What's up with the Economy?

Well friends, it looks like the battle is underway!

Our beloved federal government is throwing more cash at the recession that most have admitted is either upon us or looming around the corner. Jim Juback, at MSN Money says, "Don't count on a 'normal' recession" citing that recessions post-1983 lasted shorter and were less protracted than 'normal recessions' between 1959 - 1983. He argues for a 12 month long recession with at least a 2% decline in real GDP. What does this mean? Basically, there's -2% expansion for 4 quarters....simply put. (see Jubak's Journal Don't count on a 'normal' recession 1/25/2008)

In a recent issue of Businessweek, Europe reports a housing slump in Britain, and forecasts of a 5.5% profit drop for European companies. It reads, "The subprime crisis has clobbered Europe's financial sector, with banks such as Switzerland's UBS and Britain's Barclays and Royal Bank of Scotland taking huge writedowns in recent months..." (BusinessWeek Behing Market Turmoil, Europe is Weakening 1/24/2008) Essentially, the author says that you can look to the European Central Bank (the Fed's cousin) to start lowering interest rates soon, in order to stave off Euro-style recession.

These are weird times, we've never really seen such interconnectedness among international markets fraught with such issues. For instance, take Ambac Financial and MBIA. These two companies are "AAA" rated bond insurer companies. What does this mean? Basically, these investments are the safest investments possible on the market: hence the triple A rating. A bond insurer is a company that insures public works projects (roads, schools, etc.) against default. Ultimately, if these bond insurance companies are not bailed out, you will see a severe shakeup on the domestic front. There will be fewer government, tax-funded projects. (This can be a good thing depending upon your political viewpoint).

And, beyond all this, you have the housing slump, slouching even further. Even though we are technically not a 'declining market' according to Fannie Mae (nation's largest home mortgage underwriter) it has now come to the Pacific Northwest and the resilient Charlotte, North Carolina. The correction is fully underway now, and in the words of one realtor in Arizona, "For now, people trying to sell homes 'don't seem to have a prayer' in competing with lenders offering foreclosed homes and builders dumping excess inventory". (The Wall Street Journal Housing Slump Starts to Hit Stronger Cities 1/24/2008) The article goes on to report that prices in Seattle will fall further due to all the condominium building downtown (just look out your downtown window and check out all the cranes). Suffice it to say, it's a buyer's market folks! I hope you have your cash on hand! I'm counseling clients to sell only if they have to, and get ready to buy a steal of a deal either at the auction block or through a short-sale 3-9 months from now.

You will also notice that many homebuilder's ratings have been further cut. D.R. Horton has been junk status since November 2007. Meritage, Hovnavian, and M/I Homes have been cut as of 1/17/2008 to junk (that means non-investment) status.


What does all this information mean?

This means that it's a great time to have cash. It's a buyer's market out there, and it can only get better. Long-term investors should be pumping money into good mutual funds, with an allowance for commodities as hedges against inflation. It's a great time to get a 'deal' on a house, and if they don't accept your price....don't buy it! Interest rates are forced low by the Fed's actions, which means you can carry that mortgage at a low rate, in the 5's for a 30 year fixed!

Ultimately, be patient. The economy's not going to totally collapse. We've had this coming a long time, just look at our spending habits as Americans. Be patient, keep investing and diversifying for protection. The stimulus package will likely be shrugged off within a quarter of being implemented, which will likely send commodities soaring.

Pay your mortgage down. Don't sell. Be happy where you are. Work hard and save and we'll see what happens!

1-23-2008 Historic Day for Interest Rates!!!

Well, what a birthday present. I awoke this morning to see the Dow Jones tanking down to mid-11,000's levels. While that was bad for investors, it was great for interest rates. For instance, interest rates were all the way down to 5% on a 30 year fixed at the lowest point in the day.

Great birthday present right?!?

HA!

If that was all that happened, sure...

At 11am, it all started. That's because it was 2pm Eastern Time, and lenders were starting to reprice their interest rates. The Dow Jones rallied hugely, and ultimately the lender repriced their loans 4 times in 1 single day! (I've never seen that before). This means that if you had 5% on a 30 year fixed this morning, well, after the repricing settled, you were now looking at 5.75% on a 30 year fixed.

This day will go down as a hair-pulling, crazy day. I hope these markets will cool down sometime so we get some normalcy here. Volatility is great, but it sure takes years off your life.

Will Brazil's economy continue apace?

The current market crunch is largely due to investor confidence. It's not like the investors don't have the money. They do, they're just unwilling to invest in several sectors, these investments are largely in commercial paper and mortgage-backed securities.



As many investors continue look abroad, the eye falls on Brazil and its potential.



Known for its vast resources, Brazil is only starting to get into its stride. Let's take a look at some figures.



The Bovespa index .BVSP has gained 43.5% this year alone. The Brazilian stock market comprises about 70% of the total investing done in all of Latin America. You can read about the Bovespa's history here.



Latin American mutual funds have been top performers, posting gains of 48-52% for the last 5 years, per annum. While the fund BlackRock Latin America I (MALTX) has a year-to-date return of 45.63%, the initial investment required is 2MM. However, for the rest of us,
the BlackRock Latin America A (MDLTX) fund has posted a year-to-date of 45.33%. The great news is that the initial investment is $1,000....this is more to my taste. (You'll notice both these funds have the same fund manager).



Let's take a look at the future resources Brazil has. They are the world's trendsetter for sugar-cane derived ethanol, used for biofuels. Read what one newsgroup says here. And, if that weren't enough, they have discovered what may be one of the worlds largest oil reserves. The Brasilian oil company, Petrobras, has discovered an oil reserve that would rival Venezuela and Saudi Arabia. You can find what the BBC News reports here. Apparently, Brazil isn't a member of OPEC....yet.



Lastly, the currency....is it for real? (this is the extent of my humour) The Brasilian REAL has posted gains of 20.8% year-to-date against the US Dollar. You can expect the demand for this currency to grow as Brazil's natural resource grow as well. People want to be associated with a country that has potential. The Real is here.



So, we have the following.



1. A Roaring Stock Market up 43.5% on the year

2. Latin American Mutual Funds performing 48-52% on average each year for the past 5 years

3. Strong in the Boifuels industry and if that tanks....we've got some serious oil here, folks

4. The currency is being gobbled up, and is up 20.8% year to date



Given these four factors, I'd say it's definitely a good investment strategy. However, someone should study a more developed country that's similar, and see what stage of that country's development Brazil would analogously be in...that might add some wisdom to this article.



I do believe one thing. As the credit market continues to feel the crunch, and as Central Banks across the world seek to add liquidity, we don't see this kind of news coming from Brazil. Sure, they're creating liquidity, but not as much (it would appear) as other central banks. Given this, they're a good investment.

Amendment to my comment yesterday on: Senate Bill 2452...

I just received word from Alexandra, who works in the Banking division at Senator Dodd's office [D-CT] that, yes, YSP can be collected on "prime or near-prime loans" and that points and fees can be financed into these 'non-high cost mortgages'.

This is good news. Why? This is good news because the S 2452 Bill is basically eradicating subprime mortgages. Honestly, I have no problem with that. My only fear is that this will also eradicate, if passed in its current form, any legitimate Stated Income loans for self-employed borrowers or any Investment loans for investors.

So, ultimately, I must confess that I am not entirely opposed to such a bill. However, I think the market and 'reasonable regulation' should decide. Who knows....maybe this is reasonable regulation?

I would like to state that the mortgage broker will not be eliminated as a result of this bill. Why did I not understand this yesterday? Well, I read the bill in its entirety, and the legaleese got me. However, I did blog a bit prematurely on it.

Thanks for your patience!

Senate Bill 2452, The Dissolution of Yield Spread Premiums....The Mortgage Broker Extinction?

Just recently, Senator Christopher Dodd [D-CT]sponsored a bill to amend the Truth in Lending Act, "providing protection to consumers". Let's see if it really does just that.

I want to focus on the two main parts of this bill, that I believe (and others) will eliminate the role of the mortgage broker. If this happens, we will revert to a bank-only industry dominated by the big banks (due to the elimination of 205 banks this year here).


Title I, Section 102, subsection (c), part (m) states, "No Yield Spread Premiums" and goes on to labour the fact that no mortgage loan originator can receive any YSP (Yield Spread Premium) from the bank they broker the loan to.


What does this mean? Well, the broker buys the interest rate at a wholesale price (typically 0.5% less than retail banks), and they increase the interest rate to earn a commission from the bank and lower the borrower's closing costs. For example, if I get a 30 year fixed interest rate at 6% and sell it to you, the consumer, at 6.25%, then that typically means I will get 0.75% of the loan amount. If the loan amount is $300,000, that means I will get $2250. This can reduce your closing costs by $2250. *As a sidenote, easy loans with high credit and down payment normally experience of about 0.75% YSP and 0.75% Mortgage Broker Fee with maybe a $300-500 processing fee from the broker as well. More difficult loans get charged anywhere from 2% to 3% total, these would be 100% financing loans or FHA loans with poor-average credit. Don't believe me? Take a look at your former HUD-1 Settlement Statement.


Effectively, then, the elimination of Yield Spread Premium will make the mortgage broker a discounted interest rate provider. While providing interest rates 0.5%+ less than retail banks, they will charge all fees upfront, thus increasing costs to the borrower.



Section 102, subsection (c), part (o) states "Restriction on Financing Points and Fees" and goes on to practically state that the mortgage broker's fee (including processing fee and any other fee) cannot be financed into the loan. This means that the borrower would need to pay for this out of pocket.


So, the mortgage broker cannot be paid YSP by the bank, and the fee cannot be financed into the loan amount. This, I predict, would effectively eliminate the role of the mortgage broker.


Why? Aren't Yield Spread Premiums not beneficial to the consumer?


Let's take a look...


By going to a bank, you'll typically find lower closing costs, but a higher interest rate. By going to a good, honest broker, you'll find lower interest rate with higher closing costs. Which is more important? Well, if my interest rate is 0.25% lower because I'm using a broker, but my fees are $3,000 higher on my $300,000 loan...that means that after 48 months I will start saving $750/year because of my mortgage broker.


But, you say, the average American only keeps their home for 36 months before upgrading or relocating!?!


Ok, I'll take that argument. That argument, right there, proves why mortgage brokers need to be allowed to receive Yield Spread Premium--to keep the borrower's out-of-pocket costs low. (I'm not saying it's wise to move around so often, though!)


If Senate Bill 2452 is enacted under its current form, we will see a recurrence of the big banking industries controlling mortgage lending practice. We will, in short, see a monopolization. It's plain and simple logic to those who understand that 2+2=4, that, the fewer people participating in a business, the less the competition. If you have less competition, you will have higher fees ultimately.


Banks make a Yield Spread Premium, it's just called "Service Release Premium". Think there's really a No Fee Mortgage? See this. Remember, you can't get anything for free. Ultimately, with less competition, the banks will charge more Service Release Premium, which means higher interest rates.


What is the solution?


The solution is less federal government interference, with state goverments regulating both bankers and brokers. Both thriving retail and wholesale lending businesses should be allowed to enjoy free competition with eachother and amongst themselves. It should never be only brokers nor should it be only bankers. Let the consumer educate themselves, shop around, and decide who has the best loan scenario. It should be up to you how to get your own loan.

Vote Ron Paul!

Should I borrow equity from my house and invest it?

In this post, I will cover a widely debated topic: Should a homeowner take equity out of their house to invest? I will cover three aspects. The investment here are mutual funds with a 20 year history of 13-16%...
and can be found: http://www.thestreet.com/funds/mutualfundinvesting/10385337.html)
We will assume our homeowner has a $300,000 mortgage at 7% on a 40 year fixed. I'm using 7% because it is a little high right now, and the mortgage amount is right for the Pacific Northwest market. The 40 year fixed is becoming the norm.

The first aspect will be the homeowner who takes out a 40 year mortgage and doesn't invest. He just makes his payments and gets the appreciation out of the house and the tax benefits from the interest deduction.

The second aspect will be the homeowner who pays off his $300,000 mortgage early and invests the mortgage payment into mutual funds. Once his mortgage is paid off, let's assume for sake of conversation that he continues to make his payment, but into a mutual fund.

The third aspect will be the homeowners who takes $150,000 cash out from the equity he has built up in his house and dumps it down into a mutual fund, then proceeds to make his monthly payments for 40 years to pay off the mortgage. He does not invest further into the mutual fund. (I am using a 150K mortgage instead of a 300K mortgage because many folks in the Pacific Northwest, who've owned a home for the past 3 years, have realised 150K in equity. Using a 300K perspective would be too favorable and unrealistic)


Our guy in the first perspective will realise this. He has a 300K mortgage at 7% interest for 40 years. His monthly payment is $1864.29. At the end of 40 years, he will have paid $894,861.04 in total payments. His total tax deduction is $594,861.04. If he's in the 25% tax bracket, that means that he will get $148,715.25 back. That means, ultimately, he will have paid $746,145.79 in total payments. At the end of 40 years, it's safe to say the home will be worth $968,611 (assuming a 3% annual appreciation rate).

So, our 1st guy has paid $746,145.79 in total payments to get a home worth 1.5MM tops. Think you can retire on that?


Let's continue...


Our second gal pays off her 300K mortgage early, and starts to invest. Let's say it takes her 10 years to pay off the mortgage, which isn't unrealistic (the median income in Seattle, WA is 70K per year). She then invests for 30 years, which would equal the 40 years of our guy in scenario #1. She invests at an annual rate of return of 15%. You can click on the above link to find the Best Performing Funds over a 20 year Period. Yes, these 20 funds have performed anywhere between 13% and 16% for each of the past 20 years! She invests the monthly payment of our guy in scenario #1 into a mutual fund through her 401K/IRA/SEP/Deffered Tax Retirement Fund. That is $1865 each month into a fund. At 15% annual rate of return, she will have made: $11,189,036. When she taps the retirement account, she'll get taxed at roughly 30%. That means she only brings home 7.8MM dollars.

Now, do you think you can retire on that?


Our third aspect involves a hard working husband and really smart, savvy wife (whom the husband listens too). They realise their current appreciation and take $150,000 out of the equity of their home. That's all they invest into the same fund that our gal from scenario #2 invests in. They don't pay monthly into the fund, they just watch their investment grow. They use a Retirement Account for deferred tax purposes. What do you think they're worth at the end of their 40 year mortgage?

$40,179,532 dollars. Yes, that's right. But we can't forget the 30% tax can we? Awww....too bad, that means they only get 28MM dollars.

Now, do you think they can not only retire on that, but leave the principal untapped and retire only only on the interest payments? Then, when they die, they can give like they've never given before.

Work hard to live well and then give gladly~thanks!

The Home Loan Prepayment Penalty

This post will cover the nature of a prepayment penalty in how it relates to your home loan. What is it? Why do I consider it a negative thing? How do I know if I have one? Why do lenders offer prepayment penalties? What can be done to avert it?


First, what is a prepayment penalty?

A prepayment penalty is simply a 'penalty for paying your home loan off before an agreed time'. For instance, subprime loans, which most of you have heard of, come with prepayment penalties. What this means is that you typically aren't able to sell or refinance your home loan until 2-3 (in some cases, 5) years have passed. Considering that the statistical average for people paying off their home loan is 36 months, that's a tough rule to abide by.

There is a 'soft' prepayment penalty. This applies if you refinance only.
There is also another penalty, called a 'hard' prepayment penalty. This applies if you sell or refinance. Be sure which one you have.


Why do I consider a prepayment penalty a negative aspect of a home loan?

For instance, I bought a home on a 2 year fixed, subprime ARM back in 4/2006. I did my own loan, and knew it was a 2 year fixed...it was the only thing my 600 credit score could get, so the benefit outweighed the cost. My loan came with a 2 year prepayment penalty. This means that I couldn't sell or refinance within 2 years without having to pay "6 months' interest". Well, if my loan is 220,000 and the interest rate is 6.6%, then 6 months interest = $7260. WHEW! Yes, that's right: $7260. (As you're now figuring out, this is another potential hidden fee the banks place on certain loans). Let's just say I'm definitely not touching the loan until 4/08.

For obvious reasons above, I'm sure you now understand why a prepayment penalty is not a desirable thing. Some lenders will say, "You can always buy out of it!". Yeah, sure, for a 1-1.5% increase in interest rate! That isn't desirable.

However, in certain cases, a loan with a prepayment penalty is the only way you might get a home loan. The cost-benefit analysis needs to be employed; pros and cons both need to be weighed.


How do I know if I have a prepayment penalty?

Get a Truth in Lending Document from your broker/banker. There is a box near the bottom of the form, that says "You May/Will Not have to pay a penalty". You would want the "Will Not" section checkmarked.


Why do lenders offer Prepayment Penalties?

This is a more difficult question. There's no one answer. Lenders, when they fund your loan, package the loan and sell it to investors. These investors expect the loan to be performing for a certain numbers of years (3 years or so), and so the funding lender will put a prepayment penalty on the loan in order to guarantee a certain amount of income from this loan. If the borrower refinances early, then the income comes from the penalty; if the borrower keeps the loan for the specitfied period of time, then the lender gets the income from the monthly payments. Sometimes, lenders will put a prepayment penalty on the loan when the funding lender pays a 'rebate' to the broker. This is especially the case with the negative amortization/ negative interest/ Pay Option Loans (the 1% loans). I could go into this further, but suffice it to say that the prepayment penalty here is the amount of commissions your broker got when he first originated the loan....chew on that awhile.


What can be done to avert a prepayment penalty?

Trust your lender.
More specifically, try to get a Full Documentation of Income loan, where you prove your income. Some brokers/bankers will do a Stated Income loan just because it is easier and requires less documentation. Now, for those of you who are Self-Employed, like myself, and who's tax returns look like a foreign language Do-It-Yourself Handguide, Stated Income may be your only option. But, unless you write off everything under the sun, a good mortgage broker should be able to use your Tax Returns. However, there are still some very restrictive guidelines out there, and Stated Income may be the only way to go; just make sure there's no prepayment penalty. You may even have to switch loans (say from a 5/1 ARM Interest Only to a 30 year fixed full amortization).

Ultimately, though....you've got to Trust Your Lender. That's the real bottom line.