Would you pay $30,000 for a car if you could buy it for $20,000? Of course not. But it turns out that many people have done the equivalent with their mortgage loans. On May 30, 2007, CNN.money.com reported that many subprime borrowers could have gotten a prime mortgage. See http://money.cnn.com/2007/05/29/real_estate/could_have_had_a_prime/index.htm?postversion=2007053012. That means a lot of people got stuck with a more expensive mortgage than necessary.
Subprime mortgages can have an interest rate 3% higher than a prime mortgage. As the CNNMoney article points out, that difference can increase the monthly payments on a $200,000 mortgage by $300, or $3,600 a year. Can you afford to throw away $3,600 a year? That would be almost all the money you’re entitled to contribute annually to an IRA.
Why does this happen? Because mortgage brokers are rewarded to sell subprime loans. They are paid by commission, and a subprime mortgage’s commission can be as much as 5 times greater than the commission for a prime mortgage. So, like the car salesperson who wants you to buy a model with all the options, a mortgage broker has the incentive to sell you a subprime mortgage, whether or not you need one.
Who do you think covers the cost of the high subprime mortgage commissions? You, the borrower, do, if you take out a subprime mortgage.
What can you do? If you’re already in a subprime mortgage and think you're prime quality, try to refinance into a less expensive mortgage. If you're just looking for a mortgage loan, comparison shop. Shop for a mortgage just like you would shop for a car. People routinely contact several car dealers when looking for the best deal on a car. (See our recent blog on how to get a good deal on a new car: http://blogger.uncleleosden.com/2007/05/buy-new-car-without-haggling-and-save.html.) Contact several lenders—try the bank where you have an account, or a credit union if you can join one. Then try the next few banks and credit unions down the street. Do this without going through a mortgage broker, and see what quotes you get.
If you want to use a mortgage broker, look for one who will work for a fixed fee that is set in advance, without any commissions or compensation from anyone but you. A fixed fee will reduce the incentive for the broker to put you into a high-interest rate mortgage you don’t need. An organization called Upfront Mortgage Brokers Association (www.upfrontmortgagebrokers.org) may be able to help you find a broker willing to work for a fixed fee.
Interview a mortgage broker before hiring him or her. Ask about all of his or her sources of compensation and whether the broker will be paid more if you are sold a mortgage with features that may be costly to you (like higher or increasing interest rates or a prepayment penalty). Also ask the broker how many lenders he or she deals with regularly. You want to find out if the broker will work aggressively to get you the best deal, or will simply place you with a lender with whom he or she has had a long-standing relationship. Not all mortgage brokers are crooks, but it pays to be careful.
Keep your mortgage loan simple: look for a 30-year or 15-year fixed rate mortgage. These loans are pretty straightforward, which makes comparison shopping easier. Also, your risks are lower because by definition the interest rate won’t go up. See our earlier blog about why the right mortgage loan helps you build wealth
(http://blogger.uncleleosden.com/2007/05/how-right-mortgage-loan-helps-you-build.html).
Crime News: You’ve heard of cat burglars stealing jewelry. This one must have been a tiger burglar. http://www.wtop.com/?nid=456&sid=1153406.
Showing posts with label mortgages. Show all posts
Showing posts with label mortgages. Show all posts
Wednesday, May 30, 2007
Wednesday, May 23, 2007
Get Some Fast Money: The Employer Match
There is a way you can get fast money, for real and you won't have to do any extra work. It's the employer match in a 401(k) account. Employer sponsored retirement savings plans, like 401(k)s and their equivalents (such as the federal government's Thrift Savings Plan) often have a feature where your employer matches your contributions up to a certain percentage. For example, an employer might match up to 3% of your salary or wages that you contribute to the plan. The match is equivalent to an immediate 100% return on your investment. There's nothing in the financial markets that an ordinary investor can get which would be better.
With some 401(k) plans, the employer match may not "vest" (meaning, truly belong to you) unless you stay with the company for a minimum period of time, such as 3 years. Even so, the employer match is a great deal and you should get it.
What if you have high interest rate credit card debt and would like to pay it off? Should you do that before investing in 401(k) to get the employer match? No. The return on the employer match is better. Cut back on your spending in order to pay off the credit card debt.
What if you want to save up money outside a 401(k) in order to accumulate a downpayment for a house? It's good if you're trying to put a downpayment together, because these days, with the messy state of the mortgage market, people who have a downpayment are more likely to be approved for a mortgage. But the employer match pays a better return than buying a home. So get the employer match; and try to save a downpayment some other way.
What if school loans are like thunderclouds hanging over your head and you want to get rid of them as soon as possible? You'd get more value from obtaining the employer match than from paying down school loans a little faster. If the school loans are driving you crazy, ease up on unnecessary spending. But don't cut back on the best retirement financing deal most people will ever get.
The employer match is about as close as most of us will ever get to free money. Don't pass it up. If you have access to a retirement account with one, contribute at least enough to get the match; and more if you can, since retirement isn't getting cheaper.
Strange News: Drilling for natural gas begins at Dallas-Fort Worth International Airport--http://news.yahoo.com/s/nm/20070523/od_uk_nm/oukoe_uk_energy_drilling_airport. But will they share the wealth with the passengers? How 'bout some free peanuts, at least?
With some 401(k) plans, the employer match may not "vest" (meaning, truly belong to you) unless you stay with the company for a minimum period of time, such as 3 years. Even so, the employer match is a great deal and you should get it.
What if you have high interest rate credit card debt and would like to pay it off? Should you do that before investing in 401(k) to get the employer match? No. The return on the employer match is better. Cut back on your spending in order to pay off the credit card debt.
What if you want to save up money outside a 401(k) in order to accumulate a downpayment for a house? It's good if you're trying to put a downpayment together, because these days, with the messy state of the mortgage market, people who have a downpayment are more likely to be approved for a mortgage. But the employer match pays a better return than buying a home. So get the employer match; and try to save a downpayment some other way.
What if school loans are like thunderclouds hanging over your head and you want to get rid of them as soon as possible? You'd get more value from obtaining the employer match than from paying down school loans a little faster. If the school loans are driving you crazy, ease up on unnecessary spending. But don't cut back on the best retirement financing deal most people will ever get.
The employer match is about as close as most of us will ever get to free money. Don't pass it up. If you have access to a retirement account with one, contribute at least enough to get the match; and more if you can, since retirement isn't getting cheaper.
Strange News: Drilling for natural gas begins at Dallas-Fort Worth International Airport--http://news.yahoo.com/s/nm/20070523/od_uk_nm/oukoe_uk_energy_drilling_airport. But will they share the wealth with the passengers? How 'bout some free peanuts, at least?
Tuesday, May 22, 2007
The True Price of Affordable Loans
We all know it's a bad idea to let an eight-year old loose in a candy store. Temptation and self-restraint will be mismatched, and cavities, hyperactivity and weight gain will follow. Today's credit market is about the same.
The U.S. economy is awash in credit. Vast quantities of the stuff roam around in every direction, like the enormous herds of bison that swept across the prairies 150 years ago. The abundance of credit puffed up the real estate markets until they bubbled and popped. In the financial markets, the ready availability of credit has enabled hedge funds to accumulate vast investment portfolios funded by borrowed money, and more recently has financed a flurry of "private equity" deals, in which private investors and corporate managements buy up major public companies using credit that banks line up to provide. All this activity has pushed blue chip stocks to record levels. But are these prices sustainable? Only time will tell.
For consumers, there's no shortage of credit, either. Credit card offers in our daily mail kill entire forests. If you have any unused equity in your home, banks rush to offer home equity lines of credit to burn up that equity and convert it into debt payments for you. Car loans now have longer and longer terms in order to make them "affordable" (meaning small enough for you to pay each month). All of this comes at a price, and it isn't cheap.
Car loans illustrate the point. Back in the bad old days when grown men wore leisure suits, cars were usually sold with three-year loans. If you assume an interest rate of 6%, a three-year loan increases the dollar cost of the car by about 10%. For example, a $25,000 car ends up costing about $27,500.
Today, many car loans have terms of five to six years. A six year loan at 6.5% (rates on longer term loans are higher than rates on shorter term loans) will increase the total dollar cost of the car by about 20%. The same $25,000 car ends up costing in the range of $30,000. Of course, the monthly payment on the 6-year loan is much lower--maybe 40% lower (about $425 a month for the 6-year loan, versus approximately $750 a month for the 3-year loan). That's why people take out the longer loans. But they end up paying more for the same car.
A related problem comes up with real estate mortgages. Some mortgage lenders are now offering 40-year fixed rate mortgages as a way to qualify people to buy homes. Arithmetically speaking, a 40-year mortgage costs many more dollars than a 30-year mortgage (around 30% more; so if you're talking about a $200,000 mortgage, that's an extra $60,000 for the same house).
You don't plan to stay in the house for 40 years, so you ask why does it matter? Because the rate at which you build equity in the house is slower with a 40-year mortgage than with a shorter mortgage. The early payments in any mortgage are mostly used to pay interest charges. Only a small portion goes to reducing the principal balance of the loan. As you make more mortgage payments, the amount that goes to reducing the principal gradually increases and you begin to build equity in the house (equity being the value that is yours). A 40-year mortgage with an interest rate of 6% increases your equity in the house by about 8% of the amount of the mortgage loan after the first ten years (about $16,000 for a $200,000 mortgage). A 30-year mortgage with the same interest rate will increase your equity in the house by about 16% of the mortgage loan in the same time period (about $32,000 for a $200,000 mortgage). Given that housing prices are now flat or dropping in most areas, paying down the principal of the mortgage is pretty much your only way to build equity. The monthly payments on a 40-year mortgage might be about 8% or 9% lower than the monthly payments on the 30-year mortgage. But you pay a large price in terms of slower equity growth to get that reduction.
For more information about the risks of financing your home purchase with "affordable" mortgages, please read our May 10, 2007 blog, "How the Right Mortgage Loan Helps You Build Wealth" (http://blogger.uncleleosden.com/2007/05/how-right-mortgage-loan-helps-you-build.html).
Remember that you will get a finite amount of money in your lifetime--basically, what you earn, what you gain from investments, anything you inherit, and your lottery winnings (haha, just a joke for 99.9999% of us). The more of your finite lifetime income you spend on interest payments, the less you will have for steaks and champagne. This is a zero-sum game: either the banks get your money, or you get it.
The reason why banks crowd around throwing credit at you is because they stand to make big money lending to you. From your standpoint, the problem with that is the big money comes out of your pocket. Borrow if you must, and borrow for a good reason. Getting an education is a good reason. Buying a house is a good reason. Buying a car is a good reason. But not every loan is a good loan. Buy less house or less car if necessary to keep your borrowing under control. You can't borrow your way to a comfortable retirement. You can save your way to a comfortable retirement.
Celebrity News: Paula Abdul and the risks of owning a Chihuahua--http://www.nbc4.com/entertainment/13364020/detail.html.
The U.S. economy is awash in credit. Vast quantities of the stuff roam around in every direction, like the enormous herds of bison that swept across the prairies 150 years ago. The abundance of credit puffed up the real estate markets until they bubbled and popped. In the financial markets, the ready availability of credit has enabled hedge funds to accumulate vast investment portfolios funded by borrowed money, and more recently has financed a flurry of "private equity" deals, in which private investors and corporate managements buy up major public companies using credit that banks line up to provide. All this activity has pushed blue chip stocks to record levels. But are these prices sustainable? Only time will tell.
For consumers, there's no shortage of credit, either. Credit card offers in our daily mail kill entire forests. If you have any unused equity in your home, banks rush to offer home equity lines of credit to burn up that equity and convert it into debt payments for you. Car loans now have longer and longer terms in order to make them "affordable" (meaning small enough for you to pay each month). All of this comes at a price, and it isn't cheap.
Car loans illustrate the point. Back in the bad old days when grown men wore leisure suits, cars were usually sold with three-year loans. If you assume an interest rate of 6%, a three-year loan increases the dollar cost of the car by about 10%. For example, a $25,000 car ends up costing about $27,500.
Today, many car loans have terms of five to six years. A six year loan at 6.5% (rates on longer term loans are higher than rates on shorter term loans) will increase the total dollar cost of the car by about 20%. The same $25,000 car ends up costing in the range of $30,000. Of course, the monthly payment on the 6-year loan is much lower--maybe 40% lower (about $425 a month for the 6-year loan, versus approximately $750 a month for the 3-year loan). That's why people take out the longer loans. But they end up paying more for the same car.
A related problem comes up with real estate mortgages. Some mortgage lenders are now offering 40-year fixed rate mortgages as a way to qualify people to buy homes. Arithmetically speaking, a 40-year mortgage costs many more dollars than a 30-year mortgage (around 30% more; so if you're talking about a $200,000 mortgage, that's an extra $60,000 for the same house).
You don't plan to stay in the house for 40 years, so you ask why does it matter? Because the rate at which you build equity in the house is slower with a 40-year mortgage than with a shorter mortgage. The early payments in any mortgage are mostly used to pay interest charges. Only a small portion goes to reducing the principal balance of the loan. As you make more mortgage payments, the amount that goes to reducing the principal gradually increases and you begin to build equity in the house (equity being the value that is yours). A 40-year mortgage with an interest rate of 6% increases your equity in the house by about 8% of the amount of the mortgage loan after the first ten years (about $16,000 for a $200,000 mortgage). A 30-year mortgage with the same interest rate will increase your equity in the house by about 16% of the mortgage loan in the same time period (about $32,000 for a $200,000 mortgage). Given that housing prices are now flat or dropping in most areas, paying down the principal of the mortgage is pretty much your only way to build equity. The monthly payments on a 40-year mortgage might be about 8% or 9% lower than the monthly payments on the 30-year mortgage. But you pay a large price in terms of slower equity growth to get that reduction.
For more information about the risks of financing your home purchase with "affordable" mortgages, please read our May 10, 2007 blog, "How the Right Mortgage Loan Helps You Build Wealth" (http://blogger.uncleleosden.com/2007/05/how-right-mortgage-loan-helps-you-build.html).
Remember that you will get a finite amount of money in your lifetime--basically, what you earn, what you gain from investments, anything you inherit, and your lottery winnings (haha, just a joke for 99.9999% of us). The more of your finite lifetime income you spend on interest payments, the less you will have for steaks and champagne. This is a zero-sum game: either the banks get your money, or you get it.
The reason why banks crowd around throwing credit at you is because they stand to make big money lending to you. From your standpoint, the problem with that is the big money comes out of your pocket. Borrow if you must, and borrow for a good reason. Getting an education is a good reason. Buying a house is a good reason. Buying a car is a good reason. But not every loan is a good loan. Buy less house or less car if necessary to keep your borrowing under control. You can't borrow your way to a comfortable retirement. You can save your way to a comfortable retirement.
Celebrity News: Paula Abdul and the risks of owning a Chihuahua--http://www.nbc4.com/entertainment/13364020/detail.html.
Thursday, May 10, 2007
How the Right Mortgage Loan Helps You Build Wealth
One of the basic principles of personal finance is to keep things simple and understandable. Simplicity allows you to understand where your risks are, and to figure out how to deal with them effectively. Complicating your personal finances forces you to drive on foggy roads, and you may not see every obstacle in time to avoid it.
The most recent illustration of this point is in the real estate markets. Many homeowners are struggling to meet payments on interest only mortgages, adjustable rate mortgages and option ARMs. Foreclosure rates are increasing. And, with real estate values sluggish or dropping in many major markets, your ability to refinance out of a bad loan is limited or nonexistent.
Interest only mortgages and option ARMs seem like great loans at first. You need to make only modest monthly payments, and it's easy to qualify for a nicer house than you thought you could buy. However, it's important to understand that these loans allow you to delay repayment--but not indefinitely. An interest only loan lets you pay only the interest on the loan for a short time, such as a year or two or three. Then you will have to start paying the principal of the loan. Your monthly payment will jump, and by quite a bit.
The option ARM allows you not only to delay repaying the principal of the loan at first, but also to delay payment of some of the interest. But the unpaid interest is added to the principal of the loan, effectively increasing the amount of the debt. The monthly payments in options ARMs tend to increase sooner rather than later (sometimes within months). With the addition of unpaid interest to the principal, the increase in monthly payments could be seriously painful.
Adjustable rate loans begin with an interest rate that will be effective for a year, or a few years. Then the loan rate will change as interest rates in the financial markets change. But the change is likely only to go upwards. Adjustable rate loans tend not to decrease the rate (you usually have to refinance to get a lower rate). You could see a big jump in payments if interest rates rise significantly.
The common thread among all these loans is that they are complicated and often unpredictable. You can't effectively budget or plan for your long term financial well-being if you don't know what your mortgage payment will be in a year or two. Things only get worse if you can't afford the increased payment. You may be unable to buy the new car you need, and will have to hope the brakes and tires on your old car last a while longer. Money you wanted to save for your golden years or your child's college expenses may be devoted to the greater profitability of your mortgage lender.
So, what to do? Use a traditional fixed rate mortgage. This loan locks in your housing costs. You know how much you'll have to pay each month of the loan. There will be no surprises. Once the loan payment is fixed, you can budget around it and allocate money for savings. Look back at the World War II generation. Before the war, mortgages tended to be for a short duration (like 5 years) and require substantial downpayments (like 50%). When the GIs returned from the war, the 30-year fixed rate mortgage came into common usage. The housing market boomed and home ownership rates rose. With fixed housing costs, the members of this generation could and did build wealth perhaps like no generation before them. They were often able to fully pay for their homes and save money beyond that.
Yes, initially the cost of a fixed rate mortgage is higher, with a larger monthly payment. But no one can predict the direction of interest rates. A loan with an adjustable rate, or which you have to refinance in a few years because you can't afford the payment increases, may cost you more over the long term than a fixed rate mortgage. Further, incomes tend to rise over time, so your income will probably increase while a fixed rate mortgage's monthly payment does not. The extra money can enhance your lifestyle and increase your retirement portfolio. People earning $5,000 a year in 1955 might have had a mortgage payment of about $150 a month (seriously, many mortgage payments were this low). By 1975, they might have been earning $15,000 or $20,000 a year; but their mortgage payment was still $150 a month. That's a good situation to be in.
Fixed rate mortgages may not initially be as easy to get or pay as other, more complex loans. But most things in life worth doing or having don't come easily. The fixed rate loan ultimately makes your life simpler and easier. That will be conducive to your financial well-being. Even if you have to buy less house, you'll have more peace of mind.
Personal Grooming News: Men wearing makeup--http://www.wtop.com/?nid=456&sid=1137695.
The most recent illustration of this point is in the real estate markets. Many homeowners are struggling to meet payments on interest only mortgages, adjustable rate mortgages and option ARMs. Foreclosure rates are increasing. And, with real estate values sluggish or dropping in many major markets, your ability to refinance out of a bad loan is limited or nonexistent.
Interest only mortgages and option ARMs seem like great loans at first. You need to make only modest monthly payments, and it's easy to qualify for a nicer house than you thought you could buy. However, it's important to understand that these loans allow you to delay repayment--but not indefinitely. An interest only loan lets you pay only the interest on the loan for a short time, such as a year or two or three. Then you will have to start paying the principal of the loan. Your monthly payment will jump, and by quite a bit.
The option ARM allows you not only to delay repaying the principal of the loan at first, but also to delay payment of some of the interest. But the unpaid interest is added to the principal of the loan, effectively increasing the amount of the debt. The monthly payments in options ARMs tend to increase sooner rather than later (sometimes within months). With the addition of unpaid interest to the principal, the increase in monthly payments could be seriously painful.
Adjustable rate loans begin with an interest rate that will be effective for a year, or a few years. Then the loan rate will change as interest rates in the financial markets change. But the change is likely only to go upwards. Adjustable rate loans tend not to decrease the rate (you usually have to refinance to get a lower rate). You could see a big jump in payments if interest rates rise significantly.
The common thread among all these loans is that they are complicated and often unpredictable. You can't effectively budget or plan for your long term financial well-being if you don't know what your mortgage payment will be in a year or two. Things only get worse if you can't afford the increased payment. You may be unable to buy the new car you need, and will have to hope the brakes and tires on your old car last a while longer. Money you wanted to save for your golden years or your child's college expenses may be devoted to the greater profitability of your mortgage lender.
So, what to do? Use a traditional fixed rate mortgage. This loan locks in your housing costs. You know how much you'll have to pay each month of the loan. There will be no surprises. Once the loan payment is fixed, you can budget around it and allocate money for savings. Look back at the World War II generation. Before the war, mortgages tended to be for a short duration (like 5 years) and require substantial downpayments (like 50%). When the GIs returned from the war, the 30-year fixed rate mortgage came into common usage. The housing market boomed and home ownership rates rose. With fixed housing costs, the members of this generation could and did build wealth perhaps like no generation before them. They were often able to fully pay for their homes and save money beyond that.
Yes, initially the cost of a fixed rate mortgage is higher, with a larger monthly payment. But no one can predict the direction of interest rates. A loan with an adjustable rate, or which you have to refinance in a few years because you can't afford the payment increases, may cost you more over the long term than a fixed rate mortgage. Further, incomes tend to rise over time, so your income will probably increase while a fixed rate mortgage's monthly payment does not. The extra money can enhance your lifestyle and increase your retirement portfolio. People earning $5,000 a year in 1955 might have had a mortgage payment of about $150 a month (seriously, many mortgage payments were this low). By 1975, they might have been earning $15,000 or $20,000 a year; but their mortgage payment was still $150 a month. That's a good situation to be in.
Fixed rate mortgages may not initially be as easy to get or pay as other, more complex loans. But most things in life worth doing or having don't come easily. The fixed rate loan ultimately makes your life simpler and easier. That will be conducive to your financial well-being. Even if you have to buy less house, you'll have more peace of mind.
Personal Grooming News: Men wearing makeup--http://www.wtop.com/?nid=456&sid=1137695.
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