Bulls & Blogs

Getting a loan to purchase residential investment property has become more difficult. The discussion below summarizes some of the options that still remain.

Conventional financing - If you currently own fewer than 4 residential properties, conventional financing (Fannie Mae or Freddie Mac) is still available to you. However, maximum leverage is 80% (20% down), and you have to put at least 25% down to get a decent rate. While underwriting guidelines state you can qualify with a credit score of 620, you need at least 680 to get anything approaching a good rate. A score of 740 or above will get you a nominal rate of about 6.5% on a 30y fixed rate loan. Expect to pay a higher rate for duplexes, triplexes, and 4-plexes.

The 4-property limit makes it difficult to acquire multiple properties with conventional financing. (As an aside, I heard a rumor about a month ago that one or both of Fannie and Freddie are considering easing this restriction, but I have heard nothing to corroborate this rumor.) Thus, it is important to look at alternatives that are available in this tight credit market.

Local Banks - Local banks picked up some of slack in financing investment properties last year, but I'm hearing more and more from my banker friends that they have stopped. Many of the banks are scared to make real estate loans right now because of potentially falling home prices and increased foreclosures. I also understand regulators are putting pressure on them to stop lending on real estate, especially "speculative" real estate. If you can find a local bank willing to lend on investment property (when I say local, I'm suggesting smaller banks, banks with maybe only a couple branches - not the Bank of America down the street), count on no better than 75% loan-to-value and very strict underwriting rules. They will want to see liquidity - "cash in the bank" (not necessarily their banks). The idea is that these "reserves" will cover you if you're unable to keep the property rented or you have unforeseen expenses.

Rehab and Hard Money Lenders - This is private money and generally expensive money. Expect to pay 3 to 8 points and 10% to 18% interest. These are short term loans. The lender expects you to flip or refinance the property in a short period of time, usually a year or less. That begs the question why would anyone use these lenders? Well, they specialize in helping investors pick up foreclosure properties, especially ones that require some rehab work. Most of these lenders will lend based on the ARV (after repair value) of the property, and many will lend up to 100% of the acquisition and rehab costs. Most restrict the loan-to-value to around 65% (maybe a little higher) of the ARV. So, if you agree to purchase a property for $50k, and the property needs $25k in rehab, you could conceivably purchase the property with little money out-of-pocket if the ARV was around $125k. (But, remember, the lender orders the appraisal.)

That all makes it sound easier than it is. Liquidity is a HUGE issue for rehab lenders. They generally want you to have money in the bank sufficient to cover at least half the rehab costs plus 3 to 6 months of interest payments plus the closing costs (points plus other fees). This is even if the ARV is sufficient to absorb these costs into the loan. They don't want to foreclose on the property, so they want to make sure you have enough cash to cover everything, foreseen and unforeseen. Other personal financial factors are not as significant. A credit score of at least 640 will grant you consideration, but higher scores and higher incomes improve your chances.

One final comment on rehab and hard money lenders: In the last couple months, I have noticed several of them have stopped funding residential properties. I don't know why, but I suspect it stems from concern about real estate prices.

Seller Financing - Sometimes, the property seller will agree to take a lien against the property rather than cash at closing. This is more likely if the seller currently has no lien against the property or if the seller is having a hard time selling the property. There are no rules for seller financing. The financing terms are whatever you and the seller negotiate into the contract.

I hear from my realtors friends that there are some real bargain properties out there. These are the financing options available to you. While they are quite restrictive, I have talked to many investors who are making them work to their advantage.

As a closing comment, I want to mention that some investors are choosing to move their 401k money into real estate. This requires a special lender with an appetite for this sort of thing. Fortunately, a few such lenders do exist. I will save the details for another blog.

If you're in the market for a new home or thinking about refinancing, I have one question for you: What are you waiting for? I'm talking to those of you who are waiting for interest rates to get better. Interest rates are at historic lows, and sitting on the fence may cost you money.

Okay, I'm a mortgage professional, so I admit I have a vested interest in you making a decision. However, if you're really going to purchase a home or refinance, it matters not to me whether you act now or act later. (I would like to do business with you either way.) However, it should matter to you. Acting now may save you money.

Buying

Let's suppose you're thinking about buying a home. The home's price is $200,000, and you're prepared to put down $10,000 towards the purchase. Today's 30-year conforming rate is 4.75%, which equates to a $991 mortgage payment. If you're paying $1300 in rent each month, your "housing" payment would be $309 dollars less if you buy now.

You may have heard that the Federal government is considering incentives that might drop rates to 4.5%. Does it make sense for you to wait?

Consider this. Any program the government offers is probably 3 to 6 months out. (Let's use 6 months as we're talking government time.) If you buy now, in 6 months, you will have saved $1854 on your housing payment. Yes, if you wait for that 4.5% rate, you can lower your monthly payment by another $30, but:

- If you find a home you like that's priced right, is it worth the risk losing it?

- What if rates don't drop?

- How long will it take to recoup that $1854 you could have saved?

You are correct to point out that I haven't considered property taxes and insurance, which will reduce your savings. But I also didn't consider the tax benefits of owning. On balance, if you buy now and live in the home for 7 years, I calculate you will save over $27,000 by buying over renting. (Please check with you tax professional about the tax benefits of home ownership.)

Refinancing

Suppose you're already a homeowner, and you're thinking about refinancing. Should you refinance today or gamble 6 months for that 4.5% rate?

Let's say your loan balance is $200,000 with an interest rate of 6.25% - a pretty good rate last year. If you refinance today, your monthly mortgage payment would drop from $1231 to $1043 - a $188 savings each month. If you wait for 4.5%, your monthly payment would be $1013. Here's the question:

In 6 months, you will have saved $1128 if you refinance today. If you wait 6 months to get that 4.5% rate (and remember, there's no guarantee rates will drop), it will take 38 months - more than 3 years - before you recoup that $1128. (I'm assuming you have sufficient equity in your home to refinance.) Which makes more sense to you?

Of course, these are only examples, and in both cases I'm assuming you qualify for the loan. The point I want to make is that waiting involves risk AND cost. Rates are really low today. While they may get lower, they also may get higher. If you're ready to act now and decide to wait, you're not only risking today's really low rate, but you're also giving up guaranteed savings.

(You can run your own examples using the calculators on our Web site, www.LoneStarLending.com. Just click the "Calculate Payment" button in the left margin.)

If you're addicted to cable news as I am, you can't help but worry about the credit crisis gripping the world. I keep wondering how and when it's going to affect me personally. Currently, I'm not seeking credit, but what if I was? I hear the stories about car dealerships unable to make auto loans, home equity lines being cut off, and credit card limits being cut back. But you'll notice I didn't mention mortgages. That's because mortgage credit is the one segment of the financial market that remains relatively healthy. That was not a typo. Yes, you still can get a mortgage.

That may sound like an outrageous statement given what you're hearing on the news. This credit crisis began because of bad mortgages. The Wall Street boys sliced, diced, packaged, and collateralized those bad mortgages and went belly-up. Fannie Mae and Freddie Mac overindulged on those bad mortgages and were nationalized. How can the words "mortgage" and "healthy" appear in the same sentence?

Well, it's because of the Federal government's involvement that it can. Back in the good ol' days (before 2007), Fannie and Freddie represented only part, albeit a large part, of the secondary mortgage market. (The secondary market is where loans are packaged and sold to investors. In effect, it makes money available for more mortgages.) Wall Street also had a large share, and the government had a rather small share through FHA, VA, and USDA guaranteed/insured loans.

Fast forward to this year. Investors lost interest in mortgage investments, which put Wall Street out of the business. That meant a large part of the secondary market was gone (but this part was dominated by the exotic and sub-prime loan programs that were falling out of favor.) Loan originations plunged, in part because of the disappearance of these programs but also because mortgage insurance companies dramatically tightened the terms of loans they were willing to insure. Confidence in Fannie and Freddie started to wane, and investors began to question the strength of their guarantees. Both began to report capitalization problems, and questions arose about whether they would be able to continue buying new mortgages.

In steps the Federal government. First, it's rather small share of the mortgage market started to balloon. The FHA loan became the program of choice for those with marginal credit. FHA loans represented almost 30% of the total mortgage market in July, up from less than 6% just three years ago. (FHA's share is probably larger than it should be. Folks with good credit and down payment money get better terms with non-FHA loan programs, but they're being steered to FHA.)

Second, the government nationalized Fannie and Freddie. Suddenly, that implicit backing from the Federal Treasury became explicit, and the risk associated with their bonds disappeared. (In fact, the day after the nationalization, mortgage rates dropped by more than half a point.) Not only that, but the government made capital injections into both companies and promised further injections going forward. The government's goal was to insure that both companies had plenty of cash to buy mortgages.

The net effect is that virtually the entire mortgage market is controlled by the Federal government, and the government is determined to do what it can to prevent further deterioration in housing.

Lenders are making mortgages, and you probably can qualify.

So if you're considering a home purchase, what should you do? I suggest you consider these facts.

a. Housing prices are down - some even say affordable. There are even some bargains out there.

b. Mortgage rates are low. The question is will they remain low. Once this crisis ends, rates most likely will rise, especially after the government divests itself of Fannie and Freddie.

Can you qualify?

Did you ever hear the radio ad that said "Got a job, get a car?" Well, there's some truth to that right now in the mortgage market. While easy credit is gone, if you have a steady job, decent credit, and a little savings, you should qualify. But what are decent credit and a little savings? If you have avoided bankruptcy, foreclosure, and repossession for the last few years, you probably have decent credit. The FHA and Fannie/Freddie loan programs require 3% down payment, but VA and USDA loan programs still require no down payment.

Finally, how might the economic rescue bill affect housing? Should you wait?

I am confident the government will modify many of the mortgages it purchases through the rescue bill due to political pressure. In the short term, this may put slight downward pressure on home prices because mortgage investors will be forced to acknowledge lower property values to participate in loan modifications. (Their alternative is foreclosure, which can be time consuming and expensive, and I suspect that same political pressure will block or lengthen foreclosure proceedings.) Loan modifications mean fewer foreclosures. Foreclosures tend to drive home prices down. Fewer foreclosures means more stable prices and should help the market find its floor more quickly. I would argue that if you find the home you want, and it's priced right, now is the time to buy.

A clever marketing company came up with the slogan "When Banks Compete, You Win." Makes sense. Every basic Economics book will tell you that competition keeps prices lower. Well, apparently Congress doesn't agree.

Under the guise of protecting consumers from "abuses in the mortgage lending market," Reps. Brad Miller (D-NC), Mel Watt (D-NC), and Barney Frank (D-MA) have introduced The Mortgage Reform and Anti-Predatory Lending Act of 2007 (HR 3915). But instead of protecting consumers, the effect of this bill will be to disqualify many people from receiving a mortgage. The bill, as crafted, also will force mortgage brokers, most of whom are small businesses, out of business.

The bill has several sections. The first establishes a national registry for all mortgage originators. This is a laudable goal and one for which mortgage brokers have been fighting for years. We see this as one of the best ways to eliminate the bad actors from the mortgage industry.

The third section establishes minimum underwriting standards for all mortgage loans. This may sound innocuous, but, if passed, will increase interest rates for all mortgages and eliminate loan programs that cater to the self-employed and those with less-than-perfect credit. (I'm self-employed and will not qualify for a mortgage under this bill. Despite the fact that I have never been late on my loan payment, Congress feels I don't deserve a mortgage.) I'll tackle this section in another article.

It's the second section I want to tackle today. This portion puts brokers on the endangered species list. Some of you who follow the popular press may be saying, "About time we got rid of those brokers." Well, before you start celebrating, I suggest you take a hard look at what this misguided, knee-jerk bill will do to your pocketbook.

Mortgage brokers originate more than 60% of all home loans. Brokers command this large percentage because, based on several independent studies, they offer better pricing and better service than the other players in the mortgage market, bankers.

Think about it. Mortgage brokers shop wholesale lenders for loan terms that best meet their customers' needs. Customers like choice. Not everyone wants "vanilla." Moreover, different lenders have different interest rates for the very same loan program. Mortgage brokers are able to choose among the lenders to find the best rate for their customers. And they have an incentive to do so because of competition. A competing broker or banker is just a click away on the Internet.

Obviously, if you get rid of brokers, you get rid of a lot of competition. (Think about who benefits from this, and you have a hint who's pushing this bill.)

The bill affects mortgage brokers by effectively banning yield spread premium (YSP). The term makes most people's eyes glaze over, but it's really not a difficult concept. The best way to understand YSP is to consider two loan options with different interest rates, 6.00% and 6.25%. The option with the higher interest rate makes the lender more money, so the lender will pay a premium for it. This premium is YSP.

The media, and now Congress, have tagged YSP as some sinister, hidden kickback paid to mortgage brokers. It's nothing of the sort. It serves a couple important purposes and by law MUST be disclosed to customers during every step of the loan process.

Brokers use YSP to help customers pay their closing costs. Let's say the premium on that 6.25% loan was $1,000. At closing, the broker can give that premium back to the customer to pay for lender fees, the appraisal, etc. This is how "No Cost" loans are possible. (Did you really think the bank was going to close your loan for free?) With the proposed bill, mortgage brokers will not be able to offer "No Cost" loans.

However, the ban will not apply to bankers, so brokers will be at a competitive disadvantage. You see, the banker's premium has a different name, servicing release premium (SRP). It is determined by the difference between a mortgage loan's interest rate and the interest rate the banker pays for the money it lends. If it costs the banker 5.75% for the money it lends to the consumer at 6.25%, the banker pockets a handsome premium. Unlike YSP, the servicing release premium is NEVER disclosed to the consumer.

The other way brokers use YSP is to pay the bills. All mortgage originators (brokers and bankers) typically charge 1% of the loan amount as an origination fee. For a $300,000 loan, that's a substantial paycheck. However, for a $60,000 loan, the origination fee ($600) doesn't cover the cost of doing business. So, originators (brokers and bankers) raise the rate a little to generate more income.

The concern about YSP is that brokers may abuse it to pad their pockets. The mainstream media and consumer groups have used this concern to demonize YSP and brokers who receive it. What both forget is that you cannot abuse YSP without increasing the loan's interest rate. If the consumer believes the rate is too high, a competing broker or banker is just a click away. (Remember the slogan? "When Banks Compete, You Win?")

Also forgotten is that bankers have the same incentive for abuse. The big difference is that brokers, by law, must disclose their YSP. Bankers hide their premiums. As a result, bankers' premiums typically dwarf those paid to brokers. (We won a customer away from a banker who we calculated was charging a $10,000 premium. Fortunately, the customer stepped away from the closing and called us.)

Congress says it's aim is to protect consumers from this abuse. So why aren't they focusing on making the industry more competitive and transparent? Instead, they want to put "price controls" on mortgage brokers. Do we really want Congress regulating how much money businesses can make?

Think of it this way. When you buy a car, do you ask the salesman, "How much money is Ford making on this car?" Of course not. You ask how much it costs. When you buy a new computer, do you ask, "What's Dell's margin on this computer?" Heck no. You ask how many bills you're going to have to pull out of your wallet.

We should have the same focus for mortgages. What's important is how much it costs. But mortgages can be confusing, so how do you know how much one costs? Years ago, federal law mandated that all mortgage originators disclose the annual percentage rate (APR) on every loan. The APR is the loan's effective interest rate that accounts for closing costs, discount points, and the premium paid to the originator (YSP or SRP). Borrowers can avoid YSP abuse by carefully going over any offer they receive and comparing the APR.

But you say comparing offers can be difficult because of all the forms and legal mumbo-jumbo. Well, mortgage brokers agree and have proposed simplifying mortgage disclosures to make comparisons easier. Unfortunately, this proposal has gained little support in Washington (for reasons I cannot fathom).

The goal of the proposed bill is laudable: protecting consumers from bad mortgages. However, this bill really is the wrong way to do it. In its attempt to prevent the abuses of a small number of originators, it will dramatically reduce loan options and lead to increased interest rates for those who still can qualify for a mortgage. It will eliminate an entire business class (mortgage brokers) that has largely been responsible for creating the competitive mortgage market we enjoy today.

Please tell your Congressman you want banks to compete and to vote against HR 3915.

With alacrity unbecoming of this Congress, the House of Representatives passed the Expanding American Homeownership Act of 2007 in September. After passage of the bill, Rep. Maxine Waters, Chairwoman of the Subcommittee on Housing and Community Opportunity stressed its critical nature. "There is an affordable housing crisis in America. In recent months, that crisis has exploded beyond the poorest renters and homeowners to threaten the domestic economy." said Chairwoman Waters.

The Senate Banking Committee promptly passed its own version of FHA reform the very next day by a 20-to-1 bipartisan vote. Chairman Christopher Dodd promised to "fight for swift passage so that homeowners can get the relief they deserve."

But here we are more than a month later, and all that urgency seems to have dissipated. According to the Washington Post's Kenneth Harney in a 10/27 column, "the Senate FHA bill doesn't even have a number and has not been sent to the majority leader's office for scheduling a floor vote. A spokesman for Dodd, Marvin Fast, said committee staff work on the bill is underway, but he had no explanation about what happened to earlier promises of quick action to aid homeowners in distress."

Congress must have breathed a sign of relief when foreclosure filings dropped 8% last month. I hope they caught their breath again when it read that the September reading is still double the number reported a year ago and is the second highest monthly total on record.

The problem is still very real. HUD Secretary Alphonso Jackson estimates that 500,000 subprime mortgage borrowers could wind up in foreclosure when their interest rates adjust upward over the next 18 months. A consumer advocacy group pegs the number two to four times higher.

The FHA reform legislation would provide relief by raising loan limits in high-cost areas of the country, reducing required down payments, and opening up FHA lending to more competition. Many consider it a crucial relief measure for homeowners who need to refinance out of adjustable-rate loans to avoid foreclosure.

One cannot help but wonder if the Democratic Congress is more interested in manufacturing a campaign issue than in helping strapped homeowners.

The Democratic leadership held a news conference on 10/3 to bash the President for his handling of the mortgage crisis. Senate Majority Leader Harry Reid said, "This is a national crisis. Too bad it's taken so long to realize that we have a crisis." He joined Dodd and House Speaker Nancy Pelosi in calling for President Bush to make an emergency appointment of a "mortgage czar" to respond to rising delinquencies and foreclosures.

Where have these guys been? For two years, President Bush has sought legislation revamping the Federal Housing Administration but Congress has done nothing, according to Housing and Urban Development Secretary Alphonso Jackson. "To place even one family at risk is irresponsible, and Congress should stop playing politics with homeowners' financial security," Jackson said.