One of the most common questions in real estate is “What is this property really worth?”
The easy answer is the same as the deepest, most profound one I can come up with, “Whatever you can get someone to pay for it.” It’s the answers in between that you’ve got to watch out for. The appraised value is simply a guesstimate based upon the sales of similar properties. But there is no such thing as an identical property. A Price Opinion is just a guesstimate based upon what an expert thinks might be an appropriate asking price. Even an accepted offer means nothing if the offerer backs out, changes their mind, or can’t qualify.
Now it’s no secret that some people can get folks to pay more for real estate than others, and others can bargain the price down better. But the bottom line is that if it’s not worth what you paid, why did you buy it? If it’s worth more than you sold it for, why did you sell it? There isn’t a good answer to either one of these questions. It’s worth what it sold for. Period. The only exceptions are when there’s a distress sale, and even then, the answer reads, “Under the circumstances, that’s what the property was worth,” which is remarkably similar (like identical) to what the answer is in all other situations.
This goes for the other side of the coin, failed transactions, as well. Why didn’t you sell to a good offer? Why didn’t you offer more? Because it wasn’t a good offer, or because it wasn’t worth more, to that person.
If you walked up to the average person on the street and offered to sell them a parcel of land on which there’s a home, anywhere in the US, for $5 or $10 or $100 or even $1000, most people would take you up on it sight unseen so long as you could deliver clear title. I can safely say that the average residential property in this country is worth at least $1000 to every legal adult in the country. Why then all of these elaborate rituals of listing contracts and MLS and inspections and offers and escrow and title insurance for the transfer of property?
The answer lies in the fact that sellers want to get the highest price possible. Ideally, they want to find the one buyer who will bid more than anyone else on that particular property, because the property is worth more to them than anyone else.
To find that one perfect buyer is actually fairly rare, in my experience. But you can certainly find buyers willing to pay more than $1000, in most cases. How much more? Well, that depends upon the property and the buyer, how widely and effectively your net is cast and how long you are willing and able to wait. As with all investments, it’s a trade off and sometimes the money you’ll get from a better buyer isn’t worth the money you spend finding them. Knowing stuff like that is part of what I get paid for.
It does you no good to accept the offer of someone who can’t qualify for the loan they need in order to purchase the property. It does no good to make such an offer. How do you tell, as a seller? Make it a part of your counteroffer that the deposit revert to you the day after contingencies expire. That’s not friendly, and it may lose you some potential buyers, particularly in a buyer’s market, but it’s the only way to be sure. Prequalification letters are basically used paper, for all they really mean.
There is nothing wrong with saying, “My property is worth $X” as long as you understand that it’s shorthand for “Similar properties in my area are selling for about $X”. Because your property is never worth $X. Nor are any of mine, Donald Trump’s, or anyone else’s. It’s not worth that unless you sold it for that, and if you sold it, it’s not yours anymore, is it?
People get caught up in the damnedest ego blocks on comparatively few dollars. You put the property up for sale because you wanted something other than that property, right? You’re out there offering money for the property because you think you can make more money with the property than with the money, right? Trying to squeeze too many dollars out of the other side of the transaction can and often does leave you with no transaction. There is a thin line between hard bargaining that gets you a good bargain, and overplaying your hand that gets you left out in the cold.
Don’t get left out in the cold.
Caveat Emptor
The State of Our Educational System
US News has an interesting editorial by Mortimer Zuckerman in their latest issue, having to do with the departure of Lawrence Summers and the downside for Harvard’s students.
It seems that Summer’s celebrated episode of Hoof in Mouth Disease was only a public reason for the faculty turning on them. It seems he wanted the professors to teach, and not just the courses they thought up to coincide with the most recent research, but more basic stuff as well. Furthermore, he was fighting grade inflation. When 91 percent of your graduating class gets honors, honors are meaningless. Particularly when a large portion of the student body was emerging from the undergraduate program ignorant of core subjects.
Does the vast majority of this fight sound familiar? It should. Parents of schoolchildren from kindergarten through twelfth grade are fighting it, and into college for those who continue in public colleges. I’ve got a kindergartner who, I’m convinced, learns more in the hour or so per night my wife and I can devote before bedtime than the seven hours she’s in class. They play around with sight words all day, and we come home and teach her phonics. The math they’re doing is pathetic. They’re still working on counting, and we come home and teach her about how adding is really just about fast counting. In fact, they seem to concentrate on feel good subjects. She comes home with songs about Rosa Parks and Martin Luther King that she sings ad nauseum, but she can’t tell us anything about what they did, nor did she know who George Washington and Abraham Lincoln were and what they did until we took the time to teach her. MLK and Rosa Parks deserve admiration and respect, but let’s get the basics first (I have yet to hear of a high school or lower civics class mentioning General George Catlett Marshall, who in my opinion was probably more important to history than any of the presidents he served. He ran World War II, strategically, then took someone else’s idea of rebuilding our former enemies and sold it to the american public, which was arguably the best investment we’ve ever made as a country. Wikipedia has a good overview, if your school failed you.
My point is this: The schools don’t teach what the students need to know. They teach what the teachers want to teach, what is easy for the teachers to teach. I have heard, secondhand, tales of their children dealing with teachers who are mathematically incompetent – who literally could not do arithmetic without a calculator. This is unacceptable, even in an English teacher. The schools don’t teach rational thought, or methods of evaluation. How can they, when the teachers cannot handle mathematics themselves?
What they have is not an easy job. Those that actually do their job are underpaid. But there are too many that shouldn’t be in the teaching profession at all, and their organizations are doing their best to keep us from improving the situation. And, it appears, the phenomenon touches even the most prestigious of private universities. If the professors will not teach, how are they supposed to be in touch with what the students need to learn? How are they, and not grad students who do the actual teaching, supposed to be better equipped to set academic policy? Why are they not, instead, in a purely research position in private industry? Tell me again why they are receiving a salary from a college? Here’s a hint: It’s not to shelter them from inability to get a grant.
They are paid to teach, and they are paid to teach what the students need to learn. If they won’t do it, that’s called refusal to work, and is grounds for terminating anyone. If they can’t do it, that’s called incompetence, and also grounds for terminating anyone.
If you are getting the idea that the tenure system is out of control, you’re on the right track.
The Perceived Will to Fight
Power = capabilities X interest X will
If any of the elements on the right are zero, power is zero, no matter how strong the other elements. If interest and capabilities to defeat an enemy are great, but will appears weak, then so is power.
He also deals with the differences between actual will and perceived will. If your will is perceived to be weak, you will be forced to fight battles that never would have happened if your will had been perceived to be stronger. Every time something happens to weaken the ability, or the perceived ability, of the United States to respond in an appropriate manner, our enemies are encouraged to launch attacks and fight battles that they otherwise would not.
Is it treason to advocate “cut and run from Iraq”? Not unless you’re being paid to do so. But every time somebody does so, they become a part of the cause why american servicemembers are killed in subsequent attacks, and Iraqis also. This places a very high bar on what I consider – what is – worthwhile criticism of the Iraq war. Of course, those making the criticisms of the war knows that the ones harmed by it will overwhelmingly vote for the other side, anyway.
And just because it’s not treason doesn’t mean scoring cheap political points that get our defenders and Iraqi innocents killed is in any way admirable. Quite the opposite, and I hope that those who say they support the troops will suit actions to words in the voting booth this year, as well as everyone with a friend or relative in the military. It is incorrect to claim that there can be no valid criticism of the war or its handling. But it is also very possible to criticize the war and its conduct without encouraging our foreign enemies, and those who are unable to see the distinction or make the distinction need to be voted out. Such actions will not only improve the quality of the debate, but send a clear message to our enemies that we have the will to carry this through, and therefore save lives because of attacks the enemy is not emboldened to make, and battles that remain unfought.
In short, if you support the troops, don’t get them killed needlessly.
Leverage – Making a Decent Investment Spectacular
One of the concepts I keep seeing without a decent treatment is the concept of leveraging an investment. Real Estate has this like no other investment. You go talk to a bank about leveraging eighty to ninety or even one hundred percent of your investment in the stock market, or the same percentage of a speculative venture, and see what happens. Be prepared for laughter, and they’re not laughing with you. But real estate they will do it. Why? Because it’s land. It’s not going anywhere, and they’re not making any more.
The fact is that real estate has the potential for leverage like no other. This is due to the interplay of two factors. One is the fact that you can rent the property out to pay for the expenses of owning it, and even if you use it yourself, you’re able to save the money you would be paying in rent. Everyone’s got to live somewhere, and every business needs a place to put it. The other, more important factor is leverage, the fact that you’re able to use the bank’s money for such a large portion of your investment. The bank will loan you anywhere from fifty to one hundred per cent of the value of the property. Yes, you’ve got to pay interest on it, but you’re paying that through the rent – either the rent you’d save or the rent you’re getting – and there are tax deductions that make such costs less than they might appear.
Now here are some computations based upon the situation local to me. Suppose you have a choice as to whether to buy a three bedroom single family residence for $450,000 (to pick the figure for a starter home) or rent it for $1900. Let’s even allow for the fact that the home may be overpriced by $100,000. You have $22500 – a five percent down payment. More than most folks, and you would invest that and the difference in monthly housing cost, and earn ten percent tax deferred if you didn’t buy the house. Let’s crank the numbers and see what they say.
| Year 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 | Value $450,000 $374,500 $400,715 $428,765 $458,778 $490,893 $525,255 $562,023 $601,365 $643,460 $688,502 $736,698 $788,267 $843,445 $902,486 $965,661 $1,033,257 $1,105,585 $1,182,976 $1,265,784 $1,354,389 $1,449,196 $1,550,640 $1,659,185 $1,775,328 $1,899,601 $2,032,573 $2,174,853 $2,327,093 $2,489,989 | Rent $1,900.00 $1,976.00 $2,055.04 $2,137.24 $2,222.73 $2,311.64 $2,404.11 $2,500.27 $2,600.28 $2,704.29 $2,812.46 $2,924.96 $3,041.96 $3,163.64 $3,290.19 $3,421.79 $3,558.66 $3,701.01 $3,849.05 $4,003.01 $4,163.13 $4,329.66 $4,502.85 $4,682.96 $4,870.28 $5,065.09 $5,267.69 $5,478.40 $5,697.54 $5,925.44 | Equity 22,500 -48,406 -17,287 15,999 51,604 89,691 130,432 174,014 220,635 270,509 323,864 380,943 442,008 507,340 577,237 652,020 732,034 817,645 909,249 1,007,266 1,112,149 1,224,382 1,344,484 1,473,009 1,610,553 1,757,754 1,915,294 2,083,904 2,264,370 2,457,532 | Benefit -31,500 -110,236 -94,761 -77,990 -59,828 -40,176 -18,930 -4,021 28,797 55,524 84,333 115,367 148,774 184,712 223,349 264,861 309,432 357,261 408,553 463,526 522,407 585,438 652,869 724,964 802,381 885,736 975,442 1,071,939 1,175,697 1,287,213 |
The Net Benefit Column is net of taxes, net of the value of the investment account. The cost of selling the property is also built in. Now most people won’t really do this, invest every penny they’d save. I have intentionally created a scenario that contrasts a real world real estate investment where you bought in at a temporary top, with a hopelessly idealized other investment.
There is a potential downside, and it could be big. This is a real risk, and anyone who tells you otherwise is not your friend. Look at the beginning of years numbered 2 through 5 in the equity column. You haven’t gotten your initial investment back until sometime in the fourth year. Look at years 1 through 7 in the net benefits column. You’re immediately down $31,500, due to me assuming it would cost you seven percent to turn around and sell the property. A year later, due to me assuming the bubble has popped, you’re down by over one hundred ten thousand dollars, as opposed to where you’d be in you put it in the idealized ten percent per year investment. There is no such thing, but for the purposes of this essay I’m assuming there is. This is the illustration of why you need to look ahead when you’re playing with real estate – a long way ahead. A loan payment that makes you feel comfortable for a couple of years isn’t going to cut it. You need something viable for a longer term. If you’ll look at projected equity at the beginning of years five and six, it goes between fifty odd thousand and eighty some thousand, assuming you’ve been making a principal and interest payment. You have plenty of equity to refinance there if you need to. If you need to do something in year three, however, you’re hosed. If you’ve been negatively amortizing, you’re hosed. You owe more than the property is worth. The payment adjusts, you can’t afford it, you can’t refinance, and you have to sell at a loss, as well as getting that 1099 love note from the lender that says “You Owe Taxes!”
But now look ten years out. At the beginning of year 11, you have $323,000 in equity, and if you sell at that point, you are $84,000 ahead of where you would have been if you invested that money in the idealized investment I’ve posited. That’s four times your original investment, and I only assumed real estate went up seven percent per year, whereas the alternative investment went up by ten percent per year. How could that possibly be right?
The answer is leverage. That $450,000 was almost entirely the bank’s money. The appreciation applied to this entire amount. But you only invested $22,500. The bank isn’t on the hook for the value; their upside is only the repayment of the loan. If the property goes to a value of $481,500 and then $515,205 (normal seven percent appreciation in two years), then that extra money is yours. Think Daffy Duck shouting “Mine! Mine! All Mine!“. Daffy’s got to pay some money to get the property sold, as real estate is not liquid. The bank gets all of it’s money. The bank always gets all of its money first. After that, however, then the extra belongs only to the owner, not the lender.
The lender gets none of the appreciation. This is all fine and well with them, by the way. They’ve been well paid whether the property increased in value or not. This money from increased value is all yours. This applies even, as in our example, if the property lost value for a while. Yes, if you had had to sell in year two, you’d have been up the creek. But you didn’t; you kept your head and waited until the property increased again. Given that you didn’t, the only numbers that are important are the numbers when you bought it, and when you sold it. The rest of the time is completely irrelevant to the equation, a fact that is true for any investment, by the way. Doesn’t matter if the value is ten times what it was when you bought on paper, it only matters that when you actually sold, it was for a loss. Doesn’t matter if the value goes to zero the day after you buy, and stays there for thirty years. If in the thirty-first year it rebounds to fifty or a hundred times the original purchase price and that’s when you sell, then you really were a genius. Get it? Got it? Good.
So when the property appreciated back to $688,000 and change at the beginning of year eleven, and you only owe $364,000 and change, that’s $323,000 in equity. You’re almost fifty percent owner. Even after you pay seven percent to sell the property, you come away with $275,000, as opposed to a little over $191,000 that you’d have in the idealized but unleveraged investment.
Keep in mind this whole scenario is a hypothetical. Every Real Estate transaction is different. Every property is different, every market is different, and the timing makes a critical difference. That’s why you can’t just call your broker to sell it and get a check within seven days, like you can with stocks and bonds. That’s why a decent agent is worth every penny, and a good one is worth more than you will ever pay us. But properly executed, a leveraged investment pays off like nothing else can, and real estate is the easiest way to make a highly leveraged investment that is stable until such time as it is favorable to sell.
Caveat Emptor
Investing in Second Trust Deeds
From an email:
I’ve been enjoying your blog posts on mortgages. I’ve learned more from you about what to expect than I have from any other source, and I’ve gotten 10 mortgages in my life.
I was reading Larry William’s website this week, and on there I saw one of his newsletters from last summer:
http://www.ireallytrade.com/
http://www.ireallytrade.com/freestuff.htm
the May 2005 Right Stock.
Larry Williams you may be familiar with, he’s written many books on trading.
Anyways, the newsletter talks about buying 2nd mortgage notes as an investment. And that’s something I haven’t seen you write about.
With the softening of the housing market in many areas, and overextended borrowers, I suspect that the market for 2nd notes will be heating up over the next few months and years.
I’d appreciate hearing your views on the opportunities and pitfalls in this area.
Let us consider the efficiencies of the market. The Institutional lenders have economies of scale, underwriting guidelines, and a set checklist of procedures as to how to approve (or decline) loans. They have a system that makes them effective. They can do this because they have enough loans to make it cost-effective, and because of their experience, they know how to price their loans. From advertising to wholesaling to pricing to packaging and servicing, they are set up for efficient service. Lest people think I’m saying lenders are a better place to get loans than brokers, I am not. Quite the reverse is true. But the the vast majority of broker originated loans are with regulated institutional lenders.
What happens if you’re not set up like that? The answer is you’re either more highly priced than they are, or you’re not as profitable. I’ve said more than once that without regulated institutional lenders, every loan would be a hard money loan. So in trying to originate loans, an individual is competing at a disadvantage. Where then, can they make a profit?
The answer is in the loans that the regulated lenders won’t or can’t touch. Now we need to ask ourselves why they can’t or won’t touch them. There are three common reasons. First is there is something wrong with the borrower. Second is that there’s not enough equity. Third is that there is something wrong with the property.
Something wrong with the borrower has several subtypes. Credit Score too low, in bankruptcy, too many mortgage lates, no source of income to pay back the loan. Most of these can be gotten around in one degree or another unless they take place in combination with insufficient equity. Most single problems are surmountable by a good loan officer, providing you’ve got the equity required to convince the bank they won’t lose their investment. You’ll pay a higher rate or higher fees than you would without, but better that than no loan. It’s when they take place in combination that problems arise which break the loan beyond the ability to rescue. And of course, if the property is not marketable in its current condition, no regulated lender will touch it.
What the first category reduces to is increased chance of default. The second category reduces to increased risk of losing money in case of default. The third category, something wrong with the property, reduces to you’re going to get stuck fixing the property if they do default, which means sinking thousands to tens of thousands of dollars into it, above and beyond the amount of the trust deed. Furthermore, both the second and third categories are also at increased risk for default, even if the borrower has the wealth of Midas and the credit score to match.
So let’s consider what happens when something goes wrong. The borrower doesn’t make their payments, and it becomes a non-performing loan. You’re not getting your money. If you need it every month, that’s a problem. Do you know the proper procedure to foreclose without missing any i-dots or t-crossings? If you don’t, your borrower can spin it out a long time. Well, that’s what a servicer is for, but a servicer cuts into your margin, and they get their money every month regardless of whether or not you get paid. This means they’re a monthly liability if the loan isn’t performing. Furthermore, over half the time, some low-life attorney talks the people into filing bankruptcy to delay the inevitable. It’s stupid, and it almost always ends up costing them still more money and making their final situation much worse, but they do it anyway – and now you have to start paying an attorney to have any hope of getting your money.
Suppose the property does go all the way to auction? You are second in line behind the holder of the first trust deed. They get every penny they are due before you get one penny. And if the first trust deed holder forecloses (or the government for property taxes), your trust deed is wiped out. The only way to defend against this is go to the auction with cash to defend your interest. And if the borrower isn’t paying you, may I ask why you think they’ll pay their property taxes or first trust deed? The answer is “they’re probably not.” They are going to lose the property anyway, so why make payments that don’t prevent that?
(There are a lot of details in the foreclosure process. The stuff in the above paragraph should not be taken for anything more than a broad brush child’s watercolor type painting of the process, as including those details would digress too far)
Now, suppose you’re not originating the loan, you’re just buying the right to receive payments, either on an individual loan or a package of loans, after the fact?
Well, can I ask you which loans you think the lenders are selling? If you answered “The ones in greatest danger of default” you get a star for the day! The lenders will either sell them off individually, if there are people inclined to buy, or actually repackage them thusly. The ones that are still performing, and still going according to the original guidelines will go to other regulated institutional lenders in mass packages, but those lenders won’t take these, or if they will, it’ll bring the price of the entire package down by more than it’s worth. So they separate out the dogs before they sell the package. So unless you’re buying them as part of the original loan package, this is what’s happening. Now mind you, there are always those who want the non-performing loans because they know how to deal with them, but they know to only buy the ones with enough equity to cover the loans in case they need to foreclose. Those who specialize also know what these loans are really worth, and they don’t pay full value – usually not even close.
So the aftermarket loans that are available tend to be in danger of default and without sufficient equity to cover if it goes to auction. If you’re looking to lose your money, you’ve just found a very good way. You can also spend thousands of extra dollars trivially trying to defend your interests.
The equity issue is going to assume increased importance as prices in some overheated areas subside. If the loan was underwritten and approved on the basis of a $500,000 appraisal, but now similar properties are only selling for $420,000 and the loans total $450,000, it doesn’t need a genius to understand you’re not in the best of positions. Even if it sells at auction for as much as comparables are going for, you’re still down at least $30,000 plus the expenses of the sale.
Now, with that said, second trust deeds can, if the equity is there, put you in the catbird seat. Suppose there’s an IRS lien junior to you? Our office dealt with a $700,000 property with a $1.6 million lien against it – junior to the $28,000 second we bought. Nobody else could touch that property. The owner just wanted out – he wasn’t getting any money regardless of what happened. He stopped making payments, and we had to step in with thousands of dollars to keep the holder of the first happy. There ended up being a fair amount of money made, although it took some serious cash for a while, because we had to make the payments on the first loan as well as everything else. This is not for the weak of wallet. If buying the Note had taken all of our ready money, we would have been SOL.
There are also all of the standard diversification of investment concerns. If ninety percent of your money is tied up in this deed, that’s a pretty serious risk to your overall financial health. No matter how many precautions you take, some do go sour.
In short, while there is a lot of potential for gain, it’s some serious work to evaluate the situation, and usually some serious work and serious cash to make it work for you when it is right.
Caveat Emptor
Helping Yourself Qualify for a Home Loan
There are a fair number of specific helpful suggestions to make in helping you purchase a home. All of them revolve around the loan. Let’s face it, the loan is far and away the most hypothetical and uncertain part about most real estate transactions. If there is a non-loan related problem, chances are that you really didn’t want to buy that particular property anyway. Most of the time, these problems mean that you would be buying into trouble, and nothing but. Unless you have specialized knowledge in sorting out that particular problem, it’s likely to be more expensive than any money you saved through reduced purchase price.
A poor loan officer can always botch a loan, of course, and even the best may not be able to push it through if you are a marginal enough case. So how do you improve your case standing?
The first thing is to get a credit score above 720. If you’re there already, keep doing what you’re doing. Even if you’re not there yet, it’s easier to improve than most people think, although it takes time. Make all of your credit payments on time, especially any mortgages and rental payments. These are the most important things to mortgage lenders. Note that you make a payment a few days later than it is due, and you may even pay a penalty, but the lender will not report it as late until 30 days later, and that’s when it counts as late to everyone else. In order to qualify for the A paper loan, at the top of the market, the general rule is no more than two 30 day late payments on revolving debts within two years, or one 30 day late on mortgages or rent.
Most lenders want you to have three lines of credit, and a twenty-four month credit history. Not all of them need to be still open, but if you don’t have at least two open lines of credit, a given reporting bureau may not report a score, and if you don’t have two different scores from the three big bureaus, only a few sub-prime lenders will give you a loan. The longer your particular lines of credit are open, the higher your score will be. So if you keep opening new lines of credit, expect your score to be low.
Revolving credit balances should be kept low, less than half of their limit. There is a significant hit if your credit line is more than half its limit, and the higher you go, the worse it is. If you have two $5000 limit credit cards, it is much better to have $1500 on each than $3000 on one and nothing on the other. It make even more difference if you have $2000 balance on each as opposed to $4000 on one. And if you’re one of those people who keeps doing the “transfer your balance to a new card and get zero interest for six months” thing, it will really impact your credit in a negative way, because if your credit balances sum to $8000, that’s usually what the limit on the new card will be, and so you’ve got a brand new credit card that’s maxed out, which is a major hit on your credit.
One of the best ways to improve your credit score relatively quickly is to use your credit regularly but pay it off every time you get a bill. Once per month, charge something small that you know you will be able to pay off when the bill arrives. This may still take some months to improve your score, but better months than years.
The next way to improve your ability to afford a house is not to have any large monthly payments. The best rates are for full documentation loans, where you prove to the lender that you make enough money to be able to afford all of your payments. “A paper” lenders will allow you to have total monthly payments of 38 to 45 percent of your gross monthly income. Some sub-prime lenders will go to 55 percent. If your family makes $6000 per month, this means that total payments can be up to $2700 for certain A paper loans, up to $3300 for sub-prime and still qualify full documentation. This also means that the more income you can document, the more house you can afford.
This number includes not only the amount of the mortgage, but also the property taxes, homeowners insurance, association dues (if applicable), and anything else you may need to pay in order to keep the home, as well as car payments, credit card payments, and any other debts you may have. This means that somebody with other payments of $80 per month can afford a lot more house than somebody with other payments of $900 per month. This should be intuitive, but you’d be surprised how often people don’t realize it.
The final thing that is helpful is a down payment. The larger your down payment, the less you have to borrow. Lending money is a risk-based business. Up to a point, the lower the ratio of loan balance to value of the property will help you get a lower interest rate and more favorable terms, because the bank will be more certain of getting all of their money back. A 5% down payment is better than none. 10% is better than 5%. The first 5% makes the most difference, but every bit helps. Of course the larger your down payment, the less you have left over for other purposes. It seems to be a phenomenon today that people don’t want to risk any more of their own money than they have to, and 100% loans can be done right now, although how much longer that will be the case is anyone’s guess. Still, people who make a habit of saving money are always in a stronger position that those who do not.
Caveat Emptor
Did That Slap On The Back Leave a Knife?
One of the things the place I work does to attract clients is advertise foreclosure lists to our clients. Several times a week, people call and ask for the lists, and we say, “Great! Just come on down, fill out a loan package and an agency agreement, and we’ll get them to you fresh every morning, and when you see one you might be interested in, we’ll help you get it!”
Before the end, over 95% of the people have stopped us, saying they are already working with someone. “I just want the foreclosure list. Can’t I get it?” Well, we pay money for that. Why should we give it to someone who is not our client and has the ability to pay for it on their own? Why didn’t their agent get it for them? (Everyone can get a weekly list for free from the county – but that list is worthless except as a timewaster, because that list is three to ten days out of date and they’ve already been swarmed.) If they want to work the foreclosure market, they should have signed up with an agent who has daily foreclosure lists. They haven’t even found a property they are interested in yet, and already they know their agent isn’t cutting the mustard for their purposes. But they are still stuck with them.
Another trick high margin (“expensive”) people use is social groups. Nothing wrong with social groups and using people you know there, but make certain you’re not paying three or five times the going rate for a loan, and that your agent really knows what they are doing before you sign on the dotted line. Church groups, soccer coaches, scoutmasters – I can’t tell you all of the social acquaintances I’ve rescued people who became my clients from. These predators look at other members of the group as a captive audience. It isn’t so, of course, those people have the option of going elsewhere – it’s just difficult socially, and many of them are unwilling to make the effort.
One of the worst of these is family. Your brother, sister, aunt, or nephew is in the business, and your family makes it difficult not to choose them. “You simply must use your sister Margaret!” Well, if subsidizing Margaret to the tune of two points more than anyone else would get is your cup of tea. Around here, that’s $8000 or so for the average transaction. You are not writing the check for the extra to Margaret directly, but you’re paying her just the same.
Lest I be misunderstood here, there is nothing wrong with using friends, family, members of your social group. Please do check with them. The mistake is not in giving them a shot; it lies in giving them the only chance. That’s what you call a monopoly situation, and the chances of you getting the best possible treatment are horrid. But if Aunt Marge or Uncle Bob know you’re shopping around, they have more incentive to do their best work. If they know you’re not, well I hate to break it to you, but the average person is looking for a bigger paycheck for the same work, and this includes friends, family, and social acquaintances, particularly because you are not the one writing the check, but you will pay for it, guaranteed. The worst mess I’ve ever had to clean up was caused by my client’s uncle, who had been in the business twenty years, and was trying to extort just a little too much money for the deal to work.
On the other hand, when my cousin calls me out of the blue, I can cut him a deal because here is a transaction that I didn’t have to spend time and money on wrestling it in the door; it walked in of its own volition. This is far and away the toughest part of any transaction, and one of the most expensive to any real estate practitioner – getting a potential client into your office. It’s why the “big names” spend so much on advertising nationally, and give their folks half (or less) of the cut a smaller place will give them. (Hint: just like in financial planning or any other service, what’s important is always the capabilities and conscientiousness of the individual performing the service, not the company).
So here’s how you live up to the social expectations. Give them a shot, but not the only shot. If you are looking to buy and they are an agent, sign a non-exclusive buyer’s agreement with them. This gives you free rein to work with other folks as well; just don’t sign any exclusive agreements. Most agents, unfortunately, want to lock up the commission that your business represents and so they will present you with an exclusive agreement. The harder they argue for an exclusive agreement, the more you should avoid them. All an exclusive agreement does is lock you in with one agent. If they are a lazy twit, you either have to wait until the agreement expires, use them for your transaction anyway, or hope you can get them to voluntarily release you. There is no way for you to force them to let you go. I get search phrases like “breaking an exclusive buyer’s agreement” hitting the site every day. The only two ways to break an exclusive agreement are 1) wait for it to expire, or 2) get them to voluntarily let you go. I’ve never heard of the latter happening. So don’t sign an exclusive agreement in the first place. Sign a non-exclusive agreement. This puts all of the motivations for work on your side, where they belong. The one who finds the property you are interested in will get the commission, but they have to work for it, as your business isn’t locked up.
This also gives you an out if Aunt Marge or Uncle Bob doesn’t cut the mustard. You can tell anybody who gets their nose out of joint, including them, that you gave them the opportunity to earn your business, and somebody else did a better job. The other guy saved you money, the other guy found you the property you wanted, the other guy got you a better loan. You wanted to do business with them, but they didn’t measure up. Case closed, and Aunt Marge or Uncle Bob will drop it if they are smart, because the more stink they raise, the more likely it is that another family member, friend, or social acquaintance will pass them by in favor of “Could you give me the name of that guy who helped you?”
The only exception to the non-exclusive buyer’s agreement is if they are giving you a service that you would otherwise have to pay money for. I am not talking about Multiple Listing Service – those are free and plentiful. I’m talking about real time information not available to the general public – like daily foreclosure listings. Our office pays hundreds of dollars per month for that as a way to bring in business. It is reasonable for someone working the foreclosure market thusly to be asked to sign an exclusive agreement, because otherwise there may be no way to determine who introduced you to the property (Lawyer’s Full Employment Act strikes again!)
For sellers, unfortunately, you’ve got to make a commitment to list with one agent. It’s just the way it has to be, economically, in order to get them to commit to spending the kind of money it takes to get a good result. But you can interview more than one agent. What are they going to do to sell your property for the highest possible price? Put it in the contract when you do sign. Everybody can put it in the MLS, and during the bull housing market we had for years, where unless the property was obviously overpriced you’d get multiple offers within a week, a lot of monkeys masquerading as agents made a good living doing that and only that. That doesn’t cut the mustard any more. I work more with buyers than sellers, but there are venues that sell the property, venues that bring people to open houses, venues that generate people looking for the cheap bargain (which you don’t want) and venues that generate people looking for property like yours in your neighborhood (who is your ideal buyer). Especially in a major city, these are all different venues, and the agent who knows which one is which is worth more than you will pay them, and the cheap agent who doesn’t is likely to cost you a lot more money than their cheap asking price saves you.
For loans, I’ve written about this before, but shop around, ask questions of every loan provider you interview, beware of red flags, and stick to your guns. Try and find someone to act as a backup loan provider if you can, and do the work so both loans are ready to go when you need them. If you get multiple volunteers for backup provider, that would tend to indicate that they know that the loan you’re telling them about isn’t real. That’s the question I ask before I volunteer to put in the work of a backup provider. “Could the loan they are telling me about be real?” If the answer is no, I volunteer to act as backup. Every single time, it’s been my loan the person ended up getting. Your prospective loan providers should know the market if they are competent. Make use of that knowledge. And lest you be tempted to quote something at those loan officers that is not real, it’s a self-defeating strategy. Honest loan officers will tell you point blank they can’t do that, while the scamsters are going to get into the spirit of the situation, by which I mean saying anything it takes, no matter how fanciful, to get you to sign up. And those who are knowledgeable about the state of the market always know what is likely real and deliverable, and what likely is not.
Caveat Emptor
Buy Now vs. Wait: Some Practical Hypotheticals
I am hoping to buy in the (city) area and am reviewing the possibilities. While I fear that the local market may be peaking, I intend to live in the home for at least ten years, so I am not trying to time the market.
My questions have to do with the down payment. I expect to shop for a property in the $450,000 range, and currently have $60,000 available for a down payment. I make a decent salary and receive an annual bonus of $35,000 – $40,000 each February. The bonus, while not guaranteed, is very dependable. After taxes and deductions, I should realize about $20,000 – $25,000 from it.
Do you think I would be wise to wait until February, by which time I will be able to make a down payment of $90,000 and perhaps avoid PMI and pay less interest over the life of the loan, or seek to buy now and lessen the taxes on the bonus? (I itemize, am single and am in the 28% bracket). Will the greater down payment help me to capture a better interest rate on the loan? (My credit scores are right around 800). Also, if I buy now, is it possible that I will be able to negotiate a mortgage in such a way that I can pay my realized bonus in February as a lump sum towards the remaining principal without incurring penalties? Ideally, i would like to use my bonus each year to pay down principal, as I can afford to balance my budget, including regular mortgage payments, without touching the bonus.
While on the subject of credit scores, I am reminded of another question – does an 800 score do me any good as contrasted with, a 740 or 750? Thank you again for your consideration. Your writings have been invaluable to my education.
I needed some more information, so got a subsequent email
I would expect the property taxes to run about $5,000 annually and association dues to be another $350 monthly. As I don’t have a car, parking fees will be inapplicable. My closing costs should be somewhat reduced as I work for a bank (parent company) and they offer employees favorable mortgage rates with no points and no origination fees. Of course if I go elsewhere for the loan that would not apply, but I would only expect to do so if I received even more favorable terms.
As for an equivalent property, the market would price the rent at about $2,200 a month, although I am only paying $1,520 now (for a less desirable place than what I am shopping for).
First things first. You are easily A paper. Some lenders might have a small incentive (no more than 1/4 of a discount point) for folks with credit scores over 760, but most don’t, and even if you go looking for one that does, it’s no guarantee that their overall rate will be better than what you could get elsewhere. Remember, it’s not important that they give you a quarter point incentive if their trade-offs were more than that above the competition. Look for a loan based upon the bottom line to you, not a little tweak that says you get treated a little better than the next guy.
Second, split your loan into two pieces to avoid PMI. One first loan for 80% of the value, and a second for the remainder, whatever that is. The second will be at a higher rate, but better that than paying PMI on the whole balance. It’s likely to save you a lot of money this way. If you intend to pay it down, be very certain that there will be no prepayment penalty.
Now, let’s look at now versus basically a year from now (Since February is ten months away). One thing I’m going to look at is whether your location may be above sustainable levels. My rule of thumb is that if a 20% down payment won’t break even on rental cashflow, your area is likely to be overpriced. With current rates (6.25% for a thirty year fixed rate loan at par for the first, something like 9% for a 10% second), payment on $360,000 runs about $2215, plus taxes of $420 per month plus association dues of $350 plus an allowance of $50 per month for insurance. Total $3035 per month. As opposed to $2200 rent. An investor would be down $835 per month even if the place was never vacant and never needed repairs. Prices would need to drop $100,000 at least to cover that. I’m also going to assume you need $10,000 for closing costs out of your own pocket, reducing your down payment to $50,000. Now, I’m going to look 10 years out based upon this situation.
| Year 1 2 3 4 5 6 7 8 9 10 11 | Value $450,000.00 $374,500.00 $400,715.00 $428,765.05 $458,778.60 $490,893.11 $525,255.62 $562,023.52 $601,365.16 $643,460.72 $688,502.98 | Monthly Rent $2,200.00 $2,288.00 $2,379.52 $2,474.70 $2,573.69 $2,676.64 $2,783.70 $2,895.05 $3,010.85 $3,131.29 $3,256.54 | Equity 50,000.00 21,008.26 9,995.46 43,151.06 78,608.20 116,526.98 157,078.65 200,446.41 246,826.23 296,427.77 349,475.31 | Net Benefit 31,500.00 -108,625.29 -91,384.89 -72,677.63 -52,395.49 -30,423.16 -6,637.55 19,092.60 46,907.31 76,955.83 109,397.24 |
Now, let’s look at suppose prices have come down that same $100,000 in a year, but rents have gone up by inflation – roughly 4%. However, rates are a bit higher – let’s say 7 percent. Furthermore, you have $90,000 less $10,000 for closing costs leaves $80,000 down payment. I’m assuming property taxes are based upon purchase price, as they are here in California, but if they don’t go down when prices go down, that’s going to make a difference of about $100 per month to start and more later on. Let’s look 9 years out for an equivalent time frame.
| Year 1 2 3 4 5 6 7 8 9 10 | Value $350,000.00 $374,500.00 $400,715.00 $428,765.05 $458,778.60 $490,893.11 $525,255.62 $562,023.52 $601,365.16 $643,460.72 | Monthly Rent $2,288.00 $2,379.52 $2,474.70 $2,573.69 $2,676.64 $2,783.70 $2,895.05 $3,010.85 $3,131.29 $3,256.54 | Equity 80,000.00 107,242.69 136,398.64 167,602.25 200,997.33 236,737.81 274,988.43 315,925.50 359,737.71 406,627.01 | Net Benefit 24,500.00 4,200.10 18,090.11 42,543.32 69,346.64 98,702.88 130,831.85 165,971.77 204,380.83 246,338.88 |
The picture looks much better by waiting a year for the market to get rational – assuming it does. If it doesn’t, all you’ve done is taken that last year of benefits off the first chart, or worse, as perhaps the prices continue to rise for another year. Nor have I assumed that you paid extra on the loan. Quite frankly, once you’ve killed off that second trust deed, leverage is your friend, and you are better off investing the difference.
The question is “When is Wile E. Coyote going to look down?” Okay, not all that funny, but it has applicability to the situation. As long as everyone is in denial, and there is a market of folks willing to pay those prices, the market is going to stay afloat. What’s caused our local sputter is the fact that everyone has “looked down”, and they don’t like what they see. There is no convincing reason why highly paid jobs have to be even more highly paid so that they can afford local housing here, whereas a large proportion of the jobs in certain cities like Washington DC or New York don’t really have the option of leaving, as they are where they have to be. The government isn’t leaving Washington DC unless it gets nuked, and the big guns of the financial industry aren’t leaving New York unless every other big gun does so. You know better than I to where your city lies on that spectrum. My impression is that where you are is closer to the inelastic employment point. Nonetheless, if the rest of the country “looks down,” so will those places that are relatively insulated.
If a 20 percent down payment doesn’t pencil out as an investment property, as it doesn’t in your case, the question is not “if?” the market is going to adjust, but “when?” and “how?” Here locally, you can almost hear the “pop!” If things are relatively inelastic, employer- and jobs-wise, a long slow deflation may be what occurs. You may even keep current prices while inflation makes things catch up. It’s hard to say when I’m not as familiar with your city’s economic engine as I am with my own, but here’s what happens if prices stay stable for ten years:
| Year 1 2 3 4 5 6 7 8 9 10 11 | Value $450,000.00 $450,000.00 $450,000.00 $450,000.00 $450,000.00 $450,000.00 $450,000.00 $450,000.00 $450,000.00 $450,000.00 $450,000.00 | Monthly Rent $2,288.00 $2,379.52 $2,474.70 $2,573.69 $2,676.64 $2,783.70 $2,895.05 $3,010.85 $3,131.29 $3,256.54 $3,386.80 | Equity 50,000.00 53,930.19 58,150.38 62,682.08 67,548.41 72,774.22 78,386.23 84,413.13 90,885.78 97,837.36 105,303.52 | Net Benefit -31,500.00 -39,318.42 -47,361.14 -55,634.47 -64,145.15 -72,900.45 -81,908.24 -91,177.08 -100,716.30 -110,536.19 -120,648.06 |
As you can see, you build up a fair amount of equity, but would have been better off renting and investing the difference.
Which of these scenarios is most likely? Here it’s the one attached to the first two tables, except that we’re a good portion of the way towards table two right now. Where you are, I’d make an educated guess that you’re still looking at table one right now. There’s money to be made even there if you buy and hold long enough, but you could be upside down for quite a while.
Thank You for asking, and please let me know if this doesn’t answer all of your questions.
Caveat Emptor
Buying Below Market
This question:
What real estate office can I trust to help buy below market house in (location) California in the year 2006?
brought someone to the site and I have not previously written a real answer to the question.
The short answer is “nobody.”
This doesn’t have to do with trust. It has to do with the facts of life and bad assumptions.
What is the definition of market price? It is the price at which a willing buyer and a willing seller exchange a property. In other words, what you buy it for is by definition the market price.
Everybody wants to buy real estate for less than it’s really worth, just like everyone wants to sell it for more than it’s really worth. Mathematically speaking, at least fifty percent of each have to fail, and the fact that you’re even asking the question indicates that you have made incorrect assumptions.
Real Estate is not like stocks or bonds. No matter how big or how small your transaction, it’s always a one on one transaction. If you are selling, you need to find one buyer willing and able to buy that property for a price you are willing to sell. If you are buying, you need to find one property where the owner is willing to sell at a price you are willing and able to buy it at.
This is not to say that the general market is irrelevant. If someone is pricing a more desirable home lower than you, you’ve overpriced your property. If the identical condo next door to the one you bought sold for ten percent less, you probably overpaid. But it’s not for nothing that the mantra about the three most important things in real estate being “location, location, and location.” No two properties are ever identical. Think condos, even. Which would you rather have: The one right next to the parking lot, the mailboxes, and the swimming pool, or the one way in the back where you have to walk a quarter mile from your car, and further from everything else? I assure you that a goodly portion of the population would choose the one you think of as less attractive. It’s the choice of the individual buyer, and a real estate agent has to learn how to get the attention of the person who’s most likely to be interested in that property.
I keep telling people that getting a good price at sale time is nice for both the buyer and the seller, but the really important thing is your amount of time in the investment. Let’s go back in time some years. Homes in my neighborhood were worth maybe $180,000 at the time, and condos were worth maybe $65,000. Had people going around making low ball offers on everything. Offered maybe $55,000 for the condos, $150,000 for the homes. Nobody who wasn’t desperate wanted to sell, of course, and that’s just what they were checking for – desperation. Had they offered something vaguely reasonable, say $60,000 for the condos or $170,000 for the home, they likely would have gotten a property. At least one group of these people ended up not buying anything. Fast forward five years. Those same condos are worth $275,000, and those same homes are selling for $500,000. If the thought of missing out on $210,000 profit for the condos because you couldn’t make $217,000 bothers you, then you seem pretty rational to me. If, on the other hand, the thought of missing out on an extra $20,000 you’re not going to get for the single family residence makes you want to just throw $330,000 base profit (tripling your money!) out the window, please go waste someone else’s time.
There is nothing wrong with desperation sales and offers that are desperation checks, so long as you are willing and able to then proceed to something more reasonable. Nobody wants to sell to somebody looking to flip a property, but they do want to sell for a reasonable price. That’s why the property is on the market. Somebody offers me (or my client) fifteen percent less than the property is worth, I usually write something like “offer rejected. Why would I (my client) want to give you fifteen percent of my investment’s value?” and append a list of comparables. Counteroffering just wastes time when the offer isn’t even in the right ballpark. The ones who can come back with a reasonable offer want the property, or they wouldn’t have made the offer. The ones just looking for the desperation sale aren’t going to bother.
Now some potential buyers are only interested in desperation scenarios. That’s fine, but you’re going to work awfully hard and put in a lot of offers before you get one, and the ones with the most potential for quick profit are going to be the ones where there is a lot of work to be done. Additionally, right now the market just won’t support CondoFlippers Inc.
Yes, I believe in hard bargaining. Judging from evidence I see around me, I’m one of a small percentage who does. But I’m willing to come from a reasonable starting position, although I do love it when my clients decide they want to put an offer in on a discount agent’s listing, because the client I’m acting as buyer’s agent for is going to think I walk on water when the transaction is over, while the sellers are going to find out first hand the truth of the adage “You get what you pay for”.
Lest you think that your negotiation discount equals your profit, it isn’t. It’s a small part of your profit. Let’s say you get the condo for $250,000 or you won’t buy it at all, even though comparables are selling for $275,000. Let’s say you intend to flip for $290,000, not that that’s going to happen in this market, but let’s say you succeed anyway. Your net is something like $268,000, after spending $253,000 or so to buy, and you spent about $5000 making the payments on the mortgage even if it did sell right away (more likely, given the realities, that you spend the entire “profit” on the mortgage payment!)
Now let’s say, instead, that the market collapses twenty percent the day after you buy, down to $220,000. If you have a sustainable mortgage and bring in a tenant, your cash flow should be even or positive. Hold on to the darned thing for five years, and at historical seven percent average per year, the property is worth $308,000. Hold it ten years and it’s worth $432,000 under the same assumptions. The first number gives you as much profit as the flipper even has a theoretical chance for, while the latter blows the flipper out of the water. Even after a price collapse, and because you’ve been in a sustainable situation this whole time, it really isn’t critical how long the prices take to come back, because you’re not under the gun of a deadline. So long as you have a sustainable cash flow, the risk is essentially nonexistent. It’s when you have an unsustainable cash flow that you’ve got to worry. Say like, an empty unit where you’ve got to make the mortgage payment without rent because you’re trying to flip it.
In fact, given a sustainable cash flow, unless property values collapse and stay down forever, the question is closer to when you’re going to cash out and how much, rather than if. Southern California Real Estate has always moved in cycles. What’s down today is up forty percent five years from now. The trick is being able to bridge the gap between now and then.
If some of the above seems like I’m attacking the “bigger fool” theory of real estate, consider this: Somebody’s always the last, biggest, fool in line, and until you get the check for the net proceeds from the sale, that person is you. It should be an agent’s responsibility to see to it that their clients aren’t the only ones without a chair when the music stops. For all too many of them, their thinking stops at the receipt of the commission check.
Caveat Emptor
Approaching the Loan Application Process – What Loan Will You Qualify For?
On of the biggest time and money wasters in real estate is people that apply for the wrong loans – loans that they can never qualify for because they can’t meet the guidelines, or can’t prove they meet the guidelines, which amounts to the same thing. Often, loan officers are the worst offenders, judging by the people who come into my office with messes for me to clean up. They don’t know how to submit a loan, or they know full well it won’t be approved, but they get you to sign up by dangling this carrot, and then snatching it away, but now they’ve got you working with them and they end up with your business because they told you a fairy tale that sounded better than what the other guy talked about because he restricted himself to talking about loans he could actually deliver.
How do you know what mortgage market is best for you?
There isn’t a cut and dried answer unless you’re one of those folks who can qualify “A paper” full documentation. If you can do it, and a lot more folks can qualify this way than think they can, A paper full doc is the way to go. Because it’s the least risky loan, the banks give you the best pricing. What if you can’t make it, however?
The reasons why people fall away from A paper full doc is long. The two largest ones, however, are people who cannot prove they make enough money and people whose credit score isn’t high enough. At a distance from that, the third reason why folks don’t qualify, is late payments. A paper permits one thirty day late on the mortgage, or two on other credit. If you fall off the pace due to late payments, you have to go subprime.
A paper accepts only two ways of proving your income: Income tax forms and, for some employees not in construction or on commission, w-2s and year to date pay stubs. If, with the income taken from these forms does not qualify you according to A paper debt to income ratio considering your known debts (typically 45% back end ratio, but I’ve seen high seventies get accepted in some circumstances), you do not qualify full documentation. Think of full doc as being where you prove you’re got enough income to make your payments. If you can’t do full documentation, you have to go to stated income.
A paper also requires an absolute minimum credit score of 620. 619 is an automatic rejection from any A paper program out there. Some A paper may require higher credit scores (640 jumbo, 660 stated income, 680 for both), and if you haven’t got it, you don’t have the loan, either. If you don’t have the relevant credit score, you’re going to subprime.
A paper stated income is where you’ve got a good credit score and can prove that you’ve got a job (or a source of income) and you’ve had it for two years. You just can’t prove you make enough money to justify the loan. You could be making it, though, and the lender agrees not to verify, although they will look at it to see if the income you claim is consistent with your profession. You’re paying your bills on time, though, so lenders are willing to believe that you’re living within your means, and therefore qualify for the loan. They are not agreeing to close their eyes if something indicates you cannot afford it or what your real income is; they’re just not going to go out of their way to verify your income. They are going to have you sign an IRS form 4506, releasing your taxes to them. Don’t worry too much about it. The IRS takes a minimum of 60 days to respond, and the loan will be done in thirty, if your provider is competent, and it’s not fraud to overstate your income on a stated income loan. Dumb, maybe; fraud, no. The major reasons why “A paper” stated income falls out are low credit score, insufficient time with your source of income, and incompetent loan officers who allow the underwriters to find out that the client doesn’t make that much. Low credit score goes to subprime, insufficient time in line of work goes to NINA, and loans with incompetent loan officers start over with another lender.
A paper NINA is a loan driven by the credit score and the situation you find yourself in. There is no debt to income ratio, and the personal qualification consists of a good credit report. Of course, you still have to have the appraisal and the rest of the documentation relating to the property. Furthermore, the rates are higher than stated income (which is in turn higher than full documentation), and the maximum Loan to Value Ratio is lower. Common fallouts are credit score too low (go to subprime), loan to value ratio too high (go to subprime) and something wrong with the property (go to hard money)
Subprime is an entirely different world than A paper. The standards are different, the qualifications are different, everything is different. Just because you can’t go full documentation A paper doesn’t mean you can’t do it subprime. For one thing, typical subprime goes up to fifty percent debt to income ratio, and a few lenders will go higher – some as high as sixty percent! So even though the rates are higher, it may be easier to qualify.
Subprime also has another form of accepted income documentation: bank statements for the last six, twelve, or twenty-four months. When I started, this was always discounted, but of late personal bank statements have been accepted on the strength of 100 percent of the income they show. This rate will be higher than a borrower who can prove their income via one of the A paper methods, but is lower than stated income. Number one reason for falling out of subprime full documentation: Not enough income. Number two: sub-500 credit score. Number three: the underwriter believes that you manipulated your income on your bank statements. Not enough income goes to stated income subprime (with another lender, as if it was submitted full doc it cannot go stated income with that lender). Sub 500 credit score goes to hard money, which is where you might as well start when you find out, because regulated lenders can’t touch you if you don’t have at least one of your three credit scores above 500. If the underwriter thinks you manipulated your income, you or your loan officer have either got to convince them you didn’t, which usually requires w2s at least, or you are going to another lender.
Subprime stated income is fairly wide open, with the proviso that a given credit score will have a higher rate and a lower maximum permitted loan to value ratio. Number one reason for falling you here is that you don’t meet loan to value guidelines. Number two is you didn’t state enough income in the first place, and you don’t qualify by debt to income ratio guidelines. Number three is you stated too much income, and the underwriter doesn’t believe you make that much money. They can always require income documentation – they don’t have to let you state it without verification. At best, anyone suffering from any of these three problems can expect to have to go to another lender, because this lender will not now approve their loan. Maybe lose a little time if you’re working with a broker who then submits the package elsewhere. Back to square one if you were working with a direct lender.
Subprime NINA is even more wide open. A loan officer has got to be a serious bozo to blow this one, but I clean up behind ones that went bad on a distressingly frequent basis.
Hard money is the last hope of the unfortunate. These folks don’t care about your income, your credit score, or anything else. What they care about is that they can sell the house for enough to cover the loan if you default, and unlike regulated lenders, they will record that Notice of Default on the day you become eligible. Sometimes they are the only choice, but if you find yourself dealing with them you should really ask yourself if this loan is something you absolutely have to have, or if you just want it. If the answer is the latter, my advice is to reconsider getting the loan.
There you have it, something like a flowchart of what kind of loan you should apply for. These are far from the only reasons loans fall apart, of course, but they are the most common. A good loan officer knows enough of the tricks and traps to tell you the truth straight off, and apply to the appropriate loan first, without wasting your time and money. Bad ones don’t.
Caveat Emptor