Examples of documents needed for a loan approval

Sometimes we are asked why so many documents are required from our borrowers before we can approve a mortgage. Beside all the credit documents (income and asset documentation, credit report, appraisal ) there are other documents that may be required that may seem like they do not have any bearing on a loan approval.

Examples of this may include insurance information on the property, title history or home owner association information.. If there are gift funds for part of the down payment lenders will ask for donor’s statements, funds transfer and a gift letter. It all seems so redundant and creates all kinds of unnecessary activities at a time when there are already enough stress. There are reasons for all the documentation although the reasons may not be so apparent to the borrower.

Take the example of home owner association (HOA) information. Any property that belongs to a HOA or if it is a Condominium may have to provide a set of documents to reveal the articles and bylaws of the association, insurance information of the association, budget and reserves of the association and sometimes even more; down to the occupancy status of the residents and other aspects of the association. To get this information usually takes time and some money, as much a couple of weeks of time and over $100 for a set of the documents.

I have had a borrower ask me, “I have great credit, I am putting down over 20%, I am making more than enough money to qualify, why are you making me jump through hoops to get this package of documents?”

I could be funny and say “I feel you” but the reason is the lenders have an interest in the collateral which is a property in a HOA or Condominium. The information in the HOA documents is part of the make up of the value of the property. Think of it this way: If a HOA budget or reserves for the maintenance of the common areas of the community is below what the requirements and the collection of the HOA fees are not sufficient to make up for it, what will happen to that particular property value?

It is a hassle sometimes to comply with all the documentation of the lenders but the beneficial part is they looking at your interest as well. If you were paying cash for the property, you may not think of all the things you need before you pay for it, but when you are financing it, the bank will.

I know from personal experience of instances where the buyer of a property incurred significant damages when he bought a property with cash. Had they financed it, it never have happened due to the checks and verifications a lender would have put in place.

So when we ask you for documents please keep this in mind. We don’t like asking customers to jump through hoops, however they are a necessary evil that just may protect your investment.

When to lock in

In the last post I promised to provide some ideas on how to decide when to lock in your rate when applying to refinance an existing mortgage. Keep in mind that it is to everyone’s interest to maximize their saving by lowering their monthly payments, and to get the lowest rate possible. Also recognize that you cannot see the bottom of the market until the rates have gone back up. So in the typical catch 22 scenario, my approach is to do a risk/reward analysis.

First of all, every situation is unique to a certain point. Not everyone’s motivation is the same, and the scale of the risk versus reward is also different for different people.

So let’s use an example of someone looking to refinance an existing mortgage with a $500,000.00 balance and an interest rate of 6.25% on a 30 years fixed rate to another 30 years fixed rate. Current rates are fluctuating between 4.875% to 5.25% and the old loan has a payment of $3127 (principle and interest only) a month based on original loan amount of $508,000.00. The new loan will be $505,000.00 including closing cost for a new monthly payment of $2710 a month at 5.0% interest rate. Your monthly payment reduction will be $417, good enough for a new car payment.

Now, the question is, is it worthwhile to wait for the rates to drop to 4.875% or even 4.75%? If the rates hits 4.75% your new payment would be $2634, an additional saving of $75 a month, that would be your reward for waiting. What is the risk? For this example, I will assign the risk this way, at 5% you will save $417/month. If you missed waiting for 4.75% and the rate went up to 5.25% you can still save $338. So you are basically risking $75 to save $75. If you think the chances are equal of hitting 5.25% and 4.75% then it is a wash by waiting. Extrapolating this further, if there are very little chance of the rates going to 4.75% then it wouldn’t be worth it. But like a stop loss stock order, you must be prepared to pull the trigger sometime when the market is moving away from us, because locking in at 5.25% still give you over $300/month of savings.

You must keep mind that if the rates goes any higher you could lose the entire monthly savings. You don’t normally think of the reduction as money out of your pocket since you are already paying it. Most of you will look at it as some sort of lost opportunity. The reality is in this economy these savings are magnified and by locking in a rate you would have sure money in your pockets. At some point in time you will be risking $300 to save $75.

Assigning your own value of risk/reward scenario by calculating what your monthly savings are and calculating the likelihood of further rate reductions will help you make better decisions, if you are not sure how, send me an e-mail.

Rates Ticking Up

In the last couple of days we saw rates creep up a little. As of today (16 Jan 09), 30 years fixed rates for conforming loans are over 5%. Still low but last month we saw instances where it was as low as 4.75%. What does this mean and what is ahead of us?

I get asked all the time about what I think will happen to the rates. I also understand most people are expecting an opinion from me and not necessarily a reliable prediction. There is a wealth of information and opinions on TV and on the internet on the future movement of the interest rates - almost as much as the stock market. People invest in bonds and bonds trade like stocks. The value of the bonds is influenced by interest rates. So anticipating rates movements is a big part of the investment community.

The methods of analysis range from analyzing fundamentals like inflation, unemployment, commodity prices, government policy, stock market and a host of other underlying factors, to quantitative analysis based on recent and historical movements of the rates and pinpointing peaks and valley and ranges of the movement to looking into crystal balls and reading tea leafs.

I follow the news and try to make sense of all that information just like everyone else. So I cannot say my opinion is any more accurate than anyone else. But I can clear up some misconceptions I have heard from others in the past. The most common misconception is tying mortgage rates with short term rate announcements from the Federal Reserve. Announcements of Federal Reserve lowering Fed Funds rates and Overnight rates has some impact for the general trend of interest rates, but long term rates like mortgages sometime moves opposite of the short term rates.

Mortgages rates track longer term bonds rates much more closely. Fixed rates used to track the longer maturity treasuries and adjustable rates tracked shorter term maturities like one year or three year treasuries. So don’t get too excited with those short term rate announcements.

Another misconception is that government policy has a direct impact on mortgages rates. Short of doing what they are doing now ( buying mortgage backed securities or MBS directly) the market has a will of its own on the movement of the rates. So right now the government is directly influencing the rates by actively participating in the market. Other times policies are just another factor in the equation. You should also understand FannieMae and FreddieMac have no control over the rates, nor do any of lenders. These entities have some control over the margins they need over the underlying rate, but they have almost no control over the rates themselves.

Anyway, my take of the rates are, at this point in time the 30 years fixed rates will fluctuate between 4.75% and 5.25%. The other loan programs will fluctuate relatively the same. Unless we see the economy shifting significantly, we are probably within 0.5% of that range. If there is anything unique going on now, I have to speculate because the lenders are so busy, they may be holding a higher margin than normal market conditions.

I have notice in the past that rates are usually at the lowest point when people think it is going lower. You can only recognize the bottom after it has passed. This won’t help you if you are trying to pin down the best rate to the 1/8 of a point, but on the next post I will try to come up with some help on how to decide when to lock in.

Credit Scores

Your credit score is an integral part of loan application. It not only determines whether or not you can be approved, it also can make a difference on the interest rate of your loan.

For mortgage application purposes, we require a “tri-merge” credit report. It means we are receiving information from all three major credit repositories: Equifax, Trans Union, and Experian.

Your trigger score is the middle score of the three. For conventional loans like the ones we offer, the minimum score required is 740, any score lower than 740 may negatively impact your interest rate. The amount of the adjustment depends on other factors. The most important of which is the loan amount and property value ratio.

An example is if you are refinancing between 75% and 80% of your property value and your middle score is between 700 and 739, you may be subject to additional charge of 0.75% of your loan amount as an adjustment. Lower credit scores and different loan to value ratios trigger different adjustments. The guidelines are clear, one point short of stated criteria will cause the adjustment, and it is not negotiable.

So one of the things you can do is to review the credit reports for any mistakes or discrepancies. We can help you to correct mistakes and update outstanding balances to bring your score up. You will want to do this if it will help get a better rate. It takes some time and does cost up to $90 per trade-line to correct all three repositories.

I have seen dramatic increases in credit score when an account with late payment history is corrected with clear and indisputable documentation. Sometimes you can also bring your score up by reducing the balance of your credit card accounts. The process takes anywhere from a few days to a few months depending on the complexity of the disputed account.

There is vast information about credit reports and credit scores. A Google search will probably more than satisfy your curiosity. Otherwise, making your payments on time is probably the best way to protect or improve your credit score.

A far fetched prediction

On Thursday’s Washington Post there was an article about Henry Paulson’s final speech as Treasury Secretary. As reported by the Post, the speech involved proposals to replace FannieMae and FreddieMac with highly regulated “utilities” that would play a limited role in making money available for home loans.

The article went on to say that Paulson is leaving the position and changes to the future roles of Fannie and Freddie will fall on the shoulders of the new administration.

Quoting parts of the article, in the “short term” government must bring down mortgage rates, using Fannie and Freddie. In the long term, private investors operating as “housing utilities” will replace the functions of Fannie/Freddie. The idea is to 1) clearly define the role of government backing of these companies, 2) high regulatory supervision, and 3) limiting profits while keeping the entities in the hands of public investors to encourage “private market stimulus to innovation”. The old “implicit backing of the US government” no longer be what differentiate Fannie/Freddie from the private sector.

Mr. Paulson is saying the new entities should either be a government entity or a private enterprise, not a hybrid of some kind.

I also found a few interesting tidbit from the article, 1) the Washington Post made a trillion dollar error when they stated Fannie/Freddie own or stand behind $5.4 billion in mortgages, when later in the article it was stated they owned about $1.5 trillion in mortgages. 2) Mr. Paulson could almost personally save the financial crisis with his pre-Treasury Secretary investment portfolio (He left Goldman Sachs to become Treasury Secretary with about $500 million to his name).

It is clear overhaul of the financial entities dealing with the mortgages are in the works. How and when it will impact us is unknown, but it definitely will come to fruition. How much longer are we going to have these low rates or loan products are all questions with no answers.

Anyway, my far fetched prediction is this: As the wheels turn, we will see rates for the best qualified borrowers go lower and lower. The trend is already apparent; most mortgages are layering additional costs for borrowers with lower down payments, credit scores; limited documentations; and subordinate financing scenarios.

The gap between the best qualified borrower and lesser qualified will be higher and higher, and I don’t mean sub-prime borrowers. So maybe when the proposed mechanisms are functional, we will see some mortgage rates track treasury rates so closely that the spread is less than 100 basis points (1%). Based on today’s bond yields, you would have a 30 years fixed rates for some people in the 3.5% range. I am not saying to hold your breath for it. I am definitely not telling you to wait for that rate to refinance. Just making a far fetched prediction for the unforeseeable future.

Buying Bank Owned Properties: Part 1 (of many)

A lot of recent purchase transaction we have processed for our borrowers have been properties owned by the bank. In another words they are foreclosed properties.

You can write a book on the ins and outs of buying foreclosed properties, and people have. I not going to write about the pro and cons or how to find a great deal, nor I am going to write about the different ways of buying foreclosed properties (short sales, auctions, etc). What is important for me is to prepare you for some of the intricacies that seemed to occur specific to bank owned sales during the loan approval process.

The first thing that sticks out is the seller you are dealing with is not an individual. Bank owned property buyers are usually dealing with are intermediaries; either an agent or employee of the bank. Any negotiation between sellers and buyers takes a much more circuitous route.

Sometimes even the most minor issues becomes a project. An example could be a minor repair that needs to be fixed prior to closing will take days or longer to solve. Anything not specifically spelled out on the sales contract will have to go through the corporate chains of command to approve which takes much longer than dealing with an individual seller.

Most bank owned sales are sold as is, but this does not mean you are obligated to buy it as is. Most contracts allow you to inspect the property and back out if the condition is not acceptable to you. The tricky part is getting the inspection done. Many of these properties have been vacant for sometime, making the inspection more difficult. Sometimes just to get the utilities turned on for the inspection can take days to coordinate.

Back to minor repairs, if the inspection discovers some defects, the buyer no longer can easily approach the seller to negotiate a resolution. Sometimes lenders will not close on a mortgage if the inspection has identified defects. This is especially frustrating when the defect can be easily cured or the cost to cure it is minimal.

Another common occurrence is the title issue. Many approved loans have had their settlement delayed because the bank may not have clear title to the property yet. Short sales (a properties that are sold for less than the existing mortgage), with the bank holding the note approving the sale and absolving the difference and on some foreclosed properties, the bank may not have clear title yet. These are not insurmountable obstacles - they are just additional hurdles to a smooth loan closing.

A lot of these bank owned properties are great deals, but there are also many additional considerations. In future postings I will try to give more specific examples on the challenges of buying bank owned properties.

30 years VS 15 years

I have been asked many times whether a 15 years fully amortized mortgage is a better deal than a 30 years fully amortized mortgage. By amortized I mean a mortgage which is paid off completely after the term of the loan.

It is an interesting question, and I myself have had both types and both fixed rates and adjustable rates mortgages. Let’s compare the benefits and draw backs.

For 15 years mortgages, you can usually get a little better rate, combined with a quicker amortization schedule, your total payment to get the mortgage paid off is much lower than the 30 years mortgage. For example, a $300,000.00 mortgage @ 5% over 30 years is $1,610.46 of principal and interest payment per month. Multiply that by 360 month the total payments to pay off the loan is $579,767.35. The same loan amount for a 15 years loan @ 4.875% is $2,352.89 per month. Multiply that by 180 month the total payment is $423,520.61.

Over the term of the loan you will pay more than $150,000 less for the 15 year mortgage.

Looks like a simple decision. In reality most people still chooses the 30 years mortgage.
I think the higher payment is not the only consideration. Looking at my own experience for my first home, I took a 15 years mortgage with the higher payment. Years later I felt I would have done much better if I had bought a bigger home and took a 30 years mortgage with the same payment. Using the above example, a monthly payment of $2,352.89 would have allowed me to finance $438,300.00 mortgage. I could have bought a home worth $150,000.00 more.

At the time, it would meant buying a bigger home in a better neighborhood and have a much better appreciation value Beyond the monthly payment consideration another reason I felt 30 years mortgage’s lower monthly payment would be a huge benefit if I was to keep the property as an investment - giving me better cash flow as a rental.

Whether or not you can do better investing the difference in monthly payment is another consideration. You can build a model to pinpoint the minimal return needed to be worthwhile. Intuitively, if you can gain more than the interest you are paying, you should come out ahead. In today’s environment, that may or may not be realistic.

For me, I looked at it another way, I wondered how realistic the savings of $150,000 is.
To achieve that saving, you have to complete the loan cycle over 30 years, most mortgages are paid off much earlier. I remember some statistics that, 90% of mortgages are paid off in less than 7 years.

So, let do some math. Using the above example, the 15 years mortgage, assuming you stay with the mortgage for 5 years you would have paid $2,352.89 times 60 for a total of $141,173, and you would have a balance of $223,116 on your loan. Your interest expense amounted to $64,289. The same loan amount with the 30 years mortgage you would have paid $1,610.46 times 60 for a total of $96,627 and you would have a balance of $275,486. Your total interest expense is $72,113. The real difference in interest paid over 5 years is $7,824. Is this a worthwhile trade off for the higher monthly payment? (Keep in mind you get to write off the interest expense.) Probably not, maybe that is why most borrowers choose the 30 year mortgage.

If you have already paid a few years and do not wish to extend the payment terms, I can see how a 15 years mortgage would make sense. Again, there are no simple answers. My best advice is if you are pretty sure you intend to keep that mortgage for the entire 15 years, you will see the benefits. However, if you are not keeping it for more than 10 years, it probably will not give you much savings with the higher payment.