Borrow Smart

Recent Article on Foreclosures for Ameriprise Financial

I had an opportunity to contribute to the Ameriprise ViewPoints  again this month.  Click the VIewPoints link to read the article on Foreclosures.

Reverse Mortgage Paper

This is an excellent new paper on the implications of Reverse Mortgages and HELOCs on the elderly as a planning strategy... it offers good research and nice summary of strategies for consideration by the elderly as they enter retirement and must consider various ways of accessing real estate wealth to supplement savings.

I've highlighted all the key facts and summary information to allow you to review the document in 5 to 10 minutes.  This is a must read if you are a financial advisor or loan officer considering these products for your clients now or in the future.

Download Ktmetrmpaper

Should You Carry a Mortgage in Retirement?

First, let's start with some of the more interesting statements from this paper. 

Download MortgageinRetirement

• Among households aged 60 to 69 in 2007, 41 percent had a mortgage.  Of these, 51 percent had sufficient assets to repay their mortgage.
• Over the period 1925-2006, stocks yielded an average real return of 7.1 percent.
• 29% of households have sufficient non-retirement financial assets to repay their mortgage in full.
• 51% of households have sufficient non-retirement and retirement assets combined to repay their mortgage in full.
• One argument that is sometimes cited in favor of not repaying the mortgage is that retaining a mortgage increases the household’s liquidity, and enables it to better cope with sudden unexpected expenses.

This short 5-page paper attempts to argue for not having a mortgage in retirement.  And while the paper itself is short on examples that make sense to anyone without a PhD, the final conclusion is that most of those in retirement should pay off their mortgage with investment assets because they'll earn less on those assets than they'll make.

Essentially, we're back to a discussion on EPR, or effective percentage rate.  Will assets in retirement earn more on an after-tax basis than the cost of the mortgage.  With all questions of 'Suitability', the answer is always 'It Depends.'

Depends on what?  A great deal more than what was covered in this paper.  BUT, in this current market environment, I would agree with the author that emotionally many people have moved to cash, and may not have the fortitude for investing in this brave new world.  If the net cost of borrowing exceeds the net after tax return on your investment, then you are better off paying down the mortgage and using a HELOC, home equity line of credit, for any liquidity needs that may arise.  The benefit of this strategy is that you can still access the money for an investment opportunity should you need it, but in the mean time you'll get the benefit of the higher return.

EXAMPLE:  A consumer has $50,000 in a CD earning 2%.  They are in a 25% tax bracket, so they are essentially earning 1.5% on the CD after tax.  Their mortgage is $100,000 and they currently have a note rate of 6%.  Their EPR, or net cost of borrowing at the 25% tax bracket is going to be 4.5% (6% x .25% = 1.5% tax reduction... 6% - 1.5% = 4.5% EPR).  They could repay the mortgage by $50,000 and earn a 4.5% net after tax return as opposed to the cd return of 2%, BUT the need for liquidity, if there is one, should be considered and a HELOC for $50,000 used to replace access to that money.  Again, there are many other considerations one should consider.

If the author's estimate that the real return of 7.1% since 1925 is accepted, then the idea that earning more on investments net of borrowing is a real question to consider.  At the end of the day, one would need to consider inflation too.   Inflation erodes not only the investment gains, but the future real cost to repay debt.

Net:  The paper is light on substance, and it was written for the retiree that may be emotionally frustrated by a loss of personal wealth that could have already been used to repay mortgage debt.  My personal opinion is in line with the authors, but for different reasons.  Most 60+ retirees are better off paying down the mortgage due to a shorter time horion, and unwillingness to take the risk needed to invest in equities that can provide the real wealth spread needed to offset the time and risk.  Younger families with a longer term time horizon have many more options and considerations worth examining in more detail through a comprehensive Liability Management Review with a trained financial professional.

At the end of the day, ask the question 'What brings me the most peace?', and then work towards that to accomplish it in the most fiscally responsible way.  If you are right at retirement age, or already in retirement, you may not have time for this frustrating investment environment to return to a new normal.

New SAFE Act - Movement Towards Suitability

Essentially the SAFE act and the new laws are all about Suitability for the client.  As we say, Eligibility and Suitability are converging.  You'll want to begin to think about how you clearly show that your recommendation meets the new standards of the four primary rules to bring value to your client.

Download FedsNewRulesOctober09

Sec. 202. Net tangible benefit for refinancing of residential mortgage loans.

No creditor may extend credit for refinancing unless the creditor reasonably and in good faith determines, at the time the loan is consummated and on the basis of information known by or obtained in good faith by the creditor, that the refinanced loan will provide a net tangible benefit to the consumer. The refinanced loan will not be considered to provide net tangible benefit if the costs of the loan, including points, fees, and other charges, exceed the amount of newly advanced principal without any corresponding changes in the terms of the refinanced loan that are advantageous to the consumer. The Federal banking agencies will jointly prescribe regulations further defining the term “net tangible benefit.”

Special thanks to:  Dave Hershman

TARP 2.0 / Key Emerging Factors

In the future it looks like banks will be subject to a "stress test" before receiving new money... it the bank isn't healthy enough to stay the course, and lend money, they don't get it.  Like handling 50 victims in a trauma ER, if the patient is likely to die the doctor might be better off not dispensing antibiotics.

Treasury will give $100 billion of the remaining $350 billion left in the Troubled Asset Relief Program directly to shore up bank capital.

New lending program is being created that will leverage up to $1 trillion to bring down borrower costs. Additionally a new $50 billion foreclosure mitigation program could be announced in the new two weeks.

A "bad bank" will buy problem assets. What's interesting about this?  To avoid putting taxpayers on the hook for the large expense, the Treasury plans to use private capital to buy the assets.

The big problem still remains, how to you price and value these assets?

They are planning to be more transparent, I recently signed a petition to have full disclosure of all funds to the public so there is better accountability of where the funds go.

"This comprehensive strategy will cost money, involve risk, and take time," Mr. Geithner said. "We will have to adapt it as conditions change. We will have to try things we've never tried before. We will make mistakes. We will go through periods in which things get worse and progress is uneven or interrupted."

Now that is a statement of the obvious, but worth putting on the record.

Some Timely Quotes from Another Time

Interesting how history repeats itself.  I found watching this short series on the last comparable market crash of 1929 interesting hindsight. 

One thing for sure, this one is different from the last one, but we can still learn from this as a movement in Veritas.

Also, here are some favorite quotes that seem relative today.

"If you don't read the newspaper you are uninformed,   
If you do read the newspaper you are misinformed."
-Mark Twain

Suppose you were an idiot.
And suppose you were a member of Congress....
But then I repeat myself.
-Mark Twain

Government's view of the economy could be summed up in a few short phrases: If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it.
-Ronald Reagan (1986)

The ultimate result of shielding men from the effects of folly is to fill the world with fools.
-Herbert Spencer, English Philosopher (1820-1903)

I contend that for a nation to try to tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle.
-Winston Churchill

A liberal is someone who feels a great debt to his fellow man, which debt he proposes to pay off with your money.
-G Gordon Liddy

Foreign aid might be defined as a transfer of money from poor people in rich countries to rich people in poor countries.
-Douglas Casey, Classmate of Bill Clinton at Georgetown University

Government is the great fiction, through which everybody endeavors to live at the expense of everybody else.
-Frederic Bastiat, French Economist (1801-1850)

I don't make jokes I just watch the government and report the facts.
-Will Rogers

If you think health care is expensive now,
Wait until you see what it costs when it's free!
-P.J. O'Rourke

In general, the art of government consists of taking as much money as possible from one party of the citizens to give to the other.
-Voltaire (1764)

Just because you do not take an interest in politics doesn't mean politics won't take an interest in you!
-Pericles (430 B.C.)

No man's life, liberty, or property is safe while the legislature is in session.
-Mark Twain (1866 )

When the people find that they can vote themselves money, that will herald the end of the republic.
-Ben Franklin

The inherent vice of capitalism is the unequal sharing of the blessings. The inherent blessing of socialism is the equal sharing of misery.
-Winston Churchill

The only difference between a tax man and a taxidermist is that the taxidermist leaves the skin.
-Mark Twain

What this country needs are more unemployed politicians.
-Edward Langley, Artist (1928 - 1995)

Bailout Scale - Current Financial Crisis

Wonderful post from www.prorepublica.org on the scale of the U.S. current Government bailout compared in current 2008 dollars.

Industry/Corporation Year What Happened Cost in 2008 U.S. Dollars
● Penn Central Railroad 1970 In May 1970, Penn Central Railroad, then on the verge of bankruptcy, appealed to the Federal Reserve for aid on the grounds that it provided crucial national defense transportation services. The Nixon Administration and the Federal Reserve supported providing financial assistance to Penn Central, but Congress refused to adopt the measure. Penn Central declared bankruptcy on June 21, 1970, which freed the corporation from its commercial paper obligations. To counteract the devastating ripple effects to the money market, the Federal Reserve Board told commercial banks it would provide the reserves needed to allow them to meet the credit needs of their customers. $3.2 billion
● Lockheed 1971 In August 1971, Congress passed the Emergency Loan Guarantee Act, which could provide funds to any major business enterprise in crisis. Lockheed was the first recipient. Its failure would have meant significant job loss in California, a loss to the GNP and would have impacted national defense. $1.4 billion
● Franklin National Bank 1974 In the first five months of 1974 the bank lost $63.6 million. The Federal Reserve stepped in with a loan of $1.75 billion. $7.7 billion
● New York City 1975 During the 1970s, New York City became over-extended and entered a period of financial crisis. In 1975 President Ford signed the New York City Seasonal Financing Act, which released $2.3 billion in loans to the city. $9.4 billion
● Chrysler 1980 In 1979 Chrysler suffered a loss of $1.1 billion. That year the corporation requested aid from the government. In 1980 the Chrysler Loan Guarantee Act was passed, which provided $1.5 billion in loans to rescue Chrysler from insolvency. In addition, the government's aid was to be matched by U.S. and foreign banks. $3.9 billion
● Continental Illinois National Bank and Trust Company 1984 Then the nation's eighth largest bank, Continental Illinois had suffered significant losses after purchasing $1 billion in energy loans from the failed Penn Square Bank of Oklahoma. The FDIC and Federal Reserve devised a plan to rescue the bank that included replacing the bank's top executives. $9.5 billion
● Savings & Loan 1989 After the widespread failure of savings and loan institutions, President George H. W. Bush signed and Congress enacted the Financial Institutions Reform Recovery and Enforcement Act in 1989. $293.8 billion
● Airline Industry 2001 The terrorist attacks of September 11 crippled an already financially troubled industry. To bailout the airlines, President Bush signed into law the Air Transportation Safety and Stabilization Act, which compensated airlines for the mandatory grounding of aircraft after the attacks. The act released $5 billion in compensation and an additional $10 billion in loan guarantees or other federal credit instruments. $18.6 billion
● Bear Stearns 2008 JP Morgan Chase and the federal government bailed out Bear Stearns when the financial giant neared collapse. JP Morgan purchased Bear Stearns for $236 million; the Federal Reserve provided a $30 billion credit line to ensure the sale could move forward. $30 billion
● Fannie Mae / Freddie Mac 2008 The near collapse of two of the nation's largest housing finance entities was yet another symptom of the subprime mortgage and housing market crisis. In an effort to prevent further turmoil within the financial market, the U.S. government seized control of Fannie Mae and Freddie Mac and guaranteed up to $100 billion for each company to ensure they would not fall into bankruptcy.  $200 billion
● American International Group (A.I.G.) 2008 When AIG was unable to secure a private-sector loan, the federal government intervened by seizing control of the insurance giant. $85 billion
● Troubled Asset Relief Program 2008 The Bush administration has proposed a rescue plan to ease the current crisis on Wall Street. If approved by Congress, the Treasury Department will be authorized to purchase up to $700 billion of distressed mortgage-backed securities and other assets and then resell the mortgages to investors.  $700 billion

Patience and Wisdom

There are many great virtues of character, and never has character been tested more than in our recent perfect storm of financial events.

It helps to have an equal dose of Patience and Wisdom as we ride out this particular storm.

What could Fannie/Freddie Conservatorship mean to you?

Fannie / Freddie -

When your body has a blood clot, you can die.  When the financial system has a blood clot, the results are not that different.  If you interrupt any part of an ecosystem, the entire system is impacted.  Wall St. was the nation's largest lender, and then there was Fannie / Freddie.  We could call them the functioning dysfunctional siblings that controlled the door to much of the Wall St. lending flow.  The largest highway to Wall St. with an impressive 50x leverage of their financial assets.  So what happens when this source of funds can't sell to Wall St.?  The ecosystem is further impacted.  Imagine that in your favorite fishing pond, there are no more minnows.  How long would it take for that pond to die?  Not the pond itself, but the functional pond as a place for fishing.

Things start to stop, and no matter how good a fisherman you are, if someone takes your fish (access to money), the sport loses its luster - the really great fishermen(women) are hard to tell from the really poor ones, because everyone looks the same out on there sitting in their boat waiting for something to happen.

What this could mean for you?

This overdue action by the Government could very well mean that the housing recovery, which is likely years away, could be accelerating for the lenders, related institutions, Realtors, and financial advisors.

We should see now and in the remaining course of this year:

Lower interest rates on mortgages this year, increased refinancings and probably one last chance to lock in low long term interest rates for the years to come - once the crisis is over we could see rates turning upwards, but we've now got a nice window to increase refinance and purchase traffic in the near future.

One of the bigger fears is that an industry refinance movement can't be handled because of the dramatic reduction in lending personnel and infrastructure in the US.  Those who have stayed int he boat weathering this storm stand to gain as lower rates and fewer competitors create new opportunities.  Expect to also find yourself lending to many different parties, it may be more difficult to find one or two sources to fund your loan volume.

Lower overall fees will make housing more affordable, but watch as they start restricting future broad lending to a lower range of lending, which may then decentralize jumbo and higher loan amount lending as we know it today to more regional banks and savings and loans.

The combination of these two means a possible 1/2% real drop in interest rates and up to another 1/2% real drop in interest rates when fees and higher guarantees added by Fannie and Freddie are dropped now that the government is engaged.  The direction will move from their corporate profitability goals to a more important (election year) national housing recovery focus - an improvement for the consumer.

Why?  If the average house price [Download averagehouseprice.pdf] in the US in 2007 was $313,600, then 1% drop in real interest rates would yield an interest payment reduction of ( $209 a month before taxes ) based on an 80% LTV purchase.  That really helps when you have properties decreasing in value, and the cost of ownership financing going down, you'll start to see more minnows in the fishing pond, and that feeds the fish who have been starving over the last 9 months waiting for their next meal to swim by... get back in the boat now and make sure you have both individual lines and a few nets in the water.

HERA Amendment to Section 121 IRS US Code

Modification of $250,000/$500,000 Exclusion –

We have had a lot of questions on this, and I'm going try to simplify the impact and provide you some additional insight. 

The Section 121 tax incentives modification under HERA affects the $250,000 / $500,000 exclusion of gain on the sale of a principal residence.  It is the only real modification to the existing traditional Section 121 and Section 163 real estate tax codes.

Beginning 1/1/2009, a second home (or rental property) that is converted to a principal residence will have to play by some new rules. 

When the second home is sold, any gain attributable to use as a second home (or rental property) will be taxed at capital gains rates at that time.  Any gain attributable to use as a principal residence will remain excludable, up to the $250,000 and $500,000 limits.  Essentially you must now prorate the usage, whereas before you could potentially live there for 2 years and get the full exclusion... now you'd have to look back over the 5 year period and prorate the time spent as second home or investment and treat that based on capital gains, and the balance would apply toward the $250,000/$500,000 Exclusion. 

Want to learn more, watch this short video for a case study example...