[photopress:CACDQF8P.gif,full,alignright] Actually this is kind of funny.  Zillow says the whole town goes up (turquoise line) while Ardell’s house takes a nose dive (dark blue line).

Anyone have a clue as to how that happens? 

[photopress:zillow_banned_arizona.jpg,thumb,alignright]Josh Dorkin of Bigger Pockets emailed me the other day and asked me to comment on his article regarding Zillow’s troubles in Arizona.

I delayed my response for a couple of reasons.  Mostly because I do not share Josh’s view that disclaimers, of any kind, will resolve the problem.  And yes, I do believe it is a problem, and do side with Arizona on this one.

As with any action, you have to look for the underlying reasons for the action, and not simply the specific legal issue used to support the action.  I do not like to write about the negative sides of Redfin and or Zillow.  I do, and have, told them both in person how I feel about their negative sides, but hate to highlight the weak points.  I’d rather write about their stronger points.  But this is “newsworthy” and so I agreed to Josh’s request.

To me it’s real simple, and I have personally told the people at Zillow how I feel about it.  The Zestimate should pop up a RANGE of value.  PERIOD!  It is THAT simple.  None of this “house is worth $723,000” and then scroll down, look this way, no look over here, down there and around the bend and THEN you see a “range of value”. 

There should never be a SINGLE value attached to a property in the form of a Zestimate any more than an appraiser can guarantee a “TO THE DIME” value, or an Agent can say stoopid things like, “I will make sure you don’t pay a dime more than the house is worth!”.  AS IF a property can be valued “to the dime”.

As for “of course people know that’s not the REAL and EXACT value”…NO, people do not KNOW that, and they never know exactly what a house is worth, and they are always looking for some basis for value.  So I have to agree with the State of Arizona on this one.  Zillow Zestimates should be a range of value and not a specific number. 

I think it’s Ok to say this house is worth somewhere between $700,000 and $800,000…maybe.  It’s not OK to say it is worth $723,000 and then add a bunch of disclaimers up and down and around the number.  So Josh, no.  I don’t think the answer is more disclaimers, to help counteract the damage done to the homeowner in the first place.

I’m going to do a “How’s Zillow Doing” post after we get a bit more into this season and real sold comps from high season.  My guess is most sales will have fallen within the range.  My hope is that not too many have fallen AT the Zestimate and BECAUSE OF the Zestimate.

In the meantime, if every State bans Zillow because homeowners are being damaged by people’s perception that the Zestimate is meaningful.  If Zillow is banned because buyers are actually making offers at the Zestimate price (and they are).  I say let the States protect their citizens as they deem appropriate.   It’s one thing to not want the Realtor Organization to cast aspersions at new business models.  It’s quite another to not expect State Laws to protect their citizens, from broad monetary damage, on their constituents’ most valuable asset.

[photopress:fear.jpg,thumb,alignright]In my last two closings, the buyers were fearful of maybe having a prepayment penalty.  A lot of fear has been spreading around about sub-prime mortgages and pre-payment penalties, to the point where everyone is catching the fear bug.

I thought I’d try to explain what sub-prime mortgages and pre-payment penalties are about, in a way that most people can follow, to help alleviate some of this fear.

Say you go to your friend Joe and ask him to lend you $20,000.  You tell him you are more than happy to pay him interest.  Joe says, well…I was going to go buy a two year CD with that money.  The bank is going to give me 5% interest.  You say, no problem, I’ll give you 5% interest.  Joe says, well no offense, but seriously, I trust the bank a whole lot more to pay me that 5%, and to give me my $20,000 back, when the CD comes due in two years.

You think about it.  You know he’s right.  There is more risk for Joe if he lends you the money than if he just bought a CD.  More risk equals higher return.  So you say, look Joe, I’m really in a jam here.  Joe says no kidding.  Why would someone lend you money?  You told Sam you’d pay him next week and it took two months. (equivalent to low credit score-didn’t pay others on time or “as agreed) So you offer him 6%.  He says an extra 1% isn’t really worth the risk on $20,000.  An extra $400 at the end of two years isn’t worth me sweating that you might not pay me.  So you ask him at what point might he consider lending you that $20,000.  He says given the risk I’m taking on you (with a low credit ranking) I’d give you the money if it was 8% a year.  That’s $600 a year more than the bank would give me and $1,200 more over two years.  OK.  at 8% I’d lend it to you.

That is why there is a higher rate and why it is called “sub-prime”.  “A” paper” or the “going rate” would be the 5% in that example, and the “sub-prime” rate is the rate someone is willing to lend at to a lower credit worthy borrower, in this case 8%. 

Now Joe says, but hey.  You have to guarantee I’m going to get that 8% for two years.  I don’t want to stick my neck out and only get $100 bucks for my trouble and worry.  You say, but what if I have the money to pay you back in 3 or 6 months.  Joe says, NO WAY!  I have to sweat it out for six months thinking maybe I’ll never get my money back and all I get is 3 months worth of interest at 8% for my trouble?  That’s only $150 more than I would have made at the bank, and the bank’s rate might go down in three months.  No.  If I’m going to lend you that $20,000 for TWO years, I want 8% interest for TWO years.  No fair paying it off early.  I don’t want the aggravation for a measly $150 benefit. 

I want to be able to count on that 8% for at least two years IF I’m gonna take a chance on you.  You say, how about, if I pay you in 1 year, I give you 8% plus an extra $200 bucks for your trouble.  I think I’m going to be paying you 8% for AT LEAST 2 years.  BUT, if I do pay you early, I’ll give you a little more than the 8%, say $200 dollars. (the $200 is the prepayment penalty).

So Joe lends you $20,000 at 8% interest with a $200 prepayment penalty if he doesn’t get 8% for a full two years.

People talk about sub-prime and pre-payment penalties like they are something bad.  In fact they are giving someone a chance who maybe has a hard time convincing people that he’s “a safe bet”. 

If you have a credit score of 700 or more, you really shouldn’t be worried about pre-payment penalties and sub-prime loans.  The only time they can creep in to people with high credit ratings is when you are buying more than you can really afford or your other debts are higher than they should be for you to spend that amount for the house.  So make sure you know your ratios.  Your “front end” AND your “back end”.  But that’s another story for another day.

[photopress:darkside.gif,thumb,alignright]This morning I posted “the easy version” (post below this one) of the Real Estate Agent’s Role in the Lending Process.  I will now take it over to “the darkside” where the correct answer is a zero down, stated income, stacked costs, sub-prime loan with a pre-payment penalty. 

I call it “the darkside” because it goes to least conservative loan product.  But both are examples of CORRECT ways to proceed.

Buyer:  I want to see townhomes priced at $350,000.

Agent:  Have you spoken with a lender?

Buyer: Yes, and here is a pre-approval letter for up to $350,000.

Agent: OK, let’s go see some townhomes.

Buyer finds one he wants to purchase for exactly $350,000.

Agent:  How much are you planning to put down (Needed to write offer, as downpayment amount goes into the Finance Contingency.)

Buyer: Zero Down

Agent: Do you have the GFE from your lender? 

Buyer: Yes.  Here it is.

Agent: OK.  So looks like you will need $10,000 for closing costs and prepaids.  Do you have that?

Buyer: No, I need you to have the seller pay them. 

Agent:  OK, well the property has been on market for 20 days.  Let me call the listing agent and see if he has any other offers.  OK, no other offers.  Let’s try to get the property for $10,000 less by offering full price with the seller paying $10,000 toward closing costs.

Buyer:  What if the seller won’t pay them? 

Agent:  We might have to stack the costs, or part of the costs, on top, which would push the price up.  But based on the comps, it should appraise with no problem.  Let me call your lender and see if we can push this to $355,000 or $360,000, if we need to stack the costs, and how much that will increase your payment.

Buyer:  OK.  Thanks.  Here’s my lender’s number.

We call the lender.

Lender says:  You can push the price up, as long as buyer is OK with the payment at the higher price.  We’re using “stated” income because he’s hourly, and I can’t get his current income to average out for qualifying purposes.  But he has plenty of money to make the payment up to $400,000.  I just can’t get the income to qualify on a full doc.  So it will be sub-prime with a 1 year pre-payment penalty, until he has two years’ history at his current income.  Then he can refi.

Agent:  What rates are you using and what did you use for taxes and insurance when you pre-qualled him? 

Lender: 6.25% on the first and 9% on the second.  I used $250 a month for the taxes and $250 for the condo fee.

Agent:  Sounds good.  The taxes on this one are $270 but the condo fee is only $230, so it’s a wash.  Anything else I need to know to write the offer?  I’m using $10,000 for closing costs from the GFE.  Does that sound right? 

Lender:  Better make that $11,000 to be safe. Zero downs are getting harder to do on a stated income basis with stacked costs.  Not sure I can squeeze the costs back on the 2nd these days the way I used to.

Agent:  Looks like the payment on your first at $350,000 is going to be $1,725 and on the second it’s $564. plus taxes and HOA dues, that’s a payment of $2,790 a month.  If we have to stack the costs to $360,000, that will push the payment up on the first by $50 and the second by $15 making the total $2,855.

Buyer:  That’s OK.  I have no other payments and am working on my credit score to get it up by the time I refi after the pre-payment penalty is over.  I have an old judgment I’m working on to get it off my record from my divorce.  But I can always get plenty of overtime, so I can handle the payment.  I had to rent after the divorce, and I’m just tired of not having my own place and I want to get a lot closer to work with all the overtime I’m doing.  Let’s try to make the offer with the costs included in the asking price.  But I’m OK if the price pushes up with the costs stacked on top.

*******

It is the agent’s role to know that the offer they are writing is “doable”, that the buyer is aware of his payment and prepayment penalties, and is OK with all that.

I don’t have to be his “Mommy”.  I just have to know that he understands FULLY what he is “taking on” and is in full agreement with full knowledge.

Another scenario same as above could be:

Buyer: $2,855 is a lot of money until I pay off my car in a year.  Can I do interest only?  If I did interest only on the first, how much would that save me a month.

Agent:  About $250 a month.

Buyer:  Well, let’s just make the offer and I’ll be OK with the higher payment if I have to go that high.  I’ll talk about other options with the lender if we get into escrow.  If it can’t be interest only, that’s OK.  But thanks for showing me the difference in payment.  Doesn’t seem like enough to make that much of a difference.  I’ll decide later.

Buyer:  What about insurance?

Agent:  The Master Policy is included in the HOA dues, but you should have a policy for your contents and some other supplements to the Master Policy.  But that will not be included in your monthly payment to the mortgage company.

Buyer:  OK.  I have apartment insurance now, so no big deal.  Let’s just write it up and see if the seller will pay any of the closing costs without our having to stack them.

Agent:  $11,000 is a lot to get a seller to suck up in this price range, but we should be able to get $5,000 to $8,000.

Buyer:  That’s OK.  I’ll be happy with that.

Sometimes the lender gives a pre-approval for the purchase price, without going over the payment amount and prepayment penalty.  Even if the lender did, the payment could change based on the actual taxes and homeowner dues of the actual property selected.  Best for the agent to verify when the offer is written, that the buyer is OK with the monthly payment and terms of the loan, before he signs the offer.

Buyer remorse often equals that the buyer wasn’t FULLY aware of all of these factors at the time he made the offer.  Better to confirm all details of what the buyer is getting himself into, before the buyer is in escrow and his Earnest Money is in jeopardy.