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East West Mortgage • 1604 Spring Hill Rd • Second Floor • Vienna, VA 22182 • Toll Free: 1-800-844-1015 x109 • Phone: 703-891-4509 • Fax: 703-564-9836

Recipe for Foreclosure

This past weekend, I spoke again with someone who purchased a home which will now, in all probability, end up going back to the bank. At times like this, I wish I had a voodoo doll in the likeness of the loan officer who originated this loan. Here is the story which is the epitome of the mortgage melt-down.
The story begins with a borrower looking for some cashout for improvements to his existing home valued at roughly $300,000 dollars. He chose a loan officer recommended to him who also spoke his native language. This loan officer told the borrower that for the projected refinance payment, he would be able to buy a larger, newer house in a neighboring county. So the borrower pulled the equity out of his primary residence, the loan officer refinanced him into a payment-option ARM to keep his payment low while he sold his house, and they used the down-payment to put a contract on a much larger home through a Realtor referred by the loan officer. So far, not so bad, except for the owner occupied loan on a property the LO knew would be sold. Now the real mischief begins. The borrower's target payment for the new home was $1200 per month. The sales price of the new home was $575,000. (Hmmm, that's what I said.) The down-payment of $82,000 was not enough to make the loan work, so instead of finding a lower priced home, the LO also originated a second mortgage of $16,000 on the first home and wrote both a first and second mortgage on the new home with a pay-option ARM as the first loan (at $1400 per month before escrows) and just over $200 per month on the second mortgage. Looking at the HUD-1 settlement statements, these two first mortgages generated $12,000 and $18,000 in commission-able revenue to the mortgage broker, excluding anything made for the second mortgages.
Advancing the story two years, we now have a borrower who was unable to sell the first home, who now owes more than market value due to the negative amortization. He also now owes just shy of $530,000 on his beautiful new home which is worth around $500,000. Oh wait, I forgot to mention that he only makes $30,000 per year, and obtained all 4 of his mortgages as stated income loans (again, HMMM?). He rents his original home for $600 less than his interest-only payment, just above his minimum payment and has been adding $800 per month to his mortgage balance. He rents the basement and one room of his beautiful new home just to make the minimum payment, and adds roughly $1800 per month to the principal balance on that mortgage. His initial credit scores have dropped below 500, as he is barely able to cover his mortgage and has become delinquent on his credit cards and even sold one of his 2 cars. Last, but not least, the servicer for his first mortgage didn't pay his property taxes, even though the borrower paid into an escrow account, so the county sued for and received a judgement and garnishment for back taxes an proceeded to garnish the borrowers entire paycheck for over a month, until the taxes were paid by the servicing company. (The borrower did get a tax refund from the county for the overage, but still has a judgement on his credit report.) And for this "service", the loan officer and his mortgage broker made over $30,000 in revenue.
Contributing factors include a language barrier, a complex mortgage product with disclosures the borrower didn't understand and a property the borrower couldn't afford. Although it troubles me to admit, The WORST factor in this situation was the Loan Officer.
The worst part of this story is that the referred loan officer has "helped" quite a few members of his ethnic community, many of whom have also fallen into foreclosure. I do not excuse the borrower for signing documents that he did not understand, or loan applications with income that were not accurate. I can only wonder at the explanations made by the loan officer "don't worry, I'll fix it", " I can get this done for you", etc.
Unfortunately, looking at the proposed changes to regulations regarding disclosures, I also don't see anything which would have prevented this (assuming that the loan products were still being offered). Although the second mortgage market has dried up, this scenario could have occurred with first mortgages only with the same result.

About the Author: Brian Piper is a Senior Loan Officer with East West Mortgage in Vienna Virginia, one of the largest broker in the country. Also online at http://www.bestvirginiahomeloans.com/ or http://mortgageblog.bestvirginiahomeloans.com/ .

"Subprime Loans are Stupid" says the local news

That was the quote this morning on a local news show. If you believe the financial" expert", homeowners just blundered into these bad loans, or were duped into these bad loan products and he recommended people should refinance now into conforming fixed rates loans to get out of these high-rate, subprime loans. . "These subprime loans were stupid", he said.
Wow, how do I get to be an "expert" like this? Here's the problem I have with comments like this, especially in the wake of all the press regarding the current real estate market. I agree that relatively loose lending guidelines and "cheap" money provided home ownership opportunities for some people that would not have qualified for mortgages as recently as 4 or 5 years ago. The untold story is that not all of these were bad loans, not all were sub-prime loans, and not all of these will result in foreclosure. If you believe some of the hype, there are as many as 17 million foreclosures expected within the next 2 years. That number seems incredibly high, since there are an estimated 50 million homeowners, according to recent census data. Even Senator Obama only predicts 2 million foreclosures, still a historically high percentage.
Breaking down the comments from this morning shows an underlying lack of knowledge regarding the mortgage process. Subprime loans are designed for people who do not qualify for traditional conforming loan products. There is even an interim step down from the traditional "a-paper loan" referred to as "alt-A', or just outside the box A-paper. The most common reason for an Alt-A loan is inability to document income. The most common reasons for subprime loans are (low) credit score and/or mortgage delinquencies. Both of these would prohibit people from obtaining traditional mortgages, sorry to the financial guru. Hopefully the rest of his financial advice is based on better knowledge.
So what REALLY is the problem? Two factors contributed to our current situation: Rising interest rates (actually rising market indices on adjustable rate mortgages) and stagnant or declining property values. Without both of these factors, there would be no panic. So here was the sales pitch at the time for using an adjustable rate mortgage for a sub-prime or Alt-A loan: "Mr/Ms Borrower, I can get you a 30 year fixed rate on your loan, but I can also get you an adjustable rate mortgage for 1/2 point lower, which means your payment will be $$$$___ lower as well. By the time this rate adjusts in 2 or 3 (or 5 or 7) years, your house will be worth more and you can just refinance into a lower rate or 30 year rate at that time. This also give you time to improve your credit so that you can qualify for a conforming loan at an EVEN BETTER rate."
Looking at the underlying math, an adjustable rate mortgage is fixed for a period of time, then adjusts based on an index, which can adjust to market conditions, and a (bank profit) margin which is fixed and stated in your original loan documents. As a built-in protection, ARM's have an initial cap on the first interest rate increase, a cap on each periodic increase and a lifetime cap. Incidentally, these loans also have a floor rate, which is the lowest rate the mortgage can go to in the event the index goes DOWN. The problem with the majority of these loans IS NOT THE RISE IN INTEREST RATES, it is the INABILITY TO REFINANCE INTO ANOTHER LOAN BASED ON PROPERTY VALUE OR INCOME DOCUMENTATION, which is the reason most of these borrowers were not in conforming loans to begin with. These borrowers now face an increase in their payment, which they may or may not be able to pay, and the inability to sell due to lower property values. The contributing factors usually include a stated income loan with little or no down payment originally.
So to our "expert", I would like to say that for the borrowers facing the largest difficulties, the advice to just get a traditional mortgage is not a valid option. You might as well tell them to get a job where they can document all their income, (so sorry for anyone self-employed or who works multiple jobs) or instantly fix their credit (MUCH easier said than done, even when it is possible). BUT, for anyone that got a sub-prime mortgage for the heck of it, when they really qualified for a traditional conventional loan product, he would have been correct...That would have been a stupid loan.

About the Author: Brian Piper is a Senior Loan Officer with East West Mortgage in Vienna Virginia, one of the largest brokers in the country. Also online at http://www.bestvirginiahomeloans.com or http://mortgageblog.bestvirginiahomeloans.com\

Robert Kiyosaki is Smarter Than Me

Ok, so yes Mr. Kiyosaki is smarter than me (just a touch richer, too). Watching CNBC this weekend, he discussed wealth through real estate, among other things, along with a panel of 4 other people. During the show, he mentioned that he is looking for tenants to pay at least 150% of his mortgage (or full mortgage payment plus 1/2 payment as profit) in monthly rent. As a continuation of my Mortgage Math blog series, I want to actually take a look at this and, of course, run some numbers.

So let's look at a home in my area of Northern Virginia. These townhomes run around $350,000 and lease for around $1700 to $1800 per month. So, in order to have a 30 year fixed mortgage payment of less than $1800 based on a 6.5% interest rate, you would need to finance about $280,000. That means to BREAK EVEN, you need to roll equity from another investment or place a down payment of $70,000 to have your monthly rent cover your monthly mortgage payment. That is principal and interest only, so it doesn't include your taxes or insurance, but with a 20% downpayment, your lender will probably give you the option to pay your own escrows. In order to get to the target 150% of the mortgage payment (keeping market rent) you need a downpayment of 45% of the purchase price, or $160,000.

The most important thing to understand is that this is based on a traditional 30 year fixed rate mortgage. Since the math doesn't fit the mortgage, investors have tried to make the mortgage fit the math, and now you see one of the reasons we are experiencing the real estate difficulties today. Investors turned to less-traditional products to squeeze more home into the balance sheet. These products range from interest only options on mortgages and Adjustable Rate Mortgages (ARMs) to the dreaded Option ARM mortgages, where borrowers had the option to make 1 of several payment choices, including payments which DID NOT EVEN PAY THE INTEREST on the mortgage. These negative amortization mortgage products add the unpaid interest onto the balance of the loan. For buyers who are completely payment driven, it is much easier to get a mortgage payment that will be covered by the rental income. The 3.5% start rates (not interest rate) on this same property could get you a $1200 mortgage payment with only 25% down, or $87,500. *see disclosures below*

So now that we squeezed a $350,000 house into the magic 150% target, is this a good loan? For most investors, it is not. To review Adjustable Rate Mortage math, the interest rate you pay on your outstanding balance is determined by an index, which can adjust, and a margin, fixed in your loan documents. Even with a fixed "payment" of 3.5%, your interest rate on your mortage could be 7 or 8% depending on the index and margin selected when you originated your loan. Yes, you guessed it, the extra interest is added back to your principle, and now we have the (black) magic of compund interest working against us. As long as homes appreciated in the double digits, investors could sell out at a profit even if they had to bite the bullet a bit for a year or so. Unfortunately, not only have homes not appreciated (as much, if at all in some areas), but interest rates have risen as well.

So is now a bad time to buy an investment property? Probably not, since it seems there will be an abundance of distressed properties on the market waiting for capitalized investors to salvage, hold for a bit, and make a nice profit. My advice? Work with a loan officer who COMPLETELY understands the math, and even more important, can explain it to you!

*couple quick disclosures on the option arm products. most lenders limited these products to 70% loan to value for non-owner-occupied properties, and (unknown to most individuals) margins could be bought down similar to discount points on your interest rate. Buying down a margin might have cost a little up front, but could have saved quite a bit on the true interest you paid on your mortgage. *

About the Author: Brian Piper is a Senior Loan Officer with East West Mortgage in Vienna Virginia, one of the largest brokers in the country. Also online at http://www.virginialoanpro.com/

How Do I Know If I Am Getting A Good Rate?

Wow. Any loan officer that has been in the business for more than 20 minutes has heard this question. Without selling you ANYTHING, let me give you a couple quick pointers to help determine if the rate, points and fees you are getting quoted are actually competitive.

First, you need to understand how the person originating your mortgage will be compensated. After all, we don't do this for free. I get paid one of two ways. I can give you the absolute best rate that you qualify for and get paid a fee by you directly in the form of a broker fee or origination fee. This is normally expressed in terms of "points", 1 point representing 1 percent of the loan amount. I can also be paid by the lender to sell you a rate higher than what you qualify for which will require less upfront points, sometimes no points at all. The "premium" being paid to the loan originator represents a "yield spread", so you may see the term YSP or yield spread premium on your settlement statement. Sometimes, the premium paid by the bank is high enough (because the interest rate is so high ) to even pay closing costs. This is part of the way lenders offer no closing cost loans. The fees have to get paid, they are just paid out of the proceeds of the loan because the borrower is willing to pay an above-market rate. It is important to understand that points and fees are directly related.

So how do you compare fees? You need a GFE or good faith estimate that is as accurate as possible. Quotes over the phone or internet are completely useless unless accompanied by a good faith estimate correctly filled out by the loan officer after reviewing your application, credit and desired loan program. Comparing two estimates side by side and line by line will help illuminate any extra fees. Keep in mind that some GFE's will not include title fees, recording fees or taxes, title insurance, etc. just to appear that the fees are lower. Also, a rate may not be available unless you lock it in that day.

Another indication of loan comparison is (or should be) the Annual Percentage Rate or APR. All things being equal, a higher APR compared to a similar loan with a lower APR would reflect a higher cost to the borrower. Keeping that in mind, most Truth in Lending statements are not filled out correctly, so the APR does not reflect true costs. This is most common with adjustable rate mortgages. If your APR is significantly higher than your interest rate, be sure to understand why.

Remember, you DESERVE (and we are required to provide) an accurate and complete Good Faith Estimate within 3 days of completing your loan application and anytime your loan terms change, unless there has been an improvement.

About the Author: Brian Piper is a Senior Loan Officer with East West Mortgage in Vienna Virginia, one of the largest brokers in the country. Also online at http://www.virginialoanpro.com/

Are Stated Income Loans BAD?

Are stated income loans BAD?

It seems like open season right now on lenders who have issued Stated Income loans over the last several years. Here is a brief introduction to stated income loans.

Historically, when applying for a mortgage, potential borrowers would take their paycheck stubs and the (hefty) down-payment to their local bank, sit down with a loan officer and a stack of forms and begin the process of loan qualification. The bank would consider the credit profile of the borrower, the capacity to repay the mortgage (income) and the collateral securing the bank’s interest in the loan. These have been referred to as the Three C’s, although I have heard of the Four, Five and even Six C’s of mortgages, depending on which training program you look at. Based on a set of guidelines, a loan application will be approved or denied based on easy to define characteristics. This is a pretty straight-forward process, but is based on a complete understanding of a borrower’s earnings as documented by W-2s and paycheck stubs.

Now let’s consider a self employed borrower. Income calculations are suddenly much more complex, sometimes even impossible. The IRS will determine income based on your tax returns, but a self employed borrower has deductions which reduce his/her taxable income which a wage-earner will not have. Although the money deposited to each bank account could be identical in both cases, the taxable income can be drastically different. When you consider the number of people who have multiple jobs, or receive income that is difficult to verify (paid in cash) then it is easy to understand how the traditional mortgage qualification process does not fairly evaluate the ability of a potential borrower to repay the loan.

The beginnings of the reduced documentation loan reflected a shift towards stricter Credit and Collateral considerations and less stringent Capacity evaluation. Since these loans involved more risk, the rate reflected a higher profit potential for the lender, and we now have a reduced documentation loan. Don’t believe the hype that just because there were less stringent documentation requirements that these were bad loan products. Typically, the credit standards are much higher in terms of FICO score and qualifying tradelines, and the properties are reviewed more intensely as well. The problem with many of these loans revolves around the willingness of borrowers and/or loan officers to inflate the income in order to qualify borrowers for larger loans. THIS IS FRAUD AND WAS NOT THE REASON BANKS ISSUED REDUCED DOC LOANS. To make matters worse, most of these mortgages are Adjustable Rate Mortgages (ARM’s), so now we find borrowers who really couldn’t afford the loan faced with rising interest rates making these loans even less affordable. When coupled with 100% financing and lower property values, we now have the “Perfect Storm”. Borrowers who have no/limited down-payment at risk are much more likely to walk away from the problem. Without the ability to refinance, due to higher rates and/or decreasing property values, there really aren’t many options for a lot of these situations.

Could this have been prevented?

Looking back, there are some obvious factors which certainly compounded the problem and we are currently seeing corrections in the mortgage market to move back to stability. Going back to our Three C’s, we are seeing more stringent guidelines in each area.

Credit: score requirements are higher now than in the recent past, especially for the best interest rates.

Capacity: Most lenders have ceased issuing stated loans, especially for borrowers who are NOT self-employed or do not derive most of their income from self-employment

Collateral: SHOW ME THE MONEY! Expect to bring a down-payment. The 100% loans for first-time homebuyers with limited credit, limited assets and who cannot document sufficient income have gone away.


About the Author: Brian Piper is a Senior Loan Officer with East West Mortgage in Vienna Virginia, one of the largest brokers in the country. Also on the web at www.VirginiaLoanPro.com

Have You Talked to your Loan Officer Lately?

If you are deep in the loan process, I hope your loan officer is keeping you informed. Or at least, as informed as possible. Lenders seem to be dropping off like crazy right now. Loans submitted to lenders, some even "clear to close", are eclipsed by the dreaded " thank you for your past business, but we are ceasing operation" email. You think the Nigerian-millions-waiting-for-your-bank-account email is rampant, just take a look at the number of lenders shutting down.

www.ml-implode.com

OUCH!

What does this mean for a borrower? TALK TO YOUR LOAN OFFICER (assuming he/she is still employed). With lenders shutting down daily, it is harder to find program guidelines than it is to find a rate.