Many people are unaware how profoundly lending policies influence the market for residential property. So I am going to go over the various gradations in available loans for various types of property.
Pretty much everyone is familiar with the standard house, built on site, mostly by hand, from basic materials. Called “stick built” to differentiate it from other building methods, this is the default housing that everyone is familiar with. Once emplaced upon that property, there is no real way of getting it off the property intact, and therefore it is appurtenant to the land. This might come as a shock to people who concentrate on the house, but when you buy a property, you are buying the land upon which it sits – the lot – and the structure comes along because it is appurtenant – because it cannot be moved off easily. It is this type of property which has been at the forefront of liberalization of lenders loan policies, precisely because it is both universally desirable and non-portable. That land is defined by its boundaries. It isn’t going anywhere. The structure isn’t going anywhere that the land isn’t, because in order to remove it, you pretty much have to destroy it. It’s built on a several ton concrete foundation, which, if you nonetheless manage to pick it up, is still overwhelmingly likely to crack if not disintegrate, not to mention ripping out plumbing, electrical, and other connections.
Because the land isn’t movable and the structure isn’t either, lenders have gotten comfortable that you’re not going anywhere with that structure. Because the combination is so universally desired among consumers of housing, they have gotten comfortable with giving loans for essentially the full purchase cost of the property, knowing that it takes a special set of circumstances for them to take a loss on the property, and they can charge higher interest rates in order to insure against that. (I am using insure in the statistical, law of large numbers sense that is the essence of insurance.)
Once upon a time, lenders treated condominiums far less favorably than single family detached housing. But it was always obvious that condominium units weren’t going anywhere, and in recent years condominiums, in all their incarnations, have reached a level of acceptance among housing consumers that assures their marketability, and even the price discrimination against high-rise condominiums is gradually dying out. It is far less than it was just a few years ago. For condominiums four stories and less, the only difference their status makes to lending policy has to do with required expenses and Debt to Income Ratio: There is no homeowners insurance requirement, because the association dues pay for a master policy, but there is the additional expense of Association dues to charge against the borrower’s monthly income. As far as Loan to Value Ratio goes, condominiums are precisely like single family residences, and you can find 100% loans just as easily for them, at the same rate cost trade-offs, or very close. More and more, the fact that it’s a condominium is becoming irrelevant to loan officers. Many lenders have completely eliminated the “percentage of owner occupied units” guidelines that used to be such a bugbear for getting condominium loans approved. For these reasons, among others, condominium prices have taken off. In the last fifteen years, they have gone from being about half the price of a comparably sized and furnished detached home, to the point where they are basically proportional to detached single family homes, and in some areas, higher price per square foot due to the fact that they are a viable less expensive consumer’s alternative due to (usually) fewer square feet to the dwelling, and so less expensive overall if not proportionately so.
The first real step away from the “stick built’ house is the modular dwelling. These are piece-manufactured at factories, and assembled in pieces on site. Usually, it’s something like one entire room-wall in a piece, with all the necessary plumbing and electrical already embedded in it, although sometimes it does take the form of entire rooms. Think of it like modular furniture, which is manufactured in individual pieces, but those pieces are intended to be put together so that instead of an arm chair and an ottoman, you have a chaise lounge. The important difference is that unlike modular furniture, once that modular house is assembled on that foundation, it’s not going anywhere. Try to disconnect the plumbing hookups, or disassemble the pieces, and all you will likely have is much smaller pieces than you started with. Modular housing, once assembled, isn’t going anywhere. It is permanently attached to that land. For this reason, lenders are in the process of phasing out pricing discrimination against modular housing as opposed to stick built homes. For some lenders, modular gets the same exact loans as stick-built, for a few, there is a hit to the rate-cost trade-off that may be anywhere from a quarter of a point to a full point. Over half of the residential lenders in my database are happy to do residential real estate loans for modular housing on pretty much the same terms as stick-built. 100% percent financing, interest only, even the horrible negative amortization loan are all available on modular homes. As a result, prices of modular homes may be a couple percent lower than those of stick built properties, but they are very comparable and the the investment potential is just as strong and there is no large amount of difficulty getting them sold due to the difficulty of getting a loan. Some lenders still don’t want to touch them, but it’s pretty easy to find lenders that will, and on the same terms as they do any other property, so the lenders who still will not lend on modular properties are hurting no one but themselves by dealing themselves out of possible business.
The next step away is manufactured housing on land owned by the home owner. Now technically speaking, modular housing is a subset of manufactured housing, but when most lenders are talking about manufactured housing, they are talking about homes built at the factory in entire sections, and assembled with only a few total joins at the home site. True manufactured housing is portable, where modular really is not. If you’re in Idaho and decide to move that house to your property in Georgia, it’s doable.
Because it is portable, as you might guess from things I’ve said here about the prevalence of attempted scams that lenders have had issues with people dragging them off. You’d be right. Lenders file foreclosure papers on the land, and the homeowner metaphorically backs up the pick-up truck and takes that residence somewhere else, leaving the lenders with a piece of land and no residence. Because there is no longer a residence on it, it’s not worth anything like what it was when there was a residence on it. Lenders have lost multiple hundreds of thousands of dollars on individual properties around here. You get burned enough times, you start getting wise. Those real estate lenders who will lend on manufactured homes require a laundry list of conditions, and even if they are all met, they won’t loan 100 percent of the value, or anything like it, and there will be an additional charge of at least one full point of cost on their regular loan quotes. Cash out loans are typically limited to sixty-five percent of value, making it hard to tap equity. Furthermore, due to accounting standards and depreciation, Fannie Mae and Freddie Mac made a rule that manufactured homes were limited to twenty year loans, which drastically limits not only the type of loans available to their owners, but also has the effect of restricting what they can afford to borrow, because the payments principal has to be paid back over a shorter period.
Because loans are more expensive, harder to get, and amortized over a shorter period of time, this has the effect that even if someone wants to purchase a plot of land upon which the primary residence is a manufactured home, they cannot afford to pay as much for it. Let’s say par rate on a thirty year fixed rate loan for a stick built house or condominium is 6.25%. To keep it simple, let’s hypothesize that someone can afford loan payments of $2000 per month. That gives a loan amount of just under $325,000 for the stick built house ($324,824). But because of the minimum one point hit, the equivalent rate on the manufactured home loan, even though it still sits upon owned land, is about 6.75%, and you’re limited to a 20 year loan, giving a loan principal of about $263,000. The same person who can afford a stick built loan of $325,000 can only afford $263,000 for a manufactured home. This means that the manufactured home is not going to sell for as much money, because for what most people thing of as the same price (monthly payment) they cannot afford as much manufactured home as stick built. This leaves completely aside such issues that magnify this difference as the fact that because the loan terms are more favorable, it’s more cost effective to improve a stick-built home, so equivalent stick built homes have more amenities and are therefore even more attractive and more desirable. Not to mention the fact that the lender will require a twenty percent down payment on the manufactured home, where they might not require one at all on the stick built. The people who are in the market for relatively inexpensive housing are first time buyers. I can’t remember when the last time I encountered a first time buyer with a significant down payment (5% or more). Very few of them have down payments. This means that even if they are inclined to purchase a manufactured home, they are going to be constrained to purchase a stick built house by lending policy. That $263,000 loan I talked about earlier in the paragraph is only available if the buyer puts a down payment of $65,750 or more in addition to closing costs. For the vast majority of buyers, this limits their choice to stick-built, or none at all. For these reasons, when people go to sell manufactured homes, one can expect the prices to be more than proportionately lower than those of comparable stick-built homes, and so investments in manufactured homes do not tend to pay off nearly so well as property earlier on this list.
There is one further step down on the list: Manufactured homes on rented land. These are not, properly speaking, real estate loans at all. There is no land involved. If there is no land involved, it’s not real estate. Since there is no land involved, the loans are not real estate loans. They are listed in MLS because the people are buying and selling housing, but they are not real estate loans. It is very difficult finding lenders who will lend on them at all, and those few who will mostly do so through their automotive department. Furthermore, whereas space rent might be cheap if it’s your only cost of housing, it is expensive as compared to homeowners association dues, let alone property taxes, and the loans are still all twenty years or less. Because lenders don’t like to touch them, because the down payment requirements are large, and because of the additional expenses imposed by space rent, prices for manufactured housing on rented land are microscopic by comparison with everything else. Even here in southern California, $100,000 buys a really nice 4 bedroom place where by comparison the lowest priced 4 bedroom anywhere in the county right now are $337,000 (manufactured on owned land, and way out in the hinterlands of east county).
Lest anyone think that this is in any way shape or form due to inferior construction, it is not. Because these buildings are manufactured on assembly lines which are largely robotic, there are many fewer problems with things like forgetting to nail at appropriate intervals, workers getting distracted, not getting corners square, and all those sorts of problems. I’d bet that a manufactured dwelling is probably of superior construction to a site built dwelling, all other things being equal. It is purely lender policy, as influenced by the history of their experiences with these kinds of properties, which is driving these differences.
So before you think a property is a great bargain, consider what kind of property it is, because even if you have plenty of income and a huge down payment and these concerns are irrelevant to you, when you go to sell it your prospective buyers will generally not have those things, and every time you eliminate a possible buyer from being able to consider a property, you statistically make the final sale price lower, and you statistically make the sales process take much longer. Eliminate enough potential buyers, and you’re going to be very unhappy indeed.
Caveat Emptor
Making Certain You Shop Your Mortgage – Whether You Want To Or Not
Ken Harney had some welcome news on Move afoot to end uninvited mortgage pitches
To a certain extent, these are a good thing for consumers. However, it gets way overdone.
What happens is this. Let’s sat I get a client into my office, they apply for a mortgage, and I run their credit. The three credit bureaus, Experian, TransUnion, and Equifax, then turn around and sell the fact that this person has just had their credit run under a mortgage inquiry code, together with some of their more easily obtainable information.
Result? My clients are besieged with mortgage pitches. For months, every time they answer the phone it’s likely to be someone else who has paid the money for a red hot mortgage lead.
Needless to say, my clients aren’t happy. I have had several clients come out and accuse me of selling their information to telemarketers. Now, the fact that I encourage folks who come here to shop their mortgage around notwithstanding, it would be shooting myself in the head to sell their information to other providers. I know what I’ve got, I know what I quoted them, and I know I intend to deliver. The only thing that will stop me is if they do not qualify for that loan. If someone is satisfied with what I intend to deliver, far be it from me to tell them to shop around because they might be able to do better. My family and I do have to live, you know. I won’t stop or prevent or hinder them from shopping their loan around (which alone sets me apart from 90 percent plus of the loan providers out there), but telling them to do so is just not part of my job description at that point in time. It’s like expecting the mechanic as he starts working on your car to tell you that you might be able to get a better deal somewhere else.
Indeed, if I had the option of paying extra for that credit report so my clients aren’t besieged by unsolicited offers, I would take it every time. Not only would my clients be less harassed, but the prospective providers who pay for that sort of information are not precisely known for their sterling character, if you know what I mean. I’ve had clients tell me stories of people determined to sell them negative amortization loans without informing them of the drawbacks. I’ve had clients tell me of people determined to get their business that they told them of loans that do not exist, often with conspiratorial pitches like, “This is the loan they won’t tell you about! You have to ask for it!” Well then, why are you offering it? By all means, put it out there on the table and let’s compare the two loans by cranking the numbers, but the vast majority of the time it turns out the reason you have to ask for that sort of loan is that it’s a piece of garbage and no self-respecting loan professional would expect you to accept such awful terms.
Now let me tell you about the numbers of such pitches. Because each of the big three credit bureaus is innocent of the actions of the others, it starts in three places, each of which pitches to the prospective providers that it sells the information no more than four places. I don’t know why the number four became magic, but it seems to pop up everywhere in the mortgage leads industry. So each of them sells to four, and there are three of them. That’s twelve people you’re going to be getting a phone call from right there, and never mind that you’re on the “Do not call” list.
But what’s going to happen the majority of the time is that somewhere around ten of those who initially buy the information are resellers. They pay sixty bucks a pop, and turn around and sell the information to four other folks at twenty-five bucks a pop. Some of these places are in turn resellers; indeed, some of them got this information directly, which is all that keeps the whole process from snowballing until people are besieged by what seems like every last person with a valid mortgage license for the area. So twelve, forty-eight, hundred forty four, four hundred thirty two wannabe mortgage providers swarm each person I run credit on. I try to remember to warn them, but there is nothing I can do to stop it from happening, however much I might want to.
Do not get me wrong. It is a good idea to shop your mortgage, because at the end of the process the power is all in the loan provider’s hands and it is often abused.
But there is a major difference between that and setting this pack of wild ravening prospective mortgage providers on my clients, willing to promise the sun, the moon, and all of the stars and planets if my clients will simply drop me and sign up with them instead. There is a major difference between agreeing that shopping the loan is a good idea, and throwing my clients to a pack of hundreds of telemarketers who call for months – sometimes as long as two years, so that they seem to be part of the next wave the next time those folks need a real estate loan – and bulk mailers who are almost singlehandedly responsible for global deforestation and accelerated filling of our urban landfills. If it does happen, I will be pleased to see it end.
I’m also gratified to see National Association of Mortgage Brokers on the correct side of this:
But the National Association of Mortgage Brokers doesn’t agree. When credit bureaus sell overnight trigger lists to third-party lead generators, the brokers argue, they fail to comply with a key provision of the Fair Credit Reporting Act: that anyone receiving consumers’ personal information must be in the position to make a “firm offer of credit” or have previously received permission from the consumer to obtain credit file data. Third-party lead generators obtain no permission and are in no position to make any credit offers, firm or otherwise.
There is a world of difference between suggesting you shop your mortgage and making certain you shop hundreds of providers, whether you want to or not.
Caveat Emptor
Undisclosed Short Sales
What happens if a home you signed to purchase goes into foreclosure before the closing date?
We were supposed to close on a home four months ago. On the day of closing we get a call from the seller’s realtor that the sellers owe 22K and need time to figure out negotiations w/the mortgage company. We go through a series of extensions & hear a variety of excuses from the sellers realtor (sellers haven’t turned in paperwork, wrong forms filled out &new ones were overnighted, etc) In June, a Lis Pendens was filed & our realtor checked it out. He talked to the sellers realtor & found out that it had been filed but has been negotiated off &was no longer in effect. On 8/9 our realtor gets a call from the sellers realtor that they have finally been in contact with the mortgage company &there is 1 more paper that needs to be completed & they are “on top of it”. After not hearing anything last week, I check with the online courts to see if anything else has occurred to see that a foreclose decree was noted for 8/4. What happens now? Can we purchase the home from the bank?
Somebody has not been “on top of it”. Probably at least two somebodies, and they’re not exactly fulfilling full disclosure requirements, either.
Yes, an Notice of Default adds thousands of dollars to fees due. But what do you think the lender would rather have: An already negotiated sale that is consummated and they get their money, or go through that whole dismal foreclosure process, not knowing if anyone else will put an offer in?
So what is going on here is an undisclosed short sale. What this means is that the lender isn’t going to get all of their money, or the transaction would have closed by now.
So what’s most likely going on is that the bank is taking their own sweet time about approving it, but your realtor has allowed the selling realtor to feed you a line of BS. Indeed, they’ve probably actively cooperated. They’re probably afraid of losing the commission, but if they keep it open “just a little longer” maybe the lender will approve it.
It’s the listing agent’s job to talk the lender into approving the sale. Perhaps the bank is imposing some conditions that the seller can meet, but does not want to. Perhaps the bank is demanding some money, or that the realtors reduce their commission, and they don’t want to. Perhaps the listing agent just clueless, but I doubt your agent has exactly covered themselves in professionalism either.
The person with the power to break the logjam is you. Talk with a lawyer, but if you put in a 48 hour notice to perform, the lender is likely to suffer a sudden attack of rationality, especially in this market. They’ll likely net more money through the sale than through the foreclosure process, but if you allow them to go on ad nauseum they will keep the transaction open as long as possible. You see, once the transaction closes they can’t get their money back if a better offer comes along. Therefore, they are trying to put you off for as long as possible in the hopes that such a better offer will come along. From their point of view, they have this transaction well in hand, they are just hoping to get more money from someone else, and the longer you allow this to go on, the higher the likelihood they will. If you don’t force the issue, the only possible resolution is unfavorable to you. There are possible issues with the deposit, and damages they could owe you and you could owe them, which is why you need to be careful. But putting them on Notice to Perform is the thing that is going to break the logjam one way or another, and your agent should probably have done it months ago. You’re stuck with them for now, but if this transaction doesn’t close you should probably find a new agent. Good agents know that if they are willing to risk losing a particular deal, they will not only better represent their clients interests, but also that they will end up with more deals overall. Approached correctly, it’s a way to have even the client whose entire family has their heart set on a particular property that you are acting on their behalf, not just looking for a commission, and they will send you their friends, and they will come back to you when it’s time to sell, or to buy another property.
PS: A lis pendens that is recorded also needs to have the removal recorded.
Caveat Emptor
Impound Accounts Facts and FAQs
I’ve seen a fair number of questions on impound accounts in the last several months. An impound account, also known by the confusing term escrow account because the lender is holding it in escrow, is money that you give the lender in order to pay the property taxes and homeowner’s insurance on the property when they are due.
The first thing to note and emphasize is that money going into an impound account is not a cost of doing the loan. It is your money. You own it. It will be used solely to pay your property taxes and your insurance. At the conclusion of the loan, whether you paid it off with cash or refinanced or or sold the property, you get any money left in the account back. The lender is required to send you the check within sixty days of loan payoff.
An impound account is meant to address any lender’s two largest worries in regards to a loan: Uninsured destruction of the property or losing the property to an unpaid property tax lien.
The problem with an uninsured destruction should be obvious. The structure is destroyed or heavily damaged and no money exists to rebuild. The borrower doesn’t have it and the bank isn’t going to throw good money after bad. Here in California, the average property is worth maybe $500,000 or so, but without the home sitting on it, the property may only be worth fifty to a hundred thousand. Within ten miles of my office sit hundreds, probably thousands, of new homes that sold for $700,00 and up even though they sit on a lot that’s less than 5000 square feet (0.115 Acres). Many condominiums are over $400,000. Given the location, a 5000 square foot lot may be $200,000, but it’s not $500,000, and the lender will take a loss even on the $200,000 because they’re not in the business of real estate. They loan $500,000, it burns down without insurance, they lose $350,000. People also lose their jobs over this.
Property tax liens are a major issue as well. They automatically take priority over everything else, and the rules about what the condemning governmental entity has to do are much looser than they are for the bank. They will usually do quite a bit over the minimum, but they will sell the property most of the time, no matter how minimal the best bid. Minimum auction amounts and many other things mandated for when lenders sell the property go out the window when it’s the government. Many times this situation can require the lender to step in and pay the property taxes, intending to turn around and sell the property themselves merely to take a smaller loss.
A lender wants you to pay property taxes and homeowner’s insurance, and they want to know you’ve paid them. They encourage this via the method of impound accounts. The theory is simple. Every month you pay the lender, in addition to your actual loan payment, an amount equal to your pro-rated property taxes and homeowner’s insurance, and they will take this money and pay those bills when they are due.
No lender is perfect about these, and some are less so than others. A large percentage of the biggest and worst messes I have ever dealt with came about as the result of the lender somehow messing up the inpound account. Others have arisen because even though the lender acted within the law, the client got angry about something. Sometimes it’s for a good reason, sometimes it’s not.
Because lenders want you to have them, however, they are ubiquitous, and every lender I know of charges extra on your loan if you do not want to do an impound account, unless you live in a state which prohibits the practice. Usually this amount is about one quarter of a discount point. On a $500,000 loan, this amounts to a charge of over $1250 just to not have any impounds.
On the other hand, in places where property values are high, you can have to come up with $5000 or more at loan time just to adequately fund an impound account. Here’s a computation of how much you need to fund it works. The lender will divide the annual property taxes and homeowner’s insurance by twelve. This will be the monthly payment. The lender is legally able to hold up to two months over the amount required to make the payments, and they want this reserve. So they will look at the projected payments for the next year and figure out how many months they need up front to always have two months worth in reserve. I’m writing this on February 3, and California taxes were due on the first even though they are not past due until April 10th. But the lender uses February first to calculate even though they won’t actually make the payment until early April (they earn interest on the money, whether or not they pay any. Some states require that interest be paid, but it is typically something small and worthless like two percent).
February first is usually when the lenders here in California figure will be the low point of the account for the whole year. But if you closed on a loan in February, you wouldn’t make your first payment on that loan until April first, and of course, they cannot count on you making your next February payment right on the first. So they are going to figure that you will make payments on the first of every month April through January, ten months, before they have to pay your property taxes. Since they have to pay twelve months, and they get to keep two in reserve, that’s fourteen months of payments they want to have on February first. Fourteen minus ten is four months that you will have to come up with in advance, or have rolled into the cost of your loan. On a $500k property, that’s about $2000 for property taxes even in a basic tax zone, and if your insurance is $1200 per year, you’ll have to come up with another $400 for that. $2400 into the impound account.
It gets better. Because the property taxes are due within two months of your purchase, you’re going to have to come up with your pro-rated share right up front as well as paying for an entire year of insurance. Since California requires six months property taxes at a time, that adds almost another five months taxes and twelve months insurance up front. Total cost of this in the example given: $3700. Actually, this is due whether you have an impound account or not. Total you need just for property taxes and homeowner’s insurance: $5900.
It can be worse. Suppose you were closing on a refinance in October. You originally bought in February. You are only going to make two payments (December and January) before the insurance is due, so your impound total for the insurance alone $1000 for insurance. You are going to have to come up with $3000 to pay the first half of your property taxes, plus because you only have two payments before the second half is due, another $3000, or six months payments for that. Total due, $7000.
There are really only two methods for coming up with the money for an impound account: Bring in the cash from somewhere else, or have the lender loan it to you, adding it to your loan balance. Except in rare circumstances where you are refinancing the same property with the same lender (and usually not even then), existing impound accounts cannot be used to “seed” the new account. This is because it’s your money, held in trust. The rules for these accounts are rigid, and I’m not certain I understand well the rules about whether a bank even has the option of rolling one impound account into another.
This typically means that you have to come up with a good chunk of change out of your pocket for a short period, or add the additional amount into your loan, where you’ll be paying for it as long as you have a loan on the property. Every situation is different, but most often I prefer to either come up with the money myself or not have an impound account. The extra charges may be sunk as opposed to refundable, but I’m not paying interest for thirty years on thousands of dollars.
Furthermore, if you are adding the money to create the new impound account to your loan balance, since it’s going in before the computation of points, it can add another $50 to $100 to your costs of the loan per point you’re paying. Minor in and of itself, but adding insult to injury if the loan has points involved. More to the point is that adding impound creation it to your loan balance means there may be a couple years before your balance gets as low as it was before the refinance, just from this. Indeed, the fact that it raises your loan balance is the worst thing about the impound account issue. On the other hand, unless you have a “first dollar” prepayment penalty, what you can do is turn around and put the check for the previous impound account when it arrives into paying down the new loan. It typically won’t bring you even, and it won’t reduce your contractual payments on the new loan (although that is usually a good thing), but it will ameliorate the damage to your loan balance.
Initial loan closing is not your only opportunity to start an impound account if you want one. If you don’t have one to start with, the lenders will be very happy to let you start one later. I’ve literally never heard of a lender saying anything but “YES!” (usually with a pump of the fist) to a request for an impound account. Why? Because now they know that your taxes and insurance will be paid, and get to use your money, and after you paid a fee for no impounds. Oh, happy banker!
If you want to cancel an impound account, especially within a year of whenever the loan was funded, you can expect to pay the “no impounds” fee, possibly prorated, but usually just the whole thing. Roll thousands of dollars into your loan balance where you’ll be paying interest on it and then pay a lender’s charge for no impounds? Ouch!
Can you force the bank not to do any of this? Not really. They don’t have to lend you money. Yes, they are in the business of lending money, but if they don’t loan it to you, they’ll find other uses for it. Somebody else is always willing to accept the bank’s terms. You try to violate guidelines that lenders have established in order to lend you the money, and you’ll be told, “Sorry but you don’t qualify.” The golden rule of loans is that those with the money make the rules.
Furthermore, those lenders who didn’t require this would be at a competitive disadvantage as regards rates, because their loan portfolio would be a significantly riskier one, and they would have to increase their rates to compensate for this. You could qualify for a better rate or lower closing costs somewhere else. Better to not argue. Assuming that I already have an impound account, all the extra I lose is a maximum of sixty days interest. Two months interest on $5000, even at ten percent, is $83. That’s a lot cheaper than any of the alternatives.
Caveat Emptor
Dual Agency: Using the Seller’s Agent as Your Buyer’s Agent
Is it unwise to use the listing realtor as your purchase realtor?
A house I’m interested in purchasing is being sold by the realtor selling my house. Although she’s done a decent job selling my house, I fear she won’t negotiate well on my behalf if she has to divide her loyalties between these listers and me (a potential buyer). How awkward would it be not to use my listing realtor to purchase a new home?
I would not undertake dual agency myself. If I do find a buyer for one of my listings, I’ll refer them to someone else for negotiations. Everyone in the industry whom I respect agrees with this position. Too often, there is a conflict of interest between buyer and seller. Anybody who tells you otherwise is trying to rationalize money in their pocket.
It’d be fine to use her for any property she’s not listing. If you want that one, however, go find another buyer’s agent.
In every transaction, there is a tension between the interest of the sellers and the interest of the buyers. It is in the interest of the sellers to get the most money possible for the property. It is in the interests of the buyers to pay the lowest possible price. Except in the highly unlikely case where the most that buyer might possibly have paid is the exact same number that is the least that seller might have accepted, and that is in fact the sales price, such simultaneous duties cannot both be met. Since such happenings would be freak coincidence, and not only are they not known until afterward, any such lookback is prone to an agent indulging in what psychologists call confirmation bias.
Furthermore, there is tension between the interests of the buyer and the interests of the seller in other matters as well. Not far from here is a condo conversion project, currently being sold out. About 1993, there was a resident of that complex arrested on suspicion of serial murder. I am unaware of whether he was eventually convicted, but I do know they dug up several bodies as I was unfortunate enough to drive by when they were removing them. California law requires the disclosure within three years of anyone dying on the premises, but at three years and one day there is no requirement for disclosure that I am aware of. Nonetheless, if one of my clients wanted to buy one of those units it would be part of my duty of care to that client’s interests to make certain they were informed. Would you not want to know about your building being used as an impromptu cemetary for several bodies? But acting as a seller’s agent, I would be forbidden from making that disclosure. Which client’s interests do I follow?
Suppose my client is having difficulty qualifying for a loan. Okay, obviously I’m not doing the loan, but I cannot force clients to do their loans with me and the only thing I can offer is carrots, never sticks. But suppose that I, as buyer’s broker, find out from the loan officer on day 24 that they’ve been disqualified because the processor told the underwriter something they shouldn’t have, and the loan is back to square one. If I am acting as listing agent as well, my duty to the seller requires me to inform my client of this difficulty. But my duty to the buyer is equally clear about in being a violation of my other client’s best interests. Whose interest is paramount? Whose interest do I disregard? These interests are in direct conflict – there can be no compromise resolution. Indeed, as a listing agent I will demand information that it it may not be in my buying client’s best interest as buyer’s agent be disclosed, and vice versa. If they agree of their own volition, or some other agent talks them into it, then we have a willing buyer and a willing seller and full disclosure from my end and best interest of the client in furthering the transaction and so on and so forth. If I fail to ask because I am also representing the other side, I have not represented my client’s best interests. If I talk either client into it when I am representing both, then I have, ipso facto, violated that client’s best interest by getting them to agree to something which is not in their best interest. Did I do it because such was in their best interest, or the best interest of my other client? Even if I did act in their best interest, can I prove it? Probably not. Can I prove it in a court of law? Definitely not.
I like to make more money as well as the next person. But accepting dual agency is logically and provably a violation of my duty of care to someone in every case, no matter how the transaction turns out. No matter what you do, it’s kind of like the old joke about someone playing chess with themselves. Sure you always win. But you always lose as well, and when you have a fiduciary duty to someone else, setting up a situation where you are guaranteed to lose is in itself a violation of that fiduciary duty.
So I urge you in the strongest possible terms to go find another agent to represent you. There’s absolutely nothing wrong with using the same agent to represent you in multiple transactions, even simultaneous transactions. But I would never use the listing agent for a property as my buyer’s agent, and I would not allow an agent I was listing a property with to act as buyer’s agent. Force them to pick a side and stay on it, and since they’ve already got a listing contract, they have already made their choice.
This is incidentally another argument against Exclusive Buyers Agency Agreements. If they show you one of their own listings under an exclusive agency contract, they are the procuring cause and you must pay them. Nonexclusive contracts should also have explicit releases if the agent is also the listing agent.
Caveat Emptor
Book Review: The Geek Gap By Bill Pfleging and Minda Zetlin
A while ago, I had two publishers ask me if I would read books for review purposes on my site. I said that I would be glad to. One of the publishers included this little book on communicating between “suits” (businessfolk) and “geeks” (technical folk).
Having a background on both sides of the fence (math, physics, and out of date computer stuff on one side, and accounting, sales and marketing on the other), I have spent a very long time frustrated by how little each of these two groups understands the other. To be frank, it is my belief that the average member of the geek side not only knows that the business side does not care about their issues, but that they do not want to understand the business side. To use the sorts of things I’ve heard more than once, “I’ve got a Masters in Computer Science from MIT, and that turkey got a shake and bake degree in marketing from the local trade school. What could he possibly have to teach me? What could he possibly know that I don’t, or couldn’t learn?” Well the answer is that the mind boggles. On the other side, the business side tends to look at the technical folks as a cross between black box and magic wand, into which flow money and resources, and out of which flows tools for increased productivity and products they can take to market. If they’re lucky, the cost of what goes in to the black box will be less than the good stuff that comes out. They often do not realize that making technical choices in ignorance of background information or the consequences of their choices often sabotages the very projects they need to succeed the most.
This book is a good attempt to bridge that gap. Instead of merely describing it, as all too many people have done in the past, it attempts to move past that into the area of solving the communication and attitude problems between two very different sorts of worker with two very different skill sets and experiences, all of which color not only their attitude towards the company they work for and their coworkers, but all sorts of details in the rest of their lives. Just a for instance, a business person knows in their soul that there is always a reason for lower price, and although they are always looking to get what they need for the best possible price, they are open to spending more in order to get more. The typical technical person, when it comes to buying anything other than technology with their own money, is much more difficult to convince that extra money is worthwhile than any business person. It literally does not enter the average tech person’s mind that the reason something is cheaper is because you’re getting less of something that other people have found valuable. I used to be that way myself before I started working on the business side.
Now this book was written by one author from the technical side and one from the business side. They dodge the easy trap of laying all of the blame on this or that, and they give some very commonsense methods of bridging the gap from both sides – not laying the burden on either side exclusively. They do a pretty good job, far more effective than anyone else I have seen make the same attempt.
I would recommend this to either geeks or suits who have any need to understand where the other is coming from. In other works, basically everyone with a job.
The Geek Gap at Amazon
Life Insurance – Proper Prior Planning Prevents…
Life Insurance is something that nearly every adult should have, and almost every adult who buys goes about purchasing it the wrong way, at the wrong time, for the wrong reasons, and buys the wrong policy.
Is that an indictment of the system or what?
Let’s start with what life insurance is. Life insurance is a bet that you make with an insurance company that you will or will not live. The idea is that if you die, while nothing can replace you, your family will get money to replace your salary. If you die while the policy is in force, the insurance company loses the bet. If you live for the full time the policy is in effect, congratulations for being alive, but you lost the bet. If you die after the policy stops, not only did you die, but you spent all that money and your family got nothing. Now it is critically important to understanding life insurance to understand that nobody gets out of life alive. Unfortunately, everybody has to die sometime. As of this writing, the chances of you missing out on this one final life experience that practically everyone wants to avoid forever are zero. So you might as well make plans that include anybody you leave behind benefitting from it, because (I have it on excellent authority) dying stinks. (Yes, I’d use a stronger word except that I try to keep the language here family safe as much as possible)
There are two major types of life insurance, term and cash-value, and the latter type has several subtypes which I will explain in due course. Term can be thought of as “renting” life insurance, while cash value can be thought of as “buying” it. Like owning versus renting a home, there are arguments on both sides of this story as to which is better. I will attempt to cover the pros and cons of all of the major camps, and there are people for whom each makes sense, but like buying a home, if you choose the right policy, cash value life insurance is a losing proposition in the short term while becoming fantastically remunerative after a few years. The vast majority of all people would do better to consider cash value, particularly when you crank the actual numbers and consider the alternatives.
Another thing that needs to be crystal clear is that life insurance is the second most tax advantaged investment you can make, right after buying a home. In fact, it’s better in many ways although it requires more planning. If you plan properly, and die while it is in force, the death benefit comes to your heirs tax free. Furthermore, all investments in the cash value of a life insurance policy earn money tax deferred, and any money withdrawn from the cash value of a life insurance policy gets “first in, first out” treatment – something no other investment can say. There is no legal dollar limit on this tax treatment for life insurance. There are no income limits for this tax treatment of life insurance. Literally anyone who can qualify for a policy can receive these tax benefits, and so long as you comply with federal guidelines to retain this treatment, there are no dollar limits to the amount you can invest. Even if you violate those limits, the only consequence is that the tax treatment on actual withdrawals flips to “Last in, first out,” and since there is no limit on the number of policies you can have, either, there aren’t many reasons to violate those guidelines.
You can also take loans against the cash value of any life insurance policies you may have, and loans are not taxable. Let’s say that again. Loans are not taxable. Remember that. It’s going to be important later. When put together with the other parts of the tax advantaged nature of life insurance, it’s an awesomely powerful tool if used correctly.
Now I’m going to violate one of my cardinal rules for this site: no graphics. The reason is that this picture is too darned important to the essay. It’s graphic of some features of a life insurance policy. The vertical axis is money – dollars – and the horizontal axis is time. And the reason I’m putting it up is to illustrate a generic life insurance policy. It doesn’t look like much at first, but here it is:
Now I’m going to explain it. There are three areas: red, yellow, and gray. Grey is just background – dollars above policy value. Like the altitude above an airplane, it’s useless, unless you climb into it later, as some policies can, painting ever larger numbers first red, then yellow. Red, or actually, the top of the red line, is the total dollars your family (or other heirs) will receive when (not if) you shuffle off the mortal coil. Yellow is the cash value of the dollars in your policy. The difference between the two is the amount of insurance you’re actually paying your hard earned money for at any given time. Get it? Got it? Good.
Now it is necessary to note and remember that the cost of the red dollars – the difference between the top of the red curve and the top of the yellow curve – get more expensive with time. Sometime in your sixties, dollars of actual life insurance start getting expensive. Mind you, they are always getting costlier from the first day you buy any policy of life insurance out there. But in your sixties, this process accelerates rapidly, and this has all kinds of implications later in the essay as well as later in life. And now that we’ve covered the basics, it’s time to cover policy types.
Term life insurance, as I said, is like renting your life insurance. It’s like the red line, without the yellow curve in there at all. For the entire time your policy is in effect,you are going to be buying the full amount of insurance dollars every time you make a payment. This means that in an unaltered term policy, your premium goes up every year; sharply so once you’ve hit your sixties. If you are initially purchasing at a young age, most companies will give you the option of paying more starting right now, so that for a certain period your premiums will not increase. If you buy young enough, most companies have at least a 30 year fixed term product. It’s very difficult to find a company that will sell you a policy allowing this fixed period to go later than your sixty-fifth year, however. In all cases, once the fixed term is over, it converts to yearly renewable term, where you can expect the yearly bill to go higher every year. What happens when people start getting these suddenly much larger bills? They cancel. This is what the insurance companies want. Fewer than three percent of all term policies ever pay a death benefit because they are canceled. When you cancel, you’re letting the insurance company off the hook on your bet, and all that wonderful money you spent on their pretty policy bought you some peace of mind for a while, but now it’s gone, and you have nothing. Term is very expensive insurance, when you talk about real cost to the consumer in aggregate, and very profitable to the insurance companies. It doesn’t require writing a check for nearly the number of dollars now, but it doesn’t provide nearly the benefits either. Remember that stuff I told you about how tax-advantaged life insurance is? Term makes almost no use of this fact. It’s kind of like buying a Ferrari body, and putting a Yugo engine into it.
Now we’re going to move into cash value life insurance in all its variants. They’re called cash value because they have one. Now we’re putting the yellow curve back into the picture above. What these policies are calculated to do is endow at a certain age. This used to be 100 for all policies, now the companies are trending more towards 120. This is a good thing because with more people living to 100, they are getting checks when they really want life insurance. Policies endow when the yellow curve rises to meet the red line, off to the right of the rest of the picture above. If it’s your policy, you get a check for the amount of the red line in exchange for your policy of life insurance. This ends the tax benefits, and can have adverse effects upon your tax liability, too. So most folks want to get their policy value as a death benefit to their heirs, not as a check while they’re still alive. Confused? Follow me.
The first major variant of cash value is whole life. This is what that default picture above is all about, because that’s pretty much what a policy of whole life insurance looks like. The difference in dollars between the cost of the term insurance and the cost of the policy is invested with the general account of the company. It earns about eight percent or so, and they pay you about three, which is pathetic. Nonetheless, that three percent is tax deferred, tax free, First In First Out, so it’s probably close to an effective 5 percent for most folks. Like all cash value life insurance, there are provisions for tax free withdrawals and zero percent effective rate loans and all of that. Also like all cash value insurance, to an ever increasing degree over the life of the policy, this moves from paying the cost of the insurance from the check you are writing, which is after tax dollars, to money already within the policy, which is before tax dollars. Finally, like all cash value life insurance, over the life of the policy you are buying progressively smaller amounts of actual life insurance (the difference between the red curve and the yellow one), which means that your actual cost of insurance is less, particularly later on when the cost of that actual insurance goes up. Because of this, cash value policies are likely to stay in effect your whole life and not get canceled. Nonetheless, this is a putrid return and makes the insurance company even more money than term insurance. Many people would have you believe that whole life is the only variety of cash value life insurance out there. It isn’t. But you would not believe the number of straw man arguments against cash value life insurance I have read in the financial press that did their best to read as if that claim were true. For someone who is supposed to make their living informing consumers about the financial industry, this is either fundamentally ignorant, or fundamentally dishonest.
Probably about ninety years ago, some bright young person working at an insurance company realized that the need for life insurance may not be constant throughout life, and so came the first major addition to the choice of “whole life or term.” This was Universal Life. The concept was simple. You could decrease the amount of insurance in set units, or increase it in set units, up to a certain value, and the initial underwriting would still cover it. This was really cool at the time, because it meant that you didn’t have to apply again for life insurance and go through the underwriting and health insurance exam and health insurance questions all over again, and possibly get “rated” for some new health problem that wasn’t there last time, or possibly even turned down. Unfortunately, in Universal Life Insurance, you’re still investing your money in the general account of the life insurance company, and they are still only paying you about four percent. Once again this has all of the neat tax advantages, but even an effective six percent return is nothing to write home about. To most folks, it’s almost embarrassing. Nonetheless, Universal Life Insurance has broad applicability to small dollar value policies, mostly for older folks. The return is guaranteed, the company assumes the investment risk, and the policyholder gets peace of mind for the rest of their life, knowing that whatever expenses they had in mind are covered.
Not too long after the enterprising young person had the idea for Universal Life, another one had the idea for Variable Life. This is a truly different product, but it really didn’t go anywhere until the late seventies, when inflation was rampant and things were generally going south in a hand-basket until Ronald Reagan et al brought them back under control. The concept is simple: Instead of investing in the general account of the company, you have the opportunity to invest in a certain number of sub-accounts that act a lot like mutual funds. These sub-accounts are basically comparable to the ones in variable annuities, having roughly the same advantages and disadvantages except that most people do not have qualified money in life insurance because the interplay of withdrawal requirements with funding requirements gets nasty complex.
Now in those articles that do admit the existence of variable life, they most commonly write against it because “They have this expense and that expense and the other expense,” ad nauseum, with the strong implication, never proven, that they are somehow more expensive than other policies. The fact is that these are expenses associated with all life insurance. The only additional expense that the variable life insurance policy has that the term life insurance policy (or any other) does not is the expense of running the mutual fund-like sub-accounts, which actually average a bit lower than the equivalent mutual fund upon which these are usually based. Every other expense is part of every life insurance policy – indeed, most of them are part of every insurance contract of any sort. Administration, Insurance, etcetera. They buy the stuff that makes the cash value life insurance policy an interesting and potentially worthwhile investment – the death benefit, that wonderful tax treatment, among other things. But because you’re dealing with something regulated by the SEC, the agent and the company have to tell you about them in variable annuities, whereas with every other insurance policy, they are a “black box” into which money goes and insurance comes out.
Variable Life Insurance, like Variable Annuities, requires not only a life insurance license, but also an NASD Series 6 or Series 7 license to sell. This means that it is generally sold through financial planners, not “pure” insurance agents. These folks are competition for the financial “do it yourself” press, and if you are working with a professional you trust, you’re not nearly as likely to go back to the bookstore or magazine stand for generic drivel with no fiduciary responsibility towards you. Admittedly, some advisors abuse it – and when they are caught, they are prosecuted and the insurance they are required to carry pays. The generic advice in books, newspapers, magazines and websites never has this responsibility in the first place. They are specifically exempted by the Investment Company Act of 1940. But Variable Life Insurance has all of the advantages possessed by all cash value policies that I listed above, and it also has the advantage that you are getting market returns, which the tax advantages leverage significantly in your favor.
Finally, in the early 1970s, another bright young person had the idea of combining the features of Variable Life Insurance with Universal Life Insurance. This product, called Variable Universal Life Insurance, is about the most flexible, most versatile financial investment there is, because you can do so much with it, and it facilitates changes in plans like nothing else. You get market rates of return via the mutual fund-like sub-accounts, effectively augmented several points above market rates because of favorable tax treatment. You can withdraw your principal tax free, and take loans at zero effective interest rate against the earnings after that. Remember, loans are not taxable. You can increase or decrease the dollar amount of insurance within limits. Actually, variable universal has the unique ability that both the red and the yellow areas in the graph above usually start climbing into the gray area somewhere about twenty-five to thirty years in, getting to the point where the cash value of the policy can be multiple times original issue value. All of this amounts to things like you can start saving for your children’s college as soon as you decide you’d like to have some someday. You can save for literally anything, because of all of the options you have for putting money in and taking it out. Matter of fact, you get the biggest advantage from overfunding the policy, putting more money in than you have to, although there are federal limits on how much and how fast you can overfund and retain the most important tax advantage, that of “First In First Out” tax treatment. (It is to be noted that there are “single payment” policies that intentionally throw this benefit out the window, and are still an excellent investment in a lot of circumstances.)
There is one danger to variable life, and to a lesser extent variable universal life. It is possible that through inopportune timing of market declines and/or excessive withdrawals that there will not be enough money in the policy to keep it in force. This is, to use Orwell speak, double plus ungood. Let’s say you took invested some number of dollars as principal, and later withdrew them. Then you took loans of $30,000 per year every year for ten years. But then your investments went through a market decline, and you kept taking the full $30,000 per year for another ten years. If you die with the death benefit still in force, it’s all just a loan against the death benefit and therefore nontaxable because the death benefit is nontaxable. But if the policy self-destructs, now you have to pay the taxes on that $600,000 of income I’ve just described. The IRS is utterly unimpressed by “blood from a turnip” type arguments. They can usually figure a way to get their money a way that you won’t be happy with.
The oldest of these policies are only thirty-odd years old, and there were a lot of improvements made in the early years, so there’s no experience, as yet, with the first generation they were really designed for as lifelong financial instruments. The first people who bought them in their twenties are only just now starting to turn sixty, approaching retirement age. Going back via market performance in the last century or so, there does not appear to be major danger of self destruction on policies given time to mature and prudently advised, but there have been people who withdrew more than the market could really support, who had major adverse experiences as a result. Especially with the variable universal policy, there are alternatives to prevent losing the policy completely, but it’s still not something you want to have happen. I will point out, however, that the same danger exists for investors of any stripe, it’s just that the sword here is especially terrible. This is one of the good reasons why these policy require dual licensing to sell – to insure that there’s someone involved who should understand the structural limitations of the policy, and can help you avoid the lurking gotcha! by keeping your withdrawals and loans to a sustainable level.
One strategy many people, particularly in the self help financial press, advise is “buy term insurance and invest the difference.” This isn’t a bad strategy, especially if you plan on dying while the fixed term period is still in effect. But most people in their twenties and thirties are going to live well past their sixty-fifth birthday, and the fact is that most people who are young today are going to work well past it, as well. The reason why insurance premiums start to climb then is largely because that’s when folks start dying off in larger numbers. Investing in life insurance is something best begun while you are young, with few health problems and lots of time. Whatever the strategy you begin while you’re young, you’re typically stuck with the decision, even if you do figure out what’s wrong with it around the time you’re fifty. At that age, your effective compounding is marginal in most cases, even if you’re planning to delay retirement a few years. But I encourage everyone with a potential life insurance need to look at projections of not what’s likely to happen for merely the next thirty years, but for the entire rest of your life. Buying variable, or better yet, variable universal, especially while you’re young is a better way to end up with more usable money later on in life for most people. And that’s the whole purpose of retirement planning, right?
Caveat Emptor
Lenders and Insurance Proceeds
The question that inspired this was
can a mortgage company use the flood insurance claim money towards homeowners mortgage loans?
This is equally applicable to every other form of insurance on your home – earthquake, regular homeowner’s insurance, and any others that you may have or require.
The short answer is yes.
The reason that the lender requires being added to every policy of insurance you have on your home is so they have a claim on the policy proceeds. Let’s say you buy a $500,000 home for nothing down, and the value of the structure is $150,000 while the value of the land is $350,000. Let’s say the house burns down next week. If they weren’t on there as beneficiary, you could theoretically take that check for $150,000 and head off to Tahiti, leaving them with a $500,000 loan that they’re maybe going to net $270,000 for by selling the property that secured it – after all the time for foreclosure, et al, which means they’re out all those costs plus thousands of dollars in interest. If you’re a lender, you’re going to suffer this loss once at most before you decide not to trust anybody.
This is also a reason to keep your insurance updated, to the full value of what it’s going to take to replace your property. It’s a bummer to own a $500,000 house that burns down, and you’re only insured for the $150,000 you owe the lender. Insurance is not a “Get out of trouble free” card. If you’re not paying the insurance company for a policy large enough to cover a loss of the item, don’t be surprised or angry when what they pay you doesn’t replace it. In this case, you told them it would only take $150,000 to replace the asset, and that’s how much coverage they sold you. They’re not to blame if that’s not enough.
On the other hand, the lender doesn’t want the property or a partial repayment. They want the loan repaid in full. What they’re going to do is sit on any funds they get and make certain they’re used to rebuild, unless they have some reason to believe that rebuilding is a bad risk. Banks don’t throw good money after bad, so if this is the case, they’re going to keep the money. On the other hand, if you’ve been keeping your payments up, they’re going to want you to rebuild. Their taking custody of the money is a way to make certain that you do, too.
Caveat Emptor
If Your Loan Falls Through
“What do I do when the loan falls through”
That depends upon when it falls through and what situation you’re in. If you’re in a refinance situation, you generally keep making payments on your old loan until and unless you can find a refinance that is better that you qualify for. There is one exception to this: balloon loans. Balloon loans must be paid off in full on thus and such a date. These dates are known at least five years in advance, but some people insist upon leaving it to the last possible instant.
If you’re unable to refinance your balloon in time, lenders whom you ask for forbearance will generally will give you at least some time in extension of the old loan, but at a higher interest rate. This is very kind of the lenders because they don’t have to give you an extra minute. The agreement ran out last week and you didn’t pay them; they are entitled to foreclose if they want to. Good thing that the lender usually doesn’t want to.
If you’re doing a purchase, and the loan falls out any time with more than two weeks to go in escrow, that’s usually time to rush a purchase through, although you won’t be able to shop the new loan as much, and it’s unlikely to be as good. See why I tell you to apply for a back up? I’ve gotten purchase money loans done in two business days – loan approved, and documents in the hand of the notary.
However, loan providers will generally not admit that loans fell apart before the last minute, even if they were rejected out of hand back on day three. Actually, that’s a trick they pull quite often; tell you about loan A intending to deliver loan B, and then at the last minute tell you that you don’t qualify for A but you can have B. This keeps you from having time to shop around after you discover what a rotten loan they really have for you. They knew about what loan you would and would not qualify for within a week unless they are hopelessly incompetent, but their percentage lies in keeping mum until you have no choice but to accept loan B. In another amazing coincidence, loan B usually has a long prepayment penalty, and buying it off – if you can – costs two percent on the rate, and they’d have to send it all the way back to underwriting to see in you qualify, and that will take weeks, so why don’t you just sign for this loan right now. They may even say, “We’ll fix it later.” Yes, they will volunteer to get paid again after you’ve spent several thousand dollars on that prepayment penalty. I had a guy come to me quite recently, trying to fix one of those after the original company failed to do so. Unfortunately, the coals he’d been raked over, and with his credit score, there was nothing I could do and he lost the property.
So it’s now day thirty-one of a thirty day escrow, you’ve got a $10,000 deposit on the line, as your loan contingency expired back on day eighteen. Aren’t you glad you applied for a back up loan? You didn’t? Well, the situation isn’t necessarily lost.
First, call your seller, or have your agent call their agent, and find out if they’ll extend escrow. If it’s a hot seller’s market and they won’t, you’re hosed, but in a buyer’s market like this, they will if they’re smart. Most sellers, even in this market, will want you to pay extension fees and that is to be expected. The reason escrows are usually limited to thirty days is so they don’t have to keep spending money on you if you can’t qualify, and they do spend money on the transaction. This may cost you an extra $100 per day for up to ten days, but when the alternative is losing $10,000, that’s very worthwhile.
Purchase money loans can be done fast if you are in fact qualified and your loan officer knows what they’re doing. Forty eight hours is often very doable. Three to four days is much easier. Ten days is a long time in this sort of situation. The loan provider will charge more of a margin than you usually would, but this guy is likely putting everything else on hold in order to deal with your problem. That’s reasonable.
Loan providers who admit in the first week after you’ve given them standard qualifying information that you’re not going to qualify for the loan they initially told you about are probably honest, and likely thought you really would qualify. But the longer it goes, the less likely it is they intended to deliver the original loan. I might believe someone like that in the second week – but I wouldn’t believe that story from anyone in the third week after applying, even if they were backed up by everyone from Diogenes to George Washington.
Loans fall apart all the time. Locally, the percentage of escrows that fall apart because the buyer cannot in fact qualify for the necessary financing is edging up towards forty percent. So take precautions to make certain that situation does not happen to you.
Caveat Emptor
Games Lenders Play, Part V – Selling a Low Payment
Hello, I’ve been reading your website for awhile now, and have found it very helpful as I’m learning to navigate this crazy loan process! I had a question I was wondering if you could write about/answer. We currently have a mortgage and a secondary line of credit on our condo (we didn’t have a down payment, so we had to do it like this). We have been here one year, and the home values in our complex have gone up about $70,000 – $100,000 in that time period. (We live in Southern California.) Recently we got a notice in the mail telling us that they can reduce our monthly payments (“by as much as $1,500!)” if we refinance with them. Frankly, it sounds way too good to be true, and I have a feeling they’re not really telling us the truth in this notice. But it did raise a question in my mind: would it be wise to attempt to refinance, in the hopes that our higher valued home would allow us to refinance with only one mortgage, instead of two? I’m not even sure if that’s possible…I’m having a hard time understanding how refinancing works. I should mention that we are currently in an interest-only loan, with no prepayment penalties. Our first loan is 4.75%, and our secondary line of credit is 6.375%. Any help would be greatly appreciated.
Your feelings that they aren’t telling the whole truth are justified.
Refinancing is the process of replacing one loan for another on the same piece of property. The idea is that the terms of the new loan are more advantageous to you than the terms of the existing loan. There are three main issues that you need to be aware of, however. The first is that there are always costs associated with doing the new loan. The second is that there may be a prepayment penalty to get out of the existing loan. The third is to make certain the terms you are moving to are enough better, for your purposes, than the existing terms to justify the costs associated with the first and second issues.
You state that you’re in California, which is where I work. Realistic costs of doing the loan are about $3500 with everything that is necessary. This doesn’t include origination, to pay the loan provider for the work they do on the loan, or discount, to pay for a rate the lender might otherwise not offer. I explain those costs, the difference between them, and many of the games lenders play in my article on Good Faith Estimate, part I. There will also be the possibility of you having to come up with some prepaid items, explained in Good Faith Estimate Part II.
Note that not every loan has points. I actually think that, given most client’s refinancing habits, it’s usually better to pay for a loan’s cost, and the loan provider’s compensation, through Yield Spread rather than out of pocket or adding it to the mortgage balance. Yield spread can be thought of as negative discount points, and discount points can be thought of as negative yield spread. Discount points are a fee charged by the lender to give you a rate lower than you would otherwise have gotten. Yield Spread is a premium paid by the lender for accepting a rate higher that you could otherwise have gotten, and can be used to pay the loan provider and/or loan costs. Each situation must be considered upon its own merits, of course, but most people don’t keep loans long enough to recover the higher costs required to buy the rate down. There is always a tradeoff between rate and cost of a real estate loan
Now, let’s take a look at your specific situation. Your current first mortgage is at 4.75% interest only. You don’t mention what sort of loan this is (updated via email: it’s a 5/1 Interest Only ARM), but there is no such thing as a thirty year fixed rate interest only loan. At most they are interest only for a certain period, usually five years, before they begin to amortize over the remaining twenty-five. On the other hand, you said you bought one year ago, and that rate didn’t exist on thirty year fixed rate loans then and it doesn’t exist now. (Via later email, the first mortgage is a 5/1 Interest Only ARM). Your second loan is a line of credit at 6.375. I’m also guessing that either you, or the person who sold to you, paid a good chunk of change in discount points to buy the rate down, and I’m hoping it wasn’t you.
There’s no way that this is a loan that’s going to serve you indefinitely at that rate. When I first wrote this, there wasn’t a 30 year fixed rate loan comparable to that available, with any lender I know of, no matter how many points you paid (at this update, it’s getting dicey again). So what you have is at most a hybrid ARM (Yes, 5/1 Interest Only). No worries; I love hybrid ARMs. They are the only loans I consider for my own property in most circumstances. But they do have one weakness. There is likely to come a time when it is in your best interest to refinance, because after the fixed period the rate on them adjusts every so often, based upon a stated index plus a contractual margin, and the sum of these two is likely to be significantly higher than the rate for refinancing into another hybrid ARM.
Now what are they offering you? They’re talking about cutting your payment by $1500 or more. But there just aren’t any rates that much lower than yours available. Nothing even vaguely close. So how are they going to cut your payment?
The only hypothesis I can come up with that is not contradicted by available evidence is that they are offering you a loan with a negative amortization payment. I explain those in these articles:
Option Arm and Pick-a-Pay – Negative Amortization Loans and Negative Amortization Loans – More Unfortunate Details
There is more information on marketing games with this loan type in these articles: Games Lenders Play (Part II) and Games Lenders Play Part IV).
Finally, there are a few more issues that may not be relevant to everyone in these articles: Regulators Toughen Negative Amortization Loans? and Negative Amortization Loan Issues on Investment Property
One thing to understand is that when lenders are sending out advertising, they are not looking for Truth, Justice, and the American Way. They’re looking to get paid for doing a loan, and most lenders will do anything to get you to call, and then to get you start a loan. The creative fiction on many Good Faith Estimates and Mortgage Loan Disclosure Statements is only the start of this. If you find a loan provider who will pass up loans that they could otherwise talk you into because it doesn’t put you into a better situation, keep their contact information in a very safe place, because you’ve found a treasure more valuable than anything Indiana Jones ever discovered. A valuable treasure that you can and should nonetheless share with friends, family, and anybody you come into contact with because you want them to stay in business for the next time you need them. Most lenders and loan providers could care less if they are killing you financially – what they care about is that they get paid. A negative amortization loan pays between three and four points of yield spread. Assuming your loan is $300,000, they would be paid between $9000 and $12000 not counting any other fees they charge you for putting you into a loan where the real rate is at least 1.5 percent higher than the rate you’re paying now, and month to month variable. Warms the cockles of your heart, right? Didn’t think so.
In short, they’re offering you a teaser no better than a Nigerian 419 scam for most people in your situation. My advice is not to do anything unless you’re coming up on the end of your fixed period, in which case you need to talk with someone else, who might have your interests somewhere closer to their heart than the Andromeda Galaxy.
Caveat Emptor