Searchlight Crusade

This is definitely not a “Who you gonna call?”

I’ve done a couple articles in the recent past on the two ratios, debt to income and loan to value. Nonetheless, there exist a plethora of reasons why someone can be turned down for a loan even though they make it on the ratios.

The first of these is time in line of work. A paper looks for two years in the exact same line of work. One change that trips a lot of people is going from being employed by a company to being self employed in the same line of work. Believe it or not, a promotion can also sink a loan if your job title changed, for instance from salesperson to sales manager. If it was with the same company, it can sometimes be okay, but if you changed companies to get the promotion, that’s a really tough loan. Subprime loans will accept shorter time periods.

Making payments on time is probably the biggest deal buster for A paper. In general, you are allowed no more than one mortgage late, or no more than two other lates. The reason does not matter. It does not matter how justified you were in not paying. The fact remains that you are reported as being late. The only way to remove them is for the company to admit it was in error in reporting you late. Many people will not pay the charge as it gets marked later and later and later. This is self defeating. Pay it now, dispute it afterwards. Yes, it’s harder to get your money back – but the money it saves you on your home loan is typically much larger.

Store credit cards are one of the biggest headaches here. If you buy merchandise with a generic credit card, you’ve got the card company, who are neutral, looking at the transaction. Both you and the merchant are their customers, and the merchant needs to take credit cards. They’re not going to quit taking them. If you use your store credit card, the dispute department is going to take the view that you bought that merchandise at their store and therefore you owe the money. I run across five or six store card problems for every generic card problem I encounter.

Bankruptcy is another deal buster. People in Chapter 13, or just out of Chapter 7. Most banks won’t touch them. It’s not really rational, but you there you are.

Reserves can be a deal buster, particularly for stated income loans. A paper stated income requires six months PITI reserves somewhere that you can get to it. Subprime is less demanding, but if you don’t have the lender’s requirements, you won’t get the loan. Would you loan money to someone with absolutely no cash in the bank? Payment shock, where your monthly cost of housing is increasing, can increase the reserve requirements.

Related Party Transfers are another questionable point. All of the background for loans assumes that the transaction is between unrelated parties, who have no reason to cooperate in order to do the lender dirt. If you’re buying the house from your brother, that assumption goes out the window. Some lenders will do them with caveats, others won’t touch them at all. Some will but charge extra. Others will but have special requirements. Whatever they are, you have to meet them.

The appraisal coming in low is another. The lender evaluates the property on a “lower of cost or market” basis. The Appraisal is the “market” part of that, and the lender will only loan money based upon the lower of these two methods of evaluation. I have people tell me all the time that their new purchase is worth $20,000 more than the appraised value (or the purchase price). No it isn’t. By definition – it’s worth what a willing buyer and a willing seller agree upon. The bank’s evaluations are necessarily conservative, and they don’t want to take over the property. They’re not in that business. They want you to pay back the loan.

Late payments. Whatever you do, while the loan is in progress, keep making all your payments on time. Whether just indirectly due to the credit score dropping, or directly because now you’ve got a(nother) thirty day mortgage late, this can raise your rate or even break the loan.

Sourcing and seasoning of funds to close. Just because you’ve got $100,000 in the bank doesn’t mean the bank is happy. Nobody rational keeps that kind of money outside of investment accounts. At least nobody rational who needs a loan – Bill Gates might. Lots of folks hide loans that way. The bank is going to what to see that you’ve had it a while (seasoning) or prove where you got it from (sourcing). If you really just got $400,000 from the sale of a previous property, you’re going to have the escrow papers and HUD 1.

Final credit check: I have a set spiel I go through, “Until this loan is funded and recorded, don’t breathe different without getting my okay. Make the payments you’ve been making. Make them on time. Don’t take out any new credit. Don’t allow anyone (other than mortgage providers!) to run your credit. Just before the loan gets recorded, the lender will pull a final credit report. Woe be unto the person whose situation has deteriorated, and it means we’ll have to start all over again, if there even is a loan that makes sense.”

Failures of verification. Three biggies here: employment, rent or mortgage, and deposit. I do not know why people bother lying, but they do. Don’t you be one of them. World of hurt if the lender wants to prove a point.

Lines of credit/credit history/no credit score: Most lenders want to see at least 3 lines of credit with a 24 month history of making payments on time. Freezing your credit cards is a wonderful idea, but you need to use them to demonstrate a payment history. Once per month, I use mine for something small and stupid that I would otherwise pay cash for – just to show payment history (it also helps your credit score). Pay if off as soon as the bill gets there. Waivers for two lines of credit are fairly easy, but if a given bureau doesn’t know you have two open lines of credit, they may not score your credit profile. If you don’t have at least two credit scores among the big three – no loan.

Property is structurally unsound, is not certified for habitation, unsuitable or not zoned for intended use, etcetera. Wouldn’t you really find out about this before you have a very large debt to pay? Okay, this can cost you money, but it’s a “Thank (deity) I found out now!” moment.

So there you have them, most of the most common reasons why loans – and therefore real estate deals – fall through.

Caveat Emptor

“Should People in their sixties take out a mortgage?”

The short answer is “Not if you don’t have to.” Now if I suddenly vanish, the explanation will be that the loan industry put a contract out on me.

Success in loans, and sales in general, is often attributable to selling people stuff they don’t need. If you don’t sell something, you don’t eat. Getting people to call or stop by is expensive. The traditional idea of sales is that you have to make a sale at every opportunity, whether it really makes sense for the client or not.

The various tricks of selling a mortgage to retired folks is a case in point. “It’s a cushion,” “It’s there in case you need it,” and all sorts of other stuff to that effect. Combine this with the “If you wait until you need it, you won’t qualify!” and most folks who don’t know any better will cave in and apply.

This is exacerbated by the fact that most people seem to want to stay in the same home they raised their family in. This is very understandable, emotionally, and often the worst thing you can do financially.

Let’s consider the typical three or four bedroom house with a yard, and the retired couple. It becomes more and more difficult, physically, for them to do the required routine cleaning, and even more difficult to do the maintenance and repairs that any home needs from time to time. Sometimes the kids are close enough and willing to help, sometimes they aren’t. If their finances are tight in the first place, they get tighter and tighter over time.

Into this environment comes the guy with a Reverse Annuity Mortgage (RAM) to sell. This is a special kind of mortgage, with a special protection for the homeowner (here in California, and in many other states as well) that they cannot foreclose in your lifetime. You cannot be forced out. Well, what if you’re sixty-five and live to 100, as a far larger proportion of today’s 65 year olds will? That’s thirty-five years they are locking this money up for, and there is always the possibility that by the time they consider the cost of selling, etcetera, there will be no equity.

Lending is a risk based business, and that kind of lending carries its own risks. Who pays for the risk to the lender? You do. Especially as opposed to the typical loan where half have refinanced in two years and ninety-five percent in five, this is a long term loan they are being exposed to. Yes, the recipient could get cancer and die in a few years, but they could well survive that. The lender has no way of knowing what the interest rate environment for the money will be in a few years. So either the rate the clients get is variable, or the clients pay a higher rate to have a fixed interest rate.

Once you start taking money out of the RAM, it starts earning interest. Since in the most common forms you are typically not making payments, it accrues interest. If you are making payments, it makes your cash flow even tighter, and you need to take more money. In either case, your balance is increasing, faster and faster with time, until you hit the limit, at which point you can no longer get additional money. This often happens surprisingly quickly, as you have the power of compound interest working against you. This all but guarantees that the family will have to sell the home, often for less than they could have gotten had they the luxury of a longer sale time. Furthermore, if keeping the home in the family is something you would like, a Reverse Annuity Mortgage is almost certain to torpedo the hope.

Contrast this with the swap down option. Suppose instead that adult children buy a small place suited to the parents needs such as a condominium, and the parents live there, while they live in the parents home. This minimizes cleaning, upkeep, and maintenance that the parents need done.

If this won’t work, another option is selling the home and buying something smaller. Remember, a RAM will almost certainly cause the family to lose the home anyway. You get more mileage out of cashing in the equity by selling, and investing the equity, than you will from borrowing against the equity. Instead of working against you, compound interest is on your side. Most states have laws preserving property tax basis if that’s something that is advantageous.

Let’s say that with a $500,000 home, moving down to a $200,000 condo. Net of costs, you net at least $250,000 to invest, and let’s say you do so at 7 percent, well below a well invested portfolio. This gets you $17500 per year, or about $1460 per month, indefinitely, and you keep both the condo and the $250,000. Contrast this with taking the $1460 per month out of your equity. Even if you can find a RAM at the same 7 percent, the entire equity is gone out of your home in a little over fifteen years, and that’s without including initial loan charges.

Nobody can make you do this, and there are many reasons why you might not want to. But looking at it from a strictly financial viewpoint, it’s hard to find the justification for a Reverse Annuity Mortgage.

As a resource, here’s the AARP page on reverse mortgages.

Caveat Emptor

Supply and Demand.

Now that I’ve given the short answer, it’s time to explain the macro factors behind interest rate variations. But I’m going to keep referring to those first three words. It is a tradeoff between the supply of money and demand for it.

The most obvious thing influencing loan rates is inflation. This is a general environmental factor. If the inflation rate is higher, then other factors being equal, there will be fewer people willing to lend at a given rate, and more people willing to borrow. Who wouldn’t want to borrow money if the money you have to pay back is actually worth less than they money you borrowed? All loans are priced such that a given inflation is part of the background assumptions of making it. If inflation is 4 percent, someone lending money at seven is making an effective 3 percent. If inflation is ten percent, they are losing that selfsame three percent. Which scenario would you prefer to loan money in? Which scenario would you prefer to borrow money in?

On the other hand, when inflation is high, loan rates usually rise to compensate. When the prime rate is twenty-one percent, that means that a business borrower has to make a minimum of twenty-one percent on the money just to break even. That’s if they’re a prime customer. Making twenty one percent is tough. The reason you borrowed (“rented”) the money was because you have a use for it to make money. There’s a lot fewer opportunities that make enough over twenty-one percent to make them worthwhile, than there are opportunities making enough over seven. This is one reason why inflation is a Bad Thing.

What alternatives exist is a major factor on the supply side, as well. If you absolutely must invest your money in US Government securities, that’s where you’re going to invest, and since you’re increasing the supply of money to the treasury, the price is less. Supply and Demand. This is one of the many reasons why Congress’ handling of the trust fund is a national disgrace. If they were private trustees, they would be help liable for not investing it where the best returns are. If, however, you think that stocks are looking more attractive now, that means that the supply of money for loans will shrink by whatever dollars you move out, and the rates will rise. The effect for any one person is small, but there are a lot of people in the market. In aggregate, it’s many trillions of dollars. Supply and demand.

Savings rates means a lot, also. When there is a lot of new money coming available in the borrowers market that money is going to be cheaper to borrow, in the form of lower interest rates. This is partially why rates went down throughout 2002, and stayed down into 2003, and 2004. People who had been burned in stocks wanted nice “safe” mortgage bonds. When there is comparatively little new money coming into the market, the only source becomes old loans being paid off. Negative savings or negative investments in the bond market means that what money is coming off older loans is at least partially being used to fund the withdrawals. Competition for money gets fierce, and price – by which I mean interest rate – rises. Supply and Demand.

Competition for money is also a part of the demand side. When the government needs to borrow a lot, for instance, that increases the competition. Even on the scale of our capital markets, whether the government is breaking even or needs to borrow the odd $100 billion has a real and noticeable effect When they need to borrow $400 billion, you can bet it’ll raise the cost of money. The government doesn’t care, and the bureaucrats running the treasury have been told to get this money. They will do their jobs and get the money, whether it costs 4 percent, 14, or 24. Every time competition from the government drives up rates, a certain number of borrowers whose profit margin on the loan was likely to be marginal will drop out of the auction. But government spending rarely grows the tax base. It’s those corporations and small businesses investing in future opportunities that grow the tax base, and they are the ones dropping out of the auctions as money gets more expensive. This is why government deficits are a Bad Thing. Supply and Demand.

The desirability of the alternatives is another factor on the demand side, as well. There’s more than one way to make money for most. If it become prohibitively expensive to borrow (bonds), sell part ownership instead (stock). There is a point at which even the most die-hard sole proprietor needs the money, and just can’t afford it as opposed to selling some stock to new investors. This can dilute earnings, and cause you to lose control of the company (there were multiple reasons why the high inflation period of the seventies and eighties was followed by the era of the corporate raider, but that’s one part), but better to dilute your share of the pool by ten percent while increasing the size of the pool by fifteen. That is a net win, while borrowing the money at twenty-something percent is likely not.

Now, let us consider the money supply here in this country, and thence the state of likely interest rates. We have increased government borrowing. We have the social security trust putting decreasing amounts of money into the government. We have a national savings rate that’s negative (and it is the overall rate, not just working adults that we’re concerned with, here). More and more people are becoming comfortable with foreign investment. And mortgage bonds are looking jittery right now, with foreclosures up. Supply and Demand, remember?

Therefore, in my judgement, we are likely to see continued raises in the interest rate for some time. If you’re on a short term loan that is likely to adjust in the next couple of years, the time to refinance is now, unless you’re planning to sell before it adjusts. And if you had asked me a year ago if I’d ever be recommending thirty year fixed rate loans, I would have said, “Not likely”. I’m recommending them now. When it’s the same rate or higher to get a 5/1 ARM, there is no reason not to choose a thirty year fixed rate loan instead.

(If, on the other hand, you have a long term fixed rate loan, stay put. Once you’ve actually got the loan funded, they can’t just draw the money back unless you do something like fraud or default. Even if you go upside down on your loan for a while, if you’re already in a fixed rate loan, that’s okay. The market price of the home only matters at loan time and at sales time. If you don’t need a loan and you don’t plan on selling, why should you care? Note to the young: home prices will rise again.)

Caveat Emptor

A reader named Terri at Educating the Wheelers sent me an email giving me a heads up on the antics of the state of Illinois. here is the link. Here is the original article at blackprof. The link to the original source is broken, but here is the Illinois Department of Financial and Professional Regulation, here is the full text of HB4050, the new law, here is a synopsis, among other things, and here are enforcement regulations.

Critical sections:

Based on information submitted to the Department by the originator, requires the Department to make a determination as to whether credit counseling is recommended to the borrower. Requires the Department to notify each borrower for which it recommends counseling of all HUD-certified counseling agencies located within the State and direct the borrower to interview with a counselor associated with one of those agencies. Requires the borrower to select an agency from the notice and to interview with a counselor associated with that agency within 10 days after receipt of the notice. Prohibits the borrower from waiving the recommended credit counseling. Requires the title insurance company or closing agent to record simultaneously with the mortgage a certificate of its compliance with database reporting requirements and, if it fails to do so, provides that the mortgage is not recordable
and

Changes the definition of “pilot program area” to all areas designated by the Department of Financial and Professional Regulation because of high foreclosure rates due to predatory lending practices. Deletes a requirement that a broker or originator provide each borrower with a notice disclosing the names of at least 3 lenders and comparing the rates and terms of those lenders (emphasis mine). Provides that nothing in the predatory lending database provisions is intended to prevent a borrower from making his or her own decision as to whether to proceed with a transaction.

blackprof’s take:

Nevertheless, Tuesday was a key moment in African-American History. On Tuesday, in addition to Mrs. King’s passing and Justice Alito’s elevation, the State of Illinois enacted a law that requires all mortgage applications within nine Chicago zip codes to undergo a process of review by the state’s Department of Financial and Professional Regulation. The department’s review process determines whether mortgage applicants in these neighborhoods must undergo compulsory credit counseling. If they must, then the mortgage lender must pay the cost of the counseling.

Anyone familiar with Chicago geography and demography knows these nine zip codes. They are all neighborhoods on the South and Southwest side of Chicago. They are predominantly African-American neighborhoods. These neighborhoods are some of the most impoverished in the City of Chicago, and indeed, the nation. On Tuesday, they suddenly became much poorer.

Although the legislators responsible for the new law were motivated by good intentions, they failed to consider the inevitable consequences of their bill. They wanted to protect poor homeowners in certain neighborhoods from high interest rates and predatory lending practices. The new law, however, necessarily increases the costs, time and uncertainty associated with mortgage applications in these black neighborhoods. The cost of credit counseling will be born by and charged to mortgage applicants. This, in turn, will necessarily decrease the price that new home-buyers can afford to pay for homes in these neighborhoods. If they can choose to buy in other neighborhoods, where housing money is more affordable, they, on the margin, will. Furthermore, recent studies of credit counseling programs suggest that these programs have little effect on borrower behavior. The end result is that homeowners in these poor black neighborhoods suddenly have less equity in their homes than they had on Monday.

Legislation like this is often motivated by an unspoken belief that poor black people are incapable of making important decisions for themselves. We see this belief reflected in the protection of failed public schools, and now with respect to personal finances. But the very people for whom such a law was enacted were responsible and wise enough to save to make the down payments necessary to buy these homes in the first place. Suddenly, these same people must have their choices reviewed and second-guessed by state bureaucrats who have no stake in the outcome, or accountability for incorrect or unresponsive decisions. It is hard to imagine the fate of a similar but broader law imposing credit counseling upon all Illinois residents, including white professionals residing in the Chicago suburbs of Evanston, Winnetka, or Kennilworth. Would there have been enough votes in Springfield to impose these “benefits” on everyone, rather than just the residents of the Southwest side of Chicago?

I’m just a nuts and bolts guy. I see some issues here:

First, by increasing the cost of doing business in the relevant zip codes, the law is increasing the lender’s cost of doing business. It is not plain how the lenders will pass this on to the consumers, but pass it on they will. This has the effect of making loans more expensive. I can see two methods: either requiring everyone on the state of Illinois to pay more, or requiring only those owners actually within the area to pay it. If they require only those within the area to pay, an excellent case can be made that higher loan costs makes for functional redlining, and the federal courts can intervene, and almost certainly will, possibly invalidating the law. If they require that everyone pay the extra costs, this functionally raises the cost of doing business everywhere in Illinois. This will also make it harder to qualify for loans in the requisite areas, as lenders will have incentive to throw roadblocks in the way of potential clients from those areas. Due to redlining regulations, I’m not certain how far that lenders will go, but it certainly won’t make loans easier to get or cheaper.

Second issue: no matter the intent, no matter who pays, this will cause loans to take longer and cost more, in addition to previously discussed costs of the program. For previous work as to why, see my essay on Mortgage Loan Rate Locks. The point, however, is that the State of Illinois is going to take some unknown period of time to consider the case. Then the client is potentially going to have to go to a credit counselor, who is going to have to get paid before providing the necessary legal blessing to the transaction. Furthermore, if the credit counselor wants more work at the expense of delaying the transaction, they can apparently make it happen by my reading of the law. All rate locks are for a specified period of time. Given this, there are three alternatives. One, float the rate (don’t lock) and hope that rates don’t rise. Second, lock for a longer period, which costs more. Third, pay an extension. Since the outcome when you don’t lock for long enough or don’t pay extensions is pretty much universally “worst case pricing” (i.e. the worse of rates when you locked or current rates), this means significantly higher loan costs, loan rate, or (most likely) both.

Third, as I said before, since this is going to motivate lenders to not want to do business there, and makes it harder to get loans in the effected areas, and quite likely increase the rates and costs of loans in the area as a consequence. This directly restricts how much of a house, price-wise, people in the area can qualify for, which in turn will have the net effect of decreasing sales prices in the area, further hurting current residents.

There are probably further detrimental aspects to new requirements, but the Illinois legislature deleted an existing requirement that, while apparently weak and subject to abuse in that a prospective loan provider was free to provide a prospective client with information only on loans that are worse than the first proposal, at the very least gave the client some further information as to alternative loans.

In short, the actions of the Illinois Legislature in this instance could, according to my understanding, basically be taken from a manual on “How To Hurt Poor People Even More”.

Caveat Emptor (and Caveat Voter).