The Envelope Please...

Ok, so it's not so dramatic as that.

The Fed's as predicted - are keeping rates the same.
Here's a link to the press release: LINK
or you can just read it here.

Tame comments in the dialog section regarding inflation concerns.



















12:30 Update: Did you see what happened to the market when they read the "Tame" comments ? Dropped like a rock!

The Fed's and You

When we say the Fed's, we're talking about the FOMC.

That stands for the Federal Open Market Committee.
Sometimes they'll be called the Federal Reserve Board.
And then sometimes they are called other words to nasty to print here.

No matter what you call them they quietly go about their business.
They meet behind closed doors, they do very little interviews, and the twelve member board generally speaks through one voice, that of it's Chariman, Ben Bernanke.

With all this lack of fanfare and sensationalism, the entire business world watches and waits on their every move.

Let's put it this way,...
Take Britney Spears, Lindsay Lohan, Jennifer Aniston, Jessica Simpson, Angelina and Brad, Tom Cruise and his woman, end every other one not named here but had their picture on one of the grocery lines trash mag covers over the last year. Add everyone who didn't make the cover but had a picture on the inside. Heck, just for good measure we'll even throw in Madonna!
Now let's roll them all into one person - and call that The Fed.

Now take everyone who watches Wall Street, everyone who works on Wall Street, everyone who invests in Stocks, Bonds, Mutual funds. Everyone who runs a company or has a part in running a company. Every business student, every business teacher, every business writer, every business reporter, every business watcher and reader. Add all pension and retirement watchers. Add every bank VP. Add just about every person in the world who is mindful of the business world and what goes into it.
Round them all up (picture the Verizon commercials with the mass of people lined up).
All these people are The Paparazzi.

They follow the Lindsay's, and Britney's everywhere they go.
They listen to everything they say.
By the time Jessica sneezes, the head office already has the report.
These people are ruthless in finding out what the Fed thinks, what the Fed's might do next.

Is that a good analogy?

And yet with all this hoopla, the Fed's really do just one little thing.
They set the Fed Funds Rate - that's the rate in which the Feds lend money to the big institutions.

Now just like, "Why Britney shaved her head", there's much more to the story than just that.
The Fed Funds Rate influences the Discount Rate which influences the Prime Rate, which influences the private school K-Fed's kid is going to enroll in.
(I was just kidding about that last part)

But the Prime Rate effects you and I.
It's what our Home Equity Loan is tied to.
It's what our small balance commercial loan is tied to.
It's the loadstar of short term rates.

Do we need to become Paparaza of the Fed's?
No.
But we do need to mindful of what they are thinking and doing.
They'll be announcing today (11:15 AM Pacific Time) one of three things:

1. That they either have lowered rates,
   
2. They have raised rates or,
3. They have left rates the same.
   

The mindful people think they'll keep them the same, this time around.
Personally, I like this kind of stuff far better than reading the tabloids!

Commercial is Different

My main project today is to get to started on a 6 Unit Complex refinance. (Obviously this isn't the property)

This is a new client. We met and discussed ideas last week and very late on Friday she bought in the paperwork I requested.

Since she is a new client, I'm starting from scratch.
I don't know who did her original loan - and that really doesn't matter.
What does matter is she has a loan now that is rapidly painting her in a corner.

She says...
She has a 5 yr ARM.
Her rate started at 9.75% the first year.
Her rate bumped to 11.75% the second year.
Her rate is going to bump again to 13.75% very soon.
She has a Pre-Payment Penalty.
She also has a Second Pre-Payment Penalty.
She is Cash Flow Negative now.
She was barely Cash Flow Even the first year.

I ask you, does that sound anything like a Residential Loan?
Not even in the slimiest loan office - right?

I haven't started looking at her documents but I can take an educated guess at what I'll find.

She has a step loan, or for those that have been around a while a GPM.
I also think she has a Pre-Pay and a Lock Out.

While there is a Sub-Prime in Commercial, features like Step Loans, Pre-Pays, and Lock Outs are not indicators of Sub-Prime. They can be found in A Paper loans as well.

In the end, her original loan officer did a horrible job matching her loan to her goals.
She was sold a bad loan and didn't ask the right questions.

I just hope I can get in there and correct the situation.
We shall see.

Be careful out there.

Commercial PrePayment Penalties

I was catching up in my reading over the weekend and came across an interesting article.

It detailed a bit about Pre-Pays in commercial lending.
In case you didn't know, a Pre-Payment Penalty is a regular feature in the commercial side.

There's plenty of shocking differences between residential and commercial.
How about a $5,000 appraisal fee?
How about no 30 year fixed loans?
How about having a prepayment penalty and a Lockout?

What might be ugly to the residential investor is commonplace in commercial.

Back to the article, it was in an industry trade magazine and really well written.
the article speaks to the loan officer but I think it reads well enough to the layman.

"Penalties' purpose

There are many variations of the prepayment-penalty formula, but the bottom line is that lenders require them to protect a return on their investment.

To make loans, lenders have overhead costs. They rely on sales representatives and an underwriting staff to ensure everything meets their qualifications before a dime is let out of their hands. These processes are costly. Lenders try to make up this deficit by charging lender points, prepayments or both.

There are several different prepayment structures. Once you understand the different types, you can better explain to your clients why lenders use them and how borrowers can benefit.

Flat rate

Flat-rate prepayment penalties are the easiest to explain and calculate. This type of prepayment penalty would read as follows: 5 percent of the remaining principal balance for the first five years of the loan term or 5 percent for five years.

Basically, if borrowers want to sell the property or pay off the loan in the first five years after closing, they will be required to pay an additional 5 percent on top of the principal balance. The rates and time periods vary between lenders and loan programs. At the end of the prepayment term, the loan can be paid with no penalty.

Declining-rate penalties

This structure is similar to the flat-rate penalty in length of time, but it differs in that the rate changes over time.

The lender front-loads the cost it has incurred and amortizes the charges as time progresses. A typical declining-prepayment penalty would be expressed as a 10-percent declining penalty for 10 years. So if the borrowers choose to pay off the loan the first year after closing, they will have to pay 10 percent of the principal balance, the second year they'd pay 9 percent and so forth.

Exit fee

This type of fee is used in many shorter-term deals. Essentially, it is a flat-rate prepayment with no time element.

If the deal includes a 3-percent exit fee, the borrower must pay the penalty when the loan is paid off, regardless of if it is the day after closing, the date of maturity or any time in between.

Yield maintenance and defeasance

With yield maintenance, the lender protects itself from losing the mortgage interest it was earning. This is designed to make the lender indifferent to when the borrower decides to pay off the loan.

A simple example of yield maintenance would be as follows. A borrower closes a 10-year loan at 5 percent and wishes to prepay the loan at the end of year five (when interest rates have dropped to 4 percent). Because the lender will reinvest the mortgage balance at 4 percent, it will lose 1 percent per year for the remaining five years of the mortgage life. To protect its return, the lender will require the borrower to pay the value of the 1 percent that the lender would have received if the loan were brought to term.

Conversely, if the borrower prepays after five years when interest rates are at 6 percent, the lender can reinvest the proceeds at a higher rate than it was earning on the mortgage. Hence, the lender will actually pay the borrower to prepay.

Treasury defeasance is a form of yield maintenance used for loans intended to be securities. With this type of defeasance, a borrower is required to purchase a financial instrument that will match the return of the bondholders. Defeasance has the same general outcome as yield maintenance.

Lockouts

A lockout ensures the lender's return by making it too painful for borrowers to pay off the loan in the short term. A two-year lockout means the borrowers would be required to pay all the interest that would have been collected up to the 24th month and pay an additional prepayment penalty.

Benefits

Although borrowers are not keen on prepayment formulas, these penalties allow lenders to offer rock-bottom interest rates. Without them, lenders would have to factor prepayments into their rates, and rates would be higher.

So how do you sell prepayments to your clients? First, identify which one will be used for their particular loan structure and inform them about it. This is not something you want borrowers to be surprised about at the last minute. Borrowers have been known to walk away from the closing table because they did not understand the ramifications or know that a prepayment penalty was part of the deal.

Next and most important, discuss the borrowers' expectation on holding the property. If they plan on holding it long term without any desire to sell or refinance, the prepayment is a moot point. Thus, getting the best rate possible with a prepayment has no downside."

If you got this far, congrats!
The last statement was the most important and applies to all real estate investing.
You need to have and to know your exit strategy.

For more information on Commercial Mortgages see our commercial website:
http://www.patagoniafinance.com/cindex.html