In an attempt to debunk some of the slanders that are floating around out there, this article is an itemization of how lenders and brokers make money on loans.
The first method is obvious: Origination or discount points charged to the consumer. This is money that the person getting the loan is paying, or someone else is paying on their behalf. One point is one percent of the final loan amount, two points is two percent, and so on and so forth. There is an actual difference between origination and discount points, but they have become almost interchangeable in their usage by many lenders and loan officers. Origination has to do with the fee charged for getting the loan done. It’s not a trivial amount of work to get the loan done, and unless you’re a close relative or have repeatedly saved their life, the person doing the loan is going to get paid somehow (and often, those are the loans where they make the most). If you’re uncertain just how they are making money, you should ask. Discount points are theoretically a rate that the actual lender is charging in order to give you a rate better than you would otherwise get, but many brokers camouflage origination points as discount points and many banks camouflage origination points as discount points. The former makes you think the bank is making the money when it’s the broker, while the latter makes the consumer feel like the lender isn’t charging them origination, but that you are actually getting something most consumers quantify as real for their money (This also makes you feel like you’re getting something for nothing, always a good selling point to anything).
Related to this are junk fees or markups of legitimate fees that are required to get the loan done. I do not believe I’ve seen a fee that some lender or another hasn’t tried to mark up. If in doubt as to whether there’s a markup, insist upon paying it directly. If they can’t explain exactly what it was for in easy to understand words, it’s probably a junk fee. Again, real fees usually run to about $3400 on a loan, although many lenders and loan officers are adept at hiding this.
The second way that lenders and loan officers make money is in rebates, also known as yield spread. This is pretty much limited to brokers, as neither traditional lenders nor packaging houses get direct rebates from lenders. Once again, rebates can be thought of as negative discount points and discount points can be thought of as a negative rebate. There should never be both discount points and a yield spread on the same loan. It is fundamentally dishonest. If there is a yield spread, you are being charged origination, not discount. Period.
The third way that lenders and loan officers make money is in the sale of the loan. This is only applicable to actual lenders, whether traditional or packaging house. Mortgage loans, particularly grouped in vaguely compatible bunches varying from $50 million on up, are among the most secure of all investments (indeed, in terms of historical risk, only US Treasury bonds are superior). Because they are very low risk, the lender makes a nice premium on them. As I’m writing this, CMO bonds trading at 5% even are basically at par, while 6% bonds are earning about a 3 percent premium. At par means the bank gets the face value of what they’re selling, whereas a 3% premium means they get an extra $30 for every $1000 of bond value. For a $50 Million CMO offering, this is $1.5 Million. (There are other factors such as underlying quality, whether there is a pre-payment penalty, what tranches they may be assigned, and so on, but this is a basic article on the phenomenon.) By comparison, on a fairly good “A Paper” lender’s pricing sheet (the first one I grabbed), 5% is not available and 5.25% carries a discount point and a half while carrying a premium on the secondary market of half a percent or so, so the lender is making two full percent on that loan at a minimum, and unlike a broker’s yield spread, this is never disclosed to a client. Nor is there any limit as to how much this can be, but with even decent to good A paper lenders getting 2% or more, it shouldn’t stretch your mind too much to find out that this number can go to 6 or even 8 percent in the subprime and negative amortization markets. 6 percent on $50 million is $3 Million dollars the lender gets for selling $50 million worth of loans – this translates to about 100 regular 3 bedroom homes here in California. $30,000 each, over and above any points and fees these people may or may not have paid, and for holding onto the loan for maybe one month. Believe me, your lenders are not hurting – and many even have the guts to badmouth brokers who may make $5000 while cutting the consumer’s cost by $7500 to $10,000 and the bank still makes $20,000 per loan. (Note: these spreads and premiums used to be much larger 30 years ago when people didn’t reliably refinance or move about every two years).
What brokers do is essentially play these lenders off, one against another on a professional basis, to see which one will cut the best deal on your behalf, because brokers are never captive audiences while the lenders regard you as theirs from the time you walk in the door.
Also, the point needs to be again that cost of a rate is always inverse to the rate for precisely the reasons of yield spread and bond premium. The lower the rate, the higher the cost. The higher the rate, the lower the cost. Some lenders and brokers may have better cost/rate tradeoffs than others, but there is always a trade-off.
The last method of receiving traditional income is to actually hold the note and receive the interest. This is actually rare these days. More often, what the lender will do is sell the loan itself while retaining servicing rights (for which they are paid, of course). Most often, the lender can make more money by selling the note to Wall Street – whether or not they retain servicing – than they can by holding the actuial note themselves. Keep in mind that the premium they get from sale of the note is immediate, and they can “sell the same money” several times per year, as opposed to just holding on and collecting the interest as it accrues.
How can (and should) you compare a broker’s offer, where compensation is disclosed, with a bank’s offer where it is not? First off, make sure that they are on the same type of loan at the same rate. My questionnaire here is a good start. Note that the last explicit question, “Will you guarantee this rate at this cost and cover the difference, if any, yourself?” should be answered in writing, and if the answer is “No,” that’s a red flag as to what their business practices are. They know what it’s really going to take to get the loan done. They know what rates are available for locking today, right now. If it’s not locked, it’s not real, and they’re playing games with your loan. As to prospective loan providers who won’t guarantee their Good Faith Estimates, I have a retort I use with potential clients, that runs something like “Well, if he’s not going to guarantee you a 5.75 30 year fixed with one point, how about if I don’t guarantee you a 5.5 30 year fixed with no points?” If it’s not personally guaranteed in writing, chances are they are jerking you around to get you to sign up. None of the standard federal or state forms are binding in this sense; not the Good Faith Estimate, not the Mortgage Loan Disclosure Statement, not the Truth-In Lending form, and not to application form itself. Furthermore, keep in mind that for all third party items, such as title, escrow, attorney fees, appraisal, etcetera, they are able to exclude them from the precomputed costs of doing the loan, so most lenders and loan providers do. Not coincidentally, these are the biggest items in the closing costs section of your loan. Insist upon full disclosure of each item, and ask them to guarantee the total.
And once you are certain that the loans you are being told about are actually the same loan or the same type of loan, then you can make the decision as to which is better by choosing the one that actually gives you, the prospective client, the better loan.
Caveat Emptor
Lender Discrimination and Shopping for a Home Loan
They add that the fact minorities are more likely to borrow from institutions specializing in high-priced loans could mean they are being steered to such lenders or that some lenders are unwilling or unable to serve minority neighborhoods.
This is called redlining. It is illegal. HUD really gets their panties in a bunch over it, too.
One thing that the article explicitly said: This does not include/compensate for credit scores. Working with people in the flesh, I have experienced the fact that there is a difference between how various groups handle credit. Often, the urban poor have some difficulty in meeting the requirements for open and existing lines of credit. Often, they are more poorly educated about their options or think they’re a tough loan when they’re not. This extends into the general population, although it’s less prevalent. I have a friend I went to high school with. He and his wife make over $160,000 per year between them in very secure jobs they have held for over a decade each. Their credit score is about 760. The loan officer they were originally working with told them they were a tough loan to try and scare them into not shopping with anyone else. The reality is that the only question is what loan is best for them because they easily qualify for anything reasonable. This is far more common than most people think. The current standard is that if you have two or three open lines of credit and your credit score is above 640 – sixty plus points below national average – I can get 100 percent financing, and the possibility doesn’t disappear completely until you go below 560 (whether it’s smart is a question for the individual situation, but I can get a loan done if it is). With increasing equity, I can usually get a loan done even for credit scores below 500 (two hundred points below national average!). Now, the better your situation, the better your loan (e.g. rate, terms, closing costs, etc.) will be, but the question is not usually “Can I do a loan for these folks?” but “Can I find them better terms than anyone else?” and “Should I do this loan or is it really putting them in a worse situation than they’re in?”
Quite often, the loan provider that urban poor go to is the one who advertises where they see it – basically, the lender who chases their business. They think “This guy wants my business. He does business with people like me all the time. He can get me the loan.” The problem is that all too often, this loan provider has chosen this market precisely because the urban poor do not understand they’ve got other choices, and do not understand effective loan shopping, and so this loan provider makes six percent (the legal limit in California) on every loan plus kickbacks and arrangements under the table. They make more on one loan than I do on half a dozen for roughly the same amount of work, and the loan they do are not as good for their client as others that can easily be found.
Most people are better loan candidates than they think they are, and qualify for better loans than they think they do. It’s more often the property they have chosen that creates an untouchable situation than the people themselves. Even then, there are usually options available.
(I got a ten minute lecture a few months back from a nice young couple telling me they “deserved” a rate of four to five percent on a 100% loan for a manufactured home sitting on a rented space. Well, if it had been on a regular house sitting on owned land I could have gotten them that loan on very desirable terms, but nobody does 100 percent on manufactured homes, and if there’s no ownership interest in land involved then it’s personal property, not real estate, and it becomes essentially a personal loan, for which the rates are much higher.)
So keep this in mind if and when you’re in the market for a real estate loan, and shop hard. Remember that all of the times your credit is run in a two week period for mortgage purposes only counts as one inquiry, whether it is just once or whether it’s five dozen times. A loan provider does not have to run credit themselves to get a quote, but the information must be complete, accurate, and in a form they can use.
Keep in mind that the loan market changes constantly. A quote that’s good today almost certainly will not be good tomorrow. If it’s not locked, it’s not real, and a thirty day lock is not valid unless extended on the thirty-first day, for which you will pay an extension fee if necessary. So shop hard, with a real sense of urgency, get it done quick, and make your loan provider get it done quick. Any additional stress will more than pay for itself (and the longer the loan takes, the greater the opportunity for stress, too). Sight unseen, I can bet money that a loan done in thirty days from the first time you shop or lock is a better loan than the loan that takes sixty days or more.
Caveat Emptor
Mortgage Loans: The Tradeoff between Rate and Cost
The question every good loan officer hates the most is “What is your lowest rate?”
First off, everybody doesn’t get the same choices. As I’ve said before, somebody who can prove they make enough money, has a history of paying their debt, and offers the lender a situation where there’s 30 percent equity (or more) gets a different set of choices than somebody who can’t prove they make enough money, has a questionable history of paying debt, and wants to borrow 100 percent of the property value (or more).
Second, different loans get different rate-cost tradeoffs. The loan that most people seem to consider the most attractive loan, the thirty year fixed rate loan, is always the most expensive loan out there. It always has the highest set of cost/rate tradeoffs. Why? Because on top of the cost of the money, you are essentially purchasing an insurance policy that says your rate will not change for thirty years. Even when long and short term rates are inverted, as we may see soon, there is a premium charged for the thirty year fixed rate loan. It makes a certain amount of sense; insurance policies are never free, and the thirty year fixed rate loan is the most desired loan out there. Simple economics: Higher demand equals higher price. Goods perceived as more valuable carry a higher price tag. So if you’re looking for a thirty year fixed rate loan, and all you say is “What is your lowest rate?” you are likely to get quoted a rate from a Negative Amortization loan, the least desirable loan out there, because it carries the lowest nominal rates. If this is your only datapoint from the various loan providers you talk with, you are likely to do business with the one who quotes you the negative amortization loan, not the thirty year fixed rate loan. Matter of fact, the loan provider who tells you about the loan that you really wanted is least likely to get your business in this scenario, because you’re focusing in on the red cape of rate and payment when you should be paying attention to other things.
Third, and most importantly, for every situation and every loan type, there is more than one rate available. Why is this, you ask? It seems obvious to you: Why not just choose the lowest rate, which has the lowest payment? It takes a little examination to see why.
The difference between the rates is in cost of the loan. There will be a rate called par. This is the rate at which the lender will give you the money straight across. They don’t charge you any money (discount points) to get a lower rate. They don’t pay any of the costs of the loan. Getting a loan done really does take a minimum of about $3400 in costs (actually, the quote is for California, which believe it or not is one of the cheaper states to get everything done in – every other state I’ve done business in costs more). Whether points and closing costs are paid out of your pocket or added to your mortgage balance, you are still paying them (When shopping for a mortgage, the phrase “nothing out of your pocket” from a prospective loan provider should immediately put you on guard).
For rates below par, you must pay discount points. This is an upfront incentive to a lender to give you a rate lower than they otherwise would. Every situation is different and should be analysed with numbers specific to that situation, but as a rule of thumb: Unless you’re getting a thirty year fixed rate loan and you have a history of keeping loans at least ten years before sale or refinance, you should avoid paying points if you can. The lower payments you get, quite simply, are usually not worth the cost of adding points to your mortgage balance. People who don’t qualify for A paper may not have this option, but more people qualify A paper than think they do.
For rates above par, the lender will actually pay part or all of your closing costs. It’s rare that they will actually put money in your pocket, but it can happen. Note that this is different from a stealth “cash out” loan that adds the cash you get to your mortgage balance, charges you closing costs, and often puts a couple points on the whole amount of your new mortgage, and so where you’ve been told you’re getting $2000 in your pocket, there may be $20,000 or more added to your mortgage balance. This is where the lender is actually paying part or all of the costs of the loan, so it is neither coming out of your pocket nor being added to your loan balance. This is called a “rebate”. A rebate can be thought of as the opposite or negative of discount points, and discount points can be thought of as a negative rebate. There are never both discount points and a rebate on the same loan, although there can be origination points on loans where there is a rebate. I think that this is a material misrepresentation, but it is legal.
Now here is the critical fact that most consumers never figure out for themselves, and certainly never realize the implications of: The vast majority of people don’t keep their mortgage loans very long. The median age for a mortgage is roughly two years; fewer than 5 percent of all loans are five years or older. If you’re the exception, bully for you. Otherwise, take heed and remember this fact: Whatever costs you pay for a mortgage are sunk at the beginning. This money either comes out of your pocket, or goes onto your mortgage balance. If it goes onto your mortgage balance, it sticks around a very long time and you pay interest on it. When you sell or refinance, (or when your rate starts adjusting), the benefits stop. They are over. Done with. If you haven’t recovered the costs you paid to get a lower rate by that point in time, you have made a losing investment. Period. End of story. No chance for recovery. Matter of fact, even if you are technically ahead at that point in time, you can go negative later.
Let us consider a $270,000 loan. Very small for California, but large in most other areas of the country. As I said earlier, real closing costs of doing this loan are somewhere in the neighborhood of $3400. Here are some real options that were available from one lender a few days ago:
You could do a thirty year fixed rate loan at par of 5.75 percent. Or you can get a one point rebate at 6.25, or you can pay one point and get 5.25 percent.
Assume you roll any costs into your mortgage like most folks do. Your starting loan balance will be $276,162 if you choose the 5.25% rate. If you choose the par rate of 5.75%, it will be $273,400. If you choose the one point rebate rate of 6.25%, your balance will be $270,666. These are real examples off the first rate sheet I happened to look at.
Let’s compute the linear break evens: The 6.25% rate cost you $666 to get. You pay $1409.72 in interest the first month. The 5.75% rate cost you $3400, and you pay $1310.04 in interest. The 5.25% loan cost you $6162, and you pay $1208.21 interest the first month. Difference in cost divided by difference in interest.
6.25% versus 5.75% loan: $2734/$99.68 = 27.42 months.
5.75 versus 5.25 loan: $2762/101.83 = 27.12 months
5.25 loan versus 6.25: $5496/201.51 =27.27 months.
Actually, the break even is likely to come a month or two earlier. But let’s compute what happens if you refinance into a 5% fixed rate loan for zero real cost right at breakeven time, 27 months.
The 6.25% loan leaves a balance of $263,241. The new monthly interest charge will be $1096.84.
The 5.75% loan leaves a balance of $265,193. The new monthly interest charge will be $1104.97. The extra money on your balance costs you $8.13 per month, almost $100 per year. Plus you still owe almost $2000 more.
The 5.25% loan leaves a balance of $267,104. The new monthly interest charges will be $1112.94. The extra
money on your balance costs you $16.10 per month, $193 per year, from here on out. Plus you still owe almost $4000 more.
These are actually favorable assumptions compared to the real world in that they treat the 5.25% loan option much more kindly than it deserves compared to the 6.25% loan.
Most people have done this multiple times. $10 or $15 per month doesn’t sound like a lot, but do it a couple times and you have $100 per month, and owing tens thousands of dollars more than if you’d gotten a cheaper loan that carried a slightly higher payment in the first place. I believe in offering choices, but I also know which I recommend and choose for myself.
One point that needs to be made again is sometimes costs get built into the back end of a loan, via a pre-payment penalty. Most loan officers will not volunteer whether there is a pre-payment penalty, and many will lie even if you ask, just to get you to sign up, knowing that once you sign up you will likely consider yourself committed. This may not be legal, but it happens, and is another reason to apply for at least two loans, so that you’ve got a backup option just in case the first loan goes sour or the lender told fibs. Reading the Note carefully at signing of final documents is the only way to be sure that there is no prepayment penalty.
Caveat Emptor
Hurricane Katrina Insurance Issues
A few points as to what’s likely to happen with this.
Hurricane is not a named peril on most policies.
Fire, Lightning, and removal (i.e. moving stuff to a safer area after a partial destruction) are three named perils that are universally covered under National Association of Insurance Commissioner (NAIC) rules. You can get more inclusive coverage that insures for more perils. Here in California, the policies are standardized and homeowners have several levels of coverage to choose from (HO1, HO2, and HO3 are for single family residences in ascending order of coverages. HO6 is for individual condo owners, and the association is legally required to carry a master policy for the whole complex. There is also an HO 15 endorsement that many single family homeowners might wish to consider).
The peril likely to result in valid homeowners claims from a hurricane is wind. I actually imagine that the insurance companies are going to be fair about where there is a credible claim for wind damage. As always, some will be less so, but others will likely actually go somewhat overboard in granting claims, something like AAA did here in San Diego for the wildfires in October 2003 (They paid full amount of damages for people who were underinsured, treating it as a problem they should have caught in underwriting).
From my understanding of the situation, however, the thing that caused most of the damage is flood. This is a specific exclusion from most homeowners policies. The homeowners insurance is not going to pay – you don’t have this coverage with them. Flood is a separate insurance policy. Here is the FEMA website on the issue, and here is the explanation page one click away.
So unless people who bought flood insurance as a separate policy, they are likely not to be covered for what happened to their property,
(As a general rule, a lot of water related stuff is a big pain and and its insurance and other issues are a whole separate headache.)
On a meta-level, homeowners insurance is generally underpriced. People will not pay what it really costs, so insurance companies who sell it for some short term cash flow often get burned when there is a major event like this. In the wake of Hurricane Andrew in 1992, some insurance companies paid out what had been fifteen to twenty years worth of their entire national profits on homeowners claims. I remember at least one formerly well capitalized company went bankrupt, and many homeowners insurers left the state. All remaining companies raised their rates within Florida, some nationwide.
Homeowners insurance being underpriced sounds like a good idea, until you think a bit about what happens when you need it. Charges for insurance are supposed to be calculated to pay not only administration, but the costs of all claims as well, and for a little bit of profit even if your insurer is a mutual association like AAA (Pretty much every year, I get a policy rebate). If there’s an insufficient reserve for claims, the claims don’t get paid, and the insurer goes out of business. Not so great if that was your insurance company (Here in California, insurers are required to pay into an insurer’s insurance fund to cover this, but that typically pays only part of a claim). On a not so severe cash shortfall, the claims get paid and the insurance company leaves the homeowner’s market. Now you need another insurer, and you may not be able to get one. Without insurance, no lender will finance a property. Even if you buy it free and clear, without insurance, if something else happens you are out of luck. Nor will you be able to sell it for anything resembling a market price.
So maybe underpriced homeowner’s insurance isn’t such a great idea.
How to Take Steps to get around the problem? Well, there aren’t really any indicators which are reliable from a consumer’s point of view in this. The various insurance rating agencies can only rate apparent solidity, which is subject to a lot of assumptions that may be unwarranted in this kind of situation. Anywhere your company sits on the axis of insurance providers has its problems. A national multi-lines carrier (i.e. they do all kinds of insurance nationwide) is less likely to be bankrupted by a regional claim, but more likely to withdraw from your market in the aftermath. A regional specialty carrier (they only do one type of insurance, and may only be in one state) is less likely to withdraw afterwards, but more likely to go bankrupt. National specialty carriers and regional multi-line companies fall somewhere in between. As individuals, I’m as lost as anyone.
California has an assigned risk homeowners insurance program, called FAIR. Basically, homeowners who cannot otherwise get homeowners insurance are randomly assigned by market share to one of the insurance companies who does business in California. That insurance company must take you. The problem is that rates are high and coverage is minimal, and the risk is spread out between all policyholders. Because the assignments are based upon market share, all companies are hit proportional to the business they do. The difficulty, of course, is that people insist upon building in areas with a problem. Well, areas with a problem are cheaper, and where people can more easily afford to live, until the problem manifests.
New Orleans is pretty much a City with a Problem. It’s settling 3 feet per 100 years. Most of it is between five and ten feet below sea level. Unless we render it uninhabtable by opening up the levees and causing silt to be deposited, the problem is only going to continue and get worse. Of course, every time we’d open up the levees for silt deposit, the land would flood. This is the Horns of a Dilemma. The only way to escape it is not to rebuild, or only to rebuild where the land is solid and will support it, which isn’t very many places.
Let’s face it: The Army Corps of Engineers has done wonderful work to keep New Orleans in place and inhabitable for the last seventy years. But now that the hammer has fallen, rebuilding it would be an exercise in futility.
Disability Insurance
I have a confession to make: When I was doing financial planning, I didn’t put enough emphasis on Disability Income Insurance. I was hardly alone in this; Disability Insurance is one of the two most undersold financial products there is. The other is Long Term Care Insurance, which product I at least researched properly and sold enough of (and the exact right product, also).
An article I found the other day brought Disability Insurance, or as it is technically known, Disability Income Insurance back to me. It’s a good article and I really do suggest you read the whole thing, especially if you have a family or intend to. I have nothing but sympathy for the victims of this, and yet I would like to arm those reading with some information for preventing it from happening to them.
Disability Insurance isn’t sexy; in fact it’s damned hard to sell to the average person. Where I can sell Mutual Funds and Variable Annuities and Life Insurance all day long, it’s because the basic understanding of the benefits or the needs is present in most people in society. Everybody understands that when you’re making an investment, it is because you hope to Make Money. Everybody understands that Life Insurance is there for your family in case you are not. But this basic understanding is lacking for Disability Insurance. What they understand is that you Want To Sell Them An Insurance Policy. An Attacking Salesperson! Red Alert! Shields to maximum, Mr. Sulu! Fire Photon Torpedoes! Fire Phasers! Turn us around and head back to safe territory, Maximum Warp! Fire! Fire!
Disability Insurance is one of the red-headed step-children of the financial planning process. SEC and NASD guidelines don’t mention it; it is only when a practitioner really digs into the nuts and bolts of financial planning that you find out how important it is. I did at least get to the point where I would discuss Disability Insurance with every one of my clients who was still working.
It’s very easy to tell if you are in need of Disability Insurance. Ask yourself this question: If you couldn’t work for the rest of your life, starting now, would you have enough money to live the lifestyle you want for as long as it lasts? If the answer is “Hell Yes!”, you don’t need it. Otherwise, you probably do.
Some basic facts about Disability Insurance: It is three times more common for a worker to go through a period of disability and need wage replacement than it is for them to die before age 65. Family finances do not tend to recover well from lack of disability insurance, whereas they do from lack of life insurance. In other words, the consequences of no Disbility Insurance on a family without it are worse and longer lived than the consequences of no Life Insurance on a family without that. Surveys of what happens to families five or ten years after the death of an uninsured breadwinner are much rosier than the equivalent ones five or ten years after the disability of an uninsured breadwinner, and the latter scenario is far more common.
The federal government does contribute something to disability insurance. But within the financial planning community, Social Security Disability is famous for three things: Denial, Difficulty, and Delay. It is far and away the most difficult Disability Income program to qualify for benefits under. A private insurer would not be permitted qualifications so strict by any state. As a percentage of from those who have some real disability, the federal government denies more claims than any private insurer. The paperwork (which I have never filled out, so I’m reporting secondhand) is supposedly awful, and it takes months for a decision, and it doesn’t kick in and start paying benefits until at least five months have passed. It is my understanding that it doesn’t pay back benefits if the application and approval process takes longer than five months, either.
You cannot buy, nor should you want, disability insurance which replaces your entire income. I think that there is an actual legal limit of 70% on a single policy in California. On the other hand, disability income is (typically) tax free and you’re not commuting to work every day, both of which go a long way to stretch what you get. 50 to 65 percent is probably about what most folks should have.
There are two main types of disability policy: So-called “own occupation” and “any occupation,” differentiated by what triggers the benefits. Both require medical certification, but the “own occupation” policy makes it easier to qualify for benefits. What you are buying here is a policy that will pay benefits when you can no longer do basically the same thing you are doing to earn your money now. It is more expensive than the “any occupation” policy, but then again, you are getting more coverage. When you get an “any occupation” policy, you will not qualify for benefits unless you are unable to perform the duties of any occupation for which you are suited by education and training. In other words, if you can still work at 7-11 or McDonalds or as a receptionist somewhere, no benefits.
Other major factors in how expensive the policy will be are: What you’re doing now (an office worker gets cheaper rates than someone who works with dynamite), How much income you are looking to replace (it’s less costly to replace 30% of your income than 60%), how long before benefits kick in (a policy where they kick in after one month is going to pay more benefits more often than one where they don’t kick in for six months, and is therefore more expensive), and how long benefits last (a policy that pays benefits for two years is cheaper than one that pays until you’re 65. Take note of this – especially if you’re 63).
Disability Insurance is sold in two ways: as part of a group program, or individually. If you read the article, you may have figured out that this is a critical difference. As a general rule, Disability Insurance sold as part of a group plan through an employer is subject to ERISA, individual policies are not. This is a critical difference. If the insurance company wrongly denies your claims under a policy subject to ERISA, all you can get is the actual money you would have qualified for. No penalties, no interest, no legal fees, no court costs. I tend to look at buying insurance from a point of view of what happens if I need it. I want to make clear that most insurance companies are ethical. Nonetheless, if the most Colossal Insurance Company can lose by denying my claim is the actual money they would be on the hook for anyway, they might be going to look for any excuse to deny my claim, as they have nothing to lose and the prospective benefits to gain. If, as in most individual policies, you are the owner of a non-ERISA covered Disability Insurance policy, now there is a significant potential downside to Colossal Insurance denying your claim. If you sue and win, they’re on the hook for not only the benefits they denied, but potentially also interest, penalties, and the legal costs of the fight, a much larger number of dollars. They are much more inclined to consider your claim from an unbiased viewpoint in this case.
It is to be noted that group coverage is cheaper, for precisely this reason. But why anyone would want to pay money to buy an insurance policy that’s more likely to deny benefits when you need them is beyond my ability to comprehend.
Group Disability Insurance can have part of the premiums paid by an employer, group insurance can even be portable or convertible to individual policies, albeit with a higher premium. On the other hand, you can become uninsurable in the meantime, if for instance you contract any one of a number of diseases or conditions, some of which are terrible and some of which only set the stage for worse things to potentially happen. If you are uninsurable and lose you current policy through losing your employer, guess what? You literally cannot buy another policy. Individual policies offer more protection; once issued, they generally cannot be cancelled (there are exceptions!), and there are no worries with portability or conversion. If, on the other hand, you can only afford a group policy, better that than nothing. Like everything else in life, it is a set of trade-offs.
Caveat Emptor
atheism vs Atheism
Many people get confused between small ‘a’ atheism and Atheism.
atheists (small a) do not believe in the divine. Even as a non-christian, I may have an opinion that believes they are being willfully blind, but that’s okay. Turn it around 180 degrees, and they think I’m hallucinating – seeing things that don’t exist. The vast majority have developed an ethos that may differ from mine, but deals with what is and is not ethical behavior in a manner consistent with civilized behavior. I have several atheist friends and acquaintances. They’re willing to live and let live. We don’t have religious quarrels.
Atheists with a capital A believe with all their heart and mind (no soul, by definition) in a particular religion. According to their beliefs, followers of other religions are weak minded superstitious fools, if not actively Evil and Subversive, and they are bound and determined to bring us all to See The Truth Of Their Way. In all ways, including the presence of a deity, these people are practicing a religion of intolerance. To them, those of other religions are Infidel, and must be converted, or if that fail despite best efforts, be prevented at all costs from passing our weak-minded foolishness and Evil to the next generation. Because they are often able to camouflage their agenda behind the aegis of a country and society that is constitutionally neutral on religion, capital-A Atheists do a lot of damage. In many circumstances, they can be hard to distinguish from “small a atheists” and those of other religions who have learned to live and let live. There are only a few ways to reliably reveal capital A Atheists, and you know, until they start in on how everyone has to follow their preaching, usually no need. This is a matter of faith, and if anyone could prove their faith to be the Truth it would no longer be faith; instead it would be science and the opposite would be denial. Mostly, I consider Capital A Atheists to be weak in their faith, as they seem to be incapable of following it unless everyone else does, as well. Do not mistake them for small ‘a’ atheists, either. A small ‘a’ atheist is willing to live and let live – their faith is strong. Capital A Atheists do more damage to the religiously neutral cohesion of our society than any fundamentalist bible thumper or Islamic extremist, because their religion teaches that there must be no restraint in the pursuit of removing that Evil superstition called religion from the face of the earth. That they do not realize they do it in the name of an intolerant religion of their own is one of the supreme ironies of life I have thus far encountered.
Asset and Income Rentals
I found this article by Ken Harney in the Sunday paper.
WASHINGTON – Call it funny money for the housing boom: Now you don’t need actual cash in the bank to buy a house. All you need is somebody who says you’ve got money in the bank.
Need a hundred grand on deposit to convince a lender that you deserve a million-dollar mortgage? You’ve got it . . . even though you haven’t really got it because you “rented” it from a company in Nevada for an upfront fee of 5 percent – $5,000.
Sound bizarre? Welcome to the wonder world of “asset rentals” now being investigated by bank and mortgage industry fraud experts. It works like this: Say your loan officer discovers that you lack the financial wherewithal needed to qualify for the mortgage you want. Rather than lose your business, however, the loan officer turns to a service that offers “asset rentals.” For a flat fee of 5 percent of the amount you need, the service will verify to anyone who asks that the $100,000, $500,000 or $1 million in bank deposits you’ve claimed on your loan application documents are yours indeed.
I am sorry to say that this is not the first time I’ve encountered said phenomenon. Nor lenders. This is why assets require seasoning or sourcing. In other words, the lender requires you to show that you’ve had it and built it up over a period of time, or they want to know where and how you got it.
Most loans should not require a large amount of assets – A paper loans, the best loans of all, want one to two months Principal, Interest, Taxes, and Insurance (PITI) for full documentation (and I can usually get it reduced), or six months PITI for stated income loans. Neither of these is a large number if you’re really making the money, and they can be in a variety of places.
Some sub-prime lenders, however, will take large amounts of money in an account somewhere as evidence that you can afford the loan. These loans usually end up looking more like a propagandized No Income, No Asset loan than anything else. They don’t get the best rates and terms, even for sub-prime, and there’s likely to be a nastily long pre-payment penalty on them as a GOTCHA! The loan provider, be it broker or lender, is likely to make a lot of money on them – In California there is a thing called section 32 limiting total loan compensation to six points, which on a $400,000 loan is $24,000, and many so-called “discount” real estate agents turn around and require their clients to do the loan with them. It doesn’t do you a bit of good to save a couple thousand on the sale or purchase in order to get ripped for twenty on the loan, where it’s easier to conceal it. I can point you to many of these so-called “discount” houses who do these loans all day, but they are not loans you should want. If a friend came to me and asked for one, I’d try my best to talk them out of it.
But wait! It gets better!
This and other e-mail pitches, copies of which were provided to me by mortgage industry recipients, carried the sender name of Loren Gastwirth, identified on the e-mail as vice president-marketing for Morgan Sheridan Inc. of Mesquite, Nev. The asset rental attachment carried the name Independent Global Financial Services Ltd., with an address in Las Vegas.
… to a Zexxis Co., with the same Mesquite, Nev., address on Loren Gastwirth’s Morgan Sheridan card. When I called the number listed for Gastwirth, I received no reply, but instead heard back from a person identifying himself as Allen Paule. Paule is listed in corporate filings with the Nevada secretary of state as the “registered agent” for Morgan Sheridan, Independent Global Financial Services, and Zexxis Corp.
Paule said the asset rental and employment pitches – including downloadable attachments and forms carried on Morgan Sheridan’s Web site – were not connected to his firms. He said, “somebody hijacked our Web site.” He confirmed that a Loren Gastwirth works for Morgan Sheridan. And he also confirmed that Independent Global Financial Services, Morgan Sheridan and Zexxis Corp. have overlapping ownership and management. According to Nevada corporate records, a Paul Gastwirth is listed as president and director of Morgan Sheridan.
The Web site of Vault Financial Services Inc. of Las Vegas lists Paul Gastwirth as CEO of that firm, and president of Independent Global Financial Services, “a company specializing in asset rentals and enhanced credit facilities for individuals and companies worldwide.”
In other words, they are playing a Nevada Corporation shell game. A long head swallowing tail chain of corporations, each of which is likely to be a shell set up to insulate criminals from the consequences of their actions. The stuff about “somebody hijacked our web site” is almost certainly bogus.
but it gets better yet!
That’s where the asset rental service’s “VOE” (verification of employment) program comes in. Essentially you indicate on a faxed form what annual or monthly income you or a home buyer client needs to qualify for a mortgage, and the asset rental company will verify to anyone who asks that you have been paid those amounts.
The cost: just 1 percent of the claimed annual income. “For example,” says the pitch, “$100,000 of annual income – cost of $1,000. Minimum is $50,000.” The e-mail came with attachments that directed payments for asset rentals and employment verifications to an account number at Wachovia Bank in Roanoke, Va
In other words, they’re also volunteering to help you circumvent one of the most basic protections to the whole process, making sure for both the lender and the borrower that the borrower can afford the loan. If you cannot afford the loan, you are probably better off without it, although many people don’t realize that this requirement is partially for their own protection. If you can’t make the payments, you’re going to get foreclosed on. If you get foreclosed on, you’re likely to lose everything you put into the house and get socked with a 1099 form which the IRS will use to go after you for taxes as well.
Lest you not have realized this by now, all of this is FRAUD. Serious, felony level FRAUD. Lose your home and go to jail FRAUD.
I’m going to share a little secret with you, widely known within the industry but not in the general public. That real estate agent or loan officer getting you your house or your loan may not be the brightest financial lightbulb in the world. Many loan companies and real estate offices select for this, usually by only hiring people who have never been in the industry before. Some of them are even among the biggest names in the business. They select for sales ability and “make sales” attitude, not the knowledge (and more importantly, willingness) to say, “Wait a minute! Something is not right here!” Especially when it may cost them a commission. And hey, if the companies involved lose a few low-level sacrificial victims to lawsuits and the regulators, that’s no skin off the owners’ noses and they still get commissions out of it. These schemes are pitched to the agents and loan officers as a way to “save” a client. Sounds like it’s in your best interest when you put it that way, right? It is not. The bank discovers this (and Nevada Corporations, among others, are a red flag that loan underwriters look very hard at) Most of these deceptions are discovered before the loan gets funded – meaning that the client they were helping to commit FRAUD wasted their money, and they have a case against the agent and employing broker, whose insurance will probably not cover the issue.
The ones that do get funded are even worse. When the bank discovers the FRAUD, they have a right to call the loan. This means you have a few days to repay the loan, or they take the house. All of those wonderful consumer protections the federal and state governments have enacted become mostly null and void, because you committed FRAUD. You can count upon losing all of your equity in the home, and getting thrown out with nothing. Furthermore, depending upon company policy of the lender, you may find yourself sued in court, and possibly even under criminal indictment. Judgements for FRAUD are nasty, and they don’t go away. Convictions for FRAUD can really mess up your life completely and forever, not just in applying for credit, but in employment and other ways as well. If your loan is sold to another lender before the discovery happens, the probability rises even further, because the new lender is going to sue the old lender, who is going to take action against you as part of a defense that says they were acting in good faith. The shell corporations that pretended you worked for them or had deposits with them will be long gone (or untouchable) of course. You may have a claim against the agent, loan officer, broker or possibly even original lender, but if someone else beat you to it or they are out of business for some other reason, good luck in actually collecting.
In short, relying upon an agent or loan officer as an expert without doing your own due diligence is likely to get you in hot water. As good rules of thumb: Never lie. Never allow someone to lie on your behalf. No matter how desperate you are, it’s likely to buy a lot more trouble than it’s worth.
Caveat Emptor
Production Metrics versus Consumer Metrics
When I originally wrote this, every day I was passing by another real estate office where the agent had a big banner outside “I SOLD 101 HOMES IN 2004!”
This is what is called a production metric, and this one sounds fairly impressive at first glance, right?
The question I want to ask is how good the price was for the seller. Anybody can sell homes quickly by pricing them 10% under the market. Last year’s market was a hot seller’s market. In some neighborhoods, a monkey could have sold it for $20,000 over the asking price.
Is there a general “did you sell it for a good price?” metric? Not really. The best I can come up with is whether the appraiser has difficulty getting value to support the sales price so the loan can fund. If the appraisal comes in less than the sale price, the loan will be based off of the appraised value, rather than sale value, and so whereas this is always a difficult situation to be in, that your sale in in this situation says that your agent really did get you a good price. It’s comparatively rare, and with the buyer’s market we have now, practically non-existent.
Production metrics of this nature are easy to game. When I worked in the financial planning business, the metric used was GDC – Gross Dealer Compensation. How much your firm got paid because of your work. Problem was, it always has two components: how much business you really brought in, and how much turnover there is in your clients accounts. I know people who work at the “no load” fund houses, also. That’s their metric as well.
It’s a good metric to have. Firms that don’t get paid enough, don’t stay in business. But, as a consumer, it’s not precisely the sort of metric you want your financial planner to be judged on, and neither of these components measures anything important to you. Actually, I take that back. If there’s a high ratio of turnover in the client account, it’s always bad. There’s always the temptation to call an existing client and sell them the “hot new investment” than it is to generate new business. If I was shopping for a planner, I’d look for a low ratio of Gross Dealer Compensation to total assets under management.
Matter of fact, there really isn’t a metric in the investment world to measure how good an investment person is on any objective scale. What I’d really like to know is something like the return on investment of their lowest 25 percent of clients and highest 25 percent of clients, and compare that market averages and each other. This would tell me things like “How much (of any gain or loss) is the environment of the market, and how much is them?” and “Are they giving consistent advice?” (Low spread = yes, high spread = no). And not one firm I’m aware of computes this information. Not to pull any punches, what they are all set up to reward is sales ability, not investment genius.
The same can be found in real estate. There are any number of production metrics, but none of “Did Agent A’s clients get the best price?”, or on the purchase side “Did Agent B’s clients pay no more than they needed to?”
Nonetheless, here are a couple of other ideas. If everything I sell is bought by real estate agents acting for themselves, it’s not a good sign. The average real estate agent is buying property because the price is below market. They think they can re-sell for a profit, and it’s usually not a little one. They’re probably not interested in the property that doesn’t have immediate equity built in.
If everything I sell is back on the market within a few months for a higher price, that’s also not a good sign. That also means it was probably priced below the market.
The agent I talked about at the beginning of this article? I picked up a flyer listing about a third of those sales (thirty-two). Then I went to MLS and did a little search. Over half (18) were back on the market within 6 months for much higher prices. Almost forty percent (12) of total number of new owners identified themselves as being owned by licensed real estate agents on the listing. Seven been subsequently resold for at least a 10% profit, closing within three months of the original sale, even in what became a softening market. Only three are still active. The rest have sold, all at a significant profit, even in this market.
So now tell me, does this agent’s “101 houses sold” seem like something that would cause you to want to do business with them?
Didn’t think so.
Caveat Emptor
How to Use The Consumer Information Here
Yesterday, I checked my referral logs and found an article where somebody was essentially saying “If you want to be depressed, go read this site and then go rent somewhere for the rest of your life”.
I can understand where the sentiment is coming from, particularly if they were of the sort of person who wants to meander around occasionally looking at houses until they find one they like, then sign a couple of papers and move in. Lest it not be obvious to you, these are the elements of disaster. I would never put an offer in without looking at at least ten to fifteen properties in the area, without aggresively shopping the mortgage market, or without taking positive steps to insure that I have at least as much leverage over the service providers as they do over me.
The fact is that for most people, the largest transactions of their life are all going to be real estate related. When the average transaction is in the hundreds of thousands of dollars, and those transactions are so complex as to defy understanding by non-professionals, you have the elements for a system that’s going to suffer abuses. Many past abuses have been corrected through the passage of legal impediments, but many others remain, and some are illegal but keep happening anyway (See my article on “What to beware in Third Party Services linked at the bottom of this article).
What I am trying to do here is give you the insider’s appreciation for what goes on (although not the professional’s specialized knowledge. It may not be “rocket science”, but to pretend you can pick up everything a working professional learns and gets exposed to every day by reading a few articles would be false, and of no service to you). With this information, you can debunk the worst of the nonsense that you are told and get a better bargain for yourself no matter who your real estate agents and loan providers and financial planners and whatnot are. I am writing about knowledge that you need to have to understand the system, and I’m not pulling any punches about what goes on, anywhere in the transaction. I’m trying to show you limitations and blind spots in the information you may receive, and show you strategies that put you in a stronger position. Most of the articles I have written thus far pertain to real estate and mortgages, but this applies to other areas I intend to work in as well.
So if you’re the sort of person who prefers to go on in an “ignorance is bliss” state of mind, the education may be disturbing. Indeed, many people seem determined to go about their real estate (and other) transactions in this state of mind. They resist when I attempt to educate them in the realities of the market, figuratively in the same vein as people who put their hands over their ears and say “la-la-la! I am not listening! la-la-la! I am not listening!” It’s like they want to get taken, or at least not having to think about it is worth more to them than the money they’re being taken for. Since the money they’re being taken for can easily go into five figures whether it’s a purchase or a refinance, I find this difficult to believe. If you’re making that much, you shouldn’t need a loan.
Nobody does loans for free. Nobody does real estate for free (nobody does financial planning for free, legal advice for free, etcetera). “Free” is likely to be the most expensive service of all (This is different from at such a rate that yield spread pays all costs). If you’re of the school that forewarned is forearmed, what you’re reading here should give you the information you need to guard yourself against the deceits in the system. I’ve done lists of “red flags,” warning signs not to do business there, “Questions to ask” that you can print out and take with you, “Salesgoodspeakian to English,” debunking of pat phrases used to mislead you and what they really mean. I’ve given you strategies (apply for back up loans, order the appraisal yourself, don’t sign exclusive buyer’s agreements, etcetera) that give you more leverage down the line. I’ve gone through what real closing costs are, what points are, and warned you of the dangers of shopping for loans or real estate by what they tell you the payment will be. Most importantly, I’ve shown you how to keep control of your transaction by being aware at the start of the process what the likely bumps are going to be.
Not everyone in the business does everything I’ve warned you about. There are ethical providers out there; people like myself who will walk away from business or tell clients the pitfalls if something is not in the client’s best interest. You can find us if you look for us. Nor are those who practice otherwise necessarily evil. Real Estate, financial planning, and many other fields are set up such that someone new in the business learns from somebody experienced. In many cases, they’ve been told “This is the way things are,” and they just don’t know any better. The person who taught them didn’t know any better. It is my aim to ensure that people “know better.” The change is not going to come from within the industry – the system is set up for their best advantage, and any one agent or loan provider unwilling to toe the industry line is at a competitive disadvantage, and their business is likely to fail. It’s kind of the tragedy of the commons: their own individual behavior shows them nothing to gain, and everything to lose, by full truthful disclosure, and where there are people who do it anyway, we are comparatively few. Therefore, the change must come from outside the industry. So by being knowledgeable consumers and helping yourselves, you provide impetus for practitioners to reform their practices for everyone. It may take a long time, and it may never be complete, but if it’s never started I can guarantee it won’t get done.
Exclusive versus Non-Exclusive Buyer’s Agent Agreement
From an email:
I was in the process of buying and selling the house when we saw a FSBO house we liked was for sale. But sale fell through, which is a good thing anyway because of contigency on our house. But I also suspected it failed ecause the seller refuses to pay commission to our buyer agent.
My question is that this real estate agent that would represent us as a listing agent is also a buyers agent. However, I had another friend look into the contract and the buyer’s agent agreement is valid until December 31, 2005. So that means anytime we find a house, he will be paid? We do the work to find a house and he gets paid? It didn’t strike to me as ethical or fair. It will simply takes us off the real estate market until January 1, 2006 when we can start all over with a clean slate. Correct?
We don’t think it should’ve been in effect until December 31. It should be in effect only for that FSBO house we liked, and if the deal falls through, then his job as a buyer’s agent also stops.
Am I dealing with a greedy real estate agent or is this typical?
Can I have one agent to sell our house and another agent that represents us to buy a house?
This depends upon the nature of the agreement you signed with him. I use non-exclusive buyer’s agreements, which basically say that if I introduce you to the house, then I get paid when you buy it. Others use exclusive buyer’s agreements, where they get paid no matter who finds the house.
If I have an exclusive buyer’s agreement with you, then I am going to get paid on any house you buy. If I have an non-exclusive agreement, I will only get paid if I introduce you to the house, and you may have any number of non-exclusive agreements in effect as long as you are careful to inform each agent you are working with that you have previously been introduced to a given property, and therefore, any commission that takes place will be paid to the other agent. All of the forms used by California Association of Realtors state that you will pay a commission to the agent if the seller won’t, so an agent has comparatively little stake in which house you buy, as long as you buy one through them. This gives them the largest possible incentive to work on your behalf, without binding you to one particular agent who rather be working with another client who came along with a bigger budget, and therefore a bigger commission in the offing. When looking for homes to show, ethical agents won’t seek out a For Sale By Owner (FSBO) for reasons I go into near the bottom of this article (basically, protecting your pocketbook), but these do not apply if you, the client, choose to make an offer on a FSBO.
I suspect that you signed an Exclusive Buyer’s Agent Contract with him, something I would not do unless he’s providing you with lists of foreclosures or something. Once such a thing is signed, that agent is going to get paid no matter what house you buy during the agreed upon period. I would never agree to either a listing or buyer’s agents period longer than six months. This gives the agent plenty of time to sell your house or find you one. So if the agreed upon expiration is six months from now, then if you buy before then, that agent will be paid – out of your pocket, if not the seller’s.
There are two competing factors here. One is your desire not to pay for services not provided for this particular transaction, versus the agents desire to get paid if they actually do the work anyway. If they serve as your negotiating agent, or help expedite the transaction by providing services, they are ethically entitled to be paid whether or not they introduced you to the property. On the other hand, if all they do is obstruct, there is neither a legal nor an ethical reason why they should be paid. Depending upon the nature of their obstruction and how much it cost you, you may wish to contact an attorney to recover, or your state’s Department of Real Estate
Sad to say, there are agents out there looking to line their own pockets in any way they can. A better agent wants to get paid, but realizes they will make an excellent living – better in the long term – by putting your interests first. Without more evidence, I cannot say for certain, but it appears at first glance that this agent had you sign an exclusive buyer’s agent agreement in order to represent you in a transaction you found. I am not aware of any regulation prohibiting this, but it does seem like it’s excessive from a neutral viewpoint. It is probably not voidable, however.
There are standard California Association of Realtors (CAR) forms for both exclusive and non-exclusive buyer’s agents agreements. Look up at the title of your copy. If it says “Exclusive”, you are stuck with this person. If it says “Non-exclusive” you may do business with anyone you please, as it applies only to those properties this particular agent works on. Of course, many agents and brokers use non-standard forms for this, as the standard CAR forms are readable and understandable by anybody. If they want to throw curves, non-standard forms are one of the best ways to do it.
As to whether you are dealing with a greedy agent or if this is typical, the truth lies somewhere in the middle. As in all sales occupations, the idea of locking up your business creates powerful motivations for them to have you sign exclusive agreements. There are nonetheless, people such as myself who feel that if I am not helping you, I don’t deserve to be paid, and let someone else have a shot. But if I’ve got an exclusive agreement with you, I should be providing daily foreclosure lists, copies of all new listings, or at least something that goes above and beyond sitting on my hands.
Many agents want you to sign an exclusive buyer’s agent agreement before they do anything else. Unless you’re getting something special out of it, you shouldn’t sign one at all. Offer to sign a non-exclusive buyer’s agent agreement – that way you have leverage over them, not them over you. They are motivated to work for you and find you a property that is attractive to you at a price you want to pay, because if they don’t, someone else will. Even the best agent can’t find stuff that doesn’t exist, like a 3 bedroom home in La Jolla for $250,000, but if it does exist I’m going to work to find it first, and I will get paid for it because our agreement says I will get paid if I introduce you to it. If you have signed an exclusive agreement, there is no particular hurry for them to help you.
Finally, listing agreements for sale are (in general) individual agreements for a particular piece of property for a particular period of time. As long as there is no more than one listing agreement per property in effect at a time, you can have any number of different agents for sales, even if you have signed an exclusive buyer’s agreement for purchases.
Please let me know if this does or does not answer all of your questions.