Economic Update from Steve Papapietro of Opes Advisors, Palo Alto

Our view on rates this week is that the most widely followed indicators are sending different signals, but short term rates are likely to be steady with upward pressure on long-term rates. Increased  volatility is likely as the markets adjust to the new qualitative guidance from the Fed.  

Here is what we are watching:

Back to the Future

The U.S. added 192,000 jobs in March with the unemployment rate holding steady at 6.7%. Total private payrolls reached 116.1 million, finally surpassing pre-recession highs.  Employment numbers were also nudged higher for January and February.
 
In sum:  Moderate improvement in the labor market means that the Fed  will continue to gradually reduce stimulus while keeping interest rates low.
 
It’s the Weather
 
U.S. exports fell 1.1% in February to hit a five month low causing the trade deficit to widen. This shift surprised most economists who were expecting the deficit to narrow.  There were some hints that transport delays related to severe weather were to blame. Oils imports hit a 14-year low – good news for U.S. manufacturers now less dependent on more costly and volatile foreign supplies.
 
Manufacturing and non-manufacturing economic activity picked up in March, continuing an upward swing.  The Institute for Supply Management (ISM) reported growth in new orders, employment and production.  Both the overall economy and the manufacturing sector are growing and the rate of change is increasing.
 
In sum:  Economists are racing to reduce Q1 GDP estimates due to lower exports, yet the data show favorable demand and good business conditions. Combined, this is neutral to slight support for higher interest rates.
 
They Will Definitely Probably Think About It
 
The European Central Bank (ECB) kept rates steady at .25% and said it was ready to turn on its money-printing machine to avoid deflation. This is significant change and signals their thinking on the strength of economic activity in the Euro Zone.  The strong Euro is keeping prices down and too low inflation makes it harder to deal with debt burdens and slow economic growth.  The U.S. is tied to the European economy through interest rates, trade, and exchange rates.  Any shift can cause the Fed to change its stance.  Be skeptical; the ECB has perfected the art of saying one thing and doing nothing.
 
In sum: Expect no reaction from the Fed to the ECB announcement. If anything, continued weakness in Europe supports lower interest rates.
 
The Week Ahead
 
Wednesday, April 9th:   The Federal Open Market Committee (FOMC) releases detailed minutes from their last meeting.  The markets will look for signs the Fed is keeping rates low following confusion sparked by the Dot Plot  and Janet Yellen’s post-meeting remarks.
 
Thursday, April 10th:  Jobless Claims data. This has a big impact on financial markets because it measures emerging unemployment and gauges the strength of the job market. This provides insights into the direction of economic activity.
 
Friday, April 11th:  the Producer Price Index (PPI) This provides markets with insights into the direction of inflation.
 
Finally, Industrial production data are expected from a variety of big European countries. This will be an indication on the need for ECB to take action (see above).
 
In sum:   All provide insight on economic momentum and indicate the direction of interest rates. Increased jobless claims and a favorable PPI indicate a continued low rate environment. Labor market and price pressure and lack of clarity from the FOMC support higher rates.
 
While Opes Advisors, Inc. uses all reasonable efforts to ensure that the information contained on in this email is current, accurate and complete at the date of publication, no representations or warranties are made (express or implied) as to the reliability, accurate or completeness of such information. Opes Advisors, Inc., therefore, cannot be held liable for any loss arising directly or indirectly from the use of, or any action taken in reliance on, any information appearing in this email.
 
This economic update was brought to you by Steve Papapietro, Mortgage Advisor at Opes Advisors in Palo Alto. For any additional questions about this information or about your mortgage questions, please call him at 650.319.1642.

Is it Time to Refinance Your Mortgage?

Home ownership can be for many their biggest financial asset, and as a result, biggest financial concern. But with current mortgages dropping to their lowest point since the 1950s, many Silicon Valley homeowners are saving thousands a year just by refinancing. Is the time right for you? Let’s go through some considerations that cover the why, how, and hurdles of refinancing.

• Why refinance?
• Hurdles in refinancing
• Break-even calculation
• Comparing interest rates Shopping for a new mortgage

Why refinance?

The most common and obvious reason is that homeowners refinance to lower their mortgage rate. A lower rate means lower monthly payments and less money towards interest over the life of the loan.

For example, a 30-year fixed-rate loan of $400,000 at 6% would have a monthly payment of $2,398. But if you were to qualify for 5.5% on the same loan amount, your monthly payment would be $2,271, or a savings of $127 a month and $1,524 saved in a year.

Or you may want to adjust the term of a loan. Decreasing the time period of a loan results in a lower rate and paying off your loan sooner, for a slightly higher monthly cost compared to a 30-year loan. Increasing the length of a loan is a cash-flow option, freeing up cash now, but paying more over time.

You can also switch between an adjustable-rate mortgage (ARM) and a fixed-rate mortgage. The riskier ARMs float with current interest rates, so your payments increase or decrease accordingly. Commonly, homebuyers are moving to a safer fixed-rate mortgage.

Cash-out is the last option, where you refinance a mortgage for more than you owe and receive equity in cash, which can help pay for large debts now.

Options outside of refinancing are home equity loans and lines of credit, and reverse mortgages.

Common hurdles when refinancing

Before you think a refinance is the easiest route to saving your financial back, strict requirements and sometimes extra costs don’t make the trip worth it.

Similar to the first time you applied for a mortgage, lenders are looking at three qualifications: income, credit score, and property value. If any one of these has suffered, lenders will likely charge additional fees or raise your rate.

Another issue can be if your current mortgage has a prepayment penalty, which reduces the benefit of refinancing, again, because of additional costs.

So talking to a loan officer is the first step to see where you fall financially and what you qualify for in terms of refinancing your mortgage.

Break-even calculation

How long it takes to recoup the cost of refinancing realized with a lower rate, the break-even point, is useful for determining if it is worth refinancing when considering how long you plan to stay in your home.

Typical fees that add to the cost of refinancing are loan origination fee, points paid to lower your interest rate, appraisal fee, inspection fee, closing fee, title search and title insurance, and other miscellaneous lender fees. Total fees can easily get into the thousands.

Lenders sometimes offer “no-cost” refinancing. Though you may not have to pay the above fees at closing, you will have to either accept a higher interest rate or the fees will be rolled into the term of the loan.

If you leave your home before recouping the closing costs there is little point in refinancing.

Let’s use our previous example, and say a refinance will save you $127 a month but closing costs were $4,500. To break-even, you would have to keep the loan for about three years; if you were to keep the house for 10 years you would save $10,720, including the cost of closing.

There are numerous refinancing calculators on the Web, like at bankrate.com, where you can plug in your own finances and get a quick estimate.

Comparing interest rates

As we saw with the initial graph, rates have been dropping over the years. But interest rates and fees change daily from lender to lender.

In addition to the most surefire ways -- good credit, income, and equity -- to an excellent rate you can also pay points. A point is equal to 1% of the total loan amount and the more points you pay the lower the rate.

To give you an idea of the current rates for a 30-year mortgage, here are some from a Bay Area lender as of July 2010:

No point, conforming loan (under $417,00) = 4.5% No point, “no-cost” conforming loan (under $417,00) = 4.75% High-balance loan (under $729,250) = .125% - .25% higher than a conforming Jumbo loan (anything higher than $729,250) = low-to-mid 5s

Shopping for a new mortgage

Shopping around and comparing loan offers by different lenders is the best way to save money. First, talk to your current lender, as they could save you time and wave fees since you are a returning customer.

Feel free to contact us if you are looking for recommendations on Bay Area lenders or mortgage brokers; also, if you would like to find out more about our real estate services. _

Related Posts:

• Mortgage Traps: How People Get Ripped-Off
• The Three Traps of Exotic Mortgages
• Credit Surprises That Damage Mortgage Applications
• Loan Rates Based on Mind-Boggling Number of Criteria 

Preparing Your Finances For Buying a Home

"That's a lot sooner than I expected," she said as we walked out of the open house towards my car.  He nodded and I mentally went back over my notes about their priorities.  We hadn't seen that many homes so I wanted to ask a few gentle questions to make sure they were getting what they wanted before putting in an offer. 

This wasn't their first time buying a home.  Their family had done it a couple times before, here in Silicon Valley and in a different state.  But each time, there was a mad dash.  "It was never clear when we needed the money," she intimated after taking a sip from her water bottle.  She and her husband looked at each other with a knowing glance and he chimed in, "We lost a couple places because of liquidity before."

There are a lot of moving parts in buying real estate, but for the buyer, the lynchpin for the transaction --- and the greatest source of stress --- is getting money to the right place at the right time.  I want to ensure that my clients have a transaction that's as stress-free as possible, and part of that is reducing the uncertainty in the process. 

Here are some of the tips I provide my clients on how to prepare their money for buying a home and they impact the strength of their purchase offers.

Liquid Money for Your Deposit

Your deposit is up to 3% of your offer price, included with your offer as a check made out to the title company being used.  If your offer is rejected or countered, your check is returned to you uncashed.

In California, 3% is the maximum amount the seller is allowed to hold as earnest money for the purchase of a house (up to a four-plex).  I don't recommend my clients offer less than that because tells the seller one of two things: (1) that you aren't confident the deal with go through, or (2) you aren't really serious about purchasing the house. 

Why Sellers Like Larger Deposits

Obviously, neither of those implications strengthens your offer.  After all, sellers like larger deposits because it mitigates their risk.  Many folks believe that it's because the seller wants  "free money" if the deal falls through. 

It's true that they get to keep your earnest money if you back out of the deal (and the more the better), but having their home boomerang back onto the market is something most sellers would rather avoid --- putting a home back on the market may reduce the amount the seller can get for it.  Sellers like larger deposits simply because, the more money you offer in earnest, the less likely you are to break the purchase contract.

What Happens to Your Deposit If Your Offer Is Accepted

If your offer is accepted, your check is given to the title company, to be cashed immediately, with its funds held in escrow. 

Technically the word "immediately" is imprecise because the law actually requires that the check be delivered to escrow within 3 business days of when the offer is accepted.  But the reason why I use I chose "immediately" is because I work with people who have some latency in funding their liquid accounts.  (I see this a lot with high-interest online savings accounts and stock sales.) 

They ask whether they can use this "extra" time to account for that latency.  I handle this on a case-by-case basis, but, in general, I recommend against it.  The implication of presenting the check along with the offer is that it's a fully-funded check, and your ability to gain concessions from the seller after your offer is accepted --- and sometimes even to complete the transaction --- depends on your working relationship with them.  In the big picture, any marginal benefit from the extra couple days is, in most cases, offset by unnecessary red flags if or when this fact is raised with the sellers and their agent.

Loan Pre-Approval Letter

"My credit history, income, and collateral have been examined closely and I qualify for a mortgage large enough to reliably purchase this house."  That's what you tell the seller when you submit a loan pre-approval letter along with your offer.  In many parts of the country, getting a pre-approval letter from your mortgage broker is optional, but in Silicon Valley, it's standard practice because of the number of highly-qualified buyers in the area.

It's important to note that a pre-approval is stronger than a pre-qualification, which is essentially a back-of-the-envelope calculation of your debt-to-income ratio --- you take your income, subtract your expenses, and compare the resulting number to your monthly mortgage payment.

Pre-approval isn't a loan commitment or a promise to lend you the amount of money you need to purchase the house.  Even if everything is in order with your finances, the loan is still subject to the home you're purchasing appraising for an amount acceptable to the bank making the loan.  After all, the house is the collateral for the loan, and the bank doesn't want to be at risk for $1,000,000 if the collateral is worth much less than that.  The loan will also be subject to a clean title report, where it is obvious who has owned the property over its history and how that ownership has been transferred.  

Tips for Your Pre-Approval Letter

I coordinate closely with my clients' mortgage brokers on tailoring pre-approval letters for each of my clients' offers.  Pre-approval letters generally have the amount of the mortgage and some nice words about the buyer (e.g. clean credit history, stable employment, verified funds, etc.). 

Most pre-approval letters are customized so that the amount of the mortgage plus the down payment matches the amount of money offered.  Traditionally, that is thought to help in negotiations because it keeps the seller from knowing exactly how much money a buyer is approved for.

In highly competitive markets, I prefer a different approach.  When sellers gets multiple offers, the sellers and their agents often choose to negotiate with one potential buyer at a time instead of playing ping-pong with more than one party.  When I anticipate multiple offers, I'll recommend to my clients that we submit a pre-approval letter that signals our willingness to negotiate by giving the letter a slightly higher number than our offer.  Then, during the offer presentation, I'll draw the seller's attention to why there's a difference.  Sometimes our initial number will come in lower than another offer, but because the upper-bound we've signaled is higher, my clients are chosen for counter-offers.

Sometimes pre-approval letters will also include a line about how the funds being used for the down payment have been verified.  I often note to my clients that wily listing agents will often call the mortgage broker to double-check the amount that has actually been verified.  A gentle reminder keeps less experienced mortgage brokers from being caught off-guard by this thoroughness.

Cash for Your Down Payment and Closing Costs

You will need to wire or provide a cashiers check with the money for your down payment and closing costs to the title company handling escrow two business days before closing (close-of-escrow), the day you are supposed to get the keys to your home. 

The reason why I say two days is because all sorts of random things out of your control can happen that can keep you from getting the keys to your house.  For example, a surprising amount of real estate business gets done by courier.  Since it basically takes one business day for a cashiers check to clear, my client was driving up to the title company from work that day before closing to drop off his deposit before the end of business --- as he was instructed to do by the escrow officer. 

My client was well on his way when the escrow officer called me in a panic.  "Our bank courier showed up an hour early and he's about to leave.  Where is your client and the check?"  There wasn't any reason to worry since I knew my client was on his way, but it illustrates a close call out of our control which could have caused us to scramble, and --- at worst --- prevented my client from taking possession of the house on time.

I recommend my clients apply the same caution when it comes to the date their mortgage will fund for the same reasons. 

I also recommend that my clients not choose a closing date which lands on a Friday or the day before a holiday.  After all, if something does go wrong, there will be no way to fix it until after a very stressful and potentially ruined weekend or holiday.  Also, the close of business before a weekend or holiday tends to come a little sooner than it usually would on other days.  Real estate is a business of details.

What Are Interest Rates Going to Do?

Shake, shake, shake.  "Reply hazy, ask again," it says.  

For people looking to buy a home in Silicon Valley, it's the age-old question: "What are interest rates going to do?"  Especially since the difference between 6% and 6.25% on an $800,000 mortgage (30-year principal and interest) adds up to $129.34 per month.  I'd rather see that money go towards things that make you happy than on some lender's bottom line.

Data compiled since April 1971 shows that interest rates are historically low right now.  You don't need to take my word for that --- the Federal Reserve does their own surveys.

The challenge is that predicting interest rates is something no one can do accurately.  Global events such as the oil embargo in the 70s or 9/11 in 2001, which have a major impact on interest rates, can't be predicted with any certainty.  That's why mortgage lenders treat money like the commodity it is: in essence, they price their products based on how expensive the money is for the period when they need to use it.

While there is no crystal ball for determining what rates are going to do today, tomorrow, next month or next year, I'll present some "back-of-the-envelope" ways to tell which way the wind is blowing when it comes time for you to buy a house in Silicon Valley.

Be forewarned, this article is a lot more esoteric than usual and given the unpredictable nature of interest rates, needs to be disclaimed more than usual too!

Parsing the Enigma of the Federal Reserve

Predicting where mortgage rates are going to be, even in a year or two, is a very inexact science.  Folks make assumptions about Federal Reserve biases towards interest rates and listen intently to the news for those keywords from analysts: neutral, tightening, relaxed.  But those biases can shift.

And, you've probably heard the saying, "Do what I say, not what I do."  In keeping with that cliche, words coming out of the Federal Reserve ---- starting with Alan Greenspan's tenure and extending somewhat into current Fed chair Fred Bernanke's term --- are parsed and re-parsed for signals and nuances.

But when it comes to the Fed, the saying should be, "Believe what I do, not what I say" because the federal bank's real power comes from surprising the market.  (Readers who are also into the stock market know this through, sometimes harsh, experience!) 

In other words, they don't always signal their intent or the magnitude of their actions accurately, and they do this on purpose.  That said, a good start is looking at what the Fed says --- about what they say they're going to do. 

The Fed usually moves deliberately so people with a long-term view for purchasing real estate in Silicon Valley can use this as a relatively easy-to-track indicator.

Surveying the Mortgage Brokers

For those with a 30- to 90-day focus, one way to find out what interest rates are going to do is to ask a sample set of mortgage lenders.  Mortgage-X.com runs a mortgage rate trend survey of "more than 250 experts" each week to gauge what brokers think interest rates are going to do.  

Not all agree, of course.  In the April 9, 2007 edition, one broker said rates will increase over the next quarter because, "Bonds have broken their trading range now and look to rise slightly in the near future" and another said rates will decrease during the same time because, "Money has recently flowed from bonds to stocks, thus reducing bond prices and increasing yields."

But given the large sample set, they do generate an interesting bell curve that leans towards which way the crowd believes the wind is blowing. 

Looking at Short-Term Indicators

Mortgage brokers, lenders and economists will argue correctly that what I'm about to present to you is an oversimplification.  But the goal here isn't a Masters in Economics. 

By giving you a sense of what's going on inside the black box of interest rate voodoo, my hope is that you feel more at ease with a decision-making process which (I know from experience) can be life-changing.

The numbers I believe give you the best bang-for-the-time-constrained-buck, when evaluating interest rates when buying Silicon Valley real estate in the near-term, are the prime rate and the 1-year constant maturity treasury (CMT) rate.  

1/  Prime Rate.  The prime rate used to be the rate a bank would charge to its most reliable customers --- you'll see that definition all over the Internet --- it has evolved into an index that banks use to determine what your interest rate is going to be on a loan.  They do this by adding or subtracting percentage points (or fractions) from the prime rate based on the type of loan and the credit-worthiness of the customer, among other factors.

In general, the Wall Street Journal's published prime rate is "the" prime rate.  (They survey 30 institutions; 23 need to change their rate before the WSJ changes its published number.) 

This number usually changes, at most, once per month, if at all.  Its consistency and relatively low volatility make it a useful benchmark that's easy to track. Plus, changes in the prime rate reflect the Fed's major announcement decisions (i.e. changes in the Federal Reserve Funds rate.  But the prime rate, more focused on the short-term, doesn't have anything to do with mortgage rates, does it?

2/  1-Year CMT Rate.  The prime rate follows the 1-year CMT rate very closely.  This 1-year CMT rate is an index that represents the interest you would receive if you invested in a set of U.S. Treasury securities (like bonds, notes, bills, etc.) for one year.  This index is updated frequently, often weekly.  Many adjustable rate mortgages are directly based on CMT rates.  

How Home Equity and Piggy-Back Loan Rates Are Affected 

The prime rate directly affects most home equity lines-of-credit (HELOCs).  If you are planning on buying a house with less than 20% down, one of your options will be to get a "piggy-back" loan that usually comes in the form of a HELOC.

People with good to exceptional credit can get HELOCs for below the prime rate, prime minus some number or fraction of points.  In almost all cases, the interest rate on the HELOC will be more expensive than the base mortgage.  Since the piggy-back loan is smaller, getting a good rate on the HELOC is not as important as getting a good rate on the mortgage --- which is usually 8x larger (with that much more to pay interest on).

Changes in the prime rate directly affect the HELOC rates you can get and most will adjust based on the prime rate during the course of the loan.

Making Fast, Educated Guesses on Mortgage Interest Rates

The chart linked below shows mortgage interest rates since January 1992.  (This direct link to Mortgage-X.com is required for permission to republish it on my site.  We're not affiliated in any way.)  It includes data for mortgages (30-year fixed, 15-year fixed, and 1-year ARM) as well as the prime rate and 1-year CMT.

People Gravitate Towards the Cheapest Money

If you had a choice --- let's assume they're both just as easy to get and equally beneficial for you --- between getting a car loan of $20,000 at 8.5% interest or buying a car and using $20,000 from another loan at 6%, which would you choose?   Clearly you'd choose the less expensive option.

Getting a mortgage is harder, for example, than getting a prime-plus rate car loan.  But since they're substitutes, the two rates would rather approach each other than diverge from each other.  Because the two are related, it's possible to make educated guesses about one using the other.

The white line on the graph (the one with the stair step pattern) represents the prime rate.  The red line represents the 30-year fixed interest mortgage rate.  As you can see, over the past 15 years, the two have tangled together, and the prime rate has higher peaks and valleys because of it's shorter-term focus.

Gauging the Wind Behind the Prime Rate 

Nothing is certain in the land of interest rates, just like it is in the stock market, but take a look at the green line.  This is the 1-year CMT rate plus a margin.  For our purposes, this margin helps compare the 1-year CMT to the prime rate.

As you can see, changes in the 1-year CMT rate happen rapidly.  And, since January 1992, you can see from the chart that the 1-year CMT rate usually leads the prime rate by about one to four months.  In other words, you can usually see changes to the prime rate coming 4 to 16 weeks beforehand by looking at the 1-year CMT plus 2.75% margin interest rate.

Since this isn't an economics thesis, I haven't run a statistical analysis to prove that, so proof by inspection (eyeballing) will have to do.  Except for a big peak in the 1-year ARM during January 1995 and a disproportional dip in September late 1998, you can see the 1-year CMT leading the prime rate pretty consistently.

One Opinion on Mortgage Rates

Personally, I look to see whether the 1-year CMT plus 2.75% margin is less than the prime rate for a period of about three to six months.  (I prefer to think about it as when the green line is below the white one.) 

In general, I would track rates as stable or decreasing during those periods.  The chain of reasoning is that the less the government pays on their securities, the less banks pay people to deposit money with them, the more incentive people have to spend their cash rather than borrow money from banks, the more incentive banks have to lower their loan interest rates in the near-term, barring daily fluctuations.  A larger difference between the 1-year CMT and the prime rate usually means a change is afoot --- indicated through their actions, not words.

But then again, there could be another Katrina, more captured U.K. soldiers in Iran, or inordinately cold weather driving up heating costs that month. 

I believe the best advice for people looking to buy a home in Silicon Valley is to budget for varying interest rates, establish a timeline for purchasing, investigate properties in your price range, lock-in a rate you're comfortable with using a vendor you trust --- and don't look back because no one has a perfect Magic 8-Ball.

(c) Steve Leung for the Silicon Valley Real Estate Blog at 1SiliconValley.com

Recommended Reading:

• How Lenders Analyze Income
• Credit Surprises That Damage Mortgage Applications
• Four Factors in a Loan Decision
• Mortgage Rates Are Low Without Exclamation Points
• Mortgage Traps: How People Get Ripped-Off

Credit Surprises That Damage Mortgage Applications

Suppose you were just a month late paying a bill a couple of months ago (the bill got lost in your desk).  When it comes to your mortgage application, that's not such a big thing, compared to a bankruptcy or people who have a history of late payments, is it?

Stories Affecting Your Mortgage Application

A woman donated a car to charity five years prior to our running her credit report in connection with qualifying for a loan. The deed wasn't correctly changed (check with the DMV when you transfer title!), and at some point the car was towed and the new owner failed to pay the towing fee. That fee, plus hefty collection charges that were tacked on, totaled about $1400.00 and went straight to my client's record. 

Another client co-signed for a relative who was applying for a credit card. Turns out the relative didn't make the card payments, and our client's credit rating took a hit, complicating the process of getting pre-approved for a loan.  Imagine how bad things could have gotten if they were the straw buyer for their relatives!

And another client got a speeding citation but changed residences before the ticket arrived in the mail. He got busy with life and somehow forgot about the whole incident. Unbeknownst to him, the ticket went to collection, and his credit score took a hit. He didn't find out about it until he was house hunting and needed to qualify for a loan. The upshot: we had to submit the loan to three different lenders to get approval, a process that took three weeks rather than the typical ten days.

Other common problems include medical disputes, cell phone company disputes, and missed payments on student loans (the student loan deferment process is tricky).

What About That Late Payment?

That one recent late payment may be worse, depending upon timing! Three consecutive late payments three years ago have less impact on your credit score than one late payment last month. And a bankruptcy five years ago has less impact than a current 30-day-late payment.  Why?  Because recent problems may be the start of a trend.  What's your trend if your bankruptcy was years ago and you've had a perfect record since?

So what can you do? Avoid credit surprises by monitoring your credit report on a regular basis. It's like going to your doctor for an annual checkup: the sooner you discover an infection is creeping into your system and begin treatment, the easier it is to get cured. Whether or not you're buying a house or planning to refinance, check your credit regularly. If you are buying or refinancing, it's critical that we check your credit report as early as possible so you have: time to correct errors and improve your credit score. 

How Lenders Analyze Income

Different lenders interpret income in different ways.  But there are some general parameters that lenders tend to adhere to and that you should know about before your refinance or buy a property.  We'll discuss both people who are self-employed and employed by others.

Self-Employed

If you are self-employed, you must have been in business for at least two full years. The lender will require your two most recent full federal tax returns, then calculate your income by averaging the two years.

Self-employed people include:

• Sole proprietors (they must provide Schedule C on federal tax form 1040).

• Partners (income is generally reflected on Schedule E and in a KI).

• People with a 20 percent or more interest in a corporation (they must provide W2s, plus form 1040, plus corporate returns on form 1120).

• Salespeople who derive their sole income from commissions, even if they receive W2s.

When analyzing a Schedule C, lenders don't use the figure for gross revenues received but look at net after expenses.  However, certain items, such as a home office expense or depreciation can be added back in.  Although an income and expense statement for the current year is required, it's given little weight, particularly if it shows a large difference between the income and expense statement and the previous year's tax return.

On-the-Payroll

Income for people who are not self-employed is usually easier to analyze. You normally do not need a two-year history on the job. In fact, it's possible that someone just out of school and starting a new job can get full credit for his or starting salary even before the first day of work, but most lenders prefer that a borrower has been employed long enough to generate at least one pay stub. Bonuses and overtime Ronica Lee are typically averaged over a two-year period, so you would need to have been on the job for some time to qualify for this income.

Investment Income

Items in this category generally include rental income, interest and dividends.

For rental income, lenders calculate 75 percent of the gross income less PITI (principal, interest, taxes and insurance). A few lenders use a method where, on owner-occupied property, income from the rental unites) is subtracted directly from PITI. This method results in dramatically better deb¬t-to-income ratios.

Other investment income, such as interest and dividends, are calculated from 1040s by averaging the previous two years, plus documenting that the borrower still holds these assets.

Debt-to-Income Ratio

After income is determined, it's evaluated on the basis of a debt-to-income ratio that factors in what you owe. This includes housing expenses (mortgage payments plus property taxes and insurance) and all other debt (such as car payments, student loans and credit cards) as a percentage of pretax income. It's interesting to note that allowable debt-to-income ratios are much higher than when I first came into the business. Then the usual standard was 38 percent; now 45 percent is common and there are some cases where allowable ratios surpass 50 percent.

Four Factors in a Lender's Loan Decision

[ed. My friend David Marx joins us again for this week's edition of Mortgage Monday.  He is principal of Dacor Financial and brings us his multiple decades of expertise as a mortgage broker.]

When evaluating a loan, our lenders consider four major factors.  What's interesting is that the priority of the factors has radically changed since 1983, when I started in the business.  Here's a little game to illustrate what the differences are!

Each factor is discussed below in no particular order.  As you read, take a moment to prioritize these factors the way you think a lender would today. Then try to prioritize them as a lender would have back in the 1980s.

Hint: The No. 1 factor in the 1980s is the No. 4 factor today.

Choice A: Liquid Assets

Lenders need to verify that you have money readily available for the down payment, closing costs and reserves. In the 1980s, lenders considered money in savings and checking accounts, as well as securities, as liquid assets. Today, lenders also take into account semi-liquid assets, Marc Greenberg such as IRA and 401k savings that, in the electronic age, generally can be turned into cash in 24 hours.

Choice B: Credit

In the 1980s, credit reports were less thorough and more subjective. Also, there were lots of holes and missing information. Credit scoring, a standardized point system designed to rate how creditworthy a borrower is, came into our industry in the 1990s, making underwriting credit evaluations much less subjective. In the eighties, getting an "easy" was the luck of the draw; different underwriters at the same institution could very well come up with different findings on the same file. In a sense, today's credit scoring system replaces the factor that mortgage lenders referred to as "character" in days past: face-to-face evaluations with your banker have given way to computers that churn out numbers according to a set formula.

Choice C: Collateral

With a mortgage, your collateral is the property you are buying or refinancing (and generally only the property). In 1983, a minimum down payment was 10 percent; now with zero-down, 100 percent loans, collateral is virtually non-existent in some loan scenarios. 

Choice D: Income

In the 1980s, income was evaluated on every loan, with an employment verification form, W-2's, income tax returns and paycheck stubs part of the standard operating procedure. Debt-to-income ratio could not exceed 40 percent. Today, our lenders accept "stated income" for many loan programs.  In fact, if you have good credit and substantial assets, income is virtually disregarded.  And debt-to-income ratio is now sometimes as high as 65 percent.  This isn't to say that these options are recommended for everyone.  But they're now available, when before they were unheard of.

My How Things Have Changed!

Over the years, I have closed 2,249 loans.  Looking back, it's amazing how things have changed. During my first year as a loan consultant, the average loan was $76,000; in 2005 the average reached $480,000. (Larger loan amounts make increases in conforming loan limits important.)

Also, "back in the day," the minimum down payment was 10 percent, with most people putting 20 percent down. With today's higher housing prices, 20 percent represents a huge chunk of cash, and zero-down, 100 percent loans are not uncommon. 

Oh, and I'd never leave you hanging without the answers.  In the 1980s, income was always evaluated and was the most important factor.  Collateral, credit, and liquid assets followed in that order.

Today, credit is king.  A good credit rating can often compensate for weaknesses in other areas.  Collateral, liquid assets, and income is the way the order in which they follow-up today!

Mortgage Rates Are Low Without Exclamation Points

There are three key facts to note about current interest rates.  These facts are based on the data the Federal Reserve has published on the internet for the period from April 1971 to February 2007.  The statistics are for 30-year fixed mortgages.

1/  The average interest rate over that period was 9.26%.  The median was 8.75%.

2/  During that period of 431 months, interest rates were higher than they were in February 2007 for 386 of them (89.5% of the time).

3/  The only period in the last 26 years when mortgage rates were lower than February 2007 was between September 2002 and October 2005. 

So if people say that "mortgage rates are at historic lows" without exclamation points, you don't need question marks: it's an accurate statement for at least the last 36 years of data.

Loan Rates Based on Mind-Boggling Number of Criteria

[ed.  Hello!  My friend David Marx joins us for this week's edition of Mortgage Monday.  He is principal of Dacor Financial and brings us his multiple decades of expertise as a mortgage broker.  Please join me in welcoming him!]

How is your rate determined?  The process is based on a myriad of criteria, with that criteria varying from lender to lender. For example, the pricing for a 30-year fixed-rate loan from just one lender can come in at some 80 different prices, depending on such factors as the lock period and cost of rebates!

And lenders may offer as many as 10 different interest rates ranging in increments as small as 0.125 percent (1/8%).  Each interest rate will earn a different price in terms of the number of points you have to pay.

On top of that, different lenders offer better programs for certain scenarios than others.  For example, if you're financing a non-owner-occupied property, you'll incur an additional fee.  And some lenders fees will be higher than others.  The mortgage broker's job is to sift through the lender lists of surcharges and price adjustments, and then determine which lender offers the best rate relative to your specific transaction.

Here are some of the factors that alone or in combination may affect the interest rate and the price of your loan.

Factors That Impact The Price of Your Mortgage

1.  Rate lock period.  This period is the amount of time the interest rate you are quoted is guaranteed.  This period is most commonly 15, 30, 45, or 60 days. 

2.  Amount of the loan.  Loans for amounts over $417,000 on first mortgages are known as jumbo loans and are generally a fraction of a point more expensive than typical (conforming) loans.  

3.  Ratio of the loan to the property value.  The more you borrow relative to the property's actual value, the higher the risk to the mortgage lender. 

4.  Your credit score.  Credit reports generate three scores and most lenders go by the middle one when determining what your ability (and credibility) to repay the loan is. 

5.  Occupancy.  Owner-occupied properties generally qualify for the lowest rates while second homes and investment properties may command a rate premium which can be as small as a fraction of a point.

6.  Single family residence or townhouse-style condominium vs. high-rise condos.  Some lenders may place a surcharge on the latter.

7.  Loan purpose.  Cash-out refinancing, where you pull money as cash out of the loan against your property, commands a premium over regular loans that cover the purchase of the house or the straight refinancing of existing loans.

You're probably beginning to get the idea that you can't contact just one lender and expect to get the best loan.  Some lenders won't even write loans on certain types of transactions. 

Behind the scenes, your mortgage broker is juggling all these criteria, and building relationships with lenders --- the best mortgage brokers compare 30 or more --- each with a myriad of rate offerings, in order for you to get the best pricing possible for your particular transaction.

Being Upside-Down: Not Just for Mortgages

The beauty of real estate is that you can apply a lot of its concepts to other areas.  In this case, Money Crashers writes about being upside-down on a car loan and bootstrapping your way out of a situation where you owe more on the loan than your car is worth.

Traditionally it's been easier to go upside-down with cars because of the massive upfront depreciation once you drive it off the lot (and personal finance gurus will say that you should let someone else take the hit on the first two years of depreciation and buy used).

But being upside-down with negative equity in your house is happening more often because of housing depreciation in many areas as well as the negative amortization on many subprime loans.  Many people in that situation just take the credit hit and walk away.  Some have to.  

I heard a joke (at least, I hope it was a joke!) that Washington Mutual is going to be the biggest land owner in the U.S. over the next few years.  The key to ensuring that your standard-of-living goes up when you buy a house is to make sure you don't spend more than you can afford financially and psychologically. 

But catastrophic depreciation in Silicon Valley real estate, while an extremely popular notion, is offset by any of the high-paying jobs you, your neighbors, and their bosses have, plus additional growth.  Yes, there are less jobs here than during the tech bubble, but you have to be careful with statistics and inflection points --- jobs are coming back, and while our Bay Area real estate market is correcting, it's not correcting using a pinprick.