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Five-Year Mortgage Rate Freeze Looms
Wednesday December 5, 8:42 pm ET
By Martin Crutsinger and Alan Zibel, Associated Press Writers

Bush Mortgage Plan Will Freeze Certain Subprime Interest Rates for 5 Years WASHINGTON (AP) — The Bush administration has hammered out an agreement to freeze interest rates for certain subprime mortgages for five years to combat a soaring tide of foreclosures, congressional aides said Wednesday.

The aides, who spoke on condition of anonymity because the details have not yet been released, said the five-year moratorium represented a compromise between desires by banking regulators for a longer time frame of up to seven years and mortgage industry arguments that the freeze should last only one or two years.

Another person familiar with the matter said the rate-freeze plan would apply to borrowers with loans made at the start of 2005 through July 30 of this year with rates that are scheduled to rise between Jan. 1, 2008, and July 31, 2010.

The administration said President Bush will speak on the agreement at the White House on Thursday and the Treasury Department announced that Treasury Secretary Henry Paulson and Housing and Urban Development Secretary Alphonso Jackson would hold a joint news conference Thursday afternoon with mortgage industry officials.

Treasury also announced there would be a technical briefing to explain more of the proposal’s details.

Paulson, who has been leading the effort to craft a plan, said on Monday that the program would only be available for owner-occupied homes — to ensure the break is not given to real estate speculators.

The plan emerged from talks between Paulson and other banking regulators and banks, mortgage investors and consumer groups trying to address an avalanche of foreclosures feared as an estimated 2 million subprime mortgages reset from lower introductory rates to higher rates.

In many cases, the higher rates will boost monthly payments by as much as 30 percent, making it very difficult for many people to keep current with their loans.

The plan is aimed at homeowners who are making payments on time at lower introductory mortgage rates but cannot afford a higher adjusted rate.

Through October, there were about 1.8 million foreclosure filings nationwide, compared with about 1.3 million in all of 2006, according to Irvine, Calif.-based RealtyTrac Inc. With home loan defaults still rising, the trend is expected to worsen next year.

The plan represents an about-face for Paulson, who until recently had insisted the mortgage crisis could be handled on a case-by-case basis. However, he and other administration officials became convinced the tide of foreclosures threatened by the mortgage resets represented such a severe threat that a more sweeping approach was needed. They opted for a proposal that was along the lines of a plan put forward in October by Sheila Bair, head of the Federal Deposit Insurance Corp.

Paulson and other federal regulators began holding talks with some of the country’s biggest mortgage lenders, mortgage service companies, investors who hold mortgage-backed securities and nonprofit groups that provide counseling for at-risk homeowners.

Under the typical subprime loan — those offered to borrowers with spotty credit histories — the rates for the first two years were at levels around 7 percent to 8 percent. But after two years, those rates were scheduled to reset to levels around 9 percent to 11 percent.

For a typical $1,200 monthly mortgage payment, the reset could add another $350 to the monthly payment, greatly raising the risks of loan defaults by homeowners struggling with the current payment.

The wave of mortgage foreclosures threatened to make the most severe slump in housing even worse by dumping more foreclosed properties onto an already glutted market, further depressing home prices and shaking consumer confidence.

The deepening housing slump has already roiled financial markets, starting in August, as investors grew increasingly concerned about billions of dollars of losses being suffered by banks, hedge funds and other investors.

The administration plan is designed to deal with the crisis by letting subprime borrowers who are living in their homes and are current on their payments to avoid a costly reset for five years. The hope is that by that time the housing downturn will have stabilized, clearing out the glut of unsold homes and halting the steep slide in prices that is hitting many parts of the country.

With sales and prices once again rising, the expectation is that homeowners will be able to renegotiate their current adjustable rate mortgages into a more affordable fixed-rate plan.

The housing crisis has become an issue in the presidential race with Democrats Hillary Rodham Clinton and John Edwards putting forward their own proposals this week that would go further than the administration.

Clinton said her own proposal that would impose a 90-day moratorium on foreclosures and freeze the rates for five years or until they had been converted to fixed-rate loans was a better approach that would help more people.

“Although the administration is finally giving the foreclosure crisis the attention it deserves, it seems that President Bush is going to give struggling homeowners far less than they need,” she said in a statement.

Mark Zandi, chief economist for Moody’s Economy.com, called the administration plan a good first step, but said the government eventually will have to go further given the problem’s size and the threat to the economy.

“This is the most serious housing downturn we have seen in the post World War II period,” Zandi said. “It is a threat to the broader economy. The risks of a recession are very high.”

Associated Press reporters Deb Reichmann and Nedra Pickler contributed to this report.

Alan Blinderis an American economist, on the faculty of Princeton University. He has served as the Deputy Assistant Director of the Congressional Budget Office, on President Bill Clinton’s Council of Economic Advisors, and as the Vice Chairman on the Board of Governors of the Federal Reserve System. Sounds like a government conformist right? Wrong

He has recently wrote a controversial column for the Foreign Affairs magazine about globalization in which he opined that globalization could cause more disruptions in service jobs than originally believed. He says that he still believes that globalization would be a net plus for the United States. This analysis has not been published in a peer-reviewed journal of economics. His views on this issue is not widely accepted by economists.

Then comes this gem: Six Fingers of Blame in the Mortgage Mess

Who’s the first finger? Everyone who has a mortgage.

The first finger points at households who borrowed recklessly to buy homes, often saddling themselves with mortgages that were all too likely to default. They should have known better. But what can we do to guard against it happening again?

Not much, I’m afraid. Gullible consumers have been around since Adam consumed that apple. Greater financial literacy might help, but I’m dubious about our ability to deliver it effectively. The Federal Reserve is working on clearer mortgage disclosures to help borrowers understand what they are getting themselves into. (“Warning! This mortgage can be dangerous to your family’s financial health.”) While I applaud the effort, I’m skeptical that it will work. If you have ever closed on a home, you know that the disclosure forms you receive are copious and dense. Should we add even more?

Fewer words, and in plainer English, might help, especially if they highlighted the truly important risks. (“In two years, your mortgage payments could double.”) But the truth is that there is much to disclose, that complicated mortgage products are, well, complicated, and that people don’t read those documents anyway.

He does go on to blame Lenders, bank regulators, and countless others. If you don’t read the New York Times, you should. Real estate is local, mortgages are national.

I usually rely on Andy Rooney Ben Stein to make sense of whatever ails America. His self-effacing wit tends to overshadow his knowledge. He’s like the “very rich and very eccentric” grandfather we wished we had, the one who was wise beyond his years who spoke from the heart. My maternal grandfather fit this profile except there a distinct language barrier as he spoke Tagalog and I didn’t.

Earlier this month Ben Stein wrote a piece called How Speculators Exploit Market Fears. It discusses what hedge fund managers do to create action in the stock market. Rather than take snippets from the article, here’s the full article:

Here’s a fact: The speculators and hedge fund managers who run today’s stock market need market volatility in order to make money.

They can’t make enough money if the market stays flat or moves only a bit, so they like extreme and unexpected price movements. They especially like sudden, surprise movements down, when they can make money off stocks they borrow and sell — or, as they say, “sell short.”

Money Lust Satisfied

That’s what’s been happening the past couple of weeks. But it’s not interesting to say that the speculators are whipping the market around to satisfy their money lust. So the speculators themselves make up reasons for why the market is fluctuating, flog those reasons to the media, and then profit if some other speculators believe the jive reasons and jump in the way the manipulators want them to.

Supposedly, the market is “correcting” because of worries about the housing slowdown, and also because of fears that the debt markets that support mergers and acquisitions is drying up.

These are interesting theories, and people who don’t know a lot about the stock market or the economy might find them beguiling. What follows are a few truths that show how shallow these “reasons” for the stock market moves are.

Housing a Theory

Yes, the housing market has slowed from a spectacular bubble level to a simply pretty good level. Housing sales and starts are now about what they were in 2002, and no one thought we were in a housing depression then.

In any event, housing is only about 5 percent of the economy. If it falls by 15 percent, that would represent a fall-off of about .75 percent. That’s not trivial, but it’s also not the stuff of which recessions are made.

The fact is that there is no recession. The economy is suffering from a labor shortage, not a surplus of unemployment. The Fed is worried about excess demand, not slack demand.

Corporate profits set new records every day. Whatever’s happening in residential sales and building is simply not slowing down the economy. Why should a Boeing or a Merck or a Pfizer have any reaction to housing at all? Because the speculators sell everything they can when nervousness sets in — and for no other reason.

A Minor Major Mess

Subprime is a mess. But it’s a small mess. Subprime mortgages account for roughly 20 percent of mortgages even in the most heavily exposed states. About 20 percent of them are delinquent in some way. That’s 4 percent of mortgages.

Of these, maybe half, or 2 percent, will go into foreclosure. There will be roughly 50 percent recovery on sale of these. This is a loss of 1 percent in the mortgage market — a sum the lenders have already made many times over because of the hefty fees on those deals. In the context of the size of the U.S. financial sector, it’s nothing.

And why should a crisis in subprime drive down stocks in Mexico and Thailand? Again, because the speculators seek to create panic to make money by selling short, and they sell short everything.

There’s simply no connection between subprime and developed or developing nations’ stocks. This by itself shows the thin context of the selling wave late last month.

Money’s Still Cheap

What about the supposed drying up of loans for mergers and acquisitions by private equity firms? Well, here’s a good, simple test of just how valid that explanation is for stock market moves: The majority of private equity takeovers are financed with junk debt.

If there really were a major shortage of funds for these deals, the interest rate on the junk would skyrocket. Instead, while the rate has risen by about 150 basis points in the past month, the spread between junk and investment grade is now about 290 basis points, according to leading junk analyst Martin Fridson.

This is a lot lower than the year-end average of the spread from 2002 to 2006, and far below the almost 800 basis point spread during a true interest-rate crunch like the one after the tech meltdown in 2000-2002.

So that’s phony, too. Interest rates have risen, but not anything like what they’ve done in real crises. And besides, the Dow fell by about 550 points the week before last, yet not one of the Dow stocks is involved as either acquiror or acquiree in a private equity deal.

In short, money is no longer virtually free the way it was for private equity deals in the past year. But it’s not expensive by historical standards, either.

Spreading the Fear

In other words, it’s all the speculators trying to panic us so their sell programs will make money. And they’ll make money as long as they can spread their panic. When they can’t do that any longer, they’ll work the long side — and make up reasons for that, too.

In the meantime, the economy is strong. Profits are great, and interest rates are low and will stay that way. Don’t sell. With all the shrieking about the market, it only fell to what it was about five weeks ago — and we didn’t think we were poor then.

So let the speculators shout “fire.” As of right now, they’re not blowing anything but smoke.

Two quick points:

131+ mortgage companies have shut down. If you’re a consumer chances are you’ve never heard of these companies. If you’re in the mortgage business, you’ve probably heard of a fraction (i’d say 25%) of these companies. For the most part, those that bet on high risk loans (subprime, alt-a, non-owners, etc.) lost. The ones that bet on low risk loans (conforming) are still open for business.

However, one quick look at Google Trends and you’ll notice that countrywide, mortgage, credit, or liquidity don’t show up as “hot searches” in Google.

Sometimes you need Ben Stein to make sense of a nonsensical world.

The mortgage industry is imploding. High risk mortgages to high risk borrowers are becoming extinct. Credit scores will be more important than ever. There are five major factors that calculate your credit score with each factor carrying a different percentage:

- 35% Payment History
- 30% Amounts Owed
- 15% Length of Credit History
- 10% New Credit
- 10% Types of credit

Notice the first 3, that’s 80%: How you pay, how much you owe, and how long you’ve been paying carries the most weight.

Having a good credit score is a commitment. The FICO score is a solid indicator of your debt/payment habit. Rarely have I seen a borrower who takes their debts seriously with poor scores. On the other hand if a borrower has poor credit, they’ve developed poor debt/payment habits. A few years ago I worked with a couple that had poor credit. They were in a bind and relied on me to help them improve their scores. It took a few months but I helped them clean up their credit with one caveat, that the next time I pulled their credit, I would hope to see their scores improve. A year later I pulled their credit, their scores never improved. They went back to their old habit of signing up for credit cards and maxing them out.

Here’s a mortgage primer on which loans are no longer the flavor of the month on Wall Street. They’re the Michael Vick’s of the mortgage world, they were once very popular on but now nobody wants to be associated with them. Okay, that’s a little bit too harsh since these loans didn’t kill dogs. Then again, these loans have put families in dire straits so lets keep the Michael Vick analogy.

Loans the Wall Street doesn’t like:

• THE LOANS WITH THE REALLY REALLY REALLY LOW RATE AND LOW MONTHLY PAYMENT

Also called: 1%, NEGATIVE AMORTIZATION, NEG AM, OPTION ARMS, PAY OPTION ARMS or

“A CAN OF WHOOP ASS WAITING TO HAPPEN”

• THE LOANS FOR BORROWERS WITH REALLY REALLY REALLY BAD CREDIT HISTORIES

Also called: SUBPRIME, NON PRIME, POOR CREDIT, 2/28s, 3/27s, or

“I GUESS THIS IS WHAT I GET FOR NOT PAYING MY BILLS”

• THE LOANS FOR BORROWERS WHO HAVE GOOD CREDIT BUT WHOSE OVERALL LOAN APPLICATION DOESN’T MEET FANNIE MAE OR FREDDIE MAC’S STANDARDS

Also called: ALT-A or

“SO I’VE GOT GOOD CREDIT AND A GOOD JOB BUT I’M PENALIZED FOR NOT SAVING ANY MONEY”

• THE LOANS FOR BORROWERS WHO CAN’T REALLY REALLY REALLY SHOW HOW MUCH MONEY THEY’VE MADE OR HOW MUCH THEY HAVE SAVED UP

Also called: STATED INCOME, STATEDSIVA, SISA, NO DOC, or

“DON’T THEY HAVE LOANS FOR PEOPLE WHO DON’T HAVE JOBS?”

• THE LOANS FOR BORROWERS WHO REALLY REALLY REALLY DON’T WANT TO PUT ANY MONEY DOWN

Are called: 80/20, 100% Financing, NO MONEY DOWN, 103%, 107% or

“I WANT A LOAN WHERE I GET TO KEEP MY MONEY IN CASE MY JOB GETS OUTSOURCED TO INDIA”

• THE LOANS FOR BORROWERS WHO REALLY REALLY REALLY DON’T WANT TO PAY AN AMORTIZED PAYMENT

Also called: INTEREST ONLY, IO, or

“IF I LIKE PAYING DOWN PRINCIPAL MY PAYMENT GETS RECAST TO A LOWER PAYMENT EVERY MONTH”

• THE LOANS FOR BORROWERS WHO REALLY REALLY REALLY WANT TO BUY A HOME THEY HAVE NO INTENTION OF LIVING IN

Also called: INVESTMENT PROPERTY LOANS, NON OWNER OCCUPANCY, NOO or

“I’M GOING TO BE THE NEXT DONALD TRUMP”

• THE LOANS FOR BORROWERS WHO REALLY REALLY REALLY MAKE A LOT OF DOUGH

Also called: JUMBO, NON CONFORMING, SUPER JUMBO, MILLION DOLLAR LOANS, ANYTHING OVER $417,000 or

“THAT’S PRETTY LOW FOR A RATE OF RETURN AND PRETTY HIGH FOR A MORTGAGE INTEREST RATE”

It remains to be seen if Wall Street still likes:

• THE LOANS FOR BORROWERS WHO REALLY REALLY REALLY HAVE NO INTENTION OF LIVING IN THEIR HOMES FOR 15 to 30 YEARS

Also called: ADJUSTABLE RATE MORTGAGES, ARMS, 3/1, 5/1, 7/1, 10/1, TEASER RATE LOANS, HYBRID LOANS, BALLOONS or

“THE AVERAGE PERSON MOVES EVERY 5 to 7 YEARS, SO WHY SHOULD I GET A LOAN FOR 30 YEARS?”

Wall Street will always like:

• THE LOANS WITH REALLY REALLY REALLY NO RISK

Also called: FHA, VA, CONFORMING, FANNIE MAE, FREDDIE MAC or

“THE LOANS THAT MAKE UP THE MAJORITY OF THE AMERICAN MORTGAGE LANDSCAPE”

Back in September, the Feds came out with a press release entitled: Federal financial regulatory agencies issue final guidance on nontraditional mortgage product risks–September 29, 2006. The purpose of this press release was to address the problems our nation has been having with high risk mortgages.

These products, referred to variously as “nontraditional,” “alternative,” or “exotic” mortgage loans (referred to below as nontraditional mortgage loans), include “interest-only” mortgages and “payment option” adjustable-rate mortgages. These products allow borrowers to exchange lower payments during an initial period for higher payments later.

These loans often carry the following layers of risk:

• Interest Only

: Interest only payments do not require principal reduction therefore your loan balance stays the same.

• Adjustment of Rate

: When adjustable rate mortgages begin their adjustment phase, your loan payments may increase.

• Negative Amortization

: When you only make the minimum payment your principal balance increases every month.

• Prepayment penalties

: If you decide to refinance or sell your home before the penalty expires, you may face severe monetary penalties.

For more on the Feds effort to explain high risk mortgages, check out these addendum’s which explain:

1. Risks of Non Traditional Mortgages
2. Key Facts About Interest Only and Payment Option Mortgages

Phil’s take: I take pride in understanding these “high risk” mortgages inside and out. However, it took time to really understand all the nuances. On the other hand, a borrower has a month, maybe less, to really understand what they’re getting themselves into. The above documents are a good start but it won’t deter mortgage companies from coming up with even more complex loan programs in the future.

I get a lot of email. Some are linking requests. Some are spam that somehow get through GMAIL’s spam filter. Some are mortgage requests. Some are mortgage questions. Some are mortgage vendors trying to sell me something.

On Sunday, I received a well written argument from a reader who asked me to post his response to the Denver Post article NO MONEY DOWN: A HIGH RISK GAMBLE.

Phil,

I enjoy frequenting your blog, and wanted to be sure to share this with you. I am an independent Mortgage Broker with my own company Source Financial LLC, and I wrote an extended response to The Sunday Denver Post’s lead article from September 17, 2006 entitled “No Money Down: A High-Risk Gamble” [www.denverpost.com/ci_4347686].

I found the Denver Post article to be riddled with misrepresentations, one-sided accountings, and dangerous misinformation, all supporting a traditionalist approach to mortgages that has put two-thirds of all families into home ownership, but yet has led to a situation where the average fifty year-old American is worth negative $7000, only 5% of Americans retire at age 65 in financial dignity, and 9 out of 10 Americans die in debt.

In reference to my 2000 word response, Denver Post Business Editor Stephen Keating indicated that “I will take the time to read it and digest your observations, and discuss it with the rest of the reporting/editing team here.” Article author and Denver Post Business Writer Greg Grifffin wrote “This is a well-reasoned and well-supported argument. I don’t agree with everything you’ve said, but you’ve managed to get me thinking.” Unfortunately, checking today’s (September 24) Sunday Denver Post and www.denverpost.com, my response remained unpublished…

A Response to “No Money Down: A High-Risk Gamble” – The Sunday Denver Post, September 17, 2006 lead article [www.denverpost.com/ci_4347686]

As an independent Mortgage Broker that owns my own company, Source Financial LLC, in addition to being affiliated with a larger mortgage company that handles the processing and servicing of my loans, Lion Financial Corporation, I read the lead article “No Money Down: A High-Risk Gamble” with great interest. Knowing that a lot of folks along the Front Range turn to the Denver Post as an objective source for information, I was shocked and dismayed by much of the information and conclusions that were put forth on a topic that already invokes a fight or flight response among many home owners.

100% financing loans have been an amazing tool that has greatly contributed to the 5% increase over the last twenty years in percentage of homes occupied by the owner. But it is not the lack of equity that is putting these borrowers into jeopardy, it is a lack of a flexible asset base to deal with changes that has been increasing the risk of these folks defaulting. In general, people that utilize 100% financing for home purchases usually are lacking the liquid assets, emergency funds, and overall wiggle room to deal with financial hardship.

Of course lenders usually have guidelines concerning liquid asset reserves that must be held by the borrower in order to qualify for a loan, but often they only require enough to cover two to four months of mortgage payments. When people do face catastrophic events rightfully referenced by the Denver Post, “job loss, medical problems and divorce,” those reserves can often quickly disappear.

But having equity in one’s home when faced with these situations does not “give homeowners options when they face financial problems,” because it is precisely when folks are facing such dilemmas that they are quite often unable to qualify for refinancing, as at that point in time they are too high risk of a borrower for lenders to work with. As a Mortgage Broker I am deeply disturbed by this fact, but unfortunately it is a reality that we all must face when dealing with banks and lenders.

And probably the most misunderstood aspect of homeownership is the fact that equity is a ZERO PERCENT RETURN INVESTMENT. Yet two-thirds of Americans hold the majority of their wealth in home equity, which is a non-liquid asset that gives them absolutely zero return. Many people confuse appreciation, which is the increase in home value due to market trends, with getting some kind of return on their equity, but that is a common misconception. That is why it is so important for homeowners to separate their equity from their home via refinancing, and put those “cashed out” funds into investment vehicles that offer an actual rate of return. In doing so, homeowners increase their overall liquidity, improve their capacity to face emergencies, reduce their financial risk, increase their rate of return, improve their tax deductions, and diversify their investment portfolio.

Instead of spending their liquid asset base (savings) to finish their basement and send money to their parents, such as in the case of Jose Garcia and Maria Vanderhorst, borrowers with 100% financing have to exercise greater financial discipline. And putting money down and getting into a 30-year fixed would not have improved their situation, as then their down payment would be tied up as equity, which is a non-liquid asset, money that can only be accessed through refinancing or by selling their home.

100% finanacing loans are not dangerous, what is dangerous is borrowers not having a liquid asset base to deal with life’s contingencies. Unfortunately, these are the type of borrowers that tend towards 100% financing, as it really is their only option for home ownership. And tying up their wealth in the straightjacket known as equity is not part of the solution, it is part of the problem. An incredible means to access equity for the purpose of greater fiscal flexbility and all the other goods mentioned above, or “cashing out equity as one goes,” is the Option-ARM loan, which received quite a misguided slamming in the Denver Post article.

The Payment Option Loan gives the borrower four different payment options each and every month: they can make an Interest Only, 30-Year amortized, or 15-Year amortized payment based upon the fully indexed interest rate, or they can make the minimum payment that is based upon a very low “start rate” (usually between 1% and 4%), which involves deferring interest (a.k.a. negative amortization), or adding the difference between the Interest Only payment and the minimum payment onto the principal of the loan. Now while most lenders offer the Payment Option Loan with an adjustable fully indexed rate, one that starts adjusting as early as the first month, some lenders offer the Payment Option Loan with a fixed interest rate for the first five years.

The Payment Option Loan has proven to be a favorite of Real Estate Investors and Real Estate Agents, as it frees up extra cash flow on a monthly basis for much greater investment opportunities. Knowing that equity is a zero percent return investment is some powerful information to have.

The annecdote concerning Louis and India Harts conflated the fixed “start rate” with the adjustable “fully indexed rate”, such that readers were left with the impression that the Harts’ interest rate went from 2.6% to 8.1%. The start rate, which determines how much the minimum payment will be, is not a “teaser rate” that “quickly shoots up”. Some lenders do gradually increase the minimum payment itself (not its determining start rate) on an annual basis, usually somwhere in the range of 7.5% per year, to keep the borrower from deferring too much interest. But the start rates is always otherwise a fixed rate. It is the fully indexed rate, upon which the Interest Only, 30-Year amortized, or 15-Year amortized payments are based, that is adjustable is this case. And this fact is consistent with the numbers quoted in the article: the minimum payment of $919 the Harts are making would be the combination of $721 (2.6% start rate on a $180,000 loan) and $198 of escrowed Property Taxes and Hazard Insurance, which is approximately what they would be for such a home.

In the Harts’ particular case, they are going to have plenty of time to refinance before their loan starts to recast when the principal hits 115% (which would be $207,000 in their situation), as they will be well below that total when their three year prepayment penalty period is up. So the answer to Louis’ “I don’t know how we’re going to do it,” is that when those three years are up, they’ll refinance and get themselves into a loan that they feel more comfortable with and educated about. Though given their situation, if properly understood the Payment Option Loan really is their best option.

My question is how can mortgage products themselves be blamed for foreclosures? At best the article points towards a correlation, but demonstrating causation surely requires more than offhanded references to what some unnamed experts stated the next wave of defaults “may” come from. Beyond unpredictable catastrophic occurences like job loss and overwhelming medical bills, foreclosures occur because borrowers are getting into loans that they do not understand, and often they do not know that they do not understand the mortgage product. It is the responsibility of the Mortgage Broker to completely explain all the details of any mortgage product to the borrower. But it is also the responsibility of the borrower to be certain that they understand the terms of loan before signing off on it at closing. Vehicles and guns both kill in the range of 35,000 Americans each year, but it is the human misuse due to lack of education, ignorance or simple negligance that creates this reality, much like in the mortgage scenario.

Every different mortgage product serves its purpose, and what works for one borrower will not work for another given the specifics of their situation. To label certain categories of loans as “high-risk gambles” or as leaving “no room for slips” ignores the millions of families that are in these loans and find that they very much work for them. It is also a disservice to consumers to mislead them with such one-sided representations.

The true irony of the lead piece in September 17th Sunday Denver Post is that the conclusion that “Option-ARMs… could fuel a surge in foreclosures in the next few years” is the opposite of what we find is actually going on in the mortgage industry, as Payment Option Loans have proven to have the lowest foreclosure rate of any mortgage product currently on the market. World Savings is a bank that specializes in this product, which they refer to as the Pick-A-Pay Loan, as more than 90% of the loans they outfit borrowers with are of the Option-ARM variety. As a lender they have less than a 1% percent foreclosure rate! But World Savings, along with the independent Mortage Brokers like myself that they work with, take on the responsibility of educating the borrowers as to how to properly and smartly manage this incredibly powerful mortgage product.

A lot of mortgage brokers I know will not touch Payment Option loans, but I believe that is primarily because they are not all that interested in educating the consumer. Why not just throw them into a 30-year fixed APR mortgage? Everyone pretty much knows how that works. But that is also how banks make of the most money off of borrowers! The “list of higher-risk, alternative mortgages” the article refers to are not only not necessarily higher risk (Payment Option loan has the lowest risk, as discussed above), but they also provide the borrower the opportunity to increase their monthly cash flow by lowering their monthly mortgage payments by as much as 40%. In this way consumers are empowered to “become the bank” and grow their own investment portfolio, rather than falling into the trap of handing over their hard earned capital to the banks in the form of a large down payment or paying down principal so that they can have more of a zero percent return investment, equity.

Affiliates of Lion Financial Corporation, like myself through my company Source Financial LLC, do not shy away from the privilege or responsibility of educating our clients how to properly utilize alternative mortgage packages. And why is this? Because when families are taught smart mortgage product and equity management, they learn to utilize their mortgage as a financial tool for building wealth, which easily makes a $500,000 to $1,000,000 difference for the borrower over the next fifteen to twenty years. The affluent have always understood how to leverage their mortgage, pay as little down as possible, and keep very low monthly payments in order to increase cash flow for investment purposes. The American middle class is being transformed by engaging in these very same concepts and increasing their fiscal discipline, and I absolutely would not have it any other way.

Brent Ritzel
President/CEO, Source Financial LLC
Denver, Colorado, USA
An affiliate of Lion Financial Corporation
303-590-8999
Brent.Ritzel@lionfinance.com

10 tips for using a mortgage as a financial tool

Here is a list of 10 tips to building and maintaining wealth, as well as the 10 most common myths about home equity, and the reality of each myth.1. Avoid the $25,000 mistake that ensnares millions of Americans. Myth: The best way to pay off a home early is to pay extra principal on your mortgages. Reality: No method of applying extra principal payments to your mortgages is the wisest or most cost-effective way of paying off your house. Strategy: Establish a liquid side fund to accumulate the funds required to pay off your mortgage, maintain flexibility, achieve substantial tax savings and accumulate excess cash.

The equity you have in your home can be a powerful tool in managing your overall financial situation. Your equity, the value of your home minus your existing mortgage, can serve as collateral for additional borrowing. While there are some risks with this strategy (as with any borrowing), home equity loans usually offer the attractions of lower rates, longer period to pay back, convenience and often tax benefits.

4. The return on equity is always zero no matter where your property is located. Myth: Home equity has a rate of return. Reality: Equity grows as a function of real estate appreciation and a mortgage reduction; however, equity has no rate of return. Strategy: Separate as much equity from your house as feasible in order to allow idle dollars to earn a rate of return.

9. Strategically refinance your home as often as feasible to increase your net worth. Myth: Equity in your home enhances your net worth. Reality: Equity in your home does not enhance your net worth at all. Separated from your home, however, it has the ability to dramatically enhance your net worth over time. Strategy: Set the stage to substantially increase your net worth. Refinance your home as often as feasible to separate equity and accelerate the process of accumulating the resources to cover all your debts.

10. Keep your mortgage balance high to sell your home more quickly and for a higher price. Myth: The amount of equity you have in your home has no bearing on how marketable it is. Reality: Your home may likely sell much more quickly and for a higher price if it has a high mortgage balance (low equity)—rather than a low mortgage or no mortgage balance (high equity)—especially in soft real estate markets. Strategy: Always maintain as high a mortgage with flexibility on your home as feasible to keep it marketable at the highest possible price should you want to sell the property.”

6. Use debt for positive leverage. Myth: Any and all debt is undesirable. Reality: Some debt, when managed wisely, can be desirable. Strategy: Use debt wisely as a positive lever for equity management purposes, conserving and compounding equity rather than consuming it.

2. Avoid expensive risks. Position yourself to act instead of reacting to market conditions you have no control over. Myth: Home equity is liquid. Reality: When you need it most, you may not have it. Home equity is usually not-liquid. Strategy: Separate as much equity from your property as is feasible, positioning it in financial instruments that will maintain liquidity in the event of emergencies and conservative investment opportunities.

5. Make Uncle Sam your best partner. Mortgage interest is your friend, not your foe. Myth: Mortgage interest is an expense that should be eliminated as soon as possible. Reality: Eliminating mortgage interest expense through traditional methods eliminates one of your best partners in accumulating wealth and financial security. Strategy: Use the difference between preferred and non-preferred interest expense to make interest work for you instead of against you.

As you can see there are many ways you can put your equity to work for you. It might be a good idea to check with your online Mortgage Broker to see how you would be able to benefit from some of these strategies.

3. Separate home and equity to increase safety. Real properties with high equity and low mortgages get foreclosed on the soonest. Myth: Home equity is a safe investment. Reality: A home mortgaged to the hilt or totally free and clear provides the greatest safety for the homeowner. Strategy: Separate as much equity from your home as feasible to achieve greater safety of principle and reduce the risk of foreclosure.

7. Understand the cost of not borrowing compare deductible versus non-deductible costs. Myth: lower mortgages, resulting in lower payments, mean lower cost. Reality: If you take opportunity costs into consideration, low mortgage-to-home-value ratios create tremendous hidden costs that increase the time needed to pay off a mortgage. Strategy: Choose to incur deductible employment costs rather than non-deductible opportunity costs, since you have no choice but to incur one or the other.

8. Turbo charge your wealth growth rate by creating homemade wealth. Myth: Borrowing funds at a particular interest rate, then investing them at the same or lower interest rate, holds no potential growth returns. Reality: You can earn a tremendous pro fit regardless of the relative interest rates by positioning your money in a tax favored, interest-compounding investment that earns a rate of return greater than the real net cost of obtaining the money. Strategy: Learn to apply the fundamental principle that highly profitable financial institutions use to accumulate and create wealth arbitrage. Employ equity to earn a rate of return higher than the net cost of separating that equity. By doing so, you will create tremendous wealth and substantially enhance your net worth.

Nearly 6 in every 10 home owners has more home equity than stock, bond, treasury or other securities derived wealth. They key to maximizing one’s wealth is to utilize one’s home equity to invest in asset classes which on average return at a rate higher than the tax-deduction-adjusted interest rate of their mortgage. For example, if you have a 5% ARM your effective interest rate after deductions is roughly 3.75%. You should speak with your tax and investment professionals about finding a strategy which allows you to invest at a rate higher than this, and contact us for advice on how to get you the money to build your financial future.

A stated-income loan qualifies a borrower using the income the borrower states on the application form - as opposed to the income the borrower can document. With a stated income loan, the lender agrees not to attempt to verify the income the borrower has stated on the application.

Stated income mortgages are ideal for the self-employed and for home buyers in professions with salaries comprised mostly of cash tips, such as waiters and hotel porters. This type of loan applicants can often afford a mortgage, but don’t have the necessary pay stubs to document their true earnings. Self-employed business owners whose personal assets are commingled with the business assets often utilize “Stated-Income Stated-Assets” mortgage programs.

You are responsible for providing an accurate figure when the loan officer asks for your income amount. The loan officer should not coach you or fill in the amount for you. If the loan is audited and fraud is discovered you and or the loan officer can be held accountable under the law.

One of the reasons for a stated income loan is to minimize paperwork during the loan application process. A number of requirements that would normally be requested are W2 Statements, 1099 Forms, Bank Statements, and Pay Check Stubs. A stated income loan would not require the borrower(s) to find and organize this information to be approved for a loan. In many cases the interest rate difference is very minimal but normally slightly higher than a loan which requires proof of income.

On some stated income programs, the lender may require the borrowers to complete and sign Internal Revenue Service form 4506. This form gives the lender permission to access past and future tax returns of the borrowers. Having a signed and completed 4506 form in the file greatly enhances the marketability of the loan to the secondary market.

Some times this loan program has been referred to as “The Liars Loan”. It is important to understand, the existence of this loan, is for the purpose of helping borrowers, who otherwise cannot document their Actual Income. It is not designed to fictitiously inflate your income.

Stated income may be used in lieu of full documentation if you have higher credit scores. Lenders view you as less risky and therefore are willing to dismiss income documentation to speed up the loan process. The rate you receive is contingent on specific loan to value and/or down payment restrictions.

Lenders will often check with widely-available salary survey sources like salary.com to determine whether or not the income stated is consistent with the borrower’s profession and title.

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