Searchlight Crusade

Because most loan providers will not guarantee their Federal Good Faith Estimates or California MLDS forms, I’ve been telling folks that the best suggestion (other than doing their loans myself, of course!) that I can give them is apply for a back up loan. But some mortgage loan providers will guarantee their quotes, and this article is about those guarantees, their limitations, and what to watch out for.

Loan officers are not the only ones who play games in the mortgage world. Borrowers do it. A lot of borrowers do it. Some are actually intending fraud, some just want a better loan and don’t see anything wrong with painting their financial picture a little rosier than it is. Furthermore, there are reasons that lenders will decline loans that are not obvious. It has happened to me that I couldn’t do a loan at all because of fairly obscure points that the borrowers weren’t trying to conceal, they just didn’t know they were important, and I didn’t think to ask.

Keeping this in mind, loan providers are leery of offering guarantees, and indeed, since only an underwriter you will never meet or talk to can authorize the loan, for a loan provider to make a guarantee that there will be a loan is nonsense. The most they can say is, “Based upon my experience, I see no reason why this would not be approved,” or, better, “Subject to underwriter approval, your terms will be this.” That’s a key phrase. Keep in mind that loan provider guarantees are few and far between, and as a result, there is no standard terminology to use. I, as a loan officer, cannot promise the loan. I can promise, however, that if the loan is approved as submitted, it will be on a given set of terms.

Now it happens that loan officers can manipulate you by submitting a loan that they know will not be approved. This is a lot of work and often “poisons the well” at that particular lender, but then they can tell you sorry, you do not qualify for that loan, but there’s another one over here that you do qualify for, and now that you’ve already selected them, they are no longer competing on price, and they build a much higher margin into the newly proposed loan, secure in the knowledge that you’re unlikely to be shopping other lenders at this point.

You can counter that by asking what the guidelines are for the loan they are submitting. What is the maximum debt to income ratio? How much income do you need to qualify? Ask them to compute it out for you, and watch what numbers they use. What loan to value ratio is the rate predicated upon? What does the property need to appraise for in order to make that happen? (This can also help you spot hidden fees, albeit rarely. Comparatively few loan officers can tell you how much it’s really going to take to get the loan done.) How much time in the same line of work are required? Here’s a whole list of questions you should ask prospective loan providers.

Now, as to the form the guarantee should take: It should include the type of loan, to include an industry standard name for that loan type, so other loan officers you shop with know right away what they are talking about. It should also include the cost to get that loan. How many points of origination, if any, and how many discount points, if any? How much in total closing costs? How long of a lock is included?

You should beware the term, “thirty year loan,” unless the words “fixed rate” are in there. A thirty year fixed rate loan is the standard loan that most folks aspire to, but it’s usually the highest rate out there. The words “Thirty year loan” describe an Adjustable Rate Mortgage (ARM), or a hybrid ARM. A few loan officers will even describe hybrid ARMs as “thirty year fixed rate mortgages,” because they are fixed for an initial period. So ask them “how long is that fixed rate fixed for?” here is an example of one way to disclose it right. So you always want to ask, “How long is it fixed for?” if they do not volunteer the information.

If it’s a balloon loan, that means you have to refinance or pay it off before the end of the loan. Mandatory, required, there is no more loan after that point. If it’s an ARM or hybrid ARM, you also want the margin once it does start adjusting and the name of the underlying index to become part of the guarantee. You don’t have to refinance hybrid ARMs, and you’re welcome to keep them as long as you like what they adjust to, but most people refinance before the end of the fixed period or very shortly thereafter.

Finally, you most especially want whether or not there is a pre-payment penalty to be part of your guarantee, and if yes, the nature of that penalty. A loan with a prepayment penalty should be a much cheaper loan than one without, as you are looking at agreeing to pay about $12,000 around here if you refinance or sell while it’s in effect. The phrase, “What would that be without the prepayment penalty?: is one of my favorites. But you have a right to know, and a loan with a prepayment penalty is likely not as good a loan as one a quarter to a half percent higher for the same cost, without a prepayment penalty. If you already know you’re going to need to sell before it expires, it needs to be more than that. So make sure you find out, is there a prepayment penalty, yes or no? If Yes, how long is it for? Is it a hard penalty or a soft one, and does it strike from the first extra dollar or only after you pay down more than twenty percent in a year? These all make a difference, and you should be aware of their nature, and it should be honestly disclosed to you when you are shopping for a loan.

Caveat Emptor

Got a search for “mortgage closing documents do not sign changes.”

Unfortunately for this person, the documents you get at closing are what legal folks call a contract of adhesion. This means you can either accept it, sign, and adhere to all the terms as presented, or you can walk away. Basically your choice is to take it or leave it, in exactly the form presented.

Now on those rare occasions someone actually has the intelligence and good sense to walk away from a situation where the terms have been changed, the prospective loan provider does have the option of offering you a better deal as incentive to do business with them. Like, say, the loan they originally talked about to get you to sign up with them. Mind you, they don’t have to, and the costs of that other loan may mean that they would rather do no loan than that loan.

I’m not a lawyer, but the way contracts of adhesion were explained to me is that if there is any legal ambiguity, it will be interpreted in your favor. This doesn’t mean you can claim you thought it meant something different than the average person would understand; this means that if there is a legally ambiguous wording that could legitimately be interpreted two different ways, and you and your lender disagree as to the meaning, the courts will generally rule in your favor. Once again, the law is different from place to place and the courts have the final say; check with your lawyer.

Now in the loan world, it is much more common than not to be offered a loan contract at final signing which differs in some material form from the loan terms that were described to you in the beginning. The loan provider will generally offer you a loan of the same type, and usually at the same rate, but most often the costs to get that rate will be significantly higher than were listed on the Good Faith Estimate or Mortgage Loan Disclosure Statement. Neither one of these forms is in any way, shape or form a legal commitment, nor are any of the other forms you get at the beginning of the loan process, such as the Truth In Lending Advisory.

The only thing that means anything is the loan contract, or Note, that you are offered at the end of the process, together with the HUD-1 form, which is the only accounting of the loan required to be correct and complete.

Now the difference between the initial teaser loan they talked about and loan contract they actually got approved is one of the reasons why the less than ethical providers out there often want a cash deposit for the loan, particularly if their rates are not particularly competitive and they know it. If they’re nervous someone will come along behind them and offer you a better deal, they want a cash deposit so that they still get something if you pull out, and many folks obsess about the cash deposit to the point where I could offer them a deal that saves them several times the cash deposit, and they still wouldn’t switch. This isn’t to say not to pay the twenty dollars or whatever it costs them for the credit report, this is to say don’t deposit the appraisal fee (several hundred dollars, which should be paid at point of service) or even part of a point “to be refunded if the loan funds” within a certain amount of time. Chances are the loan isn’t that great, particularly not the real loan they are really going to offer, and that’s why they want to lock you in by having something to hold over you if you don’t sign on the dotted line at the end of the process.

Caveat Emptor

Every so often I get questions about loan cosigners. The main borrowers do not qualify on their own, so they get someone – most often mom and dad – to cosign. Now this is a different thing, or so I understand, in the other major credit areas – automobiles, rent, etcetera. But this is about Real Estate.

The only time this usually makes a difference is in credit history. The main borrowers qualify on the basis of income, but don’t have enough of a credit history to qualify. Sometimes they just don’t have enough open credit to have a credit score. This is rare, but I did have one executive couple who made a habit of paying cash for everything (a good habit, I might add). They had precisely one open line of credit, a credit card they paid off every month, and the major bureaus require two lines in order to report a credit score. No credit score, no loan. It’s that simple. Even there, the solution was to walk in to their credit union and apply for another, not to get a cosigner.

When you bring other folks into the loan, you’re bringing their credit history, their potentially high payments, and every other negative they have into the loan. Most of the time, the folks who are willing to cosign do not materially aid the qualification process.

Pitfall number one: If the cosigners make more money than the “real” borrowers, they now become the primary borrower, and it becomes a loan on investment property as far as the lenders are concerned, adding restrictions, raising the trade-off between rate and costs of the loan, and perhaps making the loan require a larger down payment. This does assume they won’t live there, but usually if they were going to live there, they would have been on the loan in the first place.

Pitfall number two: The cosigners are overextended also. Sure, they make $10,000 per month, but they have payments of $5000 per month already. There’s nothing left over where the bank sees them as having enough money left over to help you out. They may, in fact, have money to spare, particularly if they make a lot of money, but according to the standard ratios, they do not. You can’t have the cosigners be stated income or NINA if the main borrowers are full documentation. If you have to downgrade to stated income in order to qualify, that is going to cost a lot of money through higher rate/cost trade-off. Obviously, better that you qualify for a lesser loan than that you don’t qualify at all, but you don’t want to downgrade if you don’t have to.

Pitfall number three: This one hits the cosigners. They are agreeing to be responsible for your payments in the event you don’t make them. Suppose they want to borrow money for something else. Especially if it’s a large amount of money, as real estate payments tend to be. It really cramps their ability to qualify for other things. This works the other way, also. People come to me for real estate loans who have agreed to be cosigners for a car loan are responsible for the $400 per month for that loan. Many times, this means they don’t qualify for the real estate loan. So we have to prove to their prospective lenders that the “true” borrowers are making the payments. This is usually not difficult, but if the cosigners wrote the check for the payment anytime in the last six months to a year, it can be problematic.

Pitfall number four: This also hits the cosigners rather than the main borrowers. Suppose a payment gets made late. It impacts the credit of the cosigners as well as the “real” borrowers. It doesn’t matter if you’re the “real” borrower or the cosigner, it hurts your credit just as much and for just as long. If you cosign, you want some kind of proof that payment is being made on time, every month. You shouldn’t cosign if you don’t have the resources to make that payment pretty much indefinitely. Furthermore, should the cosigners decide to cut their losses, it can take months before the monthly hits to the credit stop. If the “real” borrowers don’t want to liquidate, the cosigners may have to go to court to get out of it, and the only people who are happy there are the lawyers.

Now suppose the loan being applied for has a Debt to Income Ratio maximum of forty five percent, and the cosigners make $10,000 per month, but they have debt expenses of $4300. This will mean that they only have $200 per month to contribute towards qualifying for the new loan. If the “real” borrowers weren’t fairly close to qualifying without them, they aren’t going to qualify with them. If they have expenses of $4600 per month, they have nothing to contribute to the loan qualification. In such cases, the work of asking them to apply is wasted.

Caveat Emptor

I got a search hit for that and, amazingly enough after 150+ articles, I’ve never dealt with this subject head on. So here goes.

One point, either discount or origination, is one percent of the final loan amount. After all of the loan amounts and fees and what have you are added, for a loan with one point, multiply the amount by 100 and divide by 99, and that will be your final loan amount. For a loan with two points, multiply by 100 and divide by 98. The general formula is multiply by 100 and divide by (100-n) where n is the total number of points.

Points come in two basic sorts, discount and origination. Origination is a fee your loan provider charges for getting the loan done. Some brokers quote in dollars, most quote in points because it sounds cheaper than an explicit dollar cost. Most brokers out there charge one point of origination. To contrast this, direct lenders do not have to disclose how much they are going to make on the secondary loan market. And many direct lenders still charge origination. Judging the loan by how much the provider makes (or tells you they make) is a good way to end up with a bad loan. My point is that it’s the rate, type of loan, and net cost to you that are important, not how much the guy is getting paid for doing your loan. Remember two things here, and they will save you. First, loans are always done by a tradeoff between rate and cost. For the same type of loan, the more points you pay the lower your rate will be, and vice versa. Second, remember to ask about “What would it be without a prepayment penalty?” It’s a good way to catch people who are trying to slide one over on you, and the lenders pay a lot more for loans with a penalty, and the lenders make a lot more on them when they sell them to Wall Street, so they often do them on what looks like a much thinner margin until you ask the question “What would it be without the prepayment penalty?” Remember it.

Discount points are an explicit charge in order to offer you a lower rate than you would otherwise have gotten. To use an example I ran across the day I originally wrote this this, six point five percent with one point, seven percent without. On a four hundred housand dollar loan, that’s essentially four thousand dollars, either out of your pocket where you’re not earning money on it, or added to your mortgage balance where you are making payments and paying interest.

Is it a good idea to pay discount points, or is it a better idea to pay the higher rate? That depends upon the loan type and how long you keep it. Let’s say the loan is $396,000 without the point, $400,000 with, just to keep the math easy. Your monthly interest charge on the first loan is $2310, on the second it’s $2166. On the other hand, you pay $361 principal on loan 2, only $324 on loan 1. Here’s the bottom line, though: You’ve got to get that $4000 back before you sell or refinance. Just a straight line computation, that second loan saves you $181 the first month. $4000/$181 per month is about 22 months to break even (and it’s a little faster than that, because loan 2 pays off more principal per month). On the other hand, even after you’ve theoretically “broken even” there is a period where if you sell or refinance, you will inexorably lose money because you’re paying interest on a balance that’s higher than it would have been.

But now let’s run the actual numbers. If the above loan is a thirty year fixed and you keep it four years, you’re well ahead. You’ve saved yourself $6944 in interest and your balance is only $2159 higher. $6944 – $2159 = $4785. Even if your next loan is at ten percent, you’re only losing $215.90 per year. Especially when you consider that at a cost of money now versus later, you’ll never make it up, because you can invest that $4785 you saved and it’ll pay more interest than that.

On the other hand, let’s say the rate was only fixed for two years. After that, it is a universal feature of hybrid ARMs that they all adjust to the same rate. You are theoretically ahead by $363, but because of your higher balance, even if the loan adjusts to five percent, you’re losing $154 per year due to your higher balance, and there is nothing you can do about it. Play now, pay later.

There is no cut and dried answer about whether it’s to your benefit to pay points. I tend not to do it, myself, because rates do vary a lot with time, and money you addsticks around in your balance. If I’ve got a zero or low cost loan and the rates drop half a percent, it’s worthwhile to refinance for free. If I have a loan I paid a point for, I’m going to have to pay that same point again to see a benefit on refinancing, and as we’ve already discussed, if you don’t keep the loan long enough, you’ve wasted your money. The median time between refinances is right about two years right now. I see no reason to pretend I’m any different from everyone else, but some folks do have a history of keeping loans a long time. You need to make your own choice to fit your own situation.

Caveat Emptor