Borrowing down payment money from 401k?

Being a fierce advocate of frugality, I caution against anyone tapping into their retirement funds. The only time I can see it making sense would be for a down payment on a home that will be lived in for a long time. If the situation arises and buyers need funds to close escrow and buy their home, it is good to know the available options.

The cost of using funds in a 401K as down payment should be compared with the cost of mortgage insurance and the cost of a second mortgage, with allowance for the risks associated with each option. The best choice can vary from case to case. Whether you take funds from a 401K to make a down payment should depend on whether it costs more or less than the alternatives, which are to pay for mortgage insurance or for a higher interest second mortgage. Income tax regulations should also be taken of the risks inherent in these different options, because mortgages are most people's biggest tax break.

As an illustration, you want to buy a house in Eagle Rock for $500,000 but have enough cash to pay only $50,000 down. Lenders will advance only $400,000 on a first mortgage without mortgage insurance (MI). You need to come up with another $50,000 to close escrow. One source for the additional capital you need is your 401K account. A second source is your first mortgage lender, who will add another $50,000 to your first mortgage, provided you purchase mortgage insurance on the total loan of $450,000. A third option is to borrow $50,000 on a second mortgage, from the same lender or from a different lender. 2nd mortgages have become rare after the credit crunch because they are a risky investment for lenders. If you were lucky enough to find a 2nd mortgage in this market, it would be at a double digit interest rate.

The general rule is that money in 401K plans stays there until the holder retires, but the IRS allows "hardship withdrawals". One acceptable hardship is making a down payment in connection with purchase of your primary residence.

A withdrawal is very costly, however. The cost is the earnings you forgo on the money withdrawn, plus taxes and penalties on the amount withdrawn, which must be paid in the year of withdrawal. The taxes and penalties are a crusher, so avoid withdrawals if at all possible.

A far better approach is to borrow against your account, assuming your employer permits this. You pay interest on the loan, but the interest goes back into your account, as an offset to the earnings you forgo. The money you receive is not taxable, so long as you pay it back.

The cost of borrowing against your 401K is only the earnings foregone. (The interest rate you pay the 401K account is irrelevant, since that goes from one pocket to another). If your fund has been earning 6%, for example, that is the cost of the loan to you. You will no longer be earning 6% on the money you take out as a loan. If you are a long way from retirement, you can ignore taxes because they are deferred until you retire.

The major risk in borrowing against your 401K is that if you lose your job, or change employers, you must pay back the loan in full within a short period, often 60 days. If you don’t, it is treated as a withdrawal and subjected to the same taxes and penalties. 401K accounts can usually be rolled over into 401K accounts at a new employer, or into an IRA, without triggering tax payments or penalties, but loans from a 401K cannot be rolled over.

Borrowing from your 401K should not prevent you from continuing to contribute the maximum amount that can be shielded from current taxes. If it does, the cost gets high.

Mortgage Insurance (MI)

You can borrow the additional $50,000 you need from the first mortgage lender by paying for mortgage insurance. FHA loans, which are the most popular in low down payment situations like this currently charge .8-.99 for monthly mortgage insurance premiums. That is approximately $200 extra per month added to the payment or $2400 per year for MI premiums.

Mortgage insurance has income tax considerations also. The cost of mortgage insurance is roughly 5% above the after-tax mortgage rate.
For example, if your mortgage rate is 6% and you are in the 35% tax bracket, your after-tax mortgage rate is 6(1-.35) = 3.90%, and the mortgage insurance cost would be about 8.90%.

Second Mortgages As An Alternative

2nd mortgages have become very rare and difficult to find. The interest rates on 2nd mortgages are always higher than 1st mortgages, because in the event of default the 1st mortgage gets paid back before the 2nd mortgage gets a dime. Naturally, in a declining real estate market 2nd mortgages are very tough to come by.

Seller financing is an option, although the 1st mortgage lender may restrict this. Using seller carry backs is a great way to close escrow, but when dealing with bank-owned foreclosures it is never done.

The cost of a second mortgage is the interest rate adjusted for taxes. If the rate is 9% and you are in the 35% tax bracket, the cost is 9(1 -.35) = 5.85%.


To 401k or not to 401k?

While borrowing from a 401K account involves risk associated with changing jobs, the mortgage insurance and second mortgage options entail risk associated with changing houses. These options reduce equity in your house, increasing the possibility that a decline in real estate prices will leave you with negative equity. This could make it impossible to pay off the mortgages in the event you want to sell the house and move somewhere else.

In most cases, however, the risks involved in reducing your equity in the house are smaller than the risks associated with borrowing from your 401K. If the costs are close to being the same, leave your 401K alone.

For specific mortgage questions, contact Sky Minor at 310-709-8283 or www.realestatesilverlake.com

Mortgage lenders being held back from foreclosing because of missing paperwork.

Much hubbub this month in the Mortgage/Foreclosure world about banks having to halt foreclosures in many states because they do not have all of the legally required paperwork. This Foreclosure Freeze has hundreds of thousands of homeowners hopeful. In most states, to bring about foreclosure the lender must furnish the signed note. During the peak of the run and gun mortgage backed securities days the loans were getting transferred many times and some of the notes were lost. It has long been a foreclosure prevention tactic for distressed borrowers to make their lenders show the note. If the lender cannot, some judges around the country are postponing foreclosure until they can. This impressive loophole has caught on like wildfire across our default-laden country. While I am certainly all for homeowners avoiding foreclosure, I can see that this is not a good thing for the market at large.

Yes, foreclosures are a bad thing, but delaying them is even worse. I have two points to justify that statement. The first is the money tied up in the house that can't be recovered or re-lent to anyone else. Those servicing companies who have put a moratorium on foreclosing on the property often times still owe the ultimate investor the scheduled monthly interest, based on their contract. And if the loan is possibly subject to a buyback situation, the originator of the loan (whoever sold it to Chase, for example) is certainly going to argue that it is not "on the hook" for interest charges that Chase voluntarily stopped making and thus owed. No one will pay and the note will be in limbo awaiting some legal verdict from a judge who is also dealing with thousands of other distressed mortgage cases. The legal system will draw out these cases and whatever money is left from these mortgages will take longer to recirculate into the lending pool. In a word, there will be less liquidity. The current foreclosure issues increase uncertainty - and markets don't like uncertainty. Bank stocks are down, and they continue to hold on to trillions of "lendable" money because of nervousness about the future. Chase announced that it would now be reviewing 115,000 foreclosure cases in 41 states. PHH's president and CEO stated, "PHH Mortgage is actively cooperating with its regulators, is responding to such inquiries and has completed a comprehensive review of its foreclosure procedures. Based on this review, PHH Mortgage has not halted foreclosures in any states and has no plans to initiate a foreclosure moratorium." When push comes to shove, the courts will tie up the process between lenders and homeowners and only the lawyers will win.

The second problem with delaying foreclosures is that it will create unnatural demand for the properties on the market because there will be less supply. Prices will be driven up in the short term, as with all bubbles but then once the bottleneck eases and the huge numbers of bank-owned foreclosures hits the market, the opposite will be true. At that point you could see a rash of new foreclosures from recent buyers who are now underwater because of price softening due to the "normal" amount of foreclosures being on the market. In Los Angeles the competition is fierce to buy properties right now. This is causing overbidding and tremendous buyer frustration when buyers have to write 25 offers to get one accepted. Stopping foreclosures is an indirect manipulation of the real estate market and will ultimately slow a true recovery by causing peaks and valleys. A natural and balanced market can only exist if all of the foreclosures are purged from the system and all the bad debt is finally settled so the banks know how much money they have.

New sites and videos

Hi all, I'm excited about having some new web projects out. First is the freshly polished site for Silver Lake Real Estate. We are making moves (pun intended) on both sides of the hill, in zip codes 90039, 90027, 90065, 90042 and 90041. Silver Lake in particular is an area we are focusing on because of it's large number of unique and architecturally significant properties and it's new (unofficial) status as the hub of LA's East Side. Silver Lake home values were the least effected out of all the East Side neighborhoods in the 2007 real estate downturn. That is attributable to heavy gentrification and real wealth moving into the area, the kind of money that can afford to hold on through downturns. Silver Lake will be the powerhouse market for years to come, and Preferred Realty and Loan will be well positioned to service the market.

Secondly, Roger has debuted my first Youtube commercial. It's quite a little production, I must say I am quite happy with how it turned out. Check it out here. We are debating running it during the Super Bowl, the jury is still out.

That's all for now. Thank you for your continued support.

Sky Minor

Bad jokes about the bad economy.

The economy is so bad, I bought a toaster oven and my free gift with purchase was a bank... If the bank returns your check marked "Insufficient Funds," you call them and ask if they meant you or them...Angelina Jolie adopted a child from America...My cousin had an exorcism but couldn't afford to pay for it, and they re-possessed her..When Bill and Hillary travel together, they now have to share a room.

OIY GEVALT!

Transactional Funding

There has been much talk lately announcing the return of profitable flipping conditions in LA. California and Los Angeles County has been among the highest in the nation in foreclosures since the real estate bubble burst approximately three years ago, and we have seen our home prices plummet by as much as 50% in some areas. Simultaneously, this wave of foreclosures has created a demand for rental properties as former home owners become home renters. This has resulted in rents that have remained relatively stable as the prices of homes have steadily dropped. This unique set of circumstances has generated bargain investment property prices for investor buyers that haven't existed in LA since the mid 90's Northridge earthquake. It has also created a niche for those looking to flip properties once again. Purchase demand is still very strong in most areas despite a large backlog of inventory held by the banks.

Most of the foreclosures that are being sold at auction and through bank owned REO listings need only minor, cosmetic repairs to bring them up to rental or FHA financing standards. Investors willing to purchase these properties, can put $5K-$10K into them and then turn around and sell them to investors for a reasonable profit. These investors are still able to purchase the property at a price that makes it possible for the property to generate strong positive cash flow at prevailing market rents.

The catch in this process is that, in order to acquire a property at the Trustees' Auction, the prospective buyer has to come with cash. Many flippers lack the personal cash reserves to tie up more than one or two properties at a time. This is where transactional funders enter the picture. My transactional funders loan money on a very short term basis for investors to purchase properties at the auction or through the banks. They require that the end buyer (the person who the investor is selling to), must have loan approval and be under contract on the property. Once that happens the transactional lender will fund the loan to the investor and the investor will enter escrow with the buyer. The investor is coming up with little or none of their own money for the deal and making a hefty profit.

These transactional funds are always protected by a first position lien on the property. Once the properties have been successfully rehabbed or otherwise turned over,(Max 30 days holding time), they are resold and the transactional funders are repaid in full. The transactional funders usually see their money tied up for no more than 30 days and they are paid 3-6% on their investment. This equates to 50%-125% annualized returns on the average transaction for them, which is phenomonal. Everyone wins.

If you are seeking transactional funding, contact me here or call/sms 310-709-8283.

Stated income loans axed by new Obama bill.

Stated income loans were mortgage loans made to borrowers without proving their income sources. They were largely removed from circulation after the 2007 mortgage meltdown. After that, loans made without income and sometimes without assets became extremely rare and coveted. Several intrepid portfolio lenders getting their money from alternative sources like hedge funds and local pension funds would offer the loans and be completely swamped by eager borrowers. Their $500m portfolios would fill in a matter of months and they would stop funding new loans. For borrowers and brokers it became a hunt for a slot with the next lender before they filled up. The market for stated income loans (also called no-doc, SIVA, Low-doc, etc.) was on its last legs.

Today that dying market was given it's Coup De Grace. The reform bill signed in by Obama outlaws stated income and no doc loans. The market already did not want these loans and now the government has finished them, albeit with some degree of nebulous wording.

Part 1074 (b) of the bill reads:

“No creditor may make a loan secured by real property [i.e., a mortgage loan] unless the creditor, based on verified and documented information, determines that, at the time the loan is consummated, the consumer has a reasonable ability to repay the loan … and all applicable taxes, insurance, and assessments.”

The bill also outlines the steps mortgage lenders must take to verify a person’s ability to repay. As is the typical practice now they must review the borrower’s credit history, current income, current financial obligations, and debt-to-income ratio. To verify the borrower’s income, the lender must review IRS W2+1040 statements, tax returns, bank records, and payroll receipts / pay stubs. This means underwriter. Loan officers at banks or mortgage brokers cannot issue a pre-qualification without seeing all this documentation. This is already effectively in place now so it's not too big a shock.

I personally think that the lenders will find way to circumvent this regulation once the market will return. When prices+inventory+employment stabilize then support will be found for loans as risky as stated income. I am a believer in the market always finding ways to do what it will naturally despite outside influences. There have been quite a lot of outside influences in the mortgage market lately and the industry itself is in a state of flux. It is reinventing itself and rewriting its rules in the midst of the best interest rate environment in recent history. When the dust settles I think that stated income loans will return but until then, get those W2s and 1040s ready.

Rapid Fire FHA mortgage loan payment tables

For pocket reference, this is the all included PITI payment amount for an FHA loan assuming the borrower puts only 3.5% down.

Loan Amount=Monthly Payment
150k = $1197
250k = $1923
300k = $2012
500k = $3792
729k = $4280

Go forth and finance!

Rachel and Sky hike some of the Naapali coast crestline

 

Sky Minor and Rachel Mintz hike in Kauai 2010.

The first timer's guide to getting a mortgage loan.

I was writing an email to a first timer who just got her offer accepted on a building and will be getting an FHA loan. As I was telling her the steps that we would be taking together, I realized the need to syndicate instructions for getting a mortgage because there is a lack of knowledge with the general public in regards to this detailed and exacting process. Considering that getting a home loan is the largest financial transaction of most people's lives I think it's important to educate and prepare those who are about to get their first mortgage. Getting your offer accepted on a property is just the beginning. Here is my letter, I've crossed out her name for privacy reasons, and because she's a mega-huge celebrity. (OK, that last part may be true).


"Hi xxxx, since this is your first time I'll outline our process here for getting you your mortgage in case you are interested in what lies ahead.
Once you send me everything I need (bank statements, paystubs, W2s, Tax Returns, ID) and I get the purchase contract and title prelim report from escrow, I will submit your loan to the lender. Danielle my processor will be running xxxx's credit and information through a computer underwriting program called DU. It underwrites the file electronically and gives me feedback and a case number which I can use to take the loan to different lenders. Right now I'm using a bank called xxxx because they are the quickest and smoothest FHA lender on the market. I can also use Wells, Citi or Metlife as the need may arise. Most lenders have the same rates because they are all selling the loans to the same place-Freddie Mac. You will have to get an appraisal for the property, which is paid by you and refunded at closing. The appraisal for a one unit property in LA is usually $300-$350. Once the appraisal is completed, the bank underwriter will look at all the items in the loan package and issue a loan approval with conditions attached. Those conditions will be things like updated paystubs, bank statements, gift letters, etc. I'll be asking you for these items and it's important that you return them quickly. We will lock our interest rate in after loan approval and at that point, the clock will be ticking. We will have 30 days to fund our loan or else re-lock it for a fee of about $500. I will consult you when its time to lock the rate. After we satisfy the underwriters conditions, you will sign your loan docs. Usually escrow sends a notary to sign with you, or you go into the escrow office to sign. After the loan docs are returned there will be some finalizing from the underwriter and then your loan funds into escrow, they give the seller the money and give you the deed and record everything at the county recorder. Once that's done the property is all yours. You usually get 1.5 months until your first payment is due. You can choose if you want your property tax and fire insurance impounded (paid monthly with your mortgage payment) or not. I recommend getting impounds because it makes less bills to manage. The lenders give you a better rate if you impound also because they know the taxes and insurance will be paid.

If there is any further questions you may have, don't hesitate to ask."

So there it is, the steps involved with closing a mortgage loan. The process has gotten more difficult since the mortgage industry meltdown of 2007-2008 and it's important to use a lender who knows what they are doing and has kept abreast of the rapid fire mortgage guideline changes. As always, I'm happy to answer any inquiries or add you to my list of 200+ closed loans.

Getting your offer accepted is just the beginning.

The Return of Foreign National Mortgages

Getting a mortgage is not easy. It's made even harder when you are a foreign citizen trying to get one. First of all, you have no social security number and therefore no credit in the US, your income is from another country and is not verifiable by US lenders, and your assets are in non-US bank accounts. It's a daunting process and it has been neigh impossible since the credit bubble/mortgage meltdown of 07.

I have come across a pair of foreign lenders (in California only). They both only go to 65% LTV for purchase or refinance loans. Their rates are between 7-9%, neither will require income documentation but both will need to see 12 months of payments in reserves. The maximum loan amount is $1m. This is a tough loan scenario to make for most situations. Considering the apparent lack of any significant bank or broker programs lending to foreign nationals here in California, I think it is a step in the right direction.

As always, you can reach me at 310-709-8283 or here

New FHA guidelines. The times they are a changin'

FHA has been under close scrutiny as of late because, quite simply, they give out mortgages to many borrowers with shaky credit histories and questionable abilities to repay. Hoping to mitigate potential losses, the government is instituting several new policies bent on making the trillion dollar FHA-insured loan portfolio less prone to subprime-style blowout.

1. UFMIP increased to 2.25% with case numbers after April 5, 2010. This is the amount that borrowers have to pay at closing for their mortgage insurance. This fee is why FHA loans are so expensive compared to conventional ones.

2. Seller contribution to closing costs reduced to 3% effective in the summer (exact date TBA).

3. Increased lender enforcement. (This means we must be diligent in the loans we approve and close-expect more patriot act type verification of identity).

4. HUD is also asking Congress for authority to increase the cap on the annual MIP.

5. Waiver of property flips. (Our lenders have verbally informed us that once a mortgagee letter is sent by HUD, they will follow the flip waiver guidance shortly thereafter). This is the good part, as many flippers will sell their finished houses to FHA first timers who don't want to do fixup work.


On the surface this looks like HUD is getting stricter, however in an effort to protect the FHA insurance fund these changes are necessary to ensure longevity in the fund. Keep in mind that HUD has had a history of lowering MIP’s once the fund improves along with the overall economy. FHA remains the only choice for many borrowers, and I believe that FHA is the linchpin that is supporting the revival (or at least sustenance) of the residential housing market.

2010 Mortgage outlook.

I hope everyone had a very happy holiday season and is ready for the new decade! 2010: The Year We Make Contact was a notable sci-fi movie and also could be an apt catch phrase for the real estate market this year. I predict that quite a few first time home buyers will "make contact" in 2010 thanks to a continued stream of REO foreclosure properties coming on the market keeping housing supply high and prices low. Extended tax-credit incentives coupled with low-down FHA financing programs make the down payment requirements less restrictive which will enable many to purchase. When it's possible to get a $400,000 house with $15,000 down payment and then later receive a $8,000 check from the IRS essentially getting into a home for $7,000 out of pocket, the buyers are going to be coming out of the woodwork. (Although it should be noted that monthly mortgage payments on low down payment FHA loans are notably higher than conventional loans). Equally important to the first time buyer or anyone getting a mortgage is the historically low interest rates, currently about 5% on a 30 year fixed mortgage under $729,000. Our $400,000 example above with only $15,000 down would be a monthly mortgage payment of $2157 at 5% interest. All of these buyer-positive factors will allow many buyers to make contact with their first homes in 2010.

Where will mortgage rates head in 2010? I personally believe that with so many dollars being printed in the last 18 months, the US has MASSIVE inflation looming. Supply and demand states that the more of any one item there are, the less valuable it becomes. The US dollar is no exception. Those who want to maintain the value of the dollar (all Americans, the gov't, the fed) must increase interest rates in order to make holding $USD more attractive. Over the longer term I believe that interest rates have nowhere to go but up, as much as Uncle Ben and the Fed will try to keep them down to encourage economic growth. Unless the fed wants to devalue the dollar to hyper-inflationary German levels it must move interest rates up. Moving rates up will increase mortgage rates. I am advising all mortgage clients to fix in their rates right now.

Remember that a fixed rate mortgage is as good a hedge against inflation as any other investment (Gold, Commodities, Chinese Yuan, etc). As the value of the dollar decreases, the amount of dollars that a borrower owes against their property remains the same but the market price for that property is increasing because dollars are worth less. It takes more dollars to buy the same things, because the value of a dollar is decreasing as more are created. Taking a 30 year mortgage loan at fixed interest will be at a fixed dollar/value ratio based on the day the loan is created. That ratio will continually diminish as inflation continues. For an example consider a person who bought their house in 1960 for $50,000 and got a $40,000 mortgage. Annual inflation back then was about 4%. So by 1970, their dollars were worth about 60% of what they were when they borrowed the $40,000 in 1960, but they still owe only $40,000. That $40,000 is now worth $66,000 but they still owe only $40,000(This example is oversimplified for educational purposes.) Track the progress of the 1960 vs. the modern day dollar here. $1 in 1960 is worth $7.15 in 2010 which means the real dollar value of the mortgage loan decreased by 710% in that time. Even if the fair market value of the real estate did not increase at all, an owner would have seen a 710% return simply because of inflation. Real Estate prices in Eagle Rock, CA and Los Angeles at large have increased by much more than that. In this case, the borrower would have paid off the mortgage from 1960 with much cheaper 1990 dollars. A fixed rate mortgage is one of the best inflation-fighting investments around.

2010 will bring a new set of guidelines and paperwork for mortgages. Banks and brokers are updating to a totally reworked set of disclosure forms. These forms were designed by HUD with the intention of making it easier for the consumer to understand the terms of their mortgage. Some think the new forms are an improvement and others do not, it is a point of contention in the mortgage world and the residential real estate industry at large. All RESPA effected institutions are required to conform to this new legislation as of 1/1/2010. I will be interested to see the general public's feedback for the new protocol in the months ahead. If you are getting a new mortgage loan in 2010, please comment here on your experience (especially if you have gotten one before-compare the old and the new). FHA appraisals will now have to be done through AMC (Appraisal management companies) which means more FHA loans will fall out because of low appraisals. This situation with AMCs has been the norm for conventional loans for a long time, much to the chagrin of many mortgage originators, brokers, appraisers and agents. Now FHA will be similarly effected. What causes the controversy with AMCs is that frequently the properties will appraise below what the buyer has purchased it for, and the lender will not fund the mortgage. Because of AMC regulation, the borrower must pay for the appraisal ahead of time (Typically $415-$720 in Los Angeles) without knowing if it will appraise for that amount. The appraisal order goes to the lowest bidder, who sometimes comes from 100 miles away and knows very little about the market conditions of the property they are appraising. Real estate is a localized thing and different zip codes can mean drastically different values. This fact usually gets overlooked by bargain AMC appraisers and their appraisals are not accurate. Getting stuck with a low appraisal is not a pleasant situation for a borrower, so if you are buying a property in a multiple-bid situation, exercise prudence with your overbidding. Having a good real estate agent and realistic expectations of value will remain important in 2010.

Still NOT allowed in 2010 are electronically signed loan docs and/or disclosures. Although a handful of pioneering lenders are adapting to E-signatures, the majority of banks and lenders are not allowing them. In this regard, I believe the mortgage industry is lagging far behind other paperwork-heavy industries. The benefits of E-signing are self-evident and numerous: Requiring paper kills trees. It costs money for paper, ink and storage and takes much longer than electronic signing. Usually the mortgage industry is an early adapter of technology, when I began in the business in 2003, the processors were already using Twitter-like dispatching programs to get conditions delivered, and were advanced systems allowed large files to be transferred easily. The lenders all had very advanced back-end programs and it seemed everyone was very high-tech. (I joined Myspace that year, incidentally from a mortgage contact.) The industry is still buzzing with tech, but is stonewalling a ground-floor innovation with E-signatures. It is confusing to me why the mortgage industry at large would not be using electronic signature technology.


To ask me any questions about mortgages email me at Sky@skyminor.com. I hope 2010 is a productive and eventful year for everyone.