Ritchie School of Real Estate Finance - Arizona Mortgage Education: December 2012

Friday, December 28, 2012

Danger Zone: Co-Signing Part II

Why does someone ask you to co-sign? They don't qualify, and you do, beware.

Danger #3: credit utilization

What is credit utilization and how can it destroy your credit? Credit utilization is the ratio of your available credit limit on a credit card and the current balance, you want this ratio to be as low as possible to benefit your credit score.

Father co-signs with son on credit card. Son uses entire credit line and pays the minimum payment on-time each month. Is dad effected? Yes. 35% of your FIO credit score is based on paying on-time, 30% is based on debts, which is impacted by credit utilization. Maxing out a credit card can damage the credit as much as being late, credit utilization, or balances, must be monitored and you should know your ratios based on the reported limits on your credit report.

Every month I see several credit scores that would easily be 100 points higher if the credit card balances weren't so high. Pay them down and the score comes back up the next time the creditor reports the lower balance, it snaps back, so that is the bright side.

Danger #4: getting sued

Father co-signs on car and son loses job, doesn't make car payment. Father gets defiant, refuses to pay car payment when lender calls because "it isn't my car." After 90 days car is repossessed, sold at auction for $3,000, loan balance was $15,000, so now $12,000 is still owed. Dad refuses to pay because "it isn't his car." Past due amount is sent to collection. Dad wants to buy a house, but can't, credit score is destroyed by late payments, repossession, past due collection, etc. Dad receives summons to appear in court, doesn't show up because "it isn't his car." Creditor gets default judgment, starts garnishment process. Dad informed by employer that they have received a garnishment for his wages. The next day money disappears from his bank account, garnished by judgment creditor.

Bottom-line: if the person you trusted to pay the debt does not, you need to pay it or life is going to get rough.

Danger #5: bankruptcy

Mom co-signs for son on mortgage, son loses job, mom tries to keep it together, juggles money to pay her mortgage, son's mortgage, and everything else. Mom realizes her efforts are fruitless and decides to file bankruptcy.

Parent co-signs for adult child on credit card, child files for bankruptcy and includes credit card, parent now has a credit card included in bankruptcy potentially reporting on their credit report and most likely owes the debt despite the fact that the co-signer filed for bankruptcy.

Never go into a co-signing situation unless you are fully prepared and able to pay the debt on your own if the other party bails out.

Danger #6: federal government naughty list

Parents co-sign on federally backed Stafford Loan for child going to college. Child attends for a few semesters, spends most of the money during spring break and for cool stuff. Takes a break from college to regroup, student loans eventually become due after 6 months of separation from school. Child not making enough money to pay student loans, puts loans into forbearance for up to three years, meaning no payment due. After three years of avoidance, the loans now need to be paid. Department of Education informs child and parents that the Higher Education Act gives them the ability to bypass the court system and garnish wages directly, and to take any tax refund owed. Oh, and by the way, student loans are not dischargeable in bankruptcy.

Something to know: Stafford Loans (federally backed student loan) are not credit based.

Students can get Stafford Loans based on need with no co-signer since the loan program is not credit driven, a credit report is not even accessed. There is no reason to co-sign on a Stafford Loan, in 2012 for a 4-year undergraduate degree a student can borrow up to $57,500, for graduate school up to $138,000 (includes amount used for undergraduate degree). PLUS Loans for graduate school and private loans are credit driven and some students may not be able to get them on their own without a co-signer.

Let me tell you a secret, add your student onto a credit card that will report as an authorized user on their credit report, ask the creditor if they will report it, if not call one of your other cards until you find a winner. The preferred card has a seven year or more history, low balance, and is paid on-time. Example, 22 year-old added to mom's credit card with a 15 year history, 1% credit utilization ratio, and always paid on-time, the result, an 817 FICO score for 22 year-old, mom and dad no longer need to co-sign on PLUS Loan for graduate school or private loan.

On the Sallie Mae website under FAQ the question "can I get a student loan with no credit"? is answered, "yes, the ones for students do not require a co-signer or credit check." Can a student get a student loan from the government even a day after bankruptcy? Yes, the answer is yes, there is no credit check for a Stafford Loan, but tell your kids about the ramifications of being chased down by Uncle Sam for federal debt if it is not paid back.

Student loans are a topic of their own, so I leave you with this, before you co-sign for anyone, think long and hard about whether you are willing to part with the money, because you may end up paying it yourself.

Have a mortgage or credit question you would like for me to cover on this blog? Shoot me an email so I can address it. If you want to apply for a mortgage for purchase or refinance in Arizona give me a call at 480-203-4641, the application process is easy, and it only takes 10 minutes for me to get the information to get you started on your way to home ownership.

Patrick Ritchie
Mortgage Finance Instructor

Ritchie School of Real Estate Finance

480-203-4641 Cell
Patrick@PatrickRitchie.com

NMLS# 276438 AZ#0913109
Click Here to go to Patrick's Mortgage Website

Danger Zone: Co-Signing Part I

Want to live on the edge? Want to wake up one day to find your financial world in disarray? Here is the recipe: co-sign on a loan.

Danger #1: payment is not made on-time

Father tempts fate, co-signs with son on car, safeguards himself by requiring son to set up automated payments, these payments do not go through properly despite the money being in the bank, car loan reports 30 days late. Credit score declines significantly. Tempted fate one, co-signing father zero, father now spends his days on the phone trying to right the wrong with the automotive lender and the bank the money was supposed to be automatically withdrawn from. Tempted fate two, co-signing father zero, as father wastes his time and encounters massive frustration trying to right the wrong.

If I co-signed for someone, which would probably be limited to my children, I would have them write the check to the creditor, give it to me, and I would send it in. I would also login online or call the automated phone system to make sure the check was good, just to make sure the payment has officially been made. Slightly anal behavior? Yes. Smart? Absolutely.

Danger #2: too much monthly debt lowers what I can qualify for when I need to borrow money

Why not just have my co-signed obligor give me the cash so I can pay it myself. Wouldn't that be easier? It would be easier, but there is a specific reason I would not do that. Debt-to-income, all monthly debt payments owed on my credit report count against my debt-to-income ratio, which translates into this: the more monthly payments I show on my credit report the less I qualify to borrow right now.

This impacts how much of a mortgage a home buyer would qualify for. The reason I want my co-signer to write a check to the creditor is because I want to be able to prove they have paid the monthly payment on their own, from their own checking account (meaning their funds, not mine), and I need the past 12 months cancelled checks to prove this, resulting in the debt being excluded from my debt-to-income ratios when I apply for a mortgage. Let's look at an actual dollar difference by playing make-believe:

Income $60,000/12 = $5,000 gross monthly income

Total debt-to-income ratio $5,000 x 45% = $2,250 (all debts including mortgage should fall inside this amount, the actual ratio ranges from 36% - 50%, I am using 45%)

Debts include car payment of $450, credit card minimum payments $150, co-signed student loan $200, and co-signed car loan $350.

Total debts with co-signed debt = $1,150

Total debts without co-signed debt (because the debts are paid by whoever the other co-signer is for the past 12 months, out of an account in THEIR name that has no trace of MY name, and can be proven with cancelled checks or automated payments shown on 12 months bank statements) = $600

$2,250 - $1,150 = $1,100 for a mortgage payment with the co-signed debt

$2,250 - $600 = $1,650 for a mortgage payment without the co-signed debt

Purchase difference? Assuming monthly taxes of $150, homeowners insurance of $50, and mortgage insurance of $150, and a rate of 3.25% fixed for 30-years:

Taxes and insurance = $350

With co-signed debt $1,100 - $350 = $750 Principal & Interest = $172,332.06 mortgage amount

Without co-signed debt $1,650 - $350 = $1,300 Principal & Interest = $298,708.90 mortgage amount

A difference of $126,376.84, just due to co-signing, voluntarily being saddled with more debt, wow, what a difference, and how disappointing for the person who cannot get what they want because of co-signing.

Do you see the dangers of co-signing just based on debt?

Do it right, if you co-sign make sure the payment is made by the other party from their account by a means that can be documented for the past 12 months, and finally, is paid on-time every month.

Read more about co-signing in Part II.

Patrick Ritchie
Mortgage Finance Instructor

Ritchie School of Real Estate Finance

480-203-4641 Cell
Patrick@PatrickRitchie.com

NMLS# 276438 AZ#0913109
Click Here to go to Patrick's Mortgage Website

Saturday, December 8, 2012

Accounts in Dispute on Credit Report = BAD

Imagine going through airport security, would you rather walk through the metal detector and be on your way or go into a small room for a slow in-depth search of you and your luggage?

For most mortgage applications the file passes through automated underwriting and moves on through underwriting to closing with relative ease, like the majority of passengers filing through security at the airport. However, just like the occasional passenger who left a bottle of liquid in their carry-on by mistake, or forgot to remove their collection of metal elements from their pockets, there are certain things that can trigger a deeper look at a mortgage file. One of the most common I encounter is when there are 'accounts in dispute' listed on the credit report, this classification on a credit report triggers a manual underwrite.

A manual underwrite is when the automated underwriting is tossed and the file has to go through the full body cavity search, often times it turns up nothing, but in regards to those pesky accounts in dispute, they will likely have to be paid barring overwhelming documentation that they are a mistake, whereas if they were not in dispute they may not have had to be paid.

What are accounts in dispute? 'Accounts in dispute' is a classification of accounts that have been disputed by the borrower, but have not been resolved. Consumers should always dispute accounts on their credit reports that are incorrect, but the problem is with disputing accounts that are correct.

When someone disputes an account that is correct it will likely remain on the credit report as an 'account in dispute' rather than falling off. When an account is in dispute it is not supposed to score in the FICO score during the first 30 days while the dispute is going on, so it is a trick the credit repair industry uses in an attempt to circumvent the system: dispute everything whether it is correct or incorrect.

The problem with this is that not everything comes off the credit report, and those accurate accounts that do happen to come off will be put back on eventually. Credit repair as an industry is a waste of money for consumers, people need credit education so they know how to correct their credit reports when the need arises. My book The Credit Road Map covers the process of correcting the credit report, if you don't have it on your shelf come by my office for a complimentary copy. I always leave copies for real estate agents on my filing cabinet, if I am out just tell the front desk I left a copy for you in my office on my black filing cabinet. Take a copy for yourself and some for clients.

People spend thousands of dollars on credit repair that gets them nowhere, and leaves accounts in dispute on their credit report. So what should they be doing? If the account is inaccurate, dispute it until it is off the credit report. If the account is accurate, do not dispute it, either pay it or don't pay it. If the client plans on buying a house in the next 12 months I would like to assess their credit report before they do anything so I can advise them on what to do. If their credit score is high enough, my advice will likely be to leave the report as it is, if there are collections, they have already done the damage by being reported, so paying them is not necessarily going to help much. If there are other past due debts out there that have not been reported on the credit report yet I want them to pay those immediately before they report and damage the credit score. Those become priority debts because they can knock the score below 620 and now the client may not qualify for a mortgage.

Here is the tale of two clients, both have a few thousand dollars in collections, the collections are accurate, the debts are owed, there is nothing incorrect about the collections. One client has done nothing with the collections, no disputing, has not paid the debts, but his score is high enough and is income is enough to qualify for a mortgage. The underwriter determined that because the collections were medical she was not going to require them to be paid.

The other client had about the same amount of debt, mostly medical collections, but had paid a credit repair person over $500 to 'repair his credit.' All the bad debts he owed were disputed, in the end they were not removed from his report, they were all classified as 'in dispute.' Due to the in dispute status the file is red flagged and has to be manually underwritten instead of automated, the mortgage was still approved, he had a high enough FICO score and had enough income, etc. The difference was that he had to pay the collections at closing in order to 'resolve' the dispute, if these were not in dispute in the first place he probably would not have had to pay them if he chose not to. If he did not have enough money to pay the collections this would have been a problem for the client.

In summary, we want to avoid manual underwriting when possible, and the best way is to make sure clients are not frivolously disputing accurate information on their credit report.

Have a mortgage or credit question you would like for me to cover on this blog? Shoot me an email so I can address it. If you want to apply for a mortgage in Arizona give me a call at 480-203-4641, the application process is easy, and it only takes 10 minutes for me to get the information to get you started on your way to home ownership.

Patrick Ritchie
Mortgage Finance Instructor

Ritchie School of Real Estate Finance

480-203-4641 Cell
Patrick@PatrickRitchie.com

NMLS# 276438 AZ#0913109
Click Here to go to Patrick's Mortgage Website

Lender Paid Closing Costs: Vital in a Seller Market

I have a handful of clients who have been writing offers to no avail for the past year. Recently one of those clients requested an updated Pre-qualification Form, they were going to make their 23rd offer in the past 12 months. I don't mind sending out updated Pre-qualification Forms, it's part of my job as a Loan Officer, but I decided to have a heart-to-heart with the client about their offers. They were always asking for the seller to pay the closing costs, in this market they might have a better chance of winning the Power Ball drawing.

I suggested rather than going with the rock bottom lowest rate of 3.125% on a 30-year fixed FHA, instead go with 3.25%, only a difference of $14 a month on a $200,000 loan amount. The appeal is that at 3.25% for the pricing that day, there is a premium (yield-spread-premium, YSP, or also called rebate) of 2%* of the loan amount that can be applied toward closing costs, so on a $200,000 loan amount the buyer can get back $4,000 to apply toward closing costs, that should be enough to cover the closing costs in most situations, lender fees ($995 flat fee for Freedom Mortgage, much lower than most of the industry), title/escrow fees, homeowners insurance, appraisal, property tax escrows, flood certification, recording, and in some cases even a home warranty, home inspection (if they will bill at close of escrow), termite inspection, termite treatment, etc. if there is enough premium, the higher the rate the more of a premium the buyer can have back toward closing costs. On that same day a borrower could have had a rate of 3.99% and received 5%* of the loan amount back toward closing, on a $200,000 loan amount that is $10,000, way more than is necessary.

The reason I am writing about this is because as a lender I work with buyers, and if buyers don't have accepted contracts it does none of us any good. When a buyer is asking for closing costs from a seller in a seller's market it is time to forge a better game plan, and the game plan is for premium pricing to cover the closing costs. It works great, but keep in mind that to use it your client needs to be in tune with what the premium pricing is for that day so if the offer is accepted the rate and premium can be locked in before it changes.

Are all lenders created equal? No. Not all lenders give this premium to their clients, some of them stick it in their pockets instead, I know this because when I talk to former colleagues this is the stuff we talk about, boring yes, yet insightful. So you and your clients should be asking about premium pricing and whether it is going back to the buyer or not. Specifically ask, "at what rate could the closing costs be covered by the lender?" If the answer is, "we can't do that," my number is 480-203-4641, we CAN do that. We also do FHA and VA down to a 620 FICO score, some lenders are as high as 640 - 660 for their minimum FICO score, this is known as a bank overlay, which vary by lender.

Patrick Ritchie
Mortgage Finance Instructor

Ritchie School of Real Estate Finance

480-203-4641 Cell
Patrick@PatrickRitchie.com

NMLS# 276438 AZ#0913109
Click Here to go to Patrick's Mortgage Website