Bill McCord's Blog

Is it a good idea to pay off a mortgage as soon as possible. My answer 90% of the time will be NO. It may make you feel good but it is economically foolish for the vast majority of people.

A mortgage is the cheapest form of debt for the average homeowner. This is partly because it has a low interest rate, but also brings with it enormous tax benefits. For most people this lowers the actual interest rate by more than a third. The real after tax rate on a 5.5% mortgage is actually 3.625%.

The vast majority of consumer debt is much higher than this. It seems clear to me that no one should be trying to pay off the mortgage with money which would be far better used to pay off a credit card.

Another major consideration should be whether tying up more money in your house is good for your on-going financial security. Once you make that payment you can never get it back without either selling or refinancing the house. Unless you have enough other assetts to handle job loss or other family emergencies you would probably be better served by investing that money where you can quickly get at it in such circumstances.

For a more detailed conversation on this topic check the following link to the New York Times.

http://www.nytimes.com/2010/03/20/your-money/mortgages/20money.html?ref=realestate

Mortgage interest rate have remainded at historically low levels for longer than we can remember. This has not been an accident. The largest factor has been the Federal Reserve program under which they have bought about $1.25 TRILLION of Mortgage Backed Securities (MBS’s) on the open market.

 MBSs are simply BONDS. Their prices go up and down based on our old friends Supply and Demand. As with all Bonds,  when   pricies go up the Interest Rate on them goes down, and vise-versa.

So in order to see where Mortgage Interest Rates are going we simply track the prices of the Bonds known as MBS’s.

You can safely ignore the uninformed pundits of the media repeating the ridiculous mantra that Mortgage interes rates are driven by the 10 year Treasury. The MBS’s deal only with Mortgages. The 10 year Treasury is an indicator of the entire U.S. financial system and will often point in the opposite direction to the MBS market.

Now let’s come back to the $1.25 Trillion worth of MBS’s bought by the Federal Reserve as part of the Governments Financial Stimulus program. Having this much money looking to buy MBS’s (DEMAND) has artificially kept the price of them up, and as a result kept Mortgage Interest Rates down. As of the last day of March this program is finished. Now there is a reduced demand for MBS’s and an inevitable inrease in Mortgage Interest Rates.

This will begin to happen right away and continue until the market stabilizes at the level dictated by regular market forces. This will be at a higher rate than we are at now.

For an excellent summary of this process check out the following link 

http://www.mortgagesuccesssource.com/ezine.php?ez=1003

The lesson here is that if you want to become a homeowner it’s time to get serious before these rate increases get too far away from what you can afford.

You probably didn’t see the reports that Goldman Sachs is talking to Fannie Mae about buying, at a discount, $1 billion worth of low-income housing tax credits from the government-controlled Agency.
Fannie Mae can’t use the credits because you have to actually earn money to use such an off-set against profits.
Goldman Sachs on the other hand is making profits hand-over-fist thanks in part to the Taxpayer Funded TARP program.
For the nation’s tax collectors the issue might boil down to this:
if we let Goldman buy the tax credits, that means a Wall Street firm that received Bail Out money, will be able to lower their taxes at a time when Uncle could really use the money.
It’s worth remembering that TARP funds were intended to help the Banks re-start making loans to individuals and small business’s.

The Fed and the Crisis

For anyone wishing to understand what the Federal Reserve actually did, and will continue to do in dealing with our current financial problems, here is a link to a San Francisco Fed web site where you will find a goldmine of facts and commentary. http://www.frbsf.org/econanswers/

It’s a great resource dealing with the process of digging out of the hole and getting back on track.

Maybe one day they will do an equally good job on their failure to prevent all this from happening. As far as I can see they did not have the courage to take away the cookie jar when this Bubble was so obviously getting seriously inflated.

Turns out that Mr. Greenspan really let us down by failing to spell out what was happening, and take the risk of being unpopular with his Political Masters. Like many before him he seemed to buy into the “New Paradigm” myth. Remember that phrase during the run up to the Dot Com bust.

In the world of smoke and mirrors called “The Finance System” the word PRIME has two very different meanings.

One is PRIME RATE (the interest rate banks charge their best clients. Normally 3% above Fed Funds Rate.

The other is SUB-PRIME to describe a mortgage (SUB-PRIME MORTGAGE) that should never have made. Hence the “The Sub-Prime Mortgage Crisis“.

In the real world occupied by most of us “Ordinary Folk” the term Sub-Prime should not be linked to a Mortgage; It actually refers to the Borrower of the Mortgage i.e. The person whose Credit, Income, and/or Cash for down payment is not good enough to get a ”Prime” Mortgage. Hereafter referred to as The Sub-Prime Borrower.

This person has always been with us. Until the unbridled greed and avarice of Banks and Wall St intervened with their “No Possible Homebuyer Left behind” programs these folks rented until such time as their financial situation allowed them to qualify for a sensible mortgage.

Let’s be clear on this. The Sub-Prime Mortgages were and are High Risk loans made to High Risk people. These loans could only be made if the Bank knew it could sell them on to a 3rd party before the inevitable late payments started. This way the Banks got their profit with effectively no responsibility for the future performance of the flakey loan.

It was effectively a game of “Pass the Parcel in a Bagdad Pub”.

By the time these loans started going bad they had spread throughout the Worlds Financial systems leading to the current situation so often referred to as the Sub-Prime Mortgage Crisis.

At the end of the day we have a large number of Banks and other Wall Street hot shots who  made enormous profits by selling what they all knew to be an unstable product to an undereducated public.

This is a recurring story in our history.

If you don’t want to become a victim of the next wave then you need to get educated in how the system really works before you meet the next Bernie Madoff.

For some thoughts on how you might do this check out my posts from 04/25/2008 “Kick Start the Kids”.

A small but very welcome glow of sanity from a historically well run Bank.

After acquiring $117.3 billion dollars worth of option adjustable rate mortgages (ARMs) in its acquisition of Wachovia last year, banking giant Wells Fargo is now practicing a rare but effective loan modification strategy: the cramdown.

Through September of this year, Wells Fargo has forgiven an average of $46,000 on approximately 43,500 high-risk loans in its portfolio. The typical debt reduction is around 20% of the loan principal, though in rare cases Wells Fargo has cut as much as 30%. Reports put the six-month default rate of loans modified by Wells Fargo at 15-20%, less than half the current rate of 40% suffered by the rest of industry’s extend-and-pretend modifications.

Debt reduction is only one of many tools Wells Fargo is using to aid its distressed borrowers, and is currently not being used as a blanket fix for all underwater homeowners.

My Opinion: While this is a national story and certainly only a very small slice of the current problem pie, a mortgage lender taking into account the need for principal reduction is a big acknowledgement that the underwater state of many homeowners’ mortgages require this type of treatment. This is something other lenders and Congress need to understand when considering the mortgage quandary. Continuing to “kick the can down the road” with “extend and pretend” modifications will do nothing to solve the massive negative equity problem. The fact that the small glimmers of hope — in the form of cramdowns — are coming from a lender and not the regulators really speaks to the hands-tied, head-buried-in-the-sand mentality which must be overcome if we are to move ahead with a recovery.

Re: Wells Fargo Cuts as Much as 30 Percent in Principal from the Wall Street Journal

Government is often criticized for putting all its efforts into helping business and nothing for the ordinary citizen. However, when they do put programs in place we have a tendency to ignore them.

Here’s just one example:

A 401-K plan usually involves an employee putting up to 6% of their salary into a company sponsored program. Typically the employer increases that contribution by adding in up to 50% of what the employee puts in. (this is increasingly being reduced but is still at least 25% in most cases). This means the employee is getting between 25% and 50% interest on their savings, plus their contribution is exempted from Income Tax for the year it is made.

So how come only 7% of people eligible for this benefit actually use it up to the max allowed? (Source Putnam Investments).

How come 20% of participants in these plans have actually reduced the level of contribution during the past 2 years?

My guess is that a large number of these people would like to maximize the use of these plans but don’t know how it could be done.

I also suspect that a large percentage of them could solve the problem with a mortgage better suited to their circumstances.

This was originally posted June 30^th, 2008. After this text I’ve added an update to Ted and Alice’s situation.

 What would you do if I offered to lend you money and charged 4% interest rate?

What if I could also show you a cast iron secure investment that would pay you a minimum 25% per year if you re-invested the money you borrowed from me?

Here is a true story.

Ted and Alice had bought their house in 1999 with 10% down, getting a 90% 3 year fixed loan, which required Private Mortgage Insurance.  ($219/m). By 2003 the value had gone up to where they could get an 80% loan with no PMI.

 When we met to discuss a possible refi I found out that during those 3 years Ted had not been able to pay in to his company 401-K program. This plan had the company match his contribution by adding 25% to whatever he put in (up to 6% of his salary). In addition, neither of them had made any contribution toward the ROTH IRA’s they were entitled to.

By refinancing into an 80% Negative Amortizing Loan with *World Savings they were able to fully fund Ted’s 401-K, AND make the maximum allowed contribution to ROTH IRA’s for both of them. They were paying $800/m less than the interest on the new loan.

What was actually happening was they were borrowing $800/month from themselves (The equity in their house) at an after tax rate of 4%, and investing most of it in Ted’s 401-K at a guaranteed 25% return. The IRA contributions were just icing on the cake.

This is not magic. It is simply making sure that your mortgage is designed to best fit your current situation, AND long term plans.

At the end of 1 year they owed $9,600 more on their mortgage BUT had accumulated $9,760 in Ted’s retirement plan, PLUS $6,000 in their IRA’s. I make that a net gain of 30% in the first year from nothing more than some intelligent Mortgage and investment planning.

This example is just the tip of the iceberg showing what can be done with a little knowledge and an open mind.

Now here’s the answer I got from Ted when I recently asked how they were doing.

 “I love my loan. Two months ago I was at 3.18% fully indexed. This month it jumped up to about 3.68%. After having this loan since March/April 2002 I have paid off about $80K in principal and well over 50% of my bi-weekly payment is going to principal reduction. I can understand how this kind of loan could be abused by people who didn’t understand it but that is the problem with THEM, NOT the Loan. For us it’s been a Blessing. Thanks a million Bill.”

The moral here is that your Mortgage is a financial planning tool. As with all tools it can be used correctly to your benefit, or incorrectly to your detriment.

* World Savings had the only intelligent Negative Amortization Mortgage. All others were ticking bombs and have been exploding all around us for the past year or so.

In todays crazy world we all know people who are struggling to get by. Here is information about some sources of help not commonly known about.

There are many free, low cost, discount and income-eligible services offered by government agencies and trusted sources. This link will take you to many of them http://www.takechargeca.ca.gov/campaigns/free.shtml.

You can also obtain this list from the Department of Consumer Affairs at (800) 952-5210. Visit their website for information on a multitude of programs provided by the State for all of us.  www.takeChargeCA.ca.gov 

The list of free and low cost services help California consumers save money!  Want a free or low cost hair cut, or manicure?  Looking for help paying for a Smog Check, or just some basic coupons for household products or food?  It’s all there and much, much, more.

The following quote is from The Economist Magazine

“Everybody wants it. Nobody understands it. Money is the great taboo. People just won’t talk about it, and that’s what leads you to the subprime mess. Take the greed and financial misrepresentation out of it, and the root of this mess is massive levels of financial illiteracy.”

 I’m one of the famous “Baby Boomers” (born between 1946 and 1964) who, if you listen to the mainstream media, are both the cause and the solution for everything wrong with the world. This is a very simplistic view, but it in one very important area I totally agree. PERSONAL FINANCE.

Our parents are children of two World Wars and a major depression. Personal finance was not a complicated issue. The Boomers are the first generation to grow up in a financially complex world while having more money to invest than their parents. They are bombarded with conflicting opinions on how best to spend and invest their money. The vast majority of the advice comes from sources which have more interest in how to separate you from your money than from increasing it.

How did they learn to navigate this brave new world? Some have been fortunate enough to choose parents who were knowledgeable enough to educate them. A few will have recognized the weakness and taken the time to educate themselves. Unfortunately the large majority did not even realize there was a problem. These are the “Goldfish” referred to in my earlier blog entry.

My concern is with the next generation, hence the title of this item. The Kids.

How are financially uneducated parent going to teach their kids how to survive in the increasingly complex financial water we are swimming in.

Here’s a suggested starting point for those who acknowledge the problem but need help with the solution.

Buy and read “The Only Investment Guide You’ll Ever Need” by Andrew Tobias, then try to make sure your kids read it before they ever receive a single dime of their own to spend. if necessary pay them to read it and discuss it with them.

You may well find the whole topic more interesting after this, so here are a couple of other books which will prove it can also be very entertaining.

1. “Freakonomics” by Steven D Levitt & Stephen J Dubner.
2. “The Undercover Economist” by Tim Harford

In addition, here is an excellent web site www.mvparents.com/ dealing with this topic and many other issues regarding our children

In my opinion, if your kids can both read and understand how money works you have given them the best gifts any parent could ever give.

Recommendations’ for other books etc will be welcome.