Mortgage Cents

"Behind the scenes" look at your mortgage being processed:

2006-07-23T12:36:00.000-07:00

Today, I wanted to give you a bit of a "behind the scenes" look at how your mortgage is processed. A lot of American consumers seem to be unaware of the amount of overhead and problems involved for lenders when trying to close a mortgage.

I do not intend for this piece to be a sob story to get you to feel sorry for me or other loan officers. However, I think if all the parties involved with a real estate transaction are made aware of how complex the process is to obtain financing, they tend to be a little less "pushy" in trying to get transactions completed in unrealistic amounts of time.

Below are the steps for completing a standard 30-year fixed-rate mortgage. These steps vary by loan program, but we will stick to the basics, for now:

1) Complete mortgage application with your loan officer
2) Your loan officer obtains automated approval for your mortgage via a computerized approval system
3) Income verification (usually, paystubs, W-2 for the last two years, and/or tax returns)
4) Asset verification (usually, bank statements for all accounts listed on the application, and statements for all retirement or stock accounts listed on the application)
5) Employment verification (your employer is either faxed a form they must complete to verify your employment and income at your current job, or they are contacted by telephone and asked to verbally verify your employment)
6) Appraisal (to verify the property is worth as much as you have agreed to pay)
7) Title examination for the property (basically, an examination of public records to verify that all taxes and loans against the property are paid satisfactory)

Only seven steps. Sounds easy, right? Think again. The potential for problems when completing these steps is fairly extensive. I will elaborate on those in my next article. Without going in to too much detail here, it is safe to say that good credit scores, good income, and lots of money in savings do not guarantee that your transaction will be "easy" to complete...

Properly Shopping for a Mortgage

2006-07-01T12:58:00.000-07:00

I have composed articles about this in the past, but the more I am in the mortgage industry, the more I see people making crucial mistakes when they shop for a mortgage. With that in mind, I decided to just make a simple list of what you shoud and should not do when finding a lender to finance your home purchase or refinance:

What you should do:

1) Shop with at least four different mortgage companies or local banks in a time frame of two days

2) Do a full application with every one of these lenders, and let them pull your credit and give you an interest rate quote based on the information you have provided in your application. Tell them to print you a good-faith estimate.

3) Take each good faith estimate you have to each different loan officer and let them analyze it to see if you are being ripped off, charged junk fees, or otherwise misled.

4) As soon as you've got a lender you like and a sales contract (if you're purchasing) or property address (for a refinance), lock the loan with the lender you like.

What you should not do:

1) You should not ask your Real Estate agent about a good mortgage lender and then simply plan on doing your loan with that person. How do you know your agent and that person have not been friends for 20 years? While your agent might think the lender is a nice person, that in no way guarantees you're getting a reasonable deal on your mortgage.

2) You should not show your Realtor a good-faith estimate because you think they can tell you whether or not you're being ripped off. Unless they happen to have been working in mortgages within the last two weeks of you applying for your loan, and unless they happen to know your complete financial situation, anything they tell you is nothing more than a poorly-informed guess.

3) You should not go talk to one loan officer, decide you like them, and plan on having them complete your loan.

4) You should not spend more than 3 days trying to negotiate terms of your mortgage among various lenders. Even spending more than 24 hours can result in a daily interest rate increase that costs you money right out of your pocket.

I've dealt with a lot of people lately who seem like they want to get 4 or 5 banks competing for their business and then spend the next two weeks trying to nickle-and-dime fees or interest rates. In the meantime, the federal reserve raises key rates .25%, and the time they were wasting trying to get $50 pulled off of closing costs has now cost them thousands of dollars in increased interest rates.

Find 4 mortgage lenders, get applications filled out with all of them in the span of 2 days, and by the end of the second day, lock your rate with the lender that gives you the best offer. If, for any reason, they tell you that they need to wait to do that (and you have a purchase contract or property address in hand), go to the next-best offer and lock with them (there is never a reason you can't lock your rate, provided you have given a full application and have a purchase contract or property address).

Rough times ahead for people who bought houses at inflated prices:

2006-03-13T17:05:00.000-08:00

This is a bit of an elaboration on the consequences that some individuals in certain sections of the nation are about to experience as the result of fraudulent loan activity and property values that are overly inflated:

Stated income mortgage fraud.

You can bank on the prediction that stated income loan programs will be the subject of massive federal investigations in the coming months and years. In a stated income loan program, the loan officer takes the loan application, and puts the income the client says he makes on the application. The bank does not verify that income. Instead, the bank simply approves the loan based on the word of the loan officer and loan applicant.

How does it get abused?

When a borrower can't afford to buy the house because their debt ratios are too high, an unscrupulous loan officer says, "well, gee, Mr. and Mrs. Borrower, if I put you in this stated program, we can say that you make any income that we want!" At that point, the loan officer puts in some arbitrary number that is supposed to be the amount of money the borrower makes every year. Instead, it's the amount of money that the application needs to show to make the debt ratio fall into the range that makes the loan approvable.

The worst part is, a BUNCH of lenders have this program and it allows you to borrow 100% of the purchase money for the home. So now, the borrower is not making a down payment, has no equity in the home, and they have been convinced by the loan officer to sign a fraudulent loan application so that their debt ratios will make the loan "work". Incredibly, loan officers will openly admit that they practice this in expensive markets on the east and west coast.

Apparently, they do not realize that a mortgage loan application is an official Federal document, and lying on it makes you subject to jail time, huge fines, and other penalties. Additionally, unscrupulous loan officers have made statements similar to this: "Hey, I didn't realize they were lying, it's not my fault!" Give me a break. Just who do you think the Federal Government is going to pursue in these fraud cases? The little borrower who claims "I was just doing what the 'professional' said I could" or the loan officer that pleads ignorance about the borrower's financial situation. The entire situation can be compared to negligence suits where an individual's irresponsible actions (in this case, the loan officer either "coaching" the borrower on what income needed to be shown on the loan application or otherwise not properly investigating a borrower's income) results in harm to others. That individual pays fines, goes to jail, or is otherwise punished. If loan officers think they are going to be immune to this, they are kidding themselves.

Here are the original purposes behind the stated income loan program:

If you are dealing with a borrower that has maybe been working a side-job for the last couple of years doing lawn care, and they get paid entirely in cash, but never document that income, this was supposedly a way to use that income to qualify the loan. Of course, it begs the question: "Why wasn't this person reporting this income on their taxes?" Additionally, if you had a borrower that was working on a job where most of the income came from tips, such as a hair-stylist or restaurant worker, this was supposed to be a way for them to document their cash income from tips. Yet again, the question arises: "Why aren't they reporting it on their taxes?”

If you are a borrower who is self-employed and has very strong credit, trying to document their income from the business they own can be difficult. If they claim large amounts of deductions on their taxes, a traditional loan must be qualified on the income AFTER deductions. The stated program was intended to allow you to use the income level BEFORE the deductions.

If you are a borrower that has income coming in from all over the place, and very strong credit history, you can simply elect to do a loan that has reduced income documentation to save you the time of verifying 5-10 different sources of income.

The purpose of stated loan programs was never to artificially inflate a borrower's income, but that is what is happening. On one popular internet discussion forum for loan officers, the discussion at that site on this issue is mind-boggling. There are loan officers on there who outright admit that they use stated income programs to exaggerate income, because they claim that without them, they could never approve anyone for a loan in expensive areas. That raises more questions.

Do these loan officers understand that the FBI regularly reads that site, and that just because an agent isn't knocking on their door with a search warrant today hardly means that they are immune to prosecution in the future. A lot of mortgage fraud cases take a long time to investigate. At this site: www.mortgagefraudblog.com you can read about some of the cases of fraud that have been uncovered in recent years. They are very complex, but are also easy to uncover. It is stunning that individuals actually believed they could get away with some of this stuff.

I wonder if the loan officers understand that part of the reason that housing prices exploded to ridiculous levels in the last few years is because of the ease of obtaining credit to purchase homes. When credit is easier to obtain, more people can qualify for the purchase. When there is more demand, prices are higher.

Potential long-term implications of fraud:

Part of the reason for the rapidly appreciating property values we have seen in the last few years have been historically low interest rates and loan programs that make it possible for people to purchase homes that they have no business purchasing, when taking their income into account.

What do you all think is going to happen when easily defrauded loan programs start to disappear and interest rates continue to rise?

First, houses are going to be a tough sell, because they are going to be unaffordable until prices adjust in a downward direction to a level that makes it realistic to buy them. Loan programs that allow easy approval of loans for people that otherwise should not be able to afford a house are about to disappear.

Second, when the values shift downward, you are going to have these “home owners” who were put into incredibly bad loan programs, didn't make a down payment, and can't afford their house payment. When they try to sell the depreciating property, they aren't even going to be able to pay off their mortgage in its entirety. If they don't pay it off, then the next buyer can't finance the purchase.

As a final slap in the face, people that are in terrible loan programs such as an adjustable-rate mortgage in which they lack equity to refinance will be faced with increasing payments that they cannot afford. Since they can't sell the house to get out from under the mortgage that they can’t pay, they will just foreclose. That translates into a massive loss for the banks, which means further evaporation of bad mortgage programs and tightening of requirements on existing programs (if we're lucky).

In a strange sense of irony, all of the foreclosures will actually result in housing that may once again be affordable. It's an interesting cycle.

Closing Costs: Why do they exist and what should I be paying?

2005-12-01T18:19:00.000-08:00

No matter where you get your mortgage, you will have closing costs associated with your loan. There are a few rare exceptions to this, but generally speaking, you are going to be charged some fees to have your loan completed.

How much you have to pay varies. It depends on the amount of money you are borrowing, your interest rate, the loan program you are obtaining, the specific bank that is servicing your loan, the price of the property appraisal, and the price of your home owner's insurance.

Today, I will show you an example of the closing costs that would be associated with doing a standard loan for $150,000 at an interest rate of 6.5% fixed for 30-years. I will do my best to explain everything in detail and indicate which fees a mortgage company does or does not control. For first-time borrowers, a lot of this information may be hard to comprehend, so do not hesitate to ask your loan officer for details on this information:

Processing fee: $250

When you do a loan with my company, I have a loan processor that is responsible for making sure all of the paperwork is in order for your loan. They have to order the property appraisal, order the title examination for the property, request a copy of your home 0wner's insurance plan from your insurance agent, etc. This stuff all has to then be submitted to the bank that will be loaning you your money. As I have to pay this processor hourly, I charge $250 to cover that expense.

Credit Report: $11 (controlled by bank and lender)

When I take your loan application, I then request a copy of your credit report from the credit reporting agencies. I am charged $11 for this. Please keep in mind that any time you apply for a mortgage loan, a credit report must be pulled. However, reputable mortgage companies do not bill you for this unless you close the loan with them. If a company is trying to charge you an up-front fee just to apply for the loan, go somewhere else.

Underwriting Fee: $550 (not controlled by mortgage company, local bank may have control)

When your loan is submitted to the lender, they have an individual who is responsible for providing the final approval for your loan. That individual is known as an “underwriter”. These people work in high-stress situations and are generally paid pretty well. The lender charges you this fee to help cover the expense of paying the underwriter. Some lenders will refer to this as an "administration fee". It should be noted that some lenders do not charge an underwriting fee for certain loan programs. Wells Fargo is one example. If you do an FHA purchase loan with them, there is no underwriting fee associated with the loan (which translates into savings for you on your loan). However, lenders like this are the nice exception and not the norm, so in most cases, you can expect to have an underwriting fee on the loan.

Appraisal Fee: $200 - $400 (not controlled by mortgage company or bank, varies by appraiser)

When you purchase your home, the property must be appraised to verify that it is worth at least as much as the amount of money you are borrowing. Generally, an appraiser charges from $200 - $400 for this service. Most of the time, your lender will ask you to pay for this out of pocket ahead of time. Alternatively, you can give the lender a check for the appraisal fee that they will hold until your loan closes. If you close, they tear up the check and roll the fee in with your closing costs at closing. If you back out, they cash the check to cover the expense of the appraisal that was ordered, but not used.

Flood Certification Fee: $9 (not controlled by mortgage company, may be controlled by local bank)

When you select a property for purchase, the lender has to hire a company to verify that your future home is or is not in a flood-prone area. If it is, they require you to purchase flood insurance. The Flood Certification Fee is to cover the expense that the lender must pay the company to verify this information about the property. Please note that not all lenders charge this fee. In fact, most do not, but if you have one show up on your Good Faith Estimate, this is the explanation for why it is there.

Title Work: $550. Varies Widely By Title Company (not controlled by mortgage company or bank)

Essentially, when you begin a purchase or refinance transaction on a house, all lenders require that the title history of the home be searched. This is meant to protect the lender and the buyer. The title company is tasked with verifying that no tax liens have been instituted against the property by the federal or state government.

Why is this necessary?

If the federal, state, or county government imposes a tax lien against a property (as a result of the current owner not staying current on their income or property taxes), then they have first rights to any proceeds from the sale of that property. So if you have a property that has a tax lien against it, the bank does not wish to loan money against that property because if you default on the loan, the bank will not have first rights to the funds from the proceeds of selling that home. Instead, the tax lien would have to be paid first, and the bank gets whatever is left over, which puts them at risk of losing more money on a defaulted loan.

Generally, title companies have a few different fees they charge. These fees vary widely from company to company, but all are required to be summarized on your good faith estimate. Title companies must keep insurance similar to malpractice insurance that a doctor would carry. This protects them in the event of a mistake where they would incorrectly report that no tax liens exist against the property. If a loan defaults, and it comes to light that there are tax liens, even though the title company did not report those liens, the title company is held responsible for the loss to the lender. This insurance would pay for that loss.

For the purposes of this post, we will say that your title company charges will amount to $550.

Interest for 'x' number of days: $406.02. Varies by Closing Date, Loan Amount, and Interest Rate (not controlled by mortgage company or bank)

When you close on a loan, the lender always charges you for the interest that will be accrued between the day of the month that you close your loan and the last day of the month. This money is charged up front in the closing costs of your loan. For example, with the loan we are using in this example, interest accrues at the rate of $27.08 per day. If you close in the month of April, on the 15th day, that means there are 15 days remaining in the month. 15 x $27.08 = $406.02. You will be charged $406.02 for this at close.

Tax and Insurance Prepays: $425.00. Varies by Insurance premium, property tax rates, and, (with refinance transactions), the time of year loan is closed and the month that your insurance premium is normally due. (these fees are not controlled by the mortgage company or bank)

Assuming you are going to escrow your taxes and insurance (meaning that you pay them in in monthly installments, rather than a lump-sum annually or semi-annually), you will have to pre-pay a few months in advance for both taxes and insurance. On a purchase loan, the standard is 3 months. So if your monthly insurance premium is $70, you will be charge $210 at close in insurance pre-pays.. If your property taxes are $85 per month, you will be paying $215 at close (assuming you are also escrowing your property taxes).

Not all lenders require you to escrow, and I will discuss the benefits and disadvantages of escrowing in a future post. Additionally, the method for calculating your prepays is different for refinance transactions. I will discuss the difference in a future post.

So how much are closing costs on this loan?

Processing fee: $250.00
Credit Report: $ 11.00
Underwriting Fee: $550.00
Appraisal Fee $350.00 (approximately)
Flood Certification: $ 9.00 (in some cases)
Title Work: $550.00 (varies by title company)
Interest to month's end: $406.02 (varies by day of the month loan closes)
Tax and Insurance Pre-pays: $425.00 (varies by premium and tax rate)

Total: $2901.02

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Obviously, this is a lot of information to digest. If you are considering purchasing a home, I would advise that you print this off and look it over.

In my next post, I will address courses of action for situations where you are being charged fees other than what have been summarized on this post.

Local Banks vs. Mortgage Companies: Which is better?

2005-11-23T08:43:00.000-08:00

A topic of debate in the last few years has been the perceived benefits or disadvantages between using a local bank to finance your home purchase and using a mortgage company.

Some people are convinced that their local bank can provide better customer service, interest rates, or closing costs. In some cases, this may be true. Banks provide incentives to borrowers who have large balances on their depository accounts or otherwise provide a large source of income for the bank. If you have numerous accounts with high balances, your local bank may provide incentives to reduce your closing costs, interest rate, or both. These programs vary widely from bank to bank, so it is best to check into the matter with your local bank and determine what incentives they provide.

Mortgage companies generally have the advantage of being able to offer wholesale interest rates. When you finance your home purchase through a mortgage company, you will not actually be making your housing payments to that company. Instead, the mortgage company provides your loan applications to numerous large banks. At that point, the loan officer at the mortgage company determines which bank will provide you with the best offer and places your mortgage at that bank.

Financing your purchase in this way has a few advantages. First of all, these large banks offer a sort of “Wal-Mart” mentality on their interest rates. Because they have such a huge volume of mortgages, they are able to offer lower interest rates while still meeting their profit goals. Additionally, mortgage companies often receive further incentives from these banks if they send a certain volume of loans to the bank each month, which translates into more savings for the borrower.

The way a mortgage company makes their money is not from interest, but from a fee the bank pays them on each loan that they send to the bank or from fees the mortgage company may charge you up-front to do your mortgage. The fee that comes from the bank is governed by the interest rate you are charged. For example, today I could do your mortgage through Interfirst Bank. On a 30-year fixed mortgage, they might pay me 1% of the value of your loan if I give you a 6% interest rate. This is because my company sends so many loans to them that they give us a bonus on the amount of money they will pay us for placing your mortgage with them.

As I examine what other banks in my area are offering right now, this is about .375% lower than what you could obtain locally. Rate reductions of only .25% can save you a lot of money in interest over the long run. For example, if you borrow $150,000 on a 30-year fixed loan at 6.5% interest, you can expect to pay $948.10 per month in principle and interest on your loan. If you are able to reduce that rate to 6.125%, your payment goes down to $911.42. That means that over the course of the year, you will save approximately $435 on your mortgage payment. This may not seem like much cash, but that extra $36 per month can be used for gas, savings, or anything else you might prefer. Over the course of five years, the difference becomes more visible. You pay about $2,150 less in mortgage payments if you have financed at the lower rate.

Additionally, if you look at it from the standpoint of total interest that you are paying, the overall amount of interest that you pay is substantially reduced by even a small reduction in your interest rate. For example, on the loan I previously mentioned, at 6.5%, you can expect to pay a total of $47,302 in interest in the first five years that you pay on the loan. If you are able to obtain a better offer of 6.125%, that amount comes down to $44,480. Some people say “well, that is only about $3,000 over the first 5 years”, but as you pay on the mortgage, the difference gets larger as time goes by. Generally, if you are purchasing a home that you intend to retire in and occupy long-term, you will want to be as picky about the interest rate as possible.

On the other hand, if you work with a mortgage company on your loan, you will not have the luxury of being able to walk into a building, speak with your favorite bank teller, and pay your mortgage, as you might do with a local bank. If you have a customer service issue or question, you will have to dial an 800 number or get on the internet. Most of the banks that mortgage companies work with provide fast customer service and you can use the internet to access information about your loan and pay your bill monthly online, so the process is really not more difficult, it is just a less personal experience.

Generally, I advise borrowers to shop with two local banks and two reputable mortgage companies. Your real-estate agent should be able to advise you on good companies and banks in your area. This will actually expose your mortgage application to several dozen banks, which gives you a much better chance of obtaining the best possible value on your mortgage.

Tomorrow, we will talk about some of the differences in available loan programs offered by mortgage companies and local banks and the differences in credit and income restrictions between the two types of institutions.

So you have a purchase contract, now what?

2005-11-22T08:09:00.000-08:00

So you have picked out a home, agreed upon a sales price with the seller, and signed the purchase contract. You are almost done!

The sales contract will be given to your loan officer along with information to verify your income and assets. Generally, this information consists of your last two years of W-2 statements, your last months' worth of pay-check stubs, and your last three bank statements. Additionally, if you have 401k, stocks, mutual funds, or other forms of savings, you will need to submit documentation to verify the balances on the accounts.

Once your lender has all of this information, they submit the loan for underwriting and order an appraisal on the property. An appraisal just verifies that the proprety is worth as least as much as the amount of money you are trying to borrow. Lenders do not want to loan you more money than the property is valued because if something causes you to default on the loan, they want to be able to sell the property to cover the income they have lost from your mortgage payments.

Along with the appraisal, the lender will have a title company examine the public records on the property to determine that there are no tax liens or other problems that would cause the lender to not have first rights to the property if you default on your loan. You will also need to obtain home owner's insurance for the property. The information for this insurance will also be submitted to the lender.

Once the underwriter has all of your income documentation, the appraisal, and the work from the title company, and the information for you home insurance, they will give final approval for your loan. Occasionally, they will ask for a few extra pieces of information that you will need to provide before they will give final approval. It is in your best interest to quickly provide this information so that your loan will close as soon as possible.

Once the lender gives final approval, the paperwork for you to sign is sent to the title company. You will go there and sign the papers. Congratulations, you now have your own home!

Tomorrow, I will post about the differences in using a mortgage company vs. a local bank to obtain your loan.

You have been pre-approved for a loan, now what?

2005-11-21T07:57:00.000-08:00

So you have been pre-approved for a loan, and you are ready for the next step: Selecting a home to purchase.

The best way to go about this is to speak with a real-estate agent. Before you begin to worry about how much money this will cost you, you should know that having a real-estate agent help you select a home will cost you nothing, in most cases. Their pay usually comes from the seller of the house.

When selecting a real-estate agent, it is important that you find someone that is going to really work to find you a house that fits your needs and wants and is in your price-range that fits your needs and wants. Not all agents are created equally. Just because they have their name in the Real Estate Book, phonebook, or your local newspaper does not mean they are a good agent.

The best advice is to speak with friends, family, or your loan officer and have them refer you to an agent they have had a good experience with in the past. Meet with an agent and speak with them personally. You can learn a lot about a person simply by sitting down and having a conversation with them.

Once you have an agent that you are comfortable with, the selection process begins. The agent will generally ask you any number of questions about the price-range you are looking in, the area of town that you would like to reside in, and specific features you are looking for in a house. You can really get as specific as you would like. Perhaps you want to stay within a certain school district. Perhaps you want the house to have a north-south or east-west orientation. Real-estate agents have access to all kinds of information about hundreds of homes for sale. Do not hesitate to ask questions.

Once the real-estate agent has an idea of what property you are looking for, they will begin searching the property listing system to find homes that fit your criteria. In most cases, they are going to come up with several homes that may potentially interest you.

You will probably meet with the agent again. They will have photographs of the property and just about any piece of information you could want regarding the property. At this point, you will want to select a few houses that you would like to visit to get a closer look.

Generally, you will set an appointment to go visit the home or homes that interest you. Take advantage of this opportunity. This is your chance to really get into places and see how they suit you. Take special notice of any possible defects or damage on the property that may affect your desire to purchase. You need to really analyze the home and be sure that it is going to be what you want to buy. After all, you are going to be spending a fair amount of money and living in this place for several years.

Once you have found a home that you wish to purchase, the process of obtaining a purchase contract begins. Generally, you will make an offer to buy the house for a certain price. This offer is then presented to the sellers. They may decide to accept your offer or make a counter-offer for a different price. This process of price negotiation will continue until you both agree upon a purchase price.

Once you have reached an agreement with the sellers, you will sign a sales contract. This contract will detail the terms of the purchase, the sales price, and the agreed upon date to complete the sale.

Generally speaking, you will be asked to make some sort of earnest money deposit. This is simply a financial commitment from you saying that you are serious about purchasing the home. This is intended to protect the seller. Once you sign a sales contract, the home is considered off the market. Because they will be turning away other potential buyers, they want a good-faith commitment from you to purchase their home. Your earnest money will be held in escrow at a title company. If you complete the purchase of the home, this money is credited to you at closing. If you back out, for some reason, the seller generally gets to keep the earnest money.

The amount of earnest money you pay will vary from sale to sale. It is usually (but not always) affected by the sales price of the home. In a lot of cases, the higher the sales price, the more earnest money you can expect to pay.

Once you have a completed sales contract, it is time to submit it to your loan officer so that the lender may begin to process your loan. More details on that in tomorrow’s post.

The basics: How you purchase a home

2005-11-19T11:29:00.000-08:00

I have decided to spend the next couple of days going over the basic nuts and bolts of what goes into your initial approval for a mortgage and how you eventually purchase your home. Hopefully, individuals will be able to keep information like this handy for themselves or people they know.

Today, I will talk about the first step in purchasing a home - getting pre-approved for a mortgage:

How it works

Ok, so you have decided that your are tired of paying rent and would rather put your money into something that you will eventually own outright. Or maybe you are a new graduate from college, have just gotten your first job, and realize that you have the income to make payments on your first home.

How do you get started with the purchase process? You get pre-qualified for a loan - usually with a couple of different places.

To do this, you need only to find a respectable local mortgage company and bank. I generally suggest that you select a combination of 3 banks and mortgage companies. You may either call or go to the physical address of the businesses. Once there, a representative of the business is going to sit down with you and take some basic information. This usually involves names of people to be on the loan, marital status, social security numbers, contact information, housing history, employment and income history, a summary of any liquid assets such as savings accounts or perhaps stocks or bonds that you own, and credit reports of all individuals to be on the loan.

Once you have provided this information to the loan officer, they assemble it, analyze it, and determine the size of loan you can be approved for. The primary factors to determine your eligibility are your debt-to-income ratio and your credit scores.

Debt-to-income ratio is simply a calculation of all the monthly debt expense that appears on your credit report divided by your total monthly gross (pre-tax deduction) income. For example:

Your credit report shows that you pay on the following 2 debts every month:

Car payment: $350
Credit Card: $ 50

So you pay a total of $400 per month. Your bi-weekly paycheck stubs from your job indicate that you gross $4,000 per month as compensation for your work.

400/4000 = .1

This means your debt ratio before considering your possible new mortgage is 10%. When the loan officer determines how much money you can borrow for your purchase, he is going to look at the proposed debt ratio. This is simply the debts that show on your credit report added onto your proposed monthly house payment, all divided by your gross monthly income. Generally, this ratio cannot exceed 55% to be approved for a mortgage. If you do not have a lot of money in reserve in something like a savings account, this ratio requirement is stricter, anywhere from 45-50% for people with strong credit. Another example:

You want to be approved for a $150,000 mortgage, 30 years-fixed. The payment on this monthly assuming $150 rolled in for taxes and insurance is right at $1,100 per month. You gross $4,000 per month in income.

Car Payment $ 350
Credit Card $ 50
Proposed Housing payment: $1,100

Total: $1,500

1,500/4000 = .375 So your proposed debt ratio is 37.5% Generally speaking, if you have decent credit, you would easily be approved for this loan on the merits of income.

It is also important to mention that your employment history (not just your current level of income) can impact your ability to be approved for a loan. If you switch jobs 2-3 times per year, you are endangering your ability to be approved. Lenders like to see steady employment histories in the same field of work. Generally, if you do switch employers but stay at the exact same position as your previous job, it will have less of a negative impact on your ability to be approved for a loan.

This is not to say that a career switch will automatically disqualify you from a loan, but it does not help. The more recent the switch, the more difficult it will be to approve your loan. Specific lenders have specific rules about this, so it is best to check with your local mortgage company or bank to get more information.

So, your loan officer examines your income and credit report and determines that you can be approved. He will issue a letter that states the maximum loan amount you can be approved for and the conditions that must be met for that approval. Please understand that a pre-approval is not a guarantee that you will get your loan. You must still provide documentation to verify your income, employment history, liquid assets, rental history, U.S. residency, and sometimes more. The pre-approval just states that this is the loan officer’s best guess on what you can borrow based on the information you have provided to him.

So now you have a letter stating how much money you can borrow. It is time to start looking for a home within that price range. That will be the subject of tomorrow’s post.

Using an interest-only payment plan to increase cash flow on rental property

2005-11-18T10:17:00.000-08:00

In my previous post, I mentioned that when you purchase rental property, the idea is generally to generate cash flow above and beyond the monthly payments you will be making on your rental property. One way to help with this is to take out a loan that has an interest-only payment plan. It works like this:

In the loan I mentioned in the previous post, the monthly payment is fully-amortized. What this means is that part of your monthly payment covers the interest that accrued on the loan that month, and another small part goes towards reducing the balance on the loan.

In an interest-only payment, your payment is covering only the interest that accrued that month. For example, assuming the same loan of $112,500 at 6.5% and total tax and insurance expenses of $150 per month, your payment on an interest-only plan is $759.38 per month. This is substantially lower than the fully-amortized payment of $861.08 (including taxes and insurance). As you can see, this runs the potential benefit of creating a larger gap between the rental income that you bring in and the amount of money that you must pay out.

The potential benefits are rather large. The extra cash that you generate each month can be put into some sort of savings that is set aside for maintenance expenses or potential gaps in occupancy of the property. Additionally, if you already have some sort of financial safety net in place for those issues, you can use the additional money for other purposes such as retirement investments, buying a car or whatever suits you the most. I am a rather conservative person, so I guess I would be putting it all into one form of savings or another.

There are potential problems with this loan, however. Obviously, if you follow this payment plan, you are not reducing the balance of your loan. For individuals who intend to hold onto the property for a long period of time, this is not as large of an issue. Assuming even slow appreciation of 1% per year, you will gain equity in your rental property over the time that you own it. However, if you intend to sell the property within a short period of time, you will find that the amount of cash you walk away from the sale with will be smaller because you will have to pay off the full amount of the mortgage. Obviously, if you put a 10% down payment on the property to begin with, you gave yourself a bit of an equity cushion anyhow.

If the property depreciates substantially, you can find yourself in a bad situation. If you have not been paying down the balance of the mortgage and did not make a large down-payment, you may find that the amount of money you can get from selling the property is actually less than what you would need to pay off your mortgage.

Again, do your homework. Speak with your real-estate agent about rates of appreciation in your area. Make some sort of a down-payment to give yourself a safety cushion. Interest-only loans can definitely work to your benefit if you are responsible enough to thoroughly examine market conditions in your area prior to making your purchase.

Is it worth my time and money to invest in real-estate?

2005-11-18T10:04:00.000-08:00

Today, I am going to post some of the math involved in determining how an investment property can work to your benefit from a financial standpoint. I will elaborate on the two basic approaches to investing that I discussed in yesterday's post. Please keep in mind that this post will not cover some investment aspects such as foreclosure investment or rehab projects:

Approach #1: I want to generate rental income

Assuming you can find a reasonable offer for your financing and a property that is easy to rent out, this is the safest approach for property investing. I will give you a basic hypothetical situation:

You find a 3-bedroom house you would like to purchase and rent out to tenants. It is for sale for $125,000. (This price is taken hypothetically from the price of homes in my area. Homes could be more or less expensive depending on where you live). Let's assume for a moment that you have 10% of the purchase price to use as a down-payment as well as sufficient income and strong credit to be approved for a loan.

With Interfirst (the bank that we broker most of our "strong" borrowers through), your interest rate would be somewhere in the neighborhood of 6.5% on this loan. This means a monthly payment of $711.08 before you take your property tax and insurance payments into account. If you are paying $75 per month for taxes and $75 per month for property tax, you see that the monthly expense for owning the property becomes $861.08. To break even on the property each month, you are going to have to charge at least that much in rent. If you are trying to generate positive cash flow from the property, you will obviously need to be charging more in rent per month than you must pay out to own the property.

This assumes you can keep the property occupied for all 12 months of the year. I would highly suggest you examine previous rent-rolls from the property and ask your real-estate agent about rental activity in the area to ensure that you run a reasonable chance of keeping the property occupied with tenants. This is very important!

These days, I'm not really sure how much you can get away with charging for rent here in Columbia. Obviously, it depends on the quality and location of the property. I remember renting a brand-new, 3-bedroom duplex for $675 per month a few years ago. Of course, I was renting from the builder himself, which means he only paid price of materials and labor when purchasing the home. Interest rates were also lower at that time and I imagine he had a special on interest rate from his bank that carried his business accounts. Furthermore, he built several more duplexes on that street over the next two years and charged more for rent on each side of the duplex.

Something else you must consider is maintenance on the property. All of the things that could go wrong with any house apply to your rental property. Roofing, siding, hot water heaters, furnaces, air conditioners, plumbing, carpets, windows, walls - all of it has the potential to go bad or be damaged by tenants, and then you get to replace it. If you choose not to, you can forget about having any tenants in your rental!

The best advice for avoiding these maintenance problems is to have the property properly inspected by a professional before you purchase. Someone who knows what they are doing will be able to warn you of potential maintenance problems that may arise. Additionally, a newer property constructed by a respectable company obviously has less potential for maintenance problems than would an older or poorly constructed property.

Approach #2: I want to sell the property at a price above what I paid for it

This is the more risky of the two approaches I have mentioned. Especially with the concerns that appreciation is about to slow significantly in the housing market (and in some cases, properties are probably actually going to depreciate in value).

It works like this:

Let's say you purchase the same $125,000 property on the same loan as previously mentioned. The plan would be that in 1-3 years, you expect the property to appreciate to the point that you can sell it for a profit. This is a risky move. If you are paying the $861.08 per month that we talked about previously, and you hold the property for one year, this means that you make $10,332.96 in payments for that year. That means to gain a return on your investment, you are going to have to be able to sell the property at a high enough price to pay off the mortgage and then pocket enough money to make a return. Since you borrowed $112,500, after 12 payments, the balance on your mortgage will be $111,242.50. So here is a summary of the expenses you must recoup when you sell the property:

$111,242.50 to pay off the mortgage
$ 12,500.00 in down payment you paid out
$ 10,332.96 in mortgage payments you made for that year

To break even, you must sell the house for: $134,075.46. That is nearly a 10% increase over what you purchased the house at just one year ago.

In some parts of the nation in the last couple of years, this goal was easily attainable. Housing prices in some areas have increased 30-50% annually. However, to expect this trend to continue is not realistic, and it is not a trend that has occurred throughout the nation.

You may ask, "Why is this sort of growth not sustainable?" Well, it simply comes down to a matter of affordability. If you buy the above mentioned home and then turn around and sell it at a sales price that is 30% higher than what you purchased it at, the person who is purchasing the home is going to be paying on a mortgage of $146,250. Assuming they were fortunate enough to get the same interest rate of 6.5% (and with the trend interest rates are taking, this is not likely) and their taxes and insurance cost the same amount of money, their mortgage payment is going to be $1,074.40 per month. That is a substantial increase over what you were paying on the property just one year ago.

As the properties become more expensive to own, fewer people are able to purchase them, which reduces demand. When demand is low, it is more difficult to sell a property, which results in reduced pricing (and reduced appreciation). The annual income of the average American family has not been increasing at the same rate as housing prices, so the incredible amounts of appreciation that some areas have seen in years past is not sustainable.

Add to this the fact that interest rates have been slowly creeping upwards, and it becomes apparent that housing will become even less affordable, even if prices remain at their current levels.
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So, that is some of the basics of property investing. I am going to make another post today about the potential advantages and risks of using an interest-only payment plan on your mortgage to increase your cash flow from your rental properties. Additionally, I am hoping to interview a local real-estate agent or property management company to discuss ways to effectively screen tenants so that you can be sure you are renting to someone who is going to make timely rental payments and not damage your property.

Investment Properties 101

2005-11-17T09:38:00.000-08:00

With the booming housing market of the past couple of years, the number of people expressing interest in purchasing investments in real-estate has never been higher. I thought I would post some of the very basics of property investing today to kind of introduce the idea to individuals who may be interested in purchasing property but do not really know what is involved:

There are two basic lines of thought when you invest in a house, duplex, 4-plex, or condominium.

The first line of thinking says that you will purchase a property and then rent it out to tenants with the idea of generating cash flow over and beyond the amount of money you must pay for the mortgage. This method of investing has been popular for years. Rental properties have been around forever. I work around clients who own dozens of them and have thousands of extra dollars in cash flow per month added onto their personal income.

The second line of thinking says that you will purchase a property, rent it out to tenants for a very short amount of time (generally two years or less), and then turn around and sell that property at a higher price than what it was purchased. The common term for this is "flipping". This method of investing has become very popular in the last two years with home prices exploding upwards. Some individuals in Florida, California, and other areas of the nation have seen returns on one-year property investments of 30-50%!!! These increases have resulted in the talk you hear of a "housing bubble".

As interest rates on available mortgages continue to increase lately, we are coming to a point where the monthly payment on housing is also increasing. This basically means that housing is becoming less affordable. As it becomes less affordable, fewer people purchase property, and this results in a slowdown of the rate of appreciation on property due to reduced demand (in extreme cases, the property may even depreciate in value. This is a situation that is very possible in some areas where homes have appreciated in value nearly 100% in the last 2 or 3 years).

This phenomenon is not a nation-wide occurrence. For example, in my hometown, the rate of appreciation has been around 1-5% per year, depending on the part of town you are in. This is a more restrained rate of appreciation for home values and is less subject to the negative impacts of increasing interest rates and slow-downs in appreciation in other parts of the nation. However, the slower rate of appreciation also means that your return on investment is going to take more time to materialize if you intend to sell the property for a profit.

Tomorrow, I am going to show you some of the math involved with real-estate investing. There will be a lot of information about how to maximize your rental income and return on investment. I will also show you how the areas of the nation that have seen the highest appreciation in property values are now the most vulnerable to depreciation because of interest rate increases. I am kind of excited about that post tomorrow, as it will be the first one I have made with what I consider some sort of "advanced" knowledge of the housing market.

Obtaining a free credit report

2005-11-16T14:13:00.000-08:00

I forgot to mention this, and I do not know why. The federal government issued a mandate that all Americans should have access to a free copy of their credit report once per year. All of you who have not done this yet should take advantage of this. You can go to the following website to get this done:

http:// www.annualcreditreport.com

It's not the most user-friendly site in the world, but the information you obtain from it is some of the most valuable you can have. If there are errors on your credit report, you need to know about them. I highly suggest everyone take advantage of this opportunity.

So you say you have poor credit history...

2005-11-16T10:03:00.000-08:00

Many Americans have poor credit scores. The number of Chapter 7 and Chapter 13 personal bankruptcies hit an all-time high in recent years. A lot of this can be attributed to irresponsible use of credit cards, pay-day loans, and other general delinquencies on bill payments. If you are extremely late on paying a bill, that bill will eventually be placed into a collection account with a collection agency. This has a massive negative impact on your credit score.

The amount of individuals I deal with on a daily basis that have serious credit problems would stun some of you. A lot of it is just irresponsibility. Of course, there are some issues that simply cannot be avoided. People have medical bills that are simply too steep to pay and are eventually getting placed into collection accounts. Sometimes an individual loses their job and cannot find new work, which means they cannot pay their bills.

So let's say hypothetically someone you know, a client of yours, or even someone who is reading this happens to have some of these issues on their credit reports. What can you do to fix them?

First of all, any accounts that have recently been late should be brought current. This can be difficult to do if you are significantly behind, but you have to find a way. If it means taking a second job that is only 10 hours per week but will give you an extra $300 per month to put towards back bills or collection accounts, do it. Most collection agencies will be happy to establish a monthly repayment plan so that you can begin to repay your debts. Whatever happens, do not close your late accounts. It is better for you to keep them open and re-establish a positive payment history with those creditors than to close the account and have only negative history as the most recent that they reported to the credit agencies.

Secondly, any collections that are less than 2 years old should be paid off. However, there are some exceptions to this. Conforming loan requirements say that you cannot have more than $5,000 in collections, and each individual collection account cannot exceed 250-500 dollars.

If you have collections that are over 2 years old, it is not recommended that you pay these off unless you have a loan approval that is conditional to these being paid off. Generally, if you pay something that has not reported to your credit in 2 years, it will cause the agency to report that account again on your credit report, which will lower your score and show a more recent derogatory remark. This sounds counter-intuitive. It would seem that if you are paying off bad debt, it should have a positive influence on your credit. For debts less than 2 years old, this is generally true, but for some reason, on older collections, it has a negative influence on your scores.

Ok, so you have read this over and say, "There is just no way that I can catch up. I'm too far behind". If this really is the case, my suggestion to you is to talk to either a consumer debt counselor or a bankruptcy attorney. Do your homework on this. There are a lot of scams out there that will try to take advantage of an individual's bad situation. Read reviews of debt counselors or attorneys on the internet or check with your local better business bureau.

I cannot advise you one way or another on filing for bankruptcy, other than to say it should be an action of last resort. In fact, it is not even legal for me to advise you when trying to make a decision like that. That is why an attorney is required when filing for bankruptcy in the first place; they are licensed to aid you in such a decision.

One thing I do advise in case you file bankruptcy is this: once your bankruptcy is complete, you need to open new credit cards. Not alot of them, just two or three in both the names of you and your spouse. These allow you to establish a new positive credit record. If you simply file bankruptcy to eliminate your debt and then do nothing to establish a new positive history, you will get nowhere.

No matter your situation, there is always a solution to the problem. It just takes discipline or obtaining help from the proper individuals.

Making sense of your credit report

2005-11-15T12:30:00.000-08:00

It surprises me how little a lot of people know about how their credit score is created. This information is crucial to obtaining any sort of loan for a car, home, new boat, etc. I decided to post this today as a basic way to inform people about the basic way their credit score is determined.

Basically, when consumer credit reporting agencies examine your credit score, they look at the payment history of accounts you have open. If you have no open accounts reporting to your credit report, then you have nothing to generate a positive opinion of your ability to repay debts. You could have a credit score over 700 (which is a strong score) and if you close all of your accounts, you can drop this by several hundred points. It is important to maintain two or three open accounts and pay them in a timely fashion so that you can maintain your credit score.

For clients I work with who have lower credit scores due to lack of accounts, I often advise that they open just two credit card accounts and then charge a hamburger, candy bar, or some other cheap item to the account once a month. When the bill comes due, pay the balance of the account off in full. This looks great on your credit report.

Additionally, you will want to have the limits on your cards as high as possible. Essentially, if you have a credit card with a $6,000 limit, but you only use $5 of that available credit per month, a credit agency will look positively on the fact that you have so much credit available to you but are financially sound enough to not have to use all of it.

That brings me to another point: you do not want to have maxed out credit cards. While having a good payment history is good for your credit, having all of your available credit used up is not. Keep your cards below 20% of their available balance at all times and request increases to your credit limit on the card once every few months.

In my post tomorrow, I will explain how you can repair negative marks on your credit report.

About this Site

2005-11-15T12:13:00.000-08:00

While sitting here at my desk today and reading the Fickletrader blog, I got to thinking about my own desire to run a blog. Basically, I decided to open up this blog as a resource for individuals who have or may have mortgages in the future.

Alot of sound advice will be available here about maintaining a good credit score, buying your home, refinancing, debt consolidation, and property investing. I hope anyone who frequents this site will be able to use the information to make effective decisions about their mortgages or property investments.

If you have any questions or suggestions for this blog, I urge you to e-mail me at mattn@gmghomeloans.com I am always open to new suggestions and ideas.