An Apparent Red Flag That Isn’t

For all of the rants I post about bad business practices, there are a lot of things the mortgage industry gets right. One of these looks like a red flag not to do business with them, and may seem like a cruel trick, but it is neither.

With every single loan that is done, you, the client, will get a package in the mail from the actual lender. It looks very official, and in fact it is.

Depending upon lender policy, it usually contains intentional mistakes on things such as the loan type, rate of the loan, or the points involved.

Every so often, I get a panicked phone call because I forgot to warn the client the package was coming.

The point of this particular package is not what it appears to be.

You see, every so often, somebody comes into the office and applies for a loan on a property they don’t own. Sometimes loan brokers actually go out and meet the client in their home, but other sorts of loan providers sit in their office and business comes to them. So the bank has really no way of knowing if this is the actually the person who owns or even lives in the property. So they mail a loan package to the property.

The idea is that if you haven’t applied for a loan, you’re going to speak up. You’re going to call the bank, the broker, and everyone else asking, “What the heck is going on? Is somebody else trying to get a loan on my property?”

This is the point of the particular package. It’s an anti-fraud measure. And it has just worked.

Types and Levels of Mortgage Documentation

No matter which provider, no matter what type of loan you get, nobody is going to loan you money without the appropriate documentation. The more documentation you have that you are a good risk, the better the rate you are going to get, and the lower your costs are going to be.

Everybody hates filling out forms and providing documentation. There’s a billboard two blocks from my house advertising, “Stress free loans.” Actually, these signs are all over. And I’ll bet they bring in a lot of business. Low documentation loans are easy money – I could do them all day and all night, and make more money, and make the lender more money, while doing less work, than I can by hunkering down and actually serving my clients best interests. Those billboards say “stress free loans” which three words look like an English sentence meaning this will be easy, but the real translation to English reads, “Hello, I am a lowlife scum who wants to take advantage of lazy people who are too ignorant to know better by making a lot of money providing loans at higher interest rates and less favorable terms than they could obtain elsewhere.”

The fact is, that for something dealing with this much money, if there is documentation you can produce to prove that you are a better risk and gets you a better rate, you should be eager to present it. If I can spend half an hour instead of fifteen minutes filling out forms and as a reward I save $40 or more every month until the next time I decide to refinance, I want to fill out the extra papers. If I refinance every two years, I have essentially been paid $960 for a quarter hour of work. That works out to $3840 per hour. I don’t know about you, the reader, but even when I’m completely inundated with clients, I don’t make that kind of money per hour. I don’t know any job that pays that much, unless you want to include wealthy investor. And let me tell you, the wealthy investors I’ve dealt with are eager to spend the extra time filling out said forms. It really is a “Rich Dad, Poor Dad” situation. They know it will Save Them Money, and don’t have to be sweet talked into filling out one more form or providing a little more documentation. They’ve got it already copied for me, and if I want their business, I’d better buckle down and get to work on finding the loan with the best terms possible. If you, the reader, wish to be wealthy, you could do worse than emulate their example.

There are, when you get right down do it, three different levels of documentation. The lowest level of documentation is NINA, which is short for “No Income, No Assets.” There are other names for it (“No Ratio” being the most common). This is a loan where the rate you get is purely driven by your credit score (as well as other factors, such as the equity in your home or down payment you’re making, but those are constants endemic to the situation, not variables about which I am talking). You’re not even documenting that you have a source of income. You’re basically saying, “Here I am! Gotta love me!” to the bank, and they really do love you because you’re filling their coffers by paying the highest rates for your loan. Guess what? You’re still filling out all the forms (or somebody is doing so on your behalf, which they can do to the same extent on other loan types!), and you’re still providing all the documentation on the property – how much it’s worth, proving you own it, proving the taxes are current, etcetera. Owing to identity theft laws, you can expect to have to provide two things that basically show that you are you. You can expect to deal with problems if the county doesn’t show the taxes as current, your landlord or current mortgage holder shows you as being behind or that you have a history of being behind or the county doesn’t show you officially in title of record, or any of a host of other potential problems, but hey, at least you didn’t have to show that you’ve got a source of income!

The next level of documentation is a “Stated Income” loan. This is where you document that you’ve got a source of income, but not that said income is sufficient to justify the loan, so you tell the bank you make that much, and they agree not to verify the actual numbers. This is going to require two additional items: verification of employment, or a testimonial letter if you are self-employed, and reserves. Reserves are quickest to explain. Industry standard is money sufficient to pay the loan, your taxes, and your homeowner’s insurance for six months, in a form that is sufficiently liquid such that the money can be accessed, for a long enough period that the bank will believe it isn’t borrowed – and the bank will require documentation of its availability if it’s in an account type such as 401k where access may be restricted. Verification of your employment is somebody in the HR department filling out a form on your behalf and verifying it over the phone. The testimonial letter for self-employed borrowers comes from your lawyer, accountant, or tax preparer on their letterhead saying that you really do have a legitimate business. It basically reads: “To whom it may concern. John Smith is self-employed as the owner of business X. He has been doing this for Y years. Based upon information provided to me, he will earn the same amount of money this year as last year.” The person providing the testimonial must sign the letter. It really is only three sentences, but that person is putting their business on the line for you if it’s not true. So they tend to require evidence if you’re coming to them for the first time to get this letter written and signed.

The bank is basically looking for two years in the same line of work or at the same company to approve this one. Sub prime lenders may take a year or even six months, although their terms will not be as favorable. What the bank is looking for is evidence that you can really afford the loan. “He’s got a source of income, He’s got a good credit score, he’s making all his payments, he’s got money in the bank, okay, we think he’s living with his means and can afford to pay us back. We’ll lend him the money.” There are variants on stated income of which “stated income, stated assets” is the most common, but these carry higher rates, higher charges, or both, in many cases actually end up looking more like a heavily propagandized NINA loan than anything else.

I’ve heard Stated Income (and NINA) commonly referred to as “liars loans”, and they are often used for such, but that is not their intended use. As a matter of fact, people get in a lot of trouble with these loans, and many times it comes back on an unscrupulous loan officer or real estate agent trying to push something through for which their clients really aren’t qualified. If you can’t afford the payment, am I doing you a favor to qualify you for the loan? I submit that I most emphatically am not. On the other hand, I’ll admit to having used the loans for that purpose in the past, but an ethical loan officer using it for this purpose should sit down, tell the people what the real payment is going to be, and make certain they can afford it – sometimes they’re renting and their effective cost of housing is going to go down! And in that case, I submit that I probably am helping them if I push the loan through. On the other hand, if you’re doing Stated Income or NINA (especially on a purchase) and the loan officer doesn’t sit you down and cover what the payment is going to be within a couple dollars per month, and make certain you’re okay paying it, this is a red flag in no uncertain terms!

What Stated Income is meant for is self employed people and people working on commission who really do make the money, but have write-offs such that their taxes aren’t going to show enough income. Or people who had a bad year, or large losses or high write offs one year, but are still basically solid.

The highest form of documentation is Full Documentation (almost everyone says “full doc” because the unabbreviated phrase is a mouthful). This does not necessarily mean I’ve got to prove to the bank that you make every penny you actually make, but only that you make enough to justify the loan. The proof the bank will accept is very straightforward. Self-employed borrowers are still going to need that testimonial letter from stated income. They will additionally be asked for their federal income tax packet. This is all of the forms, front and back, that you sent to the IRS last April 15th, and perhaps the April 15th before that, too. It’s got to be a signed copy, and it must include copies of any w-2s or 1099s that you get. People in the construction profession, as well as those who may be w-2 employees but work on commission will also need to furnish their taxes, and the bank’s underwriter can always require it of anyone. It is to be noted that banks do not have to accept your loan on a stated income basis – they can require that you furnish full documentation.

Those people who are hourly or salaried employees of a company can usually get by the full documentation of income requirement with just w-2 forms. If you are a company employee, the last 30 days worth of pay stubs will also be required.

The basic rationale for this is simple. Very few people tell the IRS that they make more money than they do, because the consequence is higher taxes. So the bank is willing to use tax forms to prove your income. In the case of a w-2 employee, the company is telling the IRS that those are the wages it paid you, and therefore wants a deduction for, and you went and paid taxes on it, so the bank will usually accept that. Similarly, your pay stubs should have year to date pay on them. Here the bank will accept the word, metaphorically speaking, of a third party without a stake in the outcome of the loan.

A subset of the full documentation loan is the streamline refinance. As the name indicates, it is available on refinances only, not purchases. There are a lot of limits on these loans, but when I get to do one it is the easiest of all loans. Basically, it’s a case where the same lender is now offering better rates, and no equity is being taken out of the home, and they’ll allow you to do it because otherwise you’ll take this client elsewhere. 90 percent of a loaf is much better to them than none.

Within the sub-prime mortgage world, they will often take the deposits from 12 consecutive months of bank statements (sometimes 6 or 24), usually discounted by a certain amount, and accept that as proof of income. This is called EZ doc, although there’s nothing easy about it and as a matter of experience there are more fights with the underwriter and jumping through hoops here than with any other type of loan documentation. The rates are somewhat higher than for full documentation, but not nearly the rates for stated income. Mind you, sub-prime rates are higher in the first place as well. Furthermore, many of these sub-prime lenders will advertise the fact that “EZ doc rates same as full doc!” I shouldn’t have to explain to adults that this translates to English as they don’t give the lower rates to true full documentation loans, now should I?

So, on the subject of documentation, I think you should be able to tell that the higher the quality of your income documentation, the lower the rate that you are going to get from a given lender. If you can qualify, a full documentation loan is probably going to save you more than enough money to pay you to do the extra paperwork, which is marginal anyway. The only reason not to do one is if you can’t supply proof that you make enough.

And as one final warning: If a loan officer requires originals not only of the forms they ask you to sign (original signatures required – really!), but of your own documentation, it is a BIG RED FLAG. I can’t think of any document that lenders will not accept copies of. The only reason to require your originals is that they don’t want you able to apply for a loan with someone else, so they’re putting an end to your shopping, and once they’ve got them, good luck trying to get them back (at least until the loan is done so they get paid). A good loan officer needs good readable copies – not your originals.

Caveat Emptor!

Real Estate – Third Party Service Providers

RESPA (Real Estate Settlement Procedures Act) prohibits an agent from requiring you to have other services performed by outside companies. RESPA also prohibits an agent from accepting payment (kickbacks) from third party service providers. Nonetheless, these are major problems in the real estate world.


It is an unfortunate fact that many agents care far more about the little bit of extra they get from third party service providers than they do about their fiduciary responsibility to the client who helps put potentially many thousands of dollars in your pocket.

For instance, never take a real estate agent’s unsupported word about a loan officer. It happens on a routine basis that I talk to people in other parts of California where I’m not set up to be their real estate agent (kind of hard for me to show someone a property in Redding when I’m in San Diego), but thanks to the modern age, I am perfectly capable and set up to be their loan officer. Approximately one real estate agent in three completely refuses to cooperate with me as a loan officer, despite the fact that I’m getting their client a better loan than the loan officer this person wants them to use. I can have written authority for the information, and they won’t give it to me. Okay, so I go through the escrow company – no big deal in most cases.

I can understand and sympathize with this attitude, if what they were worried about was my ability to do the loan at all. After all, if the loan isn’t ready at the end of the escrow period, this transaction they’ve spent so much effort on falls apart.

So I tell them what I’m going to tell you in another essay: Have your friend do the back up loan, if you’re so certain I’m full of it. If they were worried about a client’s best interest, they’d sign off on that in a heartbeat. I know that’s my attitude in those rare cases where I’m the agent but not the (primary) loan officer. This guy delivers, my client is very happy and has gotten a better loan and I have served my client’s interests. This guy doesn’t deliver, my loan is ready to go, the client doesn’t lose his deposit, and I’ve still served my clients interest.

There is only one motivation that I can think of for what happens consistently: the agent keeps carping at my client to cancel the loan with me. Let’s consider what this means.

No matter how unlikely the agent thinks it is that I’ll deliver exactly that loan, with cancellation, the probability I can deliver it goes to zero. So I can now guarantee that this client to whom he has a fiduciary responsibility doesn’t get the lower rate loan I was working on. Greatest possible benefit to client: zero. Downside: higher payments, higher costs, worse loan, zero leverage on other loan officer to deliver the loan he said he would.

Furthermore, no matter how good a loan officer, there’s always a chance something goes astray, and for whatever reason the loan doesn’t get approved. He’s now exposing his client to the possibility that his friend, the loan officer, won’t have a loan ready to go. If this happens, client loses house, deposit and other time and money invested. Possible benefit to client: $100 retyping fee for the appraisal saved. Possible downsides to client: no house, lose deposit, fees for appraiser, inspectors, etcetera wasted. Furthermore, the agent loses his prospective commission – several thousand dollars.

So what could cause an agent to want his client to cancel my loan? The only thing I can think of that explains the whole shenanigan is that this agent is in line for a payoff. Can I prove it? Absolutely not. Have I tried to think of alternative explanations that make sense? Many times. Maybe I’m missing something here (if so, email it to me), but I sure can’t see a benefit to the client or the agent.

Here’s another thing. Title and escrow companies. There are a variety of services escrow companies are supposed to provide the transaction – but title companies are actually the ones set up to provide many of these services. So the title company charges a sub escrow fee, messenger fees, etcetera for performing those services. But, they will waive those fees (not charge them) IF the escrow company in the transaction happens to be one they own.

Hey, I think, a pretty nifty way I can save my clients several hundred dollars! Makes me more valuable to them! And since kickbacks from title and escrow are illegal as well as unethical (according to RESPA and the Code of Conduct as well as good business practice, respectively) I certainly can’t see a benefit to me for urging them to choose otherwise.

(And I am truly sorry to anyone reading this who works at an independent escrow company. As far as I can determine, you’re just as competent as the title company escrows, and no more intrinsically expensive. But it’s really hard for your company to compete when choosing your competition saves my client money that’s usually about equal to the base escrow cost. Plus the fact is that it’s a violation of my fiduciary duty if I don’t tell them this)

You wouldn’t believe the resistance I get from agents who obviously want their client to choose one particular escrow company, and one particular title company that aren’t affiliated. True, it is the sellers who have the right to choose title and escrow companies. But that’s the seller’s right, not the seller’s agents. And a failure to inform them of obvious ways to save money by choosing an escrow company that will save your clients this money is a violation of fiduciary duty.

I just finished fighting one not too long ago where the seller supposedly wanted to choose an escrow company whose name just happened to be the same as the name of the real estate office that the seller’s agent worked for (I.e. X Real Estate and X Escrow company). Now it may be possible that they are unaffiliated with that real estate office, and it may be possible that they are set up to handle all of the duties that cause the title company to charge those extra fees. So my client’s counter-offer included the following phrase

“Since the seller has chosen title and escrow companies unaffiliated with each other, seller is to be solely responsible for all sub escrow, messenger, and additional fees assessed by the title company above the cost of the title policy.”

It even gives them an out – if the escrow company is set up to handle these services that are supposedly their responsibility, and does so that the title company doesn’t charge for them, it makes no difference to either client.

This guy didn’t want to present the counter to his client. He specifically asked me to drop that wording. I knew exactly what this meant, particularly in the case of the escrow company that just happened to share the name of his real estate brokerage. No evidence admissible in court, of course. But I had to threaten to have my boss call his broker with the clear intimation that my next call would be to Department of Real Estate in order just to get him to present the offer to his client. Do you think it’s possible he failed to inform his client about this trivial way to save money? How likely do you think it that there was some kind of payment going on off the books? All of this is illegal.

There are two companies that provide the vast majority of all home warranties, at least in this area. I can’t even name another home warranty company off the top of my head. Each of them is affiliated with a particular title company. The policies are the same, as far as I can tell. Somebody wants to know the differences, I tell them to consult an insurance expert (The expert I consulted concurred with my opinion). But one of these insurance carriers is more expensive. If I’m representing the buyer, I don’t care – his coverage is going to be pretty much the same. If I’m representing the seller, I’ll tell them to please consult a licensed casualty insurance agent, but B is less expensive as far as I can tell. Why then, do I keep seeing sellers who are volunteering A? I can’t believe a fully informed client is volunteering to spend more money for the buyer’s benefit in order to buy coverage that looks to be the same.

The long and the short of this post is that just because it’s illegal under the law doesn’t mean it doesn’t happen. Just because that agent has a fiduciary responsibility to you under the law doesn’t mean they take it seriously.

What can you do?

Well, choose an escrow company that’s affiliated with your title company, or an escrow company that’s affiliated with a title company, and choose that title company too. On refinances as well, do not allow your loan provider to choose title and escrow who are unaffiliated with one another (to be honest, I haven’t helped buy or sell property outside of California, so have no idea how this works in an attorney state). Look for something like “X Land Title” and “X Escrow.” This will save you hundreds of dollars.

Ask not just your real estate agent, but also your insurance agent about home warranty policies. Or look in the Yellow pages under Home Warranty Coverage and call around if you’re selling a property. Do this BEFORE you have an offer.

And above all, don’t just go with your agent’s recommendation on a service provider. It’s unethical, illegal, and just plain bad business practice, but that doesn’t stop a certain number from having their hand out behind your back. And it’s just as likely to be the highly accredited agents with years in the industry who are doing this.

Caveat Emptor.

Questions to Ask a Prospective Loan Provider

Mortgage – Questions you must ask every provider on every loan.

(This list is trying to be as exhaustive as possible, but is likely missing some important questions. If I missed one, send it to me: dm at )

What is the rate?

What is the amortization period?

Is there a possibility that the note will be due in full before the amortization pays it off? (Vaguely equivalent to “is there a balloon?” but a broader question)

Is the payment interest only, or principal and interest?

(if interest only) how long is it interest only, and what happens afterward?
Is there any possibility of negative amortization (the balance increasing) if I make the minimum payment? (if yes, warning!)

Is the nominal rate different from the real rate of interest I am being charged?

How long is the rate fixed for?

(If fixed for less than the full period of the loan) What is the rate based upon when it adjusts, what is the margin, and how often does it adjust?

What is the industry standard name for this loan type?

Is the rate you are quoting me based upon full documentation, stated income, NINA or EZ Doc?

(If full or EZ doc) Assuming I have other monthly payments of $X, how much monthly income do I have to document in order to qualify? (If this is more than you make, Warning!)

How many points TOTAL will I have to pay to get that rate.

How many points of origination will I be charged?

How many discount points will I have to pay?

What are the closing costs I will have to pay?

(because they are allowed to omit third party costs from all estimates and totals, you must add the answers to the next three questions to the previous question unless the provider specifically includes them)

How much will the appraisal fee be?

How much will total title charges be?

How much will the escrow fee be.

Who will my title company be?

Who will my escrow company be?

(If escrow company is not owned by title company, i.e. same name, be prepared for unknown additional title charges).

How much, total, will I be expected to pay out of my pocket?

How much, total, will be added to my mortgage balance?

With everything added to my mortgage balance, what will my payment be?

How long of a rate lock is included with this quote?

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After you have finished talking to this person, go check out the numbers. If you have a calculator that can handle mortgage calculations, use it. If you’re able to do the calculations yourself, even better. Otherwise, do a web search for payment calculators or mortgage calculators or amortization calculators, and try out a couple of different ones (because some web calculators on lenders sites are programmed to lie!). This is math – there is only one right answer! The numbers should come out the same except for rounding errors! If the difference is more than five dollars in any case, that’s a red flag! (You should also make certain the reason for the difference is not operator error. For instance, automobile payment calculators assume a different first payment than mortgage calculators, but student loan calculators should be compatible with mortgages.)

Caveat Emptor

Mortgage Rate and Points

Everybody knows that you want the lowest rate, and everybody knows that you don’t want to pay any money you don’t have to, in order to get it. However, not everybody makes the connection that it is always a tradeoff between the two. At any given point in time, each home lender has it’s own set of tradeoffs in place.

There are two components to the costs of a loan: Closing costs and points. Points have to do with the cost of the money. Closing costs relate to the work that has to be performed in order to get the loan done. These are not junk fees, although junk fees do happen.

Let us consider for a moment the home loan. You want to buy a home for your family, but don’t have enough cash. Without somebody willing to loan you the difference, you cannot buy. You check with your family, your friends, your neighbors and they’re all tapped out (or say they are). But there’s a bank over there willing to loan it if you meet their terms.

The banks are not being altruists, of course. They’re making a good chunk of change for doing so. But you would not believe the amount of complaints I hear out sympathetically about how this evil horrible bank is charging all this money and making people jump through all these hoops to get this money (“They want a pay stub! Actually they want two pay stubs! What is the problem with these nazis?”). Fact is that this bank is doing you a favor, risking hundreds of thousands of dollars on you so that you can own a home for your family. They are doing something for you that all of your friends and family were unwilling or unable to do: loan you the money to buy a home. I’d say that puts them pretty high on my “nifty list”, not “Nazis”, but it’s your life. When you think about it, they’re doing you a favor by making certain you can afford the payments on the loan (It’s more than many agents and many loan officers will do), as well as insuring that if something goes wrong and you can’t afford the loan, they’ll get most of their money back. Real Estate is not sold on a whim. Right now, another agent in my office has a listing of an $800,000 home. The family makes about $60,000 a year. Their interest alone is 76% of their gross pay, never mind property taxes and insurance. An unscrupulous agent sold them the house based upon the ability to flip it whenever they wanted, and found them a similar loan agent to get them a negative amortization loan so they’ve got about fifteen hundred dollars a month being added to their mortgage and they still can’t make the payment. But real estate is not like stock; you can’t sell it at will. The market cooled just a little bit. They’ve already lost their entire investment, and they’ve come to our office to get it sold before worse things happen, and we’re doing everything that can be done, and still nobody wants to buy it.

There’s a lot of this out there. You would likely be amazed at the loans a competent loan officer can qualify you for (and that if you understood what you were getting into, you’d drag them into the sunlight and run a wooden stake through their hearts before running away, instead of believing them to be your friend). I’d get an extra client a week, at least, if I didn’t sit down with the people to find out what they can really afford before I showed them the $800,000 house that’s going to get me paid a Huge Pile Of Money, when I really should be telling them about 2 or 3 bedroom condominiums, or even telling them to continue renting. It’s hard to get a client enthusiastic about a 2 bedroom condo, particularly when someone else is showing them a 5 bedroom 2800 square foot House With It’s Own Yard and No Shared Walls and telling them they know Someone Who Can Get The Loan. But the world will catch up to these agents and loan officers, and I put a certain value on staying in business.

Getting back to the issue of closing costs, there is work that has to be done before you get your loan. The people who do that work are entitled to be paid. You don’t work for free. They’re not going to work for free. As I have covered elsewhere, realistic closing costs without junk fees are about $3400, and can easily be higher. The bank is not just going to absorb the cost because they’re going to make money off the loan.

Each home loan, whether the lender intends to sell it or not, has a value on the secondary market. They also cost the lender a certain amount (they have to pay for all money they lend, whether by borrowing or by opportunity cost). Based upon these two facts, the lender sets a level of discount points or rebate for each rate for each type of loan. When you pay discount points, you are actually paying the lender money in order to buy a rate that you would not otherwise be able to get. When there is a rebate, it means that the lender will pay out money for a loan done on those terms. A rebate can be thought of as a negative discount, and vice versa. Whatever the level it is set at by the lender, there’s going to be an additional margin so that the broker or loan officer can get paid, even if the loan officer is an employee of that lender. This margin is not necessarily smaller by going direct to a lender – actually a broker usually has a better margin than that lender’s own loan officers. As I say elsewhere, the supermarket banks often have their best rates posted, and I’m usually getting someone a better loan (lower cost/rate tradeoff) with the same lender.

But within a given type of loan, the lender always sets the loan discount higher for the lowest rate. The lower the rate, the higher the discount and the higher the rate the lower the discount. Choose the lowest rate, and pay not only closing costs but the highest discount as well. Whether it’s coming out of your checkbook or being added to your mortgage, you are still paying it. Choose a somewhat higher rate, and there will be no discount points, just closing costs. There’s a name for this rate where there’s no points but no rebate; it’s called par. Rates below par involve discount points, rates above par will get you some or all of your closing costs paid by the bank or broker.

Many people will want the lowest rate; after all that has the lowest payment. It is (or should be) your choice. It’s actually easier to qualify for lower rates, because the payment is lower. However these lower rates can be costly, because the fact is that the median mortgage in this country is about two years, and fewer than 5% of all loans are less than 5 years old. This means there’s a 50% chance you’ve refinanced (or sold and bought a new home) within two years, and over 95% within 5 years. I see no reason for these consumer habits to change. Furthermore, I’m a consumer, and so are you. There are people who bought a place and paid off their 30 year loan and now own the property free and clear, but they are rare these days. Much more common is the person who bought their house in the 1970s, has refinanced ten or twelve or fourteen times, and now owes ten times the original purchase price. More common yet is the person who’s on the third, fourth, or fifth house since then. You might be one of the first group, or you might not be, pretend you are, and be hurting only yourself. It’s likely to be a costly illusion.

Let’s look at three different 30-year fixed rate loans. All of them start from needing $270,000 in loan money. Loan 1 gets a 5.5% rate, but has to pay two points to get it, so his loan balance starts at $270,000 plus $3400 plus two points, or $278,980. He paid $8980 to get his loan. Loan 2 gets a 6% rate at par, and his loan balance starts at $273,400, because he only had to pay $3400 to get the loan. Finally, Loan 3 chooses a 6.5% loan where all closing costs are paid for him by the bank or broker. His loan balance starts at $270,000.

Your first month interest with Loan 1 is $1278.66, and principal paid is 305.36, on a payment of $1584.02. Loan 2 pays $1367.00 interest and $272.17 principal with a loan payment of $1639.17. Loan 3 is going to pay interest of $1462.50, principal of $244.08, and have a total payment of $1706.58. So far, it’s looking like Loan 1 is the best of all possible loans, right? But look two years down the line when 50 percent of these people have refinanced or sold:

Loan Loan 1 Loan 2 Loan 3

Interest pd. $30,288.21 $32,418.26 $34,720.18
Principal pd. $7,728.21 $6,921.84 $6,237.83
Balance $271,251.79 $266,478.16 $263,762.17

interest diff: $-2130.05 $0 $2301.92
balance dif: $+4773.36 $0 $-2715.99
Net $ $-2643.31 $0 $+414.07

Remember, the original balance was $270,000. Loan 1 has paid $2130 less in interest the Loan 2, while Loan 3 has paid $2301.92 more. Furthermore, Loan 1 has paid down $7728 in principal, while Loan 2 has only paid down $6921 and Loan 3 still less at $6237. It’s really looking like Loan 1 was the best choice.

But remember, 50% of all loans have refinanced or sold within two years. When you refinance or sell, the benefits you paid money to get stop. But the costs to get those benefits are sunk on the front end, and you’re not getting them back. Look at the balance of Loan 1. The person who chose this still owes $271,251 – $1251 more than they did before they chose the loan in the first place. Furthermore, his balance is $4773 higher than loan 2, and even though he paid $2130 less in interest, he’s still $2643 worse off. Furthermore, whether he refinances or sells and rolls the proceeds over into a new property, the new loan is going to be for $4773 more money than Loan 2’s new loan. Assume everybody got a really fantastic new loan at 5%. Loan 1 is going to have to pay $238 more per year to start with in interest expense for his new loan, simply because his remaining balance on the old loan was higher. Loan 3 is in even better shape than Loan 2. He’s paid $2301.92 more in interest, but his balance is $2715.99 lower, for a net benefit over loan 2 of $414, not to mention that his interest costs on his new loan will be almost $136 lower simply because his starting balance is lower.

Now let’s look 5 years out, when over 95% of the people will have sold or refinanced.
Loan Loan 1 Loan 2 Loan 3
Interest pd. $74,007.65 $79,360.88 $85,144.66
Principal pd. $21,033.41 $18,989.39 $17,250.36
Balance $257,946.59 $254,410.61 $252,749.63
interest diff: $-5353.23 $0 $+5783.78
balance diff: $+3535.98 $0 $-1660.98
Net $ $+1817.25 $0 $-4122.80

At this point, Loan 1 has saved $5353 in interest relative to Loan 2, while Loan 3 has spent $5783 more. Loan 1 has cut his balance difference to $3535 more than Loan 2, so he looks like he’s ahead! Furthermore, Loan 3 is really lagging, having paid $5783 more in interest although the difference in balance is only $1660 to his good.

Well, loan 2 is ahead of loan 3 pretty much permanently at this point. Assuming all three refinance or sell and buy a new property with a 5% loan right now, Loan 3 is only going to get back $83 per year of the $4122.80 he’s down relative to Loan 2. Especially considered on a time value of money, that’s permanent. But despite Loan 1 being ahead of Loan 2 right now, Loan 2 will get back almost $177 per year. Ten years on, assuming a ver low 5% rate, loan 2 is back to even, and most of us are going to be property holders the rest of our lives. Consider also that 95% of the people who chose loan 1 NEVER got this far – they never broke even in the first place.

The point I’m trying to get across is that money you roll into your balance hangs around a very long time. And you’re sinking potentially many thousands of dollars into a bet that most people lose. Yes, if you keep the loan long enough, the lower rates (at least for thirty year fixed rate loans) will pretty much always pay for themselves, several times over in many cases. The other point I’m trying to make is that most people don’t keep their loan long enough for the benefits to pay for their costs to get those benefits.

As a final consideration, consider what happens if one year later interest rates are one-half percent lower. I can get Loan 3 the same loan that Loan 2 has for zero cost. He’s got the same interest rate as Loan 2, whom I can’t help right now, but a lower balance – neither one of his loans cost him anything. And it has happened that the rates dropped down to where I could get someone 5.5% on a thirty year fixed rate loan for zero – lender pays me enough to pay all the closing costs. Net cost to them, zip. Suppose rates do this again. I call Loan 2 and Loan 3, and now they’ve both got 5.5 %, but this doesn’t help Loan 1. Now Loan 2 has the same as Loan 1, while only adding $3400 to his balance to get it, as opposed to Loan 1 adding nearly $9000, and Loan 3 has the same loan without adding a dime to his balance. Who’s in the best position?

Caveat Emptor

May Be Out Of Touch

Starting tomorrow, I’m going to be potentially out of touch for a few days. Too cheap to buy a month of mobile broadband for a week, and I have no idea if there even is wifi coverage available. The blogs and FB Author page allow scheduling in advance, so I’m taking advantage of it. My other social media does not, so posting may be non-existent there.

I thought about putting up a post wondering if there’s a bear in this cave, but maybe you can get a laugh out of imagining I did.

Mortgage Markets and Providers

There are actually several distinct marketplaces consumers can obtain their funds from, and several types of providers. John the wealthy highly salaried person with great credit and a substantial down payment should not and usually does not obtain his mortgage from the same funds providers as his twin brother Jim, the self-employed, always-broke person with terrible credit and no down payment. They may deal with the same employee at the same business, but the funds and parameters for using those funds, are entirely different.

In order to make sense later on, I’ve first got to acquaint you with two concepts: yield spread and pre-payment penalty. The yield spread is what then lender pays the person or company who does the paperwork for your loan in order to give them an incentive to choose that lender, as well as any of several other reasons. The yield spread is based upon the rate of the loan, the type of the loan, etcetera

Prepayment penalty is a penalty you agree to pay if you sell your home or refinance before a certain period of time has passed. Industry standard is six months interest, with some lenders making this 80 percent of six months interest. Usually (not always) they will let you pay a certain amount over the normal, agreed upon principal per year without triggering the penalty, but if you sell or refinance out of their loan, the penalty is always triggered for the duration of the penalty. Some lenders will actually phase it out in stages, although this is not common.

Lest it be not plain to you, a prepayment penalty is a thing to avoid if you reasonably can. Let’s say you get transferred and need to sell the house in six months, and that you have a $200,000 loan at 6%. That’s six thousand dollars less that you will receive from the sale of your home, not to mention that the average person refinances every two years, which is typically the shortest pre-payment penalty. If you need to refinance within two years, that’s six thousand dollars of your equity gone for no good purpose. Mind you, if you need the loan, and it gets you the loan, so be it. It’s still a thing to avoid.

The top of the food chain from the point of view of consumers are the so-called A paper lenders. This market is controlled by the two federally chartered giants, Fannie Mae and Freddie Mac. Lenders who participate in these markets lend in full accordance with Fannie Mae and Freddie Mac rules, because they want to be able to sell the loan to them. In many cases, they actually do sell them seamlessly by retaining the servicing rights, and the consumer never knows they have done it. In others, they retain the loans entire, and in still others, they sell them off entire. They do this for many reasons, but mostly to raise cash so they can do more loans. In any case, the only difference it should make to you, the consumer, is where to address the check and who to make it out to. Unlike the other markets, if the lender pays a yield spread in this market it does not automatically mean that there will be a pre-payment penalty. Although they will pay a higher yield spread if the loan officer sticks the client with a pre-payment penalty (and the longer the prepayment penalty is, the more they will pay). WARNING! Many loan officers will not tell you about it unless asked (“Why bring up a reason not to choose your loan?” is a direct quote I’ve heard any number of times) and some will flat out lie even if you ask. This is not ethical, but they know they can almost certainly get away with it. There really is no reason why an A paper loan should have a prepayment penalty, except that a loan officer wanted to get paid more.

It is not difficult to qualify for an A paper loan. As long as you’re not taking equity out of the home, they can go through with credit scores as low as 620 (full documentation) or 660 (stated income), although there are caveats. Despite what you read in Internet pop-ups, according to National Mortgage Reporting a 660 credit score is more than forty points below the national average. So even someone with modestly below average credit can still qualify for an A paper loan. There are minimum equity requirements, however. And it doesn’t matter if you are King Midas who has never failed to pay a bill immediately in full or someone who barely staggers over the line into qualification by the computer models put out by Fannie Mae and Freddie Mac. This is it. The top. You all have the exact same rate choices. There is nothing better.

The next niche below A paper is called A minus. The rates are a little bit higher, and there are prepayment penalties anytime the lender pays a yield spread. Then comes the so-called Alt A, which are typically loans for fairly unusual circumstances. The credit scores here go down to about 580, although there is less standardization. The worst, most dangerous, absolutely awful loan in the world comes from the “Alt A” world. There are all kinds of friendly sounding names for it, like “Option ARM”, “pick a pay”, and such things, but they are all negative amortization loans at their heart – you end up owing more than you borrow. They sound benign: “pick your monthly payment!” But in fact most people choose the minimum monthly payment which capitalizes and then amortizes more money into your loan every month. Every single one I’ve ever heard about carries a prepayment penalty. I see adds for these abominations every day all over the internet. If anybody quotes you a mortgage rate below 3%, I will bet you millions to milliamps they are trying to sell you one of these (despite the fact that there are other loans out there below 3% right now). There seriously are providers that do nothing but these – they’re easy to sell to unsuspecting victims because the minimum payment is so small. There really isn’t space here to go over everything that’s wrong with them (or where they may be appropriate), but except in certain special circumstances, RUN AWAY! And do not do business with that person! They have just proven themselves unworthy of your business.

(Every so often, a representative from a new lender walks into my office. I’m always glad to talk to them so long as they answer my questions in a straightforward way, but I have one inflexible rule. If the first thing they talk about is a Negative Am loan – no matter the happy sounding name they call it by, I throw them out and do not allow them to return. I think it indicative of the state of things in the Negative Am world that the one time I had a client who would actually benefit from this thing, and I took the time to tell him exactly where all of the traps I knew about were, give him strategies to turn it to maximum benefit, and he agreed that he wanted to do it – not one of the five companies I tried would actually approve the loan.)

The final niche that comes from regular lenders is called sub prime. And in the world of sub prime lending you can do a lot of things that higher rungs on the ladder will not allow you to do. As in A minus, anytime the lender pays a yield spread there will be a pre-payment penalty, and I think I’ve run across exactly one sub prime loan that didn’t have a prepayment penalty in my whole time as a loan officer. However, the people who subsidize sub prime lenders just don’t have a whole lot of choice. This is typically the only way they’re actually getting a home loan, be it because of low credit, low equity, or what have you. The rates are high, but it’s that or nothing. Sub prime loans are very lucrative – the average lender or broker specializing in them usually makes about 5 points – 5 percent of the loan amount – on each and every loan. I’ve had people thank me so profusely I was almost embarrassed when I got them a loan on something more closely resembling a typical margin from higher niches. The lines between A minus, Alt A, and sub prime are blurring more and more as time goes on. It is to the point now where if someone says they do sub prime, that usually means Alt A and A minus as well – it’s just a matter of where on the spectrum a given client sits.

The final niche is Hard Money. These are not typical lenders as all. They are agents for individual investors, sometimes even carrying the loan themselves in their own person. The rates for this start an absolute rock bottom of about 13 percent, and go up from there. Typically there will be a front-end charge of about 5 percent of the loan amount, and a prepayment penalty of about 7%. These are loans for people with sub 500 credit scores, people with homes that have been damaged in some way and must make repairs before a regular lender will touch the property, and so on and so forth. The equity requirements are large – 75 percent of the value of the home based upon a conservative appraisal is about the highest a hard money lender will go, and most are less. Everybody until this point is in the business of making loans, and is likely to cut you as much slack as practical if you have some difficulty making payments, as they are not in the business of foreclosures. A hard money lender has no such constraint. They will foreclose on your home without a second thought. One way or another, they will get their money back and then some. WARNING! It is common practice on the part of hard money lenders to have you sign the Note and Deed of Trust “conditional” upon them finding an investor. The person signing the documents thinks the loan is done, and that their situation (usually a time critical one) is resolved, and everything is all roses now, but it isn’t. They may still want you to pay for multiple appraisals, jump through multitudinous hoops, and still not give you the loan in the end. This is just their way of binding you to them so that you don’t or can’t go elsewhere. Not that this is completely unknown in the higher niches, but it’s not common, as it is here.

There are three main types of places to go to get a loan. The first is a regular lender. The second is what I call a “packaging house”, although in practical terms it is very similar to a regular lender. The third is a broker or correspondent. Each has their advantages and disadvantages.

A regular lender is what you think of when you think of a bank. Most of the big names are regular lenders. They typically have their own offices, often mingled with other banking functions. They have their own funds, wherever they’ve gotten them from, and they have executives and such that put together their own loan programs, complete with criteria for approving or not approving a given loan. These people do loans with at least the possibility of keeping them in mind, and some do keep every loan they do, while others sell almost every loan. The good news is that they’ll typically be slightly more willing to make exceptions around the edges (whether or not the loan is a good one for you!). The bad news, from the consumer point of view, is that they consider you a captive from the moment you walk in the door. Even if they know of another lender with better pricing or a program that suits your needs better, they’re still going to keep you “in-house”. And their loan pricing is such that it’s going to pay for all of the salaries and benefits for all of the people in the office, and the beautiful office itself and all of its contents.

A “packaging house” is like a regular lender except that they do their loans with the explicit intention of selling off every single one, either immediately or a few months down the line. Practical difference to consumer: there’s a 100% chance you’re going to end up making payments to someone else. In other words, no big deal. The original lender recently sold my own home loan. The only difference is that now I write the check to company B instead of company A, and mail it to place X instead of place Y. California has stronger consumer mortgage protection laws than the federal government, but there are laws in place nationwide for the consumer’s protection that avoid payments being unjustly marked late because your mortgage was sold.

A broker is not lending their own money, but is being paid instead to put the loan together and get it to the point where it is funded, at which point they are out of the picture. A packaging house could, in theory, decide to keep a particular loan. A broker doesn’t have this option – it’s not their money being loaned, but instead that of a regular lender or a packaging house. On the down side, a broker has somewhat less leverage to get underwriters to make exceptions to the rules (although the difference is academic for those outside this narrow range). There is also a lot of variation on quality. You’ll find the very best loan officers in the country working as loan brokers – and the very worst, as well. On the up side, a broker always has at least the ability to get you a lower price than the other alternatives, although they may not have the willingness. First, a good broker shops many different lenders to find the program that’s priced best for you. This is less important but still very noticeable at the A paper level (A paper had pretty standardized rules) then it is for borrowers whose situations (either through credit, or through needing to do something A paper doesn’t support) need to go to markets lower down on the totem pole. On the other hand, I (as a broker) get better pricing from the lenders, either regular or packaging house, than their own loan officers. Why? Partially because they’re not paying my support expenses – office rent, furnishings, support staff salaries, etcetera. Mostly because it’s my customer, and I can and will take my customer elsewhere if they don’t give me the best possible deal. Every week when I do the family shopping, I see the banks in the local supermarkets offering their mortgage deals, and I always smile because I’m always getting somebody a better price on the same loan from that same lender. (A correspondent lender is a broker with a line of credit to fund loans. The mechanics from a consumer point of view are identical, but because they briefly fund the loan, they’re not getting Yield Spread as legally defined, so they don’t have to treat it as a cost to consumers – which it isn’t).

Caveat Emptor.

Fixing Kelo – a proposal

My mind wouldn’t let me leave this topic alone. I got to thinking about how to fix this.

I think Congress could do fix this tomorrow. Simple Public Law.

The Congress of the United States, wishing to discourage abuse of eminent domain, henceforth enacts into law:

  1. In the event of public condemnation of private property, the public entity bringing suit shall pay all expenses of the defending party in said suit, including but not limited to legal expenses, and any expenses incurred in evaluation of the property or documentation of this value. This compensation shall be immediately due and payable upon presentation of reasonable proof, and it shall accrue interest at a rate not less than double the prevailing customary rate, or additional charges incurred by the property owner as a result of tardy payment, whichever is greater. This compensation shall be paid regardless of the said suit’s resolution.

  2. In the event of a successful condemnation, the property owner shall be additionally compensated no less than the greater of either 150% of the fair value of the property determined in accordance with usual practices or 125% of the cost of replacement property.



    Okay, folks. Pick it apart. Tell me where this fails.



    (other than making communists unhappy, that is)

Cold Hard Numbers

When the Kelo decision was rendered in 2005, I had just recently attended a talk by Gregory Smith, then county assessor, on the future of home values in San Diego.

Historical text:

He expects prices to continue to rise by 5-10% per year, citing scarcity as the reason. Basically, too few homes are being built, so we are in a situation with excess demand and not enough supply.

Now, public officials of the county of San Diego have an incentive to want prices to continue to rise. I tried to ask him a question about any other factors holding the price up, and he was unable to produce any.

Unfortunately for this point of view, high demand and scarce supply has a long history in the San Diego area. This has been a constant of the market, rather than a variable, since the late 1970s. Even during the last downturn, the problem was not a lack of interested buyers, the problem was that they couldn’t afford the prices when interest rates went up. Sellers had a choice of selling at the prices people were able to qualify for or not at all. Many chose the latter option, it paid off in spades when interest rates fell and prices started rising again. Those in situations where waiting was not an option had no choice but to sell at lower prices.

The fact is that only 9% of the people can afford to purchase a home in San Diego. Even for wealthy investors who put $100,000 down on a $500,000 home with the intent of renting it out, their monthly cash requirements are $2528 to cover a 6.5% loan, plus approximately $500 per month to cover basic property taxes and then insurance, maintenance, etcetera on the property. Unless rents are well in excess of $3000 per month, which they are not, this amounts to investing $100,000 only to have to invest more every month in hopes that the market rise will eventually reimburse you. I agree with every respectable real estate investing guide that negative cash flow on an investment property is a recipe for disaster. This current situation in real estate has many parallels to the dot com investing bubble of several years ago.

Furthermore, we have many people who obtained short-term financing in the last several years, loans that must be refinanced within the next eighteen months, and will not be able to obtain terms that are as good or allow their adjustable rate loans to adjust. Either way, they are facing higher payments – payments that many are unlikely to be able to make. They will either sell voluntarily for what they can get, or involuntarily as the lender liquidates a nonperforming loan.

Even though long term rates are still remarkably affordable, short term financing, particularly on a “Stated Income” basis has become more prevalent for purchases, especially for beginning buyers, and these have risen enough to slow the market greatly. We are starting to see indications of a buyers market now. Homes are taking much longer to sell, and buyers are getting much more leverage on their offers. When longer term rates return to their historical margins above short, the effect will multiply. It doesn’t take a genius – only a calculator – to know that when owner occupied rates go from 5.5% to 6.5%, somebody who could afford a $400,000 loan at 5.5% can only afford $359,000 at 6.5% (this difference is magnified for those willing to take interest only loans).

What does this mean to you, a homeowner? If you intend to hold onto your home for many years, I am confident that the market will eventually make good any short term correction. On the other hand, now is the time to secure the long term financing that enables you to hold onto the property profitably, while the high price of comparable properties helps your equity picture. (omitted text here)

If you are in a situation where you know that you are going to need to sell within the next few years, the time to act is definitely now, lest you lose more of your precious built-up equity to the short-term vagaries of the market. This market is going to get much worse for sellers before it gets better. (omitted text here)

And if you’re looking to move to a larger house soon, the time to act is now to leverage the market! Sell while the market is still high, knowing that when prices recede later, the money you get from the sale will help you buy more house for less! (omitted text here)

Modern Addendum:

In case you’re unaware, San Diego prices did crash hard for several years. Unfortunately, the shortfall of units has continued and built up over the intervening years. Demand so far outstrips supply that even a doubling of interest rates has barely slowed prices lately.

The Ultimate Consumer Horror Story

Every so often, I get a call out of the blue that starts something like this “Hello, I’m shopping for a mortgage. Just tell me your lowest rate.”

I try to do the ethical thing, finding out on what sort of loan and all of the ancillary information that would actually make this useful information.

“No. Just tell me your lowest rate.”

Every so often, I’ll admit, I’m seriously tempted to quote them the lowest rate available on a month-to-month loan where the teaser rate has to be purchased with three and a half points – a loan such that I’d consider going homeless if that was all that was available.

Then I sigh inwardly and try to explain that unless I know the answers to a few question about the kind of loan that would be best for him, that’s like being told the ultimate answer to the ultimate question about life, the universe, and everything is 42, without being told what base it’s in, much less what the ultimate question is, so that that he, the consumer, has some way of knowing whether the answer may be appropriate.

“If you won’t help me, I’m hanging up. Click“

And then one of my neighboring co-workers wants to know who that was, and this is what I tell them:

“Some Poor Guy who’s terrified of salespeople setting himself up to get rooked for the five millionth time.”

Another example: Quite some time ago, I was dropping some papers off with a prospective client, a salesman in a different industry. Somebody came up to him and asked, “How much for an Acme Widget Master 1234?”

“$X” was the reply. The guy walked off immediately. I asked my prospect, “Aren’t you going to try and stop him? And I thought an Acme Widget Master 1234A56 cost $X+Y. They on sale?”

“Dan, I know you’re new to the sales game, so I’ll give you some help. That Guy is not my target market. He thinks he knows everything he needs to, and thinks he knows how to get the best price. He may actually know what he’s doing and not need my expertise. But he wasn’t going to give me the opportunity to explain that this was the price for the base model Widget Master 1234, and the Widget 789 with a couple options for about the same price is probably going to make him happier. You’re not my target market, either – you know enough about these to be able to figure your needs pretty accurately. You came in and told me what characteristics you needed it to possess, which is why I told you about the A56 and quoted you that price. I was grateful gave me a chance at your business, but I didn’t expect to be able to beat Major Catalog Company. All they’re selling is the item. I’m selling not only the item, but also my knowledge and immediate availability, and help setting it up and technical support. Sure, That Guy is probably going to end up with something that frustrates the hell out of him at a price higher than he thought he’d pay, but he’s terrified of me. He’s not going to give me the opportunity to talk, and until that changes I refuse to waste my time trying.”

One final example, even earlier: When my wife and I were newlyweds, we needed a household Major Item because our previous Major Item had failed. We went to several places shopping, among which were stores A and B.

Salesman at A: “You say you need type X? Oh, those are terrible, but if you spend $1000 modifying your home, you’ll really love this product. Energy efficient, does a great job, and it’s cheaper than the competition. No we don’t have any of type X, but like I said, you don’t really want those. They are awful.”

Salesman at B: “You say you need type X? I’m sorry, but we don’t carry any of those. I’m sorry but there’s not enough demand, although I understand your situation. Tell me, have you found any anywhere? At C and also at D? What did you think of the alternatives? Thank you for helping me.”

Several years later, we had need of a Different Major Item. I had kept the B salesman’s card, and we went back and ended up buying from him, although we did shop elsewhere. We tried to go back again for Another Major Item recently, but he had moved on and we were disappointed, but talked with the salesperson who was there, and although we ended up buying elsewhere that time, I could see a cultural influence at work and we will continue to make a point of shopping there.

We haven’t gone back to store A since the first conversation.

My point is this: Had I been Mr. Some Poor Guy, or That Guy, I would have bought from the A salesman – it was the cheapest product. Then another A salesman. And yet another A salesman. And been unsatisfied and unhappy, and generally angry at the need to spend a lot of extra money and frustration dealing with it each time – why didn’t they tell him? Why weren’t they simply honest? It must be because all sales scum are dishonest crooks!

Unfortunately, the real problem is not so much that the A salesman was a crook (he was a misinformed high pressure employing menace to society, but he did tell me I’d have to spend the $1000 extra), but that the strategy the customer employed is counter-productive, and does pretty much guarantee you’re going to get conned – he wouldn’t give the A salesman a chance to tell him about the $1000. I encourage keeping your guard up, but a request for context is an attempt to find you a product that meets your needs without costing you more than necessary. Wait until somebody actually tries to sucker punch you before you go for the right hook to the jaw followed by the one-two to the kidneys. Because the A salesmen (and women) play this game every day, and they’re incredibly good at it, and it’s going to be one of them that counters with a karate blow to the throat that scores a knockout (and the sale). Messrs. Some Poor Guy and That Guy are the sort who keeps the A salesmen in Lamborghinis.

The B salesman is good at a different kind of game. Typically make less money, especially at first, and so it is not the model taught by the How To Succeed in Sales Super School, and he’s not the Superstar Sales Hotshot that corporate sales managers seek out to help increase their next quarterly bonus for staff productivity, but he’s out there if you look, and a lot of companies from the corner shop up to the big corporations understand his value to their bottom line. Where A salesman is always hard at work looking for the next score (and is always a drain on their advertising budget, in whatever form), B salesman gets to the point where he’s handling all he can with what comes to him, even generating spillover to other members of the staff. Even when he gets to the point where he’s constantly saturated in business, he doesn’t get stressed, he doesn’t burn out, and he’s not a source of problems.

Now, how would you like to find B salesmen reliably?

First, you’re going to have to look hard. He’s probably not going to be the first one you talk to. You’re going to have to do some serious shopping. He’s probably busy somewhere talking to a repeat client, not one of the vultures who are waiting around the sales floor to swoop down on you and grasp you in their greedy little talons. Second, don’t expect a saint. Yes, he’ll ask for the order, he may even use some pressure to try to get it. If he’s not especially busy now, he’s cultivating habits for later, and frankly, nobody wants to spend more time selling to a given client than is really necessary. They want to make efficient use of their time, and use the extra to either make more money with other sales, or just have fun. They are there to Make Money, not because they think standing around the sale floor (or whatever they do to generate clients) is The Most Fun They’ve Had With Their Pants On. They may like or even love their clients (I do the vast majority of mine), but if they weren’t Making Money they wouldn’t be there. The reality is that if they don’t sell enough to make a living, they’re not there anymore. There is a point, in all transactions, and with all customers, that it just is not worth dealing with them anymore. The sales person has things he’d rather be doing, whether it is dealing with a repeat customer’s much larger transaction, spending time with the family, or just watching the game on TV at home. This point comes a lot sooner for a waffle iron than a house or a home loan, but there is a point where even the most desperate real estate agent stops initiating, stops returning, and finally stops accepting phone calls.

There is a cultural difference between the A salesman and the B salesman – they usually don’t work in the same place. I’ve never seen a place that didn’t have a strong preponderance of one or the other. There will usually be at least one A salesman on every staff, no matter how B culture the place is. But he’ll find another job at an A culture establishment before too long. There are places that are so A culture that the B salesman just can’t stand going to work there, so there typically aren’t any B salesmen.

How to determine if someone is an A salesman or a B salesman

First off, a B salesman will always ask what you need it for, whatever the item. He may spend quite a bit of time asking about all the stuff you need, what your tradeoffs are, and all sorts of other information. This is a good sign. He’s probably not looking for weaponry to force you to accept the El Cheapo Sterno can of fuel for the Bargain Price of only $9999.99, A Fraction Of The Cost (a very large fraction of 99 cents, but still a fraction). I’ve worked (briefly) with people who can sell ice to Eskimos at exorbitant prices, and if he’s that sort, he probably doesn’t need the information. Those sales people go straight for the kill. The more time he spends asking you about what you need or what you want or what your tradeoffs are, the happier you should be. The larger and more important the transaction, the more time he should spend asking you this stuff.

When he makes a recommendation or starts telling you about a product, he’ll remember enough of what you told him to paraphrase it back to you, “Now, as I remember, you were telling me you were looking for something that A. Well, this item does A. And as I recall, you told me you were looking for B but had a budget of C. Well, I’m afraid all of out widgets with B cost more than C, but this one appears to meet all of your other needs. If you really need B, here’s a widget that does B also, although it costs X more than C,” or “I’m afraid we don’t have any that do D, but I’d like to know if you’ve found any place that does?” Once he’s shown it to you, he’ll ask, “So does this do everything you’re looking for, or does it fall short?” as well as questions like “So if you had this, you think you’d be happy, right?”

B salesmen will answer your questions clearly, directly, and forthrightly, and ask if this information answered the questions. He will be happy to give amplifications and clarifications, not keep repeating the same phrases.

Every sales person knows – because the sales manager makes sure he knows – that if the client leaves the premises, gets off the phone, whatever, a sale becomes much less likely. Every sales program I’ve ever heard of goes over and over and over this, ad nauseum. So it’s not like it’s any great secret. The B salesman knows it as well as the A. And they’ll apply some pressure to get the sale now, whether it’s considerable (B salesman) or an avalanche (A salesman). The B salesman won’t trash the opposing products, though – he’ll simply try to tell you where his is better, why it meets your needs, and why you should Buy Now.

It is always a clue that you’re dealing with an A salesman if he finally tells you, in desperation as a last resort, “If you find a better price, come back and I’ll beat it.” First off, the fact that there’s suddenly room on the price means it may be overpriced in the first place. Second, the reason the A salesman says that is that he really doesn’t know – or care – what you want, and he’s figuring to replace it (in most cases) What He Showed You with Something Cheaper That Seems About The Same when you come back. Finally, if a B salesman doesn’t quote you a Pretty Damned Good Deal in the first place so he can Get This Transaction Onto The Books and go home, he knows he’s going to lose customers, which are then not going to come back to him because he treated them right, and not going to tell others about him because he treated them right.

Getting back to the first shopping trip my new wife and I made together, in search of Major Item, along about the ninth or tenth store when we’d just bought what we needed, my wife said, “There is no in-between with you, is there?”

“Huh?” I replied brilliantly, having no clue what she was getting at. Remember, we were newlyweds at the time.

“These sales people. You’re either the nicest guy possible or the worst (expletive) I’ve ever met. It’s a side of you I haven’t seen.”

I was well aware that she had led a somewhat sheltered life until a few months before we met, and there are obligations that one has to educate your family in case you’re not around. “Let me guess. You’re talking about how I was joking and pleasant with B, C, and D, but cut A and G off cold, chewed E out, told F to get out of my face, and was hard on H but then friendly, and friendly again while asking pointed questions when we came back to buy?”

“Yeah.”

“Beloved, B, C, and D were doing the best to help us find what we needed. They asked us intelligent questions about what we needed before showing us an item. They answered the questions I asked instead of trying to distract my attention, didn’t push more than they should have, and in general were behaving like our needs were what was important. They knew you were there and were respectful to you, but they realized I was the one who was going to have to be sold, so I was the most important person in the room. Not them.

“H was a miscommunication that got cleared up. And you should ask questions again to make certain you understand just before you buy. She knew that she was likely to get the sale once we came back, and even more likely when she showed us she knew what she was doing. The questions were to make certain there were no more miscommunications – she knows what she’s selling better than I do. It would be very easy for any kind of a sales person to misdirect a question while we’re in the midst of the hunt. When I’m ready to buy, I’m going to make certain I understand everything I need to know about this Major Item, so I’m asking the questions in a different way to make misdirection or pat phrases obvious. H knew this, and gave me straight answers without evasions. And her product met our needs. So that’s where I wanted to buy. As to why I was mean to the others, you know I’m always willing to be an (expletive) in a good cause, right?” She nodded.

“Well, A wanted to make the sale he wanted to make. Our needs weren’t important. E thought she could get away with a lie, and I called her on it. I know she’s going to make other sales, but not tonight. Penalty Box. F tried to use you as leverage against me. This would be acceptable though not welcome if I thought he was trying to meet our needs, but he wasn’t. I told him we had to have X and his item didn’t. And G didn’t have a clue about X. The appropriate thing would have been to get help or tell me he didn’t know but he’d find out and then go find out. He was wasting our time. And now we’ve got our Major Item, and we’re going to go home and be happy with it and not waste any more time on this whole issue.”

And we did. She still lets me do the most of the major shopping. But if a meteor hit me, she’d be a much savvier customer now than she was before I explained it. She’s not afraid to deal with sales people. Which puts an end, in all senses of the term, to the Ultimate Consumer Horror Story.



Caveat Emptor.