Searchlight Crusade

from an email:

On a related note, I hope you might have some advice for us. My husband and I just sold our condo. But we are NOT buying at the moment. Instead we are renting. (Not sure where we are going to be 6 months out and buying does not sound like a good idea until we are settled again.) So we are spending a small part of the profit off the sale on retiring the only credit card debt we still have and putting the rest in a money market to earn interest until we can use it as a down payment on our next house.

However, with no credit card debt and no mortgage (and one car loan that will be paid off in about a year) I am afraid that by the time we buy a house, we won’t be considered good credit risks because of not having loans we are paying on.

We DO have a credit card that we put some charges on and pay off every month. Is that enough? Or is there something else we should be doing now to make sure we remain credit-worthy for a mortgage loan?

We will be renting an apartment. Does that show up on the credit report?

In general you want to have two open lines of credit to have a credit score. This doesn’t mean that you necessarily have to have a balance on either of those lines of credit.

What you’re doing seems fine and like a good idea. It’s a rough market; I probably wouldn’t buy right now unless I knew I was going to stay (or keep it) five years or more. In general, rent does not show up on a mortgage provider’s credit report. It probably will not count as an open line of credit.

The card you use, which I gather is what you use to maintain credit, needs to be an actual credit card, which appears to be the case. If it is a debit card, it doesn’t count as a line of credit to determine whether you have two open lines of credit or not. If it is indeed a credit card, you’ve got one existing line of credit that you’ve had for a while. Keep it open, keep paying it off every month. This helps your credit score even if you never carry a balance.

However, instead of closing the (other) credit card you have a balance on, may I suggest that you simply pay it off but keep it open? Unless it has a yearly charge just for having it, it costs you nothing to keep it in your safe at home. This gives you one open line of credit, and because you’ve had it for a while, this is better than a new line of credit (length of possession of open lines is one factor determining credit scores, and over five years is best). You might want to use it once per six months or so just so they don’t think you’ve cancelled. As long as it’s a regular credit card where if you pay it off within the grace period there is no interest charge, and that’s your second open line of credit.

You also currently have a installment payment operative, which is fine as long as you keep paying it on time. Depending upon how much you’re getting in interest on the money market, it may behoove you to ask for a payoff. If the money market is getting two percent taxable and you’re paying five on the installment debt (not tax deductible), you may wish to consider paying it off. On the other hand, if either of the two above cards is a debit card, this is your second line of credit, so keep it open long enough to get something else.

I live in San Diego, which has several big credit unions, and I’ve had good experiences having my clients apply for credit cards with most of them (they’re also a decent source for second mortgages and home equity lines of credit – that’s where they’re set up to compete best – but first mortgages I can usually beat them blindfolded, because it’s not where they’re set up to shine). There are also any number of available offers on the internet, but check out the fine print carefully. Credit Unions may not be absolutely the best credit cards available, but they tend to be shorter on the Gotcha! provisions.

(Internet searches for credit unions in Los Angeles turn up fifty or more; in the Bay area a similar number. You need to do your due diligence and you may not be eligible to join most, but I’ve found it worth doing as opposed to doing business with the major banks and credit card companies that advertise like mad. The money to advertise doesn’t come from nowhere.)

This should help you make informed choices as to what to do given your current situation to maintain two open lines of credit and a good credit score. Please let me know if this does not answer all of your questions or if you have any further questions.

Caveat Emptor

One of the questions we ask all the time is whether to do your financing as one loan or two loans. Until comparatively recently, one loan was the default option, but people have been learning that splitting their home financing up into two loans can save them significant amounts of money.

There is significant resistance to the idea of having two mortgages on the part of some people. I have never had a conversation where somebody came out and said why they didn’t want to split their mortgage into two pieces, but I can offer some hypotheses. Two loans is two sets of paperwork, two checks to write, twice as much paperwork to fill out and twice as many things to keep track of. If I can’t show them concrete benefit, they don’t want to do it.

In the cases where equity is or is going to be less than 20% of the value of the house, this is not difficult. Sometimes if the client is in a subprime situation anyway, a loan between eighty and ninety percent can sometimes be marginal, but loan amounts at or above ninety percent of the value of the home is pretty much universally better as two loans.

To illustrate why, let us consider a $300,000 home with a $300,000 loan. Let us posit that your credit score is dead average (about 710), and we desire a Full documentation 30 year fixed rate loan for the primary loan, and a thirty day lock, and that this is purchase money.

I’m pulling down a price sheet on a random “A paper” lender from my deleted files, and pricing accordingly. Since A paper price sheets change every day, this is intentionally stuff I can’t (exactly) do right now, used as an example lest somebody in the Department of Real Estate otherwise construe this as a solicitation. Furthermore, I’m pricing at “par”, no discount or rebate.

If we do it at par, this would have been 6.375%. To this would be added a charge for PMI of about 2.25% on the entire value of the loan, making your effective rate 8.625%. Furthermore, the PMI component is not deductible. Your payment is $1871.61 plus $562.50 PMI for a total of $2434.11, or which only $1593.75 is potentially tax deductible. If you want to make it deductible by adding it into the rate, the payment goes to $2333.36 with potential tax deductions of $2156.25, so that’s a benefit right off, but you then have to actually refinance in order to get rid of PMI as opposed to having it removed automatically if and when your home value appreciates sufficiently. Nonetheless, most people do refinance so I’ll assume this is what you do.

Now let’s price it out as two loans. Par is 5.875 percent for the 80 percent loan. Doing the second as a 30/15 gives a rate of 8.75. This means it’s thirty year amortization, but the balance is due in fifteen years as a balloon – so you either have to pay it off by then or refinance by then. Nobody does 30 year flat fixed rates on 100 percent seconds at any kind of decent rate. Better to do is as a 30/15 second. Doing it as a variable rate home equity line of credit gives a rate of 8.75 also.

The payment is $1419.69 on the first, fixed for thirty years, and $472.02 on the second. Total payment $1891.71, potential tax deduction $1175.00 plus $437.50 for a total of $1612.50.

Comparing the one loan versus two loans directly, and assuming you’re in the 28 percent marginal tax bracket with standard deduction of $9600 and assuming your other deductions of $5000 and you did get to deduct 100% of mortgage interest, for one loan you get a tax savings of $5975, plus principle paid down of $2211 – but your total payments are $28,000.32 over the year. Net total cost to you is $19814. For splitting it into two pieces, you get tax savings of $4130, remaining principal paid down of $3448 total, and total payments is only $22,700. So your net total cost is $15,123 – a savings of $4691, plus you owe $1237 less next year, on which you will pay $74 less interest.

So you see, there are concrete advantages to having your loan split into two pieces.

Loan officers, however, typically get paid either zero or a flat fee for the second mortgage, whereas they get a percentage for the first mortgage, so they may be motivated to sell you on doing one loan to increase their compensation. As you can see, this is not usually in your best interest. Matter of fact, if your loan is above the conforming loan limit, it can be beneficial to you so split it into a conforming loan and a second for that reason alone. If you shop around, you increase the chances of finding a loan officer who will do the loan from the point of view of what works best for you, rather than what best lines their own pockets.

Caveat Emptor

From an e-mail:

I live in (City 1) and recently signed a work order on a semi-custom new contruction house in (City 2). My wife and I make a combined 120K income and still can’t afford a decent place in City 1. It was preapproved rather quickly from both the builder’s mortgage company and a few outside companies and everything was moving along splendidly, until my employer decided to refuse to transfer me (something we had mutually decided on back in April). To make a long story short, the house will be built and ready to close in early November and 2 of mortgage companies are asking for a Relocation letter from my employer. Seeing as how I make 66% of the 120K combined salary, my plan is to tough it out here until I find (1) a job in City 2, or (2) a job here that will transfer me to City 2. My question is, if I can’t supply them with a relo letter am I dead in the water? Do I have to scrap the loan (primary residence) and try to get a second home or investment loan? The broader question here, is how critical is any piece of documentation? Obviously W-2s and bank statements can be deal breakers, but what about the other stuff? I.E. relo letters, proof of homeowners dues, etc etc.

First off, you have an obvious potential issue with your current employer. If your work order was predicated upon a promise of transfer, you may have a case against them if you want one for the amount of any money you’re out. Consult an attorney, preferably one that is licensed in both states. Obviously, this poisons the atmosphere, so you may not want to. On the other hand, you may have decided by now that you are done with them one way or the other.

Second, getting to the item of contention, the relocation letter. Every lender’s guidelines are different. You didn’t say how many lenders you had applied with, but few people apply for more than two loans. Any item the underwriter asks for can be a deal-breaker, especially if you can’t provide it. What the underwriter is looking for is a coherent picture of someone who is going to be able to repay the loan. If the loan underwriter doesn’t see a coherent picture of you being able to repay the loan under the circumstances it was submitted under, the loan will be declined. The underwriter can ask for anything they want. They can ask for proof your father gave birth to identical triplets, if they think it has some bearing on the loan. If you cannot furnish them what they want, and your loan officer can’t shake an alternative or an exception out of them, the loan is dead.

Now they’re not likely to ask for proof of something impossible like my example. Everybody has a biological father, so it’s not discriminatory on the face of it. They’re certainly not going to violate anti-discrimination lending laws by asking for something based upon race or sex. However, if the underwriter approves loans that go sour, they can expect to be held accountable by their employer, and so they require and are permitted a certain degree of necessary latitude on additional requirements in order to do their jobs. If I tell an underwriter that I make $2 million a year in the stock market, I’d better be able to furnish proof. If it’s not relevant to the loan, I should keep my mouth shut about it because it’s asking for trouble. Never tell an underwriter anything not absolutely necessary for loan approval.

It’s a horrible lie about people from Missouri, but I tell people to think of underwriters as Missouri accountants. Their favorite sentence is, “Show me on paper.” All loan approvals are based upon the potential borrower and their current status quo. In other words, the situation as it is, not as you hope it will be someday. Yes, when doing Verification of Employment they ask about prospects for continued employment, but that’s just to establish that the employer isn’t willing to admit they’re about to fire you. They know that in the real world, people get told “Yes, we’re going to keep X here forever” and next week X is applying for unemployment.

What the underwriter is looking for is a coherent picture of you occupying the property and working at your current employer. You’re working in City 1 and living in City 2, which are not within daily commuting difference, but you applied for the loan as intending to make it your primary residence.

Given that they are requiring a letter of relocation, you have several options. I know it has happened in the past that employers who were not willing to relocate employees were nonetheless willing to write letters that said they were. This is stupid. This is fraud, and if the loan becomes non-performing the employer could potentially become liable for whatever the lender lost, not to mention that a lot of your protections as a consumer go out the window. Second, they could sign a letter that says you are going to be telecommuting from your new home. Yes, your job is in City 1, but you could legitimately be living in City 2 and still employed and doing your current job. Bingo, happy underwriter (probably). If your loan officers aren’t complete idiots they will have asked you about this, so I presume the answer is no.

So now we’re bringing in other issues as well. Now you have a husband living in City 1, while the wife and new home (and I presume wife’s job) are now in City 2. Fact: husband needs a place to live in City 1. “What’s that place to live going to cost him?” they ask. They take this answer and add it to the previously known total of your other monthly payments. Because you now have more in known monthly expenditures, now you may not qualify for the loan you were “pre-approved” for. Now, pre-approval doesn’t really mean diddly-squat, and the developer knows it, so they likely required at least a decent sized deposit from you, so if you don’t get the loan, you don’t get the house, and you may have a substantial forfeiture. See my first paragraph. Furthermore, some underwriters may see a potential divorce situation here, so they may ask for some kind of testimonial from third parties that you’re not getting a divorce.

Now, if you had a decent agent, he likely wrote your offer “contingent” upon your relocation. Unfortunately, if you’re buying from a developer, your agent probably works for the developer, and so didn’t do this. You may or may not have a case against the developer and the agent. Consult an attorney, but this is one area of many where buyer’s agents really pay off.

(Even if they’re inclined to trust me, I do not want to represent both sides in a sale, and will usually insist that one side go get another agent, or at least sign a release indicating that they realize I am working for the other party, not them, and have no responsibility as to their best intersts. As your experience indicates, too many actions are a potential violation of fiduciary duty to one side if you do them and to the other if you don’t. There are some agents who get greedy and do both sides, but usually they make their attorneys very happy. If your agent wants to do both sides of the transaction, that’s never a good sign.)

However, what I suspect you really want is the house and the loan you signed up for. So I’m going to go on that presumption.

You make $10,000 per month. You may be able to get a friend to rent you a room in their home in City 1 for fairly cheap, so that there is not enough difference so you don’t qualify for a loan. Several years ago before I met my wife, I rented a room out cheap to a friend who was in a situation not too different from yours. “A paper”, you are permitted up to about about a forty-five percent debt to income ratio, and it can go higher if you have a high enough credit score such that DU or LP (Fannie and Freddie’s automated loan underwriters) will buy off on it.

You could go to a different loan type, carrying a lower rate and hence a lower payment. Unfortunately, the debt-to-income limits on these are lower. Unlikely to work.

You could go to a “second home” loan. Unfortunately, the standards on those a a little tighter, and there may be an additional fee of a quarter point or even a half, and you’re still going to have to show the underwriter a residence in City 1, which means the payment qualification issue raises it’s ugly head here, also.

Finally, you can go to a subprime lender (where maximum Debt to Income ratio can be higher) or do a “stated income” loan. If you were working with a broker’s loan officer as opposed to a direct lender or packaging house loan officer, either would be no sweat – you might not even have to do another application. The broker would simply withdraw your loan package and submit it elsewhere. Unfortuantely, from a subsequent email, I know that you’re not working with any brokers. Well, the developer probably has a subprime lender on tap as well, so that may be a low stress option. On the other hand, if they are a different branch of the “A paper” lender, they may not be able to do your loan either. Or, if you’re lucky, the developer is acting like a broker in the first place rather than a direct lender.

One of the great rules of the business is that you cannot go from a higher documentation loan to a lower documentation loan on the same borrower at the same lender. If I submit to lender A “full doc,” I cannot then later submit it to the same lender “Stated Income.” The reasons for this should be fairly obvious, and this is a no-brainer without exceptions across the business.

For brokers, because the paperwork is in their name and not the lenders in the first place, this means no new reports. But since you’re not working with brokers, what this means is that you’re likely to need a completely new set of reports from the appraiser on down in the new loan company’s name. This may be done on a retyping basis if you are lucky (see my essay on appraisals), or you may have to pay for completely new ones.

I strongly advise you NOT to quit your job, unless someone a lot more familiar with your situation and prepared to take the consequences of being wrong tells you otherwise. Here’s why: You quit your job. Now you are unemployed. It does not matter if you’ve been doing what you’re doing for forty years. You are unemployed. As things currently sit, you do not qualify for the loan. Even if you’ve got a written offer of employment somewhere else, many lenders will not approve the loan until you have a paystub to show for it. Since this means waiting several weeks at least, it’s almost certainly outside your window of opportunity.

One final issue: here in California, it’s illegal for a developer (or anyone else) to require that you do the loan with them in order to get the property. But it happens anyway (I’ve been told point-blank by more than one developer’s agent that if the client doesn’t do the loan through them, the purchase contract will be cancelled. Many others won’t tell you point blank, but they throw obstacles up until you give up on the other loan), and it’s a long hard slog to prove legally and it costs you thousands and you still don’t get what you really wanted in the first place: the house you signed an order for. I am not certain the practice is even illegal in City 2, where you’re buying (although from some things I’ve heard about that state’s practices, I think it’s probably legal). So you probably want to be certain you’re not fighting the developer on this by finding your loan elsewhere. Unfortunately, you’ve already (probably) put a deposit down and you said in subsequent email that the home has appreciated while it was being built, so the developer has incentive to throw roadblocks in your path. Your transaction falls through and not only do they get to keep your deposit but they can turn around and sell the home for more. Preventing this kind of nonsense is what buyer’s agents are for (it also gives you someone easy to sue if something goes wrong!). Unfortunately, most developers will not cooperate by paying a commission to buyer’s agents for precisely this reason, which means that the average buyer will decline to pay an agent out of their own pocket and try to do the transaction on their own, which leads to situations like this.

Best of luck, and if this does not answer all of your questions, please let me know.

Here’s another advertisement that I’ve gotten in the mail within the last few days:

“Pick a Pay, Any Pay!’ The Revolutionary Option ARM!”

“Start rates as low as 1%!”

Loan amount $100,000 Payment $321.64
$200,000 $643.28
$300,000 $964.92
$400,000 $1286.56

Could this help save you money?

Let’s see, given the real rate on these, there is negative amortization of about $500 to start with per month on the $300,000 loan, compounded over the three years the pre-payment penalty is in effect. Cost me $19,000 to save this money – even if the underlying rate doesn’t rise. Not counting what it costs to do the loan. Or I refinance out of it and pay a pre-payment penalty of about $9200.

Doesn’t matter the friendly sounding name you give it. An option ARM is a Pick-a-pay is a negative amortization loan.

What this guy (in this case) is hoping is that you’ll be so enticed by this “low payment” that you won’t ask questions. These are easy loans to sell to people who don’t understand them, and impossible to those who do unless you’re the person it’s really designed for. Indeed, many prospective clients do not want the problems with this loan explained to them. It’s like they’ve chosen to be insulated from reality for a time.

But this is no surgical anaesthetic. Most folks are going to want to be homeowners for the rest of their lives, and unless your income has increased commensurate with your loan balance (and prospective interest rate increases) I guarantee you that the pain will go on for quite a long time after the time of “affordable low payments”. I’d rather not shoot myself in the foot in the first place.

You could also lower your monthly payments. Free yourself from high interest rate credit cards and debts with a loan that could reduce your monthly payments by hundreds of dollars and leave you with enough cash to buy a car, remodel, or pay property taxes. And don’t forget that mortgage interest is usually tax deductible. So you could save more at tax time.

This is all true – and only a part of the story. Remember that the easiest way to lie is to tell the truth – just not all of it. What they’re selling you is the seductive “cash now – pay later”. This was how you probably got into the situation they’re talking about. What most people do is then take the money out and spend it, and then when the payments get to be too much, refinance again. What are you going to do when the overall payments get larger (again) next time. What are you going to do when there’s no more equity? What are you going to do when you can’t afford the payments?

The consolidation refinance can be a real financial lifesaver, if you do it right, have a plan, stick to it, and pay everything off, or at least pay your mortgage down below where it was before you go acquiring more debt. Fiscal responsibility is not what they’re selling here.

You’ve earned a 30-day break from payments!

By rolling it into your mortgage, where you pay points and fees on it and the loan provider gets a bigger commission because of it. There is no such thing as a free lunch! You’ll be better off if you stop looking for it. The bank is never going to give you one day that is truly free from interest, much less thirty. And because you don’t make a payment now, you will be paying more later. Probably much more.

You’re probably going to see a lot of recurring themes when I do these quasi-fiskings. That’s because the lenders and real estate agents and everybody else keeps advertising the same misleading nonsense over and over and over again, they just say it in slightly different ways. As far as I am concerned, anybody who sends out one of these ridiculous things deserves to have their name engraved on my personal blacklist of people I will never do business with. I hope for your sake that you feel the same way.

Caveat Emptor

There’s a lot that gets written on this subject, mostly by loan officers looking for business. Well, don’t think I’m not looking for business, but not with this post. Or if anybody calls me because of this, at least I’ll know they understand how to do it right.

The basic come-on is this: Your home has appreciated in value, and is worth more than you paid for it, so now you have equity on the one hand. On the other hand, you have loads of consumer debt, which is costing you hundreds or even thousands of dollars per month, which is impacting your lifestyle. So you borrow on the equity in your home and save money on your payments as well as causing them to be tax deductible in most cases.

Let’s illustrate with some numbers. Let’s say Arnie and Annie have a $300,000 loan on a home that they bought six years ago, and comparable properties in the neighborhood are now selling for $600,000. This is 300,000 in equity.

On the other hand, because they are american consumers, Arnie and Annie have a hard time living within their means. They’ve got $15,000 in consumer credit, a $10,000 home improvement loan, and two new SUVs with associated debt of $20,000 and $30,000. These are fairly typical numbers.

Arnie and Annie’s mortgage payments are currently $1720 per month, because they have a 5.25% loan. Their monthly payments on the credit cards are $400. The payments on the SUVs are $500 and $600 per month, respectively. The payment on their $10,000 home improvement loan for landscaping is maybe $150. Arnie and Annie are forking out $3370 per month without taking into account stuff like property taxes, insurance, utilities, etcetera. It’s really cramping their lifestyle.

Suppose they consolidate these loans into one payment on a thirty year home loan? All right, so it costs them anywhere from zero to $20,000 to get the loan done. Let’s split the difference and say $10,000. That’s about two points plus closing costs.

When I originally wrote this, that put the loan over the line into jumbo territory (Now it’s not, but I’m leaving it in to make a still valid point) of a $385,000 jumbo loan. Were this a conforming loan amount, the rates would be lower, but with a 30 day lock, that’ll get you 5.875% or thereabouts today on a thirty year fixed rate loan. The new payment is $2277. Voila! Despite the higher interest rate, Arnie and Annie are saving almost $1100 per month!

Or are they? On the credit cards, their monthly interest was $225; their $400 payment would have paid the cards off in less than five years. The interest on the SUVs was $333 total on the two, and their payments would have had them done in about five years. The home improvement was a ten year loan but even so their monthly interest was only $75. Now these are all thirty year debts. The monthly interest on their old home loan was $1312. The interest charges on their home loan is now $1884, where total interest was $1945 previously. So they are actually saving money on interest.

The difference is that now they’re not paying the old loans off as fast – they’ve spread the principal over thirty years. In the meantime, the bank is getting all this lovely money in the form of interest from them, and if they refinance about every two years as most people seem to do, this is $85,000 more that they owe on their home, and that Arnie and Annie will pay points and fees on every time they refinance!

Let’s assume Annie and Arnie beat the odds and don’t refinance for five full years. This puts them ahead of 95 percent of the people out there. Let’s look at where they’ll be five years out if they make the minimum payment. They will owe $357,700 on their home. On the plus side, they will have had $66,000 to spend on other things (and they likely will, if they are typical Americans). Total debt: $357,700

If they had continued making their previous payments, they would now owe $272,100. Plus they would be done with the SUV’s and the credit cards and would only owe $6600 on the home improvement loan which they could now concentrate on. Total debts: 278,700.

Net difference: $79,000. Subtract that $66,000 they had real good time with (and nothing to show for), and they’re still $13,000 in the hole.

They do have a $572 per month potential additional deduction. Assuming they are in the 28% tax bracket and get to deduct the full amount, that gives them $9,600 less that they owe the government in taxes. Net amount Annie and Arnie are out are out: $3400, in addition to being set up for higher fees on future loans, and having a loan balance $77,100 higher. Additional interest they will pay if they can get a loan at 5 percent even: $3855 per year.

Sounds like an awful bargain doesn’t it? Many consumers have done this three and four times. I run across people who bought their home in the early 1970s, and have mortgage balances ten to twelve times the original purchase price.

Now, suppose instead of treating it like a cash flow issue, where we’re trying to minimize our monthly payments, we do it differently. Same situation, same numbers, but instead of spending that $993 per month, we use it to pay down our mortgage.

Actually, let’s pay $3300 per month, so we still have $70 per month to spend elsewhere. After five years, we still owe $286,600. We got $4200 to spend elsewhere. And all of our other debts are gone. In addition, we got that $9600 in tax reductions. Net amount to us: $5800, although we still owe $8000 more, and if we get a 7% loan, that’ll cost us $560 per year.

Now, let’s say we keep making that $3300 payment, and don’t roll anything more into the loan. We are done – the house is paid off – in less than ten more years! Now this relies upon us being thrifty and keeping those SUV’s going and not charging up any more credit and not doing anything else to make the debt worse.

So you see, even if you do it right, given the market conditions today, it takes years to show the benefits of this kind of refinance. This is years of doing something that they do not have to that most folks just won’t do. If you have an unsustainable cash flow situation, by all means you’ve got to do something about it, but don’t kid yourself that it’s financially fantastic.

Now this hypothesis is highly sensitive to initial assumptions. I previously assumed that Annie and Arnie are and always have been top of the line borrowers, able to qualify for anything. Suppose they weren’t? Suppose they were in a C grade loan at 7.25%, but now they qualify A paper at 5.875. With a payment of $2070 per month formerly, of which $1812 was interest, the new loan saves them $1450 per month in minimum payments and $561 in actual interest while still saving about $1209 on their taxes over five years. You’d have owed $288,000 on the old program, now even if you put in only the same $3300 per month in payments, you’re $1400 ahead of where you would have been on the balance, and you still had about $400 per month to spend. On the other hand, if Annie and Arnie were A paper but now they are applying for a C grade loan, it cannot be justified on anything except “the cash flow keeps us out of bankruptcy!” because it’s financial disaster.

Some alert people will have noticed I didn’t explicitly include the $10,000 cost of the loan in the computations of whether you’re better off. That’s because it is gone, sunk, included in the computations of where you ended up. It was part of your initial loan balance if you did it, included in the ending balance, and therefore included in the computations of whether you were better off.

The important thing to remember is to not get distracted by the fact that your minimum monthly payment goes down, and see if you (and your prospective loan officer) can come up with a loan and a plan that really makes you better off down the line, instead of one that sucks the life out of you financially, like many of these scenarios do.

Caveat Emptor

UPDATE: I got an email asking if the cost of doing it was actually lower, would it be more likely to be worthwhile. The answer is yes, and those are typically the consolidations I recommend people doing, even though the rate and payment are a little higher. There are other tricks as well to put yourself in a better position.

I’ve written a lot here about how to manage your mortgage so that you control it instead of it controlling you.



Let’s consider what happens when that project fails.

If you don’t pay your mortgage, on time, no big deal at first. Fifteen days later, the first consequence is that you owe the lender a late payment penalty. Four to six percent is what is typical, depending upon where you live. Here in California, it’s four percent. Doesn’t sound like so much, but four percent for fifteen days is the equivalent of ninety-six percent annualized interest, over three times the most horrible credit card I’m aware of. I don’t like paying ninety-six percent interest, and neither should you. Don’t get fifteen days late if you can help it. But once you’ve paid the penalty and brought yourself current, nobody knows and nobody cares.

Suppose you get to thirty days delinquent – one full month. At this point longer term consequences set in. First off, your lender marks your credit as being thirty days late on your mortgage. This is a big negative as far as everyone goes, and can easily make a difference of 100 points or more on your credit score. Additionally, if you are applying for a mortgage loan (or plan to), you just got a “1×30”. For A paper, this means that if your credit is otherwise excellent, you barely slide through. For subprime, this makes a difference on your rate. It takes two years for this to work its way out of affecting your mortgage application, even if your credit score recovers.

Most people end up being thirty days late for several months in a row, each month hurting their credit score, before it goes to sixty days late. They missed one payment and struggle but manage to make several more before they miss another. Occasionally, they go straight to two months late. Either way, it’s a Bad Thing. A single “1×60” might scrape through A paper if there’s no cash out and your credit is otherwise perfect. Otherwise you are subprime for at least two years. In the subprime world, a “rolling 30” is generally not as bad as a 60 day late, but both are steps down from even a “1×30” and a “rolling 60” is worse. It gets worse yet if you pay your way current and then backslide again. And of course, you are paying penalties and interest is accruing on your loan and you’re falling further behind every time you are late. So none of this is good.

On the other hand, depending upon the state you live in, until you get to ninety or 120 days late the situation doesn’t become dire. Each state’s foreclosure law is different, but once the lender has the option of marking you in default, the situation gets uglier. It is a common misconception that lenders like foreclosing. In actuality, only so-called “hard money” lenders will usually start foreclosure immediately upon eligibility, especially if you’ve been talking to them about your situation. If they have some real reason to believe yours will eventually become a performing loan again, they will cut you significant slack, by and large. It costs lenders a lot of money to foreclose and there’s always the risk they end up stuck with the property, so they’ll usually give you as much leeway as they reasonably can. One thing I keep telling people who want a loan approved based upon the equity in the property alone is “The lender doesn’t want your house. They want to make loans that are going to be repaid. The lender is not in the business of foreclosure. They don’t make any money on it.”

Nonetheless, even the most forgiving lender is going to eventually hit you with a Notice of Default. At this stage, things are starting to move towards a resolution that nobody likes, but you least of all. At this stage, you are now liable for a large amount in extra fees that was written into your contract to cover the lender’s cost of going through the foreclosure process. At this point, the lender has the right to require you to pay the loan all the way current, with all fees, in order to get them to rescind the notice. Refinancing becomes almost impossible, except with a hard money lender, and unless something about your situation has changed from what caused it to get to this point, that is only delaying the inevitable and making it worse.

As soon as that Notice of Default is recorded, you are going to get calls and letters and everything else coming out of the woodwork. One category is going to be lawyers, who will typically tell you they can keep you in the house a long time without payments by declaring bankruptcy. Well, this is true as far as it goes, but it’s not going to make the situation any better. As a matter of fact, it will steadily get worse. Just because you go into bankruptcy doesn’t mean that the penalties and fees and interest go away or stop accruing. They are still there, and they keep coming. I’m not a lawyer, and you should consult both a lawyer and an accountant if you are in this situation. Nonetheless, bankruptcy is not something I would even consider in this situation without something highly unusual going on.

The second group that will contact you are the “hard money” lenders, looking to lend you money at 15% with five points upfront and a hefty pre-payment penalty, to buy your way out of the situation. Once again, unless something about your situation has suddenly changed, not a long term solution, and it only makes it worse.

Another group that’s going to call is investors looking for a distress sale. They want you to sell it to them for less than it would otherwise be worth. This is actually something I might consider. Yes, I lose some money, but that’s better than going through denial with the lawyer for a year and a half while any equity I might have left gets frittered away in interest and fees and penalties, not to mention paying the lawyer.

The final category, and one with a significant overlap from the previous, is real estate agents looking to sell the property for you. Assuming I’m not deep in denial, this is probably the best option as to least unfavorable resolution. The drawback is that it depends upon whether somebody will make an offer in a timely fashion, a factor which is not under my control. No matter how great the price, no matter how hard my agent works, there might not be an offer. It happens.

If you do nothing, eventually a Notice of Trustee’s Sale will follow the Notice of Default. In California, seventeen days after that happens, the property gets sold at auction (unless you’ve somehow brought it current). There are some protections in place here in California. The lender must perform an appraisal, and for the property to sell at auction, the minimum bid is ninety percent of this amount. Nonetheless, these are typically very conservative appraisals by design. At this point, the lender wants the property sold at auction, because if it doesn’t sell, they own it, and they don’t want to own the house. They are in the loan business, not the real estate business. So a house that may be actually worth $500,000 on the open market gets appraised at $400,000, and sold for $360,000. If the loan was for $250,000, that’s $140,000 of equity you allowed to be taken from you because you were in denial. And if the loan with penalties and fees and interest was $450,000, that’s worse, and not only because you forfeited $50,000 you could have gotten, and not only because they may be able to go after you in court for their loss in some states.

You see, because the lender took a $90,000 loss, they want to write it off on their taxes. And in order for them to do this, they have to hit you with a form that says you got away with $90,000 from them. This is taxable income!. So the IRS comes after you for the tax on the $90,000. IRS liens are one of the things that is not discharged by bankruptcy, and it stays with you forever. Ten years absolute minimum for any purpose. Sometimes your lawyer, CPA or Enrolled Agent will get you an “offer and compromise” that cuts your liability, but that’s technically taxable income also and may be subject to another round of this crud. It it seems like to you the system is rigged so you can’t win, you’re right.

The smart thing to do? As soon as you realize that you can’t make your payment, take a long look at your situation and decide if this is something that’s going to get enough better to make a difference, or not. Then figure out how much equity in the property you have.

If the situation is likely to improve, and you’ll start making your payments in thirty days because hey, you just started your new job, that’s one thing. Truthfully, however, most folks lie to themselves on this issue, for a variety of reasons. Remember: Denial Digs Deeper, and makes the situation worse.

Even if selling the property isn’t going to net you anything, it’s still worth doing as it gets you out from under the situation. Your credit score stops dropping, you quit getting marked late by your lender, you quit getting socked with penalties and interest and fees you can’t pay.

Particularly if you have significant equity built up, the sooner you contact a real estate agent to sell, the better off you will usually be. You are likely to lose the house anyway. The sooner you sell, the lower the penalties and fees and extra interest you are charged by the lender will be. This translates into dollars in your pocket – dollars you are likely to need. If you can sell before the Notice of Default is filed, so much the better, as that’s thousands of dollars right there. You don’t have the luxury of taking your time about it, though. Taking the first reasonable offer is highly advised, and you have more time to get a reasonable offer if you start sooner. Once a Notice of Default is filed, it’s a matter of public record and so your bargaining situation gets a lot worse because the buyer should know that are over a barrel, assuming their agent does their homework. Considering that it’s two or three clicks of the mouse, it’s easy homework to do and even the greenest new agent is going to catch it more often than not.

Trying the various delaying tactics with a lawyer is likely to end up costing you more than a quick sale. Even if you remain in bankruptcy for five years or more, within about a year and a half at most, the lender will almost certainly persuade the court to cut the home and loan out of the bankruptcy as a secured debt, and sell it. Since the loans and penalties and fees and interest kept accruing all this time, you end up with less money – or none, along with a little love note from the IRS that says “You owe us thousands of dollars! Pay up NOW!”

Every situation is different. At a minimum, consult a lawyer, accountant, and real estate agent in your area. But when all is said and done, what I’ve talked about is the way most of these end up.

Caveat Emptor

From an email:

Anyway, my wife and I are about to purchase a place here in the X area and we’ve been hearing that “a tough loan” line due to the fact that I’m only 10 months into my new small business although I’ve been profitable the entire time. We’re stuck doing No Doc/Stated Income setups – I think you called these “liars’ loans” – and the rates are a bit painful.

My wife’s scores… at 720 are the lowest we have and mine are (higher).

Well, the good news is that your credit scores place you in the highest band of credit scores. There is no category beginning higher than 720.

The difficulty is that you’re running afowl of one of the background rules of the whole loan process. Fannie Mae/Freddie Mac rules limit A paper loans to those with two years in the same exact line of work. With some limitations, a good loan officer can sometimes get it approved for two years with the same employer, if they’ve been progressing normally within the company. Changing from a W-2 employee to self employed is a change that cannot be approved, at least from the point of view of A paper. A minus and Alt A rules are mostly similar. So you’re looking at subprime if you’re documenting income. Let’s examine A paper documentation levels to see if they’re a possibility.

Full Documentation: Requires documenting two years income same line of work. You can’t; you’ve only been self-employed for ten months.

Stated Income: Requires documenting that you’ve had the same source of income for two years. Nope. Yes, these and NINA loans are often called “Liar’s loans” in the business because the lender agrees not to verify your amount of income. That’s because loan officers eager to make a commission on a loan where the client really doesn’t qualify use these to qualify the client. The qualification standards are there for your protection as well as the lender’s. Just because you can use these to qualify doesn’t mean it’s smart. Locally where I am we have a huge house of cards because loan officers use these to qualify clients for negative amortization loans. Yeah, the temptation to make a commission is there, but am I really serving the client’s best interest by securing them a loan they can’t really afford where even the payment they can’t afford has them owing more money each month? I submit that the answer to this question is usually no. These are designed for self-employed folks and people on commission who make the money, they just have write offs and such so that they can’t really document it. Using stated income to say you make money that you don’t is a dangerous game. It’s likely to result in foreclosure.

NINA: Requires a good credit score. This might be your ticket. On the other hand, you don’t state how much of a down payment you have, percentage-wise. A paper NINA requires some equity in the property; I’ve never seen an actual A paper NINA approved with less than about ten percent equity. On the other hand, these are very easy loans to actually do. It’s trying to qualify you for something better that’s hard.

On the other hand, if we move down into subprime, the rules aren’t set by Fannie and Freddie. There are subprime lenders with one year same line of work programs, and even a few with six month programs. On one hand, they’re subprime loans, carrying a higher rate/cost tradeoff just by virtue of that. On the other hand, because you’re documenting your income, you get a break for that.

One of the great universal things of the loan business is this: The looser the underwriting standards, the higher the rate/cost tradeoff, and the tighter the underwriting standards, the lower. If a given lenders underwriting standards are looser, its rates will be generally higher for the same cost.

Now, given that you’ve only been self-employed for ten months, you’re not going to have much of a paper trail. There are three possible ways that banks will accept to document income. W-2? Even if you have them, they’re no longer applicable. Income tax forms? Given that it’s September, counting back ten months leaves you starting the business in November of last year. Even if you had enough monthly income to qualify for that month and a half or two months, the tax forms effectively spread it across all of last year, and that’s unlikely to show enough income. The third method of income documentation, unique to subprime, is bank statements. This, you might be able to do. Most subprime lenders have 24 and/or 12 month bank statement programs, and a large number have six month programs as well. The longer you can document for, the better the rate, but better six months than nothing.

Will this get you a better rate, at a better cost (two questions that always go together), than an A paper NINA? The answer to that is on a case by case basis. There is no way to be certain without pricing it around by the full details of your case, but there’s a good chance, and you can get 100 percent financing this way.

I will warn you that bank statement programs (often called “EZ doc” or “lite doc”) are THE most difficult loans to actually get approved. There are more problems with these than any other loan type. On the other hand, as I’ve covered elsewhere, if it gets you a better loan, the effort is likely to be worth it. Furthermore, there is a question of whether you qualify for the loan by the bank’s standards. Some banks discount the amount of money coming into the account, some do not.

So which is the better alternative for you? I don’t know without actually pricing it. I don’t know for certain that either can be done for your situation without information like how much income your bank statements show, and how big your loan needs to be, and how much of a down payment you’re making. Get a couple of good loan officers working on it in your area, and find out.

And yes, this is a tough loan situation. Both A paper NINA and subprime bank statement programs have their limitations. Failing that, you fall all the way back to subprime NINA, where somebody with your score can get 100 percent financing no worries, but the rates are rough on the pocketbook.

Caveat Emptor

Racial Gap in Loans Is High in California.

I can give a variety of reasons for this.

First off, especially in Los Angeles but to a lesser extent throughout the state, there is a huge “Spanish speaking only” community. When you limit yourself to speakers of a language which isn’t the nation’s primary business tongue, you limit your ability to find loan officers who will treat you honestly and fairly and find you the best possible loan. I speak reasonable Spanish myself, but not nearly enough to do a loan.

Second, those who speak Spanish only are ripe pickings for unscrupulous loan officers and real estate agents. Because they do not understand English, the language the regulations are written in, they have less understanding of what is a complicated and confusing process for anyone who is not a practicing professional. In fact, I can name a lot of alleged professionals who speak English and are nonetheless limited in the comprehension of the process to judge by the evidence.

Third, those who speak spanish only have a lesser understanding of their rights under the law, and since the vast majority of all loan documents are in English (a few lenders are starting to generate a few documents in Spanish, but not every document, and it will never be the main copy of anything), they have a lesser understanding of what they are agreeing to.

Gee, I hope the preceding helps the “Spanish only” lobby of separatists understand what they’re setting up for the people whose benefit they are allegedly advocating.

But more importantly than all of the preceding, real estate and loans are “sales connection” businesses. Because most people do not shop for homes or home loans in a rational fashion. “I can’t be rational! This is far too important for that!” Seems silly, but it’s true. People buy or do business with you because you have made them more comfortable, or because they think you can do something nobody else can or will for them. They do business because they connect with you on some level, not because what you’re offering is the best thing out there.

Identity politics exacerbates this. There are agents out there (often but not always necessarily of the same ethnicity) whose niche market is “black folks”, or “spanish speakers” or “Koreans”. Some people will do business just because you’re the same, or because they feel some kind of cultural connection. Others will do business because you helped their brother, or friend, whether said brother was the toughest deal in creation or the easiest thing you ever did. And if you brother had to do something, or had something happen, it’s only normal it should happen to you, too – right? One of the standard phrases in the sales lexicon is “My you were tough, but we got it done! How about some referrals.” This by itself is not evil. But if you’ve taken advantage of someone as if they were a tough loan when in fact they were not and could have gotten a better deal from someone else, you’re lining your pocket at your client’s expense. Everybody deserves to get paid for a job well done. But when my contacts in the escrow and title business tell me about people who only serve this ethnic market or that ethnic market who have six percent state of California limits on their compensation externally applied to every single loan they do, or how these people consistently have a sales compensation a full percent above the market, that tells me something: that these alleged professionals are taking undue advantage of their target market. Many of these people they are targeting literally have no way of knowing there is something better out there. Are their tactics illegal? No. Unethical? In at least some cases. Taking advantage of client ignorance? Definitely.

The process of purchasing, selling, or refinancing real estate is byzantine, with rules and regulations that get more complex every year. The average citizen has difficulty understanding the things that may be relevant to their particular transaction (I’ve had to explain to lawyers how they got taken in their previous transaction). To most people, the whole thing is like some immensely complicated magical ritual. Place the proper documents at the foot of the underwriting god, dance three time sunwise and four times widdershins round the appraisal every day for a fortnight, pray with the high priests of insurance, and you get your house.

It has elements in common, I will admit. But the processes of real estate sales and real estate loans are coldly, brutally, logical once you understand them. Unfortunately, the odds of understanding are stacked even further against those who are apart from the majority of society. Those who are concerned with minorities having inferior loans would have more success in connecting the people to the mainstream of society than in considering further burdensome anti-discrimination legislation.

Caveat Emptor