A Better Mortgage

Sub-Prime Housing Problems Limited to Just 7 States

This picture is courtesy of Kevin Depew of Minyanville (via Barry Ritholtz of The Big Picture).

It's good to know the problems aren't as wide spread as people thought!

The Priority System of Money

I have had the privilege and opportunity of working with numerous First Time Home Byers (FTHB) and I have always enjoyed the experience. There is generally a little more education required - that's a big part of the reason I enjoy it. Beyond the necessary home and mortgage questions, I spend a fair amount of time talking about money and general finances with my FTHB clients. I do not give specific investment advice as I am not a licensed financial planner, but I am more than equipped to introduce general strategies (I have a finance and marketing degree from Cedarville University). Once these strategies have been introduced, I happily refer my clients to a financial planner to help them continue developing the plan as well as assist with implementation.

Regardless of a client's income or background, there is a general road map that will help ensure financial success for those that follow it. It is a plan I have adopted and adapted from other mortgage and financial professionals and has proved to be extremely flexible to a client's unique situation. Obviously this is a general plan and my recommendations will vary depending on your situation. If you would like a customized mortgage solution, please don't hesitate to contact me (tim@timothyabbott.com). There are four general principles and we'll take a look at each one.

1. Establish an Emergency Fund - The first thing I recommend to clients is to get in the habit of relying on yourself rather than a credit card to get you out of a financial jam. These things come at every single one of us whether we like it or not - a new water heater, tires on the car, etc. Everyone should have a minimum of three months worth of income in a completely liquid fund (savings account) that you could access today if you needed it. If you are self-employed, paid largely by commission or bonus, or have an irregular income source you may want to have as much as six months worth of income set aside. This is strictly rainy-day money and is there to keep you out of the jaws of the 18%+ credit card monster.

2. No Debt Other than Mortgage - Once a client has put away their rainy day fund, the next step is to eliminate all non-preferred debt. This debt will be anything other than your tax-deductible mortgage. Typically credit cards should be paid off first, then auto loans, and lastly student loans. Often I'm asked whether this should be the first step instead of the second. These two steps could certainly be switched but the concern is usually a discipline issue. Some people are quite capable of paying off their bills and then committing to the savings plan. Other people freely admit that it will be a challenge. This is when we would recommend saving first (to develop the habit) and then focusing on paying down the debt. I want to help set my clients up for success and generally speaking we have a better chance if we start by saving the emergency fund first.

3. Build a Source of Liquidity - This fund will again be different for every person but it is typically equivalent to six to twelve months worth of your income. This is an ultra-critical part of the plan as these funds will allow us to deal with both good and bad opportunities. A bad opportunity is unfortunately all too easy to describe. Things such as job loss, extended leave from work (for your illness or a family member), disability, and natural disasters are all things that people face. I don't know about you, but I would much rather be prepared and have access in the event my wife or one of my daughters became ill and I needed to take some time off from work to help out. Without this fund a person would need to make some difficult choices.

Good opportunities can be more difficult to quantify. These opportunities can appear in the form of having the ability to start your own business, invest in a business with a friend or relative (that probably sounds more like a nightmare for most people!), buy a second home or investment property, or anything else that comes along. These are opportunities you would not even have a choice to make if you didn't have the funds available. Opportunity cost can be a very painful thing if you haven't experienced it before.

4. No Mortgage on Your Balance Sheet - Please notice I didn't say NO MORTGAGE. The goal is to have an asset account (401K, Roth IRA, taxable stock portfolio, etc) that equals or exceeds your mortgage balance. Once you have completed the first three steps, the additional money you have been putting away and/or paying towards debt can now be allocated towards this goal. This is generally the method that provides the greatest amount of safety, liquidity, and rate of return while giving you incredible flexibility and allowing you to have the capability of paying your mortgage off early. I will give you an example in a later post that shows the incredible power of leverage and arbitrage you command with your mortgage.

There is certainly no one size fits all approach, but this is a very good set of guidelines that will help a majority of people accomplish their financial dreams and goals. If you have any comments, constructive criticism, or general feedback, I would love to hear it!

The Week Ahead in the Capital Markets

We have a world class secondary market department and they are kind enough to send out weely updates to us sales monkeys. I like posting it as it is both a great source of technical and anecdotal information. Please let me know your thoughts!

The Week Ahead in the Capital Markets - June 25, 2007

When the tide goes out, you find out who’s been swimming naked. – Warren Buffet

If the Bear Stearns High-Grade Structured Credit Fund wasn’t swimming naked, it was highly levered and its investments, many of which were made in sub-prime mortgages, turned against it.  The fund had been doing well, posting 41 months of positive returns, until the mortgage market hit the skids.  The damage worsened when investors began withdrawing funds, and culminated with a Bear-Stearns-led buyout of $3.2 billion late last week.  It was the biggest rescue of a hedge fund since 1998 when more than a dozen lenders provided $3.6 billion to save Long-Term Capital Management.

The hedge fund crisis changed the bond market’s psychology yet again.  As you may recall, a week ago we were concerned about global growth driving the ten-year Treasury yield to – gasp! – 5.50% or 6.00%.  The yield curve was getting steeper, but only because long-term rates were rising sharply.  The Fed was not expected to cut rates, and it appeared that Fed funds were stuck at 5.25%.  Bill Gross shook things up by offering the possibility of a 6.50% ten-year yield within five years.  The potential of higher global wages threatened our low rate world.  Low wages in China and elsewhere have had a deflationary effect for years.  As that labor gets “used up,” wages could push prices, inflation, and bond yields higher.

The outlook for interest rates is murky, but the consensus view holds that the ten-year yield will trade between 4.75% and 5.25% for the next few months.  Last week’s uncertainty renewed hopes for a Fed ease before the end of the year.  The economy is expected to grow by 2.5% and inflation is expected to hover just above 2%.  Stocks are expected to have a positive year, although a sharp correction will probably happen sometime in the next six months.  Housing could weaken further, but the current inventory overhang is expected to be mostly gone by early 2008.

This just in: al Qaeda is claiming credit for the vague ending of 'The Sopranos.' (David Letterman)

A Home Stagers Worst Nightmare (Fun Friday)

It's the end of a long work week for many folks, so I thought I would post something a little lighter today. If this ends up being fun and I get a good response, I may very well make this a semi-permanent feature.

I am not a home stager, but I would imagine some of the absolute last things that would be found on a recommended advice list for a potential seller would be:

1. Give you bathroom a Spiderman motif:

2. Tile your nickname and number at the bottom of your pool:

   

3. Paint a large mural of yourself (bare-chested, of course) in the entryway of your house:

In case you haven't figured it out, this house belongs to Dwayne Wade of the Miami Heat. This is obviously on the extreme end of one spectrum, but it is all too common to see properties sit on the market because they have one or more undesirable elements (in this case, too many personalizations by the current owner). If you are having difficulty selling, please contact your mortgage advisor and ask them for a referral to an experienced home staging professional. Also, ask your mortgage professional about what sort of strategic financing options you can use to set your home apart from the rest of the market.

If you are curious, here are some more pictures of Dwayne Wade's estate.

Have a great weekend! 

Good in Theory (But so is the Flying Car)

Jeffrey Steele of the Chicago Tribune wrote an article last Friday that I missed until just now. The article discusses builders willing to sell partially finished homes to people and allow them to finish the job. What is the appeal?

"Especially alluring to Zamet was the notion of purchasing a new home for what he estimates was a minimum of 25 percent off list price. Depending on the amount of sweat equity he was willing to invest, he could have reaped even more savings, he said."

A 25% savings represents a huge dollar amount, regardless of the amount you're spending on a house. Before someone gets too excited, there are a number of issues to take a look at. Jeffrey does a good job covering the major ones:

"The idea that you finish the home yourself, doing the drywall, probably works if you're a tradesman, or if you can access that work among your friends," he said. "It gets the price down. The problem is that people stretch to buy the unfinished house, and don't have the wherewithal to finish it themselves."

Another roadblock may be funding the extra work.

If the homeowner is taking on a great deal of finishing work himself, he may be forced to obtain a second loan in addition to the mortgage to pay for building materials or labor.

"I think there's a financing problem," Hovany said. "The banks don't want to finance an unfinished house. ... They don't want to get an unfinished house back."

In addition, buyers and builders may run afoul of municipalities when it comes to occupancy permits.

"They'll let you get away with [an unfinished] basement, and you probably don't have to have drywall in your garage," Hovany said.

"[But] at some point, they say we're not going to give this house an OK until it's more finished. At some point, you run afoul of the building inspector. You can rough in a bathroom in the basement, but not in the master bedroom. The big concern is that the house will become derelict."

Dick Greenwood, vice president and director for Des Plaines-based Coldwell Banker Builder Marketing, agrees, noting many municipalities won't let buyers finish homes, citing building codes that safeguard health, safety and home values.

"If you finish the bathroom yourself, there's no guarantee you've done the work according to the building code," he observed. "As a result, the municipalities are against it. Nine times out of 10, [buyers] try to finish the job without building permits, no city inspector knows about it, and there are no inspections to guarantee the work is done in a professional manner.

From a lender's perspective, the two major issues are collateral and safety. Both are equally important for their own distinct reasons. One thing that you need to know before I discuss these two items is that lenders are perpetually looking at things in a glass-half-empty sort of way. It's not their job to assume the best about a situation, it's to manage risk in the event of a worst case scenario. Those that don't manage risk well? You can read all about it here: http://ml-implode.com/

First, collateral refers to the property that has been pledged to secure a loan. Lenders know that houses may be extremely similar, but ultimately no two houses are identical. They are looking to loan money on a house that is readily marketable in the event the need to foreclose. All things being equal, a finished house that is in move-in condition will sell much faster than a house that needs to be completed, even if the incomplete house is being sold at a discount. There are far fewer people that are willing and able to take on a project like that. As a result it is very difficult to secure traditional financing to purchase a partially completed home; it would almost certainly need to be a construction loan. A construction loan is not the end of the world but the guidelines tend to be significantly more restrictive than a traditional loan, meaning far fewer people will qualify.

Second, the lender will be very concerned about the safety of the house. An unfinished house such as this will most likely be missing some very key safety elements - finished electrical work (wall plates and outlet covers), hand railings on staircases, smoke and carbon monoxide detectors, etc. These hazards just scream liability. In case you missed it in the previous paragraph, lenders are not interested in any more risk or liability than necessary.

The long and short of it is that this can provide a great opportunity for a very small percentage of the home buyers that are out there. The whole article is worth a read and is very interesting, but I wanted to share a little more of the lender's perspective.   

We Did it His Way

Frank Sinatra had many hits over the year, and perhaps none were bigger than his song My Way. I can appreciate a lot of the thoughts and ideas in the song, though I hope I'm not anywhere near the end of my road. One of the things I identified very early on in my career was that I was going to do things my way.

Now, I am very open to learning and studying new things, especially within my industry. Also, very little of what I do is completely original. Most of it is bits and pieces taken from various sources and assembled into what I believe is one of the most complete mortgage planning systems that exists. I am extremely open to change and am always seeking ways to improve myself and my business in order to better serve my clients. When I said that I decided I was going to do things my way, what I meant was that I was going to control and dictate the process and not let my clients direct things. I will bend over backwards to accommodate the every need of my clients, but I will control the process.

Sometimes I find that I will run into resistance from my clients for various reasons. The most common one is someone wanting a quick interest rate quote, but there can be a huge variety of potential issues. Whenever I am tempted to cut a few corners and just toss out an interest rate or closing cost amount, I remind myself about Mark.

Mark is a client I spoke with when I first started in this business. He was in a hurry to be preapproved as he had an accepted offer on an investment property. Mark was self-employed, which I knew added another layer of complexity as it is more complicated to figure out income since we need to calculate it from the client's tax return. I had been trained to obtain copies of the tax returns before issuing a preapproval, but Mark didn't have time to fax them to me. I knew exactly what I needed off of the return, so I asked him to read a few particular lines to me. I calculated his income and issued him a preapproval.

Mark performed his home inspection and then we sat down to officially apply for the mortgage. By this point Mark had assembled all of his documents so I had a chance to review everything, including the tax returns. The income I calculated from his consulting business matched the profit and loss statement perfectly, but it did not match his adjusted gross income. I flipped through his return further and found a second profit and loss statement. I asked Mark about it and he had no idea. We started sorting through the miscellaneous expenses and found items like feed, training, and veterinarian expenses.

As it turns out, one of Mark's hobbies was buying and training race horses. His accountant had classified this 'hobby' as a second business which allowed Mark to write off approximately $25K worth of equine expense against $0 in income. This was great for Mark the 'Tax Saving Citizen' but very bad for Mark the 'Trying to Qualify for a Mortgage Citizen.' As a result of this Mark didn't qualify for the loan we had been planning on.

Looking back, it was a tough lesson for both of us. I was not sloppy or lazy and Mark did not give me incorrect info, we just didn't have all of the pieces of the puzzle. If this situation happened today, it would be a non-issue as I would absolutely insist in reviewing the tax returns prior to providing a preapproval. At the time I was very new in the business and wasn't confident enough to insist. (don't worry - that's not the case anymore!)

My message is this: If your mortgage professional wants to spend an extra 5 minutes on the phone with you or requests that you send certain documents prior to issuing a preapproval, please help them out. It helps us do a much better job and eliminates issues down the road.

Thanks for reading!

I'm Tired of Games, Too

Generally speaking, I try to keep from promoting myself and my company too often in this blog. The last thing I want is a perpetual infomercial that starts to ring hollow after the third or fourth visit. That being said, I did want to take an opportunity to mention a new marketing piece I have begun distributing to referral partners and new clients. It is a service and performance level guarantee that I am very proud to offer, and hopefully it says quite a bit about myself and my company.

I am a mortgage professional and I treat my clients with the utmost respect and honesty. I am tired of the confusing games many mortgage companies play, and as a result have instituted a four part guarantee. If I fail to deliver on any of the promises, I will pay you $500. There will be no questions or hassles, just cold hard cash.

• First, your pre-approval is as good as gold. Actually, it’s as good as cash. If we issue you a pre-approval and cannot provide an approval when the time comes, we will pay you! (As long as your employment, income, and asset picture remains the same).
• Second, the final HUD will be within $100 of the initial Good Faith Estimate (GFE). No need to worry about the accuracy of the GFE, because if it’s wrong, we’ll pay you! We guarantee the final lender fees (800 section) will be within $100 of the initial GFE.
• Third, your rate lock will not change from application to closing. No need to worry about your interest rate changing before closing. As long as your situation is the same (employment, income, and assets) we guarantee your interest rate and point structure will not change at the closing table, or we’ll pay you! 
• Fourth, we will meet your closing date. You will not have to worry about having your closing delayed because we aren’t ready. If we agree to a particular closing date, we will meet it, or we will pay you!

I want you to have a very high level of comfort when you are working with me, and this is one way I can reassure you. If I fall short in any area, I will happily pay you $500 or credit $500 towards your closing costs. In return, all you need to do is to make sure that your situation (employment, income, and assets) remains consistent from pre-approval to closing.

If you would like a copy of the marketing piece I am using please feel free to view it here:

Hit a Home Run with Tim Abbott

Please make sure you are working with a trusted mortgage planner. Ask your friends, family, or co-workers who they would recommend. Likewise, I would be happy to refer you to someone if necessary.

Time Flies When You're Unprepared

I have always enjoyed reading Ben Stein's take on money and finances, and his latest effort is no exception (also, thanks to Ben for the title of this post!). The idea that struck me the most is when Ben quotes Dr. Martin Luther King Jr. who states "Time is neutral." He is absolutely correct, we all have the exact same measure of time each day, yet we accomplish drastically different things. When I look at those folks that seem to accomplish significantly more than the average person on a daily basis, they always seem to have one thing in common: a plan.

Your mortgage is no different. You need to have a concrete plan (preferably in writing) that is reviewed at least once a year with a mortgage professional. Life is filled with curve balls (or gyroballs if you are a Red Sox fan) and that's ok, what is important is that you have a plan in the first place. Please contact your mortgage professional to schedule an annual review if it's been more than a year since you have spoken with them. In the event you are unable to find their contact info, please feel free to contact me and I would be happy to assist you.

The Week Ahead in the Capital Markets

We have a world class secondary market department and they are kind enough to send out weekly updates to us sales monkeys. I like posting it as it is both a great source of technical and anecdotal information. Please let me know your thoughts!

The Week Ahead in the Capital Markets - June 11, 2007

Like the cat that wouldn’t jump on a cold stove, bond buyers refused to buy and get burned again.  In dramatic fashion, last week extended the bond market’s month-long sell-off.  Thursday saw the largest one-day drop in three years.  30-year mortgages dropped six standard deviations, or about 0.75% of value.  The yield curve steepened sharply, with long-term rates rising 0.11% more than short-term rates.

Fears of inflation drove the market lower – a surprise rate hike in New Zealand and bearish comments from Chairman Bernanke fanned the flames – but Fed funds futures were relatively quiet.  Futures closed with a small chance of a rate cut still built in.  In spite of growing inflation fears, the market appears to think the Fed will not raise rates in the near future and may well cut them.  Many analysts disagree.  Goldman Sachs in particular reversed position and said they no longer expect the Federal Reserve to cut interest rates in 2007.  They had previously forecast cuts totaling 0.75% this year.

Two schools of thought have emerged in the sell-off.  One school compares today’s market to the market in mid-2006, and expects lower rates ahead.  In 2006, an inflation scare took the ten-year yield to 5.25% and the stock market panicked and sold off by 3%.  Sound familiar?  Subsequently, the ten-year dropped to nearly 4.50% and stocks rallied to record highs.  If higher rates further derail the real estate market, and crimp the private equity spending spree, lower rates could well be on the horizon.

The second school of thought is led by PIMCO’s Bill Gross, and calls for higher rates ahead.  In sensationalistic tones last week, Gross, who had once called for a 3% ten-year, spoke of the risk of a 6.50% ten-year yield within the next five years.  Technical analysts share Gross’ opinion, and claim that the ten-year yield has broken its multi-year downtrend line.  Technically speaking, if the ten-year closes above 5.25%, the next stop would be 6.10%.

Undaunted by the protesters (at the G8 Summit), the leaders focused on finding consensus over global warming. And by “consensus,” we mean getting Bush to agree with the other seven. (Jon Stewart)  Besides, every time someone says G8, Bush yells out, “Bingo!” (Jay Leno).

Mortgage Broker vs Mortgage Banker

I often find myself faced with an interesting conundrum when I attend various business and networking events. I will meet someone at one of these events and when I am asked what my business is I tell them I am a mortgage planner. They invariably look at me for a couple of seconds before they say "Oh! You're a mortgage broker!?" Not exactly (for a couple of different reasons). I will spend more time in another post elaborating on what a mortgage planner is and what they do, but I wanted to spend a little space today on something a bit more technical.

I consider myself and my company, Patriot Funding, to be a mortgage banker. Legally, we are both a mortgage banker and a mortgage broker. Approximately 75% of our loans are loans that we operate as a banker which means the remaining 25% we act as a broker. What is the difference between a mortgage broker and a mortgage banker? There are a number of them, and hopefully I can articulate the differences and what it means to you.

Underwriting - As a mortgage banker, we (Patriot Funding) are authorized to underwrite our own loans. This means we have a staff underwriter at Patriot Funding that underwrites all of our loans. We work with the same person daily so we receive a very consistent level of underwriting, both in the time it takes to underwrite the loan as well as any conditions that are requested. When we act as a mortgage broker, we are required to send the loan file to the lender for them to underwrite. Sometimes it takes one day, sometimes it takes three days. Also, we are sending our loans to a bank of underwriters. We could send three different loans in one day and they could go to three different underwriters who all ask for different conditions.

Closing - This is another huge difference. As a mortgage banker, we are responsible for generating all of our closing documents. We have a great electronic document package that can be emailed directly to the attorney or title company. If we know that the closing time will be tight ahead of time, we can plan so that we can receive a clear to close from our underwriter and literally send a closing package within an hour of receiving that notice. When we act as a mortgage broker it takes a minimum of 24 hours (usually its 48 hours) to receive a closing package from the lender. Even then there can be some anxiousness until the actual package has been received from the lender.

Interest rates - I am not a fan of speaking in absolutes so I will be careful how I phrase this. Generally speaking, we are able to offer slightly better rates as a banker in comparison to a broker. We take on more of the total process - see underwriting and closing above. By taking on more of the process, that is a nice way of saying we also take on more of the risks and responsibility. If there is a quality and control problem with the loan down the road they will usually go back to the company that was responsible for the underwriting. Because of the increased risk and responsibility, we are compensated more by the end investor when we eventually sell the loan as they have some recourse if there are any issues. They will pay us a little more for each loan because we are delivering a completed loan and assuming the responsibility. As a result we are able to make slightly more money and offer slightly better rates. A mortgage broker has some responsibility but not nearly the same level.

Having said all of that let me sum up my thoughts. If all other things are equal, a person is generally better working with someone that works for a mortgage banker. We have more flexibility and control over the mortgage process and generally can offer better terms, BUT.....the most important thing by far is to make sure you are working with a qualified mortgage professional. The wrong advice and mortgage plan can cost you significantly more over the long term than any of the issues I just mentioned.

If you need assistance, please don't hesitate to contact me. I would be happy to put together a custom mortgage solution for you. In the event you live outside of our service area (IL, MA, NH, ME, RI, CT, FL) I have a network of other professional mortgage planners I work with and would be happy to refer you.

Have a great weekend!