Bridge Loans

One of the things I’m seeing a lot of these days is blanket advice on bridge loans.

A bridge loan is a loan that you take out with the explicit intention of having it be short term. The most common situation is a loan against property A, which you own but plan to sell, so that you can put a down payment on property B (or buy it outright) right now.

The motivation for this comes from the fact that people get paid to do bridge loans, and they are typically very easy loans to do. Frankly, the people making the recommendation make more money by doing the bridge loan than by not doing it, and they are not motivated to do the calculations and legwork to see which is the better deal for the consumer.

When it comes to money, blanket recommendations of any sort are automatically suspect, and usually wrong. Every situation is different, and there can be factors that cause an ethical professional to recommend something in one case where they would recommend against in another superficially similar one.

Bridge loans are no exception. In the example above, the advantage is that they make you a more qualified buyer, and can get you better rates on the loan for the new property. The disadvantage is that their closing costs are just as high as any other loan. So you’re spending about $3500 extra plus points plus junk fees (if any). They are also, by definition, cash out refinances. The rate-cost tradeoff for cash-out refinances is less favorable than for purchase money loans. In plain English, they cost more.

The next major issue that arises is that they can make it more difficult to qualify for the loan on the new property, which can often mean that you need to go stated income or NINA when you might otherwise have qualified full documentation, which means you got a higher rate on the new property anyway, and that you’re going to want to refinance your new purchase as soon as Property A sells anyway, sending another set of loan costs down the drain. Don’t get me wrong, I love to do loans, and my pocketbook loves for me to do loans, but it’s a good loan officer’s job to look after your interests first.

Finally, choosing a bridge loan can force a choice upon you: A good loan that puts you in the position of having a need to sell within a specified time frame, and a mediocre loan that may not. The best (lowest) rates are for short term loans. Always have been, always will be. However, if the market sours, this can cause you to either accept an offer you would not have otherwise considered, or flush another set of closing costs down the toilet, when if you had chosen the mediocre loan, you would have been okay indefinitely.

Let’s crunch some numbers. Let’s say you have a property currently worth $250,000 that you bought for $125,000 and have paid down to $100,000. You want to upgrade to a $400,000 property now that your promotion and raise have settled in.

The first thing you do is pull cash out to 80 percent. On a 30 day lock of a 30 year conforming fixed rate loan, assuming you’ve got good credit, when I originally wrote this was about a 6.5 rate without points, and you’ll actually get about $96,500 of that $100,000 you take out. I looked at shorter term fixed rate loans as well, but with the yield curve inverted right now since you’re planning to sell, anything without a prepayment penalty is about the same, and a prepayment penalty is contra-indicated, as it means you’ll have to pay thousands of dollars when you do sell.

You take and put that $96500 down on a new home purchase loan on a $400,000 home. It’s over 20% down, so no PMI concerns, and no splitting into a second loan. But because you’ve got that $200k loan sitting over there, now you have to go stated income on the loan for the new home.

Actually, at this update, I don’t know of any stated income loans. What that means is there’s no way to qualify without coming up with more cash or waiting for the first property to sell. This means moving twice or hoping your buyer will let you lease the property back long enough to find a new property. Or simultaneous closings, a massively stress-inducing plan, because you’re betting your ability to close on someone else being on-the ball.

But when we had it, stated income was one way of making this work. This means you traded no verification of income for a higher rate/cost tradeoff. In the example we’re using, your rate would have been about 6.75 without points. Soak off another $3500 in loan costs, plus purchase costs of maybe another $1000. You now have two loans, one for $200k at 6.5 and one for about $312,000 at 6.75. Now the original home sells. Let’s say you got full value of $250,000. You pay 5% in real estate commission, and maybe 2% more in other costs. That’s $17,500, so you get $32,500 in your pocket. You have three choices, two of them productive. You can 1) Spend the money, 2) Invest the money, or 3) Use it on the other mortgage. A paydown, where you just plop the money down and keep making your same old current payment is a good idea (Unless there’s a “first dollar” prepayment penalty), but most folks are obsessed with lowering their payment. So they take that $32,500, and of which $3500 is loan expenses, and (because now they can do full documentation), they end up with something like a $283,000 loan at 6.25 percent, assuming rates don’t move. Total cost of loans: $10,500 assuming you pay no points for any of your loans. Perhaps possible for someone with above average credit. Not likely if your credit is below average.

Suppose instead, that you just leave that $100,000 loan sit on your original property. You’re still going to have to do stated income on the new loan on the new property. But instead, you go with a 80 percent first, 15 percent second (another thing you can’t do at the update because no second mortgage holder will go over 90% loan to value ratio) because you can come up with $25,000 until the first property sells. Same 6.75 rate on the first, and the second is an interest only at about 10.25, just to use the same lender whose sheet I happened to pull from the stack for the exercise. Loan costs, $4000 without points, which I priced the loan to avoid. First house sells, you get $132,500, replace the $25,000, and pay off that second, leaving you a $320,000 loan and about $47,500, holding cost assumptions constant ($1000 in non-loan costs). You could do a paydown, leaving $272,500 balance on a 6.75 loan, or you could take $3500 in closing costs and refinance to 6.25, just as above, leaving a balance of $276,000 if you don’t pay any points. Total loan costs, $7500 and you only have to avoid paying points twice (once, as opposed to twice, if you take the paydown option. It takes a little under 37 months to break even on your interest savings). Furthermore, in less than hot markets, it gives you greater leverage with your seller to pay some part of your closing costs: “Do this, or I don’t qualify”. They have the home on the market for a reason, and they can help the buyer in hand or they can hope for another buyer to come along.

In this example, not doing a bridge loan saves you about $6500, less the additional interest (about $512/month) for the second mortgage until your first home sells, but plus approximately $541 per month interest every month between the time you initially refinance your original property and the time it finally sells, a longer period of time. Plus one set of possible mortgage points. So it’s not difficult to construct scenarios where it’s a good idea not to.

Let’s look at a different scenario, however. Let’s say instead of upgrading, you’re already in the $400,000 home, and looking to downsize to a $100,000 condo. Furthermore, let’s say you bought for $200,000 and are now down to $160,000 owed, just to keep the proportions consistent. You borrow out to $265,000 (paying $3500 in loan costs), which you qualify for full doc at 6.25. You then pay cash for the condo (including $1000 for purchase transaction costs, and you’ve still got $500 in your pocket). Furthermore, an all cash, no contingency transaction is a powerful negotiating tool for a seller to give you a good price. Then when your original property sells, costing you say 7%, or $28,000, in selling costs. You net $107,500 in your pocket. If you did no bridge loan, let’s still assume you can come up with $25,000 on the short term, and you still qualify full documentation. Your rate on the condo is 6.375 without points, holding assumptions consistent. Then you sell the first property for the same $400k, paying the same 7% ($28,000) and paying off the $80,000 loan on the condo as well as replacing the $25,000. Net still $107,500 in your pocket, less additional interest charges for a little longer period, but you cut your stress level and put yourself in a stronger bargaining position, which is likely to be worth doing.

There are any number of reasons and factors to do a bridge loan or not to do a bridge loan. You may not have a minimum down payment without a bridge loan. That’s probably the most common, as not all properties and purchases are eligible for 100 percent financing (at this update, the only way I know to get 100% financing is with a VA loan, and some require as much as a forty or even fifty percent down. The way a necessary transaction is structured. The presence or absence of 1035 exchange considerations is often a factor. Your credit score may limit you, or your ability to qualify full documentation may dictate the advantage lies in a different direction. Every situation has the potential for factors that may dictate an answer other than that given by pure numerical computation, and there are therefore, no valid blanket answers to the question of whether or not to do a bridge loan.

Caveat Emptor

Reserves for Real Estate Loans

Thanks again for the terrific posts. I’ve learned more about mortgages in the past two months than I ever dreamed I might. I am looking to buy my first home soon, and have myself in a good credit position to do so. My credit score is over 800 and I have no back-end debt – no car payments, alimony, student loans, etc. My annual salary is well over $100K, and while my down payment will not be as much as I would like, I should be able to put up 20% of the purchase price. Before I shop for a loan, I have some questions and would appreciate your insight. 1. Do monthly “subscriptions” such as landline phone bill, cable, internet, cell phone, etc. come into consideration? As I have no cell phone and no cable (and don’t intend to get them), I see my monthly expenses in this regard as significantly lower than most other borrowers. 2. Do my retirement savings come into play? I have saved conscientiously for several years and between IRA’s and pension funds (fully vested) I have a significant amount put away. Thanks again for the teachings

Gosh, I didn’t think a dream client like this existed any more!

In general, there are only three instances when reserves really come into play. They are:

1) Stated Income. Since people in this category were not documenting their income, for a true stated income loan they are looking for evidence that these folks are living within your means. The measurement that has evolved is six months PITI (Principal Interest Taxes and Insurance) in a form where you can get to it – savings accounts, investments, something. If you have a retirement account, such as a 401, IRA or similar, most lenders will allow you to use a discounted amount, most often 70 percent, as the money would require the payment of taxes and penalties. Roth IRAs may be treated differently, as the rules are different. There were Stated Income Stated Assets loan programs, but when you get right down to it, those loans look more like heavily propagandized NINA (No Income, No Assets, aka No Ratio loans) than they did a true Stated Income. (at this update, I am unaware of any lender who is actually funding stated income loans of any sort)

2) Payment shock. If your payments are going to be much higher than rent was (or previous payments were), many lenders will require two to three months reserves of PITI payments in reserves.

3) Cash to close. No matter what the loan, the underwriter is going to be looking at the loan to make certain that you have the cash to close, and any reserve requirements are in addition to this. If your loan is going to require a certain amount of cash, either in the form of down payment or loan costs or most often, for prepaid interest or an escrow account, then the underwriter wants to see evidence you’ve got it. It’s no good for the bank for the loan to be approved, the documents printed and signed, the notary paid, and then the loan doesn’t close because you didn’t really have the cash. Seller paid closing costs are getting to be a really touchy point with many lenders, by the way, as they indicate the property may not really be worth the ostensible sales price.

In any of these cases, the underwriter is going to want to see evidence as to where the money came from. They want to know that you’ve either built it up over time or have had it for quite some time or that you can document where you got it from. What they are looking at with these requirements is the possibility that you got a loan from somewhere that you’re going to have to pay back, and the payments on which may mean you no longer qualify under Debt to Income ratio guidelines.

Mind you, it never hurts to have money socked away. But it’s not worth any huge amount of contortions to prove. For A paper lenders, the guidelines are razor sharp, and excessive reserves are not a part of them. You’ve either got the required amount or you don’t, and the fact that you have $100 million in investment accounts isn’t relevant – and it may cause some underwriters to start wondering why you’re not paying for the property in cash or putting more of a down payment (Anytime you give an underwriter more information than required, you run the risk that they will ask you difficult questions about it). Some subprime lenders may approve a loan they would not otherwise have approved, or maybe offer better terms than they might otherwise, but there have been enough adverse experiences with this that it is becoming more rare.

Monthly subscriptions (utilities, etcetera) are why the permissible debt-to-income ratio (DTI) isn’t higher. You can cancel cable TV, you can cancel dish network, you can cancel pay per view, you can cancel magazines, although most folks want phone, gas, and electricity. Utilities etcetera do not count against debt to income. Only the payments on actual debt count.

Caveat Emptor

Payment, Interest Rate and Up Front Costs: Choosing a loan intelligently

Most people tend to shop for a mortgage based upon the payment. They figure the lowest payment will be the cheapest loan.

This is the way most people make banks rich. Because they are looking for the loan with the lowest rate and the lowest payment, they choose the loan with two or three points that’s going to take twelve years to pay for its costs, and then after they’ve sunk all those costs into the front end of the loan, refinance within two years and sink a whole new set of costs into the new loan. The bank gets all this lovely money, and then the consumer lets them off the hook by refinancing, and the bank doesn’t have to carry through on the full amount of their end of the bargain.

In point of fact, when shopping for a mortgage loan, there are at least four factors the consumer should consider. The best loan for a given consumer in a given situation at a given time is based upon all of these factors. Each varies in importance from loan to loan.

These factors are:

The monthly payment
The monthly interest charges
The costs that are sunk into the loan in order to get it
How long you’re likely to keep the loan.

This is not to say that only these factors are of importance. For example, the possibility of “back end” costs when you refinance is likely to be a critical factor when considering a loan that has a prepayment penalty. Most people that accept prepayment penalties end up actually paying them – a thing to keep in mind before accepting a prepayment penalty. If you know there’s a good chance you’re going to get hit with an $8000 charge for paying it off too early, that needs to be added into the likely costs of the loan.

The monthly payment is important for obvious reasons. If this is not something you’re comfortable paying every month for month after month and year after year, then getting this loan is probably not something you should do. The costs of getting behind in your mortgage are significant, and the costs of going into default are enormous, and both may likely continue even after you have dealt with them. When I started this website, I was talking with people all of the time who say, “We’ve got to buy something now, before it gets even worse!” Furthermore, there are always people trying to stretch too far to buy that “perfect” house, and paying four points to buy the rate down to make the payment a little more affordable is one of the tricks of scoundrels. Many agents and loan officers will happily put people in either situation into a home, with a loan payment that looks affordable on the surface, but isn’t. If you don’t examine the situation carefully, not just for now but for the future. you’re likely to be getting into something you cannot afford, and is likely to have huge costs and ramifications for years down the line. Neither of these people is your friend. They are each making thousands, often tens of thousands of dollars, by putting you into a situation that is not stable, and that you’re going to have to deal with down the line, while they’re long gone and putting some other trusting person who doesn’t know any better into the same situation as you. If the situation is not both stable and affordable, pass it by.

Once we have noted that you need to be able to afford it, the monthly payment is actually the LEAST important of these four factors. As long as it’s something you can afford, do not charge straight ahead, distracted by the Big Red Cape of “Low Payment” while you are being bled to death by other things. Many of these Matadors (which means killers in Spanish) will bleed you to death while acting like your friend by distracting you with the “affordable low payment”, not unlike the matador distracts the bull with the cape so they never see the sword. Due to lack of a real financial education in the licensing process, a disturbingly large number do not realize they are bleeding people, but that doesn’t help their victims. A loan payment that is higher but still affordable may be a better loan for you – and in fact this is more likely true than not.

The three other factors are each far more important than payment. Payment is important. People who are unable to make their payments are called insolvent. Many of them file bankruptcy, have liens placed upon them, wage garnishments, suffer for years because of bad credit ratings, etcetera. But just because the cash flow is better right now does not mean the situation is better – that way lies the Ponzi scheme, Enron, and many other famous wrecks in the financial graveyard. I’ve been telling people this for years – and now with the loan meltdown it’s become undeniable. Negative amortization and other unsustainable loans will come back around to bite those who use them. Guaranteed.

There is no universal ranking of which of the remaining three factors is the most important. They must be compared as a group in the light of a given situation: YOUR situation.

The monthly interest charges are simple. Principle balance times interest rate. This starts at the amount of the new loan contract (with all the costs added in, of course) times the interest rate.

The costs sunk into the loan shouldn’t be any more difficult to compute, but they are. As I have gone over elsewhere, it is an unfortunate fact that rarely does a mortgage provider tell the entire truth about the costs of the loan until it’s too late to do anything about it. The rules for the 2010 good faith estimate only make it slightly more difficult to lie, while confusing the issue as to what actual costs are. If you have an ethical loan provider, the amount on the Good Faith Estimate (or Mortgage Loan Disclosure Statement here in California) should match what shows on your HUD 1 at the end of the process. Please remember to note any prepayment penalty or other back end charges as a separate dollar amount. But if these figures aren’t accurate, they’re completely worthless in any attempt to evaluate which loan is better for you, or indeed whether to get any loan. The number one reason why this is done is because from the point of view of crooks, the flip of a coin beats absolute knowledge that the other loan is better. Once people say they want the loan, most will stick with it even if evidence becomes available that they shouldn’t.

The thing that is most difficult to determine is how long you intend to keep the loan. Most people have no reliable crystal ball to gaze into the future.

The obvious answer to this dilemma is to compute a break even point. This falls short with regards to higher costs incurred after disposing of the loan as a result of having a higher balance, but it’s a start. If one loan has lower costs and a lower interest rate, there’s no need to go through the computations. But if as is common (a given lender always has a tradeoff between rate and cost), one loan has a higher sunk cost and the other has a higher monthly interest charge, divide the difference in sunk costs by the difference in interest charges per month. This gives a figure in months that is a break even point. Don’t forget to add in any possibility of a prepayment penalty.

With this breakeven figure in months, you can calculate which is likely to be the better loan for you, using your own situation as a guide. If the breakeven is 54 months and you’re being transferred in 36, the answer is obvious. If you’ve refinanced at intervals of twenty-four months your whole life, a 54 month breakeven is not likely to be beneficial. If you’re going to need to sell in two and a half years when mom retires, that’s a clue, too. And if you’re a first time home buyer starting out, remember that 50% of all homes are sold or refinanced within two years, so unless you have some reason to suspect that you are likely to be different, take that into account. Far too many people waste thousands of dollars regularly by paying the up-front costs for loans that they will not keep long enough to break even.

Caveat Emptor

Mortgage and Real Estate Red Flags

This is intended as one of those occasional posts that gets expanded and reposted from time to time. This list is not exhaustive, although over time it is intended to become closer. If you have one, send it to me (dm at)

Any of these is sufficient reason, all by itself, not to do business with that company or person, to cancel your loan if in progress, or to go get another backup loan.

Any actual lie

Up front application fees, or sign up fees.

Up front lock fees.

Up front appraisal fees, as opposed to at the point of appraisal. (NOTE: With HVCC now in effect, this has changed. Consumers are no longer allowed to pay the appraiser directly, so the lender now needs to collect it until and unless HVCC is removed)

Any up front fee beyond credit report (or for now, appraisal).

Requiring the originals of your documents.

Trying to sell you a Negative amortization loan, under any of its names, without explaining in detail all of the gotchas

I used to say “not locking your rate, or letting it float.” This is another thing that has changed now with changes in the business. Every loan we lock that doesn’t close for any reason is now costing all of our clients that do close extra fees, so we have to wait until there is a reasonable assurance of closing before locking. I’m not happy about it, but I have to do business the lender’s way or leave the business

On stated income or NINA loans, not giving a real idea of what the payment is going to be, and making sure you can afford it. (Stated income is almost non-existent now).

On full documentation or EZ documentation loans, needing to document more money than you make.

Requiring you to pay an “in house” appraiser (Who is receiving a salary)

Not allowing you to choose an appraiser if you want to. (Another change with HVCC – this is not allowed now)

Consistently using the same phrase in response to a question. “Nothing out of your pocket” ($30,000 added to your mortgage) and “Thirty Year Loan” (note the absence of the words “fixed rate”) are two that are sufficiently pervasive as to merit special mention.

An answer to a question that is somehow similar, instead of to the question you asked. Especially if said obviously intended to distract and mollify you, or is a pat phrase you’ve heard them use before.

You check their calculations on a couple of calculators and the numbers are both consistent and different from what you were quoted as a payment. (Some web calculators lie, but they usually lie in slightly different ways, although note that an auto payment calculator uses different first payment assumptions).

(Yes, regulations have been put in place that make it extremely difficult for the more ethical providers)

Buying:

Use of non-standard forms when standard forms are available

Asking you to sign an Exclusive Buyer’s Agent Agreement before they’ve shown any property.

Asking you to sign an Exclusive Buyer’s Agent Agreement at all without furnishing you something special (i.e. daily foreclosures lists, or some service you would otherwise have to pay for).

Not finding out what your budget range is and sticking with it. For example, if you’ve got $30,000 for a down payment and closing costs, can qualify for a $270,000 loan, they shouldn’t show you anything that you cannot get for $300,000 total, including all costs you need to pay.

Not finding out what you actually make, and what your current monthly obligations add up to. This lets me, as the real estate agent, know what I’m really dealing with here, even though I have no real need to know if I’m not doing the loan. In case you haven’t gotten the idea, there are a lot of mortgage folks out there who may not have your best interest at heart, and “stated income” loans allow for a lot of sins. You can get offended at invasion of privacy if you want, but I’d be grateful – This is one part of the system checking another, looking out for you, when they could just grab their commission and bow out of the picture.

Promising to find houses below market value. I do my best, but so does every other agent out there. This is something nobody can guarantee, and most require taking risks or putting all cash into the transaction, and they’re usually gone before the public even has a chance.

Telling you about “money in your pocket” when you ask about closing costs

Selling:

Use of non-standard forms where standard forms are available.

Excessive pressure to sign listing agreement immediately (Some pressure is normal and to be expected)

Not being upfront about their business model. I’ve got an article about business models in the real estate industry (there are 2 basic, and many variations). Each has situations they are best for, and situations they are not so great for. You want to know if it fits your situation.

Not explaining what properties in your area are selling for before they ask for the listing.

Promising to get more for the property than the market will support. If there is a competing property on the market cheaper, or a better property on the market for the same price, buyers will choose that one instead of yours.

Putting the property on the market before it’s ready and available to show.

Not holding at least one open house on a weekend date within two weeks of listing. Sometimes this is tough during the holiday season, but there’s no excuse for the rest of the year. Especially during the summer, if they want to take a three week vacation, there should be someone else there to take up the slack. Perhaps it might be unproductive if you live in a thinly inhabited area, but anywhere within the commuting area of a major city, this is a minimum.

Caveat Emptor

Relying Upon Reputation: There Are No Silver Bullets

On a regular basis, I get emails that ask me what I think of a particular company. When I check out public forums, I see questions about particular companies every time. “What do you think of X Realty, or Y Mortgage?”

Reputation has a certain value of course, but in my experience, these people are overvaluing reputation. These people are looking for a “silver bullet” solution to their situation that lets them relax and not pay attention, and there aren’t any. They want to be taken care of without doing the mental work of figuring out whether the person is really doing a good job. “This is a great company, and great company would never take advantage of me, so I must be getting a great bargain!”

This utterly leaves aside any number of issues. Suppose the Mortgage Firm of Dewey, Cheatham, and Howe were paying me a fee for every referral. Most people might have justifiable concerns about whether my recommendation was motivated by that fee or by the desire to get them a great loan. Well if you’re chumming for a recommendation, you have no idea if the anonymous person recommending the firm of Dewey, Cheatham, and Howe is a virtuous benefactor – or one of their loan officers. The bigger the firm, the more loan officers they have. Huge National Megacorporation can have hundreds of their loan officers log on to the website anonymously and all endorse National Megacorporations loan programs for some mysterious reason. Suppose the person isn’t affiliated with Dewey, Cheatham, and Howe, but does work for a similar firm. They could be trying to build demand for the same sort of operation that feeds them, so when people read about Dewey, Cheatham, and Howe’s methods being recommended, and then encounter this similar firm, they are ready to do business.

Suppose the person answering is a complete babe in the woods? They just plain have no idea. They’ve never gotten a loan, or if they have, they got took just as badly as anyone else in the history of the world, and worse than most. Does the possibility of such a anonymous recommendation for the Mortgage firm of Dewey, Cheatham, and Howe seem like a thing you want to follow? Unless you audit that person’s transaction and compare it to other similar transactions going on at the same time, you have no real idea whether this person would recognize a scam if it bit them. Even if you do audit their transaction, that doesn’t necessarily mean anything, good or bad, for your situation.

Suppose the reason they thought Dewey, Cheatham, and Howe did a good job was because they didn’t pay attention. They’ve read every single one of my articles, and they understand all of the things that could go wrong, and they actually know how to read a HUD 1 form, but they just didn’t bother because their Uncle Joe works for Dewey, Cheatham, and Howe, and they trust Uncle Joe completely, and Uncle Joe would never take advantage of them. This ignores the issue that Uncle Joe is unlikely to be your loan officer, and even if he was, Uncle Joe may have compunctions about his family that do not apply to you. Furthermore, a very large fraction of the most unethical stuff I’ve seen since I’ve been in this business was Uncle Joe (or Brother Moe, or Sister Sue, or Cousin Lu) raking people over the coals who they knew would not shop around for a better deal. But even if they are completely unrelated, they decided to trust Joe, and didn’t do the diligence that would have told them whether Joe was doing a good job, let alone the best possible job.

Now in both the loan and in the real estate business, service is provided by individuals, not companies. It’s the guy you’re sitting down talking to right here that decides how much of a margin they are going to work on, not some mysterious exalted Chief Operating Officer in New York City. That COO may lay out base requirements that say “no more than X, no less than Y”, but it’s the person doing your loan, or the agent doing your transaction, that decides where in that spectrum you fall. And I shouldn’t have to point out that if they say “The corporate president says we have to make at least two points on every loan!” and somebody else offers you a better loan for you, that’s their problem, not yours. They are not getting, or at least they should not get your business if you know of a better possibility. You don’t owe anyone your business.

Finally, every situation is unique. People ask me what I think of a particular lender, and I’m thinking about the clients they’ll do well with, or the clients where that particular lender’s programs are most competitive. The lender with the best thirty year fixed rate mortgage in the business is not a lender I would use for an 80/20 short term piggyback on someone with a 600 credit score. That particular lender doesn’t want to touch 100 percent financing, and refuses to do business at all with anyone whose credit score is less than 620. The lender I’d most likely use for the latter borrower has a rate and cost tradeoff for their loans that knocks them completely out of contention for the A paper full documentation 80 percent LTV thirty year fixed rate loan with no prepayment penalty. They’re not competitive for that borrower, and both that account executive and I know it. They’d be grateful to me for placing the loan with them, and they’d certainly get it done, but my wholesalers and I have an understanding: The lender who has a program that can deliver the lowest rate cost tradeoff on the best terms for the client gets the business. They don’t want to compete on price, but a good loan officer forces them to do precisely that. And if the wholesaler is one of those who refuses to compete on the basis I want them to compete on, there are plenty who will. Don’t BS me about service. Everybody should have great service. If you don’t have great service, we’re not meant for each other, and the lenders I already do business with all have great service. What I want is a great loan for this client that you can actually deliver on time. If you’ve got that, we may have some business. If you haven’t got that, we don’t. This point, incidentally, is one of the reasons you’ll end up with a better loan from a good brokerage than you will from the best lender. A broker knows how to shop loans better than any ordinary consumer.

This isn’t to say you should just trust a broker. Indeed, my point is that you shouldn’t trust anyone. Shop around, compare what’s available, ask them what for written guarantees, verify everything, and don’t give them your dollars to hold hostage until they’ve actually delivered. That’s why I put out the yardsticks for measuring performance I do, that’s why I give you the strategies for finding the people who will do a better job, and for forcing them to actually do a better job. You can’t know if something is a good bargain except by comparison with something else like it, or several somethings. Given the amount of legal wiggle room there is, unless you pin a loan officer or real estate agent down with specific guarantees and conditions in writing, what they actually deliver is completely dependent upon their good will. If they have good will, you don’t need to work nearly so hard, although comparison shopping would still be a really good idea. But if a decent proportion of agents and loan officers had goodwill, there would be a lot fewer problems with the industry.

Caveat Emptor

Option ARMs and Cash Flow

One of the standard arguments I hear about negative amortization and Option ARM loans is that they “give the client the option to make a smaller payment if they need to.” This so-called “Pick A Pay” benefit is a real benefit, but it’s an expensive benefit, one that the client will pay for many times over. They are better off just managing their money well to begin with.

Let’s go into some details. Let’s consider someone with a $400,000 loan on a $500,000 property, and dead average credit score, and to keep the playing field level, the same 3 year “hard” prepayment penalty. On this morning’s rate sheets (outdated by the time you’re reading this), I have a 30 year fixed rate loan at 6.00 percent, less than one point total net cost to the consumer. The equivalent Option ARM/”Pick A Pay”/negative amortization loan is actually a little above 7.5 percent real rate, although it carries a nominal rate of 1%. Furthermore, removing the prepayment penalty would make a difference of about an eighth of a percent to the rate on the thirty year fixed, while I have yet to see a Negative Amortization loan that even had the option of buying it off completely, and this loan carries higher closing costs to boot.

Now, let’s crank some numbers. That thirty year fixed rate loan has a payment of $2398.21. Nothing ever changes unless you change it by selling or refinancing. The first month, $2000.00 even is interest and $398.21 is principal. You pay for a year, $23,866.38 in interest and $4912.05 in principal is gone, and you’ve made payments totaling $28,778.43. You are also free to pay down up to twenty percent of the loan’s principal in any year without triggering the prepayment penalty.

Plugging in 7.5% for the real rate to keep the math a little easier, the Negative Amortization Loan has four payment “options” of $1286.56, $2500.00, $2796.86 or $3708.05. These options represent “nominal” payment, “interest only” payment, “30 year amortization” payment, and “15 year amortization” payment. Actually, the last three options will vary every month, and trend upwards under these market circumstances, but let’s hold them constant just to make my point. As a matter of fact, if you don’t make a habit of paying at least the thirty year amortization payment, the options will drift up over time. The chances of this happening in the real world are minuscule, as I make clear in my first article on this subject, Option ARM and Pick a Pay – Negative Amortization Loans, but let’s play the game, just to see how it turns out if you give the advocates everything they ask for and more.

Crank the numbers through for twelve months, and you’ve paid $29,874.96 in interest, $3687.34 in principal, and made $33,562.30 in total payments. This is the “going along, making the loan payments” that the advocates are talking about. Here’s a table, comparing this to the 30 year fixed rate loan:

Loan
Interest
Principal
total paid		30 Fixed
$23,866.38
$4912.05
$28,778.43		Option ARM
$29,874.96
$3687.34
$33,562.30


When you put it in those terms, I don’t think there’s any question which loan a rational person would rather have. But that’s not the situation the advocates would have us believe is beneficial, at least not with this particular argument. Let us presume that two months out of that year – and to keep the math as simple and as favorable as possible, let’s make them the last two months – that you decide you have the need to make minimum payments, and let’s see what happens. you’ve paid $29884.40 in interest, lost all but $657.30 in principal payments, and made $30,541.70 in total payments. Now, if you’re making the minimum payment more than one month out of six, most folks should agree it’s not an “occasional” thing, it’s more of a “regular occurrence” thing, which situation I have already done the math to refute any claims of advantage. Here is a table comparing that to the thirty year fixed rate loan:

Loan
Interest
Principal
total paid		30 Fixed
$23,866.38
$4912.05
$28,778.43		Option ARM
$29,884.40
$657.30
$30,541.70


Look very carefully at that “total paid” row. The thirty year fixed has saved you $1763.27 in total payments. Now, this begs the question of what you’re paying it out of, but if you haven’t got the income to make the payments from somewhere, you shouldn’t have the loan. It’s not good for you. So we’re assuming that money is coming from somewhere, and as I have illustrated, if you’ll just not spend it as it comes in and set a little bit aside in case something happens to your cash flow, that 30 year fixed rate loan leaves you with $1763.27 of your hard-earned money in your pocket. Not to mention just an all around better situation, as evidenced by the rest of the second table.

Now, given the fact that these loans have basically nothing to recommend them to clients, why do alleged professionals keep pushing them off on the public? Well, two reasons, both of them having to do with money. $$$. Coin of the realm. Specifically, commission checks.

First off, it should come as no surprise to anyone that lenders are willing to pay very high yield spreads for negative amortization/Option ARM/”Pick a Pay” loans. The yield spreads start at about 3 and a quarter percent of loan amount, and go up to 4 percent, with most clustering in the higher part of the range. By comparison, that thirty year fixed rate loan pays 1 percent. On a $400,000 loan, like the one in the example, that’s the difference between a $4000 check and a $15,000 check. Doesn’t that make you feel good that they left you twisting slowly in the wind so that they could make $11,000 extra? Didn’t think so.

The second reason that people do this to you is that it makes it look like you can afford a larger, more expensive property than you really can. Most people tell professionals how much property they can afford in terms of monthly payment. Well, shopping for a property or a loan by monthly payment is a disastrous thing to do, as the first part of this article, among many others, illustrates. But let’s say you tell the Realtor that you can afford $2500 per month. Now most people are thinking of mortgage payments in the same terms as rent payments, when most people can afford a higher mortgage payment than rent, but let’s use these numbers. Let’s just use that numbers, and have insurance and property taxes call it a wash. For $2500 per month payments, you can make real payments on a $410,000 property, or you can make minimum payments on a $775,000 property. At 3% buyer’s agent commission, assuming they are only representing you and didn’t list the property, and assuming they do the loan as well, they can get checks totaling about $16,400 for the buyer’s agent commission and loan in the first situation, or $52,300 in the second. Not to mention I don’t have to tell the client to limit themselves to what their pocketbook can afford in the second situation. Even here in San Diego, that $775,000 property is a beautiful five or six bedroom 2800 square foot home with all of those nice little extras like travertine floors, three car garage, marble counter-tops, etcetera, in a highly sought after area of town with great schools, whereas the $410,000 property has linoleum floors, no garage, Marlite counter-tops, and is in a neighborhood with marginal appeal and probably not so wonderful schools. Which do you think sounds like a more attractive property and an easier sale, for what the typical buyer thinks of as the same payment? Which property do you think the typical buyer is going to select, particularly if they have never had all of this explained to them?

Finally, for pure loan officers, it’s a way of appearing to compete on price without really competing on price. The average person is told about this great 1% payment of $2500 when the real payment for a thirty year fixed rate loan (allowing for the fact that this has become a jumbo loan) is $4771.80, and they just aren’t looking at little things like two extra points of origination or higher closing costs, as it just doesn’t make that much difference to the payment. They can also slide in a higher margin over index that gets them an even higher yield spread, and it doesn’t influence that minimum payment at all, which is the only thing this client has their eyes on. So what if the final payment comes in at $2600 (making the loan officer roughly $35,000 or more)? So what if their loan balance is increasing by $2000 per month? Most people just do not and will not do the work that enables them to spot this trap.

Caveat Emptor

Why Renting Really Is For Suckers (And What To Do About It)

Okay, you might expect a Real Estate Agent to have a post with that title, but I’m going to surprise the doubters by hauling out a spreadsheet and proving it with numbers.

The more you have for a down payment, the better your interest rates and the lower your payments, but even so, you can make it.

The first thing to remember is that you have to live somewhere. When you buy, you place your cost of housing forevermore under your own control. Inflation means nothing to the housing costs of someone who’s already bought. Rising rents means nothing – unless you’ve bought an investment property to rent out, also. We are currently facing a period wherein rents are likely to rise precipitously. Why? Low vacancy rates (3.4% in San Diego), and many landlords facing adjustable rate mortgages that are going to adjust upwards. It doesn’t matter that your landlord has been nice up to now. They were banking on selling for a profit and right now, they can’t. When the monthly outlay goes up, they’re going to raise the rent. They will get it, too. If you won’t pay it, someone else will.

Once you have bought, you step off of that one way escalator of rising rents. Rents increase at a yearly rate about comparable to inflation in most cases, and rents never drop. I have never heard of a rent decrease except in areas that were so far gone they might as well have been war zones. You only borrowed $X when you bought, and unless you take cash out (which is under your control) you should never owe more money next year than the previous one.

So buying stops your situation from getting worse. What about making your situation better? First off, I need to observe that with rising rents, your situation will always get worse until you do buy. But buying really does make your situation better. Not immediately; there’s always a hit for buying, and it always costs money to sell. But within a couple of years the average person will be above any reasonable return they can earn any other way, and the reason is leverage.

Fact one: you always need a place to live, and the options are to rent or to buy. Renting typically requires less cash flow, but returns nothing. Once you have bought, all that lovely appreciation belongs to you and nobody else but. Let’s look at an actual scenario for San Diego, one of the highest priced places to buy.

I looked at one particular property earlier today with an asking price of $450,000. We’re going to leave aside the issue that with the market as it is, $410,000 would be a really terrific offer, and use that $450,000 asking price. The most comparable rental in the area is $1700 per month. For people with dead average national median credit scores, I have 6.125% on a thirty year fixed rate loan for the first 80% of the loan, and 8.75% on the second mortgage. Yes, I’m assuming a 100% loan. Total loan costs, one point and approximately $3400 in closing costs. With sellers outnumbering buyers 36 to 1 right now, it’s an idiotic seller who isn’t willing to pay your closing costs. Your payments on the two mortgages are $2187 and $708, respectively. Call it $2896 with rounding. I’m going to assume you’re married, which means you get a $10200 standard deduction on your federal taxes for 2006. Furthermore, property taxes are about $470 per month, and homeowner’s insurance costs about $110 per month for an HO-3 policy, the best there is. Total cost of housing: $3476 per month. Over twice your cost of renting, yes. But $400 of that goes straight into your own pocket, in the form of principal you’re paying off from month one. Furthermore, $2960 per month is a tax deduction, from which you’ll get a benefit of $(2960*12)-10,200 (standard deduction), or slightly more than $25,500 per year, from which someone in the 28% tax bracket will see a tax reduction of about $7145, returning another $595 per month to your pocket. $3476-$400-$595=$2481 net costs per month to own that property. Less the $1700 rent, works out to $781 extra you’re spending. Furthermore, if you turn right around and sell it, you’re going to be out about 7% of that sale price. Assuming it’s the same $450,000, that’s $31,500 you’re down.

However, property values don’t stop rising just because the renters of the world would like them to. Let’s assume you’re going to make a slightly below average for this area 5% per year in absolute terms – not inflation adjusted. Most of California has been averaging seven percent per year for the long term, over cycles and cycles of pricing. The CMA for the first property I bought, at the peak of the last cycle fifteen years ago says $320,000, an 8.8 percent per year average increase. So 5% is definitely on the low side. Let’s assume you have a twin who continues to rent, and invests that $781 per month, tax free, while you take it and buy a property. Actually, let’s go ahead and give your twin the full net cash differential of $1143 per month.

One year later, he’s got about $14,400, while your property is worth $472,500. You’ve got about $27,000 in equity. On paper, you’re ahead of him, but remember that real estate isn’t liquid and there are always selling expenses. You’re really still down by about $20,000 as opposed to your twin. Darn! Just when you had a really good brag going. But wait! Now your twin’s rent is raised to $1768 – right in line with 4% inflation. But your mortgage costs are fixed.

Run it out another year. Your twin has about $29,700 in that account. Looking pretty good, right? Well, you’ve now got a value of a little over $496,000 and you have about $56,000 in equity. You’re not really ahead yet, but deducting the 7% costs of selling net you about $461,400. You’ve made over $11,000, net, not counting the equity you paid down! But your twin has almost $30,000. Why is renting for suckers, you ask?

Go out one more year. Your twin’s rent has gone to $1838 per month, but even so his investment account still has a tad over $46,000 in it. Looks like he’s pulling away! Or is he? Your property value has gone to almost $521,000, and you only owe $434,000. You’re up almost $87,000, and even allowing the standard 7% for costs of selling, you’re would now have over $50,000 in your pocket, several thousand dollars more than your twin.

Every year from then on, you pull further ahead. After ten years, when his monthly rent is over $2500 per month, you’ve got $350,000 in equity, and even after the costs of selling, are over $100,000 ahead of your dimwitted twin.

Lest you think that if your twin started with $45,000 due to a ten percent down payment it would make a difference, the answer is not really. It cuts the lead, but not the essential facts. I could cut the rate on the second mortgage a bit, but let’s leave it at 8.75% for the purposes of this exercise. True, after three years you’re still lagging your twin in this scenario, as that investment account is $95,000, but only by a few hundred bucks. Your equity is $130,000, of which $94,300 would be left after the expenses of selling. After ten years, he’s $80,000 behind you, net of the cost of selling.

Suppose you start with a full 20% down payment? You’re still $55,000 net ahead of the game after ten years. Your twin started with $90,000 earning ten percent, but not only do you not have that expensive second mortgage, you’ve got $450,000 earning 5%, and it’s all yours and then some. This is the concept of leverage. That loan turns out to have been a good thing, as it enabled you to leverage your down payment into a much larger appreciating asset. So you only earned half the return – it was on five times the principal! It translated into a much bigger number. By the way, your twin only has the edge on you in cash flow by about $120 per month at this point, and he’s going to be negative next month.

Now the real estate market doesn’t earn nice smooth returns like this. Neither does the stock market, or anything except maybe bank CDs or the money market, at a fraction of the return illustrated here. Furthermore, it reliably and unavoidably takes about three years to come out ahead on a real estate investment. There are always the twenty percent per year markets, but those don’t happen very often and never predictably. What I’m talking about are is making money in the slightly below average market years also. Note that you’ll still make twenty percent in the years the market does. Sometimes you get lucky. But “time in” is so much more important than timing that they don’t even play in the same league.

You don’t have to be a genius, you don’t have to have perfect credit, and you don’t have to make a mint. You do have to pick properties that you can afford to make the payments on, and you do have to make the decision to accept a couple of tough years for cash flow. There just is no avoiding this hard fact. There are loans that promise otherwise, but they have bitten everyone I’ve ever met who tried them. Once you have made the decision to accept those lean times, however, the good times seem to flow from them for the rest of your life. The sooner you make the choice to accept them, the better off you will be.

Caveat Emptor

What if Your Partner Refuses to Pay Their Share of a Loan or Mortgage (or Won’t Pay on Time)?

what happens if partner refuses to pay his half of the mortgage?

The lender will hold you each responsible for payment in full. That’s the long and the short of it. You both agreed to the loan contract, and if it’s not paid in full there will be all of the consequences: Hits to your credit, notice of default, foreclosure.

This is basically blackmail on the part of your partner, and a disturbing number of partnerships have this phenomenon. The only way I know of to recover the money is through the courts, which takes forever and costs more money. Even when you have a judgment, it can be difficult to actually get the money if they have taken certain steps to place it beyond your reach. Talk to an attorney right now, keep good records, and send everything Certified Mail.

Unfortunately, there are no method except time that I am aware of to repair the damage to your credit once it has been done. You just have to wait it out. For that reason, it is usually cost effective to loan your partner the money, even at zero percent interest.

What if you don’t have the money for both halves of the payment? Well, that’s a real question, and the answer is found in the article What Happens When You Can’t Make Your Real Estate Loan Payment. This is not a good situation to be in. Talk to that attorney about liquidating your investment. It takes time and a lot of money if your partner doesn’t want to.

What can you do to prevent this from happening? Pick a good partner that won’t pull this nonsense. Spend the money to protect yourself up front with a partnership agreement. But the fact is that if your partner wants to be a problem personality, you really can’t stop them in the short term. Not that it makes any difference to your pocketbook, but sometimes it’s not intentional. People do fall on bad times for reasons not under their control.

Corporations are another step people take to protect themselves from this sort of thing, but that brings in all sorts of further problems. How the corporation qualifies for a loan is often a significant problem, and many times practically speaking, is insurmountable.

Borrowing money in partnership with someone else is something to be done with a lot of forethought and preparation, otherwise there’s nothing you can do when bad things happen.

Caveat Emptor

Variable or Range Pricing of Real Estate

About half the listings around here do not have a single number asking price, but rather a range in which offers will be considered. Even many agents have trouble understanding range pricing. I’ve seen and heard more than one agent rail against it, saying that it is essentially “repricing the home”.

Range pricing began in Australia and was brought to the United States by a certain major real estate chain. That chain is not one I particularly like doing business with, but that doesn’t mean range pricing is a bad idea.

Range pricing is a way of starting people talking, and to begin the negotiating process; nothing more. If there’s no offer made in the first place, I can guarantee there will be no transaction. The idea of range pricing is to jump start the negotiations.

Range pricing is not appropriate for all properties, nor in all markets. In the buyer’s market we have now, I’m certainly more hesitant to use it, as it offers more information as to the owner’s state of mind. In a seller’s market where prices are rising rapidly and sellers have all the power, it gives an indication as to what a serious offer is and what it is not. In a buyer’s market like now it tells some buyers exactly how much leverage they may have. I’m also more leery of using it on commercial properties.

One thing many agents (and others) misinterpret range pricing to mean is that any old offer inside the range should be accepted. This is the mark of an inexperienced negotiator. If they say offers will be considered between $400,000 and $425,000, that is not the same thing as saying “I want $425,000, but I’ll take $400,000.” There are many other terms and conditions on a purchase contract besides just the price, and there is no mandate to agree with even a full asking price offer if those other terms are prohibitive. Indeed, an agent who knows how to figure out other terms to offer in place of higher price is likely to save you far more than any commission they earn. Even price is rarely just price. For instance, if I write an offer for $410,000 cash, no contingencies, with a $10,000 deposit, most sellers should rightly treat that as superior to an offer of $425,000 with the seller paying $10,000 of closing costs and only a $2000 deposit, contingent upon financing for sixty days. Note that the seller nets over $4000 more if the latter offer actually closes, but the former is a much stronger offer and if two such offers were to come in and other things were equal, I’d strongly counsel taking the cash offer, especially as the latter offer is indicative of a not very well qualified buyer without much commitment to the idea of purchasing the property, and there would be a high probability that the transaction will not actually close. There are all kinds of terms on purchase contracts, and having a discussion as to what’s important to the other side can be a way of making your offer much more attractive without necessarily raising your price. For instance, owner occupants are often understandably nervous about whether the transaction is going to close, and committing large sums to alternative housing before it actually does close. If you can think of a way to address that concern, you’re miles ahead of the negotiator who can’t. Every situation is different, and what works one time may not be appropriate to even offer the next.

So if I see a property with range pricing of $400,000 to $425,000, I want to educate my buyer clients that an offer of $400,000 even with the seller paying up to $20,000 of closing costs is not within the range indicated. Indeed, as I’ve said elsewhere for such offers, a $380,000 sales price with the buyer paying their own way is a superior offer from the seller’s point of view. If they insist, I must and will submit it, but even in the current buyer’s market I wouldn’t be surprised to see it rejected outright with no counteroffer.

In the current buyer’s market, those few buyers willing to purchase properties have an enormous amount of power, and this will continue until the seller to buyer ratio gets a little less lopsided. So in the current market, I might actually offer significantly less than the asking price range, secure in the knowledge that if this seller rejects it, I’ll find something just as good tomorrow where the seller will accept. Some will. So if some won’t, so what? You learn to spot the sellers that have the power to refuse, and the ones who have to take anything vaguely reasonable.

Now admittedly, I don’t do a lot of listings, as most sellers don’t like to listen when I tell them to price their property to the current market if they want to sell. (And if they don’t, why are they talking to me?) I’ve only got one listing right now, and quite often, none. But when I’m showing them what the market is like, and what reasonable prices for properties like theirs are right now, I’ll ask a couple of questions once I’m convinced they understand. Everyone knows what they want to get for the property, and by the time I’m done, they better understand what a reasonable asking price is and why it’s stupid to list for more. But after that, once I’ve explained that there are offers and then there are offers, and the price isn’t the only thing worth paying attention to, I’ll then ask them, “Now that you know what a realistic asking price is, what would be the lowest price you would consider selling for, if someone offered everything else you wanted? Great deposit, all cash, no contingencies for financing, etcetera?” Next I’ll ask, “How far over the realistic asking price we’ve agreed on would you require going if the buyer came up with some odious terms: takes possession early, no deposit or not much of one, wants a long escrow, etcetera?” Rebates always raise the necessary price at least dollar for dollar, by the way. A $380,000 offer with no rebate is superior to $400,000 with $20,000 rebate from both buyer’s and seller’s perspectives. Then, depending upon how much the seller needs to sell, I’ll use that information to help me figure the endpoints of the asking range (assuming I’m not just going to use a single asking price). I won’t just use either number, of course. But that, together with the state of the market and how much power buyers think they have in the market at the time, will give me a good feel for what the lower number of the range should be.

There is another, entirely different benefit to range pricing is that when the search is done on MLS or its substitutes, the lower number in the range is going to trigger your property coming up on more searches. Now, if you’re a listing agent, MLS and MLS substitute buyers are more likely to be aggressive, and often unrealistic, bargain hunters, as opposed to people who really want to live in the neighborhood around this property. MLS inhabitants are not my favorite buyers when I’m listing a property, for that and other reasons. But if this property comes up on their search, they might look, and if they look, they might make an offer my client is happy to accept. If they don’t even see it as they’re searching, I guarantee no offer will come in from them. So range pricing helps me capture these people’s attention. Whether interest, desire, and action follow is anybody’s guess. But they might, where without range pricing they definitely wouldn’t.

In short, range pricing, properly done, is not repricing the home, and it is a good way to get the buyer and seller to the table. It is not appropriate for every property in every market, but for those it is appropriate for, it’s a useful tool. Properly used in the right market, it can even help your seller get a higher price for the property than any single number asking price you’d dare use.

Caveat Emptor

Is a VA Loan a Good Deal?

Veterans Administration, or VA loans, are government guaranteed loans available to veterans and active duty members of the armed services, that enable them to purchase homes for not money down. In fact, VA loans go up to 103 percent of purchase price to allow for some closing costs as well.

VA loans are a unique creature in the world of mortgages. Because there is a government guarantee on the loan, they are available, usually at the same rate, whether your credit is perfect or abysmal. They have a qualification limit equal to the conforming loan limit from Fannie Mae and Freddie Mac.

Now, the Veterans Administration runs a website where you can get all kinds of information on VA loans, but I’m going to touch some high points.

VA loans are available both for purchase and for refinance. There is a streamlined program for pure interest rate reductions that can sometimes be at documents in as little as a week. This is called the Interest Rate Reduction Refinance Loan program, or IRRRL, but usually just called a VA streamline. There is, or so I understand, a cash out program as well, but I’ve never done one of those.

All VA loans have two important feature: Government Guarantee and Assumability. The government will guarantee a certain percentage (usually 25% of the original loan amount), which is more than enough to persuade most lenders that these are loans worthy of a fairly low rate, as they are low risk. A person with a VA loan can allow anyone else to assume it, with the approval of the lender and the VA. They have to prove they qualify for the loan, and the veteran still has some responsibility for the loan. Last I checked, prepayment penalties on these loans were prohibited.

Now the bad news. Even with the government guarantee, the rate/cost trade-off isn’t the best. Most VA lenders want at least two discount points for their VA loans, a fact which makes low cost and zero cost VA loans problematical. Even with those discount points, the rate will probably not be as good as A paper. Veterans with good credit, particularly if they have a good amount of equity or a decent sized down payment, will generally be able to obtain a better rate at a lower cost in the A paper marketplace. Even so called A paper “jumbo” loans over the confrming limit, or A paper “stated income” loans, will have a significantly lower rate/cost trade-off than the VA loan. They’re better than just about all sub-prime loans, but they lose out to A paper.

If you have good credit but not much of a down payment, the VA loan can be an option worth exploring. VA loans have no mortgage insurance requirement (aka PMI), that purpose being served by the government guarantee, and so splitting your loan into a first and a second mortgage in order to avoid mortgage insurance, with the second being at a higher rate, is generally not necessary, and your full loan amount can be at the lower rate of the first mortgage. But be careful, because once again, most VA lenders want their two discount points, and maybe more. You might want to read my article on the Trade-off between Rate and Cost in Real Estate Loans and Why You Should Ignore APR for more as to why. Nevertheless, this could go either way and is well worth shopping the loan both ways.

If you have rotten credit, a VA loan can be the only way you can purchase a home, particularly if you have no down payment. Since credit is irrelevant and there’s a government guarantee, I used to know a couple lenders that didn’t bother to run credit for VA loans. Even the ones that do, it’s just a checked box that plays no part in the decision making and underwriting process. Furthermore, you get a rate of a sort that would normally be available only to someone with a much higher credit score than yours.

Now in addition to relatively high closing costs, there are some other games that get played with Veterans Administration loans, of which the Rate Buydown is probably the most pernicious and widespread. But if you’re one of those veterans who thought they could never be approved for a loan on a home, VA loans can make it happen where nothing else could.


Caveat Emptor