Bruce Norris is joined again this week by Cary Pearce. Cary is the sales production manager for Provident Loans, and he has been involved over his lifetime involved in loans and about $ 1 billion and a half in closings.
One of the things Bruce and Cary began discussing was trying to qualify somebody for being a buyer. It is one thing when a loan does not close for somebody who is the lender; but when you have a hard money loan and are making a payment at 12% interest that falls out, there is a real hurt there. It is one of those situations where you would like to not have too many dry runs unless you happen to be a in a pretty bull market where you can say it is no big deal and you will make it up in price rises. This is something we have not had the luxury of in a while.
Because unemployment has been such a big factor, Bruce wondered how long somebody has to be on a job in order to receive an ok from the lender. Cary said generally with most any loan they want to see a two-year work history. There are some exceptions where if you have a college student with a four-year degree in his particular field and they get a job in that field, then you may be able to receive a loan on less than two years. Cary said in some cases they have done it with only thirty days of pay stubs. However, with a conventional loan this would never fly. The idea that improved employment will immediately help the real estate market is really not true. It is going to have a big lag affect. There are some people who had a two-year work history, were laid off after a year, and are now one month back on the job and wanting to buy a house. This is not going to work since the people at Provident want them to be back on the job for at least a year.
There are some overlays that still overwrite FHA’s 4155 and still do a manual approval. In cases like these it does not have to go through the automated system. However, most of the lenders are doing everything automated and have the overlays where they want the minimum FICO score and employment.
If you are self-employed, it is still required that you have two years of work experience. This means two years average of net income off the tax returns. Usually people try to be aggressive in their deductions, and it does not work so well nowadays. That is the biggest problem with a self-employed borrower, and that is why at Provident they would love to see the stated income loan come back for them because of the fact they write off a lot.
Bruce also asked about the down payment required by FHA since there was some talk about it increasing. It is still at 3 ½%, although they are hearing rumors that they are trying to get it to go up to 5%. However, Cary said he does not know if they will pass this or not. Cary does not think this was originally part of Dodd-Frank, but with a lot going around FHA right now there are many saying they are financially in dire straits. They have to make changes, and this is one of the things they are talking about changing to try to make their program a little bit more stable. Bruce wondered how down payment would help them financially. It may be safe for paper, but that is not much safer. What they are looking at is overall foreclosure ratios with a higher skin-in-the-game and less chance of default.
The safest loan in the country for the last 50 years is a VA nothing down loan. Down payment has nothing to do with it. You could not tell a VA loan from a Fannie 20% down loan. Bruce was able to present in front of Fannie and Freddie in Washington D.C., and they pointed this out. When they showed them the chart, they were surprised. It’s all nonsense about Dodd-Frank being the big saver for the mortgage industry. Whatever VA does must be good enough for the underwriting process. Obviously their percentage is not as high as FHA’s or Fannie or Freddie’s, but they are still doing a fair share of loans. It is the percentage, not the number of foreclosures historically. It is the nothing down borrower with whatever they are doing as far as underwriting, which apparently produces a fairly successful loan. They do scrutinize this package; so it will be full doc and they have to meet the ratios to make sure it is a quality loan.
Bruce asked about cash reserves for an occupant buyer. Cary said FHA does not have a reserve requirement. They have plugged some in where they have $500 left over after all their down payment in costs, and it was still approved. There are some exceptions on investor overlays that come into play. For instance, if the seller or a buyer is going to keep their current home as a rental and also want to buy a new primary residence, then in this situation the overlays will come in and they will want them to have at least a couple months of reserves on both houses. Conventionally it is even worse where in that same example they want them to have six months of reserves for every property that they own plus the new property.
Regarding property condition, Bruce wondered if there have been inspections recently that are really not so critical. Cary said they are still seeing repairs on a lot of their FHA approved appraisals, not so much on conventional. FHA flips are probably the worst only because you have to have two appraisals, a home inspection, and after reviewing the home inspection the underwriter will add any and all health and safety items to the appraisal as repair items. Those typically come in with more repairs, but those are usually the cleanest houses in the market.
Bruce asked what the theory is behind two appraisals. Bruce wondered if the right one or the low one wins, to which Cary said it is the low one. Although he already knew the answer, Bruce wondered why the low one is always right. Cary said it boggles the mind because when they order an FHA case number, you would think that the FHA appraisal should be the go to value. However, the second back-up appraisal is typically ordered conventionally. If it comes in lower, that is the number they are going to go with. There are some people out there who, on the flips, can still get it done with one appraisal. However, most people doing the flips have to have two. Bruce thinks this is insulting, and if he were an appraiser he would be asking the people why they even have a license if they cannot trust the number.
Bruce also asked about down payment gift programs and if any of these exist anymore. Cary said most of them do not. The Nehemiah, Heart, and others all went away because it was seller-driven. However, they knew the money was coming from the seller, and the market just did not like it. Bruce also wondered if there are still a fair amount of gifts coming from relatives now. Cary said they do see a lot of gifts on their FHA loans, approximately 30-40%. He also wondered what percentage of loans were multi-generational or multi-family qualifying. Cary said it was not a whole lot, but there are some out there. There are some other down payment programs, such as Cal FHA’s program Chittap where they do a 3% silent second. This is still a very popular program and helps many first-time buyers as long as they can meet the income limit.
Bruce also asked about fourplex limits. In Orange County it was around 1.2 million, although Cary said generally for a fourplex the number is a little over this number. FHA on Orange County is 1.4, and this is still with 3 ½% down. On multi units 3 and 4 they do a special calculation to make sure you go through an extra procedure and run all the numbers to see if it will still qualify for the 3 ½% down payment. There are some cases where it will qualify.
Bruce wondered if the deals Cary sees come through are mostly purchases or refis. Cary said last year their percentages went way up, and typically their branch runs at least 70% purchase to 30% refi. Sometimes they have been higher than that at 80/20. Just this last year they were about 55-60% with a higher concentration of refis, but this is only because rates were so low. Bruce said it occurred to him that there would not be much of a refi market once we leave this era since no one will touch a 3 ¼ mortgage. They will just keep it as a rental or leave it alone.
Bruce wondered how sensitive he thinks due on sale clauses will be. It is a very attractive niche to say you will sell a property and just wrap it. There are no assumable loans anymore, so it is a due on sale situation. A VA loan has a clause where you can swap the entitlements and someone else can take it over as long as they qualify. As to whether the lenders will actually exercise that due on sale and if somebody does take it over and start making the payment is not known. If they are making their payments on time, they may not ever touch it.
Bruce asked Cary if he gets a sense about where prices are headed over the last six months as far the local market. Cary said they are definitely increases. He and Bruce had talked earlier about how the appreciation is hopefully going to be at least 10% or more. We need this because Riverside alone was down 40-50%. What is interesting about the reticent saying they will have a price increase is they forget they are pairing it with a 3 ¼ to 3 ½% mortgage rate. You start calculating how much the price movement means per month, and it just disappears. At the height of the market there were 2 bedroom, 1 bathroom homes in the wood streets going for over $400,000. Today they are around $220,000. Regarding the interest rates back in the day, if they had to get a fix it was around 5 ½%. You start looking at the payment difference, and it is just night and day. That is why when it goes from $200-$260, which is a big move up, then you take $60 grand and compare it with 3 ¼% mortgage, you see that it is no big deal.
Bruce asked if there is any concern for the industry on the direction. The lending world is getting hit and blamed, some of it deservedly so, New York being an exception. Bruce asked about the changes that could be enacted by Dodd-Frank qualified residential mortgage, to which Cary said the biggest thorn in their side is the whole appraisal process. They used to be able to pick any appraiser in their local market and have them do the appraisal. Today, they have to go through a panel. As the loan officer, they have no say so in who gets the appraisal order. It goes to the corporate office, then they randomly assign it out to someone. Once the appraisal comes in the find out who received the order.
What is interesting is there is not really the same due diligence on the quality. It may come down to if you can do it faster and cheaper. Cary said when they were at National City they went for a short time through one of the national appraisal companies, Street Lengths. Here they would get some really low appraisals because the people there were just trying to get the reports back as quickly as possible without showing any concern about the comps. It was because they were only receiving half of the fee. This was a huge problem, and there is only so much due diligence you can do for $200. Thankfully with Provident’s philosophy, they paid appraiser the full fee, and the management company involved is only paid $25 to help them through the ordering process. However, the appraisers do receive a high quality report, and they are not seeing nearly the number of low appraisals they used to see.
Bruce wonders if Cary sees any evidence of lenders loosening standards. Cary said he does not see anything yet. Stated income is a program they would love to see come back, but it is not on the horizon as far as they know. Bruce wondered if that was always a conventional product that was outside of Fannie and Freddie, to which Cary said it is. Mainly things such as World Savings was very popular with that as well as Downey and a few others. Provident had broker relationships with them and sent them that type of loan.
Bruce asked how changes in loan policies usually take place and who the deciding body is that says when things will be okay. Cary said it is usually Wall Street and whatever they are willing to buy. In Cary’s experience when he was with Home 123, a company owned by New Century, he saw how fast things change. New Century was closing $4 billion a month in mostly subprime loans. The paper division was maybe 10-20% of the overall volume. In late 2006/early 2007 when they took $8 billion to market, Wall Street said they were not buying it. New Century was out of business in two weeks.
Bruce remembered early news articles that said we have basically gone back two decades in loan programs in ten minutes. It was so fast, and it was amazing how quickly the programs started dropping off. He immediately left Home 123 because he was forced out when he was told they could not fund loans or originate new loans. They took the whole team to National City, and slowly but surely they started pulling back all the programs. They took construction financing off the table as well as home equity lines. The alternate A products, where you had a lot of jumbo loans, were also pulled. The lenders and people working for the lenders had probably never even done one. The speed at which everything happened was just a matter of a few months, and it was just amazing how many programs died.
Coming back to today, Bruce wondered how Fannie and Freddie differ in regards to if you are an investor trying to receive a loan. Cary said typically you are looking at at least 20% down to do a non-owner occupied loan, but Fannie and Freddie both have their standard program where you can only have up to four financed properties which has to include the subject you are trying to buy. However, there is an overlay where they will go up to 10, and with that program you have to have 25% down and heavy reserves for all your properties. On this one they will let you go up to ten finance properties. Bruce asked if this is now for both Fannie and Freddie. Cary said he is not exactly sure who they are selling them to since Corporate does not really inform them of it. Bruce and Cary both think it is only for Freddie, but the sad thing they both found out is that they will not do cash out refis on them. Cary checked around with a couple sources in the industry, and they both told him their program would only do purchase and written terms as well. Thankfully for Bruce they found a source out in Orange County, so hopefully all goes well there.
What is interesting is you wonder about a cash out refi from a free and clear property and how yes answers either come about or don’t about in the lending world right now. You just look at the reasoning behind some of the programs and see that you are missing a lot of very safe loans just because you cannot do them. The investors would definitely help the market come back since there are so many of them out there. It is not only the Wall Street crowd buying them, but also the local investor who is really forced to write a check and hopefully get his money back.
If they do in fact just buy a property and want to get their money back, Bruce wondered if it is okay for them if they use One to Four loans. Cary said yes and that they have a program for that called the delayed financing program where an investor would come in, pay cash, and immediately pull some of the cash back. They will go up to 70% on a cash out on a property that has been owned for less than six months. However, you have to document where your down payment came from, and it had to be your own money. It could not be any gifts, so there are some restrictions to it. However, there is a program out there for it.
Bruce asked if you have a credit line on your residence if it counts as one. Cary said it does, but Bruce wondered about if it was unused if the maximum amount you could borrow against it is counted against you as well. Cary said it does, so if you have a $450,000 equity line and have zero owed against it, they are going to count the $450,000 owed against you as if you owed it all. They know you could go out and write a check tomorrow for that whole amount.
Bruce wondered if the eleventh loan exists yet. Cary said it does not as far as he is aware. The only thing you could probably do is go to a commercial local bank to receive either a line or have a loan with a very short fuse. There are some investors out there who have their own equity lines at their bank and are able to go out and do what they want. This is an elective relationship, and it still has to be renewed every year. It is a whole different thing since this will not necessarily work if you want a whole group of rental properties.
The problem with these programs is they can grow out of favor. This was Bruce’s first experience when he had a credit line. He had a $200 grand credit line and it was not a big deal, and they basically used it to just buy trust deeds in the margin. The difference in interest was something they earned. However, at the end of the renewal it was not renewed, and Bruce wondered why. Bruce found out it had nothing to do with him, but that his whole industry is out of favor. Bruce is a perfect borrower, has perfect credit, managed it very well, and none of this mattered. Provident had clients who had the same exact situation where they had no balance on their equity lines, and they received notices in the mail that their line was being closed. This is a bad day because sometimes that cushion is your cushion. You have the $400 grand line for a reason in case something happens and you can float on the boat for a long time. When they eliminate the boat, then that is not good.
If Bruce had a rental property for which he was receiving $1,000 a month free and clear, he wondered what percentage of the income actually gets credited to his side of the table. He wondered if there is a certain percentage that goes to expenses if the people qualify. Cary said in the old days they used to take 75% of the gross rent and minus out any payment you had. The excess was then used as income. Today, at Provident they have a chart they go through where they take your tax returns from the last two years, whatever your bottom line income or loss was, and they start adding back depreciation, mortgage interest paid, and tax and insurance. After a two-year average, out of all of that they deduct the PITI payment. If there is a positive it will count towards income, and if it is a negative it counts as a debt. The old rule went out the window; and in most cases when they look at somebody’s tax returns it hurts them and it is almost twice as bad. They could even have a positive cash flow and have a negative net result.
Bruce also wondered about trust deeds income. Bruce recalled in certain guidelines from a long time ago that if you have a short term trust deed that is one year or less, they won’t use it. It has to have three years of life left on it. If you do have a one-year trust deed, Bruce wondered if it is an asset in addition to being non-income. Cary said they should at least count it as an asset, but they will not count it as income or cash. It doesn’t really make sense since it is like an asset class with no home.
Regarding VA lending to investors, this only counts if the buyer purchases a VA property. At Provident, they do not do anything non-owner VA. It could be on their own inventory they would allow it, but nothing else. Any new buyer coming in and trying to purchase a VA has to be owner occupied. Bruce also wondered about self-employed investors and if they still exist. Cary said they see a few out there, and there are a lot of companies out there where they are showing the strong bottom-line net and are fine. The challenge with 70% of self-employed borrowers is they write off too much, and it hurts them when they go to qualify for anything.
If Bruce had a property that has a pretty strong negative cash flow, he wondered if this in itself would not end his loan app but rather was a ratio of everything he had. Cary said as long as you ratio out you should be okay. They have had some situations where the payment was $1500 and the fair market rent was only $1200. At Provident they can only use 75% of that $1200, so you have $900 offset to $1500. Now you have a $600 loss on paper that will go against you in the debt ratio.
Bruce also wondered about selling immediately after rehabbing and what the guidelines are now as far as conventional and FHA. Cary said for less than 90 days they can still get them done conventionally as well as FHA. Conventional loans will usually require an appraisal and at least a field review just to make sure that the value is solid. If an FHA loan is less than 90 days, then with Providence overlay they have to have two full appraisals and a home inspection to both check the value and make sure the house is in good condition. Bruce wondered if they looked at anything like rehab estimates or margin of profit. Cary said there are some rules when it comes to the profit that fall into the overlay. If it is over 100%, they are really going to scrutinize it.
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