000 balance on each as opposed to $4000 on one. And if you’re one of those people who keeps doing the “transfer your balance to a new card and get zero interest for six months” thing, it will really impact your credit in a negative way, because if your credit balances sum to $8000, that’s usually what the limit on the new card will be, and so you’ve got a brand new credit card that’s maxed out, which is a major hit on your credit.

One of the best ways to improve your credit score relatively quickly is to use your credit regularly but pay it off every time you get a bill. Once per month, charge something small that you know you will be able to pay off when the bill arrives. This may still take some months to improve your score, but better months than years.

The next way to improve your ability to afford a house is not to have any large monthly payments. The best rates are for full documentation loans, where you prove to the lender that you make enough money to be able to afford all of your payments. “A paper” lenders will allow you to have total monthly payments of 38 to 45 percent of your gross monthly income. Some sub-prime lenders will go to 55 percent. If your family makes $6000 per month, this means that total payments can be up to $2700 for certain A paper loans, up to $3300 for sub-prime and still qualify full documentation. This also means that the more income you can document, the more house you can afford.

This number includes not only the amount of the mortgage, but also the property taxes, homeowners insurance, association dues (if applicable), and anything else you may need to pay in order to keep the home, as well as car payments, credit card payments, and any other debts you may have. This means that somebody with other payments of $80 per month can afford a lot more house than somebody with other payments of $900 per month. This should be intuitive, but you’d be surprised how often people don’t realize it.

The final thing that is helpful is a down payment. The larger your down payment, the less you have to borrow. Lending money is a risk-based business. Up to a point, the lower the ratio of loan balance to value of the property will help you get a lower interest rate and more favorable terms, because the bank will be more certain of getting all of their money back. A 5% down payment is better than none. 10% is better than 5%. The first 5% makes the most difference, but every bit helps. Of course the larger your down payment, the less you have left over for other purposes. It seems to be a phenomenon today that people don’t want to risk any more of their own money than they have to, and 100% loans can be done right now, although how much longer that will be the case is anyone’s guess. Still, people who make a habit of saving money are always in a stronger position that those who do not.

Caveat Emptor

Did That Slap On The Back Leave a Knife?

One of the things the place I work does to attract clients is advertise foreclosure lists to our clients. Several times a week, people call and ask for the lists, and we say, “Great! Just come on down, fill out a loan package and an agency agreement, and we’ll get them to you fresh every morning, and when you see one you might be interested in, we’ll help you get it!”

Before the end, over 95% of the people have stopped us, saying they are already working with someone. “I just want the foreclosure list. Can’t I get it?” Well, we pay money for that. Why should we give it to someone who is not our client and has the ability to pay for it on their own? Why didn’t their agent get it for them? (Everyone can get a weekly list for free from the county – but that list is worthless except as a timewaster, because that list is three to ten days out of date and they’ve already been swarmed.) If they want to work the foreclosure market, they should have signed up with an agent who has daily foreclosure lists. They haven’t even found a property they are interested in yet, and already they know their agent isn’t cutting the mustard for their purposes. But they are still stuck with them.

Another trick high margin (“expensive”) people use is social groups. Nothing wrong with social groups and using people you know there, but make certain you’re not paying three or five times the going rate for a loan, and that your agent really knows what they are doing before you sign on the dotted line. Church groups, soccer coaches, scoutmasters – I can’t tell you all of the social acquaintances I’ve rescued people who became my clients from. These predators look at other members of the group as a captive audience. It isn’t so, of course, those people have the option of going elsewhere – it’s just difficult socially, and many of them are unwilling to make the effort.

One of the worst of these is family. Your brother, sister, aunt, or nephew is in the business, and your family makes it difficult not to choose them. “You simply must use your sister Margaret!” Well, if subsidizing Margaret to the tune of two points more than anyone else would get is your cup of tea. Around here, that’s $8000 or so for the average transaction. You are not writing the check for the extra to Margaret directly, but you’re paying her just the same.

Lest I be misunderstood here, there is nothing wrong with using friends, family, members of your social group. Please do check with them. The mistake is not in giving them a shot; it lies in giving them the only chance. That’s what you call a monopoly situation, and the chances of you getting the best possible treatment are horrid. But if Aunt Marge or Uncle Bob know you’re shopping around, they have more incentive to do their best work. If they know you’re not, well I hate to break it to you, but the average person is looking for a bigger paycheck for the same work, and this includes friends, family, and social acquaintances, particularly because you are not the one writing the check, but you will pay for it, guaranteed. The worst mess I’ve ever had to clean up was caused by my client’s uncle, who had been in the business twenty years, and was trying to extort just a little too much money for the deal to work.

On the other hand, when my cousin calls me out of the blue, I can cut him a deal because here is a transaction that I didn’t have to spend time and money on wrestling it in the door; it walked in of its own volition. This is far and away the toughest part of any transaction, and one of the most expensive to any real estate practitioner – getting a potential client into your office. It’s why the “big names” spend so much on advertising nationally, and give their folks half (or less) of the cut a smaller place will give them. (Hint: just like in financial planning or any other service, what’s important is always the capabilities and conscientiousness of the individual performing the service, not the company).

So here’s how you live up to the social expectations. Give them a shot, but not the only shot. If you are looking to buy and they are an agent, sign a non-exclusive buyer’s agreement with them. This gives you free rein to work with other folks as well; just don’t sign any exclusive agreements. Most agents, unfortunately, want to lock up the commission that your business represents and so they will present you with an exclusive agreement. The harder they argue for an exclusive agreement, the more you should avoid them. All an exclusive agreement does is lock you in with one agent. If they are a lazy twit, you either have to wait until the agreement expires, use them for your transaction anyway, or hope you can get them to voluntarily release you. There is no way for you to force them to let you go. I get search phrases like “breaking an exclusive buyer’s agreement” hitting the site every day. The only two ways to break an exclusive agreement are 1) wait for it to expire, or 2) get them to voluntarily let you go. I’ve never heard of the latter happening. So don’t sign an exclusive agreement in the first place. Sign a non-exclusive agreement. This puts all of the motivations for work on your side, where they belong. The one who finds the property you are interested in will get the commission, but they have to work for it, as your business isn’t locked up.

This also gives you an out if Aunt Marge or Uncle Bob doesn’t cut the mustard. You can tell anybody who gets their nose out of joint, including them, that you gave them the opportunity to earn your business, and somebody else did a better job. The other guy saved you money, the other guy found you the property you wanted, the other guy got you a better loan. You wanted to do business with them, but they didn’t measure up. Case closed, and Aunt Marge or Uncle Bob will drop it if they are smart, because the more stink they raise, the more likely it is that another family member, friend, or social acquaintance will pass them by in favor of “Could you give me the name of that guy who helped you?”

The only exception to the non-exclusive buyer’s agreement is if they are giving you a service that you would otherwise have to pay money for. I am not talking about Multiple Listing Service – those are free and plentiful. I’m talking about real time information not available to the general public – like daily foreclosure listings. Our office pays hundreds of dollars per month for that as a way to bring in business. It is reasonable for someone working the foreclosure market thusly to be asked to sign an exclusive agreement, because otherwise there may be no way to determine who introduced you to the property (Lawyer’s Full Employment Act strikes again!)

For sellers, unfortunately, you’ve got to make a commitment to list with one agent. It’s just the way it has to be, economically, in order to get them to commit to spending the kind of money it takes to get a good result. But you can interview more than one agent. What are they going to do to sell your property for the highest possible price? Put it in the contract when you do sign. Everybody can put it in the MLS, and during the bull housing market we had for years, where unless the property was obviously overpriced you’d get multiple offers within a week, a lot of monkeys masquerading as agents made a good living doing that and only that. That doesn’t cut the mustard any more. I work more with buyers than sellers, but there are venues that sell the property, venues that bring people to open houses, venues that generate people looking for the cheap bargain (which you don’t want) and venues that generate people looking for property like yours in your neighborhood (who is your ideal buyer). Especially in a major city, these are all different venues, and the agent who knows which one is which is worth more than you will pay them, and the cheap agent who doesn’t is likely to cost you a lot more money than their cheap asking price saves you.

For loans, I’ve written about this before, but shop around, ask questions of every loan provider you interview, beware of red flags, and stick to your guns. Try and find someone to act as a backup loan provider if you can, and do the work so both loans are ready to go when you need them. If you get multiple volunteers for backup provider, that would tend to indicate that they know that the loan you’re telling them about isn’t real. That’s the question I ask before I volunteer to put in the work of a backup provider. “Could the loan they are telling me about be real?” If the answer is no, I volunteer to act as backup. Every single time, it’s been my loan the person ended up getting. Your prospective loan providers should know the market if they are competent. Make use of that knowledge. And lest you be tempted to quote something at those loan officers that is not real, it’s a self-defeating strategy. Honest loan officers will tell you point blank they can’t do that, while the scamsters are going to get into the spirit of the situation, by which I mean saying anything it takes, no matter how fanciful, to get you to sign up. And those who are knowledgeable about the state of the market always know what is likely real and deliverable, and what likely is not.

Caveat Emptor

Buy Now vs. Wait: Some Practical Hypotheticals

I am hoping to buy in the (city) area and am reviewing the possibilities. While I fear that the local market may be peaking, I intend to live in the home for at least ten years, so I am not trying to time the market.

My questions have to do with the down payment. I expect to shop for a property in the $450,000 range, and currently have $60,000 available for a down payment. I make a decent salary and receive an annual bonus of $35,000 – $40,000 each February. The bonus, while not guaranteed, is very dependable. After taxes and deductions, I should realize about $20,000 – $25,000 from it.

Do you think I would be wise to wait until February, by which time I will be able to make a down payment of $90,000 and perhaps avoid PMI and pay less interest over the life of the loan, or seek to buy now and lessen the taxes on the bonus? (I itemize, am single and am in the 28% bracket). Will the greater down payment help me to capture a better interest rate on the loan? (My credit scores are right around 800). Also, if I buy now, is it possible that I will be able to negotiate a mortgage in such a way that I can pay my realized bonus in February as a lump sum towards the remaining principal without incurring penalties? Ideally, i would like to use my bonus each year to pay down principal, as I can afford to balance my budget, including regular mortgage payments, without touching the bonus.

While on the subject of credit scores, I am reminded of another question – does an 800 score do me any good as contrasted with, a 740 or 750? Thank you again for your consideration. Your writings have been invaluable to my education.

I needed some more information, so got a subsequent email

I would expect the property taxes to run about $5,000 annually and association dues to be another $350 monthly. As I don’t have a car, parking fees will be inapplicable. My closing costs should be somewhat reduced as I work for a bank (parent company) and they offer employees favorable mortgage rates with no points and no origination fees. Of course if I go elsewhere for the loan that would not apply, but I would only expect to do so if I received even more favorable terms.

As for an equivalent property, the market would price the rent at about $2,200 a month, although I am only paying $1,520 now (for a less desirable place than what I am shopping for).


First things first. You are easily A paper. Some lenders might have a small incentive (no more than 1/4 of a discount point) for folks with credit scores over 760, but most don’t, and even if you go looking for one that does, it’s no guarantee that their overall rate will be better than what you could get elsewhere. Remember, it’s not important that they give you a quarter point incentive if their trade-offs were more than that above the competition. Look for a loan based upon the bottom line to you, not a little tweak that says you get treated a little better than the next guy.

Second, split your loan into two pieces to avoid PMI. One first loan for 80% of the value, and a second for the remainder, whatever that is. The second will be at a higher rate, but better that than paying PMI on the whole balance. It’s likely to save you a lot of money this way. If you intend to pay it down, be very certain that there will be no prepayment penalty.

Now, let’s look at now versus basically a year from now (Since February is ten months away). One thing I’m going to look at is whether your location may be above sustainable levels. My rule of thumb is that if a 20% down payment won’t break even on rental cashflow, your area is likely to be overpriced. With current rates (6.25% for a thirty year fixed rate loan at par for the first, something like 9% for a 10% second), payment on $360,000 runs about $2215, plus taxes of $420 per month plus association dues of $350 plus an allowance of $50 per month for insurance. Total $3035 per month. As opposed to $2200 rent. An investor would be down $835 per month even if the place was never vacant and never needed repairs. Prices would need to drop $100,000 at least to cover that. I’m also going to assume you need $10,000 for closing costs out of your own pocket, reducing your down payment to $50,000. Now, I’m going to look 10 years out based upon this situation.

Year
1
2
3
4
5
6
7
8
9
10
11
Value
$450,000.00
$374,500.00
$400,715.00
$428,765.05
$458,778.60
$490,893.11
$525,255.62
$562,023.52
$601,365.16
$643,460.72
$688,502.98
Monthly Rent
$2,200.00
$2,288.00
$2,379.52
$2,474.70
$2,573.69
$2,676.64
$2,783.70
$2,895.05
$3,010.85
$3,131.29
$3,256.54
Equity
50,000.00
21,008.26
9,995.46
43,151.06
78,608.20
116,526.98
157,078.65
200,446.41
246,826.23
296,427.77
349,475.31
Net Benefit
31,500.00
-108,625.29
-91,384.89
-72,677.63
-52,395.49
-30,423.16
-6,637.55
19,092.60
46,907.31
76,955.83
109,397.24



Now, let’s look at suppose prices have come down that same $100,000 in a year, but rents have gone up by inflation – roughly 4%. However, rates are a bit higher – let’s say 7 percent. Furthermore, you have $90,000 less $10,000 for closing costs leaves $80,000 down payment. I’m assuming property taxes are based upon purchase price, as they are here in California, but if they don’t go down when prices go down, that’s going to make a difference of about $100 per month to start and more later on. Let’s look 9 years out for an equivalent time frame.

Year
1
2
3
4
5
6
7
8
9
10
Value
$350,000.00
$374,500.00
$400,715.00
$428,765.05
$458,778.60
$490,893.11
$525,255.62
$562,023.52
$601,365.16
$643,460.72
Monthly Rent
$2,288.00
$2,379.52
$2,474.70
$2,573.69
$2,676.64
$2,783.70
$2,895.05
$3,010.85
$3,131.29
$3,256.54
Equity
80,000.00
107,242.69
136,398.64
167,602.25
200,997.33
236,737.81
274,988.43
315,925.50
359,737.71
406,627.01
Net Benefit
24,500.00
4,200.10
18,090.11
42,543.32
69,346.64
98,702.88
130,831.85
165,971.77
204,380.83
246,338.88


The picture looks much better by waiting a year for the market to get rational – assuming it does. If it doesn’t, all you’ve done is taken that last year of benefits off the first chart, or worse, as perhaps the prices continue to rise for another year. Nor have I assumed that you paid extra on the loan. Quite frankly, once you’ve killed off that second trust deed, leverage is your friend, and you are better off investing the difference.

The question is “When is Wile E. Coyote going to look down?” Okay, not all that funny, but it has applicability to the situation. As long as everyone is in denial, and there is a market of folks willing to pay those prices, the market is going to stay afloat. What’s caused our local sputter is the fact that everyone has “looked down”, and they don’t like what they see. There is no convincing reason why highly paid jobs have to be even more highly paid so that they can afford local housing here, whereas a large proportion of the jobs in certain cities like Washington DC or New York don’t really have the option of leaving, as they are where they have to be. The government isn’t leaving Washington DC unless it gets nuked, and the big guns of the financial industry aren’t leaving New York unless every other big gun does so. You know better than I to where your city lies on that spectrum. My impression is that where you are is closer to the inelastic employment point. Nonetheless, if the rest of the country “looks down,” so will those places that are relatively insulated.

If a 20 percent down payment doesn’t pencil out as an investment property, as it doesn’t in your case, the question is not “if?” the market is going to adjust, but “when?” and “how?” Here locally, you can almost hear the “pop!” If things are relatively inelastic, employer- and jobs-wise, a long slow deflation may be what occurs. You may even keep current prices while inflation makes things catch up. It’s hard to say when I’m not as familiar with your city’s economic engine as I am with my own, but here’s what happens if prices stay stable for ten years:

Year
1
2
3
4
5
6
7
8
9
10
11
Value
$450,000.00
$450,000.00
$450,000.00
$450,000.00
$450,000.00
$450,000.00
$450,000.00
$450,000.00
$450,000.00
$450,000.00
$450,000.00
Monthly Rent
$2,288.00
$2,379.52
$2,474.70
$2,573.69
$2,676.64
$2,783.70
$2,895.05
$3,010.85
$3,131.29
$3,256.54
$3,386.80
Equity
50,000.00
53,930.19
58,150.38
62,682.08
67,548.41
72,774.22
78,386.23
84,413.13
90,885.78
97,837.36
105,303.52
Net Benefit
-31,500.00
-39,318.42
-47,361.14
-55,634.47
-64,145.15
-72,900.45
-81,908.24
-91,177.08
-100,716.30
-110,536.19
-120,648.06


As you can see, you build up a fair amount of equity, but would have been better off renting and investing the difference.

Which of these scenarios is most likely? Here it’s the one attached to the first two tables, except that we’re a good portion of the way towards table two right now. Where you are, I’d make an educated guess that you’re still looking at table one right now. There’s money to be made even there if you buy and hold long enough, but you could be upside down for quite a while.

Thank You for asking, and please let me know if this doesn’t answer all of your questions.

Caveat Emptor

Buying Below Market

This question:

What real estate office can I trust to help buy below market house in (location) California in the year 2006?


brought someone to the site and I have not previously written a real answer to the question.

The short answer is “nobody.”

This doesn’t have to do with trust. It has to do with the facts of life and bad assumptions.

What is the definition of market price? It is the price at which a willing buyer and a willing seller exchange a property. In other words, what you buy it for is by definition the market price.

Everybody wants to buy real estate for less than it’s really worth, just like everyone wants to sell it for more than it’s really worth. Mathematically speaking, at least fifty percent of each have to fail, and the fact that you’re even asking the question indicates that you have made incorrect assumptions.

Real Estate is not like stocks or bonds. No matter how big or how small your transaction, it’s always a one on one transaction. If you are selling, you need to find one buyer willing and able to buy that property for a price you are willing to sell. If you are buying, you need to find one property where the owner is willing to sell at a price you are willing and able to buy it at.

This is not to say that the general market is irrelevant. If someone is pricing a more desirable home lower than you, you’ve overpriced your property. If the identical condo next door to the one you bought sold for ten percent less, you probably overpaid. But it’s not for nothing that the mantra about the three most important things in real estate being “location, location, and location.” No two properties are ever identical. Think condos, even. Which would you rather have: The one right next to the parking lot, the mailboxes, and the swimming pool, or the one way in the back where you have to walk a quarter mile from your car, and further from everything else? I assure you that a goodly portion of the population would choose the one you think of as less attractive. It’s the choice of the individual buyer, and a real estate agent has to learn how to get the attention of the person who’s most likely to be interested in that property.

I keep telling people that getting a good price at sale time is nice for both the buyer and the seller, but the really important thing is your amount of time in the investment. Let’s go back in time some years. Homes in my neighborhood were worth maybe $180,000 at the time, and condos were worth maybe $65,000. Had people going around making low ball offers on everything. Offered maybe $55,000 for the condos, $150,000 for the homes. Nobody who wasn’t desperate wanted to sell, of course, and that’s just what they were checking for – desperation. Had they offered something vaguely reasonable, say $60,000 for the condos or $170,000 for the home, they likely would have gotten a property. At least one group of these people ended up not buying anything. Fast forward five years. Those same condos are worth $275,000, and those same homes are selling for $500,000. If the thought of missing out on $210,000 profit for the condos because you couldn’t make $217,000 bothers you, then you seem pretty rational to me. If, on the other hand, the thought of missing out on an extra $20,000 you’re not going to get for the single family residence makes you want to just throw $330,000 base profit (tripling your money!) out the window, please go waste someone else’s time.

There is nothing wrong with desperation sales and offers that are desperation checks, so long as you are willing and able to then proceed to something more reasonable. Nobody wants to sell to somebody looking to flip a property, but they do want to sell for a reasonable price. That’s why the property is on the market. Somebody offers me (or my client) fifteen percent less than the property is worth, I usually write something like “offer rejected. Why would I (my client) want to give you fifteen percent of my investment’s value?” and append a list of comparables. Counteroffering just wastes time when the offer isn’t even in the right ballpark. The ones who can come back with a reasonable offer want the property, or they wouldn’t have made the offer. The ones just looking for the desperation sale aren’t going to bother.

Now some potential buyers are only interested in desperation scenarios. That’s fine, but you’re going to work awfully hard and put in a lot of offers before you get one, and the ones with the most potential for quick profit are going to be the ones where there is a lot of work to be done. Additionally, right now the market just won’t support CondoFlippers Inc.

Yes, I believe in hard bargaining. Judging from evidence I see around me, I’m one of a small percentage who does. But I’m willing to come from a reasonable starting position, although I do love it when my clients decide they want to put an offer in on a discount agent’s listing, because the client I’m acting as buyer’s agent for is going to think I walk on water when the transaction is over, while the sellers are going to find out first hand the truth of the adage “You get what you pay for”.

Lest you think that your negotiation discount equals your profit, it isn’t. It’s a small part of your profit. Let’s say you get the condo for $250,000 or you won’t buy it at all, even though comparables are selling for $275,000. Let’s say you intend to flip for $290,000, not that that’s going to happen in this market, but let’s say you succeed anyway. Your net is something like $268,000, after spending $253,000 or so to buy, and you spent about $5000 making the payments on the mortgage even if it did sell right away (more likely, given the realities, that you spend the entire “profit” on the mortgage payment!)

Now let’s say, instead, that the market collapses twenty percent the day after you buy, down to $220,000. If you have a sustainable mortgage and bring in a tenant, your cash flow should be even or positive. Hold on to the darned thing for five years, and at historical seven percent average per year, the property is worth $308,000. Hold it ten years and it’s worth $432,000 under the same assumptions. The first number gives you as much profit as the flipper even has a theoretical chance for, while the latter blows the flipper out of the water. Even after a price collapse, and because you’ve been in a sustainable situation this whole time, it really isn’t critical how long the prices take to come back, because you’re not under the gun of a deadline. So long as you have a sustainable cash flow, the risk is essentially nonexistent. It’s when you have an unsustainable cash flow that you’ve got to worry. Say like, an empty unit where you’ve got to make the mortgage payment without rent because you’re trying to flip it.

In fact, given a sustainable cash flow, unless property values collapse and stay down forever, the question is closer to when you’re going to cash out and how much, rather than if. Southern California Real Estate has always moved in cycles. What’s down today is up forty percent five years from now. The trick is being able to bridge the gap between now and then.

If some of the above seems like I’m attacking the “bigger fool” theory of real estate, consider this: Somebody’s always the last, biggest, fool in line, and until you get the check for the net proceeds from the sale, that person is you. It should be an agent’s responsibility to see to it that their clients aren’t the only ones without a chair when the music stops. For all too many of them, their thinking stops at the receipt of the commission check.

Caveat Emptor

Approaching the Loan Application Process – What Loan Will You Qualify For?

On of the biggest time and money wasters in real estate is people that apply for the wrong loans – loans that they can never qualify for because they can’t meet the guidelines, or can’t prove they meet the guidelines, which amounts to the same thing. Often, loan officers are the worst offenders, judging by the people who come into my office with messes for me to clean up. They don’t know how to submit a loan, or they know full well it won’t be approved, but they get you to sign up by dangling this carrot, and then snatching it away, but now they’ve got you working with them and they end up with your business because they told you a fairy tale that sounded better than what the other guy talked about because he restricted himself to talking about loans he could actually deliver.

How do you know what mortgage market is best for you?

There isn’t a cut and dried answer unless you’re one of those folks who can qualify “A paper” full documentation. If you can do it, and a lot more folks can qualify this way than think they can, A paper full doc is the way to go. Because it’s the least risky loan, the banks give you the best pricing. What if you can’t make it, however?

The reasons why people fall away from A paper full doc is long. The two largest ones, however, are people who cannot prove they make enough money and people whose credit score isn’t high enough. At a distance from that, the third reason why folks don’t qualify, is late payments. A paper permits one thirty day late on the mortgage, or two on other credit. If you fall off the pace due to late payments, you have to go subprime.

A paper accepts only two ways of proving your income: Income tax forms and, for some employees not in construction or on commission, w-2s and year to date pay stubs. If, with the income taken from these forms does not qualify you according to A paper debt to income ratio considering your known debts (typically 45% back end ratio, but I’ve seen high seventies get accepted in some circumstances), you do not qualify full documentation. Think of full doc as being where you prove you’re got enough income to make your payments. If you can’t do full documentation, you have to go to stated income.

A paper also requires an absolute minimum credit score of 620. 619 is an automatic rejection from any A paper program out there. Some A paper may require higher credit scores (640 jumbo, 660 stated income, 680 for both), and if you haven’t got it, you don’t have the loan, either. If you don’t have the relevant credit score, you’re going to subprime.

A paper stated income is where you’ve got a good credit score and can prove that you’ve got a job (or a source of income) and you’ve had it for two years. You just can’t prove you make enough money to justify the loan. You could be making it, though, and the lender agrees not to verify, although they will look at it to see if the income you claim is consistent with your profession. You’re paying your bills on time, though, so lenders are willing to believe that you’re living within your means, and therefore qualify for the loan. They are not agreeing to close their eyes if something indicates you cannot afford it or what your real income is; they’re just not going to go out of their way to verify your income. They are going to have you sign an IRS form 4506, releasing your taxes to them. Don’t worry too much about it. The IRS takes a minimum of 60 days to respond, and the loan will be done in thirty, if your provider is competent, and it’s not fraud to overstate your income on a stated income loan. Dumb, maybe; fraud, no. The major reasons why “A paper” stated income falls out are low credit score, insufficient time with your source of income, and incompetent loan officers who allow the underwriters to find out that the client doesn’t make that much. Low credit score goes to subprime, insufficient time in line of work goes to NINA, and loans with incompetent loan officers start over with another lender.

A paper NINA is a loan driven by the credit score and the situation you find yourself in. There is no debt to income ratio, and the personal qualification consists of a good credit report. Of course, you still have to have the appraisal and the rest of the documentation relating to the property. Furthermore, the rates are higher than stated income (which is in turn higher than full documentation), and the maximum Loan to Value Ratio is lower. Common fallouts are credit score too low (go to subprime), loan to value ratio too high (go to subprime) and something wrong with the property (go to hard money)

Subprime is an entirely different world than A paper. The standards are different, the qualifications are different, everything is different. Just because you can’t go full documentation A paper doesn’t mean you can’t do it subprime. For one thing, typical subprime goes up to fifty percent debt to income ratio, and a few lenders will go higher – some as high as sixty percent! So even though the rates are higher, it may be easier to qualify.

Subprime also has another form of accepted income documentation: bank statements for the last six, twelve, or twenty-four months. When I started, this was always discounted, but of late personal bank statements have been accepted on the strength of 100 percent of the income they show. This rate will be higher than a borrower who can prove their income via one of the A paper methods, but is lower than stated income. Number one reason for falling out of subprime full documentation: Not enough income. Number two: sub-500 credit score. Number three: the underwriter believes that you manipulated your income on your bank statements. Not enough income goes to stated income subprime (with another lender, as if it was submitted full doc it cannot go stated income with that lender). Sub 500 credit score goes to hard money, which is where you might as well start when you find out, because regulated lenders can’t touch you if you don’t have at least one of your three credit scores above 500. If the underwriter thinks you manipulated your income, you or your loan officer have either got to convince them you didn’t, which usually requires w2s at least, or you are going to another lender.

Subprime stated income is fairly wide open, with the proviso that a given credit score will have a higher rate and a lower maximum permitted loan to value ratio. Number one reason for falling you here is that you don’t meet loan to value guidelines. Number two is you didn’t state enough income in the first place, and you don’t qualify by debt to income ratio guidelines. Number three is you stated too much income, and the underwriter doesn’t believe you make that much money. They can always require income documentation – they don’t have to let you state it without verification. At best, anyone suffering from any of these three problems can expect to have to go to another lender, because this lender will not now approve their loan. Maybe lose a little time if you’re working with a broker who then submits the package elsewhere. Back to square one if you were working with a direct lender.

Subprime NINA is even more wide open. A loan officer has got to be a serious bozo to blow this one, but I clean up behind ones that went bad on a distressingly frequent basis.

Hard money is the last hope of the unfortunate. These folks don’t care about your income, your credit score, or anything else. What they care about is that they can sell the house for enough to cover the loan if you default, and unlike regulated lenders, they will record that Notice of Default on the day you become eligible. Sometimes they are the only choice, but if you find yourself dealing with them you should really ask yourself if this loan is something you absolutely have to have, or if you just want it. If the answer is the latter, my advice is to reconsider getting the loan.

There you have it, something like a flowchart of what kind of loan you should apply for. These are far from the only reasons loans fall apart, of course, but they are the most common. A good loan officer knows enough of the tricks and traps to tell you the truth straight off, and apply to the appropriate loan first, without wasting your time and money. Bad ones don’t.

Caveat Emptor

Appraisers Speak Out Against “Make The Deal”

Appraisers Petition Against “Make The Deal”

I’ve spoken about these issues before in this post.

I’ve certainly heard of plenty of abuse on both sides of this equation, and there is plenty of motivation for lenders to abuse the situation by requiring a higher than “real” appraisal value. Still, I think that by reading only the comments from various appraisers one would get a skewed vision of what is going on.

It is the appraiser’s job to do their best to get a value that is useful. Theirs is a service occupation, just as mine is. I don’t expect to be paid if I can’t help the people with their situation. Sometimes I put in hundreds of dollars and dozens of hours of work and it all falls apart because of something beyond my control. Situations like this are part of being in business for yourself. I don’t expect to get paid when I can’t help the people. Why does the appraiser?

These houses are selling for these prices. If the last three similar houses in the neighborhood sold for $600,000, then this one is likely worth $600,000 also. When the appraiser tries to tell me a house that I’ve seen and is immaculate and further upgraded than than any of the last three is worth $150,000 less than those sold for, something is wrong, and it isn’t with the house.

Basically, what’s wrong is they don’t want to work. They want to be able to drive over and pop the customer for the bill and let the chips fall where they may. And if the house is really only worth $450,000, the house is only really only worth $450,000. But most of the time, if they worked a little bit, and maybe chose a different sale to compare to, they could justify the higher appraisal, but they don’t want to be bothered.

Let me ask you: Somebody bills you $400 or so for work that doesn’t help you and in fact makes all of the work you put in worthless, it makes you feel all happy, right? They knew before they went over and asked for the check that they weren’t going to be able to get the necessary value. You know something? I’d be more forgiving of him charging me $400 in those circumstances than charging my client $400. If the appraiser called first, and told me he couldn’t get value, that gives me a chance to re-work the loan and save everyody’s investment in this by talking to the client before the client has written a check for $400. If I can’t get the client to accept the new loan, at least they’re not telling people I screwed them out of $400 on the appraisal. That’s right, it’s the loan provider that gets the blame for this in the customer’s mind. If I tell them about a change before they spent $400, they’re not going to be as angry, and even if this loan falls apart they’re likely to tell people I was honest and saved them from being out $400 rather than that I took their $400 and didn’t deliver. As I think you might have gathered by now, I didn’t get that $400 – the appraiser who screwed the loan up did. If I can’t turn it into a new different loan, the appraiser is out a little bit of work. I’ve put ten times as much into making this happen. It’s much easier to tell the client their house is only worth $450,000 before they’ve written that check for $400. The check gets written, and the whole thing is gone up in smoke.

The appraiser, understandably, wants to get paid for their work. So do I. All I ever ask is that they don’t intentionally waste my client’s money. If they can’t get value, give me a chance to re-work the loan or find someone who can get value. In some situations on a sale, this allows me a chance to re-negotiate the price down so my client gets a better price on the house they want. If they just make the call that gives me a chance to fix it first, I will use them again. That’s the kind of appraiser I want to work with. But do a “hop pop and drop” (“hop on over, pop the customer for the bill, and drop a useless appraisal on the bank”) so that they get paid once while I’m stuck with a pissed off customer who is now going to tell all their friends and family what an awful person I am, and I think they’ve earned a spot on my personal blacklist of appraisers I will never do business with again. I’ll forgive it once, maybe even twice, if this appraiser has a history of calling me first and this time it just happened that they couldn’t get value when they thought they could. Treating your customers right is part of the requirements of being in business for yourself, and sometimes this means you did some work and didn’t get paid. You want a job with a steady income where you don’t take any risks, go find something with a w-2 involved, and the only risk you take is being fired. You won’t make as much money, but you will get paid for all the work that you do. For as long as they put up with you.

Caveat Emptor

“Lenders Are All The Same”

Just like Mohandas Gandhi and Genghis Khan and Attila the Hun were all human beings, lenders make money by lending money to people who want it.

That’s about the limit of the truth in that statement.

Lenders do, by and large, get their money to lend from the bond market. But not all lenders get their money from the same part of the bond market. Some get the money from low-risk tolerance folks looking for security, and willing to accept comparatively low rates. Some get the money from high risk tolerance folks looking for more return for their risk. Within each band, there are various grades and toughnesses of underwriting. A lender with tough underwriting will have a very low default rate, and practically zero losses. A lender with more relaxed underwriting will have more defaults, and higher losses, meaning they must charge higher rates of interest in order to offer the investors the same return on their money.

I have literally just finished pricing a $600,000 loan for a client with top notch credit and oodles of income (he’s putting $800k down). Even A paper and with the yield curve essentially flat, I got variations of three eighths of a percent on where their par rate was. Every single one of them had significant differences in how steep the points/yield spread curve was (if you need these terms explained this is a good place). For one lender it was “offsheet pricing” below their lowest listed rate. This lender is more interested in low cost loans, and they take it for granted that folks will not be in their loans very long. This lender is appropriate for those who are likely to refinance within a few years. For another lender, it was “offsheet pricing” above their listed sheet prices. This lender specializes in low rates that cost multiple points, so they can market lower payments. For those few people who really won’t sell or refinance for fifteen years, these are superior loans.

Which do you think is really better for the average client? Well, let’s evaluate a 6.5 percent 30 year fixed rate loan that costs literally zero (I get paid out of yield spread, while rebating enough to the customer to cover all their costs), with a 5.875% 30 year fixed rate loan that costs $3400 plus two points. I always seem to be computing $270,000 loans here, but since this was “jumbo” pricing and a $270,000 loan is “conforming”, which carries lower rates, I’ll run through both.

The 6.5 percent loan is zero cost to the client. Nothing out of pocket, nothing added to the loan balance. Gross Loan Amount: $270,000. The 5.875% loan cost 1.875 points in addition to $3400 in closing costs. Gross loan amount $278,625. You have added $8625 to your mortgage balance to save yourself $98.40 per month. You theoretically are ahead after 88 months (7 years, 4 months), but not really even then.

Every so often I get a question that asks why they can’t have A for the price of B. The answer is the same as the reason why you can’t have a Rolls Royce for the price of a Yugo. Another funny thing about Rolls Royces is how expensive they are to maintain. A middle class person with a Rolls better plan on living in it. The funnier thing is, your friends, family and neighbors can’t even see you in it, so there is no point in a “Rolls Royce” home loan except for utility, and if it’s not paying for itself, then there is no utility (or negative utility, i.e. something you don’t want), and therefore, money wasted.

Now, let’s crank the loans through five years – longer than 95 percent plus of all borrowers keep their loans, according to federal statistics – and see which is really better for most borrowers. The 5.875% loan makes monthly payments of $1648.17. Over five years – 60 payments – they pay $98,890 and pay their balance down to $258,869. Total principal paid: $19,756. Actual progress on the loan (amount owed less than $270,000): $11,131. Interest paid: $79134, which assuming a 30 percent combined tax rate, saves you $23,740 on your taxes.

Now let’s look at that 6.50 percent loan that didn’t add a penny to your balance. Monthly payments of $1706.58, total over five years $102,395. Looking pretty awful, so far, right? But your total amount owed is now only $252,750. Total principal paid: $17,250. But this same number is also the actual progress! Interest paid $85,145, and assuming 30 percent combined tax rate, same as above, it gives you a tax savings of $25,543.

Now let’s consider where you are after five years.

With the 5.875% loan, you saved $3505 on payments. But you also owe $6118 more, and the 6.5 percent loan saved you $1803 more on your taxes. Furthermore, if you’ve learned your lesson and rates are as low when you refinance or sell (6.5 percent on your next loan), it’s going to cost you $397.67 per year from now on for that extra $6118 you owe! Net cost: $4416 plus nearly $400 more per year for as long as you have a home loan. Assuming that’s “only” 25 years, your total cost is $14,358. I never spent so much money to save a little for a little while!

Now, let’s consider that $600,000 loan in the same context. After all, the pricing really applies there (conforming rates are lower). Appraisal costs a little more, and so does title and escrow, for jumbo loans on million dollar houses. Let’s say $3700 in costs. Your new 5.875% loan would be for $615,236 (disregarding rounding). Payment $3639.35, which over 5 years goes to $218,361 in payments. Crank it through 60 payments, and you’ve paid the loan down to $571,612. Principal paid $43,388, actual progress $28,388. Total Interest paid, $174,973, which assuming a combined 40% tax rate (higher income to qualify!) gives you a tax savings of $69,989.

At 6.50 percent, the payment on a $600,000 loan is $3792.40. Times 60 payments is $227,544. Crank the loan through those 60 payments, and you’ve paid the loan down to $561,666. Principal paid and actual progress made: $38,344. Total interest paid $189,209, which at the same combined 40% rate is a tax savings of $75,684.

With the 5.875% loan, you saved $9183 in payments. Yay! However, you owe $9946 more, paid $5695 more in taxes, and on your next loan, assuming it’s at 6.5 percent, you pay $646.49 per year in additional interest. Total cost is $6458 plus $646 per year for as long as you have a home loan, which assuming that’s 25 years equates to a total of $22,620!

Which of these two loans and lenders is better for you? Well, if you’re going to stay 15 years or more and never refinance, the lender who wants to give you the 5.875% loan. That rate wasn’t even available from the 6.5 percent lender. On the other hand, if you’re like the vast majority of the population that refinances or sells within five years (for whatever reason) you really want the 6.5 percent loan whether you knew it before now or not, which also was not available from the 5.875 percent lender.

The billboards advertising rates aren’t going to tell you cost, of course. They’re trying to lure clients who don’t know any better, and often they’re playing games with the loan type as well. But when the rate spread between the rate their selling and APR is over 3 tenths of a percent, you know they’re building a blortload of costs into it. Keep in mind that the examples I used were almost two full points, and they were each only about a 0.25% spread between rate and APR. You are never going to recover those costs in the time before you refinance. The lender who offers you 6.5 percent for zero cost is probably offering you a better loan.

Now, there were lenders targeting the markets between these two lenders, some that overlapped the whole market, and even another lender specializing in rates even lower and with higher pricing. Keep in mind that this article was limited to A paper 30 year fixed rate loans, which are limited in what they can possibly accept by Fannie Mae and Freddie Mac rules. Once you get out of the A paper market and especially down into sub-prime lenders, the diversity between offerings really multiplies, as the differences they are permitted in target market cover all parts of the spectrum. Some wholesalers walk into my office with the words, “Got any ugly sub-prime today?” Other sub-prime wholesalers ask me about “people that could be A paper but are willing to accept a prepayment penalty to get a lower rate” (I don’t use those much). Some want short term borrowers, and their niche is the 2/28. Some want the thirty year fixed with a prepayment penalty. The ones who ask me about negative amortization loans, I throw out of my office but they’re selling them somewhere. A lot of somewheres, judging from the evidence that they were 40 percent of purchase money loans here locally last year.

So lenders are not all the same. Indeed, every single one of them is different, and you need to shop enough different ones to find the program that’s right for you, and ask lots of questions every time. Just asking about rate is not going to make you happy, as I hope I have just demonstrated. If you walk into their office, they’re not going to tell you that you’re not the client they’re really looking for unless they just don’t have any loans at all that you qualify for (and if you’re in this category, do not blindly accept any recommendations they make. Most places, they’re sending you to the place that pays the most for the referral, not the lowest cost provider).

Caveat Emptor

Short Payoffs

A while ago I wrote an article called, “What Happens When You Can’t Make Your Real Estate Loan Payment.” This is kind of a continuation of that, as I got a search that asked, “What is necessary to persuade a bank to accept a short payoff on a mortgage”

Poverty. In a word, poverty. You have to persuade the bank that this is the best possible deal they are going to get. You can’t make the payments, and if they foreclose they will get less money.

A “short sale” or short payoff is defined as a sale where the proceeds from the sale will not cover the secured obligations of the owner. The cash they will receive from the sale is “short” of the necessary amount. The house is no longer worth what they paid for it.

There are more and more of these happening around here. There are always people that lost their good job and can’t get a replacement nearly as good. But now there are also people that were put into too much house, and approved for too much loan, and now they can’t make the payments. Unscrupulous agents that wanted a bigger commission, loan officers going along, and nobody acting like they were responsible for the consequences to their clients. My concern for lenders who do stated income and negative amortization loans (and a lot of loans that are both!) is kind of minimal. Okay, it’s very minimal. Like nonexistent smallest violin in the world playing “My Heart Cries For Thee” level sympathy. I forsee many lenders going through bad times ahead, to use a forecasting method that’s about as mysterious as falling rocks.

On the other hand, for the people who were led into these transactions by agents with a fiduciary responsibility towards them, I have great heaping loads of sympathy and I’ll do anything I can to help. Yes, they’re theoretically responsible adults, but when the universe and everyone is telling them all the things that buyers were told these last couple of years, it’s understandable. Sure there’s a greed component in many cases but when they’re told by both loan officers and the real estate agents that they “wouldn’t have qualified for the loan if you couldn’t afford it,” they are being betrayed by the same people who are supposed to be professionals looking out for their interests. I really do suggest finding a good lawyer to these folks, as those agents who did this to them (and their brokerages) better have had insurance which said lawyer can sue to recover money they never should have been out.

I’m going to sketch it out in broad terms, but there are a lot of tricks to the trade. This is not something to try “For Sale By Owner.”

First off, you need to draw a coherent picture of the loan payment being unaffordable. If you were on a negative amortization approaching recast, or hybrid ARM (usually interest only for the fixed period) that is now ready to adjust, you’re facing a much higher payments. Even if you were able to afford the minimum payment before, now you can’t and you’ve decided to sell for what you can get before it bankrupts you to no good purpose. You’re going to have to prove you can’t afford it, of course, the bank isn’t just going to accept your word, but several late payments or a rolling sixty day late that looks headed for ninety have been known to be persuasive. Nonetheless, there are a lot of tacks that you don’t want to take. Remember, lenders want to be repaid and they’ve got a couple of pretty powerful sticks to shake at you. They are not going to agree to sacrifice money merely because to make the payments would be uncomfortable for you. You’re going to have to persuade them it’s impossible.

Second, you’re going to have to persuade the lender that this is the best possible price that you are going to get, and that anything more they might get from foreclosure is going to be more than offset by what they’ll lose through the expenses involved. Not to mention that they might end up owning the property, which they don’t want to do because then they have to spend more money selling it.

Third, you’ve got to be on the ball about the transaction itself. All the ducks have to be in the row from the start, which is when you approach the lender with a provisional transaction. If they’re not, the lender is just not going to go through the process of approving a short sale until they are. Since this takes time, it has the effect of dragging out the transaction. Every missed deadline means the lender will look at the whole thing again, possibly changing their mind about approving the short sale. You need a qualified buyer.

Fourth, just be prepared for the fact that the lender is not only not going to approve the transaction if you get any money, but that they’re also going to send you a form 1099 after it is all done. This form 1099 will report income for you from forgiveness of debt. This is taxable income! Many agents eager to make a sale will not tell the sellers this, and when you get right down to it, there is no legal requirement to do so, but I’ve always thought this was one of the ways to tell a good agent from a not-so-good one. It does seem like something you should be told about before you’ve got the 1099 form in your mailbox, right? At that point, you are stuck with all of the consequences, where if you had known before, you might not have been so complacent. It is to be noted I’ve been made aware of ways to circumvent the “no money to the owner” requirement, but they are FRAUD, as in go to jail for a while and be a convicted felon for the rest of your life FRAUD. It can be tempting, but committing fraud is one of the most effective ways I know to make a bad situation worse.

For the buyer, short sales are attractive for any number of reasons. Typically the seller is in a situation where they have to sell, and everyone knows it. The option of waiting for a better offer really isn’t on the table if what you’re offering is anything like reasonable. They can’t bluff you, they should know that bluffing you is a waste of effort, and somebody should have explained to them that they really just want out now (and why this is so) before it gets worse. What’s not to like?

Your competition. Because there’s fast money to be made, these folks are the target of “flippers” everywhere. The large city, highly inflated markets more so than most. A couple weeks ago we put one on the market and got three ugly low-ball offers within 48 hours, and this is part of why you need an agent to sell one. Remember, the seller isn’t getting any money, but they are going to get a 1099 form that says they have to pay taxes. Don’t you think most folks would rather it was for less money, and therefore, less taxes, instead of more? The more money the lender loses, the higher your liability. Had any one of the three made a better offer in the first place, they would have gotten the property at a price to make a profit, but they had to prove how rapacious they were, or something. As it was, we jawboned the first three vultures and two other, later entries, into a quasi-decent price, with minimal later tax obligation to our seller.

In summation, “short sales” are a way to cut your losses for sellers, and a way to get a wonderful price for buyers, but you have to know how to convince the lenders to accept them, and how not to overplay your bargaining position, lest you get left out in the cold.

Caveat Emptor

Seller Paid Closing Costs (or, When Your Prospective Buyer Has No Money)

In many transactions these days, the buyer has absolutely no money, or an amount that is not sufficient to pay the costs that they would traditionally be expected to pay in order to close the transaction. Nonetheless, in today’s buyer driven market, often the seller still wants to do business with them.

The usual way it’s handled is in Seller Paid Closing Costs. The Seller gives the buyer an allowance to cover their share of the costs.

Lenders have been somewhat tolerant of the practice of late, at least so long as the appraisal comes in at or above the official sale price. However, more of them are once again starting to revert to the treatment this trick traditionally got, which is to say, if the sale price included a rebate to the buyer, then the sale price as far as the lender was concerned was the official price less the rebate. In other words, seller’s net. Remember, lenders value real estate the same as accountants, on the LCM principal – Lesser of Cost (which is to say purchase price) or market (which is to say the appraised value). If the seller is giving the buyer money back, then the official price listed on the transaction isn’t really the price, is it? Do advertisers tease you with the gross price of stereo or computer gear before the rebate, or the net price after the rebate? Same principle here. The lenders traditionally took this stance, although it has been more relaxed in the highly competitive lender’s market of late. The lenders are (typically) not going to lend more money than the lesser of those the two variables, cost and market, and they will base the loan parameters on whichever is less. You can always buy a house for more money than the value, as long as you have the cash to make up the difference. But 100 percent financing seems almost de rigeur of late.

The Sellers get their house sold. That and the ego thing of the official sale price seem to be the benefits to them. I would certainly rather sell for the seller’s net in the first place, if I’m a seller, without an allowance, because I have to pay commission on that higher amount. A $10,000 allowance (as has become common here) costs the seller $700 to $800 or so in increased costs – agents commissions, title insurance, escrow fees, transfer taxes – even if the sale price is $10,000 higher because of it. This is neglecting the potential effects of taxes due to exceeding the $250,000 (or $500,000) maximum gain exemption from the IRS code Section 121. I recommend against it for sellers unless there is a substantial deposit, as it is often indicative of a not very qualified buyer. Even then, it’s a real good idea to talk to your tax person.

The Buyers get a deal, or so it appears at first blush. A piece of property without having to save for closing costs. In many cases, they don’t have to put a penny down, either. Pretty cool, eh? Get a house and actually skip a month (due to the allowance covering prepaid interest), so effectively putting cash in your pocket. Keep in mind, however, that the average seller is going to inflate the sales price to match, where (if they were smart) they would rather have accepted the net sales price without rebate. Furthermore, at least here in California, property taxes are based upon official original sales price, so you’ll be paying for it as long as you own the property. Finally, because your purchase price, and therefore your loan, is going to be higher, your payment is going to be higher, you’ll pay higher loan costs every time you refinance, and your eventual net on the property will be lower. If it is the only way to get into the property, and the deal otherwise makes sense, that’s fine – but don’t kid yourself that you got free money. Chances are that you’re going to pay far more than the amount of any allowance because you got it.

If it’s bad for the seller, bad for the buyer, and risky for the lender, why does it keep happening so much?

Well, it’s a sale for sellers. The property has now been disposed off. It’s also an ego defense for sellers. Instead of $470,000, they can tell everyone they got $480,000. So long as they don’t mention the allowance, it sounds like a far better price to their friends, family, and soon to be ex-neighbors. In short, bragging rights. Buyers, it gets them into the property, often without coming up with a penny and allowing them to save one month’s rent or payment, effectively putting cash in their pocket.

Real Estate and Mortgage folks, get bigger commissions. $10,000 in sales price gets translated to $100 per 1 percent of commission. This is anywhere from an extra $100 to an extra $300 or $400 for each of the offices, buyer’s, seller’s, and loan. Furthermore, I know of loan agents who extract larger commissions because “it’s such a hard loan.” It does make the loan harder, but not by another point of origination’s worth. Wouldn’t you like to have extra money for essentially the same work? I assure you that your average real estate agent and loan officer are no different than most folks.

There is nothing wrong with this practice, so long as everybody knows what’s going on. But it’s certainly not something you want to do if you have a choice.

Caveat Emptor

Related Party Transfers of Real Estate – Family, Corporate, or Partners

One of the things that has a lot of issues is any transaction between related people. Actually, this is not limited to purely family transactions, but applies also to transfers among partnerships and their partners, corporations and their officers

The market theory holding that the value of a property is what is agreed to between a willing buyer and a willing seller is subject to the proviso that neither buyer nor seller has a reason to inflate or deflate what the property is worth to them. If the parties are related, there is an obvious reason to think that this may not necessarily be the case. Parents do things for their children all the time, siblings for each other, and as you’re probably aware if you work in corporate America, major stockholders, investors, and executives often manipulate corporate versus personal transactions for less than wholesome reasons. Partnerships do the darnedest things, as well.

The issue, as far as the lender goes, is that they are trying to safeguard their money. Lending is a risk based business, and the lender wants to know that they are not taking more of a risk than they intend to when they take on this loan.

Let’s say Jane Jones is CEO of SuperColossal Corporation. She wants to manipulate her compensation, so she has SuperColossal sell her property for half its real value.

Now this is actually okay by most lenders, if not securities regulators, IRS agents, et al. The loan is based upon the purchase price, the appraisal comes in double the purchase amount, and the lender assumes less risk than they price the loan for. Remember, the property is valued based upon LCM: Lower of Cost (purchase price) or Market value. When market value comes in high, the lender is covered. What isn’t so cool is if Jane Jones sells SuperColossal the property back at twice its value. If the corporation gets a loan for 75 percent of value, that’s at least a third of the lender’s money they’re not going to get back in case of default, which becomes likely when Jane is fired and the new CEO asks why they are paying the loan when they owe half again what the property is worth.

Needless to say, the lenders want to guard against that. Many lenders will not do related party transactions, period. For the ones that do, they will want to be very careful on the appraisal, which has now become their only guard against getting into an indefensible position. Many times, lenders may require related party transactions to go through certain appraisers, they may require in house appraisers, they may require multiple appraisals, and they may require that there be no contact between principals and appraisers. Whatever their required precautions, they need to be followed, as failing to do so will cause the loan to be rejected.

I’m going over this to make a point. Many lenders have other requirements as well. Some may require full documentation only, others require that the loans have full recourse (they can come after you legally if they lose money). Each and every lender creates their own policy, and if your transaction is between related parties, it is probably more important to inquire about related party transfer policy and requirements than it is to get a good rate at a competitive price. Not much use having a great quote if you can’t meet the lender’s requirements. Even worse if it causes you to waste time with a lender whose requirements you cannot meet, and now your deadline for the transaction is here and you don’t have a loan, and so cannot complete the transaction.

Caveat Emptor