Buying off a Prepayment Penalty

Been reading some of your informative tips. I am looking at refinancing and getting a $378000 mortgage. Now in the case of having a 3 yr prepay penalty, vs paying 1.5% in points to make it a 1 yr prepay, am i right in assuming it’s wiser for me to pay the points than accept a three yr prepay when i know I will sell/move within 2 yrs? Any info you can provide would be great. I’m wondering if I’m missing something here.

I think they points would cost me around $5800.


I compute 1.5 points on $378,000 as being approximately $5756.

Here in California, the maximum pre-payment penalty is six months interest, and that is the industry standard nationwide for when there is a pre-payment penalty. A few lenders will pro-rate it, but for the vast majority, they will charge the same penalty on the day before it expires as on day one. This is pure profit, and they’re generally not going to turn down pure profit any more than most people will turn down a bonus. So if your interest rate is 6 percent, you’re going to pay a 3 percent pre-payment penalty if you sell or refinance before the pre-payment penalty expires. For Negative Amortization loans, the pre-payment penalty is based on the real rate, not one percent, of course.

On some loans, the pre-payment penalty is triggered by paying any extra money. One extra dollar and GOTCHA! But probably eighty percent or so give you the option of paying it down a certain amount extra each year, usually 20 percent, without triggering the pre-payment penalty.

Assuming that it is a case of you won’t move in less than one year, this is equivalent to the prepayment penalty on a loan with interest rate of between 3.05% (100 percent prepayment penalty) and 3.81% (80% prepayment penalty). Since even the 1 month LIBOR is a little over 3.8 percent right now, this seems like a cut and dried case of pay the point and a half.

Of course, if there is a possibility that you will need to move in less than one year, paying these 1.5 points could well be a costly exercise in futility. I can’t begin to gauge that risk without more information. But if you’re in any number of professional situations ranging from the military to corporate executive, this is common.

Given that you’re talking about pre-payment penalties, you’re likely in a subprime situation. Subprime has a fairly uniform rate of 1.5 points of cost equals 3/4 of a point on the interest rate. I’m going to assume you’re getting about a 6.25% rate. If you decided to buy it off via rate, you’d be looking at a 7% rate.

Let’s punch in the two loans. $383,750 (balance with 1.5 points) at 6.25% gives you a payment of $2362.81. Running it out 24 months gives you a balance of $374,467. You have spent $56,708 on payments.

378,000 at 7% gives you a payment of $2514.84. Running it out 24 months gives you a balance of $370,043.00, and you’ve spent $60,356 on payments, while paying your balance down $7957.

Now, assume you sell the home for $X at the end of this period. The first loan saves you $3648 in interest. The second loan gives you $4424 more in your pocket in two years. The second loan, with the higher interest rate and higher payment, as opposed to the higher balance, nonetheless saves you $776 as opposed to the loan with the lower interest rate, and also leaves you more money with which to buy your next home, which means lower cost of interest on your next home loan, as well. Of course, this is subject to some pretty significantly naked assumptions as I don’t know anything more about your situation. Furthermore, it assumes that your income is not marginal, and that you would qualify for both loans. It is perfectly possible that you would qualify for the lower payment, and hence the lower rate would be approved, but not be able to qualify for the higher payment associated with the higher rate (The reverse is not the case). Finally, I assumed that because you know you’re going to have to move in two years, you are looking at a two or three year ARM in the first place, as opposed to a longer fixed term.

I hope this helps you. If you have any further questions, please let me know.

Caveat Emptor

Biweekly Mortgage Spam

Sometimes spam makes writing an article all too easy.

Here is a piece of spam I got today because my email at work contains “realestate.com”, with identifying information taken out. This goes to show that the financial ignorance of most mortgage providers is astounding.

Thank you for your interest in the X Broker Program. Our program is designed to help you provide more value added service for your clients, increase your fee income and help you generate more loans. By simply providing a one page custom amortization and a completed one page enrollment form in your loan packages you will achieve a high enrollment ratio. By illustrating the three key benefits of the Bi-Weekly Payment Program for your clients, they will clearly see that your goal is to help them accomplish their financial goals sooner by saving thousands of dollars in interest, paying off their mortgages 5-10 years early and achieving a low effective interest rate. Please find enclosed an example of a custom calculator and our simple one page enrollment form.


Or the client can just make 13/12 of the regular payment, or make an extra payment once per year, and achieve the same result without any cost. This option without cost lets the customer choose to pay however much extra they can afford that month, or pay nothing extra if they’re on a tight budget. As I computed in this article, the fact that you’re making payments more often saves you almost nothing. It’s the fact that you’re making an extra mortgage payment per year that’s saving you all that money.

Getting started is easy. All you have to do is pay a one time setup fee of $99. You will be provided with custom online tools and resources as well as training upon request. To sign up, just go to our online broker enrollment form and complete the required fields, shortly after you will receive an email with your broker code user name and password. Please be sure to save this email. Once you have these instructions you will be able to go to X.com and access your custom calculator and other online resources.


So I (the provider) pay a sign up fee of $99 for an internet driven startup. Cha-ching!

The X program is a great value at $395.00. You earn 300.00 on each enrollment, X retains only 95.00. We also charge a $3.75 per debit fee (emphasis mine). Our customers truly appreciate our one-time only enrollment fee, if the client moves, refinances or the loan gets sold, X will simply take them off the system and put them back on with the new loan information. Most customers prefer to pay the enrollment fee and choose the 3 debit option, where we will take an additional 135.00, 130.00 and 130.00 over the first three debits to comprise our one-time fee. We pay commissions on the 15th of the month for all enrollments on the system the month prior. Once you receive your approved broker email you’ll be able to start signing up clients immediately.

Now we get to the real meat of what’s going on. For me doing the work of signing someone up on the internet, they get $95 to start with, while dangling out a $300 stroke to mortgage providers to betray their clients by getting them to pay for something they could do themselves, with more flexibility, for free.

Then, once this is started, they make $3.75 per transaction, every two weeks, for an automated process that costs them somewhere between $0.25 and $0.50. Great work if you can get it. Three guesses who gets stuck with all the problems if they screw up.



This is one more reason why you want to shop your mortgage around and get multiple opinions. Anybody wants you to pay anything for a biweekly payment program, that is a red flag not to do business with them.



Caveat Emptor

Not Becoming a Victim of Bad Real Estate Practice

This woman made herself a victim

stayed in a hotel for 7 weeks looking for my “Dream Home.” And, when I found it, even though it wasn’t in my price range, I knew I would do anything I could to get it. I was vulnerable, emotional and became a victim.

Actually, that is not quite accurate – I made myself a victim.


First mistake: shopping outside your price range. Assuming that you get it, the bottom line is that you are going to have to make the payments, every month, from here on out. I can get you the loan, any competent loan officer can get you the loan, but I would not even look at any home not in my price range. First, it’s a useless exercise. Second, the reason it’s outside your price range is because it has something extra. So it’s going to be more attractive to the average buyer than the ones you are looking at. Many agents will capitalize on this by showing you such a property, knowing that a large percentage will fall in love with the property right there, and bingo, they’ve got a higher commission for an easy sale. Despite their highly touted “code of ethics” the proportion of Realtors® who do this is every bit as high as regular agents. “Well, it’s just a little bit. I can handle the extra.” Demand to know the asking price before you agree to view the property, and if it is outside your range, refuse to go. Fire any agent who suggests this to you more than once. I’d fire them the first time, myself.

Being self-employed, (actually at the time, I was on disability from hand surgery), the only loan I could qualify for was a Stated Income Loan. That’s where you just tell them what you make, and it is not verified except through two years od tax records and your FICO score

This is not correct. You do sign a 4506 form, but the whole idea behind a stated income loan is that the bank agrees not to verify your income. They verify only that you have a source of income, and the amount you claim you make must be reasonable for someone in your profession. If you can show income via two years of tax returns, that is a full documentation loan, and you get better rates (See this for information on documenting income). However, documenting income via tax returns is tougher because whereas the bank loves doing it, the number they will accept is the number that is after all the write-offs, often a significantly lower number. This is the reason for the stated income loan in the first place. Many business people, particularly small business people, are earning a heck of a good living but they find legal ways to pay for most of it with before tax dollars that they then are actually able to deduct. So they’re living as if they make $10,000 per month, which they do, but the tax return only shows $3000 per month. Stated Income is intended to serve this niche, not the niche of people on weekly paychecks who don’t really make enough money to justify this loan.

six months later, when the interest rate changed, my payment went up. But I still had some disability money, so I didn’t think about it – I just knew work would come.

What she is saying here is that she had to accept a short-term adjustable rate mortgage in order to get a rate low enough to qualify. Or that she was sold one on the basis of “low payment” and she didn’t bother to check the fine print.

There are loan officers and real estate agents and realtors out there who make one heck of a living off the fact that people buy loans (and homes) on the basis of payment. They have “interest only” and even negative amortization loans out there. I’m not going to say you should never buy a home with a negative amortization loan, but it’s a good way to get yourself in serious trouble. Let’s just say that of all the home loans I’ve done (and I’ve done a lot of loans) I’ve never seen a situation where I would recommend it.

Look for terms that are going to be stable for at least a couple of years, particularly if this is your first time in a home or the payments are going to be near the upper edge of what you’re comfortable with.

I:

* Did not shop lenders (I felt I wasn’t in a position to).

* Did not tell the truth about my income.

* Took the first loan they offered me.

* Didn’t read the fine print.

* Did not fix a budget and stick to it.

* Bought way too much house.

Fact: If anybody tells you not to shop lenders, what they are really telling you is that their loans are not competitive and that they are afraid of the competition. The National Association of Mortgage Brokers got a law through congress a couple of years ago that all the mortgage inquiries within a thirty day period count as one inquiry, so it no longer hurts your credit score to shop around. I tell everybody who comes to this site to apply for a back-up loan if they can find somebody willing to do it.

There are issues out there with loan providers who will tell you with a Good Faith Estimate or, in California, Mortgage Loan Disclosure Statement, that they can do the loan on a given set of terms when they have no intention of and no ability to actually deliver those terms. Certainly the HUD 1 form at the end of the loan process is nothing like the earlier form. Furthermore, many loan providers cannot or will not deliver within a stated time frame, which is critical when you’re buying, and still important when you are refinancing. So look for someone who’s going to stand behind their quote with something that says they mean it.

(It’s hard for anyone you’ll actually be able to talk to to use the word “guarantee” with regards to a loan. It’s not just loan providers who pull unethical tricks. People attempt fraud regularly. Furthermore, there are “nobody’s fault” impediments that happen regularly, and they always change the transaction. That property doesn’t appraise for enough value is probably the most common. Only an underwriter can give a loan commitment, you as a loan applicant will never talk to your underwriter, and until you’ve got that commitment, there is no guarantee it can be done at all. So the real guarantees are always conditional).

Here is a List of Red Flags, real estate and loan practices that should have you running away, and here is a list of Questions to You Should Ask Prospective Loan Providers. Those who are doing business honestly should be happy to answer these sorts of questions – it gives us assurance that we’re not going to be competing with somebody blowing sunshine and wet sloppy kisses at you. Because the fact that you’re asking the questions means you’re not going to do business with those who give you unsatisfactory answers. Finally, here is an article on What to look for at Closing, to make certain all of your due diligence paid off and determine if you should go with your backup loan provider.

Caveat Emptor

Virtues of the Housing and Mortgage Market in the US

The scope of the problems that exist in the United States Mortgage market are huge. Enormously, mind-bogglingly, “How Big Is Space?” type huge. Yet, the problems are almost entirely on a retail level, when one provider works with one consumer. The system works, and it works extremely well. Consider:

Most consumers in Europe or any other country in the world would trade their loans for yours in a heartbeat. Rates there are typically around nine percent or so. Here, that’s a ratty sub-prime rate. Mexican rates start at about fourteen percent. Hard money lenders here can sometimes do better than that.

No matter where you are in the United States, you have ready access to home loan capital. It’s considered almost a one of our inalienable rights. Due to our secondary markets, as long as you can meet some pretty basic guidelines, you can find somebody eager to lend to you. You can find very long mortgage terms and very short terms. You can find loans without prepayment penalties, and you can choose to get a lower rate by taking a prepayment penalty. You may end up with something that’s not as good as someone else if their situation is better, and the lender wants more money to compensate them for the risk of your loan, but even so, the rates here are better than almost anywhere else in the world.

Consumer protections are also better here than almost anywhere else in the world. There are federal laws that give you time to call off a transaction if you change your mind, disclosure requirements, consumer protections against builders with teeth in them, and a tort system that, if it does go overboard some times, still gives you an excellent chance at recovering what unethical people took from you. Many states (California, for instance) go well beyond mandatory federal consumer protections.

So keep this in mind when you see me ranting on and on about the problems with our financial markets here. Consider a capital market willing to loan the average person several years worth of wages. I can get a family making $6000 per month a loan for nearly $400,000 on an A paper 30 year fixed rate basis – most expensive loan there is in the most favorable, hardest to qualify for loan market – no surprises, no prepayment penalties, no “gotchas!” of any kind, and I can do it without hiding or shading the truth in the least. That’s more than every dollar they will make for the next five years, and this family is every bit as chased after as the richest person in the world (more actually, because there are more of them). When you stop and think about it, that’s a pretty wonderful situation. For all of the rants I make, the unethical things that happen, and the problems that exist in our capital markets, they are pretty damned good, and have chosen a set of tradeoffs that appears to be working better than anywhere else in the world, at any other time in history.





Amortization: Fixed rate, Balloon, ARM and Hybrid Loans

One of the things that always seems to be aiming to confuse mortgage consumers is advertising based upon whether the loan is fixed rate, and for how long.

First, I need to acquaint you with two concepts: amortization and term. The term of the loan is nothing more than how long the loan lasts. How many months or years from the time the documents are signed until it is done. At the end of the term, the loan is over. In some cases, the payoff schedule (or amortization) will not pay the loan off in this amount of time, leaving you with a balance which you must pay off at that time. When this happens, it is known as a “balloon payment.”

Amortization is the payoff schedule. In other words, if the term was long enough (it isn’t always) how long would it take you to pay the loan off with these payments?

There are four basic types of loan rate determination out there. The first is the “true” fixed rate loan, the second is the “true” ARM, or Adjustable Rate Mortgage, the third is the hybrid, which starts out fixed but switches to adjustable, and finally, the Balloon.

“True” Fixed rate loans have the interest rate fixed for the entire life of the loan. Loan term of a true fixed rate loan is always the same as amortization period. Until you pay it off or refinance, the rate never changes. They are most commonly fixed for thirty years, but are fairly common in fifteen year variety, and widely available in 25, 20, and even 10 year variants, and the 40 year loan appears to be making a comeback. The shorter the period, the lower the rate will be at the same time, but the higher the payment, as you have to get the entire principal paid off in a much shorter period of time. I seem to always use a $270,000 loan amount, so let us consider that. Making and holding a few background constraints constant, a few days ago from a random lender a thirty year fixed rate loan was 6.25% at par (no points, no rebate). The 20 was 6.125, the 15 year 5.75. The 15 sounds like a better deal, right? But where the payment on the 30 year fixed rate loan is $1662.43, the payment on the 20 year fixed rate loan is $1953.88, and the payment on the 15 year loan is $2242.11 So you may not be able to afford the payment on the 15 year loan. (This particular lender doesn’t have 25 or 10 year loans.)

Some thirty year fixed rate loans are available with interest only for a certain period, usually five years, and then they amortize over the last 25 years of the period. Some people do this because they expect a raise in their income over the next few years, and some just do it for cash flow reasons, planning to sell or refinance before the end of the fifth year. Using the example in the preceding paragraph, this would have you making a monthly payment of $1406.25 for the first five years, then $1781.11 for the last twenty-five.

If there is a pre-payment penalty on a thirty year fixed rate loan, it is typically in effect for five years. Considering that over 50% of everybody will refinance or sell within two years, and over 95 percent within five, this is an awfully long time for a pre-payment penalty to be in effect. Practically everyone with a five year pre-payment penalty is going to end up paying it.

“True” Adjustable Rate Mortgages, or ARM loans, are adjustable from day one. The interest rate is, from the time the loan starts, always based upon an underlying rate or index, plus a specified margin. There is no fixed period whatsoever on a “true” ARM. This makes them in general hard to sell, because people cannot plan their mortgage payments, and except for the Negative Amortization loan (also known as “Option ARM” or “Pick a Pay”) these loans are very rare.

(If someone offers you a rate that appears way below market rates, like 1%, they are offering you a Negative Amortization loan. The 1% is a “nominal” or “in name only” rate, the real rate on these is month to month variable from the start based upon an underlying index, making this a “true” ARM.)

If there is a prepayment penalty on a “true” ARM, it must therefore be for a longer period than the fixed period, which is zero. You are taking a risk that you will have to pay a pre-payment penalty because the rate did something that you did not anticipate, and you may not be able to afford the payments if the rates change but the penalty is still in effect.

Rate adjustments on ARMs can be monthly, quarterly, biannually, or annually, with monthly being most common, including for every Negative Amortization loan I’ve ever seen.

The third category is the hybrid loan. Hybrids are often called Adjustable Rate Mortgages, and most loan officers are really talking about hybrids when they discuss ARMs. You should ask if uncertain, but in general, everybody from the lender on down calls them ARMs (I myself almost always call them ARMs), but when you get down to the technical details, they are a hybrid. Hybrids start out fixed rate for a given period, then become adjustable. The overall term of the loan is usually thirty years, but the forty is becoming more common again for subprime. Unlike Balloons, if you like what they adjust to, you are welcome to keep hybrids for as long as they fit your needs. There is no requirement to refinance a hybrid after the fixed period.

Hybrids are widely available with 2, 3, 5, 7 and 10 year initial fixed rate periods, and they may also be available “interest only” for the period of fixed rate at a slightly higher interest rate. Two years fixed is typically a subprime loan, and while five and seven and ten year fixed periods are available from some subprime lenders, they are more commonly “A paper” loans. Three is common both subprime and “A paper”. Once they begin adjusting, “A paper” typically (not always!) adjusts once per year, while every hybrid subprime I’ve ever seen adjusts every six months.

WARNING: I often see hybrid loans advertised and quoted as “fixed” rate loans, and you find the fact that they are hybrid ARMs buried in the fine print somewhere. Yes, they are “fixed rate” for X number of years. But this is fundamentally dishonest advertising. This is one of the reasons I keep saying that any time you see the words “Fixed rate,” you should immediately ask the question “How long is the rate fixed for?” Please go ahead and ask, for your own protection. Ethical loan officers know that people get sold a bill of goods on this point every day, and so they’re not offended. And you don’t want to do business with the unethical ones, right?

Now, I am a huge fan of hybrid loans myself. I will go so far as to say that I will never have a thirty year fixed rate loan on my own home (unless the rates do something economically unprecedented, anyway). You get a lower interest rate because you’re not paying for an insurance policy that the rate won’t change for thirty years, without jacking up the minimum payment to something you may not be able to afford. Most people voluntarily abandon their thirty year interest rate insurance policy (also known as “Thirty year fixed rate loan”) within about two years anyway. So why would I want to spend the money for that policy in the first place, when I’m likely to only use two or three or five of those years?

Nonetheless, particularly with subprime loans, you need to be careful. I have seen precisely one subprime loan in my life without a pre-payment penalty, and I’ve seen a lot of loans (at least thousands, maybe tens of thousands – I wasn’t counting at the time – where your average real estate agent has seen maybe a few dozen, and your average bank loan officer maybe a few hundred). Many loan providers, even “A Paper” loan providers will stick you with a three or five year pre-payment penalty on a two year fixed rate loan. Why? Because it increases their commission. So if you take one of these loans, you will have a period of time when you don’t know what the rate will be doing, but if you refinance or sell during that period, you will have to pay your lender several thousand extra dollars. This puts many people on the horns of a dilemma – whether to keep making payments they can’t afford, or pay the pre-payment penalty. The bank wins either way.

One final point about hybrid loans. Once they adjust, they all adjust to the same rate plus the same margin. Unless you need the lower payment to qualify for the loan, it makes no sense to pay three points to buy the rate down on a five year hybrid ARM (or anything else) when it takes eight to ten years to recover the cost of your points. Why? Because you’ll never get the money back! When the rate adjusts on the loan you paid three points for (IF you keep it that long), it goes to the same rate as the loan where they paid all of your closing costs. Judging by the evidence, most people don’t understand this.

The final category of loan that I’m going to discuss here is the Balloon. This is a loan where the amortization is longer than the term. So if the amortization is thirty years, you make payments “as if” it were a thirty year loan, but since the actual term of the loan is shorter, you will have to sell, refinance, or somehow make extra payments before the loan term expires. The thing I don’t understand is that Balloon rates are typically higher than the comparable hybrid ARM, despite the fact that you either have to come up with a large chunk of cash at the end or sell or refinance prior to that. This makes them a less attractive loan. Furthermore, pre-payment penalties are every bit as common. Balloons are widely available in five and seven year terms with thirty year amortization, and I’ve seen three and ten, as well. Probably the most common “balloon” loan, though, is for those who do a second fixed rate mortgage, where the best loan available is usually a thirty year amortization with a fifteen year balloon. Since over half of everybody has refinanced within two years anyway, and 95 percent within five, the fact that it’s got a fifteen year balloon payment just doesn’t affect a whole lot of people.

WARNING!: I have seen Balloon Loans mis-advertised in the same way as I talked about with hybrid ARMS a few paragraphs ago. I regard this as even more misleading than advertising hybrid’s as fixed. Unfortunately, many states do not have good regulations on rate advertising, and in many others, enforcement is lax. When a loan provider advertises, the entire game is to get you to call, and then control what you see and what you learn from that point on. Your best protection from this is to talk to other loan providers. Shop around, compare offers, tell them all about each others’ offers. If something is not real, or it has a nasty gotcha!, if you talk to enough people, somebody will likely tell you about it. If you only talk to one person, you’re at their mercy. Even if you somehow ask the right question to discover the gotcha!, the people who do this have long practice in distracting you, or answering another question that somehow seems similar enough that you let it go.

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.

However, 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 examing 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 (now part of Fidelity), was started in 1876, 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.

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.

Now 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 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 has a client right now 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 the 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.

Caveat Emptor

Why You Should Ignore APR

One of the things you get with every mortgage loan quote is an APR, or Annual Percentage Rate. There is even its own special form, the federal Truth-In-Lending (TILA) form.

This was mandated by congress back in the early 1970s as a way to give consumers some way to compare between competing loans of equal rate, and it is governed by Federal Reserve Regulation Z.

The problems with APR are threefold. First off, it is computed from numbers on the Good Faith Estimate, which are often intentionally and legally under-stated. “Mis-underestimated,” to use President Bush’s famous phrase in an entirely different context where it is not a good thing. If the numbers on the Good Faith Estimate are incorrect, the computations that result in the APR will be similarly incorrect.

Here is a routine example, from an unfortunate soul I encountered awhile ago. They told him they were going to do his $230,000 loan for 3/8ths of a point and $1895, which works out to about $3400 total, APR was listed as 6.136 on a 6% loan when he signed up. But when the final documents were ready, the interest rate was 1/4 percent higher, the points were 2.25 points, and the closing costs were actually over $4000. Total cost: $9400 added to his mortgage, and the APR on final documents was 6.568 on a 6.25% loan. It stands out in my memory because I had been competing for his business, and offered to do a back up loan because I was certain the first quote wasn’t real. He didn’t want to do the paperwork for a back-up loan, but he came back to me during his three day right of rescission. Unfortunately, rates had moved up and by that point I couldn’t do anything he liked better, so he rewarded the company who misquoted his loan (to use technical parlance, lied) by getting them paid. Unfortunately, you can’t go backwards in time with what you learn at the end of the process. You need to be right the first time.

The second reason to ignore APR is that it is an attempt to compress what is fundamentally at least a two-dimensional number into a one dimensional number. Remember back in school when you learned graphing on a “number line” and then a Cartesian Plane? Which of them contains more information? The Cartesian Plane, of course. APR is an attempt to force a Cartesian Plane onto number line. In order to do it, you need to make some assumptions, and you still lose a lot of information.

The third, most important reason to ignore APR is that the assumptions that Congress and the Federal Reserve mandate were reasonably based on the reality of the 1960s, which has now changed. Back then, people bought homes they were going to live in for the rest of their lives, and re-financing was much less common. People are now living in homes about nine years on the average, and refinancing about every two years. But the regulation still reads that the costs of doing the loan, which are included in the APR calculation, are assumed to be spread out over the entire term of the loan, even with ARMs and hybrid ARMs, which almost nobody keeps after the initial fixed period. With the term of most loans being 30 years (some 40 now), and the average person refinancing about every two years, this computation makes absolutely no sense as it exists today. The costs of the loan should be spread over the period that the person getting the loan is likely to keep it, not the entire theoretical term of the loan.

Let us look at the earlier example in this light. Let’s assume that it’s a five year ARM, and compute APR as if he’s going to keep it the full five years of the fixed period, rather than the thirty years he theoretically could keep it. The APR would have been listed as 7.067% on the final documents.

Let us go a step further and assume that instead of keeping his loan 5 full years, like less than 5 percent of the population, he keeps it for something close to the national median of two years, and compute APR based upon that. His final documents would have listed an APR of 8.293 percent.

To offer a better strategy: At the time, I could have done the loan at zero total cost to him – literally nothing. Zero added to his mortgage, he pays for the appraisal but is reimbursed when the loan funds – at 6.75%, APR 6.750 no matter how you compute. Yes, the payment is $17.75 per month higher than what he ended up with. But he wouldn’t have added $9400 to his mortgage balance. Let’s compare these two loans five years out, when 95 percent of the population has sold or refinanced and is no longer reaping the benefits of that payment that’s lower by $17.75 per month. If he has the zero total cost loan I could have put him into his balance is $215,914.00, and he has paid $89,506 in payments. The loan he ended up with, he’s going to owe $223,449, and he’s paid $88,441 in payments. Okay, he’s save $17.75 per month, about $1065 total, in payments. But he owes $7535 more. If he sells the property and puts it all in a savings account, he would have been permanently ahead by $6470 if he initially choses the higher rate, higher payment, but lower cost loan. Not to mention that he would get $7535 extra all at once, as opposed to little dribbles of $17.75 per month that most people would never notice. If he buys another house, or if he keeps this home but refinances, he owes $7535 less with the zero cost loan. Let’s say he gets a really great loan next time, with a thirty year fixed rate of 5%. That $17.75 per month he “saved” on his payment for five years is still going to cost him $376.75 per year, $31.40 per month for as long as he keeps the new loan. This is what comes from relying upon APR as a valid measurement of a loan.

This is not nitpicking. The so-called 2/28 and 2/38 are the most common subprime loans nationwide. They are subprime hybrid ARMS with an initial two year fixed period. People get into them because they don’t have the money for a down payment. With a dozen agents in my office, I can’t tell you when the last time I saw a first time buyer who had the money for a down payment. Considering that they’re all straining to buy as much house as they possibly can get a loan for, this means they’re in the subprime market. According to SANDICOR figures I saw a while back, something like 40% of all purchase money loans locally in the last year being negative amortization loans which have no truly fixed period and are practically impossible to keep longer than five years with the best will in the world. Another thirty percent plus, according to SANDICOR, were interest only, so my estimate is that subprime lenders have at least eighty percent of the purchase money market locally, and probably fifty percent or more of the refinance market. With the vast majority of these loans being of the short-term variety as illustrated above, APR is worthless as a measure of a loan.

Caveat Emptor

The Searchlight Crusade Mission

(Mild language warning applies, but nothing you can’t say in prime time broadcast TV)

When I was twelve years old, my uncle Robert introduced me to the writings of John Masters. John Masters was an officer in the Indian part of the British Army in the waning days of the Raj, starting in 1934 and ending shortly after World War II. At the tender age of 24, he was named battalion adjutant of the second Battalion, Prince of Wales Own Fourth Gurkha Rifle Regiment. The adjutant’s job in the British Army at the time was different in many ways from modern counterparts in the US Army. A large part of the job was to look impressive. “Before the adjutant’s feet, pits were filled, obstacles became smooth paths, and order arose out of chaos.”

Did this happen on it’s own? No, he had a subadar assistant. There is no comparable rank to subadar in the modern US armed forces. They ranked below second lieutenants but were nonetheless full officers commissioned by the Viceroy of India instead of by the King. This subadar was typically an older soldier who had joined as a private and risen through the ranks to his current exalted status. His task was partly to see to it that the adjutant looked impressive, i.e. to fill the pits, knock down the obstacles, pave the paths, and cause order to arise out of chaos. In short, to make it seem as if the adjutant was magically gliding through life on the force of his personality.

I’m doing that subadar’s job.

That’s it in a nutshell. That is what a good loan officer does (or a good real estate agent). I metaphorically fill in the pits, knock down the walls, pave the paths so that my customer has a clear path to what they want.

A mortgage loan is not something people want. Mortgages suck. People don’t want a mortgage. They want the house, and they have to have this sucky thing called a mortgage in order to get it.

Is that a ringing endorsement of the greater half of my profession, or what? I get people something that sucks so they can have something they want. But that thing they want is their new home. A place for their family to be safe and secure and (we hope) happy for as long as they decide to keep it. Also, it happens to be historically the greatest source of personal wealth for large numbers of people ever devised. No trivial thing, when you put it like that.

Okay, you ask, so where is this going?

I’m not one for false modesty. I’m good at what I do and getting better at it. People come to me because I did a good deal for their friend on excellent terms, and I made it look easy. No loan officer can ever really guarantee a loan will go through – that is the exclusive province of the underwriter at whatever lender is being used. You (as a customer) will never talk or communicate directly with your underwriter – it’s a universal anti-fraud measure, everywhere in the industry. But I have a bet that I make with those who are dubious. I’ll write a check for $1000 and put it in the custody of a neutral party. Providing the client tells me everything, and does what I need them to do in a timely fashion, if the loan doesn’t go through, on time and exactly on terms quoted, they get that money.

What I’m really saying, of course, is “I’m this certain I can do the loan.”

Sad to say, the average loan officer out there is not up to this standard. Actually, a lot of them are out and out crooks. Oh, they’ll get a loan done, most of the time, if only because they don’t get paid if they don’t close a loan. But the resemblance borne to the originally quoted loan may be extremely vague, and it may be weeks after the date it was originally promised, and therefore useless to you because they guy who was going to sell you the home lost patience and cancelled escrow.



Much as I would like to, I cannot do every loan in the country. I’m only licensed for California as an individual, and I no longer work for firms that have widespread licenses. Furthermore, I can only do so many loans at once. Even with the best support staff, 100 loans a month seems to be about the limit, even if all I do is the submission and customer handholding. Finally, although it strains credibility :-), I have reliable reports of other loan officers here, locally even, earning a living at times when I am not saturated with business.

Your first home and your first loan is a exciting but nervous time for most folks. You obviously want the house, and you don’t want the loan to go wrong or you’ll lose the house. You have no idea of how to navigate this arcane labyrinth called real estate. You have no reliable guide to separate the wheat from the chaff of all the claims out there.

Some people never pay it any mind. They go through life and may buy and sell multiple properties and refinance each one several times, and not want any more knowledge than the fact that what they wanted is done. Unless they’re my clients, I can’t help them.

Some people, however, are like John Masters, who was wary of testing his newly appointed superpowers, and so looked out of the corner of his eyes first to make certain the pit was filled and the obstacle was gone and the path was smooth. They want some way to tell the subadar who’s filling the pit with quicksand from the one who fills it with good solid dirt, some method to tell the one who manages to pave the path solidly and perfectly from the one who can’t pave it at all, preferably before they trip and break something.

That’s what I’m trying to do here, give you a set of skills and strategies to increase your likelihood of having a nice smooth solid path with no obstacles to your real objective: That home.

Some people just want to be float oblivious through life, and if you’re only here for the political or other stuff, glad to have you and have fun and please let me know how I’m doing.

Others want to know how the nuts and bolts fit together, at least for the biggest stuff. Not just for mortgage, but also for real estate, insurance and financial planning, (and other fields if I can find co-contributors that will write to my standards) you are the audience I’m trying to help, and will do my darnedest to write informative articles from a real world practical perspective on how to put yourself in a better place than you’re in. I don’t have any kind of an exclusive Truth on all of it, and alternative viewpoints are both necessary and welcome. Some of what I say may be contrary to what others tell you, and their methods may work just as well. I do know that I am telling you how things work, and I do have a track record of getting the job done.

Why am I doing this? Well, partly in support of a commercial idea that I am working on. Mostly because I’m trying to improve the climate in which we all do business, and every person who reads anything here will raise the bar by just that little bit. I think that if those who aren’t the best, most competent, and most ethical have a choice of “improve and make more money or continue as you are and go out of business”, most of them will take the former course, and we’re all better off without the others. I happen to believe that most of them are victims of the system as much as any client who they’ve ever taken advantage of; they just don’t know that there’s a better way to do business. This is the way they were taught, and their trainers before them, and their trainers before that. It ticks me off every time I have to tell someone all of the things that every other loan officer and real estate agent has lied to them about, usually by omitting a nasty gotcha! (or several), and they get mad at me because I told them the truth when the appropriate target for their anger is elsewhere. Yes, sir, I can put you into that $800,000 house and get paid a whole slew of money. But I think you might like to know ahead of time if there’s likely to be a problem sometime down the road after I get my check and ride off into the sunset. If you’re fine with the problem, step right up and sign on the dotted line and here are the keys and thank you very much. Otherwise, maybe you might want to reconsider your course of action.

What I’m trying to create here is a reality check that you have available to you to warn you of problems when I can’t, before you’re locked on an irrevocable course for disaster. So pull up a chair, sit down, and enjoy the ride, just like John Masters, secure in the knowledge that you’ve checked out of the corner of your eyes and your superpowers are fully charged and working.

Caveat Emptor

The Nature of Estate Planning

I’ve seen some fairly intelligent people completely fail to understand the value of estate planning, how easy it can be, and what it can accomplish.

To start with, there are some issues that happen when you die. The first is probate. This is a process whereby the state approves the distribution of your assets. Whether the state has any business putting their big nose into the process is not the discussion we’re having here. The current fact is that they do, and this doesn’t look likely to change. In the case of things like a home, where the family is living in it already, it’s usually not too obnoxious as the state will typically allow the family to continue living in it, pending resolution of probate.

But liquid assets – the money you left – are tied up in the probate and cannot be accessed without court approval unless you titled the account correctly. This can be a major issue to a family that’s just lost their major breadwinner – or either breadwinner in the case of a two income family. Unless you don’t want your family to get it right away, titling accounts jointly in both your name and your spouse’s as joint tenants with rights of survivorship is one way to deal with this. In the case of most accounts, there is the TOD, or Transfer on Death option of naming a beneficiary (or beneficiaries) for the account. The money then transfers upon your death to that person outside of probate. Estate and inheritance taxes are still potentially applicable, however.

The minimum charges for probate are about seven percent of the amount of estate under probate. If this includes your house and other major assets, it gets expensive quickly. A surcharge per year the probate is in effect is also usual. Probate sometimes doesn’t get settled for several years – and some unusual ones have gone over twenty years, and with increasingly complicated family relationships, increasingly complicated probate becomes more likely. While probate is going on, your heirs will not have access to the money without court approval, and the court’s priorities are not likely to be the same as your family’s.

The number one tool for effective estate planning is not a will. That’s an important component, especially if you have children and need to determine who their guardians will be, but for distribution of your assets, it falls woefully short. Everything disbursed by the will goes through probate, and estate and inheritance taxes as applicable. Wills can be and are challenged successfully every day, and the cost of the fight drains the estate even if the challenge is unsuccessful.

The most important tool for effective estate planning is the trust. There are varying kinds of trusts, so consult an attorney in your area. A trust is not a corporation, but if that helps you in your understanding, use it. A better way to think of it is as a robot that takes control upon your death and acts according to your instructions. When you create (or alter) the trust, you wind the robot, but (if written correctly) it acts like a string marionette during your life. You don’t technically “own” the assets you transfer to the trust, the trust does – but you control the trust, and it dances upon your strings. Once the strings are cut by your death or incapacitation, the robot takes over and does what you told it to do in those circumstances. You might have told it to attach itself to someone else’s strings, or you might have told it to disassemble itself, or both, as well as many other things. The important thing to remember about trusts is that they do not go through probate and they are (if written correctly) outside of estate tax as well. Remember, the “robot” owns this stuff, and the robot didn’t die!. There may be a successful challenge to a trust on record somewhere, but I’ve never heard of one and (although not a lawyer) I can’t see an angle for doing so. I do know of people who wanted to challenge them, and who appeared to have much better claims on the surface than the person who the trust had been instructed to deliver its assets to, who got their legal noses bloodied in a hurry. Ethical lawyers will generally tell potential clients seeking to challenge a trust “I’ll look at it if you want, but if it’s written correctly there’s not a thing I can do except spend your money.”

Next, life insurance. There are so many uses for Life Insurance in estate planning that it is hard to conceive of a good plan that doesn’t use life insurance, and by that I don’t mean term life insurance either, but one of the cash-value variety. Term life gets so expensive after age 60 that 97 percent of it gets cancelled before it pays benefits. For estate planning purposes, life insurance is useless if it doesn’t stay in effect the entire rest of your life. Many people will tell you to buy term, but that’s a particularly short-sighted, short-term solution that presumes your need for life insurance will vanish as soon as you’ve got some decent assets or your kids graduate college. Neither is likely to be the case for anybody middle class today.

This is most deeply rooted in straw-man arguments that claim term insurance is better by comparing it to whole life, ignoring the superior cash value life insurance types, and claim to have refuted the value of all cash value life insurance when they have only refuted whole life, and only within the set of parameters they have set. For older people (age seventy and up at time of plan) universal life is likely the way to go, while with younger people (definitely anyone under 50) it is difficult to come up with a scenario where Variable Universal Life does not outperform its term competitor in every way.

It appears that the difficulty of estate tax is likely to come soon, but there are issues. Even if a permanent repeal takes place, there is nothing to say it could not be re-imposed later. Second, it does nothing about state levied estate taxes. Third, some states have started re-exploring inheritance taxes as a consequence, which would be a disaster. Since estate tax is levied strictly on assets you own when you die (albeit with some recapture of stuff up to three years previously), it is avoidable to such an extent as to render it basically a voluntarily paid tax on denial. All I can say is that the people paying it must have wanted to pay it, because there are legal ways not to owe the tax and all you have to do is plan ahead.

I want estate tax gone, mind you, but if I have to choose between complete and permanent estate tax repeal, or say, indexing the Alternative Minimum Tax (AMT) to inflation and putting estate tax back to where it was pre-2000, I’ll support the latter option unreservedly. So just because the sentiment is there for repeal doesn’t mean it’ll happen, or that it’ll be permanent if it does. So I suggest planning for estate tax as if it’s going to effect you, and some of the methods of estate planning can actually increase the size of your gross estate beyond what it would have been without planning.

Will. Trust(s). Life Insurance. A good plan will have all of these, as well as others (Durable Power of Attorney for Health Care, to name one). I’d say Caveat Emptor, except it’s more a case of “Be careful what you wish for. You may get it.”

Credit Reports and Credit Score Manipulations

I’ve been to two conferences this week. The stuff for the other one is more important and is going to have to simmer for a little while longer before I’m ready to write an article on it, but the other is a “direct from the providers” seminar on credit reports and credit scores.

Some of this has changed from last report, and some of it will change in the future.

A FICO score is nothing more or less than a prediction of the likelihood of a particular consumer having a 90 day late in the next 24 months. It is a snapshot, based upon your position and your balances as reported at the exact moment it was run.

I learned a bit more about the various other credit reports besides mortgage. They emphasize different things (naturally) and score differently. Auto scores go to 900, where mortgages range 300 to 850. Landlord tenant screens are different from a mortgage score. Revolving credit screens are different than mortgage screens. Finally, and most important, the “Consumer Screen” reports you get on yourself will always have a higher credit score than the ones mortgage providers run.

Inquiries are 10 percent of your credit score. They only go back twelve months. Whereas I’ve been informed in the past that additional inquiries will get you zonked, that is not the case currently. Depending upon your length of credit history, after three to five “hard” inquiries in the last twelve months, they quit counting. now. A hard inquiry is done at your request for reasons of granting credit. Fewer is better. Longer history of credit means they will allow you more inquiries.

Mortgage inquiries, if done within the correct time frames, still only count as one, no matter how many. Automobile inquiries also count differently than other inquiries.

Types of credit used is 10%. They’re looking for a reasonable balance between types. The absolute worst type of account to have is from one of those zero interest finance companies. You know the ones, “Buy this sofa now and no payments and no interest for twelve months.” People who are broke but need or want stuff now do this, and that’s why the hit happens. They are deferring payment. You suffer guilt by association.

15 percent is length of credit history. How long you have had revolving accounts divided by the number of revolving accounts you have had. You have three cards that have all been going for thirty years, that’s a better picture than five cards of which four are brand new.

I’ve been telling people not to close open accounts. This is confirmed as not a good thing to do. Closing an open account can cause your credit to drop by as much as 80 points in some circumstances. If it doesn’t cost you anything, don’t close it.

Balances is thirty percent of your score. There are significant hits at fifty and seventy five percent of your credit limit on each card. Significantly, a small balance is a little bit better than zero, even. This is one reason you want to charge something you’d buy anyway to your credit card. Just make sure you pay it off. Some credit cards (specifically charge cards in particular, not to mention any specific names of charge card companies where the balance is due in full every month) will report your high balance as being your limit. So make certain your credit limit is being accurately reported. If your balance is incorrectly reported, in general the only way to correct it quickly is with a letter from the provider, signed and on their letterhead, saying “Your balance as of (date)is $X”

Payment history is 35 percent of your score. This is divided into three categories: 0-6 months, 7 to 23 months, and 24 months or older. If you have had a delinquent credit reported within 6 months, you are getting the full impact in terms of lowering of credit score. Between 7 and 23 months is a lesser impact. Over 24 months is still less impact.

Important: DO NOT PAY OFF OLD COLLECTION ACCOUNTS! It can cause a 100 point drop in your score. Here’s why. You owed $X to company A, and five years ago they sent it out for collection. Now you go back and pay it off, and the date it’s marked with is TODAY. It’s gone from being over two years old to being current as of now, bringing the full impact to bear once more. The one exception to this is a deletion letter. If you get a deletion letter on their letterhead signed by them saying “Please delete this account,” you can make it vanish off your credit report as if it never was. Note that you may still have to pay off collection accounts, but do it as a part of escrow, where the loan is done before your credit is hit.

There are tools out there that can be used to analyze and tell you how to improve your score or how best to improve it with a given amount of money.

Bankruptcy: Three things determine what kind of credit score you’ll have coming out of bankruptcy. 1) Percentage of trade lines you include in the bankruptcy. More is worse, lower is better. Including half your trade lines will not hurt you nearly so bad as including all your trade lines. 2) Number of inquiries. If you’ve still got one or two open lines you didn’t include, you may not need more after discharge and you won’t go apply for more. The poor schmuck who includes everything needs more to start a credit history, and is dinged HARD for each turndown inquiry. 3) Post bankruptcy payment history: if you included everything in the bankruptcy, you have no history until you get more credit. Can you say, “Vicious Circle,” boys and girls? Knew you could. No payment history is even worse than a bad payment history, but any reports of delinquencies after bankruptcy hits you much harder than if you were never bankrupt and had a late.

Last individual points:

Rate on credit card does not affect FICO score.

Nor does salary, occupation, employment history, title, or employer.

Credit Repair Services cost a lot of money for things you can do for free.

If you are disputing a medical collection (only) it doesn’t count on your score.

Finally, a note about a likely coming change. If you are a regular around here, you may realize what a hole negative amortization loans can be. There is a high likelihood that in the near future the fact that you possess a negative amortization loan will be counted heavily against you, score-wise. The reasons this change is coming is obvious: Your payment every month is not covering your interest charges. This is not a situation that can go on indefinitely, and it is indicative of someone who is likely to be in over their head.

Caveat Emptor