Bad mortgage advice could cost you tons of money and time.
Are you thinking about buying or refinancing a home in the near future? If so, chances are you’re getting all kinds of advice from well-intentioned friends and family.
Just remember to keep this important piece of advice in mind: Don’t listen to everything you hear. According to industry professionals, some words of wisdom are not wise at all.
To help you separate the bad advice from the good, check out five common statements that should cause you to cover your ears immediately.
Bad Advice No. 1: “A 30-year fixed-rate mortgage is best for everyone.”
The common perception is that a 30-year fixed-rate mortgage is always the best option, because it typically offers lower monthly payments than other shorter-term mortgages. But the kicker is that interest payments over the course of the loan can be quite substantial when compared to mortgages with shorter terms and lower interest rates.
Consider this example based on rates from Freddie Mac, as of March 20, 2014:
A 30-year loan on a $200,000 property with a 4.32 percent interest rate has a monthly payment of $992 and interest payments totaling $157,153 over the life of the loan. On the other hand, a 15-year loan for the same property with a 3.32 percent rate has monthly payments of $1,412 and yields $54,187 in total interest paid. So by opting for the shorter mortgage, you could save more than $100,000 in interest, which is worth it if you can meet those higher monthly payments.
Whether or not a 30-year fixed mortgage is the right choice depends on the borrower’s goals and financial situation, says Houtan Hormozian, vice president of Crestico Funding, a Los Angeles-based mortgage brokerage firm.
For example, if you have cash saved up for job, family, or medical emergencies and you already have college and retirement funds set up, then a 15-year mortgage might be a better option. Without money saved up, losing a job or an expensive surgery could deal a hard blow to someone’s finances, including their ability to make mortgage payments.
Bad Advice No. 2: “Stay away from adjustable-rate mortgages.”
An adjustable-rate mortgage (ARM) is a loan with an interest rate that is fixed for a period of time then adjusts, causing the ARM payments to increase or decrease.
ARMs get a bad rap, because they’re seen as risky products that contributed to the housing bubble, easy credit, and ultimately, the subprime mortgage crisis.
“The 30-year fixed-rate mortgage is the most popular type, because everyone is afraid of adjustable [rates],” Hormozian says.
In fact, only 3 percent of homebuyers chose adjustable-rate mortgages in the first half of 2013, reports Freddie Mac. With that low figure it’s easy to get scared off, too. But the fear associated with ARMs is somewhat unjustified, according to Hormozian.
“Depending on the consumer, circumstances, and knowledge of their economic situation, there could be an ARM that fits them,” says Frank Percival, board president of the Washington Association of Mortgage Professionals.
One major benefit of an ARM is that it typically will have a lower interest rate than fixed-rate mortgages at the outset. For example, a 5/1 ARM will have an initial fixed rate for the first five years then adjusts afterward.
This is a great option for homeowners who plan on moving out of their house before the rate adjusts. However, this does carry some risk, since personal finances and the condition of the housing market may make moving difficult in a set amount of time.
So choosing an ARM may come down to your financial situation and your aversion to risk. Percival explains that if a homebuyer with a 5/1 ARM saves $200 a month in interest compared to a 30-year fixed mortgage, it may make sense to choose that type of loan. However, if someone wants to err on the side of caution, given the risks discussed, a 30-year fixed mortgage might be the more sensible choice.
Bad Advice No. 3: “If your home is underwater, consider a short sale.”
“When the housing market was bad a year or a year and a half ago and the values of homes were low, people were encouraged from realtors [and] buddies at work to walk away from their home,” says Percival. He calls this “one of the worst pieces of advice in recent history.”
If desperate homeowners took that advice, they would usually do a short sale on their home. What exactly is that? It’s a real estate transaction in which a lender agrees to let the borrower sell his or her property for less than – or “short” of – what is owed on the mortgage.
Even if your home is underwater, it’s a bad idea, asserts Percival. If homeowners can still afford to make their mortgage payments, then they shouldn’t do a short sale.
“People who didn’t have medical emergencies or lose their jobs were dropping their keys and leaving their homes,” Percival says. This is a dumb choice, he adds, since it’s possible that their home value could go have gone up.
Plus, if you do a short sale, you may have to wait several years to qualify for a home again, says Percival. The reason? Because a short sale usually lowers your credit score just as a foreclosure would, according to myFICO, the consumer division of FICO. Shortsellers may be able to qualify for a mortgage in as little as two years, but this may depend on a variety of factors, like how much you are able to put down.
Beyond your own finances, short sales have a far-reaching effect, according to Percival.
“Every short sale or foreclosure reduces the value of every home in the neighborhood,” he says. “If folks would have waited for the recovery to kick in and housing prices to go up, they could have sold it at a profit. People just wanted to walk away from debt.”
Bad Advice No. 4: “An FHA loan is your only option.”
First-time homebuyers are particularly susceptible to bad advice. For example, homeowners who can’t afford a large down payment may hear that a government-backed FHA loan is their only option, since the down payment requirement can be as low as 3.5 percent of a house’s purchase price. But that’s not necessarily the case.
Some homeowners might be surprised that getting a conventional loan might be better suited – and easier – for them than an FHA loan, says Aaron Vantrojen, president of the Arizona Association of Mortgage Professionals, says.
The standards to qualify for an FHA loan have tightened, says Vantrojen. Plus, the FHA loan has become more expensive in recent years due to its rising mortgage insurance premium (MIP).
According to the U.S. Department of Housing and Urban Development, the mortgage insurance on an FHA loan must be carried for the life of the loan. On the other hand, the private mortgage insurance (PMI) on conventional home loans can be dropped when equity in the home reaches 20 percent, Vantrojen says.
As a result of dropping the insurance premium, homeowners can save thousands of dollars in the long run. “The annual mortgage insurance for FHA loans is so high, we are trying to get people into conventional loans if they qualify,” Vantrojen says.
The biggest advantage FHA loans have over conventional loans is the low down payment requirement. But conventional loans, with a 5 percent down-payment required, might be a better deal when you factor in the mortgage insurance payments, says Vantrojen.
“I will always look at options for conventional loans [for homebuyers],” says Vantrojen, president of Geneva Financial, a mortgage banking firm based in Tempe, Arizona. “The guidelines for conventional loans are changing, and a person who couldn’t qualify for one a month ago might be able to qualify now.”
Bad Advice No. 5: “Trust me, I know what I’m talking about.”
If you’re in the market for purchasing a home loan and in need of a little guidance, you might want to think twice about listening to someone who tells you: “Trust me, I know what I’m talking about.”
“One of the most common mistakes is not getting advice from a mortgage investment advisor,” says Hormozian. “Any time you don’t seek advice from a professional, you could be in trouble.”
But not all mortgage professionals are created equal, which is why Hormozian says homebuyers should make an effort to consult and get the opinions of established mortgage advisors, licensed mortgage companies, and reputable professionals when they are ready to purchase a loan.
“At the end of the day, my job is to make sure my client will have a comfortable life and a sound investment,” Hormozian says. “If I feel they are going to have a hard time making a payment or living up to that liability, I have to advise against it.”
For example, if someone tells you it’s a great idea to buy investment property as a source of instant income, you better consider the source. Instead of talking to real estate agents, homebuyers should talk to unbiased resources, who could help them avoid potential mortgage heartaches, says Vantrojen.
“Do your due diligence, talk to industry professionals – people who have been real estate investors and [who] can tell you the highs and lows of owning real estate,” he explains.
If owning a new home for you and your family is a main objective, Percival says it might be a good idea to check whether you are dealing with licensed mortgage professionals. He suggests verifying mortgage loan originators (MLOs) and their MLO license numbers through the National Mortgage Licensing System (NMLS), which performs this service for free.
Some banks show an uptick, but often, the loans are harder to get.
Seeking money for a pressing need or unexpected expense? A TV commercial airing these days from U.S. Bank suggests a solution: A home equity line of credit.
The spot may be reminiscent of the housing bubble for some, but it also represents a sign of the recovery.
“A small fraction of banks are actually reporting they’re seeing stronger demands for home equity lines of credit over the last 3 months,’’ says Keith Leggett, vice president and senior economist at the American Bankers Association.
“The lenders are still going to be cautious, but the fact that you are seeing lenders actually tip toe back into that water is an indication that the housing market has probably stabilized and is actually beginning to recover,” he says. “Lenders would not be going into this market if they viewed (that) housing prices were scheduled to drop further.”
ComericA bank says it’s seen an increase in home equity lines of credit in Orange County. The bank had a 55 percent rise in applications for them as of mid-October this year compared with the full year 2011, and a 36 percent increase in money taken out by borrowers, bank spokeswoman Nancy Tovar Huxen said. There was a 74 percent jump in home equity credit applications in September year to date over the same period ending September 2011, and a 68 percent increase in money taken out.
BOOM VS. BUST
During the housing bubble, many homeowners used their home like ATMs. Income documentation and a healthy amount of collateral often were not deemed necessary. Home prices were soaring.
But since the crash, the rules for such credit, as with other types of loans, have tightened significantly.
“They’re being very careful about who they’re giving that loan to,’’ says Houtan Hormozian of the Orange County Association of Mortgage Professionals. “Banks definitely don’t give them out like they used to.’’
Now homeowners typically need a 720 FICO score, at least 20 percent equity in the home, and documentation of income and mortgage payment stability, mortgage brokers say. And home equity lines of credit don’t come cheap: Average fixed interest rates were 6.68 percent as of Oct. 5, down from 7.06 percent a year ago, according to HSH Associates, which collects data on the mortgage market.
So who qualifies for a HELOC nowadays?
U.S. Bank officials say though the bank’s commercial is airing now, their careful lending practices haven’t significantly changed, and that the bank continued to give out home equity lines of credit even after the housing crash.
“It’s really for the crème de la crème,’’ says Dave Haub, president of CMC Lending in Garden Grove, of typical guidelines for the loans. “There’s not a lot of people who have the equity. It’s almost for the people who really don’t need it.”
PAYING IT BACK
But borrowers who took out home equity lines of credit in the past could face trouble ahead. In a couple of years, more than half of these loans will begin amortizing.
Some people may say yes!
Upward sloping yield curve. It’s important to understand that due to the time value of money and inflation, the longer you borrow the higher your interest rate. If you borrow money from me today to pay me back tomorrow, I won’t charge you interest. But, if you want to borrow money from me today, to pay back over the next 30 years, you better hell believe I’m going to charge you an interest rate above inflation to counteract inflation, make some money, and bake in some risk of default.
Average length of stay. First of all, the average duration one lives in and owns a home is 7 years. If that’s the case, what on earth are you doing borrowing a 30-year fixed rate mortgage for? A 23 year + overestimation of ownership is a serious miscalculation based on the statistics at hand. With a 5/1 ARM, your underestimation is only 2 years, but you already have baked that in.
Match fixed rate with length of stay. If you plan to live in your house for 10 years, take out a 10 year fixed rate (amortizing over 30 years) as the most conservative loan duration. A 10 year fixed rate is cheaper than a 20 year or 30 year fixed rate. It is only logical that you match your mortgage fixed rate with your expected duration of stay. Sure, you might stay longer, but you might also stay shorter as well. If you know you plan to stay in your house forever, it’s more justifiable to take out a 30-year fixed, but I still wouldn’t because 1) You will likely pay down your loan faster than 30 years, and 2) The spreads are unjustly high in this environment.
Adjustable rate loans have an interest rate cap. People think, thanks to fear mongering by the media and mortgage officers, that once the adjustable rate loan period is over, your mortgage rate will skyrocket and make things super unaffordable. This is not the case because everything is relative and rates are capped. I’m refinancing to a 5/1 ARM at 2.625% with all fees included, and after 5 years, the interest rate can reset one time to a maximum of 7.25%. Whoopdee doo! After 5 years, if I don’t pay any extra principal, my principal mortgage amount is about 10% less. A 7.25% mortgage rate on a 10% lower principal amount is very digest-able.
If rates rocket higher, you will be celebrating. Things don’t happen in a vacuum. The 10-year yield is a reflection of inflation expectations. If the 10-year yield, and therefore mortgage rates are skyrocketing, that means inflation expectations are at the very least skyrocketing. However, you don’t have inflation expectations going higher unless demand for real goods and services going higher. Higher demand is a reflection of a stronger economy, and your real assets (property), by very definition or inflating! So what if inflation rises from 2% to 5%, causing your mortgage to reset to 7% due to the 2% spread? If your home is now inflating by 5%, and you have a 80% loan-to-value ratio, your cash on cash return is going up by 25%!
0 years in a row of deflation. Look at the historical 10-year treasury yield. Rates have gone down for 30 years in a row. That’s right folks. THIRTY YEARS! Are you telling me there’s no trend here? Are you saying that we are going to see massive inflation spikes on the way (which are fine as I just wrote) all of a sudden? In these 30 years, we’ve become a much more efficient society who enacts monetary and fiscal policy in anticipation or with shorter lead times. Yes, there will be occasional upward blips in pricing, but I highly doubt there will be a 5-10 year continuous ramp in inflation, which means your 5-10 year ARM is just fine.
Section 129B(d) of TILA, as added by the Dodd-Frank Act, permits consumers to bring actions against individual mortgage loan originators for violations of certain provisions of TILA. For example, while LO’s can be held personally liable for receiving compensation in violation of the Rule, they are not personally liable under TILA/LO Comp for failing to maintain the records of compensation required by the rule. The LO Comp Rule, which implements the DFA’s statutory authority confirms this personal liability through its changes to Reg. Z’s definitions. Specifically, the change to § 1026.36 (a)(1)in the LO Comp Rule clarifies the definition of “loan originator” to mean either the individual LO or the company. The following is from the CFPB’s small business compliance guide which seeks to use plain language explanations for the Rule (although it still warns you that you need to see the actual Rule for details): “A “loan originator” is either an “individual loan originator” or a “loan originator organization.” “Individual loan originators” are natural persons, such as individuals who perform loan origination activities and work for mortgage brokerage firms or creditors. “Loan originator organizations” are generally loan originators that are not natural persons, such as mortgage brokerage firms and sole proprietorships”
TILA is confusing for a lot of reasons, but one of the biggest areas of confusion in the LO Comp and Ability to Repay rules are the differing obligations imposed on “Creditors”, “Loan Originators”, and “Loan Originator Organizations”. These definitions are critical in determining who is responsible for any obligation under TILA. LO comp is one of the few times where the obligation extends all the way down to the individual LO, but the liability is potentially huge. I don’t know about the issue from the LO’s perspective (ask an attorney; see below) – does the borrower have a life of loan defense? As best I understand it, the life of loan defense is true as it relates to foreclosure but the remedy is not a free house, it is three years of interest and other fees (loan, attorney) – a monetary judgment. So there shouldn’t be any runs on any particular company.
Attorney Brad Hargrave (MedlinHargrave) writes, “Loan originator compensation is one area of Truth in Lending and Regulation Z wherein someone other than a creditor; namely, the loan originator, can also be held liable for a violation. The citation in support of this proposition is found at 15 USC §1639b(d)(1) which provides, in pertinent part, that ‘for purposes of providing a cause of action for any failure by a mortgage originator, other than a creditor, to comply with any requirement under this section, and any regulation prescribed under this section, section 1640 shall be applied with respect to any such failure by substituting ‘mortgage originator’ for ‘creditor’ each place such term appears in each such subsection.’ And, §1640 is that section of TILA that imposes civil liability for various TILA violations, including those sections regarding LO Compensation. (I have not addressed the recoupment and setoff issues in the event of foreclosure in the context of the LO, given that an LO would not be the party initiating the foreclosure; and thus, this section really isn’t applicable to an LO).”
Mr. Hargrave’s note continues, “The penalties are potentially severe. In an individual civil action brought by a consumer, the creditor who paid the violative compensation could be liable to the borrower for actual damages, plus twice the amount of any finance charge in the transaction (capped at $4,000), plus an amount equal to the sum of all finance charges and fees paid by the consumer (unless the creditor can demonstrate that the failure to comply is not material), plus reasonable attorneys’ fees and court costs if the borrower were to prevail. The loan originator’s exposure to such a claim (per 15 USC § 1639b(d)(2))is the greater of actual damages to the consumer or three times the total amount of direct and indirect compensation paid to the LO in connection with the subject loan, plus the costs to the consumer of the action, including reasonable attorneys’ fees. In addition, the CFPB could sue the creditor and the loan originator in Federal District Court and seek any one of a number of remedies, including restitution and/or disgorgement, and appropriate injunctive relief, as to all loans wherein the LO received unlawful compensation. It is also possible that the matter could be referred to another agency for enforcement.”
A new analysis suggests that the tide of home foreclosures isn’t going to recede soon. The report from the Center for Responsible Lending, “Lost Ground, 2011,” finds that at least 2.7 million mortgages loaned from 2004 through 2008, or about 6%, have ended in foreclosure and that nearly 4 million more home loans (roughly 8%) from the same period remain at serious risk. Put another way, “The nation is not even halfway through the foreclosure crisis,” says the report, which analyzed 27 million mortgages
made over the five years. Across the country, low- and moderate-income neighborhoods and neighborhoods with high concentrations of minorities have been hit especially hard, the report found. The report also noted that certain types of loans have much higher rates of completed foreclosures and serious delinquencies. They include loans originated by brokers; hybrid adjustable-rate mortgages, option ARMs, loans with prepayment penalties and loans with high interest rates (subprime). African Americans and Latinos were more likely to receive a high-cost mortgage with risky features, regardless of their credit. For example, among borrowers with good credit (a FICO score of over 660), African-Americans and Latinos received a high-interest-rate loan more than three times as often as white borrowers.
Delinquencies down, foreclosure inventory sets record high
The October Mortgage Monitor report released by Lender Processing Services, Inc. (LPS) shows mortgage delinquencies continue their decline, now nearly 30% off their January 2010 peak. Meanwhile,
foreclosure inventories are on the rise, reaching an all-time high at the end of October of 4.29% of all active mortgages. The average days delinquent for loans in foreclosure extended as well, setting a new record of 631 days since last payment, while the average days delinquent for loans 90 or more days past due but not yet in foreclosure decreased for the second consecutive month. Judicial vs. non-judicial foreclosure processes remain a significant factor in the reduction of foreclosure pipelines from
state to state, with non-judicial foreclosure inventory percentages less than half that of judicial states.
This is largely a result of the fact that foreclosure sale rates in non-judicial states have been proceeding at four to five times that of judicial. Non -judicial foreclosure states made up the entirety of the top 10 states with the largest year-over-year decline in non-current loans percentages. The October data also
showed that mortgage originations are on the rise, reaching levels not seen since mid-2010. Mortgage prepayment rates have also spiked, as much of the new origination is related to borrower refinancing; loans originated in 2009 and later are the primary drivers of the increase. While FHA origination activity
is down, GSE and FHA originations still account for the vast majority of all new loans – nearly nine out of every 10 new mortgages.
Jobs up, looks better than it is
Job creation remained weak in the US during November, with just 120,000 new positions created, though the unemployment rate slid to 8.6%, a government report showed Friday. The rate fell from
the previous month’s 9.0%, a move which in part reflected a drop in those looking for jobs. The participation rate dropped to 64%, from 64.2% in October, representing 315,000 fewer job-seekers.
The actual employment level increased by 278,000. The total amount of those without a job fell to 13.3 million. The drop in participation rate is significant in that had the labor force remained steady, the jobless rate would have dropped to 8.8%, according to Citigroup calculations. If the labor force had
followed trend growth, unemployment would be at 8.9%. “Overall, the continued modest employment gains reflect an economy that plods along at an uninspiring pace,” Kathy Bostjancic, director
of macroeconomic analysis at The Conference Board, said in a statement. “These modest job gains are still not enough to propel economic growth to a sustainable 2%-plus growth path.” The
measure some refer to as the “real” unemployment rate, which counts discouraged workers, also took a fall to 15.6% from 16.2%,its lowest level since March 2009.
However, economists were treating the rate drops with skepticism. “When the unemployment rate declines, we want to see both employment and participation increase as discouraged workers
return to the labor force. Today, we got the former, but not the latter, making the 0.4% drop look a bit suspect,” Neil Dutta, US economist at Bank of America Merrill Lynch, told clients. “We would not be surprised to see the unemployment rate give back some of its decline in the coming month(s).” Average earnings were essentially flat, up two cents to $23.18 an hour. Private payrolls increased 140,000, considerably less than a report earlier this week showing that nongovernment jobs were up by more
than 200,000 for the month. Government payrolls fell 20,000, including a 4,000 drop in federal positions.
Long-term unemployment remains a big problem: The average duration for joblessness surged to a record-high 40.9 weeks. Stagnation in wages also continues, as more employed workers took
on second jobs. There were just under seven million multiple job-holders for the month, the highest total in 2011 and the most since May 2010. Traders offered little reaction to the report.
Futures already had been indicating a positive open but lost some ground in the ensuing minutes after the Labor Department report hit the tape. “At this pace of job growth, it will be more than two decades before we get back down to the pre-recession unemployment rate. Moreover, a shrinking labor force is not the way we want to see unemployment drop,” said Heidi Shierholz, economist at the Economic Policy Institute. “At this rate of growth we are looking at a long, long schlep before our sick
labor market recovers.”
All these scary reports create opportunities for the investor no matter where you live.