Knowing where you stand before applying for a mortgage is key to negotiating a better interest rate. Yes, you can negotiate your rate!
But if you don’t know what type of risk you present to a bank or lender, how can you be sure you’re getting a good deal?
While it may seem obvious to those in the industry, many prospective and existing homeowners don’t seem to know when they have the easiest approval on their hands, or the trickiest deal in the history of man.
Let’s take a look at some common loan scenarios to help you better understand your position.
Vanilla
This is your full doc
800 FICO score
W2 borrower
With a conforming loan amount
And no obvious red flags
This is the most common mortgage “flavor” you’ll hear about. When someone says the loan is “vanilla,” they’re basically saying it’s a flawless loan scenario.
In other words, the borrower has great credit, good income and assets, and plenty of home equity (or a sizable down payment).
The property is also an owner-occupied, single-family residence, meaning there should be no pricing adjustments whatsoever.
As a result, this type of mortgage presents very little risk to the originating lender, and pricing should be very favorable.
Expect mortgage rates at or below those advertised and fight for the lowest rate out there. Shop your rate with confidence, knowing everyone and their mother should be fighting tooth and nail over your loan.
For the record, the mortgage rates you see advertised assume your loan is premium, imported french vanilla…
Mint Chip
This borrower might have excellent credit
But display one or two nagging issues
Such as limited assets or occupancy concerns
Or perhaps they’re just self-employed
Most people like mint chip, and it’s a pretty common flavor, but it also means something isn’t exactly right, even if seemingly minor.
It could be that the borrower has good credit, but not a lot of money to put down, or very little equity.
Or it could be that the borrower has marginal credit, despite having a great job and tons of assets in the bank.
[What credit score do I need to get a mortgage?]
Perhaps they’ve changed jobs recently or have some other funky income structure (paid seasonally, on commission, self-employed), or their assets aren’t too impressive.
Maybe there are occupancy issues – think the homeowner buying a house down the street, but claiming they’re going to rent out the old property, even though the new house is smaller.
Whatever it is, the issue presents some difficulty, and as a result, some lenders may not want to touch it.
Put simply, the fewer banks willing to do the deal, the less you can shop around. And you may be stuck submitting the loan with a lender that offers less favorable interest rates.
You can still go nuts looking around for the best deal, but you may not have access to every bank out there. There may also be more snags along the way…so working with a reputable lender is more important.
Rocky Road
This is the flavor of subprime
And perhaps layered risk
But I’m not referring to nuts and marshmallows
We’re talking low credit score, low down payment, and other questionable stuff
Mint chip ain’t so bad when there’s Rocky Road around. While some people like the heavenly mix of chocolate ice cream, nuts, and marshmallows, not everyone will be so enthused.
In other words, you may have a hard time getting your deal to close with ANY bank or lender, even so-called subprime lenders (if they still exist).
This is your “bad news” loan scenario, one where multiple things are going wrong all at once.
Think poor credit score, minimal assets, low down payment/equity, funky job situation, and maybe even more serious issues like previous late mortgage payments or a short sale/foreclosure.
Long story short here is that approval is more of a concern than the mortgage rate you ultimately receive.
Your first priority is finding a lender that is willing to work with you. You should certainly shop around, but expect rates much higher than those advertised for the significant risk you present.
Bubble Gum
This is a special edition flavor
Dedicated to those who took out mortgages right before the bubble burst
Many are now in underwater positions (owe more than the mortgage is worth)
Thanks to those zero down home loans they used to buy homes at the height of the market
Here’s a bonus flavor in light of the ongoing mortgage crisis. Post-housing bubble, there are a ton of good homeowners out there with negative equity.
In other words, their loan-to-value ratios exceed 100%, making their loans very high-risk, even if they’ve got a great job, stellar credit, and plenty of money in the piggy bank.
Fortunately, there are numerous options for severely underwater homeowners, including the popular HARP Phase II.
So all hope is not lost, even if it’ll take you a decade or two to get back in the black…
You can even snag a super low mortgage rate when refinancing, so again, be sure to shop around with a variety of banks, credit unions, and mortgage brokers.
The moral of the story, regardless of your flavor, is to know it before you apply for a home loan.
This can help you prepare for the road ahead, and better align your expectations with reality.
Over the past several years, scores of homeowners have elected to ditch their unmanageable mortgages via short sales to avoid foreclosure.
It’s estimated that roughly 370,000 short sales closed last year alone. Because short sales have been so popular, there will inevitably be tons of former homeowners re-entering the marketplace in the near future.
In fact, there are already plenty of so-called “boomerang buyers” who dumped their old homes via short sale and acquired new ones.
Of course, whether you’ll actually be eligible for a mortgage after a short sale will depend on a number of factors.
There are already plenty of qualification requirements for a mortgage, and you’ll need to add “prior short sale” to that list as well.
The Short Sale Waiting Period Depends on Mortgage Type
The short sale waiting period is dependent on loan type
Along with what transpired leading up to the short sale
Those with extenuating circumstances may not have to wait at all
Assuming they weren’t delinquent on the loan before the sale
Perhaps the easiest loan to qualify for after a short sale is a FHA loan, mainly because it has the shortest post-short sale waiting period.
In fact, it has NO waiting period if you weren’t delinquent on your former mortgage during the 12 months preceding the short sale and the proceeds of the sale served as payment in full.
Additionally, you must have stayed current on all other installment debts during the same time period.
Sadly, most borrowers who pursued short sales didn’t keep up with mortgage payments because lenders tend to be more willing to work with those who are behind and in danger of default.
Assuming you did stay up-to-date, you can’t buy a similar property within a “reasonable commuting distance” of your old home.
In other words, if you sold short just to take advantage of declining property values, you won’t be approved for a FHA loan.
So only a small percentage of those who pursue short sales will be eligible for a FHA with no waiting period.
If you were delinquent when you pursued the short sale, the FHA waiting period is three years, though it can be reduced if you can prove extenuating circumstances.
The main advantage to a FHA loan is the low-down payment requirement, as compared to conventional loan options.
For VA loans, the waiting period after a short sale is two years. However, there is NO waiting period for those who managed to avoid late payments on the mortgage and all other lines of credit, similar to the FHA rule.
Get a Conventional Loan Just Two Years After Short Sale
If you sold your home short
And can prove extenuating circumstances
You can get a conforming home loan just 2 years after a short sale
But most borrowers will have to wait 4 years to get a mortgage
For conventional loans, it depends if the new loan is backed by Fannie Mae or Freddie Mac, which shouldn’t matter much to the borrower.
Fannie Mae was the more lenient of the two, allowing a new loan just two years after the completion date of the short sale with 20% down payment. But they changed that, perhaps because it sent the wrong message.
Nowadays, there is a standard 4-year wait without extenuating circumstances, or two years if you do have a valid excuse.
For Freddie Mac, the waiting period is also four years (48 months) for what they call “financial mismanagement,” or just two years (24 months) if you can prove extenuating circumstances, just like Fannie Mae.
But the max loan-to-value ratio (LTV) and combined LTV (CLTV) is 90%. That means you need a minimum 10% down payment. In other words, they want skin in the game this time around…
What Are Extenuating Circumstances?
Something beyond the borrower’s control
Such as sudden job loss and reduced income
And/or increased expenses
That render the borrower unable to make mortgage payments
For the record, extenuating circumstances include things like the passing of the primary wage earner, a long-term illness, a divorce, sudden job loss, etc.
Basically something outside the borrower’s control that resulted in major financial hardship.
If any of these events took place, the borrower must be able to provide third-party documentation as confirmation, and they must re-establish their credit profile to acceptable levels.
Note: There are other types of loans out there, such as jumbo loans, VA loans, USDA loans, and so on.
Be sure to inquire about all types when working with your loan officer or mortgage broker to cover all your options.
Your Credit Score Matters Too
On top of these waiting periods, you must also re-establish your credit to meet the minimum score required by the lender who originates your loan.
In other words, if your credit score is shot as a result of the short sale, and hasn’t improved during the waiting period, you still may not be eligible.
And even if you are eligible, your credit score may result in a higher mortgage rate, so there are consequences beyond the waiting period.
But this should illustrate the major benefit of a short sale vs. foreclosure.
When you get foreclosed on, the waiting period to obtain a new loan is significantly longer.
So even if the credit score impact of both a foreclosure and short sale are similar, this detail alone is pretty important for those looking to get back in the game.
Tip: After a short sale, be sure to stay current on all your credit lines to ensure you re-establish good credit and get your score back to a reasonable level.
It will make qualifying easier and should result in a lower mortgage rate as well.
Short Sale Waiting Periods
Getting an FHA Loan After Short Sale:
– NO waiting period if certain conditions met (see above) – Otherwise three (3) years unless extenuating circumstances (it’s now one year!)
(HUD source)
Getting a VA Loan After Short Sale:
– NO waiting period if certain conditions met (see above) – Two (2) year waiting period otherwise
Getting a Fannie Mae Loan After Short Sale:
– Two (2) year waiting period if you can prove extenuating circumstances – Four (4) year waiting period otherwise
(Fannie Mae source)
Getting a Freddie Mac Loan After Short Sale:
– Two (2) year waiting period if extenuating circumstances – Four (4) year waiting period otherwise – Max LTV/CLTV of 90% if within 7 years of short sale
(Freddie Mac source)
*The Fannie and Freddie rules are the same for a deed-in-lieu of foreclosure or a pre-foreclosure.
As an active-duty service member or veteran, you have access to one of the best mortgage products on the market — the VA home loan. It requires no down payment, no monthly mortgage insurance premiums, and has lenient credit requirements.
As of October 2020, five percent of all home-purchase loans were VA home loans.
— Ellie Mae’s Origination Insight Report
This VA home loan calculator shows your overall buying power, including today’s current VA funding fees, estimated property taxes, and HOA dues. With zero down payment and no private mortgage insurance (PMI), you may be surprised at how much you can afford.
Check your VA home loan eligibility today.
VA Loan Calculator
Determine your VA loan payment
A VA loan calculator can help you determine what your potential VA loan payment might be and, in turn, what home purchase price you can afford.
VA home loan rates for 2023
Mortgage rates for VA home loans are currently at historic lows. In fact, VA mortgage rates today are generally lower than other loan types like conventional and FHA. For example, Ellie Mae October 2020 Origination Report shows that the average interest rate for VA home loans is 2.75%, while the average interest rate for both conventional loans and FHA loans is 3.01%.
Interest rates vary and depend on multiple factors like credit score, down payment amount, and interest rate type, so every home buyer’s rate is unique to their situation.
Qualifying for a low-interest rate is important for VA home buyers.
Qualifying for the lowest possible rate gives home buyers three distinct advantages:
Lower monthly payments
Lower overall interest costs over the life of the loan
More buying power (lower mortgage payments mean you can afford a more expensive home)
Each lender offers different interest rates and terms, it’s best to comparison shop with multiple lenders. Not only will this ensure you’re getting the best rate, you may be able to negotiate better terms and fees for your loan as well.
VA mortgage calculator definitions
Down payment. This is the amount you put towards the purchase of your home. The VA requires no down payment, unlike other loan types, which generally require at least 3 to 10 percent.
Funding fee. The VA requires an upfront, one-time funding fee payment to help sustain the program. It’s why lenders are able to offer zero-down loans with low rates. The fee is either wrapped into the loan amount or paid in cash at closing.
Funding fee percentage. The percentage you’ll be charged will depend on your down payment and whether you’ve used a VA loan before. The most common funding fee is 2.3% of the loan amount — or $2,300 for each $100,000 borrowed.
HOA/other. If you’re buying a condo or a home in a Planned Unit Development (PUD), you’ll likely be responsible for homeowners association (HOA) dues. Lenders factor in this cost when determining your debt-to-income ratio.
Homeowners insurance. Lenders require you to insure your home from damages like fire. The fee is generally added to your monthly mortgage payment and paid for you by the lender.
Interest rate. The mortgage rate your lender charges for the loan. Pro tip: Shop around with multiple lenders to find the best rate for you.
Loan term. The number of years you have to pay off the loan (assuming you haven’t made additional principal payments). Typical loan terms are 30 or 15 years.
Principal and interest. The principal is what you’ll pay every month towards the loan balance, while the interest is the amount you pay your lender for lending you the money.
Property tax. You’ll owe the county or municipality where the home is located yearly taxes. Your lender will collect this as part of your monthly mortgage payment — the yearly cost is split into 12 installments. (Calculator estimates are based on averages from tax-rate.org.)
Service type. The funding fee percentage changes based on the type of military service. Servicemembers in the Reserves have slightly higher fees than those who are active-duty.
VA loan use. If you’ve used a VA loan to purchase or refinance a property previously, then higher funding fees will apply.
VA mortgage eligibility
Interested home buyers should confirm their eligibility for the loan program with a VA lender as each service member’s situation is unique. That said, there are general eligibility guidelines, including:
VA funding fees
Type of Veteran
Down Payment
First-time Use
Subsequent Use
Regular Military
0%
2.3%
3.6%
5-10%
1.65%
1.65%
10+%
1.4%
1.4%
Reserves/ National Guard
0%
2.3%
3.6%
5-10%
1.65%
1.65%
10+%
1.4%
1.4%
Source: U.S. Department of Veterans Affairs
VA loan limits
As of January 1, 2020, VA-eligible borrowers can get any size loan with no down payment. There are no official limits.
But remember, you’ll still have to qualify for the mortgage.
Apply for a VA loan
If you’re a homebuyer with military experience, then see if a VA loan is the right mortgage loan product for you. Many active-duty servicemembers and veterans are eligible to purchase a home with zero down payment and a low monthly payment — many just don’t know it yet.
Not everyone has the financial means to put 20 percent down on a home purchase. The good news is, forking over 20 percent upfront is not a requirement to buy a home. Plus, you might also be eligible for down payment assistance programs.
How do down payment assistance programs work?
Down payment assistance can potentially give you money that can help you afford a down payment, or it can help with closing costs, which are the fees and charges you pay when you finalize your mortgage. These total approximately 2 percent to 5 percent of the loan principal (and more when you factor in the escrow for insurance and taxes). For instance, on a $200,000 loan, the closing costs could be around $4,000. If all of your money has gone to saving for a down payment, you might need help paying for closing costs.
While a few programs exist at the federal level and even with some individual lenders, the majority of down payment help is offered at the local level through state, county and city government programs, and come in the form of a loan, grant or matched savings.
Down payment assistance eligibility requirements
The vast majority of down payment assistance is offered to first-time homebuyers. Many cities and counties have other housing programs available, but down payment assistance is typically reserved for those who have not owned a home in the last three years.
Many programs restrict owners of rental or investment properties from participating, so you’ll need to be a first-time homebuyer (or haven’t owned a home in the past three years) and the home should be your primary residence. If you’re unsure if you qualify, contact the program before you apply.
Types of down payment assistance
Grants: Grants are a type of housing assistance that provides a one-time cash sum, often in the form of a no-interest second loan, to cover all or part of a down payment or closing costs. The funds don’t have to be repaid.
Low-interest loans: These are similar to grants, but they must be repaid, usually over the course of a few years. Since you’ll be repaying this loan in addition to your regular mortgage, you’ll have a higher monthly payment.
Deferred-payment loans: These types of loans generally don’t charge interest, but usually need to be repaid in full when you sell your home or refinance your mortgage. Many times, these are zero-interest loans, which means you are only responsible for repaying the amount you borrowed initially.
Forgivable loans: These are similar to other kinds of assistance, but you might never have to pay them off. Generally, forgivable loan debt is erased after a certain period of time so long as you still own the home and are up-to-date on your mortgage payments.
Individual Development Accounts (IDAs): Also called a matched-savings account, with an IDA, the account holder’s contributions are matched by either private or public money. To get this kind of account, there are typically income caps and employment requirements, and participants usually need to complete free financial literacy training.
Some mortgage lenders offer their own down payment assistance. For example, In many states, Chase offers up to $3,000 that can go toward closing costs and down payment needs. While this program is just for first-time homebuyers, it does have other stipulations: You’ll need to get a 30-year fixed-rate loan and live in the home as your primary residence. You’ll also need to attend a homebuyer education course to receive the full amount.
What mortgages can down payment assistance be applied to?
Down payment assistance is available for all kinds of mortgages. Government-backed mortgage programs like FHA loans, VA loans and USDA loans often come with their own down payment assistance built-in. You can also apply for down payment assistance with conventional mortgages.
Individual lenders are likely to have their own requirements and restrictions when it comes to how down payment assistance is accounted for and applied to your loan. So, if you know you’re planning to take advantage of a down payment assistance program, it’s a good idea to talk to prospective lenders about how this will affect your mortgage.
How to find down payment assistance programs
Most payment assistance programs are local, though there may be a few statewide ones too. Some of the places to check out for down payment assistance include:
State housing finance authority: Many state housing finance authorities (HFAs) offer homebuying assistance and education. Find your state’s HFA here.
City and county government programs: As a means to boost homeownership, many counties and cities offer down payment assistance programs for first-time homebuyers. Check your municipality’s website for more, or speak to your loan officer to get more details about local DPA programs in your region.
U.S. Department of Housing and Urban Development (HUD): Check HUD’s website for local homebuying programs by state. Every state also has HUD-approved counselors who will simplify the finer points of homebuying and help you find financial assistance.
Down Payment Resource: Down Payment Resource provides a plethora of resources for homebuyers, real estate agents and lenders, including an eligibility and lookup tool.
How to apply for down payment assistance
There is no shortage of down payment assistance options, but there is also no universal application that will go to all of them. Because of this, you will need to apply to each one individually. Depending on the program, you might call to see if you are eligible, complete the application online or in-person and possibly take certain education courses.
Some programs require you to have a specific loan to qualify. For instance, you might need an FHA loan instead of a conventional loan.
Aside from being a first-time homebuyer, eligibility is usually based on income. Many programs target low- to moderate-income earners, so if you are in a higher bracket, you might not qualify. You might also need to contribute a certain percentage of your own income to get the assistance.
Pros and cons of down payment assistance programs
There are a lot of benefits to receiving down payment assistance, but it is not all upside. Here are some key things to keep in mind.
Pros
Can help you become a homeowner faster
Can save you money upfront
Can help you afford more house or get more favorable loan terms
Cons
Can cost you more in the long run if it’s an interest-bearing loan
Can be time-consuming due to the amount of down payment assistance available; you’ll need to do your research and apply to each one individually
Not everyone qualifies
You need to be even more careful about sticking to your budget and refrain from using assistance to overextend yourself financially
You might be required to occupy the home for a minimum number of years in order to have certain types of assistance fully forgiven
Alternative forms of down payment assistance
Not everyone qualifies for down payment assistance programs. If you have owned a home in the last three years, your income is too high or you are planning to rent out the property or otherwise use it as an investment, you might not qualify for many programs.
However, there are other housing programs you might qualify for. Visit HUD.gov/states, select your state and click “Learn About Homeownership.” From there, you can find ways to avoid foreclosure, find home counseling services and get money for home renovations or repairs. Depending on where you live and your needs, you might find housing resources geared towards seniors, disaster relief and help to pay utility bills.
Home assistance programs are vast and vary by needs and location. You might find that if you do not qualify for down payment assistance, you might be eligible for assistance in other ways.
Down payment assistance FAQ
Since programs are usually administered at the local level, the time it takes for them to disburse funds can vary widely. It’s best to initiate your research and applications as soon in the home-buying process as possible to give yourself as much runway as you can. Your lender will work directly with the assistance program to secure the necessary funds.
This, too, depends on where you are. Terms and funding amounts are determined primarily by individual states — find out what’s offered in your area, and what you need to do to apply, by contacting your state’s HFA.
In most cases, yes, you can use multiple sources of down payment assistance, provided you qualify. Check with your lender to ensure you’re obtaining a mortgage through a program that allows for more than one source of assistance.
Last Updated on February 24, 2022 by Mark Ferguson
One of the biggest roadblocks to investing in rental properties is the money required to buy a rental property. I believe buying rental properties is one of the best investments for increasing wealth and creating passive income. I am relying on my rental properties to give me enough income for retirement as well as offer a luxurious life. However, it is not easy saving money to buy rentals. Although there are ways to buy rentals with less money down, this article will focus on how much money you need to buy a rental the traditional way with a bank. I have purchased 20 rental properties since December 2010 and I am seeing at least 15 percent cash-on-cash returns on them.
Rental properties are a great investment, but they require a lot of money in most cases. It is simple to figure the cost on a rental property if you are paying cash, but things get more complicated when dealing with financing. Most banks require 20 percent down when buying a rental property and you have to consider carrying costs and repairs as well.
How much money do you need to buy a rental?
It can be expensive to buy rental properties since most banks require at least 20 percent down. If you are looking to buy many rental properties as I do, it is tough to avoid putting 20 percent down. Many banks start requiring 25 percent down once you have four mortgages in your name. Most banks will stop lending to you all together once you reach ten financed properties. There are ways to finance more than four and more than ten properties with a portfolio lender. Down payments are not the only factor when determining how much money is needed to buy a rental property.
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Closing costs
Depending on house values in your area, a 20 percent down payment can be a lot of money. The houses I buy are usually right around $100,000, which is about $20,000 needed for the down payment. You will also have closing costs when purchasing an investment property, which consists of interest, insurance, recording fees, origination fees, tax certificates, appraisals, and more. It is usually safe to assume closing costs will be at least three percent of the purchase price, but you can ask the seller to pay all or part of your closing costs. I usually ask the seller to pay part of my closing costs to reduce the amount of cash I have into a property. You also may have to pay for an inspection, which can cost $250 to $500 and some sellers such as HUD do not pay for title insurance, which can add another $500 to $1,000.
Repairs and carrying costs
Repairs can add a huge chunk to how much money is required to buy a rental property and you have to wait for the repairs to be completed before it can be rented. While you are waiting for repairs, you are paying carrying costs on that property, which also increases the money needed. You will have to pay interest, utilities, taxes, and insurance until the home is rented. In a perfect world, it should only take a week or two to have a professional contractor complete most repairs, but it usually takes longer.
As for repairs, they usually cost more than you think they will. On a house that needs minimal repairs, I still assume that I will need at least $5,000 in work done before it can be rented. On a house that requires more repairs and updates, I can easily spend $20,000 or more. It is always the little things that take time and add up to big repair costs. As a general rule of thumb, I always add $5,000 for unknown costs on any rental or fix and flip that I buy.
Make sure you get bids if you are not an expert at estimating repairs. Estimating repairs can be a very difficult thing to do, even for experienced investors. Repairs always seem to cost more than the investor thinks they should and contractors always seem to find more things that need to be repaired.
Turnkey rental properties are one way to save money on repairs and put less money into rental properties.
Total amount needed
Here is a breakdown of the costs that I would normally have on a $100,000 rental property.
Down payment: $20,000
Closing costs: $3,000
Repair costs: $10,000
Carrying costs: $1,000
Total investment: $34,000
These figures would be on a home that needs moderate work. I am a real estate agent, which means that if I had purchased this house from the MLS, I would get back about $3,000 in real estate commissions. I could also ask the seller to pay $3,000 of my closing costs if I thought it would not jeopardize my chances of getting the deal.
Having to put 25 percent down on a property would greatly increase the amount of money needed. Repairs costs will affect how much money you would need as well. Another factor to consider is that the bank will want you to have money in reserves when you get an investment property loan.
Can you buy rentals with less money?
There are ways to decrease how much money is required to buy a rental property. You may find a gem that needs no repairs at all, but it is rare to find a home that is a great deal and in good shape. Rental property number ten and rental property number nine were both in decent shape and purchased below market value. You can ask the seller to pay part of your closing costs when making an offer. It is very common for a buyer to ask for two or three percent of closing costs to be paid by the seller. If the seller does not want to budge on price, raise the price of the property to make up for the closing costs. The cash you save upfront will make up for the slightly higher loan and purchase amount.
If you are a real estate agent, you can also save a lot of cash on each property you buy. I am a real estate agent and I save thousands on each property I buy because I am paid a commission for my side of the transaction. This decreases how much money is required to buy rental property tremendously. Here is a much more detailed article on how becoming a real estate agent will save you money when investing. Here is another article on how much money real estate agents can make.
What about reserves?
If you find yourself looking to invest and have saved just enough to buy and renovate a property, be careful! There are always unexpected costs and delays associated with repairs. Make sure you have a cushion in the bank for the worst-case scenario. I suggest at least six months of mortgage payments, taxes, and insurance as reserves for each property you own. This would be money on top of the initial investment used for repairs and carrying costs.
Conclusion
You may need as much as $30,000 to buy a $100,000 house, but that can increase if many repairs are required or if you have to put down more than 20 percent. You need to make sure you have enough reserves if things do not go as planned. Remember, if you are purchasing more expensive homes, that number will increase significantly and it will decrease if you are buying lower-priced homes.
A Virginia-based mortgage lender has launched a loan officer compensation plan that provides originators with a piece of the loan servicing fee.
Typically, a loan officer closes a loan and gets paid a commission, then moves on to the next loan. In this respect, they don’t need to worry about the future performance of the loan. It’s a done deal and they can focus on bringing in more loans.
However, the loan servicer (which is sometimes also the lender) will earn money throughout the life of the loan as monthly mortgage payments are made.
Now one lender has decided to share a portion of this ongoing revenue with its top producing loan officers.
Atlantic Bay’s Progressive Earnings Plan
Atlantic Bay Mortgage Group out of Virginia Beach, Virginia refers to this participation in the income stream of the loan as the “Progressive Earnings Plan.”
The way it works is fairly simple. If you’re able to muster $14 million in retail loan production in a calendar year, you can take part.
For every loan funded that is retained by the company, Atlantic Bay will give a portion of the servicing fee to the loan officer who originated the mortgage.
As you can see from the chart above, a loan officer able to produce $120 million annually could receive an additional $30,500 the first year, $60,000 the second year, and a whopping $197,000 in year seven.
A more conservative figure of $15 million in annual production could net the LO an additional $3,800 in year one, $7,500 in year two, and $11,800 in year three.
After seven years, that number rises to nearly $25,000 in extra annual income.
Of course, this all assumes that 65% of the loan production will be retained (that’s how much Atlantic Bay Mortgage Group currently services). And they’re just estimates.
The rest of their loans are ostensibly sold off and as such, do not earn any revenue via the Progressive Earnings Plan.
It’s unclear if the chart accounts for loans that are paid off early or refinanced much earlier than maturation. That would also affect the actual servicing income.
In any case, this extra income provides loan officers with an ongoing revenue stream that can be a lifesaver if they happen to have a slow month here and there.
All loan officers experience slow months, so receiving a supplementary income to offset any temporary decrease in earnings can certainly help.
Is This Type of Compensation Better for Loan Performance?
One could also argue that aligning compensation with ongoing loan performance might improve the quality of the underlying loans.
Sure, the loan officer still gets paid for making the loans, regardless of what happens to them in the future, but knowing they can earn ongoing revenue might foster better lending.
As a loan officer who earns servicing income, you’ll want your loans to perform for years to come. So loan officers under this plan will be incentivized to make the best loans possible.
During the financial crisis, there was criticism of the so-called originate-to-distribute model, which basically provides incentives for loan volume regardless of quality.
Essentially, most mortgages back then were originated and quickly sold off to investors instead of being retained by the lender. And it just so happens that these types of mortgages default at a higher rate.
It’ll be interesting to see if other lenders follow suit and give their employees a slice of the servicing pie.
The mortgage landscape has changed a ton over the past several years.
Mortgage lending guidelines have firmed tremendously since the housing crisis took hold, and mortgage rates have fallen to new all-time lows.
Meanwhile, home prices seem to have bottomed, and decent home price appreciation is in the forecast.
This has created an interesting environment for both prospective and existing homeowners.
Determining Your Homeownership Horizon
When to buy real estate and take out a mortgage
You need to determine how long you plan to keep the property
And in that same sense, the home loan that goes along with it
As it will dictate loan choice, paying points, and more
Perhaps one of the biggest changes in thought is that those who take out a mortgage today will keep it for as long as they own their home.
In the past, this wasn’t the case, with mortgage rates very high, and then in a downward trend for many years since.
That allowed existing homeowners to refinance and tap home equity via cash out refinances and HELOCs, while also reducing monthly mortgage payments.
Even recent homeowners were able to refinance just six months or a year after purchasing their homes, thanks to the precipitous drop in interest rates.
[The refinance rule of thumb.]
But that march downward seems to have come to an end, and could in fact reverse course, which will equate to slower prepayment speeds and far fewer refinances.
After all, no one will be keen to lose your super low mortgage rate, even if they do need cash.
It also makes the question of which mortgage to get more difficult. Additionally, one really has to question whether they should buy down their mortgage rate.
Why Homeowners Sell Their Homes
People sell their homes for all types of reasons, and many do so well before their mortgages ever reach maturity.
The most common reason all homeowners move is to obtain a better home, this according to data from the 2017 American Housing Survey (AHS).
It’s also pretty normal to sell a home in order to buy in a better neighborhood, or for a first-time buyer to sell in order to form a household (think more space).
Other reasons include being closer to family, shortening a commute, relocating for a job, reducing housing costs, being forced to move, or simply because of a change in household.
You should consider all these reasons before you decide on a particular type of home loan. It might sway your decision.
Most People Keep Their Homes for Six to 10 Years
Prior to the housing crisis the median tenure was around six years
Meaning millions of homeowners took out 30-year loans
But kept them for a fraction of the time
Nowadays tenure is climbing as homeowners hunker down
Take a look at this chart from the National Association of Realtors Profile of Home Buyers and Sellers.
The median tenure for a home seller over the past two decades has been just six years. I guess forever homes are a thing of the past.
As you can see, tenure increased after the mortgage crisis, mainly because underwater mortgagors had no choice but to wait it out.
But many of those who persevered have now listed their homes, just as they are getting their heads above water.
The point I’m trying to make is that very few mortgages are actually held to term, or anywhere close to it.
For one reason or another, mortgages just don’t last that long, despite many being 30-year fixed mortgages.
When looking at this chart, one could reasonably wonder why more homeowners don’t take out short-term adjustable-rate mortgages, such as 5/1 or 7/1 ARMs. The savings would massive.
Both offer lower mortgage rates than their fixed-rate cousins, which would result in a lower monthly payment, less interest paid, and more principal accrued.
Yet most homeowners seem reluctant to go with an ARM, perhaps because it’s difficult to predict the future.
[30-year fixed vs. adjustable-rate mortgage]
Still, the numbers don’t lie – scores of homeowners are on the move in just six short years, whether they hold 30-year fixed mortgages or whatever else.
Will You Keep Your House Longer Now?
As you can see from the graph above homeowners are staying put longer
Thanks to lower interest rates and high home prices
The latest data says homeowners are sticking around for about 10 years on average
So that may affect your mortgage decision too
As I noted, the landscape has changed quite a bit. So will the same trend hold true going forward, or will more homeowners choose to stay put for longer?
I’m sure the average homeowner tenure will increase somewhat, but probably not by that many years. There will still be tons of homeowners that sell in a short period of time for a bevy of reasons.
And so homeowners will continue to take out long-term fixed mortgages that don’t do them much good, aside from the peace of mind of knowing their rate won’t change.
More recent data suggests an average holding period of about a decade.
Sure, it’s slightly longer, but since most mortgages come with terms of 30 years, it should still make you question why you’d pay to lock in a rate for triple the time necessary.
Of course, rates on fixed mortgages and ARMs aren’t all that different at the moment, so it’s not a terrible mistake to make, if you can even refer to it a mistake.
Still, you might be able to save some big bucks if you go with a 10/1 ARM as opposed to a 30-year fixed over the course of 120 months, not to mention build equity a bit faster.
Where Homeowners Stay the Longest
El Paso, TX (99 months)
Albuquerque, NM (98 months)
Oxnard, CA (97 months)
Greensboro, NC (97 months)
Philadelphia, PA (96 months)
Cleveland, OH (95 months)
Seattle, WA (94 months)
Baltimore, MD (93 months)
Rochester, NY (93 months)
Jacksonville, FL (92 months)
In the cities listed above, tenure is the longest, per updated data from NAR for 2018. In El Paso, Texas, a full 99 months go by between sales on the average home there.
While it sounds like a long time, it’s still just over eight years. A 7/1 ARM would cover most folks there, and even if the rate adjusted higher for one year once it became adjustable, the savings realized during the first seven years would likely eclipse any payment increase.
Where Homeowners Stay the Shortest
Providence, RI (33 months)
Cape Coral, FL (35 months)
Greenville, SC (36 months)
New Orleans, LA (44 months)
Madison, WI (47 months)
Grand Rapids (51 months)
Knoxville, TN (54 months)
Boston (57 months)
Omaha, NE (66 months)
Augusta, GA (66 months)
As you can see, lots of homeowners in the cities above could benefit from the short-term financing afforded with an ARM. In most cases, a 5/1 ARM would mean a fixed rate during their entire stay.
What’s even more worrisome is that some homeowners are paying to refinance, or paying mortgage points at closing to obtain a lower rate.
Unfortunately, many of these homeowners won’t hold their mortgages long enough to benefit from the future savings. So use a refinance calculator if you’re thinking about doing this.
After all, the trend to sell in 10 years or less is one that will be hard to shake, even in light of the unprecedented situation we find ourselves in today.
Still, you should definitely ponder the fact that the mortgage rate you receive today will likely be the lowest you’ll ever have – that may sway your decision to part with it so soon.
Last Updated on February 24, 2022 by Mark Ferguson
Paying cash for rental properties may seem like a safe bet, but it may actually be costing you a lot of money. I am trying to buy as many rental properties as I can because I feel they are one of the best investments available. Many people feel paying cash is the best option because you don’t have to pay any interest, but I make more money when I use loans. I can buy more rentals, which means I have more tax advantages, more equity, more cash flow, and more appreciation. So should you pay cash or get a loan on rental properties?
The key to my strategy and obtaining great returns is being able to leverage my money. Leveraging is using other people’s money for investments so you use less of your own money. By using other people’s money, you can buy more properties and increase your returns on the total cash invested. If you pay cash your returns decrease dramatically, and all the benefits of owning rental properties decrease as well.
How can debt be a good thing?
Many people assume all debt is bad but debt can be an amazing tool if used correctly. Some of the largest companies in the world have used debt to grow faster and bigger as have some of the richest people in the world. If you have an investment or business that makes more money than the interest rate costs you on the debt, it might make sense t0 get a loan to multiply your returns.
If you have too much cash and nothing to invest in, debt will not do you any good. If you want to make a lot of money very quickly, debt can help you. With real estate, you can control an asset that is worth hundreds of thousands of dollars (or more) with 20 percent down or less as an owner occupant. If you have a house worth $100,000 and it increases in value 10 percent it is now worth $110,000. You made a 10 percent return paying cash or a 100 percent return if you put 10 percent down and only has $10,000 invested into the property.
Now, real estate is not that simple and there are many more costs than just the down payment, but I wanted to start with a straight forward example to show how debt can make you money.
Is it riskier to pay cash or get a loan and go into debt?
Many people shy away from debt because it is risky. I tend to think that using all cash to buy rentals can be risky as well. The problem with real estate is that it is not very liquid. If you need to take money out of a property you can get a loan against it (refinance or line of credit) or you can sell it. It can take 30 days to get a loan if all your finances are in order. If you have a high debt to income ratio, don’t have an income, or have bad credit you may not be able to get a loan at all even if you have a property completely paid for.
If you need to sell a property it can take 30 days under the best of circumstances when you price it very well. If you want top dollar it may take months to sell. If you sink all of your money into a property so that you can pay cash it is very hard to get that cash out. If you have an emergency or lose your job, you will be in trouble will all your money tied up in real estate.
I would rather use a loan to buy a property so that I have cash in reserves and readily available than spend all my money to buy with cash. I also believe that is is better to have more cash flow with multiple rentals than less cash flow with one paid off property.
Do you make more money from cash flow with loans?
I am going to use some basic figures to outline the benefits of leveraging your money. If you buy a $100,000 house with cash that makes $500 a month in cash flow, you are making about a 6 percent return from the cash flow alone. Cash flow is the profit you make after paying all expenses on a rental property.
If you buy a $100,000 house and put 20 percent down, you will have a mortgage payment, but the return on your money increases. If you are paying a 4 percent interest rate, your principal and interest payment will be about $382 (check out the bank rate mortgage calculator for calculating mortgage payments). You are only making $118 a month cash flow after subtracting the mortgage payment, but you are making a 7 percent return on your money due to the lower cash investment.
Even though the cash on cash return is 7 percent, you are actually making much more than a 7 percent total return in the above scenario. You are also paying down the principal on the loan by an average of $118 each month. That $118 equals another 7 percent return on your money that you would not have on a cash purchase! You have more than doubled your return by getting a mortgage instead of paying cash.
The exciting part about using leverage is when you get a higher cash flow, the returns increase even more. If you can make $800 a month cash flow without a mortgage, you will be making 9.6 percent cash on cash return. With 20 percent down on the same property, you would cash flow $418 a month after the mortgage payments and make over 25 percent cash on cash return just from cash flow! The way to make big money in rental properties is finding properties that will give you big cash flows and buying as many as possible while leveraging your money.
Below is a video that goes over this topic as well:
[embedded content]
How does debt allow you to buy more rentals?
The best part about leveraging your money is it allows you to buy more properties. You can buy three or four homes with $100,000 instead of just one home paid for with all cash. Using the cash flow figures from above and buying three properties instead of one, you are now making $1,254 a month cash flow instead of just $800 a month. Not only does your cash flow increase by purchasing more properties, but the equity pay down increases, the tax benefits increase and the appreciation increases. If you can purchase homes below market, then every time you buy a home, your net worth increases as well!
Tax benefits
Rental properties have many tax benefits including depreciation. The IRS allows you to depreciate a percentage of your rental properties every year and write that off as an expense. You can depreciate a rental over 27.5 years, which means you can deduct 1/27.5 of the value of the structure every year from taxes. You can also deduct the interest paid on the loan and most expenses. If you have three houses instead of just one, you can get triple the tax deductions.
Appreciation
If you have three properties instead of one and the market appreciates, you also have the benefit of triple the appreciation. It is the same situation if rents go up, the more properties you have, the more money you will make. I never count on rents to go up or appreciation, but it is a nice bonus. I live and invest in Colorado where we have seen crazy appreciation. Some markets may not see any appreciation at all.
Equity pay down
With multiple rental properties, you are also paying down the loans on three properties, which increase your returns as well. Most of the payment will go to paying interest at the beginning of the loan, but as time passes a larger portion will go to the principal of the loan.
Buying below market
One of the biggest advantages of real estate is being able to buy below market value. I can buy a house for $100,000 that is worth $120,000 or even $150,000 today. I did 26 flips last year and I used the same concept. There are many ways to get great deals but it is not easy. If I buy one house with cash I would gain $30,000 in equity if I bought it $30,000 below market (this assumes it needs no repairs). If I buy 3 houses with a loan, I would gain $90,000 in equity!
When you think of the tax savings, possible appreciation, buying below market, and equity pay down the returns shoot through the roof. With leverage, I can buy three properties for every one property with cash. I am making more money per month, plus paying off loans, plus saving money on taxes and creating a ton of equity.
How can you be safe using a loan?
When you use leverage, do not blindly get a loan for as much money as you can. Make sure you have enough cash flow as we have already discussed. You also need to make sure you have reserves in place. Reserves are extra cash you have available in case a problem comes up. If you have an eviction, someone stops paying rent, or repairs to make you need cash available to cover those expenses. Most banks will want 6 months of reserves for every mortgage payment you have including a new purchase. If you have one or two mortgages I would suggest having even more cash ($10,000 would be ideal).
How can debt be bad?
There is a downside to more properties. You will have to pay more for repairs and improvements since each property will need repairs, not just one. You will also have three rental properties to manage instead of one. However, if you are able to cash flow $400 or more with a mortgage, you will still be way ahead of the game by leveraging your money. You will also have more total cash flow coming in, which can pay for a property manager. We accounted for the repairs and maintenance when we figured the cash flow, so it won’t be an added expense with more properties, but it will be more work if you manage the properties yourself.
Some people think it is less risky to buy with cash than with a loan, but I would also disagree. Here are some reasons why cash may be riskier than getting a loan.
Diversification
When you buy with cash you have fewer properties. The fewer properties you have, the fewer sources of income you will have, and the more a loss of an income will hurt. If you have 1 property paid for with cash, it really hurts when it goes vacant. But if you have three rentals that have loans on them, one may go vacant, but you have two more that are bringing in money. When you have multiple rentals, you also have more diversification. If you happen to have one rental, you are more susceptible to neighborhood changes, storm damage etc. With multiple rentals, you have less of a chance of all your properties being damaged or hurt by other factors.
Market Crash
You actually lose less money when prices go down with multiples properties. I know that may not make sense at first, but consider this. If you buy three houses below market value for $100,000 (they are worth $125,000 when you bought them) and the market goes down 20 percent. Your houses would be worth $100,000 so you are not losing any money if the market goes down since you bought below market value. If you bought one house with cash below market value you would be in the same position, no loss or gain.
If you are able to get better deals and bought the houses for $90,000 that were worth $125,000 you would be in good shape if the market goes down 20 percent. You would have three houses worth $100,000 that you bought for $90,000. You would have $30,000 in equity from buying below market value. If you only bought one house for $90,000 with cash and the market went down 20 percent, you would only have $10,000 in equity from buying below market value.
If the market went down even more or you bought with properties with less equity you would lose more money using loans. It can be riskier to use loans if the market crashes, but not always. The main thing to remember is that you don’t have to sell in a market downturn. If you have plenty of cash reserves in the bank, and the houses are rented, there is no reason to sell them. Ride out the bad market.
Over-leveraging
The riskiest move using loans is when you over-leverage. That means loan values are very high compared to the rents or the value of the property. When I buy a property with 20 percent down and below market value I have a lot of equity. On the example above the loan would be $80,000 and the value $125,000 when I buy a house for $100,000 that is worth $125,000.
If you have a loan of $100,000 on a house that is worth $110,000 you may be asking for trouble. You are asking for more trouble if you are only making $50 a month in cash flor or losing money every month. Almost all the horror stories from the last housing market crash came from investors who were breaking even or losing money on their rentals every month. Most of the investors who were making money every month made it through okay.
Conclusion
If you are wondering if it is smart to pay cash for a rental, consider the returns you may be giving up. In my opinion, it is better to use other people’s money and increase your returns versus paying cash. Some people are very averse to any risk and do not want any debt at all. If the idea of debt makes you sick to your stomach, maybe paying cash versus getting a loan is the best route for you. I will continue to get as many loans as I can and to buy as many rental properties as I can because of the incredible benefits rental properties offer.
There are so many possibilities for living arrangements once you move out on your own. You can decide to live alone or with one or more roommates. You can share space in a house or get an apartment. Another option, that has been around longer than you may think, is buying into or renting within cooperative housing.
Unlike all these other options, people who buy into a co-op own a piece of the entire building. It’s a unique way to own property that’s often more affordable than buying a condo or home.
It’s also a big investment. As a renter, living in a co-op creates a different, more communal atmosphere that you may not find elsewhere.
Before deciding to research co-ops in your area, it’s important to understand what a co-op apartment is.
What is a co-op apartment?
Cooperative housing is where you buy in to become a part-owner of that entire piece of property. “When you buy into a co-op, you become a shareholder in a corporation that owns the property. As a shareholder, you are entitled to exclusive use of a housing unit in the property,” says Lisa Smith from Investopedia. Rather than owning a single unit, you become a part-owner of the whole building. This gives you the right to live on the premises, in an available apartment.
Everyone who is a part of a particular co-op shoulder some of the financial responsibility of ownership. This includes primary expenses of mortgage payments, maintenance costs and taxes. Other fees can consist of utility bills, the expense of running the building, maintaining amenities and insurance premiums. Each cost breaks up among the total number of people vested in the co-op.
The history of co-op apartments
“There is no clear-cut answer as to when the first housing cooperative appeared in the United States.” Says Lynne Goodman from The Cooperator New York. She does reference authors Richard Siegler and Herbert J. Cooper-Levy in “Brief History of Cooperative Housing,” who claim the first American residential co-op was established in 1876 in Manhattan.
As the starting point for co-ops, New York City continued throughout history to offer this housing option. Moving in waves of popularity in this ever-growing city, co-ops began as home clubs, where people organized with the intention of building an apartment building together.
Co-op popularity hit another high in the 1920s as urban populations boomed, post-WWI. The next uptick was in the 1940s as a response to rent control provisions. In the 1980s, popularity rose as a result of increasing oil prices.
Today, co-ops are more than just living arrangements. You can buy into a food co-op or shop at a store that produces goods from a co-op. The methodology of being a part of a larger group has grown beyond investing in housing.
Where can I find cooperative housing?
In varying degrees of availability, you can find cooperative housing in every part of the country. “Housing cooperatives are quite common in certain parts of the country, such as New York City, Washington, D.C. and Chicago, but can be harder to find in other areas,” according to the National Association of Housing Cooperatives. They’re popular throughout the Northeast but exist elsewhere.
How do fair housing laws impact cooperative housing?
The Fair Housing Act consists of laws that prohibit discrimination based on race, skin color, sex, nationality, religion, disability and more when it comes to buying, selling, renting or financing housing.
Co-ops must abide by these laws, but at the same time, their approval processes for tenants is very different than what you find in a regular apartment. There’s no landlord-tenant relationship. Instead, a community board reviews applications. The members of this board can set up their own qualification system within the fair housing parameters. This can include net worth minimums or a certain debt-to-income ratio for eligibility.
“The board must not reject an applicant based solely on his or her race, gender, national origin, religion, sexual preference, marital status or familial status. The board can, however, take into consideration factors that impact an applicant’s ability to meet the financial obligations of the community, as well as governing responsibilities,” according to the law firm, Pentiuk, Couvreur & Kobiljak P.C.
A community board can be more restrictive than other housing options when it comes to inviting people to become owners or renters. This can make for a longer and more tedious approval process that doesn’t always feel so fair.
Is it worthwhile to buy in and become a part-owner?
Personal preference is what makes a co-op apartment appealing. To figure out whether it’s the right place for you, weigh the pros and cons carefully.
The perks
As a part-owner within a co-op, you influence how the building runs. You attend board meetings and get to vote on all decisions. This includes shaping rules and regulations for how the building is managed and who is eligible for consideration to join the co-op. You pretty much get to pick your neighbors and prevent anyone from moving in who might not maintain their space in the same way as the rest of the shareholders.
Another perk is the cost. Cooperative housing can cost less than owning a condo. “Co-ops tend to be cheaper per square foot. They typically offer buyers more control as an individual shareholder and often have lower closing costs,” says Lester Davis from The Washington Post.
The last primary perk to co-op living is community. This special living situation gives you more than somewhere to live, you get a whole community. You more often than not know your neighbors, have a network of people watching out for you and our home and connect with people you can rely on when in need of assistance.
The drawbacks
To get into a co-op, prepare for a more rigorous approval process. Not only will the board run a background and credit check, but you’ll have an in-person interview to get through. Everyone receives the same treatment. Once you’re approved, you’re in, but the process can also make it harder to sell when you’re ready to leave the co-op.
Rules within cooperative housing can feel more confining than in other living situations. Because you don’t own the unit you live in, you’ll have to contend with restrictions on how you can use your unit, whether you can sublet and more. You’ll also need extra insurance for your personal belongings since the building’s insurance won’t cover it.
One final key drawback goes back to cost. It may cost less to buy into a co-op, but with shared expenses comes more potential financial responsibility. If someone defaults on their payments, you and your neighbors are obligated to cover a portion of their missed payment.
Can I rent within a co-op?
This is a tricky question. Since a set of shareholders own the building, no single unit belongs to any one person. Because of this, many co-ops don’t allow renters at all. Additionally, the rate of owner occupancy in cooperative housing is much higher than you’d find elsewhere.
If a building does allow it, you may face a large application fee, along with set limits on the length of your lease. You’re also technically subletting rather than renting outright since you rent the unit from the co-op shareholder who holds a lease on that particular space. It’s a little more work to rent within a co-op, but it’s not a terrible option. If you want something more flexible, with a little less upfront cost and rigidity when it comes to the approval process, you may want to consider other options.
Is a co-op right for me?
A co-op may be right for you if, after learning more about what it really is, the idea still sounds appealing. It all depends on your own personal needs, which is why it’s good to know you have options when searching for your perfect living situation.
While co-ops can get you more square footage for your dollar, they can also feel more strict when it comes to rules and regulations. Finding the perfect balance of cost and comfort will help you know whether it’s time to start looking for a co-op.
After the previous mortgage boom and subsequent crash, many questions were asked regarding what exactly went wrong.
There was plenty of finger pointing, from overreliance on credit scores, to endless investor speculation, to Wall St. packaging substandard mortgages and the government’s accommodative policies.
But one source of blame that kept resurfacing was the prevalence of high-risk loan products, such as the option arm.
Others blamed “subprime” for the housing crash, though that infamous eight-letter word was often used as a one-size-fits-all definition for any mortgage that went bad.
Regardless, it was clear that shoddy mortgages held some material amount of blame for the previous crisis.
After all, many of the loans were destined to fail, seeing that the teaser rates offered were the only way one could afford the property to begin with.
Today’s Mortgages Are Pristine
If you want to compare the previous housing run-up to that of today’s, you should consider the mortgages behind the properties being purchased.
Back during the mid-2000s, the quality of mortgages was awful. Scores of homeowners were purchasing properties with credit scores well below 620, which is the subprime cutoff.
Additionally, these borrowers were purchasing homes with zero down financing, or worse, with zero documentation. Not to mention many of the properties were non-owner occupied four-unit properties, often with second mortgages stuck at 12%.
One of the most common loan documentation types was stated income, which allowed borrowers (or their loan reps) to put any amount of monthly income they’d like in the box on the application.
This was all good and well in the eyes of pretty much everyone because it banked on home prices soaring ever higher, despite already chalking massive gains.
The idea, in short, was that it didn’t matter if the borrower was sound if the property was expected to surge in value.
At worse, the borrower could refinance again or sell (for a profit) if they couldn’t keep up with their mortgage payments. We all know how badly that ended…
Just a few short years later, the quality of mortgages has done a complete 180. The average credit score for newly originated loans is north of 700. Additionally, average LTVs have dropped, meaning borrowers have home equity in case something goes wrong.
If anything, LTVs are going to keep dropping as bidding wars force new homeowners to put more down in order to get their offers accepted.
At the same time, more and more borrowers are opting for long-term fixed-rate mortgages, and with mortgage rates are at or near record lows, it makes for a pretty solid bet (even Buffett backs it).
The low rates are good for the housing market because it means homes are more affordable in payment terms, and it also means many previously stuck with higher rates can refinance.
Even those with underwater mortgages have benefited, thanks to HARP 2.0, which erased the LTV ceiling.
Yes, there will be consequences of this quantitative easing down the road, but for now, quality mortgages are being originated at rock-bottom rates.
And some banks are even compensating their loan officers based on loan quality, as opposed to loan volume.
Is This a Housing Boom or a Mortgage Boom?
You almost have to question whether this is a play on housing, or a play on getting a mortgage at a ridiculously low rate.
If mortgage rates were closer to historic norms, would prospective home buyers have the same voracious appetite?
My guess would be no, seeing that home prices have already returned to fairly high levels in many parts of country.
In fact, they aren’t too far off their previous bubble highs in some regions, meaning the low rates must be part of the equation.
Still, if and when rates do rise, it doesn’t mean home prices will plummet like they did before. It will probably result in a cooling off period, but that doesn’t equate to a bubble bursting.
[Mortgage rates vs. home prices]
The reason most people lost their homes or walked away during the previous crisis was due to a lack of home equity (and down payment), coupled with an unsustainable housing payment.
Today’s borrowers are a lot more qualified and invested, holding mortgages they can truly afford. This makes owning long term a lot more attractive, even if home prices have shot up recently.
These homeowners will be able to sit tight and enjoy their low, low fixed housing payments, even if home prices bounce around a bit. Why walk away from that?
Read more: How it became a bad time to buy a home.