Revised Credit Card Rules

This article appeared in The Times Union today. It details important revisions to the laws governing credit cards. It's something we all should be aware of.

Regulators adopt new credit card rules
Consumers to be spared from higher rates on existing balances under new rules for credit cards

By MARCY GORDON, Associated Press Last updated: 9:25 a.m., Thursday, December 18, 2008

WASHINGTON -- Federal regulators on Thursday adopted sweeping new rules for the credit card industry that will shield consumers from increases in interest rates on existing account balances among other changes. rules, which take effect in July 2010, will allow credit card companies to raise interest rates only on new credit cards and future purchases or advances, rather than on current balances.
They were approved Thursday morning by the Office of Thrift Supervision, a Treasury Department division. The Federal Reserve and the National Credit Union Administration were expected to act on them later in the day. The changes mark the most sweeping clampdown on the credit card industry in decades and are aimed at protecting consumers from arbitrary hikes in interest rates or inadequate time provided to pay the bills.
John Reich, the thrift agency's director, said the rules "will enhance public confidence in financial institutions and establish a level playing field for institutions that want to do business fairly without suffering competitive disadvantages."
Most of the rules were first proposed in May and drew more than 65,000 public comments -- the highest number ever received by the Fed. They also restrict such lender practices as allocating all payments to balances with lower interest rates when a borrower has balances with different rates.
But the changes also could make it more difficult for millions of people with bad credit to get what is known as a subprime card carrying higher interest rates, some experts say.
In addition, consumers will have to be given 45 days notice before any changes are made to the terms of an account, including slapping on a higher penalty rate for missing payments or paying bills late. Under current rules, companies in most cases give 15 days notice before making certain changes to the terms of an account.
The changes could cost the banking industry more than $10 billion a year in interest payments, according to a study by the law firm Morrison & Foerster.
Roughly 16,000 companies in the U.S. issue credit cards. The biggest lenders include Discover Financial Services LLC, Bank of America Corp., Citigroup Inc., JPMorgan Chase & Co., Capital One Financial Corp., American Express Co. and HSBC Holdings.
The head of the American Bankers Association called the changes "strong new regulations ... (that are) unprecedented in their scope and signal the beginning of a new market structure for credit cards."
"While the new rules are designed to increase protections for consumers, the Fed itself has recognized that they may result in increased costs for most card users and reduced credit availability, particularly for consumers with lower credit scores or limited credit history," ABA President and Chief Executive Edward Yingling said in a statement. "With the uncertainty facing our financial system, it's absolutely vital for policymakers to understand the full impact of these regulations on consumers and the economy before judging their success or further restricting the marketplace."
The new rules prohibit:
--Placing unfair time constraints on payments. A payment could not be deemed late unless the borrower is given a reasonable period of time, such as 21 days, to pay.
--Placing too-high fees for exceeding the credit limit solely because of a hold placed on the account.
--Unfairly computing balances in a computing tactic known as double-cycle billing.
--Unfairly adding security deposits and fees for issuing credit or making it available.
--Making deceptive offers of credit.
Travis Plunkett, legislative director of the Consumer Federation of America, said customer frustrations run deep, as reflected in the comment letters submitted to the Fed.
Many of them "were spontaneous from consumers who feel they've been treated unfairly by their credit card companies and are literally begging the Fed for help," he said.
Many people acknowledged paying late, often mistakenly, and felt it was unreasonable for their card issuer to increase the interest rate on the balance, Plunkett said. Another common theme came from people who pay on time but are hit with a rate increase because the company needed to recoup losses from other cardholders, he added.
Under the new rules, credit card lenders will be required to apply any payment above the minimum to the part of the balance with the highest interest rate.
The so-called subprime cards for people with low credit scores typically have no more than a $500 credit limit but require a large upfront fee.
The rules cap that fee at 50 percent of the credit limit and allow the cardholder to pay off the initial balance over a year, not immediately.
The Consumer Federation estimates that credit card debt held by U.S. consumers is about $850 billion, some four times what it was in 1990.
----
Associated Press writer Carson Walker in Sioux Falls, S.D., contributed to this report.

Where We're at Now

Let me take this opportunity to wish you and your family a Joyful Holiday Season and a Happy and Healthy New Year.

A lot has happened in the housing and finance markets over the past year. In addition to the chaos in the market the amount of conflicting information being distributed by the media is overwhelming. I want to give you a factual picture of the mortgage market as it currently exists. You will then be able to determine if there are opportunities that you should be taking advantage of.

The government intervention into the market is beginning to show progress in lowering mortgage rates. The standards being used to qualify for a mortgage are conservative and will continue to be so for the foreseeable future. Any applicant with less than sterling credit will see a pricing adjustment, increasing the financing costs. No longer will a lender extend credit to anyone who cannot document sufficient income or assets.

With the softening of housing prices, applicants are required to have a vested interest in the property they are looking to finance. This means that the maximum loan-to-values on all mortgages types have been reduced.

The mortgage rate reductions that we’re seeing are applicable to conforming loan amounts, that is mortgages that are less than the Fannie Mae limit of $417,000 for a one-family home. Mortgages greater than $417,000 but less than $625,500 are currently being priced 0.375% higher with even more restrictive underwriting standards. Mortgages above $625,500 are more expensive now than they have ever been.

If you’re interested in exploring what options you have available today, give me a call @ (516) 627-0800 or write an e-mail to Don@Shelter-Rock.com. We’ll discuss how the current market conditions can be used to your benefit. Have a recent mortgage statement available when you contact me. I’ll need information from that statement to accurately calculate any potential savings.

Prudent Refinancing in Today’s Market

Mortgage rates are finally beginning to drop. Lenders of all sizes are firing up their marketing divisions and reaching out to homeowners to solicit business. Before jumping in and refinancing your mortgage you need to make sure what your saving really will be. Is it worthwhile to refinance your current mortgage if you can get a rate that’s 0.5% lower than you’re paying? Do you need a 1.0% drop for it to make sense? The answer is, “it depends.”

The size of your mortgage, the number of years left on your mortgage, the value of your home today and the total cost of refinancing are just some of the things that need to be considered in making your decision. In most cases you will not be presented a detailed analysis by the originator you’re talking to. In many cases you are speaking to a customer service person that is doing nothing more than reading a script to you.

If you don’t have the time or expertise to do you own analysis then you have to go to a professional and have it done for you. A good place to start is to read this article, http://www.shelter-rock.com/Refinancing.htm. It will give you an understanding of what you will need to consider.

Clients contact me regularly to discuss the refinance option. Sometimes this is their first call, other times they are seeking information after another company has contacted them and they want to confirm what they’ve been told. Here are three e-mail threads that will illustrate what you need to be aware of.

This first client was approached by his current bank. They presented him with an offer to reduce his monthly payments. He wanted to confirm he was making the right decision.

Hi Don

This is [name deleted], you did my mortgage about 2 years ago for [address deleted], at one time you had called and said that if we noticed that the rate have fallen more than 1 point we should consider refinancing. I have been talking to the Chase people since they have our mortgage already and this is what they are offering.

Loan Amount: $457,000.00
Product Type: FHLMC Only 30yr
Assumed Interest Rate: 5.250
Assumed Discount Points 1.875

My outstanding balances are:

Mortgage Loan: 406,262.01 at 6.375%

Line of Credit: 27,339.59 at 4.625%

So my question is can you do better or should I even do the refinancing at this time?

Thank You

[name deleted],

It’s good to hear from you, I hope all is well with you and the family.

Dealing with the customer service people at any lender yields incomplete information at best and a sales pitch at worse. Let me give you a brief update on what’s going on. After you read this e-mail, give me a call and I’ll get more specific.

To begin with getting a drop in interest rate of 1 percent by paying points isn’t a drop of 1 percent. 5.25% with 1.875 points is the same as 5.75% with 0 points. Interest rates and points are tied together. Simply put, you can pay the bank now (points) or later (interest).

It still may make sense to refinance, but we need to take a closer look at things .To begin with, under the current pricing structure there is a 0.25% increase in rate when you move the mortgage amount from $417,000 to $417,001. I would like to avoid having you pay an extra ¼ of a percent on the entire mortgage balance. Your combined mortgages add up to approximately $433,600. Closing costs will only add $4,500 so you only need a mortgage of say $438,000 not $457,000.

If we refinance for $417,000 we need to make up $21,000 somewhere. If you have $21,000 available in cash, this wouldn’t be a bad investment. If this is an option you are considering, I’ll work out the actual return on your investment. Assuming this isn’t the preferred path, we have another alternative. We can ask Chase to subordinate your existing Line of Credit to a new first mortgage of $417,000. They could even lower the limit of the line to $25,000 and this approach will still work. In a normal market this happens regularly, today we will have to do a detail request for it with no guarantee of success.

Today you can get 5.5% with 0 points for $417,000 making it worthwhile to consider.

Unfortunately customer service personnel aren’t given sufficient training to address to specific attributes of every person they talk to. It’s an ongoing flaw in the industry. Of course, this flaw is good for my business so I’m not complaining!

Give me a call when you’re free and I’ll give you a more complete picture of what I talking about.

Don

We did have a telephone conversation at this point. I did a rough calculation to compare his current mortgage payments to what the payments would be if he went through with the proposal that was given to him by the Chase customer service person. It worked out that it would take 105 payments before he made back the money he invested is doing the refinance. I told him I didn’t think that was a sound financial decision.

The next morning he e-mailed me again.

Hi Don

I was talking to the Misses last night and we might be able to come up with the 21000 in cash, if that makes the most sense, can you please run the numbers just so we can see how it will work out.

Thank You

[name deleted],

The first thing I want you to address is the impact to your cash position in the event you pay down your mortgage by the $21,000. I don’t know the current amount of liquid assets you have on hand but I want to make sure you consider the impact to your personal financial position after you make this investment. Cash reserves are important and in the current financial market reserves are of utmost importance. I want to make sure you address the big picture and not just today’s mortgage payment.

Assuming you want to continue with the refinance, here’s some numbers. I’m giving you various interest rate with 0 points because the mortgage rates are bouncing day-to-day. Where yesterday I could get you locked in at 5.50% today it would be 5.75%. I suspect we will see rates below 5.5% by the end of the year or early next year. If you decide to move forward I wouldn’t lock-in until we see an attractive rate. I would however get the commitment and title done so we are in a position to lock and set a closing date at the same time. This way we can take the shortest lock period available and therefore the best pricing. It also gives us the opportunity to take advantage of any drop in the conforming/jumbo adjustment. If in fact the government decides to waive the adjustment, even temporarily we can take advantage of that and not invest your cash.

$417,000 @ 5.75% yields a monthly payment of $2,433.50
$417,000 @ 5.50% yields a monthly payment of $2,376.68
$417,000 @ 5.25% yields a monthly payment of $2,302.69
$417,000 @ 5.00% yields a monthly payment of $2,238.55

You need to add your escrow payment to these numbers to get your new mortgage payment. The escrow payment calculated at the time of closing may be different than you are currently paying but that will be reflective of updated property tax figures and/or insurance payments.

Don

I sent that e-mail yesterday afternoon and I haven’t gotten a response as yet. The important thing here is now this client is thinking about a refinance with enough facts to make an informed decision.

This client heard the good news regarding mortgage rates and wanted to check things out.

hey don..

how are you ? how was thanksgiving ?

i noticed some 30yr fixed rates as low as 5.375% for a high balance..

i have enough cash to get our current balance down to $625k (i believe the upper limit for a high balance loan).

if we could get that rate - it would knock approx $500 /mth off our repayments.

seeing as our money is not making anything at the moment in terms of interest.. do you think it is worthwhile looking into this ?

i guess the risk is that they value our property significantly lower.. (i presume it would need to be revalued ?) &/or i no longer qualify for a loan (even tho i already have one!!).

great to hear your thoughts.

regards,

[name deleted]

This was my response. You do need some background information. My client closed on this purchase 10 months ago with a piggyback mortgage. That is, we used 2 mortgages instead of one to avoid paying a substantially higher interest rate. At the time this purchase was being done, the mortgage rates for mortgages over $417,000 were nearly 2.0% higher that what a borrower would pay for $417,000. We used a 3/1 ARM (the mortgage rate would be fixed for 3 years and then become a 1 year adjustable) on both mortgages.

[name deleted],

It’s good to hear from you. All is fine except it would be nice to see business get back to normal. These are certainly interesting times! And we’re nowhere near the end. I wouldn’t refinance right now for $625,000. Let me give you my thoughts and we’ll take it from there.

First, in order to get the 5.375% rate you will need to pay 2 points today. So you’re really paying closer to 5.75% then 5.375%. Currently there is a 1 point or 0.25% rate increase to the pricing for mortgages over $417,000. There is a very good chance that this will change, eliminating the adjustment. This is one good reason to wait.

There also is a good possibility that we will see an additional drop in mortgage rates before they begin to increase again. The Federal Government is focusing a lot of attention and tons of cash to make that happen. There is a good probability that we will see some drop in rates in the next couple of months.

Refinancing will require you not only to pay down the mortgage but also pay for the closing costs. In addition to the $40,000 you will be investing to pay down the mortgage you will need an additional $6,000 in transaction costs.

In today’s economy liquidity is king. Keeping the cash on hand, instead of tying it up in the condo might be a more prudent course of action. When the financial markets settle down might be a better time to commit your cash into the apartment.

The bulk of your mortgage is at 5.0% and will stay there for the next 2 years before there is any possibility of a rate change. 5% is less than 5.375%, I wouldn’t’ be so quick to increase the cost of borrowing the $417,000 right now. You will be increasing the cost of financing the $417,000 by $96.55 for the next 2 years.

You are rightfully concerned about the current market value of the apartment. We would need it to appraise out for $781,300 in today’s market. You’re in a better position than I am to make that initial evaluation. We know your financial strength will be more than adequate it’s only an issue of the current market value of the condo.

I know you want to pay off the mortgage as quickly as possible and with the lowest cost of financing. Assuming you’re ready to commit $45,000 of cash to the condo. I would just prepay the second mortgage. That will bring your balance down to $200,000. Your mortgage payment will stay the same but the mortgage will be paid off in 204 months instead of the remaining 350. You are effectively getting a rate of return of 7.625% on the money you are investing. This has no effect on your ability to refinance when it makes economic sense.

Don

This is his response:

yes it is a bloody mess right now!!! i too hope things get back to normal - but i agree - it's probably a way off..

thx for the great advice as always - sounds good..

i understand your logic re putting it into the 2nd - however - based on everything else you have said - i'd probably just as soon sit tight and have the benefit of the cash on hand so i can quickly react if things do become more favorable..

best regards,

[name deleted]

Finally, we have a client who also wanted to see if he could save some money by doing a refinance.

Hi Don,

I want to see the possibility of refinancing with minimum cost. Pls refer to attd statement and advice what you think. Tks.

Rgds/[name deleted]

[name deleted],

It’s good to here from you. I hope all is well with you and your family.

Let me show you how I calculate the saving in a rate refinance. After you review it fell free to call and we can discuss it in more detail.

The analysis is to determine exactly the saving due to rate alone. It’s easy to make a refinance appear to save you money if you compare a new 30 payment to say a 20 year remaining term on the existing mortgage. We need to factor out the impact of extending the term of the mortgage over the remaining life of the current mortgage.

We start by calculating the remaining term of your current mortgage. Your current balance is $213,389.40. You are paying monthly $1,539.30. At your current interest rate of 6.25% your mortgage will be paid off in 247 payments. You obviously made some prepayments of principal over the last year. For this comparison I’m going to assume no additional prepayments are to be made. You will be paying $1,539.30 a month for the next 247 months.

There will be some cost incurred in doing a refinance. I’m going to add it into the loan balance. The exact number isn’t important so I’m going to work with a new mortgage amount of $217,000 to cover any closing costs.

The current interest rate is 5.5%. If I take a mortgage amount of $217,000, an interest rate of 5.5% and a term of 247 months I come up with a payment of $1,469.53. This is a saving of $69.77 a month.

$217,000 – 213,289.40 = $3,710.60 is what I allocated for closing costs. $3,710.60/$69.77 = 53.18. That is it will take over 53 payments before you received your closing costs back. I recommend refinancing when this number is 24 or less.

Of course it’s your decision and I will be happy to take care of the refinance for you but I would suggest waiting to see if the rates drop to around 5.0% before refinancing. I’m not predicting we will ever see that rate, but I feel we need to be closer to 5.0% before a refinance yields adequate savings.

What’s your opinion?

Don

Hi Don,

Tks for the msg and really appreciate your honest opinion. I perfectly u/stand your point and know you are looking after my best interest and giving these scenarios. Will wait and see how market works in the future. Again thanks for the time taken to write detail msg below.

Take care.

B.rgds/[name deleted]

This is common mistake. The remaining term on the existing mortgage is ignored giving the illusion of greater savings. The older the original mortgage is or if a prepayment of principal was made the greater the illusion. If I calculated the mortgage payment based on a new 30-year mortgage the payment would be $1,232.10. It would appear there is a potential saving of $307.20 per month ($1,539.30-$1,232.10). $69.77 of which was due to the lower interest rate and $237.43 due to extending the mortgage payments out and additional 113 months.

There may be a need to lower the mortgage payments now that supercedes the downside of extending the term. Then, by all means the refinance should be done. You need to make the decision based on facts and your personal financial situation. Whatever you do, you want to do it for the right reason.

Bailout Dilemma

It’s no secret that we are currently in a recession. The government is exploring various approaches in trying to get the economy on the right track as quickly as possible. Which industries should be bailed out? Which companies should be offered financial help? How much aid is too much? Should homeowners be bailed out directly? Which homeowners should be bailed out? How much help should be given? The questions go on and on and we can only guess what the right answers are. It’s only in looking back years from now will we be able to judge the success or failure of today’s decisions.

We live in a society that has grown accustomed to instant gratification. We expect instant results whenever we do something. We expect our associates to answer their cell phones on the first ring; e-mails need to be answered within minutes of hitting the send button. Shipping of anything is expected to be done overnight and we are annoyed when our computers take more than 30 seconds to boot up.

With this level of expectation we expect the government to turn the economy around overnight and we are disappointed when a program is implemented and we don’t see positive results within a matter of days. It’s important to recognize that there is nothing that can be done that will make this a short recession. We will be in a much stronger position to deal with this economy if we recognize that fact.

In my article, “Today’s Financial Paradigm Shift” I pointed out that we, as a society, need to change the way we handle our finances. Society’s resistance to this change is only going to make matters worse and this recession longer. Let me list a few examples.

It’s fair to say that the average American doesn’t save enough. Statistics show that our nation’s saving rate has been 1 to 2% on average over the last several years with it drifting into negative territory at some points. Statistics also show that the average American lives day to day off their credit cards not even paycheck to paycheck but day to day. It’s generally assumed that we would all be better off financially if we increased our rate of savings.

We’re told that one of the reasons the economy is in the state it’s in is that we are living above our means. This applies not only to individuals but companies and the government. We can conclude that for us to have a vibrant economy we need to curtail spending and increase our savings. By being less credit dependant we’ll all be better off.

What approach has the government used to stimulate the economy? Last year they gave every American a rebate check and encouraged them to go out and spend it. This didn’t have any long-term impact so now they are considering doing it again.

The price of gasoline has dropped substantially over the last few months. The economy still isn’t getting stimulated because Americans are paying down their debts instead of spending the money. This is perceived as a negative because it’s not turning the economy around in the short term. It fact it is making for a stronger economy in the long-term. This change in spending habits should be encouraged, not discouraged.

We are told that Washington bailed out Bear Stearns, Fannie Mae & Freddie Mac and the money could have been better spent somewhere else. There may have been better ways to spend the money but I have a problem with identifying these actions as a bailout. The owners of Bear Stearns, the stockholders, loss 90% of their investment in the company. The stockholders of Fannie and Freddie lost 100%. These stockholders are no better off than the stockholders Lehman Brothers, which was allowed to go into bankruptcy. The cash infusions into the major banks, insurance companies and possibly the auto manufacturers is enhancing shareholder value, making those investments bailouts.

Were these decisions the right decisions or the wrong decisions are open questions. We do need to avoid calling all these actions bailouts, since clearly not all of them are. We are again attempting to address the short-term economic problems with the same actions that got us into trouble in the first place. These companies were making investments outside their means getting them into the same financial hardships consumers got into when they spent above their means. Unfortunately we need to deal with painful short-term problems if we hope to attain a long-term cure.

The latest focus of Washington is to address the high rate of foreclosures throughout the country at the homeowner level. A foreclosure not only hurts the homeowner and his lender but the local community also. If the number of foreclosures is reduced there will be an economic boost at the local level that will permeate though the entire economy.

This approach also has a “feel good” component to it. We, as a society, are helping out our neighbors that need it the most. Theoretically this seems like the perfect way for the government to invest in the greater good of the economy and it may turn out to be the most viable approach to the problem. It also can prove to be the most devastating if it is not handled very carefully.

There are 2 pitfalls that need to be avoided. The first one is finding the proper balance between helping out those that need help without encouraging other homeowners to put themselves in need. For example, if you decide to help out any homeowner that is currently 60 days behind in their mortgage payment you are also announcing to any homeowner that is 30 days late that they should miss the next payment. Whatever guideline that used, this problem will arise making this a difficult issue to address.

The second pitfall is even more difficult to deal with. The most common reason homes are falling into foreclosure in many parts of the country is that the current value of the home is less than the outstanding mortgage balance. This situation can occur for several reasons. The cause that put the homeowner underwater must be considered in determining if a mortgage should be modified or else we will be assisting borrowers that don’t deserve to be helped.

A homeowner could have been scammed into purchasing an over priced house due to a fraudulent transaction. Obviously this is a situation where the mortgage should be modified.

The real estate market could have dropped substantially since the homeowner closed on his house. Should his mortgage be modified if the mortgage balance is in excess of the resale value of the home? What about his neighbor, who made a substantial down payment when he bought his house, should something be done to help him? Is it fair to help out the first borrower who didn’t invest as much of his own capital in the purchase and ignore the neighbor who decided to do the prudent thing and carry a smaller mortgage?

What about the homeowner who bought his house 5 years ago, refinance it last year taking as much equity out of the house as possible who is now underwater with his mortgage? Should this mortgage be modified? Should it make a difference if he took the money and invested in upgrades to the house, paid off other bills with it or just took a vacation?

The banks will have to be selective in deciding which mortgages to modify. The effect of this selection process will be (1) homeowners who genuinely need to be helped getting help, (2) homeowners who shouldn’t be helped getting help and (3) homeowners who were conservative, did what they thought was the prudent thing to do and are just hanging on watching from the sidelines.

The animosity this will cause between neighbors needs to be considered when addressing foreclosures on the local level.

In attempting to turn this economy around in the shortest period of time and with the least amount of pain we run the risk of encouraging people to continue with their bad spending habits. We need to take advantage of this recession by encouraging people to live within their means and save for their futures. By taking the pain of this recession and turning it into an opportunity we will all benefit. We just need a little patience.

Security Alert

I just received this security warning from the FDIC and wanted to pass it along.

The Federal Deposit Insurance Corporation (FDIC) is warning consumers, businesses and financial institutions to be aware of fraudulent e-mails allegedly from, or related to, financial institutions that have been the subject of recent news stories. Phishing e-mails often incorporate aspects of high-profile news stories – such as bank mergers, acquisitions and failures – to create a sense of urgency and legitimacy for requesting information or action.

These types of fraudulent e-mails may request recipients to verify computer logon credentials, update personal information, or activate new online security features. The fraudulent e-mails may include a link that directs the recipient to a fraudulent or "spoofed" Web site that looks similar to the subject institution's legitimate Web site. Once there, users may be prompted to provide information about online banking credentials or other personal and confidential information that could be used to gain unauthorized access to online banking services or perpetrate identity theft. These spoofed Web sites may also direct the user to download software updates or digital certificates, which may actually be malicious code or software attempting to collect online banking credentials or other personal and confidential information.

Consumers, businesses and financial institutions should be wary of unsolicited e-mails purportedly from financial institutions recently in the news and take the following precautions:

• Do not follow Web links in unsolicited e-mails from apparent financial institutions. Instead, use Web browser bookmarks or type your institution's Web address into the browser address bar when accessing your bank's Web site or online banking services.
• Always use anti-virus software and ensure the virus signatures are automatically updated. Ensure the computer operating system and common software applications are up-to-date with security patches installed.
• Do not open unsolicited or unexpected e-mail attachments claiming to be from a financial institution because of the risk of malicious code or software. As a precaution, call the financial institution using an appropriate telephone number, such as one from an account statement, to validate the e-mail and attached file before opening any attachment.
• Be aware that phishing e-mails frequently use new and innovative ways to trick recipients into providing logon credentials and confidential information or into unleashing malicious code.
• Regularly review financial account statements and immediately report any discrepancies to your institution.
  Be mindful that financial institutions generally deliver notices to consumers in writing about changes in account terms and conditions unless the consumer previously agreed to receive the notice electronically.

Today’s Financial Paradigm Shift

A Paradigm shift is a radical change in personal beliefs, complex systems or organizations, replacing the former way of thinking. The chaos we are dealing with today’s credit market is a Paradigm Shift of unprecedented magnitude.

The use of credit has evolved drastically over the last several decades. Individuals as well as businesses of all sizes including all levels of government have redefined the proper use of credit. Up until recent times, borrowing money was something that wasn’t done without careful consideration.

Consumers borrowed money only as a last resort to tie then over a rough patch. An illness prevented then to earn a salary; a lay off required them to find new employment or an emergency repair was needed. It was only conditions such as these that Americans borrowed money in previous generations. Then a new need surfaced. That was a desire to buy goods that were expensive and had a long useful life. Through a combination of savings and borrowing money we were able to buy the cars and the homes we wanted.

Our grandparents hated the idea of owing money to anyone. They reluctantly borrowed money when needed and looked forward to the day the loan was paid off. Families checked off the major events in their lives; getting married, having children, raising a family and retiring their mortgages. The mortgage burning party was a more major event than a birthday.

Their pride kept them from taking on too much debt. In the event something happen in their lives that forced them to fall behind they were ashamed. They wouldn’t talk about it and would do whatever possible to hide the fact. The goal was to pay back what was owed before any friends or family heard about it. Bankruptcy was considered the ultimate failure. A man failed his family and his community if he was forced into bankruptcy. The people of this generation didn’t go into bankruptcy; they were forced into it.

These people saved for things they wanted to own. As children we were all taught to save our money for what we wanted. We learned by example, we made compromises. Our families couldn’t buy us everything we wanted, we needed to prioritize. We could only expect the toy we really wanted, anything else would have to wait.

As time passed we became more self-centered. Borrowing evolved from being something to be embarrassed of to an acceptable way of life. We no longer used Christmas Clubs as a saving plan to pay for holiday gifts, we just charged the gifts and planned on paying back what was borrowed at a later date. However, paying back the money would limit what we could spend on other things. This wasn’t acceptable; any form of sacrifice just wasn’t in our nature. We just kept borrowing more. Paying back what we borrowed was always something that could be put off until tomorrow.

As we continued running our personal lives this way some of us had jobs that gave us the responsibilities of handling the financial obligations of companies and government agencies. The spend now; pay later attitude that became the norm at home naturally became the norm at work. Companies and the government began doing the same thing. From a business standpoint having cash-on-hand was not the most efficient use of capital. Invest whatever capital is on hand and borrow funds as needed to pay bills while you are waiting to collect on your receivables.

Once the stigma of borrowing money was no longer a concern, it wasn’t long before “living up to your word” became an outdated concept. Utilizing any method available to avoid paying a bill quickly became the expected way of conducting business. Bankruptcy was no longer the ultimate embarrassment but became a valuable tool to be used by individuals and businesses as needed.

In 50 years we have financially evolved as a country from “neither a borrower nor a lender be” mindset to a “let’s live for today” way of life. 2008 became the year of reckoning. We live in a society that needs credit to survive yet we’ve entered an age where no person, company or bank trusts anyone. Banks are afraid to lend to companies. Companies are afraid to extent credit to consumers. Banks are afraid to lend to each other. We are now force into a Financial Paradigm Shift.

Every person and company needs to immediately change their standard operating procedure and begin to conduct themselves in a similar manner that our grandparents did. The problem we are facing is much like that of a dieter. After many years of small incremental increases of weight year to year the dieter is now trying to reverse the trend in weeks. The only difference is that the dieter acknowledges that a change in needed and knows it’s not going to be easy.

As Americans we are in a financial state of denial. We’ve yet to recognize how each and every one of us contributed to the crisis. We spend our days trying to figure out who is to blame for our troubles and refuse to consider our personal contribution.

We can’t blame the lender for giving us the financing we asked for to buy the house we couldn’t afford. We can’t blame the lender for giving us the second mortgage we needed to pay off our credit card debt and buy that big screen television we desperately wanted. We can’t blame the car company that built the SUV that we couldn’t live without and then arrange for the financing that enabled us to buy the vehicle.

Why are we surprised that the creditor that lend us the money to buy the car actually wants to get paid what he’s owed? Why are we surprised that he’s willing to take the car away from us because he hasn’t gotten paid when the car is worth less than what is owed? Why are we surprised that the utility company turned off the electric when they know for a fact we just don’t have the money to pay the bill? Why are we surprised that we can no longer borrower money to support the lifestyle we’ve grown accustomed to?

Every decision made by a company, bank or government was made by a person or persons. The decision may prove to be right or wrong. The decision may have been made with the best of intentions or motivated by pure greed or stupidity. The only thing we have direct control on is the individual decisions we make. Just as the dieter looks at himself, realizes a change needs to be made and addresses his lifestyle to suit we need to objectively analyze our personal financial shape and consciously made the required changes.

Until we make a Financial Paradigm Shift in our personal lives our country will not be able to weather this storm. It’s a massive undertaking that requires all of us to do our part. We need to stop feeling sorry for ourselves and begin to move forward with change.

Looking Back in History for Clarity

When trouble arises, it's important to look back for clues as to how we ended up were we are. This was published in The New York Times on September 30, 1999. It illustrates that during the housing boom years the Federal Government mandated that Fannie Mae purchase mortgages that were below their quality standards.

These are the same subprime mortgages that got Fannie into such trouble that they were nationalized. We, the public, are being told these subprime mortgages should never have been purchased. Did they really have any choice in the matter?

Fannie Mae Eases Credit To Aid Mortgage Lending - By Steven A. Holmes

In a move that could help increase home ownership rates among minorities and low-income consumers, the Fannie Mae Corporation is easing the credit requirements on loans that it will purchase from banks and other lenders.

The action, which will begin as a pilot program involving 24 banks in 15 markets -- including the New York metropolitan region -- will encourage those banks to extend home mortgages to individuals whose credit is generally not good enough to qualify for conventional loans. Fannie Mae officials say they hope to make it a nationwide program by next spring.

Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits.
In addition, banks, thrift institutions and mortgage companies have been pressing Fannie Mae to help them make more loans to so-called subprime borrowers. These borrowers whose incomes, credit ratings and savings are not good enough to qualify for conventional loans, can only get loans from finance companies that charge much higher interest rates -- anywhere from three to four percentage points higher than conventional loans.

''Fannie Mae has expanded home ownership for millions of families in the 1990's by reducing down payment requirements,'' said Franklin D. Raines, Fannie Mae's chairman and chief executive officer. ''Yet there remain too many borrowers whose credit is just a notch below what our underwriting has required who have been relegated to paying significantly higher mortgage rates in the so-called subprime market.''

Demographic information on these borrowers is sketchy. But at least one study indicates that 18 percent of the loans in the subprime market went to black borrowers, compared to 5 per cent of loans in the conventional loan market.

In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980's.

''From the perspective of many people, including me, this is another thrift industry growing up around us,'' said Peter Wallison a resident fellow at the American Enterprise Institute. ''If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.''

Under Fannie Mae's pilot program, consumers who qualify can secure a mortgage with an interest rate one percentage point above that of a conventional, 30-year fixed rate mortgage of less than $240,000 -- a rate that currently averages about 7.76 per cent. If the borrower makes his or her monthly payments on time for two years, the one percentage point premium is dropped.

Fannie Mae, the nation's biggest underwriter of home mortgages, does not lend money directly to consumers. Instead, it purchases loans that banks make on what is called the secondary market. By expanding the type of loans that it will buy, Fannie Mae is hoping to spur banks to make more loans to people with less-than-stellar credit ratings.

Fannie Mae officials stress that the new mortgages will be extended to all potential borrowers who can qualify for a mortgage. But they add that the move is intended in part to increase the number of minority and low income home owners who tend to have worse credit ratings than non-Hispanic whites.

Home ownership has, in fact, exploded among minorities during the economic boom of the 1990's. The number of mortgages extended to Hispanic applicants jumped by 87.2 per cent from 1993 to 1998, according to Harvard University's Joint Center for Housing Studies. During that same period the number of African Americans who got mortgages to buy a home increased by 71.9 per cent and the number of Asian Americans by 46.3 per cent.

In contrast, the number of non-Hispanic whites who received loans for homes increased by 31.2 per cent.

Despite these gains, home ownership rates for minorities continue to lag behind non-Hispanic whites, in part because blacks and Hispanics in particular tend to have on average worse credit ratings.

In July, the Department of Housing and Urban Development proposed that by the year 2001, 50 percent of Fannie Mae's and Freddie Mac's portfolio be made up of loans to low and moderate-income borrowers. Last year, 44 percent of the loans Fannie Mae purchased were from these groups.

The change in policy also comes at the same time that HUD is investigating allegations of racial discrimination in the automated underwriting systems used by Fannie Mae and Freddie Mac to determine the credit-worthiness of credit applicants.

Concerned about buying?

This question was raised by a client of mine in a recent e-mail. I'm sure she's not the only house hunter with this concern. I thought it would be informative to post it here along with my response.

"I have to say, this financial "crisis" situation has me scared silly. I'm watching my stocks plummet, my down payment money disappearing, and the future forecast of economics in this country is just plain scary. I feel like it's just the wrong time to buy, but everyone says it's ok, go ahead and buy a cheap place. What do you think?"

You have reason to be concerned about the current market conditions. What we're seeing going on has never happened in this country before. In a way, it's exciting being right in the middle of history being written.

Is it the right time for you to be buying? Yes, because you are personally ready to become an owner. The property you buy is primarily a place for you to live. When you find a place you can see yourself living in with a payment that you are comfortable with just go ahead and do it. You'll have to pay rent somewhere anyway, so why not pay for a mortgage instead? Chances are the property value will go up over time but if it doesn't? You still had a place to live. You're not speculating, buying a house with the intention of flipping it. You are buying a home and you are not going to buy something you can't afford. Relax and find something you like.

Don't buy something just because it's cheap. You'll end up with something you're not happy with. Find something you can see yourself living in for the foreseeable future. Buying a home is a lot like buying anything else. If you buy solely on price, you end up disappointed. You need to strike a balance and buy something that you see the value in. Value is a combination of size, location, layout, condition and price. The decision is a personal one; the property needs to feel right to you.

Being concerned is a good thing. It keeps your thought process grounded, helping you make rational decisions. You can't allow concern to grow into panic resulting in an inability to move forward with your life. Balance market conditions with your personal financial situation and develop a plan of action from there. You may decide to buy now or you may decide to put off buying. The choice is yours. All I suggest is that you look at all facts and come to a logical decision, not an emotional one.

Take charge of your life, leading it in the direction you want to go. Don't become a lemming and blindly follow the leader off the edge of the cliff.

The New Fannie Mae

I’ve read the announcements. I’ve gone though what’s been written over the last 2 days. I’ve studied the history of Fannie Mae. What’s happened this weekend is that Fannie has gone full circle. Fannie originally was a government program created to create liquidity in the mortgage market. No different than what the government is looking to achieve today. (Freddie Mac was created in 1970 for the sole purpose of creating a competitor to Fannie Mae. It’s nothing more than Fannie Mae’s younger sibling.)

Fannie Mae was chartered in 1938. The impetus for creation of Fannie Mae was twofold: the national commitment to housing and the inability or unwillingness of private lenders to ensure a reliable supply of mortgage credit throughout the country. The primary purpose of Fannie Mae was to purchase, hold, or sell FHA-insured mortgage loans that had been originated by private lenders. In 1968 Fannie Mae was split into two parts: Ginnie Mae and a reconstituted Fannie Mae. Ginnie Mae would continue as a federal agency and be responsible for the then-existing special assistance programs, and Fannie Mae would be transformed into a "government-sponsored private corporation" responsible for the self-supporting secondary market operations. The reconstituted Fannie Mae was to be stockholder-owned and managed.

In the Sunday, September 7, 2008 edition of The New York Times a staff writer identified the obvious flaw in the creation of Fannie Mae. The government mandate to Fannie Mae required it to serve 2 masters, a situation that is designed for failure. As a private company it was suppose to put the shareholders’ interests above all else and as a government agency it was required to assist first time homebuyers, maintain liquidity in the mortgage market and time keep the cost of mortgages down.

Things were moving along fine until the same greed and corruption that ripped through Wall Street and the banks got into the GSEs. Could it have been avoided? Should we have seen it coming? It doesn’t matter now; we’re already in trouble.

The government had the right to take over the GSEs under their original charter going back to 1968. The recently enacted emergency housing bill gave the Treasury to ability to invest in the GSEs though various avenues. This was an excellent gambit by Treasury Secretary, Paulson. If having the authority to buy into Fannie created stability in the marketplace, great. If it didn’t work, don’t use the additional freedom to invest and move directly to the takeover. Taking this path the government now has full managerial control. We are already seeing the first positive steps, a new chairman has been brought in, dividends have stopped being paid to shareholders and the lobbying budget has been eliminated.

I have been promoting that way out of this mortgage mess we’re currently in was for the government to become the secondary market. They could create an agency in the mirror of Ginnie Mae. But instead of securitizing government mortgage loans it would be in the business of securitizing mortgages issued by private industry. This would slowly recreate a secondary market. This is exactly what’s happening here. But instead of creating a new agency they are taking over the GSEs (Fannie Mae & Freddie Mac). The infrastructure needed to package mortgages and then issue mortgage backed securities is already in place. The existing systems will now be working for the government instead of for the shareholders.

Although the media is calling this a bailout of the GSEs, it really isn’t. Current shareholders have lost their dividend payments and the stock they’re holding is worthless. It’s only after the Fannie Mae and Freddie Mac reimburse, with 10% interest, any capital invested and the government decides not to exercise their option to purchase 80% of the stock of the GSEs at a price of $1.00 a share will the existing shares have any market value.

It’s my opinion that unless the government totally screws thing up, this will turn out to be a profit center for Washington. Washington will then have the option to keep Fannie and Freddie under direct government control, turn then back into private enterprises or break them up into smaller more manageable private entities.

This is the beginning of the end of the housing crisis.

Do you have an Adjustable Rate Mortgage?

Over the last several years many people chose an Adjustable Rate Mortgage (ARM) for financing their home. Most ARMs fall into one of three categories. An ARM in its simplest form is a mortgage that is open to a rate change every 1, 3 or 5 years. In this scenario the borrower elects to pay a lower interest rate on his mortgage in exchange for taking on the liability of future interest rate movements.

In a fixed rate mortgage the lender commits to an interest rate for the entire term of the mortgage. The lender charges an interest rate that is high enough to cover any increase in their costs of funds during the mortgage’s term. When a borrower elects to use an ARM he agrees to give the lender a guaranteed profit over their costs of funds. If rates go up, the borrower pays more. If rates go down then the borrower pays less.

The second type of ARM is a hybrid adjustable. Here there is an initial term of 3, 5, 7 or 10 years where the rate remains the same. At the end of this initial period the mortgage becomes a 1-year ARM. At this point the rate will change every year as the financial markets move.

Finally, there is the pay option ARM. Under this program in addition to the rate changing periodically the borrower has the option of selecting, with certain limitations, the dollar amount the payment should be for a particular month. The borrower can elect to pay as much principal he wants, pay no principal just the interest due for the month or pay less than the interest charge for the month effectively borrowing additional money.

Due to all the negative press directed at the subprime mortgage market and their ARM programs everyone that currently has an ARM is panicking. We are warned about the number of hybrid ARMS that are resetting this year or will reset in the next year or two. This is encouraging anyone who currently has an ARM to immediately refinance into a fixed rate mortgage regardless of the cost or their personal financial situation.

If you are in an ARM you need to understand the details of your mortgage before doing anything else. You could very easily be in the proper mortgage and not even realize it. Refinancing may be an expense that you don’t need to incur right now.

One thing that all ARMs have in common is that there is a formula that specifies what the rate will become at a rate change. Another common attribute of all ARMS is that there are limitations (caps and floors) that dictate the range you mortgage can rest to each time it adjusts. Before doing anything you need to find these details.

At your closing you signed numerous papers and you were given a copy of everything you signed. Hopefully you kept those papers. Go back and look for a document labeled “Note”. The 2 most important documents you signed are the “Mortgage” and the “Note”.

The mortgage is the actual lien that is filed against the property. There are no details in this document regarding interest rate, mortgage payment, term etc. All that information is contained in the “Note”. The “Note” specifics the details of how you have agreed to pay back the money you borrowed from the lender. It’s here that you will find the formula used in calculating your interest rate and the limits of the change.

You can’t find those papers. Now what do you do? The servicer, that is the company you make out your mortgage payment to each month, has a copy of the “Note” in their files. Many even provide access to your closing documents through their website. The servicer will supply you with a copy of the “Note”; all you need to do is request it.

The formula to calculate you new interest rate will consist of an index rate and a margin that are added together and give you your new interest rate. The index rate is a rate reflects market conditions, it is an interest rate that the lender doesn’t have influence over.

Typically it will be the yield on 1-year Treasury Bills or on the 1-year LIBOR. The 1-year T-Bill is the current rate the US government needs to pay an investor to borrow money for 1 year. LIBOR (the London Inter-Bank Offer Rate) is a rate that reflects what banks need to pay other banks when they borrow money for a period of one year any where in the world.

The margin is a constant that when added to the index rate yields the new interest rate on your mortgage. What that calculates to needs to be considered before rushing into a refinance.

For example, if your mortgage was resetting today to a rate of 1-year LIBOR plus 2.25% you rate for the upcoming year will be 5.50% (3.231% plus 2.25% equals 5.481% which is rounded up to the nearest 0.125% making the rate 5.50%). This is assuming that the rate cap specified in the “Note” isn’t crossed. If the rate cap yields a rate lower than 5.50%, then that is the rate you will be adjusting to.

With fixed rate mortgages today costing 6.50% should you be rushing to refinance into a fixed rate? You still may elect to refinance for other reasons but you certainly shouldn’t be doing it because of the new rate.

When you originally closed on this mortgage you had made the decision that it was the best product for your situation. Don’t let the news media lead you into a refinance when in fact this still may be the cheapest financing available. Make your decision based on the specifics of your mortgage and how it fits into your current financial situation. Don’t feel forced to refinance because it appears to “be the thing to do”.

Is the Time Right to Buy?

The decision to buy a home is derived from 2 major considerations; your analysis of the housing market & your analysis of your personal financial situation. Both considerations need to conclude that buying now is right for you. We’re going to begin by examining your current status and what your goals are for the future.

How long do you plan on living in this community?
This is the most general, yet the most relevant question you need to ask yourself. If you don’t see yourself and your family, if you have one, staying in the area for more than 3 years, then buying a home is probably not a good idea. The transaction costs in the buying and the selling of a home are large. If you plan on moving within a few years, any property you purchase will need to appreciate at least enough to cover your transaction costs just to break even. Real estate investments can yield that kind of appreciation but it's probably not a smart decision to take that gamble unless you are convinced the market has bottomed out and appreciation is going to kick in immediately.

What’s the status of your current rental?
Examine the remaining term of your lease. Are you paying an attractive rent right now? Will you need to move soon for any reason? You may need to move because the apartment is too small for your growing family, you’re facing a substantial rent increase, the landlord is not offering you a renewal lease, etc. The plausibility of staying in your current apartment will be a major influence in the decision.

What’s your income situation?
How secure are you in your job and what is the potential for salary increases? Obviously, if you are going to take on the financial responsibility of owning a home, you want to feel comfortable knowing that you will be able to meet the expenses.

How much have you saved?
Purchasing a house today requires you to come up with a down payment and cover your closing costs. The amount of money you have saved will determine that you have the assets to make the purchase and will be a factor in deciding the maximum price you can pay for your home.

What’s your track record with utilizing debt?
We are all aware how important your credit history is when applying for a mortgage. In today’s lending environment any payment history that’s less than perfect will impact the cost of financing. Looking beyond the payback history, you now also need to take a closer look your balances. Are your credit card balances increasing or decreasing over time? If they’re increasing, that’s a sign that you are spending more than you are making and you will need to correct this before going any further. If you are paying down debt, you may want to get closer to the goal of zero balances before buying your home.

Are you prepared to make a lifestyle change?
Living in a home is different than living in an apartment. You are now responsible for all the maintenance and repairs, not your landlord. Some people enjoy working on their home. They see it as a hobby and get personal satisfaction in it. Others have no interest in this and see it as an infringement on their lifestyle. Owning a home is not for everybody. You need to be sure that this is a lifestyle you are going to be happy with.

Once you are comfortable knowing that owning a home is a goal that you can afford and look forward to the new lifestyle, you can begin to study the current housing market. Everywhere you look you are going to find scary housing news. The housing market is dealing with a perfect storm. Inventory is at an all time high, prices are dropping, foreclosures are up, mortgage defaults are up, mortgage options are extremely limited, credit standards have never been tighter and utility costs are at a record high. Why would anyone consider buying a house under these conditions?

The first thing to be considered is that a home not only an investment but it also serves as a place to live. Its primary purpose is shelter for the family and we can’t lose sight of that. There is a cost for shelter that’s paid by everyone; it’s either paid as a mortgage payment or in rent. Real estate is a long-term investment. That’s a concept that was lost during the housing boom cycle. Historically, housing appreciation has been measured in decades, not weeks. During the overheated housing market people expected prices to go up almost daily. Reality finally set in and prices are correcting from their peak, but housing prices are still higher than they were 10 years ago. They’re just not as high as they were 2 years ago.

The high inventory of houses on the market allows today’s buyer to find the best house to fit their needs. No house is ever perfect but you can come a lot closer when there is a larger inventory to choose from.

The declining price of houses is a double-edged sword. Houses are a bargain today compared to 2-years ago but will they be even cheaper tomorrow? No one can answer that question. What needs to be done is to take all the factors of the marketplace, add your personal considerations and come to a logical conclusion. There are no guarantees that you are going to make the right decision, only time will determine that. All you can do is give it your best shot.

A good place to start is to compare the monthly expense of carrying a home to paying rent for a similar space. As the cost of ownership comes closer to the cost of renting in the same community, the price of a home in that community is reaching its lowest point. Owning a home provides shelter and an opportunity for property appreciation. The increase in carry cost from a rental to being an owner is the premium the market is demanding for the potential appreciation.

Any seasoned investor knows you can’t expect to buy anything at its absolute lowest point. You look to buy as low as possible. You only know the lowest point has been reached when prices begin to rise and then it’s too late to buy at the bottom.

Mortgage rates are historically low and no one can predict when and how fast they will rise. So, deciding when to buy, you need to consider what’s happening with the cost of money. The increase in financing costs will offset a portion, if not all of the saving, in a lower purchase price.

If housing prices stabilize or begin to increase at the same time mortgage rates go up, you may find yourself unable to afford the house you want to buy and will be forced to settle on a lower priced home.

From an investor’s prospective, the best buying opportunities become available when buyers disappear. In our corner of the housing market we are closer to the bottom than the media is leading you to believe. Anyone who had the confidence (or luck) to purchase a home in the early eighties when we were facing double-digit inflation, mortgage rates at 18% and OPEC dominance in fuel costs saw their houses double in value in a short period of time.

If it is the right time in your life to become a homeowner, don’t let the pessimism in today’s market stop you. Find the house you want, buy it, raise your family in it and ignore today’s gloom and doom. Years from now, when it’s time to move, you’ll sell the house at a profit.

Mortgage Brokers and Refinances

As a homeowner you should periodically review your personal financial position. For most people, their mortgage is their largest, long-term liability and therefore carries substantial weight in the review.

A meeting with a professional mortgage broker is the most efficient way to do this. He brings his knowledge of the current market conditions to the meeting; you bring the details of your current financial situation. During this discussion not only will an analysis of your finances be done but also your short and long term goals will be addressed. From here you will be able to make an informed decision. Should you refinance now? Should you wait until a later date? Maybe this is the time to trade-up or downsize to another property. This meeting will help you organize your thoughts and improve the focus of your goals.

Why can’t you have this discussion with a banker? Why is the mortgage broker a superior source of information? Before I can answer these questions you need to understand the differences between a broker and a banker. A banker is an entity that provides money to the public meeting the various individual needs of the consumer.

The organizational structure of a bank typically works like this. They have staff that actually meets with the consumer; they are responsible for the actual loan origination. The bank will then have an underwriting department that is responsible for the decision to approve or deny the application for credit. After the approval process is completed then the file would move to their closing department whose responsibility is to finish the transaction and distribute the proceeds of the loan.
Because of the high level of regulation in the banking industry as well as the risk of litigation, banks restrict the freedom of the Loan Originator to voice opinions or make recommendations. The originator is not working in a decision-making capacity and a consumer may interpret statements made by the originator incorrectly. If the consumer walks away from the discussion feeling he was denied credit, the bank could be facing a lawsuit. Because of the expenses both in money and reputation, banks try to avoid this problem. The bank originator’s job description limits his scope of responsibility to explaining the banks products and taking the application.

The mortgage broker is working for the consumer, not the bank. The broker’s obligation is to the applicant and therefore is free to talk openly and make the recommendations that are in the best interests of his client. This makes the broker better suited for this discussion.

Not all mortgage brokers are created equal. It’s important that you choose one that is both knowledgeable and ethical to meet with. Professionals in this field depend on referrals for the majority of their business. Their reputation is their primary tool in generating future business.

Any reputable mortgage broker will welcome the opportunity to have this meeting with you and do it free of charge. He will use this meeting to prove to you how valuable his services are. It doesn’t matter to him if refinancing is not in your best interests at this time, he knows you’ll be back when the time is right, or recommend others to him.

These are the factors that will be considered in determining the feasibility of refinancing:
The current market value of your home
The current outstanding balance of your mortgage
The current interest rate on your mortgage
The type of mortgage that you currently have (fixed, ARM, etc)
The remaining term of your mortgage
The current interest rate environment
The current underwriting standards
How long to you plan on keeping your home
The amount of outstanding loans you have and the details of those loans
Are there any upcoming expenses you will be facing (college, renovations, etc)
What does your current credit profile look like
Your current family income
Your anticipated future income (are you retiring soon, expecting a promotion, etc)
What is the total of your current liquid assets

This is not an all-inclusive list. The unique conditions of your personal financial position will bring up additional considerations. Every item on this list needs to be addressed for the analysis to be truly meaningful.

Most people don’t pay enough attention to their personal finances. The only person you can depend on for your future financial well being is you. Don’t let yourself down!

Mortgage Brokers and Purchases

You’ve decided to begin the process of purchasing a house. If you elect to utilize a mortgage broker, what services should you expect to receive?

Purchasing a home is not something you do every day. You are dealing with one of the largest purchases of your life. All your friends, family and co-workers are trying to help out by giving you advice. Although they have the best of intentions, you have no idea how accurate that advice is. You do some research on the Internet and find an overwhelming amount of information that will range from being accurate to totally wrong.

The role of the mortgage broker is to supply the facts you need to make an informed decision, analyze your personal financial position to see how this purchase fits into your life, help you in prioritizing and organizing your ideas. A competent mortgage broker will allow you to make decisions through a logical analysis of available information, minimizing the stress involved in the home buying process.

You need to get the mortgage broker involved in the process as soon as possible in order to maximize his usefulness. Arrange a meeting with the mortgage broker before you do any serious house hunting. At this meeting you will decide what price range you should be focusing in on. This decision will be based on what range you can financially afford as well as what price range you feel comfortable with. This is also the time to discuss anything you should be addressing now to improve your ability to obtain a mortgage. There may be some credit issues you need to work on, maybe some debts you should be paying off or property that needs to be sold. If there is anything that needs to be done, the earlier you address it the easier it is to repair.

This meeting will also get you familiar with the whole process. You will know what to expect and when to expect it. You will also gain useful insight into how to negotiate the sale. There are several details that go with an offer besides the price. Knowing this will make you a stronger negotiator. You will learn how to enhance your strong points and minimize your weak points when making an offer. Each meeting or telephone conversation you have with your mortgage broker increasingly strengthens your confidence in what you’re doing and enables you to negotiate a better deal with the seller.

Once the negotiations are satisfactorily completed, you can begin to focus your attention on the details of the financing. You’ve already had some general discussions regarding mortgage programs and market prices. Now those discussions get more specific. You will be deciding on the mortgage amount, the mortgage product, whether you want to pays points, when should you be locking in, etc. Now that you have chosen a property being purchased at an agreed upon price, that is going to close within a specific timeframe, you can now concentrate on the details of the mortgage.

As you move through the signing of the contract you are now ready for the mortgage broker to assemble and submit your mortgage application for approval. Because of all the preparation work that’s been done up to this point the mortgage application process becomes an exercise in organizing paperwork and submitting it to underwriting. The mortgage broker can easily answer any questions that the underwriter has because by this time he knows as much about your finances as you do.

You can then expect to smoothly move towards closing after the lender commits on the mortgage. All the preliminary work that was done between you and the mortgage broker takes the stress and aggrevation out of the commitment and closing process. That frees you up to concentrate on any work that you plan on doing on the property prior to moving in as well as arranging for the move itself.

The initial reason that you considered using a mortgage broker was to make sure you would be paying no more for your mortgage than you are entitled to and you would be closing on the mortgage product that best suits your needs. A competent mortgage broker not only meets these needs but also provides you with a bundle of services. He not only arranges for the best mortgage for you but also empowers you to make the best deal you can on the purchase.

There is no doubt you are making the right decision utilizing a competent mortgage broker when buying a house.

Why use a mortgage broker?

There are three general reasons why a person decides to use the services of a mortgage broker. The first reason is necessity. A person may have complications in their financial profile or possibly credit issues that will make the application process more involved. By utilizing a professional mortgage broker, the applicant will have access to the tools and the advice necessary to arrange the best financing. The mortgage broker is hired by the applicant and will present the applicant in the best possible way. The mortgage banker, on the other hand, is looking to originate the highest quality mortgage but at the same time yield the bank the highest possible profit . A professional mortgage broker is focused on doing the best he can for his client, the applicant. The more unique the applicant’s profile, the greater the need to hire a professional.

The second reason that consumers utilize the services of a mortgage broker is for “peace of mind”. Applying for a mortgage is not something most people do on a regular basis. Most consumers will apply for a mortgage only a few times in their lives. They don’t feel confident that they have the necessary knowledge to make an informed decision on their own and feel better having access to professional advice. Many Americans hire accountants to file their income taxes each year instead of doing it themselves. They rather hire a professional because it’s not reasonable to expect to do something once a year and do it right. This same attitude applies to hiring a mortgage broker. There is a “peace of mind” in utilizing a professional instead of going it alone.

The third reason is convenience. The person does not have the time or the inclination to deal with the mortgage process. They don’t want to deal with the details, the phone calls, voice mail hell, etc. They want to deal with one person who handles everything for him and is conveniently accessible. He can go on with his everyday life knowing his mortgage needs are being addressed professionally.

Working with a mortgage broker that is both ethical and professional in the manner in which he conducts business is by far the most efficient way of arranging for your mortgage. However, not all mortgage brokers conduct business in the same manner. Working with the wrong mortgage broker can be more of a problem and potentially cost you extra money than doing it on your own. So, how do you find the right mortgage broker to work with?
Ask people whose opinion you value. If your attorney, accountant or a close friend used the services of a mortgage broker and was satisfied with the level of service he received, then this is the broker to hire. There is no better way to choose a professional then through a personal recommendation.

Another approach would be to visit the UpFront Mortgage Brokers Association website and search for a broker in your State. This is an association of mortgage brokers that agree to conduct business in an ethical and transparent manner. Important attributes you would want to have in the person you are trusting with your mortgage application.

You can also utilize the services of the Better Business Bureau (BBB). A broker that is accepted by the BBB agrees to abide by their code of ethics. Consumers can file complaints with the BBB and the broker has agreed to utilize the BBB as the arbitrator.

The mortgage industry is evolving rapidly in addressing the current economic problems. This evolution is making it much more difficult to arrange for financing and the process is taking much longer. It is more beneficial now, than ever before, to have an experienced, professional mortgage broker working for you.

Inflation

Inflation is damaging to many areas of the economy but there are certain situations where inflation is helpful. Many of the problems we are currently facing originated in the housing market. Without going into the details, we can summarize the 2 core issues. The cost of housing got too high and many borrowers are carrying more mortgage debt that they can comfortably afford.

Over the last few years there were many mortgages that were granted to people who couldn’t afford the payments. These are the sub-prime mortgages that are currently in trouble, with many of them destined to go into foreclosure. This represents 20% of the mortgages that were written over the last few years. I want to look at the other 80%.

Most of these homeowners have fixed rate mortgages in the 5 to 6.5% range. Soon the inflation rate could easily be higher than this range. But even if the rate of inflation only grows to the 5% range, these borrowers are paying the bank with dollars that have lesser value than the dollars they borrowed in the first place.

Currently, housing prices are depressed throughout the country. Some areas such as Florida have seen major drops in value while other like New York have seen minor drops. As the effects of inflation move through the economy, the price of everything goes up, including houses. The homeowner who presently, has little or no equity in his home, will begin to build up equity simply due to the influence of inflation.

The current price for housing is either at its lowest point or close to it. This means that today’s renters will see their rents increasing and will be motivated to purchase a home. Why? If for no other reason than to stabilize their cost of rent. Rents move up with inflation but a fixed rate mortgage payment doesn’t. This brings us back to why most people buy their home in the first place; to own a place where they can raise their family. It’s only over the last few years that a residence was viewed as an investment vehicle first and a place to live second.

The housing market is currently in a transition period. As we approached the peak in market prices last year the spread between paying rent and paying a mortgage increased to the point that owning became unaffordable without some form of exotic financing. The carry costs of ownership became too much for many owners and mortgage defaults began to pile up. This brought housing prices down and forced the disappearance of the exotic mortgage programs. Now we’re beginning to see the cost of renting going up in response to the increase in the number of renters.

Currently inflation is affecting everything except wages. We are now dealing with a higher cost of living (especially housing costs), tighter credit standards and a lack of confidence in the price of real estate. As time progresses we can expect to see housing prices stabilize (due to the increase in rent), credit guidelines becoming more realistic (a direct response to the stabilizing of housing prices), wages rising (since inflation will eventually impact labor costs) and consumer confidence increase (a natural response to all of the above).

Individually we won’t be better off financially when the economy comes out of this transition period but we will feel like we are. This is what a moderate level of inflation does for you. You make more money; it costs you more to live yet psychologically you fell wealthier. The more money flowing through your hands, the richer you feel.

There will be one group of people that will actually be richer, those homeowners who bought their homes with pre-inflation dollars and fixed rate mortgages. Inflation drives the cost of everything up except for the mortgage payment for these individuals. The buying power of every dollar earned by these people has dropped except for the dollars used to make the mortgage payment. Inflation will drive the cost of borrowing money up, it will drive up the yield paid on savings accounts but it has no adverse impact on the fixed rate mortgage payment.

These borrowers entered into a long-term contract with their lenders. This contract obligates the borrower to write the same monthly payment to the lender for as long as it takes to retire the loan. The contract obligates the lender to a specific interest rate; regardless of how much the lender’s cost of funds increases.

The inflation cloud does have a silver lining, but only for those who had the foresight not to buy more of a home than they needed and used a conservative fixed rate mortgage. If you’re a member of this group don’t get discouraged by all the bad economic news. It is only temporary and you will be in a stronger financial position when the economy emerges from this transition period.

Personal Financial Tip 10

We’ve been very lucky over the last few years. Inflation has been very low for some time. Our luck is running out and that means we need to adjust our spending habits to reflect the new reality.

A low inflation rate has made us complacent. Price increases for our day-to-day purchases have been nominal. Any real increase in our spending week to week was mainly due to buying more “stuff” or buying higher priced “stuff”. We could slow or prevent any increasing in our spending with little pain. All we needed to do was to buy less “stuff.”

We are now living in a different world. We are forced to spend more money every week for the same “stuff.” In order to keep our spending in line with our incomes we are forced to buy less. This adjustment is going to prove to be even more painful when you consider the fact that even with a low rate of inflation we were spending more that we earned. The availability of easy and cheap credit made up the difference.

Cheap credit is quickly disappearing. Access to new credit is almost non-existent and existing credit limits are being reduced across the board. Everyone is going to need to make serious adjustments to their spending habits in order to avoid financial ruin.

Inflation has been low for such a long time most of us either don’t remember how we dealt with double-digit inflation or aren’t old enough to have faced it in the past. We’ve developed an instant gratification mentality. We want to live for today, enjoy ourselves now, buy the newest toys now and pay for it later. That’s way the debt load of the average American is at a historic high.

Budgeting hasn’t been one of our strong points but it’s a skill we are going to need to master and master quickly. The price of everything we buy is getting more expensive. Inflation becomes a justification for instant gratification. It subtly encourages us to overspend today. Putting off a purchase not only means that we lose the enjoyment of the product today is also means that it is going to cost more when we do buy. The bad habit of living for today now seems to have a logical foundation. Why wait, it’s only going to cost more tomorrow so I’m actually saving money by buying it today. This attitude is only going to make matters worse.

We are already seeing the effects of inflation on the decisions investors are making. In a low inflationary marketplace investors will focus their investments on paper investments. That is, stocks and bonds. When investors expect a period of higher inflation. They tend to move their investments into hard assets such as commodities.

Look at what’s happen in the stock market for the first half of this year. Every major stock exchange throughout the world has seen a drop in overall value ranging from 15 to 50%. Now look at the commodity market. The cost of all raw materials from oil to food has seen record run up in values. Investor money is moving from paper to hard assets.

Yes, global demand for raw materials has been steadily rising over the years. This is influencing the increasing prices of commodities. This underlying cause for increasing commodity prices has set the foundation for the spiking price increases caused by investors.

Profits are down for most companies. This means they are selling fewer goods. If they are selling fewer goods they need to produce less. In producing less, they will need fewer raw materials. A softening in demand for raw materials should stabilize or even lower the price of these resources. We are not seeing that, prices are continuing to increase. This is the result of investors moving their money into this asset class.

The only sensible assumption we can make is that inflation will increase and stay higher for the foreseeable future. By making adjustments to our spending habits in line with this assumption what’s the worse that can happen? Inflation stays low; we are spending less money with the result that we either end up with less debt or more saving. There’s no downside here.

We could continue on the path we’re on because we’ve assumed that inflation will be kept in check. However, we have a downside with drastic consequences if we’re wrong. We end up deeper in debt, assuming we don’t lose access to credit, or in bankruptcy. We just can’t afford to be wrong. It is too dangerous to make this assumption.

Most of us don’t need to make drastic changes. Getting rid of your SUV and buying a hybrid isn’t necessary. Fuel costs can be reduced without major lifestyle changes. Just by eliminating wasted trips your fuel bill can be reduced. Then when it’s time to replace your vehicle, downsize. This could be a perfect time to quit smoking. There’s a substantial cost saving here in addition to the health benefits. Tie in eating out less with that diet you keep promising to go on. Stop buying you kids every new gadget that comes out. In addition to the money saved your kids will be less spoiled and will grow into stronger adults.

Reducing spending is difficult to do. However, if you make a lifestyle change that improves your life, like becoming more environmentally sensitive or eating healthier, that also reduces spending the process becomes easier.

If we don’t change the way we handle our money today we will be risking financial insolvency tomorrow. Be proactive.

Personal Financial Tip 9

We live in a marvelous time. Never in the history of mankind has information been so readily available. We don’t even have to leave our desks. We can access information on any topic through a few mouse clicks. This empowers us to make more informed decisions. However, having easy access to so much information does have a downside. We can put ourselves in a position of information overload. This happens when the volume of information collected causes confusion instead of clarity. This overload inhibits our ability to prioritize the information making it difficult to focus on what’s truly important.

Even more dangerous is coming to the conclusion that we are now experts. A little knowledge is a dangerous thing. An example of this problem is what’s happening in doctors’ offices. Patients are meeting with their doctors with preconceived ideas as to the course of action that should be taken. If the doctor doesn’t conform to these preconceived ideas then the patient loses confidence in the doctor and may avoid coming back. The doctor may simply give in to the patient’s wishes concluding, “There’s no harm done”. This is a major reason why doctors prescribe unnecessary medication so often.

In the past we’re hired experts because we knew we couldn’t do the job as well as they could or we couldn’t do the job at all. In selling a home we would hire a real estate broker to handle the transaction. We would use a mortgage broker to arrange for the financing when purchasing a home. We didn’t know how to do it, so we hired someone else to do it for us.

Today we hire professionals for the experience they bring to the transaction more than their knowledge. Theoretically we can learn enough to get by through our own research but that’s not enough to get the job done. We can absorb all the knowledge that’s needed to fly a plane but without hands on experience we can’t be considered pilots.

The same holds true when working with a broker. You can have done all the research but the lack of experience will put you at a disadvantage in the transaction. The questions you need to answer are these. Is the money I am savings by not hiring a professional worth the time that’s spent researching? Is my lack of experience going to make the transaction more expensive for me? Am I going to make an expensive mistake?

A professional is hired because he brings a level of expertise that can only be developed over time. He will explain what is happening, what he needs to do, what you need to do as well as the consequences of all actions taken. Research that’s done on your part allows you to utilize the professional’s service efficiently. You already know the basics so all discussions between the two of you are on a higher level giving you more value for the money.

In choosing a professional to work with you should be looking for a person with years of experience, one who takes the time to explain what needs to be done, is willing to answer your questions and most importantly one you are comfortable doing business with. Each one of us has our own unique personality and every professional has his own personality. If these personalities clash, if the two of you aren’t on the same wavelength, then this is not the person you should be conducting business with.

Once you have chosen a professional to work with you need to trust him. He has been picked by you to become a member of your team. If you are going to second-guess his advice or worse question everything he does you are making him ineffective. You will be paying for a service that you aren’t using, the worse possible combination.

Utilize the Internet and any other reference material you have available. Take the time to become an empowered consumer. With that knowledge choose the professionals to work with, surrounding yourself with the most competent team you can. Now, allow them to do their jobs. Working with them, respecting the skills they are bringing to the transaction and having faith in the decision you made when you hired them will yield the best results.