When I was a young whippersnapper, I played a game with my fellow whippersnappers –both boys and girls –called Telephone Line. I’m sure most of you have played this game in one form or another, whether it was called “Telephone Line” or something else. You would sit in a circle –the more people the better –and one person would start the game by whispering a phrase like “my dog has fleas” into the ear of the person to her/his right (or left, depending on your political leanings). The person in whose ear the phrase is initially whispered turns to the next person in the circle and repeats that phrase in a whisper, and the game follows in that manner until the phrase has been passed to the last person in the circle. At that point, the final person in the circle repeats out loud the phrase as she/he understood it.
Ninety-nine times out of one hundred, the original phrase changes rather dramatically through repeated retellings usually due to poor hearing, muffed whispers, possible regional accents, and the kid who’s chewing a wad of bubble gum while passing the phrase along to her/his circle mate. And when it gets to the end, “my dog has fleas” has become “the designated hitter rule has ruined the game of baseball” (or something along those lines). Sure, it’s possible that you have one smart aleck kid in the middle of the line who purposefully changes the phrase (I don’t know anyone who would do that), but this usually happens because humans are involved –and humans, the well-intentioned beasts that we are, just don’t have a corner on the market of perfection. That’s how myths and misconceptions come into existence –and the mortgage world is certainly not immune to them. Let me address just two myths concerning credit scores.
Myth #1: having your credit report pulled by a lender will hurt your credit score. That’s a bold-faced lie! Honestly, it’s PARTIALLY true, but it’s not NEARLY as adverse in its effects as so many rampantly believe. The true part is simple: when you have a lender pull your credit report, this signals that you’re considering as assumption of debt, so the credit scoring trolls who live under a bridge (in a van down by the river) note that you’re displaying “risky” behavior. However, the REAL TRUTH is that such a pull doesn’t knock your score down into basement –and along those same lines, if you have your credit pulled by multiple lenders in a short period of time because you’re shopping for the best mortgage provider, those pulls will only be viewed as one action.
Myth #2: closing out credit cards will improve your score. Paying them off, yes, will improve your score, but closing them can actually HURT your credit score. In general, credit scoring models don’t measure risk by how much credit you have availablebutrather by how much of that credit you’re using – a ratio known as “credit utilization”. When you close an unused account, you reduce your total available credit, so your credit utilization goes up. The trolls don’t like things that go up.
The moral here, of course, is don’t believe everything you hear/read (except this column because this is the absolute truth, of course). Ask questions and investigate so you can be better informed –but be careful who you ask because it might be that kid with the giant wad of gum in his mouth all grown up, and you won’t understand a word he says.
In the early days of Word War II, before the United States joined in the fray, England’s European allies were quickly and systematically falling to the Nazi war machine. England, on its tiny island, was the David to Germany’s Goliath. Germany had an unparalleled advantage with an abundance of technological, industrial, and intellectual wealth at their disposal. Winston Churchill, the Prime Minister of England in these dark days, had no illusions about the Nazis’ power and resolve, but he refused to bow to what so many of his fellow citizens thought was inevitable: the surrender of Great Britain’s sovereignty to Adolf Hitler. Mr. Churchill knew he was outgunned and outmanned, and he had few allies. The only way he and his nation were going to gain an edge over the Germans was through creativity.
One such occasion, Operation Postmaster, involved an island off the coast of West Africa that was under Spanish control. At that time, Spain was neutral in the war, and there were certain rules of what you could and couldn’t do in neutral territory. The Italians had parked a large ship in the island’s tiny bay and turned it into a listening post for German U-Boats to hunt and destroy England’s ships in those waters. Alongside the Italian ship were parked two German ships that acted as support. This was really a no-no, but the Spanish governor of the island looked the other way. It was absolutely critical that these ships and their operations be neutralized, but destroying them would be an act of war committed in a neutral territory – this would not help England’s cause. They chose a more piratical solution.
On an moonless evening, a small group of commandos slipped into the small island’s harbor aboard two tugboats. On shore, English spies threw a large party for the Italians and Germans so the ships were virtually unmanned. While the party was in full tilt, the commandos boarded each vessel, destroyed the moorings, and tethered the Italian ship to one tug and the two German ships to the second tug. On board the Italian ship was a small crew of men who had not gone ashore, and they were summarily taken prisoner. As the party continued into the small hours of the morning, the tugboats whisked the Axis ships away and towed them out to international waters where an English battleship commandeered them as spoils of war. No casualties, and no violation of the rules of war. If it could ever be proven, the worst the English could be found guilty of would be grand theft boat (is that a term?) or “piracy” – which would fit nicely with their heritage.
Creative thinking is crucial in this business. A gentleman excitedly called me recently to ask about a hard-money option to finance the purchase of a home that he wanted to fix and flip. When I told him about the terms, interest rate, and down-payment requirements of a hard-money loan, his excitement turned to gloom, and he almost hung up on me. I told him he actually had three other options that had better interest rates, better terms, and no down-payment requirements. Recently, I worked with a woman who is self employed and didn’t have close to the necessary income to purchase a home on her own, and a co-borrower wasn’t an option for her. I then told her about another option that would enable her to purchase a home in her current circumstances, and she was excited. What are these options at which I’ve hinted? They’re not secret, but they are creative – creative enough that a lot of other lenders wouldn’t think of them at all. Give me a call and let’s discuss your plan of attack!
Lately, I have had a number of borrowers come to me specifically with the desire to purchase a home using a down-payment-assistance program. These programs take on many different looks, but the gist is basically the same: someone is willing to give a borrower a percentage of the purchase price of a home to be used as a down payment, and the obligation is forgiven when the borrower has lived in the home for a certain period of time.
A lot of these borrowers who come to me call it “free money” –and that always makes me pause for a moment before I remind them that nothing is free and that there are two major factors that accompany these programs that MUST be considered and always have a direct effect on the amount of money a buyer can borrow:
- When someone uses a down-payment-assistance program, the banks who are lending the money will increase the interest rate, usually, by about 1.5%. Obviously, the reason is the banks feel there’s more risk, so they require a little more from the borrower –and the other reason, let’s be honest, is the banks are legally allowed to charge that increased rate, so they do.
- The debt-to-income ratio, when compared to other options like an FHA loan, is significantly lower –this means that banks aren’t willing to lend as much money based on the borrower’s income.
After I explained this to a couple I recently met to discuss mortgage options, they asked me what this meant in “real” numbers, so I presented them with exactly that:
Based on their income, with the interest rate increase that the DPA program entails and the lower debt-to-income ratio, they would qualify for a mortgage of roughly $112,000. Conversely, with the same income, if they came up with the down payment themselves (3.5% of the purchase price), the interest rate would be lower, and the debt-to-income ratio allowed would be higher –this means that they would qualify for a mortgage of roughly $193,000. Before I could get that second number completely out of my mouth, one of the borrowers said, “That’s an $81,000 difference! Are you serious?”
While I assured the couple that I was serious, I then asked them which option they would prefer: buy a smaller house so they could get “free” money or look into ways they could put together the 3.5% needed to make the down payment themselves so they could afford a larger house and have more choice of houses. They decided to find the money to make the down payment themselves –the $81,000 cost of “free” was a lot more expensive than $6,755 (which is 3.5% of $193,000). Can’t argue with that!