Articles for ‘Mortgages’
Monday, December 6th, 2010 by Randy Whiting
There are a few common ways that I have seen an FHA 203k loan used. Predominantly the clients I’ve worked with use this type of loan to purchase a property that either needs some general rehabbing throughout or to finish a job that was left incomplete for one reason or the other. As rehab loans of any other type have virtually disappeared the FHA 203k loan has been on the tip of many buyer’s tongues lately. The only challenge is that the type of property that would motivate a buyer to seek this type of loan typically ends up in a multi-offer situation; speaking in terms of my local market. If you had a chance to read my short article on TheChicago77.com entitled, “Short Sale and Foreclosure Multi-Offer Strategy“ or you have had any experience as a buyer or buyer’s agent attempting to purchase distressed properties then you already know that in a multi-offer situation an FHA 203k loan gets the lowest priority of any offer on the table. For an in-depth explanation of why please visit the article mentioned above. The long and short of it is that the FHA 203k loan has a huge amount of contingencies, outs, or reasons to fail before close, and that is very unattractive to a bank. As banks are the ultimate decision makers in many distressed property sales it is their opinion that counts, and they want nothing more than the quickest close possible.
Clearing The Air
I’m sure there will be some of you reading this who have used an FHA 203k loan to buy a distressed property, and I do not mean to say it is impossible. Local market conditions significantly impact the possibility that this loan will be accepted for the purchase of a distressed property. For example, with most suburbs of Chicago and a few of the fringe neighborhoods of the city proper the competition is virtually nonexistent. A bank attempting to sell a property in areas with low demand are often so desperate for any type of offer that on the slight chance that one comes it matters not what type of loan it is; they’ll pounce on it like a starving cat.
Back To Business
The purpose of this article is to illustrate an example that worked out very well for a buyer that I have been working with for quite some time. As with many savvy investors my client was very particular about what he wanted in a property. His goal was to find a distressed building, preferably a multi-unit, and convert it into a beautiful modern single family home for himself. As such it took us quite some time to locate the perfect property. When we finally did it was a gutted two unit that had little more than the bricks, the studs and a pile of rubble lining the floors. With an asking price of around 180K it was ripe for the plucking. When he asked me to put an offer in on the place, protocol demanded a pre-approval or proof of funds and I asked him for such. A few moments later he forwarded me a pre-approval letter from his lender for an FHA 203k loan. Knowing what I know about this type of loan and also about the desirability of this type of property to other investors I correctly surmised that a multi-offer situation was at hand. Given a very small number of days on the market, there was little chance the seller of this property would jump on a 203K loan. Instead, they would graciously acknowledge our offer and hold out for something more attractive; cash or a conventional loan offer with a low number of contingencies. Given this, I called a couple lenders who I know that have their fingers on the pulse of the lending market and we came up with a solution.
Our challenge was how to make our offer stand out on top versus the others that were sure to come. Knowing my client had enough cash to buy this property with some to spare, I asked him why he chose an FHA 203K loan. He gave me the answer I was expecting, “I want to save my cash for the rehab.” Knowing what we now know about the low desirability of this type of loan it was only natural that I council him on the unlikeliness that his offer would be considered. As the ball was in my court to find a superior alternative I shared my discovery with him.
FHA 203K Refinance
Let me cut to the chase. If you buy a property with cash there is no title seasoning requirements to re-finance the property with a 203K loan. As such the refinance can happen immediately after purchase. Combine that with the huge desirability of cash in the eyes of the seller and this significantly increases the likelihood of a win-win situation.
What If I Don’t Have Cash?
Here’s the good news for investors out there who want to take advantage of this scenario but don’t have enough capital to purchase with cash. The FHA 203k refinance has the same title seasoning requirement (zero days) if you purchase with a conventional mortgage. In other words, if you buy a property with a conventional loan, right after you close you can turn around and re-finance it with a FHA 203k loan allowing you to obtain extra money to do some rehabbing on the property. So why not make the initial offer with an FHA 203k loan and why did I not recommend a conventional loan to my client and encourage him to save the cash for the rehab? To get that answer I suggest you read my article on Multi-Offer Strategy.
Ciao for now!
Wednesday, September 15th, 2010 by Gary Lucido
Buyers often wonder what bureaucratic torture they are going to be subjected to in order to obtain a mortgage. Therefore, I asked Russ Martin of Perl Mortgage to explain the required documentation for a mortgage application.
In general, a conforming loan (i.e. conforms to the guidelines established by Fannie Mae and Freddie Mac) will require the following documentation:
- Driver’s license
- Two years w-2’s
- Two year tax returns, all schedules. If self-employed, we will also need two years business returns
- Most recent 30 days paystub(s)
- Three month’s statements for all assets – checking, savings, 401k/investments. The bank will want ALL pages of the statement, so if the statement says Page 1 of 4, they need to provide all four pages even if one page is blank
- If paying rent to an individual, they will also have to provide 12 mos of cancelled rent checks
- Any large deposits or movement of funds on the asset statements will need to be verified
- If not a US citizen, we will need a copy of their work visa such as an H1-b.
Keep in mind that these documentation requirements could change over time. And non-conforming loans could have different requirements – possibly even more stringent than the list above.
The list doesn’t look too onerous unless you have a complicated financial situation. For conventional financing, banks pull a 4506-t which is a request to get copies of the borrower’s tax returns from the IRS directly on every mortgage. Most underwriters will ask about other income that is showing up on the returns if it is not documented. For example, you may be getting a salary and w-2, but you may also have income as a minority partner in a small business. They are going to see that on the tax returns and request information on it. This is the primary reason I ask for the borrower’s copy of their tax returns ahead of time so I know about it before the underwriter does. That way we can prepare for the questions that are going to come up.
It used to be easier to deal with borrowers who have more complicated financial situations back in the day when we had stated loan programs which is what those loans were for. However, they were abused so now it doesn’t matter how complicated an individual’s personal/business life is…. EVERYTHING has to be documented.
The reason most borrowers complain about the paperwork is because most borrowers never really sit down and get themselves pre-approved and truly prepare for their financing ahead of time. This is why financing is so spotty and inconsistent on real estate transactions. Realtors are really disconnected from how their clients truly shop for mortgages. Most borrowers aren’t nearly as qualified as they think these days because they really have no idea what it takes to get a mortgage. Combine that with the fact that they also are so focused on getting the lowest rate and what they perceive to be the best deal, it causes problems because they wait till the last minute to really get their financing in order because they don’t want to commit to anyone ahead of time fully until they know their rate/fees which can’t be guaranteed until a property is under contract which is when we can lock rates. So in short, most borrowers don’t know squat [edited for a family audience] about their ability to buy a house until they are under contract.
Part of this is probably driven by big bank advertising which shows the call center monkey talking about getting pre-approved in five minutes. No one gets approved to borrow hundreds of thousands of dollars in five minutes.
Wednesday, February 24th, 2010 by Gary Lucido
It’s hard enough to time investments. Finance theory says it’s impossible and there is plenty of evidence to prove that it can’t be done. So it should come as no surprise that timing a home purchase would be even more difficult.
As I’ve said before, I don’t think people should think of a home as an investment. If it were, it would be the only one that regularly springs leaks, begs for a makeover, and falls apart over the course of 30 years (maybe sooner depending upon your builder). Regardless of what the National Association of Realtors would like you to believe, a home is simply a lifestyle purchase, with some pretty hefty financial considerations. Therefore, the timing of when to buy a home should be largely influenced by lifestyle goals.
That doesn’t mean that there aren’t times when it’s prudent to wait for homes to “go on sale” – such as the last few years. But trying to pick the absolute bottom of the housing market is a fool’s errand. And it’s not just because you don’t know where the price of housing is going. You also have to figure in the impact of mortgage rates, which can have an even bigger impact on the cost of housing than the price of the house.
Let me demonstrate. Consider the purchase of a $500,000 home with 20% down and a 5.1% mortgage. Your monthly payment would be $2,171.80. However, if mortgage rates go up by 100 basis points to 6.1% then the price of the home would have to drop to $458,386 in order for you to have the same monthly payment with the same down payment. That’s an 8.3% price drop. So you have to ask yourself what is more likely at this stage: that housing prices will drop another 8.3% or that mortgage rates will go up by another 100 basis points? How about another 200 basis points?
Look at where Chicago housing prices are right now relative to their long term trend. I’m not saying that they are a steal but they are certainly fairly priced relative to where they have historically been. Now look at mortgage rates. Recently they have been at the lowest level in the past 50 years! I pulled the data below from the Federal Reserve and since that series doesn’t go past April, 1971 I estimated the prior data back to January, 1962 (light blue line) based upon the rate on 10 year treasuries. That estimate is a bit crude but the conclusion is still the same since 10 year treasuries are now at lower rates than they were in 1962.
Actual And Estimated 30 Year Fixed Rate Mortgage Rates
But what about this debate that rising interest rates will depress home prices? Well, let’s look at the period from the 60s to the 80s when 30 year rates went up from around 5% to 18%. According to the theory, during that period, home prices would have dropped by almost 52%! Well, they didn’t.
I’m trying to avoid repeating the realtor’s mantra of “now is the time to buy” because it really does sound lame and self-serving. However, the fact of the matter is that current conditions are extremely favorable for buying.
Monday, February 22nd, 2010 by Gary Lucido
Understanding the relationship between interest rates and home prices is particularly important now because most people believe that interest rates are heading up in the not-to-distant future. One might quite logically expect that when mortgage rates rise it depresses home prices. After all, most people determine the affordability of a home by looking at the monthly payment. In fact, buyers and their lenders usually target their price limit based upon how much they can afford to pay in principal, interest, taxes, and assessments, given their income. And the interest component of that equation is a big driver of the size of the payment. So when interest rates rise you would expect that all buyers would have to shift their expectations down scale and that this would depress home prices.
However, about a month ago one of my clients sent me a link to a BusinessWeek article on the impact of interest rates on home prices. In this article the author, who is the founder and president of Home Warranty of America, claims that the data just doesn’t support the notion that rising interest rates depress home prices. Although he doesn’t provide the direct analysis in his article he does provide links to several data sources so that you can do your own analysis. However, I would like to point out that this is not the first time I’ve heard this claim and I myself have glanced at the data before and found this to be true – especially in the late 70s and early 80s, which is the time period referenced by this author. During that time period home prices rose, despite interest rates that approached 18% ?!?!?! Or at least home prices didn’t decline like you would have expected.
Well, last week a spirited debate transpired on Cribchatter about this very topic. This has to be one of the longest threads in Cribchatter history with 234 comments. The people who argued that higher interest rates would push home prices down were initially arguing based upon the same logic I articulated above. However, eventually both sides of the debate started to link to various studies and articles that proved their point of view. Like most academic endeavors, when someone makes a career out of spending grant money they can prove anything they want so it’s not surprising that there are plenty of studies to support either side. Personally, I got a headache from following the debate, not to mention that it was full of insults.
However, I would like to point out a few things:
- Many of the articles referenced as proof that higher interest rates depress housing prices were nothing more than opinion pieces, based upon financial logic, or were based upon anecdotal data. Hardly real studies. Nevertheless, several legitimate studies were referenced to support this thesis.
- There could be several logical explanations as to why higher interest rates would not depress home prices as expected:
- Buyers assume they can refinance at a lower rate in the future
- Buyers have other financing alternatives, including adjustable rate mortgages and higher down payments. (I remember buying our first home in the summer of 1984 and an ARM was a no-brainer.)
- Higher interest rates are usually associated with inflation and inflation pushes up housing prices
- Buyers assume that if interest rates are higher now they will go down in the future and that will elevate home prices
- When rates go up buyers shift their focus to the lower end of the spectrum but demand at every price level is replaced by demand shifting down from a higher price level – except of course as you get to the higher levels there isn’t as much replacement demand as exiting demand
- When rates go up buyers simply allocate more of their income to interest payments.
For further reading you may want to check out some of the referenced studies and one that I have been meaning to read for a while:
- What Moves Housing Markets – demonstrates that interest rates do not affect home prices. “…our results provide evidence that changes in risk-free interest rates may not have done much to change housing valuations over the 1975 to 2007 period.”
- The Effect of Real Rates of Interest on Housing Prices – demonstrates that real interest rates do affect home prices. “This ebb and flow of real interest rates appears to explain market price levels.”
- Assessing the Role of Income and Interest Rates in Determining House Prices – demonstrates that interest rates do affect home prices. “Our results support the existence of a long-run relationship between actual house prices and the amount individuals can borrow.”
- Why do House Prices Fall? – demonstrates that interest rates do not affect home prices. “Interest rates appear to play a relatively minor direct role, though they may play an important indirect role.”
Friday, February 12th, 2010 by Gary Lucido
FHA has been a popular financing option for condos because of the tightening mortgage guidelines on conventional condo financing and because of the FHA’s low down payment requirement. Currently representing 30 – 40% of the mortgages, any changes to this program can have a huge impact on the housing market. And one such big change just went into effect.
On February 2nd HUD (the Department of Housing and Urban Development), which administers FHA, switched to a new condominium approval process and it represents both good and bad news to the condo market. The good news is that buildings with the right of first refusal (and there are many of them) can now be FHA approved. The bad news is that the FHA spot loan is no longer available – which means that it is no longer possible to quickly approve an individual condo for an FHA mortgage. These changes will cause temporary headaches for lenders and homebuyers. Why? Because in the short run there will be fewer condo properties that are eligible for FHA financing.
So how do you get the condo you want to buy or sell approved for FHA financing now that spot approval is gone? As Pete Thompson’s post explains it is now a bit of a can of worms (or as the British say “a bit of a dog’s breakfast” – not that British dogs eat worms). Basically, the entire building has to be approved and under the new guidelines, there are two ways to approve a building:
- Go directly to HUD (HRAP) and file all the paperwork directly with them
- Go to an FHA Direct Endorsement lender (DELRAP) who has the authority to approve the projects on their own
Despite the complications we are advising our seller clients to pursue these options – after all how can you ignore 30 – 40% of the buyers? There is an entire questionnaire that needs to be filled out but some of the key red flags are as follows:
- Is the project involved in any litigation?
- Does any single entity own more than 10% of the total units?
- Are more than 15% of the owners delinquent with their association dues?
- Are at least 50% of the sold units owner-occupied?
- Does the project meet requirements for FHA concentration (no more than 50%, unless certain conditions are met)?
- Are there any pending special assessments?
We are working with mortgage lenders like Pete who can facilitate the approval process. But there is a cost, since the process is more involved and the lenders need to be really, really careful. For instance, getting an 11 – 25 unit building approved will cost around $2,000. However, when you divide that up among the number of units it’s not that bad and well worth it. Surely this approval increases the value of a unit by more than the $100 – 200 share of costs on average.