The Fine Art of Mortgages

The Evolution of the Mortgage Market

2009-07-07T10:35:00.003-04:00

There have been 3 major inflection points in the mortgage industry over the last 30 years. The first occurred in the mid 1970s when mortgage rates were no longer set by the Federal Government and became market driven. This was a much needed change. It was the only was to maintain a steady availability of mortgage financing to the public. Up until this point with the mortgage rate being set by Washington, lenders would only focus in on mortgages financing when it made good business sense. When mortgage rates were fixed at 8.75% and lenders could charge 10.00% on business loans their focus would be to originate business loans. On the other hand if they could only charge 7.00% on a business loan then mortgages became an attractive source of business.

The mortgage market responded to changes in market rates by varying the number of mortgages they were willing to close. Once mortgage rates became market driven there would always be mortgage money available to the public, just the cost of the financing would be higher or lower depending on the overall cost of money at the time.

Once the shock of this wore off consumers slowly got accustomed to mortgage rates being differently from day to day and lender to lender. A person would purchase his home at whatever mortgage rate is available at the time. If rates come down at a later date he would simply refinance and take advantage of the lower cost of financing.

Mortgages were still a local business. The majority of mortgages were placed with local Savings Banks that served the community and kept the mortgages after they closed. This system worked well until the mid 80s when we faced the Savings & Loan crisis which forced most of the Saving Banks out of business. A new business model for delivering mortgages to the public emerged. No longer were mortgages originated by the local institutions they were now being offered through mortgage bankers and brokers whose sole business was mortgage origination. No deposits were taken in, no branch network was needed, and no car loans were written. They focused on originating mortgages, bundling them and selling them off to investors. This system worked well until we entered the third and latest inflection point, the mortgage crisis we're currently facing.

The weak point of this delivery system became painfully obvious when housing prices stopped their rapid rate of appreciation and began to depreciate. Add industry mismanagement and greed on top of a global recession and you have the disaster we are currently dealing with. This has caused the greatest change in the financial marketplace since the Great Depression.

Institutions are closing down, being taken over by larger institutions or reaching out to the government for financial assistance. This is causing a major consolidation in the mortgage market. For a lender to survive it needs access to a reliable and moderately priced source of funds. The only source of funds that meets theses requirements are deposits. Institutions that have relied on Wall Street for capital to operate their businesses cannot operate in this environment. Only banks that deal with consumer deposits can be committed to the mortgage business today.

For a mortgage broker to deliver the proper level of services to his clients he needs multiple sources of mortgage products and lenders. My analysis of the industry confirms that the era of the mortgage broker and mortgage banker is coming to an end. It's my prediction that that the market will be dominated by those institutions that are "too big to fail". Government support comes with strings attached. As long as the government needs to supply financial support to these lenders, the lenders will be obligated to supply mortgage products to the public. They will also be expected to deliver these products at a fair price.

It is for this reason that I have decided to close Shelter Rock Mortgage Corporation and partner with an institution that is not only committed to the mortgage business but large enough to stay committed. I am now working exclusively with Bank of America. It is the largest mortgage lender in the country, has a corporate culture focused on customer service and has the financial strength to aggressively price their products.

By combining the strength of the largest bank in the country with my years of experience I will be able to continue to delver the level of service that my clients expect from me. I'm excited about this transition and look forward to the benefits this partnership will bring to all concerned.

Revised Credit Card Rules

2008-12-18T12:18:00.003-05:00

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

2008-12-10T16:22:00.001-05:00

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

2008-12-04T16:29:00.002-05:00

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

2008-11-14T15:38:00.002-05:00

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

2008-10-28T17:35:00.002-04:00

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

2008-10-17T16:00:00.000-04:00

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

2008-10-10T10:19:00.000-04:00

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?

2008-09-29T15:38:00.000-04:00

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

2008-09-08T15:23:00.000-04:00

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?

2008-08-27T13:16:00.000-04:00

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?

2008-08-19T14:55:00.000-04:00

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

2008-07-31T13:05:00.000-04:00

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

2008-07-30T14:55:00.000-04:00

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?

2008-07-28T15:06:00.000-04:00

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

2008-07-10T12:45:00.000-04:00

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

2008-07-01T13:11:00.000-04:00

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

2008-06-23T16:14:00.000-04:00

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.

Personal Financial Tip 8

2008-06-12T14:17:00.000-04:00

A common way to prevent your credit card balances from getting any larger is to try to make all your purchases the old fashion way, with cash. An alternative to carry cash around is to use a debit card. When using a debit card you are not borrowing money that you agree to pay back at a later date, you are authorizing the store to immediately deduct the amount of your purchase directly out of your checking account. Banks across the country have been encouraging consumers to use debit cards as an alternative to credit cards promoting the advantages of a debit card over a credit card.

At first look this seems like a reasonable approach to rein in your credit card spending and at the same time eliminate the need to carry large sums of cash around. However, you need to recognize all the negatives of taking this approach before you decide to modify your spending habits in this way.

The first issue is that using a debit card doesn’t supply the same restrictions that using cash does. Remember you are making this decision to help you become more conscious of your spending with the goal of exercising greater control over your debt.

The reasoning behind making your purchases with cash is that you have limited your buying power to the amount of cash you’re carrying. If you don’t have the money, you can’t spend it. Using a debit card doesn’t have this very important restriction. You spending limit is not the amount of cash you are carrying at the time of purchase but the balance in your checking account, as well as any overdraft protection you have on the account.

If you plan on using a debit card you better keep track of the balance in your checking account at all times. The purchase you are making triggers an immediate transfer of money from your checking account into the merchant’s account. If you’re not careful you may find yourself bouncing checks that your recently wrote out as a result of a recent purchase. In reality you are not adding a true level of discipline to your spending habits when you move from a credit to a debit card.

Next there is a security concern when using a debit card. There is a major difference between a debit card purchase and a credit card purchase. In using a credit card a bank is entering into a loan agreement with you for the amount of the purchase. When you sign your name you are agreeing to the terms of the loan being offered. The bank is obligated to confirm that the person using the credit card is actually you. If your credit card is stolen and used by another person, you have little or no liability to pay the bank for that outstanding balance. Your maximum liability on a credit card that was stolen is $50.00 but it’s rare for a lender even to collect that from you. Their ongoing business relationship with you is more valuable to the bank than $50.00.

When using a debit card, an authorization is given by the holder of the card to the store to do an electronic transfer. Proof of this authorization is when the cardholder supplies the “pin”. It’s the cardholder’s responsibility to keep the “pin” private. In the event a thief was to gain access to the “pin” he could clean out your account. You are stuck with the loss.

The government has imposed an important level of responsibility on a lender when it issues a credit card. There is business relationship between the lender and the merchant making both entities responsible to you, the consumer. For example you buy a piece of furniture with your credit card and have it delivered. The furniture is damaged and the store isn’t being responsive in making the repair. Consumer protection laws permit you to dispute the purchase with the credit card company, who then withholds payment to the store until you are satisfied with the repair. Your credit card is credited with the full cost of the transaction and you incur no interest charges while the store addresses your problem. In your fight with the store to correct the problem you have a powerful weapon, being able to withhold payment.

If this same purchase were made with a debit card you would not have this weapon available to you. When making a purchase with a credit card you have a no cost insurance policy guaranteeing your satisfaction. Not something you should give up lightly.

My suggestion is to do the following. Take one credit card and use it for all your purchases. If you currently have an outstanding balance on that card concentrate on paying down the balance on that credit card first. Your goal is to have a credit card with no running balance on it and treat it as a debit card. Make all your purchases on that card during the month and pay off the entire balance when the bill comes in.

The benefits of taking this approach are:
1. You have one less thing to worry about. Your checking account has one less way to be accessed by a thief. Should the card be stolen, your losses are minimized.
2. You have all the consumer protections afforded to you by the government whenever you make a purchase.
3. You don’t have to be concerned with overdrawing your checking account. All withdrawals are done when you decide to focus on paying your bills at the end of the month not every time you make a purchase.
4. You have an accounting statement sent to you every month itemizing all your charges. This allows you to easily review your ongoing spending habits each month, making changes going forward as you see fit.
5. When you pay off the entire outstanding balance on a credit card each month there are no interest charges. The bank that issued the card is giving you an interest free loan every month to cover your purchases during the month. It’s a nice feeling getting something back from a credit card for a change!

By taking this approach you have all the advantages of a debit card with none of the risks. What more can you ask for?

Personal Financial Tip 7

2008-06-09T16:39:00.000-04:00

The time has come to sell your home. For whatever the reason, the home no longer suits your needs. Maybe you have a growing family and you need something bigger, maybe you’re an empty nester and need something smaller or maybe you’ve had some financial difficulties and can’t afford the expense of this particular property. You’ve made the decision now you need to get the job done.

Regardless of whether you are going to hire a real estate broker to market the home or you plan on doing it yourself you goal should be to sell for the best price in the most efficient manner. You can only do this by separating your emotional attachment to the home from the realities of the marketplace.

The home you’re living in has a special value to you. You decided to buy this home, you decorated it, it has been a part of your life and you may have even raised your family in it. No potential buyer is going to have these attachments to the property. A buyer, just as you did when you bought this home, will be comparing this property to everything else he’s seem. If he likes the property and it suits his wants and needs an offer will be presented. This offer will be based on the buyer’s personal evaluation of the marketplace and his evaluation of your home. In order for you to be equipped to respond to the offer you need to have a working knowledge of the local housing market.

You need to know which houses in your neighborhood have recently sold, for what price and when the closing occurred. You need to discover which other homes in your community are on the market and at what price. You want to be as knowledgeable as the buyer and recognize the fact there is no special add on to market price because your home is special to you.

It’s based on your knowledge of the market that you will negotiate. The only way you can properly negotiate the terms of an offer is by putting yourself in the potential buyer’s shoes. You need to know where he’s coming from. Without doing the necessary research you home will not sell at the proper price or worse, never even get an offer because your expectations are out of line with the market.

Once you have done your research you are now prepared to market your home. Keep in mind that this is going to be a job, it is going to be a major distraction in your life and it is going to require an investment on your part. You are going to be investing your most valuable asset, your free time. This is why it is important to sell your home in the most efficient way possible.

Once you have calculated a price that you can reasonably expect to get for your home you need to decide on an asking price. The theory that you should start high because you can always lower your price doesn’t work. You end up wasting time on the market and the longer your house in on the market the more likely buyers will assume there is something wrong with the property. This results in fewer buyers viewing your home and encourages them to make lowball offers, neither of which is a path to selling your home at the best price.

Let’s say that your research supports a sales price of $500,000 and you decide to put your home on the market for $700,000 figuring that you can always reduce your price and hope for the best. Think about it, individuals that can afford a $500,000 home aren’t looking as high as $700,000 and people looking to buy a $700,000 house are expecting more house for the money. When you overprice your house, you are marketing to the wrong set of potential buyers.

The closer to your targeted price of $500,000 you start your marketing at, the more activity you are going to get. The activity you get will be from buyers who are interested in buying in your price range. Now you are marketing to the right people.

You have also earned the right to be firm when you are negotiating with a buyer. Any serious buyer will recognize that you have priced the home properly and therefore expect to settle on a number that is close to your asking price. You have no reason to talk to any one presenting a lowball offer because you have the data to support your numbers. You have the freedom to pick and choose which offers you are willing to entertain.

After you’ve determined your asking price, the next step is to prepare your home. You are dealing with a buyers’ market. Meaning that there are a lot of homes on the market and buyers can be more selective in making their decisions. There are things you need to do to that will make your house more appealing. You don't need to spend a lot of money or drastically changing your lifestyle.

There in no reason to take on major remodeling projects, bring in an interior decorator to stage your property or totally depersonalize your home. Variations of these approaches are being suggested in “how to” books and the news media. My theory is “less is more”. The less you do to the home the more attractive it is to a buyer.

The first step is to do a general cleaning. Take the day-to-day clutter of family life and get it organized. Wash all the windows and adjust your window treatments to allow as much light into each room. The interior of the home will have a more appealing “feel” to it if it is organized and bright. Any opportunity to air out the house should be taken. Every day the weather permits, shut off the air conditioning and open the windows. Any closed space will begin to smell stale trapping any pet or cooking odors in the air.

Any damage in the home need to be repaired but upgrades shouldn’t be done. Repair the dripping facet in the bathroom but don’t remodel the bath. If the bathroom on the second floor is leaking into the first floor then remodeling may be appropriate but updating the bath because it’s 50 years old would not be a good investment. Replacing the stove in the kitchen because it’s not working is one thing. Replacing a working stove with one with a fancy nameplate on it is something else.

A suggestion that I come across a lot is to paint. A fresh coat of paint makes any room seem more appealing. If you feel a need to paint every room in your house, fine. If you are thinking about painting one or two rooms, don’t. Although those rooms will shine it will make every other room look more worn. In most cases you are better off not painting, unless you plan on doing the entire house.

Keep in mind that anything that is done to the property will look like it’s just been done. A potential buyer will assume that the only reason the work was done was for the purpose of selling the home. This raises a question in the buyer’s mind. Better the buyer see a 50-year-old well maintained bathroom than a brand new bath that looks like it was never used. The buyer will prefer to buy a home that presents itself as being well maintained yet dated over one that looks like it’s been cosmetically renovated for sale. Remember, any investment in the renovation will be in the sales price and the buyer is well aware of that.

The outside of the house is as important as the inside. Keeping the lawn moved and the bushes trimmed makes for the right first impression. This is called “curb appeal” in the industry. Be sure to keep the lawn well watered, lawns are expected to be green and that means plenty of water.

Lastly, the home needs to be accessible. Buyers won’t buy what they can’t see. The easier it is for people to come see your home the faster you will get is sold. Be prepared to be available on the weekends as well as in the evening.

It’s a tough market right now but houses are still selling. If you price it right, present it in its best light and make it convenient for potential buyers to see it, it will sell. You just may have to be a little patient.

Personal Financial Tip 6

2008-06-02T17:25:00.000-04:00

You’ve tired of paying rent and you’ve decided to purchase a home. You feel now is a good time. There’s plenty of inventory to choose from and although the credit market is tight rates are still attractively low. Now it’s time to get organized.

House hunting is exciting but it’s also a lot of work. You are going to be investing a lot of your time in researching, viewing and then negotiating the property. The time you are investing is your most scarce commodity. That is your free time. You don’t have a lot of it to begin with and now you are going to use a good portion of it in your desire to buy a place to live.

There are several avenues available to you as you begin your search. There’s direct advertising such as newspapers and the Internet. There’s open houses held every weekend that you can take advantage of. You can talk to your friends, co-workers and relatives to discover what’s currently on the market. And finally, you can work with Realtors.

Every avenue should be utilized to help you develop your own opinion as to where you want to live, the type of home you’d like to buy and the price you are willing to pay for that property.

Before you start actively searching there is some homework you need to do first. Begin by getting an idea of what your housing needs are, but keep this general. Starting off with a detailed list of what you want will work against you. In its worse form it can discourage you from even looking. As you view properties you will note the attributes of each property. You will begin to develop a list of priorities. The action of looking at properties will supply you with the data from which you can determine what is really important to you from things that would be nice to have from things you really don’t want.

You also need to find out what you can afford and more importantly what you feel comfortable paying each month. The way you do this is to total up your current assets and your current income and then talk with a professional. Get a recommendation for a mortgage broker from you accountant, attorney or use the Internet to find one. In using the Internet begin your search with the UpFront Mortgage Brokers Association and The National Association of Mortgage Brokers. Brokers who become members of these associations tend to take their business more seriously, especially those who take an active roll in the association. They also tend to have more experience.

Once you meet with the broker and feel comfortable with his knowledge as well as his personality you can then discuss your financial situation. The broker needs to prove to you that he is not only knowledgeable but also willing to take the time to understand your position and help you in making decisions that you will be happy with.

Based on your financial data and his understanding of your wants and concerns the broker can then make suggestions as to the price of the home you should be looking for. You will be leaving this meeting with more than a prequalification letter. You should have an understanding of the current underwriting criteria, the process in getting a mortgage, what the maximum financing that a lender will be willing to grant you and most importantly, where you want to be after closing on the purchase. After you close on the purchase you will be facing a new monthly expense and less cash assets that you had when you were paying rent. You need to understand that you will be facing a balance between the mortgage payment and the amount of cash left on hand.

As your hunt progresses you will be talking with your broker. You will be updating him as to what you’ve found in terms of price, property tax etc. and he will be updating you to the current mortgage market.

Now that you an idea as to what features you want to have and what you feel comfortable paying you can begin your search. If you don’t have a specific area your interested in then you need to superficially look at as wide a geographic region as necessary. Use the media and the Internet to find open houses. By visiting these properties you will be able to develop a feel for the neighborhood, the styles of homes that are typical for each neighbor and a general idea of the housing costs. This will give you the background from which you will be able to focus in on one or two areas. Now you can begin to look seriously.

You will be using multiple sources of information in your search. Always keep in mind the strengths and weaknesses of each source. Friends, relatives and co-workers have the best intentions when then give you information. They sincerely have your best interests in mind. They are however limited in the quality of their data. They may have purchased a home in a different market or at a different time. Recent sales activity that they are giving you may not be accurate. The information typically comes from a friend of a friend. Before depending on anything information you should confirm it through another source.

The media, the Internet and open houses will give you the asking prices of the properties you’re viewing. This is not the market value; it is a price a homeowner is asking. You need to keep in mind that there is no formula available that converts an asking price to the market price.

Realtors, except in the rare condition that they are working as a buyer’s broker, represent and are compensated by the seller. You need to keep this in mind for two reasons. Information supplied to you will be from the seller’s prospective. The Realtor’s job is to get the highest and best price for the seller. Conducting business through a Realtor does not cost you any more that dealing directly with the owner. You will be buying the property at a price that you feel is right for you. What financial commitment the seller has made with the proceeds of sale doesn’t impact what you’re prepared to pay.

The Realtor has access to closed sales in the neighborhood. This is date you need to negotiate intelligently. There is no way for you to know how close a seller’s asking price is to market price if you don’t have market data available. Based on your analysis of the closed sales data you will be able present an offer based on facts. This will force the seller to argue your facts if he wants to get a higher price from you.

Let’s take a simple example. You are selling your home. This is a house that you have lived in for many years and therefore has special value to you. You are selling the home for $500,000. There are two buyers interested the home. The first buyer offer you $425,000 claiming that’s all they can afford, there are a lot of homes on the market, they’ve read in the paper that housing prices are down and there are sure prices are going to fall further.

The second buyer offers the same $425,000. This buyer acknowledges the qualities of the home as the reason he wants to buy it. The buyer points out that six months ago a house around the corner was sold for $440,000 and last month the house across the street closed for $425,000. He couldn’t find any other sales in the neighborhood.

The first buyer is negotiating with the same thought process as the seller. The property is worth $425,000 to the buyer because that’s what he wants to pay and it’s worth $500,000 to the seller because that’s what he wants to get. This is similar to 2 kids fighting over a piece of candy.

The seller has a different issue when address the second buyer. Here the seller can take the position that he doesn’t care what the market value is, he wants what he wants. It’s obvious that this seller will not be selling his home anytime soon with that attitude. If the seller is truly interested in selling the property he is now forced to address the recent sales. He will have to find similar closed sales at a higher price then the second buyer or will have to prove that his property is substantially better that what already sold. Maybe the house is bigger or it’s been updated, etc. The seller is pressured to deal with facts and figures, not emotion.

There is another benefit in negotiating with facts. What if there are higher priced sales in the neighborhood justifying a higher price for this property? The seller identifies them and presents them to this buyer. Should the buyer want to purchase this property and is willing to increase the offer, he can do that with the confidence that he paying a proper price for the home. The buyer is dealing with facts, not emotion, in the negotiating process.

When finding a home that you would to buy, there in no guarantee that you will be able to buy it at a price you’re happy with. You do however stand the best chance if you are properly prepared and negotiate based on facts.

Buying a home is a job. You need to dedicate the time necessary to do the search and develop the skill set that gives you the ability to identify the right house and purchase it at the right price.

Personal Financial Tip 5

2008-05-21T15:41:00.000-04:00

Routine maintenance is something that needs to be performed on everything. We periodically change the oil in our cars, we have the car inspected annually, we have annual physical check-ups, etc. We do this in the hope of preventing problems and to discover minor problems before they become major ones.

One thing we tend to ignore is our credit report. They only time we think of our credit is when we are applying for a loan. If there are any problems with our credit profile, we can end up being declined for the loan or find ourselves paying more for credit than we should.

Today, more than ever, it is important that you do ongoing routine maintenance on your credit report. Lenders examine your credit profile when you are applying for credit, employers when you are applying for a job, landlords when you are looking to rent an apartment and insurance companies when you are looking for insurance. Errors on your credit report will negatively impact all these major decisions.

Mistakes are not common in credit profiles, but they do happen. Correcting mistakes takes time so it is in your best interests to discover a mistake before it can cause you any harm. I’m going to tell you what routine maintenance you need to do as well as the steps that you will need to take to address any problems that you may find.

Before we begin, you need to understand how the industry works. Think of the credit bureaus as nothing more than large filing cabinets. Every month each creditor you deal with sends an update to the bureaus. If you’ve borrowed more money, paid off a loan, made a timely payment or made a late payment, this data is added to your file. There are 3 major credit bureaus (Equifax, Experian and Trans Union) and most creditors report to all three. You will need to monitor all three bureaus for accuracy.

When an entity wants to see your credit profile, they need to first receive your permission and then an inquiry is submitted to the bureaus. The bureaus then assemble all the data that has been supplied to them by your creditors and searches public records for any judgments and bankruptcy filings. This data is combined to create your credit report and if requested, a credit score is calculated. The score is a computer analysis of your report that yields a short cut to your creditworthiness.

For a more detailed analysis of credit scoring please visit http://www.shelter-rock.com/Credit%20Reports.htm.

You are entitled to get a free credit report once a year from each of the bureaus. What you want to do is to request a report from each bureau once a year, spread out throughout the year. This way you get to see a report three times a year without any cost. Visit www.annualcreditreport.com to access your report.

In reviewing your report you’re looking for any derogatory data, judgments, collection accounts, charge-offs, late payments, etc. If you find any incorrect information you will then need to work on getting the item(s) corrected. This will be a time consuming process and you will need to document every step.

Contacting the credit bureau with a consumer complaint is not going to guarantee the correction will be made. When you file a dispute with a credit bureau, the bureau is responsible to forward your complaint to the creditor in question. The creditor has 30 days to respond. If the creditor doesn’t respond, then the bureau must remove the item in question.

If the item is removed because the creditor corrected the error, you’re fine. If it is removed simply becaues the creditor did not address the dispute within the 30 days, you have not solved the problem and that same error will re-appear on your report. Remember, each creditor reports to the bureaus every 30 days. If their records haven’t been corrected, then the item in dispute will be re-entered into your credit profile in the next cycle. There is no way for you to know what initiated the removal of the disputed item unless you are fortunate enough to get a written acknowledgement from the creditor.

The only way to assure that the error is permanently corrected is to contact the creditor and/or collection agency directly. Before making contact, assemble any documentation you have available to support your claim that there is a reporting error. Send any written correspondence by certified mail/return receipt requested and keep a telephone log of any conversations with the creditor. Through your persistant contact with the creditor you will eventually get the problem resolved.

It will appear that the creditor is just being difficult and doesn’t want to cooperate in correcting their mistake. In some cases this is true, but in most cases you are dealing with a creditor that is being overwhelmed with invalid disputes. Until your valid claim is separated from the overwhelming number of invalid complaints it cannot get the attention it deserves.

The bureaus and creditors receive a combination of legitimate, valid disputes as well as disputes where the consumer is wrong and the data is correct; and then there are the disputes filed by "credit repair" companies. These are companies that promote themselves as professionals in removing derogatory items from credit reports. Their business model is to overload the system with disputes. Every time a dispute is proven to be invalid, they simply resubmit the dispute complaint. In every batch of disputes sent to the bureaus and creditors, a few get randomly removed. Their goal is to create enough confusion at each of the agencies, that errors begin to happen. In this case however, the error is removing a valid derogatory item from a report.

You need to do everything possible to separate your valid dispute from the hundred of thousands of invalid ones. That is the only way to you can be sure the mistake is removed, permanently.

Mistakes in your credit file don’t happen often. Minor mistakes such as an occasional late payment will have no material impact on your creditworthiness. If you do however discover an error, just be prepared for a long and frustrating task. As frustrating as it is, it’s definitely worth the effort.

Personal Financial Tip 4

2008-05-19T14:08:00.001-04:00

Credit cards are powerful financial tools. They allow us the freedom to make purchases today and pay for them over time. They eliminate the need to carry large sums of cash around. They provide a great convenience that we’ve all grown dependent on.

We are all aware of how easy it is to accumulate large balances on our cards. We try, with varying degrees of success, to resist the temptation to purchase things we don’t really need. We hope that through this exercise in self-control we can keep our credit card balances from growing any larger than absolutely necessary.

No matter how successful we are in controlling our spending, our credit card balances will still creep up if we’re not careful. This stems from the fact we rarely purchase anything with cash anymore, we use our credit cards. It’s not practical to carry around enough cash for our day-to-day purchases. In today’s society the simple actions of filling up your gas tank and picking up groceries will require you to have over $100.00 in cash. It is more convenient, as well as safer, to charge the purchases and then pay the credit card bill at the end of the month.

There is a problem in addressing your personal expenditures this way. If you left home yesterday with $100.00 in your pocket and bought a tank of gas for $50.00 you now have $50.00 to spend at the grocery store. You are limited to what you can buy with that $50.00. Today you are planning to do the same thing. Leave the house with $100.00 buy gas and groceries. You stop to buy gas and that same tank of gas now costs you $55.00, leaving you with only $45.00 to spend on groceries. You start with $100.00, you have no control over the price of gas and since you can’t print up money at will you are now forced to spend less on groceries.

Living day-to-day on cash forces you to reduce your spending habits immediately in response to inflationary pressure on the cost of your previous purchases. By using credit cards for these purchases you typically will not modify your spending habits but end up having charged more at the end of the day. This results in a slow yet steady increase in the outstanding credit card balances that can easily go unnoticed.

Until recently we’ve been living in an economic period of little or no inflation. Increases to our monthly expenses were primarily due to lifestyle decisions. We bought a new car and now have a car payment to make or we added a movie channel to our cable package and now have a higher cable bill. We spent more because we consumed more.

Today we are faced with a new reality. We are forced to spend more every month because everything costs more. In order to maintain the same level of living, we need to earn more money or be forced to borrow more money. Few of us have the ability to make more money so if we don’t want to go deeper into debt we now must adjust to living with less.

In today’s financial environment we now need to think about any major purchase. We want to prevent ourselves from living off of tomorrow’s income, today. Income committed to paying interest charges cannot be spent to buy anything else. This is only a first step. We need to watch all our minor purchases as well, to make sure we’re not unknowingly taking on additional debt.

Addressing your personal financial needs is a job. If it’s not taken seriously, trouble awaits.

Personal Financial Tip 3

2008-05-09T13:05:00.000-04:00

Creditors have gotten much more conservative in response to the problems in the financial markets. It’s now more important than ever to do everything possible to maintain the highest credit score you can. Creditors are looking for any excuse to restrict a consumer’s access to credit or to increase the consumer’s cost for credit.

Simply paying all your bills on time may not be enough to maintain an excellent credit score. Yes, timely payments have the largest impact on your credit score (roughly 35%). There is more you should do, especially in this credit environment.

The second most important component of your score is credit utilization and it’s here where you have ability to increase your score even more.

This is going to be the focus of today’s Personal Financial Tip. Credit utilization is an analysis of the amount of credit you have available and how much of that credit is actually outstanding. Credit utilization contributes 30% to your score, making it something that shouldn’t be ignored.

Credit falls into 2 general categories. There is installment debt, such as a mortgage, car loan, student loan, etc. The second category is revolving credit. Here you are granted a credit limit and you have the flexibility to borrow up to that limit without asking the lender’s permission or applying for additional credit.

They only thing you can do with installment debt is to pay it on time. There is nothing you can do here to help your credit score, except to comply with the terms of the loan documents. You do have the ability to lower your score, by not paying on time but there is nothing you can do here to increase your score.

The way you use revolving credit is reflected in your score. You can substantially improve your credit score by doing some very simple things. Before we can address what you can to do, we need to understand what aspects of credit utilization the analyst is looking at.

The general components that are used in the analysis are:
The length of time the accounts have been opened
The number of accounts that are active
The overall percentage of the available credit that’s being utilized
The percentage of the available credit on each card that’s being utilized

Not having the ability to go back in time, there is no way you increase the length of time you’ve had an account opened. The one thing you can do is resist the urge to close inactive accounts. By closing an old account that you no longer use actually works against you. You are shortening your credit history.

My first piece of advice is to never close accounts simply because you are no longer using them. If you’re afraid of the “temptation” of keeping too many accounts open, then either destroy the physical card, not the account, or lock the cards away somewhere.

If you only have one or two credit cards, you should consider opening another one or two. This helps out in a couple of ways. It not only increases the number of accounts in your credit profile but also increases the available amount of credit you have.

Let’s say you have one credit card with a credit limit of $5,000 and you are carrying a balance of $2,500. You are using 50% of you available credit. If you open a second card with a $5,000 limit and carry a zero balance on it you are now utilizing only 25% of your available credit. This improvement in the credit utilization will reflect in a higher credit score as time passes. It won’t help immediately, but you will see a steady increase in your credit score as the months go on.

You can now go one step further and move $2,500 off of the original credit card and onto the new card. Now not only have you improved your overall percentage of credit use you’ve also improved the individual percentage on the original card, again contributing to a better score.

Don’t use credit cards? It definitely is a great feeling having no credit card debt and you should be proud of your success in exercising self-control over your spending habits. My suggestion in this case, though, is to use credit cards to make your purchases and pay the outstanding balance in full when the bill comes. You will incur no finance charges by doing this so there is no cost involved. This does, however supply data to your credit profile. This gives the program that generates your score, something to work with. It’s all positive information; balances appearing and being paid off on an ongoing basis, generating a higher credit score than having no activity.

By being proactive with your credit profile you can be confident that credit will be available to you when you want it and at the best possible cost.

Personal Financial Tip 2

2008-04-30T16:09:00.000-04:00

New York State has the highest closing costs in the Nation. One of the main reasons for this is the New York State Mortgage Recording Tax. This is a fee paid by the borrower to the State and local government for the privilege of having a mortgage. It is always priced as a percentage of the mortgage amount but varies, depending on the county where the property is located. For example, a mortgage placed on a home in Nassau county would trigger a tax of 0.8% of the mortgage amount paid by the borrower and 0.25% paid by the lender. The exact same mortgage, placed on a property within the boundaries of New York City (the 5 boroughs) would have an addition 1.0% paid by the borrower to the city.

This is a substantial amount of money. The Mortgage Recording Tax can be reduced, or even eliminated, with the use of a Consolidation, Extension and Modification Agreement (CEMA). By changing the mechanics of the filing process from paying off an existing mortgage and placing a new mortgage on the property, to the purchase of the existing lien on the property, the Mortgage Recording Tax can be avoided.

The clearest way to understand this is through an example. Our borrower owns his own home and is refinancing his existing mortgage. The current balance is $300,000 and he wants a new mortgage of $400,000. When he closes on his new mortgage of $400,000, he could pay off the old mortgage, receive a Satisfaction of Mortgage from the lender and then file the Satisfaction (removing the old lien) and the $400,000 mortgage (recording the new lien) in the county clerk’s office. This announces to the world that the old $300,000 mortgage is no longer valid and there currently is a $400,000 mortgage on the property. He would then pay a Mortgage Recording Tax on a $400,000 mortgage.

A less expensive approach would be to use a CEMA. In this case the old mortgage isn’t satisfied, but consolidated into the new mortgage. An additional $100,000 is extended to the borrower and the terms of the old mortgage are modified to reflect the terms of the new mortgage. The recording tax is now paid on $100,000 (what’s called the "new money") not the entire $400,000 reducing the tax by 75%.

There are additional legal fees, filing fees and bank costs when doing a CEMA but it’s a simple calculation to weigh the additional costs to the savings in Mortgage Recording Tax. If the savings is large enough, then this approach is utilized. CEMA’s do take longer to close. The process involves several steps and many people. This naturally takes time. Lenders are not required to do CEMAs. Not every lender will accommodate a borrower’s request to do it. Without lender cooperation, a CEMA cannot be done.

CEMAs can also be done on purchases. In this case you are modifying the mortgage that the seller placed on the property. This will have additional fees involved; it’s more complicated and will take even more time than when a CEMA is used in a refinance, specifically because it’s more involved.

This brings us to today’s “Personal Financial Tip.” When purchasing a homen have your attorney investigate the possibility of doing a CEMA. Not only is there a possibility of saving money on the closing you may uncover something that can adversely impact your closing.

There is enough stress in purchasing a home under the best of circumstances. The last thing you need is a last minute surprise that may delay or even prevent your ability to close. In today’s housing market you can’t assume that the seller is selling his property for more that he owes on it. It is not uncommon today that when a seller, working with his attorney, finalizes the closing calculations, discovers he is short on funds. Working back from the agreed upon sales price and subtracting off the seller’s closing costs, they may be left with a balance that is less than the outstanding liens on the property. What happens now?

They may be no issue here. The seller simply comes to closing with the money necessary to cover the shortfall. Here, there is no impact to the buyer. What happens if the seller doesn’t have the money?

The seller may be planning on negotiating with one or more of the lien holders on his property. His goal will be to have them take less than what’s they’re owed, executing what’s known as a “short sale”. A lender would only consider doing this if it feels that it will recoup a larger portion of their investment through a short sale than exercising its right to foreclose. This is a time consuming negotiation. If the seller waited too long to start this process, it will delay your closing. Remember there is no financial incentive for the seller to efficiently move to a closing. He’s not leaving the closing with any money. In fact, if he is living in the property that he’s selling and not making his mortgage payments, he has every incentive to delay. He’s currently living rent free under these circumstances. Why would he be in a hurry to move out of the house and into an apartment where he is going to be paying rent?

By having your attorney investigate the feasibility of doing a CEMA on the purchase, you not only have a potential saving in closing costs but also find out much sooner if there should be any concern about a short sale.

Without a time constraint to be concerned with, you have more options available to choose from and have less stress in your life. This will lead to better decisions.

Personal Financial Tip 1

2008-04-25T12:48:00.000-04:00

If you are one of the thousands of people that have a Home Equity Line of Credit (HELOC) on your home you need to be aware of what your lender is doing. In the documents that were signed when you placed the HELOC on your home, there is a clause that allows the lender to freeze the line in the event they feel that properties in your neighborhood have declined.

During the housing bubble lenders were aggressively promoting HELOCs to consumers, encouraging people to have one in place just in case of an emergency or to be prepared for an upcoming expense. Many of these lines were written at a very high loan to value, meaning that most of the equity in the home is used leaving little or no room for a decline in property values.

Lenders now are routinely examining their portfolios of HELOCs comparing the appraisal value that was used at the time of closing with current market values. If the current make value has decreased and there is insufficient equity in the property today the line will be frozen.

Due to the high default rate today on HELOCs lenders are also reacting harshly to any late payments by a consumer. If you make a payment after the grace period and incur a late charge there is a very high probability that your line will be frozen immediately.

I have also heard of instances where a lender has actually called the line. Meaning that the entire outstanding balance needs to be paid back immediately. This situation is not common and would require something more than a late payment to trigger this response, but the fact is, it can happen.

You can prevent your HELOC from being called by living up to the responsibilities you agreed to at closing. In general, that would be making timely payments, keeping the proper insurance on the property and if the line is on your current residence, don’t move out and rent the property. If you are living up to your responsibilities, the lender does not have the right to call the line.

Freezing the line is another story. Declining market values are out of your control and determining market value is open to wide interpretations. If you think you are going to need to draw off your existing credit line in the near future or feel that having this safety net is more important now more than ever there is something you need to do.

You need to take a draw off your HELOC, that is, increase the outstanding balance on the line immediately. How much of a draw you take will be determined by weighing the size of the cash reserve you want to the carry cost of paying the monthly interest expense you will be incurring. Fortunately most HELOCs are adjustable rate loans that are controlled by the Prime Rate. The poor shape of the economy responsible for this problem is also lowering the Prime Rate. This means the interest charges will be moderate.

This action of drawing down the HELOC is similar to taking out insurance. We pay for insurance, to cover ourselves financially in the event of a problem and hope to never use it. Here we’re paying interest on funds we don’t need just to have the money available in the event we need it, again hoping we never do.

Remember once your HELOC is frozen, it’s not likely that you will be able to arrange for financing though an alternate source at a later date. The same economic conditions that lead the bank to freeze the line will discourage another lender from advancing funds. We are also dealing with the most conservative lending environment that we’ve ever seen. This will contribute to the problem.

My advice is to play it safe. Draw the most you can off your HELOC. When the economy strengthens again and confidence in the financial markets improve, you can always return the money and stop the interest charges.

Predatory Lending 101… Consumer Choice

2008-04-18T13:31:00.000-04:00

Kurt Davis wrote this article for the Virginia Law Weekly. It is an excellent article that sums up the foundation of the credit problems we face in America today, pointing out the inadequacies of what’s being done in addressing the issues. It’s something we all need to think about.

One of the best definitions I have come across lately relating to predatory lending has been: “Predatory lending is defined as intentionally placing consumers in loan products with significantly worse terms and/or higher costs than loans offered to similarly qualified consumers in the region for the primary purpose of enriching the originator and with little or no regard for the costs to the consumer.” In the discussion around subprime mortgages, however, the phrase has been used loosely without regard for the entire situation. Predatory lending is always a possibility in financial markets, specifically where there is a large pool of low-income borrowers.

The crumbling of the subprime mortgage market and the subsequent slowing of the American economy has led to a natural knee-jerk reaction from politicians in Washington. Subsequently, Congress has sought to push through stronger regulations which protect current and potential homeowners from falling prey to high-cost loans that lead to foreclosures and bankruptcy, among other problems.

We must ask ourselves, however, what are the costs of these new regulations? Forgotten are the benefits that have fallen to millions of American homeowners who would not be homeowners in the absence of the subprime mortgage market. The United States saw unparalleled growth in home ownership in the midst of this market boom, particularly among low-income and minority borrowers. Regulating the riskiness of banks is not always the answer, as it was a risk for banks to even try providing loans for risky borrowers. Though clearly these banks were attempting to maximize profits, their risk benefited Americans who would be outside the housing market in any other situation. If any regulation is to come to this market, it should be done with both a sensibility for the benefits of the market and also a recognition of the choices Americans are making in their borrowing and saving practices.

The latter of those sensibilities has almost been forgotten. Democrats and Republicans have pushed through an economic stimulus plan that focuses on getting money to Americans so they can spend even more. The incessant consumer spending is part of the reason we are in the current situation. According to the Treasury Department, the personal savings rate of Americans is in negative territory and has been for a good while. The average household owes somewhere between 15 and 20 percent more than what it makes in a year.

The availability of credit, in all its well-deserved glory, has lead to a lack of prudent decision making on the American consumer’s behalf. The obvious example of this is when Americans are buying homes that cost four or five times their yearly income. Such a ratio only leads to constant insecurity concerning payments on the home and other bills.

Other examples include the high credit card debt of many Americans. The ease with which Americans can get credit leads to the spending of the future dollar. In other words, Americans spend money they don’t have in expectation of it coming in the future—payday loans are a prime example. The refinancing of mortgage loans to cover the costs of numerous other expenses was, somewhat predictably, driven by the continued increase in the value of the home each year. The boom in the market clearly invigorated consumers with a recklessness for taking risk on what they could afford at the moment, and in the future.

The insecurity of the American economy accentuates the problems that can arise with this universal credit. First, the American economy, for all its strengths, is too dependent on consumer spending. No one considers saving. Many Americans expect Social Security to bail them out when retirement comes, forgetting that the debt is not accounted for in those payments. Second, the world economy is too dependent on American consumerism. The minute Americans slow their spending, the world economy feels the repercussion through slower returns on resources, slower returns on treasury debt, inflation, and so on. Accordingly, a minor shock (or major one in the current situation) is an immediate hit in the pocket of most Americans and can send many plummeting towards bankruptcy, or just short of it.

In other words, the pre-existing debt only becomes larger. Yet, in the wake of these problems, Congress is asking Americans to spend more through the upcoming tax rebate. This is exactly the opposite of what they should be doing. It would be better for Americans to use the rebate to pay down their debt or just save the money. Instead, Americans are fundamentally being asked to go against their best interest for the sake of the larger American group or economy.

One possible regulation could be to limit the amount a person can borrow. Do this in concurrence with better financial education for American consumers and Congress could substantially reduce the problems associated with the current economy. Nevertheless, the former should not be introduced in Congress. While bad times may increase urgency and force quick reaction, paternalism should not be the medicinal remedy for any situation. In its best-case scenario, it would stop some Americans from unwittingly entering into situations that will hurt them in the end. At the same time, it will severely limit those Americans who wittingly play the American market to their advantage through smart investments. The small business owner who took a reasonable risk on a new business, with a loan against his house, would almost be eliminated from the business world.

Lastly, it should not be encouraged that Americans just save money and pay off all their debt. Again, debt is a great instrument through which many Americans can create better financial prospects and even create wealth. The American economy would fail with extremely high savings and no debt. It should come as no surprise that many other countries have been trying to push their citizens to spend more to strengthen the financial outlook of their economies. Without spending and some debt, investments and returns as we know them would not exist. That would be a huge loss for Americans. With all that said, many American consumers, who complain about being left of the previous good times in the market, could easily better their positions with a little less debt and a little more savings, and see the American economy prosper with them as a part of it.

Choosing the Right Mortgage Broker

2008-04-18T12:55:00.000-04:00

Start with asking friends, business associates or family. See if they have recently dealt with a broker. A satisfied customer is always the best place to start. Be leery in taking the recommendation of your Real Estate Broker. Unless you’ve specifically engaged his services as a buyer’s broker, he is working for the seller. The Mortgage Broker that he recommends may be more interested in getting the deal closed than in supplying you with the best advice.

Another avenue to use is Trade Association web sites. Visit the UpFront Mortgage Brokers Association and see if there is a broker listed for your State. Members here pride themselves on offering the highest level of professionalism to their clients. Another source is the National Association of Mortgage Brokers or the New York Association of Mortgage Brokers. Here you will find brokers that are dedicated enough to their profession to invest their time and money for the common good of the industry.

Finally, the Better Business Bureau should be visited. Here you can quickly check if the broker you are considering hiring is willing to hold himself accountable to an independent consumer oriented organization.

Your first contact with the broker is the most important one. Whether it’s by phone or a face-to-face meeting, it’s here where you decide if you want to conduct business with this individual. You may be talking with the most competent individual in the field but if there are frictions between your individual personalities, you need to move on. A clear communication flow between the two of you is of utmost importance.

During this meeting you want to see how the broker handles himself. Is he giving this conversation his undivided attention? There are times when you’re talking to someone on the phone and you know that person is multi-tasking. Your business should be important enough to the broker that he’s not trying to do two things at once.

How quickly does he answer a question? In order to properly answer a question, a professional will need certain details. So before answering questions, the broker will need to get a detailed picture of what’s going on. I often need to remind clients that they’ve lived their lives and take many things for granted. I need to get as familiar with their finances as they are, in a 10-minute conversation. It’s a simple reminder that I’m not being nosey, I just need certain details in order to do my job properly.

This first conversation will take time. So if you’re in a hurry don’t start the conversation. Do it at a time when you can commit your undivided attention to the meeting. You are as guilty as the broker if you’re multi-tasking during the conversation. Why should he invest his time with you if you’re not paying attention?

Do you feel rushed into doing an application? Is the broker concentrating on your concerns and helping you get your thoughts organized or is he focusing in on getting an application signed? He needs to be willing to invest his time in answering your questions in order to earn the right to conduct business with you.

How detailed are the answers? In answering a question he should be providing enough of an explanation so that you are able to understand the reasoning behind the answer. This is an educational experience for you. Simple yes or no answers just don’t cut it.

Is he talking in “industry speak”? Any professional needs to be conscious of this. We deal with other people in our industry all day long. Every industry has its own language. It’s extremely easy for anyone to allow industry specific terminology to slip into a conversation with someone outside his or her profession. There are individuals who use “industry speak” as a form of intimidation. Essentially, by speaking in a foreign language, they are trying to make you feel stupid. This is uncalled for and not the sign of a true professional. There is no reason to continue working with this individual.

Is he clearly explaining his fee to you? There should be no reason why you don’t know exactly how the broker is being compensated and what the total amount of that compensation is, before utilizing his services. If you’re not sure, ask. If you’re still not sure, go elsewhere.

How accessible is he? Does he return phone calls promptly? Does he respond to your e-mails within the same day? Does he have responsive support staff to assist you? There will be several times that you are in contact with the broker before you actually do an application. As you navigate through these discussions, you deserve a level of responsiveness. If you don’t feel you’re getting the attention you deserve, consider moving on.

The mortgage broker profession is a service business. You are the client. Without you, the broker has no reason to be in business. The professional mortgage broker’s goal is to arrange for the best financing to fit your needs and to do it at a competitive price. Notice, I didn’t say best price. No one in this business can promise the best price. There are too many variables and the cost of mortgage money changes throughout the day. A broker promising the best price is a signal to find another broker.

Making promises that can’t be met is not being professional.

Go it Alone or Hire a Professional

2008-04-14T16:48:00.000-04:00

The Internet is the most empowering tool we have ever had in history. Knowledge is power and the Internet is the ultimate source of knowledge. Within a few minutes, a person can find updated information on just about any topic. With this vast amount of information available at your fingertips why would anyone need to hire a professional?

It’s natural to conclude that with the help of the Internet, a person can arrange for mortgage financing without the cost of utilizing a mortgage broker. It must be cheaper to do something yourself that to hire someone to do it for you. What can an expert do for me that I can’t do myself with the power of the Internet at my disposal?

All the advertisements and promotions that we are exposed to all day long, encourage this way of thinking. Buy your car insurance on line it’s cheaper; It’s tax time, go on line and do it yourself, are but two examples. There is an endless list of services that have an on-line alternative to dealing with a professional. In many instances there is a cost saving, other times there’s not. When conducting business this way, you run the risk of not buying the right product or service. This is where the professional comes in; an individual who can help you interpret and understand the wealth of information you have assembled and offer advice to assist in the process.

Before the crisis in the mortgage market, the public was overwhelmed with the various mortgage products. The assortment ranged from the simplest, the fully amortized fixed rate mortgage, to the most complicated, the payment option ARM. Adding to the confusion, you then had various pricing structures that were dependant on the credit grade of the applicant and balancing the short term expense of points with the long term impact of interest rate. It was an unrealistic expectation for an applicant to become an expert using research alone.

In the current lending environment, things have gotten more complex. Lenders are taking losses on mortgage they wrote during the housing boom and new applicants are paying the price in two ways. Underwriting standards have gotten much more stringent and there is a desire to increase profits on every new mortgage closed. Adding to this complexity we are also dealing with a non-stop flow of revisions to underwriting standards.

Previously, when lending standards were liberal, or in some cases non-existent, getting approved for a mortgage was easy. It was only a question of deciding on the right product and for the best price. Today just getting approved is a challenge. Confirming that the pricing on the mortgage is proper for the credit profile that’s been presented is almost impossible for someone outside the business to do.

A person that decides to arrange for financing without involving a competent professional will first need to invest enough hours to become familiar with the current lending environment. He will need to become educated enough to separate fact from fiction. The Internet contains a tremendous amount of information to draw from, but there are no flags, rating the accuracy of what’s found. Only after the facts are identified and all aspects fully understood, can the application be submitted. He will then need to be able to address all concerns that the underwriter has, before a commitment is issued. He will be depending on his research to decide on the best mortgage product, the time to lock in a rate and the number of days the rate should be locked in for.

How many hours will all this take? What is the real cost of hiring a professional? Investing a few minutes doing this cost analysis will prove that hiring a professional is cheaper than investing the time to do it yourself. This isn’t even considering the experience and inside industry contacts the professional brings to the transaction.

In addressing your mortgage financing needs the best way to invest your time is in seeking out an experienced and ethical mortgage broker to work with. You will find that there is little or no additional cost in taking this route. The process will be smoother, less stressful and you will end up with financing that best fits your needs.

In the current lending environment it is the only way to be assured financing is available.

Sensible Consumer Protections

2008-04-04T16:19:00.000-04:00

The abuses in the Sub-prime market fall into two categories. The first category is the situation when borrowers are paying too much for their financing needs because they were placed in a mortgage that was over-priced, yielding higher profits to the broker and/or lender. This is called “Upselling”, the practice of increasing the interest rate charged on the mortgage that entitles the originating entity a fee that is reflective of the higher interest rate. This additional fee is paid as part of the Yield Spread Premium (YSP).

The solution to this would be to require the broker to identify his total compensation, from all sources, at first contact with the applicant through the Fee Agreement. This way the applicant knows exactly what the broker is earning. If the YSP turns out to be greater than the agreed upon fee, then the broker would be required to credit that excess to the borrower’s remaining closing costs. If the YSP is less than the agreed upon fee, then the borrower would have to pay the shortfall as part of his direct out-of-pocket closing costs.

There would be no economic incentive for a broker to increase the interest rate on a mortgage in order to increase his profit on that mortgage. The broker would still be able to offer the applicant a 0 point mortgage as well as giving the applicant the option to reduce his out-of-pocket closing costs by accepting a higher interest rate on the mortgage. New York State has the highest closing costs in the country. The biggest hurdle for the first time homebuyer today is saving enough cash to purchase a home. The proper use of YSP can help out this buyer.

This revision would eliminate all incentives to a mortgage broker to Upsell his applicants. Lenders taking applications directly from the public have much to lose if they continue to permit their staff the freedom to Upsell. Routine audits will expose different pricing to different applicants with the same credit profiles. It wasn’t that long ago when Ameriquest paid dearly for allowing their originators the freedom to price mortgages (and their commissions) on a case-by-case basis. With lenders being held accountable and mortgage brokers being required to commit to a fee structure at application, we not only protect consumers in the Sub-prime market but all applicants.

Before we can address the second category of abuse we need to identify the basic characteristics of the typical Sub-prime borrower. An applicant that needs to use a Sub-prime mortgage to fulfill his borrowing needs will be dealing with one or more of the following issues:

1. A high loan-to-value (LTV) or a high combined-loan-to-value. Whether it’s a first mortgage, second mortgage or a combination of both (a piggyback) the vast majority of the equity of the subject property is taken out in a mortgage or mortgages.
2. Temporary financial setback. A loss of job, a divorce, medical problems or any other unexpected financial setback can temporally cause delays in bill payments, adversely affecting the credit profile.
3. Applicant is living “paycheck to paycheck” and is forced to accumulate additional debt. They then look to their home to restructure their debt, lowering their monthly payments with the goal of getting their monthly expenses in line with their monthly income.
4. Bad payment habits. A total disregard to paying bills on time, resulting in a poor credit profile yet the applicant still needs mortgage financing.

The applicants we are looking to protect are the same people that are placed into a Sub-prime mortgage, not by their choice or financial circumstance, but with the banker/broker’s encouragement. We don’t want to prevent people from making their own decision, even if we disagree with that decision. We are all given the right to make our own choices. Given 10 minutes, any one of us can put together a list of examples illustrating properly thought out decisions that didn’t work out as planned as well as a list of poor decisions that turned out just fine. Our intention is to create a system whereby we can protect applicants from being taken advantage of, yet maintain each person’s right to choose.

First time homebuyers with limited cash assets or homeowners looking to take most of the equity out of their home, are the most susceptible to abuse. Their financial position puts them in what is considered the middle class. I propose the following criteria as trigger points:

A first time homebuyer that is financing greater than 80% of the purchase price, or appraised value, whichever is lower, through any combinations of liens on the subject property, and
The property is being used (if it is a refinance) or will be used (if it is a purchase) as a primary residence, and
A homeowner who is looking to take cash out of the current appraised value of their residence leaving a total value of liens on the residence greater than 80%, and
Any one borrower whose income is equal to or less than the “HUD area median income” for the area where the subject property is located. The median annual income for downstate New York is currently $71,300.

If an application package meets these combined conditions, then the following requirements will need to be met:

1. Once the loan is underwritten, a preliminary commitment is issued, subject to credit counseling. The counselor needs to receive the commitment as well the completed application that was used to underwrite.
2. The counseling is to give the borrower(s) a full understanding as to what to expect after closing.

This empowers the borrower, who may not have access to professional financial opinions, givng him the knowledge to make an informed decision going forward with closing.

Higher-income individuals looking to go high leverage will more likely do it by choice rather than by need. They are deciding to use the money to invest elsewhere. They are also more likely to do their own research or ask the advice of co-workers and family to supplement the information received from the industry. A repeat buyer has first hand experience at being a homeowner, so is well aware of what being a homeowner entails.

We should be looking to empower the applicant with the tools necessary to make an informed decision regarding his personal financing needs. If we try to protect the applicant from himself, playing the role of big brother or mother, we are actually doing the applicant a disservice. It is impossible to write rules that can address all the various situations that an applicant can be faced with. Inexperienced applicants deserve the power that knowledge affords them. It’s the best long-term solution in preventing a recurrence of this mortgage crisis.

Comments on the proposed “Home Valuation Code of Conduct”

2008-03-26T11:30:00.000-04:00

Shelter Rock Mortgage Corporation has been a New York State Registered Mortgage Broker for over 20 years. During this time we have seen the mortgage marketplace go through extreme cycles. Time has shown that governmental over-reaction to market conditions can make a bad situation, worse. A detailed analysis of the issue, followed with input from all industry participants, yields a superior response. We would like to recommend that the agreement, creating The Home Valuation Code of Conduct, be reconsidered based on its overall impact to the consumer.

We understand the desire to address the current mortgage crisis and to take whatever action necessary to prevent this situation from ever happening again. We have worked closely over the years with State government, as well as the New York State Banking Department, in drafting laws and regulations regarding the mortgage industry.

There is no question that we are currently in a mortgage crisis. Numerous mortgages were written based on overly optimistic projections of our economy, in addition to those that were written due to criminal actions. The Federal Bureau of Investigation divides these criminal actions into 2 classes, Fraud for Property and Fraud for Profit. Fraud for Property involves the direct actions of the borrower to obtain a mortgage for either a purchase or a refinance, by knowinly misrepresenting his income, debt or property value usually involving only that one loan. According to the FBI, this represents 20% of the total of fraudulent mortgages. Fraud for Profit is what the FBI identifies as the actions of industry professionals in criminal actions to close mortgages, which involve many many properties and mortgages.

An accurate appraisal report is the foundation of a well underwritten mortgage. Without a proper evaluation of the collateral an underwriter is ill equipped to do his job. The Home Valuation Code of Conduct attempts in improve the overall accuracy of appraisals. We feel that the agreement reached between Andrew Cuomo, the GSEs and OFHEO does not address the real issues and will result in increased costs to the borrower both in money as well as in time, without adding any tangible benefit to the consumer.

The current policy regarding the ordering of appraisals is that the originating entity orders the appraisal from a state licensed appraisal. Some entities have their own list of approved appraisal companies; others have a list of appraisers that they will not do business with, and others may actually have appraisers on staff. The Home Valuation Code of Conduct was written under the assumption that the entity ordering the appraisal has the ability to influence appraisers to generate appraised values reflecting what the entity needs and not fair market value.

Only a fool would say this situation can never happen but it’s not reasonable to claim the problem is wide-spread without assembling the necessary data. Appraisal services are not high profit businesses. The typical fee for the work necessary to produce a finished report on a 1-family residence is $350.00. How many professionals are willing to jeopardize their livelihood for an additional $350.00? We can’t forget that appraisals are reviewed for accuracy by a lender before accepting the value shown. In addition to the underwriter’s review, prior to commitment, it is also common practice for the investor who finally purchases the closed loan, to utilize one of the various databases available that are designed to confirm the reasonableness of the appraised value.

The appraiser’s name and license number is tied to the mortgage from the beginning of the process right through to when the mortgage is paid off. It at any time a question regarding the accuracy of the appraisal is raised, the appraiser will be questioned. If a lender’s underwriter is not doing a review of the appraisal when approving a mortgage and the investor isn’t doing the proper due diligence when purchasing a portfolio of mortgages, shouldn’t we be addressing these weaknesses in the mortgage process?

There is no data presented showing that the GSEs have purchased large numbers of mortgages with inaccurate appraisals. The only apparent reason this agreement was made with the GSEs is strictly based on the fact they purchase the majority of the mortgages written in this country, so this agreement then covers the majority of appraisal reports.

A contributing factor for a mortgage going into default is an inflated appraisal. The vast majority of mortgages that are currently in default, are subprime mortgages. The GSEs do not purchase subprime mortgages. From this we can conclude that although this agreement covers the majority of mortgages, it does not address the subset of mortgages that are most likely to go into default. If this agreement were in place during the housing bubble, it would have had no effect in reducing the number of mortgages going into default. Therefore, there is no reason to conclude it will help the industry going forward.

The money that will be spent in implementing The Home Valuation Code of Conduct would be better spent in enforcement actions against those committing Fraud for Profit. Taking the criminals out of the industry will have a more far-reaching impact and help rebuild confidence in the mortgage market.

The appraisal business is like any other business. In order to be profitable, an appraisal company needs to provide a higher level of service to its clients, than its competitors, in order to maintain its share of the market. Appraisers do this by giving their clients what they want. This doesn’t mean bringing in the value based on what the client wants. It does mean doing their job in a professional manner. Arranging for appointments that meet the homeowner’s busy schedule. Treating the homeowner with the respect they deserve. Developing a more extensive knowledge in certain geographical areas, making themselves a more valuable commodity. This puts them in greater demand to clients who need work done in those regions.

In order to comply with The Home Valuation Code of Conduct, a lender will develop a list of appraisal companies and randomly select off that list each time an appraisal in needed. This will give the larger appraisal companies an advantage over the smaller shops, forcing many of the smaller shops out of business. Why would this happen? Larger shops will naturally have a larger staff of appraisers. If they are also randomly assigning appraisers, just like the lender’s policy is when selecting the appraisal company, the lender separates himself further away from the appraiser. This would be a good business practice on the part of the lender; allowing for a greater diversification of appraisers from a shorter list of appraisal companies.

A mortgage broker that currently orders appraisals will deal with the companies that have a reasonable turnaround time in completing a report, schedule appointments at the homeowner’s convenience, arrives on time for the appointment and will answer any questions that an underwriter has regarding his work in a timely and complete manner. If an appraiser doesn’t fulfill any of these expectations, he will no longer get appraisal orders. Once the appraisal is complete the broker can use that appraisal in submitting application packages to as many lenders as needed, without additional cost to the applicant. A broker’s obligation to his applicant is to help the applicant arrange for the best financing that fits his needs. This can mean submitting a package to more than one lender.

If The Home Valuation Code of Conduct is implemented, the broker and the applicant will not be able to predict how long it will take for the appraisal to be completed. If the file needs to be submitted to more than one lender, the applicant will need to pay for multiple appraisals as well as wait for each new appraisal to be completed.

Currently, a broker has the appraisal report prior to submitting the application package to the lender. The actual appraised value permits the broker to accurately calculate the loan-to-value (LTV), adjust pricing to reflect that LTV, calculate the mortgage insurance properly as needed and update the applicant regarding any changes to his profile based on the appraisal report. None of this can be done if the appraisal is performed later in the process. Any preliminary work that was done before the package was submitted will now need to be redone with the updated data. We are not helping the applicant by slowing down the process, only making the entire process more expensive and tedious.

Longer processing time will require applicants to lock-in for a longer period. This costs the applicant money. Should an applicant need to go to a second lender, a second appraisal will need to be done. This costs the applicant money. This agreement will increase each lender’s cost in conducting business and this will be passed onto to applicant. This costs the applicant money.

The consumer is not getting any real benefit in return for what it’s costing him.

The Tightening Mortgage Market

2008-03-21T14:11:00.000-04:00

It seems that every day we see reports that the credit market is tightening. I though it was time that we review where we are and how it affects the consumer.

Before we go into details I want to make a comment on current interest rates. The rate of interest one needs to pay to borrow money is directly related to the perceived risk the lender is taking when it decides to give you the loan. This applies to consumer borrowing as well as business borrowing. It also applies to the rate of return an investor wants when he purchases that closed loan from the lender.

The Federal Reserve has been lowering the rate it charges to banks to borrow money from them. With banks having a lower cost of funds this encourages lenders to offer loans to consumers and businesses at a lower rate of interest. It would seem that this would result in lower mortgage rates. Unfortunately, this isn’t happening. The perceived risk is, writing a mortgage by a lender, is greater than it has ever been. This translates into higher, not lower, mortgage rates. Until the financial market settles down, we are going to see interest rates higher than they should really be. Depending on the day, the benchmark 30-year conforming fixed mortgage interest rate with 0 points in ranging from 5.50% to 6.50%. Although still a low range by historic standards, the range would be lower if it wasn’t for the risk premium that the marketplace is factoring in on mortgages.

So don’t conclude that all the decreases in interest rates that we’re reading about in the paper have brought mortgage rates down. They haven't yet, although it may bring them down in the future or we may never see rates this low again. There is no way to accurately predict the direction.

There have been two areas of lending that have benefited from the Fed’s actions. The Prime rate moves in tandem with the Fed rate. Any existing credit line mortgages, which are typically indexed to the Prime rate, now have lower interest rates, yielding lower monthly payments. Credit card interest rates are also tied to the Prime rate so the interest due on everyone’s credit card balances has also dropped.

Now lets look at the current availability of mortgage products.

This financial crisis started in the subprime mortgage market. This is an area of lending that addresses the needs of applicants with issues that prevent them from borrowing money through the more traditional channels. The availability of subprime mortgages has almost completely disappeared. A consumer that has a less than perfect credit history will not be able to use a subprime mortgage as a tool to consolidate debt and improve their credit profile. A consumer in this situation is now limited to one course of action. That is to make timely minimum payments on all the outstanding debts and wait for this new payment pattern to improve his credit profile over time.

Homebuyers were, until recently, able to purchase their home with no money down. This is no longer available. There is still some 95% financing available, depending on the specific neighborhood, but for the most part a 10% down payment will be needed. If a neighborhood is showing signs of declining market values, 95% financing will not be offered. We are even seeing some programs holding to an 85% loan to value.

The only high loan-to-value program that is still available is the FHA program. 97% financing is still available here. The FHA loan limit was always low. It was a program designed to help first time homebuyers purchase their homes. This has limited the usefulness of this program in this region of the country. The good news is that the FHA limits have been temporarily raised. The bad news is that we don’t know as of yet what changes to the underwriting guidelines or what pricing changes will be imposed along with these new limits.

Any mortgage that exceeds the conforming loan limit ($417,000 for a one-family property) becomes a jumbo mortgage that carries a higher interest rate. Historically this rate increase has been in the 0.25% to 0.375% range. Currently this spread has increased to 2.0%. To ease the credit crunch, the conforming limit was temporarily raised at the same time the FHA limit was increased. But the same problem exists here as with FHA. The underwriting standards and any pricing issues are still being drafted and we are awaiting the details.

A common way to avoid paying mortgage insurance has been to us a piggyback or a combo mortgage. Instead of taking out one large mortgage, the borrower takes out a first mortgage at 80% and a second mortgage for the remainder. This eliminates the mortgage insurance premium that one large mortgage would require. This product is disappearing quickly and I suspect that we will no longer have it available from any source shortly. A borrower will now need to pay for mortgage insurance on all mortgages over an 80% loan to value.

Home Equity Lines of Credit (HELOC) or Credit line mortgages are now carrying a much higher interest rate. In the past, a rate of Prime was typical. Now we’re seeing pricing ranging from Prime to Prime plus 3.5% depending on the credit score and loan-to-value. Credit Scores are also influencing the maximum loan-to-value available to the borrower as well as impacting the rate.

Fewer and fewer borrowers are able to obtain "limited" or"no-documentation" mortgages. Nearly all mortgage products today require documentation confirming all aspects of the mortgage application package. This is making it difficult for self-employed borrowers to arrange financing. This type of mortgage was also utilized for borrowers with very complicated income profiles. Individuals in this category will now have to spend time and money to assemble an income package that can be understood by the underwriter.

Credit scores are playing a larger role in the pricing of mortgages. It used to be that a scores of 620 or better received the same pricing. It was only when the score was below 620 that pricing varied, based on how low the score was. Now we’re seeing pricing differences through the entire range of scores. Today a borrower with a 740 score will be priced better than a borrower with a 700 score. The borrower with a 660 score would be paying an even higher interest rate and the borrower with 620, higher still.

Applicants today are faced with a requirement to invest more money into the home they are looking to purchase. They are going to need to prove that they have the financial capability (through income documentation) and the desire to meet their contractual obligations with their creditors (through their credit profiles). There are no shortcuts right now.

There used to be a saying years ago that went, “banks only lend money to people who don’t need it”. After decades of developing new programs and standards to make homeownership more available, we have gone full circle. Banks are again lending money only to those who don’t need it!

Legislation Needs to be Carefully Crafted

2008-03-14T15:48:00.000-04:00

One of the last acts of Governor Elliot Spitzer, prior to his resignation, was to proposed legislation to address the subprime mortgage crisis in New York. The New York Association of Mortgage Brokers asked Don Romano to draft their response to the proposal. This is the text of the response.

The New York Association of Mortgage Brokers comments to Program Bill #44

The New York Association of Mortgage Brokers (NYAMB) is the only trade association in New York State that represents the mortgage broker community. It was founded in 1986 and is the State Affiliate of the National Association of Mortgage Brokers (NAMB).

We understand the desire to address the current mortgage crisis and to take whatever action necessary to prevent this situation from ever happening again. We have worked closely over the years with State government as well as the New York State Banking Department, drafting laws and regulations regarding the mortgage industry.

We appreciate the opportunity to comment on this proposed legislation. We are focusing our comments only on the sections that directly impact our business. This does not mean we are supportive of the other sections, it simply means that we are not in the position to comment on areas of the mortgage business that we are not directly involved in.

In Subdivision 1 of section 6-1 of the banking law, paragraph (f) we are creating a new category of mortgage, the “Non-conventional home loan”. The intent is to separate sub-prime mortgages from prime mortgages through the use of a rate and/or fee trigger, modeling it after the existing high-cost mortgage trigger approach. The trigger model, as used to define high-cost mortgages, works reasonably well. It’s not a perfect solution but works adequately for high cost loans. The cost for a high-cost mortgage consists of 2 components, the market price for mortgage money and the addition cost the lender is imposing to address the weaker attributes of the file (risk based pricing). The interest rate trigger which would make a first lien a high-cost loan is 8 percent over the treasury yield. There is no doubt that the additional cost, based on risk based pricing, represents the larger percentage of this spread.

By using the same approach to define a “Non-conventional home loan” we run into an unforeseen consequence. By taking the yield on Treasury Bills and adding 3 percent to create the trigger, market pricing for mortgage money carries enough weight to bring many prime loans into the “Non-conventional home loan” category.

For example, let’s look at the yield on 30 year T-Bills as published on March 10, 2008. That rate was 4.53%. If we add 3 percent to that we end up with a trigger point of 7.53%. The rate for an FHA mortgage on March 10, 2008 is 7.0%, putting us within 0.53% of being a “Non-conventional home loan”. A FNMA conforming rate is at 6.50% but if a “my community” product is used the rate is increased to 6.75%. On March 10, 2008 none of these loans would trigger, but after seeing what has happened in the bond market since August 2007, would anyone be truly surprised if mortgage rates moved up more? If this law was already passed and mortgage rates continued to trend upward, we could be facing FHA and FNMA conforming loans that would be categorized as a “Non-conventional home loan”.

If this law was already in place, all mortgages between $417,000 and $750,000 closed since August 2007, would be “Non-conventional home loans”, since the jumbo fixed rate mortgage has been over 7.53% every day. Do we see the need to protect high net-worth individuals from themselves? This is an immediate unintended consequence of the bill. Any lender that elects to write non-conventional home loans to high net-worth individuals, would be exposed to "predatory borrowers". Borrowers who have the knowledge and the deep pockets to utilize those same consumer protections meant for the non-conventional borrower, would be able to relieve themselves of their financial obligations to their lender, whenever they felt that they would benefit financially.

This would be reason enough to make the prudent business decision and not be involved in originating non-conventional home loans.

We predict that with the passage of the Bill with this language, lenders will immediately stop writing mortgages between $417,000 and $750,000 until the secondary market sets the yield on jumbo mortgages to some percentage less than 7.53%. If the market for mortgage-backed securities continues to worsen, we could see lenders halting all mortgage originations in New York State. This cannot be what the author of this Bill intended.

We need to develop a “Non-conventional home loan” test that truly captures the mortgage that was the real intent of this Bill.

The NYAMB would like to propose two suggestions that can be used as a starting point to address this issue. Current events in the financial marketplace have shown that the spread between conforming loan size pricing and jumbo loans can vary greatly. No longer can we assume that jumbo pricing will consistently be 0.25% to 0.50% higher than a conforming mortgage. With this in mind, our first suggestion is to use a different rate-based trigger point for conforming and jumbo mortgages.

We feel it would be reasonable to use a 1 percent higher trigger point for jumbo mortgages. This will allow the secondary market pricing to respond to investor demand without capturing the mortgages that should not be captured, into the “Non-conventional” category . A closer investigation into the abuses in the sub-prime market over the last several years will show that the vast majority of these loans fall under the conforming loan limit.

Our second suggestion is to raise the rate trigger from 3 to 4 percent for conforming loan sizes. As we have illustrated in the above example, the 3 percent margin over T-Bills doesn’t allow for the secondary market to demand the higher yield on mortgage backed securities over T-Bills that is currently being used, without capturing prime loans in the “Non-conventional” category. In capturing prime loans, we draw attention away from the issue that “Non-conventional” home loans require special protection and at the same time we run the risk that lenders will become reluctant to conduct business in New York State. Reduced availability of mortgage money into our economy will cause additional damage to our housing market.

T-Bill rates are published in every major newspaper daily, making it readily accessible to the consumer. Unfortunately, as recent events have shown us, the spread between T-Bill interest rates and prime mortgages is erratic. An alternative to increasing the margin for the rate trigger that we considered, was to use the FNMA mandatory 60-day delivery rate, instead of the T-Bill. This way we would be using a base rate that is representative of prime mortgages. Our conclusion was that the superior distribution of the T-Bill was too valuable an asset to the consumer. This is why we have recommended the higher margin, as opposed to a different index rate.

The Bill proposes adding a new paragraph, (l). This paragraph confuses the definition of “Yield Spread Premium” and “Upselling”. The proposed definition of “Yield Spread Premium” reads’ “compensation that a mortgage broker receives from a lender for originating a home loan that is more costly than that for which the consumer qualifies, or that is based on, or varies with, the terms of the home loan.” Wholesale lenders, that are lenders dealing with mortgage brokers, recognize the cost benefits to themselves when originating mortgages in this manner. They routinely price their mortgages lower to a mortgage broker than they do to the public, that’s the reason the term “wholesale” is used in the definition. For example, a lender prices a mortgage directly to the consumer at 6.0% with 0 points and to the broker at 6.0% with a 1 point yield spread premium. The broker offers the product to the consumer at 6.0% with 0 points. The broker is being compensated 1 point for placing the mortgage but the consumer is paying the same regardless of which channel is chosen.

The term that is being defined here is “Upselling”. Going back to our example, the broker offers the mortgage to the consumer at 6.25% with 0 points. Here the broker has increased the interest rate in return for higher profits. This practice is what we want to address, not the concept of “Yield Spread Premium”. We also need to recognize that brokers, in designing the right mortgage for their clients, will at times take this additional point as a credit to the borrower to offset closing costs.

Our suggestion is to change the term “Yield Spread Premium” to “Upselling” in the proposed bill. Instead of banning “Yield Spread Premium” on “High cost” and “Non-conventional home loans” we suggest that any “Yield Spread Premium” generated due to “Upselling”, be credited back to the borrower. This still gives the broker the ability to use “Yield Spread Premium” to offset the borrower’s closing costs yet takes all potential economic gain to the broker out of the equation.

Section 590-b is an attempt to write a set of underwriting standards into State Law. We feel this is bad public policy. Underwriting standards are modified in the industry to reflect market conditions and needs. Once something is written into Law, it becomes inflexible. We suggest that restrictions regarding income documentation be done through regulation, not Law. This will afford the consumer protections that are needed today but allow for changes to meet markets needs in the future without needing to draft new legislation. We are all well aware of the time involved in reaching consensus on pending legislation and how rapidly the mortgage market can change. It is not in the best interests of New York residents to create a set of standards that cannot evolve with market conditions.

In paragraph (b) of the same section we are defining the standard of practice for which mortgage brokers are to be held to. The NYAMB has been promoting ethical standards for our members to follow since our inception. We are happy to see that the author of this Legislation is putting into Law what we’ve been promoting to the brokerage industry for decades.

We hope that you understand the basis of our concerns and we look forward to working with you.

Mortgage Broker Regulation

2008-03-12T15:40:00.000-04:00

The mortgage brokerage community is taking the brunt of the blame for the mortgage crisis. Currently, there is no way to track a closed loan back to the actual originator. This makes it difficult, if not impossible, to identify the individual who originated the mortgage application in the first place. Without the ability to identify each position in the origination, processing and closing process there is no real way to identify the trouble spots. This prevents regulators from focusing in on specific issues that need to be addressed.

In attempting to respond quickly and effectively, the regulators and well as the legislators are revising the laws and regulations that govern the way we conduct business. The revisions are broad in scope. Some of the proposed changes are long over-due and others will result in un-intended consequences that may actually cause more harm than good.

I want to review what has already been enacted as well as what’s being proposed as it relates to the mortgage brokerage business. Mortgage Brokers originate over 50% of the mortgages in the country. Because of their small size (the average business has 7 employees) they are located throughout the various communities. These small community-based businesses are able to offer a wide array of mortgage products to the consumer, as well as keep the consumer informed throughout the mortgage process, in a more personal and efficient manner.

Mortgage Brokers have operated over the years with minimal supervision and nominal educational and experience requirements. If anything good should come out of the mortgage crisis, it is that the supervisory agencies have exposed this weakness in the system. We just need to be careful that, in their haste to address problems in the industry, they don't hinder a broker’s ability to supply the quality of service the consumer deserves.

In 2006 New York State finally acknowledged the weakness in their mortgage relations and passed a law requiring all mortgage originators to submit to a background check, complete mandatory ongoing education and register with the State. The New York Association of Mortgage Brokers had been pressuring the State for nearly 20 years to implement these requirements. Any reputable broker welcomed this long time in coming revision.

Ten years ago, the National Association of Mortgage Brokers, in conjunction with the Mortgage Bankers Association, attempted to implement these requirements on a National level. Although we were successful in gaining a consensus of the majority of the industry participants, we couldn’t move forward with implementation because of the resistance received from Citibank. With Citibank opposed to the idea, full implementation would be impossible.

One of the responses from Washington to the mortgage crisis is a Bill mirroring New York State’s Law, taking the new standards for originators, National. This is a concept that should have been in place years ago. We may finally see accountability on a National scale.

Several years ago laws were passed, on the Federal level as well as on each State’s level, addressing high-cost mortgages. These are mortgages that carry very high rates and/or fees and are given to borrowers that are not qualified for conventional financing because of particular circumstances in their profiles. There could be credit issues, income issues, the condition of the property or a time constraint. Lenders wishing to do high-cost mortgages would be required to issue additional disclosures, including a recommendation that the applicatant go to counseling, before taking on the mortgage. It also gives a greater range of consumer protection once the mortgage closes. The end result was that, only a handful of banks do high-cost mortgages.

We’re not seeing consumers that need to utilize a high-cost mortgage complain that their financing needs aren’t being met. This verifies that there still remain enough lenders willing to originate this type of product to meet the needs of the consumer. This legislation has done what it was designed to do, increase consumer protections without shutting off the availability of mortgages to the public.

Currently, there is legislation pending, both in Washington and Albany, that will create another classification of mortgages. The Washington version calls it “higher cost mortgages” and Albany is using the term “non-conventional home loans”. Both versions are creating a category of mortgages that are perceived to be more expensive than a prime or conventional mortgage but less than that of a “high cost mortgage”.

The theory here is that additional disclosures and consumer protections would be beneficial for consumers to have when they are outside prime lending. Upon closer examination you find that not only will it cover consumers that need additional protection, it also covers a large percentage of prime jumbo mortgages. Should mortgage rates increase from where they are today, all conforming mortgages will also be reclassified as “higher cost” or “non-conventional”. This is an example of legislation that results in creating more problems than it is intended to solve. Before passage, it needs to be revised in such a way that it does what it was intended to accomplish.

The New York State Attorney General, Andrew Cuomo opened an investigation into inflated value appraisals performed by eAppraiseIT, under the direction of Washington Mutual several months ago. The result of this investigation was an agreement that lenders, as well as brokers, would no longer be able to select the appraisal company when ordering an appraisal on a conforming mortgage. The idea is to keep the appraisal as independent from underwriting as possible.

The effective date of this new policy is January 1, 2009 and the details haven’t been worked out yet. The repercussion of this new policy will be longer turnaround times for appraisal reports and many small appraisal companies will be forced out of business. It’s ironic that eAppraiseIT will end up with a larger market share when they were the reason for the investigation in the first place.

The mortgage industry is going through major changes. More and more regulations will be written in an attempt to prevent another lending crisis in the future. Tighter regulation and more thorough oversight is definitely called for. It’s important to be careful not to over-regulate an industry that, for most if its existence, has functioned well. More people own their own homes in this country than in any other country in the world. Without a vibrant mortgage industry that wouldn’t have been possible. Mistakes have been made over the last few years. Lending standards became too liberal and greed motivated too many people. We are now suffering the consequences.

Through all of this we can’t lose sight of the risk in over-compensating for these mistakes. It is very easy to force too many businesses to close and to write underwriting standards that are too restrictive. This will result in allowing this crisis to last longer that it should. Liberal underwriting policies allow people who can’t afford to be homeowners buy houses and end up in foreclosure. Conservative standards discourage qualified individuals from buying a home. The net result in both cases is the same. Houses don’t get sold; inventory increases and prices are driven down.

A Government Bailout

2008-02-29T13:46:00.000-05:00

In attempting to address the current foreclosure crisis, many are looking back in American history to see how this problem had been addressed previously. When reasonable people are faced with a problem, a good first step is to look around. See if someone has faced the same issue, examine what actions were taken, qualify how successful the actions were and then decide if that solution will adequately solve the problem at hand.

A possible solution to today’s foreclosure crisis is a program mirrored to what Franklin D. Roosevelt created in 1933, The Home Owners’ Loan Corporation (HOLC). The mission of the HOLC was to purchase non-performing mortgages from banks and write new mortgages that homeowners could afford. I’m not going to go into the details of the program but during the period the HOLC was conducting business, it acquired nearly 20% of the outstanding mortgages in the country. It couldn’t help every homeowner and ended up foreclosing on approximately 200,000 homes. It was however, successful in rewriting over 80% of the mortgages.

The corporation was closed in 1951 showing a small profit for their efforts and had sold off the entire inventory of foreclosed properties. The HOLC proved to be an example of a successful federal program that not only accomplished its goals but also did it at no cost to the taxpayer.

A growing group of influential people, ranging from Senator Christopher Dodd of Connecticut to Alan S. Blinder, former vice chairman of the Federal Reserve as well as Nicholas Retsinas, former Federal Housing Commissioner, are pushing for the creation of a similar corporation.

I agree that this is a solution that deserves to be discussed and is a viable solution to the problem at hand. We do need to keep in mind that we will not be as fortunate this time around. The fact that the HOLC successfully completed their mission with no cost to the taxpayer should not lead us to think that a similar program today could be effective at the same cost. Today’s borrower's live by a different set of standards then those of the thirties.

The attitude that our parents and grandparents had, of paying your rent (or mortgage) first, is no longer prevalent. The fear of being thrown out of your home and having no place to live is no longer first and foremost in our minds. In addition, today’s homeowner has little or no money of his own invested in the property.

The February 29th, 2008 issue of The New York Times contains an article, “Facing default, some walk out on new homes”. This article confirms what I’m saying.

“I think I could make a case that some borrowers were ‘renting’ (with risk), rather than owning,” Nicolas P. Retsinas, director of the Joint Center for Housing Studies at Harvard University, [and former Federal Housing Commissioner] said in an e-mail message.
For some people, then, foreclosure becomes something akin to eviction — a traumatic event, and a blow to one’s credit record, but not one that involves loss of life savings or of years spent scrimping to buy the home.
“There certainly appears to be more willingness on the part of borrowers to walk away from mortgages,” said John Mechem, spokesman for the Mortgage Bankers Association, who noted that in the past, many would try to save their homes.

Todd Sinai, an associate professor of real estate at the Wharton School of Business at the University of Pennsylvania is quoted in the same article:

“Now it’s like they can do their renting from the bank, and if house values go up, they become the owner. If they go down, you have the choice to give the house back to the bank. You aren’t any worse off than renting, and you got a chance to do extremely well. If it’s heads I win, tails the bank loses, it’s worth the gamble.”

The National Association of Realtors tracks ongoing trends in homeownership. This is what they’ve found:

“Last year the median down payment on home purchases was 9 percent, down from 20 percent in 1989 Twenty-nine percent of buyers put no money down. For first-time home buyers, the median was 2 percent. And many borrowed more than the price of the home in order to cover closing costs.”

The mortgage industry has been meeting the needs of the first time homebuyer by developing programs that enable people to purchase homes with little or no money down. This was done to encourage home ownership. History has proven that a higher percentage of homeowners in a community creates a more stable community. Over time, as mortgages are paid down and property values increase, each family’s wealth increases.

Over 60% of the US economy is based on consumer spending. In order to keep the economic engine of our economy running, the government encourages consumers to spend. Consumers are expected, if not encouraged, to spend above their means. Homeowners have been using their homes as an ATM machine, drawing down the equity in their homes to feed their spending addiction.

The majority of the mortgages today that are in default are not purchase money mortgages; they are cash-out refinances. Recently, homeowners bought their homes with very little or none of their own money. They have little motivation to make their mortgage payments when they see the value of their homes falling. Those who took the equity out of their homes by refinancing, have even less motivation. They converted the paper profits of the housing bubble into cash. Cash they could spend anyway they wanted. It’s hard to find any motivation for these individuals to pay what they owe to the bank.

The homeowner from the thirties that got into financial trouble appreciated whatever the government or any one else did to help them out. They were determined to do whatever they could to live up to their financial obligations and hold on to their home. Today’s homeowner feels that he is entitled to be bailed out and feels no obligation to live up to his responsibility to the lender. In fact, they believe that the lender is the cause of the problem!

Communities can’t survive with a high level of foreclosures. Some form of intervention needs to be implemented and a modern day HOLC is an excellent approach to address the problem. We all need to realize though, that there will be a hefty cost to the taxpayer this time around.

Understanding Yield Spread Premiums

2008-02-25T12:10:00.000-05:00

The New York State's Governor's office requested that the New York Association of Mortgage Brokers (NYAMB) provide an explanation of the use of the Yield Spread Premium and what suggestions they have to curtail the abuse of it. Don Romano drafted their response and it is presented here.

Yield Spread Premium (YSP) is an important tool available to brokers in servicing the applicant. As is the case with any tool, its improper use results in damage. The goal is to implement a mechanism that will eliminate the ability for abuse of YSPs yet maintain the consumer’s options in determining the most advantageous way to pay for his or her mortgage.

The real cost to a consumer for a mortgage is paid through a combination of interest rate and points. We are defining a “point” as any upfront fee that is priced as a percentage of the mortgage amount. A discount, broker or origination fees are all the same. Each one is priced as a percentage of the mortgage amount and higher upfront fees on the same mortgage will yield a lower interest rate on the mortgage.

There are 2 features of YSP that open the door to abuse. One is the difficulty of the consumer to easily understand how YSP works and the other is a weakness in the current disclosure regulations. It is our opinion that the door for abuse can be closed through a revision to the current regulation.

Before we delve into the workings of YSP it is important to recognize that it is cost effective for Lenders to work through a network of Brokers. Due to the cost saving to the Lender, a lender offers a wholesale price structure to the broker. Through this pricing mechanism a Broker can offer pricing that is competitive with the pricing that Lenders offer directly to the public.

The mortgage application process is very labor intense, with the majority of the hours being dedicated to customer service. The volume of mortgage applications taken by a Lender varies greatly from year to year. This makes it difficult for Lenders to hire and keep good people since the number of employees that are required will be different from year to year.

Getting past the customer service component and looking at the actual underwriting process we find the next benefit. A Lender is forced to take an application from a consumer in any condition the consumer decides to present it. The application may not be filled out completely, it may not be signed, the supporting documentation may not be there or what’s there isn’t complete. This results with more man-hours being spent on the file.

When a Lender conducts business with a broker, it is a business-to-business relationship. The Lender can dictate to the broker what condition a package needs to be in before it gets to underwriting, require the broker to confirm the package meets certain guidelines before submission, demand a minimum closure rate on packages that are submitted, etc. The Lender can pick and choose which brokers it wants to work with and can stop dealing with a broker for any reason.

Now we can focus on how YSPs are utilized. As we have already said, the cost of a mortgage is a combination of points and interest rate. A consumer engages a Mortgage Broker’s service to arrange for the placement of a mortgage. For this example we will assume the consumer agrees to compensate the broker 1.0% of the mortgage amount for his services. We are also going to use an over simplified pricing model for the purposes of our example.

The mortgage is committed and the rate is set at 6.0% plus a 1-point broker fee. Straightforward enough, the consumer pays a 6.0% annual interest on his mortgage for as long as it’s outstanding and writes out a check to the Broker for 1.0%. The consumer also has the option to lower his monthly payment by increasing his upfront costs. He could decide to pay 2-points instead of 1 and lower his interest rate to 5.75% or he can decide to pay 3-points instead of 1 and lower his interest rate to 5.50%. These additional points are paid to the lender to make up for the reduction in the monthly mortgage payment.

The concept of paying more upfront in order to pay less over time is easy for the average person to understand. If paying more upfront lowers the payments over time then the opposite is also true. The less you pay upfront the more you pay over time. For a consumer that is either tight on cash or prefers to maintain a higher cash reserve after closing this is an important option to consider.

If 3-points buys an interest rate of 5.50, 2-points buys a rate of 5.75% and 1-point buys an interest rate of 6.0% is it surprising to find that if the consumer elects to pay a 6.25% interest rate, it entitles the consumer to pay 0 points upfront? It’s not a difficult concept for the consumer to understand. As long as the intention of the Broker, or the originator, is to bring clarity to the explanation then the consumer will have no problem in understanding.

Those in the business who are looking to abuse the use of YSP don’t want clarity. The poorer the understanding of YSP by the consumer, the better it is for the abusers. This brings us to feature number 2, the weakness in the current disclosure regulations.

The exact dollar value of a YSP isn’t determined until the mortgage rate is locked. A NYS Registered Mortgage Broker doesn’t have the authority to commit a lender to fund a mortgage application or commit a lender to a particular rate. The current regulation requires a Broker to disclose the exact fee that an applicant agrees to compensate the Broker for his services and a maximum amount the Broker can receive from the lender in the form of a YSP. There is nothing in the regulation that requires any connection between the upfront broker fee and any YSP. This situation creates the opportunity for abuse.

Going back to our example. The consumer starts off expecting a rate of 6.0% and a 1-point broker fee. Our consumer ends up closing at 6.50% with 1-point. He doesn’t really know why the rate changed. It could have been that the consumer didn’t qualify for that particular rate and the lender needed to charge more. Maybe there was a change for the worse in the market price for the mortgage between the rate quote and the rate lock. Or it could have been that the Broker just wanted to abuse the system by representing that he was making only 1-point on the mortgage but in reality was making 3, 1-point from the consumer and 2-points in the form of YSP.

Yes, we can definitely prevent this from happening by banning the use of YSP, but at what cost? When the power chain saw was initially sold to the public there were many injuries. Instead of banning the sale of this product, they modified the mechanism by adding an automatic brake making the tool substantially safer. We’re suggesting a similar modification to the existing regulation.

The residents of New York State are faced with the highest closing costs of any State in the nation. The biggest hurdle for the first time homebuyer is raising the cash needed to buy a home. One of the most important tools a Broker has at his disposal is YSP because it allows him to offer his clients the ability to offset out of pocket expenses with a higher interest rate.

Recently the State of Massachusetts implemented regulations with the intention of eliminating a broker or banker’s ability to steer an applicant into a mortgage that generated a higher profit than the quality of the applicant deserved. The language of the regulation implied a banning of YSPs. Immediately, Lenders began to stop the origination of mortgages in the State. The regulation was put on hold, meetings were held with the industry groups and the language was modified.

We need to be careful when drafting new regulations in order to make sure that we don’t restrict the availability of mortgages to the public. It’s important that we don’t repeat the mistake that Massachusetts made.

Personal Fiscal Responsibility

2008-02-20T13:54:00.000-05:00

The amount of money owed out by the average person is growing daily. This is proven by the government statistic that shows that America has a negative savings rate. This confirms what we all are afraid to admit; we are spending more than we make to support our lifestyles.

We can’t influence other people’s decisions but we owe it to ourselves to evaluate our own financial position. Are we making poor spending decisions? Are we prepared to deal with what the future has in store for us? Do we find ourselves moving from one crisis to another? What steps can be taken to bring order to our fiscal well-being?

These are the things I want to address today with the goal of giving you something to think about that can help you reach your long term needs.

Let’s start by looking at debt. There are 3 types of debt. We have Good, Bad and Emergency Debt.

Good Debt is money you borrow with the intent that you will get a greater return on your investment than the interest rate you are paying. An example of this would be a student loan. You take a student loan to pay for an education that will yield you a higher income in the future. Another example would be a mortgage. You want to buy a home today instead of paying rent because you believe that in the future, when the time comes to sell your home, you will sell it for substantially more than you paid for it.

There are no guarantees that you will finish your education and land a better paying job and there is no guarantee that when the time comes to sell your home you will make a profit. What makes Good Debt good is that you take it on with a reasonable expectation that the decision will be profitable in the future.

Bad Debt is money you borrow to feed your need for instant gratification. We purchase cloths today on a credit card. We don’t expect the cloths to have a higher value in the future but we’re willing to take on the debt, along with the interest charges, because we want the clothes now. We will at times justify doing this because what we’re purchasing is “on sale”. We conveniently forget to add the interest charges on the sales price, because if we did, it would become obvious that there is no bargain here.

Emergency Debt is debt we take on due to unforeseen circumstances. You lose your job and you are out of work for a month before taking a new position. You will be forced to take on addition debt during this time. You may be faced with an unforeseen car repair or home repair. These are examples than can require you to borrow money unexpectedly.

Money borrowed to bridge you through a rough period (Emergency Debt) tends to be paid off in as short a period of time as possible. This is probably due to psychological reasons. You want to get past the problem as quickly as possible and eliminate all references to the problem.

Good Debt generally is kept around for a long period. Student loans or mortgages are usually for large amounts and can’t be paid off quickly. In addition, this type of debt enables you to increase your net worth. These are two good reasons for you to pay off this debt only after all other debt is retired.

Credit card debt in this country has increased from 3.2 percent of the median family income in 1980 to 12.5 percent in 2004. Student loans, mortgages and any other Good Debt is typically not appearing on credit cards. This debt is held in long-term mortgages or loans. Emergency Debt by definition is not increasing regularly either s it is only bridge funding during unforeseen problems with cash flow.

Conclusively then, Bad Debt is the main source of this increase in credit card debt and the primary cause of this nation’s negative savings rate. Take a close look at your own debt position. Are you falling deeper and deeper into debt every month? Do you make only the minimum payment on your credit card bills? Are things getting so tight that you are afraid you may need to borrow from one credit card to pay the minimum payment on another? Are you afraid to even look at your total debt position?

Reaching out for help in personal financial matters is the last taboo. We are more likely to discuss health problems or sexual issues with others than we are to discuss our financial matters. By being afraid to analyse our own finances and at the same time, afraid to discuss solutions among our family, friends or professionals, we are boxing ourselves into a corner with no way out.

We need to begin to take responsibility for our fiscal well-being. We need to begin by reversing the trend of increasing our monthly debt and begin to reduce the amount of debt we are carrying. We need to change our attitude towards purchases. Instead of buying now and paying later we need to do what our parents did. Save up and make the purchase when we have the money. Changes like this are not going to be easy and will take time. Adjusting our spending habits is a part-time job and needs the same level of attention we give to our 9 to 5 jobs if we want to be successful.

The root of all the financial turmoil this economy is dealing with right now is our attitude of spending tomorrow’s money, today. This is the day of reckoning. The well of tomorrow’s money that every person, company and every level of government has been drawing from, is running dry. How is the leadership of this country addressing the problem? By borrowing even more money so every American receives a check. Then encourage everyone to go out and spend it. This is after forcing interest rates to drop in the hope of encouraging businesses to spend more!

We certainly are not finding long-term solutions from the government. The only thing we can do is to clean up our own financial house so as individuals we can better weather this financial storm.

The Facts of Life

2008-01-29T14:44:00.000-05:00

You can’t always get what you want. Whether you are looking to buy a home or refinancing your existing mortgage, you need to realize that compromises need to be made.

It’s easy to become over-selective when shopping for a home in a market that has a record high inventory of properties. It’s natural to think that you will be able to find a home that has every possible attribute you want. Unfortunately, that never happens and compromises need to be made or you will never be a homeowner. House hunting is a part time job and it comes with all the same stresses as working your regular job. The only difference is that “burnout” comes much quicker.

When deciding to refinance your current mortgage during what is now being called a “recession” by many, it’s easy to get greedy. When rates are drifting down, you continue to wait for even better rates to appear and you end up missing out on a good rate because you’re waiting for a great rate. The great rate doesn’t come and you miss the window of opportunity to refinance and save some money.

Being realistic with your housing needs or rate target is the prudent thing to do.

There are no free rides. In your house hunting, don’t feel rushed into making a purchase. You may be led to believe that you’re going to lose the deal if you don’t move quickly. Give yourself adequate time to completely analyse the purchase. Don’t take shortcuts such as forgoing an engineer’s inspection or making commitments without proper legal advise.

Don’t feel pressured when shopping for financing. If a rate quote seems too low or the monthly payments work out to be lower than you expected, look deeper into the details. Maybe the closing costs are inconsistent with other quotes; take the time to find out why. The majority of borrowers who find themselves in financial trouble got there because they jumped into a mortgage without thinking it through.

The most common error is looking at the initial monthly payment and nothing else. This is how people unknowingly get into an adjustable rate mortgage or end up with closing costs that are much higher than were expected. They heard only what they wanted to hear.

You can’t afford to win if you can’t afford to lose. There are no sure bets in life. Every decision we make can be good, bad or anything in between. People have entered into a contract to purchase a house or condo with the expectation that they could sell the property without having to close on it. They saw the potential profit in the transaction. Many ignored the potential loss if things didn’t work out as planned.

Any investment decision that you make needs to be based on realistic projections as well as your acknowledgement that things don’t always go as planned. The questions “how much money can I afford to lose” or “how long can I afford to wait” need to be addressed before entering into the investment. If you can’t afford to lose on the investment, you shouldn’t make the investment.

The only thing worse than a bad decision is no decision. If you never buy that house you wanted or never made that investment you liked, you can’t be wrong. Of course, you’ll never be in your dream house or make a profitable investment. By not making a decision you are stagnant, you will never improve yourself. By making a bad decision, you will take your losses but at the same time learn from the experience. This will make you better prepared in making the next decision.

Mistakes will be made. Accept that fact and move on. Make the best choices you can, based on the information you have at the time. The goal is simple; be right more times than you’re wrong. This yields you a comfortable life.

Learn from the mistakes that others make. We’ve all heard the expression “an education is expensive.” Whether we are paying for a formal education or paying the price of a bad decision there is an expense to be paid. However, if we watch what others are doing and try to understand what they did wrong, we can learn a lot without paying the price.

It’s easy to fall into the trap of following others blindly. Your neighbor makes money on a stock so you buy the same stock. Your neighbor loses money on an investment and you compliment yourself that you didn’t make the same mistake. You need to take the time to understand the reasoning behind each of these transactions. Was the stock purchase just a lucky guess? Why did the second investment go bad? Knowledge is power; it’s all around you. You just need to take the time and look out for it.

Don’t get caught in mob psychology. When real estate values were rising everyday, the push was to buy as soon as possible to avoid paying more for the same house at a later date. Now the general consensus is home prices are falling and waiting to buy is the best course of action. It’s great to be able to buy at the bottom of the market. Unfortunately, the only way to find the bottom is after it has passed. Remember, a house is primarily a place to live. The investment component is secondary. You need to buy when the time is right for you, based on your family needs, your proximity to work and schools, your financial situation, etc.

There is a great opportunity now for renters to become homeowners. Inventory of homes are high, interest rates are low. House prices have come down from their peak. If buying a home is a goal of yours do not let the fear of making a mistake or the gloom and doom of the news media decide for you. Take advantage of the market, move forward and don’t look back.

Purchasing a home is a long term investment and as such will ride the ups and downs of the marketplace. Your home provides shelter for your family over the years. It’s only when the time comes that you need to move on and sell your home will you see how profitable the investment component of the purchase decision was. If history is any guide, you will find that buying will prove to have been the right choice.

The Borrower's Responsibility

2008-01-17T14:18:00.000-05:00

Caveat Emptor, Latin for “let the buyer beware” is a phrase we have all seen but too many of us, don’t live by. At the end of the day, we are responsible for the decisions we make. The world is full of con men and thieves constantly looking for ways to separate us from our assets. The government can only do so much to inhibit their ability to steal from us. Your last line of defense is your personal ability to analyse the information available to you and making the decision.

What does this have to do with mortgages? Over the last few weeks I’ve been addressing how each section of the mortgage market contributed to today’s problems. Companies made mistakes, employees of the companies made mistakes and con men and thieves have entered the industry. The trouble in today’s mortgage market derived from poor business decisions, incompetence, greed and fraud. It’s impossible to identify the magnitude of the contribution that each one of these components made to the problem. What we do know for sure is that in each instance the borrower let his guard down and either made a poor decision or allowed himself to be a victim.

We are all human and we all make mistakes. We do whatever we can to avoid injury, both physical as well as fiscal, with varying degrees of success. The big problem we face when dealing with our own personal financial position, is being objective. Emotion clouds our judgment. Emotion will make us hold onto a property longer than we should; it will lead us to believe that “everything will work out fine” without any basis in fact; it will enable us to ignore a problem, blindly hoping it will “go away”. In its worse case, emotional attachment to property will set us up to be scammed. It allows us to ignore the concept that something can “be too good to be true” and only see it as a solution to the problem. It is this mindset that a con man looks for.

During the period of easy lending that we’ve just been through I would tell my clients “getting the mortgage is the easy part, living with the payments is the hard part.” By addressing how the new housing expense was going to fit into the client’s budget we could see how their lifestyles would change. In many cases, this was an eye opener. Some clients saw how overextended they were going to be and modified their house hunting to suit. Other clients that were looking to improve their cash flow via a debt consolidation, quickly realized how deeply in debt they really were. Some discovered that they weren’t going to lower their payments enough and a refinance wouldn’t be the right course of action. There were even some that didn’t like what I was saying and went to another mortgage broker that told them what they wanted to hear.

There are areas of the country where there was a high level of investor speculation that is now seeing depressed prices such as the Florida market. Investors here are suffering due to one of a number of reasons. They could have been experienced investors that made a bad business decision in buying. They may have been novice investors that got caught up in the buying frenzy and ended up, in over their heads. There is also the group that was conned into buying. They are all suffering the same way from a down market but for different reasons. How many of these individuals may have avoided the problem if they would have just taken the time to do a more detailed evaluation before making the decision to buy?

We have other markets, such as Ohio, that have been hard hit with the contraction of the auto industry. As high paying jobs became hard to find, many homeowners over the last few years decided to cash out the equity they had in their homes. The theory was that they would ride out the soft employment market. They believed that things would get better and they would soon be earning the income they were accustomed to. The employment picture never improved, the values of their homes have declined and the mortgages started to go into default.

The news media keeps telling us that these mortgages should never have been written. If it weren’t for the cash out refinances, these homeowners would still have equity in their homes right now. There is one big problem with this statement. If these homeowners didn’t refinance their homes, they would have been forced to sell at that time or would have defaulted on their mortgages then instead of now. These individuals either had the false hope that the local job market was going to improve or they were sold on the idea by the mortgage originator. Two causes of action that lead to the same conclusion.

Did the industry become too easy in approving mortgage applications? Yes. Did the volume of originations and the profits that were being generated from them blind all the people and companies involved in the mortgage market? Yes. Did the mortgage industry become a destination for con men and thieves to practice their profession? Yes.

Should the industry take all the blame for the trouble we’re in? No, there is a level of accountability that the borrowers are also held to.

Should the government enact laws that make it difficult for the con men and thieves from entering the business? Yes. Should the government, through its regulatory bodies, do whatever is possible to make sure all companies are operating in an ethical manner? Yes.

Should the government enact laws that protect consumers from themselves? No, It would make the availability of financing for individuals too restrictive and make it more difficult for families to improve their financial well being.

One of the basic tenants of the American culture is we all have the freedom to take a chance. Whether you want to start your own business or invest in your own home, you are free to try. If you’re successful you are entitled to all the benefits associated with the decision. If you’re not, you deal with the consequences, and try again. It’s this attitude that has made this country great and a destination for people from all over the world who want to establish a new life.

If we encourage the government to enact laws that protect us so completely that we lose the ability to overextend ourselves, we will never discover our true potential. We will tend become a country devoid of all innovation and creativity. Is this something we really want?

Originators - Good and Bad

2008-01-08T14:16:00.000-05:00

The originator can be working for a banker, broker, credit union, commercial bank, etc. Any entity taking applications for a mortgage will need a person to work directly with the applicant. This individual’s job title is “Originator”.

The originator’s compensation depends on the entity he is working for. He could be on straight salary. This means it wouldn’t matter how many mortgages he writes, the size of the mortgages he writes or the profit margin on the mortgages that closed, he was still paid the same. An entity that doesn’t depend on mortgages as a major source of their business would probably have a member of their staff take on the role of an originator as one part of their job description. Under these circumstances, the originator is most likely on salary.

Most originators are paid based on some form of commission structure. The entity an originator works for sees the position as a sales position and as is typically done in sales, compensation is based on productivity. This is done to motivate the originator but it can have a negative side effect; in his drive to write more applications, the originator may not be giving his client the level of service that they deserve.

Making matters worse, there are some entities that give their originators a certain level of pricing flexibility. This allows the originator to increase his compensation from certain mortgages by simply charging more when he feels he can get away with it. This “up pricing” as it’s called, is not fair to the consumer and is done in such a way that the consumer doesn’t even know it is happening. There are nationally renowned lenders that utilize this form of compensation to their originators, making this a wide spread problem. Fortunately, up pricing is becoming less and less prevalent as it has gained the attention of both Federal and State regulators.

As long as the originator presents himself to the public as a source for a person to obtain a mortgage, and nothing else, there is no problem. When a customer goes to buy a car, he anticipates that the salesman is looking to maximize his profit on the sale. As long as the customer sees the originator as a salesman, the customer will deal with him with the same expectations as when buying a car. The problem arises when the originator presents himself as an "advisor" to the applicant but in reality is only looking to maximize his profit. Now the customer thinks he is dealing with an individual who is looking out for his best interests when, in fact, he is dealing with nothing more than a salesman.

Not all originators work as salesman. Many do conduct themselves as advisors to their clients. Those that do, strive to give a high level of professional service so their clients are better equipped to make informed decisions about their mortgage financing. These originators see themselves as professionals and the business is not just a job, but their career. Their greatest source of business is from satisfied clients recommending new clients.

The untrained, unethical originator’s contributed to the current mortgage market trouble by putting their own personal interests above those of their clients. Making matters worse, they were purposely misleading their clients into thinking that they were the client’s advocates.

The mortgage market grew at an unprecedented pace and the industry’s need for manpower grew accordingly. With such a large number of new employees entering the industry, training suffered. This problem was most evident at the originator level. As companies pushed for higher and higher levels of originations they increased their staff of originators without any thought given to training. Originators were giving out incorrect information and making promises they couldn’t keep to their customers. The contact person that the consumer was using to access the mortgage industry, in many instances, knew less about the business than the consumer.

One positive effect of this market correction is that these untrained originators are leaving the business as fast as they entered. Mortgage companies are now more concerned about the quality of originations and less about the quantity. A welcome approach that is totally different from the one that was used over the last several years.

Mortgage Brokers

2007-12-27T15:21:00.000-05:00

The mortgage broker is the middleman between the applicant and the rest of the mortgage industry. As banks and lenders grew in size, they lost personal contact with their applicants. This, in addition to the increasing complexities associated with financing a property, a need developed for a service that would help the applicant. This service gives the applicant the tools needed to make intelligent decisions when applying for a mortgage. The mortgage broker fills this need.

The lenders quickly realized that is was cost effective to deal with mortgage brokers. The manpower they required to deal directly with the consumer was large and the demand for mortgages was different year to year. If the lender didn’t hire additional personnel during periods of high volume, their staff would be overworked, errors would occur and they wouldn’t be able to capitalize on the increased volume of originations. If they increased their staff during periods of high volume, they would have too many people on their payroll when the market corrected, thus forcing them to lay off staff. This didn’t make for a healthy work environment.

The support staff that a lender needs to service a mortgage broker is far less than when dealing directly with the public for several reasons. To begin with, lenders can make demands on the broker that they can’t impose on the general public. Packages being submitted by a broker must be complete. If they are not, the lender is under no obligation to accept the package. The lender can demand that most of the application packages submitted not only meet the lender’s standards, but that they will also close. Typically, only 40% of the applications submitted directly to a lender by consumers, actually close. A lender will expect at least 80% of the applications submitted by a broker will close. All the “hand holding” that is an important part of customer service is passed onto the broker. A lender has better control of their manpower requirements over time, making for a stronger company because their employees feel secure in their positions.

The discounted pricing that a lender gives to a broker costs them less than it would cost the lender to originate the same total value of closed mortgages. This makes dealing with a mortgage broker a sound business decision for the lender.

Most mortgage brokers are small businesses. Their staff tends to develop a personal relationship with their clients. This gives the applicant the ability to be in constant communication with the same people over and over throughout the process. Becasue of the discounts provided to the broker from the lender, this personalized level of service comes with little or no cost to the consumer, making it a win-win situation for the applicant. This is the reason that the market share of broker originated mortgages reached nearly 70% a couple of years ago. An impressive number, when you consider residential mortgage brokers have been in existence for less than 20 years.

As efficient as this system was, it was missing one thing- accountability. Lenders were not as careful in deciding which brokers they wanted to deal with. A lender may have been negligent in their due diligence prior to working with a broker; they may have been afraid of losing market share if their standards were too high; they may have over-estimated their staff’s ability to underwrite mortgages; they may have under-estimated the greed of many brokers, etc. This resulted in the inferior quality of mortgages that were being closed on. Lower quality mortgages yield higher default rates, which lead to higher foreclosure rates, which lead to decreasing values of Mortgage Backed Securities, which in turn yields losses to investors.

The common element that we’ve seen, in all the businesses involved in the mortgage market, is that everyone was assuming that all other entities were doing their job properly. The lender assumed the broker was doing the right thing, the wholesaler assumed the lender had properly underwritten all mortgages, the investor had confidence in the rating agencies, the broker assumed that the lender’s interpretation of underwriting standards was valid, etc.

None of the industry players were doing their job as thoroughly as they should have. Something was bound to give. The spark that initiated the problems in the mortgage market was that the housing market began to slow down. Once appreciating housing prices could no longer be relied on and the entire mortgage marketplace gradually became stressed. The sloppiness of all the industry participants quickly became apparent and the downward spiral accelerated.

The access the industry has to the applicant is through the lender and the mortgage broker. The mortgage broker’s role is pure; he is only working as the middleman between the public and the industry. The lender, as we noted earlier, plays a duel role. He is not only dealing with the consumer but also has a responsibility to write profitable mortgages. Of all the industry players, I feel the broker had the greater degree of responsibility to the applicant and therefore was in the position to minimize the damage of the mortgage meltdown. Unfortunately, too many brokers did not live up to this responsibility. Far too many brokers were putting their own interests over the interests of their clients. There were three general reasons for this: greed, incompetence and the lack of respect for their clients. I don’t want you to conclude that all mortgage brokers failed to do their jobs properly. As a mortgage broker and being active in the various broker associations, I can say with confidence that many of us do our job right. It’s just unfortunate that not all brokers fall into this category.

From the consumer’s prospective I feel that using the right mortgage broker is the best way to finance a home. I also feel that with additional government regulations and improved due diligence from the wholesalers’ and lenders’ prospective, that finding the right mortgage broker will get easier every day.

Let’s look at each of the reasons. Greed is the easiest one, so we’ll start there. There has never been any regulatory limit on the fees charged by mortgage brokers or any other business involved in the mortgage process. The government’s position is to allow for the competitive marketplace do its job. For the most part it has. In most areas of the country there are numerous sources of financing and the free market works. Wholesalers and lenders were historically cautious in limiting broker compensation, although over the last few years this has been changing. This system fails when high-pressure selling tactics are employed or access to mortgages is limited in a community. Greed, in any profession, will never be eliminated. All we can hope to do is to minimize it. Lenders and wholesalers are now recognizing they need to be more proactive in this regard as well as becoming more particular in choosing the brokers they want to deal with.

Regulators are finally addressing the incompetency issue. Someone looking to become a mortgage broker needed little or no education or work experience. For example, in New York State, there was never an educational requirement to become a mortgage broker. This changed on January 1, 2008, but it took 20 years of fighting with State government and a mortgage meltdown, before any education requirement was imposed on a mortgage broker. There is no worse combination; incompetent professionals in a field that the public assumes has at least minimum standards. This low standard literally invites criminals in. This is why the FBI has identified mortgage fraud as the fastest growing white collar crime in the country.

The most ethical person can be incompetent. If the owner doesn’t take the time to teach his originators all the details of the various mortgage programs and underwriting standards, how competent can the originator be? This has been a big problem in the industry. The standard to become an originator is lower than the standard to become a mortgage broker. This puts a high level of responsibility on the mortgage broker regarding the education of his staff. Many mortgage brokers are more interested in hiring salesmen, not financial consultants. A large number of applicants were put into mortgages that were not in the applicants best interest, simply because the originator didn’t know any better.

Regulations are being passed by each State that will not only add an education requirement for originators and a criminal background check but will also assign an identification number to the originator. The number will be put on every application taken by the originator. Now a mortgage can at any time, be tracked ,creating accountability.

The final reason is the most important, lack of respect for the client. If you have respect for your client, regardless of your quality of education or experience level, you will be an asset to your client. Respect requires you to find the answer to a question that is posed to you instead of making something up. Respect requires you to ask enough questions of your client to get a complete picture of their needs and goals. Respect prevents you from charging more for your service than is fair. The most important quality, respect for your client, is the easiest standard to meet. You just need to be a professional.

The easy lending standards we’ve been working with over the last few years have been a powerful set of tools for a mortgage broker to work with. But like all power tools they need to be used intelligently. A chain saw in the right hands takes all the work out of cutting trees, in the wrong hands you are left with a bloody mess. The mortgage meltdown we are currently experiencing is the bloody mess when powerful tools were misused.

Where the Lender Fits In

2007-12-26T12:42:00.000-05:00

The Lender is the entity that deals directly with the customer in originating a mortgage, commits to fund and then closes on the mortgage. It can use its own money to fund mortgage, use an investor’s money or broker the mortgage out to another funding source. Every lender operates in a way that best suits its needs. A large lender with substantial cash reserves may be closing the majority of mortgages with its own money whereas a small lender will elect to close most of its mortgages using investor’s money. A savings bank would be an example of a large lender. They have a depositor base supplying the cash needed to fund its own mortgages. A mortgage banker would be an example of a small lender. Not having access to a depositor base it will need to depend on investors to fund mortgages.

A lender utilizing its own funds writes its own underwriting standards and sets its own pricing. A lender that uses investor funds will be using the investor’s underwriting standards and is more limited in setting pricing. Now let’s look at the impact each style of operation has on the mortgage market in general.

A lender that uses its own capital to fund mortgages is called a portfolio lender. As the name implies, this lender is holding all their mortgages in their own portfolio. The underwriting standards they use will directly influence the performance of the portfolio. If they are too conservative, they may not be writing enough mortgages to generate the profits needed. If they are too liberal, the performance of the portfolio will be poor due to a higher than expected default rate. The portfolio lenders suffered the same problems that the wholesalers faced in this market. The combination of a desire to increase their volume of originations and turning a blind eye to the risk exposure of their underwriting standards, leads them down the path to a non-performing portfolio.

It’s a little different with the smaller lender. Here, thier wholesalers and investors are dictating the underwriting standards. A mortgage banker is interpreting those guidelines that have been given to him. The act of underwriting the mortgage application is one of matching the attributes of the applicant to the underwriting standards. The mortgage banker’s contribution to our current problems is their liberal interpretation of the underwriting standards. They were closing on mortgages that they should not have closed on. Common sense was ignored, in order to keep the volume of closed mortgages as high as possible. The moertgage banker didn’t feel responsible since they were following the guidelines of their investors. The investors, however, saw it differently and quickly stopped funding their mortgages with an end result of driving the mortgage banker into bankruptcy.

In theory, lenders could have prevented a lot of our current problems. Using a common sense interpretation of underwriting standards, a more diligent investigation of the details of the purchase transaction and the financial profile of the applicant, our problems would be much less severe. Few lenders took this approach, preferring to “go with the pack” and do the same thing their competitors were doing. This seemed to be the safer path. Investors were looking to buy high yielding mortgages, the rating agencies gave these pools of mortgages high marks, the population was demanding that they be given mortgages and the Federal government was praising the high percentage of Americans who now owned their own homes. Additionally, the expanding mortgage market was keeping the country’s economy strong. In such an environment, it’s extremely difficult for any person or company to break away from the pack.

This, in no way, is meant to minimize the responsibilities of the lenders for this mortgage market nightmare. It is being presented to give you an overall prospective of how we’ve gotten to where we are. They only way we can avoid making the same mistakes again, is to identify the underlying factors that caused the problem in the first place.

The Responsibility of the Wholesaler

2007-12-20T15:56:00.000-05:00

Before we can discuss the responsibility of the Wholesaler in this mortgage market, we first need to define what the wholesaler does. We know that once a mortgage is originated and closed, it will eventually wind up in the secondary market. It will become part of the portfolios of the GSEs or a MBS on Wall Street. The mortgage will move from the originating entity though an intermediate entity until it finally makes its way to the investor. An entity whose primary job is that of an intermediary, is called the wholesaler.

The wholesaler doesn’t deal with the consumer; the broker or banker does that. The wholesaler bundles mortgages and sells them to either a GSE or Wall Street firm who will then proceed with the securitization. The wholesaler is obligated to pool mortgages to meet the specific standards of the company. They pass on these same specifications to the originating entities they work with.

Wholesalers will buy closed mortgages from bankers or they will underwriter mortgages for brokers. A banker will use a wholesaler for an expanded product line. They may not originate enough of a particular mortgage type to warrant selling to them directly, so they will utilize a wholesaler instead. Or they may use a wholesaler during times of heavy volume of originations. A broker needs a wholesaler to place his mortgages since he doesn’t have direct access to the GSEs or Wall Street.

The long-term success of a wholesaler is dependant on how accurate they are in writing their underwriting specifications and how diligently their staff follows their investors’ guidelines. If the investor’s requirements are interpreted liberally, the quality of the pools of mortgages will suffer. If their staff isn’t kept informed of changing standards, they can easily be approving mortgages that cannot be pooled. If the staff is overworked or additional manpower is brought in that isn’t properly qualified, the wholesaler’s ability to function suffers.

While the mortgage market was rapidly expanding and Wall Street grew more hungry for mortgages they could securitize, the wholesalers got caught up in the momentum. To meet the record setting volume of business, additional personnel needed to be hired and current employees were working longer hours. This caused the quality of the mortgages to suffer. As commonly happens in industry, the production volume became more important than the quality of the finished product. As the quality of mortgages quickly began to fall, the wholesalers found themselves holding mortgages they couldn't sell. This forced many out of business.

These issues can easily be addressed. Internal communications improve, new employees gain experience and the workload for all employees becomes more manageable. The increased workload was responsible for only a portion of the problems we see.

If the wholesalers were doing their job properly, the problems we’re realizing today would be much less severe. We keep hearing that the originators placed people into mortgages they couldn’t afford. Wall Street was buying mortgages at such a rapid rate, they didn’t care what they were buying. Originators wanted their commissions by hook or by crook and Wall Street needed product to securitize. I have no argument with these statements. I only question the magnitude of the impact of bad originators and greed on the Street.

Wall Street needed mortgages; there is no question about it. They wrote underwriting standards that were generous; again, no argument. The wholesalers were in the position to maintain a narrow interpretation of those standards and should have. The perfect example of this is the "stated income" mortgage, which has now been dubbed the “liar’s loan”. When this product was originally designed, it was meant for business owners, individuals whose financials are not consistent from year to year, thereby making it difficult for them to qualify for a loan under traditional underwriting standards. In an effort to minimize the risk associated with mortgages of this type, a higher down payment was required. This higher down payment not only put more of the borrower’s personal funds ito the transaction, it was also a way to confirm that the borrower has proven fiscal responsibility by saving up the required assets.

In their drive to increase volume, Wall Street began to work with lower down payment requirements and began accepting salaried employees under a stated income program. Here’s where the wholesaler’s responsibility is. An applicant who is putting a small down payment on his purchase and is working in a fast food restaurant probably isn’t making the $100,000 a year that is "stated" on the application. The wholesaler needed to be responsible and use good judgment by not approving this applicant. The mortgage may have technically met the standards but the wholesaler wasn’t doing his job. The standard wasn’t written for mortgages to be granted to individuals that have no ability to make the payments.

Now let’s look at it from the originator’s position. Let’s assume that the originator didn’t care about the applicant and was only interested in making his commission on the mortgage. The application is taken and then submitted to the wholesaler. If the wholesaler were doing his job responsibly, the application would be declined.

Bottom line is that wholesalers were not doing their jobs. They were solely concerned with production figures. Refering back to my example, a wholesaler would have been afraid to decline this loan for two reasons. First, the fear that the wholesaler down the block would close on it anyway. Second, fear that the originator would no longer submit mortgages to them. This logic is the reason so many wholesalers are now out of business.

The Problems on Wall Street

2007-12-17T15:07:00.000-05:00

Wall Street is where Mortgages are pooled, securities are created and then sold to investors. Basically it’s the marketplace. This is a world of alphabet soup. RMBS, CDOs, SIVs, etc. is the language of this market place. For the rest of us they are referring to residential mortgage backed securities, collateralized debt obligations and structured investment vehicles.

The brokerage houses role in the mortgage market is to take a pool of mortgages and create securities with various yields. The best way to gain an understanding of what they do is with an example. Let’s say we have a pool of mortgages with an average interest rate of 8%. Not all mortgage are going to perform as expected. A series of tranches, securities yielding a specific rate of return, are created. For our example we use 3, one yielding 6%, one yielding 8% and one yielding 10%. As the borrowers make mortgage payments the investors who purchased the securities yielding 6% are paid first. Once all those obligations are met then the next group of investors, those expecting 8%, is paid. Only after the obligation to these securities are satisfied can the investors who purchased the securities yielding 10% see any money. As this example illustrates, the higher the yield, the higher the risk of the investment.

These securities can then be pooled with other securities, creating new tranches that are also sold. Mortgage backed securities can be pooled with credit card receivables, personal loans, car loans, etc. The brokerage houses of Wall Street create complicated investment vehicles that are designed to meet the goals of all the various investors. This system is totally dependant on the ability to accurately predict the performance of the underlying mortgages and promissory notes. The current problem in the mortgage market today is because the predictions were very wrong.

How could all these experts be so wrong? There are several reasons, all of which have contributed to the problem. We’ll probably never know for sure the magnitude each reason played but we do know the results, today’s mortgage meltdown.

The first reason is both the investor as well as Wall Street depend on the rating agencies to analyse the risk of each security offered. As discussed earlier, the rating agencies miscalculated the risk of the securities. The Wall Street firms, as well as all investors, use the rating of a security as a starting point. They will then do their own calculations to determine risk. It’s obvious now that those calculations were no better that those performed by the rating agencies.

The next issue is the magnitude of the complication of the securities being offered. It’s being discovered only now that the securities that have been offered are so intertwined with each other that, every missed mortgage payments is magnified a hundred times over. It seems that the people who designed the securities didn’t have a full understanding of this. To make matters worse, the investors that were purchasing these securities also had no clue about all these inter-dependencies.

This brings us to the most important question. Were the people involved in this market aware of these shortcomings and just ignored them? Millions of dollars were made, both by the company as well as the individuals working in the industry. Did the money they were making blind them all or were they ignorant to what they were doing?

Whatever the reason, it is clear that Wall Street is not living up to its obligation to maintain a marketplace where investors can depend on the data provided. Investors need to be able to make informed decisions. Wall Street can only function if it has the confidence of the investment community. We live in a global economy; Wall Street isn’t the only marketplace for investors. Once investors lose faith in Wall Street, they will simply invest in other markets. Should this occur, we will no longer be a leader in world economics; we will become a second rate country. The current state of our economy isn’t as strong as it should be; what state of economic health will we be in, when investors begin to put their money elsewhere?

Wall Street needs to regain its international creditability before we can hope to re-ignite our economy. The mortgage market is only one piece of a large security market; yet when it went bad, the effects were and stil are, being felt around the world. Imagine what will happen if another component of the market was to go bad.

The Investor's Role

2007-12-13T15:23:00.000-05:00

The process of pooling mortgages and selling shares to investors is called securitization. Without investors willing to buy these shares, there would be no way for lenders to convert closed mortgages into fresh capital to lend out. This is the basic problem we are facing today. Investors have lost their desire to purchase these securities and when there are no buyers in a market sellers are forced to hold onto their wares.

Investors are extremely important to the mortgage market, because without them there is simply no market. The class of investors purchasing these securities is made up of individuals, companies, mutual funds, pension funds and government entities, both domestic as well as foreign. The spread of these securities is amazing, they seem to be held in every investor’s portfolio regardless of how large or small the investor is.

The world economy has been awash with available cash for some time now and there seems to be no end in sight. Countries that were once seen as “third world” have developed thriving economies and are responsible for generating new wealth. Their economy can be based on modernization; such as we’ve seen happen in China and India. It could be based on the development of a country’s national resource; such as we’re seeing in Nigeria and Venezuela. Whatever the source, new wealth is being created at a record pace.

What this means is there has been and still is a tremendous amount of capital throughout the world looking to be invested somewhere. This has resulted in lower yields than have been historically available. It’s basic economics, the law of supply and demand. In this case, the commodity or “supply” is money and the user or “demand” is companies needing cash to run their businesses. In the case of the mortgage market, lenders need to sell off closed mortgages in order to free up capital to close fresh mortgages. The avenue used is securitization. Investors will typically want to diversify their investments. Some money will be invested in more speculative and therefore higher yielding ventures; other money will be invested conservatively with the appropriate low yield that accompanies a safer investment.

In looking at the different levels of risk an investor is involved in, he will try to get the highest yield possible in each investment made. This includes whatever money he is investing in secure ways. Mortgage Backed Securities have traditionally been considered a safe investment while giving a slightly higher yield than, say, US Treasuries.

As investors pushed for higher yields, the lenders were encouraged to originate mortgages that were at a higher interest rate. The only way for a lender to close loans at higher interest rates was to attract less qualified borrowers, who would be willing to pay the higher rates. This cycle of investors looking for higher yields and the lenders responding by lowering their lending standards brought us to today’s problems in the mortgage market.

What went wrong? The obvious answer is, greed. In the drive for higher profits, the investors destroyed the money making machine know as the mortgage market. I’m not satisfied that investor greed is the only issue in play here. We assume that investors are number-crunching businessmen and all decisions are calculated with nothing else influencing the decision. Humans make investment decisions and all humans have a set of consistent qualities that may vary in intensity from person to person but are always present. The attribute that’s important to this discussion is the desire to be part of the group. The comfort zone we have of running with the pack, the uncomfortable feeling we have in being different, and the fear of jeopardizing our income or reputation by disagreeing with the opinions of our company or the general assumptions of the industry we’re in.

When you combine greed with a pack mentality, the result is always a severe market correction. We’re seeing it right now in the mortgage market, we experienced it with the dot com market and I’m sure 10 years from now we’ll be experiencing yet another speculative bubble burst. Until investors develop the strength to think independently and the confidence to base their decisions on their personal analysis, we are destined to move from bubble to bubble.

Investors have no one to blame their losses on but themselves. Today’s troubled mortgage market is going to prove to be one of the most lucrative investment opportunities for independent thinking investors. One by one we are going to see major investors, hedge funds, companies, high net worth individuals and even foreign governments making selective purchases that will prove to be brilliant investment decisions over the next few years.

We all need to be more independent in our thought process. If we continue to hide in the pack we are destined to eventual failure.

The Rating Agencies

2007-12-11T14:55:00.000-05:00

The rating agencies play an important role in the financial marketplace. Their job is to evaluate publicly traded securities and estimate the risk an investor exposes himself to when purchasing the securities. The agencies review past performance of the type of security they are evaluating, the history of the particular security, current overall market conditions and future trends of the market.

Reviewing the historical performance of the market or a particular security is straightforward. The data is readily available and it is simply a mathematical analysis. The tough part is developing future market trends. This is where the rating agencies earn their money. By studying historical market trends and evaluating current market conditions they then attempt to predict the future. In the case of rating Mortgage Backed Securities (MBS) it is now obvious that the predictions were wrong. Not a day goes by that we don’t see a rating agency lowering the credit grade on some MBS.

How could they be so wrong? Until I see some solid evidence, I’m not buying the conspiracy theory. On the surface it seems to me that the agencies have far too much to lose in jeopardizing their creditability by misclassifying the bond ratings. I feel the problem lies within the combination of two issues. To begin with, there is not a long history of subprime mortgages and whatever history that is available only covers a timeframe of rapidly appreciating home values in a strong economy. In addition, the volume of subprime mortgages originated was increasing on a monthly basis. Without a dependable history to work with, the reliability of future projections becomes questionable.

Should this short history have impacted the rating? After all, they certainly must have seen this? I believe they did recognize the limitations of the data they were working with and concluded that it wasn’t a big enough issue to negatively affect their rating. In hindsight this proved to be a bad decision and became a major component in the mortgage meltdown.

Investors make money by finding abnormalities in a market. They search for opportunities where they feel the yield on a particular investment is not in line with its level of risk. If the investor is right, he makes money. If he’s wrong, he loses money. Investors were seeing high rated MBSs carrying a higher yield than other investments with the same rating. Many investors focused on this imbalance and bought. They were betting on the credit rating being a better barometer of risk that the actual yield on the security. The bet proved to be wrong, the market yield proved to be a better representation of the risk of the mortgages.

Under normal market conditions, securities are bought and sold on an ongoing basis. This provides investors the opportunity to sell when they feel the investment is becoming riskier, or buy when they feel the timing is right. This results in small market fluctuations day-to-day as investors adjust their portfolios.

The problem the market faced in August is that, almost overnight, there were no buyers for MBSs. With no buyers there is no market and therefore a market price couldn’t be determined. This started a cascading effect throughout the mortgage market, the domestic security markets as well as the foreign security markets. The end result has been massive writedowns of the values of the securities held by investors, mortgage companies going out of business, consumers finding mortgage money harder to find with a resulting increase in foreclosures and real estate depreciation.

Just as the value of MBSs got too high before investors responded, we are currently seeing the value being too low. Buried in all the bad news we’ve been reading, there are some positives things happening. As investors begin to look closely at the financial institutions and MBSs, they are finding buying opportunities. It started with the $7.5 billion investment in Citicorp by Abu Dhabia. They saw a buying opportunity and took advantage. Goldman Sachs is on the verge of buying Litton Loan Servicing, another example of an experienced investor taking advantage of an undervalued asset. Investors from Singapore and the Middle East purchased a 10% ownership of UBS. We are going to see more and more of this as the weeks go on.

The market is slowly re-establishing. Many investors, both large and small, have taken huge loses in the meltdown of the mortgage industry. This has created a buying opportunity for other investors and they will be taking advantage of this.

Will investors lose faith in the ratings given by the agencies? Will investors look to other avenues for risk evaluation? Only time will give us answers. There is one thing we all can re-learn from this situation. There are no sure things in life; every investment is a gamble. In any market there will be winners and there will be losers. Winners are quick to take credit for their wise decisions and losers are just as quick to try to find someone to blame for their losses.

Government Sponsored Enterprises

2007-12-05T16:38:00.000-05:00

The Government Sponsored Enterprises (GSE) play an important role in the mortgage market. Fannie Mae and Freddie Mac contribute to the increase of homeowners in the country through the symbiotic relationship they have with government.

The GSEs develop programs specifically targeted to first-time homebuyers and operate under the supervision of the Office of Federal Housing Enterprise Oversight (OFHEO). The government’s contribution is granting them access to a credit line from the US Treasury and allowing them to operate with lower cash reserves than the private industry is required to have. This lower cost of operation is then passed onto the marketplace. That’s why mortgages that are underwritten to conform to Fannie or Freddie standards carry a lower interest rate.

Before we see how the GSEs impact today’s mortgage market we need to take a look at how they evolved. Fannie Mae website will supply you with a more detailed history but this brief summary will give us all we need right now.

The FHA Administrator chartered Fannie Mae on February 10, 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. After World War II, Fannie Mae's authority was expanded to include VA-guaranteed home mortgages.

The 1968 Charter Act split Fannie Mae 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. Fannie Mae retired the last of its government stock on September 30, 1968, and transformation to a government-sponsored private corporation was completed in 1970. The 1968 Act provided the authority to issue Mortgage-Backed Securities (MBS).The Act also established a regulatory structure to ensure Fannie Mae's adherence to its public purpose. It provided for continuing HUD oversight of Fannie Mae, granting "general regulatory power ... to insure that the purposes of this Title are accomplished."

The Emergency Home Finance Act of 1970 created Freddie Mac and authorized it to create a secondary market for conventional mortgages. Parallel authority and limitations to deal in conventional mortgages were given to Fannie Mae.The Federal Housing Enterprises Financial Safety and Soundness Act ("FHEFSSA") of 1992 modernized the regulatory oversight of Fannie Mae and Freddie Mac. It created the Office of Federal Housing Enterprise Oversight ("OFHEO") as a new regulatory office within HUD with the responsibility to "ensure that Fannie Mae and Freddie Mac are adequately capitalized and operating safely."

OFHEO is funded by assessments on Fannie Mae and Freddie Mac and is authorized to act without HUD oversight on a range of regulatory issues enumerated in the statute. FHEFSSA established risk-based and minimum capital standards for Fannie Mae and Freddie Mac. And, it established HUD-imposed housing goals for financing of affordable housing and housing in central cities and other rural and underserved areas.

Fannie Mae and Freddie Mac purchase over 50% of the mortgages originated in the country. Because of their market share they essentially wrote the underwriting standards for the industry as well as developed nearly all of the standard documents that the industry uses. The public purpose component of their mission is to maintain an orderly mortgage market, encourage homeownership to as many consumers as possible and to keep the cost of mortgage financing as low as possible.

Roughly 2 years ago both agencies were involved in accounting scandals. There were several companies involved in accounting scandals at the time but the GSEs issues were different. Companies typically try to make their financial statements look as profitable as possible. A more profitable company yields higher stock prices and that makes shareholders happy. When accountants get too creative in their jobs they find themselves crossing the line and break the law, this creates the scandal.

The GSEs were caught declaring less income than they actually made that year. Their reason was they were smoothing out their income over the years. They felt that consistency in year-to-year profits made for a better public image. It doesn’t matter if their intentions were good or bad. It was not an accepted practice, it was unlawful and they were forced to reissue their financial statements for several years. Coming off the boom years their profits, as you would have expected, were extremely high.

Combine record high profits with their government mandates and you have the foundation for a problem. The government, seeing the record profits, pushed the GSE’s to purchase mortgages with a lower credit grade than they historically did. The feeling was that the profits weren’t due to an overactive housing market but due to underwriting standards that were too conservative.

Not all mortgages perform perfectly. They is always a percentage of borrowers that don’t live up to their contractual obligations with their lenders. The reasons that borrowers can’t keep their mortgages current are numerous. There could be a job loss, a medical emergency, a natural disaster, a divorce, etc. Things happen in lifenand they aren’t always good things.

A lender, or an investor in mortgages, tries to predict the percentage of mortgages that are not going to perform before pricing the mortgage or pools of mortgages. This is a very important piece of information because that is the largest factor in the profitability of the final decision. If the prediction is more than the actual number of defaults, the investor finds himself making more money that he expected. If the prediction is too low, meaning that more mortgages go into default than planned, the profit seen by the investor is less than expected or could even become a loss.

In an attempt to maintain the growing percentage of people becoming homeowners in the country and to offer lower cost financing to more people, the government made the GSEs revise their lending standards. Their profits were high because the rate of defaults were lower than anticipated. This was viewed as justification in requiring the underwriting standards to be lowered. The GSEs were now purchasing mortgages that were considered Alt-A or Subprime previously.

What’s been happening over the last 6 months is that the portfolio of mortgages held by the GSEs were no longer performing as well as they had been. Not only were the newer mortgages not performing as well as they were expected to but the default rate of the entire portfolio was increasing. The net result is that both agencies are no longer in a strong financial position. Their stock prices have suffered and they are raising their cash reserves to handle the higher level of defaults. This will prove to be a manageable problem for the GSEs. They are large enough and financially strong enough to weather this.

The biggest problem is that the public is losing confidence in the GSEs and this is fueling their negative attitude to the housing market. The average person is seeing the large drop in profitability from last year to this year but they are not taking into account that last year was a record year. Once the financials of Fannie and Freddie are looked at over a several year period, a different conclusion becomes evident. Yes, this is a bad year for both GSEs, there is no argument there. A longer historical prospective will yield a more accurate evaluation of the magnitude of the situation.

The facts are that the more liberal underwriting standards that the GSEs used, made a substantial contribution to the problems in the housing market today. Both the GSEs and the government had the best of intentions; more people becoming homeowners and at a lower cost. Unfortunately, it encouraged some people to take on more debt than they were financially ready for resulting in a mortgage default that could quickly become a foreclosure statistic.

We shouldn’t condemn the GSEs for lowering their standards. Not every mortgage closed under these standards went into default. We need to encourage Fannie and Freddie to review their standards and make revisions as needed, that will allow them to continue to fulfill their government mandates and at the same time maintain adequate profits.

The GSEs share responsibility for the mortgage crisis in yet another way. We’ve just shown that one of the consequences of lowering their underwriting standards was an increase in their default rate. An increase that was larger than they anticipated. In lowering their standards, they began funding the better-qualified Alt-A and Subprime borrowers. The lenders who specialized in Alt-A and Subprime were now loosing their better borrowers. This meant that these lenders would now be exposed to a higher rate of default because the better quality mortgages that were adding stability to their portfolio were now elsewhere.

The problems in the mortgage market caused by the aggressive lending policies of the Subprime lenders were now being magnified. Less qualified borrowers were being given mortgages which resulted in higher defaults and at the same time, their better-qualified borrowers were leaving the Subpirme marketplace. The default rate was now being pushed up from both sides.

The GSEs need to avoid fast changes in their underwriting standards no matter how much they are pushed by the government. Revisions need to be done slowly so as not to shock the marketplace. They need to be careful now and not tighten their standards too much, too quickly, in response to the current market. An overreaction now will cause serious damage and only make matter worse.

The Goverment's Influence

2007-11-30T18:35:00.000-05:00

What role does the government play in the mortgage market? All levels of government impact the mortgage market each through a different avenue.

The local level, county or city, influences the inventory of housing and job creation. Utilizing zoning laws, local municipalities can increase or decrease the rate at which additional housing units come on the market. By creating tax incentives they can attract or hold onto businesses, with the result of increasing the desirability of the community. Local government directly influences the supply/demand equation for housing inventory. This has a direct impact on house values.

Home resale values determine the amount of equity one has in his home and therefore the security of a lender. Mortgage defaults tend to increase in regions with flat or declining real estate value and tend to reduce during times of appreciation. We’re seeing this occurring right now. The areas with the greater defaults are also the areas with the greater depreciation in sale prices.

The State level and to a lesser degree, the local level, sees the housing and mortgage markets as a source of revenue. Government on all levels need funds in order to supply services to the communities. Generally speaking our elected officials prefer to collect the most amount of money from the smallest set of voters. For example, an increase in a sales tax impacts everyone. Those in office run the risk of not being re-elected if too many voters blame them for taking their hard earned money away from them. Collecting money through a real estate transfer tax or a mortgage tax only effects the voters who are conducting a real estate transaction. The set of voters in this category is only a small percentage of the voter population. An elected official stands exposed to lose a lot less votes in this case.

By increasing the cost of executing a real estate transaction the State, government effectively discourages sales. At this level the mortgage market is influenced through a reduction in transactions that results in a lower rate of appreciation or worse, acceleration in the rate of depreciation in a declining market.

For example, let’s look at a property being sold in New York City. The seller will pay a transfer tax to the State of approximately 0.4% of the sales price as well as an additional tax to the City of 1.0 to 2.625% (depending on the type of property) of the sales price. The buyer will be giving the State a mortgage tax of 0.8% of the mortgage amount and an additional 1.0 to 1.8% to the City. If the purchase price is $1 million or greater the buyer will be paying an additional 1.0% of the sales price to the State. These taxes provide a windfall of revenue during a rapidly appreciating market but can discourage sales in a down market. It’s easy to see how large an influence State and local governments can have on a local housing market.

The Federal Government has the largest direct impact on the mortgage market. Washington is constantly searching for the proper balance of taking as many people from being renters to being owners, maintain the integrity of the banking industry, keeping the cost of financing as low as possible for every American and at the same time allow the free market to do its job.

Until The late seventies, the Federal Government set mortgage rates nationwide. This provided a consistency that everyone looking to purchase a home would be facing a 30 year fixed rate mortgage at 8.75% (or whatever the rate at the time was) with 0 points. The downside to this approach was that a lender would only allocate capital to mortgages if they couldn’t get a better return than 8.75% on their money elsewhere. The availability of mortgages would vary over time, reflecting market conditions. It was decided that this was not a healthy situation, especially during a period of high inflation, which was the case at that time. The government decided it was better that mortgage money consistently be available to everyone and allowed mortgage rates to vary, based on market conditions. This created a situation where there would always be mortgage money available but the cost of the money would now reflect market conditions. This decision opened up various options to the borrower. He could now elect to pay points upfront in order to get a lower rate for the duration of the mortgage term. He could borrower money on an adjustable rate to lower the initial payments, etc. This free market of mortgage rates gave the consumer a multitude of choices and gave the industry the opportunity to create products to accommodate the different needs of the borrower giving him even more options. The downside here is that the borrower needed to develop the skill set necessary to make a proper & informed decision.

The bigger problem this created for the mortgage market was that this freedom of pricing combinations and types of mortgage products, could be used by criminals. The same tools that an applicant used to get the best mortgage for his needs could be used by the crimminal to confuse the applicant and take advantge of that confusion. White-collar crime comes in all shapes and sizes, from the lender looking to steal homes out from under an innocent borrower to the thief looking to rip off a lender. The industry, law enforcement and all levels of government are in a constant battle to minimize the criminal activities.

The conclusion here is that the positive effects of a free market mortgage rate environment gives the consumer greater access to mortgages and the ability to capitalize on a low mortgage rate when the time is right. The negative effect is that obtaining a mortgage has become more complicated for the consumer and both the consumer as well as the industry, needs to be diligent in protecting themselves from the criminal element.

The Federal government has had an ongoing goal to increase the number of homeowners in the country. The basis of this focus on homeownership, is the wealth of most American families found in the equity that is built up in their home. The thinking goes that as more people own homes, there will be more families building up equity and therefore, personal wealth. Various government departments and agencies are constantly looking to design programs to aid the first time homebuyer. It’s because of this effort the FHA program was developed. A government insured program that helps people purchase homes with little or no money down, less than perfect credit and/or need more generous qualifying ratios. The government has also encouraged the GSEs as well as the rest of private industry, to create programs to accommodate the needs of first time homebuyers.

It doesn’t matter what industry we talk about, you won’t know that you pushed a standard too far until problems arise. An engineer can’t tell you how much weight a piece of steel can hold without first taking a sample and placing increasing weights on it until it finally breaks. We have pushed the underwriting standards of the mortgage industry to its limits. We know this because we are currently suffering the consequences, increasing number of defaults, foreclosures and depreciation of home values.

The best example of the negative impact of government pressure is what’s currently going on with the GSEs (Fannie Mae and Freddie Mac). They had record profits a year ago. The government reminded them that they have certain obligations, one of which is to keep the cost of mortgages down for as many consumers as possible. The GSEs responded by cautiously loosening their credit standards to permit the better quality Alt-A and subprime borrowers to be eligible for their loan products. This had the positive effect of lowering the cost of financing for these individuals. It also has the negative effect that the GSEs are currently suffering huge loses. In hindsight we can see that the standards shouldn’t have been made as liberal as they were. There was no way of knowing how far they could go without suffering the consequences of going too far.

The current market conditions are leading many to conclude that we should go back to the old ways of lending. Banks holding all mortgages in their portfolio, only lend to individuals with the best of credit, require substantial down payments and don’t let a borrower spend too much of his income on housing expenses. It’s believed that these standards need to be written into law by the government. This would be the worst possible path for the government to take. It would be an over-reaction to the current situation and by putting the standard into law, make it extremely difficult to correct the new problems that this would cause.

The government needs to concentrate on keeping the criminal out of the industry. This is done though mandating accountability of all individuals and entities in the mortgage process and creating monitoring systems that are capable of identifying every company and person that was involved in a particular mortgage. This way when problems arise, patterns will be found and the people and entities responsible for the damage become exposed. Any other government intervention needs to be kept to a minimum.

Overview of The Mortgage Market

2007-11-28T16:06:00.000-05:00

With all that’s been written over the last few months about the mortgage market we need to step back and look at all the workings of this market. One obvious conclusion that can be made from what we’re reading is that the market is much more complicated than anyone ever imagined. In this respect the news media has done a fine job. On the other hand, by focusing on one or two issues, the media is creating the condition that will draw the reader to conclusions that may not be valid.

What I want to accomplish over the next few weeks is to give you an overview of how each player fits into the mortgage market and how the actions of each player impact the actions of all the other players.

The financial marketplace, which includes the mortgage market, can be best described as an ecosystem. Just as we now recognize that driving a car not only depletes the world’s oil supply is also impacts the temperature in Antarctica which in turns impacts the temperature of the oceans which in turn has an impact on the seacoasts around the world. As in the global climate, the decisions made by every player in the mortgage process, from the applicant, through the banks, the government and every step in between will have an effect on the overall process.

When a scientist or engineer looks to address a complex interaction such as what I’m describing here they will start by analyzing each component by itself. From there they will determine how the components impact the others with the ultimate goal of building as complete a model of the workings of the system as possible. This method of analysis is what I will be using in this study of the mortgage market.

I am going to begin with identifying each player in the process. From there, I will describe the problems each faces and the directions that can be chosen. I will be identifying the pros and cons of the various choices and the motivations that are behind each decision. This is not a witch-hunt; I’m not looking to accuse any one player as the cause of the mortgage meltdown we are now dealing with. The goal here is to gain a better understanding of how decisions are made at each step.

The players in the mortgage market are:
The applicant – the person looking for a mortgage.
The originator – the individual working for a broker or lender who is the source of information for the applicant.
The broker – a middleman that works with the applicant to find a lender that will commit and fund the mortgage.
The lender – the entity who commits to and funds the mortgage.
The wholesaler – an entity that doesn’t deal directly with the applicant but funds mortgages for the lender or broker.
Wall Street – we will use this term to encompass all the entities that package mortgages, securitize the package and then sell securities to investors.
The investors – an entity that invest money in order to get a return that is reflective of the amount of risk it is taking.
The Rating Agency – An entity that is in the business of evaluating the risk that a particular investment has. The investor looks to this rating as an aid in determining what investment to make.
The GSE – Government Sponsored Entity, chartered by the Federal Government for the purpose of supply liquidity to the mortgage market and to help more Americans become homeowners.
The Government – All levels of elected leadership whose purpose is to increase the well being of each citizen they govern.

Entities can play multiple roles in the mortgage market. For instance a commercial bank can be a lender (writing mortgages directly), a wholesaler (taking applications through mortgage brokers and other lenders), a broker (by placing mortgages that do not fit their standards with other lenders), a wall street firm (handling securitization) and at the same time act as an investor (through purchasing securities).

When I am discussing players I will not be talking about specific entities but positions in the industry. Each player has a different prospective on the market. For example, the applicant simply wants to borrow money at the lowest cost that fits his needs whereas the investor is looking for highest rate of return with the lowest risk. No decision is pure, that is, every decision will have both positive and negative results. A decision made with the best of intentions can suffer from the law “of unexpected consequences” turning a good idea terribly bad. The mortgage industry has felt the effects of this law more times than anyone wants to count.

You’ll see several examples as you continue to read this blog.

Subprime Meltdown - How widespread is it?

2007-11-20T12:08:00.000-05:00

I've been having an ongoing discussion of the mortgage market with a client of mine (Bill) for some time now. I thought our latest series of e-mails were very interesting so I thought I would post them here for your comments.

Yesterday Bill wrote, "Don, It seems the big banks have pretty heavy exposure to the debt they enabled. Economic rule number one is when there's easy money to be made, pigs will wallow in mud and in this case their own excrement as Merrill has done. They say humans and pigs share 97% of the same genes. Too bad the 3% aren't all the undesirable ones. Human greed is reliable, and it is always the setup for the crisis. Let's see how bad this gets. I was relying on this aspect of human nature in my assessment of the crisis that is unfolding. It looks bad from everything I read."

I responded with, " There's no question that Merrill made some bad business decisions. I do find it interesting the brokerage houses such as Merrill are now regularly being identified as banks, but that's a different issue. As bad as Merrill played the market, Goldman represents the other end of the spectrum; look at today's Times. Every so often you read about some investor or hedge fund looking at buying heavily discounted securities and/or insolvent mortgage companies. The market is bad right now and it may get worse before it gets better but there is a lot of money sitting on the sidelines positioned to take advantage of buying opportunities. We can't lose sight of the fact that the high foreclosure rate in the subprime arena represents a small percentage of the mortgages in the MBS market. The entire world of MBS has suffered in price yet the majority of the mortgages in the pool are performing. It's only a matter of time before the investor community takes advantage of this."

"I agree with what you say that it's probably a small percentage, but other stories also indicate that people overextending themselves straddled all income classes. Let's agree that the nonperforming percentage is small, the accelerant is the amount of leverage that was taken on by the holders of those assets. When the stock market crashed in 2000, the investors that used leverage to purchase securities exacerbated the natural downturn. That's why the hedge funds are blowing up over this. Then you have Merrill that did what Lucent did during the .com craze, they funded their own sales. Chaos theory says that small events when they weave themselves through a system, have profound effects on the overall system. I tend to believe in that science, and currently there's a lot of evidence supporting that position. I have been reading about Goldman Sachs, but think about if a second. If they only concluded the problem was small, they wouldn't have taken the contrarian position and they wouldn't be so exemplary. It's the fact that the problem is bigger than everyone thought makes them so uncommon because they had good acumen when others didn't." - Bill

I ended the day with, "Yes, people overextending themselves throughout all income classes. You need to look at 2 things. First, the number of people overextended is relatively small compared to the total population of homeowners. Then secondly, not everyone that is currently overextended is going to go into default. For example, someone who is temporarily unemployed is overextended but living off of saving or additional borrowing. He will work his way through this situation without going into default.
It's not a good comparison when you compare housing to the stock market. Stocks can be bought or sold on a phone call, there is mob psychology as well as panic thinking that influences the market moment to moment. The housing market operates on a much longer timeline and current market value is not something you can open to a newspaper section and get today's price on your home. This creates a buffering effect that forces people to cool down before reacting.
This is both a positive as well as a negative but in the end, you don't see the equity of your home moving up and down on a daily basis as you see your stock portfolio move. We're not even considering the fact that your home serves the duel purpose of a shelter as well as an investment, something that does play an important role.
I don't think Goldman realized the magnitude of the decision they made. The impression I got from the article was that they made a business decision that the risk outweighed the reward when looking at MBS and they invested accordingly. In hindsight the risk proved to be substantially larger that they anticipated. Instead of making a prudent business decision it turned out to be a brilliant business decision.
There is no question things are not good in this economy. The question is how bad is the economy and how large an influence has the housing market had. There is a layering of influences going on and housing is just one of them. It's a long list: oil prices, the Iraq war, the trade deficit, the ongoing cost of terrorism, etc. When you begin to identify all the ongoing issues you can't help coming to the conclusion that it's amazing the economy is as healthy as it is.
This housing problem is going to nowhere near the magnitude of the dot com collapse. It's just not that far reaching."

What's your opinion? We all see events differently. By sharing our views we can each develop a better viewpoint and therefore be better equipped to make decisions.

Housing Fundamentals

2007-11-09T12:10:00.000-05:00

In an article written by Floyd Norris in the New York Times on Nov 9, 2007 entitled
"Blame for Poor Home Sales? It’s the Press, a Builder Says" there are some interesting observations on our housing market from a builder that builds homes all over the country.

The news media is extremely effective at keeping the public informed. Unfortunately in their quest to distribute information there is a magnifying effect. When housing values were growing non-stop a few years ago, all we read about was how people were getting rich in real estate. There was praise for the wealth created in the economy due to the rising home values. The mortgage industry's creativity in developing programs that allowed renters to buy homes with little or no money down was credited for the increases in the percentage of homeowners in the country. The combination of easy lending, low interest rates and raising home values was the perfect storm to keep the economy humming along. This helped fuel the real estate boom.

Today we are dealing with a different picture. Home values have been dropping, lending standards have tightened and the attitude that every American should own their own home has changed to home ownership in not for everyone. The industry has given mortgages to people that couldn't afford them and the industry professionals should have known better.

The magnifying effect of the news media is now working in reverse. Instead of inflating a hot real estate market it is now taking a bad situation and making it worse. "The housing market is horrible in most parts of the country, says the chief executive of the luxury home builder Toll Brothers, and he fears it will not get better until the newspapers stop saying how bad it is."

Robert I. Toll, the chief executive, studied the markets his company is involved in and handed out grades. Most got a mark of "F" or worse. "The fact that I differentiate between F, F-minus and F-minus-minus" shows just how bad things are, he told analysts during a conference call. He said those grades go from miserable to outright purgatory."

Toll Brothers is not building in every area of the country so this study is not very scientific but it does have its use. Mr. Toll goes on to say, " Nearly all the decent grades went to markets in and around New York City."

What makes our region different? There are certain things that cannot be questioned. One is the law of gravity & another is the concept of supply and demand. If you look at the regions of the country that have the largest declines in home values, you will find they typically have one thing in common. That is, too much available housing. Inventory increases for one of two reasons or both. There is too much new construction with the result that supply is out of balance with demand or the area is suffering from a decline in population that again is destroying the balance.

There will always be certain cities or regions that suffer an economic downturn. Typically they are cities that depends on one specific business or industry for employment. When that company or industry suffers problems and is forced to reduce the number of people they employ, the ecomony of that city suffers. With fewer jobs, people are forced to relocate elsewhere. The city is ecomonically weakened and there is no reason for anyone to move into the homes that have been left vacant, therefore, resulting in a drop in home prices. Even during the growth years of the housing market, there were areas of the country where prices came down.

The more common reason however, is over building. If you look at the cities with the largest drop in home values, you will find they have been over-developed. Even in a region with a growing population, it is possible to build faster than the rate of population growth. If the rate of increase in residents begins to drop that only makes things worse.

Now let's take a look at our region, New York City and its surrounding areas. What are the two obvious problems that we deal with? First, there is a scarcity of apartments. This is due to a constant increase in the population. Second, it's extremely expensive, if not impossible in many parts, to build additional housing. "Buildable" vacant land is virtually non-existent. To build new housing, a builder usually needs to purchase an existing structure, tear it down and then build something new. We don't have the ability to increase our housing stock by any significant number. This combination of population growth and restrictions on building creates a buffer from house values taking a serious drop.

The cost of a commodity will not decrease as long as the demand for that commodity is increasing. No matter how out of hand a market gets, eventually the laws of supply and demand will bring things back to normal.

If you're thinking about buying a home but you're waiting for prices to collapse, you may want to rethink that position. Local housing demand is going to prevent any serious drop in prices. Although lending standards have tightened, mortgages are still being granted and at historically low interest rates. If inflation becomes a problem, cheap money will disappear, thus making owning a home more & more expensive.

No one can predict the future. Don't let the "magnifying effect" of the news media determine the decisions you make. Look at all the facts as objectively as possible, draw you own conclusions and make the decision from there. If nothing else, it will be your decision!

Impact of a Fed Rate Cut

2007-10-30T13:30:00.000-04:00

What will happen if the Fed cuts the rate tomorrow? We've read about the overall effects. Lower short term rates may bring some stability to the bond market and lower long term rates will bring the cost of mortgage money down. It will further devalue our dollar making our exports cheaper around the world. By the same token, it will make imports more expensive and should encourage Americans to buy domestically produced products. It's generally hoped to stimulate the economy somewhat.

I want to look at the effects of a rate cut from the consumer's position. What is the impact of a cut in the Discount Rate to the average consumer? Most credit line mortgages as well as nearly all credit card interest rates are adjustable and are controlled by the Prime Rate. The Prime Rate moves in tandem with the Discount Rate. A rate cut by the Feds, as we had in September, has the immediate effect of reducing the minimum payments on nearly all credit line mortgages and credit cards. Since the average American carries a substantial amount debt, this increases the amount of disposable money available to most families at the end of the month. Americans have shown that given additional money, they are more likely to spend it than to save it, so this will encourage an increase in consumer spending. For the last few years our economy has been surviving on consumer spending and this helped keep the economy on track.

The downside of a rate cut is that it can fuel inflation. If you think back 20 to 25 years ago you will remember the problems we faced as a nation, because of inflation. We even went through a period of national price controls as a means to reduce the inflation rate. Double digit inflation was the norm and the goal was to force it into single digits. We've now gotten so accustom to a low inflation rate that the thought of inflation moving up to 4% is frightening.

Inflation erodes buying power but it does have a positive impact on people, companies or nations in debt. With the amount of outstanding debt in this country being so high, an argument can be made that inflation may actually be a good thing. I'm not suggesting that we develop a policy to encourage inflation, I'm just pointing out that if we begin to lose control of inflation there will be some positive effects in addition to all the negative ones.

There are no easy fixes to the financial problems we are facing. Until we all individually curb our spending habits and begin to take a long term view of our personal finances, we will always be in financial trouble. No government intervention will be able to get this economy back onto a strong foundation unless all Americans change their ways. There is no excuse for a negative saving rate for the citizens of the largest economy in the world.

The Basis of Today's Problems

2007-10-29T13:27:00.000-04:00

We are now witnessing the convergence of three economic circumstances. First, the subprime meltdown woke investors up to the real risk in low-grade paper. This sent the financial markets into turmoil. Housing markets such as Las Vegas and Miami had already laid the foundation for a disaster, by over building and excessive investor speculation. Even without the problems in the financial markets, these housing markets were headed for trouble. Prices in both these markets have been softening since last year.

Secondly, the unemployment numbers in the real estate field will get much worse before teh situation begins to get better. Layoffs in this industry impact communities to a lesser extent than other industries. When GM or Ford cut back, the economies of entire cities collapse. The real estate/mortgage industry is spread out all over the country; there are no “company towns” in this field. People that have been laid off can move into other fields without much, if any, retraining. Real Estate agents and mortgage originators are essentially salespeople. They will move into selling some other product. Even the back-office personnel can be more readily absorbed into the workforce. I’m not trying to minimize the difficulty of these transitions but I want to point out that, for these employees it’s a less stressful transition than it would be for employees of a manufacturing plant or a research facility that had to shut down.

Thirdly, and perhaps most signigicantly, today’s economy is forcing America into finally facing its day of reckoning. Deficit spending on both the governmental and personal levels have reached the breaking point. People have been supporting their lifestyles with the equity of their homes and their credit cards. The housing market wouldn’t be in crisis if people weren’t using their homes as ATM machines. Whatever programs are developed to address the problems in today’s economy will be just band-aid solutions. Until the basic spending habits of Americans and their elected leaders become more realistic, we are going to move from one economic crisis to another. You can spend more than you make for only so long.

Laws need to be thought through

2007-10-23T18:46:00.000-04:00

NY Times WASHINGTON, Oct. 22 — "House Democrats introduced legislation on Monday that would for the first time let homeowners sue Wall Street firms for relief from mortgages that the borrowers never had a realistic chance of repaying."

I don’t disapprove of the concept of holding people in the industry accountable for their actions. I do, however, have a problem with giving the consumer too much wiggle room.

I don’t have a lot of respect for subprime originators. I truly believe that the bad apples out-number the good by a large margin in this particular segment of the mortgage industry. I have a friend, Jim, who is a mortgage broker in Ohio, working exclusively in the subprime market. He started out working for a bank, eventually went out on his own and another bank bought his operation. I don’t know much about the way he conducts business but he did make an interesting point one day over dinner.

He raised the question, “When do you know a loan is a predatory mortgage?” Answer, “When the borrower misses his first payment!” His point is this. In most cases, the consumer is fully aware of the loan and it's terms and uses the loan specifically for a "bail out" scenario. As long as everything goes according to plan, the borrower moves towards getting back on his feet and repairing his financial situation. The borrower is satisfied with the mortgage, uses it for as long as it suits his needs and then as his situation improves, can refinance with better terms & rate, or sell the property and move on with his life.

But what happens when things don’t go as planned? The new job position that the borrower just took is eliminated or his marriage breaks up or a medical problem arises. The borrower can’t make his mortgage payment. The words "predatory mortgage" become the exit strategy for him to use to get out of a bad financial situation. People never blame themselves for their actions, it’s always someone else’s fault. A deep pocket lender then becomes an excellent target. "The broker should never have arranged for that loan," or "the broker should have known better."

You see my point. A law written that would be as one-sided as this one is, doesn’t do anyone any good. What needs to be written is a law that gets the thieves out of the mortgage business and at the same time permits a borrower to make a bad decision and deal with the consequences. Enacting a law that punishes the industry for all bad decisions does more harm than good. The net effect would be that there would be fewer options available for an individual to help himself out. This would not good public policy. We need to encourage the industry to develop mortgage programs and underwriting standards that would be difficult to abuse by originators as well as consumers, and at the same time afford consumers the tools needed to help them through bad financial periods in their lives.

We need to increase the level of quality of originator as well as hold him accountable for his advice. We also need to develop a means to verify that the consumer understands the potential consequences of his actions and is making an informed decision. We can't demand the industry prove that a borrower is making the right decision, especially in hindsight. The "right" choice is a subjective opinion. All we can hope to do is equip the applicant with the tools needed to make the decision that is "right" for them.

Be Careful What you Wish For

2007-10-20T16:20:00.000-04:00

I'm hearing more and more industry commentaries, wishing for the days of old when mortgages were written by the local bank. The friendly banker knew the customer, gave the customer a mortgage and collected the mortgage payments until the mortgage was paid off. The concept being that in the event the borrower ran into financial trouble, the banker would be in a position to work something out with the borrower so the borrower didn't lose his home.

Most mortgages today are written by lenders that will then sell the mortgage into the secondary market. The job of the secondary market is to pool large numbers of mortgages together to create a diverse group of credit grades, geographical regions, interest rates and loan-to-values. This pool in then securitized. That is, bonds are then issued at various interest rates that represent the level of risk the buyer is taking on. A simple example would look like this. A pool of mortgages having an average interest rate of 8.0% is assembled. The servicer of the pool collects the interest payments from each borrower. Bonds, called Mortgage Backed Securities (MBS), are issued yielding 3 different interest rates; 6.0%, 8.0% & 10.0%. As the mortgage payments come in, the buyer of the 6.0% MBS gets paid first. Once that obligation is satisfied then the holder of the 8.0% security is paid. Only then is the holder of the 10% note receiving any money. The investor willing to take the highest risk (the last in line to get paid) is entitled to get the highest return on his money (in this example 10.0%).

The problem in the mortgage market right now is because the actual default rate of mortgages is higher than expected, so not only is the investor who bought the highest yielding securities not getting paid, the more conservative investors are not getting paid what they expected. This is the basis of all the turmoil we are now seeing in the mortgage market.
There is no direct contact with the investor who purchased the MBS and the borrower. To make matters worse, pooling by its very nature makes it impossible to create a link from any one borrower to any one investor. This makes any form of a workout with a borrower that's in trouble, impossible. It's from here that the desire to go back to the "good old days" of lending seems appealing.

Securitization of mortgages was not only encouraged by the federal government, they created the first organization to implement it, Fannie Mae. The reason for the creation of securitization is being overlooked in these recent media commentaries. To begin with, securitization allows consumers to borrow money at a lower rate. A banker who expects to hold a mortgage for 30 years, at a fixed interest rate, will need to charge a rate high enough to cover his long term cost of money as well as the long term effects of inflation. A banker today can close on a mortgage and keep it on his books only for as long as he wants to. He can sell the mortgage into the secondary market any time he feels it make good business sense for the bank.

The other big advantage of securitization is that it allows for more liquidity in the marketplace. A banker holding every mortgage he closes is limited in the actual number of mortgages he can write. His total amount of outstanding mortgages can't exceed the total amount of money that has been deposited in his bank. By selling closed mortgages into the secondary market he is able to continue to write mortgages well in excess of his depository base. This gives him the tools he needs to continue writing loans into the community he is serving, supporting all levels of the local economy.

Nothing in life is perfect. For every positive there is a negative and the mortgage market is no different. The mortgage model of the "good old days" had the advantage of personal interaction between the borrower and the banker, yet was limited in the number of people it could serve. Securitization enables the industry to service a greater percentage of the population and at a lower cost. Its drawback is that when trouble arises it doesn't have the flexibility to address the problems facing each individual borrower.

So be careful what you wish for. You will regret having your wish for the "good old day" granted if you find yourself seeking a mortgage and can't get one. Being turned down because you've harmed your credit or don't earn enough money is one thing. Being turned down because the bank has no money to lend is a totally different problem, one this country hasn't had to face for many decades. Hopefully we'll never go back to the "good old days."

The Piggyback Risk

2007-10-18T10:24:00.000-04:00

Ever since the first FHA mortgage was written, lenders required an added level of insurance when writing a mortgage on a property that the owner had less than a 20% equity participation. FHA called this insurance MIP (Mortgage Insurance Premium). From the borrower's prospective, this required him to pay an additional upfront insurance payment in additional to the customary closing costs and an additional monthly insurance premium in addition to his normal housing expenses. From the lender's prospective, they could close on a mortgage in which the borrower had little or no cash investment in the property knowing that in the event of a default there was insurance available to absorb a portion of the lender's loses.

Learning from this government program, the insurance industry developed policies that lenders could use on non-government mortgages. Mortgage Insurance (MI) was offered to borrowers to enable them to purchase a home without investing 20% of of the purchase price. These MI policies have more flexibility than FHA's MIP. A borrower could elect to pay based on an annual policy, a monthly policy or can even elect to pay a higher interest rate on his mortgage and have the lender pay for the insurance. Instead of dealing with a flat rate for all mortgages , as in the case of MIP, private MI companies price the premium base on the risk profile of the borrower. For example, a borrower investing 15% of the purchase price carries less risk of default than a borrower investing 3% and is therefore entitled to pay a lower premium.

In addition to reducing the risk to the lender, MI also added one more level of underwriting approval on a mortgage application. Not only does the lender's staff investigate the details of the transaction and of the borrower's qualifications but the MI company also underwrites the application and is a second set of eyes looking over everything prior to a mortgage being committed.
In an attempt to offer borrowers more options in mortgage financing the industry developed a new program known as the piggyback. The piggyback is the utilization of 2 mortgages instead of one when financing a property. Although there are numerous reasons to do this, we are only going to look at one in particular. That is, using a combination of 2 mortgages to replace the need for MI. On the surface, there shouldn't be a problem here. The first mortgage is typically written as an 80% loan-to-value (LTV) and priced as a first mortgage should be. A second mortgage is then underwritten and priced as a higher risk loan. From the borrower's prospective this usually meant that the overall cost of the financing would be less that when MI is added onto a high LTV first mortgage. Saving a consumer money is a good thing so this became a popular mortgage program to be recommended by originators.

Unfortunately, the default rate on piggyback mortgages is proving to be higher than on first mortgages written with MI. Since there is no insurance company involved, the lender is exposed to all losses in the event of foreclosure.

The reason for this stems from the fact that insurance companies are better equipped to identify the magnitude of risk associated with an event and price the premium to suit. A mortgage written with MI added onto it wasn't generating more profits for the investors than a piggyback it was more accurately priced to reflect the risk of default. When lenders developed the piggyback, their analysis concluded that the higher interest rate they were receiving on the 2nd mortgage was adequate coverage for the projected performance of the mortgages. For a few years, their analysis proved correct. Market conditions changed and the default rate grew.
This is why we will be seeing tighter underwriting standards, as well as higher pricing, on piggyback mortgages going forward. Many lenders will likely stop accepting applications for piggybacks in response to the miscalculation of the risk associated with this form of financing.

Like most industries, the mortgage industry mirrors a pendulum motion. It swings towards more liberal underwriting standards until it goes too far. It then swings back to a more conservative period until is moves too far in that direction. It then begins the cycle all over again.

Responsibility

2007-10-16T11:12:00.000-04:00

There has been a lot written in the media recently regarding the problems in the mortgage market. The tone of most of what has been written, has focused on the poor treatment of the homeowner/home buyer by the industry through the originator. The point of contact between the applicant and the mortgage market is the originator, making him responsible for most of the customer interaction. Problem mortgages occurred for a number of reasons. Right now I want to focus on the originator and the products he has at his disposal. We are not going to address the reasoning behind the formulation of the various products and their associated underwriting standards now, we'll do that at a later date.

The originator has a toolbox of programs at his disposal and it is his job to help the applicant decide what product best suits his needs. We need to keep in mind that I will be addressing originators working for a mortgage broker not a mortgage banker. There is an important difference. The originator working directly for a lender has a limited job description. His job is to explain the various products offered by his employer and then accept the application from the applicant. His job is information delivery, he is not serving as an advisor to the applicant.

The originator working for a mortgage broker has a higher level of responsibility. Not only is he expected to be able to explain the various products to the applicant but he is also there to aid in the decisions made by the applicant. It's important for a consumer to be aware of this difference. A consumer's expectation of an originator's scope of work needs to be in alignment with what the originator can do.

The industry, for the most part, has not done an adequate job in training and supervising its originators. This situation is in the process of being corrected through two main avenues. First, through government intervention. Up until now there were no standards for education, for an originator. It was left up to the employer to set his own standards. It seemed reasonable enough, after all the employer would ultimately bear the cost of any incompetence of an employee, so is motivated to set reasonable standards. Time has proven that this hasn't been the case, so each State is setting its own educational standards and is also doing background checks on originators before permitting then to conduct business. The second avenue is employers have learned that giving pricing flexibility to their originators is not sound business. It encouraged originators to price loans based on maximizing their personal profit, not based on competition in the marketplace. This resulted in applicants paying more than they should have for their financing when they trusted their originator. More bankers as well as brokers have moved towards more standardized pricing models.

The actions of these poorly trained and unprofessional originators are responsible for a portion of the problems we are currently facing in the marketplace. We'll never be able to calculate what percentage of the problems can be attributed to these individuals but they were not responsible for 100% of the problems. This is the subject of this post. The shared responsibility of the applicant and his originator.

For the purpose of this discussion the originator is working for a mortgage broker. He is knowledgeable and offers the same pricing model to all his clients. The applicant has his own particular goals and his own personal level of risk aversion. It's important to recognize that the originator and the applicant will have a different level of acceptable risk in their individual decision making process. Some people only feel secure working for a company & getting a regular pay check and full benefits. Others are more daring, owning their own business and never really knowing when their next pay check is coming. Some people have a lifestyle that carries heavy expenses every month, leaving less to pay a mortgage where other people are so focused on owning a home they will make whatever sacrifices necessary to own the home of their dream.

It is the originator's job to explain to the applicant, the details of the financing he/she is seeking, allowing the applicant to make an informed decision. When I'm training originators, I make a point of telling them they are the applicant's consultant, not his mother. It's not the originator's job to impose his opinion onto the applicant but to help the applicant understand the impact the mortgage payment is going to have on the applicant's personal life. It is the applicant's right to take whatever risk he feels comfortable with and only time will tell if he has made the right decision. If the applicant gambles and wins, he now can enjoy the benefits of the decision. If he gambles and loses, he then suffers the consequences.

The originator's responsibility is to supply the applicant with a clear understanding of what he is doing, make suggestions as to the recommended course of action and explain the potential consequences of the various courses of action available. His job is not to protect the applicant from making a bad decision, only warn him of potential shortcomings of the decision.
When the housing market is strong, all homeowners look brilliant. Even bad decisions turn out to be profitable ones to the homeowner. However, when the market takes a bad turn, the opposite occurs. What seemed like good conservative decisions do not turn out to be as profitable as they should and bad decisions become much worse.

It's at this point that a homeowner begins to look for reasons they got into trouble. When we are in trouble or facing a problem we reach out to find the reason it's happening. People will generally look outside themselves for the cause of the problem. They didn't make a bad decision, someone else told them what to do or nobody explained to them what could happen.
This attitude is wrong on a number of levels. If we don't look to see our own mistakes, we'll never learn from them and be destined to repeat the same mistake over and over. By blaming the mortgage industry for all the current problems, the availability of mortgage products will be drastically curtailed, limiting the options of tomorrow's borrowers. Originators who have been conducting business in a professional manner may be forced to leave the business, making it more difficult for a consumer to find good advice.

In order to minimize the damage of this housing correction and reduce the chances of it happening again, we need to examine all the contributing factors and address them. Everything from the government's drive to increase the homeowner percentage of the population, through aggressive underwriting standards from the lenders, to originators not doing their jobs properly right down to mistakes made by consumers. All aspects need to be considered not just the contribution made by the industry.

Introduction

2007-10-15T14:30:00.000-04:00

The consumer has never dealt with a mortgage market such as we are dealing with today. Even industry veterans are having problems understanding it. I've always tried to give my clients a complete understanding of the home buying process and the skills needed to fit a particular mortgage into their lives. There is a library of articles I've written and courses that I teach at http://www.shelter-rock.com/. I invite anyone to visit the site to learn more. What I am hoping to accomplish here is to create a place for people to post any questions, concerns or comments they have regarding the housing market and through an ongoing discussion, we can all develop a better understanding as to what's happening.