Archive for the ‘Finance 101’ Category
Got a question from a client the other day that I hear a lot, so I thought I’d post my response to it, in the hope that it would be helpful to more than just her.
Q: Why do I need to provide my social security number and birthday? I’m not sure I want to give out that information.
A: Good Morning!
Let me give you a bit better idea what the approval and discovery process is for your loan. There are, of course, a number of loan programs we can access. Based on the info you provided already, we can eliminate most of those, and we’re left with three or four that are possibilities.
The closer we get to choosing a program, the more information we need, and the more specific that information has to be. When we get to where we are now, choosing one loan out of the entire set of options, we are essentially underwriting the file as we go. The Desktop Underwriter system is the same framework that the lender will use in underwriting the file, which has great advantages, but one of the disadvantages is that it requires mountains of specific data in order to function. It is making very fine calculations about income, assets, and credit, and without the exact numbers, it doesn’t work. We provide the income and asset numbers – though we will later have to verify to a human that those numbers are accurate – but the credit numbers it gets for itself. To get those, it requires social security numbers and birthdays.
When it’s finished, we can have confidence that we have a real approval on a real loan that will eventually make it to closing. But until we get the data, we can’t proceed from here.
A couple weeks ago I posted about debt and spending in A Conundrum Wrapped in a Paradox, Stuffed in a Burrito. The point was that we as a country can get – and have gotten – to a place where we can’t keep spending as we have, because we weren’t spending our money, and now the debt service is so high that we can’t pay it all back unless we start economizing.
Today, here’s this from the San Francisco Fed:
In the long-run, however, consumption cannot grow faster than income because there is an upper limit to how much debt households can service, based on their incomes. For many U.S. households, current debt levels appear too high, as evidenced by the sharp rise in delinquencies and foreclosures in recent years. To achieve a sustainable level of debt relative to income, households may need to undergo a prolonged period of deleveraging, whereby debt is reduced and saving is increased.
Now that it appears that mortgage cramdowns are going to be stripped out of the housing bill in Congress, let’s talk about why they were a bad idea in the first place.
Yes, I know that bankruptcy judges re-write credit card debt all the time. This is the argument that Elizabeth Warren, the chief TARP watchdog, used yesterday in her statements to Congress. Perhaps someone ought to point out to Ms. Warrent that credit card interest rates are in the 20% range, and ask her to consider how much of that high interest is due to the additional risk credit-card issuers have to take on because bankruptcy judges can re-write their contracts with their borrowers any time they like.
The economy functions based on trust. No trust, no economy. If I don’t trust the guy I’m dealing with, then I have to borrow that trust from being able to count on stable financial arrangements, like contracts, being enforceable as written. If I can’t trust those contracts, either, then I’m just not going to do business. What’s the point? I could be taken advantage of at any time.
Don’t want to pay me back if I lend you money? Hey, no biggie. Let the judge just write off your debt for you. Why would a lender be willing to lend under those circumstances?
And the answer is – very good, you there in the back – they won’t. Or, more accurately, they will, but they will cover their butts by raising interest rates so they can make sure that those of us that WILL pay them back can cover their losses on the ones that won’t. This is basic economics.
Then, when lenders raise their rates, the government can step in again, this time to stop rate-gouging, or whatever, and within a fairly short period of time the government will be the nation’s banking system as well. And won’t that be better for everyone?
Once again, the government is contemplating action that will benefit a few people at the expense of everyone else. But then, this is what large, centralized bureaucracies do. It gives them life, because they never, ever run out of problems to “solve”.
Count me out. Kudos to the Republicans (I can’t hardly even write this sentence) and the couple of Democrats that could see this, and refuse to pass the bill with the cramdowns in it.
Periodically, I hear the same question from enough people that I know it’s time for a detailed primer on some part of the mortgage process. So today, let’s take a close look at how mortgage interest rates and fees are determined, what “points” are, and what you need to know to make sure you’re getting the best possible deal on your loan.
First, a definition: a “point” is 1% of the loan amount, also rendered as 100 basis points, or bps.
Before we talk about “paying points”, we ought to divide the costs of the loan from the costs of the rate for the loan. There are two sets of costs, and they don’t really have very much to do with each other. This is, I think, a major point of confusion.
Cost of the loan: To borrow $200,000 costs X. X varies a bit from lender to lender, just like the cost of grapes from grocery store to grocery store. Do not be confused here by “no-cost refinances”; the cost is still there, however you hide it, just as grapes cost money even if someone happens to be giving them away.
Cost of the rate: Different rates cost different amounts, just as faster cars cost more than slower ones.
Keep those two principles in mind as we go through an example.
Jane wants to get a $200,000 loan. This is going to cost Jane $4000. Now Jane has to decide what rate she wants on the money. People call up all the time and say “what are rates today”, which is exactly like calling a car dealership and asking “how fast are your cars?” Which car? What engine? How fast do you want them to be?
Lenders sell their money to brokers, and the price sheet for that money is called a rate sheet. On that sheet is the cost of any rate Jane could want. At lower rates, the lender will charge the broker, and at higher rates the lender will pay the broker. Want an example? Here you go:
The rate where the broker makes nothing from the lender and pays nothing to the lender is called par. The closest to par on this sheet is 4.75%, in red there. As you see, the broker is actually making a couple bucks at that rate – .162 x the loan amount, to be exact. Usually, a broker will quote you a rate higher than par, so he can make some money on the margin.
This may look complicated, but it isn’t. Think of it like a car dealership. There’s the base cost, and then the sales price, which is the base plus the dealer markup. As you would expect, the better car you get, the more it costs. And just like at a dealership, a lender can sell you a crappy car for the same price as a good one, and pocket the difference. This is why, unless you have a dealer you trust, you always compare prices, and the same should absolutely hold true for mortgage brokers.
So in our example, the wholesale rate is 4.75%. The lender quotes Jane 5% as the rate for her loan. If Jane wants a better rate, say, 4.5%, it will cost .248 (times the loan amount) – this is called paying points. If she wants 5.5%, Jane should get back a chunk of money to defray her loan costs.
In other words, JANE should decide what her rate is, not her broker. The lower she wants it, the more it will cost. The higher she can stand it, the less it will cost, to the point that at some rates, the rate will pay her, and eliminate some of the cost of the loan.
And that’s how it works. It works this way for every lender, no matter what they tell you.
Now that you know the super double-secret mortgage code, here’s the fastest way to use this knowledge to get a good deal: get three Good Faith Estimates (GFEs), one for each rate you pick. The difference in closing costs will tell you how much of the fees are loan fees and how much are rate fees. Then you can decide whether you want a great rate and more fees, or great fees and a higher rate.
See? It’s not rocket science. But I guess I wouldn’t call it simple, either.