Searchlight Crusade

I keep getting hits for this, so people must want it explained. Loan Amortization is nothing more than the process of paying the loan off by regular payments over time. Leave it to the experts to come up with a fancy word for an everyday process, eh?

A loan which is fully amortized (or fully amortizing) is one which the required payments will pay it off in full by the end of the term of the loan. Fixed rate loans are the classic example of this. A thirty year fixed rate loan has 360 payments of equal amount, at the end of which the loan will be paid off, assuming you have made all the payments on time. The last payment may be somewhat smaller due to the fact that they may round the payment up to the next penny, and over thirty years it makes a difference.

However, most hybrid ARMs are also fully amortizing loans. The difference between these and the fixed rate loan is that the rate, and therefore the payment, is fixed only for the first few years, and after that the rate varies based upon an underlying index. Nonetheless, the loans are still calculated to pay off the entire balance by the end of the loan. You are welcome to keep them after the fixed period if you want to, but few people do.

Balloon loans are partially amortized. Their payments are calculated as if they were a longer loan than they are. Because they amortize based upon a longer loan period, the regular payments do not pay the loan off in its entirety by the end of the loan. Unlike the hybrid ARM, these loans are over in a shorter period of time, and you do not have the option of keeping them. You must either pay the loan off, whether by paying it or by refinancing, or sell the property.

I don’t see it in a federally approved list of loan terms, but I have heard interest only loans called delayed amortization. These loans, whether fixed rate or hybrid ARM, have interest only payments for a given time, and then amortize over the remainder of the loan. For instance, a five year interest only loan is then paid off (amortized) over the remaining twenty five years of the loan. Note that when they start to amortize, they will then have payments that are higher than the equivalent fully amortized loan, because the balance is paid off over a shorter period. They will also typically carry a higher interest rate (most subprime lenders charge 1/4 percent higher interest rate for an interest only loan, and there are additional limitations on availability).

If there were such a thing as an interest only loan that stays interest only until you refinance, it would be an unamortized loan. Years ago, I was invited by a company to take a seminar because they offered these to financial planners clients. Fortunately, when I checked NASD regulations, I found out that what they were trying to sell was prohibited. The interest rates they were talking about were very high as well. The reason I said “fortunately” about finding out NASD regulations prohibited what they were doing is that I later found out that they were a scam and shut down by the regulators. I might have found out had I done all my due diligence, or it’s possible I might not have. Either way, I’m glad I didn’t have any clients with them.

Finally, there is the negative amortization loan, where if you make the minimum payment your loan balance actually increases, effectively digging yourself deeper into whatever hole it was that motivated you to do it. There are circumstances where they are the best thing to do given the situation, but in my opinion, (at least for owner occupied property) it should be a temporary solution of last resort.

Caveat Emptor

“Trust Deed Incorrect Legal Description”

There are all kinds of legal descriptions. Lot, Block and Map, or just Lot and Map, are probably the most common. Sectional portions (Portion A of Section B of Township C, Range D) are probably next most common, followed by “metes and bounds”, and often the two are mixed. Finally, in some areas of the country (like Southern California) there are remnants of prior systems here and there, like the Ranchos here, parishes in Louisiana, etcetera. What they all have in common is descriptions of the boundaries of the parcel concerned. Condominiums are based upon cubes of airspace exclusively with an undivided common interest in the communal property.

There are technically incorrect legal descriptions, and there are significantly incorrect descriptions. There are three main categories.

1) Descriptions that describe the land with some technical difference. Missing an easement, missing part of a defined lot, something like that. This is by far the most numerous of these errors and basically means nothing. They land the trust deed describes was pledged as security. Practically speaking, these might as well not have the imperfection, and if you fight in court, you’re probably wasting your money. If the legal description is missing part of the land, but the whole thing is only one legally zoned lot, they’re going to get the whole thing, by and large. If it’s out in the country somewhere and not covered by things such as lot regulations, they might split the part that was covered by the description off from what wasn’t covered. Obviously, only part of the property was pledged as security, right? But most of the time, the lot cannot legally be subdivided anyway, and the lender is likely to get the whole thing.

2) Descriptions that partially describe the property. There are three main subcategories: a) they describe part of the property, but not the whole thing b) they describe part of the property and part of some more, and c) they describe the entire property and some extra besides. Subcategory a, that describes part of the property but not the whole thing, usually count as the “technical difference” category. In other words, no big deal. Subcategory b, where they describe something extra as well, is only of special note if you owned the other piece of property, also, at the time the Trust Deed was signed. Otherwise, you deeded property you didn’t own. Your neighbor may end up defending his title in court and coming after you for his expenses, but you can’t deed away what you don’t own. It’s the part that you own that’s important. Subcategory c, like b, is only interesting if you own the extra property as well. Then the lender might get a little extra! Otherwise, you can’t deed away what you don’t own.

3) Descriptions that describe another property. You can’t deed what you don’t own, so unless you owned the other piece of property as well, the lender is basically out of luck. It is to be noted that they’re still going to do their best to come after you, and your neighbor may come after you for his expenses in defending his title, and the cops may be interested in you if they think you intended fraud.

Of course, the law varies and you should check with your lawyer and it’s the court’s decisions that are final. Your mileage may vary; these are just some rules of thumb.

Caveat Emptor

Somebody asked, “What are my legal options when there’s a change on a good faith estimate.”

Short answer: Sign the documents or don’t. Same thing with a Mortgage Loan Disclosure Statement here in California. Neither one means anything binding; that’s why they call the one an estimate. Nonetheless, because there is a perception that they mean something, that people think the lenders are trying to disclose everything fully. The fact is that some are while others aren’t, and there is no correlation with size of the lender, how well known they are, or even what the loan officer at the next desk over is doing.

The fact is that if the loan officer cannot persuade you to sign up, there is a guarantee that neither they nor their company will make anything. This creates an incentive to tell you whatever it takes to get you to sign up. Once signed up, most folks consider themselves committed or bound to that lender, and stop looking around.

But the only documents that mean anything, legally, all come at the end of the loan process. Note, Trust Deed, HUD-1. So you can see the motivation exists to pull a bait and switch, or more often just not to tell the whole truth. Nor will they point out the differences at closing from what you signed up for. That would get you upset to no good purpose, from their point of view. The fact is that a majority doesn’t take the time to spot the difference, and of those who do, some just don’t understand how to spot the difference. Of those who do take the time, and do spot the difference, most will cave in and sign just to be done with the process, and of course there are those who are trying to purchase who won’t get it and will lose the deposit if they don’t sign.

The fact is that these forms are estimates. They may or may not be accurate estimates. In some cases, the loan provider tells you about every single dollar you’re going to need up front, in others they might as well be telling you the loan is going to be done for free at a rate two percent below any real loan out there. If they can’t get you to sign up, they don’t make anything, so the incentives are for them to over-promise and under-deliver. In other words, tell you about something better than what you’ll end up with. Now the loan officers know what it’s going to take to get the loan done – or they should know, anyway. But they often tell you a fairy tale that might as well begin “Once upon a time…” to make it seem like their loan is better than the competition, because if they can’t get you to sign up, they don’t make anything.

Now, the fact is that the vast majority of people out there go out shopping for loans in the wrong fashion. They find someone they think they can trust, because they are family, because they are the scoutmaster, or because they go to church with them. Exactly what type of loan will they deliver, and at what rate? With what costs? It is always a trade-off between rate and cost on any given loan type.

Even less likely to get a good rate at a decent cost are the people who do shop around, but won’t give loan officers a chance to figure out what’s really the best loan for them. The first group of people might stumble onto someone trustworthy who gives them a good loan at a reasonable rate for a reasonable cost; these people are going to fall for the biggest lie, because a loan officer can always tell you about a better loan than really exists and they are motivated to get you to sign up. They call around asking about the lowest rate or the lowest payment, and don’t want to hear anything else out of the loan officer.

The fact is that it’s going to take a good, in depth conversation about your situation for a loan officer to figure out the best loan for you, and you want to have that conversation with at least three or four loan officers. Why? Because the first one could have told you exactly what they thought you wanted to hear. Ditto the second. Keep going until you hear a couple of different suggestions. Furthermore, once they’ve given you their suggestions, ask about the other suggestions you heard in the past. Don’t shop by lowest payment; that’s a good way to get stuck with an abomination like the so-called Option ARM or another loan type that you don’t want. Don’t shop by interest rate alone, because you’ll get stuck with a loan that has six points and you’ll never save enough money on the payments to recover those sunk costs. Shop by the trade-off between rate and cost, because there always is one.

Now at the end of the process, the lender has all the power. You need or want this loan, and they’re the ones with it ready to go. In the case of a purchase, you’ve got a deposit you’re going to lose and a home you wanted that you won’t get if you don’t sign the loan documents. If you sign the documents, you are stuck with the loan, that probably isn’t on the terms you were originally told about. I pointedly did not say “promised” because the earlier forms are not promises unless somehow guaranteed, and very few loan providers guarantee their quotes. Chances are, if they won’t guarantee their quotes, they are not telling the entire truth about the loan they are telling you about.

The most important question on this page of Questions You Should Ask Prospective Loan Providers is “If I say I want this right now, will you personally guarantee this rate with those closing costs, and will you cover the difference (if any) between the quote and the actual final cost?” You won’t get a flat “Yes.” If you do get a flat “yes”, they’re making a promise on something that is not under their control, and I wouldn’t trust it as far as I can throw an aircraft carrier. What you’re hoping for is something like “Subject to full underwriting approval, yes we will guarantee this quote as to rate, type of loan, and total cost.” This is a simple sentence that makes a specific guarantee subject to a reasonable condition, as loan officers never know if a prospective borrower is intentionally hiding or shading something at loan sign up. If you get a response full of nonsense about how long they have been in business, how they honor their commitments, or any such equivalent claptrap, then they are trying to buffalo you. None of the stuff when you initially inquire about the loan is a loan commitment in any way, shape or form. I’d rather have a higher quote that was guaranteed than a lower one that wasn’t, and I strongly suggest you adopt that attitude as well. For an illustration as to why: If the quote is guaranteed, there’s no incentive to stick you with a rate an eighth of a percent higher so they can make a little more money – they’re going to have to make it good. There’s no incentive to pad the closing costs with junk, because they’ve got to turn right around and give it back to you. If I offered you a choice between two envelopes, one transparent where you can see the $100 bill (guaranteed), and the other one opaque where I told you there might be anywere up to $110 in it (not guaranteed), which envelope would you choose? The same thing applies to whether the loan is at 6.5 percent with no points and no more than $3400 of closing costs guaranteed, or 6.375% with no points and no more than $3000 of closing cost, but not guaranteed. From my experience, the first quote intends to deliver a better loan than the second quote.

So (if you can’t find someone who guarantees their quotes) how do you force the loan provider to deliver the loan they told you about in the first place? You can’t.

Now the loan provider is going to make money, or they won’t do your loan. Judge loans by the benefits and costs to you, not by how much they loan provider is making, or whether they even have to disclose it (brokers do, direct lenders do not). The important thing to you is that you were delivered a thirty year fixed rate loan at 6.5 percent without paying any points, as opposed to 6.625% with one point and higher costs, not that loan provider A had to tell you they made $4000 by doing it while loan provider B doesn’t have to tell you anything. Sounds obvious, but I have seen people who chose the higher rate at more cost for the same loan, even stuck themselves with a prepayment penalty where my loan had none, because they thought I was making too much. In point of fact, I would have made a fraction of what the other guy did make, and therefore, by the only universal measure, I performed work considerably more valuable to my client. So don’t shoot yourself in the foot like that.

Now expect to spend a little bit extra (about a $100 retyping fee, if you’re the one who orders the appraisal and therefore controls it) on the second loan. That $100, together with the extra time you spend getting the other loan through, is the best, cheapest, most cost-effective insurance policy you can buy anywhere for any financial purpose. It will not indemnify you for your losses, but the odds are overwhelming that it will certainly keep you from losing several times as much, by giving the loan providers a concrete incentive to deliver the best loan they really can deliver. From my experience, and that of my clients who have brought me more horror stories than most folks believe, I would judge it unlikely that either loan quote will be as good as the loan the loan provider originally talked about, unless one company or the other guaranteed their quote, but with another loan ready to go, chances are you’ll get something a lot closer to what they talked about in the first place. Even if you can find a loan provider who will guarantee their quote, a backup loan is a really good idea, because going to court to force them to deliver is costly and time consuming, and you need that loan now. The existence of the other loan is an excellent reason to actually produce that loan they talked about way back on day one, with the initial Good Faith Estimate or Mortgage Loan Disclosure Statement. Because no matter how little they make with the loan they told you about, if they don’t produce it they will make nothing.

Caveat Emptor

Because most loan providers will not guarantee their Federal Good Faith Estimates or California MLDS forms, I’ve been telling folks that the best suggestion (other than doing their loans myself, of course!) that I can give them is apply for a back up loan. But some mortgage loan providers will guarantee their quotes, and this article is about those guarantees, their limitations, and what to watch out for.

Loan officers are not the only ones who play games in the mortgage world. Borrowers do it. A lot of borrowers do it. Some are actually intending fraud, some just want a better loan and don’t see anything wrong with painting their financial picture a little rosier than it is. Furthermore, there are reasons that lenders will decline loans that are not obvious. It has happened to me that I couldn’t do a loan at all because of fairly obscure points that the borrowers weren’t trying to conceal, they just didn’t know they were important, and I didn’t think to ask.

Keeping this in mind, loan providers are leery of offering guarantees, and indeed, since only an underwriter you will never meet or talk to can authorize the loan, for a loan provider to make a guarantee that there will be a loan is nonsense. The most they can say is, “Based upon my experience, I see no reason why this would not be approved,” or, better, “Subject to underwriter approval, your terms will be this.” That’s a key phrase. Keep in mind that loan provider guarantees are few and far between, and as a result, there is no standard terminology to use. I, as a loan officer, cannot promise the loan. I can promise, however, that if the loan is approved as submitted, it will be on a given set of terms.

Now it happens that loan officers can manipulate you by submitting a loan that they know will not be approved. This is a lot of work and often “poisons the well” at that particular lender, but then they can tell you sorry, you do not qualify for that loan, but there’s another one over here that you do qualify for, and now that you’ve already selected them, they are no longer competing on price, and they build a much higher margin into the newly proposed loan, secure in the knowledge that you’re unlikely to be shopping other lenders at this point.

You can counter that by asking what the guidelines are for the loan they are submitting. What is the maximum debt to income ratio? How much income do you need to qualify? Ask them to compute it out for you, and watch what numbers they use. What loan to value ratio is the rate predicated upon? What does the property need to appraise for in order to make that happen? (This can also help you spot hidden fees, albeit rarely. Comparatively few loan officers can tell you how much it’s really going to take to get the loan done.) How much time in the same line of work are required? Here’s a whole list of questions you should ask prospective loan providers.

Now, as to the form the guarantee should take: It should include the type of loan, to include an industry standard name for that loan type, so other loan officers you shop with know right away what they are talking about. It should also include the cost to get that loan. How many points of origination, if any, and how many discount points, if any? How much in total closing costs? How long of a lock is included?

You should beware the term, “thirty year loan,” unless the words “fixed rate” are in there. A thirty year fixed rate loan is the standard loan that most folks aspire to, but it’s usually the highest rate out there. The words “Thirty year loan” describe an Adjustable Rate Mortgage (ARM), or a hybrid ARM. A few loan officers will even describe hybrid ARMs as “thirty year fixed rate mortgages,” because they are fixed for an initial period. So ask them “how long is that fixed rate fixed for?” here is an example of one way to disclose it right. So you always want to ask, “How long is it fixed for?” if they do not volunteer the information.

If it’s a balloon loan, that means you have to refinance or pay it off before the end of the loan. Mandatory, required, there is no more loan after that point. If it’s an ARM or hybrid ARM, you also want the margin once it does start adjusting and the name of the underlying index to become part of the guarantee. You don’t have to refinance hybrid ARMs, and you’re welcome to keep them as long as you like what they adjust to, but most people refinance before the end of the fixed period or very shortly thereafter.

Finally, you most especially want whether or not there is a pre-payment penalty to be part of your guarantee, and if yes, the nature of that penalty. A loan with a prepayment penalty should be a much cheaper loan than one without, as you are looking at agreeing to pay about $12,000 around here if you refinance or sell while it’s in effect. The phrase, “What would that be without the prepayment penalty?: is one of my favorites. But you have a right to know, and a loan with a prepayment penalty is likely not as good a loan as one a quarter to a half percent higher for the same cost, without a prepayment penalty. If you already know you’re going to need to sell before it expires, it needs to be more than that. So make sure you find out, is there a prepayment penalty, yes or no? If Yes, how long is it for? Is it a hard penalty or a soft one, and does it strike from the first extra dollar or only after you pay down more than twenty percent in a year? These all make a difference, and you should be aware of their nature, and it should be honestly disclosed to you when you are shopping for a loan.

Caveat Emptor

Got a search for “mortgage closing documents do not sign changes.”

Unfortunately for this person, the documents you get at closing are what legal folks call a contract of adhesion. This means you can either accept it, sign, and adhere to all the terms as presented, or you can walk away. Basically your choice is to take it or leave it, in exactly the form presented.

Now on those rare occasions someone actually has the intelligence and good sense to walk away from a situation where the terms have been changed, the prospective loan provider does have the option of offering you a better deal as incentive to do business with them. Like, say, the loan they originally talked about to get you to sign up with them. Mind you, they don’t have to, and the costs of that other loan may mean that they would rather do no loan than that loan.

I’m not a lawyer, but the way contracts of adhesion were explained to me is that if there is any legal ambiguity, it will be interpreted in your favor. This doesn’t mean you can claim you thought it meant something different than the average person would understand; this means that if there is a legally ambiguous wording that could legitimately be interpreted two different ways, and you and your lender disagree as to the meaning, the courts will generally rule in your favor. Once again, the law is different from place to place and the courts have the final say; check with your lawyer.

Now in the loan world, it is much more common than not to be offered a loan contract at final signing which differs in some material form from the loan terms that were described to you in the beginning. The loan provider will generally offer you a loan of the same type, and usually at the same rate, but most often the costs to get that rate will be significantly higher than were listed on the Good Faith Estimate or Mortgage Loan Disclosure Statement. Neither one of these forms is in any way, shape or form a legal commitment, nor are any of the other forms you get at the beginning of the loan process, such as the Truth In Lending Advisory.

The only thing that means anything is the loan contract, or Note, that you are offered at the end of the process, together with the HUD-1 form, which is the only accounting of the loan required to be correct and complete.

Now the difference between the initial teaser loan they talked about and loan contract they actually got approved is one of the reasons why the less than ethical providers out there often want a cash deposit for the loan, particularly if their rates are not particularly competitive and they know it. If they’re nervous someone will come along behind them and offer you a better deal, they want a cash deposit so that they still get something if you pull out, and many folks obsess about the cash deposit to the point where I could offer them a deal that saves them several times the cash deposit, and they still wouldn’t switch. This isn’t to say not to pay the twenty dollars or whatever it costs them for the credit report, this is to say don’t deposit the appraisal fee (several hundred dollars, which should be paid at point of service) or even part of a point “to be refunded if the loan funds” within a certain amount of time. Chances are the loan isn’t that great, particularly not the real loan they are really going to offer, and that’s why they want to lock you in by having something to hold over you if you don’t sign on the dotted line at the end of the process.

Caveat Emptor

Every so often I get questions about loan cosigners. The main borrowers do not qualify on their own, so they get someone – most often mom and dad – to cosign. Now this is a different thing, or so I understand, in the other major credit areas – automobiles, rent, etcetera. But this is about Real Estate.

The only time this usually makes a difference is in credit history. The main borrowers qualify on the basis of income, but don’t have enough of a credit history to qualify. Sometimes they just don’t have enough open credit to have a credit score. This is rare, but I did have one executive couple who made a habit of paying cash for everything (a good habit, I might add). They had precisely one open line of credit, a credit card they paid off every month, and the major bureaus require two lines in order to report a credit score. No credit score, no loan. It’s that simple. Even there, the solution was to walk in to their credit union and apply for another, not to get a cosigner.

When you bring other folks into the loan, you’re bringing their credit history, their potentially high payments, and every other negative they have into the loan. Most of the time, the folks who are willing to cosign do not materially aid the qualification process.

Pitfall number one: If the cosigners make more money than the “real” borrowers, they now become the primary borrower, and it becomes a loan on investment property as far as the lenders are concerned, adding restrictions, raising the trade-off between rate and costs of the loan, and perhaps making the loan require a larger down payment. This does assume they won’t live there, but usually if they were going to live there, they would have been on the loan in the first place.

Pitfall number two: The cosigners are overextended also. Sure, they make $10,000 per month, but they have payments of $5000 per month already. There’s nothing left over where the bank sees them as having enough money left over to help you out. They may, in fact, have money to spare, particularly if they make a lot of money, but according to the standard ratios, they do not. You can’t have the cosigners be stated income or NINA if the main borrowers are full documentation. If you have to downgrade to stated income in order to qualify, that is going to cost a lot of money through higher rate/cost trade-off. Obviously, better that you qualify for a lesser loan than that you don’t qualify at all, but you don’t want to downgrade if you don’t have to.

Pitfall number three: This one hits the cosigners. They are agreeing to be responsible for your payments in the event you don’t make them. Suppose they want to borrow money for something else. Especially if it’s a large amount of money, as real estate payments tend to be. It really cramps their ability to qualify for other things. This works the other way, also. People come to me for real estate loans who have agreed to be cosigners for a car loan are responsible for the $400 per month for that loan. Many times, this means they don’t qualify for the real estate loan. So we have to prove to their prospective lenders that the “true” borrowers are making the payments. This is usually not difficult, but if the cosigners wrote the check for the payment anytime in the last six months to a year, it can be problematic.

Pitfall number four: This also hits the cosigners rather than the main borrowers. Suppose a payment gets made late. It impacts the credit of the cosigners as well as the “real” borrowers. It doesn’t matter if you’re the “real” borrower or the cosigner, it hurts your credit just as much and for just as long. If you cosign, you want some kind of proof that payment is being made on time, every month. You shouldn’t cosign if you don’t have the resources to make that payment pretty much indefinitely. Furthermore, should the cosigners decide to cut their losses, it can take months before the monthly hits to the credit stop. If the “real” borrowers don’t want to liquidate, the cosigners may have to go to court to get out of it, and the only people who are happy there are the lawyers.

Now suppose the loan being applied for has a Debt to Income Ratio maximum of forty five percent, and the cosigners make $10,000 per month, but they have debt expenses of $4300. This will mean that they only have $200 per month to contribute towards qualifying for the new loan. If the “real” borrowers weren’t fairly close to qualifying without them, they aren’t going to qualify with them. If they have expenses of $4600 per month, they have nothing to contribute to the loan qualification. In such cases, the work of asking them to apply is wasted.

Caveat Emptor