Have You Heard? 2+2 = 4.3

We're all looking for the "good deal".  Often, it's right in front of us, rather than off in the distance. 

The idea of paying your mortgage twice a month is not new.  It's been around for a long time, and comes in a few different flavors.  The most common setup is called a "bi-weekly".  You pay half of a normally scheduled payment every two weeks. Either the regular loan servicer or sometimes a third party offers this with the popular notion that it's a good deal and provides big savings over the life of the loan.  They usually charge a significant setup fee of something like $300-500, and then a payment processing fee of a few dollars with every payment made.  The promise is that the loan is paid off years earlier and saving thousands...or tens of thousands of dollars in interest. 

For almost everyone, it's neither a big savings, nor a good deal.  It's just math.  And it doesn't necessarily work out in your favor.  Here's how it works: 

Notice that in a bi-weekly, you pay every two weeks, not twice a month.  There's a difference.  There are 52 weeks in a year.  Paying every other week, there are 26 payments.  Each is half of a normal payment.  Twenty six half-payments is the same as 13 whole payments.  All you've done is made an extra payment.  You can do that without a bi-weekly plan, without committing yourself to the higher cash flow, and without the fees. 

Not only that, but the claim that you can save thousands misses the forest for the trees.  The question isn't whether you can pay your loan off faster, its "should you".  What???  Sacrilege!!!  Surely it's better to pay off sooner and save all that money, right???  Well, if you could save thousands on a new Rolls Royce, should you run out and buy one?  See my point?

Paying off a loan faster may be dangerous for this simple reason:  Most folks have insufficient savings.  We should build emergency savings, and then more.  Savings for life, for college, for disability, illnesses, or transitions.  Or from a more positive light...we should have savings for investment and opportunities that come along and require fleeting moments of liquidity.  We should build savings in places we can get at, because it does no good to stuff a bunch of cash into the walls of your house and then seal it up with sheetrock.  You can't get to it when you really need it.  I have yet to see someone with a foreclosure looming or an unexpected disability who wishes they'd put more money into their house.  They all wish for one thing.  Cash.  And if you save that cash in a reasonably secure place, earning anything near the rate on your mortgage (not too hard to do), you can come out ahead by NOT paying off faster. 

The only borrowers whom I'd give the green light to on accelerating their mortgage payoff are the folks that already have a TON of savings, and are in no risk of being cash-poor.  And even then, it may not be good.  For most folks, the best deal is in paying your normal scheduled payments, combined with an aggressive savings plan...outside the walls of your house.  It is the truly conservative thing to do.  If you do things right, you'll be safer, more secure, and maybe even richer in the end. 

By the way, there are 4.3 weeks in a month, not 4.  It's not magic...it's just math! 

Getting to Loan Approval: Your Tax Returns

Several years ago, banks were derided if they had the audacity to ask a borrower with perfect credit for his/her tax returns. Today, as they did for decades prior to the bubble, lenders ask for two or three years of your tax returns, plus K1s, W2s, and sometimes more. Next, they also cross-check directly with the IRS by using a now-common Form 4506T. This ensures the provided returns match what was filed, and reduces the chances of fraud in the mortgage system. This is one of many steps that take time and can’t be rushed. It’s one of the prices we’re paying today for the too-loose mortgage lending approach of the past.

Keepin' it real... 
If your last mortgage experience was in 2003 +/- 3 years, then you're in for a rude awakening.  But that's not to say today's lending practices are rude.  What lenders are asking for today is about the same as what they required 20 or 30 years ago.  It's intended to be enough for them to make a wise lending decision.  And that return to sanity is good for all of us. 

A few tips to ensure successful loan approval:

1. Provide your complete income documentation as requested at the time of application. If you’re missing something requested, talk with your loan officer…there are ways to find the documentation you need, like a quick call to the HR or payroll department where you work can easily produce copies of lost W2s or long-shredded paystubs.

2. Email your CPA or tax preparer (and CC your your loan officer) with permission to provide information as needed for the purpose of loan processing.  Your tax pro usually will have copies of your filed returns, amendments, W2s, and more readily available in a PDF file they can email to us.  Easy. 

3. Be sure your loan officer reviews your documented sources of income/loss (i.e. tax returns and other docs) before issuing a loan approval or “preapproval”. Don’t rely on a preapproval when income documentation hasn’t been reviewed fully.  The devil truly IS in the details, and you'll save yourself a bunch of heartache if you don't blow this one off. 

4. Avoid red tape delays by reviewing your 4506T when you sign it, to ensure your name, address, and SSN exactly match what shows on your tax returns as filed.  If there's a digit, initial, or address out of place, it can cause a late closing.  Something you can easily avoid with a touch of prevention. 

5. Allow extra time for processing your loan around tax-heavy seasons: primarily April, June, and October. That's when processing of 4506T requests can slow down at the IRS.  Just tweak your expectations a tiny bit... 

Today, regulators require mortgage lenders to scrutinize sometimes even absurd details. That’s just the way it is. Now here’s the good news…to a large part, YOU are in control of how this will go. If you provide super-detailed documentation, and do it promptly, the chances of a late-game upset are minimal. Do yourself a favor and ask us lenders early and often… “Is there anything else you need?” That’s a game we can all win.

Tax Tips: The Seventh Wonder of the World…Property Taxes

Curiously, two comparable homes can have vastly different tax bills.  Why?  And if taxes may be billed one, two, or three installments a year…then what’s the best way to pay?  And then there’s the sometime-debated “escrow account”… is it right in your case?    The tax man cometh.  It’s just too bad he doesn’t come with a sense of humor and a user-manual.  But never fear…while I can’t make him go away, I can make it all clear!  

Why the diff?  
If you want to know the intricacies of how a home’s tax bill is calculated…you need to know two things: the tax assessed value and the tax rate.  Multiply the two and voila…you have your annual tax bill!  If you look carefully, you'll find that similar homes don't always have the same tax bill.  There are usually only a few reasons why this may be the case.  One has to do with the tax rate, which is simply the lawful taxes levied against that parcel of land, for government provision of services like roads, sewers, schools, and so on.  Another reason has to do with the property's assessed value.  It's possible for two identical homes to be assessed differently, which happens over time with improvements to individual homes and infrastructure over the years.  If taxes seem very low or very high, it may be due to being under or over-assessed.  Low taxes may also be due to a special deferment of taxes.  Be extra careful here...the deferment may not be permanent, or may have strings attached, so you should research it carefully. 

Check it out!
When home-seeking, make it a top priority to find out the taxes on any home you’re interested in.  Get familiar with the neighborhood’s typical tax amounts so you can plan accordingly for the monthly or annual cost.  You may be lucky to find the taxes are low…or not.  But it’s a key for budgeting.  If they're low, find out why.  When I preview real estate online, I ALWAYS look for the annual tax amount.  It tells a story.  I budget high and then hope to get lucky. 

The Escrow Account: Man's Best Friend? 
If you put less than 20% down, on almost all loans, an escrow account is mandatory.  This is a fund you seed at closing and then add to with each monthly mortgage payment.  If you put 20% or more down, it’s usually optional.  The option does carry a price, though.  In most cases, banks charge a .25 point fee (0.25% of the loan amount at closing) if you opt to forego the escrow account.  Partly for this reason, I recommend setting up an escrow account for most folks.  The other big factor is that the escrow account lets you pay as you go and have no big annual bill to face.  For most folks, the peace of mind here is compelling.  If there's any controversy here, it's because some folks validly and adamantly want to manage their own dollars and pay the bill only when it's due.  They are often passionate about their preference, nevermind that their average balance in the escrow account may only be $2000, and the interest they'd be losing at 1% might only amount to $20/year.  The valid argument they make is that they can earn 10% on that money...or they have cash flow needs that change over time...or for whatever reason they sleep better with it that way.  OK by me. 

Getting the discount
In some locales, there’s a discount for paying taxes in lump sum when they're due or early.  If true where you are, try to do so.  Having an escrow account should guarantee you get that discount, since the funds are all saved up ready to go when the bill comes.  The lender/servicer receives the bill, and pays it for you, on time to get the discount.  That's the design, and you should review the tax and escrow account statements annually to make sure it happens.  If you don't have an escrow account per se, set up your own, informally!  Budget and set aside funds for when the bill comes due. 

Taxes too much? 
Yes, it's your duty to pay your taxes. But no more. Examine your tax bill every year, particularly the tax-assessed value noted by the tax assessor.  If it’s significantly more than your home’s current value, then contact your county assessor and find out about making an appeal.  The process usually entails getting a current appraisal, which can be a significant cost...so weigh the possible benefit of a slightly lower tax bill against that sure cost.  Talk by phone in person to the assessor's office to anticipate the likelihood of success before you embark. 

New Lingo in the Mortgage World

Closing costs are hard enough to understand without lenders adding to the confusion.  There are many different terms thrown about, and I find daily that clients are confused by disclosures and terms that sound similar but have different meanings.  Here comes help...

First off, two super-useful, old-school terms that will be most helpful:

Closing costs:  These are the one-time, transactional costs or fees associated with getting the loan.  It should be all inclusive, and may or may not include “discount points” or “points”, which are related to the interest rate.  In many cases, your costs and points are not dictated, but a matter of your choice. 

Prepaid expenses:  These “prepaids” are prorated/recurring charges that are NOT a cost of getting the loan, but ongoing expenses.  Primarily property taxes, homeowners’ insurance premium and/or dues, and some prorated daily interest for the odd days at the month-end when you close. 

Plus a few new ones added by recent regulation, just to add to the excitement:
NOTE: Added or highlighted in 2010, when HUD (the Department of Housing and Urban Development) changed the old one-page Good Faith Estimate into a new unrecognizable 3 page document, and added new terms.  You may or may not find them useful. 

Total Settlement Charges:  total of all closing costs and prepaid expenses

Origination Charge:  subtotal of only the fees that the lender receives, without other third party fees/costs or prepaids

Adjusted Origination Charges: subtotal of “Origination Charge, plus or minus “Points” (see below).  It is much clearer to look at “Closing Costs”, since that’s more inclusive. 

And a few more to be super clear:

Interest rate: the rate at which interest accrues day by day on your loan…the true rate. 

APR:  “Annual Percentage Rate”, a less useful figure, promoted as a shopping tool for consumers, but one that has major problems.  Attempts to show the total annualized rate (cost as a percentage) of borrowing.  Like: “if you do exactly such and such, and finish in so many years, the annual cost was X.”  Not the same as interest rate. 

Points or “Discount Points”:  One "point"  = 1% of the loan amount.  Either positive or negative…a fee you either pay or finance at closing for a lower rate, “positive points”; or what I call “negative points”, a lender credit to reduce your closing costs.  Either one is possible with most loans, and it’s partly a matter of your choice. 

“Prepaid Finance Charge”:  A subtotal of only SOME of the closing costs specified by the law to calculate APR.

“Amount Financed”: This is the loan amount LESS the prepaid finance charge, used only to calculate APR.

P&I:  “Principal and Interest” payment.  This is the monthly payment for just the mortgage, without taxes, insurance, etc.  This is what pays the interest as it accrues, plus a portion to reduce loan balance over time. 

PITI:  “Principal, Interest, Taxes and Insurance” payment.  This is the total payment (sometimes shown to include homeowner’s dues, and mortgage insurance if applicable).  Used by underwriters in qualifying you.  You’ll see this on many disclosures whether you pay your taxes and insurance in the monthly payment or not.

Is Mortgage Qualifying Too Tight???

It feels like a very twisty road to closing loans these days, and there's a notion out there that "banks aren't lending", but it's far from true.  Some kinds of transactions are much harder to finance, but money is flowing.  You might be surprised to hear me say that standards are arguably still "loose".   No doubt, banks have found some sanity again, and refuse to lend to Jane who is without verifiable income, or Joe who has years of spotty credit.  But reasonably-well-qualified Jack, who has decent credit and income can get a loan.  And he can still get away with a high debt to income ratio (DTI), by historical standards.

The way it was
Years ago, the maximum DTI was in the range of 33 to 36%. That means about a third of your gross monthly pay could go to servicing the house payment (and any other debt service like car, student loan, credit card payments).  From the late 1970s until 2005, DTI standards continued to get looser and looser. Eventually, even those with sketchy credit records could get a mortgage regardless of DTI.  Today banks hold the line around 45% DTI.  That's an improvement, but think about it...

That's 45% of your gross monthly pay. Once you have had withholdings for taxes (30% or so), health insurance (5-15%), etc., and you have 45% going to debt service, there is very little left to live on.  If that's not immediately clear, try it with your own gross household monthly income... how do you feel about a house payment that's 45% of gross?  Make you crazy?  A bank might still approve it today.

Sure, there are cases where the DTI can be high because of extenuating circumstances, but the average household with stable income at 45%?  Not so much.  It would barely leave room for paying the bills, let alone saving for a rainy day or retirement.

High Hurdles
Now, to distinguish qualifying standards from regulatory hurdles.  Regulatory hurdles aren't about what it takes to qualify, but the required process to get to funding.  Today, those hurdles and our processes are beyond insane.  We have to deal with pointless but mandated timeframes to adhere to, checkboxes ad nauseum, and even more disclosures than a seasoned borrower can imagine.  The process is more expensive and slower, and no more consumer-friendly, 180 degrees opposite to what the regulators intended.  In that sense, lending is stupid-tight today.
 
The Future
Going forward, two things must change, although the change may come slowly. 

1. Near term, we're seeing even more regulation (a la the 2300 page Dodd-Frank monstrosity, for example) and then a prolonged fight to lessen the regulatory hurdles back to something more reasonable...and make them truly serve borrowers and lenders, rather than impede smart lending and smart borrowing.  There's no other way. 
2. We'll also see debt ratio guidelines tighten further, back toward the historical standards of 25/33 or 28/36.  They must as well.