Matters of Interest

We would like to think that the worst is over. Certainly, we have seen a lot of trouble; but the residual of the current problems that are racking the market will be with us for a long time.

More than many know, we have modeled our finances after Biblical principals. Specifically, there was a time when every seven years, debtors were forgiven their obligations, and essentially given a clean slate.

The American homeowner has achieved this "Year of Jubilee" by means of selling their homes, and using the equity to pay off their consumer debt, make a down payment on another (larger) home, and repeat the cycle.

A typical first-time homebuyer owns their home for 3 years- the average move-up buyer? You may have guessed: 7 years.

So, what of our market today with no equity in homes and consumer debt rising? No Jubilee.

My goal as a financial planner is to build a comprehensive plan to equity, debt, and risk in the form of a balanced budget for my clients. The balance in the budget is not simply income/outgo (critical first stop!); but also short term/long term. We should enjoy (some woth more moderation) the lives we live today- but not to the exclusion of a sound retirement tomorrow.

In the coming years, in keeping up with the Jones we may find ourselves in the wrong neighborhood.

Watch for my 7 Step Program to Financial Recovery, coming to a blog near you soon.

Nothing.

Well, realistically, if you have steady income, decent credit (not perfect is okay), and some savings (even no savings), there is plenty of attractive financing available for you.

Rarely will the market not lend on reasonable risk factors.

Declining Property Values

Now this hurts if you are considering selling or refinancing. This is the factor that is locking people into their current home.

The return of the Short Sale (selling for less than the actual mortgage balance, with the bank's approval- as they are taking a loss- reserved for those who have fallen behind on their mortgage payments) has brought out the worst in some. There are instances of owners intentionally allowing their loans to go into arrears (late payments), even though they could make their payments. They simply have elected not to do so.

This is a flawed strategy, and unethical at best. Sorry.

So if you are in there- stay there- unless your work or family obligations require a move, and you simply cannot afford to maintain the home.

Trouble Ahead

Often the sale of a home results in a windfall of sorts during the typical real estate market. The appreciation of the home and the forced savings plan (zero rate of return) payments to principal result in cash at closing that is typically used for that next home purchase...and to pay off the other debt that may have accumulated since the last purchase.

Beware. Keep a handle on that credit card and installment debt (which statistics say most are not), because with home values haven fallen, there may not be that "get out of jail free card" coming with the next sale.

Nonetheless (finally to that good news), it is a great time to buy or build! Home values have dropped into a real value zone, and builders need to clear inventory, and...well, they are builders...they need to build some homes.

If you have questions about budgeting, building better credit, or buying a home, contact us for a free consultation.

Experience You Can Trust, For Your Best Interest...

888.795.2470 or email us.

While property values continue to show declines nationally; some areas are showing meaningful signs of a bottom.

Now is the time to shop.

Rates are bottoming also, as increasingly The Fed turns its focus toward inflation concerns.

Now is the time to shop.

First Stop - Pre-Approval

In busy markets the best practice of real estate agents is to have the prospective buyer speak with a Lender before seeing any property. First, this puts the buyer into the right price range for their budget; and second, it makes for a more efficient home search.

The real values in the market place are moving fast. Over priced homes where the seller is holding out and hanging on to a market-gone-by are the homes that are languishing and giving the impression of a sluggish market.

Unfortunately, some agents, (even with $4/gallon gas) are so excited to have a warm body in the car, that they skip the pre-approval process. This can end in much heartache when the home one falls in love with is beyond one's loan qualification; or worse, down the road the payments overwhelm the new owner's budget.

It's simple to get pre-approved, with an actual loan approval based on income and credit. The rest of the qualifying is reviewed once a property is found and put under contract and appraised. This actually assists in the price negotiation, because the buyer is ready to move quickly to closing.

Next Stop - The American Dream

It's not corny- owning your home gives you a sense of pride, security, and an investment foundation for the future.

It is a great time to look at real estate- just make sure you get the process in order to make sure your dream doesn't turn into a nightmare.

Firstly, I am not trying to put myself out of business.

America, America. We have so much and we push each other for so much more. Not always in a good way.

Homeownership, of which I am a fan, has been turned into an exercise of Vanity for many. The goal is no longer to provide one adequate shelter and a hedge against inflation, but in the minds of many it is an outward display of one's success. More often it is an outward display of the success we want others to think we have, whether we actually do is another question.

So, for outward appearances, we strap ourselves into this asset that is not liquid, can (and does) lose value, and we form emotional attachments to it. We do this to the exclusion of our long term financial wellbeing and more immediate risk management (adequate emergency cash and life insurance); not to mention the ability to tithe to our church or give to those truly less fortunate than ourselves.

I believe the problem arose with the invention of the combustion engine.

This was the invention that began the era of personal mobility. Sure we had the wheel- but the engine that was small and economically feasible enough for an individual multiplied the impact of the wheel exponentially. Now we get get away. Way away. The traditional family structure's end; the disbursing of our moral and social accountability from the intimately familiar to the superficially seen.

Now we build and buy edifices to impress the hundreds of people who drive by our home and take notice. Or, they fly in for the weekend, and we pull it together long enough to entertain and showoff our success. Then Monday, it's back to the bills and trying to make ends meet.

We are an enabling society. "If I don't sell it to them, then someone else will". And yet, each individual is still accountable for their own actions, despite all the attempts to blame others.

It is a great time to buy a home. Declining values in much of the country are essentially a price rollback to the late '90's. Mortgage rates are at historical lows.

A Recession is an economic correction that can be quite useful in getting people's attention. Let's hope that gas prices approaching $4.00 per gallon can slow down our combustion engines enough to return some reason to the way we decide to spend the resources that come our way.

Personally, I believe it is a great time for a qualified buyer to work with responsible professionals to secure adequate, even comfortable, housing to hedge against inflation; while advising that buyer to have a working budget, sufficient savings, proper levels of insurance, and a long-term savings plan to assure a successful retirement.

That's just how I roll.

The good news is that the system fundamentally works. The bad news is that most of the news that is printed isn't about that aspect, it's about the sensational breakdowns that are "newsworthy".

The fact is that there are adequate protections in place to inform the consumer. Likely, the protections have been over-developed and complicated as to compound the problem.

There are dusty stacks of pamphlets at offices across the country, and in peoples homes. They are produced by the writers at the FTC, HUD, and Treasury. When they are handed actually handed out, they land on top of a stack of no less than 18 other documents written in a language that most loan officers don't even understand.

The current Good Faith Estimate (GFE), contains suffcient information (when it is complete and accurate) for a consumer to make a comparative decision. The flaws are not in the formulas, but in the explanations.

Since 2000, at least, many inexperienced, sales-driven loan originators have flooded the market. Relaxed guidelines and complicated loan programs made disclosure to the lay person a real challenge, even for those equipped with the knowledge to explain.

And, yes- those consumers who really didn't want to be left out. If one lender wouldn't, another would. The consumer could be coached, or unintentionally taught how to work the system. Without guilt or remorse, but with a sense of entitlement- that for many became outrage when they ended up in default.

Wall Street and their appetite for securitizations are culpable; there are those whose practices are driven by greed; there are those who naively believed what they were told. Some in each category didn't know what they didn't know (and still probably don't). Some did.

Integrity isn't required in any profession unfortunately, because society has made this too difficult to assess and 'too expensive' to pursue. Too bad, considering the long run costs.

Consumers should demand that they understand, and should not lack the discipline to stop a process they do not understand.

If a lender simply points to the lines on the page and explains the cost the problem is less.

Realistically, the time and effort to provide a $100,000 loan is not much different than a $1,000,000 loan. This, as a result of automation & operational efficiencies and low overhead allow my company to have a set revenue ($2,500 or 1% of the loan, whichever is less). To do this also requires a reasonable profit motivation, considering most companies seek 1.5-2.5% of the loan amount as there target revenue, unless they can get more.

The current GFE allows me to disclose this as an upfront fee, or as a "rebate" from the servicing lender to whom I sell the loan. This "rebate" is referred to as Yield Spread Premium (YSP), and appears as a non-cash item in the 800 Section of the GFE. It is non-cash, because the client doesn't pay it in cash, it is paid out of the premium paid because the client takes a slightly higher interest rate, effectively financing the fee.

This isn't complicated, but it is foreign to the typical consumer. It just requires that someone explain it in plain English when pointing to the page.

Oh, and telling the Truth.

Michael Noel is principal of American Home Financial, a licensed Florida Lender. Mr. Noel is one of only a few Certified Mortgage Consultants & Certified Mortgage Planners in the country, and has been helping clients make smart decisions about debt and equity for over 20 years.

The scapegoat, with some culpability of course, continues to be “sub-prime mortgages”.

As usual, The Truth is more complex.

In 1991, our economy was just bouncing back from a slow down and record high foreclosure rates. This is a foggy memory for most of us. Great times ensued.

Post 9/11, the financial markets were rocked and cash flooded the ever reliable real estate market. Over development and rising prices didn’t dissuade anyone. More product, buy more. Prices rise, flip and buy more. Anyone can play, no experience necessary.

Wall Street seized this opportunity to restore its capital appeal with Real Estate Investment Trusts (REITs) and mortgage-backed securities. Their ever-growing appetite required “new” mortgage instruments to accommodate more buyers- now securities analysts were authoring guidelines for mortgages, not just mortgage bankers.

The frenzy drove prices higher creating a large gap of affordability for the homeowner. More accommodations to draw more buyers and investors. More development; more rising prices.

Rising property values translated into higher tax revenues. Short-sighted politicians planned budgets as if the trend would continue spending the tax windfall on long term spending projects and new jobs.

Insurers raise rates. (Despite fewer storms in Florida for two years). Higher home values- more risk, more return.

Higher home prices, taxes and insurances costs translate into higher wages to attract and keep employees near business centers.

And we should have seen it coming.

Home appreciation rates were unsustainable. We know real estate is cyclical, and yet politicians chose to ignore this. Then when faced with cuts into programs launched during the euphoria, they have the unconscionable gall to use fear tactics, claiming cuts would have to come in Essential Services. Were we so under-protected in 2001? How could politicians budget for new arenas and levy taxes to pay for projects that prudent private sector investor would not touch with a 20-foot pole?

Greed and a lack of restraint have brought us to this place, not simply “sub-prime mortgages”. We live in larger homes than we need; we speculate in areas outside of our expertise; we choose to use the facts that support our arguments and special interests; we seek to profit in the moment and ignore the consequences.

The cure is not a bail-out that transfers the burden back to tax payers (tacit socialism). Unfortunately the cure is for us to fail. To rebound and rebuild. To take the losses, and pay the cost. The market will correct at a large cost to us all as we absorb the ripples that Greed has created, and Fairness will not preside over the process.

Now is the time to consider preventative measures without a doubt, but the market will purge the obvious perpetrators; we need to look at the factors outside of market forces that allow this situation to manifest. Incompetence in government has exacerbated this problem with irresponsible spending and lack of restraint. Many a homeowner would be far more able to afford the adjustment in their loan payment if taxes and insurance had not doubled over this period.

Ultimately the public needs to understand the responsibility that give to elected officials and hold them accountable. We must ask the questions and not be satisfied until we understand the answer. If they can’t give a clear explanation, they are not qualified to serve.

I continue to be disappointed by experts not knowing what they don’t know. Each time one of these “experts” parrots the phrase “mortgage meltdown” in the media, it extends the life cycle of the problem. They stumble across the commercial paper aspect of the problem. Lenders are supposed to disclose according to the Truth-in-lending Act- why can’t we get some truth in reporting on lending. It would require some homework, or they could interview some real mortgage experts.

1. “Alt A” loans are not Sub-prime loans. Thornburg for example is an “A” paper lender, caught in a break down of commercial paper markets. Has anyone asked them if their assets are performing? Talk about the actual relative performance of assets by risk grade instead of just saying, “mortgage meltdown”? Talk about specific relative mortgage segment performance: A-paper, Alt-A, Sub-prime, home equity, Jumbo prime paper (Thornburg)?
2. Our grandparents had little choice but to put down 20% because there was no risk-based pricing model based on credit like there is today. The Fannie and Freddie engines are working just fine. Today we can substitute good credit for cash and lending can be sound. American Home Mortgage, among others, invested heavily in the “exotic mortgages” that are often characterized as “sub-prime”. These loans were NOT 100% loan-to-value programs and required good credit borrowers (typically 680+ credit scores). The deferred interest potential is offset in a typical appreciation market of 5-6%, and required a minimum 5% down (115% growth cap), most 10% down (125% growth cap).
3. As an investment real estate is: non-liquid; has no guarantee of principal; and gives no rate of return on additional principal contributions. The only strengths are in tax advantages and leverage. Take those away and we are all better off renting.
4. These loans were not the product of booming real estate values per se. This is chicken and egg. The abuses of these were consumer responses to achieving a certain lifestyle. In other words, borrowers weren’t satisfied with moderate housing, so they went upscale with an “Option ARM” to keep up with the Jones. The borrower may have been coached, or the transactional mortgage broker (living from transaction to transaction with no regard for the client’s future) may have lied, but one read through the disclosures and the borrower would have an understanding or enough fear to ask questions. Yes, conspiracy. Title and Attorney Closing agents even do a quick overview of the note at closing. Do they see borrowers with glassy eyes signing these notes? Are they notarizing documents they don’t review or ask if the borrower understands? When these show up in court, will the authors of the Truth-in-Lending Act be named in the suit? Call it immediate gratification or greed or whatever you like from borrowers- this is not new behavior.
5. Legislators created permanent budgets on the cyclical rising property values and therefore taxes have created an affordability problem that is as much to blame in most markets as adjusting mortgage rates for defaults.
6. Insurance costs have contributed to rising home costs and have an impact on defaults.

I heard one analyst as if he were doing an exposé describing how he repeatedly asked lenders if the had relaxed their underwriting standards over the course of the last couple of years- “And they said they had not”. I’m hoping as an analyst he was fired, because one cursory look at the lender’s matrices over the course of two years would have clearly demonstrated they had.

By the way, let me describe a loan program to you. 10% down required, payment rate of 2.5%, with an actual note rate of 8%, so the potential to defer interest (add back to the loan balance) is 5.5%, but this can change as often as month an annualized basis. The loan can grow to 125% of the original balance over a 5-year period, when the loan is subject to recast. Your experts they are probably thinking “Option ARM”, one of those new exotic loans that sprang up during the roaring 2001-2005 real estate boom. They would be right; but, they would also be right if they were recalling the mid 1980’s and a loan called the “Flex”, that had been very popular during the days of 14-16% mortgage rates in the day that sparked a refinance wave back then. History repeats itself?

Approximately 65% of the licensed mortgage brokers in business today have less than 5 years of experience. These loan originators were taught how to get people qualified under the most profitable program available. These inexperienced originators were focused on the transaction today, not the client down the road.

The easiest sales were Adjustable Rate Mortgages (ARMs) with profits hidden in the margin, especially the Cash-flow Option ARMs, offering a payment rate as low as 1%.

When a loan rate adjusts, it adjusts based on the Index (a benchmark which reflects current market rates, i.e. the One Year Treasury Bill, or the London Interbank Offer Rate (LIBOR), or the Prime Rate (the Fed Funds Rate plus 3%). To this benchmark, one adds the Margin- that is, the Profit Margin for the Lender/Bank. Margins typically range from 2.25 to 2.75, but often can be as high as 3.25 or more.

When distracted by a Payment Rate of 1%, the typical borrower can easily forget that the real rate of interest is that Index Rate (LIBOR today is around 5.34%) plus the Margin could result in a real rate between 7.54% and 8.59%. Originators make money selling the closed loans to Lenders. Lenders make more money when the loan has a higher Margin, therefore they pay more to the originator to encourage higher margins.

This abuse has created an unfortunate backlash against good loans improperly used. A Harris Interactive poll of 2,383 U.S. adults released last month indicated the a hugh majority don't trust mortgage advertising and most do not like ARMs or Interest Only loans.

Indeed, a renewal of "Depression Era Thinking" is occurring that will cost the average borrower $25,000 over a five year period when compared with proper debt and equity management.

This "Depression Era Thinking" is the practice of prepayment of loan principal and shorter fixed term loans. Prior generations were taught that owning one's home free of any debt would protect the ownership and value of the home because early mortgages were callable- the bank could simply call the loan because they needed the cash, even if the borrower had a perfect payment history. This is no longer possible, but this nonetheless started the practices. Like the tradition of cutting off the ends off a roast passed down through the generations, a grand-daughter preparing the family dinner one night asked how it effected the roast's flavor. The grandmother recalled that she actually did that because her old oven was too small for it to fit the whole roast- it had nothing to do with the present day rationale for the practice.

The $25,000 mistake that most borrowers make is in prepaying their mortgage. If one were to put down $20,000 and buy a home for $100,000, and realize no appreciation for 5 years, and then sell the home for $100,000, they would walk away with $20,000 (less the cost of sale). The $20,000 had no rate of return.

If the same borrower bought for $100,000, with $20,000 down, and realized 5% appreciation, they would walk away with $47,628. The appreciation of $27,628, plus their original $20,000, which again had no rate of return. In other words the rate of appreciation has nothing to do with whether the property has a mortgage, and additional payments to principal earn no rate of return. In fact, the build up of equity makes the home more attractive to the bank in foreclosure, and gives the bank less reason to work with a borrower in distress. It is easy to conclude then that prepayments actually reduce the bank's risk while increasing the borrower's risk.

The prepayments are plowed into an "investment" that has no rate of return, can lose value and is not liquid. Not the kind of "investment" that a prudent saver would use!

Consider two brothers with identical income and the same amount of savings, $100,000. One buys a $500,000 home with a 15 year fixed loan at 5.875% APR using all of his savings for a 20% down payment. His payment is $3,348, but after tax deductions feels like $2,983. He also adds an extra $200 per month to prepay the loan.

His brother also buys a $500,000 home, but with only 5% down, he takes a 6.375% Interest Only 30 year loan. His monthly payment is $2,523, which after tax deductions feels like $1,690.He leaves the remaining $75,000 in  a safe, guaranteed, money-making Investment Account earning 6%. Every month he sends the monthly payment savings difference of $1,293 plus the same extra $200 his brother does into his Investment Account.

Five years later, the first brother has received $33,796 in tax savings, but has no Investment Account.

The second brother has received $49,955 in tax savings and his Investment Account has grown to $205,330. This strategy will ultimately allow the brother to pay off his loan more quickly than the first brother anyway.

Now, which would you rather be if you suddenly lost your job, or became disabled. Both brothers have equity in their homes, but neither could qualify for a loan to extract it! Brother Two has a significant cash reserve to sustain him through difficult times.

The facts are that the average first-time homebuyer owns a home for an average 3 years; a move-up buyer averages 7 years; and the average life of a mortgage loan is 5 years. For the average borrower, a 30 year loan is a waste of interest, and the principal paid over these time frames is much less than the lost investment opportunity.

The answer lies in the fact that the best loan is the lowest rate on the right loan. These are rarely short term ARMs with monthly, 6-month, or even 1 year adjustment periods. Many Clients can be well served by intermediate term hybrid ARMs with guaranteed 5, 7, and 10 year fixed periods with annual adjustments after the fixed period, and with Interest Only options for the right Clients. Rates could cycle lower during the term or the savings will more than offset the cost of a refinance if the Client wants to extend the term or separate appreciation equity from the home.

The best loan scenario will match the Clients goals for how long they want to own the home, how aggressively they want to save, and will match income trends and life cycle changes (marriage, kids, college, retirement). This is best accomplished by a Certified Mortgage Planner with several years of experience, who uses a regular process of annual review to assure the plan continues to meet the client's goals.

Troubling times for many in the mortgage industry.

When I first entered the industry, over 20 years ago, rates were just coming down from the 16% range. People had been taking off from work to wait in line to refinance. Many clients were getting out of a loan known as "The Florida Flex", that they had taken to avoid those 16% fixed rates.

The "Flex" Loan was a loan that had a low payment rate that was not enough to pay even the interest due on each payment. The remaining interest was added back on to the loan balance as "deferred interest", or negative amortization. Nobody liked that name- it was too , well, negative.

Sound familiar? It should if you've heard of the "Option ARM", or those commercials for 1.25%, or borrow a million dollars for only $1,000/month. The old is forever new.

There were some problem loans, and everyone got excited. The "Flex" went away. Rates continued to improve (which they have for the past 40 years). Credit guidelines constrict and relax. Banks and mortgage companies come and go.

The "meltdown" is the down part of the cycle. This one is worse in my opinion, than the last two such cycles I've been through for some convergent reasons.

After 9/11, there was a "flight to safety" in real estate. Real estate is diverse, spread out, easy to touch, hard to misplace. And, in this rush, unrealistic and sustainable appreciation occurred. This drew many inexperienced investors into the market now seeking huge profits.

Most of these investors did not look at real estate as an investment objectively, and poured to many resources from already savings poor budgets into an investment whose greatest advantage is in utilizing leverage.

More people, with less investment sophistication, with less reserves, borrowing more on leveraged assets that were unrealistically appreciating and rapidly becoming overvalued.

Add in some overzealous lenders with sales people acting as loan advisors and one finds greed and get-rich quickness driving a market quickly beyond reason.

Among the last straws are our elected officials who took the tax revenue windfall from this cyclical and exaggerated event and spend it on long term budget projects as if the rise were going to continue.

What were they thinking? Continued appreciation? A plateau at levels that drive people from the State because they can't downsize out of there high taxes into less home with the same high taxes? The gap in housing affordability places wage pressure on employers to attract good employees which ultimately results in inflation.

The difference from the refinance era of the 80's is that people could still afford to refinance and qualify. They didn't get the option of exaggerating their "Stated Income" the first time around.

Ultimately what it means you, and me, is that we need to run our personal finances like a business for the long term. We will need to balance our budgets and defer some gratification. We will put off the extras and take care of what we have so it will last. Market pressures will return us to a balance within the next 12-18 months. Appreciation will normalize at 5-6% after we pay back some of the extraordinary gains we perceived. Rates will top out around 7% and moderate over the next 18 months, while meandering in the 6-7% range for the rest of this year. Some of the market losses will result in higher borrowing costs for certain borrowers. We will have to earn rather than expect progress.

Hopefully we will seek out wise counsel. My goal as a mortgage planner is to serve as one member of the Personal Board of Directors of each of my clients. To work in concert with CPAs and Financial Planners to optimize each client's resources to take every advantage to save at each opportunity that arises. And for those who don't have their Personal Board elected, to start with the basics of savings, real estate and life insurance to build a foundation from which to grow.

It will take time to turn these market conditions. The shortest route to recovery will come via sound planning, discipline, and smart decisions.