Searchlight Crusade

I got a search hit for that and, amazingly enough after 150+ articles, I’ve never dealt with this subject head on. So here goes.

One point, either discount or origination, is one percent of the final loan amount. After all of the loan amounts and fees and what have you are added, for a loan with one point, multiply the amount by 100 and divide by 99, and that will be your final loan amount. For a loan with two points, multiply by 100 and divide by 98. The general formula is multiply by 100 and divide by (100-n) where n is the total number of points.

Points come in two basic sorts, discount and origination. Origination is a fee your loan provider charges for getting the loan done. Some brokers quote in dollars, most quote in points because it sounds cheaper than an explicit dollar cost. Most brokers out there charge one point of origination. To contrast this, direct lenders do not have to disclose how much they are going to make on the secondary loan market. And many direct lenders still charge origination. Judging the loan by how much the provider makes (or tells you they make) is a good way to end up with a bad loan. My point is that it’s the rate, type of loan, and net cost to you that are important, not how much the guy is getting paid for doing your loan. Remember two things here, and they will save you. First, loans are always done by a tradeoff between rate and cost. For the same type of loan, the more points you pay the lower your rate will be, and vice versa. Second, remember to ask about “What would it be without a prepayment penalty?” It’s a good way to catch people who are trying to slide one over on you, and the lenders pay a lot more for loans with a penalty, and the lenders make a lot more on them when they sell them to Wall Street, so they often do them on what looks like a much thinner margin until you ask the question “What would it be without the prepayment penalty?” Remember it.

Discount points are an explicit charge in order to offer you a lower rate than you would otherwise have gotten. To use an example I ran across the day I originally wrote this this, six point five percent with one point, seven percent without. On a four hundred housand dollar loan, that’s essentially four thousand dollars, either out of your pocket where you’re not earning money on it, or added to your mortgage balance where you are making payments and paying interest.

Is it a good idea to pay discount points, or is it a better idea to pay the higher rate? That depends upon the loan type and how long you keep it. Let’s say the loan is $396,000 without the point, $400,000 with, just to keep the math easy. Your monthly interest charge on the first loan is $2310, on the second it’s $2166. On the other hand, you pay $361 principal on loan 2, only $324 on loan 1. Here’s the bottom line, though: You’ve got to get that $4000 back before you sell or refinance. Just a straight line computation, that second loan saves you $181 the first month. $4000/$181 per month is about 22 months to break even (and it’s a little faster than that, because loan 2 pays off more principal per month). On the other hand, even after you’ve theoretically “broken even” there is a period where if you sell or refinance, you will inexorably lose money because you’re paying interest on a balance that’s higher than it would have been.

But now let’s run the actual numbers. If the above loan is a thirty year fixed and you keep it four years, you’re well ahead. You’ve saved yourself $6944 in interest and your balance is only $2159 higher. $6944 – $2159 = $4785. Even if your next loan is at ten percent, you’re only losing $215.90 per year. Especially when you consider that at a cost of money now versus later, you’ll never make it up, because you can invest that $4785 you saved and it’ll pay more interest than that.

On the other hand, let’s say the rate was only fixed for two years. After that, it is a universal feature of hybrid ARMs that they all adjust to the same rate. You are theoretically ahead by $363, but because of your higher balance, even if the loan adjusts to five percent, you’re losing $154 per year due to your higher balance, and there is nothing you can do about it. Play now, pay later.

There is no cut and dried answer about whether it’s to your benefit to pay points. I tend not to do it, myself, because rates do vary a lot with time, and money you addsticks around in your balance. If I’ve got a zero or low cost loan and the rates drop half a percent, it’s worthwhile to refinance for free. If I have a loan I paid a point for, I’m going to have to pay that same point again to see a benefit on refinancing, and as we’ve already discussed, if you don’t keep the loan long enough, you’ve wasted your money. The median time between refinances is right about two years right now. I see no reason to pretend I’m any different from everyone else, but some folks do have a history of keeping loans a long time. You need to make your own choice to fit your own situation.

Caveat Emptor

Right now lender X is offering me a loan that looks something like this:

80/20 No down payment
On the /80: 6.5% FIXED interest for 30 years, interest-only payment option for 15 years
On the /20: 8.75% FIXED interest for 25 years (amortized to 30) 6-month lock for 1-point ($3800) refundable fee with float-down option

My response:

Devil is in the details.

Is there a pre-payment penalty?

They want 1 point to lock for 6 months? Cash, I presume? Quite frankly, the usual cost for locking in six months out is about three points. Nor is X usually that cheap on the lock (they have some excellent rates, but what they’re quoting you is a market current quote for a 30 day lock. Long term rates are expected to rise, and long lock periods aren’t free. There’s something they are not telling you.)

What are the discount/origination on the underlying loan? How much are they going to charge in closing costs to get it done?

Will they guarantee their quoted costs (as in they eat the difference if there is one, not you)? You might want to ask them all of the questions here

A developer’s condo sell out is not the most difficult loan, but it’s a long way from the easiest, as well. There are a lot of lenders that will not do them. Furthermore, what’s being presented to you looks much cheaper than is likely to be true. If you insist on going with it, call me thirty days before the place will be done, and I’ll do a back up loan, because I don’t think what they’re offering you is real.

(Note: due to changes in the market, nobody can do backup loans any more, but that was a real offer at the time)

he did get back to me as to what lender X’s response was:

Is there any pre-payment penalty on this loan? NO…..

What is the total refundable cost for the 6-month lock? YOU PAY 1% UP FRONT AND IT IS REFUNDABLE IF YOU CLOSE WITHIN 6 MONTHS (emphasis mine)

How much will the closing costs be to get this loan done? I DON’T KNOW WHAT YOUR ESCROW AND TITLE COSTS WILL BE. YOUR LENDERS COSTS WILL BE APPROXIMATELY $1,200. (emphasis mine)

Is the rate being quoted based upon full documentation, stated income, NINA or EZ Doc? 100% FINANCING IS FULL DOC….

Do I have to pay any discount points, points of origination, or any other points to get the quoted rates? NO POINTS NOR ORIGINATION FEE (ONLY THE 1% LOCK IN FEE OF WHICH WE SPOKE) (I prefer no points)

Regarding third party costs, can you tell me, or will the papers you send me make clear, the following third party costs:
– Appraisal fee: THIS SHOULD BE AROUND $400 BUT IS PART OF THE $1,200 I QUOTED.

– Total title charges: ??????????

– Escrow fee: ???????????

The builder has already assigned an escrow and title company for the property — may I use this company with the (lender X) loan? YES!

How much, total, will I be expected to pay X upfront, out of my pocket, to get this loan? THE $400 FOR THE APPRAISAL AND THE 1% TO LOCK IN….

How much, total, if any, will be added to my mortgage balance on top of what is quoted? ????????????????? NOTHING IS ADDED TO YOUR MORTGAGE.

If I agree to this loan after reviewing the papers, are the rate and closing costs guaranteed, and will X cover the difference (if any) between the quote and the actual final cost? WE’VE BEEN IN BUSINESS SINCE X. WE CONTINUE TO STAND BY OUR COMMITMENTS. (emphasis mine)

Now for the emphasis points, last first

-This question of is the rate guaranteed requires a simple yes/no response. This evasive reply tells you the answer is no, but that they don’t want to admit it. If this answer is not yes, none of the other stuff is written in anything more permanent than beach sand somewhere below the high tide line. It’s funny they mention commitments. Neither a Good Faith Estimate nor a Mortgage Loan Disclosure Statement (the California equivalent) is a loan commitment, or any kind of commitment at all. Regulations leave so much room for the unethical to maneuver without running afoul of the law that either one of those forms is nothing more than the loan officer or company wants it to be. A few are right on, and those companies will typically guarantee their quote. More are somewhere in the ballpark, amazingly enough usually noticeably on the low side. And quite a large fraction are nothing more than an exercise in creative writing. He didn’t guarantee his quote. Tell me this: Two companies are bidding on doing building work for you. Both are large firms. The first company asks you all sorts of questions about specifications, and guarantees they’ll get it done for $5000, and if there’s a problem on their end, they will fix it for no additional money. The second says they think they can do it for $4500. Which would you feel more comfortable with? If you know anything about building contractors, the latter is a joke compared to the former. Lenders and estimates on the initial paperwork to get you to sign up are, if anything, worse.

-I do business with this lender. Their costs are $1295 not including the appraisal to brokers, who perform some of the services they charge their clients for performing. By the time you’ve added escrow and title, you’re roughly at the $3400 mark.

-It’s easy to talk a good game to most folks who aren’t experienced with how the game is played. The point of this particular game is trying to lock you in with that 1 percent cash upfront payment, so that when clients discover that he’s not going to be able to deliver what he’s talking about, they’ll be thinking about recovering/losing that money, rather than focusing your attention on getting the best loan. This is called creating a distraction, and is in accordance with the tell you anything to get you to sign up school of thought.

When it comes time to close, he’d be licking his chops due to the fact that the client paid $3500 (or whatever one point comes to) cash upfront, and when he delivered something different, the client believes they have no choice but to agree in order to save their money. I’ve offered people in that situation a loan that was more than 1 point better, and they still went with the guy who had rooked them out of the 1% upfront, because they’re worried about that cash when they should be worried about the rate/cost tradeoff.

He also went to the builder’s lender

If I’m interested in getting my monthly payments down lower and I consider getting a 5/1 ARM loan to do so, is that a completely horrible idea, or could I refinance into another 5/1 ARM after the first five years to continue getting a pretty good rate, if for example the 30-year fixed rates
have gone up a bunch in 5 years?

That’s precisely what I’ve been doing for the past fifteen years. On the other hand, with the difference in rate/cost tradeoff being so narrow right now between a thirty fixed and a 5/1 (roughly a quarter of a percent interest rate wise), there’s a strong argument to be made for the loan you never have to wonder about. Where I thought I would never have a thirty year fixed rate mortgage, I’d consider it if I were going to buy or refi right now. Don’t know if I’d do it, but I’d think about it.

80/20 No-down 5/1 ARM
No pre-payment penalty
Total loan amount: $379,900

80%, $303,000: 5.25% fixed & interest-only for 5 years, payment: $1329.65
20%, $78,000: 9.5% fixed for 5 years, interest-only for 15 years, payment: $601.50

Total monthly payment: $1931.15

Aside from the fact that the putative loans total $381,000, which is likely picking nits, I don’t believe that loan exists, as 5/1 ARMS are running up around 6.25% at “par” right now. I couldn’t find a lender that is even offering 5.25, no matter how many points you paid, and that’s wholesale. He attached some GFEs which show $4180 in points charges (plus $875 in pure junk fees and about $150 in well padded costs on the first loan and shorted the likely interest, in addition to all the real stuff), adds $5000 that he’s evidently already paid to the closing costs, requires another $3200 plus at closing, and still comes up with final first loan of $303,920.

On the second, the loan required another $1140 in fees but a loan amount of only $75980, thereby balancing the 80/20 requirement correctly, at least, thereby negating the nitpick in the previous paragraph.

(I’d also shoot his agent for not negotiating any givebacks, given the current market, except I’m prepared to bet he didn’t have one. I’ve covered some of these issues, precisely as they relate to this particular situation, at the end of this article), of which which I’ll reproduce the relevant section here

Unfortunately, you’ve already (probably) put a deposit down and you said in subsequent email that the home has appreciated while it was being built, so the developer has incentive to throw roadblocks in your path. Your transaction falls through and not only do they get to keep your deposit but they can turn around and sell the home for more. Preventing this kind of nonsense is what buyer’s agents are for (it also gives you someone easy to sue if something goes wrong!). Unfortunately, most developers will not cooperate by paying a commission to buyer’s agents for precisely this reason, which means that the average buyer will decline to pay an agent out of their own pocket and try to do the transaction on their own, which leads to situations like this.

Now the market is falling, but it looks like to me the guy paid full asking price (since he’s local to me, I can look), and the market is incredibly squishy on prices.

Now getting back to the loans, this is how lenders Play The Game of getting you to sign up. They are looking for you to build what salesfolk call commitment to a loan before they tell you the whole truth – usually by springing it on you at closing. They make it look better than it is for a while. They can do this because the only form that has to have correct accounting is the HUD 1, which comes at the very end of the process (It’s usually prepared by the escrow officer. You should get a provisional when you sign loan documents and a final within 30 days of the end of the transaction). In the case of a purchase, this is usually at the last possible instant, which means that if you haven’t prepared a back-up loan there is no time to get one before the deal goes south, which means your choices are limited to sign or lose the property, the deposit, and all that time and aggravation. This is providing that you even notice. Industry statistics say that somewhere around half the folks won’t, and even on refinancing, where people can almost always just keep the loan they have without bad consequences, eighty-five percent or so of those who do notice will cave in and sign.

Caveat Emptor

Not interested? Most people aren’t when it’s talking about how they got taken advantage of in the past. First off, it’s in the past so it is over and done with, and there’s no use dwelling on it, right? Second, there’s the ego thing. Nobody who’s been bragging about what a great deal they got likes to find out they’ve been had. Taken for a ride. Conned. Big time.

Anyone reading this who isn’t interested in improving what happens next time can tune out now, because that’s what the rest of this article is about: educating you in how to shop for a loan and what the tricks are, and if you’ve never had a real estate loan but want one someday, chances are you’ll benefit from reading it to. If you’re the sort of person who isn’t interested in improving your future loan, chances are you’re not a regular reader because helping folks understand their financial options for next time is the most consistent thing I do here.

On a very regular basis people tell me how they got taken advantage of by a loan provider. Actually, a lot of them think they’re bragging about what a great deal they think they got, when in their situation, I wouldn’t take that loan if the bank paid me. High points charges that stick around in the balance essentially forever. Points on hybrid ARM loans (3/1, 5/1 and 2/28 are the most common). Prepayment penalties, especially needless prepayment penalties, or prepayment penalties that last longer than the period of fixed interest rate. Fixed rate loans where hybrid ARMS are more appropriate. Long terms where a shorter term would be more in your best interest. Most loan officers are looking for an easy sale, and no loan officer ever complains that a sale was too easy to make. Failing an easy sale, they’ll look for any sale. If they don’t get you signed up for any loan, they don’t make any money. They are not responsible for your best interest, they are responsible for making money and not stepping over legal limits which are very different (in the sense of being less restrictive to loan officers) than most members of the public believe. If ever a loan officer tells you that in your circumstances, they wouldn’t refinance, make sure you get their contact information and put it someplace you will be able to find it when you go looking for your next loan.

First off, if your credit score is above about 660 and you have a prepayment penalty, chances are excellent that you were taken for a ride. People with credit scores above 660 should usually be A paper, not subprime. A paper does not need a prepayment penalty except when the loan officer wants to get paid more. A 2 year prepayment penalty is worth a good chunk of change on the secondary bond market – usually about 4% of the loan amount. This means that if you have the $270,000 loan I use as the default here, they made almost $10,000 over and above the normal price spread when they sold your loan. And even when they retain servicing rights, lenders sell loans over 95 percent of the time. At the very least, you should get some kind of benefit for accepting a prepayment penalty A paper. A current “maximum conforming” loan of $417,000 would be worth almost $17,000 more to the lender with a prepayment penalty than without. This, all by itself, is often a reason they stick folks in subprime situations. If you think you’re A paper, make them show you the turn-down from the automated loan underwriting program before you even consider a subprime loan.

If your credit score is below 620, you’re almost certainly stuck with a loan where you have a prepayment penalty by default. Buying it off is usually a good idea, but buying them off isn’t free. Between 620 and 659, there’s some wiggle room as to whether you will get an A paper loan.

But most people never undertake the three most important steps they can to get a better loan. They don’t shop multiple lenders. They don’t ask for a guaranteed quote. And they certainly don’t sign up for a back up loan.

I’ve been looking for a new place to hang my license, and the one thing (other than looking for loan officers who don’t understand the way the business works) that most of the firms have in common is that they don’t want to compete on price. They know they may have to the first time, but they want the client that just automatically comes back to them that they can soak for two or three points on every loan, in addition to whatever they earn for the prepayment penalty. I understand this yearning very well; it’s a normal human desire to want to make more for the same amount of work, and also to lock up the customer for the future. If all you think about is how easy the loan is to get, you are these firms’ favorite type of client. Guess what? You may not see their extra $10,000 or $15,000 as a separate charge on any of your paperwork, but it is there and you are paying it, and someone who knows what they are looking for can find it. Most folks would never dream of paying $50 for the same toaster that everyone else is buying for $13.99 at Target, but the way loans are priced is confusing at first sight, and people don’t want to sort it out. It’s pretty easy, actually. Figure out what kind of loan you want and qualify for, then price the rate/cost trade-offs of that loan type amongst the various loan providers. Figure break-evens on the extra cost of the lower rate. One rule I have never encountered an exception to is that if a loan provider pushes a low payment to sell a loan, they are a crook. If they sell by interest rate, they may be worth talking to, providing the loan type is what you’re looking for. If they sell by the Tradeoff between rate and cost, they’re definitely worth talking to. And if someone suggests a different type, hear them out but make certain they tell you all of the details. There is always a reason why one loan is significantly cheaper than another loan

Another very common tactic used to induce your business is advertising. Remember the loan ads that went “Lost another one to (mega corporation which shall remain nameless)”? That particular mega corporation is not competitive rate-wise or underwriting wise with others. Joe ShadyBroker who earns six points on every loan can often deliver better rates than they can. What they were trying to via their advertising is create the illusion of low prices by telling you they have low prices. Then, when you call and they quote the superficially low payment due to a rate where you have to pay three points to get it, they’ve got the average potential client suckered. Because their payment on a 2/28 loan with a 3 year prepayment penalty where you have to pay three points to get the rate is lower than mine on a thirty year fixed with zero points, people will sign up. Why? Because it looks more attractive to them at first glance. Get the calculator and the checklist of questions and ask the questions and do the math. Nobody can take advantage of you without your consent, but those who allow themselves to be intimidated by numbers are giving their consent. Actually, with most places, it’s like begging, “Oh, please, I want to pay thousands of dollars more to get a higher interest rate!”

If someone doesn’t ask questions like “how long are you planning to keep it?” or “how long do you usually keep real estate loans?”, especially if they just launch right in to a spiel based upon a low payment, they are a cash-sucking Vampire. They may be an intelligent vampire doing what they are doing in full cognizance of what it does to you, or they may be an innocent vampire who doesn’t really understand the business and who is being controlled by a green-blooded master cash-sucking vampire, but in either case you don’t want to do business with them. Yes, these are sales questions. Yes, they get you talking to a salesperson, who then has a possible opening to talk you into something that may not be in your best interest. If they don’t ask the questions, I guarantee that they’re trying to push you into something that isn’t in your best interest. Which is better: Not talking to a salesperson and being certain of being messed with, or talking to a salesperson and possibly being messed with? Note that there is no option that says “Don’t talk to a salesperson and not get messed with.” If their people don’t know enough to help you from their own knowledge, those salesfolk were probably intentionally hired because they didn’t know any better. It is not a crime to make money. They are looking to make money, I am looking to make money, everybody in every line of business is looking to make money, including your employer – that’s how they pay you. If I were independently wealthy and never needed or wanted to make money again, I certainly wouldn’t be doing real estate loans, and neither would anyone else. You can take the attitude that you’re going to pay a reasonable amount, and while you can take steps to hold that amount down and make certain it doesn’t get outrageous, you know you’re going to pay what it costs, or you can take the attitude that a cheaper quote means you’ll actually get that rate at that cost when the overwhelming probability is that they’re lying to get you to sign up. You need to look gift horses in the mouth. If someone’s quoted fees are lower or higher than everyone else’s, there is a reason. If they’re too low, it’s probably because they’re pretending that a large percentage of what you are going to pay doesn’t exist, because that gets people to sign up. Ask them if they will guarantee their total fees and the rate in writing. If the answer is no, they are lying. Actually, most of the liars won’t tell you “no” in response to that question. They’ll tell you some line about how they’re a major corporation or how they honor their commitments or any of several other lines that mean absolutely nothing. The MLDS and Good Faith Estimate are not commitments. Major corporations pull the same games as everyone else. In fact, they usually get away with playing even worse ones than Joe ShadyBroker because of their “name recognition”.

So shop around. Ask every single prospective loan provider every single question in this article. Pull out the calculator to see if it’s believable, to see if the numbers work. Ask them if they’ll guarantee the quote, subject to underwriting. And then go out and apply for a back-up loan as well, because even if you’ve got a guarantee, it’s difficult to enforce, and impossible within the time frames most folks need the loan to be done.

The typical savings of being a savvy consumer is literally thousands of dollars every time you get a real estate loan. You may not see the savings directly on the HUD-1 at closing, but they will be present nonetheless. If you don’t accept a prepayment penalty, that’s thousands of dollars you’ve saved yourself down the line when you’ve been transferred and need to sell. If you get a rate that’s a quarter of a percent lower on a $270,000 loan, that’s $675 interest you are saving per year. That’s a couple of car payments; perhaps enough to let you buy for cash next time you need a car. If you invest the difference over the potential lifetime of your mortgage, a difference of over $127,000! If you save yourself the two extra points of origination that they were going to charge you, that’s over $5500 that either is in your pocket, and that you can invest or spend on other things, or $5500 that isn’t in your mortgage balance, where you’re going to pay hundreds of dollars in interest on it per year ($357.50 per year at 6.5% interest), in addition to owing the base sum.

My point is this, folks. If I were a financial advisor trying to score an extra quarter percent commission off of you, most of you would be upset. Many people are so upset by 0.25% 12b1 fees in mutual funds that they won’t pay the advisor who would save them a lot more money than the 0.25% per year simply by simply reminding them of sound investment principles. If I were a car salesperson trying to pad the cost of the car you were interested in by $5500, a large percentage of the population would most likely slug me. But because real estate transactions are complex and people don’t want to take the time to understand them, they unwittingly walk into situations like this, and many people do so repeatedly throughout their lives, making the same mistakes every two years. The dollar amounts are large enough that even small differences are thousands of dollars. If you’re not going to guard your pocketbook, most loan providers will pick it.

Now the workman is worthy of his or her hire. The person who gets you the loan is entitled to be paid. Judge the loans on the bottom line to you; how much it costs and what you will get. The proof that they got you a better deal was that they delivered a better loan, not that they made less money. And if the person who does your loan can make an extra half-point while actually delivering you a loan that is the same rate on the same loan at less cost than the other provider, haven’t they earned that money? You came out ahead because of their work – had you gone with any other loan, you would have paid more or had a higher rate. They made more. Definition of win-win. There is a loser here, by the way, but you’ll never know who it was. It is the lender that the broker you didn’t sign up with would have put you with. But by finding you a program you fit better, the loan officer you did sign up with got you a better deal and made more money. It happens every day, if you make the effort to look for it, and go about it in the right fashion.

Caveat Emptor

Every so often I run across a reference to a “rate buydown” I don’t like to use them because they don’t benefit the client, but I should explain them, what they are, and how they work.

A rate buydown is where for an upfront price, the lender agrees to give you a lowered interest rate for a time. 2/1/0 buydowns, where the rate is two percent lower the first year, one percent lower the second year, and then at the loan rate the third year, are the most common, but I’ve seen one year buydowns of two percent, two year buydowns of one percent for those first two years period, and any number of other tricks.

Now, this isn’t free. A 2/1/0 buydown usually costs three points. In fact, what usually happens is the three points go into an escrow account somewhere where they pay out the money to make up the difference in interest to the lenders as the loan goes along. When the buydown period is over, the lender who originally funded your loan then gets to keep what’s left over.

Now, here’s what this means to you. Let’s make this easy. Say you would have had a $291,000 loan, fixed at 7 percent, without a buydown. But with the buydown, you have a $300,000 loan at 5 percent the first year, six percent the second, and 7 percent from there on out. In order to really understand this, let’s first take a look at your loan without a buydown:

Month 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24

Balance $291,000.00 $290,761.47 $290,521.55 $290,280.23 $290,037.50 $289,793.35 $289,547.78 $289,300.78 $289,052.34 $288,802.45 $288,551.10 $288,298.28 $288,043.99 $287,788.22 $287,530.95 $287,272.19 $287,011.91 $286,750.12 $286,486.80 $286,221.94 $285,955.54 $285,687.58 $285,418.06 $285,146.97

Payment $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03 $1,936.03

Interest $1,697.50 $1,696.11 $1,694.71 $1,693.30 $1,691.89 $1,690.46 $1,689.03 $1,687.59 $1,686.14 $1,684.68 $1,683.21 $1,681.74 $1,680.26 $1,678.76 $1,677.26 $1,675.75 $1,674.24 $1,672.71 $1,671.17 $1,669.63 $1,668.07 $1,666.51 $1,664.94 $1,663.36

Principal $238.53 $239.92 $241.32 $242.73 $244.14 $245.57 $247.00 $248.44 $249.89 $251.35 $252.82 $254.29 $255.77 $257.27 $258.77 $260.28 $261.79 $263.32 $264.86 $266.40 $267.96 $269.52 $271.09 $272.67

Tot Int. $1,697.50 $3,393.61 $5,088.32 $6,781.62 $8,473.50 $10,163.97 $11,852.99 $13,540.58 $15,226.72 $16,911.40 $18,594.62 $20,276.36 $21,956.61 $23,635.38 $25,312.64 $26,988.40 $28,662.63 $30,335.34 $32,006.51 $33,676.14 $35,344.22 $37,010.73 $38,675.67 $40,339.02

Tot Prin $238.53 $478.45 $719.77 $962.50 $1,206.65 $1,452.22 $1,699.22 $1,947.66 $2,197.55 $2,448.90 $2,701.72 $2,956.01 $3,211.78 $3,469.05 $3,727.81 $3,988.09 $4,249.88 $4,513.20 $4,778.06 $5,044.46 $5,312.42 $5,581.94 $5,853.03 $6,125.70

Now let’s look at it with the buydown:

Month 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24

Balance $300,000.00 $299,639.54 $299,277.57 $298,914.09 $298,549.10 $298,182.59 $297,814.56 $297,444.99 $297,073.87 $296,701.22 $296,327.01 $295,951.24 $295,573.90 $295,257.63 $294,939.77 $294,620.32 $294,299.27 $293,976.62 $293,652.36 $293,326.47 $292,998.96 $292,669.81 $292,339.01 $292,006.55

Payment $1,610.46 $1,610.46 $1,610.46 $1,610.46 $1,610.46 $1,610.46 $1,610.46 $1,610.46 $1,610.46 $1,610.46 $1,610.46 $1,610.46 $1,794.15 $1,794.15 $1,794.15 $1,794.15 $1,794.15 $1,794.15 $1,794.15 $1,794.15 $1,794.15 $1,794.15 $1,794.15 $1,794.15

Interest $1,250.00 $1,248.50 $1,246.99 $1,245.48 $1,243.95 $1,242.43 $1,240.89 $1,239.35 $1,237.81 $1,236.26 $1,234.70 $1,233.13 $1,477.87 $1,476.29 $1,474.70 $1,473.10 $1,471.50 $1,469.88 $1,468.26 $1,466.63 $1,464.99 $1,463.35 $1,461.70 $1,460.03

Principal $360.46 $361.97 $363.48 $364.99 $366.51 $368.04 $369.57 $371.11 $372.66 $374.21 $375.77 $377.33 $316.28 $317.86 $319.45 $321.05 $322.65 $324.26 $325.89 $327.51 $329.15 $330.80 $332.45 $334.11

Tot Int. $1,250.00 $2,498.50 $3,745.49 $4,990.96 $6,234.92 $7,477.35 $8,718.24 $9,957.59 $11,195.40 $12,431.66 $13,666.35 $14,899.48 $16,377.35 $17,853.64 $19,328.34 $20,801.44 $22,272.94 $23,742.82 $25,211.08 $26,677.71 $28,142.71 $29,606.06 $31,067.75 $32,527.79

Tot Prin $360.46 $722.43 $1,085.91 $1,450.90 $1,817.41 $2,185.44 $2,555.01 $2,926.13 $3,298.78 $3,672.99 $4,048.76 $4,426.10 $4,742.37 $5,060.23 $5,379.68 $5,700.73 $6,023.38 $6,347.64 $6,673.53 $7,001.04 $7,330.19 $7,660.99 $7,993.45 $8,327.56

It is also to be noted that in the very next month, your payments go to $1982.23, as opposed to the $1936.03 they would have been in the first place, and that they will stay there the rest of the loan, all 336 months should you keep it the rest of that time. Why? Because your balance is larger than it otherwise would have been, so the payment is higher, in this case by $46.20, due to the higher loan amount.

Finally, let’s look at the differences:

Month 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24

Escrow Acct. $8,552.50 $8,176.27 $7,796.79 $7,414.04 $7,028.00 $6,638.63 $6,245.92 $5,849.83 $5,450.34 $5,047.43 $4,641.06 $4,231.22 $3,817.87 $3,647.29 $3,475.21 $3,301.60 $3,126.46 $2,949.78 $2,771.53 $2,591.72 $2,410.32 $2,227.32 $2,042.72 $1,856.50

Net cost $8,552.50 $7,982.95 $7,413.19 $6,843.21 $6,273.02 $5,702.62 $5,132.02 $4,561.21 $3,990.21 $3,419.02 $2,847.64 $2,276.08 $1,950.65 $1,687.67 $1,424.51 $1,161.18 $897.67 $633.98 $370.13 $106.11 -$158.09 -$422.44 -$686.97 -$951.65

What this means is that your lender’s escrow account ends up with $1850 that they get to keep, on top of everything else they made from the loan. The final column is the net cost to you, what you paid to get it less the interest it saved you. Hey, look at this! In month 21 it goes negative! You must be saving money if you keep it that long, right?

Nope. This is a temporary and illusory savings phenomenon, and I don’t know of any way to make it permanent. You see, the benefits stop in month 24. They are over. Kaput. Gone. That’s all, folks. But you owe $6798.14 more (at the start of month 25, not illustrated above) than you would have without the buydown. There are exactly three possibilities as to what happens. First, that you keep the loan. Due to the extra interest you’re paying every month, you are negative again in month 56, and it keeps getting worse the longer you keep the loan. After 120 months of the loan, you are $1755 down. This actually peaks in month 242 at $3351 negative, then starts decreasing, but you don’t get it back before the loan is paid off.

The second possibility is if you refinance the loan. Let’s say you get a really fantastic deal and refinance at 5 percent on a 30 year fixed rate loan, and I’ll even give you that your higher balance doesn’t cost you any more in fees. Your payment is $85.35 per month higher than it would otherwise have been, your interest charges $28.32 higher (and the difference represents you paying the principal off faster if you don’t pay for a buydown). Your savings is gone in less than three years, and there’s nothing you can do about it.

The third and final possibility is that you sell the house. You get $6798.14 less in your pocket. This means that you don’t have $6798.14 earning money for you in the stock market. At ten percent your benefit is gone in less than a year and a half. If you take the money and buy another property, that’s $6798.14 higher your loan balance will have to be. Let’s say you get that same fantastic 5% loan we talked about two paragraphs ago on the new property. Guess what? The same math applies here also. There is no way to win in the end with a buydown, unless someone else pays for it (for example, seller paid closing costs).

So they are a piece of garbage. Why are buydowns attractive, and why do otherwise rational people sign up for them?

Because they lower the payment for a while. People choose loans based upon the payment. In particular, they choose loans based upon the payment in the first check they are going to have to write. Most people figure that the check they are going to have to write two or five years out isn’t important. Unscrupulous lenders and loan officers know this. That’s why the (censored) negative amortization loans are so popular, despite them being time-delayed financial poison. So don’t shop for loans based upon the payment, and if someone starts talking about ways to cut the payment as opposed to the interest rate, put your hand on your wallet and leave. If they persist, drag them out into the sunlight and put a wooden stake through their heart. It’s the only way to be sure.

Before I go, I want to mention one specific group that gets targeted for these things, and that is veterans. The Veterans Administration loan, aka VA loan, has the ability to roll (not coincidentally) three points closing cost over and above the cost of the home into the loan. Most military folks are busy learning their trade, which is usually not something having to do with finance. Indeed, I’ve never heard of any MOS that included this type of financial training. So when the loan officer whispers sweet nothings into their ear about cutting the payments for the first couple of years, they don’t know any better and they sign right up. They could have used those three points for something potentially useful, like discount points that buy you a lower rate for the entire term of a VA loan. If you keep it long enough, they will eventually net you money and the VA only accepts fixed rate loans, not ARMS or hybrids. The veterans could just not pay those three points, and not start out with what is basically negative equity. But rate buydowns make a loan appear attractive on the surface to someone with insufficient financial training, while costing them money in the long term and allowing the initial lender to make more money than they otherwise would.

Caveat Emptor

Hi Dan wondering if you could help me out I’m getting a lot of different answers from a lot of people and I’m really searching for help I bought my house brand new (three years ago) for 550,000, and (the next year) I refinanced into a mta loan. which at that time was around 4.25% and now is 7.125%. I have a hard prepay of $12,000.00 which expires in (fifteen months) house just appraised for $775,00 balance on 1st loan 440,000 balance on 2nd 148,000. should I ride the next 15 months out to avoid pre pay or refinance now into a fixed. The rate on the second is prime plus zero.

First off, a disclaimer. A precise infallible answer depends upon the rates when your prepayment penalty expires, something that is not currently known. I think thirty year fixeds will be in the low sevens, but I might as well be sorting through animal entrails to get that answer. I also think that the five year hybrid ARMS will stay about where they are, or perhaps even decrease a tad once the fed announces that they are done with hikes. But I don’t know; nobody does. It also depends upon what comparable homes are selling for then, which determine your appraisal, and how long you keep the new loan.

Your rate moving like that is one of the reasons I recommend so strongly against negative amortization loans. The person who did your loan at the time had to know that, due to the nature of the mta yours is based upon, the rates were already set to rise into the mid fives for certain, and likely further, as older months were dropped from the average in favor of newer. Were it fully explained, would anyone rational agree to take a loan where you get a lower rate for six months, but then the rate rises inexorably, as the treasury rates the loan is based upon had already been rising, to a level that is well above what is available on A paper three or five year fixed? And with a three year prepayment penalty, so you’re in precisely this sort of situation?

“No points” thirty year fixed rate loans are sitting right around 6.75 right now, and you’re at 75% Loan to Value. The bad news is you’re definitely a jumbo loan, as the conforming limit is $417,000. This boosts your rate a tad, depending upon the lender, to 6.875 or 7.00 percent without points. I prefer to discuss loans without prepayment penalties or points, but it might be in your best interest to pay a little to buy the rate down if you refinance. I’m going to use seven, as it makes the math slightly easier.

The good news is your loan to value ratio. According to the numbers you gave me, you’re below 80 percent, even with the prepayment penalty. You owe $588,000 (If you bought for $550,000, the turkey did this negative amortization loan scammed you out of a lot of money), and the prepayment penalty boosts this to $600,000. Assuming you have enough liquid reserves to put up the money for interest and impounds, this means the costs of doing your loan are going to put you at about at $605,000 new balance (perhaps a bit below, but let’s keep the math as friendly as possible).

Basically, it cost you $17,000 to save yourself an eighth of a percent on the interest rate. Under more normal circumstances, I wouldn’t even put that one through the calculator. No way that’s in your best interest. But your real rate on that MTA is going to keep rising – by at least another quarter percent due to increases already on the books, more likely half. I’ll use 7.5 as your mean rate. Furthermore, the second is at 8 percent, likely to soon be 8.25. Monthly interest under the current loan at that rate: $2750 for the first, $987 for the second as it is. Monthly interest on the new loan, $3530. It saves you $200 per month in interest, albeit with a higher payment, $4025 as opposed to what you’ve got now. I am assuming you have documentation that you make enough money to justify the loan in the underwriter’s eyes, and that your credit score is about average. On the other hand, divide $17,000 by $200 per month, and you get 85 months to break even on the cost of doing it.

However, this decision does not take place in a vacuum. You can’t let that negative amortization loan go forever. In fifteen months, I think equivalent rates will be about 7.25, which translates to 7.5 percent for your loan. Furthermore, I believe prices will be a little lower then, so in order to refinance, you’re likely to have to split into two loans. Assume prices are 10 percent lower. Any of these prognostications is an educated market guess, no more, and I could be way off. The appraisal would come in just under $700,000, but let’s say $700,000. Your first, for $560,000, would be at 7.5%, and for your second, I’ll presume you get a new HELOC on the same terms, on which the balance would be about $33,000. Interest on first and second, at 7.5% and 8.25% respectively, comes to $3500 plus $227. The payment on the first would be $3915, plus $227 (assuming interest only HELOC) for a total of $4142. So $12,000 saved if you wait, versus about $200 per month less in interest charges per month if you dive in. Divide that out and it comes out to 60 months. Five years. If you keep the new loan five years, approximately, or more, you’ll be better off refinancing now. If you keep it less than five years, you’re better off waiting is what the calculations say. Plus chop off the $200 per month you save starting right now for the next fifteen months, and the answer turns into forty five months or a little less, being your time until break-even.

I’m a reasonable risk taker. Were I plopped down in your situation, I have to tell you I would probably hang tight until the prepayment penalty expires. Roll the dice and bet on my personal ability to come up with a good loan. On the other hand, you may not be as much of a risk-taker as I am. The stuff I quoted you for refinancing now is available now, no suppositions about it. The rates could well be higher in fifteen months than I have estimated, perhaps much higher, or they could be lower (although I don’t think so with increased federal borrowing). You need to decide what your level of comfort is. If you’re the sort that is averse to risk, refinancing now could pay for itself just in peace of mind, because you’re not worrying about it. That’s why I always offer a 30 year fixed rate loan, no matter how wide the interest rate spread is between that and my favorite hybrid ARM. There are folks who just won’t sleep nights. The difference comes out to about $7 per night, and my sleep is worth more than that, so I presume yours is, as well.

Caveat Emptor.