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September 2006

Interest only mortgages

Posted at 8:42 AM, Sep. 30, 2006

More and more home buyers are considering interest-only mortgages to get the most bang for their buck in the current low interest rate market. The loans are, however, double-edged financial swords.
First "interest-only" is a bit of a misnomer. It's not as if the loan is principal free. It's just that the loan's terms permit you to make monthly interest-only payments -- for a period. During that period, of course, the loan balance doesn't shrink.
I met one homeowner who had taken an interest only mortgage plan when he bought a lakefront home, it had a low 'fixed rate' and a low fixed payment -- it's just that the principle went up over time to support the low rate. It was a shock to him that he owed more than he had paid for the home and a good deal more than the place was worth, in today's market.
Mortgage expert Jack Guttentag, the "Mortgage Professor" says the interest-only period is typically 5 to 10 years and at the end of that period the loan converts and your monthly mortgage payment is raised to the fully-amortizing level. The new payment will be larger than it would have been if it had been fully-amortizing when you first signed for the loan. Otherwise at the end of the 5- to 10-year period the borrower can opt to refinance for a lower rate or sell the home and take on another mortgage.
Some interest-only loans never convert and, at the end of 30 years, demand a balloon payment for the principal balance.
You'll have to have the money for the larger payment or the balloon payment or be qualified to refinance the loan. If you can't hack it, you could suffer not only the loss of the property, but also a serious credit report ding. Also, your home may appreciate in value, but your equity gain will be zero during the interest-only period.
The biggest negative is that you never build equity. That's fine if there is appreciation, not so good in a down market, because the value of the note goes down if it has to be sold.
Why then, would you want to pay interest only?
An interest-only payment is less than a principal and interest payment. That gives you additional leverage to buy a larger home, or the same home with less money down or otherwise enjoy greater financial flexibility.
With the reduced monthly cash flow, if there is no prepayment penalty, you can pay extra to bring down the loan balance, while affording a more expensive home in the qualification process. For any period that you only pay interest you will, however, defeat one of the primary purposes of buying a home -- to gain wealth.
"When you pay down the balance of your mortgage, you are increasing your wealth by reducing debt. But so long as you have an interest only mortgage, you are not increasing your wealth in that way," says Guttentag.
"Of course, you may be increasing your wealth by accumulating assets instead. If you have such a plan and you have determined that it is more effective in building wealth during the interest only period than paying down mortgage debt, fine. But for most homeowners, paying down mortgage debt is the most effective way to build wealth, especially in today's financial environment," he added.
Overall it seems as though there may be circumstances that make an interest only loan attractive. The nagging problem with them is that consumers are overspending and this does nothing to stop them from getting in over their heads. If you are going to look into an interest only loan you should talk to a trusted financing pro, like Ed Harrigan at Simons and Leoni Home Loans.

The real deal on foreclosures in NH

Posted at 10:17 AM, Sep. 4, 2006

Recently, I have found myself explaining foreclosures to more potential buyers than usual. (Hang onto your seats, this is a blog of built up info..) I can see 2 reasons why this might be an increasingly attractive route to own a home. First and most obvious, there is a perception of getting a great “deal”. You know, that property that will be worth $500,000 when the market turns around in the next 6 months, but you can pick up for under $100,000 due to foreclosure today. The second reason for more interest may be that more homes are being foreclosed. Therefore there is more selection aka “supply”. This increase in interest has given rise to my inspiration for today’s entry. Let me explain some of the details about properties that are either in foreclosure or REO (Real estate owned) by a bank or lender.
A common misconception, outside of the real estate industry, is that foreclosure and an REO purchase are the same thing. Although they are similar, they are in fact different; they are related  to each other, with an REO sale being a direct result of a failed foreclosure sale. Let me try to define what each is, and their respective merits.
The term Real Estate Owned property has a specific meaning in the real estate industry; a property that has been foreclosed on by a lender and has reverted back to the ownership of the lender. So as already explained above an REO is the result of property that has been foreclosed on, and is available only as a result of a failed foreclosure sale.
What is foreclosure? What are the benefits of buying a house that has been foreclosed on and what are the reasons they fail to find a buyer?
Under the terms of foreclosure a lender repossesses the property due to the borrower’s inability to continue with payments on their loan. Typically, a lender will try to work out an arrangement with their borrower to avoid foreclosure. When there are no other options the lender will begin the foreclosure process.
Once the foreclosure notice has been issued and foreclosure has started the lender can legally sell the property; regardless of whether the borrower has vacated the property.
There are a number of conditions which must be met for a potential buyer to purchase a property at a foreclosure sale: First, the buyer has to submit a minimum bid that includes the loan balance on the property, all accrued interest on the property, attorneys fees, and all costs associated with the foreclosure process. **Note** This is a great time to reflect on the problems created by refinancing or equity lines that come close to 100% LTV (Loan to Value).
To bid at foreclosure, the buyer must also have a cashier’s check in hand for the full amount of the bid. The property is always sold in “as is” condition, complete with tenants who need evicting and any other liens secured by the property.
Because of all the difficulties and lack of concrete benefits in buying at foreclosure, most people who want to buy a foreclosed property will go through the REO route.
The REO method of purchase offers more benefits, and less risk than the foreclosure method.
When a lender takes back a property they then have the property listed for sale by a local realtor. The real estate agent provides them with a current market analysis. The role of the bank is to maximize the wealth of its shareholders. If the foreclosed property can be sold at full market value to release cash to invest, then this is the goal of the lender.
In most situations a bank will already be looking for a quick sale, and as such they will look at the price range of competing properties and price their listing in the lower 25% of that range. The lender knows that this will generate more activity and produce more offers.
Because the lender is working with a real estate agent, and is following a typical market process, a potential buyer will have access to the property for home inspections and all back taxes and liens will be paid off (clear title).
Although the benefits of an REO seem to out weigh those of a foreclosure purchase you should not take them at just face value; you should always look into exactly what you are getting and what you are liable for, should you choose to purchase a property.
In an REO sale, the bank will evict the tenants (or you could leave them there and let them pay rent), remove any liens and clear title. Most of the time however, the bank will not make any repairs to the house and will sell it to you in what is called ‘as-is’ condition: the condition the house was in when repossessed. If this is the case you should seek the services of a home inspector, to find out the condition of the property and to help you decide whether you wish to continue the transaction.
Although a bank owned property might look like a good deal on the outside, it is necessary that you do your background research on the property before you commit to any contracts. Your first priority should be to find out what the house is worth in today’s current market by having a comparative market analysis completed. It is best to arrange to work with a qualified buyer’s agent, so that the comparative data is objective. The listing agent works for the seller and is obligated to try to make you see the value in paying the most for the property. A buyer’s agent is on your side of the table.
Realistically, a lender that is trying to sell its REO property does not, necessarily, sell the property at a bargain price; such would be going against their role to maximize shareholder worth.
It is most likely that the lender will have a whole department to handle their REO transactions. On top of that, many times the board of directors will make the actual decisions regarding offers. They will do this at their monthly board meetings. What happens in real life is that an attractively priced  REO property will collect a few offers before the next board meeting and although most buyers want to get a little negotiating under their belt, at least for pride’s sake, the first offer is often the only chance. The board will select the best and strongest offer with no options for other counter-offers, most of the time.
If the bank approves your offer, then great for you! If they reject your offer and present an opportunity for counter-offers, it will most likely be motivated by strong competing offers and a desire to drive the sale price higher. In my experience, if this happens, you will have 1 last shot at the purchase. The factors that make an offer strong or weak involve inspections, time frames, financing and other contingencies and quick closing, as well as price.
Once your offer is accepted you are in an enforceable contract. It is necessary for you to take a good look at the contract beforehand and maybe have your attorney go over it with you. Once you sign it, you are liable for what it states.
You should have the house inspected by a professional inspector or specialist for your areas of concern. If you have an inspection contingency written into the agreement, you can pull out of the transaction, if the result of an inspection produces surprises or faults with which you are not comfortable. You should always remember that the lender will always want to sell the property ‘as-is’. The decision is typically, whether or not you still want to buy.
You should always consult a buyer’s agent before making your offer. When you do have a realtor working for you, you should ask him or her to find the following details about the property, before you come to a conclusion on price: Are there any inspection reports? What repair work has the bank agreed to? Is there a special "as is" form? How long will it take the bank to accept your offer? How do you deliver the offer?
Working as a team with your agent will further protect you from making uninformed decisions and will help insure that the transaction complies with local, state and federal laws. Your agent will also give you access to the specific data that will help you determine your offer price. Most of all, your agent should bring experience that will work to protect you during the search for a property, negotiations and, ultimately, the transaction closing.
North Conway and many other parts of NH, including most of the seacoast, and certainly the Ossipee Lake and other lakefront areas does not see as large a share of foreclosures as suburban/metro areas. Many properties are second homes or investment or rental properties, and are quite often paid off long ago, resulting in no mortgage. An owner with no mortgage can weather tough times better than those of us that are financed to the hilt. However, the second home market has witnessed much more attractive and aggressive financing in the last 10 years, so I think we will start to see a higher proportion of foreclosures than in the past.
In a buyer’s market, like we are seeing now, lenders and other sellers have to be more flexible. The actual potential of getting a steal with an REO is limited since they are imbedded in our local market at a fair market value, if not already slightly discounted. Therefore, I have concluded that, other than the lack of negotiating, there is no difference between these listings and any other listing that is for sale. In fact, a private seller may have personal reasons to discount the property even further (banks have deep pockets to cover carrying costs), and the private seller will, most likely, negotiate, and may respond to inspection issues more favorably.
In conclusion: Foreclosure auctions require a cash buyer with no inspections allowed and no promise of clear title. These properties may carry large mortgages but, at the least, will have the balance, interest, fees and auction costs built into their lowest “reserve” bid. REO properties are “bank” owned properties listed for sale at fair market value to maximize the return for the lender’s shareholders, with little room for negotiation. Overall it appears reasonable to conclude that no one is giving any real estate away. A smart search starts with a buyer’s agent and looks at the entire market, inclusive of REO and privately owned properties. The best “deal” is the property that suits a buyer’s needs at a price commensurate to those needs being satisfied.