September 2007 Archives

On Tuesday, September 18, 2007 the Federal Reserve made their first interest rate cut in four years. The federal funds rate, the interest rates that banks charge each other for borrowing dropped .5% (50 basis points) from 5.25% to 4.75%. The Federal Open Market Committee meets roughly every six weeks to assess numerous economic indicators and work to slow inflation and encourage job growth. This reduction is an attempt to avert some of the issues surrounding the current crisis surrounding housing and sub-prime mortgages. Average consumers may not immediately be impacted by this change. Prime rate - the interest rate banks charge consumers - can be based on the federal funds rate in which case consumers may see a drop, but possibly not the full .5%. Home equity loans and credit cards are the areas consumers most likely will see a drop but it may take up to 3 billing cycles for current accounts to see change. New borrowers will see an immediate drop in interest rates.

If on the other hand, you are not a borrower but a lender (have lent money to the bank in accounts such as savings, CD's or money market mutual funds) the decrease in the federal funds rate will also decrease the interest you will be earning on these accounts.

Do you have an adjustable rate mortgage? Before you begin your joyful dancing - check your mortgage origination papers to see WHICH index your loan is tied to. Half of ARM's are tied to short-term (3-month) Treasuries NOT the federal funds rate. More risky ARM's (for people with limited or poor prior credit histories) are tied to the LIBOR - London Interbank Offered Rate. Because these loans are tied to interest rates in a foreign country, decisions made by America's central bank may have little or no impact on dropping the interest rates at this time.

What to do?
1. Review your mortgage to determine if you have a fixed or adjustable rate mortgage.
2. If you have an adjustable rate mortgage - determine what index to follow to determine the impact these decisions may have on you personally.
3. Explore your options. Is it possible for you to refinance your ARM to a fixed mortgage and reduce your exposure to extreme increases in your monthly housing payments.
4. If you have money in bank accounts - continue to seek out the highest interest bearing accounts. Generally the longer the term, the higher the interest. But, remember to stagger the lenghth of time you have money maturing so you don't incur high penalties if you need to cash out the money prior to maturity.

Getting Your Financial House in Order BEFORE You Buy a House!

Buying a home is actually two separate events:
Determining the housing you need and can afford
Finding a loan that best meets your needs

I am going to address the financial aspects of buying a home.

Mortgage delinquencies and foreclosures are at an all time high. It's shocking to review published statistics about millions of people who've fallen behind on their mortgage payments. It's alarming to read stories about people whom you don't know who are struggling to keep their home. It takes on an entirely different perspective when you know real people who are on the brink of losing their home.

If you don't pay your mortgage payment over a period of time, a mortgage company has the legal right to take possession of your home. A foreclosure is a major negative on your credit report. It can have an adverse effect on you when buying insurance, applying for a job, or obtaining financing in the future. With a foreclosure, there's a good chance that the lender will sell the property for less than what is owed on it. Should this happen, they'll pursue you for the deficiency balance plus various fees. There's nothing worse than paying for something you no longer own. Foreclosure is a gut- wrenching, humbling experience that you want to avoid like the plague.

How can you prevent and avoid foreclosure?

Get your financial house in order first and then seek homeownership. - As Benjamin Franklin said, "An ounce of prevention is worth a pound of cure." Before you move into a home, you should have your spending under control, little to no consumer debt, savings set aside for emergencies and a reasonable down payment.

1. Spending Under Control –
Budget – a plan for where you want your money to go, not wondering where your money went? Are you able to pay all of your bills…on time… and do you have money left over at the end of the month? If not – you need to do some serious recordkeeping to find your spending leaks (record book). Develop your budget around your baseline income. If you have the opportunity to take on a second job or pick up overtime – that is great for extras but don’t count on that money. Also if you have irregular income – find a baseline and those weeks that you are making wads of dough over your baseline – this is money you bank for those weeks when you are underemployed.

2. Little or no consumer debt –
How much of your monthly income is devoted to paying down debt? If more than 15% of your take-home pay is going to debt service, you’re in trouble. Add up your car payments, student loans, credit card and any personal loans and divide by your monthly take home to determine what percent is going out to debt service.

3. Credit Worthiness-
In order to qualify for a mortgage – you need to demonstrate to the lender your ability to repay what you borrow. They analyze this ability in several ways such as where you work, how long you’ve been there, how much money you make. They also look at your past used of credit, your credit history. Generally the better your credit history (and score) the more likely you are to qualify for a mortgage and for a lower interest rate than someone with credit issues.
I recommend that everyone check their credit history annually as a means of detecting identity theft early. This is especially important several months before making a large purchase such as a home. You don’t want to have your heart set on a dream house and find that the bank won’t give you a loan because of credit history problems. If you have credit issues, there is no easy fix. Make it a goal to pay all bills on time and follow the lenders rules. As time passes those credit blemishes become less important and lenders tend to look at the past 12-24 months of your credit use. Even a bankruptcy may not prevent you from getting a mortgage – but you are viewed as a credit risk and will most likely pay a higher interest rate if you are approved for a loan. Even if you are a victim of identity theft it takes time to prove which debts are yours and which are not.
It is NOT essential that you know your credit score. If you know your history, you can guess where your score stands. Also each lender may use a different scoring system so the number you know from one scoring agency may be useless to your lender.

4. Emergency Savings-
After all the expenses of buying a house; closing costs, new furniture, appliances and equipment, will you have any money left in the bank for emergencies? Don’t leave yourself short. Ideally, you should have between 3 and 6 months of living expenses set aside – some in a bank or credit union savings account and the remainder where it will earn you the best interest rate such as a money market account, CD or even US Savings Bonds. Go back to item number 1- you should have money left over at the end of each month and this is money that goes into the emergency fund. Now if one of you loses a job, gets hurt and can’t work, a new baby comes, the car needs new tires or you even need a new car, you have some money to get them instead of relying on credit. Lenders like to see that you have been prudent in the past about saving and investing so when they see you have some money set aside that is another point in your favor they will lend you money.

5. Reasonable Down Payment-
An old bank requirement was at least 20% down. This is their way of spreading risk. Alternative financing arrangements are available where you put less money down but this often requires you purchase PMI – private mortgage insurance that you must pay until you reach the point where you have attained at least 20% equity in the home. This is the banks way of protecting themselves from your defaulting. You also need to understand how your loan is amortized. During the early years of the mortgage your monthly payment is mostly interest and a little bit of principal. If you can put down a sizeable down payment you reduce the amount of interest you will pay over the life of the loan.

6. 35% rule of thumb-
ALL of your housing expenses – mortgage, insurance, taxes, and utilities, when added together should not exceed 35% of your take home pay. Just because the bank is willing to give you a mortgage that requires a higher monthly payment than 35% of your take home doesn’t mean it is a good idea. When we add this 35% and previous 15% of consumer debt, we’ve just spent 50% of your money. Contrary to popular belief, homeownership is not "The American Dream." It's a component of "The American Dream." You still want to eat, keep the lights on, send the children to college, save for retirement and have a life. When you take on a mortgage payment that exceeds 35% of your take home pay, you hinder your ability to have a fulfilling life and you're more prone to falling behind on your mortgage payments.

In summary there are six elements to putting your financial house in order BEFORE You Buy a House:
1. Develop a budget or spending plan and follow it – get in the habit of spending less than you make – bank the excess
2. Pay down your consumer debt so that the total of your monthly payments are equal to or less than 15% of your take-home pay.
3. Credit Worthiness-what types of loans have you had in the past and have your honored those business agreements by paying on time? Open a credit card account, charge what you need and get in the habit of paying it off in FULL each month.
4. Emergency Savings: Multiply your monthly take-home pay by 6 and set that as your goal. Start by setting aside money each pay toward that goal. If you can afford to save $10 a pay can you increase it to $15? Small amounts add up over time.
5. The bigger the down payment the less in finance charges and PMI you will pay over the life of the loan.
6. Do the math-all expenses to keep you in the house of your dreams should not exceed 35% of your take-home pay.

December 2010

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