Available Real Estate Loan Types

So what else is available, besides the thirty year fixed?

There are many kinds of loan out there. Here’s a quick overview:

A Paper

In addition to the thirty year fixed, there are several other varieties of fixed rate loan available, and several that are not. Commonly available are five year fixed, ten year fixed, fifteen year fixed, twenty year fixed, and twenty-five, as well as forty making a comeback.

I tend to avoid them all with my clients, except for the thirty year fixed. You can always pay more if you have more money that month, but you cannot always pay less. The shorter the term, the lower the interest rate should be, as not only are they guaranteeing the rate will not change for a lesser period, but the shorter the term, the more principal you are paying every month and the less risky the loan is. Nonetheless, they are also harder to qualify for because the minimum payment is higher.

For instance, if you have $2000 per month payment that you qualify for, then at 6.5 percent interest rate, here are the amounts you qualify for:

term
40
30
25
20
15
10
5		amount
$341,600
$316,400
$296,200
$268,200
$229,500
$176,100
$102,200


Thirty year fixed rate loans also come in interest only loans, usually for five years.

A paper loans also come in Balloon Loans, with thirty year amortization, where you make payments “as if” if were a thirty year fixed rate loan, but they are due in full after five or seven years (a few ten year balloons exist, and fifteen year balloons are almost exclusively Home Equity Loans). The shorter the balloon period, the lower the rate should be.

A paper loans also come in hybrid ARMs, with thirty year amortization and payoff term, but shorter fixed period. Unlike Balloons, you are welcome to keep them the full thirty years if you want to, but most folks want to refinance or sell before the adjustment begins. One, three, five, seven and ten years are commonly available fixed terms. Once they begin adjusting, they are based upon an underlying index plus a set margin above that, and the vast majority of A paper hybrids adjust once per year, and all the loans from a given lender will, once they adjust, adjust to the same rate no matter what you bought the start rate down to. For A paper, the base index is usually the US Treasury rate or the one year LIBOR. COFI, COSI, and MTA are Alt-A negative amortization loans, not A paper, and all three varieties of negative amortization loan are the same stuff from different outhouses. There are probably a hundred times more negative amortization loans than there should be, because they are so easy for those in search of a quick commission check to sell by the payment when you slap a friendly sounding label like “Pick a pay” on them.

Finally, there are some few A paper that are true ARMS, or so close that they might as well be. Month to month loans, adjust every three month loans, and adjust every six month loans. Their adjustments are usually on the same basis as hybrid ARMs, and they have thirty year amortizations. Some are even available in interest only.

Sub-prime

Sub-prime loans come in more flavors. The most common are fixed for two years, the next most for three. Both come in thirty and forty year amortization periods, as well as interest only. Interest only usually carries a higher rate for the fixed period, because they are riskier loans from the lender’s point of view, but the payment is lower. These are usually called 2/28, 2/38, 3/27 and 3/37 loans, for the fixed period and the remaining term thereafter. Interest only variants are all 2/28 or 3/27, and when they begin adjusting they begin amortizing, which can make a sudden sizable difference in payments. Some sub-prime lenders also offer 5/25 and 7/23 programs, including interest only variants. Once they adjust, all of these loans adjust every six months, which is one way to usually tell if you have a sub-prime or A paper hybrid ARMs, as the latter almost always adjust once per year, although a few lenders also have A paper hybrids that adjust at six month intervals.

Sub-prime loans also have thirty and forty and are starting to come out with fifty year fixed rate loans, with some thirty year fixed rates having an interest only option, usually carrying a quarter of a point higher interest and an interest only period of five years. Nonetheless, the rate spread between sub-prime hybrid and sub-prime fixed is usually larger than the spread between A paper hybrid and A paper fixed. Where you might get the A paper thirty year fixed for one percent above the rate of a 5/1 ARM, the difference between a 3/27 and a 30 year fixed is usually closer to two percent (this is by recent standards. When I initially bought in 1991, I was offered a choice between 5.75 percent 5/1 and 11 percent 30 year fixed)

I tend to like the five year fixed for myself and my A paper clients. It saves a lot in interest, and you’ve got five years where nothing can change, which is a longer period than most folks go without refinancing, and it’s usually only about an eighth percent or so more expensive, interest wise, than the 3/1 while being a quarter percent or so cheaper than a 7/1. For the sub-prime clients, I tend to prefer the 2/28 if I think they’ll be A paper at the end of two years, the 5/25 if not and if I can find it (3/27 if I can’t). Of course, if you really want to pay the higher rates for a long term fixed rate loan, I may believe you’re wasting money, but it’s your money to waste, and you’re the one making the payments.

Two final types worth covering are the HELOC (“he-lock”), or Home Equity Line Of Credit, and HEL (“heal”), or Home Equity Loan. They are usually used as Second Trust Deeds, the second loan on a property. A HELOC is a variable rate interest loan, usually prime plus a margin, and there is often an interest only period. It is a line of credit, and so long as you stay within your credit limit, the initial underwriting covers it. Nobody does fixed rate HELOCs; what they do when you “fix the rate” is fix that part of it you’ve already taken out and lower the maximum available credit. HELOCs have two phases, a draw period, when you can take more out (up to the approved limit), and a repayment period, when you’re repaying what you took. Most folks end up selling or refinancing, however. Home Equity Loans are one time, fixed rate loans. I’ve seen all sorts, but the most common is a 30 year amortization with a 15 year balloon, although the twenty year fixed is almost as common. You need to refinance, sell, or pay the loan off prior to the end of fifteen years, lest the lender call the note.

Caveat Emptor

Inducements to Use A Particular Lender for a Purchase

One of the things I’m seeing more of in MLS listings and developer advertising, among other places, is the phrase “$X in closing cost credit (or “$X in free builder upgrades”) given for using preferred lender”

Sounds like a bargain, right? Just use their lender and you get this multi-thousand dollar credit. After all, “All Mortgage Money Comes From The Same Place!” Free money, right?

Well possibly, but not very likely. What most companies are looking to do with this advertising is give people a reason not to shop around. They hope that because most people think that “All Mortgage Money Comes From The Same Place”, the average customer will just stay there to apply for a loan. Many builders and conversion companies will throw roadblocks in your way if you try to use another lender. They cannot legally require you to use their loan company (at least not in California), but they can make it exceedingly difficult to go elsewhere. I’ve been told by builder’s representatives on two occasions that I was wasting my time with a loan, because “If they don’t use our lender, they won’t get the property!” despite already having a signed purchase agreement. Roadblocks take all sorts of turns. They won’t let the appraiser in. They won’t cooperate with requests for information, without which the other loan is going nowhere. And so on and so forth.

The builders wouldn’t give those incentives to use their lender, or throw roadblocks in your way when they’re trying to sell you a property, if they weren’t making more money with the loan. Quite often, they’re making more money on the loan than they are from the sale. Put you into a loan half a percent above market, stick a three year prepayment penalty on it, and voila, anywhere from a 6 percent premium to perhaps 10 percent. To give you a comparison, around here an agent makes 2.5 to 3 percent from a transaction, and I do my loans on anywhere from half a point to a point and a half, depending upon difficulty and size. But the average consumer is distracted by these “free” upgrades or closing costs that they don’t realize how badly they’ve been raked over the coals. If I can get you that $400,000 loan half a percent cheaper and with no prepayment penalty, I’m saving you $2000 per year for certain, and very likely about $12,000 on the prepayment penalty.

Furthermore, on some of the builder’s loans I’ve analyzed, they’re getting you a rate that would carry a point and a half retail rebate, even without the prepayment penalty. This means on a $400,000 loan at that rate, the lender would be paying you a $6000 incentive to do that loan, more than covering normal closing costs. Have no fear, that builder is doing quite well for having loaned you that money.

What can an average person do about this sort of thing? As I’ve said before, builders often throw roadblocks in the way of outside lenders, and there’s not a lot that you or anyone else can do about this fact.

Many people want brand new homes if they can get them. Given the realities about Mello-Roos and how prevalent homeowner’s associations are in more recent developments, I’m not certain I understand this. It’s one thing to deal with Mrs. Grundy when you’re all cheek by jowl in a condominium high rise. It quite another thing to deal with her complaints because you left your garage door open ten minutes longer than the rules say, you want to paint your detached home a couple shades darker or lighter than everyone else, or whatever’s got her dander up today.

I do have a trick or two up my sleeve for when I’m a buyer’s agent in new developments. It’s my job to outmanouever the selling agents the builder has on staff (who tend to be heavy hitting pressure salesfolk). But they are dependent on some things that change from transaction to transaction, so I can’t really describe them in any kind of universal terms. Writing an offer contingent upon an outside loan has its limits. Builders who throw roadblocks have that one wired; they wait for the contingency to expire at which point they’ve either got your deposit or your loan business as you are so desperate not to lose your deposit you’ll do almost anything, particularly since most folks don’t understand how much that loan is really likely to cost them.

Caveat Emptor

Cold Hard Numbers

(This is a somewhat redacted letter I was been sending out during the 2000s mortgage crisis)

I have just recently attended a talk by Gregory Smith, the county assessor, on the future of home values in San Diego. 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. It might work if you’ve got that kind of excess income, but I agree with every respectable real estate investing guide that unsustainable 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)

Changing the Purchase Contract

What is the reasonable amount of notice to give when changing contract terms in California


That was a search I got. Unfortunately for this person, a real estate contract is not something like Lando Calrissian’s bargain with the Empire, where Darth Vader was free to alter it at will.

The real estate contract is negotiated until both sides are in complete agreement as to the terms the exchange will be made upon. There cannot be any differences in the terms of the proposed agreement and accepted agreement, or you aren’t done negotiating yet.

Once accepted by both parties, the contract terms are not unilaterally alterable by either party. They can, in most cases, walk away from the deal completely if something isn’t right, but they can’t say, “The deal is still on, but you’re paying me $5000 more than you thought,” any more than they can tell you, “And I get your car, too!”

Now, if something pops up such that you don’t think it’s a good exchange to be making any more, in most cases you can walk away from it, albeit with possible consequences for the deposit. In such cases, if the other party wants to keep the deal going, they can offer concessions, but you cannot force them to change the terms of the contract. The same thing holds true in reverse. They can’t force you to alter the terms of the contract, but if they’re ready to walk away and you want to keep them in the contract, you can offer concessions or ask what it would take to keep the transaction going. If you don’t like what they say, you don’t have to accept those terms, any more than they had to accept the contract in the first place.

In short, contracts to purchase real estate are two-sided contracts, and are not alterable by any party to it without the agreement of all parties.

Caveat Emptor

Appraisal Fraud

I enjoyed finding your blog today. It was enlightening, particularly in the area of real estate appraisals.

Mortgage fraud is something I’ve been reading about lately. Since the FBI says 80% of it involves collusion and usually with the appraiser, it made me wonder why underwriters don’t just ask for second appraisals when a loan looks like it could be part of a flipping scheme (e.g., the owner hasn’t had it for long and the new appraisal has it coming in much higher than the last one).

Have you looked at this area at all? I’d be interested in your point of view.

Appraisal Fraud is more of a problem than it was. A couple of years ago, the appraisal was treated and regarded differently than it is now. On the one hand, appraisers were regarded as gods sitting in judgment of a property, which never was true. They’re human, subject to human foibles and tendencies. On the other hand, it has perhaps swung a too far in the opposite direction, with many appraisers doing whatever the loan provider wants in order to continue to attract business.

A good balance is somewhere in between. Appraisers don’t want to work any harder than necessary, of course, but they’ve got to remember that they are, first and foremost, businessfolk selling a service. I agree with the law that says minimum appraisals are prohibited, as it protects everyone. On the other hand, when I ask an appraiser to reconfirm if comparables don’t support a value of $X, what I’m trying to do is protect my client. This gives me a chance to re-work the loan, or re-open negotiations with the seller, before my client has wasted hundreds of dollars for an appraisal that doesn’t help. Eighty to ninety percent of the time, the appraiser who tells me the value isn’t there gets paid anyway, because I can re-work the loan or renegotiate the deal to the point where everybody’s happy and the transaction proceeds. If the appraiser just goes out, takes the check, and drops an appraisal that’s $20,000 low on my client, I have a screaming mad client on my hands who is poison to my business because in their eyes I was the one who “tricked” this money out of them, and perhaps a seller and seller’s agent who are angry as well because I hired an “incompetent” appraiser, with repercussions next time I write an offer for one of my clients, and nobody is happy, least of all me.

On the other hand, an appraiser who is willing to manipulate the data to come up with value no matter what is one I want to stay away from, and it’s because of fraud. If there’s no default and the loan gets paid back in full, appraiser fraud doesn’t matter in terms of people getting hurt. But that’s not the usual thing that happens with appraiser fraud.

I keep writing that a certain percentage of all attempted real estate transactions are fraudulent, and a good agent and especially a good loan officer keeps their eyes peeled for evidence. Real Estate transactions are very large dollar amounts. A one bedroom condo around here goes for over $200,000. This is more than most families make in a couple of years. An average single family residence might be $500,000 or more. This makes the temptation level considerable, and there are always folks around who have an eye for the quick easy dollar and never mind the effects on others or the prospects of prison if caught. Sometimes the lender is the intended mark, sometimes the other party to the transaction. I could tell you about all varieties of scams, but appraisal fraud is one of the most common.

Before we go any further, let’s examine what an appraisal is. Accountants value goods using a method called “Lesser of Cost or Market,” or LCM for short. This means a given property is valued for accounting purposes at either the purchase price (cost) or appraised value (market), whichever is lower. But this has been modified from its original form for real estate lending purposes, because in the real world real estate appreciates in value. At purchase, the cost or value argument still applies. No matter what, the lender will not lend based upon a value greater than the purchase price. Later on, however, they will, because land does not depreciate, it does not in general vanish or get used up, and it does increase in value (Pretty much universally over time frames of a decade or more).

This gives scam artists all the leeway they need. Some of them are relatively harmless, in that all they’re looking for is a better rate on a loan that they do intend to repay. This doesn’t mean it’s smart to cooperate with them, as many agents and loan officers who did are likely to discover quite soon, as the loans default and the lender investigates why. The balance sheet reads a little differently when you discover that cooperating with the guy who just wanted to cut a few corners is going to cost you your license.

Appraisal fraud, however, is usually aimed at a large quick score. I’m going to keep my examples basic, lest I inadvertently release a couple more ideas into the wild. Let’s say you own a property that’s worth (pinky finger extended) one million dollars. You owe $900,000. If you sell, you’re going to net about $30,000. But if you can persuade a buyer that property values are increasing much faster than they are, many will bite off on an increased sales price. You tell the appraiser “Appraise it for $1,250,000 and it’s worth $25,000 to you!” He does so. You pay him his $25,000 and your net is still around $235,000 to $240,000. It’s fraud, but fraud that many folks have gotten away with because the buyer doesn’t realize he’s been had and keeps paying the bank. Or you can’t keep up the payments but want to walk away with as much cash as possible. Instead of a distress sale, where you’d be very lucky to break even with a sharp buyer’s agent, you pay the appraiser $25,000 to appraise it at $1.25 million, refinance for cash out to maybe 90 percent of that value, pay the appraiser and walk away with a cool $200k, never making a single payment on the new loan.

Appraisal fraud can also be intentionally low. A buyer wants to buy the property, pays the appraiser to appraise it low, and renegotiates the price. I had this tried on me about two years ago. It didn’t work.

Now once upon a time, there were real constraints to keep an appraiser from pulling this, on residential properties at least. To a certain extent, there still are but those guidelines have been relaxed due to the hypercompetitive market we’ve had the last few years. For instance, it used to be that the lenders would accept a value for a property on a refinance no higher than an annualized increase of 10 percent for the first couple years. That’s gone by the wayside, as lenders get used to the fact that values are increasing faster than that. With many lenders, it’s whatever the appraiser says the day after the sale. This is an invitation to fraud. Invitations to fraud do not excuse fraud, but they certainly make it easier. It used to be that no matter what, you couldn’t pull cash for six months after a sale. That’s now changed.

Underwriting in many lenders no longer has to pass a “smell test,” where the lender pulls up the local market and sees what similar properties have really sold for recently. They’re competing for loans! First time they tell the folks “no” that loan officer may not give them any more chances to do loans, choosing instead other lenders with more accommodating employees and policies. They have to do loans to stay in business, and avoid layoffs, but those lenders with more accommodating employees and policies are going to be in a world of hurt if the local market cools much further.

Now appraisers that do this are subject to discipline and legal penalties, starting with the fact that the lender has the option of never accepting one of their appraisals again and going up through loss of license and jail time. I’m not up on the penalty structure, but fraud that costs in excess of $100,000 is a serious felony. They’ve got the appraiser’s name, license number, and other identifying information. In my opinion, aiding and abetting fraud is stupid and if you can’t get them to fly straight, walking away as quickly as possible is your best option, but real estate compensations (and the amounts at stake) are large enough that many will do it. If you’re not a pro yourself, your best protection is a good agent that’s working for you only not the seller as well, splitting loyalty between both sides of the transaction, and making sure somebody working for you is there at the property to meet the appraiser.

Caveat Emptor

Saving Money by Refinancing Your Mortgage

One of the bloggers I used to read talks about debunking a money myth and perpetuates one of his own. He took issue with someone refinancing to lower their monthly payment, insisting instead that the term of the loan was all important.

His point is understandable in that because folks tend to buy more house than they can really afford, they also tend to obsess about that monthly payment. The solution to this is simple to describe but it takes someone with more savvy and willpower than most to bring it off: don’t buy more house than you can afford.

Actually, there is nothing that is all important, but if I had to pick one thing as most important, it would be the tradeoff between interest rate and cost and type of loan. This is always a tradeoff. They’re not going to give you a thirty year fixed rate loan a full percent below par for the same price as loan that’s adjustable on monthly basis right from the get-go.

If you have a long history of keeping every mortgage loan you take out five years, ten years, or longer, then perhaps it might make sense for you to take out a thirty year fixed rate loan and pay some points. To illustrate, I’m going to pull a table out of an old article of mine because I’m too lazy to do a new one.

rate
5.625
5.750
5.875
6.000
6.125
6.250
6.375
6.500
6.625
6.750
6.875
7.000		discount/rebate
1.750
1.250
0.625
0.250
-0.250
-0.750
-1.250
-1.500
-2.000
-2.250
-2.500
-3.250
cost
$4725.00
$3375.00
$1687.50
$675.00
-$675.00
-$2025.00
-$3375.00
-$4050.00
-$5400.00
-$6075.00
-$6750.00
-$8775.00


Now I’m intentionally using an old table, and rates are different now. I’m assuming no prepayment penalties, and the third column is cost of discount points (if positive) or how much money you would have gotten in rebate (if negative), assuming the $270,000 loan I usually use by default. Add this to normal closing costs of about $3400 to arrive at the cost of your loan, thus:

(I had to break this table into two parts to get it to display correctly)

Rate
5.625
5.75
5.875
6
6.125
6.25
6.375
6.5
6.625
6.75
6.875
7		Points/Rebate
$4,725.00
$3,375.00
$1,687.50
$675.00
($675.00)
($2,025.)
($3,375.)
($4,050.)
($5,400.)
($6,075.)
($6,750.)
($8,775.)		Total cost
$8,125.00
$6,775.00
$5,087.50
$4,075.00
$2,725.00
$1,375.00
$25.00
($650.00)
($2,000.)
($2,675.)
($3,350.)
($5,375.)		New Balance
$278,125.
$276,775.
$275,087.
$274,075.
$272,725.
$271,375.
$270,025.
$270,000.
$270,000.
$270,000.
$270,000.
$270,000.		Payment
$1,601.04
$1,615.18
$1,627.25
$1,643.22
$1,657.11
$1,670.90
$1,684.60
$1,706.58
$1,728.84
$1,751.21
$1,773.71
$1,796.32
rate
5.625
5.750
5.875
6.000
6.125
6.250
6.375
6.500
6.625
6.750
6.875
7.000		New Balance
$278,125.
$276,775.
$275,087.
$274,075.
$272,725.
$271,375.
$270,025.
$270,000.
$270,000.
$270,000.
$270,000.
$270,000.		Interest*
$1,303.71
$1,326.21
$1,346.78
$1,370.38
$1,392.03
$1,413.41
$1,434.51
$1,462.50
$1,490.63
$1,518.75
$1,546.88
$1,575.00		$saved/month
$130.80
$108.29
$87.73
$64.13
$42.47
$21.10
$0.00
($27.99)
($56.12)
($84.24)
($112.37)
($140.49)		break even
62.119221
62.561019
57.993558
63.540017
64.156958
65.177138
0
0
0
0
0
0


I’ve modified the results based upon some real world considerations. Point of fact, it’s rare to actually get the rebate (typically, the loan provider will pocket anything above what pays your costs), and so I’ve zeroed out those costs. You take a higher rate, you’re just out the extra monthly interest. The fourth column is your new balance, the fifth is your monthly payment. For the second table, I’ve duplicated rate and new balance for the first two columns, the third is your first month’s interest charge (note that this will decrease in subsequent months), the fourth is how much you save per month by having this rate, and the fifth and final column is how long in months it will take you to recover your closing cost via your interest savings as opposed to the cost of the 6.375% loan, which cost a grand total of $25 (actually, this number will be slightly high, as interest savings will increase slowly, as lower rate loans pay more principle in early years).

However, let’s look at it as if your current interest rate is 7 percent. Your monthly cost of interest is $1575, there, so let’s see how long it takes to actually come out ahead with these various loans.

Rate
5.625
5.75
5.875
6
6.125
6.25
6.375
6.5
6.625
6.75
6.875
7
Loan Cost
$8,125.00
$6,775.00
$5,087.50
$4,075.00
$2,725.00
$1,375.00
$25.00
$0.00
$0.00
$0.00
$0.00
$0.00
New Loan
$278,125.
$276,775.
$275,087.
$274,075.
$272,725.
$271,375.
$270,025.
$270,000.
$270,000.
$270,000.
$270,000.
$270,000.
Saved/month
$271.29
$248.79
$228.22
$204.63
$182.97
$161.59
$140.49
$112.50
$84.38
$56.25
$28.13
$0.00
Breakeven
29.949604
27.232189
22.292335
19.91447
14.893465
8.509266
0.1779458
0
0
0
0
0

In short, since you’re recovering costs quickly, it would make sense for folks with a rate of 7 percent to refinance in this situation, no matter how long they have left on their loan. For $25, they can move their interest rate down to 6.375, saving them $140 plus change per month. It’s very hard to make an argument that that’s not worthwhile. On the other hand, I would have been somewhat leery of choosing the 5.625% loan, as more than fifty percent of everyone has refinanced or sold within two years. On the other hand, I have a solid history of going five years between refinancing, so it makes a certain amount of sense, considered in a vacuum. Considered in light of the real world, rates fluctuate up and down. So I tend to believe that if I don’t pay very much for my rate, I’m likely to encounter a situation within a few years where I can move to a lower rate for zero, or almost zero, whereas if I paid the $8125 for the 5.625%, rates would really have to fall a lot before I can improve my situation.

Do not make the mistake of thinking that the remaining term of the loan is more important than it is. You now have (assuming you took the 6.375% loan) $140 more per month in your pocket. It’s up to you how you want to spend it. If you want to spend it paying down your loan more quickly, you can do that (providing you don’t trigger a prepayment penalty, of course!). Let’s say you were two years into your previous loan. Your monthly payment was $1835.00. If you keep making that payment, you’ll be done in 288 months; 48 months or 4 full years earlier than you would have been done. So long as you don’t trigger the prepayment penalty, you can always pay your loan down faster. Just write the check for the extra dollars and tell the lender that it’s extra principal you’re paying. I haven’t made a minimum payment since the first time I refinanced!

Now some folks focus in on the minimum payment. By doing this, you make the lenders very happy, and likely your credit card companies as well. Not to mention that you are meat on the table for every unethical loan provider out there. It is critical to have a payment that you can afford to make every month, and make on time. But once you have that detail taken care of, look at your interest charges and how long you’re likely to keep the loan, not the minimum payment.

Caveat Emptor

Refinancing Has No Effect Upon Property Taxes

do your property taxes go up in California when you refinance your property

This is one of those urban legends. People are concerned that because the house is appraised by the lender, the assessor is somehow going to find out that their property is worth more and send their tax bill soaring.



However, thanks to Proposition 13 in California, the formula for property taxes has little to do with what the home is really worth. The formula is based upon the purchase price plus two percent per year, compounded. If you can document that your home is worth less than this amount, contact your county assessor’s office. But if it’s worth more, they cannot increase it beyond this number.

Indeed, certain family transfers can preserve this lower tax basis. Mom and dad deed it to the kids, and the kids keep paying taxes on it based upon a purchase price of perhaps $60,000 (Plus thirty-odd years of compounding at two percent, so maybe $115,000) when comparable homes may be selling for $600,000.

There are two major exceptions. First, a sale. If you sell it to someone else, then repurchase, you don’t get the old tax basis back. Second, improvements. If you take out a building permit, the assessor will add the current value of your improvements to your tax bill. This can, in situations like the previous paragraph, result in a tax bill that literally doubles if you add a room. Indeed, this is one of the main reasons for the growth of the unlicensed contractor industry, because licensed ones have to make certain the permits are in order, and homeowners are trying to sneak one over on the county. This is why a very large proportion of properties in MLS have the notation that “this addition may not have been permitted.” They know good and well that the addition wasn’t permitted, and quite likely isn’t to code, either. If it’s built to code, subsequent owners can get forgiveness as innocent beneficiaries who bought the house like that, and so the purchase price included the value of that room (and occasionally, the state finds it worth its while to go after the previous owner for back taxes and possible penalties, and I believe that the incidence of this will likely increase dramatically in the next couple of years). If it’s not built to code, however (an offense unlicensed contractors often commit), the subsequent owner can be looking at a large mandatory repair bill, or perhaps even demolishing the addition they paid for if the county inspector deems it unsound. You want to be very careful about properties with the “addition may not have been permitted” disclosure.

Other states, by and large, still follow the assessment model California used to follow, pre-Proposition 13. They have county records of the property characteristics, and evaluate the home based upon those characteristics, whence comes your assessment, and hence, your property tax bill. This still encourages unlicensed contractors and working without required permits, with effects much the same as the previous paragraph, which is definitely not good, but in this case subsequent owners have nothing but incentive to keep improvements off the county books, where in California, subsequent owners have motivation to want improvements updated into county records. I am not aware of any state which follows a model whereby refinancing will alter your tax bill.

Caveat Emptor

Recording Errors and Title Insurance

I just got a google search where the question asked was “What if the mortgage is recorded in the wrong county?”

I’ve never actually seen this (and San Diego County, once upon a time, included what is now Riverside, Imperial and San Bernardino counties), but if it’s the mortgage on your loan, no big deal. You should get a copy of the recorded trust deed, and the county recorder’s stamp should tell you the county it was recorded in. You probably want to record it in your own county, as when the document is scanned in both recorder’s stamps will appear, thus making it obvious that these two documents are one and the same. There may be better ways to deal with it. Since the error was (everywhere I’ve ever worked) your title company’s, they should be willing to repair it to eliminate the cloud on your title. If and when you refinance this loan or sell the property, make sure that the Reconveyance is recorded in both counties, and references both recordings.

More dangerous is the issue of what if it’s the previous owner’s loan that was wrongly recorded. The previous owner is obviously no longer making payments on the property. The lender may or may not have been paid off properly; if they were there may not be any difficulties. It could just disappear into some metaphorical black hole of things that weren’t done right and were never corrected, but just don’t matter because everybody’s happy and nobody does anything to rock the boat. However, unlike black holes in astronomy, things do come back out of these sorts of black holes.

If the previous lender was not paid off correctly, or if they were paid but something causes it to not process correctly, they’ve got a claim on your property, and because the usual title search that is done is county-based, it won’t show up in a regular title search. Let’s face it, property in County A usually stays right where it’s always been, in County A. There is no reason except error for it to be recorded in County B. Therefore, the title company almost certainly would not catch it when they did a search for documents affecting the property in County A; it would be a rare and lucky title examiner who caught it.

In some states, they still don’t use title insurance, merely attorneys examining the state of title. When the previous owner’s lender sues you, you’re going to have to turn around and sue that attorney who did your title examination for negligence, who is then going to have to turn around and sue whoever recorded the documents wrong. If it’s a small attorney’s office and they’ve since gone out of business, best of luck and let me know how it all turns out, but the sharks are going to be circling for years on this one, and the only sure winners are the lawyers.

In most states, however, the concept of title insurance has become de rigeur. Here in California, lenders don’t lend the money without a valid policy of title insurance involved.

Let’s stop here for a moment and clarify a few things. When we’re talking about title insurance, there are, in general, two separate title insurance policies in effect. When you bought the property, you required the previous owner to buy you a policy of title insurance as an assurance that they were the actual owners. By and large, it can only be purchased at the same time you purchase your property. This policy remains in effect as long as you or your heirs own the property. The first Title Company, which became Commonwealth Land Title, was started in 1853, and there are likely insured properties from the 19th century still covered. If you don’t know who your title insurance company is, you should. Most places, the company and the order of title insurance are on the grant deed.

The other policy of title insurance is a lender’s policy of title insurance. This insures your lender against loss on that particular loan due to title defects, and when the loan is paid off (either because the property is sold, refinanced, or that rare property where the people now own it free and clear), it’s over and done with. Let’s face it, most people are not going to continue to make payments if they lose the property. If you take out a new loan, your new lender will require a new policy of title insurance. You pay but they are the ones insured by the policy. Their money; they set the terms for lending it out.

To get back to the situation, what happens when you order title insurance is that a searcher and/or an examiner go out and find all of the documents they can find that are relevant to the title of the property. These days, they typically perform an automated search, and sometimes documents are indexed and cross referenced incorrectly and therefore they do not show up when they should. Nonetheless, the title company takes this list of documents and tells you about known issues with the title, and then basically says “We will sell you a policy of title insurance that covers everything else.” This document is variously known as a Preliminary Report, PR, or Commitment.

It shouldn’t take a genius to figure out why you want a policy of title insurance. Around here, the average single family residence goes for somewhere on the high side of $500,000. You’re committing a half million dollars of your money on the representation that Joe Blow owns the property and that if you give him that half a million, he’ll give you valid title. I would never consider buying property without an owner’s policy of title insurance. Even with the best will in the world and my best friend whose family has owned it since the stone age, all kinds of issues really do crop up (Another agent in the office had a client who bought a property via an uninsured transfer – and there was an unrecorded tax lien. Ouch. Say bye-bye to your investment). The lenders are the same way. No lender’s policy, no loan.

So what happens when this old mortgage document is uncovered? Well, that’s one of the hundreds of thousands of reasons why you have that policy of title insurance. You go to your title company and say, “I have a claim.” Since they missed that document in their search, they usually pay off the loan (there are other possibilities). After all, if they hadn’t missed it, it would have been taken care of before Joe Blow got paid for the property and split to the Bahamas.

None of this considers the possibility of fraud, among many other possibilities, but those are all beyond the scope of this article.

So when buying, insist that your seller provide you with a policy of title insurance. When selling, it really isn’t out of line for your buyer to require it – it shows that you have a serious buyer. Some places may have the buyer purchasing his own policy, but most places that use title insurance, the seller pays for the owner’s policy out of the proceeds. Of course, anytime there is a loan done on the property, the lender is going to require you pay for a lender’s policy. If the quotes you are given do not include this, be certain to ask why. There really isn’t a good reason for not including that quote – they are going to require it, you are going to pay it. Better to know about it ahead of time, don’t you think? That way you can make a fair, accurate comparison between the loans you are shopping.

Caveat Emptor

Making Prepayment Penalties Illegal

I got a search for “which states allow prepayment penalties”. I’m not aware of any that don’t. If there are any, I’d like to know. Any such states should immediately be renamed “Denial”.

I really hate prepayment penalties, for a large number of reasons. Nonetheless, to make them illegal would not be in the best interests of consumers.

Let’s examine why. Let’s consider a hypothetical couple, the Smiths, who don’t have much of a down payment, and have difficulty qualifying for the loan. They want to become owners rather than renters, and it is in their best interests to do so.

The cold hard fact of the matter is that nobody does loans for free. Real Estate loans are complex creatures, and they don’t just magically appear out of some hyperspatial vortex upon demand. I may cut my usual margin by half if I’m the buyer’s agent as well, but that’s because I’ve found I’m going to do a large portion of the work anyway, have to ride herd on the loan officer, and stress out because it’s a major part of the transaction that can really hurt my clients that is not only not under my control, but I cannot monitor with any degree of confidence I’m being told the truth. I keep telling folks that the MLDS or GFE don’t mean anything. They are not contracts, they are not loan commitments, they are not the Note or Deed of Trust, and they definitely aren’t a funded loan. They are supposed to be a best guess estimate of your loan conditions, but with all the limitations and wiggle room built into them, the regulators might as well not have bothered. By themselves, they are worthless. None of the paper you get before you sign final loan documents means anything unless the loan officer wants it to. Unless the loan officer guarantees it in writing that says that someone other than you will eat any difference in costs, what you have is a used piece of paper with some unimportant markings on it. If I, as a better more experienced loan officer than the vast majority of loan officers out there, cannot monitor what another loan officer is doing with any degree of confidence, do you want to bet that you can?

So we have some folks who can just barely stretch to do the loan. In order to buy them a little space on their payments, so that any bill that comes in isn’t an absolute disaster they cannot afford, and also so I can get paid without it coming out of the money these people don’t have, I talk to them about the situation and we all agree to put a two year pre-payment penalty on the loan. This buys them a lower rate with lower payments, without adding anything to their loan balance. They don’t owe any more money, they get a lower rate, I get paid, and they didn’t have to come up with money they don’t have. Everybody wins, whereas without the prepayment penalty they would be paying $200 per month more, and perhaps they couldn’t qualify. No loan, no property, no start to the benefits of ownership. They certainly wouldn’t have that $200 per month cushion that’s likely to save their bacon from their first emergency. Leaving aside for a moment the issue that most folks want to buy more house than they can afford, that really stinks from the point of view of the people that those who would outlaw prepayment penalties altogether say they are trying to help, those who are trying to buy a home and just barely qualify.

Many folks have a long mortgage history, and they are comfortable in the knowledge that they will not refinance or sell within X number of years. They’re willing to accept a pre-payment penalty in order to get the lower rate. They want that $200 per month in their pocket, not the bank’s, and they are willing to accept the risk that they may need to sell or refinance in return. After all, if they don’t sell or refinance within the term of the penalty, it cost them nothing. Zip. Zero. Nada. For all intents and purposes, free money. I may advise against it, but it is their decision to make or not make that bet, not mine, not the bank’s, not the legislature’s, and definitely not some clueless bureaucrat’s, let alone that of some ignorant activist who only understands that lenders make money from them, and not the benefits that real consumers can receive if they go into it with their eyes open.

Pre-payment penalties get abused. Badly abused. I know of places that think nothing of putting a three year pre-payment penalty on a loan with a two year fixed period. There is no way on this Earth anyone can tell those folks truthfully what their payments will be like in the third year. I may be able to tell them what the lowest possible payment could be, but not the highest. I’ve seen five year prepayment penalties on two and three year fixed rate loans, and that situation is even worse. I’ve heard of ten year prepayment penalties on a three year fixed rate loan. I’ve seen even A paper lenders slide in long prepayment penalties on unsuspecting borrowers that mean they get an extra six or eight points of profit when they sell the loan. So there are some real issues there.

With this in mind, there are some reforms I could really get behind. The first is making it illegal for a prepayment penalty to exceed the length of time that the actual interest rate is fixed. Regardless of what the contract says, once the real interest rate starts to adjust, no prepayment penalty can be charged (This means no prepayment penalties on Option ARMS, among other things). The second is putting a prepayment penalty disclosure clause in large prominent type on every one of the standard forms, and making it mandatory that the loan provider indemnify the borrower if the final loan delivered does not conform to the initial pre-payment disclosure. In other words, if I tell you there’s no pre-payment penalty and there is one, I have to pay it for you. If I tell you there’s a two year penalty, and it’s a three year penalty, I have to pay it if you sell or refinance in the third year (in the first two years, it’s your own lookout because you agreed to that from the beginning).

But to completely abolish the pre-payment payment penalty is not in the best interest of the consumers of any state. Show me a state that has abolished them completely, and I’ll show you a state that has hurt its residents to no good purpose. Sometimes there is a good solution to a problem, as I believe I have demonstrated here. It’s just not the first one that springs to mind.

Caveat Emptor

What Does Escrow Do?

This is a question that gets asked a lot.

Escrow is nothing more or less than a neutral third party that stands in the middle of a real estate transaction and makes certain all of the i’s are dotted and t’s are crossed. They make certain that all of the terms of the contract have been met, and then they make certain that everyone who is a party to the transaction gets what is coming to them via the contract.

Many times folks complain about the escrow company or escrow officer, when it’s not their fault and the problem lies elsewhere. The escrow company is obligated to make certain all of the terms of the contract have been followed, not just most of them. I’ve talked before about how if the contract is not accepted exactly as proposed in the most recent modification, you don’t have a deal. There cannot be any points of disagreement, or you don’t have a purchase contract. Similarly for escrow. If it’s not all done in compliance with the contract, the transaction is not ready to close. Usually problems that the client sees are not the escrow officer’s doing, but rather someone else’s. Quite often, the person complaining is the person who caused the problem. The escrow officer can’t do anything without mutual agreement. If the loan officer doesn’t get the loan in a timely fashion, it’s not the escrow officer’s fault. If the agent doesn’t meet the inspector or appraiser so they can get their work done in a timely fashion, it’s not the escrow officer’s fault. If you can’t qualify for the loan, if you have to come up with more money, if you don’t get as much money as you thought, it’s not the escrow officer’s fault. But in many cases, the escrow officer makes a convenient whipping boy for the sins of others.

This is not to say that it’s never the escrow officer’s fault that something goes wrong, but if one party or the other is not in compliance with the terms of the agreement, the only thing the escrow officer can do is get an amended agreement or get them into compliance. Nonetheless, I have seen many transactions fall apart because the escrow officer was a bozo. The really good escrow officers are like chess masters – several moves ahead of the whole game, and when I find one, I want to use them all of the time. Unfortunately for buyer’s agents, the seller is the one with real control over where the escrow transaction goes, and when the seller’s agent decides they want to use some bozo, that’s probably where it’s going. I can do all kinds of things that should move them, but the bottom line is they want to use their broker’s pet escrow (who is more likely to be staffed by bozos than any other escrow company, as they’ve got captive clients), I as the buyer’s agent cannot force them to go elsewhere.

As the escrow process moves forward, the escrow officer collects documentation that the various requirements of the contract have been fulfilled. When they have all been fulfilled, the transaction is ready to close and record.

The loan is usually the last thing left hanging after everything else is done. There are a variety of reasons for this, most obvious of which is that the loan’s conditions are likely to include everything else being done before the loan funds. Appraisal, grant deed, inspection, etcetera and ad nauseum. When the borrower meets underwriter’s guidelines, they go and sign loan documents. Signing loan documents does not mean the loan will fund, and it is a major misapprehension to believe so. It is legitimate to move conditions from prior to docs to prior to funding if doing so serves some interest of the client, such as funding the loan before the rate lock expires. If they go to documents before the client’s income and occupational status have been verified, that’s an unethical lender looking to lock the client into their loan or none at all. Always demand a copy of outstanding conditions to fund the loan before you sign loan documents.

Once the loan documents are signed is when the real fun begins, because that’s when the underwriter takes a step back and the funder steps to the forefront. The loan funder is an employee of the lender who fulfills much the same function as the escrow officer – make sure all of the conditions have been met before they release the money. The loan funder has responsibility only to the lender, though, not the borrower, not the seller, not anyone else. It’s their job to ask such questions as when the homeowner’s insurance got paid (and where is the proof?), has the final Verification of employment been done (assuming they aren’t required to do it themselves), or work out a procedure whereby they get proof that all of this stuff is satisfied before the funds get released. If the loan officer has done their job correctly, the funder is working primarily with the escrow company. If I have to talk to the funder as a loan officer, that’s usually a sign I should have worked a little harder earlier on, because my part should be done before the funder gets involved.

Once all of the conditions to fund the loan and close the transaction have been met, the escrow officer records the transaction. In point of fact, it’s the title company who usually is set up to record the documents, something they will charge for. Until the transaction is recorded, the lender can pull the funds back. It’s not the escrow officer’s fault (in most cases) if they do this. It’s because something about the borrower’s situation changed, and now the lender is unhappy. Only rarely is it caused by a bozo of an escrow officer who doesn’t understand what’s going on, and tells the funder something that causes the lender to get nervous. Remember, they are loaning a lot of money, and the list of reasons why lenders justifiably get nervous is fairly long, especially as a certain percentage of all mortgage applications are fraudulent.

Once the loan is funded and the transaction recorded, the escrow officer has some final stuff to do. Send out the checks to everyone who’s getting one, complete with an accounting of the money. Make certain all charges relating to the transaction are paid, for which they will usually keep a small “pad” for last minute expenses, so that the buyer and seller are likely to see a check a few days later after the escrow officer has made certain everything is paid to the penny. And so ends the transaction, and this article.

Caveat Emptor