Thursday, January 24, 2008

Would You Drive Your Car Using Only Your Review Mirror?


This is exactly what many of us try to do with our personal finances. Instead of looking to the future through a clear large windshield we view our future by focusing on the past, as if we are looking behind ourselves and trying to drive our financial future by looking through the rearview mirror of life. Let me explain what I mean by this analogy. What do you think most will do this month if the stock market corrects to a point of a crash? The stock market has been declining in the New Year at an accelerating rate. Are most going to sell their mutual funds, stocks and other equities that make up qualified retirement plans at work or brokerage firm accounts and move these assets to cash? Do you think most will be able to stomach the same losses that have already been experienced during the last market correction earlier this decade? Well if the answer is -- sell! I am too close to retirement to wait for the market to rebound and replace these losses, or I don't know what to do I keep getting different advice from CNBC, financial writers and other experts. This is exactly like trying to drive a car using only the rear view mirror - it can be done but it is very hard. What if there was a different way of having your savings kept safe from loss of principal and you only risked the yield or return on those funds? There is a way to drive toward your financial future looking through the front windshield.

Let's assume you were looking to buy a home last year and instead of purchasing the home in a traditional way you offered the seller an option to buy the home at a specific price a year later. For this option you pay him $3,000 from the interest earned on money you have earmarked for the down payment on this property. Now the seller may not like this offer but decides to accept the option because of the current lack of buyers. A year passes and you assess the real estate market and the current value of this home - now you are able to decide whether or not to exercise your option. If the market has improved by 10%, then you would buy the house at last year's price - with the 10% gain intact. If the market on the other hand lost value - maybe decreased by 20% -- then all you lost was the $3,000 you paid for the option. By using this option you have limited your risk and remained in control.

You can do the same thing with your long term savings accounts like retirement, college funding and other future needs. I have shown many clients the benefits of creating liquidity, safety and respectable rate of return on their retirement accounts by using their idle lazy home equity and other savings to propel the future retirement income. There is no reason why you can't use these safe albeit unconventional strategies to increase your control over your financial future. Stop driving to your financial destination using only your rearview mirror. Let me show you how to look through the windshield. Call me to schedule a presentation of these unique savings strategies and financial vehicles.

Where's The Mortgage Money?



This is a slight take off from an ad in the 80's in that Wendy's asked "Where's The Beef?" Well the mortgage money resides with the three government institutions Fannie Mae, Freddie Mac and Ginnie Mae. If your mortgage loan falls outside of any one of these three institutions guidelines, then you will have a harder time finding your beef or new mortgage money. Without trying to give a history of these institutions lets suffice to say that because each of these is backed by the Federal Government taxing ability to some degree (Ginnie Mae the greatest) that investors that buy mortgages in the market are comfortable buying these agency's mortgage debt.

Here is the current mortgage landscape. Fannie Mae and Freddie Mac lending guidelines are virtually the same when compared to one another. These agencies are primarily known for lending on residential property consisting of one and up to four units. A number you need to understand is the maximum loan limit allowed to be lent on a single family residence, including condominiums, which stands at $417,000. This loan limit has been consistently raised each year until 2006 where it has remained at the $417,000 (the limit in Alaska, Hawaii, Guam, and the U.S. Virgin Islands is 50 percent higher than the limits for the rest of the country.) You can go to http://rs6.net/tn.jsp?t=5yzpyicab.0.0.uoqzytbab.0&ts=S0313&p=http%3A%2F%2Fwww.fanniemae.com%2Faboutfm%2Floanlimits.jhtml%3Fp%3DAbout%2BFannie%2BMae%26s%3DLoan%2BLimits&id=preview for a history on loan limits and the current limits for 2, 3 and 4 unit properties. What is little known is that both Fannie Mae and Freddie Mac offer a wide variety of lending products to the lending industry. For example: Interest only loans both fixed and adjustable, 100% financing loans to both highly qualified and as part of community lending initiatives with income restrictions but mortgage insurance subsidies. On the adjustable mortgage matrix you can borrower on a 3, 5, 7 and 10 year fixed term with either a LIBOR (London Interbank Offered Rate) or US Treasury as the underlying index. They also offer what the industry calls expanded criteria or "A" minus loans - a higher credit standard than sub-prime but with loosened guidelines compared to its "A" paper counterpart. These agencies have been offering these products for the past several years as the Alt A and Sub-prime industry grew. The only difference is the lenders offering those loans did not have the backing of the government or our tax dollars therefore those lenders have gone out of business when the market "re-priced the perceived risk" of these loan products.

Ginnie Mae has also been sanctioned to step up to the plate and lend with the full and complete guarantee of the Federal Government taxing ability. This agency is better known for providing FHA and VA loans. In January the congress passed legislation allowing FHA to increase its loan limits to those of Fannie and Freddie. FHA via the Department of Housing and Urban Development is the insurer of mortgage debt that is pooled into Ginnie Mae Securities. So instead of having private mortgage insurance companies (PMI) underwrite the risk of mortgages when loans are greater than 80 percent of the property's value, the government underwrites this risk called MIP (mortgage insurance premium). Today loans that the private mortgage market priced at rates of between 9 to 15% the government is pricing this risk at 5.5%. Once you have an FHA loan you never have to qualify to refinance it again as long as you make your payments, the new interest rate is lower and you don't take cash out. FHA has effectively replaced the entire sub-prime industry in the last six months. One way to learn if a loan product is popular and profitable for a lender; listen for increased radio and television ads promoting the product. FHA also insures the Reverse Mortgage loan product that has become popular recently with seniors.

Ok you say that is all well and good for those that have mortgages that fit the government guidelines. What if you owe or need a mortgage larger than agency loans limits? The answer is stay highly qualified. Highly qualified translates into high credit scores - try to get them above 720 or at least above 680 middle score. By now the industry seems to be doing a good job of educating the consumer on what a credit score is, how to protect it and how to get it. If you need assistance in this area I will be more than happy to take the time to consult on your credit situation and how to improve your scores. Part of the real estate market downturn, raise of foreclosures and mortgage lenders imploding is the State's Legislature is working on passing more regulations to protect the consumer. Recently for example the Attorney General of Massachusetts, Martha Coakley, has issued an expansion on Chapter 93A laws governing unfair and deceptive business practices with respect to mortgage lending effective at the beginning of January 2008. I cannot comment fully on this expansion but it has had an affect to keep potential lenders from doing business in Massachusetts and others to pull out of the State all together. It also affects the mortgage broker and lenders that have offered no income verified loans to its borrowers. The new expansion does not ban these loans but it has effectively eliminated a lot of the programs that would offer this reduced guideline. Therefore if you are self-employed or have income from various sources that you are used to expensing to reduce your tax burden - you will have a harder time getting a loan unless you submit the tax returns and hope to qualify for a mortgage loan.
Yes lending has tightened outside of government agency mortgage loans because there are effectively no buyers (investors) of private (non-government backed) mortgage debt. This will change over time and as a mortgage broker we have a high likelihood of finding a loan product to meet your immediate needs so call for a consultation. We know where to look.

The Fed Rate Cut(s) and How It Affects You


There are still a lot of homeowners that think when the Federal Reserve cuts "The Rate" that this will automatically translate into lower mortgage rates. Let me define three key terms that you need to understand so you can assess the impact of the Federal Reserve's rate reduction.

The Discount Rate - is the rate at which The Federal Reserve's twelve regional banks lend money to their Member banks - normally for short periods of time up to thirty days, generally only overnight. This interest rate was cut by .75% or 75 basis points on January 22, 2008 to 4%. Typically the Discount Rate is 1% or 100 basis points higher than the Federal Funds Rate - at the moment it is only .50% or 50 basis points higher than the Federal Funds Rate.
The Federal Funds Rate - is the target rate the Federal Reserve sets in which private lending institutions (banks) lend money to one another - normally for very short periods of time, again overnight. This target rate was cut on January 22, 2008 by .75% or 75 basis points to 3.5%

The Prime interest rate - is the rate that banks lend money to their "Prime" customers, this rate is 3% higher than the Federal Funds Rate, therefore, as of January 22, 2008 it stands at 6.5%. The Prime interest rate is also used as an index for adjustable rate loans - generally second mortgage loans on homes and credit card debt. Therefore if you have a Prime based loan, then you will be directly affected by the Federal Reserve interest rate cuts. Further, when used as an index you will notice that there is a margin on the adjustable rate loans that can be a negative or positive percentage (this is a fixed percentage for the term of the loan). For example, if your Home Equity Loan is Prime minus .25%, the new rate will be 6.25% next month or if your Home Equity loan is Prime plus 1%, then your new rate will be 7.5% next month -- check the terms of your loan. In the case of some credit cards generally the rate is based on Prime plus a high margin.

Is there a relationship in fact when the Federal Reserve cuts these key interest rates? The answer is yes; the Federal Reserve, by cutting these rates, in fact is creating greater liquidity in the banking system as well as signaling the desire to have overall interest rates decline in the credit markets in general. The Federal Reserve has the ability to increase or decrease the money supply via purchasing or selling government securities respectively (open market operations) or cutting the key interest rates discussed above. The intent is to give the banks greater liquidity to lend money out - however if the banks don't lend then the policy will not have the desired effect. The general relationship to typical mortgage interest rates when the Fed cuts rates is negative. The reason for this is that the Equity Markets (Stock Market) typically favor a rate cut and therefore investors buy stocks on the cut and take money out of bond positions (selling mortgage bonds) that drive up interest rates. So in 2007 when the Fed cut its rates the typical 30 year fixed rate mortgage actually increased.

The greatest relationship to mortgage interest rates is the stock market. The wisdom is when the stock market sells off, the money flows to government guaranteed bonds thereby lowering interest rates. The fact is that the mortgage market is a market of buyers and sellers of the mortgage debt and interest rates have an inverse relationship to the price of the security - when money flows into the credit market (bonds are purchased) the yield or the interest rate paid to the purchaser decreases in direct relation to the price paid. This can be a confusing concept but the rule of thumb is if the stock market goes down in price so goes interest rates in the same direction -- down.

The current consensus is the Federal Reserve will continue to cut its key interest rates at the end of the month again and during subsequent meetings. The lowest the Federal Funds rate in the recent past has been 1%. We may be headed there again. If this happens, then we are looking at the Prime interest rate to be at 4% and this will make a lot of Home Equity loan holders very happy but at the same time their retirement savings will suffer so don't be too giddy.