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Jim Simms' Blog

By Jim Simms | Mortgage Broker
or Lender in Louisville, KY
  • Work Arounds

    Posted Under: Home Buying, Home Selling, Financing  |  November 22, 2011 9:22 AM  |  1,427 views  |  No comments

    The most common question I hear from buyers that do not qualify for the loan they want is, “How do I get around that?”

    Regardless of what you have heard about tough underwriting guidelines, the truth is they have not changed much in the last 20 years.  Recently, I ran across some of my notes from 1991 and the guidelines today are the same as they were back then.  In fact, the income ratios are a little more liberal today than they were back then. 

    Most consumers and Realtors believe the mortgage underwriting guidelines exist just to protect the lender.  Actually, they protect the borrower just as much if not more than they do the lender.  Most lenders can easily survive a foreclosure whereas most families are financially devastated by one.  The loss is but a fraction for the lender, it can exceed 100% for the borrower, they could lose everything and still owe a deficiency.  

    My best advice to a borrower that wants to “work around” something is, “Don’t do it!”  Any such maneuver increases the risk level significantly.   

    The examples are endless but I will show a couple.  Let’s look at a buyer with a low credit score.  They want to know a short cut to bump their score (see Credit Repair can be a Crime).  There are two distinct reasons for low credit scores, first a credit file that has a few factors that are causing the ding, nothing serious.  But the other is a credit file that has a history of mismanaging money, much more serious.  The first individual may pay down a credit card and see their scores jump, nothing at all wrong with that.  The other person is the one that will be most allured by a work around, exactly what they should avoid.

    For the second guy, trying to go further in debt with a track record of late payments is significantly raising the risk factor.   It is simple math really, if you are having trouble making payments when your housing expense is $1,000 per month, you can’t make them at all if your housing expense increases to $1,400.  Yet people will fight trying to work around the system and get a loan.  The goal by the way is not to get a loan but to buy a home.  That is the motivating factor. 

    Will be back later with more examples, thanks for checking back.  See Part 2

  • I Cause My Own Problems

    Posted Under: Market Conditions, Home Buying, Home Selling  |  November 19, 2011 11:15 AM  |  1,535 views  |  No comments

    As I look back every problem I have ever had seems to have only one common element, me.

    It is easier to see this when it is someone else’s problem, the message gets lost when it is my problem.

    I have worked with the public all my adult life and have witnessed thousands of examples that seem to support my observation.  Everyone creates most of their own problems.  It is interesting how true this is when discussing buying, selling and financing a home.

    There are numerous questions asked on Trulia by both buyers and sellers about problems during a real estate transaction.  I am amazed how often I see consumers ask if they are being treated unethically or if they are victims of fraud.  I have never seen a question asking, “What did I do wrong?”

    The root of most of the issues being tossed around today will fall in one of two categories and sometimes both.

    1)   The “Oink Factor”

    2)   The “Work Around”

    The Oink Factor is a term I came up with to describe the degree of greed behind the motivation that is driving the individual to do something.  We are hard wired with this, just follow us when my Honey wants to go to Zappos.  Men, do not stand between a woman and shoes that are on sale!

    The Work Around happens when a home buyer has a loan application denied yet they still want to move forward.  They want to find a “Work Around” for whatever is holding them back from buying a home.

    These are two traits that we all have to some degree or another and are the foundation to most self-inflicted real estate problems.

    A buyer that purchases a home they can’t afford will try to place the blame on the lender.  Don’t misunderstand; I am not talking about issues beyond our control like the loss of job, illness, death in the family, etc.  Bad things happen to good people all the time.

    What I am referring is the countless number of people that have contacted me wanting to finance a home they couldn’t possible afford.  I had one fellow years ago apply for a mortgage that had a monthly payment of $2,100 per month and he only earned $2,000 a month, gross, before taxes!!   Go figure…

    Unfortunately that is not uncommon. 

    We have all heard how strict the mortgage underwriting guidelines have become today; let me tell you that is BUNK!

    Last week I ran across some old papers from the early 90’s and the basic mortgage guidelines are the same today as they were in 1991.  In fact the income ratio is more lenient today than it was then, a full 3% better for the borrower, if you think higher is better.

    Let’s look at some examples of how the two issues I am picking on impact buyers and sellers.  First the Oink Factor, I coined this term long ago after firing a client over $50 in closing cost.   His Realtor begged me to come in on a Saturday, my day off, to do a loan application.  I approved his application and then he called me first thing Monday morning to inform me I was $50 higher in closing cost than some out of town lender and I needed to pay $50 of his closing cost.  Not only did I fire him but the Realtor as well.   My interest rate was cheaper than the other lender and I paid for a one year temporary buy down.  But that wasn’t good enough, he needed more.    

    In its simplest form the Oink Factor is easy to pinpoint, no matter how good the deal is it isn’t good enough.  I have buyers contact me all the time saying they want to buy a foreclosure a short sale or an REO.  Not that they want to buy a home, but specifically a distressed property situation.  The motivation behind carving out that type of property as a niche is plain old greed.  In a buyer’s market there are many non-distressed properties that are priced aggressively.  But for some people that simply isn’t good enough.

    I am not saying a buyer should rule out an REO, just pointing out that excessive greed can cost a great deal.  If a short sale takes months and months to close and the interest rate spikes during the process, how much sense does that make?   Play with some numbers, knock off 10% on the sale price and then increase the interest rate.  You’ll see it can cost a pile of money to mess around with the Oink Factor.

    Another example would be a buyer messes around trying to buy a short sale and misses a good deal on a better home.  Then the short sale falls apart.  Would they not have been better off to focus on finding the best home?   

    This phenomenon can impact sellers as easily as it does buyers.  I have witnessed sellers countering a good offer asking for a few hundred dollars more, lose the deal and sell later for a lot less.  I suspect some prospective sellers are waiting for values to firm up or improve, a move that prohibits them from the next deal.  Follow this, a potential seller has an existing mortgage with an interest rate of 6% but is waiting for the value of their home to increase before them move.   If the value of their home is down chances are so is the value on the one they want to buy after they sell their existing home.   How much does their existing home need to go up in value to offset what they can achieve on the next deal? 

    Okay, the Love of My Life just called, I have to log off for now, will continue this subject later, please check back.

      

     

     

     

     

  • Rent to Own (continued)

    Posted Under: Home Buying, Home Selling, Financing  |  November 4, 2011 11:41 AM  |  1,813 views  |  2 comments

    In the last blog entry we touched on the reasons behind Rent to Own or Lease Option Transactions.  In this segment we will take a look at the subject for a lender’s point of view.  Any transaction that falls into one of these categories is going to be reviewed with a little more skepticism from the very start.  Not because there are not valid reasons for the use of a lease/purchase, it is because most buyers seek such a transaction because they have some obstacle keeping them from securing financing through normal channels.  It is like a signal from the buyer that I have been rejected for financing so I did this instead.

     

    Is this bad?  No, just saying it starts out with a raised eyebrow from the beginning.  What underwriter or loan officer wouldn’t question why the lease option, at least in their own mind.  Human nature is going to cause us to question, why did you do that?  Is the industry instructed by underwriting guidelines to ask this question, nope.  I am just sharing that we are people also and will question weird stuff just like anyone that isn’t working in the industry. 

     

    Buyers and sellers are under a misconception that they are the only parties that matter when negotiating a contract, any purchase contract, not just lease options.  Not true if either of the parties are using traditional financing to make the deal work.  Example, if the buyer is trying to do a lease option until they correct some credit issues or waiting for some time period to pass so they will be eligible for financing, then the lender will also touch the lease option.  Especially true if the buyer is going to receive some credit for money paid during the lease agreement.

     

    Credits

     

    Credits under a lease option or rent to own usually fall in one of two categories, 1) money paid upfront as a deposit or option consideration  2) a portion of the rent.

     

    I have seen some very poorly written lease options over the years.  The buyers and sellers usually allocate more of the rent towards down payment than underwriting guidelines allow.   This can be a disaster for the buyer if they believe they are making a down payment to the seller over time only to have it denied by an underwriter once they apply for permanent financing. 

     

    Okay, this gets strange, hang in there and we will sort it out.  Let’s say a buyer and seller write up a lease option and nothing extra is paid for the option part of the contract.  However, they establish the rent will be $1,000 a month with all of the rent for the first year to be applied to the purchase price once the buyer exercised the option to purchase.  Let’s assume the option to purchase is for a year at a price of $120,000.  The buyer assumes they are going to have a 10% down payment in the form of a credit when they apply for permanent financing.  Not the case!! 

     

    The mortgage underwriter can reduce the sale price from $120,000 to $108,000, but not recognize any of the $12,000 reduction as a down payment.  It may be a credit towards the purchase price, but will not meet the definition of a down payment for obtaining a loan.  Rent is rent and down payments are down payments, not the same things.  If the market rent of the property was only $600 a month then the extra $400 could be used towards down payment.  It is easy to see how this can mess up the plan.  The buyer thought they were going to have a $12,000 down payment when only $4,800 qualified.  

     

    Here’s the weird part, according to the contract $12,000 gets knocked off the purchase price of $120,000 leaving $108,000 to be financed.   After the underwriter adjusts the transaction to meet guidelines, the sale price is $112,800 with only $4,800 going towards down payment and still leaving $108,000 to be financed.  The buyer expected the down payment to be 10% of the purchase price but the underwriter only accepted 4.25%. 

     

    You might wonder why does it matter?  The buyer still only needs to borrow $108,000 under either scenario.  It could be a deal killer and the buyer could lose all of the money they paid in rent expecting it to be a down payment.  If the market rent should have been $1,000 a month none of the rent can be used to qualify as a down payment for a loan therefore the loan application would be denied.

     

    Who determines what the market rent is for the home?  The appraiser that does the appraisal for the lender.  The only way to be safe is to document the market rent on the front end by having an appraisal that specifically calculates the market rent.  Something I have never seen done in advance.

     

    An easy fix, don’t allocate any of the rent to the purchase price, only the amount of money paid upfront for the option consideration or deposit.  That does not raise a red flag and cause the underwriter to re-cast the transaction.   

  • Rent Option or Rent to Own

    Posted Under: Home Buying, Home Selling, Financing  |  November 2, 2011 11:44 AM  |  3,518 views  |  3 comments

    It doesn’t matter what they are called, leasing a property with an option to purchase is one of the current buzz transactions.  I am contacted frequently by sellers as well as buyers asking how these transactions work. 

     

    The basic contract is nothing more than a regular lease that contains a clause in which the seller gives the buyer the right to purchase the home for a period of time.  The buyer in our example is not required to purchase the home, but has the “option” to do so for an amount that is specified in the option clause.  An astute seller would not grant such an option unless, 1) they receive a large upfront deposit  2) are under duress from the existing mortgage or other debts 3) using it as a marketing tool to sell the property at a higher price.   At least one of these reasons should cause the tenant/buyer to be concerned.

     

    Does this mean all lease options are bad deals for the tenant/buyer?  Not at all, just make sure you understand the transaction and all that it entails.   

     

    This method differs from a land contract or deed with a lien where the seller is actually carrying back the financing for the buyer.  In that type of transaction the buyer owes the purchase price to the seller under the terms of the contract. 

     

    In a lease option the lessee (buyer) does not owe the purchase price unless they exercise the purchase option in the lease.  Note, the lease and option to purchase could be entirely separate agreements but are usually contained in the same document.

     

    Other than the reasons already mentioned the seller may prefer a lease option over a land contract because of a due-on- sale clause contained in their existing mortgage.  Most mortgages in recent years contain a clause that calls the debt due if the owner does anything that changes the circumstances of title.  Selling the property and carrying back the financing is a very good example of a transaction that would trigger the due-on-sale clause.  A lease option may not be such a trigger. 

     

    Another seller assumption is that it is easier to evict a tenant than it is to foreclose on a land contract, this may not be exactly true if the lease option calls for a large upfront deposit from the tenant/buyer.

     

    I view most of these transactions as pacifiers, nothing more than making a tenant feel warm and fuzzy about leasing instead of owning a home.  This feeling could be very expensive for the tenant if things do not go as planned.  From the tenant/buyer’s side the risk is twofold, losing the upfront deposit if they cannot exercise the option and the seller defaulting on the existing mortgage. 

     

    We have already touched on why the seller may enter into such a transaction.  There are many reasons a buyer may seek one but the most common reason is they have been declined for financing from a lender.  This fact alone should be a red flag to the seller.  Contrary to popular opinion, my position is that mortgage underwriting guidelines are actually very liberal.  A seller should have a strong reason to tie up their property if the buyer is currently not able to secure financing from a lender.   

     

    I also believe the underwriting guidelines protect the buyer more than they do the lender.  A lender will financially survive a bad loan, a buyer may not.  The loss is miniscule to a large lender but it may be a 100% loss/disaster to the buyer.  If a buyer does not qualify for traditional financing it may be best to view the decline as a sign instead of something to work around.  Any work around increases the risk to the buyer. 

     

    Lease options may also be a signal of a recent fraud.  If the buyer recently went through a short sale and all of a sudden has a large deposit for a lease option, something may be amiss.  If they hid funds from their previous lender during that process (something I hear a lot from buyers that have done a short sale) then a seller should be careful accepting those funds.

    Be sure to check out the article about Work Arounds.

     

    In my next blog entry I will cover how this type of transaction is viewed from the lender’s - it isn’t what you expect.  Continue to read it here. 

 
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