FAQ: Mortgage Loans - Conforming, Jumbos, FHA, Jumbo Lights

Although I’m not a mortgage broker or lender, I get a lot of questions from my clients and in my first time homebuyer classes about interest rates, points, and fees. There’s a lot of confusion out there right now about what the conforming limits are, how FHA works, and what the stimulus package impact will be. The short answer is that we don’t have all the answers yet—the mortgage market changes by the minute. I always recommend to my clients that they choose a lender they trust and then stick with him/her (I’m happy to make a recommendation or two if you contact me.) An online mortgage calculator will never keep up with the pace of change and options (both coming and going) in today’s market. In my opinion they are nearly worthless if you're seriously thinking of buying a home (though if someone has found a good one, by all means, let me know!)

Here are some of the basics, including some basic economics on risk and reward (I admit these are over simplified, but I think will suffice to give buyers an idea.) You have to think of your mortgage as an investment product. Somewhere out there is an individual investor with a million dollars to invest; He can invest in the stock market, in gold, in CDs, are in mortgages, for example. The higher the risk he takes with his money, the more reward he will expect. These are some of the “flavors” of mortgages and rates:

• “Conforming” Loans. Until recently this meant ONLY loans less than $417,000 that met Fannie and Freddie underwriting guidelines. Fannie and Freddie are government sponsored entities that purchase loans from banks, package them up, and sell them off. Because the bank has a “guaranteed” buyer for your loan, it lowers their risk and hence lowers the interest rate (low risk for a bank = low reward for a bank.) Fannie and Freddie also slap their own guarantee on these products, so the people they sell them to are willing to earn a lower return because there is less risk. These loans have the most competitive rates. All Fannie and Freddie loans are subject to their underwriting guidelines, including their downpayment restrictions. Because both entities have slapped a "declining market" label on our area, downpayment requirements are higher now than they were a year ago to the tune of 5%. So if previously you were the quality of borrower that could have qualified for a 95% loan-to-value (that is 5% downpayment), this new label means that you now only get 90% (a 10% downpayment) if you want a Fannie- or Freddie- backed loan.
  
• “Jumbo” Loans. Loans that are above $417,000. They carry a higher rate because Fannie and Freddie are prohibited from buying them, and hence the risk to your bank is higher—they need to find a buyer out there, or they need to keep it in-house.
• “Jumbo light” or “jumbo conforming” Mortgages. These are new in 2008 as a result of the stimulus package. Fannie and Freddie are temporarily allowed to buy loans up to 125% of the median purchase price of an area. For the Washington, DC, area, that means $729,950. So this new layer represents a loan that meets Fannie and Freddie’s guidelines and is between $417K and $729,950. Rates on these loans are still in flux, but chances are that it will be somewhere between “conforming” and “jumbo.” Fannie and Freddie put some limitations on which ones they will buy though, so expect some hoops: at least 10% down, or 20% if your FICO score is less than 700, among others; Below 660 and you’re out of luck altogether. One thing the market (our individual investor out there) doesn’t like about this new layer is that it’s temporary, so he’s not sure what will happen to it in the future. Investors don’t like uncertainty, so even though there’s a theoretical “buyer” out there in Fannie and Freddie, he nonetheless wants a premium for it in the term of a higher rate of return.
• FHA Loans. Once the stepchild of the mortgage industry, it’s quickly coming back in favor because of its low down-payment (3%) requirement. FHA loans are guaranteed by the government, so risk to an investor is low. Low risk = low reward, or in other words, lower rates charged to borrowers. FHA until recently had a very low limit, so was not widely used in this area. But Congress recently approved an upper limit of $729,950 in our area (same as the “jumbo lights”). Similar to that scenario, rates on that mid-tier (between the old limit of $362K and the new limit of $729K) will likely carry a small premium over “regular” FHA loans below $362K. FHA comes with its own set of hoops to jump through; for example condos must be on the FHA approved list.

Again, I highly recommend speaking to a mortgage professional if you’re not sure which product is right for you – they all have advantages and disadvantages, and programs and guidelines are changing daily. In a future post I’ll try to touch more on FHA loans, the Nehemiah program (a roundabout way for a seller to “gift” your downpayment!), and the rates/points/fees tradeoffs (the best rate isn’t always the right answer!)

If you’re interested in learning more, I encourage you to attend my first time home buyer class. Details are here, and you can email me to register.

Are you ready to begin your home search? I’d be happy to speak with you about some of the advantages and disadvantages of loan programs and how they impact your negotiating ability in a transaction. Just drop me an email or call and we’ll set up some time to talk about your search.

Read more: Why Don't Fed Cuts Always Cause a Drop in Mortgage Rates?

Read more: What is Private Mortgage Insurance (PMI)?

Want to learn more or have more questions? Attend a free first time home buyer seminar that I teach.

Foreclosure Risks: Financing Complications

Buying a bank owned property creates a multitude of financing risks—not because a buyer may have any particular problems with their credit or loan otherwise, but simply because the transaction is complicated and timing is difficult to control (read previous post on timing difficulties in buying a foreclosure here.)

It’s critical that buyers protect themselves with appropriate financing contingencies (and make sure that the protections you want are not negated by those pesky bank addenda – read post here.) Buyers take on enough risks in buying a foreclosure—don’t expose yourself to unnecessary interest rate risk as well. Let’s take an example. You make an offer on April 1 (no, there’s no hidden message there just because I’m using April Fool’s Day as my example) when rates are at 5.875%. The bank takes four weeks to get back to you, at which time rates have jumped to 6.25%, or even worse, the 10% down program you were planning to use is no longer available and now you need 15%, which you may not have. Sure, you can still back out of the contract (the upside of having to sign off on the bank addenda mentioned earlier), but obviously the situation is far from ideal. Let’s take a riskier situation: the contract is ratified and the buyer has signed off on the bank addenda. The buyer locks into a rate for 30 days, and settlement is scheduled for day 27. But the week before settlement the bank has a problem with the deed, and needs to delay settlement for a few days/weeks. So much for that rate lock—now your financing is floating with the market, and you take on all that interest rate risk.

Another pitfall to look out for is inconsistencies between your type of financing and the property condition. FHA is a great example; FHA loans require that repairs for issues that “rise above the level of cosmetic defects, minor defects, or normal wear and tear.” In a “normal” sale, the seller has to pay for those repairs. But, as we’ve discussed before in the property condition post, the bank is not about to take their time to hire plumbers and electricians to come in and fix those items—the sale is “as is.” The bank won’t pay. You don’t own the property so even if you wanted to repair it yourself, you’d have some hoops to jump through. So the property needs repairs, the bank won’t do them, and so FHA won’t fund your loan. (There may be some creative ways to still make this happen, but I can’t give all the secrets away here, can I?)

So to wrap up, don’t underestimate the financing risks you take on in buying a bank owned property. It’s not a bargain unless you’re adequately compensated for that risk, in the form of a lower-than-market price.

Read more: Foreclosure Risks: Unpredictable Transaction Timing

Read more: Foreclosure Risks: Bank Addenda

Read more: Foreclosure Risks: Property Condition and Inspections

Open Houses - Route Optimizer

My clients know that I am a big fan of open houses—both for my buyer clients and also my listing clients. (I hold my listings open at least once per month. I just don’t buy the line from agents that “Open houses don’t sell homes.” I’ve seen it happen, and I don’t want to deny my clients that opportunity.)

I’m even a fan of visiting open houses even in cases where one may not be interested in that particular home. Why? Because if it’s in a neighborhood you’re exploring, it’s a great chance to get a data point for a property (and then a chance to monitor that property to see how quickly it does/doesn’t sell). For any buyer, after you see a dozen or so homes in a neighborhood, you have a very good idea of what the going price is for homes in various conditions in a subdivision. So when you finally find the home in that neighborhood that you ARE interested in, having seen as many homes as possible only gives you more comfort—or discomfort, as the case may be--about the price being asked. Sure you can look at the comps when you sit down to decide what to offer, but nothing compares to your own personal experience having seen a home in person. While I can certainly guide my clients as to what the reasonable range is for a neighborhood, or how one property compares to another that I had seen, at the end of the day, it’s the client’s money, and their own interpretation of value, that matters. And so the client has to be comfortable with the offer price, and there’s no match for your own two eyes when you're comparing two homes.

I feel so strongly about the value of open houses that I send my clients lists each week of homes that fit their criteria that they should consider visiting. Now there’s a tool to help visit those homes more efficiently – a route optimizer from VAR. Simply enter the addresses and then hit calculate to produce a set of directions to make the most of your Sunday afternoons.

Foreclosure Risks: Property Condition & Inspections

One of the most common scenarios in a bank owned (or REO) sale is that the property is “as is.” But most people don’t understand exactly what this means, or how to protect themselves from buying a home that may need tens of thousands in repairs.

Let’s back up a moment, and put “as is” in the context of a “regular” (i.e., non-REO) sale. “As Is” is a commonly misused term. We first must understand the home inspection process and one particular paragraph in the regional sales contract – the Property Condition paragraph, also known as paragraph 7 (because it’s literally paragraph #7 in the contract…sometimes we agents aren’t all that creative.) Paragraph 7 indicates that the systems of the house, including plumbing, electrical, and appliances, must be in “normal working order.” Unless the parties agree to strike through this paragraph, that means the seller must ensure all of those systems work at the time of settlement.

Beyond that, buyers may wish to also get a home inspection (highly recommended). If the home inspector notes items related to plumbing, electrical, or appliances that are not in “normal working order” then the homeowner must fix these—they’ve already agreed to based on paragraph 7. Any OTHER items the home inspector may find—e.g., foundation problems, roof problems, window/door problems, etc.—are negotiable.

Sometimes a listing will be marked “as is” but technically, unless they’ve crossed through paragraph 7, or unless an addendum supersedes paragraph 7 (see Bank Addenda post here.), then the seller is still obligated to fix those systems of the house indicated in that paragraph. They’re simply telegraphing to potential buyers that they will not repair or provide a credit for any additional items.

In a foreclosure, banks always say “as is”, and most Bank Addenda trump any inspections that you may think you’ve negotiated. The last thing a bank needs is the back and forth negotiating to give a buyer a small credit for some electrical problem—they’re way too busy and have tons more foreclosures to get off their books. Most banks though, do not have a problem with you having a home inspection; they just want a “go or no go” decision immediately following. You either take it as it is with the inspection findings, or void the contract. Tip: Even when a bank allows you to do an inspection, make SURE it includes a “right to void” based on the results!

You should always try to get an inspection so you know what you’re getting into with an REO property. It’s a sad fact that many frustrated borrowers take out that frustration on the property on their way out the door. (Read a WSJ posting discussing that approximately half of all bank-owned properties have "substantial" damage inflicted by angry homeowners prior to vacating. ) Often the repairs are simply cosmetic—a good scrubbing, some patched drywall, missing cabinets or appliances, or a fresh coat of paint—and those are good opportunities for a quick bargain. But structural and mechanical issues can easily run into the tens of thousands of dollars. And once settlement occurs, you have no claim against the seller, even if there was a problem that wasn’t disclosed to you (unlike other transactions). So remember that taking on that additional risk requires an additional reward, in the form of a very discounted price; otherwise that bank owned property isn’t such a good deal after all.

Read about some other risks of foreclosures here:
Foreclosure Risks: Title Defects
Foreclosure Risks: Bank Addenda
Foreclosure Risks: Unpredictable Transaction Timing
Foreclosure Risks: Financing Complications

Buyer FAQ: Do I need to hire an attorney?

In Virginia, buyers have the right to choose their own settlement attorney. The settlement attorney represents neither the buyer nor the seller though. So buyers often ask me if they need to hire their own attorney as well. Marcus Simon of Ekko Title, a well respected settlement attorney in the area, has written this special "guest post" to address the ins and outs of attorneys during the real estate process here in the DC area. (I highly recommend Marcus for anyone looking for a real estate attorney, by the way!)

Many real estate sellers and purchasers wonder if they need to hire an attorney to represent their legal interests during the course of the transaction. The answer - predictably - is it depends.

In some parts of the country it is routine for both parties to a real estate transaction to engage counsel. I know this because clients coming from New York and Boston expect to need a lawyer. In California and other west coast states, the real estate transaction is treated more like a financial transaction and there is little attorney involvement, with closing or "escrow" services provided by the bank or mortgage lender.

In the Washington D.C. Metropolitan area a sort of middle ground approach as evolved over the last 20 years or so. Most real estate settlements are handled by non-attorney Settlement Companies or Title Companies. Most of these companies affiliate with law firms to provide certain necessary legal services, like the drafting of Deeds, Powers of Attorney, and other legal documents.

In the vast majority of cases, neither the Purchaser or Seller hires their own attorney, but both agree to allow the Title Company’s affiliated attorney to provided certain legal services and acknowledge the potential that legal conflicts of interest may arise. Contract negotiations, both before and after ratification, including home inspection and other issues, are handled by the Real Estate agents. Occasionally issues arise that the agents cannot resolve without attorney involvement. For instance, there may be a difference of opinion about whether a lien on the property is a cloud on title that would allow the Purchaser to get out of the contract, or what responsibility a Seller has to remedy an encroachment shown on their house location survey. In those cases, the Title company attorney should have provided a list of three independent attorneys for the parties to engage.

In some cases attorneys are engaged from the start. In many Estate cases, for instance, attorneys are hired to handle the sale of property where there are a number of heirs involved in the transaction and there will be additional documentation require to convey clear title. In commercial transactions the parties almost invariably use attorneys throughout the process to draft contracts (as opposed to form contracts usually used in residential transactions) deeds and loan documents.

For most sales, however, from the $300,000 condominium, to the $3 million mansion, the parties rely on their real estate agents and an experienced, competent, and professional Title Company attorney to guide them through the process and help mediate any issues before they become disputes.

Marcus Simon

Founder, Ekko Title

Partner, Leggett, Simon, Freemyers & Lyon, PLC

Foreclosure Risks: Unpredictable Transaction Timing--Don't Pack Those Boxes Yet!

I’m often asked about the risks involved with buying a foreclosure. This is the second post in a series of as-yet-undetermined size. (Have a question on the risks? Contact me.) The first post on REO Bank Addendums covered the all encompassing risk—the risk that the bank can basically do whatever they want, including walking away at any time with no penalty, if you’re not very careful with what you sign. That addendum always includes one or more clauses protecting the bank if they are unable to meet certain deadlines—like actually proving they are the owner (oh, do I have to OWN the property before I sell it?) before settlement. These broad clauses lead to our second major category of risk: controlling the timing of the transaction.

In a typical transaction, you make an offer, the seller takes a day or so to review it and either a) accept, b) counter, or c) reject. If you’re concerned that a seller might be “sitting on the offer” to wait for a better one, or even “shopping it around” by calling all the agents who have previously visited the property to see if they can scrounge up a competing offer, then you might consider including an expiration or exploding clause. These clauses state that the offer will expire by x time and date if not responded to in writing. It’s a great way to protect a buyer and maximize your chances of a quick turnaround.

However, with a bank owned property, the bank takes as long as they darn well please. Might be a day, might be a month, might be several months. They don’t really care about your expiration clause. Well, maybe not that they don’t care, it’s just that they’re a big corporate entity, and your offer is likely to be sitting in a pile of paperwork that needs to get done asap, but the individual sitting in a cube somewhere really doesn’t have the right incentives to make sure he gets to your offer today, or tomorrow, or the next day.

In the meantime, you’d be wise to keep looking at properties to see if there’s anything better that catches your eye. As a buyer you have the right to withdraw your offer anytime before the bank gets back to you. In reality, the bank’s response will NEVER be an “accept.” Rather, it will ALWAYS include that pesky Bank Addendum that you will have to read (please, I beg of you, read) and sign before your contract becomes official.

Once you’re ratified, is it time to give notice on your lease and call the movers? Hardly. Remember one of the common clauses is for the bank to give themselves the right to back out at any time. I’m not saying the bank does this out of malice…there are a million reasons (deed issues or delays are common) the bank might be very willing, but simply unable, to proceed to settlement. (You’d be out the cost of your appraisals, inspections, moving deposits, etc in this case.) As an aside, you can be sure that one of the clauses in that Addendum imposes a hefty daily financial penalty on the buyers if they aren’t ready for settlement on time, so apparently what’s good for the goose is NOT good for the gander.

Other than not being sure when to start packing, this open-ended timing creates issues with financing. Most loans are locked for just 30 days, and after that you need to pay a fee to maintain the lock. If you pay the fee, you may be out that money and never close. If you don’t pay it, and rates change, you may be in an even worse situation—in fact you may not even qualify for the loan anymore if rates change too much! Make sure you fight hard for a financing contingency that will protect you in the even that settlement gets delayed. (Side note—often banks will offer to give you financing in the event of problems…but they never specify the terms!)

So when can you start making plans? Not until the deed has been recorded, which is typically the day after settlement. Yes, you read that right. Don’t make any plans to move until a day AFTER SETTLEMENT OCCURS.

If your lease is up soon without the option to go month-to-month, make sure you have a back up plan for where to stay in the event of unforeseen delays. The timing risk can be partially mitigated by 1) continuing your search knowing you have the option to walk away and 2) keeping a financing contingency. But chances are strong that you’d incur extra expenses, along with sleepless nights, along the way.

Thinking of buying a foreclosure? Contact me to discuss the other risks and how you might be able to mitigate some of them. Remember, it's not a bargain if you're taking on too much risk for not enough reward.

Read the next post in the series on Foreclosure Risks: Property Condition & Inspections

Read more on the differences between short sales, foreclosures, and REO properties.

Read the first post in the series--risks related to Bank Addenda--here.

Foreclosure Risks: Read Those Bank Addenda!

I get a lot of questions on foreclosures. How could I not? Some neighborhoods are flooded with them (though some are not...see the graph in my post on Beyond Auctions.) Buyers want to know if they’re a good deal, what the risks are, and how they can get in on one.

I’ve decided to write a series of posts on the risks specific to buying foreclosures—trust me that there are too many risks to put into one post! Some risks can be mitigated, some can be eliminated, but most remain; that’s part of the trade off you make in deciding to buy a foreclosed property.

First, a quick overview on the process. (For a review of how a home moves from short sale to auction to REO, read the post “I want to buy a foreclosure.”) Once a home is foreclosed upon, also known as Real Estate Owned or bank-owned, it is usually listed in the MLS with a listing agent, similar to any other home for sale. It will usually be noted right in the comments that this is a “bank owned property” or “special addenda required.” What is this special addenda?

When you decide to make an offer on a foreclosure, you put together the offer using the standard regional forms, just like any other resale (though not the same as new construction—for those you use the builder’s contract.) You include any contingencies or other negotiables you want—home inspection, seller subsidies, etc. Then you send it off to the listing agent, who sends it to the bank. The bank’s representative may respond right away, they may throw it into a pile to see what else comes in, or they may not do anything. (So controlling the timing becomes a big risk of a foreclosure, but I digress.) Let’s say they get back to you and let’s assume they even agree to all of your terms. They’ll return it all with a copy of their own Bank Addendum. An addendum is simply the legal term for a condition that amends the main contract. Even “regular” resales have a half dozen addenda-- for home inspections, appraisals, and to meet jurisdictional requirements. Bank Addenda are written by the bank’s lawyers to protect themselves during foreclosure transactions. Any guesses on which side they favor?

Every bank’s addendum is different, and it’s critical that you read and understand every clause prior to signing it. Because it’s an addendum, which amends the main contract, it doesn’t really matter what you think you negotiated—anything in the addenda trumps the main contract. Think you negotiated an inspection but the addendum says no? Or what if the addendum says you can inspect but not void? The addendum wins the day. A lot of good that inspection does you if the home inspector says the place needs to be demolished by you aren't allowed to walk away.

Unless you sign the addendum, there’s no deal, so you can still get out if you don’t like what you read. Occasionally, on some clauses, you may be able to negotiate certain clauses, but that increases the likelihood of slowing down the process—after all, some guy in a cube in Idaho (no offense, readers in Idaho) has to get that change sent to the bank’s lawyers to review, and I guarantee that those lawyers have their hands full with all their other foreclosures right now. If you decide to live with the clauses, then once you sign the addendum, the contract proceeds as is more typical.

There are many examples of egregious clauses, but here are a few of my favorites:

- The bank may not own the property and may not be able to go to settlement. You may be required to go to settlement even if the bank cannot deliver the deed at that time.

- The bank may guarantee only insurable title, not marketable title (more on that in another post)

- The bank may give themselves the right to change their mind and walk away at any time up to settlement for no penalty

- There may be easements or restrictions on the property that aren’t recorded; if you find one, the addenda may prevent you from backing out of the contract as a result

There are many more, as these addendum often run about ten pages. Because they are written to apply nationwide, there are occasionally even clauses that are illegal in Virginia!

So read those addenda carefully, and caveat emptor on this foreclosure pitfall. It’s a doozie.

I’ll continue the series with future posts on these other critical risks:

- Lack of control over turnaround and the dependent risks it creates for buyers (and not just your move date)

- Inspections, repairs, and warranties

- Financing complications (Don’t rely on using an FHA loan!)

- Title and deed issues

- Condo/HOA docs

Have another risk you want addressed? Add it in the comments and I’ll write about it.

Are you thinking about buying a foreclosure and want to know the risks you’ll face? Contact me to discuss the risks and some mitigation strategies.

Read the second post in the series, about the challenges in controlling the timing of a foreclosure transaction, here.