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House Price Vs. Interest Rate: Which Is More Important?

2010-11-04T05:45:00.001-07:00

Filed Under: Interest Rates, Mortgages, Personal Finance, Real Estate

Two housing market shifts encourage potential homebuyers to call real estate agents: drops in housing prices and low interest rates. But deciding which factor is more important than the other can make a difference in monthly payments, the ability to move if your home value drops and HOA fees. TUTORIAL: Mortgage Basics

Monthly PaymentLet's say you started the home search process when interest rates were 7%. You saw a one-bedroom condo for sale for $100,000. You calculated your 30-year monthly mortgage payment on $80,000 – the amount you are mortgaging after a 20% down payment and your closing costs. Your monthly payment would be $532. You decide you don't like this payment and rate, so you wait six months and the interest rate drops to 5%. However, a condo in the neighborhood you want now averages $120,000. You put down 20% plus closing costs, and you are left with a mortgage amount of $96,000. Your monthly payment on a 30-year mortgage is $515. Your payment dropped by $17. But does a payment drop financially make up for the higher down payment? Factoring in that your down payment was $4,000 more, you still save about $5 to $6 per month - around $2,100 of savings over the course of 30 years. If real estate prices never rose in your perspective neighborhood from the $100,000 price point you started your search with - and you snagged a 5% interest rate - your mortgage would be $430. However, the volatility of housing prices and interest rates cannot be accurately predicted to move in your favor.
IN PICTURES: Financing For First-Time Homebuyers
Down PaymentRegardless of your interest rate on a lower-priced home, you can get into a home with less money. In the example of the condo that rose from $100,000 to $120,000, your monthly payment dropped. But would the lower payment help you if you didn't have an extra $4,000 for a larger down payment? The down payment amount difference could eliminate the possibility of buying the home you want, or knocking out of the buyer's market altogether if you can't find a cheaper neighborhood.
Plus, the extra $4,000 can impact your ability to pay for unexpected home repairs, your emergency savings and ability to afford to furnish your new home.
Can Low Interest Rates and Low Prices Unite?Yes. In September 2010, interest rates and housing prices were both rather low. But how do you know what a low rate is comparatively? You can find historic mortgage rates on the Freddie Mac website. Look at the last five years for highs and lows.
Although such an opportunity was presented in the past, there is no assurance that history will repeat itself. More importantly, if you need a house soon, the option to wait an extra five years for the ideal housing market circumstances may not be a realistic alternative.
MovabilityInterest rates don't matter as much, as long as you can easily afford your payments, if you live in your home for five years or less. While it's never a guarantee that housing prices won't drop further, you can view estimated housing prices for the last 10 years by selected an address in the neighborhood you are studying online. Always compare neighborhood values instead of national or city-by-city. Home price patterns vary rapidly from neighborhood-to-neighborhood and state-to-state. The likelihood you will end up owing more than the remainder of your mortgage can be lower if you buy a home when your local real estate market is below its peak.
HOA FactorHomeowners Association (HOA) fees are often more expensive for higher-priced homes, plus they can climb higher when more homes are vacant. Why? HOAs cover shared services such as lawn maintenance, condo maintenance, clubhouses, pools, tennis courts and/or private streets. Similar to other historic data, you should contact potential HOAs and ask for historic rates over the last 10 years. You should also ask about maximum fees, or what factors determine rate hikes and decreases. Always ask about HOA fees on all homes you are considering. HOA fees may be lower on a slightly higher priced home, especially if less services are offered.
In low interest rate environments, HOA payments can present an excessive monthly burden, so make sure that these payments are factored into your monthly budget. (For more on Homeowner's Association's see 9 Things You Need To Know About Homeowners' Associations and Buying A Condo.)
RefinancingA big perk to a lower home price versus a lower interest rate is that your home can be refinanced or modified in the future. Basically, the problem with high initial interest rates can be mitigated in the future if rates decrease. If your home's interest rate isn't at a five-year interest rate low, ask potential mortgage bankers about costs to modify your loan. The range can be anywhere from free to thousands. There isn't a guarantee your home loan's interest rate will drop, but you can insure you can afford to refinance when it does.
ConclusionThe decision to buy a home should always be based on your ability to afford your monthly payment, your down payment, emergency savings, home repairs and furnishings. Always consider potential future factors such as HOA fees and the option to pay down your mortgage if you have to move quickly.
There isn't an exact right time to buy a home, but there is a time when you're financially ready and know you're going to stay put for at least five years. Buy a home that you can afford both now and five years in the future.
For further reading, checkout New Home Repair Troubleshooting, Are You Ready To Buy A House?, Buying A Home: Calculate How Much Home You Can Afford, and Will You Break Even On Your Home?.

by Reyna Gobel,MBA (Contact Author | Biography)

Reyna Gobel is a freelance journalist and self-professed financial geek, who realized in her finance classes that personal finances weren't nearly as complicated as she thought they'd be and set out to spread the word.Gobel is also the author of "Graduation Debt: How To Manage Student Loans And Live Your Life" (2010). Her website is Graduation Debt.

Filed Under: Interest Rates, Mortgages, Personal Finance, Real Estate

Top 6 Mortgage Mistakes

2010-11-04T05:44:00.001-07:00

Filed Under: Mortgages, Personal Finance, Real Estate, Young Investors

During the 2007-2009 financial crisis, the United States economy crumbled because of a problem with mortgage foreclosures. Borrowers all over the nation had trouble paying their mortgages. At the time, eight out of 10 borrowers were trying to refinance their mortgages. Even high end homeowners were having trouble with foreclosures. Why were so many citizens having trouble with their mortgages?

Let's take a look at the biggest mortgage mistakes that homeowners make. 1. Adjustable Rate Mortgages
Adjustable rate mortgages seem like a homeowners dream. An adjustable rate mortgage starts you off with a low interest rate for the first two to five years. They allow you to buy a larger house than you can normally qualify for and have lower payments that you can afford. After two to five years the interest rate resets to a higher market rate. That's no problem because borrowers can just take the equity out of their homes and refinance to a lower rate once it resets.
Well, it doesn't always work out that way. When housing prices drop, borrowers tend to find that they are unable to refinance their existing loans. This leaves many borrowers facing high mortgage payments that are two to three times their original payments. The dream of home ownership quickly becomes a nightmare. (For more on types of mortgages, see Mortgages: Fixed-Rate Versus Adjustable-Rate.)
2. No Down Payment
During the subprime crisis, many companies were offering borrowers no down payment loans to borrowers. The purpose of a down payment is twofold. First, it increases the amount of equity that you have in your home and reduces the amount of money that you owe on a home. Second, a down payment makes sure that you have some skin in the game. Borrowers that place down a large down payment are much more likely to try everything possible to make their mortgage payments since they do not want to lose their investment. Many borrowers who put little to nothing down on their homes find themselves upside down on their mortgage and end up just walking away. They owe more money than the home is worth. The more a borrower owes, the more likely they are to walk away.
3. Liar Loans
The phrase "liar loans" leaves a bad taste in your mouth. Liar loans were incredibly popular during the real estate boom prior to the subprime meltdown that began in 2007. Mortgage lenders were quick to hand them out and borrowers were quick to accept them. A liar loan is a loan that requires little to no documentation. Liar loans do not require verification. The loan is based on the borrower's stated income, stated assets and stated expenses.
They are called liar loans because borrowers have a tendency to lie and inflate their income so that they can buy a larger house. Some individuals that received a liar loan did not even have a job! The trouble starts once the buyer gets in the home. Since the mortgage payments have to be paid with actual income and not stated income, the borrower is unable to consistently make their mortgage payments. They fall behind on the payments and find themselves facing bankruptcy and foreclosure.
4. Reverse Mortgages
If you watch television, you have probably seen a reverse mortgage advertised as the solution to all of your income problems. Are reverse mortgages the godsend that people claim that they are? A reverse mortgage is a loan available to senior citizens age 62 and up that uses the equity out of your home to provide you with an income stream. The available equity is paid out to you in a steady stream of payments or in a lump sum like an annuity.
There are many drawbacks to getting a reverse mortgage. There are high upfront costs. Origination fees, mortgage insurance, title insurance, appraisal fees, attorney fees and miscellaneous fees can quickly eat up your equity. The borrower loses full ownership of their home. Since all of the equity will be gone from your home, the bank now owns the home. The family is only entitled to any equity that is left after all of the cash from the deceased's estate has been used to pay off the mortgage, fees, and interest. The family will have to try to work out an agreement with the bank and make mortgage payments to keep the family home. (For more information, take a look at Is A Reverse Mortgage Right For You?)
5. Longer Amortization
You may have thought that 30 years was the longest time frame that you could get on a mortgage. Are you aware that some mortgage companies are offering loans that run 40 years now? Thirty five and forty year mortgages are slowly rising in popularity. They allow individuals to buy a larger house for much lower payments. A 40-year mortgage may make sense for a young 20-year-old who plans to stay in their home for the next 20 years but it doesn't make sense for a lot of people. The interest rate on a 40-year mortgage will be slightly higher than a 30 year. This amounts to a whole lot more interest over a 40-year time period, because banks aren't going to give borrowers 10 extra years to pay off their mortgage without making it up on the back end.
Borrowers will also have less equity in their homes. The bulk of payments for the first 10 to 20 years will primarily pay down interest making it nearly impossible for the borrower to move. Besides, do you really want to be making mortgage payments in your 70's?
6. Exotic Mortgage Products
Some homeowners simply did not understand what they were getting themselves into. Lenders came up with all sorts of exotic products that made the dream of home ownership a reality. Products like interest only loans which can lower payments 20-30%. These loans let borrowers live in a home for a few years and only make interest payments. Name your payment loans let borrowers decide exactly how much they want to pay on their mortgage each month.
The catch is that a big balloon principal payment would come due after a certain time period. All of these products are known as negative amortization products. Instead of building up equity, borrowers are building negative equity. They are increasing the amount that they owe every month until their debt comes crashing down on them like a pile of bricks. Exotic mortgage products have led to many borrowers being underwater on their loans. (For more on IO loans, read Interest-Only Mortgages: Home Free Or Homeless?)
The Bottom Line
As you can clearly see, the road to home ownership is riddled with many traps. If you can avoid the traps that many borrowers fell into then you can keep yourself from financial ruin. (For related reading, take a look at Mortgages: The ABCs of Refinancing.)

by Mark Riddix (Contact Author | Biography)

Mark Riddix is the founder and president of New Horizons Financial Management. New Horizons is an independent investment advisory firm that provides personalized consulting services in investment and asset management. Riddix has a degree in finance and has worked in investment management for the past five years. He has also written a personal finance column for Baltimore and Washington metropolitan newspapers and writes a financial blog at BuylikeBuffett.com.

Filed Under: Mortgages, Personal Finance, Real Estate, Young Investors

How The Federal Reserve Was Formed

2010-11-04T05:42:00.001-07:00

Filed Under: Banking, Economics, Forex

The Federal Reserve is widely considered to be one of the most important financial institutions in the world. The Fed can either be your kindly grandmother or the mother-in-law from hell, and its character is usually a function of the Federal Reserve's board of governors. Its monetary policy decisions can send waves through not only the U.S. markets, but also the world. (To find out what the Fed does for investors, check out our Federal Reserve tutorial.)

In this article we will look at the formation of the Federal Reserve and follows its history as it riles the market and then turns it around and sends it to new highs.

Life Before the Federal ReserveThe United States was considerably more unstable financially before the creation of the Federal Reserve. Panics, seasonal cash crunches and a high rate of bank failures made the U.S. economy a riskier place for international and domestic investors to place their capital. The lack of dependable credit stunted growth in many sectors, including agriculture and industry. (To learn more about the history of banking, see Cold Hard Cash Wars and The Evolution Of Banking.)

J.P. Morgan and the Panic of 1907It was J.P. Morgan who forced the government into acting on the central banking plans it had been considering off and on for almost a century. During the Bank Panic of 1907, Wall Street turned to J.P. Morgan to steer the country through the crisis that was threatening to push the economy over the edge into a full crash and depression. Morgan was able to convene all the principal players at his mansion and command all their capital to flood the system, thus floating the banks that, in turn, helped to float the businesses until the panic passed.

The fact that the government owed its economic survival to a private banker forced the necessary legislation to create a central bank and the Federal Reserve. (Keep reading about this in Get To Know The Major Central Banks.)

Learning from EuropeIn the years between 1907 and 1913, the top bankers and government officials in the U.S. formed the National Monetary Commission and traveled to Europe to see how the central banking was handled there. They came back with favorable impressions of the British and German systems, using them as the base and adding some improvements gleaned from other countries.

The Federal Reserve was given power over the money supply and, by extension, the economy. Although many forces within the public and government were calling for a central bank that printed money on demand, President Wilson was swayed by Wall Street arguments against a system that would cause rampant inflation. So the government created the Federal Reserve, but it was by no means under government control.

The Great Depression The government soon came to regret the freedom it had granted the Federal Reserve as it stood by during the crash of 1929 and refused to prevent the Great Depression that followed.

Even now, it is hotly debated whether the Fed could have stopped the depression, but there is little doubt that it could have done more to soften and shorten it by providing lower interest rates to allow farmers to keep planting and businesses to keep producing. The high interest rates may even have been responsible for the unplanted fields that turned into dust bowls. By restricting the money supply at a bad time, the Fed starved out many individuals and businesses that might otherwise have survived.

The RecoveryIt was World War II, not the Federal Reserve, that lifted the economy out of the depression. The war benefited the Federal Reserve as well by expanding its power and the amount of capital it was called on to control for the Allies. After the war, the Fed was able to erase some of the bad memories from the depression by keeping interest rates low as the U.S. economy went on a bull run that was virtually uninterrupted until the '60s.

Inflation or Unemployment?Stagflation and inflation hit the U.S. in the '70s, slapping the economy across the face, but hurting the public far more than business. The Nixon administration ended the nation's on and off again affair with the gold standard, making the Fed that much more important in controlling the value of the U.S. dollar. The big question for the Fed was whether the nation was better off with inflation or unemployment. (To learn more, read The Gold Standard Revisited.)

By controlling interest rates, the Fed can make corporate credit easy to obtain, thus encouraging business to expand and create jobs. Unfortunately, this increases inflation as well. On the flip side, the fed can slow inflation by raising interest rates and slowing down the economy, causing unemployment. The history of the Fed is simply each chairman's answer to this central question. (For more insight, check out All About Inflation.)

The Greenspan YearsAlan Greenspan took over the Federal Reserve a year before the infamous crash of 1987. When we think of crashes, many people consider the crash of 1987 more of a glitch than a true crash - a non-event nearer to a panic. This is true only because of the actions of Alan Greenspan and the Federal Reserve. Much like J.P. Morgan in 1907, Alan Greenspan collected all the necessary chiefs and kept the economy afloat.

Through the Fed, however, Greenspan used the additional weapon of low interest rates to carry business through the crisis. This marked the first time that the Fed had operated as its creators first envisioned 80 years before. (To read about a more modern-day Fed, check out The Federal Reserve's Fight Against Recession and A Farewell To Alan Greenspan and Ben Bernanke: Background And Philosophy.)

The Bottom Line
Criticisms of the Federal Reserve continue. Boiled down, these arguments center on the image people have of the caretaker of the economy. You can either have a Fed that feeds the economy with ideal interest rates leading to low unemployment - possibly leading to future problems - or you can have a Fed that offers little help, ultimately forcing the economy to learn to help itself. The ideal Fed would be willing to do both. Although there have been calls for the elimination of the Federal Reserve as the U.S. economy matures, it is very likely that the Fed will continue to guide the economy for many years to come.

by Andrew Beattie (Contact Author | Biography)

The Rise And Fall Of The Shadow Banking System

2010-11-04T05:40:00.001-07:00

Filed Under: Banking, Economics, Economy, Recession

Before getting into an analysis of how the shadow banking system played a role in the 2008 economic downturn, we must first understand what this system is in the most basic sense. Although the term "shadow" may conjure up all sorts of nefarious and unpleasant images in one's mind, it would simply be unfair to characterize this aspect of our financial system in such an emotional or negative context. (Four major players slice and dice your mortgage in the secondary market. To learn more, check out Behind The Scenes Of Your Mortgage.) Tutorial: Banking
We all know the traditional banking system provides checking and savings accounts, auto and home loans, and various other financial services. But most people fail to understand that these institutions do not possess infinite capital, and are therefore limited in the amount of loans they can provide to consumers or small businesses. This limitation is where the shadow banking system came into play.
The Rise of Shadow Banking
Prior to the Great Recession, banks realized their ability to profit from lending was limited by access to capital and the size of their balance sheet. So instead of lending and holding loans like banks did in the "good old days" (limiting profit potential), they began specializing in originating loans, packaging them and selling them to other investors through securitization processes via investment banks; hence the inception of the unregulated "shadow banking system" which provided a conduit capital seeking to purchase these securities.
How this worked is rather simple. A financial institution would lend as much money as possible for home, general consumer and auto loans, and would then work with investment bankers to securitize these pools of assets. These securities would then be sold to a variety of investors such as pension funds, endowments, mutual funds, hedge funds and other financial institutions; these were the funders of the shadow system. These instruments could take a great many forms such as asset-backed securities (ABS), collateralized debt obligations (CDO), mortgage-backed securities (MBS) and collateralized loan obligations (CLO). (Learn more in CDOs And The Mortgage Market.)
It was through these instruments that more and more people were easily able to access credit as financial institutions could profit from making ever increasing amounts of risky loans. This led to the lending institutions selling these loans to other investors in the form of innovative fixed-income securities. So it seemed a win-win situation for everyone involved. Consumers got the cheap credit they desired and investors found a way to earn higher returns over Treasuries with minimal perceived risk in the face of robust and stable economic growth.
The Problem
So if this was such a good thing, how did it turn so ugly? Well the answer to this question centers on one very persistent aspect of investor behavior in that people tend to extrapolate current events too far into the future. In this particular instance, investors implicitly believed through their pricing of risks (or required credit spread over Treasuries) that the economic stability we enjoyed during the mid 2000s would persist. Premiums investors required for bearing the credit risks associated with MBSs, CDOs, ABSs etc., were not priced accordingly for the level of underlying risk. This relationship can be dimensioned by using the proxy of falling credit spreads between the U.S. 10-Year Treasury and Moody's AAA rated corporate bonds as demonstrated in Figure 1. (Despite investor distrust, rating agencies can be helpful. Just be sure you use these ratings as a starting point. For further, see Bond Rating Agencies: Can You Trust Them?)

Figure 1: Spread Between Moody's AAA and U.S. 10-Year Treasury

Source: Federal Reserve

What Went Wrong?
The question then turns to what went wrong and why did investors sour so precipitously on what had become an apparently successful means to provide easy access to credit for the average American and bolster investor returns? The answer to this question is rather simple in that it involves the relationship between leverage and the cost thereof.

Although Americans were more than happy to have easy access to credit cards, cars and home loans, it is unlikely they were aware this practice was placing the U.S.'s societal balance sheet in the most precarious position in its entire history. As you can see from Figure 2, total leverage in American society had not only reached its highest levels in history, but had done so at an accelerating pace in recent years. The result was our economy had become extremely addicted to leverage and overburdening unrealistic budget practices.

Chart 2: Total Societal Leverage (Household, Farm, Corp. Government and Financial) - June 2007

Source: Federal Reserve

One of the many problems in hindsight is that the Federal Reserve failed to take into consideration not only the incredible leverage inherent in our economy, but the reliance on low interest rates. Corporations were not the only parties dependent on low interest rates, home owners could only pay off their mortgage if rates remained low. Thus, they could not pay interest payments on their mortgages that exceeded the initial teaser rate. The shadow banking system enabled such a system to flourish because many of these economic anomalies remained hidden in the unregulated market.
So with the dual effect of high 2008 energy costs (recall gasoline at around $4 per gallon) alongside the higher interest rates that followed the mortgage teaser rates, the economy began to sputter. But more importantly, investors began to discount a recession into their pricing of securities and willingness to bear risk. This in turn created a positive feedback loop that hit the economy with higher credit costs as investors now required greater compensation for bearing risk given the fragility of the U.S. economy and peoples' ability to service their interest payments. See Figure 3.

Figure 3: Spread Between Moody's AAA and U.S. 10-Year Treasury

Source Federal Reserve

So the end of result of this confluence of events was exactly what the economy did not need. Investors were far less likely to lend money over fears over economic weakness and the shadow banking system essentially collapsed. So any lending that did take place was done at far higher interest rates than people were accustomed to. On top of this, the highly levered U.S. economy was not only unable to bear these precipitous increases in interest rates, but the lack of availability of credit in general. This is what led to the precipitous decline in U.S. economic activity, or the "Great Recession." See Figure 4.

Figure 4: Total Borrowing/Lending in U.S. Economy And Annualized Real GDP Growth

Source: Federal Reserve, BEA

The Bottom Line
The point of this article is two-fold. The first is to serve a big picture history lesson for what the shadow banking system was, what caused its failure, how that failure contributed to the 2008 economic woes, and also to provide a demonstration of how important this system is to our economy given societal leverage. Albeit people always seek to demonize someone or something when things go wrong, it's important to remember that the shadow banking system could never have existed if there had been no demand for its services - the demand created the supply.
Like it or not, this aspect of our economy is essential given our country's penchant for borrowing to support consumer spending. Can we regulate it for the betterment of society and preclude such future meltdowns? Well, that remains to be seen. (Find out how this economic cycle affects both small and big business. Read The Impact Of Recession On Businesses.)

by Eric Petroff (Contact Author | Biography)

Eric Petroff is the director of research of Wurts & Associates, an institutional consulting firm advising nearly $40 billion in client assets. Before joining Wurts & Associates, Petroff spent eight years at Hammond Associates in St. Louis, another institutional consulting firm, where he was a senior consultant and shareholder. Prior to Hammond Associates, he spent five years in the brokerage industry advising retail clientele and even served as an equity and options trader for three of those years. He speaks often at conferences and has published dozens of articles for Investopedia.com and the New Zealand Investor Magazine.

Filed Under: Banking, Economics, Economy, Recession

Parties For Taxes: Republicans Vs. Democrats

2010-11-04T05:39:00.001-07:00

Filed Under: Economics, Taxes

We often boil down the tax policy of our major political parties into its simplest form: Democrats raise taxes to fund social programs, and Republicans lower taxes to benefit big businesses and the wealthy. Both ideas simplify the policy of each party, yet both ideas are essentially true.

Whether you agree with more government spending or tax breaks for corporations, each party's agenda will affect your taxes.

Political Ideology: Republican"We believe government should tax only to raise money for its essential functions," the Republicans state their case plainly on the Republican National Convention web site. That is, Republicans believe government should spend money only to enforce contracts, maintain basic infrastructure and national security, and protect citizens against criminals.

The literature of the House Republican Conference goes on to illuminate the role of the government and how tax policies affect individuals: "The money the government spends does not belong to the government; it belongs to the taxpayers who earned it. Republicans believe Americans deserve to keep more of their own money to save and invest for the future, and low tax policies help drive a strong and healthy economy."

Tax relief is the Republican route to growing the economy. A Republican government would reduce taxes for businesses to allow businesses to grow and thus hire more employees. Republicans also seek to limit income taxes for individuals so that people can hold on to more disposable income, which they can then spend, save or invest.

Political Ideology: DemocratThe tax policy for the Democratic Party calls for raising certain taxes to provide money for government spending, which in turn generates business. The party platform asserts that government spending provides "good jobs and will help the economy today."

Many Democrats are adherents to Keynesian economics, or aggregate demand, which holds that when the government funds programs, those programs pump new money into the economy. Keynesians believe that prices tend to stay relatively stable and therefore any kind of spending, whether by consumers or the government, will grow the economy. (Check out Giants Of Finance: John Maynard Keynes, to learn more about Keynes' theories.)

Like the Republicans, Democrats believe the government should subsidize vital services that keep cities, states and the country running: infrastructure such as road and bridge maintenance and repairs for schools. Democrats also call for tax cuts for the middle class. But who benefits most under each platform? The conventional wisdom is that corporations and the wealthy will benefit more with a Republican tax policy while small businesses and middle-class households will benefit from a Democratic tax policy.

A Misunderstood ConceptMany of the quarrels that flare up when people debate tax policy evolve out of misunderstood concepts. Possibly the most misunderstood concept is the tax rate. We hear that a politician wants to raise taxes on income and we cringe, convinced that higher taxes will whittle away every dollar we earn. But we don't pay a flat tax; we pay income taxes on a marginal rate.

The marginal tax rate is the rate you pay on the last dollar of income you earn. For example, if you were single in 2008 and you brought in $50,000, you fell into the 25% tax bracket. But that doesn't mean that every dollar was taxed at 25%. It means that your first $8,025 was taxed at 10%, then everything up to $32,550 was taxed at 15% and everything above $32,551 was taxed at 25%.

Thus, when a Republican administration announces lower taxes, it is lowering the marginal tax rate - and critics grumble that the decrease benefits folks sitting on the higher rungs of the income ladder. Similarly, when Democrats announce an increase to the marginal rate, critics gripe that the increase will burden only high-income earners. (Read The Market And Presidential Promises to see how, no matter who you vote for, announcements like tax changes can affect the markets.)

Tax ReformOf course, filing taxes is never as simple as plugging in your income and calculating your marginal rate. The IRS has bequeathed us a mishmash of regulations, deductions, credits and other magical formulas to thwart our efforts to file a quick federal return. Both political parties agree that the colossal tax code needs to be restructured and simplified. And, of course, each party has its own plan for how to tackle the problem.

The Democrats state that they "will shut down the corporate loopholes and tax havens and use the money so that we can provide a … middle-class tax cut that will offer relief to workers and their families."

The Republicans assert that they "support giving all taxpayers the option of filing under current rules or under a two-rate flat tax with generous deductions for families. Religious organizations, charities and fraternal benevolent societies should not be subject to taxation."

A Recent History of Taxes and SpendingTax policy and the marginal rates we pay have volleyed back and forth, as Republicans and Democrats each took the reins of the White House. Under the Reagan administration, Congress passed the Economic Recovery Tax Act of 1981, which gave a 25%, across-the-board tax cut to individuals in all tax brackets - an act that became associated with the term supply-side economics. Then Congress passed the Tax Reform Act of 1986, which, among other changes, lowered the highest marginal tax rate from 50-28%, and reduced the corporate tax rate.

In 1993, the Clinton administration repealed some of the Reagan tax cuts with the Omnibus Budget Reconciliation Act of 1993, which tacked on 36% and 39.6% marginal tax rates for individuals and a 35% rate for corporations. Note, however, that as inflation fell after the 1981 tax cuts, and the economy began to slow, Reagan agreed to repeal some of his own tax cuts, with the Deficit Reduction Act of 1984. The Reagan and Clinton tax increases served to reign in a budget deficit, which then allowed Clinton to announce a budget surplus of $230 billion in 2000.

Under Clinton, The Taxpayer Relief Act of 1997 offered a new tax benefit to families through the Per-Child Tax credit. This credit was refundable for many lower-income families and began a new trend of individual, refundable tax credits.

Under George W. Bush, in 2001, Congress signed into law a $1.35 trillion tax cut, which gave tax relief to individuals and families, with $300 to $600 rebates, doubled the child tax credit and again dropped the top marginal rate from 39.6-35%. The Bush tax cuts also provided major tax incentives for businesses. The Bush administration followed up with more rebates in the Jobs and Growth Tax Relief Reconciliation Act of 2003. (Not all promises were acted upon in previous years. Read Talk Is Cheap: Campaign Promises And The Economy, to take a look at a couple of past promises, and why they were not implemented.)

Political DogmaConservative think tanks denounce the Democrat tax policy and its Keynesian ideology as wasteful spending that injects only temporary money into the economy, as they praise Republican tax policy for protecting business, investments and personal income. The liberal establishment condemns the Republican tax approach - and supply-side economists - as funneling money only to the wealthy and big corporations, as they commend Democrats for spreading the wealth, supporting small business and reaching out to lower-income workers.

Both sides have their own experts and statistics lined up to support their economic dogma, but tax policy is complicated and tightly interwoven with many other aspects of government. The benefits of one approach may take years to materialize, which can frustrate our ability to distinguish which tax cuts or which tax increases fuel growth. (To learn more about party differences, read our related article For Higher Stock Returns, Vote Republican Or Democrat?)
by Stephanie Barton (Contact Author | Biography)

Stephanie Barton is a writer and editor who has spent the past decade tackling a wild range of topics. She has hit the local bar scene to rate cocktails for ForbesTraveler.com, test-driven a Porsche Boxster on the autobahn for a European lifestyle magazine, produced campaign reports on tax assistance programs for the United Way, edited books on software for Sybex/Wiley & Sons and edited books on health care for Elsevier. Stephanie provides writing and editing services through www.tougheditor.com.

Filed Under: Economics, Taxes

Parties For Taxes: Republicans Vs. Democrats

2010-11-04T05:38:00.001-07:00

Filed Under: Economics, Taxes

Jobless Recovery: The New Normal Since 1990

2010-11-04T05:35:00.001-07:00

Filed Under: Careers, Economy, Recession

Economist Nick Perna coined the phrase "jobless recovery" following the recession of 1990-1991 to describe a situation in which the economy recovered from a recession but the job market does not. In 1990, this phenomenon was a new development. In the decades following, with numerous fluctuations in the economic cycle, 1990 is now viewed as the beginning of the new normal.

The History and the NumbersPrior to 1990, the unemployment that accompanied economic downturns began to reverse itself, shortly after the recessions reached their troughs as employers began to recall workers. The cycle was broken after the recession that took place from July 1990 to March 1991, as unemployment continued to rise even after the recession ended, and did not rebound to pre-recession levels until 1997.

Unemployment prior to and following the recession of July 1990-March 1991
Year	Unemployment Rate
1989	5.3%
1990	5.6%
1991	6.8%
1992	7.5%
1993	6.9%
1994	6.1%
1995	5.6%
1996	5.4%
1997	4.9%

The new pattern continued in the aftermath of the recession that took place at the beginning of the new millennium, following the collapse of the dotcom bubble. Unemployment continued to rise following the end of the recession, and pre-recessionary employment levels were not revisited, even prior to the start of the next recession. Before the global financial industry experienced a meltdown in 2008, unemployment continued to fluctuate around the levels witnessed in the previous recession.

Unemployment prior to and following the recession of March 2001-November 2001
Year	Unemployment Rate
2000	4.0%
2001	4.7%
2002	5.8%
2003	6.0%
2004	5.5%
2005	5.1%
2006	4.6%

Unemployment prior to and following the recession of December 2007-November 2010
Year	Unemployment Rate
2006	4.6%
2007	4.6%
2008	5.8%
2009	9.3%
2010	+9.5%

CausesWhy did a cycle that held true for decades change? Why doesn't employment rebound following a recession? The experts cite a variety of causes, including structural changes in the economy and increased worker productivity. Globalization is one well-known factor, as jobs once based in the United States are sent overseas to lower-paying labor markets. (The Globalization Debate provides a closer look at thistopic.)
Executive compensation is another factor. Since the 1980s, executive pay has been increasingly linked to stock options. A high stock price is directly related to high personal profits for the CEO, so labor costs must be minimized to maximize profits and keep the price of the stock rising. (To learn more about executive compensation, see Reining In CEO Rewards and Lifting The Lid On CEO Compensation.)
It's simply a case whereby a minority of the population has strong financial incentive to act in their own best interests. In colloquial terms, those benefiting from the arrangement would say that it is capitalism at work, while the opposing view would say that the rich get richer at the expense of the middle class and the poor.
Consumer behavior also plays a role. Consumers want to spend as little as possible when they shop. By choosing to purchase less expensive imported goods rather than more expensive domestically produced goods, they minimize their expenses. Here again, there is a financial incentive to act in their own self interest. The down side of this behavior is that the money they spend creates jobs overseas and simultaneous unemployment at home. Although there is much debate regarding whether or not opening domestic borders to international exports reduces jobs, some economists justify a jobless recovery with the preceding logic. The significant presence of imported clothing, cars, steel and other items once produced domestically supports the argument with regard to a variety of formerly high-paying manufacturing jobs. In more recent years, the outsourcing of white-collar jobs from engineering and computer programming to journalism and radiology has also attracted significant attention.
Technology and increased productivity are also considerations. As companies demand greater productivity from workers and replace manual processes with machines, fewer employees are required to complete the necessary tasks. Jobs that once required an assembly line filled with workers are now done by automatic processing technologies. Manufacturing plants that once employed hundreds of workers now require only a few highly skilled technicians to monitor the process.
The nature of the recessions themselves is something else to consider. From 1969-1982, recessions typically occurred when the Federal Reserve raised interest rates to control inflation. In the more recent downturns, economic bubbles and other factors beyond the Fed's control contributed to the malaise.
When these factors are combined, white collar workers begin to experience what blue-collar workers in the steel and auto industries had been living with for years. The dynamics of employment change. Layoffs and call backs that once ebbed and flowed in response to supply and demand become permanent. It's not that workers can't find jobs, but rather that those jobs no longer exist.
Impact: Financial Planning and Investment Implications Looking to the future, none of the factors that lead to jobless recoveries are going away. Long-term unemployment following economic downturns is likely to be an expected outcome. With this in mind, there are some steps you can take to prepare for this environment.
The first is to live below your means, so that you are not financially devastated by the temporary loss of a job. Working a second job is also a consideration. Having another source of reliable income provides a safety net should your primary source of income disappear. (5 Signs That You're Living Beyond Your Means will help you evaluate your current spending habits, and Two Roads: Debt Or Financial Independence? provide additional information.)
You might also consider a more flexible approach to your job search. While people are often reluctant to relocate, willingness to move can be an advantage if there are no jobs where you currently live. (Once you've made the commitment to watch your spending, The Beauty Of Budgeting will help you accomplish your task.)
Conclusion
During economic downturns, consumers do tighten their belts, but some purchases (food, water and toilet paper for instance) cannot be avoided. When times are tough, firms that sell life's necessities tend to fare better than firms that sell discretionary items. It is often in these industries where job safety can be ensured, despite stagnating economic activity.

by Lisa Smith (Contact Author | Biography)

Filed Under: Careers, Economy, Recession

Why Leveraged ETFs Don't Always Boost Returns

2010-11-04T05:34:00.001-07:00

Filed Under: Active Trading, ETFs

In recent years, exchange traded funds (ETF) have grown massively popular, and for many good reasons. ETFs have some attractive characteristics and provide individual investors an easy way to gain sector or broad market exposure. However, ETFs don't always work the way you may expect judging by their names. Many people who look at the returns of an ETF, compared to its respective index, get confused when things don't seem to add up. Investors should know the following factors when investing using ETFs. (Learn more in Ultra ETFs: The Ultimate Investment?)

Does Leveraging Work?Leveraged ETFs feature some of the most glaring naming mistakes when investing over an extended period. These ETFs generally come with the names "Ultra Long" or "Ultra Short," and if you look into their descriptions they promise two to three times the returns of a respective index, which they do - sort of. Let's look at a few examples of how ETFs don't always work the way you would expect.

The Ultra S&P 500 ProShares is an ETF designed to return twice the S&P 500. Leveraged ETFs boost results, not by actually borrowing money, but by using a combination of swaps and other derivatives. However, the effect is the same, and if the S&P 500 returns 1%, the SSO should return about 2%. But let's look at an actual example. During the first half of 2009, the S&P 500 rose about 1.8%. If the SSO had worked, you would expect a 3.6% return. In reality, the SSO went down from $26.27 to $26.14. Instead of returning 3.6%, the ETF was essentially flat.

It's even more troubling when you look at the SSO along with its counterpart, the UltraShort S&P 500 ProShares which is designed to return twice the opposite of the S&P 500. Over the 12 months ending June 30, 2009, the S&P 500 was down nearly 30%. The SSO behaved pretty well and was down about 60%, as you would expect. The SDS, however, was down about 20%, when it should be expected to be up 60%! (Learn more in Dissecting Leveraged ETF Returns.)

Are SPDRs More Predictable?Leveraged ETFs aren't the only ones with problems. S&P 500 Depository Receipts, also known as SPDRs, seek to exactly mimic the S&P 500. Over the twelve months ending June 30, 2009, SPY shares were down just under 30%, which is about right. Its counterpart, however, Short S&P 500 ProShares, which seeks to move exactly the opposite, was curiously down around 4% during the period.

The CausesSo now that we've looked at a few examples of how ETFs don't always do what they are supposed to do, let's examine why. ETFs are really designed and marketed to track the daily movements of a corresponding index. You may ask yourself why that would matter, since if it tracks its index properly each day, it should work over any extended period of time. That is not the case. The compounding effects of daily returns will actually throw off the math, and can do so in a very drastic way.

Leveraged ETFsFor example, if the S&P 500 moves down 5%, the SSO should move down 10%. If we assume a share price of $10, the SSO should be down to about $9 after the first day. On the second day if the S&P 500 moves up 5%, over the two days the S&P 500 return will be -0.25%. An unaware investor would think the SSO should be down 0.5%. The 10% increase on day two will bring shares up from $9-9.90, and the SSO will, in reality, be down by 1%. It decreases a full four times the decline of the S&P 500. Typically, you will find that the more volatile the benchmark (S&P 500 in this example) for a leveraged ETF, the more value the ETF will lose over time, even if the benchmark ends up flat or had a 0% return at the end of the year. If the benchmark moved up and down drastically along the way, you may end up losing a significant percentage of the value of the ETF if you bought and held it.

Normal ETFsAs for the problems with normal ETFs, the math works similarly, but on a smaller scale. If you start at an index value of 100 and it drops 5% on the first day, a long ETF with a starting value of $100 will drop 5% to $95, while the short ETF also at $100 will increase 5% to $105. If on the next day, the index rebounds by increasing 5%, the short ETF will drop 5% to $99.75 [105 x (1-0.05)], and the long ETF will rise 5% to $99.75 [95 x (1+0.05)]. Both end up at the same value, and both have dropped 0.25%, when they are supposed to be inverses of one another. Taking this over more extended periods can cause even more accentuated problems. In volatile markets, like those seen in 2008 and 2009, even unleveraged ETFs can show significant discrepancies. (See Investment Strategies For Volatile Markets to learn how to adapt your strategy based on market conditions.)

We used the S&P 500, and its corresponding ETFs, as the basis for all of the examples above because they are some of the most visible and heavily traded ETFs, but there are similar ETFs designed for other indexes and sectors, where all the same rules apply. Long, unleveraged ETFs will generally behave as you would expect when comparing with its index. Levered and short ETFs, however, can look like they have significant differences, especially when an unknowing investor buys one as a long-term investment. ETFs can be useful for short-term plays, but many are not the best choice as long-term plays.

ConclusionCompanies that sponsor ETFs outline the issues that investors will likely experience, if holding the ETF over an extended period of time. Many ETFs are generally designed for short-term (daily) plays on an index or sector, and should be used that way. Most, except long unleveraged ETFs, will not work as you may expect over a long period of time, especially in volatile markets.
For additional reading on ETFs, take a look at Mutual Fund Or ETF: Which Is Right For You?
by Wayne Pinsent (Contact Author | Biography)

Filed Under: Active Trading, ETFs

The Gold Showdown: ETFs Versus Futures

2010-11-04T05:33:00.000-07:00

Filed Under: Commodities, ETFs, Futures

In 2004, the first exchange-traded fund (ETF) specifically developed to track the price of gold was introduced in the United States. It was touted as an inexpensive alternative to owning physical gold or buying gold futures, and since its introduction ETFs have become a widely accepted alternative. Many investors look to certain gold-specific ETFs as a convenient and exciting way to participate in gold without having to be exposed to the risks of physically purchasing bullion or becoming savvy on how gold futures operate. However, what many investors fail to realize is that the price to trade ETFs that track gold may exceed their convenience and that trading gold future contracts may be a better alternative under the right circumstances. In this article we'll explore whether it's better to invest in gold ETFs or to go with the more traditional gold futures. (To begin with the basics, read Getting Into The Gold Market.)

Problems With Gold ETFs
For more sophisticated investors, or those with investing capital that exceeds a few hundred dollars, there are significant drawbacks to investing in gold-specific ETFs that go beyond the day-to-day fluctuation of gold prices. These problems include tax implications, non-gold related market risk and additional fees.

Problem No.1 - Taxed as a CollectibleAn investment in an ETF that tracks gold prices does not consist of actual gold ownership on the part of the shareholders. An investor cannot make a claim on any of the gold shares and under IRS law, their ownership in the ETF represents an ownership in a "collectible". Despite the fact that the managers of gold ETFs do not make investments in gold for their numismatic value, nor do they seek out collectible coins, the shareholder's investment is treated as a collectible. This makes long-term investing in gold ETFs (for one year or longer) subject to a relatively large capital gains tax (maximum rate of 28%, rather than the 15% rate that is applicable to most other long-term capital gains). In order to avoid this tax implication, investors often exit their positions before a year, which diminishes their ability to profit from any multiyear gains that may occur in gold. (For added insight, see Contemplating Collectible Investments.)

Problem No.2 - Market Risk
Exchange-traded funds that track gold are also exposed to a hosts of company risks that have nothing to do with the actual fluctuation in gold's value. In the SPDR Gold Trust prospectus, for example, the trust can liquidate when the dollars in the trust fall below a certain level, if the net asset value (NAV) drops below a certain level, or by agreement of shareholders owning at least 66.6% of all outstanding shares. These actions can be taken regardless of whether gold prices are strong or weak.

Problem No.3 - Fees, Fees and More Fees
Finally, gold ETFs are inherently diminishing investments. Because the gold itself produces no income and there are still expenses that must be covered, the ETF's management is allowed to sell gold to cover these expenses. Each sale of gold by the trust is a taxable event to shareholders. That means that a fund's management fee along with any sponsor or marketing fees must be paid by liquidating assets. This diminishes the overall underlying assets per share, which, in turn, can leave investors with a representative share value of less than one-tenth of an ounce of gold over time. This can lead to discrepancies in the actual value of the underlying gold asset and the listed value of the ETF. (For related reading, check out The Hidden Costs Of Investing.)

Given these drawbacks, many ETF investors turn their attention to trading gold futures.

Think About Gold Futures
The risks that gold-focused ETFs have are not seen in gold futures. Gold futures, in comparison to the ETFs, are fairly straightforward. Investors are able to buy or sell gold at their discretion. There are no management fees, taxes are split between short-term and long-term capital gains, there are no third parties making decisions on investors' behalf, and at any time investors can own the underlying gold. Finally, because of margin, every $1 that's put up in gold futures can represent $20 or more worth of gold.

For example, while a $500 investment in an ETF such as GLD would represent half of an ounce of gold (assuming gold was trading at $1,000), using that same $500 an investor can have a mini-futures gold contract that represents 33 ounces of gold. The drawback to this kind of leverage is that investors can both profit and lose money based on 33 ounces of gold. Couple the leverage of futures contracts with their periodic expiration and it becomes clear why many investors turn to an investment in an ETF without really understanding the fine print. (For more, see Trading Gold And Silver Futures Contracts.)

ConclusionETFs and gold futures both represent a diversification into the metals asset class. There are pros and cons to both instruments, but that doesn't automatically make gold-specific ETFs superior to gold futures. Investors must be aware that, while on the surface an ETF can instantly create portfolio reallocation in one place, the fund may end up costing them more than they expected in both taxes and management fees on the back end.

by Noble DraKoln (Contact Author | Biography)

Noble DraKoln is founder and President of Liverpool Trading Company, and Speculator Academy. He is a licensed futures professional. He has been a guest speaker at various futures and forex trading conferences around the world including Los Angeles, Las Vegas, Chicago, New York, Paris, Frankfurt and Madrid, and is a former editor of Futures Magazine. His new book "Winning the Trading Game" is set to be released in March 2008 and is currently available on Amazon.com.

Filed Under: Commodities, ETFs, Futures

How To Pump Up Your Portfolio With ETFs

2010-11-04T05:32:00.001-07:00

Filed Under: ETFs, Mutual Funds, Portfolio Management

Similar to mutual funds, exchange-traded funds (ETFs) allow access to a number of types of stocks and bonds (or asset classes), provide an efficient means to construct a fully diversified portfolio, include index- and more active-management strategies, and are comprised of individual stocks or bonds. But ETFs also differ from mutual funds, and in ways that are advantageous to investors.
Unlike mutual funds, ETFs are traded like any stock or bond and offer liquidity throughout the day. Moreover, ETFs generally do not pay out dividends and capital gains - instead, distributions are rolled into the trading price, allowing investors to avoid a taxable event.
In this article, we'll show you how to add these funds to your portfolio to make it more liquid, user-friendly and profitable.

Tutorial: All About Exchange-Traded Funds (ETFs)
Portfolio ConstructionModern portfolio construction theory (MPT) is centered on the concept that asset classes behave differently from one another. This means each asset class has its own unique risk and return profile, and reacts differently during various economic events and cycles. The idea of combining various asset classes, each with unique attributes, is the basis for building a diversified portfolio. ETFs provide small investors with a vehicle to achieve asset class diversification, substantially reducing overall portfolio risk. (To learn more about MPT, see Modern Portfolio Theory: An Overview.)
Risk reduction is a concept that means many things to many people; therefore, a brief discussion of its use in this context is warranted.
Reducing RiskMany investors believe that by holding a portfolio of 30 or more U.S. large-cap stocks, they are achieving sufficient diversification. This is true in that they are diversifying against company-specific risk, but such a portfolio is not diversified against the systematic behavior of U.S. large-cap stocks.
For example, U.S. large-cap stocks' monthly returns as a whole averaged in the high teens, as seen in the S&P 500's 15% average return between 1997 to 2007. So this means that if you held just U.S. large-cap stocks, you should reasonably expect to see volatility in your portfolio of plus or minus 15% on any given month. Such a high degree of volatility could be unsettling and drive irrational behavior such as selling out of fear or buying and leveraging out of greed. As such, risk reduction in this context would involve the minimization of monthly fluctuations in portfolio value.
Many ETF Asset ClassesThere are many equity asset class exposures available through ETFs. These include international large-cap stocks, U.S. mid- and small-cap stocks, emerging market stocks, and sector ETFs. Although some of these asset classes are more volatile than U.S. large caps traditionally, they can be combined to minimize portfolio volatility with a high degree of certainty. Simply put, this is because they generally "zig" and "zag" in different directions at different times. However, in times of extreme market stress, all equity markets tend to behave poorly over the short term. Because of this, investors should consider adding fixed-income exposure to their portfolios.
ETFs also offer exposure to U.S. nominal and inflation-protected fixed income. Unlike equities, fixed-income asset classes generally offer mid-single-digit levels of volatility, making them ideal tools to reduce total portfolio risk. However, investors must be careful to neither use too little or too much fixed income given their investment horizons. You can even purchase ETFs that track commodities such as gold or silver or funds that gain when the overall market falls.
Investment HorizonAn individual's investment horizon generally depends on the number of years until that person's retirement. So, recent college graduates have about a 40-year time horizon (long-term), middle-aged people about a 20-year time horizon (mid-term), and those nearing or at retirement have a time horizon of zero-10 years (short-term). Considering that equity investments can easily underperform bonds over periods as long as 10 years and that bear markets can last many years, investors must have a healthy fear of market volatility and budget their risk appropriately. (Read more about time horizons in Seven Common Investor Mistakes and The Seasons Of An Investor's Life.)
Let's look at an example:

Example - Investment Horizon and Risk

It could be appropriate for a recent college graduate to adopt a 100% equity allocation. Conversely, it could be inappropriate for someone five years away from retirement to adopt such an aggressive posture. Nonetheless, it is not uncommon to see individuals with insufficient retirement assets bet on equity market appreciation to overcome savings shortfalls. This is the greedy side of investor behavior, which could rapidly turn to fear in the face of a bear market, leading to disastrous results. Keep in mind that saving appropriately is just as important as how you structure your investments. (Find out who shouldn't be involved in 100% equity allocation in The All-Equities Portfolio Fallacy.)

ETF Advantages in Portfolio ConstructionIn the context of portfolio construction, ETFs (especially index ETFs) offer many advantages over mutual funds. First and foremost, index ETFs are very cheap relative to any actively managed retail mutual fund. Such funds will typically charge about 1-1.5%, whereas index ETFs charge fees around 0.25-0.50%. Consider the benefits of saving 1% in fees on a $1-million portfolio - $10,000 per annum. Fee savings add up over time and should not be discounted during your portfolio design process.
Additionally, index ETFs sidestep another potential pitfall for individual investors: the risk that actively managed retail funds will fail to succeed. Generally speaking, individual investors are often ill-equipped to evaluate the prospective success of an actively managed fund. This is due to a lack of analytical tools, access to portfolio managers and an overall lack of a sophisticated understanding of investments. Studies have shown that active managers generally fail to beat relevant market indexes over time. As such, picking a successful manager is difficult for even trained investment professionals.
Individual investors should therefore avoid active managers and the need to continuously watch, analyze and evaluate success or failure. Moreover, because the majority of your portfolio's return will be determined by asset class exposures, there is little benefit to this pursuit. Avoiding active managers through index ETFs is yet another way to diversify and reduce portfolio risk. (To find out more about management, read Words From The Wise On Active Management.)
ConclusionIndex ETFs can be a valuable tool to individual investors in constructing a fully diversified portfolio. They offer cheap access to systematic risk exposures such as the various U.S. and international equity asset classes as well fixed-income investments. They are traded daily like stock and can be purchased cheaply through your favorite discount brokerage firm. Index ETFs also avoid the risks of active management and the headaches of monitoring and evaluating those types of products. All in all, index ETFs offer unsophisticated investors the opportunity to build a relatively sophisticated portfolio with few headaches and at substantial cost savings. Consider them seriously in your investment activities.
by Eric Petroff (Contact Author | Biography)

Eric Petroff is the director of research of Wurts & Associates, an institutional consulting firm advising nearly $40 billion in client assets. Before joining Wurts & Associates, Petroff spent eight years at Hammond Associates in St. Louis, another institutional consulting firm, where he was a senior consultant and shareholder. Prior to Hammond Associates, he spent five years in the brokerage industry advising retail clientele and even served as an equity and options trader for three of those years. He speaks often at conferences and has published dozens of articles for Investopedia.com and the New Zealand Investor Magazine.

Filed Under: ETFs, Mutual Funds, Portfolio Management

The Unique Advantages Of VA Mortgages

2010-11-04T05:31:00.001-07:00

Filed Under: Home Insurance, Mortgages

There was a time when Veterans Administration (VA) loans were so time-consuming to obtain that lenders did not want to process them and home sellers were likely to reject offers from buyers planning to finance with VA loans. Thanks to changes in the system, it has become much easier to take advantage of the unique benefits offered by VA loans.

BackgroundVA loans are offered through the Veterans Administration, a U.S. government organization that provides benefits and services to eligible veterans, active duty, reservists and National Guard members along with their families. While the VA does encourage lenders to offer these loans by guaranteeing to repay a significant percentage of any loan that goes into default, VA loans are actually made by private lenders, not by the VA itself. This means that the lender, not the VA, determines whether a borrower is eligible for a loan and what loan terms the borrower qualifies for. As such, it’s still important to shop around for the best deal on a VA mortgage.

Unique Characteristics: No Down Payment, No PMIA few years ago, lots of lenders were offering 0%-down loans. After the housing market crashed, that option disappeared. The VA loan program, however, still offers the option to buy a home with no down payment. Not having to make a down payment will help you maintain your emergency fund, which is crucial when you're a homeowner. And if you already have plenty of money in your emergency fund, not having to make a down payment might allow you to make repairs or renovations that you couldn't otherwise afford. (Find out how to find the best mortgage possible, read Score A Cheap Mortgage.)

Here's an illustration of how much money you can hang onto in the short-term with a zero-down payment loan:

	Traditional Down Payment	Conventional Loan	FHA Loan	VA Loan
Down Payment Percentage	20%	10%	3.50%	0%
Purchase Price	$200,000	$200,000	$200,000	$200,000
Down Payment Amount	$40,000	$20,000	$7,000	$0

Furthermore, unlike FHA loans and other low-down-payment mortgages, there is no private mortgage insurance (PMI) requirement with a VA loan. Not having to pay PMI won't help you with the up-front costs of purchasing a home, but it will help significantly with your monthly cash flow and will also decrease the long-term cost of owning your home.

Unique Benefits Bring Unique DisadvantagesUnfortunately, VA loans aren't available to everyone. They're limited to eligible veterans, active duty, reservists and National Guard members, and some surviving spouses, all of whom must prove that they're qualified by obtaining a certificate of eligibility from the VA (the lender can often complete this step for the borrower). You can learn more about who is eligible at the United States Department of Veterans Affairs website.

VA loans are only allowed for owner-occupied primary residences, so don't plan to use one if you’re looking to finance an investment or vacation property. Also, lenders won't finance VA construction loans according to the book Your Guide to VA Loans by David Reed.

Perhaps the biggest disadvantage of a VA loan for those who are eligible is that it requires a funding fee. For homebuyers taking out a VA loan for the first time and not making a down payment, the funding fee is 2.15% of the loan amount for regular military veterans, and 2.4% for members of the reserves or National Guard. If it's not your first time using your VA entitlement, the funding fee jumps to 3.3%. Since this cost is a fee, it doesn't contribute to your home equity. It is essentially a closing cost. The VA uses these funding fees to help pay the guarantees on VA loans that go bad.

Few people will be exempt from the funding fee. Borrowers who don't want to pay for it can try asking the seller to pay it, just like they might ask the seller to pay any other closing cost. It's also possible to roll the funding fee into the loan, which is a good short-term solution for cash-strapped buyers but a bad long-term solution because then the borrower must pay interest on the funding fee for the life of the loan.

VA Vs. FHA Vs. ConventionalBecause they are the two lowest down-payment options available, many borrowers who are eligible for VA loans might also be considering FHA loans - a loan insured by the Federal Housing Administration. If you qualify for both, which one should you choose and why? (Learn more in Buying A Home: Get Preapproved For A Loan.)


Watch: Mortgage Basics

FHA mortgages require a fee similar to the VA loan's funding fee. It's called up-front mortgage insurance and it costs 2.25% of the loan amount as of May 2010. FHA mortgages also require borrowers to pay monthly private mortgage insurance at a rate of about 0.5% annually of the loan amount until the borrower accumulates 22% equity.

On a $200,000 house, then, an FHA loan would require you to put down $7,000, pay a fee of $4,243.50 (0.0225 x $193,000), and pay an additional $965 (.005 x $193,000) a year for PMI. If you rolled that funding fee into your loan, your monthly mortgage payment and PMI would go up slightly.

A VA loan, on the other hand, would require $0 down, a fee of $4,300 to $4,800, and no PMI. If the interest rate on your mortgage was 6% and your term was 30 years, your monthly principal and interest on the FHA loan of $193,000 would be $1,157.13; on the VA loan of $200,000, it would be $1,199.10, a difference of $41.97 a month or $503.64 a year.

If you have a significant down payment, your best option might be a conventional mortgage. You'll avoid the funding fee of 1.25% to 1.5% that the VA charges even when borrowers have a down payment of 10% or more. On a $200,000 home with a 10% down payment, the VA's funding fee would be $2,250 or $2,700 (.0125 x $180,000 or .015 x $180,000).

ConclusionDespite the funding fee, the lack of a down payment requirement and PMI make VA loans a very attractive option for qualified homebuyers.
by Amy Fontinelle (Contact Author | Biography)

Amy Fontinelle is a financial journalist and editor for a variety of websites, public policy organizations, and book publishers. She has written hundreds of published articles and blog posts on topics including budgeting, credit management, real estate and investing. Her articles have been featured on the homepage of Yahoo! and on Yahoo! Finance, Forbes.com, SFGate.com and numerous local news websites.

Filed Under: Home Insurance, Mortgages

Reverse Mortgage Pitfalls

2010-11-04T05:30:00.000-07:00

Filed Under: Credit Cards, Insurance, Mortgages, Real Estate, Retirement

Reverse mortgages are a way for elderly people to draw an income (either in installments or a lump sum) against the equity that they've built up in their homes. For many older people in need of funds to live on, it is nothing short of a blessing, but there are some pitfalls to the process that everyone should consider. Find out what you need to know before taking the plunge. (For further reading on reverse mortgages, see The Reverse Mortgage: A Retirement Tool.)

High CostsAlthough an individual is technically tapping the equity on his or her own house, the bank charges a fee to initiate the transaction. In fact, according to ReverseMortgage.Org, as part of a reverse mortgage, homeowners may be required to pay an origination fee of $2,000 or 2% of the loan amount, whichever is higher. Some homeowners choose to fold this fee into the loan and pay it back over time with interest.

In addition, there are other fees that homeowners may be responsible for, such as an appraisal fee, which can range in the hundreds of dollars, a recording and credit report fee, which tends to be about $200, and a pest inspection and a flood certification fee, which are about $150 (for both). Finally, homeowners may also be asked to get mortgage insurance, and may be charged a flat monthly account "service fee", which can range from $30 to $35 a month. In short, the costs associated with a reverse mortgage can initially nibble away at the income you'll receive.

Homeowners in need of liquidity who are considering selling their homes within the next several years would probably be better off applying for a more traditional line of credit, a home-equity loan or a personal loan, given the large upfront costs associated with the process. (To learn more about home equity loans, see Home-Equity Loans: The Costs and The Home-Equity Loan: What It Is And How It Works.)

Your Kids Might Not Inherit the Family HomeParents may like to pass the family home onto the next generation. However, when a reverse mortgage is taken out, even though the lending institution does not take title to the home, the mortgagee has an obligation to pay back the loan over time with interest. In many cases, that repayment is made by selling the home and then turning over the proceeds (or a portion of them) to the bank.

As a possible workaround to avoid selling the family home, some families will take out an insurance policy on the homeowner and then make an adult child or the lending institution the beneficiary. Using this strategy, the bank may be repaid without having to sell the property upon the homeowner's death. Consider consulting with an insurance agent to determine the best way to ensure that proceeds from such a policy are sufficient enough to satisfy the outstanding loan.

Impact on Future FinancingWhen an individual initiates a reverse mortgage, he or she is creating a huge liability because the loan must be repaid with interest. However, many individuals do not realize that establishing a reverse mortgage may jeopardize their ability to obtain financing at a later date.

On the surface, this may not seem like a concern for elderly homeowners given that they are unlikely to buy another home or make a sizable purchase, but it can have an adverse impact on applications for car and personal loans. It may also impact a homeowner's ability to acquire credit cards.
Reverse Mortgages May Impact Medicaid BenefitsLending institutions are quick to say that obtaining a reverse mortgage will not affect one's Medicaid payments, but according to RateEmpire.com a site dedicated to lending sources, education and information, "if you receive Medicaid, any reverse mortgage proceeds that you take delivery of must be utilized right away." More specifically, the site says that any retained funds "will count as an asset and may affect your Medicaid eligibility." In other words, this means that if you were to receive $10,000 in a lump sum, you would have to spend that money shortly after receiving it. If you fail to do this, any money left over may count as an asset for Medicated eligibility purposes.

RateEmpire also states that if the total liquid resources are more than $2,000 for an individual or $3,000 for a couple, this could make the person ineligible for Medicaid.

Individuals currently receiving or anticipate receiving Medicaid should consult an accountant and a financial advisor in order to make certain that they are aware of all of the potential ramifications of taking out a reverse mortgage. (To learn more about Medicaid and long-term care, see Medicaid Versus LTC Insurance, Failing Health Could Drain Your Retirement Savings and Long-Term Care: More Than Just a Nursing Home)

Potentially Unfavorable TermsWhile the lending institution may neither go after your heirs for money, nor are they entitled to take more than the appraised value of your home, there are several items usually located in the fine print of these contracts that can be disturbing.

For example, some reverse mortgages have clauses that state that the loan must be repaid if the home is unoccupied for a certain period of time. This means that the homeowner could (hypothetically) be in the hospital receiving treatment for a medical condition, and be released to find that their home is in foreclosure.
Furthermore, because homeowners remain responsible for all taxes, insurance and upkeep on the home, failure to pay taxes or maintain adequate insurance could cause the loan to be called.

Keep in mind that the property is also subject to an appraisal. So, while you might have put a large amount of money into your home over the years, there is the chance that it's worth less than you paid. This means that the proceeds that you receive as part of the reverse mortgage process may be less than what you might have anticipated.

Bottom LineReverse mortgages are a great way for people to tap the equity in their homes, either in installments or in a lump sum. However, be aware of the potential downsides to entering into such an agreement. (To find out more, check out Is A Reverse Mortgage Right For You?)
by Glenn Curtis (Contact Author | Biography)

Glenn Curtis started his career as an equity analyst at Cantone Research, a New Jersey-based regional brokerage firm. He has since worked as an equity analyst and a financial writer at a number of print/web publications and brokerage firms including Registered Representative Magazine, Advanced Trading Magazine, Worldlyinvestor.com, RealMoney.com, TheStreet.com and Prudential Securities. Curtis has also held Series 6,7,24 and 63 securities licenses.

Filed Under: Credit Cards, Insurance, Mortgages, Real Estate, Retirement

Buzz up!

Remodeling The Housing Finance Industry

2010-11-04T05:28:00.001-07:00

Filed Under: Mortgages, Real Estate

History suggests that Fannie Mae (FNMA) and Freddie Mac (FHMLC), along with the less popular Government National Mortgage Association (GNMA) and Federal Home Loan Banks (FHLB), should have limited-life charters as government-sponsored enterprises (GSEs). These GSEs were created by the United States government to respond to specific problems in the housing finance markets that existed at certain times.

However, these organizations continue to exist - and there's some dispute as to whether this is a good thing. Here we'll look at how the current system came about as well as what the future holds for housing finance. (Looking to buy? Check out Top Tips For First-Time Home Buyers.)

In the BeginningFannie Mae was created in response to the Great Depression when the economy made it difficult for homeowners to meet mortgage terms. Fannie Mae purchased and securitized Federal Housing Administration (FHA) and Veteran's Administration (VA) mortgages to inject liquidity into the mortgage markets. GNMA, or Ginnie Mae, was created thereafter to guarantee receipt of principal and interest payments on securitized loans. Freddie Mac was created along with GNMA to provide another type of securitization further enhancing liquidity. Similarly, Federal Home Loan Banks were created to provide liquidity directly to lending institutions that fund mortgage loans. Once these problems were effectively solved and the goals were achieved, government-sponsored enterprises should have continues as wholly private businesses without the special privileges afforded by government charter status.

Balancing Risk and RewardWhat is the rationale behind limited-life charters for GSEs? Simply put, the primary goal is to facilitate privatization and increase competition in the secondary mortgage market. One of the primary structural problems with GSEs is the risk-reward balance. With the exception of contributions to affordable housing initiatives, the government has minimal share in the profits of GSEs while bearing the majority of risk associated with maintaining their existence. (Find out what went wrong with this set-up in Who Is To Blame For The Subprime Crisis?)

This risk is ultimately absorbed by taxpayers who fund the government that charters and supports these GSEs. Privatization shifts risk management back to shareholders and managers of GSEs, and away from taxpayers, legislators and government bureaucrats. Engaging in business activities that produce revenues and profits, instead of relying on legislation to ensure funding guarantees, will ensure survival of individual companies and draw new companies into the market mix that will guarantee the long-term survival of the housing finance industry. (To learn more about the benefits of privatization, take a look at Why Public Companies Go Private.)

Limited but Proactive ApproachPrevious markets were characterized by residential mortgage backed securities (MBS), a type of security that relied on the past trend of rapidly increasing house values and income generated from high interest rate mortgages. Throughout the history of U.S. real estate lending, the government as well as private companies in the market adjusted to change by modifying their products and services. Through legislation, the government modified institutions like FNMA, FHLMC and GNMA to provide liquidity and availability of funds to private lenders. Meanwhile, private lenders modified underwriting guidelines and created designer loan products to meet and/or create greater demand for residential mortgage loans. (Learn about one of the factors behind housing prices in How Interest Rates Affect The Housing Market.)

The conservatorship of Fannie Mae and Freddie Mac in 2008 was a critical and essential strategy for solving the specific housing and mortgage problems that have prevailed through the early 21st century. The terms of conservatorship allow Fannie and Freddie to continue extending mortgage loan guarantees, but limit their investment activities in purchasing and holding loans in a portfolio. Instead, the U.S. Treasury will directly purchase more mortgage-backed securities. This step does something to spread the risks associated with investing in the housing market and related securities, but is insufficient without strategies to support private sector activities and investments.

Future TrendsWhat does the future hold for the mortgage industry and the secondary mortgage market? Even with the housing and mortgage crisis that has lasted through the first decade of the 21st century, financial creativity will not cease. Rather investors will focus less on direct investment in residential mortgages and more on activities including land acquisition, real estate development, construction and commercial lending. This change should neither hinder the path to homeownership nor reduce homeownership rates. It will, however, change the nature and landscape of homeownership. As a result, the new path to homeownership may be characterized by various rent-to-own or lease-purchase options as a prerequisite qualification for mortgage borrowers. (Learn about some of the issues in Rent-To-Own Real Estate Full Of Pitfalls.)

Why is this a necessary consideration? Availability of consumer and residential mortgage credit will continue to decline, or at least will not increase in the first few years of the second decade of the 21st century. Subprime loans with low to no down payment requirements will be difficult for buyers to come by with even the best credit and income. Those with marginal credit and income histories will be even further affected. Rent or lease options may be used to satisfy the down payment requirements associated with historical and re-emerging mortgage loans requiring as much as 20% down payments.

What Does It Mean for Investors?How does this affect investors? Simply by changing the underlying assets that make up the securities they invest in. Investment in credit obligations will be “secured” by corporate cash flows based on business activity derived from receiving rental payments from home buyers instead of relying solely on individual consumers' ability and willingness to repay high rate mortgage loans.

Customized Service
Why does this work better than direct-to-consumer mortgage lending? When an individual borrower defaults on a mortgage loan, the lender's only option is foreclosure on the property. The lender cannot step in and manage the borrower in a way that can produce income to help the borrower keep up with the mortgage payments. (Foreclosure is not always bad for investors. Learn more in Foreclosure Opens Doors For Real Estate Investors.)

However, an investor in corporate securities could effectively assume and manage the business operations in a manner that could increase revenues and cash flows. Investors will invest in companies that earn revenue and cash flow from business activities that create stable homeownership opportunities. This does not completely eliminate the residential mortgage loan, but will redirect the borrowing process in a way that will diminish some of the detrimental risk associated with subprime lending and mortgage derivative securities.

The Final AnalysisIf history has taught us anything, it' that housing and homeownership are staples of the U.S. economy and way of life. Both public and private sectors will continue to play a critical role in maintaining the housing finance industry. Government sponsored enterprises were created and exist to solve current problems in the housing and mortgage finance markets. Private businesses and corporations exist to maintain the markets once these issues are addressed.

As housing prices have declined and the greater economy has suffered, the government has spent the early part of the 21st century finding solutions to the total of economic concerns that accompany declines in the housing finance markets. However, the ball will soon be back in the private sector's court. The businesses that survive the next phase of transition in the housing and mortgage industry will be those that focus on developing new and non-traditional paths to homeownership as opposed to simply creating new forms of mortgage securities to sell in the secondary markets. (There are many ways to get into the housing market. Learn about them in Simple Ways To Invest In Real Estate.)

Learn more about these GSE's in How Fannie Mae And Freddie Mac Were Saved and Fannie Mae, Freddie Mac And The Credit Crisis of 2008.
by Denise Finney (Contact Author | Biography)

Denise Finney started her career with an investment company. She has worked extensively as a financial trainer, consultant and coach; conducting seminars on personal financial planning, as well as working one on one with people and families helping them to manage their financial lives.

Finney is a mortgage industry veteran, having worked in both commercial and residential lending as an originator, wholesale lending executive and licensed mortgage broker in Ohio. At this time, Finney is a consultant and freelance writer.

Filed Under: Mortgages, Real Estate

Self Employed? 5 Steps To Scoring A Mortgage

2010-11-04T05:27:00.000-07:00

Filed Under: Credit, Credit Cards, Credit Report, Insurance, Loans, Mortgages, Options, Personal Finance, Real Estate

While getting a loan as a W-2 employee may be cheaper and easier than if you're self-employed, you don't have to go running back to your cubicle to qualify for a mortgage. Some lenders may be concerned that you won't earn a steady enough income to make your monthly payments, and others may simply not want to deal with the additional paperwork that can be involved in providing a mortgage to a self-employed person. But don't worry; if you're self-employed, there are mortgage products available as well as steps you can take to make yourself a more attractive loan candidate.

What to Expect
As someone who is self-employed, lenders may not see you as the ideal borrower. Expect to pay higher interest rates than the ones commonly advertised on mortgage websites; those rates are for prime borrowers, or borrowers who are considered to be particularly creditworthy because of their steady, verifiable incomes and excellent credit scores. Similarly, because you may be a less attractive candidate, you might have a reduced ability to shop around and negotiate a lower interest rate. You may also have to put more work into finding lenders who are willing to work with you in the first place. (For more, see The Importance Of Your Credit Rating.)

Another problem you may encounter is that if you've used lots of business expenses to reduce your taxable income on your tax returns, lenders may wonder if you make enough money to afford a home. Finally, banks may want to see a lower loan-to-value ratio (LTV ratio), meaning that you'll need to come up with a larger down payment.
Mortgage OptionsDue to the subprime mortgage crisis, it may become more difficult for the self-employed to obtain mortgages as banks shy away from riskier investments to protect their financial interests and their reputations. (To find out more, see Who Is To Blame For The Subprime Crisis? and The Fuel That Fed The Subprime Meltdown.)

However, some lenders may still be willing to give you one of the following types of loans.

Stated Income/Stated Asset Mortgage (SISA)
This type of mortgage is based on what you tell the bank your income is; the bank will not seek to verify this amount. Stated income loans are sometimes also called low-documentation loans; this is because while lenders will not verify how much you make, they may seek to verify the sources of your income. Be prepared to provide a list of your recent clients and any other sources of cash flow, such as income-producing investments. The bank may also want you to submit an IRS Form 4506 or 8821. Form 4506 is used to request a copy of your tax return directly from the IRS, thus preventing you from submitting falsified returns to the mortgage company, and costs $39 per return. But you may be able to request Form 4506-T for free. Form 8821 authorizes your lender to go to any IRS office and examine the forms you designate for the years you specify. This service is free.
No Documentation Loan In this type of loan, the lender will not seek to verify any of your income information. This may be a good option if your tax returns show a business loss or a very low profit. Because it is riskier for the bank to lend money to someone with an unverified income, expect your mortgage interest rate to be higher with either of these types of loans than with a full-documentation loan. Low and no documentation loans are called Alt-A mortgages, and they fall between prime and subprime loans in terms of interest rates. For lenders, they are considered more risky than prime loans, but less risky than subprime loans.

While many self-employed individuals and couples may choose one of the above options due to the difficulty of sufficiently documenting their incomes, those who can prove their incomes and who are willing to submit the extra paperwork can still apply for full-documentation loans, which will have lower interest rates than their low- and no-doc cousins. While a traditional employee might simply need to provide copies of W-2s for the last two years, because self-employed individuals do not receive this document, they may need to provide information about their businesses, such as previous years' tax returns, a current business license, a signed statement from an accountant, profit and loss statements, and balance sheets.

Getting a joint mortgage with a co-borrower who is a W-2 employee, such as a significant other, spouse, or trusted friend, is another way to improve your prospects of getting approved for a mortgage if you are self-employed. This provides more assurance to your lender that there is a steady income to pay back the debt.
Finally, a parent or other relative might be willing to cosign your mortgage loan. Keep in mind that this person will need to be willing and able to assume full responsibility for the loan if you default.
Can You Really Afford It?
It can be easy to get into trouble with low- and no-documentation loans because it's easy to fudge the numbers. Realize that you, not the bank, know best about whether you can really afford the loan, and that you will be the one who truly suffers if you lose your home. Learn from the experiences of all the subprime borrowers who have gone into foreclosure and don't get in over your head. (For more insight, read Mortgages: How Much Can You Afford?)

Make Yourself an Attractive CandidateIf you know you can make the payments, you can do some of the following things to improve your chances of getting a loan.

Max Out Your Credit Score
In any type of borrowing situation, a higher credit score will make you a more attractive candidate to get the loan in the first place and to qualify for lower interest rates if you're approved. (For more insight, read Five Keys To Unlocking A Better Credit Score.)
Offer a Large Down Payment The higher your equity in the home, the less likely you are to walk away from it in times of financial strain. Therefore, the bank will see you as less of a risk if you put lots of cash into your purchase up front.
Have Significant Cash ReservesIn addition to a large down payment, having plenty of money in an emergency fund shows lenders that even if your business takes a nosedive, you'll be able to keep making your monthly payments. (Find out how in Build Yourself An Emergency Fund.)
Pay Off All Your Consumer Debt
The fewer monthly debt payments you have going into the mortgage process, the easier it will be for you to make your mortgage payments. If you pay off your credit cards and car loans, you may even qualify for a higher loan amount because you'll have more cash flow. (Check out, Digging Out Of Personal Debt.)
Have an Established Track Record of Self-Employment
If you can show that you know how to play the self-employment game and win, lenders will be more willing to take a chance on you. Some advice suggests that you should have at least two years of self-employment history; other advice, however, says that when interest rates are low, you should try to get a mortgage as soon as you're ready, even if you don't have a long history of successful self-employment.
Be Willing to Provide Documentation
Being willing to fully document your income through previous years' tax returns, profit and loss statements, balance sheets and the like will increase your chances of qualifying for a loan.

Conclusion
If a W-2 employee loses his or her job, the person's income will drop to zero in the blink of an eye in the absence of unemployment insurance benefits; those who are self-employed often have multiple clients and are unlikely to lose all of them at once, giving them more job security than is commonly perceived. Of course, if you're self-employed, you're already used to having to work extra hard to file additional tax forms, secure business licenses, get new clients and keep your business running. Don't let anyone tell you that you'll never get a mortgage if you're self-employed, or that you shouldn't quit your day job to pursue your dream of running your own business until you've already purchased a home. Armed with a little knowledge and patience, you'll be able to have your own home and work in it, too.

by Amy Fontinelle (Contact Author | Biography)

Amy Fontinelle is a financial journalist and editor for a variety of websites, public policy organizations, and book publishers. She has written hundreds of published articles and blog posts on topics including budgeting, credit management, real estate and investing. Her articles have been featured on the homepage of Yahoo! and on Yahoo! Finance, Forbes.com, SFGate.com and numerous local news websites.

Filed Under: Credit, Credit Cards, Credit Report, Insurance, Loans, Mortgages, Options, Personal Finance, Real Estate

6 Tips To Get Approved For A Mortgage

2010-11-04T05:25:00.001-07:00

Filed Under: Mortgages, Real Estate

Go to any mortgage lending website and you'll see images of smiling families and beautiful homes accompanied by text that makes it sound like lenders are standing by just waiting to help you find the loan that works for you no matter what your situation. (To learn more about mortgages, see Mortgage Basics.)

Filed Under: Mortgages, Real Estate

But the truth is that lending such large amounts of money is a risky business, and that money isn't handed over to just anyone. If your home ownership fantasies have been rudely awakened by loan officers denying your application, it's time to take control of your situation and learn what you can do to turn that rejection into an approval.

What Are Your Options?Everyone's financial situation is unique. With that in mind, here are six different options for making your homeownership dreams a reality.

1. Get a CosignerIf your income isn't high enough to qualify for the loan you need and if you can find a cosigner with enough disposable income, part of that person's income can be considered toward your loan amount regardless of whether the person will actually be living with you or helping you pay the bill. In some cases, a cosigner may also be able to compensate for your less-than-perfect credit. Overall, the cosigner is guaranteeing the lender that your mortgage payments will be paid.

If you decide to go this route, just make sure that both of you understand the financial and legal obligations the cosigner takes on when he or she signs the loan documents. In the event that you default on your mortgage, the lender can go after your cosigner for the full amount of the debt. What's more, not only will your credit score plunge, but your cosigner's will too.

Of course, you shouldn't take this route if you know you aren't responsible enough to pay the mortgage on time or can't afford the monthly payments, but if you have income that a lender isn't willing to consider (such as self-employment income from a new business that has been very successful) and you and your cosigner are both confident that you can make the payments on your own, then getting a cosigner may be a good option. (Find out more in Getting A Loan Without Your Parents and Mortgages: How Much Can You Afford?)

Watch: Mortgage Basics

2. Wait
Sometimes conditions in the economy, the housing market or the lending business make lenders less generous with loans. If you're in a climate where everyone is panicking, then it may be best to wait things out. When conditions improve, lenders may become more accommodating.

In the meantime, you can work on improving your credit score, reducing your debt and increasing your savings. While you're waiting, home prices or interest rates could drop. Either of these changes could also improve your mortgage eligibility. On a $290,000 loan, for example, a rate drop from 7% to 6.5% will decrease your monthly payment by about $100. That may be the slight boost you need to afford the monthly payments and qualify for the loan.

3. Set Your Sights on a Less-Expensive PropertyIf you can't qualify for the amount of mortgage you want and you aren't willing to wait, switching to a condo or townhouse instead of a house, accepting fewer bedrooms or bathrooms, or moving to a less attractive or more distant neighborhood may give you more options. As a more drastic option, you could even move to a different part of the country where the cost of home ownership is lower. When your financial situation improves down the road, you might be able to trade up to the property, neighborhood or city where you hope to end up.

4. Ask the Lender for an Exception
Believe it or not, it is possible to ask the lender to send your file to someone else within the company for a second opinion on a rejected loan application. In asking for an exception, you'll need to have a very good reason, and you'll need to write a carefully worded letter defending your case. Your letter should avoid excuses and sob stories and focus only on the facts. Explain how the incident that is preventing your loan from being approved, such as a charged-off account, was a one-time event that will never occur again. This one-time event should have been caused by a catastrophe such as a large and unexpected medical expense, natural disaster, divorce or death in the family. The blemish on your record will actually need to have been a one-time event, and you'll need to be able to back your story up with an otherwise flawless credit history. (If your credit history could use some house cleaning, see Five Keys To Unlocking A Better Credit Score.)
5. Try a Different Lender Sometimes one lender will say no while another will say yes. If the first lender you approach rejects you, there's no reason not to try out a few other options. If every lender rejects you for the same reason, though, you'll know that it's not the lender that's the problem, it's your financial situation. Your only choice at this point is to fix the problem.

When shopping for a second opinion, don't give lenders any inkling that you are feeling even remotely desperate for a loan or they may take advantage of you by tacking higher fees onto your loan or raising your interest rate. Of course, if you are a higher-risk borrower, you may encounter some of these fees no matter what.

Be careful to avoid loan sharks, too. Remember, you don't want just any loan, you want a reasonable loan. One major potential benefit of homeownership is the financial security it can bring, but if you get a bad loan, that aspect of homeownership disappears. In a worst-case scenario, a bad loan could result in your losing the home, as it did for many who bought homes during the carefree lending days of the housing bubble. (To learn more about the housing bubble, see Why Housing Market Bubbles Pop.)

6. Team Up With Someone Else
Two incomes are better than one, so if you can't qualify on your own, perhaps you have a family member or friend that you trust enough and like enough to make a major purchase with and live with. It won't be enough to just put them on the loan, of course - they'll need to actually help with the mortgage payments to make it work, and chances are they won't want to pay half the mortgage unless they're living in the new home with you.

Conclusion
To go from rejected to preapproved, it's important to know what lenders are looking for in an applicant. If you've been turned down for a mortgage, make sure to ask the lender plenty of questions about things you could do in your specific situation to make yourself a more attractive loan candidate. With time, patience, hard work and a little luck, you should be able to turn the situation around and become a residential property owner.

by Amy Fontinelle (Contact Author | Biography)

Amy Fontinelle is a financial journalist and editor for a variety of websites, public policy organizations, and book publishers. She has written hundreds of published articles and blog posts on topics including budgeting, credit management, real estate and investing. Her articles have been featured on the homepage of Yahoo! and on Yahoo! Finance, Forbes.com, SFGate.com and numerous local news websites.

Filed Under: Mortgages, Real Estate

Buzz up!

Filed Under: Mortgages, Real Estate

Will Your Home Remodel Pay Off?

2010-11-04T05:24:00.001-07:00

Filed Under: Personal Finance, Real Estate

Remodeling certain areas of a single-family house is an excellent way for homeowners to add increased functionality and beauty to a property at someone else's expense. By choosing the right project to enhance your living space, a significant portion of the expense can be passed on to future owners in the form of increased property values. Read on to find out how.

Think Before You BuildThe return on investment (ROI) of any given renovation project is a function of local market characteristics, the condition of the residential real estate market when the property is sold and the quality of the work performed. Historically and on average, certain projects, such as the addition of a wood deck, kitchen and bathroom upgrades and window replacement, have shown the greatest ROI regardless of the property's location or the state of the residential property market.

However, unless the remodeling project is designed to fix a structural issue or design flaw, it is unlikely that a homeowner will earn back more than the cost of construction. If cost recovery is as important a consideration as increased enjoyment from enhancing the property, then homeowners should consider the tastes of prospective purchasers when deciding which projects to pursue. (Find out which home improvements will boost your bottom line come selling time in Fix It And Flip It: The Value Of Remodeling.)

For investors remodeling rental property, the cost of enhancing a property can be recovered not only through sale, but also through the increased rental rates commanded by updated residences. (Owning property isn't simple, but there are plenty of perks. Learn more by reading Investing In Real Estate.)

Homeowners, however, need to be careful of which projects they choose to complete, since the potential value gains can only be realized to the extent that there are buyers willing to pay for the renovations.
Consider Your LocationWhen considering any type of project, it is essential to make sure that any improvements made are appropriate for the particular type of dwelling and local property area. One mistake homeowners often make is improving their homes well above the average of neighboring houses. Buyers are attracted to particular neighborhoods because of the services located nearby and because houses in that area are trading in that buyer's price range. Although a house improved well above others nearby may still receive the same or more interest than others being marketed, it is unlikely that it will command a premium well above average because of the extra improvements.

Real estate agents will tell you that when depressed real estate markets rebound, percentage value increases are higher for the average- or below-average-priced homes in a given neighborhood and lower for houses priced at the top of their respective markets. It is during these periods of increased economic activity and increased real estate demand that improvements will have the greatest impact on a home's market value. (Read How Interest Rates Affect Property Values to learn more about this driving force behind house prices.)

Time also will have an impact on the ability of an improvement to increase property values. Structural or design improvements, such as building additions or finishing raw space, will add value for much longer than projects like updates to kitchens and bathrooms or technological improvements, such as new air conditioning systems, because these risk becoming obsolete over time.

Geographic location will also have a great impact on which projects will have the quickest or greatest payback. For instance, the maintenance time and cost of in-ground swimming pools make it difficult to recover the cost of installation and in some cases will reduce the overall value of a home. However, this may not be the case in the southeast and southwest U.S., where extended periods of very hot weather make swimming pools a valuable addition for some homeowners. (Choosing the right location can lead to big profits - read more in Profit With Real Estate Land Speculation.)

Government IncentivesBecause of the deductibility of mortgage interest from income taxes, Uncle Sam may help to subsidize home improvement, making the cost of construction even less burdensome for property owners. (Learn how to take advantage of this credit in The Mortgage Interest Tax Deduction.)
For the less risk-averse, property owners that have accumulated adequate equity in their homes can use financial instruments, such as a cash-out refinance or home-equity loan to finance their construction projects. Using these methods, the only cash necessary to complete the contemplated projects would be the interest payments to maintain the loans, which in most cases are tax deductible. The principal will be repaid when the property is finally sold. (Is a home-equity loan a good idea? Find out in The Home-Equity Loan: What It Is And How It Works.)

Project Returns on InvestmentThe ultimate reason to take on any home remodeling project as an owner-occupant is the enjoyment received from living in an updated home. For those hoping to profit from a remodel as well, there are several sources that will give some insight into expected payback for particular projects. For example, REALTOR® magazine publishes an annual "Cost vs. Value" report that compares the cost of common remodeling projects and shows the payback that homeowners can expect. These payback estimates are based on the residential real estate market fundamentals at the time and the average cost of construction.

Table 1 are national average estimates, but homeowners can find more specific information at Remodeling Online that will provide the same estimates for different geographic areas of the U.S. These average payback ranges for the most common remodeling projects give prospective sellers a broad indication of which projects have the greatest probability of returning a bulk of the project cost at sale. Differentials in average recoveries are explained by the scope and quality of work performed, with smaller, less-useful projects being on the lower end of the range.

Table 1

Project	Avg. Recovery %
Wood Deck Addition	80-85%
Siding Replacement	75-83%
Minor Kitchen Remodel	75-83%
Window Replacement	75-80%
Bathroom Remodel	70-78%
Major Kitchen Remodel	70-78%
Attic Bedroom Remodel	65-76%
Basement Remodel	65-75%
Two-Storey Addition	65-74%
Garage Addition	60-70%

Improvements, such as office and bedroom remodeling had the largest recovery ranges: from 50-70%. The large spread is due to differences in the size of the renovations and the importance the room has on the overall design of the home, such as guest bedroom versus master suite. (Interested in remodeling a flip? See Top 5 Must-Haves For Flipping Houses.)

ConclusionWhen contemplating any remodeling project, homeowners should consider the value they will receive from the project over any cost recovery that may be available from sale. However, when contemplating two equally useful changes, homeowners should research local real estate guides to determine which projects are most likely to pay for themselves. Remember that bigger is not always better, and spending more does not always ensure a greater amount of value creation. Home prices will always reflect the tastes of local property buyers and the amounts that buyers are willing to pay in a particular neighborhood or subdivision.

by Robert Stammers,CFA (Contact Author | Biography)

Robert Stammers, CFA, uncovers and analyzes stock and option trading opportunities as a senior equity analyst at stock market education company BetterTrades. Previously, he was portfolio manager for a $1 billion enhanced real estate fund, a public timber fund and multiple pension fund separate accounts, while acting as a senior executive for several institutional fund managers. Mr. Stammers holds The CFA Institute's Chartered Financial Analyst designation, a Bachelor of Arts in economics from Connecticut College, and a Master of Business Administration with honors from Emory University. Visit Bettertrades.com to learn more timely strategies and tactics for creating cash flow with stocks and options.

Filed Under: Personal Finance, Real Estate

Why Housing Market Bubbles Pop

2010-11-04T05:23:00.001-07:00

Filed Under: Economics, Real Estate

Unlike the stock market, where most people understand and accept the risk that stock prices might fall, most people who buy a house don't ever think that the value of their home might decrease.

Traditionally, the housing market has not been as subject to pricing bubbles as other asset markets have been because the large transaction costs of purchasing a home and the carrying costs of owning and maintaining a home discourage speculative behavior. However, housing markets do go through periods of "irrational exuberance". In this article, we'll discuss what causes housing price bubbles, the triggers that cause housing bubbles to burst and why home buyers should look to long-term averages when making critical housing decisions. (To read more about deciding to purchase a home, see Investing In Real Estate.)

Mean ReversionToo often, homeowners make the damaging error of assuming recent price performance will continue into the future without first considering the long-term rates of price appreciation and the potential for mean reversion. The laws of physics state that when any object (which has a density greater than air) is propelled upward, it will return to earth because of the forces of gravity act upon it. The laws of finance say that markets that go through periods of rapid price appreciation or depreciation will, in time, revert to a price point that puts them in line with where their long-term average rates of appreciation indicate they should be. This is known as mean reversion.

Prices in the housing market follow this law of mean reversion too - after periods of rapid price appreciation (or depreciation), they revert to where their long-term average rates of appreciation indicate they should be. Home price mean reversion can be rapid or gradual. Home prices might fall (or rise) quickly to a point that puts them back in line with the long-term average, or they might stay constant until the long-term average catches up with them.

Source: Office of Federal Housing Enterprise Oversight

The theoretical value shown above has been derived by calculating the average quarterly percentage increase in the Housing Price Index from the first quarter of 1985 through the fourth quarter of 1998 (the approximate point at which home prices began to rise rapidly above the long-term trend). The calculated average quarterly percentage increase was then applied to the starting value shown in the graph and each subsequent value to derive the theoretical Housing Price Index value.

The Causes of a Housing Market BubbleThe price of housing, like the price of any good or service in a free market, is driven by supply and demand. When demand increases and/or supply decreases, prices go up. In the absence of a natural disaster that might decrease the supply of housing, prices rise because demand trends outpace current supply trends. Just as important is that the supply of housing is slow to react to increases in demand because it takes a long time to build a house, and in highly developed areas there simply isn't any more land to build on. So, if there is a sudden or prolonged increase in demand, prices are sure to rise. (To learn more about supply and demand, see Economics Basics and Stock Basics: What Causes Stock Prices To Change.)

Once you've established that an above-average rise in housing prices is primarily driven by an increase in demand, you might ask what the causes of that increase in demand are. There are several:

1. An upturn in general economic activity and prosperity that puts more disposable income in consumers' pockets and encourages home ownership.

2. An increase in the population or the demographic segment of the population entering the housing market.

3. A low general level of interest rates, particularly short-term interest rates, that makes homes more affordable.

4. Innovative mortgage products with low initial monthly payments that make homes more affordable. (To learn more about mortgages, see our Mortgage Basics tutorial.)

5. Easy access to credit (a lowering of underwriting standards) that brings more buyers to market.

6. High-yielding structured mortgage bonds, as demanded by investors, that make more mortgage credit available to borrowers.

7. A potential mispricing of risk by mortgage lenders and mortgage bond investors that expands the availability of credit to borrowers.

8. The short-term relationship between a mortgage broker and a borrower under which borrowers are sometime encouraged to take excessive risks.

9. A lack of financial literacy and excessive risk-taking by mortgage borrowers.

10. Speculative and risky behavior by home buyers and property investors fueled by unrealistic and unsustainable home price appreciation estimates.

All of these variables can combine to cause a housing market bubble. They tend to feed off of each other. A detailed discussion of each is out of the scope of this article. We simply point out that in general, like all bubbles, an uptick in activity and prices precedes excessive risk-taking and speculative behavior by all market participants: buyers, borrowers, lenders, builders and investors.

The Forces that Cause the Bubble to BurstThe bubble bursts when excessive risk-taking becomes pervasive throughout the housing system. This happens while the supply of housing is still increasing. In other words, demand decreases while supply increases, resulting in a fall in prices.

This pervasiveness of risk throughout the system is triggered by losses suffered by homeowners, mortgage lenders, mortgage investors and property investors. Those losses could be triggered by a number of things, including:

1. An increase in interest rates that puts homeownership out of reach for some buyers and, in some instances, makes the home a person currently owns unaffordable, leading to default and foreclosure, which eventually adds to supply.

2. A downturn in general economic activity that leads to less disposable income, job loss and/or fewer available jobs, which decreases the demand for housing.

3. Demand is exhausted, bringing supply and demand into equilibrium and slowing the rapid pace of home price appreciation that some homeowners, particularly speculators, count on to make their purchases affordable or profitable. When rapid price appreciation stagnates, those who count on it to afford their homes long term might lose their homes, bringing more supply to the market.

The bottom line is that when loses mount, credit standards are tightened, easy mortgage borrowing is no longer available, demand decreases, supply increases, speculators leave the market and prices fall.

Making Price Appreciation Estimates When Buying a HomeToo many home buyers use recent price performance as a benchmark for what they expect over the next several years. Based on their unrealistic estimates, they take excessive risks. This excessive risk-taking is usually associated with the choice of a mortgage and the size or cost of the home the consumer purchases. There are several mortgage products that are heavily marketed to consumers and that are designed to be relatively short-term loans. Borrowers choose these mortgages based on the expectation that they will refinance out of that mortgage within a certain number of years, and will be able to do so because of the equity they will have in their homes at that point. (For related reading, see Mortgages: How Much Can You Afford?)

Recent home price performance is generally not a good prediction of future home price performance. Home buyers should look to long-term rates of home price appreciation and consider the financial principle of mean reversion when making important financing decisions. Speculators should do the same.

While taking risks is not inherently bad and, in fact, taking risks is sometimes necessary and advisable, the key to making a good "risk-based" decision is to understand and measure the risks by making financially sound estimates. This is especially applicable to the largest and most important financial decision most people make - the purchase and financing of a home.

ConclusionA simple and important principle of finance is mean reversion. While housing markets are not as subject to bubbles as some markets, housing bubbles do exist. Long-term averages provide a good indication of where housing prices will eventually end up during periods of rapid appreciation followed by stagnant or falling prices. The same is true for periods of below average price appreciation.
by Barry Nielsen,CFA (Contact Author | Biography)

G. Barry Nielsen is a homeowner with a large household of six children. Nielsen holds the Chartered Financial Analyst (CFA) designation and has worked for several large mortgage lenders and financial institutions, including Freddie Mac, American General, Washington Mutual and Countrywide Home Loans. Nielsen owns and operates MortgageGraphics, Inc., a web-based mortgage calculator designed to help consumers make educated, risk-based mortgage decisions.

Filed Under: Economics, Real Estate

Investing With Purpose And For Profit: Affordable Housing

2010-11-04T05:17:00.001-07:00

Filed Under: Mortgages, Real Estate

Successful real estate investors are more than just landlords, they are savvy business executives. They operate much like portfolio managers and business managers who focus on maximizing profits while creating value for clients. This article discusses affordable housing investment as a business and investment strategy. We start with a definition of affordable housing and look at three groups that represent the best target market. Next, we discuss affordability which is the defining characteristic of the target market. Then we turn to profitability and marketability, issues that make a good investment great. Finally we look at financing, action steps, and wider business and social implications of affordable housing investment.

Investment Options Seniors and People with Disabilities
People 65 or older and with disabilities are a significant percentage of the U.S. population. Studies show these numbers increasing and estimated record levels in the next 20 to 30 years. People in these groups need housing that is close to public accommodations and is modified to assist them in everyday living. Modifications include ramps instead of stairs, wheelchair accessible bathrooms, handrails, and modified cabinets and closets to name a few.
Student Off-Campus Housing
The growing numbers of adult and non-traditional college and university students have increased the need for off-campus housing. Adult students with families need private housing close to campus. International students need housing that is available year-round because it is less expensive and more convenient than frequent international travel on holiday and summer breaks. (Living on campus can have many benefits, but they often come at a price. To learn more, check out College Dorms: Good Value Or Ripoff?)
Military Off-Base Housing
Military service members have housing options on and off-base. On-base housing requires construction, property management and grounds maintenance, while off-base housing requires additional location assistance, custom construction and purchase financing. Off-base housing needs to be close to the base and easy to move into and out of. Military housing investors should be familiar with federal contracting as well as the specific guidelines for each branch of service.
Rehabilitation and Re-Entry Programs
Transitional housing for homeless people and families, halfway houses for recovering addicts and newly released from correctional facilities, and group homes for children and adults in state protective service and mental health systems need neighborhood-based housing. Apartments and boarding houses should be large enough to provide adequate facilities and privacy for residents, but must also facilitate needed security and accessibility levels appropriate for each group.
How to Determine Affordability
Affordability is important to investors because it determines two important things: profitability and marketability. Subsidized housing programs like Section 8 helps lower income families afford rent by paying a portion of the market price for rental units. Determine the median income for your area. There are several sources of information to determine median income. The U.S. Census Bureau compiles average incomes for states, counties, and cities. Real estate websites also provide this information for people interested in buying homes in particular regions Information is also available through state and local governments, economic development agencies and housing authorities.

For affordable rent calculate 30% of median income. This is your expected gross income per affordable rental unit.
For affordable homeownership calculate 35% of median income for principle, interest, property tax, homeowner insurance, and association fees. Then calculate your expected sale price by deducting the amount for tax, insurance and fees based on going rates for the area. Use the difference, principle and interest, to determine the purchase price based on going interest rates for your area. A banking or mortgage professional can help you quickly determine these amounts.

How to Determine Profitability
Start by determining your operating expenses. For rental units start with taxes and insurance you pay as owner. Do you pay the utilities, if so which ones? Calculate the cost for building and grounds maintenance for multiple unit buildings. Don't forget transfer costs such as inspection, occupancy certification, registration, and other fees required by your county or municipality.
For sale units, determine your financing costs, closing costs at acquisition and at the time of sale, material and labor costs for construction/rehabilitation and transfer costs. For both determine your marketing and advertising costs. The greatest project will flop if you cannot attract renters or buyers in a timely manner. Even a simple, effective advertising strategy will cost both money and time. Consider these costs of doing business that affect your bottom line.
Next, determine your income. For rental units use the amount of expected gross income per affordable unit. For sale units use the purchase price determined above. Use the standard formula: Income – Expenses = Gross Profit.
Consider your cash flow. If you pay utilities, some programs allow additional amounts to be paid by the subsidizing authority to cover a portion of tenant utilities. Finally, look at your income tax situation. Depreciation will affect your tax liability and will have varying affects on the actual cash flow or real net profit.
How to Ensure Marketability
Focus on locating and modifying units that meet guidelines for rental subsidies which are available through local housing authorities. For sellers focus minimizing construction and rehabilitation costs on units to be sold at market. (Investing in big buildings means big money - and bigger risks. For further reading, refer to Find Fortune In Commercial Real Estate.)

Start with simple logic. If it is not profitable, it is not marketable. The reverse is also true.
Take advantage of foreclosed homes. There are many single and 2 to 4 family homes and that have been abandoned due to foreclosures.
Contact local economic development agencies who acquire these units below market costs and sell to or contract with local developers to rehabilitate and resell. Also, learn the ins and outs of Sherriff's sales in your area. Check the guidelines for each county you will target as guidelines may differ among counties in the same region or state. These units are often purchased site unseen and may represent significant rehabilitation costs and turnaround time to resell.
Work with a realtor and learn about the local for sale by owner (FSBO) market. Here you will find opportunities for short sales where the seller or selling agent has made arrangements for a reduced mortgage payoff to facilitate a reduced price for quick sale. These units may be the least expensive to fix up and resell.

Successful investors know when and how to move in the market. Don't forget to perform ongoing buy-sell-hold analysis on rental units. If labor, material, and financing costs are high, now may not be the time to buy more properties. If there are more renters in your market, now may not be a profitable time to market units for sale even if interest rates are low. If market rent and median income in your area is high, now may be the most profitable time to retain property for the monthly rental income it can generate. Treat your real estate portfolio just like your retirement portfolio with a little more paint and fixtures. (For savvy real estate investors, times of lower prices reveal investment opportunity. For more information, see 7 Steps To A Hot Commercial Real Estate Deal.)
Financing
Research the various financing alternatives available to investors. Read websites for Fannie Mae, Freddie Mac, and HUD Multifamily Financing. Work with a local banker and a commercial mortgage broker or consultant to identify lender programs and find private investors. Join local homebuilder, remodeling, and real estate investor associations. Become a member of the chamber of commerce and affiliate with economic development agencies. Use these relationships to identify public and private financing and operating partnerships.
Action Plan

Be informed. Learn about affordable housing across the country and in your area.
Be involved. Make a market for affordable housing. Identify a niche in your area and fill it. Forge partnerships with likeminded investors and financing sources.
Be a profitable investor. Function as both portfolio manager and business manager. Apply conventional investment wisdom and business strategy advice.

Beyond Landlording
Don't just be landlords. Be a landlord, an investor and a business executive. As a landlord, incorporate the human element. Remember that you can create a market by helping families and your community. As an investor, create a blue-chip portfolio of real estate. Have the best properties, in the most desired areas, at the best prices, that turn the most profit. As a business executive, create a brand, generate goodwill and maximize the market value of your brand not just on individual units. Remember that your activities also create jobs and employment opportunities for construction workers and real estate sales agents. Your marketing and property managing activities help to attract workers to the labor force in the areas where you units are located. Not only can you create personal profits, but you can also create economic opportunities for people and communities through affordable housing investment. (Owning property isn't always easy, but there are plenty of perks. Find out how to buy in. Read Simple Ways To Invest In Real Estate.)

by Denise Finney (Contact Author | Biography)

Denise Finney started her career with an investment company. She has worked extensively as a financial trainer, consultant and coach; conducting seminars on personal financial planning, as well as working one on one with people and families helping them to manage their financial lives.

Finney is a mortgage industry veteran, having worked in both commercial and residential lending as an originator, wholesale lending executive and licensed mortgage broker in Ohio. At this time, Finney is a consultant and freelance writer.

Filed Under: Mortgages, Real Estate

10 Worst First-Time Homebuyer Mistakes

2010-11-04T05:16:00.001-07:00

iled Under: Mortgages, Personal Finance, Real Estate

Are you gearing up to buy your first place? Shopping for a home is exciting, exhausting and a little bit scary. In the end, your aim is to end up with a home you love at a price you can afford. Sounds simple enough, right? Unfortunately, many people make mistakes the prevent them from achieving this simple dream. Arm yourself with these tips to get the most out of your purchase and avoid making 10 of the most costly mistakes that could put a hold on that sold sign. (Don't know even where to get started when purchasing a home? Check out Financing Basics For First-Time Homebuyers and our First-Time Homebuyer Guide.)
1. Not Knowing What You Can Afford As we've all learned from the subprime mortgage mess, what the bank says you can afford and what you know you can afford or are comfortable with paying are not necessarily the same. If you don't already have a budget, make a list of all your monthly expenses (excluding rent), including vehicle costs, student loan payments, credit card payments, groceries, health insurance, retirement savings and so on. Don't forget major expenses that only occur once a year, like any insurance premiums you pay annually or annual vacations. Subtract this total from your take-home pay and you'll know how much you can spend on your new home each month.
If you end up looking at homes that are outside your price range, you'll end up lusting after something you can't afford, which can put you in the dangerous position of trying to stretch beyond your means financially or cause you to feel unsatisfied with what you actually can afford. You may even learn that you can't afford the type or size of home that you desire and that you need to work on reducing your monthly expenses and/or increasing your income before you even start looking. (Read Six Months To A Better Budget and Get Your Budget In Fighting Shape to learn more.)
2. Skipping Mortgage Qualification What you think you can afford and what the bank is willing to lend you may not match up, especially if you have poor credit or unstable income, so make sure to get pre-approved for a loan before placing an offer on a home. If you don't, you'll be wasting the seller's time, the seller's agent's time, and your agent's time if you sign a contract and then discover later that the bank won't lend you what you need, or that it's only willing to give you a mortgage that you find unacceptable.
Be aware that even if you have been pre-approved for a mortgage, your loan can fall through at the last minute if you do something to alter your credit score, like finance a car purchase. If you cause the deal to fall through, you may have to forfeit the several thousand dollars that you put up when you went under contract. (To learn more, read Pre-Qualified Vs. Pre-Approved - What's The Difference?)
3. Failing to Consider Additional ExpensesOnce you're a homeowner, you'll have additional expenses on top of your monthly payment. Unlike when you were a renter, you'll be responsible for paying property taxes, insuring your home against disasters and making any repairs the house needs (which will occasionally include expensive items like a new roof or a new furnace).
If you're interested in purchasing a condo, you'll have to pay maintenance costs monthly regardless of whether anything needs fixing because you'll be part of a homeowner's association, which collects a couple hundred dollars a month from the owners of each unit in the building in the form of condominium fees. (For more information, see Does Condo Life Suit You?)
4. Being Too PickyGo ahead and put everything you can think of on your new home wish list, but don't be so inflexible that you end up continuing to rent for significantly longer than you really want to. First-time homebuyers often have to compromise on something because their funds are limited. You may have to live on a busy street, accept outdated decor, make some repairs to the home, or forgo that extra bedroom. Of course, you can always choose to continue renting until you can afford everything on your list - you'll just have to decide how important it is for you to become a homeowner now rather than in a couple of years. (For related reading, read To Rent or Buy? The Financial Issues - Part 1 and To Rent or Buy? There's More To It Than Money - Part 2.)

5. Lacking VisionEven if you can't afford to replace the hideous wallpaper in the bathroom now, it might be worth it to live with the ugliness for a while in exchange for getting into a house you can afford. If the home otherwise meets your needs in terms of the big things that are difficult to change, such as location and size, don't let physical imperfections turn you away. Besides, doing home upgrades yourself, even when you have to hire a contractor, is often cheaper than paying the increased home value to a seller who has already done the work for you. (For more information on remodeling, read our related article Fix It And Flip It. The Value of Remodeling.)

6. Being Swept Away Minor upgrades and cosmetic fixes are inexpensive tricks are a seller's dream for playing on your emotions and eliciting a much higher price tag. Sellers may pay $2,000 for minimal upgrades or staging that you'll end up paying $40,000 for. If you're on a budget, look for homes whose full potential has yet to be realized. Also, first-time homebuyers should always look for a house they can add value to, as this ensures a bump in equity to help you up the property ladder.

7. Compromising on the Important Things Don't get a two-bedroom home when you know you're planning to have kids and will want three bedrooms. By the same token, don't buy a condo just because it's cheaper when one of the main reasons you're over apartment life is because you hate sharing walls with neighbors. It's true that you'll probably have to make some compromises to be able to afford your first home, but don't make a compromise that will be a major strain.

8. Neglecting to InspectIt's tempting to think that you're a homeowner the moment you go into escrow, but not so fast - before you close on the sale, you need to know what kind of shape the house is in. You don't want to get stuck with a money pit or with the headache of performing a lot of unexpected repairs. Keeping your feelings in check until you have a full picture of the house's physical condition and the soundness of your potential investment will help you avoid making a serious financial mistake.

9. Not Choosing to Hire an Agent or Using the Seller's Agent Once you're seriously shopping for a home, don't walk into an open house without having an agent (or at least being prepared to throw out a name of someone you're supposedly working with). Agents are held to the ethical rule that they must act in both the seller and the buyer parties' best interests, but you can see how that might not work in your best interest if you start dealing with a seller's agent before contacting one of your own. (To learn more, read Do You Need A Real Estate Agent?)

10. Not Thinking About the Future It's impossible to perfectly predict the future of your chosen neighborhood, but paying attention to the information that is available to you now can help you avoid unpleasant surprises down the road.
Some questions you should ask about your prospective property include:

What kind of development plans are in the works for your neighborhood in the future?
Is your street likely to become a major street or a popular rush-hour shortcut?
Will a highway be built in your backyard in five years?
What are the zoning laws in your area?
If there is a lot of undeveloped land? What is likely to get built there?
Have home values in the neighborhood been declining?

If you're happy with the answers to these questions, then your house's location can keep its rose-colored luster.
ConclusionBuying a first home can seem stressful and overwhelming, and it isn't without its share of potential pitfalls. If you're aware of those issues ahead of time, you can protect yourself from costly mistakes and shop with confidence.
For many people, a home is the largest purchase they will ever make, but it need not be the most difficult.
Be sure to read Investing In Real Estate to learn more about the perks of owning property.
by Amy Fontinelle (Contact Author | Biography)

Amy Fontinelle is a financial journalist and editor for a variety of websites, public policy organizations, and book publishers. She has written hundreds of published articles and blog posts on topics including budgeting, credit management, real estate and investing. Her articles have been featured on the homepage of Yahoo! and on Yahoo! Finance, Forbes.com, SFGate.com and numerous local news websites.

Filed Under: Mortgages, Personal Finance, Real Estate

5 Types Of REITs And How To Invest In Them

2010-11-04T01:46:00.000-07:00

Filed Under: Investment, Mortgages, Real Estate

Real estate investment trusts (REITs) are a key consideration when constructing any equity or fixed-income portfolio. They provide greater diversification, potentially higher total returns and/or lower overall risk. In short, their ability to generate dividend income along with capital appreciation make them an excellent counterbalance to stocks, bonds and cash. REITs generally own and/or manage income-producing commercial real estate, whether it's the properties themselves or the mortgages on those properties. You can invest in the companies individually or through an exchange-traded fund or mutual fund. There are many types of REITs available. Here we look at a few of the main ones and their historical returns. By the end of this article you should have a better idea when and what to buy. (For a primer on buying real estate, take a look at Simple Ways To Invest In Real Estate.)

Historical ReturnsReal estate investment trusts are historically one of the best-performing asset classes available. The FTSE NAREIT Equity REIT Index is what most investors use to gauge the performance of the U.S. real estate market. Between 1990 and 2010, the index's average annual return was 9.9%, second only to mid-cap stocks, which averaged 10.3% per year over the same period. In comparison, fixed income assets managed 7% annual returns and commodities just 4.5% a year. Real estate was the worst performer of eight asset classes in just two years out of 20. Fixed income, on the other hand, was the worst performer six times in the same 20-year period. Historically, investors looking for yield have done better investing in real estate than fixed income, the traditional asset class for this purpose. A carefully constructed portfolio should consider both. (Learn more in How To Assess A Real Estate Investment Trust.) Retail REITsApproximately 24% of REIT investments are in shopping malls and freestanding retail. This represents the single biggest investment by type in America. Whatever shopping center you frequent, it's likely owned by an REIT. When considering an investment in retail real estate, one first needs to examine the retail industry itself. Is it financially healthy at present and what is the outlook for the future?

It's important to remember that retail REITs make money from the rent they charge tenants. If retailers are experiencing cash flow problems due to poor sales, it's possible they could delay or even default on those monthly payments, eventually being forced into bankruptcy. At that point, a new tenant needs to be found, which is never easy. Therefore, it's crucial that you invest in REITs with the strongest anchor tenants possible. These include grocery and home improvement stores.
Once you've made your industry assessment, your focus should turn to the REITs themselves. Like any investment, it's important that they have good profits, strong balance sheets and as little debt as possible, especially the short-term kind. In a poor economy, retail REITs with significant cash positions will be presented with opportunities to buy good real estate at distressed prices. The best-run companies will take advantage of this. (For more insight on commercial real estate, check out 7 Steps To A Hot Commercial Real Estate Deal and Find Fortune In Commercial Real Estate.)
Residential REITsThese are REITs that own and operate multi-family rental apartment buildings as well as manufactured housing. When looking to invest in this type of REIT, one should consider several factors before jumping in. For instance, the best apartment markets tend to be where home affordability is low relative to the rest of the country. In places like New York and Los Angeles, the high cost of single homes forces more people to rent, which drives up the price landlords can charge each month. As a result, the biggest residential REITs tend to focus on large urban centers.

Within each specific market, investors should look for population and job growth. Generally, when there is a net inflow of people to a city, it's because jobs are readily available and the economy is growing. A falling vacancy rate coupled with rising rents is a sign that demand is improving. As long as the apartment supply in a particular market remains low and demand continues to rise, residential REITs should do well. As with all companies, those with the strongest balance sheets and the most available capital normally do the best. (Learn more about residential real estate in Making Money In Residential Real Estate.)
Healthcare REITsHealthcare REITs will be an interesting subsector to watch as Americans age and healthcare costs continue to climb. Healthcare REITs invest in the real estate of hospitals, medical centers, nursing facilities and retirement homes. The success of this real estate is directly tied to the healthcare system. A majority of the operators of these facilities rely on occupancy fees, Medicare and Medicaid reimbursements as well as private pay. As long as the funding of healthcare is a question mark, so are healthcare REITs.

Things you should look for in a healthcare REIT include a diversified group of customers as well as investments in a number of different property types. Focus is good to an extent but so is spreading your risk. Generally, an increase in the demand for healthcare services (which should happen with an aging population) is good for healthcare real estate. Therefore, in addition to customer and property-type diversification, look for companies whose healthcare experience is significant, whose balance sheets are strong and whose access to low-cost capital is high. (For related reading, see Investing In The Healthcare Sector.)
Office REITsOffice REITs invest in office buildings. They receive rental income from tenants who have usually signed long-term leases. Four questions come to mind for anyone interested in investing in an office REIT

What is the state of the economy and how high is the unemployment rate?
What are vacancy rates like?
How is the area in which the REIT invests doing economically?
How much capital does it have for acquisitions?

Try to find REITs that invest in economic strongholds. It's better to own a bunch of average buildings in Washington, D.C., than it is to own prime office space in Detroit, for example. (For more on commercial real estate, see Find Fortune In Commerical Real Estate.)
Mortgage REITsApproximately 10% of REIT investments are in mortgages as opposed to the real estate itself. The best known but not necessarily the greatest investments are Fannie Mae and Freddie Mac, government-sponsored enterprises that buy mortgages on the secondary market.

But just because this type of REIT invests in mortgages instead of equity doesn't mean it comes without risks. An increase in interest rates would translate into a decrease in mortgage REIT book values, driving stock prices lower. In addition, mortgage REITs get a considerable amount of their capital through secured and unsecured debt offerings. Should interest rates rise, future financing will be more expensive, reducing the value of a portfolio of loans. In a low-interest rate environment with the prospect of rising rates, most mortgage REITs trade at a discount to net asset value per share. The trick is finding the right one. (Learn more about the effects of interest rates in The Impact Of Interest Rates On Real Estate Investment Trusts.)
The Keys to Assessing Any REITI've talked about specific types of REITs as well as what to look for when investing in them. However, there are a few things to keep in mind when assessing any REIT. They include the following:

REITs are true total-return investments. They provide high dividend yields along with moderate long-term capital appreciation. Look for companies that have done a good job historically at providing both.
Unlike traditional real estate, many REITs are traded on stock exchanges. You get the diversification real estate provides without being locked in long term. Liquidity matters.
Depreciation tends to overstate an investment's decline in property value. Thus, instead of using the payout ratio (what dividend investors use) to assess an REIT, look at its funds from operations (FFO) instead. This is defined as net income less the sale of any property in a given year and depreciation. Simply take the dividend per share and divide by the FFO per share. The higher the yield the better.
Strong management makes a difference. Look for companies that have been around for a while or at least possess a management team with loads of experience.
Quality counts. Only invest in REITs with great properties and tenants.
Consider buying a mutual fund or ETF that invests in REITs, and leave the research and buying to the pros.

The Bottom LineThe federal government made it possible for investors to buy into large-scale commercial real estate projects as far back as 1960. However, only in the last decade have individual investors embraced REITs. Reasons for this include low interest rates, which forced investors to look beyond bonds for income-producing investments, the advent of exchange-traded and mutual funds focusing on real estate and, until the 2007-08 real estate meltdown, an insatiable appetite on the part of Americans to own real estate and other tangible assets. REITs, like every other investment in 2008, suffered greatly. But despite this, they continue to be an excellent addition to any diversified portfolio.

For related reading, take a look at The Basics Of REIT Taxation and Get A Round-Trip Investment With International REITs.

by Will Ashworth (Contact Author | Biography)

Will Ashworth lives and works in Toronto, Canada. He's worked in and around the financial services industry for much of his adult life. He loves investing and is passionate about helping others learn how to put their money to work.

Filed Under: Investment, Mortgages, Real Estate

An Introduction To The FHA 203(k) Loan

2010-11-04T01:44:00.002-07:00

Filed Under: Mortgages, Personal Finance, Real Estate

Are you interested in buying a fixer-upper, but don't have the cash to remodel it? Or maybe you have saved money for remodeling and you've found a house you love, but your lender won't allow you to buy it because the house isn't considered habitable without toilets. There are always properties on the market that weren't maintained by cash-strapped former owners, were treated poorly by renters or were deliberately trashed by formers owners who were foreclosed on. Shouldn't there be a way for someone like you to fix up these neighborhood eyesores and bring them back to life?

A Gift from the GovernmentThere is, and it's brought to you by the federal government. The Federal Housing Administration's rehab loan product, the FHA 203(k) loan, was designed for individuals who want to rehabilitate or repair a damaged home so they can live in it as their primary residence. These loans are endorsed by the government to encourage lenders to offer what would otherwise be considered a risky loan product. Because of the risk and expense involved, rehab projects are normally handled by professional real estate investors who can buy properties with cash and therefore don't need any bank to approve the property's condition.
This article will describe how much money you need to save up, the two different types of 203(k) loans, eligible properties, eligible repairs and more - in short, what you need to know to see if this type of loan is right for you. (For background reading, see Insuring Federal Housing Authority (FHA) Mortgages.)
How Much Cash You NeedThe FHA 203(k) loan lets you include the money needed for repairs and related expenses (materials and labor) in the loan. If you wanted to buy a home where the kitchen had been ripped out, you could include in the loan the price of new cabinets, countertops, flooring, a fridge, stove, oven, microwave, sink, dishwasher, garbage disposal, and the cost to design, permit and install it all. The loan can also include a 10-20% contingency reserve for expenses above and beyond your repair estimates. You can also get up to six months' worth of mortgage payments included to cover the mortgage while you're renovating the home so that you won't have to make a double housing payment.
Types of 203(k) MortgagesThere are two types of FHA 203(k) mortgages: regular and streamlined (also called "modified"). Regular is for properties that need structural repairs; streamlined is for those that need only non-structural repairs. Either can be used for purchase or refinance.
For the regular 203(k) purchase loan, the maximum mortgage amount is based on the lesser of the as-is value of the property plus rehab costs or 110% of the expected value of the property after rehab. This means that you wouldn't want to buy a house with an as-is value of $150,000 if it needed $25,000 in repairs unless you had an extra $10,000 in cash, because the most you could borrow would be $165,000 (110% of $150,000). The streamlined loan allows homebuyers to add a maximum of $35,000 to the purchase price to pay for improvements. (To learn more, see Mortgages: How Much Can You Afford?)
Of course, in any case, you have the income to support the mortgage - you can't just take out a loan for a certain amount because the house warrants it.
Eligible Properties
FHA 203(k) loans are intended for owner-occupants, not investors. The following types of properties are eligible:

Single-family to four-family dwellings
Existing construction that has been completed for at least one year
Tear downs, as long as part of the existing foundation will remain
An existing house that will be moved to a new foundation
The residential portion of a mixed-use (commercial/residential) property
FHA-approved condos

With such a wide range of qualifying properties, almost anyone can find the right property that will qualify for a 203(k) loan.
Financing Conditions and Allowable Rehab and Repair ExpensesRegardless of what work you may think the house needs, the lender and FHA have their own requirements that you'll also have to meet. The U.S. Department of Housing and Urban Development (HUD) "requires that properties financed under this program meet certain basic energy efficiency and structural standards" to "comply with HUD's Minimum Property Standards (24 CFR 200.926d and/or HUD Handbook 4905.1) and all local codes and ordinances."
The energy efficiency standards include caulking, insulation and ventilation as well as using the correct size heating and air conditioning systems for the home. The home is also required to have smoke detectors adjacent to each sleeping area.
You might be surprised by the variety of home repairs and improvements that can be financed with the 203(k) loan. These include, but are not limited to, the following:

painting
room additions
decks
patios
site grading and drainage
bathroom remodeling
kitchen remodeling, including appliances
finishing an attic or basement
structural alterations and repairs
adding or decreasing the number of units in a dwelling (e.g., single family to duplex)
new siding
second story additions
elimination of lead-based paint problems
heating, ventilation, and air conditioning systems (HVAC)
plumbing
roofing
flooring
energy conservation
disabled access

The FHA does not allow "luxury items" such as tennis courts, swimming pools, hot tubs and barbecue pits to be financed with a 203(k) loan, but some items that you might think of as luxuries, such as whirlpool bathtubs, are actually allowed. Talk to your lender about the specific improvements you want to make to see what you can finance.
Completing the RehabOnce you complete the purchase and the home is yours, you can start the repairs and remodeling. The FHA requires all repairs to be completed within six months, though lenders can require a shorter timeframe.
You'll begin making mortgage payments right away, like you would on any home. After all, you own it - it doesn't matter if you're not living in it yet. However, as mentioned earlier, you can finance your first few mortgage payments.
The rehab and repair money is placed in an escrow account and released as the work is completed and inspected to ensure HUD approval. HUD must also approve the finished product once all work has been completed.
Problems to AvoidMany lenders don't do FHA 203(k) loans, whether because they don't know how or don't want to do the extra paperwork. Working with a lender who isn't experienced with FHA 203(k) loans is something you should avoid - the process is complex enough as it is. Don't give yourself any headaches by working with someone who doesn't know what they're doing.
Also, make sure you don't overinvest in the home - don't spend so much on repairs and improvements that you won't be able to recoup your costs if you sell the house one day. Look at the average sale prices of move-in ready homes in your neighborhood and try to put your home within this range. You don't want to own a $300,000 home in a neighborhood of $200,000 homes, because most people who can afford a $300,000 home will want to live in a nicer neighborhood where all the homes are comparably valued.
DrawbacksFHA 203(k) loans have a longer closing period than other types of loans. They usually take 60 to 90 days to close, compared to the 30 to 45 days that are common for other loans, including regular FHA loans. If you're in a hurry to move, the 203(k) loan is not the product for you. You can also expect to pay a higher interest rate because of the increased risk associated with home-improvement loans. (For more, check out Mortgage Points – What's The Point?)
These loans are also more work for lender and require specialized loan knowledge, so it can be harder to find a lender that will work with you. The application and renovation processes are lots of work for homeowner, and there is lots of red tape involved. Some borrowers have reported delays in receiving their rehab funds, which adds additional stress to the process.
Conclusion
Though it can be more work to find a lender who does FHA 203(k) loans and to complete both the application and renovation processes, the extra effort can pay off. This loan product can make it possible for you to buy that perfect house that just needs some reconditioning to be livable again. It can also make it possible for you to make the leap from renting to home ownership, since there might be a fixer-upper out there in your price range when there aren't any move-in ready homes you can afford. (For more, see Are You Ready To Buy A House?)

by Amy Fontinelle (Contact Author | Biography)

Amy Fontinelle is a financial journalist and editor for a variety of websites, public policy organizations, and book publishers. She has written hundreds of published articles and blog posts on topics including budgeting, credit management, real estate and investing. Her articles have been featured on the homepage of Yahoo! and on Yahoo! Finance, Forbes.com, SFGate.com and numerous local news websites.

Filed Under: Mortgages, Personal Finance, Real Estate

Applying For An FHA 203(k) Loan

2010-11-04T01:44:00.000-07:00

Filed Under: Loans, Mortgages, Personal Finance, Real Estate

The FHA 203(k) loan is a unique product that allows would-be homeowners who don't have a lot of cash to buy a property in need of repairs. But when you combine the red tape of government agencies with the additional financial risks associated with average people (people who aren't experienced home rehabbers) buying a property in poor condition, the 203(k) loan can be one of the most challenging mortgages to get approved for. This article will walk you through the process so you'll know what to expect. (For background information, read An Introduction To The FHA 203(k) Loan.)

Make Sure You Have Enough CashAs of early 2010, you only have to come up with a down payment of 3.5% of the home's purchase price plus repair costs to buy a house with this type of loan. So if you were buying a house with an asking price of $150,000 and needed repairs of $15,000, you would need 3.5% of $165,000, or $5,775, as your down payment. Make Sure You're a Solid Loan CandidateOf course, you'll also have to meet the usual borrower requirements for an FHA loan, like having a steady, verifiable income and a good credit score. But otherwise, as long as you can make the monthly payments on the property you want to purchase, there are no further special requirements to qualify for this loan. Just remember that it's for owner-occupants only, not investors. (For more, see Understanding FHA Home Loans.)
Pick the 203(k) Loan that Best Fits Your SituationBefore you apply, determine which type of loan you'll need. There are actually two types of FHA 203(k) mortgages: the first is called "regular," and it's meant for properties that need structural repairs. The second is called "streamlined" or "modified." It's designed for properties that need only non-structural repairs. Your real estate agent and/or lender can help you make this determination. Of course, if you don't know the difference between structural and non-structural repairs, a rehab project might be way over your head.
Choose a LenderAny time you're applying for a government-subsidized mortgage, whether it's a VA loan, FHA loan, green mortgage or FHA 203(k) loan, your choice of lenders will be somewhat limited. FHA 203(k) loans in particular are not very common, so many lenders either won't know how to process them or won't want to deal with the extra paperwork and hassle involved. Since the loan application process for 203(k) loans is complex, you definitely want to work with a lender who has experience with this specialty loan product.
Not all lenders are approved to handle 203(k) loans. The FHA must grant lenders permission to offer them. To find an approved lender, see HUD's approved lender search here. Make sure to check the box at the end of the page to limit your search to lenders who have done 203(k) loans in the last 12 months.
Create Your Rehab ProposalIn addition to the usual mortgage loan application requirements, such as proof of income, proof of assets and credit reports, the 203(k) loan application requires the creation of a rehab proposal. Your proposal must describe the work to be done on the property and provide an itemized cost estimate for each repair or improvement. Architectural exhibits, such as a plot plan and proposed interior plan, are required for any structural repairs. HUD's checklist, available here, will help guide you through the items your proposal should address. The checklist covers every area of the home that might need repairs, from gutters and driveways to flooring and windows.
You don't have to hire professionals to do the repairs, but the FHA says that the work must be completed to professional standards and in a timely manner. Also, if you plan to do the repairs yourself, you can't use the loan to pay yourself for your labor. You can only use the loan toward the cost of materials if you'll be doing the work yourself. If this sounds like a bum deal, remember that borrowed money, even at a low interest rate, is not free money - it's money that you'll have to pay back, with interest. So as long as you know what you're doing and can afford to spend the time on the project, you can come out ahead by doing the work yourself. Also, you may be able to use the money you save by not hiring contractors to make additional improvements to the property that you couldn't otherwise afford.
Even if you are going to do the work yourself, your proposal must still include the cost of labor. Why? Because if something goes wrong and you have to hire professionals after all, the FHA wants you to have the money to hire them. (For some helpful hints, check out Do-It-Yourself Projects To Boost Home Value.)
Get an AppraisalThe home you want to buy must be appraised as it would be for any loan, except that the appraiser must estimate what the value of the home will be once the repairs and improvements are made. An as-is appraisal may also be required, but sometimes the purchase price can stand in for the as-is appraisal.
Hire HelpSome people choose to hire a specialist called a 203(k) consultant to help them complete all the extra paperwork required for this type of loan, such as preparing architectural exhibits. The fee to hire such a consultant can be included in the mortgage, provided it does not exceed limits established by HUD. For example, for a home requiring $15,001 to $30,000 of repairs, HUD does not expect the consultant to charge more than $600. However, it is perfectly acceptable to complete all the paperwork yourself, though you'll probably want some input from your potential contractors (if you're hiring any).
Is It Worth the Trouble?The FHA 203(k) application process is a lot of work, to be sure. If it seems like too much trouble, you might be better off continuing to search for a home that's closer to move-in ready or continuing to save until you can afford a nicer place. But if you have the time, energy and patience, the 203(k) loan is often the only way to finance the purchase of a property needing significant repairs. Otherwise, you'll need to have enough cash to pay for the property and the repairs outright. (For more, see New Home Repair Troubleshooting.)

by Amy Fontinelle (Contact Author | Biography)

Amy Fontinelle is a financial journalist and editor for a variety of websites, public policy organizations, and book publishers. She has written hundreds of published articles and blog posts on topics including budgeting, credit management, real estate and investing. Her articles have been featured on the homepage of Yahoo! and on Yahoo! Finance, Forbes.com, SFGate.com and numerous local news websites.

Filed Under: Loans, Mortgages, Personal Finance, Real Estate

9 Things You Need To Know About Homeowners' Associations

2010-11-04T01:43:00.000-07:00

Filed Under: Home Insurance, Personal Finance, Real Estate

When you purchase a condominium, townhouse or other type of property in a planned development such as a leased land property, a gated community, or even an ordinary subdivision, you are obligated to join that community's homeowners' association (HOA) and pay monthly or annual HOA fees for the upkeep of common areas and the building. If you are considering purchasing one of these types of properties, you should be aware of the following nine things about homeowners' associations and how they work before you buy.

Tutorial: A Step-by-Step Guide To Buying A Home

HOA BasicsFirst, let's take a look at what HOAs are all about. HOA fees often range from $200 to $400 per month. The more upscale the building and the more amenities it has, the higher the homeowners' association fees are likely to be. In addition to monthly fees, if a major expense such as a new roof or a new elevator comes up and there aren't enough funds in the HOA's reserves to pay for it, the association may charge an extra assessment that can run into the thousands of dollars. (To help you decide if you're ready for condo living, see Does Condo Life Suit You?)
Because multiple parties live in the same building, all residents of condominiums and townhomes must be equally responsible for maintaining the common areas of the building such as landscaping, elevators, swimming pools, clubhouses, parking garages, fitness rooms, sidewalks, security gates, roofing and the building exterior. Many of these types of common areas, such as pools and tennis courts, also exist in subdivisions of single family homes. Regardless of whether the HOA governs a building, such as a condo or townhome structure, or a neighborhood of individual houses, HOA fees help maintain the quality of life for the community's residents and protect property values for all owners.

In addition to maintaining common areas, HOAs also set out certain rules that all residents must follow called covenants, conditions and restrictions (CC&Rs). In a common building, rules may include what color front door you may have, whether you are allowed to line dry your laundry outside, whether you can have a satellite dish, the size and type of pets permitted, and so on. In many ways, these rules are similar to the types of rules apartment dwellers must follow.

In a subdivision with individual homes, regulations may include what color you can paint your home, the exterior landscaping you can do, the types of vehicles you can park on the street or in your driveway (no RVs, for example), permissible type and height of fences, and restrictions on window coverings for windows facing the street. If you want to do anything that differs from these rules, you will have to convince the HOA to grant you a variance, which is probably unlikely. No matter where you live, you are likely to be subject to city ordinances and restrictions related to the use of your property. HOAs add yet another layer of restrictions and because their members are more likely to know what you're up to, the HOA is more likely to enforce the rules. So, let's take a look at some of the rules and regulations you need to know about before you decide to join one of these communities.

What You Need To KnowWhile there are laws governing the behavior of HOAs, these associations can still have a powerful impact on your rights as a homeowner. Before buying a property in a community that has an HOA you should:

1. Learn the HOA's rules
You may be able to find an HOA's CC&Rs online as well as information about what happens if you violate a rule. Make sure any online information is current. If you cannot find this information online, ask your real estate agent to acquire these documents for you or contact the HOA yourself. Pay particular attention to rules regarding fines and whether the HOA can foreclose on your property for nonpayment of HOA dues or fines resulting from CC&R violations. Also, learn about the process for changing or adding rules and whether HOA meetings are held at a time you will be able to attend, if you wish to do so. If the rules are too restrictive, consider buying elsewhere. (Keep reading on this subject, in Do You Need A Real Estate Agent?)

2. Make sure the home you want to buy is not already out of compliance with HOA rules
Buying into an existing problem can be a headache, so find out what the rules are and whether you would have to make changes to the home to comply.

3. Assess environmental practices
If environmentally-friendly living is important to you, be aware that some HOAs may dictate that you use fertilizers, pesticides, sprinkler systems, and whatever it takes to keep your lawn picture-perfect. They may not allow xeriscaping (an environmentally friendly form of landscaping) and may limit the size of gardens, ban compost piles and prevent you from installing solar panels. If these things are important to you, make sure you check the fine print first. (For more information, see Building Green For Your House And Wallet.)
4. Consider your temperament
Are you the type of person who hates being told what to do? If so, living in a community with an HOA may be a very frustrating experience for you. One of the major benefits of homeownership is the ability to customize and alter the property to suit your needs, but HOA rules can really interfere with this.

5. Find out about feesFees will differ for each community. Because of this you should make sure to ask your HOA the following questions:

How are HOA fee increases set?
How often do increases occur, and by how much have they historically been raised?
Can you get a printed history of HOA dues by year for the last 10 years?
How large is the HOA's reserve fund?
Also, ask for a record of special assessments that have been made in the past and ask if any special assessments are planned for the near future. Note that economies of scale can mean that special assessments are higher in smaller HOAs.
Find out what the monthly dues cover. Will you still have to pay extra for garbage pickup? Is cable included?

Compare dues for the complex or neighborhood you are considering to the average dues in the area. Keep in mind that you will have to pay for recreational facilities whether you use them or not. Find out the hours for amenities like pools and tennis courts. Will you be around during those hours, or will you be paying for facilities you'll never be able to use? Be aware that the HOA may have rules about how many guests can use common facilities. If guest restrictions are severe, forget about that housewarming pool party you envisioned.

6. Try to get a copy of minutes from the last meeting or sit in on an HOA meeting before you buy
The meeting minutes can be very telling to the policies of the HOA. Some questions to ask are:

What are current and past conflicts?
What is the process for resolving any conflicts?
Has the HOA sued anyone? How was that resolved?

Be alert for potential drama. Power trips and petty politics can be an issue in some HOAs. Talk to some of the building's current owners, if possible - preferably ones who are not on the HOA board and who have lived in the building for several years. Talk to the HOA president and get a sense for whether you want this person making decisions about what you can do with your property. If a private company manages the HOA, investigate it before you buy. Some HOAs are professionally managed, but it is common for the association to be managed by building residents who fill the position as volunteers. Even if you like the current HOA board or management company, it can change after you move in and you may end up getting something totally different than what you bargained for.

7. Watch for under-management
Not all HOAs are over-managed. The opposite problem may be an HOA where no one really cares and where no one is interested in maintaining the building, making repairs, hearing resident grievances, or being on the board. Residents may simply take turns serving as HOA president or randomly appoint someone, so be prepared to serve in this role whether you want to or not if that is the case with your community's HOA.

This would also be a good time to check into any restrictions preventing you from renting out your property or that make it difficult for you to do so. If your property is being under-managed you might not have an issue, but if you've got a hyperactive manager it could be a totally different story.

8. Find out what kind of catastrophe insurance the HOA has on the building
This is particularly important if you're considering a condo or townhouse purchase and you live in an area that is prone to floods, earthquakes, blizzards, fires, tornadoes, hurricanes, or any other type of potential natural disaster - and that is virtually anywhere. (Find out more about insurance needs in Insurance Tips For Homeowners.)
9. Consider the impact of HOA fees on your short- and long-term finances
A condo with high HOA fees might end up costing you as much as the house you don't think you can afford.

ConclusionHomeowners' associations can be your best friend when they prevent your neighbor from painting her house neon pink, but your worst enemy when they expect you to perform expensive maintenance on your home that you don't think is necessary, or impose rules that you find too restrictive. Before you purchase a property subject to HOA rules and fees, make sure you know exactly what you are getting into.

by Amy Fontinelle (Contact Author | Biography)

Amy Fontinelle is a financial journalist and editor for a variety of websites, public policy organizations, and book publishers. She has written hundreds of published articles and blog posts on topics including budgeting, credit management, real estate and investing. Her articles have been featured on the homepage of Yahoo! and on Yahoo! Finance, Forbes.com, SFGate.com and numerous local news websites.

Filed Under: Home Insurance, Personal Finance, Real Estate

Housing Cooperatives: A Unique Type Of Home Ownership

2010-11-04T01:42:00.001-07:00

Filed Under: Mortgages, Real Estate

Buying a house or renting an apartment aren't the only living arrangements available in the marketplace. Housing cooperatives provide an alternative to the traditional methods of acquiring a primary residence. In this article, we'll explain what a cooperative is and how it differs from other housing options.

Tutorial: Buying A HomeCondominiums vs. Cooperatives
Condominiums are multi-unit dwellings with privately owned residences and shared common areas. Condominiums are classified as real property, meaning that buyers own the deeds to their dwellings. (To learn more about condominiums, read Buying A Condo.)

Co-ops are not considered real property. When you buy into a co-op, you become a shareholder in a corporation that owns the property. As a shareholder, you are entitled to exclusive use of a housing unit in the property.

CostsTo purchase shares in a co-op, each buyer takes out a "share loan" in lieu of a mortgage. These loans operate much like mortgages. In addition to the loan payments, which are made to the lender, co-op residents are responsible for paying a pro-rata share of the costs of running and maintaining the building. These costs are generally paid to the partnership via a monthly fee and are billed on an at-cost basis. Prices rise when the cost of goods and services go up.

The cost of the property's mortgage may be included in the monthly fee because it's possible for the building to have a mortgage even if an individual tenant has paid off his or her share of the loan. This can occur because the actual mortgage on the building is held by the corporation, not by an individual partner. The share loan pays the cost of buying into the partnership. It has nothing to do with the underlying mortgage on the property itself. Buyers are entitled to all of the tax deductions enjoyed by homeowners, including the deductions for interest and real estate taxes.

Additional expenses include monthly utility bills for each buyer's residence, which are paid on an individual basis, and insurance costs. While the building itself should be covered under a blanket insurance policy, the contents of each individual residence are not. A personal insurance policy, known as an HO-6, is required to protect personal possessions from water damage, fire, theft and other calamities. (For more insight, read The Beginner's Guide To Homeowners' Insurance.)

FeaturesCo-ops are often less expensive than apartments because they operate on an at-cost basis, collecting money from residents to pay outstanding bills. In areas where the cost of living is high, such as New York City, co-ops may be an attractive option from a financial perspective.

Co-ops must abide by the laws that govern fair housing, but they can be more restrictive than other housing options when it comes to ownership requirements. Because there is no landlord and there are no tenants, the rules for purchasing shares in the partnership are set by the partners. For example, new buyers may be required to have a specific net worth or a certain debt-to-income ratio in addition to demonstrating the ability to meet the financial obligations of the co-op purchase. (To learn more, see What's Your Debt-To-Income Ratio?)

A background check may also be required. Like other types of housing, some co-ops are designed to cater only to senior citizens or other specific groups. These more stringent ownership requirements lend an air of security and exclusivity to co-op ownership. In exchange for this exclusivity, co-ops are generally run in a more restrictive manner than condos. High-end units, for example, may forbid subleasing. All partners share in the costs of operating the building. A default by one partner may require the other partners to cover that partner's costs, although the strict ownership requirements generally keep defaults to a minimum.

The structure of housing co-ops varies, depending on the specific country of its location. In the U.S. and Canada, the most popular options include:

Market Rate Co-ops - Allow partners to buy and sell shares at whatever rate the market will bear.
Limited Equity Co-ops - Set restrictions on the price at which shares may be bought and sold.
Leasing Co-ops - The co-op corporation leases the building rather than owning it and builds no equity. In this case, the co-op may have a cash reserve in hand if the building is up for sale.

In addition to the financial aspect of co-op ownership, there is also a social aspect that must be taken into account. Smaller co-ops are run strictly by the residents, with everyone pitching in to take care of duties, such as maintenance, landscaping and setting rules. Large units may be run by a board of directors consisting of a subset of residents. In either case, there are rules to be followed and a certain degree of social interaction that takes place. If you don't like sharing decision-making authority, co-op living may not appeal to you.

Before You BuyBefore buying you'll want to consider the following:

Location
Amenities
Costs

Because you're buying shares of a company, be sure to check out the company's financial situation and meet the company's shareholders. Not only will they be your business associates, they will also be your neighbors.

Bottom LineRead the co-op's articles of incorporation, bylaws, subscription agreement, rules and any other available documentation. Make sure you truly understand how the partnership works, including how it is managed, what you will be required to pay for and how much that payment will cost. Ask about the terms of any underlying mortgage, the policy toward pets and your ability to make changes to your residence. There's no harm in asking questions; a little extra effort up front can go a long way toward ensuring a harmonious long-term living arrangement.
by Lisa Smith (Contact Author | Biography)

Filed Under: Mortgages, Real Estate

10 Habits Of Highly Effective Real Estate Investors

2010-11-04T01:41:00.001-07:00

Filed Under: Real Estate

Real estate has long been regarded as a sound investment. Wholesaling and property management of commercial and residential property are just a few of the ways investors can profit from real estate, but it takes a little savvy to become successful in this competitive arena. While certain universities do offer coursework and programs that specifically benefit real estate investors, such as the Johns Hopkins Carey Business School’s Master of Science in Real Estate, a degree is not necessarily a prerequisite to profitable real estate investing. Whether an investor has a degree or not, there are certain characteristics that top real estate investors commonly possess. (From caves to condos, we look at how Homosapiens have hunted for homes over the years. For further reading, check out No Longer Nomads: The History Of Real Estate.)
IN PICTURES: 5 Simple Ways To Invest In Real Estate

Successful real estate investors:

Treat Investments as Businesses
It is important for real estate investors to approach their real estate activities as a business in order to establish and achieve short- and long-term goals. A business plan allows real estate investors to not only identify objectives, but also determine a viable course of action towards their attainment. A business plan also allows investors to visualize the big picture, which helps maintain focus on the goals rather than on any minor setback. Real estate investing can be complicated and demanding, and a solid plan can keep investors organized and on task.
Know Their MarketsEffective real estate investors acquire an in-depth knowledge of their selected market(s). The more an investor understands a particular market, the more qualified he or she will be to make sound business decisions. Keeping abreast of current trends, including any changes in consumer spending habits, mortgage rates and the unemployment rate, to name a few, enables savvy real estate investors to acknowledge current conditions, and plan for the future. Being familiar with specific markets allows investors to predict when trends are going to change, creating potentially beneficial opportunities for the prepared investor.
Maintain High Ethical StandardsRealtors are bound to act according to a code of ethics and standards of practice policy, and real estate agents are held to each state's real estate commission rules and standards. Real estate investors, however, unless they are associated with membership-based organizations, are not usually required to maintain a particular degree of ethics in their business practices, as long as they operate within the boundaries of the law. Even though it would be easy to take advantage of this situation, most successful real estate investors, and especially those who remain in the business for the long haul, maintain high ethical standards. Since real estate investing involves actively working with people, an investor's reputation is likely to be far reaching. In the case of an investor lacking in ethics, the consequences can be damaging. Effective real estate investors know it is better to conduct fair business, rather than seeing what they can get away with.
Develop a Focus or NicheBecause there are so many ways to invest in real estate, it is important for investors to develop a focus in order to gain the depth of knowledge essential to becoming successful. This involves learning everything about a certain type of investment - whether it is wholesaling or commercial real estate - and becoming confident in that arena. Taking the time to develop this level of understanding is integral to the long-term success of the investor. Once a particular market is mastered, the investor can move on to additional areas using the same in-depth approach. Savvy investors know that it is better to do one thing well than five things poorly.
Strive to be Good Customer Service RepresentativesReferrals generate a sizable portion of a real estate investor's business, so it is critical that investors treat others with respect. This includes business partners, associates, clients, renters and anyone with whom the investor has a business relationship. Effective real estate investors are good customer service representatives by paying attention to detail, listening and responding to complaints and concerns, and representing their business in a positive and professional manner.
Stay EducatedAs with any business, it is imperative to stay up to date with the laws, regulations, terminology and trends that form the basis of the real estate investor's business. Keeping current does require additional work, but it can be viewed as an investment in the future of the business. Investors who fall behind risk not only losing momentum in their businesses, but also legal ramifications if laws are ignored or broken. When it pertains to the law, ignorance is no excuse. Successful real estate investors take the time and make the effort to stay educated, adapting to any regulatory changes or economic trends.
Understand the RisksThose choosing to invest in the stock or futures markets are inundated with myriad warnings regarding the inherent risks involved in investing. Numerous agencies, such as the Commodity Futures Trading Commission, require disclaimers to warn potential market participants about the possibility of loss of capital. While much of this is legalese, it has made it clear to people that investing in the stock or futures markets is risky; meaning, one can lose a lot of money. Greenhorn real estate investors, however, are more likely to be saturated with advertisements claiming just the opposite - that it is easy to make money in real estate. Prudent real estate investors understand the risks associated with the business - not only in terms of real estate deals, but also the legal implications involved - and adjust their businesses to reduce any risks.
Invest in a Reputable AccountantTaxes comprise a significant portion of a real estate investor's yearly expenses. Understanding current tax laws can be complicated and take time away from the business at hand. Sharp real estate investors retain the services of a qualified, reputable accountant to handle the business's books. The costs associated with the accountant can be negligible when compared to the savings a professional can bring to the business.
Find Help When They Need ItReal estate investing is complicated and requires a great deal of expertise to engage profitably in the business. Learning the business and the legal procedures is challenging to someone attempting to do things on their own. Effective real estate investors often attribute part of their success to others - whether a mentor, lawyer, accountant or supportive friend. Rather than risk time and money solving a difficult problem on their own, successful real estate investors know it is worth the additional costs (in terms of money and ego) to find help when they need it and embrace other peoples’ expertise. (Don't let a slow real estate market drag you down - steer clear of these pitfalls. To learn more, see 5 Mistakes Real Estate Investors Should Avoid.)
Build a NetworkA network can provide important support and create opportunities to a new or experienced real estate investor. This group of associates can be comprised of a well-chosen mentor, business partners, clients or a non-profit organization whose interest is in real estate. A network allows investors to challenge and support one another, and can aid significantly in advancing one's career through shared knowledge and new opportunities. Because much of real estate investing relies on experiential-based learning, rather than on reading a book, for instance, savvy real estate investors understand the importance of building a network.

ConclusionDespite abundant advertisements claiming that real estate investing is an easy way to wealth, it is in fact a challenging business requiring expertise, planning and focus. In addition, because the business revolves around people, investors benefit in the long run by operating with integrity and by showing respect to associates and clients. Tough it may be relatively simple to enjoy short-lived profits, developing a viable real estate investing business that can last for the long-term requires additional skill and effort. Whether focusing on apartment buildings or commercial property, highly effective real estate investors share these 10 essential habits. (Owning property isn't always easy, but there are plenty of perks. Find out how to buy in. Read Simple Ways To Invest In Real Estate.)

by Jean Folger (Contact Author | Biography)

Filed Under: Real Estate