The Mortgage Reports Blog

As Mortgage Rates Move Higher, So Do Savings Rates

This simple chart from Bankrate.com illustrates an interesting point about mortgage rates and savings rates.  Notice how they seem to move in lock-step.

The green line represents the path of the 5-year ARM since 2003.

The blue represents the path of your garden variety, FDIC-insured, 5-year Certificate of Deposit.

If you're a homeowner that likes to limit a home downpayment in favor of buying interest-paying CDs, this chart may help you rest easy the next time you're shopping for a mortgage.

Buying A Home With Your Boyfriend, Girlfriend, or Partner Before You Get Married? Watch This Video.

At any given time, I am working with handful of first-time homebuyer clients that are boyfriend and girlfriend, fiance and fiancee, or something similar.

Usually, the rental lease is ending for one or both of them so they decide that its easier to just move in together.  Rather than rent, the combined incomes and bright future lead to the decision to buy their first home together.

Until that marriage or civil union happens, though, there are a number of financial and legal issues to consider.  As always, Barbara Corcoran does a terrific job of straight-shooting on The Today Show.

This clip from May 2007 is timeless because it reminds us how love is blind, and also blinding.  Non-married homebuyers can't forget to take proactive measures for long-term protection.  The most important of which is opening a life insurance policy.

For all of her real estate savvy, Barbara sometimes sounds like a well-versed mortgage planner. 

I love that she reminds the viewer how accidents happen and people sometimes die unexpectedly.  The worst legacy you can leave a loved one is a mortgage payment that was manageable with two incomes, but is an impossibility with just one.  A basic life insurance policy can protect against that and the policy is cheap.

Watch the video and listen for Barbara's sound bites.  At three minutes in length, it's a powerful segment.

Falling Prices And Adjusting ARMs : Real Estate Investors Have A Way Out

Unless you live on the moon, you've heard about the issues facing American homeowners with respect to mortgages.  You've heard it on TV, in the papers, and on blogs. 

The good news is that relief is on the way (somewhat).  Momentum to "help the homeowner" started with the states (Ohio), moved into Congress (FHASecure), and is now heading onto mortgage servicers (Countrywide).

The bad news is that not all homeowners are going to be relieved equally. 

The least protected class of homeowners in America right now are real estate investors that bought homes from 2001-2007.  There's not a line of legislation that will come to the rescue of any member of the over-extended-real-estate-investor class.

One television pundit was overheard saying this:

"They bought their tickets, they knew what they were getting into.  I say, let 'em crash."

Now, with respect to real estate investors, it's important to differentiate between the two types who may have bought from 2001-2006.

1. The buy-and-hold investor who makes money off rent, tax write-offs, and long-term property gains.  This is a long-term strategy.
2. The buy-and-sell investor who makes money off selling a property for more than its purchase price within a short period of time.  This is a short-term strategy.

For Type #1, the current market conditions are a stress, but nothing major.  Because their real estate strategy is a long-term one, the home was likely financed with a long-term fixed mortgage, and excellent rent prospects for the unit(s).

For Type #2, however, the financing tends to be much different.  Because their strategy was a short-term one, the home was likely financed with a short-term sub-prime ARM, and in an area that was designated as "hot", or "likely to appreciate".  Rent prospects were not necessarily a factor when the purchase was made.

Now, both investor types likely bought with very little downpayment.  Lenders didn't require it, so the investors didn't give it.  Real estate investment is about leverage, after all.  In a rising market, buying one property with 20% down generates a dramatically lower ROI versus buying four properties with five percent down.

But now the market is changing. 

As we mentioned, the long-term investor basically shrugs it off.  He knows that weak markets come and go and -- long-term -- real estate is a winning investment. 

By constrast, the short-term investor is facing some very real problems. 

First, sub-prime loans are no longer available for real estate investors.  And second, real estate property values are declining in many of the areas that attracted investment between 2001-2006.  The short-term investor hadn't expected the market to change while they were still in the midst of their "flip".

To impress upon how big of a deal this is, let's look at a "Sunny Skies" scenario for a short-term real estate investor.  We know that most investors have "Stormy Skies", but this is meant to show how all short-term investors are feeling a pinch:

In 2004, a person buys an investment condo in Chicago for $300,000, and mortgages $285,000 with a 3-year ARM that includes principal + interest.

The condo appreciates 4.000% annually and is now worth $338,000.  The mortgage balance is now $275,000.

Today, the home's LTV is 81% and the loan is about to adjust. 

So, for the "Sunny Skies" guy, it looks like everything's coming up roses.  But is it really?

For one, nearly every investment property home loan over 80 percent loan-to-value is going to be considered sub-prime, and the market for those loans vanished months ago.  In order to get out of sub-prime territory, it's necessary to pay down the loan to at least 80 percent.  75 percent is ideal.

Plus, if the investor decides to sell the investment property, he's competing for sales with every other investor nearby that also wants to divest.  The extra supply means lower prices for everyone.  It should also equate to more time on the market.

Meanwhile, the clock on all of those ARMs is still ticking so if an investor has a fire sale just to cut his losses, it's going to drop the value of every other unit nearby.  Ouch.

In other words:

• To remortgage will cost money as a paydown
• To not remortgage will cost money as a mortgage rate hike
• To sell the home will cost money in the form of depreciation
• To not sell the home will cost money in the form of lower home values

Ouch again. 

But, it's not all bad!  Many short-term investors can readily convert their short-term strategy into a long-term strategy by re-assessing their real estate portfolios.  And it starts with the mortgages.

See, in the current market, the biggest risk to a highly-leveraged investor is that there are no highly-leveraged mortgage products available for refinancing.  When the mortgage begins to adjust, therefore, the investor has no choice but to absorb the adjustment.  This impairs cash flow and usually leads to financial distress. 

Probability of Foreclosure: Very High.

This is why the first step to convert a short-term real estate strategy into a long-term strategy is to convert to long-term mortgages.  And, in order to do this in our current market, the home has to become un-highly-leveraged.  This requires the principal balance to be paid down to at least 80 percent, and preferably 75.  With less leverage, the loan is considered less risky and the mortgage moves from sub-prime territory into the conforming world.  Backed by Fannie and Freddie, the home loan programs are plentiful and relatively cheap.

Once the capital is ready, the next step is to remortgage the investment property into a long-term home loan with a lower LTV.  The new mortgage doesn't have to be a 30-year fixed, but it should be long enough to match your long- and short-term investment goals.  Your mortgage planner can help you formulate a plan.

Now, with a long-term mortgage locked in, the long-term payment is locked in, too.  By knowing the payment, you can set a monthly rental price and know exactly how much cash will be required to cover the monthly nut on the home.  Having a fixed cost also helps to build a predictable monthly budget.

Probability of Foreclosure: Very Low.

Yes, the hardest part about converting from a short-term real estate strategy to a long-term one is finding cash for a principal paydown; most people don't have access to that sort of capital at a moment's notice, nor do they know where to find it. 

Surprisingly, most investors ignore the most likely source because -- despite investors' tendency to leverage non-owner-occupied properties -- they don't always take the same approach on the homes in which they live.  The primary residence is an excellent source of capital and the equity existing on paper can be accessed and redeployed somewhere else. 

The same applies for second homes and vacation homes -- the equity is there and is sitting idle. 

So, let's come full circle on this. 

Remember that states, Congress, and mortgage servicers are trying to help homeowners, but not investors.  Therefore, there are loads of mortgage programs available for primary and secondary residences.  Plus, cash out transactions are still be approved to high LTVs.   This means that the equity required to go long on your real estate investments may be waiting there in your own home(s).

Buy-and-hold strategies works in real estate -- we've seen it historically.  In fact, other than baseball, long-term increases in real estate prices has been the one constant in America.  It's this short-term flipping that is causing problems. 

The good news is that with available equity, a real estate investor can change his tune, thereby protecting his assets, his credit, and his investments.

In mortgage planning circles, we call this process "equity repositioning" -- removing home equity from properties in order to meet financial goals.  There are risks inherent in strategies like this and it's not something to undertake on your own.  If you don't have an experienced mortgage planner with whom you work, email me and I'll walk you through it.

(Images courtesy: Captain Zoom, Scout Slides)

Defining Home Equity And How It's Created

First, a definition:

(Home Equity) = (Value of Home) - (Amount Owed On Home)

There are two ways that equity is created:

1. The homeowner pays down the principal balance on the mortgage. 
2. The home's value increases because of appreciation

But just because both methods increase the equity position in a home, that doesn't mean that they're equal.  Quite the contrary.

---

Method #1: The homeowner pays down the principal balance on the mortgage. 

When a homeowner pays down a mortgage, he is using funds from a paycheck.  As all of us know, by the time we get our paycheck, the earnings have already been taxed by local, state and federal governments. 

Now, if the money was left in the bank, it would earn interest.  By contrast, once the money is withdrawn and used to pay down the mortgage, those interest payments are forfeited in favor of a 0.00% rate of return.  A home is not a bank account and it does not pay interest for making "deposits". 

Neither does a home make "deposits" readily available to its owner; if a homeowner wants to access a portion of their principal paydown, he is required to ask the bank for a remortgage.  Not only can the application be denied for a number of reasons, it can also take up to three weeks to process.

---

Method #2: The home's value increases because of appreciation

Equity is also created when the home itself creates value.  Looking back 100 years, real estate has appreciated so we should expect that it will continue to appreciate as a long-term investment.

As homes increase in value, homeowners benefit from additional "dollars-on-paper" and this is where building equity via appreciation really shines. 

When a homeowner sells his appreciated residence, he not only earns a profit for just having owned the home, but the profit from the sale may be 100% tax-free.

For couples filing jointly, up to $500,000 of gains from the sale will be exempt from taxes; for individuals, $250,000.  Check with your accountant to see how tax law applies to you personally.

So, not only is home equity an asset, it's an asset that may not get taxed.  Clearly, that's a huge advantage.

---

Now, this isn't to say that paying down your principal balance is a poor financial planning decision.  It's just to say that there may be smarter targets for your investable dollars. 

Paying down principal, after all, is not creating wealth -- it's just moving wealth from your liquid bank account to your illiquid house.

The only way that wealth is truly created in real estate is through home appreciation.  The home is the "thing of value", not the mortgage.

The mortgage is just the debt.

The Dow's Bounce : Back Above 14,000

One look at this chart and I wonder:

1. Long-term investing is a viable investment strategy
2. You can't time the market
3. Those that forget the past are condemned to repeat it
4. So much for the "Economy Is Going Sour" theory
5. This could be the hugest dead-cat bounce ever

Or, maybe markets are just like life: a series of events that appear to have meaning at the time, but are irrelevant over the course of 90 years. 

It's only when life ends that we realize the truly significant moments were the ones that seemed strangely ordinary at the time.

(Image courtesy: Wall Street Journal Online)

How Visa USA Tried To Scare Us All Into Using Its Credit Scoring Web Site

There's a fine line between marketing savvy and outright misdirection.  Visa USA may have crossed it.

Earlier this month, Visa USA published a "report" titled "Americans Unaware That Employers Can Legally Refuse to Hire Job Applicants with Low Credit Scores". 

"Wow", I thought, "this would make an excellent blog topic."  And I started to write.  Only I couldn't shake the idea that this was marketing piece from Visa and not a true report.

So, like any other curious person, I turned to Google to dig a little deeper.  Here's what I found:

What Visa USA said originally in the press release:

Many employers have made checking a credit score a mandatory part of the job application process, just as drug testing and criminal background checks are now common requirements for jobs in many industries.

How Experian spokeswoman Maxine Sweet contradicts Visa USA:

"We do not score for employment reports.  If you chose to do that, I think you would be breaking the law."

How Fair Isaac spokesman Craig Watts contradicts Visa USA:

"Credit scores don't help employers make smarter employment decisions.  They are for judging credit risk."

How the Fair Credit Debt Reporting Act contradicts Visa USA:

The Fair Debt Credit Reporting Act restricts employers from using credit reports for hiring or employment decisions. If such a report is made, companies are required to advise the applicant or employee that the report is being ordered, together with the name and address of the credit agency supplying it. Finally, the report can be ordered only if it serves a legitimate business purpose.

How the EEOC's policies contradict Visa USA:

An applicant's poor credit rating has also been ruled by the courts to be an unlawful basis for refusal to hire unless a business necessity for such a policy can be established.  Inquiries about charge accounts and home or car ownership may be unlawful unless required because of business necessity.

What Visa USA said after being pressed by Detroit News columnist Brian O'Connor about all of the contradictions:

"We don't have figures on whether that's true or not, but anecdotally it seems that more and more employers are doing it."

Now, yes, it's technically true that an employer can legally not hire you because of low credit scores, but the types of jobs in which a person would be subject to credit scoring scrutiny is limited to those very few jobs in which a person's credit rating matters for their job's basic functions. 

One example I can think of is a position in which an employee is required to have a company credit card in his/her own name.  If a person can't qualify for a credit card, that person can't fulfill the job's basic requirements.  I am sure there are other examples, too, but the point is that the Visa USA headline is misleading to the average consumer.

And there you have it.  One more reason to read beyond the headlines.  Especially when the source of the information is a company with something to sell.

Sources
Americans Unaware That Employers Can Legally Refuse to Hire Job Applicants with Low Credit Scores
Visa USA
September 13, 2007
http://www.usa.visa.com/about_visa/press_resources/news/press_releases/nr429.html

Employers myth out on credit scores
Brian O'Connor
Detroit News, September 15, 2007
http://detnews.com/apps/pbcs.dll/article?AID=/20070915/OPINION03/709150334/1308

Discriminatory Interview Questions
Findlaw.com
http://earthlink.findlaw.com/employmentbook/HFCHP1_h.html

The Fed Saved Americans Nearly $15 Billion Annually Tuesday Afternoon

I fielded a lot of phone calls yesterday from my clients about the Fed lowering the Fed Funds Rate and how it impacts them personally.  I love days like those -- it shows me that my clients are paying attention to the financial world and how it impacts them.

Education is the benchmark of my practice and I really enjoy talking to everyone, helping them relate the news to their lives.

See, in all of the talk about the Fed Funds Rate, specific numbers tend to get left out of the article in the newspapers and from the graphics on the TV.  That's why I built the graph above.

The Fed Funds Rate has little impact on the everyday lives of people like us because its an interest rate that banks use in lending to each other.  Think of it like an interest rate "among friends" -- a little bit lower than what you'd charge someone else, but still high enough to get compensated.

Now, there's a little trick here.  The "someone else" are consumers like me and you.  When they're lending to us, the banks tack on three percentage points and they call that new interest rate "Prime Rate". 

This is why Prime Rate is always 3.000% higher than the Fed Funds Rate.

Therefore, because the Fed Funds Rate is now 4.750%, Prime Rate is now 7.750%.

That small detail is a pretty big deal because banks tend to use Prime Rate as a starting point for consumer loans.

• Home equity lines of credit may be Prime + 0.500%
• Credit card loans may be Prime + 8.999%
• Auto loans may be Prime + 2.000%

Here's where it gets interesting for the everyday American. 

According to the L.A. Times, consumer debt in the United States (not including mortgages) is $2,456,000,000.  Chop 1/2 percent from that and Americans are saving $1.228 billion in interest every single month because of what the Fed did.

Now, for people that don't carry consumer debt, the impact is likely to be small.  But many people hold balances on their credit cards, or have not paid down a HELOC.  Starting Tuesday afternoon, the rates on those debts dropped.

Prime Rate was 4.000% in June 2004 before the Federal Reserve started a string of 17 rate hikes to 8.250%.  Tuesday's drop is the first reversal since the rate hikes began.

What To Do If Your Home Is Losing Value And You Aren't Planning To Sell

A few clients called me this week to share concerns about a declining housing market and how it would impact their long-term financial planning. 

"I need my home equity for retirement", one said.  "What if foreclosures on my neighbors ruin my nest egg."

Our ensuing conversation covers some basic facts about home equity:

• Home equity is an asset -- just like stocks, bonds, or a stamp collection
• Home equity grows or shrinks as a home's value grows or shrinks
• Home equity grows or shrinks at the same rate, regardless of the mortgage payment, rate, or product
• Home equity tends to represent a disproportionate share of a homeowner's net assets

If you are a homeowner worried about your home equity evaporating in a falling housing market, one realistic solution is to separate the equity from the home via a remortgage.  Then, hand the equity to a financial planner who can invest it somewhere safer than real estate. 

Money market fund or basic savings accounts often fit the bill.

An astute observer will recognize that equity separation creates a larger mortgage balance and that may result in a higher monthly payment. 

Well, some of my clients have an ingenious way to handle that circumstance: they choose to think of the extra monthly expense as "equity insurance" payments. 

I like that idea because it makes complete sense to me -- pay a little more each month in order to preserve the value a large chunk of cash.  Brilliant!

Now, there are also two major benefits to extracting equity that usually get overlooked (so I'll point them out):

1. The dollars you put in the bank account earn interest
2. The dollars you put in the bank account are available in a moment's notice for emergencies

These are two huge deals.  Dollars that are still in the form of "equity" not only earn a 0% interest rate, but aren't available for 2-3 weeks because of the time it takes to remortgage a home (if the bank even approves the application).

And this is what my clients and I review. 

Right now, the equity separation wildcard is that tightening lending guidelines are reducing the number of families that are eligible to do it.  So, if you feel at-risk with the amount of equity in your home and want to diversify or add safety to your holdings, call your loan officer and your financial planner for ideas and make a plan.

The Credit Bureaus Can't Google Your Dating History

Here's a lesson to take from the wholesale shift in mortgage lending: Your credit gets you access to low rate mortgages and, therefore, your credit score is worth protecting.

Some keys to good credit lie in the basics:

• Pay your bills on time every month
• Don't surpass your credit limits
• Don't co-sign on a loan and expect that it's being paid on time

Some are not so obvious:

• Don't close a credit card just because you don't use it any longer
• A credit limit should be always be THREE TIMES its current balance (at least)
• Capital One credit cards could be bad for your credit score

One of the most overlooked, common sense tips, though, relates to having a credit history.  To help earn a good credit score, you need to show that you have successfully managed credit in the past.

Let's use a good metaphor to hammer home the point.

A credit history is like a dating history.  On the first date with somebody, you're probably going to wonder one or both of the following:

• How many boyfriends/girlfriends has this person had?
• What's the longest relationship he/she has been in?

If your date has never been in a relationship, you're going to think twice about making a commitment,  After all, he/she has no track record and no history.

On the other hand, if your beau/belle has been in a series of long-term relationships, you feel just a little bit safer knowing that he/she understands responsibility and commitment.

Let's tie it all in.

Credit bureaus take your "dating history" into account -- the longer your history, the better.  This is why leaving credit cards open (even if the balance is $0) is a good thing and why applying for cards (even if you don't really need them) helps buoy your credit score. 

Anyway, to make a long story short (too late!), improving your credit scores is about more than just the basics -- it's also about being commitment-capable.

(Image courtesy: Ladym)

The Biggest Banks Are Eliminating The Most Prevalent Sub-Prime Loan

One more sign that the sub-prime apocalypse is upon us...

Washington Mutual, Countrywide, Wells Fargo, and Merrill Lynch's First Franklin all recently announced the discontinuation of the staple 2/28 sub-prime mortgage product. 

The "2/28" is an adjustable rate mortgage in which the interest rate remains fixed for two years, and then adjusts for the loan's remaining 28 years.  Think of it like a 2-year ARM, if that helps.

But that's not the end of the changes. 

WAMU and First Franklin took it a step further, eliminating the 3/37 from their respective sub-prime product menu altogether.

Because the four lenders named above are the market leaders and are major buyers of sub-prime loans nationwide, expect other sub-prime lenders to follow their lead very, very soon.  I won't document the list of lenders, but just be aware that's happening.

As it has been since September 2005 when sub-prime first exploded, life as a sub-prime borrower is a challenge.  The importance of keeping your finances in order cannot be underestimated. 

One missed mortgage payment, or a late credit card bill won't do you in, but a series of them will because that is one characteristic of a sub-prime credit profile.

Look, folks, sub-prime mortgages are not designed to be long-term solutions.  The proper use of a 2/28 is to apply it to reach a short-term goal (i.e. pay off debt, purchase a home) and then manage and monitor your finances to get "a better loan" as soon as possible. 

Sub-prime mortgages are stepping stones into Conforming World and nothing else.  Sub-prime homeowners should approach their sub-prime loans as their gateway to a better financial life.

If you believe you are a sub-prime borrower, speak with your loan officer and/or financial planner.  If you don't have a plan to exit the sub-prime arena, make one -- your ability to get a sub-prime home loan in the future will certainly get harder before it gets easier.

Paying Down Your Mortgage Does Not Automatically Increase Your Net Worth

Mathematics is highly-relevant to financial planning.  It helps us grasp concepts such as compounding interest, amortization schedules and return on investment.

But, forget all of the complex equations.  Basic math is all you need to get to the key point:

(Net worth) = (Total value of assets) - (Total value of debts)

There are two ways to increase your net worth -- you can increase your assets, or you can decrease your debts.  Either way works.

Most people think that paying down a mortgage increases their net worth.  But that's wrong.  Every dollar used to pay down mortgage debt was really just a dollar that previously existed as an asset.

In other words, paying $1,000 to your mortgage means subtracting $1,000 from both sides of the equation above -- a net gain of zero.

To take it a step further, the $1,000 was an asset that earned interest in your bank account.  After using it to pay down debt, it's no longer earning that interest.  Long-term, therefore, you forfeit the gains of compounded interest.

Additionally, by reducing free cash, you lose access to "emergency funds".

Should you ever need that money down the road, you'll have to apply for a remortgage with the bank to get access to it.  That process can take 2-3 weeks, and the bank may decide to turn you down.

Paying down your mortgage reduces your debt, but it isn't a safe course of action for most people.

Now, to be fair, there are plenty of instances when paying your mortgage balance down does makes sense.  For example, your mortgage interest rate greatly exceeds your savings rate and you are fully-funding your matching 401(k) plan and have a qualified insurance plan in place.  There are others, too. 

My point is that there are plenty of situations when it doesn't make sense to pay down your balance -- you just have to be tuned into to your own life goals to understand what those situations are.

There are no blanket truths when it comes to personal financial planning.  Carefully consider all of your options and make sure to talk with a professional first.

Don't Be Fooled When Opinion Masquerades As News

Even as I chuckle at this cartoon, I can't help but get a little miffed by it.  It's just another in a long line of subtle digs at interest only loans, or other home loan types.

The journalistic term is "editorializing" -- to insert a personal opinion into an objective statement.

Cartoons are not news, of course, but the caption made me think of how many times I see words of negative connotation used in explaining mortgages.

That's why it's important that when you're researching mortgages, you pay attention to the objectivity of your source. 

Often, a writer will deploy key adjectives, phrases, and/or images that distort an otherwise factual story.

This cartoon from clangnuts.com is just one example. 

It implies that interest only home loans are for people that can't otherwise afford homeownership.

Some other examples include:

• Business Week's now-famous cover: Nightmare Mortgages that blasted nagatively-amortizing Option ARMs
• Associated Press using the term "creative" about interest only loans.  Then following it with "cash-strapped", "lure buyers", and "come back to bite" you.

The truth is that interest only and Option ARM loans are used by all economic classes of homeowners -- not just those that need payment relief. 

Many people choose these loans for their flexibility, or as a financial planning tool.

Sure, there are some people that use them to "get onto the housing ladder", but that is a statement about the homeowner and not the mortgage product.

Our opinions are often formed by the words and images we hear in a public forum.  Sometimes, it pays to look a little deeper.

When Considering Specialty Coffee Like Starbucks, Try Investing Instead of Ingesting

Every now and again, a basic Web site hammers home a major personal financial tip. 

Have you ever wondered what your coffee habit is costing you?

Courtesy of software developer Hugh Chou, the Coffee Calculator calculates what you pay for your store-bought coffee each year, and how much money you forgo in life savings because of it.

Did you know:  If you buy a plain $1.87 grande drip coffee from Starbucks every working day versus drinking free coffee in your office, you'll forfeit more than $6,000 over 10 years' time?

But you don't take your coffee "plain", right!  You're of the grande, sugar-free vanilla, non-fat latte ilk!  Well, in that case, you'd best check out the savings for yourself.

The next time you're struggling to pay your bills, or to build a 12-month asset reserve, or to fund your 401(k) plan at work, review the dollar you spend on non-essential items in your life.

Starting with specialty coffee.

How To Reduce Sub-Prime ARM Foreclosures

The graphic at right comes from The Wall Street Journal and it paints an ugly picture about sub-prime ARMs.

Quick primer on sub-prime ARMs:

When sub-prime adjustable rate mortgages reach the end of their "fixed rate" period, some homeowners are unprepared for the upward-adjusting mortgage payments and that can lead to payment shock. 

The initial fixed period is usually 24 months, although it may be 36 or 60 months.  In rare cases, the initial period is 6 months.

This "initial fixed period" is where I'd like to spend some time today.

24 months is a very long time to the credit bureaus.  So much so that all credit blemishes associated with an account are forgiven if the account "stays clean" over a period of two years.

Stated differently: if you come clean with your creditors -- no matter how bad the offense -- your credit scores will stop being impacted by the delinquency after two years. 

Credit bureaus believe in the Fresh Start and sub-prime ARM borrowers can use that to their advantage by doing any/all of the following in the two years immediately following the start of their home loan:

• Pay collections, charge-offs and other delinquent accounts
• Make timely payments on loans, credit cards, and open charge accounts
• Reduce monthly debt loads with systematic payments to creditors 

All of these actions contribute to promoting the homeowner from sub-prime to "prime" borrower status so that they'll never need to worry about that sub-prime loan adjustment. 

Once the homeowner qualifies for something "better", he remortgages from the loan he's in with the help of his loan officer (who should be actively managing the mortgage for his client).

Therefore, for borrowers who follow "the plan" and whose loans are actively managed by their loan officers, the sub-prime loan will never adjust because the homeowner is rid of the loan before the adjustment ever begins. 

It's May So Non-Cook County Residents May Need To Bring A LOT Of Money To The Closing Table

Quick note to residents of non-Cook County residents in Chicagoland: your next tax bill is due June 1. 

The upcoming payment takes on added significance if you're in the middle of a refinance and you are planning to escrow, though.  Heads up!  Your cash required for closing may be significantly higher than what you expect.

Here's why.

Your new lender wants ample reserves in order to pay your June 1 real estate tax bill for you, and your subsequent bill September 1.

Therefore, they will require you to populate your new escrow account with 11 months of "T&I" (taxes & insurance).

(A quick Escrow Reserve Chart for all Chicagoland counties not named Cook is at right.)

On June 1, your new lender will disburse 6 months worth of reserves to pay your bill, leaving you with 5 months left in your escrow account.

When your July 1 mortgage payment is made, it adds one month to the reserve pile.  In August, your payment adds one more. 

By then, you will have 7 months worth of reserves in the account.

Now, sometime towards the end of August, your new lender will pay your tax bill and you will be left with somewhere around one month's worth of reserves.  This is because tax bills tend to go up over time and if your individual bill was higher than anticipated, that extra reserve month may have been spent.

In September, with each mortgage payment, you'll start building your reserves again -- one month at a time -- to get ready for the following June.  That's when the lender will pay your real estate taxes for you again.

Now, back to the May closing.

When a home loan closes in May, the first payment on that home loan is made in July (in most cases).  According to the chart above, that means that -- at closing -- the borrower is required to bring 11 months of reserves to the table.

11 months of reserves is a lot of money!  It can be a huge imposition on a family that wasn't prepared to make that sort of payment in one lump sum -- especially if they live in a county like Will County where taxes can exceed 2 percent of a home's value.

The good news is, though, that paying the 11 months in advance is only a temporary strain.  Shortly after your closing, the former lender will refund whatever existing escrow reserve was held with them. 

Of course, that doesn't help today with the 11 months worth of cash-to-close.

If you plan to escrow your taxes and insurance and don't have the money required to populate your new account, make sure to talk with your lender prior to closing.  With enough advance notice, your lender can make accommodations to help you out.

How Closing Costs In A Home Purchase Are Shared (Chicago Edition)

 

This graphic is from a seminar I regularly co-host and I thought it would play well for the Chicago crowd. 

The percentages are based on a few assumptions:

• $300,000 mortgage
• Condominium purchase
• Property inside the Chicago city limits
• The average the fees from more than ten purchase closings where purchase price was $250,000-$400,000
• No discount or origination points

I was the loan officer for all of the transactions and verified numbers against the HUD-1 (i.e. settlement statement).  These are accurate, folks.

In seminars, I use the above graphic to illustrate the relative helplessness that a mortgage lender has with respect to overall closing costs in a purchase. 

After all, a lender can only control what his company charges and the rest of the pie is determined by the fee structures of the other parties involved. 

In our Chicago-based world, the lender's portion is about 7% of a home buyer's total "closing costs".

When I share this with my first-time clients in Rate Shopping Mode, I make a point to show them how other mortgage lenders may purposefully understate the other 93% of purchase fees so that the Good Faith Estimate I provided looks ridiculously expensive by comparison.

My competitors sometimes reduce the title charges to unreasonable levels, skimp on real estate attorney fees, or omit other third-party expenses completely to make the line item labeled "Estimated Closing Costs" as low as possible. 

It's a deceptive, unconscionable practice and all home buyers can fall for it -- even the most experienced ones.  I try to use the graphic to minimize the number of times that it happens, and to protect people that -- in their quest for the "best deal" -- forget the old adage: If it looks too good to be true, it probably is.

As we all know, an educated consumer is less likely to fall for the puffery of a dodgy loan officer.  Hopefully, you've learned something, too.

Is Bigger Really Better At Tax Time?

The Justice Department is pressuring national tax-preparer Jackson Hewitt to close down 125 of its tax preparation stores.  Allegedly, these stores stole $70 million from the IRS. 

Each store is owned, or partially owned, by the same franchisor and are spread across four separate states.

The tax stores and its owner are accused of using fake W-2s, bogus deductions and other fraudulent claims to reduce the tax liabilities of its clients, and also of paying kickbacks to store managers and employees.

I am highlighting this story because income tax preparation is similar to mortgage planning in several ways:

1. It's not One Size Fits All -- each individual needs individual counseling
2. It's a crucial part of a person's short- and long-term financial plans
3. There are plenty of low-cost providers in the marketplace

I am not picking on Jackson Hewitt -- these stores targeted by the DOJ represent just 2% of the corporation's total franchises -- but this is a terrific example of how fraud permeates every level of every business, no matter how big or small.

There will be huge penalties for the franchise owner, but the penalties will be worse for the individuals whose tax returns will need to be amended.  Corporations have insurance and can declare bankruptcy. 

Tax penalties and liens can hurt an individual forever.

At this time of year, I get a big kick out of watching tax stores pop-up, and then fade away beginning April 15.  It creaes the notion that taxes are a seasonal thing when we all know that the reverse is true.

Taxes and tax planning is an all-year thing. 

If your accountant is a temporary employee who only works from January 1 - April 15, that should tell you something.

Look.  You are going to pay for your accounting, one way or another so make the choice to make taxes a bigger part of your plan.  It's best to work with a trusted accountant that can help you plan for the long-term and fit your tax strategy into your overall financial plan.

Need a referral?  Just ask.

Source
Jackson Hewitt accused of tax fraud in IL., 3 other states
Crain's Chicago Business, April 4, 2007
http://chicagobusiness.com/cgi-bin/news.pl?rssFeed=news&id=24475

91% Of People Need To Do Some Fact-Checking On Their Mortgage

The pie chart at right comes from a Bankrate.com survey, sampling 1,000 adults about their current housing situation.

The question asked: What type of mortgage do you currently have? 

The answers were all over the map.

I am actually okay with the 34% "Don't Know" figure.  I have worked as a loan officer for long enough to know that some people just don't know.  At some point, these people seek help.

It's the 57% "Fixed Rate" figure that scares me. 

The sample size was small, but there is no way that 57% of homeowners carry fixed rate mortgages (even though they think they do).  A "5-year fixed rate mortgage" is not really a fixed rate mortgage -- it's an ARM in which the interest rate remains fixed for 5 years.  Some folks, unfortunately, don't (or can't) make that distinction.

These people have been lulled into a sense of security about their mortgage.  They specifically don't seek help with mortgage management because they believe their mortgage payment can't change over time.

And then it changes.

I am not providing a direct link to the Bankrate.com story because the biggest value of the story is in the graphic used here.  If you own a home, you need to understand the basic structure of your own mortgage just as you need to balance your checkbook each month.

Looking over your mortgage statement or reviewing your closing documents never goes out of style so if you don't know how to interpret what you're reading, get help from a professional.

Following Up On The 15-Year Mortgage As A Sucker's Bet

A year ago, I called the 15-year fixed mortgage a "sucker's bet" in one of my most popular posts ever.

There was a fair amount of debate around the subject and some of you posted legitimate economic discourse on the subject.  It made me feel good about my audience, actually.  What is a "safe" investment anyway?  In what investment vehicles can returns be maximized?  How do tax deductions apply, or not apply, to certain Americans.

There were a ton of interesting comments.

Only one person, however, went so far as to create a spreadsheet to uncover the heart of debate.  Using pure mathematics, an Air Force veteran in Virginia dissected the argument and drew the most logical conclusion of anyone.

Thank you, Dave Goodridge.

Dave put his dual degree in economics and electrical engineering to work in building an Excel spreadsheet.  You can download the file and test your own scenarios with the usual caveats and qualifiers (i.e. borrower itemizes his interest tax deductions, interest payments are within the bounds of the top marginal tax bracket, invested refunds are paid into a 100% tax-deferred account).

In the end, it appears that the better of the options -- 15-year fixed versus 30-year fixed -- comes down to the likely investment return on the payment delta.

Dave made a terrific case that it's not the 15-year mortgage that's for suckers -- it's the failure to manage your own mortgage and finances that is. 

If we can learn anything from Dave, it's that math never goes out of fashion and to always question what you read.

Are Americans Saving Too Much For Retirement?

We have all heard the "Save for Retirement" message enough times that we are practically hard-wired to do it, or feeling guilty that we aren't. 

New York Times writer Damon Darlin wrote a piece last month with the headline: Save Less and Still Retire With Enough.  The premise of the article is that Americans are saving more money for retirement than is necessary. 

Unfortunately, I don't have a New York Times subscription and the article has slipped into "Pay Per View" Land.  This is my caveat because all I have access to is a few snippets of the original text and some general commentary.  Hopefully I am not taking the piece out of context.

Update: Thank you, David Brown, for this link to the article!

To summarize the piece, we need to all recognize that "Saving for Retirement" is a concept that is beaten into our collective consciousness.  Usually, it's accompanied by "Doom and Gloom" retirement scenarios:

• Long-term health care costs are rising
• General medical costs are rising
• Social security and pension benefits are in jeopardy

In addition, people are living longer and makes the impact of these valid points all the more impactful. 

But, as the author suggests, we all have to take a step back and consider the source of the message.  Just who is telling us to save every last dime for our retirement? 

The answer?  The same people that are collecting a management fee for every dollar in custody.

I know that's a cynical view, but after talking to a few economists, Darlin concludes that a lot of people are over-saving for retirement because of marketing and sales messages.  Many Americans could retire comfortably by setting aside as little as half of their current savings levels.

This is a bust-up-everything-you-know-to-be-true-type comment.  So, I figured -- why not test it out.

As an exercise, I ran my personal figures through a "Retirement Savings" calculator and nearly fainted.  To say that my family saves diligently is an understatement, and we routinely add to our retirement nest egg.  Yet, to meet the goals set for us by the calculator, we'd have to triple our monthly savings and even then, we'd fall a little short. 

Cue: panic.

On the other hand, I know that our family is doing a terrific job in preparing for our future and that we our retirement will not require the same income levels as we earn today -- a major assumption made by the online calculator. 

So, who to believe?  The money management professionals and their calculators, or my gut feeling that my family practices good savings habits?  Ouch... who wouldn't want to go with the former?

In the end, the answer turns out to be a little bit of both and that's exactly what the economists quoted in the article have to say.  They don't recommend eschewing saving for retirement; only doing your own research before committing to funding a money management plan with what may be too much money. 

There is utility in having money for retirement, but there is utility in having it for today, too.

How A Homebuyer Can Save An Extra $4,250 In 5 Years

It's just good luck for post-Super Bowl home buyers this week.  On the heels of less-than-hawking testimony from Fed Chairman Ben Bernanke, mortgage rates have dropped by about 0.25% across the board.

The impact of lower rates is palpable.  A $300,000, 30-year fixed mortgage is now $49 less expensive per month and a similar 5-year ARM with interest only option is $62.50 less expensive per month.

Savings add up over time.  At a 5% rate, $62.50 grows to $4,250 in 5 years.

The best part is a lot of folks are going to benefit from the drop -- purchase contracts are arriving in our office at a dizzying clip right now.

Now, the key is: just because rates dropped doesn't mean you should buy a bigger home.  Treat lower rates like a reverse form of "found money" and maybe one day that money will find you -- in need of $4,250.

The Latest, Not Greatest , or How I Learned to Stop Worrying and Start Loving FICO

The much-hyped VantageScore credit scoring system seems to be getting a lot of press lately, so thank you to Holden Lewis at Bankrate.com for keeping it real.

According to the VantageScore Web site, it is the "new standard in credit risk scoring". 

"Why did we create VantageScore?  Simply put, the industry expressed a need for a new approach to credit scoring across the three major credit reporting companies...VantageScore is a cutting-edge scoring model that consumers tell us is easy to understand and use." (emphasis added)

That's fine and all, but here is the other side of that hype as it pertains to mortgage lending (from the BankRate.com piece):

"People in the mortgage industry say there's no chance that home lenders will adopt VantageScore. They will stick with the FICO score because it has proven to be accurate."

For the mortgage industry to adopt VantageScore, it would literally eliminate hundreds of millions of data sets that predict the likelihood of mortgage default with near-certainty.  As I was quoted in the article: "How is the industry going to turn its back on that?"

In the case of VantageScore, cutting-edge does not mean better, it just means newer.

Fixed Income CDs Flat-Line; Could A Recession Be Ahead?

It appears that banks offering fixed income investments are preparing for a period of declining interest rates.

Beginning in June 2004, short-term interest rates began to rise.  Buoyed by the Fed Funds Rate, interest rates for fixed income securities such as Certificates of Deposit began to rise, too. 

For example, in November 2005, the highest yielding 12-month CD at Fidelity Investments was at 4.40%.  By November 2005, it was up to 5.20%.

It appears the upward trend is over, however.

A look at today's CDs on Fidelity's Web site shows the following yields over specific periods of time:

• 3-Month: 5.20%
• 6-Month: 5.15%
• 9-Month: 5.15%
• 12-Month: 5.10%

In other words, banks feel that interest rates will decline over the next 12 months and they certainly don't want to be paying you any more interest than they have to.  And remember -- CDs are guaranteed because they are FDIC-insured.  This is as risk-free as you can get with an investment.

This is simple research that you can do on your own, too.  Just open up your local daily and take notice of how many advertisements you find for CDs.  You'll see the trend, too!

The longer the term on the CD, the lower the offered rate will be.  This is because banks and businesses expect the U.S. economy to slow down in 2007.

Are Stocks Replacing The Home As A Piggy-Bank?

Just to throw a thought out there...

As home values level-off (and in some cases drop), there is a lot of chatter that homeowners will feel less wealthy because of "equity lost". 

In theory, this will translate into less money spent by homeowners.

How To Use Housing Futures To Protect Against Losses In Real Estate

Futures contracts allow a person to buy or sell a specific amount of a product on some specific date in the future.

For example, an Iowan corn farmer may be nervous about how the winter will impact his 2007 harvest.  So, to protect his income, he can buy futures contracts that guarantee a buyer for his crop at a specific price in June 2007.

Regardless of the market price for corn in June 2007, the farmer can know exactly what price he'll get.  If market prices are higher than what his Futures contract is for, he loses.  If prices are lower, he wins.

The Merc provides a helpful Web site to learn more about the product.

Bankrate.com's Jay MacDonald penned a very smart piece about how savvy real estate investors can use the Housing Futures markets to hedge against losses in home equity, or exposure to declining real estate markets. 

It is an interesting concept that homeowners can protect their "income" just like the corn farmer from Iowa.  Imagine some of the goals you could accomplish:

• Plan to avoid capital gains taxes by keeping your net proceeds below $500,000 for married couples; $250,000 for singles
• Know exactly how much money you will have for a downpayment on your next home
• Combine Housing Futures with a Mortgage Rate Futures Market and lock your next loan years in advance
• Remain fully-leveraged on your home and use the extra equity for investment and retirement

The list goes on.

Or, as noted by University of Houston's Bauer College of Business Finance professor Craig Pirrong, the Futures markets can give people with a $50,000 minimum investment the chance to speculate on real estate markets without buying homes directly.

In buying financial instruments that mimic real estate markets, a real estate investor can avoid all of these arduous and costly steps:

• Buying a home
• Paying closing costs
• Finding tenants
• Paying for maintenance
• Insuring the home

And, in theory, Futures Contracts are much more liquid than an actual investment property so it can be sold immediately.

Source
Housing Futures to Allay Bubble Fears
Jay MacDonald
Bankrate.com
http://www.bankrate.com/brm/news/real-estate/20060810a2.asp

(Images courtesy: Fortune's Pawn, The Brattle Group)

Why You Should Protect Your Credit Scores During A Divorce (And Your Partner's Credit Scores, Too)

The Orlando Sentinel picked up a terrific BankRate.com story this weekend about failed marriages and the mortgages left behind.

"Divorce is one of the leading causes of foreclosure today," says William Martin, a lawyer in Lowell, Mass., who specializes in real estate. "The other major cause is a catastrophic health event."

Health problems can leave a family unable to make regular monthly payments and turn a mortgage into a financial burden. Divorce can turn a mortgage payment into a financial weapon. Though a divorce decree can end or nullify a marriage contract, it cannot end or nullify a loan contract.

It is easier to break a marriage contract than it is to break a mortgage contract.  That's pretty powerful stuff. 

I have witnessed this issue on several occasions.  A family splits up, and while the paperwork is being filed, emotions run high and the battles are frequent.  Neither the husband nor the wife pay attention to the family bills (or choose to ignore them out of spite), and then the real financial chaos begins.

Most married couples jointly signed on their mortgage, their credit cards bills, and utilities.  It shouldn't surprise you, therefore, that divorcing couples tend to emerge from divorce proceedings with heavily damaged credit ratings because neither party wanted to cover the other's "expenses" during the separation period. 

Even when payments are court-ordered, bills still go unpaid because people can be people, at times. 

When bills go unpaid, it's a bad thing. 

When mortgage bills go unpaid, though, it's a disaster! 

After 90 consecutive days of non-payment, the lender files for foreclosure with the county and then both parties to the divorce officially enter a World of Hurt.

• Credit scores plummet
• Interest rates on credit cards increase
• Home loan eligibility over the next 3-7 years is severely hampered

When divorcing couples ignore mortgage payments in a game of Chicken, both parties are playing with fire and probably don't even know it. 

Once a foreclosure process begins -- even if you "settle up" and keep your house -- the default history follows you forever on your credit report, and on your title report.

During divorce proceedings, the usual resolution is that one party keeps the home and remortgages it in their name only, dropping the other party from the mortgage obligation and the title. 

This process is incredibly simple and pain-free -- but only if both parties have maintained their strong credit rating throughout the divorce.  If the credit is damaged, the mortgage can't be reworked and the divorce proceedings can grow more contentious.

Therefore, the most efficient and least costly approach is to address the mortgage early with your divorce attorney and reach a common sense agreement that benefits both parties. 

Ignoring the mortgage out of spite is a foolish game in which both parties lose.

Source
Divorce ends a marriage, but the mortgage lives on
Bankrate.com, April 23, 2006
http://www.orlandosentinel.com/features/home/orl-mortgage2306apr23,0,3191875.story?coll=orl-shoppinghg-headlinesforthe

The Key To Living Within Your Means : Don't Buy Stuff You Can't Afford

Saturday Night Live ran a terrific skit a few weeks ago with Steve Martin (Husband), Amy Poehler (Wife), and Chris Parnell (Announcer) called Don't Buy Stuff You Can't Afford!

The transcript from SNL Transcripts is funny, but the video is funnier.  YouTube pulled it for copyright reasons.

[ open on couple trying to balance their checkbook ]

Wife: (sighs) I just can't get these numbers to add up.

Husband: Like we're never going to get out of this hole.

Wife: Credit card debt, does it ever end?

CP: [walks in] Maybe I can help.

Husband: We sure could use it.

Wife: We've tried debt consolidation companies.

Husband: We've even taken out loans to help make payments.

CP: Well, you're not the only ones. Did you know that millions of Americans live with debt they cannot control? That's why I developed this unique new program for managing your debt. It's called [presents book] "Don't Buy Stuff You Cannot Afford."

Wife: Let me see that... [grabs book, reads] "If you don't have any money, you should not buy anything." Hmm, sounds interesting

Husband: Sounds confusing.

Wife: I don't know honey, this makes a lot of sense. There's a whole section here on how to buy expensive things using money you save.

Husband: Give me that... [grabs book, looks at it] And where would you get this saved money?

CP: I tell you where and how in Chapter 3.

Wife: Ok, so what if I want something but I dont' have any money CP: You don't buy it.

Husband: Well let's say I don't have enough money to buy something. Should I buy it anyways?

CP: No-o-o-o.

Husband: Now I'm really confused!

CP: It's a little confusing at first.

Wife: Well what if you have the money, can you buy something?

CP: Yes.

Wife: Now take the money away. Same story?

CP: Nope. You shouldn't buy stuff when you don't have the money.

Husband: I think I got it. I buy something I want, and then hope that I can pay for it right?

CP: No. You make sure you have money, then you buy it.

Husband: Oh, THEN you buy it. But shouldn't you buy it before you have the money?

CP: No-o-o-o.

Wife: Why not?

CP: It's in the book. It's only one page long. The advice is priceless and the book is free.

Wife: Well, I like the sound of that.

Husband: Yeah, we can put it on our credit card.

CP: [shakes head]

Announcer: So get out of debt now, write for your free copy of "Don't Buy Stuff You Cannot Afford." If you buy now you'll also receive, "Seriously, If You Don't Have the Money, Don't Buy It!" Along with a 12-month subscription to "Stop Buying Stuff Magazine." So order today!

SNL positioned the skit as a parody, but it does hit close to "home" for a lot of folks, pardon the pun. 

Regardless of what home you buy, and with what mortgage you buy it, the key is word is discipline in terms of your finances.  Earn more than you spend, and save your money wisely.